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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Input Foreclosure and Customer Foreclosure

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

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

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

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

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

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

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

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

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

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

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

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

The Inappropriateness of a Dispositive Price-Cost Test

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

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

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

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

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

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

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

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

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

* * *

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

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

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

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

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

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

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

Today, a group of eighteen scholars, of which I am one, filed an amicus brief encouraging the Supreme Court to review a Court of Appeals decision involving loyalty rebates.  The U.S. Court of Appeals for the Third Circuit recently upheld an antitrust judgment based on a defendant’s loyalty rebates even though the rebates resulted in above-cost prices for the defendant’s products and could have been matched by an equally efficient rival.  The court did so because it decided that the defendant’s overall selling practices, which involved no exclusivity commitments by buyers, had resulted in “partial de facto exclusive dealing” and thus were not subject to the price-cost test set forth in Brooke Group.  (For the uniniated, Brooke Group immunizes price cuts that result in above-cost prices for the discounter’s goods.)  We amici, who were assembled by Michigan Law’s Dan Crane, believe the Third Circuit’s decision threatens to chill proconsumer discounting practices and should be overruled.

The defendant in the case, Eaton, manufactures transmissions for big trucks (semis, cement trucks, etc.).  So did plaintiff Meritor.  Eaton and Meritor sold their products to the four manufacturers of big trucks.  Those “OEMs” installed the transmissions into the trucks they sold to end-user buyers, who typically customized their trucks and thus could select whatever transmissions they wanted.  Meritor claimed that Eaton drove it from the market by entering into purportedly exclusionary “long-term agreements” (LTAs) with the four OEMs.  The agreements did not require the OEMs to purchase any particular amount of Eaton’s products, but they did provide the OEMs with rebates (resulting in above-cost prices) if they bought high percentages of their requirements from Eaton.  The agreements also provided that Eaton could terminate the agreements if the market share targets were not met. Each LTA contained a “competitiveness clause” that allowed the OEM to purchase transmissions from another supplier without counting the purchases against the share target, or to terminate the LTA altogether, if another supplier offered a lower price or better product and Eaton could not match that offering.  Following adoption of the LTAs, Eaton’s market share grew, and Meritor’s shrank.  Before withdrawing from the U.S. market altogether, Meritor filed an antitrust action against Eaton.

Eaton insisted, not surprisingly, that it had simply engaged in hard competition.  It grew its market share by offering a lower price that an equally efficient rival could have matched.  Meritor’s failure, then, resulted from either its relative inefficiency or its unwillingness to lower its price to the level of its cost.  By immunizing above-cost discounted prices from liability, the Brooke Group rule permits and encourages the sort of competition in which Eaton engaged, and it should, the company argued, control here.

The Third Circuit disagreed.  This was not, the court said, a simple case of price discounting.  Instead, Eaton had engaged in what the court called “partial de facto exclusive dealing.”  The exclusive dealing was “partial”  because OEMs could purchase some transmissions from other suppliers and still obtain Eaton’s loyalty rebates (i.e., complete exclusivity was not required).  It was “de facto” because purchasing exclusively (or nearly exclusively) from Eaton was not contractually required but was instead simply the precondition for earning a rebate.  Nonetheless, reasoned the court, the gravamen of Meritor’s complaint was some sort of exclusive dealing, which is evaluated not under Brooke Group but instead under a rule of reason that focuses on the degree to which the seller’s practices foreclose its rivals from available sales opportunities.  Under that test, the court concluded, the judgment against Eaton could be upheld.  After all, Eaton’s sales practices won lots of business from Meritor, whose sales eventually shrunk so much that the company exited the market.

As we amici point out in our brief to the Supreme Court, the Third Circuit ignored the fact that it was Eaton’s discounts that led OEMs to buy so much from the company (and forego its rival’s offerings).  Absent an actual promise to buy a high level of one’s requirements from a seller, any “exclusive dealing” resulting from a loyalty rebate scheme results from the fact that buyers voluntarily choose to patronize the seller over its competitors because the discounter’s products are cheaper.  In other words, low pricing is the very means by which any “exclusivity” — and, hence, any market foreclosure — is achieved.  Any claim alleging that an agreement not mandating a certain level of purchases but instead providing for loyalty rebates results in “partial de facto exclusive dealing” is therefore, at its heart, a complaint about price competition.  Accordingly, it should be subject to the Brooke Group screening test for discounts resulting in above-cost pricing.

The Third Circuit wrongly insisted that Eaton had done something more sinister than win business by offering above-cost loyalty rebates.  It concluded that Eaton “essentially forced” the four OEMs (who likely had a good bit of buyer market power themselves) to accept its terms by threatening “financial penalties or supply shortages.”  But these purported “penalties” and threats of “supply shortages” appear nowhere in the record.

The only “penalty” an OEM would have incurred by failing to meet a purchase target is the denial of a rebate from Eaton.  If that’s enough to make Brooke Group inapplicable, then any conditional price cut resulting in an above-cost price falls outside the decision’s safe harbor, for failure to meet the discount condition would subject buyers to a “penalty.”  Proconsumer price competition would surely be chilled by such an evisceration of Brooke Group.  As for threats of supply shortages, the only thing Meritor and the Third Circuit could point to was Eaton’s contractual right to cancel its LTAs if OEMs failed to meet purchase targets.  But if that were enough to make Brooke Group inapplicable, then the decision’s price-cost test could never apply when a dominant seller offers a conditional rebate or discount.  Because the seller could refuse in the future to supply buyers who fail to qualify for the discount, there would be, under the Third Circuit’s reasoning, not just a loyalty rebate but also an implicit threat of “supply shortages” for buyers that fail to meet the seller’s purchase targets.

This is not the first case in which a plaintiff has sought to evade a price-cost test, and thereby impose liability on a discounting scheme that would otherwise pass muster, by seeking to recharacterize the defendant’s conduct.  A few years back, a plaintiff (Masimo) sought to evade the Ninth Circuit’s PeaceHealth decision, which creates a Brooke Group-like safe harbor for certain bundled discounts that could not exclude equally efficient rivals, by construing the defendant’s conduct as “de facto exclusive dealing.”  Dan Crane and I participated as amici in that case as well.

I won’t speak for Dan, but I for one am getting tired of working on these briefs!  It’s time for the Supreme Court to clarify that prevailing price-cost safe harbors cannot be evaded simply through the use of creative labels like “partial de facto exclusive dealing.”  Hopefully, the Court will heed our recommendation that it review — and overrule — the Third Circuit’s Meritor decision.

[In case you’re interested, the other scholars signing the brief urging cert in Meritor are Ken Elzinga (Virginia Econ), Richard Epstein (NYU and Chicago Law), Jerry Hausman (MIT Econ), Rebecca Haw (Vanderbilt Law), Herb Hovenkamp (Iowa Law), Glenn Hubbard (Columbia Business), Keith Hylton (Boston U Law), Bill Kovacic (GWU Law), Alan Meese (Wm & Mary Law), Tom Morgan (GWU Law), Barak Orbach (Arizona Law), Bill Page (Florida Law), Robert Pindyck (MIT Econ), Edward Snyder (Yale Mgt), Danny Sokol (Florida Law), and Robert Topel (Chicago Business).]

The American Antitrust Institute has announced plans to draft a comprehensive set of jury instructions for antitrust trials.  According to AAI president Bert Foer:

In Sherman Act Section 1 and Section 2 civil cases, judges tend to gravitate towards the ABA Model Instructions as the gold standard for impartial instructions. … The AAI believes the ABA model instructions are, in some situations, confusing, out of date, or do not adequately effectuate the goals of the antitrust laws. To provide an alternative, the AAI will develop a set of jury instructions that can be widely disseminated to lawyers and judges.

Foer is certainly right about existing jury instructions.  They’re often confusing and frequently provide so little guidance that jurors are effectively invited simply to “pick a winner.”  Crafting clearer, more concrete jury instructions would benefit the antitrust enterprise and further AAI’s stated mission “to increase the role of competition [and] assure that competition works in the interests of consumers.”

But clarity alone is not enough.  Any new jury instructions should set forth (in clear terms) liability standards whose substance enhances the effectiveness of the antitrust.  Here’s where I worry about the AAI project.

Throughout its history, AAI has shown little regard for the inherent limits of antitrust.  Those limits arise because the antitrust laws (1) embody somewhat vague standards that factfinders must flesh out ex post (e.g., they forbid “unreasonable” restraints of trade and “unreasonably” exclusionary conduct by monopolists) and (2) are privately enforceable in lawsuits giving rise to treble damages.  The former feature ensures that courts, regulators, and business planners face difficulty in evaluating the legality of business practices.  The latter guarantees that they’re regularly called upon to do so.  It also discourages borderline practices that might wrongly be deemed, after the fact, to be anticompetitive.  Antitrust therefore creates significant “decision costs” (in both adjudication and counseling) and “error costs” (in the form of either market power resulting from improper acquittals or foregone efficiencies resulting from improper convictions and the chilling of procompetitive conduct).  Those decision and error costs constitute the limits of antitrust and are inexorable:

  • you can’t decrease decision costs (by simplifying a liability rule) without increasing error costs (incorrect judgments and enhanced chilling effect);
  • you can’t decrease error costs (by making the rule more nuanced in order to better separate pro- from anticompetitive conduct) without increasing decision costs; 
  • you can’t reduce false acquittals (by easing the plaintiff’s proof burden or cutting back on affirmative defenses) without increasing false convictions, and vice-versa.

In light of this unhappy situation, antitrust liability standards should be crafted so as to minimize the sum of decision and error costs.  As I have recently explained, the Roberts Court has taken this tack in its eight major antitrust decisions.

AAI, by contrast, has shown little concern for false positives and seems to equate an effective antitrust regime with one that produces more liability.  Time and again, the Institute has advocated “pro-plaintiff” liability rules that threaten high error costs in the form of false convictions (and the chilling effect that follows).  In all but one of the Roberts Court’s antitrust decisions (which, as noted, are consistent with a “decision-theoretic” framework that would help minimize the sum of decision and error costs), AAI has advocated a pro-plaintiff position that the Supreme Court ultimately rejected.  (See AAI’s positions in Twombly, Leegin, Credit Suisse, Dagher, Weyerhaeuser, LinkLine, and Independent Ink.)  This is a stunningly bad record. 

Moreover, AAI remains out of antitrust’s mainstream (which now acknowledges antitrust’s inherent limits and the need to constrain error costs) on practices involving somewhat unsettled liability rules.  Consider, for example, AAI’s views on: 

  • Resale Price Maintenance (RPM).  Even after Leegin abrogated the per se rule against minimum RPM, AAI urged courts to adopt a rule of reason that would burden a defendant with “justifying” any instance of RPM that results in an increase in consumer prices.  Such an approach is likely to generate excessive liability because all instances of RPM — even those aimed at such procompetitive effects as the elimination of free-riding, the facilitation of new entry, or encouraging “non-free-rideable” demand-enhancing services — involve an increase in consumer prices.  AAI’s preferred rule essentially amounts to a presumption of illegality for RPM.  As I explained in this article, such an approach would involve huge error costs (and certainly wouldn’t minimize the sum of decision and error costs).
     
  • Loyalty Rebates.  Efficiency-minded antitrust scholars have generally concluded that there should be a safe harbor for single-product loyalty rebates resulting in an above-cost discounted price for the product at issue.  The leading case on loyalty rebates, the Eight Circuit’s Concord Boat decision, agrees.  The thinking behind such a safe harbor is that any equally efficient rival could match a defendant’s loyalty rebate that resulted in an above-cost discounted price; permitting liability on the basis of such a rebate would chill discounting and create a price umbrella for relatively inefficient rivals.  AAI, however, has urged courts to reject the safe harbor approved in Concord Boat.
     
  • Bundled Discounts.   Efficiency-minded antitrust scholars have also approved a safe harbor for some sorts of multi-product or “bundled”
     discounts: such a discount should be legal if each product in the bundle is priced above cost when the entire amount of the bundled discount is attributed to that single product.  The Ninth Circuit approved this safe harbor in its PeaceHealth decision.  Again, the rationale behind the safe harbor is that an equally efficient, single-product rival could meet any bundled discount resulting an above-cost pricing under this so-called “discount attribution” test.  And again, AAI has opposed this safe harbor.

These are but a few examples of AAI’s wildly pro-plaintiff view of antitrust—a view that ultimately injures consumers by ignoring the error costs (e.g., thwarted procompetitive business practices) associated with false convictions.  So in the end, I’m a bit worried about AAI’s jury instruction project.  If the Institute can simply provide clarity without pushing substantive liability standards in its preferred, pro-plaintiff (error cost-insensitive) direction, antitrust will be better off because of its efforts.  But I’m not optimistic.

Flying back from a hiking trip to spectacular Glacier National Park (see pics below the fold), I overheard a flight attendant say something that made me think of, what else?, bundled discounts.  “We also fly for Delta,” the United flight attendant told the woman in front of me.  That’s when I realized I was really flying on Skywest, a regional airline that provides service to the major airlines.

Skywest, it seems, flies between major airlines’ hub cities (Salt Lake City for Delta, Denver for United) and smaller destinations like Kalispell, Bozeman, Jackson Hole, etc.  (Full route map here.)  It does so, though, under the auspices of the major airlines, so one never buys a “Skywest” ticket, always a Delta or United ticket.  (This is pretty common.  Columbia, Missouri, where I teach, is serviced by Pinnacle Airlines, which flies back and forth between Columbia and Memphis for Delta.)

So what has this to do with bundled discounts?  Well, first recall why such discounts (price-cuts conditioned on purchasing products from multiple product markets) create anticompetitive concerns.  Courts, regulators, and scholars have worried that a multi-product seller may use bundled discounts to exclude equally or more efficient rivals that sell less extensive lines of products.  In theory, a multi-product seller who has market power over at least one of its products (i.e., the ability to charge an above-cost price for that product) could offer a bundled discount that results in an above-cost (and thus non-predatory) price for the bundle, but would still tend to exclude an equally efficient, but less diversified, rival.

The classic example of this strategy involves a bundled discount offered by a producer of shampoo and conditioner.  Suppose that manufacturer A sells both shampoo and conditioner, is a monopolist in the conditioner market, and competes in the shampoo market against manufacturer B, which sells only shampoo.  B is the more efficient shampoo manufacturer, producing shampoo at a cost of $1.25 a bottle compared to A’s cost of $1.50 per bottle.  A’s cost of producing a bottle of conditioner is $2.50.  If purchased separately, A’s per-bottle prices for shampoo and conditioner are $2.00 and $4.00, respectively.  But A offers customers a $1.00 bundled discount, charging only $5.00 for the shampoo/conditioner package.  While this discounted price is still above A’s cost for the bundle ($4.00), it could tend to exclude B.  Assuming that shampoo buyers must also buy conditioner (in equal proportions), buyers would have to pay A’s unbundled conditioner price of $4.00 if they purchased B’s shampoo and would thus be unwilling to pay more than $1.00 for the B brand of shampoo.  That price, though, is below B’s $1.25 cost.  Thus, A’s bundled discount would tend to exclude B from the market even though (1) the discounted price ($5.00) is above A’s aggregate cost for the bundle ($4.00), and (2) B is the more efficient shampoo producer.

Regional airlines like Skywest and Pinnacle find themselves in the same position as the shampoo-only manufacturer.  A significant impediment to these smaller airlines is the major carriers’ ability to offer a type of bundled discount — a price for a “bundle” of flights going from departure point to hub to destination that is significantly lower than the sum of the prices of two flights, one from departure point to hub and the other from hub to destination.  For example, a Delta flight from Columbia, Missouri to Memphis (a Delta hub) to New York City might cost $400, while purchasing separate flights from Columbia to Memphis and then from Memphis to NYC might cost a total of $500 ($200 for the Columbia to Memphis leg and $300 for the Memphis to NYC leg). This is, in effect, a bundled discount of $100.  If Pinnacle wanted to compete for passengers flying from Columbia to NYC, it would have to absorb the entire amount of the package discount on the single leg it offered (Columbia to Memphis), charging no more than $100 for the flight.  That price, though, may be below its cost.

Despite this impediment, regional airlines like Pinnacle and Skywest have not been driven out of business by the major carriers’ pricing strategies.  Instead, they have remained in business and have often delivered higher profits than their major carrier rivals.  How did they accomplish this feat?  By becoming suppliers to the major air carriers, offering to provide short-haul air service more efficiently than the majors.

So what are the implications for legal restrictions on bundled discounts?  A number of commentators have suggested that a bundled discount should be illegal if it would result in below-cost pricing on the competitive product after the entire amount of the discount is attributed to that product.  They take this position because they assume that such a discount would exclude an equally efficient, single-product rival by forcing it to price below its own cost.

The continued existence of Pinnacle, Sky West, and the other regional airlines, though, undermines this assumption.  Equally or more efficient single-product rivals confronted with the sort of bundled discount discussed above have a way to stay in business:  they can become suppliers to the bundled discounter.  If they are, in fact, more efficient than the discounter, it should jump on the opportunity to outsource production to them.  Thus, I would argue, a plaintiff complaining of exclusion by a bundled discount that does not run afoul of standard predatory pricing rules should have to show, among other things, that it could not stay in business by becoming a supplier to its discounting rival.  (It should also have to show that it could not replicate the bundle by collaborating with other product suppliers.)

For greater discussion of the appropriate liability rule for bundled discounts, see Part III of this article and Part IV of this article.  For some Glacier photos, see below the fold.  Continue Reading…

Have you ever had to get on your hands and knees at Office Depot to find precisely the right printer cartridge?  It’s maddening, no?  Why can’t the printer manufacturers just settle on a single design configuration, the way lamp manufacturers use common light bulbs?

You might think the printer manufacturer is trying to enhance its profits simply by forcing you to buy two of its products (the printer + the manufacturer’s own ink cartridge) rather than one (just the printer).  But that story is wrong (or, at best, incomplete).  Printers tend to be sufficiently brand-differentiated to enable manufacturers to charge a price above their marginal cost.  Ink, by contrast, is more like a commodity, so competition among ink manufacturers should drive price down near the level of marginal cost.  A printer manufacturer could fully exercise its market power over its printer — i.e., its ability to profitably charge a printer price that exceeds the printer’s cost — by raising the price of its printer alone.  It could not enhance its profits by charging that price and then requiring purchasers to buy its ink cartridge at some above-cost price.  Consumers would view the requirement to purchase the manufacturer’s “supracompetitively priced” ink cartridge as tantamount to an increase in the price of the printer itself, so the manufacturer’s tie-in would effectively raise the printer price above profit-maximizing levels (i.e., profits would fall, despite the higher effective price, because too many “marginal” consumers — those who value the manufacturer’s printer the least — would curtail their purchases).

If printer buyers consume multiple ink cartridges, though, a printer manufacturer may enhance its profits by tying its printer and its ink cartridges in an attempt to price discriminate among consumers.  The manufacturer would lower its printer price from the profit-maximizing level to some level closer to (but still at or above) its cost, raise the price of its ink cartridge above the competitive level (which should approximate its marginal cost), and require purchasers of its printer to use the manufacturer’s (supracompetitively priced) ink cartridges.  This tack enables the manufacturer to charge higher effective prices to high-intensity users, who are likely to value the printer the most, and lower (but still above-cost) prices to low-intensity users, who likely value the printer the least.  Economists call this sort of tying arrangement a “metering tie-in” because it aims to meter demand for the seller’s tying product (the printer) and charge an effective price that corresponds to a buyer’s likely willingness to pay.

When a seller imposes a metering tie-in, higher-intensity consumers get less “surplus” from their purchases (the difference between their outlays and the amount by which they value what they’re buying), but total market output tends to increase, as the manufacturer sells printers to some buyers who value the printer below the amount the manufacturer would charge for the printer alone (i.e., the profit-maximizing, single-product price).

In his recent high-profile article, Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory, Professor Einer Elhauge contends that metering tie-ins like the one described above tend to reduce total and consumer welfare.  He maintains that tie-ins of the type described are a form of welfare-reducing “third-degree” price discrimination.  He illustrates his point using a stylized example involving a printer manufacturer who sells consumers up to three ink cartridges. 

In a response to Professor Elhauge’s interesting article, I attempted to show that his welfare analysis turns on his assumption that printer buyers use only 1, 2, or 3 ink cartridges.  I demonstrated that Professor Elhauge’s hypo generates a different outcome — even assuming that this sort of metering tie-in is “third-degree” price discrimination — if ink cartridges are smaller, so that high-intensity consumers purchase 4 or more ink cartridges.

In some very helpful comments on my forthcoming response article, Professor Herbert Hovenkamp observed that there is a bigger problem with Elhauge’s analysis:  It assumes that the price discrimination here is third-degree price discrimination, when in fact it is second-degree price discrimination.

Below the fold, I discuss Elhauge’s analysis, my initial response (which remains valid), and the more fundamental problem Hovenkamp observed.  (And for those interested, please download my revised response article, which now contains both my original and Hovenkamp’s arguments.) Continue Reading…

In recent years, antitrust scholars have largely agreed on a couple of propositions involving tying and bundled discounting. With respect to tying (selling one’s monopoly “tying” product only on the condition that buyers also purchase another “tied” product), scholars from both the Chicago and Harvard Schools of antitrust analysis have generally concluded that there should be no antitrust liability unless the tie-in results in substantial foreclosure of marketing opportunities in the tied product market. Absent such foreclosure, scholars have reasoned, truly anticompetitive harm is unlikely to occur. The prevailing liability rule, however, condemns tie-ins without regard to whether they occasion substantial tied market foreclosure.

With respect to bundled discounting (selling a package of products for less than the aggregate price of the products if purchased separately), scholars have generally concluded that there should be no antitrust liability if the discount at issue could be matched by an equally efficient single-product rival of the discounter. That will be the case if each product in the bundle is priced above cost after the entire bundled discount is attributed to that product. Antitrust scholars have therefore generally endorsed a safe harbor for bundled discounts that are “above cost” under a “discount attribution test.”

In an article appearing in the December 2009 Harvard Law Review, Harvard law professor Einer Elhauge challenged each of these near-consensus propositions. According to Elhauge, the conclusion that significant tied market foreclosure should be a prerequisite to tying liability stems from scholars’ naïve acceptance of the Chicago School’s “single monopoly profit” theory. Elhauge insists that the theory is infirm and that instances of tying may occasion anticompetitive “power” (i.e., price discrimination) effects even if they do not involve substantial tied market foreclosure. He maintains that the Supreme Court has deemed such effects to be anticompetitive and that it was right to do so.

With respect to bundled discounting, Elhauge calls for courts to forego price-cost comparisons in favor of a rule that asks whether the defendant seller has “coerced” consumers into buying the bundle by first raising its unbundled monopoly (“linking”) product price above the “but-for” level that would prevail absent the bundled discounting scheme and then offering a discount from that inflated level.

I have just posted to SSRN an article criticizing Elhauge’s conclusions on both tying and bundled discounting. On tying, the article argues, Elhauge makes both descriptive and normative mistakes. As a descriptive matter, Supreme Court precedent does not deem the so-called power effects (each of which was well-known to Chicago School scholars) to be anticompetitive. As a normative matter, such effects should not be regulated because they tend to enhance total social welfare, especially when one accounts for dynamic efficiency effects. Because tying can create truly anticompetitive effect only when it involves substantial tied market foreclosure, such foreclosure should be a prerequisite to liability.

On bundled discounting, I argue, Elhauge’s proposed rule would be a disaster. The rule fails to account for the fact that bundled discounts may create immediate consumer benefit even if the seller has increased unbundled linking prices above but-for levels. It is utterly inadministrable and would chill procompetitive instances of bundled discounting. It is motivated by a desire to prevent “power” effects that are not anticompetitive under governing Supreme Court precedent (and should not be deemed so). Accordingly, courts should reject Elhauge’s proposed rule in favor of an approach that first focuses on the genuine prerequisite to discount-induced anticompetitive harm—“linked” market foreclosure—and then asks whether any such foreclosure is anticompetitive in that it could not be avoided by a determined competitive rival. To implement such a rule, courts would need to apply the discount attribution test.

The paper is a work-in-progress. Herbert Hovenkamp has already given me a number of helpful comments, which I plan to incorporate shortly. In the meantime, I’d love to hear what TOTM readers think.

I’ve just finished a draft of a paper for an upcoming conference on the Roberts Court’s business law decisions. Volokh blogger Jonathan Adler, who directs the Center for Business Law and Regulation at Case Western, is organizing the conference. The other presenters are Adam Pritchard from Michigan (covering the Court’s securities decisions), Brian Fitzpatrick from Vanderbilt (covering pleading standards), and Matt Bodie from St. Louis University (covering labor and employment). My paper discusses the Roberts Court’s antitrust decisions.

I am not the first to analyze the Roberts Court’s antitrust jurisprudence. Both Josh and Einer Elhauge have written terrific papers on the themes underlying the Court’s antitrust decisions. Josh has argued that the Court’s antitrust jurisprudence reflects Chicago School thinking; Elhauge contends that it’s more aligned with the Harvard School. While I’d probably side with Josh in that debate (mainly because I think the “new” Harvard School, having correctly jettisoned the old Structure-Conduct-Performance paradigm, moved so starkly in Chicago’s direction that it should really be called Chicago-Lite), I need not take sides. That’s because the unifying theme I identify in the Roberts Court’s antitrust decisions, one acknowledged by both Josh and Elhauge, is common to both the Chicago and Harvard schools. That theme is a recognition by the Court that antitrust is an inherently limited body of law that must be constrained in its reach — even to the point of allowing some undesirable conduct — if it is to do more good than harm.

Lots of folks are upset by the constraints the Roberts Court has imposed on antitrust. As Josh noted on this blog, Erwin Chemerinsky has complained that the Court’s antitrust decisions exemplify a “sharp turn to the right” and systematically “favor[] business over consumers.” Chemerinsky, of course, is no antitrust expert. But even well-respected members of the antitrust community have sounded a similar refrain. For example, William Kolasky, a former Deputy Assistant Attorney General in the Antitrust Division of the U.S. Department of Justice and an associate editor of the ABA’s Antitrust Magazine, recently (though before the Court’s most recent antitrust decision) wrote that “Our Supreme Court, especially under the leadership of Chief Justice John Roberts, seems equally intent on cutting back on private enforcement. … This record led Antitrust to ask in its last issue whether the Supreme Court’s recent antitrust decisions represent ‘The End of Antitrust as We Know It?'”

In my paper, “The Roberts Court and the Limits of Antitrust,” I argue that anti-consumer/pro-business/”radical shift” meme the Chemerinskies and Kolaskies of the world assert is wrong and reflects a fundamental misunderstanding of the inherent limits of the antitrust enterprise. Below the fold, I describe the paper. Continue Reading…

TOTM Welcomes Dan Crane

Josh Wright —  26 July 2010

TOTM is pleased to announce Professor Daniel Crane (Michigan Law) as — for now we hope — a guest blogger.  Dan is a prolific scholar in antitrust and intellectual property.  Dan’s recent work has focused on antitrust and economic regulation, particularly the institutional structure of antitrust enforcement, predatory pricing, bundling, and the antitrust implications of various patent practices.  You can download some of Dan’s work here (including, if I may, our co-authored reply to Einer Elhauge on bundled discounts and exclusion).  TOTM readers may already be familiar with Professor Crane, who has been a frequent contributor to our blog symposia on Section 2 and the Proposed Horizontal Merger Guidelines, and has recently done excellent work on Section5 and the Intel case.

We are thrilled to having Dan join the TOTM team and look forward to his contributions.  Welcome Dan!

One of my summer writing projects is a response to Einer Elhauge’s recent, highly acclaimed article, Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory.  In the article, which appeared in the December 2009 Harvard Law Review, Elhauge defends current tying doctrine, which declares tie-ins to be per se illegal when the defendant has market power in the tying product market and the tie-in affects a “not insubstantial” volume of commerce in the tied product market.

Efficiency-minded scholars from both the Chicago and Harvard Schools of antitrust analysis have criticized the prevailing liability rule for failing to require that a challenged tie-in foreclose a substantial percentage of marketing opportunities in the tied product market.  Absent such foreclosure, those scholars have argued, tying cannot create anticompetitive harm and should not constitute a per se antitrust violation. 

Elhauge insists that these scholars are wrong.  Even in the absence of substantial tied market foreclosure, he observes, a tie-in can facilitate price discrimination and can extract additional surplus from consumers.  He contends that these price discrimination and surplus extraction effects are anticompetitive effects that are properly addressed by antitrust.

No one seriously doubts Elhauge’s initial observation about tying’s potential non-foreclosure effects.  Indeed, even Chicago School scholars have long recognized that a monopolist may use a tie-in to meter demand for its monopoly tying product, charging higher effective prices to consumers with high reservation prices.  A printer monopolist, for example, may expand its profits by lowering its printer price from profit-maximizing levels but requiring customers to purchase its ink cartridges at supracompetitive prices.  High-value customers, who use lots of ink, will end up paying higher effective prices than will low-value customers.  Thus, a “requirements tie” of this type may permit a monopolist to price discriminate and to redistribute surplus from high-value consumers to itself.     

Elhauge’s second claim — that price discrimination and surplus extraction are anticompetitive effects that tying doctrine should police — is another matter entirely.  In support of that claim, he asserts both positive and normative arguments.  As a normative matter, he contends that the sort of price discrimination occasioned by tie-ins is likely to reduce both consumer and total surplus and should thus be condemned.  As a positive matter, he argues that Supreme Court precedent does, in fact, deem tying’s price discrimination/surplus extraction effects to be anticompetitive.

In future posts, I’ll address Elhauge’s normative argument.  For now, let me take a stab at his positive claim. Continue Reading…

Danny Sokol posted his blog’s list of top antitrust publications for the year.  The big winners were Einer Elhauge, Bundled Discounts, and the Death of the Single Monopoly Profit Theory, 123 Harvard Law Review 397 (2009), and Nathan Miller, Strategic Leniency and Cartel Enforcement, American Economic Review.  In the holiday rush,  I forget to send in my votes.  Sorry about that Danny.  With the normal caveats that I’m sure I’m leaving off some articles I’m just forgetting about at the moment, that the list is entirely subjective, and that the methodological sophistication of the list is essentially equivalent to trying to remember articles and find links while counting with my fingers, here are my top 10 for 2009:

  1. William Kovacic, The Federal Trade Commission at 100: Into Our Second Century (Jan 2009)
  2. Nathan Miller, Strategic Leniency and Cartel Enforcement, American Economic Review, Vol 99, No. 3 (2009), 750-568
  3. Benjamin Klein, Competitive Resale Price Maintenance in the Absence of Free-Riding (forthcoming, Antitrust Law Journal)
  4. Paul Seabright, The Undead? A Comment on Professor Elhauge’s Paper,  5 (2) Competition Policy International 277 (2009)
  5. Bruce Kobayashi and Joshua D. Wright, Federalism, Substantive Preemption, and the Limits of Antitrust: An Application to Patent Holdup, 5 Journal of Competition Law and Economics 469 (2009).
  6. Dennis Carlton, Why We Need To Measure the Effect of Merger Policy and How to Do It, 5(1) Competition Policy International 77 (2009)
  7. Thomas Lambert, Dr. Miles is Dead. Now What?: Structuring a Rule of Reason for Minimum Resale Price Maintenance, 50 WILLIAM AND MARY LAW REVIEW 1937 (2009).
  8. Daniel A. Crane, Chicago, Post-Chicago and Neo-Chicago, 76 University of Chicago Law Review (2009)
  9. William Page and Seldon J. Childers, Measuring Compliance with Compulsory Licensing Remedies in the American Microsoft Case, 76 ANTITRUST L.J. 239 (2009)
  10. Alan Devlin, The Stochastic Relationship between Patents and Antitrust, 5(1) Journal of Competition Law and Economics 75 (2009).

Chairman Kovacic’s FTC at 100 Report (all 200 or so pages) is not traditional academic scholarship as such, but is a must read material for anybody who does serious thinking about antitrust institutions and enforcement a legal or economic perspective and so I wanted to call some attention to it here.

What have I left off?

And if I don’t hear from you before then, Happy New Year!

Josh’s thoughtful response (Bitchslap? Nah.) to my post criticizing the Ninth Circuit’s recent Masimo decision raises a number of important matters. I started to just submit a comment to Josh’s post, but then I figured a reply was post-worthy. (I don’t want the antitrust nerds who read these technical posts — and here’s to you, dweeby friends! — to miss the discussion.)

Here’s a run-down of the discussion so far:

I criticized the Masimo court for reasoning that a plaintiff complaining of a rival’s bundled discounting may proceed on a de facto exclusive dealing theory when (1) there’s no express covenant of exclusivity (so it is merely the defendant’s low prices that are leading buyers to forego rivals) and (2) the defendant’s bundled discount would pass muster under the Ninth Circuit’s PeaceHealth standard. Under that so-called “discount attribution” standard, a bundled discount is immune from liability if each product in the bundle is priced above cost after the entire amount of the bundled discount is attributed to that product alone.

The basis for the PeaceHealth court’s safe harbor was a desire to immunize bundled discounts that cannot exclude any single-product rival that can produce its own product as efficiently as the defendant. After all, any bundled discount that results in above-cost pricing on each bundled product, even after the entire discount amount is attributed to that product, could be matched by, and thus cannot exclude, any equally efficient single-product rival. Because such discounts do not make it impossible for equally efficient rivals to stay in the market, the PeaceHealth court reasoned, they are not unreasonably exclusionary.

In my initial post, I argued that this same analysis should apply even when the bundled discount is so successful that it induces customers to drop rivals’ brands and to purchase only from the discounter. If a discounter doesn’t procure a contractual covenant of exclusivity and instead just offers a really attractive discount, that discount, which provides immediate consumer benefit, should be immune from liability as long as it doesn’t threaten to exclude an equally efficient rival. The discount can’t pose such a threat unless it’s so extreme that an equally efficient single-product rival (who must match the entire dollar amount of the bundled discount on its single product) could not match it, and that will be the case only if the discount results in a below-cost price on some item in the bundle after the entire amount of the discount is attributed to that item. Thus, I argued, an allegation (or even proof) that a bundled discount resulted in de facto exclusive dealing should not alter the PeaceHealth safe harbor.

Now, there are two ways one might interpret my position. I could be saying simply that the optimal liability rule would not condemn de facto exclusive dealing induced solely by bundled discounts that pass muster under PeaceHealth. I could appropriately stake that claim, even if I acknowledged potential anticompetitive harm from such discounts, if I concluded that the likelihood and magnitude of such harm was low and the likelihood and magnitude of harm from “false positives” (i.e., improperly condemned discounts) was high. Alternatively, I could be making a more aggressive economic claim, asserting that de facto exclusive dealing accomplished via bundled discounts that satisfy PeaceHealth cannot be anticompetitive.

In his thoughtful and nuanced post, Josh suggests he might, given more empirical analysis, agree with the former position (about what liability rule is optimal, given error costs). But he rejects the more aggressive economic claim. That claim, he maintains, is deficient because it fails to account for the fact that bundled discounts resulting in de facto exclusive dealing may “raise rivals’ costs” even if the discounts would pass muster under PeaceHealth.

Here’s the intuition (my understanding of it, at least): A bundled discount that’s big enough to usurp lots of business from the discounter’s rivals, but not big enough to run afoul of PeaceHealth, may still preclude those rivals from attaining minimum efficient scale (i.e., the output level at which all scale economies are exhausted). The discount may thus prevent rivals from achieving equivalent efficiency with the discounter. That would be anticompetitive. Thus, it is not true, as I said, that “[w]hen it comes to bundled discounts, … 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.” Rather, Josh suggests, a bundled discount that results in substantial foreclosure of the discounter’s rivals may raise those rivals’ costs and thus be anticompetitive, even if the discount would pass muster under PeaceHealth and therefore not amount to predation.

So what to make of all this? Continue Reading…