This analysis evaluates the antitrust law ramifications of proposals requiring pharmacy benefit managers (“PBMs”) to open up their networks to “any willing provider” meeting the same terms and  conditions as other network members. Providers which have failed to meet a PBM’s terms have frequently sought the enactment of any-willing-provider (“AWP”) legislation (or comparable administrative action). A recent federal proposal, The Pharmacy Competition and Consumer Choice Act of 2011 (“the Act”) — provides a useful model for this analysis. Both economic analysis and available empirical evidence suggest  the bill will harm consumers by restricting competition.

Read the full piece here.

Douglas Holtz-Eakin and my former George Mason colleague and Nobel Laureate Vernon Smith are in the WSJ today discussing the economic wisdom and constitutionality of ObamaCare.  From the WSJ:

The Obama administration defends the mandate on the ground that a person’s decision to not buy health insurance affects commerce by materially increasing the costs of others’ health insurance. The government adds that health care is unique and therefore can be regulated constitutionally in ways other markets cannot.

In reality, the mandate has almost nothing to do with cost-shifting. The targeted population—the young, healthy and not poor who choose to forgo coverage—has a minimal role in the $43 billion of uncompensated health-care costs. In 2008, for example (the latest figures available), the Department of Health and Human Service’s Medical Expenditure Panel Survey showed that the uncompensated care of the mandate’s targeted population was no more than $12.8 billion—a tiny one-half of 1% of the nation’s $2.4 trillion in overall health-care costs. The insurance mandate cannot reasonably be justified on the ground that it remedies costs imposed on the system by the voluntarily uninsured.

The government’s other defense is that the health-care market does not exhibit textbook competition. No market does. The economic features relied upon by the government—externalities, imperfect information, geographically distinct markets, etc.—are characteristic of many markets.  The presence of externalities and other market imperfections does not justify a departure from the normal rules of the constitutional road. Health care is typically consumed locally, and health-insurance markets themselves primarily operate within the states. The administration’s attempt to fashion a singular, universal solution is not necessary to deal with the variegated issues arising in these markets. States have taken the lead in past reform efforts. They should be an integral part of improving the functioning of health-care and health-insurance markets.

Holtz-Eakin and Smith conclude:

Without the individual mandate, ObamaCare imposes total net costs of $360 billion on health-insurance companies from 2012 through 2021. With the mandate, the law would provide a net $6 billion benefit—i.e., revenues in excess of costs—over that same time period. In other words, the benefits of the individual mandate to health-insurance companies, along with their additional revenues provided by ObamaCare’s Medicaid expansion, are projected to balance, nearly perfectly, the costs that the law’s various regulatory mandates impose on insurers.

The individual mandate and Medicaid expansions appear to many to be unconstitutional. They are certainly bad economic policy. When they go, the entire law must fall. The administration built an intricate, balanced policy on a flawed economic foundation. It is up to the Supreme Court to pull it down.

Go read the whole thing.

Filed under: business, commerce clause, constitutional law, economics, health care, nobel prize

From a pure antitrust perspective, the real story behind the DOJ’s Apple e-book investigation is the Division’s deep commitment to the view that Most-Favored-Nation (MFN) clauses are anticompetitive (see also here), no doubt spurred on at least in part by Chief Economist Fiona Scott-Morton’s interesting work on the topic.

Of course, there are other important stories here (see Matt Yglesias’ excellent post), like “how much should a digital book cost?” And as Yglesias writes, whether “the Justice Department’s notion that we should fear a book publishers’ cartel is borderline absurd, on par with worrying about price-fixing in the horse-and-buggy market.”

I can’t help but notice another angle here.  For those not familiar, the current dispute over e-books emerges over a shift in business models from a traditional one in which publishers sold at wholesale prices to bookstores who would, in turn, set the prices they desired — sometimes below the book’s cover price — and sell to consumers at retail.  Much of the dispute arises out of the incentive conflict between publishers and retailers with respect to the profit-maximizing price.  The WSJ describes the recent iteration of the conflict:

To build its early lead in e-books, Amazon Inc. AMZN +0.19% sold many new best sellers at $9.99 to encourage consumers to buy its Kindle electronic readers. But publishers deeply disliked the strategy, fearing consumers would grow accustomed to inexpensive e-books and limit publishers’ ability to sell pricier titles.

Apple’s proposed solution was a move to what is described as an “agency model,” in which Apple takes a 30% share of the revenues and the publisher sets the price — readers may recognize that this essentially amounts to resale price maintenance — an oft-discussed topic at TOTM.  The move to the agency-RPM model also entailed the introduction of an MFN clause stipulating that publishers could not sell to rivals at a lower price.

Whether Apple facilitated a collusive agreement among publishers or whether this industry-wide move to the agency-model is an efficient and consumer-welfare enhancing method of solving the incentive conflict between publishers and retailers remains to be seen.  What is somewhat new in this dispute about book distribution is the technology involved; but the underlying economics of vertical incentive conflict between publishers and retailers is not!

Many economists are aware Alfred Marshall’s Principles of Economics textbook was apparently the first commodity sold in the United States under an RPM agreement!  (HT: William Breit)  The practice apparently has deeper roots in Germany.  The RPM experiment was thought up by (later to become Sir) Frederick Macmillan.  Perhaps this will sound familiar:

In 1890 Frederick Macmillan of the Macmillan Company was casting about for a book with which to conduct an experiment in resale price maintenance.  For years it had been the practice in Great Britain for the bookselllers to give their customers discounts off the list prices; i.e. price cutting had become the general practice.  In March, 1890, Mr. Macmilan had written to The Bookseller suggesting a change from the current discount system and had inserted a form to be filled out by the dealers.

Experimentation with business models to align the incentives of publishers and sellers is nothing new; it is only wonderful coincidence that the examples involve a seminal economics text published as the Sherman Act was enacted.  Nonetheless, an interesting historical parallel and one that suggests caution in interpreting the relevant facts without understanding the pervasive nature of incentive conflicts within this particular product line between publishers and sellers.  One does not want to discourage experimentation with business models aimed at solving those incentive conflicts.  What remains to be seen is whether and why the move to the new arrangement was executed through express coordination rather than unilateral action.

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-books, iBookstore, major publishers, MFN, most favored nations clause, per se, price-fixing, publishing industry, Rule of reason, vertical restraints

The DOJ’s recent press release on the Google/Motorola, Rockstar Bidco, and Apple/ Novell transactions struck me as a bit odd when I read it.  As I’ve now had a bit of time to digest it, I’ve grown to really dislike it.  For those who have not followed Jorge Contreras had an excellent summary of events at Patently-O.

For those of us who have been following the telecom patent battles, something remarkable happened a couple of weeks ago.  On February 7, the Wall St. Journal reported that, back in November, Apple sent a letter[1] to the European Telecommunications Standards Institute (ETSI) setting forth Apple’s position regarding its commitment to license patents essential to ETSI standards.  In particular, Apple’s letter clarified its interpretation of the so-called “FRAND” (fair, reasonable and non-discriminatory) licensing terms that ETSI participants are required to use when licensing standards-essential patents.  As one might imagine, the actual scope and contours of FRAND licenses have puzzled lawyers, regulators and courts for years, and past efforts at clarification have never been very successful.  The next day, on February 8, Google released a letter[2] that it sent to the Institute for Electrical and Electronics Engineers (IEEE), ETSI and several other standards organizations.  Like Apple, Google sought to clarify its position on FRAND licensing.  And just hours after Google’s announcement, Microsoft posted a statement of “Support for Industry Standards”[3] on its web site, laying out its own gloss on FRAND licensing.  For those who were left wondering what instigated this flurry of corporate “clarification”, the answer arrived a few days later when, on February 13, the Antitrust Division of the U.S. Department of Justice (DOJ) released its decision[4] to close the investigation of three significant patent-based transactions:  the acquisition of Motorola Mobility by Google, the acquisition of a large patent portfolio formerly held by Nortel Networks by “Rockstar Bidco” (a group including Microsoft, Apple, RIM and others), and the acquisition by Apple of certain Linux-related patents formerly held by Novell.  In its decision, the DOJ noted with approval the public statements by Apple and Microsoft, while expressing some concern with Google’s FRAND approach.  The European Commission approved Google’s acquisition of Motorola Mobility on the same day.

To understand the significance of the Apple, Microsoft and Google FRAND statements, some background is in order.  The technical standards that enable our computers, mobile phones and home entertainment gear to communicate and interoperate are developed by corps of “volunteers” who get together in person and virtually under the auspices of standards-development organizations (SDOs).  These SDOs include large, international bodies such as ETSI and IEEE, as well as smaller consortia and interest groups.  The engineers who do the bulk of the work, however, are not employees of the SDOs (which are usually thinly-staffed non-profits), but of the companies who plan to sell products that implement the standards: the Apples, Googles, Motorolas and Microsofts of the world.  Should such a company obtain a patent covering the implementation of a standard, it would be able to exert significant leverage over the market for products that implemented the standard.  In particular, if a patent holder were to obtain, or even threaten to obtain, an injunction against manufacturers of competing standards-compliant products, either the standard would become far less useful, or the market would experience significant unanticipated costs.  This phenomenon is what commentators have come to call “patent hold-up”.  Due to the possibility of hold-up, most SDOs today require that participants in the standards-development process disclose their patents that are necessary to implement the standard and/or commit to license those patents on FRAND terms.

As Contreras notes, an important part of these FRAND commitments offered by Google, Motorola, and Apple related to the availability of injunctive relief (do go see the handy chart in Contreras’ post laying out the key differences in the commitments).  Contreras usefully summarizes the three statements’ positions on injunctive relief:

In their February FRAND statements, Apple and Microsoft each commit not to seek injunctions on the basis of their standards-essential patents.  Google makes a similar commitment, but qualifies it in typically lawyerly fashion (Google’s letter is more than 3 single-spaced pages in length, while Microsoft’s simple statement occupies about a quarter of a page).  In this case, Google’s careful qualifications (injunctive relief might be possible if the potential licensee does not itself agree to refrain from seeking an injunction, if licensing negotiations extended beyond a reasonable period, and the like) worked against it.  While the DOJ applauds Apple’s and Microsoft’s statements “that they will not seek to prevent or exclude rivals’ products form the market”, it views Google’s commitments as “less clear”.  The DOJ thus “continues to have concerns about the potential inappropriate use of [standards-essential patents] to disrupt competition”.

Its worth reading the DOJ’s press release on this point — specifically, that while the DOJ found that none of the three transactions itself raised competitive concerns or was substantially likely to lessen the competition, the DOJ expressed general concerns about the relationship between these firms’ market positions and ability to use the threat of injunctive relief to hold up rivals:

Apple’s and Google’s substantial share of mobile platforms makes it more likely that as the owners of additional SEPs they could hold up rivals, thus harming competition and innovation.  For example, Apple would likely benefit significantly through increased sales of its devices if it could exclude Android-based phones from the market or raise the costs of such phones through IP-licenses or patent litigation.  Google could similarly benefit by raising the costs of, or excluding, Apple devices because of the revenues it derives from Android-based devices.

The specific transactions at issue, however, are not likely to substantially lessen competition.  The evidence shows that Motorola Mobility has had a long and aggressive history of seeking to capitalize on its intellectual property and has been engaged in extended disputes with Apple, Microsoft and others.  As Google’s acquisition of Motorola Mobility is unlikely to materially alter that policy, the division concluded that transferring ownership of the patents would not substantially alter current market dynamics.  This conclusion is limited to the transfer of ownership rights and not the exercise of those transferred rights.

With respect to Apple/Novell, the division concluded that the acquisition of the patents from CPTN, formerly owned by Novell, is unlikely to harm competition.  While the patents Apple would acquire are important to the open source community and to Linux-based software in particular, the OIN, to which Novell belonged, requires its participating patent holders to offer a perpetual, royalty-free license for use in the “Linux-system.”  The division investigated whether the change in ownership would permit Apple to avoid OIN commitments and seek royalties from Linux users.  The division concluded it would not, a conclusion made easier by Apple’s commitment to honor Novell’s OIN licensing commitments.

In its analysis of the transactions, the division took into account the fact that during the pendency of these investigations, Apple, Google and Microsoft each made public statements explaining their respective SEP licensing practices.  Both Apple and Microsoft made clear that they will not seek to prevent or exclude rivals’ products from the market in exercising their SEP rights.

What’s problematic about a competition enforcement agency extracting promises not to enforce lawfully obtained property rights during merger review, outside the formal consent process, and in transactions that do not raise competitive concerns themselves?  For starters, the DOJ’s expression about competitive concerns about “hold up” obfuscate an important issue.  In Rambus the D.C. Circuit clearly held that not all forms of what the DOJ describes here as patent holdup violate the antitrust laws in the first instance.  Both appellate courts discussion patent holdup as an antitrust violation have held the patent holder must deceptively induce the SSO to adopt the patented technology.  Rambus makes clear — as I’ve discussed — that a firm with lawfully acquired monopoly power who merely raises prices does not violate the antitrust laws.  The proposition that all forms of patent holdup are antitrust violations is dubious.  For an agency to extract concessions that go beyond the scope of the antitrust laws at all, much less through merger review of transactions that do not raise competitive concerns themselves, raises serious concerns.

Here is what the DOJ says about Google’s commitment:

If adhered to in practice, these positions could significantly reduce the possibility of a hold up or use of an injunction as a threat to inhibit or preclude innovation and competition.

Google’s commitments have been less clear.  In particular, Google has stated to the IEEE and others on Feb. 8, 2012, that its policy is to refrain from seeking injunctive relief for the infringement of SEPs against a counter-party, but apparently only for disputes involving future license revenues, and only if the counterparty:  forgoes certain defenses such as challenging the validity of the patent; pays the full disputed amount into escrow; and agrees to a reciprocal process regarding injunctions.  Google’s statement therefore does not directly provide the same assurance as the other companies’ statements concerning the exercise of its newly acquired patent rights.  Nonetheless, the division determined that the acquisition of the patents by Google did not substantially lessen competition, but how Google may exercise its patents in the future remains a significant concern.

No doubt the DOJ statement is accurate and the DOJ’s concerns about patent holdup are genuine.  But that’s not the point.

The question of the appropriate role for injunctions and damages in patent infringement litigation is a complex one.  While many scholars certainly argue that the use of injunctions facilitates patent hold up and threatens innovation.  There are serious debates to be had about whether more vigorous antitrust enforcement of the contractual relationships between patent holders and standard setting organization (SSOs) would spur greater innovation.   The empirical evidence suggesting patent holdup is a pervasive problem is however, at best, quite mixed.  Further, others argue that the availability of injunctions is not only a fundamental aspect of our system of property rights, but also from an economic perspective, that the power of the injunctions facilitates efficient transacting by the parties.  For example, some contend that the power to obtain injunctive relief for infringement within the patent thicket results in a “cold war” of sorts in which the threat is sufficient to induce cross-licensing by all parties.  Surely, this is not first best.  But that isn’t the relevant question.

There are other more fundamental problems with the notion of patent holdup as an antitrust concern.  Kobayashi & Wright also raise concerns with the theoretical case for antitrust enforcement of patent holdup on several grounds.  One is that high probability of detection of patent holdup coupled with antitrust’s treble damages makes overdeterrence highly likely.  Another is that alternative remedies such as contract and the patent doctrine of equitable estoppel render the marginal benefits of antitrust enforcement trivial or negative in this context.  Froeb, Ganglmair & Werden raise similar points.   Suffice it to say that the debate on the appropriate scope of antitrust enforcement in patent holdup is ongoing as a general matter; there is certainly no consensus with regard to economic theory or empirical evidence that stripping the availability of injunctive relief from patent holders entering into contractual relationships with SSOs will enhance competition or improve consumer welfare.  It is quite possible that such an intervention would chill competition, participation in SSOs, and the efficient contracting process potentially facilitated by the availability of injunctive relief.

The policy debate I describe above is an important one.  Many of the questions at the center of that complex debate are not settled as a matter of economic theory, empirics, or law.  This post certainly has no ambitions to resolve them here; my goal is a much more modest one.  The DOJs policymaking efforts through the merger review process raise serious issues.  I would hope that all would agree — regardless of where they stand on the patent holdup debate — that the idea that these complex debates be hammered out in merger review at the DOJ because the DOJ happens to have a number of cases involving patent portfolios is a foolish one for several reasons.

First, it is unclear the DOJ could have extracted these FRAND concessions through proper merger review.  The DOJ apparently agreed that the transactions did not raise serious competitive concerns.   The pressure imposed by the DOJ upon the parties to make the commitments to the SSOs not to pursue injunctive relief as part of a FRAND commitment outside of the normal consent process raises serious concerns.  The imposition of settlement conditions far afield from the competitive consequences of the merger itself is something we do see from antitrust enforcement agencies in other countries quite frequently, but this sort of behavior burns significant reputational capital with the rest of the world when our agencies go abroad to lecture on the importance of keeping antitrust analysis consistent, predictable, and based upon the economic fundamentals of the transaction at hand.

Second, the DOJ Antitrust Division does not alone have comparative advantage in determining the optimal use of injunctions versus damages in the patent system.

Third, appearances here are quite problematic.  Given that the DOJ did not appear to have significant competitive concerns with the transactions, one can create the following narrative of events without too much creative effort: (1) the DOJ team has theoretical priors that injunctive relief is a significant competitive problem, (2) the DOJ happens to have these mergers in front of it pending review from a couple of firms likely to be repeat players in the antitrust enforcement game, (3) the DOJ asks the firms to make these concessions despite the fact that they have little to do with the conventional antitrust analysis of the transactions, under which they would have been approved without condition.

The more I think about the use of the merger review process to extract concessions from patent holders in the form of promises not to enforce property rights which they would otherwise be legally entitled to, the more the DOJ’s actions appear inappropriate.  The stakes are high here both in terms of identifying patent and competition rules that will foster rather than hamper innovation, but also with respect to compromising the integrity of merger review through the imposition of non-merger related conditions we are more akin to seeing from the FCC, states, or less well-developed antitrust regimes.

Filed under: antitrust, contracts, economics, google, intellectual property, licensing, litigation, markets, merger guidelines, mergers & acquisitions, patent, technology, telecommunications, wireless

An interesting story in the WSJ Online today about American International Group (AIG)’s use of a standard tax write-off and the political firestorm it is creating…all because the Washington establishment thought it could hide behind semantics during the bailout era.

Read the full piece here. 

A recent report notes that while Apple may be shifting away from Google Maps, Google remains the default search engine in Safari, and thus, remains the default search on a variety of Apple devices.  Google competes vigorously for this right; indeed, competition among search engines drives the price paid to Apple for its ability to shift its users from one engine to another.

The chart below illustrates some analysis estimating Google generates $1.3 billion in revenue from toolbar searches on Apple devices of which over 75% goes to Apple.

This form of competition is a normal part of the competitive process, though as Geoff notes in his recent post (and in our joint work on the flaws in the antitrust case against Google), often misdiagnosed in competition settings.

Filed under: antitrust, economics, google, technology

Six months may not seem a great deal of time in the general business world, but in the Internet space it’s a lifetime as new websites, tools and features are introduced every day that change where and how users get and share information. The rise of Facebook is a great example: the social networking platform that didn’t exist in early 2004 filed paperwork last month to launch what is expected to be one of the largest IPOs in history. To put it in perspective, Ford Motor went public nearly forty years after it was founded.

Read the full piece here. 

One of the more significant papers in antitrust of late has been Professor Kaplow’s Why (Ever) Define Markets?  Kaplow provocatively argues that the entire “market definition/ market share” paradigm of antitrust is misguided and beyond repair.  Kaplow describes the exclusive role of market definition in that paradigm as generating inferences about market power, argues that market definition is incapable of generating reasonable inferences for that purpose as a matter of basic economic principles primarily because one must have a “best estimate” of market power previous to market definition, and concludes that antitrust ought to do away with market definition entirely.  As my description of the paper suggests, and Kaplow recognizes, it is certainly an “immodest” claim.  But it is a paper that has evoked much discussion in antitrust circles, especially in light of the recent shift in the 2010 HMGs toward analysis of competitive effects and away from market definition.

Many economists were inclined to agree with the basic conceptual shift toward direct analysis of competitive effects.  Much of that agreement was had on the basis that the market definition exercise aimed to do a number of things directed toward identifying the potential competitive effects of a merger (identifying market power is certainly one of those things), and that if we had tools allowing for direct inferences we ought to use those instead.  Kaplow’s attack on market definition, however, was by far the most aggressive critique.

Greg Werden has now posted an excellent paper in response, “Why (Ever) Define Markets?  An Answer to Professor Kaplow.”  Here is the abstract:

Professor Louis Kaplow has argued that market delineation in antitrust should be abandoned because it is not useful in assessing market power or evaluating competitive effects. This article takes issue with that view, explaining that market delineation serves purposes overlooked by Professor Kaplow. Most importantly, market delineation separates active forces of competition from those in the background. This separation is significant in the application of economic models and in the narrative of presenting an antitrust case. This article also explains why Professor Kaplow’s proposed analyses dispensing with market delineation would break down in important circumstances.

The entire paper is worth reading.  It provides an important perspective on the debate over the value of market definition not only from an economic perspective, but also with respect to the role of market definition in the law.  I summarize a few of the key points and basic arguments of the paper for readers.

Werden first begins by attacking the presumption in Kaplow’s argument that the exclusive purpose of market definition in the modern antitrust paradigm is to infer market power from market share.  For example, Kaplow claims that “the entire rationale for the market definition process is to enable an inference about market power.”  Werden claims, I think correctly, that Kaplow’s premise is incorrect.  While Werden makes the point that courts use market definition to infer market power even in the absence of market shares, the more important argument is that courts have long recognized the high shares themselves do not establish market power — indeed, the law requires the market power be “durable.”  The durability requirement, in turn, requires some analysis of entry conditions before a court can infer market power and, as Werden points out, market delineation is a useful tool for understanding which products — upon entry — would be sufficiently close substitutes as to preclude a firm from charging supra-competitive prices.  Similarly, of course, courts use market definition to cabin where the relevant antitrust injury might occur.

Keith Hylton makes a related, but distinct, argument about the value of market definition in his paper on the 2010 HMGs published in a symposium in the Review of Industrial Organization (note: Professor Kaplow has a shorter article in the Review of IO symposium previewing his arguments in the longer Harvard Law Review piece; I also have an article (with Judd Stone) on the new Guidelines’ treatment of efficiencies in the same issue).  Hylton objects to the change in focus in the new HMGs on the grounds that courts have used the market definition exercise for a number of valuable functions involving the trading off of error concerns in merger analysis:

In implementing the discretionary test of Brown Shoe, courts have traditionally required a definition of the relevant market. In order to determine whether competition appears to be structurally or operationally intense, or whether entry is easy, courts first have to define a relevant market. The definition of a relevant market has involved a fact intensive inquiry that trades off many concerns, in addition to the strict concern of finding a market which could be monopolized by the defendant (through an acquisition or through some anticompetitive conduct). When courts determine a relevant market, they are taking into account the consequences of that decision for the competitive process itself. If defining a market too narrowly will lead to the replacement of the market process of industrial rationalization with an administrative process, or discourage innovation incentives, courts are likely to take those costs into account. They are aware of the possibility that they could err in the decision, and will therefore tend toward a market definition that minimizes the costs of errors.36 The FTC’s standard would relegate the market definition component of a merger dispute to a lesser status. In so doing, it would constrain the ability of courts to make the tradeoffs that currently go into a market definition finding.37

Werden acknowledges that market definition can be avoided in some cases, such as consummated mergers with evidence of actual anticompetitive effects after the acquisition, or in some cases involving unilateral price effects.  Note that while Werden would likely dispense with market definition in some of these cases, the role Hylton ascribes to market definition as applied by the courts would still provide value in both of these types of cases.  Werden also makes the key point that Kaplow’s “direct” analysis of market power assumes that “all of the competitive action is confined to a single homogenous good, and his analysis goes awry when the sellers of the good have a significant strategic interaction with the sellers of close substitutes.”

A related point is that Kaplow’s analysis implicitly uses perfect competition as a competitive benchmark for inferring market power.  Indeed, the analysis presumes that all sellers other than the producer at issue “behave as price-takers.”   As Werden points out, the direct analysis of market power Kaplow prefers establishes market power as a matter of degree measured by the Lerner Index (i.e. the price – cost margin).  For a number of reasons, setting perfect competition as a competitive benchmark can be problematic; but for present purposes, note that to the extent that courts use the market definition inquiry to incorporate considerations wherein a firm might have high margins but yet face intense competition rendering it incapable of harming the competitive process, this would be yet another valuable function of that market definition inquiry.

Werden ends the paper by offering up some examples of the differences between the “conventional” approach and Kaplow’s analysis that are helpful.  You can go to the paper to read them — but Werden’s key point, as I read the paper, is that market definition is useful not only for allowing the assignment of market shares, but also for separating the important elements of the competitive story of a proposed merger (for example) from unimportant elements.   The distinction between those important and unimportant elements can inform modeling choices in unilateral effects cases, or the likelihood of post-merger coordination, and focuses courts on the competitive process to be investigated for potential harm.  His conclusion in response to Kaplow is direct:

Placing less emphasis on market delineation and market shares would be for the best in many antitrust cases, but market delineation serves analytical and narrative purposes not served by other tools.  Professor Kaplow’s proposal to abandon market definition would bring chaos to antitrust litigation.

Please go do read the whole thing.  There is some narrow sense in which I find the debate trivial.  Courts are highly unlikely to adopt Professor Kaplow’s proposal.  There are a number of barriers to eliminating market definition and there is no demand to do so from courts or agencies.  But that would be far too narrow a viewpoint on the issues raised by the paper.  The debate over market definition in the 2010 HMGs, and now spurred by Kaplow’s provocative and well argued paper, is very useful in helping us understand exactly what we aim to achieve through market definition.  The role of market definition in antitrust analysis is much more flexible under the new Guidelines — even if all agree that the agencies must define markets.  How flexible courts and agencies are and should be with respect to market definition does depend precisely upon the answer to the questions Werden tangles with in his paper, i.e. what does market definition accomplish, how well does it accomplish it, and when might we rely upon other tools to accomplish those ends?

Filed under: antitrust, economics, merger guidelines, mergers & acquisitions

Last week’s business news highlighted two tremendous subsidy programs. In one case, the company received no direct payment for product development. None of its suppliers received targeted subsidies to produce parts. But consumers were subsidized to encourage them to buy the product.

In the other case, the company received direct payments to underwrite the cost of product development, one of the company’s suppliers received an even larger subsidy to create critical components, and consumers were given subsidies to encourage them to buy the product.

One of those products is among the best selling products in the world. The other just halted production. The successful one was subsidized through private market transactions. The other was subsidized by the US government using taxpayer dollars.

If you haven’t guessed by now, I refer to the Apple iPhone and the Chevy Volt, respectively.

The irony of these twin tales is that they highlight the problems of subsidies in general, but particularly when the subsidy is used as a tool for the government to pick winners and losers in the market (i.e., industrial policy).

In the case of the iPhone, cellular phone companies subsidize the phone in the hope of being able to recoup those costs in the price of the service contracts that are bundled with the subsidized phones. Basically, the subsidy really amounts to nothing more than a marketing expense for the cell phone companies to expand their market share of (particularly data) service contracts. Cell phone carriers recognize that consumers value the features of the phone and are willing to take a loss on the phone to get the consumers locked into a service contract. The subsidy creates value all the way around, since the cellular companies would not offer the subsidy if they did not believe they could more than recoup the cost on the service contracts.

In the case of the Volt, the government had no concern for being able to break even. The motive was to unlevel the playing field by giving GM an (unfair?) advantage in developing an electric vehicle, whether compared to other electric vehicle manufacturers or to traditional combustion engines and recent hybrids. (Actually, according to the WSJ report, the Feds also subsidized Fisker Automotive’s Nina plug-in, which is also no longer in active production.) The problem is, consumers don’t want the product—even at the whoppingly-low, subsidized price of $40,000 per car. GM sold barely half of its originally target of 15,000 cars in 2011. The company has built up so much excess inventory that it shut down production and laid off 1,300 workers for a couple months, with the hope that consumers will eventually buy up the excess.

This doesn’t mean that private market “subsidies” are necessarily good either. As the WSJ reported, Apple is facing an uphill battle. As the market for contract cell service begins to get saturated, Apple finds itself unable to effectively compete in the non-contract market because it doesn’t have affordably-priced phones for that segment and cellular companies cannot (or simply will not) subsidize the iPhone if they can’t recoup the cost. Some investment fund managers have even grown leery of Apple because they see a rough road ahead as Apple tries to expand into LDC’s where non-contract phone plans dominate and consumers cannot afford the pricy iPhone.

As the WSJ headline indicates, subsidies provide a crutch for producers. In every case, over-reliance on the crutch will inhibit long-term growth and economic viability. The difference between privately-provided crutches and government-provided crutches is that the private sector market has a much stronger incentive to make sure the patient has a realistically good prognosis to begin with, rather than Washington’s knack for picking losers.

Filed under: business, markets, Sykuta, truth on the market