I was very pleased to thumb through the newest version of Antitrust Magazine and see a TOTM post get some attention.  Its always nice to be cited and have folks take the time to respond to your work — or in this case, blog post.  Its even more tickling when the person doing the responding is a prominent and well respected figure such as former Federal Trade Commissioner Leary.  Commissioner Leary revisits the FTC’s enforcement action in Ovation and takes on the criticism of that enforcement action in this post.  You can see Commissioner Leary’s article here (I believe ABA registration and password required).  I’m grateful for the response and am going to take the opportunity  to argue that, despite the Commissioner’s criticisms, the troublesome implications that I pointed out in the earlier post associated with the enforcement approach in Ovation remain (see also guest blogger Mary Coleman’s related concerns).

A brief recap is in order.

The Concurring Statement offered the following description of the facts of the transaction and potential antitrust theory:

Merck was a very large ($25 billion in sales in 2007) and sophisticated company. If it profitably could have sold Indocin at a monopoly price it arguably would have done so. However, there is evidence that Merck had a large product portfolio that included a number of pharmaceutical products that were more profitable than Indocin. It is arguable that if it sold at a monopoly price a product used to treat premature babies, that could damage its reputation and its sales of those more profitable products….

There is reason to believe that the sale of Indocin to Ovation had the effect of eliminating the reputational constraints on Merck that had existed prior to the sale. There is evidence that Ovation lacked Merck’s large product portfolio and thus arguably was not concerned, as Merck had been, that the sale of Indocin at a monopoly price would damage its reputation and sales of more profitable products. More specifically, there is evidence that after the transaction, Ovation began charging roughly 1300 percent more than the price at which Merck sold the same product. Put differently, there is reason to believe that Merck’s sale of Indocin to Ovation had the effect of enabling Ovation to exercise monopoly power in its pricing of Indocin, which Merck could not profitably do prior to the transaction. Moreover, there is also reason to believe that the transaction had the effect of substituting Ovation, a firm that had an incentive to protect its ability to engage in monopoly pricing, for Merck, which lacked the same incentive. It is arguable that Merck had no incentive to acquire NeoProfen, but Ovation had an incentive to do so in order to maintain its monopoly pricing in the PDA market. That, in my judgment, would be a violation of Section 7.

The anticompetitive theory is simple:  Merck was a multi-product monopolist who was constrained in its pricing of Indocin because it was concerned at a reduction in demand for its other products because consumers would be upset if it priced this life-saving drug at “too high” a level.  Under the theory, Merck is setting a profit-maximizing price and figures out that Indocin’s profit-maximizing price would be higher because it is unconstrained by these reputational considerations.  I asked:

Assuming it is correct that the decision to lower the price is to do with these reputational demand concerns, why does it become a violation if they assign something that they were entitled to do under the antitrust laws to a third party?

My criticism was equally simple.  I argued that:

The implicit answer is that the antitrust laws condemn evasion of pricing constraints.  This answer is getting more and more familiar at the current Commission.  Let’s follow the pattern.  First, Rambus is based on the concept that evasion of patent disclosure rules in the standard setting context violation Section 2 and Section 5.  Second, N-Data is based on the concept that evasion of a contractual pricing constraint in the form of a RAND commitment is a violation of at least section 5 even when the monopoly power is lawfully acquired.  Third, Ovation now adds to the list the evasion of reputational constraints on pricing as the genesis of actionable antitrust conduct.

I went on to cite a myriad of examples that would satisfy the FTC “evasion of constraint” theory as described but were problematic because they were not likely to involve the exercise of monopoly power or produce harm that the antitrust laws were designed to prevent and might even be welfare increasing:

Why not a monopolist whose pricing is constrained by current demand.  That is, the profit-maximizing monopoly price is $20 but the monopolist would REALLY like to charge $25.  It is only the fact that current demand is not high enough to support that price that prevents the monopolist from charging it.  So, our monopolist comes up with a plan (lets call it a scheme, it sounds worse) to evade the pricing constraint created by current demand by advertising its product to consumers and touting its virtues.  Or perhaps its going to invest in the quality of the product.  In either event, the purpose of the advertising is to shift the demand to the right and result in higher prices.  No matter that output increases, it doesn’t matter because the monopolist is evading a pricing constraint and presumably has violated Section 2.  Evading reputational constraints on demand for X is not analytically any different evasion of the constraints imposed on demand by consumer preferences.

But its much worse than that.  There is virtually no limit to this evasion theory.  Let’s run through some examples.  What if Merck evaluated its product line and decided that it would be be better off by dropping some of its product portfolio so that it could increase the price of Indocin?  Merck’s decision to drop products from its portfolio, or even the design of those product offerings, are surely an evasion of pricing constraints and a violation of Section 2 if it has monopoly power — and perhaps even if it doesn’t under Section 5.  So much for competition as a discovery process.  Or what if Merck decided to create a subsidiary to sell Indocin under a different brand name and trade dress to mitigate the reputational costs it would bear from charging a higher price?  Or fired the CEO who decided that charging the monopoly price in the first instance would be a bad idea in favor of a new manager who reached a different conclusion and wanted to increase the price?  This evasion theory fairly quickly evaporates to the notion that the antitrust law governs prices that are determined to be unreasonable and not the competitive process.

Former Commissioner Leary takes me to task for apparently misunderstanding a very basic point.  Citing my concern that the Ovation theory has virtually no limits and the various examples of evading pricing constraints that I discuss, he points out that the fact that just because the firm could achieve the same result another way does not mean that it is not reviewable under Section 7.  That is, as he writes, “mergers are different” and “the mere fact that companies could have achieved the results by different means without antitrust enforcement does not necessarily mean that the merger is legal.”  Next, Commissioner Leary goes on in the article to question my conclusion that Rosch’s analysis in Ovation reflects “his increasingly apparent view that economics and economists should play a minimal role in the shaping of antitrust enforcement decisions.”

I’ll simply refer readers to this post for evidence supporting my conclusions about Commissioner Rosch’s views on economics and antitrust and add the observation that talking vaguely about incentives is not the same thing as doing economics or “expanded application of economics.”

But what about Leary’s central disagreement?  Did I miss the basic point that the mere fact that a merger that violates Section 7 is not legal simply because the firms could form a cartel instead?  I don’t think so.  And will explain why after the break.

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Commissioner Rosch has offered a defense of the withdraw of the Section 2 Report.  This is an important step and the Commissioner, who readers know I’ve criticized from time to time here, should be credited for laying out his specific objections to the Report.  The objections are, in short, that the Report:

1. Was “too ambitious” because it “not only purported to summarize the case law, but went on to assert what the law should be”  and thereby “significantly overstated the level of consensus regarding the proper framework for analyzing single-firm conduct”
2. The Report set forth safe harbors that, in Commissioner Rosch’s view, had “that had little, if any, basis in Supreme Court precedent” (Rosch points to the Report’s treatment of unconditional refusals to deal as an example)
3. The Report over-emphasized the risk and significance of Type I error relative to Type II error — which led it to the disproportionality test which Rosch criticizes as inconsistent with rule of reason balancing
4. The hearing themselves “were not representative of the views of all Section 2 stakeholders, despite the efforts of both agencies to assemble balanced witness panels” and “consumer interests were not fairly represented.”  Business was also underrepresented in terms of actual business executives rather than their lawyers.  Further, Rosch noted that 28% of the witnesses were from defense firms (though I wonder how many of those have had jobs at antitrust agencies as enforcers as well and gave testimony reflecting their own experiences rather than representing the views of clients)
5. The Report, Rosch argues, “suggested that the Merger Guidelines’ SSNIP test (and hence critical loss analysis) is the only appropriate way to define the relevant market in a Section 2 case” which Rosch is mistaken because of dangers of the Cellophane Fallacy in monopoly maintenance cases and the possibility of proving market definition through direct evidence.  Rosch faults the Report for acknowledging the direct evidence approach but giving it too little role and for failing to discuss the practical indicia approach of Brown Shoe.
6. The Report handled each type of single firm conduct on a stand alone basis, which the Commissioner finds some merit in, but does not discuss how to handle cases involving allegations of multiple forms of conduct in “monopoly broth” situations
7. The Report did not adequately discuss how intent might be taken into account in Section 2 cases other than a suggestions by panelists that such evidence is unreliable
8. The Report fails to distinguish between Section 1 and Section 2 single firm conduct cases

The Commissioner concludes that:

In sum, the withdrawal of the DOJ’s unilateral conduct report was a welcome development: while the Report’s demise may not have any direct effect on the FTC, the agencies’ approaches toward Section 2 enforcement now appear to be in closer alignment than they have been in some time. And while important substantive and procedural differences remain, the withdrawal of the Report may also bring the U.S. agencies and the European Commission in closer alignment on unilateral conduct issues.

In my view, none of these reasons independently or collectively justify the withdraw of the Report, much less the vitriolic fashion in which it was done, for example, describing the Report as one that “At almost every turn, the Department would place a thumb on the scales in favor of firms with monopoly or near-monopoly power and against other equally significant stakeholders.”

I’ll save more specific critiques of some of these objections for later.  I note for now that it is natural for readers to view a document summarizing the entire corpus of monopolization law, and 2 years of panels with over a hundred witnesses and weeks worth of testimony — even a 250 page document — as incomplete or imperfect in some way.  In fact, I also have plenty of quibbles with the Report.  I’ve written about some of these with respect to exclusive dealing and loyalty discounts.  I suspect my quibbles are different than Commissioner Rosch’s.    But make no mistake that these are small disagreements relative to the size of the endeavor and the potential value generated for consumers by producing certainty in an area of law that desperately needs it.  But I do not believe that these imperfections justify withdraw of a document that, to its credit, goes to great lengths to summarize the views of the antitrust community on both what the law is and should be.

As I see it, if the Commissioner would like a more in depth discussion on the role of intent, distinguishing between Section 1 and Section 2 in single firm cases and whether such differences should exist as a matter of policy, how to handle cases with monopoly broth allegations, or if Brown Shoe and direct evidence should have a role in market definition — by all means, let’s have the discussion.  If what is needed is a more rigorous discussion of error cost analysis and Type I and Type II errors in antitrust analysis, and based on recent pronouncements from both agencies I agree that discussion clearly needs to take place center stage, then let’s have that discussion too.  And while the Commissioner is fond of quoting the Justice Breyer’s line that “antitrust law cannot, and should not, precisely replicate economists’ (sometimes conflicting) views”, I’m fairly confident that he would agree that a rigorous examination of the facts on the ground in the form of reliable empirical evidence on single firm conduct should play a central role in that discussion as well.  As to the more serious allegations that the panels were unbalanced or too defendant friendly, those are easy to fix.  Let’s have new hearings with panels that come closer to the balance the Commission is looking for by including consumer groups and business representatives.

All four Commissioners have noted that some parts of the current Report have merit while taking issue with some specifics.  AAG Varney has also recognized in her own speech repudiating the Report “provides a comprehensive evaluation of the history of single-firm enforcement and careful consideration of the risks and benefits of particular enforcement strategies.”  All must agree that somewhere in the record of the two years of hearings that there is some potentially valuable information.  What must not be done is to do nothing and simply rely on the existing approach that gave rise to the need for hearings in the first place — I do not recall any objections from just about any antitrust constituency prior to the hearings with respect to their potential value.  And simply put, and with all due respect to AAG Varney’s view that we can simply plow ahead by committing to acting ” in furtherance of the principles embodied” in cases like Lorain Journal, Aspen Ski and Conwood, that is no answer to the problems facing monopolization enforcement.

Here’s my solution: Let’s have new Section 2 hearings.

I’ve not read a single objection to the Report that could not be solved by supplementing the existing record with additional hearings on some of these issues or, if the current FTC/DOJ is feeling ambitious, let’s just re-do the whole thing.  Invite old panelists and new ones that help solve the perceived balance problems.  Add these omitted agenda items to the list and lets get together and have a serious discussion of them, what the law is, what the law should be, and the existing economic and empirical knowledge that can be brought to bear on finding consensus areas for improving our approach to monopolization.

If we’re really interested in getting this right, and I hope we are interested in a rigorous approach to answering these questions rather than the alternative ideological approach, lets have the hearings.

What do you say, Commissioner?