Fortiline LLC: Invitations to Collude in Dual Distribution Systems

Fortiline LLC distributes ductile iron pipe. It competes with the manufacturer which somewhat regularly undercuts its distributor in the market.  Fortiline on several occasions asked the manufacturer not to do so.  Fortiline emailed the manufacturer complaining that the manufacturer was not keeping its numbers up compared to other manufacturers.  Fortiline also stated that “[w]ith this approach we will be at a .22 [margin] soon instead of a needed .42.” Fortiline later complained that the manufacturer was pricing at a 0.31 margin, “20% below market.”

The FTC sued under Section 5 of the FTC Act, and Fortiline entered into a consent agreement. The FTC alleged that Fortiline had invited the manufacturer to collude in price to the end consumers.  The consent prohibits Fortiline from attempting to enter into an agreement to fix prices among other things. It allows Fortiline to discuss “procompetitive aspects” of the manufacturer-distributor relationship The order lasts for 20 years.  Commissioner Ohlhausen dissented.

With regard to that “exception,” the Order states:

PROVIDED, HOWEVER, that it shall not, of itself, constitute a violation of Paragraph II. of this Order for Respondent to engage in any conduct that is (1) reasonably related to a lawful manufacturer-distributor relationship, lawful joint venture agreement, or lawful merger, acquisition or sale agreement; and (2) reasonably necessary to achieve the procompetitive benefits of such manufacturer-distributor relationship or of such agreement. For the avoidance of doubt, it shall not constitute a violation of Paragraph II of this Order for Respondent: (i) to communicate with a Manufacturer regarding Respondent’s desire to receive prices or rates (including rebates and discounts) at least as favorable as those granted by that Manufacturer to a Competitor or Contractor; (ii) to request, negotiate, or enter into an agreement with a Manufacturer under which Respondent shall be that Manufacturer’s exclusive or quasi-exclusive distributor; or (iii) to request or enter into an agreement with a Manufacturer under which Respondent distributes that Manufacturer’s ductile iron pipe to a Contractor previously or potentially served by that Manufacturer.

[Emphasis mine.] A “Manufacturer” is “any Person engaged in the business of manufacturing or fabricating ductile iron pipe, and any such Person’s employees, agents, and representatives.”

Fortiline sells the manufacturers’ product. It is invested in understanding and promoting the product and developing the brand.  This is a case where Fortiline’s own vendor is free riding off Fortiline’s investment in the local market.  It is outrageous to think that Fortiline would have to sit by and take that.  And the consent itself embraces this fundamental circularity.  The exception allows the very behavior the complaint condemns.  The only thing this complaint achieves is to raise Fortiline’s costs by imposing a regulatory burden on it that no other competitor otherwise has.  It also causes them to incur needless legal fees as they will assuredly have to pass by their lawyers each missive they write to the manufacturer.  If anything this process has distorted this market.

The real lesson from this case is never enter into an agreement where your supplier can target the market directly. As soon as you complain about their free riding, you’ll be sued by the FTC.

Causality and Diluting Trademarks Through Online Searches: What the FTC Missed in 1800Contacts

The FTC sued 1800Contacts for entering into a series of agreements with competitors that limited the competitors’ ability to bid on certain trademarked terms as search terms in online search term auctions.

Search engines like Google sell search terms. An advertiser will bid for a search term.  If it wins, its advertisement will be listed as an “advertisement” above the search results whenever someone types that search term into the search engine.  Google allows companies to bid for search terms that are trademarked by others.  So, a company that is not 1800Contacts that sells contacts on line bids for and wins the search term “1800Contacts.”  When someone searches for that term, the company’s ad will appear first in the list of results before the results from the search.  The mere acquisition of an AdWord that is trademarked by another company is not a trademark violation, according to the courts.  How the acquiring entity uses that trademarked name in the advertisement that appears in the search results can be, however.

Key to this case is going to be the relevant product market and what role advertising placement in response to online search plays in the acquisition of contacts. Do customers buy online and from bricks-and-mortar stores?  Is search, and in fact is ad placement first in the list responses, key to how consumers locate and purchase contacts, or is it one of many ways?  Absent isolating online sales as a relevant market, and proving that the majority of customers locate contact vendors through search and do so by clicking on the first ad they see, the Commission is going to have a hard time proving the agreements have negatively affected competition.  Intuitively, there appears to be many ways to acquire contacts.  I can call 1800Contacts.  I can go to Costco.  I believe my ophthalmologist and optometrist sells them as well.  I might also search for “contacts” online.  I doubt I would search for “1800Contacts” unless I specifically wanted to buy from them.  The more avenues I have, the lesser the influence of search on my product acquisition.  And if I can recognize that the first selection is an advertisement, the role of AdWords acquisition plays an even more attenuated role in my decision making.  Ultimately, the Commission has to show an effect in a relevant market.  For there to be that effect, search as well as ad click through has to be the critical method by which consumers acquire contact lenses.  Otherwise, these agreements have no effect on competition.

The other way the Commission could back into liability would be for them to claim that there is no procompetitive rationale for the restraint. Since there is no procompetitive value and potential anticompetitive effect, the restraint should be condemned.  The way they win there is the general notion that simply buying a competitor’s trademark as an AdWord is not infringement, and therefore not a protectable interest.  Absent that interest, the restraint is naked and condemnable.

But just because there is no trademark violation doesn’t mean that there is no commercial harm or protectable business interest. If I enter “1800Contacts” into a search engine, at least intuitively, it seems like I would be looking for that company.  Even though there is a graphic that says “ad,” if I weren’t a sophisticated user of the Internet, I might very well think I’m getting service from that company where I might not in fact be.  Moreover, Google’s process of selling trademarked AdWords to anyone who wants to buy them may in fact be diluting the marks.  A person who searches 1800Contacts and is shown a variety of different competitors might come to think that that term is generic and will pick up any contact seller.  It would be improper of an antitrust court to conclude that because a trademark holder does not suffer trademark infringement it cannot be otherwise harmed.  Protecting its brand from become generic in the minds of users and ensuring that folks who want to buy on line can find their products could very well have value to a company, value that it is entitled to protect.  Given the ostensibly inconsequent role search plays in the ability of purchases to locate contacts, that benefit may very well be sufficient to support legality.

This case is a solution in search of a problem.

Didi Acquires UberChina

Uber Technologies Co. announced today that it was selling its Chinese affiliate to rival Didi Chuxing Technology Co.  The Wall Street Journal reports that the sale is the end of a three-year effort by Uber to penetrate the Chinese market.  In the end, Uber had approximately 10.1 million riders to Didi’s 42.1 million.  Didi merged with another rival in 2015, Kuaidi Dache, effectively extinguishing the Kuaidi brand post consummation.  Uber will be taking a sizeable stake in Didi in exchange for its business.

From an American antitrust standpoint, this deal could have drawn significant investigative interest.  While not faring nearly as well as its local rival, Uber had invested a great deal of time and effort into developing a Chinese presence.  Indeed, it had developed a base of over 10 million riders.  By most measures, Uber is not an insignificant competitor and would not be considered “failing” or even “flailing.”  Indeed, one might even see them as a classic maverick.

A particularly aggressive enforcer might also take a hard look at what was actually promised in the negotiations between Uber and Didi.  Uber is taking a large chunk of Didi’s stock in exchange for exiting the market.  The noncompete will also be of particular interest.

But this is China.  Their anti-monopoly law is relatively new, and they bring few actual challenges to transactions.  Didi is also a national champion in the high tech space, a place where very few companies worldwide successfully challenge American supremacy.

Implementation of the Damages Directive: The Changing Landscape of EU Competition Law

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Somewhat overshadowed by media attention surrounding the repercussions of the Brexit vote and subsequent impact on the United Kingdom’s laws and economy, the landscape of Europe’s competition law regime is undergoing a notable change this year, as well.  By December 27, 2016, each EU member state is required to implement the European Union’s Damages Directive (2014/104/EU) – meaning that each state must offer a mechanism to facilitate private enforcement of damages claims for the infringement of competition rules.

This summer, member states such as Germany, Spain and others have unveiled proposals that call for amending current competition  acts to comply with the Directive’s conditions.  Final parliamentary votes are expected this fall – in advance of the late December deadline –after draft legislation has been published and commented g(upon in each jurisdiction

I.   Considerable Changes

The changes imposed by the Directive are significant, as it is designed to use national courts to help victims of anticompetitive conduct and cartel behavior obtain damages for losses suffered.  The Directive, which entered into force on December 25, 2014 after more than a decade of debate and negotiation, thus promotes a less fragmented standard for private antitrust damages actions across all member states.  Indeed, the implementation of the Directive is likely to lead to a surge in private actions brought in national courts.

Although the European Commission has an active competition authority which regulates anticompetitive conduct and punishes cartel behavior, it is not conventional practice for European consumers to bring follow-on claims for damages as a result of the Commission’s findings of infringement. While the United Kingdom, Germany, and the Netherlands are known as claimant-friendly jurisdictions, other member states have effectively blocked private claimants from bringing successful damages cases. The Damages Directive changes this by establishing specific minimum requirements that all member states must implement by the end of 2016.  The requirements under the Directive include:

  • Expanded access to evidence: all parties (including third parties) must comply with court orders mandating the disclosure of relevant evidence to the other side; the judge will be responsible for ensuring that evidence disclosure orders are proportionate and that confidential information is protected;
  • Precedential effect of national infringement decisions: final decisions by national competition authorities determining that an antitrust violation occurred will become binding on the national courts in that member state and constitute full proof that the infringement happened – an expansion from the former regime whereby only European Commission antitrust rulings were given precedential effect;
  • The right to full compensation: Member states now must ensure that any claimant harmed by a competition law infringement can claim and receive full compensation for the harm suffered;
  • Longer limitations period: The statute of limitations will increase, allowing victims at least five years from the time that the infringing activity ended (and the claimant had the possibility to discover that they suffered harm) to bring damages claims;
  • Indirect purchaser claims: The burden of proof will decrease, allowing indirect purchaser claimants to rely on the assumption that direct purchasers of price-fixed goods passed on the overcharge; and
  • Quantification of harm: A rebuttable presumption that the infringement of antitrust law by cartelists caused harm to consumers will be established, and the presumption requires that national courts be able to estimate the amount of harm suffered. This presumption is a clear divergence from standard legal practice in some member states (especially in Nordic countries) where the burden previously had rested with the claimant to prove that damages were suffered.  However, defendants have the right to refute the presumption by offering evidence that no damages were caused.

Notably, the Directive does not mandate that EU member states introduce class actions or other methods for collective redress of claims.  However, in some jurisdictions such as Germany, existing case law permits injured parties to jointly bring actions by assigning their respective claims.

II.   The Ongoing Process and Innovative Approaches by Member States

The implementation process for member states to incorporate the Directive into their legal systems is ongoing.  Latvia already has partially adopted legislation.  Legislative proposals are pending in the Netherlands (submitted to parliament on July 7, 2016), Luxembourg (submitted to parliament on July 5, 2016), and Finland (submitted to parliament on May 19, 2016).  Spain has proposed a “first draft” of implementation measures, while at least eight other member states have held public consultation periods to receive comments and input.

The realization of the Directive will require many states to enact sizable amendments to their current competition law regimes.  In a somewhat surprising twist, the proposals offered by some states have advanced the minimum standards mandated by the Directive.  Member states thus seem to be using the Directive as a baseline while employing their discretion to propose new standards beyond simply replicating the Directive’s provisions into national law.

For example, in following the Directive’s requirements on the disclosure of evidence, Spain has proposed a completely revamped set of rules on access to evidence as part of an amended Civil Procedure Act.  Therefore, in implementing the Directive, Spain is addressing more than antitrust cases – the new rules on disclosure would be applicable to all civil litigation.

On July 1, 2016, the German Federal Ministry of the Economy and Energy published a draft bill to amend Germany’s competition law act, which would serve to implement the Directive into German law.  After a period of public comment, the Ministry expects Parliament to vote on the bill this fall before the December deadline.  Although it is already considered a claimant-friendly jurisdiction, Germany’s proposal also creates a more vigorous discovery-like procedure.  Under the draft law, the new Section 33g provides for widespread disclosure under German substantive law – a broader right than the Directive itself, which only mandates that states enable national courts to order disclosure in the courts’ discretion.  Additionally, Section 33g (7) of the draft law requires the party requesting disclosure of documents to reimburse the other party for reasonable costs associated with producing the documents.

In Finland, the proposed law would enact tough standards for parental liability.  Under the Finnish proposal, the purchaser of a business would be liable for antitrust violations associated with that business if the purchaser was, or should have been, aware of the infringements at the time of the purchase.  This focus on parental liability exceeds the scope of the Directive, which is geared toward addressing measures to compensate victims of cartel behavior and does not mandate changes to parental liability laws.  A similar emphasis on parental liability exists in Portugal’s initial legislative proposal, in which liability automatically would be extended to parent undertakings for antitrust infringements committed by subsidiaries.  According to Article 3 of Portugal’s proposal, the parent and the subsidiary must form a single economic unit and the parent must have exercised significant influence over the subsidiary’s behavior and actions (referred to as “decisive influence”).

III.   Impact on European Corporations

The UK, Germany, and the Netherlands had emerged as the main jurisdictions for claimants seeking to bring competition law claims, based on favorable laws for follow-on damages as well as experienced judiciaries familiar with private damages cases.  The Directive, however, strives to allow victims of anticompetitive conduct to obtain damages in the national courts of any EU member state.  It should remove the procedural obstacles that currently exist in some member states with less developed frameworks for private damages actions.

Corporations across Europe will have to closely observe how certain provisions in the Directive are adopted into national law.  For example, the provisions on the disclosure of relevant evidence should lead all businesses to consider enacting document retention policies – and such policies may not currently be in place at certain businesses located in member states where robust discovery has not been a central feature of previous litigations.

It is an open question whether member states with less established competition regimes will become more feasible fora for antitrust damages claims after the implementation of the Directive – leading to a loss of business for the courts in the UK, Germany and the Netherlands.  The implications of Brexit in the UK also may impact the UK’s leading role in the private damages regime. It remains to be seen if claimants will continue to engage in forum shopping once all member states have enacted the Directive’s minimum requirements. Corporate law departments are advised to follow the differing provisions proposed by some member states and track how national laws on private damages claims are transitioning as a result of the implementation of the Directive.

Microsoft buys LinkedIn for $26.2 Billion – Antitrust Issues?

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Microsoft has an entrenched, enduring monopoly in both personal computer operating systems and office software. LinkedIn is the largest business-oriented social network.  Are there antitrust issues with the combination?  Likely not.

Microsoft is not strong in social media, and LinkedIn doesn’t make operating systems or business software. So there does not seem to be many horizontal issues.  There similarly does not seem to be many vertical issues.  LinkedIn’s social network is not a key input for any entity that makes software that competes with Microsoft.  And Microsoft’s software is not a critical input for any competitor of LinkedIn.  You don’t need to be using Windows to create a social network on the Internet.

So why do the deal? My guess is that Microsoft is concerned that cloud-based programs (like Google Sheets and Google Docs) are going to start cutting into sales of their machine-based products.  Part of the desirability of the cloud-based products is the ease with which parties can collaborate.  For you lawyers, think iManage or PCDOCS.  Those programs allow multiple users to edit and share documents without users tripping over each other, losing track of versions and edits, and the like, but in a private, closed-network.  Google’s products do the same thing but in the cloud.  Because Google’s products are free, and many people have access to Google’s free email, Google’s cloud already has an expansive network of users and can add new users very easily.  What buying LinkedIn does is give Microsoft a ready-made network of users for Microsoft’s cloud-based (or at least cloud-interoperable) products.  Their products are suddenly more useful because you can readily share your work product with the people you actually work with.  And now that Microsoft owns LinkedIn, it knows who you work with.  This isn’t an antitrust violation.  In fact, they are making Microsoft’s products more useful and desirable.

Notwithstanding the foregoing, I do think the deal will be investigated by at least the Europeans and probably the Americans as well. For the Europeans, it would be an excellent opportunity to put some meat behind their musings on big data and competition law.  The Americans are “behind” the Europeans on big data, and could use the investigation of Microsoft’s acquisition of LinkedIn to educate themselves.  I say “behind” because I don’t think knowing things about people, who voluntarily share that information, can give rise to competition issues.  The economic value of big data is in its ability to anticipate future demand and put suppliers together with consumers.  The more data these companies have, the better they will be at anticipating that demand, indeed perhaps to the point where they will know what you want before you do, and can have a vendor there ready to go when that demand germinates.  LinkedIn’s data set is much more complex and thus harder to mine than either Google or Facebook, so the value of their “data” isn’t going to be nearly as great at least with regard to selling members things.  We see that David Evans wrote a scathing piece on the inutility of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, two months ago.  I bet he’d like to buy a pizza.

I think this deal is about competing with the 800 pound gorilla in cloud-collaboration. And instead of leveraging a market they dominate to crush the competition, Microsoft has bought a genuinely complementary product.

Who knew.

Screening Room Alone Won’t Save AMC-Carmike

Last month, AMC and Carmike announced plans to merge. They would form the nation’s largest cinema chain with over 8,000 screens. Also last month, Napster founder Sean Parker announced a new product—Screening Room—which will stream first-run movies into the home potentially in competition with entities like AMC/Carmike. Screening Room customers purchase a proprietary box for $150, and each movie will cost $50. Several commentators have suggested that Screening Room will revolutionize film distribution, and, with regard to AMC/Carmike, that Screening Room represents such clear competition that whatever incremental market power AMC/Carmike might accrue as a result of their merger would be easily constrained.

While movies may seem to be a single product—a collection of images and sounds—they are in fact many different products. And this is so because of how movies are distributed. In the most common form of distribution, movies are first shown in theaters, then made available for purchase/rent (DVD, Blu-ray, 4K, streaming), cable, and ultimately broadcast. This routine is the “release windows” business model. Movies can also be released simultaneously or straight-to-video. Some content distributors, like Amazon, are vertically integrating and creating and distributing (streaming) their own content outside of these models. NBC/Universal may be buying DreamWorks for this reason.

The release windows business model is designed primarily to maximize profits by waterfalling movies through a series of price-discrimination markets. The studios make the movie available in different formats at prices that decline over time based on the format: each new window opens in series after demand in the previous window has been satisfied. At one end of the spectrum is a consumer who very much wants to see the movie will pay a lot to see it immediately. She is happy to go to a theater to do so. She may spend on concessions. At the other end of the spectrum is the price sensitive consumer who would not expend any effort or pay any money to watch a movie. Perhaps he doesn’t even subscribe to cable. He would wait for the movie to be shown for free on television. Staggering allows the studios to target the most price insensitive first, and then progress along the demand curve saturating each demand band before moving to the next.

Releasing a movie in all formats and at different price points at the same time allows cannibalization between bands. A consumer might go to a movie in the more-expensive theater band, but wouldn’t go to the theater at all if the film were also available on DVD at the same time. If movies were released in all formats at the same time, the theater would lose a sale at a higher price. By staggering the windows, the studios may capture revenues associated with these marginal customers that it might not otherwise.

In this regard, Screening Room creates a whole new “window” along the curve. It addresses the marginal customers in the “theatrical band” who might consume more movies if the prices were better and the marginal customers in the “purchase/rent” band who might pay a little bit more to see a first run movie but may not want to go to the theater. As such, Screening Room will likely not be a substitute to the majority of theater-goers. It is also unlikely that Justice will find this “disruptive technology” argument compelling. If a merger is otherwise anticompetitive, a disruptive technology actually has to be disrupting something for it to be compelling, all else equal. The prospect that a technology could disrupt a market is insufficient to carry the day. So I doubt the emergence of Screening Room will play any meaningful role in the analysis of the AMC/Carmike deal.

Wait, What?

AMC-Carmike aside, there may be other antitrust issues percolating. Variety is reporting Screening Room is looking to be the exclusive content partner to the studios. That may mean that the studios agree to stream first run films only through Screening Room and no other over-the-top or other service. If so, Screening Room becomes the default provider for content in that particular window, excluding other potential providers. In many respects, this requirement is reminiscent of the exclusive dealing arrangements in the early days of B2B ecommerce markets. In order to get the market off the ground, the markets were asking the participants to participate only on one platform. The FTC shot that idea down in October 2000, by announcing their view that a market for marketplaces could be monopolized through these exclusive dealing arrangements.

There are aspects of Screening Room that also reminds one of the Justice Department’s successful complaint against Apple in eBooks. In that case, the Justice Department alleged that Apple induced the major book publishers into dropping the “wholesale” model of distributing books and adopting an “agency” model. Under the wholesale model, stores like Amazon were free to set whatever price they wanted for books, including below cost. Under the agency model, the publishers retained title to the books selling “through” sellers like Amazon at the price the publishers wanted. Making a unilateral decision to move from the wholesale to agency model would not have violated the Sherman Act. The Justice Department, and ultimately the courts, found that Apple had induced the publishers to do so and that was an illegal conspiracy violating Section 1 of the Sherman Act. The Justice Department alleged that the conspiracy had the effect of raising prices to consumers of bestsellers, and that Apple did so to pocket a portion of those rents. Purportedly, Screening Room has approached the major studios, is seeking exclusive dealing arrangements, and is setting the price of a first run home-shown film, offering the theaters a piece of the sale, perhaps like Apple.

Books are in many ways like films. There will be a band of consumers that very much want to read the best sellers when they come out and will pay more to do so. There are also consumers who are happy to wait until the book is available for less, later, like in paperback format. By charging one price for all eBooks irrespective of where they are in the distribution timeline, Amazon is collapsing the release window business model for books. They are charging less to the band that is most willing to pay more and they are ultimately charging more to folks who would prefer to wait for their books at cheaper prices. The consumers that would buy a bestseller but for the higher price benefit, but only in accelerating consumption that they would have engaged in anyway.

Amazon’s practice is economically suboptimal: raising the price of books that are not best sellers reduces sales and leaves demand unmet. While consumers of bestselling eBooks pay less, they would have paid more. Their welfare is being met inefficiently. The benefit to the marginal consumer that would have consumed the lower priced product is only in accelerating consumption that would have occurred anyway when the price of the book decreased. By destroying windowing in books, Amazon is reaping rents from the price sensitive consumers, denying access to eBooks for some class of price sensitive consumers, and denying revenues to the publishers who rely on those revenues to curate new talent. The publishers were right to try to stop Amazon’s practice.

Screening Room does not suffer from this infirmity, however. They are actually bringing a product to market that would not otherwise get there as quickly absent the exclusivity. I believe that the exclusivity the B2B eMarketplaces asked for was necessary in order to establish the markets and so was justified, and that the FTC’s decision to condemn it played a meaningful role in the failure of so many e-markets.

It will be interesting to see what Justice does with Screening Room given eBooks and the B2B “market for markets.”

News Corp Complains about Google

News Corp Complains about Google

News Corp recently filed a complaint with the European Commission against Google over “improper scraping of content for use in search results.”  News Corp alleges that Google takes News Corp content and makes it available in Google’s search results.  According to News Corp, displaying their content on Google’s sites bypasses News Corp’s sites (and therefore ads) and deprives News Corp of revenue.  Google will take the content down if News Corp asks.  But if News Corp does so, Google will not display any News Corp content, including the links to stories that would otherwise come up.  News Corp believes failing to display these links is an abuse of dominance.

It is not an abuse of dominance.

Taking News Corp content and displaying it in search results is a form of free riding. Google didn’t create the content; News Corp did.  News Corp’s content enhances the value of Google’s search engine and may in fact drive ad click-through revenues for Google.  But News Corp benefits too.  In exchange for being able to display the content, Google promotes News Corp’s websites to readers interested in that topic.  That promotion drives readers to News Corp’s website where they generate revenue for News Corp.

In this sense, the Google-News Corp relationship is a form of symmetrical reciprocal free riding. Rather than attempt to quantify and clear between them complex and perhaps indeterminable costs, both parties agree to free-ride off each other in roughly equal portions.  If symmetrical, their cross-externalizations create an efficient outcome.  In other words, both companies profit from using each other’s materials—Google improves the desirability of its search engine; News Corp gets more readers, higher click-throughs and revenues.

In addition, the content Google takes is a snippet of the article, not the whole article. Absent Google, News Corp would not have nearly the same traffic.  I suspect that the number of people who read only the first few sentences of a news story on Google is not large.  If those people are so disinterested in the story that the first few lines is satisfying, it would also seem that they would not be likely to spend a lot of time perusing advertisements, which are presumably related to the article, on a news site.  The losses News Corp is complaining about—consumers of light news-summaries in lieu of actual articles who otherwise buy a lot of related products through ads on News Corp’s sites—must be at the margins.

What News Corp is really complaining about is that it can’t free ride off Google’s search engine. It wants all the value from placement without paying any price.  And placement has value.  The ads at the top of the page are paid ads.

Antitrust Issues in Common Ownership of Natural Competitors: A New Storm Coming

On Wednesday, March 9, 2016, Assistant Attorney General of the Antitrust Division Bill Baer testified before the Senate Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights that the Division is presently investigating minority common ownership of natural competitors in concentrated industries.  These investigations are likely in response to two important papers—an economic analysis by Jose Azar, Martin Schmalz and Isabel Tecu, of minority common ownership that showed an increase in price to consumers where competitors in a market shared common minority shareholders; and a law review article by Einer Elhauge calling for increased antitrust enforcement against minority common ownership.

Professor Elhauge concludes that common ownership of competitors alone is sufficient to trigger the price effect and therefore harm consumers. His theory is essentially a per se theory.  If you own shares in competitors, there will be a price effect, so the overlap must be eliminated.  Professor Elhauge states that “active communication is unnecessary for horizontal shareholdings to have anticompetitive effects.  Without any active communication, corporate managers know the identity of their shareholders and the fact that their shareholders also own shares in their rivals” p. 1270.  He states further that “[m]anagers thus know that taking away sales from rivals imposes a cost on their shareholders…” Id. And lastly, he states that the “anticompetitive incentive created by this horizontal shareholding is purely structural, changing the price setting incentive of each firm acting separately” Id.

The economic paper is significant from a policy perspective. It is one of the first to identify an actual price effect related to common ownership and so an actual harm to competition.  And it’s getting serious consideration from the academic, and now, enforcement community.  Private equity firms that hold minority positions in natural competitors should be very concerned about the potential increased enforcement that may result from the papers.

Professor Elhauge is correct that the antitrust laws currently provide an effective vehicle for that enforcement as well. An activist shareholder that communicates a desire that his company stabilize price or margins in a particular market and communicates the same desire to that company’s competitor may in fact be acting as a hub of a conspiracy that violates Section 1 of the Sherman Act.  Indeed, this model is the very model that resulted in Apple being held liable for price fixing in the ebooks market.  Section 7 is also available.  Section 7 prohibits mergers or acquisitions that substantially lessen competition or tend to create a monopoly.  Section 7 applies equally to consummated transactions as it does to transactions subject to the notification provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

There are issues with Professor Elhauge’s approach, however. In the absence of evidence of communication between the minority shareholder and the competing firms, proving that it was the minority shareholding alone that caused the price increase will be much more difficult that Professor Elhauge anticipates.  Competitors in concentrated markets are incentivized to act in parallel.  Removing shareholder overlaps will not decrease concentration in the relevant product markets and therefore will have little effect on the ability of competitors to act in concert.  The elimination of the overlap will not affect the structure of the market as it will not reduce concentration.  What it does do is eliminate an avenue of communication between the parties and so a means to police an agreement.

More importantly, though, I do not agree that managers set price or other terms of dealing in order to enhance the profitability of large minority shareholders absent direction from those shareholders and his CEO. The individuals that set the workaday price on products in a large corporation are typically not the CEO.  They are mid- to low-level managers who are most likely compensated based on their sales.  They are incentivized to undercut their competitors’ prices because the profits they gain exceed the price reduction.  Their compensation is likely not tied to how their competition is doing, and certainly not how a particular investment fund is performing.  In fact, the only individuals the activist shareholders have sway with are the officers of the company—they are the ones that the activist can demand the board fire.  If a CEO feels that her job is on the line, she will be the one that instructs the managers to harmonize price.  It is that instruction that realigns the incentives of the manager.  Rather than lose his job, he does what the CEO says.  Absent the pressure from the CEO, the manager will seek to maximize his personal earnings.  Compensating the CEO based on market performance may incentivize her to compete less, but at the end of the day, the Board will still be looking at the metrics of the company and assessing that CEOs performance.  The Board owes a fiduciary duty to the shareholders, not to the market.  Absent pressure from the activist, the CEO will have her company behave competitively.

Given the causal connection between ownership (without more) and the manager’s incentives to set price is so tenuous, it would appear that condemning joint ownership without more is overly broad. The better rule would be to see if there is an actual hub-and-spoke conspiracy going on.  Is the activist inciting the two companies to act in parallel and is there an actual effect in the market.  Is there real pressure being put on the CEO that is being telegraphed to the actual price setters in the company such that they are altering their behavior.  Absent that evidence, the agencies should be loath to condemn common ownership because there may in fact be no competitive problem at all.

Private equity should not fear common ownership of natural competitors. If they do have such cross holdings, however, funds should either restrict activism or create separate clean teams for each holding.  From the agency’s perspective, it might want to revisit the investment purposes only rules, possibly limiting its availability only to blind holdings.  Any fund anticipating taking an activist role should seriously consider filing an HSR notification irrespective of whether it takes a formal role as an officer or director of the company.

Germany’s Probe of Facebook

On Wednesday, March 2, 2016, the Bundeskartellamt (BKA), Germany’s antitrust enforcer, announced that it had initiated a probe of Facebook.  In announcing the probe, BKA president Andreas Mundt stated that, “For advertising-financed internet services such as Facebook, user data are hugely important.  For this reason it is essential to also examine under the aspect of abuse of market power whether the consumers are sufficiently informed about the type and extent of data collected.”  The view is that the BKA is probing whether Facebook’s terms of service, which permit the use of user data for ad-tracking, are an abuse of Germany’s data protection laws and of its dominant position within the social network market.

The BKA’s investigation appears to be related to the European Union’s broader “digital single market” initiative. The EU is generally looking at its digital markets in an effort to make them more competitive.  As part of that initiative, for example, in September 2015, the EU initiated a public consultation on the regulatory environment for platforms, online intermediaries, data and cloud computing and the collaborative economy.  The first brief results are available from that survey.  This initiative, at least in part, is ostensibly designed to reduce the amount of regulation applicable to these markets, to help “level the playing field” and make the collaborative economy more competitive.  Some commentators are skeptical of that stated intent, notwithstanding promises from Europe to the contrary.  These commentators seem to think the EU is targeting US tech companies with a view toward breaking them down to the benefit of national champions.

It seems fairly clear from this investigation of Facebook that that is in fact their goal. It may not be their intent, however.

Europe differs from America in its treatment of dominant firms. They believe that once a company is dominant, it effectively becomes a utility that needs to be regulated.  They also believe that the antitrust authorities can serve as ad hoc regulatory boards that step in freely whenever a dominant participant materializes and before the state can set up proper regulatory agencies.

The American bias is that dominant participants have achieved dominance because of business acumen and that it is market distorting to regulate those businesses absent actual exclusionary behavior. Very few Americans think the antitrust agencies should be regulating markets as part of their antitrust mandate.  So, when an American says, let’s level the playing field, it means, let’s create the freest possible market ab initio, throw the participants out into that market and allow the participants to fight to achieve dominance if they can.  When a European says it, it means, let’s make sure no one entity takes the field for any appreciable amount of time.  To them, the perpetual state of “competition” as evidenced by a market with large numbers of participants is the ends.  Sort of like an interminable game of whack-a-mole.  To Americans, the finish, or even perhaps the race itself, isn’t nearly as important as how the race starts.  Let’s turn to Facebook and the BKA.  At first blush, it would appear the question is whether Facebook is so dominant in social media that they can use that dominance to force consumers into giving up personal information that they would not otherwise absent that dominance.  The idea being that with that unlawfully gained data, Facebook can serve advertisements that are so perfectly tailored that other entities that offer advertising cannot compete with Facebook, or perhaps that the purchasers of advertising must always turn to Facebook as a source of supply.

As with any technology market, the critical first step is to unbundle the components of the offering to indentify the basic functional quanta that make up offering. Technology is very fluid.  One can move a hundred lines of code from one piece of “software” to another in a blink of an eye.  Looking at just the four corners of a piece of software to determine whether it’s a “product” is therefore a less-than-useful tool in assessing potential market power because it obfuscates the source of the potential market power—the functionality, or functionalities, that drive consumer demand.

Facebook offers several “functions.” One is the social interaction—keeping up with ones friends and acquaintances.  Users like you and I are consumers of social interaction.  Another is the advertisements.  Facebook sells a service to advertisers where they will serve up to particular individual advertisements for products that they believe the individuals will like.  Facebook has developed an algorithm—a model that can identify what its users like and may want to buy—by observing click-throughs on their own pages, by entering into tracking agreements with third parties like Amazon, and by correlating bits and pieces of what individuals post to their own pages with what they click through and purchase, among others.

Let’s look at Google briefly. Google knows, by virtue of its tracking systems, that when someone types in “pissed” in a search engine at 8:00 a.m. from a mobile device in a tunnel going into Manhattan that that person is probably angry about traffic.  So Google serves up anger management, alternative commuting resources and the like.  But let’s say someone types in “pissed” at 11:00 p.m. on a Friday in Cardiff.  Google might serve that person advertisements of pubs within walking distance of his location.  Google knows that “pissed” to a New Yorker means angry.  Google also knows that “pissed” means drunk to a Welshie at 11:00 p.m.  Repeat those interactions over billions of events over time, and Google becomes a massive lexicon, learning what people mean through their language and behavior as well as other indicia like location and time.

Facebook is the same. Except by virtue of its ability to understand what individuals are posting on their pages, Facebook’s knowledge can be far deeper than what Google can achieve because Facebook simply sees more into a person’s life.  Let’s say I type in “florist” in Google sometime near Valentine’s day.  Google serves up a few local florists that specialize in red roses.  It assumes that I want roses because it’s near Valentine’s.  Now let’s say, I’m on Facebook, however, and I have updated my status to say I’m going to a funeral on Friday in Austin and need to send some flowers.  Instead of the advertisement for rose-selling florists, I’m given a picture of a funeral flower arrangement and the name of a local Austin florist.  Facebook understands me better because it has a better context.  My best friend knows me better than a friend I play golf with at the club because my best friend has had more interactions with me in more contexts.  He knows I hate pastrami and would never suggest getting a couple sandwiches.  My golf buddy doesn’t.  If my best friend were to design ads for me, they’d be much more effective.

On its face, Facebook and Google (I’m ignoring Google plus) are very different products. In essence, however, they are very close substitutes.  In fact, given Facebook’s intimacy with users, Facebook has probably surpassed Google in its desirability as a competitor for advertising.  But because some people conceptualize the two as very different products, they will not see the two of them as competitors and as a consequence may in fact see much less competition between them than there is.  In a world where a presumption of dominance can lead easily to market distorting regulation, that ignorance can prove quite dangerous.

The value of each firm is in its ability to drive a diverse group of participants by offering meaningful services on their platforms. If they didn’t offer a great social service, then there would be no data.  And remember, that service is both a luxury and free.

There is some argument that people don’t realize how much companies like Facebook understand them. (I would not be surprised to see someday a “Facebook Career Coach” app that can tell you with some accuracy what career you should pick.  People who post obsessively about the Cure, cats and buy Size 10 Doc Martens should not become lawyers as 80 percent of those people who have done that live alone with their cats and post morose life defeating updates in mid-life…)  As long as people are told, however, that those data are being collected as you post about your most recent, well-earned sandwich, then they should be allowed to make that choice.  But that’s my American voice again.

In any event, the “lexicons” that Google, and now Facebook, have developed, have been developed because of the business acumen of those companies. Europe is free to come up with a product that is just as alluring as Facebook.  They are also free to require their social media to explain in whatever detail they want to users how those user’s data will be used.  But from an antitrust perspective, those lexicons are the hard-earned intellectual property of the companies that invested the time and money to develop them.  Giving access to those lexicons to undeserving, late arrival rivals in the interests of “leveling the playing field” is inefficient market distortion.

Beware: You May Not Be Immune

New York State Health Care—DSRIP, PPSs,
COPAs and Antitrust “Immunity”

New York has received permission to use over $8 billion in Medicare and Medicaid funds to revamp how healthcare is provided throughout the State.  As part of this process, the New York State Department of Health (DOH) is encouraging, and sometimes, requiring, competing healthcare and other service providers to form collaborative groups (PPSs) and enter into other agreements.  The DOH has stated that these groups may request certificates of immunity (a COPA) from the federal and state antitrust laws for those activities.  Notwithstanding what the DOH has declared, it is not clear that antitrust immunity will be available for those groups or activities even if they apply for and receive a certificate.

New York State cannot unilaterally exempt parties from prosecution under the federal antitrust laws.  Under the concept of “state action immunity,” a State may establish and actively operate a regulatory regime that displaces normal competition.  Whether that regime does in fact sufficiently displace competition is a question of law and fact for a court.

In addition, the market in New York is replete with well-funded, legally sophisticated parties that are against immunity.  These parties include a good number of the State’s major healthcare plans.  The United States Federal Trade Commission regularly challenges ineffective state supervision under this doctrine, and a recent Supreme Court case, North Carolina State Board of Dental Examiners, has mobilized the plaintiffs’ bar.

Given how the DOH has structured the program, how many powerful parties are aligned against it, and the significant amount of money involved, healthcare providers in New York (and in other DSRIP states) should be cautious about engaging in behavior that might otherwise violate the antitrust laws.  Even if one has a certificate of immunity or is explicitly directed by the DOH to engage in a particular activity, providers can nonetheless face meaningful antitrust risk.  Ultimately, PPSs, and their members, should not assume immunity will be available.  They should closely evaluate not only future COPA projects, but what the DOH is telling them to do under DSRIP as well.

Regulatory Background

New York State recently entered into an agreement with the Centers for Medicare and Medicaid whereby the State will be allowed to spend up to $8 billion of Medicare and Medicaid funds on reducing avoidable hospitalizations and restructuring the New York State health care delivery system.  The New York State Department of Health has created a program to distribute these funds, the Delivery System Reform Incentive Payment (DSRIP) program.  As part of this program, the DOH is requiring that healthcare and other service providers form groups, Performing Provider Systems, to apply for DSRIP funds.  These PPSs are designed to be permanent fixtures of New York health care.

New York has the “Certificate of Public Advantage” law.  It allows healthcare providers to apply to the DOH for a certificate of immunity from the antitrust laws.  If the DOH grants the certificate, the parties may engage in the reported activity without triggering antitrust liability.  It is a general purpose healthcare statute.  The DOH must issue regulations with regard to how the statute is applied in any given situation and actively supervise the potentially exempted behavior.  The DOH has recognized that the PPSs and other activities contemplated under the DSRIP program may raise antitrust issues.  In response, the DOH has declared that the antitrust immunity afforded under the COPA law will be available to parties that apply for and receive a certificate and has issued regulations.

The Common Law of State Action Immunity

The DOH cannot simply declare activities immune from federal law.  The state can, however, create a regulatory regime that can fully displace the federal antitrust laws.  Under this doctrine, the “state action immunity” or Parker doctrine, otherwise anticompetitive activities are immunized from the antitrust laws if they are the intentional or foreseeable result of state or local government policy.  The Supreme Court has held that there are two requirements for antitrust immunity under this doctrine:  (1) the challenged restraint must be one clearly articulated and affirmatively expressed as state policy; and (2) the policy must be actively supervised by the State itself.  There is some question whether the articulated policies of a state executive department or agency, if not specifically articulated in the legislation, constitute the action of the state itself.  COPA can only invoke these concepts.  A court decides whether the State has been successful.

The DOH Process

There is reason to believe that the State may not be successful.  Under the Parker doctrine, the state must actively supervise the ostensibly immunized behavior.  If it does not, the activity will fail to obtain immunity notwithstanding the state’s intent.  The inquiry is not a one-time exercise.  State supervision must be ongoing.  And, at least according to the FTC, it is not enough that the board approve or casually review an activity:  it should develop and evaluate an unbiased evidentiary record; supplement the record if appropriate; undertake a de novo review of the merits of the action; and issue written opinions.  It should therefore not be sufficient for New York to declare that the participants in a PPS may agree on the price they charge for a particular service.  The DOH would have to actively supervise that pricing scheme.  Similarly, it should not be sufficient for the DOH to declare an otherwise anticompetitive merger exempt.  They would likely have to supervise the merged parties post-consummation to insure that whatever anticompetitive activities they could engage in as a consequence of the transaction are monitored and approved.  A broad certificate designed to exempt large categories of activities would likely not be sufficient.

Whether the DSRIP/COPA regime is valid “state action” under the doctrine is also unclear.  The DSRIP program is a creation of the DOH, not the legislature.  The PPS and DOH requirements like data-gathering are similarly a creation of the DOH.  And, while the COPA law was passed by the Assembly and signed by the governor, the DOH and not the Assembly declared that COPA would be available to participants in its DSRIP plan.

The DOH has issued regulations with regard to the application of the COPA law to DSRIP activities.  In part, the regulations provide that “[p]arties to a Cooperative Agreement or planning process may apply to the [DOH] for a [COPA] governing that Cooperative Agreement of planning process.”  Section 83-2.2(b).  The application must include a copy of the agreement, a description of the nature and scope of the agreement, a description of the consideration and other information.  Id.  The parties must publish notice on their website, and third parties may comment.  The DOH is obliged to review the application, looking at both the “advantages” and “disadvantages.”  83-2.5.  These disadvantages include reductions in competition.  Id.  The DOH must consult with the Attorney General and others.  Section 83-2.6.  The DOH may also impose conditions including, for example, implementation of a clinical integration plan, and achievement of quality benchmarks.  Id.  The regulations require filing annual reports.  Section 83-2.9.  The DOH may require reports to be filed with greater frequency.  The regulations specify what must be addressed in the reports.  Id.  This information includes “price, cost and savings information, including efficiencies achieved and additional information as requested…”  Id.  The reports also include other information like an analysis of the benefits and expected benefits of the agreement covered by the COPA.  Id.  The DOH is obliged to review the reports and seek additional information if it appears that the parties are not living up to their commitments.  And the DOH may revoke the COPA.  Section 83-2.12.

This process does appear to be consistent with active supervision.  A COPA can be for a particular agreement or activity.  The DOH requires regular reports and has the power to ask for additional information or condition granting of the certificate on the parties making particular promises.  The danger is that the DOH will not review the application or reports, or will not apply the standards with any rigor.  It is also not clear to what extent the particular responsible individual or group at DOH will have the expertise to evaluate sufficiently the proposed activities.  And while there is an external notice and comment provision, it’s unclear whether that process is sufficient to insure the DOH has a full and complete understanding of the application or the market necessary to make an informed decision.  A failure at any of these points could raise significant issues given who the potential plaintiffs might be.

But Is There Real Exposure?

One may argue that if the State itself is directing a party to collect and disseminate data, to jointly negotiate the purchase of inputs, or even the terms of offering services, for example, that the spirit of Parker is certainly invoked and the activity should be immunized.  Participants would certainly have a strong argument.  In the absence of powerful antagonists, or case law that supports a rigorous review of process, it would be reasonable to conclude exposure and risk are not high.

But there are in fact powerful antagonists.  Several of the State’s major health plans actively lobbied the Federal Trade Commission and Department of Justice to challenge the plan.  They include the New York State Conference of Blue Cross and Blue Shield Plans, the National Federation of Independent Business, and the New York State Health Plan Association.  And cases like North Carolina Dental have signaled to both the FTC and the plaintiffs’ bar that there is a meaningful chance of success.  Given the complexity of the DSRIP regime and the presence of sophisticated plaintiffs that dislike the program, it would seem that there is meaningful risk.

Next Steps

The PPSs need competent antitrust counsel as part of their ongoing operations.  PPSs are, almost by definition, groups of competitors.  Their agreements, indeed even their very conversations within a PPS meeting, could create problems.  The members of the PPSs too need to educate themselves on what is appropriate within this complex regime.  And certainly the plans and the consumers that would be exposed to potentially anticompetitive activities should know what their rights are.

At the end of the day, there are ways for members as well as PPSs to operate as good citizens under DSRIP and not violate the antitrust laws.  It is also possible to take advantage of COPA and DOH supervision to accomplish socially beneficial goals that might otherwise be unavailable, even given the problems inherent in the DSRIP implementation of COPA.  These are complex exercises, however, that require a meaningful analysis not only of the proposed activity but how the state and the DOH can participate in the activity sufficiently such that the parties’ risks are managed properly.

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