principal lecturer professor steven c. salop williamsburg lodge, williamsburg, va october 1, 2010

The Antitrust Masters Course VABA Section of Antitrust Law

Plenary Session Slides Day 2, Session 2

Principal Lecturer

Professor Steven C. Salop

Williamsburg Lodge, Williamsburg, VA

October 1, 2010

Session Agenda:

Exclusionary Conduct: Analytical Framework

– Collusive and Exclusionary Conduct – Exclusionary Conduct Paradigms

• Predatory Pricing• Raising Rivals’ Costs

– Diagnosing and Analyzing RRC Conduct

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Anticompetitive Exclusion

Conduct that allows a firm (or group of firms), to …Achieve, enhance or maintain market power,

by …Disadvantaging competitors, and thus …Harming consumers.

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Collusion and Exclusion• Two anticompetitive ways to achieve, maintain and then exercise

market power– Collusion: Marry your competitors (“classical” market power)– Exclusion: Kill your competitors (“exclusionary” market power)

• Single firm monopoly – No need to marry – May need to engage in exclusionary conduct to prevent entry

• Exclusion – May involve single firm as the excluding firm – Or, may involve exclusionary joint conduct by rivals

• Key properties of collusion and exclusion:– Both harm consumers and reduce efficiency– Can occur separately or together– Can reinforce one another

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Example: JTC Petroleum

Seller 1 Seller 1

Cartel Applicators

(cartel)

Cartel Applicators

(cartel)

Consumers (Muncipalities)

Consumers (Muncipalities)

AsphaltMarket

Seller 2 Seller 2

JTCJTC

Applicator Market

More Distant Asphalt Pits

More Distant Asphalt Pits

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Chronology: Analytic Steps

• Applicator cartel members allocate customers and fix prices

• JTC refuses to join conspiracy (“maverick”)• Applicator cartel members pay nearby asphalt

producers not to sell to JTC• JTC’s competition neutralized by cartel

– JTC can only buy asphalt from distant producers, raising its costs very substantially

• Cartel maintained– Asphalt producers get part of the cartel profits

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Exclusionary Conduct Paradigms

Predatory Pricing(Chicago-School Paradigm)

• Reduce price as an investment

• Cause rival to exit, at which point the firm can raise price to monopoly level

Raising Rivals’ Costs (Post-Chicago Paradigm)

• Raise competitors’ costs, which leads them to reduce output and raise price, which permits firm to raise its price

• Encompasses “foreclosure” allegations from exclusive agreements

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Some conduct arguably might be characterized either way.

Example: market share discounts; bundling rebates

Exclusive Agreements and Foreclosure

Excluder’s Rivals

Excluder’s RivalsExcluderExcluder

ConsumersConsumers

SuppliersSuppliers

Input Market

Output Market

“Input Foreclosure” that raises rivals’ costs”

“Customer Foreclosure” that reduces rivals’ revenues”

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Comparing the Paradigms for Antitrust Policy

• Conventional “view” of predatory pricing – “Seldom attempted and

rarely succeeds”– Success requires victim to

exit– Significant short-term

consumer benefit from lower prices

– Speculative longer-term consumer harm

– Short-term profit-sacrifice by firm

• Compare raising rivals’ costs conduct– “More credible and more

dangerous strategy”– No exit requirement –

higher costs lead to higher prices

– Significant short-term consumer benefits may not exist

– Immediate consumer harm: higher prices raise prices

– No short-term profit-sacrifice: higher prices raise profits immediately

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Conclusion: RRC raises greater antitrust policy concerns

Analyzing Raising Rivals’ Costs Conduct

• 3 Components– Raising Rivals’ Costs (RRC): impact in upstream (input) market

• “Harm to competitors” • Relationship to upstream market definition

– Power Over Price (POP): impact in downstream (output) market • “Market power harms to consumers” • Raise price or prevent price from falling (e.g., deter entry)• Relationship to downstream market definition

– Efficiencies (EFF): efficiency benefits from the conduct (e.g., elimination of free riding)

• “Procompetitive benefits to consumers”• Reduce cost or increase quality

• Consumer Welfare Effects– Balancing POP and EFF effects, to estimate “net” effect on

consumers

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Example: Klors Exclusionary Group Boycott as RRC

Admiral ...Admiral ...

Non-Excluded Stores and Competing Products

Non-Excluded Stores and Competing ProductsBroadway-HaleBroadway-Hale

ConsumersConsumers

Wholesale Market

...Zenith...Zenith

KlorsKlors

Retail Market

Non-ForeclosedTV Manufacturers

Non-ForeclosedTV Manufacturers

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Basic Defenses

• No harm to rivals (No RRC)– Competitors have cost-effective alternatives– Non-restrained suppliers– New entrants/backward integration

• No harm to consumers (no POP)– Consumers have alternatives – Competition from non-excluded firms (including

multiple excluding firms)• Consumer benefits from the conduct (EFF)

– Reduce costs– Raise product quality– Prevent free riding

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Other Possible Defenses

• Input suppliers have disincentives to create/support downstream market power

• “Single monopoly profit” eliminates incentive to exclude

• Rivals have market counterstrategies to avoid exclusion– “Competition for exclusives”

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Input Suppliers’ Incentives:Rebuttal

• Incentive to deter downstream monopoly is limited– Deterrence of monopoly is a “public good,”

subject to free rider problems. – Downstream firm may share monopoly profits

with input suppliers (e.g., JTC Petroleum)• Paying for an exclusive as a way to “purchase”

market power

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Single Monopoly Profit Theory:Affirmative Story

• Leveraging power from one market into another is unnecessary – Monopolist can extract all monopoly profits in

the primary monopoly market

• Thus, vertical mergers, refusals to deal and other exclusivity must be pro-competitive– No anticompetitive motive

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SMP Theory Ignores Plausible Exclusionary Strategies

• Exclusionary conduct can protect or achieve first monopoly, rather than create second monopoly

– Microsoft as example– Generalization of “two-level entry” theory

• Exclusionary conduct can permit monopolization of consumers who do not buy the first, monopoly product

– Drive rivals below minimum viable scale– Microsoft media player as example – achieve monopoly for devices where

no Windows monopoly

• Foreclosure can incentivize competitors to compete less vigorously or tacitly coordinate

• If regulation or contracts prevent exercise of monopoly in the first monopoly market, exclusion may allow exercise in a related unconstrained market.

– Example: Discon– Trinko/Credit Suisse may have eliminated this cause of action,

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Competition for Exclusives

Bidding for Exclusives:Affirmative Story

• Winning bidder will be the more efficient firm.

– Thus, rivals’ costs not raised unless it is efficient to do so

– Buyer-driven exclusives: Competition among efficient firms, each with some exclusives, is the best outcome

• Rivals have the incentive and ability to counterbid, which will raise the cost of exclusion and thereby deter inefficient exclusion

• Rebuttal

– Exclusives sometimes are efficient

– Rival does have the incentive to protect itself and can sometimes succeed in deterring exclusion

– But, the categorical claim is flawed18

Flaws in Bidding Theory: Bargaining on Non-level Playing Field

• If entrant must pay to avoid exclusion, then the payment raises its costs

• Entrant’s potential coordination problem– If very limited distribution is sufficient for success, then entrant

counterbids can deter exclusion (AMD?)

– But, if rival needs wide distribution from multiple retailers in order to succeed, then Incumbent has the bargaining advantage because of entrant’s fundamental “coordination problem” (Dentsply? LePages?)

• Value of exclusive to incumbent systematically exceeds value of non-exclusive to entrant,– Incumbent may be purchasing market power, not just distribution

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Non-level Playing Field:Entrant’s Coordination Problem

• Suppose that Entrant can only succeed if it gains wide distribution with multiple distributors

• Entrant is a risky bet for distributors because entry will fail unless many distributors forgo the exclusive from the incumbent

– Distributors less likely to take entrant’s bid

– This creates a coordination problem for entrant

• Thus, entrant must compensate distributors for risk, raising its costs and making counterbids less likely to succeed

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Pepsi v Coca Cola:Bidding for Exclusives

Food“Systems”Distributors

Food“Systems”Distributors

PepsiPepsiCokeCoke

Fast Food ChainRestaurants

Fast Food ChainRestaurants

Bottlers/Other Distributors

Bottlers/Other Distributors

DistributionMarket

Fountain SyrupMarket

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Coordination Problem: Distributors Choose To Serve

Larger Base

Food Systems Distributors

Food Systems Distributors

Pepsi Restaurants(25%?)

Pepsi Restaurants(25%?)

Coke Restaurants(75%?)

Coke Restaurants(75%?)

Thus, FSDs will accept a Coke exclusive for a very low fee, unless Pepsi can get many restaurants to switch at the same time, which is difficult to coordinate 22

Purchasing Market Power• Value of exclusive to incumbent systematically

exceeds value of non-exclusive to entrant– Competition reduces profits– Competition transfers benefits to consumers

• Incumbent that buys exclusives also may gain market power– Thus, higher bid does not reflect higher efficiency or

higher consumer welfare

• Numerical example illustrates differential bid values

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Can Entrant Win a Non-Exclusive vs. Incumbent Getting

an Exclusive?

Monopoly Outcome (No Entry)

Competitive Outcome

(Successful Entry)

Maximum Bid

Incumbent 200 70 130

Entrant 0 70 70

Total Profits 200 140

Consumers are not involved in the bidding

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Day 2, Session 2

The End

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