Archives For Minimum efficient scale

I’ve criticized the European Commission’s antitrust attack against Intel here and the resulting $1.44 billion fine.  Now the EU is drawing fire for allegedly burying testimony, or at least failing to record it in a satisfactory manner, from Dell that it chose Intel’s chips not because of the coercive force of any of Intel’s rebates but because it preferred the performance of those chips over AMD’s product offerings.  Part of the problem here is that the EU’s 542 page  decision remains confidential and so it is impossible to tell what kind of impact this testimony would have on the issue of liability — and indeed the WSJ story sensibly suggests that there is little reason to believe that disclosure of this evidence would have changed the outcome.  The WSJ story concludes by taking a swing at EU procedure:

The entire EU antitrust regime—in which the Commission can assess guilt without any semblance of a trial or the involvement of an independent judge or jury—is an affront to any reasonable notion of due process. Deliberately withholding exculpatory evidence is, and should be, grounds for retrial, and not merely a sympathetic report from a toothless Ombudsman.

It now falls to the EU’s Court of First Instance, to which Intel has appealed, to offer Intel redress. The Court may not have jurisdiction to give the Commission’s discredited antitrust theories the thrashing they deserve, but it can, at a minimum, stand up for the rights of the accused when they are trampled by Europe’s antitrust cops.

But to return to the liability issue for a moment, I think it is easy to understate the importance of this evidence from Dell in light of the 542 page Commission opinion by assuming it would have minimal weight.  Indeed, that is likely true under EU law where Intel’s loyalty rebates with other OEMs would likely be sufficient to establish a violation. In that sense, the failing to disclose or record the exculpatory Dell testimony is likely to be “harmless error” only in the sense that it would not have impacted the liability ruling under Article 82 jurisprudence — but the error is obviously far from harmless in terms of calculating appropriate fines and from a procedural perspective.

But from an economic perspective, recall that the anticompetitive theory underlying the investigation is that Intel uses these loyalty rebates, conditioned on exclusivity, to foreclose its rival AMD from sufficient access to distribution to achieve minimum efficient scale.  In other words, the rebates result in de facto exclusivity that deprives AMD of efficient scale, raises its costs, and allows Intel to maintain its monopoly power in the microprocessor market.  A key part of that story is that AMD cannot compete on the merits for distribution because it is foreclosed.  In the United States, a key analytical issue (in addition to whether any of the rebates resulted in below cost pricing, presumably under Brooke Group or some attribution test) is whether the distribution contracts foreclosed ENOUGH distribution to have an effect on competition.  In this analysis, how the Dell business figures into the competitive analysis could be a very big deal.  While Dell is just a single buyer, the OEM market is relatively concentrated with a handful of large buyers.  Evidence that AMD was not foreclosed from Dell sales — or could have competed for those sales and earned them on the merits with an equivalent product — would be incredibly important (and tends toward a finding of no liability) under Section 2 analysis and conventional exclusive dealing/ exclusionary contract analysis generally.

Reacting to the EU fines imposed on Intel, Geoff raises a nice point about the difficulty of constructing the but-for world in antitrust cases generally, but particularly in cases where prices are falling.   This discussion reminded me of Thom’s excellent post responding to the NYT editorial and an AAI working paper and putting theoretical anticompetitive concerns to an empirical test and discussing evidence of falling prices for both Intel and AMD products and increased operating margins for AMD.  So how are we to sensibly evaluate the EU decision?

To make some progress here, let’s all agree for the sake of discussion that there are logically valid anticompetitive theories of loyalty discounts, exclusive dealing contracts, and conditional rebates generally and that there are valid and sensible pro-competitive justifications for these types of distribution contracts as well.  And lets also assume for the sake of analysis that it makes analytical sense to consider the possibility that the loyalty rebates operate like exclusive dealing contracts and that therefore the competitive concern is that the contracts will deprive AMD of the opportunity to compete for distribution sufficent to achieve minimum efficient scale — thus creating the possibility of future harm from a theoretical perspective.  And finally, without making any contentious statements about the empirical literature, lets assume that it is a fair characterization (and I think this is mild) to say that there is evidence both that there is evidence both that firms without market power frequenty use exclusive dealing contracts and or similar loyalty rebate schemes and that evidence of anticompetitive exclusive dealing is scarce.

Given all of the above, lets look at the loyalty rebate problem through the error cost lens.  The Intel case is a perfect example for application of this approach because even the most interventionist antitrust thinkers do not debate the proposition that lower prices have some redeeming competitive qualities and generate consumer benefits.  So it makes sense to think about the tradeoffs here between what we expect to gain from a decision like the EU’s (or here in the US) versus what we expect to lose.  The error cost framework allows us to assess these tradeoffs objectively, relying on existing theory and evidence to inform our estimates.  Here is what I wrote in my post during the Section 2 Symposium on this exact issue:

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.

The same analysis applies to loyalty rebates:

The key points here from an evidence-based perpsective are both that we have little empirical evidence that loyalty discounts lead to anticompetitive outcomes, but we do know that the discounts are passed on to consumers and increase welfare.  Like exclusive dealing, this state of knowledge ought to lead to a liability rule that places a strong burden on the plaintiff to demonstrate actual competitive harm, and safe harbors based on sound theory and evidence where they can be crafted reasonably.  In this case, since the anticompetitive theories all require foreclosure of a significant share of distribution and substantial economies of scale, it is quite sensible in the case of loyalty discounts to allow defendant’s a safe harbor that would make per se legal loyalty discount programs that foreclose less than a pre-specified share of the retail/distribution market.  I believe the right starting point for such a safe harbor comes from the cases, and could be set at 40 percent.  But building on the DOJ’s analysis, the argument  can and should be made that the exclusive dealing safe harbor logically can and should apply to loyalty discounts as well.

Of course, the EU approach does not make room for such safe harbors.  Not even close.  To describe the EU approach to Intel’s loyalty rebates as either remotely “effects-based” or “evidence-based” would strip both those terms of any useful meaning.  But that’s not an incredibly interesting point.  It does not appear that the EU approach is going to change any time soon.  Nor does it appear that there will be any pressure placed on the Europeans from domestic agencies (in fact, the pressure appears to moving in the opposite direction to “do something”).  By the way, for all the criticism that Tom Barnett at DOJ took for criticizing the EU Microsoft decision a few years back, at least that approach had the benefit of informing US companies that they would not adopt the European approach, and that US law was importantly different because it required a more rigorous form of economic analysis and more substantial evidence of consumer harm rather than speculative possiblity theorems coupled with harm to competitors.  That is a message that I’m quite sure the business community in the United States would be interested in hearing today from the US agencies.  And rightly so.  Thom is right that these developments give antitrust academics a lot to do!  Its a very exciting time for antitrust.

But that’s generally a bad sign for companies in high tech markets with significant market shares who are facing some pretty scary times.  On the one hand, the EU has sent the signal that competitors who can’t quite cut it in product market competition and innovation can get a second bite at the apple by running to the friendliest regulator around for help in tying a competitor’s hand behind its back.  I imagine that another concern is that the messages sent collectively by the FTC and “new” DOJ in repudiating the Section 2 Report and that error costs are hereby assumed out of existence raise the possibility that there will be a competitive dynamic between the EU and US to see who will be the global monopolization policeman — and also between the FTC and DOJ.

But what is more interesting to me is to watch how this will play out in th United States.   Long before the Section 2 Report scuffle I predicted that we might be headed toward a sort of convergence where rather than the EU moving to a more US-based approach, the US went the other way.  That looks like a much more likely possibility today than it did a few weeks ago.  So what’s going to happen in the US?

Nellie Kroes recently made the statement that Intel, after the recent fines, is now “the sponsor of the European taxpayer.”  Cute.  But given the fears that the EU is using antitrust law as a protectionist weapon, this statement was not well advised and I hope catches the attention of the new antitrust regimes in the U.S. (including new AAG Christine Varney, who could have had something like the Intel decision in mind when she described the European approach to monopolization as “much more extreme than I would ever be“).  Bottom line: I wouldn’t quite celebrate the new sponsorship if I were a European taxpayer (nor as an American one) who was planning on buying products with microprocessors any time in the near future.  The most likely consequence of the EU’s action is going to be higher prices.

Take a look at these pictures, which I suspect matter a great deal more in the US than the EU in terms of the antitrust analysis.  Given the complexities of predicting the speculative welfare gains from the EU’s enforcement action against the more certain gains from lower prices, would Kroes really bet against intervention ultimately increasing prices to consumers?  I think the pictures below tell a story that begs the following question of Kroes, and the folks at the AAI who issued a press release prematurely celebrating the EU fines as a victory for consumers and calling for the FTC to get in the action:

(1) How confident are enforcers that the but for world would result in an increase in consumer welfare?  For example, what probability would they assign to the prediction that EU intervention will result in lower prices for consumers?

(2) On what basis is that belief formed? are they consistent with the existing empirical evidence?

(3) What probability to the enforcers assign to the likelihood that the contracts actually are pro-competitive and so the enforcement action will create some consumer losses?

[Ed – Sorry the pictures are fuzzy — I’ll get better ones up.  But suffice it to say for now that the steeply declining yellow line is Intel microprocessor prices and the four lines in the second picture (also declining fairly quickly) are Intel and AMD prices.  Source data from]



This leads me to my last point about what happens now in the US.  I’m quoted in the WSJ as saying that I believe it is much more likely that the US gets involved in the Intel litigation than was the case two weeks ago.  Its hard to avoid that conclusion after reading the combination of statements from the FTC on the repudiation of the Section 2 Report, the new life of Section 5, as well as the competitive pressures placed on that agency from the DOJ’s new agenda and the EU fines.

The problem is that the content of the Section 2 Report was not just policy statements from the Bush administration political appointees about what the Section 2 should be.  It was a serious project with engagement from DOJ and FTC appointees, staffers, the academic community, and business representatives to summarize the existing law and existing evidence as well as generate some guidance on best practices where available.  Turns out that with two years to work on the project and that breadth of resources and diversity of viewpoints, the Section 2 Report really does accurately state the law with respect to exclusive dealing, predatory pricing, loyalty rebates, and such.  And that law isn’t going anywhere.  Perhaps the mission of the new DOJ and FTC will be to change the law?  Or perhaps the FTC will avoid the unfavorable Section 2 law by substituting Section 5 for cases like Intel where they are unlikely to win under a Section 2 theory.  But the Supreme Court and the federal case law under Section 2 remain substantial obstacles to convergence that extends beyond the hallways of the agencies.

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…

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.
Continue Reading…

Anybody want to share a copy of the complaint?  (Email: jwrightg at gmu dot edu).

UPDATE: Here’s a copy of the TradeComet Complaint.

Thanks to an anonymous reader.

Some brief comments on the highlights of the Complaint.  Per Thom’s comment below, it looks like the thrust of the complaint is not the price hike which would be ruled out by Trinko, but exclusive search syndication arrangements allegedly entered into by Google with highly trafficked websites like AOL which deprive rivals of the opportunity to compete for minimum efficient scale.  There is other allegedly exclusionary conduct specified in the complaint, e.g. the use of “default defenders” which restrict the ability of users to switch their default search engine using Google’s toolbar (sound familiar?).   Some allegations involve the use of Google’s Landing Page Quality metric to give preferential (or disfavored) treatment to friends (or foes).  In paragraph 110, the Complaint hints at a unilateral refusal to deal theory built upon the termination of a previously profitable course of business involving TradeComet.

Here’s the press release: LLC filed in the United States District Court for the Southern District of New York, a complaint asserting Google violates antitrust laws by eliminating competition and choice. TradeComet was forced to file the lawsuit when Google refused to stop engaging in predatory conduct to block search traffic by imposing massive, unjustified price increases. Google’s anticompetitive conduct eliminated TradeComet as a competitor. Cadwalader, Wickersham & Taft, LLP, one of the world’s leading international law firms, will represent, a subsidiary of, operated a thriving global business-to-business (B2B) search engine enabling buyers of industrial products to easily connect with suppliers. focused on a specialized type of industrial search, which it positioned as a competitor to Google’s general purpose search engine. Due to SourceTool’s utility for buyers, sellers and advertisers, the site took off—within months reaching 650,000 visits per day. also was named a ‘2006 Rising Star of Specialized Search’ by InfoCommerce and the ‘Second Fastest Growing Internet Site in the World’ by Comscore.

Google initially embraced its relationship with, naming them Google’s ‘Site of the Week’; was reinvesting approximately 80 percent of its revenue by purchasing $500,000 per month or more in Google keywords.

In its complaint, provides details of how Google subsequently identified as a competitive threat and then engaged in illegal conduct to diminish and ultimately extinguish’s platform.

“ offered a valuable service and had a thriving business before Google decided to eliminate them as a competitor,” said Rick Rule, Chair of Antitrust for Cadwalader, Wickersham & Taft, LLP, and former head of the United States Justice Department Antitrust Division. “We believe this complaint has strong merit and represents a serious antitrust violation.”

“With no notice, Google changed from cheerleader to tyrant when it realized we were a competitive threat,” said Dan Savage, founder and CEO of and “For example, Google raised my prices by 10,000 percent, which strangled our business, virtually overnight. Citing an ambiguous quality score determined by a secretive algorithm to justify the price increase, Google refused to consider reductions even after invested the company’s savings to make the changes that Google said would rectify the supposed problems. As a result of Google flexing its monopolistic muscle, currently averages about one percent of the traffic it previously had and is no longer a competitively viable business.” aims to recover damages caused when Google’s anticompetitive conduct eliminated’s primary source of search traffic.

Teaching Antitrust

Josh Wright —  6 September 2008

I’m two weeks into the semester here at UT, and the antitrust course.  I’ve made a few changes to the course this year.  Specifically, I’m using the new 2nd edition of the Gavil, Kovacic and Baker.  So far so good on that front on adjusting to the new edition.  Its an excellent textbook.  In large part its advantage is that it outpaces the other books in inclusion of important non-SCOTUS cases, coverage of agency practice, and economic content.  I want to talk about two changes I made last year and am also experimenting with this year and see what other antitrust law profs and/or students think.

The first is starting the course with a few lectures of straight economics.  This year, its two 705 minute lectures.  I’m always a bit afraid that this will scare some students off.  I do promise no calculus!  The lectures also assume no economic background.  But the truth of the matter is that I think its just not possible to teach modern antitrust law and agency practice without some basic economics.   I think integrating important economics concepts adds significant value to the education the students receive in the sense that it will make them better antitrust lawyers.  With the degree of integration of economics and antitrust in modern doctrine, the bottom line is that its just too important not to cover basic economics.

Antitrust is fairly unique in its wholesale incorporation of a second discipline into the substantive doctrine (by the way, this is also another advantage of the Gavil, Baker, Kovacic book — it includes some useful economic exercises, sophisticated but accessible explanations of economic concepts, plus graphs and other material on important economic issues).  The payoff, in theory, of doing it early is that we’ve discussed some basics early that we will return to repeatedly throughout the semester.  Hopefully, we’ll be able to focus on applications of these concepts later in the semester without re-learning the basics, thereby saving some time to get into some more interesting doctrinal complexities and policy issues.  I imagine some other antitrust profs choose to teach some basic concepts as they go.

Others might do the same sort of economics bootcamp early in the semester.  We spend one lecture of demand principles and another on cost/supply concepts.  The focus is conceptual and not mechanical or about memorization.  For instance, we spend most of the demand lecture trying to understand some basics about what demand curves are, what their shape means, and how to think about elasticities.  On the cost side, we spend a lot of time learning about differences between fixed and marginal costs, average cost and concepts like economies of scale, diminishing marginal returns, and minimum efficient scale.   This is my second year starting off this semester with some basic economics and I’m pretty sure I’m going to stick with it.  Of course, the dynamics with this at George Mason were a bit different because we include a basic economics course in our mandatory 1L curriculum.  But I thought the lectures went relatively well.  At least, I didn’t see any dramatic decreases in enrollment.  Not yet anyway.  But its early.  How do other antitrust professors incorporate economics into their lectures?  Do students prefer learning the economic material early and then having it reinforced through applications throughout the semester or would you rather learn it as you go?  Does knowing this material is on the syllabus scare off students?

The second innovation I’m experimenting with is something I’ve never heard anybody else do, but it might be more common than I think.  I cover horizontal mergers first.  I stole borrowed this idea from a highly respected practitioner at top antitrust practice who told me that he would cover mergers first if he were ever to teach antitrust law.  While this creates some jumping around the textbook, which students never like, I think there are some real pedagogical advantages.  Let me make the case here.  First, the primary advantage is that doing mergers first allows the class to immediately jump into economic and legal concepts that will be used throughout the semester: market definition, demand elasticities, entry, efficiencies, burden-shifting analysis and balancing, and factors conducive to collusion (in coordinated effects cases) to name a few.  This allows us to reinforce some of the Week 1 while getting some merger doctrine under our belt.  Second, mergers are probably the most practically important area of modern antitrust analysis.  Leading with it seems right.  I spend 4-5 lectures on mergers and by putting it early, I think, calls attention to the importance of the topic if not only symbolically.  Third, I think there are some natural synergies to the sequence of economics, followed by mergers, followed by horizontal restraints.  Specifically, we’ll have already cover coordinated effects stories and factors that facilitate collusion in mergers when we get to collusion and horizontal restraints.  We’ll also have under our belt a basic understanding of how the rule of reason works in the horizontal restraint context — at least in terms of the basic structure of prima facie burdens and efficiency arguments.  Other than the downside of having to jump around the textbook, I’ve never heard a compelling reason for the standard sequence of material (typically leading with cartels).  So, theres my case for starting with mergers.  Are you sold?  If not, what costs of this approach am I missing from the pedagogical perspective?  What about for the students?  Do any other antitrust professors lead with mergers?

Comments appreciated!

Dennis Carlton and Michael Waldman have posted an insightful DOJ working paper on antitrust safe harbors for unilateral conduct involving quantity discounts and bundling. The discussion is very timely in light of the Microsoft CFI decision, AMC Report, Section 2 Hearings, and various monopolization cases in the United States, EU, and other antitrust jurisdictions. The Carlton & Waldman paper is short, very accessible, and makes several very important points about the benefits of safe harbors to guide antitrust policy in this area generally and some weaknesses in the proposed AMC approach to bundling. Anybody interested in single firm conduct issues in antitrust should read this paper.

The issue they raise — safe harbors for single firm conduct — is one I’ve written about quite a bit. And I want to test out some thoughts on it here that I’ve sketched out partially in some academic writing and blog posts with respect to safe harbors for quantity discounts, loyalty rebates, exclusive dealing and competition for distribution more generally. I am on record defending two very specific safe harbors (one for short-term contracts and another for contracts that foreclose < 40% of the distribution market). I’ll return to the issue of a foreclosure safe harbor in a moment, and that will be the focus of the post, but for now, let me start with Carlton & Waldman’s framing of the antitrust problem of exclusion:

An antitrust claim involving exclusion requires that there be harm to a rival, harm to consumers and a linkage between the harm to the rival and the harm to consumers … This reasoning suggests that all mechanisms of exclusionary pricing conduct that do not alter a rival’s costs of operating or impair his ability to exist should not trigger an antitrust violation. In particular, this means that if there are no such effects, as for example occurs when the production technology is constant returns to scale, then there can be no anticompetitive harm. This does not mean that the rival’s business is unaffected nor that consumers are unaffected by a new pricing policy, but simply that the mechanism of harm, if there is one, has nothing to do with excluding a rival.

Carlton & Waldman focus in on the key issue for antitrust policy related to competition for distribution in the form of discounting conduct: the question of whether the defendant’s conduct has deprived a rival of scale to a degree that it is foreclosed from profitable access to the market altogether, or to a sufficient degree that its competitive constraint on the exercise of the defendant’s monopoly power is reduced, and competition is harmed.

So far so good. This economic insight is at the heart of the “foreclosure” requirement that appears in exclusive dealing cases that involve analytically identical claims concerning exclusion. Carlton & Waldman address claims of exclusion involving single product pricing in a predatory pricing framework and make the following statement about the “recoupment” requirement of the standard two pronged Brooke Group analysis:

[The recoupment prong] is a reflection of the principle that with constant returns to scale rivals will always constrain price and there can be no recoupement. The reason is that with no fixed costs, entry is always possible and guarantees that there is a competitive constraint on price. [The recoupment requirement] is phrased more practically to cover deviations from constant returns to scale that are not so large as to allow recoupment. With no possibility of recoupment, there is no reason to incur the initial loses associated with pricing below cost.

This is very interesting, and perhaps optimistic, understanding of courts are doing when the apply the recoupment requirement. My preliminary reaction is that most single product predatory pricing cases involve an analysis of barriers to entry at the recoupment stage as if the court was answering the question: “can the monopolist increase prices for a sustained period of time without attracting entry and therefore, recoup the losses associated with its period 1 prices?” I don’t think the courts explicitly conceptualize the recoupment prong in the way Carlton & Waldman describe here as it relates to scale. Rather, my tentative view is that analysis concerning the potential to deprive rivals of scale, the presence of substantial economies of scale, and even foreclosure are generally missing from these single product predatory pricing cases.

To be clear, thats not to say that courts are not analyzing in the recoupment prong the issue of whether the pricing scheme is likely to exclude rivals in some sense. But I think this sort of scale and foreclosure analysis that is typically present in exclusive dealing cases is generally absent in single product pricing cases. Now, I do believe that the recoupment requirement in these cases should be applied in the manner Carlton & Waldman suggest it already is. In fact, that is basically where I am going with this post. Keep reading and I’ll explain why I think this would be a good idea.

Continue Reading…

One of the more interesting parts of the November 29 DOJ/FTC hearing on loyalty discounts (where I presented these remarks) was the panelists’ discussion of a number of “propositions” advanced, for purposes of discussion only, by the agencies. Unfortunately, we didn’t have time to discuss all the propositions. I’ve reproduced them below the fold, along with my own thoughts on whether they’re sound. (Please note the agencies’ insistence that “[t]hese propositions are solely for the purpose of discussion and do not necessarily represent the agencies’ views.”) Continue Reading…

Dan Crane and Thom (who has promised more remarks!) have now both posted their prepared remarks for the Section 2 hearings panel on bundled discounts. Both call for bright-line, administrable liability rules for all forms of unilateral exclusionary conduct, and have important things to say about designing antitrust rules for bundled discounts. Both are worth reading in their entirety. Administrable rules that sensibly balance Type I and II errors are certainly an indisputably admirable goal for antitrust analysis and bundled discounts have proven to be a particularly tricky form of conduct for Section 2 analysis. Despite all of the agreement around here between Thom, Dan and I on the design of antitrust rules in a world of costly Type I errors, I think I have found a topic upon which I can at least offer a mild dissent (or at least a different perspective) regarding the usefulness of the analogy of various anticompetitive theories of bundled discounting practices to exclusive dealing.

The overlap between exclusive dealing and bundled/ loyalty discounts is frequently addressed by commentators, and is a topic of newfound interest in what has become the quest for a “holy grail’, one size fits all standard for Section 2 analysis of exclusionary conduct. At times, I detect a tension between the analysis of bundled discounts and exclusive dealing contracts which both purport to exclude exclude by depriving rivals from the opportunity to compete for distribution sufficient to support minimum efficient scale. For example, I discuss what I perceive to be a tension in Professor Hovenkamp’s very sensible analysis of bundled discounts and exclusive dealing in this post:

Hovenkamp concludes that adminstrative costs justify a predatory pricing-type rule in the context of for bundled discounts where the anticompetitive mechanism is de facto “foreclosure” or deprivation from distribution resources (i.e. shelf space) that would prevent rivals from achieving minimum efficient scale and extend the duration of monopoly by increasing barriers to entry. One would think that it would follow from Hovenkamp’s position that a predatory pricing-type rule would also be sensible for exclusive dealing and tying arrangements where the anticompetitive mechanism is the economic equivalent. To the contrary, Hovenkamp advocates rule of reason analysis (p. 201) for exclusive dealing and tying, noting that “foreclosure concerns can be assessed meaningfully only via the rule of reason” and that “the antitrust law of exclusive dealing,” which generally requires proof of substantial foreclosure as a necessary condition of competitive harm, “seems to be on the right track.”

The basic tension here is that the anticompetitive theories underlying both forms of conduct require foreclosure of a rival sufficient to deprive the opportunity to compete for minimum efficient scale. Of course, the pro-competitive side of the ledger differs. One might sensibly believe that the standard for the two forms of exclusion should be different because lower prices are inherently pro-competitive whereas exclusive dealing may not invoke the same immediate consumer benefits. This is certainly a sensible position. But it only suggests that the standard for bundled discounts ought to be more difficult to satisfy than the exclusive dealing standard given equal administrative costs and the same anticompetitive mechanism. This point is not sufficient to render the exclusive dealing analogy fruitless. I offer below some tentative thoughts on the usefulness of the exclusive dealing analogy to bundled discounts.

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Starbucks Antitrust Update

Josh Wright —  29 September 2006

WSJ Law Blog offers a follow up (and the complaint!) to Keith’s post (also check out the discussion in the comments) on the antitrust suit filed by an independent coffee shop owner against Starbucks concerning the use of exclusive leases with landowners. After reviewing the complaint, I agree with Lauren Albert, the antitrust lawyer quoted in Lattman’s story who concludes that: “The facts here don’t really seem to allege a violation of antitrust law.” Indeed, they do not.

Pages 11-13 are particularly telling, i.e. the description of the handing out of free samples in response to plaintiff’s entry as “predatory and retaliatory,” and noting that “the intent and effect is to drive out independently owned coffee shops.” The alleged anticompetitive effect? While the complaint does cite an “espresso blogger” for the proposition that Starbucks intentionally over-roasts its coffee, there is very little here in terms of alleging an antitrust violation (though para. 16 alleges that market output has been increasing, and that Starbucks has been primarily responsible for the growth). As I pointed out in the comments to Keith’s excellent post:

The relevant inquiry, assuming market definition and even market power, is whether Starbucks’ leases can foreclose rivals substantially foreclose rivals from achieving minimum efficient scale. Clearly, they do not . . .. The Starbucks leases do not, and cannot possibly, “tie up� more than a trivial fraction of this real estate. Such foreclosure is a necessary condition of this type of claim and is clearly absent. Competition for favorable locations for coffee shops, even when it includes exclusivity terms in the leases for good reason, is competition on the merits.

I predict a successful motion to dismiss.

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.

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Ok, not really. But the Antitrust Modernization Committee voted overwhelmingly in favor to repeal the Act (HT: Antitrust Review). Apparently, nine Commissioners voted in support of a the statement: “that Congress should repeal the Act in its entirety” on the grounds that: (1) the Act does not serve any purposes not already served by the Sherman Act, and (2) the Act is a net cost to consumers and competition. Though I doubt that Congress will accept the AMC’s invitation to act on behalf of consumers and repeal the Act, this the right result.

I have written previously (and in this paper) on the role of antitrust regulation of business practices facilitating price discrimination in the wake of Independent Ink. My views are consistent with the AMC’s position that price discrimination alone should not give rise to antitrust scrutiny because the Sherman Act is sufficient to cover all practices that harm competition:

“The court could have rid antitrust law of the inference that price discrimination is anticompetitive in any manner. Benjamin Klein and John Wiley, Jr., for example, have argued that (70 Antitrust LJ 599 (2003)) price discrimination should be a defense. This sounds right to me. This does not mean that all such practices would be immune from antitrust liability totally. Practices that facilitate price discrimination may be happen to injure competition for other reasons, i.e. a tying arrangement may foreclose a rival from sufficient distribution as to achieve minimum efficient scale for a significant period of time, thus raising barriers to entry. But price discrimination adds nothing to that analysis on its own.”

This conclusion obviously also applies to the Act, which allows condemns pricing behavior without proof that competition has been injured or consumers are any worse off. For this reason, there is near uniform consensus has been a significant cause of consumer welfare losses. Though I suspect the Act will stick around for awhile (though perhaps without criminal penalties?) — it has survived other calls for repeal — the AMC’s conclusion may be influential at the agency level and otherwise.