Robert Crandall and Clifford Winston’s op-ed in today’s Wall Street Journal makes the case for deregulating the practice of law…

Read the full piece here. 

Here’s the decision; here is my prior post concerning the district court decision.  I suspect the FTC was fairly confident it would succeed in persuading the panel to reverse.  The appeal turns on whether the district court was clearly erroneous in ruling that the FTC had failed to properly define a relevant market, and in turn, whether evidence of switching between the two drugs (Indocin IV and NeoProfen) by neonatologists (and/or hospitals) supported the a product market that encompassed both drugs.  The Eighth Circuit concluded the district court’s findings were not clearly erroneous, and thus, affirmed its judgment.

Here, I think, is the key paragraph on the FTC’s argument about behavior of marginal consumers and market definition:

Further attacking the district court’s reliance on consumer preference, the FTC argues that the court ignored the ability of marginal customers to constrain prices.  Whether there are enough marginal consumers to constrain prices is a factual question
that requires analyzing consumer-demand and profit-margins. See Tenet Health Care Corp., 186 F.3d at 1050-51, 1054 (marginal consumer substitution and profit-margins must be supported with more than “common sense.” This court pointed to the “compelling and essentially unrefuted [critical loss analysis] evidence that the switch to another [product] by a small percentage of [consumers] would constrain a price increase” as evidence of marginal consumer’s ability to constrain prices in a broader geographic market); see also United States v. Engelhard Corp., 126 F.3d 1302, 1306 (11th Cir. 1997) (requiring evidence in order to evaluate the possibility that losing marginal customers responsible for high-margin purchases may constrain prices). The FTC offered testimony of one expert explaining that “marginal customers”–neonatologists who are ambivalent between prescribing Indocin IV or NeoProfen–may constrain prices on either drug. Although not addressing this testimony in its fact-findings, the district court did state that it generally found the FTC expert unpersuasive. See Fox v. Dannenberg, 906 F.2d 1253, 1256 (8th Cir. 1990) (“The question of the expert’s credibility and the weight to be accorded the expert testimony are ultimately for the trier of fact to determine.”). Critically, the
district court did credit Lundbeck’s expert who stated that the number of neonatologists willing to switch between the drugs based on price was insufficient to exercise price constraint. See Pioneer Hi-Bred Int’l v. Holden Found. Seeds, Inc., 35 F.3d 1226, 1238 (8th Cir. 1994) (“[This court] will not disturb the district court’s decision to credit the reasonable testimony of one of two competing experts.”).
Lundbeck’s expert was clear that even those neonatologists who might be willing to switch in response to a price difference would do so only if there was a very significant price decrease, indicating that the level of cross-elasticity was low.

The Eighth Circuit panel also quickly dismissed the Commission’s arguments based upon internal documents and apparent functional similarity between the drugs.   On the internal documents, here is the relevant portion of the opinion:

According to Lundbeck’s internal documents, it anticipated that a dramatic price increase of Indocin IV would draw generic competitors into the market. As a result, it ceased promoting Indocin IV, focusing instead on increasing the market share of NeoProfen–as a superior PDA treatment. The FTC argues that this business strategy–to market NeoProfen as better than Indocin IV–means that Lundbeck viewed NeoProfen as a direct competitor to Indocin IV, and thus the drugs must be in the same product market. However, Lundbeck’s strategy to discontinue promoting Indocin IV in favor of NeoProfen can also be interpreted to mean that while Indocin IV was vulnerable to generics, NeoProfen was not, and thus the products are not interchangeable. If there are two permissible views of evidence, the factfinder’s choice between them is not clearly erroneous. Anderson, 470 U.S. at 574.

Judge Kopf offers up an interesting and reluctant concurrence, which appears here in full:

When defining the product market, and considering the issue of cross-elasticity of demand, the district court relied heavily upon the testimony of doctors that they would use Indocin or NeoProfen without regard to price. Admittedly, those doctors had no responsibility to pay for the drugs or otherwise concern themselves with cost. Thus, the doctors had scant incentive to conserve the scarce resources that would be devoted to paying for the medication. Why the able and experienced trial judge relied upon the doctors’ testimony so heavily is perplexing. In an antitrust case, it seems odd to define a product market based upon the actions of actors who eschew rational economic considerations. See, e.g., F.T.C. v. Tenet Health Care Corp., 186 F.3d 1045, 1054 & n.14 (8th Cir. 1999) (observing that “market participants are not always in the best position to assess the market long term” and that is particularly so where their testimony is “contrary to the payers’ economic interests and thus is suspect”).  That oddity seems especially strange where, as here, there is no real dispute that (1) both drugs are effective when used to treat the illness about which the doctors testified
and (2) internal records from the defendant raise an odor of predation. The foregoing having been said, the standard of review carries the day in this case as it does in so many others. As a result, I fully concur in Judge Benton’s excellent opinion.

It will be interesting to see whether the Commission press release on this doubles down on its earlier assertion that “Ovation’s profiteering on the backs of critically ill premature babies is not only immoral, it is illegal.”

Filed under: antitrust, federal trade commission, merger guidelines, mergers & acquisitions

Given the crucial role debit card “swipe” fees played in causing the recent financial crisis, Illinois Senator Dick Durbin insisted that the Dodd-Frank law (you know, the one that left Fannie and Freddie untouched) impose price controls on debit card transactions.  Ben Bernanke, who apparently doesn’t have enough on his plate, was tasked with determining banks’ processing and fraud-related costs and setting a swipe fee that’s just high enough to cover those costs.  Mr. Bernanke first decided that the aggregate cost totaled twelve cents per swipe.  After receiving over 11,000 helpful comments, Mr. Bernanke changed his mind.  Banks’ processing and fraud costs, he decided, are really 21 cents per swipe, plus 0.05 percent of the transaction amount.  In a few weeks (on October 1), the government will require banks to charge no more than that amount for each debit card transaction.

SHOCKINGLY, this price control seems to be altering other aspects of the deals banks strike with their customers.  The WSJ is reporting that a number of banks, facing the prospect of reduced revenues from swipe fees, are going to start charging customers an upfront, non-swipe fee for the right to make debit card purchases.  Wells Fargo, J.P. Morgan Chase, Suntrust, Regions, and Bank of America have announced plans to try or explore these sorts of fees — “Durbin Fees,” you might call them.

Whoever would have guessed that Mr. Durbin’s valiant effort to prevent future financial crises by imposing brute price controls would have had these sorts of unintended consequences?

Fortunately for me, I can just switch to using my credit card, which will not be subject to the price controls imposed by Messrs Durbin and Bernanke.  Because I earn a decent salary and have a good credit history, this sort of a switch won’t really hurt me.  In fact, as banks increase the rewards associated with credit card use (in an attempt to encourage customers to use credit in place of debit cards), I may be able to earn some extra goodies. 

Of course, lots of folks — especially those who are out of work or have defaulted on some financial obligations because of the financial crisis and ensuing recession — don’t have access to cheap credit.  They can’t avoid Durbin Fees the way I (and Messrs Durbin and Bernanke) can.  Oh well, I’m sure Mr. Durbin and his colleagues can come up with a subsidy for those folks.

Filed under: banking, credit cards, markets, regulation

Flying back from a hiking trip to spectacular Glacier National Park (see pics below the fold), I overheard a flight attendant say something that made me think of, what else?, bundled discounts.  “We also fly for Delta,” the United flight attendant told the woman in front of me.  That’s when I realized I was really flying on Skywest, a regional airline that provides service to the major airlines.

Skywest, it seems, flies between major airlines’ hub cities (Salt Lake City for Delta, Denver for United) and smaller destinations like Kalispell, Bozeman, Jackson Hole, etc.  (Full route map here.)  It does so, though, under the auspices of the major airlines, so one never buys a “Skywest” ticket, always a Delta or United ticket.  (This is pretty common.  Columbia, Missouri, where I teach, is serviced by Pinnacle Airlines, which flies back and forth between Columbia and Memphis for Delta.)

So what has this to do with bundled discounts?  Well, first recall why such discounts (price-cuts conditioned on purchasing products from multiple product markets) create anticompetitive concerns.  Courts, regulators, and scholars have worried that a multi-product seller may use bundled discounts to exclude equally or more efficient rivals that sell less extensive lines of products.  In theory, a multi-product seller who has market power over at least one of its products (i.e., the ability to charge an above-cost price for that product) could offer a bundled discount that results in an above-cost (and thus non-predatory) price for the bundle, but would still tend to exclude an equally efficient, but less diversified, rival.

The classic example of this strategy involves a bundled discount offered by a producer of shampoo and conditioner.  Suppose that manufacturer A sells both shampoo and conditioner, is a monopolist in the conditioner market, and competes in the shampoo market against manufacturer B, which sells only shampoo.  B is the more efficient shampoo manufacturer, producing shampoo at a cost of $1.25 a bottle compared to A’s cost of $1.50 per bottle.  A’s cost of producing a bottle of conditioner is $2.50.  If purchased separately, A’s per-bottle prices for shampoo and conditioner are $2.00 and $4.00, respectively.  But A offers customers a $1.00 bundled discount, charging only $5.00 for the shampoo/conditioner package.  While this discounted price is still above A’s cost for the bundle ($4.00), it could tend to exclude B.  Assuming that shampoo buyers must also buy conditioner (in equal proportions), buyers would have to pay A’s unbundled conditioner price of $4.00 if they purchased B’s shampoo and would thus be unwilling to pay more than $1.00 for the B brand of shampoo.  That price, though, is below B’s $1.25 cost.  Thus, A’s bundled discount would tend to exclude B from the market even though (1) the discounted price ($5.00) is above A’s aggregate cost for the bundle ($4.00), and (2) B is the more efficient shampoo producer.

Regional airlines like Skywest and Pinnacle find themselves in the same position as the shampoo-only manufacturer.  A significant impediment to these smaller airlines is the major carriers’ ability to offer a type of bundled discount — a price for a “bundle” of flights going from departure point to hub to destination that is significantly lower than the sum of the prices of two flights, one from departure point to hub and the other from hub to destination.  For example, a Delta flight from Columbia, Missouri to Memphis (a Delta hub) to New York City might cost $400, while purchasing separate flights from Columbia to Memphis and then from Memphis to NYC might cost a total of $500 ($200 for the Columbia to Memphis leg and $300 for the Memphis to NYC leg). This is, in effect, a bundled discount of $100.  If Pinnacle wanted to compete for passengers flying from Columbia to NYC, it would have to absorb the entire amount of the package discount on the single leg it offered (Columbia to Memphis), charging no more than $100 for the flight.  That price, though, may be below its cost.

Despite this impediment, regional airlines like Pinnacle and Skywest have not been driven out of business by the major carriers’ pricing strategies.  Instead, they have remained in business and have often delivered higher profits than their major carrier rivals.  How did they accomplish this feat?  By becoming suppliers to the major air carriers, offering to provide short-haul air service more efficiently than the majors.

So what are the implications for legal restrictions on bundled discounts?  A number of commentators have suggested that a bundled discount should be illegal if it would result in below-cost pricing on the competitive product after the entire amount of the discount is attributed to that product.  They take this position because they assume that such a discount would exclude an equally efficient, single-product rival by forcing it to price below its own cost.

The continued existence of Pinnacle, Sky West, and the other regional airlines, though, undermines this assumption.  Equally or more efficient single-product rivals confronted with the sort of bundled discount discussed above have a way to stay in business:  they can become suppliers to the bundled discounter.  If they are, in fact, more efficient than the discounter, it should jump on the opportunity to outsource production to them.  Thus, I would argue, a plaintiff complaining of exclusion by a bundled discount that does not run afoul of standard predatory pricing rules should have to show, among other things, that it could not stay in business by becoming a supplier to its discounting rival.  (It should also have to show that it could not replicate the bundle by collaborating with other product suppliers.)

For greater discussion of the appropriate liability rule for bundled discounts, see Part III of this article and Part IV of this article.  For some Glacier photos, see below the fold. 

Filed under: antitrust, bundled discounts, law and economics, regulation

Zipcar apparently has been the exclusive user of the 84 or so parking spaces D.C. allocates to car-sharing companies until very recently when the District’s DOT put them up for auction:

The city’s department of transportation offers what are now 84 curbside parking spaces to car-sharing companies, which had up until recently been all Zipcar’s. The long-established company enjoyed their free use for years and last year began paying $200 a space. It’s been the only car-sharing service at all in the District since 2007. In 2011, DDOT announced they wanted to open up the District’s car-sharing market by letting companies bid on the parking spaces, with a minimum bidding price of $3,600 per space. Well, bid they did. After interest from Hertz, Daimler, and Enterprise in addition to Zipcar, three of those four companies bid on the District’s parking spots, according to DDOT spokesman John Lisle earlier this month. He couldn’t tell me more then.

The big news is that Zipcar lost a significant fraction of these spaces:

But word is now in — Zipcar went from having all of what were once 86 curbside parking spots to what’s looking like 12 of the 84 that exist now, according to Zipcar consultant John Williams. You hear that? 12. Zipcar only received a dozen of the 84 spaces that have been allocated, it seems, with a slight possibility they’ll be able to increase the number to 14 due to the District’s wishes that all the car-sharing companies operate in all the wards. D.C.’s car-sharing market has just transformed in a dramatic way and more than I ever would have imagined.

But the economic news is what the story reveals about the auction mechanism implemented by the DDOT!

Multiple companies apparently bid the same amount for the spaces, Williams told me, and this morning the car-sharing companies literally drew straws at DDOT to determine how the spaces will be divided. Can you imagine the sight? They actually drew straws!

So all of the firms bid the minimum.  Strategic?  Collusive?  Coincidence?  More importantly, why wouldn’t the DDOT turn to an English auction mechanism with all of the tied bidders in the room?  Well, there’s a rule of course.  Details of the auction are here; tie-breaking rules (yes, drawing lots) are here (see Rule 1543.3).

HT: Steve Salop.

Filed under: business, economics, markets, regulation

Here is an interesting looking lawsuit involving restraints that Upper Deck imposes on Internet-only distributors:

Upper Deck filed a lawsuit on its new distribution policy against Blowout Cards and other (as of yet unnamed) Internet-only stores in June 2011. Without rehashing the entire article, Upper Deck’s distribution policy basically requires its authorized hobby distributors to sell its current, sealed products only to Brick and Mortar hobby shops for the first 90 days. This policy prevents Internet-only sellers from having new Upper Deck products until those products are three months old. In its lawsuit, Upper Deck asked the court to find that its distribution policy was legal, especially in regards to Blowout Cards.

There are other aspects of the case, including a tying allegation.  Read here for further details on the distribution policy and the underlying lawsuit.

Filed under: antitrust, economics, exclusive dealing, resale price maintenance

Abstract

In its recent report entitled “The Evolving IP Marketplace,” the Federal Trade Commission (FTC) advances a far-reaching regulatory approach (Proposal) whose likely effect would be to distort the operation of the intellectual property (IP) marketplace in ways that will hamper the innovation and commercialization of new technologies. The gist of the FTC Proposal is to rely on highly non-standard and misguided definitions of economic terms of art such as “ex ante” and “hold-up,” while urging new inefficient rules for calculating damages for patent infringement. Stripped of the technicalities, the FTC Proposal would so reduce the costs of infringement by downstream users that the rate of infringement would unduly increase, as potential infringers find it in their interest to abandon the voluntary market in favor of a more attractive system of judicial pricing. As the number of nonmarket transactions increases, the courts will play an ever larger role in deciding the terms on which the patents of one party may be used by another party. The adverse effects of this new trend will do more than reduce the incentives for innovation; it will upset the current set of well-functioning private coordination activities in the IP marketplace that are needed to accomplish the commercialization of new technologies. Such a trend would seriously undermine capital formation, job growth, competition, and the consumer welfare the FTC seeks to promote.

In this paper, we examine how these consequences play out in the context of standard-setting organizations (SSOs), whose activities are key to bringing standardized technologies to market. If the FTC’s proposed definitions of “reasonable royalties” and “incremental damages” become the rules for calculating damages in patent infringement cases, the stage will be set to allow the FTC and private actors to attack, after the fact, all standard pricing methods through some combination of antitrust litigation or direct regulation on the ground that such time-honored royalty arrangements involve the use of monopoly power by patent licensors. In consequence, the FTC’s Proposal, if adopted, could well encourage potential licensees to adopt the very holdout strategies the FTC purports to address and that well-organized SSOs routinely counteract today. Simply put, the FTC’s proposal for regulating IP by limiting the freedom of SSOs to set their own terms would replace private coordination with government hold-up. The FTC should instead abandon its preliminary recommendations and support the current set of licensing tools that have fueled effective innovation and dissemination in the IP marketplace. FTC forbearance from its unwise Proposal will improve bargaining incentives, reduce administrative costs, and remove unnecessary elements of legal uncertainty in the IP system, thereby allowing effective marketplace transactions to advance consumer welfare.

The August 2011 issue of Review of Industrial Organization is a special issue on the 2010 Horizontal Merger Guidelines edited by Roger Blair.

The issue is available here, and includes articles from:

• Herbert Hovenkamp
• Robert Willig
• Wayne-Roy Gale, Robert C. Marshall, Leslie M. Marx and Jean-Francois Richard
• Roger D. Blair and Jessica S. Haynes
• John F. Lopatka
• Keith N. Hylton
• Louis Kaplow
• Dennis Carlton and Mark Israel
• Roger Blair and Christina DePasquale
• Judd E. Stone and Joshua D. Wright
• Michael A. Salinger

My own contribution, The Sound of One Hand Clapping: The 2010 Merger Guidelines and the Challenge of Judicial Adoption, focuses upon the asymmetric economic updating of the Guidelines on the “competitive effects” side of the ledger without corresponding updates with respect to efficiencies analysis.  We explore whether this asymmetric updating might risk the widespread judicial adoption the Guidelines have thus far enjoyed.

 

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

There is an embarrassing blind spot in the behavioral law and economics literature with respect to implementation of policy whether via legislation or administrative agency.  James Cooper and William Kovacic — both currently at the Federal Trade Commission as Attorney Advisor Commissioner, respectively — aim to fill this gap with a recent working paper entitled “Behavioral Economics: Implications for Regulatory Behavior.”  The basic idea is to combine the insights of public choice economics and behavioral economics to explore the implications for behavioral regulation at administrative agencies and, in particular given their experiences, a competition and consumer protection regulator.

Here is the abstract:

Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. These scholars replace the assumption of rationality with one of “bounded rationality,” in which consumers’ actions are affected by their initial endowments, their tastes for fairness, their inability to appreciate the future costs, their lack of self-control, and general use of flawed heuristics. We posit a simple model of a competition regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she gets from the political overseer – whose optimal policy is one that focuses on short-run outputs that garner political support, rather than on long-term effective policy solutions – and the weight she puts on the optimal long run policy. We use this model to explore the effects of bounded rationality on policymaking, with an emphasis on competition and consumer protection policy. We find that flawed heuristics (e.g., availability, representativeness, optimism, and hindsight) and present bias are likely to lead regulators to adopt policies closer to those preferred by political overseers than they otherwise would. We argue that unlike the case of firms, which face competition, the incentive structure for regulators is likely to reward regulators who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). This sample selection process is likely to lead to a cadre of regulators who focus on maximizing outputs rather than outcomes.

Here is a little snippet from the conclusion, but please go do read the whole thing:

The model we present shows that political pressure will cause rational regulators to choose policies that are not optimal from a consumer standpoint, and that in a large number of circumstances regulatory bias will exacerbate this tendency. Our analysis also suggests special caution when attempting to correct firm behavior as regulatory bias appears likely more durable than firm bias because the market provides a much stronger feedback mechanism than exists in the regulatory environment. To the extent that we can de-bias regulators – either through a greater use of internal and external adversarial review or by making a closer nexus between outcomes and rewards – they will become more effective at welfare-enhancing interventions designed to correct biases.

Thinking about the implications of behavioral economics at the regulatory level is incredibly important for competition and consumer protection policy (think CFPB, for example).  And I’m very happy to see scholars of Cooper and Kovacic’s caliber — not to mention real world agency experience to bring to bear on the problem — tackling it.   For full disclosure purposes, I should note that I have or am currently co-authoring with each of them.  But don’t hold that against them!  Its a thought provoking paper upon which I will have some more thoughts later on, as well as tying it in to some of the work I’ve done on behavioral economics.  For example, Judd Stone and I explore a related problem of the implications of firm level irrationality — both for incumbents and entrants — in this piece, and find the implications for antitrust policy less clear (and in some cases, absent) than have behavioral antitrust proponents.  See also Stone’s post during the TOTM Free to Choose Symposium on BE and Administrative Agencies.

Filed under: antitrust, behavioral economics, consumer financial protection bureau, consumer protection, federal trade commission