Global Antitrust Institute

Economics Institute for Competition OfficialsNovember 2015

Predatory Pricing and Bundled Discounts

Bruce H. Kobayashi, Professor of Law and Director, Global Antitrust Institute

• Arevolutioninpredatorypricinglawbasedlargelyuponananalysisoferrorcosts

• Inparticular,courtsrespondedtoevidenceineconomicliteratureshowingapparentlowprobabilityoffalsenegativesandintuitivelylargecostoffalsepositivesfrompreventinglowprices

Error Cost Matrix for Predatory PricingTruly Anticompetitive

Truly Procompetitive

Antitrust Liability Based Upon Predatory Pricing

Correct Positive (Liability)

False Positive (condemn procompetitivepricing behavior)

No Antitrust Liability Based Upon Predatory Pricing

False Negative Error (failure to address predatory pricing)

Correct Negative Outcome (No Liability)

The Economics of Predatory Pricing• BasicPredationTheory:pricingataleveldesignedtodriveout

competitorsuntilonecaneffectivelychargethemonopolypriceorchargeitforalongerperiodoftime.

• Thefollowingassumptionsunderliethistheoryinitsbasicform:- Rivalhaslittleornoaccesstocapitalmarkets- Therearesubstantialbarrierstoentry- Rivalshavelimitedcounterstrategies

• Theseproblemshavecausedsomecommentatorsandcourtstobeveryskepticalaboutpredatorypricing

Matsushita: Is Predation Rational?• CostsNow,BenefitintheFuture

• AsymmetricCoststhatdisfavorpredator• FutureBenefitsspeculative

MonopolyProfits(πMperperiod)time

timet=0

NonPredationProfits(πD perperiod)

CostofPredation

MonopolyProfits(πMperperiod)time

timet=0

NonPredationProfits(πD perperiod)

CostofPredation

MonopolyProfits(πMperperiod)time

timet=0

NonPredationProfits(πD perperiod)

CostofPredation

MonopolyProfits(πMperperiod)

time

timet=0

NonPredationProfits(πD perperiod)

NonPredationProfits(πD)

CostofPredation

Brooke Group• Price below relevant measure of cost• Dangerous probability of recoupment:

• Rule of reason style analysis focusing on market conditions: barriers to entry, concentration, financial strength, pricing incentives

Areeda-Turner Test and Above Cost Safe Harbor• The basic economic logic of the first prong of the

“Areeda-Turner” test is that observing single product pricing below cost raises some questions about the motivation of the pricing strategy.

Areeda-Turner Test and Above Cost Safe Harbor• The basic economic logic of the first prong of the

“Areeda-Turner” test is that observing single product pricing below cost raises some questions about the motivation of the pricing strategy.

• Rules versus Standards• Per Se Illegal• Rule of Reason• Per Se Legality

Montana– 1995to1999– NoFixedDaytimeSpeedLimitDeFactoLimits80-90ReasonableandPrudentheldtobeunconsitutionally vague(Statev.Stanko)

Pure Bundling

Marketing Bundle – Mixed Bundling

Discountattributiontest(akaHEECTest):

“afterallocatingalldiscountsandrebatesattributabletotheentirebundleofproductstothecompetitiveproduct, thedefendantsoldthecompetitiveproductbelowitsincrementalcostforthecompetitiveproduct.”

$225+$54=$279BundledDiscount$279- $165=$114

BrookeGrouptest:

$165>incrementalcostofproducingthebundle

U.S. v Loew’s

• Blockbookingleveragesmarketpowerinpicture1(GWTW)topicture2(GGG).

• CompelTVstationthatwantsGWTWtobuyvaluelessGGG.• ButifGWTWisvaluedat10KandGGGvaluedat0K,whatdoes

suchleveragingachieve?

Block Booking• Awouldpay8KforGWTW,2.5KforGGG• Bwouldpay7KforGWTW,3KforGGG

• Pricedindividually:• Pgwtw =7K,Revenue=14K• Pggg =2.5K,Revenue=5K• Totalrevenue=19K

Sell Bundle of GWTW and GGG:

• Bundle Price = 10K• A would be willing to pay 10.5K for bundle

– (= 8K + 2.5K)• B would be willing to pay 10K for bundle

– (=7K + 3K)• Total Revenue = 20K• Negative correlation in demand results in more uniform demand for block

(A has higher than average demand for GWTW and lower than average demand for GGG, while B has the opposite).

• Aggregation allows for extraction of more of the revenue than selling the films separately.

Block Booking and Bundling• Efficiency

– DeBeers/Loew’s (lowered information costs)– BMI/ASCAP (lowered transactions costs)

• Hazeltine Research (block license of 570 patents and 200 patent applications)– Automatic Radio Mfg. v. Hazeltine Research, 339 U.S. 827

(1950) (not unlawful, convenient mode of operation).– Zenith v. Hazeltine, 395 U.S. 100 (1969) (% of sales royalty

patent misuse).

Blanket Licensing – BMI v. CBS, 441 U.S. 1 (1979)

• CBS files antitrust suit against BMI alleging that the use of blanket licenses to perform copyrighted musical compositions was illegal price fixing that was per se unlawful under the antitrust laws.

• Court reversed court of appeals and held that the issuance by ASCAP and BMI of blanket licenses does not constitute price fixing per se unlawful under the antitrust laws

• The blanket license is not a "naked restrain[t] of trade with no purpose except stifling of competition"

Performing Rights Organizations as Coasian37’ Organizations

• BMI, ASCAP, SESAC• Organizations are “a market response to copyright problems caused by

high transactions costs. Number of users of copyrighted music makes individual negotiations with individual copyright holders to acquire performance rights infeasible." (Landes and Posner (1989))

• PROs eliminate the costs of individual market transactions with blanket licenses to entire repertoire.

• Are responsible for distributing license fees net of costs to songwriters or publisher that holds the copyright to the musical work

Performance Rights Organizations (not involving digital audio transmission) in U.S.

• License and collect performance royalties for publishers and songwriters• Do not collect songwriters/publishers mechanical royalties (some are

collected by organizations such as the Harry Fox Agency)• Do not collect digital performance royalties (collected in the U.S. by

SoundExchange)• In other countries a single copyright collectives collects multiple

performance royalties (for composition and sound recording) or performance and mechanical royalties.

Antitrust and Consent Decrees• Antitrust Decrees entered into in 1941 with BMI and ASCAP (but not

SESAC) oversee the rates charged:• Require that ASCAP and BMI to license all similarly situated users of music

under the same rates and standards• Rate Court oversight (currently SDNY) to determine reasonable rates when

voluntarily negotiations between PRO and music licensee do not result in an agreement

• Last modified in 2001 (ASCAP) and 1994 (BMI)• Congressional Hearings and DOJ Consent Decree Review

• Allow ASCAP and BMI to expand beyond current business model and license rights other than rights to public performance

• Replace rate courts with mandatory arbitration• Allow ASCAP and BMI to allow rights holders to withdraw rights for some types

of users

Digital Performance Right in Sound Recordings Act of 1995 (DPRA)

• 17 U.S.C. §§106(6), 114-5• Owners of copyright in sound recordings have an exclusive right to

public performance by means of a digital audio transmission• Non subscription broadcast transmissions (e.g., terrestrial radio stations)

exempt• Non-interactive internet transmissions required to pay a statutory license

established by the Copyright Royalty Board (Pandora, Web Radio, Satellite Radio), administered by Sound Exchange

• Interactive Internet transmission services must negotiate a license agreement with the copyright holder (YouTube)

• Payments are in addition to those paid for public performance or the musical composition

MUSICALCOMPOSITIONRIGHTS

SOUNDRECORDINGRIGHTS

Withdrawal of Digital Rights from BMI/ASCAP

• EMI announces intent to withdrawal from ASCAP in 2010• Compendium modification by ASCAP to allow partial withdrawals of

performance rights from ASCAP• EMI, Sony and UMPG announce intention to withdraw of new media

rights from ASCAP• Direct negotiations with large new media entites (including non-

interactive services such as Pandora and iTunes radio)• Rate Court holds that partial withdrawals are not allowed under modified

consent decrees• Pandora v. ASCAP• Pandora v. BMI

MUSICALCOMPOSITIONRIGHTS:

SOUNDRECORDINGRIGHTS

PROFULLREPERTOIRE

PUBLISHERDIRECTPROPARTIALREPERTOIRE

Coase 1937 and the Rate Court’s Hobson’s Choice

• Technological change and changes to the copyright laws has changed the nature of transactions costs that determined the nature of the PROs

• One would expect PROs to adapt to these changes, or face obsolescence when that copyright holders choose to use alternative mechanisms to appropriate the royalties from public performances.

• Indeed, this is what we have observed, with integrated music publisher (owning copyrights to performances and sound recordings) attempting to withdraw their digital rights from both ASCAP and BMI.

• The rate court’s creation of a Hobson’s choice in an attempt to continue the application of the antitrust consent decrees will:

• Speed the demise of traditional PROs• Raise transactions costs for the traditional users of works that remain in ASCAP and

BMI• Prevent use of potentially more efficient alternative to price determination through

consent decree

MUSICALCOMPOSITIONRIGHTS©:

SOUNDRECORDINGRIGHTS℗:

PROFULLREPERTOIRE

PUBLISHERDIRECTPROPARTIALREPERTOIRE