INTERESTS OF AMICUS CURIAE[1]

The International Center for Law & Economics (“ICLE”) is a nonprofit, non-partisan global research and policy center aimed at building the intellectual foundations for sensible, economically grounded policy.  ICLE promotes the use of law & economics methodologies to inform public policy debates and has longstanding expertise in the evaluation of antitrust law and policy.  ICLE has an interest in ensuring that antitrust promotes the public interest by remaining grounded in sensible legal rules informed by sound economic analysis.

Amici also include five scholars of antitrust, law, and economics.  Their names, titles, and academic affiliations are listed in the Addendum.  All have longstanding expertise in, and have done extensive research in, the fields of antitrust law and economics.

Amici have an interest in ensuring that antitrust law remains grounded in clear rules, established precedent, record evidence, and sound economic analysis.  The district court’s decision erodes such foundations by focusing on the number of competitors rather than the impact on competition.  Overall, amici have a profound interest in an intellectually coherent antitrust policy focused upon safeguarding competition itself.[2]

INTRODUCTION

Over a century ago, the Supreme Court wisely recognized that “[t]he true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition.”  Bd. of Trade of Chi. v. United States, 246 U.S. 231, 238 (1918).  Echoing that foundational insight, the district court opinion (the “Opinion”) opened by posing, “This case turns on what ‘competition’ means,” only to proceed by applying a flawed analysis of the Sherman Act and governing authority.  ADD10.[3]

The Opinion launches its scrutiny of the NEA by positing as an aim of federal antitrust law the fostering of “participation by a diverse array of competitors.”  Id.  But the Opinion provides no citation or clarification for this proposition, which is at odds with the Opinion’s later recognition that the antitrust laws are concerned with competition, not the specific competitors.  See ADD68 (“[T]he Sherman Act ‘unequivocally’ establishes a policy favoring and protecting competition.”).  The Opinion further leaves out that “consumer welfare” is the touchstone of antitrust analysis, not the health of any particular array of competitors.  See Concord v. Bos. Edison Co., 915 F.2d 17, 21 (1st Cir. 1990); see also Apex Hosiery Co. v. Leader, 310 U.S. 469, 500-01 (1940).

This amicus brief addresses three fundamental failings of the Opinion, each of which requires reversal:  First, the Opinion equates the simple reduction in the number of competitors by one with a fatal (and illegal) reduction in competition.  Second, the Opinion analyzes the Northeast Alliance (“NEA”), involving specific operations focused on New York, New Jersey, and Boston, as a horizontal merger.  Finally, the Opinion subjected the NEA to an inappropriate, truncated review rather than a full rule of reason analysis.

This Court should reverse the district court’s faulty application of key competition law principles.  A counting exercise tallying autonomous rivals is not what matters under the Sherman Act; rather, the focus is on an economic process that assesses impacts on “material progress.”  N. Pac. Ry. Co. v. United States, 356 U.S. 1, 4 (1958).  Getting the competition definition right matters greatly, as everything else follows from that foundation.  An opportunity to reiterate and cement proper understandings seldom appears; seizing this occasion is imperative.

ARGUMENT

I.              Alliances Are Not of Themselves Synonymous With Anticompetitive Harm

Inherent in any joint venture is some degree of restraint on the direct competition between the joint venture parties themselves as they create a single venture with the goal of greater competition against other competitors and better results for consumers, usually through increased output or improved products or services at competitive prices.  See Fed. Trade Comm’n & Dep’t of Justice, Antitrust Guidelines for Collaboration Among Competitors (April 2000) at 2 (hereinafter “Collaboration Guidelines”) (“[P]articipants in a collaboration typically remain potential competitors, even if they are not actual competitors for certain purposes (e.g., R&D) during the collaboration.”) (emphasis added).  As Appellant’s brief summarizes, through the NEA, the two airlines here achieved exactly those goals of increasing output and enhancing the quality of services without any demonstrated price increases, such that consumer welfare was greatly enhanced in a procompetitive fashion, notwithstanding that on certain routes they were no longer direct competitors.  App. Br. 6-14.

Throughout, the Opinion’s analysis is skewed by the notion that “the number of competitors has literally decreased by one,” which the Opinion treats as an intrinsically intolerable “assault on competition.”  ADD43, ADD92.  Simply put, the Opinion improperly conflates “competition” with “number of competitors,” effectively ignoring established legal authority and economics confirming that safeguarding the overall competitive process is the paramount means for maximizing consumer welfare—not preserving an existing market structure with a particular number of rivals.  As this Court has long held:

[T]he Court recognizes that the antitrust laws exist to protect the competitive process itself, not individual firms. [citations omitted] And the antitrust laws protect the competitive process in order to help individual consumers by bringing them the benefits of low, economically efficient prices, efficient production methods, and innovation.

Grappone, Inc. v. Subaru of New Eng., 858 F.2d 792, 794 (1st Cir. 1988) (Breyer, J.) (collecting cases, including Brown Shoe and Broad. Music, Inc.).

The Opinion’s treatment of the mere reduction of competitors by one on NEA routes in favor of a limited, regional collaboration as an “assault on competition” infected all of the Opinion’s analysis of the impact of the collaboration, and this error independently requires reversal.  Economics and binding precedent caution that static market shares and a mere reduction in the number of competitors do not constitute a basis for condemnation absent proof that prices increased, output decreased, or quality suffered.  See, e.g., Ohio v. Am. Express Co., 138 S. Ct. 2274, 2288 (2018) (“This Court will ‘not infer competitive injury from price and output data absent some evidence that tends to prove that output was restricted or prices were above a competitive level.’” (citing Brooke Grp. Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 237 (1993))).

A.            Joint Ventures Depend on Collaboration to Increase Consumer Welfare

The Opinion concludes that there will be future competitive harm based on a minor reduction in competitors without requiring a showing—despite the “tidal wave of evidence” (ADD12)—that output diminished or prices increased.  Such a showing is an essential prerequisite to render concentration economically meaningful.  See Am. Express Co., 138 S. Ct. 2274 at 2284 (“Direct evidence of anticompetitive effects would be ‘proof of actual detrimental effects’ . . . such as reduced output, increased prices, or decreased quality . . .”) (citations omitted).  The Opinion is rife with statements demonstrating that the loss of one competitor on regional routes was dispositive here—the ultimate thumb on the scales:

• “First, the NEA has eliminated the once vigorous competition between two of the four largest domestic carriers in the northeast . . .” ADD76 (underlining in original).
• “This, in and of itself, is a fundamental assault on competition and an actual harm the Sherman Act is designed to prevent . . . .” ADD77.
• “Eliminating potential competition is, by definition, anticompetitive.” Id. (quoting Impax out of context).
• “As explained already, the overarching purpose of the NEA is anticompetitive. Through the NEA, American and JetBlue cease to compete and, instead, operate as a single carrier in the northeast.  That it is the core of the relationship, and it is a naked assault on competition.”

Such quick and premature condemnation of business collaborations on flimsy theories of concentration and alleged loss of independent decision-makers contravenes the precedent of this Court and of other circuit courts.  See, e.g., Augusta News Co. v. Hudson News Co., 269 F.3d 41, 47 (1st Cir. 2001) (under rule of reason, “adverse effects on consumer welfare are an important part of the equation” and that “it is hard to imagine a rule of reason violation absent a potential threat to the public”); Marucci Sports, L.L.C. v. Nat’l Collegiate Athletic Ass’n, 751 F.3d 368, 377 (5th Cir. 2014) (“A restraint should not be deemed unlawful, even if it eliminates a competitor from the market, so long as sufficient competitors remain to ensure that competitive prices, quality, and service persist.”) (emphasis added); Rebel Oil Co. v. Atl. Richfield Co., 51 F.3d 1421, 1433 (9th Cir. 1995) (“reduction of competition does not invoke the Sherman Act until it harms consumer welfare”).  Such summary disposition virtually assures penalizing or prohibiting beneficial alliances that advantage consumers and enhance consumer choice.

As the Collaboration Guidelines have recognized for over two decades, “collaborations often are not only benign, but procompetitive.”  Collaboration Guidelines at 2.  Further, the Collaboration Guidelines emphasize, in the first sentence of the preamble, that “[i]n order to compete in modern markets, competitors sometimes need to collaborate.”  Id. at 1; see also id. at 6 (“A collaboration may allow its participants to better use existing assets, or may provide incentives for them to make output-enhancing investments that would not occur absent the collaboration.  The potential efficiencies from competitor collaborations may be achieved through a variety of contractual arrangements including joint ventures . . . .”).  Notably, the Opinion largely ignores the Collaboration Guidelines and their explication of the benefits of joint ventures, citing them only in passing as a “see also” for the proposition that “some collaborations” should be treated like “complete or partial merger[s].”  ADD69.  In the Opinion’s take on the Collaboration Guidelines, the tail wags the dog.

The Collaboration Guidelines are consistent with established Supreme Court precedent recognizing the common benefits of competitor collaborations, even as they require specific, limited collaboration rather than competition between enterprises that are otherwise competitors.  See Nat’l Collegiate Athletic Ass’n v. Alston, 141 S. Ct. 2141, 2155 (2021) (“[M]any joint ventures are calculated to enable firms to do something more cheaply or better than they did it before.  And the fact that joint ventures can have such procompetitive benefits surely stands as a caution against condemning their arrangements too reflexively.”) (citation omitted); Texaco Inc. v. Dagher, 547 U.S. 1, 6 n.1 (2006) (recognizing the “economic justifications,” “numerous synergies and cost efficiencies” resulting from a joint venture).

And this Court has recognized that “bona fide joint ventures”—like the U.S.-Department-of-Transportation-approved NEA here—allow two competitors to pool their resources to “provide offerings” that neither “could easily provide by itself.”  Augusta News, 269 F.3d at 48.  This Court’s articulation in Augusta News of the joint venture providing offerings that neither partner “could easily provide by itself” is a more permissive standard than the Opinion’s jaded view requiring a joint venture to pool “complementary assets.”  ADD93; see also id. (“[T]he defendants have not established their pooled assets are ‘complementary,’ . . . such that they enable the defendants to create an innovative product”).

The Opinion seems to hold that for a joint venture to overcome its intrinsic “assault on competition” it must produce something novel, as opposed to enhancing competition (through better service or greater output) against other competitors.  Rejecting the NEA’s plaintiffs-conceded, pro-competitive benefits, the Opinion notes that “other firms (Delta and United), acting independently, already offer ‘products’ comparable to the one they claim their collaboration will enable . . .”   ADD92; see also id. (“Collaboration between the defendants is not required in order to create a new product or market that could not otherwise exist.”).  But under the Sherman Act and the Collaboration Guidelines, horizontal joint ventures are not held to a “Eureka!” novel-creation standard.

Notably, the DOJ’s Collaboration Guidelines expressly contemplate a similar asset-collaboration.  Collaboration Guidelines at 31.  In Example 6, two major software producers—neither of which was a “major competitor” of the two dominant firms in the word-processing software market—joined forces “to develop a markedly better word-processing program together than either [could] produce on its own.”  Id.  This combination was “an efficiency-enhancing integration of economic activity that promotes procompetitive benefits.”  Id.  So too with the NEA.

Indeed, if combinations were held to a novel-creation standard, the joint venture analyzed by the Supreme Court in Dagher for refining and selling gasoline in the western states (where Texaco and Shell previously competed) could not have survived scrutiny.  547 U.S. at 4 (describing Texaco and Shell Oil joint venture agreement as “ending competition between the two companies in the domestic refining and marketing of gasoline”).  The Supreme Court not only accepted as lawful a joint venture between two companies that were previously direct competitors (547 U.S. at 4 n1.), but also ruled that even the joint venture’s price-setting was not subject to per se treatment, citing the combination’s overall procompetitive benefits.  Id. at 8 (“[T]he pricing decisions of a legitimate joint venture do not fall within the narrow category of activity that is per se unlawful.”).

In insisting that American and JetBlue create something novel, i.e., not offered by competitors like Delta or United, or contribute only “complementary” assets to the NEA to do something each could not have done on its own, the Opinion is unsupported by legal authority and should be reversed.

B.            The Proof Is in the Pudding, Not in the Number of Rivals

By enshrining the mere independence of competitors above actual competitive performance and by failing to examine the NEA’s actual consumer welfare effects, the Opinion unjustifiably penalized the NEA’s consumer-enhancing aspects.  See ADD94-ADD95 (recognizing that NEA allowed for certain benefits, such as better route scheduling, but faulting parties because such benefits occurred through parties “cooperat[ing] in ways that horizontal competitors normally would not”).  Indeed, the Opinion sharply (and repeatedly) minimizes or ignores altogether tangible evidence regarding NEA-generated network expansions, connectivity optimization, increased service frequencies to underserved airports, enhanced schedule optionality, reciprocal loyalty benefits, and codesharing conveniences enhancing routing choices.  See ADD30 (noting, without further acknowledging, that the NEA-generated services and benefits “extend to most of the carriers’ flights to and from Logan, JFK, LaGuardia, and Newark”).

Moving beyond the reduction of competitors on certain routes, the proof was in the pudding of the extensive trial record.  The evidence demonstrated that the NEA (1) increased capacity by more than 200% at NEA airports (2-JA1293),
(2) offered almost 50 new nonstop routes, (3) increased their frequency on over 130 routes, and (4) increased their capacity on 45 New York City flights (2-JA1367-68).  In fact, the record shows that the NEA well-exceeded the growth commitments for 2022 and beyond to which American and JetBlue had agreed with the Department of Transportation to obtain its blessing.  See 2-JA821.

But the Opinion rejected all of these procompetitive, consumer-friendly benefits because, in its view, they were the result of the “unlawful” reduction of competitors by one.  The Opinion’s rejection of these benefits was erroneous and in contravention to settled authority.  See United States v. Interstate Commerce Comm’n, 396 U.S. 491, 523 (1970) (affirming dismissal of complaint challenging railroad merger where “the long-run effect of the merger would be to benefit communities . . . , and that the brief and transitory dislocations the merger would occasion were not sufficient to outweigh the merger’s benefits”); Penn-Central Merger & N & W Inclusion Cases, 389 U.S. 486, 500-01 (1968) (affirming dismissal of competitor suits opposing merger, noting that evidence showed merger would benefit general public, allowing “the unified company to ‘accelerate investments in transportation property and continually modernize plant and equipment . . . and provide more and better service’”).  The Opinion’s singular focus was also contrary to the Collaboration Guidelines, which state that, even in cases where the number of competitors drops, “the evaluating Agency would take account of . . . any procompetitive benefits . . .  under present circumstances, along with other factors.”  Collaboration Guidelines at 29-30.

This Court has the opportunity to underscore that, under federal antitrust law, efficiency assertions deserve a balanced assessment in calculating net effects, rather than the cramped disposal through summary scapegoating of innovative integration models that occurred in the Opinion (ADD88-ADD99).  See Cont’l T.V. v. GTE Sylvania, 433 U.S. 36, 49 (1977) (under rule of reason, “the fact-finder weighs all of the circumstances of a case in deciding whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition”); see also Am. Express Co., 138 S. Ct. at 2290 (affirming judgment for defendants where plaintiffs could not show anticompetitive effects and thus “failed to satisfy the first step of the rule of reason”); Leegin Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 886 (2007) (“In its design and function the rule [of reason] distinguishes between restraints with anticompetitive effect that are harmful to the consumer and restraints stimulating competition that are in the consumer’s best interest.”).

II.           THE DISTRICT COURT ERRED BY TREATING THE NEA’S LIMITED REGIONAL COLLABORATION LIKE A FULL-ON HORIZONTAL MERGER

One of the core flaws permeating the Opinion’s analysis is its effective adoption of the plaintiffs’ view that the NEA should be analyzed as a merger— comprehensively eliminating the rivalry between American and JetBlue—instead of a joint venture.  See ADD37 (“Nevertheless, as implemented by the parties, its effects resemble those of a merger of the parties’ operations within the northeast . . . .”), ADD38 (“[T]hey function like a single airline in the NEA region, as much as possible.”), ADD40 (faulting airlines for adjusting certain nationwide priorities, including American’s deprioritizing Philadelphia for New York and JetBlue pausing plans for growth in Fort Lauderdale); ADD46 (faulting JetBlue for supposedly increasing its operating costs).  But contrary to the Opinion’s suggestion (ADD69), not even the Collaboration Guidelines support the Opinion’s analysis.  See, e.g., Collaboration Guidelines at 5 (“The competitive effects from competitor collaborations may differ from those of mergers due to a number of factors.”).

A.            The NEA Is a Limited Regional Joint Venture That Preserved Each Participant’s Pricing Decisions Even Within the Region

The Opinion’s merger-like view of the regional collaboration ignored or downplayed important distinctions between the NEA’s operation and those of a national merger of competitors, not the least of which was that American and JetBlue maintained independent pricing.  See ADD77 (“American and JetBlue do not discuss the fares they will set . . . .”).  More generally, the NEA is structured like the archetypical limited joint venture, including (1) a fixed scope and duration, (2) no asset transfer, (3) no price coordination, and (4) separate management and business strategies, even in the NEA’s market.  See ADD27-ADD37; see also id. at ADD37 (“Both [American and JetBlue] have operations that fall beyond the NEA’s reach, and the agreement does not formally embody a complete combination of the partners’ operations even within the NEA region.”).

Critically, each airline retained control over routes not covered, with flexibility in responding through tactical fare adjustments even within the Northeast region.  See 1-JA572 (“Q. And do you ever discuss capacity outside the Northeast Alliance with American.  A. Absolutely not.”)); ADD30 (noting that each partner “will continue to make independent decisions regarding pricing, capacity, and network management”).

These characteristics, among many others, make it inappropriate and legal error for the Opinion to analyze the NEA effectively as a horizontal merger.  See, e.g., Addamax Corp. v. Open Software Found., 152 F.3d 48, 52 (1st Cir. 1998) (when “there is patently a potential for a productive contribution to the economy, [] conduct that is strictly ancillary to this productive effort (e.g., the joint venture’s decision as to the price at which it will purchase inputs) is evaluated under the rule of reason”).

B.            Joint Ventures Offer Unique, Pro-Competitive Benefits

The Opinion’s treatment of the NEA as a merger and not a limited joint venture was error, particularly given that joint ventures such as the NEA offer unique benefits, often superior both to firms operating independently and to a merger.  Joint ventures and mergers differ substantially in structure, scope, competitive impacts, and efficiency gains.  Whereas mergers combine entire firms under common ownership and control, joint ventures allow companies to “pool a portion of their resources within a common legal organization” through partnership, while still operating as independent entities.  See Bruce Kogut, Joint Ventures: Theoretical and Empirical Perspectives, 9 Strategic Mgmt. J. 319, 319 (1988).  The remaining independence is what distinguishes joint ventures from mergers.  See Herbert Hovenkamp & Phillip E. Areeda, Antitrust Law: An Analysis of Antitrust Principles and Their Application, ¶2100c (5th ed. 2022) (“[J]oint ventures are calculated to enable firms to do something more cheaply or better than they did it before” making them “presumably efficient.”).  This allows greater flexibility to renegotiate or unwind collaborations without the permanence of an acquisition.  Joint ventures allow valuable collaboration and access to partners’ knowledge without requiring a permanent, fully integrated merger that may be costly to reverse.  See Srinivasan Balakrishnan & Mitchell P. Koza, Information Asymmetry, Adverse Selection and Joint-Ventures: Theory and Evidence, 20 J. Econ. Behav. & Org. 99, 103 (1993).

Joint ventures also frequently have a narrower objective than mergers, focusing on specific areas rather than seeking complete integration across all business functions.  In the case of the NEA, the focus areas were increased service frequencies to underserved airports, enhanced schedule optionality in the face of tight FAA regulations and limited gate availability, and reciprocal loyalty benefits in one geographic location.  ADD30.  And by maintaining separate pricing decisions (ADD77), the NEA could realize productive efficiencies for the parties and consumers from collaboration, asset pooling, and knowledge sharing without the potential anticompetitive effects of an outright merger.

Economic theory and experience suggest that joint ventures pose fewer anticompetitive concerns because they do not reduce the number of independent competitors in a market, contrary to the Opinion.  For example, Gugler & Siebert find that mergers and joint ventures in the semiconductor industry increased participating firms’ market shares on average, identifying net efficiency gains allowing the participating firms to win more of the market.  As such, joint ventures represent desirable alternatives to mergers from a consumer welfare perspective.  See Klaus Gugler & Ralph Siebert, Market Power Versus Efficiency Effects of Mergers and Research Joint Ventures: Evidence from the Semiconductor Industry, 89 Rev. Econ. Stat. 645, 646 (2007).  By maintaining separate ownership and pricing control, joint ventures allow firms to pool assets and improve productivity while preserving more market participants.  Thus, the structure enables collaboration without the consolidated market power of an outright merger.  This further highlights the key differences between joint ventures and full integration through acquisition, which the Opinion misses entirely.

III.        JOINT VENTURES LIKE THE NEA REQUIRE FULL RULE OF REASON ANALYSIS—NOT QUICK LOOK OR SHORT CUTS

Finally, the Opinion incorrectly concluded that agreements between competitors that reduce the number of market participants was “especially harmful.”  ADD83.  The Opinion then subjected the NEA to an inappropriate truncated style of review, tantamount to the “quick look” approach the Opinion claimed to recognize was not in fact permitted here.  See ADD75.  Rather than conduct a full rule of reason analysis, the Opinion holds that as to the NEA, “no deep and searching analysis is required in order to discern its unlawfulness.”   ADD76 (going so far as to state that “the NEA is situated ‘at one end of the competitive spectrum’”)); see also ADD87 (indicating that NEA could be deemed unreasonable “in the twinkling of an eye”).  Nowhere does the Opinion conduct the required weighing of the competitive benefits identified by Appellant against presumed, long-run risks alleged by the plaintiffs.  See Dagher, 547 U.S. at 5 (rule of reason “presumptively applies” absent per se violations).

A.            In Dagher, the Supreme Court Confirmed the Presumptive Application of Rule of Reason to Joint Ventures

In Dagher—under similar facts to here—the Supreme Court overturned a decision by the Ninth Circuit condemning the practices of a gasoline refining and sales joint venture, Equilon Enterprises, set up by oil giants Shell and Texaco in the western region of the United States.  As the Supreme Court explained, the district court had rejected plaintiffs’ request to apply quick look, and at summary judgment had upheld the joint venture’s challenged activities procompetitive.  547 U.S. at 4.  The Ninth Circuit reversed, characterizing the position of the petitioners as seeking an exception to the per se prohibition on price fixing.  Id. 

In confirming that the rule of reason applied to the joint venture’s challenged activities, the Supreme Court unambiguously stated that “this Court presumptively applies rule of reason analysis, under which antitrust plaintiffs must demonstrate that a particular contract or combination is in fact unreasonable and anticompetitive before it will be found unlawful.”  Id. at 5 (emphasis added).  The Court specifically rejected applying per se or anything other than full, rule of reason scrutiny to Equilon, effectively rejecting any sort of Topco-like suggestion that there should be “an especially heavy burden on the collaborators to justify what otherwise would be obviously unlawful collusion.”  ADD14; see also Dagher, 547 U.S. at 5 (“These cases do not present such an agreement, however, because Texaco and Shell oil did not compete with one another in the relevant market—namely, the sale of gasoline to service stations in the western United States—but instead participated in the market jointly through their investments in Equilon.”).  The Court was also clear that any challenge to the formation of the joint venture itself would need to prove that “its creation was anticompetitive under the rule of reason.”  Id. at 6 n.1.

Here, the district court transgressed the fundamentals of Dagher and other Supreme Court authority on joint ventures by dispensing with the NEA based on a truncated analysis.  See Alston, 141 S. Ct. at 2155 (rejecting a “quick look” analysis for the challenged joint venture and affirming that “[m]ost restraints challenged under the Sherman Act—including most joint venture restrictions—are subject to the rule of reason”); Broad. Music, Inc. v. Columbia Broad. Sys., Inc., 441 U.S. 1, 23 (1979) (per se rule does not apply to all agreements between competitors, “[j]oint ventures and other cooperative arrangements are also not usually unlawful”).  Only by insisting on disciplined economic welfare-based analysis—not conclusory structural shortcuts—can this Court correct methodological shortfalls and realign doctrine in this Circuit to safeguard innovative joint ventures that enhance consumer choice and welfare.

B.            “Quick Look” Analysis Applies Only to a Narrow Category Of Agreements That Does Not Include the NEA

Beyond Dagher and other Supreme Court authority, since at least 1978 the Supreme Court, in decisions like Professional Engineers, has carefully confined the application of truncated “quick look” analysis.  “Quick look” analysis is reserved for that limited category of restraints where genuinely anticompetitive effects are so intuitively obvious that “no elaborate industry analysis is required to demonstrate the anticompetitive character of such an agreement.”  Nat’l Soc’y of Prof’l Eng’rs. v. United States, 435 U.S. 679, 692 (1978); see Alston, 141 S. Ct. at 2155 (noting that joint venture restrictions are subject to rule of reason).

Such cases typically feature overt, horizontal output restrictions, price agreements, or naked market divisions devoid of cognizable efficiencies.  In Professional Engineers, it was a bidding agreement that “operates as an absolute ban on competitive bidding.”  435 U.S. at 692.  The NEA—with its established output expansion and consumer choices—falls far outside such restrictions.

And it remains equally settled that where defendants provide plausible justifications that a practice enhances overall efficiency and makes markets more competitive, per se and quick look approaches must end and full rule of reason procedures must begin.  As the Supreme Court has explained, “per se rules are appropriate only for ‘conduct that is manifestly anticompetitive,’ . . . that is, conduct ‘that would always or almost always tend to restrict competition and decrease output.’”  Bus. Elecs. v. Sharp Elecs., 485 U.S. 717, 723 (1988) (internal citation omitted) (citing cases); see also Fed. Trade Comm’n v. Ind. Fed’n of Dentists, 476 U.S. 447, 458-59 (1986) (“[W]e have been slow . . . to extend per se analysis to restraints imposed in the context of business relationships where the economic impact of certain practices is not immediately obvious.”).  Numerous decisions underscore that quick-look bypassing of comprehensive balancing is permissible only for “agreements whose nature and necessary effect are so plainly anticompetitive that no elaborate study of the industry is needed.”  Nat’l Soc’y of Prof’l Eng’rs, 435 U.S. at 692.

C.            The Opinion Erred by Not Applying Full Rule of Reason Review

While the Opinion stated it “declines to apply per se analysis,” the Opinion intimates that its approach was effectively per se.  See ADD83 (“deliberate market allocation inherent in the NEA is strong evidence of its actual anticompetitive effect”).  Given the wide gap between the NEA and per se agreements, the Opinion was without legal basis “to conclude that the NEA is situated ‘at [one] end[] of the competitive spectrum” such “that no deep and searching analysis is required in order to discern its unlawfulness.”   ADD76 (citing Alston, 141 S. Ct. at 2155).

Instead, when business collaborations between competitors incorporate sets of tradeoffs, immediate condemnation remains wholly improper without balanced vetting.  The default rule of Dagher requires a full rule of reason analysis, given intrinsic efficiency possibilities.  547 U.S. at 5.  Reasoned scrutiny becomes imperative for collaborations with facially plausible claims of providing new products, penetrating untreated geographic segments, optimizing scheduling, capturing scale economies, or administering loyalty programs more seamlessly than individual participants could achieve alone.  See ADD30 (noting such NEA arrangements).

The airline context poses heightened calls for caution before neutralizing innovative business formats with a quick look, because alliances there can generate acknowledged consumer value through coordinated flight timing, codesharing, reciprocal lounge privileges, baggage handling, and enhanced network connectivity.  See ADD100 (competing domestic carriers “commonly” make arrangements for codesharing and loyalty reciprocity to benefits consumers); ADD25 (the West Coast International Alliance includes codesharing and reciprocal benefits); see also ADD27 (no other domestic airline joint venture has received antitrust scrutiny).

In no sense does the NEA fit into the category of agreements that are so facially anticompetitive that they merit a presumption of illegality.  Rather, the NEA reflects efforts to construct integrated national networks—responding in part to consumer choice expansion pressures from low-cost carrier growth, and in part to competitive pressures from other major carriers in the region.  See ADD21 (“It is against this backdrop of industry consolidation, in this competitive landscape . . . that the agreement at issue here arose.”).  The NEA established intricate revenue-sharing calculations, reciprocal loyalty programs, coordinated scheduling committees, and joint corporate customer arrangements—all premised on maximizing efficiency and reducing operational costs.  See 1-JA342, 1-JA348, 2-JA1224-25.

These provisions aimed at forging a unified domestic connector system warrant more than a quick look before abandoning them as hopeless.  Indeed, the Opinion accepted that the NEA generated capacity increases at slot-constrained airports in the Northeast region, while expressing concern “that capacity growth within the NEA comes at the expense of resources and output by the defendants elsewhere, as well as evidence the defendants each would have pursued at least some of this growth with or without the partnership.”  ADD95-ADD96.  Neither theoretically nor actually did the NEA reflect a naked restraint on output or pricing.  The important point is not to settle whether there was a net capacity increase or a reallocation that increased consumer welfare.  The important point is that, at minimum, such contractual complexities command a balanced rule of reason review rather than a truncated analysis through thinly substantiated assumptions.

By dispensing with the NEA with an abbreviated analysis, the Opinion departed from binding case-law.  See Alston, 141 S. Ct. at 2155 (joint ventures “are subject to the rule of reason, which (again) we have described as ‘a fact-specific assessment of market power and market structure’ aimed at assessing the challenged restraint’s ‘actual effect on competition’”) (citing Am. Express Co., 138 S. Ct. at 2284); Augusta News, 269 F.3d at 48 (“[I]t is commonly understood today that per se condemnation is limited to ‘naked’ market division agreements, that is, to those that are not part of a larger pro-competitive joint venture.”).

CONCLUSION

Because the district court equated competition to the number of competitors, effectively treated the NEA erroneously as a horizontal merger, and applied an improper, truncated analysis far short of a full rule of reason analysis, this Court should reverse the judgment of the district court and vacate the permanent injunction.

[1] Under Rule 29(a)(4)(E) of the Federal Rules of Appellate Procedure, amici certify that (i) no party’s counsel authored the brief in-whole or in-part; (ii) no party or a party’s counsel contributed money that was intended to fund preparing or submitting the brief; and (iii) no person, other than amici or its counsel, contributed money that was intended to fund preparing or submitting the brief.

[2] All parties have consented to the filing of this brief.

[3] “ADD” refers to the Addendum attached to the Appellant’s Brief.  “JA” refers to the Joint Appendix filed with the Appellant’s Brief.

Abstract

The Global Antitrust Institute (“GAI”) provided comments to the U.S. Federal Trade Commission (“FTC”) in response to the FTC’s proposal to make significant amendments to the rules governing premerger notification under the Hart-Scott-Rodino Antitrust Improvements Act. The proposal will, if implemented, substantially increase burdens on all merging parties, regardless of whether the transaction reported poses an anticompetitive risk. In Section I we review the market for corporate control and the benefits it can have for effective firm management, allocative efficiency of economic resources, and consumer welfare. In Section II we explain how, contrary to the FTC’s view, the proposed changes will significantly increase the burden imposed on filing parties. This will impede the market for corporate control and consequently reduce productivity and inhibit innovation in other markets. In Section III we highlight potential conflicts between the proposed rule amendments and the Administrative Procedures Act.

Abstract

The economic theory of the firm teaches that vertical (and complementary goods) mergers differ fundamentally from horizontal mergers. Given incomplete contracting at arm’s length, improved coordination post-merger tends to increase competition and improve market outcomes in the case of vertical merger but tends to lessen competition and degrade market outcomes in the case of horizontal merger. Countervailing effects can of course reverse these tendencies, but rational merger analysis should take the fundamental differences of merger types into account.

The economic analysis of Section II.5 of the Draft Merger Guidelines (DMGs) conveys a rational—though incomplete—antitrust treatment of vertical mergers based on sound economic analysis. The one glaring omission in Section II.5 is the absence of any discussion of the elimination of double marginalization (EDM)—a feature typically inherent to vertical mergers and thus a procompetitive effect rather than an exogenous efficiency requiring separate evidence and analysis. EDM arises from improved coordination between the merging parties, with the salutary effect of increasing competition in the relevant market. EDM can manifest as improvements in the merged firm’s product price or non-price features. We urge the Agencies to add a discussion of EDM to Section II.5 of the DMGs.

Section II.6 of the DMGs, however, stands in stark contradiction to the economic analysis in Section II.5. The market-share threshold for a presumption of harm in Section II.6 has no support in either economics or legal precedent, and the “plus factors” when the presumption threshold is not triggered offer no reliable indication of competitive harm. We urge the Agencies to entirely eliminate Guideline 6 and the material in Section II.6 from the DMGs.

Emergence of the ‘Neo-Brandeisians’

Thus, matters unfolded until the curtain began to descend on the second Obama term in 2016. In the midst of presidential primary season, a targeted political challenge to the prevailing economic approach to antitrust first came to light. No one has yet clearly identified who was doing the targeting, but the March 26, 2016 edition of The Economist magazine included an article that suggested U.S. firms were earning excessive profits because new entry was blocked by monopoly abuses and by “lobbying” to obstruct competition. The Economist suggested scrutiny of U.S. antitrust policy as one item on a broad list of suggested remedies.

Read the full piece here.

The Evolution of FTC Antitrust Enforcement – Highlights of Its Origins and Major Trends

1910-1914 – Creation and Launch

The election of 1912, which led to the creation of the Federal Trade Commission (FTC), occurred at the apex of the Progressive Era. Since antebellum times, Grover Cleveland had been the only Democrat elected as president. But a Democratic landslide in the 1910 midterms during the Taft administration substantially reduced the Republicans’ Senate majority and gave the Democrats a huge majority in the House, signaling a major political shift. Spurred by progressive concern that Standard Oil—decided in 1911—signaled judicial leniency toward trusts and monopolies, government control of big business became the leading issue of the 1912 campaign. Both the progressive Democrats and the so-called Republican “insurgents” favored stronger antitrust laws, reduced hours and an antitrust exemption for workers, and closer federal regulation of banking and currency, among other items. Progressive agendas led both Woodrow Wilson’s “New Freedom” platform and the “New Nationalism” of former Republican President Theodore Roosevelt and his Bull Moose Party.

Read the full piece here.

Abstract

The EC has proposed a regulatory framework for SEPs, the heart of which is the establishment of a regulatory authority—a “competence center”—charged with maintaining a registry of SEPs with detailed information drawn from required submissions by SEP holders and “administering a system for essentiality checks and processes for aggregate royalty determination and FRAND determination.” The proposal’s stated aim is to facilitate licensing negotiations between SEP holders and implementers, applying a balanced approach towards the bargaining parties. The approach is highly unbalanced, however. It would sharpen incentives for holdout by implementers and thereby substantially weaken SEP holders’ ability to appropriate the value of their IP. In particular, implementers would be empowered to substantially delay requests by SEP holders for injunctive relief against infringement in national courts of law. It is a truism that justice delayed is justice denied. Likewise, IP rights delayed are IP rights denied. Beyond delay, the Proposal would entirely bar the recovery of some losses from infringement in certain circumstances. As a result, the practical effect of the Proposal would be to induce licensing disputes where there would otherwise have been none, supplanting private bargaining with a less well-informed and inefficient administrative process that would materially depress incentives for innovation and standardization.

IDENTITY AND INTEREST OF AMICUS CURIAE AND SOURCE OF AUTHORITY TO FILE BRIEF

The International Center for Law & Economics (“ICLE”) is a nonprofit, nonpartisan, global research and policy center aimed at building the intellectual foundations for sensible, economically grounded policy. ICLE promotes the use of law and economics methodologies, and economic findings, to inform public policy, and has longstanding expertise in antitrust law.

Amici also include 28 scholars of antitrust, law, and economics at leading universities and research institutions across the United States. Their names, titles, and academic affiliations are listed in Appendix A. All amici have extensive expertise in antitrust law and economics, and several served in senior positions at the Federal Trade Commission or the Antitrust Division of the Department of Justice.

Amici have an interest in ensuring that courts and agencies correctly apply the standards for evaluating horizontal and vertical mergers, and take into account the benefits commonly associated with vertical mergers.        

Amici ‌are authorized to file this brief by Fed. R. App. P. 29(a)(2) because all parties have consented to its filing.

RULE 29(a)(4)(e) STATEMENT

Amici hereby state that no party’s counsel authored this brief in whole or in part; that no party or party’s counsel contributed money that was intended to fund the preparation or submission of the brief; and that no person other than amicus or its counsel contributed money that was intended to fund the preparation or submission of the brief.

INTRODUCTION AND SUMMARY OF ARGUMENT

The FTC’s decision to require Illumina to divest Grail rests on at least two misguided premises. The first is that the same scrutiny applies to both horizontal and vertical mergers. The second is that benefits typically associated with vertical mergers do not apply here.

A horizontal merger combines firms that compete in the same relevant market, which necessarily reduces the number of firms engaged in head-to-head competition and may eliminate substitutes. That reduction inherently tends to increase prices, but the price effect may be trivial.  In addition, market responses (competitive repositioning or new entry) or other benefits of the merger (savings in transaction and other costs, enhanced investment incentives) may neutralize or offset the impetus to higher prices. But because those benefits are not automatic (and the reduction of direct competition is), they must be proven rather than assumed if the merger otherwise poses a significant risk of anticompetitive effects.

A vertical merger, in contrast, combines firms with an upstream-downstream (e.g., seller-buyer) relationship—that is, “firms or assets at different stages of the same supply chain.” Dep’t of Justice, Antitrust Division and FTC, Vertical Merger Guidelines 1 (2020). Examples include a manufacturer’s acquiring a distributor or a firm providing a manufacturing input.

The economic consequences of combining complements rather than substitutes are fundamentally different. Whereas the first-order effect of a horizontal merger is upward pricing pressure, the first-order effect of a vertical merger is downward pricing pressure. Vertical mergers typically entail the elimination of double marginalization (“EDM”), which is akin to downward pricing pressure (and often considered alongside efficiencies). David Reiffen & Michael Vita, Comment: Is There New Thinking on Vertical Mergers? 63 Antitrust L.J. 917, 920 (1995). Vertical integration also typically internalizes externalities in research and development, resulting in greater investment. Henry Ogden Armour & David J. Teece, Vertical Integration and Technological Innovation, 62 Rev. Econ. & Stat. 470 (1980). Like horizontal mergers, vertical mergers often confer other benefits such as operational and transactional efficiencies. Dennis W. Carlton, Transaction Costs and Competition Policy, 73 Int’l J. Indus. Org. 1 (2019); Oliver Williamson, The Economic Institutions of Capitalism 86 (1985).

Thus, while both types of mergers can create benefits from cost savings, their intrinsic effects move in opposite directions: higher prices and less investment with horizontal mergers, and lower prices and more investment with vertical mergers.

1. The FTC’s conclusion that the same scrutiny applies to horizontal and vertical mergers, Opinion 75, conflicts with precedent (and long-standing economic research). Courts and economists alike recognize that vertical integration typically is procompetitive, and it is widely accepted that vertical mergers and horizontal mergers should be evaluated under different presumptions. As the leading antitrust treatise puts it, “[i]n the great majority of cases no anticompetitive consequences can be attached to [vertical integration], and injury to competition should never be inferred from the mere fact of vertical integration.” 3B Phillip Areeda & Herbert Hovenkamp, Antitrust Law ¶?755a (4th ed. 2017). That vertical mergers can be anticompetitive—under specific facts and circumstances—does not establish that vertical integration is likely to be anticompetitive (it is not) or that there is no useful antitrust distinction between vertical and horizontal mergers (there is).

The Commission did not simply presume that this vertical merger would be anticompetitive, however. It also discounted both the likelihood of efficiencies in vertical mergers and specific evidence of efficiencies associated with the already-consummated merger. As a result, the Commission did not properly assess the likely competitive effects of the merger.

2. The Commission also disregarded evidence of a current and operative constraint on any potential anticompetitive effects of the merger. Illumina’s Open Offer appears to be contractually binding, and addresses the risk of foreclosure that is the primary competitive concern here. Proper consideration of the Open Offer should have shifted the Commission further away from presuming harm. Instead, the Commission gave it no weight.
3. The existing standards for vertical merger scrutiny are informed by, and consistent with, economic research regarding vertical mergers and other forms of vertical integration. That research shows that the Commission was wrong to hold that vertical and horizontal mergers should be analyzed identically, and wrong to disregard the well-established benefits of vertical integration. While economic theory indicates that vertical mergers can be anticompetitive, the weight of the empirical evidence overwhelmingly indicates that they tend to be procompetitive or competitively neutral. Indeed, the large majority of vertical mergers that have been studied have been found to be procompetitive or benign. That suggests that case-specific evidence is paramount in assessing both potential anticompetitive effects and countervailing pro-consumer efficiencies.

ARGUMENT

I.    Vertical and Horizontal Mergers Should Be Scrutinized Differently.

A.  Prima Facie Standards and the Government’s “Ultimate Burden” Differ in Horizontal and Vertical Merger Cases.

Courts have long recognized that horizontal and vertical mergers are categorically different. “As horizontal agreements are generally more suspect than vertical agreements,” courts are “cautious about importing relaxed standards of proof into vertical agreement cases.” Republic Tobacco v. North Atlantic Trading Co., 381 F. 3d 717, 737 (7th Cir. 2004). Thus, for vertical mergers, “unlike horizontal mergers, the government cannot use a shortcut to establish a presumption of anticompetitive effect.…” United States v. AT&T, Inc., 916 F.3d 1029, 1032 (D.C. Cir. 2019) (“AT&T II”). In a vertical merger case, “the government must make a fact-specific showing that the proposed merger is likely to be anticompetitive,” and the “ultimate burden of persuasion… remains with the government at all times.” Id. (emphasis added; cleaned up).

As the ALJ’s Initial Decision (ID) recognized (at 132), the burden-shifting approach is not bound by any specific, sequential form. Then-Judge Thomas stressed in United States v. Baker Hughes, 908 F.2d 981, 984 (D.C. Cir. 1990), that “[t]he Supreme Court has adopted a totality-of-the-circumstances approach…, weighing a variety of factors to determine the effects of particular transactions on competition.” As the ALJ aptly put it, the Baker Hughes “‘burden-shifting language’” provides “‘a flexible framework rather than an air-tight rule’”; “in practice, evidence is often considered all at once and the burdens are often analyzed together.” ID 132 (quoting Chicago Bridge & Iron Co. v. FTC, 534 F.3d 410, 424-24 (5th Cir. 2008)).

The differential treatment of vertical and horizontal mergers parallels the Supreme Court’s vertical restraints jurisprudence. The potential anticompetitive effects of vertical restraints are similar to those posed by vertical mergers, as both obtain between firms at different levels of the supply chain.

Over time, the Supreme Court has eliminated per se condemnation for vertical restraints. In 1977, the Court rejected per se illegality for vertical non-price restraints, Cont’l T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 49, 52 n.19, 58 (1977) (overruling United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967)), later confirming that “a vertical restraint is not illegal per se unless it includes some agreement on price or price levels.” Bus. Elecs. Corp. v. Sharp Elecs. Corp., 485 U.S. 717, 735-36 (1988). Eventually, the Court repudiated the last vertical per se prohibition—of vertical minimum price restraints. Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877 (2007) (overruling Dr. Miles Med. Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911)). In these decisions, the Court emphasized that any departure from the evidence-specific rule of reason “must be based on demonstrable economic effect, rather than . . . upon formalistic line drawing.” Bus. Elecs., 485 U.S. at 724.

These decisions reflect a nearly categorical repudiation of presumptions of illegality in dealings involving entities at different levels of the supply chain. Here, however, the Commission took the opposite approach, presuming anticompetitive effect while rejecting the significance of rigorously established benefits in a way that approaches a per se standard. This Court should reject that departure from sound law and economics.

B.  The FTC Did Not Undertake the Necessary Fact-Specific Examination of the Merged Firm’s Incentives Given the Merger’s Efficiencies.

The FTC had to show that Illumina has a greater incentive to foreclose rivals following—and because of—the merger. Instead, the Commission adopted a standard of review that elides the requirement that, in a vertical merger case where there is “no presumption of harm in play,” “the government must make a fact-specific showing that the proposed merger is likely to be anticompetitive” both at the prima facie stage and in the final analysis. United States v. AT&T Inc., 310 F. Supp. 3d 161, 192 (D.D.C. 2018) (“AT&T I”), aff’d, 916 F.3d 1029 (D.C. Cir. 2019); see AT&T II, 916 F.3d at 1032.

To be sure, there is little recent case law regarding the standard of review for vertical mergers because the federal antitrust agencies have rarely challenged, let alone litigated, vertical acquisitions. The Department of Justice challenge to the AT&T/Time Warner merger marked “the first time in 40 years that a court has heard a fully-litigated challenge to a vertical merger.” Joshua D. Wright & Jan M. Rybnicek, US v. AT&T Time Warner: A Triumph of Economic Analysis, 6 J. Antitrust Enforcement 3 (2018).

Nevertheless, up to now, the agencies have considered likely structural benefits, transactional efficiencies, and potential remedies, along with potential harms, in toto and on net, in assessing a merger’s likely competitive impact. Hence, the Vertical Merger Guidelines—jointly adopted by the FTC and the Antitrust Division of the Department of Justice in June 2020 (although withdrawn by the FTC while this case was pending)—state that “[t]he Agencies do not challenge a merger if cognizable efficiencies are of a character and magnitude such that the merger is unlikely to be anticompetitive in any relevant market.” Vertical Merger Guidelines at 11. Even under the Horizontal Merger Guidelines, “[t]he Agency will not challenge a merger if cognizable efficiencies are of a character and magnitude such that the merger is not likely to be anticompetitive.” Dep’t of Justice, Antitrust Division & FTC, Horizontal Merger Guidelines § 10 (Aug. 19, 2010).

But here the Commission did not seriously account for likely efficiencies or other benefits that may be derived from practices inconsistent with foreclosure. Put simply, Illumina’s ability to profit from the merger without foreclosing rivals reduces its incentive to foreclose. Although the foreclosure incentive may remain on some margins, the question of the greater incentive cannot be resolved without assessing the incentives against foreclosure as well as those for it.

Illumina’s post-merger incentive to foreclose rivals may be constrained by:

• its interest in revenue realized from a broader array of sequencing clients than the relatively few engaged in multi-cancer early detection (MCED) research;
• the procompetitive—and pro-consumer—cost advantages it is likely to realize from integration with Grail;
• the relatively low risk of entry by close substitutes for Galleri in the near, or even foreseeable, future;
• the Open Offer;
• reputational or transactional harms that may result from refusing to deal with firms in its industry; and
• the litigation and regulatory risks attending attempted foreclosure.

But the FTC presumed away these and other factors that could mitigate the risk of harm.

1.   Presumptions Suitable to Horizontal Mergers Are Not Fit for the Analysis of Vertical Mergers

The Commission maintains that the same scrutiny applies to efficiencies claims in vertical and horizontal transactions. To justify this conclusion, the Commission declined to “simply take managers’ word for efficiencies without independent verification, because then the efficiency defense ‘might well swallow the whole of Section 7,’ as managers could present large unsubstantiated efficiencies claims and courts would be hard pressed to find otherwise.” Opinion 75-76 (quoting United States v. H&R Block, Inc., 833 F. Supp. 2d 36, 91 (D.D.C. 2011). But this is a non sequitur, and wrong for three reasons.

First, the Commission need not (and the ID did not) “simply take managers’ word for efficiencies.” As the Initial Decision noted, courts and academic authorities both recognize procompetitive effects, including efficiencies, generally observed with vertical integration. ID 133-35, 196. See also ID 135 (noting case-specific evidence regarding research and development efficiencies, EDM, and the acceleration of access).

Second, to support its rejection of competitive benefits, the FTC continued to conflate the legal standards for horizontal and vertical mergers, relying only on serial string citations to horizontal merger cases. Opinion 75-76. Because a vertical merger puts direct, downward pressure on prices and upward pressure on complementary investments—the inverse of horizontal merger effects—the reliance on horizontal cases highlights the Commission’s failure to recognize the fundamental difference between horizontal and vertical integration. See AT&T II, 916 F.3d at 1032.

Third, ignoring that distinction, and the resulting need for a “fact-specific showing” of the likely anticompetitive effects of a vertical merger, id. at 1032, the Commission repeatedly relied upon H&R Block, which says nothing about standards of review for vertical mergers. H&R Block involved a horizontal merger that allegedly would have produced “an effective duopoly.” 833 F. Supp. 2d at 44.

The FTC’s Opinion also cites a horizontal merger decision, FTC v. H.J. Heinz Co., 246 F.3d 708, 713 (D.C. Cir. 2001), and AT&T II—a vertical merger case—for the proposition that the Baker Hughes framework applies to both horizontal and vertical mergers. That is misleading. Again, AT&T emphasizes that the distinction between horizontal and vertical mergers precludes similar presumptions of anticompetitive effects, and makes it easier to establish certain recognized efficiency and other benefits of vertical integration.  See AT&T II, 916 F.3d at 1032; Vertical Merger Guidelines at 5. Not incidentally, the Government lost its merger challenge in AT&T, both at trial and on appeal.

2.   The Commission Failed to Give Due Consideration to Evident Benefits

The Commission also discounted—or ignored—various efficiencies and other benefits on the ground that “efficiencies are ‘inherently difficult to verify and quantify.’” Opinion 75 (citing H&R Block, 833 F. Supp. 2d at 89). To justify this approach, the Commission cites five horizontal merger matters: H&R Block; H.J. Heinz; Otto Bock HealthCare N. Am., Inc., 168 F.T.C. 324 (2019); FTC v. Wilh. Wilhelmsen Holding ASA, 341 F. Supp. 3d 27 (D.D.C. 2018); and FTC v Penn State Hershey Medical Center, 838 F.3d 327 (3d Cir. 2016).

Although some claimed efficiencies from horizontal mergers can be hard to verify, many efficiencies from vertical mergers are inherent. Specifically, if upstream and downstream margins are positive, basic economic theory predicts that the merger will mitigate double marginalization. Empirical research confirms this. See, e.g., Gregory S. Crawford, et al., The Welfare Effects of Vertical Integration in Multi­channel Television Markets, 86 Econometrica 891 (2018). Similarly, when vertically related firms make complementary investments, theory predicts—and empirical research confirms—that vertical mergers will internalize investment spillovers in a way that tends to expand investment. See, e.g., Chenyu Yang, Vertical Structure and Innovation: A Study of the SoC and Smartphone Industries, 51 Rand J. Econ. 739 (2020). Meanwhile, operational and transactional efficiencies can be supported by both theoretical and empirical evidence, as well as case-specific evidence about the merging firms.

Here, the ALJ’s findings of fact detail ongoing innovation by Illumina, including improvements to its next generation sequencing (NGS) technologies ranging from the release of new reagents to software updates expected to result from the merger. ID 88-89. The Initial Decision also describes a complex process of integration between Illumina’s NGS technology and the requirements of different MCED testing programs. ID 89-91.

Given the Commission’s disregard of efficiencies, it is unclear when or how procompetitive benefits could ever offset the harm alleged to result if the consummated merger were left undisturbed—harm that the Commission did not quantify in either magnitude or likeli­hood.

3.   The Commission’s Speculative Prima Facie Case Fails to Account for the Likely Risk of Actual Harm

The efficiencies and competitive benefits here seem substantially easier to verify and quantify than the magnitude or likelihood of the supposed harm that the Commission neither quantified nor estimated. The Commission did not seriously try to quantify the effects of the merger on the timing and competitive significance of entry of complex clinical products, such as MCED tests, in early stages of development. Rather, the Commission simply asserted that “likely substantial harms to current, ongoing innovation competition in nascent markets are sufficiently probable and imminent to violate Section 7” of the Clayton Act, Opinion 60-61 (cleaned up). But the Commission identified no evidence to support this assertion, or to refute the ALJ’s determinations that MCED tests in development were not poised to enter into competition with Grail’s Galleri test, ID 143-144, that most of the research on possible MCED tests was relatively preliminary, ID 144-145, and that most of the tests being investigated appeared to be far from close substitutes for Galleri. ID 145-153; see also ID 27-28, 44-61.

Instead, the Commission disputed the legal relevance of those findings, stating that its analysis “rests on harm to current, ongoing R&D efforts, rather than the precise timing or nature of any firm’s commercialization of an MCED test.” Opinion 56 n. 38. But that harm, too, is assumed rather than observed, and is neither verified nor quantified.

Thus, the Commission’s prima facie case rests both on a peremptory dismissal of competitive benefits and efficiencies and an uncritical acceptance of speculative theories of harm. Pre-merger, Illumina maintained a substantial ownership interest in Grail of no less than 12%, ID 7-11, yet the Commission did not identify any attempts by Illumina or Grail to interfere with research and development of any MCED test that might enter to compete with Galleri. The only head-to-head R&D competition noted was between Grail and one firm with a pipeline MCED test (Exact/Thrive), on two dimensions: first, various “prelaunch” activities, such as “competing for mindshare with physicians, with health systems, with payers,” ID 34; second, competition for research scientists capable of contributing to the development of MCED tests, id. But there was neither allegation nor evidence that Illumina or Grail engaged in anticompetitive conduct in these areas, and no obvious way in which Illumina could exploit whatever market power it enjoys in NGS markets to foreclose access to “mindshare” or research scientists.

Given no past, present, or ongoing harm to third-party R&D efforts, there is no basis to ignore the likelihood of entry into the MCED test product market, the likely timing of entry, or the likely competitive significance of entry by particular MCED tests that might be relatively close or poor substitutes for Galleri.

Each of those factors is directly relevant to the present risk of potential harm to future competition. They determine whatever risk ongoing R&D into MCED tests would pose to Grail, and hence affect the merged firm’s foreclosure incentives. Equally relevant is the risk to Illumina’s core income stream from NGS sales and services should it prove unreliable or capricious in fulfilling its contracts. That core business includes diverse clinical testing well beyond the potential rivals at issue, ID 92-93, with clients including “leading genomic research centers, academic institutions, government laboratories and hospitals, as well as pharmaceutical, biotechnology, commercial molecular diagnostic laboratories, and consumer genomics companies.” ID 6.

4.   Evidence of Likely Procompetitive Effects Should Not Be Ignored at Any Stage of Analysis

Finally, the Commission contends that “[c]ourts have never held that efficiencies alone immunized an otherwise unlawful transaction.” Opinion 75. That puts the cart before the horse, as benefits from aligning incentives between producers of complements (what the Commission terms “efficiencies”) often determine whether a transaction—especially a vertical transaction—is “unlawful” in the first place.

Most important, the courts have never held that these benefits are irrelevant generally (as the FTC would have it), or to the question whether a transaction is unlawful in the first instance. To the contrary, analysis of a vertical merger must account for the procompetitive benefits and efficiencies it is likely to achieve. See AT&T I, 310 F. Supp. at 198 (noting need “to ‘balance’ whether the Government’s asserted harms outweigh the merger’s conceded consumer benefits.”). Even in horizontal mergers, sufficiently large efficiency benefits may prevent a merger from being illegal. New York v. Deutsche Telekom AG, 439 F. Supp. 3d 179, 207 (S.D.N.Y. 2020).

Because AT&T II made clear that no presumption of illegality applies to vertical mergers, the Commission properly faces a rigorous burden to prove on case-specific evidence that the proposed merger is likely to cause substantial, actual harm to competition and consumers—not a possibility of some degree of harm to competition that in theory could harm consumers.  The Commission has not carried that burden.

II.          The Open Offer Undercuts the Commission’s Prima Face Case and Its Disregard of Potential Remedies.

The Commission’s legal error went beyond its application of a misplaced presumption of illegality that is impervious to evidence of the benefits from combining complements. The Commission also failed to recognize key structural differences between horizontal and vertical mergers.

The primary source of potential anticompetitive harm from vertical integration is foreclosure. While foreclosure is not consistently defined, one passable definition is:

[A] dominant firm’s denial of proper access to an essential good it produces, with the intent of extending monopoly power from that segment of the market (the bottleneck segment) to an adjacent segment (the potentially competitive segment).

Patrick Rey & Jean Tirole, A Primer on Foreclosure, in 3 Handbook of Industrial Organization 2145, 2148 (Mark Armstrong & Robert H. Porter, eds.) (2007). Because denial of access is a crucial aspect of foreclosure, agreements (or remedies) granting access to essential goods or services can mitigate the risk of foreclosure.

Illumina’s “Open Offer” appears to grant such access, yet the Commission failed to give proper weight to its effect on the risk of anticompetitive conduct. In contrast, the ALJ examined the Open Offer in detail, see, e.g., ID 98-125, 182-189, finding that it “provides a compre­hensive set of protections for Illumina’s customers for all aspects of conduct and competition.” ID 120. The Commission rejected those findings, relying in part on a mischaracterization of the Open Offer as only a proposed remedy, and in part on an overbroad repudiation of behavioral remedies.

First, the record indicates that the Open Offer is binding under New York law, at least with respect to several firms engaged in MCED research, and that it will remain so through August 2033. ID 103-04. Firms that have accepted (or will accept) the Open Offer can enforce it whether or not the merger is blocked; and they would have every incentive to do so if Illumina interfered with their R&D efforts. That is not just a proposed remedy, but a fully operative constraint.  If accepted, the Open Offer will become part of the institutional framework within which Illumina operates, further reducing or eliminating the firm’s incentives and ability to raise its rivals’ costs. ID 103-04, 179. Cf. United States v. General Dynamics Corp., 415 U.S. 486, 501-02 (1974) (noting importance of existing contracts in assessing competitive landscape).

That constraint seems especially significant given how few firms might someday enter to compete with Grail’s MCED test, and the difficulty inherent in trying to forecast R&D competition so far in advance.

Second, the Commission strains credulity in disregarding the Open Offer on the grounds that behavioral remedies can be hard to monitor and tend to be disfavored. If the Open Offer were incorporated into a consent order, the FTC would have to monitor only a very few agreements. The affected parties would assist in monitoring compliance, well-funded would-be entrants would have every incentive to report any difficulty gaining access to Illumina’s sequencing technology, and the FTC could modify the order as needed. Illumina, for its part, would face both the risk of damages imposed under state law and the risk of statutory penalties, among other remedies, for violations of FTC consent orders.

Under the flexible Baker Hughes approach, the Commission should have accorded substantial weight to the Open Offer in assessing whether the Illumina-Grail transaction is truly likely to cause harm. This behavioral remedy is neither cumbersome nor ineffective. Given the Open Offer, the Commission does not appear to have established that harm to R&D competition is likely or imminent.

III.       The Economics of Vertical Integration Support the Differential Treatment of Vertical and Horizontal Mergers.

Economic and empirical research confirm that the Commission was wrong to conclude that vertical and horizontal mergers should be analyzed identically. Horizontal mergers, by definition, remove a competitor from a relevant market; vertical mergers do not. As the economics literature makes clear, that structural distinction is central to antitrust analysis.

A.           In Theory, The Competitive Implications of Vertical Mergers Are Ambiguous.

The Supreme Court’s modern vertical restraints decisions underscore the importance of developments in the economic literature for assessing how to evaluate any type of integration under the antitrust laws. The Court removed per se prohibitions on vertical restraints in part because “economics literature is replete with procompetitive justifi­ca­tions for” them. Leegin, 551 U.S. at 889.

The economics literature is equally “replete with procompetitive justifications” for vertical integration. Vertical integration typically confers benefits, such as eliminating double marginalization, Reiffen & Vita, supra, 63 Antitrust L.J. 917; increasing R&D investment, Armour & Teece, supra, 62 Rev. Econ. & Stat. 470; and creating operational and transactional efficiencies, Carlton, supra, 73 Int’l J. Indus. Org. 1.

The logic behind EDM is simple: Vertical mergers can increase welfare, even if the upstream or downstream firm has market power. When firms “markup” their products over their marginal cost of production, that reduces output and increases the (input or distribution) costs of their (downstream or upstream) rivals. In other words, independent upstream and downstream firms can exert negative externalities on each other that ultimately push prices upwards. When firms have no incentive to consider the effect of their price (and output) determinations on downstream firms’ profits, see, e.g., Michael A. Salinger, Vertical Mergers and Market Foreclosure, 103 Q.J. Econ. 345 (1988), there is an additional markup over the downstream firm’s marginal cost of production, or “double marginalization.” Vertical mergers enable firms to coordinate their pricing behavior, eliminating this externality without the negative effects that coordination would entail in horizontal merger cases. See Reiffen & Vita, supra, 63 Antitrust L. J. at 920.

In a vertical merger, EDM is likely automatic. Id. That is “precisely opposite of the outcome that arises under the frequently used Cournot oligopoly model of horizontal competition with substitute products. Under Cournot oligopoly, joint pricing raises price; under Cournot complements [as in a vertical merger], it lowers price.” Daniel O’Brien, The Antitrust Treatment of Vertical Restraint: Beyond the Possibility Theorems, in Konkurrensverket, Swedish Competition Authority, Report: The Pros and Cons of Vertical Restraints 22, 36 (2008).^[1]

To be clear, vertical mergers are not necessarily procompetitive. An integrated firm may have an incentive to exclude rivals, see Steven C. Salop & David T. Scheffman, Cost-Raising Strategies, 36 J. Indus. Econ. 19 (1985), and a vertical merger can have an anticompetitive effect if the upstream firm has market power and the ability, post-acquisition, to foreclose its competitors’ access to a key input. See Janusz A. Ordover, Garth Saloner & Steven C. Salop, Equilibrium Vertical Foreclosure, 80 Am. Econ. Rev. 127 (1990). In that regard, raising rivals’ costs can “represent[] a credible theory of economic harm” if other conditions of exclusionary conduct are met. Malcom B. Coate & Andrew N. Kleit, Exclusion, Collusion, and Confusion: The Limits of Raising Rivals’ Costs, FTC Bureau of Economics Working Paper No. 179 (1990). But this is merely a possibility, not a likely conclusion without solid empirical evidence: “The circumstances… in which [raising rivals’ costs] can occur are usually so limited that [it] almost always represents a minimal threat to competition.” Id. at 3.

The implications of vertical mergers are thus theoretically ambiguous, not typically anticompetitive. But while the Commission now seeks to equate horizontal and vertical mergers,

[a] major difficulty in relying principally on theory to guide vertical enforcement policy is that the conditions necessary for vertical restraints to harm welfare generally are the same conditions under which the practices increase consumer welfare.

James C. Cooper, et al., Vertical Antitrust Policy as a Problem of Inference, 23 Int’l. J. Indus. Org. 639, 643 (2005).

This structural ambiguity weighs against any presumption against vertical mergers, and suggests the importance of empirical research in formulating standards to evaluate vertical transactions.

B.           Empirical Research Establishes that Vertical Mergers Tend to Be Procompetitive In Practice.

Empirical evidence supports the established legal distinctions between horizontal mergers and vertical mergers (as well as other forms of vertical integration), indicating that vertical integration tends to be procompetitive or benign.

A meta-analysis of more than seventy studies of vertical transactions analyzed groups of studies for their implications for various theories or models of vertical integration, and for the effects of vertical integration. From that analysis

a fairly clear empirical picture emerges. The data appear to be telling us that efficiency considerations overwhelm anticompetitive motives in most contexts. Furthermore, even when we limit attention to natural monopolies or tight oligopolies, the evidence of anticompetitive harm is not strong.

Francine Lafontaine & Margaret Slade, Vertical Integration and Firm Boundaries: The Evidence, 45 J. Econ. Lit. 629, 677 (2007).

On the contrary, “under most circumstances, profit-maximizing vertical integration decisions are efficient, not just from the firms’ but also from the consumers’ points of view.” Id. And “[a]lthough there are isolated studies that contradict this claim, the vast majority support it….” Id. Lafontaine and Slade accordingly concluded that “faced with a vertical arrangement, the burden of evidence should be placed on competition authorities to demonstrate that that arrangement is harmful before the practice is attacked.” Id.

Another study of vertical restraints finds that, “[e]mpirically, vertical restraints appear to reduce price and/or increase output. Thus, absent a good natural experiment to evaluate a particular restraint’s effect, an optimal policy places a heavy burden on plaintiffs to show that a restraint is anticompetitive.” Cooper, et al., supra, 23 J. Indus. Org. at 639.

Subsequent research has reinforced these findings. Reviewing the more recent literature from 2009-18, John Yun concluded “the weight of the empirical evidence continues to support the proposition that vertical mergers are less likely to generate competitive concerns than horizontal ones.” John M. Yun, Vertical Mergers and Integration in Digital Markets, in The GAI Report on the Digital Economy (Joshua D. Wright & Douglas H. Ginsburg, eds., 2020) at 245.

Leading contributors to the empirical literature, reviewing both new studies and critiques of the established view of vertical mergers, maintain a consistent view. For example, testifying at a 2018 FTC hearing, Francine Lafontaine, a former Director of the FTC’s Bureau of Economics, acknowledged that some of the early empirical evidence is less than ideal, in terms of data and methods, but reinforced the overall conclusions of her earlier research “that the empirical literature reveals consistent evidence of efficiencies associated with the use of vertical restraints (when chosen by market participants) and, similarly, with vertical integration decisions.” Francine Lafontaine, Vertical Mergers (Presentation Slides), in FTC, Competition and Consumer Protection in the 21^st Century; FTC Hearing #5: Vertical Merger Analysis and the Role of the Consumer Welfare Standard in U.S. Antitrust Law, Presentation Slides 93 (Nov. 1, 2018) (“FTC Hearing #5”), available at https://www.ftc.gov/system/files/documents/public_events/1415284/ftc_hearings_5_georgetown_slides.pdf. See also Francine Lafontaine & Margaret E. Slade, Presumptions in Vertical Mergers: The Role of Evidence, 59 Rev. Indus. Org. 255 (2021).

In short, empirical research confirms that the law properly does not presume that vertical mergers have anticompetitive effects, but requires specific evidence of both harms and efficiencies.

C.           New Research Does Not Undermine the Prevailing View of Vertical Mergers.

Critics of prevailing legal standards and agency practice have pointed to a few studies that might cast doubt on the ubiquity of benefits associated with vertical mergers. We briefly review several of those studies, including those discussed at the FTC’s 2018 “Competition and Consumer Protection in the 21^st Century” hearings that purported to suggest that the “econometric evidence does not support a stronger procompetitive presumption [for vertical mergers].” Steven C. Salop, Revising the Vertical Merger Guidelines (Presentation Slides), in FTC Hearing #5, supra, Presentation Slides 25. In fact, these studies do not undermine the longstanding economic literature. See Geoffrey A. Manne, Kristian Stout & Eric Fruits, The Fatal Economic Flaws of the Contemporary Campaign Against Vertical Integration, 69 Kansas L. Rev. 923 (2020). “[T]he newer literature is no different than the old in finding widely procompetitive results overall, intermixed with relatively few seemingly harmful results.” Id. at 951.

One oft-cited study examined Coca-Cola and PepsiCo’s acquisitions of some of their downstream bottlers. Fernando Luco & Guillermo Marshall, The Competitive Impact of Vertical Integration by Multiproduct Firms, 110 Am. Econ. Rev. 2041 (2020). The authors presented their results as finding that “vertical integration in the US carbonated-beverage industry caused anticompetitive price increases in products for which double margins were not eliminated.” Id. at 2062. But the authors actually found that, while such acquisitions were associated with price increases for independent Dr Pepper Snapple Group products, they were associated with price decreases for both Coca-Cola and PepsiCo products bottled by vertically integrated bottlers. Because the products associated with increased prices accounted for such a small market share, “vertical integration did not have a significant effect on the price index when considering the full set of products.” Id. at 2056. Overall, the consumer impact was either an efficiency gain or no significant change. As Francine Lafontaine characterized the study, “in total, consumers were better off given who was consuming how much of what.” FTC Hearing #5, supra, Transcript 88 (statement of Francine Lafontaine), available at https://www.ftc.gov/system/files/documents/public_events/1415284/ftc_hearings_session_5_transcript_11-1-18.pdf.

In another study often cited by skeptics of vertical integration, Justine Hastings and Richard Gilbert examined wholesale price changes charged by a vertically integrated refiner/retailer using data from 1996-98. Justine S. Hastings & Richard J. Gilbert, Market Power, Vertical Integration, and the Wholesale Price of Gasoline, 33 J. Indus. Econ. 469 (2005). They observed that the firm charged higher wholesale prices in cities where its retail outlets competed more with independent gas stations, and concluded that their observations were consistent with the theory of raising rivals’ costs. Id. at 471.

In subsequent research, however, three FTC economists publishing in the American Economic Review examined retail gasoline prices following the 1997 acquisition of an independent gasoline retailer by a vertically integrated refiner/retailer. Their estimates suggested that the merger was associated with minuscule—and economically insignificant—price increases. Christopher T. Taylor, et al., Vertical Relationships and Competition in Retail Gasoline Markets: Empirical Evidence from Contract Changes in Southern California: Comment, 100 Am. Econ. Rev. 1269 (2010).

Hastings explains the discrepancy with Taylor et al., by noting the challenges of evaluating vertical mergers with incomplete data or, simply, different data sets, as seemingly similar data can yield very different results. Justine Hastings, Vertical Relationships and Competition in Retail Gasoline Markets: Empirical Evidence from Contract Changes in Southern California: Reply, 100 Am. Econ. Rev. 1227 (2010). But that observation does not undercut Taylor et al.’s findings. Rather, it suggests caution in drawing general conclusions from this line of research, even with regard to gasoline/refiner integration, much less to vertical integration generally.

Other commonly cited studies are no more persuasive. For example, one study examined vertical mergers between cable-programming distributors and regional sports networks using counterfactual simulations that enforced program access rules. Crawford, et al., supra, 86 Econometrica 891. While some have characterized their findings as “mixed” (FTC Hearing #5, supra, Transcript 54 (statement of Margaret Slade))—suggesting that vertical integration could have some negative as well as positive effects—their overall results indicated “that vertical integration leads to significant gains in both consumer and aggregate welfare.” Crawford, et al., supra, 86 Econometrica at 893-894.

Harvard economist Robin Lee, a co-author of the study, concluded that the findings demonstrated that the consumer benefits of efficiency gains outweighed any harms from foreclosure. As he testified at the FTC’s 2018 hearings,

our key findings are that, on average, across channels and simulations, there is a net consumer welfare gain from integration. Don’t get me wrong, there are significant foreclosure effects, and rival distributors are harmed, but these negative effects are oftentimes offset by sizeable efficiency gains. Of course, this is an average. It masks considerable heterogeneity.

FTC, Competition and Consumer Protection in the 21^st Century: FTC Hearing #3: Multi-Sided Platforms, Labor Markets, and Potential Competition, Transcript 101 (Oct. 17, 2018), available at https://www.ftc.gov/system/files/documents/public_events/1413712/ftc_hearings_session_3_transcript_day_3_10-17-18_0.pdf.

While these studies indicate that vertical mergers can sometimes lead to harm, that point was never disputed. What is important is that the studies do not support any general presumption against vertical mergers or, indeed, any revision to either the legal distinction between horizontal and vertical mergers or to what was, up to now, established agency practice in merger review. The weight of the empirical evidence plainly indicates that vertical integration tends to be procompetitive; hence, no presumption of anticompetitive effects or of illegality should apply, and none should have been applied here.

CONCLUSION

There is much at stake here. The potential for harm from the merger seems speculative, but the benefits seem conspicuous and substantial, not only reducing the risk of net competitive harm but promising significant enhancement to consumer welfare. As the Commission observed, “better screening methods to detect more cancers at an earlier stage … have the potential to extend and improve many human lives.” Opinion 3. Those benefits should not be forestalled by speculation about possible harms that ignores the differences between vertical and horizontal mergers.

The FTC’s decision should be reversed.

^[1] Many discussions of the competitive effects of vertical mergers, including the Vertical Merger Guidelines, conflate EDM, investment benefits, and transactional efficiencies.

Abstract

The GAI filed this Comment with the Canadian Competition Bureau in response to the Bureau’s request for public feedback on draft Guidance on Wage-Fixing and No-Poaching Agreements. Such agreements will be subject to a new statute (subsection 45(1.1), Canadian Competition Act) taking effect June 23, 2023, prohibiting such agreements as per se offenses and making violations subject to criminal remedies. The GAI’s Comment commends the Bureau for seeking public comment prior to implementation and generally concurs with the basic approach taken by the Bureau. To further refine and improve the Bureau’s approach, the Comment identifies potential ambiguities in the Guidance. Ambiguity complicates compliance, since businesses are likely to avoid even procompetitive or competitively neutral conduct potentially exposed to challenge. Avoidance of lawful conduct by business firms due to uncertainty regarding applicable legal standards may inhibit competition and ultimately reduce economic performance and innovation. Per se condemnation and criminal remedies should be reserved for conduct always or almost always anticompetitive and lacking plausible procompetitive rationale. The GAI therefore asks the Bureau to take particular care in defining the types of agreements that may be subject to the new law. Principal areas of focus involve (1) transition provisions; (2) the scope of an exemption for agreements between “affiliates”; (3) the definition of what constitutes an “employment relationship,” a key term defining the scope of the new law; (4) the line between permissible information sharing and impermissible coordinated conduct, and (5) the proper interpretation of the “Ancillary Restraints Defense” that will be applicable.

Interest of Amicus Curiae[1]

The International Center for Law & Economics (“ICLE”) is a nonprofit, non-partisan global research and policy center aimed at building the intellectual foundations for sensible, economically grounded policy. ICLE promotes the use of law and economics methodologies to inform public policy debates and has longstanding expertise in antitrust law.

Amici also include twenty scholars of antitrust, law, and economics at leading universities and research institutions across the United States. Their names, titles, and academic affiliations are listed in Appendix A. All have longstanding expertise in antitrust law and economics.

Amici respectfully submit that their amicus brief will aid the Court in reviewing the order of dismissal by explaining that Plaintiffs did not plead and could not prove any plausible product or geographic market. This is a point that Plaintiffs attempt to elide in their appellate brief that warrants this Court’s attention. The foundation of almost every antitrust claim is a plausible market definition, yet Plaintiffs’ claims in this case are premised on a labor market—limited to one company (McDonald’s), but nationwide in scope—that has no basis in economic reality.

In addition, amici explain why Plaintiffs’ claims are subject to rule of reason scrutiny. This case involves a vertical, intrabrand restraint between McDonald’s and its franchisees, which promoted interbrand competition. It was not a naked restraint on trade, but rather an ancillary restriction that furthered McDonald’s procompetitive goal of creating a strong and stable brand. Treating such a restraint as per se unlawful, as Plaintiffs ask this Court to do, would stifle the type of legitimate cooperation that facilitates output and would ultimately harm consumers.

INTRODUCTION AND SUMMARY OF ARGUMENT

Until 2017, McDonald’s franchise agreements included a provision that prevented franchisees from hiring workers from other McDonald’s restaurants within the six-month period immediately following the workers’ prior employment. Two employees sued McDonald’s in a putative class action, alleging that this provision—which the parties refer to as “Paragraph 14”—was an unlawful agreement under Section 1 of the Sherman Act, 15 U.S.C. § 1, that harmed competition by artificially suppressing wages. Plaintiffs argued that Paragraph 14 was per se unlawful or failed “quick look” review; on appeal (but not below), Plaintiffs also argue that Paragraph 14 fails scrutiny under the rule of reason. Brief of Appellants at 31-33, Deslandes v. McDonald’s USA LLC, No. 22-2333 & 22-2334 (7th Cir.) (“App. Br.”).

Under the rule of reason, Plaintiffs had the burden to plead and prove the relevant product and geographic markets within which McDonald’s allegedly exerted market power and caused the alleged anticompetitive effects. Plaintiffs’ claim has always been premised—explicitly or implicitly—on a single-brand and nationwide labor market for McDonald’s employees. (§ I.A). Although Plaintiffs shy away from that market on appeal, it is the only one discernible from the record and the only one on which Plaintiffs’ claims could possibly be premised. But that market is fatally flawed along the two axes that typically delineate antitrust markets: (1) geography and (2) products or services.

First, the relevant labor market is local: there is no national market for fast-food restaurant employees, as Plaintiffs suggest. Low-skilled restaurant workers sell their labor in local markets, primarily to avoid long commutes or relocation. The economic (and commonsense) reality is that a person applying for a McDonald’s job in Chicago, Illinois is not also looking for a McDonald’s job in Florida or Montana; nor are local McDonald’s restaurants recruiting employees nationwide. (§ I.B). Second, there is no McDonald’s-specific labor market for restaurant employees. McDonald’s restaurants compete vigorously with other fast-food and quick-service restaurants—and with firms outside the restaurant industry—for labor. Empirical economic evidence refutes Plaintiffs’ arguments to the contrary. (§ I.C).

Further, Plaintiffs cannot avoid the rule of reason (or their burden to plead and prove a relevant market) by invoking per se scrutiny. (§ II). First, Paragraph 14 was not a horizontal restraint; it was a vertical, intrabrand restraint between McDonald’s and its franchisees. (§ II.A). Second, Paragraph 14 was not a naked restraint on trade but was instead “ancillary” to McDonald’s procompetitive endeavor of developing its brand. (§ II.B). Third, Paragraph 14 does not fall in the narrow class of restrictions—like price fixing—universally condemned as anticompetitive. Nor are there sufficient economic studies showing that restraints like Paragraph 14 have a demonstrable and negative impact on trade, such that there would be a basis to depart from the default rule of reason standard. (§ II.C).

I.             There is no Nationwide, Single-Brand Market for McDonald’s Employment

Market definition enables courts to determine whether firms possess market power capable of restricting competition. The market provides a locus for the assessment of that market power and of whether that power has been exploited to harm competition and consumers.

Accordingly, “courts usually cannot properly apply the rule of reason without an accurate definition of the relevant market.” Ohio v. Am. Express Co., 138 S. Ct. 2274, 2285 (2018). The rule of reason requires a court to assess the “actual effect” that a defendant’s conduct has on competition. Id. at 2284 (quoting Copperweld Corp. v. Indep. Tube Corp., 467 U.S. 752, 768 (1984)). And without knowing the relevant market, “there is no way to measure the defendant’s ability to lessen or destroy competition.” Id. at 2285 (quoting Walker Process Equip., Inc. v. Food Mach. & Chem. Corp., 382 U.S. 172, 177 (1965)).[2]

A.             Plaintiffs Must Allege and Prove a Relevant Market

In the district court, Plaintiffs did not clearly define the relevant market in which Paragraph 14 allegedly harmed competition; and that failure defeats their claim under the rule of reason. See Agnew v. Nat’l Collegiate Athletic Ass’n, 683 F.3d 328, 347 (7th Cir. 2012) (affirming dismissal where “[p]laintiffs appear to have made the strategic decision to forgo identifying a specific relevant market,” and rejecting “post hoc arguments attempting to illuminate a buried market allegation”).

Plaintiffs are wrong to assert that they can rely on “direct evidence” of anticompetitive harm to avoid establishing a relevant market. App. Br. at 31. Even if they had such evidence, Plaintiffs would still have the burden to sketch out the “rough contours” of the relevant market and to show that McDonald’s commanded a substantial share of that market. See Republic Tobacco Co. v. N. Atl. Trading Co., 381 F.3d 717, 737 (7th Cir. 2004) (“[I]f a plaintiff can show the rough contours of a relevant market, and show that the defendant commands a substantial share of the market, then direct evidence of anticompetitive effects can establish the defendant’s market power[.]” (emphases added)). But Plaintiffs never inform this Court what product or geographic markets are involved here, even “roughly” speaking. Accordingly, Plaintiffs’ references to their supposed “direct evidence” of anticompetitive harm, without regard to any market boundaries, App. Br. at 31-32, do not suffice.[3]

Rather than define a market, Plaintiffs fault the district court for assuming that their claim “depended upon a single, nationwide geographic market.” App. Br. at 31. But that assumption came not from the district court but from Plaintiffs themselves—as that was the only market potentially discernible in their complaints. See First Am. Compl. ¶¶ 1, 117; Turner Compl. ¶¶ 109-13 (implying a single-brand, nationwide market). While Plaintiffs try to obscure their single-brand, nationwide market for McDonald’s labor on appeal, that is the only one that Plaintiffs rely upon in their opening brief, albeit obliquely. See App. Br. at 31 (arguing that Paragraph 14 “suppressed worker pay nationwide”); id. at 33 (arguing that McDonald’s and its franchisees were the “discrete group of buyers” that were able to “hold down wages”).

Plaintiffs’ proposed market is both implausible and economically unsound. Antitrust markets typically have two dimensions: (1) a geographic market and (2) a product or services market. See Brown Shoe Co. v. United States, 370 U.S. 294, 324 (1962). Plaintiffs’ single-brand, nationwide market fails along both dimensions.

B.        The Relevant Market is Local, not National

First, to identify a relevant geographic market, the court must make a “careful selection of the market area in which the seller operates, and to which the purchaser can practicably turn for supplies.” Republic Tobacco, 381 F.3d at 738 (citing Tampa Elec. Co. v. Nashville Coal Co., 365 U.S. 320, 327 (1961)). In labor markets, the “sellers” are workers or job applicants selling their services (like Plaintiffs), and “purchasers” are employers (like McDonald’s) that compete with other firms to hire, employ, and retain the workers.

As the district court correctly found, low-wage restaurant employees sell their labor locally and McDonald’s restaurants compete only with geographically proximate employers to purchase that labor. See D.E. 372 (“Class Cert. Op.”) at 20-21. Fast-food and quick-serve restaurant employees are generally low-skilled and/or entry-level workers who “are looking for a position in the geographic area in which they already live and work, not a position requiring a long commute or a move.” Id. at 21.

While some employees might relocate for other reasons first, and then seek a restaurant job, it is not economically plausible that they would “search long distances for a low-skill job with the idea of then moving closer to the job.” Id. The costs of relocation—in economic terms, the “search” costs and “transition” costs—would far exceed any cost-adjusted increases in pay and benefits.

In practical terms, an hourly McDonald’s worker in Apopka, Florida who does not otherwise desire to move to California would not uproot her life, and leave family and friends, for a McDonald’s job in Los Angeles—even if the Los Angeles franchisee offers to raise her wages a few dollars per hour. The employee has many alternative opportunities that do not require relocation and, in any event, the higher cost of living in Los Angeles would negate the benefits of the wage increase. The total costs of relocation likely outweigh the marginal wage gain.

For similar reasons, an employee is unlikely to commute long distances—for example, from Urbana to Chicago, Illinois—to work at a McDonald’s, even if the McDonald’s in Chicago pays slightly higher wages than the one in Urbana. A marginal wage increase would not offset the time and “commuting costs”—i.e., gas and mileage. See Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 552 (5th ed. 2022) (explaining that “commuting costs” limit a supplier’s ability to operate in a distant geographic market).

Nor is it plausible that a McDonald’s franchisee in Apopka, Florida would recruit workers nationwide. That franchisee also faces search costs in the labor market. It must advertise its job openings, hire recruiters, and interview applicants, among other things. It would not be worthwhile to incur the substantial costs of a nationwide search for employees, when those employees would likely remain at the job for a relatively short time, and when there are many local workers with similar skills who could fill the role.

To be sure, some highly skilled employees in other industries—for example, corporate executives or professional athletes—undoubtedly search for high-paying or prestigious jobs nationwide. And their potential employers recruit nationwide. For those types of job-seekers, their decisions turn on the scarcity of those jobs, the substantial personal and financial investments (“sunk costs”) they have made to be qualified for such positions (which essentially “lock” them into the nationwide market), and the high salaries or total compensation that make relocation worthwhile. Likewise, for the hiring firm, the search is justified by the small number of qualified candidates, widely distributed across the country, and by the expected benefits. For example, it would be worthwhile for a firm to  search far and wide for a new CEO, knowing that there are only a few people in the country with the skills and leadership ability to lead the company out of financial troubles.

These rarefied exceptions confirm that the vast majority of labor markets are “geographically quite small.” Herbert Hovenkamp, Competition Policy for Labour Markets, U. Pa. Inst. L. & Econ. ¶ 12 (May 17, 2019). Applicants for low paying and fungible jobs have fundamentally different incentives than do corporate executives and professional athletes. The former do not have adequate incentives for a national search, given the substantial costs, plus relocation or long-distance commuting.

These intuitive points are supported by data and established economic methods. Several recent economic studies demonstrate that, “in a wide range of industries[,] geographic markets for employment are rather small,” and that this is “particularly true of low-wage employees.” Areeda & Hovenkamp, supra ¶ 550b (collecting studies). One empirical study shows that “more than 80% of [all] job applications occur where the applicant and prospective employer are within the same ‘commuting zone.’” Ioana Marinescu & Roland Rathelot, Mismatch Unemployment and the Geography of Job Search, 10(3) Am. Econ. J. Macro. 42 (2018).

The U.S. Bureau of Labor Statistics (“BLS”) employs a methodology that confirms the district court’s findings with respect to localized markets. When BLS collects employment and unemployment statistics, it examines the “economically integrated geographic area within which individuals can reside and find employment within a reasonable distance or can readily change employment without changing their place of residence.” BLS, Local Area Unemployment Statistics Geographic Concepts, (Mar. 20, 2020). According to BLS, metropolitan and micropolitan areas are the “major” “labor market areas” (LMAs)—not the country as a whole. Id. The balance of the nation’s LMAs comprise a larger number of smaller geographic areas. Id. BLS identifies thousands of these small LMAs for each decennial census, based on its analysis of highly localized commuting flows. Id; see also Data.Gov, Commuting Zones and Labor Market Areas,  (Nov. 10, 2020).

Plaintiffs’ own expert witnesses acknowledged that a nationwide market was implausible in this case. Dr. Peter Capelli conceded that restaurant workers are employed in local geographic markets, defined by commuting distances. Class Cert. Op at 22-23 (citing Capelli Dep. at 235-36, D.E. 302-1 at 608-09) (“My testimony is that for the restaurant employees in particular, the crew employees, there may be labor markets of different geographic size and that the key issue there might not even be size, it might be commuting distance.”). And Dr. Hal Singer calculated that only 8% of McDonald’s employees commute ten or more miles to work. Id. at 23 (citing Singer Rep. ¶ 64, D.E. 271-5 at 54).

Other evidence in this case also demonstrates that market conditions vary substantially by location. McDonald’s own guidelines on worker pay account for local conditions. D.E. 302-19 at -997; D.E. 302-19 at -432, -444; see also D.E. 380 ¶¶ 40-50. The guidelines do not set forth a single, rigid nationwide formula—which one would expect to see if McDonald’s understood that its franchisees were competing for labor nationwide.

As this Court recently explained, “[t]he antitrust statutes require a ‘pragmatic’ and ‘factual’ approach to defining the geographic market,” and “[t]he market must ‘correspond to the commercial realities of the industry.’” Sharif Pharmacy, Inc. v. Prime Therapeutics, LLC, 950 F.3d 911, 917 (7th Cir. 2020) (quoting Brown Shoe, 370 U.S. at 336). Plaintiffs’ proposed nationwide market is neither pragmatic nor factual. It ignores the obvious commercial reality that local McDonald’s franchisees do not compete nationwide for low-skilled labor, and it ignores the empirical evidence that McDonald’s employees (and similarly situated low-wage employees) do not commute long distances or relocate for these types of jobs.

C.        The Market is not McDonald’s-Specific

The outer boundaries of a product market are defined by the “reasonable interchangeability of use or the cross-elasticity of demand between the product itself and substitutes for it.” Sharif Pharmacy, 950 F.3d at 918 (quoting Brown Shoe, 370 U.S. at 325). Cross-elasticity of demand, here, reflects the degree to which a significant increase or decrease in wages paid by alternative employers changes the number of workers hired or hours worked (quantity demanded) at the employer in question. In the classic company town, the cross-elasticity of demand is zero. When there are substitutes, it is positive, indicating that “consumers would respond to a slight increase in the price of one product by switching to another product.” Todd v. Exxon Corp., 275 F.3d 191, 201-02 (2d Cir. 2001); IIA Areeda & Hovenkamp, supra ¶ 562a.

In a “buyer-side” labor monopsony, such as Plaintiffs have alleged, the market is defined not by the competing sellers (employees), but by the availability of competing buyers (employers). See Todd, 275 F.3d at 201 (citing Roger D. Blair & Jeffrey L. Harrison, Antitrust Policy and Monopsony, 76 Cornell L. Rev. 297, 297-301, 308 (1991)). Thus, the key question is whether employees would see the various employers as reasonable substitutes for one another, such that they would respond to compensation changes by seeking those substitutes. Id. If so, then any of the reasonable substitutes must fall within the market definition for the plaintiff’s market to be plausible. See Rock v. Nat’l Collegiate Athletic Ass’n, 928 F. Supp. 2d 1010, 1021 (S.D. Ind. 2013) (“Plaintiffs’ proposed market is impermissibly narrow because it ignores the existence of [substitutes].”).

In a properly defined labor market, the greater the availability of substitute employers, the less “market power” each employer can have, as employees can go elsewhere when one employer lowers its wages or fails to meet wage increases by others. When a labor market is highly concentrated, by contrast, the employer may be able to exert monopsony buying power. For example, a pure labor monopsony might exist in the classic “company town,” where there is only one large employer—such as a lumber mill or coal mine—that has wide discretion to set wages without employees leaving for other jobs. Those employees are, in effect, “locked in” to selling their labor to the single employer. Cf. Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 472-73, 476 (1992) (seller can “lock in” customer to aftermarket for equipment repairs, if customers already purchased equipment in the foremarket and switching costs are high). In the modern economy, however, such examples are rare; and the market for hourly restaurant employees bears no resemblance to a company town.

Nevertheless, Plaintiffs here allege that McDonald’s is a monopsony buyer of labor—not just in a highly concentrated market, but in a single-brand market for McDonald’s labor. App. Br. at 7. In other words, McDonald’s allegedly has monopsony power to set the wages at which it hires and retains employees because employees (or applicants) generally would not see any non-McDonald’s employment opportunities as reasonable substitutes.

Plaintiffs’ theory thus depends upon implausible assumptions about McDonald’s market power and the elasticity of demand: that substantial wage increases by alternative local employers—including, but not limited to, fast food or quick-service restaurants like Wendy’s, Burger King, KFC, and Subway—would have little or no impact on the ability of a local McDonald’s franchise to hire or retain workers at a given antecedent wage. That is not only implausible in this case, but there is no evidence that it is the norm across low-wage labor markets. See, e.g., Jordan D. Matsudaira, Monopsony in the Low-Wage Labor Market? Evidence from Minimum Nurse Staffing Regulations, 96(1) Rev. Econ. & Statistics 92, 102 (2014) (empirical data in low-wage labor markets are “difficult to reconcile with the notion that low-wage labor markets such as those for fast food workers are monopsonist”).

These assumptions underlying Plaintiffs’ alleged market defy basic economic principles and common sense. Courts are highly skeptical of alleged single-brand markets with no substitutes at all, as those markets are almost always artificial and litigation-driven. See, e.g., Sheridan v. Marathon Petroleum Co., 530 F.3d 590, 595 (7th Cir. 2008) (rejecting single-brand market); Todd, 275 F.3d at 200 & n.3 (“Cases in which dismissal on the pleadings is appropriate frequently involve . . . failed attempts to limit a product market to a single brand, franchise, institution, or comparable entity….” (collecting cases)).

McDonald’s does not have monopsony power in any relevant market because, from an employee’s perspective, there are many reasonable substitutes in the geographic areas in which a given McDonald’s franchisee operates. McDonald’s franchisees compete vigorously for labor with other local employers within and without the quick-service industry. As the district court observed, there are multitudes of adequate, substitute employers for low-wage employees—including (1) other quick-serve restaurants, like Burger King, Wendy’s, Arby’s, KFC, Taco Bell, Chick-fil-A, Chipotle, and Jimmy John’s; (2) other restaurants, like Applebee’s; (3) larger retailers, like Walmart, Sam’s Club, and Costco; and (4) a host of other businesses like grocery stores and hotels. Class Cert. Op. at 21-22.

Even narrowing substitutes to just quick-service restaurants, the district court found numerous (even hundreds of) substitute employers within close geographic proximity to each of the named Plaintiffs, and the number of alternative quick-service restaurants dwarfed the number of McDonald’s franchises in the same area. Id. at 6.

Plaintiffs’ claim of monopsony buying power thus depends on the far-fetched premise that McDonald’s can suppress wages, notwithstanding hundreds of non-McDonald’s quick-service restaurants—and numerous other alternative employers—near Plaintiffs and other putative class members. In reality, if McDonald’s lowered its wages (or other employers raised theirs, and McDonald’s did not match), McDonald’s would lose its supply of labor. See Madison 92nd St. Assocs., LLC v. Courtyard Mgmt. Corp., 624 F. App’x 23, 29 (2d Cir. 2015) (in labor markets involving entry-level work, “it is beyond doubt that [employers] would have to increase their wages to retain any employees” if nearby employers “suddenly doubled the wages they paid to their employees”).

To evade this economic and commonsense reality, Plaintiffs and their expert, Dr. Singer, attempted to attribute monopsony power to McDonald’s as a structural feature of the labor economy in general. In other words, in their view, all employers of low-wage workers enjoy monopsony power in their labor markets, and, ipso facto, McDonald’s has market power in a single-brand market nationwide (or in each and every local labor market) because it employs low-wage workers.

In his expert report, for example, Dr. Singer characterizes economic literature as arguing that the ability of firms to suppress wages is “surprisingly common throughout the economy.” D.E. 271-5 (Singer Rep. ¶ 17). Thus, he stated, it “would be consistent with this literature . . . [t]hat McDonald’s-branded restaurant owners also face a low elasticity of labor supply[.]” Id.; see also id. ¶ 39 (“In light of [the economic literature], it is likely that both McDonald’s Franchisees and the McOpCos would continue to exercise some degree of monopsony power over their employees, even in the absence of the No-Hire Agreement.”).

On appeal, Plaintiffs point to Dr. Singer’s opinions about labor monopsonies, in general, as evidence that McDonald’s, specifically, had market power and could suppress wages in a proposed single-brand market for McDonald’s labor. See App. Br. at 30-33 (arguing that Plaintiffs “buttressed their direct proof of detrimental effects with substantial economic scholarship showing that low?wage employers, including those in the fast food sector, possess market power over their employees”); see also id. at 51 (arguing that “an overview of economic research demonstrat[es] that employers exercise significant monopsony power over their employees”).

Whatever the “structural” features of broader markets—comprising many low-wage employers and firms—those features say nothing about one company’s individual market power and ability to harm competition in a properly defined market. In any event, even if such a sweeping claim could suffice to carry one’s burden of proof as to a specific defendant, the claim is still inaccurate and inconsistent with the economic features of the quick-service restaurant industry. That industry is characterized by low barriers to entry for employees, extremely high turnover rates, and substantial wage growth.[4]

First, “[f]ood and beverage serving and related workers typically have no requirements for formal education or work experience to enter the occupation.” BLS, Occupational Outlook Handbook, Food and Beverage Serving and Related Workers, (Sept. 8, 2022). Unlike corporate executives and professional athletes, fast-food restaurant employees do not make large investments to obtain restaurant positions. Thus, they are not “locked in” to any one restaurant or even the restaurant industry, contrary to Plaintiffs’ argument that there are “high switching costs” for restaurant employees. App. Br. at 34.

Indeed, recent data show that the turnover in the quick-service sector is incredibly high, at around 144%—which means that if a restaurant has a total of 30 people on staff at any given time, it faced about 43 departures in the last year alone. See Daily Pay, The Turnover and Retention Rates for QSR Businesses (Nov. 15, 2022). BLS also recently found that the seasonally-adjusted “quit rate” for the accommodation and food services industry was 5.8% as of October 2022—higher than any other industry. See BLS, Economic News Release, Job Openings and Labor Turnover, Table 4, Quits levels and rates by industry and region, seasonally adjusted (Jan. 4, 2023). When restaurant workers quit, moreover, they frequently leave the restaurant industry altogether, creating high numbers of job openings for new entrants into restaurant sector employment. See BLS, Occupational Outlook Handbook, Food and Beverage Serving and Related Workers, (Sept. 8, 2022).

Moreover, fast-food workers in 2021, on average, benefitted from a 10% wage increase from 2020. See Dominick Reuter and Madison Hoff, A 10% pay increase and 8 other stats show how crazy it is to work in fast food right now, Business Insider (Aug. 24, 2021). Such rapid wage growth undermines Plaintiffs’ claim that monopsony power is a structural feature of the restaurant industry. To the contrary, this wage growth suggests that normal market factors of supply and demand are at play. Cf. Richard A. Epstein, Antitrust Overreach in Labor Markets: A Response to Eric Posner, 15 NYU J. L. & Liberty 407, 432 (2022) (“There is no global evidence, given the chronic fluctuations and frequent shortages, to believe that labor markets are rife with hidden pockets of monopsony power that function as economic black holes.”).

Finally, the most robust study of the relationship between wages and hours worked in fast-food labor markets yielded results that are consistent with competitive labor markets, rather than a monopsony model. See David Neumark and William Wascher, Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment, 90 Am. Econ. Rev. 1362, 1382 (2000) (critiquing the famous Card & Krueger minimum-wage study using direct data, rather than surveys, and looking at hours worked rather than overall employment; and finding that fast-food employers make wage and hour decisions consistent with “the prediction of the textbook [competitive] model”); see also David Neumark and William L. Wascher, Minimum Wages 106 (MIT Press 2007) (reviewing literature on low-wage restaurant workers and concluding that “the low-wage labor market can be reasonably approximated by the neoclassical competitive model”).

Overall, the empirical data show that the labor markets in which restaurants participate are dynamic and competitive, not dominated by monopsonists with the power to suppress wages at will.

II.         Paragraph 14 is Subject to the Rule of Reason

Plaintiffs cannot avoid their burden to plead and prove a market by insisting on per se analysis or even “quick look” review of Paragraph 14. The rule of reason governs Plaintiffs’ antitrust claims with respect to Paragraph 14 for at least three reasons. First, the restriction was a vertical, intrabrand restraint, not a horizontal one. Second, even if it were horizontal, it was still ancillary to the procompetitive franchise agreement. Third, Paragraph 14 does not fall within that narrow class of restrictions—such as price fixing—universally and historically condemned as anticompetitive. See Nat’l Collegiate Athletic Ass’n v. Alston, 141 S. Ct. 2141, 2155-56 (2021) (explaining “spectrum” of antitrust analysis).

As noted above, McDonald’s vigorously competes with numerous firms in both labor markets and the output market. Its competitive efforts have included various intrabrand restraints among its franchisees that foster a strong, consistent brand identity, along with shared marketing and product development. That successful brand identity is what attracts individual franchisees to open and operate McDonald’s restaurants. Because Paragraph 14 was such a vertical restraint, and ancillary to McDonald’s procompetitive objectives, it cannot be per se unlawful. Rather, it is subject to full rule of reason analysis.

A.        Paragraph 14 is a Vertical, Intrabrand Restraint

Paragraph 14 is a vertical, not horizontal, restraint. It was conceived and imposed by the franchisor, McDonald’s—not competing franchisees.

In 1955, McDonald’s included in its franchise agreement the predecessor to the Paragraph 14 restriction as part of an initial bundle of brand standards. That original franchise agreement also included limits on, among other things, product offerings and territorial exclusivity, as many franchise agreements do. D.E. 380-20. The terms of the agreement were consistent across franchisees, and were designed, insisted upon, and monitored by McDonald’s itself. Paragraph 14 was not created as part of an agreement among horizontal competitors, nationally or in any particular geographic labor market. Indeed, the large national (and subsequently international) network of McDonald’s franchises did not yet exist when the key elements of the franchise agreement were established.

Plaintiffs suggest the restraint was per se unlawful because corporate-owned restaurants, McOpCos, were horizontal competitors with independently owned franchisees. See App. Br. at 25, 44. In those local markets comprising both McOpCos and independently owned franchises, the district court found the restraint horizontal, but ancillary and subject to the rule of reason. Op. at 9. But the district court also identified vertical aspects to the terms that, in fact, obtain in most geographic markets. Id. at 4-5.

Paragraph 14 was necessarily a vertical restraint in the twenty states in which there were no McOpCo restaurants at all. Class Cert. Op. 17. In the remaining states, Paragraph 14 still operated as a vertical restraint in the local labor markets that had only independently owned franchisees or McOpCos, but not both. In other words, it was impossible for the restraint to operate horizontally on a national level, because the putative competition between independent franchisees and McOpCos could not have occurred in the many labor markets in which there were no McOpCos. Id. (finding that Plaintiffs have “not [ ] put forth evidence that McOpCos compete with franchisees in every part of the United States”).

Vertical restraints, like Paragraph 14, are generally evaluated under the rule of reason because they often foster interbrand competition. Thus, for decades, the Supreme Court has whittled down the types of vertical restraints that are subject to per se condemnation. In 1977, the Court refused to extend per se illegality to vertical non-price restraints, noting that vertical restrictions tend to promote interbrand competition, “the primary concern of antitrust law.” Cont’l T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 49, 52 n.19, 58 (1977). A decade later, the Court observed that “a rule of per se illegality for vertical nonprice restraints was not needed or effective to protect intra brand competition.” Bus. Elecs. Corp. v. Sharp Elects. Corp., 485 U.S. 717, 725 (1988). And, in 2007, the Court repudiated the prohibition of vertical price restraints that it had adopted nearly a century earlier. See Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877 (2007) (overruling Dr. Miles Med. Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911), and subjecting vertical price restraints to rule of reason analysis).

In these decisions, the Court repeatedly emphasized that any departure from the rule of reason “must be based on demonstrable economic effect, rather than . . . upon formalistic line drawing.” Bus. Elecs., 485 U.S. at 724; see also Leegin, 551 U.S. at 889 (applying rule of reason in part because “economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance”).

While Plaintiffs seek a departure from the rule of reason here, economic research confirms that vertical restraints—including franchisor-franchisee restraints—tend to be procompetitive. Reviewing the empirical and theoretical literature on vertical restraints, Lafontaine and Slade observed that:

[T]he empirical evidence concerning the e?ects of vertical restraints on consumer wellbeing is surprisingly consistent. Speci?cally, it appears that when manufacturers choose to impose such restraints, not only do they make themselves better o? but they also typically allow consumers to bene?t from higher quality products and better service provision.

Francine Lafontaine & Margaret Slade, Exclusive Contracts and Vertical Restraints: Empirical Evidence and Public Policy, 10 Handbook of Antitrust Economics 391, 408-09 (Buccirossi ed., 2008); see also Francine Lafontaine & Margaret E. Slade, Transaction Cost Economics and Vertical Market Restrictions—Evidence, 55(3) The Antitrust Bulletin 587 (2010).

The rule of reason is especially appropriate here because Paragraph 14 is not only a vertical restraint, but an intrabrand one as well. And intra-franchise no-hire agreements are fundamentally different from inter-company restraints for two principal reasons.

First, intra-franchise labor restraints do not restrict output or price in the labor market because they do not affect the ability of alternative employers to compete for workers—whether those employers operate other types of quick-service restaurants or any of the myriad establishments that compete for the same pool of lower-skilled workers.

Second, even if McDonald’s did have the ability to confer labor monopsony power on local franchisees (it does not, see infra), it had no economic incentive to do so. Creating local labor monopsonies would suppress wages in those areas. That would reduce the quantity of labor employed and, in turn, suppress output in the downstream product market (i.e., food sales). See, e.g., Herbert J. Hovenkamp, Worker Welfare and Antitrust, __ U. Chi. L. Rev. 1, 10, 13 (2022) (“[T]he demand for labor as an input is closely correlated with the amount of product or service output that the firm is generating.”). But McDonald’s as a franchisor depends on product output for royalties; it has no desire to reduce its royalties by creating dysfunction in the labor market.

Because Paragraph 14 is a vertical and intrabrand restraint, it must be subject to the rule of reason.

B.        Paragraph 14 is Ancillary to the Franchise Agreement

Paragraph 14 is also subject to scrutiny under the rule of reason (rather than per se or quick look analysis) because it was “ancillary” to a procompetitive franchise agreement. In other words, there was a clear procompetitive rationale for the entire bundle of vertically imposed restraints embodied in the McDonald’s franchise agreement: brand quality and consistency. Paragraph 14 promoted that larger endeavor and was not a naked restraint on trade.

For example, Paragraph 14 limited the ability of individual franchisees to free-ride on training investments by McDonald’s and other franchisees. That in turn encouraged investment in employee development and training, and in the McDonald’s system and brand more generally. Limits on intrabrand employee raiding foster brand consistency and stability, which also are advantageous for the growth of a nationwide brand. See, e.g., Gregory J. Werden, The Ancillary Restraints Doctrine after Dagher, 8 Sedona Conf. J. 17, 21 (2007).

Plaintiffs nonetheless argue that Paragraph 14 cannot be regarded as ancillary because it was not “reasonably necessary” to the procompetitive goals of the franchise agreement, purportedly demonstrated by the fact that the cessation of the restraint in 2017 was not fatal to McDonald’s franchise system. App. Br. at 23. That argument claims too much and shows too little.

As a legal matter, ancillarity does not require a showing that restraints are strictly necessary, but only that they “may contribute to the success of a cooperative venture.” Polk Bros., Inc. v. Forest City Enters., Inc., 776 F.2d 185, 189 (7th Cir. 1985). A restraint is ancillary, in other words, if, “at the time it was adopted,” it bears a reasonable relationship to the joint venture’s success. Id. (emphasis added); see also Major League Baseball Props., Inc. v. Salvino, Inc., 542 F.3d 290, 339-40 (2d Cir. 2008) (Sotomayor, J., concurring). By pointing to the fact that McDonald’s was still able to sign franchisees after 2017, Plaintiffs implicitly argue that a restraint can be ancillary only if its removal destroys the entire endeavor. That is not the law. In other words, a company’s decision to remove one part of a bundle of its practices does not mean the part that was removed never contributed to success of the business. Moreover, to require that businesses precisely calibrate the timing of their policy changes and the substance of those changes would chill the ability of businesses to develop and test new policies and business models. Cf. Werden, supra, at 23-24 (comprehensive analysis by DOJ economist rejecting strict-necessity test).

C.        Paragraph 14 Does not Fall in the Narrow Category of Per Se Unlawful Conduct

Paragraph 14 is not one of those few restrictions—such as price fixing and boycotts—that have been universally and historically condemned as anticompetitive; we are aware of no cases holding that this restraint is per se unlawful, and Plaintiffs cite none. See App. Br. at 25 (citing only inapposite decisions and Arrington v. Burger King Worldwide, Inc., 47 F.4th 1247, 1257 (11th Cir. 2022), which held that a no-hire agreement was “concerted activity” under Section 1 of the Sherman Act but instructed the district court “in the first instance” to determine the level of scrutiny). Accordingly, there is a strong presumption that the rule of reason applies. Bus. Elecs., 485 U.S. at 726; see also Alan J. Meese, In Praise of All or Nothing Dichotomous Categories: Why Antitrust Law Should Reject the Quick Look, 104 Geo. L.J. 835, 878-79 (2016) (“Declaring all horizontal restraints inherently suspect would presumptively condemn all manner of cooperation necessary to allocate resources to their highest valued use, relegating economic actors to cooperation achieved through atomistic interaction in the spot market or complete integration.”).

Plaintiffs do not offer any reason to depart from that standard, nor is there one. As the Supreme Court has held, a departure from rule of reason must be “justified by demonstrable economic effect.” Id. Yet there is a dearth of economic studies on the effects of this type of intrabrand no-hire or no-poach agreement on the labor market. Indeed, the Ashenfelter and Krueger study, on which Plaintiffs’ expert relied, states that “systematic evidence on the impact of no-poaching agreements on workers’ pay and within-franchise job mobility is unavailable.” Ashenfelter & Krueger, supra n.4, at 21. Moreover, to evaluate the impact of no-poach agreements on pay and mobility, one would have to control for a number of important variables—e.g., inter-firm variation in the terms of no-poach agreements, inter-firm variation in the bundling of employment restrictions, and interstate variation in the enforceability of employment restrictions. The only study we are aware of that attempts to do so concludes that elimination of no-poach clauses “causes minimal reductions in job concentration and no increase in wages.” Daniel S. Levy, et al., No-Poaching Clauses, Job Concentration and Wages: A Natural Experiment Generated by a State Attorney General, Advanced Analytical Consulting Group, Inc., at 1 (Jan. 23, 2020).

While the Court has said that a departure from the rule of reason should not be based on “formalistic line drawing,” that is precisely what Plaintiffs (and amici Federal Trade Commission and U.S. Dept. of Justice) propose. For example, Plaintiffs argue that per se treatment is appropriate because (1) in a small number of geographic markets, there are both McOpCos and independently owned franchisees,[5] and (2) interbrand no-poach agreements have been found by some courts analogous to market allocation agreements. App. Br. at 25, 44. But two analogies do not an equivalence make. Even in the limited and atypical markets comprising both McOpCos and independently owned McDonald’s franchises, there is still no evidence of monopsony power over the labor market. As the district court noted regarding Plaintiff Deslandes, alternative employers outnumbered McDonald’s franchises by more than a factor of twenty.

Judicial inexperience and limited economic literature, as well as the facts on the ground, all suggest that this was precisely the type of business practice for which more elaborate economic study is needed before subjecting it to per se condemnation.

Conclusion

For the foregoing reasons, this Court should affirm.

APPENDIX A

Amici Scholars of Law and Economics

Dirk Auer is the Director of Competition Policy at the International Center for Law & Economics and Adjunct Professor at the University of Liege in Belgium.

Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California Gould School of Law.

James C. Cooper is a Professor of Law at George Mason University School of Law.

Richard A. Epstein is the Laurence A. Tisch Professor of Law at New York University School of Law.

Luke M. Froeb is the William C. Oehmig Chair in Free Enterprise and Entrepreneurship at Vanderbilt University Owen School of Management.

Harold Furchtgott-Roth is a former commissioner of the Federal Communications Commission and a senior fellow at the Hudson Institute.

Daniel J. Gilman is a Senior Scholar at the International Center of Law & Economics.

Janice Hauge is a Professor of Economics at the University of North Texas Department of Economics.

Justin (Gus) Hurwitz is a Professor of Law at the University of Nebraska College of Law.

Stan J. Liebowitz is the Ashbel Smith Professor of Economics at the University of Texas at Dallas.

Abbott (Tad) Lipsky, Jr. is an Adjunct Professor at George Mason University School of Law.

Daniel A. Lyons is a Professor & Associate Dean for Academic Affairs at Boston College Law School.

Geoffrey A. Manne is President and Founder of the International Center for Law & Economics and a Distinguished Fellow at the Northwestern University Center on Law, Business & Economics.

Scott E. Masten is a Professor of Business Economics and Public Policy at the University of Michigan Ross School of Business.

Alan Meese is the Ball Professor of Law and Dean’s Faculty Fellow at William & Mary Law School.

Paul H. Rubin is the Samuel Candler Dobbs Professor of Economic Emeritus at the Emory University Department of Economics and Law School.

Vernon L. Smith is the George L. Argyros Endowed Chair in Finance and Economics at the Chapman University Argyros School of Business of Economics. Professor Smith was awarded the Nobel Memorial Prize in Economic Sciences in 2022.

Michael E. Sykuta is an Associate Professor of Economics at the University of Missouri.

Gregory J. Werden is a retired economist at the U.S. Department of Justice, Antitrust Division.

John M. Yun is an Associate Professor of Law at George Mason University School of Law.

[1] All parties have consented to the filing of this brief. Pursuant to Federal Rule of Appellate Procedure 29(a)(4)(E), counsel for ICLE represents that no counsel for any of the parties authored any portion of this brief and that no entity, other than amicus curiae or its counsel, monetarily contributed to the preparation or submission of this brief.

[2] See Gregory J. Werden, Why (Ever) Define Markets? An Answer to Professor Kaplow, 78 Antitrust L.J. 729, 741 (2013) (“Alleging the relevant market in an antitrust case . . . identifies the competitive process alleged to be harmed.”); Jonathan B. Baker, Market Definition: An Analytical Overview, 74 Antitrust L.J. 129, 129 (2007) (“Market definition is often the most critical step in evaluating market power and determining whether business conduct has or likely will have anticompetitive effects.”).

[3] Cf. Toys “R” Us, Inc. v. FTC, 221 F.3d 928, 937 (7th Cir. 2000) (“direct evidence” suffices where the parties agreed on a nationwide market, and the defendant held “20% of the national wholesale market and up to 49% of some local wholesale markets”).

[4] Dr. Singer misconstrues a key study in the limited economic literature regarding franchise hiring terms. That study—Orley Ashenfelter & Alan B. Krueger, Theory and Evidence on Employer Collusion in the Franchise Sector, IZA Discussion Paper, No. 11672 (July 2018) (cited at Singer Rep. ¶¶ 20, 23)—did not employ a causal design, and it did not establish—nor even purport to establish—that employers generally have or exercise antitrust-relevant market power, as Dr. Singer suggests. Singer Rep. ¶ 23. The study also found widespread use of no-poach terms among many brands that did not enjoy significant market, indicating that market power is not a prerequisite for a franchise to impose no-poach agreements.

[5] FTC and DOJ argue that assessing the horizontality of “employee-allocation agreements in the franchise context . . . requires a fact-bound evaluation of whether the agreement limits rivalry between actual or potential competitors.” DOJ & FTC Br. at 26-27 n.8. But, as noted above, there is undisputed evidence that in several states and local markets there was no competition between independently owned franchisees and McOpCos. Class Cert. Op. 17.