1. Antitrust Treatment of Exclusionary Conduct in Network Markets

2. General Standards

3. 28 November 2005 Antitrust and Exclusion in Network Industries 3 Overview of Statutes Sherman Section 1 Makes illegal “every contract, combination or conspiracy in restraint of trade” Courts have limited it to unreasonable restraints Sherman Section 2 specifies two offenses that can be committed by a firm acting unilaterally Monopolization Attempted Monopolization Clayton Section 3 covers exclusive dealing and tying. More stringent than the Sherman Section 1, particularly for exclusive dealing. Robinson-Patman covers price discrimination. Slightly weaker standard of proof required than under Sherman Section 2. Brooke Group at 222.

4. 28 November 2005 Antitrust and Exclusion in Network Industries 4 Monopoly power is necessary for monopolization. Absent monopoly power, there is a belief that the market will sort things out on its own. Defining Market Power ‘The power to control prices or exclude competition.’ Not the economist’s definition: lots of market power. Finding Monopoly Power Typically inferred from high share of a relevant market May be inferred from a supplier’s conduct or performance (e.g., profitably set prices above competitive level) Other market characteristics can also affect the analysis (e.g., low entry barriers)

5. 28 November 2005 Antitrust and Exclusion in Network Industries 5 “Schumpeterian competition” challenges antitrust. Dramatic innovation may lead to sweeping changes in market positions and industry structure. Predicting future market outcomes can be difficult. Raises important issues about the interpretation of current market positions and actions. Market structure may be a series of temporary monopolies. Antitrust opponents focus on “temporary.” Are hopes of competition misguided? Competition within the market Competition for the market

6. 28 November 2005 Antitrust and Exclusion in Network Industries 6 We’re all Schumpeterians now. The government and Microsoft appeared to agree about the potential for dramatic change in the software industry. The government’s concern was that Microsoft was attempting to make its monopoly persist through exclusionary and predatory tactics. Might have been a particularly important time because of the importance of generations and paradigm shifts. Microsoft’s claimed it was competing in the face of huge forces of change in the industry.

7. 28 November 2005 Antitrust and Exclusion in Network Industries 7 Anticompetitive conduct is also necessary. Monopoly power alone is not an offense. “To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.” Trinko

8. 28 November 2005 Antitrust and Exclusion in Network Industries 8 Exercising market power in pricing is generally legal. “The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system.” Trinko “The Robinson-Patman Act … condemns price discrimination only to the extent that it threatens to injure competition.” Brooke Group at 209.

9. 28 November 2005 Antitrust and Exclusion in Network Industries 9 Antitrust concern is with harm to competition, not competitors. Pro-consumer, efficient actions often harm rivals. “The challenge for an antitrust court lies in stating a general rule for distinguishing between exclusionary acts, which reduce social welfare, and competitive acts, which increase it.” Microsoft at 26.

10. 28 November 2005 Antitrust and Exclusion in Network Industries 10 General Test for Exclusion DOJ view in Trinko: “conduct is not exclusionary or predatory unless it would make no economic sense for the defendant but for its tendency to eliminate or lessen competition.” Similar views stated in academic literature and many court decisions. “Thus, ‘exlcusionary’ comprehends at the most behavior that not only (1) tends to impair the opportunities of rivals, but also (2) either does not further competition on the merits or does so in an unnecessarily restrictive way.” Aspen Skiing at 605 n.32., quoting Areeda and Turner.

11. Predatory Pricing

12. 28 November 2005 Antitrust and Exclusion in Network Industries 12 Schematic of Predation time $ flow profits Offer high value to consumers today to weaken ability of rivals to offer consumers value in the future

13. 28 November 2005 Antitrust and Exclusion in Network Industries 13 Predatory Pricing General Standard Pricing that involves short-run losses that would make no business sense but for the long-term private benefits of eliminating or weakening a rival. Brooke Group Two-prong Test Price below some appropriate measure of cost Probable recoupment

14. 28 November 2005 Antitrust and Exclusion in Network Industries 14 Brooke Group Prong One “First, a plaintiff… must prove that the prices complained of are below an appropriate measure of its rival's costs.” Brooke Group, 222. Rationales Concern with chilling price competition. Some courts interpret below-cost pricing as indicative of a lack a legitimate business rationale. Some courts believe this is an “equally efficient rival” test.

15. 28 November 2005 Antitrust and Exclusion in Network Industries 15 Brooke Group Prong Two “… a demonstration that the competitor had a reasonable prospect, or, under §2 of the Sherman Act, a dangerous probability, of recouping its investment in below-cost prices.” Rationales Reality check—maybe. Consumer welfare standard—no.

16. 28 November 2005 Antitrust and Exclusion in Network Industries 16 Network Effects Complicate the Analysis of Predatory Pricing Network effects increase likelihood of recoupment and thus predation. However, Network effects also create “legitimate” incentives to set low prices; With two-sided markets, looking at just one side of the market can be misleading (similar issue with American Airlines); and Networks markets are inherently dynamic, which creates risks for static policies.

17. Refusal to Deal

18. 28 November 2005 Antitrust and Exclusion in Network Industries 18 Refusal to Deal Strong presumption of legality “the act does not restrict the long recognized right of [a] trader or manufacturer engaged in entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal.” Colgate at 307. But “The high value that we have placed on the right to refuse to deal with other firms does not mean that the right in unqualified.” Aspen Ski at 601. In fact, the quotation from Colgate starts with “In the absence of any purpose to create or maintain a monopoly,” Colgate at 307.

19. 28 November 2005 Antitrust and Exclusion in Network Industries 19 Su casa es mi casa: The Essential Facilities Doctrine Supreme Court has never recognized “essential facilities” doctrine. Especially not for unilateral conduct by an unregulated supplier. But some circuits do. Rivals granted access if that access is essential to their being able to compete.

20. 28 November 2005 Antitrust and Exclusion in Network Industries 20 The economics of mandatory access are complex. Effects on original investor’s incentives Reduced rewards to innovation Effects on follow-on investor’s incentives Reduced for substitute facilities Increased for complementary facilities Team problem with complements. It’s all about the money. Focusing solely on total denial or exclusion is too limited—look at the price. Getting the price right can be very hard

21. 28 November 2005 Antitrust and Exclusion in Network Industries 21 Aspen Skiing had some very striking features. “Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant ’s decision to cease participation in a cooperative venture. See id.,at 608,610 –611.The unilateral termination of a voluntary (and thus presumably profitable ) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. Ibid.” Trinko “Similarly,the defendant ’s unwillingness to renew the ticket even if compensated at retail price revealed a distinctly anticompetitive bent.” Trinko

22. Exclusive Contracts

23. 28 November 2005 Antitrust and Exclusion in Network Industries 23 Exclusive Contracts High threshold for attacking if a single supplier (e.g., not U.S. v. Visa USA et al.) Must involve foreclosure from a significant percentage of a relevant market. Tampa Electric.

24. Tying & Bundling

25. 28 November 2005 Antitrust and Exclusion in Network Industries 25 The Ins and Outs of Tying Tie In: Condition sale of A on purchase of B. Tie Out: Condition sale of A on not purchasing B from a rival. Tying out is more problematical With IP, MC = 0 and bundling can be efficient.

26. 28 November 2005 Antitrust and Exclusion in Network Industries 26 Tying is per se illegal if the rule of reason shows it is harmful. “[E]lements to a per se tying violation: (1) the tying and tied goods are two separate products; (2) the defendant has market power in the tying product market; (3) the defendant affords consumers no choice but to purchase the tied product from it; and (4) the tying arrangement forecloses a substantial volume [not share] of commerce.” Microsoft at 70 citing Eastman Kodak Co. v. ITS and Jefferson Parish.

27. 28 November 2005 Antitrust and Exclusion in Network Industries 27 Is there an exception for Microsoft? “We hold that the rule of reason, rather than per se analysis, should govern the legality of tying arrangements involving platform software products.” Microsoft at 69. Microsoft Court cites: physical integration benefits to makers of complementary products, and rapid technological progress.

28. 28 November 2005 Antitrust and Exclusion in Network Industries 28 Monopoly Leveraging Second Circuit condemned behavior that merely gave rise to a “competitive advantage” in a second market. This approach would very likely harm consumers and overall efficiency by denying firms the ability to take advantage of economies of scope. Supreme Court arguably struck this down in Spectrum Sports. Monopolization is required. Leveraging is not a separate antitrust offense. Big issue in the European Union

29. Specific Practices in U.S. v. Microsoft

30. 28 November 2005 Antitrust and Exclusion in Network Industries 30 Allegedly Bad Behavior Tying (Bundling) & Predation “Integration” of IE with Windows 95 and later versions made incremental cost of IE equal 0. Paid Apple to adopt IE. Government: way to protect OS monopoly by blocking two-stage entry of Navigator platform Microsoft: same product and, if not, efficient distribution

31. 28 November 2005 Antitrust and Exclusion in Network Industries 31 Allegedly Bad Behavior continued Polluting Java Developed a version of Java that fully ran only on Windows. Government: polluting to destroy standard. Microsoft: optimizing to the benefit of consumers.

32. 28 November 2005 Antitrust and Exclusion in Network Industries 32 Allegedly Bad Behavior continued OSP and ISP contracts that rewarded them for not offering competing browsers Agreements with PC OEMs that IE icon had to stay and could not be outdone ICPs were rewarded for promoting IE and making their content work better with IE than other browsers

33. 28 November 2005 Antitrust and Exclusion in Network Industries 33 An Outsider’s View of U.S. v. Microsoft Microsoft’s ISP, OSP, and OEM contracts harmed consumers in both the short and long runs. The net effects of the ICP contracts are not clear. Giving IE away for free and bundling it with Windows benefited consumers in the short run, but reduced the likelihood that Netscape/Java would emerge as a long-run platform competitor. Microsoft’s Java efforts may have benefited consumers in the short run, but probably lowered the likelihood that platform competition would emerge in the long run.

34. 28 November 2005 Antitrust and Exclusion in Network Industries 34 The Microsoft Function Issue

35. Conclusion

36. 28 November 2005 Antitrust and Exclusion in Network Industries 36 Summary Possessing a monopoly and exercising monopoly power is not a legal offense in the United States. Courts focus on actions that extend or enhance monopoly power through unfair or anticompetitive means. Critical distinction between harm to a competitor and harm to competition. Market power or dominance is a first-stage test: necessary but not sufficient. Burden primarily falls on the plaintiff. Defendant sometimes has to offer a legitimate business reason as a defense.

37. 28 November 2005 Antitrust and Exclusion in Network Industries 37 Summary continued General test for exclusion: behavior would not have been profitable but for the anticompetitive benefits it generated. Predatory pricing: Brooke Group two-prong test Refusal to deal: Strong presumption of legality absent clear intent Exclusive Contracts: High threshold for attacking if a single supplier Tying: per se illegal if rule of reason finds that it’s bad