More Evasion of Pricing Constraints as Antitrust Violations: Vertical Merger Edition

Josh Wright —  3 February 2009

I’ve criticized elsewhere what appears to the the FTC’s new “evasion of pricing constraint” theory of monopolization emerging from Ovation (see also here), N-Data, and Rambus.  I expressed some concern that this theory had no limiting principles and was detached in important ways from sound economics:

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

What if Merck evaluated its product line and decided that it would be be better off by dropping some of its product portfolio so that it could increase the price of Indocin?  Merck’s decision to drop products from its portfolio, or even the design of those product offerings, are surely an evasion of pricing constraints and a violation of Section 2 if it has monopoly power — and perhaps even if it doesn’t under Section 5.  So much for competition as a discovery process.  Or what if Merck decided to create a subsidiary to sell Indocin under a different brand name and trade dress to mitigate the reputational costs it would bear from charging a higher price?  Or fired the CEO who decided that charging the monopoly price in the first instance would be a bad idea in favor of a new manager who reached a different conclusion and wanted to increase the price?  This evasion theory fairly quickly evaporates to the notion that the antitrust law governs prices that are determined to be unreasonable and not the competitive process.   This is what happens when antitrust law unhinges itself from economics, which I fear is a trend at the Commission if N-Data and Ovation are representative…. Reliance on the general principle that evasion of pricing constraints through merger or other conduct is a sufficient condition for antitrust liability is misguided and unsound policy precisely because it is without limiting principles, unhinged from sound economic foudnations, and threatens to turn antitrust enforcement into more general regulation of prices and optimal allocation of resources, e.g. which firm should have Indocin?

Here’s another example.  The WSJ is running a story on the proposed merger between Live Nation and Ticketmaster:

The combined company would be called Live Nation Ticketmaster, and would merge the world’s biggest concert promoter with the world’s dominant ticketing and artist-management company. The resulting firm would be able to manage everything from recorded music to ticket sales and tour sponsorship. It could package artists in new ways, for example, allowing corporations such as a cellphone provider to sponsor a concert tour and to sell an exclusive download of a song.

Because it would be so vertically integrated, the new company would also be able to muscle out competing concert promoters and have more power to dictate ticket prices to consumers.  The boards of both companies have yet to approve the all-stock merger, these people said. Terms of what these people described as a merger of equals have yet to be worked out. It was unclear last night which company would be acquiring the other. Live Nation’s market capitalization, at $390 million, is slightly higher than Ticketmaster’s $351 million. But the concert promoter has more debt and less cash.

Sticking points remain to any deal. Because a merger would concentrate so much power in the music industry under one company, it would require review by antitrust authorities. The deal, which wouldn’t entail any exchange of cash, could be announced as early as next week, these people said.

First, let me say that the first sentence in the second paragraph seems like out of place.  Its an economic prediction that ticket prices will go up rather than a fact that the parties will have more power to dictate ticket prices to consumers.  In fact, the evidence on vertical mergers suggests that they are predominantly pro-competitive.

But back to the point, it is fairly clear that Ticketmaster and Live Nation are “evading pricing constraints” by attempting to merge in order to do things like “It could package artists in new ways, for example, allowing corporations such as a cellphone provider to sponsor a concert tour and to sell an exclusive download of a song.”  Of course, any attempt to circumvent or evade constraints on market prices, e.g. current demand conditions, ranging from quality investments to the use of vertical restraints to facilitate promotional effort from retailers to vertical mergers such as this one run afoul of the definition adopted by some at the Commission as sufficient for antitrust liability.   Once one understands the broad swath of conduct that is typically part of the competitive process that would “evade” pricing constraints (advertising, promotion, changing product line composition or mix), it is clear that this definition is not only unhelpful as an economic guide to identifying conduct likely to prove anticompetitive, but also likely to deter procompetitive business practices.

I have no information as to whether any antitrust enforcement agency will challenge this deal, though the WSJ indicates review is likely.  But if the FTC does the review, given the endorsement of this evasion theory and in the current antitrust environment,  I’d be quite concerned if I were the parties.  Based on the evasion theory, I’m not sure how the Live Nation/Ticketmaster deal (or many, many other deals) are not in the same boat as the Ovation/N-Data/Rambus trio.  I’m on the record that I think this economic approach is unsound.  Kobayashi and I set forth some of the case against this evasion approach in greater detail in our paper on antitrust federalism and patent holdup.  I also believe that it is highly unlikely that there is support for this approach from the Bureau of Economics.  More generally, the general principle that evasion of pricing constraints through vertical merger or other conduct is a sufficient condition for antitrust liability is misguided and unsound policy precisely because it is without limiting principles, unhinged from sound economic foundations, and threatens to turn antitrust enforcement into more general regulation of prices and optimal allocation of resources.

6 responses to More Evasion of Pricing Constraints as Antitrust Violations: Vertical Merger Edition

  1. 

    Perhaps we disagree about how broadly the evasion theory has been articulated. I see no evidence that the vertical nature of the merger puts it off limits. I never said there were not other reasons to challenge the merger. As you say, there may be. Maybe not too. But you only need one successful theory to prohibit the merger so the evasion theory is certainly relevant despite any potential competition or Clayton issues.

    I disagree that only if it passes Section 7 would we need to think about the evasion theory. Why not under Section 2 as an alternative theory?

    Again, I agree speculation on the facts here would be premature. But criticism of the theory is not.

  2. 

    Josh, your point about the breadth of the Ovation “evasion” theory is well made and well taken. And given the theory’s breadth, it could, as you say, apply to any case that would not otherwise be anticompetitive. But that doesn’t mean that any otherwise procompetitive (or not-anticompetitive merger) illustrates the point very well.

    First off, this is a vertical merger. Perhaps it’s anticompetitive, perhaps it’s not. Maybe there’s a potential competition issue, or two-stage entry problem. We’d have to know more facts and how those fit within a traditional Clayton Act analysis.

    At that point, if it passes Section 7, only then would we have a concern that it nonetheless violates Section 5 of the FTC Act through “evasion”. We’re not even close to that point, and I want to see Comm’r Rosch (and any others) articulate how it fits within the Ovation “evading a price constraint” concern. Based on the limited facts we have here, I’m not sure how that would work–right now, so far as I can tell, Verizon and other cell cos. already sponsor concert tours and have exclusive ringtone/songs available for download. (here’s an example google turned up: http://www.mobilemarketer.com/cms/news/music/1344.html

    What would the transaction change? How is LiveNation or Ticketmaster constrained by anything at this point? (If they are, is it that LiveNation may enter into the ticket sales market or that Tickemaster may enter into the concert promotion market?)

  3. 

    One more try. I’m critiquing the FTC theory here because it eviscerates most defenses to for vertical mergers where the the theory is applied, we know these efficiencies occur in practice (so its not harmless error), but most importantly, because it contemplates a Section 2 violation without regard to those efficiencies. It does other bad things, e.g. eviscerate the distinction between extraction and extension of monopoly power. But thats besides the point. The potential merger here was a way to illustrate I don’t know why you characterize these as defenses. The anticompetitive theory of the merger would ignore the defenses. Yes, I think the defenses are relevant.

    So, how serious is the basis for speculation? You raise a fair point. Maybe I shouldn’t talk about the FTC theory when the DOJ will probably conduct the investigation. I don’t know. Good enough for a blog post in my view by revealed preference I guess.

    But I object to the argument that it doesn’t look like Ovation, N-Data, or Rambus as a reason that the theory wouldn’t apply here. The theory has been articulated several times and never with an explicit limiting principle that would render it inapplicable to this vertical merger or many, many other transactions (including many that most economists would find pro-competitive).

    More generally, the willingness of the FTC to push the theory without regard to the economics is worthy of condemnation too. So, maybe the DOJ is off the hook for now. Good point. But I do not think that pointing out that this transaction would (in my view) be swept into the evasion theory is worth pointing out. And just to provide an additional basis for the speculation on my part, the prospects of convergence on Section 2 between the agencies (with the DOJ moving toward the FTC approach on issues like patent holdup and elsewhere and potential revocation of the Section Report) — suggest to me that there is no reason not to discuss the merits of the theory generally.

  4. 
    antitrust entity 4 February 2009 at 8:00 am

    I think you missed my point. You have supposed that the merger would lead to a higher price for some product, and that the FTC might, in challenging the merger, reject two defenses you like. The first is that the higher price reflects the increased value that buyers receive as a result of the efficiencies of vertical integration. The second is that (if the efficiencies are small), the higher price reflects the way the merger would relax some constraint on pricing that has nothing to do with pre-merger competition. My point is that independent of the merits of these defenses, there is no serious basis for either speculation here, particularly given that DOJ may conduct the investigation and that the facts look nothing like those in Ovation, N-Data or Rambus.

  5. 

    Either you missed the point, I was unclear, or both. I’ll try again.

    Obviously the fact that the empirical evidence overwhelmingly demonstrates that MOST vertical mergers are not anticompetitive doesn’t show this one isn’t. The point is that the evasion of constraint theory would render virtually all vertical mergers violations despite the fact that we know many of them shouldn’t be. The theory is overinclusive, detached from sound economics, and will lead to bad results. Whether this particular hypothetical investigation would be such an example is unknowable and besides the point.

    “The Ovation theory may not apply”.

    Again, the point is that the theory almost always applies. The examples of product portfolio changes and the like are just examples. If you apply the theory in the way that it has been articulated by its proponents in N-Data, Ovation, in Rambus, there is a whole spectrum of conduct that may be viewed as evading a pricing constraint (whether it be contractual, regulatory, based on current supply and demand conditions, etc.).

    For example, the story indicates that the post-merger firm would be exploiting economies of scale and scope (“able to manage everything from recorded music to ticket sales and tour sponsorship” and “package artists in new ways, for example, allowing corporations such as a cellphone provider to sponsor a concert tour and to sell an exclusive download of a song”).

    What are these strategies, if not an attempt by the post-merger firm to “evade” the constraints imposed on it by its prior production technology, demand for its own products, etc. Btw, the merger pretty obviously changes the product portfolio, no?

    As to whether there is also a horizontal component. Sure, but I don’t see any reason for that to stop the operation of the evasion theory.

    Perhaps we’ll get a chance to see if there is some convergence between the FTC and DOJ on monopolization afterall?

  6. 
    antitrust entity 4 February 2009 at 6:04 am

    Getting a little ahead of the story?
    This is probably a DOJ case (DOJ investigated Ticketmaster a few years back). The merger may have a horizontal component. Even if the merger is purely vertical, the fact that many vertical mergers are procompetitive doesn’t mean this one necessarily is. Even if the FTC investigates this as a vertical merger, the Ovation theory may not apply. Neither firm appears to be dropping a product from its portfolio, creating a stand alone product that might be freed from a pricing constraint arising from its ownership by a multi-product producer.