Refusals to Deal
Steven C. Salop
Georgetown University Law Center
FTC/DO J Hearings on Exclusionary Conduct
July 18, 2006
General Exclusion Standards
- Alternative Standards
- Consumer Welfare Effect
- Profit Sacrifice/No Economic Sense
- Benefits of CWE
- Focused on goal of antitrust
- Flexible - "an enquiry meet for the case"
- Implies tailored structured inquiry for each type of exclusionary conduct
- Unifies Section 1 and Section 2 analysis under the rule of reason
- Misperceptions about CWE standard
- Does not require open-ended balancing - permits different specific legal tests in different exclusion settings
- Does not lead to false positives
- Sacrifice/NES standard causes false negatives and false positives
- Innovation incentives are a claimed rationale for restricting Section 2
- But, basis and significance of concern are unclear
- Firms have strong incentives to innovate in competitive markets
- Market innovation incentives improved by competition
- Monopolists have weaker incentives than competitors
- Exclusionary conduct reduces innovation incentives of entrants and rivals, by reducing or eliminating their market prospects
- No evidence of weakened innovation from fear of antitrust
- Thus, justification for restricting Section 2 is weak
Comparing Standards for Refusals to Deal: Summary
- Alternative Standards
- Consumer Welfare Effect
- Profit-Sacrifice/No Economic Sense
- Per Se Legality
- CWE and Sacrifice/NES have similarities
- Both require a price benchmark
- But, Sacrifice/NES standard may not require proof of anticompetitive effects (causes false positives)
- Per se legality leads to reduced competition and significant false negatives
- Limits of per se rule also are unclear
Proposed Rule under CWE Standard: What Plaintiff Must Prove
- Monopoly power
- Monopoly power in input market
- Actual or likely monopoly power in output market
- Plaintiff has made a genuine offer to buy at or above the appropriate "non-exclusion benchmark" price, as defined below; whereas defendant has failed to accept such an offer or made a genuine offer to sell at or below that benchmark price, ("compensation" test)
- Refusal to deal would cause prices to be raised or maintained at supra-competitive level. ("effects test")
- Output market
- Input market
- Another market where the entrant is an actual or potential competitor of defendant
Non-Exclusion Benchmark Price
- Non-exclusion benchmark price: potential alternatives
- Prior price charged to plaintiff
- Price charged to other buyers
- Price that compensates defendant for monopoly profits on output sales lost to plaintiff ("protected-profits" benchmark)
- Potential adjustments to benchmark
- If dealing raises defendant's production costs
- If plaintiff creates reputational free riding
- If monopoly power attained or maintained illegitimately
- Burden may shift to defendant to show plaintiff's price offer is below benchmark
- If non-negotiable ("flat") refusal to deal
- Properties of benchmark
- Compensates for lost output market monopoly profits from defendant's customers who switch to entrant
- But, no compensation for price competition caused by entry by firm with lower costs or superior product for some consumers
- Derived from ECPR literature
- Commentators (e.g., Armstrong/Doyle/Vickers/White)
- Benchmark input price: W = Cu + D x Md
- Cu= monopolist's marginal cost of input (in dollars)
- Md= monopolist's output "gross margin" over costs (in dollars)
- D = fraction of entrant's output sales diverted from monopolist
Example: Verizon and AT&T
- Protected-profits benchmark is practical for courts and firms to calculate
- Assumptions: relevant data
- Verizon's incremental cost of DSL inputs is $10
- Verizon earns monopoly margin over costs of $50on retail DSL
- If Verizon deals with AT&T, 50% of AT&T DSL customers would come from Verizon retail DSL, with rest from cable and dial-up.
- Benchmark input price: W = $35 .
- If D=1 (100% diversion), then W=$60
- No general Sherman Act duty to deal
- Cf Colgate (no duty "in the absence of any purpose to create or maintain a monopoly")
- Forced dealing raises red flags
- Compelling firms to share may lessen investment incentives.
- Enforced sharing requires courts to act as central planners
- Compelling negotiation can facilitate collusion.
Investment Incentives Concern: Some Answers
- Benchmark price compensates defendant for monopoly profits on lost customers.
- Entrant unlikely to enter input market
- Defendant's input market monopoly power implies durable entry barriers
- This also makes leapfrog competition by entrant less likely
- Competitive market will increase defendant's innovation incentives
- Monopolists have weaker innovation incentives
- Ability to enter output market will increase entrant's innovation incentives
- Entrant cannot be called a free-rider on the grounds that it competes with defendant in only one market, rather than entering both markets
- Kodak ("this understanding of free-riding has no support in our case law")
Courts as Central Planners Concern: Some Answers
- Courts and agencies routinely compare prices and costs, and use other quantitative economic evidence
- Eg, Brooke Group, Ortho, Kraft, agency merger analysis
- Task is not beyond the capabilities of District Court judges
- Market prices often provide a good benchmark
- Protected-profits benchmark is not too difficult to evaluate
- If antitrust withdraws, then alternative may be new public utility regulation
- Is FOSC the next step?
- Federal Operating System Commission
- Rare use of essential facilities doctrine could serves as an intermediate stopping point
Facilitating Collusion Concern: Some Answers
- Court's caution is very broad. Firms have independent incentives to negotiate, and independent incentives to collude.
- Would Court's reasoning lead it to prohibit voluntary dealing between competitors because it can lead to collusion?
- Or, prohibit joint ventures, which can (and sometimes do) serve as forums for collusion?
- Or prohibit patent settlements, which can (and sometime are) used to strike non-compete agreements or collude on price?
- Refusals to deal against competitors may hide (or amount to) non-compete agreements:
- "I will sell to you if you promise not to compete with me."
- Collusion is less likely when negotiation is forced (and potentially monitored) by a court
- Incremental effect of forced negotiation on collusion likely insignificant or negative
How Would a Rule of Per Se Legality be Limited?
- If it is per se legal to refuse to deal with firms that compete with you ...
- Then why not also per se legal to refuse to deal with firms that...
- Sell output to your competitors? ("exclusive dealing")
- Purchase inputs from your competitors? ("exclusive dealing")
- Buy other products from your competitors? ("tying")
- Announce their intention to compete with you in some product market? ("non-competition agreement")
- Charge low prices for their competing products? ("price fixing")
The Overarching Antitrust Standard: "Consumer Welfare" vs "Total Welfare"
Economic Welfare Standards
- True consumer welfare standard
- Total welfare standard
- Total surplus
- Bork named this "consumer welfare" -- deception or just confusion?
- Why use the true consumer welfare standard?
- Does not permit competitor injury to trump consumer benefits
- But, total welfare standard does allow this trump -- Did Bork know?
- Consistent with precedent
- Simpler to evaluate (price and output)
- Induces efficient conduct
- Firm can marginally restructure transactions in efficient ways to eliminate consumer harm and raises total welfare in the process
- Offsets unwillingness of courts/agencies to rigorously apply less restrictive alternative standard or gain full information about potential alternatives, thereby preventing inefficiencies
- Better supports innovation incentives
Innovation Incentives and Welfare Standards
- Consumer welfare standard supports greater overall innovation incentives
- Total welfare standard allows the dominant firm to destroy higher cost rivals that otherwise would innovate, thereby reducing innovation
- Total welfare standard allows mergers and exclusion that eliminate competition, leading to a dominant firm with less incentive to innovate
- These harms likely are larger than any marginal efficiency benefits from allowing mergers or exclusionary conduct that modestly reduce costs, while leading to higher prices to consumers
- Thus, adopting the true consumer welfare standard leads to higher long-run total welfare, as well as higher long-run consumer welfare.