Archives For bundled discounts

Should PeaceHealth Apply to De Facto Exclusive Dealing Claims?

Josh Wright —  10 November 2009

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?

In Antitrust & Competition, Economic Theory, Error Costs, Exclusive Dealing , ,
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PeaceHealth Should Apply Even When a Bundled Discount Results in "De Facto" Exclusive Dealing

Thom Lambert —  3 November 2009

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

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

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

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

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

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

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

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

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

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

***

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

In Antitrust & Competition, Exclusionary Conduct, Exclusive Dealing, Law & Economics, Tying
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Another Way DOJ Might Pursue "Vigorous Antitrust Enforcement in This Challenging Era"

Thom Lambert —  24 August 2009

DOJ’s top antitrust enforcer Christine Varney had hardly gotten settled in her office before she repudiated the existing DOJ guidelines on policing single-firm conduct. In the spirit of Rahm Emanuel’s famous “never let a serious crisis go to waste” directive, Ms. Varney invoked the current economic crisis as grounds for her decision to throw out the product of more than a year’s worth of hearings (from all sides).

Ms. Varney began her speech announcing DOJ’s new stance (reactions from Josh and Geoff here and here) by noting how the absence of antitrust enforcement during the Great Depression injured American consumers. She then stated that a “lesson[] learned from this historical example” is that “vigorous antitrust enforcement must play a significant role in the Government’s response to economic crises to ensure that markets remain competitive.” She concluded by announcing that the Department would therefore throw out the Section 2 report and pursue unilateral firm conduct more aggressively.

It was a strange speech. The Depression-era anticompetitive harms to which Ms. Varney referred were not unilateral firm actions, the subject of the Section 2 report, but were instead collusive acts facilitated by protectionist legislation like the National Industrial Recovery Act. Thus, Ms. Varney’s Rahmesque syllogism — “competition suffered after the Depression; we’re experiencing Depression-like conditions now; therefore, we must throw out existing guidelines on single-firm conduct” — didn’t really work.

But let’s suppose DOJ really does want to avoid Depression-era anticompetitive harms. What should it do?

Well, it could start by flexing its advocacy muscle against this sort of madness. (The linked WSJ article discusses “a Depression-era federal program designed to keep prices from plummeting.” Under that program, a federally authorized panel of fruit processors has directed cherry farmers to leave up to 40% of their crop unharvested.) Or maybe DOJ could express support for this effort to raise the Depression-era import quotas that keep American sugar prices artificially high. Not only would raising import quotas increase competition to consumers’ benefit, it might also decrease Americans’ consumption of high fructose corn syrup, which tends to make us fatter than sugar does. (Health care savings, anyone?) Unfortunately, the Obama administration has thus far resisted any effort to enhance consumer-friendly competition among sugar sellers.

I’m not suggesting that these programs run afoul of the antitrust laws. I realize that various governmental immunities preclude antitrust liability. My point, though, is that these sorts of programs — not unilateral actions like loyalty rebates, bundled discounts, and tying — are the primary type of consumer-unfriendly action spawned in the wake of the Depression. If DOJ wanted to pursue competition policy in a manner that reflects what we’ve learned from the events Ms. Varney cited in her speech repudiating the Section 2 Report, it would push hard to reduce or eliminate these programs.

In Antitrust & Competition, Justice Department, Tying
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Neo-Chicago Meets Evidence-Based Antitrust

Josh Wright —  12 May 2009

Dan Crane has an excellent essay (“Chicago, Post-Chicago and Neo-Chicago“) reviewing Bob Pitofsky’s Overshot the Mark volume.  Here’s Dan’s brief abstract:

This essay reviews Bob Pitofsky’s 2008 essay compilation, How Chicago Overshot the Mark: The Effect of Conservative Economic Analysis on U.S. Antitrust. The essay critically evaluates the book’s rough handling of the Chicago School and suggests a path forward for a Neo-Chicago approach to antitrust analysis.

Readers of the blog will sense similar themes from Crane’s essay and my own review of the Pitofsky volume, Overshot the Mark? A Simple Explanation of the Chicago School’s Influence on Antitrust.

Dan and I both criticize the volume for overplaying its hand on two key points: (1) that the Chicago School’s dominance in antitrust has been a function more of right-wing political ideology than economics, and (2) that the Post-Chicagoans can claim superior predictive power over Chicago models with respect to the existing empirical evidence.  What interests me most about Dan’s excellent work is that we’ve come to very similar conclusions about a “path forward” for antitrust out of the Post-Chicago v. Chicago debates which have become largely political and lost economic meaning to most using the term.  Our conclusions each embrace an empirically motivated style of analysis that is sensitive to error costs.

Dan identifies the “Neo-Chicago School”, a term coined by David Evans and Jorge Padilla, as the optimal “third way.”  Basically, the Neo-Chicago school is the combination of price theory, empiricism and the error-cost framework to inform the design of antitrust liability rules.  The new addition to the Neo-Chicago label is the addition of the error-cost framework.  As I’ve written elsewhere, while I consider myself a subscriber to the Neo-Chicago approach, I’m not too convinced there is anything “Neo” about it.  Here’s my mathematical proof of this proposition:

Neo-Chicago = Chicago + Error Cost Framework

Neo-Chicago = Chicago + Intellectual creation of Frank Easterbrook

Neo-Chicago = Chicago + Chicago

Neo-Chicago = 2*Chicago

It’s trivial to demonstrate then that Neo-Chicago is really just a double dose of the Chicago School.  QED.

I’m not sure what that means, but there is a more serious point underlying all of this that goes beyond semantics.  I think that Dan and Evans & Padilla both have it right that this theory + empiricism + error-cost framework is the most intellectually powerful approach to generating a coherent approach to antitrust based on the best available theory and evidence.  In my recent work, including the Pitofsky book review linked above, I’ve calling this approach “evidence based antitrust” largely to avoid the whole Chicago v. Post-Chicago debate which has become so loaded that folks often use it as an excuse to say unreasonable or simply incorrect things.

As I articulate the “evidence based antitrust” approach, it too is the combination of the best available theory + empirical evidence + the error-cost framework.   It may have the advantage of avoiding some of the political rhetoric that has become increasingly mainstream in these debates and shift our attention to the existing body of empirical evidence.  But these things are very hard to predict.  And of course, to the extent that a greater fraction of the antitrust debates nowadays are taking places in Congress, sensitivity to the existing empirics might be less likely.

Dan’s essay is highly recommended.  Go read it.  And look for some work from Crane and Wright in the future in a joint paper applying this sort of framework to bundled discounts.

In Antitrust & Competition, Error Costs , ,
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Section 2 Symposium: Josh Wright on An Evidence Based Approach to Exclusive Dealing and Loyalty Discounts

Josh Wright —  6 May 2009

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…

In Antitrust & Competition, Economic Theory, Exclusive Dealing, Justice Department, Law & Economics, Section 2 Symposium, Truth on the Market, Vertical Restraints ,
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Section 2 Symposium: Dan Crane on Buyer-Instigated Bundled Discounts

Dan Crane —  6 May 2009

craneDaniel Crane is a Professor of Law at Cardozo Law School (soon to be at University of Michigan Law School).

Bundled discounts have been one of the hottest monopolization topics of the last decade. Much of the trouble began with the Third Circuit’s en banc decision in LePage’s v. 3M, which reversed an earlier 2-1 panel decision which in turn had overturned a plaintiff’s jury verdict largely based on 3M’s bundled discounts. After the Solicitor General’s amicus curiae brief asked the Supreme Court to deny cert on the grounds that there wasn’t sufficient scholarship on bundled discounts, there was a flurry of legal and economic scholarship, the overwhelming majority of which was highly critical of LePage’s.

Over the past five years or so, it seemed that a consensus was emerging that some sort of discount reallocation or attribution test should be used as a screen in bundled discounting cases. There are various formulations of the test, but in general it requires the plaintiff to show that defendant priced the competitive product below cost after the discounts on the non-competitive product are reallocated to the competitive market. Versions of that test have been adopted by a variety of commentators, agencies, and courts, including the DOJ in its Section 2 report, the Antitrust Modernization Commission, the Areeda-Hovenkamp treatise, and the Ninth Circuit’s PeaceHealth decision. I have been—and continue to be—a staunch defender of some formulation of that test.

Just when I thought we were close to reaching a strong majority position on bundled discounts, along comes a significant new article by Einer Elhauge (to be published this coming December in the Harvard Law Review) challenging the entire basis of the theory. Einer argues that bundled discounts manifest anticompetitive “power effects” if the unbundled price for the linking product exceeds the but-for price level (i.e., the price the defendant would charge in the absence of the bundle) and that such bundles should be treated as tie-ins.

Einer’s article is sure to attract lots of attention and give courts and perhaps the agencies pause in adopting the until-now consensus position on bundled discounts. Although I profoundly disagree with much of Einer’s analysis, it is a provocative and important article. Josh Wright and I are planning a full response at a later date. For the moment, let me just preview one responsive angle. Continue Reading…

In Antitrust & Competition, Justice Department, Law & Economics, Section 2 Symposium, Truth on the Market ,
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Section 2 Symposium: Thom Lambert on The DOJ-FTC Divide on Bundled Discounts

Thom Lambert —  6 May 2009

lambertThom Lambert is an Associate Professor of Law at University of Missouri Law School and a blogger at Truth on the Market.

A bundled discount occurs when a seller offers to sell a collection of different goods for a lower price than the aggregate price for which it would sell the constituent products individually. Such discounts pose different competitive risks than single-product discounts because, as I explained in this post, they may have an exclusionary effect even if they result in a price that exceeds the cost of producing the bundle. In particular, even an “above-cost” bundled discount may have the effect of excluding rivals that (1) are more efficient at producing the products that compete with the discounter’s but (2) produce a less extensive product line than the discounter. In other words, bundled discounts may drive equally efficient but less diversified rivals from the market.

Given that they are a “mixed bag” practice (some immediate benefits, some potential anticompetitive harms) and pose risks beyond those presented by straightforward predatory pricing, courts and commentators have struggled to articulate a legal standard that would prevent unreasonably exclusionary bundled discounts without chilling procompetitive bundling. With the notable exception of the en banc Third Circuit’s LePage’s decision, which is essentially standardless, most of the approaches courts and commentators have articulated for evaluating bundled discounts have involved some sort of test that compares prices and costs. Chapter 6 of the Department of Justice’s Section 2 Report explains the various “price-cost” tests in detail.

Based on the presentations in the Section 2 hearings, the Department reached essentially four conclusions concerning bundled discounts:

Continue Reading…

In Antitrust & Competition, Economic Theory, Exclusive Dealing, Justice Department, Law & Economics, Section 2 Symposium, Truth on the Market ,
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Section 2 Symposium: Herbert Hovenkamp on Predatory Pricing and Bundled Discounts

Herbert Hovenkamp —  6 May 2009

hovenkampHerbert Hovenkamp is Professor of Law at The University of Iowa College of Law.

The baseline for testing predatory pricing in the Section 2 Report is average avoidable cost (AAC), together with recoupment as a structural test (Report, p. 65). The AAC test or reasonably close variations, such as average variable cost or short-run marginal cost, seems about right. However, differences among them can become very technical and fine. The Report correctly includes in AAC those fixed costs that “were incurred only because of the predatory strategy, for example, as a result of expanding capacity to enable the predatory sales.” (Report, pp. xiv, 64-65) Such a strategy would make some sense for a predator if the fixed costs in question are easily re-deployed once the predation has succeeded – for example, in the case of an airline whose planes can be shifted to a different route. The test virtually guarantees that in industries that require heavy investment in production capacity that cannot be redployed the test will approach strict average variable cost. In cases where fixed costs are relatively high, an investment of this nature that lasted only through the predatory period and became excess capacity thereafter would not be worth it. Further, if fixed costs are low the market is almost certainly not prone to monopoly to begin with. AVC is probably underdeterrent, but it is also probably the best we can do without chilling procompetitive behavior.

However, when prices are under AVC, then a strict recoupment requirement (see Report, pp. 67-68) is unnecessarily harsh. Proving recoupment requires a prediction about the dominant firm’s prices, costs, and output over a defined future period, which in turn requires a prediction about when new entry will occur, how many firms will enter, and their growth rates. As a result recoupment is much too difficult to prove and does not serve to distinguish aggressive promotional price cuts from those that are anticompetitive. Rather, structural proof should consist of those things that are ordinarily required in a Section 2 case; namely, a dominant share of a properly defined relevant market and high entry barriers. That is, the question should be “is durable monopoly pricing in this market possible,” but not “can predation be predicted to yield a durable period of monopoly pricing with sufficient monopoly returns to pay off the investment in predation.” As a factual matter the former requirement is much more manageable and requires far less speculation. An important additional ingredient is causation in the classical tort sense – namely, can the plaintiff show that the prices below average variable cost were of sufficient magnitude and duration to cause its exit from the market? Sporadic or episodic price drops below AVC are unlikely to meet this requirement.

The biggest concern is with false positives. Are there cases in which prices were below AVC for a substantial length of time to meet the causation requirement and the structural components for monopoly were present, but where we would not want to condemn the conduct because dollars-and-cents proof of recoupment is not possible. I doubt it.

Continue Reading…

In Antitrust & Competition, Law & Economics, Section 2 Symposium, Truth on the Market
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Section 2 Sympoisum: Welcome to the Final Day

Geoffrey Manne —  6 May 2009

manne

Geoffrey Manne is Director, Global Public Policy at LECG and a Lecturer in Law at Lewis & Clark Law School. He is a founder of Truth on the Market.

wright

Josh Wright is Assistant Professor at George Mason University School of Law and a former Scholar in Residence at the FTC. He blogs regularly at Truth on the Market.

Welcome to the third and final day of the TOTM Symposium on Section 2 and the Section 2 Report.

Yesterday we had a great series of posts discussing the difficult question of whether Section 2 should be governed by a general standard or rather by conduct-specific standards, as well as the merits of the Section 2 Report’s endorsement of the “substantial disproportionality” test. For convenience, yesterday’s posts are linked here:

Today we’ll turn our attention from the debate over general standards to more specific substantive issues throughout the Report ranging from the Report’s proposed treatment of practices like predatory pricing, bundled discounts and exclusive dealing to issues including defining monopoly power, crafting effective monopolization remedies, the intersection of monopolization law and intellectual property, and the implications of the Section 2 Report for international antitrust.  Today we’ll hear from (in some cases more than once):

  • Bruce Kobayashi (George Mason) on predatory pricing
  • Herbert Hovenkamp (Iowa Law) on predatory pricing and bundled discounts
  • Thom Lambert (Missouri Law) on bundled discounts
  • Dan Crane (Cardozo/Michigan) on bundled discounts
  • Howard Marvel (Ohio State) on exclusive dealing
  • Josh Wright (George Mason) on exclusive dealing and loyalty discounts
  • Tim Brennan (UMBC) on distinguishing predation from exclusion
  • Bill Kolasky (WilmerHale) on monopoly power
  • Herbert Hovenkamp (Iowa Law) on patents and exclusionary conduct
  • Tim Brennan (UMBC) on the relationship between regulation and antitrust
  • Bill Page (Florida) on monopolization remedies
  • Alden Abbott (FTC) provides an international perspective on single firm conduct

We’re looking forward to hearing from the participants, and hope you’ll join in the comments.

In Announcements, Antitrust & Competition, Error Costs, Exclusionary Conduct, Exclusive Dealing, Intellectual Property, Justice Department, Law & Economics, Patent, Section 2 Symposium, Truth on the Market ,
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Section 2 Symposium: Michael Salinger on Error Costs and the Case for Conduct-Specific Standards

Michael Salinger —  5 May 2009

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Michael A. Salinger is a managing director in LECG’s Cambridge office and a professor of economics at the Boston University School of Management, where he has served as chairman of the department of finance and economics. He is a former Director of the Bureau of Economics at the FTC.

The source of much of the disagreement between the Antitrust Division and the FTC is based on chapter 3, which discusses general standards for Section 2 liability.

A major portion of chapter 3 concerns whether there is a unifying principle underlying appropriate doctrine for all behavior challenged under Section 2. A substantial portion of the chapter is devoted to specific proposals: “effects balancing,” “no economic sense,” “profit sacrifice,” “equally-efficient competitor,” and “disproportionality” tests. I found most of the discussion in chapter 3 to be quite sensible. The problems it cites with the effects balancing test are well-founded. It would be a great test for the incomes of consulting economists, but it requires more precision in economic analysis than the current state of the art can deliver and will likely lead to errors in both directions. The discussion of the profit-sacrifice and no-economic- sense tests helps clarify the distinction between the two. A mere profit sacrifice test is too loose a liability standard. A no-economic sense test is sometimes useful, but it should not be the universal standard for Section 2 liability. The discussion of the equally-efficient competitor test was balanced and useful.

The most controversial part of the chapter is the discussion of the disproportionality test and in particular the conclusion that, even though the Department does not believe that there is a preferred test, the disproportionality test is its preferred test. I am puzzled by that conclusion. It is at odds with the ultimate conclusion that different kinds of conduct warrant different tests because of differences in the costs of false positives and false negatives.

The standard for predatory pricing established in Matsushita and Brooke Group is, in effect, a “no economic sense” test. Pricing below the relevant notion of cost is behavior that qualitatively makes no sense unless it drives out rivals. (Of course, they also include the requirement that the exclusionary hypothesis makes economic sense.) Aspen Ski relies on “no economic sense” logic. (Exclusion was the only plausible reason that Aspen would not sell lift tickets to Aspen Highlands on the same terms as it sold them to the general public.) In my opinion, predatory pricing and refusals to deal are both classes of conduct for which we should be more concerned with false positives than false negatives.

One of the standard criticisms of the no economic sense test is that $1 of efficiencies can get a company off the hook for behavior that generates $100 of competitive harm. The disproportionality test addresses that criticism. A disproportionality test may be a better conceptual standard than “no economic sense” for refusals to deal (and perhaps Aspen Ski is more accurately characterized as a disproporitionality test), but the difference between the two is a marginal adjustment. Substituting a disproportionality test (which one can think of as a “little economic sense” test) for a “no economic sense” test does not address the primary concern with these tests as general standards. There might be other classes of behavior (like bundled discounts) where the relative concern with false positives and false negatives dictates a standard which trades off those two risks much differently.

The DOJ embrace of the disproportionality test reflects a greater concern with false positives than false negatives for all behavior subject to challenge under Section 2. I agree with the objection Commissioners Harbour, Leibowitz, and Rosch raised with respect to this aspect of the DOJ report. Of course, other aspects of their statement were regrettable. First, there is the rhetoric (“a blueprint for radically weakened enforcement”). And who are all the “stakeholders?” The historical position of the FTC has been consumers are the only proper stakeholders in antitrust. What other stakeholders did they have in mind? Is the antitrust bar (or the plaintiff’s side of it) a proper stakeholder to consider? And their discussion of the individual topics failed to reflect a nuanced, decision-theoretic analysis of which practices require standards that tolerate false negatives to avoid false positives and which require standards where a risk of false positives should be tolerated.

The final conclusion in chapter 3 of the DOJ report is that different classes of conduct require different standards based on differences in the relative risk of different types of errors. I think that is the right conclusion and that is what should frame the entire debate.

In Antitrust & Competition, Antitrust Division, Error Costs, Federal Trade Commission, Justice Department, Law & Economics, Section 2 Symposium, Truth on the Market
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Section 2 Symposium: Thom Lambert on Defining and Identifying Exclusionary Conduct

Thom Lambert —  5 May 2009

lambertThom Lambert is an Associate Professor of Law at University of Missouri Law School and a blogger at Truth on the Market.

There’s a fundamental problem with Section 2 of the Sherman Act: nobody really knows what it means. More specifically, we don’t have a very precise definition for “exclusionary conduct,” the second element of a Section 2 claim. The classic definition from the Supreme Court’s Grinnell decision — “the willful acquisition or maintenance of [monopoly] power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident” — provides little guidance. The same goes for vacuous statements that exclusionary conduct is something besides “competition on the merits.” Accordingly, a generalized test for exclusionary conduct has become a sort of Holy Grail for antitrust scholars and regulators.

In its controversial Section 2 Report, the Department of Justice considered four proposed general tests for unreasonably exclusionary conduct: the so-called “effects-balancing,” “profit-sacrifice/no-economic-sense,” “equally efficient competitor,” and “disproportionality” tests. While the Department concluded that conduct-specific tests and safe harbors (e.g., the Brooke Group test for predatory pricing) provide the best means of determining when conduct is unreasonably exclusionary, it did endorse the disproportionality test for novel business practices for which “a conduct-specific test is not applicable.” Under the disproportionality test, “conduct that potentially has both procompetitive and anticompetitive effects is anticompetitive under section 2 if its likely anticompetitive harms substantially outweigh its likely procompetitive benefits.”

According to the Department, the disproportionality test satisfies several criteria that should guide selection of a generalized test for exclusionary conduct. It is focused on protecting competition, not competitors. Because it precludes liability based on close balances of pro- and anticompetitive effects, it is easy for courts and regulators to administer and provides clear guidance to business planners. And it properly accounts for decision theory, recognizing that the costs of false positives in this area likely exceed the costs of false negatives.

While it has some laudable properties (most notably, its concern about overdeterrence), the disproportionality test is unsatisfying as a general test for exclusionary conduct because it is somewhat circular. In order to engage in the required balancing of pro- and anticompetitive effects, one needs to know which effects are, in fact, anticompetitive. As the Department correctly noted, the mere fact that a practice disadvantages or even excludes a competitor does not make that practice anticompetitive. For example, lowering one’s prices from supracompetitive levels or enhancing the quality of one’s product will usurp business from one’s rivals. Yet we’d never say such competitor-disadvantaging practices are anticompetitive, and the loss of business to rivals should not be deemed an anticompetitive effect of the practices.

“Anticompetitive” harm presumably means harm to competition. We know that that involves something other than harm to individual competitors. But what exactly does it mean? If Acme Inc. offers a bundled discount that results in a bundle price that is above the aggregate cost of the products in the bundle but cannot be met by a less diversified rival, is that a harm to competition or just a harm to the less diversified competitor? If Acme pays a loyalty rebate that results in an above-cost price for its own product but usurps so much business from rivals that they fall below minimum efficient scale and thus face higher per-unit costs, is that harm to competition or to a competitor? These are precisely the sorts of hard (and somewhat novel) cases in which we need a generalized test for exclusionary conduct. Unfortunately, they are also the sorts of cases in which the Department’s proposed disproportionality test is unhelpful.
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In Antitrust & Competition, Exclusionary Conduct, Justice Department, Law & Economics, Section 2 Symposium, Truth on the Market , ,
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Section 2 Symposium: Dan Crane on Framing the Debate

Dan Crane —  4 May 2009

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Daniel Crane is a Professor of Law at Cardozo Law School (soon to be at University of Michigan Law School).

I must confess that my basic reaction to the Section 2 report was disappointment.  It’s not that I find much fault with the report itself–a few quibbles yes, but generally I find it quite satisfactory–but that after all of the time and effort put into the joint hearings by the FTC, the FTC wasn’t able to join the report.  Moreover, the shrill dissenting statement by three commissioners will probably prevent the report from playing influencing judicial decisions or legislation.

That’s a real pity.  Many staff members at both agencies and many outsiders (myself included) put a lot of work into the hearings and the report.  Contrary to the suggestion in the dissenting statement, I saw no evidence that the hearings were stacked against more interventionist perspectives on Section 2.  That certainly was not the case at the bundled discount hearings at which I testified.  To the contrary, my general impression was that the hearings were constructive and made substantial progress toward agreement on some basic principles.  Certainly, they lacked the rancor that characterized the release of the report.

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In Antitrust & Competition, Exclusionary Conduct, Exclusive Dealing, Intellectual Property, Justice Department, Law & Economics, Patent, Section 2 Symposium, Truth on the Market , ,
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