Search Results For RPM

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.

Here’s the press release. Congratulations to Chairman-to-be Leibowitz.

I also note that this marks the end of Chairman’s Kovacic’s reign at the Commission. On a personal note, I had the pleasure of working for the Chairman during my stint as the FTC Scholar in Residence and consider myself extremely fortunate to have had the opportunity. There is simply nobody that has given as much thought to the question of how competition policy enforcement institutions should be designed to achieve their objectives. Don’t believe me? Read this.  I hope one that I believe that the Chairman’s quest to make the Commission the “thinking man’s competition agency” will be viewed as amongst his most important contributions. The FTC at 100 program and self-study, the series of conferences on important competition policy issues ranging from RPM to the appropriate scope and application of Section 5, and the new FTC & Northwestern University Microeconomics Conference are among the projects that have Chairman Kovacic’s signature on them.

Congratulations to Chairman and soon to be Commissioner Kovacic for a job well done.

Varney on RPM

Josh Wright —  4 March 2009

I just saw this very good piece in The Deal from Sean Gates and Tej

During her tenure at the FTC, Varney advocated greater enforcement against vertical restraints. In a speech before the American Bar Association in early 1995, she explained her thoughts on resale price maintenance cases: “Our enforcement agenda today is that resale price maintenance agreements are unlawful per se and the commission will enforce the law in this area.” This was a clear change from Reagan administration antitrust enforcement. Even though the Supreme Court had long held RPM to be per se unlawful, the Reagan administration enforcers did not challenge these types of restraints. In fact, they did not bring a single pure vertical restraint challenge.

True to her word, Varney joined in several important RPM challenges, including cases that expanded the scope of the per se rule in RPM cases. In a case against American Cyanamid, Varney joined the majority in inferring the existence of a per se illegal RPM agreement despite the fact that the defendants had never announced resale prices nor sought a commitment from distributors to sell at or above a certain price level. In a case against Reebok, Varney joined the Commission in condemning an RPM policy, enjoining Reebok from using “structured terminations” to effect RPM even though such terminations “falls into the ‘gray’ area of RPM jurisprudence.” Varney also joined in a number of other cases challenging vertical price fixing agreements.

The Bush administration, however, did not bring a single challenge to an RPM policy. Instead, the Bush administration urged the Supreme Court to overturn the per se rule against RPM, which the Court did in Leegin Creative Products v. PSKS Inc. Since then, there has been much speculation regarding when, under a rule of reason analysis, RPM is unlawful. Given her prior positions in this area, Varney’s antitrust division may lead the charge in testing the boundaries set in Leegin by bringing challenges to vertical price restraints.

If past is prologue, Varney’s appointment suggests that Obama is looking to make good on his campaign promise to pursue a more aggressive and active antitrust enforcement agenda.

Varney’s speeches are available here. And I’ve previously noted my disappointment about a recent statement from the future AAG that “there is no such thing as a false positive.” Here is a speech from 1996 on vertical restraints. It is difficult to know what to make of the speech in terms of predictive power since it was made during the Dr. Miles era. Though my own view is that P(Dr. Miles Return) = .53. But it will be interesting to watch. As readers of the TOTM know, my own view on RPM is that the theoretical and empirical evidence do not warrant an aggressive antitrust enforcement approach.

I’ve posted to SSRN a new essay entitled Overshot the Mark?  A Simple Explanation of the Chicago School’s Influence on Antitrust.  It is a book review of Robert Pitofsky’s recent volume How the Chicago School Overshot the Mark: The effect of Conservative Economic Analysis on U.S. Antitrust, and is forthcoming in Volume 5 of Competition Policy International.

The book review is a critical review of the Post-Chicago antitrust agenda adopted by many of the volume’s authors, and a defense of what the editors describe as conservative economics (but seem to mean Chicago School), from an empirical, evidence-based perspective.  The idea of the review is avoid the ideological component of the Chicago v. Post-Chicago debate by choosing to focus instead on the relative predictive power of the economic models.  In short, the evidence-based antitrust concept is one that requires running a horserace between the competing economic models of various forms of antitrust relevant behavior (I focus on RPM and exclusive dealing in the review) in order to identify the best available economic learning upon which antitrust policy can and should be built.  The standard requires flexibility over time but also commits policy makers to take seriously predictive power of models rather than grabbing whatever is convenient from the menu.

There are a number of other critical points about the volume, the approach to antitrust it advocates, and responses to specific essays in the review.

Here is the abstract:

Using George Stigler’s rules of intellectual engagement as a guide, and applying an evidence-based approach, this essay is a critical review of former Federal Trade Commission Chairman Robert Pitofsky’s How the Chicago School Overshot the Mark: The Effect of Conservative Economic Analysis on U.S. Antitrust, a collection of essays devoted to challenging the Chicago School’s approach to antitrust in favor of a commitment to Post-Chicago policies. Overshot the Mark is an important book and one that will be cited as intellectual support for a new and “reinvigorated” antitrust enforcement regime based on Post-Chicago economics. Its claims about the Chicago School’s stranglehold on modern antitrust, despite the existence of a perceived superior economic model in the Post-Chicago literature, are provocative. The central task of this review is to evaluate the book’s underlying premise that Post-Chicago economics literature provides better explanatory power than the “status quo” embodied in existing theory and evidence supporting Chicago School theory. I will conclude that the premise is mistaken. The simplest explanation of the Chicago School’s continued influence of U.S. antitrust policy — that its models provide superior explanatory power and policy relevance — cannot be rejected and is consistent with the available evidence.

You can download it here.

Answer: not by a long shot.  Not in the Supreme Court.  Not in the empirical economics literature.  But perhaps according to at least one FTC Commissioner in the new FTC annual report:

Commissioner J. Thomas Rosch believes the current financial crisis has undermined the Chicago school of economics that has so heavily influenced antitrust enforcement over the past forty years and has broad implications for the FTC’s mission. Markets are not perfect; imperfect markets do not always correct themselves, and business people do not always behave rationally. Commissioner Rosch believes the Commission may need to move more towards “behavioral economics” and must provide competition law enforcement at least as strict as during times of prosperity.

This is a variant of Commissioner Rosch’s earlier pronouncement that “the orthodox and unvarnished Chicago School of economic theory is on life support, if not dead.”

While these sorts of claims are increasingly popular in the current financial climate, repetition does not make the claim any more correct.  As I’ve blogged previously, reports of the death of the Chicago School of antitrust economics have been, as they say, greatly exaggerated.

A few responses:

  1. Does the financial crisis really say anything about microeconomics?  As a commenter to this post points out, while debate abounds about the causes of the current financial crisis, the appropriate share of blame to be placed on market failure versus government failure, and what it tells us about the merits of various macroeconomic theories — there’s just not much of a substantive argument to be made that it tells us anything about the applied microeconomics relevant to antitrust analysis.  I suspect that attempts to link the financial crisis to calls for greater antitrust fall into the “you never want to waste a good crisis” category.  Historically, of course, poor economic conditions have been correlated with imposition of impediments to vigorous competition.
  2. The Chicago Roots of the Post-Chicago Movement.  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.  Not to mention that the foundation of modern coordinated effects theories, to the best of my knowledge, is still Stigler (1968).
  3. “Markets are Perfect”.   Did anybody really argue this?  The contributions of Stigler and Director and others suggest otherwise though they did often argue that some of these concerns were either empirically irrelevant, policy irrelevant (i.e. we could not identify and distinguish them from pro-competitive conduct), or that both markets and governments failed but that the latter errors were more costly.  This is decidedly different from the caricature offer by the Commissioner.  Of course, not only did Chicagoans anticipate many of the anticompetitive theories prevalent in the more interventionist literature today, but it is instructive to note that it is economists 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.
  4. What about behavioral economics anyway?  It remains unclear to me why the observation that firms might act irrationally in markets leads to a conclusion that more interventionist antitrust is appropriate.  Perhaps entry will not occur when it would otherwise be profitable and so a monopolist can exercise monopoly power longer than if one supposed free entry.  But that’s not the only story one can tell about behavioral quirks.  What about the firm that irrationally chooses not to exercise monopoly power when it would be profitable to do so?  This is not to say that behavioral economic theories of firm behavior should be irrelevant.  Like the other theories, whether Chicago, Post-Chicago, behavioral or otherwise, the key question is one of model selection, i.e. which theories have the best empirical support and should guide policy decisions.
  5. Empirical Evidence.   Recent comprehensive literature surveys from folks very well respected IO economists, including some who have spent significant time at the enforcement agencies, conclude that the best available empirical evidence is that most forms of single firm conductare  predominantly pro-competitive in practice (See great slides here from Lafontaine & Slade, Dan O’Brien or the paper from Froeb, et al).
  6. Is It All Wrong?  If the Chicago School of the “past 40 years” has been undermined, where do we go from here?  Are folks that are arguing that the entire Chicago School antitrust revolution was folly because it was based on erroneous assumptions about markets working taking the position that everything based on that notion is wrong?  Are we willing to talk about which theories are right and which might be more suspect?  Can we agree that testing competing theories against the existing evidence is the right way to resolve these disputes?  Calling the past 40 years undermined sounds like we are making some serious claims about re-writing antitrust and not just tinkering with the margins. This is not a rhetorical question.  Which cases are wrong because they are “Chicago-based” and where is the evidence in support of the claim?

We should continue to have the debate over which models present the best empirical and theoretical basis from which to build antitrust policy that will help consumers.  The debate should be one that is determined, as much as possible, by the quality of theory and evidence —- not t-shirt slogans and assertions.  In my view, a rigorous review of the empirical evidence suggests not only that the Chicago School of antitrust is not only alive, but in my view, that it is the “best available” mode of analysis for understanding many business practices relevant to antitrust enforcement.

What I hope is taken as my first contribution to this debate, including a fuller discussion of the available theory and evidence with respect to RPM and exclusive dealing, appears in my forthcoming book review: Overshot the Mark?  A Simple Explanation of the Chicago School’s Influence.

Dont Call It A Comeback

Josh Wright —  11 April 2009

When I came onto the job market in 2004, a number of advisers told me that I should not market myself as an “antitrust guy.”  The prevailing view on the job market was that “antitrust was dead.”  This perception was conveyed one way or another in interviews or conversations with folks in the legal academy.  The conventional wisdom was that nothing exciting had happened in the antitrust world since the Reagan era.  On top of that, the story goes, there were few important questions that remained to be answered and not only minor contributions left around the margins.  I ignored the advice at the time thanks to an uncle (and antitrust lawyer) who had turned me on to economics and antitrust in high school.  Truth be told I really didn’t want to study or write about anything else at the time and really wasn’t interested in saying otherwise. 

Five years later it is my impression that outside the antitrust community this conventional wisdom still prevails.  Antitrust, to many, is viewed as a “luxury” which I take to mean that a serious law school can get along quite fine without having a faculty member whose primary teaching and research interests is antitrust.  Antitrust, they say (I paraphrase and oversimplify but not by much), is in low demand in the legal academy because with the exception of a few big names cases from time it’s a field of little practical importance, there is not tremendous demand from students, and it’s a less intellectually interesting field than other areas of commercial law that have thus far had less exposure to economic and empirical thinking. 

To the extent that this is the conventional wisdom in the legal academy (and I’ve heard it often enough to suggest that its at least a widely held view), it is mistaken and has been for the last decade or so.  And that’s not just the case at George Mason where law and economics is a research and teaching priority and where antitrust has had fairly stable and relatively high demand.  For several reasons, contrary to the conventional wisdom I hear from the legal academy, it is an incredibly exciting time to practice, think about, and write about antitrust issues.  I obviously can’t make the comparisons from firsthand knowledge, but I suspect that right now is one of the most intellectually active antitrust eras in history.  I suspect that most antitrust practitioners and academics would agree with that proposition, perhaps with quibbles over whether it ranks at the top of the list or somewhere like second or third.  I don’t want to get bogged down in that debate here.  But when I explain to colleagues how exciting of a time it is in antitrust right now (and especially as an antitrust academic) the response is normally surprise more than anything else.   The interesting point though is not that antitrust has really been around and in a growth phase for the last decade or so.  Rather, the more interesting point to me is that the legal academy appears to finally be catching on to these changes.

While my sense is that most TOTM readers have some familiarity (or at least interest) in the field and a sense of the growth over the past decade, the frequent expression of surprise and interest from colleagues outside the antitrust community suggests that a post explaining these developments might be of general interest.  First, let me start with some evidence that the antitrust is no longer should be considered a law school luxury and that the legal academy is starting to catch on this new state of affairs.  Then I’ll talk a bit about some underlying causes.

THE LEGAL ACADEMY FINDS ANTITRUST AGAIN

Recent antitrust movements on the lateral market, and especially at highly ranked schools, are one type of evidence that the field is attracting attention.  In just the last year, consider the recent moves of Dan Crane to Michigan, Howard Shelanski to Georgetown, Christopher Leslie to Irvine, and Abe Wickelgren to Texas (and I might be missing others).  On top of those moves, there are several other schools in the top 20 and top 10 that either have current visitors, are considering various antitrust candidates for the future or have scheduled visits.   For this reason, my sense is that 2009 is not a one-time phenomenon for antitrust moves.  Another reason that this trend is likely to continue is demographics.  Many of the prominent antitrust scholars who were prominent figures in the antitrust battles of the 1970s and 80s are nearing retirement age or have already retired, leaving a number of schools in the top 15 or so that either have no significant antitrust presence or will not in the near future.

Another piece of evidence that the legal academy is learning that antitrust is back as a high demand area for scholars is the attention it is paid at conferences and in top journals.  Consider, for example, the reemergence of antitrust at ALEA where it will have a total of four panels this year — which is as many or more than all other fields.

The growth in intellectual activity in antitrust can also be observed in the expansion of journals dedicated to the area and the number of publications in prominent journals.  For example, in recent years new journals like Competition Policy International, Global Competition Policy, and the Journal of Competition Law and Economics (among others) have emerged and published a steady stream of high quality scholarship.  On top of that, my more casual empirical observation is that the number of antitrust articles in JLE, JLS, and top law reviews has increased in recent years.

Another observation is the emergence and activities of antitrust related centers and institutes at law schools across the country.  For example, we’ve noted the recent emergence of such centers at GW, and the competition related programs at the Searle Center at Northwestern.  These are in addition to similar centers at Berkeley, Loyola, across the Atlantic, as well as more familiar domestic and non-academic voices in the antitrust policy landscape like AAI.

WHY THE GROWTH IN DEMAND FOR ANTITRUST AT LAW SCHOOLS?

So why has antitrust come back in this way over the past decade or so?  I think there are 4 primary causes. 

The first is the emergence of antitrust & intellectual property as a field.  Not only has the growth of this field and the intersection of patent and antitrust in particular created jobs for lawyers, but its raised to the forefront a number of new intellectual challenges for antitrust law in areas such as licensing, patent holdup, patent pools, reverse payments, and monopolization generally.

The second is the proliferation of antitrust internationally.  There are two components here that I think explain much of the growth in addition to the fact that we now have more than one hundred national antitrust laws — which creates all sorts of special challenges but would not itself, in my view, create the explosion in demand that we’ve seen in the legal academy.  The first is the emerging Chinese antitrust law and the high stakes battle between US and European regulators to influence the analytical underpinnings of applications of that law.  The second is the emergence of the European Commission as the most active and aggressive enforcer of single firm conduct in cases involving US firms like Intel, Qualcomm, Rambus and others.

The third cause is the unprecedented flurry of activity from the Supreme Court in recent years and the apparent willingness to address important antitrust issues.  For a number of reasons I suspect that this trend will continue and we’ll see the Supreme Court continue to take cases for the next few years.

A fourth factor is related to the others.  Over the last few years it has become difficult to read popular news sources without seeing an antitrust issue getting coverage.  The sheer number of high profile cases in recent years has a lot of attention. Consider recent cases that have got mainstream press: Whole Foods, all permutations of deals involving Google-Yahoo-Doubleclick, Ticketmaster-Live Nation, Sirius-XM, Whirlpool-Maytag, Intel, Microsoft, Rambus, and others. 

There are other factors  I think are at play here as well but probably have less influence despite contributing to the overall sense that antitrust is important again.  For example, political change has resulted in considerable debate over the Section 2 Report and also generated proposed legislation involving RPM and reverse payments that has raised the overall profile of antitrust.  Increasing concerns over consumer protection have given rise to a growth in antitrust related consumer protection actions. 

Overall, my sense is that these developments have created significant antitrust activity in practice, but more importantly for the changes in the legal academy, generated important new topics to think and write about.  For example, intellectual battles are now raging in antitrust scholarship over the appropriate scope of Section 5, antitrust analysis of single firm conduct (see, e.g., the AMC/Section 2 Report), the prospects of re-writing the Merger Guidelines, consumer protection and antitrust, empirical antitrust and evaluation of agency performance, patent holdup, resale price maintenance, reverse payments amongst other topics.   In turn, my sense is that the growth in practice has made antitrust a high demand subject for students (here’s a post on why to take antitrust).

kobayashiBruce Kobayashi is a Professor of Law at George Mason Law School.

One of the most important changes in the antitrust laws over the past 40 years has been the diminished reliance of rules of per se illegality in favor of a rule of reason analysis. With the Court’s recent rulings in Leegin (eliminating per se rule for minimum RPM) and Independent Ink (eliminating the per se rule against intellectual property tying), the evolution of the antitrust laws has left only tying (under a “modified” per se rule) and horizontal price fixing under per se rules of illegality. This movement reflects advances in law and economics that recognize that vertical restraints, once condemned as per se illegal when used by firms with antitrust market power, can be procompetitive. It also reflects the judgment that declaring such practices pre se illegal produced high type I error costs (the false condemnation and deterrence of pro competitive practices).

The widespread use of the rule of reason can be problematic, however, because of the inability of antitrust agencies and courts to reliably differentiate between pro and anticompetitive conduct. Conduct analyzed under Section 2 often has the potential to generate efficiencies and be anticompetitive, and finding a way to reliably differentiate between the two has been described as “one of the most vexing questions in antitrust law” (Section 2 Report, p. 12). Under these conditions, applying a rule of reason analysis on a case by case basis may not substantially reduce error costs and can drastically increase the costs of enforcement. Thus, under the decision theory framework widely used by economists and courts, which teaches that optimal legal standards should minimize the sum of error costs and enforcement costs, “bright line” per se rules of legality and illegality can dominate more nuanced but error prone standards under the rule of reason. Continue Reading…

wrightJosh Wright is a Professor of Law at George Mason Law School, a former FTC Scholar in Residence and a regular contributor to Truth on the Market.

The primary anticompetitive concern with exclusive dealing contracts is that a monopolist might be able to utilize exclusivity to fortify its market position, raise rivals’ costs of distribution, and ultimately harm consumers.  The unifying economic logic of these anticompetitive models of exclusivity is that the potential entrant (or current rival) must attract a sufficient mass of retailers to cover its fixed costs of entry, but that the monopolist’s exclusive contracts with retailers prevent the potential entrant from doing so.   However, the exclusionary equilibrium in these models are relatively fragile, and the models also often generate multiple equilibria in which buyers reject exclusivity. At the exclusive dealing hearings where I testified, a sensible consensus view emerged that a necessary condition for exclusive dealing or de facto exclusive contracts such as market-share discounts or loyalty discounts to cause competitive harm is that they deprive rivals of the opportunity to compete for access to distribution sufficient to achieve minimum efficient scale.  The Report (p. 137) reflects this consensus:

In particular, exclusive dealing may be harmful when it deprives rivals “of the necessary scale to achieve efficiencies, even though, absent the exclusivity,” more than one firm “would . . . be large enough to achieve efficiency.”68 In other words, exclusive dealing can be a way that a firm acquires or maintains monopoly power by impairing the ability of rivals to grow into effective competitors that erode the firm’s position. As one panelist put it, “the exclusive dealing case that you ought to worry about” is where exclusivity deprives rivals of the ability to obtain economies of scale.

The Report also goes on to note the competitive justifications for exclusive dealing, ranging from the variety of ways in which exclusive dealing can prevent free-riding, facilitate relationship-specific investments, and intensify manufacturer competition for scarce retailer shelf space or access to distribution with the benefits of that intensified competition passed on to consumers in the form of lower prices or higher quality.

The situation antitrust enforcers find themselves in with respect to exclusive dealing is not unfamiliar.  On the one hand, there are a set of possibility theorems which indicate that exclusive dealing and de facto exclusives can lead to anticompetitive outcomes under some specified conditions, including substantial economies of scale or scope.  On the other, there are a set of sensible and economically rigorous pro-competitive justifications for the practice.  On top of that is the casual empiricism that we observe exclusive dealing contracts in competitive markets and adopted by firms without significant market power.  As David Evans noted on the first day of our symposium, quite a bit can be learned about the relative probabilities of anticompetitive and pro-competitive uses of certain types of business behavior by understanding the incidence of use by competitive firms.  Exclusive dealing is no different.

Still, we find ourselves between battling theories.  The standard error cost approach to this problem, an approach discussed by many in this symposium as a powerful tool to ensure that our liability rules do not do not needlessly harm consumers by overdeterring pro-competitive conduct or under-deterring anticompetitive conduct, is to turn to the evidence.  What do we know about the incidences of anticompetitive exclusive dealing and de facto exclusive dealing contracts?  The question is not one of the logical validity of any of the competing theories.  It is one of their empirical (and therefore policy) relevance.  A sensible approach to designing antitrust liability rules for exclusive dealing would be to design a conduct-specific standard sensitive to the particular relative risks of Type I and Type II errors informed by the best available existing evidence.  Of course, it should be noted that more evidence is always better and there is certainly a need for more empirical research about single firm conduct.  But the limited nature of the evidence does not mean we have zero information to update our priors on the critical policy question.

So what does the evidence say?  What approach would it lead to?  And how does that approach compare with that endorsed in the Section 2 Report?  I’ll focus on those issues in the remainder of the post. Continue Reading…

Dear Mr. Toobin

Josh Wright —  3 June 2009

Jeff Toobin has an interesting profile on John Roberts in the New Yorker (HT: Jonathan Adler who also takes issue with Toobin’s description of Leegin, but goes on to challenge Toobin’s general account of Roberts as a “stealth nominee”).   Toobin’s column has very little to do with antitrust.  with the exception of one sentence describing the Leegin decision where he writes:

That same day, the Justices overturned a ninety-six-year-old precedent in antitrust law and thus made it harder to prove collusion by corporations.

Mr. Toobin clearly did not get this memo.  Descriptions of resale price maintenance agreements between manufacturers and retailers are not collusion in the antitrust sense, a label that connotes horizontal price-fixing between competitors.   Toobin’s explanation implies that what the Roberts court did was make it more difficult to prove a price-fixing agreement that harms consumers.  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.  If one was not paying attention, or knew nothing about antitrust economics, they could take the wrong impression from Toobin’s description that the Court reached an anti-consumer and pro-business result.  That’s a silly way to think about RPM as discussed here.

UPDATE: A reader reminds me that the Antitrust Section at the American Bar Association, which I don’t believe can fairly be characterized as a “conservative” (if that’s a useful label at all in this context) antitrust group, has made an official statement in support of the Roberts Court’s analysis in Leegin:

The ABA supports the position that under the federal antitrust laws—and analogous state and territorial antitrust law—agreements between a buyer and seller setting the price at which the buyer may resell a product or service purchased from the seller should not be illegal per se. Instead, these agreements should be analyzed under a rule of reason analysis. The ABA also believes that the Supreme Court’s recent decision in Leegin is consistent with that position.

Thom answers this question in the affirmative in his excellent post about the Ninth Circuit’s analysis in Masimo and is disappointed that the Ninth Circuit rejected the discount attribution standard as the sole test for Section 2 in favor of a separate inquiry as to whether the bundled discount arrangement resulted in a substantial foreclosure of distribution and competitive harm.  Thom describes this reasoning as “sorely disappointing.”  I’m tentatively not convinced things are as bad as Thom sees them and want to explain why.  Maybe Thom can persuade me that I ought to be more upset about Masimo than I am.

Let me start with two preliminary points.

First, I agree that bundled discounts are generally pro-competitive for all of the reasons Thom states as well as some others.  While there is some empirical evidence that bundled discounting appears in highly competitive markets where anticompetitive theories do not apply, suggesting pro-competitive efficiencies, but little empirical verification of a high likelihood of competitive harms.

Second, despite our agreement about the generally efficiency of bundled discounting, Thom’s claim that a bundled discount distribution arrangement cannot result in anticompetitive effect is overstated as a matter of economic theory.  My basic point is that it is possible, as a matter of economic theory, for distribution arrangements involving bundled discounts that satisfy the PeaceHealth safe harbor to result in anticompetitive effects.  Despite this economic point, I’m not sure that Thom and I disagree on the ultimate appropriate legal treatment of bundled discounting.  I’ll get back to that.

Now, to defend my claim.

Let’s start with Thom’s position that, contra the Ninth Circuit, a bundled discount scheme that satisfies PeaceHealth’s discount attribution test (i.e. prices are still above cost after the discount is fully attributed to the competitive product in the bundle) should be immune from Section 2 liability even if the arrangement results in the “foreclosure” of a sufficient share of distribution to deprive rivals of the opportunity to have access to a critical input (such as shelf space) required to achieve minimum efficient scale.

What is the anticompetitive story in these “bundled discount as de facto exclusive dealing” set of cases?  Put simply, the anticompetitive theories are based on the notion that the monopolist’s distribution arrangement will deprive the rival of the opportunity to reach minimum efficient scale through the foreclosure of access to some critical input do not depend on offering distributors a price that fails the discount attribution standard.  A broad set of “exclusionary distribution” cases allege that various forms of marketing arrangements between manufacturers and retailers result in a situation where the monopolist is purchasing exclusion + distribution rather than just distribution.

The economic literature giving rise to these anticompetitive theories of exclusive dealing as “raising rival’s costs” is about the conditions under which manufacturers will be able to purchase exclusion from downstream firms and the price that they will have to pay to do so.  Manufacturers make payments to distributors for access to shelf space in a lot of ways: lump sum payments such as slotting fees, rebates, loyalty discounts, bundled discounts, RPM, cooperative marketing dollars, trade promotions, and more.  But the key question should not turn on the form of those payments.  It should turn on whether the contracts satisfy the conditions necessary for anticompetitive harm: are rivals foreclosed from a sufficient share of distribution that they cannot achieve minimum efficient scale?

This begs the question: is a price that fails the discount attribution test a necessary condition for the above set of theories to operate?  I don’t think so as a matter of theory.  One can think of the raising rivals’ costs theories of distribution as the manufacturer paying a set of distributors to join the manufacturer’s cartel.  What payment would be sufficient to sustain that agreement without defection (distributors would all have the standard incentive to cheat)?  The answer to that question depends on a lot of things: upstream and downstream entry conditions, switching costs, number of distributors, the existence and magnitude of economies of scale or scope, etc.  But I don’t think that there is any reason to believe that economic theory provides a linkage between passing the discount attribution test and failure to satisfy the necessary conditions for standard raising rivals’ cost-based exclusion theories.  Thus, in theory one suspects that there are distribution arrangements that could logically survive PeaceHealth but also potentially create anticompetitive effects because they satisfy the conditions of the exclusion theories.  Let’s call that set of agreements X.

The existence of X doesn’t necessary mean that I disagree with Thom about the appropriate legal rule.  If X is very small such that it would be more costly to identify these agreements and prosecute them, one could justify Thom’s rule on those grounds.  If enforcement actions against X would lead to substantially greater error costs than Thom’s rule, one could also justify his position on those grounds.  The existing empirical evidence, to my knowledge, is insufficient to make such fine grained determinations.  However, the same evidence also tells us that manufacturer arrangements to pay for distribution and promotion are incredibly common, provide benefits to consumers, and occur in competitive markets.  Indeed, I’ve written a great deal about the set of conditions under which the normal competitive process generates payments for distribution. As such, I agree with Thom that it is incredibly important to establish workable and broad safe harbors in this area that minimize error costs. What I reject is the strong economic claim that appears in Thom’s post:

When it comes to bundled discounts, which generally reflect (or promote) cost-savings and which provide an immediate benefit to consumers, there can be no anticompetitive harm in the form of predation, unreasonable exclusion, or foreclosure if the competitive product is priced above the defendant’s cost once the entire discount is attributed to that product.

If the plaintiff is making a predation claim involving bundled discounts, I think the PeaceHealth standard is workable and useful and we should keep it.  A potential case might even be made, as discussed, to justify PeaceHealth as the universal standard for bundled discount claims even when they alleged exclusionary deprivation of scale because we think X is sufficiently small or unimportant or especially susceptible to Type I error.  But I don’t read Thom as making that case.  Perhaps he is and I hope he’ll clarify.

To repeat: I just don’t think that there is any reason to believe that exclusion in the sense defined here is not theoretically possible as a matter of economics because we observe a price that passes PeaceHealth.  As such, I don’t want to throw out foreclosure analysis as an important and relevant part of the antitrust inquiry.  Let me end with a few words in defense of foreclosure analysis which I think gets a bad rap nowadays.

There are costs to keeping the foreclosure analysis, and having two standards for two different allegations of anticompetitive harm.  Beyond that, of course, foreclosure analysis is full of its own complications, e.g. foreclosure of what? does duration of contract matter? what about staggered expiration dates?  But despite its complications and the potential for abuse, the foreclosure analysis asks the right question in deprivation of scale questions and the one that we know is explicitly linked to an important necessary condition of a very large set of the theories of harm alleged in monopolization cases.  Getting a legal standard reasonably tied to the necessary conditions for anticompetitive harm, as Thom knows from his important work in the RPM area, is not always an easy thing to do in antitrust.

By the way, I think that my objection here survives Thom’s “Hydra critique” that the mode of antitrust analysis should be a function of economic substance rather than form.  I agree that the critical question is whether the conduct is likely to impair the competitive process to the detriment of consumers.   The point here is that the the deprivation of scale claims are or at least can be, as a matter of economic substance, different than pure price predation claims.

The critical economic point is that the set of distribution arrangements must, as the literature says, raise a rival’s cost of operating or impair his ability to exist.  Those arrangements that do not should not trigger antitrust violations.  And of course, those that do not satisfied a necessary but not sufficient condition for competitive harm.  The key point is that in cases involving allegations of deprivation of scale, the economic consensus is that those claims require allegations of exclusion require foreclosure sufficient to deprive rivals the opportunity to compete for minimum efficient scale.  If we are ready to accept that this is the state of economic consensus, then we ought to explicitly include this showing in the part of the plaintiff’s burden.  The antitrust law currently attempts to get at this inquiry through foreclosure analysis, requiring something around 40 percent foreclosure share in de facto exclusionary cases.  That seems sensible to me.

Antitrust can handle different standards.  If the plaintiff is alleging deprivation of scale, lets make substantial foreclosure a necessary (but not sufficient) condition.  If the plaintiff is alleging a price predation argument that does not depend on deprivation of scale, PeaceHealth is a safe harbor.  Would that be so bad?  And one more question for discussion purposes, if Thom is right about PeaceHealth in the context of bundled discounts, doesn’t this also apply to any payment distribution?  For example, I think the logic clearly applies that single product loyalty discounts ought to be analyzed the same way, i.e. we should use discount attribution to apply the discount on so-called non-contestable units to the contestable ones and apply the same filter.  But if that’s true, exclusive dealing with discounts is a loyalty discount where the threshold volume is set to 100% of the distributor purchases.  If that’s right, Thom are you arguing that we should get rid of all exclusive dealing law whenever there is a discount scheme?