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1

1UNITED STATES FEDERAL TRADE COMMISSION

2and

3UNITED STATES DEPARTMENT OF JUSTICE

4

5

6SHERMAN ACT SECTION 2 JOINT HEARING

7UNDERSTANDING SINGLE-FIRM BEHAVIOR:

8BUSINESS HISTORY SESSION

9BUSINESS STRATEGY SESSION

10Thursday, October 26, 2006

11

12

13HELD AT:

14UNITED STATES FEDERAL TRADE COMMISSION

15HEADQUARTERS BUILDING, ROOM 532

16600 PENNSYLVANIA AVENUE, N.W.

17WASHINGTON, D.C.

189:30 A.M. TO 4:00 P.M.

19

20

21

22

23

24Reported and transcribed by:

25Susanne Bergling, RMR-CLR

2

1MODERATORS:

2KENNETH L. GLAZER

3Deputy Director, Bureau of Competition

4Federal Trade Commission

5and

6EDWARD D. ELIASBERG

7Attorney, Antitrust Division

8U.S. Department of Justice

9

10PANELISTS:

11Morning Session:

12Tony Allan Freyer

13Louis Galambos

14James P. May

15George David Smith

16

17Afternoon Session:

18Jeffrey P. McCrea

19David J. Reibstein

20David T. Scheffman

21George David Smith

22

23

24

25

3

1C O N T E N T S

2

3MORNING SESSION (BUSINESS HISTORY SESSION):

4

5Introduction

6Presentations

7     Tony Allan Freyer

8     Louis Galambos

9     James P. May

10     George David Smith

11Moderated Discussion

12Lunch Recess

13

14 AFTERNOON SESSION (BUSINESS STRATEGY SESSION):

15

16Introduction

17Presentations

18     Jeffrey P. McCrea

19     David J. Reibstein

20     David T. Scheffman

21     George David Smith

22Moderated Discussion

23Conclusion

24

25

4

1P R O C E E D I N G S

2- - - - -

3MR. GLAZER: Good morning. My name is Kenneth

4Glazer, and I am the FTC's Deputy Director for the

5Bureau of Competition. I am one of the moderators for

6this morning's session. My co-moderator is Ed

7Eliasberg, Antitrust Division, U.S. Department of

8Justice.

9A couple of housekeeping matters before we get

10started. First of all, please turn off all cell phones,

11BlackBerries or other electronic devices or turn them to

12vibrate. The men's room is immediately to the left,

13through the double doors you just came through; the

14women's room is to the left on the far side of the

15elevator banks.

16One safety tip, in the unlikely event the

17building alarms go off, please proceed calmly and

18quickly as instructed, and you must leave the building

19through the stairway, which is to the right, which is

20the Pennsylvania Avenue side. After leaving the

21building, please follow the stream of FTC people. They

22have practiced this many times. You will all go to the

23Sculpture Garden, which is across the intersection of

24Constitution Avenue.

25Finally, we request that you not make comments

5

1or ask questions during the session. Thank you.

2This morning's panel is entitled Business

3History, and as the title suggests, we will be turning

4the clocks back today and looking at some of the

5landmark monopolization cases in the past, not the

6recent past, as in the Microsoft case, but antitrust's

7deep past, milestone cases such as Standard Oil, Alcoa,

8American Tobacco and AT&T. Like the ghosts of Christmas

9past, the ghosts of antitrust past continue to haunt us

10in good ways and bad.

11We have come a long way since those cases, to be

12sure. In many ways, antitrust in the Sherman 2 area,

13the area of unilateral conduct, is still coming to grips

14with the issues faced by the courts in those cases,

15which dealt with the industrial giants of their day.

16Think, for example, of Learned Hand's Alcoa

17decision and how to this day his enigmatic

18pronouncements in the Alcoa case are still invoked and

19debated. Think of "monopoly thrust upon it," "superior

20skill, foresight, and industry," and "the successful

21competitor, having been urged to compete, must not be

22turned upon when he wins."

23Take Standard Oil. One historian's view of the

24record in that case, the Standard Oil case, led to a

25complete rethinking of the whole area of predatory

6

1pricing. Anyone who thinks history is unimportant

2should look at John McGee's article on Standard Oil and

3the impact it had on the case law.

4To help us understand this critical part of our

5antitrust heritage, we are honored today to have with us

6four distinguished business and legal historians. Our

7panelists this morning are Jim May from the Washington

8College of Law at American University; George Smith from

9the Stern School of Business at New York University;

10Louis Galambos from the Johns Hopkins University; and

11Tony Allan Freyer from the School of Law at the

12University of Alabama.

13Ed, do you have any introductory comments you

14would like to make?

15MR. ELIASBERG: Thanks, Ken.

16Let me just second how important the Antitrust

17Division thinks it is for us to take a look back at

18these major monopolization cases of the past, so with

19that, let me turn it back to you again so we can get

20started.

21MR. GLAZER: Thanks, Ed.

22So, at this point, let me introduce our first

23speaker. Jim May is a law professor at the Washington

24College of Law at American University, where he teaches

25antitrust, U.S. legal history. He was an attorney with

7

1the Antitrust Division and senior staff assistant to the

2National Commission for the Review of Antitrust Laws and

3Procedures. He is the author of many law review and

4other articles on the historical foundation of U.S.

5antitrust law. He is about a year away from completing

6a book entitled Standard Oil Company Versus United

7States, the Supreme Court, and the Foundations of a New

8American Society, which will be published by the

9University Press of Kansas.

10Complete biographical information for each of

11the four speakers can be found on the FTC and DOJ

12Antitrust Division Sherman Act Section 2 web sites.

13Now, I will turn it over to Professor May.

14DR. MAY: Well, I am very pleased to be here

15this morning with everyone and to be part of this very

16distinguished panel, and I want to thank Ed and Ken and

17Jack and Jim and everyone who has been responsible for

18pulling this session together.

19This morning we are talking about insights to be

20gained from historical scholarship, and I am not going

21to talk at length about that, but certainly we know that

22there are many. There are benefits for better

23understanding the past in its own terms, some having

24considerable value, but also better insight in our

25thinking about modern day issues. History often

8

1provides a useful point of comparison or contrast or a

2source of additional questions and perspectives we might

3not consider otherwise, and it can help to inform modern

4decision-making in a variety of ways.

5Historical writing comes from people from a

6variety of different disciplines and backgrounds, as

7well as a variety of personal perspectives, business

8historians, legal historians, intellectual historians,

9economists, legal scholars, and others, and all of this

10work can be very valuable to take into account and to

11compare one with another.

12When we talk about the potential value of

13looking back at early episodes and periods of antitrust

14law in particular, as Ken has said, there is much to be

15learned, and particularly much convincing to convince

16people in the antitrust field that looking at the

17Standard Oil story may, in fact, be of some value in

18thinking about antitrust law, where it has been, how it

19got here and where we are today.

20Now, in his landmark book, The Antitrust

21Paradox, in 1978, Judge Robert Bork famously remarked

22that one of the uses of history is to free us from a

23falsely imagined past. Understanding antitrust's past

24better allows us to understand more clearly how many of

25the ideas that are currently in the mainstream first

9

1came to be established in antitrust law. At the same

2time, for example, historical understanding, I think,

3provides insight into how early antitrust thinking was

4not merely a less sophisticated early form of

5neoclassical economic thought, how variations from

6modern economic analysis that we find in earlier

7antitrust analysis do not merely reflect the power of

8"non-economic" concerns uninformed by any systematic

9theoretical approach, and a look to the past also can

10give us insight into how much of early antitrust debate,

11legislation, lawyering, and judicial decision-making was

12influenced by a different kind of theoretical outlook,

13an outlook that embraced as a part of, and not simply

14alongside of, its economic analysis, simultaneous

15concerns for individual opportunity, freedom of

16contract, efficiency, economic progress and prosperity,

17fair distribution of wealth, and political freedom, all

18to be promoted through a process of largely

19"non-discretionary" judicial decision-making, it was

20still widely thought, in the late 19th and early 20th

21Centuries.

22Such an outlook, still widely if not universally

23influential at the time of the Standard Oil decision, of

24course, today runs deeply counter to antitrust thinking

25across the entire spectrum of antitrust opinion. Modern

10

1antitrust thinking assumes the inevitability of

2trade-off choices among these various values and is

3influenced strongly by a modern economic paradigm or

4paradigms distinctly different from the broader

5theoretical outlooks most familiar in the late 19th and

6early 20th Century lawyers and judges.

7Okay, but that having been said, I want to talk

8about something else this morning, and that is a

9different set of issues arising in connection with the

10rise of the Standard Oil combination and the federal

11antitrust case brought to challenge it. This is a very

12big topic, indeed, and a very great deal has been

13written about it, and in the very brief time I have this

14morning, I am just going to try to suggest some of the

15most important themes in the historical record and in

16the scholarship assessment. If we have time this

17morning in the discussion period to go into more depth

18as to some of these points, I will be happy to try to do

19so.

20Okay, well, with regard to the ascent of

21Standard Oil and the challenge to it by the Federal

22Government, well, to begin with just a single small

23refining plant established in Cleveland, Ohio in the

24mid-1860s, John D. Rockefeller and his associates,

25within a remarkably short period of time, came to

11

1dominate both trade in refined petroleum products and

2the long distance pipeline transportation of crude oil.

3Exactly how that was accomplished was a subject of

4considerable controversy in the late 19th and early 20th

5Centuries, and it has continued to be ever since.

6As we know, Standard rose to dominance before

7the era of the automobile, and thus, its main product in

8the era that we are talking about was not gasoline, but

9was kerosene for illumination in homes and businesses,

10but there were other important products as well, such as

11lubricating oil and naphtha.

12Now, within just a few years of Rockefeller's

13entry into oil refining, he and his associates were

14heavily involved, along with the railroads that were

15serving the oil fields of Northwest Pennsylvania, in

16efforts to establish cartels to reduce production and

17raise and stabilize prices.

18By 1871 -- oh, here, I have a few pictures

19that -- this is in 1870. This was Standard Oil's

20refining operation. It obviously got bigger and much

21more substantial as time went on.

22Now, in the 1860s, on to the 1870s, we have

23these efforts to cartelize refining as well as rear it,

24but by 1871 as well, Rockefeller had embarked on a

25successive campaign to acquire what is called the

12

1competing refiners in Cleveland, Ohio, and not long

2thereafter, disenchanted with the possibilities for

3desirably organizing the oil industry through

4cartelization, Rockefeller and his associates made

5determined and successful efforts to acquire the

6refiners in other parts of the country as well.

7Now, coordination of the operations of the

8various acquired firms was achieved first through the

9trust arrangements of 1879 and 1882, and then more

10effectively, through the 1899 establishment of the

11Standard Oil Company of New Jersey as a holding company.

12Transportation of crude oil to refineries and of

13refined products to market was a crucial dimension of

14the early oil business, and early on, transportation of

15both crude oil and refined products was by rail, and

16critics charged that the railroads had charged Standard

17Oil much lower freight rates than they charged

18Standard's competitors, thereby giving Standard what was

19seen as an unfair competitive advantage.

20Later on, with the development of long distance

21crude oil pipelines that were pioneered by a consortium

22of crude oil producers in the late 1870s, this newer

23mode of transport became the most important method for

24transporting crude oil, and Standard made determined and

25successful efforts to dominate it.

13

1With the discovery of the major new oil field on

2the Ohio-Indiana border, Standard Oil for the first time

3made significant investment in oil lands and crude oil

4production in the late 1880s. Standard Oil aggressively

5expanded forward as well into retail marketing, and as

6of the 1890s, this would have been a ubiquitous site in

7America, the horse-drawn Standard Oil wagons filled with

8kerosene from which the local grocery, et cetera, would

9be getting their fill.

10Now, during the decades following the

11establishment of the first Standard Oil refinery, the

12combination expanded the size of its individual

13refineries to achieve economies of scale, found other

14ways to cut costs, developed an effective managerial

15hierarchy that included talented executives who joined

16Standard Oil after their own firms were acquired and

17developed new by-products from petroleum, yet John D.

18Rockefeller and Standard Oil faced growing public and

19private criticism and in the fear for their dominance

20and for the abusive tactics they were thought to use,

21and as a result, Standard Oil ultimately was challenged

22in numerous states before the federal case was

23litigated.

24In 1882, the trust itself -- the 1882 trust

25itself was dissolved. In the 1890s, in the wake of a

14

1challenge to the participation of Standard Oil's Ohio

2trust, a challenge brought by the Attorney General of

3Ohio. This then led in 1899 to the establishment of the

4Standard Oil Company of New Jersey as the new holding

5company. Seven years later, during the administration

6of President Theodore Roosevelt, the antitrust suit was

7brought.

8Now, Standard's market position we have to look

9at in two different parts with regard to the export

10trade and the domestic trade. In the late 19th Century,

11most refined petroleum that was produced in the U.S. was

12sold overseas, and of that oil, Ron Chernow in his

13recent book Titan estimates that in the late 1880s,

14nearly 80 percent of the refined oil purchased overseas

15came from Standard Oil.

16With regard to domestic trade in oil, by the

17late 1870s, Standard's share of refined oil production

18within the United States was close to 90 percent. It is

19estimated that Standard's market share of crude oil

20production in the United States was a share of one-third

21achieved in 1898. Most of those market shares declined

22in subsequent years.

23Okay, well, what about the antitrust challenge?

24And one of the things that is always great about this

25period, the cartoons of the period, here is the classic

15

1fear of Roosevelt swinging his big stick to bust the

2trusts, here facing down a symbol of Standard Oil in

3this period of the octopus.

4Okay, well, I am going to largely skip over the

5Government's position except to say that the Government

6charged a conspiracy that allegedly had started in

71870 -- oh, the case was filed on November 15th of 1906,

8so we are just short of three weeks away from the great

9centennial of the filing of this case, so hopefully

10there will be both a Division and FTC celebration in

11just a few weeks.

12Okay, the Government's primary emphasis in its

13case was a merger-to-monopoly theory. The predatory

14pricing and other bad acts conduct was much less

15prominent, although also included in the case.

16Now, let us talk about the case in hindsight

17just a little bit, okay? Here is a young John D.

18Rockefeller in the early days of the conspiracy, okay?

19Here are some other things stressed in the case: Market

20shares, profits, alleged increases in prices of

21principal products, okay? But I want to go quickly

22through this.

23Now, the remedy in the case, of course, was

24breaking up Standard Oil. This is not an exact diagram

25of how the breakup worked, neither accurate in its

16

1verticality nor in the number of units involved, but it

2is the best I have. So, in any case, what are we left

3with in the scholarship today about Standard Oil as we

4think about the case in hindsight? A couple of key

5things to note.

6What was right about the Government's position

7in the case? How might the case be approached

8differently today, informed by historical as well as

9economic learning? Some things seem clear. A modern

10Sherman Act case would be unlikely to focus on a

11defendant's market intelligence gathering or the

12operation of bogus independents, as the Government did,

13in part, and likely would place less reliance on

14evidence of increased profitability. Analysis of merger

15activity, predatory pricing and barriers to entry would

16be more sophisticated today than it was in the earlier

17years of the 20th Century, although merger to monopoly

18essentially would remain at the heart of the case. More

19consideration would be paid today to potential economies

20of scale and other efficiencies, and in hindsight, more

21careful attention would be paid to the question of what

22would be an appropriate remedy in the case.

23I have things I can say about the remedy, but we

24are short on time. I will save that for the discussion

25session in case there are questions about that.

17

1Okay, now, what about the scholarship on the

2rise of Standard Oil and the question of remedy? Well,

3it is very striking the degree to which -- there is

4actually some vigorous disagreement about what we would

5think might be some very basic issues, such as was

6Standard Oil, in fact, a monopolist? And if a monopoly

7had been achieved, a monopoly of what? Pointing to

8increasing output and falling prices for refined

9petroleum products in the late 19th Century, Dominic,

10Arendt and Connell, for example, has concluded that

11Standard Oil never reached or set monopoly prices, even

12when it had a high market share, and "Standard was a

13large competitive firm in an open competitive market," a

14position that has been strongly challenged by, for

15example, Professor Scherer in a draft paper he presented

16in an earlier hearing session in this series.

17Elizabeth Granitz and Benjamin Klein in their

181996 article contend that entry into refining was made

19easy in the late 19th Century and assert that "although

20Standard earned a significant share of industry profits

21on its dominant refining operations, it was petroleum

22transportation and not refining that was monopolized,"

23and that "the profits earned by Standard in refining

24should be thought of as merely a share of the monopoly

25profits from the transportation cartel." Others

18

1continue to believe that at least until the early years

2of the 20th Century, it was possible to acquire monopoly

3power in the sale of refined petroleum products and that

4Standard Oil did so.

5What is the state of thinking about the sources

6of Standard Oil's profits? Today we have not one but a

7number of prominent interpretations. Let me just say a

8real brief word about some of these, and then maybe I

9can expand later.

10One is economies of scale or other efficiencies.

11Alfred Chandler, an eminent business historian, has

12declared that oil refining is a prime example of an

13industry in which cost advantages of scale critically

14shape the growth of firms and determine the structure of

15the industry. He notes that the Standard Oil Company

16was one of the first enterprises in the world to exploit

17the economies of scale by making the three key

18interrelated investments in production, market and

19management.

20Others have pointed to other varieties of

21efficiency achieved by Standard Oil as significant

22contributors to its success. On the other hand, others

23have questioned at least the magnitude of some of the

24efficiencies claimed by Standard Oil.

25A second explanation has again focused,

19

1understandably, on the large number of mergers and

2acquisitions, either coerced or uncoerced, that Standard

3Oil is seen to have engaged in.

4Another major area that Ken already alluded to,

5of course, is predatory pricing, and it was noted by the

6United States in the briefs but not central to its

7theory of the case, it was famously debunked by John

8McGee in his 1958 article reflecting the influence of

9Aaron Director at the University of Chicago. McGee we

10know declared the claims of predatory pricing in the

11Standard Oil case were neither in theory nor by direct

12evidence, but scholarly commentary since McGee's article

13has been split on whether Standard Oil may ever have

14engaged in predatory pricing, and, if so, how much this

15may have contributed to its acquisition or maintenance

16of monopoly power.

17Okay, Elizabeth Granitz and Benjamin Klein, in

18the article we mentioned previously, have presented a

19much discussed thesis embracing a raising rivals' cost

20interpretation of Standard's power, and this

21interpretation is, as we know, that it was

22transportation, not refining, that could be monopolized.

23The railroads wanted some help with enforcing a cartel

24among railroads. They had an incentive to want Standard

25Oil to have a large volume of shipments that could be

20

1moved around among the railroads to enforce compliance

2with the railroads' cartel agreement, so that the

3railroads were happy to let Standard Oil be in a more

4dominant position in refining to serve that function. I

5am happy to talk about that more at greater length, too.

6Okay, now, I think that we do not need much

7convincing to think that people in the antitrust field

8look to Standard Oil in a variety of ways, as a symbol,

9and as a detailed case record to be examined as new

10theories of antitrust action become prominent; thus, as

11Aaron Director had articulated a very different approach

12to predatory pricing, it is not entirely surprising that

13John McGee comes up with an article looking back at

14Standard Oil and drawing an explicit moral, which is we

15cannot get Standard Oil wrong, says Professor McGee,

16because it can be taken to stand for the wrong

17proposition, that what we should be looking out for is

18unilateral abusive conduct by dominant firms, and if we

19got it wrong in the first place about Standard Oil, we

20should not be paying that much stress to that behavior.

21We should be worried about group behavior than

22unilateral behavior.

23Similarly, at a time when theories of raising

24rivals' costs have become prominent in antitrust law, we

25get an article reflecting those ideas and trying to

21

1compare them to the extensive record in the Standard Oil

2case in the Granitz and Klein article, and again,

3drawing an explicit moral, saying the Standard Oil case

4tells us that this is a valid kind of theory, but

5warning -- take it only so far and not further. Take it

6only so far as situations where there is a horizontal

7agreement upstream, and worry about the horizontal

8combination aspect, not the vertical aspect.

9Well, I will stop there since I am about out of

10time. There is much for us to mine and give serious

11consideration given the scholarship on Standard Oil and

12the federal challenge to it, and historical scholarship

13relating to American business, the economy and antitrust

14law in general, and again, I thank you very much for

15organizing this event and look forward highly to

16discussing these possibilities.

17(Applause.)

18MR. GLAZER: Thank you very much, Professor May.

19Our next speaker is George Smith. He is a

20Clinical Professor of Economics and International

21Business at the Stern School of Business at New York

22University. Among the courses he teaches at Stern is

23U.S. business history. He is the author of From

24Monopoly to Competition: The Transformations of Alcoa,

251888 to 1986, and was co-author with Frederick Dalzell

22

1of Wisdom From the Robber Barons. He has a book coming

2out again called The Concise History of Wall Street.

3Professor Smith?

4DR. SMITH: Thank you. Good morning. I am

5delighted to be here.

6I am not going to repeat what Jim said about the

7value of history. As an economist, or at least someone

8who teaches economics, I am going to assume that you

9already understand that, but suffice it to say that I am

10going to deal with the case history here, and one of the

11things that historians bring to the party is that

12through our studies, we get very much involved in what

13we would call "the nonrational" or "the extraeconomic"

14aspects of policy and its enforcement, and we also worry

15about the consequences of particular decisions and

16actions and can reflect on those. It is hard to

17generalize from one case study, but an accumulation of

18case studies over time might be useful in guiding policy

19in the future.

20This is the Alcoa case, which, of course, is a

21famous, if not notorious, case in antitrust law, and I

22am also going to assume that all of you at some point in

23your education have read, if not in its entirety, at

24least some excerpts from the decision written by Judge

25Learned Hand. My understanding is that the Alcoa case

23

1is a staple of law school education.

2The Alcoa case, of course, describes one of the

3important boundaries of the law in antitrust with

4respect to size and power and market dominance, and it

5is important for that reason. I am going to take you a

6little bit through the Alcoa history, the history of the

7case, but I want to focus most importantly on the

8remedies and some of the consequences of the remedies.

9Let's begin with Alcoa in 1937. This is Alcoa's

10market share in 1937. It is pretty good, you know,

11having 100 percent of the market in your core

12businesses, aluminum production, extracted from aluminum

13oxide, or alumina, also a big capital-intensive

14business. Alcoa also controlled the critical imputs, in

15this case the bauxite ore and alumina, at 100 percent

16market share, in what we quaintly describe as the U.S.

17market. Remember the days when the U.S. market was the

18only relevant market? Right? Alcoa had 100 percent,

19that is pretty good!

20It also had robust positions in downstream

21markets in various aluminum semifabricated and end

22products, as you can see from the table on the right.

23Suffice it to say that Alcoa was a sitting duck for the

24antitrust lawyers in the second Roosevelt Administration

25who were mounting a rather frontal assault on big

24

1business in the late 1930s.

2Alcoa is, of course, one of the great

3Chandlerian firms, and like Standard Oil, managed to do

4business by not only achieving economies of scale and

5scope but by bringing the prices of its product

6consistently down in order to expand its markets. In

7that sense, it was a rather good and benign monopoly.

8Some of the practices it engaged in, in order to

9build that monopoly, would now be considered to be

10somewhat dubious if not outright illegal, but the

11company managed during a period of time -- when it had

12what looked like a controlling patent in the aluminum

13smelting process -- to achieve substantial scale

14economies and was integrated completely from the

15extraction of the ore from the mines all the way down to

16the production of end products, which was a completely

17self-sufficient enterprise, and in the process, Alcoa

18created substantial barriers to entry that nobody was

19able to penetrate in the production of primary aluminum.

20Alcoa secured its position with the help --

21although not exclusively -- of some exclusive contracts

22with suppliers of scarce inputs, like hydropower,

23bauxite, alumina, and developed its own research and

24development capabilities with respect not only to the

25technology, but also the science of metallurgy, and

25

1built one of the great industrial laboratories in the

2first half of the 20th Century.

3Alcoa also relied, of course, on the U.S.

4Government to keep tariff protection high enough to

5restrain imports, and it established operations in

6Canada, which proved to be very useful for managing

7relations with cartels, European cartels, which strictly

8divided markets along national lines and relegated the

9North American market to the Canadian company, a market

10that was, in fact, serviced by Alcoa.

11During the period of time that Alcoa was

12building its monopoly, it was constantly reducing its

13costs and prices in order to establish markets and built

14its markets largely by taking share away from other

15metals, other substances, copper, nickel, iron and

16steel. By World War I, there were no new entrants in

17primary production. One French firm had attempted to

18enter, but when World War I broke out, it left the

19field.

20It is not that Alcoa was left alone. Alcoa was

21always in the cross-hairs of the Department of Justice

22and later on the FTC. In 1911, it was subject to an

23antitrust investigation, and Alcoa agreed to cancel all

24its exclusive supply contracts, to refrain from directly

25participating with foreign cartels. The Canadian

26

1subsidiary continued to do so but apparently with the

2blessing of the Justice Department for some years to

3come. Alcoa also agreed to refrain from such downstream

4practices as price discrimination, and market

5allocations of aluminum products.

6In the 1920s, Alcoa went through a rather

7lengthy and continuous investigation from the Federal

8Trade Commission. Reports were written, but no action

9was taken, but this led to an awful lot of bad

10publicity, and then Alcoa was subject to a lot of

11private antitrust suits from customers, the most

12important of which was a case known as Baush v. Alcoa,

13which went through two trials, two sets of appeals, and

14wound up being settled out of court. It was a

15price-squeezing issue.

16In 1937, Alcoa was charged with violating the

17Sherman Act, it reflected a big policy shift in the

18Roosevelt Administration, the second Roosevelt

19Administration. Alcoa at that time, as I mentioned

20before, was a real sitting duck for the Justice

21Department. It was a monopoly, it had a poor public

22image, it had the misfortune of being closely tied to

23Andrew Mellon, who was a great scapegoat for the Great

24Depression. The accumulation of antitrust

25investigations over a period of time had also made it a

27

1likely target. So, it was charged with the usual

2kitchen sink of antitrust violations in 1937, but as

3luck would have it, Alcoa wound up with a trial judge

4that it liked, Judge Caffey, in the U.S. District Court

5for the Southern District of New York, and this is where

6some of the interesting stories begin.

7It turns out Alcoa had a superb trial lawyer

8 named William Watson Smith who led the defense of its

9case. He was an older gentleman who had read the law --

10that is how he learned the law -- and he and Judge

11Caffey seemed to have bonded very nicely in the

12courtroom. Irving Lipkowitz, who was the economist for

13the DOJ at the time, and who sat through the entire

14trial, described the situation as follows: "The judge

15and Mr. Smith were the old guys. They had wisdom. They

16had judgment. And we had a bunch of kids over here,

17scurrying around..." Right! He also recalled that

18Smith was very prone to calling the DOJ lawyers boy

19scouts during the trial, and the Judge never bothered to

20intervene.

21The Judge, however, as this trial went on -- it

22turned out to be the longest trial in Anglo-American

23history -- the Judge got rather angry and impatient, and

24I think he essentially blamed the Justice Department for

25this trial. In any case, Alcoa was able systematically

28

1to refute -- through their expert witness and company

2witnesses and through its own presentation of the case

3-- all of the behavioral charges brought by the Justice

4Department, and Arthur Vining Davis, the Alcoa chairman,

5delivered rather stunning, persuasive testimony over a

6period of time. In the end, the Judge, of course, ruled

7in favor of Alcoa on the grounds that it had built a

8good business, it had brought prices down, and it, in

9 fact, fell within the rule of reason as a benign, good

10trust.

11Of course, the Justice Department announced its

12intention to appeal, and Judge Caffey said, great, get

13it out of my room courtroom! That is what they did. Of

14course, the appeal languished during World War II, when

15the Government had no interest in disturbing the

16operations of businesses that were supplying critical

17war material, but in 1944, the appeal was heard

18following an Act of Congress, which enabled the U.S.

19Court of Appeals in the Second Circuit to hear the case

20in lieu of the Supreme Court because too many of the

21Supreme Court Justices had conflicts of interest in this

22 case.

23In the meantime, a number of important things

24happened in the industry environment. As the war geared

25up in 1941 -- as the United States was preparing for

29

1war, it became apparent that Alcoa, as dominant as it

2was in the industry, was not going to be able to meet

3aluminum demand for military operations, and so the

4Government financed the building of primary aluminum as

5well as fabricated aluminum plants, and effectively

6doubled U.S. aluminum capacity between 1941 and 1943.

7Alcoa, of course, built and managed all these

8plants, but at the same time, it opened the door for new

9entrants in primary production. And as the war wound

10down, it was quite clear that Alcoa managers were

11anticipating that they were going to face some

12competition in all sectors of the aluminum markets.

13Then there was the great opinion written by

14Learned Hand in 1945 (I have extracted some of the

15quotes here), in which he entirely rejected the idea

16that the monopoly of Alcoa had been thrust upon them or

17was inevitable, and he also rejected the doctrine of the

18rule of reason. It was quite clear that Learned Hand,

19through some rather sophisticated economic thinking,

20determined that Alcoa simply had too much market power

21and was thereby forestalling possibilities for

22innovation and long-term price competition.

23He writes in his opinion in very beautiful

24prose, "It was not inevitable that it [Alcoa] should

25always anticipate increases in the demand for ingot and

30

1supply them, to keep doubling and redoubling its

2capacity. We can think of no more effective exclusion

3of competitors than progressively to embrace every

4opportunity as it opened, and to face every newcomer

5with new capacity already geared into a great

6organization, having the advantage of experience, trade

7connections and the elite of personnel."

8Now, I teach in a business school. This is what

9we try to teach our students how to do!

10"Having proved that 'Alcoa' had a monopoly of

11the domestic ingot market, the plaintiff had gone far

12enough; if it was an excuse that 'Alcoa' had not abused

13its power," and he found no evidence that it had, "it

14lay upon 'Alcoa' to prove that it had not. But the

15whole exercise is irrelevant anyway, for there is no

16excuse for 'monopolizing' a market that the monopoly has

17not been used to extract from the consumer more than a

18'fair' profit." It was all beside the point! The whole

19decision can be reduced to this single paragraph.

20And then, in what seems on the surface like a

21wildly nostalgic passage -- although I think in

22retrospect I would argue that what he was really trying

23to do was establish what the thinking of Congress was in

241890 when it passed the Sherman Act -- Judge Hand says,

25"Congress did not condone 'good trusts' or condemn 'bad'

31

1ones; it forbade them all," which is saying if you want

2to change the law, change the law, change it, but I

3cannot do anything about it. "It is possible to prefer

4a system of small producers, each dependent for his

5success upon his own skill and character," and so forth.

6Now, from the point of view of Alcoa, of course,

7this looked like a superb exercise in reductionist

8reasoning, and Leon Hickman, who was an attorney on the

9case for the defense, a gentleman in his nineties when I

10interviewed him, looked back at this case and said, "I

11can see why Judge Hand felt that no matter how we got to

12where we were, that it was not in the public interest.

13If you kept that in mind, then you worked back from

14that. 'What do I pin on them?' The fact that we were

15the first in every market that we opened up.

16"But suppose that we had acted as a monopoly is

17supposed to act, and we simply sat back and took our

18profits and had not developed the market? You would say

19now that there is a monopoly of action. There is a

20great need for new markets and the uses for aluminum and

21you are not meeting it. So, in a way, from his

22approach, we had no escape. He'd get us either way."

23What was the remedy? Well, obviously one

24potential remedy was to break up the company, but

25fortunately, there were all these government plants

32

1sitting there from World War II, and Judge Hand thought

2this might be a good remedy, and Stuart Symington, who

3had been the CEO of Emerson Electric and eventually a

4Senator from Missouri, was head of the Surplus Property

5Board, and through a lot of painful negotiations, he

6managed to persuade Alcoa to allow the Government to

7sell off these plants in a fire sale into two would-be

8competitors, Kaiser and Reynolds Corporations, so that

9they could establish themselves as fully integrated

10aluminum producers. And part of the deal was that Alcoa

11would license critical patents in technology to these

12companies, free of charge.

13In a subsequent court ruling, Aluminum Limited,

14which was Alcoa's Canadian affiliate, was effectively

15spun off as the shareholders in both companies had to

16unwind their position in one or the other, so that there

17would be no longer any issues about participating in

18cartels.

19Now, my concern in writing the book was to look

20at the impact of this decision on Alcoa's behavior, and

21here is where things get really interesting. There were

22a number of consequences to the remedies which I think

23are worth thinking about today. There is no question

24that once this oligopolistic industry structure was

25established, there was a lot greater competition in

33

1developing new products, especially end products. This

2was largely due to the efforts of Reynolds, which had a

3particularly high sensitively to end markets, so all

4kinds of new aluminum products appeared, everything from

5baseball bats to aluminum cans in which you drink your

6beer and your soda pop, and aluminum siding and so

7forth, and that was probably an okay thing.

8But it is also quite clear when reading the

9testimony of congressional hearings that throughout this

10period, aluminum prices, both for primary aluminum and

11probably many downstream products, might have been

12higher than they needed to be, because Alcoa always had

13to keep a pricing umbrella over its less efficient

14competitors to ensure that they stayed in business.

15Alcoa worried about this a lot, and there was lots of

16internal documentation of this. Alcoa had an economist

17named Stanley Malcuit who wrote extensively about how

18Alcoa conducted its pricing operations. The idea was to

19keep prices low enough to ensure that demand would grow

20but high enough at the same time to ensure that the

21competition would stay in business, and these prices

22were administered through conventional oligopolistic

23price signaling.

24A couple of things that probably people did not

25understand very well was that the Alcoa Laboratories,

34

1which had been a great scientific laboratory -- very

2productive in advancing the fundamental science in

3metallurgy and its related chemistry -- saw its focus

4change after the war. The laboratory replaced its

5scientists with more engineers, focused on short-term

6process and product engineering. It withdrew from the

7academic community -- where it had traditionally worked

8closely with universities, participated in conferences,

9gave papers and so forth -- and it became more

10secretive.

11It began to rely more on trade secrets as

12opposed to patents to protect its technology, and it is

13quite clear that although Alcoa had a store of

14fundamental knowledge it could draw on by the 1950s, by

15the mid-1960s, early 1970s, that fundamental knowledge

16was pretty well depleted, and Alcoa and the industry as

17a whole became less technologically innovative.

18And finally, the management of Alcoa during this

19period spent probably an inordinate amount of time, if

20not most of its time, worrying about complying with the

21antitrust remedies. Alcoa remained under court

22jurisdiction all the way through 1957, and the business

23of Alcoa's top management was to make sure that the

24company was in compliance, and so long-term planning and

25fundamental thinking about resource allocation took a

35

1back seat to these considerations, and there is some

2question as to whether that was, again, good or bad for

3the industry.

4I think the larger question I would raise here

5and something I hope we can discuss subsequent to the

6presentations today -- is how much do policy-makers and

7attorneys who bring cases or actions think about the

8second and third-order consequences of remedies? I

9know, obviously, there is a long history of economic

10analysis and the evolution of economic analysis as it

11applies to antitrust and the thinking of the FTC and the

12Department of Justice. But in recent years, as

13antitrust seems to be increasingly focused on changing

14firm behaviors as opposed to looking for structural

15remedies in a global economy, I would just like to

16suggest that new methods in game theory and futuristic

17planning scenarios might be better incorporated into the

18way antitrust lawyers think about remedies and the

19possibilities of what might occur pursuant to their

20implementation.

21So, I will leave it there, and we will turn it

22over to Lou.

23(Applause.)

24MR. GLAZER: I will introduce Lou. Our next

25speaker is Louis Galambos. He is a Professor of History

36

1at John Hopkins University, has written extensively on

2the historical development of America's

3telecommunications system. His publications include

4Competition and Cooperation, The Role of Innovation in

5the Modern Bell System, and Anytime, Anywhere, a study

6of early wireless development.

7Professor?

8DR. GALAMBOS: Now, as you have already figured

9out, you cannot talk about business history without

10talking about Alfred D. Chandler, Junior. His books are

11very long, and so I will try to give you a very short

12explanation. His books are kind of chest-crushers. If

13you read them and you fall asleep, they come down on you

14and hurt, so I will try to give you a little bit on Al

15and what he did to the history of business.

16When he started his career after the Second

17World War, at that time, the dominant historical

18paradigm for business, which was very closely attuned

19with the view of the Department of Justice and later the

20FTC, was provided by Matthew Josephson, who was the

21author of a very popular book called The Robber Barons.

22It had a lot of personality, you know, like the columns

23on the two sides of the Wall Street Journal, a lot of

24personality there and a lot of quotes. It was published

25in the depths of the Great Depression, and it focused on

37

1scoundrels who ran and robbed corporations and the

2American people.

3In the years that followed, business historians

4responded to that by trying to show that the scoundrels

5were really good guys. This has also been done in

6women's history, it is called worthy woman history, so

7the business leaders were really doing a whole lot, and

8it was great for America, and they were builders, not

9robbers.

10Chandler set out to develop a new context for

11business history, and by the time he retired, he is now

12Professor Emeritus at the Harvard Business School, he

13had achieved that. He and his students had established

14a new context for looking at business.

15Now, Chandler built and constructed this on the

16basis of two bodies of theory, one of which you have

17heard about and one of which you have not. One was a

18sociological theory stemming from Max Weber through

19Talcott Parsons' study, and the other is Joseph

20Schumpeter's theory of modern capitalism. He changed

21both of these. Probably most people don't read

22Schumpeter, but they have heard of creative destruction,

23which you see often in newspapers.

24I once lived in Texas, where they condemned

25Joseph Schumpeter because he had once been in a

38

1socialist government. They never bothered to read him.

2He was a great friend of capitalism.

3What Chandler did was he built up a dynamic,

4comparative history of the role of large corporate

5enterprise and tracked its progress in the early 19th

6Century through the end of the 20th, and he used the

7idea of Schumpeterian entrepreneurship, but he looked to

8organizational capabilities rather than heroic

9individuals. The organizations that were successful

10over the long term, he said, were those that made the

11vital three-pronged investments in an effective

12managerial hierarchy, in mass production, and in mass

13distribution, and most of the large second industrial

14revolution firms he looked at combined those two

15functions, combined distribution and mass production.

16Chandler left no doubt about the positive impact

17of large enterprise over the long run, and I quote, "the

18modern industrial enterprise played a central role in

19creating the most technologically advanced,

20fastest-growing industries of their day. These

21industries...were the pace setters of the industrial

22sector of their economies -- the sector so critical to

23the growth and transformation of national economies into

24their modern, urban industrial form."

25He did this in very careful, meticulous,

39

1historical studies, the first of the United States, then

2a comparative study with Germany and the United Kingdom

3added, then finally, near the end of his career, he

4brought Japan into the picture and a list of other

5countries.

6The Chandlerian construct became linked very

7closely to developments in two other disciplines that I

8just want to mention. In economics, Richard Nelson and

9Sidney Winter developed an evolutionary theory of

10economic change and tried to bring in dynamic elements,

11all right, as opposed to comparative static or static

12analysis of the neoclassical kind of equilibrium

13analysis. Their effort carried them from theory into

14history, from a discussion of national innovation

15systems, a great book that you might want to look at,

16into the sources of industrial leadership. This left

17them close to the context in which Chandler was working,

18as did the work done in transactions costs economics by

19Oliver Williamson and others. Williamson, like the

20evolutionary economist, was introducing historically

21particular elements to theory, and when you think about

22that, you can see that it does strange things to theory

23when you add history. It was moving it toward a view

24that had very strong historical elements, just as was

25Paul David, who is an economist at Stanford, who was

40

1working on path dependency, which had the same impact.

2All I am suggesting here is that the context in

3which scholars, a large number of them, placed and

4analyzed big business was changing in important ways.

5The comparative static analysis of industrial

6organization theory was co-existing at this time with

7dynamic styles of analysis with important elements of

8place- and time-related history, and they were all

9answering that great question that Coase asks, "Why Are

10There Firms?" If markets are more efficient, why do

11firms exist at all? A great question, all right, and

12there were a lot of new answers developing for that.

13Now, similar changes were taking place at the

14same time in management studies. Management scholars

15were now devoting a lot of attention to the environment

16external to the firm, the aspects of the environment

17that affect the firm's capabilities, and that yielded

18innovation over the long term, and everything I am going

19to talk about touches on this: the difference between

20long-term analysis and short-term analysis, between what

21is called static or comparative statics and secular or

22dynamic analysis of the kind I am talking about. So,

23they looked at how firms responded to drastic changes in

24their technological environment.

25This work added something important to the

41

1Chandlerian concept, because Al had focused most of his

2attention on successful firms. (Aside: he was my

3second mentor; I followed him at Johns Hopkins, took the

4position that he had, did the same things that he did,

5so you should be aware of that.)

6The firms he studied were what are called at the

7Harvard Business School "Chandler firms". They were all

8successful, okay? So, they were very carefully

9selected, all right? And after some of them failed, he

10did not follow them through. He stopped his history at

11when they were successful, had a very strong positive

12element. He also ignored the political history, the

13administrative state. And scholars at business schools

14have, since that time, begun to look seriously at the

15political dimension of the large corporation.

16Now, at the same time that this was happening,

17in the seventies and the eighties and the nineties,

18significant changes were taking place out beyond the

19academy where academic research was being done by

20historians, economists and management scholars. The

21world was changing in a significant way. After the

22breakdown of Bretton Woods and the decisions by the

23leading OECD countries to foster relatively free trade,

24the world entered the second great phase of

25globalization, and along with that came the third

42

1industrial revolution, and these two forces changed

2things in very dramatic ways for the United States and

3for our view of competition.

4Now, that, I believe, is the context in which we

5have to place the antitrust case against AT&T in the

61970s and the subsequent developments that have taken

7place in telecommunications.

8The Bell System had done all the right things

9according to the Chandler paradigm. They had done those

10three things, and really well, okay? They knew that

11aside from Sweden, they were the best telecommunications

12system in the world. They told little telephone jokes:

13that in France, half of the people are waiting for a

14telephone, and they were right, and the other half, they

15said, are waiting for a bell tone. They could make

16these jokes about almost every country. When I went to

17Italy, and this has been in the recent past, the last

18time I was in Italy, I was looking for a touchtone phone

19so I could get on my phone in Baltimore and check

20messages. After looking around, I went into a good

21hotel and I used the only touchtone phone I could find.

22But that still didn't work, and I listened carefully,

23and could hear da-da-da-da. It was a dial phone with a

24touchtone top on it. Italy was far behind and our

25telephone people knew this. They knew that they had

43

1done all of this and done it extremely well.

2Bell had not only done that but created a very

3powerful social ethic to the company; in addition to

4service, it embraced a network mystique in the Bell

5System that pervaded the enterprise. Bell Labs was a

6marvelously creative institution. It had developed

7crucial elements of the modern telephone technology.

8And it is significant that Bell is where the transistor

9came from, out of Bell Labs. This was what created the

10information age.

11In the 1970s, American productivity was drifting

12toward zero. Productivity gains reached zero in the

13beginning of the 1980s. This helps you understand why

14we had political change at that time. Productivity

15increases account for two-thirds of our growth in the

1620th Century, and they were going to zero, and the

17Japanese were doing really well, and the Germans were

18doing really well, and we were doing poorer than the

19British. Could you believe that? We were doing poorer

20than the British. So, we were in trouble, economically.

21So, it was in that context, then, that the case took

22place.

23 The Bell accomplishments I've mentioned

24establish a pretty impressive record, and so it helps

25you understand why AT&T leaders ignored their own

44

1history, because, in part, that history was not in the

2Chandler paradigm. When the modern Bell System was

3being created in the years before World War I and during

4its subsequent history, AT&T had compromised with public

5authority, and in my courses, I always distinguish

6between two kinds of monopolists, dumb monopolists and

7smart monopolists.

8AT&T became, under the leadership of Theodore

9Vail, a smart monopolist. That is why they could

10maintain that monopoly for such a long period of time in

11a country that was opposed to it, all right? They did

12the right things. Their social ethic and their behavior

13and their performance was extremely important.

14But at a crucial point in the early 1970's, AT&T

15forgot about that. It threw down a gauntlet to the DOJ

16and FTC and said, "We are great, and we want to stay

17just like we are." The DOJ picked up the gauntlet,

18brought a suit against AT&T, and by the end of the

19decade, the company's leaders saw they were losing the

20case, losing the federal case in Judge Green's court.

21AT&T settled out of court by breaking up the Bell

22System.

23Now, at that crucial point in the development of

24our telecommunications network, the largest in the

25world, AT&T's leaders and the Government both shifted

45

1gears. Now, they paid too much attention to history and

2too little attention to those two changes that were

3taking place in the global economy; that is,

4globalization, with intense competition, and the third

5industrial revolution.

6The settlement opted for the Chandlerian

7vertically integrated model, with AT&T keeping what was

8then called the Western Electric business and Bell Labs.

9It sacrificed the so-called Baby Bells -- no babies any

10longer -- and the local networks. AT&T gave away the

11mobile phone business it had created! (I have my cell

12phone on. It is on vibrate, I hope yours are, too.)

13So, underestimating the changes that would take

14place from the top to the bottom of the organization,

15AT&T struggled and then failed to implement a successful

16strategy. AT&T failed to make the transition to

17competition and adopted the strategy of convergence,

18which failed. The market worked, and AT&T recently had

19a rendezvous with creative destruction, okay? There's

20AT&T out there, but it is not the historical AT&T we

21have been discussing.

22I probably should not be so harsh with AT&T's

23leaders, because the Government seems to have been

24similarly unmindful of the changes taking place in the

25global economy. There was no consideration in the

46

1antitrust case of the Bell System's efficiency. It was

2ruled out. There was no consideration of the remarkable

3innovations that Bell Labs had produced. I was told by

4somebody at DOJ that if the Government wanted a lab, it

5could build one -- just like that, as if it did not take

630 or 40 years to really create an effective

7institution. You just build one, you know, if you want

8one. That was the attitude.

9There was no consideration of the vast market

10for telecom equipment that was being thrown open to

11foreign suppliers. There was no consideration of

12whether deregulation might not serve the public interest

13better than structural settlements under the Sherman

14Act. There was, instead, dedication to a policy that

15was rooted in the past when the most important market

16was the American market, when American public policy

17could be framed almost entirely in matters of the

18domestic economy.

19Now, subsequent to that decision -- a very

20important one, the United States Government seems to

21have learned faster than did the large integrated

22corporation or the subdiscipline of business history.

23The United States changed its antitrust policy in the

241980s. There were no more structural cases under

25Section 2 of the Sherman Act until the Clinton

47

1Administration launched its attack on Microsoft.

2Fortunately, from my point of view, attention to global

3competition and a need for the United States to remain

4competitive in the world economy seems to have modified

5even the Microsoft settlement in ways that are suited to

6the world we actually live in.

7 This is a different world from the one that was

8at the heart of Chandler's history, and business

9historians have recently begun to come to grips with

10that. There is an important work by Naomi Lamoreaux,

11Dan Raff and Peter Temin who are providing a new

12understanding of business history. This work and

13related studies are shifting the field and helping us to

14understand why in the United States we are spinning off

15and de-integrating firms. As this new synthesis of

16business history suggests, this is a world economy

17rapidly being reconstructed by information technology

18and intense global competition.

19So, my conclusion is twofold: First, do not

20ignore your history or you may suffer, as the Bell

21System did, and Bill Gates almost did, and second, do

22not get locked into an historical model when major

23changes in the political economy are taking place and

24new ideas are needed. And both conclusions bring me

25back, I believe, to an evolutionary model broadly

48

1conceived.

2Thank you.

3(Applause.)

4MR. GLAZER: Thank you, Professor Galambos.

5Our last speaker this morning is Tony Freyer.

6He teaches legal history at the University of Alabama

7Law School. His publications include Regulating Big

8Business: Antitrust in Great Britain and American, 1880

9to 1990, and the recently published Antitrust and Global

10Capitalism, 1930 to 2004.

11Professor?

12DR. FREYER: I want to repeat as my colleagues

13on the panel, I really feel honored to speak before you

14today. In that book that was just mentioned, I spent

15about 13 years interviewing antitrust enforcers around

16the world as well as business people and drawing on the

17scholarship of the members of the panel, and so I am

18grateful to be able to speak and share some thoughts at

19a program like this.

20Also, I was really surprised when I got the

21invitation that there would be attention to business

22history at an enforcement agency, and so I am really

23grateful for the opportunity to say something about

24that.

25What I would like to begin with is to just think

49

1about what do enforcers need to be aware of when it

2comes to history, and I would like to suggest a couple

3of things that historians can provide a view for. One

4is a sense of change, and one is a sense of choices that

5either have been forgotten or ignored and that those

6forgotten sources of change may be useful in

7appreciating kind of the current situation, whatever the

8current problem, in this case dominance, might be

9concerned with.

10So, to do that, I would just like to give you

11two quotes, kind of one way to think about what are

12alternatives to what you have in your mind now as kind

13of the current enforcement options with regard to

14dominance, and the first is a quote from Barry Hawk, who

15we all know is a U.S. merger lawyer who runs the Fordham

16Antitrust Policy Program that is comparative, and he

17said, "for good or ill, we shall have to live throughout

18most of the world with clones of Article 81 and 82.

19That means dominant firms' behavior will be more closely

20scrutinized than would be the case if the Sherman Act's

21Section 2 were the model."

22Eleven years later, the OECD Journal of

23Competition Law and Policy published the results of a

24worldwide survey of all major antitrust regimes. The

25U.S. antitrust regime's core objectives -- the U.S. core

50

1competition objectives were exceptional in that they

2combined solely the achievement of greater economic

3efficiency with promoting and protecting the competitive

4process. So, what did the other major antitrust regimes

5do, all of the other except the few such as the United

6States, they combined the core competition objectives

7with what were called public interest objectives.

8So, the United States is basically the outlier

9when it comes to enforcement in the dominance area, and

10I would like to just suggest that by comparison, there

11may be some choices that might be useful to look at to

12rethink or at least understand our current approach to

13dominance, but at the same time, one of the things that

14comes from this comparative perspective is that those

15regimes, antitrust regimes, have arrived at their

16enforcement policies, that is, including public

17interest, because particularly of the business history

18of their particular countries.

19All right, what I would like to do, first of

20all, just to give you just a very quick comparison of

21two kinds of histories of two antitrust regimes,

22originally I had grand ideas of giving you Australia and

23Japan as well as the EU and the United States, but now I

24am just going to have to give you a couple of thoughts

25about the EU and the U.S. in particular, and hopefully I

51

1can bring up the Japanese and the Australian material

2later on in our discussion.

3What I would like to first of all note is just

4it is helpful to remember, it has come up in the

5discussion, that the U.S. did arrive at its antitrust

6approach because it reflects these ingrained values that

7are distrustful of established authority. Now, what is

8the alternative? What is the alternative to ingrained

9values of the distrusting alternative authority? And

10that is for an enforcement regime to rely upon

11bureaucratic intervention. That is, government is good.

12Government is good, and what we have, and just in the

13antitrust area, it took until after World War II for

14Europe, Australia and Japan and so forth to appreciate

15the degree to which antitrust had become part of

16antitrust intervention in a way that was effective.

17Now, just to give you an illustration of how

18that change took place, I would like to just quote from

19Jean Monnet, who was the founder or father, I guess you

20would say, of European integration, and he described

21American antitrust in this way. Harvard Law professor

22Robert Bowie reconciled American antitrust principles

23with German principles governing the abuse of dominance

24in the Treaty of Paris in 1951 in the European coal and

25steel community, and in that, Monnet argued that Bowie's

52

1reconciliation of the German approach to dominance and

2the American approach to dominance created a new

3alternative, and that alternative was to achieve not

4only market integration, but it was also to achieve

5equality of opportunity within the community, and those

6two goals, integration and equality of opportunity,

7would be the principal goal of the European competition

8policies.

9Now, in 2003, the European economist Matthias

10Pflanz echoed that same thinking, so this is pretty

11current, and let me just read what he had to say about

12 U.S. antitrust policy. He said it is defined primarily

13in terms of ultimate prices paid by consumers, but the

14focus of EU competition policy has been on behavior by

15companies which prevent others from competing on equal

16terms. Thus, the creation of a level playing field

17between actual and potential competitors and across

18different states have been primary objectives of EU

19competition policy.

20Now, during the 1970s and the 1980s, the policy

21of Chicago economics, defining efficiencies,

22particularly in terms of microeconomic price theory,

23came to prevail, and that is what we have today, even

24though there has been kind of modification of in the

251990s, but what I would like to indicate is that the EU

53

1approach, where you have to consider these public

2interest norms, it may provide some useful choices,

3particularly in light of the fact, as we will indicate

4by concluding with Microsoft, that most countries

5outside the United States follow the dominance theory of

6the European Union.

7Now, I have got just two industries I would like

8to look at. One is a traditional industry from an old

9economy, and that is tobacco, and then I will conclude

10with the leading example from computers, and that is

11Microsoft. This is a later American Tobacco case, that

12is in 1946, it is not the famous one of 1911, and what

13that case did, it was the first time the United States

14Supreme Court actually upheld the Alcoa decision.

15 Alcoa, of course, was decided by a Special Appeals

16Court, and a couple of things are interesting to

17remember about the American Tobacco case.

18First of all, it originated at roughly the same

19time as the Alcoa case did itself. We saw that Robert

20Jackson initiated the Alcoa case, and it was, as we will

21see at perhaps some other point, a relevant

22international cartel question, but when -- the

23replacement for Robert Jackson was Thurman Arnold, and

24Arnold was a very activist litigator, and his approach

25to these dominance problems was to try and litigate as

54

1many of them as possible, and one of the firms he chose

2was tobacco, because it had so much prominence as a

3consumer -- as a consumer good.

4Now, what is often forgotten about Arnold is

5that he specifically hired economists to employ and

6develop theories that were of the new economic theory at

7the time, which was an oligopolistic theory pioneered by

8Joan Robinson and E.H. Chamberlin, and what Arnold did

9in the American Tobacco case was to develop an approach,

10a theory to monopoly that would kind of carry through

11with what they subsequently won in the Alcoa decision;

12that is, carry through an approach that uses

13circumstantial evidence to try and prove a conspiracy.

14Now, in the American Tobacco case of 1946, it

15actually had arisen -- Arnold had argued it back in

161939 -- in that case, there was extensive devotion to

17proving the monopoly through circumstantial evidence by

18looking at disparity in prices and what we would call

19various kinds of predatory pricing and this sort of

20thing, and Arnold and his crew were able to put together

21a pretty impressive showing that American Tobacco had

22abused its dominant position, but it was all based upon

23circumstantial evidence using this monopoly theory that

24I have just referred to. In 1946, they won the case,

25and in the process, they established this important

55

1precedent.

2Now, for my purposes, what I would like just to

3indicate is that first of all, what we might take from

4this as an example is that you can talk about Alcoa pro

5and con as a useful theory, but what is also important

6to remember is that both Tobacco and Alcoa were the

7cases in which the procedures to establish the remedies

8in these cases also went from being exceptional to

9becoming the norm, and that is, to establish the rules

10of discovery.

11In both of these cases, as Professor Smith

12indicated, you had these massive records that were

13accumulated, and what is interesting about Caffey's

14decision in Alcoa is that he specifically, of course,

15decided against Alcoa, but what he also did was to say

16that the arguments presented for acquiring the evidence

17I am going to accept; that is, the discovery theories,

18which were new. Jackson and Arnold organized those

19theories, developed those theories, using the

20oligopolistic theory of Robinson and of Chamberlin.

21Now, those theories are the same theories, of course,

22that in the 1970s would be reshaped by the Chicago

23School to use discovery in a new way.

24Okay, that is kind of the American approach to

25tobacco. I would like to give another case that gives

56

1you the European Commission's approach, and this is the

2Philip Morris case of 1987, and the Philip Morris case

3is -- it is very interesting in that it is an American

4firm trying to restructure, move into the European

5market, and it is up against these integration, equal

6opportunity values, public interest values that I have

7just referred to, and this involved Philip Morris

8forming a merger with the Rembrandt Group, which was

9attempting to dominate the tobacco industry in Europe,

10and they established a 50/50 control of RTH, which was

11the Rothmans Tobacco Holdings Company, and that, in

12turn, controlled this Rothmans International, which was

13a subsidiary, and what the Commission was up against was

14trying to decide whether or not these purchases would

15constitute a violation of the dominance theory under

16Article 82.

17What we found in this case was that not only was

18dominance talked about from the point of view of prices,

19but it was also talked about from the point of view of

20these public interest values that were protecting small

21business, protecting regions, this sort of thing, and

22what the Philip Morris case did was to establish a

23precedent within dominance where these kinds of

24financial mergers, this financial restructuring, would

25be a basis for making a judgment on whether or not a

57

1firm was abusing dominance. And what the European

2Commission and subsequently the Court of First Interest

3held was that absolutely, these public interest values

4would be taken into account to decide whether or not

5there had been abuse of dominant position, and in the

6case of Philip Morris, it would amount to a consent

7decree, that it was established to specifically to hold

8Philip Morris and Rothmans to ongoing oversight,

9ongoing, and it is a vigorous oversight, to ensure that

10this dominance has occurred, so it is a bureaucratic

11intervention, but it is to achieve these various public

12interest goals.

13Now, there also are a couple of spin-offs that I

14would just like to indicate as well, and that is from

15Philip Morris, they established what was called a

16decisive influence doctrine, and this is a doctrine

17where even the most minimum kind of influence by a

18subsidiary that has been acquired, even that could be,

19found to be evidence for abuse of dominance if there is

20a threat to these broader public interest values, and in

21addition, the Court of First Instance also applied an

22analysis of microeconomic theory to this decisive

23influence to try and use these kind of investments or at

24least to analyze these kind of investments to see

25whether or not they lead to oligopolistic dominance.

58

1Now, what Philip Morris did in establishing

2 these doctrines, both from the standard of proof as well

3as with regard to the indirect influence, is that the EU

4Commission applied them when it came to Microsoft, and

5in just the last few minutes that I have, I would like

6first of all to draw the distinction between the U.S.

7Microsoft decision and the EU Microsoft decision in

8terms of what are the ultimate values, the ultimate

9outcomes.

10The policy goals in the U.S. Microsoft case was

11to preserve this efficiency that had grown up through

12the internal investment and development of the company,

13and that, of course, was able to preserve the control of

14the web browser. The approach from the European

15Commission was in an effort to try and -- reflected this

16concern for these public interest values and the

17integration, and the outcome there was that the remedy

18was stronger. It required Microsoft to surrender its

19monopoly over the media player.

20And in the process of doing that, both the Court

21of First Instance and the Commission specifically

22recognized the need to uphold these external interests;

23that is, the integration and the public interest values

24as well.

25The claim was that Microsoft or the European

59

1Commission's decision simply was protecting competitors.

2Indeed, the response of the European Commission and then

3later on the Court was that we had a broader range of

4values to be concerned with than efficiency, and I have

5got the quotes from those decisions to uphold that.

6Okay, just in conclusion, then, what I would

7suggest is that in the early Tobacco case, as well as in

8the Microsoft case and in the Philip Morris case, each

9of those reflected different business history contexts

10and also reflected different kind of enforcement regime

11that was concurrent in those times, in that if you look

12at them, they provide kind of a range of choices,

13comparisons, and those comparisons might be helpful in

14formulating current policy.

15Thank you very much.

16(Applause.)

17MR. GLAZER: At this time, we will take a break

18and come back at ten minutes after.

19(A brief recess was taken.)

20MR. GLAZER: Okay, let's resume. Thank you for

21those presentations.

22Professor Galambos, I think you wanted to make a

23couple of general comments in response to the other

24presentations.

25DR. GALAMBOS: Since we are doing history, three

60

1of the industries we have touched on, oil,

2telecommunications and aluminum, have all in the recent

3past reconsolidated. They are reconsolidating in some

4cases along global lines, and I think my own view is

5that we are moving, particularly in commodity

6industries, we are moving relentlessly toward global

7oligopoly, and we do not have any way to talk about

8global markets really very effectively. Most of what we

9work with is national statistics and stuff. That is a

10problem.

11MR. GLAZER: And, George, I believe you also

12wanted to make a comment.

13DR. SMITH: Just one point following that.

14Standard Oil -- well, let me put it this way. The oil

15industry in the world today is only three transactions

16away from establishing the pre-1911 Standard Oil

17Company, so look out.

18And in the aluminum industry, Lou reminded me,

19rang a bell on the Reynolds-Alcoa merger recently. The

20aluminum industry worldwide today is more concentrated

21than ever, but it is also more competitive than ever,

22you know, and aluminum was subject to administered

23pricing, does now appear a commodity and trading in the

24world markets, and that is an interesting point.

25Finally, with respect to these three cases, I

61

1think one thing that makes AT&T exceptional or different

2from the other cases is it was through most of the 20th

3Century a regulated monopoly, and part of what was going

4on in the 1970s was what the Government gives, it can

5take away, right? And as a regulated monopoly, I think

6its behavior was somewhat different from the other two

7companies, which had become monopolies through pure

8market development.

9MR. GLAZER: Okay.

10DR. GALAMBOS: I think that Alcoa, through most

11of its history, judging by George's own history of it,

12was a smart monopolist. I think they did all the right

13things, and so in their case they got into trouble even

14though they were a smart monopolist, but that is how

15tenuous I think it is, to hold that kind of market

16position.

17MR. GLAZER: You think they were a smart

18monopolist, but do you think they did anything that

19today would be judged to be illegal under the antitrust

20laws to achieve or preserve that monopoly?

21 DR. SMITH: Well, sure. No, I certainly --

22MR. GLAZER: No, the question to Professor

23Galambos.

24DR. GALAMBOS: Well, I think they were smart

25insofar as they worked over the long term to be

62

1innovative, to be efficient, to provide consumers with

2what they wanted. They worked closely to develop new

3uses for aluminum, and remember, when they started, you

4know, it was a curiosity, and for a while they sold

5aluminum as jewelry, and so their behavior over the long

6term certainly favored consumers, and in that regard,

7they were a smart monopoly.

8MR. GLAZER: It sounds as though you were on the

9Judge Caffey side of the case, then.

10DR. GALAMBOS: That is right.

11DR. SMITH: If I could just add one point, I

12mean, what all of these enterprises were doing, these

13great Chandlerian, vertically integrated,

14capital-intensive businesses were doing, is they were

15transforming luxuries into commodities. That is how

16they made their money, and in turn, were deriving, you

17know, wealth creation and productivity increases for all

18of society. So, I mean, you know, I guess from a

19business historian's standpoint, these were pretty good

20companies.

21MR. GLAZER: Jim, let me ask you, you touched on

22remedies before, indicated you wanted to say a few more

23things about remedies.

24DR. MAY: Sure, I would be happy to since that

25 is an important issue.

63

1MR. GLAZER: And if you would move the

2microphone up.

3DR. MAY: Oh, sure. Obviously perhaps the --

4you know, certainly one of the most commented upon,

5criticized aspects of the Standard Oil case was the

6remedy. Certainly Justice Harlan was very upset about

7the remedy at the time, as were the progressive

8reformers, and part of the criticism was that the

9dissolution was by way of a pro rata stock distribution,

10so that every shareholder in Standard Oil of New Jersey

11got a proportionate share in every one of the Standard

12Oil companies, and so you ended up with the same set of

13shareholders owning the stock in each of the spun-off

14companies, and it was thought at the time and later that

15tempered the interfirm competitive fervor that might

16otherwise have resulted.

17It is also the case that the spun-off firms were

18not vertically integrated, that they tended to be

19specialized as marketing firms or refining firms, and

20scholars have widely suggested that the remedy also may

21have been in some sense not as harmful as it might

22otherwise have been in the sense that changes were

23already occurring outside of antitrust litigation to

24erode Standard Oil's position.

25There was new intensified competition overseas

64

1with a combination of Royal Dutch and Shell. There was

2new competition from monopoly to oligopoly already

3underway with the discovery of new oil fields in Texas

4and California and new integrated firms arising in the

5wake of those discoveries, and so there has been

6scholarly criticism that first, maybe what really

7changed the industry was not so much the antitrust

8litigation as other changes that were going on anyway,

9and criticism, in addition to the pro rata distribution,

10in that a lot of the old patterns were sort of

11continued.

12The spun-off companies continued to have the

13same geographic market definition among the marketing

14companies as they had before, but on the other hand, the

15scholarly assessment is not completely negative. There

16is a notion that a number of writers have suggested that

17over a decade after 1911, the various companies did

18 become vertically integrated, did become more effective

19competitors on their own, and there is also this

20argument that whereas Standard Oil may have been a real

21pioneer and a real success in bringing together a

22tremendous managerial hierarchy, that it may have been

23becoming a bit height-bound and maybe overcentralized

24and sort of telling, for example, Indiana Standard,

25okay, well, you have got this new cracking process, but

65

1we are not as enthused about it as you are, and maybe we

2will not move forward, and that there is an argument

3that the dissolution really allowed some of the younger

4generation in the separate firms to really have more of

5an opportunity to go their own way and to try things

6that were not getting approved as quickly, and there is

7also this notion that another change afoot, apart from

8antitrust, was that there was a whole big new demand for

9gasoline that was opening up new opportunities and

10spurring competition as well. So, those were a few

11things I wanted to say.

12MR. GLAZER: So, it sounds like, in sum, you are

13saying the record is mixed. The historical record is

14mixed on whether the remedy had long-term positive or

15negative effects.

16DR. MAY: Yes, I think that the consensus is

17pretty strong that the remedy was not as well thought

18out or as effective as it should have been in hindsight,

19but I think it is a mixed record as to what were its

20effects.

21MR. GLAZER: Or even whether it mattered or not

22in light of the other changes taking place in the

23industry?

24DR. MAY: Right.

25MR. GLAZER: Did you want to comment?

66

1DR. SMITH: Well, Wall Street certainly liked

2the remedy, because at least in the short run, the

3breakup value of Standard Oil was much greater.

4DR. MAY: Rockefeller's fortune just soared

5because of it. He had a big windfall himself.

6DR. GALAMBOS: And you cannot eliminate this

7from the politics. Politically, the American Tobacco

8and Standard Oil cases were very important in developing

9a feeling in the population that things were going to be

10okay, because the Government was going to move in and do

11something. Now, it did not shape the American business

12system and it allowed the development of oligopolies

13that I think on the long run were efficient, and that is

14what our productivity record shows, so in that sense, it

15was something that eased us into a new system, and it

16had that political impact, and so it seems to me that

17some of these cases can be understood in that way, not

18just the economics of what they did, but the politics.

19DR. FREYER: Could I just follow up on that as

20well? It is kind of helpful to think about politics in

21a sense from the enforcer's point of view of symbolism,

22and that is why Thurman Arnold is kind of the archetype.

23He was conscious at every part of the litigation that

24the outcome in court was actually secondary to what

25people thought about it, and it is just something I

67

1think for enforcers to bear in mind as well, but he was

2very proactive, and in that proactivity -- yet he was

3able to kind of bring the economy or at least he was

4able to bring antitrust enforcement to a whole new level

5of effectiveness, and, in fact, the system that he put

6in place at the Justice Department, you know, would last

7until 1980 in terms of the resources that would be put

8into cartels versus mergers/monopoly, it was basically a

960/30 or 60/40 kind of apportionment, and in support of

10the economists, as well, in the Justice Department.

11All of that was tied to his perception of what

12was the cost of the litigation given the evidence that

13we need to achieve these results, and we do not really

14need to win if we can also get the public to think and

15the Congress to think, particularly the Congress to

16think, that we are making a difference, and then that

17image actually -- one of the things I was fascinated

18with when I went to Fortune Magazine, I traced Fortune

19through into the 1980s, how receptive they were to

20Arnold's activism for solid business ends, right?

21Now, you can debate it one way or the other in

22terms of the actual economic effect, but what I am

23talking about is the symbolism, you know, he succeeded

24in capturing the imagination of business journalists, at

25least a lot of business journalists, as well

68

1politicians.

2DR. MAY: And if I could pick up, too, on some

3of those comments, of course, the other reason that

4Standard Oil led to a feeling in the popular mind that

5now the trust question is really getting resolved and we

6can feel good about that, is that it was complimented by

7the reaction to the case in the political realm, which

8was a revitalized antitrust debate in the 1912 election

9and the legislative effort that led to the Clayton Act

10and gave rise to the FTC in this building we are now

11sitting that provided this other alternative way of

12thinking about approaching these questions in addition

13to courtroom litigation.

14MR. GLAZER: So, thank God for the Standard Oil

15case you are saying? Otherwise, we would be on the

16street at this moment.

17Jim, did you want to expand also on the raising

18rivals' costs aspect of the case?

19DR. MAY: Well, we can if you want me to.

20Essentially, if people have looked at this particular

211996 article, essentially what Professors Granitz and

22Klein try to do is pick up on some of the -- often what

23is heard as post-Chicago theory that people in the

24antitrust field have been very familiar with in the last

25ten years, and basically say, okay, can we make sense of

69

1the Standard Oil record in a new way in light of this

2new theory, this way of understanding exclusionary

3behavior, and taking issue with John McGee's earlier

4piece that said, ah, yes, it was not that Chicago School

5Aaron Director's view, that is the way to understand

6Standard Oil. Instead, it is a raising rivals' costs

7theory, but one that is sort of circumscribed and does

8not go as far as Professor Salop and Krattenmaker in

9their raising rivals' costs article which got a lot of

10attention in the antitrust field a few years go, and so

11basically they say one way in which you can have

12effective exclusion of new entrants into a particular

13line of business would be if, in fact, an upstream firm

14that provides some central service like transportation,

15in fact, cooperates with you to raise a barrier to entry

16that otherwise might not be there, and in this

17particular variant of that notion, the idea is that

18whereas a supplier of a certain commodity, a railroad

19normally would say, oh, I would like to have as much

20competition on the downstream level as possible, because

21I want just as much demand for my services as possible

22and why would I ever want to cooperate with increasing

23market power downstream, that is against my interests,

24the notion is that if you are having trouble stopping

25cheating and having trouble maintaining a cartel at your

70

1own level, through your own devices at that level, you

2could, in fact, find downstream firm to be a useful

3enforcer.

4In Standard Oil, they called it being an evener

5among -- you know, if everybody gets their quota as to

6how much of the freight business they supposedly can

7get, it is the evener who is supposed to make sure that

8nobody's breaking ranks in terms of the quota of how

9much of a particular business they are getting. So, the

10notion is you want to have somebody downstream who has a

11great enough volume that if they see somebody, in fact,

12trying to pick up too much business, they shift a lot of

13their own volume of demand to somebody else as a way of

14punishing cheating and to keep a cartel going.

15The notion in Granitz and Klein's theory is that

16that is what was going on between the railroads and

17Standard Oil. It was not the old story that Standard

18Oil had so much power independently, that it was just

19coercing a better deal with the railroads, extracting a

20better deal with the railroads. No, no, no, it was the

21railroads who had incentive to try to have a player with

22a large volume, not just for cost savings, for dealing

23in volume, right, with a shipper, but for this other

24reason, to provide this cartel enforcement function, and

25that that is what they were doing, and that the

71

1railroads liked it because they got a cartel going more

2effectively and it was worth it to them, and they had to

3share something with Standard Oil, and Standard Oil got

4its return on the monopoly power that was possible, but

5only possible in transportation, by being able to be in

6position to have monopsony power to get a better deal on

7crude oil, and to have power to raise prices to

8consumers on petroleum prices. That is their theory,

9okay?

10And, you know, people here, it sounds very

11familiar, as you know, just in our own field, you know,

12there are these kind of raising rivals' costs theory,

13they are basically taking that and saying, "A-ha, that

14is how we understand it." It is not a theory that

15everybody has agreed to. I mean, other people have

16different explanations for it, but it is a very

17prominent theory among antitrust people. It is a very

18leading interpretation now among antitrust folks as to

19how to think about it.

20MR. GLAZER: I guess when your book comes out we

21will find out what you think of the theory.

22Moving now to the Alcoa decision, George, with

23the many attempts by the Government to file antitrust

24cases against Alcoa over the years, was it just a matter

25of the times and circumstances ultimately caught up with

72

1Alcoa and its management, or did Alcoa just finally

2cross the line into anticompetitive conduct in your

3view?

4DR. SMITH: No, I think it is the former, in a

5word, yes, I think things caught up with Alcoa. I think

6briefly what I tried to do is describe the political

7context in which these cases were based. There was no

8question that the Justice Department was going to go

9after Alcoa, because it was probably the purest monopoly

10that existed in the economy at the time, and it really

11had no choice given its own doctrine, and Alcoa was a

12public relations disaster.

13I mean, if you go back and re-read the

14newspapers and the press accounts, there is a wonderful

15story I have in my book of Arthur Vining Davis in 1933

16leading a cheerleading session with a band in a hotel in

17Washington, saying, you know, "How much of the market do

18we have?" And everybody would shout, "100 percent."

19They had a song about this. They did not have a good PR

20guy around to tell them that, you know, you do not talk

21this way.

22But, you know, to be serious about this, I think

23it --

24DR. GALAMBOS: Senior counsel.

25DR. SMITH: -- as historians we are taught that

73

1nothing is inevitable, but if something comes close to

2inevitable, I think it was bringing of the antitrust

3case.

4DR. FREYER: Can I just add something for the

5enforcers in this room to remember, that there is

6amazing room for unintended consequences, and because of

7the great work in Alcoa that Professor Smith did, I

8incorporated it in my new book, and I was really

9surprised when I went to the Justice Department records

10and the Jackson papers how they went after Alcoa for

11entirely different reasons than ended up being the basis

12for the decision in the case.

13They went after it because it was an

14international cartel, an international cartel was a

15push-button, hot issue in the 1930s because of Hitler

16and to a lesser degree the Italians, international

17cartels and so forth, and then there was the threat to

18the western hemisphere, where the U.S., you know,

19considered to be dominant markets and so forth, and

20there was an issue over the venue, whether or not it

21would be in Pittsburgh or whether or not they would get

22it in in New York, and to show you how significant it

23was, they had to get the President involved and they had

24to go to Congress to get the case moved from Pittsburgh

25into New York City.

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1And then, it was Caffey. Caffey ended up

2looking like they failed anyway, right? But what they

3got from Caffey -- again, unintentionally -- was the

4success of this discovery, which led to this trail of

5these international cartel arrangements and patents that

6it was exactly what Arnold needed to get these huge

7increases in the Justice Department's budget from 1939

8to 1942. He was able to remake the Justice Department

9primarily because he was able to connect national

10defense in the war years with antitrust, and he was

11actually being criticized by Bernard Baruch and others

12who were saying, you know, this is the wrong approach

13and we need to do what we did in World War I and so

14forth.

15So, the Justice Department was looking at Alcoa

16and these other cases, American Tobacco and so forth,

17for a different reason, but since all the cases were put

18on hold during World War II, they were still able to do

19the discovery and so forth, when they have peace. Peace

20comes, and then we get the decisions in peacetime that

21looked much more -- I mean, what we are used to and so

22forth, but it was all driven by these unintentional

23motives.

24MR. GLAZER: And, George, another point on

25Alcoa, shifting from monopoly an oligopoly, did the

75

1aluminum industry seek the types of increases in

2innovation and productivity that the Government hoped

3for in seeking its relief?

4DR. SMITH: Well, it is not clear to me what the

5Government hoped for other than kind of a general notion

6they had that if more competitors were in the field,

7there would simply be more innovation. What I am

8suggesting is that it depends on what kind of innovation

9you are talking about. Clearly there was an explosion

10in product development, which perhaps had some social

11benefits, but there was also a problem with, as I

12suggested, in the research and development side of the

13business, not just for Alcoa, but for the whole

14industry.

15One thing monopolies do well is science, because

16they can afford to do it, and in oligopolistic industry

17structures, there is more pressure to focus on the short

18term and do less of that, and I think it is not just

19Alcoa. You can look at other industries as well to see

20this pattern.

21And then the question is, well, where does the

22science go? Obviously we know that the history of the

23United States research and development since World War

24II, the Government plays an increasing role in fostering

25fundamental science, but that did not happen so much in

76

1the aluminum industry.

2So, to answer your question, I do not think the

3Government's attorneys, you know, had a clear notion,

4other than this general idea that it would promote

5innovation, but I would make another argument, and this

6is a hypothesis, but based on my reading of the history,

7it is important to understand that monopolists, at least

8in growing industries, have to remain alert, you know,

9and they have every incentive to reduce their costs and

10drive prices down in order to increase their markets,

11and we see that again and again in the stories of the

12great dominant firms of the late 19th Century and early

1320th Century.

14That may change as markets mature, but certainly

15in the growth phases, I think there is a risk in

16tampering too much by monopolists. They have to remain

17alert, because there is always room for substitutes and

18there is always room for competitors to enter under a

19pricing swell. What happens when industries mature is

20different, but I would argue that, well, aluminum was

21mature in terms of its organizational -- Alcoa was a

22mature company in terms of its organizational

23capabilities. The markets were still in a growth mode

24when the Government brought its suit, and to me, that

25might have been a problem. So, the timing of the suits

77

1becomes a big issue as well.

2MR. GLAZER: And it lasted so long as well.

3DR. SMITH: Yeah.

4MR. GLAZER: Professor Galambos, did the breakup

5of AT&T lead to the increased innovation and

6productivity that the Government sought in that case?

7DR. GALAMBOS: That is good, because I was

8thinking about George's answer, too. I think it is very

9important to distinguish between the short term and the

10long term, and I think that almost always the structural

11cases will probably bring you short term a higher level

12of innovation. That is not invention, but innovation,

13as the introduction of something actually in the

14competitive market. So, that is the important

15distinction you have to make.

16That is why I am saying, that is what history I

17think has to offer, is that you have to look at both the

18short-term impact of things and the long-term impact on

19the national economy and now a global economy. So, it

20seems to me that the Alcoa case brought about

21accelerated short-term innovation, but what George is

22suggesting is that long term, it probably did not, and

23it may have actually hurt the pace of innovation over

24the long term. That is what I am suggesting in my

25analysis of the AT&T case. I think, is that in the

78

1short term, it clearly did, but in the long term, it

2probably did not. This is one of those alternatives we

3do not actually get to measure -- we are doing "what-if"

4history, what if we had kept this, you see?

5What we do know is we do know the history. We

6do know where the transistor came from. We do know

7where the switching systems came from. We do know that

8they had a very efficient telephone system, and that

9accomplishment was based on innovation over the long

10term.

11I think the hard thing to think about in public

12policy is to think about long-term implications and what

13you mentioned about the unanticipated consequences on

14the long term I think is a very important point, because

15it is very hard to construct these counterfactuals. The

16only one who has really tried to do it methodically that

17I know about is Robert Fogel, the Nobel Prize winner in

18Chicago, and if you look at his carefully, you

19understand just how difficult it is to construct a

20really good counterfactual for railroad development in

21the 19th century U.S. so, it is a hard thing.

22It is a difficult public policy choice. It is

23difficult for people under immediate pressure to come to

24these conclusions. I guess what we are calling for is

25some kind of political-economy statesmanship and a look

79

1at that long-term view.

2MR. GLAZER: Yeah, I think Zhou Enlai was once

3asked about the French Revolution, and he said, "It's

4too early to tell." It takes decades sometimes for

5these things to sort themselves out, and in the case of

6telecommunications, we are still trying to figure out

7whether it was a good thing or not to break up AT&T 25

8years ago.

9George, you were about to --

10DR. SMITH: No.

11MR. GLAZER: Okay.

12DR. FREYER: I just would like to add, one of

13the challenges is not to be certain that you can predict

14the future, because I know that Professor Galambos

15interviewed Baxter and -- yeah, I only interviewed him

16once, but one of the things that he -- when I

17interviewed him, he was receiving a lot of flak from

18historians for -- and this was six years later, I guess,

19after the breakup, and he was absolutely certain that

20they were all wrong in that everything that -- you know,

21that his motives and -- I mean, the whole policy, in

22other words, was absolutely right.

23There was one interesting outcome of that as

24well that he also told me about, which I also think

25enforcers can bear in mind, and that is he said what

80

1people do not realize is that then helped me to take a

2budget that was declining, an antitrust budget that was

3declining, and put 15 percent of it, whereas before it

4had been 40 percent of it, into monopoly, which was the

5AT&T stuff, and then 85 percent I could go after

6price-fixing cartels and so forth, and I would get a lot

7more attention, and I would almost win all of those, and

8so forth, right?

9See, and I can go to Congress and say, well,

10look, you know, how aggressive we are, so on and so

11forth. So, just the point is that not only was he

12certain, but he also had motivations that were within

13the institutional culture of the Justice Department as

14well that explained what he was doing, and they

15reinforce one another.

16MR. GLAZER: And Professor Galambos, do you

17believe that deregulation was the more appropriate

18government response to AT&T's dominant position?

19DR. GALAMBOS: Yes, I have suggested today that

20I think that regulation or deregulation in that case, in

21some cases markets win over the long run, have brought

22about a more satisfactory solution than the one that we

23created. These cases were so enormously complex and

24would take so long to finish that a great deal had

25changed while the case was being decided.

81

1So, even though getting a legislative answer was

2very difficult in the 1970s, as we know from the

3legislative history, it would have been, it seems to me,

4a more satisfactory solution. I think we were moving

5towards solution, as it was, and I think we could have

6continued in that more gradual way.

7MR. GLAZER: In light of this --

8DR. GALAMBOS: Can I say -- I think what I am

9suggesting is that the time -- the historical time of

10structural cases may have passed. That is what I think

11I am suggesting. They had an important function at one

12time, and that time now may have passed. We are in a

13new age.

14MR. GLAZER: For structural changes?

15DR. GALAMBOS: For structural cases, yes.

16MR. GLAZER: And some of it may have even passed

17by 1911 as well.

18DR. GALAMBOS: What?

19MR. GLAZER: It may have passed by 1911 as well?

20DR. GALAMBOS: No, I do not think so, because of

21the political saliency of the issue. There were just a

22tremendous number of Americans very upset about the

23trusts and very upset about what was happening. You

24have just got to remember, this was an agricultural

25commercial society in which this industry was growing,

82

1but most of the people, until the 1940s, lived either on

2farms or in towns of 2500 or less, and this was a

3society that was very upset about monopoly, did not

4understand it very well. They were worried about all

5kinds of things.

6They were worried about bankers who were making

7decisions that were affecting, you know, how I can sell

8my corn and my wheat, and so this had a political

9importance that you cannot ignore -- this is a

10democracy, and you cannot ignore all of those people and

11the way they think about things. So, I would see this

12as a function of democracy that we have moved in this

13direction, did all of this work over this period of

14time, and then the times changed, and now we have to

15respond to that.

16DR. SMITH: One thing about that period you have

17to remember, the Standard Oil revenues were bigger than

18state budgets, and the $1.4 billion transaction creating

19U.S. Steel took place in a $21 million economy. I mean,

20these things were huge by the standards of time, and

21these businesses operated in secret, they were

22unregulated, and, you know, it was occurring, as Lou is

23suggesting, in an agrarian environment where these

24things were really scary. So, it was a different time.

25MR. GLAZER: In light of the consolidation that

83

1we are seeing in the telecommunications today, do you

2think we are closer to what AT&T was at the time of the

3lawsuit?

4DR. GALAMBOS: No, I do not think we are moving

5back to the Bell System, but we are getting

6reconsolidation. It seems to me I think you are seeing

7the effect of economies of scale and some economies of

8scope, so you are getting reconsolidation.

9In wireless, you have got consolidation along

10international lines, not necessarily national lines.

11So, you are getting reconsolidation in the industry, but

12I do not see a move toward vertical integration such as

13the Bell System had, and I do not see myself a move

14toward re-regulation. I think that there is such a bad

15feeling about rate of return regulation and the problems

16of trying to impose that that we moved away from that,

17and I do not see any move back toward creating a

18regulated monopoly.

19Just remember that Theodore Vail, at the AT&T

20system, accepted regulation. He said, we have got to

21have a regulation, we are going to have universal

22service, we are going to have one big supplier, and it

23is going to be regulated. But I think that the

24attitudes now have changed dramatically all around the

25world.

84

1MR. GLAZER: How do other forms of communication

2such as VOIP, voice over internet protocol, affect the

3antitrust analysis in your view?

4DR. GALAMBOS: This industry is changing

5enormously and very fast, and in those kinds of

6situations, it seems to me the best thing to do is sort

7of stand back and watch it, because the whole industry

8is being transformed. I do not know about you, but I

9have a number of friends who are no longer hard-wired,

10okay? They are just on wireless -- and there are big

11parts of the world that are never going to be

12hard-wired, in which wireless is now taking over and the

13internet moving in. And so you can see by my age that I

14am not doing internet telephone calling myself, but

15young people are, and that is going to increasingly

16happen.

17MR. GLAZER: Tony, as we look at the

18developments of the worldwide competition law

19enforcement, are we seeing consensus that dominant firm

20behavior needs to be at the top of antitrust enforcement

21by all developed and developing jurisdictions?

22DR. FREYER: Yeah, on that question, there is,

23you know, Australia, Japan, the EU, and then the United

24States, it is a big topic of -- you know, it is a big

25focus of attention. The big difference is the -- you

85

1know, how the enforcers respond, and in the three

2outside the United States, it is largely bureaucratic

3intervention.

4I mean, Japan, they have never had a monopoly

5case since the occupation that went to court, but they

6do it virtually every day through administrative

7guidance, and they -- you know, it is -- you know, all

8these sectors are -- you know, they have their own --

9the person in charge of them, and they are working

10intergovernmental with the treasury ministries as well,

11continuously, and they have been much more geared to

12more entrepreneurial kinds of approaches and so forth.

13In Australia, because you have got a highly

14concentrated market already, the same kind of

15bureaucratic intervention, except that there is more

16willingness to resort to kind of innovative enforcement,

17things like shaming, you know, relying on publicity

18extensively, and then working out what we would call

19consent decrees, but they are compliance programs where

20the businesses, the corporations or whatever, they are

21presented in public forums with the enforcers as having

22agreed to some remedy, you know, on television and this

23sort of thing.

24I mean, it is a -- I think it is a highly -- it

25is a publicity-centered kind of enforcement, and perhaps

86

1you can do it in a small country like that, but I would

2urge all enforcers to look at the Australian example,

3partly because of this guy, his name is John

4Braithwaite, and he has tried to develop a lot of

5alternative, publicity-centered kinds of remedies.

6Courts -- do not get me wrong, courts are

7important, but he has tried -- he has, again, found that

8what he calls these good citizen corporations are to be

9found if they are given a kind of -- the right kind of

10incentives. I guess that is one point.

11Another point I think, that the U.S. really is

12not going to be able to avoid dealing with the other --

13you know, dealing with dominance in a global context for

14the main reason that Lou indicated, that from the point

15of view -- if you just talk to the Australians or the

16Japanese or the Europeans about dominance, they all are

17very aware -- they use the language of a global economy,

18globally, that is what they talk about.

19You know, I think the U.S. still, with its huge

20market and so forth, there is still an awful lot of -- a

21sense of insularity, maybe not purposefully, just

22subconsciously or whatever, but these other places are

23not, and a lot of that has to do with because they do

24not see such a division between antitrust enforcement

25and trade policy. There is a lot more interaction

87

1between the two, and that gets back to those public

2interest goals that are common in these other

3enforcement -- you know, things like preserving jobs is

4a legitimate antitrust goal in most other antitrust

5regimes. Now, how you do it is not automatic, but I am

6just saying it is a legitimate goal.

7MR. GLAZER: Let me open it up now. These

8questions will be to all the panelists.

9From the research that you all have presented

10today on these landmark cases, and we have touched on

11this to some extent already, but do you believe there

12are lessons learned that would be helpful for the

13Antitrust Division and the FTC in assessing the proper

14level of antitrust under Section 2 of the Sherman Act?

15Jim, do you want to begin?

16DR. MAY: As to the proper level of antitrust

17enforcement? I am not sure of what lesson I would draw

18to that just from the Standard Oil case. Certainly

19there are lessons to be drawn that are commonly drawn

20with regard to --

21MR. GLAZER: Use the microphone, please.

22DR. MAY: Oh, sorry, that are commonly drawn.

23You know, we begin with respect to how thoroughly things

24are thought out ahead of time and given attention, but

25Standard Oil, you know, is an unusual set of facts, an

88

1unusual time period, as Professor Galambos, talked

2about, and drawing a broader conclusion about how many

3structural Section 2 cases you should bring based on the

4record of Standard Oil is something I am somewhat

5hesitant to draw conclusion about.

6 MR. GLAZER: Other panelists? George?

7DR. SMITH: Well, I think there are many lessons

8that can be learned here. One, of course, is that

9antitrust always has a political dimension to it, and

10one always must be sensitive to whether politics must be

11paid attention to as well as the economic issues at

12hand, and sometimes the politics are important and

13cannot be overlooked. It is not just about economics.

14I think a second lesson is that I think, looking

15historically back in time and also considering where we

16are in the world today, that structural remedies are

17probably less desirable than more flexible kinds of

18remedies, because over time, it is hard to undo

19structural remedies, and that suggests that people in

20the Government have to become at least as sophisticated

21as managers in big business corporations in anticipating

22what possible futures lie ahead.

23DR. GALAMBOS: I think that the lesson that I

24would draw particularly would be to look to the global

25economy and look to what needs to be done. Where I see

89

1the great need right now is for consideration of the way

2the firms are operating and evolving and for a related

3attempt to level the field of concern and public policy.

4I do not think you can level the economic field myself,

5and I am very worried about the way public interest

6becomes a cloak for private interest.

7In other words, you claim the public interest,

8but what you really want to do is you do not want

9another strike in the middle of Paris. I do not want

10people to get out in the streets and destroy things, and

11so I am very worried about the gap that still exists

12between various countries and the way they approach

13public policy and competition. I would say that is a

14really important issue.

15DR. FREYER: Yeah, I think that there are kind

16of two -- it is useful to bear in mind that there are

17two ranges of issues. One is from the point of view of

18institutional culture of the enforcer themselves, and

19the other that is from, you know, the business impact.

20From the enforcers themselves, I think that

21there are just -- just maybe you all do this, and

22since -- you know, I do not know, but it is to pay just

23real attention that there really is a nexus between the

24resources that you have and what you -- and the evidence

25that you need to make a case, and that is what drives

90

1how you allocate, you know, what -- whether it is cartel

2cases or merger/monopoly kinds of cases, right, how

3those are apportioned.

4And what is very interesting in going to these

5other places is that there is a very conscious awareness

6that they have got to select cases in a way that they

7have got to increase resources given the kind of

8evidence standards, and in all other countries except

9the U.S., the evidence standards are -- you know, they

10are just not as tough, you know, as they are in the

11United States, because it is not conspiracy. It is more

12towards results and this sort of thing.

13So, just being aware of -- you know, that is a

14lesson from the -- as I say, you may do it consciously,

15hopefully you do, but one thing that Braithwaite did is

16actually develop a way to look at this. It is called an

17enforcement pyramid. It is a way to apportion costs

18based -- and evidence kinds of things, and it is a

19useful kind of illustrative device.

20Yeah, on the other point, you know, Lou's point,

21what is interesting about whether or not you could go --

22there is no doubt whatsoever that what is public

23interest to one person and the public is different, and

24that is why public choice now is what dominates, you

25know, the teaching in law schools and in business

91

1schools and so forth, you know, because there is no --

2you know, there -- public interest is relative, but

3again, all I would say on that is that in these other

4places, they are very conscious that there is a policy

5benefit in, you know, linking competition policy to

6environment, and that is one of the things they do in

7the European Union, you know, maintain environmental

8protection.

9Sure, you have a kind of abuse with the state

10aids and with the telecoms, you know, Monty's last days

11was he was absorbed in whether or not he was going to

12sign on to saving the French from the Italian, you know,

13big state company and so forth, and he ends up saying

14okay, you know, but he insisted that he have these very

15rigorous accountability-based things.

16So, what I would say, though, when it comes to

17specific doctrines, like verticals and conglomerate

18mergers and monopoly, that done rightly or done

19effectively, the public interest has a lot to be said

20for in terms of broader interest rather than narrower

21type interest, and I think that was actually the problem

22with the U.S. remedies, just looking at conduct.

23Microsoft was so far ahead of what they could

24do, what they knew they could do, beyond what the

25government remedies were, that the Government just, you

92

1know, just was not aware. I mean, whereas in the EU,

2they did not have that problem, because they were just

3worried about results, right?

4MR. GLAZER: We have time for one final

5question, and the question is, drawing on all this

6history, what would be your advice to the agencies as to

7what type of conduct the agencies should focus on? When

8you look back at these cases, what type of conduct do

9you think had the greatest anticompetitive effect,

10whether or not it was found by the Court or the agency

11at the time to have that effect, but from your studies

12of the actual underlying records of the cases. Any

13thoughts on that?

14DR. GALAMBOS: Well, I clearly am very close to

15Bill Baxter's conclusions about what we should do. It

16seems to me that there are forms of predatory behavior

17that you would want to look at in terms of behavior, not

18necessarily the structure so much as behavior,

19performance, and I think that some of those -- both for

20their political impact and their economic impact deserve

21emphasis.

22What I am arguing is that you have got to be

23sensitive to both the political impact and the economic

24impact. So, it seems to me that there are forms of

25behavior that we want to eliminate from our competitive

93

1economy, and the question is how best to do that.

2So, I am interested in a very restrained

3approach. I am interested, as I have said, I do not

4see -- I just have no confidence in these structural

5cases at all, but there are certain forms of behavior,

6and that is the dumb monopolist behavior, I think. They

7are dumb at times, they do do stupid things, and I think

8we can see that when it happens.

9 MR. GLAZER: Any particular examples?

10DR. GALAMBOS: Well, failure to innovate, I

11think, failure to innovate over the long run. I am

12opposed to the structural cases. I am enormously

13enthusiastic about anti-cartel behavior, for instance.

14I want to eliminate cartels, and I think the public

15policy of leniency for the first person to come forward,

16that is, the prisoner's dilemma game, is marvelous, I

17think it is just wonderful. So, I want to attack that

18-- this is the kind of behavior that I think we can

19limit sharply -- collusion is dumb monopoly behavior,

20and so that kind of behavior deserves attention and

21government action.

22DR. SMITH: I would say from, again, from a

23layperson's perspective, if you look at the Sherman Act,

24and it has two proscriptions, those shall not conspire

25to restrain trade, and thou shall not monopolize, and I

94

1have a lot of problems with the second, unless in the

2process of getting to monopoly you violate the

3provisions of the first, and I think that is -- so, I

4would agree with Lou.

5DR. GALAMBOS: Yeah, when a company has to use a

6shell company to sneak something through, there is

7probably something wrong, you know, you can smell that.

8You do not have to be terribly -- you do not have to be

9a really good economist to know something is probably

10wrong when they are trying the shell game on you. So, I

11think that we could handle this.

12MR. GLAZER: Tony?

13DR. FREYER: Just on these two points, first of

14all, there might be something to be said for looking at

15all of the other regimes outside the United States do

16pay a lot more attention to verticals and do pay a lot

17more attention to conglomerate mergers, and the main

18reason that is so is because of the sophistication in

19financial arrangements and constructs and this sort of

20thing, and I am not sure that that sophistication is --

21I mean, I think there could be more research done to see

22if there was not room to move U.S. efficiency theories

23in the dominance area into kind of capturing more of the

24wide range in which this financial sophistication is

25worked out, and in that connection, I would give a plug

95

1for Professor Smith's book on KKR, primarily because he

2provides the context for the --

3DR. SMITH: KKR?

4DR. FREYER: -- for the use of depth, which has

5just become a pervasive influence in financing. A lot

6of it has to do with tax policy, but the problem with

7the book from my point of view is he says how important

8antitrust is in setting the precondition for the triumph

9of debt financing in the seventies, which dominates

10today, but does not explain what the problem is, and in

11the last point, that is I think there is a lot of room

12for looking at conglomerates, in using the kind of

13indirect influence that the EU has and at least thinking

14about that as a way to get at these financial kinds of

15problems.

16MR. GLAZER: Well, with that, I want to thank

17the panelists very much for their participation in what

18was a fascinating panel. Thank you very much.

19(Applause.)

20(Whereupon, at 12:00 p.m., a lunch recess was

21taken.)

22

23

24

25

96

1AFTERNOON SESSION

2(1:30 p.m.)

3MR. ELIASBERG: Good afternoon. Welcome back to

4the hearings. My name is Ed Eliasberg, and I am an

5attorney with the Legal Policy Section of the Antitrust

6Division of the United States Department of Justice, and

7I am one of the co-moderators for this afternoon's

8session on business strategy. My co-moderator is Ken

9Glazer. Ken is Deputy Director of the Federal Trade

10Commission's Bureau of Competition.

11Before I start, let me cover a few housekeeping

12matters. They are four in number. First of all is with

13respect to cell phones, BlackBerries, everything else

14that may make noise, it is time to turn them off. You

15can turn them on again after the session is over.

16The second, the men's room is through this door

17right here and an immediate left, first door on the

18left. The ladies room is across the elevator bank, take

19a left, first door on the left.

20The third point is a matter of safety. If in

21the very rare event there should be some sort of

22building alarm going off or something like that, please

23proceed calmly and quickly as instructed. If we must

24leave the building, that will be on the stairway on the

25right here on the Pennsylvania Avenue side. After

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1leaving the building, please follow the stream of other

2FTC people -- they have practiced this many times, so

3they know what the drill is and where to be going -- and

4we will all go to Sculpture Garden, which is across the

5intersection of Constitution and Seventh Street on the

6other side of the building, where you will be

7re-assembled and we will take things from there.

8Finally, we request that you not make comments

9or ask any questions during the session. So, that is it

10for the housekeeping side.

11Now, for the session itself, we are honored to

12have assembled a distinguished panel of business school

13professors who teach business strategy and marketing and

14consult with major corporations, as well as an Intel

15vice president involved in marketing and strategic

16planning on a day-to-day basis.

17Our panelists this afternoon are, to my

18immediate left, Jeff McCrea, who is vice president of

19the sales and marketing group at Intel. Next to him is

20Professor David Reibstein, who teaches at The Wharton

21School of the University of Pennsylvania, where he is

22the William S. Woodside Professor and Professor of

23Marketing.

24Next to Dave Reibstein is Professor David

25Scheffman, who is a director of the LECG Consulting

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1Group, an Adjunct Professor of Business Strategy and

2Marketing at the Owen Graduate School of Management at

3Vanderbilt University, and the former director of the

4Bureau of Economics here at the FTC, not once, but

5twice, okay?

6DR. SCHEFFMAN: Still trying to get away.

7MR. ELIASBERG: And finally at the end of the

8table is Professor George David Smith, who is a Clinical

9Professor of Economics, Entrepreneurship and Innovation

10at the New York University, Stern School of Business.

11Professor Smith spoke this morning quite eloquently at

12the business history session, and although he is not

13going to be making a presentation at this particular

14discussion, he has been kind enough to join us as a

15discussant for this session on strategy. He is the

16author of the book From Monopoly to Competition: The

17Transformation of Alcoa, and the co-author with

18Frederick Dalzell of Wisdom from the Robber Barons, and

19has a book coming out soon called A Concise History of

20Wall Street.

21Both this morning's panel on business history

22and this afternoon's panel on business strategy are

23attempts by the Antitrust Division and the FTC to bring

24together the experience and expertise of different

25disciplines beyond law and industrial organization

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1economics to see what we here at the enforcement

2agencies can learn about single-firm conduct that can

3help us in analyzing it under the antitrust laws.

4In this morning's very interesting session, we

5heard from the historians. This afternoon, we look

6forward to insights from the field of business strategy

7from this stellar panel that brings several

8perspectives, from teaching business strategy to future

9leaders in MBA programs and consulting with major

10corporations on business strategy, to planning and

11implementing business strategy on a day-to-day basis

12within a corporation.

13We are interested in exploring ways in which

14current mainstream antitrust analysis of single-firm

15conduct might be enriched by a better appreciation of

16what is actually being taught to current and future

17executives regarding how to successfully operate in the

18marketplace, and including competitive positioning and

19obtaining market power, and how business strategy in the

20real world is developed and implemented within the firm.

21As we think about incorporating the teaching of

22business strategy in antitrust analysis, we are all

23interested in understanding what role, if any, antitrust

24plays in the teaching of business strategy. It is our

25hope that this session on business strategy will answer

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1some of these questions. In particular, we hope holding

2this session will enhance the antitrust agencies'

3understanding of business strategy that is taught

4business students and how strategic business thinking

5might inform our analysis and evaluation of the

6competitive implications of certain types of conduct.

7So, with that, let me tell you a little bit

8about the first of our speakers. That is going to be

9Professor David Reibstein, who has been at Wharton since

101987, and in addition to his current professorship at

11Wharton, has held a variety of professorships and

12administrative and adjunct positions. He has been

13actively involved as a consultant with a number of major

14companies. Notably, Bud Selig, the Commissioner of

15Major League Baseball, appointed Dave from 2004 to 2006

16to a Blue Ribbon Special Task Force working to address

17the issues facing major league baseball.

18Dave has also been featured in Fortune Magazine

19as one of the nation's eight favorite business school

20professors and was recently named by Business Week as

21one of the cream of the business school crop of

22professors. Dave has received teaching awards at

23Wharton every year he has taught since joining the

24school. He has recently co-authored the book Marketing

25Metrics: 50-Plus Metrics Every Manager Should Master.

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1He also co-edited Wharton on Dynamic Competitive

2Strategy, and has co-authored a book, Marketing:

3Concepts, Strategies and Decisions, and Strategy

4Analysis with Value War, and Cases in Marketing

5Research, and is the author or co-author of numerous

6articles.

7I might add that for complete biographical

8information on Dave and other speakers, it is in the

9handout that is available on the table out front, and

10also can be found on the FTC and Antitrust Division

11Sherman 2 hearings web site.

12So, with that, Professor Reibstein, welcome, and

13we look forward to what you have to say.

14DR. REIBSTEIN: Thank you for inviting me to be

15part of this panel, and I must confess, it is not

16totally clear to me why it is I am invited to be here.

17I say that because, you know, I just am a professor of

18marketing, and I teach marketing, and I do not know

19exactly what its real role is other than I have been

20asked to come, tell us what it is that you teach, and

21part of my view is I cannot do that unless I have a

22semester, but I have been allotted only 20 minutes, and

23I will talk about that.

24It is also the case I have worked with a number

25of businesses, and I have worked with them on their

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1marketing strategy, although it does not surprise me in

2the introduction, the only one that is picked out is,

3"Well, let's talk baseball."

4MR. ELIASBERG: It is that time of year.

5DR. REIBSTEIN: It is that time of year for sure

6and it is always fun to talk about.

7So, what I am going to talk about is I am just

8going to give a little bit of overview of what it is I

9cover in my marketing strategy course. That is the area

10I was told is of greatest interest. I will spend a

11little bit of time talking about what it is that sort of

12are general approaches to the topic area, and then I

13thought, well, I might as well take the areas that might

14be most controversial as it might apply to the

15Department of Justice and Federal Trade Commission and

16at least put a statement around of stating what it is

17that is a philosophy that I teach my students.

18What I will also say at the outset is that at

19The Wharton School, we have a course that is required of

20all of our students, you cannot graduate from The

21Wharton School without taking a course on business

22ethics, and within that course, everybody is exposed to

23all the issues that might pertain to legal practices of

24business and trying to provide an ethical perspective,

25so that there are issues that go beyond the law that one

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1needs to be sure and question and make sure that one is

2incorporating in their everyday life and how everyone

3goes about practicing. That is not part of my course.

4On the other hand, I do feel the responsibility

5as a professor of marketing and when I am talking about

6marketing practices and how I think about marketing

7strategy, one needs to pause and incorporate any

8perspective of what one needs to at least question doing

9and where there might be some legal boundaries to the

10degree that I understand them, okay?

11So, just, you know, my view of marketing

12strategy, marketing itself sits between the company and

13the customer. It really is the interface between the

14company and the customer, and therefore, has a major

15responsibility of making sure that -- and what we

16traditionally think of as marketing, is making sure the

17customers understand what it is that we have to offer to

18them, often viewed as thinking about marketing in the

19role of its advertising.

20I also -- I do not state it that way. I state

21it as being an interface, because I think part of the

22responsibility of marketing is making sure the

23communication goes the other direction to the company,

24from the customers to the company of what it is the

25customers really want.

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1The objective, then, once the company has the

2knowledge and familiarity with what it is that the

3customer might really want, is to try and satisfy them

4and do so better than others, better than the

5competition will, and to do so while making a profit,

6and that becomes some of their particular objectives.

7So, they have a marketplace objective of satisfying the

8customers; they have an objective for their shareholders

9of trying to maximize their profits.

10When I talk about marketing strategy, it is

11looking beyond the tactics that one needs to use on a

12day-to-day basis or a quarter-to-quarter or maybe even

13year-to-year basis, but more taking a long-term

14perspective and trying to think through, you know, where

15are we trying to go? What is our objective? What are

16we trying to accomplish? And then what is the pathway

17for trying to get there? And it should set the

18principles for guiding all the particular tactics.

19You know, I feel a little bit silly standing up

20here talking to you about this, because A, this seems

21fairly fundamental, and B, then you would be enrolled in

22a course of marketing strategy, but I am just going to

23give you an overview of what it is I intend to cover.

24There are different paradigms that exist out

25there in the field of marketing strategy. The one that

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1is probably the best known is Porter's Five Forces.

2Many people would contend that is broader than marketing

3strategy and it is sort of business strategy, and

4undoubtedly, marketing strategy is a subset within

5business strategy, but most of what it is he talks

6about, not all, is it really infringes upon and covers a

7strong part of marketing as well, so I mention it up

8here.

9It is hard to talk about marketing strategy

10without thinking about the competitive advantage, and

11generally, you know, there are views that there are two

12basic forms of competitive advantage. One is a

13cost-based one. That is, we have lower cost structure

14than our competition, we have got that, and there is a

15variety of ways that one could try and acquire that; or

16we have in some way differentiated ourselves for a

17particular segment and are able to appeal to that

18particular part of the market by offering something

19different than what the competition is offering, and we

20often do that by having some unique capabilities that

21allow us to do that.

22There is an overall view about what I am really

23looking for is superior performance, and I am going to

24break each of these down a little bit. Superior

25performance can come in a variety of forms, and I will

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1lay that out. And then sort of this notion of value

2leadership, but I look at those four bullet points and

3say these are just -- they are general terms to be

4thinking about.

5This is just the Porter's Five Forces that I

6have up here, and many of you are more familiar with

7this than I am, and it may be, you know, having some

8supplier power, that there is some concentration in

9suppliers. An interesting one is trying to think about

10barriers to entry. To me, there are many barriers to

11entry that one can establish within marketing, and one

12often tries to create those to try and minimize some of

13that competition, and I recognize there are some

14dangerous terms I just threw out there, you know,

15barriers to competitive entry and trying to avoid

16competitive entry are potentially very dangerous things.

17There is also this notion of buyer power, and

18buyer power is related to, you know, I get to be so big

19and so strong that when I am dealing with any of my

20suppliers, I have some real advantage, because I am an

21important customer, and I can help influence what it is

22that my competition will do. And there is also this

23other philosophy of substitutes, that there is some

24switching that may exist, any of my customers may

25switch, and what I often think about are what are the

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1costs to any of my customers switching and how do I try

2and minimize some of my customers switching to another

3competitive product.

4It is a general philosophy, and frankly, I do

5not talk much about this. Part of the reason I do not

6talk much about this is because I teach a capstone

7course in final semester of our students, and they

8probably have heard this about four or five times

9before, so they get about as much coverage as you just

10got from me. Instead, you know, I will spend time

11thinking about competitive advantage, which could, as I

12say, happen from lower price, lower cost enabling lower

13price, but it could be because I have got a superior

14product or a superior service. Sometimes that can be

15protected through intellectual property, and I add the

16opportunity for that.

17One that we do not often think about, but I

18spend a fair amount of my time thinking about it, is by

19having a really strong brand and having what is often

20referred to as brand equity. In marketing, competition

21can match almost everything that it is that we do. We

22 drop our price, competition can match the price; we

23increase our advertising, competition could increase

24their advertising; we extend our service, we add product

25features, et cetera, et cetera, and almost always

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1competition can match that.

2The brand belongs uniquely to us, and it is

3something that if we can build up perceived customer

4value in our brand, it really helps lock customers in to

5us, and that works to our advantage, and I do not shy

6away from talking about that within my classes.

7Distribution is an opportunity for some

8competitive advantage. If I can find the key

9distributors, if I can occupy a dominant part of their

10shelf space, that is a competitive advantage that I

11might have.

12And the last thing I have up there is sort of

13owning customers and trying to think about loyalty

14programs that we see everywhere and the notion of what

15is it that we do to try and enhance and reward our

16customers when coming back. One that is not talked

17about very much in terms of owning customers, and I

18think it is going to become a bigger and bigger issue,

19is customer familiarity or intimacy -- those terms used

20a lot -- but I am really thinking now about familiarity

21because of the data that we have about our customers,

22and we can think about an Amazon, who has a customer and

23a customer record of what it is that they have bought,

24and they can now use that for trying to get the customer

25to come back.

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1We are going to get better -- we, Amazon, are

2going to better serve our customers because of what we

3know about each of those particular customers, and that

4really gives them a competitive advantage, and people

5will be hesitant to switch to another brand or another,

6you know, online bookseller because of the detailed

7amount of information that a company might have. All of

8those -- and I put this out as just a general

9philosophy.

10This, by the way, is -- a colleague of mine,

11very well known, who teaches another section of the

12marketing strategy course at The Wharton School is

13George Day. He talks about achieving superior

14performance, talks about it by positions of advantage

15that one could have, positions of outcomes and

16performance of outcomes, and sort of what some of the

17sources of advantages are, and I wanted just to put this

18up so that one could see this.

19And then there is sort of -- he talks about

20three ways to provide value. One is by price, and one

21is through the relationship, and one is through

22performance, and that generally is performance that is

23superior to our competitors' products. And basically

24the decision is you have to decide which of these three

25it is that you are going to be. Many people strive to

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1be all three. It is often difficult to be excellent on

2all three. So, you generally say, I am going to go out

3and be the low-cost provider, or I am going to know my

4customers better than anyone else knows them and know

5how to serve them better, or I am going to go out there

6with a superior performing product. Three different

7approaches that could be combined to various degrees. I

8am not an advocate that you can only be strong in one.

9I thought -- actually, I was asked, you know,

10so, how do you go about teaching this stuff? I have

11lectures to talk about it, and there is lots of cases,

12which are cases not just of what has happened

13historically, but try to have, you know, current cases

14where you put students in the position of, you are in

15this position for this business, what are you going to

16do, and they are all real life cases, and we go through

17a dialogue trying to walk through how to think through

18the process of what one should do, and then we have some

19discussion and debates about what would be a logical

20step to take from this point forward.

21The other one that in some of my

22pre-conversations stimulated a lot of conversation was

23the use of simulations. I use simulations a lot in my

24marketing strategy class. Actually, in the Intro to

25Marketing course offered to all students at the MA

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1program at Wharton, we put them all through a marketing

2strategy simulation that I help manage, and in that, we

3take our students, we break them up into groups, we

4assign them to teams, and they need to go out and try

5and compete against each other and try and win the

6customer's favor, and that is all they do.

7In all instances, what I talk about through any

8of these three approaches is I spend some time, you

9know, trying to talk about improving one's position,

10which could be through sales, it could be through market

11share, but ultimately, it needs to be by increasing the

12overall profitability of the firm, and that often

13happens through improving your customer satisfaction and

14improving your customer loyalty, and I find any time I

15talk with a group of lawyers, those terms seem to get

16people's attention when we talk about, you know,

17customer loyalty, customer satisfaction, striving for

18increasing of market share.

19The simulation is one that if there is a market

20that has, you know, a product life cycle, goes through

21its growth, some hypothetical product called the Korex

22one, and there is a new market that will emerge if

23people elect to go into it, and the different firms that

24the students represent are allowed to collaborate with

25their competitors for licensing agreements of IP and for

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1doing some joint ventures, and they can do that across a

2variety of technologies, and they operate in an economic

3environment that is a growing environment, has

4inflation, and a risk of antitrust intervention.

5So, if they are seeing -- and by the way, this

6is a slide that is shown to my students. This is not

7something I have put together for this. It is put out

8there very clearly, you know, there are things that you

9can do which are inappropriate, and I am going to go

10into that in just a second, but you need to go and

11operate and try to do the best that you can at

12increasing the value of your simulated firm within the

13confines of the law, and all the competitors are open

14for bringing actions against them. It is not just that

15I as a professor play that role of the policeman.

16This is another slide that I show which really

17tries to highlight, they have got intense competition,

18and you have got to be aware of what the competition

19might be trying to do to you, and I will try not to make

20any comments obtain taking a bite out of the

21competitor's market share or position at all.

22And the last slide that I am going to show you

23that I put up in front of the students is, again,

24talking about collaboration. So, there are some

25guidelines that are provided for students on that, and

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1it makes it very clear, you know, that they can, you

2know, do agreements for licensing and joint venturing.

3There is going to be some royalties that are paid from

4one or another.

5One of the things that it is inappropriate to do

6is to agree on how one will go to market. One can agree

7on IP and how it will be shared, and one can agree on

8licensing arrangements. One cannot agree on prices.

9One cannot agree on you go for this market and I go for

10that market, and that is a stipulation that is made

11very, very clear to them of what it is they are about to

12do.

13Now, I thought what I would do is highlight some

14areas that -- I was trying to figure out what -- you

15know, why in the world you were having me here, and I am

16going to highlight some of the things that are on there,

17but always the focus is we want to acquire customers,

18and we need to figure out how to acquire them, and some

19of that is going to be by getting nonusers to start

20using our product. It could also be by acquiring

21customers from our competition, and those sort of take

22different approaches. So, that is one task of acquiring

23customers.

24The second task is how do we retain customers,

25and that is, you know, done generally by satisfying

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1them, and if we satisfy them a lot, there is some good,

2strong, empirical evidence that very satisfied customers

3tend to be very loyal, and so the real key is keep

4customers happy, and that is going to lead to greater

5levels of loyalty, but they will not always be happy if

6you are doing the same thing, so you have to be

7continuously improving, and improving on what it is that

8you are learning from customers is important, and I

9thought, well, it has got to be done where you improve

10and you satisfy your customers better than the

11competition does. So, I have that in there as well.

12 The general principle is that retaining

13customers is even more important than acquiring

14customers, because if you acquire them and it is a leaky

15 boat, then you will just have to be continually

16replacing them, and in general, there is, again, some

17good strong empirical evidence that retaining customers

18 is orders of magnitude cheaper than it is to acquire

19customers, and so the real key is how do we satisfy

20these customers and keep them coming back.

21Here were the issues that I thought, well, what

22would this group potentially be more interested in, and

23so I thought, given what we are talking about, the topic

24of the day, I should talk something about monopolies. I

25will tell you I am an advocate of local monopolies. I

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1have to be clear on my definitions of that, and by local

2monopolies, what I am really referring to is identify a

3segment of the market. Do not treat the market as an

4overall market. Identify a segment of the market,

5understand them better than anyone else -- and I have

6got to be careful not to say "own" or "dominate" or

7"monopolize" -- but establish a very, very strong

8position with those customers, okay?

9By being very focused, you can satisfy that set

10of customers better than people that are not focused on

11that set of customers, and the example I cite to often

12just for illustrative purposes is you can look at the

13toothpaste industry and say, well, there is lots of

14different brands all out there competing for people

15brushing their teeth. If we are the ones that are

16offering smoker's toothpaste and we develop a toothpaste

17that is going to be better at removing nicotine stains,

18then we could have a product that is going to satisfy

19those customers more.

20The fact that it is a relatively -- I do not

21want to say dying segment, but small segment, allows us

22the opportunity to appeal to that segment when others

23might say there is not room for a second one who comes

24in and specializes in that market, and I will confess

25that I am an advocate of trying to get very good at

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1doing very well within a particular segment, okay? And

2that is one position I take.

3Another thing that I spend a fair amount of my

4time talking about is anticipating competitive response,

5and basically the position that I take on that is before

6taking any move, one should anticipate what one's

7competitor's moves are going to be, and also assess, and

8how are those competitors' moves likely to change and be

9altered by the action that I take? And if I would take

10a particular action, there is probably going to be some

11response to it, and I should take that into

12consideration in advance to my taking some particular

13action, rather than take an action, look at what it is

14they have done, and then say, "Oops, now I need to

15respond to that."

16So, my position is build a likely competitor's

17actions and reactions into our strategy and into our

18plans before we act, just that simple. There are some

19game theoretic perspectives that are probably brought

20into this as well.

21Predatory pricing, I started to say, well, we

22all know predatory pricing is illegal, and I said, no,

23we are going to talk to this group and say, predatory

24pricing may be illegal, and the key part of that is

25"predatory," and somebody defined for me predatory

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1pricing recently as predatory pricing is pricing below

2cost, and actually, for the most part, I have got to

3strongly advocate against then, but I think there are

4some exceptions that one could make as to when one could

5potentially price below cost.

6In general, it is not very smart, because it is

7hard to make money when you are pricing below cost. In

8general, when you lower your prices, your competition

9turns around and lowers their price, so if you couple

10this with the slide I just showed you before, all you

11are doing is bringing the market prices down, and so

12that works to you and your competitor's disadvantage,

13and yet there may be some times, particularly when you

14are starting out, that you may want to have a very low

15price on a temporary basis to build awareness, to build

16some trial, to build some traffic, or in some cases, to

17help sell other products.

18Now, I recognize, by the way, that as I am

19talking about this, I wanted to just put myself out

20there, recognizing I may be removed in cuffs, that, you

21know, these are all dangerous topics, but I thought it

22is best to sort of hear what it is that students are

23hearing and perspectives that they are taught, and they

24are made very aware of, you know, some applications of

25the Robinson-Patman Act and some concerns about anything

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1that might be predatory with respect to trying to drive

2competition out of the market and that there has got to

3be some rules and regulations against that, and

4certainly against dumping.

5We often think about that being brought against

6 many of our companies rather than being the doers of

7dumping, and I must confess, I have never advocated

8anybody doing any dumping or suggesting that that would

9be a good thing for any of our students to do.

10Then the last thing I will put out here is

11collusion, and you saw what it is that we talk about

12within the simulation. We certainly make it very clear

13you cannot collude on price and you cannot collude on

14who goes after which market, and those are the things

15that I really try and cover in the courses that I teach,

16and I hope this gives you some perspective of what

17happens at one course in one business school as

18approached by one professor.

19So, that is what it is that I hope to try and do

20with the notion that the goal is to serve customers and

21build better capabilities and deliver the better value

22to your customers.

23So, thank you.

24(Applause.)

25MR. ELIASBERG: Thank you, David.

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1Our next is Jeff McCrea, vice president of sales

2and marketing group at Intel Corporation. Jeff earned

3his MBA from the University of Michigan in 1991 and

4received a Bachelor's Degree in electrical engineering

5from Duke University in 1987.

6Jeff has held several marketing management

7positions since joining Intel in 1991. Most recently,

8Jeff served as co-president for Intel Americas, Inc.,

9where he was responsible for all sales and marketing

10activities in both North and South America.

11Welcome, Jeff. We are very much interested in

12what you have to say.

13MR. McCREA: Thank you.

14Well, if you are kind of wondering what I am

15here for, I guess I am the single firm today to talk to

16you about the single-firm approach. What I wanted to do

17today was talk a little bit differently -- I know that

18my colleagues will talk a lot more about what students

19are taught. Instead I thought I would give you a bit

20more insight into our business, and more importantly, I

21thought I would do that through a particular case, and

22what I am going to do is I am going to talk more about

23our Centrino mobile technology.

24Let me start off by suggesting if you look at

25Intel's business, I am going to talk about our core

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1business, which I think all of you are familiar with,

2which is our microprocessor business, how we build and

3support the industry of PCs. Clearly any user who owns

4a PC today, if you look at mature markets like the

5United States, you have to have a reason to go out there

6and buy a new one, and that new one is either to replace

7the existing one or to add another PC, and that is how

8we pursue our business, and the way we look at it, the

9vast majority of the growth in this market particularly

10is going to come from that.

11So, you kind of start with the basics, well, why

12would anyone want to do that? And the simple answer and

13the most obvious answer is that they really upgrade just

14because they can do something new, and that is because

15the one that they have no longer does something that

16they want to do. So, a lot of what we spend a lot of

17effort on is trying to not only figure out what else

18they can do with it, what are they going to value, and

19most importantly, what are they going to pay for it?

20Through the course of the last 15 years that I

21have been at Intel, we have done a number of things

22which is part of our long history of developing the

23market, which is working with the industry on developing

24I will call them complementary technologies, and you can

25think of these things as everything from new interface

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1buses within a PC, things like PCI. You all are

2probably familiar with things like USB, if you have ever

3used a USB key or many different devices, your iPod

4plugging into a PC.

5We have been developing that with the industry

6for many years in terms of how to bring it to market,

7and the net result of that is it is a benefit. By

8bringing these new capabilities to the platform, if you

9will, now the user has a new use for that PC, and

10ideally, it is going to take advantage of your new

11capabilities of your new products.

12So, like everything at Intel has a three-letter

13acronym, CMT is our Centrino mobile technology. If You

14have looked at your PC recently, you probably saw a

15little butterfly-looking logo on it, assuming you have a

16notebook -- and if you do not, there is a Best Buy down

17the street -- and what that is is this is a pretty good

18shift for us in the way that we went to market, and I

19will talk a bit more about that.

20Centrino, unlike all our previous Pentium

21generation products, is a combination of three things.

22It is a microprocessor, it is an Intel chipset, which is

23the core logic that enables the microprocessor to talk

24to other components in the PC, memory, et cetera, and it

25is also an Intel wireless product. So, the only way you

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1can get that logo is actually if you have all three of

2those components in there, and that is one of the things

3that we require of our customers before they go to the

4market.

5The real use or the intention of this was for

6several things. Number one is that Centrino was

7delivered -- we believe it was a radically different

8usage model to what people had seen before, and this,

9just to take you back, this was introduced in March of

102003, so relatively recently, and at the time, you know,

11this was the first product that we designed from the

12ground up for the notebook segment. That included, you

13know, just a stellar microprocessor. The architecture

14was a break-through technology for us that really

15enabled several things, including, you know, thinner and

16lighter notebooks -- I will pick this one up, although

17this one is not exactly thinner and lighter, but it is a

18lot better than most of the ones you had previously

19seen, which were Bodeckers (ph).

20Secondly, it had much longer battery life, and

21most importantly, which is what we spent a lot of time

22marketing, was the ability to connect wirelessly, and I

23will talk a lot more about what that really took in

24terms of creating that ecosystem in wireless.

25So, to do this, to create that value proposition

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1I just talked about, we had to do several things.

2 Number one is we had all the three components that we

3had already developed, but this was a pretty radical

4shift for us. In the past, at least since 1993 when we

5introduced our first Pentium processor, all of our

6products were really focused around the branding of just

7the microprocessor and the PC. If we just called it

8Pentium, in fact, this PC has a Pentium, which is

9actually the processor that is inside there, it is the

10same exact processor that is in our Centrino, but it

11does not necessarily have all the other components, and

12by branding the Centrino, what we were able to do, and

13bundling, if you will, these three pieces, we were now

14able to talk about that usage model.

15If we were just talking about Pentium, we could

16not guarantee that it had wireless in it, or more

17importantly, that it worked seamlessly. So, we did a

18number of things to do that. So, first of all, branding

19was a key component to be able to get really unwired for

20this usage. When I say unwired, it had to be not only

21not having to plug in to get connectivity, but also long

22battery life so you did not have to plug in literally to

23the wall.

24What we did was we did several things that were

25really done in the background. One of them was doing a

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1lot of work on validation. When I say validation, we

2validate all of our components just as a standard course

3of business, making sure that they work and they do

4exactly as we specify, you know, that is kind of

5natural. What was unnatural in this, we literally spent

6tens of millions of dollars to do, was ensuring that

7this worked seamlessly with other components that the

8user would want to take advantage of, for example, other

9wireless routers and access points, in particular, as

10well as validating with other software, so we did a lot

11of intraoperability testing of components that did not

12necessarily have any of our silicon in it or any of our

13software in it, but we wanted to make sure that, again,

14the user had a better experience, so that when they

15opened it up, it just worked. What a novel concept.

16Again, how do we create that value proposition?

17So, to that end, we still looked at, what do

18users actually want? Number one, high performance was

19clearly key, and as I have talked about previously, we

20had always taken our desktop processors, made some I

21will call them minor changes, although they were more

22than minor, to make them work in a notebook form factor,

23and a lot of times we had to trade off less performance

24to be able to get that.

25With this product, it was very different, and

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1that was because it was designed for this, and we were

2actually achieving at the time desktop levels of

3performance and would fit into this different form

4factor. Having that seamless wireless connectivity,

5being able to connect anywhere anytime, was something

6that is pretty much with a notebook today, I call it the

7new normal. Once you are able to connect wirelessly,

8you never even think about plugging in again, right?

9Being able to get your information anytime, anywhere,

10and it sounds like it is pretty easy today, but at the

11time, you know, it was a pretty novel concept, and it

12sounded interesting, but it was very unclear that the

13users actually would want that or, more importantly, pay

14for it.

15Long battery life, since you are actually now

16connecting wirelessly, you certainly do not want to be

17tethered to your desk or to the nearest plug. You want

18to be able to take it with you, if you were taking notes

19in a room or taking notes at a park bench, to be able to

20get outside and get some fresh air, out of this

21building.

22Other things, back to that, again, when you are

23start carrying around, all of a sudden, you want to make

24it better and lighter, so again, you go to the gym for

25your exercise rather than carrying a notebook around.

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1So, how do you take this and get more mobility, take it

2with you wherever you want to go.

3So, to do this, we looked well beyond just our

4products. We looked at what we call ecosystems, which

5was all the other players around us. I talked about

6wireless hot spots, and anyone who travels, frankly, I

7take for granted, you can always get connected at the

8airport and download your files when you are across the

9country. Well, literally three years ago hot spots, if

10you can remember, were not only not pervasive, they were

11not common, and it was pretty rare you saw one. So, we

12worked with service providers, actually physically we

13worked with the airports, people like Marriott, the

14hotel chain, and then retail establishments, to go in

15and establish, you know, a network, if you will, of hot

16spots, to enable that connectivity.

17So, it was just a ton of what I will call heavy

18lifting in the industry. In fact, we spent a huge

19amount of money and effort to go do that, because again,

20you had to go and create that market. Obviously without

21that, you know, who cares if you have wireless

22connectivity? You cannot connect anywhere, right? So,

23how do you create that to enable that value proposition,

24working with a number of partners?

25And the other side of this is that we also spent

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1hundreds of millions of dollars to go promote the new

2brand, and most importantly, that capability. That was

3important not only for us to be able to, again, garner

4that value proposition, but more importantly, and create

5that brand that the Professor just talked about in terms

6of that brand value, so people can recognize it and they

7can similarly make that connection and understand, it is

8in there, and it is just going to work, but as

9important, it is for our partners.

10So, knowing that we were going to go out and

11talk about this new usage model so that the average

12consumer could actually understand that, hey, this is

13now here and I can do it. We did several other things

14in terms of doing everything from what we called mobile

15experience zones, which were putting in place, you know,

16wireless notebooks in airports, among other places,

17where we just literally had some people that could

18actually see it and experience it, see what it was like

19to actually use it, and most importantly, see how easy

20 it was to do.

21So, one of the things I was asked to talk about

22is how did we come up with this decision to go down this

23path? This was a pretty radical departure for us and a

24pretty big gamble if you think about it. As I talked

25about, we had this product which frankly we knew was

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1exactly what we needed from a notebook market

2standpoint, from a processor standpoint, but we had very

3little experience in the wireless arena, and actually,

4this was a brand new product for us, so we had to come

5back and we had to develop a whole new product that was

6going to be part of this, because the only way that we

7could validate and make that promise, again, is that we

8knew it was going to work, again, back to our brand

9promise and our ability that we wanted to ensure that

10the quality is there.

11Other technological challenges. Well, if you

12are just introducing a single product, you know,

13complexity is death, right? You want to simplify

14everything. You now suddenly have three different

15components, you have got tight schedules, you have got

16technical risk in terms of are they all going to really

17work together, are they going to perform at the same

18level, are they going to perform adequately with each

19one.

20Branding, I talked a bit about, you know, there

21was huge, huge brand equity in Pentium. I think

22everyone hopefully recognizes that very quickly. When

23you think about it, though, Centrino was going to take a

24huge amount of money to brand something else, and you

25could argue, hey, why don't you put both brands on it,

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1but again, that just creates confusion. So, we had to

2take a business risk in terms of choosing to do that.

3And then finally, I talked about these large

4investments on hot spot enabling, co-marketing with many

5partners. We did this intra-operability testing and we

6had this huge advertising budget. At the end of the

7day, we spent an awful lot of money, and is it going to

8pay off? Are you going to get a return for that

9investment?

10So, obviously we made the big bet. We bet it

11was going to succeed. You know, when you look at this,

12it was a longer term bet. This is not a -- you do not

13go back. So, the intent is that you now suddenly have

14to think about all these components and all these pieces

15going forward as part of the overall platform and ensure

16that that is going to keep up.

17We had to make sure that wireless was actually

18going to deliver the experience, you know, betting on a

19new engineering team, as well as, hey, are you actually

20going to be able to grow your market, and specifically

21the notebook market.

22The other piece I did not mention that I

23probably should have earlier was that, you know, in

24fairness, we do not do this out of the goodness of our

25heart, you know, we are in business to make money. So,

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1one of the keys of this product was also this is one of

2our premium products, so our goal here, too, is to

3actually shift our mix up to enable people -- to give

4them that better experience with the Centrino, and plan

5on and hope that they will pay more, so, in effect, will

6Centrino increase our revenue as a result of doing this,

7but by focusing people on these added benefits,

8arguably, they will pay more at the end of the day.

9So, obviously the bet paid off. For us, it

10turned out to be a phenomenal seller, continues to be.

11It continues to be a strong uplift for us on our overall

12sales, but I think as importantly, if you look at the

13notebook segment today, it is grown dramatically versus

14the desktop segment, and we think that is one of the

15results of doing this, which actually helps all of our

16customers, as well as enabling these other usage models

17and these other revenue streams for other service

18providers and other components around it. So, you know,

19we call it the Centrino effect, if you will, which

20really lifted all boats around us, and I think the

21result is pretty clear.

22So, today, wireless computing is ubiquitous, you

23know, two years after a huge investment and a lot of

24time, and obviously you will see what is coming next

25from us shortly.

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1Thank you.

2 (Applause.)

3MR. ELIASBERG: Thank you very much, Jeff.

4Our final speaker before we take a break and

5then begin our round table discussion is David

6Scheffman, a director of the consulting firm LECG and an

7Adjunct Professor of Marketing and Strategy -- excuse

8me, Business Strategy and Marketing at the Owen Graduate

9School of Management at Vanderbilt University, where he

10was a chaired professor from 1989 until 1998.

11He created and taught the business strategy

12curriculum at Owen, at the Owen School, and continues to

13teach one course a year every other weekend in the fall,

14so I guess we are in the middle of it right now, on

15business strategy and the Executive MBA Program and has

16won a teaching award for this program.

17Dave is a noted scholar in the area of

18industrial organization and antitrust economics, among

19others, having authored several important articles and

20books on topics such as market definition, merger

21analyses, analysis of the various injury and vertical

22analyses. He also has written on, taught and consulted

23on issues involving business strategy, marketing,

24pricing and intellectual property.

25Dave, thank you for coming, and we very much

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1look forward to your presentation.

2DR. SCHEFFMAN: Okay, thanks. It is good to be

3back. I have got my usual audience, usual small

4audience. I can tell I am not in a business school,

5because probably you cannot read the slides, which

6should be, you know, you bounced out of the school

7immediately if that was true. Your students would

8revolt, and you do not have good sight lines and

9comfortable chairs and hookups for your computer so you

10can search the web while I am talking. All right.

11A little bit more about my background. I

12started out as an economist, and I taught Ph.D.

13economists and did research in theoretical economics

14before I happened to come on leave to the FTC in 1979, a

15very exciting time at that time, because I remember we

16were trying to break up the cereals companies and DOJ

17was trying to break up IBM, and we were investigating

18the auto industry and stuff. I will talk a little bit

19about that.

20Then I came -- I was here for a really exciting

21time, which was with HSR and the Reagan Administration

22and the change in merger policy, and we actually had

23horizontal mergers to look at for a change, because we

24had not for many years, because most horizontal mergers

25were blocked by the Government and were not attempted,

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1so because of HSR, we got to look at all sorts of

2industries. It was really very interesting, and I

3learned a lot, and a lot of us that have been involved

4in industrial organization in that period learned a lot,

5and what we learned is, gee, the real world of business

6behavior and competition is just a lot more complicated

7than our simple models.

8I worked on, I was lead staffer on one of the

9last real oligopoly cases, the ethyl investigation,

10which the companies actually did behave like a real

11oligopoly as they priced -- as they largely priced in

12lockstep and had uniform prices, which is that they fit

13very well a standard economic model of oligopoly, and

14the FTC challenged that and argued that that was because

15there were certain practices they were engaging in, and

16the FTC lost that case, but what was striking about that

17case is I have never seen another industry since. We

18had a number of other investigations at the time that I

19was involved in and looked at similar industries, and

20none of the rest of them looked like that. So, none of

21them looked like a classic economic model of oligopoly.

22So, I spent a lot of time, most of my time in

23the eighties was spent looking at mergers. I learned

24all sorts of stuff, where I learned facts and saw all

25sorts of interesting things, and then I went to

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1Vanderbilt, where the dean was an economist, and said,

2well, you can come in and, you know, kick off our

3business strategy program, and I said, what? Well, I am

4a Ph.D. economist, and I have learned a lot about

5competition, so I can do that.

6So, I went in and, it was not overly successful.

7As David can tell you, teaching MBAs is a very

8challenging task, and I had to -- you know, I taught it

9and actually dropped out for a year, and I sat in on

10some things, and I read a lot of material and everything

11and I thought about it, and then gradually I got it

12right. So, actually, my course is -- I will give myself

13a plug -- is usually the highest rated course in the

14program, and that is in part, as David will tell you,

15anybody who can do a good job teaching strategy is going

16to get high ratings, because it is what students come

17into the program for. So, if you get it right, you

18know, they are going to like you.

19But I think I did contribute a lot, because I

20think I do get it right, add value, particularly -- now,

21I still -- the only thing I teach these days is

22executive MBA students, which I delight to teach,

23because they are actually on the job. MBA students,

24even though they have a number of years of business

25background before they come, that is the requirement in

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1any major business school, you know, a couple weeks into

2the program, they have forgotten about that entirely.

3They are back in school, you know, you try to engage

4them about real stuff, and they say, what is on the exam

5and how are we going to get a job? But the executive

6MBA students are wonderful, because they really take it

7seriously. The problem is sometimes they take it back

8to the job and apply it. So, that is my background.

9So, when I was called by Pat to do this, I said,

10gee, this is great. I have done both these things, so I

11can talk about this. Well, then actually I thought

12about it, and I said actually it is going to be

13difficult to figure out what I would say. So, I am

14going to tell you what I do have to say.

15First of all, because I want to say a number of

16things critical about Section 2 and Section 2

17enforcement, Section 2 is -- I have been an antitrust

18enforcer for many years, I believe in the antitrust

19laws, and Section 2 is important, but the context here

20is most markets have become increasingly competitive

21over the past 25 years, and it is strikingly different

22from when I arrived at the FTC in 1979 and now today.

23If you think about the auto industry in 1979,

24think about IBM and, you know, things change so fast

25because of globalization, because of technology, because

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1of information, because of sophistication of customers,

2because overwhelmingly competition in almost all markets

3is about a product now, in the real sense, not like in

4the 1950s auto industry, they come out with a new model

5each -- a somewhat changed model of each other. The

6competition in most markets, even in industrial or

7commodity markets is overwhelmingly about product these

8days. So, it is not an economic climate conducive to

9coordinated oligopoly behavior, which is what we learned

10about as economists in my day, probably still do.

11Section 2 is important under the purpose -- the

12real effect of the antitrust laws, an important effect

13of the antitrust laws is deterrence, and I think

14deterrence largely works. I am concerned that if it

15works too well. I see a lot of counseling as a business

16consultant and in other ways, seeing companies being

17advised not to do stuff that I wonder why they are being

18advised to do that other than having been an enforcer, I

19can understand that particularly the risk of not

20enforcement but private litigation is a significant

21deterrent to otherwise, you know, procompetitive

22activity.

23Federal enforcement policy has advanced a lot in

24the last 25 years, I think in a permanent way. I think

25we might -- you know, a new administration might be more

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1aggressive than the current administration is, but I

2cannot imagine going back to the 1970s and trying to do

3things like break up the cereal companies or IBM or

4things like that. I think this has come because of a

5learning experience, an experience in litigating and

6very fact-intensive cases, like the cases I talked

7about, and other -- and lot of learning from HSR and

8mergers.

9The beauty of Section 2 enforcement, as I have

10written, is that, you know, for most real Section 2

11violations, you are going to have a lot of complaining

12parties, and so you do not need to worry about finding

13Section 2 cases. The real problem is finding the ones

14that are worth pursuing, which are far less than the

15ones that come to your door.

16Clearly economic theories have a very important

17impact on Section 2 law and policy, but there are

18limitations to economic theory. I am an economist, but,

19you know, I had a very good marketing professor

20colleague at -- who was -- went to the Sloan School, an

21economics-oriented business school, but they all are

22these days, and he wrote a book that said everyone in

23marketing or business should learn some economics, just

24do not learn too much, and I think that is right,

25because what economics is good at and is very good at

138

1gives you a very limited slice of what business behavior

2and conduct is about, and it is difficult actually with

3an economist, strong economist mind set, to get out of

4that and try to understand.

5I remember once seeing in a document in a

6merger, a company -- they were considering the strategy,

7this was a branded product, they were going to raise the

8price of the product, use the money that they got

9from -- the extra profit they got from raising the price

10to do advertising and promotion, and as a result of

11that, they thought they would be able to increase the

12sales of the product. Now, that is a pretty foreign

13idea to an economist. I do not think it is a foreign

14idea to a marketing professor, which takes into account

15that price is just one of the four Ps, and two, most

16product lines and businesses are largely self-financing,

17so if marketing wants to do something, they have to come

18up with the money somewhere, and this was their idea of

19how to come up with the money.

20Okay, limitations of economic theory. The power

21of economic theory for antitrust is in market power

22models and the model of monopoly and oligopoly and other

23sorts of things like that. That is the economic basis

24of antitrust enforcement, but economic models largely

25totally assume away all the important businesses

139

1considerations. They assume there is a product. They

2assume there is a demand curve. And the issue is, well,

3choose the price on the demand curve.

4 Well, that has very little to do with real -- it

5has something to do, but it has very little to do with

6real business behavior, especially these days, which is

7speaking about what products should we have, what can we

8create, what can we introduce, and who can we find to

9buy them, and how, how do we get to market. So, real

10world products and companies have to create and modify

11products and services, they have to find customers, they

12have to try and sell.

13So, the demand curve is that convenient

14construct, and it does tell you something about pricing,

15which I think any marketing person would agree with, but

16it is not -- a demand curve is not -- it is a result

17fundamentally of business and marketing strategy.

18Also, a great puzzle to economists are that, you

19know, production and cost curves are things that just

20exist. They result as the existence of what happens

21inside a firm, and what we have seen, great revolutions

22of that in our economy, for example, the so-called

23Toyota manufactured cars and other sort of consumer

24durables fundamentally, you know, fundamentally

25revolutionized automobile production. You could

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1actually produce higher quality cars at lower cost than

2what at the time -- in the 1940s, say -- was the GM

3approach, was clearly, as far as we knew, the most

4efficient way to do it. It was no longer -- it was no

5longer efficient to do that. So, competition on costs

6and production techniques is very important and cannot

7be taken as given.

8I think a real problem with economics is that

9although there are dynamic models of competition in

10firms, in reality, they are really static and a snapshot

11of economics is static, and competition these days in

12all markets is not fundamentally dynamic. It is about

13developing new products, new services, new technology,

14new capabilities, et cetera. I am not saying that, you

15know, that the static view is always wrong, but let's

16say I think that it gets us into trouble in Section 2

17when we try and apply Section 2 sometimes, particularly

18in high technology markets.

19The problem with economics is there is very -- I

20think there was a session I was not able to attend on

21empirical analyses for unilateral conduct. I do not

22know what it said, but I think I know the literature,

23and I think the answer is there is very little. There

24is very little credible use for economic -- empirical

25economic research. There is a lot of research -- there

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1is a lot of research on business strategy, not of the

2sort mostly that economists would do, but very

3insightful, and I will talk about that a little bit

4 later.

5 So, what is the relationship between business

6strategy and economics? Economics provides a lot of

7tools. The tools for profit maximization, that is

8consumer demand and the cost curve, and the lessons for

9profit maximization are profit-maximizing capacity,

10expansion of R&D expansion or whatever, tools for

11analyzing competitive strategies, equilibrium analyses,

12really important, which is -- that is a really unique

13contribution I think of economics, of understanding --

14and game theory is part of that, but understanding that

15-- you have to understand how the interactions of the

16various actors in the competitive arena you are looking

17at, what the outcome of that is, and economics is really

18plus game theory, and the use of game theory by

19economists have really been the main contribution to

20that.

21Fortunately, the tools -- economics has very

22limited tools for analyzing the efficiencies or business

23justifications in the sense we use in antitrust, either

24in mergers or in Section 2.

25What is the discipline of business strategy?

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1Well, it is largely multi-disciplinary, largely case

2study and industry study focused, very rich in facts.

3It is very interesting because if you look at what

4industrial organization economics was in the fifties

5before it was taken over by the theorists, it was

6exactly that. It was some combination of Professor

7Smith's and Professor Reibstein's combination of

8marketing and history and use of economics, case

9studies, and was what industrial organization economics

10largely was, and then it was taken over by the

11theorists, and now we are somewhat coming back, but as

12consultants, unfortunately, rather than as active

13academicians, because we usually cannot publish the

14results when you have proprietary information. So, what

15we do now as antitrust consultants is we do a lot of

16case study analyses, apply the tools of economics and

17other tools.

18The practitioners of business strategy, when I

19went to graduate school in economics, there was not such

20a thing as business strategy really. I mean, there were

21people, but the people who invented business strategy

22somewhat after that, which were Bruce Henderson, my

23departed colleague, who actually started The Boston

24Consulting Group, and Michael Porter, and a number of

25others, and this -- I was lucky because about the time I

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1went to Vanderbilt in the late eighties, business

2strategy began to become a real discipline -- it had

3been for a while, but it became a real discipline and

4actually has made great inroads since that time, and

5practitioners in business strategy have typically been

6marketing people. That is probably the typical person

7who teaches business strategy. I think the original

8people that taught business strategy were often

9organizational theory people or, you know, people with

10general business background, and then the economists.

11We economists got into it because we said, well,

12we know about strategy, so you increasingly, including

13at Wharton in the business -- in the business strategy

14area, you have a lot of economists floating around, I

15think with -- and more and more Kellogg probably

16teaching business strategy in other places, like me at

17Vanderbilt and others. So, it is a very fertile field

18in which a lot of lines of research are done.

19What does it do? Well, what is accomplished, I

20think, is, you know -- which it seems trivial but was

21actually quite important, which was to analyze and flesh

22out the rules of value creation, value appropriation,

23and I will talk a little bit about that, really

24understanding in a way relevant to real business and

25real business behavior how value is created and how

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1value is appropriated, what the bases of success are,

2develop the template and tools for strategic analysis.

3What is taught in the typical business strategy

4courses? Not antitrust. Certainly if anything is

5broaching on collusion or anything pop up in class, we

6certainly say do not do that. I teach -- antitrust

7issues come into my class, I teach a case about the

8breakfast cereals industry in the eighties, which was

9somewhat based on the FTC cereals case, but the emphasis

10entirely is on business strategy, and the context of the

11FTC was investigating the industry, so we spend very

12little time.

13That is not to say any good business school

14program will have an ethics and business law program, so

15they will warn people about antitrust, but it is really

16quite striking how little -- the learning of antitrust,

17 how little use it is really for actual business

18strategy.

19Okay, business strategy learning teaches us

20that, you know, what the basic conditions are that are

21necessary for sustainable competitive advantage, and

22probably you cannot see this unfortunately, but a

23sustainable competitive advantage means that you make a

24very good return on your invested resources compared to

25what your opportunity costs are, and in simple terms, I

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1think what I would articulate in a business strategy

2 session is you have the right combination of resources

3and capabilities, and you put them together in a way to

4develop and get to market products and services in a

5situation where you are somewhat limited from the

6competitive forces. That is a positioning.

7You have taken something that can create

8significant value for downstream customers, and you get

9the contribution of significant parts of value, and the

10key part of that learning is you have got to be in a

11situation where it is not a commodity type competition.

12So, you have got to be differentiated in some respects.

13And as David said, business strategy teaches us really

14two ways of competing, competing on a lower cost basis

15or a differentiation basis.

16I am going to -- since I have run out of time

17almost, let me try and get to the punch line here on

18Section 2. We try lots of things. There are lots of

19economic theories, and they have been around for a lot

20of years, and all the things you might think about

21Section 2, manipulation of capacity, intellectual

22property, predatory pricing, bundling, which is

23unfortunately a new event, manipulation of product

24characteristics, distribution, and you have heard now we

25have purchasing, so those theories have been around a

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1while and they have been tried in various capacities,

2and we have a pretty checkered record of enforcement.

3 It is interesting, if you take the cases of the

4late seventies, early eighties, they were business

5strategy cases. That is what -- exactly what generated

6them, the Dupont case, the Kellogg's case, IBM, are

7really fundamentally business strategy cases, and I

8think none of those cases were won in the end, they were

9settled or lost, but the fact finder said, well, this

10looks like competition to us.

11And I think the lesson -- since I am almost out

12of time -- the lesson I would draw for business strategy

13is, business strategy and business conduct is really

14fundamentally about value creation, and to some extent,

15about value extraction, of course, because you have got

16to make money to justify your resources in it, and we

17tend in Section 2 in antitrust to look at a snapshot of

18the way the world is and think about what a firm maybe

19should not do if it is got a "dominant position."

20Now, with Section 2 -- there is certainly a role

21for Section 2. Where Section 2 gets into trouble is

22when it tries to meddle around with what is really core

23value creating activities in a market. Microsoft, there

24are very, very good reasons for Microsoft to move into

25lots of other applications of the browser. I mean, it

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1was interesting and not a major part of the case, but

2the -- I am sorry, the operating system, but the

3operating system had devoured all sorts of software by

4the time the case was brought. Remember all the file

5management utilities and being able to have files with

6longer names and all those other sorts of things, which

7are now part of the operating system? Of course they

8should be part of the operating system.

9In other things, it is not surprising, you know,

10 more and more complementary things, like office type

11software and everything, it is not surprising that those

12might be complementary to the operating system at all.

13So, the focus on that and the idea that that should be

14regulated was, you know, really in my view a very bad

15idea. I was not involved in Microsoft in any way, and I

16do not have deep knowledge of it, and I am not defending

17the things that Microsoft did, but certainly from what I

18understand, it looks like things you would expect

19them -- that they should have done.

20But Section 2, messing around with what is

21fundamentally about value creation in a market is not --

22you are essentially regulating the competitive process,

23and we know antitrust is not a regulatory instrument and

24should not be regulated.

25The other thing is when Section 2 tries to

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1regulate what the competition is about. I was fortunate

2enough to be an expert for U.S. Tobacco in the Conway

3case where one was allegations was U.S. Tobacco was

4using category management. Duh. Every major consumer

5product company uses category management, and the

6argument was that somehow U.S. Tobacco used category

7management to either hoodwink WalMart or coerce WalMart

8or bring WalMart into some collusion against U.S.

9Tobacco's competitors.

10That was silly, okay? The jury did not think it

11was silly, but it does show if you get a private case,

12which is where the action is in Section 2, if you have

13got a situation where you have, arguably, you know,

14market power, monopoly power, as U.S. Tobacco argued

15they did because it was, you know, a very large share,

16then you have got to be -- the lesson is in the

17Microsoft decision, at least that is the -- you have got

18to be really careful what you do, and that is I think

19where Section 2 really gets into trouble, is when you

20start regulating normal business behavior, when you

21start trying to regulate the way value gets created, is

22where you get into trouble, I think particularly in high

23technology markets that move so fast.

24Remember, whatever there was in the IBM case was

25over by the time it settled. The market had moved so

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1fast by that time, it was silly, and the market actually

2moves so fast in operating systems and other things

3that, you know, it was not anything like the market that

4the Justice Department attacked in the original case.

5Again, I am not criticizing bringing the case.

6So, I think where Section 2 -- where business

7strategy can help is it provides us a deeper

8understanding about the way competition really works,

9about the rules of value creation and how they differ in

10different contexts, how value extraction works and why

11it is important, and that is what is missing, and

12industrial organization economics does not provide that,

13the law does not provide that. We take each new

14situation as lawyers and economists and we try and fit

15what we see into the paradigms we know, and we have to

16enlarge our understanding and our knowledge to be able

17to understand better business behavior.

18Okay, that is not to say there are not good

19Section 2 cases and there is not a role for Section 2,

20but that is where I see where the problems are and what

21the contribution of business strategy could mean to

22that.

23Thanks.

24(Applause.)

25MR. ELIASBERG: Thank you, Dave. With that,

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1let's take a ten-minute break, and then we will return

2for first some thoughts and commentary by Professor

3Smith, and then a round table discussion. So, a

4ten-minute break, please.

5(A brief recess was taken.)

6MR. ELIASBERG: If folks wouldn't mind taking

7their seats, and we can get started with the

8observations of George Smith, and then we can give each

9of the presenters a chance to comment on what they have

10heard, any thoughts they may have on that, and then we

11will open it to a round table discussion.

12So, George, please go ahead.

13DR. SMITH: All right, thank you. Good

14afternoon. I was here this morning, and I was added to

15this panel more or less at the last minute as -- I am

16not sure why. I guess they thought I might have

17something useful to say, and I was also asked to speak

18specifically about what gets taught about antitrust in

19business schools, and I will address that, but I did

20want to at least make a couple of observations about the

21presentations that we just heard, which I found

22particularly fascinating.

23For those of you who were not here this morning,

24I am an historian by training, even though I teach in

25the Economics Department at the Stern School, and I am

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1very interested in how business strategy has developed

2over time and how we have to think about business

3strategy as a discipline and possibly a way of thinking

4that may be increasingly useful to antitrust authorities

5and policy-makers.

6In business schools, of course, what we teach

7our students is how to drive toward monopoly. That is

8what we are there to do. That is our mission. Nobody

9wants to live and work in a world of perfect competition

10where the prices are driven by costs and you do not have

11any incentives to innovate or create new wealth. That

12would be pretty boring. So, explicitly, what we do is

13we help create cases for you to prosecute, and that is

14our function.

15Now, we heard some interesting stories today,

16very different points of view and sort of vision on this

17problem of business strategy and the drive toward

18monopoly. First of all, we hear that at Wharton, they

19teach marketing strategy as a way of gaining a

20competitive advantage. And a competitive advantage

21means, of course, putting yourself in a position where

22you can charge higher prices for your products and

23services.

24Then we heard about Intel, which is a company

25that practices this sort of thing, and at Intel, of

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1course, branding is very important, and we heard a

2wonderful story about how creating a brand not only

3enables Intel maybe to charge higher prices than they

4might otherwise receive if it were just offering its

5product as a commodity. But it also implies a promise

6on which they have to continuously deliver at higher and

7 higher levels of quality over time, and that seems to me

8to be a pretty good thing.

9And finally, we heard about the limits of

10economic theory and an invitation to think more broadly

11about strategy as a discipline for understanding how

12business people really think and really behave and to

13improve our appreciation for that as people interested

14in policy.

15Now, I will just leave that hang there and hope

16that we will have lots of questions and thoughts about

17those basic issues.

18As for what gets taught in business schools

19about antitrust, I did not have a lot of time to think

20about this, even though I have been involved in academic

21administration for a period of time in the executive

22programs at NYU, where I was the academic director for

23three years, and I learned a lot about the curriculum

24and what gets taught in it, and I certainly have

25colleagues who know something about this.

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1When I am put in a position like this, what do I

2do? I do what every good academic does. I rip off

3somebody else's work which does not fall within your

4jurisdiction but my colleague, Larry White, some of you

5know him, he has had a career in public service as well

6as academics, did a survey a few years ago, I think

7around 19 -- excuse me, 2002 -- I am stuck in the wrong

8century -- 2002, where he surveyed about 33 leading

9business schools to see what they were doing in

10antitrust, and he discovered that there was scarcely a

11business school that offered a course in antitrust

12unless it was offered once in a while as an elective.

13More and more business schools over the years have

14withdrawn from teaching IO, for example, industrial

15organization. He did find that what antitrust was being

16taught in business schools generally cropped up

17episodically in courses, such as David's, where

18occasionally you have to remind students that some

19things they might do might transgress or fall outside of

20the law.

21And then Larry gave some thought to what should

22be taught in business schools about antitrust and how,

23and his conclusion, and I largely agree with him, is

24that in a business school, where we are mainly concerned

25with teaching people skills and providing them insights

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1on things that they can use on Monday morning as well as

2hopefully ten years from now, there is not a lot of room

3for teaching the fine points of the law in business

4schools in a way you would in a law school. And

5business school students, of course, are not demanding

6that we teach them the intricacies of tying and

7bundling, predatory pricing and that sort of thing. But

8Larry did come up with some interesting formulations

9which I will share with you about what students need to

10know about antitrust and how it should be delivered.

11First of all, students should always be aware

12that antitrust policy exists, and there are good reasons

13for it. There are good social and economic reasons for

14antitrust. They should understand that there are dead

15weight losses in monopoly situations, and very often the

16drive to monopoly power leads more toward income

17redistribution rather than wealth creation and that is

18something that society has to worry about. It is always

19been my feeling that businesses are supposed to be in

20the business of wealth creation and politicians are

21supposed to be in the business of wealth redistribution,

22and when businesses start doing welfare distribution,

23you lawyers should start paying attention.

24Then there should be some admonishments given to

25students in the context of the course materials that

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1certain actions that they take may make their firm

2liable for antitrust action and in some cases may make

3themselves liable for criminal action. They need to

4know that. They need to be sensitized to categories of

5issues for which they should be talking to their

6corporate counsel or seeking advice from their

7superiors. There are other things one might bring up,

8but I think those are the main points.

9Finally, I was asked at lunch today to talk more

10specifically about the role of ethics courses in

11business schools, and I can speak to that. I am

12delighted to hear that ethics is taught as a course as

13Wharton. Ethics is offered as a course in some business

14schools but not in others. Columbia University, which

15pioneered a lot of modern business ethics teaching,

16actually dropped its ethics course for a while under the

17assumption that professors ought to introduce an ethics

18model into every course they teach. I think that kind

19of decentralized approach can carry some hazards, if

20only because in any population, there are going to be

21sociopaths who ignore this instruction, and to be

22serious, I do not know a single professor who thinks he

23or she has enough time to even advance their core

24disciplines in whatever amount of time they have, let

25alone introduce something else.

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1So, I think it is a good thing for schools to

2offer ethics courses that deal not only with legal but

3also extralegal and nonlegal problems, nonmarket

4problems in business decision-making.

5What we have done at Stern is to develop an

6ethics course which has unfolded over a period of time

7from the 1980s through the 1990s and has evolved into

8what I think is a pretty good model. We organize the

9course around our existing senior faculty from all the

10disciplines of the school, and faculty take turns

11offering instruction in the ethics courses. We do not

12leave it to ethicists or philosophers to do this. We

13think the students feel that the course is a lot more

14credible if it is delivered by the finance guru, or

15 marketing professor, and then we bring the faculty

16together into seminars where we go through particular

17cases to help them better present the cases in

18classroom.

19With respect to antitrust, I can say that it

20forms a very small part of the ethics curriculum, but a

21good part of the ethics curriculum deals with problems

22of compliance, and we do spend a lot of time on the

23sentencing guidelines in an attempt to scare the

24daylights out of our students as to all the terrible

25things that might happen to them, even if they are just

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1peripheral to schemes that are going on in their

2companies.

3So, that is what business schools are doing, but

4clearly, business schools do not focus on the core

5antitrust issues, and I think, ultimately, it is

6precisely because antitrust, as it is traditionally been

7addressed in the economics curriculum, does not fit the

8criteria that David Scheffman laid out for the real

9business world. It does not help people understand what

10really goes on in the business decision-making

11processes.

12 Finally, in David Reibstein's presentation there

13was one slide where he introduces a discussion about how

14people should think about anticipating likely outcomes

15of their own behavior -- it relates to game theory and

16scenarios that have become integral to the teaching of

17business strategy, marketing, and I know I beat this

18drum this morning, but I think those kinds of tools, as

19they become more and more refined and more accessible,

20are things that policy-makers should incorporate into

21their own analysis of business practice, in addition to

22the economic analysis one already uses, all right?

23So, I will leave it there and hope for a lively

24discussion.

25MR. ELIASBERG: Thank you, George.

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1(Applause.)

2MR. ELIASBERG: What we thought we would do now

3is to allow each of our three presenters from before the

4break if they would like to say a few words, and then

5turn to a guided discussion with Ken and myself.

6So, Dave Reibstein, you were first, if there is

7anything you care to add or comment on what you have

8heard, we would be delighted to hear it. If you could

9speak into -- all the speakers, if you could speak into

10the microphone for posterity's sake here.

11DR. REIBSTEIN: Sure, okay.

12One of the things, by the way, you did not

13provide in my background, and it wasn't relevant at the

14time, is I served for several years as the dean at

15Wharton Graduate School, and in that role, one of the

16questions that I had to ask was where within our

17curriculum we should have, you know, business ethics and

18business law taught, and we spent some time addressing

19the question that George was just raising of whether or

20not it should be taught as a separate course or taught

21within existing courses as it applies along each of

22those disciplines, a very controversial issue.

23In one sense, the great advantage of having it

24as a separate course, because we could have some of

25our -- we have a Department of Business Studies and

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1Business Law, and these are all lawyers that teach in

2these courses, and they know the law better than the

3rest of us that sort of do not really know the law, just

4know about the law, a little bit about it, and it seemed

5like that was a logical place for it.

6On the other hand, gee, when you are talking

7about making real marketing decisions, maybe it should

8be in the marketing aspect. There is this real

9trade-off that we wrestled with quite a bit, and the

10argument against the separate course is that, you know,

11it is sort of like you go to church on Sunday, and then

12the rest of the week you do whatever you want to do. We

13have a business ethics and law course, and then the rest

14of the week, you do all the things that you want to do,

15and that did not make sense, yet the reality is, you

16know, as George pointed out, it is hard for people to

17keep up with enough time for their own discipline and

18the knowledge base, and so we elected to do, you know, a

19separate course, and then we have elective courses

20within each of the disciplines. So, in marketing, we

21have a marketing law course that I did not mention.

22The problem with that is, we get about 30

23students a year out of our 800 a year that take that

24course, and my guess is that the 30 who take it are the

2530 that do not need to take it, and that is a problem

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1that we have.

2The other thing that I am curious about, and I

3really raise it as a broader question, is I think most

4of the law that we have is U.S. law. Most of our

5students -- actually, most of our students think

6globally. Almost half of our students are -- carry

7non-U.S. passports. Almost all of them have spent some

8time living outside the United States, and all of them

9aspire to go to work for global businesses. So, trying

10to think about, so, what are the laws and what are the

11standards that I should be thinking about globally, and

12do I need to think about, well, I have got a monopoly or

13undue power in Indonesia, or do I need to think about,

14well, what is my, you know, overall position globally,

15and do I need to understand each of those local laws --

16you know, it is a complex issue, and it is a real

17struggle for us to try and think about, and it is an

18issue of how do we try and take a broader global

19perspective on some of the standards and perspectives

20that we are going to take and even how we view the law

21as it applies to business.

22MR. ELIASBERG: Thank you, David.

23Jeff, any thoughts or comments?

24MR. McCREA: Just to add to that, I will give

25you one perspective as a former student as opposed to a

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1professor. There was a business ethics class taught at

2Michigan when I was there ten years ago, and I will be

3the first to tell you I did not take it, because there

4were a lot of other interesting things to be doing, so I

5think it is interesting there is a trade-off of do you

6build it into your classes or do you have it as

7something separate.

8The second comment, which I think you just took

9my thunder on, was exactly the global nature of all the

10businesses. When we look at this, we absolutely have to

11look at this globally. We will not survive if we just

12look at it in a local market. So, both in terms of

13where manufacturing is moving to to becoming the lowest

14cost to how you compete in that environment, as well as

15what are the local laws, how do they apply to the U.S.,

16and frankly, you know, what -- if you are building

17something somewhere else, how does that apply to the

18work in the market that you are actually selling to

19here, and I think that is becoming pervasive in all of

20our industries today.

21It is a great point that I was going to build in

22as well, which is when we look at this, we do not just

23think of the U.S. at all. I mean, in fact, very few

24businesses that I know of do.

25MR. ELIASBERG: Thank you, Jeff.

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1Dave Scheffman, any thoughts or comments?

2DR. SCHEFFMAN: Yeah, I want to give the rest of

3my presentation, but I do want to talk about something

4that George -- because George, I can respond to George.

5George said something that I know I cannot quite

6characterize, he said what we are teaching is how to get

7market power and charge high prices, and I know that is

8not what he meant, maybe that is what I am

9characterizing, but that is not -- you know, I think an

10important thing for us to understand is a sustainable

11competitive advantage usually has nothing to do with

12market power other than in a trivial sense. Most firms'

13products or services, when they raise the price, they

14would not lose all their customers, so in that sense

15their demand curve in the short run is downward sloping,

16but that is not what sustained competitive advantage is.

17It is about producing a product or service and

18finding it -- in the right way and getting it to market

19in the right way and finding customers who are willing

20to pay significantly more than what it cost, and in part

21it means that it is difficult for other folks to do that

22same thing, but that is not market power, and that is

23not what we mean in Section 2 other than in the early

24termination cases, antitrust cases where you get these

25real narrow markets alleged by plaintiffs, et cetera,

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1but it is really not about market -- it is really not

2about market power, what we are teaching about at all.

3You are trying to create the demand curve and

4move it up. Of course, the demand curve is downward

5sloping in some sense, but that is not the important

6point at all, okay? It might be you are creating a

7demand curve that is quite elastic. Look at WalMart.

8WalMart has nothing to do with a downward-sloping demand

9curve. It has lower costs and it prices below the

10competition and it tries to drives sales.

11Now, firms that are competing on a

12differentiation advantage, which George was alluding to,

13where you try to get a premium for your product are a

14little bit different, but it is, again, generally

15fundamentally not about how downward sloping the demand

16curve is. It is what demand curve you can create and

17what willingness to pay can you create that was not

18there before in the products and services you are

19bringing to market.

20MR. ELIASBERG: Thank you, Dave.

21Let me ask the first question, and it is kind of

22basic, but it is important for us laboring here in the

23agencies.

24 We have heard mention of the positioning school,

25what is associated with Professor Michael Porter, the

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1resource-based school and the abolitionary school of

2business strategy. It would be very useful for us if

3you could provide a brief description of the different

4schools and views, business strategies, just so that

5everyone is talking about the same thing. If I do not

6have a volunteer, David Reibstein, you are going to get

7it.

8DR. REIBSTEIN: So I am looking for volunteers.

9MR. ELIASBERG: If you can help us out here,

10just a brief description of what the various schools or

11camps within the business strategy schools are.

12DR. REIBSTEIN: Yeah, and I tried to give a

13little bit of an overview of that when I put up, you

14know, Michael Porter's Five Forces and talked briefly

15about that, and there are sort of different defined

16schools that are out there.

17I actually do not think there is a lot of -- you

18know, while there are sort of -- all of us that are

19teaching this stuff struggle to find something to teach,

20I do not think there is an addiction that any of us have

21or even a strong philosophy that most of us have other

22than here are the different perspectives when you are

23going to market, and frankly, if you asked me, so, Dave,

24you teach this stuff, marketing strategy, what is the,

25you know, resource-based school, I would say, well, that

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1must be Harvard, because we do not have any resources at

2Wharton, you know, but I do not know anything else that

3would describe what that school is.

4MR. ELIASBERG: Okay, fair enough. Just one

5follow-up question on that. Having said that, do any of

6these camps or classifications say anything in

7particular or specifically or differently than the

8others with respect to Section 2 and what we ought to be

9looking at with regard to Section 2?

10DR. REIBSTEIN: I am going to turn to Dave.

11DR. SCHEFFMAN: Let me say, I do not think they

12really differ. Industry analysis is a tool. Michael

13Porter, when he came out with that book, that the theme

14of the book was market structure is really important.

15He very quickly learned after that that that is not

16true. There is a lot of empirical evidence that market

17structure is not determinative. Market structure is

18something you need to take into account, and it is one

19of the fundamental contributions in the strategy, that

20you need to understand the external competitive forces,

21but it is not -- there is not a five forces school.

22There is no -- no one seriously believes that market

23structure is the determinative strategy. It is an

24important ingredient that you need to understand in

25crafting your strategy.

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1I think everyone -- anyone who teaches strategy,

2you can think about the resources-based, that is a

3better articulated version of Michael Porter's second

4book, which came shortly after, Competitive Advantage,

5which is all about, you know, more of what strategy is

6really about, and resource-based was a really good

7articulation of I think the basic economics of that. I

8do not think there are schools. These are tools in

9strategy. There is an understanding in strategy that it

10is a mixture of what you do internally matched with the

11external environment.

12And for Section 2, I do not think I have

13anything new to say other than what I said before, which

14is be careful when you are messing around with what is

15basic value creation and what the basic rules of

16competition in the industry are, and that is something

17that Section 2 should be very careful of getting into.

18The agencies I think largely have been recently, but

19most of Section 2 is about private litigation.

20MR. ELIASBERG: Okay. Just any disagreement

21with that George or Jeff?

22(No response.)

23MR. ELIASBERG: Okay, sort of following on that,

24and I think I foresee the answer, but let's be sure.

25What explanations or insights into particular types of

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1conduct that has been challenged under Section 2, you

2know, for example, things like unfair dealing, tying,

3predatory pricing, loyalty discounts, things like that,

4you know, what does business strategy provide with

5respect to explanations or insights with respect to that

6type of conduct that are different from those derived

7from industrial organization?

8Anyone? Dave Scheffman, you are a logical

9choice. Shall we start with you?

10DR. SCHEFFMAN: Well, I think -- and I have

11talked about this often in the past, I mean, you know,

12industrial organization -- the framework of industrial

13organization does not -- I am not saying there are not

14really smart people in industrial organization that have

15in some understanding of markets, but it is not

16something that industrial organization fits very well,

17okay? The marketing function is not understood in

18industrial organization, because of, to start with, the

19demand curve.

20So, we have funny things like an economist's

21explanation, eureka, you might have, you know, exclusive

22distributors or RPM because your distributors "provide

23services," and then you look for the elusive services

24like in Dentsply. There is something to that, but it is

25not those services. You think about what a captive

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1sales force does. Distributors are not resellers. They

2are important to branding, and they are your

3distribution. You are going to want to control them.

4There are reasons why -- in some cases clearly why you

5would want to control the margins of your product or

6your distributors when your distributors sell a lot of

7other stuff because that provides them the incentive to

8sell yours.

9So, it is really about sales and marketing

10things where the elusive search for the services, it is

11really about providing the right structure and

12incentives for marketing and sales, for middle men to

13sell your products, and that was a very -- Dentsply was

14very disappointing in many ways, but sort of saying,

15well, we do not see any services there, and they are all

16created out of whole cloth. Well, yes, because you were

17not even looking in the right place. In Dentsply,

18exclusive distributors are probably fundamental. The

19reason why Dentsply was where it was, it was often in an

20exclusive distribution situation.

21So, I think that is really -- I think in

22marketing practices, that is something where the

23antitrust law is not helped by economics in

24understanding what is really going on in business, the

25way distribution and marketing works.

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1MR. ELIASBERG: Okay. Anybody else on this one?

2DR. REIBSTEIN: Actually, you know, I do not

3even want to elevate it to the notion of a theory or a

4marketing or a business strategy theory, and I think it

5goes back to simply when we look at a lot of these

6practices, and we think about how do we need to acquire

7or how do we retain our customers, and one of the

8examples of those practices you sort of mentioned was

9loyalty discounting, just a way to try to encourage our

10customers to continue to buy from us, and it falls under

11the philosophy of I am trying to retain my customers

12because it is more economically efficient to do that

13than it is to attract new customers. Nothing more

14complex than that.

15 MR. GLAZER: What do you teach about loyalty

16discounts in school? Do you get into any level of

17detail about how to structure loyalty discounts?

18DR. REIBSTEIN: There is some discussion about a

19couple of aspects of it. One of them is -- you know,

20actually, I have got some colleagues that are working on

21some work that says, so, the tiered discounting, the

22tiered programs are really individual cases, and by that

23what I am referring to is sort of the gold, silver,

24platinum levels, making sense with that.

25What is ironic is one definition of loyalty is

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1customers are so loyal to you, they are willing to pay

2 extra for you, and what we do to our most loyal

3customers is we give them some of the better discounts,

4and it sort of is ironic that it works in this, you

5know, very convoluted way.

6 Now, I think it was Amazon that got themselves

7in trouble for one brief moment when they recognized

8that their loyal customers were less price-sensitive,

9and so they started offering discounts to new customers

10and higher prices to their loyal customers, and they got

11caught in that, not legally caught, but they caught at

12that by some users who, you know, blew the whistle on

13them, and they immediately abandoned that. But we do

14spend some time sort of talking about it is of value to

15you, the company, to keep your customers loyal, and

16because it provides value to you, you might be willing

17to charge a lower price, and so some of that discounting

18can make sense from a business perspective.

19MR. GLAZER: Do you teach anything about -- and

20this is for anybody -- anything about sort of what might

21be called absolute loyalty programs, a situation where

22you tell the customers that you will not sell to them if

23they go to other suppliers, which was the situation in

24the Dentsply case, a loyalty policy? Just moving a

25little bit away from a loyalty discount program to say

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1refusing to deal with customers who are not loyal to

2you. Are there sort of things that are taught or

3thought about in the business strategy courses?

4DR. REIBSTEIN: I do not think we put it in that

5frame -- I do not put it in that frame. On the other

6hand, I have an understanding and an explanation for it,

7of why one might not explicitly put it that way, if you

8sell to somebody else, I am not going to carry you, and

9the logic might go something like this.

10If you sell to competitor resellers, there is

11going to be competition on the market for this product

12driving the margins down that I would make on your

13product. If I have got other people that exclusively

14sell to me, the margins are protected at those other

15products, and as a result, I am going to be more

16inclined to carry the products that give me more of an

17exclusivity.

18And so one of the things that I do teach is a

19way to get more reseller support by providing them more

20of an exclusivity.

21MR. GLAZER: Okay. Now, how about flipping

22that? I think you were addressing a situation in which

23the reseller is getting exclusive distributorship, in

24other words, he gets a deal where the supplier is not

25selling that product to anyone else. Now, take the

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1reverse of that where the reseller agrees that he is not

2going to be buying from any other suppliers.

3DR. REIBSTEIN: If I am not going to be buying

4from any other suppliers, I am in essence giving you

5more shelf space, therefore, you are going to capture a

6larger share within my business, and as a result, I

7ought to be able to extract from you, the manufacturer,

8a higher support, margin, placement money, something, et

9cetera.

10DR. SCHEFFMAN: Well, that is the focus of the

11conversation, because where we get in trouble with

12antitrust is that the bribe is the quid pro quo for the

13monopolization, and I think it is really much more

14simple than that, but there may be some cases like that.

15It is how do you align the incentives of the reseller to

16sell your product? It is a no-brainer.

17In a lot of situations, you see captive sales

18forces doing the same thing that resellers do, and yet

19the sales forces, of course, are almost never selling

20competitors' products. Manufacturers' agents sell

21competitors' products, and that is because it is a

22no-brainer that if your reseller is selling only your

23product, they are going to do a better job, not just

24because they will not cannibalize your sales selling

25something else.

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1They are going to do a better job in a lot of

2circumstances, even taking that aside, in selling your

3product and really learning about it and giving the

4sales pitch for your product as opposed to saying, well,

5you could have this and you could have this and just buy

6something, I do not care.

7Now, there are some markets, we see downstream

8markets, supermarkets, of course, live by selling

9everyone's product. There is some point in distribution

10where exclusion is not going to work in a lot of

11industries. What the middle man does, the function they

12provide is just putting stuff on the shelf in a variety.

13That is what you expect. But any time where the middle

14man is involved seriously in things related to the brand

15and the sales effort, you know, actually trying to get

16people to buy the product, exclusion and exclusive is

17going to make a lot of sense.

18It is going to be the dominant -- in a real

19sense, it will be the best way to have distribution,

20whereas in a lot of cases it will not work. It is like

21the Monty Python Scotch tape store. The economics do

22not work, so the middle man has to carry competitive

23products, but where they do not, it is a no-brainer that

24exclusive -- it is the most efficient, and it does not

25have to be fundamentally to the exclusion of

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1competitors. It has to do with someone selling --

2concentrated on selling a particular product, where

3sales effort is the important thing, is going to do a

4better job than if they can say, well, you can buy this,

5 you can buy this, this, this, this, this does that, and

6they are simply going to do a better job.

7You have the same problem within companies,

8captive sales forces, where they are selling a range of

9products. You have to manage so they do not, you know,

10devote all their sales effort to, you know, the

11high-selling stuff, and you say, no, we actually want to

12push this product. You have got to direct them to, no,

13you have got to do that. So, if you look at captive

14sales, you can understand right away really why you have

15exclusives and why you could not in some cases because

16the economics just do not work.

17DR. REIBSTEIN: So, let me add just a little tag

18onto that, which I like the framing that David just

19provided, and we are looking at the manufacturer and the

20reseller, and one of the things he said is sometimes the

21reseller has to carry multiple -- you know, a wide range

22of products, and that is because the reseller has got a

23set of customers, and those set of customers may be

24demanding some choice and some variety, and so we have

25to look at sort of that complete picture. So, there

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1might be an advantage with respect to the manufacturer

2but a disadvantage otherwise.

3MR. McCREA: The other thing to add to that is

4from a reseller perspective, you can also look at the

5cost of carrying fewer products, and I will train my

6sales force to be more knowledgeable so that we have a

7range, but also everything from inventory carrying costs

8to just the overall breadth of the product line that

9they want to cover. So, if it is something it needs to

10meet and that is what they want, then they do not need

11to carry multiple products in that case.

12MR. GLAZER: I remember Monty Python's cheese

13shop, but that didn't have any cheese, okay? So, I do

14 not know what that reflects.

15DR. SCHEFFMAN: This is a store that only sold

16Scotch tape.

17MR. GLAZER: Yeah. I remember a bird shop and a

18cheese shop.

19DR. SCHEFFMAN: And it was not bundled either.

20MR. ELIASBERG: Jeff, let me ask you a question:

21You mentioned in your presentation that obviously Intel

22took a big bet, and let me ask you, what sort of

23simulations or some of the other things that we have

24heard about, especially from David Reibstein, were done

25before that happened, without getting into proprietary

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1information, but, you know, what sort of techniques were

2used to sort of scope out whether this was of value or

3not?

4MR. McCREA: Several things. I mean, from an

5overall understanding of the marketplace and

6understanding of the market environment, you have to

7look at what the competitive landscape looked like from

8both other wireless suppliers, if you will, we had to go

9through a ton of market research to go understand

10whether consumers would actually buy and pay for it.

11 I talked a lot about building an ecosystem

12around it and how expensive that would be. So, we did a

13lot of work into understanding what we thought we had to

14do, how to kind of get it to critical mass, so you did

15not -- kind of seeded it, if you will, and to let it

16grow with the business around it.

17Other things we looked at is what our

18competitive advantage was in terms of we talked about --

19in the space of microprocessors, having a product that

20was fundamentally built for a notebook and something we

21thought was unique at the time, and it was unique in the

22marketplace, so I think that fundamentally by itself

23offered us a competitive advantage and provided a value

24to the customers.

25MR. ELIASBERG: Right. In some of the materials

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1that Dave Reibstein's written, he has talked about the

2idea of war rooms and war games being played out,

3thinking out how a strategy might work out, a marketing

4strategy in particular. Anything like that done with

5respect to --

6MR. McCREA: There were some war games, but I

7think it is more in terms of understanding what the

8options are, frankly, for all these decisions, both in

9terms of launch timing, in terms of some of the risk

10factors, you have to look at several different options

11in terms of how to do it, and we looked at pros and cons

12of each and just applied basic business theory or

13business practice, which is deciding what is going to

14get you the highest return and the level of risk you can

15handle for what cost.

16MR. ELIASBERG: Okay. Another question for you,

17Jeff, before I let you off the hook. In your

18presentation, you made several references to ecosystems.

19How common is that phenomenon in marketing and are there

20any other examples that come to mind in general?

21MR. McCREA: At Intel or --

22MR. ELIASBERG: In general, if you could just

23help us out here a little bit.

24MR. McCREA: Hmm. I think that when you think

25of traditional -- we are probably in a somewhat unique

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1position, probably because we are involved in an

2important end product, the end product being a PC in

3this case, so as a result, you start looking around for

4all the other things that you need, and whether they are

5other things that are going to enable your product to be

6better -- you know, my favorite example -- I will answer

7your question a little differently.

8My favorite example is looking for uses for

9baking soda. So, if you think of baking soda 20 years

10ago, people use a pinch in what they are baking. Today

11most of you have some in your refrigerator, some in your

12toothpaste, et cetera, and so you start thinking about

13other uses for that product that you can use a much

14higher volume, so think of it in terms of that gave

15baking soda a whole new life cycle, if you will, product

16life cycle.

17A similar concept in terms of ecosystem that

18other companies do look at, who their partners are. You

19look at what is going on in the industry today, there is

20 tons and tons of co-marketing, where you see two

21companies who will pool their marketing resources in

22terms of how they go to market for complementary

23products. In particular, we talked about cell phones as

24an example, service providers subsidizing the actual

25phone itself, right, and then cable or satellite TV

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1companies do something similar with their boxes.

2Some of those dollars come from -- could come

3from the phone maker, it could come from the service

4providers. There is a lot of different examples where

5they do look beyond their own particular product, but

6look at how all the products work together.

7MR. ELIASBERG: With respect to this question,

8let me just ask if any of the three strategy professors

9have anything they would like to add or comment on with

10respect to the ecosystems.

11DR. REIBSTEIN: It is sort of just like

12bundling, right, that the bundle of the phone and the

13phone service, we are going to come up with a package

14that is logical with what it is that the customers want

15and hope to sell the thing, you know, in putting some of

16those things together.

17MR. ELIASBERG: And fairly common in marketing?

18DR. REIBSTEIN: And becoming more and more

19common.

20MR. GLAZER: Could we talk about -- go back to

21predatory pricing, which you talked about, David, in

22your remarks, and I think you distinguished between

23 predatory pricing and below cost pricing. Could you

24expand on that?

25DR. REIBSTEIN: Well, I actually said that there

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1were some times that you could price below cost that I

2would advocate, and I sort of distinguished it being --

3the distinction between pricing below cost and predatory

4pricing in that predatory pricing has some intent in it,

5and almost within the word, you hear, you know,

6predatory, trying to do something to one's competition,

7versus the below cost, which undoubtedly would have some

8impact, but the intent might be to make people aware, to

9try to get people to try.

10And then in the examples that Jeff just talked

11about, where you price below cost, which was the third

12set that I was talking about of where one might want to

13price below cost, of I am going to give you a phone and

14sell you phone service; I am going to give you a cable

15 box and sell you cable box service; I am going to price

16my computer printer at a relatively low price and sell a

17lot of the supplies, and that would the incentive, not

18that I know much about it.

19DR. SMITH: I wanted to change the subject just

20a little bit, if I may. When we think about business

21strategy, I think it is important from an historical

22perspective to ask the question to what extent antitrust

23becomes a component of business strategy for most firms,

24especially in private suits, and I wanted to ask David

25Scheffman to address this. We had a brief exchange

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1about that, meaning private suits to the degree where

2lawsuits are brought under the antitrust statutes as a

3competitive weapon or as an attempt to transfer from

4large firms to small firms and that sort of thing.

5DR. SCHEFFMAN: I do not know if I would want

6to -- the real exposure is private litigation under

7Section 2 of antitrust generally, and I think major

8firms have counsel, and, Jeff, I am sure you are totally

9lawyered up and not making any serious business without

10legal looking at it, and, you know, that is not -- I

11worry about that a lot, actually. I did some work at

12the FTC in the -- it was during my first stint, and it

13is really quite amazing how much lawyers have penetrated

14the management in American firms, and I think I have

15seen that some lawyers are really effective managers as

16lawyers, but I do not think lawyers are necessarily a

17good fit for someone running an enterprise, so I view

18that -- again, what I have seen in -- and you talk about

19predatory pricing, and it is impossible to win a

20predatory pricing case with a plaintiff, right?

21You get a lot of counseling within firms about,

22you know, if you are thinking about doing aggressive

23pricing nonetheless, because it is really expensive to

24defend, someone might bring a case, it is very bad for

25reputation, you know, so even for something like that

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1where there really is a pretty black line, it would be

2very, very difficult to actually win a case, and people

3still are pretty conservative, and you get much more

4conservative -- I am sure, Ken, from your former

5employer -- you get much more conservative in counseling

6on marketing practices generally, and boy, be careful

7how you term things and all that sort of stuff, which

8leads to a lot of counter-productive and devotion of

9effort for non-value creating things, but it is part of

10the over-litigation, the over-litigation climate, that

11the real exposure is much more, and the RICO is bad

12these days and environmental, which are worse than

13antitrust.

14MR. ELIASBERG: George, I am going to put you on

15the spot on this one given some of the discussions this

16morning in the session, but I am going to open it up

17again to the other panelists.

18What insights or values does -- lessons does

19business strategy teach us about crafting remedies in

20Section 2 cases?

21DR. SCHEFFMAN: I did not hear you. About what?

22MR. ELIASBERG: What does the business

23strategy -- what lessons or insights does business

24strategy give us with respect to crafting remedies in

25Section 2 cases, for Section 2 violations?

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DR. SMITH: Well, this really falls somewhat
1

2outside my expertise. I have to fly pretty high over

3the landscape to answer this one, I think.

4You know, I think what I suggested before, that

5business strategy as a basket of tools is probably

6something that ought to be incorporated more in

7assessing remedies or relief in particular antitrust

8actions, but also even preventively, I mean, before

9suits are brought, as David has suggested, it is

10important to understand I think more about how business

11people really think and what they are trying to achieve

12in business strategy as distinct from what economic

13models will necessarily predict, but I think this has,

14you know, pretty much already been said.

15Now, with respect to the history, there is

16something important that was raised this morning, and I

17think the development of the Chandlerian firm in the

18second industrial revolution I think, as it is

19 understood by academics, showed that the strategies of

20the dominant firms in the center industries were, in

21fact, aimed more at wealth creation and value creation

22than they were at predatory practices. That is pretty

23well demonstrated by the history.

24Now, the results in some cases may have been

25undesirable from the point of view of the law, but I

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1think we know a lot more about the intentions of

2successful businesses over time, that you do not stay

3successful for a long time unless you are creating value

4and you intend to do that.

5There is also a relationship the Chairman

6brought up about the dynamics of strategy and structure,

7organizational structure, which is something that was

8left out of the discussion this morning, but it came up

9at lunch, and that is that what we have learned

10historically -- it is a very simple problem, but it took

11a long time to really think through -- is that for every

12strategy, at least in theory, there is an optimal

13organization under which companies pursue that strategy,

14but organizations, once developed, are hard to change.

15Strategies are easy to change.

16And we find examples of firms like AT&T or

17Standard Oil in the early part of the century that at

18some point acquired a set of organizational rigidities

19and corporate cultures that were no longer productive,

20and in both cases we see that actions by the Government,

21whether intended or not, inadvertently led to more

22value. I mean, the breakup of Standard Oil, you know,

23turned out to create an awful lot of value in the equity

24markets, because the breakup value, you know, was much

25greater than the previous combination.

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1And with respect to AT&T, my own feeling was --

2and I did not say this this morning -- was that it was

3probably a good thing to bring the Bell System to an end

4when it came to an end, if only because it just

5unleashed a torrent of innovation for a long time, and

6having worked at the Bell System myself for some period

7of time from 1970 until '82, you could see this was an

8old, tired company, and you got to know the managers of

9the operating companies, and they were just itching to

10get out from under. History shows that there was a lot

11of dynamic wealth creation and innovation as a

12consequence.

13I am not sure what this all means for antitrust

14policy, but I do think that the relationship between

15strategy and organization is just yet another thing that

16at least academics certainly want to take into account

17and may factor into thinking about where firms are in

18their life cycles and what this means for the economy.

19MR. ELIASBERG: Dave Scheffman, you have had the

20advantage of teaching business strategy and being on the

21 enforcement side.

22DR. SCHEFFMAN: Well, I think we know a lot more

23from the enforcement side. I mean, I think we all as

24antitrust economists and lawyers that learn antitrust is

25about competition. It is not a regulatory instrument,

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1and we should not be -- we back into the regulatory role

2sometimes, essentially from what we have learned from

3mergers, and try to do something fairly simple, which

4the market does all the time, which was shop baskets,

5and sometimes it does not work very well. Sometimes the

6FTC -- the AOL/Time Warner consent and how that has

7played out, regulatory nightmare, and we have the EU

8looks like it is going to regulate Microsoft for -- into

9 the -- well into this century.

10I mean, we do not -- I think when we bring

11Section 2 cases -- I know this was the -- in the Section

122 cases I have been involved a lot on the inside, the

13ethyl case, there was not really a lot of serious

14thought about what the remedy was going to be. It was,

15 you know, win the case. I think there was more serious

16thought in Microsoft, but the idea -- and the antitrust

17principles were followed, I guess, break it up, seemed,

18you know, a ridiculous idea to me and to many others,

19and so you are left with a regulatory structure, which

20the appeals court, you know, did a relatively light hand

21on the EU.

22So, I think we have learned from Judge Green in

23AT&T and can just look at what the EU does, you know, we

24should think of Section 2 cases in terms of the remedy,

25the remedy is going to be regulatory, but think about

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1what the case is about and how much you want to pursue

2it, than to think more about the regulatory side.

3MR. GLAZER: One of the speakers earlier

4referred, maybe more than one, referred to the -- did

5not use the word "chilling," but the basic idea was

6chilling business strategy by concerns about antitrust

7law. I am wondering if anyone can point to a specific

8instance that they know of, and you can speak

9hypothetically, you do not have to identify the case,

10but where -- in which you think there was chilling of

11business conduct based on fear about legal liability.

12DR. SCHEFFMAN: Yeah, I had something I thought

13was actually quite absurd under Robinson-Patman in a big

14company that, you know, I advised it was a relatively

15small number of customers, selling telecom equipment to

16the RBOCs largely, and I suggested it was trying to

17drive incremental volume discounts, pretty common these

18days, not an unreasonable thing, and business people

19thought, gee, that is really a good idea, and it was

20squashed by legal in a second.

21You cannot do that because of Robinson-Patman.

22Now, that is really absurd. I am not a lawyer, but I

23think that is very conservative Robinson-Patman, you

24know, counseling these days, and again, I have seen

25situations where they counsel about predatory pricing,

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1which seems to be, you know, the company was not talking

2at all about pricing below -- were not thinking at all

3about pricing below cost.

4So, I do not know what -- Intel probably cannot

5say, but I would -- you know, doing stuff with

6interfaces and technology these days, I assume you have

7got lawyers crawling all over that, because, I mean,

8what we have learned is through the Microsoft case, and

9I am not saying it was only learned in Microsoft, but it

10was learned that sophisticated entities can move the

11needle a lot, you know, and cause a lot of trouble, and

12you might get the antitrust agency involved in the end

13with Microsoft or you are certainly going to get some

14private litigants involved.

15So, I think there is, what I have seen in high

16technology companies, a lot of care in thinking about

17their product choices and interfaces and things like

18that, despite that there might be complaints about that,

19I think it is still very conservative among companies

20typically what their lawyers actually do.

21MR. GLAZER: Do other panelists have any -- have

22 other panelists seen instances of competitors -- I mean

23of large firms pulling their competitive punches?

24DR. REIBSTEIN: I have been amazed at the number

25of strategy meetings that I have been in where people

189

1have been hesitant even to use certain language, and in

2a word, somebody might say, well, we -- you know, what

3we want to do -- in some, you know, macho or aggressive

4way, somebody might say, well, we are going to try to

5kill company XYZ, and everybody -- you know, do not put

6 that down on paper, do not say anything, you know, or --

7 I mean, terms of, you know, being aggressive or trying

8to capture, you know, the market, and there would be a

9 great deal of hesitancy in having some of those

10discussions even, and this is sort of all companies that

11have been beaten around by their lawyers, saying, whoa,

12 you just cannot go in any of these territories.

13So, I think it has had a major influence and has

14changed the language and the behavior, and I certainly

15see it in some of the strategy meetings.

16MR. ELIASBERG: I would like to ask a follow-up

17question to Ken's here, does business strategy suggest

18safe harbors, presumptions, other sign posts that

19businesses and courts can use to assess some kind of

20safe harbor, that this is stuff we are not going to be

21looking at under Section 2 or some sort of sign post

22that this is something we should not be worried about?

23MR. McCREA: I am not sure I understood the

24question, so these guys can go ahead.

25MR. ELIASBERG: Let me try again.

190

1Picking up on Dave Reibstein's point about even

2fear of talking, using some language and things like

3that, out of your experience in business strategy work,

4are there particular areas of conduct that should be

5safe harbors in which folks just should not have to

6worry about Section 2 enforcement, at least from the

7federal enforcement agencies, for example, or are there,

8for example, sign posts of things that would suggest

9that maybe some safe harbor is something that probably

10we really should not be worried about?

11DR. REIBSTEIN: So, essentially following up on

12your comment -- and now that I do understand the

13question, thank you -- I will admit that in some of

14those sessions I was referring to, I have written

15things -- the most dramatic step was I wrote something,

16and somebody came up, pulled it off of the flip chart

17and ate it, because he thought there was a certain word,

18and I think we should not be harassing companies and

19bothering companies for wanting to beat competition. I

20think competition to be very, very healthy.

21Granted, there is a point when, you know, their

22power gets out of line, but in general, the notion of

23coming in and beating competition in a market, serving

24customers better, is something that should be

25encouraged, not something that we need to have companies

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1overly concerned about, and I think there is so much

2fear that we have instituted from some of the regulation

3that there is this intimidation to talk about if -- you

4know, there is -- I do not think there are many

5companies that are too worried about beating

6competition, but there is, you know, you do not know who

7is listening, and it has affected, you know, some of the

8language, and in some cases, you know, some of the

9decision-making.

10Now, I know a company that has got large market

11share, and I do not know that you guys are worried about

12them, you know, their market share is too big, do we

13have to worry about -- do you worry about damaging AMD?

14MR. McCREA: I am not going to go near that.

15DR. REIBSTEIN: See, you will not go near it,

16because that is something we cannot talk about.

17MR. McCREA: You know, I think that in my

18opinion I agree with your comment, that competition is

19good and that to comments that we have heard all day

20from all the business professors is that everyone

21teaches competition is good. That is exactly why we are

22all in business, right? You do business to win.

23To your point, I think you -- depending on your

24market position, you may look at how you grow the market

25more than how do I beat my competitor, because I work at

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1a bigger -- I will get a bigger return by growing the

2overall pile than I will by trying to take one more

3point of share, right? So, it may shift -- depending on

4the company, it may shift what your focus is, where you

5spend more of your resources and revenue.

6Having said that, I think you are absolutely

7right in that I think that we probably are overly

8cautious in some ways -- I do not mean Intel, I mean in

9general, right now -- because of the reasons you just

10articulated. I think that frankly we should be figuring

11out ways to become more competitive and encourage

12companies to become more competitive, because back to

13our global comment, it is not competing within the

14United States. It is competing with the next company in

15China, the next company in Russia, the next company in a

16lower cost area, and that is what I think the attention

17is.

18DR. REIBSTEIN: And actually, I would come back

19to that, which is I think as we get so concerned about

20doing so well that we might, you know, get an undue

21market share, it may take away some of our efficiency,

22 which makes U.S. corporations perhaps more vulnerable to

23information competition, and I worry whether or not we

24have overly struck a fear in some companies by being

25myopic in looking just U.S. centered and not thinking

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1 more globally.

2DR. SCHEFFMAN: There are three cases in the

3queue that we do not know if you guys are going to

4submit if you get an opportunity, Twombley, where you

5have to have some credible basis for alleging that there

6is collusion or conspiracy? Have I got the name wrong?

7Is that --

8MR. GLAZER: Twombley.

9DR. SCHEFFMAN: Twombley, okay, that was a

10textile case. You have got the RPM case that is

11rumbling around? There is another that's -- I guess

12Weyerhauser, those three cases are -- I mean, we have

13had -- you know, we have -- the law has worked, taken a

14long time, but we have -- you know, the law resolved on

15predatory pricing really, and Shott (ph)was really

16important, Matsushita was very important, so that is

17what we -- that is the only way -- we are going to raise

18the cost of bringing frivolous cases, so we have got

19three in the queue, at least pursuing, and we are trying

20to get some help in the antitrust section to do some

21submissions on some of those.

22DR. SMITH: Historically we know that we

23discussed this morning some cases, the Alcoa case, where

24clearly the fear of antitrust pressure drove their

25pricing strategy, and Dupont earlier in the century, you

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1know, after 1912, was very self-conscious about how it

2competed, and General Motors, after 1956, was very

3careful -- we know this, it was very careful to maintain

4its market share at around 50 percent so not to drive

5American Motors out of business in particular, and you

6have to wonder, you can speculate about what impact that

7might have had on the competitiveness of these companies

8long-term.

9 MR. ELIASBERG: Well, I see that we have arrived

10at 4:00, and it was fascinating, and I understand people

11have travel arrangements and other commitments. I want

12to thank all the panelists for their excellent

13presentations and useful information and your insights

14here today, and I hope the audience will join me in a

15round of applause. Thank you very much.

16(Applause.)

17(Whereupon, at 4:00 p.m., the hearing was

18concluded.)

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1C E R T I F I C A T I O N O F R E P O R T E R

2DOCKET/FILE NUMBER: P062106

3CASE TITLE: SECTION 2 HEARING

4DATE: OCTOBER 26, 2006

5

6I HEREBY CERTIFY that the transcript contained

7herein is a full and accurate transcript of the notes

8taken by me at the hearing on the above cause before the

9FEDERAL TRADE COMMISSION to the best of my knowledge and

10belief.

11

12
 DATED: 11/13/2006


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 SUSANNE BERGLING, RMR-CLR


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18C E R T I F I C A T I O N O F P R O O F R E A D E R

19

20I HEREBY CERTIFY that I proofread the transcript

21for accuracy in spelling, hyphenation, punctuation and

22format.

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 DIANE QUADE