Antitrust Policy and Regulation Chapter 16. Antitrust Policy: Judgment by Performance or Structure?...

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Chapter 16Chapter 16

Antitrust Policy: Judgment by Performance or Structure?

• Antitrust policy is the government’s policy toward the competitive process.

• The two views of competition are judgment by performance and judgment by structure.


• Judgment by performance – we should judge the competitiveness of markets by the performance (behavior) of firms in the market.


• Judgment by structure – we should judge the competitiveness of markets by the structure of the industry.

History of U.S. Antitrust Laws

• Americans generally are in favor of laissez-faire and government noninvolvement in business.

• There has simultaneously been a populist sentiment that fears bigness and monopoly.


• Trusts and cartels burst forth in the late 1800s.• A trust or cartel is a combination

of firms in which the firms have not actually merged, but act as a single entity.


• A trust sets common prices and governs the output of individual member firms.

• A trust can, and often does act like a monopolist.


• In the 1870s and 1880s, trusts were being form in railroads, steel, tobacco, and oil, as well as in many other areas of the economy.


• John D. Rockefeller’s Standard Oil Company was the first and largest trust.

• As competitors were driven out of business, Standard Oil raised prices.


• When the oil trust was formed, Standard Oil used its monopoly power to close refineries, raise prices, and limit the production of oil.


• The price of oil rose from a competitive level to a monopolistic level thereby hurting the consumer as well as Standard Oil’s competitor’s.

The Sherman Antitrust Act

• Public outrage at the formation and activities of trusts such as Standard Oil led to the passage of the Sherman Act, the Clayton Act, and the Federal Trade Commission Act.


• The Sherman Antitrust Act of 1890 was a law designed to regulate the competitive process.


• Its two main provisions are:– “Every contract, combination in the

form of trust or otherwise, or conspiracy in restraint of trade or commerce . . . is declared to be illegal . . .”


• Its two main provisions are:– “Every person who shall monopolize, or attempt

to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce . . . shall be guilty of a misdemeanor . . .”


• The Sherman Act is broad and sweeping, but vague.

• Although the Act prohibits monopolization, it did not prevent monopolies.


• Congress designed the Act in such a way as to allow the courts to decide its meaning.


• Economists in the 1890s debated whether mergers reflected increased economies of scale or attempts to restrict output and generate monopoly profits?"


• Economists reflecting the performance viewpoint argued that competition was strong and it would ultimately limit monopolies.


• Economists reflecting the structure viewpoint argued that trusts should be broken by government because competition is fragile and needed a large number of small firms

The Standard Oil and American Tobacco Cases

• In 1911, the U.S. Supreme Court determined that both Standard Oil and American Tobacco were structural monopolies in that each controlled over 90 percent of their markets.


• In spite of this, they were not judged to have violated the Sherman Act because of their structure but because of their “unfair business practices.”


• This judgment on performance, not structure, is often called the abuse theory since a firm is legally considered a monopoly only if it commits monopolistic abuses.


• In the 1920 U.S. Steel case, the Court ruled that while company was a structural monopoly, it was not a monopoly in performance.

Clayton Act and Federal Trade Commission Act

• The Clayton Antitrust Act and the Federal Trade Commission Act were enacted in 1914.


• The Clayton Antitrust Act made four monopolistic practices illegal when their effect was to lessen competition:


– Price discrimination, that is, selling identical goods to different customers at different prices.

– Tie-in contracts in which the buyer must agree to deal exclusively with one seller and not to buy goods from competing sellers.

– Interlocking directorships in which memberships of boards of directors of two or more firms are almost identical.

– Buying stock in a competitor’s company when the purpose of buying that stock is to reduce competition.


• The Federal Trade Commission Act made it illegal for firms to use “unfair methods of competition.”

• It also made it illegal to engage in “unfair or deceptive acts or practices,” whether or not those actions had any effect on competition.


• The Federal Trade Commission was given little direction as to how to police markets and for about 20 years, it drifted.


• In 1938, Federal Trade Commission was given the job of preventing false and deceptive advertising which is one of its main functions today.

The ALCOA Case

• Judgment by performance was the criterion governing U.S. antitrust policy until the ALCOA case of 1945.

The ALCOA Case

• In this case, the Court ruled that although ALCOA had not been guilty of unfair practices the structure of the market which it dominated was unlawful.

The ALCOA Case

• ALCOA dominated the market in two ways:

– It used its knowledge of the market to expand its capacity before any competitor had a chance to enter the market.

– It kept prices low to prevent market entry.

Judging Markets by Structure and Performance: The Reality

• Judging by structure seems inherently unfair since the alleged wrongdoer is doing what it is supposed to be doing—producing the best product at the lowest possible price.

Judging Markets by Structure and Performance: The Reality

• Supporters of this position recognize this problem, but they nevertheless favor the structure criterion because of its practicality.

Contextual Judgments and the Capabilities of the Courts

• Judgment by performance requires that each action of a firm must be analyzed on a case-by-case basis.

• This is enormously expensive and time-consuming.

• Courts must find a way to limit the cases they look at.


• The Supreme Court provides guidelines that tell firms when the Court will take a closer look at their performance.

• These guidelines invariably refer to structure.


• Some argue that structure is a predictor of future performance.• A monopolist may be charging low

prices now.• Once the competition melts away, the

offending firm jacks up its prices.

Determining the Relevant Market and Industry

• The structural approach is not without faults.

• Choosing the relevant market when evaluating competitiveness is difficult to do.


• The relevant market in the ALCOA case was the aluminum market not the metals market at large.


• In the du Pont case (1956), the relevant market for cellophane was the flexible- wrap industry not the cellophane market of which du Pont owned 100 percent.

• Therefore, du Pont was not considered a monopolist.


• In the Pabst Brewing case (1966), the relevant market was judged to be the state of Wisconsin not the national market, thereby disallowing its merger with Blatz Brewing Company, another Wisconsin brewer.


• Both structure and performance criteria have ambiguities, and in the real world there are no definitive criteria for judging whether a firm has violated the antitrust statutes.

Recent Antitrust Enforcement

• In recent years, antitrust law has worked mainly through its deterrent effect.

• Many potential mergers are never even proposed because firms know the merger would not be allowed.


• The government has been more lenient recently in its interpretation for three reasons.


• Political pressure for antitrust action waned.

1. In the 1950s and 1960s, big business was considered “bad.”2. In the 1980s the ideology held that big business was “bad”

as well as “good.”3. International competition became fierce while domestic

competition created by U.S. market structure became less important.


• Technology was changing so fast that by the time litigation reached the courts, the issues were no longer relevant.

Three Recent Antitrust Cases

• The modern era of antitrust policy has been marked by important cases in the computer and telecommunications market.

The IBM Case

• In 1969, the U.S. Department of Justice sued IBM for violation of antitrust laws charging that the company was unfairly bundling hardware, software, and maintenance services on a take-it-or-leave-it basis (tie-in contracts).

The IBM Case

• The government also charged that IBM was constantly redesigning its hardware making it impossible for competitors to keep up.

The IBM Case

• IBM responded that the market was much larger than the government claimed and that fast-moving technology and customers’ desires forced it to constantly upgrade its equipment.

The IBM Case

• In 1982, the government dropped its suit because mainframe computers were replaced by PCs, and the globalization of the computer industry made IBM's dominance in the U.S. far less important.

The IBM Case

• The prosecution likely led to IBM’s problems in the 1990s.

• IBM refused to buy the DOS operating system from Microsoft because of the pending litigation, but allowed Microsoft to sell their DOS to anyone.

The IBM Case

• The PC market swelled while the mainframe market was dying making Microsoft the controlling force in the PC market.

The AT&T Case

• Up until 1982 AT&T controlled most long-distance and local telephone services and produced telephones and other communications equipment.

• It was considered a natural monopoly and was regulated by law.

The AT&T Case

• Natural monopoly – an industry in which significant economies of scale make the existence of more than one firm inefficient.

The AT&T Case

• AT&T was required to provide universal service so that it would not engage in cream skimming.

• Cream skimming – providing service to low-cost areas and avoiding high-cost areas.

The AT&T Case

• AT&T was regulated by the FCC and state utility commissions.

The AT&T Case

• AT&T’s expectation of “fair returns” gave them a strong incentive to act as a lazy monopolist and to invest heavily in new equipment thereby increasing costs and subsequently, profits.

The AT&T Case

• Technological change and competition changed the natural monopoly character of the phone industry.

The AT&T Case

• Satellite transmissions and fiber-optic cable turned AT&T into a traditional monopoly.

• Potential competitors sued because they felt AT&T was charging too much to gain access on their system.

The AT&T Case

• In 1978, the Justice Department sued AT&T on antitrust grounds.

• The suit was settled out of court in 1982.

The AT&T Case

• In 1984, AT&T agreed to be broken up into 22 operating firms called “Baby Bells”

• It kept its long-distance telephone service, manufacturing arm and Bell Laboratories.

The AT&T Case

• In return, AT&T was subject to much less regulation than before, including the right to enter any unregulated business it chose, such as data transmission and computers.

The AT&T Case

• This resulted in enormous upheaval in the industry.• Local telephone rates doubled and

tripled.• Two major competitors, MCI and

Sprint, developed.

The AT&T Case

• The telephone supply industry became competitive and cheap phones flooded the market.

The AT&T Case

• AT&T may have lost the antitrust case but it may have won the war—at least temporarily.

The AT&T Case

• Its entry into the computer market bombed, but it developed technology that could be used for two-way information transmittal.

The AT&T Case

• It became a potential competitor of cable TV monopolies since its fiber-optic networks could be used to transmit TV programming.

The AT&T Case

• It bought McCaw Communications, a cellular telephone company, making it a major player in the wireless communications market.

The AT&T Case

• It expanded into the Internet access supply market, becoming the largest Internet provider in 1996.

The AT&T Case

• As international telecommunications mergers take place, this market will be in enormous flux – flux that should continue over the next decade.

The AT&T Case

• There has been a globalization of the market.

– For example in 1996, British Telecom merged with MCI.

The AT&T Case

• Competitors are operating in new markets.

– In 1996, Worldcom, a long distance phone company bought MFS Communications, a local phone company, thereby becoming the first company to offer both local and long distance phone service since AT&T's breakup.

The Microsoft Case

• Microsoft is the dominant player in the software industry, controlling over 50 percent of the world market for software and between 80 and 90 percent of the operating systems market worldwide.

The Microsoft Case

• Since all software must be compatible with an operating system, Microsoft has an enormous competitive advantage for its other divisions.

The Microsoft Case

• The U.S. Justice department charged Microsoft with an antitrust violation:– Possessing monopoly power in the market for personal

computing operating systems.– Tying other Microsoft products to its Windows operating system.

The Microsoft Case

• The U.S. Justice department charged Microsoft with an antitrust violation:

– Entering into agreements that kept computer manufacturers that install Windows, from offering software that competes with Windows software.

The Microsoft Case

• Prosecutors were initially hesitant to bring charges until a judge offered the government an expedited process.

Is Microsoft a Monopolist?

• Monopolists need barriers to entry.

• The computer software industry has two sources – network externalities and economies of scale.


• Network externalities exist because as the number of applications supported by a single platform increase, the value of the platform also increases.


• Economies of scale exist because of the cost of developing a new platform and new software is significant while the cost of producing it is minimal.


• With its stable 90 percent market share, it certainly is a monopoly.

• But there are other operating systems, especially Linux, which are coming up fast on the outside.


• Another potential competitive force is the merging of software and hardware.

• Much of software can be delivered over the Internet.

• If this happens Microsoft may lose its competitive advantage.

Is Microsoft a Predatory Monopolist?

• By directing the development of in-house software to favor Windows, Microsoft strengthened the barrier to entry created by network externalities.


• Microsoft also penalized computer manufacturers that installed Windows if they installed competing software.


• Microsoft packaged Internet Explorer as part of Windows 95 at no additional cost to the buyer which froze out Netscape Navigator.


• Sun Microsystems was developing Java, a software language designed to create software applications on a variety of platforms not just Windows.

• Microsoft undermined the platform neutrality of Java by altering it despite agreeing not to do so.

Resolution of the Microsoft Case

• In late 1999, a federal judge ruled that Microsoft violated the Sherman Act by attempting to maintain its monopoly power by anti-competitive means.

• Microsoft has vowed to appeal the judge’s ruling and any court remedy.

Resolution of the Microsoft Case

• If operating systems do not matter, Microsoft’s advantage disappears along with the threat of litigation.

Assessment of Antitrust Policy

• Economists' assessment of antitrust policy is mixed.


• Most feel the IBM case went too far.

• However, most believe the Standard Oil and American Tobacco cases provided a healthy precedent by encouraging a more competitive business environment.


• Almost all economists agree that antitrust enforcement has not reduced the size of firms below the minimally efficient level, the level at which a firm can take full advantage of economies of scale.


• Performance advocates generally believe enforcement was not needed while structural advocates generally believe that it was.


• They are also mixed on their judgment about whether any type of antitrust action is feasible in a rapidly changing technological arena.

Mergers, Acquisitions, and Takeovers

• The industrial structure of the U.S. economy has changed significantly in the 1990s.


• In order to achieve economies of scope and economies of scale, firms have been simultaneously breaking up and merging.


• The law allows firms to break up any way they like.

• Mergers, on the other hand, must fall within the law's antitrust guidelines.


• Acquisitions and takeovers both result in the combining of firms.

Acquisitions and Takeovers

• The term merger is a general term meaning the act of combining two firms.

• Two types of mergers are takeover and acquisition.


• A takeover is the purchase of one firm by a shell firm that then takes control of the purchased firm’s operations.

• A shell corporation is one that exists primarily to buy up other firms.


• Most takeovers change the control over the firm, but do not affect market concentration.


• Another type of merger is an acquisition.

• An acquisition is a merger in which a company buys another company and the purchaser has the right of direct control over the resulting operation, but does not always exercise that right.


• Takovers can be friendly or hostile.• A friendly takeover is one in which one

corporation is willing to be acquired by the other.• A hostile takeover is a merger in which the firm

being taken over does not want to be taken over.


• In a hostile takeover, the shareholders ultimately decide whether to sell their shares.

Mergers

• There are three types of mergers: horizontal, vertical, and conglomerate.

Mergers

• A horizontal merger is the merging of two companies in the same industry.

• Most antitrust policy has centered on horizontal mergers.

Mergers

• Since the passage of the 1950 Cellar-Kefauver Act, almost all mergers of firms with substantial market shares in the same industry have been prohibited.

• “Substantial market shares” has different meanings.

Mergers

• For concentrated industries, the government would challenge all mergers involving the following combinations of market share:

Mergers

• For less concentrated industries, the guidelines were slightly different.

Mergers

• A vertical merger is a firm merging with the supplier of one of its inputs.

Mergers

• If the merged firms are able to limit access of other buyers or sellers to the market, the merger would be in violation of the Clayton Act.

Mergers

• In the 1980s, the U.S. government challenged any vertical merger in which the supplying firm had a 10 percent or more market share and the buyer company bought 6 percent or more of the market.

Mergers

• A conglomerate merger is the merging of two companies in unrelated industries.

Mergers

• Conglomerate mergers are generally approved by antitrust legislation under the assumption that they do not significantly restrict competition.

Mergers

• There are five reasons why unrelated firms would wish to merge.– To achieve economies of scope.

– To get a good buy.– To diversify.– To ward off a takeover bid.– To strengthen their political-economic influence.

Recent Merger Activity and De-acquisitions

• Globalization leads to mergers because firms can gain instant foreign distribution, knowledge of local markets, and lower the costs by redirecting production to low-cost areas.

Recent Merger Activity and Deacquisitions

• Deregulation has caused mergers to occur among banks, electricity, and telecommunications companies.


• Technological change has created takeover targets.

• If a firm wants a new technology it could buy the firm that owns it.


• The merged companies did not necessarily become larger.

• Companies spin off parts of their business where they do not think they have a competitive advantage.


• Regulators sometimes will not let mergers to go through without a de-acquisition program.

• De-acquisitions occur when a firm sells parts of another company it has bought or parts of itself.

Assessment of Mergers and Acquisitions

• Assessment of mergers and acquisitions is mixed because mergers have good and bad effects.

Mergers in the United States Since 1892

Num

ber

of m

erge

rs(L

ogar

ithm

ic s

cale

)

9,000

6,5005,0003,000

2,000

1,000

0 1900 1920 1940 1960 1980 2000

International Competition

• The internationalization of the U.S. economy is changing the political climate in the U.S.

• Antitrust policymakers now view that the relevant market is the international market.


• The policy focus is shifting:– From: “Is U.S. industry internally competitive so

that it does not take advantage of the consumer?”– To: “Is U.S. industry internationally competitive so

that it can compete effectively in the world economy?”

Antitrust Policies in Other Countries

• Antitrust legislation in other countries is much weaker than that in the U.S.

• No other country forces companies to break up for antitrust violations.

Antitrust Policies in Other Countries

• Other countries oppose antitrust laws because of economies of scale, lack of a strong ideology supporting competition, and strong cultural ties between government and business.


• From Antitrust Policy to Industrial Policy– U.S. policy is slowly shifting toward

allowing mergers and cartels that will strengthen the U.S. internationally and will actively encourage cooperation among U.S. firms.


• From Antitrust Policy to Industrial Policy– The practice of cooperation among

competitors has become known as – co-opetition.


• Activist Industrial Policy– An industrial policy is a government’s

formal policy toward business.


• Activist Industrial Policy– The government always has had and

always will have an industrial policy per se.


• Activist Industrial Policy– What some politicians want is an

activist industrial policy by which the government will provide funds, background research, and encouragement to businesses to keep them internationally competitive.


• Two arguments for an activist industrial policy are:– That it will create gains from

cooperation among firms.– That it will channel funds to high-

growth industries.

Regulation, Government Ownership, and Industrial

Policies

• Governments can affect the competitive process by:– Regulating the activities of firms.– Taking direct charge of the firms and

owning them directly.– Industrial policy – influencing firms with

laws and taxes.

Regulation

• The two types of regulation are 1. pricing regulation and 2. social regulation.

Regulation

• Pricing regulation is regulation directed at industries that have natural monopoly elements.

Regulation

• In order to allow them to take advantage of economies of scale, firms are given an exclusive right to conduct business, but are subject to pricing controls.

– Examples include the FCC and the FERC.

Regulation

• Problems with pricing regulation include:

– Regulated firms have little incentive to hold down costs.

– Regulatory boards are often made up of individuals from the industry being regulated.

– Industries that could very well compete desire to be declared natural monopolies.

Regulation

• All these criticisms have led to significant deregulation over the past twenty years.

Social Regulation

• Social regulation concerns with the conditions under which goods and services are produced, the quality of those goods, and the side effects of production on society.

Social Regulation

• Social regulation affects large aspects of all aspects of business: working conditions, the quality of the products, and the production process firms are allowed to use.

• Social regulation has increased substantially.

Regulation

• Some economists argue that this is bad.

– The regulatory costs outweigh the social benefits derived from the regulation.

– Regulations are poorly written and ambiguous.– Regulatory burdens become unbearable for

small firms.

Regulation

• Others argue that this is good.

– The benefits outweigh the costs.– Better regulation is needed.

Government Ownership

• Government ownership is when government takes over the entire operations of a firm.


• European governments had a history of taking over large industries and running them themselves.


• Sadly, they found out that government ownership precluded keeping costs down and introducing new technology.


• Workers in government-owned firms were guaranteed jobs, and used political threats to hold their wages high.


• The economic integration of Europe has been accompanied by theprivatization of many of the formerly government-owned industries.

Industrial Policies

• In the 1980s and early 1990s, some politicians argued that the country needs an industrial policy modeled on Japan's MITI.

• When Japan's economy began to shrink in the 1990s, cries for the policy ceased.

Industrial Policies

• In a way the U.S. has always had an industrial policy.

• It is embedded in the tax code, its laws, regulatory structure, and negotiations with foreign nations regarding tariffs and trade.

Industrial Policies

• Many close connections between and business have developed over the years:

– The military-industrial complex.– Government-drug complexes.– Government-higher education complexes.– Government-high tech complexes.

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Antitrust Policy and Regulation Chapter 16. Antitrust Policy: Judgment by Performance or Structure?...

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