LOYALTY DISCOUNTS AND BUNDLED PRICING UNDER U.S. ANTITRUST LAWS 1 Scott A. Westrich Orrick, Herrington & Sutcliffe LLP May 19, 2010 DRAFT I. LOYALTY DISCOUNTS A. Introduction Various forms of customer loyalty, incentive, and discount programs are common in many sectors of the U.S. economy. Most of these programs do not pose any antitrust concerns whatsoever. They are procompetitive because they offer benefits usually in the form of lower prices to buyers as an incentive for them to buy more. The low prices and other incentives ultimately benefit consumers. This is exactly the type of conduct that the antitrust laws are designed to encourage. The analysis is somewhat more complicated if the firm offering the incentive program has significant market power (or monopoly power) in one of the affected product markets. There is nothing inherently suspect, however, in a monopolist offering attractive pricing or other incentives to encourage repeat business from loyal customers. Rewarding customer loyalty promotes competition on the merits. 2 But there are legal risks associated with different types of customer loyalty programs for firms with monopoly power or large market shares in any of the businesses covered by the discount program. A firm considering a loyalty or discount program will want to structure the program so as to minimize antitrust risks. The structure and terms of the program may affect the substantive legal rule that would be applied in determining the program s legality under the antitrust laws. 1 Mr. Westrich and other attorneys at Orrick, Herrington & Sutcliffe LLP have represented clients in several of the cases discussed herein, including, 3M on appeal in LePage s v. 3M, PeaceHealth on appeal in Cascade Health Solutions v. PeaceHealth, and Masimo on appeal in Masimo v. Tyco Health Care. This outline is intended to provided an objective summary of the law and not espouse any particular viewpoint. To the extent any views are expressed herein, they are those of Mr. Westrich and not Orrick, Herrington & Sutcliffe LLP or any other entity. Lastly, this document is a work in progress. Although we believe the citations are correct, it has not been thoroughly cite-checked. 2 Virgin Atlantic Airways Ltd. v. British Airways PLC, 257 F.3d 256, 265 (2d Cir. 2001).
Loyalty discounts come in many different forms. For example, a company might offer discounts or rebates expressly conditioned on exclusivity. Or a company might offer its customers simple volume discounts if they reach pre-established volume thresholds. Another common form of loyalty discount is a market share discount, which conditions the receipt of a discount or rebate on a customer buying a certain percentage of its needs (the market share ) from the seller. Although the rest of this outline discusses these different categories separately, many loyalty programs do not fit clearly into any particular category and may involve elements of each. To a large extent, each loyalty discount program needs to be analyzed on its own merits. 1. Statutory and Analytical Framework This outline addresses only federal antitrust law. Most case law concerning loyalty discounts and bundling is focused on claims under Section 2 of the Sherman Act. Section 2 prohibits unlawful monopolization or attempted monopolization, and requires a showing of monopoly power or a dangerous probability that the defendant will acquire monopoly power as a result of the challenged discounting practices. Discounting practices also can raise claims under Section 1 of the Sherman Act and Section 3 of the Clayton Act. Section 1 is directed at unreasonable restraints of trade. Its agreement requirement usually can be satisfied in the context of a loyalty discount program. Section 3 regulates unlawful exclusive dealing and expressly prohibits discounts conditioned upon exclusivity. 3 For all practical purposes, at least in the context of loyalty discounts, there is no difference between the standards applied under Section 1 and Section 3. 4 Lastly, discount programs can raise issues under the Robinson-Patman Act if the discounts are not functionally available to all buyers. This outline does not address price discrimination issues. While claims can be, and are, brought under Section 1 and Section 3, we are not aware of any case in which a plaintiff successfully challenged a firm s discounting practices without prevailing on a Section 2 claim. Conversely, a number of the key cases in this area address Section 2 only. 5 As this indicates, monopoly power, or at least substantial market power, is a predicate for liability for discounting practices. Unfortunately, there is not one clear analytical framework for assessing the legality of discount programs under Section 2 or the other statutes. But there are two 3 See 15 U.S.C. 14 (making unlawful a 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... of a competitor ). 4 See Mozart Co. v. Mercedes-Benz of N. Am., 833 F.2d 1342, 1352 (9th Cir. 1987); Roland Mach. Co. v. Dresser Indus., Inc., 749 F.2d 380, 393 (7th Cir. 1984); see also ROBERT H. BORK, THE ANTITRUST PARADOX 299 (1978) ( Section 1... has come to apply doctrine distinguishable from the doctrine of Clayton 3 only by a metaphysician. ). 5 See, e.g., LePage s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003) (appeal limited to Section 2 claims); see also United States v. Dentsply Int l, Inc., 399 F.3d 181 (3d Cir. 2005) (government appealed only Section 2 exclusive dealing claim); United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001) (same). 2
bodies of law that are most relevant: predatory pricing and exclusive dealing. Very broadly, if loyalty programs are subject to pricing rules, the court will apply a price-cost test as it would to a claim of predatory pricing (as discussed below, the test can be modified to fit the circumstances). On the other hand, exclusionary agreements such as exclusive dealing can violate the antitrust laws if they foreclose competitors from a substantial share of the market without regard to any price-cost safe harbors. The substantial foreclosure test is a fairly open-ended analysis of the effects of the program on the defendant s competitors and consumers. 2. Standards Applicable to Predatory Pricing Firms without market power are generally free to set their prices at any level they choose even below cost so long as they do not violate the price discrimination laws. Firms with significant market shares, however, need to be careful not to price below their costs to avoid liability under Section 2 of the Sherman Act. Under the Supreme Court s decision in Brooke Group v. Brown & Williamson Tobacco Corp., 6 a plaintiff seeking to prevail on a predatory pricing claim must prove: (1) the defendant s prices were below an appropriate measure of the defendant s costs; and (2) there was a dangerous probability that the defendant would recoup its investment in below cost pricing. 7 The test is objective and does not depend on the dominant firm s intent good or bad. 8 Although the Supreme Court has never decided the issue of what cost measure should be used, most courts use average variable costs to determine whether there is below cost pricing. The recoupment prong of the test is equally important. If, for example, there are relatively few barriers to entry in the relevant market, the plaintiff will be unable to prove recoupment even if the defendant s prices were below cost. By establishing a standard that is very difficult for plaintiffs to satisfy, Brooke Group comes down in favor of avoiding false positives (i.e., finding illegal low prices that actually benefit consumers) rather than false negatives (permitting conduct that is actually harmful). In general, recent Supreme Court cases have been very protective of conduct that reduces prices to consumers. 9 Since Brooke Group, we are not aware of any plaintiff who has obtained judgment on the merits in a predatory pricing case. 10 Even when pricing fails the Brooke Group price-cost test, it is not necessarily 6 509 U.S. 209 (1993). 7 Id. at 222, 224. 8 Some earlier decisions would have found unlawful predatory pricing at prices above average variable costs (but below average total costs) if there was evidence that the defendant intended to exclude smaller competitors. Those cases are no longer good law after Brooke Group. 9 See Weyerhaeuser Co. v. Ross-Simmons Hardware Lumber Co., 127 S. Ct. 1069 (2007) (extending Brooke Group to predatory buying context); Pacific Bell Telephone Co. v. LinkLine Telecommunications, Inc., 129 S. Ct. 1109 (2009) (no liability for price squeeze absent (i) a duty to deal or (ii) below-cost prices). 10 In the Spirit Airlines case, the parties settled after the Sixth Circuit reversed summary judgment for defendant Northwest Airlines. See Spirit Airlines, Inc. v. Northwest Airlines, Inc., 431 F.3d 917 (6th Cir. 2005). 3
illegal. But there is little or no law, post-brooke Group, discussing when predatory pricing constitutes an actual violation of the Sherman Act. A few general rules apply. First, short term promotional prices that are below cost generally should not violate Section 2. Second, whether prices are predatory is usually determined across a product line, not on a single SKU. Third, a very small amount of predatory pricing should not constitute a violation. But the predatory pricing does not need to affect all of the defendant s sales. It might be enough if sales to one significant customer were below cost. It is commonly thought that there is a safe harbor under Section 2 of the Sherman Act when a dominant firm matches, but does not beat, a competing offer from a smaller competitor even if the resulting prices are below cost. However, there is no clear precedent for a meeting competition defense to predatory pricing. The defense is borrowed from Robinson-Patman Act jurisprudence, and it is not entirely clear that a monopolist may match a competing offer with impunity without regard to whether the resulting prices are below cost. 11 As a practical matter, courts are probably unlikely to find liability premised solely on a defendant s having matched but not beaten a competitor s low prices. The antitrust laws are intended to encourage competition even by monopolists and therefore should not be used to prevent this type of price competition. The alternative would be to require a dominant firm to lose business because it cannot compete on price. Because the current law regarding predatory pricing is so favorable to defendants, most plaintiffs do not allege predatory pricing in cases involving loyalty discounts. Rather, they try to avoid the Brooke Group test by asserting claims based on theories such as de facto exclusive dealing, bundling, monopoly broth, or some other category of claim that is not clearly subject to the Brooke Group standard. 12 Conversely, 11 See United States v. AMR Corp., 140 F. Supp. 2d 1141, 1208 (D. Kan. 2001) (adopting a bright line meeting competition defense and finding no illegal predatory pricing), aff d on other grounds, 335 F.3d 1109, 1120 n. 15 (10th Cir. 2003) (declining to adopt a meeting competition defense for predatory pricing claims); Spirit Airlines, Inc. v. Northwest Airlines, Inc., 2003 WL 24197742, at *11-12 (E.D. Mich. March 31, 2003) (rejecting the application of a meeting competition defense to a predatory pricing claim but granting summary judgment to defendant on other grounds), rev d on other grounds, 431 F.3d 917 (6th Cir. 2005) (not addressing the issue). 12 For example, in the U.S. Department of Justice s action against American Airlines, the government challenged (among other things) American s practice of adding flights on routes when a discount competitor began flying the route, and then reducing capacity as soon as the competitor exited the market. The government characterized this as a predatory capacity claim to try to avoid Brooke Group. The district court rejected this as a fundamentally flawed attempt to circumvent the high standards for proof of a predatory pricing claim by semantic sleight of hand. 140 F. Supp. 2d at 1194. See also Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039, 1062 (8th Cir. 2000) (defendant argued that its market share discounts were per se lawful because plaintiff did not try to prove below cost pricing; court disagreed and engaged in full analysis of legality of discounts); N.W.S. Michigan, Inc. v. General Wine & Liquor Co., 2003-1 Trade Cas. (CCH) 73,956 (6th Cir. 2003) (claim about defendant s rebate and discount program was a claim about defendant s pricing; competitor has no standing to bring a pricing claim absent an allegation of predatory pricing); Ortho Diagnostic Systems, Inc. v. Abbott Labs., Inc, 920 F. 4
defendants often argue that all of the challenged conduct can be reduced to price competition and it is therefore legal unless it runs afoul of Brooke Group. 3. Standards Applicable to Exclusive Dealing Exclusive dealing is an express or implied agreement not to deal or to limit the buyer s dealings in the goods of a competitor. Exclusive dealing encompasses a variety of different types of agreements, including an agreement between a manufacturer and a distributor or an agreement between a manufacturer and a retailer. Exclusive dealing is usually procompetitive. It can involve potentially significant efficiencies, including increasing interbrand competition, reducing free riding, assuring quality, and providing volume commitments necessary to achieve economies of scale. But exclusive dealing can violate the antitrust laws if it substantially forecloses competition in the relevant market. 13 According to the Supreme Court in Tampa Electric, to determine whether the competition foreclosed by the contract is substantial, it is necessary to take into account the relative strength of the parties, the proportionate volume of commerce involved in relation to the total volume of commerce in the relevant market area, and the probable immediate and future effects which preemption of that share of the market might have on effective competition therein. 14 While what constitutes substantial foreclosure in a particular case depends on the specific circumstances, the courts have developed some benchmarks based on the percentage of the market covered by the exclusive deals. In most cases, exclusive dealing that covers less than 30% of the market will be found to be legal. 15 Courts also often view short term exclusive dealing contracts or those that are readily terminable as presumptively lawful. 16 Exclusive distribution is often said to be of less concern than exclusive contracts with end consumers. Exclusive distribution is usually held legal if Supp. 455, 468 n.16 (S.D.N.Y. 1996) ( The parties have expended a good deal of energy in debating whether [plaintiff s] claim is properly characterized as one of predatory pricing. ). 13 See Tampa Elec. Co. v. Nashville Coal Co., 365 U.S. 320, 327 (1961) (Once a contract is found to be an exclusive dealing arrangement, it does not violate the section unless the court believes it probable that performance of the contract will foreclose competition in a substantial share of the commerce affected. ). 14 Id. at 329. See also Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 45 (1984) (O Connor, J., concurring) ( In determining whether an exclusive-dealing contract is unreasonable, the proper focus is on the structure of the market for the products or services in question the number of sellers and buyers in the market, the volume of their business, and the ease with which buyers and sellers can redirect their purchases or sales to others. Exclusive dealing is an unreasonable restraint on trade only when a significant fraction of buyers or sellers are frozen out of a market by the exclusive deal. ). 15 See, e.g., Jefferson Parish, 466 U.S. at 46 (O Connor, J., concurring) (suggesting that 30% could be a reasonable benchmark); Omega Environmental, Inc. v. Gilbarco, Inc., 127 F.3d 1157, 1163-64 (9th Cir. 1997) (38% potential market foreclosure not unlawful). 16 See, e.g., Roland Mach. Co. v. Dresser Indus., Inc., 749 F.2d 380, 394-95 (7th Cir. 1984); Gilbarco, 127 F.3d at 1163-64. 5
competitors can reach consumers through alternate channels. 17 In general, the case law is relatively hostile to exclusive dealing claims brought against firms without monopoly power. 18 However, courts have not necessarily adopted firm rules about what amount of exclusive dealing will or will not violate the antitrust laws. 19 Furthermore, there is some debate about the extent to which the presumptions that exclusive dealing is efficient and procompetitive should apply when the exclusive dealing involves a dominant firm. 20 Courts have tended in recent years not to require plaintiffs alleging violations of Section 2 of the Sherman Act to show the same degree of foreclosure as in cases under Section 1 or Section 3 of the Clayton Act. 21 One issue relevant to the application of exclusive dealing principles to loyalty discounts is whether exclusive dealing jurisprudence requires an actual, express exclusive dealing contract. In Tampa Electric, which involved an agreement by a utility to purchase a minimum amount of coal each year for a period of 20 years, the utility argued that the contract was not an exclusive dealing contract for purposes of Section 3 of the Clayton Act (or the Sherman Act). The Court, however, assumed that the contract was an exclusive dealing agreement for purposes of Section 3. 22 It also cited with approval the lower courts treatment of the contract as the practical equivalent of a total requirements contract 23 and United Shoe s 24 admonition that it is the practical effect of the contract that matters, not whether it is expressly exclusive by its terms. 25 More recent cases, at least in the context of Section 2, also have applied exclusive dealing principles to agreements that were not truly exclusive. 26 Courts do, however, consider the fact that 17 See, e.g., Gilbarco, 127 F.3d at 1162-63; CDC Technologies, Inc. v. IDEXX Labs., Inc., 186 F.3d 74 (2d Cir. 1999). 18 See, e.g., Gilbarco, 127 F.3d at 1162-64; Roland Mach. Co. v. Dresser Indus., Inc., 749 F.2d 380, 394-95 (7th Cir. 1984). 19 For example, the Ninth Circuit has never expressly disavowed decisions finding a violation based on 24% foreclosure (Twin City Sportservice, Inc. v. Charles O. Finley & Co., 676 F.2d 1291 (9th Cir. 1982)) or finding a jury question at 10-15% foreclosure (Cornwell Quality Tools Co. v. C.T.S. Co., 446 F.2d 825 (9th Cir. 1971)). 20 See United States v. Dentsply Int l, Inc., 399 F.3d 181 (3d Cir. 2005); United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001). These cases indicate that exclusive dealing by a monopolist will be analyzed against a competitive backdrop that includes other allegedly anticompetitive conduct. 21 Microsoft, 253 F.3d at 70. 22 365 U.S. at 330. 23 Id. at 324. 24 See United Shoe Mach. Corp. v. United States, 258 U.S. 451, 457 (1922). 25 365 U.S. at 326. 26 In Microsoft, the D.C. Circuit analyzed a series of different agreements as the legal equivalent of exclusive dealing. These included Microsoft s agreement with AOL, which allowed AOL to supply up to 15 percent of its subscribers with a browser other than Internet Explorer. 253 F.3d at 68-69. The court also applied the same legal standards to Microsoft s First Wave Agreements with independent service providers because, although not literally exclusive, they were exclusive in practice. Id. at 75. See also Dentsply, 399 F.3d at 191 (Dentsply s Dealer Criterion 6, which prohibited Dentsply s dealers from adding competing tooth lines to 6
the contract at issue was not a true exclusive dealing agreement in determining liability. 27 B. Applicable Law 1. Discounts Conditioned on Exclusivity Although the issue has not been squarely decided, courts are likely to treat discounts expressly conditioned on 100% exclusivity as the legal equivalent of actual exclusive dealing contracts. 28 According to Professor Hovenkamp, [a] discount conditioned on exclusivity should generally be treated as no different from an orthodox exclusive-dealing arrangement. 29 One possible argument against treating a discount conditioned on exclusivity the same as an actual exclusive dealing contract is that the discount program might not have the same foreclosure effect as a written, binding contract. 2. Volume Discounts Single product volume discounts are legal if they do not constitute predatory pricing, i.e., if they are above cost and there is no dangerous probability of recoupment. Although some commentators have argued that volume discounts can have the same exclusionary effect on competition as exclusive dealing, courts have uniformly held that single product, above-cost volume discounts cannot give rise to liability under the their product offerings, contained a grandfathering provision allowing dealers to continue selling the lines they sold in 1993 when Dentsply adopted Dealer Criterion 6. At the time of trial, Dentsply s top five dealers, which represented 83 percent of Dentsply s sales, all carried competing brands.). 27 See Barry Wright Corp. v. ITT Grinnell Corp., 724 F.2d 227, 237 (1st Cir. 1983) (Breyer, J.) (noting that there was an important difference between the fixed dollar amount contract at issue and a true requirements contract, as a true requirements contract flatly eliminates the buyer from the market for its duration whereas the former leaves open the possibility that the buyer s needs will exceed his contractual commitment ); Barr Labs., Inc. v. Abbott Labs., 978 F.2d 98, 110 n.2 & 111 (3d Cir. 1992) (stating that [a]n agreement affecting less than all purchases does not amount to true exclusive dealing but concluding that the contracts at issue were not unlawful based on a full rule of reason analysis under standard exclusive dealing law). 28 See LePage s, 324 F.3d at 158-59 (discussing 3M s discounts expressly requiring exclusivity); Microsoft, 253 F.3d at 68-70 (analyzing arrangements under which Microsoft provided various incentives such as technical support in return for some form of exclusive distribution of Microsoft s products as traditional exclusive dealing); see also 15 U.S.C. 14 (Clayton Act 3) (making unlawful a 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... of a competitor ). 29 11 HERBERT HOVENKAMP, ANTITRUST LAW 1807b, at 127 (2d ed. 2005). [A]ntitrust policy should not differentiate between the manufacturer of widgets that explicitly imposes exclusive dealing on its dealers and the manufacturer that gives such dealers a discount or rebate for dealing exclusively in the manufacturer s widgets. Id. at 128 & n.4 (gathering cases). 7
Sherman Act. 30 In determining whether a volume discount is above cost, courts use the price and cost of the entire volume purchased. In other words, the price-cost analysis is not performed on only a portion of the total purchases needed to earn the volume discount or rebate. This is true whether there is a single volume threshold or multiple volume discount tiers. We are not aware of any U.S. court that has distinguished between lump sum discounts or rebates paid upon reaching pre-established volumes and so-called first dollar or retroactive discounts. First dollar discounts are those that apply retroactively to all purchases once a particular volume threshold is achieved. For example, a company might offer a 20% discount off list prices if the customers buys more than $1 million in a year. The competitive effect of this discount may be different depending on whether it applies retroactively to all purchases or only to incremental purchases over $1 million. Although current U.S. law does not prohibit first dollar discounts so long as the total discount or rebate does not bring the price of all goods purchased below cost, there may be risk in companies with dominant market shares using first dollar discounts. The courts that have addressed the legality of volume discounts have not focused on the distinction between retroactive and incremental discounts. 31 3. Market Share Discounts Market share discounts require the customer to buy a certain percentage of its total needs from the firm offering the discount. For example, a company might offer a 20% discount for buying 90% of all purchases from the seller. There is a relative dearth of case law addressing market share discounts, and the little law there is does not establish clear rules. The principal legal issue regarding market share discounts is whether they should be analyzed under pricing law or the law applying to exclusive dealing and similar exclusionary contracts. The leading decision analyzing market share discounts is Concord Boat Corp. v. Brunswick Corp. 32 Brunswick offered a 3% discount to boat builders who bought 80% of their engines from it; 2% for 70% of all purchases; and 1% for 60% of purchases. The court upheld the legality of the market share discounts in question but declined to hold as the defendant had asked it to that market share discounts are necessarily legal if they are above cost. 33 Rather, the court began its analysis with the premise that Section 1 30 See, e.g., Western Parcel Express v. United Parcel Services, 190 F.3d 974, 976 (9th Cir. 1999) ( Such volume discount contracts are legal under antitrust law. ); Advo, Inc. v. Philadelphia Newspapers, 51 F.3d 1191, 1203 (3d Cir. 1995) (volume discounts offend no antitrust principles ); cf. LePage s, 324 F.3d at 154 (distinguishing concededly legal volume discounts). 31 Commentators also have argued that volume discounts can foreclose competition in product markets where a portion of the demand is inelastic. See Willard K. Tom et al., Anticompetitive Aspects of Market-Share Discounts and Other Incentives to Exclusive Dealing, 67 ANTITRUST L.J. 615 (2000). 32 207 F.3d 1039 (8th Cir. 2000). 33 Id. at 1058-59, 1062. 8
claims that allege only de facto exclusive dealing may be viable. 34 Applying Tampa Electric s substantial foreclosure test, the court concluded that the market share discounts did not exclude competitors and were not the functional equivalent of exclusive dealing contracts. 35 Having found no exclusive dealing or its practical equivalent, the court then considered whether the discounts as a matter of price competition could have violated Section 2 even though there was no claim that the prices were below cost. The court concluded that the attractive prices alone were not coercive they did not create golden handcuffs and therefore the discounts were legal. 36 Concord Boat is frequently cited in support of the proposition that market share discounts are legal if they are above cost. But the court s discussion of the issue is more nuanced and leaves open the possibility that market share discounts that have the same practical effect as exclusive dealing whether they are above cost or not can violate the Sherman Act. 37 In contrast, in Masimo Corp. v. Tyco Health Care Group, L.P., 38 the district court upheld the verdict finding Tyco s market share and sole source agreements illegal under Sections 1 and 2 of the Sherman Act and Section 3 of the Clayton Act. The market share discounts offered hospitals substantial discounts (e.g., 40% off list prices) for committing 34 Id. at 1058. 35 The court evaluated the legality of Brunswick s market share discount program by considering the extent to which competition has been foreclosed in a substantial share of the relevant market, the duration of any exclusive arrangement, and the height of entry barriers. Id. Applying this standard, this court held that the plaintiffs did not produce sufficient evidence demonstrating that Brunswick had foreclosed a substantial share of the market or that the discount program was in any way exclusive. The programs did not require the boat builders to commit to Brunswick for any specified period of time. They were free to walk away from the discounts at any time.... Id. at 1059. 36 Id. at 1063. In other words, because, on the facts of the case, there was not a basis for analyzing the contracts under exclusive dealing law, the plaintiff could not prevail on a pricing claim without showing prices below cost. Boat builders and dealers were free to walk away from Brunswick s discounts at any time, and the evidence showed that they did so when Brunswick s competitors offered better discounts, thus discrediting the boat builders theory that the discounts created golden handcuffs and entry barriers for other engine manufacturers. Id. In fact, the record showed that the initial success of a competitor, OMC, reduced Brunswick s market share to 50% and that Brunswick s market share later climbed only when OMC was forced to recall its popular new product. Id. at 1045. 37 In general, the facts of Concord Boat were not especially compelling for the plaintiff. The discounts offered were not very large; they did not require very high market shares; and, most important, the evidence showed that customers switched back and forth between suppliers depending on who offered the best product or price. For other decisions finding no liability for market share discounts, see Virgin Atlantic Airways v. British Airways, 257 F.3d 256 (2d Cir. 2001) (rejecting claim that British Airways incentive program for travel agents harmed competition absent any evidence that consumers paid higher prices or that British Airways priced below cost for incremental added flights attributable to the incentive program) and Allied Orthopedic Appliances, Inc. v. Tyco Health Care Group LP, 592 F.3d 991 (9th Cir. 2010) (discussed infra at n. 41). 38 2006 WL 1236666 (C.D. Cal. March 22, 2006), aff d, 350 F. App x 95 (9th Cir. 2009). 9
to purchase large percentages (e.g., 90%) of their pulse oximetry products from Tyco. There was no allegation that these discounts resulted in below-cost prices. Although the district court s JMOL opinion does not discuss the distinction between antitrust law s treatment of price competition and exclusionary contracts, it clearly placed Tyco s market share discounts in the latter category. 39 The court held that there was sufficient evidence to find that Tyco s agreements foreclosed competition and harmed Masimo, a relatively new entrant to the market. 40 In an unpublished opinion, the Ninth Circuit affirmed. Although the Ninth Circuit s reasoning is not entirely clear, it necessarily rejected Tyco s argument that its market share discounts were legal because they were above cost. 41 Other recent cases involving market share discounts include: ZF Meritor LLC v. Eaton Corp. 42 ; Advanced Micro Devices, Inc. v. Intel Corp. 43 ; and Eisai Inc. v. Sanofi- Aventis LLC. 44 Not surprisingly, these cases originated in districts in the Third Circuit, where, in view of that court s en banc decision in LePage s v. 3M (discussed below), it is very likely that the court would hold that market share discounts that tend to exclude smaller competitors should be analyzed under general monopolization principles or as de facto exclusive dealing. In addition, the FTC has recently instituted actions alleging that 39 See 2006 WL 1236666, at * 5 (applying Tampa Electric and discussing the market share contracts as exclusive dealing). 40 See id. at *6 ( Although the Market Share Discount agreements appear to have been terminable on short notice on their face, the jury could reasonably have concluded that in practice they were not. A number of hospitals were financially locked into purchasing a fixed amount of Tyco sensors to support their installed Tyco monitors. This fixed demand for Tyco sensors for an extended period of time, when combined with the Market Share Discounts, effectively prevented the hospitals from purchasing sensors outside of the Market Share Discount agreements on short notice. The jury, therefore, could reasonably conclude those agreements were defacto exclusive. ). 41 See 350 F. App x at 97-98. In follow-on litigation against Tyco involving the same products but a different time period, a putative class of hospitals and other health care providers alleged they overpaid for Tyco s pulse oximetry products because Tyco used market share discounts (among other things) to foreclose competition from generic sensor manufacturers. See Allied Orthopedic, 592 F.3d at 994. The Ninth Circuit rejected this claim because the market share discounts could not explain why customers continued to buy Tyco s own sensors in the face of less expensive generic alternatives. See id. at 996-98. The court distinguished Masimo, which was a direct competitor suit focused on an earlier time period, on the grounds that (1) Tyco faced increased competition from generic sensors after the expiry of a key patent and (2) the group purchasing organization agreements no longer required members to buy pulse oximetry products only from Tyco. Id. at 997 n.2. Furthermore, in Allied Orthopedic, the court never considered whether the market share agreements violated Section 2. It appears that this was due to the structure of the plaintiff s claims. In any event, in discussing a different Section 2 theory (based on Tyco s changes to its own technology), the court noted that Tyco s share of new monitor sales was less than Masimo s and it faced competition from several manufacturers of generic sensors. Id. at 1002. 42 Case No. 06-623 (D. Del.) (liability verdict for plaintiff; damage phase proceeding). 43 Case No. 05-441 (D. Del.) (settled prior to trial). 44 Case No. 3:08 Civ. 4168 (D.N.J.) (ongoing). 10
market share discounts violated Section 5 of the FTC Act. 45 This limited jurisprudence does not clearly answer whether and when market share discounts should be viewed as a type of pricing conduct that is legal unless it runs afoul of the Brooke Group predatory pricing rule or as a form of exclusionary conduct subject to substantial foreclosure analysis. Furthermore, relatively little has been written about what legal rules should be used to assess the legality of market share discounts. Professor Hovenkamp has acknowledged that market share discounts could bear some resemblance to exclusive dealing, but concludes on balance that such discounts are covered by antitrust s ordinary predatory pricing rule. 46 Commentators arguing that all above-cost market share discounts are legal distinguish them from exclusive dealing on various grounds, including that: (1) market share discounts do not bar all purchases from competitors 47 ; (2) they involve discounts and so are presumptively procompetitive 48 ; and (3) they are usually only offers, not firm contractual commitments to buy only from the seller. 49 Other commentators have argued that courts can and should address the competitive harm caused by market share discounts even if those discounts do not constitute predatory pricing. 50 They assert that market share discounts may not involve 45 These include against Intel (File No. 06-10247) (ongoing) and Transitions Optical, Inc. (File No. 09-10062) (consent decree). 46 PHILIP E. AREEDA & HERBERT HOVENKAMP, ANTITRUST LAW 749b, at 146-48 (Supp. 2009). Professor Hovenkamp reasons that, although market share discount schemes can harm competition, those concerns are more than offset by the risk of overdeterrence and administrative difficulties. Id. at 149-50. 47 See, e.g., id. at 148 ( [T]he discount scheme excludes less than an exclusive dealing contract insofar as a buyer can earn the discount without purchasing everything from the seller. The impact of course varies with the percentage. But even an absolute requirement that the buyer take a specific share of purchases from a particular seller can foreclose much less than full exclusive dealing. ). 48 Numerous Supreme Court decisions, albeit none involving market share discounts, provide support for this position. See, e.g., Brooke Group, 509 U.S. at 226-27 ( It would be ironic indeed if the standards for predatory pricing liability were so low that antitrust suits themselves became a tool for keeping prices high. ). 49 See, e.g., AREEDA & HOVENKAMP, supra note 46, 749b at 148-49 ( [M]ost discount programs lack the lock-in feature that characterizes unlawful exclusive dealing. In a case of unlawful exclusive dealing the defendant seller enters into a contract for a specified period requiring the purchaser to take all of its product from that seller.... By contrast, the typical discount contract is usually conditional: if you want to obtain a 20% discount, then you must purchase all (or a specified percentage) of your goods from the contracting seller. The penalty for not taking the specified percentage is not a breach of contract suit or termination of a franchise. Rather, it is simply the loss of the discount. But the loss of the discount is not a penalty at all if a rival is willing to match the discounted price. As a result, the quantity discount case typically presents a contract of zero duration. ). 50 See Einer Elhauge, Antitrust Analysis of GPO Exclusionary Contracts 31-35 (Sept. 26, 2003), available at http://www.law.harvard.edu/faculty/elhauge/pdf/statement_ftcdoj.pdf; Willard K. Tom et al., Anticompetitive Aspects of Market-Share Discounts and Other Incentives to Exclusive Dealing, 67 ANTITRUST L.J. 615, 634-35 (2000); see also Louis Kaplow & Carl 11
true discounts but rather penalties for not committing to the seller 51 and have similar foreclosure effects to exclusive dealing. The percentage of potential foreclosure could be calculated by multiplying the percentage of the market covered by the dominant firm s market share discounts by the market share commitment percentage (e.g., market share discounts requiring a 90% commitment covering 70% of the market are analogous to exclusive dealing covering 63% of the market). The effect of market share discounts is likely to be greater in markets where, as a practical matter, smaller competitors cannot entirely replace the dominant firm, because of capacity issues or entrenched buying habits. This has led some to suggest that courts should assess the potential exclusionary effects of the discounts by determining the portion of a customer s purchases that is realistically in play. Using a form of price-cost test, the entire market share discount would then be attributed to the contestable portion of the customer s purchases. If the resulting price is below cost, competitors would not be able to match the prices and they would constitute a potential violation of Section 2. 52 U.S. courts have not expressly used this method to assess the legality of market share discounts, but the European Commission did so in its Intel decision. 53 Although this Shapiro, Antitrust, in 2 HANDBOOK OF LAW AND ECONOMICS 5.4, at 1203 n.98 (A. Mitchell Polinsky & Steven Shavell, eds., 2007) (noting that market share discounts can have very similar economic effects as explicit exclusivity ). 51 See EINER ELHAUGE & DAMIEN GERADIN, GLOBAL ANTITRUST LAW AND ECONOMICS 624 (2007); see also Kenneth L. Glazer & Brian R. Henry, Coercive vs. Incentivizing Conduct: A Way Out of the Section 2 Impasse?, ANTITRUST 45, 46-47 (Fall 2003) (distinguishing coercive and incentivizing pricing programs based on whether they represent true discounts off but for prices). 52 For example, if a large company offers a 30% discount to buyers who purchase 90% of their needs from it, and if customers will buy half of their needs from the dominant firm under all circumstances, the entire market share discount would be attributed to the remaining 40% market commitment. See Tom, supra note 50, at 627 (discussing effect of market share discounts in market in which the dominant firm offering the discounts faced inelastic demand in 60% of its business). Although not discussed in these terms by the Third Circuit, LePage s arguably involved a market in which 3M faced an inelastic demand in some portion of its sales of Scotch brand transparent tape. See 324 F.3d at 144 (discussing market structure). 53 In its guidelines for applying Article 82 (now Article 102) of the EC Treaty, the Commission indicates that it will calculate the effective price of the goods for the relevant portion of the market and compare that price against the dominant firm s costs, using average avoidable costs (AAC) and long run average incremental costs (LRAIC, which includes product-specific fixed costs from before the time period in question) as the relevant cost measures. Guidance on the Commission s Enforcement Priorities in Applying Article 82 of the EC Treaty to Abusive Exclusionary Conduct by Dominant Undertakings 42-44 (Feb. 24, 2009) [Article 82 Guidance]. For incremental rebates (those that apply only to volumes above the market share or volume threshold), the relevant portion of the market is normally the portion of the market above the threshold. For retroactive rebates (first dollar discounts), the relevant portion of the market is the contestable share, which is how much of a customer s purchase requirements can realistically be switched to a competitor. Id. 42. See also Nicholas Economides, Loyalty/Requirement Rebates and the Antitrust Modernization Commission: What Is the Appropriate Liability Standard, 54 ANTITRUST BULLETIN 259, 261 (Summer 2009) (arguing that same test should apply to bundled discounts and market share discounts; [t]he only difference is 12
analysis might seem to provide firms with an objective means of assessing the antitrust risks of their conduct, in practice the amount of the market that is up for grabs is likely to be a subject of dispute and, in the event of litigation, might turn on information that the company would not necessarily have known at the time it offered the discounts (such as information in the buyer s files). 54 The Department of Justice s now-withdrawn 2008 Section 2 report highlighted some of the tensions between the various competing views regarding how market share discounts and similar loyalty programs should be analyzed. The report found that commentators and panelists generally agree that even where a single-product loyalty discount is above cost when measured against all units, such a discount may in theory produce anticompetitive effects, especially if customers must carry a certain percentage of the leading firm s products and the discount is structured to induce purchasers to buy all or nearly all needs beyond that uncontestable percentage from the leading firm. 55 But the DOJ found there is little consensus about when above-cost discounting practices are harmful and whether it is possible to devise rules that would not harm competition on balance because of the possibility of false positives. 56 The DOJ concluded that further assessment of the real-world impact of [loyalty discounts] is necessary before concluding that standard predatory-pricing analysis is appropriate in all cases. 57 The current DOJ and FTC have not issued any guidelines applying to market share discounts. II. BUNDLED DISCOUNTS Bundled pricing refers to discounts, rebates or other incentives tied to the participant s purchase of multiple products. Bundled discounts implicate different issues that in the multiproduct case, sales in market A are leveraged to obtain higher sales in market B, while in the single-product case, the uncontested sales in market A are leveraged to obtain the contested sales in market A ). 54 The test could be applied based on the seller s subjective understanding or an objective analysis of all information available at the time of litigation. 55 U.S. DEP T OF JUSTICE, COMPETITION AND MONOPOLY: SINGLE-FIRM CONDUCT UNDER SECTION 2 OF THE SHERMAN ACT 107 (Sept. 2008) (internal citations omitted) (report now withdrawn) [SECTION 2 REPORT]. 56 See id. at 116; AREEDA & HOVENKAMP, supra note 46, 749b, at 144 ( It is one thing to develop a theory showing that a particular practice can be anticompetitive. It is quite another to show that this theory explains a particular practice without producing an unacceptably high number of false positives. ). According to the DOJ, there is no consensus on how likely it is that above cost single-product discounts will be anticompetitive. SECTION 2 REPORT at 107. 57 Id. at 116. However, the Section 2 Report came down on the side of applying pricing rules where possible: The Department believes that the standard predatory-pricing approach to single-product loyalty discounts has a number of advantages. Compared to other possible approaches described above, a predatory-pricing rule would be relatively easy for courts and enforcers to administer and would provide businesses with the clarity necessary to conform their conduct to the law using information available to them. Further, this approach has a relatively low risk of chilling desirable, procompetitive price competition that immediately benefits consumers. Id. 13
than other types of loyalty discounts because, by definition, they cover more than one product line. However, they also can incorporate elements of other forms of discounts. For example, the bundled discount could be conditioned on the buyer reaching a particular volume threshold or market share requirement, or it could involve a first dollar discounts. To that extent, the principles discussed above also could apply to bundled discounts. Bundled pricing is sometimes described as coercive in the sense that the rebates or discounts offered on a bundle of products might be so large that it would be economically irrational for a customer to buy a single product in the bundle from another seller and risk not earning a discount or rebate on the entire bundle. Courts have tended to treat bundled pricing as different from other types of loyalty discounts. To illustrate why this is so, take a simple example (borrowed from an early court case dealing with bundled discounts, Ortho Diagnostic Systems, Inc. v. Abbott Laboratories, Inc. 58 ). Assume that Firm A sells both shampoo and conditioner and that it has monopoly power in the shampoo market. Firm B sells shampoo only, in competition with Firm A. Also assume that Firm B is just as efficient as Firm A in making shampoo. Further assume that consumers need both shampoo and conditioner. If Firm A offers volume discounts on shampoo alone, Firm B will be able to match those discounts and compete so long as Firm A s prices remain above cost. But if Firm A offers a discounted package price on shampoo and conditioner together, Firm B may find itself unable to match Firm A s prices even though it is an efficient producer. For example, assume Firm A sells shampoo alone for $15 and its costs are $12. It sells conditioner alone for $10 and its costs are $7. Firm B s costs to manufacture shampoo are also $12. Firm A then offers shampoo and conditioner sold as a package for $20. This price is above its combined cost of $19. Firm B will be unable to compete with this bundled discount because it would need to sell shampoo at $10 to match Firm A s package price a price that is below Firm B s cost of $12. That is, if Firm B s price is $10, the buyer will be indifferent between buying shampoo from Firm A or Firm B. This example shows that bundled pricing can be used to foreclose competitors not based on lack of efficiency, but simply by virtue of the fact that they do not offer the same range of products. A. Early Bundling Cases and LePage s The earliest case to address bundled pricing directly was SmithKline Corp. v. Eli Lilly & Company. 59 In SmithKline, the Third Circuit affirmed a district court decision finding unlawful Lilly s discount on a bundle of three antibiotics two of which were available only from Lilly. The court found the bundle unlawful because Lilly linked products on which it faced no competition with a competitive product. The result was to sell all three products on a non-competitive basis in what otherwise would have been a competitive market for [the two recently introduced antibiotics sold by SmithKline and 58 920 F. Supp. 455 (S.D.N.Y. 1996). 59 575 F.2d 1056 (3d Cir. 1978). 14
Lilly]. 60 The court did not evaluate whether the bundle resulted in Lilly selling below cost if the entire discount were applied to the product where it faced competition, although the district court found that an equally efficient firm that sold only the competitive product would not be able to afford to match Lilly s bundled price. The next key case to take on the issue of bundled pricing was Ortho Diagnostic Systems, Inc. v. Abbott Laboratories, Inc. In Ortho, the court proposed a test for determining the legality of a monopolist s bundling of products on which it faces competition with products for which it is the only source. The plaintiff must allege and prove either that (a) the monopolist has priced below its average variable cost or (b) the plaintiff is at least as efficient a producer of the competitive product as the defendant, but that the defendant s pricing makes it unprofitable for the plaintiff to continue to produce. 61 The court granted summary judgment to Abbott on the bundled pricing claim under Section 2 because the evidence showed that the plaintiff could match the discount and still make a profit, albeit a smaller profit than before. The next significant bundled pricing case was LePage s Inc. v. 3M. 62 3M was the dominant manufacturer of transparent tape in the United States through its Scotch brand products. LePage s was a much smaller manufacturer of transparent tape. It sold only private label (store brand) tape, which began making inroads into 3M s Scotch tape sales. 3M made the decision to begin selling private label tape itself in addition to branded tape. 3M also began offering various discount programs to large retail customers, such as Kmart, Wal-Mart, and Office Depot. These programs varied from year to year and by category of customer, but they generally made discounts contingent upon meeting or exceeding purchase volume targets in a variety of 3M product lines. With some minor exceptions, the discount programs did not involve express exclusive dealing or any promises by retailers not to buy from LePage s. LePage s sued under Section 3 (exclusive dealing); Section 1 (unreasonable restraints of trade); and Section 2 (monopolization). All of these claims were based on the same facts: i.e., that 3M s bundled rebates and other discount and incentive programs harmed competition in the market for the sale of transparent tape. LePage s did not claim that 3M sold any of its tape below cost. LePage s also never attempted to prove that it could not match 3M s discounts. LePage s expert conceded that it was less efficient than 3M. The jury found that 3M had not violated Section 3 or Section 1, but that it had engaged in unlawful monopolization under Section 2 of the Sherman Act. It awarded LePage s $22.8 million before trebling. On appeal, LePage s argued that this was an old fashioned monopoly case to which no specific standard should be applied other than very generic Section 2 principles. This is exactly how the case went to the jury: Judge Padova had instructed the jury that they could find 3M liable if its conduct had the effect of preventing or excluding competition or if its conduct impaired the opportunities of rivals. 3M, on the other 60 Id. at 1065. 61 920 F. Supp. at 469. 62 324 F.3d 141 (3d Cir. 2003). 15
hand, argued that Brooke Group governed the pricing practices at issue. The only way that an equally efficient competitor could not match 3M s rebate programs was if 3M priced below its costs, i.e., 3M s discounts were legal so long as the price of the bundle exceeded 3M s costs for the goods in the bundle. An alternative test would ask whether 3M priced tape below cost if the entire amount of the rebates in question were attributed to the price of its tape. LePage s never made any attempt to prove that it could not match 3M s discounts, either under Brooke Group or an attribution analysis. The original panel agreed with 3M and reversed, over a strong dissent by Judge Sloviter. The en banc court, however, reinstated the jury verdict in an opinion written by Judge Sloviter. The court held that Brooke Group simply did not apply, because 3M was a conceded monopolist (3M conceded monopoly power for purposes of the appeal). The court also held that 3M s de facto exclusive dealing arrangements and bundled rebates violated Section 2 because they harmed 3M s only other competitor in the market, LePage s. The court never identified exactly how 3M violated Section 2 or what specific conduct was unlawful. 3M petitioned for certiorari. Many amici joined 3M in asking the Court to review the case. The Court then invited the Solicitor General to express its views. The United States took the position that although the Third Circuit s opinion was almost certainly wrong, it was not an appropriate vehicle for the Court to address the issue of bundled pricing. 63 The United States believed that lower courts, economists, and other experts and commentators needed to develop the issues further before being addressed by the Court. The Supreme Court denied 3M s petition. LePage s has been widely criticized both by commentators and district courts in other circuits. 64 Nonetheless, it remains good law in the Third Circuit. The next court of appeals to address bundling directly was the Ninth Circuit in Cascade Health Solutions v. 63 Notwithstanding its recommendation that the Court deny certiorari, the Solicitor General s brief acknowledged that the business community and consumers would benefit from clear standards governing the legality of bundled discount programs. It also pointedly criticized the Third Circuit s opinion, noting that the decision provided few useful landmarks on how Section 2 should apply as a general matter in future cases involving bundled rebates and failed to explain precisely why the evidence supported a jury verdict of liability in this case, including what precisely rendered 3M s conduct unlawful. 64 See J.B.D.L. Corp. v. Wyeth-Ayerst Labs., Inc., 2005 WL 1396940, at *16 (S.D. Ohio June 13, 2005) (criticizing LePage s for favor[ing] letting a jury sort it out, using the same imprecise, conflicting Section 2 standards transformed into jury instructions, and granting summary judgment for the defendant), aff d on other grounds, 485 F.3d 880 (6th Cir. 2007); Ramallo Bros. Printing, Inc. v. El Dia, Inc., 392 F. Supp. 2d 118, 137-38 (D.P.R. 2005) (granting summary judgment for defendant where plaintiff failed to show that it lost any sales as a result of defendant s bundled pricing); Masimo Corp. v. Tyco Health Care Group LP, 2006 WL 1236666, at *13 (C.D. Cal. March 22, 2006) (after allowing Masimo s bundling claim to proceed to trial under LePage s and giving a generalized Section 2 instruction, court granted Tyco s JMOL motion on bundling and ruled that bundled pricing does not violate Section 2 absent proof of predatory pricing or illegal tying), aff d on other grounds, 350 F. App x 350 (9th Cir. 2009). 16
PeaceHealth. 65 B. AMC and PeaceHealth Prior to the Ninth Circuit s decision in PeaceHealth, the Antitrust Modernization Commission (AMC) issued an influential report containing a proposed test for determining the legality of bundled discounts under Section 2 of the Sherman Act. The AMC identified discounts on bundled products as being one of two specific areas of concern under Section 2 (the other was refusals to deal with rivals). It concluded that the lack of clear standards regarding bundling, as reflected in LePage s v. 3M, may discourage conduct that is procompetitive or competitively neutral and thus may actually harm consumer welfare. 66 After singling out LePage s for extensive criticism, the AMC recommended that courts adopt a three part test to determine whether bundled discounts or rebates violate Section 2. Under this test, the plaintiff would be required to show each of the following (along with the standard elements of a Section 2 claim): (1) after allocating all discounts and rebates attributable to the entire bundle of products to the competitive product, the defendant sold the competitive product below its incremental cost for the competitive product; (2) the defendant is likely to recoup its short term losses; and (3) the bundled discount or rebate program has had or is likely to have an adverse effect on competition. 67 In PeaceHealth, McKenzie-Willamette Hospital, a medium sized hospital near Eugene, Oregon, sued PeaceHealth, a Bellevue, Washington-based health care company that owned other, larger hospitals in the Eugene area. McKenzie offered general acute hospital care, but not tertiary care (such as cardiovascular surgery and intensive neonatal care). McKenzie claimed that PeaceHealth violated the antitrust laws by offering certain insurers and health plans low prices on its tertiary care services in which it had a monopoly in return for exclusivity in primary hospital care. The case went to a jury under various theories including express and de facto exclusive dealing, predatory pricing, and bundled pricing. As to the latter, the court instructed the jury that bundled discounts violate Section 2 if they are offered by a monopolist and substantially foreclose portions of the market to a competitor who does not provide an equally diverse group of services and who therefore cannot make a comparable offer. This instruction is taken almost verbatim from language in the LePage s opinion. And like that opinion, it leaves the question of when bundled pricing is unlawful completely up to the jury. It offers no objective criteria for determining when competitors supposedly cannot make comparable offers. The jury returned a verdict of $5.4 million before trebling on the plaintiff s attempted monopolization claim. The jury found for PeaceHealth on the monopolization and exclusive dealing claims. On appeal, the plaintiff again took the position that bundled discounts offered by a firm with monopoly power are effectively per se illegal 65 515 F.3d 883 (9th Cir. 2008). 66 ANTITRUST MODERNIZATION COMMISSION, REPORT AND RECOMMENDATIONS 94 (2007) [AMC REPORT]. 67 Id. at 99. 17
or, at least, that their legality is determined solely by looking at their effect in the market along with any subjective consideration the jury might want to consider, without regard to whether an equally efficient competitor could have matched the discounts. PeaceHealth made a number of arguments, including that bundled pricing offers that lead to exclusivity cannot be treated any more stringently than express exclusive dealing. In this case, PeaceHealth s purported de facto exclusives covered only 15% of the market, which would be too low for liability under the substantial foreclosure test applied to contractual exclusive dealing. Alternatively, PeaceHealth asked the Ninth Circuit to reverse because McKenzie had not shown that PeaceHealth s pricing programs were unlawful under any accepted standard except LePage s, which it urged the court not to follow. After oral argument the court took the unusual step of inviting amici to submit further briefing on the issue of what the appropriate test for determining the legality of bundled discounts should be. A large number of corporations and other organizations filed amicus briefs, urging one of three basic positions. At one end of the spectrum, some amici argued in favor of a pure Brooke Group test, meaning that bundled pricing is lawful if the total price of the bundle is above the combined cost of the individual items in the bundle. Opponents argued that this is basically a rule of per se legality and that it ignores the reason that bundling can exclude single product competitors. At the other end of the spectrum, various consumer groups argued in favor of a fluid standard for determining when bundled pricing is unlawful. They would apply a rule of reason-type analysis that recognizes that bundling is more like tying than predatory pricing. They agree that one way that a plaintiff could show harm to competition is by proving that the defendant failed one of the cost-based tests, but that there are other ways that a plaintiff could prevail. Among other things, opponents of this position argued that it is contrary to prior Supreme Court decisions and that it discourages companies from offering discounts for fear of antitrust liability. Lastly, some amici espoused a middle approach modeled on the attribution test proposed by the AMC. The Ninth Circuit ultimately followed the latter approach. The court expressly rejected LePage s and held that the Supreme Court s teachings required that a price-cost test be applied to bundled discounting claims under Section 2. Also recognizing that bundled pricing could exclude efficient single product competitors, the court adopted an attribution test under which the full amount of the discounts given by the defendant on the bundle are allocated to the competitive product or products. If the resulting price of the competitive product or products is below the defendant s incremental cost to produce them, the trier of fact may find that the bundled discount is exclusionary for the purpose of 2. 68 The court further held that the appropriate measure of cost for the bundle pricing (and predatory pricing) analysis is average variable cost. The court rejected the AMC s recommendation that the bundled pricing test include a recoupment requirement, because exclusionary bundling does not necessarily involve any loss of profits for the bundled discounter. 69 The court also declined to adopt the third proposed element of the AMC test, which would require a showing that the bundling had or was likely to have an 68 515 F.3d at 906; see also id. at 909. 69 Id. at 910 n.21. 18
adverse effect on competition. The Ninth Circuit thought that this element was redundant because it is no different than the general requirement of antitrust injury that a plaintiff must prove in any antitrust action. 70 In other words, it would appear that the court assumed that bundled pricing falling outside the price-cost safe harbor would be analyzed under the rule of reason. 71 The court vacated the verdict and judgment for McKenzie and remanded for further proceedings. Remand was stayed, however, pending an answer from the Oregon Supreme Court on whether Oregon would follow Brooke Group in requiring below-cost pricing to prevail on a claim for primary line price discrimination under Oregon s Robinson-Patman Act state law analog. The case settled prior to a ruling from the Oregon Supreme Court and remand to the district court. The Ninth Circuit s ruling on bundling remains in effect. C. Open Issues With the AMC Report and PeaceHealth, the use of an attribution test to determine the legality of bundled pricing has entered the antitrust mainstream. 72 Nonetheless, there remains considerable uncertainty about how courts will analyze bundled pricing outside the Third and Ninth Circuits. The fact that prominent commentators continue to argue for different tests 73 suggests that bundling law may remain unsettled until the Supreme Court addresses the issue. One significant open issue regarding bundled discounts is the relevance and application of tying law. Bundled discounts have frequently been compared to tying 70 Id. 71 Cf. Jonathan M. Jacobson, Exploring the Antitrust Modernization Commission s Proposed Test for Bundled Pricing, 21 ANTITRUST 23, 26 (Summer 2007) ( The most important component of the AMC s test is its third part, the requirement of actual or probable harm to competition i.e., a basic rule of reason test. ). 72 In its withdrawn Section 2 report, the DOJ adopted Professor Hovenkamp s analysis of the issue recommending the use of an attribution test safe harbor in cases where bundle-to-bundle competition is not reasonably possible. SECTION 2 REPORT, supra note 54, at 101-02 (citing PHILIP E. AREEDA & HERBERT HOVENKAMP, ANTITRUST LAW 749, at 171 (Supp. 2008)). The European Commission has stated that bundled discounts would be considered lawful if the incremental price paid by customers for each of the bundled products covers the long run average incremental cost of including the product in the bundle. See Article 82 Guidance, supra note 53, 60. When bundle-to-bundle competition is reasonably possible, a total bundle predatory pricing safe harbor would apply. Id. 61. 73 Compare, e.g., Timothy J. Muris & Vernon L. Smith, Antitrust and Bundled Discounts: An Experimental Analysis, 75 ANTITRUST L.J. 399 (2008) (arguing in favor of a total bundle safe harbor, i.e., a pure application of Brooke Group) with, e.g., Einer Elhauge, Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory, available at http://ssrn.com/abstract=1345239 (Feb. 2009) (arguing that the attribution test is never appropriate and that the per se tying rule should be applied to some bundled pricing); Economides, supra note 53, at 267-73 (criticizing the AMC and PeaceHealth tests for, among other reasons, using the monopolist s costs and not focusing only on the contested units of the competitive product). 19
because a bundled discount or rebate could be so attractive as effectively to coerce buyers to buy one or more products from the defendant that they otherwise would have purchased from other sellers. 74 We are not aware of any court, however, that has explicitly decided the question of when bundled pricing is the legal equivalent of tying, i.e., when it constitutes de facto tying. In PeaceHealth, the plaintiff cross-appealed the grant of summary judgment on its tying claim. The Ninth Circuit vacated the district court s order granting summary judgment to PeaceHealth and remanded for further proceedings. 75 The court declined, however, to decide whether the attribution test used to assess the legality of bundled price offers also should be used to test whether there is coercion for purposes of a de facto tying claim. 76 The issue remained unresolved in PeaceHealth because the case settled before remand. In the end, although it is not clear that a court ever would apply a per se tying rule to a bundled pricing claim, the theoretical possibility of a per se claim might be attractive to plaintiffs. 77 A related question is whether bundled discounts or rebates that are conditioned on market share commitments or similar terms should be analyzed under the substantial foreclosure test (as de facto exclusive dealing) or whether they also should be treated as a form of price competition under PeaceHealth. This issue was raised directly in the Masimo appeal, but was not reached by the Ninth Circuit. 78 74 Professor Hovenkamp has written that coercion could result from an absolute refusal to sell the tying product without the tied product, technological design integrating the two products, or a discount, rebate or other financial incentive given to buyers who also take the tied product. HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY 410 (3d ed. 2005). See also Nicholas Economides & Ioannis Lianos, The Elusive Antitrust Standard on Bundling in Europe and in the United States in the Aftermath of the Microsoft Cases, 76 ANTITRUST L. J. 483 (2009) (advocating a unified test for bundling and tying that would focus on foreclosure and the presence of objective justifications). 75 PeaceHealth s practice of giving a larger discount to insurers who dealt with it as an exclusive preferred provider may have coerced some insurers to purchase primary and secondary services from PeaceHealth rather than from McKenzie. We conclude that, as a whole, the evidence shows genuine factual disputes about whether PeaceHealth forced insurers either as an implied condition of dealing or as a matter of economic imperative through its bundled discounting, to take its primary and secondary services if the insurers wanted tertiary services. 515 F.3d at 914. 76 515 F.3d at 915-16 & n.27. Although the court noted that [s]ome commentators would require a plaintiff alleging that a bundled discount amounts to an illegal tie to prove belowcost prices, the court also explained that the AMC did not clearly state that its three-part rule was intended to apply to de facto tying claims. Id. 77 Cf. Elhauge, supra note 72. 78 One issue in the Masimo appeal was the effect of PeaceHealth (which was decided after the Masimo trial but before the appeal) on Masimo s claims relating to bundling agreements. Masimo argued that Tyco s bundling agreements, which contained embedded market share requirements (i.e., the hospital was required to buy 90 or 95% of its needs for all products in the bundle from Tyco to earn the discount), were not entitled to the price-cost safe harbor set forth in PeaceHealth. The Ninth Circuit agreed that PeaceHealth did leave open the possibility that application of the discount attribution test may be inappropriate in tying or exclusive dealing cases. See 350 F. App x at 97. It also appeared to agree with Masimo that pricing rules should 20