Three years ago this month, the 3rd Circuit's controversial en banc decision in LePage's Inc. v. 3M brought forth a torrent of -- mostly critical -- analysis from the antitrust commentariat. There were multiple warnings regarding the expected "LePage's effect" -- an undue chilling of aggressive pricing practices by low-cost but high-market-share companies and an undue coddling of high-cost but smaller-market-share rivals. The Supreme Court's denial of certiorari left other courts and antitrust counsel to sort out the practical implications.
The intervening years have confirmed the reality of the mess left by LePage's . Disgruntled rivals have been emboldened to bring copycat suits that challenge sales-enhancing, cost-reducing, loyalty-building incentives offered to buyers as unlawful "bundling" or "de facto" exclusives. The haziness of anti-monopolization standards since LePage's has called into question long-standing sales and marketing practices.
In this post-LePage's world, how should antitrust lawyers counsel their clients to avoid becoming the "next" 3M? And how should courts be analyzing these claims?
THE NEXT CASES
In the key holding of LePage's, the U.S. Court of Appeals for the 3rd Circuit said that companies with "monopoly power" that use "bundled rebates" or "de-facto exclusive deals" to "foreclose the opportunities of rivals" in an "unnecessarily restrictive way" are subject to treble damages. While few reported decisions rely on (or reject) that holding, there are enough to confirm the impact of the 3rd Circuit's surprising conclusion.
Consider McKenzie-Willamette Hospital v. PeaceHealth, decided Oct. 13, 2004, by the U.S. District Court in Oregon. The court applied LePage's to uphold the jury's finding of liability for PeaceHealth's mere bundling of primary, secondary, and tertiary health care services in bids for insurance contracts (McKenzie did not offer tertiary services). Indeed, this bundling theory sprang directly from LePage's. The initial focus of the case was exclusive dealing; the bundling claims were not asserted until the close of discovery after the 3rd Circuit's en banc decision.
The jury instructions were even copied verbatim from LePage's. "Bundled pricing occurs when price discounts are offered for purchasing an entire line of services exclusively from one supplier. Bundled price discounts may be anti-competitive if they are offered by a monopolist and substantially foreclose portions of the market to a competitor who does not provide an equally diverse group of services and who therefore cannot make a comparable offer."
Thus, as in LePage's, the jury was permitted to assign treble damages whether or not it found that (1) the defendant engaged in below-cost pricing, (2) the defendant's discounts could be matched, (3) the plaintiff was being driven from the market, (4) the defendant's actions raised the plaintiff's costs, or (5) the incremental business obtained through bundling was profitable to the defendant. In essence, the jury was allowed to punish the defendant for competing "unfairly" with a given competitor with no proof of an actual effect on competition.
Antitrust counsel for high-market-share companies are in a bind. While counseling on the Sherman Act's Section 2 has never been a paint-by-numbers exercise, certain nearly bright-line rules did apply: Above-cost discounts were fine; below-cost discounts were trouble. Bundled sales were OK; tied sales required more careful analysis. Actual long-term exclusive deals needed special scrutiny; de facto short-term exclusive deals did not.
LePage's shakes up each of these tenets. Above-cost discounting went from pro-competitive to potentially anti-competitive. Bundled sales will be tested under the entirely unrelated, and largely discredited, standard for exclusionary conduct set forth by the Supreme Court in Aspen Skiing Co. v. Aspen Highlands Skiing Corp. (1985). Sales agreements that lasted a mere year and were open for bidding annually might be condemned, even if there was no actual exclusivity.
Ironically, as Section 2 litigation has grown more tangled, other areas of antitrust law have been clarified to cut back on the type of claims that plaintiffs can pursue. Over a mere seven weeks this year, the Supreme Court has issued three decisions in three separate areas requiring plaintiffs to prove actual harm to competition under a rule-of-reason standard, while declining to rely on a company's size or other presumptions as a substitute for rigorous economic analysis of the costs and benefits of the challenged conduct.
In Volvo Trucks North America v. Reeder-Simco GMC, the Court on Jan. 10 rejected the notion that under the Robinson-Patman Act competitive injury could be presumed from bidding situations in which the plaintiff did not compete with the beneficiaries of price discrimination. In Texaco v. Daugher, the Court on Feb. 28 rejected a presumption of anti-competitive harm caused by price setting by an integrated joint venture. Most recently (and most important for this discussion), in Illinois Tool Works v. Independent Ink, the Court on March 1 rejected the long-standing presumption that the "legal monopoly" afforded by a patent warranted a finding of market power for purposes of finding liability for tying the purchase of other products to purchase of the patented product. The Court required proof of actual adverse effects on competition in that context as well.
But confusion over Section 2 claims, particularly those based on bundling, remains. And the plain text of LePage's is of little help in framing advice. The government's own certiorari brief noted that the opinion "provided few useful landmarks on how Section 2 should apply" in the future and "fail[ed] to identify the specific factors that made 3M's bundled discounts anti-competitive."
Thus, while counsel can still help clients assess risks associated with their pricing practices, the conundrum created by LePage's would best be solved by a Supreme Court determination -- consistent with its trio of recent rulings -- that plaintiffs must prove actual harm to competition in attacking the sales and marketing programs of even those companies with "monopoly level" market shares.
A PROPER ANALYSIS
To ensure that only those practices that harm consumers are condemned, courts should employ a four-step process to analyze LePage's-type claims.
1. The plaintiff must precisely identify the terms of the offending offer. The most difficult part of any LePage's -type claim is determining when products were bought bundled and when they were simply purchased concurrently. Only if the precise nature of the incentive is measured can the court determine whether there is a legitimate, economically rational basis for it; whether the plaintiff can match it; and whether it is sufficient to harm competition by driving out (or foreclosing) enough competitors from the market.
The plaintiff should have the burden to identify and prove the terms of both the bundled offer and the "but for" unbundled offer. The bundled offer is the actual offer made by the manufacturer. The "but for" offer consists of the terms that would have been accepted by the buyer but for the bundled terms.
Proving these terms is critical if the court is to assess which sales the plaintiff can and cannot compete for. It is also critical to determining the economic value of the incentive used to "force" the customer to accept the bundled offer. Therefore, the defendant should have an opportunity to rebut the plaintiff's argument.
2. The court must find that the bundling incentive makes no economic sense absent foreclosing competition. Because the incentive benefits customers, it is important to show that the offer has no adequate business justification. Liability should only attach where the cost of the economic incentive causes the defendant to lose money on the additional sales made possible by the bundle -- i.e., where the defendant is not pricing the bundled product above its own costs. The defendant, which has a better understanding of its own costs, should bear the burden of proof here.
At this stage the court can also examine the flip side of the bundling incentive, the disincentive to do business with anyone but the defendant. This disincentive is actionable only if it takes the form of a retaliatory action. If the defendant threatens to withdraw a substantial advantage (e.g., a promotional payment) offered to the buyer if the buyer elects to do business with a competitor, the court should analyze whether that threat is actually punitive.
The test is simple. If it is legal to offer the payment to obtain the incremental business -- because the price of the competitive product is not below cost -- then the withdrawal of an offered payment (or a payment made in prior years) cannot be illegal when the incremental business is not obtained. Why pay benefits to someone who is using the seller to "bait and switch" or just phasing the seller out?
3. The plaintiff must demonstrate that the defendant's prices cannot rationally be matched. The court should require the plaintiff to show that it would be unable to profitably make an equally attractive offer. The plaintiff must demonstrate that actually making the winning bid would have been economically irrational -- i.e., below its own costs.
For purposes of analyzing the bundling effect, it should not be dispositive that the pricing practice earned the defendant exclusive access to the buyer's business. So long as an efficient competitor had the ability to compete for a piece of the plaintiff's business, the fact that the defendant gained all of that business represents the purchaser's choice. In short, if the dominant company's prices are above cost, and the plaintiff could have matched them but chose not to, the court's inquiry should end here.
4. The court should examine the likelihood of recoupment. Where the plaintiff is unable to make an equally attractive offer and where the defendant fails to prove that the bundling incentive is economically profitable, the court should then determine whether there will be an adverse effect on competition. Will the incentive harm the defendant's rivals or foreclose future competitors because the defendant will be able to recoup losses associated with the incentive by raising future prices? The point is not to chill low-cost, or even below-cost, price competition that cannot injure consumers absent future price increases, as the Supreme Court noted in adopting the recoupment requirement for predatory pricing in Brooke Group v. Brown and Williamson Tobacco Corp. (1993).
As a matter of Antitrust Economics 101, proof of recoupment requires proof that the incentive will lead to a market-wide restriction of output. The burden of proof should be borne by the plaintiff.
Besides being economically sensible, this four-step process would provide guidance and comfort to big (but not bad) companies that would like to offer pro-competitive discounts, rebates, and exclusive contracts that also benefit consumers. This analytical framework still protects against economically irrational conduct designed solely to drive out emerging or efficient rivals. And it closes the opening that LePage's has given to competitively impotent rivals seeking to recoup with litigation or intimidation what they cannot get in the rough and tumble of the market.
Tefft W. Smith is a Washington, D.C.-based partner in Kirkland & Ellis' antitrust and competition law practice group. Colin R. Kass is an antitrust partner and Scott Abeles is an antitrust associate in Kirkland's D.C. office. The authors routinely represent clients in cases challenging dominant-firm pricing practices, although the opinions expressed here do not reflect those of any client.