Summary

“Today’s video marketplace is shaped by a byzantine set of rules from a bygone era. In the 1990s, cable was as mighty as the Byzantines themselves were at the height of their power: Cable’s control over the single physical conduit to the home gave cable providers gatekeeper power over video programming, much as the Byzantines’ control over the Eastern Mediterranean gave them control over commerce.

But cable today is simply one of several competing conduits for video programming distribution. Today’s regulations were intended to prevent cable from thwarting the rise of satellite DBS service. They have succeeded: Virtually the entire country has access to the two primary DBS providers in addition to a cable provider. Meanwhile, telcos like AT&T and Verizon have offered a fourth alternative to cable in a third of the country. Even more importantly, the MVPD paradigm is increasingly being challenged by consumers either switching to an OVD like Netflix, Hulu or Amazon (“cord-cutting”) or cutting back on their MVPD subscription and relying, in part, on an OVD (“cord-shaving”)….”

“Rather that continuing to try to tweak the laws of a bygone era, Congress should embrace the default tool for dealing with market power across the economy: antitrust law. Properly applied, antitrust is perfectly capable of governing a market in which programmers have clear property rights for their content. Indeed, antitrust is the best tool for policing market power in evolving (if not perfectly competitive) markets, to ensure that distributors with market power do not use their power to harm consumers, while recognizing the benefits that come from experimentation in new ways and business models for delivering video content to consumers….”

Satellite Television Law Media and cable executives from small and large companies testified on the Satellite Television Extension and Localism Act (STELA), scheduled to expire on December 31, 2014. The hearing focused on whether to reauthorize, repeal, or revise the law.

ICLE President Geoffrey A. Manne testified before the U.S. House Energy and Commerce Subcommittee on Communications and Technology in a hearing about the Satellite Television Extension and Localism Act (STELA), scheduled to expire on Dec. 31, 2014. The hearing focused on whether to reauthorize, repeal, or revise the law. Video of the full hearing is embedded below.

The Securities and Exchange Commission (SEC) recently scored a significant win against a Maryland banker accused of naked short-selling. What may be good news for the SEC is bad news for the market, as the SEC will now be more likely to persecute other alleged offenders of naked short-selling restrictions.

“Naked” short selling is when a trader sells stocks the trader doesn’t actually own (and doesn’t borrow in a prescribed period of time) in the hopes of buying the stocks later (before they must be delivered) at a lower price. The trader is basically betting that the stock price will decline. If it doesn’t, the trader must purchase the stock at a higher price–or breach their original sale contract.Some critics argue that such short-selling leads to market distortions and potential market manipulation, and some even pointed to short-selling as a boogey-man in the 2008 financial crisis, hence the restrictions on short-selling giving rise to the SEC’s enforcement proceedings.

Just one problem, there’s a lot of evidence that shows restrictions on short-selling make markets less efficient, not more.

This isn’t exactly news. Thom argued against short-selling restrictions seven years ago (here) and our late colleague, Larry Ribstein, followed up a couple years ago (here).  The empirical evidence just continues to pile in. Beber and Pagano, in the Journal of Finance earlier this year examine not just US restrictions on short-selling, but global restrictions. Their abstract reads:

Most regulators around the world reacted to the 2007–09 crisis by imposing bans on short selling. These were imposed and lifted at different dates in different countries, often targeted different sets of stocks, and featured varying degrees of stringency. We exploit this variation in short-sales regimes to identify their effects on liquidity, price discovery, and stock prices. Using panel and matching techniques, we find that bans (i) were detrimental for liquidity, especially for stocks with small capitalization and no listed options; (ii) slowed price discovery, especially in bear markets, and (iii) failed to support prices, except possibly for U.S. financial stocks.

So while the SEC may celebrate their prosecution victory, investors may have reason to be less enthusiastic.

Filed under: financial regulation, securities regulation, Sykuta

It’s not often that I disagree with my friend and co-author, FTC Commissioner Josh Wright, on an antitrust matter.  But when it comes to the proper legal treatment of loyalty discounts, the Commish and I just don’t see eye to eye.

In a speech this past Monday evening, Commissioner Wright rejected the view that there should be a safe harbor for single-product loyalty discounts resulting in an above-cost price for the product at issue.  A number of antitrust scholars—including Herb Hovenkamp, Dan Crane, and yours truly—recently urged the Supreme Court to grant cert and overturn a Third Circuit decision refusing to recognize such a safe harbor.  Commissioner Wright thinks we’re wrong.

A single-product loyalty discount occurs when a seller conditions a price cut (either an ex ante discount or an ex post rebate) on a buyer’s purchasing some quantity of a single product from the seller.  The purchase target is often set as a percentage of the buyer’s requirements, as when a medical device manufacturer offers to pay a 20% rebate on all of a hospital’s purchases of the manufacturer’s device if the hospital buys at least 70% of its requirements of that type of device from the manufacturer.  Because a loyalty discount tends to encourage distributors to carry more of the discounting manufacturer’s brand and less of the brands of the discounter’s rivals, such a discount may tend to “foreclose” those rivals from available distribution outlets.  If the degree of foreclose is so great that rivals have to cut their output below minimum efficient scale (the minimum output level required to achieve all economies of scale), then the discount may “raise rivals’ costs” relative to those of the discounter and thereby harm consumers.

On all these points, Commissioner Wright and I are in agreement.  Where we differ is on the question of whether a loyalty discount resulting in a discounted price that is above the discounter’s own cost should give rise to antitrust liability.  I say no.  I take that position because such an “above-cost loyalty discount” could be matched by any rival that is as efficient a producer as the discounter.  If, for example, a manufacturer normally charges $1.00 for widgets it produces for $.79 each but offers a 20% loyalty discount to retailers that buy 70% of their widget requirements from the manufacturer, any competitor that could produce a widget for $.79 (i.e., any equally efficient rival) could stay in business by lowering its price to the level of its incremental cost.  Thus, any rival that loses sales because of a manufacturer’s above-cost loyalty discount must be either less efficient than the manufacturer (so it can’t match the manufacturer’s discounted price) or unwilling to lower its price to the level of its cost.  In either case, the rival is unworthy of antitrust’s protection, where that protection amounts to prohibiting price cuts that provide consumers with immediate benefits.

Commissioner Wright disputes (I think?) the view that equally efficient rivals could match all above-cost loyalty discounts.  He maintains that loyalty discounts may be structured so that

[a] distributor’s purchase of an additional unit from a rival supplier beyond the threshold level can result in a loss of rebates large enough to render rival suppliers unable to attract a distributor to purchase the marginal unit at prices at or above the marginal cost of producing the good.

While I’m not entirely certain what Commissioner Wright means by this remark, I think he’s making the point that a loyalty discounter’s equally efficient rival might not be able to attract purchases by matching the discounter’s above-cost loyalty rebate if the rival’s “regular” base of sales is substantially smaller than that of the discounter.

If that is indeed what Commissioner Wright is saying, he has a point.  Suppose, for example, that the market for tennis balls consists of two brands, Penn and Wilson, that current market shares, reflective of consumer demand, are 60% for the Penn and 40% for Wilson, and that retailers typically stock the two brands in those proportions. Assume also that it costs each manufacturer $.90 to produce a can of tennis balls, that each sells to retailers for $1 per can, and that minimum efficient scale in this market occurs at a level of production equal to 35% of market demand. Suppose, then, that Penn, the dominant manufacturer, offers retailers a 10% loyalty rebate on all purchases made within a year if they buy 70% of their requirements for the year from Penn. The $.90 per unit discounted price is not below Penn’s cost, so the loyalty discount would come within my safe harbor.

Nevertheless, the loyalty discount could have the effect of driving Wilson from the market.  After implementation of the rebate scheme, a typi­cal retailer that previously purchased sixty cans of Penn for $60 and forty cans of Wilson for $40 could save $7 on its 100-can tennis ball require­ments by spending $63 to obtain seventy Penn cans and $30 to obtain thirty Wilson cans. The retailer and others like it would thus have a strong incen­tive to shift pur­chases from Wilson to Penn. To prevent a loss of mar­ket share that would drive it below minimum efficient scale (35% of market demand), Wilson would need to lower its price to provide retailers with the same total dollar discount, but on a smaller base of sales (40% of a typical retailer’s require­ments rather than 60%). This would require it to lower its price below cost. For example, Wilson could match Penn’s $7 discount to the retailer described above only by reducing its $1 per-unit price by 17.5 cents ($7.00/40 = $.175), which would require it to price below its cost of $.90 per unit.  Viewed statically, then, it seems that even an above-cost loyalty discount could occasion competitive harm by causing rivals to be less efficient, so that they could not match the discounter’s price.

In light of dynamic effects, though, I’m not convinced that examples like this undermine the case for a safe harbor for above-cost loyalty discounts. Had the nondominant rival (Wilson) charged a price equal to its marginal cost prior to Penn’s loyalty rebate, it would have enjoyed a price advantage and likely would have grown its market share to a point at which Penn’s loyalty rebate strat­egy could not drive it below minimum effi­cient scale. Moreover, one strategy that would prevent a nondominant but equally efficient firm from being harmed by a dominant rival’s above-cost loyalty rebate would be for the non-dominant firm to give its own volume discounts from the outset, secur­ing up-front commitments from enough buy­ers (in exchange for discounted prices) to ensure that its production stayed above minimum efficient scale. Such a strategy, which would obvi­ously benefit consumers, would be encouraged by a liability rule that evaluated loy­alty discounts under straight­forward Brooke Group principles (i.e., that included a safe harbor for above-cost discounts) and thereby signaled to manufacturers that they must take steps to protect themselves from above-cost loyalty discounts.

Commissioner Wright maintains that all this discussion of price-cost comparisons is inapposite because the theoretical harm from loyalty discounts stems from market exclusion (and its ability to raise rivals’ costs), not from predation.  He says, for example:

• “[T]o the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion and, as a result, the legal framework developed to evaluate exclusive dealing claims ought to be used to evaluate claims relating to loyalty discounts.” [p. 12]
• “[P]redatory pricing and raising rivals’ costs are distinct paradigms of potentially exclusionary conduct. There simply is not a stable relative relationship between price and cost in raising rivals’ cost models that form the basis of anticompetitive exclusion, and hence it does not follow that below cost pricing is a necessary condition for competitive harm.”  [pp. 19-20]
• “When plaintiffs allege that loyalty discounts … violate the antitrust laws because they deprive rivals of access to a critical input, raise their costs, and ultimately harm competition, they are articulating a raising rivals’ cost theory of harm rather than price predation.”  [p. 24]
• “Raising rivals’ costs and predation are two different economic paradigms of exclusionary conduct, and economic models within each paradigm establish the necessary conditions for each practice to harm competition and give rise to antitrust concerns. Loyalty discounts and other forms of partial exclusives … are properly analyzed under the exclusive dealing framework. Price?cost tests in the predatory pricing tradition … simply do not comport with the underlying economics of exclusive dealing.”  [p. 33]

I must confess that I’m baffled by Commissioner Wright’s oddly formalistic pigeonholing.  Why must a practice be one or the other—either pricing too low or excluding rivals and thereby raising their costs?  That seems like a false dichotomy.  Indeed, it seems to me that a problematic loyalty discount is one in which the discounter excludes its rivals from a substantial portion of the distribution network (and thereby raises their costs) via the mechanism of conditional price cuts. It’s “both-and,” not “either-or.”  And if that’s the case, then surely it makes sense to limit which price cuts may occasion liability—i.e., only those that could not be matched by equally efficient rivals.  [It is important to note here that I don’t advocate a price-cost test as an alternative to a foreclosure-based analysis.  Rather, a plaintiff should have to establish below-cost pricing (to show that the plaintiff was deserving of antitrust’s protection via the highly disfavored prohibition of discounts) and demonstrate that the discounting at issue resulted in substantial foreclosure from distribution outlets (the latter showing is necessary to prove harm to competition rather than simply to a competitor).]

Throughout his speech, Commissioner Wright emphasizes that the primary competitive concern presented by loyalty discounts is the possibility of “anticompetitive exclusion.”  He writes on page 8, for example, that “[t]he key economic point is that the antitrust concerns potentially arising from loyalty discounts involve anticompetitive exclusion rather than predatory pricing….”  On page 12, he reiterates that “to the extent loyalty discounts raise competition concerns, the concerns are about anticompetitive exclusion.”  He then apparently assumes that loyalty discount-induced exclusion is “anticompetitive” if it is sufficiently substantial—i.e., if the discounter’s rivals are foreclosed from so many distribution outlets that they are driven below minimum efficient scale so that their costs are raised relative to those of the discounter.

I would dispute the notion that discount-induced exclusion is anticompetitive simply because it’s substantial.  Rather, I’d say such exclusion is anticompetitive only if it is substantial and could not have been avoided by aggressive pricing.  Omitting the second requirement creates the possibility that antitrust will be used by a laggard rival to prevent a more aggressive rival’s consumer-friendly price competition.  (LePage’s anyone?)

Suppose, for example, that there are two producers of widgets, A and B, which both produce widgets at a marginal cost of $.79 and, given their duopoly, charge $1.00 per widget.  A, whose market share has hovered around 50%, institutes a loyalty rebate of 20% for retailers that purchase 70% of their requirements from A.  If B offers the same deal, or simply cuts its price to $.80, it should lose no market share.  But suppose B doesn’t do so, A captures 70% of the market, and B falls below minimum efficient scale.  Would we say that B’s exclusion is “anticompetitive” because A’s discount scheme resulted in such substantial foreclosure that it raised B’s costs?  Should B be able to collect treble damages for based on its “anticompetitive exclusion”?  Surely not.

Commissioner Wright, from whom I have learned more about “error costs” than anyone else, seems oddly unconcerned about the chilling effect his decidedly pro-plaintiff approach to loyalty discounts will produce.  Wouldn’t a firm considering a loyalty discount—a price cut, don’t forget!—think twice if it knew its rivals could sit on their hands, claim “exclusion” if the discount successfully moved substantial market share toward the discounter, and collect treble damages?  The safe harbor Hovenkamp, Crane, and I have advocated would provide assurance to potential discounters that they will not face liability if they charge above-cost prices, prices that could be matched by equally efficient, aggressive rivals.  Isn’t that approach more likely to minimize error costs?

Two closing points.  First, despite my disagreement with Commissioner Wright on this issue, I share the widely held view that he is one of the most brilliant antitrust thinkers out there.  He’s taught me more about antitrust than anyone (with the possible exception of the uber-prolific Herb Hovenkamp).  His questioning of my views on loyalty discounts really makes me wonder if I’m missing something.

Second, to those who think Commissioner Wright has “drifted” or “turned,” let me assure you that he’s long held his views on loyalty discounts.  As you can see here, here, and here, we’ve been going round and round on this matter for quite some time.

Perhaps one day one of us will persuade the other.

Filed under: antitrust, economics, error costs, exclusionary conduct, exclusive dealing, federal trade commission, law and economics, monopolization, regulation

If we’ve learned anything from the pending IRS scandal, it’s that bureaucrats matter.  Senate Minority Leader Mitch McConnell apparently thinks so.  According to a recent National Review article, McConnell, unlike most minority leaders, has put a great deal of effort into recommending highly qualified individuals for spots on the more than 100 bipartisan agencies and commissions in the federal bureaucracy.  He views his role in recommending appointees as a way to combat regulatory overreach and equip a “farm team” that will be poised to take over the reins of agencies the next time there’s a Republican in the White House.

Read the full piece here. 

Trial begins today in the Southern District of New York in United States v. Apple (the Apple e-books case), which I discussed previously here. Along with co-author Will Rinehart, I also contributed an  essay to a discussion of the case in Concurrences (alongside contributions from Jon Jacobson and Mark Powell, among others).

Much of my writing on the case has essentially addressed it as a rule of reason case, assessing the economic merits of Apple’s contract terms. And as I mention in this Reuters article from yesterday on the case, one of the key issues in this analysis (and one of the government’s key targets in the case) is the use of MFN clauses.

But as Josh pointed out in a blog post last year,

my hunch is that if the case is litigated its legacy will be as an “agreement” case rather than what it contributes to rule of reason analysis.  In other words, if Apple gets to the rule of reason, the DOJ (like most plaintiffs in rule of reason cases) are likely to lose — especially in light of at least preliminary evidence of dramatic increases in output.  The critical question — I suspect — will be about proof of an actual naked price fixing agreement among publishers and Apple, and as a legal matter, what evidence is sufficient to establish that agreement for the purposes of Section 1 of the Sherman Act.

He’s likely correct, of course, that a central question at trial will be whether or not this is a per se or rule of reason case, and that trial will focus in significant part on the sufficiency of the evidence of agreement. But because this determination will turn considerably on the purpose and function of the MFN and price cap terms in Apple’s agreements with the publishers, I don’t think there should (or will) be much difference. Nor do I think the government should (or will) win.

Before the court can apply the per se rule, it must satisfy itself that the conduct at issue “would always or almost always tend to restrict competition and decrease output.” But it is not true as a matter of economics — and certainly not true as a matter of law — that MFNs meet this standard.

After State Oil v. Kahn there can be no question about the rule of reason (if not per se legal) status of price caps. And as the Court noted in Leegin:

Resort to per se rules is confined to restraints, like those mentioned, “that would always or almost always tend to restrict competition and decrease output.” To justify a per se prohibition a restraint must have “manifestly anticompetitive” effects, and “lack any redeeming virtue.

As a consequence, the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue, and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason. It should come as no surprise, then, that “we have expressed reluctance to adopt per se rules with regard to restraints imposed in the context of business relationships where the economic impact of certain practices is not immediately obvious.” And, as we have stated, a “departure from the rule-of-reason standard must be based upon demonstrable economic effect rather than . . . upon formalistic line drawing.”

After Leegin, all vertical non-price restraints, including MFNs, are assessed under the rule of reason.  Courts neither have “considerable experience” with MFNs, nor can they remotely “predict with confidence that they would be invalidated in all or almost all instances under the rule of reason.” As a recent article in Antitrust points out,

The DOJ and FTC have brought approximately ten cases over the last two decades challenging MFNs. Most of these cases involved the health care industry and all were resolved by consent judgments.

Even if the court does take a harder look at whether a per se rule should govern, however, as a practical matter there is not likely to be much difference between a “does this merit per se treatment” analysis and analysis of the facts under the rule of reason. As the Court pointed out in California Dental Association,

The truth is that our categories of analysis of anticompetitive effect are less fixed than terms like “per se,” “quick look,” and “rule of reason” tend to make them appear. We have recognized, for example, that “there is often no bright line separating per se from Rule of Reason analysis,” since “considerable inquiry into market conditions” may be required before the application of any so-called “per se” condemnation is justified. “[W]hether the ultimate finding is the product of a presumption or actual market analysis, the essential inquiry remains the same–whether or not the challenged restraint enhances competition.”

And as my former classmate Tom Nachbar points out in a recent article,

it’s hard to identity much relative simplicity in the per se rule. Indeed, the moniker “per se” has become somewhat misleading, as cases determining whether to apply the per se or rule of reason become as long as ones actually applying the rule of reason itself.

Of course that doesn’t end the analysis, and the government’s filings do all they can to sidestep the direct antitrust treatment of MFNs and instead assert that they (and other evidence alleged) permit the court to infer Apple’s participation as the coordinator of a horizontal price-fixing conspiracy among the publishers.

But as Apple argues in its filings,

The[ relevant] cases mandate an inquiry into the possibility that the challenged contract terms and negotiation approach were in Apple’s independent economic interests. The evidence is overwhelming—not just possible—that Apple acted for its own valid business reasons and not to “raise consumer prices market-wide.”…Plaintiffs ask this Court to infer Apple’s participation in a conspiracy from (1) its MFN and price cap terms and (2) negotiations with publishers.

* * *

What is obvious, however, is that Apple has not fixed prices with its competitors. What is remarkable is that the government seeks to impose grave legal consequences on an inherently pro-competitive act—entry—accomplished via agency, an MFN, and price caps, none of which is per se unlawful.

The government’s strenuous objection to Apple’s interpretation of the controlling Supreme Court authority, Monsanto v. Spray-Rite, notwithstanding, it’s difficult to see the MFN clauses as evidence of Apple’s participation in the publishers’ alleged conspiracy.

An important point supporting Apple’s argument here is that, unlike the “hubs” in the other “hub and spoke” conspiracies on which the DOJ bases its case, Apple has no significant leverage over the alleged co-conspirators, and thus no power to coordinate — let alone enforce — a price-fixing scheme. As Apple argues in its Opposition brief,

The only “power” Apple could wield over the publishers was the attractiveness of a business opportunity—hardly the “make or break” scenarios found in Interstate Circuit and [Toys-R-Us]. Far from capitulating to Apple’s requested core business terms, the publishers fought Apple tooth and nail and negotiated intensely to the very end, and the largest, Random House, declined.

And as Will and I note in our Concurrences article,

MFNs are essentially an important way of…offering some protection against publishers striking a deal with a competitor that leaves Apple forced to price its ebooks out of the market.

There is nothing, that we know of, in the MFNs or elsewhere in the agreements that requires the publishers to impose higher resale prices elsewhere, or prevents the publishers from selling through Apple at a lower price, if necessary. Most important, for Apple’s negotiated prices to dominate in the market it would have to enjoy market power – a condition, currently at least, that is exceedingly unlikely given its 10% share of the ebook market.

The point is that, even if everything the government alleges about the publishers’ price fixing scheme were true, it’s extremely difficult to see Apple as a co-conspirator in such a scheme. The Supreme Court’s holding in Monsanto stands for nothing if not the principle that courts may not infer a vertical party’s participation in a horizontal price-fixing scheme from the existence of otherwise-legal and -defensible interactions between the vertically related parties. Because MFNs have valid purposes outside the realm of price-fixing, they may not be converted into illegal conduct on Apple’s part simply because they might also “sharpen [a publisher’s] incentives” to try to raise prices elsewhere.

Remember, we are in a world where the requisite anticompetitive conduct can’t be simply the vertical restraint itself. Rather, we’re evaluating whether the vertical restraint was part of a broader anticompetitive scheme among the publishers. For the MFN clauses to be part of that alleged scheme they must have an identifiable place in the scheme.

First of all, it is unremarkable that Apple might offer terms to any individual publisher (or to all publishers independently) that might be more favorable to the publisher than terms it is getting elsewhere; that’s how a new entrant in Apple’s position attracts suppliers. It is likewise unremarkable that Apple would seek to impose terms (like the MFN) that would preserve its ability to offer a publisher’s books for the same price they are offered elsewhere (which is necessary because the agency agreements negotiated by Apple otherwise remove pricing authority from Apple and confer it on the publishers themselves). And finally it is unremarkable that each publisher would try to negotiate similarly favorable terms with other distributors (or, more accurately, continue to try: bargaining over distribution terms with other distributors hardly started only after the agreements were signed with Apple). What would be notable is if the publishers engaged in concerted action to negotiate these more-favorable terms with other publishers, and what would be problematic for Apple is if its agreement with each publisher facilitated that collusion.

But I don’t see any persuasive evidence that the terms of Apple’s deals with each publisher did any such thing. For MFNs to perform the function alleged by the DOJ it seems to me that the MFNs would have to contribute to the alleged agreement between the publishers, just as the actions of the vertical co-conspirators in Interstate Circuit and Toys-R-Us were alleged to facilitate coordination. But neither the agency agreement itself nor the MFN and price cap terms in the contracts in any way affected the publishers’ incentive to compete with each other. Nor, as noted above, did they require any individual publisher to cause its books to be sold at higher prices through other distributors.

On this latter point, the DOJ alleges that the MFNs “sharpen[ed publishers’] incentives” to raise prices:

If a retailer were allowed to remain on wholesale terms, and that retailer continued to price new release e-books at $9.99, the Publisher Defendant would be forced to lower the iBookstore price to match the $9.99 price

Not only does this say nothing about the incentives of the publishers to compete with each other on price (except that it may have increased that incentive by undermining the prevailing $9.99-for-all-books standard), it seems far-fetched to suggest that fear of having to lower prices for books sold in Apple’s relatively trivial corner of the market would have an apreciable effect on a publisher’s incentives to raise prices elsewhere. For what it’s worth, it also seems far-fetched to suggest that Apple’s motivation was to raise prices given that e-book sales generate only about .0005% of Apple’s total revenues.

Beyond this, the DOJ essentially argues that Apple coordinated agreement among the publishers to accept the terms being offered by Apple, with the intent and effect that this would lead to imposition by the publishers of similar terms (and higher prices) on other distributors. Perhaps, but it’s a stretch. And if it is true, it isn’t because of the MFN clauses. Moreover, it isn’t clear to me (maybe I’m missing some obvious controlling case law?) that agreement over the type of contract used amounts to an illegal horizontal agreement; arguably in this case, at least, it is closer to an ancillary restraint or  justified agreement (as in BMI, e.g.) than, say, a group boycott or bid rigging. In any case, if the DOJ has a case at all turning on this scenario, I think it will have to be based entirely on the alleged evidence of direct coordination (i.e., communications between Apple and publishers during dinners and phone calls) rather than the operation of the contract terms themselves.

In any case, it will be interesting to see how the trial unfolds.

Filed under: antitrust, cartels, contracts, doj, e-books, economics, error costs, law and economics, litigation, MFNs, monopolization, resale price maintenance, technology, vertical restraints Tagged: agency model, Amazon, antitrust, Apple, doj, e-book, e-books, iBookstore, major publishers, MFN, most favored nations clause, per se, price-fixing, publishing industry, Rule of reason, Section 1, United States Department of Justice, vertical restraints

Last Thursday, the FTC settled a challenge to a company’s acquisitions of two key rivals. The two acquisitions, each of which failed to meet the threshold for required reporting under Hart Scott Rodino, occurred in 2005 and 2008. Because the acquired companies have been fully integrated into the acquirer and all distinct operations have been shut down, it was impossible for the Commission to “unscramble the eggs” by imposing a structural remedy that separates the companies or parts thereof. The Commission therefore opted for a behavioral remedy — i.e., a list of restrictions on how the combined company may operate its business in the future. The purported goal of the behavioral remedy is to enhance consumer welfare by restoring competition that was destroyed by the anticompetitive acquisitions.

Commissioner Josh Wright took exception to a couple of the restrictions in the consent order. In a separate statement, he set forth a principle reflecting his concerns that antitrust implementation be both evidence-based and sensitive to error costs. One hopes that the principle he articulated — a version of the Hippocratic maxim, “First, do no harm” — will influence future FTC decisions on behavioral remedies.

The defendant here was Graco, the leading manufacturer of “fast set equipment” (FSE) used by contractors to apply polyurethane foams and coatings. The two companies it purchased, Gusmer in 2005 and GlasCraft in 2008, were its two closest competitors in the North American market for FSE. Graco’s acquisitions of those companies eliminated almost all market competition. In addition, Graco allegedly coerced and threatened FSE distributors so that they would not carry competitors’ products, and it filed a questionable lawsuit against a rival, Gama/PMC, causing FSE distributors to grow leery of that supplier and drop its products.  These post-acquisition actions have helped cement Graco’s market power by denying its actual and potential rivals access to the distribution networks they need to effectively market their products.

In light of Graco’s post-acquisition conduct, the consent order agreed to Thursday prohibits Graco from threatening, coercing, or retaliating against distributors who carry its rivals’ products.  It also requires settlement of the lawsuit that was impairing Gama/PMC’s access to distributors, and it forbids Graco from bringing a similar suit in the future.

But the order then goes further.  It prohibits Graco from entering into exclusive dealing contracts with distributors, and it places limits on Graco’s freedom to give loyalty discounts to distributors.  (Specifically, it limits the purchase and inventory levels upon which Graco may condition distributor discounts.)

The problem, in Commissioner Wright’s view, was that there was no evidence that these forbidden activities – exclusive dealing arrangements and loyalty discounts – contributed to the absence of competition in the FSE market.  Because exclusive dealing arrangements and loyalty discounts are usually procompetitive, prohibiting their use by Graco in the absence of evidence that they are responsible for the lack of competition in the market or are likely to be used to effect anticompetitive harm rather than to achieve a procompetitive benefit is more likely to hurt than help consumers.

Wright notes (and the Commission acknowledges), for example, that the market for FSE is precisely the sort market in which exclusive dealing arrangements achieve the procompetitive benefit of avoiding “inter-brand free-riding.”  Manufacturers of FSE will enhance total sales if they train distributors on the proper use and various complicated features of FSE.  Consumers benefit from (and sales are increased by) such training, because the distributors pass along their learning to end-user purchasers.  But if one FSE manufacturer trains a distributor on how to use the equipment, other manufacturers whose product is carried by that distributor won’t need to do so themselves.  The possibility that they will “take a free-ride” on the manufacturer providing the training tends to dissuade all manufacturers from providing such training, to the detriment of consumers.  Exclusive dealing helps out by preventing free-riding and thereby assuring a manufacturer that it will receive the full benefit of its training efforts.  By banning exclusive dealing, then, the Commission’s consent order may cause a consumer injury, and there’s no reason to take that risk absent evidence that exclusive dealing has been used – or is likely to be used in the future – to create anticompetitive harm.  First, do no harm!

It is important to note that not including exclusive dealing and loyalty discounts on the list of behaviors prohibited by the consent order would not give Graco free rein to use those practices in a manner that causes anticompetitive foreclosure.  The Commission or a competitor could always challenge a future exclusive dealing arrangement or loyalty discount if there were evidence that the practice had caused anticompetitive harm.  The remainder of the Commission’s behavioral remedy assures that there will be a viable competitor – Gama/PMC – that is in a position to challenge any such conduct, and, in light of the consent order, the Commission and any reviewing court would take any future complaints quite seriously.  Doesn’t it make more sense, then, to limit the behavioral remedy to actions that have contributed to the anticompetitive situation at hand and not ban behaviors that may well inure to the benefit of consumers?  As Commissioner Wright put it:

A minimum safeguard to ensure [that] remedial provisions … restore competition rather than inadvertently reduce it is to require evidence that the type of conduct being restricted has been, or is likely to be, used anticompetitively to harm consumers.

I think Wright’s right on this one.

Filed under: antitrust, error costs, exclusive dealing, federal trade commission, mergers & acquisitions, regulation