Search Results For RPM

I’ve recently finished reading Jonathan Baker’s Preserving a Political Bargain: The Political Economy of the Non-Interventionist Challenge to Monopolization Enforcement, forthcoming in the Antitrust Law Journal.

Baker’s central thesis in Preserving a Political Bargain builds on earlier work concerning competition policy as an implicit political bargain that was reached during the 1940s between the more extreme positions of laissez-faire on the one hand and regulation on the other.  The new piece tries to explain what Baker describes as the “non-interventionist” critique of monopolization enforcement within this framework.  The piece is motivated, at least in part, by the Section 2 Report debates.  Baker’s basic story is fairly straightforward.  Under Baker’s account, competition policy is the outcome of the political bargaining process described above.  The “competition policy bargain” was then successfully modified in the 1980s in response to the Chicago School critique.  According to Baker, during the 1970s and 80s, “the Supreme Court revised many if not most of aspects of antitrust law along the lines suggested by legal and economic commentators loosely associated with the University of Chicago,” though this revolution changed the antitrust laws “dramatically but not fundamentally” and reflected a “bipartisan consensus in favor of reforming antitrust rules to enhance the efficiency gains arising from competition policy.”

Baker applies his “political bargain” framework to argue that the “modern non-interventionist critique,” unlike the successful attempt to modify the “terms” of the bargain in the 1980s, is highly likely to fail.  Baker defines the non-interventionist critique as relying on a particular series of legal and economic arguments.  For example, Baker describes the economic arguments deployed by the non-interventionists as that “markets are self-correcting,” “monopoly fosters economic growth,” “there is a single monopoly profit,” “excluded fringe rivals may not matter competitively,” “courts cannot reliably identify monopolization,” and so on.  Animated by the Section 2 Hearings, Report, its withdrawal, and the subsequent controversy, Baker begins from the assumption the non-interventionists are trying to modify an existing bargain, since non-interventionists are “the primary source of recent criticism of monopolization standards.”  From there, Baker argues that this concerted effort to modify the competition bargain in favor of less intervention is unlikely to succeed because such an attempted modification is unlikely to mobilize broader political support in the current social environment.

Let me start by saying that I agree entirely with the ultimate conclusion in so far as I don’t think there is any doubt that, in the current environment,  it is unlikely that the implicit “policy bargain” will be modified in a way that makes it more difficult for monopolization plaintiffs.  I have much more trouble with the premise of the exercise, and on how one knows a deviation from the current policy bargain when he sees one, and so will focus my critique on those issues.

Baker paints the picture of a dramatic and fundamental attack by non-interventionists on monopolization enforcement.  My response to the premise of the paper was: What non-interventionist effort to further relax monopolization standards?” To be sure, there are plenty of folks who have cautioned against expansive use of Section 2.  It strikes me that the fundamental weakness in Baker’s analysis is that his starting point – the “terms” of the current political bargain — derives from  assumptions that don’t seem to square with reality.    In other words, rather than envisioning the current debates around Section 2 as an assault by non-interventionists, there is a much more compelling case that it is the interventionists attempting to “deviate” from whatever implicit political bargain exists with respect to competition policy.  Christine Varney’s declaration that there is “no such thing as a false positive” – the presence of such being a seminal observation since The Limits of Antitrust (in 1984, no less) immediately leaps to mind.  I will turn to making the case that it is the interventionists making the offer for modification below.

But first note that Baker leaves out of his list of “economic arguments” against Section 2 both error costs and that there is little empirical evidence that aggressive monopolization enforcement generates consumer benefits.  This is, in my view, an important omission since Baker makes the point that all of the other economic arguments have attracted rebuttals.  If there has been a rebuttal of the argument that the empirical evidence suggests that instances of anticompetitive exclusive dealing, RPM, tying and vertical integration are quite rare, or an empirical demonstration that monopolization enforcement has generated consumer welfare gains bet of error and administrative costs, I’d like to see it.  Further, note that the original Chicago School argument, a la Director & Levi, against monopolization enforcement was not that anticompetitive exclusion was impossible, but rather that it was sufficiently rare in the world as an empirical matter as to be irrelevant to policy formation.  Baker ignores this empirical, evidence-based non-interventionist critique, which, for example, has been the core of the position taken by modern academic skeptics of monopolization enforcement like myself, Dan Crane, Tim Muris, Bruce Kobayashi, Luke Froeb, and David Evans.

What is the evidence that there is a non-interventionist attack on the current competition policy bargain as it exists with respect to monopolization? Not much.  The first is that the non-interventionists are the “source of criticism of recent monopolization standards.”  In parts of the paper, Baker equates the non-interventionists with business interests.  But under that formulation, there is not much evidence to support this proposition.  If anything, and as Baker readily acknowledges in a footnote, the headlines seem to tell a story of AMD, Google, Microsoft, Adobe and others expending resources to instigate antitrust enforcement against rivals not to restrict the scope of Section 2.

Baker cites more generally the recent monopolization controversy as driven by the non-interventionist attempt to deviate from the status quo.  But this part of the analysis reads to me as driven entirely by assertion that the competition policy preferences that Baker appears to prefer are in the “political bargain” and deeming opposition to those (interventionist) policies attempted “deviations.”  Perhaps this is a problem of hammers and nails.  Baker’s more interventionist than I and so sees obstacles between his ideal vision of antitrust law and reality as caused by non-interventionists.  But I’ve got a different hammer and see different nails.  For example, I read the Section 2 Report as largely (but not entirely) limited to a description of Section 2 law as it exists and the vigorously dissenting voices coming from the interventionist crowd.  As George Priest has put it:

It’s fair enough for a succeeding administration to reject policies of its predecessor. But the Justice Department report was not authored by John Yoo or Alberto Gonzales. It was the work of a year-long study that considered recommendations from 29 panels and 119 witnesses, most of them critical of the minimalist Chicago School approach to antitrust law. The report’s conclusions basically track Supreme Court law with modest extensions in areas where the Supreme Court has not ruled. Ms. Varney denounced the report in its entirety.

Finding the evidence lacking of some strong non-interventionist attempt to impose dramatic change on Section 2 that deviates from the current political bargain, I offer an alternative hypothesis: it is the interventionists that are attempting to deviate from the current political bargain and propose change.

For starters, I think that Baker and I would agree that there actually is a “stable” competition policy bargain with respect to monopolization that has drawn bipartisan over the last twenty years – at least in the courts.  Note that even restricting attention to decisions during the George W. Bush administration from 2004-08, the total vote count of these decisions was 86-9, with 7 of 11 decisions decided unanimously, and only Leegin attracted more than two votes of dissent (and more likely, as others have pointed out, for its implications with respect to abortion jurisprudence than anything to do with the antitrust analysis of vertical restraints!).  The monopolization-related decisions of the modern era, including Trinko, Linkline, Credit Suisse, and Brooke Group have all made lift more difficult for plaintiffs in one way or another.  But as I’ve written on this blog over and over again, the error-cost analysis embedded in these decisions is a key feature of modern Section 2 jurisprudence that is part of the current bargain.  So as I understand it, these decisions must be part of the current bargain.  It would be difficult, in fact, to find another area of law in which the Court has articulated principles with such overriding unanimity despite persistent attempts by some scholars to advocate for an alternate overarching legal framework.  I think there is a much more compelling story – and one backed by greater evidence than Baker’s narrative — to tell about the modern attempt of the interventionists to renegotiate terms.    Let’s discuss some of the evidence.

For starters, the strongly-toned dissents from the Section 2 Report from both Agencies after Hearings with witnesses and testimony from all possible sides of debate — even the parts that merely describe the law — suggest dissatisfaction with the terms of the modern bargain Baker describes and that are represented by the monopolization case law created over the past several decades by supermajority Supreme Court decisions.  It is AAG Varney who recently, as Baker acknowledges in the paper, minimized the importance of Trinko under Section 2 in favor of “tried and true” cases like Aspen Skiing.  This is, of course, to say nothing of AAG Varney’s endorsement of an antitrust policy free of error-cost considerations.

Further, it is the interventionists at the Federal Trade Commission that have turned to an expanded vision of Section 5 to evade the constraints imposed by Section 2.  In fact, the Commission has explicitly announced that it does not think that the constraints imposed on plaintiffs under Section 2 should apply to the antitrust agencies!  If this is not an attempt to deviate from the existing political bargain in an interventionist direction, I’m not sure what is.  Put another way, interventionists are currently attempting to re-write existing Section 2 law – the “political bargain” – through Section 5. Given the Complaint in Intel and promised use of Section 5 in broad circumstances previously covered under the Section 2 law envisioned under the “stable” bargain that Baker describes as generating bipartisan support from Democrats and Republicans, surely this is an attempt to deviate from the prior bargain.

It is the interventionists that have provided new economic arguments in favor of greater antitrust enforcement.  For example, the recent trend towards reliance on behavioral economics endorsed by the agencies emerges out of dissatisfaction with Chicago and Post-Chicago School theories that adopt rational actor models and, presumably, inability to get substantial traction in the federal courts from existing interventionist models provided by the Post-Chicago School.

The interventionist assault on the current implicit competition policy bargain goes further than the agencies though.  Congress currently has in front of it pending legislation to take out of the courts the development of a rule of reason standard for minimum RPM, a Twombly-repealer, legislation to make reverse payments in pharmaceutical patent settlements illegal, and legislation to regulate interchange fees.  Every one of these proposals represents an interventionist reaction attempting to overturn a judicial application of current competition law and suggest that perhaps the interventionists do not trust the courts to oversee the political bargain.

The premise of Baker’s analysis (that the non-interventionists are strongly challenging the current status quo) is either false to begin with or practically irrelevant in light of the much more important interventionist challenge.  Note again that Baker’s claim is that the non-interventionists would fail in any attempt to reduce the scope of monopolization enforcement because they will not be able to generate more broad political support in the current environment.  No doubt that is true.  But what about the interventionists chances for success?  Baker’s analysis provides a very interesting lens to analysis evaluate questions like whether the interventionists will be successful in renegotiating the terms of the competition policy bargain.  At the moment, though things may be changing, they seem to have greater political support.  I think the most interesting conflict arising out of Baker’s interesting conception of competition between stakeholders in antitrust policy is that it illuminates what might be a battle for supremacy in governing the bargain between agencies and courts.  As Baker notes, the courts have been a critical part of establishing the terms of the bargain and adjudicating attempts to “re-negotiate” by private plaintiffs and agencies over time.  Recently, interventionists have attempted to shift antitrust (and consumer protection) enforcement away from courts and towards administrative agencies, such as with Section 5 and the proposed CFPA.   To me, these present more important and interesting policy questions than whether non-interventionists will be successful in further shrinking Section 2 law.  I believe that the prediction emerging from Baker’s model depends on what happens with the political environment in the next few years.

My prediction, for what its worth, is that the current policy bargain will certainly hold together in the courts.  The remarkable strength of the current Section 2 status quo is held together by a combination of the intuitive appeal of price theory for generalist judges relative to more interventionist Post-Chicago and Behavioral economic alternatives, the relative explanatory power of the so-called Chicago School theories relative to contenders.  Nothing there has changed.  I have less of a sense about the impact of Congressional changes, judicial nominations, and the rise of the EU as monopolization enforcer have on monopolization in the US.

I was recently reading Dean Chemerinsky (Irvine Law) on the Roberts Court at Age 3. One of Chemerinsky’s standard takes when he talks about the Roberts Court is that the Court’s pro-business stance is one of its defining characteristics. Readers of the blog will know that I’ve been critical of Chemerinsky for his superficial antitrust commentary. For example, in this California Bar Journal piece, under the heading “Favoring Businesses over Consumers and Employees,” Chemerinsky argues that the Roberts Court antitrust decisions favored businesses over consumers by overturning Dr. Miles, “make it more difficult to sue business for antitrust violations” in Credit Suisse, and, in Twombly, made it “harder for plaintiff to get into court.”

Of course, this sort of superficial journalist-level analysis of Supreme Court antitrust decisions would not be appropriate for a law prof doing a serious law review piece. And of course, the point is wrong. Previously I wrote:

what gets me about this section is the heading: “Supreme Court favors businesses over consumers.” Is that really what these cases are about? I have read political accounts of the Supreme Court opinions in newspapers and periodicals or blogs that read this way (”The Roberts Court wants to stick it to the consumer — I can prove it: the Defendant won in all 4 cases this term”). But I’ve not heard law professors take this route too often, and never an antitrust commentator. In fact, a reasonable reading of the Court’s antitrust output this year suggests that the issues are much more nuanced than this oversimplified soundbite that pits business against consumers.

Is Leegin a pro-business and anti-consumer decision? I’m not sure I even know what that means in this context. Let’s turn the question on its head for a moment to illustrate its absurdity. Is a decision that prohibits a firm from engaging in some behavior clearly anti-business and pro-consumer? Of course not! It depends on the competitive effects of the conduct at issue and how the antitrust rule will impact firm behavior. Justice Kennedy’s opinion on behalf of the majority does allow manufacturers to engage in behavior that was previously constrained. Perhaps that is a sufficient condition for a pro-business label? On the other hand, the very reason the Court overturned the per se rule was the result of evidence that minimum resale price maintenance made consumers better off! Now, one might think that the Court got it wrong and that RPM actually harms consumers. I disagree and believe Leegin was correctly decided. But to argue that the Court got there by favoring business over consumers is not accurate, and obvious from reading the opinion.

The point here is that the issues are far more nuanced than his misleading characterization of the cases suggests. It is a short article, I know. There is not always room to get in every detail about every case. But these are not minor details. These sorts of misleading descriptions aimed at producing soundbites. That sort of thing should be left to journalists, not law professors.

I was interested in reading the law review length piece to see if Chemerinsky would push harder on his antitrust claim as evidence that the court was too pro-business. Interestingly, to his credit, and I think correctly, he dropped the point. Perhaps he reads the blog. Chemerinsky is not the only law professor, economist, or commentator to argue that the high defendant win rate in antitrust cases is evidence that the Supreme Court is anti-consumer and pro-business (to be distinguished from pro-business and pro-consumer), or to make the related point that we can simply look at the level of enforcement activity levels to figure out how well enforcers are performing (see, e.g. examples we’ve discussed here and here). I’ve also increasingly noticed reliance on the low plaintiff win rate before the SCOTUS in antitrust cases as evidence that antitrust law is moving away from a consumer welfare standard or favoring firms over consumers.

There are at least two major analytical flaws with these arguments that render the evidence irrelevant for the purposes frequently asserted.

The first is that plaintiff win rates do not account for the merits of the underlying case. It doesn’t make much sense to argue that Independent Ink favors businesses over consumers because it makes life more difficult for plaintiffs who must now prove market power in tying cases. There is an economic consensus that market power is required to do competitive harm and that patents are not sufficient to confer such power. The rule in Independent Ink thus eliminates the potential for serious error costs and chilling of pro-competitive tying and is good for consumers. Yes, even though the defendant won. One could conduct a similar analysis of decisions like Leegin where there is simply no evidence that the per se rule for minimum RPM is appropriate or benefits consumers. The important analytical point is that whether an antitrust decision is good or bad for consumers is not obviously related to who wins the case! One must understand the competitive effects of the conduct at issue, and the likelihood and social costs of errors in evaluating the conduct in order to assess a change in the liability rule in this way. Win rates just don’t cut it. This is similar to the point that one can’t just look at merger enforcement activity and make inferences about whether more is better. Rather, one has to have some idea about whether the “marginal”merger enforcement action is likely to increase or decrease consumer welfare. That necessitates a strategy of identifying those marginal merger enforcement decisions and some reliable evidence of their welfare effects. Without out, claims linking activity level to quality of enforcement don’t make any sense.

Second, the cases the Supreme Court selects are endogenously determined not randomly assigned. What types of decisions are they accepting one how might that impact win rates? Judge Douglas Ginsburg (with Leah Brannon in Competition Policy Int’l) recently described the case selection: “the Court, far from indulging in a pro-defendant or anti-antitrust bias, is [instead] methodically re-working antitrust doctrine to bring it into alignment with modern economic understanding.” I make a similar point here, arguing that the Roberts Court’s antitrust jurisprudence has identified low hanging fruit where there is an economic consensus. If the Court is looking for areas to bring modern antitrust law in align with economic theory, relative to the plaintiff friendly law of the 1960s, one would expect systematically that these decisions would come out in favor of defendants. It is no surprise that they do.  Defendant win rates in cases bringing what everybody agrees was a very anti-consumer and anti-business set of laws in the 1960s in step with modern economic theory and evidence is likely to substantially improve consumer outcomes.  Given the body of doctrine from which antitrust is coming from, to argue that defendant wins are evidence of consumer harm strikes me as implausible without some other corroborating evidence.

Litigation win at the Supreme Court, and enforcement activity levels for that matter, might be interesting for all sorts of reasons. But they are not reliable evidence of the quality of the substantive doctrine, enforcement, or consumer welfare.

Once again displaying its tenacious devotion to old Dr. Miles, the FTC is investigating whether makers of musical instruments and audio equipment have engaged in illegal resale price maintenance (RPM). Yesterday’s WSJ reported that the Commission has issued subpoenas to a number of prominent musical instrument manufacturers, including Fender, Yamaha, and Gibson, as well as to the retailer, Guitar Center, Inc. The Commission is apparently seeking to determine whether the manufacturers’ minimum advertised price (MAP) programs, which forbid retailers from advertising prices below some minimum level, amount to unreasonable vertical restraints of trade. In the post-Leegin world, even those MAP programs that amount to agreements to set retail prices are not automatically illegal. Instead, a challenger must establish their anticompetitive effect.

Most likely, these arrangements are pro- rather than anti-competitive. To see why, consider the possible anti-competitive harms and pro-competitive benefits that may result from RPM agreements and the pre-conditions for their occurrence.

The potential anti-competitive harms stemming from RPM are (1) facilitation of a cartel at the retailer level [i.e., retailers persuade the manufacturer to establish and enforce a retailer cartel by “requiring” them to adhere to minimum resale prices] and (2) facilitation of a cartel at the manufacturer level [i.e., colluding manufacturers all require their retailers to charge minimum resale prices in order to (a) reduce the manufacturers’ individual incentives to cheat on the fixed price they charge retailers, who can’t enhance total sales of the manufacturer’s brand by passing any price cut on to consumers, and (b) enhance price transparency so that their cartel is easier to monitor].

In order for either of these anti-competitive harms to materialize, a number of structural pre-requisites must be present. For RPM to facilitate a dealer-level cartel, the retail market must be capable of cartelization (e.g., it must be fairly concentrated, with significant entry barriers, etc.). Moreover, because manufacturers would normally want retail mark-ups to be as small as possible and would thus tend to resist requests for RPM, the retailers seeking to enlist manufacturers in establishing/policing their cartel must have some power in the retail market. Given the low barriers to entry in retailing, such retailer market power is rare. For RPM to facilitate a manufacturer-level cartel, the manufacturers’ market must be susceptible to cartelization (e.g., concentrated, subject to entry barriers, etc.) and the use of RPM must be fairly widespread among manufacturers comprising a substantial percentage of the market.

It’s unlikely that the structural pre-requisites to either form of anti-competitive harm exist here. With respect to the dealer cartel possibility, the relevant retailer market is unconcentrated, and entry barriers are low. Retailers couldn’t very well cartelize, and if they tried to do so, retailers offering lower mark-ups would enter the market. It’s therefore unlikely that RPM could facilitate a dealer cartel. I don’t know about the structural pre-requisites to the “facilitation of manufacturer cartel” theory, but the fact that the FTC isn’t (to my knowledge) investigating direct collusion among the instrument manufacturers themselves suggests that there’s no basis for supposing that the RPM here is being used to facilitate any such cartel.

So the potential anti-competitive harms of RPM are unlikely to exist here. What about the pro-competitive benefits?

Well one pro-competitive benefit is pretty darn obvious. A musical instrument is the sort of thing whose attractiveness to consumers will be greatly influenced by point-of-sale services. If a customer can try out a brand of an instrument, ask questions of a knowledgeable salesperson, see the various features demonstrated, maybe take a lesson or two, and be assured that he can return the instrument to the store for occasional servicing, the amount he is willing to pay for that brand will increase. A manufacturer thus has an interest in ensuring that these point-of-sale services remain available. If low-overhead retailers (like Internet retailers) can free-ride off the efforts of high-service dealers, then these output-enhancing point-of-sale services will eventually disappear, to the detriment of the manufacturers. The manufacturers thus have an interest in forbidding the advertising — and even the charging — of low prices by low- (or no-)service retailers. Such restrictions are necessary to promote the services that are desired by consumers and will maximize the total output of the manufacturers’ products.

As Josh has noted a number of times, the free-rider explanation is not the only pro-competitive explanation for RPM agreements. In this case, though, the free-rider story seems pretty plausible. The collusion-facilitation stories, not so much.

It will be interesting to see what the FTC finds and how much proof of pro-competitive effect it requires before it acquits the MAP arrangements at issue. Based on its recent action in the Nine West case, I expect that it will scrutinize the arrangements very closely. I, of course, would recommend that it follow the approach set forth in my forthcoming William & Mary Law Review article, Dr. Miles Is Dead. Now What?: Structuring a Rule of Reason for Evaluating Minimum Resale Price Maintenance.

It looks like the FTC is interested in doing more than just investigating RPM (see Thom’s excellent post), as the agency just announced a series of public workshops on the question of how best to distinguish pro-competitive uses of RPM from those that raise competitive concerns. From the announcement:

The FTC is requesting public comment from attorneys, economists, marketing professionals, the business community, consumer groups, law enforcers, academics, and other interested parties on three general subjects:

  1. The legal, economic, and management principles relevant to applying Sections 1 of the Sherman Act and Section 5 of the FTC Act to RPM, including the ability to administer current or potential antitrust or other rules for applying these laws;
  2. The business circumstances regarding the use of RPM that the Commission should examine in the upcoming workshops, including examples of actual conduct; and
  3. Empirical studies or analyses that might provide better guidance and assistance to the business and legal communities regarding RPM enforcement issues.

Thom’s paper offers one proposed test based on the available theoretical and empirical evidence and grounded in the error-cost approach. One of the key virtues of Thom’s test is that he would initially place the burden on the plaintiff to demonstrate an output effect. I’ve written before, as have many others, that all of this talk about RPM and its effect on prices is nothing more than distraction given that both pro-competitive and anti-competitive theories predict a price increase. Thom’s test is nuanced and includes structured rule of reason inquiries for establishing the likelihood of such an effect through circumstantial evidence. You should read the paper if you haven’t already.

In the paper, Thom is a bit too kind to the proponents of proposed tests that would either turn on observing prices before and after the imposition of RPM or would place a burden on the defendant utilizing RPM to first show, without a predicate showing of actual or likely reduction in output, that its use fit some pre-determined justification for RPM. The former tests are wrong on the economics because we want price and not output. We should not entertain price tests as relevant here. We should also dismiss as inconsistent with economic learning tests that do not at least attempt to reconcile burdens with the theoretical and empirical learning on vertical restraints and RPM more specifically. I’ll leave as an exercise to the reader to figure out which tests those might be and which errors they commit.

The latter tests are also wrong on the economics, but in a different way. One of the many advantages to setting the rule of reason as the analytical default for business practices and reserving the per se rule for those practices which we know, through judicial learning or economic experience, “always or almost always reduce output” is that it constrains antitrust enforcers and judges from condemning business practices which look unfamiliar or which we do not understand simply because we do not yet have an efficiency justification. Antitrust has a long history of condemning business practices which we later found out are a normal part of the competitive process. We can tell that story for RPM, vertical mergers, horizontal mergers, exclusive dealing contracts, tying — well, we can tell it about nearly everything within antitrust’s domain. This is what Ronald Coase was warning us about when he wrote:

One important result of this preoccupation with the monopoly problem is 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.

Many of the proposed tests which would place substantial burdens on defendants to explain their conduct with reference to some narrowly accepted justifications for RPM, usually based on what I view to be an overly restrictive and erroneous reading of Leegin, come very close to looking like attempts to design structured rule of reason approaches with the goal of circumvent the burden shifting consequence of overturning Dr. Miles. The notion that we know so much about the competitive effects of RPM such as to justify its treatment as “inherently suspect” or worthy of summary condemnation under certain specific and identifiable conditions is both wrong as a matter of economics and empirical evidence and inconsistent with Leegin.

There is a lot that we do know know about precisely how RPM works, when and by whom it is adopted, and to what effect. But both what we do and what we don’t know about RPM can and should cut in favor of adopting burdens which require plaintiffs to show meaningful competitive harm before we condemn a business practice which all agree is efficient most of the time. Precisely how we specify those burdens, presumptions and safe harbors in a way that is consistent with the principles of rule of reason analysis and economic learning is a very important question (Thom’s paper is a step in the right direction toward answering that question) and one that the FTC should be applauded for allocating resources toward in these workshops. I’d also note that while much attention has been paid to developing a sensible structured rule of reason approach for the plaintiff’s prima facie burden in RPM cases, less (but not zero) has been paid to developing safe harbors grounded firmly in economic theory and empirical evidence which would provide firms using RPM to distribute their products some certainty with respect to antitrust exposure.

I’ll have more thoughts on RPM, the economics of vertical restraints, and sensible safe harbors later.

Danny Sokol makes some predictions about Post-Obama antitrust, and about my disappointment in what he perceives to be the likely direction of antitrust policy in the Obama administration:

1. increased challenges of mergers and monopolization cases, especially at DOJ

2. more consumer protection work at the FTC with a push to more expansive consumer rights

3. less language by US enforcers internationally about “convergence” and more on “harmonization”

4. a move away from cartels as the supreme evil of antitrust to more holistic approach that elevates unilateral conduct (if I am right, Josh Wright must be beside himself in terms of what this means under an error/cost framework)

Interesting. Though I agree with 1, 3, and 4 more than 2. I think the right place to start if we’re going to predict what an Obama antitrust regime will look like is what the President-elect has said he will do. There are other sources as well. Many have made much, far too much in my view, of Obama’s ties to the Chicago School, the Harvard School via Professor Elhauge who is an advisor, or behavioral economics via Cass Sunstein. But that seems like a reasonable place to start. So, here’s Obama’s Policy Statement on Antitrust to the American Antitrust Institute, which I’ve commented on previously.

Let’s start with what Obama says he’s going to do:

  1. Bring more cases. “Regrettably, the current administration has what may be the weakest record of antitrust enforcement of any administration in the last half century. Between 1996 and 2000, the FTC and DOJ together challenged on average more than 70 mergers per year on the grounds that they would harm consumer welfare. In contrast, between 2001 and 2006, the FTC and DOJ on average only challenged 33. And in seven years, the Bush Justice Department has not brought a single monopolization case. The consequences of lax enforcement for consumers are clear.”
  2. Aggressive enforcement against international cartels. “My administration will take aggressive action to curb the growth of international cartels”
  3. Prosecute Against Pharmaceutical Settlements that Prevent Generic Entry. “An Obama administration will ensure that the law effectively prevents anticompetitive agreements that artificially retard the entry of generic pharmaceuticals onto the market, while preserving the incentives to innovate that drive firms to invent life-saving
    medications.”
  4. Prevent Insurance and Drug Companies from “Abusing Monopoly Power.” “My administration will also ensure that insurance and drug companies are not abusing their monopoly power through unjustified price increases – whether on premiums for the insured or on malpractice insurance rates for physicians.”
  5. Relatedly, Introduce legislation to repeal the antitrust exemption for malpractice insurance with respect to price-fixing claims. “I have introduced legislation in the Senate that would repeal the longstanding antitrust exemption for medical malpractice insurance. This narrow bill would do so only for the most egregious cases of price fixing, bid rigging, and market allocation. As president, I will sign this bill into law.”
  6. Competition Advocacy in the U.S. and Internationally. “My administration will strengthen the antitrust authorities’ competition advocacy programs to ensure that special interests do not use regulation to insulate themselves from the competitive process. Finally, my administration will strengthen competition advocacy in the international community as well as domestically. It will take steps to ensure that antitrust law is not
    used as a tool to interfere with robust competition or undermine efficiency to the detriment of US consumers and businesses. It will do so by improving the administration of those laws in the US and by working with foreign governments to change unsound competition laws and to avoid needless duplication and conflict in multinational
    enforcement of those laws.

Two of these proposals are specific and easy to evaluate: prosecuting patent settlements that prevent generic entry and legislation to repeal the antitrust exemption for medical malpractice insurance. The fourth, standing alone, doesn’t make much sense. I’m not sure whether this is referring to prosecuting monopolists for charging monopoly prices (which he cannot do under current law) or something else. The next sentence in the statement is refers to this exemption bill, so perhaps that is what he is referring to. The statement about patent settlements in the pharmaceutical industry, however, could signal a major change to the extent that the FTC/DOJ rift on patent settlements disappears.

Numbers 1 and 6 are less specific: bring more cases and strengthen competition advocacy programs. Without particulars on competition advocacy, a program that is strongly supported by the current Chairman, I’m not sure if there is anything to evaluate here.

I’ve criticized the idea that merely bringing more cases strengthens or reinvigorates antitrust enforcement in any meaningful sense or from a consumer welfare perspective. I don’t think it does without a clear showing that the marginal case is going to improve consumer welfare. That may or may not be the case at current levels of enforcement. I’m not sure. But I haven’t seen any compelling evidence that this is true. As I’ve noted previously:

As a general matter, I do not find “more is better” arguments (see, e.g., here) causally linking agency activity to the quality of antitrust policy to be very persuasive. All of these claims should be taken with a grain of salt or two. It is one thing to make observations about trends in public antitrust enforcement over time….

All of this can be quite productive in terms of generating dialogue concerning potential improvements in antitrust policy. However, it is quite another thing to assert that such data are capable of establishing a causal link between enforcement activity level and the “quality” of antitrust enforcement and/or consumer welfare. I should be incredibly clear here: I do not read Baker & Shapiro to be claiming to have demonstrated such a link empirically (though it is clear from the article that they believe more enforcement would be a good thing) and am not making this point in response to their article. Rather, I am responding to appeals to evidence on activity levels alone to suggest that “more” or “less” enforcement would bring about positive changes for consumers. Maybe such a link would be useful if we were talking about dramatic changes in the rate of enforcement (say, abruptly plummeting to zero or increasing tenfold).

But one should be very cautious about making inferences about consumer welfare from small changes in aggregate enforcement data or anecdotal evidence from a handful of cases. I offer this word of caution in the spirit of the current season when these types of claims are quite popular with the politicians and journalists: while it may be true that the most active antitrust agency is the most influential for a number of reasons, there is simply no theoretical or empirical basis to suggest that the most active agency produces the greatest benefits for consumers.

And let’s not forget that “more antitrust enforcement” depends on what type of enforcement actions we are talking about. That brings me back to Danny Sokol’s point about the mix of cases in an Obama regime shifting away from cartels and toward monopolization on the margin. I suspect he is right in some sense. But we should note that a movement toward monopolization cases, where we know the least about the likely consumer welfare consequences of particular forms of single firm conduct, the marginal case is less likely to have a positive impact for consumers.

All of that said, let me take a stab at some predictions about antitrust in the Obama regime:

  1. Monopolization Enforcement will Increase, but Moderately. There will be a prominent monopolization case or two filed during the first four years. I don’t think we’ll see much of a shift toward monopolization cases.  So, I’m not quite “beside myself” about what this means in terms of the error-cost framework which I believe should guide antitrust policy decisions.   But I’m not optimistic either.  While the FTC or DOJ might want to bring these cases, current law makes single firm conduct cases (especially those involving pricing conduct, e.g. Intel) extremely difficult to win. And whatever impact Obama does have on the antitrust enforcement agencies, I suspect that loss aversion is relatively stable across political administrations. So, look for a few big name monopolization suits in prominent industries: health care, pharmaceuticals, microprocessors. I suspect that Post-Chicagoans hoping that the Obama administration is their chance to pursue a lot of monopolization cases are going to be a little bit disappointed.
  2. Reverse Payments. This is relatively low hanging fruit. The inter-agency tensions concerning the right approach to reverse payment settlements is going to go away with the new DOJ. The agencies will join together and successfully petition the Supreme Court to grant cert and apply per se/ inherently suspect analysis to patent settlements that delay generic entry. This, to some extent, overlaps with my first prediction. So let me note that I predict at least one, but probably not more than two, major monopolization suits excluding reverse payment cases.
  3. Competition Policy Advocacy. Nothing will change. Except perhaps, as Danny Sokol predicts, there will be much more talk about harmonization and much less about convergence. I do wonder how aggressive competition policy advocacy under the Obama administration will be against international antitrust efforts against U.S. firms that have been occasionally criticized as protectionist.
  4. Minimum RPM is Per Se Illegal Again. Dr. Miles was dead, but will come back to life via proposed federal legislation sponsored by Senators Clinton, Kohl and Biden. Empirical economists everywhere will be disappointed as the opportunity to exploit state variation in the legal status of RPM to identify its competitive consequences will disappear.
  5. Increased Merger Activity. Again, this is what President Obama said about his plans for antitrust enforcement if elected and I have no reason to believe it is not true. Whether this is good or bad for consumers depends a great deal on case selection and, even more so, the mix of mergers presented to the agencies during the next four years. Given that economic conditions have changed substantially, there is no doubt that the mix of cases will be substantially different than those under the second term of G.W. Bush. This will be interesting to watch.
  6. Patent Holdup. This one involves conjecture on my part and does not derive specifically from anything in the Obama statement. But I would be willing to bet that President Obama will strongly support both the FTC patent holdup agenda, as well as using the antitrust laws and FTC Act Section 5 to pursue cases like N-Data. I suspect we are likely to see an expansion of the patent holdup / conduct before SSO enforcement agenda. For my views on this subject (along with co-author Bruce Kobayashi, see here). This point also ties into the likely monopolization agenda. I think one might observe the expansion in monopolization enforcement linked to cases involving patent holdup and/or other forms of so-called “regulatory gaming,” e.g. pharmaceutical settlements and product hopping cases. The advantage of these cases is that they circumvent the problem of case law that makes it very difficult to win traditional pricing / discounting cases and that they usually involve big-name industries and firms.
  7. Network Neutrality legislation. I’m going to count this as an antitrust issue.

Those are my thoughts. My personal views on these are that 4, 5 and 7 are likely to make consumers worse off. Collectively, 1, 2 and 6 each depend on the types of cases that are brought. While I have less strong views about a more aggressive agenda pursuing some patent settlements, I think an expansion of the patent holdup enforcement agenda as represented by N-Data would harm consumers as well. I also believe monopolization enforcement under Section 2 in pricing cases involving loyalty or bundled discounts are not likely to improve consumer welfare — though I suspect these are not winners in federal court. I don’t suspect 3 will change much, and so I don’t suspect there will be any large changes on the margin here. One question I have is whether the Obama administration will prioritize competition research and development and take an economic and empirical approach to addressing current unknowns? That remains to be seen. The FTC Microeconomics conference and FTC at 100 events, I think, have been and will be productive endeavors in this area and ones that I hope will continue over the next four years.

More on Error Costs

Josh Wright —  20 January 2009

Speaking of error cost analysis, this paper from a trio of lawyers in the General Counsel’s Policy Studies’ group at the FTC has a section entitled “Error Costs: The False Positive/ Negative Debate.” A frustration for me in discussing the error cost issue with respect to antitrust policy is that many people do not seem to understand that it is error costs and not just errors that we are concerned with. A common refrain is: show me a false positive monopolization case! We bring so few, we don’t have to worry about false positives anymore. QED. Of course that is wrong. The social costs of false positives are not about the single business practice that is condemned by an antitrust judgment. The real costs are the chilling of pro-competitive behavior by other firms in response to the expectation of the same type of judgment against them. You cannot just count cases. Those aren’t where the costs are! Not to mention much of the expectation of liability from pro-competitive behavior is to do with the threat of settlements. Oh, and you want a false positive? Here’s one.

Much of the confusion surrounding this basic point of the error-cost approach to antitrust rules can be read in the hearings on the Section 2 Report with proponents of more interventionist antitrust policy constantly invoking the mantra that we just don’t see that many false positives in the cases as evidence in favor of the lack of error costs. Some go so far as to argue that the social costs of a false negative in the context of monopolization is likely to outweigh the costs of a false positive. While monopolization can have the same economic impact as cartel behavior, of course, economic theory tells us that there are some offsetting forces to correct market failure in the case of false negatives but none for false positives. This was one of Easterbrook’s key points in the Limits of Antitrust. The other key point, which is not as well appreciated, is that errors are more likely when we do not have a good basis for identifying anticompetitive conduct. This is nowhere more true than in the case of monopolization. In this era of no monopolization enforcement, there ought to be bundles of empirical examples abound documenting exclusionary distribution contracts with convincing statistical evidence. The literature isn’t there. So I’m not sure exactly how one would identify the false negative if they saw it. On the other hand, the bulk of the literature on vertical restraints and single firm conduct suggests that the conduct is pro-consumer most of the time. Another point in favor of fearing false positives instead of negatives.

Anyway, back to the paper. Its generally very good in framing the debate and pointing out what Section hearing panelists had to say on the issue. It doesn’t quite, at least to my tastes, separate out the issue of errors versus error costs nor the theoretical underpinnings of the error-cost approach sufficiently. Still, its good and better than most on this issue. And they do cite Easterbrook’s argument with respect to higher social costs for false positives relative to negatives. However, it wraps up the discussion with a little bit of a tone of “some say false positives, some say false negatives, lets ignore both of them because there is no evidence.” For example, on this issue it includes the following paragraphs:

This debate reflects both the potential promise of decision theory as an analytical framework and its current limits as a calibrated tool. While decision theory provides “a way to organize our thinking about legal standards,” the lack of reliable data limits its ability to identify optimal rules.186 As one panelist observed, “[F]alse positives [and] false negatives” should be considered “on the basis of empirical data and not on theoretical assumptions.”187 Yet the hearings suggested no basis for reliably quantifying the likelihood and magnitude of false positives and negatives under potential liability rules.

When evidence is limited, decision theory primarily provides general directions and broad insights, leading courts and enforcers to identify circumstances in which concerns regarding either false positives or false negatives are likely to be especially significant, and where greater tolerance or heightened vigilance may be appropriate.188 The Supreme Court’s application of decision theory in antitrust cases has reflected these limitations, identifying two areas—predatory pricing and predatory buying—in which concerns regarding false positives warrant the use of a specially-designed test.189

The conclusion here on the error cost debate seems to be that the error-cost framework (and the decision-theory that necessarily goes with it) is less useful when we do not have empirical data on the likelihood and magnitude of false positives and negatives. Perhaps no data came out of the hearings on these issues, but there is a substantial economic literature on single firm practices ranging from RPM to exclusive dealing to tying. See, e.g. this recent survey of that literature by colleagues of these FTC authors over in the Bureau of Economics. There are authors surveys as well. E.g., Lafontaine & Slade.

Here’s a quote from the first linked survey piece by Luke Froeb, James Cooper, Dan O’Brien and Michael Vita summing up the state of play:

Empirical analyses of vertical integration and control have failed to find compelling evidence that these practices have harmed competition, and numerous studies find otherwise. Some studies find evidence consistent with both pro- and anticompetitive effects; but virtually no studies can claim to have identified instances where vertical practices were likely to have harmed competition.

The error cost approach allows one to focus on an evidence-based antitrust policy. And frankly, at least in the monopolization area, the empirical basis for a more aggressive policy just isn’t there no matters. Assertions about the rarity of judicial errors in favor of plaintiffs in antitrust cases do not change that given the current state of our empirical knowledge.

More settling economic debates by declaration and without regard to the evidence.  When you make declarations like this it is best to do your homework.  Consider the following:

  • The Post-Chicago theoretical advances are well known to be built upon the foundation laid by Chicago School founders like Aaron Director — it is simply misleading to argue that Chicago School economists did not understand that certain business practices could lead to inefficient outcomes.  Rather, the Chicago version of these models was that they were empirically irrelevant.
  • Speaking of empirical evidence, it is instructive to note that it is Chicagoan (or at least Chicago friendly) authors like Ben Klein (on Standard Oil) and Tom Hazlett (on predation) who have offered two of the only existing real world empirical accounts of the Post-Chicago “raising rivals’ cost” phenomenon, not to mention fundamental contributions to its theoretical development by Chicagoan Dennis Carlton.
  • There is no attempt in the article to distinguish between the Chicago School generally and the Chicago School of antitrust economics.  Apparently, because Alan Greenspan abandoned “the Chicago School theory” and now rejects it, and because of a financial crisis over which substantial debate still exists as to its causes, we are to believe that the substantial body of theory and evidence supporting Chicagoan views of predation, vertical restraints, exclusive dealing, tying, shelf space contracts, and other business practices is now irrelevant to modern antitrust enforcement (tell me again why Fannie Mae and asset bubbles are relevant to monopolization policy and the economics of exclusive dealing?).
  • Once more on the actual evidence, recent comprehensive literature surveys from folks who are not Chicagoans (that shouldn’t matter but maybe it does) conclude that most forms of single firm conduct are (as hypothesized by Chicagoans) predominantly pro-competitive in practice (See great slides here from Lafontaine & Slade, Dan O’Brien or the paper from Froeb, et al — btw, the last two are by enforcement agency economists!).
  • The consensus on these issues is easily observed from recent economist amicus briefs on issues like predatory pricing, price squeezes, refusal to deal and RPM which consistently reveal views that are consistent with a constrained approach to antitrust enforcement of these business practices but represent a mix of economists.

The irresponsible use and mischaracterization of the Chicago School in antitrust has been somewhat of a pet peeve of mine (see, e.g. here):

I do not claim any authority or special ability to describe what “Chicago School” price theory is.  There are more worthy authorities for that.  But I had thought that the “Chicago School” stood for the proposition that microeconomic theory should be applied rigorously, with care and attention to institutional detail, and with an eye towards producing testable implications.  These are qualities, especially empiricism, that do not lend themselves to a reflexive “faith” that markets will produce only efficient behavior.  That faith, where it exists, is earned by persuasive theory and evidence.

The focus on empiricism embedded in the Chicago approach, by the way, was not merely lip service.  George Stigler, a Chicago economist if ever there was one, described what is now known as industrial organization economics as “Microeconomics-with-evidence.”  I love this description.  And I would like to think that it is still represents what is the most interesting work being done in industrial organization today — though the editors of the top journals may disagree with me.

But we all agree, don’t we, that predictive power matters?  “Conservative economists” have always highly valued empirical evidence and predictive power.  Post-Chicago economists who have contributed game theoretic models of unilateral conduct, collusion, and mergers generally motivate these models with the notion that they will improve predictive power relative to the simple Chicago approach — much like the behavioral models now popular in the L&E literature.  The respective models either improve our understanding of real world economic phenomena or they do not.  They are either consistent with the evidence or they are not.

And with all due respect to the Commissioner, an intellectually honest survey of the state of evidence concerning the actual competitive effects of antitrust-relevant business practices reveals that the Chicago School isn’t close to dead.  In fact, Chicago School principles are alive as ever in the Supreme Court’s jurisprudence.  Perhaps this disappoints the Commissioner and others who might like economics (and particularly Chicago School antitrust economics) to be a lesser constraint on antitrust enforcement decisions.  But it’s the state of play in both the federal courts and in the empirical antitrust literature.  The debate over whether to deviate from the state of play should be determined by the quality of theory and evidence.   A rigorous review of the empirical evidence suggests not only that the Chicago School of antitrust is alive, but in my view, that it is the “best available” mode of analysis for understanding many business practices relevant to antitrust enforcement.

The search for evidence-based antitrust cannot be conducted by assertion.  Instead, if it is to be fruitful, it must take a more scientific approach.

The headline of this Bloomberg story on the Swiss Competition Authority’s complaint against Bayer, Pfizer and Lilly announces that the firms operated an “Erection Drug Cartel.” I read a bit further to learn something about what I suspected, from the title of the story, would be a horizontal agreement between the firms — that is an agreement between rivals to set prices. Then I read this:

Pfizer, which makes Viagra; Lilly, the maker of Cialis; and Bayer, which sells Levitra, made “inadmissible vertical competition agreements” by maintaining a recommended public selling price for the drugs, the panel said today. “The recommended public selling price covered the drugmakers, pharmacies and physicians,” Olivier Schaller, a spokesman for the commission, said in a telephone interview. “It was widely followed.”

So, instead of a horizontal conspiracy between pharmaceutical firms, it looks like Pfizer, Lilly and Bayer were independently entering into agreements with distributors to adhere to a suggested price. In other words, these were the analytical equivalent to the Minimum Resale Price Maintenance (RPM) agreements recently held to be properly evaluated under the Rule of Reason in the United States. These are two very different things. I wish that reporters doing antitrust stories would convey more information about the nature of the complaint. A few things could be going on here:

  1. There could be a horizontal price fixing cartel between Pfizer, Lilly and Bayer.
  2. There could be a horizontal agreement between Pfizer, Lilly and Bayer to institute these vertical agreements with their distributors.
  3. There could be a horizontal agreement between distributors or pharmacies and the pharmaceutical companies which is enforced through the vertical agreements.
  4. There could be the common presence of these vertical RPM agreements which are “widely followed” through much of the market but do not involve any horizontal component (e.g. an agreement between the firms).

These are very different agreements for antitrust purposes. At least in the US. RPM agreements (at least for now!) are evaluated under the rule of reason in the United States. Cartels involving horizontal agreements to fix price are per se illegal. Further, they are different on the economics. VERY different. Naked horizontal agreements to fix price reduce consumer welfare and output. RPM agreements, the evidence overwhelmingly shows (see also here), are highly likely to make consumers better off in practice.

Now, what is likely going on here is that minimum RPM is the analytical equivalent to per se illegal under Swiss competition law. That’s fine. But its still not a cartel without the horizontal agreement. My complaint here is not technical, its descriptive. One can read the headline and story and be left completely in the dark about what the complained about conduct is.

Further, this confusion about horizontal and vertical agreements infects reporting on these issues in the United States where the legal important of the distinction really is important. While Min RPM remains per se illegal in some states, and there is pending legislation to overturn Leegin and restore the Dr. Miles rule, the current state of affairs is that both Min and Max RPM are evaluated under the rule of reason under the Sherman Act. A horizontal agreement may be per se illegal, condemned in a much more cursory fashion, and may even involve criminal penalties! And again, the economic effects of purely vertical RPM agreements and cartels are strikingly different.

In the United States where the difference is not only economic but also legal, there is simply no excuse to use the words “cartel” or “price-fixing” to describe RPM. Yes, a vertical agreement “fixes prices” but this is a fairly transparent attempt to obfuscate the economic issues (empirically RPM generally increases consumer welfare and does not have cartel-like effects) by analogizing it to a cartel. I hesitate to describe this as a mistake in labeling because in some cases it is not a mistake. For example, the learned antitrust scholars at the American Antitrust Institute released the following statement after Leegin:

Antitrust experts from the government, legal and academic communities joined retailers, “e-tailers” and consumer advocates in Washington, D.C. today to discuss the sweeping anti-consumer effect that newly legal price-fixing, also known as ‘resale price maintenance’ (RPM), has had on the cost of consumer products. Despite widespread discounting in parts of the market where competition is being allowed to work, holiday shoppers are finding fewer discounts this season on price-fixed products ranging from toys to baby strollers.

Later in the press release we’re told by AAI President Bert Foer that:

The Supreme Court underplayed the magnitude of the anticompetitive risks of price-fixing. The Court did not account for the fact that it leads to higher prices, reduced efficiency and lost innovation in retailing. They failed to recognize how those risks have grown with increasing retail concentration.

They know better. The evidence simply doesn’t support the assertion that RPM leads to losses of consumer welfare. Read Lafontaine & Slade (linked above) which surveys the literature. The evidence overwhelmingly points the other direction. That doesn’t mean that RPM cannot be anticompetitive. Just that there’s no evidence that it is systematically anticompetitive and deserves legal treatment like a horizontal conspiracy to fix prices. Its frankly not even close. Buy by invoking the “price-fixing” label, the hope is to win in the court of public opinion, in the press, and perhaps with policy makers.

It may be working. Joseph Pereira in the Wall Street Journal echoes the AAI stance (“Manufacturers are embracing broad new legal powers that amount to a type of price-fixing — enabling them to set minimum prices on their products and force retailers to refrain from discounting”), though his piece a few months later is far more objective. Antitrust scholars like to use the same rhetorical / marketing strategy to group in RPM with cartels in order to justify more aggressive antitrust intervention against the practice.

There is no question they are winning the marketing game. But a serious analysis of RPM and its appropriate antitrust treatment demands an evidence-based approach. This is, indeed, the approach called for by Leegin. While I have written about some of my qualms with Leegin’s approach to the economic and empirical evidence (by both the majority and the dissent), as has Thom, there is a lot of room to talk about sensible approaches to the appropriate rule of reason analysis. It is my hope that these discussions take an evidence based approach. In my view, while there is still a lot to learn about precisely how RPM works, when and by whom it is adopted, and to what effect, there is simply no empirical evidence that its effects warrant per se illegality. Consider the following. Nobody seems to be arguing that predatory pricing is per se illegal. But is the empirical evidence of the competitive effects of RPM really that different than the literature on predatory pricing. Its true its easier to intuitively grasp the competitive benefits of low prices than the increased point of sale services (and thereby, output) facilitated by RPM contracts. But antitrust economists and lawyers know better than to ignore the possible pro-consumer effects of vertical restraints.  And they argely agree that an evidenced based approach is that is sensitive to both Type 1 and 2 errors is the right way to design antitrust policy. Its my sincere hope that the policy debate to be had on RPM with the pending legislation and FTC Workshops upcoming will be fought on this margin rather than on marketing.

FTC RPM Workshops This Week

Josh Wright —  15 February 2009

Tuesday and Thursday this week the FTC will be hosting the first two in a series of workshops on Resale Price Maintenance.  Presentation materials, slides, and papers are available on the website.

I’ve been reading the papers for the FTC RPM Workshops, though I cannot attend.  On the procompetitive side, I especially recommend Ben Klein’s explanation of how RPM facilitates the supply of promotional services in the absence of dealer free-riding.  Critics of RPM, in my view, generally do not understand the fundamental economic point that retailer competition alone is not sufficient to guarantee the supply of promotional services because of incentive conflicts between manufacturers and retailers.  Klein and Wright (JLE, 2007) explains this incentive conflict in great detail, and how fixed per unit time payments (slotting contracts) can be used to solve this common incentive problem and are part of the normal competitive process.  Klein’s newest RPM explains how RPM contracts can be used to achieve the same effect, that is, solving the incentive conflict between manufacturers and retailers to facilitate the supply of efficient promotional services.

The most common argument raised by defenders of the Dr. Miles rule, including Justice Breyer in Leegin, is that Telser’s (1960) classic discount dealer free-riding story for RPM (RPM solves the problem of consumption of promotional services at the full service retailer before buying the product at the discounter — and thus unraveling the supply of services in equilibrium) does not apply to a number of products where we observe RPM used.  This is where Klein & Murphy’s (1988) seminal explanation comes into play, documenting how the incentive conflict is a real economic problem solved by these vertical restraints, and part of the normal competitive process.  The Klein’s RPM Workshop piece builds on and updates that analysis.

One of the other issues that I’ve been keeping my eye on during the hearings is the evaluation of the current empirical evidence.  I’ve written before that in my own evaluation of the evidence, “the evidence overwhelmingly shows (see also here) [that RPM agreements] are highly likely to make consumers better off in practice.”  I also wrote that I hoped the RPM Workshops would take a hands on and rigorous approach to evaluating the state of evidence in order to design appropriate antitrust enforcement approaches to RPM and vertical restraints generally:

In my view, while there is still a lot to learn about precisely how RPM works, when and by whom it is adopted, and to what effect, there is simply no empirical evidence that its effects warrant per se illegality…. Its my sincere hope that the policy debate to be had on RPM with the pending legislation and FTC Workshops upcoming will be fought on this margin rather than on marketing.

In this light, it caught my eye that Patrick Rey’s slides and paper, which offers yet another possibility theorem of how RPM “could” result in anticompetitive outcomes.   The possibility theorem paper is nothing new in the sense that there are a ton of these around.  But the claim of empirical support is.  Indeed, my views on this matter are well known that there is not much empirical support at all for the anticompetitive theories of vertical restraints including RPM (see also the Lafontaine & Slade and Cooper et al literatuer surveys).  So I did some digging.  Here’s the claim from Rey’s paper with Thibaud Verge:

Our analysis supports this claim and shows that RPM can actually eliminate competition, not only among competing fascias, but also among competing brands. This possibility has been validated by recent empirical studies. Using data about retail prices of food products in French retail chains during the period 1994-1999, Biscourp, Boutin and Vergé (2008) find that the correlation between retail prices and the concentration of local retail markets was important before 1997 and no longer significant after that date. This suggests that the price increases that occurred after 1997 were indeed due to the impact of the new legislation on intrabrand competition.

So what does the Biscourp et al. study actually analyze?  You might think from the context that BBV (2008) studies Minimum RPM contracts.  But you would be wrong.  What did they actually study?  Get this: a set of French laws that make it illegal for retailers to sell “below cost.”  The Loi Galland came into force in 1997 and clarified a pre-existing ban on below-cost sales.  In other words, the Loi Galland set mandatory government enforced minimum price floors that apply to all retailers.  Boutin & Guerrero provide some details on the 1996 Loi Galland:

The Loi Galland gave a simple, precise definition of the actual purchase price and hence of the below-cost retail price floor: `The actual purchase price is the unit price stated on the invoice plus taxes on sales, specific taxes applied to the resale, and transportation costs.’  Since 1997, the definition of purchase price has thus been restricted to the price stated on the invoice, with no deductions such as year-end discounts. The Act also tightened official verification and raised fines. Only the margins formally applied at the invoice date and shown on the invoice the “upfront margins” can be passed on to final consumers through reductions in the final selling price. By contrast, all other discounts are described as “hidden margins” and therefore excluded from the below-cost retail price floor. Examples include margins linked to an annual sales volume, to the retailer’s display of the product on a minimum shelf length, to business cooperation, or simply to the respect of mutual commitments over a certain period. Consequently, hidden margins can in no way be passed on to consumers.

The law in other words, is similar to sales below costs laws i the US that are designed to anticompetitive raise prices, are binding on all sellers, and enforced by the government with significant fines.  Unsurprisingly, a law designed to prevent price-cutting achieves its intended effect and is found to have an anticompetitive effect.  But I’m frankly lost as to how Rey & Verge claim from this study of government imposed sales below cost laws that there is empirical support for the proposition that voluntary, privately negotiated RPM contracts are likely to be anticompetitive.  Note that Lafontaine & Slade’s leading survey of the literature argues that this distinction is quite important — concluding that mandatory restraints are far more likely to generate anticompetitive outcomes.

There is more.

Rey and Verge also claim that another paper from Bonnet and Dubois (2008) “supports his analysis of RPM.”  Curious, I took a closer look at this paper.  Does this second paper actually study RPM agreements?  Again, the answer is no.  B&D (2008) do something different: (1) they get retail prices and quantities for branded and unbranded bottles of water, (2) estimate a random coefficients logit model for the demand for bottled water (no data on costs or markups except for general input price indices), (3) infer wholesale and retail markups under a variety of assumptions about the nature of wholesale and retail competition which amount to 12 different models, and (4) from these estimated markups, estimate marginal costs (e.g. 12 different cost equations).  From these cost equations, they conduct a series of non-nested hypothesis tests, comparing the 12 different models against each other (table7, p. 34 at link above).  The authors conclude that “the results finally show that the best model appears to be model 10, that is the case where manufacturers use two part tariffs with resale price maintenance.”  From this series of assumptions and steps, the authors conclude that the branded water sellers are actually using RPM and two-part tariffs (“Our empirical analysis allows it to be concluded that manufacturers and retailers use nonlinear pricing
contracts and in particular two part tariff contracts with resale price maintenance.”)!  Further, the authors simulate the effect of moving from model 10 to other models of pricing and find that pricing is lower in other models and therefore conclude that RPM has anticompetitive effects.

There are some problems with this analysis.  First, suffice it to say that it is difficult to make confident policy statements about the effects of RPM contracts without studying actual RPM contracts.  There is no actual evidence that the water sellers are using RPM.  Indeed, RPM is illegal in France.  The inference is generated because the non-nested hypothesis test (which is notoriously weak) implies the model best fits the data.   Second, my understanding of merger simulations at the FTC is that when marginal costs are inferred from equilibrium conditions, attempts are made to verify the validity of the inference by comparing the inferred level to some actual measure (so that the model can be tossed if they don’t correspond to one another).

Evaluating the empirical evidence in favor of the various pro- and anti-competitive theories is an incredibly important step in the process of identifying the appropriate legal test to apply to resale price maintenance (and other vertical restraints). While the Rey & Verge piece offers an interesting theoretical effect of RPM, the key issue identified by Justice Breyer’s Leegin dissent is understanding how RPM contracts work in practice. In my view, Rey & Verge’s claim that there is empirical support for their model is unfounded. To the contrary, neither the BBV or BD papers add any empirical contribution to the debate over the appropriate antitrust treatment of privately and voluntarily adopted RPM contracts.

I want to second Josh’s commendation of Ben Klein’s submission to the recent FTC Hearings on Resale Price Maintenance. Klein’s paper, which bears the same title as this post, is lucidly written (blissfully free of equations, Greek letters, etc.) and makes a point that, at this juncture in antitrust’s history, is absolutely crucial.

In the pre-Leegin era, commentators who were critical of Dr. Miles‘s per se rule (including yours truly) usually emphasized the so-called free-rider rationale for minimum RPM. According to that rationale, manufacturers frequently set minimum resale prices for their products in order to encourage demand-enhancing point-of-sale services upon which retailers could free-ride. Golf club manufacturer Ping, for example, tried to control its dealers’ resale prices because it wanted dealers to expend great effort helping customers find the perfect set of highly customizable clubs. It worried that the ability to compete on resale price would lead some dealers to cut their own customizing services (and thus their costs), direct their customers to high-service dealers for the necessary customization, and then offer a discount to those customers on the clubs selected by the high service (and thus higher cost) dealers, who couldn’t afford to match the discount. If such free-riding were pervasive, Ping dealers would eventually stop providing the sort of customizing services that enhance demand for Ping clubs.

In the pre-Leegin era, it made sense for critics of Dr. Miles to emphasize the free-rider rationale because (1) it’s easy to explain, and (2) it applies often enough that we can say with confidence that RPM — often motivated by a desire to avoid free-riding on output-enhancing services — is not “always or almost always anticompetitive.” That, of course, is all we Dr. Miles critics needed to establish in order to undermine the per se rule against minimum RPM. (Per se illegality is appropriate only for practices that are always or almost always anticompetitive.)

It’s now a new day in antitrust. Dr. Miles is dead, and the key question for courts, commentators, and the regulatory agencies is how particular instances of RPM should be evaluated to determine their legality. Answering that question requires more than a simple showing that RPM can, under a fairly common set of circumstances, lead to higher output. Indeed, if our rule of reason focuses exclusively on the free-rider rationale for RPM, it may well lead to condemnation of procompetitive instances of RPM in circumstances in which the free-rider rationale does not apply. For example, the highly influential Areeda-Hovenkamp treatise proposes a rule of reason that would automatically condemn RPM arrangements on “homogeneous products,” for which there are unlikely to be any point-of-sale services that are susceptible to free-riding. (See par. 1633c of the Second Edition.) The assumption here is that RPM’s only significant procompetitive effect is the elimination of free-riding.

Fortunately, the Supreme Court’s Leegin decision recognized that RPM may be output enhancing even in the absence of free-riding. The Court explained (page 12):

Resale price maintenance can also increase interbrand competition by encouraging retailer services that would not be provided even absent free riding. It may be difficult and inefficient for a manufacturer to make and enforce a contract with a retailer specifying the different services the retailer must perform. Offering the retailer a guaranteed margin and threatening termination if it does not live up to expectations may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services.

The idea here — developed fully in Klein & Murphy (1988) — is that RPM, which guarantees retailers a healthy margin on sales of the product at issue, can be used to generate retailer services that are hard to secure contractually. Exhaustively specifying ex ante all the services a retailer should provide would be quite difficult for a manufacturer. In addition, monitoring and enforcing a dealer’s performance obligations along multiple service dimensions would require substantial effort. RPM coupled with a liberal right of termination can provide an alternative means of securing the retailer services(attractive product placement, etc.) that enhance demand for the manufacturer’s products. If the manufacturer generally observes its retailers’ performance, retains an unfettered right to terminate underperformers, and provides an attractive retail margin as an incentive to avoid termination, then the manufacturer can motivate its retailers to provide demand-enhancing point of sale services without specifying them exhauastively.

While the Leegin majority nicely explained how RPM can be used to enhance demand-enhancing retailer services even when those services are not subject to free-riding, it failed to address one crucial question: Why would a manufacturer need to use RPM to encourage these services, since retailers themselves would also benefit from increasing the sales of their manufacturers’ products?

Justice Breyer pounced on this omission in his Leegin dissent. Referring to the majority’s contention that RPM “may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services,” Justice Breyer stated (pages 14-15):

…I do not understand how, in the absence of free-riding (and assuming competitiveness), an established producer would need resale price maintenance. Why, on these assumptions, would a dealer not “expand” its “market share” as best that dealer sees fit, obtaining appropriate payment from consumers in the process? There may be an answer to this question. But I have not seen it.

Klein’s submission to the FTC’s RPM hearings provides a straightforward answer to Justice Breyer’s question. RPM may be necessary, Klein contends, because a manufacturer and its dealers often have divergent incentives when it comes to services that expand demand for the manufacturer’s products. Frequently, a manufacturer will stand to gain much more from its dealers’ promotional efforts than the dealers themselves. Thus, “RPM plus a liberal right of termination” may be needed to incentivize dealers to provide the services that will maximize sales of the manufacturer’s products. Klein points to three commonly present economic factors that create the sort of incentive divergence that warrants RPM:

(1) Manufacturers often enjoy a larger per-unit profit margin than do their retailers. Because manufacturers’ products tend to be more highly differentiated than the services retailers provide, and because the ability to charge prices in excess of one’s costs is a function of the uniqueness of whatever one is providing, manufacturers will generally earn higher per-unit profits on their products than will the retailers who resell those products. Accordingly, manufacturers stand to gain more from incremental sales of their products than do their retailers, and they may therefore need a way to give their retailers an extra incentive to promote their products.

(2) Many manufacturer-specific retailer promotional efforts lack significant inter-retailer demand effects. While some retailer promotional efforts, such convenient free parking or extended store hours, would provide competitive benefits for both the manufacturers whose products are carried by the retailer and the retailer itself, other retailer promotional efforts, such as prominent placement of the manufacturer’s product within the “impulse buy” section of the retailer’s store, would really benefit only the manufacturer without enhancing demand for the retailer’s services over those of its competitors. Absent some nudge from the manufacturer, retailers won’t be adequately incentivized to perform these sorts of services. RPM can provide the needed nudge.

(3) Manufacturer-specific retailer promotional efforts may cannibalize a multi-brand retailer’s sales of other brands. Many retailer services that would promote a manufacturer’s brand of a product would merely reduce the retailer’s sales of competing brands of the same product and would thus provide little, if any, net benefit to the retailer. Granting favored shelf space to one brand, for example, may require moving a competing brand to less favorable shelf space, thus reducing the sales of that brand. A manufacturer can induce its retailers to provide it with “cannibalizing” promotional services by employing RPM to guarantee the retailer a higher markup on sales of the manufacturer’s brand.

These sources of divergence between manufacturers’ and retailers’ incentives are discussed in more detail in Josh’s 2007 collaboration with Klein, The Economics of Slotting Contracts, 50 J. L. & Econ. 421 (2007). Taken together, the various sources of divergence make it in the interest of many manufacturers to adopt some sort of RPM policy, even when the product at issue is not one that is sold along with services that are susceptible to free-riding. The RPM policies manufacturers adopt to address incentive divergence enhance the manufacturers’ overall output and should thus be assumed to be procompetitive. Accordingly, liability rules such as that proposed in the Areeda-Hovenkamp treatise, which maintains that “[p]roduct homogeneity is an easily observable fact that is inconsistent with known legitimate uses of RPM” (Par. 1633c, at 334 (2d ed.)), are unsound and should be rejected.

Unquestionably Correct?

Josh Wright —  25 February 2009

An anonymous reader reminds me of the FTC Statement from Commissioners Harbour, Leibowitz and Rosch (but not Chairman Kovacic, who was recused) making the case against certiorari in Linkline:

“The holding of the Ninth Circuit is unquestionably correct, and indeed merely echoes what other courts of appeals have held on the narrow issue presented to the court below: that claims of a predatory price squeeze in a partially regulated industry remain viable after Trinko.”

In all seriousness, I wonder why the use of the word unquestionably there? Its strong language for an issue where the Solicitor General disagrees and ultimately, so do all nine Supreme Court Justices.  This sort of strong language has become a hallmark of this trio of Commissions late in other debates.  For example, I’m reminded of the assertion that the DOJ Section 2 Report was a “blueprint for radically weakened enforcement of Section 2 of the Sherman Act”, that it “placed a thumb on the scale in favor of firms with monopoly power” and was “chiefly concerned with …  prescribing a legal regime that places these firms’ interests ahead of interests of consumers.”

Whatever one thinks about the merits of the arguments in Linkline, there were and have been serious doubts about the viability of price squeeze theories of liability for a long time.  Similarly, whatever one thinks about the merits of the Section 2 Report on specific issues, I’m not sure it advances the state of argument to contend that the drafters of that report (many career antitrust enforcers) are interested in harming consumers in order to help monopolists.  The working assumption ought to be that both sides are operating in good faith until there is evidence to the contrary.  The Section 2 Report deserves that presumption as well.  To be sure, it should be exposed to criticism where appropriate.  There are plenty of reasonable and vigorous debates that can be had over what types of conduct harm consumers and when, the evidence supporting competing theories of economic behavior, and how to design appropriate legal rules to protect consumers.  For example, there remain important wars to be waged on RPM, single firm conduct generally, the appropriate scope of Section 5, and more.  But these debates ought to be based on reasonable discourse about theory and empirical evidence, and a working assumption that both sides are interested in getting it right.