Understanding Single-Firm Behavior: Loyalty Discounts Session

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1	UNITED STATES FEDERAL TRADE COMMISSION
2	and
3	UNITED STATES DEPARTMENT OF JUSTICE
4
5
6
7	SHERMAN ACT SECTION 2 JOINT HEARING
8	UNDERSTANDING SINGLE-FIRM BEHAVIOR:
9	LOYALTY DISCOUNTS SESSION
10	WEDNESDAY, NOVEMBER 29, 2006
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12
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14
15	HELD AT:
16	UNITED STATES FEDERAL TRADE COMMISSION
17	601 NEW JERSEY AVENUE, N.W.
18	WASHINGTON, D.C.
19	9:30 A.M. TO 4:00 P.M.
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21
22
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24	Reported and transcribed by:
25	Brenda Smonskey

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1	MODERATORS:
2	PATRICK DEGRABA
3	Economist
4	Federal Trade Commission
5	and
6	DAVID MEYER
7	Deputy Assistant Attorney General
8	U.S. Department of Justice
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10	PANELISTS:
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12	Morning Session:
13	Joseph Kattan
14	Thomas Lambert
15	Barry Nalebuff
16	David Sibley
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18	Afternoon Session:
19	Daniel A. Crane
20	Timothy J. Muris
21	Janusz Ordover
22	Willard K. Tom
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1	C O N T E N T S
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3	MORNING SESSION:
4	Introduction
5	Presentations:
6	Joseph Kattan
7	Thomas Lambert
8	Barry Nalebuff
9	David Sibley
10	Moderated Discussion
11	Lunch Recess
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13	AFTERNOON SESSION:
14	Introduction
15	Presentations:
16	Daniel A. Crane
17	Timothy J. Muris
18	Janusz Ordover
19	Willard K. Tom
20	Moderated Discussion
21	Conclusion
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1	P R O C E E D I N G S
2	- - - - -
3	MR. DEGRABA: Good morning, and welcome to our
4	first panel of the day on loyalty discounts which is
5	part of an ongoing series of public hearings on
6	single-firm conduct jointly sponsored by the Department
7	of Justice Antitrust Division and the Federal Trade
8	Commission.
9	This series is designed to help advance the
10	development of the law concerning treatment of
11	unilateral conduct under the antitrust laws.
12	My name is Patrick DeGraba. I'm an economist
13	here at the Federal Trade Commission Bureau of
14	Economics, and I'm one of the moderators for this
15	morning's session.
16	My co-moderator is David Meyer, Deputy Assistant
17	Attorney General of the U.S. Department of Justice.
18	Before we start, I need to do a few housekeeping
19	matters.
20	As a courtesy to the speakers, please turn off
21	your cell phones, Blackberries and all other devices
22	that will beep during the proceedings. Mine's off.
23	Second, the restrooms are across the hall to the
24	left of the guard desk where you came in. So ask a
25	guard because that description won't help you get there.

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1	The third is in the unlikely event that the
2	building's alarm goes off, please proceed calmly and
3	quickly as instructed. If we must leave the building,
4	exit through the main entrance. After leaving the
5	building, please follow the stream of FTC people that
6	are going to the staging area. They have practiced a
7	number of times and some of them know where they are
8	going.
9	Also, we request that you not make comments or
10	ask questions during the session. It is a moderated
11	hearing. For the speakers, I'm going to ask you to
12	please speak into the microphones. The sessions are
13	being transcribed and videotaped and the microphones are
14	the means by which the sound is captured.
15	The transcripts and other materials from the
16	session will be available on the DOJ and the FTC Web
17	sites. And finally, our next hearing will be next
18	Wednesday, December 6th, on misleading and deceptive
19	conduct.
20	Today's session, loyalty discounts include a
21	host of related contracting practices. The simplest,
22	often referred to as single-product loyalty discounts,
23	involve the seller providing a discount on all units of
24	a good sold to a buyer once that buyer has reached some
25	purchasing threshold.

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1	More complicated practices, often called
2	bundling loyalty discounts, involve the seller offering
3	discounts or rebates when a buyer has reached a
4	purchasing threshold on several possibly unrelated
5	goods.
6	Such practices have raised antitrust concerns
7	recently, and the appropriate antitrust treatment of
8	such practices is clearly in a state of flux. We are
9	honored to have this morning a distinguished panel of
10	academists, economists, and private practitioners who
11	will discuss the current thinking regarding the
12	treatment of these loyalty discounts.
13	Our panelists this morning will include Barry
14	Nalebuff, a professor of economics and management at the
15	Yale University; Tom Lambert, an associate professor at
16	the University of Missouri Columbia School of Law; David
17	Sibley, a professor of economics at the University of
18	Texas at Austin; and Joe Kattan, a partner in Gibson,
19	Dunn & Crutcher, LLP in Washington, D.C.
20	The organization of the panel is as follows.
21	The four panelists will give presentations of
22	approximately 15 to 20 minutes. It will be timed by our
23	staff here in the front row.
24	We will then take a short break. And after we
25	reconvene, the panelists will have a couple minutes to

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1	respond to each other's presentations, and then there
2	will be a moderated discussion. We will end about noon.
3	David, do you have any comments?
4	MR. MEYER: Not at this point.
5	MR. DEGRABA: All right. Let's get on with it.
6	Our first speaker today is Barry Nalebuff, who
7	is the Milton Steinbach professor of economics and
8	management at the Yale School of Management.
9	Professor Nalebuff has written extensively on
10	applications of game theory to business strategy and has
11	coauthored the first popular book on game theory, which
12	is used in colleges and business schools throughout the
13	world.
14	His current academic research focuses on
15	bundling and tying. He has provided expert testimony
16	and seminars on antitrust matters to federal
17	administrative agencies and courts in Australia and
18	Europe and has extensive experience consulting with
19	multinational firms.
20	Barry.
21	PROFESSOR NALEBUFF: Thanks. I'm going to be up
22	there and control it?
23	Greetings, good morning. What I'm going to try
24	and do is give you my overall perspective in terms of
25	the way I think about loyalty discounts and bundling.

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1	And I'm of the view to start with that unlike
2	physics, where one is searching for a brand unification
3	theory, you won't find that here.
4	I still believe there is nothing so practical as
5	a good theory. In this case it will be multiple
6	theories. The reason is that it is different horses for
7	different courses.
8	What matters is the nature of the competition.
9	You care about whether the products in the bundle are
10	substitutes with each other, as would be the case of
11	branded and generic tape; where they are complements,
12	such as aircraft engines and avionics; where they are
13	used in some fixed proportions, like in a nail cartridge
14	and a nail; whether or not one is essential to the
15	other, such as Windows and a media player.
16	Sometimes the goods are neither complements nor
17	substitutes, in the sense of Aspen skiing. Before you
18	go to Aspen, the different mountains are complements.
19	Once you are there, they are substitutes.
20	Sometimes there is no connection, substitutes or
21	complements between them. For example, different blood
22	tests are all essential but it is not that you use them
23	together.
24	The goods that are in the bundle might be
25	positively correlated, negatively correlated or not

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1	correlated at all.
2	All of these factors end up changing the
3	motivations and the effects of bundling and you have to
4	consider that when you are trying to understand the
5	effects and what to do about it.
6	The good news is that we are not in the desert
7	here lost, that in fact in each case where when you
8	understand where you are, we have the tools to analyze
9	it.
10	In my speed attempt to do 10 propositions in 10
11	minutes, here we will go. I want you to know these are
12	not bundled. You are free to accept any one of these
13	individually. But there is a discount if you take more
14	than three.
15	The first point is that often bundled discounts
16	or loyalty discounts lead to negative prices. The
17	reason for that is the discount often goes back to the
18	first unit that you buy. The end result of that is very
19	peculiar prices, things that are hard to justify.
20	This issue arises both with single and
21	multiproduct rebates. Below, this is an example that is
22	an amalgam of actual prices that I have seen from
23	different cases where things have been normalized and
24	discussed.
25	But the way it works is your price for the first

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1	31 units was 100. Your price for the 32nd unit was
2	minus 6000. Your price for the next couple units is 100
3	again. When you get to the 95th unit, your price is
4	about minus 800. And then for units 96 through 100, it
5	is 97.
6	Now, if you thought about that as sort of a
7	rational way of doing it, you would say what is going on
8	here, does that really make any sense?
9	Of course the customer should never be in a
10	position of buying fewer than 31 items because in fact
11	the first 32 are free. But then having bought 32, now
12	they are okay until they get to 85 because once you get
13	to 85, 85 through 95 is free.
14	What that means is if a rival wants to come in
15	and displace the firm entirely, it will not happen
16	because 31 units are free. Moreover, a rival will never
17	be able to sell between 85 and 95 or, in that case,
18	between 5 and 15.
19	The solution, in my view, to that is to still
20	give out discounts but to give out discounts on
21	incremental volume rather than go back to square 1.
22	And note, if that's your objective to give
23	people low prices, we have ways of doing that. I'm not
24	preventing the discounts, just trying to make them a way
25	that actually makes some sense.

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1	The second point is that loyalty discounts can
2	actually create no cost predation. And I'm going to
3	give you a quick example of this in terms of numbers.
4	The reason is that what we do is we inflate the
5	price of A rather than really give a discount. Imagine
6	the normal monopoly price of A is 100 and you can get it
7	at the normal monopoly price if you also buy B at 20.
8	But if you don't buy the B, then I will raise
9	the price of A to 120. Hence, the effective price of B
10	is zero or certainly below cost in this case.
11	Now, the key observation is that nobody actually
12	pays the 120 because nobody is foolish enough to only
13	buy A on an a la carte basis. Therefore, since the
14	threat is credible, it doesn't have to be used and it is
15	not costly.
16	The difference between predation and this type
17	of loyalty discount is that under predation, the firm
18	actually charges below cost, and so customers benefit
19	from those low prices.
20	Here all that is happening is the firm is
21	threatening to charge a high price if you don't go
22	along. It is like the mugger who says "your money or
23	your life," and when you give him your wallet, he wants
24	credit for actually saving your life. Actually, I don't
25	think that gets to count.

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1	Because there is no need for recoupment, it is
2	easier to implement this. Hence, there is a greater
3	danger of it. Because customers aren't necessarily
4	winning along the way, there is also more reason to be
5	suspicious.
6	To give you another disguised example of this,
7	the following is a case where an incumbent firm had a
8	market power in three goods, 1, 2 and 3, and they
9	offered prices like you see in column 1.
10	However, if you were to buy all four of their
11	products, including their competitive fourth product,
12	then you would get the discount, 16, 26, 51, so on
13	percent.
14	If you added up those discounts, what you
15	discover is that the cost of buying all of the three
16	products on an a la carte basis, which essentially you
17	had to do anyway because they were the only supplier of
18	those three products, ended up being sufficiently high
19	that you were going to save $1-1/2 million by buying the
20	bundle.
21	The end result of that was it was actually a
22	negative incremental price to go and take the
23	competitive product.
24	Once again, that is something that is very hard
25	to compete with. That leads to the following proposed

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1	test, which is if you have a firm which has market power
2	in A and you are worried about whether or not it is
3	going to extend that to another good, B, look at the
4	price of the A-B bundle versus the price of A alone and
5	ask how much more is the firm charging for A and ask
6	could that firm itself make money selling A at that
7	incremental price or B at that incremental price.
8	So instead of asking whether or not the rival
9	can make money selling B at that price, is the firm
10	itself apparently making incremental profits or not. If
11	it isn't, then what we have is a case of exclusion, and
12	that exclusion can be achieved without cost.
13	One of the things that is nice about this test
14	is that we actually don't have to look at actual rivals
15	or hypothetical rivals, we can look at the incumbent
16	firm's own cost structure. The incumbent firm which
17	knows its own cost structure.
18	Therefore, it is well equipped to discover
19	whether it is passing this test or not. It knows
20	whether it is in the safe harbor or it isn't.
21	There is an extra element to this test that
22	David Sibley and his co-authors have emphasized, which
23	is did the price of A go up or did the price of A-B, the
24	bundle, go down.
25	We should be more worried about the case when A

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1	alone goes up than when the A-B bundle goes down
2	because, of course, when it is a threat, there is no
3	benefit. Whereas, if the bundle has been discounted, at
4	least customers are getting some value along the way.
5	One point that I think the courts have really
6	missed about loyalty discounts is that some of the ways
7	that these rebates are paid end up being significantly
8	less competitive than a straight price cut.
9	So, again, think of a case where the incumbent
10	has market power in A, and B is a substitute. And the
11	two examples I will take you through are Scotch tape and
12	generic tape or Keflin and Kefzol, two cephalosporins,
13	where Keflin was the big money maker and Kefzol was the
14	new product which is the competitive one.
15	In the cephalosporin market, we had Lily with
16	its monopoly and Keflin, Keflex, Loradine, Kaphacen and
17	facing competition with SmithKline Ancef, which was the
18	exact same compound as Kefzol.
19	The first thing they tried doing was just
20	discounting Kefzol to match the prices on Ancef. The
21	problem with that was that Kefzol ended up being a
22	substitute for Keflin.
23	So not only did they have trouble capturing the
24	market against Ancef, as prices starting getting lower,
25	it started eating in on the demand to Keflin.

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1	Then they got wise and said okay, we will give
2	you a rebate on Keflin and the other products if you buy
3	enough of our goods.
4	Now, note what happens here. The price of
5	Kefzol ends up being high. I'm getting a million
6	dollars back or some fixed amount of money back, but I
7	don't end up discounting Kefzol.
8	In essence, I'm bribing you to say if you buy
9	all of my goods, I will give you this fixed amount of
10	money. But because Kefzol keeps its price high, that
11	reduces the competition between Kefzol and Keflin, and,
12	hence, customers don't get that benefit.
13	We also see that by its equivalent it is almost
14	as if Lily says to the customer we will give you 100
15	units of Kefzol for free on the condition that that's
16	all you use, which of course is something again that
17	rivals would have a hard time matching.
18	We have the same issue in LePage's. If you are
19	3M, you don't want to get into a price war with LePage's
20	over generic tape, because the cheaper generic tape
21	gets, the more that will eat into Scotch tape prices.
22	What you want to do is how can I beat LePage's
23	without discounting my generic tape. Well, if I give
24	them a bribe, a million dollars just to take my goods,
25	even if they are high priced and you can spread out that

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1	million dollars over their expected sales, then you can
2	say the overall deal is better for me, Staples, than it
3	is for taking LePage's.
4	But note the incremental cost of another roll of
5	tape is high. What that means is the price to consumers
6	for that tape is going to be high and there will be less
7	substitution of generic for branded product.
8	So in that sense, these rebates don't get passed
9	on to consumers and don't threaten the incumbent
10	monopoly.
11	That's an aspect of these loyalty rebates that I
12	don't think has been appreciated and I think is
13	problematic.
14	Another area is that loyalty rebates make
15	pricing incredibly hard to understand. If somebody
16	offers 2.93, I know that is cheaper than 2.97. But if
17	somebody says you get 3 percent off A and B if you buy
18	B, is that a good deal or not? Well, it depends on how
19	much A I'm going to buy. And sometimes I know the
20	answer to that and sometimes I don't.
21	Moreover, if rivals are trying to compete and
22	think about how much they have to undercut to get the
23	business, that means the B rival has to forecast my
24	demand for A, and, generally speaking, they are not very
25	well equipped to do that.

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1	So we have seen cases where people misforecast
2	these demands, end up buying the wrong product or don't
3	get discounts as large as they think.
4	I have also found that actually analyzing these
5	price things can often take an MBA. And it is not an
6	understatement to say it costs $10,000 to actually
7	figure out what price is the cheapest, and many times
8	that is not worth it for the individual customer to do.
9	An issue that bothers me about loyalty discounts
10	is that the price a firm charges to a customer shouldn't
11	depend on who else the customer buys from. I have less
12	a problem if the price says if you buy many units,
13	here's the charges. If you buy this many more units
14	this year compared to last year, here's the charge.
15	I think it is very funny to say to the customer,
16	"oh, and if you buy 10 units from Fred, I'm going to
17	charge you more money" or "if you buy 3 percent of your
18	products from Fred, I'm going to charge you more money."
19	The price that I charge you should ultimately
20	depend only on what it is that you buy from me, not what
21	it is that you buy from other people.
22	Now, I realize that the effect may be the same
23	through some volume discounts. But that still leaves
24	many more options in an uncertain environment for a
25	rival to come in than when you literally price based on

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1	what you are doing with your rivals.
2	You will hear many what I will flat out call
3	bogus justifications for bundled discounts. For
4	example, it is often said that customers like bundles
5	and, hence, that's a justification for doing bundling.
6	Yes, that's true, but it is not a justification
7	for a bundle discount. Because a customer likes it, in
8	theory you could charge more for it. You don't have to
9	offer it as a discount if you are providing something
10	customers like better.
11	We do the discount for price discrimination.
12	Well, there is no room for price discrimination if A and
13	B are consumed in fixed proportions.
14	Moreover, the arguments for price discrimination
15	generally rely on having a negative correlation between
16	the two products or no correlation in valuation between
17	the two products.
18	For example, opera tickets and wrestling tickets
19	you think of as having negative correlation. However,
20	if you look at what's bundled out there, I think you
21	will find that they generally have a positive
22	correlation in value and, hence, don't fit the normal
23	framework that we would expect price discrimination to
24	fall under.
25	Yes, Virginia, bundling can leverage and protect

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1	market power. Here is an example of how that works.
2	If we have a monopolist whose demand is
3	represented by 10 minus P and the cost is zero, the
4	monopoly price would be 5. Profits would be 5 times 5.
5	Price is 5, quantity is 5.
6	I'm having the B product be competitive with a
7	cost of one. So the price is one. Demand I'm making
8	just to be one unit.
9	Chicago School says don't sell A and B together
10	at 6. I do better just to sell A alone at 5, because
11	there are some people who may not want B, even at the
12	competitive price.
13	What I say is consider the following contract.
14	If you buy my B, I will lower the price of A to 4. But
15	if you don't buy my B, I will raise the price of A to 6.
16	Well, if you think about the cost of that threat
17	and promise, the customer is going to save at least $2
18	on A by buying the B product since they are going to be
19	buying at least four units of A.
20	That means that it is a net savings to them of
21	at least 8, which means they are willing to pay up to 9
22	in order to get that discount. They will pay 9 on B to
23	get that discount.
24	Well, the discount doesn't cost the firm very
25	much. And the reason is that discounts my price from 5

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1	to 4 only lowers my profits from 25 to 24. Raising my
2	price from 5 to 6 also only lowers my profits from 25 to
3	24.
4	So at a cost to me of only a dollar here, I can
5	do something that will either reward or punish the
6	customer to the tune of 8. And the reason for this is
7	the monopoly is inefficient.
8	So in essence, what I'm saying to the customer
9	is I'm willing to be a less inefficient monopolist if
10	you play ball with me and do what I'm asking on good B.
11	It doesn't make sense to take out all of your monopoly
12	rents on the monopoly product because that's what leads
13	to dead weight losses.
14	What I would like to do is some type of lump sum
15	payment and incremental pricing and charge the customer
16	for the right to buy my goods at a reasonable price.
17	Oftentimes the way we see that happen is the way
18	I charge them for being less of a monopolist is I say
19	you have to buy my other goods at B at inflated prices.
20	It is also the case that the bundle allows firms
21	with multiple market powers to protect themselves. So
22	if I have market power in A and B and charge 10 for A
23	and 10 for B but only 16 for the two together, there is
24	a $4 discount that any single-firm rival would have to
25	meet in order to undercut me.

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1	Note that my average price is 8. In essence, I
2	get to use that same $4 discount on multiple fronts. So
3	the customer isn't benefitting $4. The customer is only
4	benefitting 2 on each.
5	Rivals would actually have to go 4 below. That
6	is a special sauce in multigood bundling that makes the
7	incumbent have an advantage over rivals. It is sort of
8	why it works.
9	It also explains to me why the right test should
10	not be whether or not the overall bundle is above or
11	below cost but whether or not the individual components
12	at the appropriate incremental price is above or below
13	cost.
14	So the Chicago School story is correct in its
15	limited environment, but it misses most of the
16	interesting cases that we look at when it comes to
17	bundling.
18	Even where there is one monopoly profit, that
19	monopoly profit can be of different sizes. In
20	particular, bundling can allow price discrimination,
21	such as through metering and some of the examples you
22	have seen, which, therefore, leads to greater profits to
23	the monopolist but less surplus to the consumer.
24	It is also the case that many of the motivations
25	for bundling are dynamic, that by preventing somebody

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1	from getting into the B market, that may be their
2	subsequent entry into the A market which is where I
3	still have market power.
4	It is also the case that bundling and tying
5	provide potential for no cost for closure, which has the
6	same effect as predatory pricing but at no cost.
7	I recognize that bundles versus bundles is
8	generally more competitive than individual items versus
9	each other. So what I would like to be able to do is
10	take the advantage of that competition without the harm.
11	And the way that I do that is the following. I
12	actually take the example from Johnson & Johnson who
13	said, look, U.S. Surgical, you have a full line, we have
14	a full line, Coke and Pepsi, you each have full lines,
15	you can compete against me bundle for bundle.
16	But if I don't have a full line, I will not
17	count your sales in my 80 percent number or 90 percent
18	number. Whatever target I make, it is only a target for
19	other full-line competitors.
20	We have come our way through the deserts often
21	through intuition. There are now some tests that I hope
22	you will believe offer more formal approaches.
23	And I believe -- maybe this is a temptation here
24	-- that the theories of bundling loyalty discounts are
25	now ready for prime time. So I hope you will be able to

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1	use them.
2	Thank you.
3	(Applause.)
4	MR. DEGRABA: Thank you.
5	Our next speaker is Tom Lambert, who is an
6	associate professor at the University of Missouri
7	Columbia School of Law, where he has achieved the
8	university's Gold Chalk Award for excellence in graduate
9	teaching.
10	Professor Lambert's scholarship focuses on
11	regulatory theory, including antitrust policy and
12	business law. His 2005 Minnesota Law Review article
13	provided one of the first scholarly treatments of the
14	law of bundling discounts.
15	Tom is a member of the eSapience Center for
16	Competition Policy and is a regular contributor to Truth
17	on the Market, a Weblog devoted to academic commentary
18	on law, business, economics and more.
19	Tom.
20	PROFESSOR LAMBERT: Thank you.
21	It is an honor to be here on such a
22	distinguished panel. I will talk today about bundled
23	discounts entirely. I will not focus on single product
24	loyalty discounts.
25	A word about the scope of my remarks. I'm a

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1	lawyer, not an economist. I'm very concerned with
2	structuring rules in a way that they can be administered
3	by judges and juries and used by antitrust counselors to
4	advice their clients.
5	My focus is on the law, how we would structure
6	the rules.
7	I have a three-pronged agenda that's very
8	ambitious for 20 minutes.
9	Why are bundled discounts troubling, and I will
10	give you the straightforward view the courts have
11	adopted and most of you are familiar with this.
12	Summarizing and critiquing of the leading
13	evaluative approaches offers an alternative proposal
14	that I think is very administrable.
15	The problem with bundled discounts the courts
16	have recognized is they may lead to the exclusion of an
17	equally efficient but less diversified rival even if
18	they are above cost.
19	The classic example of this came in the Ortho
20	Diagnostic case. It is I think a little bit
21	unrealistic, but this is what the court wrote in its
22	opinion and it illustrates the problem, I think.
23	You can have two manufacturers who sell the same
24	product, manufacturer A and manufacturer B. They both
25	make shampoo. Manufacturer B is the more efficient

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1	producer. It can produce shampoo at $1.25 a bottle.
2	Manufacturer A, it costs $1.50 to produce the shampoo.
3	Manufacturer A, though, is a more diversified
4	rival. It sells conditioner as well as shampoo.
5	So by bundling its shampoo and conditioner and
6	by offering an above-cost bundled discount -- and what I
7	mean there is that the price, the discounted price of
8	the bundle is in excess of manufacturer A's cost of
9	producing the bundle -- manufacturer A can effectively
10	exclude manufacturer B from the market.
11	If the separate price of shampoo and conditioner
12	for A is $2 and $4, so that buying them separately you
13	would have to pay $6, and manufacturer A charges a
14	package price of $5, that is still a dollar in excess of
15	its average variable cost of four dollars. Manufacturer
16	B can't compete with that.
17	In order to sell its shampoo -- and any buyer
18	that buys both shampoo and conditioner will have to pay
19	$4 for the conditioner and will not be willing to pay
20	any more than $1 for the shampoo. Manufacturer B is
21	excluded despite the fact that it is the more efficient
22	producer.
23	So the fundamental problem the courts have
24	identified is that bundled discounts can lead to the
25	sort of exclusion of equally efficient but less

26

1	diversified rivals, and that's the case even if the
2	discount is above cost.
3	All right. I have identified six approaches in
4	the case law and commentary for evaluating the legality
5	of bundled discounts. I want to march through them
6	quickly and explain why I think each is a little bit
7	troubling.
8	The first and the most sort of laissez-faire is
9	a rule of per se legality. This is the rule that's been
10	advocated most recently by Professor Hovenkamp in his
11	new book, "The Antitrust Enterprise," and also the rule
12	advocated by Demicci in the LePage's case.
13	It basically says a bundled discount should be
14	per se legal if the discounted price of the bundle
15	exceeds the aggregate cost of the products within the
16	bundle.
17	The reason for this rule is not that we don't
18	believe that above-cost bundled discounts can ever be
19	anticompetitive. The Ortho Diagnostic example showed
20	how they could lead to the exclusion of a more efficient
21	rival.
22	Administrability concerns motivate this rule.
23	The idea is that it is simply too difficult to separate
24	the pro-competitive wheat from the anticompetitive chaff
25	and will end up chilling pro-competitive bundled

27

1	discounting if we don't have the sort of safe harbor,
2	and so the best approach is to have a per se legality
3	rule for above-cost bundled discounts, very much along
4	the lines of the Brook Group rule.
5	My criticism is -- well, I'm not all that
6	critical. In the long run, this may be the best
7	approach to take. However, I'm not willing to concede
8	that at this point.
9	I think the search for anticompetitive bundled
10	discounts may be worth the cost, including the cost of
11	deterring some pro-competitive bundled discounts.
12	It is very easy to imagine instances of
13	anticompetitive exclusion. Professor Nalebuff and
14	Professor Sibley have modeled cases where this could
15	occur. The Ortho Diagnostic example is a good example.
16	I think there is a fairly easily administrable
17	weeding device that can help us separate pro-competitive
18	from anticompetitive bundled discounts. I will get to
19	that in just a minute.
20	The second approach is at the other end of the
21	spectrum -- and this is an approach from the raising
22	rivals costs literature. I'm thinking in particular of
23	Will Tom, who will speak this afternoon, and Einer
24	Elhauge, who has discussed this in testimony on hospital
25	group purchasing organizations and also in his Stanford

28

1	Law Review article defining better monopolization
2	standards.
3	This approach says that bundled discounts are
4	discounts are illegal if they unjustifiably usurp so
5	much business from their rivals that their rival's costs
6	are erased.
7	Now, the $64,000 question here is how do you
8	determine what is unjustifiable. Every discount tends
9	to usurp some business from rivals. And obviously we
10	don't want to ban discounts.
11	The concern here is that so much business will
12	be usurped from rivals that it will deny rivals
13	economies of scale, make it harder for them to raise
14	capital.
15	A couple of approaches have been advocated for
16	identifying what are unjustifiable instances of raising
17	rival's cost.
18	Will Tom suggests in his article on the
19	Antitrust Law Journal that we adopt a case-by-case test
20	where the courts look to see is this an exclusionary
21	usurpation of the business or a pro-competitive
22	usurpation of the business.
23	That is difficult because that leaves a lot open
24	to the whims of juries and judges and will likely have a
25	chilling effect on pro-competitive bundled discounts.

29

1	Professor Elhauge has suggested an approach
2	where a business-usurping discount is justified only if
3	the discounter's business stealing, business usurpation
4	occurs because the bundling has made the discounter more
5	efficient.
6	If you are stealing business because your
7	bundling is making you more efficient, then that's okay.
8	But if you are stealing business for any other reason,
9	then that's illegal.
10	I think this is a troubling approach for several
11	reasons. First, it would prevent price cutting by a
12	monopolist who has reached minimum efficient scale and
13	can't achieve any additional distribution efficiencies
14	by bundling.
15	That person is not getting any efficiency
16	benefits from the bundling and then would be precluded
17	from cutting prices, which seems bad for consumers.
18	Secondly, this approach is very difficult to
19	administer. A court would have to figure out what is
20	minimum efficient scale, very difficult for judges and
21	juries to do.
22	In addition, it has to figure out what discount,
23	what amount of discount is necessary to get the
24	discounter to the point of minimum efficient scale. Any
25	discount beyond that would be excessive discount and

30

1	under Professor Elhauge's test would be exclusionary.
2	That is extremely difficult for judges and
3	juries to administer. For that reason, this approach is
4	likely to have a major chilling effect. Discounters
5	discount at their own peril.
6	The third approach is the approach we sort of
7	see in LePage's. Everyone in this room knows it is very
8	difficult to articulate a rule of law from the LePage's
9	case.
10	There were some key facts that were very
11	important in the court's analysis there. LePage's was
12	not required to prove that it couldn't match the 3M
13	discount. It was not required to prove it was as
14	efficient a manufacturer as 3M was.
15	Instead, it just had to show that it was being
16	excluded. And once it showed that, the burden shifted
17	to 3M to justify its behavior.
18	So if you want to take away a rule from that --
19	and lots of smart antitrust counselors are trying to do
20	so and advise their clients accordingly -- it would seem
21	to be the following. A bundled discount is
22	presumptively exclusionary if the discounter is bundling
23	products not sold by rivals and is winning business from
24	those rivals.
25	Now, the discounter may rebut that presumption

31

1	if it proves a business reasons justification. There is
2	a suggestion in the LePage's case that that
3	justification must show that the bundling saves costs
4	approaching the amount of the discount, very similar to
5	Professor Elhauge's suggestion in the Stanford Law
6	Review.
7	This I believe is a very troubling rule. First
8	of all, since the plaintiff need not establish its
9	equivalent efficiency, this approach essentially creates
10	a price umbrella for less efficient rivals.
11	And there is a suggestion in LePage's that's
12	exactly what happened. LePage's expert economist
13	conceded that LePage's was a less efficient manufacturer
14	of tape than 3M and yet LePage's won.
15	Moreover, since the focus is on product line
16	breadth and not whether an efficient rival is being
17	excluded, this approach will tend to chill bundling,
18	which has a number of pro-competitive benefits which we
19	will talk about in the roundtable discussion. I assume
20	that some of my co-panelists will discuss that issue.
21	The third approach here -- fourth approach, I
22	guess -- the approach we see in the Ortho Diagnostic
23	decision, in that case, the court reasoned that a
24	bundled discount is illegal if the plaintiff shows
25	either that the bundle is priced below average variable

32

1	cost, straightforward predatory pricing, or that the
2	plaintiff is at least as efficient a producer of the
3	competitive product but cannot match the discount
4	without pricing below cost on that product.
5	In other words, you have to show you are an
6	equally efficient rival, and after you show you are an
7	equally efficient rival, you show if you attribute the
8	full amount of the discount to the competitive product,
9	that will result in below-cost pricing by the
10	discounter. You couldn't match that discount.
11	My criticism of this rule, it is a great rule in
12	theory, but this is a very difficult rule to administer.
13	The plaintiff, in order to prevail, has to show
14	that it is an equally efficient rival. To do that, it
15	has to establish its own cost and the discounter's cost.
16	In addition, there are going to be joint costs
17	in here because this is a bundling case. In figuring
18	out the discounter's cost on its competitive product, it
19	has to figure out what percentage of the joint cost it
20	should attribute to that competitive product.
21	That is an incredibly difficult rule to
22	administer. For that reason, I believe this rule, the
23	rule of law in Ortho Diagnostic, may be underdeterrent,
24	because plaintiffs are going to have a hard time winning
25	these cases.

33

1	The next approach is what I'm calling the
2	original antitrust law approach. This is the approach
3	that was advocated in the Areta/Hovenkamp treatise. It
4	was updated this summer. I had to update my
5	presentation.
6	The original approach advocated by the treatise
7	was focused on trying to fix the administrability
8	problems with the Ortho Diagnostic test.
9	Rather than asking if the plaintiff itself was
10	an equally efficient rival, the original antitrust law
11	approach said let's ask if a hypothetical equally
12	efficient single-product rival would be excluded by this
13	discount and without adequate business justification.
14	So essentially we take the Ortho Diagnostic
15	test, we lop off the part where the plaintiff has to
16	show that it is actually an equally efficient rival, and
17	we say if you attributed the entire amount of the
18	bundled discount to the competitive product, would a
19	hypothetical single product be excluded by this
20	discount.
21	This is definitely an easier to administer test
22	because plaintiffs don't have to prove the defendant's
23	costs where there are joint costs. It is troubling,
24	though, for a couple reasons.
25	First, it prevents discount cross-subsidization.

34

1	Consider a situation where you have a seller that sells
2	products A, B and C. Its cost is $4 each. It sells
3	them separately for $5 each. But it would sell the
4	bundle for $13.50.
5	Under the antitrust law approach, this would be
6	a presumptively exclusionary discount because a single
7	product seller of A that was equally efficient at a cost
8	of $4 couldn't match this discount because it would have
9	to charge a price of $3.50, a price below its cost.
10	Now, if you think about an oligopolistic
11	market -- it is not cartelized, but there is a lot of
12	what looks to be tacit collusion -- if you assume the
13	seller that sells A, B and C is selling in that market,
14	it is great that the seller can engage in the sort of
15	complicated pricing.
16	Professor Nalebuff says it is very difficult to
17	figure out exactly what price is being charged.
18	That's a fantastic thing in an oligopolistic
19	market. This sort of pricing can disrupt, this sort of
20	bundling can disrupt oligopolistic pricing. In
21	addition, it is a discount for customers. That would
22	seem to be good in itself.
23	A second problem with the antitrust law approach
24	is there was no requirement that the foreclosed market
25	be capable of monopolization, there was no requirement

35

1	that there be entry barriers in the foreclosed market
2	that the plaintiff was being excluded from.
3	The revised antitrust law approach is definitely
4	superior to the original. But I still think it is a
5	little bit troubling.
6	What Professor Hovenkamp is now saying -- which,
7	by the way, seems to conflict with his book, "The
8	Antitrust Enterprise" -- is that we should analogize
9	bundled discounts to tying and say there is a tie-in if
10	the price is below cost when the entire discount is
11	attributed to the competitive product.
12	Very importantly, the treatise points out there
13	will not be this tie-in if there is another significant
14	rival that sells all products. In the Johnson & Johnson
15	versus Tyco case or U.S. Surgical case,
16	Johnson & Johnson engaged in this bundling, but there
17	was another significant rival that had the same bundle
18	in place.
19	Professor Hovenkamp would say that does not
20	constitute a tie. But absent such a significant rival,
21	there would be a tie-in if there was a below-cost price
22	after the discount was attributed to the competitive
23	product.
24	The treatise then says that after you find time,
25	you should apply a basic rule of reasoned approach, ask

36

1	whether the foreclosed market is capable of
2	monopolization, ask if a collaborative bundle is
3	probable, ask if there are pro-competitive
4	justifications for the bundling.
5	This is a definite improvement on the original
6	version. My criticism is why involve tying at all. It
7	seems to me that the reason that we are concerned about
8	tying in cases like this is that it leads to
9	foreclosure.
10	Why should we focus on the tie rather than
11	focusing directly on the foreclosure issue?
12	Here is my alternative proposal. The goals of
13	the proposal is we want to condemn bundled discounts
14	that could eliminate competitive rivals and result in
15	price increases. We don't want to condemn other bundled
16	discounts. And we want the rule to be easy to
17	administer.
18	What I want to structure my rule to show is that
19	the complaining rival has exhausted its competitive
20	options. You are not a competitive rival unless you
21	have done everything you can to stay in business.
22	The complaining rival must have the ability to
23	match the bundled discounter's efficiency. You are not
24	a competitive rival if you are not as good as the
25	bundler.

37

1	We have to show the foreclosed market is capable
2	of monopolization. We don't want to ban discounts in
3	markets that can't be monopolized because there are very
4	low barriers to entry.
5	Here is a proposed rule. I would have a rule
6	that says that the above-cost discount, and that means
7	that if you add up the cost of all the items in the
8	bundle, they are exceeded by the price of the bundle.
9	So the above-cost discount is per se legal
10	unless the plaintiff could not match without pricing
11	below cost and, number one, barriers to entry exist in,
12	A, the product market in which the plaintiff doesn't
13	participate, and, B, the market for the competitive
14	product, a collaborative bundle is impracticable, a
15	good-faith supply offer was rejected. That means that
16	the foreclosed firm goes to the bundled discounter and
17	says, hey, let me supply my products to you, you buy my
18	product and bundle it.
19	And if those are established, then the bundle is
20	considered presumptively exclusionary, but the defendant
21	gets a rebuttal opportunity to show that it rejected
22	this good-faith supply offer because it wasn't
23	attractive, either the price being offered was too high
24	or the quality was insufficient.
25	Let me explain how this meets all of my goals of

38

1	protecting competitive rivals. We want to protect
2	competitive rivals and only competitive rivals, and we
3	want to ensure that the market that is being foreclosed
4	is capable of monopolization.
5	The above-cost discount is per se legal unless
6	the plaintiff could not match without pricing below
7	cost. That requires a complaining plaintiff to lower
8	its price to the level of its marginal cost.
9	That's what we expect will happen in perfect
10	competition. We should demand that of a complaining
11	rival.
12	Next, it has to show that barriers to entry
13	exist in a product market in which the plaintiff doesn't
14	participate. An option for a plaintiff that's
15	confronting a bundled discount is to enter the other
16	markets in which it doesn't participate. It needs to
17	show there are some entry barriers that prevent it from
18	being able to do so.
19	In addition, it has to show barriers to entry
20	into the market for the competitive product. That's
21	required to show the market is in fact capable of
22	monopolization.
23	Supercompetitive prices could be charged in that
24	market without inviting so much entry that it is
25	impossible to charge those prices.

39

1	Next, the plaintiff would have to show that a
2	collaborative bundle is impracticable. It cannot
3	compete with the bundle by entering into agreements with
4	sellers of other products to craft a competing bundle.
5	These sort of cross-seller bundles are
6	incredibly common. I sent my research assistant to
7	Target, and he found an Olympus digital voice recorded
8	bundled with batteries, Suave body wash bundled with a
9	Schick razor, Colgate White-Plus teeth whitening cream
10	bundled with a camera. Americans are vain.
11	The prima facie case here is intended to show
12	that the plaintiff has exhausted its competitive options
13	and that the market being foreclosed is capable of
14	monopolization.
15	Then we have a rebuttal opportunity. The
16	defendant may rebut by showing that the supply offer was
17	not attractive.
18	The defendant has to show that when the
19	plaintiff came and made the supply offer to me, I didn't
20	accept it because the price it was charging me was
21	higher than my cost. That shows that the plaintiff is
22	in fact a less efficient rival.
23	If the plaintiff can show its prima facie case
24	and the defendant can't rebut, then we have an exclusion
25	of a competitive rival in a market that is capable of

40

1	foreclosure or capable of monopolization, and it would
2	seem to me that liability is appropriate.
3	Otherwise, I would have a rule that these sorts
4	of discounts which are discounts, good to customers, are
5	legal.
6	Thanks.
7	(Applause.)
8	MR. DEGRABA: Our next speaker is David Sibley,
9	who is the John Michael Stuart Centennial professor of
10	economics at the University of Texas at Austin.
11	Professor Sibley was previously the head of the
12	economics research group at Bell Communications Research
13	and served as a member of the technical staff in
14	economics at Bell Labs.
15	In 2003 and 2004, David served as a Deputy
16	Assistant Attorney General for economic analysis in the
17	Antitrust Division.
18	Professor Sibley has carried out extensive
19	research in the area of industrial organization,
20	microeconomic theory and regulation, and his
21	publications have appeared in numerous leading economics
22	journals. He has consulted extensively for various
23	firms and agencies, both in the United States and
24	abroad, on antitrust and regulatory matters.
25	David.

41

1	PROFESSOR SIBLEY: Thank you.
2	The title of my talk, what have we learned since
3	LePage's about bundled discounts, I guess is sort of
4	inspired by the feeling of knowing not what to say at
5	the Antitrust Division when the parties representing
6	both sides of LePage's came to convince us either to
7	support a take cert brief or not.
8	There was not a whole lot the economists had to
9	say. Greg Warden was on the right track when he said
10	"what do the prices do?"
11	It turned out you couldn't tell from the
12	evidence in the record. I take LePage's as kind of a
13	baseline as sort of very useful knowledge.
14	What have we done since then? Well, there has
15	been some progress. We understand now I think better
16	the effects of bundled discounts on both foreclosure and
17	customer welfare.
18	I mentioned foreclosure and customer welfare
19	separately here because, as we will see, it is possible
20	to have a bundled discount which increases customer
21	welfare and yet excludes equally efficient rivals.
22	I expect that to be the case from the way
23	bundled discounts can be structured. I will also talk
24	about tests to determine if a bundled discount is
25	anticompetitive.

42

1	This would be in the spirit of the Ortho test
2	with its explication of extension by Barry Nalebuff or
3	tests whether customer welfare rises or falls. The
4	reference here would be what I was aware of without
5	having to go to any trouble to look up more, Wrightman,
6	Sibley and Roy Nalebuff.
7	The tests here I guess were designed originally,
8	both to try to see whether we could figure out whether
9	bundled discounts are good or bad but also with a view
10	toward the same type of goal that Tom Lambert had,
11	administrability here.
12	We wanted simple tests that didn't require you
13	to calculate complicated things or use data that you are
14	not likely to be able to get in practice. The result is
15	we have tests that will work sometimes but not all the
16	time.
17	To start, I will take a very simple set-up which
18	is actually I think probably the set-up behind some of
19	the slides here.
20	A is a monopoly market served by a firm we will
21	call Firm 1. B is a competitive market. It might not
22	be perfectly competitive. I think for the next five
23	minutes or so I will assume it is perfectly competitive.
24	But it doesn't have to be.
25	Firm 1 is a seller in the B market too. I think

43

1	for the purpose of the rest of the slide, I want to
2	assume a couple things, one, that the B market is
3	perfectly competitive and some B customers will buy B
4	only and some will buy A only.
5	A couple of preliminary observations. Starting
6	from independent pricing, a bundled discount or a BD can
7	raise both profits and customer welfare. That doesn't
8	mean that it will actually happen by a profit-maximizing
9	profit discounter, but it is capable of happening.
10	We should keep that in mind. The logic is
11	really as follows. Let's suppose we have a preexisting
12	time that we can observe where Firm 1 is engaged in
13	independent pricing and it is a monopolist in market A.
14	We will assume that if it hasn't anticipated the
15	onset of the regulatory rule I will be talking about,
16	that the price it charged to the A market was probably a
17	monopoly price.
18	As Barry was saying, if the monopoly price is --
19	if the price charged by firm one in the A market really
20	was the profit-maximizing monopoly price, then it is
21	always possible to have a slight discount on the price
22	of A, which will have an insignificant effect on profits
23	that Firm 1 generates in market A.
24	In Barry's example, it was a $1 increase in
25	profits. From a customer welfare standpoint, that is

44

1	not an insignificant increase in customer welfare.
2	That allows the firm, Firm 1, to bundle that
3	slightly lower price of A with a price of B that's above
4	marginal costs and still get A and B consumers to select
5	the bundle in preference to buying any A at all or
6	paying a bundled price for it and getting B at a
7	marginal cost.
8	In that situation, the A/B consumers are better
9	off. They can all select the bundle that will make them
10	better off.
11	B-only consumers are nowhere better and no worse
12	off than before. They are getting B at marginal cost
13	from all the other perfect competitors out there.
14	If the bundled discount in doing this has an
15	out-of-bundled price no higher than the previous
16	monopoly price under independent pricing, then we know
17	that consumers' options within the bundle are no worse
18	than before.
19	In fact, we have designed the bundle to attract
20	them away from independent pricing of A and marginal
21	cost of B. So they are better too.
22	So starting from independent pricing, which
23	would be the marginal cost of B for everyone, including
24	Firm 1, and the profit-maximizing monopoly price of A by
25	Firm 1, we can always construct a bundled discount which

45

1	raises customer welfare and also raises profits for Firm
2	1.
3	Now, this has an interesting effect here. There
4	is implicit in this the foreclosure result.
5	Since the A and B customers are better off
6	taking the bundle, even at a price of B that is slightly
7	above marginal cost, this means that a B-only seller,
8	one of those perfect competitors, can't appeal to these
9	folks without charging below-market costs. Equally
10	efficient providers are foreclosed and, yet, consumer
11	welfare has gone up.
12	Clearly I have contrived this example to make a
13	point. But it is a point that I suspect in practice
14	comes up often enough to make it interesting.
15	It at least points out when we are talking about
16	bundled discounts, we should not equate foreclosing
17	equally efficient firms with lowering consumer welfare.
18	In my example, consumer welfare is higher. The
19	single-line producers of B would just sell to B-only
20	consumers.
21	Okay. Another point that is implicit to what
22	Barry said which I should have mentioned a moment ago,
23	we are going to assume here that under independent
24	pricing, the Firm 1, the monopolist in the market for A,
25	has not been able to extract all consumer surplus in the

46

1	market for A.
2	In principle, the firm might do this by a
3	perfect two-part tariff, for example. In practice, I
4	think neither Barry nor I think this is a big deal. If
5	it were, we would see lots more two-part tariffs with a
6	lot fewer loyalty discounts than we do.
7	If consumers' demands have some uncertainty and
8	consumers know more about what their demands are, then
9	you will not have a two-part tariff anyway, and you
10	would find that would still be of some use.
11	So far we are talking again about a monopolist
12	in the market for A and everyone inside is a perfect
13	competitor in B.
14	Had I taken more time on this particular slide,
15	I would have had a third bullet point which contrasts
16	what you might expect Firm 1 to actually do with the
17	possibility of raising both consumer welfare and
18	profits.
19	In practice, you wouldn't expect the firm to be
20	interested in raising consumer welfare. So profit
21	maximizing in a very simple setting where B is perfectly
22	competitive and products are not differentiated and the
23	only thing consumers care about is price, in that
24	setting profit-maximizing behavior by Firm 1 is to raise
25	the out-of-bundled price of A a great deal.

47

1	The only point of the out-of-bundled price is to
2	essentially stampede consumers into buying product. In
3	fact, you would give them very bad out-of-bundle
4	alternatives, $10 trillion an ounce or whatever it might
5	be.
6	Of course, they could buy B at marginal cost
7	from competitors. This puts consumers of A and B in a
8	much worse position.
9	So in that setting, the effect of
10	profit-maximizing bundling would not be to raise
11	consumer welfare. It would be to increase profits and
12	lower consumer welfare.
13	Let's not lose sight of the fact that if the
14	out-of-bundled price of A is no higher than the
15	preexisting monopoly price of A under independent
16	pricing, we have the result which has the interesting
17	effect, as I said a moment ago, of excluding sellers in
18	B market from selling to consumers that buy A and B.
19	What I will do next is to change the story and
20	the market for B a little bit. What I talked about so
21	far I suspect people in the audience have heard before
22	from me, from what I have heard. It is on the paper on
23	SSRN for a while. My coauthors and I have labored to
24	extend the results and have had some progress.
25	The story I will tell next, suppose that the

48

1	market for B is not perfectly competitive. It has two
2	firms, one of which is Firm 1. They produce
3	differentiated products.
4	So yes, there are substitutes but not perfect
5	substitutes. Consumers have tastes which are some will
6	prefirm firm 2's version of B and some prefer Firm 1's
7	version. You have a distribution of tastes in the
8	market for B.
9	Some consumers want only B, but there is also a
10	population of A and B consumers. If you look at those
11	folks, the ones who want A, we will assume the same
12	distribution of taste as regard to B. So there are some
13	A/B consumers who really like Firm 1's flavor of B but
14	some who really like Firm 2's.
15	In this setting, the world changes a fair
16	amount. Let me talk you through things before I go to
17	the bullet point here.
18	Firm 1 now has a much more interesting role for
19	the out-of-bundled price of A than it had a moment ago
20	when I assumed that the B market was perfectly
21	competitive and all sellers in B produced a homogeneous
22	product.
23	In this case, Firm 1 realizes there are folks
24	out there wanting to buy my monopoly product which
25	really want to buy B from the other guy.

49

1	The tools at my disposal if I'm Firm 1 are I
2	will have out-of-bundled prices for A and B and bundled
3	prices for A and B.
4	I also know there are some A consumers who also
5	prefer my version of B. How hard do I want to try to
6	retain consumers that want to buy A but really want to
7	buy firm 2's version of B?
8	If I am going to keep those folks, I might have
9	to really discount the price of the bundle a lot. If I
10	do that, then I'm passing up profits that I could make
11	on A and B consumers that like my version of B.
12	So maybe I won't do it. Maybe it is better not
13	to try so hard. I will simply concede A/B consumers
14	that prefer firm 2's version of B to Firm 2.
15	Now, I still would like to make some money off
16	them. I would like them to continue to buy A from me.
17	So my out-of-bundled price for A in this
18	setting, although it is a high price, is no longer set
19	at some infinite level that is designed solely to
20	stampede people into buying the bundle. It is low
21	enough so that A/B consumers that like Firm 2's version
22	of B are still going to buy some A product.
23	So the stand-alone price of A, the out-of-bundle
24	price of A in this setting has a price discrimination
25	goal as well as incentive to buy the bundle. It is a

50

1	more complicated world.
2	Now, look at the first bundle here. Compared to
3	independent pricing, consumer welfare can go up or down
4	assuming that Firm 2 does not exit the B market. In
5	this bullet, when I say consumer welfare can go up or
6	down, I mean in the aggregate. I don't necessarily mean
7	every single consumer.
8	Now, Firm 1 -- why would that work? Firm 1 --
9	there's sort of an interesting effect here. Firm 2 has
10	a tougher job with bundling than under independent
11	pricing because it has to convince consumers to buy B
12	from it at the expense of them having to pay a higher
13	price for A.
14	Under independent pricing, it didn't have this
15	problem. In this set-up here, Firm 2 lowers its price
16	of B because it is now competing, trying to pull people
17	out of the bundle from Firm 1, which it didn't have to
18	do under independent pricing.
19	Firm 1's best response to that is to set an a la
20	carte price for B which is lower as well so B-only
21	consumers are better off in this setting here.
22	If you look at the people buying the bundle, it
23	is not clear whether they are individually better off or
24	not. Usually some are worse off.
25	In that setting, B-only consumers are always

51

1	better off. A and B consumers may be, may not be.
2	Aggregate consumer welfare can go up or down.
3	There is an interesting permutation of this for
4	either entry deterrents, if that's how you want to think
5	about this, or driving firms to another market.
6	Since Firm 2 always sets a lower price of B
7	because it has to work harder to capture consumers
8	because they will be tempted to buy B to get a lower
9	price of A, it always charges a lower price, its cash
10	flow is lower. Depending on the costs it may have, it
11	may in fact exit the market.
12	Look at this from another way. Imagine that
13	Firm 2 has not yet entered the market but it is thinking
14	about doing that and asking itself what would happen if
15	I did enter the market.
16	Well, the story I have gone through here depends
17	on a result which is in the paper that Firm 1's best
18	response to entry by Firm 2 is always to bundle.
19	Firm 2, if it hasn't entered yet, knows if it
20	does, Firm 1 will respond by bundling. Therefore, if
21	there is some cost of entry specific to the active entry
22	that Firm 2 had to incur, they may be deterred from
23	entering, somewhat like the one in the tying literature,
24	the paper by Mike Winston.
25	But there is a difference. You recall that

52

1	Mike's entry deterrence result depends on the equivalent
2	of Firm 1 giving a precommitment to a time, meaning if
3	an entry were to occur, it has to precommit to the tie.
4	There is no precommitment requirement because
5	bundling is what Firm 1 will want to do anyway, the best
6	response. So it is possible to induce Firm 2 to exit
7	even without the precommitment assumption of Winston and
8	others in the tying literature.
9	For a long time in this more complicated set-up,
10	I didn't think we were going to get any sort of fact
11	pattern that would tell us we had a safe harbor here the
12	way we did in the previous story that I just told.
13	My coauthor, David Wrightman, actually came up
14	with one. A sufficient condition in this set-up for
15	consumer welfare to be higher under bundling than under
16	independent pricing, assuming Firm 2 does not exit, is
17	the following.
18	If the a la carte price of A or the
19	out-of-bundled price of A is no higher than it would be
20	under independent pricing and if Firm 2's price for B
21	falls, then whatever happens with the bundle, we can
22	infer consumer welfare has to have gone up, even though
23	the price of B in the bundle may be a little higher.
24	So if we have this fact pattern, we can conclude
25	not only that overall consumer welfare is higher but in

53

1	fact every single consumer is better off.
2	A couple of remarks here. I talked about two
3	kinds of safe harbor tests here. The previous result or
4	model were the B markets perfectly competitive, and we
5	compare the a la carte price of A under bundling to the
6	monopoly price of A and we have a result.
7	And in this case we do the same thing. We can
8	only do that if there is a preexisting independent
9	pricing regime followed by an onset of bundling.
10	And in practice you may not find such a clean
11	set-up. Perhaps bundling began in 1932 or something
12	like that. However, in a litigation setting, the
13	chances are reasonably good that you will run up against
14	this set-up.
15	Typically what happens is firms compete, and one
16	of them will start bundling, and then there is an
17	antitrust complaint. Typically there is a before and
18	after if things make it to the litigation stage.
19	Let me contrast this with the doability of
20	Barry's test. Barry's test does not have the problem of
21	needing to find a before and after situation.
22	It basically lists as attributes the discounts
23	to the competitive line and asks if an equally efficient
24	competitor could undercut that. We could use that in
25	principal using data from the firms if we didn't have

54

1	any reason to think that was a strange point in time to
2	consider.
3	The advantage of -- Barry has a safe harbor, and
4	it's really oriented towards saying when do we exclude
5	competitors. That doesn't necessarily mean consumer
6	welfare is lower if in fact this test has failed.
7	Okay. To sum up, then, in the right
8	circumstances, at least, it seems possible that simply
9	by looking at pricing patterns in order to prepare
10	out-of-bundled prices so the monopoly must carry them to
11	the preexisting prices or by allocating discounts to the
12	competitive line, we do have some safe harbor tests at
13	this point, most of which weren't around or at least
14	weren't understood by us at the time of LePage's.
15	Okay, thank you.
16	(Applause.)
17	MR. DEGRABA: Our last presenter for the morning
18	is Joe Kattan.
19	He has asked that I waive the reading of his bio
20	and simply say he is a partner at Gibson, Dunn &
21	Crutcher in Washington, D.C.
22	MR. KATTAN: Thank you. I will also waive the
23	use of PowerPoint, the pervasiveness of which may be
24	testament to the bundling of the Microsoft Office Suite.
25	I'm a lawyer, too, and I'm going to look at

55

1	things from the perspective of the lawyer. And I want
2	to start out with a fairly obvious proposition which is
3	that both bundling and loyalty discounts involve price
4	cutting.
5	This is an area which U.S. law has tread very
6	carefully, and for a good reason. The cost of error in
7	this area, as we all know, is deterring firms from
8	engaging in aggressive price cutting, which the courts
9	have been loathe to do, viewing such deterrents as
10	antithetical to the goals of antitrust.
11	Justice Breyer back when he was in the First
12	Circuit captured this idea in the Barry Wright case,
13	where he said, "The consequence of a mistake here is not
14	to force a firm to undergo a legitimate business
15	activity that it wishes to pursue. Rather, it is to
16	penalize appropriate competitive price cuts, perhaps the
17	most desirable activity from an antitrust perspective
18	that can take place in a concentrated industry where
19	prices typically exceed costs."
20	This has been the foundation of U.S. antitrust
21	policy in the price arena. We have obviously seen that
22	in a number of Supreme Court cases in the predatory
23	pricing area, where the Supreme Court said that cutting
24	prices to increase business is the very essence of
25	competition.

56

1	Although this policy has its underpinnings in
2	the predatory pricing area, at least from a narrow legal
3	perspective, it is important to note that the Supreme
4	Court has made it clear that this policy has a broader
5	applicability.
6	This point was made in the Arco versus USA
7	Petroleum case which involved, as you all know, maximum
8	RPM, where the court said in the context of pricing
9	practices, only predatory pricing has the requisite
10	anticompetitive effect.
11	The reason for that it said was that low prices
12	benefit consumers regardless of how those prices are
13	set, and so long as they are above predatory levels,
14	they do not threaten competition.
15	We have adhered to this principle regardless of
16	the type of antitrust claim involved.
17	So at least from the legal perspective, we have
18	to start from the standpoint that discounting practices,
19	regardless of their form, can only violate the law when
20	they result in some form of predatory pricing.
21	Obviously there are economic models that attempt
22	to show how various discounting practices can harm
23	consumers, sometimes even when price exceeds cost.
24	But the courts have stubbornly clung to this
25	bright-line standard. And the reason for that is that

57

1	courts have been loathe to sacrifice the immediate
2	benefits of a price cut for the much more speculative
3	possibility that some future harm to competition might
4	be avoided if we curb the ability of firms to discount,
5	at least in the absence of more tractable and, more
6	importantly, more general economic models that can
7	predict harm.
8	Essentially what the courts have said, we like
9	the bird in the hand, the immediate price cut, much more
10	than the birds in the bush, which is the possibility
11	that at some point down the line we may have a more
12	competitive market and lower prices.
13	This obviously embodies assumptions about the
14	efficiency of progressive price cutting and about the
15	cost of false positives.
16	Regarding efficiencies, the courts are assuming
17	that price cuts that remain above cost enhanced both
18	consumer and total welfare. And with regard to the cost
19	of false positives, what the courts are saying is we are
20	worried very much about inhibiting price cutting that we
21	view is the essence of competition.
22	There are clearly several worries that the
23	court's fixation with false positives has made them
24	insensitive to the possibility of false negatives.
25	The basic critique is that anticompetitive

58

1	pricing conduct involving mixed bundling, involving
2	loyalty, is likely to be more pervasive and more
3	permanent than predatory pricing, so that the risk of
4	underdeterrents is greater than in the predatory pricing
5	area where this policy has its roots.
6	The reason for this, and I think we have heard
7	some of it today, is that while predatory pricing often
8	requires a large profit sacrifice, uncertain possibility
9	of recoupment, which leads to the predation approach not
10	being tried very often, anticompetitive bundling or
11	loyalty rebates could -- and I want to underscore
12	"could" -- entail in profit sacrifice or alternatively
13	enable instant recoupment.
14	For that reason they are more likely to occur.
15	For that reason, they are also more likely to be
16	durable, which is to say it can go on for a long time.
17	To me, the absence of a profit sacrifice would
18	also suggest, at least in the realm of pricing and what
19	we are talking about here is pricing -- not talking
20	about blowing up a competitor's factory or lying to a
21	standard-setting body -- is that an equally efficient
22	competitor would be able to match the discounts as a
23	general proposition.
24	We have heard about some exceptions and that to
25	the extent that the rivals are excluded, they are being

59

1	excluded on the basis of superior efficiency.
2	In addition, I think we have to take into
3	account the pervasiveness of bundling, the pervasiveness
4	of discounts that have a retroactive feature, which is
5	to say you hit a threshold and the discount applies to
6	it for marginal units.
7	Volume discounts are fundamentally structured
8	that way. Buy a hundred units and you get 10 percent
9	off is a fairly common form of doing business.
10	The pervasiveness of these types of practices
11	throughout the economy, the prevalence of their use by
12	firms that don't have market power and have no hope of
13	excluding competitors would suggest or at least caution
14	that there is a good possibility that the efficiency
15	explanation for these practices is the dominant one.
16	Now, there are models that show that equally
17	efficient competitors can be excluded even without a
18	sacrifice of profits.
19	But I think the issue with these models is that
20	they don't necessarily show consumer welfare being
21	reduced by the discount. In fact, I think some of the
22	models depend on consumer welfare being enhanced. I
23	guess we are really in the dark about this area of the
24	law.
25	Some of these models depend on consumers

60

1	actually being better off with the bundled price
2	offered. What we see is that both producer surplus and
3	consumer welfare is better off.
4	So what this shows is that there are
5	circumstances in which bundled pricing can harm
6	competitors, even efficient competitors, but they don't
7	necessarily harm consumer welfare.
8	Another question is whether these models at this
9	point are sufficiently general to support changing the
10	current legal regime.
11	Professor Hovenkamp argues that they are not,
12	that they cannot support a legal standard. What he says
13	is that the economic modeling showing that certain
14	discounts can be anticompetitive tend to be highly
15	complex, often making unrealistic assumptions.
16	The result is proposed legal standards that make
17	impossible informational demands on the courts.
18	A more benign way of looking at this is the
19	early models that have questioned the conventional
20	thinking and basically challenged the Chicago view have
21	worked with stylized assumptions to knock down at least
22	the universality of the received wisdom and more work
23	needs to be done before we know whether the results can
24	be generalized enough to support a rule of law, whether
25	basically what we have are some interesting footnotes

61

1	that show that the current legal regime can lead to
2	false negatives under some severe assumptions.
3	To base a rule of law on the economic models, we
4	have to have general models on which we can base clear,
5	predictable and administrable rules. Models that show
6	that anticompetitive results could happen are not good
7	enough to prescribe rules of law.
8	What we need are models that identify the
9	particular circumstances in which aggressive pricing is
10	likely to be anticompetitive and do so in a way that can
11	be reliably administered within the constraints of legal
12	factfinding.
13	The challenge is to have rules that capture the
14	circumstances in which discounts harm competition, rules
15	that do not discourage price cutting and do not serve as
16	an instrument for strategic behavior by rivals to attack
17	discounting by more efficient competitors, rules that
18	offer sufficient guidance to business executives to
19	enable them to respond and can be administered within
20	the constraints of legality.
21	We need rules that are general, sufficiently
22	general to have application beyond a narrow range of
23	stylized assumptions, do not lead to incidents of false
24	positives, are capable of application by business
25	executives, capable of implementation with the types of

62

1	evidence that are available to us in the litigation
2	setting rather than some idealized laboratory setting.
3	The virtue of the cost-based test as a starting
4	point or as an initial screen for analyzing pricing
5	practices -- and that would include bundling and include
6	loyalty discounts -- is that it does all of the above.
7	It is highly general in distinguishing between
8	discounting to reflect a seller's superior efficiency in
9	price cutting that has the potential to drive out an
10	equally efficient competitor.
11	It avoids false positives by limiting liability
12	to cases in which it is economically rational to incur a
13	profit sacrifice in the hope of subsequent recoupment,
14	following exclusion of a rival from a market.
15	It also sets a very understandable guideline for
16	business executives, what they need to understand is
17	their own cost, the cost of producing the goods that
18	they make. They don't need to understand what the cost
19	of their rivals are. They don't need to have a more
20	detailed understanding regarding the consequences of
21	their business conduct on market performance.
22	The test is administrable, because determining
23	average variable cost, which has been the measure of
24	costs used by the courts in most cases, which almost
25	always is going to be a good proxy for avoidable cost,

63

1	presents a relatively tractable problem, even though it
2	is a fairly complicated one, as anyone who has been
3	involved in any kind of cost analysis will tell you. It
4	leads to predictable results.
5	One cannot overemphasize the importance of
6	generality, predictability and consistency. Unclear or
7	open-ended rules can have some serious negative effects
8	because in and of themselves they can deter firms from
9	engaging in discounting.
10	In fact, predictability is the reason why the
11	predatory pricing test is a test that's grounded in a
12	price-cost comparison rather than being a true profit
13	sacrifice test.
14	A true profit sacrifice test would condemn
15	failing to maximize short-term profits. It would
16	condemn failing to recover the opportunity cost
17	associated with particular pricing behavior. And the
18	reason we don't do that is that a rule like that would
19	make pricing decisions by firms with large market shares
20	basically a roll of the dice.
21	So we have a clear rule that omits, I think,
22	false negatives but one that is administrable and
23	enables firms to base pricing decisions on an objective
24	measure that is easy to follow.
25	Now, what does all this mean in the context of

64

1	the practices that we are talking about here? What
2	would a plaintiff have to show in challenging a
3	multiproduct discounting?
4	The first thing a plaintiff has to show is it
5	cannot offer the multiproduct bundle either on its own
6	or in cooperation with other firms. If the plaintiff
7	can match the entire bundle alone or cooperatively, the
8	bundle is incapable of excluding, at least by virtue of
9	being a bundle, other than on the basis of superior
10	efficiency.
11	It can obviously ask whether the price of the
12	entire bundle exceeds the cost of the entire bundle.
13	But the bundling doesn't give the bundling firm a lever
14	over its rival because we don't have the asymmetry of
15	the ability of the rival to match a component of the
16	bundle.
17	To the extent that an equally efficient
18	competitor cannot match an offer because consumers are
19	better off with a bundle than from a la carte purchases,
20	any exclusion that might occur, and we have heard that
21	it might occur based on perhaps differentiated demand
22	for the products included in the bundle, may show harm
23	to a competitor, but they would not show harm to
24	consumers.
25	The same principle I think would apply, as

65

1	Professor Hovenkamp has argued, to single-product
2	discounts if the price charged by the defendant is above
3	cost.
4	That should be the end of the story. If the
5	plaintiffs can show that it can't match the bundle
6	either alone or cooperatively, then I think the Ortho
7	test is probably today the best means that we have for
8	identifying whether harm to competition may occur, if
9	allocating the discount to the competitive product
10	yields an above-cost price that is no more exclusionary
11	than having the bundling firm price the competitive
12	product on that stand-alone basis.
13	If the bundling firm flunks that test, then we
14	need to look at a couple of other things. One is has
15	the price been extended to a sufficient share of the
16	market to result in exclusion, because unlike the
17	classic predatory pricing situation, where the predatory
18	price is extended across the entire market and every
19	unit is sold below cost, mixed bundling discounts may be
20	extended on a selective basis.
21	Critics of bundling cite this as evidence that
22	the strategy is less costly than predatory pricing. By
23	the same token, it also tells us the strategy is less
24	likely to exclude.
25	It is also tempting for plaintiffs to focus on

66

1	what happens at the margin, at some point which is near
2	the threshold that triggers the discount.
3	To use an example from the Concord Boat case, in
4	that case a defendant offered a graduated discount. The
5	first level was 1 percent if a consumer bought 60
6	percent of its requirements from Brunswick.
7	Now, obviously, if you look at this from the
8	standpoint of a hypothetical consumer who otherwise
9	would buy 59 percent of its requirements from Brunswick,
10	then you could say the last 1 percent is being given
11	away for free and that is surely below cost. And that
12	observation is as irrelevant as it is true.
13	To compete for just 10 percent of a buyer's
14	requirement, an equally efficient competitor would have
15	only had to extend a 6 percent discount to match the
16	Brunswick offer in that case. And obviously an equally
17	efficient competitor can match the offer to compete for
18	the entire amount of the business, in which case its
19	discount doesn't need to be any larger than the
20	Brunswick discount.
21	It has to match the discount dollar for dollar,
22	which is a 1 percent discount.
23	I think it is also important to take the
24	duration of arrangements into account. Supporters of an
25	interventionist approach assume that bundling loyalty

67

1	discounts can go on forever because of the absence of a
2	profit sacrifice.
3	In a litigation setting, this is an empirical
4	question. We know in the exclusive dealing arena, the
5	law presumes that arrangements of a year or less are
6	presumptively legal.
7	Where we are talking about an arrangement that
8	does not require exclusivity but simply offers an
9	economic incentive to buy more from the seller, the same
10	presumption should be applicable here.
11	Finally, I would say the plaintiff has to show
12	real rather than conjectured harm. This means exclusion
13	of the plaintiff that results in harm to consumers. We
14	have seen in too many cases -- Ortho being one of them,
15	but there are many others -- the spectacle of a
16	plaintiff that is actually doing well in the
17	marketplace, claiming that a rival's pricing practices
18	are making it hard for it to compete, that it would have
19	done better.
20	"I would have done better" shouldn't be the
21	basis for a monopolization. The basis for a
22	monopolization case ought to be exclusion.
23	Again, there are models that attempt to rebut
24	the Chicago thesis. Maybe down the road they would call
25	for a reevaluation of the law, but I think at this point

68

1	they are too ambiguous in terms of impact on consumer
2	welfare and too limited in their assumptions to support
3	a change in the legal regime.
4	Thank you.
5	(Applause.)
6	MR. DEGRABA: We are at the break portion of our
7	morning festivities. It looks like we should get back
8	here in about 10 minutes.
9	We will reconvene. It is 11:00 now. So 11:10.
10	(Recess.)
11	MR. DEGRABA: Welcome back. We will continue
12	for about 50 more minutes.
13	This is the sort of the moderated discussion
14	part of our day, where we will present a number of
15	propositions up here on the slides.
16	These propositions are not meant to represent
17	necessarily the views of the Commission. They are
18	simply statements made to generate some discussion.
19	But before we move to the propositions, I want
20	to go through each of the presenters and ask if any of
21	the presenters want to respond to anything any of the
22	other presenters said.
23	So we will start in the same order that we did.
24	So we will ask Barry. Is there anything you
25	want to say in response to something someone else said?

69

1	PROFESSOR NALEBUFF: I guess I was a little
2	disappointed in the lack of response in terms of the
3	presentation we had from Mr. Kattan in the sense of I
4	think it is manifestly the case that bundled discounts
5	do not mean lower prices, and that's actually a
6	distinguishing feature of them.
7	The example I gave you, historical prices that
8	had always been charged for these goods that you saw
9	sort of 1, 2 and 3, suddenly the firm says if you don't
10	buy all of my goods, now this competitor, I will raise
11	them substantially.
12	In fact, the evidence would suggest that I'm
13	going to raise them above what would be the monopoly
14	level.
15	It is really a case of if you don't give me your
16	wallet, I'm going to shoot you. To say that is now good
17	for the consumers because they have the absence of being
18	shot and calling that a discount strikes me as just a
19	perversion of what's really going on here.
20	The fact is that when you do predatory pricing,
21	you actually buy the stuff cheaply. But when you see a
22	bundle, quote, "discount," it is not required that the
23	customer actually was ever paying that high price. It
24	is only that they weren't being threatened to be charged
25	that high price.

70

1	That is a fundamental distinction which has to
2	be recognized, and it is one of the reasons why we want
3	to treat these things differently.
4	It is also, of course, central to David Sibley's
5	perspective of when we see the price being raised for
6	the single product by the absence of the bundle, that
7	really should set off alarm bells.
8	In terms of Tom's presentation, just one thing
9	to observe is there are times when the purpose of the
10	exclusion is not to raise the price in the B market.
11	And in particular, there are cases I have seen
12	where firms would never be able to raise the price of B,
13	would always be competitive, but nonetheless, equally or
14	more efficient B firms were excluded because that was
15	going to be the platform for them to come into the A
16	market and, therefore, attack monopoly, because it would
17	be establishing sales force, establishing manufacturing
18	in that territory.
19	So one has to look not just at the potential of
20	the B market to be monopolized but what is the purpose
21	of the exclusion here.
22	MR. DEGRABA: I will give Joe a chance to
23	respond to the statement that bundled discounts don't
24	always mean lower prices.
25	Joe, do you want to respond to that at all?

71

1	MR. KATTAN: It is certainly an empirical
2	proposition that can be tested, whether bundled prices
3	or unbundled prices represent an increase in the price
4	vis-a-vis the price levels that prevail in the absence
5	of the bundle.
6	I have not seen evidence suggesting that that's
7	the pervasive way in which we encounter bundled
8	discounts.
9	Now, is it theoretically possible to set up a
10	construct that says here is what a seller can do, it can
11	jack up the prices on an unbundled basis and offer a
12	discount that simply takes you back to where you would
13	have been in the absence of the bundle.
14	Yes, that is obviously arithmetically plausible.
15	But the question is how common is that empirically and
16	whether that is something that in the context of
17	litigation also lends itself to the kind of proof that
18	we have in the litigation setting, particularly when you
19	have changes in quality, performance, product attributes
20	that may take place over the same period of time.
21	MR. DEGRABA: Thank you.
22	And Tom Lambert, do you want to respond to the
23	exclusion doesn't always mean an increase in the price
24	in the B market?
25	PROFESSOR LAMBERT: Sure. May I bundle my

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1	response?
2	MR. DEGRABA: Is somebody controlling the volume
3	on this thing? Let's continue.
4	PROFESSOR LAMBERT: I will bundle my response to
5	Barry, along with my comments.
6	Joe began by quoting the Barry Wright case, and
7	I believe that that is absolutely spot on in this
8	context. So I will quote a bit from that.
9	Then Judge Breyer writes, "Unlike economics
10	laws, an administrative system, the effects of which
11	depend on the content of rules and precedents only as
12	they are applied by judges and juries in courts and by
13	lawyers advising their clients."
14	And here is the key part. "Rules that seek to
15	embody every economic complexity and qualification may
16	well, through the vagaries of administration, prove
17	counterproductive, undercutting the very economic ends
18	they seek to serve."
19	So my response to Barry's two points, one is the
20	point that he makes in response to Joe, that you could
21	have these phony discounts where you have jacked up the
22	price and then said "hey, we are giving you a discount,"
23	and he seems to think those are very pervasive, it seems
24	to me that most of the bundled discounts I see are not
25	like that at all.

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1	McDonald's, go to McDonald's.
2	PROFESSOR NALEBUFF: They are not the ones the
3	antitrust cases are about.
4	PROFESSOR LAMBERT: Correct, but they are the
5	ones that are affected if we adopt a rule of law that is
6	designed to deal with .0001 percent of bundling cases.
7	That to me is troubling and it's exactly what Judge
8	Breyer is talking about in Barry White.
9	Sometimes we have to sacrifice the last 1
10	percent to protect the 99 percent.
11	It also seems to me that we could deal with
12	those cases by -- the legal rule I propose presumes the
13	legality of above-cost bundled discounts.
14	It seems to me that it would be possible -- and
15	I think Joe mentioned this in his talk -- to identify a
16	phony discount. If you see a price jack and then a
17	discount, well, that's not really a discount.
18	So we could withhold the presumption of legality
19	for that type of bundled discount.
20	And then I guess I would make the same point
21	with respect to Barry's argument that sometimes bundling
22	is done not to charge supercompetitive prices in the B
23	market, foreclose competitors and get monopoly power in
24	that market but instead to monopolize the A market.
25	That very well may be the case, and this is

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1	incredibly casual empiricism, but my guess is that
2	doesn't happen enough to justify writing a law, a rule
3	that is so complex that it chills the procompetitive
4	bundled discounting.
5	I am very much motivated by this idea that we
6	have to make these theories workable as laws,
7	understandable, administrable by juries and judges and
8	useful to counselors who are advising their clients.
9	MR. DEGRABA: Thank you.
10	David, do you have any comments on anybody's
11	presentations?
12	PROFESSOR SIBLEY: Yes. This is more in the
13	nature of something I meant to say but forgot rather
14	than a comment.
15	One thing that motivated some of the original
16	work that Greenlee and Wrightman and I did on bundled
17	discounts was try to figure out as nonlawyers what
18	branch of antitrust law was it appropriate to use in
19	analyzing these.
20	We concluded predatory pricing wasn't the right
21	branch. For a while we thought that tying was. The
22	reason for that is if the B market is perfectly
23	competitive and the A market is a monopoly, the only
24	function of the bundle discounts is to set an
25	out-of-bundled price of the monopoly product so high

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1	that consumers are faced with a choice of buying at high
2	bundled prices or buying the competitive product and
3	buying none of the monopoly product at all.
4	That is really equivalent to a tie.
5	The version of the model which involved two
6	firms offering differentiated products tells us that no,
7	there is lots more going on with bundled discounts than
8	simply being equivalent to a tie.
9	The out-of-bundled price on my third slide
10	wasn't in place simply to force people to face the
11	option of buying the B market at a competitive price but
12	no A or buy the bundle at outrageous prices.
13	It actually played a price discrimination role
14	and people buy at that price. That suggests to me that
15	if there is a general legal theory of bundled discounts
16	to be had, it is not predatory pricing and it is not
17	always going to be the same as tying either.
18	It is going to be something else, and I don't
19	know what it is.
20	I would like to comment on something that both
21	Joe and Tom said about sort of requirements that the
22	plaintiff would have to meet in a bundled discount case
23	in order to prevail.
24	One of them was that the plaintiff would need to
25	show that it is impossible, either alone or with someone

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1	else, to assemble a bundle that would match the bundle
2	being offered by the defendant in such a case. I think
3	that rule has a lot of appeal to it.
4	There is one big caveat. Of the many things we
5	have learned about bundled pricing from Barry, one of
6	them is that the more symmetrical firms are, the more
7	you would expect head-to-head competition to be very
8	severe.
9	If in fact a firm were able to match the items
10	in another firm's bundle, the result of that might
11	simply be low-profit dog-eat-dog competition bundle
12	versus bundle.
13	Knowing that to be the likely result, the firm
14	might not incur the cost of assembling that bundle in
15	the first place.
16	So it could well be that you could ask a
17	plaintiff why haven't you assembled a counterpart to the
18	defendant's bundle, and it seems perfectly possible, and
19	the plaintiff would say yes, it is perfectly possible,
20	it is just it would be unprofitable for me to do it
21	because all I'm doing then is bundling myself into a
22	price war and it is not worth the cost of doing it.
23	So I have a choice, either get into a price war
24	which isn't going to make any money or stay where I am
25	now and be excluded.

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1	Although I think it is an appealing rule, you
2	could probably anticipate a come-back like that.
3	I do want to quibble some with the notion that
4	the existing models are simply too complicated or too
5	data intensive to say anything useful. Before I do, let
6	me make it clear I'm sure there are fact situations in
7	which that charge would be true.
8	But the test that Barry has advocated which is
9	sort of the refinement of the Ortho test, I don't think
10	it is any more complicated to implement that test to do
11	a lot of things that we do in antitrust cases.
12	I don't view that as having any incremental
13	complication or data requirements over and above things
14	we engage in any way.
15	Secondly, if you have a situation that is
16	analogous to what Greenlee and Wrightman and I looked
17	at, where there is a before and an after independent
18	pricing of model discount, really a test for consumer
19	welfare would simply be to say are the out-of-bundle
20	options that consumers face after the bundle discounts
21	are put into effect better or worse or the same as prior
22	to the bundling.
23	If the out-of-bundled price for A is no higher
24	than the previous price of A and if prices in the B
25	market are either the same are have gone down, then we

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1	can infer that whether people take the bundle or not,
2	they can't be worse off and they are probably better off
3	than they were before.
4	That is not a complicated test. It does involve
5	some work, sure. It is a lot less complicated than a
6	number of things I have had to do in antitrust cases.
7	MR. DEGRABA: Thank you, Dave.
8	Joe, do you have any comments on anything that
9	was said here?
10	MR. KATTAN: Certainly.
11	I am wondering whether the second model that
12	David talked about is one that has antitrust
13	significance.
14	It certainly shows that a firm that's facing
15	differentiated demand in the second product market can
16	raise its profits by bundling not necessarily for the
17	purpose of excluding the second firm but simply in order
18	to extract more surplus.
19	But that usually does not fit within the
20	paradigm of antitrust cases. It is simply charging a
21	higher price of its consumers.
22	PROFESSOR SIBLEY: I would agree that if there
23	is no foreclosure effect, I probably wouldn't worry
24	about it.
25	Some of the -- the model does suggest there can

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1	very well be, that the institution of bundling by Firm 1
2	puts the other firm in a situation where it has to
3	charge lower prices than it has before, and this can
4	make it viable.
5	MR. DEGRABA: Thank you.
6	We now move on to the propositions. Can I have
7	slide 2 up there, please.
8	We have assembled a set of propositions that we
9	will read and ask anyone who would like to comment on
10	them to comment. Some of them have actually been
11	covered at least in some part in some of the talks, but
12	we will go through these anyway.
13	The first proposition is single-product
14	discounts should be per se lawful if the overall price
15	for all units exceeds cost.
16	Is there anyone that disagrees with that
17	proposition?
18	PROFESSOR NALEBUFF: And, again, if it turns out
19	that somebody could replace another firm 100 percent,
20	sure, no problem.
21	But the Concord Boat case is a great one where
22	in fact there is evidence that they had a monopoly for
23	some share of the market based on installed base.
24	So it wasn't realistic. Maybe you could get 20
25	percent or maybe 50 percent of the market, but you

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1	weren't going to get 100.
2	The chart that I showed you was also from other
3	cases like that. Do we think that rivals should always
4	have to do 100 percent replacement? That's a pretty
5	strong test for a firm that's not yet proven itself.
6	It may well be that incumbent buyers want to
7	only take 10 percent chance, 10 percent of their supply
8	before they decide to go whole hog in this.
9	So you have to ask do these discounts that go
10	back to volume 1 really provide an opportunity for
11	somebody to come in at a reasonable scale or not. If
12	the answer is no, then I think we have a problem.
13	MR. DEGRABA: Anyone else?
14	PROFESSOR SIBLEY: Let me comment on what Barry
15	said.
16	Barry, if the proposition were rephrased in the
17	following way, would you have a problem with it?
18	Single-product discounts are lawful if sellers, each
19	seller in the market can serve 100 percent of each
20	buyer's needs. In other words, each seller can bid for
21	all of each consumer's business. Then there shouldn't
22	be a problem, should there?
23	PROFESSOR NALEBUFF: They may have the capacity
24	to do it. It turns out it may well be the buyers are
25	unwilling to have a sole source, or they may be

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1	unwilling -- the incumbent supplier might have a
2	monopoly over 40 percent, in which case the fact that I
3	could supply 100 percent and undercut them isn't really
4	relevant.
5	MR. DEGRABA: David, would your proposition be a
6	problem if there was a significant amount of product
7	differentiation amongst the competitors so that a
8	particular consumer may not be willing to switch 100
9	percent out of supplier A into supplier B?
10	PROFESSOR SIBLEY: Yes, I might have a problem
11	then because the buyer then is faced with competition
12	really only for all his business and the buyer might not
13	want that. Knowing that, one firm might end up with a
14	lot of that buyer's business, charging a higher price.
15	Really I guess it is only if everything inside
16	is as homogeneous as you would like and sellers are all
17	perfectly positioned to serve each buyer and there is
18	none of the stuff Barry was talking about, then it
19	should be okay without further ado.
20	MR. MEYER: Is there some increment of the
21	volume where it would be relevant to you that the price
22	is above cost?
23	In other words, if there is an installed base,
24	if you leave that out of it and ask about the
25	contestable units, would it be relevant if as to those

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1	units the price is above cost overall?
2	PROFESSOR NALEBUFF: You have to ask is there
3	some normal, sensible way that a firm could come into
4	this.
5	If you can say the picture I first showed you, a
6	firm could only come in for below 5 percent of the
7	market in some sensible way, in some area between 30
8	percent and 50 percent.
9	That didn't strike me as a normal thing. The
10	other point is what's wrong with having significant
11	discounts on incremental units rather than going back to
12	01? You could achieve very similar objectives. We are
13	not stopping firms from cutting prices.
14	So I think in general, firms aren't going to
15	offer negative prices under that scheme, but they may
16	offer low prices over longer ranges. That strikes me as
17	pro consumer. Since I have another way of achieving
18	price discounting that doesn't have that exclusionary
19	effect, why not use it?
20	MR. KATTAN: I think the same logic would apply
21	to simple volume discounts, say if you buy 100 units, I
22	will give you 5 percent off. That has exactly the same
23	effect as something that may be more individually
24	tailored.
25	If you look at Concord Boat, you can see that

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1	the rivals there didn't have to compete for very much
2	business in order to -- unless you assume that 6 percent
3	discount would have forced them to be below cost. They
4	wouldn't have to compete for very much business to be
5	able to recover their cost and compete against the
6	discount.
7	I think the other issue is how do you determine
8	which is the inframarginal business that you are going
9	to say this is not contestable, it is sacrosanct, it
10	belongs to the monopolist and they are really competing
11	only the following units which are incremental units to
12	which we would allocate the costs. I think that gets to
13	be incredibly complicated because in most cases it is
14	not going to be clear what is inframarginal and what's
15	marginal.
16	PROFESSOR NALEBUFF: The solution is to ask for
17	an equally efficient firm, the monopolist itself, what
18	units could it compete for. You can see what range it
19	is.
20	If it turns out the discount is small enough, as
21	it may have been in Concord Boat, so that a large range
22	of entry is possible, I'm not worried about it. It is
23	an empirical question.
24	You can say 1 percent doesn't work, 5 percent
25	does, up to 30 percent does, but you can't go beyond

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1	that. Okay. So show what the range is based on what
2	these discounts create.
3	PROFESSOR SIBLEY: Let me point out, really
4	supportive of Barry's feeling, that this really isn't
5	all that undoable. There has been a fairly recent -- I
6	know that antitrust or patent was used, but in a case I
7	was involved in in which we had discounts like this.
8	You can calculate which units have negative
9	prices associated with them and what level of entry you
10	would need to achieve if you were a new entrant and
11	wanted to cover costs. The prices do look bizarre, just
12	like Barry's picture, but it is really not that hard.
13	PROFESSOR LAMBERT: Can you do it ex ante if you
14	are the business planning to give a loyalty discount?
15	PROFESSOR SIBLEY: Ex ante, the picture is
16	actually somewhat easier. Right? It is one thing to
17	think about an incumbent being there and there are a lot
18	of reasons why incumbents are hard to unseat. Perhaps
19	you are dealing with a loyalty discount scheme, which
20	makes it tougher.
21	Ex ante, we could all be competing with loyalty
22	discount schemes.
23	PROFESSOR NALEBUFF: If you can't do it ex ante,
24	because it is so damn hard. If you as a seller can't
25	figure out what it is, the buyer will probably have

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1	trouble, the rival would have trouble.
2	I would hope that a firm who is setting a price
3	could actually figure out what its profits are at
4	different levels.
5	MR. KATTAN: I think the reason the firm
6	offering the discount can't do it ex ante is it doesn't
7	know the scale at which the entrant is able to enter,
8	which is something known to the entrant, the firm
9	offering the discount.
10	I think part of what we need to do here is to
11	make sure that the test that we apply is one that is
12	based on information which is available to the firm
13	that's offering the discount and doesn't depend on
14	things that are outside of ability to know or control.
15	MR. DEGRABA: Thank you. We will move on to the
16	next slide, slide number 3.
17	We have heard about this a little bit. The
18	LePage's decision's vagueness is likely to chill pricing
19	behavior that enhances consumer welfare.
20	I will ask sort of a two-part question, one to
21	the lawyers and one to the economists.
22	The one I want to ask the lawyers is so what
23	counsel are you giving to your clients, if at all, if
24	you have run into this problem or what other counsel
25	have you heard other attorneys giving to their clients?

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1	For the economists, have there been any other
2	empirical studies or any other data in the market that
3	might suggest there's a problem? Anyone?
4	PROFESSOR LAMBERT: I'll start.
5	I think the answer -- the proposition is
6	correct. And if you want empirical evidence, it is not
7	very rigorous, but go to Google and enter "client alert
8	LePage's," and you will end up with pages of client
9	alerts from law firms saying "warning, this practice is
10	potentially troubling, be very, very careful," blah,
11	blah, blah.
12	It is likely, I believe, that that means there
13	is a chilling effect.
14	In terms of counsel to clients, I would say give
15	bundled discounts at your own risk, be very, very
16	careful before you do it, and you might want to think
17	about whether your rivals could compete with those
18	discounts, even if your discounted price is above your
19	cost.
20	Another piece of advice that I would give is
21	something that Barry mentioned, I think -- maybe not --
22	and this is based on the Johnson & Johnson versus
23	Applied Medical case.
24	PROFESSOR NALEBUFF: I mentioned it.
25	PROFESSOR LAMBERT: I knew you did but I wasn't

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1	sure if it was in private conversation.
2	In the Johnson & Johnson versus Applied Medical
3	case, Johnson & Johnson was giving bundled discounts
4	primarily to compete against an equally diversified
5	rival, U.S. Surgical, a small, less diversified rival,
6	Applied Medical, and several others who couldn't compete
7	because they didn't sell the full product line.
8	And after receiving complaints, Johnson &
9	Johnson responded by carving out the purchases of those
10	smaller rivals. And nonetheless, Johnson & Johnson got
11	sued by Applied Medical even after this act of
12	generosity.
13	The judge granted summary judgment in favor of
14	Johnson & Johnson on the basis of those carve-out
15	purchases. So this does seem to be a way that a company
16	can protect itself.
17	MR. KATTAN: I certainly agree that the
18	vagueness of LePage's is problematic.
19	I think one of the things that is not clear from
20	LePage's -- and when I have talked to people who have
21	been associated with the case, I have gotten different
22	answers on this -- is whether 3M simply showed that the
23	price of the total bundle exceeded cost or whether it
24	actually passed the Ortho test.
25	People who have studied the record tell me that

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1	they don't think that 3M passed the Ortho test. That
2	still creates a problem for us because the burden of
3	proof normally would be allocated to the plaintiff to
4	show that the Ortho test wasn't met.
5	But to the extent that this is a case where the
6	discounts allocated to the competitive products resulted
7	in a below-cost price, it may be less exceptional than
8	we think it is and we just need to wait and see how the
9	law develops in this area.
10	MR. DEGRABA: Joe, could you articulate what the
11	Ortho test is for anybody in the audience who doesn't
12	know.
13	MR. KATTAN: It says that we will allocate the
14	discount in a multiproduct bundle discount to the
15	competitive product.
16	So the example would have been the shampoo and
17	conditioner example that I think Tom used in his
18	presentation.
19	In this case, the question was whether
20	allocating the discount to the generic transparent tape
21	would have resulted in an above-cost or below-cost
22	price. I gather that the record is silent on that
23	issue.
24	So it may be simply -- what the case may come
25	down to, then, is really who bears the burden of proof

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1	in showing whether the Ortho test has been satisfied as
2	opposed to some of the broader readings that have been
3	given to the case as basically setting a formless and
4	vacuous test for exclusion and a Section 29 test.
5	MR. DEGRABA: Thank you.
6	You want to say something, David?
7	PROFESSOR SIBLEY: I don't know whether LePage's
8	has had a chilling effect or not because to answer that
9	question, I would have to know all the firms that have
10	thought about doing loyalty or bundled discounts but
11	have chosen not to.
12	I will simply observe that there are antitrust
13	cases going on now or recently concluded which, if you
14	believe the plaintiffs in those cases, involve firms
15	that have been engaging in bundled discounts in time
16	periods subsequent to LePage's.
17	It may have chilled such activities in some
18	senses, but it certainly hasn't stopped them.
19	MR. DEGRABA: We will move on to the next slide,
20	please.
21	PROFESSOR NALEBUFF: One more comment.
22	One should also take the perspective that the
23	vast majority of bundled discounts that we see out
24	there, whether it be the Happy Meal at McDonald's and
25	the like, wouldn't come close to the test we are

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1	describing here in terms of leading to incremental
2	products being below cost.
3	Those in my view are just red herrings in terms
4	of thinking about the type of bundled prices that you
5	would see. They are not affected by LePage's and they
6	are just not relevant for any discussions we have here.
7	MR. DEGRABA: Okay. Our next proposition is a
8	bundled rebate or discount can exclude an equally
9	efficient single-product competitor, even if the
10	postdiscount price of the bundle as a whole is above
11	cost.
12	We have talked about that at some length here.
13	There is actually kind of two off-shoot questions I want
14	to talk about.
15	The first is what happens if we instead of
16	looking at existing competitors in the market, what if
17	we were to also consider entry deterrents. How would
18	entry deterrents be considered in this proposition?
19	PROFESSOR NALEBUFF: I have written on that. In
20	the paper in the quarterly Journal of Economics, the
21	challenge is that same rebate gets to be used in
22	multiple dimensions, and, therefore, it makes it less
23	profitable for somebody to come in.
24	It is also rational that a firm would want to do
25	that rebate and do that bundling in the face of

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1	competition.
2	It is also the case that it limits the potential
3	market of a rival to consumers who like that entrant's
4	product and don't like the A product and therefore can
5	shrink the potential market available to an entrant.
6	Bundling is one of the most effective tools to
7	prevent entry that we know, I think.
8	PROFESSOR SIBLEY: Let me follow along with what
9	Barry is saying.
10	In the last line of my talk, when I had the two
11	firms offering differentiated product, it is not only
12	the case that it is possible to exclude an equally
13	efficient B competitor in that set-up where the overall
14	price of the bundle exceeds the cost of the bundle.
15	In fact, the individual prices would all be
16	higher than costs as well. In no sense are you pricing
17	below cost, and, yet, you can exclude an equally
18	efficient competitor.
19	MR. KATTAN: I think the question is whether in
20	these models that show that an equally efficient
21	competitor can be excluded, consumers are better off or
22	worse off.
23	At least as I read the exclusionary bundling
24	paper by Professor Nalebuff, in one of the examples he
25	gave with the A and B products with one of his

92

1	propositions today actually showed that both consumer
2	welfare and producer surplus go up.
3	So total welfare goes up, consumer welfare goes
4	up, and yet an equally efficient competitor gets
5	excluded.
6	And the question is do we want an antitrust
7	policy that says that we are going to punish firms for
8	conduct that actually raises consumer welfare.
9	PROFESSOR SIBLEY: I think we are not to
10	punish firms for conduct that raises consumer welfare.
11	The sort of policies at least the economists at
12	the table have been talking about are not policies which
13	are finely designed enough so they attempt to root out
14	consumer welfare reducing activities, consumer welfare
15	increasing activities, but simply to construct safe
16	harbors. That is, if the following is true, then
17	consumers are not harmed.
18	It does not mean that if the following is not
19	true, they are benefitted necessarily or are harmed.
20	But at least the safe harbor test we have been
21	talking about I think are on sound ground there.
22	By the way, you asked earlier about examples of
23	what Barry was talking about in terms of bundled
24	discounts just involving sort of fictitious discounts.
25	Barry went through a pharmaceutical example.

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1	Who are the firms in that one, the Keflin and the rest
2	of it?
3	PROFESSOR NALEBUFF: That was SmithKline and
4	Lily.
5	PROFESSOR SIBLEY: That's a case where the
6	discount was in some sense fictitious.
7	What the defendant did there was to raise the
8	out of bundled price 3 percent and give them a 3 percent
9	discount on the bundle. That was pretty close to what
10	you have heard us talking about.
11	MR. KATTAN: My recollection is that that case
12	could be addressed by application of the Ortho test.
13	PROFESSOR SIBLEY: It was addressed by the
14	application of the Ortho test. The point is simply it
15	isn't just a figment of economists' imagination that
16	these things could happen. They did in that case.
17	MR. KATTAN: What you are citing is a 25-year
18	old case. If that's the only example we can come up
19	with in 25 years, I'm not persuaded that it is
20	pervasive.
21	The question is, do we need a test that is more
22	stringent than the Ortho test, or is the Ortho test
23	adequate to address the kind of concerns that have been
24	articulated through these models?
25	PROFESSOR SIBLEY: It depends on what your

94

1	concerns are. The Ortho test is a test designed to see
2	whether a single-line firm can undercut a bundle.
3	You can say if you want to call that a test of
4	anticompetitiveness, that's what it does. It gives a
5	sort of safe harbor.
6	The sorts of things that Greenlee Wrightman and
7	I talk about were not tests for that, does consumer
8	surplus go up or down, when can we be assured it only
9	goes up. There are circumstances under which it is an
10	easy test to do.
11	PROFESSOR NALEBUFF: The one place where Joe and
12	I do agree is what I proposed is really a modification
13	of the Ortho test.
14	There are some parts of the test that are
15	missing. For example, it turns out the right time to
16	apply the test is not ex post. It is ex ante. It is
17	when the consumer is trying to decide who to buy from.
18	Therefore, you have to use the anticipated
19	volumes, not the ex post volumes, which can often be a
20	challenge here. You also have to use the incremental
21	cost as opposed to thinking about what I'm selling, the
22	bundles or just selling things individually.
23	Subject to correcting for what expectation
24	should be and how you measure costs, actually I think it
25	is the way to go.

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1	MR. DEGRABA: Let me skip ahead here to slide
2	number 7 because it is a related question.
3	The proposition here is loyalty discounts,
4	either single product or bundles, should never be
5	condemned without applying some kind of price-cost test.
6	Do you agree or disagree? Or kind of agree?
7	PROFESSOR SIBLEY: It kind of depends. If what
8	Barry and I call the B market is perfectly competitive
9	and the demand for A and B are independent and all that
10	sort of thing, then in that case you can say whether
11	consumer welfare has gone up or down or stayed the same.
12	Simply by comparing the out of bundled price to
13	the prebundled price, to the independent pricing level
14	of the monopoly good, you don't need to know anything
15	about costs.
16	MR. DEGRABA: Outside of the nice, clean test on
17	prices, is there any other conditions under which you
18	would condemn a bundled discount without a price-cost
19	test? Is this essentially a price-cost issue?
20	PROFESSOR NALEBUFF: I have this general matter
21	and issue where my price depends on what it is that you
22	buy from other people as a general statement, as opposed
23	to the price I charge you depends on what you buy from
24	me.
25	So that to me -- it is of the form I will charge

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1	you one price if you buy from David and another price if
2	you buy from Joe.
3	I think that is problematic, as opposed to my
4	pricing depends on what you buy from me.
5	PROFESSOR SIBLEY: If I was going to use that as
6	a test, if I'm a bad guy and I want to charge you more
7	if you buy from Fred as opposed to me, can't I always
8	mimic an anonymous-looking thing just by appropriate
9	choice of quantity discount with grade points which
10	happen to exclude Fred?
11	PROFESSOR NALEBUFF: You can try and do that.
12	It is much more difficult to do it. I didn't claim
13	excluding that is going to be perfect. When you do it
14	directly, it is problematic and I shouldn't -- we should
15	know how.
16	MR. MEYER: If we grant you an exception for the
17	moment for discounts specifically or rebates
18	specifically keyed to purchases from identified
19	competitors, leave that off the table, is there some
20	kind of price-cost test safe harbor that you would
21	acknowledge is appropriate here?
22	PROFESSOR NALEBUFF: That first one is basically
23	a statement of my price to you depends on the market
24	share I get. My market share test is ultimately a test
25	that you don't buy from somebody else.

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1	Those things are very common. They are not
2	exceptional out there.
3	MR. MEYER: You wouldn't limit your exception to
4	specifically identified purchasers? You would say if
5	there is anything that is keyed to how much the consumer
6	is buying?
7	PROFESSOR NALEBUFF: Not volume. Percent.
8	Ultimately --
9	MR. MEYER: If you have an estimate of the
10	customers' total needs, don't you also have an estimate
11	of their share?
12	PROFESSOR NALEBUFF: I have an estimate. The
13	price will depend on what they buy, an absolute amount,
14	not punishing them for buying something from another
15	firm.
16	MR. KATTAN: If you buy 800 units from me, you
17	get a 5 percent discount, that's okay, even if I say to
18	him if you buy 600 units from me, you get a 5 percent
19	discount?
20	PROFESSOR NALEBUFF: I'm much happier with that
21	than saying i will take away your discount if you buy
22	anything from David.
23	MR. MEYER: Defining this exception to mean
24	market share discounts, where do you end up after that?
25	PROFESSOR NALEBUFF: I think if you pass the

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1	modified Ortho test, if you would like, so that the
2	incremental price, based on expected volumes and such,
3	is above the incremental average variable cost, you are
4	fine. And you are using your own cost in doing that
5	test. Because you could offer a competing B product by
6	itself without any difficulty.
7	MR. MEYER: Is there congruence, David, between
8	that statement and the situation you were describing of
9	the conditions where an increase in the out of bundled
10	price for A goes up or doesn't go up?
11	PROFESSOR SIBLEY: I guess in some sense. I
12	would want to think about that more. Simply saying buy
13	from Fred, pay a lot for A.
14	PROFESSOR NALEBUFF: I thought the question was
15	something else. I thought we all agreed on that safe
16	harbor, by the way, in terms of if the incremental price
17	for B compared in the A/B bundle story is sufficiently
18	high, then it actually isn't below the actual variable
19	cost to B, for the firm selling it, I think we all
20	believe you are in no danger.
21	The question is what about if that test isn't
22	passed.
23	PROFESSOR SIBLEY: If it isn't passed, then it
24	is hard to tell. It is not a simple test. At least I
25	personally don't have anything ready for primetime on

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1	that.
2	MR. DEGRABA: Let's go back to slide number 5.
3	It says a loyalty discount that allows a competitor to
4	operate profitably at some scale can never be harmful to
5	consumers.
6	Basically what we want to know here is is the
7	sort of antitrust objections to loyalty discounts
8	strictly one of driving competitors out of the market or
9	can there be serious harm to consumers simply by
10	shrinking, if you will, some competitors' output.
11	PROFESSOR LAMBERT: I would say, just as a
12	factual matter, sure, there can be harm to competitors
13	and to consumers by shrinking the rivals' output through
14	a discount.
15	The problem is, beating a dead horse here, we
16	have to come up with a way to write a rule that
17	implements that notion, and that requires us to know
18	something about minimum efficient scale, which is almost
19	impossible to know.
20	So while I would concede that it is possible to
21	harm rivals and harm consumers by reducing the rival's
22	scale by usurping so much business from them with your
23	loyalty discount, nonetheless we should have this
24	Hovenkamp legality rule if the discounted price is above
25	cost.

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1	It could be met by equally efficient rivals.
2	The discounting practice might actually affect rivals'
3	efficiency by diminishing their scale.
4	But I can't think as a lawyer of a way to design
5	a rule that doesn't have a chilling effect if we are
6	having to focus on what is minimum efficient scale and
7	what amount of a discount is permissible before you
8	usurp so much business that you prevent someone from
9	achieving minimum efficient scale. I think that is too
10	hard to administer.
11	MR. MEYER: What if you instead define the
12	defense, which is if the plaintiff is continuing to
13	operate profitably in the market for B, even if it is at
14	much lower volume than it had or market share than it
15	had, then the plaintiff's claim fails?
16	PROFESSOR LAMBERT: I would certainly have that
17	defense. I would say that if a plaintiff can match the
18	discount --
19	MR. MEYER: He may not have been able to match
20	the discount for all the customers to which it was
21	operating but still operating in the market for B is my
22	question.
23	PROFESSOR LAMBERT: Yes, I would give that
24	defense.
25	MR. KATTAN: That is exactly what happened in

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1	the Ortho case.
2	PROFESSOR SIBLEY: I think people who know the
3	facts of LePage's better than I may tell me I'm all
4	wrong here.
5	As I recall, LePage's didn't claim it was going
6	out of business. It just had a lower market share and
7	it wasn't making as much money as it was before.
8	If this rule were applied to LePage's, I guess
9	it would have been over in favor of 3M. Let me
10	speculate as well. I don't know if this is true, and I
11	haven't thought about it before this second.
12	Even if we accept that a rival can only compete
13	profitably for a subset of consumers, maybe based on
14	some peculiar behavior scale of economies, something
15	like that, nonetheless, if the other firm, the one that
16	is not the rival in this case is pricing some other set
17	of consumers very high, it may be possible for the
18	rival, even though it can't serve the entire set of
19	consumers, to sort of skip around between subsets that
20	it does in fact serve and keep prices down that way.
21	PROFESSOR NALEBUFF: It seems to me that this
22	can still be a problem. And actually we saw a recent
23	case against Briggs and Stratton here in the lawn mower
24	industry, where some of the rivals were making some
25	money and others were actually losing so much that they

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1	were exiting the business.
2	The view was that if the type of loyalty
3	payments had been different, those rivals would have
4	been at 20 percent of the market, they would have been
5	at 50 percent and the competition would have been much
6	more vigorous in that industry, that the customers would
7	have been able to have a whole collection of different
8	companies to buy from, that there would have been a lot
9	more innovation going on here.
10	So, if you are able to keep your rivals at 10
11	and 15 percent, they may choose not to invest in this
12	business, not to try and expand it. And I think there
13	can be tremendous harm in the long run here.
14	MR. DEGRABA: Anyone else?
15	Okay. Thank you.
16	I have time for one more before we break for
17	lunch. We will move to slide 8, which reads "In a
18	loyalty discount case, intent is relevant to proving
19	monopolization."
20	Do you agree or disagree? That comes from
21	LePage's, by the way.
22	MR. KATTAN: The question is intent to do what?
23	Every firm intends to take business away from its
24	rivals. When I discount, I'm hoping that by offering
25	the discount, I'm going to get more business for myself

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1	and that my rivals are going to get less business.
2	That intent certainly shouldn't have any bearing
3	on the outcome of the case. You can assume that it did
4	in every case.
5	MR. MEYER: What if the intent were the converse
6	or the flip side of that, which is intent to achieve
7	some business justification, if you will -- I'm not
8	interested in what those might be -- evidence that there
9	wasn't a desire to exclude rivals or that that wasn't
10	the dominant driving factor in the business's behavior?
11	MR. KATTAN: I think that presents a more
12	complicated question. I think if you have a test that
13	focuses on objective factors, did I price below or above
14	cost, if I priced below cost, did that exclude
15	competitors, that you probably would not need to go
16	through things like that.
17	PROFESSOR NALEBUFF: I think this actually gets
18	to some of what Tom was asking about, which is is this
19	market ultimately monopolizeable, and I would extend
20	that to is there something else that you could achieve,
21	maybe not monopolize B but A.
22	It is harder to understand why firms would be
23	engaged in this type of exclusion if there was no
24	ultimate benefit for them. I also share the view that
25	trying to either look for evidence of intent one way or

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1	the other is sufficiently manipulable or hideable that
2	I'm worried about playing that game.
3	You would have the advantage the first time it
4	is being done in that people aren't aware of it. So you
5	can have a lot of bad evidence.
6	And, of course, people say things that they
7	don't really mean in ways when they get into court that
8	can often not sound as good as sometimes they really did
9	mean it to.
10	MR. DEGRABA: Okay. Given that it is 12:00, I
11	will thank the panelists for all of their insight.
12	(Applause.)
13	MR. DEGRABA: We will reconvene at 1:30 after a
14	tasty lunch.
15	(Whereupon, at 12:00 p.m., the hearing was
16	recessed, to be reconvened at 1:30 p.m. this same day.)
17
18
19
20
21
22
23
24
25

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1	AFTERNOON SESSION (1:30 p.m.)
2	MR. MEYER: Let's get started.
3	Welcome to the second of today's sessions on
4	loyalty discounts. My name is David Meyer. I'm the
5	Deputy Assistant Attorney General at the Antitrust
6	Division. I will be monitoring this afternoon's session
7	with the help of Patrick DeGraba, who is at the Bureau
8	of Economics at the FTC.
9	The Department and the FTC are sponsoring
10	jointly this series of public hearings on single-firm
11	contracting to help advance the development of the law
12	concerning the treatment of unilateral conduct under the
13	antitrust laws.
14	Transcripts and other materials from prior
15	sessions are available on the DOJ and FTC Web sites, and
16	in due course, hopefully soon, the transcripts of
17	presentations from today's sessions will also be posted.
18	Our next hearing will be December 6th -- that's
19	next Wednesday -- addressing misleading and deceptive
20	conduct.
21	Today's session concerns the law and economics
22	of loyalty discounts.
23	Bundled discounts or rebates involving two or
24	more products have been a hot topic in antitrust forums
25	for some time, particularly since the LePage's decision

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1	of several years ago.
2	In addition to bundled discounts, today's
3	panelists are also addressing single-product loyalty
4	discounts, sometimes referred to as first-unit
5	discounts, by which a seller provides a discount on all
6	units sold once certain targets are reached, not just
7	the discount on the incremental units sold above or
8	beyond the set targets.
9	Our morning panel offered many interesting
10	comments and observations about loyalty discounts of
11	both sorts, and we look forward to learning more from
12	this afternoon's panelists.
13	This afternoon's speakers are, starting with Tim
14	Muris, a George Mason University Foundation professor of
15	law. He is of counsel at O'Melveny & Myers and, as
16	perhaps all of you know, a former chairman of the FTC.
17	He also has the distinction of having headed
18	both the FTC's Bureau of Competition and the FTC's
19	Bureau of Consumer Protection.
20	PROFESSOR MURIS: Not at the same time.
21	MR. MEYER: That may be debatable.
22	Our second panelist is Daniel Crane, who is an
23	associate professor at law at the Yeshiva University
24	Benjamin N. Cardozo School of Law.
25	Our third panelist will be Janusz Ordover, who

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1	is professor of economics at NYU and a former Deputy
2	Attorney General in the Antitrust Division.
3	And, finally, Will Tom, who is a partner at
4	Morgan, Lewis & Bockius and a former deputy director of
5	the FTC's Bureau of Competition.
6	More detailed bios are available out front. So
7	I will not bore you with all of the accomplishments of
8	all of these esteemed panelists.
9	The organization of the panel will be as
10	follows. Each of the four panelists will deliver a
11	presentation, approximately 15 to 20 minutes. We will
12	then take a short break.
13	When we return, we will start with each panelist
14	having an opportunity to take a few minutes to respond
15	or comment on the presentations made by the other
16	panelists, at which point after hopefully only 10 or 12
17	minutes, we will turn to a moderated discussion among
18	the panelists and with the panelists.
19	Unfortunately, I will not be able to take
20	comments or questions from the audience. We plan to end
21	around 4:00, but if the discussion is lively and
22	entertaining, we don't have any necessary hard and fast
23	end time.
24	The doors will be locked. So don't worry about
25	that. Before we start, I need to cover a few

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1	housekeeping matters.
2	First, as a courtesy to everyone and given the
3	way the electronic system works here, I would ask you
4	all to turn off your cell phones and Blackberries or at
5	least turn them off of transmit so they don't cause a
6	problem with interference.
7	Second, as you may know, restrooms are all the
8	way across the hall past the elevators where you came in
9	this morning.
10	Third, and this is a required safety
11	announcement here at the FTC, if the building's alarms
12	go off, move calmly and quickly but act in the manner in
13	which you are instructed to. You will be exiting
14	through the main entrance if necessary. Presumably
15	there will be a lot of FTC folks who know what they are
16	doing. Just follow them.
17	With that, I would like to introduce and welcome
18	Tim Muris.
19	PROFESSOR MURIS: Thank you very much for the
20	very kind introduction.
21	In the long time since I left law school -- and
22	I think I look younger than my actual age -- I have had
23	a lot of jobs and six of them in the federal government.
24	With apologies to my many friends at the Antitrust
25	Division, four of them were at the FTC Commission, which

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1	I guess makes me an FTC guy. But I have had a deep
2	fondness and respect for both agencies.
3	I'm going to talk today a lot about some
4	experimental economic work. Let me put it in an overall
5	framework.
6	I do want to disclose that I was retained by the
7	United States Telecom Association, the views in the
8	paper, and I will express views that are my own as well.
9	And this slide presents a framework that we all
10	know, I believe, which is the basic economic framework
11	about not just economics but about what a legal system
12	needs to do.
13	A legal system needs to be efficient, needs to
14	minimize some of the error costs and indirect costs, and
15	I believe we all know a lot about both of those. We all
16	know about type I, type II, and the direct costs makes
17	livings for lots of us.
18	The history of Section 2 is one that ought to
19	give us -- which I have written and many people have
20	written on -- one that ought to give us great pause. It
21	has largely been a history of mistakes, not exclusively.
22	As someone who launched the most aggressive use
23	of Section 2 of any enforcement head since the '70s, I
24	hope the pattern and history of mistakes doesn't
25	continue.

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1	There obviously have been some good cases, I
2	believe, along the way. But as Hovenkamp says in the
3	second bullet, the scope and meaning of exclusionary
4	behavior remains, indeed, very poorly defined.
5	There's a few key cases in the bundling world
6	and in the broader world. Brooke Group clearly wanted
7	to minimize the type I error, recognized the high type I
8	costs, rejected the theoretical possibility of harm as a
9	sufficient basis for liability and focused on market
10	realities.
11	Probably the most important thing about Brooke
12	Group is Brooke Group is about having a bright-line test
13	that is administrable for judges, juries and parties.
14	I think my good friend Greg Warden phrased it
15	best, that it is a recognition that we don't want to
16	contemplate making mistakes in this area. I don't know
17	if I quoted Greg exactly, but I think I paraphrased in
18	the spirit.
19	Concord Boat is another important decision. It
20	doesn't address bundling but single-product market share
21	discounts in a manner that is consistent with the varied
22	cost approach of Brooke Group.
23	The discounts were above cost. They are
24	ordinary business practices often used in competitive
25	markets. They are not unlawful exclusive dealing.

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1	The bottom line, it was not a Section 2
2	violation.
3	Then we come to LePage's. And whatever one
4	thinks of potential problems with bundled discounts, I
5	think it is hard to find supporters of the standardless
6	LePage's opinion.
7	It is an opinion that did not exercise caution,
8	a very poorly articulated theory of harm and an
9	incomplete record.
10	If you believe, which is usually a good thing to
11	do, to take the opinion at face value, the jury could
12	find a dominant firm liable under Section 2 based on the
13	possibility that bundled rebates, regardless of their
14	effect on consumer welfare, could exclude an equally
15	efficient competitor.
16	The point is that when you apply the
17	standard-free approach of LePage's to Section 2
18	liability, you are going to likely have high error costs
19	from false positives.
20	We know, and particularly because we live in a
21	world where bundles are everywhere, bundles can reduce
22	transaction costs in both the purchasing and selling
23	side of the market, they can serve as an alternative
24	traditional advertising, and they can be used, and a
25	very important part of the literature, they can be used

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1	by companies to give retailers strong incentives to
2	promote and sell their products and services, which is
3	an efficient and important vertical control function.
4	As an example, one can think of bundling. The
5	consumers of telecom products and services demand
6	bundles. And we live in a world increasingly where the
7	competition of the future is between the traditional
8	so-called wireline companies and the cable companies
9	selling consumers bundled products, video, data, voice,
10	and now the cable companies are even offering wireless.
11	That's just one of -- we could go forever on
12	examples of bundling.
13	Now, the economic literature on exclusionary
14	bundling indeed shows that bundling can exclude
15	competitors. And from that it is possible that
16	anticompetitive harm could exist. They certainly don't
17	show that such harm is likely.
18	These models contain many restrictive
19	assumptions. They don't consider efficiencies from
20	bundling, and they have not been tested for robustness
21	or empirical application to the real world.
22	They simply don't show whether the potential for
23	anticompetitive harm outweighs the benefits from
24	bundling.
25	Now, there have been lots of suggested theories,

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1	and one of the ones that would be a vast improvement
2	over LePage's but I still think has problems is the idea
3	of excluding a hypothetically equally efficient
4	competitor.
5	This in itself focuses by itself -- I believe
6	Professor Hovenkamp has supported this but now in a much
7	narrower version than he originally did.
8	By itself this focuses on harm to competitors,
9	not competition, and the bundled discount would exclude
10	-- using this test, would exclude a bundled discount
11	that could help consumers.
12	My basic problem with the test can be summarized
13	in one simple sentence, which is all else equal, how can
14	a firm that offers you less of what you want be equally
15	efficient with a firm that offers you more?
16	And I think the government in its 3M brief had a
17	sentence alluding to the fact that, indeed, the whole
18	concept of equally efficient might be a difficult
19	proposition here.
20	This is an example. I won't go through the
21	arithmetic because I do want to get to the experimental
22	economics. This is an example that Professor Hovenkamp
23	uses, and it's an example clearly where bundling
24	increases consumer welfare.
25	Yet, you can see that the alleged equally

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1	efficient competitor is excluded.
2	Let me move to what I in my ways believe is a
3	significant contribution to moving the ball forward on
4	the issue of bundled discounts, and that is work that
5	was done by Vernon Smith and his colleagues at the
6	Interdisciplinary Center for Economic Sciences at George
7	Mason, where I teach, so-called ICES.
8	Vernon is one of the fathers of experimental
9	economics, and for that work he received the 2002 Nobel
10	Prize in economics.
11	Experimental economics uses laboratory subjects
12	to test the validity of economic theories.
13	One of the many good things about experimental
14	economics is in numerous settings, experimental
15	economics has been shown to be consistent with the way
16	the real world works.
17	One of the most interesting things --
18	experimental economics is sometimes criticized because
19	they use college students. I have watched the
20	economists compete with the students. And the college
21	students have nothing in mind but making money in these
22	experiments, and the economists are often trying to
23	think of some theory. And the college students
24	invariably kill them.
25	And I participated in these experiments myself.

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1	My colleague at George Mason, Bruce Kobiashi, can
2	remember going down many a time for beer money, to pick
3	up a little money. But you had to be good at the
4	experiments.
5	What ICES did was they conducted an experimental
6	evaluation of various theories of anticompetitive
7	bundling using a baseline case and then variations on
8	the case.
9	The variations included changes in the
10	correlation of reservation values. I don't know if
11	Professor Nalebuff and Sidley talked about that this
12	morning, but the relationship of the reservation values
13	is extremely important in this literature, the existence
14	of efficiencies from bundling and the introduction of a
15	fringe competitor to the monopolist.
16	What you have is an A market with a monopolist.
17	100 percent of the literature assumes 100 percent that
18	also sells in the B market. And in the experiments, the
19	B market was served by up to three sellers of only B.
20	The baseline experiment tested cases in which
21	bundling by the monopolist was first prohibited and then
22	permitted. There are lots of details about this that
23	are available in the paper.
24	The baseline results showed that despite no
25	efficiencies and despite a setting under which you would

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1	think that bundling could be problematic, consumer
2	welfare still increased, although it wasn't
3	statistically significant.
4	And then when you added efficiencies, that is,
5	transaction costs, savings or the assumption of perfect
6	correlation and demand, the welfare-increasing effects
7	of bundling rose.
8	Here are again the details that are in the
9	paper, and the slides are available, and obviously we
10	have given you a set of the slides.
11	What was measured was consumer surplus, total
12	surplus and the number of competitors. And then the
13	variations were the transaction cost savings, the
14	negative correlation.
15	The Stigler paper on black booking, which was
16	one of the first papers here, had as opposed to perfect
17	positive correlation, perfect negative correlation,
18	which was a situation that allowed price
19	discriminations.
20	Under each of these, sometimes it was
21	statistically significant and sometimes it wasn't, but
22	there were not welfare losses. And only when bundling
23	was efficient did statistically significant exclusion
24	occur, which is interesting.
25	Now, what happened is after these -- I consulted

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1	throughout this experimental process. We were hoping
2	that what we would find is under these very simple
3	conditions here, you have anticompetitive effects of
4	bundling which these models had predicted, and then we
5	would tweak them some and see what happened.
6	Since we couldn't find anticompetitive bundling
7	effects, what we decided to do was modify the demand
8	conditions to make exclusionary bundling more
9	profitable.
10	The reservation value for the B good was raised
11	to greatly exceed the reservation value for the A good
12	for a lot of consumers, which meant there was more to
13	get out there.
14	Under the modified demand conditions, the
15	bundled discounts can exclude competitors in the B
16	market. And, indeed, welfare did fall, but it was very
17	little and it wasn't statistically significant.
18	Look at the conditions that had to occur. There
19	were extreme assumptions regarding the demand in the B
20	market. There was perfect positive correlation between
21	the A and B market demand.
22	There was no fringe seller in the market, and
23	there were entry and exit frictions in the sense that if
24	you entered, you had to stay for some periods, and if
25	you exited, you had to stay out for some periods.

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1	And here are the results. You can see there was
2	a big drop in the number of competitors. And there was
3	actually a drop in surplus, both consumer and total, but
4	very small and not statistically significant.
5	Now, then the results of the experiments were
6	changed to add -- one of the nice things about
7	experiments, you can hold a lot equal and make a lot of
8	variations, to add a fringe seller, with the fringe
9	seller having a small fraction of the capacity of the
10	market.
11	With the fringe seller, the total surplus
12	increased, and also they tested the effects of removing
13	those entry and exit frictions that I talked about.
14	Those alone reversed the negative welfare results that
15	were shown in table 2.
16	And here in table 3 are the results, showing the
17	various effects of what I just described.
18	Let me briefly say what a lot of this means, and
19	I do hope to do this under my 20 minutes.
20	We have the various tests. The hypothetically
21	equally efficient competitor test, for reasons I stated
22	before, it is overinclusive, and it would condemn
23	bundled discounts that increased welfare.
24	The de facto tying test requires knowledge of
25	the hypothetical monopoly price in the absence of

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1	bundling, which is a price generally not easily
2	ascertained, to say the least.
3	If deviations from perfect competition in the B
4	market or other alternatives are considered, this
5	further complicates the test.
6	I don't know what Professor Sidley talked about
7	this morning, but in the second paper he did, he showed
8	that his results of anticompetitiveness depended on
9	perfect competition in the B market.
10	And, of course, perfect competition in the B
11	market is not -- perfect competition anywhere is not
12	something we find much of in the real world.
13	Based on the experiments, the conditions under
14	which this de facto tying will emerge are very limited.
15	And, of course, we already have rules about tying.
16	I think that the most appropriate test would be
17	a modified Brooke Group test, which would be based on
18	the bundled price exceeding the bundled cost. It would
19	minimize the cost of false positives, and it would be
20	administrable.
21	And in that sense, in the absence of evidence
22	that the cost of false negatives from anticompetitive
23	exclusionary bundling is large, I submit that we should
24	use the modified Brooke test.
25	So just a few points in conclusion.

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1	I believe and I think that Barry Wright's case,
2	as Professor Crane and others have stated, Professor
3	Lambert, who was here this morning -- clearly the
4	federal courts have ruled on single-product pricing
5	behavior.
6	But that is not true for bundled discounts.
7	LePage's is standard free and it has spread beyond the
8	Third Circuit. Read Pease Health, a Ninth Circuit
9	District Court case which is discussed in the paper.
10	Given the history of Section 2 and given that we
11	are dealing with price application of Section 2 to any
12	exclusionary conduct, particularly this one, we should
13	follow a cautious approach that is consistent with that
14	applied to the single-product pricing in order to
15	minimize the sum of error and direct costs.
16	And the courts and those subject to potential
17	liability would benefit from guidance that reduces the
18	uncertainty that LePage's has created and stems the
19	general application of the Third Circuit's flawed
20	approach.
21	I'm hoping that these hearings, among many other
22	good things they will do, will accomplish that result.
23	Thank you very much.
24	(Applause.)
25	MR. MEYER: Our next speaker is Daniel Crane,

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1	who, as I said, is an associate professor of law at the
2	Cordozo School of Law. He is also counsel at Paul,
3	Weiss, Rifkind, Wharton & Garrison.
4	PROFESSOR CRANE: It is my pleasure to be here
5	today. I'm going to speak primarily about bundled
6	discounts, the LePage's issue, and I'm afraid I will
7	repeat some of what was said this morning, but hopefully
8	to good effect.
9	I should disclose I am been involved and
10	continue to be involved in some cases as a lawyer in
11	which bundled discounts are at issue, though, of course,
12	the views I present today are my own.
13	I will not use any slides. We can just listen,
14	I hope.
15	At the outset, let me stress that the rule that
16	I'm going to defend as a safe harbor, the Ortho test, or
17	perhaps the Ortho test with some modification, is not a
18	rule that is perfect.
19	It is not a rule that will achieve a state of
20	affairs where all discounts that are harmful to
21	consumers will be said to be illegal and all that are
22	pro-competitive will be lawful.
23	But what I think is important as a lawyer, of
24	course, now as an economist, is to articulate
25	practicable, workable rules for the courts. This is

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1	particularly important for private litigation.
2	At the end of my remarks, I will talk about how
3	I would welcome a perhaps different approach in
4	injunctive cases brought by the government than in
5	private litigation. Because of some features of private
6	litigation, I am quite confident that the LePage's test
7	is doing far more harm than good.
8	Let me sort of set forth four background
9	conditions against which I will defend the Ortho test as
10	a safe harbor in litigation.
11	The first background condition which has been
12	addressed already today is that bundled discounting is
13	pervasive and has many pro-competitive or competitively
14	neutral reasons.
15	When a practice is widespread and usually
16	competitively neutral or pro-competitive, courts should
17	be particularly concerned about condemning instances of
18	that conduct without very strong proof of
19	anticompetitive consequences because of the dangers of
20	false positives.
21	Just to give an example about how widespread and
22	pervasive bundled discounting is, when I was working on
23	my article for the Emory Law Journal about bundled
24	discounting, I looked at my e-mail, and lo and behold, I
25	got an e-mail from the ABA antitrust section advertising

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1	"Market Power Handbook" and "Econometrics," two separate
2	books, for a package price which is a 12 percent bundled
3	discount off of the retail price of the two
4	individually.
5	I ran into Dan Rubinfeld a short while later,
6	who is the editor of one of the books, and I promptly
7	served on him a complaint for monopolizing the economics
8	and antitrust literature market.
9	Of course, bundled discounting happens in all
10	sorts of places where there can be no suspicion of
11	anticompetitive conduct.
12	That doesn't mean that cases like that will be
13	litigated, but what it shows you is when you have a
14	pervasive practice, there are often likely to be good
15	explanations for it, which should make us particularly
16	reluctant to condemn instances where there might be
17	anticompetitive consequences without very strong reasons
18	to do so.
19	A second background condition is that bundled
20	discounts in commercial contexts are often driven by
21	buyers rather than sellers. Significantly, many of the
22	recent bundled discount cases to be litigated did not
23	involve sales to end consumers but to retailers or
24	manufacturers acquiring components or other large
25	oligopsony or monopsony buyers.

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1	Large diversified buyers often leverage their
2	buying power across multiple product lines to exact a
3	bundled discount from the manufacturer. And, of course,
4	these buyers have a strong incentive not to demand
5	discounts when doing so would weaken competition in the
6	markets that supply them.
7	So my own view is that bundled discounting,
8	often driven by buyers in these cases, the incentives of
9	the buyers themselves are much better at controlling
10	competition than litigation is.
11	This morning Barry Nalebuff said that oftentimes
12	in bundled discounting cases, one of the problems with
13	bundled discounts is that they sort of conceal what the
14	real price is, it is hard to know what the real price
15	is, it can cost up to $10,000 for a buyer to really
16	compare apples to apples unbundled versus bundled.
17	When we are talking about buyers like Wal-Mart
18	or GPOs and the medical devices cases, AMD, Intel,
19	Broadcomm, Qualcomm, Information Resources versus A.C.
20	Nielsen, many of these litigated cases involve very,
21	very large sophisticated buyers.
22	So even if it is true that sometimes comparing
23	apples to apples is difficult, if you look at the cases
24	litigated today, it seems to me that is simply not an
25	objection.

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1	A third background condition is that I believe
2	that courts need rules and not merely open-ended
3	standards, particularly in sensitive areas of price
4	competition and Section 2.
5	I have a forthcoming article in the Washington
6	and Lee Law Review about the rules and standards debate
7	as applied to antitrust law where I argue in favor of
8	bright-line rules to immunize defendants from lawsuits
9	in cases involving particularly private litigation and
10	unilateral practices.
11	Committing economic policy to juries in cases
12	like LePage's is a really miserable way to run a legal
13	system.
14	A fourth and related background condition is
15	that a growing literature -- including my co-panelist,
16	Janusz Ordover, has written in this area -- shows that
17	firms can strategically misuse antitrust law to prevent
18	pro-competitive behavior by their rivals.
19	As I will discuss in a few minutes, I believe
20	that many of the recent bundled discounting cases
21	involve frustrated competitors seeking to deny
22	commercial advantage to a more diversified rival, not
23	firms that are in any real danger of being excluded from
24	the market.
25	Well, with these background conditions as

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1	considerations, let me say a word about why it is not
2	sufficient to analogize bundled discounting to tying or
3	exclusive dealing, as some cases like LePage's have
4	suggested.
5	In a tying case the consumer is required to take
6	the tied product if he wants the tying product as well.
7	In a bundled discount case, the consumer always has the
8	choice to buy simply the tying product.
9	Of course, it is possible that the discount is
10	so large that it would be economically irrational for
11	the consumer who wants both products to buy just the
12	tying product and then purchase the tied product
13	separately from the plaintiff or a smaller, less
14	diversified firm.
15	But that would only be the case if the plaintiff
16	was unable to offer a discount that would make the
17	consumer indifferent on whether it accepted the
18	defendant's package discount or bought the two items a
19	la carte. Of course, that's a question that tying
20	analysis lacks the tools to answer.
21	Similarly, an exclusive dealing analysis focuses
22	on whether the defendant's contractual practices
23	foreclose a substantial share of the relevant market to
24	rivals.
25	But foreclosure is, again, an empty concept

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1	unless it means that rivals cannot compete for the
2	business.
3	To put it another way, if a rival would be able
4	to profitably match the defendant's bundled discount,
5	what we have is ordinary price competition and not
6	foreclosure.
7	The problem with using exclusive dealing
8	analysis to assess bundled discounts is that exclusive
9	dealing analysis begins with the assumption that
10	whatever contracts are covered by the relevant contracts
11	are foreclosed to rivals, a fact which is not even in
12	evidence yet in bundled discounting cases.
13	So either a tying analogy or a bundled discount
14	analysis, without first looking at sort of economics of
15	the discount, is really putting the cart before the
16	horse.
17	Let me now turn to the rule for bundled
18	discounts that I will defend as a safe harbor. Janusz
19	tells me he created this on the back of a napkin. So we
20	will leave it to him to give you a history of this.
21	The rule traces back at least to the Ortho
22	decision. It was adopted in some litigated cases,
23	including Information Resources versus Dun & Bradstreet,
24	a Southern District of New York case, and I believe is
25	reflected in Professor Hovenkamp's 2006 supplement to

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1	the antitrust treatise.
2	A plaintiff challenging a seller's bundled
3	discounts as predatory must show as a minimum
4	requirement that the bundled discounts resulted in at
5	least one product in the package being sold at less than
6	cost after reallocation of the discounts on other
7	products in the package to the predatory product.
8	Another way of saying this is that the bundled
9	discount is not unlawful unless the effective price of
10	the product in the competitive market is below cost,
11	taking into account the discounts on noncompetitive
12	products that the consumer would forego by buying the
13	two products individually instead of in the package.
14	In my Emory Law Journal article, I propose a
15	number of additional showings the plaintiff would have
16	to make. I won't discuss those here, in the interest of
17	time.
18	I want to defend the sort of core concept
19	underlying this analysis which is an analogy of two
20	predatory pricing, although with some modifications for
21	bundled discounts, which is what I think the LePage's
22	court says should not be done, we should not analogize
23	to predatory pricing. I argue we should, although it
24	may take some qualification of the rules.
25	The basic argument is based on the Brooke Group

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1	standard itself. Under Brooke Group, a single-product
2	discount is per se lawful unless it results in pricing
3	below an appropriate measure of cost.
4	I will put aside what the appropriate measure of
5	cost should be and assume we know what it is in a
6	particular circuit. Let's call it X.
7	What that means is that a defendant would have
8	an unqualified right to offer a discount on the good Y
9	so long as the price continued to exceed X.
10	Now, suppose the defendant offers a bundled
11	discount on goods Y and Z and that the plaintiff sells
12	only Y. The plaintiff cannot offer a discount on Z.
13	But by reducing the price of Y, it can make up for the
14	discounts that consumers would forego by continuing to
15	buy the goods unbundled.
16	So long as the effective price for the
17	single-product firm is not below X, it is no more
18	disadvantaged than if the defendant had offered the same
19	above-cost prices through a single-product discount on
20	Y.
21	Since a single-product discount resulting in a
22	price above X would be per se lawful, a multiproduct
23	discount resulting in effective price above X should
24	also be lawful per se.
25	Let me sort of answer some arguments against

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1	this logic that I have seen discussed in economics
2	literature, actually moreover in litigation briefs,
3	which are probably not a good source of economic
4	reasoning, but nonetheless, let me discuss a few things.
5	One sort of very common argument is that where a
6	single-product predation is expensive and risky because
7	it involves sustaining losses for an indefinite period
8	of time to drive out or discipline rivals, the
9	multiproduct predator sustains no losses from the
10	bundled discount because it can cross-subsidize the
11	discount in the competitive market with discounts off
12	the prices in the monopoly product.
13	Of course, the diversified firm that uses a
14	multiproduct discount to exclude rivals is also
15	sacrificing profits with the hopes of long-term
16	recoupment.
17	A discount of one dollar off the monopoly
18	product for the purpose of subsidizing the campaign of
19	exclusion in the competitive product is economically
20	identical to a single-product firm taking a dollar out
21	of a bank and subsidizing single-product predation.
22	Unless there is rate regulation over the
23	products and the bundled discount is somehow being used
24	to fool rate regulators, this cross-subsidization story
25	doesn't really hold up.

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1	This morning Professor Nalebuff argued that
2	loyalty discounts can create noncost predation by
3	threatening to inflate the monopoly price. In his
4	model, the monopolist says I'm going to jack up the
5	monopoly price of the monopoly product unless you take
6	my bundled discount.
7	Of course, as Professor Nalebuff recognized,
8	this only works if the threat to jack up the monopoly
9	price is credible.
10	Of course, the reason that the defendant has not
11	charged a price higher than the current price, the
12	current monopoly price is that any further price
13	increase would by definition be unprofitable because
14	there would be substitution to other products.
15	So the buyer has its own very credible threat,
16	which is if you jack up the price even further, I will
17	substitute to other products. By definition, the
18	profit-maximizing price being charged already is one
19	which will become less profitable to the seller if he
20	jacks up his price even further.
21	Although I'm not saying it could not happen, it
22	is certainly the case that the threat I will raise my
23	price where the defendant is already charging the
24	profit-maximizing price gives rise to another threat by
25	the buyer, which is in that case I will substitute to

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1	something else.
2	A second argument that is sometimes made is that
3	bundled discounts, unlike single-product below-cost
4	pricing, can go on indefinitely. If that is true, it is
5	because there is no sacrifice in profits and no need of
6	future recoupment.
7	That suggests to me that the reason that the
8	diversified firm is able to offer the bundled discount
9	indefinitely is that there are legitimate business
10	reasons for doing so that do not depend on the exclusion
11	of competitors.
12	Of course, competitors can be excluded from the
13	market by any number of strategies, but those should
14	typically not be of concern under the antitrust laws if
15	they reflect reasons that have legitimate business
16	justifications. That is to say, business justifications
17	that make the practice profitable, even assuming
18	continued competition.
19	A third and final criticism I will just touch on
20	briefly is sort of really a criticism of the equally
21	efficient competitor hypothesis in the Ortho case.
22	Under the Ortho formulation, the plaintiff would
23	have to show that it is as efficient a producer as the
24	defendant in at least the competitive product.
25	This has been criticized on the grounds that

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1	what if the plaintiff is a new entrant, it is trying to
2	achieve economies of scale, it is the defendant's very
3	practices that prevent it from reaching economies of
4	scale, so how can a defendant say that he should have
5	been equally efficient in order to sue.
6	For present purposes, I don't want to take a
7	position on this, although I do think the equally
8	efficient competitor hypothesis is probably correct. I
9	would be happy with a test that simply required some
10	price-revenue comparison, because that would at least,
11	different than LePage's, force the focus back on to
12	whether the plaintiff really had options or simply
13	whether the defendant's discounts were exclusionary in
14	the market.
15	I think even that would be a substantial
16	improvement on sort of the open-ended standardless
17	approach of the LePage's case.
18	Let me conclude my remarks, then, by arguing for
19	the need for bright-line rules in unilateral
20	exclusionary practices cases, particularly in private
21	actions for damages.
22	As I noted at the outset, it is not difficult
23	for law professors and lawyers and economists to create
24	sort of armchair assumptions about markets that show
25	exclusionary practices in various forms.

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1	Nonetheless, adoption of bright-line rules is
2	necessary to prevent strategic misuse of antitrust law
3	by rivals.
4	Many of the cases brought in recent years are
5	not cases brought by very small firms that are on the
6	margins of the market. These are cases brought by very
7	dominant, large firms with very substantial market
8	shares, with a good bit of profitability and a recent
9	history of success in the market.
10	One has to ask if the exclusion story doesn't
11	seem to be strong on its face, what's really going on
12	here.
13	The answer may very well be, although I can't
14	prove what any individual plaintiff intends, that there
15	is simply an effort being made to prevent more
16	diversified firms from using their diversification as a
17	competitive tool.
18	Now, it is one thing to say that we will commit
19	these issues to juries, as LePage's did, but of course
20	jury trial is extremely rare.
21	The statistics from the U.S. courts
22	administrative offices show that there are approximately
23	nine civil antitrust cases a year out of about 860 that
24	are terminated. So less than 1 percent of all private
25	antitrust cases will end up before a jury.

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1	LePage's is the exceedingly rare case. What
2	happens is that all the cases either are dismissed on
3	summary judgment or a motion to dismiss or they have to
4	settle, they have to settle because defendants simply
5	cannot take the risk of going to trial.
6	So what happens, then, is unless the courts are
7	given good, solid, antitrust rules that can serve as
8	screening devices on a motion for summary judgment or a
9	motion to dismiss, the only question becomes how big is
10	the price tag, the settlement that the defendant has to
11	pay to avoid the trial.
12	I think this is sort of a culture that LePage's
13	has encouraged. Courts often interpret the LePage's
14	standard as really a commitment of these issues to
15	juries, although we haven't had lots of jury trials. In
16	some cases it is because defendants have had to pay to
17	get out of them.
18	Let me conclude by saying though I think rules
19	are necessary as screening devices for private
20	litigation, I'm actually more sympathetic to
21	experimentation by the government with different
22	theories of exclusionary conduct.
23	I think one of the unfortunate things that has
24	happened in unilateral cases is that these same rules
25	that have been designed to protect against abusive

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1	litigation by private plaintiffs have been applied
2	wholesale to government cases, and I think a good
3	example of this is the U.S. versus American Airlines
4	predatory pricing case, where the court simply used sort
5	of off-the-rack rules that were really not sort of
6	designed to prevent against abusive private litigation
7	but didn't take into account the differences that occur
8	when a government sues.
9	So while most of my comments have been very
10	skeptical about bundled discounting cases and supportive
11	of strong rules to weed out these cases early on in the
12	litigation, except the most meritorious cases, I do
13	think the government, whether FTC or DOJ, as plaintiff
14	should be given more latitude.
15	Thank you.
16	(Applause.)
17	MR. MEYER: Our next speaker is Janusz Ordover,
18	who needs no introduction. He is professor of economics
19	at NYU, as I mentioned, former deputy Assistant Attorney
20	General of the Antitrust Division and a frequent
21	participant in antitrust debates of all sorts.
22	PROFESSOR ORDOVER: Thank you very much, David,
23	for the kind words. As I say, I always need an
24	introduction just to keep my name in front of the
25	public, like Coca-Cola and Pepsi or Marlboros, maybe.

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1	My topic today is loyalty rebates. I frequently
2	do something which is inappropriate which is create way
3	too many slides. I have not deviated from my strategy
4	here either.
5	What I do have is way too many slides. Plus, I
6	have also asked the organizers to post two of my papers
7	which deal with the issue of loyalty rebates and which
8	are in order to show the economists' schizophrenia are
9	quite adversarial to each other.
10	I mean that one tries to demonstrate
11	circumstances in which loyalty rebates, back to first
12	unit type discounts, are potentially anticompetitive,
13	and we actually demonstrate how they can be so. And the
14	other paper in which the same kind of loyalty rebates
15	turn out to be powerfully procompetitive.
16	I have spanned the universe of possible
17	outcomes. The big challenge is to try to figure out how
18	to marry these two approaches. It is at this marriage
19	level that the huge challenges to economic modeling are
20	likely to come about. I will come back to these papers,
21	of course, in a very short minute.
22	There is no point to running you through the
23	usual introductions, as you have been here this morning,
24	many of you.
25	We also already talked about what the loyalty

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1	rebates entail.
2	The main point that I wanted to make, other than
3	the fact that we don't know yet enough about their
4	economic effects in the wide variety of settings, the
5	point that I really think is worthwhile keeping in mind
6	is we both need more empirics, more technical research,
7	and also I think a lot of bright-line rules, because I
8	believe strongly that absent bright-line rules, we are
9	going to create mischief on both sides.
10	Remember, there are two types of errors. We
11	always forget that.
12	The point that is I think worthwhile is the
13	interesting aspect of these loyalty rebates that really
14	comes to play as the driver behind the variety of
15	outcomes from models of these settings. And really the
16	loyalty rebates create complex links in the product
17	space between the supplier and the consumer.
18	These links could be across volume, across time
19	or across products. Because of these links, because of
20	these externalities that come about as a result of the
21	loyalty rebates or bundled rebates, different
22	manifestations, the typical analyses that we have are
23	difficult to carry out.
24	Normally we do not think very easily in terms of
25	mathematical modeling or empirics in which there are

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1	these kind of versions of almost network-like effects.
2	In this case, the network-like effects are much
3	more concentrated as between the pair of transactors and
4	spilling into the outside world in which the third
5	parties are being affected one way or the other by the
6	internal contractual arrangement between the seller and
7	the buyer.
8	It is quite true, as I have seen in litigation
9	myself, that often it is the actual buyer that is
10	requiring or asking for or demanding the creation of
11	those kinds of links.
12	Of course, I missed here Professor Einer
13	Elhauge, who would have talked about these kinds of
14	links extensively in the context of GPO purchasing
15	practices, which are being litigated as we speak.
16	I also have to fess up that I have an interest
17	in the outcome of these litigations.
18	In any case, it is the nature of these links
19	that creates complexity for economic modeling of the
20	sort that I think is illustrated in some kind of
21	examples that have been put forth.
22	This is the Hovenkamp example that Tim Muris
23	already took apart. So I don't want to waste my time on
24	that because this example actually proves nothing. It
25	proves nothing because it is not embedded in any known

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1	economic model of anything.
2	I second Professor Muris's point that learning
3	from stripped down examples is a dangerous thing to do,
4	that we really have to rely on the complete and deep
5	understanding of the circumstances in which the practice
6	takes place and understand fully and well all the
7	economic forces that act upon the practice, the
8	transacting parties as well as on the third parties and,
9	in particular, on consumers ultimately, ultimately
10	consumers.
11	A simple example that people have often used
12	showing that it excludes an equally efficient competitor
13	is, okay, so what, is there any problem with exclusion
14	of this equally efficient competitor, assuming -- again,
15	I agree here with the previous speaker -- that what it
16	means to be an equally efficient competitor is subject
17	to debate.
18	Indeed, some of you may be as old as I am.
19	Although -- do I look younger or older than you? We
20	will debate that later.
21	What I'm trying to say is that when the issue of
22	that kind of an equally efficient competitor came out
23	way back in the Turner treatise days, in the context of
24	multiproduct firms predating against single-product
25	firms, Professor Areta said -- I think it in a letter to

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1	Will Dommel commenting on the Ordover paper efforts --
2	saying there is absolutely no reason to give a
3	multiproduct firm a leg up in competition against the
4	single-product firms because there is no reason why
5	should we take into account these deep potential links
6	on the demand side or on the supply side or the cost
7	side and the cross-elastic side in terms of lowering the
8	benchmark price against which the rival ought to
9	compete.
10	Now, that was Professor Areta probably now 20 --
11	maybe 18, 19 years ago. I think our thinking has deeply
12	changed.
13	We do understand a lot of complex relationships
14	in terms of the efficiencies that are involved, whether
15	it is on the cost side, gains from a multiproduct
16	production, whether it is on the savings side, the
17	bundling effects from offering a wide variety of
18	products in order to minimize efficiency, inefficiency
19	of transacting and so on, coupled again with the Barry
20	Nalebuff point, which is now very fashionable at MIT and
21	at Harvard, when economists talk about so-called
22	shrouding. You know what the hell it means, is it some
23	kind of religious ceremony? No.
24	It involves marketing practices precisely of the
25	sort that make it very hard for a consumer to figure out

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1	what the price is. Is shrouding good or is it bad? We
2	don't know. It depends on the model and the facts.
3	The facts are the driver of our analysis when
4	properly slotted into some well-understood economic
5	theory.
6	So what I want to do is to give you a quick run
7	through the two papers with Greg, who threatened to be
8	here but I don't see him, thank God. Otherwise, he
9	would take me to task for misrepresenting our research.
10	The research in fact can be misrepresented or
11	represented in a variety of ways. It goes back to
12	something that happened to me and Steve Salaw in
13	connection with our paper on vertical issues where Steve
14	viewed that as a theorem, proof that vertical
15	relationships could be anticompetitive. I viewed it as
16	a proof that circumstances under which vertical
17	relationships could be anticompetitive is actually
18	difficult to implement.
19	We had the same paper, and the two authors
20	agreed to stay neutral on the subject. The same paper
21	can been seen from a variety of perspectives.
22	What it is that Greg Schaefer and I have tried
23	to do, and we are hard at work at probably a few more
24	versions of these kind of analyses, is to construct
25	economic scenarios which I think are plausible as

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1	opposed to two-by-two examples that do not reside in any
2	well known market setting -- other than Ortho -- in
3	which these types of loyalty rebates which is what I
4	want to talk about or back to first-unit discounts do
5	emerge as equilibrium offers.
6	Remember that much of the problems we had with
7	examples is it is never tested whether or not what is
8	happening in the example is an equilibrium or not. If
9	it is, what is the gain that underlies the example.
10	Greg and I have specified two sets of cases in
11	which these kind of loyalty rebates as equilibrium
12	offers. One is the one in which -- the first one is the
13	one in which exclusionary loyalty rebate does come
14	about.
15	This is a model, a very stripped down model.
16	Let me take you quickly through it. The papers are
17	posted. Probably incomprehensible for the lawyers in
18	the audience, but maybe not.
19	The setting is straightforward. It is stripped
20	down. We have two competitors, one of which is, quote,
21	unquote, "dominant" in the following simple sense, that
22	is, it is capable of producing output for the whole
23	market. Whereas, the other, the rival, the smaller
24	competitor, the entrant can only produce one unit of
25	output.

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1	From a social welfare standpoint, ideally we
2	would like one unit to be sold by each. And the reason
3	for that is there a heterogeneity of preferences. The
4	consumers who would like to buy in the marketplace, they
5	like the incumbent's product and some other people like
6	the challenger's product.
7	In an equilibrium, we would like to see people
8	being optimally served, which takes me back to the
9	question of what do I mean by an equally efficient
10	competitor.
11	In the model that we have constructed, each firm
12	has the same marginal cost of production, but their
13	products are not equal. So they are equally efficient
14	on the cost side, but they have heterogeneous offerings,
15	which is an environment where economics is not entirely
16	clear, what do we mean by an equally efficient
17	competitor.
18	When I am selling A and you are selling B, and
19	they are not perfect substitutes for each other, it is a
20	bit of a challenge to give a crisp and clear definition.
21	In that model, there are some assumptions that
22	actually have to be made in order to create a
23	circumstance whereby an equilibrium exclusionary offer
24	arises, i.e., an offer that denies consumers the ability
25	to purchase the product they would like to get.

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1	Again, this goes back to my misspent youth with
2	Shaffer and Salaw. You can argue amongst yourselves --
3	I will be happy to chip in later on -- whether the
4	conditions that we have specified are necessary, are
5	they sufficient and more or less are they realistic,
6	because the usefulness of the model stems, at least in
7	my view, from modeling circumstances that are not so off
8	the wall as to give no guidance to anything. But the
9	conditions we have specified I think are of interest.
10	For example, in the paper we have the assumption
11	that the incumbent can supply all of the market but the
12	entrant can supply only at most one unit. Whether it is
13	one unit versus two or two versus five is not
14	necessarily an issue. But it is the foundation of the
15	differential that exists.
16	The second assumption that I think is important
17	is that the model has two periods involved. Remember I
18	told you about the links that are being created through
19	these exclusionary, potentially exclusionary offers.
20	Here the link is intertemporal. That is,
21	through time. And it is that fact in the model that
22	actually is another of the key drivers.
23	In period two, the buyer becomes locked in to
24	the seller or the sellers from whom it purchased in
25	period one.

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1	What does that mean? In a normal economic
2	model, it would mean people would beat their brains out
3	to get the second period profits and would give them all
4	up in the first period.
5	Remember the Supreme Court profound economic
6	analysis in ITS v. Kodak on that subject.
7	So, no restriction on feasible sale of
8	contracting. However, the entrant faces a financing
9	constraint, a cap on how much it can borrow against its
10	potential period two lock-in gains in period one.
11	Now the question comes in whether you are the
12	believer in the old fashioned finance literature or more
13	inclined to the new old fashioned financial literature
14	in which the financing constraints are in fact a fact of
15	life for a variety of reasons. And I refer you to
16	Turro's new brilliant finance textbook.
17	The second aspect of this whole thing is that
18	the entrant cannot commit to its second period price in
19	period one. How realistic is it? I don't know. It
20	depends on the setting.
21	So there are two key assumptions or three that
22	limit the capacity of the entrant. The inability to pay
23	for all of the first period battle, either with borrowed
24	money or with the second period money, whether these are
25	realistic, that depends on the particular circumstance.

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1	And I believe that there are settings like that in which
2	these conditions are likely to be satisfied.
3	In such an equilibrium, such as we do have
4	equilibria in which the entrant gets no sales, the
5	incumbent makes the sales despite the fact that he is
6	going after or she is going after or it is going after
7	the marginal unit which is less valued to consumers
8	being supplied by the incumbent firm versus the
9	challenger.
10	Now, again, this goes against the grain of the
11	Chicago -- perfectly on time -- against the Chicago view
12	of life, which is why would anybody pay to gain sales
13	against somebody who can offer those same sales more
14	efficiently?
15	And the answer is well, there are these
16	intertemporal links. These kind of relationships do
17	change the analytics. Moreover, and here is why these
18	constraints that we have talked about are key.
19	Moreover, how much you have to pay in order to
20	steal or to grab or to sell that second unit is clearly
21	tied to how much the rival, the entrant can pay to keep
22	it for itself.
23	If the price is low because the rival can only
24	offer the buyer a penny but you would be happy to offer
25	two pennies to something that would lead you to three

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1	cents gain tomorrow, you are going to do that.
2	The Chicago view is again somewhat too
3	simplistic in terms of the underlying economics. I'm
4	not saying as a matter of empirics it is flawed, but as
5	a matter of underlying economics, we all know we are not
6	Chicagoans anymore. I believe that's the right place to
7	be, out of Chicago, leaving Chicago yet again.
8	It is a slide. To switch direction completely,
9	Shaffer and I with his graduate students have come up
10	with another model in which in fact the efficiency of
11	the first-unit discount rebate comes out in a very
12	stripped down equilibrium as well.
13	In that model, there is no competition. There
14	is only a supplier that has a monopoly, and he is facing
15	two states of the world of which one is the high demand
16	and the other one is the low demand.
17	As you all know, obviously, from your
18	microeconomics textbooks, in such a world the seller
19	would like to create incentive to sell as much as
20	possible in the high-demand state.
21	But the buyer may not want to reveal whether it
22	is a high-demand state or not. You have this asymmetry
23	of information.
24	If there is an asymmetry of information, you
25	have to implement some kind of sophisticated pricing,

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1	which we see everywhere. It is that sophisticated
2	pricing that in fact is the explanation why we see these
3	kind of schedules in real life.
4	Now, in our model, we have a typical
5	self-selection equilibrium that comes about. The
6	benefit from the loyalty rebate is clearly going to
7	accrue to the seller, not to the buyer, because the
8	loyalty rebate gives greater power to price
9	discrimination.
10	We don't know whether price discrimination is a
11	good thing or a bad thing as a general economic
12	proposition. In our model, we would say, look, if the
13	driver behind the loyalty rebate is to incentivize the
14	downstream, these buyers or a buyer could be either in
15	the high state or the low state, and that should be
16	enough to stop somebody trying to condemn the particular
17	loyalty rebate as being potentially anticompetitive.
18	So you can see that is the theorem right here.
19	If you compared this diagram relative to the prior
20	diagrams, you can see where the difference comes from.
21	As I said, the basic insight of that paper is
22	that loyalty rebates permit more efficient price
23	discrimination than simple two-part tariffs because of
24	the nondifferentiability of the outlay schedule of the
25	self-selection point chosen by the high-demand buyer.

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1	Price discrimination is not always welfare
2	enhancing, but we don't believe there should be public
3	policy prohibitions for reasons to discourage the use of
4	loyalty rebates for such purposes.
5	Here I will stop, given that you have my slides.
6	Here are the references for those of you who are
7	interested. Greg will be happy to send you our papers
8	if you ask for them.
9	Thank you very much. And I hope I was not way
10	too confusing.
11	(Applause.)
12	MR. MEYER: Thank you very much.
13	Our final panelist is Will Tom, a partner at
14	Morgan, Lewis & Bockius here in Washington.
15	As I mentioned earlier, Will has also been the
16	deputy director at the FTC's Bureau of Competition.
17	MR. TOM: Thank you very much, David.
18	I will make up for Janusz's too many slides by
19	having none at all.
20	I am also going to free ride on all the previous
21	panelists, both this morning's and this afternoon's, by
22	assuming that you have heard all their presentations,
23	you are now up to speed on all that they have said.
24	So I will not rehash any of the previous
25	discussions or points that were made, which may lead

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1	some of you to wonder whether there is anything more
2	left to be said after all of the education that you have
3	gotten.
4	I do think that one of the things that comes out
5	pretty clearly in hearing the lawyers and the economists
6	and listening for some of the differences between what
7	they are doing here is that the lawyers are looking for
8	rules that you can apply in real litigation situations
9	and a state of imperfect information.
10	We have had a lot of talk about the precise
11	contours of those rules and what models can guide us in
12	formulating what those rules are.
13	At least for us simple-minded lawyers, the
14	attraction of the incremental revenue versus incremental
15	cost or Ortho standard or whatever you want to call it
16	is that it is simple enough for us to understand, and it
17	can actually provide some guidance. It provides
18	guidance on which most lawyers for a fairly wide
19	spectrum of so-called Chicago School or post-Chicago
20	School adherents can agree on.
21	But it obviously provides that guidance only
22	when the incremental costs and the incremental revenues
23	are known.
24	And it seems to me that the interesting problems
25	in actually deciding the cases is how the case should be

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1	decided in the large number of cases where it is not
2	known or where that is the very subject of the
3	litigation, with the two sides arguing for different
4	factual inferences.
5	One of the things that struck me in hearing the
6	lawyers talk, particularly this morning, is that there
7	wasn't a lot of mention of the legal framework and the
8	legal doctrines by which these kinds of rules were
9	introduced in the first place, particularly in the
10	predatory pricing scenario.
11	The question for the factfinder in these rule-of
12	-reason kinds of cases is simply in a Section 1 kind of
13	case, a vertical case where you have a contract and
14	therefore you can bring it under Section 1, does the
15	anticompetitive harm exceed the procompetitive benefit.
16	In the Section 2 case, it is, "was the defendant
17	able to apply or maintain monopoly power as a result of
18	the conduct or did it dangerously threaten to do so?"
19	And the way the rules and the economics come
20	into play is in helping the court decide what kinds of
21	inferences are permissible from the evidence, or in the
22	words of a famous case from way back in the '60s or
23	'70s -- I guess I'm showing my age -- if a frog be found
24	in the party punch bowl, one can infer the presence of a
25	mischievous guest, but not the presence of spontaneous

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1	generation.
2	That is the role of economics or that has been
3	the role of economics. That's how it has guided us in
4	the question of what inferences are possible, what
5	inferences are reasonable, from the facts that are
6	given.
7	So suppose, to take a hypothetical or a
8	paraphrase of a hypothetical that was used within the
9	Supreme Court in the last couple days, suppose you had
10	board of directors' minutes that said we are adopting
11	this practice even though it will be costly, even though
12	it is not going to earn us any profits because it will
13	cut off our rivals' air supply and ensure we will not
14	have serious competition for a generation.
15	In the absence of proof by the plaintiff that
16	the Ortho test is failed, can defendant get summary
17	judgment, or does plaintiff get to a jury, having
18	presented that evidence?
19	Well, I guess those of us who still remember the
20	law school side of the house -- and I realize that all
21	of us antitrust lawyers have slowly gravitated over the
22	years to being economists that simply haven't studied
23	enough to get a degree have to ask, what is the legal
24	framework, what is the legal system, how does the law
25	control what the role of the district judge is or what

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1	the role of the jury is, what the role of the Court of
2	Appeals is?
3	You would think that that case goes to the jury,
4	at least unless defendant can prove that this could not
5	possibly have caused the acquisition or maintenance of
6	monopoly power.
7	Now, it may be that people write documents all
8	the time, as someone earlier said, that they don't mean
9	or they are just deluded, and there may be a defendant
10	who can prove that. A lot of the real questions in
11	these areas devolve into questions of burden of proof.
12	When you get to the question of when is the
13	legal system confident enough to take those kinds of
14	questions away from the factfinder and to impose rules
15	that say this case cannot go to the jury, we will decide
16	it as a matter of law that such an outcome is right, you
17	are really looking for the kind of confidence that we
18	have in the predatory pricing area.
19	I think Tim started out his presentation with a
20	little bit of a refresher course on decision theory,
21	which I think is very apt, that we are all trying to
22	minimize the administrative costs plus the costs of
23	error, and having sensible administrable rules to do
24	that is a very valuable thing to do.
25	But at the end of the day, the question is in

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1	order to have a basis for applying that kind of rule, do
2	we have the kind of confidence that the cost of the
3	false positives in this kind of setting is going to so
4	swamp the cost of the false negatives that we should
5	simply say no, this kind of inference is not
6	permissible.
7	And I think, to borrow again from things that
8	I'm sure Tim Muris and others have said, one of the
9	virtues of the market is that it tends to be
10	self-correcting; whereas, misguided government
11	intervention tends not to be self-correcting, but,
12	rather, is persistent for a long time.
13	I think we should be cautious in this area as
14	well in applying per se rules that essentially cut off
15	the debate and end up not being self-correcting,
16	because, of course, if these instances of loyalty
17	rebates are per se lawful, unless plaintiff meets the
18	burden of proving something that is very difficult for
19	plaintiffs to prove, then those cases will never be
20	brought and you will not have the opportunity for the
21	development and refinement of those legal rules.
22	So I think I am much more comfortable with
23	presumptions and with rules of thumb that can be
24	overcome in the particular case. And in this
25	connection, I am somewhat taken by Dan Crane's

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1	suggestion that the legal standards might be different
2	purely in injunctive cases from the treble damage
3	situation.
4	I do think that to a large extent in antitrust
5	laws, our view of the substantive legal rules are shaped
6	by the institutional setting in which those rules are
7	developed, and properly so, because that tells you what
8	the cost of the false positives are, at least to some
9	extent.
10	In a setting where you don't have treble
11	damages, where the relief is purely prospective, you can
12	perhaps afford to experiment a little bit more or to be
13	somewhat more precise in the way you apply complex legal
14	rules or complex economic theories.
15	Here I am not going to please the Department of
16	Justice representatives or any of my former colleagues
17	at the Department of Justice. Because of the different
18	institutional settings that apply to those two agencies,
19	it is much easier for the Federal Trade Commission to do
20	that sort of thing than for the Department of Justice.
21	I have long found the portion of the Areeda-
22	Turner treatise that talks about applying a lower
23	substantive standard in Department of Justice injunctive
24	proceedings somewhat problematic because they are
25	applying the same statute that is applied in private

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1	cases, and to some extent the court doesn't have the
2	freedom to write different rules for the two different
3	sides, unlike Section 5, which is entirely different.
4	Indeed, if you go back and look at the
5	legislative history of the Federal Trade Commission Act,
6	it seems to be one of the very purposes for which the
7	Commission is created is to explore some of the cutting
8	edges, if you will, of the law and allow this expert
9	body to define prospective rules of the game in a way
10	that doesn't punish companies for past conduct that they
11	did not have reason to believe was unlawful.
12	I think given how much there is to talk about
13	among the panelists and how late it is in the day, I
14	think I will stop there and leave as much time as
15	possible for any discussion.
16	Thank you.
17	(Applause.)
18	MR. MEYER: Thanks very much. I think we will
19	take about 10 minutes as our break. It looks like it is
20	about quarter to three.
21	If we could all be back here in five minutes to
22	the hour, that would be great.
23	(Recess.)
24	MR. MEYER: We are ready.
25	We will start, as I said, with an opportunity

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1	for each of the panelists to comment on or reply to or
2	question the others about their remarks.
3	Just to shake things up a bit, I'm going to
4	suggest that we alter the order and start with Dan.
5	PROFESSOR CRANE: Sure. I guess I would like to
6	respond to one thing that Will said, which was the
7	hypothetical memo to the board of directors about the
8	reasons for a discount and how it could be exclusionary
9	of rivals.
10	The problem I would have with a legal standard
11	that focused on the intent of the defendant is that
12	usually it will not be a memo to the board of directors
13	but an e-mail to some third-tier manager that has some
14	inflammatory war metaphors for its metaphor about
15	crushing a competitor. And it won't be just one, it
16	will be three or four or five or six of these strung
17	together from millions of documents. You will always
18	find these in someone's files.
19	Although the memo to the board of directors
20	might be better evidence, in private litigation, if we
21	even raise intent as a consideration, it is those third
22	and fourth-tier manager e-mails that will become the
23	evidence that get to the people in the jury, even though
24	those e-mails really tell us very little about the true
25	efficiency consequences of the bundled discount program.

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1	I agree with Richard Posner that intent evidence
2	is evidence of anticompetitive conduct only two people
3	who sort of are foolishly taken by sort of aggressive
4	language. And juries certainly can be influenced by
5	that.
6	I think in the Brooke Group case, the post-jury
7	or post-trial interview showed the jurors had no
8	understanding about oligopoly, the average variable cost
9	test, but they were highly influenced by Brown and
10	Williamson's war documents. To me, that is not a good
11	standard.
12	MR. MEYER: Thanks very much.
13	Janusz, any thoughts?
14	PROFESSOR ORDOVER: I think that we are all
15	pretty much in agreement on a lot of aspects of how to
16	approach these kind of business practices.
17	My only question would be actually to Tim Muris,
18	whether or not we really have that much faith in
19	experimental economics to create the edifice of a big
20	chunk of antitrust laws, what it is that
21	well-incentivized graduates, undergraduates or even
22	faculty of the law school can do in these games.
23	I historically have been rather skeptical of
24	experimental economics. In this case, I think my
25	skepticism is probably heightened by virtue of the fact

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1	that the kind of environments in which litigation
2	actually takes place, the market settings in which the
3	actual litigations take place are very hard, I think, to
4	reproduce in the pure experimental setting.
5	I'm not saying there is no insight to be gained.
6	I'm trying to figure out whether or not this is enough
7	to say that we should allow X or that we should disallow
8	Z. I would say it is not.
9	It may be an interesting angle to look at
10	matters through the prism of these experiments. But I
11	would hate to have someone go to court and say that
12	Professor Vernon Smith, how much I admire his work over
13	the years, has shown that the experimental setting with
14	three firms, a bunch of graduates, X, Y, and Z cannot
15	happen, therefore the case should be dismissed.
16	I don't know whether you would go there. But I
17	would say that one shouldn't even try to go there.
18	That's my strongest reaction.
19	As to the Ortho test, of course I find it rather
20	attractive. The problem in that setting again, the test
21	was somewhat limited as to the broad application,
22	because it did involve again a very specific set of
23	relationships.
24	There was only one buyer, Red Cross, which
25	needed a whole panoply and did specify a whole panoply

161

1	of red blood tests that it needed, and it commanded the
2	two offerors to give them bundled and unbundled pricing.
3	Where the issue arose, where I really fell down
4	flat on my face, was because we had no cost data for
5	anybody to be able to apply any of these scratchings on
6	the napkin that I have generated as a foundation for
7	this whole analysis.
8	But again -- so now the question does arise
9	whether what the court did there and how they looked at
10	the allocation of margins and so on would be directly
11	translatable into other circumstances.
12	So from an intellectual standpoint, the source
13	of that test is of course the so-called compensatory
14	pricing test that Bobby and I have invented since 1980.
15	I'm sort of asking myself those questions
16	because I see the possibility for the application. But
17	I also understand the limited setting in which the test
18	actually had its traction may not have the kind of
19	traction that we would need in other contexts.
20	MR. MEYER: Thanks, Janusz.
21	When DOJ develops and opens its museum on
22	loyalty discounts, it will ask you to donate that
23	napkin.
24	PROFESSOR ORDOVER: I think it is part of the
25	record. Mr. Weinstein, whoever was the lawyer for the

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1	other side, actually he attached it to my deposition.
2	It should be someplace. I think I have it.
3	MR. MEYER: We will leave no stone unturned.
4	Since you have now posed two questions for Tim,
5	one that you just asked him about, experimental
6	economics, and the earlier one about age and looks, Tim,
7	you can respond now.
8	PROFESSOR MURIS: We will leave the second one
9	to a market test.
10	Let me make four points. You will probably hear
11	me either way. The first is just a point I repeatedly
12	make to the world, which is that when people say
13	Chicago, they are talking Posner and Bork, who don't
14	even -- Posner and Bork are the most extremely
15	differentiated on mergers. But Posner and Bork had
16	certain views that were not the views of a so-called
17	Chicago economist.
18	I don't consider myself a Chicago economist. I
19	like what is called the new institutional economics.
20	As a matter of fact, what is called Chicago
21	economics before 1960 invented and dismissed as
22	empirically irrelevant raising rivals' costs, variable
23	proportions as an explanation for why tying is
24	anticompetitive and why, RPM could be anticompetitive in
25	certain circumstances, all this by 1960.

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1	Posner and Bork came along, particularly in the
2	vertical practices, with what I think was a restrictive
3	and extreme view.
4	On experimental economics, there are some
5	economists who are concerned about experimental
6	economics. I think there is enormous validity to
7	experimental economics in the sense that basic
8	theoretical propositions of economics are verified in
9	the lab.
10	The beauty of the experiments is that one can
11	take Janusz's paper, which I obviously haven't studied
12	and deals with a different problem than was modeled in
13	the bundling, you could take that paper and you could
14	run it in the lab and run various differences and see
15	what happened.
16	In this world, for better or worse, experimental
17	economics is the one-eyed man in the kingdom of the
18	blind.
19	We are dealing with almost complete ignorance
20	about the empirical effects of bundling. We are taking
21	a ubiquitous practice in nonmarket power settings and
22	saying in market power settings there are problems here
23	based on an extreme set of assumptions.
24	My third comment is about bright-line rules,
25	which Will was talking about. Even -- I guess this will

164

1	turn out to be a point that Janusz may want to talk
2	about as well.
3	Even in Brooke Group, which appears to be a very
4	bright-line rule, courts are pushing it. Janusz
5	testified for Northwest in the Spirit -- is that --
6	PROFESSOR ORDOVER: Yes, I did successfully the
7	first time around.
8	PROFESSOR MURIS: Right, right.
9	The point is that the Sixth Circuit, Brooke
10	Group or no Brooke Group, was pushing the envelope
11	there.
12	And I think what we ought to do is look at the
13	world as we know it, and the world as we know it is a
14	world in which LePage's has caused lots of damage. We
15	have highly theoretical evidence of problems without
16	real world evidence.
17	Of course, the experiments were designed to push
18	and test and find exclusionary bundling and didn't. But
19	someone can go run modifications if they want, which
20	leads me to my fourth point, which is the Ortho test.
21	The Ortho test, as they say, Parker, is
22	obviously much better than the standard LePage's world.
23	The problem is that it is so easy for -- one of many
24	problems with Ortho besides the fact that it would
25	condemn efficient practices is that it is so easy to

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1	turn the safe harbor into the test.
2	I assume Professor Crane would reject that.
3	Professor Hovenkamp rejects that. But it would be very
4	easy to cross over that line.
5	When you are shifting presumptions makes a
6	difference. One of the interesting things on the
7	Twombley argument Monday was Justice Stephens through
8	the course of the argument, it appeared -- who knows
9	exactly, obviously -- it occurred to him that if he
10	allowed the complaint, from his questioning, if you
11	allowed the complaint, there was going to be some fact
12	that was going to survive a motion for summary judgment.
13	As a practical matter, maybe you did want to
14	scream at the complaint level. I wrote an amicus brief,
15	along with some other people at O'Melveny, supporting
16	the petitioners in Twombley. So I obviously have a dog
17	in that hunt.
18	Recognizing these real world practical
19	considerations, as Will and others have said, is
20	absolutely essential.
21	MR. MEYER: Thanks.
22	Will, your final opportunity.
23	MR. TOM: Let me just respond to Dan Crane's
24	last remark by repeating something that Joe Kattan said
25	this morning, and that is "intent to do what?"

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1	I think there is a danger in a lot of these
2	areas in using broad classifications to stand for a
3	whole bunch of disparate things, and that applies to
4	evidence as well as it does to some of the economic
5	issues we have been discussing here today.
6	I think most courts nowadays confronted only
7	with the intent evidence that says "let's crush our
8	competitors" would say that that is insufficient
9	evidence to go to the factfinder.
10	Whether you should then sweep into that every
11	other piece of evidence that you find in an internal
12	company document I'm highly dubious about.
13	MR. MEYER: Okay. With those comments, I think
14	we will turn now to the propositions.
15	In these hearings, we have been using
16	propositions merely as a starting point for discussion
17	and not necessarily as a set of propositions that
18	reflect the agencies' views either for enforcement or
19	otherwise.
20	If we go to slide 3, we will start with this. I
21	think perhaps we might have something like agreement,
22	but I will ask.
23	The proposition is the LePage's decision's
24	vagueness is likely to chill pricing behavior that
25	enhances consumer welfare. Agree or disagree?

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1	PROFESSOR ORDOVER: I agree.
2	MR. MEYER: We all agree?
3	PROFESSOR CRANE: I do agree. And from a
4	client-counseling perspective, I have been on a number
5	of calls in cases where someone is not a defendant but
6	simply trying to figure out what they can do and what
7	they can't do.
8	Without being too specific, for attorney-client
9	privilege reasons, if you have any moderate degree of
10	risk aversion, you can guess what the answer is.
11	It is oftentimes the case that you probably
12	wouldn't get sued, but you don't want to be the person
13	who gives the advice that we could bring in the smart
14	economist and convince the court to dismiss the case on
15	summary judgment.
16	You tell them you don't want to invite
17	litigation at all and it is always better to try to
18	unbundle a discount than to face the prospect of
19	litigation.
20	MR. MEYER: I certainly understand the need to
21	mask the specific facts. But are the situations that
22	you are describing ones where, at least in the mind of
23	the company involved, there is a clear pro-competitive
24	motivation or rationale for wanting to structure a
25	discount program and they are asking can we do this

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1	without fear of litigation or is it where they have the
2	structure and they are being asked is this going to pose
3	problems?
4	PROFESSOR CRANE: It really varies. Even what a
5	pro-competitive justification is I'm not always clear
6	on.
7	There are certainly cases where clients are
8	asking. Sometimes these bundled discounts are customer
9	driven, and large diversified buyers are putting
10	pressure on sellers to give them a concession for
11	buying, and that is simply responding to pressure from
12	the client.
13	Sometimes there is a question simply about using
14	as a competitive advantage, not to necessarily exclude a
15	rival, but because you think you can increase your
16	market share through a discount that takes advantage of
17	your diversification.
18	I think certainly I tell the client if the
19	discount is one that looks like it is going to really
20	harm the competitor to the point of extinction,
21	obviously you shouldn't do it. Even far short of that,
22	clients often think about this as a competitive
23	strategy.
24	PROFESSOR ORDOVER: Would the answer differ in
25	the following two settings?

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1	One, there are bundled discounts but we have
2	something called mixed bundling. In other words, you
3	offer a bundle, there is a good price, like the one that
4	ABA offered for two volumes of writings, but there is
5	also a stand-alone price.
6	Because of the not total disattractiveness of
7	the stand-alone prices, people can avail themselves of
8	buying one of the volumes and then buying a substitute
9	product somewhere else. But there are recognizable
10	efficiencies from bundling.
11	Does one get protected under any of these
12	LePage's standards or their progeny from the challenge
13	if you do indeed offer mixed bundling and you also
14	demonstrate that people are buying at the stand-alone
15	price?
16	PROFESSOR MURIS: That's an important point. I
17	think the hypothesis of the attack with LePage's is you
18	don't have a de facto time. It is calling it mixed
19	bundling.
20	MR. MEYER: Is the problem with LePage's from
21	the perspective of its vagueness and potential to chill
22	behavior, which I think we all agree to, is the problem
23	the lack of a safe harbor, the lack of a concrete cast
24	or the focus on the impact on rivals or something else
25	or all of the above?

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1	PROFESSOR CRANE: I think it is the lack of a
2	concrete test. Even though we had the Ortho standard,
3	it would be sometimes hard in a client-counseling
4	situation to anticipate how that would come out in
5	practice.
6	I think most bundled discounts would clearly
7	meet the Ortho safe harbor. And it is not even a
8	question of most cases.
9	What I think that would do is change the culture
10	of this issue in the courts, where you could tell a
11	client that only in really sort of egregious cases of
12	bundled discounting that has a clearly exclusionary
13	effect on single-product rivals will a court condemn it.
14	That will certainly change your willingness to
15	say go ahead and do it.
16	MR. MEYER: Let's turn to proposition 6.
17	This problem situation is as follows: Because
18	lower prices immediately benefit consumers, we should be
19	extremely careful not to adopt legal rules that can
20	result in false positives, that is, condemn legitimate
21	price cutting.
22	Do we agree or disagree with that proposition?
23	MR. TOM: I think the disagreement here will be
24	more on whether this proposition is one that is relevant
25	to the loyalty discount kind of setting rather than

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1	agreement or disagreement with the proposition itself.
2	I think we all agree that in general we like
3	lower prices to consumers as long as it is not an
4	exercise of monopoly power. You will not get a lot of
5	disagreement on that.
6	MR. MEYER: Is your question, Will, whether in
7	certain situations the loyalty rebates that are being
8	offered to particular customers actually result in the
9	overall prices paid by them being higher rather than
10	lower in the short term, or is this a long-term versus
11	short-term problem you are identifying?
12	MR. TOM: Even in the short term, there are
13	issues of what would the stand-alone prices have been,
14	absent allowing it.
15	MR. MEYER: Have we seen any cases where the
16	prices in the short term were higher?
17	MR. TOM: There was one mentioned this morning.
18	PROFESSOR CRANE: The SmithKline case this
19	morning.
20	The discussion this morning was that in
21	SmithKline, the offer was a 3 percent increase
22	accompanied by a bundled discount to buying the package,
23	which would suggest there was the possibility that even
24	in the short run, the defendant was not sacrificing
25	profits immediately by taking market share from

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1	single-product rivals.
2	MR. MEYER: Fine. Going back to the beginning
3	here and with Will's amendment, if the bundled discount
4	or loyalty discount results in lower prices in the short
5	term, we all agree that care should be taken to avoid
6	chilling such conduct?
7	PROFESSOR MURIS: I agree. Let me add, I wasn't
8	here this morning, but I assume that Professor Nalebuff
9	was probably the most aggressive on behalf of his
10	various rules.
11	If you look at Tim Brennan's comment on his
12	paper, it shows that in the equilibria, consumers are
13	better off in the short run virtually all the time.
14	That's the nature of excluding, what it means.
15	So the theory is really a long-run theory. It is not a
16	theory in the model. But that is really the theory.
17	And that's I think a very strong reason to agree with
18	the proposition that we need to be very careful.
19	PROFESSOR ORDOVER: I think to emphasize what
20	Tim said, I agree 100 percent. And that is in order to
21	close the model of these adverse effects, you really
22	have to have the second stage or the third stage and
23	when something bad actually does happen from a price
24	discount, unless you can show that, you don't have a leg
25	to stand on in the rest of the case.

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1	It could be a complicated set of issues to be
2	addressed, these intertemporal linkages, the R&D
3	incentives. But if the marketplace is not of the sort
4	that it is susceptible to exclusionary conduct over a
5	long haul, then I think we should really be very
6	protective of price cutting.
7	I think where the problem comes in is much of
8	the literature on loyalty rebates, as summarized in much
9	of Professor Elhauge's writings, actually show this
10	concept -- sort of like the rug carpet dealership or the
11	vitamin store where you always get 20 percent off. They
12	don't say what the benchmark over which you are
13	discounting is.
14	There is that issue. The equilibria in many of
15	these games, the discount is off of what appears to be a
16	super-monopoly price, and then really it boils down to
17	another point Tim made very importantly earlier today,
18	which is to say is that a credible threat for the
19	incumbent firm to say if you don't buy it from me, I
20	will charge you monopoly price plus 15 percent on top of
21	that.
22	Again, that is a complicated analytical issue,
23	whether or not this is a credible threat or not. It
24	really much depends on how you view this monopolist
25	power to guide the transactions.

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1	After all, you can say the same thing to a
2	monopolist who says, "look, I'm charging you $10 for the
3	widget." You say "hell with you, I'm not paying $10."
4	He says, "okay, okay, I will charge you 9." Then the
5	whole thing begins to unravel.
6	Every monopolist issue is that of credibility.
7	I think as Carlos pointed out, when the monopolist
8	cannot stick credibly to his threat, the monopolist
9	competing against himself will drag the price down to
10	his marginal cost.
11	We have the same question here. How credible is
12	the super-monopoly price as a way to enforce an
13	equilibrium in which everybody is paying close to
14	monopoly price, which is what the outcome is in the
15	naked exclusion model.
16	That's the story of that basic model which
17	Elhauge finds very attractive.
18	MR. TOM: For a clarification point, aren't most
19	of these models that are based on a super monopoly price
20	for the monopolized good and a discounted price for the
21	competitive good ones in which commitment is not
22	necessary because the purchaser of the bundle does not
23	face a price increase? That is, the excess of the
24	monopoly price on good A is no greater than the discount
25	on the competitive price.

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1	PROFESSOR ORDOVER: You end up in equilibrium
2	with something close to the monopoly price. In the
3	naked exclusion model, you end up with an equilibrium
4	where everybody is getting a penny off the dollar price.
5	That is again supported by what some people may
6	consider not credible threats of how the firm will
7	behave out of equilibrium.
8	That is the same problem in all of these models
9	potentially, actually, other than the Ordover-Shaffer
10	model in which the equilibrium is supported by credible
11	contracts.
12	I'm talking about game theory stuff. I don't
13	know whether it makes any difference to anybody here.
14	If you are trying to be serious about it, you try to
15	model it seriously. It is very difficult because it
16	does require this credibility.
17	MR. TOM: The credibility issue is that you will
18	still give the discount on the below marginal cost on
19	the competitive product even if he doesn't buy the
20	monopoly product?
21	PROFESSOR ORDOVER: Right. Or if somebody
22	refused to transact with you, that you will not revise
23	the market off.
24	MR. MEYER: Didn't you mean the other way
25	around? If you don't buy the competitive product, the

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1	monopolist will still charge just the monopoly price,
2	not the super-monopoly price.
3	PROFESSOR MURIS: Right. A couple points.
4	On FTC.gov, you can find in terms of naked
5	exclusion the originator of the concept, Michael Winston
6	-- unfortunately, this was a workshop we had that turned
7	out to be on September 11, 2001, which was a pretty
8	crazy day.
9	Anyway, the economists, they all stayed and
10	talked. And he said he didn't have a clue whether this
11	has any empirical significance or not, which I think is
12	an honest position.
13	In terms of the super-monopoly price, the
14	de facto time is the special case here. The reason the
15	Nalebuff thing is so important if it had empirical
16	significance is it is above-cost exclusion with mixed
17	bundling.
18	One of the interesting results of the
19	experiments that I did talk about is mixed bundling
20	still occurs a lot, virtually under every setting.
21	Mixed bundling again being where they are selling the
22	stand-alone as well as the bundle offering and selling
23	it.
24	And a further point of interest of the
25	experiments and in terms of -- remember, when you talk

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1	about exclusionary behavior, we are all agreeing the
2	point is on welfare, not on excluding competitors.
3	When ICES tweaked their model to try to really
4	push and show that bundling decreased welfare, they did
5	show big-time exclusion. But they showed very small
6	reductions in welfare, not statistically significant,
7	even under very extreme assumptions.
8	MR. MEYER: Let's go to proposition number 5, if
9	we could.
10	PROFESSOR MURIS: I think he is trying to
11	confuse us.
12	PROFESSOR ORDOVER: Like Lenin, two steps
13	forward, one step back.
14	MR. MEYER: I think the comments that Janusz and
15	Tim made may be a good segue to this proposition, and
16	that is a loyalty discount that allows a competitor to
17	operate profitably at some scale can never be harmful to
18	consumers.
19	Anyone want to take that one on?
20	PROFESSOR ORDOVER: I think that to use such
21	things as "never," even in the proposition --
22	MR. MEYER: How about taking it on as usually
23	can't?
24	PROFESSOR ORDOVER: I think we just don't know.
25	I think if the competitor can operate profitably, then

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1	there has to be a showing to condemn the practice that
2	somehow that scale which it can operate is so
3	sufficiently constricted as to render basically the
4	competitor, the rival marginally profitable, much less
5	constraining of the market outcome than in a less
6	constricted equilibrium.
7	So the question is that of the benchmark,
8	really. The consumers benefit from having competition.
9	If the scale is sufficiently large, the
10	competitor cannot be profitable and exert competitive
11	pressure. Then I would say that's good enough. If the
12	competitor is completely marginalized, it is one of the
13	few competitors that can exert any kind of competitive
14	pressure, I believe that possibly could be a
15	circumstance that may require some remedial
16	intervention.
17	MR. MEYER: Others?
18	PROFESSOR MURIS: Let me preface this by saying
19	all of my comments reflect this basic framework of the
20	efficient legal system.
21	George Stigler once wrote a piece where he just
22	numbered the comments, the first one, of course, being a
23	Chicagoist, this is just a coast theorem.
24	Everything I'm saying is in the context of
25	efficient legal rules. Here the models that people are

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1	positing are models of complete exclusion. If we have
2	quote partial exclusion, Janusz is absolutely right; I'm
3	sure you can conjure up a situation where that is bad.
4	As a practical matter we ought to be cautious if
5	the exclusion is partial in terms of false positives.
6	PROFESSOR ORDOVER: I agree. The European
7	Union's white paper, pink paper, whichever color they
8	use on anticompetitive conduct has some complicated rule
9	dealing with something called the suction test and the
10	loyalty rebates.
11	I tried to figure out what it means empirically,
12	how to apply it. It strikes me as a rather difficult
13	undertaking.
14	If the competitor can operate profitably, the
15	burden shifts drastically against the complaining rivals
16	to show that something else could have happened but for
17	this conduct that truly would benefit welfare.
18	I would apply a very strict test to what it is
19	that can be shown or should be shown. It was a minimum
20	showing in such a circumstance from the competitor.
21	MR. TOM: In fact, you are looking for the
22	rival's marginal cost to be raised in such a way that
23	the perpetrator can raise prices.
24	MR. MEYER: In the spirit of jumping around, I
25	think we will go to slide 8.

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1	We have already heard a little bit of debate
2	about this in the earlier dialogue, but to state this
3	proposition. In a loyalty discount case "intent is
4	relevant to proving monopolization." Quoting from
5	LePage's.
6	I will start this, conscious of the prior
7	comments, by first asking whether if you have intent --
8	maybe we can all agree on this. If the evidence is
9	simply that the defendant intended to cause harm to his
10	rivals, to drive its rivals out of business, to raise
11	their costs, to steal sales from them, is that ever
12	enough to get to a jury?
13	PROFESSOR CRANE: Just to repeat what I said
14	before, part of the problem is I don't know what a
15	corporation's intent is.
16	A corporation is a fictional person. Will's
17	suggestion that we can't simply lump all intent in the
18	same category maybe is right in theory.
19	When you get to actual litigation, if the legal
20	standard is framed as an intent-oriented standard or one
21	where intent is a relevant proposition, how do we
22	separate out the different kinds of intent and at what
23	stage in the litigation?
24	Is this a role for the court in summary judgment
25	to sort of talk about different kinds of intent and sort

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1	of sort them out as a screening device?
2	I think that would get rather difficult to do.
3	Again, it would also create a predictability problem.
4	In most cases, the objective economic evidence
5	will be available for something like the Ortho test, and
6	it really should not be necessary to go to intent.
7	MR. MEYER: Any other reactions to the first
8	question?
9	MR. TOM: To your specific question, certainly I
10	think everyone would agree on 1 and 3. I'm not sure
11	that everyone would agree that a demonstration that your
12	plan was to raise your rival's cost would necessarily
13	get a free pass.
14	PROFESSOR ORDOVER: Competition is about killing
15	your rival, really, or diminishing its capability as far
16	as you can do that.
17	The real question is is it done in a way that is
18	conducive to consumer welfare or done in a way that
19	harms it for horizons we are comfortable to deal with,
20	whether you can sort it out efficiently without running
21	into these other problems or without having the current
22	rival abusing the system.
23	I think one should not view intent as really a
24	bunch of nasty e-mails. One should look to intent as a
25	manifestation of business practice that has a likelihood

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1	of harming competition.
2	From my perspective, when I teach my kids about
3	competition, they say what do you do when you run
4	experiments at NYU, yes, you try to vanquish your rival,
5	but try to do it in such a way that is conducive to
6	welfare. Let them figure out what that means. That's
7	the true story.
8	MR. TOM: Is that the jury instruction?
9	MR. MEYER: What if instead of being evidence of
10	1 and 3, as the shorthand we will use, and I think what
11	that means, if I'm recalling my own comment, is evidence
12	of a desire to kill the rival or eliminate the rival or
13	steal sales from the rival, instead of that you had
14	documents or testimony that constituted a very detailed
15	analysis of the reasons why the business wanted to
16	engage in this practice of structuring the discounts in
17	the way they were structured that had appeared on its
18	face to have nothing to do with hurting the rival or
19	excluding the rival.
20	Would that be probative in some way?
21	MR. TOM: It seems like it would be probative of
22	an efficiency justification or lack of competitive
23	effect, if I'm understanding your question right.
24	PROFESSOR ORDOVER: It could be probative of the
25	fact that the practice makes sense, that the competitive

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1	practice irrespective potentially of how it affects the
2	competitive marketplace, if that's your question.
3	PROFESSOR MURIS: Under Brooke Group, since I'm
4	arguing for modified Brooke Group, you have this
5	price-cost safe harbor. If you fail that, you need to
6	show the entity competitive effect. There are obviously
7	places where the law makes intent relevant, including
8	Norr Pennington, for example, especially in the
9	so-called pattern case because of the nature of the
10	First Amendment protection.
11	But here I think you need -- this is one of your
12	other propositions, if I'm jumping the gun. I think you
13	do need price-cost benchmarks to start with.
14	PROFESSOR CRANE: Intent is certainly relevant
15	in an attempt-to-monopolize case, because intent is a
16	specific intent crime and the Supreme Court has made
17	clear that intent is relevant.
18	But intent in a case like Spectrum Sports would
19	only come in in addition to a showing of exclusionary
20	conduct.
21	As to that element, a legal defense might
22	concern LePage's in that it seems to make intent part of
23	that element of the offence, which is anticompetitive or
24	exclusionary conduct, which seems to suggest that even
25	if you have weak evidence, sort of economic evidence of

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1	exclusionary conduct, that intent can make up for the
2	weakness in that showing, which I think should not be
3	right.
4	MR. MEYER: What are your thoughts on this
5	question? Can good intent save you even if it turns out
6	that you were wrong?
7	For example, there are detailed analyses that
8	all the prices are going to be above cost, no matter how
9	you measure them incrementally or in the aggregate, and
10	it turns out there was a math error. How does that case
11	come out?
12	PROFESSOR CRANE: That's the historical accident
13	standard, where you monopolize completely by mistake. I
14	will use that on my antitrust exam. It is a
15	hypothetical case.
16	I don't think the defendant should have a
17	defense that we had benign intent. But, of course,
18	pro-competitive justifications as the explanation for
19	the conduct could be like the defendant's intent. I
20	think, of course, that's always permissible.
21	PROFESSOR ORDOVER: Especially in certain areas
22	of business conduct, for example, R&D, research, it may
23	turn out it is more costly than you planned or more
24	successful than you thought it was going to be.
25	When you have business activities with

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1	themselves, random outcomes hard to predict, it is key
2	that one should not hang somebody for a circumstance
3	that is one of the possible many outcomes, most of which
4	or at least ex ante believe that you are going to be
5	acting in a pro competitive manner.
6	If you embark on an R&D program which may cause
7	some problems for your competitors but it turns out you
8	are now going to be spending 10 percent more, somebody
9	said if you knew you were going to spend 10 percent
10	more, now you are killing us.
11	It is the sort of ex ante nature of the
12	calculation that is the right way to look at it.
13	MR. MEYER: Janusz, you promised one step back.
14	We will go back to slide 7.
15	PROFESSOR ORDOVER: I'm no Lenin.
16	MR. MEYER: Loyalty discounts, either single
17	product or bundled, should never be condemned without
18	applying some kind of price-cost test.
19	Tim, I think you said you agree with that.
20	PROFESSOR MURIS: Sure, for the reasons of
21	administrability and an efficient operation of the legal
22	system.
23	PROFESSOR CRANE: I would add in addition to
24	what Tim said also just for the purpose of disciplining
25	litigation.

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1	The problem with sort of open-ended standards
2	that don't contain sort of concrete legal rules is that
3	the district courts tend to interpret these as
4	invitations to punt issues downstream to juries, and
5	that then leads to forced settlement because people are
6	risk averse and don't want to go to trial.
7	Part of this is not simply from business
8	planning purposes. It is also to give a more
9	disciplined structure to motions to dismiss, and for
10	summary judgment that allows very serious screening of
11	cases so that only the very most meritorious cases ever
12	make it to a jury.
13	MR. TOM: I'm not sure if this one is right or
14	not. The reason I say that is that what you are
15	essentially saying is the application, the passing or
16	failing of a price-cost test is part of plaintiff's
17	burden of proof and that without meeting that burden,
18	the plaintiff should fail.
19	Maybe that's right. Maybe we know enough about
20	these price-cost tests and we know enough about the
21	ability to prove this that it should be part of
22	plaintiff's burden.
23	On the other hand, if you take my board of
24	directors hypothetical, if you will, maybe one should
25	say, well, the ultimate question under the law as it has

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1	been handed down to us is is this conduct on that
2	pro-competitive or anticompetitive.
3	Plaintiff has come forward with some evidence.
4	If defendant is able to rebut it by application of the
5	price-cost tests, then we will accept that as a trump.
6	But it is not part of plaintiff's prima facie case.
7	I don't know which one is right. Maybe the
8	economists on the panel or others can give us all some
9	empirical basis for knowing which is more likely to lead
10	to better results.
11	MR. MEYER: It sounds like your alternative
12	approach as you have described it would mean there is no
13	safe harbor that a business can rely upon but, rather,
14	that cases would go to summary judgment, past summary
15	judgment to the jury if there is any evidence from which
16	a jury could reasonably find --
17	MR. TOM: No, I don't think that's quite right,
18	because, of course, if it is a trump, if the price cost
19	is a trump, it is defendant's trump, of course the state
20	of the record on summary judgment may be such that there
21	is no question of material fact in dispute as to that
22	trump. Then it doesn't go to the jury.
23	It is really -- I think that the difference is
24	not whether these cases automatically go to the jury.
25	The difference is who has to come up with this evidence

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1	and which way do these cases get decided under a state
2	of uncertainty as to the price-cost test.
3	Or another way of putting it is is our knowledge
4	of the price-cost test so superior to any other
5	knowledge that we can bring to bear on the ultimate
6	question of competitive effect that we should make it
7	part of the prima facie case.
8	MR. MEYER: Let me flip the question around a
9	little bit and ask let's say it were an affirmative
10	defense so that at summary judgment the defendant could
11	prevail if it demonstrated there was no dispute that
12	prices were above cost.
13	Is it a different answer in that case or you
14	still want to allow more of what I will call an
15	open-ended inquiry into that.
16	MR. TOM: If defendant can show that, that's
17	pretty convincing.
18	MR. MEYER: Janusz, any thoughts?
19	PROFESSOR ORDOVER: As an economist, I'm very
20	fond of tests that are clear-cut and also try to compare
21	some sort of price to some sort of cost.
22	But I think a price versus cost test is a very
23	ambiguous standard because we already have heard today
24	that there could be average price, average cost, there
25	could be marginal price vis-a-vis opportunity cost,

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1	which is what the Ortho cost was, where the marginal
2	price was the incremental revenue under tests that Ortho
3	could have provided against Abbott. And the question
4	was which of the allocation of the costs ought to be
5	brought into the particular calculation.
6	So there is nothing wrong with price versus cost
7	tests. The question is is it the right test in each and
8	every case that involves possibly anticompetitive
9	conduct.
10	As an economist, I really don't know. If I were
11	to be advising petitioners, I would say let's try to
12	come up with as clear rules as we can. We ought to be
13	comfortable with understanding the meaning of the price
14	and the meaning of the cost in the test, comfortable
15	with advocating the correct price and the correct cost.
16	MR. MEYER: Is there a clear rule you would be
17	comfortable with, Janusz, as to a particular price and a
18	particular cost as a safe harbor for these kind of
19	loyalty discounts?
20	PROFESSOR ORDOVER: In the Ortho test, I thought
21	the rule, which was already my prior work and which is
22	consistent with much of the telecommunications
23	regulatory practice, where it came from, the efficient
24	component pricing rule, which is the progeny for all of
25	this, I thought was a good rule. And I would like to

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1	see that be applied if possible.
2	But there could be circumstances in which one
3	can try to argue that it is not the right one, that a
4	better calculation would be to look at the average cost
5	versus average price of some sort.
6	I think that in, for example, U.S. versus
7	American Airlines, I thought that the relevant test
8	would be applied to profitability of the route, because
9	the contestable object there was the route or a large
10	portion of the route, as opposed to marginal flight,
11	which was not what the gain was all about.
12	I don't have a hard and fast rule, and I would
13	like to be able to argue for some degree of flexibility,
14	in part because different circumstances may call for a
15	different version of this thing called the price-cost
16	test.
17	MR. MEYER: Is there any rule that you would say
18	a monopolist or a firm --
19	PROFESSOR ORDOVER: Let me come back next year.
20	MR. MEYER: -- could take comfort in as a safe
21	harbor?
22	Is there some minimum least common denominator
23	in your various approaches so that you would be
24	comfortable with a rule that said these situations will
25	never be the source of Section 2 liability?

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1	PROFESSOR ORDOVER: I don't think that I'm that
2	smart or that obnoxious to have such a vision.
3	Again, as I said, I said something along these
4	lines in the Ortho test. I thought that was not a bad
5	test.
6	I also think in different settings, much broader
7	increments of output ought to be the test. I think it
8	has to be looked at in the specifics of a particular
9	case as much as possible.
10	MR. MEYER: Tim?
11	PROFESSOR MURIS: I think then-Judge Breyer said
12	we just have to remind ourselves, in Barry Wright,
13	"unlike economics, law is an administrative system, the
14	effects of which depend on the content of rules and
15	precedents only as they are applied by judges and juries
16	in courts and by lawyers advising their clients" in this
17	pricing area.
18	We get ourselves away from price-cost benchmarks
19	and we are lost, I think.
20	That's what the world was like when predatory
21	pricing cases were brought at the drop of a hat.
22	I sat in a Commission conference room in 1975
23	and 1976 when the coffee case was debated, and it was a
24	case that everyone in this room would now regard as nuts
25	but was seriously being pursued as any of the above.

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1	And what happened there was when Proctor &
2	Gamble was relieved from a Commission order that
3	prevented it from expanding that was the condition of
4	purchasing Folger's, it immediately marched into the
5	east into General Foods' territory.
6	General Foods, panic faced with the Proctor &
7	Gamble of the 1960s, 1970s, created horrendous
8	documents, and the FTC wanted to bring the case and they
9	voted repeatedly not to bring it, and the staff kept
10	bringing it back until they voted to bring it.
11	Again, it was a manifestation of lots of things,
12	but there were lots of predatory pricing litigation,
13	lots of uncertainty. And it was ended by Brooke Group,
14	and I think purposely so.
15	Even now we still have fighting at the edges.
16	It was ended by a test that will have some mistakes, but
17	I think it is essential.
18	PROFESSOR ORDOVER: I want to comment on this.
19	I think as you so beautifully said, the thing that makes
20	me be less sure than I generally try to be of myself is
21	that the source of that price quote status was a notion
22	that in a perfectly competitive environment, the firm
23	would not go below marginal cost. That's what it was.
24	That was the foundation.
25	The problem that we have is in many of these

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1	cases that we are dealing with, all of them do not take
2	place in perfectly competitive environments.
3	Because they don't take place in perfectly
4	competitive environments, the question then becomes what
5	lessons can we learn out of a perfectly competitive
6	model that would illuminate the competitive effects of
7	these interactions in markets which are by definition or
8	by experience two or three standard deviations from the
9	perfectly competitive ones.
10	I really want to make sure that we don't get
11	ourselves entangled in this price-cost test as being an
12	economic foundation of anything. But I am perfectly
13	happy to view those as being the right things to look at
14	given the administrability and the clear-cut statement
15	that one can make to the firm that is trying to compete
16	hard in the marketplace.
17	PROFESSOR MURIS: Perfect competition exists
18	nowhere. I would agree with that.
19	My favorite example is the hot dog vendors out
20	there on the street. When they rise their price, they
21	don't lose all of their sales. That means they have a
22	downward-sloping demand curve, period.
23	That is because of transaction costs and various
24	things, not because of market power. Even Areta and
25	Turner in the article admitted that firms for lots of

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1	reasons would price below something that looked like
2	marginal cost for their average variable cost proxy.
3	I obviously accept that and understand, as you
4	said, that administrability is a key part of the
5	equation.
6	MR. MEYER: I will jump to proposition 2, which
7	is an extension from the prior proposition. Maybe we
8	will make progress if you will move backwards.
9	This is a quote from Herb Hovenkamp's recent
10	paper.
11	"Single-product discounts should be per se
12	lawful if the overall price for all units exceeds cost."
13	Janusz, why don't we start with you.
14	PROFESSOR ORDOVER: I was paying attention to
15	something else.
16	MR. MEYER: Talking about various price-cost
17	tests and situations where you thought a broader
18	calculation of price cost -- is this one?
19	PROFESSOR ORDOVER: I think, again, it much
20	depends on the circumstances. I think that if the
21	average price is above cost, then again there is a
22	burden-shifting exercise saying, well, there are these
23	discontinuities or jumps in the loyalty schedule and
24	they have potentially serious competitive effects.
25	Is there a reason why we should not look at the

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1	average price versus average cost as being the right
2	indication of how competition will play itself out?
3	It could be that in some particular settings,
4	comparing the two averages may just be inadequate in
5	trying to really sort out all the potential competitive
6	effects. But I would try to do that through the burden
7	kind of shifting as opposed to per se blanket rule.
8	In particular, in Ortho it was quite clear that
9	Abbott was going to get an average return on all of its
10	five tests that were way above its total average cost
11	across these five tests. There was still a potential
12	competitive issue.
13	MR. MEYER: This statement is limited by its
14	terms to a single-product situation.
15	PROFESSOR ORDOVER: Wait a second. If you
16	believe in the competitive equilibrium model, every good
17	is a single different thing.
18	We shouldn't get all hung up on this just
19	because I called something -- there is something to be
20	said about the uniformity of widgets versus not.
21	But what about airline flights? Is flight 05
22	the same product as flight 07? How should we look at
23	it?
24	We have to try to think a little bit more
25	broadly as opposed to saying this is a bundled rebate

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1	and therefore two different products as opposed to the
2	single product and, therefore, the 17th widget is the
3	same thing as the 15th widget. That is all true.
4	In particular circumstances, the 17th widget
5	gets a certain kind of weight in how the equilibrium
6	outcome looks that you have to try to pay attention to.
7	In my opinion, we should not hide behind just
8	the differences in the product names but in the economic
9	circumstance that is driving it.
10	PROFESSOR CRANE: To the extent this is directed
11	at the Concord Boat situation as opposed to the LePage's
12	situation, it is correct. One can imagine circumstances
13	where single product loyalty discounts or volume
14	discounts, market share discounts could have
15	anticompetitive consequences.
16	The same sort of discipline that one needs in
17	litigation for bundled discounts also applies in cases,
18	in fact, applies arguably even more in cases involving a
19	discount on a single product.
20	I think this actually is a law today in Brooke
21	Group quite clearly and it is appropriately law.
22	MR. TOM: Let me just take exception to that.
23	I actually find what you just said a little bit
24	surprising in light of the fact that you were defending
25	an incremental revenue, incremental cost test in the

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1	multiproduct situation. And I think Janusz is
2	completely right, that it can be very difficult to
3	distinguish single product from multiproduct situations
4	as a theoretical matter.
5	So in terms of appropriate safe harbors, the
6	ones that we have mostly had on the table today have
7	been either incremental revenue, incremental cost or
8	average revenue, average cost, which I think Professor
9	Muris was advocating.
10	I think this proposition can only be justified
11	on the administrability and cost of false positives and
12	false negatives kind of argument because there are
13	certainly plenty of possibility proofs that show that
14	you can have anticompetitive effects in this situation
15	even with overall price exceeding overall cost.
16	So the piece that I'm not hearing -- and maybe
17	Hovenkamp lays it out in this article, and I haven't had
18	the opportunity to read it -- is how do we know, what do
19	we know about the prevalence of false positives or the
20	prevalence of false negatives and the cost of false
21	positives and the cost of false negatives?
22	Is this situation such that you would advocate
23	an average cost, average revenue rule rather than an
24	incremental cost and incremental revenue rule?
25	MR. MEYER: For the benefit of all of us, the

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1	average revenue/average cost rule is what you are
2	saying --
3	MR. TOM: What I read this proposition to say,
4	yes.
5	MR. MEYER: Divide total units by total dollars.
6	PROFESSOR MURIS: Let Dan respond.
7	PROFESSOR CRANE: I wasn't trying to defend any
8	particular measure of cost, whether it is variable cost
9	or average total cost.
10	I was simply suggesting that you should use a
11	cost-based test in all cases involving single-product
12	discounts.
13	Again, even in a classic predatory pricing case,
14	what the appropriate measure of cost should be is
15	something that there is a lot of debate over.
16	Without defending any particular cost test,
17	though, I think that the proposition is correct, that is
18	to say, whatever the appropriate measure of cost is, if
19	that cost is recouped on the overall sale to a client,
20	then the discount that created the overall sale should
21	be legal.
22	PROFESSOR MURIS: Perhaps Professor Hovenkamp
23	had some idea of long run here. It doesn't matter. If
24	you are going to apply these tests, in the short run
25	real world, you will have to separate out the variable

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1	costs, I would think.
2	You can have differences in different industries
3	and how you define costs. And the airline case raises
4	lots of complex problems, I agree. But I don't think I
5	read this to say that we are talking averages total cost
6	versus average total revenue.
7	MR. TOM: Sorry for being less than clear. I
8	wasn't really addressing what kind of cost is
9	appropriate in the Brooke Group kind of situation.
10	What I was addressing was the kinds of tests
11	that have been applied in the writings on Concord Boat.
12	Do you look at the incremental sales that were
13	induced by the loyalty program and look at the revenues
14	from those incremental sales and compare it to the
15	incremental cost or do you apply a Brooke Group test
16	that says you take all of the sales, all of the revenues
17	and compare it to all of the costs for all of the sales.
18	That's all I was saying. Frankly, I don't know
19	which is the right test. I think if finding out what
20	the facts were cost free and error free, then I would
21	think this is clearly the wrong test.
22	PROFESSOR ORDOVER: If you take the Concord Boat
23	stylized example in which the challenger can go
24	profitably after a particular dealership in the view of
25	the loyalty schedule that applies to the dealership,

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1	obviously there is nothing to debate anymore, right?
2	If indeed it is profitable to serve that by
3	virtue of the fact that what the incumbent is charging
4	is sufficiently above cost, whatever the right measure
5	is, then you would think the effective or efficient
6	challenger should be able to squeak under it somehow and
7	capture the sale, which is why these price-cost tests
8	make some economic sense.
9	But, again, the issue is what it is that can be
10	challenged and how much of an obstacle it is if you are
11	required to challenge just the margin.
12	MR. MEYER: If you all have a few more minutes,
13	I would like to ask one further question, taking us out
14	of the realm of safe harbors.
15	Assume that whatever safe harbor is out there is
16	not applicable, and we are now asking the question
17	should the court condemn a particular loyalty discount
18	program.
19	What sorts of business justifications or
20	efficiencies should the defendant be entitled to bring
21	forward to escape liability?
22	And, for example, perhaps it is obvious that if
23	there is a particular efficiency associated with
24	incenting a bundle, that that ought to be clearly
25	cognizable, but what about simply the lower prices that

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1	are being paid by consumers in the short run or gains in
2	share that the firm realizes by making its bundle more
3	attractive to those consumers. Reactions?
4	MR. TOM: I'm not sure how we quite leapfrogged
5	from the safe harbor to the efficiency justification.
6	It seems to me we have skipped the anticompetitive step
7	in between.
8	You can fail the price-cost test, but you would
9	still want some sensible explanation of how this gives
10	the defendant power over price, how prices go up as a
11	result. And if price doesn't go up or indeed goes down,
12	then I think you never get to those efficiencies.
13	MR. MEYER: Assume a plaintiff is coming forward
14	and arguing that you are going to be excluding your only
15	competitor by pricing this way, that you won't have any
16	competition because a competitor cannot match the
17	bundled price or the program. Assume that.
18	MR. TOM: Then you may get into a debate I don't
19	like to get into about consumer welfare versus total
20	welfare, which is a little too theological for my taste
21	or at least for my knowledge.
22	So I will leave that to more expert folks.
23	MR. MEYER: What justifications can a firm offer
24	for successfully excluding its rival using some kind of
25	pricing program like this?

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1	PROFESSOR CRANE: I think obviously there are
2	plenty of pro-competitive reasons, like it costs less to
3	sell the bundle. Those are obvious ones.
4	The real question would come up if the plaintiff
5	met whatever its prima facie case was and then the
6	defendant was put to the burden of responding through
7	some sort of explanation for why they offer the discount
8	package. And things like price discrimination would
9	come up.
10	To the extent that mixed bundling is explicable
11	because it is device for price discrimination, how
12	should that cut? Price discrimination could be good for
13	output. It can increase output. It can reduce output.
14	Very hard to show sort of which way that cuts.
15	So to me, any explanation that the defendant
16	could offer that's accepted as the true explanation that
17	is not an exclusionary explanation should be legitimate.
18	MR. MEYER: That sounds like a no economic sense
19	test.
20	PROFESSOR ORDOVER: It is a good one.
21	PROFESSOR CRANE: It is a pretty good one. We
22	have some support on the panel for it.
23	I think the sacrifice test or no economic sense
24	test is difficult as a starting point. When it comes to
25	defenses, it makes some sense, I think.

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1	MR. MEYER: Other reactions?
2	MR. TOM: Let me just pose a question on that
3	last one.
4	I said I didn't want to get into the total
5	welfare versus consumer welfare. But I want to know if
6	that's the question you are posing.
7	You are hypothesizing that the result of this
8	conduct is that prices to consumers go up. That is,
9	whatever the efficiency justification, it doesn't lower
10	the monopolist cost sufficiently that the price actually
11	goes down. Am I correct in understanding that?
12	MR. MEYER: That's a good question. I wasn't
13	being nearly so theological.
14	MR. TOM: Go ahead.
15	PROFESSOR MURIS: There are lots of them, and I
16	prefaced them at the beginning and in the paper,
17	specific efficiency justifications one can think of to
18	stick with bundling.
19	We need to step back and realize we are in a
20	world where bundling is everywhere in very competitive
21	markets. That in itself is an enormous empirical
22	proposition of the efficiency benefits of bundling.
23	PROFESSOR ORDOVER: I think that is
24	undisputable. In fact, it is the case with many of
25	these kinds of loyalty rebates as well.

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1	You go to Starbucks. You used to get your 10th
2	cup of coffee free if you bought nine. Then you have a
3	big discontinuity.
4	MR. MEYER: No one else can sell you that 10th
5	cup, right?
6	PROFESSOR ORDOVER: It makes you drink the 10th
7	cup and get jittery.
8	There are some good reasons for stimulating
9	demand, especially when you have a world in which the
10	marginal cost is really low and you want to drive
11	demand. It is a very powerful driver.
12	When you have asymmetric information between the
13	buyer and the seller or in many of these environments
14	that people talk about, the GPO is insisting on
15	discounts that are not volume driven but share driven in
16	part on this theory that the differently situated
17	hospitals are to be equally treated. And just because
18	you are a small hospital, you can only buy 10 units of
19	X, and if you are the big one, you can buy 100 units.
20	You should not be somehow disadvantaged because of that
21	because you are under the umbrella of the GPO.
22	Some people say that is silly or what. There
23	are -- if you go back to the case that was not quite
24	fully litigated, Virgin British Airways case which
25	pitted Schmazi against Bernheim, two pillars of

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1	antitrust and higher economics.
2	There was a lot of discussion as to the
3	usefulness of these various mechanisms as drivers of
4	volume of sales at the travel agency level, which is
5	where much of the action was.
6	Rewinding the Areta paper by ten years, we will
7	learn a lot of what the economics was at that time.
8	Schmazi had a large number of defenses that he
9	put forth why share-driven contracts were in fact
10	efficient or optimal in some cases, and Bernheim took a
11	somewhat different legal, working for Virgin.
12	It is a case which we have not cited here, but
13	it has a lot of levity in economics.
14	MR. MEYER: We could go on forever here, but we
15	won't.
16	I want to thank everyone on the panel for an
17	excellent discussion. Thank you all for attending.
18	The next session will be next week, December
19	6th, I think, on misrepresentation and deceptive
20	practices.
21	Thank you all for coming.
22	(Whereupon, at 4:08 p.m., the hearing was
23	concluded.)
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C E R T I F I C A T I O N O F R E P O R T E R

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DOCKET/FILE NUMBER: P062106

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CASE TITLE: SECTION 2 HEARING

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DATE: NOVEMBER 29, 2006

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I HEREBY CERTIFY that the transcript contained

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herein is a full and accurate transcript of the notes

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taken by me at the hearing on the above cause before the

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FEDERAL TRADE COMMISSION to the best of my knowledge and

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belief.

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DATED: 12/18/2006

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BRENDA SMONSKEY

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C E R T I F I C A T I O N O F P R O O F R E A D E R

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I HEREBY CERTIFY that I proofread the transcript

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for accuracy in spelling, hyphenation, punctuation and

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format.

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DIANE QUADE

Updated January 2, 2024