Journal of Information, Law and Technology
Proceed with Caution: The Application of Antitrust
to Innovation-Intensive Markets
Calvin S. Goldman , Q.C., Richard F.D. Corley
and Michael E. Piaskoski of Blake, Cassels and Graydon LLP
www.blakes.com
This is a refereed article published on: 30 April 2004
Citation: Piaskoski, Corley and Goldman, 'Proceed with Caution: The Application of
Antitrust to Innovation-Intensive Markets ', 2004 (1) The Journal of Information, Law
and Technology (JILT).
<http://elj.warwick.ac.uk/jilt/04-1/piaskoskicorleyandgoldman.html>.
Kohlbach
Making Sense of Electronic Money
Abstract: The explosion of the information economy, combined with the rapid
introduction of the associated new technologies, hardware, software and shareware,
etc., has challenged many of the traditional tools of legal protection and enforcement,
causing regulatory authorities, law enforcement agencies, lawyers, judges and
lawmakers to play 'catch-up' with this dynamic industry. As a result, established legal
understandings of copyright, jurisdictional borders, illegal content and contracts must
be revisited in this era of innovation, information and e-commerce.
So too of antitrust and competition law. Antitrust authorities are finding themselves
faced with the challenges posed by markets that refuse to stand still and shun the
traditional trappings of competition law that use a 'snapshot' of product and
geographic markets, market shares, monopolies and barriers to entry. As the products
and services of the information economy become increasingly complex and change
occurs almost daily with successive innovations, antitrust authorities are (and will
continue to be) faced with questions that many of their traditional understandings of
markets and methods of analysis and enforcement. For example, as a variation on the
'chicken and the egg' theory, one might ask, 'does innovation spur competition or does
competition spur innovation?' The answer to this conundrum is important as any
attempt to limit one may have significant effects on the other. Further, is it acceptable
from an antitrust perspective to hinder the creation of a widely-accepted technological
standard (and a therefore dominant market position for the company creating the
standard) if consumers and society as a whole will benefit from the ongoing
innovation and wide use of the standard? Should the protection of consumers from the
static effects of short-term price increases trump the long-term effects of dynamic
gains arising from innovation? The answers are not straightforward and continue to be
discussed and reviewed by antitrust authorities around the world.
Keywords: Competition Law, Antitrust, Information Economy ,Intellectual
Property, Network Effects, Low Barriers to Entry, Minimal Marginal Costs,
Vertical and Horizontal Integration, Complementarity, Traditional Product and
Service Markets, and IP Markets.
1. Introduction
In this paper, we attempt to draw attention to the unique characteristics of high
innovation markets that make it difficult for antitrust authorities to know when and
how to intervene. We do not suggest, however, that antitrust has no role in the
information economy. Nor do we suggest that, in general, the authorities have done a
poor job of assessing mergers and conduct in these industries. Indeed, many antitrust
authorities have made considerable efforts to study, analyze and otherwise understand
the competition issues related to high innovation markets. In fact, in 2002, antitrust
enforcement agencies from ten different jurisdictions participated in a Roundtable on
Merger Assessment in High Innovation Markets chaired by the Competition
Committee of the Directorate for Financial, Fiscal and Enterprise Affairs for the
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OECD (the 'OECD Roundtable'); many of their insightful comments and observations
have been included throughout this paper. [1]
Rather we argue that antitrust authorities must formulate a clear picture of the industry
and technologies under their review, acquire an enhanced understanding of some of
the underlying economic principles of the new economy, and respect intellectual
property laws that act to encourage and facilitate innovation. We suggest that
developments and changes in information technology markets have ameliorated the
conditions which have in the past prompted antitrust enforcement action against
companies such as Microsoft, and raised serious questions about the desirability of the
antitrust enforcement actions taken in those cases. Most importantly, we believe that
antitrust authorities must act with restraint and caution in dealing with high innovation
industries and appreciate the consequences of their actions on this economy and, in
particular, on the incentive to innovate.
2.Competition Law Objectives
While firmly established in economic theories such as the protection of consumer
welfare and the efficient allocation of resources, the objectives of antitrust and
competition law have been influenced over the years by the evolution of 'economic
activity' in society in general. Early competition law was concerned with the
concentration of wealth and the effects of wealth transfers on consumers and
farmers. As western society became more highly industrialized and the field of
industrial organization economics developed, the academic literature, legislation and
judicial decisions focussed increasingly on the promotion of allocative efficiency [2]
as the principal objective of competition law enforcement, downplaying the
importance of other objectives, such as the maintenance of fragmented industries and
markets.
More recently, competition law economists and policy makers have recognized that
dynamic change and innovation, the pillars of the information economy, are important
sources of economic activity; they can lead to long-term efficiency and productivity
gains which will ultimately benefit consumers. Accordingly, they are gaining
increasing acceptance as very important sources and indicia of competition. [3]
However, despite acknowledgement and acceptance of these new indicia of economic
activity and competition, the traditional underlying theories of and analytical
approaches to competition are challenged by the innovation market paradigm. Teece
and Coleman state that:
… we do not believe the antitrust agencies anywhere in the world are at present well
equipped to deal with competition policy in high-technology industries.…The very
nature of competition, the definition of industries, the basis of competitive advantage,
the effects of 'restrictive' practices and the nature of economic rents are all different in
the context of innovation. The costs of error are great … [4]
The reasoning of the United States Court of Appeals for the District of Columbia
Circuit in the Microsoft case [5] highlights the challenges faced by both antitrust
authorities and independent arbiters who are increasingly confronted with issues
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arising from the interface of competition law with industries undergoing rapid
technological change:
Antitrust scholars have long recognized the undesirability of having courts oversee
product design, and any dampening of technological innovation would be at crosspurposes with antitrust law.
(…)
We suggest here only that the limited competence of courts to evaluate high-tech
product designs and the high cost of error should make them wary of second-guessing
the claimed benefits of a particular design decision.
(…)
Apart from the lack of textual support, we think that a balancing test that requires
courts to weigh the 'synergies' of an integrated product against the 'evidence of distinct
markets,' is not feasible in any predictable or useful way. Courts are ill equipped to
evaluate the benefits of high·tech product design, and even could they place such an
evaluation on one side of the balance, the strength of the 'evidence of distinct markets,'
proposed for the other side of the scale, seems quite incommensurable. [6]
3. Is There a Role for Antitrust in the Information Economy?
Robert Pitofsky observes that the importance of high innovation industries to the
economy, combined with limited antitrust experience regarding the uses of intellectual
property, should cause antitrust authorities to pay careful attention to ensure that
overall economic growth is not compromised by the abuse of private market power.
[7] Some (including the defenders of Microsoft) believe that antitrust should have no
role in the information economy at all as it is dangerous to challenge and undermine
investment incentives in these dynamic industries. [8] Others suggest that, due to the
rapid pace of innovation in high-tech industries, regulatory authorities should refrain
from intervening 'unless certain that doing so will benefit consumers and the
economy.' [9]
The basic question then is whether the information economy 'is so different in kind
from the economies of the past as to warrant the view that practices that restrict
output, create or enhance monopoly power, or raise artificial barriers to new
competition are no longer the sorts of things the law should strive to prevent'. [10]
Further, should antitrust’s conventional role as enforcer of competitive principles be
abandoned because it may be unnecessary or counter-productive, or, as some would
believe, harmful? Should basic antitrust principles continue to apply, after taking due
notice of different characteristics of the high-tech sector of the economy, or should a
whole new set of rules be created for the information economy?
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Advocates of a 'hands-off' approach rely on the theories of Joseph Schumpeter that
posit that monopolies tend to innovate more vigorously due to their scale economies
in R&D and greater opportunities to exploit the value of their innovations [11] and
that, in any event, high-tech monopolies will be eroded by the effects of 'creative
destruction', under which innovation destroys old business models or entire industries
and creates new ones. Based on these theories, those opposed to antitrust involvement
in the high-tech sector argue that: (1) traditional antitrust rules may discourage
innovation by diminishing the rewards incumbent firms expect to gain from their
inventions and developments; (2) incumbent firms may reduce their investments in
innovation unless allowed greater freedom to exploit their market power and respond
to new technologies [12] ; (3) change is too rapid; (4) the markets are self-correcting;
and (5) in any event, the markets are too complex and the technology too difficult to
understand.
The Schumpeterian theories have been challenged on a theoretical level by those who
believe that the high-tech monopolist is unlikely to dilute its own monopoly rents
through 'creative destruction' and self-generated inventions that will render its
products obsolete and cannibalize its own sales. Further, there appears to be little
empirical evidence or consensus that the application of ordinary antitrust rules will
retard innovation generally. Rather, studies show that unchecked market power will
impair rather than enhance long-run innovation. [13]
Jacobson believes that competition in innovation markets is well within the scope of
legitimate antitrust protection: 'Exempting all acquisitions that are consummated
before a foreseeable market has developed would risk preventing new discoveries
from ever coming to market and allowing significant price increases for those that do
— while spurring no incremental innovation.' [14] He observes that, in the Microsoft
case, two different opinions regarding antitrust intervention formulated by the court of
appeals. While the court specifically rejected the innovation exemption when
evaluating whether Windows gave Microsoft monopoly power [15] , it appeared to
accept such an exemption when determining whether Microsoft had unlawfully tied its
Internet Explorer browser to the Windows operating system. In particular, the court
held that software markets were too new and the courts were too inexperienced in
dealing with them to apply the same per se rule for tying arrangements that had been
adopted in other industries. [16]
The experience of the European Commission (EC) does not support the proposition
that there is a need for an innovation exemption · for example, it has not found that
competition is largely 'for the market' and that market power is undermined quickly by
other innovations. It has, in fact, intervened in a number of merger cases that
threatened to create or strengthen a non-transient dominant position in markets that
can be characterized as high innovation markets. [17] It believes that antitrust
authorities have shown that they are well-suited to monitor the information economy
by, for example, relaxing their normal preference for structural rather than behavioural
solutions to perceived problems.
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The U.S. Federal Trade Commission (FTC) and the Department of Justice (DOJ)
believe that claims that antitrust has no relevance in high-tech markets are
overstated. Market dominance can still exist due to a variety of reasons, including
large sunk costs, network effects, an installed base of customers, and other barriers to
entry. For example, once a network monopoly is established, it is relatively easy for
the monopolist to exclude potential competitors by adopting a policy of allowing only
its own products to connect with the existing network. The monopolist may be able to
monopolize successive generations of product, or complementary products or
services. This means that the best products or services may not necessarily succeed
and potential competitors, recognizing the tremendous difficulties of challenging the
incumbent monopolist, may lose incentives to compete. Antitrust, therefore, can still
play an essential role in order to prevent abuses of market power. Healthy
competition, after all, spurs further innovation.
Therefore, assuming that there is a role for antitrust in the information economy, the
characteristics of high-tech markets still require that antitrust laws be applied
cautiously, informed by the facts of the specific situation. It is important that antitrust
authorities know when to intervene and when to forbear; it may be extremely difficult
to judge when a market will be sufficiently 'innovation-intensive' to justify nonintervention.
The unique economic characteristics of the information economy require that antitrust
authorities consider carefully the implications of their actions for future investment,
research and innovation. They must keep in mind that overly static efforts to promote
(or protect) competition within the framework defined by existing markets may preempt or inhibit innovation and future competition for the development of new
products, services and markets; any efforts to promote static efficiency by protecting
certain competitors from the normal economic consequences of vigorous competition
in markets characterized by demand-side network externalities are likely to inhibit the
achievement of the dynamic efficiency gains associated with the development of new
products and markets. In the context of the information economy, innovation is the
key determinant of competition and should not inadvertently be impeded by the
enforcement actions of antitrust authorities.
4. What Is So Unique About the information Economy?
A. Introduction
Some of the many competition law challenges posed by high-innovation markets can
be illustrated with reference to the economic characteristics of the segment of the
economy commonly referred to as the 'information economy', i.e., the segment of
domestic and global economies that is engaged in the creation, processing and
communication of information. The movement toward IP and information as a
primary source of value, network effects, the rapid rate of industry change, falling
barriers to entry and the other factors discussed in this paper suggest that dynamic
change and the long-term increases in efficiency that flow from innovation are more
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important to competition than are short-term static efficiency gains. As suppliers
compete to develop products, systems and standards that deliver greater value to
consumers, a number of factors will encourage innovation, including the relatively
low marginal costs of producing and reproducing information, low barriers to the
marketing and distribution of information-based products over the Internet, the
durable nature of information products (which requires that all suppliers, including
those with high sales shares, innovate to compete against the installed incumbent
base).
As a result, the underlying economic assumptions, sources of market power and
conduct that may be considered anti-competitive differ in the information economy
from those applicable in the traditional industrial economy. The rapid rate of change
in such markets and the inability of antitrust authorities (or anyone else for that
matter) to assess or predict the development and market impact of new inventions
suggest that antitrust authorities should err on the side of caution so as to avoid
causing any unnecessary harm to innovation and competition in such
markets. Consequently, information-based economies may be expected to present the
following implications and challenges for antitrust enforcement.
B. High-Tech Markets are Complex and Uncertain
Former FTC chair Robert Pitofsky describes the hurdles faced by
'technologically·challenged' antitrust authorities:
Many high-tech industries involve questions that are challenging for lawyers and
judges who typically lack a technical background. For example, defining relevant
markets, i.e., the process of identifying those firms that compete so closely with other
firms that they can substantially influence the exercise of market power, is difficult
enough under any circumstances. But it can become far more difficult in high-tech
industries such as biotechnology, where products that might curtail the market power
of a dominant incumbent firm are not in existence yet, and will not reach the market
for several years; or in the cable industry where the essential question is when satellite
transmission will become a real competitive force in the cable market. Similar
problems arise with respect to telecommunications, a sector of the market where many
believe competition for local operating companies will eventually be offered by
electric utilities through their existing grid and electricity wires into the home. Each of
these issues raises questions in the realm of science and technology that often will be
difficult to address. [18]
However, technological and specialized expertise is generally required in all merger
cases, regardless of industry. Antitrust authorities must familiarize themselves with
the unique characteristics of the relevant industry. We believe this should be no
different in high innovation industries.
The job of antitrust authorities is made more difficult by the uncertainty associated
with the success of any given R&D project, the evolution of a particular market and
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the introduction of new competitors, new technologies and new downstream
products. The joint venture between BSkyB and the Hilton Group demonstrates the
difficulties associated with the uncertainty of future innovations. The case involved
the establishment of a 50:50 joint venture between BSkyB and Hilton Group to
develop a fixed odds betting business linked to Sky Sports channels on BSkyB’s
digital satellite platform. The joint venture proposed to offer interactive 'in-vision'
betting in which viewers could place bets on the very events they were watching. One
of the reasons the merger was referred to the UK Competition Commission was the
lack of certainty about new developing innovations and whether the joint venture
would have an adverse effect on the evolution of competition within this market. [19]
In advising the UK Secretary of State for Trade and Industry, the Director General
concluded:
This proposed joint venture presents a dilemma. In some respects it may enhance
innovation and competition in the wider betting market. But its exclusivity provisions
pose possible risks to the development of competition in interactive betting (which is
forecast to be a large market within the next few years) and in the acquisition of sports
rights. These risks require a more thorough examination which the Competition
Commission is best placed to undertake. [20]
While the parties subsequently abandoned the proposed joint venture before the
Competition Commission could complete its review of the static and dynamic effects
of the merger, antitrust authorities will have to make predictions and assessments and
draw conclusions on the expectancies of future markets.
C. The Interplay With Intellectual Property
The principal source of value in the information economy is knowledge and
information, rather than tangible resources or capital. As a general rule, information
may copied freely, endlessly and virtually costlessly, and can be used simultaneously
by an unlimited number of individuals. Information is exclusive only to the extent that
it is kept confidential by the owner and/or protected by applicable intellectual property
(IP) laws, including domestic copyright, patent, trade-marks and trade secret laws and
under applicable international treaties.
While it is understood, at least at an abstract level, that IP laws and competition law
are both intended to promote the development of an efficient economy, each employs
fundamentally different mechanisms to achieve this common long-term goal. In
general terms, IP laws foster long-term dynamic efficiency gains by providing
incentives for investments in the development of valuable works. IP laws create
legally enforceable private rights that protect (to varying degrees) the form and/or
content of information, expression and ideas. IP laws confer on an IP owner the right
to unilaterally exclude others from using that property and to maximize its value
through exploitation and exchange in the marketplace, enhancing the incentive for
investment and future innovation. The primary purpose of these laws is to define the
scope of these rights and determine under what circumstances they have been
infringed upon or violated.
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Competition law, on the other hand, is principally concerned with the achievement of
static allocative efficiencies by preventing the inappropriate accumulation or exercise
of market power with respect to existing products or services offered by existing
competitors. [21] The pursuit of shorter-term allocative efficiency goals could
adversely affect the incentives of companies to invest and innovate, and thereby
reduce the long-term benefits to society that flow from research and development
(R&D) activities and the protection of IP rights. Since the right to exclude is necessary
for efficient, competitive markets, the enforcement of competition law should not
interfere with the exercise of this basic right and should only be applied to conduct
associated with IP that impedes the efficient production and diffusion of goods and
technologies and the creation of new products.
Each of the U.S., the EU and Canada have developed intellectual property guidelines
that attempt to find a balance between IP and competition laws and define the role of
the relevant enforcement agencies when reviewing IP licensing arrangements.
D. Dynamic Versus Static Efficiencies
The role played by innovation in the information economy highlights the differences,
and sources of potential conflict, between static and dynamic efficiency goals. Static
efficiency is epitomized by the economist’s model of perfect competition, under
which a large number of perfectly-informed suppliers compete with one another to
supply an undifferentiated product to a large number of perfectly informed
consumers. Dynamic efficiency is achieved as a result of the development of new
products or new processes for producing existing products, through innovation and
technological change. Innovation is antithetical to perfect competition to the extent
that innovations are generally created with a view to developing new markets within
which the innovator (for a certain period of time) hopes to be the sole supplier, rather
than to assist the innovator to compete more effectively with other competitors within
existing markets.
Antitrust authorities need to recognize and appreciate the types of innovation that may
occur in a high innovation industry. For example, 'drastic innovation', which involves
an innovation that is so superior to existing products and processes that a smaller new
market entrant will be able to 'leapfrog' over the technological leader, can negate the
alleged market dominance of a firmly-entrenched technological incumbent, even
pushing the incumbent out of the market. [22] In that sense, significant market power
by one firm may be quickly diluted. Further, some markets may be continually
dynamic while others experience an innovative phase before maturing. These
characteristics illustrate the need to understand and assess the nature of innovation
before determining what impact a merger will have on dynamic and static
competition.
As discussed above, advocates of the Schumpeterian school of thought believe that a
more concentrated market will provide the profit incentive firms need in order to
innovate [23] , meaning that a trade-off between static and dynamic efficiency can
exist. This would suggest that antitrust authorities should refrain from making
decisions in the interest of promoting static efficiency that may constrain competition
in innovation/R&D markets. However, more recent theory and empirical evidence
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suggests that competition in the product market can enhance dynamic efficiency based
on the notion that competitive firms will have a strong incentive to innovate so that
they can 'escape' competition. Therefore, in order to determine whether a trade·off
between static and dynamic efficiency exists, merger cases will need careful, in-depth
analysis on a case-by-case basis, including determination of whether an innovation is
drastic or non-drastic. [24]
E. Network Effects, Competition 'For the Market' and Tipping
The phrases 'network effects' or 'demand-side network externalities' are typically used
to describe the manner in which the addition of further users of a product or
technology will increase the value of the product or technology to the benefit of all
other existing users. [25] For example, the very first telephone on a network would
have no value at the time it was purchased because there would be no other telephones
to call. However, each telephone subsequently added to the network adds to the value
of the first telephone and all other telephones on the network, thereby conferring
benefits and value to the other members of the network that are external to the
purchaser of the additional telephone. The same type of network externalities arise
whenever users adopt a product or technology which becomes more valuable to
existing users and, perhaps, less expensive to provide.
Networks are not defined only by the interconnection of physical assets such as
twisted copper pairs, fiber optic cables or radio spectrum. 'Virtual networks' are
comprised of users of compatible technology who are not linked by a physical
network, but who generate network externalities as a result of their adoption of the
common technology of the network. The users of Windows·based computers, VHS
cassette players, audio CDs, Playstation and Xbox games, MP3 files and the Internet
protocol comprise examples of five highly successful virtual networks where the
widespread adoption of the particular technology has increased the value to consumers
of the compatible products which they had previously purchased in essentially the
same manner as the increase in the number of telephone users increased the value of
that network. [26]
Network externalities and the minimal marginal cost of duplicating information
challenge fundamental economic assumptions that relate value to scarcity and
increased quantity to diminishing marginal value. However, it is important to note that
the principal beneficiaries of network effects, in most cases, are consumers rather than
suppliers.
The effects of network externalities played an important role in the U.S. Department
of Justice’s review of WorldCom Inc.’s acquisition of MCI Communications. In
particular, the review focused on the 'Internet backbone' market and the effect of the
merger on the Internet industry. The merger contemplated the combination of two of
the four U.S. or world-wide Internet backbones used for wholesale Internet
transmission services to retail internet service providers dedicated high-speed internet
access for large multinational firms. Given the complex and highly technical web of
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independent relationships, and the dynamic nature of a market characterized by rapid
technological change, it was difficult to define a relevant product market. [27] In
particular, each of WorldCom and MCI, as a backbone provider, were dependent on
each other and, therefore, had an incentive to support and implement efficient
interconnections to ensure no degradation in quality that might result in losing
customers to the other backbone networks. Following their merger and the integration
of their networks, MCI/WorldCom would have far less need to depend on the other
backbones than those backbones would have to depend on it. [28]
High innovation markets are often characterized by competition 'for the market ' (i.e.,
based on performance) rather than competition 'in the market' (i.e., based on
price). Competition for the market results in highly differentiated products, and buyers
who are, for the most part, unresponsive to a small post-merger price increases. Paul
Geroski characterizes 'competition for the market' as follows:
At bottom, it is about establishing a standard and imposing it on the market. This
means, in effect defining what the product is, what it works well with and what
consumers should expect when they use it. A firm that is able to do this and keep
control of that standard is often referred to as a ‘first mover’ and is usually thought
likely to benefit from various ‘first mover advantages’ which protect it from imitative
entrants who, in due course, try to compete in the market. In the context of a standard,
first mover advantages arise whenever control over the design plus accumulated
production experience or scale related cost savings give rise to cost differences
between incumbents and entrants, when pre-emptive investments in product specific
plant or in controlling scarce inputs raise entry hurdles for followers, and when
network externalities create large collective switching costs for consumers who may,
in any case, have formed habits of purchase or a degree of brand loyalty to the first
mover. [29]
The exponential growth and positive feedback characteristics of markets with strong
network externalities that are characterized by competition for the market can make
such markets dynamically unstable and subject to 'tipping' in favour of the perceived
market leader. 'Tipping' refers to the propensity for markets with network externalities
to become 'winner take most' if not 'winner take all.' By definition, network
externalities imply that, all else being equal, consumers would rather have the same
product that most other consumers have. In these markets, any small early advantage
that a seller might acquire, whether real or perceived, that leads consumers to think
that it will have a plurality of sales, could translate into a dominant market share as
everyone wants to jump on the same technological bandwagon. [30]
For example, the purchasing decisions of computer users will be affected by their
expectations and perceptions of which hardware, operating systems and other software
will be the most popular and widely disseminated (and compatible with their
customers and suppliers), and therefore the most effectively supported by wide
varieties of innovative competitively-priced, compatible products and
accessories. Purchasers will tend to buy the system they perceive to be the 'likely
winner', while ignoring less popular (but not necessarily inferior) computer
systems. Similarly, the expectations of software suppliers will shape their decisions on
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what support software products to develop, i.e., they will attempt to develop
compatible software for which there is likely to be a significant potential market. [31]
Firms attempt to exclude competitors in order to 'tip' the market towards their
products and shorten the period of time for 'intense' competition. Therefore, as
Brennan observes, attempting to interpret pricing tactics and other activities when
competition is for the market is not straightforward. Pricing below cost might be
considered predatory in ordinary markets, but will be the expected 'first mover
advantage' in the development of a tipping-prone market, when the expected result is
that the winner will get a monopoly. Essentially, firms seeking future monopoly rents
may compete them away by offering first-time below-cost discounts to early adopters.
[32]
In some cases, the propensity of a market to tip may warrant additional antitrust
vigilance. In ordinary markets, a firm may have to exert considerable effort to
appropriate market share from its competitors. If the market is subject to tipping and
characterized by network externalities, a firm’s tactic that creates what would
normally be considered a relatively small and harmless competitive advantage could
prevent competitive entry altogether. [33]
A related concern is that in a tipping-prone market, the 'right' monopoly will not
necessarily emerge to be the next industry standard. For example, standards may last
too long because of inertia as network externalities discourage users from departing
from the incumbent standard, even if the adoption of the newer standard would be
better for all concerned. Standards may also be adopted too easily if every consumer
decides to adopt because they expect other consumers to migrate, regardless of
whether the original standard objectively was the preferred standard. [34]
F. Low Barriers to Entry and Minimal Marginal Costs
The growth of electronic networks, in particular the Internet, has substantially reduced
barriers to entry and continues to reduce the costs of processing, distributing and
acquiring information through low-cost automation of these functions. The Internet
and Internet protocol extranets are being used to create highly efficient markets for a
vast array of products and services, including consumer-to-consumer auction sites
(such as those operated by eBay), business-to-consumer Internet sites (such as
Amazon.com) and sites which facilitate direct business-to-business sales of
commodities, manufactured goods and all other forms of products and services. In
addition, the principal productive resource required by information economy
companies is skilled human capital rather than the costly physical facilities and raw
materials typically required by companies operating in the industrial economy. [35]
The initial cost of creating information and information-based products is generally a
sunk cost and the marginal cost of producing additional copies of such products is
minimal. For example, much software is distributed at minimal cost and for no charge
over the Internet or licensed for relatively nominal prices using 'shareware'
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products. The cost/performance ratios of other products and services that have a
substantial information content are also continuing to fall. The falling costs of
computer processors, memory and disk drives, and telecommunications services
reflect the high percentage of low marginal cost information content incorporated in
these products and services, scale economies and the other factors discussed in this
section.
Minimal marginal costs mean that the average cost of information-based products will
fall continuously with increasing volume. Therefore, at a conceptual level, continually
declining average and marginal costs are inconsistent with the economic assumptions
underpinning the classical, micro-economic analysis upon which domestic
competition laws are based. In other words, marginal costs will not rise with
increasing quantity to intersect the demand curve at an equilibrium price and quantity.
Open access to markets through efficient electronic networks such as the Internet has
allowed both suppliers and customers to bypass more costly and constrained
traditional distribution channels. This phenomenon is perhaps best demonstrated by
the rapid development and worldwide distribution of successive generations of
software products, such as media players, document viewers and browsers using the
Internet.
Information and information-based products (such as software) are durable goods,
which may in most cases be used indefinitely without any additional costs or
expenditures. In order for a supplier to sell replacements for such products, users must
be persuaded that the new features and enhancements incorporated in the replacement
not only justify the cost of the upgrade, but are superior to other new and competitive
products. Consequently, information economy suppliers are frequently in the position
of having to compete against the prior generations of their own products, as well as
the products and upgrades offered by their competitors.
In high innovation markets, antitrust authorities must determine what barriers to entry
exist (i.e., what resources are necessary to innovate successfully, how quickly they can
be obtained and assembled, and on what terms). Careful consideration must be given
to how easy it would be for consumers to switch from the products of the merging
parties to those of new entrants. It may be, for example, that network effects, when
combined with significant switching costs, act as powerful barriers to entry to new
competitors. On the other hand, it may be that the resources needed to successfully
innovate can be obtained quickly by hiring away qualified staff from other firms. [36]
Further, when assessing market power in the information economy, an important
distinction must be drawn between the barriers to entry created by unique physical
facilities and those which have been created by a widespread consumer preference for
or acceptance of a particular product or service offering. While the former may give
rise to circumstances in which market power is being exercised inappropriately and
intervention is required, the latter should not be viewed as a source of market power,
insofar as consumers were free to purchase an alternative product at the time of the
original acquisition and are generally free to switch, and in practice will switch, to a
superior product if one is offered.
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Competition in high innovation industries typically depends upon the implementation
of ideas that have little respect for geographic borders or entrenched market
power. Therefore, competitive problems that arise in high innovation industries may
be self-correcting through the rapid and seemingly perpetual introduction of new
products, especially through 'drastic innovations'. [37]
G. Exclusion of Competitors: Vertical and Horizontal Integration
One of the most common ways that mergers in innovation·intensive markets can
exclude competitors is through vertical integration and 'gatekeeping'. Innovationintensive markets often involve complementary products in vertically-related
markets. Dominant companies in one particular market may seek to merge with a
company operating in a vertically-related market. The merged entity may be in a
position to exploit complementarities between its own portfolio of products in order to
foreclose the downstream market to other players. This will have a particularly
significant effect where competition is for the market and may cause the market to 'tip'
towards a firm that would not otherwise have gained a position of dominance. [38]
Gatekeeper effects and foreclosure in high innovation markets have been a major
source of concern for the EC. [39] For instance, in the AOL/Time Warner case, the
EC was concerned that AOL, through its existing European joint venture with
Bertelsmann and its proposed merger with Time Warner (which in turn had planned to
merge its music recording and publishing activities with EMI), would have controlled
the leading source of music publishing rights in Europe. Further, the merger created
the first Internet vertically-integrated content provider, distributing Time Warner’s
branded content (music, news, films, etc.) through AOL’s network. [40] Because of
AOL’s structural and contractual links with Bertelsmann, the EC determined that the
merged entity would have preferred access to Bertelsmann’s large library of
music. Therefore, by having de facto control over the leading source of music
publishing rights in Europe in connection with its ubiquitous network, the merged
entity could become the dominant player in the market for Internet on·line music
delivery, effectively becoming the ‘gatekeeper’ and dictating the conditions for the
distribution of music audio files over the Internet. A further concern was that the
merged entity may be able to format Time Warner’s and Bertelsmann’s music such
that it would be compatible with only AOL’s music player (Winamp), and not
competing music players. (Winamp, however, would still have the ability to play the
music of competing record companies using non-proprietary formats.) [41]
Competitors may also be excluded by horizontal mergers that use the enhanced
position in the primary market to foreclose vertically·related markets. For example,
Vivendi’s proposed acquisition of an interest in satellite pay-TV broadcaster BSkyB
contemplated the merger of their two different conditional access technologies (SECA
and NDS, respectively), which together would have accounted for more than 60 per
cent of all pay-TV subscribers within the European Union. [42] Another example of
foreclosure by horizontal integration is the prohibited MCI WorldCom/Sprint merger
involving the combination of two operators’ networks. The EC’s investigation
concluded that, through the combination of the two networks and customer bases, the
merger would have led to the creation of a 'company of such absolute and relative size
compared to its competitors that both competitors and customers would have been
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dependent on the new company for universal Internet connectivity'. As a result, the
merged entity would have been in a position to behave independently (in respect of
both its competitors and customers), control technical developments, raise prices and
discipline the market by selective degradation of its interconnections with
competitors. [43]
H. Complementarity
Complementarity (or compatibility) among components is crucial in high innovation
economies such as the computer industry. As discussed above, computer operating
systems and applications software that are compatible with each other form a 'virtual
network', exhibiting increasing value per unit sold as total sales of compatible goods
increase. [44] One of the benefits of complementarity is the standardization and
interoperability among components, known as an 'open systems architecture.' A good
example is the Intel/Windows PC structure, where many brands of computers conform
to the same technical standards and can utilize the same operating system. Once an
operating system is functional, users can take advantage of a variety of applications
that are compatible with that operating system, thereby reaping the benefits of
complementarity.
From the point of view of a high innovation firm, complementarity and compatibility
can cut both ways. On the one hand, a firm can benefit from the externality of the total
sales of all compatible firms. On the other hand, compatibility implies more similar
products, and therefore more intense competition among the firms that produce
compatible products. (To avoid the more intense competition, a firm may want to be
incompatible with others.) As a result, it is society that reaps the benefits from the
increased competition in an environment of compatibility, and not the firms. [45]
I. Role of Standards and Open Specifications
Competition in information economy markets frequently revolves around the
development of a popular specification or standard, whether developed as a de facto
standard by industry or as de jure standard by government. As is particularly apparent
for the Internet, minimal marginal costs and the desire of many companies to establish
their new products or services as a virtual network standard have led to a veritable
explosion in the range of products and services which are offered at no charge over the
Internet.
The acceptance of standards reflects certain product characteristics that competitors
are willing to agree on for their mutual benefit of growing the size of the
market. Characteristics which are not the subject of standardization are used by
companies to differentiate their products and provide the basis for competition. [46]
The success of open specifications and standards, such as those underlying the global
telephone and fax systems, the Internet and the IBM-compatible personal computer,
have clearly demonstrated the positive network externalities that result from open
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access to specifications and networks, as well as the development of fully compatible
and interoperable products. Increasing recognition of the economic value of ubiquity
and the minimal marginal cost of reproducing information-based products are
increasingly leading customers to further demand, and suppliers to provide, products
that comply with clearly documented specifications and standards. Another result is
the formation of industry coalitions and joint ventures to develop and support open
standards in order to facilitate the development of larger interdependent networks and
markets for new types of interoperable and compatible products. The adoption of
industry standards provides manufacturers with some measure of assurance that
compatible new products will find a ready market. Firms have no doubt also noted
that delays in the development of a consensus regarding the technical specifications of
a new type of product or service may impede or block the introduction of that product
or service. [47]
Standard-setting has the potential to create market power and enhance the market
value of a technology by reducing or eliminating the selection of close
substitutes. Firms may seek to make their technologies the standard of choice by
participating in 'competitions' (whether in the market (de facto) or before standardsetting bodies (de jure)). [48]
Ernest Gellhorn notes that, on the one hand, standard-setting can be an efficiencyenhancing tool and can support innovation and market competition by providing an
agreed-upon 'base' for further product development and ensuring product quality,
increasing output, fostering innovation and reducing prices. On the other hand, if
misused, standard-setting can block entry and increase costs by excluding new
innovative products and services, especially if such standards are incorporated in
governmental codes. [49] While express standard·setting agreements among
competitors may occur, abuse of the standard-setting process can be more subtle;
achieved through nonpublic cooperation/coordination among incumbent producers
(for example, through their trade associations). [50] Therefore, Donald Deutsche of
Oracle Corporation recommends that, in order to achieve broad acceptance of
standards and the resulting largest possible market, it is important to include all
stakeholders (large and small and from all technical/philosophical camps) in the
standards development process. As history has repeatedly shown, attempts to seek
competitive advantage through standardization by precluding major stake holders
result in failure – the ignored constituency can merely initiate a competing standards
effort that confuses the market and ensures that there is more than one 'standard'
option. [51]
5.Market Definition and Market Power
While market definition and market power must remain pillars of antitrust analysis,
caution needs to be exercised to ensure that the unique characteristics of high
innovation markets are reflected in the market definition analysis and, hence, the
resultant determination of market power. While antitrust authorities may rely upon
traditional product and service market definitions for certain sectors of the information
economy, more 'elusive' technology sectors may demand a more creative approach.
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It would appear that the various sectors of the information economy can be described
by three possible types of market definitions: (1) traditional product (goods) and
services markets; (2) technology or IP markets; and (3) innovation markets. Indeed,
the joint DOJ and FTC 1995 Antitrust Guidelines for the Licensing of Intellectual
Property (the 'US IP Guidelines') address each of these three types of markets as they
may relate to IP licensing arrangements:
If an arrangement may adversely affect competition to develop new or improved
goods or processes, the Agencies will analyze such an impact either as a separate
competitive effect in relevant goods or technology markets, or as a competitive effect
in a separate innovation market. [52] [Emphasis added]
A. Traditional Product and Service Markets
Product and service markets are the markets with which antitrust has been
traditionally concerned; they include such readily identifiable markets as
pharmaceuticals, hardware, software, computer chips, telecommunications services,
Internet services or computer services.
An example of the application of the product and service markets is the market for 'the
provision of universal Internet connectivity', which was first defined in the EC’s
review of the 1998 WorldCom/MCI merger. There, the EC found that the merged
entity’s network would have created a dominant position in this market. When the
merging parties notified their subsequent merger with Sprint in 2000, they argued that
recent changes in the European wholesale Internet market negated any new claims of
dominant position. These changes included the liberalization of the EC
telecommunications markets (and the resulting increase in the number of European
ISPs and content providers), content delivery techniques controlling the flow of
Internet traffic, and lowered leased line prices. As a result of these technological
developments, the parties argued that the Internet could no longer be considered
hierarchical in nature and that European ISPs were no longer dependent on the largest
Internet connectivity providers to obtain global connectivity. The EC’s investigation
concluded, however, that none of the above factors had had any significant impact on
the structure of the market - even the largest European Internet connectivity providers
were still dependent on the top-level global connectivity providers and lacked the
ability to impose any competitive constraints on these providers. [53]
In high innovation product and service markets, pre- and post-merger concentration
levels may not always serve as useful indicators of a transaction’s possible effects on
competition as they will only be able to capture static effects. For example, in
biotechnology, pharmaceutical or next generation aerospace cases where the product
has yet to reach the market, market share information will be of little relevance and
use. Faced with an absence of proper concentration information, the FTC has stated
that it may look at other factors, such as the merging companies’ investment levels,
R&D progress, experience in previous generation products, and success in related
markets. [54] Situations such as these have led authorities to adopt technology or
innovation markets where competition is for the market rather than in the market, and
market share data and concentration levels may not provide an accurate picture of
actual market power. [55] Firms may offer temporarily low prices and incur nominal
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profits or even losses in an attempt to acquire the whole market and enjoy the allimportant 'first mover advantages'. Under these circumstances, the application of a
standard market definition approach may result in a misleadingly narrow market.
While market power is normally attributed to market concentration and barriers to
entry, market power in the information economy depends on other unique factors,
including the intensity of network effects, the size of the installed base, users’
switching costs, and the degree and ease of compatibility granted to competitors and
their products. [56]
In some high-tech industries, network effects can make competition between different
systems/networks fierce in a dynamic sense. As Stenborg argues, signs of relaxed
competition using static measures (e.g., high concentration ratio, high price-cost
margin, etc.) may in fact conceal vigorous competition in the dynamic sense. Further,
conclusions drawn from static measures such as market share may result in a distorted
conclusion of strong market power, even though dynamic competition is healthy and
may ultimately control static market power. Indeed, the expectation of significant
market power for some period of time is a necessary condition for dynamic
competition. Under conditions of healthy dynamic competition, the existence of shortrun market power is not a matter for concern. Instead it is a consequence of
information economy characteristics such as network effects. [57] Accordingly,
equating high market share with dominance can be potentially dangerous to
innovation. [58] In this regard, the minimum antitrust authorities should be concerned
with is the possibility of entry and other potential competition. [59]
Determining market shares was a challenge in the 1998 investigations of the U.S. DOJ
and the EC of MCI/WorldCom because, at that time, there was no
commonly·accepted method upon which to rely. The DOJ and EC examined market
shares using a variety of methods, including: (1) shares of overall Internet industry
revenues generated by ISPs connected to a specific backbone; (2) percentage of ISPs
connected to a specific backbone versus the total number of ISPs connected to all of
the backbones combined; (3) the volume of Internet traffic originating, terminating or
transmitting on a backbone’s network; (4) the number and type of Internet points of
presence (POPs) on a backbone’s network; (5) the number of circuits connecting
customers to a backbone; (6) the density of a provider’s network and web of
customers; and, finally, (7) the number, type and significance of each network’s
customers. However, under any of the foregoing measures of market share (none of
which was ideal), it was determined that MCI/WorldCom would be the dominant
player and substantially larger than any other player. [60]
A further challenge faced by antitrust authorities is that market definition can be
guided by the characteristics of future products that are at an advanced stage of
development. [61] Therefore, market power not only refers to a strong position in
today’s market, but also to strength in a future market characterized by present 'first
mover' advantages and network externalities. [62] This results in current market
power being maintained, rather than being transient. The existence of these dynamic
effects makes it difficult to formulate a proper method to ascertain acceptable pre- and
post-merger market shares. [63] In other words, a currently high market share is not
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necessarily indicative of the presence of market power today and a currently low
market share may change to market power in the near future.
In the BSkyB/Hilton Group merger, the difficulties associated with relying on premerger market shares were described in the Director General’s advice to the Secretary
of State for Trade and Industry:
Given that iDTV betting is a new and evolving market segment, market share figures
are not reliable and it is more difficult to determine the likely effects of the JV than
with a merger in a more mature market. [64]
Faced with these difficulties, antitrust authorities have turned to more 'innovative'
methods of defining elusive and ephemeral high tech markets.
B. Technology or IP Markets
Some jurisdictions, including the U.S., EU and Canada, have introduced the concept
of 'technology' or 'IP' markets, i.e., markets in which companies compete in the
licensing of intellectual property, have been introduced by many antitrust
authorities. For example, the U.S. FTC and DOJ will analyze the competitive effects
in technology markets when rights to intellectual property are marketed separately
from the products in which they are used. [65]
In the Draft EC Guidelines on the application of Article 81 of the EC Treaty to
technology transfer agreements [66] (the 'Draft EC Technology Guidelines'), the EC
describes the use of a separate 'technology market':
Technology is an input, which is either integrated into a product or a production
process. Technology licensing can therefore affect competition both in input markets
and in output markets. An agreement between two parties which sell competing
products and which cross licence technologies used for the production of these
products may restrict competition on the product market concerned. It may also
restrict competition on the market for technology and possibly also on other input
markets. For the purposes of assessing the competitive effects of licence agreements it
may therefore be necessary to define relevant goods and service markets (product
markets) as well as technology markets. [67]
Under this approach, technology markets consist of the licensed technology and its
substitutes, i.e., other technologies customers could use as substitutes. Technology
markets can be defined using the same principles as used for product markets. In other
words, starting from the relevant technology, identify those other technologies to
which customers could switch in response to a small but permanent increase in
relative prices, i.e. the royalties. [68] Alternatively, the market for products
incorporating the licensed technology may be used.
The Canadian Intellectual Property Enforcement Guidelines (the 'Canadian IP
Guidelines'), which use the 'IP market', expands on the EC’s approach. They provide
that the relevant market may be defined based on: (a) the intangible knowledge or
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know-how that constitutes the IP; (b) processes that are based on the IP rights; or (c)
the final or intermediate goods resulting from, or incorporating, the IP. [69] This
means that markets are not defined based on R&D activity or innovation efforts alone,
but also the effects on price or output.
In order to violate the Canadian Competition Act, a firm must engage in anticompetitive conduct that 'creates, enhances or maintains market power', i.e., the ability
to price independently of market forces. [70] This suggests that antitrust intervention
should occur only where market power has been created, enhanced or maintained as a
result of an arrangement between independent entities (whether in the form of a
transfer, licensing arrangement or agreement to use or enforce IP rights), and not just
from the mere exercise of an owner’s IP right. Under this principle, antitrust
authorities would only intervene where an IP owner licenses, transfers or sells the IP
to a firm (or a group of firms) that are (or would have been) actual or potential
competitors without such an arrangement. [71]
An example of a U.S. case involving technology markets was the proposed joint
venture of Montedison and Royal Dutch Shell. [72] There, the FTC was concerned
that the joint venture would lessen competition in the licensing of polypropylene and
polypropylene catalyst technologies. On a product market basis, the combined market
share of the two firms for polypropylene production was relatively modest. However,
the technologies controlled by the firms represented over 80% of production capacity
pursuant to technology licence. [73]
Another example is Dow Chemical Company’s acquisition of Union Carbide. [74] In
this case, the FTC required Dow to divest and license intellectual property for the
production of polyethylene to BP Amoco, its former partner in developing the
technology. The FTC alleged that the merging firms’ control over polyethylene
production technology would lead to anti-competitive effects, both in the licensing of
the technology and the market for polyethylene, as the two firms would control over
almost all commercialized catalyst technology.
Calculation of IP market shares and market power incorporates many of the principles
used in traditional product and goods markets. In Canada, market power is established
in the context of many factors relevant to an innovation-intensive market, including
the level of concentration, the existence of effective substitutes for the IP in question,
barriers to entry, the rate of technological change and the ability of competitors to
enter into the market by 'innovating around' or 'leap-frogging over' incumbent and
dominant technologies. [75] Often, conditions of entry will be more important than
market concentration. In other words, a high degree of market concentration is not
sufficient to justify a conclusion that the transaction or conduct will create, enhance or
maintain market power.
The Draft EC Technology Guidelines suggest that there are two methods to calculate
market shares in case of technology markets: (1) on the basis of each technology’s
share of total licensing income from royalties, representing a technology’s share of the
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market where competing technologies are licensed; or (2) on the basis of sales of
products incorporating the licensed technology on downstream product markets. [76]
C. Innovation Markets
1. Innovation Markets Defined
In simple terms, innovation markets are markets in which firms compete in research
and development. The 'innovation market' approach to antitrust analysis, which was
first introduced by Gilbert and Sunshine [77] , attempts to introduce dynamic
efficiency considerations into merger enforcement, recognize the importance of
innovation as a means of non-price competition and a source of welfare gains, and
prevent mergers that would reduce competition in innovation.
Gilbert and Sunshine believe the innovation market is necessary because a merger that
reduces the level of competition in innovation will harm consumers through adverse
changes to prices, product characteristics and the rate of new product introductions in
downstream product markets. However, since innovation is hard to quantify, the
innovation market approach focuses on the level of R&D expenditures, the primary
innovation-creating activity of modern firms. [78] Therefore, under this approach,
reductions in R&D expenditure are treated as an expression of market power. [79]
Many antitrust authorities believe that the innovation market approach is wellgrounded in economic theory and that traditional antitrust analysis cannot adequately
address anticompetitive effects of mergers on the incentive to innovate, particularly
where there is no existing market. [80]
The 'innovation market' concept has been adopted in the US IP Guidelines, which
define an innovation market as follows:
An innovation market consists of the research and development directed to particular
new or improved goods or processes, and the close substitutes for that research and
development. The close substitutes are research and development efforts,
technologies, and goods that significantly constrain the exercise of market power with
respect to the relevant research and development, for example, by limiting the ability
and incentive of a hypothetical monopolist to retard the pace of research and
development. The Agencies will delineate an innovation market only when the
capabilities to engage in the relevant research and development can be associated with
specialized assets or characteristics of specific firms. [81] [Emphasis added]
The Guidelines further explain:
A licensing arrangement may have competitive effects on innovation that cannot be
adequately addressed through the analysis of goods or technology markets. For
example, the arrangement may affect the development of goods that do not yet exist.
Alternatively, the arrangement may affect the development of new or improved goods
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or processes in geographic markets where there is no actual or likely potential
competition in the relevant goods. [82]
The application of the U.S. innovation market approach is limited to merger cases
where specialized 'innovation assets' or capabilities can be identified. Under this
approach, antitrust authorities must be able to identify 'markets in which R&D [is]
directed toward particular new products or processes [that] require specific assets that
are possessed by identified firms.' [83] Such specialized assets most often include
physical assets, experience, production capability, and intellectual property.
In EU case law, the innovation market idea has not been used; rather, the effects on
innovation are analyzed in an ad hoc manner, often using the notion of potential
competition. [84] In the Draft EC Technology Guidelines, the EC states that it will
attempt to confine itself to examining the impact of technology transfer agreements on
competition within existing product and technology markets. It notes that only in a
limited number of cases would it be useful and necessary to define and use innovation
markets. Such cases may include where an agreement affects innovation aiming at
creating new products and where it is possible at an early stage to identify R&D
poles. In these cases, it can be analyzed whether, after the agreement, there will be a
sufficient number of competing R&D poles left for effective competition in
innovation to be maintained. [85]
2. Criticisms of the Innovation Market Analysis
Beyond the expected additional cost of enforcement both to antitrust authorities and to
merging firms in R&D-based industries, there is a considerable body of criticism as to
why the innovation market concept is not workable. [86] The discussion below
summarizes some of these criticisms.
(a) The state of knowledge regarding innovation is insufficient to permit the
assessment of the innovation effects of mergers. - R&D competition is generally more
complicated than price competition, and the incentives, path of progress and outcomes
are much harder to predict. Rapp states that the basic problem is a lack of means for
judging whether innovation is harmed or served by a merger when there are as yet no
products to evaluate: 'The more removed the R&D projects in question are from
issuing commercially viable products or processes, the less predictable and more
fragile is their state. Just where the innovation market approach is most apt, it is most
dangerous.' [87]
(b) The connection between concentration and output on innovation market is
problematic - Innovation market theory is based on the beliefs that (1) an increase in
R&D concentration is likely to reduce the level of R&D undertaken and (2) a
reduction in the level of R&D is likely to diminish innovation. However, Rapp
believes that there is little basis in fact or theory for these beliefs. While it may be
accepted that smaller firms in unconcentrated markets which do not have the
economies of scale to support R&D efforts may not engage in R&D, a monopolist will
generally have less incentive than a new entrant to engage in R&D that may lead to a
substitute for an existing product or that may lower the cost of producing an existing
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product. This is because such R&D efforts may cannibalize the monopolist’s supracompetitive rents and make its current sunk investments obsolete. [88]
Several studies have attempted to find statistical relationships between firm size or
market concentration and various measures relating to R&D and innovation (e.g.,
R&D expenditure, R&D productivity, patent counts and counts of significant
innovations). However, the conclusions appear to be that there is no correlation
between the number of firms engaging in related R&D projects and the level of total
R&D or innovation activity in the market. [89] Further, there are many historical
business examples of large firms with significant R&D 'assets' losing the competitive
race for innovation to much smaller firms with limited R&D resources. [90]
(c) R&D expenditure is not a suitable proxy for innovation - Innovation is intangible,
uncertain, unmeasurable and often even unobservable, except perhaps in
retrospect. There are no market transactions in innovation, only in the inputs - the
labor of scientists, engineers and entrepreneurs and the capital to build research
facilities and to fund R&D in advance of returns - and the outputs - technology and
products. Thus, R&D expenditure is an input to the process of innovation. [91] To
measure market shares in terms of R&D expenditures or R&D capacity requires an
assumption that innovation and R&D are indeed the same thing and that there is a
positive functional relationship between the rate of R&D expenditure (or the amount
of R&D capacity) and the quantum of innovation produced by a firm. [92]
Rapp argues that the level of R&D expenditure is a poor proxy for the level of
innovation at the market level; there are several market factors that influence a firm’s
R&D expenditures, including diminishing returns to R&D investment, the opportunity
cost of funds and expectations about the appropriability of the gain. Even if one could
predict with confidence that a merger would lead to a reduction in R&D expenditure,
there is no principled basis for saying whether this is good or bad for competition and
innovation [93] Rapp concludes that, since there is no principled way to distinguish
good cutbacks in R&D from bad ones, an innovation market approach, even
performed on a case-by-case basis, would be a mistake. [94]
(d) The capacity to innovate is hard to monopolize - There is little in the history of
modern technology to suggest that firms are able to monopolize innovative
capacity. Although patented technology can be monopolized, the normal inputs to
R&D - research scientists, engineers, software developers, laboratories, computer
centres, etc. – may be acquired by competitors. If the main inputs to innovation are
continually on the market for sale, there is no opportunity to corner the market for
innovation. [95]
3. Product and technology markets are sufficient to address all significant competitive
harm
The general consensus appears to be that there are, in fact, very few cases in which the
innovation market approach should be used. First, cases where there is a clear
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competitive overlap between the merging firms at the product market level, the
innovation market analysis can presumably be dealt with using a traditional product
market analysis. Second, for cases where one or the other firm is a potential entrant
into the product market of the other (with both entrant and incumbent engaging in
R&D), traditional 'potential competition' analysis will generally suffice. Presumably,
firms that are engaged in overlapping R&D projects can threaten to enter the product
markets in the overlapping areas of R&D. In other words, R&D makes one or both
firms either potential competitors or entrants in conventional product markets. Since
the release of the US IP Guidelines, the FTC has brought complaints against several
additional mergers on the grounds that innovation markets would be harmed and has
obtained relief either in divestiture or compulsory licensing. However, many,
including the US FTC, believe that, given the nature of the direct product market
competition in these cases, the enforcement actions employing the 'innovation market'
concept could have legitimately been brought using the traditional analytical tools
such as potential competition theory, without resort to innovation market theory. [96]
Perhaps the only situation that warrants the innovation market approach is where no
products have emerged and the only competition subject to analysis is R&D
competition. Because there are as yet no actual downstream products, the assessment
of the anti-competitive effects must be based upon a determination of whether the
combination will advance or retard technical progress. [97]
An example of properly-used 'innovation markets' is the U.S. FTC’s review of
American Home Product’s 1994 acquisition of American Cyanamid. [98] In this case,
the FTC was required to allege that competition in the market for the R&D of a
Rotavirus vaccine would be harmed since neither of the merging firms manufactured a
Rotavirus vaccine at the time of the merger. Since the product market was nonexistent, no argument for potential competition could be made.
The innovation market approach attempts to capture the principles of product market
analysis but, in doing so, misses the mark. We note that in product markets, the
optimal product price is based on marginal cost and any increase in price away from
this benchmark will be bad for consumers. On the other hand, in innovation markets,
the optimal level of R&D is unknown. Moreover, it is impossible to predict the effect
of a change in the structure of an innovation market on the level of R&D activity. [99]
6. Do We Need a Whole New Set of Rules?
Many of the jurisdictions participating in the OECD Roundtable, including the EC,
the UK, Australia, the Netherlands, Japan and Korea, suggested that the traditional
competition law principles can be applied to high innovation industries and there is no
need to adopt or develop a new set of principles or analyses. For example, the EC
considers that the general nature of its merger rules when applied to the factual
circumstances of a particular case allows the rules to keep pace with technological
developments in a way that more specific regulatory frameworks cannot, regardless of
how quickly industries develop or change. [100] ) The UK’s non-statutory merger
guidelines do not refer to specific arrangements, approaches or checklists to deal with
mergers in high innovation markets. [101] In the UK’s view, it would be difficult and
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confusing to have different and rigid approaches to merger review, i.e., one for static
industries and one for innovative industries.
The Netherlands Competition Authority does not favour a modified approach to hightech mergers because it is difficult to define the situations under which such an
approach would be apply – the following significant obstacles would have to be
overcome: (1) the criteria to be applied would have to be clear and transparent; (2) the
situations and relevant markets to which they apply would have to be determined; and
(3) given that every transaction is different, one would have to decide if a specific deal
qualifies according to the specified criteria. [102]
The overly ambitious application of competition law can deter socially desirable
investments in innovation and technology transfers; therefore it is important that
antitrust agencies understand the likely impact of their enforcement efforts on
innovation markets. As stated above, where innovation is a key determinant of
competition, it should not be inadvertently impeded by the intervention and
enforcement actions of antitrust authorities. In other words, competition policy should
be used to promote, not hinder innovation. As U.S. Federal Reserve Chairman, Alan
Greenspan, was quoted in a 17 June 1998 article in the Wall Street Journal, 'I would
feel very uncomfortable if we inhibited various different types of mergers or
acquisitions on the basis of some presumed projection as to how markets would
evolve.' Mr. Greenspan went on to state that, particularly in technology industries,
'history is strewn with people making projections that have turned out to be grossly
inaccurate.' Therefore, as noted by many of the countries in the OECD Roundtable, a
somewhat customized approach is needed in high innovation markets, requiring a case
by case approach, with due consideration to standard concentration measures and
barriers to entry.
Given the inherent uncertainties in predicting how a market is going to evolve,
remedies for mergers in innovation·intensive industries can be particularly difficult to
design and the precise effect the remedy is largely uncertain. [103] Appropriate
remedies in high innovation markets should therefore be customized to consider the
specific nature of the markets concerned. An example of a custom-made remedy can
be found in the EC’s review of the Vodafone/Mannersmann case, where the
Commission was faced with the problems associated with the creation of a seamless
pan-European mobile telecommunications service market and the markets for panEuropean wholesale roaming. These concerns were addressed by undertakings
provided by the merged entity designed to give other mobile operators the possibility
of providing their services using the integrated network of Vodafone
Airtouch/Mannesmann. [104] This remedy is particularly interesting because due to
anticipated developments in the sector, it was limited to a period of three years. This
case illustrates that antitrust authorities do not have to accept situations of temporary
market power and they can respond with temporary remedies.
One possible remedy to a 'network monopoly' is to break up the network. However,
this is a drastic measure that may not be feasible and may result in substantial injury to
consumer welfare. [105] Another remedy is to mandate the network operator to
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provide access to the network for all qualified suppliers, customers and competitors on
fair, reasonable and non-discriminatory terms (as has been imposed on 'bottleneck
monopolies' such as local telecommunications facilities or cable televisions highspeed Internet network). [106] However, there is still a need for antitrust enforcers to
proceed cautiously in breaking up or mandating access to an existing network, even
when that network is dominant, until the origins and significance of network
efficiencies are clearly understood. Rather, antitrust authorities should concentrate on
their traditional role of ensuring that network monopolies are achieved through
legitimate competitive conduct and that network dominance is maintained only
through superior skill, foresight and industry, and not by unnecessarily exclusionary
conduct. [107]
To minimize any adverse effects on innovation, the focus of antitrust remedies should,
where appropriate, shift from structural correction to behavioural correction and
monitoring. In its submission to the OECD Roundtable, Brazil indicated its preference
to use time-limited 'contingent' remedies: 'In general, due to the monitoring costs
incurred in the enforcement of behavioural remedies, antitrust agencies favour
structural ones. However, innovative markets are a dangerous terrain to keep
allegiance to traditional practices, because the changing nature of technology can
easily overcome any apparent market power arising in the short run.' [108] In Canada
in circumstances where the potential efficiencies and anti-competitive effects of a
merger are very difficult to ascertain and weight, a merger may be assessed ex-post
using behavioural monitoring, coupled with a specific right of the competition
authority to take further action (including ordering divestiture) should anticompetitive effects appear in future. In the appropriate circumstances, this is
preferable to taking immediate and drastic action that may have the effect of inhibiting
innovation and market growth.
In summary, while the authors of this paper take the view that the principles of
traditional antitrust and competition law may be applied to high innovation markets,
they must be informed by, and customized to take into account, the realities and
sensitivities of these markets. Accordingly, it is suggested that antitrust authorities
apply the following principles when dealing with high innovation markets. In doing
so, they should be guided by the following two questions. First, are the resources
being applied to protect the process of competition or a particular
competitor/complainant? Second, is the application of enforcement resources in the
particular instance truly in the interests of consumers? [109]
(a) When deciding whether innovation competition will be harmed, the authorities
must first understand the market-specific, firm-specific facts about innovation. The
drivers of innovation must be identified, whether they are participants, customers,
component suppliers, collaborators or independent R&D entities. Further, the nature
of the current market players must be understood and whether they are 'leaders' or
'followers' in innovation. [110]
(b) Antitrust enforcement should be careful to avoid deterring research or innovative
activities by inappropriately interfering with IP rights.
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(c) Antitrust authorities must determine if a merger will affect incentives to perform
R&D, if overall R&D spending will decrease, and whether the merger will affect the
diversity of likely innovations.
(d) The authorities must be cognizant of the rapid rate of innovation and technological
change which is resulting in competitors entering areas in which they did not
previously compete, and leading to the development of new systems and markets
which are competing with and displacing existing market leaders, entire markets or
technologies. [111] Since antitrust considers predictions of future effects, the more
uncertain the future is, the greater the need for caution rather than
intervention. Similarly, the more dynamic the market, the more certainty should be
required before intervention. [112]
(e) Antitrust analysis has traditionally focussed on high market shares in the context of
'perfect competition' featuring a large number of relatively small firms. Static,
perfectly competitive market structure cannot persist in many information
industries. The promotion of innovation and the resulting long-term dynamic
efficiency benefits should be favoured over static efficiency goals and short-term
market effects.
(f) Consumers should not be prevented from enjoying the benefits of the network
externalities resulting from the widespread consumer adoption of common systems
and standards even though this may result in universal acceptance of a single product
and potentially market dominance). [113]
(g) Where network externalities and the effects of 'tipping' appear to render an
industry closer to oligopoly or monopoly, the authorities must exercise caution and not
act based on imprecise or contradictory information regarding emerging technologies.
(h) The marketplace should determine which new features and products should be
introduced to the marketplace. Similarly, the marketplace should determine which
standards succeed and whether open standards are to achieve widespread acceptance.
[114] As the focus of competition will shift from competition among existing
products to competition to develop new systems and standards which are of value to
consumers, consumers should not be prevented from enjoying the benefits of
competition between competing systems and standards and competitors should not be
protected from the adverse consequences of consumer decisions to adopt competing
systems and standards. [115]
(i) The authorities must take into account, where applicable, the low barriers to entry
associated with the intangible nature of the underlying products, the almost costless
deliveries of products and services over the Internet and the absence of any physical
restraints or constraints on the ability of competitors to quickly duplicate and deliver
competing products.
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(j) The authorities must be wary of the gate-keeping effects of vertical integration and
foreclosure.
(k) The concept of innovation markets should be used sparingly and not where
traditional concepts of product markets, IP markets and potential competition can be
applied.
Finally, as a passing thought, we draw attention to the borderless features of
technology and global networks, as well national protection of IP rights and
technology licences, requires caution and co-operation. The globalization of markets
and the movement of commerce into cyberspace may be expected to increase the
occurrence of extra-territorial anti-competitive conduct that adversely affects the
domestic markets of other countries. Any attempts to constrain such conduct become
difficult where IP rights and related technologies are licensed from abroad and are
subject to the laws of the foreign jurisdiction. Interjurisdictional issues relating to
inter-agency cooperation, the exchange of confidential information and the
requirement that national agencies work together in a spirit of positive comity must be
addressed more frequently and expanded to high-tech industries subject to IP
licensing. [116]
7. Conclusion
The appropriate application of competition law in high innovation markets requires
that antitrust authorities understand the characteristics of these markets and the
rationale for and economic implications of the particular conduct or transaction under
consideration. The movement toward IP and information as a source of value, network
effects and the other characteristics of the information economy, require that antitrust
authorities focus on dynamic change and long-term increases in efficiency rather than
short-term static efficiency gains. The rapid rate of change in such markets and the
inability of the authorities to assess or predict the likely market impact of new
inventions strongly suggests that they should err on the side of caution in order to
avoid unnecessarily generating high cost errors which, in the end, could do more harm
to competition in the marketplace by pre-empting innovation and the development of
standardized products which would be of great value to consumers. [117] If antitrust
authorities move too quickly without a full appreciation of the potential future
consequences of any challenge, be it to a merger or other non-criminal conduct, there
can be a chilling effect on the market, which can lead to significantly less investment,
innovation and growth and a very real loss of potential benefits to consumers. It can
also cause potential entrants to be wary of investing in the market, unless and until the
uncertainty is corrected.
Notes and References
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[1] The resultant issue paper, 'Merger Review Emerging High Innovation Markets',
DAFFE (2002) 20 ('OECD Innovation Paper'), was published on January 24, 2003 and
is available at:
<http://www.olis.oecd.org/olis/2002doc.nsf/0/46a9379605013b67c1256cb80048067f/
$FILE/JT00138124.PDF>.
[2] Allocative efficiency is achieved when suppliers are selling products at a price that
is equal to the marginal cost of those products. Micro-economic theory predicts, in a
competitive market in which numerous small suppliers are competing to sell a scarce
but undifferentiated product to a large number of well-informed customers, that the
market will converge at a price equal to marginal cost. By way of contrast, a
monopolist will increase the price charged until the marginal revenue equals the
marginal cost, thereby capturing the maximum amount of monopoly rents and,
incidentally, creating dead weight losses due to the fact that certain consumers have
purchased less appropriate alternatives or foregone consumption due to the
unnecessarily high prices.
[3] Innovation increases economic activity and long-term efficiency by creating new
products and services which are superior to and/or less expensive than existing
alternatives and more efficient processes for the manufacture and/or delivery of
products and services. For example, the use of packet-switching technology such as
that employed by the Internet has facilitated the development of innumerable new
products and services and has given users access to communications services for a
small fraction of the cost associated with the use of dedicated private circuits to
perform the same function.
[4] D. Teece and M. Coleman 'The meaning of monopoly: antitrust analysis in hightechnology industries' (1998) 43:3-4 The Antitrust Bulletin ('Teece and Coleman') 801
at ·.
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[5] United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998).
[6] Id. at 948-952.
[7] R. Pitofsky, 'Antitrust Analysis in High-Tech Industries: A 19th Century
Discipline Addresses 21st Century Problems' (Prepared Remarks for the American
Bar Association, Section of Antitrust Law's Antitrust Issues in High-Tech Industries
Workshop, 26 February 1999) ('Pitofsky'), available at
< http://www.ftc.gov/speeches/pitofsky/hitch.htm>.
[8] See, for example, C. Ahlborn, D. Evans and J. Padilla, 'Competition Policy on
Internet Time: Is European Competition Law up to the Challenge?' (2001) European
Competition Law Review 5; T. Bresnahan, 'Competition, Cooperation, and Predation
in Innovative Industries' (Paper presented at 3rd Nordic Competition Policy
Conference, Stockholm, 2000); D. Evans and R. Schmalensee, 'Some Economic
Aspects of Antitrust Analysis in Dynamically Competitive Industries', NBER
Working Paper W8268 (2001).
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[9] Teece and Coleman at 845.
[10] J. M. Jacobson, Do We Need a New Economy Exception for Antitrust?' (Fall
2001) Antitrust ('Jacobson'), available at
http://www.akingump.com/docs/publication/6.pdf.
[11] See J. Schumpeter, Capitalism, Socialism, and Democracy (1942) at 81-106
(1942). See also R. T. Rapp 'The Misapplication of the Innovation Market Approach
to Merger Analysis', (1995) 64 Antitrust L.J. 19 at 22 ('Rapp'), available at
http://www.ftc.gov/opp/global/rapp2.htm.
[12] Jacobson.
[13] M. Stenborg, 'Do We Need New Competition Policy in the 'New Economy'?'
2002(2) The Finnish Economy and Society 49 at · ('Stenborg'), available at http://brieetla.org/_pdf/stenborg_fes_2002-2_pp49-60.pdf.
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[14] Jacobson.
[15] 234 F.3d at 48-50.
[16] Others however, have suggested that the problem was not really the 'new
economy' aspects of software integrations, but the per se tying rule itself. See J. M.
Jacobson & A. Qureshi, 'Did the Per Se Rule on Tying Survive Microsoft?' (14
August 2001) N.Y.L.J. at 1.
[17] OECD Innovation Paper, Contribution from the European Commission ('EC
Contribution') 161 at 161.
[18] Pitofsky.
[19] OECD Innovation Paper, Contribution from the United Kingdom ('UK
Contribution') at 128.
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[20] Id.
[21] See G. Roberts and J. Putnam, 'Allegations of Harmony Between IP and
Competition Policies: In Search of the Lost Chord' (Address to the Canadian Bar
Association Competition Law Conference, Ottawa, 1 October 1999) at 3.
[22] 'Non-drastic innovation' will simply involve a step change to permit technological
laggards to catch-up but not to overtake the incumbent technological leaders. UK
Contribution at 134.
[23] This is a different argument to the need for high profits in existing markets in
order to fund innovation.
[24] UK Contribution at 127.
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[25] J. Rohlfs, 'A Theory of Interdependent Demand for a Communications Service',
(1974) Bell Journal of Economics and Management Science 5.
[26] To expand on a few of these examples, the success of Windows-based computers
has greatly expanded the range and ability of, and continues to reduce the price of,
compatible hardware, software and services available to the owners of these
computers; the ubiquity and dominance of VHS cassette players created a massive
market for compatible media and video rentals (now being replaced by another virtual
network of DVD players); and the success of the Internet has greatly increased the
value of e-mail services, HTML pages and other Internet facilities.
[27] OECD Innovation Paper, Contribution of the United States ('US Contribution')
141 at 144-145.
[28] Id. at 145.
[29] P. Geroski, 'Competition for Markets', in Finnish Competition Authority (2002)
Workshop on Market Definition – Compilation of Papers from the 4th Nordic
Competition Policy Conference (Helsinki, Finland, 5 October 2001) at 66.
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[30] T. J. Brennan, 'Do Easy Cases Make Bad Law? Antitrust Innovations or Missed
Opportunities in United States v. Microsoft' AEI-Brookings Joint Center for
Regulatory Studies (May 2002) at 46. Also published in (2002) 69:5-6 George
Washington University Law Review ('Brennan').
[31] However, tipping may be of limited competitive significance in most cases in the
information economy as low barriers to entry, minimal marginal costs and positive
feedback effects permit a superior new product or service to rapidly displace an
inferior, incumbent product, notwithstanding the initial success and widespread
acceptance of the inferior product.
[32] Brennan at 46.
[33] Id.
[34] Id.
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[35] Studies comparing software producers to other manufacturing companies have
found that the percentage of total revenues accounted for by labour costs are
approximately five times higher for software producers than for other
manufacturers. Conversely, the cost of goods sold expressed as a percentage of total
revenues is more than three times as great for manufacturing firms as it is for software
producers.
[36] Secretariat Background Note at 27-28.
[37] See Pitofsky. For example, the acquisition by Microsoft of a 24% interest in the
UK cable operator, Telewest, involved two vertically-linked innovative sectors; the
supply of software for digital TV set boxes and the supply of cable delivery
platforms. It was not possible to assess the case by using references to 'potential'
competition, as it was uncertain as to how the industry would develop and how
exactly potential competitors would enter the market. Entry through innovation in this
quickly evolving industry could change not only with respect to the number of
competitors in the market, but with respect to the relevant market itself. Therefore, the
static idea of a 'contestable market' is not necessarily relevant nor easy to apply in
these circumstances. UK Contribution at 131.
[38] UK Contribution at 130-131.
[39] OCED Innovation Paper, Summary of the Discussion ('OECD Summary') at 170171.
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[40] EC Contribution at 164.
[41] Id.
[42] UK Contribution 131.
[43] EC Contribution at 163.
[44] N. Economides, 'Competition and Vertical Integration in the Computing Industry'
in Competition, Innovation, and the Role of Antitrust in the Digital Marketplace, J. A.
Eisenach and T. M. Lenard, eds. (Kluwer Academic Publishers, 1998) (Presented at
the conference Competition, Convergence, and the Microsoft Monopoly: The Future
of the Digital Marketplace, Progress and Freedom Foundation, 4 February 1998)
('Economides') at 2.
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[45] Id.
[46] D. Deutsch, 'Intellectual Property Strategies in Standards Activities' Remarks
before the FTC/DOJ Hearings: Competition and Intellectual Property Law and Policy
in the Knowledge-Based Economy, (18 April 2002) ('Deutsch') at 2.
[47] For example, delays in the development of widespread support for one of the
alternative specifications for digital radio and high definition television have
substantially delayed the introduction and widespread adoption of these technologies.
[48] By contrast, when the invention would dominate the alternatives in a technology
market on its own inherent merits, ratification of the market outcome by formal
standard setting is an afterthought; it changes nothing. R. Rapp and L Stiroh, 'Standard
Setting and Market Power' (FTC/DOJ Hearings: Competition and Intellectual Property
Law and Policy in the Knowledge-Based Economy, 18 April 2002) ('Rapp & Stiroh')
at 3-4.
[49] Prof. E. Gellhorn, 'Standard-Setting' (Remarks before the FTC/DOJ Hearings:
Competition and Intellectual Property Law and Policy in the Knowledge-Based
Economy, 18 April 2002) ('Gellhorn') at 1.
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[50] Id. at 2.
[51] Deutsche at 2-3.
[52] US IP Guidelines at ¶ 3.2.3.
[53] EC Contribution at 162.
[54] US Contribution at 143.
[55] UK Contribution at 129.
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[56] Stenborg at 55.
[57] Id. at 57.
[58] C. Ahlborn, D. Evans and J. Padilla, 'Competition Policy on Internet Time: Is
European Competition Law up to the Challenge?' (2001) European Law Review 5.
[59] Stenborg at 57.
[60] US Contribution at 143.
[61] EC Contribution at 163.
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[62] Id.
[63] Id.
[64] UK Contribution at 129.
[65] US IP Guidelines at ¶ 3.2.2.
[66] Available at http://www.les-ch.ch/Media/TTBE_Guidelines.pdf.
[67] Draft EU Technology Guidelines at ¶ 18.
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[68] Id. at ¶ 20.
[69] For example, a merger between two firms that individually license similar patents
to various independent firms that, in turn, use them to develop their own process
technologies may reduce competition in the relevant market for the patented knowhow if the two versions of that know-how are close substitutes for each other, if there
are no (or very few) alternatives that are close substitutes for the know-how and if
there are sufficient barriers that would prevent the development of conceptual
approaches that could replace the know-how of the merging firms. This last condition
may hold if the scope of the patents protecting the merging firms’ know-how is
sufficiently broad to prevent others from 'innovating around' the patented
technologies, or if the development of such know-how requires specialized knowledge
or assets that only the two merging firms possess and that potential competitors could
not develop or obtain in less than two years. Canadian IP Guidelines at 11.
[70] However, there will be no violation if market power was attained solely by
possessing a superior quality product or process, introducing an innovative business
practice or other reasons for exceptional performance. Canadian IP Guidelines at 12.
[71] For example, the Canadian Competition Tribunal has held that the mere exercise
of the IP right to refuse to license was not an anti-competitive act: competitive harm
must stem from something more than just the mere refusal to license. However,
conduct that goes beyond the unilateral refusal to grant access to the IP could warrant
enforcement action. For instance, if a firm acquires market power by systematically
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purchasing a controlling collection of IP rights and then refuses to license the rights to
others, thereby substantially lessening or preventing competition in markets associated
with the IP rights, the Competition Bureau could view the acquisition of such rights as
anti-competitive. Canadian IP Guidelines at 7.
[72] Montedison S.p.A., 119 F.T.C. 676 (1995).
[73] M. H. Morse, 'The Limits of Innovation Markets', (Spring 2001) Antitrust &
Intellectual Property Newsletter at 22 ('Morse'), reprinted at
<www.dbr.com/file/Morse_Limits_Innovation2.pdf> at 4.
[74] The Dow Chemical Company and Union Carbide Corp., FTC Dkt. No. C-3999
(15 March 2001).
[75] Canadian IP Guidelines at 12.
[76] The EC considers the second approach as a good indicator of the strength of the
technology. First, it captures any potential competition from undertakings that are
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producing with their own technology and that are likely to start licensing in the event
of a small but permanent increase in the price for licenses. Secondly, even where it is
unlikely that other technology owners would start licensing, the licensor does not
necessarily have market power on the technology market even if he has a high share of
licensing income. If the downstream product market is competitive, competition at
this level may effectively constrain the licensor. An increase in royalties upstream
affects the costs of the licensee, making him less competitive, causing him to lose
sales. A technology’s market share on the product market also captures this element
and is thus normally a good indicator of licensor market power. Draft EC Technology
Guidelines at ¶ 21.
[77] R. J. Gilbert and S. C. Sunshine, 'Incorporating Dynamic Efficiency Concerns in
Merger Analysis: The Use of Innovation Markets' (1993) 63(2) Antitrust Law Journal,
569-601 ('Gilbert & Sunshine').
[78] Rapp at 20.
[79] Gilbert & Sunshine at 594-597.
[80] Morse at 6.
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[81] US IP Guidelines at section 3.2.3.
[82] Id.
[83] Gilbert & Sunshine at 596.
[84] Stenborg at 57.
[85] Draft EC Technology Guidelines at & 22.
[86] See generally Rapp and Morse. See also G. A. Hay, 'Innovations in Antitrust
Enforcement' (1995) 64 Antitrust Law Journal 71 and R. Hoerner, 'Innovation
Markets: New Wine in Old Bottles', id at 49.
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[87] Rapp at 45.
[88] Monopolists may indeed engage in incremental innovations to existing products
and processes, quickly copy innovations introduced by smaller rivals, or engage in
other defensive R&D, but are less likely to pursue 'disruptive technologies' that
threaten their products and dominance. Therefore, empirical studies show that 'drastic'
or 'paradigm-shifting' innovations are most often created by niche firms and new
entrants. See Morse at 6.
[89] Rapp at 28.
[90] R. B. Starek, III, Commissioner, Federal Trade Commission, 'Innovation Markets
in Merger Review Analysis: The FTC Perspective' (Prepared Remarks before
Continuing Legal Education Seminar, The Florida Bar, Orlando, 23 February 1996)
('Starek'), available at: <http://www.ftc.gov/speeches/starek/orlando.htm>.
[91] Rapp at 36.
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[92] Id. at 27.
[93] The evidence from financial markets is that firms often invest in projects including R&D projects - which have negative discounted cash flows, i.e.,
'losers.' One reason is imperfect foresight: managers cannot always tell beforehand
which investments will pan out and which will not. Miscalculation and dashed hopes,
however, are not the only reason for wasteful R&D investment. See Rapp at 34.
[94] Id. at 36.
[95] Gilbert & Sunshine at 570, 599.
[96] See, for example, US Contribution at 149, Morse at 8 and Rapp at 3746. Examples include: the FTC’s 1997 challenge of Ciba-Geigy’s proposed
acquisition of Sandoz, Baxter Int’l, Inc., Dkt. C-3726, 123 F.T.C. 904 (1997); Upjohn
Co., Dkt. C- 3638, 121 F.T.C. 44 (8 February 1996); the 1997 transaction between
Digital Equipment Co. and Intel and the Halliburton/Dresser merger; Glaxo plc., File
No. 951 0054 (16 March 1995); Sensormatic Electronic Corp., File No. 941 0126 (4
January 1995); Wright Medical Technology, Inc., C-3564 (23 March 1995); Boston
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Scientific Corp., File No. 951 0002 (24 February 1995) Shell-Montedison, File
No. 941 0043 (11 January 1995).
[97] Rapp at 44.
[98] American Home Products, 119 F.T.C 217 (14 February 1995)
[99] Rapp observes that an R&D project can have four different results: (1) a
paradigm-shifting blockbuster innovation that transforms whole technologies and
markets; (2) a curve-shifting innovation that saves substantial costs or creates
important new products; (3) a minor improvement over current technology; or (4) a
waste of money, none of which can be predicted with certainty. Rapp at 47.
[100] EC Contribution at 161.
[101] UK Contribution at 125.
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[102] OECD Summary at 168.
[103] UK Contribution at 134.
[104] EC Contribution at 164.
[105] Pitofsky.
[106] Id.
[107] Denial of mandatory access may encourage applicants to challenge the dominant
firm by establishing their own competitive network or joining smaller rival
networks. However, these solutions may be no longer viable where an incumbent
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network passes a 'tipping point' leading to a single dominant network. Pitofsky. In this
scenario, there will be no viable alternative networks that can be organized or joined.
[108] OECD Innovation Paper, Contribution from Brazil at 76.
[109] These points are addressed more fully in an article by William Gates, Chairman
and CEO of Microsoft, which was published in The Economist on 13 June 1998. The
detrimental effects on consumers that are likely to result from inappropriate antitrust
intervention in technology markets are also discussed in an article written by Professor
Paul Kedrosky of the University of British Columbia, which was published in the
Wall Street Journal on 10 June 1998.
[110] See US Contribution at 146.
[111] This characteristic of the information economy is demonstrated by the rapidity
with which apparently dominant software products can rise and fall in popularity as
better products are developed and quickly take their place; for example, Wang word
processing systems, Visicalc, Wordstar, dBase, Lotus 123 and earlier video game
products.
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[112] Jacobson.
[113] Lind argues in favour of adopting a 'substantial lessening of competition'
threshold for merger review in high innovation markets: '…it provides a more useful
focus than that of dominance because often markets will have a dominant firm in any
case. For many mergers in the new economy the relevant question is whether a merger
will strengthen or weaken competition in the process of determining the dominant
firm.' R. Lind, P. Muysert and M. Walker, 'Innovation and Competition Policy' (Office
of Fair Trading, Economic Discussion Paper 3: A report to the Office of Fair Trading
prepared by the Charles River Associates, March 2002) at 129.
[114] As discussed by the D.C. Circuit Court in Microsoft, any dampening of
innovation which resulted from courts overseeing product design would be at crosspurposes with antitrust law.
[115] These benefits may include below-cost pricing and other incentives offered by
competitors, each of which is seeking to have its product or system adopted as the
basis of a virtual network. The desire of suppliers to capture some of the benefit of
potential network externalities means, in many cases, that competing innovators will
in effect be 'bidding for the field' in an effort to confer network externality benefits
upon their customers and thereby ensure the success of their products. Such conduct is
not only economically rational but also inevitable and desirable in view of the
economic characteristics of the information economy.
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[116] The OECD and the International Competition Network are making considerable
efforts in these areas.
[117] This is not markedly different than the principle that antitrust authorities have
recognized over the years of applying considerable caution when deciding whether to
challenge mergers or other conduct that involves a prospective analysis of likely
effects.
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