The Federal Trade Commission (FTC) and United States Department of Justice (DOJ) hosted a workshop on June 23, 2014 discussing the law and economics of “conditional pricing” programs. Most panelists were academics, including economists and law school professors. The bulk of the presenters advocated a more aggressive posture towards these arrangements than the courts have recently adopted.
Conditional pricing programs. Conditional pricing generally encompasses pricing, discounting and contracting practices in which a company’s prices charged will vary depending upon the level of purchases the customer makes from the company’s competitors. Examples include:
Bundled discounts: Supplier X, which sells dominant product A and competitive product B, grants a discount on product A (which the customers have to buy) so long as customers buy a certain percentage of their needs of product B from Supplier X, rather than from its competitors.
Loyalty / market share discounts: Supplier X, which has a dominant position in product A, grants discounts from its baseline pricing if customers purchase a high percentage (e.g., 90 percent) of Product A from Supplier X, rather than from its competitors.
Theories of harm. The panelists discussed two basic categories of theories of competitive harm.
Exclusion of rival manufacturer. When a smaller rival, perhaps a new entrant, tries to break in to a market, the dominant incumbent may impose a conditional pricing program that makes it hard for the new entrant to get a significant share of sales, which may deprive it of critical scale efficiencies and render it a marginal supplier, or perhaps even force an exit.
Coordination / collusion of customers / distributors. A retailer can be viewed as providing retailing services in the sale of the manufacturer’s products. The purchases and contracts different retailers receive from manufacturers can be thought of as inputs in the retailer’s provision of its services. Some of the economists stated their view that customers who may desire to coordinate their behavior as sellers can use conditional pricing programs from their suppliers to ensure that the input costs are comparable, which can reduce competition among retailers. For example, the conditional pricing program may ensure that no retailer switches over from the dominant supplier to the new entrant with a lower cost product. Keeping the customers from switching to the new entrant may make it easier to achieve or maintain coordination.
Relevance of cost based tests. The panel addressed cost-based safe harbors in great detail, with most of the economists opining that they were simply not helpful. The issue is whether conditional pricing programs that result in a product being sold “above cost” should fit within a safe harbor.
Legal background. This discussion starts with the Supreme Court’s Brook Group case, which found that above cost pricing cannot create liability under a predatory pricing theory. In cases involving bundled /multiproduct discounts, there has been a circuit split with the Third Circuit (LePage’s) allowing liability even if prices are above costs, and the Ninth Circuit (Peace Health) holding that above cost pricing is within a safe harbor. The courts, including the Third Circuit, have generally held that in the case of a single product loyalty discount, above cost pricing is lawful.
Economists generally viewed the cost-based tests as not relevant. The vast majority of the economists argued that the cost-based tests were simply not helpful in analyzing conditional pricing programs. There are difficulties in measuring costs that make them difficult to implement. There are also concerns about measuring what the “price” is. In some cases, a dominant supplier could have a monopoly price of $100 for a product, but then raise it to an above monopoly price of $110 as a new entrant enters, and then offer a discount for loyalty that takes the price back down to $100. In that case, several of the economists were of the view that there was no discount at all, but rather a “disloyalty tax.”
More importantly, the economists were of the view that even an above-cost pricing program could exclude or marginalize a new entrant trying to compete against a conditional pricing program from a dominant incumbent, which could have anticompetitive effects. They found no economic basis for applying a safe harbor based on a test that would allow for what they viewed to be anticompetitive conduct. In addition, the economists indicated that while the cost-based tests have some potential relevance to looking at the potential harms based on the exclusion of a smaller rival, they shed no light at all on the theory that the manufacturer’s conditional pricing program is used by buyers to facilitate coordination among themselves. There were some proponents of cost-based tests to allow for some degree of certainty for suppliers who want to discount, and who want to be sure their conduct cannot be challenged. In essence, they argued that you need certainty to enable discounting, which is generally procompetitive.
Economists generally rejected any standard based on whether an “equally efficient rival” could compete above cost. Another factor with cost-based tests is if in applying the test, courts should measure whether the seller engaging in conditional pricing is selling above its own cost, or whether the smaller competitor could meet the discount and sell above its costs. In general, the economists were strongly of the view that even a less efficient competitor could have significant procompetitive effects on a market that has been dominated by an incumbent supplier, and therefore rejected the relevance of an “equally efficient competitor” standard focused on the seller’s own costs and whether its prices were above cost.
Conclusion. The academic community, which is likely to be influential to the antitrust agencies, generally indicated that conditional pricing programs had significant potential to be anticompetitive. This applied equally to single product loyalty discounting programs and to multi-product “bundled discount” arrangements. The panelists generally advocated case-by-case analyses of these programs, focused on the potential anticompetitive effects, rather than on broad safe harbors such as price / cost tests. There seem to be some similarities between the analysis of these conditional pricing programs and the reverse payment cases that have been so predominant in the pharmaceutical industry. In the Actavis case, the Supreme Court rejected what was essentially a safe harbor for settlements that did not extend beyond the scope of the patent, instead subjecting reverse payment cases to rule of reason analysis. It seems that the academic community is similarly pushing for the FTC and DOJ to evaluate conditional pricing programs under the rule of reason, rather than allowing for safe harbors where price is above cost. It appears the law in this area continues to evolve.
The agencies will be accepting comments for the next 60 days, through August 22, 2014. In some prior situations, similar workshops have led to agency enforcement guidelines. Companies engaged in, or potentially impacted by, conditional pricing programs may wish to comment.