Does Apple's Tightly Controlled Ecosystem Strategy Constitute an Illegal Tying Arrangement?

The fundamental weaknesses of an integrated value chain like the one that exists between iTunes and Apple's iPod products and, now, the iPhone, is that even the most fawning of customers inherently rebel - some in the form of hacking the system - against such a compulsion against consumer choice. Today, in the face of growing hegemonic power in realms expanding from media to telecommunications with last Friday's iPhone launch, those same hackers are trying to disintegrate that value chain for themselves, attempting to rid the revolutionary new device from the grip of AT&T's last generation data network.

What defines value for Apple's customers? Well, in addition to the innovation in user experience and design packed into every one of its products, Apple's brand itself is as much the performance defining characteristic that draws legions of loyal buyers to iconic products like the iPhone.

But even as the company protects its inherent advantage by erecting barriers to competition in its value chain, that same source of strength can become the company's greatest weakness. Just as Apple's hegemony in the digital music distribution business has been based on the inseparable linkage between iTunes and the company's iPod media players, the integration between the new iPhone and the AT&T network as the sole wireless carrier presents a target for disintegration that hackers have found hard to resist. What's at stake is nothing less than Apple's compelling value proposition itself - its formidable proprietary product linkages.

Since the iPhone release a week ago, hackers have been working around the clock to bypass Apple's restrictions tying activation of the iPhone to signing up for a two-year contract with AT&T. Many hackers believe that unlocking the encryption that governs this system will come in a week or less. The first step to cracking the iPhone was done three days after the release by DVD Jon who found a way to activate the iPod and Wi-Fi capabilities, but hasn't found a way to decrypt the SIM token and activate the phone with another carrier. The phone also requires iTunes to activate functions such as the camera. The following article breaks down the challenges one hacker - John McLaughlin of the UK firm, Uniquephones - is confronting as he tries to skirt both technical and possible legal barriers Apple is likely to erect for his ilk:

Prising an iPhone away from its ties with AT&T is a more complex business than providing an unlock code. Firstly, it's necessary to make changes to an AT&T SIM other than the one supplied with an iPhone that can work with the phone and be activated through iTunes. After this has been achieved there's still the problem of cracking the protection that means attempts to change the iPhone's firmware in order to support another carrier's SIM card can break the phone.

Even then the device would only work on GSM-based US networks and could be undone if Apple issues a firmware upgrade (through the iPhone synchronisation process) or frustrated by legal challenges. McLaughlin concedes that Apple is likely to take legal action against Uniquephones based on changes its unlocking process makes to the firmware loaded on iPhones rather than the act of unlocking the phones, which is legal. "They'll probably come after us for copyright infringement," he said.

If the best defense is a good offense, then there is a legal approach to Apple's ecosystem hegemony that could put a damper on Apple's whole strategy, known in antitrust law as illegal tying, as explained in the excerpt below:

Llegal tying is one of the most common antitrust claims. Although the Supreme Court and the lower courts have regularly addressed the merits of tying claims and much has been written about the basic requirements needed to establish a tying claim, tying claims still remain somewhat unpredictable in nature. Most of the confusion stems from the nomenclature. Tying is often referred to as per se, or automatically, illegal. Nevertheless, tying arrangements may sometimes be justified or subject to rule of reason analysis.

Simply put, a tying arrangement is an agreement by a party to sell one product but only on the condition that the buyer also purchases a different product (often known as a positive tie), or at least agrees that he will not purchase that product from any other supplier (often known as a negative tie). The product that the buyer is required to purchase in order to get the product the buyer actually wants is called the tied product. The product that the buyer wants to purchase is called the tying product. In the most basic sense, the seller has tied two products together, as if in a knot. The only way the buyer can get the one product is to also purchase another product that he or she may or may not want.

Tying arrangements can violate a number of antitrust laws. The confusion surrounding tying arrangements has arisen not because such arrangement might violate a number of different antitrust laws, but because the courts use confusing language when analyzing tying arrangements.

The antitrust laws are designed to protect competition. In antitrust law, there are some arrangements or restrictions that have such a deleterious effect on competition that courts have ruled them per se or automatically illegal. What this means is that if the basic elements of the antitrust violation are established, the court will consider the arrangement illegal and will not examine any justifications or reasons as to why the arrangement might actually benefit competition in some manner. Tying arrangements are often considered per se illegal. The basic requirements that must be met for tying to be per se illegal are as follows:

1. There must be two separate products or services.
2. There must be a sale or an agreement to sell one product (or service) on the condition that the buyer purchase another product or service (or the buyer agrees not to purchase the product or service from another supplier).
3. The seller must have sufficient economic power with respect to the tying product to appreciably restrain free competition in the market for the tied product.
4. The tying arrangement must affect a "not insubstantial" amount of commerce.

Now, whether iTunes and the iPod franchise constitute an illegal tying arrangement is for the courts to decide. But perhaps, hackers afraid of a legal challenge against their will to innovate out of Apple's value chain can mount one of their own. And, if Apple's needs friends who know how to deal with antitrust action, it picked the right partner in Ma Bell.