B2B or Collusion That Is the Question Antitrust Enforcers Will Ask of Business-to-Business Sites

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1 Reprinted with permission from Legal Times (p.36, April 3, 2000) B2B or Collusion That Is the Question Antitrust Enforcers Will Ask of Business-to-Business Sites by Charles F. "Rick" Rule, Mark E. Plotkin, and Michael J. Fanelli (Charles F. "Rick" Rule, a partner at D.C.'s Covington & Burling, is a former head of the Justice Department's Antitrust Division and now head of the firm's antitrust and trade regulation practice. Mark E. Plotkin, also a partner in Covington's D.C. office, is head of the firm's electronic commerce practice and represents Fortune 500 companies, banking organizations, and Internet start-ups. Michael J. Fanelli is an associate in the antitrust and trade regulation practice group.) Most consumers would agree that Internet commerce is a revolutionary economic phenomenon. But the "e-tailing" sites of which they're thinking like Amazon.com or ebay represent only a fraction of the total business occurring online. Although few consumers have heard of them, the majority of Internet sales transactions now go through "B2B" (business-to-business) sites, such as Agex.com and Metalsite.net. In fact, Agex and Metalsite are just two of an estimated 500 B2B exchanges that have emerged on the Internet over the past year. Recently, the three major automakers announced such a site, as have four of the major defense contractors. Both developments made headlines. B2B marketplaces offer certain advantages over traditional marketplaces: dynamic realtime pricing, informed price competition, transaction timeliness, and convenience. To a greater or lesser extent, these sites integrate sourcing, purchasing, and billing for suppliers, manufacturers, distributors, and customers. Most B2Bs target a single industry, bringing together every link in the supply chain. Some sites are modeled on an auction: A site displays the current offerings of sellers, and buyers sign on to bid. The other principal model is an exchange: The B2B operates a neutral platform that gathers buyers and sellers together and requires them to operate under strict ground rules; the site receives a fee for each transaction. The B2B sites now in place (and more are springing up daily) have many fans. They applaud the price transparency; they laud the sites as convenient means to auction excess inventory and below-par goods. Someday, B2Bs that deal in commodities could conceivably supplant the Chicago Board of Trade.

2 - 2 - But B2Bs are not just exciting opportunities. There are significant regulatory concerns over the prospect of hundreds or even thousands of B2Bs operating without proper licenses, violating commercial laws, becoming insolvent, or running afoul of the securities laws. But perhaps the biggest shadow is that cast by antitrust law. Despite the obvious efficiencies of B2B transactions, the electronic marketplace is no more immune to competitive scrutiny than the traditional marketplace that it is beginning to supplant. To avoid accusations that a particular B2B is a virtual "smoke-filled room," businesses must pay careful attention to antitrust concerns. Who, What, and When One of the most pro-competitive features of B2B exchanges is their ability to help consumers obtain better and cheaper goods by providing quick and easy access to information about the price, quality, and availability of products. By allowing the realtime exchange of such information, B2Bs reduce the costs that buyers and sellers would otherwise expend to locate and negotiate with each other. Supply and demand conditions are more rapidly and accurately revealed. All this improves efficiency. On the other hand, by eliminating uncertainty and making transactions more transparent, B2B exchanges may enhance coordinated interaction in concentrated industries. And depending on how transactions are structured, a B2B exchange might be seen as facilitating illegal agreements on price among the participants. The recently released Draft Competitor Collaboration Guidelines from the Federal Trade Commission and the Justice Department note that, although the exchange of information can be pro-competitive, such sharing among "actual or potential competitors may increase the likelihood of collusion on matters such as price, output, or other competitively sensitive variables," particularly where the information relates to "price, output, costs, or strategic planning." Because B2B sites sometimes permit sellers to view the prices and volumes at which other sellers have consummated sales or to learn whether other sellers have excess capacity, participating businesses ought to give careful thought to keeping some sensitive information confidential. Many B2Bs allow buyers to bid confidentially and do not disclose the results of consummated transactions. But others might be designed to encourage cozy behavior between competitors or to make transactions more profitable for powerful sellers or buyers. Antitrust challenges to electronic information exchanges are not theoretical. In 1994, the Justice Department settled a case alleging that the major airlines used their joint electronic fare system, ATPCo, to increase fares and discourage discounting. United States v. Airline Tariff Publishing Co., Trade Cas. (CCH) 70,687 (D.D.C. 1994) (final consent decree).

3 - 3 - The department alleged that ATPCo, which collected actual and future price information from member airlines for use by travel agents, also generated detailed reports that allowed the members to coordinate their pricing decisions. Unlike most B2B exchanges, the airline tariff system contained information about future and "hypothetical" prices not realistically available to consumers and included protocols that allegedly allowed the airlines to "signal" one another. The ATPCo case predates the explosive growth of the Internet, yet it is a harbinger of the risks confronting a B2B that fails to employ the proper safeguards. The availability of competitively sensitive information on a B2B site can facilitate collusion among buyers as well. For example, if a B2B allows participants to view the identity of, amount purchased by, and price paid by buyers on the exchange, and if most or all of the competitors in an industry buy on the exchange, the B2B may convey information that facilitates downstream coordination among buyers. Antitrust concerns will become serious if a competitor has access to information about an input or a group of inputs purchased by the buyer that constitute a significant portion (typically 20 percent) of the value of the finished goods produced by the buyer. More generally, antitrust concerns may arise from the spill-over effects of information shared between competitors who jointly operate a B2B. There will no doubt be a demand for reports that aggregate information about competitors' transactions on the exchange. However, properly constructed firewalls can make anti-competitive effects less likely. Besides the speed and timeliness of information exchanges, another reason that B2Bs are attractive is because they provide a means by which to pool the purchasing power of many buyers to obtain goods at a lower cost (through volume discounts or reduced transaction costs). Generally, buyers will form a joint B2B exchange to purchase common inputs, or they will pool their purchasing power to bid on goods offered over another B2B exchange. In one prominent example, Ford, General Motors, and DaimlerChrysler recently agreed to abandon their own proprietary Internet purchasing operations and to create an independent automotive parts exchange. This B2B will represent more than $240 billion of purchasing power. The FTC is reportedly investigating the venture. The Competitor Collaboration Guidelines recognize that joint buying is often procompetitive because it can provide economies of scale and promote efficiencies in the purchasing, warehousing, and distribution of inputs. However, the guidelines also recognize that joint buying can have anti-competitive effects, particularly where the combined purchasing of the firms creates monopsony power, i.e., the power to drive the price of a good or service below competitive levels. Generally, antitrust concerns are not likely if the combined purchasing power of the joint operators of a B2B exchange accounts for less than 20 percent of a particular market (the threshold established in the Competitor Collaboration Guidelines). Even many joint

4 - 4 - purchasing arrangements outside this safety zone are lawful, depending on the particular market circumstances. The Site to See As with virtually any other service provided over the Internet, antitrust enforcers are also likely to worry that so-called network effects may result in a single B2B exchange for a product or group of products coming to dominate all others. The more buyers and sellers that use a particular exchange, the more valuable the site will be. It could be argued (and perhaps it is true) that, once a given exchange for a product gains critical mass, network effects will drive it to become the market-making site for that product. At least theoretically, other sites will then have to differentiate themselves (i.e., find a unique niche) or go out of business. The possibility that network effects will influence or be seen by the antitrust enforcers and courts to influence the development of B2B exchanges raises several serious issues. First, rules that require participants in a B2B exchange to transact most or all of their e- business on that exchange might be viewed as exclusionary, particularly if the exchange is responsible for a large share of all e-business transactions for the given product. The concern would be that exclusivity could entrench the dominant player here, the dominant B2B. There may be good reasons for obtaining minimum commitments from participants (e.g., to cover the costs of setting up and operating the site). But the findings of fact in United States v. Microsoft suggest that, in the presence of apparent network effects, antitrust enforcers and some judges can be very, very sensitive to the competitive impact of arguably exclusive obligations. Second, if a B2B exchange becomes dominant, or if an exchange is owned or controlled by competing buyers or sellers, then rules that limit, exclude, or discriminate against participation by certain competitors may run the risk of antitrust liability. An agreement among buyers not to deal or to deal only on certain terms with a particular supplier is almost always illegal even if the supplier is a poor credit risk, unethical, or a price-cutter. But the discrimination does not have to rise to the level of outright exclusion to raise antitrust issues. A decision by a group of B2B sellers to charge higher transaction fees to raise the costs of competing sellers could be unlawful. Likewise, if a buyer- or selleroperated B2B gathers statistical or other valuable information from its members for use by the B2B operators and denies competing buyers or sellers access to that information, antitrust risks could arise. At some point in the future, transactions that consolidate similar B2B sites may also raise antitrust issues. While in some cases, robust, all-inclusive B2B exchanges may yield the greatest efficiencies, competition between exchanges might drive down commissions and other transaction costs and provide consumers with valuable choices

5 - 5 - between different transaction protocols. At least after the exchanges have matured, antitrust enforcers may decide that B2B consolidation eliminates beneficial competition. Because the Internet marketplace is still young, the antitrust aspects of B2B sites may not loom large today. But as the B2B marketplace grows and evolves, antitrust scrutiny is likely to follow. If the ground is not laid early to address competition issues, firms that conduct business over the Internet may someday find themselves in a precarious position. (c) 2000 NLP IP Company. All rights reserved. Reprinted with permission of Legal Times, 1730 M Street, NW, Suite 802, Washington, DC