B2B Internet Exchanges: The Antitrust Basics

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1 A N T I T R U S T R E P O R T B2B Internet Exchanges: The Antitrust Basics William Blumenthal E xchanges have a long antitrust history. Chicago Board of Trade v. United States 1 remains the classic statement of the rule of reason. Silver v. New York Stock Exchange 2 was an important decision in the evolution of boycott law. Gamco, Inc. v. Providence Fruit & Produce Building, Inc., 3 now largely forgotten, was for years a leading statement of the essential facilities doctrine. In the electronic era, automated clearing houses in banking, 4 multiple listing services in real estate, 5 computerized reservation systems in airlines, 6 and, most recently, Nasdaq 7 have all been the subject of antitrust enforcement actions. Significantly, none of the actions has challenged the legality of the exchange itself. All relate to operating rules or other collateral restraints governing the particulars of operation of the exchange access standards, pricing rules, trading hour limitations, and similar details. The antitrust issues posed by exchanges are again erupting with the rapid, almost faddish proliferation of Internet-based business-to-business (in modern jargon, B2B) networks. During the first few months of 2000, the business press virtually every day has carried a report of the development of another site, most often for industry-specific inputs. Prominent examples from February and March alone include efforts among participants in the aeronautics, automobiles, farming, consumer products, paper, medical products, and retailing industries to develop Internet-based exchanges for the supply of inputs. 8 The participantcontrolled networks have lagged (and to some degree responded to) entrepreneurial efforts to develop proprietary networks serving a wide range of industries. 9 As the initial euphoria accompanying the announcement of the sites has subsided, the recognition of potential antitrust issues has taken a more central WILLIAM BLUMENTHAL, a member of the Board of Editors of ANTITRUST REPORT, is a partner in the Washington, D.C., office of King & Spalding. He thanks Kathryn E. Walsh for research assistance and David A. Balto and Peter C. Fleming for valuable comments on earlier drafts of this article. [ 34 ]

2 M A Y role. The recognition is not subtle it has even found its way into headlines of stories addressing the hurdles in moving the intended sites from aspiration to operation. 10 Noting that the Federal Trade Commission is reviewing the automotive industry s participant-controlled site to determine if the structure lends itself to unlawful price signaling or coordination among buyers or sellers, the Wall Street Journal states that the mere hint of FTC concern could cause other industry exchanges to put their plans on hold to see what, if anything, the FTC says. 11 This article summarizes the key issues that are likely to arise in connection with the antitrust evaluation of the new Internet business exchanges. Part I provides background on the exchanges themselves and on the guidance that government enforcement Enforcement agencies have challenged operating rules of exchanges, but not the authorities have thus far provided on legality of the exchanges themselves. the exchanges. Part II addresses the antitrust considerations relating to the formation of the exchanges. Part III addresses the antitrust issues arising from the types of collateral restraints that might govern the operation of particular exchanges. These operational matters include the transparency of competitive information, auction rules and exchange fees, and limitations on participation through denials of access or requirements of exclusivity. A. About the exchanges I BACKGROUND Internet business exchanges are variously known as B2B exchanges, B2B Web sites, b-webs, Internet trading hubs, and virtual marketplaces. Nomenclature aside, all of these terms refer to the same general concept a distinct system of suppliers, distributors, commerce services providers, infrastructure providers and customers that use the Internet for communications and transactions. 12 Basically, the sites provide an electronic marketplace, in which buyers and sellers meet to transact goods and services. The particulars of the marketplace will vary from site to site; but many of the sites (and probably most) are structured as some form of auction, in which sellers will bid against one another to provide a specified input used by the buyer. The principal benefit of the sites is the likelihood of substantial reduction in transaction costs. Finding potential suppliers, managing the bid process across [ 35 ]

3 A N T I T R U S T R E P O R T suppliers, structuring contracts with suppliers, and coordinating deliveries by suppliers all require resource commitments by the procurement units of industrial buyers. If cheap, rapid electronics can successfully supplant a system based on paper and human contact, those resource commitments can be scaled back. The numbers are big. A press account describing one of the announced sites reported the following: General Motors, Ford and DaimlerChrysler hope to move all their business, involving more than $250 billion and 60,000 suppliers, to the Internet. The exchange s earliest benefits are straightforward. It will replace a bloated procurement process built on phone calls and fax machines. GM, for example, issues more than 100,000 purchase orders a year, with an average processing cost of $ The new sites can be viewed as lineal descendants of electronic data interchange arrangements that have been emerging since the mid-1980s. Recognizing the potential to reduce transaction costs through so-called EDI, many industries have adopted electronic protocols to govern trade in inputs. The protocols, which in some instances have been adopted as technical standards by the International Organization for Standardization ( ISO ), 14 generally relate to the formatting of electronic transaction documents (e.g., purchase orders and invoices) transmitted between a supplier and its customer. The new sites go further in several respects (a) by adopting Internet protocols, rather than the older technology that typified earlier EDI efforts, (b) by linking multiple suppliers with multiple customers at the site, and (c) in many instances by adding an auction component. The first wave of Internet business exchanges began in 1994, with a consortium among high-tech companies to promote business-to-business use of the Internet. 15 Through 1999, most of the exchanges were developed by entrepreneurs, who saw a business opportunity in the form of proprietary online marketplaces that would function as intermediaries at which buyers and sellers could transact business on a fee-for-service basis. More than 600 such ventures have emerged to date. 16 Whether any of the proprietary sites will ripen into genuine exchanges or viable business operations remains speculative. 17 The first half of 2000 has seen another wave involving a different type of site, organized by the buyers and, in some instances, by the sellers as well. Basically, the parties to the transaction are seeking to eliminate the middleman. These participant-controlled sites have been the principal focus of the recent headlines [ 36 ]

4 M A Y addressing B2B exchanges. They have also been the focus of expressions of potential antitrust concern and, in some instances, the subjects of government investigation. 18 B. About pertinent guidance from the enforcement agencies In light of the obvious potential benefits from B2B sites, the FTC and U.S. Department of Justice have taken care not to voice undue discouragement. Their guidance to date, however, necessarily has been preliminary, with the agencies taking caution in their statements until they have developed a better understanding of the sites. 19 The most comprehensive statement has been in the form of a speech delivered by an FTC official at the ABA Antitrust Section Spring Meeting in April. The speech has not been published; it is recounted in detail in a Washington-based antitrust newsletter, 20 which indicates that the speech addressed five questions antitrust enforcers would ask : (1) what are the efficiencies that the joint auction site seeks to achieve? (2) is it too large? (3) are there any exclusionary rules? (4) are there sufficient protections to prevent collusion among either buyers or sellers? and (5) could the buyer auction lead to the exercise of monopsony power? 21 Also relevant, although more dated and not focused specifically on B2B exchanges, are a speech and article by a former FTC bureau director with respect to horizontal coordination in cyberspace. 22 Some press reports have mistakenly stated that the Antitrust Guidelines for Collaborations Among Competitors, 23 issued in final form by the agencies in early April, were spurred by B2B concerns. 24 Although the principles expressed in the Competitor Collaboration Guidelines are relevant to Internet exchanges, the agencies had been working on the Guidelines for years, and the final Guidelines are largely unchanged from an October 1999 draft that predated any serious consideration of the issues posed by B2B sites. More significantly, the Guidelines are phrased with such generality and ambiguity as to offer little practical guidance on the particular issues arising from B2B sites. 25 Ironically, the government guidelines that may be most closely tailored to the issues of Internet exchanges are more than a generation old the U.S. Department of Justice 1977 Antitrust Guide for International Operations. 26 Notwithstanding its nominal topic, the Guide took positions on a wide range of policy issues, including the basic mode of analysis governing joint ventures. The [ 37 ]

5 A N T I T R U S T R E P O R T discussion was substantially informed by the matters that the Department was addressing during the 1970s, at the birth of an earlier generation of electronic commerce. A challenge to exclusionary practices of automated clearing houses in banking was underway. 27 The Department had just completed a policy statement with respect to sharing of an early form of automated teller machines for the National Commission on Electronic Fund Transfers. 28 It had completed a business review of the interbank network that became Visa, 29 and it was nearing completion of a business review of a proposed interbank electronic switching arrangement in Nebraska. 30 Against this backdrop, the Department offered the following guidance: The antitrust inquiry into the legality of a particular joint venture generally involves three major issues. The first is whether the creation of the joint venture itself unreasonably restrains competition. The second is whether the joint venture has any unreasonable collateral restraints that must be struck down even if the venture is allowed. The third is whether the joint venture is in essence a bottleneck monopoly which is so important to those in the business 31 that it must be opened to all on reasonable and nondiscriminatory terms. Elsewhere in the Guide the Department expressed a position relevant to the second issue: Terms of an agreement may be permitted, despite the fact that they restrict some competition, provided that the restriction is clearly ancillary to some legitimate purpose and is appropriately limited in scope. Stated more broadly, the antitrust concern is very often not so much with the particular form of a transaction, but its surrounding circumstances.... First, is it an anticompetitive restraint which is ancillary to the lawful main purpose? Second, is its scope or duration greater than necessary to achieve that purpose? Thirdly, is it otherwise 32 reasonable, either alone or in conjunction with other circumstances? The Guide was revised and reissued in 1988; the Department used different terminology, but adopted a substantially similar framework. 33 The 1988 version, in turn, was withdrawn in part in 1992 and in whole in 1995, when it was replaced by guidelines issued jointly by the Department and the FTC and limited to jurisdictional and transnational issues. 34 The other government guidelines that most directly address the types of issues applicable to Internet exchanges are the Statements of Antitrust Enforcement Policy in Health Care. 35 Although obviously focused on a very [ 38 ]

6 M A Y different class of economic activity, the Statements provide important elaboration on the general principles articulated in the International Guide. Among other institutional specifics that they address, the Statements speak to dissemination of fee and non-fee information to purchasers, exchange of price and cost information among providers, joint purchasing, and appointment of a common messenger to communicate with purchasers. 36 The application of the various legal standards to Internet exchanges yields conclusions that are consistent with the historical outcomes in the exchange cases with which we began namely, that the mere creation of an Internet exchange will seldom face significant antitrust impediments, but the specification of the operating details will pose issues galore. As historically has been the case with health care networks, participant-controlled exchanges are likely to face greater exposure and legal complexity in their operating rules than are independently controlled, proprietary sites. We consider the issues in turn. II FORMATION ISSUES As a general proposition, exchanges represent a classic form of joint venture. They are one of the oldest forms. They provide the inspiration for one of the standard illustrations of what can constitute a joint venture (as distinct from cartel) a collective enterprise that makes a market. They typically provide efficiency benefits by reducing search costs and other transaction costs. When they are rendered in electronic form, they offer the potential for reducing transaction costs massively. 37 There should be no question, then, that an Internet exchange is an arrangement of a type that should be presumptively lawful, in the sense that the mere decision by participants to create the exchange (leaving aside operational restraints) should be permissible in the absence of proof of an adverse competitive effect. In the evaluation of possible adverse effects, the principal concern at the formation stage will be overbreadth. This, in essence, is the second question in the recounting of the FTC s April speech is the site too large? 38 In addressing this concern with respect to Internet exchanges in particular, one should be mindful of several important distinctions, some of which begin to shade into operational aspects. [ 39 ]

7 A N T I T R U S T R E P O R T First, is the exchange purely a forum in which independent decision makers on the buy and sell sides will interact with one another, or will it entail collective action on either the buy side or the sell side? A forum is considerably safer than a joint buying or selling arrangement, and it will be evaluated by reference to Collateral restraints can affect the different standards. Some of the concern analysis of the scope of the exchange. expressed by the enforcement agencies The reverse is true as well. to date with respect to B2B exchanges is predicated on the possibility that the exchanges might be structured as joint buying arrangements, 39 in which the controlling participants plan to make collective purchase decisions. If this were the case, the agencies would evaluate the arrangement by reference to their standards for joint purchasing. Those standards are most fully defined in the Health Care Statements, where the agencies provide: The Agencies will not challenge, absent extraordinary circumstances, any joint purchasing arrangement among health care providers where two conditions are present: (1) the purchases account for less than 35 percent of the total sales of the purchased product or service in the relevant market; and (2) the cost of the products or services purchased jointly accounts for less than 20 percent of the total revenues from all products or services sold by each competing participant 40 in the joint purchasing arrangement. To the extent that the exchange does not involve joint purchasing, the agencies enforcement standards are almost certain to be more permissive, and broader participation is likely to be cleared. Second, will the exchange involve significant collateral restraints such as exclusivity or transparency? These collateral restraints may present issues of their own, as we will see shortly; but we address them in connection with formation analysis for a more limited purpose there will typically be an inverse relationship between the permitted scope of the exchange and the permitted strength of the collateral restraints. If the collateral restraints are minimal in both contract and practice, a broader exchange should be permissible. In the extreme case, if the exchange were structured so as to be limited to private bilateral contracting without disclosure of prices, quantities, or other material terms and if the parties were free to use other sites or contracting mechanisms, universal participation might well be defensible. By contrast, if the exchange provided for complete transparency and if participants agreed to use [ 40 ]

8 M A Y the exchange exclusively, prudence would dictate limiting the scope of participation in the exchange. Third, insofar as market share matters, one needs to take care to measure it properly. The markets that matter for purposes of formation analysis are the products or services transacted over the exchange. For sellers on the exchange, this is the commonplace measurement of market share. But for buyers on the exchange, one should be looking to their share of purchases of the input. Even if the buyers (say, all the manufacturers of industrial widgets) were dominant in their primary business, they might account for a small share of products (say, office supplies or electric power) bought on the exchange. (Their share in their primary business, however, would still matter for purposes of spill-over analysis conducted during the evaluation of collateral restraints.) III COLLATERAL RESTRAINTS ISSUES We have already seen that collateral restraints can affect the analysis of the scope of the exchange. The reverse is true, as well. In the evaluation of the legality of particular collateral restraints, market power usually matters. This means that a broad venture one with high share or widespread participation faces greater exposure. A collateral restraint that might be permissible if imposed by a small, weak venture might be illegal if imposed by a strong, universal venture. And a collateral restraint that is lawful when the venture is a fledgling might ripen into illegality as the venture matures into a position of strength. 41 Some have postulated that B2B exchanges may be characterized by network externalities; 42 if this is correct, certain exchanges could become dominant within their respective industries and could, at that time, be compelled to modify their mode of operation. When exchanges encounter antitrust difficulty, the cause almost invariably is an overly restrictive collateral restraint. The potential sources of trouble are many. We catalogue the important ones below. A. Transparency, facilitating practices, and spillover effects Effects from price transparency The primary concern that the enforcement agencies have articulated to date with respect to B2B sites is that the sites will enhance the feasibility of price signaling and other facilitating practices that foster anticompetitive coordina- [ 41 ]

9 A N T I T R U S T R E P O R T tion. The concern largely reflects the agencies experience in the computerized reservation systems case, 43 where the airline participants were alleged to have used fare designators and advance announcement of fare changes to stabilize pricing. The concern has validity, but its implications for policy are open to debate. The effect of widespread disclosure of pricing information is ambiguous. As the FTC has noted, rapid, costless, and extensive exchange of information among sellers can increase the ease by which the sellers tacitly coordinate The primary concern that the enforcement price and monitor compliance. agencies have articulated to date is that B2B 44 At the same time, under certain sites will enhance the feasibility of price conditions, transparency can enhance overall market efficiency signaling and other facilitating practices that foster anticompetitive coordination. and improve competitiveness. 45 Through the dissemination of information, virtually all markets move towards price equilibrium one of the classic definitions of a market is a grouping within which prices tend towards equality 46 ; and as Alfred Marshall wrote in 1920, the more nearly perfect a market is, the stronger is the tendency for the same price to be paid for the same thing at the same time in all parts of the market. 47 For any particular instance of transparency, the questions are whether it alters the process by which equilibrium is reached (it usually does) and whether it affects the level of the equilibrium (it may, but one cannot a priori say in which direction). Whether transparency concerns are implicated by any particular B2B site depends largely on the site s operating rules. An exchange can be structured with appropriate firewalls, so that information is contained to those parties with a legitimate need to know. A buyer s bid request, for example, could be made available to potential suppliers, but not to other buyers; and the suppliers respective offers could be made available to the buyer who had issued the request and to no one else. At the other extreme, all bid requests and all responsive offers could be publicly posted for review by all participants on the exchange. The latter structure obviously is more transparent and raises greater concern than the former. Other rules of the site may also be relevant. Will information be displayed immediately, for example, or will lags be built in? Will identities of market players be disclosed, or will information be displayed anonymously? Will information be displayed in disaggregated form, or will the site compile and [ 42 ]

10 M A Y display summary statistics? Depending on the particulars of the site, all of these considerations may affect the analysis of transparency. The industry context in which the site operates is also relevant. Is the industry concentrated or atomistic? Is its structure one that is susceptible to oligopolistic coordination and strategic behavior? In an atomistic setting, transparency often enhances the operation of the market. In most cases in which transparency has presented antitrust concerns, the industries have been concentrated. For additional insight into the agencies likely views on transparency-related spillovers, guidance can be gleaned from several provisions of the Health Care Statements. The guidance is imperfect, however, because the Statements do not translate neatly or directly to B2B exchanges. Addressing health care providers collective provision of fee-related information to purchasers of health care services, the Statements carve out a safe harbor when three conditions are all satisfied: (1) the collection is managed by a third party (e.g., a purchaser, government agency, health care consultant, academic institution, or trade association); (2) although current fee-related information may be provided to purchasers, any information that is shared among or is available to the competing providers furnishing the data must be more than three months old; and (3) for any information that is available to the providers furnishing the data, there are at least five providers reporting data upon which each disseminated statistic is based, no individual provider s data may represent more than 25 percent on a weighted basis of that statistic, and any information disseminated must be sufficiently aggregated such that it would not allow 48 recipients to identify the prices charged by any individual provider. Arrangements outside the safe harbor are not necessarily unlawful under the Statements, but are subject to closer scrutiny. 49 Elsewhere, the Statements address a class of transactions known as messenger model arrangements, by which competing providers can convey price information to purchasers. Noting that arrangements are not per se illegal when they are designed simply to minimize the costs associated with the contracting process, and that do not result in a collective determination by the competing network providers on prices or price-related terms, 50 the Statements explain: [ 43 ]

11 A N T I T R U S T R E P O R T Messenger models can be organized and operate in a variety of ways. For example, network providers may use an agent or third party to convey to purchasers information obtained individually from the providers about the prices or price-related terms that the providers are willing to accept. In some cases, the agent may convey to the providers all contract offers made by purchasers, and each provider then makes an independent, unilateral decision to accept or reject the contract offers. In others, the agent may have received from individual providers some authority to accept contract offers on their behalf. The agent also may help providers understand the contracts offered, for example by providing objective or empirical information about the terms of an offer (such as a comparison of the offered terms to other contracts agreed to by network participants). The key issue in any messenger model arrangement is whether the arrangement creates or facilitates an agreement among competitors on prices or price-related terms. Determining whether there is such an agreement is a question of fact in each case. The Agencies will examine whether the agent facilitates collective decision-making by network providers, rather than independent, unilateral, decisions. In particular, the Agencies will examine whether the agent coordinates the providers responses to a particular proposal, disseminates to network providers the views or intentions of other network providers as to the proposal, expresses an opinion on the terms offered, collectively negotiates for the providers, or decides whether or not to convey an offer based on the agent s judgment about the attractiveness of the prices or price-related terms. If the agent engages in such activities, the arrangement may 51 amount to a per se illegal price-fixing scheme. Addressing the information that the messenger/agent may disclose, a footnote in the Statement refers to the discussion of collective provision of fee-related information. 52 How these standards will be applied to B2B exchanges remains uncertain. An exchange can readily be structured to operate as or through a third-party messenger. The analytical problem comes with the speed and ease of information transmission in an e-commerce world extensive, real time, disaggregated, unblinded information is likely to become widely available. To limit the dissemination is likely to compromise the operational benefits of the exchanges and to reduce the potential efficiencies. Striking the proper balance between adverse effects from transparency and the loss of efficiency presents the challenge for public policy. [ 44 ]

12 M A Y Effects from nonprice transparency The concerns with transparency are not limited to pricing. Other competitively sensitive information could potentially be revealed in the bid process, depending on the particulars of the site s rules. Disclosure of the quantity to be purchased, for example, could provide competitors with advance information about the buyer s intended production run. The specifications of the item to be purchased might signal shifts in the design of the product that the buyer is bringing to market. In most instances buyers will want to protect this information from their competitors and will assure that this information is not disclosed. Presumably the operating rules of the site will be designed accordingly. One cannot, however, rule out the possibility that some industries might develop a practice of broader disclosures, with corresponding effects on the nature and vigor of competition. A close reading of the Health Care Statements suggests that the agencies view nonprice transparency as generally presenting less competitive exposure than price transparency. Addressing health care providers collective provision of non-fee-related information to purchasers of health care services, the Statements carve out a safe harbor with language that is less hedged than the conditions imposed for fee-related information. 53 It is clear, though, that the Statements are focused on information such as medical outcome data and practice protocols. Nonprice information of greater commercial sensitivity, such as quantity data and strategic information, poses greater antitrust risk. B. Agreements on pricing The preceding discussion of transparency reflects the primary concern that the agencies have voiced to date with respect to B2B exchanges, namely, the potential that the mere disclosure of information will facilitate anticompetitive coordination. The adverse effects do not require any express agreement on competitive terms. The effects may be viewed as arising from either (1) tacit agreement reached through unilateral, strategic action in the face of enhanced information or (2) express agreement on the disclosure of information, as distinct from agreement on the terms. The exchanges, however, also present potential antitrust issues arising from express agreement on prices or other competitive terms. We address those issues below. [ 45 ]

13 A N T I T R U S T R E P O R T Express agreement among buyers or sellers on prices of goods and services transacted on the exchange Most B2B sites announced to date do not involve joint decisions among buyers or sellers as to price; the price on the particular transaction will be set through electronic communication between the individual buyer and the individual seller. A smaller number of sites, however, may involve a joint buying arrangement, in which buyers coordinate the purchase prices they are willing to pay. A smaller number yet may involve a joint selling arrangement, in which competing sellers appoint the site as a common pricing agent 54 or otherwise coordinate the selling prices they are prepared to charge. Such joint buying and selling arrangements involve an express agreement among competitors as to price, and they therefore face greater antitrust exposure than mere exchanges. As between joint buying and joint selling, joint buying is materially less Standardizing auction terms and risky. Outside of the electronic realm, specifying auction mechanics purchasing cooperatives have become potentially pose antitrust concerns. commonplace. If properly structured, they seldom confront serious difficulties before the antitrust enforcement agencies 55 or the courts. 56 We have already quoted the provisions by which the Health Care Statements create a safe harbor for certain joint purchasing arrangements. 57 Joint selling is considerably more perilous, for the line between permissible collective action activity and unlawful cartelization is not always clear. 58 The principal distinction between the two relates to integration and efficiency collective price determination among competitors is permissible when it is ancillary to an efficiency-enhancing integration, such as an arrangement in which the competitors create a new product 59 or share financial risk. 60 Where those conditions are not satisfied, the burden falls on the coordinating competitors to demonstrate an efficiency or other legitimate business justification for the elimination of competition. The agencies Competitor Collaboration Guidelines, 61 while not expressly opposed to joint selling, are inhospitable. 62 Where a B2B site does nothing more than allow for joint electronic selling of products that the participating competitors previously sold independently, without complementarities such as new product bundles and without participants taking significant economic interests in each other s sales, it is questionable as to whether the legality of collective price determination can be sustained. [ 46 ]

14 M A Y In light of the potential exposures, any site that contemplates collective price determination by participating sellers should be carefully scrutinized by counsel. Auction rules The exchange will need to define the rules by which its auctions are conducted. Doing so will pose two antitrust concerns. First, the exchange may wish to limit the number of variables that will be open to competitive bid during the auction. That is, in order to allow for a more efficient auction process, the exchange may wish to standardize a number of factors that might otherwise be open to negotiation terms governing delivery, for example, or credit or risk of loss. To the extent that the standardization is the product of agreement among competing participants on the exchange, it raises issues under Catalano, Inc. v. Target Sales, Inc., 63 in which the Supreme Court held that a conspiracy among competing wholesalers to standardize credit terms offered to a purchaser was per se illegal because credit terms must be characterized as an inseparable part of the price. An agreement to terminate the practice of giving credit is thus tantamount to an agreement to eliminate discounts. 64 Catalano, of course, is fundamentally different from an exchange, in that its fact pattern involved a naked restraint. Standardizing the rules of an exchange in good faith would more properly be analyzed as an ancillary restraint, subject to rule of reason treatment under the classic logic of Chicago Board of Trade 65 the true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress and even destroy competition. 66 Second, the institutional mechanics of the auction itself are potentially problematic. Will the auction be single stage or multiple stage? If multiple stage, will it proceed from bottom up or top down? Will the transaction be priced at the winning bidder s bid or at the second-place bid? 67 While the specifics of auction design generally will not be of paramount antitrust significance, their relevance cannot be excluded. One of the issues in the Nasdaq litigation, for example, was the minimum step value by which successive bids were required to increase or decrease. 68 In explaining the basis for government challenge to certain Nasdaq practices, the Department wrote: The Complaint alleges that the twenty-four market making firms named in the Complaint and others, through the adherence to and enforcement of a quoting convention, inflated the inside spread of certain stocks quoted on The [ 47 ]

15 A N T I T R U S T R E P O R T Nasdaq Stock Market, Inc.... (The inside spread is the difference between the best price to buy stock being quoted by any market maker and the best price to sell stock being quoted by any market maker.) As a result, according to the Complaint, investors would have been required to pay more to buy and sell such stocks that [sic] they would have in a competitive market. Under the quoting convention, market makers are required to quote prices at which they are willing to buy and sell stocks in even-eighth amounts (25 cents) rather than odd-eighth amounts(12.5 cents), whenever their individual dealer spreads are 75 cents or more per share. (A dealer spread is the difference between the price at which an individual market maker offers to buy a stock and the price at which it offers to sell the same stock, on a per share basis.) A narrower dealer spread increases the financial risk of trading stock and, in some instances, the convention operated to deter a trader from improving his or her quote by an eighth of a point, when the trader would have 69 been willing to do so, absent the convention. Pricing of exchange services The exchange will have costs. Depending on the strategic purpose of the exchange, its promoters might also want to earn a profit. In either case, the exchange will need a source of revenue. As a legitimate joint venture, the exchange will be legally entitled to set a fee for its services. To the extent that the exchange seeks to regulate the fees charged between its participants for exchange-related activities, however, it will potentially implicate a series of cases that govern pricing among network participants. 70 One commentary also posits that a decision by a group of B2B sellers to charge higher transaction fees to raise the cost of competing sellers could be unlawful. 71 C. Limits on participation Access With the flood of Internet business sites, all embryonic and potentially unsuccessful, it might seem premature to address antitrust issues arising from a would-be participant s inability to access a particular site. Access disputes, however, have proven over time to be the most frequently recurring issue to face competitor-controlled networks. Independent B2B exchanges do not face similar exposure an individual proprietor is entitled to make a unilateral decision with whom to deal, except in extreme circumstances. 72 Participant-controlled exchanges have some flexibility, but it is not so great. [ 48 ]

16 M A Y The provision of access is governed by Northwest Wholesale Stationers v. Pacific Stationery & Printing Co., 73 which held that denial of access is permissible except where the cooperative possesses market power or exclusive access to an element essential to effective competition. 74 The plaintiff in Northwest Wholesale had challenged its expulsion from a wholesale purchasing cooperative without explanation, notice, or hearing. Relying on Silver v. New York Stock Exchange, 75 which had held expulsion from the Exchange without procedural safeguards to be a per se unlawful group boycott, the Ninth Circuit held for the plaintiff. The Supreme Court reversed on grounds that Silver was inapplicable because the wholesale purchasing cooperative, unlike the Exchange, lacked market power. For the immediate future, as B2B sites remain in their early stages, access limitations undertaken for legitimate business purposes are likely to be viewed as permissible. If a particular site develops a significant presence, denial of access may become problematic. The exposure associated with a denial of access may depend on the particulars of the exchange s access rules. Consider two alternative mechanisms by which a participant-controlled exchange might grant access. Under the first approach, a Membership Committee (initially composed of the founding participants) determines which other traders will be allowed to participate. Under the second approach, any participating buyer (supplier), once admitted, is entitled to sponsor the membership of any supplier (buyer) with which it wishes to deal. Depending on circumstances, the first approach may be defensible, but the second will be safer. Exclusivity and bypass So long as the exchange is small and powerless and has a legitimate interest in building volume, it generally will be permitted to impose exclusivity requirements on its participants. As a component of exclusivity, the exchange generally will be permitted to require that participants, once introduced by the exchange, will not engage in bypass (through direct links or the formation of a sub-network) in order to avoid exchange fees. The Health Care Statements again are instructive: they carve out a safe harbor for exclusivity requirements in networks so long as participation is limited. 76 One commentary, however, cautions that 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. 77 [ 49 ]

17 A N T I T R U S T R E P O R T Exclusivity issues are important in three respects. First, as discussed in connection with formation, exclusivity requirements may be at cross-purposes with a desire to achieve greater universality in participation. Depending on their business model, promoters of new exchanges may wish to achieve both broad participation and active use by participants, where the level of activity is probably linked to exclusivity. Although breadth and exclusivity may be defensible at the startup stage, antitrust risk will still be present and promoters may need to sacrifice either breadth or exclusivity if they seek to avoid risk. Second, exclusivity may affect the likelihood that an alternative exchange will develop in the same industry. The causal link, though, is not clear. Perhaps exclusivity will allow the realization of the network externalities that yield a dominant network in the particular industry. At the same time, exclusivity, if coupled with limited participation, might force nonparticipants to develop a competing exchange. Many antitrust counsel would suggest that the development of a competing exchange would be desirable not so much because we are bound to defend the legitimacy of a competitive model, as because the market power associated with being a dominant industry exchange will limit the exchange s operating flexibility in the future. Third, exclusivity is related to the analysis of transparency and spillover. If all transactions of a particular type must be channeled through the exchange, transparency is likely to be a greater source of concern. If only some transactions are processed over the exchange, such that other activity may be occurring at different prices, competitors can take less comfort in the information that they receive through exchange disclosures. IV CONCLUSION Internet business exchanges, like generations of older-technology exchanges before them, pose antitrust issues. The issues are manageable. Although the courts and enforcement agencies have yet to develop authority that addresses B2B exchanges in particular, one can draw guidance from an extensive body of law that addresses more traditional exchanges and other forms of competitor collaboration. Because exchanges offer important efficiency benefits through the reduction of search costs and other transaction costs, their mere formation is almost always lawful. The antitrust exposure more typically arises from operating rules or other collateral restraints governing the particulars of [ 50 ]

18 M A Y operation of the exchange auction rules, exchange fees, access standards, exclusivity requirements, and similar details. To the extent that B2B exchanges present important new issues, those issues derive mainly from the fact that technology offers the prospect of materially increasing the transparency of competitive information. That transparency, in the form of compilation and dissemination of information, is a principal source of the exchanges efficiency benefits. In many circumstances, transparency is procompetitive; in others, it facilitates tacit coordination and oligopolistic interdependence. The challenge for public policy governing the exchanges is to frame appropriate standards that balance the efficiency benefits of extensive, real time, disaggregated information against the potential adverse competitive effects that might arise from the same disclosures. N O T E S U.S. 231 (1918). See infra notes and accompanying text U.S. 341 (1963) F.2d 484 (1st Cir. 1952). For other exchange cases involving restraints on membership, see American Federation of Tobacco Growers v. Neal, 183 F.2d 869 (4th Cir. 1950); United States v. New England Fish Exchange, 258 F. 732 (1st Cir. 1919). 4. See United States v. Rocky Mountain Automated Clearing House Ass n, No (D. Colo., dismissed Nov. 17, 1977); United States v. California Automated Clearing House Ass n, No LTZ (C.D. Cal., dismissed Oct. 28, 1977). These were bottleneck monopoly cases seeking to compel regional automated clearing houses to admit thrift institutions to full membership. For a detailed description of the cases and their underlying theory, see Donald I. Baker & Roland E. Brandel, The Law of Electronic Fund Transfer Systems 22.01[1] (2d ed. 1988). 5. See United States v. Realty Multi-List, Inc., 629 F.2d 1351 (5th Cir. 1980). 6. See United States v. Airline Tariff Publ g Co., Trade Cas. (CCH) 70,687 (D.D.C. 1994) (consent order); 59 Fed. Reg. 15,225 (Mar. 31, 1994) (competitive impact statement). 7. See, e.g., United States v. Alex. Brown & Sons, Inc., Trade Cas. (CCH) 71, (S.D.N.Y. 1997); see also In re Nasdaq Market-Makers Antitrust Litig., 894 F. Supp. 703 (S.D.N.Y. 1995). 8. See Clare Ansberry, Let s Build an Online Supply Network!, Wall St. J., Apr. 17, 2000, at B1. 9. For the distinction between participantcontrolled networks and proprietary networks, see text accompanying notes The participant-controlled networks in some instances will face greater antitrust exposure. See infra notes 38-40, 58-63, 70, 72, and accompanying text. For one list of illustrative independent sites, see Multiple Madness, Forbes, May 1, 2000, at 124. The text of that article indicates one of the sites serves 56 narrow businesses, from meatandpoultryonline.com to solidwaste.com. Daniel Lyons,B2Bluster, Forbes, May 1, 2000, at 122, The Wall Street Journal story, supra note 8, carries the subhead As the Trend Grips Industries, Some Big Hurdles Loom: Logistics, Antitrust, Culture. [ 51 ]

19 A N T I T R U S T R E P O R T 11. Ansberry, supra note 8, at B Don Tapscot, Virtual Webs Will Revolutionize Business, Wall St. J., Apr. 24, 2000, at A Id. The same article reports that the announced site among aerospace manufacturers will involve 37,000 suppliers to companies with annual sales of more than $400 billion. Id. Similarly, an announced plan among six major airlines to form an Internet marketplace for carriers and suppliers to buy and sell airline-related goodsand services from paper cups to engine parts at a discount will involve about $32 billion of purchases annually. Melanie Trottman, Airline Alliance Is Set to Form Online Market, Wall St. J., Apr. 28, 2000, at B2. An announced plan among six tire and rubber companies will involve $50 billion each year of raw materials, equipment, and services. Robert Guy Matthews, Six Largest Tire and Rubber Companies Join Forces to Create Online Marketplace, Wall St. J., Apr. 18, 2000, at A See (visited Apr. 29, 2000). 15. See Anatomy of a Fad, Forbes, May 1, 2000, at See Lyons, supra note 9, at Addressing the proprietary networks, one leading business publication has explained that [f]altering Web retailers are leaping into B2B. Great they re just in time for the massacre. See Lyons, supra note 9. A cover banner referring to the story read B2B: The Next Web Massacre. Id. at cover. For expression of similar concern elsewhere, see Lee Gomes, Once Hot Business-to-Business Dot-coms Are Next Area of Web Worry, Wall St. J., Apr. 7, 2000, at B1; Bob Tedeschi, How Killer B-to-B s Slid to the Endangered List, N.Y. Times, May 7, 2000, 3, at See supra notes and accompanying text. 19. The FTC has scheduled a public workshop on B2B marketplaces for June 29, 2000, with the goal to enhance understanding of how B2B electronic marketplaces function and the means by which they may generate efficiencies, and to identify any antitrust issues that they raise. FTC, Press Release, FTC to Hold Public Workshop to Examine Competition Issues in Business-to-Business Electronic Marketplaces, May 4, FTC Enforcers Believe B2B Auctions Are Similar to JVs, FTC:Watch, No. 542, Apr. 10, 2000, at 6 (reporting on comments of David A. Balto, Assistant Director for Policy and Evaluation, FTC Bureau of Competition). 21. Id. at Jonathan B. Baker, Director, FTC Bureau of Economics, Horizontal Price-Fixing in Cyberspace, Speech before the Conference Board, 1996 Antitrust Conference: Antitrust Issues in Today s Economy (Mar. 7, 1996), available at confbd4.htm; Jonathan B. Baker, Identifying Horizontal Price Fixing in the Electronic Marketplace, 65 Antitrust L.J. 41 (1996). Also useful, but even more distant from the specific issues of Internet exchanges, is a thoughtful treatment of joint venture policy by an attorney advisor to the FTC Chairman. See Michael S. McFalls, The Role and Assessment of Classical Market Power in Joint Venture Analysis, 66 Antitrust L.J. 651 (1998). 23. U.S. Dep t of Justice & Federal Trade Comm n, Antitrust Guidelines for Collaborations Among Competitors (Apr. 7, 2000), reprinted in Antitrust Rep., Apr. 2000, at See Paul A. Greenberg & Lori Enos, FTC and DOJ Issue Joint Antitrust Guidelines, E- Commerce Times, Apr. 10, 2000, available at 000/ shtml. 25. For a discussion of the problems of generality and ambiguity in the draft Competitor Collaboration Guidelines, see ABA Section of Antitrust Law, Comments on the Antitrust Guidelines for Collaborations Among Competitors Issued in Draft on October 1, 1999 by the Federal Trade Commission and U.S. Department of Justice (Feb. 2000), available at net.org/anti trust/collaborations.html. The final Guidelines were substantially unchanged from the draft, and the concerns expressed by the ABA Antitrust Section with respect to the draft were not materially re- [ 52 ]

20 M A Y dressed. 26. U.S. Dep t of Justice, Antitrust Guide for International Operations (Mar. 1, 1977) (revising version of Jan. 26, 1977) [hereinafter Guide for International Operations]. 27. See supra note U.S. Dep t of Justice, Policy Statement on Sharing for the Nat l Comm n on Electronic Fund Transfers (Jan. 13, 1977). 29. See Business Review Letter from Thomas E. Kauper to Francis R. Kirkham concerning National BankAmericard, Inc. (Oct. 7, 1975). 30. See Business Review Letter from Donald I. Baker to William B. Brandt concerning Nebraska Electronic Terminal System (Mar. 7, 1977). 31. Guide for International Operations, supra note 26, at 20 (emphasis in original). The discussion is contained in a case (Case C) that considers the legality of a venture to engage in joint bidding in a Latin American country. 32. Id. at 6-7 (note omitted; emphasis in original). 33. U.S. Dep t of Justice, Antitrust Enforcement Guidelines for International Operations (Nov. 10, 1988). The analytical framework as expressed in the 1988 Guidelines is as follows: First, the Department determines whether the joint venture would likely have any anticompetitive effect in the market or markets in which the joint venture proposes to operate or in which the economic integration of the parties operations occurs (the joint venture markets ). Second, the Department determines whether the joint venture or any of its restraints would likely have an anticompetitive effect in any other market or markets ( spill-over markets ) in which the joint venture members are actual or potential competitors outside the joint venture. Third, the Department analyzes the likely competitive effects of any nonprice vertical restraints imposed in connection with the joint venture. The Department will not challenge a joint venture if under the first three steps, the Department concludes that the joint venture would not likely have any significant anticompetitive effects. If, however, the Department s analysis under the first three steps reveals significant anticompetitive risks, then the Department considers whether any procompetitive efficiencies that the parties claim would be achieved by the joint venture would outweigh the risk of anticompetitive harm. Id. at 15 (footnotes omitted). 34. U.S. Dep t of Justice & Federal Trade Comm n, Antitrust Enforcement Guidelines for International Operations (Apr. 1995), reprinted in Antitrust Laws and Trade Regulation: Primary Source Pamphlet (1999 Matthew Bender). The Department states that the 1995 Guidelines are intended to provide antitrust guidance to businesses engaged in international operations on questions that relate specifically to the Agencies international enforcement policy. They do not, therefore, provide a complete statement of the Agencies general enforcement policies. The topics covered include the Agencies subject matter jurisdiction... ; comity; mutual assistance in international law enforcement; and the effects of foreign government involvement on the antitrust liability of private entities. In addition, the Guidelines discuss the relationship between antitrust and international trade initiatives. Id. at 1 (footnote omitted). 35. U.S. Dep t of Justice & Federal Trade Comm n, Statements of Antitrust Enforcement Policy in Health Care (Aug. 28, 1996) [hereinafter Health Care Statements], reprinted in Antitrust Laws and Trade Regulation: Primary Source Pamphlet (1999 Matthew Bender). 36. For particular provisions of the Statements that relate to B2B sites, see infra notes 40, 48-54, 76, and accompanying text. [ 53 ]