Toward a Unified Theory of
Exclusionary Vertical
Restraints
Daniel A. Crane
University of Michigan Law School
Graciela Miralles
European University Institute
June 17, 2010
Variety of exclusionary vertical
practices
•
•
•
•
Exclusive dealing
Tying
Predatory pricing
Bundling
• Bundled discounts
• Market share
discounts
• Loyalty rebates
Our project: Both broad and narrow
• Broad: Comprehensive framework for
addressing all exclusionary vertical
restraints
• Narrow: Just exclusionary vertical
restraints.
– Not addressing collusion or exploitation
Collusion:
Agreeing with your competitor to stop
competing in order to secure a mutually
beneficial outcome, at the expense of
someone else.
Austria vs. Germany
1982 Group Stage
Exploitation:
Taking advantage of someone else's
weakness to extract an excessive
amount of surplus.
World Cup Qualifying 2001
Australia 31, American Samoa 0
Exclusion:
Disabling one's competitor from
competing by anticompetitive means.
Oh dear.
Exclusion, collusion, and
exploitation
• Different legal tests.
• Plaintiff must identify which theory it is
pursuing.
Both US and EU law lack a
consistent framework
• Three sources of confusion:
– Price vs. non-price
– Single product vs. multi-product
– Primary line vs. secondary line
US Example
• Primary line price discrimination =
predatory pricing.
• Secondary price discrimination requires no
market power, no injury to competitive
process, not even threat to competitor's
continuation in market.
US Example
• Bundled discounting:
– LePage's: don't analogize to predatory pricing;
analogize to tying and exclusive dealing.
– PeaceHealth: analogize to predatory pricing,
using discount reallocation test.
EU Example
• Delimitis: Exclusive dealing agreement
under Article 101 analyzed under a
substantial foreclosure framework.
• Michelin II: Loyalty rebates analyzed under
Article 102 form-based approach without
regard to amount of foreclosure or general
effects on the market.
Comprehensive two-part test,
regardless of form of restraint
• Foreclosure
• Substantial
Foreclosure
• “[V]irtually every contract to buy
‘forecloses’ or ‘excludes’ alternative sellers
from some portion of the market, namely
the portion consisting of what was bought.”
-Judge (now Justice) Stephen Breyer, Barry
Wright v. ITT Grinnell (1983).
• Too broad; foreclosure becomes a useless
category.
Our test
• A restraint "forecloses" if it denies equally
efficient rivals a reasonable sales
opportunity.
• Different applications depending on kind of
restraint, but all answering same ultimate
question.
Example: Exclusive dealing
• Exclusive dealing may not foreclose if rival
could reasonably offer its own competitive
exclusive dealing contract. But, may
foreclose if (for example):
– New entrant facing preexisting long-term
exclusives
– Exclusive is for too large a piece of business for
small rival to bid.
– Dominant firm is "must carry" brand.
Example: Predatory pricing and
bundled discounts
• Below-cost pricing forecloses (but may not
be substantial)
• An above-cost bundled discount may
foreclose if the rival could not offer its own
above-cost competitive discount in the
competitive market.
– Discount reallocation test determines whether
or not there is foreclosure.
Example: Secondary line price
discrimination
• Must disadvantaged retailer sell below cost
in order to remain competitive with
advantaged retailer?
– If not, no foreclosure.
Substantial
• Legal test: Does amount of foreclosure
deny rival a reasonable opportunity to
survive in the market?
• Economic test: Is rival reasonably able to
reach and maintain minimum viable scale
by competing for business in the nonforeclosed segment of the market?
Minimum viable scale
• Total sales new entrant needs to achieve
hurdle rate on invested capital. (Salop,
1986)
• Familiar concept from horizontal merger
analysis.
The tricky part: Incumbency
advantage
• Even in non-foreclosed segment,
incumbent/dominant firm may have decided
advantage:
– Customer loyalty
– Switching costs
– Brand preference
Effect of incumbency advantage on
"substantiality"
•
•
•
•
50% market foreclosure
20% minimum viable scale
70% incumbency advantage.
New entrant's initial share is 15%, < mvs
But, legal test must look past first
round
• Incumbency advantages can degenerate
quickly.
• Even in a completely non-foreclosed
market, new entrant often must absorb
losses for years to reach mvs.
Illustration
• Static market with 2,000 units purchased
monthly
• 50% foreclosure
• 90% incumbency advantage
• Minimum viable scale: 20% (400 units)
Market Share Change with 90% Incumbency Advantage and
Monthly Customer Decision
1000
Units
800
600
400
200
0
1
3
5
7
9
11
13
Month
15
17
19
21
23
Implication:
• As a general rule, foreclosure should not be
deemed substantial if the minimum viable
scale is less than the units or revenues in the
non-foreclosed segment of the market
divided by the number of competitors.
• In a two-firm market, foreclosure is never
substantial if mvs < 50% of non-foreclosed
segment.
Qualifications
• New entrant often claims superior price or technology,
hence should more than overcome any incumbency
advantage.
• If there are very long intervals in the competitive cycle,
then incumbency advantage may erode slowly. But then
market may be a natural monopoly.
• Markets with partial foreclosure and many competing
firms raise special questions:
– Aggregate foreclosure?
– Generic probability of success falls with multiple competitors.
– Exclusion of any one competitor may have little competitive
significance.
Concluding Thoughts
• Unified test adds rigor and consistency, but
does not eliminate all difficulties.
• Opportune time to pursue unified test on
both continents:
– "Antitrust policy toward vertical restraints is
the biggest substantive issue facing antitrust.”
Richard Posner, 2005.
– EU: shift toward effects-based rules.
Toward a Unified Theory of
Exclusionary Vertical
Restraints
Daniel A. Crane
University of Michigan Law School
Graciela Miralles
European University Institute
June 17, 2010