1. The Antitrust Masters Course V ABA Section of Antitrust Law Plenary Session Slides Day 3, Session 1 October 2, 2010 Principal Lecturers Professor Andrew I. Gavil Honorable William E. Kovacic Professor Steven C. Salop Williamsburg Lodge, Williamsburg, VA

2. Session Agenda Exclusionary Conduct –Legal Framework –Cases and Examples Distributional Restraints Post-Leegin –Meaning of Leegin –Post-Leegin Developments 2

3. Part I: Legal Framework Cases and Examples 3

4. 4 Traditional Section 2 Elements Monopolization –Monopoly Power –Willful Acquisition or Maintenance Attempt to Monopolize –Specific Intent –Exclusionary Conduct –Dangerous Probability of Success The Common “Power + Conduct” Framework The Common “Power + Conduct” Framework: Market Power (“Big”) + Exclusionary Conduct (“Bad”) (justifications included)

5. Section 2 – Basic Assumptions “Monopoly” alone is not an offense –Preserve incentives to invest & for dynamic competition –“Exploitative” conduct not an offense despite Allocative efficiency losses, and Wealth transfers “Exclusionary Conduct” is essential element –But not luck, skill, foresight, superior product, or business acumen 5

6. Section 2 Synthesis cont’d BUT…dominance matters: –"[B]ehavior that might otherwise not be of concern to the antitrust laws--or that might even be viewed as procompetitive--can take on exclusionary connotations when practiced by a monopolist." Kodak v. Image Tech., 504 U.S. 451, 488 (1992) (Scalia, J., dissenting). –What if smaller rivals utilize same practice? Might suggest efficiency justifications, but Does not eliminate inquiry into effects –Same practice by a smaller firm may not pose any threat to competition BOTH effects and justifications must be evaluated 6

7. 7 Effective “Safe Harbors” Insufficient Market Power –Less than a VERY large market share Exception for strong direct evidence of effects? –No Substantial Barriers to Entry No significant impact on rivals’ costs/output MOST competitive strategies are protected: Lower, but above-cost prices Improved quality Greater efficiency Innovation Most distribution strategies No separate offense of “Leveraging” –Must prove elements of Attempt offense –But, Tying remains formally per se illegal (with conditions) Little government enforcement; few winning private cases

8. What Do Courts Mean by “Willful Acquisition or Maintenance”? How did the monopolist get to be (or remain) a monopolist? –Luck, skill, foresight, business acumen? –“Predatory/exclusionary” conduct? Why differentiate “good” from the “bad”? How can we differentiate? –Results look the same regardless of the means Vanquished rivals; monopoly power 8

9. Three Perspectives on “Exclusionary” Alcoa – Broad definition –Reflects fear of False Acquittals (false negatives)/under-deterrence –Concern: Lazy monopolists Bork – Narrow definition (Scalia too?) –Reflects fear of False Convictions (false positives)/over-deterrence –Concern: Don’t discourage innovation/protect weak rivals Raising Rivals Costs – Middle Ground –Reflects need to balance false positives and negatives –Concern: Exclusion is genuine concern 9 Source: Adapted from Gavil, Kovacic & Baker,Chapter 6 (2d ed. 2008)

10. Presumptions that Influence Perspectives (“Priors”) How common are successful efforts at exclusion? –Strategies and counterstrategies –Self-correcting markets How effective are courts and government at correctly identifying true acts of “exclusion”? –Can we tell the difference between success from superiority and success from exclusion/predation? Likely impact of under- and over-deterrence? –Under: permit durable market power; compromise ability to remedy –Over: diminish incentives to compete/innovate 10

11. Two SCT Models in Tension Aspen/Kodak –Assess impact of conduct on: Consumers Rival Monopolist –Test: (Areeda & Bork) Exclusion on some basis other than efficiency Impair competition in an “unnecessarily restrictive way” –Suggestive of structured RofR –Implicit endorsement of RRC, but Bork’s articulation (n.31) Matsushita/Brooke Group –Specialized test for predatory pricing: Below cost? Probability of recoupment? –Reinforced by Weyerhaeuser & Linkline –Presumed incidence and cost of false positives Triumph of Chicago and Harvard Schools? Note the Irony: Chicago and Harvard provided intellectual basis for BOTH models 11

12. Integrating Analytics into Law: Some Approaches Methods of defining the line between permissible and impermissible single firm conduct Unitary framework with burden shifting. E.g., Aspen, Microsoft (D.C. Cir. 2001) Unitary standard drawn from economics. E.g., Profit sacrifice/NES, Less efficient rival, Consumer welfare ROR, Disproportionality ROR Individualized tests based on error cost assessment. E.g., Predatory Pricing; RTD 12

13. Unitary Framework: The Microsoft Synthesis (ROR?) Source: Gavil, Kovacic & Baker, at 656 (2d ed. 2008)( Figure 6-6). 13

14. The Standards Wars Inspired by Aspen & Microsoft –Disproportionality –Consumer Welfare Effect Intervention more likely? Inspired by Brooke Group –Profit Sacrifice –No Economic Sense –Equally Efficient Rival Intervention less likely? 14 Q: Is this still a live debate?

15. 15 Some Areas of Controversy Predatory Pricing –Measuring costs –Above cost predatory pricing Tying –Still formally per se illegal. How much longer? Loyalty Discounts and Bundled Pricing –“Good” Discount or “Bad” Tax –Often tied to degrees of exclusivity Refusals to Deal –Essential Facilitie s

16. Predatory Pricing – Circuit Split? U.S. v. AMR, 335 F.3d 1109 (10 th Cir. 2003) –S/J for ∆ Issue: “Appropriate measure of cost” for airlines? Court Rejected Four DOJ Proposed Tests –Poor surrogates for incremental cost –Best Measure? Maybe AVC, but no definitive answer Spirit Airlines v. Northwest Airlines, 431 F.3d 917 (6 th Cir. 2005) –Reverses S/J for ∆ Evidence of below cost pricing sufficient to go to trial Above Cost Pricing Can Still be Predatory 16

17. Bundled Rebates – Circuit Split LePage's (3d Cir. 2003) –NOT same as PP –More like non-price exclusionary conduct, esp. exclusive dealing –Could eliminate equally efficient rival Apply Aspen/Microsoft –Anticompetitive effect and no justification, so condemn Peace Health (9 th Cir. 2008) –Pricing must be below cost –Use “discount attribution” method –Incremental cost/AVC –Relates to EER std –But NO recoupment prong Modified Brooke Group 17

18. 18 Judicial Approaches to Exclusion: Some Critical Factors Characterized & Analyzed as Non-Price Exclusionary Conduct Substantial monopoly power Actual anticompetitive effects –On prey, and –On consumers/competition Difficult Entry Defendant failed to show business justifications Characterized as Predatory Pricing Lack of monopoly power Absence of exclusivity Above Cost Pricing Lack of Antitrust Injury Business Justifications ? –Not Clear that Burden Shifted to Defendant to Demonstrate –Maybe Presumed When Plaintiff PrevailsWhen Defendant Prevails Reminiscent of old style Rule of Reason vs. Per Se Battles?

19. Trinko & Refusals to Deal Trinko (U.S. 2004) –H: Refusal to assist rival not actionable –Rationale? “Inspired by Brooke Group” Priors –High costs of error –Inhibit incentives or both predatory and prey Antitrust adds nothing to regulation of entry Courts as Commies (“Central Planners”) No judicial proctology –Exception: Aspen But it’s at the “outer boundary” of Section 2 Voluntary prior dealing + Profit sacrifice 19

20. A Closer Examination of Trinko Are Trinko’s Assumptions Contestable? –Likelihood of harm to competition from RTD –Impact on competitive incentives –Judicial administrability of duty to deal –Sufficiency of regulation to police entry-barring conduct –Value of private enforcement What are Trinko’s implications for public enforcement and partial deregulation? –See Shelanski Testimony (June 2010) http://www.ftc.gov/os/testimony/100615antitrusttestimony.pdf 20

21. 21 Innovation Incentives and Antitrust Enforcement Innovation incentives are a claimed general rationale for restricting antitrust cases against monopolists –“The ability to charge monopoly prices – at least for a short period – is what attracts “business acumen” in the first place.” Trinko (2003) –“The successful competitor, having been urged to compete, must not be turned upon when he wins.” Alcoa (1945) But, economic basis and significance of concern about monopolists’ innovation incentives are unclear –“Immunity from competition is a narcotic, and rivalry is a stimulant to industrial progress.” Alcoa (1945) –There is no evidence of weakened innovation incentives from fear of antitrust Questions: What is the best middle ground (if any)?

22. 22 Trinko’s Cautions Trinko (2003) – U.S. refusal to deal case –No general Sherman Act duty to deal, even by a monopolist “Forced” dealing raises red flags –Compelling negotiation can facilitate collusion. –Compelling firms to share may lessen investment incentives –Enforced sharing requires courts to act as central planners Key question: At what price must monopolist sell? –Would that price properly compensate “legitimate” monopolist? –Can courts determine that price in practice?

23. 23 Impact on Investment Incentives Leap-frog competition by entrant to enter input market would be unlikely in situations where this refusal to deal rule applies. –Defendant’s has monopoly power only if there are durable entry barriers in the input market Market competition will increase innovation incentives –Monopolists have weaker incentives than competitors –Monopolists have stronger incentives when monopoly is being threatened with competition –Exclusionary conduct reduces innovation incentives of entrants and rivals, by reducing or eliminating their market prospects Labelling an entrant a free-rider simply because it competes with a defendant with proven monopoly power in only one market (rather than entering both markets) is an extreme view Well-formulated price standard can protect monopolist’s investment incentives –Compensates defendant for monopoly profits on lost customers, while permitting competition to occur.

24. 24 Central Planning Concern: Can Courts Set a Price Standard? Task is not beyond the capabilities of courts and agencies –Market prices often provide a good price benchmark –Brooke Group relies on judicial price-cost comparison Eg, Predatory pricing, bundled rebates, Courts and agencies routinely compare prices and costs, and use other quantitative economic evidence (e.g., merger analysis) If antitrust withdraws, then next-best alternative may be full-fledged public utility regulation –Refusal to deal law by courts in these limited circumstances can serve as an episodic intervention short of full regulation

25. 25 Non-Exclusion Benchmark Price: Potential Alternatives Marginal cost –Problematical since does not compensate legitimate monopolist for investment Market prices –Price previously charged to plaintiff (if prior voluntary dealing) –Price charged to other buyers (if sell to others) –Problematical if world has changed; or, if no prices exist. “Protected-Profits” price benchmark –Price that compensates defendant for monopoly profits on output sales lost to plaintiff –Derived from the “Efficient Components Pricing Rule” (ECPR) used in regulation

26. 26 Calculating the Protected-Profits Benchmark: Example “Protected-Profits” price benchmark –Price that compensates defendant for monopoly profits on output sales lost to plaintiff Suppose –Current monopoly price = $100 –Monopolist’s current profits = $50 –Monopolist’s input costs = $10 Then, benchmark input price = $60 –Monopolist will earn $50 on input sales ($60-$10) Equally efficient entrant will just survive More efficient entrant will prosper and lead to price competition –Monopolist not compensated for the impact of this price competition on its profits

27. 27 Finally, How Would a Rule of Per Se Legality be Limited? If it is per se legal to refuse to deal with firms that compete with you … Why not also per se legal for defendant to refuse to deal with firms that … –Announce their intention to compete in some product market? (“non-competition agreement”) –Charge low prices for their competing products? (“price fixing”) –Buy other products from dfn’s competitors? (“tying”) –Sell output to dfn’s competitors? (“exclusive dealing”) Defendant’s “reputation” as substitute for “agreement”

28. Part II: Distributional Restraints Post-Leegin 28

29. 29 The Conventional View of Leegin “Leegin reaffirmed and extended Sylvania to vertical intrabrand price restraints.” –Ended the disparate treatment of price and non- price restraints… –Restored consistency and harmony to the law…. –And all thanks to well-settled economics! The Brighton Line The Sylvania Color TV c. 1966

30. 30 Sylvania’s Theory of Anticompetitive Effects – Non-Price Restraints Sylvania, 433 U.S. at 52 n.19: –“[W]hen interbrand competition exists … it provides a significant check on the exploitation of intrabrand market power because of the ability of consumers to substitute a different brand of the same product.” Implicit: Intrabrand restraints might be anticompetitive absent interbrand competition, i.e. when the upstream firm has market –Endorsed in Graphic Products v. Itek

31. 31 Leegin’s Theory of Anticompetitive Effects for RPM Explicit and Extensive Treatment –Facilitate Collusion Manufacturer Dealer –Facilitate Exclusion Dominant manufacturer Dominant retailer –Three Relevant “Filters”: Widely utilized? (necessary for cartel theory) Dealer initiated? (necessary for either dealer-related theory) Market Power? (necessary for all theories) Note Absence of Sylvania’s core theory.

32. 32 Some Issues Going Forward Did Leegin effectively overrule Sylvania in part? –Has interbrand competition become the sole, not merely the “primary” concern of U.S. antitrust law? Was Leegin correct, re four anticompetitive scenarios? –Can RPM be used like MFN as a facilitating practice to induce rivals to raise prices? –Compare with EC Vertical Block exemption What is effect of Leegin on Colgate? Monsanto and Sharp? –Are “agreement” rules still valid? –Was Sharp’s cartel focus effectively overruled? What is the significance of Breyer’s Dissent? Motivation?

33. 33 Public Sector – A Summary FederalState CongressDOJFTC Legislature Courts OAG Public Sector Pending Bill to overrule Leegin Work within Leegin to develop structured rule of reason approach. Possible split among Commissioners Some already had specific prohibitions of RPM; others have added in response to Leegin; some are following Leegin Continuing support for per se rule.

34. 34 Congress; “Overruling Leegin” S. 148/H.R. 3190 – “The Discount Pricing Consumer Protection Act” –“Findings” recount history of Dr. Miles and abandonment in Leegin –Amends Sherman Act, §1: “Any contract, combination, conspiracy, or agreement setting a minimum price below which a product or service cannot be sold by a retailer, wholesaler, or distributor shall violate this Act.” –Second attempt since 2007; depth of support not clear –Would abandon generality and flexibility of Section 1

35. 35 FTC -- A More Complex Picture “Overrule or Work Within Leegin?” Chairman Leibowitz –January 2007 Then Commissioner, he dissents from Leegin Amicus –May 2008 Votes in favor of Nine West petition –Spring 2009 As Chairman, supports bill to overrule Leegin at ABA Spring Meeting Commission Positions –Pre-Leegin Amicus Brief Kovacic & Rosch supported –Post-Leegin Nine West Consent Decree Modification –New Commissioners Could Determine FTC Position Ramirez & Brill

36. 36 FTC -- A Closer Look at Nine West Petition Granted (4-0) –General Principles RPM NOT per se lawful Leegin’s “invitation” could mean agencies should explore truncated approaches using three factors RPM could be “inherently suspect” (Polygram) –“presumptions and phased inquiries” –Nine West demonstrated: No market power + RPM initiated by Nine West, …so no likely anticompetitive effect But…NW failed to demonstrate how RPM would increase demand for its products, so monitoring required What was involved? A petition by a shoe mfr to modify a pre- Leegin consent decree that prohibited its use of RPM.

37. 37 A Closer Look at Nine West cont’d “Through the Commission’s own enforcement work, research, and external consultations such as workshops, we anticipate further refinements to this analysis, including the further specification of scenarios in which RPM poses potential hazards and those in which it does not.” Workshop held in May 2009; no Report yet

38. 38 DOJ/Antitrust Division: “Working Within Leegin” Speech by Christine Varney (Oct. 7, 2009) –Sees Leegin as an “invitation”: “As courts gain experience considering the effects of these restraints by applying the rule of reason over the course of decisions, they can establish the litigation structure to ensure the rule operates to eliminate anticompetitive restraints from the market and to provide more guidance to businesses. Courts can, for example, devise rules over time for offering proof, or even presumptions where justified, to make the rule of reason a fair and efficient way to prohibit anticompetitive restraints and to promote procompetitive ones.” Leegin, 551 U.S. at 898-99.

39. 39 DOJ/Antitrust Division cont’d General Principles –“Structured rule of reason” Euphemism for something less than comprehensive rule of reason –Presumptions and burden shifting –“Sliding scale” as in mergers –Preserves possibility of per se rule Specific Tests for Each Leegin Scenario –Collusion Scenarios –Exclusion Scenarios Role of three Leegin factors

40. 40 Basis for Federal Consensus? If Leegin is not overruled by Congress… DOJFTC Common Ground : Look for structured/truncated ways to identify “bad” RPM.

41. 41 The States Courts & Legislation –Most state antitrust laws expressly or by court decision follow federal law So far, at least two state courts have decided to follow Leegin –Some states have specific prohibitions of RPM (NY) –Maryland amended law to reject Leegin So far the only “Leegin repealer” OAG Enforcement –Amicus in Leegin supporting Dr. Miles (37 states) –Opposed Nine West Petition (27 states) –Cases Filed Since Leegin Herman Miller (NY, IL, MI) Tempur Pedic (NY) Derma-Quest (CA)

42. 42 Concluding Thoughts on RPM If Leegin is not overruled… –DOJ/FTC will focus on refining test for effects –Few cases are likely (never been a high priority) FTC more likely to pursue? –Courts will need to address Monsanto and Sharp –Will courts be receptive to abbreviated analysis? Regardless of Leegin… –Some states will continue to prosecute –Will these cases trigger private damages actions?

43. Day 3, Session 1 The End 43