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Slide 1
Holding Innovation to an Antitrust Standard
Richard Gilbert
U.C. Berkeley
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 2
A Simple Model
- Old technology has social value
 for each use
- New technology has social value
- Zero marginal costs
- N users
- R&D cost R
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 3
A Simple Model
- Innovation is socially desirable if
- If
 is the price the innovator can collect for the new technology, it is privately profitable if 
- Innovations can be socially desirable but not privately profitable, or privately profitable but not socially desirable
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 4
Antitrust Standards
- Total Rule of Reason
- Consumer Rule of Reason
- Profit Sacrifice
- No Economic Sense
- Sham Innovation
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 5
Total Rule of Reason
- Should account for spillover costs and
benefits
Can have  or 
- Should account for ex ante innovation incentives
- Sheer complexity can lead to false positives and false negatives
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 6
Consumer Rule of Reason
- Similar problems as with a total rule of reason analysis (spillovers, complexity, ex post v. ex ante, etc)
- Can lead to conclusions that don’t make sense
- E.g., A process innovation that saves many millions, but increases prices by a few cents
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 7
Profit Sacrifice Test
“Predatory intentions are present if a practice would be unprofitable without the exit that it causes, but profitable with the exit.”
Ordover and Willig, “An economic definition of predation: pricing and product innovation,” Yale L.J., 91(1) (1981)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 8
Profit Sacrifice Test
- Innovation almost always involves a profit sacrifice
- Innovation sometimes excludes competitors
- Exclusion of competitors may be necessary to motivate efficient investment in research and development
- Profit sacrifice is not a useful test for predatory innovation
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 9
No Economic Sense Test
“Conduct is not exclusionary or predatory unless it would make no economic sense for the defendant but for the tendency to eliminate or lessen competition.”
Werden, “Identifying exclusionary conduct under Section 2: The “No Economic Sense” Test,” Antitrust L. J., 73(2) (2006)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 10
No Economic Sense Test
Two interpretations of “no economic sense” applied to innovation -
- Innovation is not profitable
- Innovation always makes economic sense
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 11
No Economic Sense Test
If (1), the no economic sense test is similar to the profit sacrifice test
If (2), the no economic sense test is similar to a sham innovation test
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 12
Predatory Innovation for Complements
- IBM peripherals litigation (late 1970s)
- Microsoft
- Others (e.g. Bard v. M3 Systems)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 13
Predatory Innovation for Complements
- In nearly all cases, weak evidence of efficiencies was sufficient to avoid liability for predatory innovation
- Only Microsoft purported to apply a rule of reason analysis
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 14
U.S. v. Microsoft
- The plaintiff must demonstrate that the conduct harmed consumers (an anticompetitive effect);
- if a plaintiff successfully demonstrates anticompetitive effect, then the monopolist may proffer a procompetitive justification for its conduct; and
- the plaintiff can rebut the proffered procompetitive justification or, if the justification stands unrebutted, then the plaintiff must demonstrate that the anticompetitive harm of the conduct outweighs the procompetitive benefit.
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 15
U.S. v. Microsoft
- Three challenged design elements
- excluding IE from the “Add/Remove Programs” utility;
- designing Windows so as in certain circumstances to override the user's choice of a default browser other than IE; and
- commingling code related to browsing and other code in the same files, so that any attempt to delete the files containing IE would, at the same time, cripple the operating system.
- Court concluded that Microsoft offered no procompetitive justifications for (i) and (iii)
- Court concluded that plaintiffs did not rebut Microsoft’s justifications for (ii)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 16
U.S. v. Microsoft
Court never got to the rule of reason balancing in the third step
The practical effect of the Court’s analysis was similar to a “no economic sense” test
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 17
Product line extensions in the
pharmaceuticals industry
Drug patents that may delay generic competition:
Tricor: used to control blood triglyceride and lipid (cholesterol) levels
Prilosec/Nexium: for treatment of persistent
heartburn (Prilosec and Nexium) and esophageal and duodenal ulcers (Nexium)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 18
Product line extensions in the
pharmaceuticals industry
Allegations that:
- Innovations are costly, but minor, improvements
- Contrary to the intent of Hatch-Waxman legislation
- Have adverse competitive effects by delaying generic competition
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 19
Product line extensions in the
pharmaceuticals industry
Issues:
- Hatch-Waxman legislation was a tradeoff between more generic competition and more protection for patented drugs
- Product line extensions increase incentives for drug innovation
- Hard to assess innovation benefits
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 20
Consistency with Other
Antitrust Rules
“Too many people make decisions based on outcomes, rather than process.”
Michael Lewis, quoting Paul DePodesta in Moneyball (2004)
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 21
Consistency with Other
Antitrust Rules
- Most innovations that exclude competitors have effects that are no more severe than a refusal to deal. E.g.,
- IBM refuses to make mainframes compatible with third party components
- Microsoft refuses to make Windows compatible with other browsers
- Branded drug manufacturer refuses to supply a drug that generics can copy
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 22
Consistency with Other
Antitrust Rules
- Yet a unilateral refusal to deal rarely incurs antitrust liability
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
Slide 23
Conclusions
- Rule of reason and profit sacrifice tests have limited value to evaluate predatory innovation
- Hard to do, likely to get wrong answer
- No economic sense is better, but only if
interpreted as a test of sham innovation
- This is what courts typically have done, and is
probably at least as good an approach as any
| DOJ/FTC § 2 Hearings | Berkeley, CA Jan 30-31, 2007 | |
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