Archives For mergers & acquisitions

Last month the Wall Street Journal raised the specter of an antitrust challenge to the proposed Jos. A. Bank/Men’s Warehouse merger.

Whether a challenge is forthcoming appears to turn, of course, on market definition:

An important question in the FTC’s review will be whether it believes the two companies compete in a market that is more specialized than the broad men’s apparel market. If the commission concludes the companies do compete in a different space than retailers like Macy’s, Kohl’s and J.C. Penney, then the merger partners could face a more-difficult government review.

You’ll be excused for recalling that the last time you bought a suit you shopped at Jos. A. Bank and Macy’s before making your purchase at Nordstrom Rack, and for thinking that the idea of a relevant market comprising Jos. A. Bank and Men’s Warehouse to the exclusion of the others is absurd.  Because, you see, as the article notes (quoting Darren Tucker),

“The FTC sometimes segments markets in ways that can appear counterintuitive to the public.”

“Ah,” you say to yourself. “In other words, if the FTC’s rigorous econometric analysis shows that prices at Macy’s don’t actually affect pricing decisions at Men’s Warehouse, then I’d be surprised, but so be it.”

But that’s not what he means by “counterintuitive.” Rather,

The commission’s analysis, he said, will largely turn on how the companies have viewed the market in their own ordinary-course business documents.

According to this logic, even if Macy’s does exert pricing pressure on Jos. A Bank, if Jos. A. Bank’s business documents talk about Men’s Warehouse as its only real competition, or suggest that the two companies “dominate” the “mid-range men’s apparel market,” then FTC may decide to challenge the deal.

I don’t mean to single out Darren here; he just happens to be who the article quotes, and this kind of thinking is de rigeur.

But it’s just wrong. Or, I should say, it may be descriptively accurate — it may be that the FTC will make its enforcement decision (and the court would make its ruling) on the basis of business documents — but it’s just wrong as a matter of economics, common sense, logic and the protection of consumer welfare.

One can’t help but think of the Whole Foods/Wild Oats merger and the FTC’s ridiculous “premium, natural and organic supermarkets” market. As I said of that market definition:

In other words, there is a serious risk of conflating a “market” for business purposes with an actual antitrust-relevant market. Whole Foods and Wild Oats may view themselves as operating in a different world than Wal-Mart. But their self-characterization is largely irrelevant. What matters is whether customers who shop at Whole Foods would shop elsewhere for substitute products if Whole Food’s prices rose too much. The implicit notion that the availability of organic foods at Wal-Mart (to say nothing of pretty much every other grocery store in the US today!) exerts little or no competitive pressure on prices at Whole Foods seems facially silly.

I don’t know for certain what an econometric analysis would show, but I would indeed be shocked if a legitimate economic analysis suggested that Jos. A. Banks and Men’s Warehouse occupied all or most of any relevant market. For the most part — and certainly for the marginal consumer — there is no meaningful difference between a basic, grey worsted wool suit bought at a big department store in the mall and a similar suit bought at a small retailer in the same mall or a “warehouse” store across the street. And the barriers to entry in such a market, if it existed, would be insignificant. Again, what I said of Whole Foods/Wild Oats is surely true here, too:

But because economically-relevant market definition turns on demand elasticity among consumers who are often free to purchase products from multiple distribution channels, a myopic focus on a single channel of distribution to the exclusion of others is dangerous.

Let’s hope the FTC gets it right this time.

Commissioner Wright makes a powerful and important case in dissenting from the FTC’s 2-1 (Commissioner Ohlhausen was recused from the matter) decision imposing conditions on Nielsen’s acquisition of Arbitron.

Essential to Josh’s dissent is the absence of any actual existing market supporting the Commission’s challenge:

Nielsen and Arbitron do not currently compete in the sale of national syndicated cross-platform audience measurement services. In fact, there is no commercially available national syndicated cross-platform audience measurement service today. The Commission thus challenges the proposed transaction based upon what must be acknowledged as a novel theory—that is, that the merger will substantially lessen competition in a market that does not today exist.

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[W]e…do not know how the market will evolve, what other potential competitors might exist, and whether and to what extent these competitors might impose competitive constraints upon the parties.

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To be clear, I do not base my disagreement with the Commission today on the possibility that the potential efficiencies arising from the transaction would offset any anticompetitive effect. As discussed above, I find no reason to believe the transaction is likely to substantially lessen competition because the evidence does not support the conclusion that it is likely to generate anticompetitive effects in the alleged relevant market.

This is the kind of theory that seriously threatens innovation. Regulators in Washington are singularly ill-positioned to predict the course of technological evolution — that’s why they’re regulators and not billionaire innovators. To impose antitrust-based constraints on economic activity that hasn’t even yet occurred is the height of folly. As Virginia Postrel discusses in The Future and Its Enemies, this is the technocratic mindset, in all its stasist glory:

Technocrats are “for the future,” but only if someone is in charge of making it turn out according to plan. They greet every new idea with a “yes, but,” followed by legislation, regulation, and litigation.

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By design, technocrats pick winners, establish standards, and impose a single set of values on the future.

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For technocrats, a kaleidoscope of trial-and-error innovation is not enough; decentralized experiments lack coherence. “Today, we have an opportunity to shape technology,” wrote [Newt] Gingrich in classic technocratic style. His message was that computer technology is too important to be left to hackers, hobbyists, entrepreneurs, venture capitalists, and computer buyers. “We” must shape it into a “coherent picture.” That is the technocratic notion of progress: Decide on the one best way, make a plan, and stick to it.

It should go without saying that this is the antithesis of the environment most conducive to economic advance. Whatever antitrust’s role in regulating technology markets, it must be evidence-based, grounded in economics and aware of its own limitations.

As Josh notes:

A future market case, such as the one alleged by the Commission today, presents a number of unique challenges not confronted in a typical merger review or even in “actual potential competition” cases. For instance, it is inherently more difficult in future market cases to define properly the relevant product market, to identify likely buyers and sellers, to estimate cross-elasticities of demand or understand on a more qualitative level potential product substitutability, and to ascertain the set of potential entrants and their likely incentives. Although all merger review necessarily is forward looking, it is an exceedingly difficult task to predict the competitive effects of a transaction where there is insufficient evidence to reliably answer these basic questions upon which proper merger analysis is based.

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When the Commission’s antitrust analysis comes unmoored from such fact-based inquiry, tethered tightly to robust economic theory, there is a more significant risk that non-economic considerations, intuition, and policy preferences influence the outcome of cases.

Josh’s dissent also contains an important, related criticism of the FTC’s problematic reliance on consent agreements. It’s so good, in fact, I will quote it almost in its entirety:

Whether parties to a transaction are willing to enter into a consent agreement will often have little to do with whether the agreed upon remedy actually promotes consumer welfare. The Commission’s ability to obtain concessions instead reflects the weighing by the parties of the private costs and private benefits of delaying the transaction and potentially litigating the merger against the private costs and private benefits of acquiescing to the proposed terms. Indeed, one can imagine that where, as here, the alleged relevant product market is small relative to the overall deal size, the parties would be happy to agree to concessions that cost very little and finally permit the deal to close. Put simply, where there is no reason to believe a transaction violates the antitrust laws, a sincerely held view that a consent decree will improve upon the post-merger competitive outcome or have other beneficial effects does not justify imposing those conditions. Instead, entering into such agreements subtly, and in my view harmfully, shifts the Commission’s mission from that of antitrust enforcer to a much broader mandate of “fixing” a variety of perceived economic welfare-reducing arrangements.

Consents can and do play an important and productive role in the Commission’s competition enforcement mission. Consents can efficiently address competitive concerns arising from a merger by allowing the Commission to reach a resolution more quickly and at less expense than would be possible through litigation. However, consents potentially also can have a detrimental impact upon consumers. The Commission’s consents serve as important guidance and inform practitioners and the business community about how the agency is likely to view and remedy certain mergers. Where the Commission has endorsed by way of consent a willingness to challenge transactions where it might not be able to meet its burden of proving harm to competition, and which therefore at best are competitively innocuous, the Commission’s actions may alter private parties’ behavior in a manner that does not enhance consumer welfare. Because there is no judicial approval of Commission settlements, it is especially important that the Commission take care to ensure its consents are in the public interest.

This issue of the significance of the FTC’s tendency to, effectively, legislate by consent decree is of great importance, particularly in its Section 5 practice (as we discuss in our amicus brief in the Wyndham case).

As the FTC begins its 100th year next week, we need more voices like those of Commissioners Wright and Ohlhausen challenging the FTC’s harmful, technocratic mindset.

Last Thursday, the FTC settled a challenge to a company’s acquisitions of two key rivals. The two acquisitions, each of which failed to meet the threshold for required reporting under Hart Scott Rodino, occurred in 2005 and 2008. Because the acquired companies have been fully integrated into the acquirer and all distinct operations have been shut down, it was impossible for the Commission to “unscramble the eggs” by imposing a structural remedy that separates the companies or parts thereof. The Commission therefore opted for a behavioral remedy — i.e., a list of restrictions on how the combined company may operate its business in the future. The purported goal of the behavioral remedy is to enhance consumer welfare by restoring competition that was destroyed by the anticompetitive acquisitions.

Commissioner Josh Wright took exception to a couple of the restrictions in the consent order. In a separate statement, he set forth a principle reflecting his concerns that antitrust implementation be both evidence-based and sensitive to error costs. One hopes that the principle he articulated — a version of the Hippocratic maxim, “First, do no harm” — will influence future FTC decisions on behavioral remedies.

The defendant here was Graco, the leading manufacturer of “fast set equipment” (FSE) used by contractors to apply polyurethane foams and coatings. The two companies it purchased, Gusmer in 2005 and GlasCraft in 2008, were its two closest competitors in the North American market for FSE. Graco’s acquisitions of those companies eliminated almost all market competition. In addition, Graco allegedly coerced and threatened FSE distributors so that they would not carry competitors’ products, and it filed a questionable lawsuit against a rival, Gama/PMC, causing FSE distributors to grow leery of that supplier and drop its products.  These post-acquisition actions have helped cement Graco’s market power by denying its actual and potential rivals access to the distribution networks they need to effectively market their products.

In light of Graco’s post-acquisition conduct, the consent order agreed to Thursday prohibits Graco from threatening, coercing, or retaliating against distributors who carry its rivals’ products.  It also requires settlement of the lawsuit that was impairing Gama/PMC’s access to distributors, and it forbids Graco from bringing a similar suit in the future.

But the order then goes further.  It prohibits Graco from entering into exclusive dealing contracts with distributors, and it places limits on Graco’s freedom to give loyalty discounts to distributors.  (Specifically, it limits the purchase and inventory levels upon which Graco may condition distributor discounts.)

The problem, in Commissioner Wright’s view, was that there was no evidence that these forbidden activities – exclusive dealing arrangements and loyalty discounts – contributed to the absence of competition in the FSE market.  Because exclusive dealing arrangements and loyalty discounts are usually procompetitive, prohibiting their use by Graco in the absence of evidence that they are responsible for the lack of competition in the market or are likely to be used to effect anticompetitive harm rather than to achieve a procompetitive benefit is more likely to hurt than help consumers.

Wright notes (and the Commission acknowledges), for example, that the market for FSE is precisely the sort market in which exclusive dealing arrangements achieve the procompetitive benefit of avoiding “inter-brand free-riding.”  Manufacturers of FSE will enhance total sales if they train distributors on the proper use and various complicated features of FSE.  Consumers benefit from (and sales are increased by) such training, because the distributors pass along their learning to end-user purchasers.  But if one FSE manufacturer trains a distributor on how to use the equipment, other manufacturers whose product is carried by that distributor won’t need to do so themselves.  The possibility that they will “take a free-ride” on the manufacturer providing the training tends to dissuade all manufacturers from providing such training, to the detriment of consumers.  Exclusive dealing helps out by preventing free-riding and thereby assuring a manufacturer that it will receive the full benefit of its training efforts.  By banning exclusive dealing, then, the Commission’s consent order may cause a consumer injury, and there’s no reason to take that risk absent evidence that exclusive dealing has been used – or is likely to be used in the future – to create anticompetitive harm.  First, do no harm!

It is important to note that not including exclusive dealing and loyalty discounts on the list of behaviors prohibited by the consent order would not give Graco free rein to use those practices in a manner that causes anticompetitive foreclosure.  The Commission or a competitor could always challenge a future exclusive dealing arrangement or loyalty discount if there were evidence that the practice had caused anticompetitive harm.  The remainder of the Commission’s behavioral remedy assures that there will be a viable competitor – Gama/PMC – that is in a position to challenge any such conduct, and, in light of the consent order, the Commission and any reviewing court would take any future complaints quite seriously.  Doesn’t it make more sense, then, to limit the behavioral remedy to actions that have contributed to the anticompetitive situation at hand and not ban behaviors that may well inure to the benefit of consumers?  As Commissioner Wright put it:

A minimum safeguard to ensure [that] remedial provisions … restore competition rather than inadvertently reduce it is to require evidence that the type of conduct being restricted has been, or is likely to be, used anticompetitively to harm consumers.

I think Wright’s right on this one.

Although it probably flew under almost everyone’s radar, last week Josh issued his first Concurring Statement as an FTC Commissioner.  The statement came in response to a seemingly arcane Notice of Proposed Rulemaking relating to Hart-Scott-Rodino Premerger Notification Rules:

The proposed rules also establish a procedure for the automatic withdrawal of an HSR filing when filings are made with the U.S. Securities and Exchange Commission (SEC) announcing that a transaction has been terminated.

The proposed rulemaking itself isn’t enormously significant, but Josh’s statement lays down a marker that indicates (as anyone could have predicted) that he intends to do everything he can to improve the agency and its process.

The rule, as suggested above, would automatically withdraw an HSR filing whenever transacting parties filed certain notices with the SEC announcing the termination of a deal.  You may recall that the Hertz/Dollar Thrifty deal had been in the works for at least five years when it finally closed.  When Hertz withdrew its tender offer in October 2011, it did not withdraw its HSR filing.  As reported at the time, Hertz withdrew its bid over difficulty securing FTC approval, which had plagued other offers for Thrifty:

In a sign of frustration, Mr. Thompson said that the company had spent some $30 million over the last few years dealing with the barrage of takeover offers.

Obviously, given the difficulty of securing FTC approval and the costs imposed by the uncertainty it created, there was real benefit to Hertz (and perhaps Thrifty, for that matter) from receiving a decision from the FTC without meanwhile tying up the company’s resources, restraining its decision- and deal-making abilities, complicating negotiations and weakening its credit by maintaining a stalled-but-pending merger.  So the deal was withdrawn, but the HSR filing was not.

In August 2012 the parties re-initiated the merger following ongoing consultations by Hertz with the FTC, and, in November 2012 — a full year after the deal was withdrawn (and a year and a half after the HSR filing) — the FTC approved the deal.

But, understandably, FTC staff don’t want to be wasting resources reviewing hypothetical transactions, and so, following on the heels of the Hertz/Dollar Thrifty deal, wrote the proposed rule to ensure that it never happens again.

Except it didn’t happen in Hertz because, after all, the deal was eventually made. According to Josh, in fact, the situation intended to be avoided by the rule has never arisen:

The proposed rulemaking appears to be a solution in search of a problem. The Federal Register notice states that the proposed rules are necessary to prevent the FTC and DOJ from “expend[ing] scarce resources on hypothetical transactions.” Yet, I have not to date been presented with evidence that any of the over 68,000 transactions notified under the HSR rules have required Commission resources to be allocated to a truly hypothetical transaction. Indeed, it would be surprising to see firms incurring the costs and devoting the time and effort associated with antitrust review in the absence of a good faith intent to proceed with their transaction.

This isn’t to say (and Josh doesn’t say) that the proposed rule is a bad idea, just that, given the apparently negligible benefits of the rule, the costs could easily outweigh the benefits.

Which is why Josh’s Statement is important. What Josh is asking for is not that the rule be scrapped, but simply that, before adopting the rule, the FTC weigh its costs and benefits. And as Josh points out, there could indeed be some costs:

The proposed rules, if adopted, could increase the costs of corporate takeovers and thus distort the market for corporate control. Some companies that had complied with or were attempting to comply with a Second Request, for example, could be forced to restart their antitrust review, leading to significant delays and added expenses. The proposed rules could also create incentives for firms to structure their transactions less efficiently and discourage the use of tender offers. Finally, the proposed new rules will disproportionately burden U.S. public companies; the Federal Register notice acknowledges that the new rules will not apply to tender offers for many non-public and foreign companies.

Given these concerns, I hope that interested parties will avail themselves of the opportunity to submit public comments so that the Commission can make an informed decision at the conclusion of this process.

What is surprising is not that Josh suggested that there might be unanticipated costs to such a rule, nor that cost-benefit analysis be applied. Rather, what’s surprising is that the rest of the Commission didn’t sign on. Why is that surprising? Well, because cost-benefit analysis is not only sensible, it’s consistent with the Obama Administration’s stated regulatory approach. Executive Order 13563 requires that:

Each agency must, among other things:  (1) propose or adopt a regulation only upon a reasoned determination that its benefits justify its costs (recognizing that some benefits and costs are difficult to quantify) . . . In applying these principles, each agency is directed to use the best available techniques to quantify anticipated present and future benefits and costs as accurately as possible.

Unfortunately, as Berin Szoka has pointed out,

The FCC, FTC and many other regulatory agencies aren’t required to do cost-benefit analysis at all.  Because these are “independent agencies”—creatures of Congress rather than part of the Executive Branch (like the Department of Justice)—only Congress can impose cost-benefit analysis on agencies.  A bipartisan bill, the Independent Agency Regulatory Analysis Act (S. 3486), would have allowed the President to impose the same kind of cost-benefit analysis on independent regulatory agencies as on Executive Branch agencies, including review by the Office of Information and Regulatory Affairs (OIRA) for “significant” rulemakings (those with $100 million or more in economic impact, that adversely affect sectors of the economy in a material way, or that create “serious inconsistency” with other agencies’ actions). . . . yet the bill has apparently died . . . .

Legislation or not, it is the Commission’s responsibility to ensure that the rules it enacts will actually be beneficial (it is a consumer protection agency, after all). The staff, presumably, did a perfectly fine job writing the rule they were asked to write. Josh’s point is simply that it isn’t clear the rule should be adopted because it isn’t clear that the benefits of doing so would outweigh the costs.

It may have happened before, but I can’t recall an FTC Commissioner laying down the cost-benefit-analysis gauntlet and publicly calling for consistent cost-benefit review at the Commission, even of seemingly innocuous (but often not actually innocuous), technical rules.

This is exactly the sort of thing that those of us who extolled Josh’s appointment hoped for, and I’m delighted to see him pushing this kind of approach right out of the gate.  No doubt he rocked some boats and took some heat for it. Good. That means he’s on the right track.

by Larry Downes and Geoffrey A. Manne

Now that the election is over, the Federal Communications Commission is returning to the important but painfully slow business of updating its spectrum management policies for the 21st century. That includes a process the agency started in September to formalize its dangerously unstructured role in reviewing mergers and other large transactions in the communications industry.

This followed growing concern about “mission creep” at the FCC, which, in deals such as those between Comcast and NBCUniversal, AT&T and T-Mobile USA, and Verizon Wireless and SpectrumCo, has repeatedly been caught with its thumb on the scales of what is supposed to be a balance between private markets and what the Communications Act refers to as the “public interest.” Continue Reading…

There are a lot of inaccurate claims – and bad economics – swirling around the Universal Music Group (UMG)/EMI merger, currently under review by the US Federal Trade Commission and the European Commission (and approved by regulators in several other jurisdictions including, most recently, Australia). Regulators and industry watchers should be skeptical of analyses that rely on outmoded antitrust thinking and are out of touch with the real dynamics of the music industry.

The primary claim of critics such as the American Antitrust Institute and Public Knowledge is that this merger would result in an over-concentrated music market and create a “super-major” that could constrain output, raise prices and thwart online distribution channels, thus harming consumers. But this claim, based on a stylized, theoretical economic model, is far too simplistic and ignores the market’s commercial realities, the labels’ self-interest and the merger’s manifest benefits to artists and consumers.
Continue Reading…

By Geoffrey Manne and Berin Szoka

Everyone loves to hate record labels. For years, copyright-bashers have ranted about the “Big Labels” trying to thwart new models for distributing music in terms that would make JFK assassination conspiracy theorists blush. Now they’ve turned their sites on the pending merger between Universal Music Group and EMI, insisting the deal would be bad for consumers. There’s even a Senate Antitrust Subcommittee hearing tomorrow, led by Senator Herb “Big is Bad” Kohl.

But this is a merger users of Spotify, Apple’s iTunes and the wide range of other digital services ought to love. UMG has done more than any other label to support the growth of such services, cutting licensing deals with hundreds of distribution outlets—often well before other labels. Piracy has been a significant concern for the industry, and UMG seems to recognize that only “easy” can compete with “free.” The company has embraced the reality that music distribution paradigms are changing rapidly to keep up with consumer demand. So why are groups like Public Knowledge opposing the merger?

Critics contend that the merger will elevate UMG’s already substantial market share and “give it the power to distort or even determine the fate of digital distribution models.” For these critics, the only record labels that matter are the four majors, and four is simply better than three. But this assessment hews to the outmoded, “big is bad” structural analysis that has been consistently demolished by economists since the 1970s. Instead, the relevant touchstone for all merger analysis is whether the merger would give the merged firm a new incentive and ability to engage in anticompetitive conduct. But there’s nothing UMG can do with EMI’s catalogue under its control that it can’t do now. If anything, UMG’s ownership of EMI should accelerate the availability of digitally distributed music.

To see why this is so, consider what digital distributors—whether of the pay-as-you-go, iTunes type, or the all-you-can-eat, Spotify type—most want: Access to as much music as possible on terms on par with those of other distribution channels. For the all-you-can-eat distributors this is a sine qua non: their business models depend on being able to distribute as close as possible to all the music every potential customer could want. But given UMG’s current catalogue, it already has the ability, if it wanted to exercise it, to extract monopoly profits from these distributors, as they simply can’t offer a viable product without UMG’s catalogue. Continue Reading…

Judge Douglas Ginsburg (D.C. Circuit Court of Appeals; NYU Law) and I have posted “Dynamic Antitrust and the Limits of Antitrust Institutions” to SSRN.  Our article is forthcoming in Volume 78 (2) of the Antitrust Law Journal.  We offer a cautionary note – from an institutional perspective – concerning the ever-increasing and influential calls for greater incorporation of models of dynamic competition and innovation into antitrust analysis by courts and agencies.

Here is the abstract:

The static model of competition, which dominates modern antitrust analysis, has served antitrust law well.  Nonetheless, as commentators have observed, the static model ignores the impact that competitive (or anti-competitive) activities undertaken today will have upon future market conditions.  An increased focus upon dynamic competition surely has the potential to improve antitrust analysis and, thus, to benefit consumers.  The practical value of proposals to increase the use of dynamic analysis must, however, be evaluated with an eye to the institutional limitations that antitrust agencies and courts face when engaged in predictive fact-finding.  We explain and evaluate both the current state of dynamic antitrust analysis and some recent proposals that agencies and courts incorporate dynamic considerations more deeply into their analyses.  We show antitrust analysis is not willfully ignorant of the limitations of static analysis; on the contrary, when reasonably confident predictions can be made, they are readily incorporated into the analysis.  We also argue agencies and courts should view current proposals for a more dynamic approach with caution because the theories underpinning those proposals lie outside the agencies’ expertise in industrial organization economics, do not consistently yield determinate results, and would place significant demands upon reviewing courts to question predictions based upon those theories.  Considering the current state of economic theory and empirical knowledge, we conclude that competition agencies and courts have appropriately refrained from incorporating dynamic features into antitrust analysis to make predictions beyond what can be supported by a fact-intensive analysis.

You can download the paper here.

From Competition Policy International (via The Blog of Legal Times):

Matt Reilly, former Assistant Director of the Federal Trade Commission, is joining Simpson Thacher & Bartlett. Reilly will partner the firm’s Antitrust Practice and be based in its D.C. office. His move comes after 13 years at the FTC, where he was the lead litigator in high-profile cases like the agency’s challenge to the Whole Foods-Wild Oats merger. From 2007, Reilly served as head of the Mergers IV decision.

Congratulations to Matt — formerly head of Mergers IV — and to Simpson Thacher.

The DOJ’s recent press release on the Google/Motorola, Rockstar Bidco, and Apple/ Novell transactions struck me as a bit odd when I read it.  As I’ve now had a bit of time to digest it, I’ve grown to really dislike it.  For those who have not followed Jorge Contreras had an excellent summary of events at Patently-O.

For those of us who have been following the telecom patent battles, something remarkable happened a couple of weeks ago.  On February 7, the Wall St. Journal reported that, back in November, Apple sent a letter[1] to the European Telecommunications Standards Institute (ETSI) setting forth Apple’s position regarding its commitment to license patents essential to ETSI standards.  In particular, Apple’s letter clarified its interpretation of the so-called “FRAND” (fair, reasonable and non-discriminatory) licensing terms that ETSI participants are required to use when licensing standards-essential patents.  As one might imagine, the actual scope and contours of FRAND licenses have puzzled lawyers, regulators and courts for years, and past efforts at clarification have never been very successful.  The next day, on February 8, Google released a letter[2] that it sent to the Institute for Electrical and Electronics Engineers (IEEE), ETSI and several other standards organizations.  Like Apple, Google sought to clarify its position on FRAND licensing.  And just hours after Google’s announcement, Microsoft posted a statement of “Support for Industry Standards”[3] on its web site, laying out its own gloss on FRAND licensing.  For those who were left wondering what instigated this flurry of corporate “clarification”, the answer arrived a few days later when, on February 13, the Antitrust Division of the U.S. Department of Justice (DOJ) released its decision[4] to close the investigation of three significant patent-based transactions:  the acquisition of Motorola Mobility by Google, the acquisition of a large patent portfolio formerly held by Nortel Networks by “Rockstar Bidco” (a group including Microsoft, Apple, RIM and others), and the acquisition by Apple of certain Linux-related patents formerly held by Novell.  In its decision, the DOJ noted with approval the public statements by Apple and Microsoft, while expressing some concern with Google’s FRAND approach.  The European Commission approved Google’s acquisition of Motorola Mobility on the same day.

To understand the significance of the Apple, Microsoft and Google FRAND statements, some background is in order.  The technical standards that enable our computers, mobile phones and home entertainment gear to communicate and interoperate are developed by corps of “volunteers” who get together in person and virtually under the auspices of standards-development organizations (SDOs).  These SDOs include large, international bodies such as ETSI and IEEE, as well as smaller consortia and interest groups.  The engineers who do the bulk of the work, however, are not employees of the SDOs (which are usually thinly-staffed non-profits), but of the companies who plan to sell products that implement the standards: the Apples, Googles, Motorolas and Microsofts of the world.  Should such a company obtain a patent covering the implementation of a standard, it would be able to exert significant leverage over the market for products that implemented the standard.  In particular, if a patent holder were to obtain, or even threaten to obtain, an injunction against manufacturers of competing standards-compliant products, either the standard would become far less useful, or the market would experience significant unanticipated costs.  This phenomenon is what commentators have come to call “patent hold-up”.  Due to the possibility of hold-up, most SDOs today require that participants in the standards-development process disclose their patents that are necessary to implement the standard and/or commit to license those patents on FRAND terms.

As Contreras notes, an important part of these FRAND commitments offered by Google, Motorola, and Apple related to the availability of injunctive relief (do go see the handy chart in Contreras’ post laying out the key differences in the commitments).  Contreras usefully summarizes the three statements’ positions on injunctive relief:

In their February FRAND statements, Apple and Microsoft each commit not to seek injunctions on the basis of their standards-essential patents.  Google makes a similar commitment, but qualifies it in typically lawyerly fashion (Google’s letter is more than 3 single-spaced pages in length, while Microsoft’s simple statement occupies about a quarter of a page).  In this case, Google’s careful qualifications (injunctive relief might be possible if the potential licensee does not itself agree to refrain from seeking an injunction, if licensing negotiations extended beyond a reasonable period, and the like) worked against it.  While the DOJ applauds Apple’s and Microsoft’s statements “that they will not seek to prevent or exclude rivals’ products form the market”, it views Google’s commitments as “less clear”.  The DOJ thus “continues to have concerns about the potential inappropriate use of [standards-essential patents] to disrupt competition”.

Its worth reading the DOJ’s press release on this point — specifically, that while the DOJ found that none of the three transactions itself raised competitive concerns or was substantially likely to lessen the competition, the DOJ expressed general concerns about the relationship between these firms’ market positions and ability to use the threat of injunctive relief to hold up rivals:

Apple’s and Google’s substantial share of mobile platforms makes it more likely that as the owners of additional SEPs they could hold up rivals, thus harming competition and innovation.  For example, Apple would likely benefit significantly through increased sales of its devices if it could exclude Android-based phones from the market or raise the costs of such phones through IP-licenses or patent litigation.  Google could similarly benefit by raising the costs of, or excluding, Apple devices because of the revenues it derives from Android-based devices.

The specific transactions at issue, however, are not likely to substantially lessen competition.  The evidence shows that Motorola Mobility has had a long and aggressive history of seeking to capitalize on its intellectual property and has been engaged in extended disputes with Apple, Microsoft and others.  As Google’s acquisition of Motorola Mobility is unlikely to materially alter that policy, the division concluded that transferring ownership of the patents would not substantially alter current market dynamics.  This conclusion is limited to the transfer of ownership rights and not the exercise of those transferred rights.

With respect to Apple/Novell, the division concluded that the acquisition of the patents from CPTN, formerly owned by Novell, is unlikely to harm competition.  While the patents Apple would acquire are important to the open source community and to Linux-based software in particular, the OIN, to which Novell belonged, requires its participating patent holders to offer a perpetual, royalty-free license for use in the “Linux-system.”  The division investigated whether the change in ownership would permit Apple to avoid OIN commitments and seek royalties from Linux users.  The division concluded it would not, a conclusion made easier by Apple’s commitment to honor Novell’s OIN licensing commitments.

In its analysis of the transactions, the division took into account the fact that during the pendency of these investigations, Apple, Google and Microsoft each made public statements explaining their respective SEP licensing practices.  Both Apple and Microsoft made clear that they will not seek to prevent or exclude rivals’ products from the market in exercising their SEP rights.

What’s problematic about a competition enforcement agency extracting promises not to enforce lawfully obtained property rights during merger review, outside the formal consent process, and in transactions that do not raise competitive concerns themselves?  For starters, the DOJ’s expression about competitive concerns about “hold up” obfuscate an important issue.  In Rambus the D.C. Circuit clearly held that not all forms of what the DOJ describes here as patent holdup violate the antitrust laws in the first instance.  Both appellate courts discussion patent holdup as an antitrust violation have held the patent holder must deceptively induce the SSO to adopt the patented technology.  Rambus makes clear — as I’ve discussed — that a firm with lawfully acquired monopoly power who merely raises prices does not violate the antitrust laws.  The proposition that all forms of patent holdup are antitrust violations is dubious.  For an agency to extract concessions that go beyond the scope of the antitrust laws at all, much less through merger review of transactions that do not raise competitive concerns themselves, raises serious concerns.

Here is what the DOJ says about Google’s commitment:

If adhered to in practice, these positions could significantly reduce the possibility of a hold up or use of an injunction as a threat to inhibit or preclude innovation and competition.

Google’s commitments have been less clear.  In particular, Google has stated to the IEEE and others on Feb. 8, 2012, that its policy is to refrain from seeking injunctive relief for the infringement of SEPs against a counter-party, but apparently only for disputes involving future license revenues, and only if the counterparty:  forgoes certain defenses such as challenging the validity of the patent; pays the full disputed amount into escrow; and agrees to a reciprocal process regarding injunctions.  Google’s statement therefore does not directly provide the same assurance as the other companies’ statements concerning the exercise of its newly acquired patent rights.  Nonetheless, the division determined that the acquisition of the patents by Google did not substantially lessen competition, but how Google may exercise its patents in the future remains a significant concern.

No doubt the DOJ statement is accurate and the DOJ’s concerns about patent holdup are genuine.  But that’s not the point.

The question of the appropriate role for injunctions and damages in patent infringement litigation is a complex one.  While many scholars certainly argue that the use of injunctions facilitates patent hold up and threatens innovation.  There are serious debates to be had about whether more vigorous antitrust enforcement of the contractual relationships between patent holders and standard setting organization (SSOs) would spur greater innovation.   The empirical evidence suggesting patent holdup is a pervasive problem is however, at best, quite mixed.  Further, others argue that the availability of injunctions is not only a fundamental aspect of our system of property rights, but also from an economic perspective, that the power of the injunctions facilitates efficient transacting by the parties.  For example, some contend that the power to obtain injunctive relief for infringement within the patent thicket results in a “cold war” of sorts in which the threat is sufficient to induce cross-licensing by all parties.  Surely, this is not first best.  But that isn’t the relevant question.

There are other more fundamental problems with the notion of patent holdup as an antitrust concern.  Kobayashi & Wright also raise concerns with the theoretical case for antitrust enforcement of patent holdup on several grounds.  One is that high probability of detection of patent holdup coupled with antitrust’s treble damages makes overdeterrence highly likely.  Another is that alternative remedies such as contract and the patent doctrine of equitable estoppel render the marginal benefits of antitrust enforcement trivial or negative in this context.  Froeb, Ganglmair & Werden raise similar points.   Suffice it to say that the debate on the appropriate scope of antitrust enforcement in patent holdup is ongoing as a general matter; there is certainly no consensus with regard to economic theory or empirical evidence that stripping the availability of injunctive relief from patent holders entering into contractual relationships with SSOs will enhance competition or improve consumer welfare.  It is quite possible that such an intervention would chill competition, participation in SSOs, and the efficient contracting process potentially facilitated by the availability of injunctive relief.

The policy debate I describe above is an important one.  Many of the questions at the center of that complex debate are not settled as a matter of economic theory, empirics, or law.  This post certainly has no ambitions to resolve them here; my goal is a much more modest one.  The DOJs policymaking efforts through the merger review process raise serious issues.  I would hope that all would agree — regardless of where they stand on the patent holdup debate — that the idea that these complex debates be hammered out in merger review at the DOJ because the DOJ happens to have a number of cases involving patent portfolios is a foolish one for several reasons.

First, it is unclear the DOJ could have extracted these FRAND concessions through proper merger review.  The DOJ apparently agreed that the transactions did not raise serious competitive concerns.   The pressure imposed by the DOJ upon the parties to make the commitments to the SSOs not to pursue injunctive relief as part of a FRAND commitment outside of the normal consent process raises serious concerns.  The imposition of settlement conditions far afield from the competitive consequences of the merger itself is something we do see from antitrust enforcement agencies in other countries quite frequently, but this sort of behavior burns significant reputational capital with the rest of the world when our agencies go abroad to lecture on the importance of keeping antitrust analysis consistent, predictable, and based upon the economic fundamentals of the transaction at hand.

Second, the DOJ Antitrust Division does not alone have comparative advantage in determining the optimal use of injunctions versus damages in the patent system.

Third, appearances here are quite problematic.  Given that the DOJ did not appear to have significant competitive concerns with the transactions, one can create the following narrative of events without too much creative effort: (1) the DOJ team has theoretical priors that injunctive relief is a significant competitive problem, (2) the DOJ happens to have these mergers in front of it pending review from a couple of firms likely to be repeat players in the antitrust enforcement game, (3) the DOJ asks the firms to make these concessions despite the fact that they have little to do with the conventional antitrust analysis of the transactions, under which they would have been approved without condition.

The more I think about the use of the merger review process to extract concessions from patent holders in the form of promises not to enforce property rights which they would otherwise be legally entitled to, the more the DOJ’s actions appear inappropriate.  The stakes are high here both in terms of identifying patent and competition rules that will foster rather than hamper innovation, but also with respect to compromising the integrity of merger review through the imposition of non-merger related conditions we are more akin to seeing from the FCC, states, or less well-developed antitrust regimes.