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Antitrust Basics Teleconference Series

Exclusionary Conduct by Dominant Firms Under Section 2 of the Sherman Act

Presentation byPresentation by

Professor Andrew I. GavilProfessor Andrew I. Gavil

Howard University School of LawHoward University School of Law

Of Counsel, Sonnenschein Nath & Rosenthal LLPOf Counsel, Sonnenschein Nath & Rosenthal LLP

October 17, 2006October 17, 2006

Copyright Andrew I. Gavil, 2006

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Outline of Presentation

1.1. Legal FrameworkLegal Framework of Section 2 of Section 2

2.2. Overview of the Overview of the Economics of ExclusionEconomics of Exclusion

3.3. Some Recent Some Recent Case StudiesCase Studies

4.4. The Section 2 The Section 2 Standards DebateStandards Debate

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Part I:Traditional Legal Framework for

Evaluating Exclusionary Strategies by Dominant Firms Under Section 2

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Legislation: Single Firm Conduct

U.S. – Sherman Act Section 2U.S. – Sherman Act Section 2 Three OffensesThree Offenses

MonopolizationMonopolizationAttempt to MonopolizeAttempt to MonopolizeConspiracy to MonopolizeConspiracy to Monopolize

E.U. – Article 82E.U. – Article 82 ““abuse of dominant position”abuse of dominant position” Some specifically prohibited practicesSome specifically prohibited practices

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Traditional Section 2 Elements

MonopolizationMonopolization Monopoly PowerMonopoly Power Willful Acquisition or Willful Acquisition or

MaintenanceMaintenance

Attempt to MonopolizeAttempt to Monopolize Specific IntentSpecific Intent Exclusionary ConductExclusionary Conduct Dangerous Probability Dangerous Probability

of Successof Success

Common ElementsCommon Elements:

Market Power (“Big”)+

Exclusionary Conduct (“Bad”)

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Section 2 Synthesis

Mere size not enoughMere size not enough Conduct is essential elementConduct is essential element

But notBut not luck, skill, foresight, superior product, or luck, skill, foresight, superior product, or business acumenbusiness acumen

BUT…size matters:BUT…size matters: "[B]ehavior that might otherwise not be of concern to "[B]ehavior that might otherwise not be of concern to

the antitrust laws--or that might even be viewed as the antitrust laws--or that might even be viewed as procompetitive--can take on exclusionary connotations procompetitive--can take on exclusionary connotations when practiced by a monopolist."when practiced by a monopolist."

Kodak v. Image Tech., 504 U.S. 451, 488 (1992) ( (Scalia,, J., J., dissenting).dissenting).

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Proving Market Power Circumstantial Evidence – Three StepsCircumstantial Evidence – Three Steps

1)1) Define relevant marketDefine relevant market (product and (product and geographic)geographic)

CellophaneCellophane cross-elasticity test cross-elasticity test Merger Guidelines - SSNIPMerger Guidelines - SSNIP

2)2) Calculate Calculate Market SharesMarket Shares3)3) Infer Market PowerInfer Market Power from Large Share from Large Share

For Monopolization > 70%For Monopolization > 70% For Attempt > 40-50%For Attempt > 40-50%

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Proving Market Power II Direct Evidence (Developing Trend?)Direct Evidence (Developing Trend?)

Direct MeasuresDirect Measurese.g. demand elasticity, econometric analysise.g. demand elasticity, econometric analysis

Actual ExerciseActual Exercise of Market Power of Market PowerE.g., higher prices, actual exclusionE.g., higher prices, actual exclusion

• Must both effects be “market-wide”?Must both effects be “market-wide”?

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Market Power in Aftermarkets

Kodak v. Image Tech., 504 U.S. 451 (1992) Installed base opportunismInstalled base opportunism Information & switching costsInformation & switching costs Controversial and debated caseControversial and debated case

But see Harrison Aire v. Aerostar, 423 F.3d 374 (3d Cir. 2005) Limits of Limits of KodakKodak No power where all costs knownNo power where all costs known

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Exclusionary Conduct

Predatory Pricing (Matsushita/Brooke Group)Predatory Pricing (Matsushita/Brooke Group) Pricing below some measure of costPricing below some measure of cost

Sacrifice of Sacrifice of all profitsall profits Probability of recoupmentProbability of recoupment

Non-Price Exclusionary Conduct (Aspen/Kodak)Non-Price Exclusionary Conduct (Aspen/Kodak) Competition on some basis other than Competition on some basis other than

efficiencyefficiency ““Unnecessarily” restrictive effectsUnnecessarily” restrictive effects

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Part II:The Economics of Exclusion

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The Economic Issue

Antitrust 101Antitrust 101: Relationship Between Power and Entry : Relationship Between Power and Entry (Cartels (Cartels andand Single Firms) Single Firms) Can’t exercise market power without controlling entryCan’t exercise market power without controlling entry Restricting one’s own output vs. restricting the output Restricting one’s own output vs. restricting the output

of rivalsof rivals When/how can exclusion/impairment of a rival create or When/how can exclusion/impairment of a rival create or

help to maintain power over some element of competition help to maintain power over some element of competition (e.g. price, innovation)?(e.g. price, innovation)?

CreateCreate MaintainMaintain Prevent ErosionPrevent Erosion

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Involuntary Cartel: Restricting Rival Access to Supply

Firm A

Suppliers

Buyers

X

Firm CFirm B

1. Firms A and B are colluding,;

2. Firm C either refuses to join Firms A & B, or Firms A & B arenot interested in inviting C to join;

3. Firms A & B solicit their suppliers to refuse to sell to Firm C,or at least to refuse to sell to Firm C on equal terms.

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Involuntary Cartel: Restricting Rival Access to Customers

Firm A

Suppliers

Buyers

X

Firm CFirm B

1. Firms A and B are colluding,;

2. Firm C either refuses to join Firms A & B, or Firms A & B arenot interested in inviting C to join;

3. Firms A & B solicit their customers to refuse to purchase dealwith Firm C, or at least to refuse to purchase from Firm C onequal terms.

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Exclusion: Theme and Variations Price -- Increased output in short term; decreased output in Price -- Increased output in short term; decreased output in

long termlong term Above Cost Simple Discounts & RebatesAbove Cost Simple Discounts & Rebates Predatory Pricing & Predatory OverbuyingPredatory Pricing & Predatory Overbuying

Non-Price -- Decreased output possible in short term (No Non-Price -- Decreased output possible in short term (No losses or immediate recoupment)losses or immediate recoupment)

Refusals to DealRefusals to Deal Exclusive DealingExclusive Dealing Tying/BundlingTying/Bundling Product DisparagementProduct Disparagement Abuse of Category ManagementAbuse of Category Management Other strategic conductOther strategic conduct

MixedMixed Loyalty Discounts, Bundled Product Discounts, Rewards & Incentives tied to Loyalty Discounts, Bundled Product Discounts, Rewards & Incentives tied to

degrees of exclusivitydegrees of exclusivity

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The Economic Dilemma

For Price CasesFor Price Cases What is an “What is an “appropriate measure of cost”appropriate measure of cost”?? When is When is recoupment probablerecoupment probable??

For Non-Price CasesFor Non-Price Cases When is above cost conduct fairly characterized When is above cost conduct fairly characterized

as “as “exclusionaryexclusionary”?”?““Exclusion” vs. “exclusionary”Exclusion” vs. “exclusionary”Hard competition Hard competition vs.vs. “predation” “predation”

Are the two categories sufficiently distinct? Are the two categories sufficiently distinct? Should we have a unitary test?Should we have a unitary test?

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Section 2 Safe Harbors Insufficient Market PowerInsufficient Market Power

Less than a VERY large market shareLess than a VERY large market share No Substantial Barriers to EntryNo Substantial Barriers to Entry

No significant impact on rivals’ costs/outputNo significant impact on rivals’ costs/output MOST competitive strategies are protectedMOST competitive strategies are protected::

Lower pricesLower prices Improve qualityImprove quality Exploit greater efficiencyExploit greater efficiency InnovateInnovate

No offense of “Leveraging”No offense of “Leveraging” Absent Attempt Elements Absent Attempt Elements Little government enforcement; few winning private casesLittle government enforcement; few winning private cases

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Areas of Controversy

High Profile Issues (AMC List; DOJ/FTC High Profile Issues (AMC List; DOJ/FTC Hearings; EC Discussion Paper; ABA Programs)Hearings; EC Discussion Paper; ABA Programs)

Refusals to dealRefusals to deal• Essential FacilitiesEssential Facilities

Bundling and Bundled PricingBundling and Bundled Pricing• Loyalty Discounts, Rewards & IncentivesLoyalty Discounts, Rewards & Incentives• Often tied to Often tied to degrees of exclusivitydegrees of exclusivity

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Part III:Some Recent Case Studies

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Predatory Pricing

U.S. v. AMR, 335 F.3d 1109 (10U.S. v. AMR, 335 F.3d 1109 (10thth Cir. Cir. 2003) (S/J for 2003) (S/J for ∆)∆) ConductConduct: : Capacity ShiftingCapacity Shifting in response to new in response to new

entry (flights/seats)entry (flights/seats)No debate that result was exit of new entrant No debate that result was exit of new entrant

and higher pricesand higher prices Analyzed as Analyzed as predatory pricingpredatory pricing IssueIssue: What is an “appropriate measure of : What is an “appropriate measure of

cost”?cost”?

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Predatory Pricing Cont’d

GoalGoal: Marginal (“incremental”) costs: Marginal (“incremental”) costs Surrogates? AVCSurrogates? AVC ProblemProblem: Integrating : Integrating accountingaccounting and and

economic economic measuresmeasures Court Rejected Four DOJ Proposed TestsCourt Rejected Four DOJ Proposed Tests

Poor surrogatesPoor surrogates for incremental cost for incremental cost Best MeasureBest Measure? Maybe AVC, but no ? Maybe AVC, but no

definitive answerdefinitive answer

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Predatory Pricing -- Circuit Split?

Spirit Airlines v. Northwest Airlines, 431 Spirit Airlines v. Northwest Airlines, 431 F.3d 917 (6F.3d 917 (6thth Cir. 2005) (cert almost Cir. 2005) (cert almost pending – 06-77 and 06M7)pending – 06-77 and 06M7) Reverses S/J for Reverses S/J for ∆∆ Evidence of below cost pricing sufficient Evidence of below cost pricing sufficient

to go to trialto go to trial Above Cost Pricing Can Still be Above Cost Pricing Can Still be

PredatoryPredatory

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Predatory Overbuying:Case to Watch

Siletz Indians v. Weyerhaeuser, 411 F.3d 1030 (9th Cir. 2005)

Cert granted, No. 05-381 Predatory Pricing Std Inapplicable to Predatory Pricing Std Inapplicable to

Predatory OverbiddingPredatory OverbiddingNo need for sacrifice of all profitNo need for sacrifice of all profitNo need for probability of recoupmentNo need for probability of recoupment

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Refusals to Deal

Trinko (U.S. 2004)Trinko (U.S. 2004) FRCP 12(b)(6)FRCP 12(b)(6) Refusal to Refusal to assist assist

rivalrival not actionable not actionable ExceptionException: : AspenAspen

prior dealingprior dealingprofit sacrificeprofit sacrifice

• Correct?Correct?

Covad (D.C.Cir. 2005)Covad (D.C.Cir. 2005) FRCP 12(b)(6)FRCP 12(b)(6) Applies Applies TrinkoTrinko re re

refusals to assist refusals to assist rival, BUTrival, BUT

Refusals to Refusals to deal deal with customer of with customer of rivalrival are actionable are actionable

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Refusals to Deal, Cont’d Context MattersContext Matters

Regulation focused on competition (Regulation focused on competition (TrinkoTrinko)) Statutory compulsion to deal (Statutory compulsion to deal (TrinkoTrinko))

When ActionableWhen Actionable?? Disruption of previous (and presumptively profitable) course of Disruption of previous (and presumptively profitable) course of

dealing (dealing (AspenAspen)) Sacrifice of Profits in Dealings with customers/suppliers of rivals Sacrifice of Profits in Dealings with customers/suppliers of rivals

((CovadCovad)) TrinkoTrinko mischaracterize mischaracterize AspenAspen??

Essential FacilityEssential Facility Theory? Theory? Very narrow if it is still viableVery narrow if it is still viable

Limits of Limits of TrinkoTrinko:: Trinko Trinko marginalized result in marginalized result in AspenAspen, but did not , but did not directly address definition of “exclusionary”directly address definition of “exclusionary”

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Bundled Rebates/Exclusivity

LePage's Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003) -- -- Bundled RebatesBundled Rebates AnalysisAnalysis::

NOT same as predatory pricingNOT same as predatory pricing More akin to non-price exclusionary conduct, esp. More akin to non-price exclusionary conduct, esp.

exclusive dealingexclusive dealing Could eliminate equally efficient rivalCould eliminate equally efficient rival Anticompetitive effect and No justificationAnticompetitive effect and No justification

In EU see In EU see Michelin IIMichelin II and Discussion paper and Discussion paper Other cases to watch: AMD v. Intel; Broadcom v. Other cases to watch: AMD v. Intel; Broadcom v.

Qualcomm (recently dismissed)Qualcomm (recently dismissed)

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Exclusive Dealing

U.S. v. Dentsply, 399 F.3d 181 (3d Cir. 2005)U.S. v. Dentsply, 399 F.3d 181 (3d Cir. 2005) Exclusive Dealing Agreements with Prefab Tooth Exclusive Dealing Agreements with Prefab Tooth

Mfr’s Dealers were exclusionaryMfr’s Dealers were exclusionary Limited customer choiceLimited customer choice and competition and competition Alternative distribution channelsAlternative distribution channels were less efficient were less efficient Raised Raised Barriers to EntryBarriers to Entry No business justificationNo business justification

NicSand, Inc. v. NicSand, Inc. v. 3M Co3M Co.,., 457 F.3d 534 (6457 F.3d 534 (6thth Cir. Cir. 2006) (reversing dismissal of complaint) 2006) (reversing dismissal of complaint)

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Judicial Approaches to Exclusion: Some Critical Factors

Characterized & Analyzed as Characterized & Analyzed as Non-Price Exclusionary ConductNon-Price Exclusionary Conduct

Substantial monopoly powerSubstantial monopoly power Actual anticompetitive effectsActual anticompetitive effects

On prey, andOn prey, and On consumers/competitionOn consumers/competition

Difficult EntryDifficult Entry Defendant failed to show Defendant failed to show

business justificationsbusiness justifications

Characterized as Predatory Characterized as Predatory PricingPricing

Lack of monopoly power Lack of monopoly power Absence of exclusivity Absence of exclusivity Above Cost PricingAbove Cost Pricing Business Justifications ?Business Justifications ?

Not Clear that Burden Shifted Not Clear that Burden Shifted to Defendant to Demonstrate to Defendant to Demonstrate

Maybe PresumedMaybe Presumed

When Plaintiff Prevailed When Defendant Prevailed

Reminiscent of old style Rule of Reason vs. Per Se Battles?

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Easy and Hard Cases

The Easy CasesThe Easy Cases Significant anticompetitive Significant anticompetitive

effectseffects AND AND little or no little or no efficiencyefficiency

““Cheap Exclusion”Cheap Exclusion”• Harm to comp.Harm to comp.• Little cost to Little cost to ∆∆• Little benefit to Little benefit to ∆∆

Significant efficienciesSignificant efficiencies AND AND little or no little or no anticompetitive effectsanticompetitive effects

The Hard CasesThe Hard Cases Significant productive Significant productive

efficiencyefficiency AND AND SignificantSignificant allocative inefficiency allocative inefficiency (exercise of market power)(exercise of market power)

Formula for controversy Formula for controversy throughout antitrustthroughout antitrust

Rule of reasonRule of reason MergersMergers MonopolizationMonopolization

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Refining the Question for Antitrust Counselors

When can a monopolist lawfully purchase exclusivity? Presumptively lawful if above cost? Presumptively unlawful if:

Excludes rivals (must rivals be “equally efficient?) Probability of long-term harm to consumers?

Should inquiry focus on: Impact on monopolist alone? Impact on Rivals and Consumers? Practices of less dominant rivals? What kinds of effects in what degrees matter?

What shifts a burden of production to the monopolist to justify?

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Current Status: “Test” Wars ““No Economic Sense” TestNo Economic Sense” Test

Would conduct have made NES but for its exclusionary Would conduct have made NES but for its exclusionary effect?effect?

Profit SacrificeProfit Sacrifice Did conduct involve Did conduct involve sacrifice of profitsacrifice of profit?? Related to NESRelated to NES

Balancing/DisproportionalityBalancing/Disproportionality Were effects Were effects predominantly anti or pro-competitivepredominantly anti or pro-competitive? ?

(Section 2 rule of reason?)(Section 2 rule of reason?) Choosing the Right Choosing the Right Welfare StandardWelfare Standard

Are producer and consumer welfare equals?Are producer and consumer welfare equals?

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Understanding the Debate

The “The “StandardStandard” is “” is “exclusionary conductexclusionary conduct”” The The DebateDebate is over the is over the TESTTEST The GoalThe Goal::

Economically soundEconomically soundMinimize false positives and negativesMinimize false positives and negatives““Unitary” test may not be advisableUnitary” test may not be advisable

AdministrableAdministrable by Courts by Courts PredictablePredictable for Firms for Firms Unitary Concepts Unitary Concepts ≠ Unitary Test≠ Unitary Test

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Some Suggested Sources

DOJ/FTC HearingsDOJ/FTC Hearings AMC Hearings AMC Hearings EC Discussion paperEC Discussion paper ABA Section Comments to AMCABA Section Comments to AMC

http://www.abanet.org/antitrust/at-comments/2006/06-06/http://www.abanet.org/antitrust/at-comments/2006/06-06/exclusionary-conduct.shtmlexclusionary-conduct.shtml

ALJ Symposium, 73/2 (2006)ALJ Symposium, 73/2 (2006)

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The End!