Saami ZainAntitrust & Economics

Professor Lawrence WhiteSpring 2005

TYING, BUNDLING, & EXCLUSIVE DEALINGS

This paper reviews how antitrust law assess tying, bundling and exclusive dealing

arrangements. Initially, I started out looking at just tying and bundling, but found out that

in many cases involving the two, exclusive dealings was present and likely effected the

outcome of the case. In addition, all three are examples of “exclusionary conduct” which

is primarily concern with harm to competition by substantial foreclosure of rivals to a

market. Finally, although factually the distinctions between the three are not manifest,

the law analyzes them differently, and in any particular case, the characterization may be

outcome determinative. Accordingly, in this paper, I review the law and economics of

these three common forms of exclusionary conduct, and attempt to understand the

rationale behind the legal distinctions. Part I will review the definitions and semantics

involved in tying, bundling, and exclusive dealings. Part II will discuss the underling

harms and benefits of these three, from an antitrust perspective. Part III will review how

antitrust law examines each type of conduct. Finally, in Part IV, I will comment on the

legal treatment of theses three common forms of exclusionary conduct, offering some

suggestions.

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I. DEFINITIONS & CHARACTERIZATION

As any review of law or economic journals will evince, a great deal of ink has been

spilled over tying, bundling, and exclusive dealings, which for sake of simplicity I will

hereinafter refer to collectively as “Market Strategies.”1 Notwithstanding this copious

literature and analysis, antitrust law’s treatment of these Market Strategies is perplexing.

This is partly the result of semantics, with both courts and commentators using “tying”

and “bundling” interchangeable to describe any circumstance when two products are sold

together as a package, and partly a result of the similar nature of the Market Strategies,

with many arrangements capable of being structured as either a tie, bundle or exclusive

dealing. As a result, there is a lack of consistency and coherence in the assessment of the

anticompetitive effects of these Market Strategies.

The distinction between tying and bundling (and to a lesser extent exclusive dealings) is

more a matter of degree and characterization than substance. However, because the

characterization of the arrangement may be outcome determinative as to whether it is

held lawful or not, I shall attempt to briefly explain the differences. Assume two

products, A, and B, and two firms, X and Y. Assume also that firm X produces both A

and B, while firm Y produces only B. A “pure bundle” is where A and B are sold

together in some fixed proportion and cannot be purchased individually.2 A “mixed

1 This term has no independent significance, but was chosen solely for ease of use and to limit redundancy. Also, although there is wide disagreement as to the reasons for tying, bundling and exclusive dealings, I think its safe to say that all would agree that all used to assist the firm’s market performance, either in the short term or long term, hence the term “Market Strategies.”

2 See Barry Nalebuff, Bundling, Tying, and Portfolio Effects, DTI Economics Paper No.1, Part I – Conceptual Issues, at pg 14 (2003), available at http://www.dti.gov.uk/ccp/topics2/pdf2/bundle1.pdf.; Hermon Simon and Martin Fassnacht, Price Bundling, 11 European Management Journal 4, 403-411

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bundle” is an arrangement whereas A and B are sold together as a package and sold

separately, with the packaged price being less than the sum of the individual prices for A

and B.3 A “pure tie” is where a consumer wants to purchase only one of the products,

say A, but the seller requires that in order to purchase the good, the consumer must also

purchase good B.4 Thus, it is impossible to buy A without also buying B.5 Finally in a

“mixed tie” the firm will sell A and B together and individually, but the stand-alone price

of A is substantially higher than its proportionate price when offered in a bundle.6

In contrast to tying and bundling, exclusive dealings are much easier to understand and

less obfuscated. An exclusive dealing is simply an agreement where one party agrees to

deal exclusively with another. Most exclusive contracts are categorized as either

“requirements” contracts or “output” contracts: the former occurs when a purchaser

agrees to buy all or substantially all of its requirements, or needs, of a particular good or

set of goods from a specific seller. The later is where a seller agrees to sell all or

(1991). Because purchases must be in fixed proportions, the ratio of sales of A and B must always be the same.

3 See Barry Nalebuff, Bundling, Tying, and Portfolio Effects, DTI Economics Paper No.1, Part I – Conceptual Issues, at pg 14 (2003), available at http://www.dti.gov.uk/ccp/topics2/pdf2/bundle1.pdf.; Tying and Bundling, RBB Brief 16, January 2005; Hermon Simon and Martin Fassnacht, Price Bundling, 11 European Management Journal 4, 403-411 (1991).

4 Alternatively, the consumer wants to buy B but on different terms, or may just prefer to purchase B from another seller, for whatever reason. See Edwin Mansfied & Gary Yohe, MICROECONOMICS, Chapter 10, Pg 385 (11th Ed. 2004).

5 See Barry Nalebuff, Bundling, Tying, and Portfolio Effects, DTI Economics Paper No.1, Part I – Conceptual Issues, at pg 15 (2003). In pure tying, obtaining B is usually not a problem – it is available individually and often is sold by several sellers in a competitive market. Note that in a pure tie, it is assumed that there is consumer demand for the products independently, whereas in a pure bundle, this is often not the case. Id.

6 See Barry Nalebuff, “Bundling as a Way to Leverage Monopoly,” Working Paper#36 available at http://ssnr.com/abract=586648, at fn 3.

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substantially all of its output to a particular buyer.7 Some agreements may contain both a

requirement contract and output contract.8 The lack of an actual agreement is not

dispositive – courts will often look at the actual dealings between the parties to determine

whether a de facto exclusive dealings agreement occurred.9

Evident from the nature of the aforementioned Market Strategies, is that they have the

potential for excluding rivals from the markets. As will be shown, infra, this may or may

not harm ultimate consumers (as compared to distributor or other “middlemen”) via

increased prices, decreased output and/or lack of choice. 10 In addition, such conduct may

be used to obtain or maintain monopoly power in a market. Infra.

Two cases which are particularly illustrative of many of the issues raised in this paper

regarding the Market Strategies are Jefferson Parish Hospital District No. 2 v. Hyde, 466

U.S. 2 , 104 S.Ct. 1551(1984), the U.S. Supreme Court’s latest word on tying, and Roy B.

Taylor Sales v. Hollymatic Corp., 28 F.3d 1379 (5th Cir.1994), a dealer/manufacturer

case. Jefferson Parish concerned an exclusive contract between a hospital and a firm of

anesthesiologist, which required that the firm provide the hospital with all the

anesthesiologists which it needed, and that the hospital would restricts it use of

7 See William Holmes, ANTITRUST LAW HANDBOOK, §2.22.

8 An excellent example was the contract at issue in Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 466 U.S. 2 (1984).

9 See e.g. United States v. Microsoft, 84 F.Supp.2d 9 (D.D.C. 1999)(findings of facts); 253 F.3d 34, 51 (D.C.Cir.2001)(holding that de facto exclusive dealings Microsoft had with IAP, ISPs, and content providers violated Section 2 of the Sherman Act, and may have violated Section 1 – remanded); Julian Von Kalinoswki, et al. ANTITRUST AND TRADE REGULATION: DESK EDITION (2nd Ed.2004) at §2.05[a].

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anesthesiologist to those recommended by the firm.11 The plaintiff was a certified

anesthesiology who was not affiliated with the firm and challenged the restriction under

the Sherman Act. In the opinion, the Court focused not on the contact, but on the effect it

had on patients, and thereby characterized the restraint as a tie between surgery and

anesthesiology. Finding that the elements of a per se tie were not satisfied, the court

remanded for a determination under the rule of reason. Id. at 28-31. In a concurring

opinion, four justices agreed with the result, but after pointing out that the arrangement

could have been characterized as an exclusive dealing, argued that all ties should be

judged under the rule of reason – ending any per se treatment for tying arrangements. Id.

at 45-46 (concurrence). In Hollymatic, the plaintiff, a dealer of food handling equipment

and supplies, challenged a contract it had with a manufacturer of hamburger patty

machines, requiring it to purchase all its patty paper exclusively from the manufacturer as

a condition of buying the machines. Id. at 1381. A jury found that the arrangement was

a per se tie and awarded the Plaintiff damages. The Court overturned the verdict as a

matter of law on grounds that: (1) the tie was “instrumental” to a vertical restraint

imposed by the manufacturer, and such restraints are judged by the rule of reason; and (2)

lack of evidence that the tie was anticompetitive. Critical to the decision was evidence

that although Plaintiff was losing money as a result of the tie, customers were not injured

by the deal, as they were purchasing patty paper elsewhere:

“[W]here a dealer is serving as an intermediate link in a distribution chain, if one

manufacturer is foreclosed from selling to a dealer because of [an] arrangement, it

is likely going to find another way to take its product to market, providing a profit

11 Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 , 4, 104 S.Ct. 1551(1984). Thus the contract was BOTH a requirements contract and an output contract.

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potential continues to exist. In such a case, there is no ultimate foreclosure to the

consumer of a choice of goods. In other more traditional tying arrangement there is

an ultimate foreclosure of choice to the ultimate consumer. Thus, a foreclosure of

choice to an ultimate consumer appears to be the principal key to a tie that is illegal

per se.” Id. at 1384.

II. HARMS/BENEFITS OF TYING: ECONOMICS

In this section I will review the potential harms and benefits of tying, bundling and

exclusive dealings. As will be demonstrated, all three raise similar anticompetitive

concerns. Recall that all three are types of “exclusionary” conduct, with the primary

concern being potential foreclosure of competition and limiting (or abrogating)

consumer choice. More elaborately, in commenting on courts’ diverse and inconsistent

treatment of various exclusionary conduct, Professors Thomas Krattenmaker and Steven

Salop noted:

“Notwithstanding the divergent formal tests of illegality, cases falling within

any one of these classifications of exclusion all begin and end at the same

point. In each, the expressed fear is that, rather than enhancing competition

by reducing costs or improving quality, the challenged practice may destroy

competition by providing a few firms with advantageous access to goods,

markets, or customers, thereby enabling the advantaged few to gain power

over price quality or output.”12

12 Thomas Krattenmaker and Steven Salop, Anticompetitive Exclusion: Raising Rivals’ Cost to Achieve Power over Price, 96 Yale Law Journal 2 (1986).

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A. Benefit: Cost Savings

Tying, bundling and exclusive dealing arrangements all have the potential of lowering

costs, and thus, hopefully, prices. To the extent that lower costs are passed on to the

consumer in lower prices or is used for pro-competitive reasons,13 it should benefit

consumer. Cost savings may result if the Market Strategies create economies of scale,

which may occur if the arrangement results in increased output, or economies of scope,

which may occur if inputs, labor, equipment, adverting, or other costs can be shared

among products.14 Alternatively, cost savings may be achieved as a consequence of

reducing transaction costs, which may result from a customer having to only negotiate

with one firm instead of multiple firms, as well as foregone costs of searching for the best

prices on individual products.15

B. Benefit: Prevent Free Riding and Incentive to Promote

As discussed in the seminal Supreme Court cases which effectively hold that all non-

price vertical restraints will be analyzed under the rule of reason, other benefits of the

Marketing Strategies may be to create incentives for dealers to actively promote their

13 E.g., used for advertising or promotional purposes to increase awareness or demand, or used for product innovation ( rather than for rent-seeking purposes or increasing executive compensation beyond what would be necessary to obtain competent management).

14 For detailed analysis on “volume tying” doctrine and how it may create economies of scale, see Christopher Leslie, Cutting Through Tying Theory with Occam’s Razor: A Simple Explanation of Tying Arrangements, 78 Tulane L.R. 727, 751-772 (2004). “Economies of scope” occur when a single firm can produce two or more products at lower costs then if the products were produced by separate firms. See Edwin Mansfied & Gary Yohe, MICROECONOMICS, Chapter 10, Pg 267 (11th Ed. 2004).

15 See e.g., Chun-Hsiung Liao & Yair Tauman, The Role of Bundling in Price Competition, 20 INT. J. OF INDUS. ORG. 365 (2002); Gary Eppen, Ward A. Hanson & R. Kipp Martin, Bundling – New Products, New Markets, Low Risks, SLOAN MGT. REV. 7 (1991); Thomas Nagel & Reed Holden, THE STRATEGY AND TACTICS OF PRICING: A GUIDE TO PROFITABLE DECISION MAKING 245 (1999).

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products and to prevent dealers from free riding off other dealers promotional efforts.16

As a result, they tend to restrict Intrabrand competition and promote Interbrand

competition.

C. Benefit: Consumer Demand

Under a welfarist point of view, tying, bundling and exclusive dealings may be beneficial

simply because they are desired or preferred by customers. This may occur in cases

where the aggregate value of the products exceed their stand-alone value, or where the

consumer does not wish to (or is unable to) combine the separate products. In a case of

exclusive dealing, a customer may prefer to obtain all goods from one firm (for simplicity

or cost sake), and may even obtain additional value from it.17

D. Benign: Protect Good-Will or Brand Name

It has been argued that tying and bundling may be used to protect the quality of the

primary product, thereby safeguarding its brand name.18 Similarly, one may justify

exclusive dealings by arguing that it will improve the services provided (because the

extensive business created by the exclusive dealing justifies increased expenditures and

16 Business Electronics v. Sharp, 485 U.S. 717 (1988); Continental Television v. GTE Sylvania, 433 U.S. 36 (1977). Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §16.02.

17 For example, if Harry’s Burritos becomes the “exclusive burrito” provider for the N.Y. Giants, it may gain additional sales as a result of its new prominent status, above and beyond the sales via the exclusive contract.

18 This argument was raised in defense of the tying arrangement in Eastman Kodak v. Image Technical Services, 504 U.S. 451, 112 S.Ct. 2072 (1991). See also See Dennis Carlton, A General Analysis of Exclusionary Conduct and Refusal to Deal – Why Aspen and Kodak Are Misguided, 68 Antitrust LJ 659 (2001); Barry Nalebuff, Bundling, Tying, and Portfolio Effects, DTI Economics Paper No.1, Part I – Conceptual Issues, at pg 31-61 (2003), available at http://www.dti.gov.uk/ccp/topics2/pdf2/bundle1.pdf

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assistance.) Although these justification may benefit firms using the Market Strategies,

whether it will benefit the ultimate consumer is questionable. Thus, I term this a

“benign” justification.

E. Price Discrimination: Benefit or Harm?

One of the most commonly proffered rationale’s for use of a tie or bundle has been to

effectuate price discrimination.19 Price discrimination is defined generally as when a firm

sells a product at different price – cost margins.20 According to modern economic theory,

the effects of price discrimination on consumer welfare is ambiguous – it may promote or

harm consumer welfare, depending on how effectuated.21 Yet, it is believed that the

benefits to consumers will occur only when price discrimination leads to an increase in

output.22 An examples of price discrimination that may benefit consumers is where

consumer valuations for a product are very diverse and producers are able to segment

sales without fear of substantial arbitrage. Price discrimination may then lead to increase

19 See e.g., Walter Bowman, Tying Arrangements and the Leverage Problem, 67 Yale LJ 23 (1957); William Adams and Janet Yellen, Commodity Bundling and the Burden of Monopoly, Quarterly Journal of Economics, Vol. 90 (Aug.1976); Richard Schalensee, Output and Welfare Implications of Third-Degree Price Discrimination, American Economic Review 242-247 (1981); Michael Salinger, A Graphical Analysis of Bundling, 68 Journal of Business 85 (1995).

20 See Derek Ridyard, Exclusionary Pricing and Price Discrimination Abuses under Article 82 - -An Economic Analysis, E.C.L.R. 2002, 23(6), at 288; see also Edwin Mansfied & Gary Yohe, MICROECONOMICS, Chapter 10, Pg 378 - 383 (11th Ed. 2004)(discussing various forms of price discrimination by a monopolist).

21 See Richard Schalensee, Output and Welfare Implications of Third-Degree Price Discrimination, American Economic Review 242-247 (1981).

22 Id. See also Derek Ridyard, Exclusionary Pricing and Price Discrimination Abuses under Article 82 - -An Economic Analysis, E.C.L.R. 2002, 23(6), at 288; OECD Competition Committee, Loyalty and Fidelity Discounts and Rebates, OECD Journal of Competition Law and Policy, Vol.5, No2, at pg 150 (2003)(“The welfare effects of price discrimination are complex . . .About the only generally applicable principle is that price discrimination will increase welfare only if it increases the total quantity sold.”). Price discrimination will often increase producer surplus while decreasing consumer surplus and thus may increase total welfare.

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output, with consumers playing an amount close to their valuation (airline tickets are a

good example).23 Another example may be so-called “metering,” where the producer

charges a flat rate for the initial purchase and subsequent per usage fee.24 It has been

argued that price discrimination is particularly likely to improve consumer welfare in

industries with high fixed costs and low marginal cost, as it may allow the producer to

recoup its fixed costs.25 However, where price discrimination does not lead to increases

in output but rather leads to transfers of consumer surplus and/or an increased “dead-

weight loss,” the effects on consumers will be a decrease in consumer welfare.26

F. Harmful: Substantial Foreclosure of Competition

The primary long-term concern regarding the use of these Marketing Strategies is the

potential anticompetitive effects of substantially foreclosing competition in the market –

23 Under this scenario, while some consumers are paying more than what would otherwise be the competitive price (absent price discrimination), others are paying less. Thus depending upon the circumstances, aggregate consumer welfare may improve.

24 See Barry Nalebuff, Bundling, Tying, and Portfolio Effects, DTI Economics Paper No.1, Part I – Conceptual Issues, at pg 16 (2003), available at http://www.dti.gov.uk/ccp/topics2/pdf2/bundle1.pdf. Again, if this leads to increase in output, it may raise consumer welfare. It should be noted that such “metering” practices often require a tie of two of more products, a classic case being where printer manufacturers require purchasers to purchase their ink cartridges. Id; See also Herman Simon, Martin Fassnacht, Price Bundling”, European Management Journal, Vol. 11, No 4, pg 403-411 (1993).

25 Benjamin Klein and John Wiley, Competitive Price Discrimination As An Antitrust Justification of Intellectual Property Refusals to Deal, 70 Antitrust L.J. 599 (2003); Derek Ridyard, Exclusionary Pricing and Price Discrimination Abuses under Article 82 - -An Economic Analysis, E.C.L.R. 2002, 23(6), at 287.

26 This classic example is the “sham tie” or “de facto tie.” In this scenario, prior to implementing a tie or bundle, the firm increases the stand-alone price for the tying good even above the profit maximizing price for a monopolist – extracting nearly all of the consumer surplus. The firm then introduces the bundled product along with the tied product, with the bundle priced above the combined stand-alone price of the goods in a competitive market. See Patrick Greenlee, David Reitman, and David Sibly, An Antitrust Analysis of Bundled Loyalty Discounts, Economic Analysis Group Working Paper, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=586648; Hermon Simon and Martin Fassnacht, Price Bundling, 11 European Management Journal 4, 403-411 (1991).

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and particularly as to as efficient or more efficient competitors.27 It should be noted that

although tying and bundling concern “vertical” foreclosure, while exclusive dealings are

concerned primarily with “horizontal” foreclosure, the analysis is substantially the

same.28 Whether these Marketing Strategies will result in substantial foreclosure of

competition in one or more markets, and more importantly, the likelihood that even

substantial (or total) foreclosure will lead to consumer harm, will depend upon an

analysis of several factors, including structures and concentrations of the relevant markets

(focusing on market power in particular), the market demand for the goods (including

elasticity and availability for substitutes), barriers to entry in the relevant markets, and the

availability of other effective means of either obtaining inputs or distributing outputs

(depending on the particular case.)

The primary mode by which foreclosure of rivals is effectuated is by raising rivals cost –

which is generally done by either increasing the cost of inputs, denying rivals efficient

means of distribution, or denying rivals a necessary output to be profitable.29 All of the

Market Strategies have the potential for creating anticompetitive foreclosure.

27 It should be disclosed that as a non-economist, the author relied heavily upon the following article to understand the potential harms of foreclosure: Jean Tirole, A Primer on Foreclosure, in the forthcoming text by Mark Armstrong and Rob Porter, HANDBOOK ON INDUSTRIAL ORGANIZATION III (2003), available at http://venus.unive.it/roson/papers/primer20030716.pdf.

28 The economic harm of foreclosing a market is the same for all three Market Strategies, although achieved by different means. The effect may be distinct in that tying or bundling concern leveraging existing market power into another market, while exclusive dealing concern obtaining or maintaining market power in the same market.

29 See Thomas Krattenmaker and Steven Salop, Anticompetitive Exclusion: Raising Rivals’ Cost to Achieve Power over Price, 96 Yale Law Journal 2 (1986); Jon Jacobson, Exclusive Dealing, “Foreclosure,” and Consumer Harm, 70 Antitrust L.J. 311 (2002); Earl W. Kintner, et al, FEDERAL ANTITRUST LAW (2004) §13.7; RBB ECONOMICS, BRIEF 16, Tying and Bundling – Cause for Complaint? (Jan.2005); Barry Nalebuff, “Bundling as a Way to Leverage Monopoly,” Working Paper#36 available at http://ssnr.com/abract=586648.

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In the context of a tie or bundle, successful foreclosure of a substantial portion of the

another “tied” market will likely only occur by a firm which has market power in some

other “tying” product.30 A firm with market power in one good may be able to foreclose

competition in the market for another good by using the tie or bundle as a means of

deterring entry or inducing exit.31 Alternatively, a firm with market power in a product,

may use a tie or bundle to deter entry into the same market, in order to protect its

monopoly in that markets.32

Exclusive dealings by a firm with market power may also be used to substantially

foreclose competition in the same market, and thereby maintain market power. This is

most likely to occur when done via a requirements contract with a distributor or firm

which provides an essential input for the firm, and the result of this contact is to deny

rivals sufficient input or distribution to achieve a sufficient profitable scale to be able to

compete effectively against the firm. Alternatively, foreclosure could also be

30 But see Slawson, Excluding Competition Without Monopoly Power: the Use of Tying Arrangements to Exploit Market Failures, 36 Antitrust Bull. 457 (1991)(Arguing that when substantial market failures are present in the “tied” market, monopoly power is not necessary for competitive harm in tied market to result).

31 Even a monopolist in one good may not be able to successfully “leverage” into another good and thus substantially foreclose the market to rivals. It will depend on several factors including the market conditions in the tied market, entry barriers in the tied market, how the tie or bundle is done (e.g., fixed proportions or variable proportions, use of discount with the tied/bundle), etc. See Michael D. Whinston, Tying, Foreclosure and Exclusion, 80 American. Economic Rev. 837 (1990); Dennis Carlton and Michael Waldman, The Strategic Use of Tying to Preserve and Create Market Power in Evolving Industries,” 38 RAND Journal of Economics at 194 – 220 (1998); Barry Nalebuff, Bundling as an Entry Barrier, 119 Quarterly Journal of Economics No. 1 pg 159-187 (Feb.2004); Barry Nalebuff, Bundling as a Way to Leverage Monopoly, Working Paper#36 available at http://ssnr.com/abract=586648.

32 Dennis Carlton and Michael Waldman, The Strategic Use of Tying to Preserve and Create Market Power in Evolving Industries,” 38 RAND Journal of Economics at 194 – 220 (1998); U.S. v. Microsoft, 253 F.3d 34 (D.C.Cir.2001).

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accomplished if the exclusive dealing raised rivals cost sufficiently, by requiring them to

use a less efficient mode of distribution or more costly substitute input.33

G. Harm: “Coercion” or Restricting Consumer Choice

In the short run, a pure tie or pure bundle may abrogate consumer choice by “forcing” the

consumer to buy something he does not want (or would rather purchase elsewhere or on

different terms), or alternatively, foregoing the product she desires. In the long run, when

these Market Strategies cause substantial foreclosure of rivals, so as to force rivals to exit,

and entry barriers are significantly high, an additional negative will be to reduce

consumer choice for the product.34

III. GOVERNING LAWS AND INTERPRETATIONS

This section will briefly review the underlying law governing tying, bundling and

exclusive dealings in the United States..35

A. Governing Statutes

33 In both cases, for foreclosure to harm competition (and thus enable the firm to increase prices) and not just rivals, there must be substantial entry barriers. See Thomas Krattenmaker and Steven Salop, Anticompetitive Exclusion: Raising Rivals’ Cost to Achieve Power over Price, 96 Yale Law Journal 2 (1986); Jon Jacobson, Exclusive Dealing, “Foreclosure,” and Consumer Harm, 70 Antitrust L.J. 311 (2002).

34 To be fair, exit may occur and result in limited consumer choice absent anticompetitive conduct (for example, if rivals are not as efficient, limited demand, market where demand can be met most efficiently with a single supplier, or network effects and first mover advantage result in a dominant firm). Yet in such cases (hopefully) exit will be the result of a dominant firm having efficiencies, lower costs, or a better product (or possibly the market demand or structure forced entry, e.g., oversaturated market.

35 I will not review the tortuous history of tying law, which has changed greatly from a bright line per se rule to a more quasi-per se/rule of reason analysis. For an excellent and brief review of both the legal history and underlying changes in policies of tying law see Christopher Leslie, Cutting Through Tying Theory with Occam’s Razor: A Simple Explanation of Tying Arrangements, 78 Tulane L.R. 727, 731-751 (2004).

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Section 1 of the Sherman Act, 15 U.S.C. §1, bans any agreement which unreasonably

restrains trade and is thereby anticompetitive. Section 1 provides in part:

“Every contract, combination in the form of trust or otherwise, or conspiracy, in

restraint of trade or commerce among the several States, or with foreign nations,

is declared to be illegal.”

In determining whether any particular conduct “unreasonably” restrains trade, courts

have developed two different methods of analysis: (1) a per se test which condemns

certain types of conduct which are believed to be “inherently anticompetitive” and

without any valid, pro-competitive justification36; and (2) a “rule of reason” in which the

court examines and weighs the anticompetitive effects of the challenged conduct against

its asserted pro-competitive justification, and condemns the conduct if on the whole it is

anticompetitive.37 Modern antitrust jurisprudence has defined “anticompetitive conduct”

to be conduct which adversely affects consumers, that is, where the conduct will result, or

likely result, in consumer harm, not merely harm to competitors.38 Tying, bundling, and

exclusive dealings are types of “exclusionary” conduct which may be anticompetitive and

36 “[T]here are certain agreements or practices which because of their pernicious effect on competition and lack of any redeeming virtue are conclusively presumed to be unreasonable and therefore illegal without any elaborate inquiry as to the precise harm they have caused or the business excuse for their use.” Northern Pacific Railroad v. United States, 356 U.S. 1, 5 (1958).

37 “The true test of illegality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition. To determine that question the court must ordinarily consider the facts peculiar to the business to which the restraint is applied: its condition before and after the restraint was imposed; the nature of the restraint, the evil believed to exist, the reason for adopting the particular remedy, the purpose or end sought to be attained, are all relevant facts.” Chicago Board of Trade v. United States, 246 U.S. 49, 59 (1918). See also FTC vs. Superior Court Trial Lawyers Ass’n, 493 U.S. 411, 110 S.Ct.768 (1990); National Society of Engineers vs. U.S., 435 U.S. 679, 691-92, 98 S.Ct. 1355 (1978)(discussing requisite analysis under the rule of reason).

38 See e.g., United States v. Microsoft, 253 F.3d 34, 58 (D.C.Cir.2001); Spanish Broadcasting of Florida v. Clear Channel Communications, 376 F.3d 1065, 1071; KMB Warehouse Distributors v. Walker Manufacturing, 61 F.3d 123, 127 (2nd Cir. 1995)(consumer welfare is the primary concern of antitrust). See also Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §6.04d.

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lead to consumer harm by decreasing competition in a market, raising prices, and

decreasing consumer choice. See infra.

Section 3 of the Clayton Act, 15 U.S.C. §14, prohibits certain types of agreements, as

follows:

“[I]t shall be unlawful for any person engaged in commerce, in the course of such

commerce, to lease or make a sale or contract for sale of goods, wares,

merchandise, machinery, supplies or other commodities, whether patented or

unpatented, for use, consumption or resale within the United States or any

Territory thereof or the District of Columbia or any insular possession or other

place under the jurisdiction of the United States, or fix a price charged therefore,

or discount from, or rebate upon, such price, on the condition, agreement or

understanding that the lessee or purchaser thereof shall not use or deal in the

goods, wares, merchandise, machinery, supplies, or other commodities of a

competitor or competitors of the lessor or seller, where the effect of such lease,

sale, or contract for sale or such condition, agreement or understanding may be to

substantially lessen competition or tend to create a monopoly in any line of

commerce.”

Because courts have applied the same rule of reason analysis under Section 3 of the

Clayton Act as under Section 1of Sherman Act, with the result that a violation under

Section 3 of the Clayton Act for tying, bundling or exclusive dealing, would also violate

Section 1 of the Sherman Act, I will refrain from any analysis of the Clayton Act.39 39 See Robert Bork, THE ANTITRUST PARADOX at pg 299 (1978); Jon Jacobson, Exclusive Dealing, “Foreclosure,” and Consumer Harm, 70 Antitrust L.J. 311 (2002)(noting the lack of distinguishing features between the case law’s analysis under §1 of the Sherman Act and §3 of the Clayton Act. See also Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 , 29-30 at fn 51, 104 S.Ct. 1551(1984)(brought

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Section 2 of the Sherman Act, 15 U.S.C. §2, proscribes “monopolization,” and attempted

monopolization.40 Monopolization has two elements: “(1) the possession of monopoly

power in the relevant market and (2) the willful acquisition or maintenance of that power

as distinguished from growth or development as a consequence of a superior product,

business acumen, or historic accident.”41“Monopoly power,” or market power, has been

defined as “the power to control prices or exclude competition”42 or more specifically, the

ability of a firm, to “profitably raise prices substantially above the competitive level.”43

Market power can be shown directly or inferred by evidence demonstrating that the firm

has a dominant share of the relevant market, which is protected by significant entry

barriers.44 In contrast to monopolization claims, a Plaintiff alleging attempted

monopolization must prove the following three elements: “(1) that the defendant has

engaged in predatory or anticompetitive conduct with (2) a specific intent to monopolize

and (3) a dangerous probability of achieving monopoly power.”45

under §1 of the Sherman Act but citing 2 cases under §3 of the Clayton Act).

40 Section 2 of the Sherman Act provides: “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $100,000,000 if a corporation, or, if any other person, $1,000,000, or by imprisonment not exceeding 10 years, or by both said punishments, in the discretion of the court.”

41 United States v. Grinnell Corp, 384 U.S. 563, 570-571, 86 S.Ct. 1698, 16 L.Ed.2d 778 (1966). 42 United States v. E.I. Du Pont de Nemours & Co., 351 U.S. 377, 391, 76 S.Ct.994, 100 L.Ed. 1264 (1956).

43 United States v. Microsoft, 253 F.3d 34, 51 (D.C.Cir.2001)(citing AREEDA, ET AL, ANTITRUST LAW, 2A ¶501, at 85 (1995)).

44 Id.

45 Spectrum Sports vs. McQuillan, 506 U.S. 447, 459 (1993).

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A Section 1 violation is “legally distinct from that under Section 2 . . . though the two

sections overlap in the sense that a monopoly under Section 2 is a species of trade

restraint under Section 1. [Citation omitted.] The same kind of practices, therefore, may

evidence violations of both..”46

B. Case Law

1. Tying

Depending on how structured and its effect on competition, a tying arrangements may

violate the Sherman Act is three ways: (1) per se unlawful restraint of trade; (2)

unreasonable restraint of trade; and (3) monopolization or attempted monopolization.

Regardless of under which statutory scheme it is brought, the nature of “tie” is as follows:

“[T]he essential characteristic of an invalid tying arrangement lies in the seller’s

exploitation of its control over the tying product to force the buyer into the

purchase of a tied product that the buyer either did not want at all, or might have

preferred to purchase elsewhere on different terms.”47

For a tying arrangement to be per se illegal under Section 1 of the Sherman Act, the

following elements must be met:

(1) There are two separate products or services;

46 Dickson v. Microsoft, 309 F.3d, 193, 201 (4th Cir.2002). See also United States v. Microsoft, 253 F.3d 34, 70 (D.C.Cir.2001)( “[W]e agree with plaintiffs that a monopolist’s use of exclusive contracts, in certain circumstances, may give rise to a §2 violation even though the contracts foreclose less than the 40% or 50% share usually required in order to establish a §1 violation.” )

47 Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 466 U.S. 2 (1984)

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(2) The purchase of one of the products is conditioned on the purchase of

another product;

(3) The seller has appreciable economic power in the market for the tying

product to enable it to restrain trade in the market for the tied product; and

(4) A “not insubstantial” amount of commerce in the market for the tied

product is foreclosed.48

Unfortunately, as with nearly all legal elements when applied to factual scenarios, they

are not as simple as they appear. Regarding whether a particular tying arrangement

receives per se treatment, the dispute is usually over either the first element, which is

measured by whether there is independent consumer demand for the products, the third

element, measured by whether the seller has market power over the tying product; and

the fourth element, which has been interpreted by several courts as requiring a showing

of a likelihood of substantial foreclosure in the tied market or actual anticompetitive

effects.49

The substantial analysis done in this test belies its usefulness as a true per se test, which is

intended to obviate the need for an in-depth analysis of competitive effects in cases where

the restraint is of a type which is likely to be anticompetitive.50 Accordingly this test, set

forth in Jefferson Parish, has been called a modified per se rule – falling somewhere 48 Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 466 U.S. 2 (1984); Eastman Kodak v. Image Technical Service, Inc., 112 S.Ct. 2072, 504 U.S. 451, 112 S.Ct. (1992).

49 Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 466 U.S. 2 (1984). See also Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §17.03; Julian Von Kalinoswki, et al. ANTITRUST AND TRADE REGULATION: DESK EDITION (2nd Ed.2004) at §2.04[b].

50 Moreover, many courts have permitted defendants to raise business justifications for tying and have weighed these justifications in considering the legality of the tie, thereby stretching the imagination to call it a “per se” test. See Earl W. Kintner, et al, FEDERAL ANTITRUST LAW (2004) §13.30.

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between a true per se test and a rule of reason analysis.51 Recently, the Court of Appeals

for the D.C. Circuit, refused to apply the per se test, on the basis that it was not

appropriate in given the nature of the product and industry.52

If a particular tying arrangement does not satisfy all of the elements of the per se test, it

may still be deemed unlawful under the “rule of reason.”53 However, given that a rule of

reason analysis mandates a full analysis of the markets and effects (both anticompetitive

and pro-competitive), it is less likely that a party will pursue a claim under the rule

reason, particularly if per se analysis is found improper on summary judgment.

A tie may also violate Section 2 of the Sherman Act, if the firm imposing the tie has

substantial market power in the tying product and the tie is deemed a means for

maintaining or increasing the firm’s power in the tying market.54 Previously, a Section 2

tying violation may have been premised on monopoly leverage from the tying market to

51 See e.g., Christian Ahlborn, David S. Evans, Jorge Padilla, The Antitrust Economics of Tying: A Farewell to Per Se Illegality, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=381940; Earl W. Kintner, et al, FEDERAL ANTITRUST LAW (2004) §13.21; Jay Choi, Antitrust Analysis of Tying Arrangements, CESinfo Working Paper No. 1336 (Nov. 2004), available at http://ideas.repec.org/p/ces/ceswps/_1336.html.

52 see U.S. v. Microsoft, 253 F.3d 34 (D.C.Cir.2001). What’s interesting is that the Court outright and explicitly rejected the per se test, rather than finding some way to work around it or massage it to fit the Court’s needs (as is often done why lower courts when forced to use a given rigid analysis which they do not wish to use).

53 Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 1567, 466 U.S. 2 (1984)

54 United States v. Microsoft, 253 F.3d 34 (D.C.Cir.2001); See Virgin Atlantic v. British Airways, 257 F.3d 256, 272 (2nd Cir.2001); Dennis Carlton and Michael Waldman, The Strategic Use of Tying to Preserve and Create Market Power in Evolving Industries,” 38 RAND Journal of Economics at 194 – 220 (1998).

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the tied market,55 yet it appears that a recent Supreme Court has made that all but

impossible.56

2. Bundling

As noted supra, the distinction between tying and bundling is largely a matter of

semantics and degree, with courts and commentators using either term, often

interchangeably, when describing any structure where two or more goods are sold

together. However, in legal analysis, characterization can be important, with different

tests used for different types of conduct. As the most likely of the Market Strategies to be

coercive and anticompetitive, “pure ties” will generally be evaluated under the modified

per se test. The legal treatment of “mixed ties,” “pure bundles,” and “mixed bundles,”

however, has been less than consistent (or coherent). These Market Strategies have been

assessed under various forms of legal jurisprudence: tying, exclusive dealing, predatory

55 See Advanced Health Care Serv. vs. Radford Comm. Hospital, 910 F.2d 139 (4th Cir.1990); Key Ent. of Del. V. Venice Hosp. 919 F.2d 1550 (11th Cir.1990); Multistate Legal Studies v. Harcourt Brace Jovanovich, 63 F.3d 1540 (10th Cir.1995); Virgin Atlantic Airways vs. British Airways, 257 F.3d 256, 272 (2nd Cir.2002);)(acknowledging at least the possibility of leverage theory as violating section 2, even if not so holding due to facts or other legal issues).

56 See Verizon Communication v. Law office of Curtis Trinko, 540 U.S. 398, 124 S.Ct. 872 at FN 4 (2004)(“The Court of Appeals also thought that respondent’s complaint might state a claim under a ‘monopoly leverage’ theory . . . . We disagree. To the extent the Court of Appeals dispensed with a requirement that there be a ‘dangerous probability of success’ in monopolizing a second market, it erred.” [citation omitted]). See also Spectrum Sports vs. McQuillan, 506 U.S. 447, 459 (1993).

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pricing,57 and sometimes even as a refusal to deal.58 Accordingly, it is not surprising that

the outcomes of the assessments under the varying legal tests have not been the most

intelligible. To complicate matters, it is not uncommon to have arrangements where

exclusive dealings are used in conjunction with a tie or bundle, resulting in inconsistency

regarding how to evaluate the restraint: as an exclusive dealing or a tie/bundle.59

Further exacerbating an already opaque jurisprudence, are recent cases evaluating the

competitive effects of “bundled discounts,” which are multiple product discounts with the

57 Based on the belief that cost cutting is usually pro-competitive, and will always benefit the consumer in the short run, U.S. Courts are very suspicious of claims of predatory pricing. In general, discounts are presumptively legal unless prices are below some appropriate level of cost and recoupment of lost profits is at least possible (if not probable). See e.g, Brooke Group v. Brown & Williamson Tobacco, 509 U.S. 209, 113 S.Ct. 2578 (1993)(rejecting plaintiff’s claim that defendant’s below cost discounts were unlawful absent evidence of likely competitive harm, e.g., likelihood of recoupment); United States v. AMR, 335 F.3d 1109 (10th Cir.2003)(lowering of prices and increasing output by a dominant firm in response to entry not violate Sherman Act if above cost); Virgin Atlantic Airways v. British Airways, 257 F.3d 256 (2nd Cir. 2001)(finding that discounts to travel agents not an agreement in violation of section 1 of the Sherman Act and not below cost); Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039 (8th Cir.2000)(target rebates by boat engine manufacturer who had 75% market share not unlawful); Western Parcel Service of America v. United Parcel Service of America, 190 F.3d 974 (9th Cir.1999)(finding that even if defendant had a dominant position, its volume discounts were lawful); Barry Wright Corporation v. ITT Grinnell Corp., 724 F.2d 227 (1st Cir.1983)(price cuts above incremental and average costs by firm with market power per se legal). Of course, determining the appropriate level of cost, i.e. marginal cost, average variable cost, or average cost, and actually calculating the cost in any specific case can be difficult to say the least. Moreover, evidence of likely anticompetitive harm as a result of pricing below cost can be even more difficult.

58 “Pure bundles” and “pure ties” will likely be treated under tying doctrine or exclusive dealings. “Mixed bundling” likely treated under predatory pricing. “Mixed tying” has been treated under de facto tying. For a case rejecting plaintiff’s characterization of an exclusive dealing effectuated by a tying arrangement as a refusal to deal see CDC Techs v. IDEXX Lab, 186 F.3d 74 (2nd Cir.1999). Refusal to deal cases have traditionally arisen in scenarios where a dominant firm has control over an essential facility and unique asset. See e.g. Aspen Skiing Co v. Aspen Highland, 472 U.S. 585 (1985); Otter Tail Power Company v. United States, 410 U.S. 366 (1973). However, in a manufacture/dealer scenario, an exclusive dealing may have the same effect as a refusal by a dominant firm to deal with a rival. By imposing the exclusive dealing on a downstream supplier, it may act to prohibit the supplier from selling to or purchasing from rivals of the dominant firm. See Dennis Carlton, A General Analysis of Exclusionary Conduct and Refusal to Deal – Why Aspen and Kodak Are Misguided, 68 Antitrust LJ 659 (2001).

59 For example, in Jefferson Parish, the challenged conduct was the exclusive contract between the hospital and the anesthesiology firm. In arguing that the restraint should be judged under the rule of reason, the four justices who signed the concurring opinion contrasted that emphasized this point and used it to highlight the inconsistency with the court’s per se treatment of the restraint. In addition, in Hollymatic, Plaintiff alleged both an exclusive contract and a tie, but the court treated it as a typical tying case.

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following features: (1) discounts are granted on all purchases, but only after the buyer’s

purchases exceed a certain percentage of its requirements for a given time period;60 and

(2) discounts are made for purchases across several products (or product lines) instead of

for each product individually.61 Courts and commentators have grappled with how to

best scrutinize these “bundled discounts:” under tying jurisprudence, predatory pricing

jurisprudence, or a combination of the two. At least seven different proposed guidelines

have been offered, with no consensus.62

3. Exclusive Dealings

60 Discounts can come in various forms. “Quantity” or “Volume” discounts are based solely upon the quantity of the product purchased, and are generally given for every unit purchased after the buyer has reached some specific quantity. “Target” discounts are granted on the condition that the purchaser exceed some specified “target” or threshold of purchases. However, unlike with volume discounts, the targets are not based upon purchasing an absolute quantity, but rather, are based upon either (1) a purchaser buying a certain percentage of his requirements from the seller during a specified time period (often called a “reference period”); or (2) a purchaser increasing his purchases from the seller, as compared to prior purchases. The target threshold and respective discount may be a part of the purchase agreement which the parties negotiated, or a unilateral policy of the seller. “Loyalty” or “fidelity” discounts are those granted in exchange for exclusivity, near exclusivity, or de facto exclusivity (when a buyer is “coerced” to purchase a percentage of his requirements from a particular seller. The “coercion” is a measurement of the “switching cost” and the risk associated with losing a target discount by making purchases from rivals). These discounts are often structured the same way as “target” discounts, offering the discount for all units purchased, but only after the buyer actually meets the exclusivity, near exclusivity, or defacto exclusivity requirements.

61 See Lepage v 3M, 324 F.3d 141 (3rd Cir.2003); Ortho Diagnostic Systems v. Abbot Laboratories, 920 F.Supp. 455 (S.D.N.Y.1996); SmithKline v. Eli Lilly, 575 F.2d 1056 (3rd Cir.1978).62 The most common tests are as follows: (1) per se legality; (2) illegal if discounts “unjustifiably” raise rivals costs; (3) illegal if inadequate business justification for the discount, and the bundles include products not sold by rivals; (4) illegal if the discount harms competitors and discount only makes sense under a “sacrifice of profits” scheme (5) illegal if plaintiff’s firm is as efficient as the dominant firm and unable to compete with the bundles; (6) illegal if a “hypothetical” efficient competitor is excluded; and (7) above cost bundles are presumptively legal, but plaintiff can rebut. For an excellent review and analysis of most of these tests, see Thomas Lambert, Evaluating Bundled Discounts, CORI Working Paper No. 2005-01, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=650326. For a review of the commentary arguing that bundled rebates should be assessed under tying doctrine see Patrick Greenlee, David Reitman, and David Sibly, An Antitrust Analysis of Bundled Loyalty Discounts, Economic Analysis Group Working Paper, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=586648; Philip Areeda & Herbert Hovenkamp, ANTITRUST LAW (2nd Ed.2002) at Vol 3A, ¶768b2.

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“In its simplest form, an exclusive dealing arrangement is a contract between a

manufacturer and a buyer forbidding the buyer from purchasing the contracted good from

any other seller, or requiring the buyer to take all of its needs in the contracted good from

that manufacturer.”63 As with tying arrangements, exclusive dealings may violate Section

3 of the Clayton Act as well as Section 1 or Section 2 or the Sherman Act.

Pertaining to Section 1, these dealings typically arise in vertical relationships between

manufacturers and “middlemen,” e.g., dealers, franchisor, retailers, brokers. Thus,

despite the fact that the potential harm of exclusive dealings is to competitors of the

company imposing the restraint, and are thereby “horizontal” in nature, based upon the

relationship of the parties to the agreement and the belief that intrabrand restraints are

generally procompetitive, a Section 1 analysis will characterize these deals as non-price

vertical deals and examine it under the rule of reason.64 A rule of reason assessment of

exclusive dealings focuses on two primary elements: (1) whether the particular exclusive

dealing will foreclose a substantial portion of the downstream market thereby either

denying competitors a viable scale or otherwise raising rivals costs (i.e. by making the

most cost effective inputs or efficient means of distribution unattainable); and (2) and

63 Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §18.01d.

64 Business Electronics v. Sharp, 485 U.S. 717 (1988); Continental Television v. GTE Sylvania, 433 U.S. 36 (1977); Jefferson Parish Hospital District No. 2 v. Hyde, 104 S.Ct. 1551, 1567, 466 U.S. 2 (1984)(concurring opinion)(exclusive dealings are judged under rule of reason); Tampa Electric Company v. Nashville Coal, 365 U.S. 320, 81 S.Ct. 623 (1961)(Analyzing a requirements contract under Section 3 of the Clayton Act using a rule of reason analysis); Stop & Shop v. Blue Cross & Blue Shield, 373 F.3d 57 (1st Cir.2004)(rule of reason used to exclusive dealing between a joint prescription drug program established by two competing health care networks); PepsiCo v. The Coca-Cola Company, 315 F.3d 101 (2nd Cir.2002)(upholding exclusive distribution agreement under the rule of reason); Morales-Villalobos v. Garcia-Llorens, 316 F.3d 51 (analyzing challenge to exclusive dealing agreement between anesthesiology practice group and two hospitals).

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scrutinize barriers to entry in the downstream market.65 In making this evaluation, courts

generally consider a wide range of factors, including an assessment of the market

structure and entry barriers in both the upstream and down stream markets, Defendant’s

market power in the upstream market, relevant power in the upstream market, alternative

distribution channels, duration of the exclusive contracts, whether the contracts were

requested or imposed, and any pro-competitive business justifications.66

Regarding Section 2, exclusive dealings may be held to be an unlawful means of

obtaining or maintaining monopoly power by foreclosing competition,67 or alternatively,

as attempted monopolization.68 To win on these claims a plaintiff must define the

relevant markets and demonstrate that the defendant has market power on the upstream

market, and then weigh the anticompetitive effects of the exclusive dealings on the

upstream market with the pro-competitive justifications.69

65 Tampa Electric Company v. Nashville Coal, 365 U.S. 320, 81 S.Ct. 623 (1961). See also Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §18.02b.

66 Julian Von Kalinoswki, et al. ANTITRUST AND TRADE REGULATION: DESK EDITION (2nd Ed.2004) at §2.04[5][b]; W. Kintner, et al, FEDERAL ANTITRUST LAW (2004) §13.4; United States v. Visa, et al., 344 F.3d 229, 238 (2nd Cir.2003); PepsiCo v. The Coca-Cola Company, 315 F.3d 101 (2nd Cir.2002); Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039 (8th Cir.2000); Barry Wright Corporation v. ITT Grinnell Corp., 724 F.2d 227 (1st Cir.1983);Tampa Electric Company v. Nashville Coal, 365 U.S. 320, 81 S.Ct. 623 (1961).

67 Telecor Communications v. Southwestern Bell Telephone, 305 F.3d 1124, 1133 (10th Cir.2002); United States v. Microsoft, 253 F.3d 34 (D.C.Cir.2001); Conwood v. U.S. Tobacco, 290 F.3d 768 (6th Cir.2001); Beard v. Parkview Hospital, 912 F.2d 138 (6th Cir.1990).

68 ). See e.g. Albani v. Southern Arizona Anesthesia Services, 1997-2 Trade Case ¶71,927 (D.Ariz.1997); Beard v. Parkview Host, 912 F.2d 138 (6th Cir.1990); Brown v. Hansen Publications, 556 F.2d 969 (9th Cir.1977); Lessig v. Tidewater Oil Co., 327 F.2d 459 (9th Cir.1964), overruled on other grounds.

69 United States v. Microsoft, 253 F.3d 34 , 36 (D.C.Cir.2001)

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As a final note, it has been suggested that a recent trend in cases under both Section 1 and

Section 2 of the Sherman Act has taken a skeptical view of foreclosure as a proxy for

anticompetitive effects, and instead has required a plaintiff to demonstrate that the

particular challenged exclusive dealings arrangement increases the monopolists market

power upstream.70

IV ANALYSIS & COMMENTS

Based on the above review of tying, bundling and exclusive dealing arrangements, in this

part I will make three comments, which although are not novel by any means, I believe

are worth mentioning. First, I argue for consistency in the treatment of the Market

Strategies. Absent a valid justification, as they all have similar concerns, they should be

treated similarly. Second, I address the “leverage theory” and query as to whether

antitrust law ought to be more concerned with leveraging monopoly power into a new

market or monopoly maintenance. Third, I question the appropriateness of looking at

business justification for the Market Strategies, at least when the firm using them has

substantial market power.

A. Consistency

The Marketing Strategies all raise analogous antitrust concerns: foreclosure of

competition in a market and limiting consumer choice by either raising rivals’ costs of

inputs or distribution, denying them essential inputs or distribution, or restricting their

output enough as to impede them from obtaining a necessary viable scale to be profitable.

70 Jon Jacobson, Exclusive Dealing, “Foreclosure,” and Consumer Harm, 70 Antitrust L.J. 311 (2002)

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Hence, one would assume that the law would treat all three Marketing Strategies

similarly. But as we have seen, such is not the case. In particular, the per se treatment of

certain tying arrangements is rather odd. First, it is inconsistent with the treatment of

exclusive dealings and bundling – which are often factually indistinguishable.71 Second,

it is inconsistent with the general treatment of all non-price vertical restraints under a rule

of reason.72 Third, as has been pointed out by Areeda et al, the law’s historical aversion

to tying arrangements are not predicated on sound theories or empirical evidence, but on

a misplaced belief they have a greater tendency to harm the ultimate consumer by

restricting consumer choice.73 Yet this is not always the case, but rather depends on the

circumstances. Exclusive dealings may cause just as great a harm as tying. Using

Hollymatic, supra, as an example, the court found that there was no anticompetitive harm

because although the Defendant required the Plaintiff to purchase its patty paper as a

condition of purchasing its patty machines, the court found that consumers were not

harmed because “competition in patty paper sales was fierce” and as a result of the tie,

customers were purchasing their patty paper elsewhere.74 Although consumers were not

71 Per se treatment for ties is especially strange when contrasted with recent cases being particularly skeptical as to challenges to exclusive dealings, supra. The effect may be to create three different standards for the Market Strategies: presumptively illegal for ties, neutral for bundling, and presumptively legal for exclusive dealings.

72 Business Electronics v. Sharp, 485 U.S. 717 (1988); Continental Television v. GTE Sylvania, 433 U.S. 36 (1977).

73 “. . .[A]lthough the Supreme Court has treated tying as ‘inherently’ more anticompetitive than exclusive dealing, that proposition cannot be defended as a general matter. To the extent exclusive dealing limits the ability of an entire firm to sell the products of a rival it often has more anticompetitive potential than tying, which often requires use of the tied product only with specific tying [products]. In all cases, competitive injury is best measured by examining the degree to which the restraint limits the effective choices of consumers, and this question is not answered simply by determining that the restraint itself is tying rather than exclusive dealing, or vice versa.” Philip Areeda & Herbert Hovenkamp, FUNDAMENTALS OF ANTITRUST LAW (3rd Ed. 2004) at §18.01b.

74 Hollymatic, 28 F.3d at 1384.

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harmed by the exclusive dealing in Hollymatic, harm is not impossible or even unlikely.

In scenarios where rival’s products are not so accessible, such as where there is little

interbrand competition or where the distance between retailers of similar products is

considerable or if there are problems with distribution, exclusive dealings could have an

enormous impact on consumer choice.75 This is particularly because tying generally only

involves two products, whereas exclusive dealings may involve entire product lines,

thereby restricting consumer choice in a broad array of product line.

B. Leverage

In my review of the harms of the Market Strategies, I intentionally avoided discussing

“monopoly leverage.” Given it tortuous, storied, and contentious past, I felt it was better

to avoid the quagmire. Nevertheless, as I believe that “monopoly leverage” is at the heart

of policy issues raised by the Market Strategies, I feel it must be addressed.

Monopoly leverage concerns the transfer of monopoly power from one market to another.

To review, from the early 1900’s until the 1960’s, this type of transfer of power was

perceived as a significant threat, and was the underlying policy justification for the per se

rule against tying.76 In the 1960s, the so called “Chicago-School” attempted to discredit 75 Two examples where exclusive dealings caused substantial harm to consumers were in U.S. v. Microsoft, 253 F.3d 34 (D.C.Cir.2001), and United States v. Visa, et al., 344 F.3d 229, 238 (2nd Cir.2003). In Microsoft, Defendants’ various anticompetitive actions, including tying and exclusive dealings, effectively killed Netscape, a competing browser which may have evolved into an alternative platform for software, thereby challenging Defendant’s monopoly in the market for personal computer operating systems. In Visa, the exclusive dealing policy prohibited member banks from issuing American Express or Discover Cards. As banks were the primary mode of distribution for the cards, consumers choice was substantially harmed. 76 For a review of the history regarding leverage theory, See Christopher Leslie, Cutting Through Tying Theory with Occam’s Razor: A Simple Explanation of Tying Arrangements, 78 Tulane L.R. 727, 731-751 (2004); Keith Hylton and Michael Salinger, Tying Law and Policy: A Decision Theoretical Approach,

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the theory by asserting that if a firm holds monopoly power in one market it is irrational

for the firm to leverage its monopoly power into a competitive market, because there is

only “only monopoly profit” to extract (and thus the firm gains nothing from the

leverage).77 The Chicago-School theory was highly influential, and is at least partially

responsible for monopoly leverage no longer being a valid stand-alone theory under

Section 2 of the Sherman Act. (i.e. Post Trinko, any plaintiff who seeks to challenge

monopoly leverage must satisfy all the elements of attempted monopolization.78)

However, over time, the Chicago School’s theory has been criticized and it its conclusion

questioned. Economists and lawyers have demonstrated that in many instances, its

underlying assumption fail to hold, casting serious doubt on its usage as a basis for a

general legal rule.79 The combined effect of these academic critiques exposing the

available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=267170 ; Jay Choi, Antitrust Analysis of Tying Arrangements, CESinfo Working Paper No. 1336 (Nov. 2004), available at http://ideas.repec.org/p/ces/ceswps/_1336.html.

77 Barry Nalebuff does an excellent job of explaining the theory, as follows: “Imagine that the monopoly price of good A on its own is m, and the competitive price of good B is c. If the monopolist were to earn higher profits at price b for a bundle of A and B, then consider the implied monopoly price m’= b –c. Since good B is available at c, anyone who buys the bundle is willing to pay an incremental price of b-c for A. Were the monopolist to charge b-c for A alone and eliminate the bundle, its demand and, hence, its profits would be at least as large (as there may be some consumers who do not value good B even at its cost c). This suggests that bundling does not lead to higher profits.” See Barry Nalebuff, “Bundling as a Way to Leverage Monopoly,” Working Paper#36 available at http://ssnr.com/abract=586648.

78 Verizon Communication v. Law office of Curtis Trinko, 540 U.S. 398, 124 S.Ct. 872 at FN 4 (2004)(“The Court of Appeals also thought that respondent’s complaint might state a claim under a ‘monopoly leverage’ theory . . . . We disagree. To the extent the Court of Appeals dispensed with a requirement that there be a ‘dangerous probability of success’ in monopolizing a second market, it erred.” [citation omitted]); Spectrum Sports vs. McQuillan, 506 U.S. 447, 459 (1993)(holding that Section 2 “makes the conduct of a single firm unlawful only when it actually monopolizes or dangerously threatens to do so.”)

79 See e.g. Michael Winston, Tying, Foreclosure, and Exclusion, 80 American Economic Review 4, 837-859 (1990); Dennis Carlton and Michael Waldman, The Strategic Use of Tying to Preserve and Create Market Power in Evolving Industries,” 38 RAND Journal of Economics at 194 – 220 (2002); Jay Choi and Christodoulous Stefanadis, Tying, Investments, and the Dynamic Leverage Theory, 32 RAND Journal of Economics at 52-71 (2001); Ioana Chioveanu, Is Bundling Anticompetitive? (June 2004), available at http://ideas.repec.org/p/aub/autbar/568.03.html; Barry Nalebuff, Bundling as an Entry Barrier, 119 Quarterly Journal of Economics No. 1 pg 159-187 (Feb.2004) (showing that tying can be used to leverage

28

shortcomings of the “one monopoly profit” theory in varied circumstances demonstrate

that the Chicago School theory is merely a particular case and not the general rule.80

Accordingly, anticompetitive effects of leveraging of monopoly power is something in

which courts ought to be concerned with as a means of both increasing monopoly profits

and maintaining monopoly power (via deterring entry), despite the refusal of the U.S.

Supreme Court to acknowledge its legitimacy.81

The relevance of the monopoly leverage theory to this paper pertains to the distinction

between exclusive dealings and tying/bundling: In the former, the anticompetitive harm

(if any) is “horizontal” in nature, while in the latter, the anticompetitive harm (if any) is

“vertical” in nature. As a result, leveraging of monopoly power is only possible for tying

and bundling. In contrast, exclusive dealing cases are generally concerned with firms

maintaining or increasing its power in the same market, and thus are “horizontal” in

nature.82 Thus, the policy question which counters my argument that the Market

monopoly power as a deterrent for entry and to raise profits even after entry in certain cases). The primary assumptions which the Chicago School theory have been based on, and which have led to their undermining are: (1) homogenous consumers; (2) marginal consumers who would either purchase the product or not purchase the product as a result of a bundle and/or price increase; (3) fixed proportions in all bundles sold; (4) constant returns to scale in the tied market; and (5) the tied/downstream market is perfectly competitive. Also, note that the Chicago School argument is based on static, short term notions of efficiencies and profits. A long-term, dynamic analysis may differ. Recent papers have shown that when done in variable proportions and with heterogeneous purchasers, bundling can unequivocally be used to leverage monopoly power and that bundled rebates may foreclose an equally efficient rival. See Barry Nalebuff, Bundling as a Way to Leverage Monopoly, Working Paper#36 available at http://ssnr.com/abract=586648; and Patrick Greenlee, David Reitman, and David Sibly, An Antitrust Analysis of Bundled Loyalty Discounts, Economic Analysis Group Working Paper, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=586648.

80 Id. The numerous works of Barry Nalebluff of the Yale School of Management in the area of bundling and tying are particularly impressive and helpful. Several of his articles are cited in this paper.

81 Verizon Communication v. Law office of Curtis Trinko, 540 U.S. 398, 124 S.Ct. 872 at FN 4 (2004); Spectrum Sports vs. McQuillan, 506 U.S. 447, 459 (1993).

82

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Strategies should be treated the same, is does the “horizontal” vs. “vertical” nature justify

disparate treatment? Are we more concerned with monopoly leverage or maintenance?

On one hand, as the Chicago-School has demonstrated, monopoly leverage is a long-term

harm and tenuous. Still, what if the market trying to be leveraged is an important

market? If it is a technological market, or a market for innovation? If the market is

prone to network effects, first mover advantage and “tipping?” Alternatively, should we

be as concerned with a monopolist maintaining it monopoly power? If the firm already

has substantial market power, does it matter? Is it relevant how the market power was

obtained or whether the firm is more efficient than current/potential rivals?

I do not profess to know the answers to any of the aforementioned questions. Rather, I

merely wish to raise the issues as a means of countering my “consistency” argument.

There may very well be policy reasons for a dissimilar treatment of the tying, bundling

and exclusive dealings. What is important, though, is that the different treatment is based

upon policy and sound analysis rather than superficial, formalistic distinctions or

discredited beliefs or theories.

C. Business Justifications

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Under the rule of reason, courts will consider the business justifications for alleged

anticompetitive conduct. As noted above, even in the modified per se test used in

analyzing certain tying arrangements, courts will sometimes permit defendants to provide

business justifications.83 However, given that the primary anticompetitive concern of the

Market Strategies is foreclosure of competition, I do not quite understand the rationale for

permitting a defendant to introduce business justification – at least not in the case where

the defendant has substantial market power. I believe that the underlying rationale for

considering the justification is to not deter beneficial pro-competitive discounts. Yet, if

that is the case, this can be more effectively measure by the effect on consumers, i.e.,

whether the particular Market Strategy at issue will have the likely effect of increasing

output, enhancing the product, or is otherwise innovative. To focus on the intent or

purpose of the particular Market Strategy, or whether it provides the defendant cost

savings or efficiencies seems to be misplaced. A firm with substantial market power is

not subject to the same competitive pressures as other firms. As a result, although cost

savings or efficiencies flowing from implementation of a particular Market Strategy may

very well increase the firm’s profits, I don’t see it likely that those profits will be passed

on to consumers due to the lack of competitive pressures. Consequently, I believe that

when assessing a particular tying arrangement, bundle, or exclusive dealing, business

purpose/justification is irrelevant and should not be considered when assessing whether

the conduct anticompetitive or not.84 Rather, courts should assess whether discounts are

below costs under traditional predatory pricing doctrine as well as assess and compare the

83 See supra note 50.84 Again, I limit this to when the firm imposing the Market Strategy has substantial market power.

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pro-competitive effects of a decrease in price or increase in output with the potential long

term anticompetitive effects of foreclosure of competition.

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