Business Testimony

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1

1UNITED STATES FEDERAL TRADE COMMISSION

2and

3UNITED STATES DEPARTMENT OF JUSTICE

4

5

6SHERMAN ACT SECTION 2 JOINT HEARING

7BUSINESS TESTIMONY

8TUESDAY, FEBRUARY 13, 2007

9

10

11HELD AT:

12UNIVERSITY OF CHICAGO

13GRADUATE SCHOOL OF BUSINESS

14EXECUTIVE CENTER - 450

15NORTH CITYFRONT PLAZA DRIVE

16CHICAGO, ILLINOIS 60611

179:30 A.M. TO 4:00 P.M.

18

19

20

21

22

23Reported and Transcribed by:

24PAMELA A. STAFFORD, CSR, RMR

25

2

1APPEARANCES:

2

3MODERATORS:

4

5Morning Session:

6JAIME TARONJI, JR.

7Attorney, Policy Studies,

8Federal Trade Commission

9and

10JOSEPH J. MATELIS, II

11Attorney Advisor, Legal Policy Section

12Antitrust Division, Department of Justice

13 and

14WILLIAM COHEN

15Deputy General Counsel for Policy Studies

16Federal Trade Commission

17

18

19PANELISTS:

20

21Morning Session:

22David Balto

23Patrick Sheller

24Ron Stern

25

3

1APPEARANCES CONTINUED:

2

3MODERATORS:

4

5Afternoon Session:

6JOSEPH J. MATELIS, II

7Attorney Advisor, Legal Policy Section

8Antitrust Division, Department of Justice

9and

10KAREN GRIMM,

11Assistant General Counsel for Policy Studies

12Federal Trade Commission

13

14

15PANELISTS:

16

17Afternoon Session:

18Sean Heather

19Bruce Sewell

20Bruce Wark

21

22

23

24

25

4

1REPORT OF PROCEEDINGS

2FEBRUARY 13, 2007

3MR. TARONJI: Good morning.

4I'm Jim Taronji from the Federal Trade

5Commission. I'm one of the moderators for

6this morning's session. I'm joined this

7morning by Bill Cohen, Deputy General Counsel

8for Policy Studies at the Federal Trade

9Commission. Our other co-moderator today is

10Joe Matelis from the Antitrust Division of

11the U.S. Department of Justice.

12Before we start today, let me

13cover a few housekeeping matters. As a

14courtesy to our speakers, please turn off

15your cell phones, Blackberries, and other

16devices, or put them on vibrate. And I will

17do that myself.

18Finally, we request that the

19audience not ask any questions or make

20comments during the hearings. Thank you.

21Before introducing our

22speakers, I would like to first thank the

23University of Chicago Graduate School of

24Business for hosting these joint FTC/DOJ

25hearings to solicit business testimony on

5

1single-firm conduct under Section 2 of the

2Sherman Act. In particular, I would like to

3thank Dean Ted Snyder and the staff of

4the Gleacher Center for offering us their

5facilities and for making the necessary

6arrangements for us to hold these

7hearings.

8And finally, I would like to

9thank my FTC and DOJ colleagues as well as

10the FTC's Midwest regional office who have

11worked very hard to put together these

12hearings in the Windy City, in the cold Windy

13City.

14We are honored to have

15assembled a distinguished group of panelists

16from a number of companies and associations

17that have agreed to offer their testimony in

18connection with these hearings. These

19panelists will provide their perspectives on

20how companies operate within the complex area

21of Sherman Section 2 jurisprudence,

22including for some companies how they

23navigate not only the U.S. application of

24antitrust laws to single-firm conduct, but

25that of the diverse antitrust regimes around

6

1the world.

2Our panelists this morning

3are David Balto for the Generic

4Pharmaceutical Association, Patrick Sheller

5from Kodak, and Ron Stern from G.E.

6Our format this morning will

7be as follows. Each speaker will make a 20-

8to 25-minute presentation. We will then take

9a 15-minute break. After the break, we will

10reconvene and have a moderated discussion

11with our panelists.

12These hearings in Chicago are

13an important component of the joint FTC and

14Antitrust Division hearings on single-firm

15conduct under Section 2 of the Sherman Act.

16They are designed to identify areas where

17single-firm conduct is causing competitive

18harm, areas where antitrust enforcement may

19be chilling desirable activity, and areas

20where additional guidance would be most

21valuable.

22FTC chairman, Deborah Majoras

23made it clear at the opening session of these

24hearings that she wanted to hear from

25businesses, either through their executives

7

1or their legal advisers. As Chairman Majoras

2said, and I'll paraphrase, we want these

3panels to discuss business conduct from the

4market perspective from the ground up. That

5is, examine why and when firms engage in it,

6how they do it, and what effect it produces

7for the firm, for other firms, customers and

8competitors and for consumers. We want these

9discussions to include knowledgeable business

10people or their legal advisers.

11Over these last eight months

12we have held hearings on specific types of

13business conduct, such as predatory pricing,

14refusals to deal, bundled and loyalty

15discounts, tying arrangements, exclusive

16dealing, and misleading and deceptive

17conduct.

18Some of these panels have

19included business executives or their legal

20advisers. In addition, we've covered some

21general areas, such as business strategy,

22business history, and economic empirical

23studies.

24The sessions today are

25designed to further FTC Chairman Majoras's

8

1goal to obtain as much insight and real-world

2experience as possible from business

3representatives.

4This is the second set of

5hearings that have specifically been devoted

6to obtaining testimony from company

7representatives and associations. The first

8set of business testimony hearings were in

9Berkeley, California on January 30th, 2007.

10We look forward to hearing

11the panelists' comments and to the

12round-table discussion. I want to thank all

13of them for agreeing to participate in

14today's hearings. We know that it takes a

15lot of time to prepare for these hearings.

16So again, thank you for your time and

17efforts.

18I would now like to turn it

19over to my colleague and co-moderator Joe

20Matelis from the Antitrust Division for any

21remarks he would like to make. Joe.

22MR. MATELIS: Thank you, Jim.

23The Department of Justice's Antitrust

24Division is very pleased to participate in

25today's hearing. In the single-firm conduct

9

1hearings we have held to date, we have

2benefitted from the insights of many

3highly-skilled antitrust attorneys and

4economists.

5Today's hearing, as well as

6the sessions held last month in Berkeley,

7California, grew out of the belief that we

8could also learn much about single-firm

9conduct from businesses. Our panelists today

10are the people who help devise and implement

11business plans, aware that their firm's

12unilateral conduct may be challenged in

13private or government litigation and by

14foreign competition authorities. Their

15companies are also directly affected by the

16conduct of other firms.

17Whether you've had occasion

18to view Section 2 of the Sherman Act as a

19sword directed at the heart of your business

20or as a shield protecting you from

21anticompetitive conduct of others, we look

22forward to hearing from you today.

23On behalf of the Antitrust

24Division, I would also like to take this

25opportunity to thank the Gleacher Center and

10

1the University of Chicago Graduate School of

2Business for hosting these hearings. Also on

3behalf of the Division, I'd like to thank

4David, Patrick, and Ron for volunteering your

5time today. We know that these hearings take

6a lot of effort, especially when traveling to

7Chicago in February. And we're very grateful

8for a valuable public service that you're

9rendering. Finally, I'd also like to thank

10Jim and Bill and their colleagues at the

11Federal Trade Commission for all their hard

12work organizing today's hearing. Thanks.

13MR. TARONJI: Thank you, Joe.

14Our first speaker this

15morning is David Balto. David Balto has

16practiced antitrust law for over 20 years,

17both at the Federal Trade Commission and the

18Antitrust Division. At the FTC he was the

19attorney adviser to Chairman Pitofsky and

20assistant director for policy and evaluation

21in the Bureau of Competition. He helped

22guide many of the FTC's pharmaceutical and

23health care enforcement efforts, including

24challenging patent settlement agreements.

25David has written extensively

11

1on antitrust and health care competition and

2is the vice chair of the ABA Antitrust

3Section Federal Civil Enforcement Committee.

4He graduated from Northeastern University

5School of Law and the University of

6Minnesota. And David is speaking today on

7behalf of the Generic Pharmaceutical

8Association. David.

9MR. BALTO: Thank you, Joe.

10I want to express my privilege for -- to

11come here and testify in these hearings. And

12I want to mention on that that my remarks

13today are my own and don't necessarily

14reflect the remarks -- should not necessarily

15be attributed to the Generic Pharmaceutical

16Association or any of its members.

17Let me set out the outlines

18of my testimony. I want to start off with

19one indisputable fact, hopefully indisputable

20fact, the importance of generic competition

21in the market.

22I'm then going to try to

23talk about how pharmaceutical markets are

24different than other types of markets and why

25that should make a difference in the analysis

12

1of single-firm conduct.

2I'm then going to talk about

3two forms of anticompetitive conduct by

4branded pharmaceutical companies and how

5those forms of conduct should be analyzed,

6and then perhaps close with some suggestions.

7Let me begin with the indisputable.

8Generic competition benefits

9every consumer in the United States. Generic

10drugs sell for about 70 percent less than

11branded drugs. They account for 56 percent

12of all prescriptions and less than 13 percent

13of all pharmaceutical expenditures.

14The last time TEO studied

15this issue in 1994 they found that generic

16drugs saved consumers between 8 and $10

17billion a year at a time when generic

18substitution was vastly lower than it is

19today.

20Antitrust enforcement in the

21generic drug industry is essential. Let me

22put this into context. Today you can walk

23out of this hearing room and go to your

24local pharmacy and buy a generic form of

25Remeron, Relafen, Buspar, Taxol, Augmentin,

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1Paxil, Coumadin, and Platinol. For each of

2these drugs, the branded pharmaceutical firm,

3a dominant firm attempted to extend its

4monopoly through some form of alleged

5exclusionary conduct.

6In some cases they filed sham

7petitions before the FDA. In some cases they

8engaged in sham litigation. In other cases

9they engaged in inequitable conduct before

10the Patent and Trademark Office.

11All together, these drugs

12accounted for more that $10 billion of

13purchases by U.S. consumers. And because of

14enforcement actions taken by the Federal

15Trade Commission, the state attorneys

16general, and private antitrust attorneys,

17these actions were stopped. And today's

18consumers save billions of dollars because of

19those enforcement actions.

20Policing exclusionary conduct

21by branded pharmaceutical companies could not

22be a greater priority. In the next four

23years, over $60 billion of branded

24pharmaceuticals will go off patent.

25Unfortunately, the pharmaceutical industry

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1offers many opportunities for dominant

2branded firms to manipulate a highly complex

3regulatory system to secure monopoly profits,

4not through superior foresight, industry, and

5innovations, but by finding loopholes to

6delay competition.

7Now, let's start off with why

8pharmaceuticals are different. Now, my

9colleagues on the panel today are going to

10talk about the need for simple rules.

11They're going to talk about the need for

12going and creating bright-line tests so it

13will be easier for their business people to

14do what they're supposed to do, compete in

15the marketplace. As an antitrust

16practitioner, I can appreciate their

17perspective.

18However, I think that the

19Commission and the Antitrust Division should

20be extremely cautious about simple rules for

21dominant firms. As Justice Scalia has

22observed, the conduct of a dominant firm is

23viewed through a special lens. Behavior that

24might otherwise not be of concern under the

25antitrust laws can take on exclusionary

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1connotations when practiced by the

2monopolist.

3Now, I think there are four

4factors in the pharmaceutical industry that

5should make people cautious about bright-line

6rules in this industry. First,

7pharmaceuticals are heavily regulated; and as

8my testimony sets forward, this provides a

9remarkable number of opportunities for

10engaging in what's been called by the FTC

11cheap exclusion.

12Second, who is the buyer?

13Now, knowing who the buyer is is critical to

14defining markets and determining market power

15and also oftentimes to determine whether or

16not certain parties have standing. But in

17the pharmaceutical industry is the ultimate

18buyer the consumer, the insurance company,

19the pharmaceutical benefit manager, the

20physician who prescribes the drugs, or a

21combination of all of these?

22Third, pharmaceuticals have

23high fixed costs but very low average

24variable costs. And so when my colleagues

25today go and talk about bright-line rules for

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1predatory pricing, those might not apply that

2well in a setting with that kind of cost

3structure.

4Then finally, forms of

5distribution are complex. Pharmaceuticals

6are distributed through all these numerous

7different intermediaries, and not all

8distribution mechanisms are the same. Maybe

9in the questioning period we'll go and talk

10about distribution exclusivity cases where I

11can address some of these ideas.

12Now, I want to talk today

13about two form -- fortunately through a

14combination of the FTC's and State Attorneys

15General enforcement actions, the FTC's

16advocacy to Congress, Congressional

17legislation, many of the recipe -- the recipe

18book for anticompetitive conduct by dominant

19pharmaceutical companies has basically been

20thrown out. But like all good cooks, the

21pharmaceutical companies have come up with

22new forms of anticompetitive conduct, and I

23wanted to talk about two of them today to

24illustrate the importance of a couple things,

25the importance of antitrust enforcement, the

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1importance of a balanced rule of reason

2analysis in looking at exclusionary conduct

3and staying away from per se bright-line

4rules. And those two types of conduct are

5product line extensions and abuse of the

6regulatory process.

7Now, let me explain product

8line extensions. As in any other area, there

9are changes in products. We all try to

10improve our products. One of the key things

11to remember here is that for a generic firm

12to enter, it is essential for there to be a

13branded firm that is listed and been approved

14by the Food and Drug Administration. And the

15way this process almost invariably works is

16that the generic firm goes and copies a

17branded drug. The branded drug goes off

18patent or the generic firm prevails in patent

19litigation, and then the generic firm enters.

20But sometimes the product

21line extensions can have anticompetitive

22effects. The FTC recognized this in the

23merger of Cima and Cephalon. Cephalon made a

24branded drug that was used to treat pain when

25you underwent cancer treatments. It was

18

1acquiring Cima which was developing an

2alternative product. The FTC uncovered in

3the course of its investigation that part of

4the reason for the acquisition was a

5product-switching plan by Cephalon. They

6planned, once they acquired Cima, to go and

7take the Cephalon product out of the market,

8to delist it. And in fact, that would have

9prevented generic firms from being able to

10enter the market for this drug.

11In order to resolve the

12competitive concerns posed by this merger,

13the FTC required Cephalon to sponsor generic

14entry on the form of that drug that it

15manufactured.

16Now, if you were to read one

17case in the area of pharmaceutical antitrust,

18I suggest you read the case of Abbott versus

19Teva. Now, this case will remind you of the

20cartoon in Peanuts where Linus keeps coming

21up to try to kick the football. And every

22time Linus goes and tries to kick the

23football, Lucy picks up the football, and he

24misses it and falls flat on his back.

25There's a drug called Tricor

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1which is used to lower cholesterol. It's am

2almost billion dollar drug. Impax and Teva

3were developing a generic alternative. Each

4time they were poised to enter, the branded

5pharmaceutical manufacturer made some small

6change to the product, thus preventing them

7from being able to enter. The last change

8was changing the product from a capsule

9version to a tablet version. The tablet

10version was supposedly superior because it

11didn't have to be taken with food.

12But Abbott didn't just change

13the product. After the tablet formulation

14was approved, it stopped selling the Tricor

15capsules. It bought up all the excess Tricor

16capsules. And then there's this important

17register. It's called the National Drug Data

18File. And the only way you can get a

19generic drug into the market is if it's

20listed in the NDDF. And what Abbott did is

21it listed -- changed the code for Tricor

22capsules in the National Drug Data File to

23obsolete.

24Anyway, so let's go to the

25litigation. Abbott and Teva sued, along with

20

1a group of buyers of drugs. And the

2defendants basically say, you know, this is a

3product improvement. There is no role for

4antitrust here. There is a per se legal

5rule. In order to demonstrate a violation,

6they would have to show that quote: The

7innovator knew before introducing the

8improvement into the market that it was

9absolutely no better than the prior version,

10and that the only purpose of the innovation

11was to eliminate the complementary product of

12a rival. That was the standard articulated

13by Abbott.

14And you know, there was case

15law that supported Abbott's position, though

16not in the pharmaceutical industry. Now,

17rather than adopting the rule of a per se

18legality, the Court went back to the test

19articulated by the D.C. Circuit in Microsoft

20which suggests a rule of reason balancing

21test. And it said the per se rule as

22proposed by the defendants presupposes an

23open market where the merits of any new

24product can be tested by unfettered consumer

25choice. But here, consumers were not

21

1presented with a choice between the products.

2Instead, they eliminated that choice by

3removing the old formulations of the

4products.

5Now, I know my colleagues on

6the panel, their hair is about to stand up

7at this point because what this Court has

8basically suggested is that there is a duty

9to deal. That a dominant firm in some sense

10has some kind of obligation, a duty to deal,

11with its rivals. How could that be? Well,

12let's see what the Court said.

13It said, A co-monopolist is

14not free to take certain actions that a

15company in a competitive or even

16oligopolistic market may take because there

17is no market restraint on a monopolist's

18behavior, harkening back to Justice Scalia's

19idea that I mentioned before.

20So in this case where the

21dominant firm went beyond a simple product

22innovation, but also created obstacles for

23the other firms to effectively enter the

24market, that was a violation.

25Now, there's a similar case

22

1in the E.U. and in Canada involving Astra Zeneca,

2the drug Lobec. In this case violations were

3found in both of those jurisdictions. In

4that case what happened was as the patents on

5the drug were expiring, Astra Zeneca filed

6for additional patents, but these were

7patents that really weren't used on improving

8the drug. These were just additional patents

9to create the additional obstacles. And

10again, antitrust violations were found.

11The most interesting case

12here is a case that was just filed in the

13past year or so, and it involves the very

14well-known conversion of the drug Prilosec to

15Nexium as Prilosec was losing its patent

16protection. This again involved Astra

17Zeneca. This is something like a $4

18billion-a-year drug.

19 In the alleged

20anticompetitive conduct it was said, up to 18

21months before Astra Zeneca was about to lose

22exclusivity it stopped promoting the drug,

23and instead, started to make negative claims

24about the drug. Now, I don't know about you

25or me, but I just don't know when people

23

1start making negative claims about their

2drugs.

3More important than just

4creating Nexium, they also effectively

5withdrew Prilosec from the market, so it was

6impossible for managed care organizations to

7go and sort of continue to contract for

8Prilosec.

9And so when generic Prilosec

10was about to arise, there was no possibility

11for it to substitute for branded Prilosec.

12And one of the most

13interesting issues and maybe something worth

14discussing later on is the fact, as alleged,

15that Nexium was no improvement on Prilosec.

16Let's go on to the issue of

17petitioning and litigation. You know, one of

18the most important achievements of the

19Federal Trade Commission has been the focus

20on sham petitioning and the use of regulatory

21processes to create competitive harm.

22Probably the case in which they've brought

23the most consumer benefits was the Unocal

24case in which it attacked sham petitioning by

25Unocal before the California Resources Board

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1that costs consumers in California over $500

2million annually.

3Sham petitioning is a serious

4problem. As the FTC's recent staff report on

5the Noerr-Pennington Doctrine observed: One

6of the most effective ways for parties to

7acquire or maintain market power is through

8the abuse of governmental processes. The

9cost of the party engaging in such abuse is

10typically minimal, while the anticompetitive

11effects resulting from such abuse are often

12significant and durable.

13Anticompetitive conduct

14through regulatory abuse can be especially

15pernicious if, God forbid, Kodak or GE were

16to engage in any kind of abusive conduct.

17If they exploited their dominant power, it

18would be short lived. Why? Because there are

19numerous firms poised to go and battle them

20for that role of king of the hill. But when

21your job as king of the hill was gained

22through abuse of the regulatory process, no

23natural force can displace you. That's why

24abuse of the regulatory systems is so

25pernicious.

25

1This is especially the case

2in the pharmaceutical industry. The cases I

3identified at the beginning of my testimony

4were cases which were largely based on abuse

5of the regulatory system.

6Almost 30 years ago, Judge

7Bork observed that predation by abuse of

8governmental procedures, including

9administrative and judicial processes,

10presents an increasingly dangerous threat to

11competition.

12No statement could be more on

13point for the anticompetitive conduct in the

14pharmaceutical industry and the practice of

15so-called citizen petitions. The FDA, like

16many regulatory agencies, offers the

17opportunity for citizens to petition them to

18raise questions about safety and efficacy and

19other issues. And that process is obviously

20well intentioned, but it's abused to an

21increasingly significant extent.

22What happens is again, when a

23generic company is poised to enter the

24market, the brand company will file a

25frivolous petition on the eve of FDA

26

1approval. That may be despite the fact that

2the FDA may have granted a tentative

3approval, that maybe despite the fact that

4similar petitions have already been filed.

5The brand strategy is just simply delay the

6generic drug from the market. And you can

7imagine when you're talking about drugs in

8which the amount of profits amount to 10 to

9$20 million a day, this could be a very

10attractive opportunity.

11The FDA citizen petition

12process provides significant opportunities for

13deception. There are no requirements for

14proof of the accusations made in the

15petition. No requirements for certification

16of the accuracy of the information. There

17are no penalties for inaccurate or improper

18filings. There are no limits on the number

19of filings that may be filed. Some petitions

20contain little or no evidence or rely on

21obsolete, irrelevant, or erroneous

22information.

23The FDA has even noted the

24fact that they've seen several examples of

25citizen petitions seemingly designed to delay

27

1the approval of generic approval.

2So let's look at the numbers.

3You know, if I wanted to make it to Wrigley

4Field this spring, if I wanted to join the

5Cubs for spring training, I'd want to have a

6pretty good batting average. Otherwise, they

7wouldn't look at me.

8What's the batting average on

9citizen petitions? Since the Medicare

10Monitorization Act was passed in 2003, there

11have been 45 citizen petitions filed

12challenging the conduct trying to delay the

13entry of generic drugs. 45. 21 of these

14have been resolved. One has been resolved in

15the favor of the petitioner. One. 20 have

16been denied.

17Now, if I'm batting at .05

18percent, I'm not going to get much of a

19try-out at Wrigley Field this spring. None

20of the last-minute -- many of these petitions

21were filed within the four-month period prior

22-- half of them were filed in the four-month

23prior period to the entry of the drug. Did

24any of those succeed? None. Not one.

25Well, how much do they delay

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1things? Those late-filed petitions delayed

2things an average of ten months. And in one

3case, the amount of delay cost consumers an

4estimated $7 million a year.

5Is this a small problem?

6No. According to the statistics of the FDA,

7there's been a 50 percent increase in the

8number of citizen petitions they have

9received. And there are about 170 citizen

10petitions pending compared to only 90 in

111999.

12Now, one of the most

13illuminating observations of the FTC report

14on the Noerr-Pennington Doctrine was its

15observation about how serial sham litigation

16conduct should be analyzed. I think the FTC

17should go and apply the ideas that it has

18and the expertise it's developed, both in

19that report and in its enforcement action in

20Unocal to give a very serious look at the

21citizen petition process. Let me conclude.

22Antitrust plays a vital role

23in maintaining rivalry as the lone star of

24the marketplace. Competition is critically

25important where many of the factors

29

1identified earlier can forestall competition.

2The FTC, State Attorneys

3General, and private antitrust lawyers have

4played an important role in protecting

5pharmaceutical markets from artificial

6barriers to competition, and I hope these

7hearings keep Section 2 as a robust statute

8so that it can continue to be used to

9protect the interest of consumers and

10competitors in this vital market. Thank you.

11(Applause)

12MR. TARONJI: Thank you,

13David. Our next speaker is Patrick Sheller.

14Patrick is the chief compliance officer for

15Eastman Kodak Company. In that capacity he

16is responsible for Kodak's code of conduct

17and internal investigations.

18Prior to his current

19assignment, Patrick held a variety of

20business positions and was Kodak's chief

21antitrust counsel and also was involved in

22legal matters in Europe.

23Prior to Kodak he was in

24private practice with a law firm that is now

25known as McKenna, Long & Aldridge, and is a

30

1former Federal Trade Commission attorney,

2having worked in the Bureau of Competition

3and as attorney adviser to Chairman Daniel

4Oliver. He is a graduate of St. Lawrence

5University and the Albany Law School at Union

6University. Patrick.

7MR. SHELLER: I want to

8thank the Department of Justice and the FTC

9for the opportunity to speak to you today.

10It's an important time in antitrust

11law for our economy, and it's a particularly

12important time for Kodak. I suspect one

13of the reasons we were invited to participate

14in these hearings is Kodak's well documented

15experience with the Section 2 enforcement

16which began in 1921 when an investigation by

17the Department of Justice was settled through

18a consent decree which prohibited Kodak, among

19other things, from selling a fighting

20brand of consumer film, also known as

21private-label film.

22In 1954 we settled an

23investigation with the Department of Justice.

24This matter involved alleged tying of consumer

25color negative film with photo processing

31

1services. Under this consent decree we

2were prohibited from selling these two

3items under a single price.

4In 1979 our luck turned a

5bit. We benefitted from a primarily favorable

6ruling by the Second Circuit in the Berkey

7Photo case where one of our competitors

8challenged Kodak's introduction of the 110

9photographic system that included a camera,

10specially formatted film, and a new photo

11processing service.

12One of the key rulings in

13that case was that a monopolist has no

14obligation to predisclose new products to a

15competitor. And, to the extent that a

16monopolist engages in truthful advertising,

17that conduct does not offend Section 2.

18In 1991 our luck turned in

19the other direction again with the Supreme

20Court's decision in the ITS v. Kodak

21case. This was an action brought by

22independent service organizations that were

23competing against Kodak in the service of

24photocopiers and micrographics units. It

25was in the ITS case that the court established

32

1the so-called single-brand derivative

2aftermarket; the notion being that once a

3customer chooses to purchase an expensive

4item of capital equipment, they're now locked

5into that particular brand or manufacturer.

6Whether or not that manufacturer has

7market power in the primary market for

8photocopiers, for example, was determined to

9be irrelevant to the Supreme Court. The ITS

10case went back to the trial court on remand,

11and I'll speak more to the trial in a minute.

12In 1994 Kodak challenged some

13aspects of the 1921 and 1954 consent decrees.

14We were successful in overturning the private

15label restriction and the prohibition on

16linking film with photo finishing sales,

17primarily because we were able to demonstrate

18to the District Court and to the Second Circuit

19that market conditions had changed

20significantly.

21By 1994, Kodak was

22competing on a global basis with a number of

23foreign suppliers as opposed to the market

24conditions that existed when these consent

25decrees were entered into.

33

1Finally, in 1996 the

2Ninth Circuit heard Kodak's appeal

3of the jury verdict in the ITS case. The

4jury found that we had engaged in an unlawful

5refusal to deal by refusing to provide

6patented and copyrighted parts and copyrighted

7diagnostic software and manuals to ISO's.

8The key ruling in that case,

9for purposes of my remarks today, was

10that an IP owner faces restrictions on its

11ability to refuse to deal with ISOs by refusing

12to license its IP.

13The Ninth Circuit picked up

14on the First Circuit's decision in the Data

15General case in holding that there is a

16presumption in favor of an IP owner, that

17it has a legitimate business justification

18for refusing to deal with a rival. But that

19presumption can be overcome by evidence that

20the IP owner had an anticompetitive intent. The

219th circuit's ruling essentially opens the door

22to ISO's to come up with evidence in the form of

23internal documents showing that the IP owner

24was trying to keep out competition through

25its decision to refuse to deal.

34

1Now, the history of Kodak's

2experience with Section 2 parallels in many

3ways the evolution of our company, our

4technology, and our business model.

5Beginning in the 1880's and through the

670's, the focus of our business was on

7consumables. We primarily sold film

8products, paper products, and chemicals.

9We engaged in the sort of razor/razor blade

10model of selling cameras in order to generate

11more film sales.

12The company began to

13diversify its portfolio in the late 60's to

141970's, and we began to offer more expensive

15items of capital equipment such as

16photocopiers, micrographics equipment, and

17graphic arts equipment. And in this sense

18our business model began to change to

19offering hardware plus aftermarket service.

20It was in this context that the ITS case

21arose.

22We are now in the process of

23a monumental shift in the business model of

24our company as we try to become a digital

25company as opposed to an analog technology player.

35

1The focus of our business going forward is

2going to be on selling solutions. Solution

3selling is very common in the digital world

4where companies will bundle a portfolio of

5offerings that include hardware, software,

6consumables, consulting services, and

7aftermarket service into a single price to

8sell to customers who demand an end-to-end

9solution.

10Our sales focus going forward

11will be on digital products such as photo

12printer kiosks, image centers. We announced

13last week the introduction of a new line of

14consumer ink-jet printers, which means Kodak will

15now be competing in a new market. We will also

16offer Digital cameras, media ink, and so forth.

17Elements of the old

18business models still remain at Kodak. We

19will continue to sell film. But our focus

20will be on solution sales, and there will be

21be a real emphasis within the company on the

22ability to sell in this environment.

23We face a number of

24challenges as we try to participate in the

25digital world. Some critical success

36

1factors to our new digital model are, first

2of all, that we rapidly innovate and

3develop new technology to commercialize

4new products. Digital companies constantly

5introduce new versions of their products.

6We have to keep pace in this fast-moving

7environment. And in that sense, intellectual

8property has become increasingly important to

9Kodak.

10We need to be able to

11protect our research and development

12investments, wherever possible, through patents

13and copyrights, and we need to be able to

14protect these assets in a way that doesn't

15offend the antitrust laws.

16One of our key strategies

17going forward is to monetize our intellectual

18properties. Kodak has, for the last

19several years, entered into numerous

20licensing agreements with other digital

21players in the industry, and we need to be

22able to go about that licensing activity

23without fear of antitrust concerns, as

24I'll talk about in a few minutes.

25And finally, as I mentioned,

37

1solution selling is critical to our success

2in the digital world. A good example is

3our graphic communications business which

4sells graphic solutions to printing firms.

5These solutions include software, work-flow

6software, hardware, consumables, consulting

7services, and aftermarket service.

8So what are some of the

9Section 2 impediments to our success in this

10new digital world? First of all, we

11would encourage the antitrust agencies and

12the courts to recognize the importance of

13market changes. As we saw with our attempt

14to overturn the 1921 and 1954 consent

15decrees, we were forced to litigate with the

16Department of Justice over the issue of

17whether Kodak was competing in a worldwide

18market versus a domestic market.

19And to the extent that

20further challenges arise to our practices in

21the film environment, we would encourage the

22agencies and the courts to recognize the

23substantial influence of digital technologies

24on markets that were previously dominated

25by film.

38

1As we saw literally overnight

2earlier in this decade, our film business

3began to decline dramatically in the year

42001. We initially thought it was a result

5of reduced demand following the 9/11 attacks,

6but the market never came back. It was because

7many customers had decided to convert from film

8to digital. And many customers that make this

9conversion never come back to film.

10Another impediment to our

11success in the digital world relates to the

12antitrust line between tying and bundling. This

13line is becoming increasingly blurred as a

14result of the LePage's and other decisions, which

15I'll speak to more in a few minutes.

16 Finally, obstacles to our

17ability to monetize our intellectual property

18investments exist in the form of cases like the

19Ninth Circuit's decision in the ITS case and

20precedents in the European Union such as

21the McGill case and the INS Health case where

22the Commission required compulsory licensing

23licensing by intellectual property owners.

24Let me first turn to the

25LePage's decision and the uncertainty that

39

1case has left companies like Kodak with. While

2the Third Circuit had an opportunity to

3clarify the application of Section 2 in the

4area of bundled discounts, in our view it

5squandered that opportunity by deciding the

6case on its narrow set of facts. The court

7ruled said that 3M's practice of bundling its

8branded Scotch tape with both private-label

93M tape and with other 3M products caused

10injury to its competitor, LePage's, and

11therefore offended Section 2.

12The only parameters that

13we are able to draw from the LePage's decision

14in terms of an alleged monopolist's ability

15to engage in pricing activities are, first of

16all, that single-product volume discounts are

17permissible. The court made that clear. But

18what's at risk following the 3M/LePage's

19decision, are discounts linking products

20across multiple markets where an alleged

21dominant product is involved, and also

22discounts linking a dominant product

23with others across a single product

24line, such as the linking branded and

25private-label tape. We are left with

40

1no coherent standard with which to

2evaluate bundled pricing under the

3LePage's decision.

4We would submit there were

5better alternative paths that the Third

6Circuit could have taken in evaluating the

7case against 3M. The Eighth Circuit's

8decision in Concord Boat applied the Brooke

9Group decision by the Supreme Court to find

10that as long as single-product discounts are

11above cost, they should not be considered

12exclusionary under Section 2.

13It would have also been helpful

14if the court had given some thought to the

15Ortho Diagnostic's Systems case by the Southern

16District of New York where the court articulated

17its analysis of the alleged bundling by asking

18whether an equally efficient competitor to the

19monopolist could profitably match the bundled

20price the in the market. That would have

21been an arguably more rational test to apply.

22While we could previously

23rely on the very clear distinction between

24tying on the one hand where a monopolist

25tries to force the purchase of a second

41

1non-monopoly product, we now have to deal with a

2precedent that articulates no coherent standard

3such that bundled discounts now come under scrutiny.

4As I said before, bundling is very important to our

5ability to offer solution sales.

6Turning to the issue of IP

7rights, as I mentioned, a very importantbr>
8strategy of Kodak going forward is our ability

9to monetize our IP portfolio. The Ninth

10Circuit's decision in the ITS case has had a

11a chilling effect on that activity. There thebr>
12Court held that although there is a presumption in

13favor of an IP owner's right to refuse to license

14a competitor, that presumption can be overcome by

15evidence of bad intent. And that evidence can

16take the form of internal company documents.

17We think that the Federal Circuit,

18which considered very similar facts in the Xerox v.

19CSU case got the issue right when it held that in

20the absence of tying, fraud or sham litigation,

21it's not appropriate to inquire into the IP owner's

22subjective motivations for asserting a statutory right

23to exclude. The Xerox court held that the same

24rationale would apply to asserting copyright

25protection as the basis for a refusal to deal.

42

1As a result, we have a

2clear split among the circuits that has

3created a great deal of uncertainty on the

4part of the IP owners and companies that

5provide aftermarket service.

6Where does the uncertainty

7in these two areas leave Kodak and other

8companies? First, if we're successful with our

9digital strategy, and we're able to achieve a

10leading market position in some of the new

11digital markets where we participate, our ability

12to offer competitive bundled pricing could be

13constrained by the LePage's decision. As I

14said, bundled pricing is really the essence

15of solution selling.

16Second, notwithstanding a

17lack of market power in the primary equipment

18markets in which we compete, we still face

19potential challenges by ISO's that can allege that

20Kodak dominates a single brand aftermarket

21for a particular line of equipment. Such ISOs

22will try to require us to license or sell our

23valuable intellectual property.

24Let me offer a few examples

25of the dilemmas these ambiguities can create,

43

1and these are hypothetical examples. First,

2sell a line of photo kiosks that you may have

3seen at a number of retailers. A question

4arises as to whether Kodak can offer retailers

5bundled discounts on the kiosks, our paper

6that runs through these kiosks and the

7aftermarket service. Could we also include

8digital cameras in that bundle when we sell

9to retailers? Could Kodak refuse to license

10our valuable diagnostic software on these

11photo kiosks to an ISO that wishes to compete

12with us?

13Turning to our intellectual

14property strategy. We are in the process of

15entering into licensing agreements with a

16number of companies that we believe have

17infringed our patent portfolio in the digital

18camera area. The question arises whether,

19in approaching a particular company we

20believe violates our patents, can we refuse

21to license the companies' rights in our patents

22simply because they are competitors. And does

23that situation get any worse because we've got

24an internal document suggesting that a reason

25for refusing the license was to gain an upper

44

1hand in the marketplace.

2Could we, in licensing to

3other digital camera sellers, bundle Kodak

4software that allows customers to view their

5images on a PC?

6We offer an on-line photo

7service where you can upload your photos and

8order prints or order prints on different items

9like T-shirts and coffee mugs. This is called

10the Kodak Easy Share Gallery. The question arises

11whether in the event we were to gain a leading

12market position with our Kodak Photo Gallery,

13we could say to our customers who agree to

14store a fixed number of images on our site

15that they will get a discount on their

16prints?

17And finally with respect to

18our graphics business, which I mentioned is

19very much focused trying to meet the end to

20end work-flow demands of our customers, are

21there antitrust concerns with our selling

22graphic communications equipment, software,

23consumables, consulting services, and

24aftermarket services as a bundle? Should it

25make a difference that our customers demand

45

1such solution sales?

2These are some of the issues

3that we grapple with in light of the

4uncertainty under Section 2 that I've

5outlined, and I'll look forward to further

6discussion on these and other issues when we

7get to the questioning period.

8(Applause)

9MR. TARONJI: Thank you,

10Patrick. Our next speaker is Ron Stern.

11Ron is the vice president and senior

12competition counsel for the General Electric

13Company. Ron received his AB from Brown

14University and his law degree from Harvard.

15He clerked for Judge Harold

16Leventhal of the U.S. Court of Appeals for

17the D.C. Circuit and for Justice Potter

18Stewart of the U.S. Supreme Court. He was

19in private practice with Hughes, Hubbard &

20Reid and was a partner with Arnold & Porter.

21In addition, he was the

22special assistant to the Assistant Attorney

23General for the Criminal Division of the U.S.

24Department of Justice. Ron.

25MR. STERN: I'd like to

46

1begin by thanking the Antitrust Division and

2the Federal Trust Commission for holding

3these hearings and for providing me and

4others with the opportunity to address

5important issues relating to the application

6of the antitrust laws to single-firm conduct.

7In particular, I would like

8to thank the staff at both agencies who have

9organized these hearings and put in the hard

10work required to make them a success.

11I also want to make clear at

12the outset that the views and opinions that I

13am providing today and that are in the

14written slides are my own personal views and

15not those of the General Electric Company or

16of other General Electric officials.

17 Let me begin with an

18overview. I want to agree with the heads

19of the two agencies that are hosting these

20hearings, the Assistant Attorney General and

21the Chairman of the Federal Trade Commission,

22that it is important to have clear,

23administrable, and objective rules. This is

24a key requirement, something that's really at

25the heart of these hearings.

47

1It's important for business

2to avoid chilling procompetitive conduct.

3It's also important for consumers. It's

4important to help avoid inadvertent

5violations and disputes and investigations

6that end up wasting company time and

7resources as well as the time and resources

8of the agencies.

9And finally, it's important

10to reduce the cost of developing and

11implementing business plans to foster

12competition in the marketplace.

13Now increasingly, as the

14economy globalizes, it's not sufficient that

15the U.S. rules are clear. The rules adopted

16by other jurisdictions will, of course, affect

17U.S. commerce. And I do not believe that it

18is surprising or coincidental that the United

19States, European Commission, and the

20International Competition Network, an

21organization formed by, I believe, more than

22100 competition authorities around the world,

23are all addressing the issue of competition

24standards for single-firm conduct at this

25time.

48

1In a global economy this is

2a global issue, not just a United States

3issue; and that's important, particularly for

4companies such as mine, that operate in a

5number of global markets.

6What I'd like to do today is

7walk through from a counseling perspective

8which is a perspective, I see every day,

9and look at areas that could be clarified in

10Section 2.

11First, the issue is what kind

12of rule governs. Is your conduct unilateral,

13single-firm conduct, or is it multi-firm

14conduct? Is it something that Section 1 governs

15or Article 81 in Europe?

16Or is it something that

17Section 2 governs as single-firm conduct or

18Article 82 in Europe?

19The next issue is whether

20there is a threshold solution or a threshold

21screen that makes you comfortable that the

22conduct doesn't violate the law? And one

23important screen under the U.S. law is the

24requirement of monopoly power.

25If you can be sure that your

49

1company isn't in that kind of position, it

2doesn't control market prices, then you don't

3have to worry about the nature of the conduct

4and whether the conduct meets or doesn't meet

5any of the different rules that have been

6talked about during these hearings and are

7being discussed today.

8If the threshold isn't met,

9then you have to look at the conduct and

10decide whether the conduct is exclusionary or

11not. And oftentimes what you're looking for

12are clear rules that will guide you to allow

13you to tell your client that they can safely

14pursue X type of conduct because that's in a

15safe harbor or that's clearly not a problem.

16And then why are we going

17through this entire exercise? Well, we're

18going through the exercise basically because

19there are risks and costs if you end up in a

20gray area that someone thinks violates the

21requirements.

22There is the potential for

23government enforcement actions and

24investigations, and in the U.S. for private

25treble damage action. And there are a host

50

1of potential consequences, from injunctive

2relief to fines, not in the U.S., but in

3some jurisdictions, to treble damage awards,

4legal fees, and the like.

5 So what I'd like to do is

6continue to walk through the issues. One

7issue that reinforces the concern that I'd

8just like to touch upon is the fact that

9jury instructions in the Section 2 area are

10often particularly problematic. I've just

11set some examples up on the screen, but

12basically they involve very general types of

13words. Is the conduct wrongful? Did one

14buy more logs than were necessary or pay a

15higher price than was necessary? Did the

16firm engage in competition on the merits?

17Whatever, again, a jury believes that means.

18All of these things reinforce

19the risk, particularly in the U.S.

20environment, of treble damages and attorneys'

21fees and large litigation costs. You

22basically want to counsel to be in a safe zone

23to avoid having to worry about jury

24instructions.

25So then back to the

51

1beginning. Do you know whether you're in the

2single-firm conduct area? We obviously have

3the Copperweld decision and clear law that if

4you're a company and you're dealing with a

5wholly-owned subsidiary, you're one entity,

6and you know that you can't violate Sherman Act

7Section 1 by having an agreement in restraint of

8trade because you don't have two parties. You

9just have one.

10The problem is under

11Copperweld the application is unclear. The

12law in the lower courts is divided as to

13where the line is when you're dealing with

14non-wholly-owned subsidiaries.

15And one important thing that

16the government could do is reinstate the

17guidance that existed in 1988 with the

18antitrust enforcement guidelines for

19international operations. I've included

20that in the slides.

21And the clear guidance that

22was given then, I think, would be important

23to reinstate it, is that whenever you have

24more than 50 percent of the voting securities

25of a company owned by its parent or its

52

1sister company, that whole family of

2companies is one economic entity and is

3subject only to Section 2, the single-firm

4conduct section, and not Section 1. That's

5one area in which I think clarity could be

6added.

7Now, if we move beyond, the

8next issue is trying to identify whether your

9company in the particular situation that

10you're facing is subject to Section 2. And

11the first element of Section 2 is having

12monopoly power. The second element relates to

13the conduct. Is there a willful acquisition

14or maintenance of that power which is often

15referred to as engaging in exclusionary

16conduct.

17Now, under United States law

18there is a pretty helpful screen. You have

19to have the power to control market price.

20And in bidding markets, it's clear that if

21there are other credible competitors, you

22generally don't have the power to control

23market prices, even if you have a very large

24share.

25The case law gives some very

53

1helpful general rules of thumb. If you have

2more than a 70 percent share, you have to

3look at all of the other factors, but you at

4least know that you're in a danger zone.

5If you have less than a 50

6percent share under the U.S. case law, it's

7very unlikely that you have to worry about

8whether your conduct could be categorized as

9exclusionary.

10Some people point to the fact

11that attempted monopolization can occur at a

12lower market share threshold, but you have

13the very important counseling hook in the

14element of attempted monopolization which is

15the requirement of a dangerous probability of

16achieving monopoly power, which brings you

17right back to the monopoly power test.

18So the key is, and I think

19that's been very helpful, even for successful

20firms, and certainly my company has a number

21of successful businesses, that most

22successful firms simply do not meet the

23monopoly power test under U.S. law. And that

24is helpful in counseling. But there are two

25important howevers that I want to talk

54

1about.

2The first is the issue that's

3been discussed that Patrick talked about, the

4treatment of aftermarkets. And the second

5are non-U.S. issues, that there are lower

6dominance thresholds outside the U.S. And

7indeed, there is the curious concept of

8collective dominance, at least curious to a

9U.S. antitrust lawyer outside the U.S., so

10let me turn to those.

11First I'd like to turn to

12aftermarkets. As Patrick mentioned, this

13comes from the Kodak case. There the

14Supreme Court held that there was the

15potential, not that it was always the case,

16but the potential for there to be a single

17brand parts and service market, even where

18the company had a modest percentage and had

19no monopoly power in the interband equipment

20market. Here, Kodak had less than 25

21percent, clearly in the safe harbor of the

22interband photocopier market. Photocopiers

23are often referred to as Xerox machines, not

24Kodak machines. That's for a reason. They

25didn't have market power. But they had a

55

1very large share of an intrabrand parts and

2service market for Kodak copiers.

3Now, post-Kodak, there have

4been a number of court cases interpreting

5Kodak, and they have limited Kodak's

6application in most circuits to a situation

7in which there has been a change of policy

8with respect to aftermarket sales of parts or

9service. That however has not been uniform.

10The Ninth Circuit is sort of an outlier.

11 All in all, what this does,

12I believe, is create very significant

13problems. All suppliers of capital goods are

14exposed today to the notion of having to

15worry about whether or not they fall under

16Section 2 when they deal with parts and

17services for the products that they sell.

18And somewhat ironically, if

19you have a modest market share, you're one of

20the also-rans in the interbrand equipment

21market, you may have a higher share of your

22single-brand parts and service market for the

23very simple reason that third parties tend to

24focus on the most successful installed base

25products to develop non-OEM parts and non-OEM

56

1services.

2So the competitor with ten

3percent in the interbrand equipment market

4may be more likely to have a monopoly sharebr>
5of a single-brand aftermarket than the

6leading firm in the interbrand equipment

7market.

8So this is a problem and

9it's a problem because it chills conduct. If

10you're going to counsel, what it does is it

11really counsels you to adopt restrictive

12approaches from the outset and not change

13them. Because if you do that, you really

14don't have to worry about having a problem inbr>
15this area.

16I think the outcome is an

17incorrect one. It has been heavily

18criticized by a number of esteemed

19economists, many of which have either been

20former heads of the economic part of the

21antitrust division or the current head.

22Professor Carlton, Professor Shapiro,

23Professor Klein, and Professor Hovenkamp have

24all criticized the Kodak decision with respect

25to aftermarkets and suggested that it is

57

1unnecessary and unsound.

2And the Department of Justice

3thought it was unsound in its amicus brief in

4Kodak.

5 So I think what should be

6clarified here is this notion of single-brand

7aftermarkets. That concept from Kodak

8should be overturned. The government should

9give guidance, and should file amicus

10briefs in courts to try to clarify

11the law in this area.

12The same thing should happen

13in Europe. I have referenced comments by the

14International Chamber of Commerce that are on

15the DG Competition website with respect to

16the Article 82 discussion paper which give

17further reasons why there shouldn't be

18single-brand aftermarkets.

19Let's then turn to the issue

20of monopoly power outside of the U.S. Here,

21the International Competition Network has a

22unilateral conduct working group, and it has

23a draft report in-progress for its next

24convention in Moscow. And what it has

25found by surveying competition authorities

58

1around the world is that generally, the

2presumption of dominance, which is essentially

3the non-U.S. equivalent of monopoly power, is

4set at a 33 percent to 50 percent level.

5Now, that's below what is essentially the

6U.S. safe harbor level.

7And what it does, of course,

8in a global marketplace is tend to expose a

9much larger number of leading firms to the

10potential that you have to worry about

11whether your conduct is going to be

12characterized in these regimes as abusive, or

13if you use the United States approach, as

14exclusionary.

15Now, there's one good thing.

16There's also a trend towards taking a

17behavioral approach, which is looking at the

18ability to set market prices, the same

19approach taken under Section 2 in the U.S.,

20rather than a purely structural presumption

21based on market shares.

22I'd like to turn to another

23problem that I think is one that should be

24addressed. It's not a huge problem today,

25but it's the concept of collective dominance.

59

1The European Commission Article 82 discussion

2paper talks about the fact that there can be

3collective dominance simply in a

4oligopolistic situation. You don't have to

5have an agreement with your competitors as

6long as a small number of firms control a

7large combined share of the marketplace.

8Then they can act in a way that supposedly

9would abuse their collective dominant

10position.

11My sense is that this has

12never been applied, as far as I know, but it

13raises a real counseling concern. What are

14you supposed to do if your rival raises

15price? If all the other rivals in an

16oligopoly do what they often do, and that is

17match the price increase, have you then

18committed and abouse of collective dominance?

19If you have a policy of

20having exclusive distributors and other

21firms follow that policy because it's

22efficient, have you violated collective

23dominance? It's very hard to figure out how

24to counsel. This is something that again,

25isn't a real-world problem today, but I think

60

1should be one that is nipped in the bud so

2it doesn't become a real-world problem

3tomorrow.

4And then secondly, there's a

5separate issue in the draft anti-monopoly law

6in China in which a firm that isn't a

7leading firm, and that's true of course in

8the collective dominant situation. If you're

9not the leading firm in the marketplace,

10generally you don't have to worry about

11unilateral conduct.

12But if either an oligopoly

13situation presents a problem or under the

14draft law in China, if two firms have

15two-thirds of the market or three firms have

16three quarters of the market, and you're the

17second-ranked firm or the third-ranked firm in

18that situation, as long as you have more than a

1910 percent share, it appears that all of the

20firms are treated as dominant and subject to

21the listed abuses.

22This law hasn't been adopted.

23It hasn't been interpreted. It's not clearbr>
24what this means, but it's out there and it

25poses a potential risk that it seems to me

61

1the U.S. authorities ought to address and I

2know in fact are addressing.

3Let me turn to some of the

4issues of conduct. The first one I'd like

5to talk about are refusals to deal. And it

6seems to me that this is an area in which

7there is a real opportunity for clarity.

8My colleague Mark Whitener

9testified in the July 18 hearings on refusal

10to deal and covered this at some length, I just

11want to hit the high points. I'll refer you

12to his testimony.

13Basically, the law appears to

14have evolved that an unconditional refusal to

15deal, and from that I distinguish one that is

16conditioned on taking a second product, which

17is often referred to as tying, or a

18conditional refusal to deal which says you

19will deal with me, and you won't buy from

20anyone else, usually called exclusive

21dealing. Those things ought to be dealt

22with, in my view an exclusive dealing or

23tying. But if it's simply an

24unconditional refusal to deal, I decline to

25sell you the product, in those sorts of

62

1situations it seems to me there should be a

2per se lawful rule.

3Now what the case law has

4evolved in the Trinko decision is a notion

5that the Aspen Skiing case is the outer

6limits. And the Aspen Skiing case involved

7a refusal to continue to deal after there

8had been a voluntary cooperation with the

9plaintiff.

10And the problem that that

11approach creates is obviously it causes people

12to be incentivized not to deal in the first

13place. The concern would be if that's the law,

14you would never have had the all-mountain pass

15in Aspen in the first place because the party

16with the three mountains would have known not

17to enter into the cooperation because it

18could have been accused of violating Section

192 should it have wanted to reverse course

20later.

21This creates perverse

22incentives, and there is of course the

23entractible problem of remedies. Courts

24simply aren't set up to deal with the

25situation of how does one decide what the

63

1terms should be, what the pricing should be.

2This is another reason why if there's a

3problem in this area, there should be

4legislation and essentially a utility

5commission set up. The antitrust laws and

6the court shouldn't be handling this.

7The same thing, I think, is

8true of the essential facilities doctrine,

9which is just another way of dealing with

10unilateral refusals to deal. That doctrine

11has been questioned by the Supreme Court, but

12it seems to me the law could be clarified in

13this area because the Court simply didn't

14address it.

15Let me then turn to another

16area that's already been talked about a lot

17today, and that is the area of bundled

18discounts. It seems to me that although in

19the afternoon session I know we're going to

20hear a bit to the contrary, that unlike

21predatory pricing, where there's some pretty

22good and clear guidance about not pricing

23below a measure of cost and the need for

24recoupment, that in the bundled discounts, the

25mixed bundling area, at the moment there is a

64

1real need for clarity.

2So what I want to do is

3start with just asking some questions and

4suggesting some responses that might create

5clarity. The first one is can we identify

6types of market situations where there just

7isn't likely to be a problem.

8And I highlight one of them,

9Professor Barry Nalebuff, someone who has

10written extensively about bundling,

11suggested that in certain circumstances, at

12least from an economic theory point of view,

13it could create issues. But he's been very

14clear that that only really happens in a market

15situation in which the seller sets one price

16for all buyers of the product. And it

17doesn't happen in a situation in which there

18is bidding on an individual customer basis or

19negotiation on an individual customer basis.

20If in fact that's a valid

21distinction, having that kind of

22clarification would be very important. It

23certainly would be important for my client,

24which generally engages in negotiated sales of

25products rather than consumer products where

65

1you often set one price for all.br>
2Then another area is simply

3do most of these cases really involve a

4situation in which what is being alleged is

5you have a company with monopoly power in

6Market A that is bundling in order to try to

7create power or effect a separate Market B.

8If that's the case, then it

9seems to me that an attempted monopolization

10claim involving that second market is what is

11really involved, and you have to look at

12whether there is going to be a dangerous

13probability of achieving monopoly power in

14that second market. And others who have

15testified have noted the importance of

16showing not only a disadvantage to a

17particular rival in Product B or the

18competitive product, but also a realistic

19threat of creating monopoly power in that

20second product.

21Now, after those threshold

22issues, I guess one of the other questions is

23what framework do you use to analyze these

24bundled discounts or mixed bundling. And one

25suggestion I guess I would like to throw out

66

1for discussion is that these cases should

2generally fall into one of two categories.

3They ought to either be analyzed as tying, or

4they should be analyzed as predatory pricing.br>
5Again, Professor Nalebuff had talked about an

6example in his testimony in which he said

7well, predatory pricing really doesn't apply

8in some of these kinds of scenarios because

9there can be no-cost bundling. And his

10hypothetical was one in which you took the

11monopoly product and you raised the price of

12the monopoly product well above the monopoly

13price, and then you bundled using the

14monopoly price as the price of the monopoly

15good in the bundle, and then you priced in

16the competitive product.

17And he said in that

18circumstance, well, no one would actually

19take the monopoly product separately. Well,

20at least from my legal standpoint, most

21courts would treat that situation in which

22the second product wasn't economically

23available as a tying situation, in which you

24were simply not selling the monopoly product

25unless you also bought the other product in

67

1the bundle. And in that situation,

2particularly where you're involved with a

3second market, you should be able to deal

4with the screen of attempted monopolization.

5You also of course can solve the problem by

6making sure that the separate price is a

7realistic price so that you avoid tying.

8It seems to me then the

9other cases are situations in which you

10really are giving a discount off of the

11monopoly price in an attempt to assist in the

12sale of the competitive product.

13 And that sort of situation,

14if that's what's really going on, you do have

15discounting or loss on what you could

16otherwise sell the monopoly product for. In

17that sort of situation then the issue should

18be a predatory pricing analysis.

19Now one approach that

20sometimes is taken is to look at -- and it's

21been advocated, I believe, by Professor

22Muris in an earlier hearing -- the price

23of the bundle and compare it to the cost

24of the bundle. In some situations that

25may be an appropriate and realistic

68

1approach.

2Some criticism of that I

3think by Professor Hovenkamp is a stylized

4situation in which you have a monopoly

5product with a large monopoly margin.

6And if I simply took that margin and

7didn't bundle it, but simply took those

8profits and used it to discount the price of

9the competitive product, I might clearly be

10pricing the competitive product below my cost

11for that product.

12And I think the question is

13why should the bundle situation be treated

14any differently than the straight predatory

15pricing discount on Product B.

16In that stylized situation in

17Product B, Professor Hovenkamp advocates in the

18Ortho approach of attributing all of the bundles --

19all of the discounts to the competitive product,

20and if that's still above cost, I think provides

21a helpful screen and safe harbor. That's one

22area where there should clearly be

23clarification.

24But I think Professor Muris

25pointed out several important qualifications.

69

1It's a highly stylized situation in which

2there is no competitor. There is an absolute

3monopolist, and there is no one else selling

4Product A.

5When there are fringe sellers

6of Product A, those fringe sellers can help

7undermine the bundled price for the package.

8There may also be situations

9in which there is a bundle with two

10competitive products, and it may be that the

11plaintiff can only sell one of those, but

12some other party can sell the second

13competitive product. They can team together

14and provide their own bundled discount. Or

15particularly, when you've got sophisticated

16customers, the customers can search the

17marketplace and provide their own added ala

18carte bundles. They will look at the price

19of Competitive Offer X and Competitive Offer

20Y and compare it to the bundle.

21So this notion that it's a

22problem if you ascribe all of the discount to

23the price of the single competitive product

24that perhaps the plaintiff or the complainant

25is selling, I think is -- again, it's an

70

1over-dramatic case. It shouldn't be a problem

2if in doing that the resulting price would be

3below cost. It shouldsimply be a safe harbor

4if you're not below cost.

5And then of course in these

6situations since there's a loss, you really

7ought to be able to look at recoupment. You

8have to really look at that just like you do

9in predatory pricing.

10If you're losing money by

11subsidizing the sale essentially of the

12competitive product, how are you going to

13make that back? And if you're not going to

14force people to exit and if you're not going

15to be able to later raise price in that

16second market, the B market, the competitive

17market, then there's not a prospect for

18recoupment. And just because you have multiple

19products, it shouldn't be treated any

20different than Brooke Group, and you

21shouldn't have a violation.

22Real quick, I just wanted to

23raise some questions about the 3M LePage's

24case that Patrick talked about. In that

25case, the case was litigated on the

71

1assumption that there was only one market

2involved, a market for transparent tape.

3If in fact it had been

4litigated on the assumption that there were

5two markets, a market for branded tape and a

6separate market for generic or unbranded

7tape, then would there have been a

8violation? Remember, the record showed

9that the plaintiff, LePage's, still had

10two thirds of the generic type sales.

11Would there have been a dangerous

12probability of success of achieving monopoly

13power in that second market?

14And if it's only one market,

15I think one has to go back and look at

16Professor Muris's suggestion that you look at

17the cost of the bundle. Remember it's all

18the same market. It's just two different

19products in that market. And if the cost of

20the bundle in that one market is above --

21excuse me -- the price of that bundle is

22above the cost of the bundle, should that be

23a safe harbor in the single-market situation?

24And then separately, if it's

25all one market, would the same result have

72

1been achievable just by discounting the

2branded tape that was clearly sold at a large

3margin above cost. But if we're assuming

4it's one market and you've lowered the price

5of the branded tape, presumably that would

6have applied the same pressure to LePage's the

7generic tape. Yet that clearly would have been

8appropriate under Brooke Group. You're not

9required to charge the monopoly price. As

10long as you're just giving discounts on a

11single product, that would be lawful. Would

12that have had the same effect in LePage's?

13And then I think finally, an

14important part of this discussion -- and I

15think it goes broader than that case. This

16case is an example -- is what is achieved by

17the rule. What would have been accomplished?

18Would it have led to less discounting by 3M?

19How do you deal with situations in which you

20have leading or successful firms that you

21want to compete on price?

22If the only rule is that you

23must discount on a product-by-product basis,

24that may result essentially in less price

25competition and may harm consumers because,

73

1as people have speculated, 3M probably was

2attempting not to reduce the price of its

3successful branded tape, but trying to find a

4way to incentivize customers to buy more

5rather essentially than to switch their

6purchases from branded tape to the 3M

7generic tape.

8If in fact you have rules

9that limit the flexibility for leading firms,

10you have to look at what the economic

11consequences are going to be in the

12marketplace and for consumers.

13I think this highlights

14one of the key areas. The hardest areas,

15I believe, are situations in which

16you've got a firm that meets the monopoly

17power situation, and it engages in conduct

18that someone wants to characterize

19potentially as exclusionary. Is that simply

20enough? What kind of impact is necessary or

21harm to competition is necessary? Is a

22scintilla enough, or does it have to be

23actually a significant harm to competition,

24or are you simply into a balancing test of

25what is the benefit versus what is the harm?

74

1Now, very quickly I'd like us

2to cover one more point, which is on

3exclusive dealing, another area that could be

4clarified, and it does come up in the

5counseling context often. And that is a

6situation in which there would be exclusive

7dealing, which in a variety of contexts might

8be viewed as exclusionary conduct, but the

9exclusive dealing is at the behest of the

10customer. The customer comes and says, I

11think the best way to get the best price and

12the best terms from my suppliers is to hold a

13winner-take-all competition. So I'll invite

14everyone in and say, I'm going to buy all of

15my needs for the next three years from the

16party that gives me the best offer. And

17in that situation, I don't believe that even

18if you're the leading firm and even if you

19have monopoly power there should be a problem

20in competing and winning that kind of

21contract.

22And it seems to me that kind

23of clarification will assist in counseling

24and will assist customers in getting the best

25deal they can in the marketplace, which is

75

1what the antitrust laws are designed to

2promote.

3So in conclusion, I want to

4reinforce where I began. Clear administrable

5and objective rules are extremely important,

6and I hope they are the output of these

7hearings.

8I made several modest

9suggestions about ways in which the rules

10could be clarified. The first would be to

11clarify Copperweld so that you know when

12you're engaged in single-firm conduct.

13Whenever you've got more than a 50 percent

14share of the voting securities, the parent

15and all of those subsidiary corporations

16should be one company.

17Secondly, the aftermarket

18exception, the monopoly power rule. The

19notion that there are single intrabrand parts

20and service markets creates lots of

21counseling problems and lots of issues, I

22think, for consumers and competition. I

23think that ought to be overruled. And I

24think that the DOJ and the FTC should

25advocate that.

76

1I think all unconditional

2unilateral refusals to deal should be treated

3as per lawful, whether they involve

4intellectual property or not. That should be

5clarified. That should be advocated to the

6courts. That should be advocated in

7international settings.

8There are a number of ways I

9suggested in which the treatment of bundled

10discounts could be clarified. And finally,

11this idea of customer-initiated exclusive, I

12think a very simple, straightforward,

13helpful, practical clarification.

14Then I just want to

15underscore I think it's very important that

16we take the step of clarifying the U.S. law

17both at the Agency level for their

18enforcement discretion to go the next step

19which both agencies have done an excellent

20job of moving the agenda in the courts

21through amicus brief process and getting a

22number of key clarifications. I hope there

23are more at this term with the cases that

24are pending.

25And then finally, continuing

77

1to be active in bilateral discussions with

2other competition authorities and being a

3leader in the international competition

4network. Thank you.

5(Applause)

6MR. TARONJI: Thank you, Ron.

7We're going to take a 15-minute break and be

8back here at 11:15.

9(Break taken)

10MR. TARONJI: Well, thank

11you. The first thing I would like to do is

12offer each of the presenters an opportunity

13to comment on what they've heard from the

14other panelists. Let me start in order.

15David.

16MR. BALTO: You know, it's

17hard for me to comment on the terrific

18presentations of these two speakers. You

19know, generic -- let me make a simple point.

20Generic drug companies are almost never

21dominant. We're in like the most intensely

22competitive market. In any generic drug

23category you're certainly going to have five,

24six, seven competitors. Prices quickly

25computed down to marginal costs. So the

78

1headaches my colleagues have to live with I

2don't really have to deal with.

3I do have a little concern

4about one suggestion that Ron made, however.

5The idea that we should have a safe harbor

6for customer-instigated exclusive dealing. I

7just know from my experience in the

8enforcement agencies, you know, you'd always

9walk in there, and oh, you would have

10anticompetitive conduct investigations. And

11the parties would say, oh, customers really

12wanted this.

13Well, you know, when you

14actually sat down and were able to go and

15interview the customers you found out that,

16you know, they wanted it only because their

17arm was being twisted in a significant

18fashion.

19And also sometimes the

20interests of customers aren't really in

21confluence with the interests of consumers.

22And I think one of the kinds of practices

23that a lot of the previous speakers at these

24hearings have identified, some of the kinds

25of practices they've identified are

79

1situations where basically a dominant firm

2agrees to share its monopoly profits with its

3customers in order to keep rivals at bay.

4And you know, believe me, the customers like

5those situations, but I think those

6situations still can be harmful to consumers.

7MR. TARONJI: Patrick.

8MR. SHELLER: Really the only

9comment I'd like to make is one of gratitude

10to Ron. I suggested a number of problems

11that we at Kodak are facing because of some

12of the ambiguities in the law relative to

13bundling and also the law relative to

14aftermarkets. And I thought Ron made some

15very viable suggestions that could help maybe

16clear up some of those ambiguities. So thank

17you, Ron.

18MR. TARONJI: Ron, your turn.

19MR. STERN: Well, thank you,

20Patrick. Let me comment just briefly on

21David's presentation. I'm not particularly

22familiar with the pharmaceutical area,

23although as an antitrust lawyer these days

24you have to end up having some familiarity

25because there's so much activity in the

80

1pharmaceutical area.

2It just struck me that it

3was a situation in which perhaps it called

4out for regulatory reform to address many of

5the issues that David was talking about

6rather than having the antitrust laws and

7the court bear the entire burden in this

8area.

9It is one in which, of

10course, there are large expenditures made and

11large amounts of money at risk when the

12patent protections go off. And obviously

13that causes people to look for opportunities

14to continue to make the profits during the

15protected time period. And again, regulatory

16reforms may be a better solution.

17With respect to his sham

18petitioning point, it seems to me again this

19is an area simply in which clear rules would

20be important. I don't think anyone would

21deny the importance of First Amendment

22petitioning or the basic soundness of the

23Noerr-Pennington Doctrine.

24So if there is going to be

25greater emphasis placed on some sort of

81

1exception to that exemption, then it seems to

2me it needs to be a clear one so that people

3can counsel and take advantage of the

4governmental processes and the First

5Amendment in an appropriate way and keep

6one's clients out of a situation in which

7they expose themselves to government

8investigations and treble damages lawsuits.

9And to his other point, if I

10could take a moment on the customer-driven or

11customer-initiated exclusives, I take his

12point that there can be seller-initiated

13customer demand, and that's a fact issue.

14But it's sometimes very clear if a customer

15puts out an RFP and there haven't been any

16private discussions, that it's customer

17initiated and that's the way this will

18happen, I believe in a number of contexts.

19And if in fact you can -- you know, a seller

20tries to undermine the process by promoting

21or encouraging or incentivizing the customer

22to make such a request, you know, I think

23that can be addressed and dealt with.

24MR. TARONJI: I'm going to

25start off with some general questions, then

82

1we'll move to some of the conduct-specific

2questions that we talked about. And I'd like

3to talk about counseling.

4As a person who has given

5antitrust advice on the type of business

6conduct your company can or cannot engage in,

7have you found that there are specific types

8of conduct where the state of jurisprudence

9is such that your legal advice is either one,

10particularly easy to give and apply; or two,

11particularly difficult to give and apply?

12Let me start with you Ron, and then I'll go

13with Patrick.

14MR. STERN: Great. I'll be

15brief because that's mostly what I talked

16about.

17It seems to me in the U.S.

18it's not difficult to apply the monopoly

19power threshold element these days. At least

20I haven't found it inordinately difficult.

21In tying, it's pretty easy to counsel as to

22when you are or are not engaged in tying.

23You have some other issues, if you are

24engaged in tying, to evaluate whether the

25conduct is exclusionary or not. And as I

83

1mentioned in predatory pricing, I think

2there's some pretty clear guidance.

3The difficult areas are the

4ones I mentioned regarding bundled discounts,

5refusals to deal, and the thorny problem of

6aftermarkets. So that would be my list.

7MR. TARONJI: Okay. Patrick.

8MR. SHELLER: I would echo

9what Ron said. You know, we don't seem to

10have too much difficulty indentifying the

11market monopoly power threshold, in the

12U.S. anyways. That becomes more of a

13challenge when we counsel clients outside

14the U.S.

15Tying, as I said in my

16remarks, used to be an easier area in which

17to advise. But now, as I said, I think the

18line between tying and bundling is blurred

19because of the LePage's case. So today we have a

20have a lesser degree of confidence in couseling

21on tying arrangements.

22Exclusive dealing, predatorybr>
23pricing, I think the standards in those areas

24are fairly well established by the courts and

25by the agencies.

84

1The other area where we

2find challenges under Section 2 are the

3catch-all "other exclusionary" practices

4where you can have problems. There are

5cases like Conwood where the conduct was

6so egregious that you don't have too much

7trouble advising the client not to, e.g.

8tear down a competitor's store

9displays.

10But what other sorts of

11aggressive marketplace conduct that doesn't

12fall into the categories that we've just

13listed could offend Section 2? I think

14in many of these areas the law is either

15undeveloped or not developed to the extent

16where you can confidently advise. I mean, for

17example, how do you advise a client that has

18a relatively high market share with regard to

19how many of its competitor's employees they

20could hire? And that's an issue that has

21been litigated to some extent, but I thinkbr>
22the lines are very unclear in that

23area.

24MR. TARONJI: Okay. Great.

25And David, feel free to jump in whenever you

85

1want to.

2How do businesses such as

3yours respond to variations among different

4countries' competition laws with regard to

5single-firm conduct? Specifically, do

6international businesses decentralize decision

7making on business conduct to adapt to a

8foreign jurisdiction's competition laws?

9Patrick, from Kodak's

10standpoint as a chief compliance officer and

11ensuring that Kodak is complying with allbr>
12laws in all jurisdictions where you operate,

13how do you make those decisions where the

14standards may very well be different from one

15jurisdiction to the next?

16MR. SHELLER: Well, we're

17definitely in the decentralized model.

18We have in-house counsel in most of the

19major markets around the world. So we

20rely very heavily on their advice.

21However, there are

22circumstances where a business client

23may at the worldwide level bebr>
24considering a program that, at least based

25on our limited knowledge of the

86

1standards overseas, might pose problems,

2although they wouldn't in the U.S.

3So we do have a bit of

4centralized thinking in the international

5area. I was fortunate enough to have spent

6four years in Europe working as an in-house

7lawyer for Kodak, so I was able to pick up

8some of the thinking in competition law area.

9And I have a pretty good sense of what might

10offend the European Commission laws. But

11beyond that, we really, as I said,

12do rely on our oversees colleagues.

13MR. TARONJI: And Ron, I

14assume General Electric is organized much

15along the same lines?

16MR. STERN: Well, General

17Electric is decentralized. As people know,

18there are multiple General Electric

19businesses, each with their own CEO and own

20legal department. But there is sort of

21global assistance in the competition area,

22which is sort of what I and a small group of

23my colleagues do.

24And I would say that this

25question is a good one, and for G.E. it

87

1varies. There are a number of businesses

2we're in that are truly global businesses

3where you really need to counsel on a global

4basis rather than individualize.

5The customers may be in

6different jurisdictions, but it's probably a

7global market, and you really can't go

8through the time and effort to try to figure

9out about extra-territorial application of

10the various laws.

11So you try to counsel to

12sort of an international standard, always I

13think being concerned about the U.S. being

14necessary, because of the unique treble

15damage exposure and litigation costs in the

16U.S. But not sufficient, because you really

17want to make sure that you're meeting any

18more restrictive requirements in other areas.

19If we had it, which we do,

20businesses that operate much more locally,

21and their conduct clearly is only going to

22affect a particular jurisdiction, you can be

23confident of that, then you can get more

24localized advice about the actions that will

25just affect that jurisdiction with a key

88

1caveat, and I think this is important for

2everyone to recognize. Certainly, General

3Electric, and I expect many companies'

4business executives and even mid-tier

5employees move from country to country.

6Organizations change so that an organization

7that used to operate only in countries A and

8B the next day operates in countries A, B,

9C, and D. You don't have time when you're

10counseling to readjust everyone's headset

11when you don't know when they move.

12 So I think it's quite

13important in fact to avoid issues and to

14sensitize people to counsel to a norm because

15it's simply not efficient and it's dangerous

16in the long run to try to sort of say there's

17no competition law in country X or no enforcement,

18and so we can do as we please, even though

19we know in a neighboring jurisdiction where

20generally that conduct is likely to provoke

21investigations or litigation.

22MR. TARONJI: In looking at

23whether you can come up with a uniform

24standard for counseling purposes, do you trybr>
25to determine what is the most restrictive

89

1provision out there and counsel toward that,

2or do you go back and again look at the

3specific situation and look at it country to

4country and advise accordingly?

5MR. STERN: I think in

6general you do both. You try to make sure

7that you come up with something that's

8simple. The idea of clear and understandable

9rules is important because you have to be

10able to give clear and understandable advice.

11If you're giving advice that's too

12complicated to business people, you have to

13realize that there's a large risk that the

14execution will not be in conformity with the

15advice. And if that's a problem, then you've

16created a problem for the client.

17So it seems to me that in

18these sorts of situations, you really are

19looking for some sort of uniform standard.

20And if in fact there is a more restrictive

21approach taken by an important jurisdiction,

22one that is likely to have either private

23enforcement or government enforcement, even

24by way of investigation, then you try to find

25a way in which you're going to be in some

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1sort of comfortable, clear, safe harbor zone.

2And only if that creates real problems with

3achieving what you think is a legitimate

4business objective, are you able to spend the

5extra time and effort to see if you can

6design something that's more complicated.

7So I think the concern that

8I was trying to express about the need to

9address this globally is that U.S. legal

10clarity at least in a number of areas, could be

11overridden by a lack of clarity or by overlybr>
12restrictive rules outside the U.S. and the

13harm could come to U.S. consumers as well as

14those in other areas.

15 MR. MATELIS: Do you have

16anything to add, Patrick?

17MR. SHELLER: We also take a

18slightly different approach which is to start

19with analyzing proposed plans under the U.S.

20standard. And assuming that we can give the

21green light from a U.S. antitrust

22perspective, then the next step would

23would be to look at whether there are

24nuances under European law that might

25create a problem. Then we'd seek advice

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1from our European counsel on those

2particular aspects.

3And you know, increasingly

4now we'll look at some of the bigger markets

5and their antitrust enforcement. Ron spoke a

6little bit about the anti-monopoly law in

7China. We'll be keeping a close eye on

8developments there. And as that unfolds, it

9will be an important area that we'll focus on

10in our antitrust counseling.

11But as the starting point,

12we typically begin with the U.S. standards.

13MR. MATELIS: I have a

14question about clear rules. Ron and Patrick,

15in your remarks you both stressed the

16virtues, from your perspective, of clear

17rules in the Section 2 context.

18David, in your remarks you

19sounded a provocative cautionary note that

20maybe clear rules have some drawbacks. And

21I'd just like to get all of your perspectives

22again on a very basic question. What are

23the pros and cons that policy makers and

24courts should be thinking about when

25articulating rules? Maybe we could start/td>

92

1with you, David.

2MR. BALTO: I actually was

3interested in Ron's presentation. I thought

4the questions he posed were really good ones.

5But I sat there looking at the issues that

6Ron was posing and I said, now, what exactly

7is the rule in some of these situations that

8Ron wants that's going to make his life so

9much easier in counseling people?

10And I think that to the

11extent that it's a rule that's going to make

12Ron's life simple, Ron's life -- you know,

13Ron will be able to sleep at night because

14he knows he can give a clear message to the

15business person, and the business person can

16follow it in a relatively straightforward

17fashion, you know, I'm not sure that that's

18really going to happen. In many of these

19situations, I think that if there is -- there

20is potential for anticompetitive conduct.

21You know, you can look at

22the full range of things that Microsoft did

23that the Justice Department properly attacked

24in their lawsuit against them. And if you

25looked at them in segregation, you might be

93

1able to determine that there would be a clear

2rule that would suggest this kind of conduct

3might seem to be legal. But if you put all

4of the types of conduct together, you could

5see why the conduct was really problematic.

6 So I'm a little hesitant

7about clear rules. And for my perspective, I

8mean the clear rule, everybody in the world

9-- you read the hearing transcripts for these

10hearings, the clear rule everybody loves is

11Brooke Group and predatory pricing.

12And one of the most important

13points I want to make is in industries such

14as pharmaceuticals, going and talking about

15whether something is below your variable cost

16is a meaningless concept because all the

17costs are up front. So I don't think that

18rule -- that rule bears too great a risk of

19under-enforcement, which ultimately will harm

20consumers.

21MR. SHELLER: Well, as I

22indicated in my remarks, we would certainly

23favor clear rules in the Section 2 area for

24a couple reasons. One is that it does

25make the in-house counsel's job easier. They

94

1can draw brighter lines for the client.

2Second, I think it's

3important because it helps to make the

4antitrust laws appear more serious to

5business clients. If a business client is

6told that there's no real clear legal

7standard in the area where you're proposing a

8particular marketing plan, but here's some of

9the factors that we might consider,

10their reaction is likely to be: we might

11as well take the risk then. And so I think

12setting out clear rules helps business people

13to follow the antitrust laws.

14I would, however, note a

15caution that safe harbors in the form of

16guidelines can be can be helpful, but

17they can also in some ways be unhelpful.

18And I'll give as an example the European

19block exemption on technology transfers

20and some of the safe harbors that are built

21into that exemption relating to market share.

22The market share thresholds that the

23Commission uses are very low so that almost

24any transaction you would consider in the IP

25area is going to be outside of the

95

1thresholds. It's not helpful to set a

2threshold that low. It's too conservative.

3The Commission does provide

4some other factors and guidelines that

5companies should consider. But I think it

6sort of undermines the benefit of providing

7guidelines when you set thresholds that are

8too low.

9MR. STERN: Just comment

10briefly. I do think clear rules are

11important. I don't think there's a one size

12fits all rule, to respond to a point I think

13David made. I don't think it's a situation

14in which you need to have one principle

15that you use across all of the types of

16exclusionary conduct in Section 2.

17I think it is important

18obviously that the clear rules also be

19thoughtful, or they can do more harm than

20good. And I think what you're really looking

21for are principles that you can apply,

22understand, counsel to, and have some sort of

23confidence that the business can execute to

24them and that the courts and the enforcement

25agencies can predict -- you can predict how

96

1they're going to apply them. And that's

2really what I think we're searching for.

3And I think as my talk

4indicated, I'm happy to have them addressed in

5little half steps that do things that seem

6perhaps unimportant to some but are important

7in the real world. I think those steps are

8important and should be taken and not taken

9for granted.

10And secondly, I agree very

11much with Patrick's point. People need to

12look at guidance that's meaningful. Safe

13harbors that do nothing to clarify the

14situation because they only exist in

15situations in which you never anywhere have

16monopoly power are useless. It doesn't

17really help you. But meaningful safe harbors

18and ones that are understood not to define

19the line between legal and illegal, but to

20simply define and clarify what is clearly

21legal and not questionable are very

22important.

23 MR. COHEN: Let me just

24return to David because you've for a second

25time referred to your thought that relying on

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1average variable cost just doesn't work in

2the pharmaceutical industry as a test of

3predation. Do you have an alternative to

4that? And would any of these alternatives

5guide a firm with a large market share in

6determining what conduct it can engage in

7that increases its revenues in ways that have

8nothing to do with excluding competitors?

9MR. BALTO: Well, I think

10the answer to the second part of your

11question is no. I'm more concerned about

12possibly -- about our properly identifying

13anticompetitive conduct and stopping it. And

14the counseling question I'm going to sort of

15leave to the side.

16I look forward -- as to the

17first question, are there other standards, I

18look forward to the presentation that the

19representative of American Airlines is going

20to bring about the Justice Department case

21this afternoon.

22I think some of that same

23problem of high fixed costs, low variable

24costs were grappled with by the Justice

25Department in that case. I think because of

98

1that there is increasingly interesting

2economic literature that uses -- that talks

3about the use of predation, the use of

4above-cost price -- of certain pricing

5strategies to create a reputation for

6predation and how that kind of predation can

7be anticompetitive. And you know, I think

8that's something that I know the courts and

9the agencies need to explore further.

10MR. STERN: Can I just

11comment just for a second?

12MR. TARONJI: Go ahead.

13MR. STERN: I'm sure the

14economists who have participated in these

15hearings or will participate in later

16hearings or comment at the two hearings will

17know much better than I do.

18But it seems to me at least

19it's a bit simple to say because variable

20costs are low and fixed costs are high that

21that standard doesn't work. It seems to me

22in that context what it really means is that

23there's very little likelihood of exit

24because people are committed in the market

25and they've sunk their costs. And in that

99

1situation it's not clear how you end up with

2recoupment or whether you really have a

3problem.

4And I don't purport to have

5the answer, but it seems to me it's a bit

6too facile to simply suggest that because

7average variable costs are low that the

8standard shouldn't be used.

9 MR. BALTO: Let me just

10mention an area that I've written on and that

11the FTC is currently studying. That's the

12issue of authorized generics, which I

13deliberately kept out of my testimony because

14there's a fair amount written about this.

15An authorized generic is an

16arrangement between a branded pharmaceutical

17company that they enter into with another

18generic company to promote the entry of a

19second generic just prior to or immediatelybr>
20with the entry of the legitimate generic

21company. In other words, it's mother one of

22those situations where the generic is placed

23into the market it plans to -- you know, it

24plans to enter. And under the FDA

25regulations there's is six-month period of

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1exclusivity, which is the vast majority of

2the profits that a generic company makes when

3it enters into a generic market. And I've

4written about how this sort of strategy of,

5you know, making a deal with still another

6generic company to enter at the time of the

7legitimate generic's entry can be a strategy

8of predation. All the pricing is above cost.

9I think the pricing is meaningless.

10But what's important about it

11is that what you're doing there is sending a

12signal to the generic firm that it's -- you

13know, if you plan to enter my market, you

14can expect the rug to be pulled out from

15under you, and you're not going to get the

16reward you're expecting to get.

17And I think it's much more

18interesting to look at it from a certain

19strategic perspective.

20MR. TARONJI: As you know,

21antitrust lawyers and judges are battling

22over how much weight to give to business

23documents, from strategic plans to e-mails

24and sales and marketing personnel.

25What consideration should

101

1antitrust enforcers and courts give to intent

2documents in assessing a firm's conduct?

3MR. SHELLER: I'll start out

4with that. My view is that business intent

5documents have a role in attempted

6monopolization cases, and that is primarily

7it. There are ways in which you might use

8business documents in monopolization cases.

9But I think they need to be considered in

10terms of who wrote them.

11Often plaintiffs' lawyers,

12and to some extent the agencies, will rely

13on a bad document that might have been

14written by someone at a lower level in the

15organization. And it's really a statement of

16opinion.

17Obviously it's not something

18we as in-house antitrust counsel want to see

19from our clients. And we advise them not to

20write in that sort of manner. But you have

21to ask the question whether those views that

22are stated by a sales representative or a

23sales manager represent the views of the

24company.

25On the other hand, if you

102

1have clear statements being issued in

2internal documents by a corporate officer,

3for example, or the head of a business, then

4obviously that document ought to be given

5more weight and might be of more value in a

6Section 2 case. But again, I think documents

7play the most important role in attempt

8cases.

9MR. STERN: And I'd just

10add very quickly that it seems to me that

11objective standards are better than

12subjective ones. It's too easy in a large

13organization to find the snippet in a

14document and try to make that mean

15something more than it does, not in

16context.

17And what the law wants

18people to do in business is to compete

19aggressively and attempt to win in the

20marketplace. And that can be expressed in

21a way certainly if a lawyer writes it so

22that everyone would think it doesn't pose

23an intent problem. And that same kind of

24intent or motivation can be expressed

25in a way that someone might make more

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1out of it than I think they should.

2MR. COHEN: Would your

3suggestion to look at, in the exclusive

4dealing context, whether the policy is

5customer driven or driven by other internal

6motives take you into the area of looking at

7intent documents?

8MR. STERN: I don't think

9so. I think they might get you into the

10area that David talked about of seeing who

11actually initiated it. If the customer put

12out the RFP that I mentioned seeking a bid

13for all of their demand for three years, if

14in fact there were documents that showed that

15this was the initial idea and that they were

16essentially compensated for deciding to do

17that by the lead provider in the marketplace,

18that's, I think, the kind of situation David

19was talking about. And I don't think that's

20an intent issue. It's really: Was this the

21customer's initiated approach or was this

22essentially a supplier- initiated approach?

23It doesn't have to do with whether the intent

24for the exclusive was pro-competitive or

25anticompetitive.

104

1But it does, to be clear and

2sort of to finish the thought, the general

3notion is that a customer will not go out

4and seek, you know, this kind of

5winner-take-all situation unless the customer

6thinks it's going to benefit by it.

7In general, since the law is

8trying to promote customer welfare, the

9customer presumably would think it had enough

10competition and that by putting its demand

11out to this kind of winner-take-all bid that

12it wasn't changing the structure of the

13marketplace to its long-term detriment.

14MR. TARONJI: Well, I want

15to make sure that with the remaining time we

16have the opportunity to cover some of the

17substantive conduct issues. And let me go to

18bundle discounts.

19Does market share provide a

20useful screening mechanism for assessing

21loyalty discounts? And then I've got some

22subsets, so let me ask all of them and then

23you can comment on all of them.

24Could we state a useful safe

25harbor based on market share; and if so, what

105

1should that share be?

2MR. SHELLER: Let me address

3the question on loyalty discounts, which I

4distinguish from bundling in some respects. I

5think loyalty discounts can be an issue under

6Section 2 if they're really equivalent to

7exclusive dealing. If a customer is

8given a significant discount if they buy 100

9percent of their needs from the dominant

10supplier, then I would agree with the view

11that the European Commission takes: that

12this is tantamount to an exclusive dealing

13arrangement.

14 Therefore, market

15share thresholds could be important.

16100 percent exclusivity is obviously a good

17indication that you've got exclusive dealing.

18Whereas, if the supplier through a loyalty

19discount tied up say 70 percent of the market

20or 60 percent of the market, then you're less

21likely to have competitive harm. There would

22still be opportunities for rivals to place

23their products with that particular customer

24as well as other customers.

25MR. STERN: I guess my

106

1reaction is that the term loyalty discounts

2encompasses so many different kinds of

3pricing practices and so many different

4situations that I would be hesitant to

5provide one market share test to address it.

6You know, just -- Patrick had mentioned the

7European Commission. In their Article 82

8discussion paper they, I think, appropriately

9draw a distinction between a situation in

10which the different competitors, the

11suppliers can essentially compete to supply

12the entire demand of the customer or the

13entire demand in the marketplace versus a

14situation in which, I think as they express

15it, the customer must carry a certain

16percentage of the leading firm's products.

17That's more of a distribution kind of a

18situation. Those two are sort of night

19and day different. And you would think in a

20loyalty discount situation, you would want to

21be treating them very differently.

22To Patrick's point, you know,

23are they equivalent of exclusive dealing, or

24are they essentially just competing for the

25opportunity and competing aggressively and

107

1above cost, in which case the loyalty

2discount wouldn't be a problem.

3For these hearings,

4I went back and read some cases I'd read

5before the Concord Boat case. And in

6that situation it seemed important to

7the Court, and I think validly so, thatc

8a number of customers had decided that

9they could switch all of their demand away

10from Brunswick, who was the leading engine

11supplier, to their rivals depending on

12what kind of deal they got. In that kind of

13situation, you know, having a loyalty or a

14market-share-based discount was just one way

15of competing, which is what the Court

16determined, and it was above cost. So that

17would be my long-winded answer which is it

18depends.

19MR. TARONJI: David, in your

20presentation you suggested that the generic

21pharmaceutical industry is different, and so

22the standards, rules, guidance should

23take into effect that the pharmaceutical

24industry is different. How should the

25enforcement agencies take that into account?

108

1MR. BALTO: Well, you know,

2it's interesting if we really got into a long

3discussion of these -- you know, these

4different types of arrangements like tying,

5bundling, loyalty discounts, so on, some of

6the key cases involved pharmaceuticals and

7medical devices. Smith Klein versus Eli

8Lilly which involves, you know, a special

9pricing program to sort of compel people to

10purchase three drugs instead of two drugs.

11Ortho versus Abbott, which involves, you

12know, sort of market share discounts and so

13on and so forth.

14I think -- I'm not sure that

15in this area the rules need to be that

16different. I think it's just it's easier in

17this setting involving pharmaceuticals to

18identify the existence of an inelastic class

19of customers. And you know, most of the

20literature in this area suggests that it's

21necessary to have some set of inelastic

22customers.

23But I'm still waiting for

24Patrick and Ron to give me the market share

25threshold that makes it a safe harbor.

109

1MR. STERN: Well, I go back

2to the comments I made in my presentation.

3Oftentimes, if we are really talking about

4what is the market share of the party that's

5engaged in the conduct, you can go back to

6the monopoly power test and those thresholds

7and to the attempt threshold and the other

8aspects, as opposed though if we're asking at

9what level of market share can you set a

10market share-based discount. That, I think,

11is hard to say if you don't know what the

12context of the particular market is.c

13MR. BALTO: Can I pose a

14question for Patrick then? One thing I think is

15really interesting when you look at jurisprudence

16in this area is that the courts use this very

17hard threshold on Section 1 cases, you know,

18when it looks at bundling or market share

19discounts. And you know, you look at the

20lower court's decision in Microsoft.

21But when it comes to Section

222 they become more touchy feely and seem to

23be willing to project the potential for

24competitive problems even at lower market

25shares. And that's basically what happens in

110

1Densply and Microsoft and in LePage's.

2You know, from a business's

3perspective, how do you sort of look at that?

4MR. STERN: Well, I'll step

5up to that one. It seems to me it was the

6comment I was trying to make when I was

7asking some questions about 3M LePage's.

8I think the most difficult

9area to counsel in, just because I think the

10law isn't very clear and helpful, and the

11jury instructions aren't very helpful is a

12situation in which you are clearly in a

13category where you have monopoly power. You

14meet that threshold. You're taking conduct

15that either involves exclusive dealing or

16some other type of conduct that the law can

17characterize as being exclusionary, and then

18the question, as I think I mentioned is,

19well, what sort of impact does that have to

20have?

21And I think in the Section 2

22context your comment is correct. We don't

23have as much guidance. There is some notion

24that -- which I think shouldn't be the case,

25that if you're a leading firm, you have to

111

1act differently in some sort of way. That

2notion is reflected in the European community

3law with respect to some special

4responsibility, and some of the older case

5law affirms they're deemed to be dominant.

6I think in this situation,

7one of the areas that the hearings could

8benefit everyone is grappling with the issue,

9particularly in the area of pricing, which I

10think everyone is focused on of guidance and

11rules that make sense for firms that are

12leading firms, that you want to compete

13aggressively in the marketplaces in which

14they are leading firms because that is

15overall beneficial. But if in fact anything

16that might be characterized as too aggressive

17or characterized as exclusionary can be

18subjected to treble damages and a big

19monopolization investigation, all you're going

20to do is get people to pull their punches to

21the ultimate harm of consumers and

22competition.

23I think it's the same problem

24as I tried to illustrate with rules that turn

25on whether you've started to deal with

112

1someone or not, because they give you

2perverse incentives at the end of the

3day.

4MR. SHELLER: I think the

5market share test has limited value. I mean,

6it's a good starting point in which to advise

7clients. But what I tend to look at more

8often are other factors like whether this

9particular business has the ability to

10control prices in the market.

11I'm thinking about a

12specific example of a business that I've

13advised at Kodak which is considered to have

14a high market share for a particular segment.

15But I know from experience in working with

16the business, that if they were to raise

17their prices by five percent, we'd see

18an influx of customers turning to competing

19suppliers. So in that sense I don't think

20the market share that's attributed to that

21business is a valuable indicator of market

22power.

23And the other thing is the

24point that I made in my remarks which is

25that although you may have businesses in

113

1Kodak's world which are beginning to

2lose share to other technologies, you've

3got to take those technologies into

4consideration in determining whether you've

5got a Section 2 case or not and whether

6those technologies ought to be included in

7the market.

8MR. STERN: And just to add

9to Patrick's point, because I think it does a

10good job of illustrating one of the earlier

11questions about clear rules. I think it's --

12the clear rule about the ability to control

13market prices, that may not sound as clear,

14but I think antitrust lawyers and clients can

15work off of that kind of rule versus one

16that had some hard and fast market share

17threshold as if that were a clear rule.

18First, I think it's not a

19thoughtful one, as I mentioned, to have a hard

20and fast market share threshold. And

21secondly, it gives, I think, a false sense of

22clarity because it's all, of course, how you

23define the market and how you define the

24shares.

25Having a clear principle

114

1about one's ability to control market prices,

2it seems to me, is one you can apply in a

3market context and give -- be fairly

4comfortable about giving advice. And that's

5why I think it's important in the globalbr>
6context that people move more towards this

7kind of behavioral approach rather than a

8structural approach.

9MR. TARONJI: Let me end on

10one question dealing with misleading and

11deceptive conduct.

12Do you agree that if tortious

13conduct can be the subject of other causes of

14action or regulated under other regimes such

15as Food and Drug Administration, it should

16also be the subject of antitrust causes of

17action? I figured David had a strong feeling

18about that one.

19MR. BALTO: Yeah, absolutely.

20If something independently violates the

21antitrust laws, that's fine. We should

22realize that -- I appreciate Ron's comments

23about my testimony. The regulatory process

24moves -- that these may be regulatory

25problems. The regulatory process moves

115

1slowly and amending it is very difficult.

2Antitrust enforcement plays a

3vital role in sort of telling people where

4there are problem areas. And part of -- you

5know, what I'd like to do is show you -- you

6know, part of what we do is -- what people

7do as enforcers is raise attention to things.

8There's a recent court

9decision involving the drug DBABP which is

10used by tens of thousands of consumers, and

11there was a sham petitioning claim. And the

12sham petitioning claim was dismissed with

13seven words. That's all the district court

14judge said about the sham petitioning claim.

15You know, part of this is

16having enforcement agencies pay attention to

17these types of issues, I think, affects

18behavior of the businesses involved and

19reduces the likelihood that they engage in

20deceptive and sham conduct.

21MR. SHELLER: I would be

22very reluctant to apply a rule where the

23alleged predatory conduct, if it meets

24the standard of some state law violation,

25ought to be the basis of a Section 2

116

1claim.

2 One single violation of

3a state law, let's take tortious interference

4or theft of a trade secret as examples,

5does not amount to a Section 2 violation

6when coupled with monopoly share.

7Now, if you had a pattern of

8conduct occurring with respect to several

9customers or in several geographic

10markets, again Conwood being an example, then

11yes, you could have a Section 2 situation. br>
12But I'd be very reluctant to endorse ther>
13notion that a single violation of state law

14can be the predicate act for a Section 2

15case.

16 MR. TARONJI: Okay. Any

17other questions? Great. Well again, I want

18to thank all of our panelists for their

19interesting -- I'm sorry.

20MR. BALTO: Could I just

21end with a final comment --

22 MR. TARONJI: Go ahead.

23MR. BALTO: -- because I'm

24pushy.

25I just wanted to talk about

117

1the devices for the agencies as they look at

2Section 2 enforcement. And I think this is

3a point that all three of us would agree on.

4The role of the agencies in

5filing amicus briefs, not just before the

6Supreme Court, but in lower courts, in

7district court cases is tremendously

8important. The reason why millions of

9consumers now can buy generic Buspar is

10because the Agency, the FTC filed a brief

11before the district court judge explaining by

12the sham conduct that Bristol-Myers was

13engaging in was not immune under the

14Noerr-Pennington Doctorine. They went down

15to the district court.

16I think those types of cases

17are tremendously important. There are tons of

18headaches that these people have in trying to

19interpret LePage's. You should go look at

20what's going on in the district courts.

21LePage's type cases are currently being

22litigated. And look for opportunities to

23provide clarity in that setting so that when

24the district court judges reach decisions on

25these difficult LePage cases they're informed

118

1by sound economic and legal principles.

2 MR. TARONJI: Any of you

3want to have a final word?

4MR. SHELLER: I would

5like to endorse David's remarks and just add

6the following. The agencies, and I'm

7going to again focus on the two areas of

8concern for Kodak -- the bundling area

9and the intellectual property rights --

10had an opportunity to urge the Supreme

11Court to take up a case and really

12settle the law in that area, LePage's and

13then the Xerox case. In both cases the

14agencies took the view that maybe those

15issues weren't yet ripe for the Supreme Court

16to consider.

17I would suggest that you be

18very clear in your advice to the Supreme Court

19in the future when the time is right to take

20those issues up. We would certainly

21appreciate that. And it would provide a

22lot of helpful guidance to the business

23community.

24MR. TARONJI: Great. Ron,

25any final comments?

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1MR. STERN: Nothing other

2than to thank you and the few hardy souls

3who actually made it today for joining us.

4MR. TARONJI: Please join me

5in a round of applause for our panelists.

6(Applause)

7MR. TARONJI: And we will

8reconvene at 1:30 for our second panel.

9(At 12:00 noon a luncheon

10recess was taken until 1:30

11 p.m.)

12***AFTERNOON SESSION***

13MS. GRIMM: Good afternoon.

14I am Karen Grimm, Assistant General Counsel

15for Policy Studies at the Federal Trade

16Commission. I'm one of the moderators for

17this afternoon's session. My co-moderator

18today is Joe Matelis from the Antitrust

19Division of the U.S. Department of Justice.

20Before we start, let me cover

21just two preliminary housekeeping matters.

22First of all, as a courtesy to our speakers,

23we'd like for you to turn off your cell

24phones, Blackberries, and any other devices.

25And secondly, we ask that the audience not

120

1ask questions or make comments during the

2hearing. Thank you.

3Before introducing our

4speakers this afternoon, I would like to

5first thank the University of Chicago's

6Graduate School of Business for hosting these

7joint FTC/DOJ hearings to solicit testimony

8on single-firm conduct. In particular, I

9would like to thank Dean Ted Snyder and the

10staff of the Gleacher Center for offering us

11their facilities and for making the necessary

12arrangements for us to hold these hearings

13here.

14And finally, I would like to

15thank my FTC and Justice Department

16colleagues as well as the FTC's Midwest

17regional office in Chicago who have worked

18very hard to put these hearings together.

19We are honored this afternoon

20to have a distinguished group of panelists

21from the business community. Our panelists

22this afternoon are first Sean Heather from

23the U.S. Chamber of Commerce, Bruce Sewell

24from Intel Corporation, and Bruce Wark from

25American Airlines. Sean, I will note, is

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1standing in at the last moment for Stan

2Anderson who was unable to be with us.

3Our format this afternoon

4will be as follows. Each speaker will make

5a 20- to 25-minute presentation. We will

6then take a 15-minute break. And after the

7break we will reconvene and have a moderated

8discussion with our panelists.

9As Jim said at our morning

10session, these hearings in Chicago are an

11extremely important component of the joint

12FTC and Antitrust Division hearings on

13single-firm conduct under Section 2.

14Over the past eight months we

15have held hearings in Washington D.C.

16primarily focused on specific types of

17business conduct such as predatory pricing,

18refusal to deal, bundled and loyalty

19discounts, tying arrangements, exclusive

20dealing, and various types of misleading and

21deceptive conduct which have been challenged

22under Section 2.

23While some of these earlier

24panels have included business executives and

25their legal advisers, they have for the most

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1part focused on specific types of conduct and

2have relied most heavily on speakers from

3academia and the private bar.

4Our sessions today are

5somewhat different. They are designed to

6provide a forum for businesses to tell us

7what particular Section 2 issues are of

8concern to them, and to suggest ways in which

9we at the FTC and the Antitrust Division may

10be better able to address those issues and

11provide additional guidance on their

12particular areas of concern.

13Our panelists today have

14accepted our invitation to share with us

15their perspectives and views on Section 2

16issues and enforcement. I want to thank them

17all for agreeing to participate in today's

18hearing and look forward very much to hearing

19what insights they have to share with us.

20I would now like to turn

21over the podium to my colleague and

22co-moderator, Joe Matelis, from the Antitrust

23Division for any remarks he would like to

24make. Joe.

25MR. MATELIS: Thanks Karen,

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1and because my remarks will be brief, I'll do

2them sitting down.

3The Department of Justice's

4Antitrust Division is very pleased to take

5part in today's session, and I'd like to

6reiterate what Karen said, that we're

7interested in hearing about the perspectives

8of businesses. And so we're looking forward

9to your remarks today. And also repeating

10Karen, on behalf of the Antitrust Division, I

11would like to thank Bruce, Bruce, and Sean

12for coming here and agreeing to share your

13time and thoughts with us. We know that a

14lot of effort and work goes into these

15presentations, so we're extremely grateful

16for you for rendering this valuable public

17service, and particularly in February in

18Chicago.

19I would also like to thank

20on behalf of the Antitrust Division the

21Gleacher Center and the University of Chicago

22Graduate School of Business for hosting these

23hearings. And finally, I'd like to thank

24Karen and her colleagues at the FTC for

25organizing today's wonderful session.

124

1Thanks.

2MS. GRIMM: Our first speaker

3this afternoon is Sean Heather. Sean is with

4the U.S. Chamber of Commerce. He serves as

5its executive director for global regulatory

6cooperation. Global regulatory cooperation

7is a new program at the Chamber focused on

8regulatory divergence around the globe and

9its impact on international trade.

10Prior to leading this project

11at the Chamber, Sean worked for nearly

12eight years in the Chamber's formulation

13and lobbying shops. He has his MBA and

14undergraduate degrees from the University of

15Illinois. Sean.

16MR. HEATHER: Thank you for

17the opportunity to appear before you today to

18address the important issue of whether and

19when specific types of single-firm conduct

20may violate antitrust law. I will summarize

21my written remarks, which the Chamber has

22separately submitted. I would ask that both

23be included as part of the record.

24I appear today on behalf of

25the U.S. Chamber of Commerce, the world's

125

1largest business federation, representing more

2than 3 million businesses of every size,

3sector, and region.

4The Commission and the

5Department should be congratulated for

6holding these hearings and reaching out to

7the business community for its views on this

8critical topic.

9At the Chamber, we work

10continuously to promote free market

11principles, because we see the free market

12system as essential to ensuring a vibrant and

13productive economy. And we believe that

14balanced and effective antitrust enforcement

15is critical to ensuring a free market.

16In the U.S. we support the

17application of Section 2 of the Sherman Act

18to conduct that threatens competition and

19harms consumers. And outside the U.S., we

20support the application of similar laws.

21However, the Chamber believes

22that the U.S. and foreign competition

23authorities must use special care in policing

24single-firm conduct to avoid chilling

25behavior that is in fact both procompetitive

126

1and beneficial to consumers.

2To accomplish this, we

3believe antitrust rules must be 1)

4transparent, 2) predictable, 3) consistent

5across jurisdictions, and 4), reasonably

6stable over time.

7It is important to remember

8that new products and new business practices

9are developed well ahead of their actual

10introduction and ahead of any scrutiny by

11antitrust regulators. Firms do want to obey

12the rules of the road, but discerning and

13applying those rules is becoming increasingly

14difficult. In its September 5th written

15submission to these hearings, the Chamber

16focused on the need for clear, predictable

17standards for tying and essential facilities

18analysis to domestic enforcement of Section

192. Today I'd like to extend these principles

20to international antitrust enforcement and

21highlight the importance of cooperation among

22antitrust enforcement officials around the

23world.

24The U.S. Chamber of Commerce

25has recently announced a major new

127

1initiative, the Global Regulatory Cooperation

2Project. This project aims to increase

3awareness about and to develop successful

4strategies for combating the growing threat

5that divergent regulatory systems pose to

6competitive markets and to international

7trade.

8The need for Global

9Regulatory Cooperation is clear. Barriers to

10international trade go beyond market access

11issues. Traditionally, trade agreements and

12negotiations have focused largely on tariff

13reductions. While market access must remain

14a priority, divergent regulations are

15increasingly impeding trade, and governments

16around the world need to better understand

17the impact in-country barriers have.

18While the Chamber's project

19focuses on many types of divergent

20regulations, one area that deserves special

21consideration is competition policy. I'd

22like to make the following three points.

23First, the growing

24proliferation of antitrust enforcement around

25the world, together with the globalization of

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1business creates increasing risk of conflict

2in the application of antitrust rules to

3single-firm conduct. These conflicts impose

4costs on firms and harm consumers and are

5becoming potential barriers to international

6trade.

7Second, while many

8differences may be discerned between U.S. and

9foreign standards for single-firm conduct,

10the differences in the enforcement approach

11on tying and essential facilities analysis

12is becoming increasingly apparent.

13Third, now is the time to

14act on these differences. The U.S. must lead

15a cooperative effort among industrialized

16nations to develop and recommend appropriate

17standards for single-firm conduct and to

18promote their adoption around the world.

19Over the past 15 years, the

20number of jurisdictions with antitrust laws

21has grown from about 25 to approximately 100

22today. Many of the newer enforcement

23agencies have limited training, experience,

24and resources to police anticompetitive

25behavior and enforce their laws

129

1appropriately.

2One thing is certain, the

3impact of competition decisions by any given

4enforcement agency no longer is confined by

5its home jurisdiction. Increasingly, those

6decisions reverberate around the world,

7forcing firms to conform their behavior to

8the most restrictive enforcement policies and

9increasingly have a negative impact on the

10global marketplace.

11The underlying goals of

12antitrust enforcement and trade liberalization

13are similar in that both aim to achieve open

14and competitive markets. In their

15application, however, competition laws may

16sometimes constitute barriers to trade. In

17some countries, particular enforcement actions

18may be motivated by protectionist goals. In

19other instances, differences in general legal

20standards or in remedies may have a chilling

21effect on trade.

22In her statement opening

23these hearings, Chairman Majoras remarked

24that quote: "Disagreement among competition

25authorities about how to treat unilateral

130

1conduct produces uncertainty in national and

2world markets, reducing market efficiency and

3imposing costs on consumers."

4Other government officials,

5both in the Executive Branch and in Congress,

6as well as many business and Bar Association

7groups have also joined in recognizing the

8growing potential for conflict and the costs

9and burdens associated with it.

10The record clearly

11demonstrates that these costs are very real.

12For example, Microsoft has been subject to

13three different sets of remedies in three

14different jurisdictions for what is

15essentially similar conduct.

16In March 2004, the European

17Commission held that Microsoft had abused a

18dominant position in violation of Article 82

19of the EC Treaty by tying the purchase of

20Windows Media Player to the purchase of the

21Windows operating system and by refusing to

22share proprietary communication protocols with

23competitors and allow their use in developing

24operating systems that would compete with

25Microsoft's own products.

131

1When the EC issued its

2decision, then-Assistant Attorney General Pate

3issued a statement criticizing it as both

4costly and unnecessary in light of the final

5judgment entered against Microsoft by the

6U.S. in 2001.

7Later Pate expressed quote

8"deep concern about the apparent basis for

9this decision and the serious potential

10divergence it represents." Noting that "It

11is unfortunate that considerations of

12international comity and deference did not,

13in the Commission's judgment, carry

14sufficient weight to avoid the significant

15divergence that has now occurred."

16Soon after the EC's decision,

17the Korea Fair Trade Commission held that

18Microsoft had abused a dominant position in

19South Korea by integrating media and instant

20messaging software into Windows and posing a

21code removal remedy similar to the one

22imposed in Europe. On that day the decision

23was announced, Deputy Attorney General

24McDonald released a statement stating that

25quote: "The Antitrust Division believes that

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1Korea's remedy goes beyond what is necessary

2or appropriate to protect consumers."

3More recently, allegations of

4illegal tying have been the focus of attack

5on Apple in Europe. Apple uses Fairplay

6Digital Rights Management technology to

7encode songs from its iTunes music online

8store. As a result, the songs may only be

9downloaded using Apple iPod devices.

10Norway's Consumer Ombudsman has found that

11Apple's DRM policies have effectively tied

12the purchase of iPods to the purchase of its

13online music, and has ordered Apple to either

14license its Fairplay technology to competing

15producers of music players or to develop a

16new open standard with those companies.

17According to press reports,

18authorities in Sweden and Denmark may follow

19suit in formally charging Apple with

20violation of local laws. And the French

21Parliament has enacted legislation that may

22require music downloads to operate across a

23range of devices, empowering a government

24body to force digital providers to share the

25information as needed to ensure such

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1interoperability.

2Significantly, while the EC

3has launched an investigation into Apple's

4music pricing policies, the EC investigation

5reportedly does not focus on this purported

6tie.

7Apple's success has come

8about as a result of innovation. Consumers

9voted with their wallets to reward Apple for

10its ability to innovate and to commercialize

11its ideas. Competition authorities should

12recognize the right of innovators to reap the

13rewards of their innovation. That is to

14protect competition, not competitors.

15Assistant Attorney General

16Tom Barnett made this point recently in

17criticizing the attack on Apple pointing out

18also that quote: "If the government is too

19willing to step in as a regulator, rivals

20will devote their resources to legal

21challenges rather than business innovation".

22In addition to these cases

23involving Microsoft and Apple where U.S.

24companies have actually been charged with

25violations of foreign laws based on legal

134

1standards that are arguably divergent with

2those in the United States, there are several

3pending investigations of Intel and Qualcomm

4that may well result in significant

5conflicts.

6Recent press reports indicate

7that the E.U. might formally charge Intel

8with abusing its dominance in the market for

9microprocessors in Europe. According to

10press accounts, EC investigators potentially

11believe Intel has interfered improperly with

12the distribution and purchase of rival

13products, in part by offering rebates to

14customers that agree to purchase from Intel

15exclusively. The Korean Fair Trade

16Commission is also investigating INTEL's

17rebate policies.

18Qualcomm is also reportedly

19under investigation by both the Korean and

20Japanese Fair Trade Commissions, in part for

21offering lower royalty rates for its CDMA

22wireless technology if licensees agree to

23license such technology exclusively from

24Qualcomm.

25The EC has received a formal

135

1complaint about Qualcomm's conduct from a

2group of Qualcomm competitors, but has yet to

3actually initiate a formal investigation.

4U.S. antitrust enforcement

5officials are far more cautious than foreign

6jurisdictions, however, upon investigating and

7challenging such fidelity rebates and related

8volume discounts and exclusive dealing

9practices, because in many cases they may be

10procompetitive and result in lower prices for

11consumers. Because Intel and Qualcomm may

12not be formally charged in these proceedings,

13it is hard to tell what conflicts with U.S.

14law may emerge, how severe they may be, and

15what consequences may result.

16As significant as these

17conflicts among jurisdictions with mature

18antitrust enforcement regimes may be, they

19may be eclipsed in the coming years by the

20conflicts generated by the adoption of new

21antitrust laws in emerging and transitioning

22economies.

23For example, the current

24draft of the new anti-monopoly law in China

25now under consideration contains prohibitions

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1of abuse of dominance that remain unclear,

2creating fears of an expansive and

3inconsistent enforcement approach.

4Ambiguities abound when firms may be

5considered dominant and when they may be

6found to have engaged in illegal tying and

7other abusive conduct are concerns for the

8chamber. My written statement contains

9additional details on China's proposed law.

10A greater effort must be made

11amongst the jurisdictions with established

12antitrust enforcement regimes to improve the

13content and the consistency of their rules

14governing single-firm conduct and then share

15their learning and comparatively greater

16experience with countries that may be

17developing new antitrust statutes or

18modernizing existing ones. Legislative

19drafters in China and elsewhere will be

20influenced in a positive way by the

21development of such a consensus.

22In my testimony, I have

23quoted a number of U.S. officials who have

24recognized the growing divergence in

25antitrust standards governing single-firm

137

1conduct and what it means for U.S. companies

2and consumers. But recognizing the problem

3isn't enough. The U.S. government needs to

4address this problem with an increased sense

5of urgency. The Department of Justice and

6the Federal Trade Commission have devoted

7resources for many years to fostering

8cooperation, convergence, and consistency in

9antitrust enforcement efforts, as well as in

10remedies.

11They have been successful to

12a degree, but the success has been realized

13largely in the cartel and merger enforcement

14areas. Greater priority must be given to the

15area of unilateral conduct. Today, a handful

16of companies have been caught up or face the

17potential of being caught up in divergent

18interpretations of anticompetitive unilateral

19conduct.

20However, if this divergence

21in understanding of single-conduct behavior

22continues amongst the world's competition

23jurisdictions, more companies globally will

24be the target of future investigations and

25proceedings. It is this divergence that the

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1Chamber's Global Regulatory Cooperation

2project seeks to counter.

3First, the U.S. government

4must step up its efforts to encourage

5convergence in substantive antitrust standards

6for single-firm conduct, and in remedies. To

7do that, the U.S. must engage more countries

8bilaterally, and it must work towards greater

9convergence in the context of such

10multilateral organizations as the OECD and

11International Competition Network.

12The Chamber believes there is

13a significant opportunity for the U.S.

14government to have an impact in this area,

15given the fact that the FTC co-chairs the

16ICN's working group on Unilateral Conduct.

17In this leadership role, the U.S. should be

18in a position to call attention to diverging

19standards and work to reduce and eliminate

20them, particularly in the tying and essential

21facilities areas, which have proven so

22important as of late.

23Second, the preliminary draft

24outline of the Antitrust Modernization

25Commission recommends that the United States

139

1should continue to pursue bilateral and

2multilateral antitrust cooperation and comity

3agreements with more of its trading partners

4and make greater use of comity provisions in

5existing cooperation agreements.

6The Chamber believes that the

7U.S. should explore the concept of enhanced

8comity, including such elements as an

9agreement amongst jurisdictions to defer to

10one another in relation to remedies.

11While existing bilateral

12agreements and the existing application of

13comity principles have certainly been useful,

14they have limitations, as illustrated by the

15inconsistent remedies imposed by the U.S.,

16E.U., and enforcement authorities in the

17Microsoft matter. Jurisdictions such as these

18with mature antitrust enforcement regimes

19should set a coherent and unified example for

20other countries by expanding their

21cooperation and making them more consistently

22successful.

23Third, the U.S. enforcement

24agencies should be encouraged to participate

25more actively and cooperatively in

140

1enforcement and policy development activities

2with their foreign counterparts, by filing

3amicus briefs, for example, when U.S.

4agencies are not conducting parallel

5investigations.

6We applaud this series of

7hearings for giving your counterparts in

8Canada, Mexico, Japan, and the European Union

9the opportunity to testify last September.

10This kind of cooperative spirit and

11substantive sharing of ideas is the platform

12for starting to combat future competition

13divergence.

14Fourth, the need for

15technical assistance is clear. It is

16difficult for even the most experienced

17jurisdictions to define appropriate rules

18governing single-firm conduct, so newer

19enforcement agencies may be expected to

20struggle with them.

21U.S. agencies should review

22the adequacy of current technical assistance

23programs in the area of antitrust, and

24implement any changes that may be necessary

25to make them more effective.

141

1An agency review should

2include 1), a review of programs sponsored by

3other countries as well as the U.S.; 2) a

4review of the work of international

5organizations such as the OECN and ICN; and

63), a review of the adequacy of U.S. funding

7levels and how that funding is deployed.

8The U.S. must approach this

9issue holistically and in cooperation with

10other developed countries to ensure that

11available resources are allocated efficiently

12and effectively and to ensure that other

13important initiatives such as the protection

14of intellectual property are pursued.

15Finally, the FTC and DOJ must

16approach these issues with a great awareness

17of the interface between competition policy

18and international trade, and the impact the

19divergent antitrust standards have on trade.

20To this end, the FTC,

21Department of Justice, USTR, State and

22Commerce Departments must coordinate better

23on these issues. The Department of Treasury

24should also be involved, as it looks to lead

25a strategic economic dialogue with China.

142

1And to address protectionist tendencies,

2agencies across the U.S. government must work

3cooperatively with their counterparts around

4the world to ensure that competition policies

5support liberal trade policies.

6This effort is challenging,

7but critically important. The Chamber stands

8ready to assist the FTC and DOJ in any way

9it can, and we look forward to working with

10you. Thank you.

11(Applause)

12MS. GRIMM: Thank you, Sean.

13Our next speaker is Bruce Sewell. Bruce is

14the senior vice president and general counsel

15for Intel Corporation. He is responsible for

16Intel's legal and government affairs

17functions worldwide.

18Prior to being named general

19counsel, Bruce was Intel's director of

20litigation. Before joining Intel, Bruce was

21a litigation partner at Brown & Bane and was

22an associate at Schnodder, Harrison, Siegel &

23Lewis.

24Bruce received his J.D.

25degree from the George Washington University

143

1and his bachelor's degree from the University

2of Lancaster in the United Kingdom. Bruce.

3MR. SEWELL: Good afternoon.

4Let me begin by thanking the antitrust

5enforcement agencies for giving me the

6opportunity to participate in these very

7important hearings. I appreciate the

8considerable effort that has been devoted to

9these hearings and the dedication that the

10agencys' staffs have brought to bear on these

11important issues. I'm confident that the

12agencys' report will make a significant

13contribution to the analysis of single-firm

14conduct.

15The development of the law of

16single-firm conduct is of obvious interest to

17my company. We are the defendant in a

18highly visible Section 2 litigation that has

19generated considerable interest both in the

20press and among antitrust specialists.

21I was somewhat dismayed to

22see that the plaintiff in our case used these

23hearings as a forum to rebroadcast

24allegations that it has made already in its

25District Court filings and in the press.

144

1With respect to this I will only say the

2following. Intel prefers to litigate in the

3courtroom, and I will therefore not use this

4forum as a -- to argue the merits of our

5case other than to state that I unequivocally

6deny the allegations that were made against

7Intel at the January 30th hearings in

8Berkeley.

9Instead, my remarks today

10will address the policy issues that have been

11the focus of these hearings. In particular,

12I would like to discuss the appropriate role

13of Section 2 with respect to pricing and

14discounting practices. I hope that my

15company's perspective on these policy issues

16will help to advance the debate that the

17agencies have generated through these

18hearings.

19At the risk of stating the

20obvious, the challenge of Section 2

21enforcement is to curb anticompetitive

22single-firm conduct that harms consumers

23without deterring the type of aggressive

24competition that benefits consumers through

25lower prices and greater innovation. This is

145

1a great challenge.

2As Professors Baumol and

3Ordover have observed almost 20 years ago,

4there is a specter that haunts our antitrust

5institutions. Its threat is that far from

6serving as the bulwark of competition, these

7institutions will become the most powerful

8instrument in the hands of those who wish to

9subvert it.

10Baumol and Ordover stressed

11the important concept that rules that make

12vigorous competition dangerous clearly foster

13protectionism. And they warned of the runner

14up who hopes to impose legal obstacles on the

15vigorous efforts of his all-to-successful

16rival.

17These observations were more

18recently echoed by Professor Preston McAfee

19and Nicholas Vakkur who catalogued seven

20strategic abuses of the antitrust laws,

21including punishing non-cooperative behavior

22and preventing a successful firm from

23competing aggressively.

24In his presentation at these

25hearings, Professor McAfee stressed that the

146

1antitrust laws can be used to harass, harm,

2and extort in order to induce cooperation.

3The strategic abuse of the

4antitrust laws is of more than a passing

5concern to Intel. I was therefore

6particularly pleased to see both Chairman

7Majoras and Assistant Attorney General

8Barnett in their remarks at the beginning of

9these hearings underscore the importance of

10having rules that do not deter

11pro-competitive aggressive competition. As

12Chairman Majoras stated in her remarks:

13"There is consensus that antitrust standards

14that govern unilateral conduct must not deter

15competition, efficiency, or innovation. This

16is why we frequently worry about false

17positives. Pervasive and aggressive

18competition, in which firms consistently try

19to better each other by providing higher

20quality goods and services at lower costs, is

21crucial to maximizing consumer welfare and

22economic growth."

23Assistant Attorney General

24Barnett echoed one of our chief concerns as a

25business that devotes considerable resources

147

1to antitrust compliance by stating that

2antitrust rules in the unilateral conduct

3area must set forth "clear objective

4standards that businesses can follow and that

5are also administrable for enforcers, courts,

6and juries". Particularly in the area of

7pricing behavior, as the Supreme Court has

8emphasized on many occasions, and Mr. Barnett

9endorsed in his remarks, antitrust rules must

10avoid chilling legitimate price cutting.

11This requires objective standards that rely

12on information that is available to corporate

13decision makers when they act and that allow

14more efficient firms to exploit their cost

15advantages. Sound antitrust policy also

16requires sensitivity to the potential misuse

17of the antitrust laws by less efficient

18competitors to reduce price competition.

19Government enforcement policy

20has been appropriately cautious in the area

21of pricing, taking heed of the risk of

22chilling the very conduct that the antitrust

23laws seek to encourage, that is, aggressive

24price cutting.

25At the same time, the

148

1enforcement agencies have aggressively pursued

2many other forms of conduct that

3anti-competitively creates or maintains

4monopoly power.

5Without getting into the

6merits of any individual case, it is

7important to note that the agencies have

8pursued a number of different forms of

9conduct under Section 2 theories. Recent

10cases include patent settlements that may

11delay entry and thereby extend an incumbent

12supplier's exclusive rights to supply,

13representations to standard-setting

14organizations or governmental bodies regarding

15patent positions, exclusive dealing, and

16product design cases.

17The enforcement agencies have

18recognized the challenges inherent in

19aggressive enforcement of Section 2 cases.

20While bringing a number of Section 2 cases in

21recent years, the agencies have also

22expressed cognizance of the potential misuse

23of the antitrust laws by less efficient

24rivals.

25As Deputy Assistant Attorney

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1General Masoudi has noted elsewhere, an

2antitrust agency must be cautious about

3complaints it receives from competitors.

4Such complaints often try to avoid legitimate

5competition by seeking protection from the

6government from competitive pressures.

7This is particularly true

8when the subject of such complaints it price

9cutting. We hope that the agencies' final

10reports on these hearings will impart to the

11courts the benefit of the agency's experience

12in enforcing the law aggressively while

13resisting the demands of complainants who

14seek to use Section 2 to dampen competition.

15 I read with considerable

16interest the assertions that were made at the

17January 30th hearing that the enforcement

18agencies have been asleep on the job or that

19they have somehow failed to enforce Section

202. This view simply cannot be squared with

21the record of aggressive enforce that I've

22just outlined.

23It was also suggested at that

24hearing that the enforcement agencies have

25given the high-tech area a free pass, even

150

1ignoring the fact that high tech is not

2limited just to the computer industry. This

3claim is equally hard to square with reality.

4The Agency's most recent

5actions in the high-tech area include

6monopolization cases against Microsoft and

7Rambus, a substantial number of merger

8enforcement cases involving companies --

9software companies such as Oracle, PeopleSoft

10being the best known, and many other

11high-tech market cases including

12communications technology, disaster recovery

13systems and 3-D prototyping. Also massive

14fines imposed on DRAM companies and jail

15sentences on some company executives and

16ongoing criminal investigations involving

17SRAM, flat-panel displays, and graphics

18processors.

19The criminal cases and

20investigations are particularly notable

21because they involve price fixing, conduct

22designed to and having the effect of making

23consumers pay more. It seems eminently

24sensible that antitrust enforcement should

25direct itself at conduct that demonstrably

151

1leads to higher prices rather than to

2attacking price cutting which is the very

3conduct that the competition laws are

4designed to promote.

5It was suggested at the

6Berkeley hearing that antitrust enforcement

7should be directed at price cutting and that

8the reality, as opposed to the myth, is that

9consumers are harmed when prices come down

10due to discounting.

11Here I could not disagree

12more with the position espoused by AMD. On

13the issue of discounting we have a

14fundamentally different point of view. We

15think that enforcement resources are

16appropriately directed at conduct that makes

17consumers pay more, not conduct that gives

18them lower prices.

19I believe that our position

20is supported by both the law as articulated

21by the Supreme Court, and by very sound

22policy considerations that underlie the

23Court's decisions. The Court's statement in

24Matsushita cogently expresses both the policy

25and its underpinnings. To quote: "Cutting

152

1prices in order to increase business often is

2the very essence of competition. Thus

3mistaken inferences in cases such as this one

4are especially costly because they chill the

5very conduct the antitrust laws were designed

6to protect."

7Justice Breyer, while sitting

8on the First Circuit, made a similar

9observation in the Barry Wright case. Again

10quoting: "the consequence of a mistake here

11is not simply to force a firm to forego

12legitimate business activity it wishes to

13pursue; rather, it is to penalize a

14procompetitive price cut, perhaps the most

15desirable activity from an antitrust

16perspective that can take place in a

17concentrated industry where price typically

18exceeds costs."

19This policy has broad

20application across all areas of pricing

21conduct. As the Supreme Court said in the

22Arco versus USA Petroleum case: "Low prices

23benefit consumers regardless of how those

24prices are set, and so long as they are

25above predatory levels, they do not threaten

153

1competition". We have adhered to this

2principle regardless of the type of antitrust

3claim involved. This is not only the law,

4but it is also the right antitrust policy.

5This policy recognizes that

6false positives, which are very likely to

7occur in the absence of clear-cut cost-based

8rules, can impose a high cost on society by

9punishing and thereby deterring aggressive

10price competition.

11The courts and thebr>
12enforcement agencies have recognized that the

13very tangible bird in the hand, that is lower

14prices enjoyed by consumers today, must not

15be sacrificed for the bird in the bush, the

16speculative and almost always illogical hope

17that attacking price cutting and thereby

18producing higher prices today will somehow

19produce lower prices tomorrow.

20I can tell you from years of

21experience advising a very successful

22corporation on how to compete with a very

23aggressive rival that the need for clarity in

24this area is paramount. The challenge in

25counseling a business is to ensure that the

154

1company adheres to its legal obligations

2without forcing it to engage in gentlemanly

3competition in which business opportunities

4are squandered by pricing higher than is

5needed to win the deal, even though the deal

6can still be won profitably.

7Intel has long enjoyed a cost

8advantage due to its strong leadership

9position in manufacturing. And it is

10important to me and to the other lawyers

11advising our management that we neither

12deprive the company of the competitive

13advantage that comes from its hard-won,

14lower-cost position nor deprive consumers of

15the benefit of lower prices, simply because

16of unclear antitrust rules.

17You may have recently read on

18the front page of the New York Times about

19Intel's latest breakthrough in semiconductor

20manufacturing technology. This is the most

21significant change in the materials used for

22the manufacture of silicone chips since Intel

23pioneered the modern integrated circuit

24transistor more than four decades ago.

25It is no accident that Intel

155

1was the first to achieve this breakthrough.

2Our company has enjoyed unparalleled

3leadership in manufacturing for most of its

4existence, and the benefits of this

5relationship position are very tangible.

6With every new generation of

7manufacturing technology, each of which is

8introduced on a roughly two-year cycle, we

9double the number of chips that can be

10produced on a wafer, holding both the wafer

11size and the chip design constant. This

12means that the manufacturing cost of any

13given chip is cut by roughly 50 percent when

14the new manufacturing technology is

15introduced.

16 Now, it's a little bit more

17complicated than that because we tend to take

18advantage of this lower cost to put more

19features onto the chips which trades off some

20of that cost savings for better performing

21products. But the cost advantage of being

22first to adopt the new manufacturing

23technology is large and tangible. Our recent

24manufacturing technology breakthrough will

25ensure that we can continue to progress along

156

1the same path for many years to come.

2So Intel has been on average

3nine months to a year ahead of its

4competitors in adopting these new

5manufacturing technologies. This means that

6in any given two-year cycle, we are alone in

7achieving the cost savings during the first

8year, and we are ramping up on the new

9manufacturing process during the second year

10when our competition is just beginning to

11introduce the new technology.

12Our sales executives and our

13management want to use the cost advantage

14that they enjoy as a result of our

15manufacturing leadership to win business.

16Clear antitrust rules are essential to my

17ability to guide them through the winning

18outcome to do nothing more than exploit our

19competitive advantage.

20A clear and sensible rule is

21offered by the Areeda & Hovenkamp treatise in

22its latest supplement. Quoting from that

23treatise:

24 "When a discount is offered

25on a single product, whether a quantity or

157

1market share discount, the discount should be

2lawful if the price, after all discounts are

3taken into account, exceeds the defendant's

4marginal cost or average variable cost. That

5is, such discounts are covered by antitrust

6or antitrust's ordinary predatory pricing

7rule."

8A similar approach has been

9proposed by former FTC chairman Tim Muris,

10who advocates a modified Brooke Group test

11based on whether the price of the total

12amount of goods sold exceeds the cost of the

13goods.

14Cost-based rules have a

15number of advantages beginning with the

16avoidance of false positives. They enable

17companies to base pricing decisions on what

18they know, that is, their own cost structure

19and the relationship of price to cost instead

20of speculation about the meaning of

21potentially vague jury instructions that

22might, for example, say that a firm must be

23allowed to compete aggressively but that it

24cannot behave in an unnecessarily restrictive

25manner.

158

1Because cost-based rules are

2more predictable than the vague standards

3that have been applied by some courts in

4Section 2 cases, they are also inherently

5more administrable. And they appropriately

6condemn the type of discounting that does

7cause competitive harm, i.e. predatory

8pricing.

9The antitrust laws are a

10powerful instrument for consumer protection,

11but they can also be misused by rivals to

12attack competition. It is essential that the

13antitrust rules in the pricing area protectbr>
14consumers both from anticompetitive conduct

15that may create, maintain, or enhance a

16monopoly, and from anticompetitive abuses of

17the law by rivals that seek to stifle price

18competition.

19Thank you once again for the

20opportunity to provide these comments.

21(Applause)

22MS. GRIMM: Our third

23presenter this afternoon is Bruce Wark.

24Bruce is the Associate General Counsel for

25American Airlines, Inc., where he's been

159

1since 1993. His responsibilities include

2litigation and regulatory matters, including

3those relating to airport access, airport

4rates and charges, aviation disasters,

5patents and trade secret litigation,

6international competition, airline alliances,

7and antitrust and consumer class actions.

8Bruce serves on the ABA Air

9and Space Law Forum and has written a number

10of articles relating to legal issues

11affecting the airline industry.

12He received his JD from

13Georgetown University Law Center with Honors.

14Bruce.

15MR. WARK: I absolutely view

16it as a privilege to be here today, so I'd

17like to join others in their opening comments

18by thanking the DOJ the FTC for the

19opportunity to appear here today.

20As an in-house attorney at

21American Airlines who is responsible for

22competition matters I hope to offer a unique

23perspective, one that has been defined by the

24important, turbulent, and highly competitive

25nature of the airline industry.

160

1I've chosen to focus my

2comments on Section 2 predatory pricing

3claims because within the last few years

4there have been two Circuit Court decisionsbr>
5relating to predatory pricing in the airline

6industry.

7More specifically, these

8cases address the legality of decisions by

9carriers like American to match the prices of

10new entrants and to adjust capacity in

11response to the new price points in the

12marketplace.

13The Department of Justice

14actually brought the first of these cases

15against my client, American Airlines in 1999.

16I'm happy to say, as I'm sure many of you

17are aware, we prevailed in that dispute when

18in July of '03 the Tenth Circuit affirmed an

19order granting summary judgment.

20That decision found that the

21Department had failed to establish that

22American had priced its products below an

23appropriate measure of its cost as required

24by the Supreme Court's decision in, among

25other cases, the Brooke Group.

161

1The second recent predation

2decision in the airline industry came in a

3case that was brought by Spirit Airlines

4against Northwest Airlines. As in the case

5against American, in that case the District

6Court held that Spirit had failed to prove

7that Northwest had priced its products below

8average variable costs on the routes in

9question, and therefore, the District Court

10entered summary judgment.

11On appeal, and unfortunately

12in my opinion, the Sixth Circuit reversed in

13a decision that, I believe, fails to apply

14the objective standards that are absolutely

15necessary to distinguish between aggressive

16competition and illegal predation under

17Section 2.

18I want to use these two

19cases today to support two important themes.

20The first is that predatory pricing claims

21unconstrained by objective standards and

22based on unproven economic theory harm the

23competition that the antitrust laws were

24intended to protect.

25As Judge Easterbrook has

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1explained, and I'm quoting here: "An argument

2that a practice is predatory is likely to

3point to exactly those things that ordinarily

4signify efficient conduct. Unless we have

5some powerful tools to separate predation

6from its cousin, hard competition, any legal

7inquiry is apt to lead to more harm than

8good."

9Given the general agreement

10that almost all price reductions, sales

11increase, additions to capacity and so on are

12beneficial, we need very good ground indeed

13to treat a particular instance of such

14conduct as unlawful.

15The second and related point

16that I want to make is that these objective

17standards should be clearly articulated. The

18point was made earlier this morning that at

19least in the area of Section 2, predatory

20pricing was an area of relative clarity. If

21that point is true, it's true only on a

22relative basis.

23Our experience with the

24Department of Justice shows that there is

25still a great deal of ambiguity about what

163

1the standard should be or even how those

2standards should be applied. And as I hope

3to make clear with the rest of my comments

4today, it's also clear the courts aren't

5consistently applying these standards, as I

6think they need to be.

7Clarity on these points is

8particularly important because the antitrust

9laws can be punitive. The serious

10consequences of finding that the antitrust

11laws have been violated forces companies to

12pull their competitive punches, especially

13when the lines of aggressive competition and

14illegal conduct are not clearly delineated.

15Moreover, even if the

16defendant prevails, as we did in our case,

17merely having to defend a Section 2 case is

18a very expensive proposition, and it diverts

19a tremendous amount of management attention

20and company resources.

21Now, in making those

22comments, I recognize that given the

23complexity of markets and U.S. business,

24perfect clarity of legal standards may really

25be an unobtainable goal. Individual cases

164

1will continue to have to be decided on their

2own merits, and general legal principles will

3have to be applied to unique facts.

4That said, improving of

5clarity of legal standards in this area

6should be pursued, and there are areas

7where clarification can be immediately

8accomplished such as a clear endorsement of

9average variable cost as being the only

10appropriate measure of cost in a predation

11claim.

12In our industry, despite the

13fact we have two fairly recent Circuit Court

14decisions addressing predatory pricing,

15Section 2 standards remain unacceptably

16vague. And even worse, as I've indicated

17before, I believe the Sixth Circuit decision

18in Spirit fails to demand the objective

19standards that are necessary to show that

20aggressive competition has overstepped the

21bounds of the law and is a decision that

22protects smaller competitors rather than

23competition on the merits.

24Before discussing the

25American decision and the Spirit decision in

165

1more detail, I think it's useful to give some

2general observations on the airline industry

3and how we compete.

4The airline industry is the

5backbone for much of U.S. commerce, and the

6antitrust scrutiny that we find ourselves

7under is no doubt a product of the important

8role that the industry occupies.

9Last year alone American

10served about 100 million passengers. We took

11in about 20 billion in revenue. Yet those

12figures, as impressive as they are, account

13for only about 20 percent of the U.S.

14domestic airline industry.

15Until the early 1980's, the

16airline industry was a regulated business.

17But since deregulation, the industry has

18exploded, and air travel today, although far

19from perfect, is largely affordable and

20convenient.

21Airfares in real terms have

22fallen significantly, and American and other

23carriers are now able to offer thousands of

24convenient on-line connections that did not

25exist in the regulated environment.

166

1At the same time, new

2entrants are consistently entering the market

3with new aircraft, lower costs, and new ideas

4on how to succeed in this crowded and mature

5marketplace. One or more of these low-cost

6carriers operate in over 80 percent of the

7routes that American flies.

8Clearly, competition has

9served the air traveler well. Shareholders

10and other stakeholders haven't faired quite

11as well however.

12American is the only Legacy

13Network carrier that's never filed for

14bankruptcy. And since the turn of thebr>
15century, we've lost billions of dollars and

16have had only one profitable year, that was

17last year, where we eeked out a profit margin

18of roughly one percent.

19These results here aren't

20intended to engender your sympathy, but

21simply to remind us that the competition in

22this industry is not only very dynamic. It's

23often brutal.

24Each day the people at

25American have to make decisions on how

167

1they're going to price tens of thousands of

2markets, and in doing so they act on an

3experience base that tells them two things.

4First is that air travelers are going to be

5motivated by small differences in price.

6Second, that we are operating a network of

7interconnected routes. And when we make

8decisions as to one route, there may well be

9implication for other routes within that same

10network.

11Given our cost structure and

12position in the marketplace, maintaining a

13robust network is a competitive imperative to

14us. Our business folks are designing strategies

15that we think maximize our success, and that

16success has been and always will be adversely

17related to the success of our competitors.

18In sum, we are convinced that we have to be

19an aggressive competitor, and, in our business,

20that competition will always start with

21price.

22As the world's largest

23airline operating in this competitive

24environment, we understand the importance the

25antitrust laws play in our market-based

168

1economy. We have a longstanding antitrust

2compliance program, but the ambiguity in the

3law and the very competitive nature of the

4industry make it a challenge to provide clear

5guidance on Section 2.

6The fact that we hope to

7accomplish this legal guidance under the

8circumstances is to sensitize our clients to

9potential issues and be prepared to answer

10those questions in real time as issues arise.

11For reasons that I've already

12mentioned, pricing doesn't remain constant,

13and being noncompetitive on price for even a

14short period of time can be very costly.

15Our advice has to be as real time as the

16competitive market in which our clients are

17operating. And overly conservative advice

18can inflict substantial damage on the

19company.

20We don't have the luxury of

21a week to pull data and analyze issues,

22although we know that if we end up in a

23dispute, those on the other side will review

24that data with the luxury of both time and

25hindsight and will be seeking to substantiate

169

1a position that is predetermined by the

2requirements of its claim.

3As I'll explain shortly, I

4believe that's exactly what happened in

5Spirit's case against Northwest when it was

6able to avoid summary judgment.

7 Moreover, we have learned

8through our experience that the Department of

9Justice's attorneys and economists have their

10own views of competition in the airline

11industry. And our views of competition in

12the industry and those of theirs are often at

13odds.

14We have the right to

15challenge those factual and legal assumptions

16as we did in our lawsuit, but that is a

17position that we desperately try to avoid.

18Given the punitive nature of the antitrust

19laws and the inevitability of private class

20action litigation, including the prospect of

21treble damages, defending ourselves in that

22situation, irrespective of the courage of our

23convictions, is high-stakes poker indeed.

24Thus, I thought of several

25examples in which we have given advice or

170

1altered our conduct based not on what we

2thought was illegal, but on what we feared

3others might argue is illegal. And in these

4circumstances competition has likely been

5compromised.

6Our experience with the

7Department in its predation case illustrates

8how Section 2's lack of clarity can lead to

9significant disagreement between industry

10enforcement and how, at least in our opinion,

11overly aggressive enforcement actions

12threatened the competition that the antitrust

13laws were intended to protect.

14In making that comment,

15however, I want to note that although we

16disagreed with the Department's theories and

17decisions in that case, we didn't question

18their good faith. Despite those differences

19of opinion, I don't doubt that they decided

20to pursue the case against American, and they

21believed in the merits of their arguments and

22believed that they were fulfilling their

23obligations to protect competition and

24consumers.

25Indeed, if they're like a lot

171

1of lawyers that I know, I suspect that

2despite the loss, they still think they were

3right and it's the courts that got it wrong.

4These good-faith but

5extremely important disagreements simply

6highlight the problem of the current state of

7jurisprudence under a Section 2 predation

8claim.

9Let me put our dispute with

10DOJ in a bit more historical context. The

11lawsuit was brought in the mid to late

121990's, at which time the airline industry,

13like the rest of the U.S. economy was

14operating near the peak of the business

15cycle. American and other large network

16carriers were profitable. And although those

17profit margins were generally in the single

18digits and was modest compared with other

19industries, they were very good when compared

20to the industry's historical returns.

21In response to these

22conditions, a number of new entrants entered

23the market, some such as Frontier and Air

24Tran are still flying today and are generally

25recognized as being successful. Other new

172

1entrants that were less well managed and

2financed disappeared.

3The failure of some of

4these new entrants led to concerns that the

5markets were failing and that the actions of

6incumbent airlines, like American, where we

7matched pricing and expanded output was

8actually harming competition.

9The Department of Transportation

10even considered reregulating the industry when

11an incumbent carrier matched prices or expanded

12output in response to new entry.

13Fortunately, that regulatory

14initiative failed, and the following five or

15so years demonstrated that the marketplace

16was far more resilient and dynamic than the

17average regulations demanded.

18By the year 2000, Jet Blue

19and others had shown that a well-financed and

20managed new entrant could succeed. And

21ironically, a lot of that growth was in the

22hubs of network carriers like Denver and

23Atlanta, which were once deemed fortress

24hubs. Perhaps even more ironically, the

25alleged predators like American and Northwest

173

1either filed for bankruptcy or teetered on

2the brink, while new entrant low-cost

3carriers became the most profitable and

4fastest growing segment of the market.

5The Department's case against

6American and Spirit's case against Northwest

7both raised an array of factual and legal

8issues. I don't intend to address each of

9those, but I instead want to focus on what I

10think are two of the most important, the

11first being the definition of relevant

12market, and the second being the appropriate

13measure of cost, and more particularly

14whether average variable costs is the

15appropriate standard.

16Let's start by addressing how

17the Sixth Circuit dealt with the question of

18relevant market in its Spirit decision. As

19mentioned in that case Northwest matched

20Spirit's pricing and it increased its

21capacity on routes served by Spirit, which

22arguably forced Spirit to withdraw from the

23route. Yet even after Northwest reduced its

24price and incurred additional costs, its

25revenue on the route exceeded any reasonable

174

1measure of its average variable costs. As a

2result, if you define the relevant market as

3airline services on these routes, Spirit's

4case failed because it could not show that

5Northwest had priced its product below an

6appropriate measure of its cost as required

7by Brooke Group. These undisputed facts are

8what led the District Court to enter summary

9judgment.

10The Sixth Circuit reversed on

11appeal. The Court concluded that Spirit and

12the experts established a genuine issue as to

13a different definition of relevant market,

14one that divided passengers flying on the

15same airplane.

16In order to reach the

17conclusion necessary to its claim, that is

18that Northwest's revenues in some relevant

19market were less than its variables costs,

20Spirit's experts had to exclude some portion

21of revenue that Northwest is earning on these

22routes during the alleged predation period.

23They accomplished that

24objective by removing revenue of two types of

25passengers. First they excluded revenue from

175

1passengers traveling on any type of

2connecting itinerary. And second and even

3more surprisingly, they removed from the

4calculation passengers who paid more than

5$225 for their ticket.

6That analysis, of course, was

7completely unrelated to any analysis that

8Northwest would have undertaken at the time

9it decided to add in price due to capacity

10on these routes. Northwest instead would

11have asked a much more straightforward and

12appropriate question, that is, with new lower

13fares and additional capacity, would it be

14able to generate sufficient revenue from any

15and all types of passengers to cover its

16costs? A yes answer to that question should

17have been the end of Spirit's claims.

18Spirit's segregation of

19passengers who paid more than $225 from those

20who pay less than $225 into separate markets

21is an artificial after-the-fact analysis that

22should not have created any genuine issue of

23fact.br>
24As a result, the Sixth

25Circuit's Spirit decision is one that harms

176

1rather than promotes competition. The

2endorsement of that contrived analysis, at

3least for the purpose of avoiding summary

4judgment, puts some common carriers in a

5no-win situation of one, either not competing

6for every passenger on price and product; or

7two, recognizing that if it's too successful,

8it may have to face a treble damages jury

9trial brought by a competitor.

10Pricing capacity decisions in

11the airline industry are made in the context

12of a very dynamic marketplace, and no airline

13can possibly anticipate how the next

14plaintiff may segregate passengers on the

15same aircraft in the separate relevant

16markets, each of which is supposed to

17independently clear the test of a predatory

18pricing claim.

19I'd now like to turn to the

20question of whether a defendant priced its

21product below an appropriate measure of its

22cost. That of course was the issue that was

23determined in our case. It was also perhaps

24the most hotly disputed issue in that case

25since the facts showed that American's

177

1revenues on the routes exceeded its average

2variable costs. This caused the department

3to develop alternative tests. American had

4argued against cost measures that included as

5much as 97 percent of total costs. And

6others had argued in effect that American's

7decision failed to maximize its profits.

8My point for purposes of this

9hearing is simply this. There was a great

10deal of disagreement as to what items of cost

11were properly included, how these costs

12should be calculated, and how revenues should

13be attributed to incremental costs.

14 Although we prevailed on this

15basis, the Tenth Circuit decision left many

16of these disputed questions unanswered.

17The Tenth Circuit also left

18unanswered the important question of whether

19there should be a meeting competition defense

20in a Section 2 context.

21The problem of residual

22uncertainty in the Tenth Circuit case

23concerning these questions however is not

24nearly as problematic in my mind as the Sixth

25Circuit's treatment of this question. And

178

1what I believe is certainly the most

2troubling statement in its decision, the

3Sixth Circuit stated, and I quote here:

4"Even if a jury were to find that Northwest's

5prices exceeded an appropriate measure of

6average variable costs, the jury must also

7consider the market structure in this

8controversy to determine if Northwest's deep

9price discounts in response to Spirit's entry

10and the accompanying expansion of its

11capacity on these routes injured competition

12by causing Spirit's departure."

13This statement from the Sixth

14Circuit offers no objective standard for the

15jury to use in distinguishing aggressive

16conduct by a large but efficient incumbent in

17the marketplace. It employs none of the

18powerful economic tools called for by Judge

19Easterbrook, and is inconsistent with the

20dictates of the Supreme Court. It simply

21constitutes an open invitation for juries and

22courts to condemn aggressive competition in

23order to protect less efficient but smaller

24competitors.

25I want to wrap up my comments

179

1by offering some specific suggestions

2concerning Section 2 enforcement. First,

3given the ambiguity in the law and harm that

4a false positive can have in this area of

5the law, regulators should proceed very

6cautiously. I believe that especially in the

7context of a single product pricing case,

8regulators and courts should heed the Supreme

9Court's guidance that well-founded claims are

10extraordinarily rare, and that overly

11aggressive enforcement can harm competition.

12Predatory pricing claims are

13not an area of the law where regulators

14should pursue aggressive new theories or rely

15on untested economics.

16Second, markets are more

17resilient than is often appreciated at the

18time. The experience in our industry has

19debunked many of the theories and assumptions

20concerning the market, like that of the

21fortress hub that motivated the Department of

22Transportation to consider re-regulating the

23industry and encouraged the Department of

24Justice to file its lawsuit against American.

25Trusting markets to perceive shortcomings is

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1often the best policy.

2Third, definitions of

3relevant markets should align with the

4competitive environment, as it was perceived

5at the time by those whose conduct is being

6contested. Relevant market definitions

7contrived by lawyers and economists after the

8fact are often motivated by predetermined

9results and almost always fail to account for

10the full complexities of the market.

11Fourth, I believe there

12should be a meeting competition defense under

13Section 2. Such a rule would provide a

14clear line, and matching a competitor's price

15in the hopes of competing for every last

16customer is exactly what competitors are

17supposed to do. A competitor that cannot

18survive at the price point it has chosen is

19not the type of efficient competitor the

20antitrust laws should be protecting.

21Finally, since aggressive

22competition and predatory conduct often share

23the same characteristics, careful thought

24needs to be given to the remedies before the

25regulators commence litigation.

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1There were times in our

2dispute with the Department that we would

3have liked to resolve our differences, but

4the remedy imposed by the Department would

5have been competitively debilitating for

6American in a highly competitive industry.

7Finally, predatory pricing is

8an area of the law where remedies are more

9prone to doing more harm than good. I hope

10that these comments have been useful, and I

11look forward to the moderated portion of the

12discussion.

13(Applause)

14MS. GRIMM: I'd like to

15thank our presenters for their very fine

16presentations. We will be resuming in about

1715 minutes. We'll take a break until then.

18(Break Taken)

19MS. GRIMM: I would like to

20start at the end with Bruce Wark. Bruce, do

21you have any comments? Do you have any

22questions of your fellow panelists?

23MR. WARK: Well, there was a

24great deal of commonality, I think, between

25what I said and what Bruce Sewell said. So

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1I'll just tell you -- say he was right and

2leave it at that.

3On the question of

4convergence, I agree it's an absolutely

5important policy goal and needs to be

6pursued. But equally importantly, you need

7to make sure you converge at the right place.

8And you know, particularly with the E.U.,

9they have a different tradition. They have

10different biases. I think they are more

11inclined to protect competitors at the

12expense of competition. And what I wouldn't

13want to see is convergence away from what we

14think is the right standard, which has been

15developed in this country. And I think the

16standards employed in this country are the

17gold standard and we need to stick with them.

18MS. GRIMM: Bruce.

19MR. SEWELL: Yeah, I

20obviously return the favor, Bruce. A lot of

21mutual admiration here.

22I guess a couple of the

23points that were made in your comments that I

24picked up on, we absolutely agree that

25average variable cost is the appropriate

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1measure, and I think we're going to explore

2that a little bit more. But we absolutely

3and wholeheartedly agree.

4The other thing that I noted

5and I'd like to just sort of reinforce this,

6I think one of the things I took from your

7comments was this notion that if you were to

8try to run a business so as to avoid being

9sued for potential anticompetitive behavior,

10that almost by definition then you have

11under-optimized from a consumer standpoint.

12And that's something that we need to be aware

13of. And that the risk of lawsuits and the

14potential punitive aspects of those private

15lawsuits is enormous. And yet at the same

16time as a company you almost cannot run your

17business to say I will never put myself in

18that position. It under-optimizes.

19With respect to Sean's

20comments, again, we're very supportive of

21this activity. The critical question, as

22Bruce mentioned, is if you harmonize

23regulation, if you adopt in effect a single

24form of regulation, then it's just so

25important to make sure that you don't go to

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1the highest regulatory level so that you

2don't end up in effect, in order to get

3consensus, always choosing the most

4regulatory or the most highly regulated

5standard. That would be an easy way to get

6to convergence, but it's not necessarily the

7best way to do it. That's about it.

8MS. GRIMM: Sean, do you

9have some comments?

10MR. HEATHER: I would just

11say to clarify what the Chamber's testimony

12was in response to both the observations that

13were made. The Chamber is not about convergence

14for convergence sake. That it is important

15that the right standard is picked and would

16agree that, we believe that, the way in which

17the U.S. looks at these issues is the gold

18standard. And the importance is taking that

19gold standard, and as my father would say,

20and de-Anglesizing the rest of the world to

21it. So it's not about convergence for

22convergence sake, but it definitely is

23obviously the theme behind the remarks I

24made.

25MS. GRIMM: Thank you. I

185

1would like to delve into this question of

2average variable costs in some more detail.

3Both of our Bruce panelists have definitely

4endorsed that as a test, I would say. And I

5would just like to ask each of them to

6basically tell us more about how average

7variable costs are kind of arrived at in

8their particular industry.

9This morning we heard one of

10our panelists say that he did not think

11average variable cost was the right test,

12especially in high fixed cost industries.

13And I would just like to hear some more

14discussion from you on how the average

15variable cost test would be applied.

16MR. WARK: Yeah. Want to

17begin with me again?

18 MS. GRIMM: That would be

19fine.

20MR. WARK: I think it's

21important to recognize that average variable

22cost is really a proxy for marginal cost

23because that really it the right test.

24And when you talk about

25average variable cost, one of the questions

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1that gets buried in the next level of

2analysis is variable over what period of time

3because, you know, everything is variable if

4you give it enough time.

5That said, I do think that

6average variable cost on an appropriate time

7frame is the best test because it provides

8clear guidance. And I think the problem you

9have with people who argue that maybe it

10doesn't fit in one particular case or

11another, there really is no other standard

12that they're articulating. And you end up in

13a situation like what I pointed out in the

14Spirit case where the Court's basically

15saying well, even if they don't meet average

16variable cost, you the 12 jurors decide

17whether you think this scenario is good for

18competition or not. And that is the kind of

19unobjective predatory pricing analysis that

20is surely going to result in false positives

21and will create all kinds of problems, from a

22counseling perspective, but also, I think, as

23far as consumers should be concerned.

24MS. GRIMM: Bruce?

25MR. SEWELL: Sure. Let me

187

1start with one of the principles that I tried

2to make in my written statements. The laws

3that we're seeking to conform need to be

4understandable by the people who are asked to

5adhere to them. And that leads you to look

6for ways that you can translate concepts that

7are relevant for antitrust enforcement into

8concepts that are also common for business

9people.

10And average variable cost is

11a measure which is widely understood by

12business people, and I would argue

13particularly in my industry, potentially in

14Bruce's too, it's a metric that exists for

15other than just antitrust enforcement

16purposes, which means that it's also a metric

17which exists for legitimate business reasons,

18and therefore has some additional validity, I

19think, when you're asking for companies to

20talk about average variable costs.

21We at Intel have a model

22which enables us, and in fact we do a lot of

23our business planning based on average

24variable cost or marginal cost.

25Once the fabrication plant

188

1has been built, we have to track the cost of

2the wafer through that plant. And we've become

3quite expert at understanding and identifying

4the various components that have to go into

5creating a final finished microprocessor, so

6the cost of the wafer, the cost of the

7electricity to power the wafer through the

8plant, the cost of the etching and the

9chemicals. All of these constituent pieces

10that go into actually moving the wafer

11through the plant itself.

12And this is a model. It's a

13metric that we use regularly in business. So

14for that reason, both intellectually, I

15think, is the correct way to look at the

16price in question from an antitrust

17perspective, but it also has that added

18benefit of being something that business

19people use in the ordinary course of

20business, and therefore it has that extra

21validity.

22MS. GRIMM: I'm going to

23follow up with what might be a naive

24question, but what is the average variable

25cost of a microprocessor that you produce?

189

1MR. SEWELL: I can't answer

2that today. I could get you the answer very

3quickly, but I can't answer it off the top

4of my head. It would depend on what

5microprocessor you're talking about. So we

6have a number of different product lines

7running through different plants at different

8times on different processes. And the answer

9for one of those would be different, but it

10is known.

11MS. GRIMM: But it is known?

12MR. SEWELL: Yes.

13MS. GRIMM: In other words,

14you could go to one of your business

15colleagues and basically say give me that

16information and it would be readily

17available; is that correct?

18MR. SEWELL: Correct.

19MS. GRIMM: Sean, I'd like

20to find out more about your project that

21you're heading. I very much would. And I'd

22like you to share some additional information

23on how it is organized.

24You mentioned that divergence

25in standards is one of the things that you're

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1looking at. If we could get more information

2on that, that also would be helpful.

3MR. HEATHER: Sure. I start

4with this as background. In 1947 the average

5tariff between industrialized nations was 47

6percent. Today it stands at less than five

7percent. And that's because when international

8countries got around the negotiating table

9during the last 50 years, they began to find

10ways to open up markets.

11And so now with the Doha

12Round is hopefully coming to a successful

13conclusion, and we all cross our fingers that

14it will happen in the next few months, that

15those barriers to trade will continue to

16diminish over time.

17What is left behind is what

18we call in-country barriers, and we put these

19into kind of six buckets. Divergence in

20competition policy, intellectual property

21rights, standards, state-owned enterprises and

22subsidies, investment restrictions, and

23government procurement issues.

24In these area, we think that

25the existing policy tools that international

191

1countries have, whether it be through

2bilateral, multilateral, or organizations like

3the WTO, there's an adequate mechanism by which

4to address these problems.

5And so these kinds of

6in-country barriers are important going

7forward if we're going to protect a global

8economy and I think continue to go after open

9and competitive markets in a way which builds

10on what we've done in the past.

11So the U.S. Chamber aims

12to begin to focus the U.S. government and

13governments around the world to meet this

14challenge over the next 50 years in the same

15way in which the world took on the challenge

16to opening up markets in a tariff-related

17sense.

18In terms of how we're

19organized, we have got a number of member

20companies that have been members of the

21Chamber who have expressed specific interest

22in this project, see the need for it, see

23that this being the future of trade

24discussions and negotiations. And so they've

25challenged us to take this project on and

192

1moved forward. And we have them serving in

2a steering capacity.

3We are advancing on a number

4of different fronts in each of these

5different buckets, including today on the

6competition policy front.

7I think most notably in

8the news these days is Chancellor Merkel, the

9E.U. president, German Chancellor, has

10advanced the notion of a cooperative dialogue

11between the U.S. and the E.U. on regulatory

12issues. And so we're going to start

13there.

14Then additionally we'll

15begin to work through international

16department on China. We see that in a

17working partnership with the Treasury

18Department and the Strategic Economic

19Dialogue that's in place advancing these same

20kinds of principles and goals to bring about

21some sort of regulatory playing field that's

22more common than the patchwork that we see

23currently existing.

24MS. GRIMM: You mentioned

25tying and essential facilities as two areas

193

1that you're particularly concerned about, and

2those are also the areas that you highlighted

3in your comments that you submitted in

4September.

5Are there any areas aside

6from tying and essential facilities that you

7are concerned about internationally?

8MR. HEATHER:

9Internationally, let me answer that by saying

10this. We are interested in making sure that

11again this is not convergence for convergence

12sake, but that there is a uniform standard

13that's being applied by antitrust

14jurisdictions around the world, and that

15standard is one that is resonating from what

16we see here in the United States happening.

17So while the comments that

18we made back in September talked about tying

19and essentially facilities, our concerns

20internationally go beyond that to any

21particular Section 2 type action, whether it

22be Article 82 of the E.U. or similar laws

23in countries around the world.

24And I think the reason which

25we brought up the tying and essential

194

1facilities was because one of the concerns

2that was expressed, if you create a standard

3that is of the highest magnitude, that

4companies will then have to move to that, and

5then it would be detrimental. And I think

6that's particularly important to the issue of

7intellectual property.

8When you think about

9intellectual property, if you have as enforcement

10and remedy a disclosure of intellectual

11property, you can't contain that disclosure within

12a geographical jurisdictional of France or the

13E.U. Once the cat's out of the bag, the

14proverbial cat's out of the bag, it spreads

15quickly across the rest of the known world.

16So I think it's important

17that we highlighted essential facilities and

18tying arrangements because I think we see a

19lot of that being where the divergence is

20today. But more broadly, you would want to

21see convergence around Section 2 issues.

22MR. MATELIS: Following up a

23little bit on that, Sean, assuming that

24convergence might not be happening overnight,

25you mentioned a couple times in your speech

195

1principles that could be used in areas where

2there's not convergence. You mentioned

3Assistant Attorney General Pate's reference

4to comity principals. And then later in your

5discussion you mentioned agreements to defer

6among international competition agencies.

7I'd be interested in your

8thoughts on that area in general. And Bruce,

9I suspect this is something you've thought

10about as well, and Bruce you as well have at

11it.

12MR. HEATHER: In my comments,

13I think you're referring to where we talked

14about enhanced comity. And while the U.S.

15Chamber's not at this point prepared to say

16enhanced comity is the exact way to go, we

17believe that exploring that further is a

18potential option.

19I think that one of the

20things you could do in terms of creating

21standards across the board is potentially the

22use of safe harbors, in the sense of safe

23harbors in what I believe would be termed

24the positive saying that if you have a dominant

25market share position of 50 or 60 percent, that

196

1that is not defined as a dominant position, or

2to suggest certain conduct regarding tying or

3rebate policies and the like does not

4constitute an abuse of the dominant position.

5Coming up with some standards that could be

6adopted internationally would be one

7way by which you could put that kind of

8language into agreements between countries

9and then exploring the area of enhanced

10comity where potentially you could defer to

11decisions of other jurisdictions.

12MR. SEWELL: Yeah. On

13comity first and then on safe harbors. The

14reality is that sovereign countries and

15sovereign trading blocs, that's the right

16way to describe the E.U., are going to

17regulate, are going to exercise their

18sovereignty. That's perfectly within their

19right to do so.

20The problem, I think, is when

21you have agencies which are really reaching

22outside of their own geographic or area of

23sovereignty in trying to regulate conduct

24which occurs outside of that area.

25So for example, where you

197

1have an agreement between two U.S. companies

2to price at a certain level, and then that

3gets reviewed in a third country which is not

4the host of either of those two companies.

5And the analysis then becomes can two U.S.

6companies price in a way which the U.S. would

7find acceptable but yet some other agency

8does not? And in those circumstances I think

9the principles of comity should really be

10argued and be respected by the agency that's

11outside of the -- in this case outside of

12the U.S.

13Where there is a clear nexus

14back to non-U.S. competition, so in the case

15of Europeans, where there is a European actor

16involved, that's a more difficult argument to

17make.

18But certainly where there is

19no European actor involved and where there's

20a tenuous connection at best back to European

21commerce, then I think it's important that

22issues of comity are respected.

23With respect to the safe

24harbor question, I actually think -- I agree

25with you entirely that we are not going to

198

1get international convergence or harmonized

2antitrust laws any time soon. But I think

3there is a role for the safe harbor here. I

4think there is a threshold standard which

5some number of these 100 antitrust regulatory

6agencies around the world might be willing to

7agree should represent the -- sort of the

8bare requirements with respect to antitrust

9conduct. And that so long as companies are

10complying within that threshold standard,

11that companies should at least have a safe

12harbor from punitive litigation.

13And it might be that that's

14the first step in driving towards what would

15ultimately become a more harmonized set of

16international standards.

17MR. WARK: I really don't

18have a whole lot more to add on that issue.

19I think the points have been well made.

20MS. GRIMM: I'd like to ask

21our panelists a question similar to that that

22was asked of our morning panel, and that is

23in the area of loyalty discounts, whether

24market share provides a useful screening

25mechanism in assessing the legality of such

199

1discounts, why or why not. And Bruce Sewell,

2maybe you can take a shot at that first.

3MR. SEWELL: Let me start

4with what I think you're asking and then feel

5free to probe a little bit.

6I don't fundamentally see the

7loyalty space as different or as requiring

8different treatment than a standard pricing

9inquiry would demand. So I don't see perhaps

10the relevance of the market share test.

11It seems to me that whether

12the discount is in the form of a loyalty

13discount or some other form, the essential

14inquiry remains the same. Is the price

15that's being offered across the units being

16sold above or below a predatory level? And

17if the answer is that the price is above

18what we've defined as a predatory level, then

19I think that ends the inquiry.

20If the price it below a

21predatory level, then I think there are

22remedies available and laws available to deal

23with that. But I don't see it as a different

24analysis.

25MS. GRIMM: Bruce Wark, do

200

1you have anything to add to that?

2MR. WARK: Yeah. I think I

3bring almost a unique perspective because I

4think we have one of the world's most famous

5loyalty programs. It's called Advantage.

6And I think that anybody who looks at that

7and looks at how the loyalty program at least

8in our industry has grown up, it's absolutely

9pro-competitive. It's a point of competition

10that airlines engage in.

11On the other hand it's not

12exclusionary. It's clear that new entrants

13have been able to enter markets, either by

14developing their own loyalty programs,

15hooking those loyalty programs onto the

16loyalty programs of other airlines who may

17want to do the same thing, making their

18loyalty programs maybe quicker and easier to

19redeem.

20Or take the example of an

21airline like Jet Blue, which may say well,

22maybe what I'll do is I'll compete on some

23other ways and product.

24So I think the Advantage

25program in the airline industry is a great

201

1example of how loyalty programs can in fact

2be very pro-competitive.

3As far as the point that

4Bruce Sewell just made, I tend to agree with

5him. Unless you've got some kind of -- if

6you can equate the loyalty program with

7making it exclusive, then maybe you have to

8analyze it in an exclusive dealing context

9rather than a predatory pricing context. But

10certainly our program doesn't work that way,

11and many don't.

12MR. SEWELL: And I'd add to

13that too that really the way to look at

14loyalty discounts is these are incentives to

15buy. These are not punishments for failure to

16buy. And that's a really fundamental

17difference.

18So the focus on incenting

19behavior and providing an advantage to buying

20more is different than threatening to punish

21in the event that a supplier were to -- that

22a customer were to buy from a different

23supplier. Very different kinds of things and

24should be treated very differently by the

25antitrust laws.

202

1MR. WARK: One other point I

2guess I want to make which goes back to the

3original question is what role does market

4share play. And again, I think the airline

5industry is interesting because we're 20

6percent of the U.S. market, which no one's

7going to say is dangerously close to

8establishing monopoly. But maybe on an

9individual route or out of an individual hub

10we'll be 70, 80 percent of it.

11So are you going to apply

12the 70 percent or the 20 percent? So that

13really gets into what's your relevant market

14on the loyalty program, and could you really

15run a different loyalty program based upon

16the location of the particular participants

17in that program.

18So I think when you ask the

19question what market share means, at least in

20my mind, part of the question is being able

21to find relevant market for purposes of the

22loyalty program.

23MS. GRIMM: Bruce Sewell, as

24I understand it, Intel has faced or is facing

25inquiries in a number of different foreign

203

1jurisdictions with respect to its discount

2policies. Have you encountered differing

3standards in those foreign jurisdictions?

4And if so, how?

5MR. SEWELL: Well, I'm

6pleased to be able to say that I don't have

7the data to answer that yet because we

8haven't been the subject to different -- to

9the imposition of different standards. We

10are dealing with agencies around the world.

11As yet we have not been put in the position

12where we have to sort of harmonize those

13different issues.

14Having said that though, I am

15concerned that the standards that will be

16applied, should these agencies choose to act,

17will be different.

18And a quick example. The

19European Commission is now wrestling with

20this issue of effects based or formalistic

21application of the antitrust laws. Should

22one look at the intent, the conduct

23exclusively, should one look at a prescribed

24set of formulistic rules, or should one

25really focus on the effect that the conduct

204

1has in the market?

2And I think in that area the

3U.S. leads with its willingness to study

4effects as opposed to exclusively conduct for

5a formulistic approach.

6So the result that may obtain

7in Europe should the European competition

8authorities decide to bring an action against

9itself might be different because of the

10application of a different test. We're not

11there yet, but I worry that that's the case.

12Sean mentioned the Chinese

13anti-monopoly law. It's not at all clear

14what kind of standards the Chinese would use

15in assessing market share or in assessing

16conduct under the anti-monopoly law.

17It's not currently an issue

18for us. We're not currently under

19investigation in China. But it is not at

20all inconceivable given that we are subject

21to a competitor which has chosen to use a

22serial antitrust complaint approach, that we

23may find ourselves having to defend our

24conduct in China at some point. And I have

25very little confidence that I today could

205

1tell you what standards would be used by the

2Chinese government, how that would be

3understood.

4MS. GRIMM: Thank you. I'd

5like to ask you a general question here

6again, both Bruces, I'd appreciate your

7responding.

8We've talked about loyalty

9discounts. We've talked about predatory

10pricing. I am wondering if there are any

11other areas under Section 2 that you think

12need more guidance from the agencies, areas

13perhaps in which we could consider safe

14harbors, areas maybe needing the announcement

15of some presumptions. I know it's a broad

16question, but I wonder if you've given any

17thought to this, or in your experience that

18there are any other issues that you've found

19to be of particular concern.

20MR. WARK: Let me think on

21that a little bit. I mean, I spoke on

22predatory pricing in large part because as

23the provider of essentially a single product,

24I don't run into some of the bundling issues.

25There aren't a whole lot of exclusive dealing

206

1concerns in my business.

2And obviously having defended

3a predatory pricing case and having seen what

4happened in the Spirit case, that is the

5issue which is of most importance to me.

6So I guess, as I listen to

7Bruce, I'll think whether there's any other

8areas. I'd be happy to have that one taken

9care of.

10MS. GRIMM: Fair enough.

11Bruce?

12MR. SEWELL: There isn't

13anything that's strictly within the antitrust

14context that comes to my mind, although there

15is this intersection between intellectual

16property law and single-firm dominance which

17I think is an area that deserves a lot more

18scrutiny and could certainly benefit from

19some clearer language and clearer standards.

20So that would be one.

21And then I think also in

22this area of standardization, what happens

23when a firm, either because of its size or

24because of its intellectual property position

25engages in a standard-setting activity. And

207

1I think also we could use some clarity in

2that space.

3MR. MATELIS: This might be

4a different way of getting at sort of the

5same point, but Bruce Wark, you mentioned in

6your remarks that you can recall some

7instances where American refrained from what

8you thought was pro-competitive conduct out

9of fear of baseless antitrust suits.

10Without going, you know, into

11the details too much, could you explain in

12general what sorts of things you were

13thinking about and, Bruce Sewell, maybe you

14have some perspective on this as well. And

15Sean, anything that your members have relayed

16to you would be of interest too.

17MR. WARK: In the Section 2

18context it became clear from our litigation

19experience that the Department was as much

20concerned with capacity decisions as it is

21with pricing. Now, from our perspective they

22always went hand in hand because when you get

23a lower price, you now want to compete for

24anybody who might be into that lower price,

25which is going to be a bigger universe than

208

1what you started with.

2But it was at least in the

3DOJ's theory and it was also the theory in

4the Spirit case that maybe you could match

5the competitor, but you shouldn't expand

6capacity.

7 Also when you go back and

8you look at the history of what the DOT was

9proposing, they were basically idea of being

10well, you can match price, but we just don't

11want you expanding output.

12So with that sensitivity, you

13know, we really do have to sit there and say

14okay. We have to look at the market and say

15well, are we comfortable expanding capacity

16in that market, knowing that although we

17think it's perfectly legal and

18pro-competitive, are we going to have to

19re-address this thing that we're adding

20capacity where we shouldn't.

21There are a couple of other

22examples that primarily also we've had some

23other disputes with the Department about,

24more along the line of Section 1 cases and

25how we publish fares. And details probably

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1wouldn't interest too many people here. But

2that's also another area where we think we

3would have to be conservative, in large part

4not because we think we're wrong, but

5because, you know, we're not interested in

6having another argument.

7MR. SEWELL: I don't want to

8give you a flip answer. The temptation would

9be to say whatever happened, we haven't been

10very successful at it because we are

11currently being sued.

12The structure of my industry

13is a little different than Bruce's. We

14really primarily are worried about one

15particular competitor. And I can't think of

16any situation in which we have foregone an

17opportunity that was demonstrable and was

18understood was sitting on the table because

19we feared a suit by our competitor.

20But Intel expends an enormous

21amount of resources, legal resources, trying

22to figure out where these lines are and

23trying to make sure that we believe we can

24defend everything that we do if challenged.

25We fully expect to be challenged and we are

210

1routinely challenged.

2So I don't think we

3intentionally leave money on the table, as it

4were, or intentionally price in a way which

5does not seek to provide the maximum benefit

6to consumers. But we spend an awful lot of

7time trying to make these decisions.

8And as is apparent, we don't

9always get it right in the sense that we're

10not successfully avoiding the litigation. We

11absolutely believe that we can defend the

12decisions that we've made, and we'll

13eventually have that opportunity.

14But it is a cost. It's a

15large cost for doing business. And it would

16be helped in large part by some clearer rules

17so that we could set systems and educate our

18clients with greater certainty about where

19the lines need to be drawn.

20And then we would still

21probably have to defend ourselves in court,

22but it would be on the basis of greater

23certainty.

24MR. HEATHER: If I heard

25your question right, it's do legal

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1environments lead to businesses making

2decisions based on those.

3MR. MATELIS: Right. And

4then in particular, are there pro-competitive

5pro-consumer business decisions that companies

6-- you know, your members, for instance, are

7avoiding because they fear antitrust

8liability in some form?

9MR. HEATHER: Well, our

10members have told us on numerous occasions

11that obviously in the general sense that

12these kinds of legal environments do impact

13their business decisions. And we most

14readily track that through our Institute of

15Legal Reform, which has been around for the

16last four or five years. We release a study

17study annually that ranks the 50 states on

18whether or not they have a positive legal

19environment that encourages business

20investment or whether they have a legal

21environment that discourages business

22investment.

23In that survey we haven't

24gone into antitrust issues, so I would

25leave it at generically stating that yes,

212

1there is a link between cause and effect.

2And obviously companies react and make their

3business planning based on the legal

4environment.

5MS. GRIMM: I'd like to

6pursue that a little bit more in the

7international context again and basically ask

8very much the same question that was asked of

9our panelists this morning.

10In terms of how businesses

11such as yours, Bruce and Bruce, respond to

12variations in the competition laws

13internationally, in particular I'd like to

14know, for example, whether your business

15decentralizes decision making as to different

16foreign environments. Secondly, whether your

17business generally seeks to comply with the

18most restrictive laws in those environments.

19I'd also like to ask whether the uncertainty

20could even impact on where you, for example,

21Intel, put your factories.

22And fourth, I think maybe you

23answered this, but whether the difference in

24international enforcement standards

25substantially raises your cost of doing

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1business. Those are kind of four

2subquestions under the large question. But

3if you could try to address those, it would

4be helpful.

5MR. SEWELL: Sure. I'll

6start, and then if I miss one, then let me

7know.

8We start with the position

9that as a global company, we need to be

10compliant with the antitrust laws globally.

11And since there is not a unified standard for

12that, we have to look at each area in which

13we do business.

14For Intel philosophically, we

15start with the premise that we must be

16compliant in the U.S., and then overlay that

17U.S. compliance approach with foreign

18requirements to the extent that we can

19discern what those foreign requirements are.

20So at any given point, we

21would be able to answer this question by

22saying we are sure we are compliant with U.S.

23antitrust law, and we are doing everything

24that we can to be compliant with foreign

25antitrust law although it's more difficult

214

1because that law is less certain in many

2cases, and in some cases even is nascent, is

3not really yet codified.

4So we decentralize the

5decision making to some degree based on that

6model. So we have antitrust experts outside

7of the U.S. who focus on antitrust compliance

8issues in major regions, not in every single

9country in which we do business.

10And we have pricing experts

11outside of the U.S. who seek to inform the

12pricing people within the central core of the

13company as to where a particular price or a

14discount or an incentive program might be

15potentially problematic outside of the U.S.

16In terms of your last point,

17was could it impact where we might select to

18do business, and the answer is in general,

19yes. It's a factor that we consider. Because

20our approach is to try to say that we will

21be compliant wherever we do business, even if

22that means that we will hire lawyers and hire

23specialists to tell us how to do that, in

24the end it's a cost of doing business that

25we would normally absorb. And the decision

215

1as to where to locate a factory tends to be

2driven by things other than the antitrust

3laws in a particular country, because we just

4-- we assume that we're going to figure out

5how to live within those laws, and we'll

6absorb that cost.

7The same would not

8necessarily be true for intellectual property

9laws where the risk of putting a factory into

10a country with punitive intellectual property

11laws could be much more devastating. We'll

12figure how to get through the antitrust

13issues. Some of the IP issues are sticky.

14But the last point is that

15it certainly is that the disharmony and the

16lack of convergence represents a substantial

17and significant cost for us, and that cost

18could be alleviated or at least substantially

19reduced if we had greater consistency among

20the various laws.

21MS. GRIMM: Bruce, would you

22like to add to that?

23MR. WARK: Sure. The

24airline industry is a little different than a

25lot of industries in the sense that there

216

1isn't a whole lot of foreign investment is

2U.S. airlines in part because of law and vice

3versa.

4So my competitive footprint

5in Europe, being the most important example,

6is small. So I never really have to worry

7about an Article 82 claim standing alone.

8I think where those issues do

9come up for us is we compete with airlines

10like British Airways, but we also cooperate

11with airlines like British Airways through

12airline alliances.

13So for example, I may be

14competing with them between Chicago and

15London, but I may be cooperating with them to

16move somebody from Chicago to Tel Aviv.

17So we're kind of in this

18interesting position of sometimes competing

19with airlines, sometimes cooperating with

20airlines. That's more of a Section 1 or an

21Article 81 issue, although you do have this

22kind of concept of collective dominance. I

23don't know that anybody really knows what

24that means under Article 82. I think that's

25being developed as we speak.

217

1So when we talk to the other

2airlines about what we can do as an alliance,

3I can say that we always have to fall to the

4lowest common denominator. I personally

5believe there are some very pro-competitive

6things alliances can and would do but for the

7fact that again, you're always operating on

8the lowest level for fear that you will

9stumble on what is the highest competitive

10hurdle.

11MS. GRIMM: I have no more

12questions.

13MR. MATELIS: Something that

14a lot of people have spoken about today are

15loyalty discounts. Bruce, let's start with

16you. I wonder if you could -- you know, I

17think most people intuitively grasp how

18loyalty discounts help firms get business.

19But I wonder if you could help tell us by

20tracing that through to the potentially

21pro-competitive effects on consumers.

22MR. WARK: Which Bruce?

23MR. MATELIS: Bruce Sewell.

24MR. SEWELL: Maybe I'mbr>
25missing something, but the trace-through from

218

1my perspective is that loyalty discounts are

2discounts. Loyalty discounts reduce the

3price that the consumer pays, and for that

4reason -- I mean, that is the essential and

5the nub of what we're trying to accomplish

6through regulation of competition.

7So the track to me is very

8simple. It's a discount. As I said before,

9I think it should be looked at as any other

10kind of pricing mechanism.

11Sometimes these discounts may

12be cash discounts. Sometimes they may be

13discounts in kind. Sometimes they may be

14incentives to cooperate in areas that

15increase visibility of the products or other

16marketing areas.

17But in the end, from the

18perspective of a consumer, all of these

19discounts ultimately produce a lower price in

20the marketplace. And I think that's the

21social benefit.

22MR. MATELIS: Are there

23cost-saving efficiencies that might not be

24readily apparent to somebody outside a firm,

25or is that not significant?

219

1MR. SEWELL: Well, in our

2industry it can be very significant because

3issues of scale have such a direct impact on

4the cost. So from our perspective, there are

5pro-competitive and pro-business reasons for

6looking to expand the scale and the volume of

7parts that we sell.

8So I'm not sure that's

9directly a consumer benefit, but it's

10certainly a business justification for the

11discounting practice.

12MR. MATELIS: Bruce Wark or

13Sean, any thoughts?

14MR. WARK: I wouldn't add

15anything to that.

16MR. MATELIS: Okay. I

17wanted to return to something that Bruce

18Sewell mentioned earlier and ask it of you

19Bruce Wark. Bruce said that at Intel,

20average variable cost is a readily available

21figure often. Is that the case at American

22as well?

23MR. WARK: Well, we had a

24very long piece of litigation where in fact

25there was a great deal of argument about what

220

1average variable costs should be. I think we

2thought we knew what it meant for purposes of

3that case. It was a different number than

4what the Justice thought the number should

5be.

6MR. MATELIS: I don't mean

7to interrupt you. But outside the context of

8litigation, is average variable cost a

9concept that -- or a figure that is important

10to American's own internal deliberative

11process, or do you have different ways of

12thinking about your business?

13MR. WARK: We have a route

14accounting system that takes account of all

15kinds of different layers of cost, from fully

16allocated to something that is much more

17variable. So yes, I think that the short

18answer to your question is yes.

19MR. MATELIS: Another

20predatory pricing question for -- I guess for

21you, Bruce Wark. You mentioned in your

22prepared remarks that you thought it was

23appropriate to acknowledge a meeting

24competition defense in the Section 2 context.

25I guess the flip side to -- or the argument

221

1against the meeting competition defense is

2that if it precludes liability in exactly

3those situations where, you know, a low-cost

4-- a lower cost new entrant might be seeking

5to enter, and a higher cost incumbent lowers

6cost. So in that instance the meeting

7competition defense would provide a safe

8harbor for sort of the core theory of how

9predatory pricing can work to harm

10competition.

11Sort of in general give me

12your thoughts on why the meeting competition

13defense is appropriate and why my attempt to

14defend it might not be the right way to look

15at it.

16MR. WARK: Well, I think

17from the perspective of the alleged preditee,

18they picked a point in the marketplace where

19they have to decide they're going to be

20successful. We didn't.

21It is a different situation

22than when that cost is imposed on them. If

23I went out and imposed a cost on them that

24was below my measure of marginal or

25incremental costs with the intention of

222

1driving them out, and they couldn't survive

2at that price, then that would be a different

3situation than when you have the alleged

4victim setting the price in the marketplace.

5If they raise their price and

6we didn't follow, that might be a different

7fact. But I think that if a competitor that

8basically sets its own price in the market

9can't survive, it's not the kind of efficient

10competitor that the competition laws are

11intended to protect.

12MR. MATELIS: Do you have

13any thoughts on how easy or hard it is to

14compare costs when you're seeking to apply

15the meeting competition defense? Is the cost

16comparative always intuitive, or are there

17hidden costs that make that comparison

18difficult?

19MR. WARK: Well, I guess

20what I'm arguing is that the defense, you

21don't have to worry about my costs. I ought

22to be able to compete for every passenger I

23can at the price determined by my competitor.

24MS. GRIMM: I think those

25are all the questions that Joe and I have.

223

1I would like to ask our panelists if they

2have any additional questions or observations

3they'd like to make.

4MR. WARK: Just to simply

5extend my thanks again for the opportunity.

6MS. GRIMM: And I'd like to

7thank all of you for joining us here today.

8The weather is very challenging, and we

9really appreciate your taking time off from

10your very busy schedules to be with us and

11prepare for these hearings. Your remarks

12have been very insightful, and we appreciate

13your sharing your views with us. Can we all

14give them a hand of applause?

15(Applause)

16 MS. GRIMM: Thank you all

17and have a safe trip home.

18(Which were all the

19proceedings had in the

20above-entitled cause this

21date and time.)

22

23* * *

24

25

224

1CERTIFICATE OF REPORTER

2

3I, PAMELA STAFFORD, Certified Shorthand

4Reporter for the State of Illinois, do hereby certify

5that the

6foregoing was reported by stenographic and mechanical

7means, which matter was held on the date, and at the time

8and place set out on the title page hereof and that the

9foregoing constitutes a true and accurate transcript of

10same.

11I further certify that I am not related to any of the

12parties, nor am I an employee of or related to any of the

13attorneys representing the parties, and I have no

14financial

15interest in the outcome of this matter.

16I have hereunder subscribed my hand on the

17 day of                 ,         .

18

19

20

21

22PAMELA STAFFORD, CSR
Updated June 25, 2015