 United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT




Argued October 22, 2012           Decided January 11, 2013

                       No. 11-1179

                      GAMEFLY, INC.,
                       PETITIONER

                             v.

            POSTAL REGULATORY COMMISSION,
                     RESPONDENT

             UNITED STATES POSTAL SERVICE,
                      INTERVENOR



            On Petition for Review of an Order
           of the Postal Regulatory Commission



     David M. Levy argued the cause for petitioner. With him
on the briefs was Matthew D. Field.

    Jeffrey Clair, Attorney, U.S. Department of Justice,
argued the cause for respondent. With him on the brief were
Tony West, Assistant Attorney General, Michael S. Raab,
Attorney, and Stephen L. Sharfman, General Counsel, Postal
Regulatory Commission, R. Brian Corcoran, Deputy General
                              2
Counsel, and Richard A. Oliver, Attorney. Sarang V. Damle,
Attorney, U.S. Department of Justice, entered an appearance.

    Michael J. Elston, Chief Counsel, and Morgan E. Rehrig,
Attorney, U.S. Postal Service, were on the brief for intervenor
United States Postal Service.

   Before: SENTELLE, Chief           Judge,   GRIFFITH     and
KAVANAUGH, Circuit Judges.

    Opinion for the Court filed by Chief Judge SENTELLE.

    SENTELLE, Chief Judge: GameFly, Inc. (“GameFly”) and
Netflix, Inc. (“Netflix”) use the United States Postal Service
(the “Postal Service”) to mail DVDs to their customers.
GameFly filed a complaint under 39 U.S.C. § 3662(a) with
the Postal Regulatory Commission (the “Commission”)
accusing the Postal Service of providing preferential rates and
terms of service to Netflix in violation of 39 U.S.C. § 403(c).
The Commission issued an order finding that the Postal
Service was indeed discriminating against GameFly, but its
remedy left much of the discrimination in place. GameFly
appealed. Because we conclude that the Commission’s
explanation of the residual discrimination its remedy left in
place is unreasonable, we vacate the Commission’s order and
remand for further proceedings.

                     I.   BACKGROUND

    GameFly is in the business of renting and selling video
games to customers. Netflix, not a party to this litigation but
much a part of the subject of it, is in the business of renting
DVDs of movies and other similar content. While the
companies are not direct competitors, Netflix being
principally in the movie business and GameFly dealing in
                                    3
games, they use the same medium for the transmission of
their product.1 The DVD medium (an acronym for “digital
versatile disk” or “digital video disk”) is an optical storage
media format used for the recording of movies, video games,
and other content. The physical nature of the DVD does not
change according to the content. In their rental businesses,
GameFly and Netflix mail DVDs to customers, who later
return the disks to the company, typically in a pre-supplied
envelope or container.

     Because the disks are small and light, they qualify for
mailing in one ounce letters through the Postal Service.
Unfortunately for GameFly, but as it develops not Netflix, the
Postal Service’s automated mail processing often damages the
DVDs—particularly on the return trip. Conversely, DVD
mailers tend to jam the Postal Service’s automated letter
sorting equipment. Again, this has been to the detriment of
GameFly but not Netflix. The Postal Service has saved
Netflix—apparently its biggest DVD mailer customer—from
this crippling otherwise industry-wide problem by diverting
Netflix mail from the automated letter stream, shifting it to
specially designated trays and containers, hand culling it, and
hand processing it. Rather obviously, this is not without cost
to the Postal Service. Nonetheless, the Service provides it to
Netflix free of charge.

     GameFly has requested that the Postal Service extend to
its mailings the same treatment afforded Netflix. The Postal
Service has refused, making it impossible for GameFly to use

1
   While the record is not totally clear, it appears that a third company,
Blockbuster, Inc., may have benefitted from some of the same favorable
treatment allegedly extended to Netflix. Blockbuster is predominantly a
movie renter, but also competes with GameFly in the provision of video
games.
                              4
First-Class machinable letter rates for its DVDs. Instead,
GameFly must resort to workarounds to get its DVDs to its
customers. First, GameFly mails its inbound and outbound
DVD mailers as First-Class “flats”—a more expensive rate
category intended for larger envelopes—which prevents much
of the DVD breakage associated with automated letter
processing. Second, GameFly places a protective cardboard
insert in its DVD mailers to cushion the DVDs against shock
and to ensure that the Postal Service’s machines recognize the
mailer as a flat and not a letter.

    These workarounds are expensive. The Postal Service
charges $0.44 for a DVD mailer entered as a one-ounce First-
Class letter, but $0.88 for the same piece entered as a one-
ounce First-Class flat. The protective cardboard insert pushes
GameFly’s mailer above the one-ounce mark, triggering a
second-ounce charge of $0.20 per piece as well. All told, it
costs GameFly millions annually to avoid the Postal Service’s
automated letter processing stream.

     The Postal Service also normally charges a
nonmachinability surcharge on mailers that cannot be
processed in its automated sorting equipment, but does not
require Netflix to pay that surcharge even though its mailers
are nonmachinable. For years, some Postal Service staff have
expressed concern about the cost, operational problems,
unfairness, and potential legal exposure Netflix’s preferential
treatment creates. In 2007 an investigative report from the
Postal Service’s Office of Inspector General recommended
that the Postal Service charge extra for the special manual
processing given to Netflix. The Postal Service did not act on
that recommendation.

   GameFly filed a discrimination complaint with the
Commission on April 23, 2009. The Commission issued its
                               5
decision on April 20, 2011, and ruled in favor of GameFly on
nearly every significant issue in dispute. It found that the
Postal Service had discriminated against GameFly in rates and
terms of service. It rejected each of the Postal Service’s
arguments that the discrimination was reasonable. While
GameFly was victorious in the merits of its discrimination
claim, it was not satisfied with the Commission’s remedial
order.    GameFly had sought two remedies which the
Commission rejected. First, GameFly had requested a
Commission order requiring the Postal Service to offer
GameFly and other DVD rental companies manual culling
and processing at machinable letter rates to the same extent as
Netflix. Second, it requested a reduced automation rate for
flat-shaped DVD mailers (the rate could be set at a level
slightly above the automation letter rate for DVD mailers to
produce equal contributions per piece for the two shapes).

     The Commission rejected both of GameFly’s proposed
remedies and fashioned one of its own instead. First, it
ordered the Postal Service to waive the 20-cent second-ounce
charge for DVDs mailed as flats. Second, it ordered the
Postal Service to refrain from imposing a nonmachinable
surcharge on any qualifying round-trip DVD mailer that is
sent as letter mail and that weighs one ounce or less. The
Commission acknowledged that its order could still require
GameFly to “continue to generate more than double the
contribution per piece than Netflix mail,” but it explained that
“the remaining rate disparity is reasonable in light of the
differences between the letter-shaped and flat-shaped round-
trip DVD mailers.” GameFly petitioned for review of the
Commission’s order.
                               6
                       II.   DISCUSSION

      We have jurisdiction for this appellate review under 39
U.S.C. § 3663, which provides for petitions for review in this
court. The standard of review by incorporation of section 706
of title 5 is drawn from the Administrative Procedure Act.
Under APA review, we may set aside an agency action that is
“arbitrary, capricious, an abuse of discretion, or otherwise not
in accordance with law.” 5 U.S.C. § 706(2)(A). In reviewing
agency action under that standard, “a court is not to substitute
its judgment for that of the agency. Nevertheless, the agency
must examine the relevant data and articulate a satisfactory
explanation for its action including a rational connection
between the facts found and the choice made.” Motor Vehicle
Mfrs. Ass’n of the U.S., Inc. v. State Farm Mut. Auto. Ins., 463
U.S. 29, 43 (1983) (internal quotation marks omitted).
“Certainly, if the result reached is illogical on its own terms,
the Authority’s order is arbitrary and capricious.” Am. Fed’n
of Gov’t Emps. v. FLRA, 470 F.3d 375, 380 (D.C. Cir. 2006)
(internal quotation marks omitted). As to the substantive law
applicable to this specific matter under review, we look to 39
U.S.C. § 403(c). That section provides:

       In providing services and in establishing
       classifications, rates, and fees under this title, the
       Postal Service shall not, except as specifically
       authorized in this title, make any undue or
       unreasonable discrimination among users of the mails,
       nor shall it grant any undue or unreasonable
       preferences to any such user.

39 U.S.C. § 3662 provides administrative remedy for the
breach of the standards set forth in section 403(c).
Specifically, § 3662(a) authorizes complaints by “[a]ny
interested person . . . who believes the Postal Service is not
                               7
operating in conformance with” § 403(c). Subsection 3662(c)
provides:

       If the Postal Regulatory Commission finds the
       complaint to be justified, it shall order that the Postal
       Service take such action as the Commission considers
       appropriate in order to achieve compliance with the
       applicable requirements and to remedy the effects of
       any noncompliance . . . .

     Subsection 403(c) only prohibits “undue” or
“unreasonable” discrimination.         Where the Commission
allows discrimination to exist in the postal rate structure, it
must explain why that discrimination is due or reasonable
under § 403(c). See Nat’l Easter Seal Soc’y v. USPS, 656
F.2d 754, 760-62 (D.C. Cir. 1981). GameFly asks us to
review the reasonableness of the Commission’s rejection of
its proposed remedies. But regardless of whether it adopted
the precise remedy sought by the complainant, the
Commission was required either to remedy all discrimination
or to explain why any discrimination it left in place was due
or reasonable under § 403(c). Therefore, we begin by
examining the Commission’s explanation for the residual
discrimination its order left in place.

    Here is that explanation in its entirety:

       The difference in the rates that will be paid by Netflix
       and GameFly under the remedy is justified by cost
       differences and by general pricing differences between
       the First-Class Mail flat and letter products.
       Additional rate differences may arise between users
       depending on whether a given mailer presorts its
       outbound pieces. Such differences are the result of
       reasonable pricing differences that exist between the
                              8
       various single-piece and presort rates applicable to
       First-Class Mail letters and flats.

       The price granted by the remedy is not as low as the
       alternative remedy sought by GameFly, and even at
       this rate, GameFly mail may continue to generate
       more than double the contribution per piece than
       Netflix mail. However, the remaining rate disparity is
       reasonable in light of the differences between letter-
       shaped and flat-shaped round-trip DVD mailers. By
       making the letter-shaped and flat-shaped round-trip
       DVD mailer rates available to all qualifying mailers,
       any potential discrimination against other similarly
       situated mailers is also remedied.

(footnote omitted).

     The unstated assumption of this explanation is that
GameFly has a free choice in whether to use flats or letters.
But the Commission’s findings establish that the Postal
Service’s terms of service discrimination against GameFly,
not GameFly’s free choice, led to the companies’ use of
different mailers. The Commission found that GameFly
would switch to letter mail if the Postal Service would
provide the same service on the same terms it provides to
Netflix. The Postal Service refuses to do so. Without special
manual processing like that afforded to Netflix, switching to
letter mail could subject GameFly to an epidemic of cracked
and shattered DVDs. The Commission cannot justify the
terms of service discrimination its remedy leaves in place
(providing manual letter processing to Netflix but not to
GameFly) based on the companies’ use of different mailers
when the use of different mailers is itself the product of the
service discrimination.
                                9
     In short, we conclude that the Commission’s order is
arbitrary and capricious. Am. Fed’n of Gov’t Emps., 470 F.3d
at 380 (“Certainly, if the result reached is illogical on its own
terms, the Authority’s order is arbitrary and capricious.”
(internal quotation marks omitted)). We need not, and do not,
address GameFly’s argument that its proposed remedies
should have been adopted by the Commission. Upon
rehearing, the Commission will surely consider those
remedies, but there may be a range of other possible remedies
which would withstand appellate review.

                       III. CONCLUSION

     When, as in this case, the Commission properly finds that
discrimination has occurred, it is obligated to remedy that
discrimination, even if it concludes that none of the parties’
proposed remedies is appropriate.            Here, even if the
Commission’s rejection of GameFly’s proposed remedies was
reasonable, its order is still arbitrary and capricious because it
left discrimination in place without reasonable explanation.
Therefore, we must vacate the Commission’s order and
remand this case for an adequate remedy. The Commission
must either remedy all discrimination or explain why any
residual discrimination is due or reasonable under § 403.

                              ***

   GameFly’s petition for review is granted, the
Commission’s order is vacated, and the case is remanded.

                                                     So ordered.
