Monopolisation

Pricing “Do”s, “Don’t”s and Uncertainties for Monopolists under the US Antitrust Laws

Pricing practices are, of course, the lifeblood of any business, including that of a monopolist. Over time, the US antitrust laws have made substantial progress in sorting through a monopolist’s alternative pricing practices and putting at least some of them in either the ‘Do’ or the ‘Do Not’ category. Just this year, another category of pricing conduct, ‘price squeezes’ (at least in certain circumstances), was added to the ‘Do’ category by the US Supreme Court. The task of categorising these pricing practices is not yet complete, however, and certain categories of pricing conduct remain in a state of uncertainty, where their treatment may vary depending on the particular court that considers the practice. And, of course, the task of eliminating areas of uncertainty may never be complete as ingenious monopolists devise new ways of pricing their products that attracts litigation-willing competitors, consumers or government agencies to challenge the practice.

This article will review the current status of the ‘Dos,’ the ‘Do Nots’ and the areas of uncertainty for businesses with large market positions that are subject to the US antitrust laws. Currently, the US antitrust laws establish four clear ‘Dos,’ two ‘Do Nots’ and four areas of uncertainty for monopolist pricing practices.

Do charge high prices

It may seem odd to suggest that charging high prices is a ‘Do’ for any monopolist, given that those high prices could harm consumers. Nonetheless, as recently reaffirmed by the US Supreme Court in Pacific Bell Telephone Co v Linkline Communications Inc,1 a monopolist is free unilaterally to charge as high a price as it can persuade its customers to pay.2 Charging high prices is viewed merely as the monopolist enjoying the fruits of its monopoly,3 and is viewed as an essential incentive for innovation.4 As stated in Verizon Communications Inc v Law Office of Curtis V Trinko LLP:5

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system.

Thus, characterising a monopolist’s charging high prices as a ‘Do’ rather than a ‘Can’ is really a policy matter and a long term consumer welfare issue. In the short term, high prices may harm a monopolist’s customers, but, in the long term, those high prices may be a pro-competitive invitation to entry by new companies and innovators.6

Do not price below cost

Charging low prices will also not constitute monopolising conduct unless those prices satisfy a below-cost pricing standard established by the US Supreme Court in Brooke Group Ltd v Brown & Williamson Tobacco Corp.7 This rigorous standard – designed to avoid chilling the consumer welfare benefit of lower prices, while still protecting competition – requires two elements. First, the alleged monopolist’s prices must be ‘below an appropriate measure’ of its costs. Second, the alleged monopolist must be likely to ‘recou[p] its investment in below-cost prices’ by successfully and durably excluding sufficient competition to enable the monopolist subsequently to increase prices to earn back its earlier investment.8

One pricing uncertainty is what is really meant by an ‘appropriate measure’ of costs. While repeatedly reaffirming the Brooke Group standard generally,9 the Supreme Court has not yet provided any additional guidance as to the most ‘appropriate measure’ of costs against which to compare a monopolist’s prices. The lower courts, although devoting substantial attention to analysing this issue, have also not settled on a consistent single measure of costs. For example, the Second Circuit and the Fifth Circuit favour average variable cost as the dividing line between prices that are predatory and prices that are not.10 The Ninth Circuit still retains a more complicated standard that wholly immunises only those prices that are above average total cost and distinguishes between prices above and below average variable cost by shifting the burden of proving lack of competitive harm to the defendant when prices are below average variable cost.11

Do not fix prices

A company sometimes has a sufficiently large market position to enjoy ‘monopoly power,’ but nonetheless has less than 100 per cent of the market, and so faces individual competitors. As such, the monopolist must adhere to the same rule as all non-monopolist businesses and cannot agree with its competitors on the prices to be charged to customers.12

May charge different prices to different customers

Price discrimination – charging different customers different prices – will not generally constitute exclusionary conduct for purposes of Section 2 monopolisation liability. Instead, like charging high prices, price discrimination merely enables a monopolist to enjoy more fully the fruits of its market position. By charging customers different prices, a monopolist maximises its profits by extracting as much as it can from each customer based upon the customer’s particular preferences and need for the monopolist’s product or service.

There are only two limitations on a monopolist’s freedom to engage in price discrimination. The first is the Brooke Group prohibition on below-cost pricing discussed above.13 The second is the Robinson-Patman Act,14 when the monopolist sells to customers who compete with one another and the limitations of that statute are applicable.

Can offer single product volume discounts

A straightforward volume discount on a single product does not constitute monopolising conduct (unless the prices somehow run afoul of the Brooke Group predatory pricing standard). In Advo Inc v Philadelphia Newspapers Inc,15 the Third Circuit held that volume discounts ‘offend no antitrust principles’. Even in Le-Page’s Inc v 3M Co,16 in which the Third Circuit condemned bundled discounts (discussed below in the ‘uncertainties section,’), the court stated that ‘volume discounts [...] are concededly legal and often reflect cost savings.’

May charge rival-squeezing wholesale and retail prices

Earlier this year, the US Supreme Court, in Pacific Bell Telephone Co v Linkline Communications Inc,17 decided that ‘price squeezes’ do not violate section 2 of the Sherman Act, at least where the monopolist has no duty to deal with its rival and is charging prices that are above its costs. For all practical purposes, Linkline overruled Judge Learned Hand’s more than sixty year old decision in US v Aluminum Co of America (‘Alcoa’)18 holding that a monopolist had unlawfully exercised its monopoly power by squeezing the margins of and forcing the exit of its downstream rivals.19

A ‘price squeeze’ is possible when a vertically integrated firm sells inputs at wholesale and also sells finished goods at retail. If the firm has market power in the upstream market, it can simultaneously increase wholesale prices of inputs and reduce the price of the finished goods in the downstream market, thereby ‘squeezing’ the profit margins of any rivals in the downstream market.

The Supreme Court held that, where an upstream monopolist had no duty under the antitrust laws to sell to the downstream rival, no claim for a price squeeze could be established. The court reasoned that, if a firm had no duty to deal with a downstream rival at all, by extension, it had no duty to deal on terms that enabled the downstream rival to earn a profit or to survive. The court found the upstream wholesale price to be unchallengeable under the circumstances of the case where the upstream monopolist had no duty to deal under the antitrust laws.

Without the upstream half of the ‘squeeze,’ the court reasoned that Linkline’s only remaining claim was that its competitor’s downstream prices were too low. Applying Brooke Group Ltd v Brown Williamson Tobacco Corp,20 the court held that Linkline needed to allege and prove that the downstream prices satisfied the Brooke Group standard for predatory pricing, including the recoupment requirement. At base, the court held that Linkline’s price-squeeze claim was ‘nothing more than an amalgamation of a meritless claim at the retail level and a meritless claim at the wholesale level.’21 Relying upon a monopolist’s freedom to charge monopoly prices, the court stated:

If both the wholesale price and the retail price are independently lawful, there is no basis for imposing antitrust liability simply because a vertically integrated firm’s wholesale price happens to be greater than or equal to its retail price.22

In essence, the court viewed the ‘price squeeze’ claim as one about protecting competitors rather than the competitive process.

Areas of uncertainty

Four primary areas of ambiguity in these rules or guidelines remain. The first was already discussed above – the ‘appropriate measure’ of costs in the Brooke Group predatory pricing standard, which remains an unsettled area. The others are price squeezes where a monopolist does have a duty to deal; bundled discounts; and loyalty discounts. These will be discussed in turn.

Price squeezes by a monopolist with a duty to deal

The Supreme Court’s Linkline decision was expressly limited to alleged ‘price squeezes’ where the upstream monopolist had no duty to deal with its downstream rival under the antitrust laws. Thus, whether any ‘price squeeze’ claims remain viable after Linkline depends crucially upon whether, and under what circumstances, a monopolist still has a duty to deal with a downstream rival after Trinko. Only where a monopolist has such a duty will the upstream price potentially join with the downstream price to create a ‘squeeze.’

Two possible scenarios remain after Trinko where the duty to deal may continue to exist under the antitrust laws. Only one of these likely creates any real potential for a ‘price squeeze’ monopolisation claim under section 2.

The first of these is where regulatory statutes and rules establish a monopolist’s duty to deal with a downstream rival independent of the antitrust laws. In those circumstances, however, the courts and commentators see any ‘price squeeze’ issues as those for the regulatory agencies and not for the courts under section 2 of the Sherman Act.23

The second scenario is the, at least hypothetical, situation where an existing course of dealing or other circumstances create an obligation for a monopolist to deal or to continue to deal with a downstream rival.24 Erik Hovenkamp and Herbert Hovenkamp25 hypothesise a set of circumstances in which a price squeeze could affect the competitive process rather than just competitors, as was the case in Linkline. In a continuing dealing situation between an upstream monopolist and its downstream rival, the upstream monopolist could squeeze the downstream rival solely for the purpose of undermining the downstream rival’s resources and ability to integrate upstream. In those circumstances, a ‘price squeeze’ may harm the long term competitive process and not just a competitor, by preventing entry into the upstream market.

In those circumstances, the Hovenkamps argue, the cost-based test of Brooke Group will not adequately and accurately identify exclusionary conduct. Obviously, the upstream monopolist can reach its goal of excluding its rival from expanding upstream by simply charging higher upstream prices and maintaining downstream prices well above costs. The Hovenkamps suggest an alternative analysis. They propose testing whether the difference between the price charged by the upstream monopolist to its rival and the upstream monopolist’s own downstream output price is less than the monopolist’s average total cost or average variable cost of producing its own downstream output. If it is, an equally efficient competitor could be excluded, which arguably merits some inquiry as to whether the ‘price squeeze’ was undertaken merely to preclude the rival’s upstream integration.

Bundled discounts

The appropriate treatment of bundled discounts – discounts provided to customers who buy specified quantities across multiple product lines – under the US antitrust laws is a hotly debated topic. The debate centres around whether these bundles should be analysed under a foreclosure standard analogous to tying or pursuant to a cost-based standard like predatory pricing and, if so, how that standard should be applied in practice. In part, this debate results from the fact that bundled discounts are not all identical and can arise in different circumstances that may justify different treatment. In any event, there is a growing body of case law applying various standards and of commentary debating the propriety of those standards. Two cases, LePage’s Inc v 3M Co26 and Cascade Health Solutions v Peace-Health illustrate two different points on this spectrum.

In LePage’s, the Third Circuit summarily rejected the argument that bundled discounts could constitute monopolising conduct only if the bundle’s price was somehow below cost, a position adopted in earlier cases.27 The Third Circuit instead analogised bundled discounts to tying by a monopolist:

The principal anticompetitive effect of bundled rebates [...] when offered by a monopolist [is that] they may foreclose portions of the market to a potential competitor who does not manufacture an equally diverse group of products and who therefore cannot make a comparable offer.28

Thus, at least in the Third Circuit, a monopolist’s pricing of bundled discounts is most risky when the bundle includes products that competitors cannot offer.29

The LePage’s decision has been widely criticised for, among other things, failing to determine whether the bundled discounts were excluding an equally or a less efficient competitor – in other words, whether the bundle involved below-cost pricing. Other courts that have considered bundled rebates have required, as a precondition to liability, some demonstration of below-cost pricing or that the plaintiff was at least an equally efficient competitor.30

Cascade Health Solutions is one of the cases in which the court adopted a cost-based approach to analysing the competitive impact of the discounted bundle that consisted of a single source product and a competitive product. In particular, the court chose an approach that is being called the ‘discount allocation’ approach. The court tested whether the competitive product in the bundle was being sold above its average variable cost, when all discounts on the bundle as a whole were allocated to the competitive product.

As with any conduct contemplated by a firm with substantial market power, a proposed bundled discount should be carefully analysed as to its likely impact on competition so as to judge whether it will be perceived as competition on the merits or as a customised vehicle for reducing competition by delaying or excluding new entry.

Loyalty discounts

Loyalty discounts are another area of uncertainty and one that may threaten to overwhelm the usual comfort level with volume discounts generally. Loyalty discounts refer to price reductions that are given on every unit purchased, if a certain level of purchases is achieved. In contrast, typical volume discounts reduce the price only on additional units purchased above a specified threshold.

Loyalty discounts such as this have been challenged in various lawsuits because they are perceived to have a greater exclusionary impact than ordinary volume discounts.31 Although these cases have not been particularly successful, they also have not established any clear standards for evaluating the antitrust risks of such programmes and certainly have established no clear safe harbours.

These loyalty discount programmes can be and are evaluated from a number of perspectives. In some cases, they are analysed to determine whether they foreclose competitors by creating incentives to purchase from a single supplier to a degree that approximates the effects of an exclusive dealing contract.32 In other situations, the discounts are analysed in relation to costs to determine whether they constitute predatory pricing.33

Until clearer standards are developed, to avoid unreasonable risk in implementing a loyalty discount programme, the programme should be evaluated from a number of perspectives to determine whether, in all the circumstances, the programme would be viewed as likely to exclude existing or prospective customers or raise hurdles to entry.

***

Fairly simple dos and don’ts exist for some of a monopolist’s possible pricing practices, but not all. As a rule of thumb, however, the more complex the pricing plan, the more complicated and uncertain the antitrust analysis becomes. Particularly in the case of bundled discounts and loyalty discounts, even the framework for analysis is unsettled and care must be taken to avoid unnecessary risks in implementing those practices.

Notes

1 129 S Ct 1109, 1122 (2009).

2 See Berkey Photo Inc v Eastman Kodak Co, 603 F2d 263, 274 n.12 (2d Cir 1979), cert denied, 444 US 1093 (1980).

3 Id.; see also Report and Recommendations of the Antitrust Modernization Commission at 104: the Commission distinguished between conduct that excludes and conduct that exploits, stating that ‘exploiting conduct is that which may be undertaken by a monopolist as a fruit of its monopoly, and should not give rise to an antitrust claim.’

4 Verizon Communications Inc v Law Offices of Curtis V Trinko LLP, 540 US 398, 407 (2004).

5 540 US 398, 407 (2004).

6 Berkey Photo, 603 F2d at 274, n.12.

7 509 US 209 (1993); see also Microsoft, 253 F3d at 68.

8 Brooke Group, 509 US at 224.

9 Linkline, 129 S Ct 1109, 1120; Weyerhaeuser Co v Ross-Simmons Hardwood Lumber Co, 127 S Ct 1069 (2007).

10 See Kelco Disposal v Browning-Ferris Industries, 845 F2d 404 (2d Cir 1988), affirmed on other grounds, 492 US 257 (1989); Stearns Airport Equip Co v FMC Corp, 170 F.3d 518 (5th Cir 1999).

11 See William Inglis & Sons Baking Co v ITT Continental Baking Co, 668 F2d 1014 (9th Cir 1981).

12 15 USC section 1.

13 Brooke Group, 509 US at 221.

14 15 USC section 13.

15 51 F3d 1191, 1203 (3d Cir 1995).

16 324 F3d 141, 154 (2003).

17 129 S Ct 1109 (2009).

18 148 F2d 416 (1945).

19 148 F2d at 438.

20 509 US 209 (1993).

21 129 S Ct 1109, 1120.

22 129 S Ct 1109, 1122.

23 See Town of Concord v Boston Edison Co, 915 F2d 17 (1st Cir 1990); Brief of Amici Curiae Professors and Scholars in Law and Economics in Support of the Petitioners in Linkline, 2007 WL 4132899 (US).

24 Cf Aspen Skiing Co v Aspen Highlands Skiing Corp, 472 US 585 (1985). Given the holding in Trinko, establishing the duty to deal of an upstream monopolist will be the first and very substantial hurdle to progressing any ‘price squeeze’ claim.

25 Erik N Hovenkamp and Herbert Hovenkamp, ‘The Viability of Antitrust Price Squeeze Claims,’ 51 Ariz L Rev 273.

26 324 F3d at 154.

27 SmithKline Corp v Eli Lilly & Co, 427 FSupp.1089 (ED Pa 1976), aff’d, 575 F2d 1056 (3d Cir 1978); Ortho Diagnostic Systems Inc v Abbott Laboratories Inc, 920 FSupp 455 (SDNY 1996); Virgin Atlantic Airways Ltd v British Airways PLC, 69 FSupp 2d 571 (SDNY 1999), aff’d, 257 F3d 256 (2d Cir 2001).

28 LePage’s, 324 F3d at 155.

29 See also SmithKline, 575 F2d at 1065.

30 Ortho Diagnostic Sys Inc v Abbott Labs Inc, 920 F Supp. 455 (SDNY 1996).

31 See, eg, Virgin Atlantic Airways Ltd v British Airways PLC, 69 F Supp 2d 571 (SDNY 1999), aff’d, 257 F3d 256 (2d Cir 2001); Concord Boat Corp v Brunswick Corp, 207 F3d 1039 (8th Cir. 2000).

32 See also Masimo Corp v Tyco Health Care Group LP, CV 02-4770, 2006 WL 1236666, at *13 (CD Cal 23 Mar 2006).

33 Virgin Atlantic Airways Ltd v British Airways PLC, 69 FSupp 2d 571 (SDNY 1999), aff’d, 257 F3d 256 (2d Cir 2001).