Chapter 19: Antitrust

1. NC State University Chapter 19: Antitrust David Baumer Legal Environment of Business in the Information Age Spring 2003

2. Capitalism • Free markets generally produces lower prices, more variety, and better quality that any other system, but • Market failures occur where • One firm monopolizes an industry • Firms conspire not to compete based on price • Firms merge rather than compete • Firms tie the sale of one product to another product • There is significant evidence that innovation must be rewarded with a patent which is a legal monopoly

3. Antitrust Law • A major challenge is distinguishing between legitimate competition and anti-competitive conduct • It is not against antitrust lawto create a superior product that dominates a market, but • It is illegal to engage in deliberate conduct for the purpose of monopolizing a market • Distinguishing between the two scenarios above is difficult

4. Antitrust Law • In many antitrust cases, the market share of the def. is an important factor • Acts by a firm with a large market share may be illegal, but the same acts by a smaller firm would not be illegal • Market share is defined as MS = FS/TS*100, • where MS is market share, FS is firm sales, and TS is total sales within the industry • It is a characteristic of many high tech industries that one firm becomes the industry standard and therefore has a very high market share, e.g., MS Windows

5. Section 1 of the Sherman Act • Section 1 of the Sherman Act prohibits every • Contract, conspiracy, or combination • In restraint of trade • Since every contract restrains trade to some extent the courts outlawed unreasonable trade restraints • In some cases, courts apply per se rules to agreements that are almost always anti-competitive such as price fixing • If a firms join together and fix prices, the court do not try to determine if the agreement is anti-competitive

6. Section 1 of the Sherman Act • Per rules have been applied to agreements among rival firms at the same level in the market • Manufacturing, distribution, retailing • If rival firms agree on price, territory, or customers it is per se illegal under Section 1 of the Sherman Act • For other agreements the courts have used the rule of reason • When the rule of reason is used the pro versus anti-competitive consequences of the agreement are weighed against each other • Examples include exclusive dealerships which can be justified on efficiency grounds but could foreclose a significant share of the market

7. Antitrust Laws • The federal antitrust laws only apply to actions that affect interstate commerce in the U.S. • The jurisdiction of the antitrust laws applies to foreign firms that operate in the U.S. • Antitrust laws also apply to actions of foreign firms that take place outside the U.S. but affect prices in the U.S. • Foreign citizens can sue U.S. firms that conspire in the U.S. to raise prices abroad

8. Section 1 of the Sherman Act • Each of the following are per se violations of Section 1 • Agreements among horizontal competitors with respect to price, territory, or customers • Agreements to divide up territory or customers are treated the same as price fixing • Section 1 also prohibits boycotts, which are agreements among several firms not to trade with certain firm or firms

9. Section 1 of the Sherman Act • An exception from the application of the per se rule if the market would not exist but for price fixing • BMI (Broadcast Music Inc.) and ASCAP (American Society of Singers, Composers, and Publishers) both fix prices for the works of their members • If radio stations had to negotiate with artists individually, the radio music market would not exist • Professional baseball’s antitrust exemption is due to a Supreme Court precedent • Note further that there are a number of statutory exemptions from the antitrust laws, especially Section 1’s prohibition against price fixing

10. Exemptions from the Antitrust Laws • Union activity • Agricultural cooperatives • Firms subject to competition by regulatory agencies in transportation • Groups of sellers who organize under the Export Trading Company Act • Parker doctrine allows states to restrict competition in utilities, insurance, milk and other industries • Requires hands on treatment by the states • Noerr-Pennington doctrine allows firms to coordinate before regulatory hearings

11. Section 1 Violations • According to one study, about 40% of price-fixing conspiracies begin at trade shows • Alcohol and talking about price do not mix well • Even agreements to exchange prices charged among competitors is illegal • Publishing industry average prices is allowed by trade association, but to identify individual firms with individual prices is illegal • It is illegal for licensed professionals to agree upon price and • it is illegal for professionals to use the licensing board to sanction members who charge low prices

12. Section 1 Violations • Boycotts are per se illegal under the Sherman Act • Professionals are allowed to adhere to professional codes of ethics that are designed to protect the public • Professionals can refuse to do business with other professionals who do not adhere to these professional codes • Bid rigging--common in contracts with state and local govt. • The bidding businesses decide before hand which company will win the bid • It is very difficult to suppress information about bid-rigging from leaking out

13. Vertical Relationships • Vertical Business Relationships • Treated much more leniently by the courts in Section 1 Sherman Act cases • The threat to competition is much less when firms at different levels in the market make contracts • Traditionally resale price maintenance (RPM) or vertical price fixing has been subject to the per se rule • Recent ruling by the Supreme Court indicates the vertical price ceilings are not per se illegal

14. Vertical Market Divisions • Note that manufacturers can suggest resale or retail prices • Restrictions on maximum prices by dealers has been ruled not per se illegal • Consignment sales provides another loophole for vertical price fixing • Manufacturers can cut off price cutting dealers if they do not maintain quality control • For non-price restraints on dealers such as territorial allocations or customer restrictions, they are clearly judged under the Rule of Reason • The pro versus anti-competitive effects are weighed

15. Vertical Restrictions • Note that vertical territorial and customer restrictions often enhances interbrand competition while reducing intrabrand competition • Dealers of a manufacturer can discuss profitability and prices among themselves • Exclusive distributorships • Are judged under the rule of reason • Are only illegal when a manufacturer uses exclusive distributorships to foreclose a significant share of the market from other manufacturers

16. Monopolization • Section 2 of the Sherman Act prohibits • Monopolization of a market and • Attempts to monopolize • Market definition is often key to these cases • What is the market in the Microsoft case? • Operating systems? • Software in general? • In most Section 2 cases market power is equated with market share • It is assumed that the greater the market share the greater the market power

17. Market Share and Market Definition • Recalling the definition of Market Share (MS) [MS = FS/TS*100] • Note that FS are easy to obtain and are not subject to controversy • TS within the industry is a huge source of litigation • What is the industry? • Composed of both a product and a spatial dimensions • What cluster of products together comprise a product market? • What is the geographical extent of the market

18. Market Share and Market Definition • Unless TS is calculated, MS cannot be computed • In order for TS to be calculated the cluster of products to be included must be aggregated and geographic boundaries defined • With the Internet and global markets, MS computations in the U.S. are less meaningful

19. Section II • Monopolization is defined as • A firm with monopoly power • Deliberately acquires or maintains its monopoly power • It is not against the law to be a monopoly • It is against the law to use anti-competitive tactics to acquire or maintain monopoly power

20. Section II • It is also a violation for a large firm to attempt to monopolize • A large firm uses anti-competitive actions that if unchecked have a dangerous probability of success--meaning monopoly is likely to occur. • The line between legal and illegal competition is not well defined and must be evaluated on a case by case basis • When predatory pricing is alleged the pl. must show that the def. is setting its price below the def.’s average variable costs • If the def. simply sets its prices below the costs of rivals it is not illegal

21. Section II • How much market share is necessary? • 30, 60, 90 Rule--the Learned Hand test is frequently used in monopolization cases • The importance of market share should be apparent • At a minimum in a monopolization case the defendant must have at least a 60% MS • In attempts to monopolize cases the minimum market share of the defendant must be >20%

22. Monopolization • Critical issue in the Microsoft case and others is whether large firms • Must make it easy for smaller firms to plug into their core products or technology • Kodak case said clearly large firms do not have that obligation • The Justice Department contends just the opposite • In several antitrust cases, courts have said that the largest firm who had control of an essential facility must allow it to be used by other competitors at fair rates

23. Price Discrimination • Robinson-Patman Act • A violation occurs when the def. offers the same product to different customers at different prices • Only illegal when the effect may be to lessen competition which means the def. must have a high market share • Note that the violation is low prices by the def. • Often difficult to distinguish from ordinary price competition

24. Price Cutting • Note that Section 2 of the Clayton Act (RP Act) is violated when a buyer induces the price discrimination and the effect may be to lessen competition or tend to create monopoly • Defenses include: • cost justification for the lower prices • It is legitimate to lower prices to customers whose cost of service is lower, and • the meeting competition defense-- • it is legal to lower prices to meet a low price of a rival seller

25. Section 3 of the Clayton Act • Section 3 of the Clayton Act and Sections 1 and 2 of the Sherman Act have been used to prosecute tie-ins • An illegal tie-in takes place when the defendant has market power in the tying product and seeks to extend its market power in the market for the tied product • A tie-in takes place when the seller will only sell product A if the buyer purchases product B • Other variations involve full line forcing

26. Section 3 of the Clayton Act • Three elements of a tie-in case are: • The def. has market power in the tying product--the DOJ standard is 30% MS • The tying product and the tied product are separate • There is evidence that the tie-in will harm competition in the market for the tied good • Defenses in tie-in cases • The def. does not have market power for the tying product • The market for tied products does not produce products suitable for the def.’s tying product • The tied product is a component of the tying product

27. Section 3 of the Clayton Act • Note that that Section 3 of the Clayton only applies to tying together the sale of two goods • For services tied with a good or tied with each other, Section 1 of the Sherman Act can be used • Again, most tie-ins are legal. They are only illegal when the def. has a large market share > 30%

28. Section 3 of the Clayton Act • Exclusive Dealing contracts • The manufacturer tells a distributor or retailer that if it carries products of rivals the manufacturer will not trade with them • Exclusive dealing contracts are illegal when the effect may be to lessen competition or create monopoly • Generally only illegal when the def. has a very large market share • Generally evaluated under the Rule of Reason • Note that there are a lot exclusive dealing arrangements that are perfectly legal

29. High-Tech Products and Tie-ins • Many high-tech products derive their value by being compatible with other products • E.g., MS Word is only valuable because it is compatible with Windows • At present the state of the law is that: • (1) It is illegal to create a contractual tie-in, in order to by A, you must also buy B, but • (2) It is legal to create a technological tie-in, make Product B such that it will only work with Product A • In the MS case, the Justice Department pushed hard to have (2) declared illegal, but was mainly unsuccessful

30. Section 7 of the Clayton Act • Section 7 of the Clayton Act • Makes mergers, broadly defined, illegal where the effect may be to lessen competition or tend to create monopoly • Mergers can be classified as: • Horizontal--mergers between rival firms • Vertical--mergers between suppliers and customers • Product extension--mergers between firms that produce related products • Pure conglomerate--mergers between unrelated firms, which are not competitors, trading partners, or selling related products

31. Horizontal Restraints of Trade • Horizontal mergers (Section 7 of the Clayton Act) • Are vulnerable to antitrust attack when the two merging firms are large • Antitrust officials generally equate market share with market power • Herdindahl-Hirshman Index is used to evaluate whether a merger is legal or illegal • HHI =  MS2i • Three categories of HHI: <1000, 1000-1800, and >1800 • If the merger exceeds 50 points in the top category, it will be challenged by the Justice Dept., and by 100 points in the second group

32. Mergers and Market Definition • Market share equals market power • after adjusting for barriers to entry • MS = FS/TS, where MS is market share, FS is firm sales, and TS are total sales within the industry • If a firm has a 100% market share, they generally can set price • The assumption behind prohibiting mergers is that firms with high MS’s will amass great market share and thus greater market power

33. Merger Regulation • The courts have also considered the impact of mergers on potential competition • If a leading firm outside the industry, merges with the leading firm in the industry, potential competition may be harmed • Defenses in Section 7 cases • Failing firm defense when two large firms merge but one firm is near bankruptcy • The failing firm has no other likely buyers • All other alternatives have been tried • Power buyer defense • If purchasers are powerful enough there is little likelihood that a merger would harm competition

34. Vertical Mergers • Few vertical mergers have been challenged • The theory of harm to competition is based on foreclosure • Again the def. has to have a large MS for vertical mergers to be challenged • Conglomerate mergers • Some product or market extension mergers remove potential competition and thus have been challenged • I have never seen a case when a pure conglomerate merger has been challenged

35. Section 7 • Under the Hart-Scott-Rodino Act • Firms with more that $100 million in assets or sales must notify the Justice Dept. any time it intends to acquire a business with more than $10 million in assets or sales • Justice Dept. has 30 days to react and to decide whether it will oppose the merger • In many cases, the threat of a suit by the Justice Dept. will cause cancellation of the merger • In other cases, the Justice Dept. will agree to the merger if the merging firms will agree to sell off certain divisions

36. Justice Department Guidelines for Licensing Intellectual Property • In 1995, the DOJ and the FTC issued Antitrust Guidelines for Licensing of Intellectual Property • Basic contention of the Guidelines is that the principles of antitrust apply to electronic transactions • The Guidelines recognize that the purpose of issuing a patent is to create a monopoly • According to the Guidelines there are two situations that can give rise to antitrust liability: • A merger or joint venture of two of few firms who do research in an area, and • An acquisition of IP that may lessen competition

37. Justice Department Guidelines for Licensing Intellectual Property • According to the Guidelines, • In the vast majority of cases the rule of reason will be used to evaluate licensing restrictions in IP • The Guidelines create “safety zones” (safe harbors) such that IP licenses will not be challenged if • There are at least 4 other technologies in the market that are substitutable and are available at comparable cost

38. Remedies • Enforcement • There is a private right of action • Often unsuccessful rivals sue under the antitrust laws, e.g., USFL vs. NFL • Damages are tripled if private citizens win • If it is a criminal prosecution, the Dept. of Justice is the prosecutor • DOJ has a policy of sending executives to jail if they are found guilty • For civil suits, the DOJ or the FTC can file the suit • State attorney generals often initiate suits on behalf of state citizens

39. Enforcement • In most govt. antitrust suits the govt. is seeking a consent decree • The def. firm agrees not to do certain things • Alternatively the govt. can obtain an injunction which is a court order prohibiting certain behavior by the defendant • Cease and desist orders are the same thing • Companies have been forced to divest themselves of companies acquired in a merger • Monopolies have been broken up--Bell Consent decree, Standard Oil case • Forced licensing of essential facilities