Should There Be a Safe Harbor for Above-Cost Loyalty Discounts? Why I Believe Wright’s Wrong.

Thom Lambert —  6 June 2013

It’s not often that I disagree with my friend and co-author, FTC Commissioner Josh Wright, on an antitrust matter.  But when it comes to the proper legal treatment of loyalty discounts, the Commish and I just don’t see eye to eye.

In a speech this past Monday evening, Commissioner Wright rejected the view that there should be a safe harbor for single-product loyalty discounts resulting in an above-cost price for the product at issue.  A number of antitrust scholars—including Herb Hovenkamp, Dan Crane, and yours truly—recently urged the Supreme Court to grant cert and overturn a Third Circuit decision refusing to recognize such a safe harbor.  Commissioner Wright thinks we’re wrong.

A single-product loyalty discount occurs when a seller conditions a price cut (either an ex ante discount or an ex post rebate) on a buyer’s purchasing some quantity of a single product from the seller.  The purchase target is often set as a percentage of the buyer’s requirements, as when a medical device manufacturer offers to pay a 20% rebate on all of a hospital’s purchases of the manufacturer’s device if the hospital buys at least 70% of its requirements of that type of device from the manufacturer.  Because a loyalty discount tends to encourage distributors to carry more of the discounting manufacturer’s brand and less of the brands of the discounter’s rivals, such a discount may tend to “foreclose” those rivals from available distribution outlets.  If the degree of foreclose is so great that rivals have to cut their output below minimum efficient scale (the minimum output level required to achieve all economies of scale), then the discount may “raise rivals’ costs” relative to those of the discounter and thereby harm consumers.

On all these points, Commissioner Wright and I are in agreement.  Where we differ is on the question of whether a loyalty discount resulting in a discounted price that is above the discounter’s own cost should give rise to antitrust liability.  I say no.  I take that position because such an “above-cost loyalty discount” could be matched by any rival that is as efficient a producer as the discounter.  If, for example, a manufacturer normally charges $1.00 for widgets it produces for $.79 each but offers a 20% loyalty discount to retailers that buy 70% of their widget requirements from the manufacturer, any competitor that could produce a widget for $.79 (i.e., any equally efficient rival) could stay in business by lowering its price to the level of its incremental cost.  Thus, any rival that loses sales because of a manufacturer’s above-cost loyalty discount must be either less efficient than the manufacturer (so it can’t match the manufacturer’s discounted price) or unwilling to lower its price to the level of its cost.  In either case, the rival is unworthy of antitrust’s protection, where that protection amounts to prohibiting price cuts that provide consumers with immediate benefits.

Commissioner Wright disputes (I think?) the view that equally efficient rivals could match all above-cost loyalty discounts.  He maintains that loyalty discounts may be structured so that

[a] distributor’s purchase of an additional unit from a rival supplier beyond the threshold level can result in a loss of rebates large enough to render rival suppliers unable to attract a distributor to purchase the marginal unit at prices at or above the marginal cost of producing the good.

While I’m not entirely certain what Commissioner Wright means by this remark, I think he’s making the point that a loyalty discounter’s equally efficient rival might not be able to attract purchases by matching the discounter’s above-cost loyalty rebate if the rival’s “regular” base of sales is substantially smaller than that of the discounter.

If that is indeed what Commissioner Wright is saying, he has a point.  Suppose, for example, that the market for tennis balls consists of two brands, Penn and Wilson, that current market shares, reflective of consumer demand, are 60% for the Penn and 40% for Wilson, and that retailers typically stock the two brands in those proportions. Assume also that it costs each manufacturer $.90 to produce a can of tennis balls, that each sells to retailers for $1 per can, and that minimum efficient scale in this market occurs at a level of production equal to 35% of market demand. Suppose, then, that Penn, the dominant manufacturer, offers retailers a 10% loyalty rebate on all purchases made within a year if they buy 70% of their requirements for the year from Penn. The $.90 per unit discounted price is not below Penn’s cost, so the loyalty discount would come within my safe harbor.

Nevertheless, the loyalty discount could have the effect of driving Wilson from the market.  After implementation of the rebate scheme, a typi­cal retailer that previously purchased sixty cans of Penn for $60 and forty cans of Wilson for $40 could save $7 on its 100-can tennis ball require­ments by spending $63 to obtain seventy Penn cans and $30 to obtain thirty Wilson cans. The retailer and others like it would thus have a strong incen­tive to shift pur­chases from Wilson to Penn. To prevent a loss of mar­ket share that would drive it below minimum efficient scale (35% of market demand), Wilson would need to lower its price to provide retailers with the same total dollar discount, but on a smaller base of sales (40% of a typical retailer’s require­ments rather than 60%). This would require it to lower its price below cost. For example, Wilson could match Penn’s $7 discount to the retailer described above only by reducing its $1 per-unit price by 17.5 cents ($7.00/40 = $.175), which would require it to price below its cost of $.90 per unit.  Viewed statically, then, it seems that even an above-cost loyalty discount could occasion competitive harm by causing rivals to be less efficient, so that they could not match the discounter’s price.

In light of dynamic effects, though, I’m not convinced that examples like this undermine the case for a safe harbor for above-cost loyalty discounts. Had the nondominant rival (Wilson) charged a price equal to its marginal cost prior to Penn’s loyalty rebate, it would have enjoyed a price advantage and likely would have grown its market share to a point at which Penn’s loyalty rebate strat­egy could not drive it below minimum effi­cient scale. Moreover, one strategy that would prevent a nondominant but equally efficient firm from being harmed by a dominant rival’s above-cost loyalty rebate would be for the non-dominant firm to give its own volume discounts from the outset, secur­ing up-front commitments from enough buy­ers (in exchange for discounted prices) to ensure that its production stayed above minimum efficient scale. Such a strategy, which would obvi­ously benefit consumers, would be encouraged by a liability rule that evaluated loy­alty discounts under straight­forward Brooke Group principles (i.e., that included a safe harbor for above-cost discounts) and thereby signaled to manufacturers that they must take steps to protect themselves from above-cost loyalty discounts.

Commissioner Wright maintains that all this discussion of price-cost comparisons is inapposite because the theoretical harm from loyalty discounts stems from market exclusion (and its ability to raise rivals’ costs), not from predation.  He says, for example:

  • “[T]o the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion and, as a result, the legal framework developed to evaluate exclusive dealing claims ought to be used to evaluate claims relating to loyalty discounts.” [p. 12]
  • “[P]redatory pricing and raising rivals’ costs are distinct paradigms of potentially exclusionary conduct. There simply is not a stable relative relationship between price and cost in raising rivals’ cost models that form the basis of anticompetitive exclusion, and hence it does not follow that below cost pricing is a necessary condition for competitive harm.”  [pp. 19-20]
  • “When plaintiffs allege that loyalty discounts … violate the antitrust laws because they deprive rivals of access to a critical input, raise their costs, and ultimately harm competition, they are articulating a raising rivals’ cost theory of harm rather than price predation.”  [p. 24]
  • “Raising rivals’ costs and predation are two different economic paradigms of exclusionary conduct, and economic models within each paradigm establish the necessary conditions for each practice to harm competition and give rise to antitrust concerns. Loyalty discounts and other forms of partial exclusives … are properly analyzed under the exclusive dealing framework. Price‐cost tests in the predatory pricing tradition … simply do not comport with the underlying economics of exclusive dealing.”  [p. 33]

I must confess that I’m baffled by Commissioner Wright’s oddly formalistic pigeonholing.  Why must a practice be one or the other—either pricing too low or excluding rivals and thereby raising their costs?  That seems like a false dichotomy.  Indeed, it seems to me that a problematic loyalty discount is one in which the discounter excludes its rivals from a substantial portion of the distribution network (and thereby raises their costs) via the mechanism of conditional price cuts. It’s “both-and,” not “either-or.”  And if that’s the case, then surely it makes sense to limit which price cuts may occasion liability—i.e., only those that could not be matched by equally efficient rivals.  [It is important to note here that I don’t advocate a price-cost test as an alternative to a foreclosure-based analysis.  Rather, a plaintiff should have to establish below-cost pricing (to show that the plaintiff was deserving of antitrust’s protection via the highly disfavored prohibition of discounts) and demonstrate that the discounting at issue resulted in substantial foreclosure from distribution outlets (the latter showing is necessary to prove harm to competition rather than simply to a competitor).]

Throughout his speech, Commissioner Wright emphasizes that the primary competitive concern presented by loyalty discounts is the possibility of “anticompetitive exclusion.”  He writes on page 8, for example, that “[t]he key economic point is that the antitrust concerns potentially arising from loyalty discounts involve anticompetitive exclusion rather than predatory pricing….”  On page 12, he reiterates that “to the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion.”  He then apparently assumes that loyalty discount-induced exclusion is “anticompetitive” if it is sufficiently substantial—i.e., if the discounter’s rivals are foreclosed from so many distribution outlets that they are driven below minimum efficient scale so that their costs are raised relative to those of the discounter.

I would dispute the notion that discount-induced exclusion is anticompetitive simply because it’s substantial.  Rather, I’d say such exclusion is anticompetitive only if it is substantial and could not have been avoided by aggressive pricing.  Omitting the second requirement creates the possibility that antitrust will be used by a laggard rival to prevent a more aggressive rival’s consumer-friendly price competition.  (LePage’s anyone?)

Suppose, for example, that there are two producers of widgets, A and B, which both produce widgets at a marginal cost of $.79 and, given their duopoly, charge $1.00 per widget.  A, whose market share has hovered around 50%, institutes a loyalty rebate of 20% for retailers that purchase 70% of their requirements from A.  If B offers the same deal, or simply cuts its price to $.80, it should lose no market share.  But suppose B doesn’t do so, A captures 70% of the market, and B falls below minimum efficient scale.  Would we say that B’s exclusion is “anticompetitive” because A’s discount scheme resulted in such substantial foreclosure that it raised B’s costs?  Should B be able to collect treble damages for based on its “anticompetitive exclusion”?  Surely not.

Commissioner Wright, from whom I have learned more about “error costs” than anyone else, seems oddly unconcerned about the chilling effect his decidedly pro-plaintiff approach to loyalty discounts will produce.  Wouldn’t a firm considering a loyalty discount—a price cut, don’t forget!—think twice if it knew its rivals could sit on their hands, claim “exclusion” if the discount successfully moved substantial market share toward the discounter, and collect treble damages?  The safe harbor Hovenkamp, Crane, and I have advocated would provide assurance to potential discounters that they will not face liability if they charge above-cost prices, prices that could be matched by equally efficient, aggressive rivals.  Isn’t that approach more likely to minimize error costs?

Two closing points.  First, despite my disagreement with Commissioner Wright on this issue, I share the widely held view that he is one of the most brilliant antitrust thinkers out there.  He’s taught me more about antitrust than anyone (with the possible exception of the uber-prolific Herb Hovenkamp).  His questioning of my views on loyalty discounts really makes me wonder if I’m missing something.

Second, to those who think Commissioner Wright has “drifted” or “turned,” let me assure you that he’s long held his views on loyalty discounts.  As you can see here, here, and here, we’ve been going round and round on this matter for quite some time.

Perhaps one day one of us will persuade the other.

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

10 responses to Should There Be a Safe Harbor for Above-Cost Loyalty Discounts? Why I Believe Wright’s Wrong.

  1. 

    I want to clarify some of the key issues in Commissioner Wright’s analysis of Exclusive Dealing and Loyalty Discounts as part of the raising rivals’ costs (“RRC”) paradigm. I never thought that I would have to defend Wright against Professors Lambert and Crane. But, it appears that rigorous antitrust analysis sometimes makes what some would view as strange bedfellows.

    In my view, there should not be a safe harbor price-cost test used for loyalty discounts. Nor should these discounts be treated as conclusively (per se) illegal if the defendant fails the price-cost test. Either way, the test is a formalistic and unreliable screen. To explain these conclusions, and why I think the proponents of the screen are taking too narrow approach to these issues, I want to start with some discussion of the legal and economic frameworks.

    In my view, there are two overarching antitrust legal paradigms for exclusionary conduct – predatory pricing and raising rivals’ costs (RRC), and conduct that falls into the RRC paradigm generally raises greater antitrust concerns. (For further details, see my 2006 Antitrust L.J. article, “Exclusionary Conduct, Effect on Consumers, and the Flawed Profit-Sacrifice Standard.”) Commissioner Wright also takes this approach in his speech of identifying and distinguishing the two paradigms.

    This raises the question of which framework is better suited for addressing exclusive dealing and loyalty discounts (that is, where the conduct is not pled in the complaint as predatory pricing). Commissioner Wright’s speech articulates the view that theories of harm alleging RRC/foreclosure should be analyzed under exclusive dealing law, which is more consistent with the raising rivals’ costs approach, not under predatory pricing law (i.e., with its safe harbor for prices above cost). (Incidentally, I don’t read his speech as saying that he has abandoned Brooke Group for predatory pricing allegations. For example, it seems clear that he would support a price-cost test in a case alleging that a loyalty discount harmed competition via predatory pricing rather than RRC/foreclosure.)

    To understand which legal framework – raising rivals’ costs/exclusive dealing versus predatory pricing/price-cost test – is most relevant for analyzing the relevant competitive issues, I want to begin with a primer on RRC theories of foreclosure. This will also hopefully bring everyone closer on the economics.

    Input Foreclosure and Customer Foreclosure

    There are two types of foreclosure theories within the RRC paradigm — “input foreclosure” and “customer foreclosure.” Both are relevant for evaluating exclusive dealing and loyalty discounts. The input foreclosure theory says that the ED literally “raises rivals’ costs” by foreclosing a rival’s access to a critical input subject to ED. The customer foreclosure theory says that ED literally “reduces rivals’ revenues” by foreclosing a rival’s access to a sufficient customer base and thereby drives the rival out of business or marginalizes it as a competitor (i.e., where it lacks the ability or incentive to move effectively beyond a niche position or to invest to grow).

    Commissioner Wright’s speech tended to merge the two variants. But, it is useful to distinguish between them. (I think that this is one source of Professor Lambert being “baffled” by the speech, and more generally, is a source of confusion among commentators that leads to unnecessary disagreements.)

    In the simplest presentation, one might say that customer foreclosure concerns are raised primarily by exclusive dealing with customers, while input foreclosure concerns are raised primarily by exclusive dealing with input suppliers. But, as noted below, both concerns may arise in the same case, and especially so where the “customers” are distributors rather than final consumers, and the “input” is distribution services.

    Analysis of exclusive dealing (ED) often invokes the customer foreclosure theory. For example, Lorain Journal may be analyzed as customer foreclosure. However, input foreclosure is also highly relevant for analyzing ED because exclusive dealing often involves inputs. For example, Judge Posner’s famous JTC Petroleum cartel opinion can be interpreted in this way, if there were solely vertical agreements.

    Cases where manufacturers have ED arrangements with wholesale or retail distributors might be thought to fall into the customer foreclosure theory because the distributors can be seen as customers of the manufacturer. However, distributors also can be seen as providing an input to the manufacturer, “distribution services.” For example, a supermarket or drug store provides shelf space to a manufacturer. If the manufacturer (say, unilaterally) sets resale prices, then the difference between this resale price and the wholesale price is the effective input price.

    One reason why the input foreclosure/customer foreclosure distinction is important involves the proper roles of minimum viable scale (MVS) and minimum efficient scale (MES). The customer foreclosure theory may involve a claim that the rival likely will be driven below MVS and exit Or it may involve a claim that the rival will be driven below MES, where its costs will be so much higher or its demand so much lower that it will be marginalized as a competitor.

    By contrast, and this is the key point, input foreclosure does not focus on whether the rival likely will be driven below MVS. Even if the rival remains viable, if its costs are higher, it will be led to raise the prices charged to consumers, which will cause consumer harm. And prices will not be raised only in the future. The recoupment can be simultaneous.

    Another reason for the importance of the distinction is the role of the “foreclosure rate,” which often is the focus in customer foreclosure analysis. For input foreclosure, the key foreclosure issue is not the fraction of distribution input suppliers or capacity that is foreclosed, but rather whether the foreclosure will raise the rival’s distribution costs. That can occur even if a single distributor is foreclosed, if the exclusivity changes the market structure in the input market or if that distributor was otherwise critical. (For example, see Krattenmaker and Salop, “Anticompetitive Exclusion.”)

    At the same time, it is important to note that the input/customer foreclosure distinction is not a totally bright line difference in many real world cases. A given case can raise both concerns. In addition, customer foreclosure sometimes can raise rivals costs, and input foreclosure sometimes (but not always) can cause exit.
    While input foreclosure can succeed even if the rival remains viable in the market, in more extreme scenarios, significantly higher costs inflicted on the rival could drive the rival to fall below minimum viable scale, and thereby cause it to exit. I think that this is one way in which unnecessary disagreements have occurred. Commentators might erroneously focus only this more extreme scenario and overlook the impact of the exclusives or near-exclusives on the rival’s distribution costs.

    Note also that customer foreclosure can raise a rival’s costs when there are economies of scale in variable costs. For this reason, even if the rival does not exit or is not marginalized, it nonetheless may become a weaker competitor as a result of the exclusivity or loyalty discount.

    These points also help to explain why neither a price-cost test nor the foreclosure rate will provide sufficient reliable evidence for either customer foreclosure or input foreclosure, which I turn to next.

    (For further discussion of the distinction between input foreclosure and customer foreclosure, see Riordan and Salop, Evaluating Vertical Mergers: A Post-Chicago Approach, 63 ANTITRUST L.R. 513(1995). See also the note on O’Neill v Coca Cola in Andrew Gavil, William Kovacic and Jonathan Baker, Antitrust Law in Perspective: Cases, Concepts and Problems in Competition Policy (2d ed.) at 868-69. For analysis of Lorain Journal as customer foreclosure, see Gavil et. al at 593-97.)

    The Inappropriateness of a Dispositive Price-Cost Test

    A price-cost test obviously is not relevant for evaluating input foreclosure concerns, even where the input is distribution services. Even if the foreclosure involves bidding up the price of the input, it can succeed in permitting the firm to achieve or maintain market power, despite the fact that the firm does not bid to the point that its costs exceed its price. (In this regard, Weyerhaeuser was a case of “predatory overbuying,” not “raising rivals’ cost overbuying.” The allegation was that Weyerhaeuser would gain market power in the timber input market, not the lumber output market.)

    Nor is a price-cost test the critical focus for assessing customer foreclosure theories of competitive harm. (By the way, I think we all agree that the relevant price-cost test involves a comparison of the incremental revenue and incremental cost of the “contestable volume” at issue for the loyalty discount. So I will not delve into that issue.)

    First, and most fundamentally, the price-cost test is premised on the erroneous idea that only equally efficient competitors are worth protecting. In other words, the price-cost requires the premise that the antitrust laws only protect consumers against competitive harm arising from conduct that could have excluded an equally efficient competitor. This premise makes absolutely no economic sense. One simple illustrative example is a monopolist raising the costs of a less efficient potential competitor to destroy its entry into the market. Suppose that monopolist has marginal cost of $50 and a monopoly price of $100. Suppose that there is the potential entrant has costs of $75. If the entry were to occur, the market price would fall. Entry of the less efficient rival imposes a competitive constraint on the monopolist. Thus, the entry clearly would benefit consumers. (And, it clearly often would raise total welfare as well.) It is hard to see why antitrust should permit this type of exclusionary conduct.

    It is also unlikely that antitrust law would allow this conduct. For example, Lorain Journal is probably pretty close to this hypothetical. WEOL likely was not equally efficient. The hypothetical probably also fits Microsoft pretty well.

    Second, the price-cost test does not make economic sense in the case of the equally efficient rival either. Even if the competitor is equally efficient, bidding for exclusives or near-exclusives through loyalty discounts often does not take place on a level playing field. There are several reasons for this. One reason is that the dominant firm may tie up customers or input providers before the competitors even arrive on the scene or are in a position to counterbid. A second reason is that the exclusive may be worth more to the dominant firm because it will allow it to maintain market power, whereas the entrant would only be able to obtain more competitive profits. In this sense, the dominant firm is “purchasing market power” as well as purchasing distribution. (This point is straightforward to explain with an example. Suppose that the dominant firm is earning monopoly profits of $200, which would be maintained if it deters the entry of the new competitor. Suppose that successful entry by the equally efficient competitor would lead to the dominant firm and the entrant both earning profits of $70. In this example, the entrant would be unwilling to bid more than $70 for the distribution. But, the dominant firm would be willing to bid up to $130, the difference between its monopoly profits of $200 and the duopoly profits of $70.) A third reason is that customers may not be willing to take the risk that the entry will fail, where failure can occur not because the entrant’s product is inferior but simply because other customers take the exclusive deal from the dominant firm. In this case, a fear that the entrant would fail could become a self-fulfilling prophecy because the customers cannot coordinate their responses to the dominant firms’ offer. Lorain Journal may provide an illustrative example of this self-fulfilling prophecy phenomenon. This last point highlights a more general point Commissioner Wright made in his speech — that successful and harmful RRC does not require a below-cost price (net of discounts). When distributors cannot coordinate their responses to the dominant firm’s offer, a relatively small discount might be all that is required to purchase exclusion. Thus, while large discounts might accompany RRC conduct, that need not be the case. These latter reasons also explain why there can be successful foreclosure even when contracts have short duration.

    Third, as noted above, customer foreclosure may raise rivals’ costs when there are economies of scale. The higher costs of the foreclosed rivals are not well accounted for by the price-cost test.

    Fourth, as stressed by Joe Farrell, the price-cost test ignores the fact that loyalty discounts triggered by market share may deter a customer’s purchases from a rival that do not even come at the expense of the dominant firm. (For example, suppose in light of the discounts, the customer is purchasing 90 units from the dominant firm and 10 from the rival in order to achieve a “reward” that comes from purchasing 90% from the dominant firm. Now suppose that entrant offers a new product that would lead the customer to wish to continue to purchase 90 units from the dominant firm but now purchase 15 units from the rival. The purchase of these additional 5 units from the rival does not come at the expense of the dominant firm. Yet, even if the entrant were to offer the 5 units at cost, these purchases would be deterred because the customer would fall below the 90% trigger for the reward.) In this way, the market share discount can directly reduce output.

    Fifth, the price-cost test assumes that the price decreases will be passed on to final consumers. This may be the clear where the exclusives or loyalty discounts are true discounts given to final consumers. But, it may not be the case where the dominant firm is acquiring the loyalty from input suppliers, including distributors who then resell to final consumers. The loyalty discounts often involve lump sum payments, which raises questions about pass-on, at least in the short-run.

    Finally, it is important to stress that the price-cost test for loyalty discounts assumes that price actually represents a true discount. I expect that this assumption is the starting point for commentators who give priority to the price-cost test. However, the price may not represent a true discount in fact, or the size of the discount may turn out to be smaller than it appears after the “but-for world” is evaluated. That is, the proponents of a price-cost test have the following type of scenario in mind. The dominant firm is initially charging the monopoly price of $100. In the face of competition, the dominant firm offers a lower price of (say) $95 to customers that will accept exclusivity, and the customers accept the exclusivity in order to obtain the $5 discount. (To illustrate, suppose that absent the exclusive, the customers would purchase 90 units from the dominant firm at $100 for total revenue of $9000. With the exclusive, they purchase 100 units at a price of $95 for total revenue of $9500.
    Thus, the dominant firm earns incremental revenue of $500 on the 10 incremental units, or $50 per unit. If the dominant firm’s costs are $50 or less, it will pass the price-cost test.) But, consider next the following alternative scenario. The dominant firm offers the original $100 price to those customers that will accept exclusivity, and sets a higher “penalty” price of $105 to customers that purchase non-exclusively from the competitor. In this latter scenario, the $5 discount similarly may drive customers to accept the exclusive. These prices would lead to a similar outcome of the price-cost test. (To illustrate, suppose that absent the exclusive, the customers would purchase 90 units from the dominant firm at $105 for total revenue of $9450. With the exclusive, they purchase 100 units at a price of $100 for total revenue of $10,000. Thus, the dominant firm earns revenue of $550 on the 10 incremental units, or $55 per unit. Here, the dominant firm will pass the price-cost test, if its costs are $55 or less.) However, in this latter scenario, it is noteworthy that the use of the “penalty” price eliminates any benefits to consumers. This issue seems to be overlooked by Crane and Lambert. (For further details of the role of the penalty price in the context of bundled discounts, see Barry Nalebuff’s articles on Exclusionary Bundling and the articles of Greenlee, Reitman and Sibley.)

    * * *

    For all these reasons, treating loyalty discounts as analogous to predatory pricing and thereby placing over-reliance on a price-cost test represents a formalistic and unreliable antitrust approach. (It is ironic that Commissioner Wright was criticized by Professor Lambert for being formalistic, when the facts are the opposite.)

    This analysis is not to say that the court should be indifferent to the lower prices, where there is a true discount. To the contrary, lower prices passed-on would represent procompetitive efficiency benefits. But, the potential for lower prices passed-on does not provide a sufficient basis for adopting a price-cost safe harbor test for loyalty discount allegations, even ones that can be confidently characterized as purely plain vanilla customer foreclosure with no effects on rivals’ costs.

    Thus, the price-cost test should be one relevant evidentiary factor. But, it should not be the primary factor or a trump for either side. That is, above-cost pricing (measured in terms of incremental revenue less than incremental cost) should not be sufficient by itself for the defendant to escape liability. Nor should below-cost pricing (again, measured in terms of incremental revenue less than incremental cost) should not be a sufficient by itself for a finding of liability.

    Such “Creeping Brookism” does not led to either rigorous or accurate antitrust analysis. It is a path to higher error rates, not a lower ones.

    Nor should courts rely on simple-minded foreclosure rates. Gilbarco shows how a mechanical approach to measuring foreclosure leads to confusion. Microsoft makes it clear that a “total foreclosure” test also is deficient. Instead, a better approach is to require the plaintiff to prove under the Rule of Reason standard that the conduct harms the rival by reducing its ability to compete and also that it harms consumers.

    I should add one other point for completeness. Some (but not Commissioner Wright or Professor Crane) might suggest that the price-cost test has administrability benefits relative to a full rule of reason analysis under the RRC paradigm. While courts are capable are evaluating prices and costs, that comparison may be more difficult than measuring the increase in the rivals’ distribution costs engendered by the conduct. Moreover, the price-cost comparison becomes an order of magnitude more complex in loyalty discount cases, relative to plain vanilla predatory pricing cases. This is because it also is necessary to determine a reasonable measure of the contestable volume to use to compare incremental revenue and incremental cost. For first-dollar discounts, there will always be some small region where incremental revenue is below incremental cost. Even aside from this situation, the two sides often will disagree about the magnitude of the volume that was at issue.

    In summary, I think that Professor Wright’s speech forms the basis of moving the discussion forward into analysis of the actual evidence of benefits and harms, rather than continuing to fight the battles over whether the legal analysis used in the 1950s and 1960s failed to satisfy modern standards and thereby needed to be reined in with unreliable safe harbors.

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