PeaceHealth Should Apply Even When a Bundled Discount Results in "De Facto" Exclusive Dealing

Thom Lambert —  3 November 2009

The Ninth Circuit, whose PeaceHealth decision moved the law on bundled discounting in the right direction, recently issued another decision on bundled discounts. That decision, Masimo Corp. v. Tyco Health Care Group, L.P., threatens to limit PeaceHealth‘s effectiveness.

Medical device manufacturer Masimo sued Tyco for monopolizing the market for pulse oximetry devices. A monopolization action requires that the defendant engage in “exclusionary conduct.” One of Tyco’s purportedly exclusionary actions was offering substantial discounts to hospital group purchasing organizations, where the discounts were contingent on meeting purchase targets across numerous product lines. For example, a buyer that purchased 90% of its requirements of products A, B, and C from Tyco would receive a 5-7% discount on its Tyco purchases from all three lines.

Masimo competes against Tyco in one of the lines (pulse oximetry equipment) but not in the others. Like the plaintiff in the notorious LePage’s case, it claimed that Tyco’s bundled discount scheme would cause it to lose business unless it matched the entire dollar amount of Tyco’s multiple product discount on its single product. Because it would be difficult to match several products’ worth of discounts on one single product, Masimo argued, Tyco’s bundled discounting scheme was unreasonably exclusionary.

The district court rejected Masimo’s argument and granted summary judgment for Tyco on the basis of the PeaceHealth standard. In PeaceHealth, the Ninth Circuit held that when a single-product seller complains about a multi-product rival’s bundled discounting, it can establish liability only if it shows that attributing the entire amount of the bundled discount to the defendant’s competitive product would result in a below-cost price for that product. This so-called “discount attribution” standard ensures that antitrust condemns only those bundled discounts that could exclude equally efficient single-product rivals. That is because any such rival could match, on its one product, the entire amount of a bundled discount as long as that bundled discount results in an above-cost price for the defendant’s competitive product after the full discount is attributed to that product. Because Masimo did not show that attributing the entire amount of Tyco’s bundled discount to the competitive product resulted in a price below Tyco’s cost, it could not establish antitrust liability based on Tyco’s bundled discounting.

On appeal to the Ninth Circuit, Masimo argued that the PeaceHealth standard should not apply because Tyco’s bundled discounts resulted in de facto exclusive dealing. In order to qualify for Tyco’s bundled discounts, a buyer had to purchase from Tyco large percentages (90-95%) of the buyer’s requirements in multiple product lines, including pulse oximetry. Masimo argued that the prospect of a substantial multi-product discount led buyers to buy their pulse oximetry equipment exclusively or almost exclusively from Tyco. Claims based on such “exclusive dealing,” Masimo contended, are not subject to the discount attribution standard applicable to simple bundled discounting claims.

The Ninth Circuit agreed with Masimo that Tyco’s bundled discounts, conditioned on a high degree of loyalty (90+%), resulted in de facto exclusive dealing and that the discount attribution test doesn’t apply to such “exclusive dealing.” Nevertheless, it rejected Masimo’s de facto exclusive dealing claim because the evidence in the record couldn’t support a finding that Tyco’s bundling arrangements were so extensive that they foreclosed Masimo from a substantial share of available sales opportunities in the market. (“As the district court determined, the evidence in the trial record concerning the pervasiveness and effects of Tyco’s varied bundling arrangements was insufficient to support a finding that the arrangements foreclosed competition in a substantial share of the relevant market.”) Since there can be no exclusive dealing liability unless the exclusive arrangements at issue foreclose competitors from a substantial portion of available marketing outlets, Masimo could not prevail.

While the court was right to affirm the lower court’s judgment in favor of Tyco, its reasoning was sorely disappointing. The court essentially adopted a rule that any bundled discount that is so attractive to buyers that it leads them to purchase one product exclusively from the discounter will be treated as exclusive dealing and will not be analyzed under PeaceHealth even if there’s no actual exclusivity covenant (i.e., a buyer agreement to purchase exclusively from the seller). That flies in the face of the very rationale for PeaceHealth: that discounting behavior should be condemned only when it has the potential to exclude an equally efficient rival.

Masimo argued on appeal, and the Ninth Circuit apparently agreed, that de facto exclusive dealing goes beyond aggressive price competition and thus ought to be regulated more stringently. But that’s just wrong. Regardless of how the law treats actual (covenant-based) exclusive dealing, the de facto exclusive dealing of which Masimo complained is really nothing more than successful price competition. Tyco procured exclusivity not by getting buyers to agree to purchase only from it but by offering prices that were so low that buyers just decided to drop all other suppliers. The only pertinent legal question, then, is whether Tyco’s exclusivity-inducing prices were so low that they could not be matched by an equally efficient single-product rival. As long as its price for each product was above-cost after the entire amount of the bundled discount was attributed to that product, any equally efficient single-product rival could match the discount, and the bundled discounting should be immune from liability.

The rule adopted by the Masimo court may allow plaintiffs to evade the procompetitive protections of the PeaceHealth standard merely by attaching a new legal label (e.g., predatory pricing, de facto tying, de facto exclusive dealing, unspecified “exclusionary conduct”) to otherwise indistinguishable conduct. To avoid the legal equivalent of Greek mythology’s many-headed Hydra, the question should not be “What label has plaintiff affixed to its claim?”, but rather “Is the behavior of which plaintiff complains likely to impair competition?” When it comes to bundled discounts, which generally reflect (or promote) cost-savings and which provide an immediate benefit to consumers, there can be no anticompetitive harm in the form of predation, unreasonable exclusion, or foreclosure if the competitive product is priced above the defendant’s cost once the entire discount is attributed to that product.

The good news is that the Ninth Circuit’s Masimo decision is unpublished and may therefore have little precedential effect. Let’s hope. And let’s hope the court does better next time.

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NOTE: I submitted an amicus brief in the Masimo case. If anyone’s interested in a copy of the brief, shoot me an email.

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

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