Archives For exclusionary conduct

The International Center for Law & Economics (ICLE) and TechFreedom filed two joint comments with the FCC today, explaining why the FCC has no sound legal basis for micromanaging the Internet and why “net neutrality” regulation would actually prove counter-productive for consumers.

The Policy Comments are available here, and the Legal Comments are here. See our previous post, Net Neutrality Regulation Is Bad for Consumers and Probably Illegal, for a distillation of many of the key points made in the comments.

New regulation is unnecessary. “An open Internet and the idea that companies can make special deals for faster access are not mutually exclusive,” said Geoffrey Manne, Executive Director of ICLE. “If the Internet really is ‘open,’ shouldn’t all companies be free to experiment with new technologies, business models and partnerships?”

“The media frenzy around this issue assumes that no one, apart from broadband companies, could possibly question the need for more regulation,” said Berin Szoka, President of TechFreedom. “In fact, increased regulation of the Internet will incite endless litigation, which will slow both investment and innovation, thus harming consumers and edge providers.”

Title II would be a disaster. The FCC has proposed re-interpreting the Communications Act to classify broadband ISPs under Title II as common carriers. But reinterpretation might unintentionally ensnare edge providers, weighing them down with onerous regulations. “So-called reclassification risks catching other Internet services in the crossfire,” explained Szoka. “The FCC can’t easily forbear from Title II’s most onerous rules because the agency has set a high bar for justifying forbearance. Rationalizing a changed approach would be legally and politically difficult. The FCC would have to simultaneously find the broadband market competitive enough to forbear, yet fragile enough to require net neutrality rules. It would take years to sort out this mess — essentially hitting the pause button on better broadband.”

Section 706 is not a viable option. In 2010, the FCC claimed Section 706 as an independent grant of authority to regulate any form of “communications” not directly barred by the Act, provided only that the Commission assert that regulation would somehow promote broadband. “This is an absurd interpretation,” said Szoka. “This could allow the FCC to essentially invent a new Communications Act as it goes, regulating not just broadband, but edge companies like Google and Facebook, too, and not just neutrality but copyright, cybersecurity and more. The courts will eventually strike down this theory.”

A better approach. “The best policy would be to maintain the ‘Hands off the Net’ approach that has otherwise prevailed for 20 years,” said Manne. “That means a general presumption that innovative business models and other forms of ‘prioritization’ are legal. Innovation could thrive, and regulators could still keep a watchful eye, intervening only where there is clear evidence of actual harm, not just abstract fears.” “If the FCC thinks it can justify regulating the Internet, it should ask Congress to grant such authority through legislation,” added Szoka. “A new communications act is long overdue anyway. The FCC could also convene a multistakeholder process to produce a code enforceable by the Federal Trade Commission,” he continued, noting that the White House has endorsed such processes for setting Internet policy in general.

Manne concluded: “The FCC should focus on doing what Section 706 actually commands: clearing barriers to broadband deployment. Unleashing more investment and competition, not writing more regulation, is the best way to keep the Internet open, innovative and free.”

For some of our other work on net neutrality, see:

“Understanding Net(flix) Neutrality,” an op-ed by Geoffrey Manne in the Detroit News on Netflix’s strategy to confuse interconnection costs with neutrality issues.

“The Feds Lost on Net Neutrality, But Won Control of the Internet,” an op-ed by Berin Szoka and Geoffrey Manne in Wired.com.

“That startup investors’ letter on net neutrality is a revealing look at what the debate is really about,” a post by Geoffrey Manne in Truth on the Market.

Bipartisan Consensus: Rewrite of ‘96 Telecom Act is Long Overdue,” a post on TF’s blog highlighting the key points from TechFreedom and ICLE’s joint comments on updating the Communications Act.

The Net Neutrality Comments are available here:

ICLE/TF Net Neutrality Policy Comments

TF/ICLE Net Neutrality Legal Comments

Last Monday, a group of nineteen scholars of antitrust law and economics, including yours truly, urged the U.S. Court of Appeals for the Eleventh Circuit to reverse the Federal Trade Commission’s recent McWane ruling.

McWane, the largest seller of domestically produced iron pipe fittings (DIPF), would sell its products only to distributors that “fully supported” its fittings by carrying them exclusively.  There were two exceptions: where McWane products were not readily available, and where the distributor purchased a McWane rival’s pipe along with its fittings.  A majority of the FTC ruled that McWane’s policy constituted illegal exclusive dealing.

Commissioner Josh Wright agreed that the policy amounted to exclusive dealing, but he concluded that complaint counsel had failed to prove that the exclusive dealing constituted unreasonably exclusionary conduct in violation of Sherman Act Section 2.  Commissioner Wright emphasized that complaint counsel had produced no direct evidence of anticompetitive harm (i.e., an actual increase in prices or decrease in output), even though McWane’s conduct had already run its course.  Indeed, the direct evidence suggested an absence of anticompetitive effect, as McWane’s chief rival, Star, grew in market share at exactly the same rate during and after the time of McWane’s exclusive dealing.

Instead of focusing on direct evidence of competitive effect, complaint counsel pointed to a theoretical anticompetitive harm: that McWane’s exclusive dealing may have usurped so many sales from Star that Star could not achieve minimum efficient scale.  The only evidence as to what constitutes minimum efficient scale in the industry, though, was Star’s self-serving statement that it would have had lower average costs had it operated at a scale sufficient to warrant ownership of its own foundry.  As Commissioner Wright observed, evidence in the record showed that other pipe fitting producers had successfully entered the market and grown market share substantially without owning their own foundry.  Thus, actual market experience seemed to undermine Star’s self-serving testimony.

Commissioner Wright also observed that complaint counsel produced no evidence showing what percentage of McWane’s sales of DIPF might have gone to other sellers absent McWane’s exclusive dealing policy.  Only those “contestable” sales – not all of McWane’s sales to distributors subject to the full support policy – should be deemed foreclosed by McWane’s exclusive dealing.  Complaint counsel also failed to quantify sales made to McWane’s rivals under the generous exceptions to its policy.  These deficiencies prevented complaint counsel from adequately establishing the degree of market foreclosure caused by McWane’s policy – the first (but not last!) step in establishing the alleged anticompetitive harm.

In our amicus brief, we antitrust scholars take Commissioner Wright’s side on these matters.  We also observe that the Commission failed to account for an important procompetitive benefit of McWane’s policy:  it prevented rival DIPF sellers from “cherry-picking” the most popular, highest margin fittings and selling only those at prices that could be lower than McWane’s because the cherry-pickers didn’t bear the costs of producing the full line of fittings.  Such cherry-picking is a form of free-riding because every producer’s fittings are more highly valued if a full line is available.  McWane’s policy prevented the sort of free-riding that would have made its production of a full line uneconomical.

In short, the FTC’s decision made it far too easy to successfully challenge exclusive dealing arrangements, which are usually procompetitive, and calls into question all sorts of procompetitive full-line forcing arrangements.  Hopefully, the Eleventh Circuit will correct the Commission’s mistake.

Other professors signing the brief include:

  • Tom Arthur, Emory Law
  • Roger Blair, Florida Business
  • Don Boudreaux, George Mason Economics (and Café Hayek)
  • Henry Butler, George Mason Law
  • Dan Crane, Michigan Law (and occasional TOTM contributor)
  • Richard Epstein, NYU and Chicago Law
  • Ken Elzinga, Virginia Economics
  • Damien Geradin, George Mason Law
  • Gus Hurwitz, Nebraska Law (and TOTM)
  • Keith Hylton, Boston University Law
  • Geoff Manne, International Center for Law and Economics (and TOTM)
  • Fred McChesney, Miami Law
  • Tom Morgan, George Washington Law
  • Barack Orbach, Arizona Law
  • Bill Page, Florida Law
  • Paul Rubin, Emory Economics (and TOTM)
  • Mike Sykuta, Missouri Economics (and TOTM)
  • Todd Zywicki, George Mason Law (and Volokh Conspiracy)

The brief’s “Summary of Argument” follows the jump. Continue Reading…

The American Bar Association’s (ABA) “Antitrust in Asia:  China” Conference, held in Beijing May 21-23 (with Chinese Government and academic support), cast a spotlight on the growing economic importance of China’s six-year old Anti-Monopoly Law (AML).  The Conference brought together 250 antitrust practitioners and government officials to discuss AML enforcement policy.  These included the leaders (Directors General) of the three Chinese competition agencies (those agencies are units within the State Administration for Industry and Commerce (SAIC), the Ministry of Foreign Commerce (MOFCOM), and the National Development and Reform Commission (NDRC)), plus senior competition officials from Europe, Asia, and the United States.  This was noteworthy in itself, in that the three Chinese antitrust enforcers seldom appear jointly, let alone with potential foreign critics.  The Chinese agencies conceded that Chinese competition law enforcement is not problem free and that substantial improvements in the implementation of the AML are warranted.

With the proliferation of international business arrangements subject to AML jurisdiction, multinational companies have a growing stake in the development of economically sound Chinese antitrust enforcement practices.  Achieving such a result is no mean feat, in light of the AML’s (Article 27) explicit inclusion of industrial policy factors, significant institutional constraints on the independence of the Chinese judiciary, and remaining concerns about transparency of enforcement policy, despite some progress.  Nevertheless, Chinese competition officials and academics at the Conference repeatedly emphasized the growing importance of competition and the need to improve Chinese antitrust administration, given the general pro-market tilt of the 18th Communist Party Congress.  (The references to Party guidance illustrate, of course, the continuing dependence of Chinese antitrust enforcement patterns on political forces that are beyond the scope of standard legal and policy analysis.)

While the Conference covered the AML’s application to the standard antitrust enforcement topics (mergers, joint conduct, cartels, unilateral conduct, and private litigation), the treatment of price-related “abuses” and intellectual property (IP) merit particular note.

In a panel dealing with the investigation of price-related conduct by the NDRC (the agency responsible for AML non-merger pricing violations), NDRC Director General Xu Kunlin revealed that the agency is deemphasizing much-criticized large-scale price regulation and price supervision directed at numerous firms, and is focusing more on abuses of dominance, such as allegedly exploitative “excessive” pricing by such firms as InterDigital and Qualcomm.  (Resale price maintenance also remains a source of some interest.)  On May 22, 2014, the second day of the Conference, the NDRC announced that it had suspended its investigation of InterDigital, given that company’s commitment not to charge Chinese companies “discriminatory” high-priced patent licensing fees, not to bundle licenses for non-standard essential patents and “standard essential patents” (see below), and not to litigate to make Chinese companies accept “unreasonable” patent license conditions.  The NDRC also continues to investigate Qualcomm for allegedly charging discriminatorily high patent licensing rates to Chinese customers.  Having the world’s largest consumer market, and fast growing manufacturers who license overseas patents, China possesses enormous leverage over these and other foreign patent licensors, who may find it necessary to sacrifice substantial licensing revenues in order to continue operating in China.

The theme of ratcheting down on patent holders’ profits was reiterated in a presentation by SAIC Director General Ren Airong (responsible for AML non-merger enforcement not directly involving price) on a panel discussing abuse of dominance and the antitrust-IP interface.  She revealed that key patents (and, in particular, patents that “read on” and are necessary to practice a standard, or “standard essential patents”) may well be deemed “necessary” or “essential” facilities under the final version of the proposed SAIC IP-Antitrust Guidelines.  In effect, implementation of this requirement would mean that foreign patent holders would have to grant licenses to third parties under unfavorable government-set terms – a recipe for disincentivizing future R&D investments and technological improvements.  Emphasizing this negative effect, co-panelists FTC Commissioner Ohlhausen and I pointed out that the “essential facilities” doctrine has been largely discredited by leading American antitrust scholars.  (In a separate speech, FTC Chairwoman Ramirez also argued against treating patents as essential facilities.)  I added that IP does not possess the “natural monopoly” characteristics of certain physical capital facilities such as an electric grid (declining average variable cost and uneconomic to replicate), and that competitors’ incentives to develop alternative and better technology solutions would be blunted if they were given automatic cheap access to “important” patents.  In short, the benefits of dynamic competition would be undermined by treating patents as essential facilities.  I also noted that, consistent with decision theory, wise competition enforcers should be very cautious before condemning single firm behavior, so as not to chill efficiency-enhancing unilateral conduct.  Director General Ren did not respond to these comments.

If China is to achieve its goal of economic growth driven by innovation, it should seek to avoid legally handicapping technology market transactions by mandating access to, or otherwise restricting returns to, patents.  As recognized in the U.S. Justice Department-Federal Trade Commission 1995 IP-Antitrust Guidelines and 2007 IP-Antitrust Report, allowing the IP holder to seek maximum returns within the scope of its property right advances innovative welfare-enhancing economic growth.  As China’s rapidly growing stock of IP matures and gains in value, it hopefully will gain greater appreciation for that insight, and steer its competition policy away from the essential facilities doctrine and other retrograde limitations on IP rights holders that are inimical to long term innovation and welfare.

Last week a group of startup investors wrote a letter to protest what they assume FCC Chairman Tom Wheeler’s proposed, revised Open Internet NPRM will say.

Bear in mind that an NPRM is a proposal, not a final rule, and its issuance starts a public comment period. Bear in mind, as well, that the proposal isn’t public yet, presumably none of the signatories to this letter has seen it, and the devil is usually in the details. That said, the letter has been getting a lot of press.

I found the letter seriously wanting, and seriously disappointing. But it’s a perfect example of what’s so wrong with this interminable debate on net neutrality.

Below I reproduce the letter in full, in quotes, with my comments interspersed. The key take-away: Neutrality (or non-discrimination) isn’t what’s at stake here. What’s at stake is zero-cost access by content providers to broadband networks. One can surely understand why content providers and those who fund them want their costs of doing business to be lower. But the rhetoric of net neutrality is mismatched with this goal. It’s no wonder they don’t just come out and say it – it’s quite a remarkable claim.

Open Internet Investors Letter

The Honorable Tom Wheeler, Chairman
Federal Communications Commission
445 12th Street, SW
Washington D.C. 20554

May 8, 2014

Dear Chairman Wheeler:

We write to express our support for a free and open Internet.

We invest in entrepreneurs, investing our own funds and those of our investors (who are individuals, pension funds, endowments, and financial institutions).  We often invest at the earliest stages, when companies include just a handful of founders with largely unproven ideas. But, without lawyers, large teams or major revenues, these small startups have had the opportunity to experiment, adapt, and grow, thanks to equal access to the global market.

“Equal” access has nothing to do with it. No startup is inherently benefitted by being “equal” to others. Maybe this is just careless drafting. But frankly, as I’ll discuss, there are good reasons to think (contra the pro-net neutrality narrative) that startups will be helped by inequality (just like contra the (totally wrong) accepted narrative, payola helps new artists). It says more than they would like about what these investors really want that they advocate “equality” despite the harm it may impose on startups (more on this later).

Presumably what “equal” really means here is “zero cost”: “As long as my startup pays nothing for access to ISPs’ subscribers, it’s fine that we’re all on equal footing.” Wheeler has stated his intent that his proposal would require any prioritization to be available to any who want it, on equivalent, commercially reasonable terms. That’s “equal,” too, so what’s to complain about? But it isn’t really inequality that’s gotten everyone so upset.

Of course, access is never really “zero cost;” start-ups wouldn’t need investors if their costs were zero. In that sense, why is equality of ISP access any more important than other forms of potential equality? Why not mandate price controls on rent? Why not mandate equal rent? A cost is a cost. What’s really going on here is that, like Netflix, these investors want to lower their costs and raise their returns as much as possible, and they want the government to do it for them.

As a result, some of the startups we have invested in have managed to become among the most admired, successful, and influential companies in the world.

No startup became successful as a result of “equality” or even zero-cost access to broadband. No doubt some of their business models were predicated on that assumption. But it didn’t cause their success.

We have made our investment decisions based on the certainty of a level playing field and of assurances against discrimination and access fees from Internet access providers.

And they would make investment decisions based on the possibility of an un-level playing field if that were the status quo. More importantly, the businesses vying for investment dollars might be different ones if they built their business models in a different legal/economic environment. So what? This says nothing about the amount of investment, the types of businesses, the quality of businesses that would arise under a different set of rules. It says only that past specific investments might not have been made.

Unless the contention is that businesses would be systematically worse under a different rule, this is irrelevant. I have seen that claim made, and it’s implicit here, of course, but I’ve seen no evidence to actually support it. Businesses thrive in unequal, cost-ladened environments all the time. It costs about $4 million/30 seconds to advertise during the Super Bowl. Budweiser and PepsiCo paid multiple millions this year to do so; many of their competitors didn’t. With inequality like that, it’s a wonder Sierra Nevada and Dr. Pepper haven’t gone bankrupt.

Indeed, our investment decisions in Internet companies are dependent upon the certainty of an equal-opportunity marketplace.

Again, no they’re not. Equal opportunity is a euphemism for zero cost, or else this is simply absurd on its face. Are these investors so lacking in creativity and ability that they can invest only when there is certainty of equal opportunity? Don’t investors thrive – aren’t they most needed – in environments where arbitrage is possible, where a creative entrepreneur can come up with a risky, novel way to take advantage of differential conditions better than his competitors? Moreover, the implicit equating of “equal-opportunity marketplace” with net neutrality rules is far-fetched. Is that really all that matters?

This is a good time to make a point that is so often missed: The loudest voices for net neutrality are the biggest companies – Google, Netflix, Amazon, etc. That fact should give these investors and everyone else serious pause. Their claim rests on the idea that “equality” is needed, so big companies can’t use an Internet “fast lane” to squash them. Google is decidedly a big company. So why do the big boys want this so much?

The battle is often pitched as one of ISPs vs. (small) content providers. But content providers have far less to worry about and face far less competition from broadband providers than from big, incumbent competitors. It is often claimed that “Netflix was able to pay Comcast’s toll, but a small startup won’t have that luxury.” But Comcast won’t even notice or care about a small startup; its traffic demands will be inconsequential. Netflix can afford to pay for Internet access for precisely the same reason it came to Comcast’s attention: It’s hugely successful, and thus creates a huge amount of traffic.

Based on news reports and your own statements, we are worried that your proposed rules will not provide the necessary certainty that we need to make investment decisions and that these rules will stifle innovation in the Internet sector.

Now, there’s little doubt that legal certainty aids investment decisions. But “certainty” is not in danger here. The rules have to change because the court said so – with pretty clear certainty. And a new rule is not inherently any more or less likely to offer certainty than the previous Open Internet Order, which itself was subject to intense litigation (obviously) and would have been subject to interpretation and inconsistent enforcement (and would have allowed all kinds of paid prioritization, too!). Certainty would be good, but Wheeler’s proposed rule won’t likely do anything about the amount of certainty one way or the other.

If established companies are able to pay for better access speeds or lower latency, the Internet will no longer be a level playing field. Start-ups with applications that are advantaged by speed (such as games, video, or payment systems) will be unlikely to overcome that deficit no matter how innovative their service.

Again, it’s notable that some of the strongest advocates for net neutrality are established companies. Another letter sent out last week included signatures from a bunch of startups, but also Google, Microsoft, Facebook and Yahoo!, among others.

In truth it’s hard to see why startup investors would think this helps them. Non-neutrality offers the prospect that a startup might be able to buy priority access to overcome the inherent disadvantage of newness, and to better compete with an established company. Neutrality means that that competitive advantage is impossible, and the baseline relative advantages and disadvantages remain – which helps incumbents, not startups. With a neutral Internet – well, the advantages of the incumbent competitor can’t be dissipated by a startup buying a favorable leg-up in speed and the Netflix’s of the world will be more likely to continue to dominate.

Of course the claim is that incumbents will use their huge resources to gain even more advantage with prioritized access. Implicit in this must be the assumption that the advantage that could be gained by a startup buying priority offers less return for the startup than the cost imposed on it by the inherent disadvantages of reputation, brand awareness, customer base, etc. But that’s not plausible for all or even most startups. And investors exist precisely because they are able to provide funds for which there is a likelihood of a good return – so if paying for priority would help overcome inherent disadvantages, there would be money for it.

Also implicit is the claim that the benefits to incumbents (over and above their natural advantages) from paying for priority, in terms of hamstringing new entrants, will outweigh the cost. This is unlikely generally to be true, as well. They already have advantages. Sure, sometimes they might want to pay for more, but in precisely the cases where it would be worth it to do so, the new entrant would also be most benefited by doing so itself – ensuring, again, that investment funds will be available.

Of course if both incumbents and startups decide paying for priority is better, we’re back to a world of “equality,” so what’s to complain about, based on this letter? This puts into stark relief that what these investors really want is government-mandated, subsidized broadband access, not “equality.”

Now, it’s conceivable that that is the optimal state of affairs, but if it is, it isn’t for the reasons given here, nor has anyone actually demonstrated that it is the case.

Entrepreneurs will need to raise money to buy fast lane services before they have proven that consumers want their product. Investors will extract more equity from entrepreneurs to compensate for the risk.

Internet applications will not be able to afford to create a relationship with millions of consumers by making their service freely available and then build a business over time as they better understand the value consumers find in their service (which is what Facebook, Twitter, Tumblr, Pinterest, Reddit, Dropbox and virtually other consumer Internet service did to achieve scale).

In other words: “Subsidize us. We’re worth it.” Maybe. But this is probably more revealing than intended. The Internet cost something to someone to build. (Actually, it cost more than a trillion dollars to broadband providers). This just says “we shouldn’t have to pay them for it now.” Fine, but who, then, and how do you know that forcing someone else to subsidize these startup companies will actually lead to better results? Mightn’t we get less broadband investment such that there is little Internet available for these companies to take advantage of in the first place? If broadband consumers instead of content consumers foot the bill, is that clearly preferable, either from a social welfare perspective, or even the self interest of these investors who, after all, do ultimately rely on consumer spending to earn their return?

Moreover, why is this “build for free, then learn how to monetize over time” business model necessarily better than any other? These startup investors know better than anyone that enshrining existing business models just because they exist is the antithesis of innovation and progress. But that’s exactly what they’re saying – “the successful companies of the past did it this way, so we should get a government guarantee to preserve our ability to do it, too!”

This is the most depressing implication of this letter. These investors and others like them have been responsible for financing enormously valuable innovations. If even they can’t see the hypocrisy of these claims for net neutrality – and worse, choose to propagate it further – then we really have come to a sad place. When innovators argue passionately for stagnation, we’re in trouble.

Instead, creators will have to ask permission of an investor or corporate hierarchy before they can launch. Ideas will be vetted by committees and quirky passion projects will not get a chance. An individual in dorm room or a design studio will not be able to experiment out loud on the Internet. The result will be greater conformity, fewer surprises, and less innovation.

This is just a little too much protest. Creators already have to ask “permission” – or are these investors just opening up their bank accounts to whomever wants their money? The ones that are able to do it on a shoestring, with money saved up from babysitting gigs, may find higher costs, and the need to do more babysitting. But again, there is nothing special about the Internet in this. Let’s mandate zero cost office space and office supplies and developer services and design services and . . . etc. for all – then we’ll have way more “permission-less” startups. If it’s just a handout they want, they should say so, instead of pretending there is a moral or economic welfare basis for their claims.

Further, investors like us will be wary of investing in anything that access providers might consider part of their future product plans for fear they will use the same technical infrastructure to advantage their own services or use network management as an excuse to disadvantage competitive offerings.

This is crazy. For the same reasons I mentioned above, the big access provider (and big incumbent competitor, for that matter) already has huge advantages. If these investors aren’t already wary of investing in anything that Google or Comcast or Apple or… might plan to compete with, they must be terrible at their jobs.

What’s more, Wheeler’s much-reviled proposal (what we know about it, that is), to say nothing of antitrust law, clearly contemplates exactly this sort of foreclosure and addresses it. “Pure” net neutrality doesn’t add much, if anything, to the limits those laws already do or would provide.

Policing this will be almost impossible (even using a standard of “commercial reasonableness”) and access providers do not need to successfully disadvantage their competition; they just need to create a credible threat so that investors like us will be less inclined to back those companies.

You think policing the world of non-neutrality is hard – try policing neutrality. It’s not as easy as proponents make it out to be. It’s simply never been the case that all bits at all times have been treated “neutrally” on the Internet. Any version of an Open Internet Order (just like the last one, for example) will have to recognize this.

Larry Downes compiled a list of the exceptions included in the last Open Internet Order when he testified before the House Judiciary Committee on the rules in 2011. There are 16 categories of exemption, covering a wide range of fundamental components of broadband connectivity, from CDNs to free Wi-Fi at Starbucks. His testimony is a tour de force, and should be required reading for everyone involved in this debate.

But think about how the manifest advantages of these non-neutral aspects of broadband networks would be squared with “real” neutrality. On their face, if these investors are to be taken at their word, these arguments would preclude all of the Open Internet Order’s exemptions, too. And if any sort of inequality is going to be deemed ok, how accurately would regulators distinguish between “illegitimate” inequality and the acceptable kind that lets coffee shops subsidize broadband? How does the simplistic logic of net equality distinguish between, say, Netflix’s colocated servers and a startup like Uber being integrated into Google Maps? The simple answer is that it doesn’t, and the claims and arguments of this letter are woefully inadequate to the task.

We need simple, strong, enforceable rules against discrimination and access fees, not merely against blocking.

No, we don’t. Or, at least, no one has made that case. These investors want a handout; that is the only case this letter makes.

We encourage the Commission to consider all available jurisdictional tools at its disposal in ensuring a free and open Internet that rewards, not disadvantages, investment and entrepreneurship.

… But not investment in broadband, and not entrepreneurship that breaks with the business models of the past. In reality, this letter is simple rent-seeking: “We want to invest in what we know, in what’s been done before, and we don’t want you to do anything to make that any more costly for us. If that entails impairing broadband investment or imposing costs on others, so be it – we’ll still make our outsized returns, and they can write their own letter complaining about ‘inequality.’”

A final point I have to make. Although the investors don’t come right out and say it, many others have, and it’s implicit in the investors’ letter: “Content providers shouldn’t have to pay for broadband. Users already pay for the service, so making content providers pay would just let ISPs double dip.” The claim is deeply problematic.

For starters, it’s another form of the status quo mentality: “Users have always paid and content hasn’t, so we object to any deviation from that.” But it needn’t be that way. And of course models frequently coexist where different parties pay for the same or similar services. Some periodicals are paid for by readers and offer little or no advertising; others charge a subscription and offer paid ads; and still others are offered for free, funded entirely by ads. All of these models work. None is “better” than the other. There is no reason the same isn’t true for broadband and content.

Net neutrality claims that the only proper price to charge on the content side of the market is zero. (Congratulations: You’re in the same club as that cutting-edge, innovative technology, the check, which is cleared at par by government fiat. A subsidy that no doubt explains why checks have managed to last this long). As an economic matter, that’s possible; it could be that zero is the right price. But it most certainly needn’t be, and issues revolving around Netflix’s traffic and the ability of ISPs and Netflix cost-effectively to handle it are evidence that zero may well not be the right price.

The reality is that these sorts of claims are devoid of economic logic — which is presumably why they, like the whole net neutrality “movement” generally, appeal so gratuitously to emotion rather than reason. But it doesn’t seem unreasonable to hope for more from a bunch of savvy financiers.

 

As I noted in my prior post, two weeks ago the 13th Annual Conference of the International Competition Network (ICN) released two new sets of recommended best practices.  Having focused on competition assessment in my prior blog entry, I now turn to the ICN’s predatory pricing recommendations.

Aggressive price cutting is the essence of competitive behavior, and the application of antitrust enforcement to price cuts that are mislabeled as “predatory” threatens to chill such competition on the merits and deny consumers the benefits of lower prices.

Fortunately, the U.S. Supreme Court’s 1993 Brooke Group decision appropriately limited antitrust predatory pricing liability to cases where the defendant (1) priced below “an appropriate measure” of its costs and (2) had a “reasonable prospect of recouping” its investment in below cost pricing.  Brooke Group enhanced United States welfare by largely eliminating the risk of unwarranted predatory pricing suits, to the benefit of consumers and producers.  In particular, because courts generally have applied stringent cost measures (such as average variable cost, not the higher average total cost), findings of below cost pricing have been rare.  Consistent with decision theory, there is good reason to believe that whatever increase in antitrust “false negatives” (failure to challenge truly harmful behavior) it engendered has been greatly outweighed by the reduction in false positives (unwarranted challenges to procompetitive behavior).

The European Union’s test for antitrust predatory pricing is, by contrast, easier to satisfy.  Prices below average variable cost are presumed illegal, prices between average variable cost and average total cost are abusive if part of a plan to eliminate competitors (such prices would not be deemed predatory in the United States), and likelihood of recoupment need not be shown (enforcers presume that parties would not engage in below cost pricing if they did not think it would ultimately be profitable).  Europeans generally have been far more willing to carry out detailed case-specific predatory pricing evaluations, believing that they have the ability to get difficult analyses right.  Given the widespread adoption of the European approach to competition in much of the world, and the benefit for prosecutors of not having to prove recoupment, the European take on predatory pricing has seemed to be in the ascendancy.

Given this background, the ICN’s newly minted Recommended Practices on Predatory Pricing Analysis Pursuant to Unilateral Conduct Laws (RPPP) are a welcome breath of fresh air.  The RPPP are strongly grounded in economics, and they place great stress on the need to obtain solid evidence (rather than rely on mere theory) that predation is occurring in a particular case.  The following RPPP features are particularly helpful:

  • They stress up front the importance of focusing on the benefits of vigorous price competition to consumers;
  • They explain that a predatory strategy is rational only when a firm expects to acquire, maintain, or strengthen market power through its actions, which means that the predator expects not only to recoup its losses sustained during the predatory period, but also to enhance profits by holding its prices above what they otherwise would have been;
  • They urge that agencies use a sound economically-based theory of harm tied to a relevant market, and determine early on (before running difficult price-cost tests) whether the alleged predator’s prices are likely to cause competitive harm;
  • They advocate basing price-cost tests on the costs of the dominant firm, with concern centering on harm to equally efficient (not less efficient) competitors;
  • They provide an economically sophisticated summary of differences among potential measures of cost;
  • They recognize that to harm competition, low prices must deprive rivals of significant actual or potential sales in at least one market;
  • They stress that low barriers to entry and re-entry in the market render predation unlikely because recoupment is infeasible;
  • They call for examination of evidence relating to the rationale of a pricing strategy to distinguish between low pricing that harms competition and low pricing that reflects healthy competition;
  • They urge that agencies examine objective business justifications and defenses for low prices (such as promotional pricing and achieving scale economies); and
  • They support administrable and clearly communicated enforcement standards (an implicit nod to decision theory), the adoption of safe harbors that can be easily complied with, and agency cooperation early on with the alleged predator to understand the records it keeps and to facilitate price-cost comparisons.

Although the RPPP do not adopt the simple rules embodied in Brooke Group (which in my view would have been the optimal outcome), they reflect throughout a concern for economically rational evidence-based enforcement.  Such enforcement is based on a full appreciation of the welfare benefits of vigorous price competition, the possible procompetitive business justifications for price cutting, and the need for clear enforcement standards and safe harbors.

Overall, the RPPP demonstrate that the ICN remains capable of building consensus support for concise, economically-based antitrust enforcement principles, that take into account practical business justifications for certain practices.  As business deals increasingly take on a global dimension, the convergence of predatory pricing norms around a model suggested by the RPPP would be a most welcome, welfare-enhancing development.

I have a new article on the Comcast/Time Warner Cable merger in the latest edition of the CPI Antitrust Chronicle, which includes several other articles on the merger, as well.

In a recent essay, Allen Grunes & Maurice Stucke (who also have an essay in the CPI issue) pose a thought experiment: If Comcast can acquire TWC, what’s to stop it acquiring all cable companies? The authors’ assertion is that the arguments being put forward to support the merger contain no “limiting principle,” and that the same arguments, if accepted here, would unjustifiably permit further consolidation. But there is a limiting principle: competitive harm. Size doesn’t matter, as courts and economists have repeatedly pointed out.

The article explains why the merger doesn’t give rise to any plausible theory of anticompetitive harm under modern antitrust analysis. Instead, arguments against the merger amount to little more than the usual “big-is-bad” naysaying.

In summary, I make the following points:

Horizontal Concerns

The absence of any reduction in competition should end the inquiry into any potentially anticompetitive effects in consumer markets resulting from the horizontal aspects of the transaction.

  • It’s well understood at this point that Comcast and TWC don’t compete directly for subscribers in any relevant market; in terms of concentration and horizontal effects, the transaction will neither reduce competition nor restrict consumer choice.
  • Even if Comcast were a true monopolist provider of broadband service in certain geographic markets, the DOJ would have to show that the merger would be substantially likely to lessen competition—a difficult showing to make where Comcast and TWC are neither actual nor potential competitors in any of these markets.
  • Whatever market power Comcast may currently possess, the proposed merger simply does nothing to increase it, nor to facilitate its exercise.

Comcast doesn’t currently have substantial bargaining power in its dealings with content providers, and the merger won’t change that. The claim that the combined entity will gain bargaining leverage against content providers from the merger, resulting in lower content prices to programmers, fails for similar reasons.

  • After the transaction, Comcast will serve fewer than 30 percent of total MVPD subscribers in the United States. This share is insufficient to give Comcast market power over sellers of video programming.
  • The FCC has tried to impose a 30 percent cable ownership cap, and twice it has been rejected by the courts. The D.C. Circuit concluded more than a decade ago—in far less competitive conditions than exist today—that the evidence didn’t justify a horizontal ownership limit lower than 60% on the basis of buyer power.
  • The recent exponential growth in OVDs like Google, Netflix, Amazon and Apple gives content providers even more ways to distribute their programming.
  • In fact, greater concentration among cable operators has coincided with an enormous increase in output and quality of video programming
  • Moreover, because the merger doesn’t alter the competitive make-up of any relevant consumer market, Comcast will have no greater ability to threaten to withhold carriage of content in order to extract better terms.
  • Finally, programmers with valuable content have significant bargaining power and have been able to extract the prices to prove it. None of that will change post-merger.

Vertical Concerns

The merger won’t give Comcast the ability (or the incentive) to foreclose competition from other content providers for its NBCUniversal content.

  • Because the merger would represent only 30 percent of the national market (for MVPD services), 70 percent of the market is still available for content distribution.
  • But even this significantly overstates the extent of possible foreclosure. OVD providers increasingly vie for the same content as cable (and satellite).
  • In the past when regulators have considered foreclosure effects for localized content (regional sports networks, primarily)—for example, in the 2005 Adelphia/Comcast/TWC deal, under far less competitive conditions—the FTC found no substantial threat of anticompetitive harm. And while the FCC did identify a potential risk of harm in its review of the Adelphia deal, its solution was to impose arbitration requirements for access to this programming—which are already part of the NBCUniversal deal conditions and which will be extended to the new territory and new programming from TWC.

The argument that the merger will increase Comcast’s incentive and ability to impair access to its users by online video competitors or other edge providers is similarly without merit.

  • Fundamentally, Comcast benefits from providing its users access to edge providers, and it would harm itself if it were to constrain access to these providers.
  • Foreclosure effects would be limited, even if they did arise. On a national level, the combined firm would have only about 40 percent of broadband customers, at most (and considerably less if wireless broadband is included in the market).
  • This leaves at least 60 percent—and quite possibly far more—of customers available to purchase content and support edge providers reaching minimum viable scale, even if Comcast were to attempt to foreclose access.

Some have also argued that because Comcast has a monopoly on access to its customers, transit providers are beholden to it, giving it the ability to degrade or simply block content from companies like Netflix. But these arguments misunderstand the market.

  • The transit market through which edge providers bring their content into the Comcast network is highly competitive. Edge providers can access Comcast’s network through multiple channels, undermining Comcast’s ability to deny access or degrade service to such providers.
  • The transit market is also almost entirely populated by big players engaged in repeat interactions and, despite a large number of transactions over the years, marked by a trivial number of disputes.
  • The recent Comcast/Netflix agreement demonstrates that the sophisticated commercial entities in this market are capable of resolving conflicts—conflicts that appear to affect only the distribution of profits among contracting parties but not raise anticompetitive concerns.
  • If Netflix does end up paying more to access Comcast’s network over time, it won’t be because of market power or this merger. Rather, it’s an indication of the evolving market and the increasing popularity of OTT providers.
  • The Comcast/Netflix deal has procompetitive justifications, as well. Charging Netflix allows Comcast to better distinguish between the high-usage Netflix customers (two percent of Netflix users account for 20 percent of all broadband traffic) and everyone else. This should lower cable bills on average, improve incentives for users, and lead to more efficient infrastructure investments by both Comcast and Netflix.

Critics have also alleged that the vertically integrated Comcast may withhold its own content from competing MVPDs or OVDs, or deny carriage to unaffiliated programming. In theory, by denying competitors or potential competitors access to popular programming, a vertically integrated MVPD might gain a competitive advantage over its rivals. Similarly, an MVPD that owns cable channels may refuse to carry at least some unaffiliated content to benefit its own channels. But these claims also fall flat.

  • Once again, these issue are not transaction specific.
  • But, regardless, Comcast will not be able to engage in successful foreclosure strategies following the transaction.
  • The merger has no effect on Comcast’s share of national programming. And while it will have a larger share of national distribution post-merger, a 30 percent market share is nonetheless insufficient to confer buyer power in today’s highly competitive MVPD market.
  • Moreover, the programming market is highly dynamic and competitive, and Comcast’s affiliated programming networks face significant competition.
  • Comcast already has no ownership interest in the overwhelming majority of content it distributes. This won’t measurably change post-transaction.

Procompetitive Justifications

While the proposed transaction doesn’t give rise to plausible anticompetitive harms, it should bring well-understood pro-competitive benefits. Most notably:

  • The deal will bring significant scale efficiencies in a marketplace that requires large, fixed-cost investments in network infrastructure and technology.
  • And bringing a more vertical structure to TWC will likely be beneficial, as well. Vertical integration can increase efficiency, and the elimination of double marginalization often leads to lower prices for consumers.

Let’s be clear about the baseline here. Remember all those years ago when Netflix was a mail-order DVD company? Before either Netflix or Comcast even considered using the internet to distribute Netflix’s video content, Comcast invested in the technology and infrastructure that ultimately enabled the Netflix of today. It did so at enormous cost (tens of billions of dollars over the last 20 years) and risk. Absent broadband we’d still be waiting for our Netflix DVDs to be delivered by snail mail, and Netflix would still be spending three-quarters of a billion dollars a year on shipping.

The ability to realize returns—including returns from scale—is essential to incentivizing continued network and other quality investments. The cable industry today operates with a small positive annual return on invested capital (“ROIC”) but it has had cumulative negative ROIC over the entirety of the last decade. In fact, on invested capital of $127 billion between 2000 and 2009, cable has seen economic profits of negative $62 billion and a weighted average ROIC of negative 5 percent. Meanwhile Comcast’s stock has significantly underperformed the S&P 500 over the same period and only outperformed the S&P over the last two years.

Comcast is far from being a rapacious and endlessly profitable monopolist. This merger should help it (and TWC) improve its cable and broadband services, not harm consumers.

No matter how many times Al Franken and Susan Crawford say it, neither the broadband market nor the MVPD market is imperiled by vertical or horizontal integration. The proposed merger won’t create cognizable antitrust harms. Comcast may get bigger, but that simply isn’t enough to thwart the merger.

Commissioner Josh Wright’s dissenting statement in the Federal Trade Commission’s recent McWane proceeding is a must-read for anyone interested in the law and economics of exclusive dealing. Wright dissented from the Commission’s holding that McWane Inc.’s “full support” policy constituted unlawful monopolization of the market for domestic pipe fittings.

Under the challenged policy, McWane, the dominant producer with a 45-50% share of the market for domestic pipe fittings, would sell its products only to distributors that “fully supported” its fittings by carrying them exclusively.  There were two exceptions: where McWane products were not readily available, and where the distributor purchased a McWane rival’s pipe along with its fittings.  A majority of the Commission ruled that McWane’s policy constituted illegal exclusive dealing.  Commissioner Wright agreed that the policy amounted to exclusive dealing, but he concluded that the complainant had failed to prove that the exclusive dealing constituted unreasonably exclusionary conduct in violation of Sherman Act Section 2.

The first half of Wright’s 52-page dissent is an explanatory tour de force.  Wright first explains how and why the Supreme Court rethought its originally inhospitable rules on “vertical restraints” (i.e., trade-limiting agreements between sellers at different levels of the distribution system, such as manufacturers and distributors).  Recognizing that most such restraints enhance overall market output even if they incidentally injure some market participants, courts now condition liability on harm to competition—that is, to overall market output.  Mere harm to an individual competitor is not enough.

Wright then explains how this “harm to competition” requirement manifests itself in actions challenging exclusive dealing.  Several of the antitrust laws—Sections 1 and 2 of the Sherman Act and Section 3 of the Clayton Act—could condemn arrangements in which a seller will deal only with those who purchase its brand exclusively.  Regardless of the particular statute invoked, though, there can be no antitrust liability absent either direct or indirect evidence of anticompetitive (not just anti-competitor) effect.  Direct evidence entails some showing that the exclusive dealing at issue led to lower market output and/or higher prices than would otherwise have prevailed.  Indirect evidence usually involves showings that (1) the exclusive dealing at issue foreclosed the defendant’s rivals from a substantial share of available marketing opportunities; (2) those rivals were therefore driven (or held) below minimum efficient scale (MES), so that their per-unit production costs were held artificially high; and (3) the defendant thereby obtained the ability to price higher than it would have absent the exclusive dealing.

The McWane complainant, Star Pipe Products, Ltd., sought to discharge its proof burden using indirect evidence. It asserted that its per-unit costs would have been lower if it owned a domestic foundry, but it maintained that its 20% market share did not entail sales sufficient to justify foundry construction.  Thus, Star concluded, McWane’s usurping of rivals’ potential sales opportunities through its exclusive dealing policy held Star below MES, raised Star’s per-unit costs, and enhanced McWane’s ability to raise prices.  Voila!  Anticompetitive harm.

Commissioner Wright was not convinced that Star had properly equated MES with sales sufficient to justify foundry construction.  The only record evidence to that effect—evidence the Commission deemed sufficient—was Star’s self-serving testimony that it couldn’t justify building a foundry at its low level of sales and would be a more formidable competitor if it could do so.  Countering that testimony were a couple of critical bits of actual market evidence.

First, the second-largest domestic seller of pipe fittings, Sigma Corp., somehow managed to enter the domestic fittings market and capture a 30% market share (as opposed to Star’s 20%), without owning any of its own production facilities.  Sigma’s entire business model was built on outsourcing, yet it managed to grow sales more than Star.  This suggests that foundry ownership – and, thus, a level of sales sufficient to support foundry construction – may not be necessary for efficient scale in this industry.

Moreover, Star’s own success in the domestic pipe fittings market undermined its suggestion that MES can be achieved only upon reaching a sales level sufficient to support a domestic foundry.  Star entered the domestic pipe fittings market in 2009, quickly grew to a 20% market share, and was on pace to continue growth when the McWane action commenced.  As Commissioner Wright observed, “for Complaint Counsel’s view of MES to make sense on the facts that exist in the record, Star would have to be operating below MES, becoming less efficient over time as McWane’s Full Support Program further raised the costs of distribution, and yet remaining in the market and growing its business.  Such a position strains credulity.”

Besides failing to establish what constitutes MES in the domestic pipe fittings industry, Commissioner Wright asserted, complainant Star also failed to prove the degree of foreclosure occasioned by McWane’s full support program.

First, both Star and the Commission reasoned that all McWane sales to distributors subject to its full support program had been “foreclosed,” via exclusive dealing, to McWane’s competitors.  That is incorrect.  The sales opportunities foreclosed by McWane’s full support policy were those that would have been made to other sellers but for the policy.  In other words, if a distributor, absent the full support policy, would have purchased 70 units from McWane and five from Star but, because of the full support program, purchased all 75 from McWane, the full support program effectively foreclosed Star from five sales opportunities, not 75.  By failing to focus on “contestable” sales—i.e., sales other than those that would have been made to McWane even absent the full support program—Star and the Commission exaggerated the degree of foreclosure resulting from McWane’s exclusive dealing.

Second, neither Star nor the Commission made any effort to quantify the sales made to McWane’s rivals under the two exceptions to McWane’s full support policy.  Such sales were obviously not foreclosed to McWane’s rivals, but both Star and the Commission essentially ignored them.  So, for example, if a distributor that carried McWane’s products (and was thus subject to the full support policy) purchased 70 domestic fittings from McWane and 30 from other producers pursuant to one of the full support program’s exceptions, Star and the Commission counted 100 foreclosed sales opportunities.  Absent information about the number of distributor purchases under exceptions to the full support program, it is simply impossible to assess the degree of foreclosure occasioned by the policy.

In sum, complainant Star – who bore the burden of establishing an anticompetitive (i.e., market output-reducing) effect of the exclusive dealing at issue – failed to show how much foreclosure McWane’s full support program actually created and to produce credible evidence (other than its own self-serving testimony) that the program raised its costs by holding it below MES.  The most Star showed was harm to a competitor – not harm to competition, a prerequisite to liability based on exclusive dealing.      

In addition, several other pieces of evidence suggested that McWane’s exclusive dealing was not anticompetitive.  First, the full support program did not require a commitment of exclusivity for any period of time. Distributors purchasing from McWane could begin carrying rival brands at any point (though doing so might cause McWane to refuse to sell to them in the future).  Courts have often held that short-duration exclusive dealing arrangements are less troubling than longer-term agreements; indeed, a number of courts presume the legality of exclusive dealing contracts of a year or less.  McWane’s policy was of no, not just short, duration.

Second, entry considerations suggested an absence of anticompetitive harm here.  If entry into a market is easy, there is little need to worry that exclusionary conduct will produce market power.  Once the monopolist begins to exercise its power by reducing output and raising price, new entrants will appear on the scene, driving price and output back to competitive levels.  The recent and successful entry of both Star and Sigma, who collectively gained about half the total market share within a short period of time, suggested that entry into the domestic pipe fittings market is easy.

Finally, evidence of actual market performance indicated that McWane’s exclusive dealing policies did not generate anticompetitive effect.  McWane enforced its full support program for the first year of Star’s participation in the domestic fittings market, but not thereafter.  Star’s growth rate, however, was identical before and after McWane stopped enforcing the program.  According to Commissioner Wright, “Neither Complaint Counsel nor the Commission attempt[ed] to explain how growth that is equal with and without the Full Support Program is consistent with Complaint Counsel’s theory of harm that the Program raised Star’s costs of distribution and impaired competition.  The most plausible inference to draw from these particular facts is that the Full Support Program had almost no impact on Star’s ability to enter and grow its business, which, under the case law, strongly counsels against holding that McWane’s conduct was exclusionary.”

***

Because antitrust exists to protect competition, not competitors, an antitrust complainant cannot base a claim of monopolization on the mere fact that its business was injured by the defendant’s conduct.  By the same token, a party complaining of unreasonably exclusionary conduct also ought not to prevail simply because it made self-serving assertions that it would have had more business but for the defendant’s action and would have had lower per-unit costs if it had more business.  If the antitrust is to remain a consumer-focused body of law, claims like Star’s should fail.  Hopefully, Commissioner Wright’s FTC colleagues will eventually see that point.

In our recent blog symposium on Section 5 of the FTC Act, Latham & Watkins partner Tad Lipsky exposed one of antitrust’s dark little secrets: Nobody really knows what Sherman Act Section 2 forbids.  The provision bans monopolization, attempted monopolization, and conspiracies to monopolize, and courts have articulated formal elements for each claim.  But the element common to the two unilateral offenses—“exclusionary conduct”—remains essentially undefined.  Lipsky writes:

123 years of Section 2 enforcement and the best our Supreme Court can do is the Grinnell standard, defining [exclusionary conduct] as the “willful acquisition or maintenance of [monopoly] power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.”  Is this Grinnell definition that much better than [Section 5’s reference to] “unfair methods of competition”?

No, it’s not.  Nor are any of the other commonly cited judicial definitions of exclusionary conduct, such as “competition not on the merits.”  As Einer Elhauge has observed, such judicial definitions are not just vague but vacuous.

This is problematic because business planners need clarity.  On some specific unilateral practices—straightforward price cuts and aggressive input-bidding, for example—courts have provided clear liability rules and safe harbors.  But in a dynamic economy, business people are constantly coming up with new ideas for sales-enhancing practices that might have the effect of disadvantaging rivals, of “excluding” them from the market.  Absent some general understanding of what constitutes an “unreasonably exclusionary” act, business people are likely to forego novel but efficient sales-enhancing practices, to the detriment of consumers.

In the last decade or so, commentators have proposed four generally applicable definitions of unreasonably exclusionary conduct.  Judge Posner suggested that such conduct be defined as acts that could exclude an “equally efficient rival” from the perpetrator’s market (the “EER” approach).  Post-Chicago theorists would equate unreasonably exclusionary conduct with unjustifiably “raising rivals’ costs” (the “RRC” approach).  The Areeda-Hovenkamp treatise prescribes a balancing of the “consumer welfare effects” resulting from the practice at issue (“CWE-balancing”).  And the U.S. Department of Justice has called for defining unreasonably exclusionary conduct as that which would make “no economic sense” apart from its tendency to enhance market power (the “NES” test, or “NEST”).

Each of these approaches, it turns out, is troubling.  The EER approach is underdeterrent in that it fails to condemn practices that cause rivals to be less efficient than the perpetrator.  The RRC, CWE-balancing, and NEST approaches turn out to be difficult to apply—and largely indeterminate—for any exclusion-causing conduct involving “degrees.” For example, a 15% loyalty rebate conditioned upon purchasing 70% of one’s requirements from the defendant requires a certain “degree” of loyalty and provides a certain “degree” of price reduction.  It might well turn out that some degree of required loyalty (e.g., the increment from 60% to 70%) or some degree of discount (e.g., the increment from 10% to 15%) either (1) raised rivals’ costs unjustifiably (RRC) or (2) created greater consumer harm than benefit (CWE-balancing) or (3) made no economic sense but for its ability to enhance market power (NEST).  Because the RRC, CWE-balancing, and NEST approaches appear to require marginal analysis of exclusion-causing conduct, they become fairly inadministrable and indeterminate when applied to conduct involving degrees, a category that includes most of the novel conduct for which a generally applicable exclusionary conduct definition would be useful.  Because they provide little guidance and no reliable safe harbors, the RRC, CWE-balancing, and NEST approaches are likely to overdeter efficient, but novel, business practices.

In light of these and other difficulties with the proposed exclusionary conduct definitions, a number of scholars now advocate abandoning the search for a generally applicable definition and applying different liability standards to different types of behavior.  Eschewal of universal standards, though, is also troubling.  To the extent non-universalists are saying that there is no single definition of unreasonably exclusionary conduct—no common thread that runs through all instances of unreasonable exclusion—their position seems to violate rule of law norms.  After all, the Court has told us that unreasonably exclusionary conduct is an element of monopolization and attempted monopolization.  That means that the exclusionary conduct component of all Section 2 offenses must share something in common; otherwise, the “element” would consist of a non-exhaustive menu of unrelated features and would cease to be an element.

A less extreme “non-universalist” approach would concede that there is a single definition of unreasonably exclusionary conduct—that which reduces overall consumer welfare—but hold that there should be no universal test for identifying when a particular practice runs afoul of the definition.  This more defensible position resembles “rule utilitarianism” in ethical theory.  Rule utilitarians concede that morality is ultimately concerned with utility-maximization, but they would judge the morality of any particular act not on the basis of its actual consequences but instead according to whether it complies with a rule selected to maximize utility.  Similarly, “soft” non-universalists would select liability tests for particular business practices on the basis of whether those tests maximize overall consumer welfare, but they would evaluate particular instances of exclusion-causing behavior on the basis of whether they comply with applicable liability tests, not whether they actually enhance consumer welfare.

Because it reduces to a version of CWE-balancing (though at the rule level rather than the act level), “soft” non-universalism is subject to the same criticisms as CWE-balancing in general: it is difficult to apply and indeterminate.  Indeed, under a soft non-universal approach, a business planner considering a novel but efficient exclusion-causing practice would first have to predict the liability rule a reviewing court would adopt for the practice under consideration and then apply that rule.  Talk about a lack of clarity and reliable safe harbors!

I have recently authored a paper that critiques the proposed definitions of unreasonably exclusionary conduct as well as the non-universalist approaches discussed above and, finding each position deficient, proposes an alternative approach.  My approach would deem conduct to be unreasonably exclusionary if it would likely exclude from the perpetrator’s market a “competitive rival,” defined as a rival that is both as determined as the perpetrator and capable, at minimum efficient scale, of matching the perpetrator’s efficiency.  This “exclusion of a competitive rival” approach, the paper demonstrates, identifies a common thread running through instances of unreasonable exclusion, comports with prevailing intuitions about what constitutes appropriate competition, generates clear guidance and reliable safe harbors, and would minimize the sum of decision and error costs resulting from monopolization doctrine.

A draft of the paper, which is slated to appear as an article in the North Carolina Law Review, is available on SSRN.  Please download, and let me know if you have any comments.

Dan’s final post responding to Steve’s latest postOther posts in the series: DanSteveDanSteveDan, and Thom.

It seems that it’s time to wind down and that a further tit-for-tat might not be productive, so I’ll close with a final comment on the first point that Steve makes—one that may undergird much of our disagreement.  Steve asserts that “the $71 payment would fail a test of comparing the rival’s price and cost, but that it is not the test.  The test compares the monopolist’s price and cost.”  That would only be true if we were applying an unmodified predatory pricing rule to loyalty rebates—a position that I’ve never advocated in these posts are elsewhere.  If we applied the attribution test that Steve and I have been assuming, the question would be whether the rival could profitably remain in the market given the price it would have to charge to neutralize the effect of the monopolist’s rebate operating at the contestable share and scale.  And, since Steve and I have now agreed that using the rival’s rather than the monopolist’s costs is admissible if we don’t insist on an EEC component, then my statement that the $71 could fail the price-cost screen is accurate.  But if the effective price the rival would have to meet were $69 and not $71, there wouldn’t be any foreclosure—which is why the screen makes sense.

Thanks, Steve, for this impromptu exchange.  I hope that both our fair points and grievous errors have been educational to ourselves and to others.

Steve’s next, perhaps final, installment, responding to Dan’s latest post on the appropriate liability rule for loyalty discounts. Other posts in the series: SteveDanSteveDan, and Thom.

My invitation comes with several hopefully final observations.

(1) Dan says, “There’s neither input foreclose nor output foreclosure if a rival can neutralize a loyalty discount without pricing unprofitably.”  My examples showed several reasons why an equally efficient rival may not be able to overcome a loyalty discount to get distribution, even if the monopolist does not violate the price-cost test.  Dan’s response to my #3(a) example is that “a discount structure that would require the entrant to pay rebates of $71 even while earning revenues of $70, then the rebate system would fail the price-cost screen.” That is not a good answer for three reasons.  First, the monopolist’s profits pre-entry absent the rebate are $200, and Dan uses the pre-entry situation as the base.  Second, the $71 payment would fail a test of comparing the rival’s price and cost, but that it is not the test.  The test compares the monopolist’s price and cost.   Third, if Dan now wants to use as the base the “but-for world” where the former-monopolist would earn only $70 because he would have lowered price in response to the entrant absent the loyalty discount, then he is accepting the “penalty price” scenario, which he elsewhere rejected as unlikely.  So, Dan has to make up his mind on this last point.  And the price-cost test is defective either way.

(2) Dan says, “Steve posits ‘that economic analysis is the same’ for loyalty discounts and contractual commitments not to buy from rivals.  Really?”  The short answer is “Yes.”  As Dan observes himself, “at a high level of generality one would say that in both cases the question is whether the price or contract forecloses competitors.”  By the way, a small rebate certainly will not always exclude.  But, see #3(b) in my previous post, which is a pretty general example of why the rival often would just give up rather than get involved in a bidding war for distribution.  Dan never explain what he thinks is wrong with this example.

(3) Dan says, “Steve presents four examples of how an auction for contractual exclusivity results in a single firm obtaining contractual exclusivity with anticompetitive effects due to asymmetry of incentives, all of which begs the question of how loyalty discounts without contractual exclusivity achieve the same effect.”  I assumed no contract.  Nor is a formal auction required.  The monopolist simply can unilaterally offer a high enough bid that the entrant walks away.  And in the #3(b) example, the unilateral bid does not even need to be very high.

(4) Dan says, “The monopolist is not saved from profit sacrifice, as Steve posits, merely by threatening a price of $105 that it never has to charge.”  Why not?  The monopolist never sells any units at $105 when the threat succeeds.  And, given Dan’s model, it will succeed against an equally efficient competitor.  With adequate information, it is neither expensive nor risky.  If Dan is going to rely on it being “expensive and risky,” then he is changing his story.  More importantly, he also is opining it should be permissible for a well-informed monopolist to exclude with penalty pricing threats because poorly informed monopolists may not follow the same strategy.  That does not make sense.   He also does not provide any evidence about how well informed most monopolists who engage in loyalty discounts typically are.

(5) Dan says, “Finally, let me underline as I did in my last post that I’m not claiming that “penalty pricing” is economically impossible.  Rather, …we should therefore not assume that it will be routinely deployed, and that the starting presumption should be that most loyalty discounts are true reductions from the but-for price.”  I do not have to assume penalties will be “routinely deployed.”   It was only one of my several fatal problems with the price-cost test.  But, in terms of the evidence, what is the evidence that the typical loyalty discount by a monopolist or firm with substantial market power are true reductions from the but-for price.  Reliable presumptions need to be more than simply reflections of one’s ideology.

(6) I want to conclude by observing that modern day courts do not need the defective price-cost test to protect monopolists.  Remember that the rival must prove consumer injury.  That is a high burden to carry and some of the factors Dan mentions might throw light on that bottom line issue.  Neither Josh nor I are claiming that loyalty discounts should be per se illegal.  So, Dan, come on over to the rule of reason.