The National Jounral

DOJ attempts to lead, but FTC declines to follow

by Jane E. Willis and Matthew P. Garvey,
November 3, 2008

The U.S. Department of Justice (DOJ) opened its recent 181-page report, entitled Competition and Monopoly: Single-firm Conduct Under Section 2 of the Sherman Act, by reciting the well-established precedent that 2 of the Sherman Act prohibits "the willful acquisition or maintenance of [monopoly] power as distinct from growth or development as a consequence of a superior product, business acumen or historical accident." U.S. v. Grinell Corp., 384 U.S. 563, 570-571 (1966).

As the DOJ recognized in its report, available at www.usdoj.gov/atr/public/reports/236681.htm, a dilemma faced by the antitrust enforcement agencies and courts in applying § 2 of the Sherman Act is determining whether monopoly power has been acquired lawfully or unlawfully, and distinguishing competitively harmful conduct by a monopolist or aspiring monopolist that should be prohibited, from lawful, aggressive competition on the merits that should be encouraged. Drawing from views expressed by antitrust enforcers, academics, economists and practitioners following extensive hearings, the DOJ sought in the report to provide express guidance on the proper standards for 2 enforcement. The standards set forth by the DOJ to promote clarity and transparency, including the use of "safe harbors" and a "disproportionality" test, have stirred a vigorous debate about the extent to which the DOJ's pronouncements are a departure from existing § 2 jurisprudence.

In this regard, the Federal Trade Commission (FTC), which shares authority with the DOJ for antitrust enforcement, refused to endorse the report, and three FTC commissioners complained that the report "seriously overstates the level of legal, economic, and academic consensus regarding Section 2." Federal Trade Commission, Statement of Commissioners Harbour, Leibowitz and Rosch on the issuance of the Section 2 report by the Department of Justice (Sept. 8, 2008), at www.ftc.gov/os/2008/09/080908section2stmt.pdf. The commissioners' criticism focused on the DOJ's construction of safe harbors and the use of a disproportionality test that, in the commissioners' view, places on antitrust enforcers and private plaintiffs the burden of proving that any pro-competitive effects of a monopolist's acts are "substantially outweighed" by their harm to competition. FTC Chairman William Kovacic issued a separate statement calling for a fuller examination of the historical context and the formative judgments that influenced the evolution of modern antitrust doctrine and policy. Statement of Federal Trade Commission Chairman William E. Kovacic, Modern U.S. Competition Law and the Treatment of Dominant Firms: Comments on the Department of Justice and Federal Trade Commission Proceedings Relating to Section 2 of the Sherman Act (Sept. 8, 2008), available at www.ftc.gov/os/2008/09/080908section2stmtkovacic.-pdf.

Guiding principles

The DOJ report set forth seven uncontroversial guiding principles for 2 policy:

• Section 2 governs unilateral conduct only when the actor possesses or is likely to possess monopoly power.

• Only the anti-competitive acquisition or maintenance of monopoly power is unlawful, not the mere possession or exercise of monopoly power.

• Consumers are harmed by monopolist acts that attack the competitive process.

• Harm to competitors alone, but not the competitive process itself, does not violate 2.

• It often is difficult to distinguish competitively harmful conduct by a monopolist or aspiring monopolist from lawful, aggressive competition on the merits — both types of conduct can look alike, and indeed some conduct can have both beneficial and exclusionary effects.

• Because beneficial and exclusionary conduct often look similar, courts and enforcers need to be concerned both with underdeterrence and overdeterrence.

• Section 2 standards should take into account costs, such as errors and administrative costs, associated with adjudicating and enforcing cases and complying with 2 in everyday business decisions.

After setting forth the guiding principles, the report addressed specific areas of 2 policy and enforcement. In describing the DOJ's approach to enforcement in various areas, the DOJ endorsed the use of safe harbors and "per se" legality in several areas in an attempt, among other things, to clarify enforcement policy and to reduce the administrative costs and risk of error associated with antitrust enforcement by the department and antitrust counseling by practitioners. Both the DOJ-created safe harbors and the declarations of "per se" or presumptive legality are controversial, to the extent that they represent an emerging view and are not expressly stated in the relevant body of federal court jurisprudence.

The DOJ endorsed a "safe harbor" for determining monopoly power and said that a firm with less than 50% market share should not be deemed to have monopoly power. One basis for the DOJ's conclusion is that, although the federal courts have never expressly created such a safe harbor, no U.S. court has ever deemed a firm to be a monopolist when the firm's market share was less than 50%. This conclusion differs from practice in the European Union, where firms with less than 50% market share have been deemed to have a dominant market position.

The DOJ endorsed the standards set by the U.S. Supreme Court for determining illegal predatory pricing, Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), and illegal predatory bidding, Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., 127 S. Ct. 1069 (2007). The Supreme Court required that a plaintiff show both that an alleged monopolist has suffered a short-term loss as a result of its below-cost pricing or bidding, and that the alleged monopolist has a dangerous probability of recouping that loss. If there is no short-term loss, the defendant's conduct is immune to challenge.

Going beyond the Supreme Court's decision in Brooke Group, the DOJ recommended the use of a specific test for determining when a firm is engaging in below-cost pricing. The DOJ endorsed the use of a firm's "average avoidable cost" as the test for below-cost pricing. The average-avoidable-cost test uses the average per unit of all costs, including variable costs and product-specific fixed costs, that could have been avoided had the firm not engaged in the alleged predatory conduct. The DOJ selected this test, among several others suggested by hearing participants and commentators, because of its relative ease of administration and because it theoretically condemns only prices so low that an equally efficient competitor could be forced to exit the market. The dissenting FTC commissioners, however, criticized the use of "average avoidable cost" because such cost may not include up-front expenses that may prevent rivals from emerging to prevent the success of a predatory strategy.

The DOJ further suggested that efficiencies be considered in defense of alleged predatory conduct, even when below-cost pricing and a dangerous probability of recoupment have been demonstrated.

Exclusionary conduct

In determining whether conduct by a firm with market power constitutes unlawful exclusionary conduct, the DOJ encouraged the use of a "disproportionality" test, pursuant to which enforcement authorities and courts would determine whether the conduct causes anti-competitive effects that are "substantially disproportionate" to any pro-competitive benefits arising from the conduct. According to the DOJ's new test, if the benefits and harms to competition are "comparable or close to comparable," then the conduct should be deemed lawful. Similar to baseball's rule that a tie goes to the runner, under the DOJ's rubric, a close call would go to the defendant. The DOJ argued for its new test on the basis that it is administratively difficult to weigh harmful effects against beneficial effects with precision, and that the existing balancing test does not provide enough predictability and clarity in assessing business risks.

The three dissenting FTC commissioners complained that this disproportionality test creates a higher hurdle for enforcers and plaintiffs than the hurdle now used by courts. Indeed, no court has adopted such a "disproportionality" test under any aspect of the antitrust laws.

In its report, the DOJ declared that tying — the practice of conditioning the purchase of one product (the tied product) on the purchase of another product (the tying product) — should never be per se illegal. In recent years, the Supreme Court has rejected the "per se" rule in certain specific contexts and has said that the per se rule should be limited to situations in which the anti-competitive effects are obvious. Although it is therefore debatable whether the current Supreme Court would apply per se treatment if presented with a tying case, courts generally have ruled that tying is per se illegal if the seller has sufficient market power in the market for the tying product to be able to "force" a buyer to purchase the tied product. See Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 12 (1984).

The DOJ called for abandonment of the per se treatment of tying cases and recommends a two-staged analysis. The first question is whether the tie has the potential to harm competition and consumers. In situations in which harm to competition is implausible — when the defendant lacks monopoly power or the reasonable prospect of acquiring it through the tie, or when the sole reason for the tie is to allow price discrimination (which causes a pro-competitive increase in output), an antitrust enforcer or plaintiff will not clear this first hurdle. The second step of the analysis is the proportionality test discussed above — determining whether the anti-competitive effects of the tie substantially outweigh the pro-competitive effects.

Standards for discounts

In its report, the DOJ outlined its enforcement standards for bundled discounts. Bundled discounting is the practice of offering discounts or rebates if the buyer purchases two or more different products that are bundled. The DOJ endorsed different tests for determining whether bundled discounts are anti-competitive, depending on whether bundle-to-bundle competition is reasonably possible. When such competition is possible, the DOJ will analyze bundled discounts using the predatory-pricing test and determine whether the discounted price of the entire bundle is below the appropriate measure of cost — generally, average avoidable cost — of the products in the bundle. If the firm's pricing is above the average avoidable cost, the bundled discount is legal. If the firm's pricing is below the average avoidable cost, the DOJ will look for any likelihood of recoupment in determining whether the bundled discount is predatory.

If no competitor or group of competitors can offer the same range of items as the firm with the bundled product, the DOJ will apply the "discount-allocation" test — a variation on the below-cost prong of the predatory-pricing test. This test allocates all discounts and rebates attributable to the bundle to the competitive product, to determine the imputed price of the competitive product. It is that imputed price that is used to determine whether the bundle is being priced below cost. If the imputed price for the competitive product is below average avoidable cost, the bundled discount will be analyzed like a tying case, and may be illegal if the anti-competitive effects substantially outweigh any pro-competitive benefits.

The three FTC commissioners criticized the DOJ's analysis of bundled discounts for using the DOJ's predatory-pricing test to determine illegality, and for not considering that in some instances bundled discounts could be a form of exclusive dealing warranting separate analysis.

The DOJ endorsed the adoption of a safe harbor for exclusive-dealing claims. The DOJ said that exclusive-dealing arrangements that foreclose less than 30% of the existing market and customers are deemed per se legal. The DOJ rejected a trend by lower courts to establish safe harbors for exclusive dealing based on the length of the exclusive contracts, by declaring that "the legality of exclusive dealing should not depend solely on its length." For exclusive dealing arrangements that are not within the DOJ's safe harbor, the DOJ will require plaintiffs to establish that any harm to competition substantially outweighs any pro-competitive benefit.

Dealing with competitors

Going against the grain of several court decisions, the DOJ report said that antitrust liability for a firm's unilateral, unconditional refusals to deal with a competitor "should not play a meaningful part in Section 2 enforcement." The DOJ admitted that the Supreme Court has held, as recently as in Verizon Commc'ns Inc. v. Law Offices of Curtis V. Trinko LLP, 540 U.S. 398 (2004), that the right to refuse to deal with a competitor is qualified. Nevertheless, the DOJ found that the significant, long-term disadvantages to requiring a monopolist to deal with a competitor, including the disincentives to innovation and the practical difficulties in administering such remedy, counsel against enforcing 2 in the context of a unilateral refusal to deal.

The recently issued DOJ report provides guidance for antitrust practitioners and businesses in connection with the DOJ's views on 2 of the Sherman Act, although the weight that will be given to the report by future administrations is unknown. In addition, antitrust counsel and clients must continue looking to established precedent in determining antitrust risk in the context of a private civil plaintiff or a potential FTC inquiry. Nevertheless, the DOJ report is a useful and comprehensive resource regarding several areas of application of 2 of the Sherman Act. In addition, the report has ignited a worthwhile debate among enforcers, practitioners and others about the proper role of the courts and the agencies in policing single-firm conduct.

Jane E. Willis, a partner at Boston-based Ropes & Gray, focuses her practice on antitrust and complex business litigation. Matthew P. Garvey is a litigation associate at the firm.