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1	UNITED STATES FEDERAL TRADE COMMISSION
2	and
3	UNITED STATES DEPARTMENT OF JUSTICE
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5
6
7	SHERMAN ACT SECTION 2 JOINT HEARING
8	UNDERSTANDING SINGLE-FIRM BEHAVIOR:
9	EXCLUSIVE DEALING SESSION
10	WEDNESDAY, NOVEMBER 15, 2006
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12
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15	HELD AT:
16	UNITED STATES FEDERAL TRADE COMMISSION
17	601 NEW JERSEY AVENUE, N.W.
18	WASHINGTON, D.C.
19	9:30 A.M. TO 4:00 P.M.
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24	Reported and transcribed by:
25	Susanne Bergling, RMR-CLR

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1	MODERATORS:
2	DAN O'BRIEN
3	Chief, Economic Regulatory Section
4	Antitrust Division, Department of Justice
5	and
6	MICHAEL G. VITA
7	Assistant Director
8	Bureau of Economics, Federal Trade Commission
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10	PANELISTS:
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12	Morning Session:
13	Jonathan M. Jacobson
14	Howard P. Marvel
15	Richard M. Steuer
16	Mary W. Sullivan
17	Joshua D. Wright
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19	Afternoon Session:
20	Stephen Calkins
21	Joseph Farrell
22	Benjamin Klein
23	Abbott (Tad) Lipsky
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25

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1	C O N T E N T S
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3	MORNING SESSION:
4	Introduction
5	Presentations:
6	Jonathan M. Jacobson
7	Howard P. Marvel
8	Richard M. Steuer
9	Mary W. Sullivan
10	Joshua D. Wright
11	Moderated Discussion
12	Lunch Recess
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14	AFTERNOON SESSION:
15	Introduction
16	Presentations:
17	Stephen Calkins
18	Joseph Farrell
19	Benjamin Klein
20	Abbott (Tad) Lipsky
21	Moderated Discussion
22	Conclusion
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24
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1	P R O C E E D I N G S
2	- - - - -
3	MR. VITA: Good morning, everybody. My name is
4	Mike Vita. I am an economist here at the Federal Trade
5	Commission. My title is Assistant Director for
6	Antitrust in the FTC's Bureau of Economics. My
7	co-moderator is Dan O'Brien, Chief of the Economic
8	Regulatory Section at the Department of Justice,
9	Antitrust Division.
10	I am going to be leading the morning session,
11	and Dan will be leading the afternoon session, and
12	before we get started with the substance of today's
13	hearings, I am going to cover a few housekeeping
14	matters.
15	First, turn off the cell phones. You'll get
16	detention if you -- the BlackBerries and any other
17	devices that make noises, that's very important.
18	Second, for those of you who aren't familiar
19	with the setup here at 601 New Jersey, the rest rooms
20	are down the hall, past the guard's desk and to the
21	left. I think there are signs out there in the lobby to
22	guide you.
23	Third, a safety tip particularly for visitors.
24	In the unlikely event that the building alarms go off,
25	which they actually did yesterday, please proceed calmly

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1	and quickly as instructed. Dan and I will keep
2	everything calm and orderly. If we must leave the
3	building, exit the New Jersey Avenue exit by the guards,
4	that's where you probably came in, and follow the stream
5	of people running to a gathering point where you can
6	await further instructions.
7	Finally, we request that you not make any
8	comments or ask questions during the session. Thank
9	you.
10	Okay, today's session concerns exclusive
11	dealing, one of the most interesting areas I think of
12	all the various topics involving vertical restraints and
13	vertical contracts. It has been an active area of
14	economic research and an active area of antitrust as
15	well. We are honored to have assembled a distinguished
16	panel of practitioners and professors who are very
17	knowledgeable in the issues we are going to tackle
18	today, and there are going to be two sessions, one in
19	the morning and then one later in the afternoon.
20	I will just briefly introduce the panelists for
21	this morning before we get started, and I will give a
22	little more detailed introduction as each speaker takes
23	his or her turn. I do not know if everybody is in some
24	sort of order, but it looks like they are.
25	Okay, so immediately to Dan's left is Richard M.

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1	Steuer, who is a partner at Mayer Brown Rowe & Maw, LLP.
2	Next to Richard is Mary Sullivan, who is an Assistant
3	Professor of Accountancy at George Washington
4	University. Next to Mary is Josh Wright, who is
5	Assistant Professor of Law at George Mason University
6	School of Law. Next to Josh is Howard Marvel, who is a
7	Professor of Economics in the Department of Economics at
8	Ohio State and also Professor of Law in the Michael
9	Moritz College of Law at Ohio State University. And at
10	the very end is Jonathan Jacobson, who is a partner at
11	Wilson Sonsini Goodrich & Rosati and a Commissioner of
12	the Antitrust Modernization Commission.
13	So, I think we will just get right into it, and
14	let me introduce in detail our first speaker, and in
15	those handouts that you got, there is a more detailed
16	biographical description of each of the speakers as
17	well, and you can also find them on the FTC and
18	Department of Justice web sites.
19	Our first speaker is Richard Steuer, who is a
20	partner at Mayer Brown Rowe & Maw, where he specializes
21	in the practice of antitrust law, including litigation,
22	mergers and acquisitions, intellectual property
23	licensing, franchising and e-commerce. Richard has
24	written a book and several articles on antitrust law
25	which have appeared in various journals throughout the

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1	country. For three years Richard served as chair of the
2	Antitrust Committee of the Association of the Bar of the
3	City of New York.
4	Richard?
5	MR. STEUER: Thanks, Joe.
6	In baseball they say you can learn a lot by
7	watching, and I have been fortunate over the years to
8	have been able to observe a great deal about exclusive
9	dealing and in various contexts, both in litigation and
10	counseling, and I put what I knew into three articles
11	that I have written, and I thought that the best way to
12	try to present what I have learned about exclusive
13	dealing would be to go through those articles and
14	briefly outline what it is that I have learned from
15	watching.
16	The first one was an article on "Exclusive
17	Dealing in Distribution," focusing on how exclusive
18	dealing works when you are talking about selling to
19	resellers, and this appeared in 1983. I will not take
20	very much time on the history, but it is interesting
21	that once upon a time, the FTC considered most exclusive
22	dealing to be virtually per se unlawful. The Standard
23	Stations case in 1949 introduced the rule of
24	quantitative substantiality. Then the major case of
25	Tampa Electric in 1961 brought in qualitative

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1	substantiality, and then we found a more nuanced rule of
2	reason approach with the Beltone case from the FTC in
3	1982, Jefferson Parish in the Supreme Court in '84, and
4	added to that are the nuances of rule of reason analyses
5	we get from California Dental.
6	Now, what I have found is the level of
7	distribution really matters in assessing the impact of
8	exclusive dealing. What we are measuring with exclusive
9	dealing -- why exclusive dealing is different from other
10	restraints -- is that we are looking more at foreclosure
11	of competitors than anything else. Exclusive dealing is
12	interesting among the vertical restraints. This is the
13	one that, although it has almost always been a rule of
14	reason offense, plaintiffs win quite often, and what we
15	are looking at is something quite different than in
16	vertical resale restraints where the restraint is on
17	reselling rather than purchasing. Exclusive dealing is
18	a restraint on purchasing, not on selling.
19	So, the level of distribution could be
20	wholesalers. One wholesaler can reach every retailer in
21	America, potentially. With retailers, it is different.
22	Retailers are chained to a location typically, although
23	with the Internet, that is not quite as true anymore,
24	and this is a fluid field. Retailers could be in
25	chains, but basically they have a universe of consumers

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1	that they reach. Wholesalers are a little bit
2	different, because foreclosing wholesalers does not mean
3	that you are foreclosed from reaching retailers.
4	Foreclosing retailers may or may not mean that you are
5	foreclosed from reaching end users. Reaching end users
6	is the simplest. To the extent that there is an
7	exclusive dealing arrangement tying up 10 percent of end
8	users, you have got 10 percent of the market.
9	Type of product is important. Shopping products
10	are products for which consumers will go from place to
11	place to compare prices, to compare features. The fact
12	that each dealer only has one brand does not necessarily
13	have as much of a foreclosure effect, because consumers
14	will not stop at that dealer. They are more likely to
15	go and continue shopping, looking at other brands at
16	other dealers.
17	Convenience products, on the other hand, include
18	impulse products, products that a consumer is more
19	likely to buy because he or she is at the retailer, and
20	that goes to the concept of "can the retailer deliver
21	customers?" Is the retailer such that, when you think
22	about the nature of the retail operation, a customer
23	going to that retailer is going to buy whatever brand
24	there is, so that exclusive dealing is going to have a
25	more considerable impact.

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1	Another variable that is important to keep in
2	mind is alternate channels of distribution -- what is
3	sometimes called intertype competition -- and there was
4	a rather classic book that Palamountain published in
5	1955 on that. Today, the variation in intertype
6	competition is richer than ever with the rise of the
7	Internet and other alternate channels. So, one needs to
8	look, when you are dealing with resellers, at what other
9	types of means are there, direct sales and so forth, for
10	getting the product distributed.
11	Another possibility is simply establishing new
12	distributors. Is it more efficient, is it more
13	competitive, to have competitors with other brands
14	establish their own distribution networks than just
15	piggyback on the existing distribution network and
16	possibly compromising the amount of vigor with which the
17	intermediate, the reseller, is pushing each brand? Are
18	you better off having one brand at each reseller and
19	having them competing against one another?
20	Foreclosure is measured in many, many antitrust
21	defenses. There is a measure of foreclosure for
22	monopolization, for attempted monopolization, under
23	Section 3 of the Clayton Act, under Section 1, and I
24	recently had an opportunity to study what the different
25	tests are, and I will not belabor the point here -- we

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1	do not have time -- but they are all over the lot.
2	The interesting thing is "foreclosure" is a term
3	that is used throughout the antitrust lexicon, but it
4	has a different meaning with each substantive offense,
5	and that is important to keep in mind.
6	The procompetitive effects when you are going
7	through distribution: Combating manufacturer-level free
8	riding. This is not the kind of free riding that we
9	were talking about in a case like Sylvania where one
10	retailer free rides on the efforts of another. This is
11	one manufacturer free riding on the efforts of another
12	manufacturer, and exclusive dealing, by keeping other
13	manufacturers out of a particular wholesaler or
14	retailer, prevents that.
15	Of course, stimulate distributors. If the
16	distributor only has one brand of a product, it is going
17	to devote all of its efforts to that brand, but again,
18	in measuring how valuable that is, there is a
19	distinction between commodities and differentiated
20	products. With a differentiated product, there is
21	something more for the dealer to explain, typically,
22	about the features of the product. With commodities,
23	that is probably less so.
24	Stimulating suppliers. Exclusive dealing also
25	stimulates suppliers to put more time and effort and

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1	money behind their channels of distribution, because
2	they know that other brands are not using the same
3	retailer or same wholesaler, and they do not have to
4	worry about divided loyalties where they are wasting
5	their effort.
6	Protecting trade secrets is similar. To the
7	extent that a manufacturer is providing trade secrets to
8	a retailer or a wholesaler on how to sell, if that
9	retailer or wholesaler is carrying other brands, it can
10	use that kind of information for the benefit of the
11	other brands.
12	Quality control as well is something that can be
13	controlled more directly with exclusive dealing where
14	there are not other brands in the house, and that is
15	particularly true where retailers or wholesalers are
16	doing things with the product, to the product, where, if
17	there is some kind of adulteration, it is hard to
18	control quality with other brands in there.
19	Resale restraints. There is a lot of talk and
20	we were talking earlier about whether there is going to
21	be a change in the rule on resale price maintenance.
22	Some of these same considerations also go into the kind
23	of resale restraints we looked at in a case like
24	Sylvania, customer restraints, territorial restraints,
25	resale price maintenance, but those are all restraints

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1	on selling, not on buying. So, some of these apply, but
2	they do not apply in the same way.
3	The next thing I looked at ten years later was
4	"Discounts That Induce Exclusive Dealing," and this is a
5	little bit different again, but yet another nuance. I
6	started with single products. In the simplest case,
7	there is one product involved. The grand daddy of the
8	cases is United Shoe Machinery, 1922, but these cases
9	still continue. The latest one, and I am not going to
10	dwell on cases, but there is a case this year from the
11	Sixth Circuit that the plaintiff won on essentially a
12	single product. Big cases out of the U.S. were
13	Nutrasweet, which involved one product, and Tetra Pak,
14	packaging.
15	The important thing to know in these cases is
16	whether or not there is an offer you cannot refuse.
17	These are discounts to induce exclusive dealing. It is
18	not an outright exclusive, but it is basically a deal
19	saying if you buy 50 percent of your requirements from
20	me, you get one price; if you buy 75 percent, you get
21	another price; if you buy 100 percent, you get still
22	another price. It does not sound like it is quite as
23	much foreclosure as exclusive dealing, and in many
24	cases, it is not as much foreclosure, it is perfectly
25	fine.

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1	However, sometimes it is essential for the buyer
2	to buy some of the product from one brand, and a classic
3	case, we talked about learning from observing, there was
4	one case that I was involved in where it was almost a
5	commodity product. It was a fairly undifferentiated
6	product, but it was differentiated in certain quality
7	aspects, and because the buyers had to buy a particular
8	brand to satisfy their customers, because it was spec'd
9	in, there was one company that had 100 percent of the
10	manufacturing. When a second company came along and was
11	about to turn the key to open their factory, the first
12	company came up with a discount schedule, that as long
13	as you bought 80 percent from me, you got a much lower
14	price. If you only bought 79 percent from me, you got a
15	much higher price.
16	Well, it turned out that about half of what all
17	the customers needed they could not buy from anyone
18	else, not because one product was better than the other
19	or even very different, but it was spec'd in, they had
20	to have it, and so it was an offer they could not
21	refuse, because if they bought less than 80 percent,
22	they would be paying a lot more for everything that they
23	bought. The company that would be trying to break into
24	the market would have to replace all of those lost
25	discounts on the quantity that they could not have. So,

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1	even though it was not really a different product,
2	analytically, it almost was a different product, because
3	there was some quantity that they had to have from the
4	other brand.
5	A little like bundling. Bundling is almost
6	easier to see, because there are different products in
7	the bundle. Some of them are products you have got to
8	have because they are patented in some cases. Sometimes
9	you do not have to have them, and there are ways of
10	ameliorating it. I am not going to spend time on
11	bundling, because I know you have another program
12	devoted to that entirely, and I could spend a whole day
13	on bundling.
14	The last thing I looked at was, who is
15	instigating exclusive dealing, and should it make a
16	difference? And particularly, "Customer-Instigated
17	Exclusive Dealing." There are mixed motivations on how
18	many suppliers you would like to have in the market.
19	End users have two different motives. On the one hand,
20	they would like to assure that there are plenty of
21	suppliers, because they would like to have alternatives,
22	and they want to play one supplier off against another
23	to get the best price. At the same time, there may be
24	cases where if there is a requirements contract -- and a
25	requirements contract not only means I will buy

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1	everything from you, but the seller promising I will
2	supply everything that you need -- if one buyer can get
3	a requirements contract and there are not enough other
4	sellers to go around, it could have an impact harming
5	competitors of the buyer. So, it is possible that there
6	are situations where an end user would have a motive, at
7	least in the short term, not to have as many suppliers
8	survive.
9	Resellers, it is somewhat similar. In the short
10	term, if you are an exclusive reseller of a particular
11	brand, you would like to see all the other brands
12	disappear. They only provide competition to you. In
13	the long term, though, if that arrangement is not
14	necessarily perpetual, the day may come when you would
15	like to have some options with other brands that could
16	supply you.
17	Now, why would a customer want exclusive
18	dealing? The most obvious reason is to induce lower
19	prices, to say to a supplier, I am giving all of my
20	business to one supplier, and it may be you, but it may
21	not be, so sharpen your pencil and give me your best
22	price.
23	Another reason is to assure a dependable supply,
24	and that is the requirements contract. Another is to
25	assure quality, in that it is expensive to qualify

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1	suppliers in certain very technical industries, and you
2	do not want an unlimited number of them. In some cases,
3	assuring uniformity is important. There is a case
4	involving auto racing where it was felt to be important
5	that everybody have the same tires so that there is a
6	level playing field among competitors. And achieving
7	logistical efficiencies. In some settings, just having
8	fewer suppliers is going to wind up lowering expenses.
9	Now, how do you find an appropriate legal
10	analysis where it seems that the buyer has instigated
11	the exclusive dealing? The supplier's objectives often
12	are twofold. One is to foreclose others, and that is
13	the one we always look at when we are trying to see an
14	impact on competition -- will exclusive dealing
15	foreclose other suppliers from having customers or
16	having distribution? Another is to achieve
17	distributional efficiencies.
18	The reseller's objectives are the ones we just
19	talked about, pricing, supply, quality, uniformity --
20	and there are mixed motives about how strong a reseller
21	wants other brands to be.
22	The end user's objectives are a little bit
23	different. Again, the end user of course wants better
24	pricing, may have concerns about delivery, quality,
25	uniformity, efficiencies. It is less likely that an end

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1	user who is insisting on giving all of its business to
2	one supplier is really in favor of weakening other
3	suppliers. There may be those rare cases, but it is
4	less likely that that is what you are going to find.
5	So, what is the right analysis? When should
6	courts second-guess buyers for instigating exclusive
7	dealing and replace the buyer's judgment that it wants
8	an exclusive with the court's judgment? I think that
9	certainly when the buyer has a demonstrable motive to
10	eliminate competition at the supplier level so that it
11	is helping itself in terms of competition, that is one
12	to take a hard look at, but generally, I think it is
13	important to trust the buyer's judgment if it is
14	instigating exclusive dealing.
15	Let me just conclude by saying I hope this quick
16	snapshot has highlighted some of the very many
17	differences that exist among exclusive dealing
18	arrangements. All of us as lawyers and economists are
19	always searching for those unifying principles that make
20	it easy to do the analysis, but I think what is
21	important here is that we not get lazy and overlook that
22	some of these variables that we have just been talking
23	about really do make a difference to the analysis.
24	I will leave it there, and thank you very much.
25	(Applause.)

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1	MR. VITA: Thank you, Richard. Insightful and
2	on time, perfect.
3	Our next speaker is Mary Sullivan, who is an
4	Assistant Professor of Accountancy at George Washington
5	University. Mary received her Ph.D. from the University
6	of Chicago, Department of Economics, and taught
7	marketing at Chicago Graduate School of Business from
8	1987 through 1997. While at Chicago, she conducted
9	research on industrial organization and marketing
10	issues, such as slotting allowances, brand names and
11	trademarks.
12	In 1997, Professor Sullivan left academia for
13	the U.S. Department of Justice Antitrust Division where
14	she worked on a variety of antitrust matters and served
15	as Assistant Chief of the Competition Policy Section.
16	In 2004, she joined the Accountancy Department
17	at George Washington University, and as many of you
18	know, Mary's research has been published in numerous
19	leading economics journals.
20	Mary?
21	DR. SULLIVAN: Thank you. I would like to start
22	by thanking the DOJ and FTC for inviting me to
23	participate in these hearings, and I need to keep track
24	of the time very closely, because I have been threatened
25	by Dan and Mike that if I go over my time limit, that

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1	they might charge me a slotting allowance, although in
2	practice, I have learned that it is very difficult to
3	charge one unless you charge it in advance.
4	Nonetheless, I will try to stay on track.
5	Slotting allowances and payola are two allegedly
6	exclusionary practices that receive different regulatory
7	treatment. What I am going to do in my talk is address
8	whether the different regulatory treatment is warranted.
9	Slotting allowances and payola are similar in
10	many respects. They are basically the same practice
11	used in different settings. Slotting allowances are
12	payments made by manufacturers to retailers for stocking
13	new products. Payola consists of payments made by
14	recording companies to radio stations or DJs for playing
15	a particular piece of music. Both practices have
16	promotional effect. They serve to increase demand by
17	providing exposure to the product or music to consumers.
18	In each case, there is a scarce resource that
19	needs to be allocated, shelf space in the case of
20	slotting allowances and airspace in the case of payola.
21	For both types of fees, there are concerns about
22	exclusionary effects. If you read news articles or, you
23	know, just search the web for these practices, or if you
24	have talked to industry participants, you will learn
25	that these practices are widely believed to be

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1	exclusionary, and the potential exclusionary effect is a
2	major motivating factor in the regulatory scrutiny that
3	each of these practices has received.
4	Now, oddly, despite their similarities, the
5	practices receive different regulatory treatment.
6	Slotting allowances are not regulated by the FTC. In
7	the FTC's 2001 report on slotting allowances, they said
8	that the fees need to be judged on a case-by-case basis
9	with attention both to likely competitive harms and to
10	likely procompetitive effects. So, they take a basic
11	rule of reason approach.
12	Alternatively, the FCC does regulate payola.
13	According to the FCC regulations, payments are
14	prohibited unless an announcement of the endorsement is
15	made every time a song is played, and this increases the
16	cost of using payola. Now, in addition to the FCC
17	regulations, the major recording companies have recently
18	settled investigations brought by Elliott Spitzer, as
19	many of you are probably aware. I think what is less
20	well known about these settlements is that the terms of
21	the settlements are more restrictive than the FCC
22	regulations, with payola completely banned in most cases
23	even if an announcement is made of the endorsement.
24	Now, given over the past few years we have
25	learned a lot about slotting allowances, both in terms

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1	of the economic theories and in legal challenges, I
2	thought it would be an interesting exercise just to go
3	through some of the things we have learned to try to get
4	some insight as to why payola has received different
5	regulatory treatment and whether this makes sense.
6	Okay, so we will start with a little bit about
7	the theories of exclusion. Can theories of exclusion
8	explain slotting allowances and payola? Now, there are
9	two general classes of theories that I will talk about.
10	There are the popular theories or notions of exclusion,
11	and then there are the economic, sort of rigorous
12	economic theories of exclusion.
13	The popular theory of exclusion, according to
14	these theories, the payment of the fees increases the
15	cost of introducing a new product or a new song. The
16	increased entry cost may exclude manufacturers,
17	particularly small ones, and many of the complaints are
18	of this nature.
19	However, this so-called theory cannot really
20	explain exclusion. It is fairly well accepted that
21	auctioning scarce resource results in efficient
22	allocation, and unless something in the auctioning
23	process reduces the number of slots that are available,
24	it is very easy to see how this could result in
25	exclusion. If a product or song is very promising,

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1	someone will give the product financing in order to
2	introduce the product. Therefore, I really don't
3	consider this a valid theory of exclusion.
4	The other class of theories are the economic
5	theories, and the two that I have really looked at for
6	the purpose of this talk are Farrell 2001 and Shaffer
7	2005. Now, without going into much detail at all about
8	these theories, all these theories share the feature
9	that you need to have a contractual provision for the
10	retailer to actually exclude a competitor in return for
11	the fees. You must have a situation in which the
12	retailer is reducing the number of slots available for
13	exclusion to occur and for harm to result from it. So,
14	one important conclusion that I take away from these
15	theories is that simply paying a slotting allowance is
16	not enough to cause exclusion.
17	So, the next thing I want to do is take a look
18	at the evidence, what do we know about slotting
19	allowances and payola, and ask the question whether the
20	evidence is consistent with the Farrell/Shaffer type
21	theories of exclusion.
22	In the case of slotting allowances, the answer
23	is sometimes. Occasionally slotting allowances are
24	accompanied by a contract to reduce the shelf space
25	available to competing manufacturers which could weaken

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1	them and potentially exclude them. According to the
2	FTC's 2003 study of slotting allowances, such contracts
3	are fairly unusual, but they do occur.
4	For payola, the answer is no. There is no
5	evidence that exclusionary contracts are being used with
6	payola. The evidence that I have seen suggested that
7	recording studios are simply trying to use payola in
8	return for getting the radio stations to play their
9	songs, not that they would not benefit if they could
10	exclude a popular song of a competing recording studio.
11	I think, you know, if they could exclude a competing
12	song, it would allow them to sell more records; however,
13	there is simply no evidence at all that that is what is
14	happening, and believe me, if you take a look at some of
15	the Spitzer settlements, you will see that the evidence
16	he collected was quite thorough. What I conclude from
17	this is that according to the economic theories of
18	exclusion, payola is very unlikely to be exclusionary.
19	Now, I also wanted to take a look at some of the
20	evidence from the courts to see what the courts say
21	about slotting allowances and exclusionary effects.
22	This is not really intended to be a comprehensive review
23	of the legal cases on slotting allowances. What I did
24	do is I looked at two legal challenges to slotting
25	allowances that are both important, have been very

25

1	influential, and I see cited quite often in other cases.
2	In both of these cases, the courts found that the fees
3	are a valid means of competing, and here are the two
4	cases.
5	One of the quotes from the Gruma case is
6	particularly revealing. In this case, the Court said,
7	"Some of the plaintiffs' losses are due to a
8	'self-inflicted' wound -- they chose not to compete for
9	shelf space."
10	Now, in this case, the plaintiffs were small
11	companies, small tortilla manufacturers who were
12	complaining that Gruma, the large manufacturer, was
13	buying up all the shelf space and giving it unfavorable
14	locations. The Court ruled, well, your tough luck. If
15	you want to be in this game, you need to compete for
16	shelf space.
17	Now, in the Reynolds Tobacco/Philip Morris
18	case -- which is often referred to as the retailer
19	leaders case, which was the name of the Philip Morris
20	program that was being challenged in court -- it was a
21	somewhat different situation, because Reynolds, the
22	plaintiff in this case, was actually a large company,
23	but the conclusion of the Court was the same. In this
24	case, the Court concluded that the Philip Morris program
25	that involved the payment of slotting allowances

26

1	increased industry competition.
2	Okay, so if the theory predicts that payola is
3	unlikely to be exclusionary and the courts have ruled
4	that slotting allowances are an efficient means of
5	allocating scarce shelf space, then why -- this leads us
6	back to the original question -- why does payola receive
7	different regulatory treatment than slotting allowances?
8	The answer seems to be that since the air waves are
9	owned by the public, there is a belief that radio
10	stations should select music on the basis of public
11	interest rather than the radio station's commercial
12	interest. This view highlights the difference between
13	slotting allowances and payola.
14	The FTC and the courts see slotting allowances
15	as a valid and efficient means of allocating shelf
16	space, but the FCC believes payola results in an
17	allocation of airspace that is not in the public
18	interest apparently because it allows the radio station
19	to play music that increases their profits. Now, does
20	this make sense?
21	Another way of asking that is, will regulating
22	payola cause radio stations to select music that is in
23	the public interest, whatever that is? The answer is
24	no. To see why, it is helpful to understand a little
25	bit about how radio stations are going to decide what to

27

1	play both with and without payola.
2	Now, if payola is banned, radio stations are
3	going to earn all of their money from creative --
4	selling -- or playing music that appeals to an audience
5	that will buy advertisers' products. In other words,
6	they are going to earn all of their profits from
7	advertising dollars. So, what they are going to do is
8	they are going to select music that appeals to people
9	who buy the advertisers' products.
10	Now, if payola is permitted, radio stations earn
11	revenue from both advertising and payola, and this may
12	cause the radio stations to change their selection of
13	music. They may play more songs that appeal to people
14	who buy records and play less songs that appeal to
15	people who buy advertised products. It is not obvious
16	to me that the selection of music will be more in the
17	public interest if payola is banned. In either case,
18	the radio stations choose what music to play on the
19	basis of what maximizes its profits.
20	So, I have several conclusions from this. The
21	first conclusion from the analysis, from this exercise,
22	is that it seems highly unlikely that payola will
23	exclude promising music. This argument of exclusion
24	should not be used to support the regulation of payola.
25	Second, regulating payola will not help achieve

28

1	the goal of serving the "public interest." With or
2	without regulations, radio stations will design
3	playlists to serve their own commercial interests. This
4	is unavoidable.
5	Third, prohibiting explicit payment for radio
6	airspace will not make competition for airspace
7	disappear. There is a scarce resource, and there is
8	going to be competition for it. The competition will
9	take a different form. To the extent that recording
10	studios can find loopholes in the regulation, then there
11	will be little effect on the regulation on what is
12	played.
13	So, my own personal conclusion from this is that
14	the regulation of payola it seems to me does not serve
15	the public interest, appears to be wasteful, and leads
16	to needless enforcement costs.
17	Thank you.
18	(Applause.)
19	MR. VITA: Thank you, Mary.
20	DR. SULLIVAN: No slotting allowance?
21	MR. VITA: You are off the hook, for now.
22	DR. SULLIVAN: Okay.
23	MR. VITA: Okay, our next speaker is Joshua
24	Wright, who is an Assistant Professor of Law at George
25	Mason University School of Law, where he teaches in the

29

1	areas of antitrust, contracts, and law and economics.
2	Professor Wright's research focuses on the law and
3	economics of the competitive process for product
4	distribution, including slotting allowances, category
5	management, exclusive dealing and other contractual
6	arrangements. He has published in numerous journals.
7	Professor Wright received his Ph.D. in economics
8	from UCLA, Department of Economics, and he also received
9	his JD from the UCLA School of Law, where he was a
10	managing editor of the UCLA Law Review.
11	Joshua?
12	MR. WRIGHT: Thank you.
13	Okay, so I am going to sort of hop on the back
14	of some of Mary's comments on slotting and do a little
15	less background talking about what they are, since that
16	has already been covered. My comments here, just as a
17	preface to get out of the way, are based on two papers
18	that are up on the FTC web site, which has all of the
19	slides and papers from the other panelists, both
20	co-authored with Ben Klein, who I think will be here in
21	the afternoon.
22	So, a tiny bit more detail on -- I am going to
23	use a slightly different definition of slotting
24	arrangements than Mary used and define the contracts as
25	per unit time payments made by manufacturers to

30

1	retailers for shelf space. There is a couple of
2	differences here. One is that sometimes, and indeed, in
3	the FTC report that has been referenced, you will find a
4	distinction between per unit tying payments and
5	discounts for slotting contracts, and it is an important
6	difference and one that I am going to end up not talking
7	much about here, but there is a discussion in the paper
8	I just referenced on the economics of slotting
9	contracts, on when we might expect the efficient form of
10	a distribution contract to be a per unit tying payment
11	or a discount. That said, I am going to ignore the
12	issue for the next 19 minutes.
13	What else we know about slotting is that they
14	cover both new products and established products. So,
15	they cover -- you know, Coca-Cola pays slotting
16	allowances, products where we do not have any sort of
17	risk imposed on the retailer by giving shelf space to
18	some unproven product. We see slotting allowances on
19	those products as well.
20	What else we know is that they increased, there
21	was a spike in the prevalence and the magnitude of
22	payments somewhere between 1981 and 1984, and over the
23	last 20 years, that trend of increasing and over the
24	products covered and the magnitude of payments has
25	continued.

31

1	So, the anticompetitive theories of slotting,
2	first, before I try to explain a procompetitive
3	rationale for shelf space contracts. We see slotting
4	contracts used by manufacturers with small market
5	shares. We see -- in general, the FTC report finds that
6	the normative time for these agreements are between six
7	months and a year. We see them on products where there
8	are not significant economies of scale in manufacture,
9	one of the conditions that drives the anticompetitive
10	theories in the literature. And also, the
11	anticompetitive theories have a difficult time
12	explaining the jump in the use of the contracts in the
13	middle of the 1980s.
14	In terms of the procompetitive story for
15	slotting allowances, there are really two important
16	economic questions with respect to slotting fees, and
17	the first is why you see a separate contract at all,
18	right? The first economic intuition one might have is
19	why don't we see, like the setting of retail prices in a
20	competitive retail market, supermarkets, et cetera, why
21	don't we see manufacturers just set the wholesale price
22	and allow the retailer to set the level of shelf space
23	that is supplied for different products like we let them
24	set the price? So, why do we see this separate contract
25	for the shelf space?

32

1	And the second is, and more related to the panel
2	discussion today, is we see sometimes that these
3	contracts include exclusivity provisions, unlike the
4	payola contracts. We see provisions that say, give me
5	70 percent of the shelf space, give me a space to sales,
6	give me the full exclusive, do not put anyone else on
7	the shelf space. So, we see this additional variation
8	in the contracts that we are going to need to explain.
9	So, I will turn to that second. There are other
10	interesting questions, again, the form of the payment
11	and these things, which for the moment I am going to
12	skip so I can focus on exclusivity.
13	So, the answer provided by Ben Klein and myself
14	in the paper I alluded to earlier, the intuitive answer
15	is what you see on the screen, and it is that slotting
16	contracts solve this pervasive incentive incompatibility
17	problem where the retailer does not want to supply the
18	joint profit maximizing level of promotional shelf space
19	under the conditions where the supply and the shelf
20	space does not induce consumer switching. So, we have
21	cases like McCormick and we have 90 percent of the shelf
22	space allocated for spices. Well, supplying additional
23	promotional shelf space to spices does not induce a
24	greater number of consumers to say I will not shop at
25	this retail outlet because they have given 90 percent of

33

1	the shelf space to spices, and they have two brands, and
2	so I am going to leave. So, we expect to see this
3	incentive incompatibility problem solved with a separate
4	contract under these conditions.
5	Now, I am going to go through a little bit of
6	the analysis with a simple model with a little bit of
7	math, but here is the intuitive answer. So, the
8	fundamental point here is that for many products, and
9	differentiated products, we have manufacturers with a
10	large profit margin. So, the manufacturers, the
11	wholesale price over the marginal cost, this P sub W
12	minus the marginal cost of manufacture, is large
13	relative to the retailer's incremental profit, whether
14	it sells Coke, Pepsi or any brand of soda, okay?
15	For a number of products, this is generally the
16	case. So, the retailer, when it is making its decision
17	on the optimal level of shelf space, promotional shelf
18	space to supply to the manufacturer's products, say
19	Coca-Cola, does not take into account that these
20	promotional sales induced by giving, say, the eye-level
21	shelf space, or if you are in the children's cereal
22	aisle, the children's eye level shelf space, these
23	incremental profits are large for the manufacturer and
24	not taken into account by the retailer.
25	Now, we can make the same argument with respect

34

1	to price competition, but there is a key difference as
2	to why we see manufacturers in the retail setting, at
3	least, allowing the manufacturers to set the retail
4	price, and competition between retailers is sufficient
5	to get an optimal jointly profit-maximizing price set
6	but not the jointly profit-maximizing level of shelf
7	space. So, why do we get prices right and shelf space
8	wrong ends up being the question.
9	So, unlike the shelf space case, when we are
10	talking about price competition, you see here we have
11	got on the right-hand side is this large manufacturer's
12	margin, that P sub W minus the marginal cost of the
13	manufacturers. It is large. It is maybe 10-20 times
14	larger than the retailer's margin for a good chunk of
15	products. But we have this offsetting effect induced by
16	customer switching. So, the intuition here is that
17	while the manufacturer's margin is much larger, we have
18	got this switching effect, so the quantity response
19	faced by the retailer when it changes the price has
20	these two different components.
21	One, when it reduces the price or increases the
22	price of Coca-Cola, there are interbrand effects, so
23	sales move from Coke to Pepsi, but there also are
24	inter-retailer competitive effects, right? So,
25	consumers may end up switching stores when we are

35

1	talking about price decisions or at least are more
2	likely to do so than when we talk about moving Coke from
3	the bottom level to the eye-level shelf space, right?
4	So, the key point and argument here is that
5	because promotional shelf space does not involve large
6	inter-retailer shelf space effects, we do not see
7	consumers switching on a number of grocery products. My
8	co-author on the paper and dissertation adviser likes to
9	use the example of dog collars in the store, right? So,
10	there is some exclusive space granted for dog collars,
11	and people pay and they compete for this space, but
12	nobody switches the stores because there is one dog
13	collar versus two, okay?
14	And because we have this idea that there are
15	these small inter-retailer effects, it is the case that
16	we have this incentive incompatibility problem, right,
17	and instead of this inequality, if we had the jointly
18	profit-maximizing level, we would see at least this
19	relationship be approximately equal. The big difference
20	is this elasticity from the retailer's perspective of
21	the shelf space effect, right?
22	And so this is all to illustrate the point that
23	where we see these small inter-retailer effects, again,
24	this incentive incompatibility problem is pervasive, and
25	this is especially so in the supermarket context. Now,

36

1	there are some limits on this idea. We do not see --
2	the distinction here is not just because of price and
3	nonprice competition, okay? There are elements of
4	nonprice competition where there are inter-retailer
5	effects because all consumers value the service.
6	So, the supermarket provides a free parking lot.
7	You can go and you park and you do not pay for it, you
8	know, when you go in to park. Everyone generally values
9	that there is a parking lot, maybe there is lighting
10	there so you don't get mugged when you go to the parking
11	lot, and everybody values this, and this means, because
12	consumers value some nonprice services, then they will
13	induce some switching, that for those services, the
14	incentive incompatibility problem is solved. The
15	retailer will supply those because consumers are all
16	willing to pay.
17	So, where we see this, the very idea of
18	promotional shelf space is to give some sort of
19	effective, targeted discount to the marginal consumers
20	who are sensitive to allocations in the shelf space,
21	right? They are sensitive to what is in the eye-level
22	shelf space, and there is a substantial marketing
23	literature which demonstrates sometimes some really
24	surprising results about how large the effects can be in
25	terms of changes in sales when we play around with the

37

1	shelf space allocation.
2	So, in these fairly general circumstances, the
3	disparity in margins and the small inter-retailer
4	switching effects from the supply of promotional shelf
5	space, the manufacturer wants more shelf space than the
6	retailer is willing to supply, and so we need to have
7	some separate contract where the manufacturer pays the
8	retailer for the supply of the shelf space in order to
9	solve this incentive incompatibility problem.
10	So, now we have got a situation where Coke is
11	paying for the eye-level shelf space to the retailer,
12	and it pays them $10,000 per unit time for the month for
13	some contracted-for level of shelf space. Now, this
14	does not mean that the whole process is over, right?
15	So, the manufacturer pays the retailer with this money,
16	and the retailer has some incentive to not perform.
17	It can provide less than the contracted-for
18	level of space. It can otherwise violate the implicit
19	contractual understanding between the manufacturer and
20	the retailer to sell the space twice, in other words,
21	the simple way to think about it. So, it is taking the
22	money and not performing under the terms of the deal.
23	This is where we get to the function of full or limited
24	exclusives in shelf space contracts.
25	Now, we see that in the slotting context, at

38

1	least a full or a partial exclusive seems to be -- at
2	least appears to be thus far -- a necessary condition
3	for liability. So, we have some form of exclusive -- we
4	have -- well, there is no liability, but Gruma, Conwood,
5	McCormick, so we have these cases where the contracts do
6	not just buy the shelf space. They specify a
7	percentage. They specify a full exclusive. They
8	specify limits on the placement of rival products.
9	So, there are a number of procompetitive
10	rationales for exclusivity terms in these contracts, and
11	Mr. Steuer went over many of them, and so I am not going
12	to belabor them here, but the key, following from this
13	sort of shelf space contracting model, is that an
14	exclusive can help facilitate performance of the
15	contract, right? The retailer pockets this money and
16	can have some short-term incentives to not perform.
17	So, a couple of things that exclusivity can do,
18	it can efficiently define exactly what the manufacturer
19	is purchasing. Purchasing all of the shelf space,
20	detecting cheating becomes easy. The other thing it
21	does is it allows the retailer to say, you are bidding
22	for all or 70 percent or some large fraction of the
23	promotional shelf space, and this intensifies the
24	bidding process between the manufacturers for the shelf
25	space, and this is a good thing in terms of the

39

1	antitrust analysis, a good thing for consumers, because
2	these shelf space payments are passed on to consumers,
3	and that is whether they are discounts or per unit time
4	payments.
5	Quickly, so I can end here, category management
6	contracts are just a form of limited exclusive, where
7	what we are doing instead of saying you get 50 percent
8	of the space is the retailer delegates the function to
9	the manufacturer to allocate the shelf space, and we see
10	this in circumstances where consumers' demand for a
11	particular brand is high. So, the implicit contract is,
12	you get to feature your product, Coca-Cola, and you can
13	allocate the shelf space, but if consumers come to me
14	and say I have a high demand for Pepsi and you're
15	putting it on the bottom or you have run out or you did
16	not put it on the shelf, then I know and I terminate the
17	agreement, okay?
18	Just to finish up, Conwood seems to get this all
19	wrong. So, Conwood, despite the sort of atmospheric
20	facts and the tortious behavior and lots of bad stuff
21	going on, there is some bothersome language in the
22	opinion about imposing a standard on category managers
23	that is tougher than the standard on monopolists using
24	full exclusives, and so the key idea is that exclusive
25	dealing can make economic sense in these circumstances

40

1	and that we need to make sure that the plaintiffs are
2	demonstrating an anticompetitive effect before we engage
3	in any sort of balancing under the rule of reason
4	analysis.
5	I think I went over, sorry.
6	MR. VITA: Not too bad.
7	(Applause.)
8	MR. VITA: Thanks, Josh.
9	Okay, our next speaker is Howard Marvel who is a
10	Professor of Economics in the Department of Economics at
11	Ohio State, and he is also Professor of Law in the
12	Moritz College of Law at Ohio State. Howard's work on
13	vertical restraints is very well known. He has written
14	on a variety of different topics, including resale price
15	maintenance and exclusive dealing, and I know those
16	papers have appeared in some leading economics journals.
17	Howard also has advised the Japanese
18	International Trade Ministry, had a post in
19	telecommunications, the Federal Trade Commission and the
20	National Association of Attorneys General law on
21	vertical restraints issues. In addition, he has served
22	as an expert in vertical restraint matters for a number
23	of firms.
24	Howard?
25	DR. MARVEL: Okay, I have seen a lot of you

41

1	before. I am happy that you have invited me to come
2	talk to you outside of the Third Circuit, and the topic
3	for today is exclusive dealing.
4	It is obvious that exclusive dealing is a very
5	common thing that we see every time, when you go to a
6	MacDonald's, you do not find a Burger King hamburger,
7	and Haagen Dazs has had the exclusive dealing in their
8	distribution contracts, car dealers typically have it,
9	there is exclusive dealing in beer distribution. It is
10	all over the place, and ordinarily we do not think
11	anything about it. You know, any business format
12	franchise is basically franchise or else, and it is most
13	commonly observed for our market leaders, the big guys.
14	Anheuser-Busch has it in the Chicago area, it is
15	under study, and you don't see that elsewhere. Haagen
16	Dazs had contracts with distributors with Steve's, which
17	at the time was a premium ice cream. I do not know if
18	it is still around. Anybody from Boston? Steve's did
19	not have that. The big guys have more reason to
20	foreclose, of course, but they have also more to free
21	ride upon.
22	So, for a long time we had a rule that Richard
23	talked about, how tough it was to engage in exclusive
24	dealing. The rule seemed to be that if you had market
25	dominance or a big share somehow, somehow, and you

42

1	practiced exclusion, if you had exclusion in your title
2	of whatever the practice was, you were toast. So, it
3	was essentially a per se violation.
4	Now, exclusion there does not mean foreclosure.
5	It just means exclusion from a portion of the market,
6	and that is very different than keeping the firm totally
7	out of the market. Foreclosure is a different story.
8	Now, several of the -- I think John is going to
9	talk about the Chicago view and why it is limited, so
10	let's run through what the Chicago view of vertical
11	restraints is. It is that vertical restraints create
12	property rights. So, you have a problem that you want
13	to get somebody to do something, but you are afraid that
14	at the end of the day they will not do it because the
15	fruits of their actions will end up being frittered away
16	as other people take advantage of them, okay?
17	So, the idea behind vertical restraint is that
18	it creates a property right for somebody or other, so
19	exclusive territories, for example, create a property
20	right for customers that a particular distributor or
21	dealer generates, okay? So, I go out to get a customer,
22	how do I guarantee if I am the seller who wants that
23	customer generated, how do I guarantee the customer gets
24	generated? I protect the rights to that customer for
25	the guy who actually did the work?

43

1	Resale price maintenance is very similar. There
2	is a property right for the services that the
3	distributor provides, and Josh talked about how this
4	sort of works in slotting as well, like exclusive
5	dealing, that creates a property right for customers
6	that the supplier's actions pull in, and I think that if
7	you think about the -- almost all of the things that
8	Richard included in his discussion from the 1983 paper,
9	they all have that characteristic, that the supplier is
10	doing something to pull in customers and those customers
11	are being protected through exclusive dealing by -- from
12	some sort of bait and switch approach.
13	Now, the problem with exclusive dealing and what
14	makes it more serious and more of a worry than
15	territories and RPM is that in territories and RPM, the
16	supplier is creating a property right for somebody else.
17	It says, you do this, and you get to keep the fruits, so
18	I would police that. And I am an outsider, and I want
19	to have the distribution system to be as effective as I
20	possibly can make it be, but with exclusive dealing, the
21	property right is for the creator and the monitor of the
22	right.
23	I give myself the right, and then I protect that
24	right, and we have a problem that can emerge there if
25	the right is somehow something that you really don't

44

1	want the guy to have and be able to protect, and that is
2	really what is at the heart of Aspen Ski, because in
3	Aspen Skiing, Aspen Skiing and Aspen Highlands
4	cooperated to develop the Aspen market as a destination
5	for skiers, and then at the end of the day, Aspen Skiing
6	said, well, gee, they passed a law here in Aspen where
7	you have got to have a three-week rental instead of just
8	a one-week minimum rental or a longer rental term, and
9	so you essentially locked customers in. You didn't have
10	to compete for customers so much, because they said,
11	well, we will walk away with rents, and you can see that
12	elsewhere.
13	If you have a patent holder who has accessories
14	for his product, the patent is about to expire, the guy
15	may decide to engage in exclusive dealing to try and
16	freeze out the accessory guys that he's cooperated with
17	to build that product, and believe it or not, I was an
18	expert witness in a matter in which I thought exclusive
19	dealing was used improperly in this way, so it's not
20	clear that these are anticompetitive so much as fraud or
21	contracting problems, but they are problems.
22	Okay, so the basic exclusive dealing story is
23	simply that the manufacturer invests in a product or a
24	reputation that brings in customers, if the manufacturer
25	confers upon its customers -- its customers onto dealers

45

1	who are cloaked in its reputation. So, if I become a
2	dealer for a particular manufacturer, then customers
3	say, hey, that dealer is essentially certified as
4	knowing what he's talking about, so the customer walks
5	into the dealer, induced to do so by the manufacturer's
6	efforts, and then the dealer says, by the way, I have
7	got a better deal for you.
8	Now, a requirement for this to work is that the
9	customer cost, the cost of generating the customers has
10	to be included in the charge for the product. So, if
11	you can charge for leads separately, no sweat, okay?
12	You just charge for the leads, you do the promotion, the
13	customers walk in, and if the dealer who's paid for
14	those customers wants to switch them to some other
15	product, hey, that's fine, okay, but there are a lot of
16	circumstances in which you only charge for the customer
17	when they actually buy something, so it is rolled into
18	the product price, and this is, again, the way it works
19	with royalties in business format franchises, right,
20	because MacDonald's brings customers in, but they only
21	receive a charge, a payment, for those customers when
22	the royalty is generated, okay?
23	So, the dealer can avoid this particular charge
24	through a bait and switch scheme in which he says, okay,
25	you are a customer for firm X, firm X brought you in,

46

1	that is what you came looking for, but firm Y has got a
2	product that is cheaper, because it does not involve any
3	promotion, it is simply a free rider, so why don't you
4	switch to that one, and you can trust me, because I am
5	firm X's dealer, okay?
6	So, what is the evidence for this -- how this
7	works, okay? Is there any evidence to suggest that this
8	works? Well, you know, "can you hear me now" doesn't
9	necessarily need to be Verizon's slogan, it also should
10 </