Section 2 Symposium: Dan Crane on Buyer-Instigated Bundled Discounts

Dan Crane —  6 May 2009

craneDaniel Crane is a Professor of Law at Cardozo Law School (soon to be at University of Michigan Law School).

Bundled discounts have been one of the hottest monopolization topics of the last decade. Much of the trouble began with the Third Circuit’s en banc decision in LePage’s v. 3M, which reversed an earlier 2-1 panel decision which in turn had overturned a plaintiff’s jury verdict largely based on 3M’s bundled discounts. After the Solicitor General’s amicus curiae brief asked the Supreme Court to deny cert on the grounds that there wasn’t sufficient scholarship on bundled discounts, there was a flurry of legal and economic scholarship, the overwhelming majority of which was highly critical of LePage’s.

Over the past five years or so, it seemed that a consensus was emerging that some sort of discount reallocation or attribution test should be used as a screen in bundled discounting cases. There are various formulations of the test, but in general it requires the plaintiff to show that defendant priced the competitive product below cost after the discounts on the non-competitive product are reallocated to the competitive market. Versions of that test have been adopted by a variety of commentators, agencies, and courts, including the DOJ in its Section 2 report, the Antitrust Modernization Commission, the Areeda-Hovenkamp treatise, and the Ninth Circuit’s PeaceHealth decision. I have been—and continue to be—a staunch defender of some formulation of that test.

Just when I thought we were close to reaching a strong majority position on bundled discounts, along comes a significant new article by Einer Elhauge (to be published this coming December in the Harvard Law Review) challenging the entire basis of the theory. Einer argues that bundled discounts manifest anticompetitive “power effects” if the unbundled price for the linking product exceeds the but-for price level (i.e., the price the defendant would charge in the absence of the bundle) and that such bundles should be treated as tie-ins.

Einer’s article is sure to attract lots of attention and give courts and perhaps the agencies pause in adopting the until-now consensus position on bundled discounts. Although I profoundly disagree with much of Einer’s analysis, it is a provocative and important article. Josh Wright and I are planning a full response at a later date. For the moment, let me just preview one responsive angle.Assuming we get beyond the one monopoly profit theory (which Einer attacks earlier in his paper) and believe that bundled discounts could be vehicles for monopoly leverage, our attitude toward the legal treatment of bundled discounts depends in part on where we think they originate. Critics of bundled discounts seem to assume that they are like coercive tie-ins pushed by dominant firms on weak consumers. In fact, the evidence is that many bundled discount schemes originate with strong buyers who want to leverage their multi-product buying power to achieve price concessions.

If that’s the case, then we should be suspicious of claims that bundled discounts are frequently used as monopoly leveraging devices. Power buyers do not have an incentive to facilitate a seller’s monopoly. Sure, there are circumstances where collective action problems force buyers to accept contractual terms that harm them in the long run (even buyers aware that a price is predatory usually do not insist on a higher price) but with power buyers like group purchasing organizations, pharmacy benefit mangers, and various governmental buying organizations we shouldn’t generally worry about collective action problems. These organizations often come into existence to aggregate disparate buying power–i.e., as a solution to a collective action problem. And it’s these kinds of organizations that often make requests for proposals (“RFPs”) or publish contracting guidelines that call for bundled discounts or other sorts of loyalty discounts. I don’t mean to suggest that bundled discounts are exclusively pushed by power buyers. Often, the story is more mixed. A discount for purchasing across multiple product lines may be one negotiation element that both sides push and pull in combination with other contractual elements.

Buyers expect to get better prices when they show greater loyalty to sellers and sellers are willing to give greater discounts in exchange for greater loyalty. To be sure, there are occasions when monopolistic sellers push bundled discounts to exclude rivals, but these are by far the exception to the rule.

In medicine, there’s an aphorism that when you hear hoofbeats, you should think horse, not zebra. I think this applies neatly to bundled discounts.

Most of the time bundled discounts are competitively benign and our instinct should be to assume that they reflect ordinary business practices, not exclusion devices. Rules crafted for the exceptional cases must take care not to paint stripes on too many horses.

5 responses to Section 2 Symposium: Dan Crane on Buyer-Instigated Bundled Discounts

  1. 
    Thom Lambert 6 May 2009 at 10:29 am

    Tim Brennan challenges “the consensus Dan describes” (i.e., that there should be a safe harbor for any bundled discount that results in an above-cost price for the competitive product after attributing the entire amount of the discount to that product) by observing that challenged bundled discounts are usually given to resellers so that “the competitive problem created by these discounts is akin to that from exclusive dealing.” He suggests that the bundled discounts are effectively “payments to complement providers not to deal with rivals.”

    Even if that’s so, shouldn’t discounts that pass muster under the discount attribution test be immune from liability? Absent an express covenant of exclusivity, any “exclusive dealing” generated by a bundled discount results from the fact that the buyers (even if they’re middlemen) chose the discounter’s goods because they were cheaper than those of rivals. When the discount is above-cost under the discount attribution test, any equally efficient rival could meet that discount (and thereby avoid the “foreclosure” occasioned by the bundled discount) by lowering its price. Thus, any rival who experiences exclusive dealing-like foreclosure from a bundled discount that passes muster under the discount attribution test is either relatively inefficient or unwilling to lower its price to the level of its cost. In either case, its exclusion from the market is not a “harm to competition.”

    It seems to me, then, that no discount that falls within the PeaceHealth safe harbor can cause anticompetitive harm, even if bundled discounts are analogized to exclusive dealing. I don’t see how the exclusive dealing analogy challenges the (near) consensus on the discount attribution test. Am I missing something?

  2. 
    Herb Hovenkamp 6 May 2009 at 9:30 am

    One important difference between a bundled discount and a tie is the penalty for avoidance. If Alpha and Beta are tied together contractually a firm that already has a contract can purchase Beta from a rival only by breaching the tying contract. A firm that does not yet have a contract cannot purchase Alpha at all without purchasing Beta. As a result the contract itself tells prospective buyers that if they want Alpha without Beta or Beta from a different source they must shop elsewhere.
    By contrast, a bundled discount simply places a price on avoiding the dominant firm’s bundle – namely, the lost discount. If another firm is equally efficient and offers both Alpha and Beta this is no penalty at all. Likewise, if another firm offers only Beta but the discount passes the attribution test, then there is no penalty at all either. An equally efficient rival will be able to supply Beta and the net Alpha-Beta price will be no higher than if the customer purchased from the dominant firm.
    One variation that has become popular, particularly in the New Institutional Economics (NIE) literature, concerns the dominant firm that raises the price of Alpha and then bundles Beta, with a post-bundle price that may be no lower than the pre-bundle price, but that excludes anyway because a Beta-only rival cannot match the discount. In that case, during the bundling period the standalone price of Alpha is higher than the firm’s profit-maximizing but for price. This practice may amount to tying in situations where no one wants standalone Alpha at the higher price. In its current useable form the test generates way too many false positives because plaintiffs tend to attribute any pre-bundling price increase to this strategy. Further, there are some pretty good pro-competitive (or at least competitively harmless) explanations. For example, buyers who don’t need Beta may have a lower demand elasticity than buyers who do, and the strategy permits the firm to segregate buyers on this basis. In that case welfare effects could be positive or negative, but the bundling practice will generally not be exclusionary unless it results in higher output than pre-bundling practice. Before the strategy is ready for litigation we have to have a reliable mechanism for distinguishing anticompetitive from benign uses.
    Finally, a couple of warnings about tying, bundling and price discrimination: first, it is essential that we be able to distinguish existence theorems from proof. Economists at least since the 1930’s (particularly since Arthur Pigou and Joan Robinson) have been modeling the welfare effects of price discrimination under various assumptions. That is a far cry from looking at a particular price discrimination practice and stating its welfare or exclusonary effects. Second, §2 of the Sherman Act is an exclusionary practice provision, not a general welfare prescription. As a general proposition, price discrimination that reduces output also reduces welfare, but output reducing discrimination seldom excludes. Price discrimination by ties or otherwise that results in increased output is much more likely to be exclusionary, but it is also much more likely to be welfare enhancing.
    Reasoning from a parrticular instance of tying/price discrimination effected by a tie to a conclusion of competitive harm has proven extraordinarily difficult. One might posit that market-power-plus-output-reducing tie creates a presumtion of injury to competition – but this can result from a marketing flop just as much as from anticompetitive consequences; and, as noted before, output reducing ties rarely exclude anyone. A tie might also extract more from low elasticity buyers, but this is hardly exclusionary and may not even be welfare reducing if there are offsetting benefits in other parts of the market, particularly for high elasticity buyers whom the price discrimination tie brings in.

  3. 
    Howard P. Marvel 6 May 2009 at 9:23 am

    Tim Brennan adds LePage’s to Dan Crane’s mix, but it really doesn’t belong. LePage’s was clearly an offer to retailers of rebates conditional on their making sales targets. The question is why 3M would have offered such sweeping discounts across very broad lines for the purpose of targeting LePage’s tape. It is more plausible that the rebate schemes had other goals in mind. What might they be? I, too, can do shameless plugs: “Inventory Turnover and Product Variety”, Journal of Law & Economics, August 2008 (with Jim Peck).

    Crane is right that bundling solicited by purchasers is likely to be competition enhancing. We know that a monopolist who is able to deploy perfect price discrimination can extract all surplus from consumers, and that perfect price discrimination can take the form of a bundle offered on a take-it-or-leave-it offer. But what is less understood is that a purchaser can do substantially better than very competitive constant per-unit pricing by inducing suppliers to compete by offering bundles. Plug number two: “Group purchasing, nonlinear tariffs, and oligopoly,” International Journal of Industrial Organization, Volume 26, Issue 5, September 2008, Pages 1090-1105 (with Huanxing Yang). Jim Dana has shown supplier who wants to do even better must split surplus with the buyer, but this exclusion, while lowering price, generates some inefficiency in consumption in cases when consumers have strong preferences over which competing product they prefer.

  4. 
    Tim Brennan 6 May 2009 at 8:47 am

    I’ll chime in as a challenger of the consensus Dan describes. The conventional wisdom, embodied by the AMC’s recommendation, is to treat bundled discounts as if they were predatory pricing cases. If so, the bar should be high, and a Brooke Group like price test would be appropriate.

    However, in (almost) all of the bundled discount cases, the recipient of the discount isn’t a final purchaser, but an intermediate good provider, e.g., the tape retailers in Lepage’s. Hence, the competitive problem created by these discounts is akin to that from exclusive dealing–are they payments to complement providers not to deal with rivals? If enough of the complement market is covered, a big “if”, then the price of the complement–distribution, retailing, whatever–could rise. The anticompetitive rents created by suppressing competition among the complement providers is the reward. The bundled discount is the incentive for exclusion and way that reward from suppressing competition is spread among the distributors, retailers, etc.

    Of course, this doesn’t mean discounts are inherently anticompetitive, for the reasons Dan points out. One should be concerned with them only if those with a single supplier cover so much of the complement market that the explicit price or implicit margin the remaining complement providers charge increases. Clearly in industries where multiple upstream competitors offer such discounts, e.g., there won’t be much if any reason to infer suppression of competition.

    Since Dan mentioned Einer’s article, I’ll make a shameless plug for one of mine already out on this: “Bundled Rebates as Exclusion Rather Than Predation,” 4 J. Competition L. and Econ. 335-374 (2008); doi: 10.1093/joclec/nhn001.

Trackbacks and Pingbacks:

  1. TRUTH ON THE MARKET » Section 2 Symposium: Josh Wright on An Evidence Based Approach to Exclusive Dealing and Loyalty Discounts - September 17, 2009

    […] others to discuss cost-based approaches to loyalty discounts, such as those discussed by Thom and Dan in their earlier posts on bundled discounts, but note here that the foreclosure based safe harbor […]