U.S. Antitrust Risk Analysis in a Nutshell

Analyzing the U.S. antitrust implications of a merger, joint venture, or new pricing model or distribution scheme can be enormously complicated and time consuming. But in most instances, a few simple principles will give you a good sense of whether an activity is likely to entail significant antitrust risk. 

1.  The purpose of the U.S. antitrust laws is to prevent the creation or exercise of market power to the detriment of customers.

2.  Some conduct is so facially anticompetitive that it is unlawful regardless of its actual effect in the marketplace.

3.  Other conduct violates the antitrust laws only when it is likely to harm customers.

4.   As a general rule, the U.S. antitrust laws are more skeptical about arrangements where two or more competitors act collectively  than about distribution or other vertical arrangements or about decisions made unilaterally by a firm.

5.  The most important evidence of competitive effect is likely to come from the company's documents, customers, and competitors.

Of course, given the technicalities and idiosyncrasies of U.S. antitrust law, nothing truly substitutes for a full analysis, but these principles will go a long way to informing your intuitions about antitrust risk. 

1.   The purpose of the antitrust laws is to prevent the creation or exercise of market power to the detriment of customers.

Firms that can manipulate prices, product attributes, or conditions of supply to increase their profits have market power. Typically, customer harm comes in the form of higher prices, reduced output, lower product or service quality, or decreased rates of technological innovation or product improvement.

Market power can be exercised by an individual firm or a group of firms acting collectively. A business practice that is likely to create or facilitate the exercise of market power is said to be anticompetitive.

Significantly, the U.S. antitrust laws are designed to protect customers (direct and indirect), but not competitors. Conduct that harms competitors is actionable only if it has a reasonable probability of harming customers.

2.   Some conduct is so facially anticompetitive that it is unlawful regardless of its actual effect in the marketplace.

U.S. antitrust law regards a limited number of practices to be so likely to be anticompetitive that they are deemed unlawful without any need to determine whether they actually harm customers. These practices are called per se illegal.

Per se illegal practices include hard-core cartel activity: agreements among competitors to fix prices, allocate sales by customer type or territory, or engage in secondary boycotts (usually against a discounting competitor and usually in furtherance of a price-fixing arrangement.  These practices can be prosecuted criminally in the United States and an increasing number of other jurisdictions.

Per se illegal practices also include some tying arrangements (“I will sell you product A, but only if you also buy product B from me.”), and these types of arrangements need to be analyzed with some care.

Until recently, minimum resale price maintenance (that is, setting a floor on the minimum price a reseller may charge) was also per se unlawful under federal antitrust law. There is a movement by some in Congress to return minimum resale price to the per se illegal category, and in any event many state attorneys general take the view that minimum resale price maintenance remains per se illegal under state antitrust law.

3.   Other conduct violates the antitrust laws only when it is likely to harm customers.

All other things being equal, increasing sales by providing better products or services helps customers.  Lowering costs also helps customers if some of the cost reduction is returned to customers in the form of lower prices, higher quality, more product variety, or increased rates of innovation or product improvement. Increasing price without some offsetting customer benefit is anticompetitive.

Here are three ways to approach the customer harm question.  Each one depends on the same underlying economics, just the articulation differs.

First, if customers knew what the firm is planning to do, would they prefer the change over the status quo?  For example, would customers prefer to pay a higher price resulting from a vertical restriction because in return they would receive much better point-of-sale customer service, or would they prefer the original lower price and corresponding lower POS service? If customers on balance would like the change, then the contemplated restriction is not likely to be anticompetitive. If customers would not like the new practice, then a deeper analysis is in order to determine if the practice violates the antitrust laws.

Second, will the new practice increase the firm’s unit output by making the firm’s products more attractive to customers? When customers are free to choose what they purchase, they buy what they like the most. An increase in unit sales usually means that the new practice is procompetitive, since customers find the firm’s new value proposition more attractive than the status quo. Of course, if the new practice forecloses the competition in some way—say by cornering an essential input or otherwise raising competitor costs—the practice can be anticompetitive even if the firm’s unit sales increase.

Third, what is the business model behind the new practice?  Economics 101 tells us that there are essentially three ways for a firm to make more money:

(a)  create a more attractive customer value proposition and drive up unit sales volume, thereby increasing profits because of increased demand (“shifting the demand curve to the right”);

(b)  reduce costs of operation; and

(c)  create an artificial scarcity in the product in the marketplace, thereby increasing profits because scarcity means higher prices (“riding up the demand curve”). 

The first is unambiguously procompetitive; the second is procompetitive, especially if some of the value of the cost reduction is returned to consumers; and the third is anticompetitive.

4.   As a general rule, the U.S. antitrust laws are more skeptical about arrangements where two or more competitors act collectively than about distribution or other vertical arrangements or about decisions made by a firm about its own internal matters.

Modern U.S. antitrust law reserves its greatest skepticism toward joint competitor activity, although even here the law will permit competitor arrangements that either (a) advance customer interests, or (b) reduce costs without harming customers.

On the other hand, when the firm acts completely by itself on internal matters—say when deciding on the products it will offer, the prices it will charge, the customers to whom it will sell, or the amount of money it will invest in R&D—the U.S. antitrust laws will only rarely intervene. But internal decisions can be unlawful when they foreclose significant competition to the harm of customers (e.g., pricing below costs to drive out competitors in order to later raise prices).

The middle ground is where the firm acts in ways that restrict third parties in their marketplace activities. A manufacturer, for example, might limit the territories in which a reseller can sell or require that a distributor deal only with it. With the exception of minimum resale price maintenance and tying arrangements (see above), distribution and other vertical restrictions on resellers are presumed to increase interbrand competition and be in the customer’s interest.  Although infrequent, there are cases where the evidence shows that a vertical restriction harms customers and the restriction has been found unlawful.

5.   The most important evidence of competitive effect is likely to come from the company’s documents, customers, and competitors.

The U.S. antitrust authorities place considerable weight on company documents prepared in the regular course of business.  Company documents are likely to explain the intent of the company in adopting a new practice as well as why the company believes that the new practice will increase its profits.

“Bad” documents, that is, company documents that suggest directly or indirectly that the practice will result in higher prices or otherwise harm customers, are considered to be admissions against interest—and therefore likely true—and can be very difficult to overcome. Documents that indicate that the practice will make money by adding customer value and increasing demand, or by lowering costs or creating other efficiencies,  are valuable in setting a positive context for the practice, but they are not regarded as dispositive because they may simply be reflecting the company’s desire to avoid antitrust problems.

Since the purpose of the antitrust laws is to protect customers and since sophisticated customers are likely to be able to predict whether a new practice will help them or hurt them, customers are a natural source of evidence, especially in government investigations.  In addition, given the alignment between the purpose of the antitrust laws and the customer’s interest, customer evidence is usually given great weight in an antitrust assessment.

Competitors can also be an important source of evidence, especially given their knowledge of the industry and their ability to assess the likely effects of a challenged practice. However, firms have an incentive to impede or block procompetitive conduct by a competitor that would increase the attractiveness of the competitor’s products or service and shift demand away from other firms in the marketplace.  For this reason, competitor  complaints are typically given little weight in an antitrust assessment unless the predicate facts are confirmed through less biased sources.

Dale Collins
Shearman & Sterling LLP
599 Lexington Avenue
New York, NY  10022
Direct Tel: +1.212.848.4127
Direct Fax: +1.646.848.4127
dale.collins@shearman.com

 

 

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