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The Ninth Circuit recently issued a decision that pushes the doctrine governing tying in the right direction.  If appealed, the decision could provide the Roberts Court with an opportunity to do for tying what its Leegin decision did for resale price maintenance:  reduce error costs by bringing an overly prohibitory liability rule in line with economic learning.  First, some background on the law and economics of tying.  Then, a little about the Ninth Circuit’s decision.  

Some Background on the Law and Economics of Tying

Tying (or a “tie-in”) occurs when a monopolist sells its monopoly “tying” product on the condition that the buyer also purchase some “tied” product.  Under prevailing doctrine, tying  is per se illegal if: (1) the tie-in involves two truly separate products (e.g., a patented printer and unpatented ink, not a left shoe and a right shoe), (2) the seller possesses monopoly power over the tying product, and (3) the tie-in affects a “not insubstantial” dollar volume (not share) of commerce in the tied product market (e.g., $50,000 or so will suffice). 

Scholars from both the Chicago and Harvard Schools of antitrust analysis (including yours truly) have argued that this rule is too prohibitory and that tie-ins should be condemned only when they foreclose a substantial percentage of sales opportunities in the tied product market.  This sort of rule of reason approach, we maintain, would prevent liability for tie-ins that could not possibly be anticompetitive and would align tying doctrine with the liability rule governing tying’s close cousin, exclusive dealing.  The governing per se rule, we contend, is a relic of the days when courts believed that a monopolist could immediately earn two monopoly profits by tying in a separate product and charging both a supracompetitive price for that tied product and the monopoly price for its monopoly product.  This so-called leverage theory has been debunked.  (Consumers will view the supracompetitive tied product price as an increase in the price of the tying product, which will push the tying product price above the profit-maximizing level and cause the seller to lose profits.  In short, there is only one monopoly profit to exploit, and the seller can do so by charging its profit-maximizing monopoly price for the monopoly product alone.) 

A couple of years ago, Harvard Law’s Einer Elhauge published a much-discussed article arguing that we critics of current tying doctrine are wrong.  Prevailing doctrine, Elhauge argued, is appropriate because tie-ins can cause anticompetitive effects even if they do not occasion substantial tied market foreclosure.  In particular, a tie-in can permit a seller to price discriminate among consumers and thereby extract a greater proportion of the trade surplus for itself.  For example, in a variable proportion tie-in (one where there is no fixed ratio between the number of tying and tied units purchased, as when a buyer of a printer is required to purchase all his ink requirements from the printer seller), the seller can price discriminate by tying in a complement (ink) whose consumption corresponds to the degree to which consumers value the tying product (e.g., consumers who most value the printer likely buy lots of ink).  By lowering the price of the tying product (the printer) from monopoly levels and charging a supracompetitive price for the tied product (the ink), the seller can effectively charge higher prices to consumers who value the tying product more, thereby capturing more surplus for itself.  Elhauge argues (incorrectly, as I show in this article) that this is an anticompetitive effect.

A second form of “anticompetitive” price discrimination, Elhauge contends, may result from fixed proportion tie-ins of products for which demand is not positively correlated.  George Stigler provided the classic example of this dynamic in his discussion of the Loew’s case, which involved the block booking of feature films (i.e., selling the films only in packages). 

Suppose, for example, that a firm has two customers, A and B; that A values product X at $8,000 and product Y at $2,500; and that B values product X at $7,000 and product Y at $3,000.  (For simplicity’s sake, assume that the marginal cost of both products is zero.)  If the firm were to sell the products separately, it would charge $7,000 for X and $2,500 for Y, and it would earn profits of $19,000 ($9,500 x 2).  By tying the products together and selling them as a bundle, the seller can charge a total of $10,000 per customer, an amount less than or equal to each customer’s reservation price for the package, thereby earning profits of $20,000.  While each consumer is charged the same amount for the package, the pricing is in some sense discriminatory, for the seller effectively discriminates against A, the low-elasticity X buyer, on A’s purchase of X and against B, the low-elasticity Y buyer, on B’s purchase of Y.  (This is because, absent the tying of X and Y, A would have enjoyed surplus of $1,000 on X but no surplus on Y, and B would have enjoyed surplus of $500 on Y but no surplus on X.)  By engaging in this sort of price discrimination, the seller may enhance its profits for, as Judge Posner explains, “When the products are priced separately, the price is depressed by the buyer who values each one less than the other buyer does; the bundling eliminates this effect.”

According to Elhauge, the sort of price discrimination/surplus extraction occasioned by “Stigler-type” tying, like the price discrimination resulting from a variable proportion “metering” tie-in, is anticompetitive and justifies the prevailing liability rule against tying.  In a subsequent post, I will explain why Elhauge is wrong and why Stigler-type price discrimination is output-enhancing and thus procompetitive.  For now, though, let’s consider the Ninth Circuit’s recent case, which rejected Elhauge’s view.

The Ninth Circuit’s Recent Brantley Decision

Brantley, et al. v. NBC Universal, Inc., et al., involved a challenge by cable television subscribers to T.V. programmers’ practice of selling cable channels only in packages.  The plaintiffs, who preferred to purchase individual channels a la carte, maintained that the programmers’ policy violated Sherman Act Section 1.  As the Ninth Circuit correctly recognized, the arrangement really amounted to tying, for the programmers would sell their “must have” channels only if subscribers would also take other, less desirable channels.  (Indeed, the practice is closely analogous to the block booking at issue in Loew’s, where the distributor required that licensees of popular films also license flops.)

The district court dismissed plaintiffs’ first complaint without prejudice on the ground that plaintiffs failed to allege that their injuries (purportedly higher prices) were caused by an injury to competition.  Plaintiffs then amended their complaint to include an allegation “that Programmers’ practice of selling bundled cable channels foreclosed independent programmers from entering and competing in the upstream market for programming channels.”  In other words, plaintiffs alleged, the tying at issue occasioned substantial tied market foreclosure.

After conducting some discovery, plaintiffs decided to abandon that theory of harm.  They prepared a new complaint that omitted all market foreclosure allegations and asked the court to rule “that plaintiffs did not have to allege that potential competitors were foreclosed from the market in order to defeat a motion to dismiss.”  Defendants again sought to dismiss the complaint.  The district court, reasoning that the plaintiffs had failed to allege any cognizable injury to competition, granted defendants’ motion to dismiss, and plaintiffs appealed.

Given this procedural posture, the Ninth Circuit starkly confronted whether, as Elhauge maintains, the price discrimination/surplus extraction inherent in Stigler-type bundling is an “anticompetitive” effect that warrants liability.  In affirming the district court and holding that plaintiffs’ claims of higher prices were not enough to establish anticompetitive harm, it effectively held, as I and a number of others have urged, that there should be no tying liability absent substantial tied market foreclosure.

This holding, while correct as a policy matter, seems to conflict with the Supreme Court’s quasi-per se rule.  That rule assigns automatic liability if the tie-in involves multiple products (it did here), the seller has monopoly power over the tying product (it did here), and the tie-in involves a not insubstantial dollar volume of commerce in the tied product market (it did here).  Thus, the Ninth Circuit has provided the Supreme Court  with a perfect opportunity to revisit the liability rule governing tying. 

I for one am hoping that the Brantley plaintiffs appeal and that the Supreme Court agrees to take the case and reconsider the prerequisites to tying liability.  If it does so, I predict that it will overrule its Jefferson Parish decision, jettison the quasi-per se rule against tying, and hold that there can be no tying liability absent substantial foreclosure of marketing opportunities in the tied product market.

Filed under: antitrust, economics, error costs, law and economics, markets, price discrimination, regulation, Supreme Court, tying, tying

Although I spend lots of my time these days thinking about business, my interaction with businesses is mostly as a customer. In a former career, I spent time behind the curtain, but as a law professor, I read and profess about business more than I observe it up close and personal. But yesterday, I got a rare treat to see what it is really like to be a small entrepreneur in America.

Read the full piece here.

Summary

The regulation of innovation and the optimal design of legal institutions in an environment of uncertainty are two of the most important policy challenges of the twenty-first century. Innovation is critical to economic growth. Regulatory design decisions, and, in particular, competition policy and intellectual property regimes, can have profound consequences for economic growth. However, remarkably little is known about the relationship between innovation, competition, and regulatory policy.

Any legal regime must attempt to assess the tradeoffs associated with rules that will affect incentives to innovate, allocative efficiency, competition, and freedom of economic actors to commercialize the fruits of their innovative labors. The essays in this book approach this critical set of problems from an economic perspective, relying on the tools of microeconomics, quantitative analysis, and comparative institutional analysis to explore and begin to provide answers to the myriad challenges facing policymakers.

Available from Cambridge University Press

Sprint, perhaps the most vigorous opponent of the proposed AT&T/T-Mobile merger, has been extolling the values of competition lately.  Last Thursday and again today, the company ran full-page ads in the Wall Street Journal featuring the following text (which was apparently penned by Helen Steiner Rice):

Competition is everything.

Competition is the steady hand at our back, pushing us to faster, better, smarter, simpler, lighter, thinner, cooler.

Competition is the fraternal twin of innovation.

And innovation led us to offer America’s first 4G phone, first unlimited 4G plan, first all-digital voice network, first nationwide 3G network, and first 4G network from a national carrier.

All of which, somewhat ironically, led our competition to follow.

Competition is American.  Competition plays fair.

Competition keeps us all from returning to a Ma Bell-like, sorry-but-you-have-no-choice past.

Competition is the father of rapid progress and better value.

Competition inspires us to think about the future, which inspires us to think about the world, which inspires us to think about the planet, which inspired us to become the greenest company among wireless carriers.

Competition has many friends, but its very best is the consumer.

Competition has many believers, and we are among them.

Competition brings out our best, and gives it to you.

Sprint — All. Together. Now

The current ad is a bit more artful, though less amusing, than Sprint’s last print ad (scroll down), which was quickly pulled after it raised the ire of the (hyper-sensitive) transgender community.  That ad addressed the AT&T/T-Mobile merger more directly, stating that “the deal is bad for consumers who would see higher prices, less innovation, and two companies controlling 80 percent of wireless revenue.”

Now I’m all for competition, undoubtedly the best regulator out there, but I’m suspicious of Sprint’s claim that its opposition to the AT&T/T-Mobile merger is based on a desire to ensure vigorous competition.  Sprint, you see, benefits if the proposed merger leads to the predicted parade of horribles.  Higher prices occasioned by a Verizon/AT&T “duopoly” (Sprint’s term) means Sprint can charge more for its services or win business from the “duopolists” by underpricing them.  If the duopolists get fat and lazy and slow their innovation, as Sprint predicts, Sprint won’t have to work as hard to attract customers.  In short, most of the purportedly anti-consumer aspects of the AT&T/T-Mobile deal are pro-Sprint.

Why, then, is the company fighting this merger so vigorously?  Well, there are a couple of possibilities.  One is that Sprint is concerned that the merged AT&T/T-Mobile will be particularly good at offering customers product/service/price combinations that they find attractive.  If that’s the case, then Sprint is ultimately worried that the deal will enhance, not reduce, competition.  Alternatively, Sprint may be worried that an AT&T/T-Mobile combination will reduce competition in the sale of inputs needed to provide wireless service, making it more difficult for Sprint to access the facilities it needs to do its business.  That might be a genuine anticompetitive harm from the merger.

Sprint would do well to clarify its complaint.  When it lauds the value of competition generally and complains about things like higher consumer prices and reduced innovation (effects from which it would benefit), it loses credibility.  Give it to us straight, Sprint.

(Josh’s much more sophisticated thoughts on the proposed merger are here.)

Filed under: antitrust, economics, law and economics, markets, mergers & acquisitions, wireless

Abstract

As I mentioned previously, I testified at Thursday’s hearing on the AT&T / T-Mobile merger.  My written testimony is available here.  Links to the testimony from other witnesses are available at the link above.  I’ll post transcripts when they become available; same with the video link should one become available (I’m not aware of one — if you are, let me know).

Nothing much to report that is outside the written testimony.  Not surprisingly, most of the Committee’s attention was focused on the left hand side of the witness table.  Certainly, there was plenty of “firm counting” analysis and “what will this do for my constituents?” to go around.  But that one interesting development was that many of the hearing questions — certainly more than I anticipated based upon the Senate hearing — focused on vertical aspects of the merger (e.g. backhaul).

Filed under: antitrust, economics, federal communications commission, merger guidelines, mergers & acquisitions, wireless

Our book, Competition Policy and Patent Law Under Uncertainty: Regulating Innovation will be published by Cambridge University Press in July.  The book’s page on the CUP website is here.

I just looked at the site to check on the publication date and I was delighted to see the advance reviews of the book.  They are pretty incredible, and we’re honored to have such impressive scholars, among the very top in our field and among our most significant influences, saying such nice things about the book:

After a century of exponential growth in innovation, we have reached an era of serious doubts about the sustainability of the trend. Manne and Wright have put together a first-rate collection of essays addressing two of the important policy levers – competition law and patent law – that society can pull to stimulate or retard technological progress. Anyone interested in the future of innovation should read it.

Daniel A. Crane, University of Michigan

Here, in one volume, is a collection of papers by outstanding scholars who offer readers insightful new discussions of a wide variety of patent policy problems and puzzles. If you seek fresh, bright thoughts on these matters, this is your source.

Harold Demsetz, University of California, Los Angeles

This volume is an essential compendium of the best current thinking on a range of intersecting subjects – antitrust and patent law, dynamic versus static competition analysis, incentives for innovation, and the importance of humility in the formulation of policies concerning these subjects, about which all but first principles are uncertain and disputed. The essays originate in two conferences organized by the editors, who attracted the leading scholars in their respective fields to make contributions; the result is that rara avis, a contributed volume more valuable even than the sum of its considerable parts.

Douglas H. Ginsburg, Judge, US Court of Appeals, Washington, DC

Competition Policy and Patent Law under Uncertainty is a splendid collection of essays edited by two top scholars of competition policy and intellectual property. The contributions come from many of the world’s leading experts in patent law, competition policy, and industrial economics. This anthology takes on a broad range of topics in a comprehensive and even-handed way, including the political economy of patents, the patent process, and patent law as a system of property rights. It also includes excellent essays on post-issuance patent practices, the types of practices that might be deemed anticompetitive, the appropriate role of antitrust law, and even network effects and some legal history. This volume is a must-read for every serious scholar of patent and antitrust law. I cannot think of another book that offers this broad and rich a view of its subject.

Herbert Hovenkamp, University of Iowa

With these contributors:

Robert Cooter, Richard A. Epstein, Stan J. Liebowitz, Stephen E. Margolis, Daniel F. Spulber, Marco Iansiti, Greg Richards, David Teece, Joshua D. Wright, Keith N. Hylton, Haizhen Lee, Vincenzo Denicolò, Luigi Alberto Franzoni, Mark Lemley, Douglas G. Lichtman, Michael Meurer, Adam Mossoff, Henry Smith, F. Scott Kieff, Anne Layne-Farrar, Gerard Llobet, Jorge Padilla, Damien Geradin and Bruce H. Kobayashi

I would have said the book was self-recommending.  But I’ll take these recommendations any day.

Filed under: announcements, antitrust, economics, law and economics, patent, scholarship

Tomorrow morning.  I’ll post my written testimony here tomorrow.

Hearing on: “How Will the Proposed Merger Between AT&T and T-Mobile Affect Wireless Telecommunications Competition?”

Thursday 5/26/2011 – 10:30 a.m.

2141 Rayburn House Office Building

Subcommittee on Intellectual Property, Competition and the Internet

Witness List

Mr. Randall Stephenson
Chairman, Chief Executive Office and President
AT&T, Inc.

Mr. Rene Obermann
CEO

Deutsche Telekom AG

Mr. Steven K. Berry
President and CEO
Rural Cellular Association

Ms. Parul P. Desai
Communications Policy Counsel
Consumers Union

Professor Joshua Wright
George Mason University School of Law

Professor Andrew I. Gavil
Howard University School of Law

Filed under: antitrust, doj, economics, federal communications commission, merger guidelines, mergers & acquisitions, wireless

“Sure, but they don’t have to carry exactly the same products. It’s not that there was no competition before — we carried some of the same items — but we had matching pricing.”  That’s Shirley Ng, owner of the Country Cheese Coffee Market at 1578 Hopkins Street in Berkeley, CA.  (HT: Marginal Revolution)  The story is about how “friendly spirit of the neighborhood is at stake,” because the owners of the nearby Monterey Market “have begun to deliberately stock items that they specialize in — including certain cheeses, wine and flowers — and they are selling them at predatory prices, which threatens the local merchants’ livelihoods.”

The article ends referencing a meeting between Monterey Market and the group of unhappy specialty merchants:

Meyer said that recently the group had been approached by a representative of Monterey Market to set up a meeting. “That discussion will determine where we go from here,” he said.

Asked what he expected from the Market, Meyer said: “They should talk to their fellow merchants about how they could all flourish.”

No such flourishing for consumers in Berkeley.  Also, I’d probably skip the meeting if I were a merchant in the area.

Good comments in the thread at the original story.

Filed under: antitrust, cartels, economics