Economics of Antitrust [Hovenkamp]

Price Theory: Economic Behavior and Perfect Competition Theory

o Market economics are dedicated to the principle that, in the first instance, people are responsible for their own welfare

o Further, people are better off if they can make voluntary exchanges of goods and services in competitive market

o Point of maximum efficiency is reached when a market participant can no longer make itself better off by an exchange that is voluntary for both parties in the transaction

o AT aims to preserve the competitive market for individuals to make the voluntary choices on both sides of the transaction

Perfectly Competitive Marketo Competitive Market:

(1) Every good is priced at the cost of producing it, giving the producers and sellers only enough profit to maintain investment in the industry; and

(2) Everyone in the market willing to pay this price will buy the product

o Conditions conducive to a Perfectly Competitive Market (1) All sellers make homogenous product (2) Sellers all too small to have unilateral market effects (3) No restrictions in producing or reaching entire market (4) Strong-Market Hypothesis is in effect

o Perfect Competition Model Assumption “Constant returns to scale,” meaning that costs of

production per unit remains constant at all practical rates of output

But see Economies of Scale: Decreasing costs of extra unit of production can undermine perfect competition model

o Law of Supply and Demand As more units are produced, price has to drop in order to

reach customers who have lower reservation prices If market is strong-efficient, then all buyers will pay the

same price for a unit, regardless of their reservation price, due to available information and the opportunity to arbitrage

o Decline in Price: As you produce more units, you incur variable costs in

doing so and need to sell them if you want to override that cost and potentially produce a profit

Since you must sell all of your units at the same price, to sell all of the units you must reach lower tranches of customers with lower reservation prices

Thus, the last unit produced sold to the lowest reservation price customer in order to achieve a full sale of your goods causes you to reduce price as output increases

o Consumer Surplus As supply increases and demand at various levels of cost

increases, the market reaches equilibrium Any sales above the equilibrium price shift consumer

surplus to producerso Elasticity of Supply and Demand

Elasticity of Demand: If a change in price produces only a small change in demand inelastic market

Elasticity of Supply: Relationship between change in price of a product and the amount produced

o Elasticity & Timing: Supply:

For AT, have to consider the time it takes for supply to increase in response to a price increase

If there is a 10-year period to meet increased demand, or if there is a competitor w/ sufficient capacity ready to meet the changes in demand competitors may abstain from entering market

Demand: Consumers may face lock-in issues if they’ve

made substantial investment in durable goods and cannot switch for less than the cost of being charged supracompetitive prices

o Antitrust and Timing: AT is concerned w/ short-run dislocations in the market AT wants to make markets efficient sooner rather than

later

1

Behavior of the Competitive Firmo Assumption: Competitive market w/ large number of sellers into

which entry is relatively easy and can be accomplished in a short amount of time. Strong market hypothesis is in effect.

o Effects on Firm’s Behavior: Seller becomes a price taker; =/= capable of unilaterally

affecting market price and selling above going rate Firm faces perfectly horizontal demand curve

For competitor, market price is the same at all rates of output

BUT, firm itself has high elasticities of supply and demand

E.g., In response to a small price increase, alternative suppliers will immediately offer substitute products to the price raiser’s customers, and all customers will switch to competitors’ products

o Distinguishing between Market elasticities of S&D and Individual Firm elasticities of S&D

Pure Monopolist: Output is same as entire market Individual Firm: Faces higher elasticities of S&D than

the market as a whole Because, within the market, substitution is easy

and quick BUT, while individual firm doesn’t control price, it does

control its OUTPUT Competitors of varying sizes will produce

different output = Function of Marginal Costo Marginal Costs

Marginal Cost: Additional cost that a firm incurs in the production of one additional unit of output. Can be divided into two categories

Fixed Costs: Costs that do not change with output over the short-run, which is some finite period of time, usually less than the lifetime of the plant

o Investment in fixed cost asset must be paid regardless of whether plant produces anything

Variable Costs: Costs that change with output

o E.g., increasing costs of production by 30% requires additional investment in inputs, EE salaries, etc.

o But note: Over the long-term, even fixed costs become variable as assets reach end of useful life

Average Variable Cost:o If firm is unable to sell above its

average cost of production, then it is likely to fail

Increasing Production: Since firm incurs no increased fixed costs in

expanding an output in the short run, marginal cost is a function purely of variable cost

Pricing at Marginal Cost: Marginal cost increases w/ increased production

as variable costs increase, and even more rapidly once a firm passes its optimum production point

Firm will always try to produce at a rate of output where marginal cost = market price

o If producing above can make more money by producing less

o And, vice versao Econ Observations:

(1) All firms have the same marginal cost at current output levels

Efficiency differences appear not in marginal cost, but in the rate of output

More efficient firm produces at same marginal cost but produces more units

(2) Not every firm is profitable To achieve profitability, where the current

production point meets marginal cost must be greater than the firm’s total cost curve

(3) Unprofitable firms don’t always exit E.g., where market price is above total cost at all

production levels because of a lagging “sunk” fixed costs investment

2

Monopoly Price and Output of Protected Monopolist

o Hypothetical: Assuming monopolist has 100% market share and no concern about entry by a competitor, how much will sell and at what price?

o Output: Uniqueness of monopolist compared to individual firm in perfect competition is the monopolists ability to reduce output and increase price

BUT, monopolist is limited in what price it can charge Tranches of different consumers that value the product

differently can be exhausted by too high a price

Monopolist Economics:o Monopolist must charge the same price for each unit, otherwise it

creates a secondary arbitrage market Monopolist also has to drop price as it increases output in

order to reach all trances of available consumers to purchase its product and preclude recognizing a loss

o Marginal Revenue: Reflects the decreasing revenue per unit obtained for each additional unit produced

Monopolist is more concerned w/ marginal revenue and will produce only up to the point that any additional unit will produce greater additional cost than additional revenues

Rents: This is the monopolists focus on rents via supracompetitive pricing

If one more unit cost > marginal revenue produced monop will not produce

Contrary to competitive firm b/c competitive firm will compete at cost not marginal rev

o Substitutability: Monopolist is constraint by the elasticity of supply for its

product

Monopsony, Output Effects, and Policy implications Monopsony: A monopolist buyer rather than a monopolist seller

o Allocates resources inefficiently, just as monopolyo Because of market power, monopsonist can declare that it will only

buy at a certain price Firms with costs above this price will drop out of the

marketo Output = often reduced

Monopsony Fallacy: Courts sometimes assume that the lower prices the monopsonist is able to purchase at =/= AT concern

o Theory: These prices will be passed down to consumerso BUT, because monopsonist reduces its demand for inputs, it

presumably also makes less outputs So, although its price is lower for production, when

selling into a competitive market will sell less units And, if selling into a cartelized/monopolized market, will

sell at reduced output and sell at the higher price w/ the cartel/monopolist

De Facto Monopolies in Real World Marketso Most AT policy concerning monopolists is directed at de facto

monopolists, which have no such legal protections as the regulated monopolist

Generally =/= 100% market power; and Must consider possibility of new entrants

Therefore, Monop must be strategic in price and production, in relation to current competitors and potential entrants

Much AT law is concerned w/ the strategic decisions of the de facto monopolist trying to enlarge or protect its monopoly position

o Two Pricing Decisions: (1) Forget about new entry, charge as much as possible

now, and burn out the rents it can get by eroding its monopoly position [Short-term]

(2) Set a lower “entry deterring” or “limit price” to keep potential entrants out, while still charging a price just high enough to make small rents [Long-term]

3

Antitrust Policy and Social Cost of Monopoly Monopoly as Status; as Process

o The social cost of monopoly = Loss Produced by Monop Pricing minus Any social gains Monop produces

o Costs and Benefits? If firm, through R&D, creates new product it has a

monopoly on that product. Therefore, rules have to distinguish between the

beneficial and the harmful

o Policy Questions: How do we measure the social costs of monopoly?

Statically via “public utility” approach: If price is too high consumers substitute out to less efficient options causing deadweight loss

Costs of monopolization? AT is concerned with the restraints and

anticompetitive actions that a firm w/ monopoly power engages in to preserve or expand that position

These actions themselves create social harms of deadweight loss viz. investments in illegal, anticompetitive conduct, costs to society of higher prices and less competition, etc.

So why not condemn monopolies outright? Principle concern of AT is the monopoly created

by certain means May be because the costs and means by which

Monop is created and preserved can dwarf the costs of any misallocation caused by the monopoly pricing and output restrictions themselves

Social Cost of Monopoly: Deadweight Loss (DWL)o Society =/= poorer because monopolist exists

E.g., U.S. was better off with Alcoa existing as a monopoly vs. there being no producer of aluminum

And, market obviously valued the product more than its cost, otherwise there would have been no market in the first instance

o Society = richer, however, if competitive market exists Therefore, the social cost of monopoly is the difference in

social value between a monopolized market and a competitive market

Example: Patent market = valuable even though it creates monopolies

o Operation of DWL Occurs b/c Monop encourages some customers to engage

in an alternative transaction that produces less social value than would their first choice

Social Cost: Rent Seekingo De facto Monop worries about competitive entry and has no legal

AT protection must constantly work to exclude other firms can have an even greater negative effect on social welfare than protected monopolist

o More profitable a monopoly more likely competitors will seek entry more de facto Monop will contribute rents to entrench its power

o BUT, we assume that Monop will spend on something other than just entrenchment some social benefit arises

E.g., Lower Pricing Although, this lower price over 10-years may

still be less than the deadweight loss originally caused by monop

E.g., Research and Development Can create social value if society values the new

product more than it cost to create BUT, the more successful the harder for new

firms to enter

4

Relationship between monopoly and R&D is still uncertain today

o Unclear whether Monop produces better innovation or hinders development

Social Cost: Lost Competitor InvestmentIndustrial Organization Theory & Economies of Scale

Two Important Functions:o (1) Can help us decide whether the perfect competition model is

optimal for a particular market; ando (2) Can help us understand whether a particular firm’s activities

that affect market structure are efficient and should be encouraged, or are inefficient and ought to be condemned

General Case of Economies of Scaleo Single largest factor tending to undermine perfect competition is

economies of scale b/c perfect competition model is premised on firms indifferent to each other’s output because they all have the same marginal cost

Economies of Scale flips this presumption on its heado Minimum Efficient Scale (MES)

Refers to the smallest production unit capable of achieving all relevant economies of scale

If a firm operates at MES, no other firm can be more efficient because of its scale of operation

Maxed out all available technologies at the minimal perfect equilibrium

In a competitive market, firms gravitate towards MES BUT, where market is cartelized and a higher

price is being charged, inefficient non-cartel participant can muster along charging just below the Cartel price

o MES and AT First, MES tells us much of AT’s historic preoccupation

with bigness per se was ill-advised, at least if prices are an important goal

E.g., where MES is 25% of the market will affect the number of market competitors in the long run

Second, knowledge of economies of scale in the market can help AT policy maker distinguish between vertical integrations and horizontal mergers that increase

efficiency and competition and that have anticompetitive effects

Third, helps determine appropriate structural remedies E.g., will the split firms be large enough to reach

market MES

Persistent Scale Economies, Natural Monopoly, Franchise Bidding and Contestability

o Natural Monopoly: There are some industries where having less competitors

is better Example:

Firm A builds a bridge w/ a one time cost of $1,000 which will last for 10-years fixed costs = $100 per year.

1,000 people cross the bridge per year and are charged $0.10 per crossing to cover full fixed cost each year

Firm B builds competing bridge next to A’s under same financial circumstances

Customers are indifferent and ½ go to A’s and ½ go to B’s

Now, only 500 people go to A’s bridge w/ 500 going to B’s

o Price per crossing raises to 20¢ per person to cover fixed costs

o Customer Tranches: Some aren’t willing to pay the increased fare and substitute out

o Price increases again to make up the difference of the lost tranche

Therefore, some industries are better off with one firm dominating

Protections: Regulation and Price Fixing by government

Also provides firm some limited Antitrust protections

o But see Contestable Market Theory Involves deregulating regulated monopolies in order to

allow firms to compete for the privilege of being the monopolist in the sector

5

Less-Than-Perfect Competition Product Differentiation

o Gives individual firms small amount of market powero Also makes collusion and some kinds of oligopoly more difficult

That is, b/c it’s difficult to agree on price and output when nonidentical products are produced

o Two Contrary Implications: (1) When concerned w/ market power of a single firm

product differentiation tends to create or exaggerate market power individually held, although actually frequently in amounts too low to be of antitrust concern

(2) When concerned w/ practices that might facilitate collusion, as in traditional merger policy, product differentiation tends to be a mitigating factor

Price Discriminationo Tends to result from

(1) Informational deficiencies of consumers, and (2) Geographical constraints

o Both can allow a competitor—particularly in a product differentiated market—to charge above marginal cost

Oligopolyo Focus has shifted to merger considerations which preclude creating

oligopolies in markets that can facilitate oligopoly pricing

Less-Than-Perfect Competition & Second Besto In order to understand whether busting up a monopoly or allowing

one to be created is actually beneficial or harmful to competition, need to know about the alternative markets that the considered market effects

o Although practically infeasible in AT adjudication, can serve as premise for evaluating merger or proper remedy in AT case

Barriers to Entry Two Major Definitions:

o Bainian: Extent to which, in the long run, established firms can

elevate their selling prices above the minimal average costs of production and distribution without inducing potential entrants

o Stiglerian: Entry barriers are costs that a prospective entrant must

incur at or after entry, that those already in the market did not have to incur when they entered

That is, an entry barrier is a cost of producing at some rate of output which must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry

AT Policyo Has followed Bainian: Written into the FTC 2010 Merger

Guidelineso Justifications for Bainian preference:

Free of value judgments regarding what entries = socially valuable or harmful;

Rather, Bainian focuses on whether a particular practice is plausibly anticompetitive

Considerations for Potential Entrantso Firm must consider what its post-entry price will be (with its

output included in the available supply) rather than what the current price in the market is, also taking into account any adjustments incumbent firms might make upon competitor’s entry

Considerations for Incumbentso Allowing entry of small firms may nonetheless be the best strategy

for the incumbent firm if it can still serve a large portion of the market after the smaller firms have filled fringe demand

6

Natural vs. Artificial Barriers to Entryo Natural: If it is simply an inherent condition of operation in a

marketo Artificial: if it is strategically erected by incumbent firms in order

to make entry more difficult

Increasing Importance of Transaction Cost Economics (TCE) in AT Analysis TCE assumes that firms take transaction costs into consideration when

economizing their processeso So, firm decides whether it will produce inputs internally or

purchase them externallyo If purchase need long-term Ks that are somewhat open ended

Therefore, firms will adapt their technology to meet the other’s needs may result in lock-in where firms are synergistically more costly to separate than profitable to move on

BUT, transaction costs can also be used as a barrier to entry to keep competitors out

o E.g., By virtue of making commitments and agreements w/ vertically related suppliers/buyers, these parties form pairs as it becomes more costly than profitably (i.e., when they’re locked in) from making a switch in the market

o So, bargained for arrangements can yield Ks and practices that seem inconsistent w/ perfect competition

Vertical Relationships that Behave like Bilateral Monopolieso Where the market is unstructured, the transaction costs of moving

down the vertical chain can be higho In most vertical settings, however, the contractual form establishes

a hierarchy that imposes stability E.g., Franchise selling rights to franchisees

Sales are made individually Looks more like a business firm than a market

b/c of top down control See also Manufactures and Retailers invest in promoting

manufacturer’s product This is how bilateral monopolies get started BUT, also beneficial to both firms because the

investment gains more than offset any transaction problems that arise from co-investment

Antitrust Argument:o Bilateral monopoly of this form =/= AT concern UNLESS firms

committed to such relationship have MP in at least one external market

o No arrangement in the quasi-bilateral monop has AT significance in the absence of MP b/c external prices will not be affected

TCE & Tying / Price Discrim Analysiso In the bilateral-monopoly setting (e.g., between franchise and

franchisee) Courts have held that tying arrangement (e.g., requirement to exclusively buy all food from franchise) can constitute an AT violation

o Likewise, in Kodak where customers were “locked-in” and Kodak changed the regime and began to dictate terms of parts and service market as a tie against consumers

o Or, metering, where as in Salt purchase of the machine locked in consumers on the requirement that they purchase all salt (tied product) from the manufacturer

o Finally, exclusive dealing arrangements can (1) reduce transactional costs and pass savings down to consumers, but (2) can also reach unnecessarily anticompetitive levels that reduce or hinder competition in the market place and harm consumers

7

Hovenkamp, Ch. 3: MP & Market Definition

MP Technically Definedo MP = firm’s ability to increase profits by reducing output and

charging more than a competitive price for its producto But see Cellophane (Du Pont): Court defined MP as “power to

control prices or exclude competition” MP, however, =/= an “exclusionary” practice Sale of prods at supracompetitive price invites entry Nonetheless, exclusion of competitors is an important

mechanism by which firms obtain or maintain MP

MP in AT Caseso §2 Sherman Act:

D must have high degree of MPo Attempt to Monopolize:

D must have dangerous probability of achieving MPo Tying under §1 Sherman Act and §3 Clayton Act:

Require a showing of MP in market for tied producto Unlawful vertical restraints, dealer terminations, resale price

maintenance: All require some showing of MP

o But see §7 Clayton Act Mergers: Not required that acquiring firm have MP. BUT,

restriction is premised on post-merger firm having MPo Per Se Cases:

E.g., Price Fixing: Although MP isn’t necessary, plaintiff seeking damages needs to show that there was an “overcharge.” & w/o MP no overcharge possible

Market Share (MS) as Surrogate for Market Power (MP)o Positive correlation between MS and MPo E.g., Firm w/ 90% of market can raise prices and lower output

profitably, due to the time it will take for competitive entry and

competitors to increase capacity to meet additional demand at lower rate

o For MS to serve as a qualified proxy for MP, have to also consider the elasticity of supply and demand in the relevant market (the variables for which are different in all markets)

Market Share as More Than a Surrogateo In almost all AT cases, the claimed harm =/= result from firm’s

ability to raise prices and reduce output profitablyo Rather, claimed harm = barriers to entry, supply, distribution, etc.o The real basis for this power = Market Share

That is, the size and prominence of the firm create the opportunities to exercise what AT offenses call MP

And, when we consider the plausibility of a complaint, we’re looking at means (MS) not ends (MP)

Relevant AT Marketo Is there a relevant market in which the legally necessary market

power requirement can be inferred?o Process

(1) Determine relevant product market (2) Determine relevant geographic market (3) Compute D’s percentage of output in relevant market

thus definedo Complaining Plaintiffs:

Both §2 Sherman and §7 Clayton suggest the above approach

8

Estimating Relevant Market; SSNIP & Hypothetical Monopolist Relevant Market:

o Smallest grouping of sales for which the elasticity of demand and supply are sufficiently low that a “hypothetical monopolist” w/ 100% of that grouping could profitably reduce output and increase price substantially above cost.

SSNIP: o Small but significant and nontransitory increase in price that AT

analysis looks to as the measure of potential increase in price by the hypothetical monopolist for determining relevant market

Example:o Ford decides to raise the cost of its cars by $1,000

Customers switch to Chevyo Price of American cars is raised $1,000

Customers switch to Mazda, Toyota (foreign imports)o Price of ALL passenger cars raised $1,000

Customers have to switch out of market completely and into substitutes

Other firms are induced to enter, with the primary barrier being time to change over machinery

o Therefore, Relevant market for SSNIP to be successful = Passenger

Car Market –> Next Step = Determine Ford’s share of Passenger Car Market

o Accordingly, Ford =/= monopolist b/c its share of the passenger

automobile market is only 10% world wide Takeaways:

o Grouping of sales =/= relevant market unless both elasticity of demand and elasticity of supply are sufficiently low.

o That is, (1) Customers must not be able to find adequate

substitutes easily in response to the price increase; and

(2) Other firms must not be able to enter the market in question or change their own production so as to compete with the price increaser’s sales

o See, e.g., Brown Shoe: Cross-elasticity of production facilities may be an

important factor in defining a product marketo And, Rebel Oil:

Full-service and self-service gasoline retailing in single market b/c supplier of one could readily switch into the other

Procedure:o Court identifies some grouping of sales in which there are no close

substitutes on the demand side; ando Where entry on the supply side is low or time consumingo Then, determines whether Defendant has market power in the

relevant market

Size of Hypothetical Price Increase (SSNIP)o (1) In the real world, b/c of product differentiation and economies

of scale, some firms are able to price above marginal costo (2) Institutional costs of reducing MP through AT are high:

difficult to measure; courts are prone to make errors; more hardline rules more likely to make errors and more litigation

o (3) Size of the optima SSNIP is not necessarily the same for all markets

At least 10% above the marginal cost/competitive price in the market = about correct hypothesized price increase

2010 Merger Guidelines: Use 5% BUT, in the concentration ranges where

horizontal mergers become a matte of concern, prices are already typically somewhat above the competitive level

9

Profit Maximizing Increase; Critical Loss Analysis Inelastic Consumers:

o In some markets where different classes of consumers have different demand elasticities to a product, a 10% increase in price might be unprofitable to the firm, because although it recoups higher prices from Class-1, it loses sales to Class-2

o However, if firm increases price by 60% and Class-1 still doesn’t have a less costly substitute at that point Firm still has MP w/ respect to these consumers

o Vice Versa: in some instances, a 10% price increase can be unprofitable whereas a 4% price increase can be profitable

Critical Loss Analysiso Considers what percentage of sales a firm would have to lose in

order to make a price increase of a given magnitude unprofitable o 2010 Merger Guidelines:

FTC and DOJ may use critical loss analysis when the necessary data are available

May consider critical loss analysis to assess extent to which it corroborates inferences drawn from the evidence

Test: Asks whether imposing a SSNIP on one or more products in a candidate market would result in lost profits to the monopolist comparing critical loss & predicted loss

Critical Loss = Number of lost unit sales that would leave profits unchanged

Predicted Loss: Number of unit sales that the hypothetical monopolist is predicted to lose due to price increase

Result: Price increase raises hypo-monop’s profits if the predicted loss is less than the critical loss

Broader and Narrower Markets; General Irrelevance of Submarkets Although there may be smaller sub-markets w/in the relevant market,

determining whether a restraint or certain conduct affects these markets requires the same reasoning of determining relevant market

o That is, what’s the smallest grouping of the product market that consumers won’t easily substitute out when the hypothetical monopolist could imposes a SSNIP?

o See, e.g., Brown Shoe [Generally] when doing merger analysis, have to look at

each relevant market merger might effect (so, same analysis for sub-markets if merger might effect it)

o See also Aspen Skiing Trial Judge instructed jury to determine first whether it

found downhill skiing at destination ski resorts to be a relevant market, and if so then whether skiing in Aspen was a relevant submarket

Should have simply asked the latter b/c analysis for both is the same

Product Market; General Considerationso No grouping of sales is a relevant market unless both elasticity of

supply and elasticity of demand are sufficiently low to warrant a conclusion that the sole seller of that grouping could profitably raise prices substantially above the competitive level

o Difficulty: In large part, analysis turns on substitutability in consumers’ eyes, for which there is no easy criterion to measure

Furthermore, a superior, less expensive product may be competitive against an inferior product, but the inferior product may not necessarily be competitive against the superior product

o When there are no obvious differences in the cost of production and consumer substitutability is high inference is strong that the two products are a part of the relevant market

BUT, products that do not compete in the eyes of consumers should not be in the same relevant product market

Test: Can measure consumer response as between to products by tracing price over time

If prices of the two products move w/ no obvious correlation =/= same market

10

BUT, even if prices move together, have to determine whether one product is monopolized

o If so monopolized product’s price moves up and down w/ price of closest rivals

o Where no monopoly + consumers shifts between the product when the market seems to be competitive tends to show common market

Market and Brands; “Lock-in”: Single Brand Normally =/= Relevant Market (Kodak)

Three Presumptions:o (1) Patents, trademarks and copyrights standing alone very rarely

confer substantial market power;o (2) Sometimes, brand differences reflect very substantial

technological differences, or differences in both cost of production and consumer appeal;

Strong distinction may move product into its own relevant market

o (3) In a few extreme cases, customers may become “locked in” to a particular brand, and this fact may justify a narrower market definition

In such cases, question is whether this lock-in enables the seller to somehow take advantage of its own customers/product owners, and if any such advantage amounts to “monopoly”

Necessary Conditions for Lock-in Problem to Ariseo (1) Primary good must be durable;o (2) Its replacement parts or service unique;o (3) Customer switching costs are substantial; ANDo (4) There must be some element of surprise in the sense that

consumer could not reasonably have known when making the initial purchase that aftermarket parts or servicing would be very costly

Kodak

o BOTH Maj’s proposition that MP in aftermarkets can be inferred from uniqueness and control, & Scalia’s view that comp in primary market = competition in the aftermarket are often wrong

o The former = almost always wrong; second = sometimes wrongo Answer: Must evaluate both the primary and aftermarket

separately; market power in either can exist independently of the other

Contract Lock-in; Franchisor Brand as Marketo Queen City, (3rd Cir. 1997): Ps alleged franchise K obligated them

to purchase all pizza dough mix from franchisor-Dominos at above-market prices

B/c Ps = lock-in no demand or supply elasticity P’s stuck w/ D’s SSNIP in pizza dough provision to franchisees

o Held: Distinguished between pre-K and post-K market power (1) P’s alleged they wanted to buy substitutable pizza

dough, which cuts against finding of D’s MP (2) P’s knew about requirements K before entering

franchise agreement And, Ps chose Dominos out of any other

franchise agreement (3) No relevant market in which output is being reduced

Pizza consumers are not locked into anything Any reduction in output of Dominos pizza is

made up by competitors in the market =/= consumer issue

Submarkets vs. Complementso Relevant Market Consists of Substitutes

Placing complements in the same relevant market ignores that a market must be a set of sales that compete with each other

o Limited Rationale for “Cluster” Markets Economies of Scope:

11

When it is cheaper to offer two complementary products than only one

BUT =/= relevant market unless other firms face barriers to attempting the same economies of joint provision

See, e.g., Grinnell, (U.S. 1966): Defendant’s central station system simultaneously offered burglary, fire, and other protections

Since burglary and fire protection =/= competitors, cannot be grouped together on basis of high cross-elasticity of demand

BUT, providing services together can be cheaper than providing separately

o E.g., link the same fixed costs of wiring certain systems and receiving calls at the same service station

See also Brown Shoe: Clustering men’s, women’s and children’s shows in the same market, but only after concluding that D’s market share was equal in each

So, clustering can sometimes be employed by the court when D has market share across a certain scope of products

But See Horizontal Merger Guidelines: Generally avoid clustering in favor of defining

markets with reference to each product of each of the merging firms

Cross-Elasticity of Demand: The “Cellophane” Fallacy and Its Consequences Cross-Price Elasticities and Their Meaning:

o Cross-elasticity is a measure of the rate at which buyers substitute to some product B in response to a price increase in product A

o Used properly, cross-elasticity measures help fact-finder assemble into a single relevant market products that are close substitutes when each is sold at a competitive price

Cross-Elasticity of Demand in Du Pont / Cellophaneo Held: Relevant market must include products that have a

reasonable interchangeability for the purposes for which they are produced entire market for flexible packaging materials constituted relevant market

o Example of Fallacy: If monopolist is exerting MP and thus creating the high

cross-elasticity of demand at the current price, then the

relevant market cannot include substitutes for the monopoly pricing.

Rather, court needs to determine what substitutes customers would turn to if the monopolist’s product was competitively priced

Correcting Cellophane Fallacy:o Cross-elasticity of demand is a useful tool for determining relevant

market when products are competitively pricedo BUT, how do we determine if the current price = competitive?o Necessary Assumption:

When D is alleged of being a monopolist have to assume

(1) Its current price =/= competitive; and, (2) There is high cross-elasticity of demand as a

resulto Clues to properly determining Cross-Elasticity

(1) Are firms using sufficiently similar technology that there are low switching costs into D’s product market?

Versus, is D licensing these rights to create the product to competing firms at a high enough rate such that it can still extract rents at a lower price than its licensees

E.g., in du Pont, D licensed its IP to Sylvania (2) Cost Shocks

Did the price of an input jump at any time which the Defendant was capable of passing onto consumers?

If so inconsistent w/ horizontal demand curve in competitive market

(3) Relative Price Movements of Competing Products If A moves and B stays steady may be

different markets12

If both decline may be relatedo Even if A = monopoly, may be

responding to competitive efficiencies in competitor B’s product

Supply Elasticities; Foreign Imports Test: Can D’s current competitors increase their own output in response to

D’s price increase; or, alternatively, can firms making products similar to D’s easily switch to producing D’s product and ship them into D’s sales area if the profits are attractive?

o Divertible production: Refers to output of rivals or potential rivals that is currently not sold in D’s geographic market, but could come in if price rose

o Excess Capacity: Generally refers to unused plant capacity that can be brought into production at a cost no higher than current production costs

Foreign Imports and Alcoao Hand, J: Refused to include either (1) foreign aluminum sold

abroad; or (2) additional plant capacity of foreign producers BUT, what would have happened if Alcoa had attempted

a price raise? Foreign competitors could (1) have diverted

current aluminum production to the U.S.; or (2) produced more for sale w/in the U.S.

Thus, assuming Alcoa’s and the foreign producers’ prices were competitive, Judge Hand was wrong to include only foreign aluminum actually imported into the U.S. in the relevant market

o Cellophane Fallacy? Fact that foreign producers were coming into the U.S.

market Alcoa lacked MP to exclude them

Thus, Alcoa also lacked sufficiently low production costs in order to undercut these entrants

Other Decisions Addressing (or Failing to Address) Supply Issueso Where the technological cost of redesigning is low, presumptively

should group into same relevant market, unless there is evidence that consumer resistance to the redesigned product would be substantial

o Largely depends on the nature and sophistication of the customers

Accounting for Elasticity of Supply: Market Inclusion or Low Barriers to Entry?

o Can account for high elasticity of supply in two ways: (1) Can include in market definition those firms easily

able to switch to D’s market in response to D’s price increase;

(2) Can define market more narrowly but conclude that entry barriers are low

If supply elasticities = high under either measure D lacks substantial market power

o Effective Arguments Cannot really argue what the market output of potential

entrants would be if they entered; can really only say that barrier to entry is too low to allow D to benefit from SSNIP

More convincing argument is where there are existing suppliers who already have running production that can easily be changed to enter into D’s market

Relevant Geographic Market Relevant Geographic Market = Geographic area in which firm can increase

its price without o (1) Large numbers of its customers quickly turning to alternative

supply sources outside the area; oro (2) Producers outside the area quickly flooding the area with

substitute products

13

Application of Cellophane Fallacyo E.g., If customers already travel 10-15 miles from town A in order

to go to movies, it might be because theater in town A is already charging monopoly prices would be incorrect to include the 10-15 mile customer radius as the relevant market b/c not in response to competitive pricing

Shipped Goods; Minimum Geographic Market In general, the size of the geographic market for shipped products is a

function of three things:o (1) Shipping costso (2) Value of the product; ando (3) Size of the hypothesized price increase that expresses our

degree of concern about monopoly power

Stationary Goods and Serviceso Geographic markets may be smaller and more difficult to measure

if customers, rather than the goods or suppliers do the travelingo Grinnell, (U.S. 1966): Ct. decided D had monopolized the

business of providing central station protective services (alarm systems), and the relevant market was the entire U.S.

Price Movements and Shipping Patterns Price Movements Generally; Asymmetry

o If over a certain period of time, a price increase/decrease in area A is always followed by a corresponding increase/decrease in area B A & B are likely in same relevant geographic market

o See, e.g., Tampa Electric: Court held that D =/= have market power in the market for coal sold to Florida b/c coal producers as far away as western KY were eager to sell coal at the competitive price in Fla.

This suggested to the court that not only KY producers of coal, but all coal producers closer to Fla. than KY should be included in the relevant geographic market

Note Also: once we have determined that a remote plant in KY can provide coal to the Fla. market at competitive price must include all divertible output of KY plant, and not merely the amount that it is currently shipping into the Florida market

o Accordingly, determining relevant geographic market requires identifying an area wherein firms inside the area have a cost advantage of firms not inside the area

In that case, the favored firms will be able to raise price as much as the cost advantage permits

Asymmetrical Geographic Marketso Geographic pricing advantages are capped by the divertible output

of competitors in neighboring regions who could easily respond to a SSNIP in the prescribed area

o BUT, if production costs in market A already equal shipping + production costs in market B divertible output of B should be included in determining relevant market for A, but not vice versa

Trade Area; Non-Competition Agreementso Trade Area: Area in which D competes against others for

businesso Relevant Market: Extent of area to which customers will travel to

avoid doing business w/ D Alternatively, what is the extent to which customers in

the immediate area can readily turn to alternative sellerso Non-Compete Agreements:

Usually cover the immediate area in which D does business

Doesn’t tell us much about the degree to which customers are able to / willing to travel to get away from D

Price Discrimination: If D is able to charge $4 for product in markets A & B, but only $3 in

market C if we measure relevant market by a 10% SSNIP A & B = relevant markets b/c they’re running at +75% above market C

o Note: lower priced market also might be above marginal costo But see Predatory Pricing: pricing under cost in market C

However, can never assume pred pricing and = difficult to prove

Base-Point and Delivered Pricing:14

o Allow sellers to enable monopoly returns from nearby “captive” customers, while competing equally for more remote customers who may be equally costly to the alternative suppliers

Price Discrimination & Market Power:o While engaging in price discrimination is evidence of market

power, it rarely tells how much MP a firm haso E.g., Science Journal sells to libraries at greater cost b/c library

must carry vs. to individual consumer as inducement to buy from this particular journal

o Or, When firm has long-term K and set expectations for revenues may allow lower price vs. firms w/ high fixed costs who use price discrimination to induce customers when capacity of production isn’t met (e.g., airline)

Computation and Interpretation of Market Shares General Rule: D’s Production / Total units produced in market Difficulty: Determining total market production

o Need to account for excess capacity, divertible production, elasticity of supply, elasticity of demand, and etc.

Revenue vs. Units MS is usually based on either revenue or the number of units produced Technically, units seems to be a better measurement than revenue

o Exception: When the cheaper product is less durable and therefore requires a greater number of purchases for the same effect as the more expensive, superior product

In this case, Revenue = better measure of MS Units Manufactured vs. Units Sold

o Generally, firms will not overproduce for a long period of time units produced generally = units sold

o Therefore, better to use units produced b/c ability to produce is generally best estimate of rival’s ability to steal customers from competitor

Output v. Capacity

Capacity = generally precluded from use because in all but the most obvious cases, it has too many practical problems for application

First, any firm can increase its output if cost of production is not a factoro Properly measured, excess capacity includes capacity where

average variable cost of production does not exceed current costso But, this constraint can make excess capacity very difficult to

measure Second, properly defined capacity must include not only the capacity to

produce an extra unit, but also the capacity to distribute it to a consumer Third, capacity to produce an extra unit depends more on the existence of

unused equipment in the planto E.g., may require additional personnel, increased variable costs

Fourth, use of capacity measures greatly increases the costs of litigation because production and revenue figures are readily available, whereas capacity figures generally aren’t

Finally, D may already be charging the monopoly price which the current production of competitors has only capped at a supra-competitive rate

o Additional capacity at this point might be counterproductive—i.e., the point on the cost curve where producing an additional unit is more expensive than the additional revenue received

Therefore, OUTPUT = Best Measure

But see Exceptions:o If there is low cost excess capacity that could obviously be brought

into the market should be included in relevant marketo Example:

Four gas station competitors on a corner w/ 4 hoses each serving only 250 customers each

If one raised its prices, the others already have the fixed costs in place to take on the additional customers from the price raiser at no additional cost

Product Durability & Power Product durability affects market power in two ways:

o (1) A market for second-hand versions of the product might compete with the market for the new good

o (2) Original customer might respond to a price increase by keeping the product longer

Effect may be to either reduce the significance of D’s market share or to change the way we want to measure it

o Example: Car manufacturer raises prices: Consumers may

(1) Buy a used car; or

15

(2) Keep their current car longer Both options reflect that the manufacturer faces a higher

elasticity of demand and its ability to charge a monopoly price is correspondingly reduced

When computing market share, durability issues =/= easily assessedo One solution: Count second-hand product in relevant market

E.g., in the case of a perfectly durable good—where customers are indifferent between new and used goods—this is a valid solution

o But see Imperfectly Durable Goods See, e.g., Alcoa: Judge Hand refused to include secondary

ingot or ingot made from reclaimed aluminum products that had been discarded in the same market as virgin b/c some consumers refused to buy second-hand ingot

Effect: Significant reduction in relevant market and corresponding increase in Alcoa’s presumed market share

Durable Product: New vs. Old in Circulationo Highly Differentiated Price

If price is highly differentiated between new and old product, but equal amounts are sold, then although manufacturer has 50% MS, it has a correspondingly much higher share of revenue in the market

Shows that consumers don’t value older and newer products equally clamps down on elasticity of supply analysis and limits relevant market

o Leases vs. Sales Lease only policy may itself be evidence of MP Likewise, price discrimination through leasing also =

evidence of MPo Hold primary good for extended period

May be evidence that there is little substitutability in the market other than holding onto the aging durable good rather than buy the new one

Interpreting Market Share Data; Questions of Fact and Lawo Significance of market share data often reduces to one question:

o Does failure to meet a certain market share threshold establish the defendant’s innocence as a matter of law, or

o May the jury infer MP from alternative form’s of evidence?

o Dominant Approach: Dimmitt, (5th Cir): o Court refused to condemn a firm of monopolization where its own

MS hovered around 25% and where the top five firms controlled over 70% of the market, even where firm was price leader and had ability to discipline rivals through price cutting and where barriers to entry were high

o C.f. Broadway Delivery, (2nd Cir.): Minority Positiono Permitted jury to decide market power questions even on law

market shareso Jury was instructed that they could not find monopoly power on

MS less than 50%, and D’s MS never exceeded 50%o 2nd Cir reversed: T.C. cannot instruct jury that certain MS

threshold precludes finding of monop power, only that it is not probative of

16

Market Definition in the 2010 Merger Guidelines Purpose:

o Guidelines define markets exclusively for the purpose of analyzing horizontal mergers, in which the principal concerns are increased likelihood of collusion and also unilateral effects that might result in single firm price increases

o However, many of the economic principles of market delineation developed in the Guidelines serve equally well in other AT contexts

Product Market Delineationo Guidelines employ the “hypothetical monopolist” test in order to

determine whether a group of products constitutes a relevant product market

o SSNIP = 5% increaseo Note the possibility of a narrower market if there is a recognizable

subset of “targeted customers” who might be particularly vulnerable to a price increase

o Do not speak of “submarkets”

Geographic Market Definitiono Follows principles similar to those laid out in product market

definitiono One important factor is transportation costs. Included in this

consideration are Tariff trade barriers Custom and familiarity w/ product Reputation and service availability

o Further, firm’s ability to price discriminate based on customer location may justify recognition of small market

Calculation of Market Shareo Guidelines will usually take historical evidence to estimate MS

except where recent or ongoing changes in market conditions suggest that the current share misstate future competitive significance

o Capacity: A firm’s competitive significance may depend on its level

of readily available capacity to serve the relevant market if that capacity is sufficient enough to make such expansion profitable

In such markets: capacities or reserves may be a better measure of suppliers than revenues, and Agencies may calculate market share using those figures

Cellophane Fallacy and Difference Between Market Delineation for Mergers and Other Practices

o FN in Guidelines state that “Market definition for the evaluation of non-merger AT concerns such as monopolization or facilitating

17

practices will differ in this respect if the effects resulting from the conduct of concern are already occurring at the time of evaluation

o That is, Agency will (1) Identify situations where the current price =/=

competitive price (2) Identify what the competitive price would be in these

situations

Alternative Methods of Establishing Market Power (Supplemental) Measuring Residual Demand Directly

o Residual Demand / Residual Demand Elasticity: Refers to the demand for a firm’s product after the sales of competitors have been taken into account

Persistent Price Discriminationo Presence of persistent price discrimination of evidence that a seller

has market power in the high priced marketso Metering: Evidence of MP

Scheme only successful if D has MPo But note: Success of price discrimination turns on ability to

segregate customers and prevent arbitrage If D only able to do so in narrow market not

substantial MP

Therefore, larger market D can discriminate in more MP

Price Discrimination and Intellectual Propertyo For a franchise, the only cost of leasing the IP = cost of making Ko Therefore, receive high margin of royalties in relation to cost of

producing franchise Ko BUT, =/= MP b/c this franchise may be struggling along and other

franchises may offer better rates

Persistent Monopoly Profits; High Marginso Courts have frequently acknowledged high profits as evidence that

a firm has MP, or absence of high profits as evidence that it does not

o BUT, (1) Accounting profits =/= same thing as economic profits; and

(2) Fact-finder must be able to distinguish between monopoly profits and “rents”

o Economic Profits: Profits in excess of the amount necessary to sustain

investment in the industry Thus, firm may be earning “zero profits” but still paying

expenses and providing SHs solid IRR This is the true measure of MP Include the opportunity costs of capital—accounting

profits do not (1) Opportunity cost of capital itself shows up as

a profit for the accountant’s ledger (2) Accounting data only considers opportunity

costs sporadicallyo E.g., accountant amortizes the cost of

the building over a period of years and carries it at ZERO if fully depreciated

o C.f. Economic approach considers value of the building as opportunity cost to continue holding it as opposed to another investment

Rents v. Monopoly Profits:o Profits are the income generated above marginal cost in the

competitive market

18

If firm lacks ability to reduce output and change demand curve firm faces horizontal demand curve and only makes profits by its ability to price above marginal cost

o C.f. Rents are the profits generated by reducing output and successfully charging higher rates as an effect of monopoly MP

Market Power and Intellectual Property: o Old Presumption:

In tying arrangements, if tying product = patented MP can be presumed

See Walker Process, (1965): Ct agreed in principle that fraudulent procurement of a patent could be a violation, but remanded for a determination whether patent created any MP

o Rebuttal: IP rights are very easy to obtain Illinois Tool, (2006): Court discarded presumption,

holding that in a case where D tied a specialized printer to ink, power in the printer market could not be presumed merely b/c printer was protected by some patents

RULE: MP must be supported by proof of power in the relevant market rather than by a mere presumption thereof

o Relevance of Old Presumption? IP rights can raise barriers to entry If IP allows firm to engage in SSNIP relevant market

is the patented product market Therefore, IP rights are only one part of the calculus

Ch. 6 – Exclusionary Practices and the Dominant Firm: The Basic Doctrine of Monopolization and Attempt

The Monopolization Offenseo §2: Condemns “every person who shall monopolize . . . .”o Today, monopolization refers to a number of activities that may be

illegal when performed by a dominant firmo Grinnell, (1966): Illegal monopolization requires a showing of two

elements: (1) Possession of monopoly power in the relevant market;

and (2) Willful acquisition or maintenance of that power, as

distinguished from growth or development as a

consequence of a superior product, business acumen or historic accident

o See also Verizon v. Law offices of Curtis V. Trinko, (2004): “It is settled law that this offense requires, in addition to

the possession of monopoly power in the relevant market, ‘the willful acquisition or maintenance of that power[.]’”

“The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free market system.”

o Ambiguity Exercise of monopoly power = ambiguous

E.g., sale of products at monopoly prices = “exercise” of monopoly power; but, courts have consistently held that even the monopolist may legally sell its product at its profit-maximizing price and reduce output to a level capable of clearing the market at that price

BUT, induces entry Exclusionary Practices

Practices that deter potential rivals from entering the monop’s market, or existing rivals from increasing output in response to monop’s price increase

Creates social loss But see Not all merit condemnation

o Some make consumers better off, e.g., R&D, lower-cost product

o Case Law’s Objective: Distinguish between, and punish, harmful monopolistic practices, while permitting beneficial ones

Monopoly Power and Illegal Monopolizationo Monopoly Power = large amount of MP in relevant marketo Thus, law of monopolization is directed at relative size in relation

to some properly defined market

o Monopolization and MP Requirement See, e.g., Kodak, (Scalia, Dissent): Where D maintains

substantial MP, his activities are examined through a special lens: Behavior that might otherwise not be of concern to the AT laws—or that might even be viewed as precompetitive—can take on exclusionary connotations when practiced by a monopolist

19

MP & Bad Conduct If evidence suggests a high degree of monopoly

power certain practices will condemn D of illegal monopolization

BUT, if evidence suggests smaller amount of MP courts have used the law of attempt to monopolize, which carriers stricter and more explicit conduct requirements

MP Thresholds 90% sufficient If lower than 70% courts generally unwilling

to find requisite MS Some courts hold as a matter of law that less

than 50% = insufficient, even if D can reduce output and raise price

And, if there is doubt regarding the definition of the relevant market court should insist on higher market Share

But note: vice versa analysis doesn’t work because a market is defined by the ability a hypothetical monopolist to engage in an SSNIP without facing extra competition from entry or competitors

o Relation between MP and MS; Entry Barriers Some kinds of conduct are plausibly anticompetitive on

smaller market shares than other kinds E.g., Predatory Pricing:

Although it has been formally treated as part of the law of attempt, predatory pricing should be treated as part of the law of substantive monopolization

Vertical Ks: Where firms seek to foreclose rivals from the

market could be anticompetitive only on large market share

E.g., Kodak: Where D formed exclusive Ks w/ OEMs to exclude ISOs

BUT, practice would only drive ISOs completely out of repair market if,

o (1) D controlled all, or nearly all, of the photocopier market; or

o (b) Other photocopier makers used similar vertical Ks

Otherwise, there would be plenty other photocopiers for ISOs to repair

Abuse of Gov. Process: E.g., firm w/ 50% MS and many rivals w/ only

5-10% each might use improper litigation to restrain rivals’ expansion or increase their costs

Take Away: Must examine logic of the alleged exclusionary

practice in order to determine the minimum requisite market share to make the practice anticompetitive

The lever that the dominant firm needs in order to make its exclusionary practice work is not the present ability to price above marginal cost (economic market power) but the ability to dominate a market in a way that forecloses access to rivals

Connection to Entry Barriers:o If entry is easy, then no matter what D

tries to do, if it produces rents other firms will shortly follow suit and enter

Conduct Requirements—Is Bad Conduct Necessaryo We expect long-run monopoly profits to invite entryo When that hasn’t occurred, it raises the specter of bad conduct

even in the absence of any proof

Identifying Monopolizing Conducto Law of monopolization requires a showing that D has monopoly

power and has engaged in impermissible “exclusionary” practice with the design and effect of protecting or enhancing its monopoly position

o The rule of reason was originally formulated by the Supreme Court in Standard Oil as a means of distinguishing permissible from

20

impermissible exclusionary practices

Exclusionary Conduct Definedo §2: Must satisfy 2-criteria:

(1) Must define exclusionary conduct w/ tolerable accuracy;

(2) Must be sufficiently easy to apply that a court can administer it

o A workable definition is that exclusionary conduct consists of acts that:

(1) Are reasonably capable of creating, enlarging, or prolonging monopoly power by impairing the opportunities of rivals; and

(2) That either (a) do not benefit consumers at all; (b) are unnecessary for the particular consumer benefits that the acts produce; or (c) produce harms disproportionate to the resulting benefits

o Consider also Microsoft, (D.C. Cir. 2001): First, to be condemned as exclusionary, monop’s act must

have an anticompetitive effect That is, it must harm the competitive process and

thereby harm consumers In contrast, harm to one or more competitors =/=

sufficient Second, Plaintiff, on whom burden of proof rests, must

demonstrate that monop’s conduct indeed has requisite anticompetitive effect

Third, if P pleads prima facie case under §2 by demonstrating anticompetitive effect monop may proffer precompetitive benefit

Fourth, If monop’s precompetitive justification stands unrebutted, P must demonstrate that the anticompetitive harm outweighs the precompetitive benefit

Finally, in considering whether monop’s conduct on balance harms competition and is therefore condemned under §2 as exclusionary, our focus is upon the effect of that conduct, not the intent behind it

o §2 Conduct Test: Sometimes stated as conduct that is rational (i.e., profit-

maximizing) only on the premise that it will destroy competition

o Also called No-Economic Sense Test

See, e.g., Aspen Skiing, (U.S. 1985): Court found test satisfied where dominant ski company refused to continue JV w/ rival where JV was mutually beneficial, increased both firm’s output, but was more essential for smaller competitor than D

Thus, D could only profit from terminating JV by a sharp decline in P’s sales

And, product D sold after cutting out P was less desirable to consumers

o Sacrifice Test Where Monop is willing to sacrifice short-term profits in

order to reap benefits down the road Aspen Skiing: Court found that D was willing to sacrifice

consumer benefits and consumer goodwill in exchange for the perceived long-run impact on tis smaller rival

o Combo: Sacrifice & No-Economic Sense Verizon v. Law Offices: Government’s brief argued that a

monop’s refusal to deal is unlawful only if it “involves a sacrifice of profits or business advantage that makes economic sense only because it eliminates or lessens competition

o Aggressively Competitive or Exclusionary? Consider Microsoft, (D.C. Cir. 2001):

Nondominant seller of computer OSs would have every incentive to maximize compatibility with other types of software such as internet browsers or word processors whether or not it sold the products itself

C.f. Dominant seller: Limit compatibility able to force consumers to switch to its applications

Thus, a great deal of strategic behavior is concerned w/ “maintenance” rather than the acquisition of monop power

And, conduct only rational if firm = monop Takeaway:

If monop conduct = anticompetitive = potential §2 violation

BUT, at the same time, no duty to innovate to one’s own peril

Thus, o (1) Ex ante, rather than ex post, analysis

s the most helpful; and o (2) Considerations of subjective intent

are sometimes essential 21

Compare C.R. Bard, (Fed. Cir. 1998) D had monopoly position in patented gun for

taking tissue samples Made gun compatible (for no precompetitive

justification) with its own needles Bard Analysis:

Innovation = inherently risky and sometimes unsuccessful

Cannot look ex post and determine modification had no precompetitive benefits

Real Question = What innovator had in mindo Develop superior product? no liabo Exclude comp? §2 liability

Application/Rule: If dominant firm marketed or structured its

product in a way that made it more difficult for rivals or potential rivals to sell their product, and if this marketing or restructuring was not reasonably necessary to improve D’s own product §2 violation

BUT, can also tentacle out into arguments that D’s conduct

o (1) Raised competitors’ costso (2) Impaired competitor efficiency

Therefore, must be careful how far you let these arguments run b/c do not want to overdeter monopolist innovation

Private and Gov. Suits Distinguishedo Private Plaintiff: Must demonstrate

Damages: Causation and quantifiable injury to itself

Injunction: Threatened injury to itself; not quantified but

reasonably believed to be substantialo Government:

Presumption of anticompetitive behavior, IF: (1) Conduct is by firm w/ monopoly power (2) That is clearly harmful to competitors; and (3) Not supported by a reasonable business

justification or more harmful than necessary given the justification that is offered

Proof is sufficient to support Gov’s suit in equity but not P’s private action

Intento Court has flip-flopped on relevance of intent

Alcoa: Disregard any question of intent Grinnell: Offense of monopolization includes the “willful

acquisition or maintenance of monopoly power”o Historically:

Intent requirement has followed formula in Criminal Law That is, in attempt cases law may require a

specific intent to achieve the prohibited result BUT, in the case of completed offense courts

either dispense w/ intent, or else infer intent from evidence of monopoly power + exclusionary practices

o Evidence of Intent Objective: Inferred from D’s conduct Subjective: Evidence such as statements that indicate D

consciously had a certain end in mind If a material element vastly complicates

litigation and discovery Therefore, many courts have agreed w/ Hand

and dispensed of intent element Rationale: No monopolist is unconscious of

what it is doing; clear evidence of an impermissible exclusionary practice by a firm w/ monopoly power = only proof of intent required

o But see Aspen Skiing: Intent is relevant both to attempt and substantive monopolization.

In monopolization, “evidence of intent is merely relevant to the question whether the challenged conduct is fairly characterized as exclusionary or anticompetitive.”

Takeaway: Many kinds of conduct, such as refusal to deal

w/ a competitor (as in Aspen), are extremely difficult for courts to characterize

In such cases, evidence of intent can aid courts in the characterization problem

BUT, Limitation: Evidence of intent should be confined to those

situations where

22

o (1) D clearly has sufficient MP to justify conclusion that it is capable of monopolization; and

o (2) Challenged conduct is sufficiently threatening that evidence of intent will lead court in one direction or the other

o Analysis Applied to C. R. Baird: IF D’s modification to use only certain needles =

improvement to gun does not matter whether D intended to harm competitors

Have to protect right to innovation BUT, if D’s product is really no better off afterwards,

then raises the question of whether this was failed innovation or anticompetitive conduct

Here, evidence of intent can push us one way or the other

Offense of Attempted Monopolizationo Issue:

Many acts alleged to be illegal attempts may also be illegal monopolization or violations of another AT law

In such cases, a separate “attempt” offense is superfluous

On the other hand, expansive use of the attempt offense to reach conduct not condemned by the other AT laws may do more harm than good to competitive progress

o Principle: If attempt analysis focuses too heavily on unfair conduct

and too little on market power the offense can operate to

protect inefficient businesses from their more efficient rivals

In the great majority of cases, a firm that is Nondominant to begin with cannot create a dominant position through purely unilateral conduct

Failed attempt vs. impossible attempto Sherman Act:

Nonetheless, §2 condemns, every “person who shall monopolize or attempt to monopolize.”

See Swift & Co., (Holmes, J.): [Current] Three Element Attempt Test:

(1) Specific intent to control prices or destroy competition in some part of commerce;

(2) Prefatory or anticompetitive conduct directed to accomplishing the unlawful purpose; and

(3) A dangerous probability of success See also Cal. Computer Prods., (9th Cir. 1979)

(4) “Antitrust Injury”o Applied only (in some circuits) to

private AT plaintiffs

Attempt Law’s Specific Intent Requiremento Split in Circuit Courts over proper analysis under attempt elements o Common Position: Specific Intent is an established element of the

attempt offense, approved by S. Ct., and cannot be considered irrelevant

See, e.g., Times-Picayune: While the contemplated offense of monopolization under §2 demands only a general intent to do the act, for no monopolist monopolizes unconscious of what he is doing, a specific intent to destroy competition or build monopoly is essential to guilt for the mere attempt

o Defining Illegitimate Intent Spectrum Analysis:

23

99.9% Permissible: Creating a better product that can be sold at a lower rice, even though purpose and clear result is to take market share away from rivals

0.00% Permissible: Planning to dynamite competitor’s firm

Intent that Falls Along Spectrum E.g., Dropping price knowing it would cause a

less efficient rival to go out of business Prof. Real Estate Investors v. Columbia

Picture, (U.S. 1993): Initiating unsuccessful litigation knowing the effect would be to delay or prevent a competitor’s entry into the market

o Objective Rule: If there is an objective basis for the suit subjective intent =/= relevant

Kodak, (2nd Cir. 1979): Firm knew that its failure to predisclose a product innovation would injure competitors in a complementary product

o No requirement to disclose innovation to competitors

Morgan v. Ponder, (8th Cir. 1989): Statements such as “we will not be underbid” or “we’ll do whatever it takes” are “prime examples of remarks which, if portrayed by P’s attorneys as damning evidence of predatory intent, may lead juries to erroneously condemn competitive behavior. . . . These are phrases often legitimately used . . . in the heat of competition.

o Policy Considerations Overinclusive Rule:

One that finds specific anticompetitive intent readily and relies on it heavily may frequently end up condemning competition on the merits

Result: Higher prices for consumers, particularly when attempt allegations involve highly ambitious conduct, such as predatory pricing

But see Limitation – Brooke Gp. Ltd. [Generic Cigarettes]: Predatory pricing requires a showing of:

o (1) A price cut below cost; and

o (2) Plan to recoup through later supracompetitive pricing

Thus, lowering price just to injure a rival =/= alone sufficient

Underinclusive Rule: May result in creation of certain amount of

market power, and injury to competitors who would not have been injured in a competitive market

o What Kind of Intent Is Sufficiently Bad? FLM Collision Parts v. Ford, (2nd Cir. 1976): Intent to

achieve monopoly power, or to acquire sufficient power to control price;

Intent to exclude competition Intent to perform the specific act fulfilling the conduct

requirement for the attempt offense But note: Mere intent to do better or vanquish one’s rivals

=/= sufficient

o Problems with Categorizations of “Bad Intent” None of the above sufficiently distinguishes between

competitive and anticompetitive conduct E.g., Intent to exclude is consistent with efficient

practices such as R&D And, overly broad to say that specific intent to engage in

the act satisfies conduct requirement Can become dangerously overdeterrent bootstrapping

unless (1) Courts put strict limits on the kind of conduct

that satisfies the requirement, and

24

(2) Insist upon a meaningful showing of dangerous probability that the conduct is both anticompetitive (inefficient) and reasonably calculated to yield monopoly

BUT NOTE: If these restrictions are placed on the use of the

intent element, then the determination of intent is superfluous

Such elements satisfy a finding of attempted monopolization absent any showing of intent

o Modern Application of Intent Element: Most courts allow intent to come in when conduct is

sufficiently ambiguous that specific intent can push the decision one way or the other

Burden on Plaintiff

“Dangerous Probability of Success”o Purpose: Avoid overdeterrence where D’s conduct is difficult to

assess or market in which conduct occurred =/= clearly conducive to monopoly

o Spectrum Sports: S. C.t held that (1) Dangerous probability of success is required in any

attempt case; (2) Dangerous probability cannot be inferred from intent

alone but must be proven separately; and

(3) Dangerous probability requirement is in turn requires P to define and prove a relevant market which is threatened with monopolization

W/o market definition no way to determine exclusionary effect

Note Also: S. Ct. held that dangerous probability =/= be proven by showing that conduct alleged to be an attempt violates a different AT law

In cases where D has violated another AT law =/= improve P’s recovery by showing same activity violates more than 1 AT law

o The “Dangerous Probability” Requirement as a Screening Device

If D’s conduct is ambiguous, arguably consistent w/ both monopolization and competition on the merits, examination of the market will help determine whether a dangerous probability of monopoly existed

Moreover, since conduct = ambiguous, determination of market’s proclivity to monopoly will reduce rate and costs of error

When a market is already highly concentrated and has dominant firm w/ substantial MP cost of overdeterrence = relatively lo

On the other hand, when a market is competitive, the cost of overdeterrence is high

Dangerous Probability and MPo Spectrum Sports requires P to define relevant market in an attempt

case, but said little about the kind of proof of MP or MS necessary to support the claim

o Circuit Response: Generally led to the requirement that P in an attempt case must show that D had a certain minimum market share E.g., 4th Circuit has MS thresholds

25

o BUT, Plausibility of an attempt to monopolize depends on a host of factors, of which market share is only one

Furthermore, type of MS/MP necessary to achieve goal fluctuates with the type of exclusionary conduct alleged

o See, e.g., Loraine Journal Co., (U.S. 1951): Restraint: Newspaper refused to sell advertising to any

purchaser who also purchased advertising on a nearby radio station

Required MP/MS: Could not have been successful w/p holding dominant market share

That is, if there were competing daily newspapers in the relevant area, anyone who wanted to advertise in both radio and print would have purchased from a competitor w/o the restriction

o Takeaway: Impossible to generalize: some attempts to monopolize

require D to have significant market power Further, some schemes require not only market power but

large market share E.g., predatory pricing requires market power

and market share Going to be unsuccessful w/o large market share

to begin with; otherwise, will be competing against too many other competitors to be able to have a unilateral effect on price

o Finally: Relevant Market MUST be susceptible to monopolization Not enough to say that a firm actually lacks monopoly

power to monopolize a market, BUT then to allow attempt claim to proceed

See Spectrum Sport: Relevant market definition is required to determine markets where monopolization is possible, i.e., dangerous probability of success

Conspiracy to Monopolizeo Has never enjoyed distinctive status held by monopolization and

attempto In part, b/c a conspiracy to monopolize is virtually always a §1

violation, and conspiracy allegation is harder to prove b/c it requires a showing of specific intent and—following after the

common law—at least one overt act in furtherance of the conspiracy

o Furthermore, can upset a conspiracy claim by refuting the agreement element, just as in §1

o BUT, dangerous probability of success =/= apply to conspiracy Therefore, generally unnecessary for P to define relevant

market Reasonable?

Makes sense when the alleged agreement = per se illegal

Otherwise, makes little sense b/c under RoR, relevant market = necessary element

o Further, under RoR, overt act alone = insufficient b/c also need to show it was anticompetitive

o See American Airlines, (5th Cir. 1984): American Airlines president called president of

competitor and suggested the two increase fares by 20% D’s Contention:

This was only an attempt to fix prices, not an attempt to monopolize

And, attempts to fix prices =/= specifically condemned by Sherman Act

Held: Successful cartel acts as a single entity and

controls the market, thus monopolizing it in the truest sense of the word

To not find culpability here would incentivize competitors to invite others into cartel

26

Ch. 7 – Exclusionary Practices in Monopolization & Attempt Cases[OUTLINE]

Introduction Merger & Monopoly Output Expansion; Strategic Capacity Construction Unilateral Refusals to Deal 1: General Doctrine

o Refusals Directed at Competitorso Scope of Duty to Dealo Possible Qualifications; Dominated Networks

Unilateral Refusals to deal II: Vertical integration, Price Squeezes Tying, and Exclusive Dealing

o Kodak and its Aftermath Lock-in Requires Initial Purchase and Subsequent

Change in Policy Average Customer must be Poorly Informed; or Price

Discrimination must be Possible Summary: Aftermarket Opportunism Not Within §2’s

Purviewo Price or Supply Squeeze; Vertical Integration and linkLineo Quasi-Tying & Exclusive Dealing—Technological Tieso Use of Vertical Refusals by Private AT Plaintiffso Legitimate Business Purposeo Unilateral Refusal by Nonmonopolist

Refusals to Deal III: Essential Facility Doctrineo Qualifying Essential Facilityo Extent of Duty to Dealo Essential Facility Doctrine Inconsistent w/ General AT Goals

Forced Sharing Requires Price Administration Forced Sharing Undercuts Incentives to Develop

Alternative Sources of Supply Dominated Networks as Essential Facilities

Predatory Product Design and Development; Failure to Predisclose; Alerted Complementary Products

o Predatory Product or Process innovationo Failure to Predisclose New Technologyo Microsoft: Unnecessarily Harmful Redesigns & Licensing

Requirementso Strategic Entry Deterrence; Predatory Advertising; Excessive

Product Differentiation Leveraging Theory; Nonmonopolistic Advantage in Second Market Raising Rivals’ Costs (RRC)

o Pedigree and Judicial Development of RRCo Pre-emption of Markets or Customers as RRC

Unreasonably Exclusionary Practices Involving Patents or Other Intellectual Property Rights

o Walker Process: Obtaining Patent by Fraudo Enforcement of Patent Known to be Invalid or Unenforceable;

Noerr Issueso Accumulation; Notice

27

o Unilateral Refusal to License; Simple and Conditional Absolute Refusal to License Conditional Refusal to License

o Patent Deception and Failure to Disclose, Particularly in Standard Setting

Abuse of Government Process Business Torts as AT Violations Conduct Requirements in Attempt Cases

Ch. 7 – Exclusionary Practices in Monopolization & Attempt CasesIntroduction

Since Sherman Act was passed, many practices have been condemned as illegal monopolization if the firm that carried them out had sufficient market power. These include:

o Espionage or sabotage

o Mergerso Reduction of outputo Expansion of capacity or outputo Predatory pricingo Price discriminationo Price discounts, including quantity, loyalty, and bundled discountso Refusals to dealo Vertical integrationo Tying arrangementso Supply or price squeezeso Predatory or manipulative research and development; altered

complementary productso Failure to predisclose R&Do Attempts to leverage monopoly in one area or market into an

unfair advantage in second area or marketo Raising Rivals’ costso Patent abuses, including improperly brought infringement suits,

patent acquisition, accumulation, and refusal to licenseo Abuse of government process through vexatious litigation or

administrative claimso Business torts

Merger & Monopoly A merger or acquisition could “exclude” or discourage someone from

entering a market only if the merger created a new firm that had lower costs and was harder to compete with than the two firms had been pre-M&A

28

BUT, M&A can create firm w/ monopoly power & such power may tempt firms to engage in exclusionary practice to entrench its position

Sherman Act Condemns Merger into Monopolyo But see U.S. Steel Corp, (U.S. 1920): Divided S. Ct. refused to

condemn conduct of D as monopolization noting (a) Firm was no longer monopoly b/c its practice of

charging high prices invited too much entry (b) Gov waited over a decade before brining suit (c) Merger into monopoly stemmed from natural

development tin the industry, such as economies of scaleo See also American Can, (U.S. 1921): Involved allegations that

dominant firm bought out and closed down rivals in order to keep output low

BUT, tactic resulted in new entry rather than deterrence And, any new entry could use monopolist’s price as

umbrella to allow it to price monopolistically as well §2 Reaches Rival as much as Nascent Firm/Likely Entrant

o One effective means of entrenchment is to acquire firms perched on entry into market

Particularly effective if acquiring exclusive license of new tech from firm on fringe of entering presumptively violates §2

Clayton §7: o Condemns mergers of horizontal firms w/ sufficient market power

to be found guilty of illegal monopolizationo As a result, §2 Sherman treatment of mergers to monopoly has

become all but superfluous

Output Expansion; Strategic Capacity Construction Expansion of capacity excludes an equally efficient rival only if monopolist

increases output to the point that it sells at marginal cost (the competitive market rate)

o Otherwise, monopoly pricing induces entry by firms that can produce at the same monopoly cost

o Thus, expansion of capacity is exclusionary only at the expense of the monopolist’s monopoly profits, which are lost when output is increased to competitive level

Exception: foregoing may not apply when economies of scale are significant

o In that case, established firm might take strategic measures to deprive potential rivals of the opportunity to enter at the minimum efficient scale

o E.g., build large plant w/ excess capacity to deter potential entrants b/c monop can drop prices to competitive level or below

Implausibility of Exception:o Even assuming expansion of capacity can sometimes be

anticompetitive, AT policy cannot condemn it unless it is able to separate efficient form anticompetitive expansion

o To this point, see du Pont (Titanium Dioxide), (FTC 1980): Virtually impossible to make this distinction

Criticized Hand in Alcoa for conclusion that output expansion was anticompetitive

Here, Du Pont developed a new method for producing titanium dioxide and then built a plant large enough to supply foreseeable demand for entire market thus depriving other firms of access

Held: DuPont’s pricing strategy stemmed from tis clear cost advantage over competitors and occurred in conjunction with its long-term plan to capture future market growth

Essence of competitive process is to induce firms to become more efficient and pass the benefits along toe consumers

Post du Pont (Titanium Dioxide)o Output or capacity expansion has not been condemned under §2

unless it has resulted in predatory prices

Price Discrimination; Leasing Practices Ability to price discriminate = evidence of some MP

29

o Price discrimination occurs when a seller obtains different rates of return from the same product from different groups of customers

Output:o Sometimes price discrimination will increase output o E.g., If firm can sell to tranche 1 and tranche 2 at their price

maximizing rates, then firm will produce enough prods for both tranches

In this case, the practice may have the effect of excluding competitors who cannot price lower than the producer’s price maximizing rates

BUT, when discrimination reduces output invites entry of competitors to reap benefit of monopoly pricing

Robinson Patman Act: o Price discrimination under RPA has also been analyzed as a

monopolistic predatory pricing strategyo Theory: AT D charges customers in Area 1 high price in order to

subsidize lower price in Area 2 BUT, practice actionable only if price in lower area is

below cost Leasing =/= Covered under RPA

o Can enable monopolist of durable good to enlarge returns to its monopoly by protecting itself from competition with its own second-hand goods

o Also can create lock-in effect if lease termination prices are high United Shoe Machinery Co., (U.S. 1954):

o Restraint: D only leased its machines and did so at varying priceso Procompetitive Justification:

Efficient; maximized reliability of machines Gave D an interest in repair process and maintenance of

machines Precluded reverse engineering by competitors

o Held: S. Ct. required D to give customers option to purchase machines, not just lease

o Result: More competitive market at expense of D’s innovation w/o obvious additional benefit to consumers

Unilateral Refusals to Deal 1: General Doctrine Refusals Directed at Competitors

o Colgate, (U.S. 1919): Rule: In absence of purpose to create or maintain a

monopoly a private trader may freely exercise his own independent discretion as to parties with whom he will deal

Two Explicit Exceptions: (1) Decision not to deal must be independent

o Concerted refusals to deal =/= protected under Colgate

(2) Refusal must occur in the absence of any purpose to create or maintain a monopoly

o Monopolist and potential-monopolist cannot rely on Colgate

o Kodak, (1927): Monopoly manufacturer of camera film and other photographic supplies attempted to integrate forward into retail sales of those supplies

D refused to wholesale its supplies to an independent retailer

Held: S. Ct. condemned refusal on dubious theory that D was attempting to leverage a second monopoly out of the first

o Lorain Journal Co., (U.S. 1951): Held: S. Ct. condemned monopoly newspaper’s refusal to

sell ads to customers who also purchased from nearby radio station

o Aspen Skiing, (U.S. 1985): Held: S. C.t relied heavily in Lorain in finding that D

violated AT laws when it refused to cooperate in JV w/ smaller company-P

Propositions: (1) Monop =/= have duty to cooperate w/ rivals (2) BUT, some refusals have “evidentiary

significance” and may produce liabilityo Material Elements to Claim in Aspen:

(1) D lacked any sensible business explanation for the change

(2) D had previously cooperated w/ P ***(3) Consumers and P were harmed as a result of the

refusal to deal

o Aspen Criticism

30

(1) Court may have erred in concluding that a monopolist ever has a duty to cooperate w/ a rival

(2) May have ben right on basic principle but located the line in the wrong place

Aspen as an Applicable AT Rule: o Must be limited to preclude its application from becoming overly

broado Sensible Limitation:

Restrict to pre-existing JVs or other arrangements In this respect, Aspen prevents a firm from cancelling tis

participation I a preciously created JV w/ a competitor, where

(1) Competitor has made significant investment; (2) Consumers prefer the JV’s product; (3) No good business reason for termination

o Overly Broad Extension: Reading Aspen to create a new obligation to deal where

no arrangement had existed before Too much to ask a court to create a JV where two firms

have not cooperated in the past Application to 1992 Kodak

o AT dispute arose when D developed a more restrictive policy that made it difficult for ISOs to obtain repair parts for D’s photocopiers

o Here, Kodak changed an existing business relationship o Therefore, Kodak should not be read for proposition that a firm

that develops a new product has a duty form the onset to supply parts to ISOs wishing to repair it

BUT, if D = monop & engaged in past practice w/ competitor may itself be locked-in

Application to Verizon v. Law Offices

o Court rejected any broader implications of Aspen and described Aspen as “at or near the outer boundary of §2 liability”

o Background to Verizon P was customer at AT&T, a competitive local exchange

carrier—CLEC Under 1996 telecommunications act, D (an incumbent

local exchange carrier—ILEC)was required to enter an interconnection agreement providing for sharing of its network elements with any CLEC who so requested

Complaint arose when D failed to provide such access in timely fashion

P alleged failure was “part of an anticompetitive scheme to discourage customers from becoming or remaining customers” of CLECs

o Court’s Analysis: Natural conflict arises when court orders Monopolist to

share legally acquired inputs Further, forced sharing blends roles of AT court and

regulator And, cooperation can create the evil AT is aimed against

o Held: (1) Unlike in Aspen, there was no prior course of dealing

between Verizon and AT&T (2) Because there was no prior relationship, D’s prior

conduct sheds no light upon the motivation of the present refusal to deal

(3) Services allegedly withheld are not available to other consumers; and, if D sold on open market it could get a much higher price than P was demanding

(4) Plaintiff was not just asking for D to share excess capacity, but to design and build additional systems to then share with rivals

Ruled: These facts would stretch application of Aspen to its breaking point; thus, Court refused to do so

Scope of Duty to Deal31

o First, Should never order forced sharing as a remedy where development of alternative sources is feasible

o Second, When the forced sharing remedy is ordered, requires court to act as the price setter and turns D into a public utility

Therefore, if AT is going to impose a duty to deal on dominant firms obligation must be limited to inputs that the competitive market is not realistically capable of producing

o Kodak, (9th Cir on remand from SCOTUS): 9th Cir ordered Kodak to make available all of its parts to ISOs

However, not all of Kodak’s parts were patented and exclusive (see, e.g., nuts, bolts, glass, hinges)

Result of remedy was to disincentivize the ISOs from developing their own parts or alternative sources for the parts

Accordingly, market for fixing Kodak copy machines became less rather than more competitive

o Verizon v. Law Offices: Court silently overruled this aspect of Kodak, holding that

the duty to deal should extend only to those aspects that the market was not reasonably capable of producing independently

Possible Qualifications; Dominated Networkso Network market: market which requires collective action of more

than a single producer and buyer in order to operate That is, consumers value the network more the more that

other consumers become a part of it E.g., value of a phone network is increases as more

participants join the network allowing connectivity between any and all of them

o Refusals to Deal in Network Markets: Look more like “ties” because denying a competitor

interconnectedness tells the consumer that it must turn to the dominant provider if that consumer wants any benefits of the network

E.g., Microsoft refused to share information on compatibility with its server system and a European court ordered that it share. Absent remedy consumers would have to turn to Microsoft software, programs, hardware, etc., if they wanted to connect to the network

Unilateral Refusals to deal II: Vertical integration, Price Squeezes Tying, and Exclusive Dealing

See Port Dock & Stone Corp, (2nd Cir. 2007):o A complaint pleading that D-monopolist vertically integrated and

now refuses to deal with a previous partner on the distribution chain =/= plead an actionable refusal to deal

o Justification: Action is consistent with the notion that monopolist is expected to perform second level service more efficiently and has integrated for a valid business reason rather than an anticompetitive one

o Exceptions: However, there are situations in which vertical integration may constitute an illegal restraint, e.g.,

Where vertical integration is undertaken to facilitate price discrimination,

Avoid governmental regulation of price at one level, or To preserve its production monopoly by increase the

barriers to entry in the market

Kodak and its Aftermatho One Monopoly Rent Theorem: There is only one profit

maximizing price and a monopolist can’t do better by levering a monopoly in Market-1 into Market-2

Vertical Application: A monopolist can seldom enlarge its monopoly profits by monopolizing one or more additional stages of production

o General Rule: Claims that a firm monopolizes simply by controlling the distribution of its own product, replacement parts or service, should be viewed with deep skepticism

o In Kodak, however, after ISOs were excluded, Kodak’s prices for repair/service increased w/o an adequate explanation [i.e., a SSNIP]

o Takeaway: Therefore, case seems to stand for the proposition that when the economic theory is belied by the facts, plaintiff is entitled to take the facts to the jury

32

Mitigating Kodak: Courts have mitigated the potential damage of Kodak by construing the case narrowly in the following ways:

o (1) Lock-in Requires Initial Purchase and Subsequent Change in Policy

Lower courts have restricted Kodak-style lock-in claims to circumstances where an underinformed customer purchases at T1 and then some change in policy occurs creating a lock0in that the customer could not reasonably have anticipated at T2 when he already made her purchase commitment

o (2) Average Customer must be Poorly Informed; or Price Discrimination must be Possible

If average customer =/= underinformed plan to discriminate in aftermarket will be foiled b/c customers will turn to competitors w/ lower overall pricing

The other possibility, however, is that D engages in price discriminating by carving out the underinformed consumers from the average informed consumer

Absent these two possibilities, the Kodak lock-in isn’t possible

o (3) Summary: Aftermarket Opportunism Not Within §2’s Purview

Real problem with Kodak is that if it is taken seriously, there is nothing to stop it from applying to every non-dominant aftermarket seller

Moreover, AT =/= easy answer to every competitive problem, and certainly =/= answer to market imperfections that do not threaten marketwide competition

Finally, even when a court orders D to sell to competitors it =/= solve problem of aftermarket monopoly

That is, if D is forbidden from price discrimination D will sell all units at monopoly rate and consumers are no better off as these costs are built into repair prices

Price or Supply Squeeze; Vertical Integration and linkLineo Price and Supply Squeezes operate generally the same:

Integrated monopolist allegedly manipulates the market price order to injure the unintegrated rivals, who are squeezed both by short supply and by their own high costs relative to those of the monopoly-owned outlets

Vertically integrated firms have lower costs C.f. Nonintegrated retailers have to rely on the

market Monopolist who reduces cost through vertical integration

will sell to consumers at lower price—potentially lower than what independent retailers can match

BUT, any squeeze that results from this should not be an AT violation

Therefore, Courts must be able to distinguish between efficient refusals to deal/squeezes and harmful ones

o So, when might a refusal to deal be harmful? (1) Leverage Theory:

BUT, cannot make more rents by owning more levels of distribution

(2) Barriers to Entry: Theory: By integrating any potential entrant

must now enter at two-levels Rebuttal

o (a) New entrant will only be forced to enter on second level if integration reduced the monopolist’s costs

o (b) If profits can be made, then investment in the dual—as opposed to the single level—will be made just as readily

o Pacific Bell Tel. Co. v. linkLine, (U.S. 2009): Court categorically rejected claims of a price squeeze

directed by a vertically integrated monopolist against an unintegrated rival

Held: IF monopolist has no duty to deal w/ a rival in the wholesale or upstream market its price squeeze would not be unlawful unless in the retail or downstream market were predatory

33

o Squeezing and Predatory Pricing Claims Court is not going to review a predatory pricing claim

unless there is evidence of a measure of the defendant’s cost in producing the product

Otherwise, Court falls into position of becoming rate making agency

And, has the tendency to incentivize producers to raise their prices (a harm to consumers) in order to avoid AT litigation

Quasi-Tying & Exclusive Dealing—Technological Tieso Tying & Exclusive Dealing = §1 Sherman & §3 Clayton violations

§3 Clayton was designed to go after certain anticompetitive practices under a more aggressive standard than Sherman Act

However, Sherman Act test has evolved so as to be largely the same as the Clayton Act test

o Tying & Exclusive Dealing under §1 Sherman & §3 Clayton was intended to apply to firms falling short of the §2 market share requirement for monopolization

Today, minimum market share amount ranges from 30%-40%

o But note: One difference between §1/§3 and §2 monopolization tying/exclusive dealing is the lack of any agreement in §2 cases

o Microsoft, (2nd Cir. 2001): Restraint: Held that D violated §2 by commingling the

computer code for its Windows computer operating system and its Internet Explorer web browser

Effect of Restraint: Virtually eliminate IE’s competitive rival, Netscape

Procompetitive Justification? None from MSFTo See also Lorain Journal:

Question in the §2 case was whether practice of refusing to deal w/ customers who advertised through a nearby radio station injured rivals unnecessarily and without business justification

Court never considered the percentage of market foreclosed by D’s practices—an essential requirement in exclusive dealing cases

o Consider also Dentsply, (3rd Cir. 2005): Held: Third Circuit sustained gov’s challenge to

exclusive dealing by a market dominating seller of materials used for filling teeth

Market Share: D’s market share in these materials ranged form 67-80%

Restraint: D sold its materials through a network of dealers who, with few exceptions, were required to sell exclusively to their customers, who were mainly dental labs that filled dentists’ orders for specific artificial teeth

Effect: Restricted unreasonably the development of competing sources of dental materials b/c it was difficult for dentists to find labs able to fill orders with non-Dentsply materials

That is, preservation of monopoly at the expense of decline in innovation

o Pursuing Claim under §2 vs. §1 S/§3 C Fundamentally, both tying and exclusive dealing are

“exclusionary” practices of the kind that ordinarily fall within the purview of §2

Further, while §2 is more restrictive in its market power requirement, it is less categorical in its other requirements

**Example: If we accuse MSFT of tying IE and Windows

have to undertake “separate product” analysis Further, both §1 and §3 require an “agreement,”

but a technical tie is simply a reconstitution of two products into a single one by design rather than by K

If we apply §2, however we get to bypass tying/exclusive dealing’s technical requirements and we can instead go straight to the question of whether the practice = exclusionary

BUT, limited in using this to firms that already have requisite MP/MS

34

Use of Vertical Refusals by Private AT Plaintiffso =/= §2 violation for Monopolist to cut out a monopsonist

distributer by vertically integratingo See, e.g., Kansas City Star, (8th Cir. 1984):

Newspaper had 100% of Kansas City market and vertically integrated to distribute papers itself

Plaintiffs, paper carriers, contested the vertical integration Held: not a violation of §2 b/c did not facilitate price

discrimination—actually standardized prices—(2) did not increase barriers to entry b/c carriers were still distributing other periodicals; and (3) price regulatory avoidance concerns weren’t present b/c not a regulated monopolist

Legitimate Business Purposeo Term is ambiguouso Presumably, any act that is lawful and tends to increase profits of

the firm = product of a legitimate business purposeo Courts use the term in two primary ways:

(1) May mean simply that D had no anticompetitive animus, either generally or directed at the private plaintiff

(2) More appropriately, term means that challenged practice is efficient

o Better Rule: Seems to be that a D who can show its action produces identifiable efficiencies has presumptively acted for a legitimate business purpose, and further inquiry concerning subjective intent = inappropriate

Consider Aspen Skiing: D could proffer no efficiency reason for its refusal to deal w/ P

Unilateral Refusal by Nonmonopolisto If practice = legal for monopolist legal for non-monopo Unilateral refusals to deal by non-monop will only be illegal when

they are part of some other AT violationo Sylvania, (U.S. 1977):

Established that vertically imposed territorial restrictions are governed by RoR

Plaintiff = terminated retailer

o Likewise, in tying, exclusive dealing, or mergers, P claims that, as a result of an AT violation, D refused to deal with it, or forced others to do so

o In such cases, refusal to deal is generally mere detail in court’s evaluation of the substantive offense; but may be important in determination of P’s standing or computation of damages

Refusals to Deal III: Essential Facility Doctrine Generally, doctrine proclaims that the owner of a properly defined

“essential facility” has a duty to share it with others and that refusal to do so violates §2 Sherman Act

[Origination] Terminal Railroad, (1912): Court required a group of firms controlling a RR bridge and transfer and storage facilities at the Mississippi river to share these facilities with other RR lines

o BUT, this was a §1 case, involving agreement by a number of firms who controlled the facility

[Also Associated With] Associated Press, (U.S. 1945): Also involved concerted activities

Today, mainly concerned w/ unilateral refusals to dealo BUT, shouldn’t matter whether ownership of facility is singular or

by agreement; once the “essential” facility is identified doctrine applies

o HOWEVER, difference between concerted and unilateral action is important when it comes to analysis b/c concerted refusals to deal are granted less deference than unilateral refusals

See also Verizon v. Law Offices: Didn’t repudiate doctrine, but placed severe limits on it to situations where

o (1) Claimed facility must be essential in the sense that rivals are unable to supply it for themselves;

o (2) Where the facility is being claimed is something that D owns fully developed and is actually selling others;

o (3) Where sale to rivals would be “rational” in the sense that it is at least as profitable to D as alternative sales; and

o (4) Where there is no regulatory agency actively supervising a compulsory sharing requirement

35

Predatory Product Design and Development; Failure to Predisclose; Alerted Complementary Products

See, e.g., 1954 Kodak: Tying film development to the sale of filmo Although cannot leverage into additional rents, can exclude

competitiono E.g., If small company can only process and it requires an

extremely large company to create the film the small company can be pushed out by a tie of film and development

Predatory Product or Process innovationo California Computer Prods: Alleged D-IBM developed a new line

of computers that didn’t need P’s external processing units as “technological manipulation” designed only to eliminate the independent market for separate memory units

Held: Not an unreasonable restraint b/c computers were faster and cheaper as a result; i.e., there was a reasonable business justification

9th Cir: IBM, assuming it was a monop, had the right to redesign its products to make them more attractive to buyers . . . . It was under no duty to help Cal Comp or other peripheral equipment manufactures survive or expand

o Should Development of New Prods that Eliminates Need for Existing Product Market Ever = Monop?

1) If it is undisputed that the new product =/= superior to the old; and

2) If there is clear evidence that D’s intent was to destroy the independent market

Then, possible

o Problems With This Construction? 1) How does a court determine whether a product is

superior or inferior? See, e.g., Allied Orthopedic, (9th Cir. 2010):

There are no criteria courts can use to calculate the “right” amount of innovation . . . . A seemingly minor technological improvement

today can lead to much greater advances in the future

2) Ever inventor has the “bad intent” of injuring competition products; that’s how he makes money

o BUT, we should be on notice of maleficent intent when 1) Technology clearly raises rivals costs or excludes it

from a properly defined market; 2) Appears to render to improvement to the product/there

is no reasonable basis to believe the change was intended to be an improvement; and

3) D must have substantial market power in a properly defined relevant market to be able to affect the alleged harm in the first instance

o See, e.g., Intel, (FTC 2010): Intel entered consent decree agreeing that it would not

make a change to a relevant product if that change: (1) Degraded the performance of a relevant

product sold to a competitor of D; and (2) Did not provide an actual benefit to the

relevant product sold by D

Failure to Predisclose New Technologyo Berkey Photo v. Kodak, (2nd Cir. 1979): Held that a monopolist

was under no duty to predisclose new technology to its competitors Part of competition is allowing the temporary monopoly

created by innovating a new product to reap benefits for its developer

Microsoft: Unnecessarily Harmful Redesigns & Licensing Requirements

o Computer market subject to positive network externalities (greater connectivity = greater value to consumers)

o Sources of network externalities for computer operating systems are as follow:

(1) Users’ needs for compatibility and interchange with other users; and

(2) Software developers’ need to develop for a large number of users

o Accordingly, an operating system with a large installed base will always be more attractive to both software developers and

36

consumers than an equally good system with a smaller installed base

o Microsoft’s Network Advantage? Keeping Windows sufficiently incompatible with other

computer operating systems that users cannot run software or perform other tasks on different systems interchangeably

o Competitors? Netscape and Sun Java used computer language that

enabled software to operate on multiple systems Would create a differentiated product market where

Microsoft computers would have to compete with non-Microsoft operating systems

o Result? D.C. Cir condemned Microsoft’s actions restraining competition on the merits:

(1) Commingling Windows and IE to make IE consumers’ choice over Netscape;

(2) Preventing manufacturers from removing MSFT apps from desktop and start menu, or from modifying computers start-up sequence to favor other non-MSFT prods

(3) Prevented computer manufacturers from altering windows desktop or interface that shows various icons for the programs the computer includes

(4) Induced software developers through various contractual devices to favor IE

(5) Pressured competitors to use IE (6) Pressured Intel into not dealing w/ Java

Strategic Entry Deterrence; Predatory Advertising; Excessive Product Differentiation

o Unclear how to measure the effect of brand advertising on entry barriers

E.g., could be that, before a firm can make a single sale, they’ll need to do about $10,000,000 in advertising = prohibitive barrier

BUT, banning honest product advertising would probably do more harm than good to competition

o Furthermore, in product differentiated markets, it’s difficult to measure the effects of incumbents’ actions against new entrants

E.g., New entrant has new design which the incumbent mimics in order to deter sales from the new entrant

Question is whether this is actually anticompetitive, or a competitive response to market forces? = Difficult to

distinguish

Leveraging Theory; Nonmonopolistic Advantage in Second Market See, e.g., Alaska Airlines, (9th Cir. 1991): Levering activity may tend to

undermine monopoly power, just like monopoly pricingo Every time the monopolist asserts its market dominance on a firm

in the leveraged market 1) Leveraged firm has more incentive to find an

alternative supplier, which in turn 2) Gives alternate suppliers more reason to think they can

compete with the monopolist Spectrum Sports, (U.S. 1993): [Dicta] Supreme Court seemed to reject

leverage theory altogether o §2 of the Sherman Act makes the conduct of a single firm unlawful

only when it actually monopolizes or dangerously threatens to do so

o The concern is that §2 might be applied so as to further anticompetitive ends is plainly not met by inquiring only whether D has engaged in “unfair” or “predatory” tactics

Today: When Courts apply the leveraging theory, they require that plaintiff show that there was a dangerous possibility of monopoly being created in the second market

o Effect: Robs leveraging theory of its distinctiveness See, e.g.. Verizon v. Law Offices, (U.S. 2004):

o To the extent the Court of Appeals dispensed a requirement that there be a dangerous probability of success in monopolizing a second market in considering a “monopoly leveraging” claim, the Circuit erred.

Raising Rivals’ Costs (RRC)o Preferred (where possible) over predatory pricing b/c don’t have to

incur substantial losses for an extended period of timeo Examples of Restraints causing RRC:

Petition Gov for regulations that disproportionately affect smaller firms’ costs

Litigate against the smaller firm Bargain with EEs union for higher wages

37

R&D leader develops new tech that requires substantial scale economies for production to push out fringe firms

Unreasonably Exclusionary Practices Involving Patents or Other Intellectual Property Rights

o Monopolists have been condemned under AT for abusing rights obtained under patent law

o Courts have often found patentees guilty of exclusionary practices, particularly if they have

Tied some unpatented article to the patented one Accumulated patents to make entry into the monopolized

market more difficult Or, in a few situations, if they have refused to license the

patent to otherso Additionally, Supreme Court has stated that obtaining a patent by

fraud may violate §2, see Walker Process, (U.S. 1965) As can attempts to enforce a patent known by the holder

to be invalid and unenforceableo Walker Process: Court required AT plaintiff claiming patent

abuses to allege and prove a relevant market Patent =/= alone create relevant AT market But see Kodak: Monopoly in aftermarket product

o See also Illinois Tool, (U.S. 2006): Reversed presumption that a patent alone creates market power

o Walker Process: Obtaining Patent by Fraud Movant in AT claim alleged that

(1) D in AT claim had obtained the patent by committing fraud on patent office; and

(2) D’s attempt to enforce patent against P was an attempt to monopolize

Held: [Clark, J.] The maintenance and enforcement of a patent

obtained by fraud on the Patent office may be the basis of an action under §2 Sherman Act

Today: Courts generally hold that merely obtaining a

patent by fraud, however unlawful under Patent Act =/= AT violation until patentee actually tries to enforce the patent against someone else or use

it in some other anticompetitive manner

Enforcement of Patent Known to be Invalid or Unenforceable; Noerr Issues

o First Amendment right to petition government for redress of grievances =/= extend to baseless claims filed by a rival or prospective entrant for the purpose of excluding the rival from a certain market

In fact, can give rise to §2 claim against patentee

Abuse of Government Processo The abuse of government process is just the acto Plaintiffs still have to show the other elements necessary for the §2

violation, i.e., substantial market share in, or a dangerous probability of monopolizing, the relevant market

Business Torts as AT Violationso Definition: Refers to a variety of practices, including fraud &

misrepresentation, inducement or breach of K, “stealing” a rivals key EEs, forcible interference with customers or the movement of products, passing off, false advertising, or product disparagement

o Requires EXTREME Caution (1) State law already provides numerous remedies; and (2) Fit between tortious and anticompetitive conduct is

poor b/c most torts =/= anticompetitive in AT sense

38

Conduct Requirements in Attempt Cases Must balance three consideration:

o (1) Conduct, or planned or threatened conduct, must be capable of giving D substantial and durable market power;

P cannot make out attempt case if the alleged conduct would not have given D a monopoly

Dangerous Probability Test controlso (2) Conduct that is legal for a monopolist cannot be illegal for a

non-monopolist; Even conduct that is marginally illegal for the monopolist

should be legal for the Nonmonopolist E.g., price discrimination, failure to predisclose new tech,

aggressive R&D, expansion of capacity, acquisition of or refusal to license patents, and some dealer terminations and exclusive dealing Ks

o (3) Sometimes socially beneficial conduct can create substantial market power. This type of conduct should not be illegal

AT is supposed to foster competition We need to promote efficiencies that can be passed down

to consumers

Ch. 10 – Tie-ins, Reciprocity, Exclusive Dealing and the Franchise ContractIntroduction: Judicial Test for Tie-Ins

Sale or lease conditioned on buyer taking a second product or service §2 Sherman Act and §3 Clayton Act may prohibit Per Se Analysis:

o (1) There must be separate tied products;o (2) Evidence of actual coercion by the seller that in fact forced the

buyer to accept the tied product;o (3) Seller must possess sufficient economic power in the tying

product market to coerce purchaser acceptance of the tied product;o (4) There must be anticompetitive effects in the tied market; ando (5) There must be involvement of a not insubstantial amount of

interstate commerce in the tied product market See also Kodak:

o 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 (or tied) product, or at least agrees that he will not purchase that product from any other supplier

o Such an arrangement violates § 1 of the Sherman act if (1) Seller has appreciable economic power in the tying

product market and (2) The arrangement affects a substantial volume of

commerce in the tied market See also Jefferson Parish [Stevens, Maj.]:

o Unlawful tie if seller has sufficient market power in tying market to make buyer take a tied product he doesn’t want or would rather buy elsewhere on different terms.

But see Jefferson Parish [O’Conner]: Advocating Rule of Reason in all Tying Analysis, but only if 3 conditions met:

o (1) Market power in the tying product;o (2) Substantial threat of market power in the tied product; o (3) Coherent economic basis for treating the products as distinct;

ando (4) Showing of exclusionary or anticompetitive effect in the tied

product market (as in all ROR cases)

39

Circuits’ Interpretations:o Close to unanimous in requiring (1), (3), and (5)o Further, if the “coercion” element means that seller pressured

buyer to take tied product Plaintiff must show (2) as wello Anticompetitive Effect (4) = Most ambiguous

Some courts interpret as coercion Others as AT injury BUT, whole point of per se is to avoid expensive

individualized inquiries concerning competitive effects So, use of this element cuts against Per Se analysis

o (5) “Not insubstantial” is pure formalism There isn’t a de minimis exception to AT jurisdiction for

Tying arrangements To the extent court is concerned, should be in terms of

some amount of market foreclosed

Tying Arrangements and Consumer Welfare Tying arrangements can generate consumer welfare

o E.g., if the rule were that any customer could buy any portion of a product (e.g., button on a coat) there would be enormous costs for consumers as the cost is spread across each part of the product

o Or, how computers sell integrated products for the convenience of less technically proficient consumers

o So, as with selling 2-shoes as a pair instead of individual shoes, overall operation costs are less, consumer costs are less, but some consumers are injured by the lack of choice

Therefore, have to evaluate tying arrangements as they effect consumers as a group—not as individuals

Market Power and Per Se Unlawful Ties; Sherman & Clayton Act Tests Times-Picayune, (U.S. 1953) [Clark]:

o Tried to establish some differences between ties as considered under §1 Sherman and § 3 Clayton

o Clark believed that Clayton must have broader coverage than Sherman, otherwise §3 Clayton would be superfluous

C.f. A. B. Dick, (1912): prior to passage of Clayton Act, Court had suggested §1 may not reach all ties

o Clark concluded that P can have benefit of per se rule under §1 Sherman by showing both

(1) Seller had sufficient MP in tying product to restrain competition in tied product; and

(2) Tie-in restrained a substantial volume of competition in the market for tied product

BUT, if P can show only one of these §3 Clayton could find a violation under ROR

o Criticism: Distinction made little sense and raised to unfortunate possibilities that later court precedent has clamped down on:

(1) Some ties could be illegal even if seller lacked MP in tying product;

(2) If seller had MP, its tie could be illegal per se regardless of precompetitive justifications

Rationale and Development of Tying’s Market power Requiremento Absent any MP can be no tie that actually causes consumer AT

injury consumers just substitute to competitor w/ better termso Today most courts require a showing of market power in tying

product as condition precedent And, most have adopted a single §1/§3 test that requires

both MP and a significant effect in market for tier product C.f. Other courts have looked at non-MP factors, like

uniqueness of product (merely a conduit for limited substitutability)

o SCOTUS has never provided firm MP/MS Figure

40

E.g., International Salt and Paramount never required significant MP in the tying product

Times Picayune: Court seemed to require the seller’s “dominance” in the tying product market

But see Northern Pacific Railway, (1958): Ct. assessed a much weaker requirement that D control a “substantial” amount of the tying product and failed to even define a relevant market

Here, Court interpreted Times Picayune to require no more than “sufficient economic power to impose an appreciable restraint on free competition in the tied product”

Fortner I, (1969): Court didn’t define a relevant market for tying product, and held rather that MP in tying product could be inferred from fact seller had “unique economic advantages over his competitors.”

C.f. Fortner II, (1977): Qualified its position in Fortner I, holding that MP could not be inferred from fact seller merely sold tying product (credit) cheaper in order to obtain sales of a relatively high priced tied product (pre-fab houses)

And, uniqueness =/= MP unless there is some specific showing that it rose to a level to create MP

In Fortner II, Court determined D’s financing terms were unique b/c it offered low-price financing to consumers to purchase overpriced homes

This =/= MP If “the evidence merely shows that credit terms

are unique because seller is wiling to accept a lesser profit—or to incur greater risks—than its competitors, that kind of uniqueness will not give rise to any inference of economic power.”

o Jefferson Parish, (1984): Use of vague and diluted MP requirements was halted at least for Sherman Act cases

Plaintiff, anesthesiologist was blocked out of taking a job b/c hospital had exclusive K with provider

Found: D had 30% of MS for tying product Held: Insufficient MS b/c 70% of the market continued to

be available to patients who wanted to use other anesthesiologists than D employed

Also, Court appeared to return to Times Picayune Market Dominance test

Finally, Court appeared to require definition of a relevant market and computation of market share, at least if the tying product =/= patented

o Post-Jefferson Parish Recent cases have generally refused to condemn tying

arrangements on MS of less than 30% Likewise, conclusion expressed in Northern Pacific and

Fortner I, i.e., that MP can be inferred form the mere fact that so many people accede to the tying arrangement, has been all but abandoned

Tying Arrangements in Imperfectly Competitive Markets; Locked-in Customers

o Kodak: Alleged that monopoly on replacement parts was being used to tie in service, too

o Held: Lack of power in primary market =/= lack of MP in aftermarkets

o Plus, Lock-in Theory Rather pay increased cost in parts and service than

abandon Kodak printer for another one And, if enough customers =/= well informed even

though more sophisticated customers would forego the deal for a competitor, the scheme may successfully lock in enough current consumers

o BUT, even if benefitting of the backs of a class of uninformed consumers is possible, is it an AT concern?

There are uninformed customers in every non-perfectly competitive market

Thus, there is always opportunity for exploitation of these consumers

BUT, this kind of exploitation =/= monopoly unless it facilitates systematic supracompetitive returns in a properly defined relevant market

o Limitations on Kodak Kodak should not be read to mean that sufficient MP in

aftermarkets can be inferred merely from the fact that a manufacturer makes its own, unique replacement parts

Rather, there must be independent evidence of MP in aftermarket, evaluated by generally accepted AT criteria

Lower courts have limited Kodak to situations where (1) Tie arises after customers are locked-in by

virtue of previous purchase; and

41

(2) Where D changed its aftermarket pricing policy after a significant number of customers made their purchase, or a significant number of customers can show they were misinformed about price

Thus, cannot be locked-in if you purchase aftermarket good and primary market good at same time

Second, if there is no reason to think customers as a group are not reasonably informed, they can be locked in only if changes are made after they have made their purchases

o Relation to Franchise Agreements: Nearly all courts agree that in tying claims brought by

franchisees, MP must be established by looking at franchisor’s market position in the general market in which it sells

E.g., Dominos: Already spelled out in franchise agreement that food purchases are tied to franchise in contract

IP and the Presumption of MPo Illinois Tool, (2006): Overruled presumption that a seller had MP

in tying product when it was subject to IP protectiono Flaws in Previous Presumption

Ignored facts that majority of patents are unprofitable; almost every product in a branded market is subject to IP

Barriers to Entry in IP: Almost any original grouping of words can be copyrighted and almost any unique symbol can be trademarked

o Continuing Relevance of IP Considerations in AT Having IP =/= totally irrelevant Occasionally, a single patent can define a market and

confer substantial MP BUT, patent is only one piece to the inquiry

Must define relevant market and power within the market (SSNIP)

Uniqueness and Ubiquity as MPo Uniqueness can be used to capture the set of surrogates for market

power measurement that AT employs—i.e., large share of properly defined AT market

o BUT, does significant harm when “uniqueness” allows fact-finder to eyeball product, note some differences that make it attractive, and then proclaim MP satisfied

o Lower Court Applications 7th Cir: Uniqueness creates an inference of MP only

when evidence suggests rivals are unable t duplicate the particularly desirable characteristics of the product and this operates as a barrier to entry in the market

8th Cir: Evidence of uniqueness must be combined with market share evidence and the two together may suggest market power

Found in one case that 57% MS + Uniqueness = Sufficient

o Senseless Theories: Because people permit it, the seller has market power

Many consumers prefer tires with their vehicles Providing them in this fashion is efficient and

lowers the cost for the most purchasers Preference for the package, however, =/= MP for

the specific unit sold as a package Can infer MP in tying product if sales of tied product

increased when arrangement was imposed Evidence is at least as consistent with theory that

efficient ties reduce overall cost and thus increase sales

More relevant question: Did implementing the tie allow a reduced output of the tying product?

Separate Sherman and Clayton Act Tests? FTC Acto Times Picayune: Court suggested a tying arrangement could be

condemned under more aggressive standards under §3 Clayton than §1 Sherman

In particular, Clayton Act may not require proof of market power in the tying product

Some courts adhere to this In general, however, trend has been to apply single test

and to require some kind of showing of market power in the tying product

o Jefferson Parish: The Four Concurring Justices believed MP is required even in a rule of reason tying case

Maintaining illusion of separate Sherman and Clayton act tests for tying cases is senseless

42

o However, Court has approved Broader Standards under FTC Act

Brown Shoe, (1966): Court upheld FTC’s condemnation of a practice under which Brown provided special services to franchises in exchange for a promise they would concentrate their sales efforts on Brown Shoes

Held: Practice could be condemned under §5 FTC Act w/o showing of anticompetitive effects ordinarily required in Sherman or Clayton Act challenge

Stores at issue in this case amounted only to 1% of the nation’s shoes

Rule: Proof of anticompetitive effects =/= necessary in FTC cases b/c §5 FTC Act allows commission to “arrest trade restraints in their incipiency w/o proof that they amount to an outright violation of §3 of the Clayton Act or other provisions of the antitrust laws.”

Rationale for Per Se Illegal Tieso Although courts commonly articulate a per se rule for tying, that

usage is inappropriate and undermines effective analysis of the functions of ties and the potential for injury

On one hand, there is the efficiency analysis that you have to run: Are customers, on net, better or worse of from the efficiency gains achieved by the tie

Often courts address this problem by deciding that the two items were in fact a “single product”

Furthermore, If seller = competitor tie = likely efficient

Does not follow, however, that because there is a tie seller has MP

o Even when seller/s have substantial market power, their tying arrangement is not necessarily anticompetitive

Monopolists as well as competitors may find packaging efficient

For this reason, anticompetitive impact must separately by shown, and this fact makes the adjective per se inappropriate

o Modern Observation: Technology and networking have made tying ubiquitous

(1) With these types of products, ties make the product work better

(2) BUT, dominant firms still use ties to abuse competitive process

These two facts make tying a strong candidate for ROR rather than per se illegality or per se legality

When Are Products Tied? For there to be a tie, buyer must somehow be forced, or coerced into

accepted the tied product. Can result from:

o (1) Absolute refusal to sell tying product w/o the tied product;o (2) A discount or rebate or other financial incentive given to byers

who also take the tied product; oro (3) Technological design that makes it impossible to sell the tying

product w/o the tied product

Coercion by Contract, Condition, or Understandingo Jefferson Parish:

Tying arrangements warrant condemnation when the seller has sufficient market power “to force a purchaser to do something he would not do in a competitive market.”

Furthermore, condemnation would be warranted only if the tie restrains “competition on the merits by forcing purchases that would not otherwise be made.”

Held: Upheld hospital tie b/c there were other hospitals in the market (i.e., not being coerced)

o Criticism: Jefferson Parish is overly broad where it holds that

anytime a purchaser is required to take something they don’t want there is a tie

E.g., if 98% of ppl want cars w/ factory installed tires and the cost of providing otherwise is high efficient tie

43

Side Step: Can also classify as a “single product”

o Coercion + Some courts require coercion plus “anticompetitive

effects” BUT, “anticompetitive effect” =/= clear

Some cases suggest that there must be a treat that seller will acquire MP in the tied product market

However, “leveraging” theory has been largely debunked

In fact, if this is the concern attempted monopolization is a better approach

Proof of a Relevant Tying Agreement; Unommunicated Conditionso If D has tying agreement as part of form contract and there are a

number of buyers that would prefer to buy only one product but are unable to purchase except under the tied conditions presumption of illegal tie

o C.f. If there is a competitive market and D is tying and selling into it tie may be procompetitive

Here, P has to establish that some consumers would have preferred the tying product w/o the tied product

Package Discountso “Attribution” Test:

Is the seller offering a primary product discounted to the extent that the markup on the tied product =/= deter purchaser

C.f. Other rivals can make the same bundle and charge competitive price

o § 3 Clayton: Condemns tying not only when D absolutely requires purchaser to take tied product but also when D offers a “discount from, or rebate upon, purchase price in exchange for tying.”

=/= inconsistent w/ attribution test Condemns ties only where effect of tie may be

substantially to lessen competition BUT, if other rivals can readily match the

discount competition =/= lessened

Coercion by Package Design; Technological Tieso Times Picayune: Cheaper to not offer the products separately

because technological process for making ads was such that making the same copies for morning and evening papers was more cost effective

o IBM: As technology progressed, became cheaper (and beneficial to consumers) to produce integrated machine with all parts included

o Hovenkamp’s Presumption: Any demonstrated and significant cost reduction that results from the way an arrangement of items is manufactured and sold should create an inference that the combination is a single product

o Operation of Technological Ties: Usually results from the design of the product rather than

from an explicit contractual agreement In this respect, is unilateral §2 over §1 Sherman may

be a better mechanism for attacking it See, e.g., Microsoft, (D.C. Cir. 2001): “Putting code

supplying browsing functionality into a file with code supplying operating system functionality “ensure[s] that the deletion of any file containing browsing-specific routines would also delete vital operating system routines and thus cripple Windows.”

Requirement of Separate Products Introduction; Basic Competitive Market Test

o There is no tying violation unless (1) D bundles separate tying and tied products; and (2) Either (a) refuses or sell the tying product w/o the tied

product, or, alternatively, (b) charges a higher price when the products are bought separately

o Separate Prods; Basic Test: Is the tying item commonly sold separately from the tied

item in a well functioning market? Note: Focus is on whether the tying product is commonly

sold w/o the tied product under ordinary conditions, not vice versa

o But see Jefferson Parish: Incorrectly stated test Court determined appropriate test was whether a

sufficient demand for purchase of anesthesiological services (tied product) existed separate from surgical services (tying product)

44

Rather: Relevant question should have been whether, in a competitive market, a hospital might offer surgical services w/o prepackaged anesthesia services

o See also Kodak Use of “Efficiency” Court used efficiency to ask whether the market as a

whole included sufficient demand for parts without service that it is efficient for a firm to provide products separately

“New” Productso See, e.g., Jerrold Electronics, (E.D. Pa. 1960) aff’d per curiam,

(U.S. 1961): D created early form cable system using a large antenna,

booster receivers, and cable connections going to numerous homes. Held:

(1) Early stages of sales: Okay for D to insist upon selling all products and service as single product b/c don’t want product to suffer lost of goodwill from finger pointing between customer, unknowledgeable technician and D

(2) Later Stages: Once introductory period passed, previous rationale no longer applied and the products were better classified as separate prods

o Critique: Raises 2 Questions— (1) When is an amalgamation a “new” product and when

is it just plain tying? (2) How long should a market dominating defendant be

entitled to rely on the “new product” rationale for finding a single product?

o (1) New Creation or a Tie? Has to be some reason for thinking:

(a) Combo works better than spate provision; and

(b) Consumer of package cannot achieve same result by combining herself

See, e.g., Microsoft, (D.C. Cir. 2001): Under this test, MSFT and IE were separate products, but the degree of innovation represented an integrated Windows/IE package ROR

But see Consumer Combination: Consumers are no stranger to downloading

software they want Under (b), test should find that consumers could

have reached this same result by downloading the IE themselves

o (2) How long should the new product rationale entitle seller to insist that formerly competing goods be sold as a package?

See Jerrold: All we know is that there can be an “introductory period” and once it has lapsed procompetitive/proconsumer justifications don’t support the tie

Complete and Partial Substitutes as Separate Productso More of the Same:

Buy 200 engines before you get lowest price for each one 199 unwanted engines (tied product) to get price wanted (tying product)

More of the same thing =/= separate product Would have to run market analysis to determine

whether output in the engines is decreasing or whether price is increasing overall

o Imperfect Substitutes: Monopolist CD-ROM maker wants to start tying DVD-

ROM’s to all of its sales b/c it realizes DVD will replace CD

Rule: Imperfect substitutes should be regarded as spate products, at least where there is a realistic threat that the dominant firm in prod-1 can use its monopoly power to move into a dominant position in prod-2

C.f. Carrying a Full Line: If manufacturer has two established lines of

products and only wants to sell to retailers where both are available =/= more than requiring retailers to carry full line

Microsoft, (D.C. Cir. 2001): Because MSFT was using its compatibility

between Windows and IE as an entrenchment

45

method against Java/Netscape Windows & IE = Separate products

IP and Labor as Separate Productso E.g., Baskin-Robins franchisee wants to use BR’s trademark, but

does not want to buy BR ice cream. Instead, wants to buy cheaper ice cream and hold itself out as Baskin-Robins

o Rule: If TM identifies the good itself as made by the manufacturer or made according to manufacture’s specifications single-product conclusion is required

Justification: Consumers may be willing to pay more if they think they’re getting Baskin Robins ice cream

Opposite Result: Otherwise, court is complicit with franchisee in committing fraud

o Vice Versa Rule: If there is little or no connection between the TM and the source or quality of the good good and TM are separate products

Justification: E.g., pizza franchisor may require franchisee to take its pizza dough, even though the dough is completely indistinguishable from pizza dough generally and consumers attach no special value to the franchisor’s particular dough

o But Note: A great many franchisors lack the market power in the

tying product to make their ties unlawful in the first placeo Labor Ties:

E.g., when firm moves from contracting for a service to providing for itself internally

BUT, if only labor involved not a tie C.f. Jefferson Parish: Restraint turns on level of MP to

effectuate anticompetitive harm in relevant market

Efficiencies—Economies of Joint Production Two Types:

o (1) Transactional efficiency; ando (2) Productive or technical efficiency

Transactional:o E.g., shoes (presumably) cannot be manufactured more cheaply in

pairs than individuallyo BUT, much cheaper to sell in pairs than to hold inventory of

mismatching shoes and produce pairs for those who want them Productive/Technical:

o Times Picayune: Cheaper for seller and for down-stream consumer for Newspaper to sell identical morning and evening ads

o But see Jefferson Parish: Five-Justice Majority appeared to reject idea that efficiency of joint provision could justify finding a single product

Concluded: Whether separate products exist depends “not on the functional relation between” the two items, but rather “on the character and demand” for them

o § 2 Sherman Act: Permits monopolist to create technologic innovations that bundle formerly separate products provided there is a good business justification

See, e.g., Aspen Skiing: A good business justification includes better product/service; or

See, e.g., Times Picayune: A cost savings that can be passed down to consumers

46

Competitive Effects Judicial test for illegality of tying =/= explain how ties affect competition As a result, courts have often condemned ties w/o understanding the

economic function of the arrangement D’s distribution scheme BUT, if tying is going to be condemned, there has to be some understanding

of why it is bad

Leverage Theory: Using Ties to Turn One Monopoly Into Two; Tipping Procedure: Monopolist w/ patent uses tie to create a “limited” monopoly in

second product market that is essential to the use of the tying product See, e.g., International Salt: Monopolist derived its profits not from its

invention, but from the unpatented supplies which is usedo If permitted practice monopolist can expand and an owner of a

patent for a single product might conceivably monopolize commerce in a large part of the unpatented materials used in its manufacture and operation

Perceived Evils are Two-Fold:o (1) Seller can make two monopoly profits and force consumers to

pay even more for products than if there were only one monopoly;o (2) By creating a monopoly in second product, monopolist in tying

product can drive other producers of the tied product out of business, or at least foreclose them from a part of the market

Implausibility of Leveragingo See One Monopoly Rent Theorem o Even less plausible in tying arrangements

Seller benefits most when what would be the tied product is sold at its lowest price b/c that increases the room for price increase on part of what would be the tying product

E.g., if buyers will only pay max $1.80 for a jar and lid lower lid price, higher jar price can be

Plausible Variations on Leveraging:

o Assume Kodak was able to control all of its aftermarket parts and thus all service

Competition will arise when service is more expensive than just buying a new replacement part or refurbishing a part

If Kodak can control the output of labor and parts and tie its labor to parts it can bring the mixture to its profit maximizing price

AT Harm: Making it more difficult for customers to substitute out to something not controlled by monopolist

o Likewise, Successive Technology Leveraging If CD-ROM monopolist can tie DVDs to its CD-ROM

sales for computer installations, then it can tip itself into the DVD market and as that market begins to supersede CD-ROM, monopolist is strategically positioned w/ dominant market share

Entry Barriers, Foreclosure, Collusion Entry Barriers and Ties

o Tying can raise entry barriers in market for either tying or tied product

o Foreclosure Theory: Tie foreclosed P’s ability to compete in the market

See, e.g., Heatransfer Corp., (5th Cir. 1977): Condemned an arrangement under which an automobile manufacturer required its distributors and retail dealers to use their “best efforts” to sell VW’s own air conditioners rather than those of competitors (including P)

Held: P was unlawfully foreclosed from the market for VW air conditioners

o Criticism: (Same as for all entry barrier arguments) Says nothing about whether it is socially beneficial or

harmful E.g., Efficient ties can raise barriers to entry.

If Times Picayune can lower its overall cost by tying morning and evening ads less efficient competitor who must charge above the Times’s cost is foreclosed on efficiency grounds, not tying grounds

47

And, inefficient ties present no barrier to entry: e.g., Bolt manufacturer who ties sale of nuts to product loses to competitors unless price of tied products is now lower

Entry Barrier Argument Potentially Successful Where—o Economies of scale or other impediments forbid entry or make it

more difficulto Example: Where seller = regulated monopolist and ties a product

which =/= have legal monopoly protection E.g., where telephone company has legally protected

monopoly in its lines may require lessees of its lines to rent a telephone instrument as well

BUT, profitable only if telephone company can use it to “cheat” on its regulated price

Foreclosure; Market Shareo Jefferson Parish: Shifted emphasis in tying cases away from

leverage and towards foreclosure (or, the degree to which the tie denies market access to rivals)

Thus, also turns proper market “power” analysis into a “market share”

So, when the challenged anticompetitive effect is foreclosure, we want to know something about the coverage of the restraint, not necessarily about the ability of the seller to charge supra-competitive prices in the short run

o Entry Barriers + … Entry barriers aren’t likely to arise in the ordinary case of

tying There must be some economy of scale or other

impediment that prevents entry at one market level, and thus which could restrain competition at a second level if the two were joined as a tie

E.g., Patent monopolist of can-filling machinery ties its cans to the lease of its canning machines

Effect: Rival makers can be driven out of business or denied an opportunity to expand sales

Ties and Collusion Can serve to make collusion or oligopoly pricing more stable or more likely

to succeed E.g., Take the facts of Northern Pacific

o Tie: Lease land around the railroad, so long as the lessee agrees that when shipping freight, unless a competitor’s rate is less than D’s have to go w/ D

o Effect: If a cartel member is cheating, then customer notifies D by refusing to ship w/ D by electing to go with the Defector

General Rules for Collusion and Ties (1) If horizontal agreement for all competitors to use tie likely per se

illegal price fixing (2) If no overt agreement, then arrangement might be considered in the

same was as cartel facilitators generally, and certain questions emerge:o Is the market concentrated and conducive to collusion?o Is the arrangement being used by all (or at least most) of the firms

in the market?o Note: Sherman and FTC Act have not been very successful in

tackling these arrangements w/o overt agreement

48

o But see Clayton §3: Condemns tying arrangements whose effect “may be to substantially lessen competition or tend to create monopoly.”

o And Clayton §7: Same language from §3 operates in condemnation of mergers on theory that they will facilitate collusion w/o requiring an actual horizontal agreement between competitors

Remember: Always Consider Whether Tie = Efficiento Most tying arrangements are competitiveo Further, efficient practices tend to be copied by other firms on the

market widespread use of a tying arrangement in a concentrated market may tell us no more than that the arrangement is one the firms are competing on to obtain market share

o Unless court is sure that tie is operating as a collusion facilitator, would be inefficient to apply §3 to condemn

Evasion of Rate Regulation If price regulated rate is still lower than profit maximizing rate regulated

monopolist may tie nonregulated products to its provision of service to make up the difference

C.f. If the regulated price is higher than the competitive price may tie in additional “freebies” to make a more competitive package

Tying-Upwards to Meet Profit Maximizing Price = Most Common in Price Regulated Industry Litigation

o Here, a version of the leverage theory can work: regulated monopolist makes more profits by adding an unregulated monopoly to a regulated monopoly and thereby avoiding regulation

Public Utilities = Ideal Candidateso (1) Most of them are natural monopolies (or are at least thought to

be);o (2) Most public utilities have very low marginal costs and very low

elasticities of demand at a marginal cost price

E.g., most people would be willing to pay considerably more for electricity and phone service than the marginal cost of providing it

Thus, profit-maximizing price is often much higher than the regulated price

But Note:o Many of these issues are better handled on their respective

regulatory regimeso And, there may be some beneficial efficiency results that we don’t

want to outright condemn when they arise through a tie

Predatory Pricing and Other Attempts to Monopolize Instead of pricing below marginal cost to engage in predatory pricing, firm

can also tie an additional cost or service at no additional charge or some price less than cost

Areeda-Turner Test: If price for the resulting is less than average variable cost predatory

Injury to Competitors: Only injured when the net price of tied products is below average cost

Injury to Consumers? Consumers are harmed if scheme gives rise to monopoly appropriate to challenge as attempt to monopolize §2 Sherman

Ties as Price Discrimination and Metering Devices; Franchise Agreements

o Difficulties of Engaging in Price Discrim: (1) Certain forms are illegal under Robinson-Patman Act,

which can prevent sale of same product at two different prices;

(2) In order to price discriminate, seller has to—in a low cost manner-segregate individuals into high-price and low-price groups; and

(3) Seller has to somehow prevent arbitrageo Potential Workaround:

Variable Proportion Tying Arrangement (e.g., International Salt or “metering”)

(1) Not violating Robinson-Patman b/c all products are being sold at same price;

(2) Easy to discern high- and low-paying customers by their purchase and consumption of the tied product;

49

(3) Arbitrage is ineffective b/c there’s no spread btwn items sold

o Unsuccessful Defenses: Salt: D argued that the tie was necessary to protect its

equipment. Held: Rejected argument and condemned

arrangement Note: Even though D’s K contained clause that

allowed customers to purchase from D’s competitors so long as they offered the right quality and beat D’s price

But see Northern Pacific: There are anticompetitive opportunities that arise when buyers have to inform seller that someone is offering a lower price

o Cartel Discipline / Facilitationo Price Discrimination

IBM, (1936): IBM tied paper tabulating cards yo its patented computation machines

Held: Rejected efficiency/product protection defense

Market Power and Price Discriminationo Seller must have some MP in order to price discriminate o And, in variable proportion ties, capability to tie proves some MPo BUT, amount of MP seller needs to actually engage in price

discrimination is small, and can result from no more than product differentiation in a relatively competitive market

o Therefore, evidence of a price discrimination =/= also mean D has corresponding MP to make its tie anticompetitive

Franchises and Price Discriminationo Usually seen in the instance of selling the franchise right at a low

price, but tying the requirement that franchisee buy all goods from franchisor

Output: Greater overall output because there are more franchises

Customers: Not affected b/c if the tie price passed down is too high, the customers can buy from a competitor to the franchise

Franchisees: Able to get the IP they might otherwise not be able to buy

Franchisors: So long as they can get at least above marginal cost of the transaction costs of licensing the franchise they can make a profit

Furthermore, if the goods are priced in a manner to cover the transactional costs of licensing no price discrimination

o See also “Simulated Price Discrimination” E.g., A & B place different value on Prods 1 & 2. Seller

can maximize output and return by pricing a package of 1 & 2 close to the aggregate value A & B ascribe the tow items

Result: A & B will place different value on either product 1 or 2 (e.g., as the high value product) but both pay same price

Tying and Double Marginalization; “Reverse Leveraging”o Double Marginalization: When two firms w/ large market power

are in vertical distribution, so Seller 1 adds its markup and seller 2 adds its markup

Effect: Higher prices and lower output at bottomo Double Marginalization in Complementary Products

In such a case, a single firm packaging the complementary products at a lower price actually would cause the firms w/ MP in the individual prods to lower their prices

o Policy Note on Tying & Double Marginalization If a tie reaches across two imperfectly competitive or

highly concentrated markets of complementary products and produces a lower package price procompetitive and we should support such an arrangement

Only where its found that the tie is foreclosing competition in the market should we condemn

50

Ties and Efficiency: Toward a General Rule of Reasono Efficiencies of Tying Law’s Idiosyncratic Per Se Rule

(1) Efficiency =/= expressly included in per se tying analysis BUT can slip in through the “separate products” analysis

That is, where tying items reduces cost, the two might be considered a “single product”

(2) Per se rule also idiosyncratic b/c it requires some showing of Market Power, which requires definition of Relevant Market

(3) Even when market power is established, courts permit a D to show various defenses: For example—

Jerrold Electronics: Court accepted defense that in a developing market for new technology, package sales might be necessary to encourage customer acceptance

Other courts have accepted that a history of customer dissatisfaction w/ their own bundling could justify a seller’s pairing

o E.g., New computer might need to be bundled w/ its own operating system so that it works correctly

o Moreover, this also prevents free rider problems, allows D to monitor quality, and metering in tied product

o Distribution Economies; Full-Line Forcing and Unwanted Tied Product; Lack of Consumer Injury

Full-Line Forcing [Seen in Franchise Agreements]: Occurs when manufacturer requires dealer to carry a full line

of manufacturer’s products, not just the ones the dealer finds most profitable

Courts have Upheld since the 1970s on the theory that the full-line constitutes a single-product

Economic Justifications: Hard to find an economic harm:

o Helps manufacturers achieve economies of scale or scope in distribution

o And, manufacturers are using the retailers in place of vertically integrating, so it allows for more independent businesses

At the same time, manufactures are thus dependent on retailers to sell all of its products

Effect: Full-line forcing actually increases output and customer choice

Unless Exclusive Dealing Enforced, No Competitor Foreclosed:

o BUT, may be onerous to the dealer who is forced to bear the cost of carrying the full line of products

o Note also: May result in foreclosure if all physical space in store is taken up by larger sellers, precluding smaller sellers from competing on quality (i.e., drowned out)

No Competitive Injury…o Full-line forcing is a member of the set of “no

competitive injury” ties that occur when customer is forced to take a product that it doesn’t want at all

See, e.g., Jefferson Parish: No tie can be per se unlawful “when a purchaser is ‘forced’ to buy a product he would not have otherwise bought even from another seller in the tied product market”

o In that event, “there can be no adverse impact on competition because no portion of the market which would otherwise have been available to the other sellers has been foreclosed.”

Remember, gravamen of a tying claim is injury to competition not a buyer’s right to divide up purchase into smaller packages

Finally, Consumers =/= injured b/c the full-line forcing only applies to the retailers, not to customers

o Conclusion: Moving Tying Law Toward Rule of Reasono Microsoft, (D.C. Cir. 2001): Circuit decided to depart from per se

rule and apply ROR in tying arrangement Held: There are strong reasons t doubt that the integration

of additional software functionality into an OS falls among these arrangements.

Applying per se to such amalgamation creates undue risks of error and of deterring welfare-enhancing innovation

Also, court noted that the software bundle was unlike anything the Court has ever considered judicial experience was insufficient to warrant per se condemnation

However, this severely overlooks the level of market that was foreclosed by this tie

Even under ROR was likely a per se violation

Reciprocity

51

Reciprocity / Reciprocal Dealing: Sale or lease on condition that seller purchase a different product from the buyer

Merger Context: Court has condemned conglomerate mergers under this context (e.g., increased likelihood of reciprocal dealing)

Legal Prohibition:o §1 Sherman Acto Have not been raised under §3 Clayton Acto FTC Act §5’s expansive standards have provided grounds for FTC

to go after these deals Courts’ Approaches

o Spartan Grain, (5th Cir. 1978): Held reciprocity should be judged under the per se rule used for ties b/c both practices involved the extension of economic power from one market to another

o See also Key Enterprises, (11th Cir. 1992): Held reciprocity agreement between hospital which required EEs to recommend durable medical goods to patients from hospital’s JV partner constituted §1 Sherman Act violation & §2 Attempted monopolization violation

o Other Courts: Apply ROR, require MP showing, and proof of reciprocity agreement

Procompetitive Uses?o Merge two sales into single transaction can reduce cost of using

the marketo Can also yield efficiencies in distribution

E.g., Firm A conditions its purchase of Firm B’s product on Firm B taking a certain amount of A’s product. So, when Firm B ships, A buys and uses same vessel sends its goods back to B

o Guarantee Output Requirements Helps firms guarantee their market share in advance Also increases the cost of buyer cancelling order

o Spartan Grain: Defendant acted as a broker for baby chicks; but, refused to act as broker for egg producers not using its feed charge of reciprocity

o Betaseed, (9th Cir. 1982): Producer of sugar beet seed agreed to purchase sugar beets only from farmers who used its hybrid seeds

Purpose: Quality Control And note, before condemning, D could have planted

itself or K’d w/ farmers to do so Facilitating Price Discrimination w/o Violating Robinson-Patman

o Instead of charging different prices to buyers, agree to buy items from them at a premium to offset their purchase price

o See also Cartel / Oligopoly / Concentrated Market Cheating: Through reciprocity, cartel member can cheat by offering rebate to buyers in form of purchased from them at a premium

o See also Regulatory Firm: Can enter the same agreement to either cheat up or down on its regulated price depending on what is being purchased, from whom, and whether at premium or discount

o Thus, to the extent that reciprocity agreements have an effect on collusion, they appear to undermine it more so than to facilitate it

o Accordingly, a court that condemns a reciprocity agreement is more likely shoring up a cartel or oligopoly that might otherwise fall apart

Exclusive Dealing Exclusive Dealing: Requirements contract, where buyer promises to buy its

requirements of one or more products exclusively from a particular sellero C.f. Output contracts: Often treated as exclusive dealerships—or

promise by supplier that its entire output in that area will be sold through a single dealer

Legal Prohibition:o §1 Sherman Acto §3 Clayton Acto §5 FTC Acto New Development: §2 Sherman when firm imposing it is

monopolist Advantages to §2 Approach

o (1) Exclusive dealing is likely to be anticompetitive only when the firm is fairly dominant in that market

52

o (2) While §2 assesses a higher market power requirement, it is less categorical about doctrine, asking only whether a practice is unreasonably exclusionary

o (3) Doesn’t require an agreement element; thus, a monopolist who unilaterally refuses to sell to another firm using a competitor’s product doesn’t fall under §1/§3

Anticompetitive Foreclosure and its Variation Foreclosure Theory of Exclusive Dealing

o Standard Stations, (U.S. 1949): Court found contracts illegal under “foreclosure” theory, where independent retailers agreed to buy all their gasoline from one refiner and no where else and collectively foreclosed 6.8% of the gasoline market to D’s competitors

o Do Exclusive Ks Reduce Competition? Same agreement against foreclosure theory in vertical

integration apply here Competitive threat, if any, is generally less in exclusive

dealing than in more durable and extensive forms of vertical integration

(1) Exclusive Ks do not give operating rights away to supplier;

(2) Exclusive Ks are of limited term; can compete for renewal

Possible Foreclosureo If upstream supplier is in dominant market position and entry into

downstream market is restricted (e.g., geographical location) may inefficiently foreclose competition

BUT, as long as new downstream facilities can readily be constructed, effective foreclosure is unlikely

Raising Rivals’ Costso Exclusive Dealing may be more pernicious when we look at its

capability to raise rivals’ costso E.g., Standard Oil K’d w/ railroads for preferential scheduling and

lower priceso American Can: Bought up technology so that competitors resorted

to inferior production

Defining Markets to measure Vertical Foreclosureo Premise: before anticompetitive foreclosure can occur, a firm w/

relatively large percentage of the upstream market must foreclose a significant percentage of access to the downstream market

o Example: Major watch manufacturer forms exclusive dealing arrangement where its product will be the only one in jewelry store

Effect: Only if there are no other outlets for distribution to consumers would the watch manufacturer’s competitors be foreclosed

Rule: Even though a channel of distribution may be foreclosed, if there are other efficient channels through which products can be sold likely not “foreclosed”

Vertically Related Markets Can Be Different Relevant Markets:o E.g., the only hospital in town = regional monopolisto BUT, the pathologist who contracts with it to review cases

competes with all other pathologists in the area or who could readily move into area

Exclusive Dealing as a Cartel Facilitatoro May facilitate collusion by denying buyers an opportunity to force

sellers to bid against each other Example: If upstream gasoline market is cartelized, then

the use of exclusive dealing agreements can reduce the likelihood and potential frequency of the cartel members bidding with the individual retailers.

Instead, the individual retailers would become “branded” resellers

o Remedy: Limit the terms of the contracts in order to increase their bidding frequency so the benefits (i.e., efficiencies) of exclusive dealing can be retained while cutting down on the competitive threat of harm

53

Difference Between Exclusive Dealing and Tyingo Tying applies to products whereas Exclusive Dealing applies to

firms So, the extent to which a firm can use or sell multiple

brands of the tying product, the less competitive harm tying has on the firm

o See Standard Stations [Frankfurter]: While tying “arrangements serve hardly any purpose beyond the suppression of competition” exclusive dealing can create efficiency in the market by insuring buyer has guaranteed sales, helps determine output, enables long-term planning on the basis of known costs…

o THUS, Exclusive Dealing gets Rule of Reason, whereas Tying gets per se

BUT, §3 of Clayton Act doesn’t provide any basis for the distinction

o Tying and Exclusive Dealing Can Be Blended: Ex: Retailer agrees to exclusive deal but as a condition is

also required to advertise for the seller’s producto Franchise Agreements:

In most franchise arrangements, ties and exclusive dealing perform the same economic function

Courts have distinguished the two, however, and apply a more lenient test to exclusive dealing once they have characterized the arrangement as such

Chief Difference: In exclusive dealing court finds no distinct tying product

See, e.g., Jefferson Parish [O’Conner]: Once O’Conner determine that anesthesiology and surgical services were not “separate products” so continued on an exclusive dealing analysis of the arrangement

o Tying in Exclusive Dealing Agreements Tying products exists even in exclusive dealing

arrangements—namely, the right of retailer to sell supplier’s merchandise and perhaps to display a sign showing itself to be an “authorized dealer”

Such right is worth more to high volume seller than low volume seller exclusive dealing can be used to facilitate price discrimination just like tying

Efficiency Explanations and Defenses for Exclusive Dealingo (1) Reduce market risk by guaranteeing supply and demand at least

to a certain extent

o (2) Allow the benefits of vertical integration but without the capital investment costs of vertical integration and without reducing the number of small businesses in the retail market

See, e.g., Justice Douglas Dissent in Standard Stations: If no exclusive dealing suppliers will just move into and dominate the retail market as well

o (3) Avoid freeriding For example, if Standard Oil licensed a new gasoline

station and made some capital investments in the form of free road maps, dealer financing, and equipment acquisition, and the dealer then purchased gasoline from another supplier, that second supplier, without any investment would be benefitting form Standard’s investment

Legal Standard for Exclusive Dealing Contracts o Tampa Electric, (1961): Have to determine relevant market, show

how the practice in question served to foreclose rivals, and what portion of the market was foreclosed

o Relevant Market for Determining Foreclosure: Market that the restraint is alleged to affect

Also, subtract out parts of the market that are denied to competitors for other reasons

o Share of Market Foreclosed: Generally all courts today follow Tampa’s suggested

ROR approach

54

Foreclosure necessary to avoid Sum J for D is about 30 – 40%

Once foreclosure is found court looks at factors spelled out in Tampa opinion

That is, whether any procompetitive justifications justify the foreclosure

o FTC Has Been More Aggressive: Toys R’ Us: Condemned output agreement on market

shares of 30% or less Special Characteristics: Highly differentiated

product market not all toys compete directly probably higher foreclosure than aggregate market of 30% + no real justification for the requirement not to sell to discounters

o Per Se Analysis of Foreclosure Amount See, e.g., Ryko Mfg. Co., (8th Cir. 1987): Where the

degree of foreclosure caused by the exclusivity provisions is so great that it invariably indicated the supplier imposing the provisions has substantial market power, we may rely on the foreclosure rate alone to establish the violation. However, where as here, the foreclosure rate is neither substantial nor even apparent, plaintiff must demonstrate that other factors in the market exacerbate the detrimental effect of the challenged restraint

o Rule of Reason When Sufficient (but not gross) Foreclosure: Tampa: (1) Duration of the Ks; (2) Likelihood of

collusion in the industry and degree to which other firms in the market also employ exclusive dealing; (3) Height of entry barriers; (4) Nature of the distribution system and distribution alternatives remaining after taking into account exclusive dealing; and (5) Other obvious anti- or pro-competitive effects

Pro Competitive Effects Courts have Cited: Prevention of free riding and encouragement of the dealer to promote supplier’s product more heavily

o Exclusive Dealing and Monopoly Pricing Exclusive dealing should be condemned only when it

facilitates monopoly pricing and this is not likely to occur if entry is easy

Thus, there must be sufficient free capacity at either both levels of distribution, or enough capacity in at least one to facilitate competitive entry

C.f. If two-level entry is the only option must consider whether this rises to level of substantial barrier under the 1992 Horizontal Merger Guidelines

o FTC’s Current Approach: More recent trend has been to adhere more closely to

Sherman and Clayton Act standards, BUT to take market imperfections and product differentiation more seriously

This is consistent w/ principle that more aggressive substantive rules are appropriate when remedies are limited and the rules cannot be enforced by private parties

Ch. 11 – Intrabrand Restraints on Distribution Introduction Perceived Competitive Threats of Minimum Resale Price Maintenance

(RPM) and Vertical Territorial Restraintso Introductiono Vertical Restraints as Collusion Facilitators; Powerful

Individual Dealers Dealer Power; Policy Implications Manufacturer Collusion and Vertical Restraints

o Foreclosure Effectso Third Degree Price Discrimination

55

o Other Theories Vertical Restraints and Efficiency

o Free-Rider Problem Economics of Vertical Restraints to Combat Free

Riding Domain and Efficiency of Vertical Restraints to

Combat Free-Ridingo Variations on the Free-Rider Problem and Alternative

Explanations Purchase of Preferred Distribution Services; Shelf

Space; Quality Certification Facilitating Resale Density Facilitating Supplier Entry Protection of Dealer Margins; Enforcement of

Distribution Contractso Vertical Restraints and Efficiency Reconsidered

The Agreement Requirement in Vertical Restrain Caseso Agreements—Horizontal and Vertical; Price and Non-Priceo The Colgate Doctrineo Dealer Terminationso Agreement Requirement and AT Policy Respecting Vertical

Restraints; Restraints Initiated by Powerful Dealers Resale Price Maintenance in Courts

o From Dr. Miles to Leegino Meaning of “Resale”—Consignment Exceptiono Maximum RPMo Difference Between Price and Non-Price Agreements

Vertical Nonprice Restraints Under the Rule of Reasonso Balancing Intrabrand and Interbrand Competitiono Sylvania’s Impact in Lower Courtso Boycott Claimso Exclusive Dealerships, Sole Outlets, and Refusals to Dealo Deal Distribution

Conclusion: Rule of Reason for Distribution Restraintso General Policy Concerns o General Efficiency of Vertical Integration Not Decisiveo Rejected Approacheso Rule of Reason Inquiry Summarized

Ch. 11 – Intrabrand Restraints on DistributionIntroduction

Section deals w/ two broad categories of vertical integration by contract:o (1) Vertical price fixing, i.e., Resale Price Maintenance:

Manufacturer or supplier regulates price at which a product is resold by independent dealers

o (2) Vertical non-price restraints: E.g., territorial divisions, customer restrictions, supply

restrictions, etc. “Intrabrand” Connotation:

56

o Denotes that the restraints regulate a dealer’s sale of a single brand without creating limitations on its sales of brands of other suppliers

C.f. Interbrand Restraints:o Distribution restraints that limit the way downstream firms can use

brands made by someone other than the firm imposing the restraint See, e.g., Exclusive Dealing & Tying (supra)

Applicable Law:o Intrabrand: §1 Sherman Acto Inter-brand: §3 Clayton Act

Possible Combination:o Dealer might place a vertical territorial limitation on a dealer

(vertical Intrabrand) as well as a requirement to deal only in that supplier’s products (vertical Interbrand restraint)

Terminology for this Chapter:o *** Vertical Restraint = an Intrabrand Vertical Restraint

Controlling Precedent and Lawo Until fairly recently, the two sets of practices were governed by

two different legal standardso Today, however, all are governed by the ROR, although

application may vary depending on the type of restrainto Major Developments:

(1) Sylvania, (U.S. 1997): Held that Congress’s repeal of a statute enabling Intrabrand RPM in 1975 signified approval of a per se analysis of vertical price restrictions

(2) Leegin, (U.S. 2007): Rejected Sylvania and held that ROR applies

Perceived Competitive Threats of Minimum Resale Price Maintenance (RPM) and Vertical Territorial Restraints

Introductiono Reasons Courts Have Suggested for Restricting RPM

(1) Permits manufacturer to take advantage of retailers and deny them the freedom to set a price most advantageous to them

(2) Acts as a manifestation of price fixing among retailers who have involved the manufacturer in the agreement so it can help police the cartel

(3) A variation on (2), where a dominant retailer insists on RPM so it can control the prices of its rivals

o Skepticism of Theories First, manufactures pay to have their product distributed

in the form of the markup between the sale price to the retailer and what the retailer charges

Further, manufacturers want to keep distribution costs to consumers as low as possible

Therefore, if the retailers costs of distribution are $1 and the profit maximizing price to consumers is $8, then the manufacturer will sell wholesale at $7 to retailers

If the retailers are competitive they will sell at $8 = the consumers profit maximizing price

Moreover, if the manufacturer sells to the retailer at any price less than $7 but forces the retailer to still charge $8, then any surplus between cost to retailer and cost to consumer remains with the retailer

Vertical Restraints as Collusion Facilitators; Powerful Individual Dealers

o Second argument above is that retailers could use RPM viz. the manufacturer to engage in price fixing

Because retailers don’t normally deal with each other but do all deal with the manufacturer can disguise the agreement element

Further, under Colgate, manufacturer is allowed to set unilateral restraints on the conditions under which it will deal no AT violation

o Criticism:57

BUT, in order for an Intrabrand RPM to successfully allow retailers to charge supracompetitive prices for the product, the manufacturer itself needs to have enough MP to charge supracompetitive prices, too

That is, if Sylvania only had 5% of the relevant market and attempted a price increase, customers would substitute to Sony or Vizio

Likewise, at the retail level, unless the other suppliers are enforcing supracompetitive RPM, consumers will substitute to a competitor

C.f. Interbrand Cartel Vice Versa, if Sylvania was a monopolist and capable of

charging supracompetitive prices itself, then Intrabrand RPM would only bolster this effect

o In Practice: RPM and vertical territorial restrictions can be evidence of retailer collusion only if

(1) Manufacturer imposing restriction = monopolist in retailer’s relevant market; or

(2) Restriction is used by a very high percentage of manufacturers in the market

o BUT, in Most Big Vertical Cases SCOTUS Has Heard: Products at issue were those produced by manufacturers with relatively small market shares, and there was little evidence that manufacturers of the same product were imposing similar restrictions

See e.g., Monsanto, (U.S. 1984): D’s market share in corn herbicides was 15% and in soybean herbicides 3%

Sylvania, (1977): D’s national market share was less then 5% and its market share in the restricted territories involved in litigation was 2.5 and 15%

Sealy, (U.S. 1967): Aggregate market share of manufacturers was 20%

FTC Magnavox Investigation, (FTC 1971): D’s market share was found to be about 9%

o No Economic Reason for Manufacturer to Facilitate Retailer Cartel:

Creates double marginalization problem: Monopolist charges its profit maximizing price, retailers add their spread on top, and overall output is reduced thus circling back and harming manufacturer

Alternatively: Manufacturer whose retailers can charge supracompetitive prices, can instead just charge the retailers supracompetitive prices and avoid the double

marginalization issue all together and keep all of the monopoly profits

E.g., by substituting retailers or by vertically integrating

And, if retailer cartel pushes back, manufacturer can just report them to DOJ

o Analogous Reasoning to Vertical Territorial Restrictions: Here, retailers would also prefer that the territorial

allocations are made by the Manufacturer See Topco, (U.S. 1972): Court held that per se

rule applied to D’s distribution scheme as a “horizontal” agreement to allocate market territory among Topco members

Thus, since 1977, vertical territorial allocations have been analyzed under ROR, whereas horizontal allocations are per se illegal

No Economic Justification: Just as above, the manufacturer could earn more by selling to additional outlets in the territories or by opening up its own outlets

o However, Cannot Completely Dismiss Possibility of Anticompetitive Restraints and Collusion

See, e.g., Dr. Miles, (U.S. 1911): First decision condemning RPM was byproduct of one of the biggest cartels in U.S. history—an agreement by members of a national association of wholesale and retail druggists to fix the price of proprietary medical drugs

o Effective Retailer Collusion: When suppliers cannot evade dealer collusion, it is likely

when economies of scope at the retail level make single-brand distribution impracticable

Example: Monopolist bow tie maker’s product would do poorly at a retail level in a store that only sold these bow ties. Thus, vertical integration is not an effective solution. Like a network market where a product is bettered by additional participants, the monopolist bow tie maker needs its product to be at the retail level where

58

complementary products are efficiently available for consumers

Thus, this bowtie monopolist may be forced to acquiesce to the retailers’ double marginalization of its products

o Dealer to be Weary Of? Likely to be multibrand stores and the affected products

are most likely to be those that cannot easily be sold by a single brand or single product store, and thus lack power to discipline retailer

Dealer Power; Policy Implicationso Chicago School: Advocates for per se Legality

Justification: Retail stores generally don’t require any specialized building or productive assets, and stores selling one set of products can easily move to 2

Further, manufacturers can always move into retail if a dominant retailer is subjecting them to double marginalization

o Criticism: Overlooks primarily that large box stores have reached

certain efficiencies that manufacturers themselves might not be able to easily merge into

Furthermore, if there are multi-brand scale economies in retailing, individual retailers may have significant leverage over suppliers simply in the way they promote individual products

o Further, little reason for thinking dealer collusion is unusually easy to detect

First, horizontal price fixing is illegal per se and for that reason is ordinarily kept secret

Second, certain kinds of price fixing don’t require explicit agreement among dealers, but can be accomplished through informal or tacit communications not reachable under §1

Collusion of this kind can be facilitated by RPM Concentrated retail markets are particularly

conducive to oligopoly coordination b/c public advertising is the only effective way of communicating price

Third, When restraints are solicited by a powerful single retailer, there is no horizontal cartel agreement at all

o In this case, what should ROR Address?

(1) Market power of those imposing the restraint Dealer must deal in multiple brands and this

must be necessitated by distributional economies When a product must be sold by a large

multibrand store, tables are turned b/c manufacturer shutting off supply only injures itself

(2) Product must be one that can be sold at a supracompetitive price

That is, must have some kind of dominance within a properly defined retail product market

Important question focuses on the product’s share in the municipality or other geographic area where the retail customers shop and can seek out alternatives

And, supracompetitive pricing needs to be just enough to make a profit: possibly 40-50%

(3) Size of dealer =/= material Even if the dealer is small, it can still bottleneck

the supplier in the relevant area BUT, must have certain dominance in sales of

the good subject to the restraint E.g., 50% Market Share

(4) Whether dealer sells in different markets and replacing such dealer would be costly to supplier

E.g., Nationwide or regional chain of department stores with 50 or more well placed stress, means a supplier wishing to switch would have to find alternative outlets in all 50 areas

o Effect of RPM Under These Conditions: If dealer is highly desired by customers, RPM could

enable it to increase its own market share even as overall output is reduced in a particular market

That is, stores with less prestige compete on price. If the powerful dealer can get RPM in place, then shoppers are going to go to whichever store they find more attractive. Since major dealer will already be popular and carry large selection, it’s likely customers will go

59

there, all things being equal on price

Manufacturer Collusion and Vertical Restraints Vertical integration can enable a cartel to police

its members more carefully Sales made to wholesalers or distributors are

generally large, secret, and individually negotiated

o Cartel members thus have incentive to cheat, generally, by providing extra services, engaging in reciprocity, or providing secret rebates

o And, since chances of detection increase w/ the number of cheating sales, it is important that each sale be large

Retail prices, on the other hand, are publicly broadcasted ad relatively standardized at particular locations and individual transactions are small

Thus, by imposing RPM or territorial restrictions on retailers, a manufacturers’ cartel may be able to monitor prices and number of sales at the retail level to detect cheating

Foreclosure Effectso [Sweeten the Pot in order to get Exclusive Dealing]o Might facilitate a dominant manufacturer’s scheme to limit rivals’

ability to find suitable dealerso Success of scheme, however, depends on entry barriers in dealer

market and market share of the scheming dealero Although Tying and Exclusive Dealing are better ways of

excluding competitors from the retail market, vertical RPM or

territorial allocations might be an effective way of compensating desirable dealers for taking the next step and also agreeing to an Exclusive Dealing arrangement

Third Degree Price Discriminationo The biggest problems with price discrimination are:

(1) The cost and difficulty of identifying and segregating groups of customers; and

(2) Preventing arbitrageo Vertically imposed territorial or customer restrictions can enable a

manufacturer to solve both these problems Example: Manufacturer of disinfectant w/ enough market

power sells to two retailers, each of which is limited in territory and customer class. One sells to hospitals who lack effective substitutes at a high price and the other sells to restaurants at a more competitive price

Result: The classes self-segregate and neither has reason to know the other is getting a different deal

Alternatively: Manufacturer could sell directly to hospital and sell to one retailer who supplies the restaurants

o Should this be condemned? Really turns on whether there is a lot of wasted cost in

facilitating the discrimination or if there is a reduction in output in the relevant market

Otherwise, if rivals aren’t being excluded and output in the market isn’t decreasing, then the only real condemnation is sapping up consumer surplus from this high affinity group

Vertical Restraints and Efficiency Free-Rider Problem

o Most RPMs are entered into to in order to increase output by encouraging retailers to market the manufacture’s product more aggressively and efficiently

o Free Rider Problem:

60

In order to compete effectively, a manufacturer must be able to inform consumers about its product and advertise it to them in an attractive manner

Thus, if Firm A builds into its cost of goods sold the relevant advertising and consumer goodwill it builds for the manufacture’s product although the price is higher, output increases

However, if Firm B moves to town, sells all of the same products, but makes none of the investment in advertising and developing goodwill, thus allowing it to charge a lower price than Firm B Consumers will go to Firm A to get their information; and, then, go to Firm B to make their purchase

Eventual Result: Firm A will either go out of business or cease its investments in advertising, information, and developing goodwill for the manufacturer’s products as a result, overall output will decrease because demand for a product consumers are uninformed of and unfamiliar with will decline

o Combating Free-Riding With RPM If RPM is in place Both Firm A and Firm B will have

to charge the same price Thus, consumers will then prefer the Firm that provides

some non-price fringe that they enjoy Accordingly, both Firm A and Firm B will have incentive

to compete on advertising, information, and developing consumer goodwill for the manufacturer’s product in order to drive consumers to them over their competitor

o Similar Analysis Applies to Vertical Territorial Restraints If manufacturer terminates dealings with the cut-rate firm

and only sells to Firm A within a particular exclusive territory Firm A no longer faces competition from Firm B but Firm A still competes with other dealers in other manufactures’ competing goods

o Domain and Efficiency of Vertical Restraints to Combat Free-Riding

Where RPM Fails: Assume manufacturer imposes RPM Instead of offering any key benefits, however,

Firm B now throws in a free item (e.g., a free

TV) and thus reduces the net cost of the vehicle to the consumer notwithstanding the RPM

Some Products are More Susceptible to Freeriding: (1) Greatest in “Brand-Specific” markets

o E.g., customer is going to need to inform herself before choosing between a Ford, Chevy, or Dodge

o C.f. RPM for fungible products, e.g., potatoes, makes little sense under this rationale

(2) Greatest in markets for complex or new products where customer education is particularly important

o But note: Sometimes even relatively simple commodities are subject to this kind of freeriding

o That is, where information is needed prepurchase and some retailers provide this while others only provide a lower price

Variations on the Free-Rider Problem and Alternative Explanationso Purchase of Preferred Distribution Services; Shelf Space;

Quality Certification

61

Competitive explanation for vertical restraints in products that appear to require no point-of-sale services have been manifold

Many products sold subject to RPM but where point-of-sale services seem insubstantial all share one characteristic: economies of scale or scope at the retail level demand that they be sold by multi-brand or multi-product retailers

E.g., an independent Levi store probably wouldn’t be successful

BUT, using a department store like Macy’s is likely efficient and reaches more consumers

By using RPM, Levi can incentivize Macy’s to exercise its discretion in a favorable fashion to create attractive displays, place in a favorable location in store, and incentivize employees to sell the product to customers shopping

o Facilitating Resale Density Some customers are willing to travel further than others to

get a discount, whereas others are willing to buy at the higher price but from the closer location

Through RPM, resellers both near and far from customers sell at the same price makes it profitable for both groups of stores to sell the papers and if customers can’t find a better price, then the issue of having to drive elsewhere is also eliminated and can increase overall purchases

o Facilitating Supplier Entry Can also be used to facilitate entry E.g., for a new product, some retailers may want

assurances (i.e., a reduction in transaction costs and risk) that their carrying of the product will result in sale

Note also: As a matter of inertia, once these retailers have RPM and making profit, they’re not likely to want to switch to a different regime

o Protection of Dealer Margins; Enforcement of Distribution Contracts

RPM and vertical restraints may serve to ensure that dealers earn positive profits by protecting them from significant Intrabrand competition

Effect of the profits is that terminating of a dealership is costly to the dealer, thus giving it a powerful incentive to honor the terms of whatever contractual understanding it has with the supplier

Likewise, providing the profit margin benefit and reduced intrabrand competition can be used to induce the dealer to carry a full line—even of unsuccessful products

E.g., when books are published, unclear which ones will be stars and which ones will flop

RPM and vertical restraints can induce the dealer to carry the full line so that each product has an opportunity to catch on

Vertical Restraints and Efficiency Reconsideredo Even a vertical restriction that increases output can be inefficient

E.g., some customers need information at point of sale whereas a much large class of consumers already value the product highly

By implementing RPM and vertical restraints to increase information at point of sale, those costs are built into price

Thus, while there’s more output in the market, consumer surplus is being drained for a smaller amount of new adopters

The Agreement Requirement in Vertical Restrain Cases Agreements—Horizontal and Vertical; Price and Non-Price

62

o Both RPM and nonprice restraints are challenged under §1 Sherman Act as contracts, combinations, or conspiracies in the restraint of trade

o However, a purely unilateral decision to impose restraints to those you sell to =/= reachable by §1

o Vertical Agreements are Conceptually Distinct from Horizontal

Suppliers deal with dealers on a regular basis and it is expected for the two to reach agreements for sale and distribution

On the other hand, competitors meeting together to discuss market prices is basically a per se violation

Thus, in vertical restraint cases, the focus tends to be on the content of the agreement, whereas in horizontal cases focuses is on existence of agreement

o Vertical Restraints Today Most vertical agreements of both price and nonprice

varieties are presumptively legal, with exceptions only for those that represent unreasonable exercises of unilateral or collusive power

Moreover after Leegin, likely to see more RPM

The Colgate Doctrineo Colgate, (U.S. 1919): Sherman Act =/= designed to restrict the

long recognized right of trader or manufacturer to announce in advance the circumstances under which he will refuse to sell

Thus, when a manufacturer simply announces its intention not to deal with price cutters and dealers respond by not cutting price no violation b/c no agreement

o Monsanto, (1984): Court expressly refused to overrule Colgate, and went so far as to say that an agreement could not be inferred from the fact that a supplier terminated one dealer in response to a second dealer’s complaints about the first dealer’s price cutting

o Colgate & RPM: Colgate seems to permit vertical restraints only where the

level of vertical integration between the manufacturer and the dealer is very small (i.e., in Colgate there was no agreement, just a unilateral refusal to deal to unfavorable retailers)

As a result, Colgate approved RPMs are most available in situations where RPM is least valuable-=where there is no organized distribution system at all

Dealer Terminationso Monsanto: S. C.t affirmed 7th Cir’s finding of liability against D,

but held that a court could not infer the existence of an RPM agreement “merely from the existence of complaints, or even from the fact that the termination came about in response to complaints.”

Rather, evidence must show “a conscious commitment to a common scheme designed to achieve an unlawful objective.”

o Monsanto Doctrine: Applies to dealer initiated restrictions as well as those that originate with the supplier

o When is Dealer Termination Result of Agreement? Retailer A tells Supplier X that Retailer B is cheating and

A will stop dealing X’s product if X doesn’t discipline A Quid-Pro-Quo?

If X prefers having both suppliers, but A’s position in the market makes X prefer A to B may be consideration for the agreement; i.e., X terminates B and A deals X’s products

o So, is A a highly sought after dealer?o That is, will X pay a premium for A?

Retailer Position: If A has limited MP but makes up 200 stores in

200 areas and B is only one discounter A may not have more MP than B, but the administrative costs to X of finding someone to replace A vs. cost of terminating B are high

See, e.g., Lock-in / Switching Costs Supplier’s Independent Best Interests?

What would supplier’s best interest be on the assumption hat some generic dealer, totally lacking in MP had made the complaint?

See, e.g., Apple Comp., (9th Cir. 1986): Apple met this test when it convinced court that its ban on law price mail order sales was necessary because it believed that optimal customer education require a face-to-face transaction

In this regard, probative evidence should include: Facts tending to show supplier employs same distribution restraints elsewhere and that it has disciplined dealers for similar violations where no inference of agreement was warranted

63

Should also consider validity of reasons advanced for terminating plaintiff

o Inferring Agreement from Dealer Complaint Post-Monsanto Murray Biscuit Co., (7th Cir. 1986): No agreement where

dealer complained about competitor’s low prices but did not ask supplier to change any prices or agree with it on price

Other courts: No agreement can be inferred if the record suggests that, even though a dealer complained about price, the supplier’s concern was not price but rather the level of the terminated dealer’s promotional services or investment in supplier’s product

Still others: Termination shall be regarded as unilateral whenever it is justified by independent business reasons, regardless of the price motive of complaining dealer

But see Group of Dealers Acting in Concert: Courts have readily found agreement when complaints came from a group of dealers whoa appeared to be acting in concert

Nonetheless, the termination still has to be the product of agreement, and not an independent judgment by the supplier terminating the dealer

Further Agreement where supplier returns to dealer and reports that the corrective action has been taken

Agreement Requirement and AT Policy Respecting Vertical Restraints; Restraints Initiated by Powerful Dealers

o Agreement requirement can help distinguish between competitive and anticompetitive uses of vertical restraints

o As a general matter, supplier’s interest lies in maximizing output, which it does when dealers supply optimal mixture of price competition and dealer services

o C.f. powerful dealer’s interest lies in protecting itself from price competition from other dealers

Thus, a restraint initiated by a dealer and that results from powerful dealer pressure placed on a supplier can be regarded as contrary to the supplier’s independent best interests

In that case, agreement requirement is clearly met, and if dealer power is proven, anticompetitive effects can be presumed as well

Resale Price Maintenance in Courts From Dr. Miles to Leegin

o Dr. Miles, (1911): Held that a K between a manufacturer and a dealer, requiring dealer to resell manufacturer’s product at a

64

specified price was unenforceable because it was contrary to the policy of the Sherman Act

Came to be read as a per se prohibition on RPMo Leegin, (U.S. 2007) [5-4 Decision]: Overruled Dr. Miles

Court turned to economic literature and found that effects of RPM were frequently analogized to the effects of vertical nonprice restraints, which had been subject to ROR analysis since Sylvania (territorial restraint)

Economic Considerations: Pro: RPM can increase Interbrand competition

by encouraging retailer services that would not be provided even absent free riding

Con: Could be used to facilitate dealer collusion, or to impose higher consumer prices at behest of a powerful dealer who demands manufacturer stop serving or discipline its price cutting competitors

Meaning of “Resale”—Consignment Exceptiono Under Dr. Miles, per se rule against resale price maintenance was

applied only when the supplier sold a god to the dealer and the attempted to regulate the price at which the good was resold

o Thus, if nothing was resold rule didn’t apply See, e.g., General Electric, (U.S. 1926): Court held Dr.

Miles didn’t’ apply to a consignment agreement in which retailer is manufacturer’s agent rather than a purchaser and reseller and tile remains with manufacturer

o But see Simpson, (U.S. 1964): Overruling General Electric Court held that a consignment agreement couldn’t exist

where a large manufacturer had large distribution networks

o Procompetitive Justifications of Consignment: (1) Can allow retailers to obtain inventory w/o tying up

capital or credit; (2) Can permit certain suppliers to reach a market more

efficiently—especially where demand for a product is unknown or the product is perishable

Seller has sunk costs and retailer incurs little risk (3) Otherwise unattractive items to dealers are given

second looko Anticompetitive Uses of Consignment

Can’t allow consignment as exception to unreasonable RPM

o Potential Rule:

Allow consignment exception where economies of a particular distribution system justify a relationship in which manufacturer bears an unusually high portion of the risk of nonsale

Maximum RPMo Procompetitive Justifications:

Allows manufacturers to control chronic price fixing by dealers

Can force a dealer to set a price closer to the competitive level and preclude output reductions of the supplier’s product at the retail level

o State Oil v. Kahn, (U.S. 1997): Eliminated per se rule against maximum resale price maintenance

Court looked to Posner’s reasoning in 7th Cir’s opinion: Under max RPM, unless supplier is monopolist,

cannot squeeze dealers to margins below a competitive level b/c the attempt to do so would drive dealer to arms of competing seller

BUT, supplier might impose Max RPM to prevent a supplier from taking advantage of a geographic monopoly

Additionally, Court recognized that effect of the per se rule against Max RPM is integration of suppliers into the dealership level at the expense of independent dealers

o Potential Challenges to Max RPM (1) Kahn only applies to vertical max RPM; any

horizontal agreement to fix prices among competitors still = naked price fixing

(2) Under ROR, plaintiff will have to define relevant market and show requisite market power

E.g., If Max RPM is alleged to be facilitating a predatory pricing scheme, then relevant market will be the product subject to the restraint

C.f. If Max RPM is alleged to be part of monopsony relevant market will be one for distribution services with the allegation being that max RPM is a mechanism for forcing a distributor or reseller to accept less than the competitive return as reward for selling D’s product

Difference Between Price and Non-Price Agreements

65

o Even after Leegin, price, as opposed to non-price, restraints may be treated more harshly

o ROR is concerned with conduct that tends to reduce market output below competitive levels in order to push up prices

Vertical Nonprice Restraints Under the Rule of Reasons Sylvania: Possibility that nonprice vertical restraints, while lessening

intrabrand competition, could increase Interbrand competition provided justification for overruling Schwinn and holding all nonprice vertical restraints subject to ROR

Balancing Intrabrand and Interbrand Competitiono In determining whether ROR favors affirming or rejecting a

nonprice vertical restrain, court has to determine whether the net effect is procompetitive

o BUT, Questions under Sylvania Remain: (1) What does it mean to say that intrabrand competition

is lessened (2) How does a court balance an increase in Interbrand

competition against a decrease in intrabrand competition?o Market Power Overlooked?

In Sylvania, D had only a 5% share To suggest that it could reduce output and increase price

is empty so too is the suggestion that through nonprice vertical restraints it can lessen intrabrand competition

E.g., had Sylvania miscalculated the appropriate nonprice vertical restraints competitors would have filled the gap and overall TV output likely would not have been reduced

Today, several Circuits hold that intrabrand competition cannot be “lessened” at all unless the manufacturer imposing the restraints has market power

Even where D = Monopolist, must determine how it will increase profits by imposing the nonprice vertical restraints

If D is imposing the restraints to keep leverage over dealers effect is actually to increase output

o What Was the Court Talking About: Balancing Intrabrand and Interbrand:

First, if intrabrand competition is actually reduced (i.e., the retailers/manufacturers are able to charge above marginal cost for the product) how is this going to cause

Interbrand competition to increase (i.e., more dealers charging closer to marginal cost)?

Therefore, if the restraint is going to increase Interbrand competition, it is actually also going to increase intrabrand competition because less dealers are going to be double marginalizing the product to consumers

o Therefore, Presumption Should be in Favor of Nonprice Vertical Restraints, Except When Plaintiff Can Show…

(1) Interbrand collusion, either at the dealer or manufacturer level;

(2) Restraints posed at the behest of a powerful dealer; or (3) That the supplier has market power and the restraints

are being used to facilitate intrabrand collusion or inefficient price discrimination

Sylvania’s Impact in Lower Courtso (1) Is there a qualifying vertical non-price restraint?o (2) Plaintiff needs to define at least some relevant market (although

the inquiry is less strict than in merger or monopolization cases)o (3) If D has sufficient MP courts look to D’s explanation for the

restraint. If there is a “valid business reason” often counts heavily in favor of legality

Top defenses include: making dealers more efficient, encouraging optimal range of dealer services, or eliminating free riding

Evaluating veracity of defenses: Was the conduct unilateral? In the best interests

of the supplier? Should the restraint at issue be considered

nonprice? Is the defense such that court can overlook effect on price?

Do other dealers operate in this fashion? Each ROR case kind of creates per se permissibility

o (4) Unless there is a strong showing of anticompetitive effects likely hold in favor of D

Boycott Claims

66

o Many Ps have tried to avoid Sylvania’s liability defeating ROR by characterizing D’s refusal to deal or dealer termination as a boycott

o Per se Boycott Liability: Must be Horizontal Agreement between competitors at

one level of distribution not to deal w/ a buyer/seller on another level

Or, where two or more dealers agree to convince supplier to terminate another dealer

o Vertical Refusal? Application in vertical context destroys Sylvania See, e.g., NYNEX, (U.S. 1998): Agreement between a

single utility and a single supplier of services to the utility could not be unlawful per se

Even if there was no valid business justification, per se only apt if two or more competing firms agreed with each other to exclude someone else

o BUT, What Constitutes Horizontal Agreement? E.g., If competing dealers make a joint appeal to a

supplier because another is free riding, then does it really rise to the level of agreement?

See, e.g., Monsanto: Is there any independent business justification for the termination?

Also, Could argue that the “agreement” AT harm lacked causation b/c supplier would have fired dealer in absence of collective appeal so long as information about free riding was correct

Exclusive Dealerships, Sole Outlets, and Refusals to Deal

o Potential For Abuse? Only where the supplier has Interbrand market power

o But, even where D has significant market share, appointing a single dealer in a territorial restraint =/= per se anticompetitive

o E.g., If D = monopolist supplier and it sells to a monopolist dealer raises double marginalization problem and cuts into D’s profits

See e.g., Double Marginalization / One Monopoly Rent Theorem

But see also Dealer Monopsonist/Dealer w/ MP in relevant geographic area

Deal Distributiono Where manufacturer sells at retail level but also distributes to

competing retailers its manufactured product, are the restrains placed on the sale vertical (ROR) or horizontal (per se)?

o But see Causation: If these are the same restraints that manufacturer could put in place viz vertical restraints, does it mater that it’s operating at the retail level too?

o Further Combating Retailer Collusion Presumption: Manufacturer would not want to spread out its rents across dealers by entering at that level itself

Rather, would likely do so in order to halt dealer collusion

67

Conclusion: Rule of Reason for Distribution Restraints General Policy Concerns

o Don’t oversimplify the matter and think all vertical restraints should be per se legal because there is potential for abuse

o Further, efficiency isn’t the primary concern of AT law—its competition Court will invalidate some efficiency creating but competition reducing restraints

General Efficiency of Vertical Integration Not Decisiveo Example of Inefficient Vertical Restraint: Restriction created at

behest of the powerful multibrand dealer If dealer gets supplier to set RPM high sales diminish

overall (but it doesn’t hurt the supplier as badly as losing the dealer) customers pay higher prices and output reduces

Rejected Approacheso Plausible Situations in Which Vertical Restraints can Injure

Competition: (1) Facilitation of supplier collusion; (2) Facilitation of dealer collusion; (3) Accommodation of a dominant dealer in its trade area

o Two Tests that Appear Unworkable: Balancing intra- and inter-brand competition; and Considering ex post whether the restraint increased or

decreased output or market share Causes of the change in MS could be endless and

it is very difficult to apportion the right amount of the restraint as responsible for the change

Rule of Reason Inquiry Summarizedo (1) Why is this particular practice anticompetitive?o (2) Whether D has market power in the properly defined relevant

market or is there horizontal collusion or collusion-like behavior by a group w/ MP in the relevant market?

BUT, MP =/= shown by large market share of a single brand, unless that brand itself has been shown to constitute the relevant market

In providing a collusion-facilitating vertical restraint, P =/= constrained by same “agreement” requirement under §1 Horizontal Conspiracy

That is, usually the qualifying agreement to deal on certain terms satisfies agreement element

And, in order to prove a particular restraint is anticompetitive, P must generally show one of the following:

(a) Restraint is being used to facilitate dealer (downstream) collusion;

(b) Being initiated for anticompetitive purposes by a powerful multi-brand dealer

(c) Being used to facilitate upstream collusion or oligopoly

Note: These factors establish no more that structural preconditions to anticompetitive vertical restraints

Thus, by themselves, =/= establish that a particular restraint is anticompetitive or that collusion is actually occurring

o (3) Once a structural precondition to anticompetitive vertical restraints is shown w/ relevant market power for restraint to be effective, burden shifts to D to show:

(a) Restraint being challenged serves some, concretely identifiable legitimate business purpose; and

(b) No less restrictive alternative to a particle restraint at hand would solve the problem the restraint was initiated to solve

68

Ch. 4: Antitrust Policy Toward Collusion and Oligopoly[Outline]

Introduction: Basic Economics of Price Fixing The (Virtual) Universality of Cartel Cheating

o Divergence Between Cartel and Single Firm Profit Maximization

o Cartel Cheating Strategieso Detecting and Punishing Cheating; Cartel “Amnesty”

Competitive Fringe Firms Internal Efficiencies of Cartel Cartel of Buyers

Oligopoly, Cooperative and Non-Cooperative Non-Cooperative Cournot Oligopoly Cooperative vs. Non- Oligopoly Strategies

Social Cost of Collusion

Antitrust Policy Toward Oligopoly and Tacit Collusion Attacking Oligopoly; The Turner-Posner Debate Identifying Tacit Collusion and Facilitators; Policy Options

Proving Price or Output “Agreement” From Indirect and Circumstantial Evidence

Reaching Oligopoly Behavior on Less Explicit Evidence of Agreement Introduction: Incomplete Agreements Challenging Facilitators Established by Agreement “Unilateral” Facilitators; Base-Point Pricing Schemes Other Facilitators; § 5 FTC Act Motions to Dismiss and Summary Judgment in Conspiracy Cases

Intraenterprise Conspiracy

69

Ch. 4: Antitrust Policy Toward Collusion and Oligopoly

Introduction: Basic Economics of Price Fixing Cartel: Agreement among otherwise competing firms to reduce output to

agreed upon levels, or sell at an agreed upon priceo Firms acting in concert can earn monopoly profits just as a single-

firm monopolist Naked Price Fixing: Where price fix involves no more than an agreement

to restrict output or to raise price with no collateral agreements organizing production or distribution

o BUT, only profitably if firms jointly have the power to raise market prices by reducing output

Penalty for Naked Price Fixing: Criminal and Civil; illegal per se Extra Scrutiny of Cartels:

o Even though they face more structural problems than the single-firm monopolist, there are several reasons for enhanced scrutiny of cartel behavior among horizontal competitors:

(1) Carte can come into existence far more easily Whereas monopoly requires several years of

building market power, a cartel can be formed virtually over night and multiply the MP of the individual firms to the aggregate of all the firms acting in concert w/o regulatory oversight at inception

(2) Because the cartel can easily fall apart (e.g., because cheating is profitable for individual members), cartels also substantially invest (economically wasteful) to preclude cheating

Six Conditions for Cartel to Succeed for Any Length of Timeo (1) Product or service being cartelized must define a relevant

market w/ sufficiently high barriers to entry so that newcomers cannot undermine the cartel’s pricing decisions

o (2) Cartel members must produce a sufficiently large share of the product or service that their decisions are not undermined by existing members outside of the cartel; further these nonmembers must either be unable or unwilling to meet additional demand for the competitively priced good or service post-cartelization of market

o (3) Cartel members must be able to arrive at an agreement about output that each cartel member will product—in most cases, the most important decision variable is output, not price

o (4) Cartel must be able to detect and punish cheating

o (6) Cartel must be able to all of these things w/o being detected from the outside

Optimum Cartel:o Has few members [with clear leader] who collectively account for

100% of production in a relevant market Gives Cartel most leeway in raising prices and reducing

output Too much democracy in cartel makes it difficult to

operate effectively and discretelyo All members = same size and equally efficient and produce

identical products Gives all the members the same profit maximizing price,

which allows them to quite easily agree on output/priceo Product would be sold by sealed auction bids made by sellers in a

market containing many, relatively small purchasers and the winning bids would be publicly announced

Provides effective mechanism for detection of cheating Application of Optimal Cartel to Real World AT

o All markets are different, but some are more or less related to the “Optimum” cartel market

o The more conducive the market is to effective cartelization more that the AT fact-finder needs to be concerned about potential abuse

70

The (Virtual) Universality of Cartel Cheatingo Even in the most effective cartels, an individual cheater stands to

gain a lot if it can go undetected E.g., in a cartel, firms are pricing above marginal cost

In an undifferentiated product market with identical prices for goods/services buyers are rationally apathetic as to which member to buy from

Therefore, if cheater can attract more buyers to itself or make more sales at a slightly discounted rate below cartel price it stands to reap a disproportionate share of the profits

o Divergence Between Cartel and Single Firm Profit Maximization

When a monopolist increases output, the cost of all goods sold decreases and monopolist bears this difference on every good sold

C.f. When the cartel cheater increases output, price drops across the board, but the cartel cheater only experiences the change in price for the fraction of the goods it produces

Example: Firm has marginal cost of $5 and produces 100 units for sale at $10. An additional product will reduce price to $9.90

If Monop increases output --> 101 units x $9.90 price = $999.90 as compared to 100 x 10 = $1,000 w/o the additional unit produced

If cartel member representing equal share in 10 member cartel increases output 11 units x $9.90 = $108.9 vs. 10 units at $10 = $100

o Therefore, Cartel member will increase output in these circumstances unless it is restrained

But see also Economic Inefficiency of Cheating: Under same circumstances, non-cheating

members still produce 10 units but now at $9.90 a piece 90 x $9.90 =$891 vs. 90 x $10 = $100

Thus, non-cheaters experience loss of $9 Cheater, on the other hand, only has additional

proceeds of $8.9 less cost of producing the additional unit $5 = $3.9

o Cartel Cheating Strategies Generally, best way to avoid detection is to generally

charge at cartel price, but look for opportunities to make large, secret sales at a lower price

Chance of detection increase w/ each cheat each cheat needs to be a part of a large transaction to maximize realized net gain from cheat/detection risk

Or, sell if one type of product sale is restricted, reclassify the product and sell in the second market

See, e.g., Trenton Potteries, (U.S. 1927): Cartel required its members to destroy or ship abroad all of its secondary (refurbished) products to avoid creation of a secondary market that cartel members could sell primary (new) products into

But see Vertical RPM: When price competition is eliminated, causes dealers to compete on non-price services; cartel members compete in the same way

o C.f. Dentists Association: When there is no longer price competition for services, there is also no incentive to compete viz. innovation

Finally, can enlist assistance of Government: E.g., Interstate Commerce Act of 1887

condemned various kinds of price discrimination among interstate railroads

Effect may have been to facilitate collusion in railroad industry by prohibiting individual cartel members from making discriminatory (cheating) sales

71

Detecting and Punishing Cheating; Cartel “Amnesty”o Cartel Detection Methods:

Agree on services that can be provided along w/ price fixed product

Agree to destroy secondary goods to preclude secondary market that competes with primary

Making all pricing information public Vertically integrating into retailing so that final output

sales are small (increased frequency) and public (higher likelihood of detection)

o Optimal Cheating Methods can be Market Specific Bidding restriction: In market where members bid for

sales, all members agree to let one member win by bidding a certain higher price than what elected member will bid; if any other member wins bid cheater

Output restriction: In market where gov makes output publicly available, firms can agree to set output (restricted) and market sets price (higher)

Market share restriction: Similar to output restriction, manifests as, although a firm’s market share remains unchanged, their profits increase and output reduces

o Horizontal market allocations [Topco]: Comes in three different kinds:

(1) Territorial Division: Firms divide map and agree that each one will obtain exclusive sale rights in a designated area

(2) Product Division: Firms agree that each will avoid production of a designated product produced by a rival

(3) Customer Division: Firms agree not to compete for one another’s pre-assigned customers

E.g., Can divide market into exclusive zones Effect of Horizontal Division:

Effectively gives each member a monopoly in its territory with a promise of no competitive entry by other members

Thus, allows each member to set their own prices and output w/o issues that plague joint-concert cartel members

Cheating in Horizontally Divided Markets: Further, firms can’t cheat by reducing price;

they’re the only ones in the geographic area That is, only way to cheat by selling into the

territory of another member

However, also means cheating may be easier to detect

Likewise, detection by regulatory authorities and plaintiffs is also easier to detect

o Punishing Cheaters: To successfully punish, cartel must simultaneously (a)

make cheating unprofitable w/o (b) causing public discovery of the cartel

Note also: For cheating to be effective, it has to harm the cheater more than the cheating is beneficial

Thus, early detection is key, otherwise costs of punishment won’t exceed reward of cheating w/o increasing risk of detection

o Possible Methods of Enforcement Non-Cheaters Drop to Competitive Price:

If detection is early and collective action by non-cheaters is possible everyone drops their prices to marginal cost as soon as there is a cheating incident

Effect: No one wants to cheat because then they lose their rents for a period of time

Problems w/ this method:o Costs non-cheaters more than it harms

the cheater Benefits of this method:

o Doesn’t require explicit agreement—as the cheater begins increasing output, others respond to preserve market share.

o Thus, price naturally falls to competitive level

Non-Cheaters Predatorily Price to Eat Up Cheater’s Market Share:

However: Uncommon, highly costly to non-cheaters, and driving cheater out of business completely (as pred pricing can do) invites lawsuit and detection

o Best Method of Enforcement: Raise Cheater’s Costs E.g., if cartel shares a common distribution network

can deny cheater access or some other necessary input for production

72

See, e.g., Summit Health: P alleged that he was excluded from the hospital system because he refused to abide by hospital’s costly second-surgeon requirement

o Finally, see also Facilitating Practices, infra for additional cheating detection method

Competitive Fringe Firmso Thorn in cartel’s sideo Non-participant gets best of both worlds: (1) no possible antitrust

liability for other competitors forming cartel; and (2) gets to increase output and price just below cartel’s price to secure market share and increased profits

o Deterring Non-Members: While predatory pricing, concerted refusals to deal, and

other business torts may be unprofitable to deter cheating, they can be much more effective for attacking non-participants

In fact, many claims alleging these practices arise because plaintiff alleges it is being attacked by firms trying to cartelize market

See, e.g., [Generic Cigarette Case]

Internal Efficiencies of Cartelo Disparate Efficiencies of Production: In a cartel, not all members

are guaranteed to have the same level of efficiency, but they will want any particular sale for itself

See, e.g., [Dentists Association Case]: Once price is set, individuals no longer have incentive to innovate b/c not longer rewarded for superior product

Applied here: Why would a manufacturer want to make additional investments in efficiency when it already will receive a guaranteed price no matter how good its product or manufacturing process is

C.f. May be increased desire in effective cartel to lower marginal costs to increase rents; however, may also have similar incentive to make no investments in process and just raise cost higher

o Example: Cartel members all bid the same price for delivering

manufactured goods to contractor for project All prices being equal, there is a rational apathy in

choosing where the pipe will come from—thus overlooks transportation costs

As a result, furthest and thus least efficient firm may win the bid and reap less benefits from the K than would the closest firm

But see Addyston Pipe, (6th Cir. 1898): Cartel members would first agree to price. Then, members would make internal bids to see who could deliver the largest bonus (i.e., savings from more efficient production) to the cartel by winning the bid. Winner got to keep a benefit from the K and transferred the efficiency bonus to the Cartel to share

o Investments to Detect and Prevent Cheating Unlike monopolist (which has single, firm interest), cartel

is composed of individuals (disparate interests) Thus, absent substantial investment in structural cheating

detection and protections will find themselves negotiating and bargaining more frequently, raising likelihood of detection

Also have less flexibility in coordinating overall production

Cartel of Buyerso Sometimes treated with less hostility than selling

arrangements: Courts sometimes reason that . . . (1) Joint purchases may be efficient because it allows a

less transactions for greater volume, thus reducing transactional costs

(2) Even when a buying cartel is naked, i.e., they do not represent joint purchasing, they result in lower input prices, and some courts have expressed reluctance to the use of AT to challenge lower prices

But see Monopsony: Lower input prices is likely only going to lower cost margins for, and be absorbed by, monopsonist buyer—not likely to be passed to consumers

But note: Likelihood turns on level of MP monopsony has in its resale market

73

Oligopoly, Cooperative and Non-Cooperative Because §1 requires as condition precedent an agreement, and because

members likely to tacitly operate in a cartel or oligopoly may have insufficient MP to satisfy §2’s requirement of monopoly power or dangerous probability of achieving monopoly, a large amount of tacit, yet consumer-harmful, conduct can slip through the cracks

Oligopoly Distinguished from Cartel: o Oligopoly strategies can be more stable and free from incentives to

cheat than cartel strategieso Further, more stable strategies are often those that come furthest

form satisfying §1 Sherman because in such markets, firms do not need to engage in the kind of explicit communication that the law tends to regard as agreement

Non-Cooperative Cournot Oligopoly o General Theory:

Two firms as a duopoly will produce like they are monopolists, where marginal revenue = marginal cost.

The firms, however, will allow the market to set the price. As the duopolists adjust to the others’ production, the

output will eventually stabilize. Thus, if both firms have equal marginal costs of

production each will make up about 2/3 of the monopoly output, for a total output of 1.33x single firm monopoly output

o Price Responses by Duopolists: To prevent any ceding of marking share, each firm will

respond to the other’s price decrease in an equal amounto C.f. Cartels:

Under collusion, each firm has marginal revenues that greatly exceed marginal cost, making cheating highly profitable

o Under Cournot Equilibrium, however: Each firm is maximizing its profits, and no one has an

incentive to deviateo See also Cournot-Nash Equilibrium:

Where no firm can profit by deviating from status quo (e.g., price cutting), provided other firms stay put as well

Cooperative vs. Non- Oligopoly Strategieso Cooperative Strategies: Devices that enable firms to reach the

same levels of price and output that would be produced by a profit maximizing monopolist or a perfectly functioning explicit cartel

o Game Theory: Depending on capability of the market to cooperate tacitly, we will see more or less cartels

o Further, where there are limited market participants, it is more likely that the participants will tacitly find an equilibrium price similar to the single-monopolist price

74

Social Cost of Collusion Social Cost of Monopoly Consists of Three Parts

o (1) The deadweight loss that results from inefficient allocation of resources resulting from inefficient consumer substitution;

o (2) Resources monopolist spends inefficiently in acquiring or maintaining monopoly position;

o (3) Certain losses that the monopolist’s anticompetitive exclusionary practices impose on others, principally competitors and potential competitors

Social Costs of Cartel Differ Slightly:o Losses under (1) may actually be lower with cartel

Because cartels have a more difficult time agreeing on output and price, disciplining cheaters and preventing defection less overall transfer of consumer surplus to cartel than to monopolist

o However, losses under (2) are likely higher than monopoly Take the costs of coordination + costs taken to secretly

cheat + costs taken to deter and punish cheaters + exclusion of rivals from relevant market who don’t wish to join cartel

Note also: Because formed by agreement and not innovation, the efficiency gains that monopolists reap aren’t there in the same respect for the individual firms w/ varying MES

o Thus, social cost of Cartel = significantly greater than Monopolist

Social Cost of Non-Cooperative Oligopolyo Under (1), the Cournot output reduction =/= as great as the

monopolist’s output reductiono Under (2), loss may be less to extent hat firms have no incentive to

cheat under the ordinary assumptions C.f. If secret discriminatory price cuts are available, firms

are likely to make them If so other firm/s will try to detect them some of the

same inefficient spending as in cartel scenario on monitoring

o Under (3), less likely to be able to coordinate exclusionary practices less likely to invest in exclusion

Major Policy Consideration:o When Policy maker tries to examine the social cost of these market

structures, what is the policy maker supposed to compare the social loss to?

o E.g., certain remedies, like breakup of oligopolies, might actually lead to increased prices for consumers because of decreased efficiency

75

Antitrust Policy Toward Oligopoly and Tacit Collusion Under §1 Sherman Act decisions, courts have held that the statute requires

an explicit agreement, but agreement may sometimes be inferred from circumstantial evidence

In such cases, the market structure itself produces a “consensus” about how each firm can maximize its own profits by tacitly participating in a strategy to maximize the joint profits of the group

Attacking Oligopoly; The Turner-Posner Debateo Whether (1) competitive, (2) Cournot, or (3) cartel equilibrium

emerges in a concentrated market is a function not only of the number of firms in the market, but also

The way in which transactions are structured; The degree to which prices must be disclosed; and The ability of firms to charge different prices to different

customerso In some cases, firms won’t be able tor each any result other than

the competitive one without coming to certain kinds of agreements, to which §1 can attack

o And, to the extent that the sale to any particular customer affects the price given to other customers, marginal revenue must be considered w/ respect to the entire group of affected customers

Identifying Tacit Collusion and Facilitators; Policy Optionso “Tacit Collusion” doesn’t fir the Cournot model of oligopoly

well, because the monopolist-like firms in a Cournot model don’t cooperate at all

o BUT, tacit collusion does fit well with two situations (1) Price fixing, were the terms of agreement are

communicated by informal or nonverbal means; (2) Cooperative oligopoly that consists in a series of

repeated actions and reaction until parties settle on an equilibrium price or output level

o Oligopoly Pricing: Aided by a highly concentrated market on selling side, but

it should also be rather diffuse on the buying side (no equal player on other side to balance out pricing)

Where there is a diffuse market of buyers, seller has to advertise to get business and possibly publicly post a price that applies equally to all customers

How to Deal With Poorly Performing Oligopoly Marketo Turner Proposal: Structural Break-upo But see MES

Large, concentrated markets usually develop because a competitive firm requires a large market share to reach MES

If we structurally break down the companies in such a market, then there is a direct increase in price borne by consumers

o In fact, market would go through periods of cartelization, bankruptcy, can eventually back to its equilibrium of concentration

76

Proving Price or Output “Agreement” From Indirect and Circumstantial Evidence

Occasionally, SCOTUS has condemned practices as collusive w/o direct evidence of explicit collusion

See, e.g., Interstate Circuit, (U.S. 1939): o Background:

D’s were group of 8 distributors and several exhibitors of motion pictures

Distributors controlled about 75% of first-class feature films exhibited in the U.S.

One of the largest exhibitors sent a letter to the eight distributors suggesting that each insert two clauses in future exhibition contracts with theaters:

(1) A clause requiring the theater to charge at least 40 admission for first-run films and 25 admission for subsequent-run films

(2) Clause prohibiting theaters from exhibiting first-run films with other films as double features

Subsequently, the eight distributors incorporated these clauses into many of their Ks

o Evidence of Horizontal Agreement: Only evidence was the letter they received and their

incorporation of its termso Analysis:

If terms had been implemented unilaterally be each distributor would be no collusion

However, use of the clauses was clearly illegal if the eight distributors had agreed among themselves to place them in every K

In that case, there would be a horizontal agreement between competitors that reduced output to consumers

In effect, letter invited distributors to enforce exhibitor collusion

o Held: Offer given to the eight distributors, plus their unanimous

acceptance was sufficient evidence from which D. Ct. could infer existence of an agreement

o Justification: Irrational unilateral decision by the distributors because in

absence of unanimous adoption, market share could have shifted to the less restrictive distributors

Takeaway from Interstate Circuito Court characterized case as not using AT laws to reach tacit

collusion, but as using circumstantial evidence to infer existence of express collusion

There was an explicit “offer” Although there may have not been explicit acceptance,

acceptance could nonetheless be inferred from the evidence

o A rigorous use of such an approach suggests the following: (1) Because proof is not available, many AT conspiracies

cannot be established by “direct” evidence, such as written agreements, tape recordings, or testimony of offer and acceptance

As a result, some kind of circumstantial proof must be accepted

(2) BUT, mere fact that the firms had an opportunity to collude or that collusion would appear to be profitable to them =/= sufficient to prove collusion

(3) Plaintiff relying on circumstantial evidence must show in addition to (2) that the defendant’s actions were rational (i.e., profit increasing) only if they were undertaken with the understanding that other firms would modify their behavior in a similar fashion

o BUT Note What is Insufficient to Establish Agreement Circumstantially:

Fact that D’s had opportunity to conspire =/= helpful if regular meetings are part of the business of the firms at issue

E.g., one should not infer price fixing merely from the fact that competitors had an opportunity to meet at trade association conventions and one of the items on the agenda was declining market conditions

Likewise, fact that competitors occasionally socialize =/= sufficient

But see If there is some evidence these meetings included some discussion of price fixing or carrying out plans to exclude a rival admissible evidence, but also back in the world of direct evidence of agreement

77

o See, e.g., Alvord-Polk, (3rd Cir 1994): Found sufficient inference of a conspiracy among full

service wallpaper sellers in their trade association’s opposition to the activities of “800-numbersellers

The 800-numbers stocked no wallpaper and advertised in various home improvement magazines that customers should go tot local wallpaper stores, identify the wallpaper they wanted by manufacturer and pattern number, and then order it from the 800-number at a substantial discount

Rule: If the trade association served as a “mere conduit” through which the full service sellers could express their frustration to the manufacturers no conspiracy could be inferred. BUT, if effect of discussions was associational pressure on the manufacturers to cut off the 800-number seller trade association discussions amounted to conspiracy

o Consider also American Tobacco, (U.S. 1946): Court identified conscious parallel behavior that seemed irrational—parallel price increases notwithstanding the arrival of the Great Depression and apparently declining costs

But note: Such conclusions are risky unless a great deal is known about the market because a cartel, just as much as a group of competitors, would ordinarily decrease price in response to falling demand and falling costs.

o Parallel Conduct Plus… General Rule: Courts often says parallel conduct alone

=/= establish an agreement, unless plaintiff can also show the presence of certain “plus factors” making the inference of agreement stronger

Plus Factors: Oligopolistic market structure Advance posting of parallel prices History of price fixing or exchange of price

information See also Interstate Circuit: Conduct was

contrary to the individual self-interest of actors and can be explained as rational behavior only on the premise that they were undertaken in concert

Why is Parallel Conduct Alone Insufficient?o Consider: Concentrated yet competitive market (e.g., airline

industry) where prices are publicly available to consumers through internet and booking cites. Failure of one industry participant to drop prices along with a price cutter would endanger its market share, particularly in loss of customers who view the carriers as fungible

Thus, this parallel conduct along does not create inference of agreement

But see Market where prices are negotiated individually and not publicly disclosed parallel conduct can create inference of agreement w/o stretching §1 too far

o Finally, even invited common action fails to establish an agreement if actors had legitimate individual business justifications for engaging in the practice, irrespective of agreement

See, e.g., Interstate Circuit: Where plan was one that would only be rational (i.e., profit increasing) through concerted action =/= independent business justification for adopting recommended restrictions

Compare to Situation where credit agencies report that X is not paying his bills. When other creditors decline to transaction w/ X =/= concerted refusal to deal b/c each creditor has independent business justification not to deal

o See also Product/Professional Quality Standard Manuals: If efficiency enhancing horizontal competitors in a

trade or professional bar will adopt regardless of whether the others adopt

Thus, cannot be a basis to show agreement unless we have an Interstate Circuit adoption, i.e., where only rational to adopt if there will be concerted action from competitors

78

Reaching Oligopoly Behavior on Less Explicit Evidence of Agreement Introduction: Incomplete Agreements

o Both Interstate Circuit and American Tobacco seem to say that an agreement in violation of §1 need not be proven by explicit offer and acceptance, but can be inferred by the facts and circumstances, or through indirect evidence.

Applying Contractual Analysis to Inferred Agreementso All contracts are somewhat incomplete and courts generally gap-

fill with the intended meaning of the parties or with any superseding law that the parties failed to opt out of

o However, as it relates to horizontal competitors, there is not going to be a paper contract

o Further, in the typical contract, Courts infer terms in order to enforce the agreement. BUT, under Sherman Act analysis, gap-filling would be with the purpose of invalidating the agreement and finding unlawful conduct

o Thus, whereas a lot of information is needed to validate a buy-sell contract, only a limited amount of agreement is required to infer §1 violation because all we’re looking for is a basis to find the agreement illegal

Accordingly, the more market structure fills in for us, the less we evidence we need from the parties themselves

o Factors such as high concentration on seller’s side and diffusion on buyer’s side, significant economies of scale, a standardized product and publicly announced prices and terms, suggest that a market is conducive to express or tacit collusion, as well as non-cooperative oligopoly

o Additional Factors that can Help Determine Degree of Collusion:

(1) Stable market shares; (2) Rigid price structure; (3) Industry-wide use of facilitating devised that make

tacit collusion easiero Important Among These Devices:

Exchanges of price or output information among competitors, standardization of products or terms of sale, and market-wide vertical integration or RPM

Facilitating devices are especially suspect if they are the product of explicit agreement among competing firms, or if they result in market-wide price discrimination of a fungible product

o Note also stability of market over time: In a competitive market, efficient firms tend to gain

dominance over time and shares within the market shift In a cartelized market, however, price tends to fall more

slowly in response to demand, market shares tend to be apportioned with little fluctuation, and price will only eventually drop to a competitive level in response to widespread cheating—a sign that the market is crumbling

Challenging Facilitators Established by Agreement o Objective: Distinguish between agreements to engage in a certain

practice as distinct from the agreement to fix prices E.g., Standardization can be pro-competitive

For instance, if 2x4 Wood and Grade A eggs all means the same thing from every seller dramatic reduction in consumer information costs (which may allow sellers to drop prices)

o But see Abusive Practices: Sugar Institute, (U.S. 1936): Court condemned

agreement among members in trade association in highly concentrated market in which members would publicize their prices in advance and not deviate from those prices, price discriminate, or give secret discounts or other price concessions.

Justification: Rules too likely to permit cartel-like pricing and cartel-maintenance

Catalano, (U.S. 1980): Court condemned agreement among beer wholesalers to eliminate a short term trade credit that many of them had formerly given to retailers

Effect of Agreement: Standardize the price terms and make a firm’s sale prices easier to monitor

Held: Per se price fixing; credit terms touched too closely on price

o Consider finally Efficiency Concerns: Standardization agreements can make distribution work

more efficiently Information exchanges, product standardization and

testing, and agreements creating markets, regulating and standardizing transactions all fall within this category

BUT, they also have propensity to facilitate collusion and cartel-maintenance

79

“Unilateral” Facilitators; Base-Point Pricing Schemeso A variety of practices can facilitate collusion, even though the

practices themselves are unilateralo Moreover, some practices may be independently efficient and thus

firms may employ them w/o regard to their ability to facilitate collusion

o Base-Point Pricing: E.g., if single firm sells to three customers located 10,

100, and 400 miles away, and each buyer places a value on the good of $100 and seller provides to each at that price (which includes delivery) seller is price discriminating—i.e., subsidizing further travel by higher costs to closest firm

C.f. In a competitive market, a supplier closer to the buyer would be willing to provide the product for a lower price

Agreement Term: Generally, set a single base point from which to

measure all deliveries All quoted prices then add freight charges

measured form the basing pint to the buyer’s deliver point

Then, no matter the geographical placement of the cartel member, the prices are indiscriminate for a would-be buyer

o But note: Only where the price of the product is also fixed does a buyer see an indiscriminate price among cartel sellers

Other Facilitators; § 5 FTC Acto Du Pont (Ethyl Corp), (FTC 1983): Agreement among horizontal

competitors provided (1) policy of announcing price changes 30-days in advance; (2) a most-favored-nation clause for buyers guaranteeing them the benefit of any price decrease; and (3) uniform delivery prices

o FTC §5 Challenge: Attacked the collusive behavior despite lack of agreement

o Argument: Commission placed great emphasis on fact that §5, unlike §1 of the Sherman Act, =/= require proof of agreement among firms

Thus, if a practice both (1) affects competition adversely and (2) violates the “basic legislative goals of the Sherman act” it can be reached under §5, even though it might fall outside of the Sherman Act

o Evidence of Collusive Conduct FTC Identified: (1) Market was highly concentrated w/ high barriers to

entry b/c of government regulation and the firms had a net rate of return 50% higher than the rate earned by most producers of chemicals

(2) The most-favored-nation clauses, or price matching guarantees

These can serve as cartel facilitators b/c customers directly report a competitor’s negotiated price to their usual provider

o Second Circuit’s Response: Unimpressed by any of Commission’s theories of tacit

collusion Held: Vacated Commission’s decision, expressly refusing

to hold that §5 FTC could be “violated by non-collusive, non-predatory and independent conduct of a non-artificial nature,” even when conduct results in substantial lessening of competition

Rule: Commission Has To Show Either … (1) Evidence of anticompetitive intent or purpose

on art of the producer charged; or (2) The absence of an independent legitimate

business reason for its conduct Court’s Premise:

Oligopoly is a market “condition,” not a “method” of avoiding competition

o Hovenkamp’s Criticism: 2nd Cir’s opinion overlooks the fact that discriminatory

price cuts given to some buyers and not others can undermine oligopoly

Whereas, practices that make these price cuts expensive or impossible =/= a natural condition in the market; they must be interposed

80

Motions to Dismiss and Summary Judgment in Conspiracy Caseso In the absence of explicit proof of agreement, courts seem to

require plaintiffs to prove the following: (1) Consciously parallel conduct; (2) Some “plus” factor; and (3) For most courts, at least some evidence of traditional

conspiracyo Reason for Three Elements:

Consciously parallel behavior alone is not enough Simple behavior in addition to a plus factor, such as

exchanges of price information, price discrimination, or actions that seem contrary to independent self-interest, has occasionally been found sufficient, but the recent trend is for courts to reject such claims and require at least some evidence of direct communication

o See, e.g., Twombly, (U.S. 2007) & Iqbal, (U.S. 2009) (extending Twombly to non-antitrust cases)

In Twombly, SCOTUS considerably heightened the pleasing requirement for actions under §1 Sherman Act

Held: Conspiracy could not be inferred from allegations that for several years regional telephone companies had the legal right to enter one another’s geographic territories but had declined to

As Iqbal recounted Twombly: FRCP §8(a)(2) requires pleadings to contain a “short and plain statement of the claim showing that the pleader is entitled to relief.”

As stated in Twombly, however, pleading standard in Rule 8 does not require detailed factual allegations, but it does require more than an unadorned, the defendant-unlawfully-harmed-me accusation

A pleading that offers “labels and conclusions” or “a formulaic recitation of the elements of a cause of action will not do.”

Nor does a complaint suffice if it tenders “naked assertions” devoid of “further factual enhancement.”

Twombly Requires: Complaint to state a plausible claim for relief

o Thus, where well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged-but it has not shown—that the pleader is entitled to relief

o Application of Twombly To Exam: Must provide sufficient specificity to create an inference

of concerted as opposed to independent action

81

Intraenterprise Conspiracy Copperweld, (U.S. 1984): For the purposes of §1, a parent and its wholly

owned but separate subsidiary should be treated as a single firm; cannot be considered separate conspiring entities

o Justification: Parent and sub have “a complete unity of interest”o Holding Otherwise: Might allow a plaintiff to turn a firm’s price

setting decision into a §1 violation But see Two Situations Complicating Copperweld:

o (1) Where ownership is less than completely unified; ando (2) Where one or more agents of the firm ahs a separate profit-

making interest distinct from the interests of the principal firm Methods to Discern Whether Single Firm or Separate?

o See e.g., Cartel Cheating: Firms in a cartel act concertedly, but there are also incentives to cheat. In the Copperweld context, if a wholly- or partially-owned subsidiary has incentive to, and does, cheat may be separate firms b/c not identical interests

But see American Needle v. NFL, (U.S. 2010): o Background:

Court looked at the opposite issue to that raised in Copperweld

NFL teams were separately owned by their licensing practices for IP were controlled by a single organization

o Held: Decision by NFL to refuse to license the IP of individual

NFL teams who were its members, should be treated as an agreement among teams, not as the unilateral conduct of the NFL

BUT Note: Court also held that ROR appliedo Basis of Complaint:

NFL teams created a new entity to manage their IP licensing rights

After a period of time of granting non-exclusive licenses, the entity then granted an exclusive license to Reebok and triggered the suit

Challenged under § 1 as concerted refusal to deal, given that the NFL team members whose individual IP

rights were being licensed were all separately owned corporate entities

o Reasoning: Not every agreement between two individuals should be

counted as a conspiracy Rather, the defining characteristic of conspiracy is that the

general organization controls the separate or potential separate businesses of the individual members

Thus, important in this case was not that the SHs in the licensing entity were independent teams, but rather that the licensing entity controlled the separate business interests of the individual teams in their own trademarks

Thus, important Q =/= who controls, but rather who is controlled

o Test: Whether the agreement deprives the marketplace of

independent centers of decisionmaking and therefore of diversity of entrepreneurial interests and thus of actual or potential competition

o Application: Here, teams compete in the market for P When each NFL team licenses its intellectual property, it

is not pursuing the common interests of the whole league, but is instead pursuing interests of each corporation itself; the teams are acting as separate economic actors each team = independent center of decisionmaking

Accordingly, lumping a portion of these independent decisionmaking into a single entity deprives the market of those portions of independent decision making and competitors

Particularly, 32 teams operated independently through the

licensing entity and =/= like components of a single firm

The teams were all separately controlled, potential competitors with different economic interests distinct from the licensing entity’s

Indeed: If the fact that potential competitors shared in profits from a JV meant that the JV was immune from §1 any cartel could avoid §1 by simply creating a JV to serve as the exclusive seller of their competing products

o Advantage of Rule of Reason Analysis:

82

There is no obvious reason why a group of football teams should be permitted to cartelize the licensing of their marks more than a group of competing restaurants should be, and if a procompetitive rationale should emerge ROR should be sufficient to handle it

Issue of Controlled vs. Being Controlledo Material to understanding American Needle and also explains why

a corporation can be such an effective cartel manager That is, one good way to reduce cartel management

issues is to create a single corporate entity that manages the business of the cartel

However, structure only works effectively if the cartel members have given up control (i.e., no longer have power to cheat)

o Example: General hospital has a peer review staff containing three

anesthesiologists, each of whom has an independent practice from which he earns substantial profit

The three use their peer review powers to deny staff privileges to a fourth anesthesiologist

The excluded Dr. may allege she was excluded for offering lower prices by . . .

(1) A single-firm monopolist (i.e., the hospital) through its agents (the peer review board) excluded P from the market

o Typically ineffective Or, (2) That the three anesthesiologists on the

board are distinct entities and have engaged in a concerted boycott against her

o Must more effectiveo Also, more plausible because physicians

with an established niche have good reason to wish to exclude an interloper threatening their profits w/ lower prices

o Note: Under Boycott Claim—Likely NOT To Include Hospital Generally, even if hospital is a monopolist, it doesn’t have

an interest in allowing inefficient output viz. double marginalization at the anesthesiologist level

As a result, courts have generally been reluctant to allow Ps to include the hospital as a member of the conspiracy in their claim

That is, because the hospital and the physician’s interests are too distinct for the Hospital to be included in the physician’s conspiracy

E.g., [Reverse Copperweld]

83

Ch. 5 – Joint Ventures of Competitors, Concerted Refusals, Patent Licensing, and the Rule of Reason

Introduction: Naked and Ancillary Agreements Among Competitorso Distinguishing Naked from Ancillary Restraints; Question of

Lawo Why Multilateral Activity Deserves Closer AT Scrutinyo Partial Condemnation; Less Restrictive Alternatives

Joint Ventures as Market Facilitatorso JVs: An Overview

Potential Harms and Benefits Two Sides of the Exclusivity Problem

o Ventures Facilitating R&D, Advertising and Promotion; Ancillary market Divisions

JVs and Free Rider Problem National Cooperative Research Act Ancillary & Naked Agreements Pertaining to

Advertising Ancillary Market Divisions and Noncompetition

Agreementso Transactional Efficiencies Justifying JV Price Settingo Relation Between JV Analysis and Merger Analysis

Competitor Exchanges of Price or Output Information; Posting Agreements

o Industry-Wide Dissemination of Price and Output Information o Direct Competitor Exchange of Price Informationo Agreements to Post, or to Post and Adhere

Concerted Refusals to Deal, JV Membership Restrictions, and Standard Setting

o Harms and Benefits; Appropriate AT Standard Rule of Reason… With A Few Exceptions Special Treatment for the Learned Professionals?

o Efficient JVs and Refusals to Deal Closed-Membership and Other Traditional JVs

Open-Membership Ventures; Positive Network Externalities

o Standard Setting and Rule Enforcement in Private Entrepreneurial and Professional Settings

o Agreements Involving Non-Competitorso Expressive and Noncommercial Boycotts

Agreements Governing the Licensing and Use of Patents and Other IPo Introduction; Basic Issueso Scope of Patent Misuse Doctrine, AT & Beyond

o Patent Licensing Price Fixing; Output Restrictions; Royalty Rates;

Exclusivity Horizontal Territorial and Other Market Division

Agreements; Patent Settlements, Pharmaceutical and Otherwise

Package Licenses Patent Pools Grantbacks

o Agreements Concerning Non-Patent IP Characterization and Evaluation: The Per Se Rule and Rule of Reason

o Supreme Court and Per Se Ruleo The Exaggerated Distinction Between Per Se and Rule of

Reasono Identifying Anticompetitive Conduct: A Tentative Road mapo The Truncated / Quick Look Rule of Reasono Burden of Proof

84

Ch. 5 – Joint Ventures of Competitors, Concerted Refusals, Patent Licensing, and the Rule of Reason

Introduction: Naked and Ancillary Agreements Among Competitors Benefits of JVs Among Competitors:

o Can enable group to carry on activity at more efficient scaleo Reduce information or transaction costso Can also eliminate free-rider problems

Therefore, AT policy needs to distinguish from harmful horizontal agreements and beneficial ones

o General Rule: If agreement cannot facilitate collusive pricing or output reductions its purpose must be the reduction of costs or the improvement of a product or service

However: Courts and AT Policy Maker Limited by Information Costso Accordingly, because of horizontal agreements’ propensity for

harm, but offsetting potential for considerable good, horizontal restraints is an area where certain shortcuts are used to avoid the information costs of fully evaluating the restraint

Three Classifications of Horizontal Restraints:o (1) “Naked” Restraint: One that is considered to have little

potential for social benefit, and thus can be condemned under a per se rule which requires little or no inquiry into market power or actual anticompetitive effects

o (2) “Ancillary” Restraint: One that arguably serves a legitimate and socially beneficial purpose, and thus analyzed under Rule or Reason, which means they can be condemned only after a relatively elaborate inquiry into power and likely anticompetitive effects

o (3) Grey Restraint in Between Naked and Ancillary: Middle group of restraint that at first glance seem highly suspicious but we are not quite sure. Perhaps judicial experience with them is

insufficient to warrant a conclusion, or perhaps they present some unique attribute not formerly encountered

In such cases, we give Ds at least an opportunity to formulate an argument that they are, on balance, pro-competitive

However, if that argument fails summary condemnation may be appropriate

Generally done under “Quick Look” Analysis Price Fixing and Per Se Analysis

o Widespread application of the per se rule to price-fixing agreements has often obscured the underlying complexities of joint arrangements involving competitors and their great potential for efficiency

E.g., It is not generally a defense to a price fixing charge that cartel members did not have enough market power to reduce output profitably

Example: Town has 10 grocery stores Three stores jointly run a newspaper

advertisement quoting retail prices Efficiency? Cuts down on ad costs for all 3 Anticompetitive? Still 7/10 other grocery stores

customers can shop at if the advertising grocers price too high

Analysis? Court is likely to hold that the per se rule prevents it from considering both the argument that the Ds had no market power and that their agreement produced a cost reduction that benefitted consumers

Distinguishing Naked from Ancillary Restraints; Question of Lawo Naked Restraint:

One that is formed with the objectively intended purpose or likely effect of increasing price or decreasing output in the short run with output measured by quantity or quality

o Ancillary Restraint: If its objectively intended purpose or likely effect is lower

prices or increased outputo Relation to Market Power?

Naked Restraint: Only profitable if the actors collectively have sufficient MP to affect market wide output and price

Ancillary Restraint: Profitable whether or not participants collectively control the market

85

General Rule: o If the explanation for the restraint makes sense even in the absence

of market power, then the restraint is at least presumptively ancillary

o While this does not necessarily save the restraint, at least affords it quick-look or ROR

o Test: Ask, would this restraint work if the participants collectively held a Nondominant position in the market?

See, e.g., Professional Engineers, (U.S. 1978): o Professional association of consulting engineers agreed not to bid

competitively for jobs and would not even discuss fees until after they had been selected

o D’s Rationale: Competitive bidding would force engineers to cut corners b/c the resulting prices would be too low to enable them to do an adequate job

o Application of Tests (supra): Would this restraint work in the absence of Market

Power? No: Customers would instead go to other

engineers who would discuss price at the front-end of the transaction

Was This a Restraint that Objectively Would Lower Price or Increase Output?

No: Restraint was initiated to keep prices higher less output

o Type of Restraint: Naked Price Fixing [Although Court gave some deference b/c it was a

professional society; but, that’s no longer a rule]

See also California Dental Assn., (U.S. 1999):o Restraint: No false price advertising for dentists in the associationo Application of Tests:

(1) Could be effective in absence of MP because customers would know that at least this particular group had honest prices

(2) If customers can choose among prices, will likely increase output and increase price competition among dentists

o But see Dissent: Found that the restraint was more likely to eliminate all or

most price advertising altogether Such a restraint would receive per se condemnation That is, a firm w/o market power could not benefit by

agreeing not to advertise prices for services [see, e.g., Engineers]

Rule:o Maricopa County Med Soc., (U.S. 1982): While the question of

whether a restraint is naked or ancillary is a mixed on of law and fact, the question of whether the per se rule or rule of reason applies is one of law

o NCAA, (U.S. 1984): The premise of the per se rule is that judicial experience with a certain class of restraints justifies more expedient treatment

o That is, Courts are looking to past precedent and lower court decisions in determining whether the restraint is per se unlawful, and this =/= question for the jury who lacks experience in the matter

86

Why Multilateral Activity Deserves Closer AT Scrutinyo Unilateral conduct: Receives the lowest level of AT scrutiny

Purely unilateral actions are unlawful only if they fall into the general classifications of monopolization or attempt to monopolize

Further, both of these claims require a strong showing of bad conduct and sufficient market power

o Joint Venture Conduct: Minority Position: Should be evaluated same as we

evaluate unilateral conduct because of the possible efficiency gains JVs offer

Majority Position: Skeptical of JVs Among Competitors

First, §1 and §2 of Sherman Act express a policy position to condemn agreements in restraint of trade, whereas condemning unilateral action only when under §2 it can be classified as monopolization or attempted monopolization

Second, JVs only profit in two ways: (1) efficiency gains; and (2) MP gains which allow them to reduce output and increase price profitably

o E.g., In comparison to a monopoly position which takes years of time to generate, a JV can give several rivals in a market the dominant position overnight

Third, monopolist positions are obtained because of innovation. A JV should not get the same deference as a monopolist unless it can

give us similar benefits for the anticompetitive social cost

Fourth, judicial relief is much easier to fashion against a JV. Whereas injunctive relief is likely to make the monopolist a regulated entity, injunctive relief against a JV simply stops the harmful combination

Partial Condemnation; Less Restrictive Alternativeso In NCAA, Engineers, and Dentists, the Court struck down naked

restraints that the association/JV entity put in place without dissolving the JV

o Thus, when an efficient JV employs an anticompetitive restraint, the court must disaggregate the restraint from the venture’s overall activities.

o Then, must determine whether the restraint serves an important, socially beneficial end

If yes P still has a chance to show that the beneficial purpose could be achieved by a less restrictive alternative

If no Inquiry into less restrictive alternatives is unnecessary

87

Joint Ventures as Market Facilitators AT policy =/= discriminate between R&D JVs or JVs entered into for scale

economies and other efficiencies

JVs: An Overview Potential Harms and Benefits

o Price fixing, output restriction, or monopoly-creating market division explain only a subset of JV agreements

Most JVs are entered so participants can achieve certain economies, either by lowering cost, or by permitting them to do something for themselves that they would otherwise have to purchase from another provider or go without

These benefits generally accrue to consumerso Making a Market

Appalachian Coals, (U.S. 1933): Court approved JV agreement among 137 coal producers, under which the producers created an exclusive joint selling agency that classified the coal, marketed it, and distributed proceeds to the participants

Because coal = fungible, the JV entity set or “fixed” the price of equal grades of coal in equal amounts

o Joint Selling and Joint Purchasing Agreements Selling Cases:

Courts have generally approved joint sales agreements, provided they found at least some integration of promotion, advertising or other activities among participants

See, e.g., BMI, (U.S. 1979): Court applied ROR and approved sale of nonexclusive packaged licenses

Buying Cases: Have to distinguish whether the JV is acting as a

monopsony—buying at a lower price, reducing its own output and raising its own price

Buying Cooperative: If purpose is to reduce costs typically not concerned w/ limiting the amount its participants purchase

Two Sides of the Exclusivity Problemo All JVs = exclusive in that they cannot offer an infinite range of

productso Antitrust Exclusivity Arises When:

(1) Membership is limited and others who might want to join are excluded;

(2) Might limit the right of existing members to engage in certain non-venture business, particularly if that business competes w/ the venture

o Justification for Restrictions: (1) The larger JV membership is, the larger it is to

manage the operation and come to standardized agreements

E.g., Leagues limit the number of players otherwise operation becomes unmanageable

(2) Both membership and extra-JV activity restrictions can help JV avoid free-rider problem

Otherwise, JV participant can freely enter, rely on the reputation of JV, operate outside of the JV and keep all profits for itself w/ no recontribution

o Anticompetitive Effects of Restrictions: Exclusion, in the presence of market power, makes

anticompetitive results much more likely BUT, also requires that JV be able to (a) reduce output

w/in the JV and (b) in the relevant market as a whole That is, if JV has free entry and participants are

allowed to compete w/ JV there can be no market control even if the JV in the aggregate has MP

88

Thus, if you want exclusivity also have to overcome our market power concerns

Ventures Facilitating R&D, Advertising and Promotion; Ancillary market Divisions

JVs and Free Rider Problemo Free Rider: one who takes free advantage of a service or product

that is valued by consumers by provided by a different firm. If free-riding = rampant that product or service is

likely to disappearo Two Biggest Areas of Free-Riding:

(1) Advertising (2) R&D (particularly where the development cannot be

patented or protected by IP)o JV Can Assist By…

For R&D, forcing all of the firms in the JV to share the costs of development not all borne by one firm and used to subsidize competitors

Ancillary & Naked Agreements Pertaining to Advertisingo JV advertising agreements pose some of the same concerns as JV

research agreements, BUT there is some justification for treating them more harshly

(1) Joint advertising is much more explicitly involved w/ “sales” than is JV research touches much closer on price

(2) Scale economies and free-rider problems may not loom as large in advertising as they do in R&D

o Inter-brand JV Advertising Agreements Most difficult to justify where products are differentiated

E.g., if Sylvania had started a JV advertising campaign w/ Sony televisions

More justifiable where product is fungible

E.g., Farmer A advertises his potatoes. Customers view potatoes as fungible. Therefore, potato sales increase, but the increase is diffused across the market and =/= directly benefit Farmer A

C.f. If potato farmers form a Growers Association and all pay a share of the advertising both customers and the diffuse farmers benefit

o Abuse of JV Advertising: When It is … Used to facilitate market division, and An agreement not to advertise (i.e., preclude customers

from making price decisions and thus reduce competition)

Ancillary Market Divisions and Noncompetition Agreements [Topco]o Market Division: Agreement among two firms that each will stay

out of some portion of the market occupied by the othero Types of Division:

Geographic: Territorial division Customer: E.g., you sell to restaurants and I will sell to

Hospitalso Legal Treatment:

Naked Market Division = per se illegal Can also be a criminal offense

o Pro-Competitive Justification? Market division agreements ancillary to other JV activity

can increase output by reducing free-rider problems, thus giving each firm an incentive to promote more aggressively

But see Can also carve out monopolies for participating firms

Topco, (U.S. 1972):o Held:

Condemned agreement as per se unlawfulo Agreement:

Involved 25 grocery chains Did not agree to advertise together, set prices together or

pool earnings Rather, association created by the agreement bought

grocery items in large quantities and redistributed them to members

JV also garnered brand recognition as Topco brand which benefitted participants

89

o Restraint: JV participants were allowed to enter any territory to sell

groceries, but could not sell Topco branded goods except in their own exclusive territories

o Gov’s Position: Challenged market division scheme as a cartel, claiming

that it operated to prohibit competition in Topco branded products among grocery chains engaged in retail operations

o Market Position of JV Members? In their exclusive territories, no JV member had larger

than a 6% market share And, entry into the grocery business was easy Therefore, market division could not have possibly

turned the JV participants into monopolists o Justification for the Restraint:

JV members were trying to compete against national grocery brands

Therefore, in order to reduce free-riding and to increase advertising and non-price competition in the Topco brand, the JV members carved out territories for each other

Effect: See, e.g., Sylvania: Limited intra-brand competition by increasing inter-brand competition, but arose as a result of a horizontal agreement among competitors

Criticism of Topcoo Failed to distinguish between naked and ancillary

restraints/horizontal market divisions While some market division = nothing more than a form

of price fixing, the Topco arrangement was almost certainly efficient

o Accordingly, should have considered whether the division reduced costs or gave the participants an incentive to invest that they otherwise would not had

If so would have gotten ROR w/ Market Share Analysis

Because MS/MP was miniscule ROR would have upheld the arrangement

Lower-Court Responses to Topcoo See, e.g., General Leaseways, (7th Cir. 1984) [Posner]:

Posner criticized Topco for ignoring the threat of free-riding the Topco arrangement had been designed to solve

In the present case, however, where Posner found that the threat of freeriding was inapplicable, he invalidated a horizontal territorial division between trucking companies

Topco and Non-Competes:o Challenges may be raised to non-competes by parties who

Are excluded from competing (e.g., in order to include a certain seller into your mall you won’t allow a competitor in for X-many months)

Parties who believed they paid a higher price because of the restrictive covenant

And, even by parties to the agreement who want to get out of it

But see In Pari Delicto: Prevents a plaintiff from recovering damages if he was at equal fault in the violation

See, e.g., Perma Life Mufflers, (U.S. 1968): Rejected an in Pari Delicto defense and permitted franchisee to challenge several provisions of its franchise agreement

Relevant Test: Whether the plaintiff was a willing participant to the conspiracy or was merely one of its victims, i.e., it was foisted upon him unwillingly

Non-Competes and AT Analysis:o Generally regarded as ancillary restraints b/c usually contained

in agreements providing for the sale of a business, start of employment, or beginning of a broad, ongoing K relationship

o Accordingly, trend = ROR treatmento But see Exception: Palmer v. BRG, (U.S. 1990):

Court treated reciprocal non-compete upon sale of bar review course in Athens, GA as per se naked horizontal territorial allocation

Restraint: Offeror sold bar review course sold its business to a competing one in the Athens market. Seller agreed not to compete in Athens but buyer also agreed not to offer the course anywhere else in the U.S.

Lower Courts, Non-Competes, and Topcoo Polk, (7th Cir. 1985) [EASTERBROOK]:

Notwithstanding Topco, upheld lease covenant between wo stores occupying the same building that one would not sell appliances in competition with the other.

90

Justification: The non-compete was ancillary to the lease and a non-compete covering a single building in an urban area lacked anything resembling MP

o Rothery, (D.C. Cir. 1986): Court refused to condemn an agreement among

independent moving firms operated as franchisees to Atlas (a national moving Co.) where firms agreed not to use Atlas’s name, Goodwill, or other services for any form of carriage made outside of the franchise arrangement for which Atlas as franchisor was not compensated

Justification: To the degree a carrier agent uses Atlas’s reputation, equipment, facilities, and services in conducting business for its own profit, the agent enjoys a free ride at Atlas’s expense

Transactional Efficiencies Justifying JV Price Setting Certain JVs of competitors are valuable b/c they reduce transaction costs so

substantially that they virtually create a new market or make a market much larger than it had been before

See, e.g., Chi. Bd. Trade, (U.S. 1918) [Brandeis]:o Issue: Call rule adopted by the Bd., which was the world’s leading

market for graino Restraint: Under the “call rule,” Board members were permitted

to trade after the close of the regular session, but only at that session’s closing price. A new price would be established when the market opened again.

o Government: Challenged the rule as price fixingo Court [Brandeis]: Rejected Gov’s argument, noting that the call

rule created a public market for grain scheduled to arrive, and this market (i.e., price determination) was made under the most public and competitive of circumstances

o How Restraint Benefitted Output: Consumer Information Costs

Where consumer information costs are high, relative to the price of the product being purchased, a consumer will do less searching

The more the consumer values the produce and the lower the information costs are, the more likely the consumer is to find the lowest, most competitive price

Accordingly, the effect of the call rule in Chi. Bd. Trade was to aggregate all of the sellers into a public area,

creating a low-cost scenario for consumers to find the competitive price

See also BMI, (U.S. 1979):o [Dramatic example of a market facilitating agreement]o Transaction:

BMI sold blanket licenses which permitted license to perform everything in BMI’s library

The licensees paid a charge that varied w/ their revenues The performance right holder received income that varied

with the amount his composition was played In addition, BMI enforced its members IP rights

o Procompetitive Justifications: Highly efficient:

Saved millions in transaction and enforcement costs—no longer had to negotiate with every single artist

Was also much faster—so song is not going to become unpopular as you’re negotiating w/ the individual artist

Effect of Bundling: Unlike in Chi. Bd. Trade which created a

market, the blanket licensing agreements essentially eliminated the market for individual artist licenses

Further, eliminated price competition among artists, because now a station could just buy the blanket license

Court’s Analysis: Refused to apply per se Rule91

Court refused to apply per se rule because the efficiency-creating potential of the arrangement was too obvious

Moreover, the licensees conferred into the blanket pool were non-exclusive, so there was no foreclosure of competitors who wanted to create their own blanket license

Relation Between JV Analysis and Merger Analysiso Dagher, (U.S. 2006):

Court approved a JV agreement between Texaco and Shell which allowed the two to pool their production resources in the Western U.S. and produce gasoline at a joint facility

Rejected §1 Challenge that this was price fixing Reasoned:

Not price fixing, more like price setting by a single entity

Shell and Texaco were acting like investors in the JV production company, not competitors

And, a single entity/JV has to have discretion to set its own prices

o Unpacking Dagher: Stands for the proposition that when firms participate in a

traditional production JV that produces an essentially undifferentiated product, the venture cannot be condemned categorically simply because it sells its output at the same price, even if part of the output is allocated to one venture participant and the other part to another

Such arrangement gets RORo But note: Important fact in Dagher is that it was the JV’s own

output that whose price was being fixed. o Compare to Situation where Texaco and Shell agree to fix the

price of a product that they create separately and not through the JV = naked price fixing

92

Competitor Exchanges of Price or Output Information; Posting Agreements Industry-Wide Dissemination of Price and Output Information

o American Column, (U.S. 1921): Court condemned practice among association members

that collected and disseminated pricing, customer, inventory, and other information among all members, notwithstanding that the association was made up of over 300 individual members and made up only 1/3 of the market

o Maple Flooring, (U.S. 1925): Court validated practice that tip-toed around the problems

found in the American Column decision, where an association of about 20 flooring manufactures making up 70% of the market collected and disseminated past price information to its members

Court also was unconcerned w/ a potential base-point pricing scheme wherein a freight rate manual was disseminated to all members, using Cadillac, Mich. as the base point because a large number of mills operated in that area

Direct Competitor Exchange of Price Informationo Container Corp., (U.S. 1969): Court held illegal practice where

horizontal competitors would contact each other prior to an upcoming bid for a project to see what the other would charge

[Douglas] Held: Regarded agreement in Container as analogous to Column

As a result, the two cases have been largely lumped together ever since

Rule: Direct competitor exchanges of price information are likely to be harmless in competitive markets. BUT, if concentration is high, the exchange is more likely to affect price, and any interference “with the setting of price by free market forces” is illegal

Effect of Restraint Here: Caused prices to stabilize—although to a downward level

But see Economic Analysis: A downward price movement is just as synonymous with competition in a fully informed market as it is with collusion

Container Rule of Reason Analysis: If the market in which the price information exchange occurred is

(1) Highly concentrated; (2) If the product is fungible so that price is the

predominant element of competition; and (3) If demand at the competitive price is

inelastic, Then, the exchange is virtually certain to be condemned,

particularly if the court finds any relationship, downward or upward, between the information exchange and the market

See also Gypsum, (U.S. 1978): o Court noted that competitor price exchanges have the “greatest

potential for generating anti-competitive effects and although not per se unlawful have consistently been held to violate the Sherman Act.”

But see also Permissible Competitor Exchanges:o As the subject of the exchanged information wanders further from

price and output, courts are less likely to condemn the exchange E.g., exchanges of credit information on customers or the

histories of customer dealings = generally legalo Justification: Such information is itself valuable IP and expensive

to produce Thus, significant economies could result from Joint

Provision Exchange of information totally unrelated to price or

output generally raises no AT issues

93

Agreements to Post, or to Post and Adhereo Price list to customer or public as unilateral decision of firm =/=

raise AT issue on its own Procompetitive Justification: Allows firm to advertise

its low prices and induce customer interactiono BUT, there is little competitive justification for competitors to

agree with each other to post their prices If posting is valuable to buyers, each firm has an incentive

to do it unilaterally Agreed posting = a strong inducement to price fixing

See, e.g., Horizontal Restraint Test: Would this restraint make sense for firms without market power to enter into?

See also Cartel Cheating: Do not want to give legal force to agreements that deter cheating

Concerted Refusals to Deal, JV Membership Restrictions, and Standard Setting Harms and Benefits; Appropriate AT Standard

o Traditionally: Concerted refusal to deal among two or more persons

with a third was per se unlawful under AT lawso But see Today:

Few cases fall under the per se prohibitiono Refusal to Deal = More of AT Harm than Violation

E.g., When P alleges D is engaged in an unlawful practice (e.g., tying, RPM, territorial division, etc.), the claim is stated as (1) unlawful practice (2) manifested itself as refusing to deal with me except on the illegal terms

o When Refusal to Deal is Primary Violation Can perform two important functions in AT law, even

when it is not a separate violation: (1) Gives a COA to Ps who have good

knowledge about a market and are highly motivated to sue

(2) The presence or absence of a refusal to deal often helps a court evaluate activities such as JVs that are arguably both efficient and anti-competitive

o Often, the efficiencies of the JV could be attained without the refusal to deal.

See, e.g., Appalachian Coal, (U.S. 1933): o Involved joint exclusive selling agency

created by competing coal producers.

o Refusal to Deal: The JV members refused to deal with any buyers except through the coal agency

o Application: Therefore, even though the JV agency may have achieved certain efficiencies, there was no reasonably justification for the refusal of the coal producers to sell outside of the agency

See also BMI: Upholding sale of bundled non-exclusive licenses where the individual artists were free to contract directly with the buyer

Rule of Reason… With A Few Exceptionso As a general matter, concerted refusals should be treated as devices

for making JVs or other associations of competitors operate more efficiently

o While this does not make then per se legal, it means that most of the time per se illegality is inappropriate

o When to Apply Per Se: Apply per se to “naked” boycotts: i.e., concerted refusals

of competitors to deal with another competitor, customer, or supplier when no case can be made that the refusal is ancillary to any legitimate joint activity

See, e.g. Superior Court Trial Lawyers, (U.S. 1990): Court reaffirmed that concerted refusals are illegal per se when their only purpose is to facilitate collusion

Rejected argument that old rates were too law Rather, unrestrained markets should determine

the rates But note: If the prices were adequate, then there

would have been no boycott Thus, Court must be saying certain collusive

actions cannot properly be considered competitive market actions

o Hartford Fire, (U.S. 1993): Court gave “boycott” a narrow definition that might exclude some previously mentioned cases

94

However, Court was only making distinction because insurance groups are allowed to cartelize. Sherman Act would otherwise find both restraints prohibited

5-4 Definition: Distinguished “boycott” from “concerted agreements on contract terms”

Cartel: If a group of firms simply refuses to sell except at an agreed upon price, their action is not a boycott, but merely a cartel

Cartel: If a group of firms agree not to sell to sell only a particular quality of product (e.g., insurance that carves out certain coverage)

Boycott: Whereas, a refusal to work changes from strike to boycott only when it seeks to obtain action from the ER unrelated to the employment K

See, e.g., Group striking to get higher wages = cartel; group striking because they refuse to work with a particular manufacturer = boycott

Special Treatment for the Learned Professionals?o Indiana Dentists, (U.S. 1986):

Restraint: Dentists agreed to withhold X-rats from health insurer who was purchasing dental servs on behalf of the insured

Rule: A concerted and effective effort to withhold (or make more costly) information desired by consumers for the purpose of determining whether a particular purchase is cost justified is likely enough to disrupt the proper function of the price-setting mechanism of the market that it may be condemned even absent proof it resulted in higher prices.

But note also: Court then observed that it had always been reluctant to apply the per se rule to the collective decisions of professional associations

o But see Trial Lawyers: No deference for the learned profession

Today’s Rule for Professionals?o Begin with premise that the learned professions trade heavily in

information and expertise, areas prone to free-riding as well as other kinds of abuse

o As a result, the efficiency-creating joint practice may be somewhat larger in the learned professions than it is in, say, ordinary manufacturing

o However, issues raised in Indiana Dentists and Trial Lawyers is no different than the ordinary case involving cartels and boycotts designed to facilitate collusion no need to give any deference

o California Dental, (U.S. 1999): Restraint: Prohibited false advertising, but was

sufficiently broad to prohibit some nondeceptive advertising as well

ROR Analysis Applied: “In a market for professional services, in which advertising is relatively rare and the comparability of service packages is not easily established, the difficulty for customers or potential competitors to get and verify information about price and the availability of services magnifies the dangers to competition associated with misleading advertising

o Potential Rule from Cal. Dental: More suspicious restraints will be tolerated in complex

markets where consumers are more likely to be misled

o But see Hovenkamp’s Criticism of this Conclusion: In complex markets were consumers are more likely to be

misled there is far less need for collective/concerted action because competitors already aren’t competing on price (e.g., can upcharge a much larger number of customers because information is lacking)

Such markets are improved by allowing more information, rather than less

o Cal Dental’s Limitation to Complex Markets: Important limitation: An association of gasoline

retailers could still presumably not defend an agreement to advertise their prices by simply noting that some gasoline price advertising is deceptive b/c not a complex services market performed by range of professionals with varying skill

Further, one area where ROR is clearly appropriate is the professional peer review, which often involves concerted exclusion of a professional from the market

95

Efficient JVs and Refusals to Deal Closed-Membership and Other Traditional JVs

o Two Question Analysis: (1) Is the JV itself competitive or anticompetitive? (2) If the venture is competitive, what policy is furthered

by the refusal to deal?o The Spectrum:

Purely Anticompetitive Conduct: See, e.g., Eastern States: Lumber association

members refused to deal with wholesalers who sold directly to customers

Absent aggregate market power, the refusal makes no sense

High Efficiency, Low Risk: Three small firms in an unconcentrated market

undertake a risky, expensive and potentially profitable JV; Firm 4 is invited to join but refuses; JV is successful and Firm 4 wants to buy in; JV refuses and Firm 4 files refusal to deal challenge

ROR Analysis:o 3 Firms have no MP could not

reduce output and increase price

o And, their intent in formation =/= anticompetitive

Should the JV be required to let the 4th Firm in?

o NO: Firm 4 is attempting to free ride on the risk that the JV members undertook

o Alternative Result: If JVs always had to let others in would be no incentive to undertake risk in first instance

o Application to JVs Broadly: When JV locks in members at formation refusal to

admit others =/= itself raise AT concerns BUT, where JV has a history of open membership and

refuses one Firm entry raises AT concerns Note also: Where JV has potential to create substantial

efficiency but the participants also collectively have significant MP in evaluating the claim of an excluded rival, court must be asked to balance the injury to competition that results from the exclusion against the inefficiency of a rule that permits all late-comers to join; =/= something courts are competent at

Open-Membership Ventures; Positive Network Externalitieso Visa, (2nd Cir. 2003):

Restraint: Visa & MasterCard allowed any FDIC member bank to issue Visa & MasterCards exclusively (i.e., no discovery or Amex if they opted in)

Held Restraint Illegal B/c: (1) Exclusionary rules limited overall output of

credit cards to consumers (2) Rule constrained competition in the network

market by precluding consumers from linking up with Amex/Discovery

Rejected Visa/MC’s Defense: Restraint necessary to preclude freeriding

If Visa and MC allowed reciprocal exceptions for banks who opted into MC to also sell Visa and vice versa, then no reason to think that allowing the banks to also issue Amex, etc., was any different

o Overuse of Free-Rider Defense: Defense has to be taken seriously when raised, but Visa

demonstrates that it can be overused

96

Free Rider: Someone who is able to take advantage of another firm’s investment in such a way that the first firm cannot appropriate the value of the investment to itself

Free Riding = Output Reducing: It undermines the primary firm’s incentive to invest in a valuable asset, with the result that less of the asset is produced overall

o When is Free-Riding Actually an Appropriate Defense? (1) Not every instance of one firm’s trading on another

firm’s investment is the kind of free riding that presents a policy concern

E.g., Ford “free-rides” on the wide availability of Shell gas stations. That is, less gas stations less cars.

Thus, complimentary products can “free ride” off the investments of the complimentary firms

(2) Free riding =/= a problem if the investor can capture the return on its investment by other means, e.g., by charging an admission to the JV

See, e.g. Topco: Creating a valuable branded product viz. JV in order to compete with larger brand-name manufacturers

(3) Anticompetitive rules designed to solve free rider problems can often be addressed by less restrictive alternatives

See, e.g., Allied Tube: Held illegal Defendant’s conduct of packing standard setting meeting so as to recommend to legislatures that plaintiff’s product be excluded as unsafe

Take Away: Allowing the open membership JV to reach a position of market dominance can

o (1) Facilitate Collusion; ando (2) Limit innovation

Principle: When an association has acquired control in the profession, it is in a position to sue standard setting for anticompetitive purposes

Therefore, when the venture or professional association wield MP, rules that exclude people, products, or techniques that seem desirable must have a satisfactory explanation, and less restrictive alternatives to outright exclusion must always be examined.

See also Los Angeles Mem. Coliseum Commn. v. NFL, (9th Cir. 1984): Although NFL’s rule requiring ¾ of members to vote in order for new team to be admitting

was reasonable in order to facilitate the league, it was unreasonable to impose a similar restriction when teams wanted to move simply on the basis that it might cause ticket-sale competition between teams in nearby areas

Standard Setting and Rule Enforcement in Private Entrepreneurial and Professional Settings

Both standard setting and rule making are generally in the best interests of consumers because they substantially reduce information costs and thus consumer search costs

But note Inevitable result of standard setting = some don’t make the cut and are excluded

When Does Exclusion Become AT Problem?o When those enforcing the standards are competitors of the

person/firm excludedo But see At the same time, these professionals/competitors may also

have the best informational advantage to determine whether one person/firm or another reasonably should be excluded

Thus, if the members of the review board act in GF consumers are better off

BUT, if they act in bad faith harms consumers and the professional excluded

AT Approach:o Problem of professional and product standard setting by private

organizations is closely akin to refusals to deal by open membership JVs

o See Radiant Burners, (U.S. 1961): Court held that manufacturer whose product was alleged excluded under arbitrary and capricious

97

rules by competitor-standard setters pled a per se Sherman Act violation COA

Note Two Particular (Maybe Material) Elements Plaintiff Pled:

(1) P’s product was not evaluated objectively, but in a capricious way by competitors who had a vested interest in disapproving of the product

(2) Ds actually forced customers not to buy the disapproved product, or in some way prevented it from entering the market

Courts have generally only found a per se refusal to deal claim when both of these elements are allegedly present

o See also Eliason Corp, (6th Cir. 1980): Held: If alleged boycott resulted from industry self-

regulation or standard making, the P “must show either that it was barred from obtaining approval of its products on a discriminatory basis from its competitors, or that the conduct as a whole was manifestly unreasonable

Compare Silver v. NYSE and Northwest Wholesalerso Silver, (U.S. 1963):

Held: Nothing in the SEC Act performs the antitrust function of insuring that an exchange will not in some cases apply its rules so as to do injury to competition which cannot be justified as furthering legitimate self-regulating rules

Therefore: Where NYSE cut off service to Silver without explanation, it was not immune to AT COA of refusal to deal / arbitrary standard setting

o Northwest Wholesalers, (U.S. 1985) Restraint: Plaintiff retailer was expelled from wholesaler

cooperative that sold products w/ special rebate to member retailers

Held: Lower court incorrectly applier per se rule. Reasoning: Activities of a wholesale cooperative that

bought stationary supplies and resold them to members represented substantial integration of the distribution process this was not a “naked” refusal to deal

Accordingly, expulsion could not be condemned w/o a showing that the cooperative had MP or unique access to a business element necessary for competition

o Post-Northwest:

Northwest substantially increases P’s burden in cases involving an association’s refusal to deal

Under Silver, Ds had to provide minimal due process and an explanation for the discipline

Under Northwest, D apparently need provide nothing at all unless P shows market power

That is, mere fact that an expulsion from JV is unexplained =/= mean that it is unreasonable un the AT case

o Plaintiff’s Burden: P has initial obligation to allege and show that an expulsion either

(1) Facilitates a naked restraint such as price fixing; or (2) Is unreasonable w/ reasonableness measured in the AT

sense of facilitating the exercise of MP o D’s Burden: If MP is shown

Failure to provide an explanation for the expulsion = highly relevant to determination whether expulsion was competitively reasonable or whether less restrictive alternatives were available

Unexplained exclusions are more likely to raise the fact-finder’s suspicions

Rule of Reason and Ancillary Restraint Caseso Since Northwest, ROR in ancillary exclusion cases is quite

burdensome to Ps, particularly if the facility or association does not have a dominant position in its relevant market

o But see Allied Tube: Where the abuses are clear, excessive or irrational, courts will still find liability for AT violation

o In sum: If association has MP and the decision is both anticompetitive and irrational or unjustified association violates AT laws

o BUT, sometimes, a violation can be established w/o the MP requirement if plaintiff can show that the challenged action was nothing more than a naked, anticompetitive exclusion disguised as an associational rule

Agreements Involving Non-Competitorso NYNEX: When two vertically related firms refuse to deal that

refusal must be treated as a type of vertical restraint, so far as AT is concerned

o Legitimately ancillary agreements between vertically related firms not to deal with a rival get ROR

98

o Remember, boycotts in which the target is vertically related to the boycotters are almost always less suspicious than horizontal boycotts

See, e.g. American Needle: ROR applied to case where NFL signed exclusive IP deal with Reebok to the exclusion of American Needle

Held: Unreasonable restraint because it allowed competing NFL teams to avoid competing with each other on sale of branded products

o But note: Care must be taken to ensure that there is not a competitor victim as well

Expressive and Noncommercial Boycottso Claiborne Hardware, (U.S. 1982): AT action brought against civil

rights groups for boycotting merchants who had allegedly discriminated on the basis of race

Held: Boycott was form of Constitutionally protected speech, thus making it unreachable under Sherman Act

o Line Between Commercial and Political Speech: Not self-defining See, e.g., Trial Lawyers: Court rejected similar

contention where D.C. defenders boycotted representation for purpose of obtaining higher court fees

o Potential Line to Draw: In Claiborne the boycotters hoped to achieve equal

protection under the laws and to deter illegal/unconstitutional discrimination, whereas in Trial Lawyers, the boycotters hoped to achieve a higher price for their services

Agreements Governing the Licensing and Use of Patents and Other IP Scope of Patent Misuse Doctrine, AT & Beyond

o Patent Misuse: Found where court believes [patent is being used inconsistently with the policy behind the IP laws or competition policy

If found Patent will be held unenforceable Accordingly, is used as an affirmative defense against

patent infringement o Clayton §2: Applies to all goods and commodities whether

patented or unpatented; was intended to apply to ties and exclusive dealing

o General Tying Rule: Unlawful to tie if seller has MP in tying product or substantial anticompetitive effects result from tie

Patent Licensingo Price Fixing; Output Restrictions; Royalty Rates; Exclusivity

General Electric, (U.S. 1926): Restraint: In a patent license to competitors GE

required that the licensee charge a stipulated price for the manufactured patented good

Held permissible Justification: GE could have included the

markup in the patent license itself which would have resulted in this price; or, GE could have just not licensed the patent and produced everything itself

Exceptions to GE (1) Price provision may not extend to unpatented

goods (2) GE extends to the price initially charged by

the licensee, but not to the resale price: i.e., licensor may not engage in RPM in which it regulates price at resale level by those who purchase from licensee

(3) If patents are cross-licensed (i.e., relicensed from the original licensee to another) the latter licensing agreement cannot restrict price

(4) Several decisions have suggested while GE permits a single patentee to fix the price with a single license, it does not apply to agreements involving multiple patentees or a patentee and several licenses [No industry wide price fixing]

o Market Division Agreements; Patent Settlements, Pharmaceutical and Otherwise

Patent act expressly gives patentee right to grant exclusive rights to the whole or any specified part of the U.S.

Accordingly, a patentee may license in a way that creates a horizontal market allocation

But see Sham Exception: BRG, (U.S. 1990): Held per se unlawful horizontal market allocation viz licensing of copyrighted bar-prep materials where parties agreed to overly broad non-compete ancillary to licensing

99

o Package Licenses See, e.g., BMI Generally legal BUT NOTE: If license is conditioned on purchasing

other licenses (i.e., tying) can be anticompetitive

o Patent Pools Occurs where group of patent holders cross license among

each other Generally treated under ROR and most are legal But see Zenith Radio, (U.S. 1969): Held illegal per se

patent pool where pool members agreed not to license to anyone outside of the group

See also AT IP Guidelines: Collective price or output restraints in pooling agreements, such as the joint marketing of pooled IP rights with collective price setting or coordinated output restrictions, may be deemed unlawful fi they do not contribute to an efficiency enhancing integration of economic activity among the participants

o Grantbacks Requires licensee to license back to licensor any patented

improvements that the licensee makes on the licensed technology

Considered under ROR and generally = legal

Characterization and Evaluation: The Per Se Rule and Rule of Reason Supreme Court and Per Se Rule

o Chi. Bd. Trade, (U.S. 1918) [Brandeis]: True test of legality is whether the restraint imposed is

such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition.

To determine that question, court must ordinarily consider the facts peculiar to the business to which the restraint is applied; its condition before and after the restraint was imposed; the nature of the restraint and tis effect, actual or probable

o Socony-Vacuum, (U.S. 1940) [Douglas]: Under Sherman Act a combination formed for the purpose

and with the effect of raising, depressing, fixing, pegging, or stabilizing price of a commodity . . . is illegal per se

o Topco, (U.S. 1972) [Marshall]: Whether or not we would decide this case the

same way under the ROR used by the D. Ct. is irrelevant [Berger, C.J.] Dissent: Per se rules are directed to the

protection of the public welfare; they are complimentary to, and in no way consistent with, the ROR

o Professional Engineers, (U.S. 1978) [Stevens]: There are two complementary categories of AT analysis.

In the first, are agreements whose nature and necessary effect are so plainly anticompetitive that no elaborate study of the industry is needed to establish their illegality—they are illegal per se

In the second category are agreements whose competitive effect can only be evaluated by analyzing the facts peculiar to the business, the history of the restraint, and the reasons why it was imposed.

In either event, the purpose of the analysis is to form a judgment about the competitive significance of the restraint; it is not to decide whether a policy favoring competition is in the public interest, or in the interest of the members of an industry

o BMI, (U.S. 1979) [White]: Price fixing is a shorthand way of describing a category of

business behavior to which the per se rule has been held applicable

However, when two PRs set the rice of their goods or services they are literally price fixing, but they are not per se in violation of the Sherman Act

Thus, it is necessary to characterize the challenged conduct as falling within or without that category of behavior to which we apply the label per se price fixing

o Maricopa Cty. Med. Soc., (U.S. 1982) [Stevens]: The costs of judging business practices under ROR have

been reduced by the recognition of per se rules Once experience with a particular kind of restraint enable

the Court to predict with confidence that ROR will condemn it, it has applied a conclusive presumption that the restraint is unreasonable

o Jefferson Parish, (U.S. 1984) [Stevens]: Rationale for per se rules in part is to avoid a burdensome

inquiry into actual market conditions where the likelihood of anticompetitive conduct is so great as to render unjustified the costs of determining whether the particular case at bar involves anticompetitive conduct

100

o Trial Lawyers, (U.S. 1990) [Stevens]: Per se rules are, of course, the product of judicial

interpretation of the Sherman Act, but the rules nevertheless have the same force and effect as any other statutory commands

Moreover, while the per se rule against price fixing and boycotts is indeed justified in part by “administrative convenience,” the Court of Appeals erred in describing the prohibition as justified only by such concerns.

The per se rules also reflect long-standing judgment that the prohibited practices by their nature have a “substantial potential for impact on competition” (citing Jefferson Parish)

o California Dental, (U.S. 1999) [Souter]: There is always something of a sliding scale in appraising

reasonableness, but the sliding scale formula deceptively suggests greater precision than we can hope for

The object is to see whether the experience of the market has been so clear, or necessarily will be, that a confident conclusion about the principal tendency of a restriction will follow form a quick (or at least quicker) look, in place of a more sedulous one.

o American Needle v. NFL, (U.S. 2010) [Stevens] (quoting NCAA): Depending upon the concerted activity in question, the

ROR may not require a detailed analysis; it can sometimes be applied in the twinkling of an eye

When Court is Going Per se vs. RORo Compare BMI:

Blanket licensing surely involved an agreement among competitors that affected price

BUT, the non-exclusive nature of the agreement and the fact that there were thousands of participants made collusion impossible

Further, defendants produced a plausible argument that the agreement resulted in substantially larger output and lower prices

o with Professional Engineers: Arrangement at issue was exclusive: it forbade Engineers

from discussing price Further, their argument that “excessive” price competition

would force engineers to cut corners was impermissible,

because it was an argument that the public had an interest in higher bid prices

Defendant will not be able to avoid condemnation by showing that low prices or high output are not in the best interest of consumers in a particular case

o So, what is Competition? Action that increases consumer autonomy, lowers price,

and increases output

101

Identifying Anticompetitive Conduct: A Tentative Road map (1) Does the agreement arguably threaten either to reduce output or raise

rice in some nontrivial way?o If not should generally be declared legalo If yes see Step 2

See also Monopsony & JVs among Buyers: Does the buying entity threaten to lower the buying price or reduce quantity of the input w/o corresponding benefit to consumers?

(2) [End of per se inquiry] Is the agreement naked or ancillary to some other JV or agreement that is itself plausibly efficiency creating or otherwise beneficial to consumers?

o Naked: Formed with the objectively intended purpose or likely effect of increasing price or decreasing output in the short run

Thus, Only rational on premise that participants have MPo Ancillary:

Reduces cost or improves the product and can be profitable whether or not firms have nay MP

o If naked illegalo If ancillary see Step 3

(3) [Start of ROR] Do the parties engaging in the alleged restraint have MP in the relevant market? How numerous are they? How concentrated is the market? Is there a substantial competitive market outside the venture? Are entry barriers high? Is the venture non-exclusive?

o If conclusion is that MP is unlikely challenged practice is legalo If exercise of MP = likely see Step 4

Note: Proof of actual anticompetitive effects can be used as a substitute for formal MP analysis

(4) Is there strong evidence that the challenged practice creates substantial efficiencies by reducing participants’ costs or improving product or service quality?

o If not illegalo If yes see Step 5

(5) Can the same efficiencies be achieved by reasonably available alternative that have less potential harm to competition?

o If yes Practice in present form is illegal, although injunctive remedy should be limited to condemning the current form or ordering the alternative

o If no less restrictive alternative see Step 6

(6) Balancing: [Only time Subjective Intent Becomes Relevant]o If threat to competition is real, and if D cannot come up with a way

of restructuring their venture so that this threat is substantially dissipated court’s only conclusion must be to condemn the arrangement

o At this point, intent and GF may become relevant, particularly in cases where Ds have technical expertise and their professional judgment must have a certain among of deference if their market is to function properly

o Nevertheless, any court faced with the prospect of balancing must go back to Step 5 and look for less restrictive alternatives

See also California Dental, (U.S. 1999) [Breyer] Dissent:o Breyer’s Suggested ROR Approach:

102

(1) What is the specific restraint at issue? (2) What are its likely anticompetitive effects? (3) Are there offsetting procompetitive justifications? (4) Do parties have sufficient MP to make a difference?

Burden of Proofo Generally lies with the plaintiffo But see ROR Burden Shiftingo Plausibility Test: Burden should generally go to the party with the

claim that is the hardest to believe

Chapter 9 – Vertical Integration and Vertical Mergers

Introduction Economics of Vertical Integration

o Implications of Coase’s Work; Transaction Cost Economieso Cost Savings, Technological and Transactionalo Efficient Vertical Integration and Multi-State MP; Eliminating

Double Marginalization; Two-Part Tariffs Plausible Anticompetitive Consequences of Vertical Integration

o Strategic Control of Inputso Price Discrimination o Foreclosure and Entry Barrierso VI by Price Regulated Firms

o VI & Cartels Vertical Mergers and AT Law Vertical Mergers and AT Division Merger Guidelines

o Increased Barriers to Entryo Vertical Mergers That Facilitate Collusiono Avoidance of Rate Regulation

103

Chapter 9 – Vertical Integration and Vertical Mergers

Introduction Vertical Integration: A firm is vertically integrated whenever it performs

for itself some function that could otherwise by purchased on the marketo E.g., Atty who washes his own office windows or a pizza parlor

that makes its own deliveries = both vertically integrated operations

o Thus, all firms are vertically integrated to some degree Three Ways Firms can Vertically Integrate

o (1) [Most Common] Can enter a new market on its owno (2) Can acquire another firm in the secondary market

o (3) Firm might enter into a long-term K with another firm under which the two firms coordinate certain aspects of their behavior

AT & VIo Under a variety of theories, all three forms of VI have been

condemned Integration by new entry, is usually only challenged when

integrating firm is a monopolist Monopolist VI = analyzed under §2 Sherman

o More generally, VI is analyzed as a merger under §7 Claytono By long-term K = §1 Sherman if it is found to involve RPM or

some other agreement in restraint of trade But, can also be condemned as illegal tying or exclusive

dealing under §3 Clayton or §1 Sherman Direction of Integration:

o Upstream: Firm integrates upward into supplier marketo Downstream: Firm integrates downward into dealer market

[Skipped] Economics of Vertical Integration

o Implications of Coase’s Work; Transaction Cost Economieso Cost Savings, Technological and Transactionalo Efficient Vertical Integration and Multi-State MP; Eliminating

Double Marginalization; Two-Part Tariffs

Plausible Anticompetitive Consequences of Vertical Integration Generally, a monopolist at any level of distribution cannot increase its

monopoly profits by integrating into another level on the distribution chain There is only one monopoly rent that can be extracted, and that is

determined by consumers’ willingness to purchase at a certain price So, only if vertical integration reduces the monopolists costs will it reap any

benefit

Strategic Control of Inputso Should condemn VI only where the firm or firms involved

(1) Have substantial MP

104

(2) Integration results in substantial foreclosure; and (3) Where case for enhanced efficiencies is very weak

Price Discrimination o Manufacturer has two groups that value its products differently

it vertically integrates into the retail levels for both of these consumers and sells at two different prices

o Output Reduction Possibilities: There is a transfer from the high value to low value

customers. E.g., if High Group values at $1.00 and this is the price D

charges Consumer who values at $0.90 cannot buy in his market, even though D also sells in Market 2 to the Low Group at $0.25.

Especially where low group values the product barely above the low sales price

Foreclosure and Entry Barrierso Other alleged injuries from VI come not from the integration per

se, but from the self-dealing that results from VIo Particularly where VI lowers costs, we would expect the integrated

firm to take advantage of these efficiencies and distribute primarily through its channels

See, e.g., du Pont (GM), (U.S. 1957): Du Pont had a majority stake in GM but GM didn’t always buy from Du Pont b/c Du Pont didn’t always have the lowest available fabric price

o Two Arguments Courts Apply Broadly (Not Very Economically Sound):

(1) VI forecloses competitors from access to markets (2) VI increases barriers to entry

VI by Price Regulated Firmso (1) Can VI upstream and upcharge itself for inputs in order to

convince regulators to allow it to increase its consumer priceso (2) Can vertically integrate into a competitive market and then

cross-subsidize using monopoly profits from the regulated area to deter entry into the competitive area

But see Raises same issues of price discrimination

VI & Cartels

o If cartel members each vertically integrate into their own retail stores, then all of their prices will be publicly advertised and it becomes more difficult to cheat

Vertical Mergers and AT Law Notwithstanding extraordinary potential for creating efficiency and limited

threat of economic harm, VI has historically not fared well under AT laws Most of the law of VI was written at a time when protection of small

businesses rather than encouragement of efficiency was the underlying AT policy

o See, e.g., Brown Shoe, (U.S. 1962): Condemned vertical merger because it permitted the post-merger defendant to undersell its unintegrated rivals

o But see Since 1960: Marks dramatic shift in judicial policy Pre-1960’s: Foreclosure Concerns

o Foreclosure: When VI by one firm denies another firm access to the market

Both new entry and merger into the secondary market can foreclose competitors

See, e.g., Kansas City Star, (8th Cir. 1984): When the only newspaper in town vertically integrates into newspaper delivery, all the previous delivery companies are now out of that business

o 1950’s: Amended §7 Clayton Legislative History: Indicates that Congress wanted

stronger merger standards that would condemn acquisitions in their “incipiency,” before they had a chance to work their full evil

Also, clarified that §7 applied to Horizontal and Vertical Mergers

Judicial Application of Amended §7o See Du Pont, (U.S. 1957):

Held: Violation of §7 for du Pont to have acquired 23% of GM

Issue: Whether du Pont’s commanding position as GM’s supplier of automotive finishes and fabrics was achieved on competitive merit alone, or because its acquisition of GM stock, and the consequent close intercompany

105

relationship led to the insulation of most of GM’s market from free competition

o Major Problems with Court’s Analysis: (1) Raised the specter of judicial inquiry into whether a

firm’s own dealings with upstream parents or downstream subsidiaries were on the competitive merits or simply a consequence of ownership interest

(2) Suggested a firm could somehow profit by making inefficient internal transfers of inputs rather than purchasing or selling them on the competitive market

o See also Brown Shoe, (U.S. 1962): Went even further than Du Pont Condemned a shoe manufacturer’s acquisition of a shoe

retailer when the manufacturer’s market share was about 5% and the retailer’s market share in the same market was about 1%

Justification: Undeniable trend was the consistent vertical integration of other shoe manufacturers into retailers

Meaning: That the efficiencies caused by VI were driving other competitors in the market to do the same

Barriers to Entry viz VIo See Ford Motor, (U.S. 1972): Court relied on “barriers to entry”

argument when it condemned Ford’s acquisition of a spark-plug manufacturer

o Hovenkamp’s Criticism: ANY efficiency maximizing firm will vertically integrate

if it means it lowers the overall costs of production Monopolist VI Consideration:

May carry more weight here E.g., if monopolist manufacturer acquires single

input firm it will produce inputs for itself and the other input makers will have to either try and tread into monopolist’s turf (high barrier) or be forced out into another market

But Consider: Are Consumers Harmed? (1) If monopolist captures all the efficiencies by

VI its profit maximizing price will also reduce

(2) Monopolist cannot make additional rents through its integration into the secondary market

(3) If the money is good enough competitors will collect the capital and enter at both levels

o Potentially large profits will attract capital more quickly than into a competitive market with only internal ROR

Current State of the Lawo SCOTUS has not decided a VI case since Ford in 1972o Circuit Courts = Increasingly Critical of Foreclosure Theory

See Fruehauf, (2nd Cir. 1979): Held: Refused to enforce FTC ruling

condemning a vertical merger under §7 and ordering divesture

Challenged VI: Largest manufacturer of truck trailers in the U.S., with about 25% of that market, acquired KH, which controlled about 15% of the market for heavy duty truck and trailer wheels

FTC Alleged: Acquisition foreclosed about 6% of the markets for heavy duty wheels

Second Circuit Rejected: Unwilling to assume that vertical foreclosure lessens competition.

Foreclosure Plus … Rule: Absent very high market concentration or some other factor threatening a tangible anticompetitive effect, a vertical merger may simply realign sales patterns, for insofar as the merger forecloses some of the market from the merging firm’s competitors, it may simply free up that much of the market for new transactions

o Focus has shifted to Raising Rivals Costs See, e.g., Silicon Graphics, (FTC 1995):

Concerned the acquisition of computer workstation graphics software producers by a computer workstation manufacturer.

Theory of Complaint: Acquisition could deny remaining independent computer workstation manufacturers adequate access to graphics software, thus increasing their costs; and,

106

remaining independent software designers adequate access to workstation producers, thus increasing their costs too.

o Example of how VI Can Raise Rivals Costs: Assume there are ten different cable systems, six of which

are owned by Firm A Further, there are two programmers who compete to

supply programing to the ten systems A program costs $10 to make $10 must be recovered

by licensing. If a programmer sells to all 10 systems cost = $1 each If programmer licenses to only 5 cost $2 each Now, Firm A acquires (or is acquired by) one of the

programmers. The post-merger firm deals exclusively with itself

Result: There are now only 4 available systems to sell to and a programmer must charge, now, $2.50 each to cover the cost of production

Response by Firm A: Firm A can now raise its prices to just below $2.50 and thus (1) charge a supracompetitive rate, (2) just below its competitors

Thus, by raising rivals’ costs, a dominant firm in the market can price supracompetitively

Vertical Mergers and AT Division Merger Guidelines 1984 Merger Guidelines:

o Replaced the 1968 Guidelines, which focused heavily on foreclosure theory

o Further, in 2010 Guidelines were amended again, but only apply to horizontal mergers

Vertical Merger Analysis Under Guidelines:o 2010: Used for market delineation and entry barrier criteriao 1984: Used for substantive criteria

1948 Guidelines Substantive Provisionso Eliminate three-tier classification of mergers in favor of a two-

category classification: (1) Horizontal (2) Non-Horizontal

o What makes two firms Horizontal? Horizontal: Firms for whose output cross-elasticity of

demand is high Potential Competitors: Involve firms for which the cross-

elasticity of supply if high Seen in the conglomerate merger setting

1984: Three Possible Dangers to Competition from VIo (1) Increased Barriers to Entryo (2) Facilitation of Collusiono (3) Avoidance of Rate Regulationo Note: “Foreclosure” =/= concern of 1984 guidelines

Increased Barriers to Entryo Guidelines provide that three conditions are generally necessary

(but not sufficient) for vertical mergers to raise anticompetitive entry barrier problems

(1) VI in the market must be so extensive that entrants must enter both markets simultaneously

Division is “unlikely” to challenge VI on entry barrier theory if the market contains enough unintegrated firms that a new, unintegrated entrant could find its essential outlets or sources of supply

Guidance: Division suggests that there must be sufficient unintegrated capacity at one level to service two minimum efficient scale plants at the other level involved in the merger

(2) Mere need for two-level entry =/= sufficient. Also have to show that the need for two-level entry serves as a significant deterrent to new entry

Test: if two level entry is so easy that one firm can’t reap supracompetitive prices for long in the short-run through VI Division likely won’t challenge

What constitutes entry barrier?o Mere two-level entry alone =/=

sufficient barrier

107

o Capital requirements =/= sufficient alone

o BUT, if two-level entry requires more than average risk and increase CCC Division will count as entry barrier

(3) Economies of scale may constitute an entry barrier if the capacity of MES plants differs significantly at the two levels

Suppose MES for input is 70% of the market Input Co. has 80% of relevant market If Input Co. VIs into product market two-

level entry now requires a substantial operation in the input level to reach MES to sufficiently compete with the 80% MS manufacturer

But see Elasticity of Supply/Demand: If there are reasonable substitutes at the input level VI alone by manufacturer won’t create illegal entry barrier

Final consideration: Barriers to entry have no effect on competitive markets—i.e., a competitive market w/ 100 perfect competitors will perform competitively in spite of insurmountable barriers against a potential 101st entrant

Therefore, Division is unlikely to challenge merges on a barrier to entry theory unless overall concentration in one market is above 1800 HHI

Vertical Mergers That Facilitate Collusiono VI =/= likely to facilitate collusion unless the manufacturer or

distributor market is itself conducive to collusiono General Rule: Division won’t challenge Vertical Mergers unless

HHI in the upstream market exceeds 1800o See also Disruptive Buyer Theory:

Division notes that VI might facilitate collusion if it eliminates a large, particularly disruptive buyer which in the past had effectively forced sellers to compete with each other

BUT, applies only when the upstream market is itself conducive to collusion

Thus, Division is unlikely to challenge merger on this ground, unless upstream market HHI exceeds 1800

Avoidance of Rate Regulation o Division nots that VI may enable price-regulated utilities to

circumvent rate regulatory inflating the costs of internal transactions with the unregulated subsidiary

o Could be particularly problematic if there is no independent market for the unregulated product or service, for the regulatory agency will have no basis for comparing prices

o ON the other hand, VI by price-regulated firms can generate the same efficiencies available to competitive forms

o Therefore, Division will challenge only if they produce “substantial opportunities for such abuses”

Final Thoughts on 1984 Guidelines:o Division doesn’t put may resources into VI enforcemento FTC has dome somewhat moreo Guidelines have all but abandoned several judicial theories of why

VI should be condemnedo Most of the factual predicates for the new theories occur only

infrequently This is consistent w/ the position that VI seldom injures

competition

Herfindahl-Hirschman Index (HHI): HHI is the sum of the squares of the market shares of all firms operating in

the relevant market A typical market with HHI of 1800 would have one firm w/ a MS of 30%,

one w/ 20% and five firms with 10% eacho HHI = 30^2, 20^2, 10^2, 10^2, 10^2, 10^2, 10^2o HHI = 1800

108

Ch. 12 – Mergers of Competitors

Introduction: Federal Merger Policy and the Horizontal Merger Guidelines

o Continuing Importance of Market Structure to Merger Analysis

o Basic Concerns of Merger Policy: Reduced Market Output, Higher Prices, and Offsetting Efficiencies

o Mergers and Exclusionary Practices; Predatory Pricing; Private Challenges

Efficiency & Merger Policyo Dubious Legacy of Warren Erao Assessing Efficiency Effects of Horizontal Mergers

Welfare “Tradeoff” Model Must Efficiencies be “Passed On”? Efficiencies Must Be “Merger Specific” and

“Extraordinary” Problems of Identification and Measurement Benefit and Threat in Different Markets

Estimating Anticompetitive Consequences I: Mergers Facilitating Unilateral Price Increases

o Introductiono Merger to Monopolyo Dominant Firm’s Acquisition of Nascent Rivalo Unilateral Effects in Product Differentiated Marketso Mergers that Threaten Innovation

Estimating Anticompetitive Consequences II: Mergers Facilitating Coordinated Interaction

o Measuring Market Concentration: CR4 and HHI Four-Firm Concentration Ratio: CR4 Herfindahl-Hirschman Index (HHI)

o Market Share Thresholds Under Horizontal Merger Guidelines

When is a merger horizontal? When the merging companies are competitors in the same relevant market

109

Ch. 12 – Mergers of Competitors

Introduction: Federal Merger Policy and the Horizontal Merger Guidelines Merger: Occurs when two firms that had been separate come under

common ownership or control

o Control: Important here because leases or contractual arrangements amount to less than fee simple ownership can be challenged as mergers

o E.g., Long-term Exclusive K which is in substance a merger though not in form

Merger in Antitrust: Broader than the corporate definition; o Can be as simple as the purchase by one firm of some or all of the

assets of another firm; or o Where one corporation buys all or some of the shares in another

corporation; oro Where two firms consolidate and a new firm emerges

Pre-1950 Amendments to §7 Clayton Merger Analysiso §7 only covered stock acquisitions that that time

Thus, stock acquisitions received the relatively strict test of §7 which condemns mergers that may “substantially . . . lessen competition . . . or tend to create a monopoly”

o §1 applied to asset acquisitions or §2 if the acquisition produced a monopoly

Today’s Merger Analysis o §7 Clayton: now reaches both stock and asset acquisitionso Further, Sherman and Clayton Act standards are probably the

sameo Note also: Pre-1980s, §7 was only applied to corporations; today,

it has been amended to apply to all “persons” whether incorporated or not

Terminology:o Horizontal Merger: Occurs when one firm acquires another firm

that manufacturers the same product or a close substitute and both firms operate in the same geographic market

Thus, the firms were actual competitors before the merger occurred

o Non-Horizontal: If the merging firms were not actual competitors under the Horizontal definition above pre-merger will be treated either as Vertical or Conglomerate depending on the relationship between the firs

2010 Merger Guidelines [Produced by DOJ & FTC]o Policy Reflected: Prevent the enhancement of MP that might

result from mergers.

110

o Guidelines State: A merger enhances MP if it is likely to encourage one or more firms to raise price, reduce output, diminish innovation, or otherwise harm consumers as a result of diminished constraints or incentives

Continuing Importance of Market Structure to Merger Analysiso In the 1960s era, highly concentrated markets caused poor

performance o Today, economic considerations are afforded to markets which, by

nature, require high concentration (e.g., because production has a high MES)

o Thus, while market share is still highly relevant, it is not a sufficient condition to invalidating a proposed merger alone

Basic Concerns of Merger Policy: Reduced Market Output, Higher Prices, and Offsetting Efficiencies

o Effect of Merging Competitors on Market: (1) There is now one less firm in the relevant market; and (2) The remaining firm has a larger MS than either of the

previous two o Principal Concerns of Merger Policy:

Horizontal mergers may facilitate market wide express or tacit collusion or oligopoly behavior

2010 Guidelines: Term this “coordinated interaction”

Merger may facilitate unilateral price increases by the post-merger firms while other firms in the market may increases their price slightly or not at all

Can also create opportunities for price leadershipo Pro-Competitive Effects of Mergers:

Can increase efficiency of firms by enabling them to attain efficient levels of manufacturing, R&D, or distribution more rapidly than the firms would accomplish through internal growth

Can make markets more competitive by creating more substantial rivals for the dominant firm

May permit firms to acquire productive assets without the costs and risks of internal development

Can also assign productive assets away from less efficient managers and towards more efficient ones

Finally, may also permit firm to achieve economies in management by eliminating redundancies

o Why are we Concerned With Mergers?

§1 is pretty inadequate at deterring collusion Difficult to detect Doesn’t attach to “unilateral’ conduct

§7, however, allows us to go after firms before a market becomes overconcentrated or before a single player becomes too large

Also, by disallowing the merger in the first instance, allows us to deter the possibility of unilateral price increases (i.e., price setting at a higher level as exercise of MP) by the post-merger firm

Policy: Consumers are entitled to a market in which both price and the package of services offered is established by competition

Mergers and Exclusionary Practices; Predatory Pricing; Private Challenges

o Private Plaintiff’s Burden: Provide a plausible showing that the post-merger market is significantly more conducive to certain kinds of oligopoly behavior than it was pre-merger

o BUT, firms don’t by nature of the market have an incentive to engage in predatory pricing or exclusionary practices

That is, they have an incentive to get the best prices, to lower their costs of product, and to sell to consumers at their marginal cost, or the next most efficient producer’s marginal cost

o Therefore, Plaintiffs should also have to show that the firm has a history of engaging in the practice or some fairly specific plans for engaging in the practice in the future, or that the merger commits the firm in some way to engage in the practice

o See, e.g., Cargill, (U.S. 1986): Merger was assumed to create a post-merger market share

of 21%--Court concluded this was not large enough to make predatory pricing possible, even if it had been properly alleged

o See also Brooke [Generic Tobacco Case], (U.S. 1993): Held: predatory pricing will not be found unless it can be

shown that they payoff, or recoupment, will be sufficiently large to make predation a profitable strategy

o Takeaway from Brooke:

111

When P challenges merger on theory that it will facilitate predation, at the very lest, Court must do a full structural analysis such as the one employed in Brooke in order to determine whether a rational profit-maximizing firm, operating after the merger, would find predation a profitable strategy

Elements to Meet This Burden: High entry barriers Highly successful oligopoly behavior And, other structural features indicating that the

payoff to predation will exceed its costs

Efficiency & Merger Policy

Horizontal mergers can create substantial efficiencies even as they facilitate collusion or enhance market power. Courts and other policymakers have entertained three different positions concerning efficiency and the legality of mergers:

o (1) Mergers should be evaluated for their effect on MP or likelihood of collusion, and efficiency considerations should be largely irrelevant;

o (2) Mergers that create substantial efficiencies should be legal, or there should at least be a limited “efficiency defense” in certain merger cases;

o (3) Mergers should be condemned because they create efficiencies, in order to protect competitors form the post-merger firm

Assessing Efficiency Effects of Horizontal Mergerso Welfare “Tradeoff” Model

2010 Guidelines: Recognize an “efficiency defense” when the merger has been found presumptively anticompetitive by structural and behavioral analysis

o Must Efficiencies be “Passed On”? Courts have rejected the efficiency defense where

defendant/s can’t show that the gains will be passed onto consumers

See, e.g., University Health [Georgia Hospital Case], (11th Cir. 1991): Court rejected efficiency defense where defendant couldn’t’ demonstrate its post-acquisition efficiencies would ultimately benefit competition and consumers

But see Cannot have a rule that requires all efficiency gains to be passed onto consumers

Would completely undermine the reason firms merge in the first place: lower costs

o If a firm can’t pocket some of the benefits of cheaper production no incentive to merge

Hovenkamp’s More Acceptable Rule: Defendants must show that efficiency created by

the merger are sufficiently large to keep post-merger prices at or below the pre-merger levels

o E.g., if a merger threatens monopoly or oligopoly efficiencies created by merger must bee sufficient to drive the post-merger price to the pre-merger price or lower

112

2010 Guidelines: State that the efficiencies must be “of a character and magnitude such that the merger is not likely to be anticompetitive in any relevant market.”

o Then, Agency will “consider whether cognizable efficiencies likely would be sufficient to reverse the merger’s potential harm to customers in the relevant market, e.g., by preventing a price increase in that market

o Efficiencies Must Be “Merger Specific” and “Extraordinary” Reasonably Available Alternatives to Merger: Firms

can provide a number of arguments on how the merger will increase efficiency (e.g., replace bad management, streamline a distribution system), but the “efficiency defense” has been only sparsely successful because many of these efficiency gains can be accomplished without merger

Plausible Alternatives to Merger Joint Venture: e.g., joint participation in R&D or

reciprocal IP licensing Distinguish Merger Efficiency from Ordinary

Efficiency Gains: All mergers produce some efficiency gains The kinds of efficiencies that qualify for the

“efficiency defense,” however, must be “extraordinary”—i.e., going beyond basic savings

When Merger Poses Significant Threat, D’s Burden: Must show (1) merger will produce significant

and extraordinary economies, which (2) could not be readily obtained by means other than merger

o Problems of Identification and Measurement

See, e.g., Heinz [Baby Food], (D.C. Cir. 2001): Beach-Nut had high operating costs and Heinz

had a large plant with unused capacity However, parties weren’t able to show

extraordinary efficiency gains and their merger would be one to duopoly with Gerber—a market structure likely to lead to higher prices

o Benefit and Threat in Different Markets Sometimes a merger increases likelihood of

anticompetitive harm in one market while benefitting consumers in a market

Would be inconsistent w/ §7 to allow efficiency in one market to risk harm to a set of customers in a second market

Absent extraordinary efficiency in one market with limited harm in the other, this type of merger should be condemned

113

Estimating Anticompetitive Consequences I: Mergers Facilitating Unilateral Price Increases

Introductiono The anticompetitive consequences from horizontal mergers come

in two different headings: (1) Merger which will allow merged firm to increase its

prices while competitors are only able, at best, to engage in a small price increase; or

(2) Where merger will facilitate collusion or other forms of coordinated interaction thus permitting all firms in the market to increase price

Merger to Monopolyo Deserve the highest level of antitrust scrutiny and should be

condemned even if entry barriers are low E.g., With low entry barriers, monopoly will buy up the

new entrants: substantial and inefficient entrenchment costs = high costs to consumers

Dominant Firm’s Acquisition of Nascent Rivalo It is a rare case where a 90% MS firm could obtain certain

efficiencies by acquiring a small 1% firm in the market that the 90% firm couldn’t obtain through another reasonable alternative

o E.g., if the 1% firm has tech the 90% firm wants, it could buy a non-exclusive license form the 1% firm.

Would serve to give 90% firm efficiency increase its after while keeping entry barriers from increasing even further

Unilateral Effects in Product Differentiated Marketso Product Differentiation: Where firms make competing products

but consumers have preferences among them and value then differently

o Offsetting Factor of Product Differentiation: Makes it much more difficult to collude or coordinate on price

o But see Can also provide firms with a cushion in which a SSNIP may occur

2010 Guidelines: Closer the merging firms products are more likely that the merger will produce a substantial price increase

But see Products need not be the “closest” rivals before the merger can have anticompetitive consequences

o Furthermore, something must prevent other firms in the market from repositioning their output to make it more like that of the

114

merging firm, thus allowing them to take advantage of the price increase

Application of Critical Loss Analysis: Begins with a price increase of a given

magnitude Then, consider how many sales must be lost

before this particular price increase would become unprofitable

Then, consider whether the actual level of sales lost in response to a given price increase exceeds the critical level

If the actual level is greater than the critical level the price increase is unprofitable and the market must be drawn more broadly

o That is, price increasing firm doesn’t have MP to engage in SSNIP and not lose customers

In some cases, large price increase might be profitable while a smaller one would not be; in orders a smaller price increase might be profitable whereas a larger one would not

But note: In most cases, the merger hasn’t happened yet, so all of this has to be simulated with the relevant losses estimated from demand elasticities

o Problems Unilateral Effects Merger Analysis: First, one difficulty with estimating unilateral effects is

that retail pricing data can exaggerate the anticompetitive effects of mergers by focusing exclusively on the demand side of the market

Excessive reliance on short-run consumer behavior gives us an exaggerated picture to the extent that consumer choice is only one of many avenues along which substitution among products occurs

Second, unilateral effects analysis requires that the two merging firms be particularly close, while the output of the non-merging firms be sufficiently distinct that they cannot discipline a higher price charged by the merging firm

Mergers that Threaten Innovationo 2010 Guidelines:

Contain a section that did not appear in the previous Guidelines concerning mergers that threaten competition by limiting innovation and product variety

Concern is mainly with unilateral effects that result from the reduction in innovation competition

o Guidelines State: Agency may consider whether a merger is likely to

diminish innovation competition by encouraging the merged firm to curtail its innovative efforts below the level that would prevail in the absence of the merger

That curtailment could take the form of reduced incentive to continue with an existing product development effort or reduced productive development effort or reduced incentive to initiate development of new products

Thus, Agencies evaluate the extent to which successful innovation by one merging firm is likely to take sales from the other, and the extent to which the post-merger incentives for future innovation will be lower than those that would prevail in absence of the merger

Estimating Anticompetitive Consequences II: Mergers Facilitating Coordinated Interaction

Both Merger Guidelines and the courts have tried to develop uniary structural rules for prima facie illegality that apply in all industries with a given level of concentration

Then they use several non-market share factors as mitigating or aggravating circumstances on a case-by-case basis

See Philadelphia Nat’l Bank, (U.S. 1963): Approved this approacho Court compared market share percentages in merger cases in a

wide variety of industries and concluded that the percentages int eh case before it (combined market share of more than 30%) “raise an inference that the effect of the contemplated merger of appellees may be substantially to lessen competition.”

Non-market share factors include:o Presence of high entry barrierso Sophistication of buyers, suppliers, or others in a position to

discipline market participantso Sales methods, shipping costs, availability of facilitating practiceso Degree of product differentiation

Measuring Market Concentration: CR4 and HHIo Four-Firm Concentration Ratio: CR4

115

Take the four largest industries in the market Add their market share percentages together If CR4 exceeds 75% market is conducive to collusion

o Herfindahl-Hirschman Index (HHI) Take the sum square of every firm in the relevant market Threshold for high concentration = 2500

o Market Share Thresholds under 2010 Merger Guidelines If post-merger HHI falls between 1500 and 2500, the

market will be deemed “moderately concentrated” Nevertheless, the agencies will be unlikely to

challenge a merger that increases HHI less than 100 points

But, if increase is greater than 100, then likelihood of challenge increase

If Pre-merger HHI exceeds 2500 “highly concentrated”

However, even here if merger produces less than 100 point increase in HHI likely won’t be challenged

If HHI increase falls between 100 and 200 points merger will be regarded as having significant anticompetitive potential and will warrant close scrutiny

If pre-merger market has 2500 HHI the dominant firm will likely be prohibited even from acquiring the smallest competitor because it will cause too large an increase in HHI

116

Jurisdiction & Scope

Interstate Commerce Requirement Summit Health, (U.S. 1991) [Stevens]

o Posture: Motion to Dismiss on Pleadings Must assume truth of the material facts as alleged in the

complainto Issue:

Is exclusion of Dr. from market in the furtherance of the scheme to control ophthalmological services in Los Angeles/CA, and does scheme affect interstate commerce?

o Hospital’s Argument: Complaint is insufficient b/c there is no factual nexus

between the restraint on this one surgeon’s practice and interstate commerce

o Majority: Holds: Complaint survives dismissal b/c (1) Essence of §1 violation = illegal agreement

Liability may be established by proof of either o Unlawful purpose; oro Anticompetitive effect

Don’t focus on consequences, but rather upon the potential harm that would ensue if conspiracy were successful

“[The complaint] need not allege, or prove, an actual effect on interstate commerce to support federal jurisdiction.” **Really?

(2) Assume agreement is successful; does it touch interstate commerce?

E.g., McLain (1980): In-state agreement that affects volume for demand of out-of-state services = touches interstate commerce

o Understanding the Restraint (Nachbar):

117

The restraint is requiring two Dr.s for every procedure which has a substantial cost and effect on interstate commerce

It doesn’t matter that hospital might not even receive money from requiring second surgeon; what matters is that there is a surplus created by deregulation, and that surplus is shifted to a producer, not a consumer.

Summit Health (cont.)o Dissent:

In the context of restraints not aimed at targeting the flow of interstate commerce, test used to be whether restraint, if successful, would have substantial effect on interstate commercial activity

Following McLain, test became whether restraint has not an insubstantial effect on the interstate commerce involved / infect interstate commerce

Here, Majority looks neither to (1) The effect on commerce by the restraint, nor (2) The effect on commerce of the defendant’s

infected activity But rather . . . to the effect on commerce of the activity

from which the plaintiff has been excluded That is, whether the entire line of commerce

from which Dr. has been excluded affects interstate commerce.

o Whether service for eye surgery affects interstate commerce.

This analysis tells us nothing about the substantiality of the impact on interstate commerce generated by the particular conduct at issue

See also Hammes, (7th Cir. 1994) [Posner] applying Summit Hosp.o It is enough for complaint to allege, without further particulars that

the defendants’ conduct in excluding it from the market “restrained (impeded, impaired, diminished – there is no magic word) interstate commerce.”

o “Though some cases state otherwise the complaint would not have to add that the restraint was substantial. No such limitations are stated in the Act.”

o In the 7th Cir “[i]t is quite enough, probably more than enough, if the complaint alleges that the plaintiff was engaged in interstate commerce and was injured by the alleged antitrust violation.”

Hence, no factual connection between commerce and the restraint needs to be alleged.

Ambiguity: Whether Antitrust Commerce Clause jurisdiction is measured by D’s activities in or affecting interstate commerce or by the alleged restraint’s effect on interstate commerce.

Federal Jurisdiction Rule: Always start with whether jurisdiction exists for the court to review the alleged conduct.

o Jurisdiction Exists at Pleading Stage if . . . [Posner]: Complaintent is involved in IC and the restraint

affects his activity [Summit Health]: Intrastate restraint touches IC by

affecting volume of demand, supply, etc., of IC commerce [C.f. Scalia, J. dissenting]: No showing of substantiality

necessary [But see also Columbia Steel (aff’d by Summit)]: If

challenged restraint affects an “appreciable” amount of interstate commerce (qualitative) quantitative effect is immaterial

o Note: If at the summary judgment stage the restraint =/= effect interstate commerce can dismiss

Foreign Reach of Antitrusto Hartford Fire, (U.S. 1993): Shearman act applies to foreign

conduct that was meant to produce and did in fact produce some substantial effect in the United States

Note: Under Int’l AT Guidelines, requisite intent is inferred just by imports coming into the U.S., but the substantial effects test is still good law.

Test = Whether challenged conduct has a direct, substantial, and reasonably foreseeable effect on domestic import, or export commerce of the U.S.

And, even if test is failed, jurisdiction may still exist if U.S. acts (1) as a commercial purchaser, or (2) in a financial role to finance purchase for consumption or use in foreign country

o Defenses: Act of State

118

Kirkpatrick, (U.S. 1990): act of state doctrine does not apply to a COA that does not rest upon the asserted invalidity of an official act of a foreign sovereign.

o Thus, challenging the underlying reason for a sovereign to enter an agreement w/ the bidder (e.g., the alleged bribe in this case) does not implicate the legitimacy of the K in the eyes of the foreign sovereign

Defenses (cont.) Foreign Sovereign Immunity

Alfred Dunhill, (U.S. 1976): Applies only when the sovereign is acting in its sovereign capacity, but not when it is merely pursuing proprietary or commercial interests

Direct Purchaser Requirement; Problems of Passing On Two Distinct (But Blended Doctrines):

o Director Purchasero Antitrust Injury

Illinois Brick Co., (U.S. 1977) [White]o Issue: Although Shoe precludes use of indirect-purchaser defense,

can it be used offensively?o Hanover Shoe: Rejected as a matter of law defense that indirect

purchaser, rather than direct purchasers, were the parties injured by the AT violation

Held: Except in certain limited circumstances (e.g., when a pass-on defense might be permitted), a direct purchaser suing for treble damages under §4 of Clayton Act is injured by the full amt of the overcharge paid by it

And, the AT Defendant =/= permitted to introduce evidence that indirect purchasers were in fact injured by the illegal overcharge

o Justification for Shoe Rule: (1) Not going to complicate treble-damages actions w/

attempts to trace effects of overcharge on line of commerce

Too tentative an analysis to determine what purchaser would have bought but-for the upcharge and how that affected his business

Going to look only at difference btwn what direct purchaser paid and what the fair price should have been

(2) B/c of how line of commerce fans out to smaller and smaller indirect purchasers, the indirect purchasers would have only a small stake in action little incentive to sue

119