Principal Lecturers Professor Andrew I. Gavil Professor Steven C. Salop

1. The Antitrust Masters Course VABA Section of Antitrust LawPlenary Session SlidesSeptember 30, 2010 – Part II Principal Lecturers Professor Andrew I. Gavil Professor Steven C. Salop Williamsburg Lodge, Williamsburg, VA

2. Session Agenda • Horizontal Restraints & Joint Ventures • Legal Standards: Structuring the Antitrust Inquiry • Proving Collusive Agreements

3. Part I:Horizontal Restraints & Joint Ventures

4. The Supreme Court and Horizontal Restraints: A Time Line NCAA, the QL and a break from the bipolar model. Copperweld, no Intra-enterprise conspiracy CDA reaffirms but limits QL; Breyer looks for structured approach; Majority: “enquiry mete for the case” Modern era begins with BMI Am. Ndle Quick correction? Dagher Detour? 1979 1982 1984 1999 2007 2010 Maricopa Deviation? Historic relic?

5. Continued Evolution at the Agencies and in the Lower Courts • DOJ & FTC – Collaboration Guidelines (2000) • Attempts synthesis of law & econ of horizontal restraints • Courts of Appeals • Structuring the Rule of Reason • Law v. NCAA (9th Cir. 1999) • U.S. v. Visa (2d Cir. 2003) • “Inherently suspect” standard - FTC • Polygram (D.C. Cir. 2005) ; North Texas Specialty Physicians (5th Cir. 2008); RealComp (FTC 2009) • The latest: “Quick Look Plus” • California v. Safeway (9th Cir. 2010)

6. Session Segment Plan • Understanding the Economics of Horizontal Restraints • The Analytics • Translating Analytics into Legal Standards • The Case Law

7. Understanding the Economics of Horizontal Restraints • Impact of Cartels and Cost-Reducing Joint Ventures on Price and Output • Look at and compare: • Initial competition • “Naked cartel” – no costs savings • Impact of cost reductions on joint venture pricing • Compare alternative joint venture structures • Pure production joint venture • Joint marketing as well as joint production • Impact of constraints on independent competition outside the joint venture

8. Initial “Perfect” Competition:Price = (Marginal) Cost P1 C1 Q1

9. “Naked” Cartel (No Cost Savings): Price Rises Consumers lose; Output falls P2 MO DWL P1 C1 Q1 Q2 MO = Monopoly overcharge DWL = Deadweight loss

10. Now Consider Impact of Cost Reductions on a Joint Venture Price • Suppose that a group of competitors comes together to produce an essential input that they all use. • By combining, they can produce the input at lower cost…e.g., • Scale economies; or, • “Best of breed” (combining the best component from each to create a better overall product) • Suppose initially that the firms distribute the input to members at incremental cost and continue to compete independently in the output market as previously.

11. Cost Reduction w/ Continued Price Competition (Production JV; No Joint Marketing):Price Falls by Amount of Cost Reduction Consumers gain; Output rises P1 C1 P2 C2 Q1 Q2

12. Joint Pricing Replaces Competition:“Cartel” Price Rises, But by Less Than if No Cost-Reduction Key point: MO, DWL,CS measured relative to initial (P1,Q1) benchmark P2 MO DWL P1 C1 CS C2 Q2 Q1 MO = monopoly overcharge DWL = deadweight loss CS=cost savings

13. Impact of JV/Cartel on Welfare: The Antitrust Standard • Pure Consumer (i.e., Customer) Welfare Falls, when Price Rises • Loss in consumer surplus = MO + DWL • MO = transfer to cartel • DWL = deadweight loss/waste • Aggregate Economic Welfare (Efficiency) May Not Fall • Only total wealth matters to total surplus, not distribution • Consumers lose MO+DWL • Cartel firms gain MO + CS • Aggregate welfare only falls if DWL > CS • MO transfer is a “wash,” when wealth distribution doesn’t matter • Thus, in theory choice of antitrust welfare standard can affect the outcome • Aggregate economic welfare standard is much less interventionist here • But, standard could be used to attack efficient entry; or conduct that harms competitors • Courts/Agency Guidelines seem to favor pure consumer welfare standard • But, note potential confusion: • Some Chicagoans (e.g., Bork) refer to aggregate economic welfare as a “consumer welfare” standard

14. Extending the Williamson Diagram

15. Very Large Cost Reduction andJoint Pricing Replaces Competition:Price Falls on Balance (no harm) Compare to Slide 12 P1 C1 P3 C2 Q1 Q3 Consumers gain relative to initial point (benchmark); Consumers would do even better if competition instead

16. Note: Why Would a Monopolist (or Cartel) Ever Lower Price? • It is counterintuitive that a cartel (or monopolist) would ever reduce price, even if its costs fall. • Counterintuitive, but true for large cost decreases • Two conflicting forces • Cartel tends to increase price, relative to competition • Upward pricing pressure • Cost reduction tends to decrease price • Downward pricing pressure • Whether price rises or falls depends on resolution of these conflicting forces: • Small cost reductions  price rises • Large cost reductions  price falls

17. Suppose Joint Pricing, But Old C1 Technology Remains Available to Rivals: Price Now Set Just Below P1 Compare to Slide 12 Old P2 New P2* < P1 C1 C2 Relative to initial P1 outcome -- No consumer harm; -- No efficiency loss Q1 Q2

18. Independent Price Competition by JV Members Using Old Technology • Slide 17 diagram similarly would apply if JV members (instead of separate rivals) can compete independently “outside the JV” with the old C1 technology (e.g., Polygram) • If JV members could “cheat” on cartel price by competing independently, price could fall even lower, closer to C2

19. Application to BMI • Both Slides 15 and 17 are consistent with SCt opinion in BMI • “Literally price fixing,” but • “New product” and “substantial lowering of cost,” and • “No … impediment to CBS obtaining individual licenses” from composers who are in ASCAP/BMI. • Thus, “it should be subjected to a more discriminating examination under the rule of reason.” • Key Take-away: “Competitive benchmark” may be the old no-JV outcome (P1) • At least if the joint pricing is “reasonably necessary” to make the JV viable and achieve the cost savings • Key Question: If JV is not permitted to jointly price, how high can it set the input price? Must input JV be a break-even operation? • If permitted to be a profit-center, then it can set a high input price to replicate the “cartel” outcome of Slide 12

20. Conclusions: When Do Cost-Reducing JV’s Not Harm Consumers • JV faces continued competition from efficient rival firms or other JVs (with old technology) (“outsider competition”)(slide 17) • JV members continue independently to price compete against each other (“insider competition”) • Independent competition outside the JV with non-JV technology (old technology) (slide 18) • Production joint venture with independent marketing/pricing (new technology) (slide 11) • JV gains durable monopoly but generates very, very large cost-savings, so “cartel” price falls below pre-JV level (slide 15) • JV gains short-run monopoly but quickly imitated by outsiders so that price rapidly falls significantly below pre-JV initial level (combining slide 12 in the short-run and slide 11 in the longer run) • See next slide for picture

21. Short-run vs Longer-Run Dynamics.Or, Probabilistic Outcome Key assumption: Pno jv is competitive benchmark.Issue is net present value of welfare. Same analysis for probabilistic outcome PSR MO DWL Pno jv C1 CS PLR C2 Q1 Q2

22. Part II: Legal Standards: Structuring the Antitrust Inquiry

23. Scope of Conduct • Section 1 Sherman & Article 101 TFEU • Cartels (typically price fixing) • Division of Markets • Horizontal Restraints • Information Exchanges and Facilitating Practices • Concerted & Exclusionary Group Boycotts • Joint Ventures • Vertical Price and Non-price Agreements • Conduct Often is Overt • Bylaws, express contractual provisions, openly joint action • E.g., BMI, NCAA, CDA, Dagher, American Needle

24. Traditional Per Se Rules Source: Gavil Kovacic & Baker, at 153 (2d ed. 2008)(Figure 2-5).

25. The Chicago Board of Trade“Unstructured” Rule of Reason Major Propositions: (1) “true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition.” (2) Three Categories of Factors to Consider: Nature; Scope; Effect Relevant Factors: • facts peculiar to the business • conditions of business before and after restraint was imposed • nature of restraint • its effect, actual or probable • history and purposes of the restraint • evil believed to exist • reason for adopting particular remedy • purpose or end sought to be attained • these are “all relevant factors” • Unclear: What shifts a burden of production?

26. Current State of the Art • Core Economic Concepts; Multiple Frameworks for Burden Shifting • Common development across traditional categories of Sherman & Clayton Acts • Takes lead from Merger Guidelines Framework • Less “uncertain” than is sometimes argued by critics? • Can core concepts harmonize seemingly conflicting frameworks?

27. The Modern, Structured Rule of Reason • First Principles Focus • Impact on competition • Anticompetitive effect • Procompetititve effect • Critical factors • Direct evidence of effects • Harm (upward price pressure) • Efficiencies/Benefits (downward price pressure) • Circumstantial evidence • Market power • Conditions of entry • A Range of Choices “Meet for the Case” • Per se (limited today to naked restraints) • Impact of BMI? If plausible efficiencies, use other approaches • Quick look to condemn • Variation: “Inherently Suspect” • Quick look to exonerate • New: Quick look “plus” • Comprehensive, but still structured rule of reason Source: Gavil, Kovacic & Baker at 202-11 (2d ed. 2008)

28. Some Examples • Comprehensive Framework • DOJ/FTC Collaboration Guidelines (2000) • Structured Approaches • California Dental (Breyer dissent)(1999) • NCAA v. Law (1998) • U.S. v. Visa (2003) • Microsoft (for Section 2)(2001) • Burden-Shifting Models • NCAA (1984) & IFD (1986) • TRU (2000); Polygram (2005); North Texas Specialty Physicians (2008) • Ancillary Restraint Analysis – continued relevance?

29. Newest Judicial Entrant: “Blended Quick Look” • Calif. v. Safeway (9th Cir. 2010)(2-1 in part) • Facts: State brought action against grocery retailers claiming that mutual strike assistance agreement (MSAA) that provided for profit sharing among rival grocery chains violated Sherman Act as unreasonable restraint on trade. • California: unreasonable, either per se or under quick look • Court: Not per se; needs more than a quick look, but not full rule of reason

30. Safeway cont’d • “We follow the Court's suggestion [in CDA], and apply a mixed or blended approach, engaging in an analysis “meet for the case”-here, a thoroughgoing analysis that compels our confident conclusion that the principal tendency of defendants' agreement is anticompetitive and that the agreement thus violates § 1 of the Sherman Act.”

31. Structured Analysis with Burden Shifting • Plaintiff’s Burden • Actual or Predicted Anticompetitive Effect • Higher market prices • Reduced output • Diminished innovation • Diminished quality or choice • Key: The Exercise of Market Power • Rebuttal: Discredit Efficiencies Evidence • Defendant’s Burden • Discredit Effects Evidence • Plausible Efficiencies • Lower costs • Superior product • Higher output • Enhanced interbrand competition • Promotes innovation

32. Common Features:Legal Standards and Presumptions Irrebuttable • Per Se Illegal • Virtually always anticompetitive • False positives not costly • False negatives unlikely • Cost/Benefit analysis suggests effort to find exceptions not justified • Per se Legal • Not often used for Section 1 • But, used for Section 2 (Eg, high prices by a single entity; low prices that remain above costs) Rebuttable • Direct Evidence of Anticompetitive Effects • Joint pricing or other apparent anticompetitive effects • E.g., BMI, NCAA, IFD, CDA • Circumstantial Evidence • Infer effects from market power (high market shares and barriers to entry), plus suspicious conduct • Economically Obvious • E.g., Polygram, North Texas Physicians

33. Is “Balancing” a Myth? • Does the Rule of Reason ever lead to “balancing” of anticompetitive effect and efficiencies as many courts suggest? • Under consumer welfare approach: • Efficiencies only count when they are sufficiently large to override anti-competitive effect (e.g. Staples) • Procedurally: Defense, not Affirmative Defense? • Relationship to aggregate welfare model • Cases are typically resolved pre-trial • If case involving effects and efficiencies goes to trial, typically resolved based on strength of evidence/probabilities • E.g., Sylvania, BMI • Microsoft an example of balancing?

34. When is a JV Treated Like a Merger? • Dagher (2007) • “As a single entity, a joint venture, like any other firm, must have the discretion to determine the prices of the products that it sells, including the discretion to sell a product under two different brands at a single, unified price.” Dagher, 547 U.S. at 7 (emphasis added). • Narrow Reading: “Fully integrated JV can jointly price like a merger”? • But was it a “fully integrated” JV? • Factors noted by Court of Appeals and not addressed by SCT: • JV was not equally owned – Shell owned 56% interest • JV agreements had initial term of five years; permitted dissolution of venture by consent or by two years notice; • Decision to jointly market brands at same price was NOT included in JV agreement, and may have been separately agreed to BEFORE JV created; • Some evidence of increase in market prices following implementation; and • Alleged efficiencies were unrelated to joint pricing

35. American Needle (2010) • More Consistent with First Principles? • “Because the inquiry is one of competitive reality, it is not determinative ….that two legally distinct entities have organized themselves under a single umbrella or into a structured joint venture. The question is whether the agreement joins together “independent centers of decisionmaking.”… If it does, the entities are capable of conspiring under § 1, and the court must decide whether the restraint of trade is an unreasonable and therefore illegal one.”130 S.Ct. at 2212. • “[The] necessity of cooperation [does not] transform[] concerted action into independent action…. Nor does it mean that once a group of firms agree to produce a joint product, cooperation amongst those firms must be treated as independent conduct.” 130 S.CT. at 2214

36. Dagher/American Needle Synthesis • Does American Needle limit Dagher? • Do the two cases blur the line between two Section 1 elements? • Did one blur and the other restore clarity? • Do they offer a coherent framework for analyzing horizontal agreements? • How do they mesh with BMI and NCAA? • Which is “the outlier”? • Dagher dicta? • American Needle - tribute to Justice Stevens?

37. Part III:Proving Collusive Agreements

38. Solving Cartel Problems • For a Stable Cartel to Form and Succeed it Must Solve Three “Problems”: • Achieving Consensus • Deterring Deviation (“cheating”) through detection of cheating and a credible threat of rapid punishment; and • Dealing with Changing Market Conditions • Including potential for entry by non-cartelists

39. Factors Facilitating or Frustrating Coordination Facilitating • Few firms • Product homogeneity • Simple products • Transparent prices • Open transactions • Predictable demand • Small transactions • Small buyers • Barriers to entry • Inelastic market demand • Excess capacity (multiple firms) • Similar costs • Symmetric market shares Frustrating • Many firms • Product heterogeneity • Complex, changing products • Non-public prices • Non-public transactions • Unpredictable demand • “Lumpy” sales • Large buyers • Easy entry • Highly elastic demand • Excess capacity (individual firm) • Asymmetrically situated firms • Vertical integration; sales of complementary products Source: Adapted from Gavil, Kovacic & Baker, at 245 (2d ed. 2008)(Figure 3-1).

40. Conscious Parallelism and Agreement • A Retail Gasoline Station Hypothetical* • Small town; four corners; four gas stations; posted prices • Recognition of Interdependence • Parallel Conduct • Key Observation: A “cartel” could solve its Stability Problems, but NOT reach an “Agreement” in legal terms • Economic vs. legal analysis can conflict • Judicial competence (errors) and Over-deterrence issue • Remedy? *Source: Gavil, Kovacic & Baker, at 237-40 (2d ed. 2008).

41. The “Conscious Parallelism Plus” Approach* Factors Suggesting the Industry is Vulnerable to Coordination • Generally: Rational motive to attempt to coordinate • Ability to solve “cartel problems” of reaching consensus, deterring cheating, and preventing new competition) • Industry market structure conducive to success (e.g., oligopolistic market structure, homogeneous products, transparent prices, barriers to entry, large numbers of small purchasers, frequent transactions) • Past history of industry collaboration (e.g., historic evidence of successful interdependent or collusive action) • Non-Competitive Industry performance (e.g., stability of market shares over time, sustained and substantial profitability, persistently supra-competitive pricing, prices rise when costs fall) *Source: Adapted from Gavil, Kovacic & Baker, at 310-11 (2d ed. 2008) (Figure 3-4).

42. The “Plus Factor” Approach (cont’d) Factors Tending to Distinguish Agreement from Conscious Parallelism • Communication or opportunity to communicate (e.g., meetings, trade association conferences) • Adoption of facilitating practices (e.g., pre-announcement of price increases, other information exchange) • Conduct too complicated to be explained by mere parallel behavior(e.g., conduct that appears irrational absent agreement) • Actions contrary to self-interest unless pursued collectively (e.g., failure to alter price based on changes in supply and demand) • Conduct lacking an evident efficiency explanation (e.g., failure to price based on relative cost advantages)

43. Invitations to Collude Sherman Act FTC Act Possible to reach under Section 5 as “unfair method of competition? Example of where FTC Act can productively augment Sherman? Note: Contrary view re liability under Section 1 is NOT based on benefits of conduct, but on limits of Sherman Act • Sherman Section 1 • Impossible to reach absent “agreement” • Sherman Section 2 • Attempt to monopolize? • Only when collective market shares are sufficiently high • American Airlines (conduct was “uniquely unequivocal” & “uniquely consequential”)

44. Day 1, Session 2 – The End