Archives For bundled discounts

Dan Crane (Antitrust Review, Cardozo) has graciously posted his testimony for Wednesday’s FTC/ DOJ Section 2 Hearings on Loyalty Discounts. Readers familiar with Crane’s scholarship on bundled discounts in the Chicago Law Review and Emory Law Journal will not be surprised that it is thorough, careful, mindful of the role that administrative costs should play in designing antitrust liability rules. At the end of the day, Professor Crane proposes a Brooke Group style-discount reallocation rule for bundled discounts, which he articulates as follows: “that the bundled discounts resulted in at least one product in the package being sold at less than cost, after reallocation of the discounts on the other products in the package to the predatory product.” Interested readers should go read Professor Crane’s testimony.
I am also looking forward to seeing TOTM co-blogger Thom’s remarks (who will also be testifying) on this subject, which has become a relatively hot antitrust issue after LePage’s. The panel lineup looks interesting, and also includes Joseph Kattan, David Sibley, Barry Nalebuff, Janusz Ordover, Willard Tom, and my colleague Tim Muris. I am particularly interested in the bundled discount testimony because it has substantial overlap with many of the issues raised in the exclusive dealing session which I participated in, and the relationship between the economics of exclusive dealing and various types of discount contracts.

Cardozo professor Dan Crane and I are living parallel lives. We both attended Wheaton College and the University of Chicago Law School (Dan was two years ahead of me). We began teaching at the same time. We both teach antitrust law and have written on bundled discounts. Like Josh, we’re both presenting at the DOJ/FTC hearings on single-firm conduct. And we’ve both recently written reviews of Herbert Hovenkamp’s terrific new book, The Antitrust Enterprise: Principle and Execution. Dan’s review, forthcoming in Michigan Law Review, is entitled Antitrust Modesty. Mine, forthcoming in Texas Law Review, is called Tweaking Antitrust’s Business Model.

As both titles indicate, Hovenkamp’s book does not call for radical change to existing antitrust rules. In that sense, the book differs from the famous antitrust expositions by Robert Bork (The Antitrust Paradox, 1978) and Richard Posner (Antitrust Law: An Economic Perspective, 1976). The difference in tone, though, does not reflect a difference in underlying philosophy. Like his Chicagoan predecessors, Hovenkamp rejects the Warren Court-era’s focus on protecting competitors rather than competition, and he defines “competition” in a manner that focuses not on the number of firms in a market but on the degree to which the market generates low prices, high output, and innovation. He maintains that

Antitrust is a defensible enterprise only if intervention into the market is economically justified. That entails that the market be “bigger” in some sense as a result of the intervention—whether “bigger” is measured by higher output, improved quality, lower prices, or more innovation. Furthermore, the increase must be enough to justify the high cost of operating the antitrust machinery.

Hovenkamp can afford to be “modest” and call for a mere “tweaking” of antitrust because the Chicago School largely succeeded in transforming antitrust doctrine. It is therefore curious that Hovenkamp takes pains to distance himself from the Chicago School, ultimately aligning himself with the competing Harvard School. Continue Reading…

As reported here, Johnson & Johnson scored a major victory last week in a case challenging some of its discounting practices. The jury concluded that J&J had not engaged in monopolization of the market for “trocars,” which are sharp cylindrical devices used in endoscopic surgery. Plaintiff Applied Medical Resources Corp., which sells trocars that compete with J&J’s, had complained that J&J’s discounting practices excluded it from the trocars market. Specifically, Applied complained about J&J’s “bundled discounts,” which provided a discount on J&J’s sutures (surgical stitches) to those hospital purchasers that also bought a certain percentage of their trocars from J&J.

Discounts, of course, are usually not illegal unless (1) they result in below-cost prices and (2) there is a likelihood that the discounter will be able to recoup its losses by charging supracompetitive prices in the future (when other firms have been driven out of the market by its discounting). This lenient rule makes sense. Any single-product discount resulting in an above-cost price could be matched by a firm that was as efficient as the discounter, so any firm excluded by an above-cost discount must be a less efficient rival. Because antitrust law favors lower prices and generally doesn’t (and shouldn’t) seek to protect less efficient rivals, single-product discounts resulting in above-cost prices are OK.

Bundled discounts — package discounts conditioned upon purchasing products from multiple product markets — are a different competitive animal. At least in theory, a bundled discount that results in above-cost pricing (for the bundle) may exclude equally efficient rivals that sell a narrower line of products. Consider, for example, a manufacturer (A) that sells both shampoo and conditioner and competes against another manufacturer (B) that sells only shampoo. B, the more efficient shampoo manufacturer, can produce a bottle of shampoo for $1.25. It costs A $1.50 to produce a bottle of shampoo and $2.50 to produce a bottle of conditioner. If purchased separately, A charges $2.00 for shampoo and $4.00 for conditioner ($6.00 total), but if the consumer purchases both products at once, A will sell the combination for $5.00. That $1.00 bundled discount results in a price that is $1.00 greater than A’s cost for the two products ($4.00). Nonetheless, the above-cost bundled discount could exclude B. B could stay in the market only if it charged no more than $1.00 for shampoo (so that a consumer’s total price of B’s shampoo and A’s conditioner would not exceed $5.00, A’s package price), but B’s marginal cost of producing shampoo is $1.25. Accordingly, A’s bundled discount could eliminate B as a competitor even though B is the more efficient producer and even though A’s discounted price is above its cost of producing the bundle.

[NOTE: This example is admittedly somewhat artificial. I use it because it appears (using slightly different numbers) in one of the leading bundled discounts decisions.]

Applied’s original claim was that it was excluded by J&J’s bundled discount even though that discount resulted in an above-cost price for the sutures/trocars bundle. Because Applied does not make sutures (an item on which J&J enjoys significant market power and, consequently, high profits), it could compete with J&J only by offering the full amount of J&J’s trocars/sutures discount on Applied’s narrower (trocars-only) product line. Doing so would require it to price below cost and would drive it out of business.

Unfortunately for Applied, there were some inconvenient facts. First, J&J’s bundled discounts were requested by the hospitals themselves (acting through buying groups called “Group Purchasing Organizations”) during a competitive bidding process. Second, J&J’s bundled discounts were primarily designed to compete with its chief rival, Tyco Corp. (formerly U.S. Surgical), which sells a complete line of trocars and sutures and was offering its own bundled discounts in competition with J&J’s. This “bundle-to-bundle” competition was fierce and consumer-friendly. Finally, J&J responded to Applied’s complaints about the bundles by “carving out” Applied’s products, so that hospitals could count purchases of Applied trocars — but not Tyco trocars — toward the purchases required to earn the discount on J&J sutures. Without doubt, J&J’s bundled discounts were aimed at competing with its chief rival, Tyco, and resulted in lower prices for hospitals.

While this case seems like a no-brainer, that didn’t stop Applied from jumping on the LePage’s bandwagon and going after $54 million in purported (pre-trebled) damages. Fortunately, this jury was smart enough to recognize that the discounts at issue were ultimately good for consumers. Who knows what will happen next time.

It’s high time for the courts to develop some clear guidelines — including manageable safe harbors — for evaluating bundled discounts. I have suggested an easily administrable, balanced approach that would approve most such discounts but would impose liability for truly exclusionary practices. As Josh has noted, Herbert Hovenkamp’s new book (The Antitrust Enterprise) suggests another workable approach. Dan Crane has proposed another. Hopefully, courts will soon latch on to one of these proposals. The very fact that the Applied Medical v. J&J case got as far as it did suggests that the LePage’s-driven status quo is intolerable.

Like Thom, I also have spent the last few weeks reading Herbert Hovenkamp’s excellent new antitrust book, The Antitrust Enterprise: Principles and Execution. I am looking forward to Thom’s review in the Texas Law Review, and wholeheartedly agree with him that Hovenkamp’s book is an important and significant contribution to the antitrust literature (see also Randy Picker’s book review here describing “The Antitrust Enterprise as The Antitrust Paradox for a post-Chicago antitrust landscape”). I’m still digesting most of the book, and perhaps will share some more thoughts in this space later on, but thought I would chime in with some thoughts on two issues relevant to my own research on slotting contracts, discounts, and competition for product distribution.

Hovenkamp endorses a generally sensible approach to antitrust treatment of manufacturer payments, e.g. quantity and market-share discounts, slotting allowances, and Lepage’s-type bundled discounts. Hovenkamp recognizes that discounting is a “pervasive feature of the American economy,” and that “quantity and market-share discounts are virtually always competitive unless they amount to outright exclusive dealing,” but he adds that “even exclusive dealing is competitively harmless in most circumstances.” Hovenkamp appears to have greater reservation about the potentially exclusionary effects of bundled discounts, but ultimately concludes that administrative costs justify a lenient antitrust rule:

Even though the theory of the bundled discount is properly analogized to tying or exclusive dealing rather than predatory pricing, an administratively prudent rule might insist on a showing the the discounted package is priced below average variable cost.

As I’ve noted in this space previously, and this paper (now in print at 23 Yale Journal on Regulation 169) antitrust rules should reflect the welfare benefits generated as shelf space payments are ultimately passed on to consumers:

If the retail sector is competitive, which is almost always the case as a result of low barriers to entry, these payments are passed on to consumers regardless of form. These payments create first order benefits for consumers in the form of lower prices and higher quality. A coherent antitrust policy will recognize that these payments are a form of the competitive process, namely price competition, and should be treated as such.

Further, where anticompetitive exclusion is the competitive concern, antitrust law would be best served by establishing safe-harbors for distribution contracts unlikely to create anticompetitive effect, i.e. short-term contracts or contracts foreclosing less than 40% of distribution assets. This approach applies to competition for distribution generally, and is not limited to bundled discounts. Thom’s post and analysis in his Minnesota Law Review piece offer sensible and similarly-minded policy proposals for evaluating bundled discounts. With all of that said about the general sensibility of Hovenkamp’s approach here, I have two quibbles upon which I will expand below the fold.

Continue Reading…

Thom recently posted about Judge Alito’s comments on the recent Lepage’s decision involving bundled discounts offered to retailers. There is presently much debate among antitrust scholars regarding the proper treatment of “above-cost” price cuts, such as the bundled discounts in Lepage’s. The anticompetitive theory in these cases is not that discounts mask what is effectively “predatory pricing.” Rather, the theory is that the payments will deprive rivals from achieving minimum efficient scale for a period of time long enough to prohibit meaningful competition.

These forms of competition have attracted a good deal of antitrust scrutiny recently: slotting allowances, category management, bundled rebates, and discounts. For some thoughts on the economics of these practices, see my papers with Ben Klein on slotting and category management. How should antitrust law deal with manufacturer payments to retailers to shelve products, increase exposure, or secure promotional effort, which I collectively label: “Competition for distribution”?

Some have argued that per se legality is the correct approach to bundled rebates, but not necessary all payments for distribution. Thom’s proposed approach (among other things) requires the plaintiff to demonstrate in the context of bundled rebates that he could not have collaborated with other firms to construct a competing bundle. Others have argued for stricter scrutiny of bundled rebates, slotting allowances and payments for distribution more generally. Still others attempt to present a “unified theory” of Section 2 which would govern predatory pricing and allegedly exclusionary conduct.
In my paper (and thus the title of the post), Antitrust Law and Competition for Distribution, forthcoming in the Yale Journal on Regulation later this year, I focus on a number of economic facts regarding competition for distribution in search of guiding principles for an antitrust approach to these practices. Read below the fold for my thoughts on these economic characteristics, and what they suggest about a coherent approach to competition for distribution: Continue Reading…

A few weeks back, Josh had a nice post (on Ideoblog) regarding Judge Alito’s antitrust record. He was pretty optimistic, dismissing Judge Alito’s antitrust critics and concluding that “what little Judge Alito has written on antitrust issues is properly described as fastidious analysis complemented by strict application of doctrine.”

Some of Judge Alito’s comments in last week’s hearings cause me to be similarly optimistic. I was particularly pleased with the following exchange between Senator Dewine and Judge Alito regarding LePage’s v. 3M, a terrible en banc decision involving “bundled discounts” (i.e., discounts granted in exchange for purchasing products from multiple product lines):

SENATOR DEWINE: Judge, you had a case that dealt with bundling like this. It was, of course, the 3M v. LePage’s case. In that case, 3M, which sells Scotch tape, was selling it as part of a bundle with other products. The result was that LePage’s, which was offering a cheaper, competing tape, was having a hard time getting stores to sell its tape because if the stores did, they would have to give up the chance to save money on all the other 3M products that they carry.

The majority ruled against 3M, but you dissented. I wonder if you could please explain your reasoning behind that dissent, and explain what type of bundle discounts you think would violate the antitrust laws.

JUDGE ALITO: …3M was selling the product, as I recall — it was selling these products — it was not selling them below its cost. It was selling them above its cost. But 3M, because of its scale or because it was more efficient, was able to produce its product more cheaply.

…[M]y understanding of the state of the scholarship on this issue right now and on the way economists view the issue is that I believe that there are many of them who believe that a situation like this does not involve monopolization, that this is not a way in which a company like that can engage in a predatory practice over a period of time.

But there’s uncertainty, really, about how the monopolization standard applies to issues of bundling. So I think it’s quite up in the air and should it come up again, I think it merits reexamination.

For why Judge Alito was right in saying that LePage’s “merits reexamination,” read on…. Continue Reading…