Copyright Law and Market Arbitrage

This coming October 29, the United States Supreme Court will hear oral argument in Kirtsaeng v. John Wiley & Sons, a case on a question of copyright law with broad social implications. At issue in this case was whether Kirtsaeng is able, under the current law, to import into the United States copies of textbooks made and sold by Wiley for distribution solely in Thailand. Working in what is known as the “gray market,” Kirtsaeng’s strategy was to buy up large quantities of books from his native Thailand at low prices, only to bring them back to the United States where he could resell them at a profit for prices lower than those that Wiley charged to American customers. 

As might be expected, the books sold overseas were in some ways inferior to those marketed in the United States, but that is par for the course for companies that do business internationally, where they must figure out what products to sell and what prices to charge for them across the globe. That challenge is not easy because wealth differences between countries are often large enough that it no longer makes sense (as with Thailand and the United States) to sell exactly the same product at exactly the same price in two or more markets. Thus, the imperative often becomes: sell the best versions at the highest prices in the U.S., where the demand is strong; sell a somewhat stripped-down version of the same basic product for a lower price in Thailand, where the demand is weaker.

This form of price and product differentiation produces large social advantages. Let the same firm sell only a single product across all markets and miscalibrations will happen at both ends.  Consumers in the strong market get an inferior product to what they prefer, while many consumers in weaker markets can be cut out altogether by a price/quality combination that they cannot afford. The seller loses out on revenues in both markets. The ability to segment markets therefore allows the seller of the copyrighted product to achieve a useful double value. It first reaches a larger number of customers from whom it can generate larger profits, which in turn increases its incentives to produce these copyrighted works in the first place.

Using this price and product discrimination does not come free because the manufacturer has to police the boundaries against arbitrageurs—those individuals like Kirtsaeng who seek to exploit the differences in price and quality across these different markets. Sometimes arbitrageurs perform a useful social service by making sure that prices of a wide range of standardized products in different markets are properly aligned. But in this case their social role is negative, because they upset price discrimination strategies that advance social welfare for the reasons mentioned above.

 The precise legal point in Kirtsaeng concerns the correct reading of section 109 of the Copyright Act, with provides that any person who owns a copy of a work “lawfully made under this title” is entitled to resell or otherwise dispose of that copy without the legal permission of the owner. It is widely understood that this section allows any person who lawfully buys a copy of the book in the United States to resell it as he or she sees fit and to pocket all the profits. The technical question is whether that person has the same right when the book is purchased lawfully overseas and is then resold after importation into the United States.

As a textual matter, it looks as though the words “under this title” extend only to works made in the United States pursuant to our Copyright Act. Any linguistic doubts on that matter, moreover, should yield to control the economics in these gray markets. That “first sale” doctrine in Section 109(a) only allows the seller of a copyrighted product to control the initial sale of a product and not its resale. That rule makes sense in those cases where the first sale and resale take place in the same market, for then the initial price can fully capture the gains from selling the work, without the added administrative burden of seeking to monitor subsequent sales. But where the second sale is in a different market from the first one, the need for price discrimination is important, so that gray market operators like Kirtsaeng should be shut down. As a matter of first principle, the Copyright Law should not be interpreted to upset these sensible social strategies.  Kirtsaeng (who lost below in the Second Circuit) should lose again.

  1. Guruforhire

    I think the pharmaceutical companies have similar problems in that they sell drugs much cheaper abroad first as a condition in some places for recognizing their IP at all, and because the market cannot support full freight.  

  2. David Knights

    Prof. Epstein, 3 questions.

    1.  If an item is purchased overseas and lawfully brought into the U.S. does its maker have any copyright protections that it can enforce in the U.S?

    2. As a practical matter, apart from a high volume dealer, such as we have in this case, wouldn’t second sale issues be nearly impossible to enforce?

    3. Would it make any difference if the reseller, operating on the internet, housed his operations in a 3rd country that didn’t recognize any distinction between 2nd sale of goods bought in that country and those bought overseas?

  3. ctlaw

    If the import of a foreign manufactured good was authorized by the US copyright owner, I believe the first sale doctrine would apply and this decision does not effect that.

    Schrodinger’s Cat: How does this affect products made overseas but purchased in the US? Many are saying that if Kirtsaeng loses, then anyone selling a product made overseas could be prevented from reselling it.

  4. Duane Oyen
    Guruforhire: I think the pharmaceutical companies have similar problems in that they sell drugs much cheaper abroad first as a condition in some places for recognizing their IP at all, and because the market cannot support full freight.   · 1 hour ago

    Bigger problem here, though, because the pharmas actually sell drugs overseas OTC and then by prescription in  the US.  You can justify price discrimination on public policy grounds (i.e., protecting TRIPS) for the same category, but not where the pharma is treating the product as essentially generic in a foreign market and using the US FDA mechanism to jack up prices in the US.  Pharmas are breathtakingly hypocritical, and deserve a large comeuppance.

  5. Duane Oyen

    I fundamentally disagree with the anti-free-trade characterization of abusive price discrimination as being somehow- net- “beneficial”.  This is just another bankrupt misapplication of broken windows theory.

    Goodbye, Amazon Marketplace!

  6. Richard Epstein
    C
    Guruforhire: I think the pharmaceutical companies have similar problems in that they sell drugs much cheaper abroad first as a condition in some places for recognizing their IP at all, and because the market cannot support full freight.   · 2 hours ago

    The issue here is indeed identical to that faced by pharmaceutical companies that have to face different demand in different places. They are against parallel importation because it undercuts the home base, which in fact covers most of the fixed costs of production. Pharma has a set of safety issues that are not relevant here, but the economics are the same.

          

  7. Richard Epstein
    C
    David Knights: Prof. Epstein, 3 questions.

    1.  If an item is purchased overseas and lawfully brought into the U.S. does its maker have any copyright protections that it can enforce in the U.S?

    2. As a practical matter, apart from a high volume dealer, such as we have in this case, wouldn’t second sale issues be nearly impossible to enforce?

    3. Would it make any difference if the reseller, operating on the internet, housed his operations in a 3rd country that didn’t recognize any distinction between 2nd sale of goods bought in that country and those bought overseas? · 2 hours ago

    Nice questions. There is no doubt an implicit understanding that individuals who import for their own use, not for resale, get a free pass against a second charge by the domestic copyright holder. The enforcement costs are too high, and individuals in general usually don’t realize sufficient gain except in limited circumstances if there are one-off cases. The world turns over when there is purchase in bulk for resale at a profit, as now the threat to domestic markets is far greater. Sales from China are no different from those made anywhere else.

  8. Richard Epstein
    C
    David Knights: Prof. Epstein, 3 questions.

    1.  If an item is purchased overseas and lawfully brought into the U.S. does its maker have any copyright protections that it can enforce in the U.S?

    2. As a practical matter, apart from a high volume dealer, such as we have in this case, wouldn’t second sale issues be nearly impossible to enforce?

    3. Would it make any difference if the reseller, operating on the internet, housed his operations in a 3rd country that didn’t recognize any distinction between 2nd sale of goods bought in that country and those bought overseas? · 2 hours ago

    In regard to the other part of the question, the place of purchase does not matter so long as it is not in the United States, because the risk of breaking down price discrimination is the same either way.

  9. Richard Epstein
    C
    Mendel: 

    The gist of his essay is “social welfare is enhanced when we erect borders to free trade” – a profoundlyun-libertarian sentiment.

    I don’t think it is. That would be the case if the state imposed these restrictions on all sellers against their will. But in this case it is the seller who makes it very clear that this sale is conditioned on the use or resale of the product in the country of origin.  Now, the insistence that the goods stay out of the U.S. is in accordance with the contract. 

    There is a further argument (not libertarian) that the restraint on trade has antitrust implications, which I don’t think is true so long as there is competition in the text book market in the United States, which constrains prices here. Lower prices do not lead to greater wealth because consumers have additional funds to spend overseas.  The book seller could use those revenues the same way. The question is whether the restraint on trade, imposed as it is by contract, advances social welfare, which it does. We granted the maker a monopoly at home to spur production, which the imports destroy.

  10. Mendel

    Prof. Epstein, I am honored that you responded to my comment – even if only to smack me down.

    My dispute is not on the legal basis (for which I have no expertise), but rather over the notion that trade exclusions lead to the best allocation of capital – in this case, the money of the American consumer. 

    Many products with high development costs (including textbooks, but especially pharmaceuticals) are sold in foreign markets at prices which do not recouperate this overhead, and the American consumer is left to “subsidize” the development costs for the rest of the world (oftentimes rich European countries with price controls).  This appears to be modified rent-seeking. 

    If the current price for the American consumer is higher than it would be in an unfettered trade market (obviously a hypothetical), my intuition is that the extra burden borne by Americans is an inefficiency.  Certainly there is competition in the textbook (and pharmaceutical) industry, but the high development costs usually limit that as well. 

    It seems to me that copyright protection by itself should be sufficient to reward a company for its investment without having to limiting re-imports.

  11. Guruforhire
    Richard Epstein

    Guruforhire: I think the pharmaceutical companies have similar problems in that they sell drugs much cheaper abroad first as a condition in some places for recognizing their IP at all, and because the market cannot support full freight.   · 2 hours ago

    The issue here is indeed identical to that faced by pharmaceutical companies that have to face different demand in different places. They are against parallel importation because it undercuts the home base, which in fact covers most of the fixed costs of production. Pharma has a set of safety issues that are not relevant here, but the economics are the same.

           · 1 hour ago

    I consider these issues to be a function of hydraulics.  A downward force overseas causes an upward pressure in the US.  One can do something about the downward pressure, or you can accept the upward pressure.  You cant do both without a blown fitting or ruptured line.

  12. genferei

    Isn’t the policy implication of this argument that the first sale doctrine should be repealed and that all resales by individuals of anything purchased anywhere should be under the control of the producer?

  13. Duane Oyen
    genferei: Isn’t the policy implication of thi argument that the first sale doctrine should be repealed and that all resales by individuals of anything purchased anywhere should be under the control of the producer? · 3 hours ago

    Which is exactly the opposite of what the Founders intended in Art. 1, Sect. 8, Clause 8.  They originally set copyright at 14 plus 14 for a reason.  That is probably too short.  The Bern Convention, a model of crony rent-seeking, driven by French artists, is too long.

  14. Duane Oyen

    There is no reason, BTW, that they can’t simply make treaties to limit import of copyrighted materials.  These bozos want all of us to enforce their rights for them, at taxpayer expense.

  15. Franz Nisswandt

    There was a wave of “buy NON-local” behavior  in Minnesota a few years back. Bus trips were organized for senior citizens to bring their prescriptions across the border to Canada and get their drugs for 50 cents on the dollar (or less).

    The result? Drug companies started limiting sales to Canadian pharmacies who were selling to Americans, thus supply/demand changed and costs went up, hence less bus trips to Canada.

    Another example is a little closer to home: I was buying a fancy camera lens for my daughter and was puzzled to find brand new, identical lenses for roughly 10% cheaper.  I trolled a bit and found  successful photographers who exclusively buy these lenses – and save 10% on capital costs.

    The rub? These gray market lenses don’t have a warranty. This is how Canon enforces it: you can buy one (made in Japan, sold in USA) – but… it doesn’t carry a warranty. Only imported Canon USA lenses carry the warranty. The pros don’t care – they are buying thousands of dollars worth of equipment and will save money how they can. 

    For my purchase, I chose Canon USA and paid the going price.  

  16. Schrodinger

    How does this affect products made overseas but purchased in the US? Many are saying that if Kirtsaeng loses, then anyone selling a product made overseas could be prevented from reselling it.

    From the amicus brief by ebay et al.:

    The Second Circuit nevertheless held below that the first sale doctrine applies “only to copies manufactured domestically.” John Wiley & Sons, Inc. v. Kirtsaeng , 654 F.3d 210, 221 (2d Cir. 2011). In so holding, the Second Circuit imposed a place of manufacturing requirement on the first sale doctrine that lacks support in the text, structure, history or purposes of the Copyright Act. The Second Circuit’s rule also dangerously expands beyond the Ninth Circuit’s requirement, as considered by this Court in Costco Wholesale Corp. v. Omega, S.A. , 131 S. Ct. 565 (2010). In stark tension with the policy against restraints on alienation, the Second Circuit’s rule affords copyright owners the ability to control the downstream sales of goods for which they have already been paid. (emphasis mine)

    Can one resell an iPhone made in China?

  17. Valiuth

    So if American version of text books are now published in Canada would that mean the publishers can shut down used text book shops on campuses across the nation on copyright grounds? 

  18. Mendel

    For once, I am unpersuaded by Prof. Epstein’s argument.

    The gist of his essay is “social welfare is enhanced when we erect borders to free trade” – a profoundly un-libertarian sentiment.

    Epstein is arguing that companies using their monopoly power to overcharge rich customers in order to allow poor customers access to a product which would otherwise be too expensive are contributing to “social welfare.” 

    But what about the opportunity costs of the overcharging?  Perhaps the American consumer would have used any money saved on textbooks to buy a device manufactured in Thailand – is that not also a social good?

  19. Mendel
    Richard Epstein:  Let the same firm sell only a single product across all markets and miscalibrations will happen at both ends.  Consumers in the strong market get an inferior product to what they prefer,…

    There are two fallacies in this passage.  First, no one is forcing a firm to only sell a single product across all markets: Wiley could still print two versions of its books, sell only the cheap version in Thailand and both versions in America.

    Second, the very existence of the grey market under debate suggests that there are many American customers who would gladly purchase a book of inferior quality at a lower price.

    The main problem here is that Wiley is in an unprofitable business – printing expensive books for niche markets.  While I have often been a consumer of such books (and groaned at their price), it pains me to see them using trade restrictions to defend a losing business model.

  20. Devereaux

    Mendel has it right.

    The question raised is basically no different that those publishers that put out a hardback book, followed by a paperback version. One is more expensive, the other less.

    Wiley has every opportunity to produce and sell whatever they wish where ever they wish. But once sold, such products have the right to travel with the owner – and be resold if it so amuses the owner. Markets always benefit from more choice, and if Wiley didn’t have enough foresight to see that, Kirtsaeng shouldn’t be punished for having it.