Corporate & Securities Law

Thoughts on Safe Harbors for Quantity Discounts (and Bundling)

Dennis Carlton and Michael Waldman have posted an insightful DOJ working paper on antitrust safe harbors for unilateral conduct involving quantity discounts and bundling. The discussion is very timely in light of the Microsoft CFI decision, AMC Report, Section 2 Hearings, and various monopolization cases in the United States, EU, and other antitrust jurisdictions. The Carlton & Waldman paper is short, very accessible, and makes several very important points about the benefits of safe harbors to guide antitrust policy in this area generally and some weaknesses in the proposed AMC approach to bundling. Anybody interested in single firm conduct issues in antitrust should read this paper.

The issue they raise — safe harbors for single firm conduct — is one I’ve written about quite a bit. And I want to test out some thoughts on it here that I’ve sketched out partially in some academic writing and blog posts with respect to safe harbors for quantity discounts, loyalty rebates, exclusive dealing and competition for distribution more generally. I am on record defending two very specific safe harbors (one for short-term contracts and another for contracts that foreclose < 40% of the distribution market). I’ll return to the issue of a foreclosure safe harbor in a moment, and that will be the focus of the post, but for now, let me start with Carlton & Waldman’s framing of the antitrust problem of exclusion:

An antitrust claim involving exclusion requires that there be harm to a rival, harm to consumers and a linkage between the harm to the rival and the harm to consumers … This reasoning suggests that all mechanisms of exclusionary pricing conduct that do not alter a rivalâ??s costs of operating or impair his ability to exist should not trigger an antitrust violation. In particular, this means that if there are no such effects, as for example occurs when the production technology is constant returns to scale, then there can be no anticompetitive harm. This does not mean that the rivalâ??s business is unaffected nor that consumers are unaffected by a new pricing policy, but simply that the mechanism of harm, if there is one, has nothing to do with excluding a rival.

Carlton & Waldman focus in on the key issue for antitrust policy related to competition for distribution in the form of discounting conduct: the question of whether the defendant’s conduct has deprived a rival of scale to a degree that it is foreclosed from profitable access to the market altogether, or to a sufficient degree that its competitive constraint on the exercise of the defendant’s monopoly power is reduced, and competition is harmed.

So far so good. This economic insight is at the heart of the “foreclosure” requirement that appears in exclusive dealing cases that involve analytically identical claims concerning exclusion. Carlton & Waldman address claims of exclusion involving single product pricing in a predatory pricing framework and make the following statement about the “recoupment” requirement of the standard two pronged Brooke Group analysis:

[The recoupment prong] is a reflection of the principle that with constant returns to scale rivals will always constrain price and there can be no recoupement. The reason is that with no fixed costs, entry is always possible and guarantees that there is a competitive constraint on price. [The recoupment requirement] is phrased more practically to cover deviations from constant returns to scale that are not so large as to allow recoupment. With no possibility of recoupment, there is no reason to incur the initial loses associated with pricing below cost.

This is very interesting, and perhaps optimistic, understanding of courts are doing when the apply the recoupment requirement. My preliminary reaction is that most single product predatory pricing cases involve an analysis of barriers to entry at the recoupment stage as if the court was answering the question: “can the monopolist increase prices for a sustained period of time without attracting entry and therefore, recoup the losses associated with its period 1 prices?” I don’t think the courts explicitly conceptualize the recoupment prong in the way Carlton & Waldman describe here as it relates to scale. Rather, my tentative view is that analysis concerning the potential to deprive rivals of scale, the presence of substantial economies of scale, and even foreclosure are generally missing from these single product predatory pricing cases.

To be clear, thats not to say that courts are not analyzing in the recoupment prong the issue of whether the pricing scheme is likely to exclude rivals in some sense. But I think this sort of scale and foreclosure analysis that is typically present in exclusive dealing cases is generally absent in single product pricing cases. Now, I do believe that the recoupment requirement in these cases should be applied in the manner Carlton & Waldman suggest it already is. In fact, that is basically where I am going with this post. Keep reading and I’ll explain why I think this would be a good idea.

Full post as published by Truth on the Market on March 04, 2008 (boomark / email).