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Slide 1

Refusals to Deal

Steven C. Salop
Georgetown University Law Center
CRA International

FTC/DO J Hearings on Exclusionary Conduct
July 18, 2006

Slide 2

General Exclusion Standards

  • Alternative Standards

    • Consumer Welfare Effect

    • Profit Sacrifice/No Economic Sense

  • Benefits of CWE

    • Focused on goal of antitrust

    • Flexible - "an enquiry meet for the case"

    • Implies tailored structured inquiry for each type of exclusionary conduct

    • Unifies Section 1 and Section 2 analysis under the rule of reason

  • Misperceptions about CWE standard

    • Does not require open-ended balancing - permits different specific legal tests in different exclusion settings

    • Does not lead to false positives

  • Sacrifice/NES standard causes false negatives and false positives

Slide 3

Innovation Incentives

  • Innovation incentives are a claimed rationale for restricting Section 2

  • But, basis and significance of concern are unclear

    • Firms have strong incentives to innovate in competitive markets

    • Market innovation incentives improved by competition

    • Monopolists have weaker incentives than competitors

    • Exclusionary conduct reduces innovation incentives of entrants and rivals, by reducing or eliminating their market prospects

    • No evidence of weakened innovation from fear of antitrust

  • Thus, justification for restricting Section 2 is weak

Slide 4

Comparing Standards for Refusals to Deal: Summary

  • Alternative Standards

    • Consumer Welfare Effect

    • Profit-Sacrifice/No Economic Sense

    • Per Se Legality

  • CWE and Sacrifice/NES have similarities

    • Both require a price benchmark

    • But, Sacrifice/NES standard may not require proof
      • of anticompetitive effects (causes false positives)

  • Per se legality leads to reduced competition and significant false negatives

    • Limits of per se rule also are unclear

Slide 5

Proposed Rule under CWE Standard: What Plaintiff Must Prove

  • Monopoly power

    • Monopoly power in input market

    • Actual or likely monopoly power in output market

  • Plaintiff has made a genuine offer to buy at or above the appropriate "non-exclusion benchmark" price, as defined below; whereas defendant has failed to accept such an offer or made a genuine offer to sell at or below that benchmark price, ("compensation" test)

  • Refusal to deal would cause prices to be raised or maintained at supra-competitive level. ("effects test")

    • Output market

    • Input market

    • Another market where the entrant is an actual or potential competitor of defendant

Slide 6

Non-Exclusion Benchmark Price

  • Non-exclusion benchmark price: potential alternatives

    • Prior price charged to plaintiff

    • Price charged to other buyers

    • Price that compensates defendant for monopoly profits on output sales lost to plaintiff ("protected-profits" benchmark)

  • Potential adjustments to benchmark

    • If dealing raises defendant's production costs

    • If plaintiff creates reputational free riding

    • If monopoly power attained or maintained illegitimately

  • Burden may shift to defendant to show plaintiff's price offer is below benchmark

    • If non-negotiable ("flat") refusal to deal

Slide 7

"Protected-Profits" Benchmark

  • Properties of benchmark

    • Compensates for lost output market monopoly profits from defendant's customers who switch to entrant

    • But, no compensation for price competition caused by entry by firm with lower costs or superior product for some consumers

  • Derived from ECPR literature

    • Baumol/Ordover/Willig

    • Commentators (e.g., Armstrong/Doyle/Vickers/White)

  • Benchmark input price: W = Cu + D x Md

    • Cu= monopolist's marginal cost of input (in dollars)

    • Md= monopolist's output "gross margin" over costs (in dollars)

    • D = fraction of entrant's output sales diverted from monopolist

Slide 8

Example: Verizon and AT&T

  • Protected-profits benchmark is practical for courts and firms to calculate

  • Assumptions: relevant data

    • Verizon's incremental cost of DSL inputs is $10

    • Verizon earns monopoly margin over costs of $50on retail DSL

    • If Verizon deals with AT&T, 50% of AT&T DSL customers would come from Verizon retail DSL, with rest from cable and dial-up.

      • D = 50%

  • Benchmark input price: W = $35 .

    • If D=1 (100% diversion), then W=$60

Slide 9

Trinko's Cautions

  • No general Sherman Act duty to deal

    • Cf Colgate (no duty "in the absence of any purpose to create or maintain a monopoly")

  • Forced dealing raises red flags

    • Compelling firms to share may lessen
      • investment incentives.

    • Enforced sharing requires courts to act as
      • central planners

    • Compelling negotiation can facilitate collusion.

Slide 10

Investment Incentives Concern: Some Answers

  • Benchmark price compensates defendant for monopoly profits on lost customers.

  • Entrant unlikely to enter input market

    • Defendant's input market monopoly power implies durable entry barriers

    • This also makes leapfrog competition by entrant less likely

  • Competitive market will increase defendant's innovation incentives

    • Monopolists have weaker innovation incentives

  • Ability to enter output market will increase entrant's innovation incentives

  • Entrant cannot be called a free-rider on the grounds that it competes with defendant in only one market, rather than entering both markets

    • Kodak ("this understanding of free-riding has no support in our case law")

Slide 11

Courts as Central Planners Concern: Some Answers

  • Courts and agencies routinely compare prices and costs, and use other quantitative economic evidence

    • Eg, Brooke Group, Ortho, Kraft, agency merger analysis

  • Task is not beyond the capabilities of District Court judges

    • Market prices often provide a good benchmark

    • Protected-profits benchmark is not too difficult to evaluate

  • If antitrust withdraws, then alternative may be new public utility regulation

    • Is FOSC the next step?

      • Federal Operating System Commission

    • Rare use of essential facilities doctrine could serves as an intermediate stopping point

Slide 12

Facilitating Collusion Concern: Some Answers

  • Court's caution is very broad. Firms have independent incentives to negotiate, and independent incentives to collude.

    • Would Court's reasoning lead it to prohibit voluntary dealing between competitors because it can lead to collusion?

    • Or, prohibit joint ventures, which can (and sometimes do) serve as forums for collusion?

    • Or prohibit patent settlements, which can (and sometime are) used to strike non-compete agreements or collude on price?

  • Refusals to deal against competitors may hide (or amount to) non-compete agreements:

    • "I will sell to you if you promise not to compete with me."

  • Collusion is less likely when negotiation is forced (and potentially monitored) by a court

  • Incremental effect of forced negotiation on collusion likely insignificant or negative

Slide 13

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 ...

  • Then why not also per se legal to refuse to deal with firms that...

    • Sell output to your competitors? ("exclusive dealing")

    • Purchase inputs from your competitors? ("exclusive dealing")

    • Buy other products from your competitors? ("tying")

    • Announce their intention to compete with you in some
      • product market? ("non-competition agreement")

    • Charge low prices for their competing products?
      • ("price fixing")

Slide 14

Appendix

The Overarching Antitrust Standard: "Consumer Welfare" vs "Total Welfare"

Slide 15

Economic Welfare Standards

  • True consumer welfare standard

    • Consumer surplus

  • Total welfare standard

    • Total surplus

    • Bork named this "consumer welfare" -- deception or just confusion?

  • Why use the true consumer welfare standard?

    • Does not permit competitor injury to trump consumer benefits

      • But, total welfare standard does allow this trump -- Did Bork know?

    • Consistent with precedent

    • Simpler to evaluate (price and output)

    • Induces efficient conduct

      • Firm can marginally restructure transactions in efficient ways to eliminate consumer harm and raises
        • total welfare in the process

      • Offsets unwillingness of courts/agencies to rigorously apply less restrictive alternative standard or gain
        • full information about potential alternatives, thereby preventing inefficiencies

    • Better supports innovation incentives

Slide 16

Innovation Incentives and Welfare Standards

  • Consumer welfare standard supports greater overall innovation incentives

    • Total welfare standard allows the dominant firm to destroy higher cost rivals that otherwise would innovate, thereby reducing innovation

    • Total welfare standard allows mergers and exclusion that eliminate competition, leading to a dominant firm with less incentive to innovate

    • These harms likely are larger than any marginal efficiency benefits from allowing mergers or exclusionary conduct that modestly reduce costs, while leading to higher prices to consumers

  • Thus, adopting the true consumer welfare standard leads to higher long-run total welfare, as well as higher long-run consumer welfare.