Focus Areas:    Antitrust

Section 2 Symposium: Thom Lambert on Defining and Identifying Exclusionary Conduct

lambertThom Lambert is an Associate Professor of Law at University of Missouri Law School and a blogger at Truth on the Market.

There’s a fundamental problem with Section 2 of the Sherman Act: nobody really knows what it means. More specifically, we don’t have a very precise definition for “exclusionary conduct,” the second element of a Section 2 claim. The classic definition from the Supreme Court’s Grinnell decision — “the willful acquisition or maintenance of [monopoly] power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident” — provides little guidance. The same goes for vacuous statements that exclusionary conduct is something besides “competition on the merits.” Accordingly, a generalized test for exclusionary conduct has become a sort of Holy Grail for antitrust scholars and regulators.

In its controversial Section 2 Report, the Department of Justice considered four proposed general tests for unreasonably exclusionary conduct: the so-called “effects-balancing,” “profit-sacrifice/no-economic-sense,” “equally efficient competitor,” and “disproportionality” tests. While the Department concluded that conduct-specific tests and safe harbors (e.g., the Brooke Group test for predatory pricing) provide the best means of determining when conduct is unreasonably exclusionary, it did endorse the disproportionality test for novel business practices for which “a conduct-specific test is not applicable.” Under the disproportionality test, “conduct that potentially has both procompetitive and anticompetitive effects is anticompetitive under section 2 if its likely anticompetitive harms substantially outweigh its likely procompetitive benefits.”

According to the Department, the disproportionality test satisfies several criteria that should guide selection of a generalized test for exclusionary conduct. It is focused on protecting competition, not competitors. Because it precludes liability based on close balances of pro- and anticompetitive effects, it is easy for courts and regulators to administer and provides clear guidance to business planners. And it properly accounts for decision theory, recognizing that the costs of false positives in this area likely exceed the costs of false negatives.

While it has some laudable properties (most notably, its concern about overdeterrence), the disproportionality test is unsatisfying as a general test for exclusionary conduct because it is somewhat circular. In order to engage in the required balancing of pro- and anticompetitive effects, one needs to know which effects are, in fact, anticompetitive. As the Department correctly noted, the mere fact that a practice disadvantages or even excludes a competitor does not make that practice anticompetitive. For example, lowering one’s prices from supracompetitive levels or enhancing the quality of one’s product will usurp business from one’s rivals. Yet we’d never say such competitor-disadvantaging practices are anticompetitive, and the loss of business to rivals should not be deemed an anticompetitive effect of the practices.

“Anticompetitive” harm presumably means harm to competition. We know that that involves something other than harm to individual competitors. But what exactly does it mean? If Acme Inc. offers a bundled discount that results in a bundle price that is above the aggregate cost of the products in the bundle but cannot be met by a less diversified rival, is that a harm to competition or just a harm to the less diversified competitor? If Acme pays a loyalty rebate that results in an above-cost price for its own product but usurps so much business from rivals that they fall below minimum efficient scale and thus face higher per-unit costs, is that harm to competition or to a competitor? These are precisely the sorts of hard (and somewhat novel) cases in which we need a generalized test for exclusionary conduct. Unfortunately, they are also the sorts of cases in which the Department’s proposed disproportionality test is unhelpful.

A problem with most of the generalized tests that have been proposed is that they never actually define “unreasonably exclusionary.” Instead, they aim merely to identify instances of unreasonably exclusionary conduct. Like the disproportionality test, the effects-balancing test (which resembles the disproportionality test but doesn’t require that anticompetitive harms “substantially” outweigh procompetitive benefits) is somewhat question-begging in that it equates exclusionary conduct with a balance toward anticompetitive effects but never says what anticompetitive means. Similarly, the “no-economic-sense” test, which would condemn a business practice that would make no economic sense but for its ability to exclude rivals from the market, merely states the circumstances under which one may assume a business practice is unreasonably exclusionary; it never says what it is about an instance of exclusion that makes it “unreasonable.”

The one exception to this observation about definitional deficiencies is Judge Posner’s “equally efficient competitor” test, which says that an action is unreasonably exclusionary insofar as it is capable of excluding from the defendant’s market an equally or more efficient rival. Under that test, the essence of “unreasonable exclusionariness” (or “anticompetitiveness”) is doing something that could rig the game — that could result in a winner other than the most deserving firm. Such conduct is, quite literally, anti-competitive.

In lauding the Posner test for providing an actual definition of “unreasonably exclusionary” conduct, I do not mean to imply that the test should be the general means of identifying such conduct. As I have elsewhere explained, the test is somewhat under-deterrent (albeit perhaps appropriately so), and it may be difficult to apply to non-pricing practices. The test does have the virtue, though, of providing an actual definition of exclusionary conduct. When a court, regulator, or business planner is confronted with a novel practice and needs to assess liability, it will want to go back to basics and ask, “What exactly does it mean for a practice to be unreasonably exclusionary?” The Posner test provides an answer to that question.

Perhaps for that reason, the Posner test has been invoked quite successfully when novel practices have arisen. For example, in Ortho Diagnostic v. Abbott Labs., 920 F. Supp. 455 (S.D.N.Y. 1996), the district court went back to basics and relied upon the Posner definition of unreasonably exclusionary conduct to craft a workable rule for evaluating the legality of bundled discounts.

At the end of the day, an ideal general standard for exclusionary conduct might incorporate both a relatively administrable “identifying” test, such as the no-economic-sense test, and a definition of exclusionary conduct, such as that offered by Judge Posner. For example, the no-economic-sense test might be used to establish presumptive liability, but the defendant could rebut by showing that its conduct could not have been unreasonably exclusionary because it could not have excluded an equally efficient rival. In any event, given that the means of both legitimate competition and illicit exclusion are myriad, any approach seeking to give guidance on as-yet-untested business practices ought to include some actual definition of “unreasonable exclusionariness.”

Posted in antitrust, law and economics, section 2 symposium, truth on the market