Archives For tying

[I am participating in an online “debate” at the American Constitution Society with Professor Ben Edelman.  The debate consists of an opening statement and concluding responses to be posted later in the week.  Professor Edelman’s opening statement is here.  I am cross-posting my opening statement here at TOTM.  This is my closing statement]

Professor Edelman’s opening post does little to support his case.  Instead, it reflects the same retrograde antitrust I criticized in my first post.

Edelman’s understanding of antitrust law and economics appears firmly rooted in the 1960s approach to antitrust in which enforcement agencies, courts, and economists vigorously attacked novel business arrangements without regard to their impact on consumers.  Judge Learned Hand’s infamous passage in the Alcoa decision comes to mind as an exemplar of antitrust’s bad old days when the antitrust laws demanded that successful firms forego opportunities to satisfy consumer demand.  Hand wrote:

we can think of no more effective exclusion than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel.

Antitrust has come a long way since then.  By way of contrast, today’s antitrust analysis of alleged exclusionary conduct begins with (ironically enough) the U.S. v. Microsoft decision.  Microsoft emphasizes the difficulty of distinguishing effective competition from exclusionary conduct; but it also firmly places “consumer welfare” as the lodestar of the modern approach to antitrust:

Whether any particular act of a monopolist is exclusionary, rather than merely a form of vigorous competition, can be difficult to discern: the means of illicit exclusion, like the means of legitimate competition, are myriad.  The challenge for an antitrust court lies in stating a general rule for distinguishing between exclusionary acts, which reduce social welfare, and competitive acts, which increase it.  From a century of case law on monopolization under § 2, however, several principles do emerge.  First, to be condemned as exclusionary, a monopolist’s act must have an “anticompetitive effect.”  That is, it must harm the competitive process and thereby harm consumers.  In contrast, harm to one or more competitors will not suffice.

Nearly all antitrust commentators agree that the shift to consumer-welfare focused analysis has been a boon for consumers.  Unfortunately, Edelman’s analysis consists largely of complaints that would have satisfied courts and agencies in the 1960s but would not do so now that the focus has turned to consumer welfare rather than indirect complaints about market structure or the fortunes of individual rivals.

From the start, in laying out his basic case against Google, Edelman invokes antitrust concepts that are simply inapt for the facts and then goes on to apply them in a manner inconsistent with the modern consumer-welfare-oriented framework described above:

In antitrust parlance, this is tying: A user who wants only Google Search, but not Google’s other services, will be disappointed.  Instead, any user who wants Google Search is forced to receive Google’s other services too.  Google’s approach also forecloses competition: Other sites cannot compete on their merits for a substantial portion of the market – consumers who use Google to find information – because Google has kept those consumers for itself.

There are two significant errors here.  First, Edelman claims to be interested in protecting users who want only Google Search but not its other services will be disappointed.  I have no doubt such consumers exist.  Some proof that they exist is that a service has already been developed to serve them.  Professor Edelman, meet Googleminusgoogle.com.  Across the top the page reads: “Search with Google without getting results from Google sites such as Knol, Blogger and YouTube.”  In antitrust parlance, this is not tying after all.  The critical point, however, is that user preferences are being satisfied as one would expect to arise from competition.

The second error, as I noted in my first post, is to condemn vertical integration as inherently anticompetitive.  It is here that the retrograde character of Professor Edelman’s analysis (and other critics of Google, to be fair) shines brightest.  It reflects a true disconnect between the 1960s approach to antitrust which focused exclusively upon market structure and impact upon rival websites; impact upon consumers was nowhere to be found.  That Google not only produces search results but also owns some of the results that are searched is not a problem cognizable by modern antitrust.  Edelman himself—appropriately—describes Google and its competitors as “information services.”  Google is not merely a URL finder.  Consumers demand more than that and competition forces search engines to deliver.  It offers value to users (and thus it can offer users to advertisers) by helping them find information in increasingly useful ways.  Most users “want Google Search” to the exclusion of Google’s “other services” (and, if they do, all they need do is navigate over to http://googleminusgoogle.com/ (even in a Chrome browser) and they can have exactly that).  But the critical point is that Google’s “other services” are methods of presenting information to consumers, just like search.  As the web and its users have evolved, and as Google has innovated to keep up with the evolving demands of consumers, it has devised or employed other means than simply providing links to a set of URLs to provide the most relevant information to its users.  The 1960s approach to antitrust condemns this as anticompetitive foreclosure; the modern version recognizes it as innovation, a form of competition that benefits consumers.

Edelman (and other critics, including a number of Senators at last month’s hearing) hearken back to the good old days and suggest that any deviation from Google’s technology or business model of the past is an indication of anticompetitive conduct:

The Google of 2004 promised to help users “leave its website as quickly as possible” while showing, initially, zero ads.  But times have changed.  Google has modified its site design to encourage users to linger on other Google properties, even when competing services have more or better information.  And Google now shows as many fourteen ads on a page.

It is hard to take seriously an argument that turns on criticizing a company simply for looking different than it did seven years ago.  Does anybody remember what search results looked like 7 years ago?  A theory of antitrust liability that would condemn a firm for investing billions of dollars in research and product development, constantly evolving its product to meet consumer demand, taking advantage of new technology, and developing its business model to increase profitability should not be taken seriously.  This is particularly true where, as here, every firm in the industry has followed a similar course, adopting the same or similar innovations.  I encourage readers to try a few queries on http://www.bing-vs-google.com/– where you can get side by side comparisons – in order to test whether the evolution of search results and innovation to meet consumer preferences is really a Google-specific thing or an industry wide phenomenon consistent with competition.  Conventional antitrust analysis holds that when conduct is engaged in not only by allegedly dominant firms, but also by every other firm in an industry, that conduct is presumptively efficient, not anticompetitive.

The main thrust of my critique is that Edelman and other Google critics rely on an outdated antitrust framework in which consumers play little or no role.  Rather than a consumer-welfare based economic critique consistent with the modern approach, these critics (as Edelman does in his opening statement) turn to a collection of anecdotes and “gotcha” statements from company executives.  It is worth correcting a few of those items here, although when we’ve reached the point where identifying a firm’s alleged abuse is a function of defining what a “confirmed” fax is, we’ve probably reached the point of decreasing marginal returns.  Rest assured that a series of (largely inaccurate) anecdotes about Google’s treatment of particular websites or insignificant contract terms is wholly insufficient to meet the standard of proof required to make a case against the company under the Sherman Act or even the looser Federal Trade Commission Act.

  • It appears to be completely inaccurate to say that “[a]n unsatisfied advertiser must complain to Google by ‘first class mail or air mail or overnight courier’ with a copy by ‘confirmed facsimile.’”  A quick search, even on Bing, leads one to this page, indicating that complaints may be submitted via web form.
  • It is likewise inaccurate to claim that “advertisers are compelled to accept whatever terms Google chooses to impose.  For example, an advertiser seeking placement through Google’s premium Search Network partners (like AOL and The New York Times) must also accept placement through the entire Google Search Network which includes all manner . . . undesirable placements.”  In actuality, Google offers a “Site and Category Exclusion Tool” that seems to permit advertisers to tailor their placements to exclude exactly these “undesirable placements.”
  • “Meanwhile, a user searching for restaurants, hotels, or other local merchants sees Google Places results with similar prominence, pushing other information services to locations users are unlikely to notice.”  I have strived in vain to enter a search for a restaurant, hotel, or the like into Google that yielded results that effectively hid “other information services” from my notice, but for some of my searches, Google Places did come up first or second (and for others it showed up further down the page).
  • Edelman has noted elsewhere that, sometimes, for some of the searches he has tested, the most popular result on Google (as well, I should add, on other, non-“dominant” sites) is not the first, Google-owned result, but instead the second.  He cites this as evidence that Google is cooking the books, favoring its own properties when users actually prefer another option.  It actually doesn’t demonstrate that, but let’s accept the claim for the sake of argument.  Notice what his example also demonstrates: that users who prefer the second result to the first are perfectly capable of finding it and clicking on it.  If this is foreclosure, Google is exceptionally bad at it.

The crux of Edelman’s complaint seems to be that Google is competing in ways that respond to consumer preferences.  This is precisely what antitrust seeks to encourage, and we would not want a set of standards that chilled competition because of a competitor’s success.  Having been remarkably successful in serving consumers’ search demands in a quickly evolving market, it would be perverse for the antitrust laws to then turn upon Google without serious evidence that it had, in fact, actually harmed consumers.

Untethered from consumer welfare analysis, antitrust threatens to re-orient itself to the days when it was used primarily as a weapon against rivals and thus imposed a costly tax on consumers.  It is perhaps telling that Microsoft, Expedia, and a few other Google competitors are the primary movers behind the effort to convict the company.  But modern antitrust, shunning its inglorious past, requires actual evidence of anticompetitive effect before condemning conduct, particularly in fast-moving, innovative industries.  Neither Edelman nor any of Google’s other critics, offer any.

During the heady days of the Microsoft antitrust case, the big question was whether modern antitrust would be able to keep up with quickly evolving markets.  The treatment of the proferred case against Google is an important test of the proposition (endorsed by the Antitrust Modernization Commission and others) that today’s antitrust is capable of consistent and coherent application in innovative, high-tech markets.  An enormous amount is at stake.  Faced with the high stakes and ever-evolving novelty of high-tech markets, antitrust will only meet this expectation if it remains grounded and focused on the core principle of competitive effects and consumer harm.  Without it, antitrust will devolve back into the laughable and anti-consumer state of affairs of the 1960s—and we will all pay for it.

Have you ever had to get on your hands and knees at Office Depot to find precisely the right printer cartridge?  It’s maddening, no?  Why can’t the printer manufacturers just settle on a single design configuration, the way lamp manufacturers use common light bulbs?

You might think the printer manufacturer is trying to enhance its profits simply by forcing you to buy two of its products (the printer + the manufacturer’s own ink cartridge) rather than one (just the printer).  But that story is wrong (or, at best, incomplete).  Printers tend to be sufficiently brand-differentiated to enable manufacturers to charge a price above their marginal cost.  Ink, by contrast, is more like a commodity, so competition among ink manufacturers should drive price down near the level of marginal cost.  A printer manufacturer could fully exercise its market power over its printer – i.e., its ability to profitably charge a printer price that exceeds the printer’s cost — by raising the price of its printer alone.  It could not enhance its profits by charging that price and then requiring purchasers to buy its ink cartridge at some above-cost price.  Consumers would view the requirement to purchase the manufacturer’s “supracompetitively priced” ink cartridge as tantamount to an increase in the price of the printer itself, so the manufacturer’s tie-in would effectively raise the printer price above profit-maximizing levels (i.e., profits would fall, despite the higher effective price, because too many “marginal” consumers — those who value the manufacturer’s printer the least – would curtail their purchases).

If printer buyers consume multiple ink cartridges, though, a printer manufacturer may enhance its profits by tying its printer and its ink cartridges in an attempt to price discriminate among consumers.  The manufacturer would lower its printer price from the profit-maximizing level to some level closer to (but still at or above) its cost, raise the price of its ink cartridge above the competitive level (which should approximate its marginal cost), and require purchasers of its printer to use the manufacturer’s (supracompetitively priced) ink cartridges.  This tack enables the manufacturer to charge higher effective prices to high-intensity users, who are likely to value the printer the most, and lower (but still above-cost) prices to low-intensity users, who likely value the printer the least.  Economists call this sort of tying arrangement a “metering tie-in” because it aims to meter demand for the seller’s tying product (the printer) and charge an effective price that corresponds to a buyer’s likely willingness to pay.

When a seller imposes a metering tie-in, higher-intensity consumers get less “surplus” from their purchases (the difference between their outlays and the amount by which they value what they’re buying), but total market output tends to increase, as the manufacturer sells printers to some buyers who value the printer below the amount the manufacturer would charge for the printer alone (i.e., the profit-maximizing, single-product price).

In his recent high-profile article, Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory, Professor Einer Elhauge contends that metering tie-ins like the one described above tend to reduce total and consumer welfare.  He maintains that tie-ins of the type described are a form of welfare-reducing “third-degree” price discrimination.  He illustrates his point using a stylized example involving a printer manufacturer who sells consumers up to three ink cartridges. 

In a response to Professor Elhauge’s interesting article, I attempted to show that his welfare analysis turns on his assumption that printer buyers use only 1, 2, or 3 ink cartridges.  I demonstrated that Professor Elhauge’s hypo generates a different outcome – even assuming that this sort of metering tie-in is “third-degree” price discrimination — if ink cartridges are smaller, so that high-intensity consumers purchase 4 or more ink cartridges.

In some very helpful comments on my forthcoming response article, Professor Herbert Hovenkamp observed that there is a bigger problem with Elhauge’s analysis:  It assumes that the price discrimination here is third-degree price discrimination, when in fact it is second-degree price discrimination.

Below the fold, I discuss Elhauge’s analysis, my initial response (which remains valid), and the more fundamental problem Hovenkamp observed.  (And for those interested, please download my revised response article, which now contains both my original and Hovenkamp’s arguments.) Continue Reading…

Josh, Berin Szoka and I have a new op-ed up at CNET on why the lessons of Microsoft suggest the FTC’s action against Google might be misguided.  A taste:

Ten years ago this week, an appeals court upheld Microsoft’s conviction for monopolizing the PC operating system market. The decision became a key legal precedent for U.S. antitrust enforcement. It also cemented the government’s confidence in its ability to pick winners and losers in fast-moving technology markets–a confidence not borne out by subsequent events.

Now this sad history seems to be repeating itself: By uncanny coincidence, news broke just last Friday that the FTC had begun an antitrust investigation into Google’s business practices. Unfortunately, there’s no reason to expect the outcome to be any better for consumers this time around.

There is, in fact, no evidence that the case against Microsoft or its settlement contributed to the spectacular innovation in the IT sector over the last decade. Indeed, they may even have solidified Microsoft’s role as the perennial also-ran in this latest wave of technological progress, as the company struggled to keep innovating under the threat of constant antitrust scrutiny in the U.S. and abroad.

The true lesson of the Microsoft case is this: antitrust intervention in information technology has a poor track record of serving consumers. Even Harvard law professor Lawrence Lessig, who was a court-appointed Special Master in that case and has since championed government tinkering with the Internet, finally admitted in 2007 that he “blew it on Microsoft” by underestimating the potential for innovation and market forces to dethrone Microsoft, particularly through the rise of open-source software (which now in part powers Apple’s popular iOS).

No surprise here.  The WSJ announced it was coming yesterday, and today Google publicly acknowledged that it has received subpoenas related to the Commission’s investigation.  Amit Singhal of Google acknowledged the FTC subpoenas at the Google Public Policy Blog:

At Google, we’ve always focused on putting the user first. We aim to provide relevant answers as quickly as possible—and our product innovation and engineering talent have delivered results that users seem to like, in a world where the competition is only one click away. Still, we recognize that our success has led to greater scrutiny. Yesterday, we received formal notification from the U.S. Federal Trade Commission that it has begun a review of our business. We respect the FTC’s process and will be working with them (as we have with other agencies) over the coming months to answer questions about Google and our services.

It’s still unclear exactly what the FTC’s concerns are, but we’re clear about where we stand. Since the beginning, we have been guided by the idea that, if we focus on the user, all else will follow. No matter what you’re looking for—buying a movie ticket, finding the best burger nearby, or watching a royal wedding—we want to get you the information you want as quickly as possible. Sometimes the best result is a link to another website. Other times it’s a news article, sports score, stock quote, a video or a map.

It is too early to know the precise details of the FTC’s interest.  However, We’ve been discussing various aspects of the investigation here at TOTM for the last year.  Indeed, we’ve written two articles focused upon framing and evaluating a potential antitrust case against Google as well as the misguided attempts to use the antitrust laws to impose “search neutrality.”  We’ve also written a number of blog posts on Google and antitrust (see here for an archive).

For now, until more details become available, it strikes us that the following points should be emphasized:

  • For several reasons, the Federal Trade Commission’s investigation into Google’s business practices seems misguided from the perspective of competition policy directed toward protecting consumer welfare.  We hope and expect that the agency will conclude its investigation quickly and without any enforcement action against the company.  But it is important to note that this is merely an investigation–and at that, one that is not necessarily new.  More importantly, it is not a full-fledged enforcement action, much less a successful one; and although such investigations are extraordinarily costly for their targets, there is not yet (and there may never be) even any allegation of liability inherent in an investigation.
  • In any such case, the focus of concern must always be on consumer harm–not harm to certain competitors.  This is a well known antitrust maxim, but it is certainly appropriately applied here.  We are skeptical that consumer harm is present in this case, and our writings have explored this issue at length.  In brief, Google of today is not the Microsoft of 1998, and the issues and circumstances that gave rise to liability in the Microsoft case are uniformly absent here.
  • Related, most of the claims we have seen surrounding Google’s conduct here are of the vertical sort–where Google has incorporated (either by merger, business development or technological development) and developed new products or processes to evolve its basic search engine in novel ways by, for instance, offering results in the form of maps or videos, or integrating travel-related search results into its traditional offerings.  As we’ve written, these sorts of vertical activities are almost always pro-competitive, despite claims to the contrary by aggrieved competitors, and we should confront such claims with extreme skepticism.   Vertical claims instigated by rivals are historically viewed with skepticism in antitrust circles.  Failing to subject these claims to scrutiny focused on consumer welfare risks would be a mistake whose costs would be borne largely by consumers.
  • The fact that Google’s rivals–including most importantly Microsoft itself–are complaining about the company is, ironically, some of the very best evidence that Google’s practices are in fact pro-consumer and pro-competitive.  It is always problematic when competitors use the regulatory system to try to hamstring their rivals, and we should be extremely wary of claims arising from such conduct.
  • We are also troubled by statements emanating from FTC Commissioners suggesting that the agency intends to pursue this case as a so-called “Section 5” case rather than the more traditional “Section 2” case.  We will have to wait to see whether any complaint is actually brought and, if so, under what statutory authority, but a Section 5 case against Google raises serious concerns about effective and efficient antitrust enforcement.  Commissioner Rosch has claimed that Section 5 could address conduct that has the effect of “reducing consumer choice”—an effect that some commentators support without requiring any evidence that the conduct actually reduces consumer welfare.  Troublingly, “reducing consumer choice” seems to be a euphemism for “harm to competitors, not competition,” where the reduction in choice is the reduction of choice of competitors who may be put out of business by pro-competitive behavior.  This would portend an extremely problematic shift in direction for US antitrust law.

Together Geoffrey Manne and Joshua Wright are the authors of two articles on the antitrust law and economics of Google and search engines more broadly, Google and the Limits of Antitrust: The Case Against the Case Against Google, and If Search Neutrality Is the Answer, What’s the Question?

Manne is also the author of “The Problem of Search Engines as Essential Facilities: An Economic & Legal Assessment,” an essay debunking arguments for regulation of search engines to preserve so-called “search neutrality” in TechFreedom’s 2011 book, The Next Digital Decade: Essays on the Future of the Internet.

Among our recent blog posts on the topic are the following:

What’s Really Motivating the Pursuit of Google

Barnett v. Barnett on Antitrust

Sacrificing Consumer Welfare in the Search Bias Debate

Type I Errors in Action, Google Edition

Google, Antitrust, and First Principles

Microsoft Comes Full Circle

Search Bias and Antitrust

The EU Tightens the Noose Around Google

When Google’s Competitors Attack

Antitrust Karma, The Microsoft-Google Wars, and a Question for Rick Rule

DOJ Gears Up to Challenge the Proposed Google ITA Merger

The Ninth Circuit recently issued a decision that pushes the doctrine governing tying in the right direction.  If appealed, the decision could provide the Roberts Court with an opportunity to do for tying what its Leegin decision did for resale price maintenance:  reduce error costs by bringing an overly prohibitory liability rule in line with economic learning.  First, some background on the law and economics of tying.  Then, a little about the Ninth Circuit’s decision.  

Some Background on the Law and Economics of Tying

Tying (or a “tie-in”) occurs when a monopolist sells its monopoly “tying” product on the condition that the buyer also purchase some “tied” product.  Under prevailing doctrine, tying  is per se illegal if: (1) the tie-in involves two truly separate products (e.g., a patented printer and unpatented ink, not a left shoe and a right shoe), (2) the seller possesses monopoly power over the tying product, and (3) the tie-in affects a “not insubstantial” dollar volume (not share) of commerce in the tied product market (e.g., $50,000 or so will suffice). 

Scholars from both the Chicago and Harvard Schools of antitrust analysis (including yours truly) have argued that this rule is too prohibitory and that tie-ins should be condemned only when they foreclose a substantial percentage of sales opportunities in the tied product market.  This sort of rule of reason approach, we maintain, would prevent liability for tie-ins that could not possibly be anticompetitive and would align tying doctrine with the liability rule governing tying’s close cousin, exclusive dealing.  The governing per se rule, we contend, is a relic of the days when courts believed that a monopolist could immediately earn two monopoly profits by tying in a separate product and charging both a supracompetitive price for that tied product and the monopoly price for its monopoly product.  This so-called leverage theory has been debunked.  (Consumers will view the supracompetitive tied product price as an increase in the price of the tying product, which will push the tying product price above the profit-maximizing level and cause the seller to lose profits.  In short, there is only one monopoly profit to exploit, and the seller can do so by charging its profit-maximizing monopoly price for the monopoly product alone.) 

A couple of years ago, Harvard Law’s Einer Elhauge published a much-discussed article arguing that we critics of current tying doctrine are wrong.  Prevailing doctrine, Elhauge argued, is appropriate because tie-ins can cause anticompetitive effects even if they do not occasion substantial tied market foreclosure.  In particular, a tie-in can permit a seller to price discriminate among consumers and thereby extract a greater proportion of the trade surplus for itself.  For example, in a variable proportion tie-in (one where there is no fixed ratio between the number of tying and tied units purchased, as when a buyer of a printer is required to purchase all his ink requirements from the printer seller), the seller can price discriminate by tying in a complement (ink) whose consumption corresponds to the degree to which consumers value the tying product (e.g., consumers who most value the printer likely buy lots of ink).  By lowering the price of the tying product (the printer) from monopoly levels and charging a supracompetitive price for the tied product (the ink), the seller can effectively charge higher prices to consumers who value the tying product more, thereby capturing more surplus for itself.  Elhauge argues (incorrectly, as I show in this article) that this is an anticompetitive effect.

A second form of “anticompetitive” price discrimination, Elhauge contends, may result from fixed proportion tie-ins of products for which demand is not positively correlated.  George Stigler provided the classic example of this dynamic in his discussion of the Loew’s case, which involved the block booking of feature films (i.e., selling the films only in packages). 

Suppose, for example, that a firm has two customers, A and B; that A values product X at $8,000 and product Y at $2,500; and that B values product X at $7,000 and product Y at $3,000.  (For simplicity’s sake, assume that the marginal cost of both products is zero.)  If the firm were to sell the products separately, it would charge $7,000 for X and $2,500 for Y, and it would earn profits of $19,000 ($9,500 x 2).  By tying the products together and selling them as a bundle, the seller can charge a total of $10,000 per customer, an amount less than or equal to each customer’s reservation price for the package, thereby earning profits of $20,000.  While each consumer is charged the same amount for the package, the pricing is in some sense discriminatory, for the seller effectively discriminates against A, the low-elasticity X buyer, on A’s purchase of X and against B, the low-elasticity Y buyer, on B’s purchase of Y.  (This is because, absent the tying of X and Y, A would have enjoyed surplus of $1,000 on X but no surplus on Y, and B would have enjoyed surplus of $500 on Y but no surplus on X.)  By engaging in this sort of price discrimination, the seller may enhance its profits for, as Judge Posner explains, “When the products are priced separately, the price is depressed by the buyer who values each one less than the other buyer does; the bundling eliminates this effect.”

According to Elhauge, the sort of price discrimination/surplus extraction occasioned by “Stigler-type” tying, like the price discrimination resulting from a variable proportion “metering” tie-in, is anticompetitive and justifies the prevailing liability rule against tying.  In a subsequent post, I will explain why Elhauge is wrong and why Stigler-type price discrimination is output-enhancing and thus procompetitive.  For now, though, let’s consider the Ninth Circuit’s recent case, which rejected Elhauge’s view.

The Ninth Circuit’s Recent Brantley Decision

Brantley, et al. v. NBC Universal, Inc., et al., involved a challenge by cable television subscribers to T.V. programmers’ practice of selling cable channels only in packages.  The plaintiffs, who preferred to purchase individual channels a la carte, maintained that the programmers’ policy violated Sherman Act Section 1.  As the Ninth Circuit correctly recognized, the arrangement really amounted to tying, for the programmers would sell their “must have” channels only if subscribers would also take other, less desirable channels.  (Indeed, the practice is closely analogous to the block booking at issue in Loew’s, where the distributor required that licensees of popular films also license flops.)

The district court dismissed plaintiffs’ first complaint without prejudice on the ground that plaintiffs failed to allege that their injuries (purportedly higher prices) were caused by an injury to competition.  Plaintiffs then amended their complaint to include an allegation “that Programmers’ practice of selling bundled cable channels foreclosed independent programmers from entering and competing in the upstream market for programming channels.”  In other words, plaintiffs alleged, the tying at issue occasioned substantial tied market foreclosure.

After conducting some discovery, plaintiffs decided to abandon that theory of harm.  They prepared a new complaint that omitted all market foreclosure allegations and asked the court to rule “that plaintiffs did not have to allege that potential competitors were foreclosed from the market in order to defeat a motion to dismiss.”  Defendants again sought to dismiss the complaint.  The district court, reasoning that the plaintiffs had failed to allege any cognizable injury to competition, granted defendants’ motion to dismiss, and plaintiffs appealed.

Given this procedural posture, the Ninth Circuit starkly confronted whether, as Elhauge maintains, the price discrimination/surplus extraction inherent in Stigler-type bundling is an “anticompetitive” effect that warrants liability.  In affirming the district court and holding that plaintiffs’ claims of higher prices were not enough to establish anticompetitive harm, it effectively held, as I and a number of others have urged, that there should be no tying liability absent substantial tied market foreclosure.

This holding, while correct as a policy matter, seems to conflict with the Supreme Court’s quasi-per se rule.  That rule assigns automatic liability if the tie-in involves multiple products (it did here), the seller has monopoly power over the tying product (it did here), and the tie-in involves a not insubstantial dollar volume of commerce in the tied product market (it did here).  Thus, the Ninth Circuit has provided the Supreme Court  with a perfect opportunity to revisit the liability rule governing tying. 

I for one am hoping that the Brantley plaintiffs appeal and that the Supreme Court agrees to take the case and reconsider the prerequisites to tying liability.  If it does so, I predict that it will overrule its Jefferson Parish decision, jettison the quasi-per se rule against tying, and hold that there can be no tying liability absent substantial foreclosure of marketing opportunities in the tied product market.

In recent years, antitrust scholars have largely agreed on a couple of propositions involving tying and bundled discounting. With respect to tying (selling one’s monopoly “tying” product only on the condition that buyers also purchase another “tied” product), scholars from both the Chicago and Harvard Schools of antitrust analysis have generally concluded that there should be no antitrust liability unless the tie-in results in substantial foreclosure of marketing opportunities in the tied product market. Absent such foreclosure, scholars have reasoned, truly anticompetitive harm is unlikely to occur. The prevailing liability rule, however, condemns tie-ins without regard to whether they occasion substantial tied market foreclosure.

With respect to bundled discounting (selling a package of products for less than the aggregate price of the products if purchased separately), scholars have generally concluded that there should be no antitrust liability if the discount at issue could be matched by an equally efficient single-product rival of the discounter. That will be the case if each product in the bundle is priced above cost after the entire bundled discount is attributed to that product. Antitrust scholars have therefore generally endorsed a safe harbor for bundled discounts that are “above cost” under a “discount attribution test.”

In an article appearing in the December 2009 Harvard Law Review, Harvard law professor Einer Elhauge challenged each of these near-consensus propositions. According to Elhauge, the conclusion that significant tied market foreclosure should be a prerequisite to tying liability stems from scholars’ naïve acceptance of the Chicago School’s “single monopoly profit” theory. Elhauge insists that the theory is infirm and that instances of tying may occasion anticompetitive “power” (i.e., price discrimination) effects even if they do not involve substantial tied market foreclosure. He maintains that the Supreme Court has deemed such effects to be anticompetitive and that it was right to do so.

With respect to bundled discounting, Elhauge calls for courts to forego price-cost comparisons in favor of a rule that asks whether the defendant seller has “coerced” consumers into buying the bundle by first raising its unbundled monopoly (“linking”) product price above the “but-for” level that would prevail absent the bundled discounting scheme and then offering a discount from that inflated level.

I have just posted to SSRN an article criticizing Elhauge’s conclusions on both tying and bundled discounting. On tying, the article argues, Elhauge makes both descriptive and normative mistakes. As a descriptive matter, Supreme Court precedent does not deem the so-called power effects (each of which was well-known to Chicago School scholars) to be anticompetitive. As a normative matter, such effects should not be regulated because they tend to enhance total social welfare, especially when one accounts for dynamic efficiency effects. Because tying can create truly anticompetitive effect only when it involves substantial tied market foreclosure, such foreclosure should be a prerequisite to liability.

On bundled discounting, I argue, Elhauge’s proposed rule would be a disaster. The rule fails to account for the fact that bundled discounts may create immediate consumer benefit even if the seller has increased unbundled linking prices above but-for levels. It is utterly inadministrable and would chill procompetitive instances of bundled discounting. It is motivated by a desire to prevent “power” effects that are not anticompetitive under governing Supreme Court precedent (and should not be deemed so). Accordingly, courts should reject Elhauge’s proposed rule in favor of an approach that first focuses on the genuine prerequisite to discount-induced anticompetitive harm—“linked” market foreclosure—and then asks whether any such foreclosure is anticompetitive in that it could not be avoided by a determined competitive rival. To implement such a rule, courts would need to apply the discount attribution test.

The paper is a work-in-progress. Herbert Hovenkamp has already given me a number of helpful comments, which I plan to incorporate shortly. In the meantime, I’d love to hear what TOTM readers think.