Search Results For loyalty discounts

In Collins Inkjet Corp. v. Eastman Kodak Co. (2015) (subsequently settled, leading to a withdrawal of Kodak’s petition for certiorari), the Sixth Circuit elected to apply the Cascade Health Solutions v. PeaceHealth “bundled discount attribution price-cost” methodology in upholding a preliminary injunction against Kodak’s policy of discounting the price of refurbished Kodak printheads to customers who purchased ink from Kodak, rather than from Collins.  This case illustrates the incoherence and economic irrationality of current tying doctrine, and the need for Supreme Court guidance – hopefully sooner rather than later.

The key factual and legal findings in this case, set forth by the Sixth Circuit, were as follows:

Collins is Kodak’s competitor for selling ink for Versamark printers manufactured by Kodak. Users of Versamark printers must periodically replace a printer component called a printhead; Kodak is the only provider of replacement “refurbished printheads” for such printers. In July 2013, Kodak adopted a pricing policy that raised the cost of replacing Versamark printheads, but only for customers not purchasing Kodak ink. Collins filed suit, arguing that this amounts to a tying arrangement prohibited under § 1 of the Sherman Act, 15 U.S.C. § 1, because it is designed to monopolize the Versamark ink market. Collins sought a preliminary injunction barring Kodak from charging Collins’ customers a higher price for refurbished printheads. The district court issued the preliminary injunction, finding a strong likelihood that Kodak’s pricing policy was a non-explicit tie that coerced Versamark owners into buying Kodak ink and that Kodak possessed sufficient market power in the market for refurbished printheads to make the tie effective.

On appeal, Kodak challenges both the legal standard the district court applied to find whether customers were coerced into using Kodak ink and the district court’s preliminary factual findings. In evaluating the likelihood of success on the merits, the district court applied a standard that unduly favored Collins to determine whether customers were coerced into buying Kodak ink. The court examined whether the policy made it likely that all or almost all customers would switch to Kodak ink, but did not examine whether this would be the result of unreasonable conduct on Kodak’s part. A tying arrangement enforced entirely through differential pricing of the tying product contravenes the Sherman Act only if the pricing policy is economically equivalent to selling the tied product below cost. The record makes it difficult to determine conclusively Kodak’s ink production costs, but the available evidence suggests that Kodak was worse off when customers bought both products, meaning that it was in effect selling ink at a loss. Thus, Collins was likely to succeed on the merits even under the correct standard.  Furthermore, the district court was correct in its consideration of the other factors for a preliminary injunction. Accordingly, the preliminary injunction was not an abuse of discretion.

The Sixth Circuit’s Collins Inkjet opinion nicely illustrates the current unsatisfactory state of tying law from an economic perspective.  Unlike in various other areas of antitrust law, such as vertical restraints, exclusionary conduct, and enforcement, the Supreme Court has failed to apply a law and economics standard to tying.  It came close on two occasions, with four Justices supporting a rule of reason standard for tying in Jefferson Parish, and with a Supreme Court majority acknowledging that “[m]any tying arrangements . . . are fully consistent with a free, competitive market” in Independent Ink (which held that it should not be presumed that a patented tying product conveyed market power).  Nevertheless, despite the broad scholarly recognition that tying may generate major economic efficiencies (even when the tying product conveys substantial market power), tying still remains subject to a peculiar rule of limited per se illegality, which is triggered when:  (1) two separate products or services are involved; (2) the sale or agreement to sell one is conditioned on the purchase of the other; (3) the seller has sufficient economic power in the market for the tying product to enable it to restrain trade in the market for the tied product; and (4) a “not insubstantial amount” of interstate commerce in the tied product is affected.  Unfortunately, it is quite possible for plaintiffs to shoehorn much welfare-enhancing conduct into this multipart test, creating a welfare-inimical disincentive for efficiency-seeking businesses to engage in such conduct.  (The U.S. Court of Appeals for the D.C. Circuit refused to apply the per se rule to platform software in United States v. Microsoft, but other appellate courts have not been similarly inclined to flout Supreme Court precedent.)

Courts that are concerned with the efficient application of antitrust may nonetheless evade the confines of the per se rule in appropriate instances, by applying economic reasoning to the factual context presented and finding particular test conditions not met.  The Sixth Circuit’s Collins Inkjet opinion, unfortunately, failed to do so.  It is seriously problematic, in at least four respects.

First, the Sixth Circuit’s opinion agreed with the district court that “coercive” behavior created an “implicit tie,” despite the absence of formal contractual provisions that explicitly tied Kodak’s ink to sale of its refurbished printheads.

Second, it ignored potential vigorous and beneficial ex ante competition among competing producers of printers to acquire customers, which would have negated a finding of significant economic power in the printer market and thereby precluded per se condemnation.

Third, it incorrectly applied the PeaceHealth standard to the facts at hand due to faulty economic reasoning.  For a finding of anticompetitive (“exclusionary”) bundled discounting, PeaceHealth requires that, after all discounts are applied to the “competitive” product, “the resulting price of the competitive product or products is below the defendant’s incremental cost to produce them”.  In Collins Inkjet, all that was known was that Kodak “stood to make more money if customers bought ink from Collins and paid Kodak’s unmatched printhead refurbishment price than if they bought Kodak ink and paid the matched printhead refurbishment price.”  Absent additional information, however, this merely supported a finding that Kodak’s tied ink was priced below its average total cost, not below its (far lower) incremental cost.  (Applying PeaceHealth, the Collins Inkjet court attributed the printhead discount entirely to Kodak’s ink, the tied product.)  In short, absent this error in reasoning (ironically, the court justified its flawed cost analysis “as a matter of formal logic”), the Sixth Circuit could not have based a finding of anticompetitive conduct on the PeaceHealth precedent.

Fourth, and more generally, the Sixth Circuit’s opinion, in its blinkered search for a “modern” (PeaceHealth) finely-calibrated test to apply in this instance, lost sight of the Supreme Court’s broad teaching in Reiter v. Sonotone Corp. that antitrust law was designed to be “a consumer welfare prescription.”  Kodak’s pricing policy that offered discounts to buyers of its printheads and ink yielded lower prices to consumers.  There was no showing that Collins Inkjet would likely be driven out of business, or, even if it were, that consumers would eventually be harmed.  Absent any showing of likely anticompetitive effects, vertical contractual provisions, including tying, should not be subject to antitrust challenge.  Indeed, as Professor (and former Federal Trade Commissioner) Joshua Wright and I have pointed out:

[T]he potential efficiencies associated with . . . tying . . . and the fact that [tying is] prevalent in markets without significant antitrust market power, lead most commentators to believe that [it is] . . . generally procompetitive and should be analyzed under some form of rule of reason analysis. . . .  [T]he adoption of a rule of reason for tying and presumptions of legality for [tying] . . . under certain circumstances may be long overdue.  

In sum, it is high time for the Supreme Court to take an appropriate case and clarify that tying arrangements (whether explicit or “coerced”) are subject to the rule of reason, with full recognition of tying’s efficiencies.  Such a holding would enable businesses to engage in a wider variety of efficient contracts, thereby promoting consumer welfare.

Finally, while it is at it, the Court should also consider taking a loyalty discount case, to reduce harmful uncertainty in this important area (caused by such economically irrational precedents as LePage’s, Inc. v. 3M) and establish a clear standard to guide the business community.  If it takes a loyalty discount case, the Court could beneficially draw upon Wright’s observation that “economic theory and evidence suggest[s] that instances of anticompetitive loyalty discounts will be relatively rare,” and his recommendation that “an exclusive dealing framework . . . be applied in such cases.”

The “magic” of Washington can only go so far. Whether it is political consultants trying to create controversy where there is basic consensus, such as in parts of the political campaign, or the earnest effort to create a controversy over the Apple decision, there may be lots of words exchanged and animated discussion by political and antitrust pundits, but at the end of the day it’s much ado about not much. For the Apple case, even though this blog has attracted some of the keenest creative antitrust thinkers, a simple truth remains – there was overwhelming evidence that there was a horizontal agreement among suppliers and that Apple participated or even led the agreement as a seller. This is, by definition, a hub-and-spoke conspiracy that resulted in horizontal price fixing among ebook suppliers – an activity worthy of per se treatment.

The simplicity of this case belies the controversy of the ruling and the calls for Supreme Court review. Those that support Apple’s petition for certiorari seem to think that the case is a good vehicle to address important questions of policy in the law. Indeed, ICLE submitted an excellent brief making just such a case. But, unfortunately, the facts of this case are not great for resolving these problems.

For example, some would like to look at this case not as a horizontal price fixing agreement among competitors facilitated by a vertical party, but instead as a series of vertical agreements. This is very tempting, because the antitrust revolution was built on the back of fixing harmful precedent of per se condemnation of vertical restraints. Starting with GTE Sylvania, the Supreme Court has repeatedly applied modern economic learning to vertical restraints and found that there are numerous potential procompetitive benefits that must be accounted for in any proper antitrust analysis of a vertical agreement.

This view of the Apple e-book case is especially tempting because the Supreme Court’s work in this area of the law is not done. For example, the Supreme Court needs to update the law on exclusive dealing and loyalty discounts to reflect post-GTE Sylvania thinking, something I have written extensively on (including here at TOTM: here, here and here) in the context of the McWane case. (Which is also up for cert review). However, the facts of this case simply make this a bad case to resolve any matter of vertical restraint law. Apple was not approaching publishers individually, but aggressively orchestrating a scheme that immediately raised e-book prices by 30% and ensured that Apple’s store could not be undercut by any competitor. Consumers were very obviously harmed and the horizontal price fixing conspiracy could not have taken place without Apple’s involvement.

Of course in the court of public opinion (which is not an antitrust court) Apple attempted to wear the garb of the Robin Hood for consumers suggesting it was just trying to respond to Amazon’s dominance over ebooks. But the Justice Department and the court quickly saw through that guise. The proper response to market dominance is to compete harder. And that’s what happened. Apple’s successful entry into the e-book market seems to provide a more effective response than any cartel. But this does not show that there were procompetitive benefits of Apple’s anticompetitive actions worthy of rule of reason treatment. To the contrary, prices rose and output fell during the conduct at issue – exactly what one would expect to see following anticompetitive activities.

This argument also presupposes that Amazon’s dominance was bad for consumers. This is refuted by Scalia in Trinko:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

The other problem with this line of thinking is that it suggests that it is OK to violate the antitrust laws to prevent a rival from charging too low of a price. This would obviously be bad policy. If Amazon was maintaining its dominant position through anticompetitive conduct, then there exists recourse in the law. As the old adage states, two wrongs do not make a right.

The main problem with the Apple e-book case is that it is a very simple case that lightly brushes against up against areas of law that and questions of policy that are attractive for Supreme Court review. There are important policy issues that still need to be addressed by the Supreme Court, but these facts don’t present them.

The Supreme Court does have an important job in helping antitrust law evolve in a sensible fashion. But this case is a soggy appetizer when there is a much more engaging main course about to be served. A cert petition has been filed in the FTC’s case against McWane, which provides a chance to update the law of exclusive dealing which the Court has not grappled with since the days of Sputnik (Only a slight exaggeration). And in McWane the most important business groups Including the Chamber of Commerce and the National Association of Manufacturers have explained that the confusion and obscurity in this area and the mischief of the lower court’s decisions create real impediments to procompetitive conduct. Professors of law and economics (including several TOTM authors) also wrote in support of the petition.

The Court should skip the appetizer and get to the main course.

Steve Horwitz is the Distinguished Professor of Free Enterprise, Department of Economics, at Ball State University

In considering the importance of the Amazon merger with Whole Foods, some history is helpful. The relevant historical context here is not just the history of those two firms, but the longer and broader history of the grocery industry. In particular, it’s helpful to see this merger as the next stage in a pattern of falling transaction costs and shifting specializations that have driven that evolutionary process. We can see how the two parties to this merger both came to prominence independently as part of that process, and how the merger is the natural next step.

At the start of the 20th century, many Americans still produced a good deal of their own food. Where the rest was purchased depended on where one lived. Small town folks had their general store while more urban folks had a variety of specialty shops to choose from. You got your meat from a butcher, your bread from a baker, fresh fruits and veggies elsewhere, and dry goods yet another place. That specialization had its advantages, but it also imposed an increasing burden on families as life got busier and more women began to enter the workforce. It required time and resources to make those multiple trips.

The modern supermarket emerges in the 1930s as a one-stop shop for many of the things that previously were purchased separately. The advent of car culture enabled firms to locate outside of downtown areas where parking was easier and land was cheaper. Smaller inventions like the shopping cart enabled people to navigate larger stores and buy more goods, which in turn aligned with the lower average costs associated with greater size. It took modern technologies such as reliable refrigeration, new techniques for freezing food, and advances in transportation to make the supermarket feasible. By the 1960s and 70s, true supermarkets were ubiquitous, though they were still small, dim, and lacking in variety compared to the food palaces of the 21st century.

Continued marginal improvements in technology and transportation enabled the supermarkets of the 70s to become the much larger and more luxurious versions that appeared by the turn of the 21st century. Since then, transportation technology has not improved that much, but communication and other forms of technology have, which brings us to one of the two players in our story: Amazon. Amazon’s rise has been fueled by the combination of increased computing power, the Internet, and the falling cost of consumer computing technology, especially smartphones. All of these factors have enabled Amazon to assemble its own inventories, tap into those of other sellers, and bring them all to consumers cheaply and quickly. Also not to be overlooked is the marketing genius of “Prime,” which convinced consumers to essentially pay their shipping costs up front, removing the pain of positive shipping costs on the margin. Amazon also built on the advances of other large-scale retailers like Walmart in the decade or two before. The irony now is that many of them are trying to match the Amazon experience of not having to go into a physical store by offering delivery to your car for orders placed online. And more mega-markets are offering pick-up or home delivery as an option as well.

On the grocery side, a different trend was emerging. Even as large mega-markets were becoming more popular, consumers with more resources and more concerns about where their food came from and its overall quality were willing to pay more for a more upscale and ethically concerned shopping experience. The growth of markets like Whole Foods, Fresh Market, and Fresh Thyme made clear there was a demand for smaller, higher quality stores that focused on fresh produce, meats, and fish as well as upscale prepared food. What all of these stores gave up to go smaller was the selection of dry goods that had come to characterize the mega-markets. This strategy made sense because of firms like Walmart and Target, which had dramatically dropped the consumer cost of those goods, not to mention the wholesale clubs like Costco. The experience that was once associated with the mega-market opportunity to get everything was being fragmented by the combination of upscale grocery stores and low-cost big boxes, with the latter’s entry into the grocery market duly noted.

So as Amazon’s growth in the delivery of non-perishable goods increased, more consumers were purchasing items previously bought in a supermarket or a big box store through Amazon. The big advantage is delivery, and that is just another step in recognizing the increasing value of people’s time that began the move to supermarkets in the first place. We’ve gone from not having the time to make multiple stops for shopping to not wanting to either get out of our car or even leave the house to do so. Given Amazon’s growth in the delivery of non-perishables, the idea of merging with a grocery store that specialized in providing high-quality fresh perishables was not hard to fathom. And a year ago that came to fruition with the merger with Whole Foods.

The merger points to what the future of the grocery industry might well look like, which in some ways looks like a return to the past. I think that we will see the hollowing out of the center of the supermarket. All of the non-perishables, whether food items like breakfast cereal or household goods like toilet paper, will slowly disappear, with consumers purchasing them at cheaper big-box stores, or through delivery services like Amazon. The grocery experience will become more focused on the periphery of the store: produce, meats, dairy, frozen foods, and prepared foods. The high-quality of those goods will make the grocery store seem something like a return to the past, with specialized butchers and bakers and the like, but now all under one roof to minimize the transportation costs. These all remain more or less experience goods that many consumers want to be able to see or touch or smell before they purchase, making them harder to sell through delivery, especially when one considers the additional shipping costs involved with keeping them fresh.

In these ways, the Amazon-Whole Foods merger is both the predictable outcome of the history of the grocery store and a pointer for where it is headed in the future. Already we are beginning to seem some interesting economic benefits coming from the synergies involved. One of the more noticeable ones is that many Whole Foods are now offering two hour delivery. As noted earlier, many of the traditional grocery chains are now offering delivery, so it makes sense that the merged firm would combine the distinctive upscale selection at Whole Foods with Amazon’s delivery capacity. To the degree consumers have a great deal of trust in the Amazon brand name when it comes to delivery, this looks like a smart move for Amazon and a win for consumers.

Another early move is to offer in-store discounts for Amazon Prime members. In essence what Amazon has done here is to use Prime membership as the equivalent of a grocery loyalty card. You get the discounts applied by scanning the Whole Foods app at the register after you have linked that app to your Amazon account. In the same way that traditional grocery store loyalty cards enable firms to have enormous data on your purchasing patterns and to then customize coupons for you, Amazon already had a lot of data on Prime members and can easily extend the same customization you get when you login to Amazon to customers who also shop at Whole Foods. Economically, the Prime discounts are, like coupons, a form of price discrimination that hopes to pull Prime members into Whole Foods who see it as a close enough substitute for their normal grocery store. Given Whole Foods’ well-earned reputation as more expensive than traditional grocery stores, the Prime discounts might be enough to pull people away from something like Kroger and into Whole Foods more often.

With Amazon’s enormous database and the logistics that it can bring to delivery, I suspect that we are shortly going to see all kinds of ways in which the grocery shopping experience at Whole Foods will become extraordinarily customized in the same way the shopping experience at Amazon already is. It will also be interesting to see if Whole Foods doesn’t move to a membership model based on having Prime.

Viewed from the long history of the evolution of the grocery store, the Amazon-Whole Foods merger made sense as the start of the next stage of that historical process. The combination of increased wealth that is driving the demand for upscale grocery stores, and the corresponding increase in the value of people’s time that is driving the demand for one-stop shopping and various forms of pick-up and delivery, makes clear the potential benefits of this merger. Amazon was already beginning to make a mark in the sale and delivery of the non-perishables and dry goods that upscale groceries tend to have less of. Acquiring Whole Foods gives it a way to expand that into perishables in a very sensible way. We are only beginning to see the synergies that this combination will produce. Its long-term effect on the structure of the grocery business will be significant and highly beneficial for consumers.

by Dan Crane, Associate Dean for Faculty and Research and Frederick Paul Furth, Sr. Professor of Law, University of Michigan Law School

The FTC was the brain child of Progressive Era technocrats who believed that markets could be made to run more effectively if distinguished experts in industry and economics were just put in charge. Alas, as former FTC Chair Bill Kovacic has chronicled, over the Commission’s first century precious few of the Commissioners have been distinguished economists or business leaders. Rather, the Commissioners have been largely drawn from the ranks of politically connected lawyers, often filling patronage appointments.

How refreshing it’s been to have Josh Wright, highly distinguished both as an economist and as a law professor, serve on the Commission. Much of the media attention to Josh has focused on his bold conservatism in antitrust and consumer protection matters. But Josh has made at least as much of a mark in advocating for the importance of economists and rigorous economic analysis at the Commission.

Josh has long proclaimed that his enforcement philosophy is evidence-based rather than a priori or ideological. He has argued that the Commission should bring enforcement actions when the economic facts show objective harm to consumers, and not bring actions when the facts don’t show harm to consumers. A good example of Josh’s perspective in action is his dissenting statement in the McWane case, where the Commission staff may have had a reasonable theory of foreclosure, but not enough economic evidence to back it up.

Among other things, Josh has eloquently advocated for the institutional importance of the economist’s role in FTC decision making. Just a few weeks ago, he issued a statement on the Bureau of Economics, Independence, and Agency Performance. Josh began with the astute observation that, in disputes within large bureaucratic organizations, the larger group usually wins. He then observed that the lopsided ratio of lawyers in the Bureau of Competition to economists in the Bureau of Economics has led to lawyers holding the whip hand within the organization. This structural bias toward legal rather than economic reasoning has important implications for the substance of Commission decisions. For example, Malcolm Coate and Andrew Heimert’s study of merger efficiencies claims at the FTC showed that economists in BE were far more likely than lawyers in BC to credit efficiencies claims. Josh’s focus on the institutional importance of economists deserves careful consideration in future budgetary and resource allocation discussions.

In considering Josh’s legacy, it’s also important to note that Josh’s prescriptions in favor of economic analysis were not uniformly “conservative” in the trite political or ideological sense. In 2013, Josh gave a speech arguing against the application of the cost-price test in loyalty discount cases. This surprised lots of people in the antitrust community, myself included. The gist of Josh’s argument was that a legalistic cost-price test would be insufficiently attentive to the economic facts of a particular case and potentially immunize exclusionary behavior. I disagreed (and still disagree) with Josh’s analysis and said so at the time. Nonetheless, it’s important to note that Josh was acting consistently with his evidence-based philosophy, asking for proof of economic facts rather than reliance on legal short-cuts. To his great credit, Josh followed his philosophy regardless of whether it supported more or less intervention.

In sum, though his service was relatively short, Josh has left an important mark on the Commission, founded in his distinctive perspective as an economist. It is to be hoped that his appointment and service will set a precedent for more economist Commissioners in the future.

Jarod M. Bona is the CEO of and Attorney at BonaLaw PC as well as a writer at The Antitrust Attorney Blog.  Steven Levitsky is also an Attorney at BonaLaw PC and a writer at  The Antitrust Attorney Blog.

One year ago, Amazon acquired Whole Foods in a $13.7 billion deal. At the time, David Balto, a disciple of current antitrust orthodoxy, wrote:

Those who are saying the Amazon-Whole Foods merger is a competition problem are leading us into the jungle without a compass and no clear objective. Antitrust law should stick to protecting consumers and let the free market work.

The FTC quickly cleared “Project Athena” and issued a very short press release saying, “The FTC conducted an investigation of this proposed acquisition to determine whether it substantially lessened competition under Section 7 of the Clayton Act, or constituted an unfair method of competition under Section 5 of the FTC Act. Based on our investigation we have decided not to pursue this matter further.”

In fact, there was a lot to love for consumers from this merger over the last year: Amazon leveraged the Whole Foods stores to provide pick up and return centers for Amazon customers. Prices dropped. There are competitive alternatives. Those are, indeed, tangible consumer benefits.

That’s great, of course, and—at least in the short run—shows that the FTC reached the right conclusion in letting the merger go forward.

But, still, something feels different here. Uncomfortable even. Like when the sky is just too still before the storm hits. At least one of the authors of this article leans strongly libertarian and even feels worry.

But let’s pause from that feeling for a moment and return to antitrust law. The federal antitrust laws are an effective regulatory mechanism—enforced through both agencies and courts—when pure competition issues are involved. There is, of course, the periodic debate about what consumer welfare should mean, but for the most part antitrust law is effective in keeping the markets open for competition. And, of course, the US Supreme Court famously explained in National Society of Professional Engineers v. United States (1978) that “The heart of our national economy long as been faith in the value of competition.”

But when it comes to mega-mergers and the related aggregation of power by some of today’s big tech companies, are there limits to the effectiveness of current federal antitrust law to protect long-term consumer welfare?

Antitrust law, of course, focuses on specifically defined, often narrow, product and geographic markets. And mega-mergers and tech company power may not necessarily threaten to lessen competition in a single market—the Amazon-Whole Foods merger certainly didn’t.

But they do something much more pernicious: they aggregate data about us; they consolidate economic power across different markets; they acquire power through control of jobs, attention, and social and political communication; and they have the ability to harm local businesses (which, of course, was a larger concern of old-timey antitrust law, before the Chicago school made its appearance).

George Orwell’s 1984 never really materialized in terms of British government power (although Orwell may have believed that the British government had already acquired excess power by 1948). But today, Amazon, or Google, or Netflix, or Facebook, or Twitter are on aggregation cycles that give them the power (metaphorically, or possibly even literally) to listen in on our lives. For example, on August 23, 2018, there was a news report that read:

Representatives from a host of the biggest US tech companies, including Facebook and Twitter, have scheduled a private meeting for Friday to share their tactics in preparation for the 2018 midterm elections.

The same report indicated that nine of those same companies had already met in May 2018. Naturally, these companies claim they discuss only cybersecurity issues. But what do we do about these same social media companies that impose censorship on messages or information they don’t like. It’s great to say there are alternatives, but in fact, there aren’t. Because of the power of network effects, many people rely on these primary social media networks for their information, and that network has essentially replaced the old town square or the newspaper as a source of information for a discussion forum. The government would not dare to silence debate the way these private companies have done.

Size has economies of scale and efficiency, but it lacks the unconnected diversity of ideas, approaches, and testing that serve as the foundation for organic systems like a free-market economy. You replace a bottom-up system with a top-down system controlled by certain corporate powers, who use network effects to take over one aspect of our lives after another.

This is where it starts to get confusing because those that typically push for free markets are confronted with a situation where worshipping efficiency could ultimately create homogeneous behemoths that can destroy any would-be competitors like an annoying gnat on a late summer night.

In another article, one of us worried about similar problems from speech filters inherent in these large networks controlling so many aspects of our lives.

This is not healthy. It is not desirable. But it is probably not a violation of the antitrust laws.

Let’s return to the Amazon-Whole Foods merger. Yes, there are pro-competitive aspects to it.

Now let’s look at the other side.

As one element, Amazon-Whole Foods now allows Amazon to collect data about individual consumers’ food-buying habits. You might say that every grocery store with a loyalty card collects the same information. But Amazon already knows what books you read (and how often you read them), what movies you watch, and what brands of deodorant you buy. Depending on how accurate rumors are, Amazon may also enter the pharmaceutical market, and if it does, it will know what medicines you take and how sick you are. Do most Americans welcome this type of invasive knowledge? No one, including antitrust enforcers, seems to have asked them.

Amazon offers Prime discounts to Whole Food customers and offers free delivery for Prime members. Those are certainly consumer benefits. But with those comes a cost, which may or may not be significant. By bundling its products with collective discounts, Amazon makes it more attractive for shoppers to shift their buying practices from local stores to the internet giant. Will this eventually mean that local stores will become more inefficient, based on lower volume, and will eventually close? Do most Americans care about the potential loss of local supermarkets and specialty grocers? No one, including antitrust enforcers, seems to have asked them.

What about small business providers, including, specifically, small organic providers? Whole Foods was a launching pad for many local organic companies and these relationships with small organic providers were negotiated locally by in-store personnel. That appears to have changed with Amazon’s acquisition. It now appears from news reports that Amazon will become a “cost-efficient, national retainer.” That’s great from an antitrust-oriented “efficiency” perspective. We recall an article by William Kovacik and Carl Shapiro, “Antitrust Policy: A Century of Economic and Legal Thinking,” in Journal of Economic Perspectives, Vol. 14, No. 1 (2000), p. 43, at 51, that speaks disparagingly of Brown Shoe Co. v. United States, 370 U.S. 294 (1962), because “The Court also held that non-efficiency goals, such as preserving small firms, were relevant to applying the statute.”

On the other hand, do most Americans place some value on promoting local, community-based, organic food production or “small firms” in general? No one, including antitrust enforcers, seems to have asked them.

Does it matter to our health whether we eat whole unprocessed locally grown food or food that has entered a national distribution chain biased toward processing for the sake of surviving the chain? We are learning more and more that it does. But the antitrust enforcers don’t ask this question.

Perhaps the antitrust laws are inadequate to meet the social challenges of today’s mega-mergers and tech company aggregation?

People unquestionably like the convenience of Amazon and value the many positive benefits it brings them, including, we presume, the potential for discounted trips to the Moon for Prime members. But will they be as happy when Amazon turns into Big Brother and becomes one of the few oligarchical providers of every product they want, tying together masses of data and analytics about you personally that no American government has ever succeeded in collecting?

The real question is how long will we have to listen to the litany that “the antitrust laws are flexible enough to cover every situation.”

We doubt that anyone in this country thinks that it is healthy to end up with extended mega-mergers whose business activities are controlled by one set of reins (like the Copperweld team of horses), that cover multiple parts of our lives, that collect and use big data that profiles our personal and medical choices, that can flick local business into oblivion, and that can destroy diversity of ideas (social, political, and business).

Maybe the mantra, “Big is Bad,” is not right. But “Gargantuan is Bad” might be right. What can the antitrust laws do to prevent that? The answer is nothing, because each creeping aggregation may meet antitrust standards—while it subverts the organic ground-up competition and diversity of ideas that we treasure.

To sum up, yes, the Amazon-Whole Foods merger may have been totally innocuous from a strict “lessening of competition” analysis. But the potential for what it (and similar mega-mergers and big tech aggregation) produces is a variety of lurking menaces progressively advancing on our society.

There is only one law that protects Americans against bad mergers and that is the Clayton Act. But the Clayton Act doesn’t effectively focus on the threats we just discussed.

Are we too reliant on antitrust law to solve these problems or should we change antitrust to address them? Do we trust other parts of the government to anticipate these problems and fix them? We have our doubts and worries about that too.

There is an approaching threat. The storm isn’t here yet. The sky is still and people are going about their day, but if we don’t address these issues, the sky could grow slowly dark, the wind may pick up, and soon it will be too late.

One is reminded of Merle Haggard’s lyrics in “America First”:

Who’s on the Hill and
who’s watchin’ the valley?
An’ who’s in charge of it all?
Who is in charge of it all?

 

In recent years, the European Union’s (EU) administrative body, the European Commission (EC), increasingly has applied European competition law in a manner that undermines free market dynamics.  In particular, its approach to “dominant” firm conduct disincentivizes highly successful companies from introducing product and service innovations that enhance consumer welfare and benefit the economy – merely because they threaten to harm less efficient competitors.

For example, the EC fined Microsoft 561 million euros in 2013 for its failure to adhere to an order that it offer a version of its Window software suite that did not include its popular Windows Media Player (WMP) – despite the lack of consumer demand for a “dumbed down” Windows without WMP.  This EC intrusion into software design has been described as a regulatory “quagmire.”

In June 2017 the EC fined Google 2.42 billion euros for allegedly favoring its own comparison shopping service over others favored in displaying Google search results – ignoring economic research that shows Google’s search policies benefit consumers.  Google also faces potentially higher EC antitrust fines due to alleged abuses involving android software (bundling of popular Google search and Chrome apps), a product that has helped spur dynamic smartphone innovations and foster new markets.

Furthermore, other highly innovative single firms, such as Apple and Amazon (favorable treatment deemed “state aids”), Qualcomm (alleged anticompetitive discounts), and Facebook (in connection with its WhatsApp acquisition), face substantial EC competition law penalties.

Underlying the EC’s current enforcement philosophy is an implicit presumption that innovations by dominant firms violate competition law if they in any way appear to disadvantage competitors.  That presumption forgoes considering the actual effects on the competitive process of dominant firm activities.  This is a recipe for reduced innovation, as successful firms “pull their competitive punches” to avoid onerous penalties.

The European Court of Justice (ECJ) implicitly recognized this problem in its September 6, 2017 decision setting aside the European General Court’s affirmance of the EC’s 2009 1.06 billion euro fine against Intel.  Intel involved allegedly anticompetitive “loyalty rebates” by Intel, which allowed buyers to achieve cost savings in Intel chip purchases.  In remanding the Intel case to the General Court for further legal and factual analysis, the ECJ’s opinion stressed that the EC needed to do more than find a dominant position and categorize the rebates in order to hold Intel liable.  The EC also needed to assess the “capacity of [Intel’s] . . . practice to foreclose competitors which are at least as efficient” and whether any exclusionary effect was outweighed by efficiencies that also benefit consumers.  In short, evidence-based antitrust analysis was required.  Mere reliance on presumptions was not enough.  Why?  Because competition on the merits is centered on the recognition that the departure of less efficient competitors is part and parcel of consumer welfare-based competition on the merits.  As the ECJ cogently put it:

[I]t must be borne in mind that it is in no way the purpose of Article 102 TFEU [which prohibits abuse of a dominant position] to prevent an undertaking from acquiring, on its own merits, the dominant position on a market.  Nor does that provision seek to ensure that competitors less efficient than the undertaking with the dominant position should remain on the market . . . .  [N]ot every exclusionary effect is necessarily detrimental to competition. Competition on the merits may, by definition, lead to the departure from the market or the marginalisation of competitors that are less efficient and so less attractive to consumers from the point of view of, among other things, price, choice, quality or innovation[.]

Although the ECJ’s recent decision is commendable, it does not negate the fact that Intel had to wait eight years to have its straightforward arguments receive attention – and the saga is far from over, since the General Court has to address this matter once again.  These sorts of long-term delays, during which firms face great uncertainty (and the threat of further EC investigations and fines), are antithetical to innovative activity by enterprises deemed dominant.  In short, unless and until the EC changes its competition policy perspective on dominant firm conduct (and there are no indications that such a change is imminent), innovation and economic dynamism will suffer.

Even if the EC dithers, the United Kingdom’s (UK) imminent withdrawal from the EU (Brexit) provides it with a unique opportunity to blaze a new competition policy trail – and perhaps in so doing influence other jurisdictions.

In particular, Brexit will enable the UK’s antitrust enforcer, the Competition and Markets Authority (CMA), to adopt an outlook on competition policy in general – and on single firm conduct in particular – that is more sensitive to innovation and economic dynamism.  What might such a CMA enforcement policy look like?  It should reject the EC’s current approach.  It should focus instead on the actual effects of competitive activity.  In particular, it should incorporate the insights of decision theory (see here, for example) and place great weight on efficiencies (see here, for example).

Let us hope that the CMA acts boldly – carpe diem.  Such action, combined with other regulatory reforms, could contribute substantially to the economic success of Brexit (see here).

Guest post by Dan Crane, responding to Steve’s post responding to Dan’s earlier post and Thom’s post on the appropriate liability rule for loyalty discounts.

Something that Thom and I both said in our earlier posts needs to be repeated at the outset:  I don’t know of anyone who disagrees with Steve and Josh that raising rivals’ costs (“RRC”) and economic analysis drawn from exclusive dealing law belong in an analysis of loyalty discounts.  There’s also no claim on the table that a loyalty discount that fails the “contestable share”/discount attribution test that Steve mentions should be treated anything like presumptively illegal.  The current debate is solely about whether there should be a price-cost screen in loyalty discount cases.  We aren’t even talking about what the measure of cost should be or how that screen should work (although, with Steve, I’m happy to assume marginal or average variable cost and the aforementioned contestable share/discount attribution approach for the sake of argument).  Josh and Steve are well justified in pointing out how aspects of RRC theory can apply in loyalty discount cases—but that doesn’t meet the objection that a screen should also apply.

It’s also important to recognize that the argument in favor of a price-cost screen for loyalty rebates does not need to entail a general argument in favor of a “profit sacrifice” theory for all monopolization offenses.  What we’re talking about here is unilaterally determined discounts to customers—something that is presumptively procompetitive, although potentially exclusionary under some circumstances.  Such discounts could be harmful if they resulted in customer foreclosure, but they would not result in customer foreclosure if the rival could profitably match the loyalty discount.  That is the point of the price-cost screen.  You might wonder why a rival would ever complain about a loyalty discount if they could profitably match it.  The reasons are many.  The rival might be losing sales because customers don’t like its product.  It might have failed for reasons completely apart from the accused firm’s loyalty discounts. It might be attempting to use antitrust law to thwart price competition, as a large body of literature suggests.  (See work by Will Baumol and Janusz Ordover, Preston McAfee and Nicholas Vakkur, and Edward Snyder and Tom Kauper, among others).

One thing I didn’t just mention—although it could often be true—is that the complaining rival isn’t an equally efficient competitor (“EEC”).  Steve is wrong to suggest that the price-cost test depends on adopting an EEC theory.  Although there is much merit to the EEC test (heck, even the Europeans have adopted it), one could formulate a version of the price-cost screen that simply requires the rival to show that the discount foreclosed a hypothetically equally efficient competitor or even this particular rival given its actual costs, as some have suggested.  The current argument is not over the formulation of the test, but whether we should dispense with a price-cost screen altogether in loyalty discount cases.

In any event, observe that the entire structure of modern predatory pricing law is premised on an EEC assumption.  If an incumbent firm with marginal costs of $50 and a current price of $100 faces entry by a new rival with marginal costs of $75 and drops its price to $74 in order to exclude the new rival, it enjoys categorical immunity under a long line of Supreme Court cases.  In another forum, Steve suggested that the difference in those cases is that the customer is getting the benefit of a lower price, so the law is hesitant to condemn the price as predatory.  But that exposes something problematic about Steve’s starting premise—he assumes that it’s uncertain whether loyalty discounts generally lower prices.  Prima facie, that seems wrong.  Customers routinely offer to trade loyalty for lower prices precisely because the prices are . . . lower.

Steve suggests that maybe loyalty discounts aren’t really discounts at all.  Maybe the seller, who was previously charging a price of $100, raises the price to $105 and then gives a discount back down to $100 in exchange for customer loyalty.  Steve notes that Thom and I didn’t consider this scenario.  That’s because Josh didn’t raise it in his speech.  It would have been very surprising if Josh had raised it in his speech, since Josh and I co-authored a paper several years ago debunking this same theory in the bundled discount context.  I discuss the “disloyalty penalty” theory at length in a forthcoming article in the Texas Law Review, really just extending the work that Josh and I started several years ago.

There are many problems with this “disloyalty penalty” theory, including the empirical one that it doesn’t fit the pattern of almost any of the recent loyalty discount cases.  But there is also a problem of basic economics.  Unless it is engaging in limit pricing, the accused firm’s $100 price is a monopoly (or market power) profit-maximizing price.  By definition, any price increase will be unprofitable to the seller.  Obviously, the $105 price would be unprofitable.  But it’s also true that a price of $100 coupled with a new obligation to buy a certain percentage of requirements from the seller to achieve that price is unprofitable because it exceeds the profit-maximizing price.  The addition of a contractual term that restricts the buyer’s freedom is economically equivalent to a price increase if the buyer valued the prior freedom from the restriction (if the buyer didn’t value the prior freedom from the restriction there’s no effective price increase but also no anticompetitive effect, since the buyer wouldn’t have bought from the rival anyway).  Hence a price of $100 with loyalty term is effectively higher than a price of $100 without a loyalty term that restricts the buyer’s purchasing freedom.  By adding a loyalty term to obtain the $100 price, the seller exceeds its profit-maximizing monopoly price.

My claim is not that “penalty pricing” for disloyalty is impossible, but that the presumption should be that loyalty discounts are true discounts off the but-for price.  Loyalty discounts belong squarely in the “hospitability” tradition for unilaterally determined pricing structures—all those judicial decisions that talk about how important it is not to chill vigorous price competition.

Steve argues that loyalty discounts may “tie up customers” before competitors arrive on the scene.  I’m not sure what Steve means by “tie up customers.”  Suppose that a monopolist, knowing that rivals are about to enter the market, goes to all of its customers and offers  them a 5% discount if they will agree to purchase 95% of their requirements from the monopolist for the next three years.  At that point we have a partial exclusive dealing contract and the cost-price screen shouldn’t be required.  But, there, the exclusionary mechanism—the thing that keeps rivals from competing—is not the loyalty discount but rather the contractual commitment not to buy any more than 5% of requirements from rivals.  Customers would have to breach their contract in order to consider even the most advantageous offers from rivals.  The point that amici made in our Meritor v. Eaton brief was that when the claimed mechanism of exclusion is a price term and not a contractual restriction on purchasing from rivals, some version of the price-cost screen should apply.

The example I’ve just attributed to Steve (and sorry Steve if this is not what you have in mind) is not what we’re talking about in almost any of the current generation of loyalty discount cases.  In Meritor, for example, the Third Circuit acknowledged that the loyalty provisions at issue did not require customers to buy any of their requirements from Eaton.  It’s just that if the customers didn’t meet the loyalty thresholds, they would lose a possible rebate.  Meritor could compete for that business by offering its own counter-rebates so long as it wouldn’t have had to price unprofitably to do so.

Steve’s point about economies of scale is one that I covered in my post and is fully accounted for by the cost-price screen.  A rival who can profitably match a loyalty discount scheme is not foreclosed from operating at any particular scale.

The same is true of Steve’s point about loyalty discount schemes foreclosing a new seller’s ability to make incremental sales that don’t reduce the accused firm’s own sales.  Again, so long the rival can profitably match the discounts, there is no reason that output should be reduced.

Finally, Steve asserts that loyalty discounts obtained by intermediaries may not be passed onto ultimate consumers.  That’s equally true of conventional single-firm price reductions that are categorically immunized from antitrust liability under a long line of precedent.  One may not like the price-cost test in any context for that reason or others, but there’s nothing special about its application to loyalty discounts. The common denominator of all of these points is that loyalty discounts aren’t exclusionary unless they force rivals to price below cost in order to match the customer’s loss of the loyalty discounts if they fail to meet the loyalty threshold.

Steve thinks the price-cost screen exhibits “formalism”—that dreaded epithet in the post-realist world—but it’s actually just an expression of economic common sense.  Steve and Josh are excellent economists and it’s hard for me to imagine a case in which they would condemn a loyalty discount if there was undisputed evidence that the allegedly excluded rival could have completely neutralized the financial inducement of the loyalty discount by offering a counter-discount of its own without pricing below cost.  If they can offer an example of a circumstance where such a loyalty discount should be condemned, I would be very interested to hear it.  If they can’t, then they have implicitly adopted a version of the price-cost screen and, to repeat a point from my earlier post, all we’re haggling over is the price.

Guest post by Michigan Law’s Dan Crane. (See also Thom’s post taking issue with FTC Commissioner Josh Wright’s recent remarks on the appropriate liability rule for loyalty discounts).

A number of people on both sides of the ideological spectrum were surprised by FTC Commissioner Josh Wright’s recent speech advocating that the FTC reject the use of price-cost tests to assess the legality of loyalty discounts and instead pursue an exclusive dealing framework of analysis.  As the author of a brief (unsuccessfully) urging the Supreme Court to grant certiorari and reverse in Z.F. Meritor v. Eaton, I want respectfully to disagree with some of what Josh had to say.  But, first, two other observations.

First, I’m delighted that Josh is charting a course as Commissioner that defies some people’s expectations (even if they sometimes happen to be my own!).  Josh has long insisted on evidence-based analysis rather than simplistic theorizing or reductionist legal rules and his position on loyalty discounts is consistent with that theme.  Early in his term on the Commission, Josh is making it clear that he will exercise independent judgment, intellectual integrity, and a principled, non-ideological approach to decision-making.  That’s a nice rejoinder to those who believe that antitrust law reduces to simplistic right-left politics.  So kudos to Josh!

Second, Josh and I probably agree on 90% of what’s important about loyalty discounts.  We agree that loyalty discounts are usually competitively benign or procompetitive, but that they can sometimes be anticompetitive when they exclude rivals and create market power.  We also agree that exclusive dealing principles and analysis can be usefully deployed in loyalty discount cases (although I would only do so after a plaintiff satisfied a price-cost screen).  Finally, we also agree that unmodified predatory pricing rules—requiring the plaintiff to show that the defendant’s sales were below average variable cost—could potentially insulate some exclusionary loyalty discounts from antitrust scrutiny.

Where we differ is on the question of whether antitrust law should ever condemn a loyalty discount that the allegedly excluded rival could have met without pricing below cost.  To say that it should not is to say that there should be some sort of price-cost screen in place in loyalty discount cases.  Josh rejects the use of such screens.

One point of clarification:  Josh asserts that one of the central claims in favor of the price-cost test is its ease of administration.  Contrary to Josh’s suggestion, that is not an argument we made in our Meritor amicus brief.  As someone who has counseled clients and litigated these issues, I can attest that the discount attribution test (the variant of the price-cost test I support for loyalty discounts) is anything but easy to apply (which Josh himself recognizes with respect to the “contestable share” idea).  The virtue of the test is not its ease of administration, but that it requires plaintiffs to show that the discount scheme actually foreclosed them from competing.  Our point was about analytical discipline, not ease of administration.

This, I think, is the crucial difference between Josh and me.  Unless a rival would have to price below cost to match a loyalty discount, it is not foreclosed from competing for the business covered by the discount.  Josh wants to apply exclusive dealing analysis that looks at foreclosure without answering a question that, in my view, is necessary to discover whether there is any foreclosure at all—whether the rival could profitably match the discount.  A rival that has a profitable “predatory counterstrategy,” to quote Frank Easterbrook, isn’t foreclosed.

A thought experiment may be helpful.  Suppose that a firm with a 90% market share offered all of its customers a 0.0001% rebate if they purchased at least 80% of their requirements from the dominant firm.  No one could imagine that such a “loyalty discount” could exclude rivals, since even small rivals could easily make up the rebates foregone if customers forewent buying the 80% from the dominant firm.  We can make the rebate 0.001% with the same result.  And we can continue to pose successive iterations of the same question, increasing the discount incrementally, until we hit a point that someone could reasonably say “well now that could be exclusionary.”  Wherever we cross that Rubicon, we cross it because what was true at 0.0001%—that the small rival could laugh it off by shelling out a few dollars in a counter-discount—is no longer true.  To play this game is to conduct a competitive response sensitivity analysis of the very kind demanded by the attribution test. For present purposes, it’s unimportant where we draw the line; it’s the fact of the line-drawing that matters. To paraphrase Winston Churchill, we’ve already established what we are, now we’re just haggling over the price.

Josh is surely right that loyalty discounts can raise rivals’ costs.  That could happen in one of two ways.  First, if a small firm were prevented from reaching efficient scale, or second if a firm were forced to ramp up to an inefficiently large scale in order to meet a competitor’s loyalty discounts.  But neither of those scenarios holds if the rival is able to compete against the loyalty discounts without pricing below cost.  The small firm will not be prevented from reaching minimum efficient scale if it can increase its share by profitably competing against the loyalty discount.  And the second firm will not be rushed into increasing its scale if it can compete profitably at a smaller scale.  In either case, the RRC mechanism is forcing the firms to price below their costs.

At the end of the day, I suspect that Josh—using whatever analytical tools he associates with exclusive dealing analysis—would be highly unlikely to condemn any loyalty discount in a case where the rival could profitably match the discounts.  That gives me assurances as to Josh, but not as to all other players in the legal system, many of whom are eager to jettison the discipline of price-cost screens so that they can get onto the “real meat” of the case—like inflammatory internal e-mails employing metaphors of coercion that Judge Posner has aptly labeled “compelling evidence of predatory intent to the naïve.”  So I remain highly confident that we’re in good hands with Josh, but worry about what others may do with his words.

Guest post by Steve Salop responding to Dan’s latest post on the appropriate liability rule for loyalty discounts. Other posts in the series: SteveDan, and Thom.

(1) Dan says that price-cost test should apply to “customer foreclosure” allegations.   One of my key points was that many loyalty discount claims involve “input foreclosure” or “raising rivals’ costs” effects, not plain-vanilla customer foreclosure.   In addition, loyalty agreements with distributors often involve input foreclosure because “distribution services” are an input and a rebate might be characterized as a reward payment for the (near-) exclusivity.    From his silence on the issue, I am inclined to presume that Dan would agree that the price-cost test should not be applied to such allegations.      Dan, what do you intend?

(2) Dan says that he agrees that the price-cost test should not be required for “partial exclusivity contracts” that involve contractual commitments to limit purchases from rivals.  He says that the price-cost test should apply only where the “claimed exclusionary mechanism is the price term.”  This distinction is peculiar because the economic analysis is the same in both situations.  In addition, even such voluntary exclusivity flowing from a price term can be anticompetitive, and even if the price-cost test is passed.  There are numerous reasons for this, as I explained in my original post. (I also discuss these issues in my contribution to Robert Pitofsky’s volume, “How the Chicago School Overshot the Mark.”  See also articles by Eric Rasmussen et. al., Michael Whinston and others.)

(3) Consider the following numerical examples that concretely illustrate the economic forces at work when there is competition for distribution, even in the absence of contractual commitments.

(a) Suppose that a monopolist is earning profits of $200.  If there is successful entry by an equally efficient entrant, each of the two firms will earn duopoly profits of $70.  (The duopoly profits are less than monopoly profits because of the price competition.)  Suppose that the entrant needs to obtain just non-exclusive distribution from a particular retailer in order to be viable.  In this case, the entrant would be willing to bid up to $70 per period for the non-exclusive distribution.  (In price terms, this would be a payment that led to the entrant’s costs equaling its price.)  But the monopolist would be willing to bid up to $130 for an exclusive (i.e., the difference between its monopoly and duopoly profits), in order to prevent the entrant from surviving.   Thus, the monopolist would win the bidding, say for a price of $71.   The monopolist would easily pass the price-cost test.   Why is the monopolist systematically able to outbid the entrant? This fundamental asymmetry does not arise because the entrant is less efficient.  Instead, the answer is that the monopolist is bidding to maintain its monopoly power, whereas the entrant can only obtain duopoly price.  The monopolist is “purchasing market power” in addition to distribution, whereas the entrant is only purchasing distribution.

(b) Or, consider this interesting variant with sequential bidding for multiple distributors.   Suppose there are two retailers and the entrant needs to get non-exclusive distribution at both in order to be viable.  Suppose that the negotiations at the two stores are sequential.  In this scenario, the entrant would have no incentive even to try to outbid the monopolist.   This is easy to see.   Suppose that the entrant wins the competition to get into the first store by paying the amount $B1.   In bidding for distribution at the second retailer, the monopolist would be willing to bid up to $130, as above.   At this second store, the entrant would not be willing to pay more than $70 (or $70 – $B1, if it is ignores the fact that the $B1 was an already sunk cost).  So the monopolist will win the exclusive at the second retailer and the entry will fail.   Looking back to the negotiations at the first store, the entrant would have had no incentive to throw away money by paying any positive amount $B1 to get distribution at the first store.   This is because it rationally would anticipate that it is inevitable that it will fail to gain distribution at the second retailer.  Thus, the monopolist will be able to gain the exclusive at both stores for next to nothing.   It clearly will pass the price-cost test even as it maintains its monopoly, merely by instituting the competition for distribution.

(c) If the entrant only needs to gain non-exclusive distribution at either one of the two stores, then the situation can be reversed and the entry can succeed.   The monopolist clearly would not be willing to pay $71 each at both stores (equal to a total payment of $142) in order to deter the entry and protect its “incremental” monopoly profits (equal to only $130 in the example).  Therefore, when the entrant bids for distribution at the first store, the monopolist might as well let the entrant win, which means that the entrant can gain access to both stores for next to nothing.   The entry succeeds, but again, the price-cost test would not be relevant to the analysis.

(d) There also can be elements of a “self-fulfilling equilibrium” because of lack of coordination by the distributors.  Suppose that there are 10 retailers and the entrant only needs to get distribution at 5 of them.   Suppose that the entrant offers to pay a $14 rebate for non-exclusive distribution, and it also will offer $14 again in the next period, if its entry succeeds in the first period.   Suppose the monopolist offers a lower rebate for an exclusive that will continue into the second period.   Suppose that each of the 10 retailers anticipates that the other retailers will accept the monopolist’s lower offer out of fear that the entrant will be unable to get 4 other retailers to accept its offer.  In that situation, the entry will fail.  This is not because the entrant is less efficient.  Instead, it is because the entrant faces a classic coordination problem.  If the retailers behave independently, the retailers’ fear of the entrant’s failure can be a self-fulfilling prophecy.   Again, the monopolist will easily pass the price-cost test.

(4) Dan makes the point that the price-cost test does not require adoption of an EEC antitrust standard (i.e., whereby only harm to EECs is relevant to antitrust).  I certainly agree that the price-cost screen does not necessarily rely on the EEC standard.   The price-cost test is better framed as a measure of “profit-sacrifice,” and EEC is simply a misleading way to express the test.  For example, I expect that Dan agrees that predatory pricing law uses the price-cost test as a measure of “profit-sacrifice,” not an assumption that only EECs matter.

(5) But, I was surprised that Dan also says that the EEC theory “has merit.”  In my view, the EEC standard has no merit in rigorous antitrust analysis. The example in my previous post illustrates why that is the case.  Raising the costs and possibly deterring the entry of a less efficient rival harms consumers and reduces output.

(6) Dan says that the “disloyalty penalty” price theory has problems, “including the empirical one that it doesn’t fit the pattern of almost any of the recent loyalty discount cases.”   The validity of Dan’s empirical claim is not obvious clear to me.  To evaluate whether there is a price penalty, you would need to know more than the path of prices over time.  You also would need to know what the price would be in the “but-for world.”   For example, suppose that in the absence of the loyalty discount, the incumbent would have reduced its price to $90.  This observation has two important implications.  First, this is a reason why it is not clear that loyalty discounts are “presumptively beneficial.”  Second, this is another reason why a price-cost test is not a good “screen” in loyalty discount cases.  Implementing the screen involves evaluating what prices would be absent the conduct.  But, after the competitive effects on consumers are known, what is the value of the screen?

(7) As to the question of whether Josh’s speech on loyalty discounts (and this issue of penalty prices) is inconsistent with their joint article on bundled discounts, I will leave that one for Josh and Dan to sort out, at least for the moment.   I certainly will concede the point that Wright is not always right.

(8) Dan began to suggest that the penalty price theory has a “problem of basic economics” in that the penalty price was not short-run profit-maximizing.   Dan subsequently seemed to withdraw this criticism, noticing that one could characterize the loyalty restriction as not profit-maximizing in the same way.   In any event, it is not a “problem” with the theory.  The reason why the firm is willing to sacrifice profits is because it gains the benefit of deterring entry.  By the way, it also may not even end up sacrificing profits.  The threat of the penalty price for non-exclusivity may be sufficient.  If the distributors succumb to the threat and buy exclusively from the incumbent, it never needs to actually charge them the penalty price.

It’s not often that I disagree with my friend and co-author, FTC Commissioner Josh Wright, on an antitrust matter.  But when it comes to the proper legal treatment of loyalty discounts, the Commish and I just don’t see eye to eye.

In a speech this past Monday evening, Commissioner Wright rejected the view that there should be a safe harbor for single-product loyalty discounts resulting in an above-cost price for the product at issue.  A number of antitrust scholars—including Herb Hovenkamp, Dan Crane, and yours truly—recently urged the Supreme Court to grant cert and overturn a Third Circuit decision refusing to recognize such a safe harbor.  Commissioner Wright thinks we’re wrong.

A single-product loyalty discount occurs when a seller conditions a price cut (either an ex ante discount or an ex post rebate) on a buyer’s purchasing some quantity of a single product from the seller.  The purchase target is often set as a percentage of the buyer’s requirements, as when a medical device manufacturer offers to pay a 20% rebate on all of a hospital’s purchases of the manufacturer’s device if the hospital buys at least 70% of its requirements of that type of device from the manufacturer.  Because a loyalty discount tends to encourage distributors to carry more of the discounting manufacturer’s brand and less of the brands of the discounter’s rivals, such a discount may tend to “foreclose” those rivals from available distribution outlets.  If the degree of foreclose is so great that rivals have to cut their output below minimum efficient scale (the minimum output level required to achieve all economies of scale), then the discount may “raise rivals’ costs” relative to those of the discounter and thereby harm consumers.

On all these points, Commissioner Wright and I are in agreement.  Where we differ is on the question of whether a loyalty discount resulting in a discounted price that is above the discounter’s own cost should give rise to antitrust liability.  I say no.  I take that position because such an “above-cost loyalty discount” could be matched by any rival that is as efficient a producer as the discounter.  If, for example, a manufacturer normally charges $1.00 for widgets it produces for $.79 each but offers a 20% loyalty discount to retailers that buy 70% of their widget requirements from the manufacturer, any competitor that could produce a widget for $.79 (i.e., any equally efficient rival) could stay in business by lowering its price to the level of its incremental cost.  Thus, any rival that loses sales because of a manufacturer’s above-cost loyalty discount must be either less efficient than the manufacturer (so it can’t match the manufacturer’s discounted price) or unwilling to lower its price to the level of its cost.  In either case, the rival is unworthy of antitrust’s protection, where that protection amounts to prohibiting price cuts that provide consumers with immediate benefits.

Commissioner Wright disputes (I think?) the view that equally efficient rivals could match all above-cost loyalty discounts.  He maintains that loyalty discounts may be structured so that

[a] distributor’s purchase of an additional unit from a rival supplier beyond the threshold level can result in a loss of rebates large enough to render rival suppliers unable to attract a distributor to purchase the marginal unit at prices at or above the marginal cost of producing the good.

While I’m not entirely certain what Commissioner Wright means by this remark, I think he’s making the point that a loyalty discounter’s equally efficient rival might not be able to attract purchases by matching the discounter’s above-cost loyalty rebate if the rival’s “regular” base of sales is substantially smaller than that of the discounter.

If that is indeed what Commissioner Wright is saying, he has a point.  Suppose, for example, that the market for tennis balls consists of two brands, Penn and Wilson, that current market shares, reflective of consumer demand, are 60% for the Penn and 40% for Wilson, and that retailers typically stock the two brands in those proportions. Assume also that it costs each manufacturer $.90 to produce a can of tennis balls, that each sells to retailers for $1 per can, and that minimum efficient scale in this market occurs at a level of production equal to 35% of market demand. Suppose, then, that Penn, the dominant manufacturer, offers retailers a 10% loyalty rebate on all purchases made within a year if they buy 70% of their requirements for the year from Penn. The $.90 per unit discounted price is not below Penn’s cost, so the loyalty discount would come within my safe harbor.

Nevertheless, the loyalty discount could have the effect of driving Wilson from the market.  After implementation of the rebate scheme, a typi­cal retailer that previously purchased sixty cans of Penn for $60 and forty cans of Wilson for $40 could save $7 on its 100-can tennis ball require­ments by spending $63 to obtain seventy Penn cans and $30 to obtain thirty Wilson cans. The retailer and others like it would thus have a strong incen­tive to shift pur­chases from Wilson to Penn. To prevent a loss of mar­ket share that would drive it below minimum efficient scale (35% of market demand), Wilson would need to lower its price to provide retailers with the same total dollar discount, but on a smaller base of sales (40% of a typical retailer’s require­ments rather than 60%). This would require it to lower its price below cost. For example, Wilson could match Penn’s $7 discount to the retailer described above only by reducing its $1 per-unit price by 17.5 cents ($7.00/40 = $.175), which would require it to price below its cost of $.90 per unit.  Viewed statically, then, it seems that even an above-cost loyalty discount could occasion competitive harm by causing rivals to be less efficient, so that they could not match the discounter’s price.

In light of dynamic effects, though, I’m not convinced that examples like this undermine the case for a safe harbor for above-cost loyalty discounts. Had the nondominant rival (Wilson) charged a price equal to its marginal cost prior to Penn’s loyalty rebate, it would have enjoyed a price advantage and likely would have grown its market share to a point at which Penn’s loyalty rebate strat­egy could not drive it below minimum effi­cient scale. Moreover, one strategy that would prevent a nondominant but equally efficient firm from being harmed by a dominant rival’s above-cost loyalty rebate would be for the non-dominant firm to give its own volume discounts from the outset, secur­ing up-front commitments from enough buy­ers (in exchange for discounted prices) to ensure that its production stayed above minimum efficient scale. Such a strategy, which would obvi­ously benefit consumers, would be encouraged by a liability rule that evaluated loy­alty discounts under straight­forward Brooke Group principles (i.e., that included a safe harbor for above-cost discounts) and thereby signaled to manufacturers that they must take steps to protect themselves from above-cost loyalty discounts.

Commissioner Wright maintains that all this discussion of price-cost comparisons is inapposite because the theoretical harm from loyalty discounts stems from market exclusion (and its ability to raise rivals’ costs), not from predation.  He says, for example:

  • “[T]o the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion and, as a result, the legal framework developed to evaluate exclusive dealing claims ought to be used to evaluate claims relating to loyalty discounts.” [p. 12]
  • “[P]redatory pricing and raising rivals’ costs are distinct paradigms of potentially exclusionary conduct. There simply is not a stable relative relationship between price and cost in raising rivals’ cost models that form the basis of anticompetitive exclusion, and hence it does not follow that below cost pricing is a necessary condition for competitive harm.”  [pp. 19-20]
  • “When plaintiffs allege that loyalty discounts … violate the antitrust laws because they deprive rivals of access to a critical input, raise their costs, and ultimately harm competition, they are articulating a raising rivals’ cost theory of harm rather than price predation.”  [p. 24]
  • “Raising rivals’ costs and predation are two different economic paradigms of exclusionary conduct, and economic models within each paradigm establish the necessary conditions for each practice to harm competition and give rise to antitrust concerns. Loyalty discounts and other forms of partial exclusives … are properly analyzed under the exclusive dealing framework. Price‐cost tests in the predatory pricing tradition … simply do not comport with the underlying economics of exclusive dealing.”  [p. 33]

I must confess that I’m baffled by Commissioner Wright’s oddly formalistic pigeonholing.  Why must a practice be one or the other—either pricing too low or excluding rivals and thereby raising their costs?  That seems like a false dichotomy.  Indeed, it seems to me that a problematic loyalty discount is one in which the discounter excludes its rivals from a substantial portion of the distribution network (and thereby raises their costs) via the mechanism of conditional price cuts. It’s “both-and,” not “either-or.”  And if that’s the case, then surely it makes sense to limit which price cuts may occasion liability—i.e., only those that could not be matched by equally efficient rivals.  [It is important to note here that I don’t advocate a price-cost test as an alternative to a foreclosure-based analysis.  Rather, a plaintiff should have to establish below-cost pricing (to show that the plaintiff was deserving of antitrust’s protection via the highly disfavored prohibition of discounts) and demonstrate that the discounting at issue resulted in substantial foreclosure from distribution outlets (the latter showing is necessary to prove harm to competition rather than simply to a competitor).]

Throughout his speech, Commissioner Wright emphasizes that the primary competitive concern presented by loyalty discounts is the possibility of “anticompetitive exclusion.”  He writes on page 8, for example, that “[t]he key economic point is that the antitrust concerns potentially arising from loyalty discounts involve anticompetitive exclusion rather than predatory pricing….”  On page 12, he reiterates that “to the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion.”  He then apparently assumes that loyalty discount-induced exclusion is “anticompetitive” if it is sufficiently substantial—i.e., if the discounter’s rivals are foreclosed from so many distribution outlets that they are driven below minimum efficient scale so that their costs are raised relative to those of the discounter.

I would dispute the notion that discount-induced exclusion is anticompetitive simply because it’s substantial.  Rather, I’d say such exclusion is anticompetitive only if it is substantial and could not have been avoided by aggressive pricing.  Omitting the second requirement creates the possibility that antitrust will be used by a laggard rival to prevent a more aggressive rival’s consumer-friendly price competition.  (LePage’s anyone?)

Suppose, for example, that there are two producers of widgets, A and B, which both produce widgets at a marginal cost of $.79 and, given their duopoly, charge $1.00 per widget.  A, whose market share has hovered around 50%, institutes a loyalty rebate of 20% for retailers that purchase 70% of their requirements from A.  If B offers the same deal, or simply cuts its price to $.80, it should lose no market share.  But suppose B doesn’t do so, A captures 70% of the market, and B falls below minimum efficient scale.  Would we say that B’s exclusion is “anticompetitive” because A’s discount scheme resulted in such substantial foreclosure that it raised B’s costs?  Should B be able to collect treble damages for based on its “anticompetitive exclusion”?  Surely not.

Commissioner Wright, from whom I have learned more about “error costs” than anyone else, seems oddly unconcerned about the chilling effect his decidedly pro-plaintiff approach to loyalty discounts will produce.  Wouldn’t a firm considering a loyalty discount—a price cut, don’t forget!—think twice if it knew its rivals could sit on their hands, claim “exclusion” if the discount successfully moved substantial market share toward the discounter, and collect treble damages?  The safe harbor Hovenkamp, Crane, and I have advocated would provide assurance to potential discounters that they will not face liability if they charge above-cost prices, prices that could be matched by equally efficient, aggressive rivals.  Isn’t that approach more likely to minimize error costs?

Two closing points.  First, despite my disagreement with Commissioner Wright on this issue, I share the widely held view that he is one of the most brilliant antitrust thinkers out there.  He’s taught me more about antitrust than anyone (with the possible exception of the uber-prolific Herb Hovenkamp).  His questioning of my views on loyalty discounts really makes me wonder if I’m missing something.

Second, to those who think Commissioner Wright has “drifted” or “turned,” let me assure you that he’s long held his views on loyalty discounts.  As you can see here, here, and here, we’ve been going round and round on this matter for quite some time.

Perhaps one day one of us will persuade the other.

The Federal Trade Commission’s (FTC) June 23 Workshop on Conditional Pricing Practices featured a broad airing of views on loyalty discounts and bundled pricing, popular vertical business practices that recently have caused much ink to be spilled by the antitrust commentariat.  In addition to predictable academic analyses featuring alternative theoretical anticompetitive effects stories, the Workshop commendably included presentations by Benjamin Klein that featured procompetitive efficiency explanations for loyalty programs and by Daniel Crane that stressed the importance of (1) treating discounts hospitably and (2) requiring proof of harmful foreclosure.  On balance, however, the Workshop provided additional fuel for enforcers who are enthused about applying new anticompetitive effects models to bring “problematic” discounting and bundling to heel.

Before U.S. antitrust enforcement agencies launch a new crusade against novel vertical discounting and bundling contracts, however, they may wish to ponder a few salient factors not emphasized in the Workshop.

First, the United States has the most efficient marketing and distribution system in the world, and it has been growing more efficient in recent decades (this is the one part of the American economy that has been a bright spot).  Consumers have benefited from more shopping convenience and higher quality/lower priced offerings due to the advent of  “big box” superstores, Internet sales engines (and e-commerce in general), and other improvements in both on-line and “bricks and mortar” sales methods.

Second, and relatedly, the Supreme Court’s recognition of vertical contractual efficiencies in GTE-Sylvania (1977) ushered in a period of greatly reduced potential liability for vertical restraints, undoubtedly encouraging economically beneficial marketing improvements.  A new government emphasis on investigating and litigating the merits of novel vertical practices (particularly practices that emphasize discounting, which presumptively benefits consumers) could inject costly new uncertainty into the marketing side of business planning, spawn risk aversion, and deter marketing innovations that reduce costs, thereby harming welfare.  These harms would mushroom to the extent courts mistakenly “bought into” new theories and incorrectly struck down efficient practices.

Third, in applying new theories of competitive harm, the antitrust enforcers should be mindful of Ronald Coase’s admonition that “if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation.  And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.”  Competition is a discovery procedure.  Entrepreneurial businesses constantly seek improvements not just in productive efficiency, but in distribution and marketing efficiencies, in order to eclipse their rivals.  As such, entrepreneurs may experiment with new contractual forms (such as bundling and loyalty discounts) in an effort to expand their market shares and grow their firms.  Business persons may not know ex ante which particular forms will work.  They may try out alternatives, sticking with those that succeed and discarding those that fail, without necessarily being able to articulate precisely the reasons for success or failure.  Real results in the market, rather than arcane economic theorems, may be expected to drive their decision-making.   Distribution and marketing methods that are successful will be emulated by others and spread.  Seen in this light (and relatedly, in light of transaction cost economics explanations for “non-standard” contracts), widespread adoption of new vertical contractual devices most likely indicates that they are efficient (they improve distribution, and imitation is the sincerest form of flattery), not that they represent some new competitive threat.  Since an economic model almost always can be ginned up to explain why some new practice may reduce consumer welfare in theory, enforcers should instead focus on hard empirical evidence that output and quality have been reduced due to a restraint before acting.  Unfortunately, the mere threat of costly misbegotten investigations may chill businesses’ interest in experimenting with new and potentially beneficial vertical contractual arrangements, reducing innovation and slowing welfare enhancement (consistent with point two, above).

Fourth, decision theoretic considerations should make enforcers particularly wary of pursuing conditional pricing contracts cases.  Consistent with decision theory, optimal antitrust enforcement should adopt an error cost framework that seeks to minimize the sum of the costs attributable to false positives, false negatives, antitrust administrative costs, and disincentive costs imposed on third parties (the latter may also be viewed as a subset of false positives).  Given the significant potential efficiencies flowing from vertical restraints, and the lack of empirical showing that they are harmful, antitrust enforcers should exercise extreme caution in entertaining proposals to challenge new vertical arrangements, such as conditional pricing mechanisms.  In particular, they should carefully assess the cumulative weight of the high risk of false positives in this area, the significant administrative costs that attend investigations and prosecutions, and the disincentives toward efficient business arrangements (see points two and three above).  Taken together, these factors strongly suggest that the aggressive pursuit of conditional pricing practice investigations would flunk a reasonable cost-benefit calculus.

Fifth, a new U.S. antitrust enforcement crusade against conditional pricing could be used by foreign competition agencies to justify further attacks on efficient vertical practices.  This could add to the harm suffered by companies (including, of course, U.S.-based multinationals) which would be deterred from maintaining and creating new welfare-beneficial distribution methods.  Foreign consumers, of course, would suffer as well.

My caveats should not be read to suggest that the FTC should refrain from pursuing new economic learning on loyalty discounting and bundled pricing, nor on other novel business practices.  Nor should it necessarily eschew all enforcement in the vertical restraints area – although that might not be such a bad idea, given error cost and resource constraint issues.  (Vertical restraints that are part of a cartel enforcement scheme should be treated as cartel conduct, and, as such, should be fair game, of course.)  In order optimally to allocate scarce resources, however, the FTC might benefit by devoting relatively greater attention to the most welfare-inimical competitive abuses – namely, anticompetitive arrangements instigated, shielded, or maintained by government authority.  (Hard core private cartel activity is best left to the Justice Department, which can deploy powerful criminal law tools against such schemes.)

Guest post by Steve Salop, responding to Dan’s post and Thom’s post on the appropriate liability rule for loyalty discounts.

I want to clarify some of the key issues in Commissioner Wright’s analysis of Exclusive Dealing and Loyalty Discounts as part of the raising rivals’ costs (“RRC”) paradigm. I never thought that I would have to defend Wright against Professors Lambert and Crane. But, it appears that rigorous antitrust analysis sometimes makes what some would view as strange bedfellows.

In my view, there should not be a safe harbor price-cost test used for loyalty discounts. Nor should these discounts be treated as conclusively (per se) illegal if the defendant fails the price-cost test. Either way, the test is a formalistic and unreliable screen. To explain these conclusions, and why I think the proponents of the screen are taking too narrow approach to these issues, I want to start with some discussion of the legal and economic frameworks.

In my view, there are two overarching antitrust legal paradigms for exclusionary conduct – predatory pricing and raising rivals’ costs (RRC), and conduct that falls into the RRC paradigm generally raises greater antitrust concerns. (For further details, see my 2006 Antitrust L.J. article, “Exclusionary Conduct, Effect on Consumers, and the Flawed Profit-Sacrifice Standard.”) Commissioner Wright also takes this approach in his speech of identifying and distinguishing the two paradigms.

This raises the question of which framework is better suited for addressing exclusive dealing and loyalty discounts (that is, where the conduct is not pled in the complaint as predatory pricing). Commissioner Wright’s speech articulates the view that theories of harm alleging RRC/foreclosure should be analyzed under exclusive dealing law, which is more consistent with the raising rivals’ costs approach, not under predatory pricing law (i.e., with its safe harbor for prices above cost). (Incidentally, I don’t read his speech as saying that he has abandoned Brooke Group for predatory pricing allegations. For example, it seems clear that he would support a price-cost test in a case alleging that a loyalty discount harmed competition via predatory pricing rather than RRC/foreclosure.)

To understand which legal framework – raising rivals’ costs/exclusive dealing versus predatory pricing/price-cost test – is most relevant for analyzing the relevant competitive issues, I want to begin with a primer on RRC theories of foreclosure. This will also hopefully bring everyone closer on the economics.

Input Foreclosure and Customer Foreclosure

There are two types of foreclosure theories within the RRC paradigm — “input foreclosure” and “customer foreclosure.” Both are relevant for evaluating exclusive dealing and loyalty discounts. The input foreclosure theory says that the ED literally “raises rivals’ costs” by foreclosing a rival’s access to a critical input subject to ED. The customer foreclosure theory says that ED literally “reduces rivals’ revenues” by foreclosing a rival’s access to a sufficient customer base and thereby drives the rival out of business or marginalizes it as a competitor (i.e., where it lacks the ability or incentive to move effectively beyond a niche position or to invest to grow).

Commissioner Wright’s speech tended to merge the two variants. But, it is useful to distinguish between them. (I think that this is one source of Professor Lambert being “baffled” by the speech, and more generally, is a source of confusion among commentators that leads to unnecessary disagreements.)

In the simplest presentation, one might say that customer foreclosure concerns are raised primarily by exclusive dealing with customers, while input foreclosure concerns are raised primarily by exclusive dealing with input suppliers. But, as noted below, both concerns may arise in the same case, and especially so where the “customers” are distributors rather than final consumers, and the “input” is distribution services.

Analysis of exclusive dealing (ED) often invokes the customer foreclosure theory. For example, Lorain Journal may be analyzed as customer foreclosure. However, input foreclosure is also highly relevant for analyzing ED because exclusive dealing often involves inputs. For example, Judge Posner’s famous JTC Petroleum cartel opinion can be interpreted in this way, if there were solely vertical agreements.

Cases where manufacturers have ED arrangements with wholesale or retail distributors might be thought to fall into the customer foreclosure theory because the distributors can be seen as customers of the manufacturer. However, distributors also can be seen as providing an input to the manufacturer, “distribution services.” For example, a supermarket or drug store provides shelf space to a manufacturer. If the manufacturer (say, unilaterally) sets resale prices, then the difference between this resale price and the wholesale price is the effective input price.

One reason why the input foreclosure/customer foreclosure distinction is important involves the proper roles of minimum viable scale (MVS) and minimum efficient scale (MES). The customer foreclosure theory may involve a claim that the rival likely will be driven below MVS and exit Or it may involve a claim that the rival will be driven below MES, where its costs will be so much higher or its demand so much lower that it will be marginalized as a competitor.

By contrast, and this is the key point, input foreclosure does not focus on whether the rival likely will be driven below MVS. Even if the rival remains viable, if its costs are higher, it will be led to raise the prices charged to consumers, which will cause consumer harm. And prices will not be raised only in the future. The recoupment can be simultaneous.

Another reason for the importance of the distinction is the role of the “foreclosure rate,” which often is the focus in customer foreclosure analysis. For input foreclosure, the key foreclosure issue is not the fraction of distribution input suppliers or capacity that is foreclosed, but rather whether the foreclosure will raise the rival’s distribution costs. That can occur even if a single distributor is foreclosed, if the exclusivity changes the market structure in the input market or if that distributor was otherwise critical. (For example, see Krattenmaker and Salop, “Anticompetitive Exclusion.”)

At the same time, it is important to note that the input/customer foreclosure distinction is not a totally bright line difference in many real world cases. A given case can raise both concerns. In addition, customer foreclosure sometimes can raise rivals costs, and input foreclosure sometimes (but not always) can cause exit.
While input foreclosure can succeed even if the rival remains viable in the market, in more extreme scenarios, significantly higher costs inflicted on the rival could drive the rival to fall below minimum viable scale, and thereby cause it to exit. I think that this is one way in which unnecessary disagreements have occurred. Commentators might erroneously focus only this more extreme scenario and overlook the impact of the exclusives or near-exclusives on the rival’s distribution costs.

Note also that customer foreclosure can raise a rival’s costs when there are economies of scale in variable costs. For this reason, even if the rival does not exit or is not marginalized, it nonetheless may become a weaker competitor as a result of the exclusivity or loyalty discount.

These points also help to explain why neither a price-cost test nor the foreclosure rate will provide sufficient reliable evidence for either customer foreclosure or input foreclosure, which I turn to next.

(For further discussion of the distinction between input foreclosure and customer foreclosure, see Riordan and Salop, Evaluating Vertical Mergers: A Post-Chicago Approach, 63 ANTITRUST L.R. 513(1995). See also the note on O’Neill v Coca Cola in Andrew Gavil, William Kovacic and Jonathan Baker, Antitrust Law in Perspective: Cases, Concepts and Problems in Competition Policy (2d ed.) at 868-69. For analysis of Lorain Journal as customer foreclosure, see Gavil et. al at 593-97.)

The Inappropriateness of a Dispositive Price-Cost Test

A price-cost test obviously is not relevant for evaluating input foreclosure concerns, even where the input is distribution services. Even if the foreclosure involves bidding up the price of the input, it can succeed in permitting the firm to achieve or maintain market power, despite the fact that the firm does not bid to the point that its costs exceed its price. (In this regard, Weyerhaeuser was a case of “predatory overbuying,” not “raising rivals’ cost overbuying.” The allegation was that Weyerhaeuser would gain market power in the timber input market, not the lumber output market.)

Nor is a price-cost test the critical focus for assessing customer foreclosure theories of competitive harm. (By the way, I think we all agree that the relevant price-cost test involves a comparison of the incremental revenue and incremental cost of the “contestable volume” at issue for the loyalty discount. So I will not delve into that issue.)

First, and most fundamentally, the price-cost test is premised on the erroneous idea that only equally efficient competitors are worth protecting. In other words, the price-cost requires the premise that the antitrust laws only protect consumers against competitive harm arising from conduct that could have excluded an equally efficient competitor. This premise makes absolutely no economic sense. One simple illustrative example is a monopolist raising the costs of a less efficient potential competitor to destroy its entry into the market. Suppose that monopolist has marginal cost of $50 and a monopoly price of $100. Suppose that there is the potential entrant has costs of $75. If the entry were to occur, the market price would fall. Entry of the less efficient rival imposes a competitive constraint on the monopolist. Thus, the entry clearly would benefit consumers. (And, it clearly often would raise total welfare as well.) It is hard to see why antitrust should permit this type of exclusionary conduct.

It is also unlikely that antitrust law would allow this conduct. For example, Lorain Journal is probably pretty close to this hypothetical. WEOL likely was not equally efficient. The hypothetical probably also fits Microsoft pretty well.

Second, the price-cost test does not make economic sense in the case of the equally efficient rival either. Even if the competitor is equally efficient, bidding for exclusives or near-exclusives through loyalty discounts often does not take place on a level playing field. There are several reasons for this. One reason is that the dominant firm may tie up customers or input providers before the competitors even arrive on the scene or are in a position to counterbid. A second reason is that the exclusive may be worth more to the dominant firm because it will allow it to maintain market power, whereas the entrant would only be able to obtain more competitive profits. In this sense, the dominant firm is “purchasing market power” as well as purchasing distribution. (This point is straightforward to explain with an example. Suppose that the dominant firm is earning monopoly profits of $200, which would be maintained if it deters the entry of the new competitor. Suppose that successful entry by the equally efficient competitor would lead to the dominant firm and the entrant both earning profits of $70. In this example, the entrant would be unwilling to bid more than $70 for the distribution. But, the dominant firm would be willing to bid up to $130, the difference between its monopoly profits of $200 and the duopoly profits of $70.) A third reason is that customers may not be willing to take the risk that the entry will fail, where failure can occur not because the entrant’s product is inferior but simply because other customers take the exclusive deal from the dominant firm. In this case, a fear that the entrant would fail could become a self-fulfilling prophecy because the customers cannot coordinate their responses to the dominant firms’ offer. Lorain Journal may provide an illustrative example of this self-fulfilling prophecy phenomenon. This last point highlights a more general point Commissioner Wright made in his speech — that successful and harmful RRC does not require a below-cost price (net of discounts). When distributors cannot coordinate their responses to the dominant firm’s offer, a relatively small discount might be all that is required to purchase exclusion. Thus, while large discounts might accompany RRC conduct, that need not be the case. These latter reasons also explain why there can be successful foreclosure even when contracts have short duration.

Third, as noted above, customer foreclosure may raise rivals’ costs when there are economies of scale. The higher costs of the foreclosed rivals are not well accounted for by the price-cost test.

Fourth, as stressed by Joe Farrell, the price-cost test ignores the fact that loyalty discounts triggered by market share may deter a customer’s purchases from a rival that do not even come at the expense of the dominant firm. (For example, suppose in light of the discounts, the customer is purchasing 90 units from the dominant firm and 10 from the rival in order to achieve a “reward” that comes from purchasing 90% from the dominant firm. Now suppose that entrant offers a new product that would lead the customer to wish to continue to purchase 90 units from the dominant firm but now purchase 15 units from the rival. The purchase of these additional 5 units from the rival does not come at the expense of the dominant firm. Yet, even if the entrant were to offer the 5 units at cost, these purchases would be deterred because the customer would fall below the 90% trigger for the reward.) In this way, the market share discount can directly reduce output.

Fifth, the price-cost test assumes that the price decreases will be passed on to final consumers. This may be the clear where the exclusives or loyalty discounts are true discounts given to final consumers. But, it may not be the case where the dominant firm is acquiring the loyalty from input suppliers, including distributors who then resell to final consumers. The loyalty discounts often involve lump sum payments, which raises questions about pass-on, at least in the short-run.

Finally, it is important to stress that the price-cost test for loyalty discounts assumes that price actually represents a true discount. I expect that this assumption is the starting point for commentators who give priority to the price-cost test. However, the price may not represent a true discount in fact, or the size of the discount may turn out to be smaller than it appears after the “but-for world” is evaluated. That is, the proponents of a price-cost test have the following type of scenario in mind. The dominant firm is initially charging the monopoly price of $100. In the face of competition, the dominant firm offers a lower price of (say) $95 to customers that will accept exclusivity, and the customers accept the exclusivity in order to obtain the $5 discount. (To illustrate, suppose that absent the exclusive, the customers would purchase 90 units from the dominant firm at $100 for total revenue of $9000. With the exclusive, they purchase 100 units at a price of $95 for total revenue of $9500.
Thus, the dominant firm earns incremental revenue of $500 on the 10 incremental units, or $50 per unit. If the dominant firm’s costs are $50 or less, it will pass the price-cost test.) But, consider next the following alternative scenario. The dominant firm offers the original $100 price to those customers that will accept exclusivity, and sets a higher “penalty” price of $105 to customers that purchase non-exclusively from the competitor. In this latter scenario, the $5 discount similarly may drive customers to accept the exclusive. These prices would lead to a similar outcome of the price-cost test. (To illustrate, suppose that absent the exclusive, the customers would purchase 90 units from the dominant firm at $105 for total revenue of $9450. With the exclusive, they purchase 100 units at a price of $100 for total revenue of $10,000. Thus, the dominant firm earns revenue of $550 on the 10 incremental units, or $55 per unit. Here, the dominant firm will pass the price-cost test, if its costs are $55 or less.) However, in this latter scenario, it is noteworthy that the use of the “penalty” price eliminates any benefits to consumers. This issue seems to be overlooked by Crane and Lambert. (For further details of the role of the penalty price in the context of bundled discounts, see Barry Nalebuff’s articles on Exclusionary Bundling and the articles of Greenlee, Reitman and Sibley.)

* * *

For all these reasons, treating loyalty discounts as analogous to predatory pricing and thereby placing over-reliance on a price-cost test represents a formalistic and unreliable antitrust approach. (It is ironic that Commissioner Wright was criticized by Professor Lambert for being formalistic, when the facts are the opposite.)

This analysis is not to say that the court should be indifferent to the lower prices, where there is a true discount. To the contrary, lower prices passed-on would represent procompetitive efficiency benefits. But, the potential for lower prices passed-on does not provide a sufficient basis for adopting a price-cost safe harbor test for loyalty discount allegations, even ones that can be confidently characterized as purely plain vanilla customer foreclosure with no effects on rivals’ costs.

Thus, the price-cost test should be one relevant evidentiary factor. But, it should not be the primary factor or a trump for either side. That is, above-cost pricing (measured in terms of incremental revenue less than incremental cost) should not be sufficient by itself for the defendant to escape liability. Nor should below-cost pricing (again, measured in terms of incremental revenue less than incremental cost) should not be a sufficient by itself for a finding of liability.

Such “Creeping Brookism” does not led to either rigorous or accurate antitrust analysis. It is a path to higher error rates, not a lower ones.

Nor should courts rely on simple-minded foreclosure rates. Gilbarco shows how a mechanical approach to measuring foreclosure leads to confusion. Microsoft makes it clear that a “total foreclosure” test also is deficient. Instead, a better approach is to require the plaintiff to prove under the Rule of Reason standard that the conduct harms the rival by reducing its ability to compete and also that it harms consumers.

I should add one other point for completeness. Some (but not Commissioner Wright or Professor Crane) might suggest that the price-cost test has administrability benefits relative to a full rule of reason analysis under the RRC paradigm. While courts are capable are evaluating prices and costs, that comparison may be more difficult than measuring the increase in the rivals’ distribution costs engendered by the conduct. Moreover, the price-cost comparison becomes an order of magnitude more complex in loyalty discount cases, relative to plain vanilla predatory pricing cases. This is because it also is necessary to determine a reasonable measure of the contestable volume to use to compare incremental revenue and incremental cost. For first-dollar discounts, there will always be some small region where incremental revenue is below incremental cost. Even aside from this situation, the two sides often will disagree about the magnitude of the volume that was at issue.

In summary, I think that Professor Wright’s speech forms the basis of moving the discussion forward into analysis of the actual evidence of benefits and harms, rather than continuing to fight the battles over whether the legal analysis used in the 1950s and 1960s failed to satisfy modern standards and thereby needed to be reined in with unreliable safe harbors.