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