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What the European Commission’s More Interventionist Approach to Exclusionary Abuses Could Mean for EU Courts and for U.S. States

Alden Abbott — 5 April 2023

The European Commission on March 27 showered the public with a series of documents heralding a new, more interventionist approach to enforce Article 102 of the Treaty on the Functioning of the European Union (TFEU), which prohibits “abuses of dominance.” This new approach threatens more aggressive, less economically sound enforcement of single-firm conduct in Europe.

EU courts may eventually constrain the Commission’s overreach in this area somewhat, but harmful business uncertainty will be the near-term reality. What’s more, the Commission’s new approach may unfortunately influence U.S. states that are considering European-style abuse-of-dominance amendments to their own substantive antitrust laws. As such, market-oriented U.S. antitrust commentators will need to be even more vigilant in keeping tabs of—and, where necessary, promptly critiquing—economically problematic shifts in European antitrust-enforcement policy.

The Commission’s Emerging Reassessment of Abuses of Dominance

In a press release summarizing its new initiative, the Commission made a “call for evidence” to obtain feedback on the adoption of first-time guidelines on exclusionary abuses of dominance under Article 102 TFEU.

In parallel, the Commission also published a “communication” announcing amendments to its 2008 guidance on enforcement priorities in challenging abusive exclusionary conduct. According to the press release, until final Article 102 guidelines are approved, this guidance “provides certain clarifications on its approach to determine whether to pursue cases of exclusionary conduct as a matter of priority.” An annex to the communication sets forth specific amendments to the 2008 guidance.

Finally, the Commission also released a competition policy brief (“a dynamic and workable effects-based approach to the abuse of dominance”) that discusses the policy justifications for the changes enumerated in the annex.

In short, the annex “toughens” the approach to abuse of dominance enforcement in five ways:

It takes a broader view of what constitutes “anticompetitive foreclosure.” The Annex rejects the 2008 guidance’s emphasis on profitability (cases where a dominant firm can profitably maintain supracompetitive prices or profitably influence other parameters of competition) as key to prioritizing matters for enforcement. Instead, a new, far less-demanding prosecutorial standard is announced, one that views anticompetitive foreclosure as a situation “that allow[s] the dominant undertaking to negatively influence, to its own advantage and to the detriment of consumers, the various parameters of competition, such as price, production, innovation, variety or quality of goods or services.” Under this new approach, highly profitable competition on the merits (perhaps reflecting significant cost efficiencies) might be challenged, say, merely because enforcers were dissatisfied with a dominant firm’s particular pricing decisions, or the quality, variety, and “innovativeness” of its output. This would be a recipe for bureaucratic micromanagement of dominant firms’ business plans by competition-agency officials. The possibilities for arbitrary decision making by those officials, who may be sensitive to the interests of politically connected rent seekers (say, less-efficient competitors) are obvious.
The annex diminishes the importance of economic efficiency in dominant-firm analysis. The Commission’s 2008 guidance specified that Commission enforcers “would generally intervene where the conduct concerned has already been or is capable of hampering competition from competitors that are considered to be as efficient as the dominant undertaking.” The revised 2023 guidance “recognizes that in certain circumstances a less efficient competitor should be taken into account when considering whether particular price-based conduct leads to anticompetitive foreclosure.” This amendment plainly invites selective-enforcement actions to assist less-efficient competitors, placing protection of those firms above consumer-welfare maximization. In order to avoid liability, dominant firms may choose to raise their prices or reduce their investments in cost-reducing innovations, so as to protect a relatively inefficient competitive fringe. The end result would be diminished consumer welfare.
The annex encourages further micromanagement of dominant-firm pricing and other business decisions. Revised 2023 guidance invites the Commission to “examine economic data relating to prices” and to possible below-cost pricing, in considering whether a hypothetical as-efficient competitor would be foreclosed. Relatedly, the Commission encourages “taking into account other relevant quantitative and/or qualitative evidence” in determining whether an as-efficient competitor can compete “effectively” (emphasis added). This focus on often-subjective criteria such as “qualitative” indicia and the “effectiveness” of competition could subject dominant firms to costly new business-planning uncertainty. Similarly, the invitation to enforcers to “examine” prices may be viewed as a warning against “overaggressive” price discounting that would be expected to benefit consumers.
The annex imposes new constraints on a firm’s decision as to whether or not to deal (beneficial voluntary exchange, an essential business freedom that underlies our free-market system – see here, for example). A revision to the 2008 guidance specifies that, “[i]n situations of constructive refusal to supply (subjecting access to ‘unfair conditions’), it is not appropriate to pursue as a matter of priority only cases concerning the provision of an indispensable input or the access to an essential facility.” This encourages complaints to Brussels enforcers by scores of companies that are denied an opportunity to deal with a dominant firm, due to “unfairness.” This may be expected to substantially undermine business efficiency, as firms stuck with the “dominant” label are required to enter into suboptimal supply relationships. Dynamic efficiency will also suffer, to the extent that intellectual-property holders are required to license on unfavorable terms (a reality that may be expected to diminish dominant firms’ incentives to invest in innovative activities).
The annex threatens to increase the number of Commission “margin-squeeze” cases, whereby vertically integrated firms are required to offer favorable sales terms to, and thereby prop up, wholesalers who want to “compete” with them at retail. (See here for a more detailed discussion of the margin-squeeze concept.) The current standard for margin-squeeze liability already is far narrower in the United States than in Europe, due to the U.S. Supreme Court’s decision in linkLine (2009).

Specifically, the annex announces margin-squeeze-related amendments to the 2008 guidance. The amendments aim to clarify that “it is not appropriate to pursue as a matter of priority margin squeeze cases only where those cases involve a product or service that is objectively necessary to be able to compete effectively on the downstream market.” This extends margin-squeeze downstream competitor-support obligations far beyond regulated industries; how far, only time will tell. (See here for an economic study indicating that even the Commission’s current less-intrusive margin-squeeze policy undermines consumer welfare.) The propping up of less-efficient competitors may, of course, be facilitated by having the dominant firm take the lead in raising retail prices, to ensure that the propped-up companies get “fair margins.” Such a result diminishes competitive vigor and (once again) directly harms consumers.

In sum, through the annex’s revisions to the 2008 guidance, the Commission has, without public comment (and well prior to the release of new first-time guidelines), taken several significant steps that predictably will reduce competitive vitality and harm consumers in those markets where “dominant firms” exist. Relatedly, of course, to the extent that innovative firms respond to incentives to “pull their punches” so as not to become dominant, dynamic competition will be curtailed. As such, consumers will suffer, and economic welfare will diminish.

How Will European Courts Respond?

Fortunately, there is a ray of hope for those concerned about the European Commission’s new interventionist philosophy regarding abuses of dominance. Although the annex and the related competition policy brief cite a host of EU judicial decisions in support of revisions to the guidance, their selective case references and interpretations of judicial holdings may be subject to question. I leave it to EU law experts (I am not one) to more thoroughly parse specific judicial opinions cited in the March 27 release. Nevertheless, it seems to me that the Commission may face some obstacles to dramatically “stepping up” its abuse-of-dominance enforcement actions along the lines suggested by the annex.

A number of relatively recent judicial decisions underscore the concerns that EU courts have demonstrated regarding the need for evidentiary backing and economic analysis to support the Commission’s findings of anticompetitive foreclosure. Let’s look at a few.

In Intel v. Commission (2017), the European Court of Justice (ECJ) held that the Commission had failed to adequately assess whether Intel’s conditional rebates on certain microprocessors were capable of restricting competition on the basis of the “as-efficient competitor” (AEC) test, and referred the case back to the General Court. The ECJ also held that the balancing of the favorable and unfavorable effects of Intel’s rebate practice could only be carried out after an analysis of that practice’s ability to exclude at least as-efficient-competitors.
In 2022, on remand, the General Court annulled the Commission’s determination (thereby erasing its 1.06 billion Euro fine) that Intel had abused its dominant position. The Court held that the Commission’s failure to respond to Intel’s argument that the AEC test was flawed, coupled with the Commission’s errors in its analysis of contested Intel practices, meant that the “analysis carried out by the Commission is incomplete and, in any event, does not make it possible to establish to the requisite legal standard that the rebates at issue were capable of having, or were likely to have, anticompetitive effects.”
In Unilever Italia (2023), the ECJ responded to an Italian Council of State request for guidance in light of the Italian Competition Authority’s finding that Unilever had abused its dominant position through exclusivity clauses that covered the distribution of packaged ice cream in Italy. The court found that a competition authority is obliged to assess the actual capacity to exclude by taking into account evidence submitted by the dominant undertaking (in this case, the Italian Authority had failed to do so). The ECJ stated that its 2017 clarification of rebate-scheme analysis in Intel also was applicable to exclusivity clauses.
Finally, in Qualcomm v. Commission (2022), the General Court set aside a 2018 Commission decision imposing a 1 billion Euro fine on Qualcomm for abuse of a dominant position in LTE chipsets. The Commission contended that Qualcomm’s 2011-2016 incentive payments to Apple for exclusivity reduced Apple’s incentive to shift suppliers and had the capability to foreclose Qualcomm’s competitors from the LTE-chipset market. The court found massive procedural irregularities by the Commission and held that the Commission had not shown that Qualcomm’s payments either had foreclosed or were capable of foreclosing competitors. The Court concluded that the Commission had seriously erred in the evidence it relied upon, and in its failure to take into account all relevant factors, as required under the 2022 Intel decision.

These decisions are not, of course, directly related to the specific changes announced in the annex. They do, however, raise serious questions about how EU judges will view new aggressive exclusionary-conduct theories based on amendments to the 2008 guidance. In particular, EU courts have signaled that they will:

closely scrutinize Commission fact-finding and economic analysis in evaluating exclusionary-abuse cases;
require enforcers to carefully weigh factual and economic submissions put forth by dominant firms under investigation;
require that enforcers take economic-efficiency arguments seriously; and
continue to view the “as-efficient competitor” concept as important, even though the Commission may seek to minimize the test’s significance.

In other words, in the EU, as in the United States, reviewing courts may “put a crimp” in efforts by national competition agencies to read case law very broadly, so as to “rein in” allegedly abusive dominant-firm conduct. In jurisdictions with strong rule-of-law traditions, enforcers propose but judges dispose. The kicker, however, is that judicial review takes time. In the near term, firms will have to absorb additional business-uncertainty costs.

What About the States?

“Monopolization”—rather than the European “abuse of a dominant position”—is, of course, the key single-firm conduct standard under U.S. federal antitrust law. But the debate over the Commission’s abuse-of-dominance standards nonetheless is significant to domestic American antitrust enforcement.

Under U.S. antitrust federalism, the individual states are empowered to enact antitrust legislation that goes beyond the strictures of federal antitrust law. Currently, several major states—New York, Pennsylvania, and Minnesota—are considering antitrust bills that would add abuse of a dominant position as a new state antitrust cause of action (see here, here, here, and here). What’s more, the most populous U.S. state, California, may also consider similar legislation (see here). Such new laws would harmfully undermine consumer welfare (see my commentary here).

If certain states enacted a new abuse-of-dominance standard, it would be natural for their enforcers to look to EU enforcers (with their decades of relevant experience) for guidance in the area. As such, the annex (and future Commission guidelines, which one would expect to be consistent with the new annex guidance) could prove quite influential in promoting highly interventionist state policies that reach far beyond federal monopolization standards.

What’s worse, federal judicial case law that limits the scope of Sherman Act monopolization cases would have little or no influence in constraining state judges’ application of any new abuse-of-dominance standards. It is questionable that state judges would feel themselves empowered or even capable of independently applying often-confusing EU case law regarding abuse of dominance as a possible constraint on state officials’ prosecutions.

Conclusion

The Commission’s emerging guidance on abuse of dominance is bad for consumers and for competition. EU courts may constrain some Commission enforcement excesses, but that will take time, and new short-term business uncertainty costs are likely.

Moreover, negative effects may eventually also be felt in the United States if states enact proposed abuse-of-dominance prohibitions and state enforcers adopt the European Commission’s interventionist philosophy. State courts, applying an entirely new standard not found in federal law, should not be expected to play a significant role in curtailing aggressive state prosecutions for abuse of dominance.

Promoters of principled, effects-based, economics-centric antitrust enforcement should take heed. They must be prepared to highlight the ramifications of both foreign and state-level initiatives as they continue to advocate for market-based antitrust policies. Sound law & economics training for state enforcers and judges likely will become more important than ever.

In Antitrust & Competition, European Union, Exclusionary Conduct, Monopolization, Supreme Court, Truth on the Market abuse of dominance, anticompetitive foreclosure, Article 102, consumer welfare standard, Duty to deal, dynamic competition, EU, European Commission, refusals to deal

Application of the Proper ‘Outer Boundary’ of Antitrust Liability for Alleged Refusals to Deal in New York v Facebook

George L. Paul, Jaclyn Phillips, & Andrew Black — 15 April 2022

The following post was authored by counsel with White & Case LLP, who represented the International Center for Law & Economics (ICLE) in an amicus brief filed on behalf of itself and 12 distinguished law & economics scholars with the U.S. Court of Appeals for the D.C. Circuit in support of affirming U.S. District Court Judge James Boasberg’s dismissal of various States Attorneys General’s antitrust case brought against Facebook (now, Meta Platforms).

Introduction

The States brought an antitrust complaint against Facebook alleging that various conduct violated Section 2 of the Sherman Act. The ICLE brief addresses the States’ allegations that Facebook refused to provide access to an input, a set of application-programming interfaces that developers use in order to access Facebook’s network of social-media users (Facebook’s Platform), in order to prevent those third parties from using that access to export Facebook data to competitors or to compete directly with Facebook.

Judge Boasberg dismissed the States’ case without leave to amend, relying on recent Supreme Court precedent, including Trinko and Linkline, on refusals to deal. The Supreme Court strongly disfavors forced sharing, as shown by its decisions that recognize very few exceptions to the ability of firms to deal with whom they choose. Most notably, Aspen Skiing Co. v. Aspen Highlands Skiing is a 1985 decision recognizing an exception to the general rule that firms may deal with whom they want that was limited, though not expressly overturned, by Trinko in 2004. The States appealed to the D.C. Circuit on several grounds, including by relying on Aspen Skiing, and advocating for a broader view of refusals to deal than dictated by current jurisprudence.

ICLE’s brief addresses whether the District Court was correct to dismiss the States’ allegations that Facebook’s Platform policies violated Section 2 of the Sherman Act in light of the voluminous body of precedent and scholarship concerning refusals to deal. ICLE’s brief argues that Judge Boasberg’s opinion is consistent with economic and legal principles, allowing firms to choose with whom they deal. Furthermore, the States’ allegations did not make out a claim under Aspen Skiing, which sets forth extremely narrow circumstances that may constitute an improper refusal to deal. Finally, ICLE takes issue with the States’ attempt to create an amorphous legal standard for refusals to deal or otherwise shoehorn their allegations into a “conditional dealing” framework.

Economic Actors Should Be Able to Choose Their Business Partners

ICLE’s basic premise is that firms in a free-market system should be able to choose their business partners. Forcing firms to enter into certain business relationships can have the effect of stifling innovation, because the firm getting the benefit of the forced dealing then lacks incentive to create their own inputs. On the other side of the forced dealing, the owner would have reduced incentives to continue to innovate, invest, or create intellectual property. Forced dealing, therefore, has an adverse effect on the fundamental nature of competition. As the Supreme Court stated in Trinko, this compelled sharing creates “tension with the underlying purpose of antitrust law, since it may lessen the incentive for the monopolist, the rival, or both to invest in those economically beneficial facilities.”

Courts Are Ill-Equipped to Regulate the Kind of Forced Sharing Advocated by the States

ICLE also notes the inherent difficulties of a court’s assessing forced access and the substantial risk of error that could create harm to competition. This risk, ICLE notes, is not merely theoretical and would require the court to scrutinize intricate details of a dynamic industry and determine which decisions are lawful or not. Take the facts of New York v. Facebook: more than 10 million apps and websites had access to Platform during the relevant period and the States took issue with only seven instances where Facebook had allegedly improperly prevented access to Platform. Assessing whether conduct would create efficiency in one circumstance versus another is challenging at best and always risky. As Frank Easterbook wrote: “Anyone who thinks that judges would be good at detecting the few situations in which cooperation would do more good than harm has not studied the history of antitrust.”

Even assuming a court has rightly identified a potentially anticompetitive refusal to deal, it would then be put to the task of remedying it. But imposing a remedy, and in effect assuming the role of a regulator, is similarly complicated. This is particularly true in dynamic, quickly evolving industries, such as social media. This concern is highlighted by the broad injunction the States seek in this case: to “enjoin[] and restrain [Facebook] from continuing to engage in any anticompetitive conduct and from adopting in the future any practice, plan, program, or device having a similar purpose or effect to the anticompetitive actions set forth above.” Such a remedy would impose conditions on Facebook’s dealings with competitors for years to come—regardless of how the industry evolves.

Courts Should Not Expand Refusal-to-Deal Analysis Beyond the Narrow Circumstances of Aspen Skiing

In light of the principles above, the Supreme Court, as stated in Trinko, “ha[s] been very cautious in recognizing [refusal-to-deal] exceptions, because of the uncertain virtue of forced sharing and the difficulty of identifying and remedying anticompetitive conduct by a single firm.” Various scholars (e.g., Carlton, Meese, Lopatka, Epstein) have analyzed Aspen Skiing consistently with Trinko as, at most, “at or near the boundary of § 2 liability.”

So is a refusal-to-deal claim ever viable? ICLE argues that refusal-to-deal claims have been rare (rightly so) and, at most, should only go forward under the delineated circumstances in Aspen Skiing. ICLE sets forth the 10th U.S. Circuit’s framework in Novell, which makes clear that “the monopolist’s conduct must be irrational but for its anticompetitive effect.”

First, “there must be a preexisting voluntary and presumably profitable course of dealing between the monopolist and rival.”
Second, “the monopolist’s discontinuation of the preexisting course of dealing must suggest a willingness to forsake short-term profits to achieve an anti-competitive end.”
Finally, even if these two factors are present, the court recognized that “firms routinely sacrifice short-term profits for lots of legitimate reasons that enhance consumer welfare.”

The States seek to broaden Aspen Skiing in order to sinisterize Facebook’s Platform policies, but the facts do not fit. The States do not plead an about-face with respect to Facebook’s Platform policies; the States do not allege that Facebook’s changes to its policies were irrational (particularly in light of the dynamic industry in which Facebook operates); and the States do not allege that Facebook engaged in less efficient behavior with the goal of hurting rivals. Indeed, Facebook changed its policies to retain users—which is essential to its business model (and therefore, rational).

The States try to evade these requirements by arguing for a looser refusal-to-deal standard (and by trying to shoehorn the conduct as “conditional dealing”)—but as ICLE explains, allowing such a claim to go forward would fly in the face of the economic and policy goals upheld by the current jurisprudence.

Conclusion

The District Court was correct to dismiss the States’ allegations concerning Facebook’s Platform policies. Allowing a claim against Facebook to progress under the circumstances alleged in the States’ complaint would violate the principle that a firm, even one that is a monopolist, should not be held liable for refusing to deal with a certain business partner. The District Court’s decision is in line with key economic principles concerning refusals to deal and consistent with the Supreme Court’s decision in Aspen Skiing. Aspen Skiing is properly read to severely limit the circumstances giving rise to a refusal-to-deal claim, or else risk adverse effects such as reduced incentive to innovate.

Amici Scholars Signing on to the Brief

(The ICLE brief presents the views of the individual signers listed below. Institutions are listed for identification purposes only.)

Henry Butler Henry G. Manne Chair in Law and Economics and Executive Director of the Law & Economics Center, Scalia Law School	Daniel Lyons Professor of Law, Boston College Law School
Richard A. Epstein Laurence A. Tisch Professor of Law at NY School of Law, the Peter and Kirsten Bedford Senior Lecturer at the Hoover Institution, and the James Parker Hall Distinguished Service Professor Emeritus	Geoffrey A. Manne President and Founder, International Center for Law & Economics, Distinguished Fellow Northwestern University Center on Law, Business & Economics
Thomas Hazlett H.H. Macaulay Endowed Professor of Economics and Director of the Information Economy Project, Clemson University	Alan J. Meese Ball Professor of Law, Co-Director, Center for the Study of Law and Markets, William & Mary Law School
Justin (Gus) Hurwitz Professor of Law and Menard Director of the Nebraska Governance and Technology Center, University of Nebraska College of Law	Paul H. Rubin Samuel Candler Dobbs Professor of Economics Emeritus, Emory University
Jonathan Klick Charles A. Heimbold, Jr. Professor of Law, University of Pennsylvania Carey School of Law; Erasmus Chair of Empirical Legal Studies, Erasmus University Rotterdam	Michael Sykuta Associate Professor of Economics and Executive Director of Financial Research Institute, University of Missouri Division of Applied Social Sciences
Thomas A. Lambert Wall Chair in Corporate Law and Governance, University of Missouri Law School	John Yun Associate Professor of Law and Deputy Executive Director of the Global Antitrust Institute, Scalia Law School

In Antitrust & Competition, Barriers to Entry, Exclusionary Conduct, Facebook, Platforms, Truth on the Market, Vertical Restraints Amicus Brief, facebook, linkLine, refusals to deal, Section 2, Sherman Antitrust Act, state antitrust enforcement, Supreme Court, Trinko

Case closed: Google wins (for now)

Dirk Auer — 19 November 2021

The European Commission and its supporters were quick to claim victory following last week’s long-awaited General Court of the European Union ruling in the Google Shopping case. It’s hard to fault them. The judgment is ostensibly an unmitigated win for the Commission, with the court upholding nearly every aspect of its decision.

However, the broader picture is much less rosy for both the Commission and the plaintiffs. The General Court’s ruling notably provides strong support for maintaining the current remedy package, in which rivals can bid for shopping box placement. This makes the Commission’s earlier rejection of essentially the same remedy in 2014 look increasingly frivolous. It also pours cold water on rivals’ hopes that it might be replaced with something more far-reaching.

More fundamentally, the online world continues to move further from the idealistic conception of an “open internet” that regulators remain determined to foist on consumers. Indeed, users consistently choose convenience over openness, thus rejecting the vision of online markets upon which both the Commission’s decision and the General Court’s ruling are premised.

The Google Shopping case will ultimately prove to be both a pyrrhic victory and a monument to the pitfalls of myopic intervention in digital markets.

Google’s big remedy win

The main point of law addressed in the Google Shopping ruling concerns the distinction between self-preferencing and refusals to deal. Contrary to Google’s defense, the court ruled that self-preferencing can constitute a standalone abuse of Article 102 of the Treaty on the Functioning of the European Union (TFEU). The Commission was thus free to dispense with the stringent conditions laid out in the 1998 Bronner ruling.

This undoubtedly represents an important victory for the Commission, as it will enable it to launch new proceedings against both Google and other online platforms. However, the ruling will also constrain the Commission’s available remedies, and rightly so.

The origins of the Google Shopping decision are enlightening. Several rivals sought improved access to the top of the Google Search page. The Commission was receptive to those calls, but faced important legal constraints. The natural solution would have been to frame its case as a refusal to deal, which would call for a remedy in which a dominant firm grants rivals access to its infrastructure (be it physical or virtual). But going down this path would notably have required the Commission to show that effective access was “indispensable” for rivals to compete (one of the so-called Bronner conditions)—something that was most likely not the case here.

Sensing these difficulties, the Commission framed its case in terms of self-preferencing, surmising that this would entail a much softer legal test. The General Court’s ruling vindicates this assessment (at least barring a successful appeal by Google):

240 It must therefore be concluded that the Commission was not required to establish that the conditions set out in the judgment of 26 November 1998, Bronner (C‑7/97, EU:C:1998:569), were satisfied […]. [T]he practices at issue are an independent form of leveraging abuse which involve […] ‘active’ behaviour in the form of positive acts of discrimination in the treatment of the results of Google’s comparison shopping service, which are promoted within its general results pages, and the results of competing comparison shopping services, which are prone to being demoted.

This more expedient approach, however, entails significant limits that will undercut both the Commission and rivals’ future attempts to extract more far-reaching remedies from Google.

Because the underlying harm is no longer the denial of access, but rivals being treated less favorably, the available remedies are much narrower. Google must merely ensure that it does not treat itself more preferably than rivals, regardless whether those rivals ultimately access its infrastructure and manage to compete. The General Court says this much when it explains the theory of harm in the case at hand:

287. Conversely, even if the results from competing comparison shopping services would be particularly relevant for the internet user, they can never receive the same treatment as results from Google’s comparison shopping service, whether in terms of their positioning, since, owing to their inherent characteristics, they are prone to being demoted by the adjustment algorithms and the boxes are reserved for results from Google’s comparison shopping service, or in terms of their display, since rich characters and images are also reserved to Google’s comparison shopping service. […] they can never be shown in as visible and as eye-catching a way as the results displayed in Product Universals.

Regulation 1/2003 (Art. 7.1) ensures the European Commission can only impose remedies that are “proportionate to the infringement committed and necessary to bring the infringement effectively to an end.” This has obvious ramifications for the Google Shopping remedy.

Under the remedy accepted by the Commission, Google agreed to auction off access to the Google Shopping box. Google and rivals would thus compete on equal footing to display comparison shopping results.

Illustrations taken from Graf & Mostyn, 2020

Rivals and their consultants decried this outcome; and Margrethe Vestager intimated the commission might review the remedy package. Both camps essentially argued the remedy did not meaningfully boost traffic to rival comparison shopping services (CSSs), because those services were not winning the best auction slots:

All comparison shopping services other than Google’s are hidden in plain sight, on a tab behind Google’s default comparison shopping page. Traffic cannot get to them, but instead goes to Google and on to merchants. As a result, traffic to comparison shopping services has fallen since the remedy—worsening the original abuse.

Or, as Margrethe Vestager put it:

We may see a show of rivals in the shopping box. We may see a pickup when it comes to clicks for merchants. But we still do not see much traffic for viable competitors when it comes to shopping comparison

But these arguments are entirely beside the point. If the infringement had been framed as a refusal to supply, it might be relevant that rivals cannot access the shopping box at what is, for them, cost-effective price. Because the infringement was framed in terms of self-preferencing, all that matters is whether Google treats itself equally.

I am not aware of a credible claim that this is not the case. At best, critics have suggested the auction mechanism favors Google because it essentially pays itself:

The auction mechanism operated by Google to determine the price paid for PLA clicks also disproportionately benefits Google. CSSs are discriminated against per clickthrough, as they are forced to cede most of their profit margin in order to successfully bid […] Google, contrary to rival CSSs, does not, in reality, have to incur the auction costs and bid away a great part of its profit margins.

But this reasoning completely omits Google’s opportunity costs. Imagine a hypothetical (and oversimplified) setting where retailers are willing to pay Google or rival CSSs 13 euros per click-through. Imagine further that rival CSSs can serve these clicks at a cost of 2 euros, compared to 3 euros for Google (excluding the auction fee). Google is less efficient in this hypothetical. In this setting, rivals should be willing to bid up to 11 euros per click (the difference between what they expect to earn and their other costs). Critics claim Google will accept to bid higher because the money it pays itself during the auction is not really a cost (it ultimately flows to Google’s pockets). That is clearly false.

To understand this, readers need only consider Google’s point of view. On the one hand, it could pay itself 11 euros (and some tiny increment) to win the auction. Its revenue per click-through would be 10 euros (13 euros per click-through, minus its cost of 3 euros). On the other hand, it could underbid rivals by a tiny increment, ensuring they bid 11 euros. When its critics argue that Google has an advantage because it pays itself, they are ultimately claiming that 10 is larger than 11.

Google’s remedy could hardly be more neutral. If it wins more auction slots than rivals CSSs, the appropriate inference should be that it is simply more efficient. Nothing in the Commission’s decision or the General Court’s ruling precludes that outcome. In short, while Google has (for the time being, at least) lost its battle to appeal the Commission’s decision, the remedy package—the same it put forward way back in 2014—has never looked stronger.

Good news for whom?

The above is mostly good news for both Google and consumers, who will be relieved that the General Court’s ruling preserves Google’s ability to show specialized boxes (of which the shopping unit is but one example). But that should not mask the tremendous downsides of both the Commission’s case and the court’s ruling.

The Commission and rivals’ misapprehensions surrounding the Google Shopping remedy, as well as the General Court’s strong stance against self-preferencing, are revealing of a broader misunderstanding about online markets that also permeates through other digital regulation initiatives like the Digital Markets Act and the American Choice and Innovation Act.

Policymakers wrongly imply that platform neutrality is a good in and of itself. They assume incumbent platforms generally have an incentive to favor their own services, and that preventing them from doing so is beneficial to both rivals and consumers. Yet neither of these statements is correct.

Economic research suggests self-preferencing is only harmful in exceptional circumstances. That is true of the traditional literature on platform threats (here and here), where harm is premised on the notion that rivals will use the downstream market, ultimately, to compete with an upstream incumbent. It’s also true in more recent scholarship that compares dual mode platforms to pure marketplaces and resellers, where harm hinges on a platform being able to immediately imitate rivals’ offerings. Even this ignores the significant efficiencies that might simultaneously arise from self-preferencing and closed platforms, more broadly. In short, rules that categorically prohibit self-preferening by dominant platforms overshoot the mark, and the General Court’s Google Shopping ruling is a troubling development in that regard.

It is also naïve to think that prohibiting self-preferencing will automatically benefit rivals and consumers (as opposed to harming the latter and leaving the former no better off). If self-preferencing is not anticompetitive, then propping up inefficient firms will at best be a futile exercise in preserving failing businesses. At worst, it would impose significant burdens on consumers by destroying valuable synergies between the platform and its own downstream service.

Finally, if the past years teach us anything about online markets, it is that consumers place a much heavier premium on frictionless user interfaces than on open platforms. TikTok is arguably a much more “closed” experience than other sources of online entertainment, like YouTube or Reddit (i.e. users have less direct control over their experience). Yet many observers have pinned its success, among other things, on its highly intuitive and simple interface. The emergence of Vinted, a European pre-owned goods platform, is another example of competition through a frictionless user experience.

There is a significant risk that, by seeking to boost “choice,” intervention by competition regulators against self-preferencing will ultimately remove one of the benefits users value most. By increasing the information users need to process, there is a risk that non-discrimination remedies will merely add pain points to the underlying purchasing process. In short, while Google Shopping is nominally a victory for the Commission and rivals, it is also a testament to the futility and harmfulness of myopic competition intervention in digital markets. Consumer preferences cannot be changed by government fiat, nor can the fact that certain firms are more efficient than others (at least, not without creating significant harm in the process). It is time this simple conclusion made its way into European competition thinking.

In Antitrust & Competition, European Union, Exclusionary Conduct, Google, International, Platforms, Truth on the Market European Commission, google, Google Shopping, refusals to deal, self-preferncing

How US and EU Competition Law Differ

Sam Bowman, Dirk Auer & Geoffrey Manne — 9 August 2021

[This post adapts elements of “Should ASEAN Antitrust Laws Emulate European Competition Policy?”, published in the Singapore Economic Review (2021). Open access working paper here.]

U.S. and European competition laws diverge in numerous ways that have important real-world effects. Understanding these differences is vital, particularly as lawmakers in the United States, and the rest of the world, consider adopting a more “European” approach to competition.

In broad terms, the European approach is more centralized and political. The European Commission’s Directorate General for Competition (DG Comp) has significant de facto discretion over how the law is enforced. This contrasts with the common law approach of the United States, in which courts elaborate upon open-ended statutes through an iterative process of case law. In other words, the European system was built from the top down, while U.S. antitrust relies on a bottom-up approach, derived from arguments made by litigants (including the government antitrust agencies) and defendants (usually businesses).

This procedural divergence has significant ramifications for substantive law. European competition law includes more provisions akin to de facto regulation. This is notably the case for the “abuse of dominance” standard, in which a “dominant” business can be prosecuted for “abusing” its position by charging high prices or refusing to deal with competitors. By contrast, the U.S. system places more emphasis on actual consumer outcomes, rather than the nature or “fairness” of an underlying practice.

The American system thus affords firms more leeway to exclude their rivals, so long as this entails superior benefits for consumers. This may make the U.S. system more hospitable to innovation, since there is no built-in regulation of conduct for innovators who acquire a successful market position fairly and through normal competition.

In this post, we discuss some key differences between the two systems—including in areas like predatory pricing and refusals to deal—as well as the discretionary power the European Commission enjoys under the European model.

Exploitative Abuses

U.S. antitrust is, by and large, unconcerned with companies charging what some might consider “excessive” prices. The late Associate Justice Antonin Scalia, writing for the Supreme Court majority in the 2003 case Verizon v. Trinko, observed that:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period—is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth.

This contrasts with European competition-law cases, where firms may be found to have infringed competition law because they charged excessive prices. As the European Court of Justice (ECJ) held in 1978’s United Brands case: “In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.”

While United Brands was the EU’s foundational case for excessive pricing, and the European Commission reiterated that these allegedly exploitative abuses were possible when it published its guidance paper on abuse of dominance cases in 2009, the commission had for some time demonstrated apparent disinterest in bringing such cases. In recent years, however, both the European Commission and some national authorities have shown renewed interest in excessive-pricing cases, most notably in the pharmaceutical sector.

European competition law also penalizes so-called “margin squeeze” abuses, in which a dominant upstream supplier charges a price to distributors that is too high for them to compete effectively with that same dominant firm downstream:

[I]t is for the referring court to examine, in essence, whether the pricing practice introduced by TeliaSonera is unfair in so far as it squeezes the margins of its competitors on the retail market for broadband connection services to end users. (Konkurrensverket v TeliaSonera Sverige, 2011)

As Scalia observed in Trinko, forcing firms to charge prices that are below a market’s natural equilibrium affects firms’ incentives to enter markets, notably with innovative products and more efficient means of production. But the problem is not just one of market entry and innovation. Also relevant is the degree to which competition authorities are competent to determine the “right” prices or margins.

As Friedrich Hayek demonstrated in his influential 1945 essay The Use of Knowledge in Society, economic agents use information gleaned from prices to guide their business decisions. It is this distributed activity of thousands or millions of economic actors that enables markets to put resources to their most valuable uses, thereby leading to more efficient societies. By comparison, the efforts of central regulators to set prices and margins is necessarily inferior; there is simply no reasonable way for competition regulators to make such judgments in a consistent and reliable manner.

Given the substantial risk that investigations into purportedly excessive prices will deter market entry, such investigations should be circumscribed. But the court’s precedents, with their myopic focus on ex post prices, do not impose such constraints on the commission. The temptation to “correct” high prices—especially in the politically contentious pharmaceutical industry—may thus induce economically unjustified and ultimately deleterious intervention.

Predatory Pricing

A second important area of divergence concerns predatory-pricing cases. U.S. antitrust law subjects allegations of predatory pricing to two strict conditions:

Monopolists must charge prices that are below some measure of their incremental costs; and
There must be a realistic prospect that they will able to recoup these initial losses.

In laying out its approach to predatory pricing, the U.S. Supreme Court has identified the risk of false positives and the clear cost of such errors to consumers. It thus has particularly stressed the importance of the recoupment requirement. As the court found in 1993’s Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., without recoupment, “predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced.”

Accordingly, U.S. authorities must prove that there are constraints that prevent rival firms from entering the market after the predation scheme, or that the scheme itself would effectively foreclose rivals from entering the market in the first place. Otherwise, the predator would be undercut by competitors as soon as it attempts to recoup its losses by charging supra-competitive prices.

Without the strong likelihood that a monopolist will be able to recoup lost revenue from underpricing, the overwhelming weight of economic evidence (to say nothing of simple logic) is that predatory pricing is not a rational business strategy. Thus, apparent cases of predatory pricing are most likely not, in fact, predatory; deterring or punishing them would actually harm consumers.

By contrast, the EU employs a more expansive legal standard to define predatory pricing, and almost certainly risks injuring consumers as a result. Authorities must prove only that a company has charged a price below its average variable cost, in which case its behavior is presumed to be predatory. Even when a firm charges prices that are between its average variable and average total cost, it can be found guilty of predatory pricing if authorities show that its behavior was part of a plan to eliminate a competitor. Most significantly, in neither case is it necessary for authorities to show that the scheme would allow the monopolist to recoup its losses.

[I]t does not follow from the case‑law of the Court that proof of the possibility of recoupment of losses suffered by the application, by an undertaking in a dominant position, of prices lower than a certain level of costs constitutes a necessary precondition to establishing that such a pricing policy is abusive. (France Télécom v Commission, 2009).

This aspect of the legal standard has no basis in economic theory or evidence—not even in the “strategic” economic theory that arguably challenges the dominant Chicago School understanding of predatory pricing. Indeed, strategic predatory pricing still requires some form of recoupment, and the refutation of any convincing business justification offered in response. For example, in a 2017 piece for the Antitrust Law Journal, Steven Salop lays out the “raising rivals’ costs” analysis of predation and notes that recoupment still occurs, just at the same time as predation:

[T]he anticompetitive conditional pricing practice does not involve discrete predatory and recoupment periods, as in the case of classical predatory pricing. Instead, the recoupment occurs simultaneously with the conduct. This is because the monopolist is able to maintain its current monopoly power through the exclusionary conduct.

The case of predatory pricing illustrates a crucial distinction between European and American competition law. The recoupment requirement embodied in American antitrust law serves to differentiate aggressive pricing behavior that improves consumer welfare—because it leads to overall price decreases—from predatory pricing that reduces welfare with higher prices. It is, in other words, entirely focused on the welfare of consumers.

The European approach, by contrast, reflects structuralist considerations far removed from a concern for consumer welfare. Its underlying fear is that dominant companies could use aggressive pricing to engender more concentrated markets. It is simply presumed that these more concentrated markets are invariably detrimental to consumers. Both the Tetra Pak and France Télécom cases offer clear illustrations of the ECJ’s reasoning on this point:

[I]t would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalize predatory pricing whenever there is a risk that competitors will be eliminated… The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors. (Tetra Pak v Commission, 1996).

Similarly:

[T]he lack of any possibility of recoupment of losses is not sufficient to prevent the undertaking concerned reinforcing its dominant position, in particular, following the withdrawal from the market of one or a number of its competitors, so that the degree of competition existing on the market, already weakened precisely because of the presence of the undertaking concerned, is further reduced and customers suffer loss as a result of the limitation of the choices available to them. (France Télécom v Commission, 2009).

In short, the European approach leaves less room to analyze the concrete effects of a given pricing scheme, leaving it more prone to false positives than the U.S. standard explicated in the Brooke Group decision. Worse still, the European approach ignores not only the benefits that consumers may derive from lower prices, but also the chilling effect that broad predatory pricing standards may exert on firms that would otherwise seek to use aggressive pricing schemes to attract consumers.

Refusals to Deal

U.S. and EU antitrust law also differ greatly when it comes to refusals to deal. While the United States has limited the ability of either enforcement authorities or rivals to bring such cases, EU competition law sets a far lower threshold for liability.

As Justice Scalia wrote in Trinko:

Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant’s decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. (Verizon v Trinko, 2003.)

This highlights two key features of American antitrust law with regard to refusals to deal. To start, U.S. antitrust law generally does not apply the “essential facilities” doctrine.Accordingly, in the absence of exceptional facts, upstream monopolists are rarely required to supply their product to downstream rivals, even if that supply is “essential” for effective competition in the downstream market. Moreover, as Justice Scalia observed in Trinko, the Aspen Skiing case appears to concern only those limited instances where a firm’s refusal to deal stems from the termination of a preexisting and profitable business relationship.

While even this is not likely the economically appropriate limitation on liability, its impetus—ensuring that liability is found only in situations where procompetitive explanations for the challenged conduct are unlikely—is completely appropriate for a regime concerned with minimizing the cost to consumers of erroneous enforcement decisions.

As in most areas of antitrust policy, EU competition law is much more interventionist. Refusals to deal are a central theme of EU enforcement efforts, and there is a relatively low threshold for liability.

In theory, for a refusal to deal to infringe EU competition law, it must meet a set of fairly stringent conditions: the input must be indispensable, the refusal must eliminate all competition in the downstream market, and there must not be objective reasons that justify the refusal. Moreover, if the refusal to deal involves intellectual property, it must also prevent the appearance of a new good.

In practice, however, all of these conditions have been relaxed significantly by EU courts and the commission’s decisional practice. This is best evidenced by the lower court’s Microsoft ruling where, as John Vickers notes:

[T]he Court found easily in favor of the Commission on the IMS Health criteria, which it interpreted surprisingly elastically, and without relying on the special factors emphasized by the Commission. For example, to meet the “new product” condition it was unnecessary to identify a particular new product… thwarted by the refusal to supply but sufficient merely to show limitation of technical development in terms of less incentive for competitors to innovate.

EU competition law thus shows far less concern for its potential chilling effect on firms’ investments than does U.S. antitrust law.

Vertical Restraints

There are vast differences between U.S. and EU competition law relating to vertical restraints—that is, contractual restraints between firms that operate at different levels of the production process.

On the one hand, since the Supreme Court’s Leegin ruling in 2006, even price-related vertical restraints (such as resale price maintenance (RPM), under which a manufacturer can stipulate the prices at which retailers must sell its products) are assessed under the rule of reason in the United States. Some commentators have gone so far as to say that, in practice, U.S. case law on RPM almost amounts to per se legality.

Conversely, EU competition law treats RPM as severely as it treats cartels. Both RPM and cartels are considered to be restrictions of competition “by object”—the EU’s equivalent of a per se prohibition. This severe treatment also applies to non-price vertical restraints that tend to partition the European internal market.

Furthermore, in the Consten and Grundig ruling, the ECJ rejected the consequentialist, and economically grounded, principle that inter-brand competition is the appropriate framework to assess vertical restraints:

Although competition between producers is generally more noticeable than that between distributors of products of the same make, it does not thereby follow that an agreement tending to restrict the latter kind of competition should escape the prohibition of Article 85(1) merely because it might increase the former. (Consten SARL & Grundig-Verkaufs-GMBH v. Commission of the European Economic Community, 1966).

This treatment of vertical restrictions flies in the face of longstanding mainstream economic analysis of the subject. As Patrick Rey and Jean Tirole conclude:

Another major contribution of the earlier literature on vertical restraints is to have shown that per se illegality of such restraints has no economic foundations.

Unlike the EU, the U.S. Supreme Court in Leegin took account of the weight of the economic literature, and changed its approach to RPM to ensure that the law no longer simply precluded its arguable consumer benefits, writing: “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” Further, the court found that the prior approach to resale price maintenance restraints “hinders competition and consumer welfare because manufacturers are forced to engage in second-best alternatives and because consumers are required to shoulder the increased expense of the inferior practices.”

The EU’s continued per se treatment of RPM, by contrast, strongly reflects its “precautionary principle” approach to antitrust. European regulators and courts readily condemn conduct that could conceivably injure consumers, even where such injury is, according to the best economic understanding, exceedingly unlikely. The U.S. approach, which rests on likelihood rather than mere possibility, is far less likely to condemn beneficial conduct erroneously.

Political Discretion in European Competition Law

EU competition law lacks a coherent analytical framework like that found in U.S. law’s reliance on the consumer welfare standard. The EU process is driven by a number of laterally equivalent—and sometimes mutually exclusive—goals, including industrial policy and the perceived need to counteract foreign state ownership and subsidies. Such a wide array of conflicting aims produces lack of clarity for firms seeking to conduct business. Moreover, the discretion that attends this fluid arrangement of goals yields an even larger problem.

The Microsoft case illustrates this problem well. In Microsoft, the commission could have chosen to base its decision on various potential objectives. It notably chose to base its findings on the fact that Microsoft’s behavior reduced “consumer choice.”

The commission, in fact, discounted arguments that economic efficiency may lead to consumer welfare gains, because it determined “consumer choice” among media players was more important:

Another argument relating to reduced transaction costs consists in saying that the economies made by a tied sale of two products saves resources otherwise spent for maintaining a separate distribution system for the second product. These economies would then be passed on to customers who could save costs related to a second purchasing act, including selection and installation of the product. Irrespective of the accuracy of the assumption that distributive efficiency gains are necessarily passed on to consumers, such savings cannot possibly outweigh the distortion of competition in this case. This is because distribution costs in software licensing are insignificant; a copy of a software programme can be duplicated and distributed at no substantial effort. In contrast, the importance of consumer choice and innovation regarding applications such as media players is high. (Commission Decision No. COMP. 37792 (Microsoft)).

It may be true that tying the products in question was unnecessary. But merely dismissing this decision because distribution costs are near-zero is hardly an analytically satisfactory response. There are many more costs involved in creating and distributing complementary software than those associated with hosting and downloading. The commission also simply asserts that consumer choice among some arbitrary number of competing products is necessarily a benefit. This, too, is not necessarily true, and the decision’s implication that any marginal increase in choice is more valuable than any gains from product design or innovation is analytically incoherent.

The Court of First Instance was only too happy to give the commission a pass in its breezy analysis; it saw no objection to these findings. With little substantive reasoning to support its findings, the court fully endorsed the commission’s assessment:

As the Commission correctly observes (see paragraph 1130 above), by such an argument Microsoft is in fact claiming that the integration of Windows Media Player in Windows and the marketing of Windows in that form alone lead to the de facto standardisation of the Windows Media Player platform, which has beneficial effects on the market. Although, generally, standardisation may effectively present certain advantages, it cannot be allowed to be imposed unilaterally by an undertaking in a dominant position by means of tying.
The Court further notes that it cannot be ruled out that third parties will not want the de facto standardisation advocated by Microsoft but will prefer it if different platforms continue to compete, on the ground that that will stimulate innovation between the various platforms. (Microsoft Corp. v Commission, 2007)

Pointing to these conflicting effects of Microsoft’s bundling decision, without weighing either, is a weak basis to uphold the commission’s decision that consumer choice outweighs the benefits of standardization. Moreover, actions undertaken by other firms to enhance consumer choice at the expense of standardization are, on these terms, potentially just as problematic. The dividing line becomes solely which theory the commission prefers to pursue.

What such a practice does is vest the commission with immense discretionary power. Any given case sets up a “heads, I win; tails, you lose” situation in which defendants are easily outflanked by a commission that can change the rules of its analysis as it sees fit. Defendants can play only the cards that they are dealt. Accordingly, Microsoft could not successfully challenge a conclusion that its behavior harmed consumers’ choice by arguing that it improved consumer welfare, on net.

By selecting, in this instance, “consumer choice” as the standard to be judged, the commission was able to evade the constraints that might have been imposed by a more robust welfare standard. Thus, the commission can essentially pick and choose the objectives that best serve its interests in each case. This vastly enlarges the scope of potential antitrust liability, while also substantially decreasing the ability of firms to predict when their behavior may be viewed as problematic. It leads to what, in U.S. courts, would be regarded as an untenable risk of false positives that chill innovative behavior and create nearly unwinnable battles for targeted firms.

In Antitrust & Competition, Broadband, Cartels, Constitutional Law, Economic Theory, European Union, Exclusionary Conduct, Exclusive Dealing, Health Care, Intellectual Property, International, International Trade, Pharmaceuticals, Platforms, Price Discrimination, Resale Price Maintenance, Supreme Court, Telecommunications, Truth on the Market, Tying, Vertical Restraints abuse of dominance, antitrust, Antonin Scalia, cartels, competition, cost-benefit analysis, DGComp, essential facilities, European Commission, European Court of Justice, European Union, excessive pricing, Friedrich Hayek, Hayek, industrial policy, Leegin, microsoft, open access, pharmaceutical industry, political economy, predatory pricing, raising rivals’ costs, refusals to deal, RPM, SSRN, Trinko, tying, Unfairness, vertical restraints

The District Court’s FTC v. Qualcomm Decision Rests on Impermissible Inferences and Should Be Reversed

Geoffrey Manne & Ben Sperry — 3 September 2019

Last week the International Center for Law & Economics (ICLE) and twelve noted law and economics scholars filed an amicus brief in the Ninth Circuit in FTC v. Qualcomm, in support of appellant (Qualcomm) and urging reversal of the district court’s decision. The brief was authored by Geoffrey A. Manne, President & founder of ICLE, and Ben Sperry, Associate Director, Legal Research of ICLE. Jarod M. Bona and Aaron R. Gott of Bona Law PC collaborated in drafting the brief and they and their team provided invaluable pro bono legal assistance, for which we are enormously grateful. Signatories on the brief are listed at the end of this post.

We’ve written about the case several times on Truth on the Market, as have a number of guest bloggers, in our ongoing blog series on the case here.

The ICLE amicus brief focuses on the ways that the district court exceeded the “error cost” guardrails erected by the Supreme Court to minimize the risk and cost of mistaken antitrust decisions, particularly those that wrongly condemn procompetitive behavior. As the brief notes at the outset:

The district court’s decision is disconnected from the underlying economics of the case. It improperly applied antitrust doctrine to the facts, and the result subverts the economic rationale guiding monopolization jurisprudence. The decision—if it stands—will undercut the competitive values antitrust law was designed to protect.

The antitrust error cost framework was most famously elaborated by Frank Easterbrook in his seminal article, The Limits of Antitrust (1984). It has since been squarely adopted by the Supreme Court—most significantly in Brooke Group (1986), Trinko (2003), and linkLine (2009).

In essence, the Court’s monopolization case law implements the error cost framework by (among other things) obliging courts to operate under certain decision rules that limit the use of inferences about the consequences of a defendant’s conduct except when the circumstances create what game theorists call a “separating equilibrium.” A separating equilibrium is a

solution to a game in which players of different types adopt different strategies and thereby allow an uninformed player to draw inferences about an informed player’s type from that player’s actions.
Baird, Gertner & Picker, Game Theory and the Law

The key problem in antitrust is that while the consequence of complained-of conduct for competition (i.e., consumers) is often ambiguous, its deleterious effect on competitors is typically quite evident—whether it is actually anticompetitive or not. The question is whether (and when) it is appropriate to infer anticompetitive effect from discernible harm to competitors.

Except in the narrowly circumscribed (by Trinko) instance of a unilateral refusal to deal, anticompetitive harm under the rule of reason must be proven. It may not be inferred from harm to competitors, because such an inference is too likely to be mistaken—and “mistaken inferences are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” (Brooke Group (quoting yet another key Supreme Court antitrust error cost case, Matsushita (1986)).

Yet, as the brief discusses, in finding Qualcomm liable the district court did not demand or find proof of harm to competition. Instead, the court’s opinion relies on impermissible inferences from ambiguous evidence to find that Qualcomm had (and violated) an antitrust duty to deal with rival chip makers and that its conduct resulted in anticompetitive foreclosure of competition.

We urge you to read the brief (it’s pretty short—maybe the length of three blogs posts) to get the whole argument. Below we draw attention to a few points we make in the brief that are especially significant.

The district court bases its approach entirely on Microsoft — which it misinterprets in clear contravention of Supreme Court case law

The district court doesn’t stay within the strictures of the Supreme Court’s monopolization case law. In fact, although it obligingly recites some of the error cost language from Trinko, it quickly moves away from Supreme Court precedent and bases its approach entirely on its reading of the D.C. Circuit’s Microsoft (2001) decision.

Unfortunately, the district court’s reading of Microsoft is mistaken and impermissible under Supreme Court precedent. Indeed, both the Supreme Court and the D.C. Circuit make clear that a finding of illegal monopolization may not rest on an inference of anticompetitive harm.

The district court cites Microsoft for the proposition that

Where a government agency seeks injunctive relief, the Court need only conclude that Qualcomm’s conduct made a “significant contribution” to Qualcomm’s maintenance of monopoly power. The plaintiff is not required to “present direct proof that a defendant’s continued monopoly power is precisely attributable to its anticompetitive conduct.”

It’s true Microsoft held that, in government actions seeking injunctions, “courts [may] infer ‘causation’ from the fact that a defendant has engaged in anticompetitive conduct that ‘reasonably appears capable of making a significant contribution to maintaining monopoly power.’” (Emphasis added).

But Microsoft never suggested that anticompetitiveness itself may be inferred.

“Causation” and “anticompetitive effect” are not the same thing. Indeed, Microsoft addresses “anticompetitive conduct” and “causation” in separate sections of its decision. And whereas Microsoft allows that courts may infer “causation” in certain government actions, it makes no such allowance with respect to “anticompetitive effect.” In fact, it explicitly rules it out:

[T]he plaintiff… must demonstrate that the monopolist’s conduct indeed has the requisite anticompetitive effect…; no less in a case brought by the Government, it must demonstrate that the monopolist’s conduct harmed competition, not just a competitor.”

The D.C. Circuit subsequently reinforced this clear conclusion of its holding in Microsoft in Rambus:

Deceptive conduct—like any other kind—must have an anticompetitive effect in order to form the basis of a monopolization claim…. In Microsoft… [t]he focus of our antitrust scrutiny was properly placed on the resulting harms to competition.

Finding causation entails connecting evidentiary dots, while finding anticompetitive effect requires an economic assessment. Without such analysis it’s impossible to distinguish procompetitive from anticompetitive conduct, and basing liability on such an inference effectively writes “anticompetitive” out of the law.

Thus, the district court is correct when it holds that it “need not conclude that Qualcomm’s conduct is the sole reason for its rivals’ exits or impaired status.” But it is simply wrong to hold—in the same sentence—that it can thus “conclude that Qualcomm’s practices harmed competition and consumers.” The former claim is consistent with Microsoft; the latter is emphatically not.

Under Trinko and Aspen Skiing the district court’s finding of an antitrust duty to deal is impermissible

Because finding that a company operates under a duty to deal essentially permits a court to infer anticompetitive harm without proof, such a finding “comes dangerously close to being a form of ‘no-fault’ monopolization,” as Herbert Hovenkamp has written. It is also thus seriously disfavored by the Court’s error cost jurisprudence.

In Trinko the Supreme Court interprets its holding in Aspen Skiing to identify essentially a single scenario from which it may plausibly be inferred that a monopolist’s refusal to deal with rivals harms consumers: the existence of a prior, profitable course of dealing, and the termination and replacement of that arrangement with an alternative that not only harms rivals, but also is less profitable for the monopolist.

In an effort to satisfy this standard, the district court states that “because Qualcomm previously licensed its rivals, but voluntarily stopped licensing rivals even though doing so was profitable, Qualcomm terminated a voluntary and profitable course of dealing.”

But it’s not enough merely that the prior arrangement was profitable. Rather, Trinko and Aspen Skiing hold that when a monopolist ends a profitable relationship with a rival, anticompetitive exclusion may be inferred only when it also refuses to engage in an ongoing arrangement that, in the short run, is more profitable than no relationship at all. The key is the relative value to the monopolist of the current options on offer, not the value to the monopolist of the terminated arrangement. In a word, what the Court requires is that the defendant exhibit behavior that, but-for the expectation of future, anticompetitive returns, is irrational.

It should be noted, as John Lopatka (here) and Alan Meese (here) (both of whom joined the amicus brief) have written, that even the Supreme Court’s approach is likely insufficient to permit a court to distinguish between procompetitive and anticompetitive conduct.

But what is certain is that the district court’s approach in no way permits such an inference.

“Evasion of a competitive constraint” is not an antitrust-relevant refusal to deal

In order to infer anticompetitive effect, it’s not enough that a firm may have a “duty” to deal, as that term is colloquially used, based on some obligation other than an antitrust duty, because it can in no way be inferred from the evasion of that obligation that conduct is anticompetitive.

The district court bases its determination that Qualcomm’s conduct is anticompetitive on the fact that it enables the company to avoid patent exhaustion, FRAND commitments, and thus price competition in the chip market. But this conclusion is directly precluded by the Supreme Court’s holding in NYNEX.

Indeed, in Rambus, the D.C. Circuit, citing NYNEX, rejected the FTC’s contention that it may infer anticompetitive effect from defendant’s evasion of a constraint on its monopoly power in an analogous SEP-licensing case: “But again, as in NYNEX, an otherwise lawful monopolist’s end-run around price constraints, even when deceptive or fraudulent, does not alone present a harm to competition.”

As Josh Wright has noted:

[T]he objection to the “evasion” of any constraint approach is… that it opens the door to enforcement actions applied to business conduct that is not likely to harm competition and might be welfare increasing.

Thus NYNEX and Rambus (and linkLine) reinforce the Court’s repeated holding that an inference of harm to competition is permissible only where conduct points clearly to anticompetitive effect—and, bad as they may be, evading obligations under other laws or violating norms of “business morality” do not suffice.

The district court’s elaborate theory of harm rests fundamentally on the claim that Qualcomm injures rivals—and the record is devoid of evidence demonstrating actual harm to competition. Instead, the court infers it from what it labels “unreasonably high” royalty rates, enabled by Qualcomm’s evasion of competition from rivals. In turn, the court finds that that evasion of competition can be the source of liability if what Qualcomm evaded was an antitrust duty to deal. And, in impermissibly circular fashion, the court finds that Qualcomm indeed evaded an antitrust duty to deal—because its conduct allowed it to sustain “unreasonably high” prices.

The Court’s antitrust error cost jurisprudence—from Brooke Group to NYNEX to Trinko & linkLine—stands for the proposition that no such circular inferences are permitted.

The district court’s foreclosure analysis also improperly relies on inferences in lieu of economic evidence

Because the district court doesn’t perform a competitive effects analysis, it fails to demonstrate the requisite “substantial” foreclosure of competition required to sustain a claim of anticompetitive exclusion. Instead the court once again infers anticompetitive harm from harm to competitors.

The district court makes no effort to establish the quantity of competition foreclosed as required by the Supreme Court. Nor does the court demonstrate that the alleged foreclosure harms competition, as opposed to just rivals. Foreclosure per se is not impermissible and may be perfectly consistent with procompetitive conduct.

Again citing Microsoft, the district court asserts that a quantitative finding is not required. Yet, as the court’s citation to Microsoft should have made clear, in its stead a court must find actual anticompetitive effect; it may not simply assert it. As Microsoft held:

It is clear that in all cases the plaintiff must… prove the degree of foreclosure. This is a prudential requirement; exclusivity provisions in contracts may serve many useful purposes.

The court essentially infers substantiality from the fact that Qualcomm entered into exclusive deals with Apple (actually, volume discounts), from which the court concludes that Qualcomm foreclosed rivals’ access to a key customer. But its inference that this led to substantial foreclosure is based on internal business statements—so-called “hot docs”—characterizing the importance of Apple as a customer. Yet, as Geoffrey Manne and Marc Williamson explain, such documentary evidence is unreliable as a guide to economic significance or legal effect:

Business people will often characterize information from a business perspective, and these characterizations may seem to have economic implications. However, business actors are subject to numerous forces that influence the rhetoric they use and the conclusions they draw….

There are perfectly good reasons to expect to see “bad” documents in business settings when there is no antitrust violation lurking behind them.

Assuming such language has the requisite economic or legal significance is unsupportable—especially when, as here, the requisite standard demands a particular quantitative significance.

Moreover, the court’s “surcharge” theory of exclusionary harm rests on assumptions regarding the mechanism by which the alleged surcharge excludes rivals and harms consumers. But the court incorrectly asserts that only one mechanism operates—and it makes no effort to quantify it.

The court cites “basic economics” via Mankiw’s Principles of Microeconomics text for its conclusion:

The surcharge affects demand for rivals’ chips because as a matter of basic economics, regardless of whether a surcharge is imposed on OEMs or directly on Qualcomm’s rivals, “the price paid by buyers rises, and the price received by sellers falls.” Thus, the surcharge “places a wedge between the price that buyers pay and the price that sellers receive,” and demand for such transactions decreases. Rivals see lower sales volumes and lower margins, and consumers see less advanced features as competition decreases.

But even assuming the court is correct that Qualcomm’s conduct entails such a surcharge, basic economics does not hold that decreased demand for rivals’ chips is the only possible outcome.

In actuality, an increase in the cost of an input for OEMs can have three possible effects:

OEMs can pass all or some of the cost increase on to consumers in the form of higher phone prices. Assuming some elasticity of demand, this would mean fewer phone sales and thus less demand by OEMs for chips, as the court asserts. But the extent of that effect would depend on consumers’ demand elasticity and the magnitude of the cost increase as a percentage of the phone price. If demand is highly inelastic at this price (i.e., relatively insensitive to the relevant price change), it may have a tiny effect on the number of phones sold and thus the number of chips purchased—approaching zero as price insensitivity increases.
OEMs can absorb the cost increase and realize lower profits but continue to sell the same number of phones and purchase the same number of chips. This would not directly affect demand for chips or their prices.
OEMs can respond to a price increase by purchasing fewer chips from rivals and more chips from Qualcomm. While this would affect rivals’ chip sales, it would not necessarily affect consumer prices, the total number of phones sold, or OEMs’ margins—that result would depend on whether Qualcomm’s chips cost more or less than its rivals’. If the latter, it would even increase OEMs’ margins and/or lower consumer prices and increase output.

Alternatively, of course, the effect could be some combination of these.

Whether any of these outcomes would substantially exclude rivals is inherently uncertain to begin with. But demonstrating a reduction in rivals’ chip sales is a necessary but not sufficient condition for proving anticompetitive foreclosure. The FTC didn’t even demonstrate that rivals were substantially harmed, let alone that there was any effect on consumers—nor did the district court make such findings.

Doing so would entail consideration of whether decreased demand for rivals’ chips flows from reduced consumer demand or OEMs’ switching to Qualcomm for supply, how consumer demand elasticity affects rivals’ chip sales, and whether Qualcomm’s chips were actually less or more expensive than rivals’. Yet the court determined none of these.

Conclusion

Contrary to established Supreme Court precedent, the district court’s decision relies on mere inferences to establish anticompetitive effect. The decision, if it stands, would render a wide range of potentially procompetitive conduct presumptively illegal and thus harm consumer welfare. It should be reversed by the Ninth Circuit.

Joining ICLE on the brief are:

Donald J. Boudreaux, Professor of Economics, George Mason University
Kenneth G. Elzinga, Robert C. Taylor Professor of Economics, University of Virginia
Janice Hauge, Professor of Economics, University of North Texas
Justin (Gus) Hurwitz, Associate Professor of Law, University of Nebraska College of Law; Director of Law & Economics Programs, ICLE
Thomas A. Lambert, Wall Chair in Corporate Law and Governance, University of Missouri Law School
John E. Lopatka, A. Robert Noll Distinguished Professor of Law, Penn State University Law School
Daniel Lyons, Professor of Law, Boston College Law School
Geoffrey A. Manne, President and Founder, International Center for Law & Economics; Distinguished Fellow, Northwestern University Center on Law, Business & Economics
Alan J. Meese, Ball Professor of Law, William & Mary Law School
Paul H. Rubin, Samuel Candler Dobbs Professor of Economics Emeritus, Emory University
Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics, Chapman University School of Business; Nobel Laureate in Economics, 2002
Michael Sykuta, Associate Professor of Economics, University of Missouri

Senate Bill Provides Remedy for Regulatory Abuse Keeping Generics Off the Market

David Olson — 20 June 2016

Thanks to Geoff for the introduction. I look forward to posting a few things over the summer.

I’d like to begin by discussing Geoff’s post on the pending legislative proposals designed to combat strategic abuse of drug safety regulations to prevent generic competition. Specifically, I’d like to address the economic incentive structure that is in effect in this highly regulated market.

Like many others, I first noticed the abuse of drug safety regulations to prevent competition when Turing Pharmaceuticals—then led by now infamous CEO Martin Shkreli—acquired the manufacturing rights for the anti-parasitic drug Daraprim, and raised the price of the drug by over 5,000%. The result was a drug that cost $750 per tablet. Daraprim (pyrimethamine) is used to combat malaria and toxoplasma gondii infections in immune-compromised patients, especially those with HIV. The World Health Organization includes Daraprim on its “List of Essential Medicines” as a medicine important to basic health systems. After the huge price hike, the drug was effectively out of reach for many insurance plans and uninsured patients who needed it for the six to eight week course of treatment for toxoplasma gondii infections.

It’s not unusual for drugs to sell at huge multiples above their manufacturing cost. Indeed, a primary purpose of patent law is to allow drug companies to earn sufficient profits to engage in the expensive and risky business of developing new drugs. But Daraprim was first sold in 1953 and thus has been off patent for decades. With no intellectual property protection Daraprim should, theoretically, now be available from generic drug manufactures for only a little above cost. Indeed, this is what we see in the rest of the world. Daraprim is available all over the world for very cheap prices. The per tablet price is 3 rupees (US$0.04) in India, R$0.07 (US$0.02) in Brazil, US$0.18 in Australia, and US$0.66 in the UK.

So what gives in the U.S.? Or rather, what does not give? What in our system of drug distribution has gotten stuck and is preventing generic competition from swooping in to compete down the high price of off-patent drugs like Daraprim? The answer is not market failure, but rather regulatory failure, as Geoff noted in his post. While generics would love to enter a market where a drug is currently selling for high profits, they cannot do so without getting FDA approval for their generic version of the drug at issue. To get approval, a generic simply has to file an Abbreviated New Drug Application (“ANDA”) that shows that its drug is equivalent to the branded drug with which it wants to compete. There’s no need for the generic to repeat the safety and efficacy tests that the brand manufacturer originally conducted. To test for equivalence, the generic needs samples of the brand drug. Without those samples, the generic cannot meet its burden of showing equivalence. This is where the strategic use of regulation can come into play.

Geoff’s post explains the potential abuse of Risk Evaluation and Mitigation Strategies (“REMS”). REMS are put in place to require certain safety steps (like testing a woman for pregnancy before prescribing a drug that can cause birth defects) or to restrict the distribution channels for dangerous or addictive drugs. As Geoff points out, there is evidence that a few brand name manufacturers have engaged in bad-faith refusals to provide samples using the excuse of REMS or restricted distribution programs to (1) deny requests for samples, (2) prevent generic manufacturers from buying samples from resellers, and (3) deny generics whose drugs have won approval access to the REMS system that is required for generics to distribute their drugs. Once the FDA has certified that a generic manufacturer can safely handle the drug at issue, there is no legitimate basis for the owners of brand name drugs to deny samples to the generic maker. Expressed worries about liability from entering joint REMS programs with generics also ring hollow, for the most part, and would be ameliorated by the pending legislation.

It’s important to note that this pricing situation is unique to drugs because of the regulatory framework surrounding drug manufacture and distribution. If a manufacturer of, say, an off-patent vacuum cleaner wants to prevent competitors from copying its vacuum cleaner design, it is unlikely to be successful. Even if the original manufacturer refuses to sell any vacuum cleaners to a competitor, and instructs its retailers not to sell either, this will be very difficult to monitor and enforce. Moreover, because of an unrestricted resale market, a competitor would inevitably be able to obtain samples of the vacuum cleaner it wishes to copy. Only patent law can successfully protect against the copying of a product sold to the general public, and when the patent expires, so too will the ability to prevent copying.

Drugs are different. The only way a consumer can resell prescription drugs is by breaking the law. Pills bought from an illegal secondary market would be useless to generics for purposes of FDA approval anyway, because the chain of custody would not exist to prove that the samples are the real thing. This means generics need to get samples from the authorized manufacturer or distribution company. When a drug is subject to a REMS-required restricted distribution program, it is even more difficult, if not impossible, for a generic maker to get samples of the drugs for which it wants to make generic versions. Restricted distribution programs, which are used for dangerous or addictive drugs, by design very tightly control the chain of distribution so that the drugs go only to patients with proper prescriptions from authorized doctors.

A troubling trend has arisen recently in which drug owners put their branded drugs into restricted distribution programs not because of any FDA REMS requirement, but instead as a method to prevent generics from obtaining samples and making generic versions of the drugs. This is the strategy that Turing used before it raised prices over 5,000% on Daraprim. And Turing isn’t the only company to use this strategy. It is being emulated by others, although perhaps not so conspicuously. For instance, in 2015, Valeant Pharmaceuticals completed a hostile takeover of Allergan Pharmaceuticals, with the help of the hedge fund, Pershing Square. Once Valeant obtained ownership of Allergan and its drug portfolio, it adopted restricted distribution programs and raised the prices on its off-patent drugs substantially. It raised the price of two life-saving heart drugs by 212% and 525% respectively. Others have followed suit.

A key component of the strategy to profit from hiking prices on off-patent drugs while avoiding competition from generics is to select drugs that do not currently have generic competitors. Sometimes this is because a drug has recently come off patent, and sometimes it is because the drug is for a small patient population, and thus generics haven’t bothered to enter the market given that brand name manufacturers generally drop their prices to close to cost after the drug comes off patent. But with the strategic control of samples and refusals to allow generics to enter REMS programs, the (often new) owners of the brand name drugs seek to prevent the generic competition that we count on to make products cheap and plentiful once their patent protection expires.

Most brand name drug makers do not engage in withholding samples from generics and abusing restricted distribution and REMS programs. But the few that do cost patients and insurers dearly for important medicines that should be much cheaper once they go off patent. More troubling still is the recent strategy of taking drugs that have been off patent and cheap for years, and abusing the regulatory regime to raise prices and block competition. This growing trend of abusing restricted distribution and REMS to facilitate rent extraction from drug purchasers needs to be corrected.

Two bills addressing this issue are pending in Congress. Both bills (1) require drug companies to provide samples to generics after the FDA has certified the generic, (2) require drug companies to enter into shared REMS programs with generics, (3) allow generics to set up their own REMS compliant systems, and (4) exempt drug companies from liability for sharing products and REMS-compliant systems with generic companies in accordance with the steps set out in the bills. When it comes to remedies, however, the Senate version is significantly better. The penalties provided in the House bill are both vague and overly broad. The bill provides for treble damages and costs against the drug company “of the kind described in section 4(a) of the Clayton Act.” Not only is the application of the Clayton Act unclear in the context of the heavily regulated market for drugs (see Trinko), but treble damages may over-deter reasonably restrictive behavior by drug companies when it comes to distributing dangerous drugs.

The remedies in the Senate version are very well crafted to deter rent seeking behavior while not overly deterring reasonable behavior. The remedial scheme is particularly good, because it punishes most those companies that attempt to make exorbitant profits on drugs by denying generic entry. The Senate version provides as a remedy for unreasonable delay that the plaintiff shall be awarded attorneys’ fees, costs, and the defending drug company’s profits on the drug at issue during the time of the unreasonable delay. This means that a brand name drug company that sells an old drug for a low price and delays sharing only because of honest concern about the safety standards of a particular generic company will not face terribly high damages if it is found unreasonable. On the other hand, a company that sends the price of an off-patent drug soaring and then attempts to block generic entry will know that it can lose all of its rent-seeking profits, plus the cost of the victorious generic company’s attorneys fees. This vastly reduces the incentive for the company owning the brand name drug to raise prices and keep competitors out. It likewise greatly increases the incentive of a generic company to enter the market and–if it is unreasonably blocked–to file a civil action the result of which would be to transfer the excess profits to the generic. This provides a rather elegant fix to the regulatory gaming in this area that has become an increasing problem. The balancing of interests and incentives in the Senate bill should leave many congresspersons feeling comfortable to support the bill.

Senator Lee’s prescription for regulatory failure in the generic drug market

Geoffrey Manne — 14 June 2016

Brand drug manufacturers are no strangers to antitrust accusations when it comes to their complicated relationship with generic competitors — most obviously with respect to reverse payment settlements. But the massive and massively complex regulatory scheme under which drugs are regulated has provided other opportunities for regulatory legerdemain with potentially anticompetitive effect, as well.

In particular, some FTC Commissioners have raised concerns that brand drug companies have been taking advantage of an FDA drug safety program — the Risk Evaluation and Mitigation Strategies program, or “REMS” — to delay or prevent generic entry.

Drugs subject to a REMS restricted distribution program are difficult to obtain through market channels and not otherwise readily available, even for would-be generic manufacturers that need samples in order to perform the tests required to receive FDA approval to market their products. REMS allows (requires, in fact) brand manufacturers to restrict the distribution of certain drugs that present safety or abuse risks, creating an opportunity for branded drug manufacturers to take advantage of imprecise regulatory requirements by inappropriately limiting access by generic manufacturers.

The FTC has not (yet) brought an enforcement action, but it has opened several investigations, and filed an amicus brief in a private-party litigation. Generic drug companies have filed several antitrust claims against branded drug companies and raised concerns with the FDA.

The problem, however, is that even if these companies are using REMS to delay generics, such a practice makes for a terrible antitrust case. Not only does the existence of a regulatory scheme arguably set Trinko squarely in the way of a successful antitrust case, but the sort of refusal to deal claims at issue here (as in Trinko) are rightly difficult to win because, as the DOJ’s Section 2 Report notes, “there likely are few circumstances where forced sharing would help consumers in the long run.”

But just because there isn’t a viable antitrust case doesn’t mean there isn’t still a competition problem. But in this case, it’s a problem of regulatory failure. Companies rationally take advantage of poorly written federal laws and regulations in order to tilt the market to their own advantage. It’s no less problematic for the market, but its solution is much more straightforward, if politically more difficult.

Thus it’s heartening to see that Senator Mike Lee (R-UT), along with three of his colleagues (Patrick Leahy (D-VT), Chuck Grassley (R-IA), and Amy Klobuchar (D-MN)), has proposed a novel but efficient way to correct these bureaucracy-generated distortions in the pharmaceutical market without resorting to the “blunt instrument” of antitrust law. As the bill notes:

While the antitrust laws may address actions by license holders who impede the prompt negotiation and development on commercially reasonable terms of a single, shared system of elements to assure safe use, a more tailored legal pathway would help ensure that license holders negotiate such agreements in good faith and in a timely manner, facilitating competition in the marketplace for drugs and biological products.

The legislative solution put forward by the Creating and Restoring Equal Access to Equivalent Samples (CREATES) Act of 2016 targets the right culprit: the poor regulatory drafting that permits possibly anticompetitive conduct to take place. Moreover, the bill refrains from creating a per se rule, instead implementing several features that should still enable brand manufacturers to legitimately restrict access to drug samples when appropriate.

In essence, Senator Lee’s bill introduces a third party (in this case, the Secretary of Health and Human Services) who is capable of determining whether an eligible generic manufacturer is able to comply with REMS restrictions — thus bypassing any bias on the part of the brand manufacturer. Where the Secretary determines that a generic firm meets the REMS requirements, the bill also creates a narrow cause of action for this narrow class of plaintiffs, allowing suits against certain brand manufacturers who — despite the prohibition on using REMS to delay generics — nevertheless misuse the process to delay competitive entry.

Background on REMS

The REMS program was introduced as part of the Food and Drug Administration Amendments Act of 2007 (FDAAA). Following the withdrawal of Vioxx, an arthritis pain reliever, from the market because of a post-approval linkage of the drug to heart attacks, the FDA was under considerable fire, and there was a serious risk that fewer and fewer net beneficial drugs would be approved. The REMS program was introduced by Congress as a mechanism to ensure that society could reap the benefits from particularly risky drugs and biologics — rather than the FDA preventing them from entering the market at all. It accomplishes this by ensuring (among other things) that brands and generics adopt appropriate safety protocols for distribution and use of drugs — particularly when a drug has the potential to cause serious side effects, or has an unusually high abuse profile.

The FDA-determined REMS protocols can range from the simple (e.g., requiring a medication guide or a package insert about potential risks) to the more burdensome (including restrictions on a drug’s sale and distribution, or what the FDA calls “Elements to Assure Safe Use” (“ETASU”)). Most relevant here, the REMS process seems to allow brands considerable leeway to determine whether generic manufacturers are compliant or able to comply with ETASUs. Given this discretion, it is no surprise that brand manufacturers may be tempted to block competition by citing “safety concerns.”

Although the FDA specifically forbids the use of REMS to block lower-cost, generic alternatives from entering the market (of course), almost immediately following the law’s enactment, certain less-scrupulous branded pharmaceutical companies began using REMS for just that purpose (also, of course).

REMS abuse

To enter into pharmaceutical markets that no longer have any underlying IP protections, manufactures must submit to the FDA an Abbreviated New Drug Application (ANDA) for a generic, or an Abbreviated Biologic License Application (ABLA) for a biosimilar, of the brand drug. The purpose is to prove to the FDA that the competing product is as safe and effective as the branded reference product. In order to perform the testing sufficient to prove efficacy and safety, generic and biosimilar drug manufacturers must acquire a sample (many samples, in fact) of the reference product they are trying to replicate.

For the narrow class of dangerous or highly abused drugs, generic manufacturers are forced to comply with any REMS restrictions placed upon the brand manufacturer — even when the terms require the brand manufacturer to tightly control the distribution of its product.

And therein lies the problem. Because the brand manufacturer controls access to its products, it can refuse to provide the needed samples, using REMS as an excuse. In theory, it may be true in certain cases that a brand manufacturer is justified in refusing to distribute samples of its product, of course; some would-be generic manufacturers certainly may not meet the requisite standards for safety and security.

But in practice it turns out that most of the (known) examples of brands refusing to provide samples happen across the board — they preclude essentially all generic competition, not just the few firms that might have insufficient safeguards. It’s extremely difficult to justify such refusals on the basis of a generic manufacturer’s suitability when all would-be generic competitors are denied access, including well-established, high-quality manufacturers.

But, for a few brand manufacturers, at least, that seems to be how the REMS program is implemented. Thus, for example, Jon Haas, director of patient access at Turing Pharmaceuticals, referred to the practice of denying generics samples this way:

Most likely I would block that purchase… We spent a lot of money for this drug. We would like to do our best to avoid generic competition. It’s inevitable. They seem to figure out a way [to make generics], no matter what. But I’m certainly not going to make it easier for them. We’re spending millions and millions in research to find a better Daraprim, if you will.

As currently drafted, the REMS program gives branded manufacturers the ability to limit competition by stringing along negotiations for product samples for months, if not years. Although access to a few samples for testing is seemingly such a small, trivial thing, the ability to block this access allows a brand manufacturer to limit competition (at least from bioequivalent and generic drugs; obviously competition between competing branded drugs remains).

And even if a generic competitor manages to get ahold of samples, the law creates an additional wrinkle by imposing a requirement that brand and generic manufacturers enter into a single shared REMS plan for bioequivalent and generic drugs. But negotiating the particulars of the single, shared program can drag on for years. Consequently, even when a generic manufacturer has received the necessary samples, performed the requisite testing, and been approved by the FDA to sell a competing drug, it still may effectively be barred from entering the marketplace because of REMS.

The number of drugs covered by REMS is small: fewer than 100 in a universe of several thousand FDA-approved drugs. And the number of these alleged to be subject to abuse is much smaller still. Nonetheless, abuse of this regulation by certain brand manufacturers has likely limited competition and increased prices.

Antitrust is not the answer

Whether the complex, underlying regulatory scheme that allocates the relative rights of brands and generics — and that balances safety against access — gets the balance correct or not is an open question, to be sure. But given the regulatory framework we have and the perceived need for some sort of safety controls around access to samples and for shared REMS plans, the law should at least work to do what it intends, without creating an opportunity for harmful manipulation. Yet it appears that the ambiguity of the current law has allowed some brand manufacturers to exploit these safety protections to limit competition.

As noted above, some are quite keen to make this an antitrust issue. But, as also noted, antitrust is a poor fit for handling such abuses.

First, antitrust law has an uneasy relationship with other regulatory schemes. Not least because of Trinko, it is a tough case to make that brand manufacturers are violating antitrust laws when they rely upon legal obligations under a safety program that is essentially designed to limit generic entry on safety grounds. The issue is all the more properly removed from the realm of antitrust enforcement given that the problem is actually one of regulatory failure, not market failure.

Second, antitrust law doesn’t impose a duty to deal with rivals except in very limited circumstances. In Trinko, for example, the Court rejected the invitation to extend a duty to deal to situations where an existing, voluntary economic relationship wasn’t terminated. By definition this is unlikely to be the case here where the alleged refusal to deal is what prevents the generic from entering the market in the first place. The logic behind Trinko (and a host of other cases that have limited competitors’ obligations to assist their rivals) was to restrict duty to deal cases to those rare circumstances where it reliably leads to long-term competitive harm — not where it amounts to a perfectly legitimate effort to compete without giving rivals a leg-up.

But antitrust is such a powerful tool and such a flexible “catch-all” regulation, that there are always efforts to thwart reasonable limits on its use. As several of us at TOTM have written about at length in the past, former FTC Commissioner Rosch and former FTC Chairman Leibowitz were vocal proponents of using Section 5 of the FTC Act to circumvent sensible judicial limits on making out and winning antitrust claims, arguing that the limits were meant only for private plaintiffs — not (implicitly infallible) government enforcers. Although no one at the FTC has yet (publicly) suggested bringing a REMS case as a standalone Section 5 case, such a case would be consistent with the sorts of theories that animated past standalone Section 5 cases.

Again, this approach serves as an end-run around the reasonable judicial constraints that evolved as a result of judges actually examining the facts of individual cases over time, and is a misguided way of dealing with what is, after all, fundamentally a regulatory design problem.

The CREATES Act

Senator Lee’s bill, on the other hand, aims to solve the problem with a more straightforward approach by improving the existing regulatory mechanism and by adding a limited judicial remedy to incentivize compliance under the amended regulatory scheme. In summary:

The bill creates a cause of action for a refusal to deal only where plaintiff can prove, by a preponderance of the evidence, that certain well-defined conditions are met.
For samples, if a drug is not covered by a REMS, or if the generic manufacturer is specifically authorized, then the generic can sue if it doesn’t receive sufficient quantities of samples on commercially reasonable terms. This is not a per se offense subject to outsized antitrust damages. Instead, the remedy is a limited injunction ensuring the sale of samples on commercially reasonable terms, reasonable attorneys’ fees, and a monetary fine limited to revenue earned from sale of the drug during the refusal period.
The bill also gives a brand manufacturer an affirmative defense if it can prove by a preponderance of the evidence that, regardless of its own refusal to supply them, samples were nevertheless available elsewhere on commercially reasonable terms, or where the brand manufacturer is unable to supply the samples because it does not actually produce or market the drug.
In order to deal with the REMS process problems, the bill creates similar rights with similar limitations when the license holders and generics cannot come to an agreement about a shared REMS on commercially reasonable terms within 120 days of first contact by an eligible developer.
The bill also explicitly limits brand manufacturers’ liability for claims “arising out of the failure of an [eligible generic manufacturer] to follow adequate safeguards,” thus removing one of the (perfectly legitimate) objections to the bill pressed by brand manufacturers.

The primary remedy is limited, injunctive relief to end the delay. And brands are protected from frivolous litigation by an affirmative defense under which they need only show that the product is available for purchase on reasonable terms elsewhere. Damages are similarly limited and are awarded only if a court finds that the brand manufacturer lacked a legitimate business justification for its conduct (which, under the drug safety regime, means essentially a reasonable belief that its own REMS plan would be violated by dealing with the generic entrant). And monetary damages do not include punitive damages.

Finally, the proposed bill completely avoids the question of whether antitrust laws are applicable, leaving that possibility open to determination by courts — as is appropriate. Moreover, by establishing even more clearly the comprehensive regulatory regime governing potential generic entrants’ access to dangerous drugs, the bill would, given the holding in Trinko, probably make application of antitrust laws here considerably less likely.

Ultimately Senator Lee’s bill is a well-thought-out and targeted fix to an imperfect regulation that seems to be facilitating anticompetitive conduct by a few bad actors. It does so without trampling on the courts’ well-established antitrust jurisprudence, and without imposing excessive cost or risk on the majority of brand manufacturers that behave perfectly appropriately under the law.

Archives For refusals to deal

The Commission’s Emerging Reassessment of Abuses of Dominance

How Will European Courts Respond?

What About the States?

Conclusion

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Introduction

Economic Actors Should Be Able to Choose Their Business Partners

Courts Are Ill-Equipped to Regulate the Kind of Forced Sharing Advocated by the States

Courts Should Not Expand Refusal-to-Deal Analysis Beyond the Narrow Circumstances of Aspen Skiing

Conclusion

Amici Scholars Signing on to the Brief

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Google’s big remedy win

Good news for whom?

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Exploitative Abuses

Predatory Pricing

Refusals to Deal

Vertical Restraints

Political Discretion in European Competition Law

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The district court bases its approach entirely on Microsoft — which it misinterprets in clear contravention of Supreme Court case law

Under Trinko and Aspen Skiing the district court’s finding of an antitrust duty to deal is impermissible

“Evasion of a competitive constraint” is not an antitrust-relevant refusal to deal

The district court’s foreclosure analysis also improperly relies on inferences in lieu of economic evidence

Conclusion

Joining ICLE on the brief are:

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Background on REMS

REMS abuse

Antitrust is not the answer

The CREATES Act

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