Principal Lecturer Professor Steven C. Salop Williamsburg Lodge, Williamsburg, VA October 1, 2010

1. The Antitrust Masters Course VABA Section of Antitrust LawPlenary Session Slides Day 2, Session 2 Principal Lecturer Professor Steven C. Salop Williamsburg Lodge, Williamsburg, VA October 1, 2010

2. Session Agenda: Exclusionary Conduct: Analytical Framework • Collusive and Exclusionary Conduct • Exclusionary Conduct Paradigms • Predatory Pricing • Raising Rivals’ Costs • Diagnosing and Analyzing RRC Conduct

3. Anticompetitive Exclusion • Conduct that allows a firm (or group of firms), to … • Achieve, enhance or maintain market power, by … • Disadvantaging competitors, and thus … • Harming consumers.

4. Collusion and Exclusion • Two anticompetitive ways to achieve, maintain and then exercise market power • Collusion: Marry your competitors (“classical” market power) • Exclusion: Kill your competitors (“exclusionary” market power) • Single firm monopoly • No need to marry • May need to engage in exclusionary conduct to prevent entry • Exclusion • May involve single firm as the excluding firm • Or, may involve exclusionary joint conduct by rivals • Key properties of collusion and exclusion: • Both harm consumers and reduce efficiency • Can occur separately or together • Can reinforce one another

5. Example: JTC Petroleum Seller 1 Seller 2 More Distant Asphalt Pits Asphalt Market Cartel Applicators (cartel) JTC Applicator Market Consumers (Muncipalities)

6. Chronology: Analytic Steps • Applicator cartel members allocate customers and fix prices • JTC refuses to join conspiracy (“maverick”) • Applicator cartel members pay nearby asphalt producers not to sell to JTC • JTC’s competition neutralized by cartel • JTC can only buy asphalt from distant producers, raising its costs very substantially • Cartel maintained • Asphalt producers get part of the cartel profits

7. Exclusionary Conduct Paradigms Predatory Pricing (Chicago-School Paradigm) • Reduce price as an investment • Cause rival to exit, at which point the firm can raise price to monopoly level Raising Rivals’ Costs (Post-Chicago Paradigm) • Raise competitors’ costs, which leads them to reduce output and raise price, which permits firm to raise its price • Encompasses “foreclosure” allegations from exclusive agreements Some conduct arguably might be characterized either way. Example: market share discounts; bundling rebates

8. Exclusive Agreements and Foreclosure Suppliers Input Market “Input Foreclosure” that raises rivals’ costs” Excluder Excluder’s Rivals Output Market “Customer Foreclosure” that reduces rivals’ revenues” Consumers

9. Comparing the Paradigms for Antitrust Policy • Conventional “view” of predatory pricing • “Seldom attempted and rarely succeeds” • Success requires victim to exit • Significant short-term consumer benefit from lower prices • Speculative longer-term consumer harm • Short-term profit-sacrifice by firm • Compare raising rivals’ costs conduct • “More credible and more dangerous strategy” • No exit requirement – higher costs lead to higher prices • Significant short-term consumer benefits may not exist • Immediate consumer harm: higher prices raise prices • No short-term profit-sacrifice: higher prices raise profits immediately Conclusion: RRC raises greater antitrust policy concerns

10. Analyzing Raising Rivals’ Costs Conduct • 3 Components • Raising Rivals’ Costs (RRC): impact in upstream (input) market • “Harm to competitors” • Relationship to upstream market definition • Power Over Price (POP): impact in downstream (output) market • “Market power harms to consumers” • Raise price or prevent price from falling (e.g., deter entry) • Relationship to downstream market definition • Efficiencies (EFF): efficiency benefits from the conduct (e.g., elimination of free riding) • “Procompetitive benefits to consumers” • Reduce cost or increase quality • Consumer Welfare Effects • Balancing POP and EFF effects, to estimate “net” effect on consumers

11. Example: Klors Exclusionary Group Boycott as RRC Admiral ... ...Zenith Non-Foreclosed TV Manufacturers Wholesale Market Broadway-Hale Klors Non-Excluded Stores and Competing Products Retail Market Consumers

12. Basic Defenses • No harm to rivals (No RRC) • Competitors have cost-effective alternatives • Non-restrained suppliers • New entrants/backward integration • No harm to consumers (no POP) • Consumers have alternatives • Competition from non-excluded firms (including multiple excluding firms) • Consumer benefits from the conduct (EFF) • Reduce costs • Raise product quality • Prevent free riding

13. Other Possible Defenses • Input suppliers have disincentives to create/support downstream market power • “Single monopoly profit” eliminates incentive to exclude • Rivals have market counterstrategies to avoid exclusion • “Competition for exclusives”

14. Input Suppliers’ Incentives:Rebuttal • Incentive to deter downstream monopoly is limited • Deterrence of monopoly is a “public good,” subject to free rider problems. • Downstream firm may share monopoly profits with input suppliers (e.g., JTC Petroleum) • Paying for an exclusive as a way to “purchase” market power

15. Single Monopoly Profit Theory:Affirmative Story • Leveraging power from one market into another is unnecessary • Monopolist can extract all monopoly profits in the primary monopoly market • Thus, vertical mergers, refusals to deal and other exclusivity must be pro-competitive • No anticompetitive motive

16. SMP Theory Ignores Plausible Exclusionary Strategies • Exclusionary conduct can protect or achieve first monopoly, rather than create second monopoly • Microsoft as example • Generalization of “two-level entry” theory • Exclusionary conduct can permit monopolization of consumers who do not buy the first, monopoly product • Drive rivals below minimum viable scale • Microsoft media player as example – achieve monopoly for devices where no Windows monopoly • Foreclosure can incentivize competitors to compete less vigorously or tacitly coordinate • If regulation or contracts prevent exercise of monopoly in the first monopoly market, exclusion may allow exercise in a related unconstrained market. • Example: Discon • Trinko/Credit Suisse may have eliminated this cause of action,

17. Competition for Exclusives

18. Bidding for Exclusives:Affirmative Story • Winning bidder will be the more efficient firm. • Thus, rivals’ costs not raised unless it is efficient to do so • Buyer-driven exclusives: Competition among efficient firms, each with some exclusives, is the best outcome • Rivals have the incentive and ability to counterbid, which will raise the cost of exclusion and thereby deter inefficient exclusion • Rebuttal • Exclusives sometimes are efficient • Rival does have the incentive to protect itself and can sometimes succeed in deterring exclusion • But, the categorical claim is flawed

19. Flaws in Bidding Theory: Bargaining on Non-level Playing Field • If entrant must pay to avoid exclusion, then the payment raises its costs • Entrant’s potential coordination problem • If very limited distribution is sufficient for success, then entrant counterbids can deter exclusion (AMD?) • But, if rival needs wide distribution from multiple retailers in order to succeed, then Incumbent has the bargaining advantage because of entrant’s fundamental “coordination problem” (Dentsply? LePages?) • Value of exclusive to incumbent systematically exceeds value of non-exclusive to entrant, • Incumbent may be purchasing market power, not just distribution

20. Non-level Playing Field:Entrant’s Coordination Problem • Suppose that Entrant can only succeed if it gains wide distribution with multiple distributors • Entrant is a risky bet for distributors because entry will fail unless many distributors forgo the exclusive from the incumbent • Distributors less likely to take entrant’s bid • This creates a coordination problem for entrant • Thus, entrant must compensate distributors for risk, raising its costs and making counterbids less likely to succeed

21. Pepsi v Coca Cola:Bidding for Exclusives Food “Systems” Distributors Bottlers/ Other Distributors Distribution Market Coke Pepsi Fountain Syrup Market Fast Food Chain Restaurants

22. Coordination Problem: Distributors Choose To Serve Larger Base Food Systems Distributors Coke Restaurants (75%?) Pepsi Restaurants (25%?) Thus, FSDs will accept a Coke exclusive for a very low fee, unless Pepsi can get many restaurants to switch at the same time, which is difficult to coordinate

23. Purchasing Market Power • Value of exclusive to incumbent systematically exceeds value of non-exclusive to entrant • Competition reduces profits • Competition transfers benefits to consumers • Incumbent that buys exclusives also may gain market power • Thus, higher bid does not reflect higher efficiency or higher consumer welfare • Numerical example illustrates differential bid values

24. Can Entrant Win a Non-Exclusive vs. Incumbent Getting an Exclusive?

25. Day 2, Session 2 The End