aai
The American
Antitrust Institute
Prepared for the Special Issue on Competition Policy & Antitrust, Volume 20 (1), Journal of
Public Policy & Marketing, pp. 51-63.
Copyright Albert A. Foer
E-Commerce Meets Antitrust: A Primer
Albert A. Foer *
*
President, American Antitrust Institute, an independent education, research, and
advocacy organization, described at www.antitrustinstitute.org.
2919 ELLICOTT ST, NW • WASHINGTON, DC 20008
PHONE: 202-244-9800 • FAX: 202-966-8711 • E-MAIL: [email protected]
www.antitrustinstitute.org
E-Commerce Meets Antitrust: A Primer
Abstract
In this introduction for non-lawyers to the nation’s antitrust laws and institutions and how
they are likely to apply to electronic commerce, the author argues that it is important for the
government to help assure that the industry will be shaped, during its current malleable phase,
along competitive lines.
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Competition. Monopolies. Trustbusting. The vocabulary of “antitrust” surely reminds
one of the copyrighted game of Monopoly, invented in 1933 by an unemployed heating
engineer named Charles Darrow, which became one of America’s favorite and most enduring
indoor sports. The popularity of the game no doubt tells us a lot about our culture. We love to
compete and we value competition. We love to win and we value winners. We also love to put
an end to competition by achieving the status of monopolist. What can be more fun than
charging your colleagues monopoly rents when they land on one of the properties that you
have brilliantly monopolized?
On the other hand, contemplate the chagrin of landing on a monopolized Park Place.
What is more frustrating and debilitating than being a consumer or business that is compelled to
pay tribute to a monopolist? We like the game of competition so much that we create antitrust to
preserve it from an endgame of monopoly. It is the fundamental ambivalence of this situation —
a social interest in motivating competitors to go all out to win and an off-setting interest in
preserving the benefits of the game itself — which underlies and complicates our national policy
of antitrust.
The sudden birth of a “New Economy” based on the Internet presents a challenge to
antitrust. Although I employ the terms “New Economy” and “Old Economy” in this paper, I have
real doubts about the accuracy and usefulness of this dichotomy. At most, it will be of only
temporary utility, as “old” industries become increasingly intermarried with “new” ones, either
through the adoption of the same technologies or through mergers.
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Can the 110-year old institution of antitrust be adapted to tomorrow’s economic realities?
Hasbro now owns the game that Parker Brothers long distributed and it has just announced its
“dot.com edition” of Monopoly. Here, the prime properties assume names like Yahoo.com,
Priceline.com, and AOL.com. “The dot-com is fun because it is about acquiring monopolies of
dot-com industries,” says the spokesman for Hasbro. (Reuters 2000) To maintain one’s social
standing, therefore, even the non-lawyer must be able to talk about antitrust in the age of the
New Economy. More seriously, for those involved in marketing for or to or in competition with
e-commerce companies, understanding the rules of competition will be particularly important as
workplace realities change. Communications (internal or external) that are uninformed by an
awareness of how the antitrust laws might be applied can break a company or a career.
So let us turn to the game of antitrust, as played not on a game board but in the real
world. (For a more detailed introductory text written for the businessperson, see Shenefield and
Stelzer 1993; an up-to-date treatise that is accessible though written primarily for lawyers and
economists is Sullivan and Grimes 2000.) “Antitrust,” incidentally, does not mean “against
credibility.” The word derives from the populist battle against the trusts (monopolistic holding
companies) that arose to control key industries after the Civil War. There are three basic laws that
establish the framework of antitrust: the Sherman Act of 1890 (15 U.S.C. section 1 et seq.), the
Clayton Act of 1914 (15 U.S.C. section 13 et seq.), and the Federal Trade Commission Act, also
of 1914 (15 U.S.C. section 5). These are enforced both by the Antitrust Division of the
Department of Justice and by the Federal Trade Commission.
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While both the FTC and the Justice Department share antitrust jurisdiction, it is probable
that the FTC will take the lead on e-commerce (Simpson 2000), although this is not to suggest
that the Antitrust Division will not be actively involved (Klein 2000). In part, this is because the
Commission has developed expertise in high-tech industries (the FTC, for example, handled the
AOL/Time Warner merger) and in part because the current development of e-commerce requires
a closer than ordinary linkage between the two missions of the FTC, i.e., maintaining
competition and consumer protection.
With the e-commerce industry itself understanding that consumer trust will be critical to
its growth, and that such trust depends on the development of adequate protection for privacy
and security, the FTC has become what the Wall Street Journal calls “the federal government’s
de facto regulator of Internet commerce.” About 80 staff members work full-time on Internet
commerce issues. FTC Chairman Robert Pitofsky has spoken about the need to encourage the
electronic revolution, but to “contain the excesses that revolutions often produce.” In a recent
speech, he focused on three e-commerce issues: Internet fraud, privacy, and the challenge of
cooperation and coordination in international law enforcement. (2000b) (On March 23, 2000, the
FTC’s Internet investigation group, in coordination with local and state officials, the SEC
Internet specialists, U.S. postal inspectors, and consumer protection officials from around the
world, launched a sweep of 1,600 sites used by con artists. (Wall Street Journal 2000)) But as
will be seen, both the FTC and the Antitrust Division are also playing a significant role in
applying antitrust to e-commerce.
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The antitrust story is not limited to two federal agencies. Most of our states have their
own versions of the antitrust laws, with which a business must also comply. Private parties may
sue for treble damages under the federal antitrust laws, and private suits outnumber federal
prosecutions by a margin of roughly ten to one. (Gellhorn and Kovacic 1994, p. 462) Finally,
other nations — now numbering over 80 — have what they tend to call “competition policy”
laws that are variations of our own antitrust. This game, clearly, has lots of ways one can pick up
an “antitrust penalty” card.
The rules of the antitrust game are typically stated in very general terms, much like our
Constitution. Indeed, the Sherman Act is often referred to as the Magna Carta of our economy. In
general, unreasonable combinations, unreasonable restraints on trade, and unfair methods of
competition are illegal and monopolization and the attempt to monopolize are illegal. In certain
respects, the statutes appear to be more specific, in effect codifying examples of the more general
prohibitions. For instance, under the Clayton Act, tying arrangements and exclusive contracts are
illegal if they reduce competition. Some statutory language may go beyond the general
principles: for instance, the Robinson-Patman Act, an amendment to the Clayton Act, defines
illegal price discrimination in great (if not necessarily intelligible) detail. But the more you look
at the antitrust statutes and the cases that interpret them, the clearer it becomes that not a whole
lot is absolutely clear. As with our Constitution, clarification comes mainly from the courts and
from certain traditions derived from judicial opinions. Today, there is, in fact, only one bright red
line: agreement on minimum prices by competitors, or bid-rigging, or dividing up markets is
always illegal. This “horizontal collusion” is the supreme no-no that can take you directly to jail
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without passing Go, and can cost you, as in the recent case of the international vitamin cartel,
nearly a billion dollars in criminal penalties and another billion or more in civil damages.
Beyond horizontal collusion, which is deemed per se unlawful, virtually every other
business action that is challenged under the antitrust laws will be measured by the so-called Rule
of Reason, a somewhat amorphous process that involves a great deal of time-consuming and
expensive fact-finding, economic analysis, and balancing of benefits against harmful impacts and
potentials. While this sounds like a wide-open subjective search for answers, there is in fact a
large body of precedent and guidance that substantially reduces the room for decision-makers’
discretion. In a forthcoming article I argue that antitrust enforcers are “trammeled” rather than
untrammeled in their decision-making, as a result of the following constraints: laws; regulatory
rules and guidelines; judicial precedents and the threat of judicial review; substantive legislative
oversight; budgetary legislative oversight; executive branch oversight; peer group oversight; an
institutional culture; personal commitment of the regulators to antitrust; and internal
whistleblowing by co-workers. (Foer forthcoming; Waller 1998)
The framework of antitrust was built over a period of more than 100 years and it has
survived war-time economic mobilizations, depression experiments with associational
alternatives to competition, political regimes of varying ideological content ranging from
populism to laissez faire, and the advent of revolutionary new technologies that have redefined
markets. (Foer and Lande 1999) Perhaps the very vagueness of its statutes has given antitrust a
flexibility that has kept it relevant, even as it has made difficult the precise predictability of how
antitrust will be applied to the facts of any particular business situation.
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There are those who question the continuing relevance of antitrust to electronic
commerce. For example, Judge Richard Posner has written an essay arguing that although
antitrust doctrine is sufficiently flexible to deal with issues likely to be raised in the New
Economy, there are two problems that antitrust will be unable to deal with: (1) New Economy
industries change much too quickly for slow-moving antitrust to keep up with; and (2) New
Economy disputes will require highly specific technical information, such that the judicial
process will only be able to make decisions with the assistance of independent technical experts
— and such independent experts are not available. (2000) And The Economist warned recently,
“Beware politicians, lawyers and economists who put too much trust in antitrust.” (2000d) These
observations can be subjected to empirical and theoretical testing, and I am by no means
endorsing them here. My advice is to act as if antitrust will be highly relevant, although exactly
how antitrust will help shape e-commerce will take years of working out.
Of course, electronic commerce itself is new and rapidly changing. As described in a
survey in The Economist,
In business-to-business transactions, in particular, the advantages and cost savings
to be had from dealing on the Internet have caused e-commerce to mushroom. At
present, such transactions account for as much as 80% of all e-commerce, which,
according to Forrester Research, an Internet consulting firm, added up to over
$150 billion last year. Forrester predicts that by 2003 that figure could reach over
$3 trillion. (2000c)
The rapid development of electronic marketplaces or exchanges, in which hundreds of
upstart online sites scramble to make themselves the new commercial hubs of industries from
aerospace to waste management is now being amended by incumbent companies “firing back
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and staking their claims on the Net.” (Hof 2000) “Y2K” may be remembered not so much as the
year when the computer failed to shut down the world’s economy as the year in which a veritable
Cambrian explosion of new business forms exploded on the Internet scene. As Business Week
summarized a single week of activity:
On Feb. 25, GM, Ford, and Daimler-Chrysler said they would collaborate on a
single exchange for auto-parts suppliers…On Feb. 28, Sears Roebuck & Co. and
the French retailer Carrefour announced an Internet retail exchange to handle the
$80 billion they spend annually on supplies. They have invited other retailers to
join…On Mar. 1, Cargill, DuPont, and Cenex Harvest States Cooperatives
announced plans for an agricultural hub, while reservations giant Sabre and
software maker Ariba formed a site for the travel biz. (Hof 2000)
By late in the year 2000, it was reported that entrepreneurs had launched more than 700
B2B marketplaces, though few if any at all had reached even 1% of the overall trading volume in
its industry. (The Economist 2000a) With such a rapidly changing and largely unpredictable
industry structure, it is particularly difficult and perhaps even premature to suggest exactly how
antitrust will apply to e-commerce. Nonetheless there are both enduring principles and straws in
the wind that give us plenty to talk about. Many consultants, economists, lawyers, and
government officials have opined on the subject. (See Stanley 2000 and Jones, Day, Reavis &
Pogue 2000.) The best single source on the subject is the Federal Trade Commission’s staff
report, Entering the 21st Century: Competition Policy in the World of B2B Electronic
Marketplaces, sometimes referred to here as “The FTC Staff Report.” The FTC web site also
contains a variety of papers and statements submitted to the workshop on which the report is
based. (Federal Trade Commission 2000)
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Keeping the Old from Murdering the New in Its Cradle
Although many business people have a knee jerk belief that antitrust can only mean
trouble, let us begin by pointing out an extremely important positive role it plays in keeping open
the channels of innovation. E-commerce represents the New. From the perspective of the legacy
businesses, it is the internal combustion engine that is about to outmode the buggy whip. “Those
who have invested money, time and effort in the previous business model — suppliers,
employees, bankers, shareholders, even customers — are likely to resist the change,” notes
The Economist. (2000b, p. 18) Antitrust helps assure that the modes of resistance do not
unreasonably restrain trade. It gives the New an opportunity to prove that it is more appealing
than the Old.
For example, the FTC in 1998 brought a little noted but significant case, which involved
an effort to boycott Internet competition. (Federal Trade Commission 1998) A Chrysler
dealership in Kellogg, Idaho, created a web site where consumers in Idaho and nearby states
could shop for cars from the comfort of their homes. By advertising on the Internet, this dealer
offered consumers in remote parts of the state — and in other states — the opportunity to
comparison shop in a far less costly and time-consuming fashion. A group of 25 rival brick-andmortar dealers responded by forming an association called Fair Allocation System (“FAS”) and
collectively threatened to refuse to sell certain Chrysler vehicles and to limit the warranty service
they would provide customers unless Chrysler changed its allocation system to disadvantage
dealers that sold large quantities of vehicles outside their local geographic area. In effect, this
was an attempted group boycott of Chrysler.
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Group boycotts are also known as concerted refusals to deal. According to Herbert
Hovenkamp, per se illegality applies to “[S]o-called naked boycotts — that is concerted refusals
of competitors to deal with another competitor, customer or supplier when no case can be made
that the refusal is ancillary to any legitimate joint activity.” (1994, section 5.4a1) As Lawrence
Sullivan and Warren Grimes note, “Though any individual trader can decline to trade with any
other trader for any reason, horizontal competitors may not act concertedly to inhibit market
access to any other trader solely because they want to be spared its competition.” (Sullivan and
Grimes 2000, section 5.8)
The Commission obtained a consent decree barring FAS from coordinating or
participating in future boycotts. Spokespersons for the FTC have made it clear that they expect
similar battles between the Old and the New to manifest themselves in antitrust violations.
A book by Philip Evans and Thomas S. Wurster, Blown to Bits, develops this theme in the
context of the battle between established companies and independent “navigators.” (2000)
The authors focus on the revolutionary process of “deconstruction,” which they define as the
dismantling and reformulation of traditional business structures, resulting from the new
economics of information. (2000, p. 39)
Deconstruction implies choice. Choice, beyond a certain point, implies
bewilderment. Hence, the rise of the navigator. Navigators may be software
programs (such as Quicken), databases (Auto Trader), evaluators (Consumer
Reports, J.D. Power), or search engines (Yahoo!). They can also be
people…Navigation may look like a small business, but it is likely to be the
fulcrum around which competitive advantage hinges. (2000, pp. 64-65)
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“Navigators lower the cost of search, increase its comprehensiveness, and align the
search process more closely with the interests of the buyer.” (2000, p. 151) Navigators pose a
critical challenge to traditional sellers because they tend to be aligned with consumers rather than
with sellers.
As their reach goes up [i.e., as navigators’ number of customers increases through
internal growth and mergers], their affiliation to sellers loosens, which provides a
further advantage in competing for buyers. Some navigators get ahead of the
others, cross the threshold of critical mass, and then march toward positions of
monopoly in their respective search domains. Winner takes all. Armed with
superior reach, a high level of consumer affiliation and trust, and equivalent
richness…, that navigator is advantaged in navigation against both retailers and
suppliers. Retailers are demoted to the physical role of distributor. Suppliers see
their business commoditized, or at least forced to compete on product-specific
characteristics such as cost, technology, and features. Much of the value potential
of the business is drained off. (2000, p. 135)
What should a company or an industry do when its business is challenged by a navigator?
The authors suggest several lines of defense for a challenged industry, perhaps the most relevant
being: “[P]revent the new navigators from achieving critical mass. [Most Internet-based
navigators lose money for a number of years, making them particularly vulnerable to aggressive
strategies during the phase when they are trying to achieve a critical mass.] Suppliers and
retailers are the source of the information on product features, price, and availability that the new
navigators need. So simply refuse to make that information available.” (2000, p. 138) But this is
not so easy. “Unless the selling business is highly concentrated, it is unlikely that the navigator’s
ability to achieve critical mass will depend on the availability of data from any one source.
Therefore, while it is undoubtedly in the interests of all sellers collectively, it is not in the
interests of any one seller individually to deny its own data to the navigator.” (2000, p. 140)
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Evans and Wurster are vice presidents of the Boston Consulting Group, which
(coincidentally?) is the consulting firm that was retained by the nation’s leading airline
companies to create a new Internet joint venture, known as Orbitz. Orbitz, representing the
established industry, expects to compete against Internet travel distributors such as Travelocity
and Expedia, as well as traditional ticket agents — in other words, against independent
navigators. It has been claimed by these and other critics that the purpose of Orbitz is to keep any
of them from achieving critical mass, and that the technique for doing so is to create a joint
venture of virtually all the airlines, who will agree to withhold their lowest fares from all
navigators except Orbitz. The Department of Justice and the Department of Transportation are
investigating. (American Antitrust Institute 2000)
The battle between established companies and newcomers is one major theme of antitrust
and e-commerce. Next we turn attention to three other important issues: networks and lock-in
effects; dependence on standards; and the rapid structural change caused by mergers,
acquisitions, and joint ventures. Finally, we will talk about B2B Electronic Marketplaces.
The Problem of Monopoly
The Sherman Act makes it illegal to monopolize or attempt to monopolize. The mere
status of being a monopolist, however, is not illegal. As one political scientist described it, it is
o.k. to be a dragon, but you cannot dragonize:
Over and over, the courts face the huge fire-breathing dragons that are incessantly
dragged up before them. But then each dragon sits down, sticks its thumb in its
mouth, and says, “It is true that you people don’t want dragons roaming your
streets, but I couldn’t help being a dragon, and I am really a very nice dragon. The
crime is dragonizing — not being a dragon — and while I admit being a dragon,
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you can’t prove I acted like one. In fact, I have always acted like a little woolly
lamb.” (Shapiro 1964, p. 268)
Because it is in the nature of dragons to dragonize, it has never been easy to say when a
monopolist is going too far. The standard is also a little different in many other countries, where
the law says that a dominant firm may not abuse its dominance. So, who is a dominant firm?
And, for that matter, who is a monopolist?
These are not easy questions. Both dominance and monopoly status entail a high degree
of market power, which is the ability to raise and sustain prices above the level that would be set
by competition. “Although market power can be exercised by a participant either as a seller or a
buyer,” note Sullivan and Grimes, “it is usually defined from the point of view of the seller:
market power is the seller’s ability to raise and sustain a price increase without losing so many
sales that it must rescind the increase.” (2000, p. 22) The first analytical step, therefore, is to
define the relevant product and geographic market, and this can be influenced by e-commerce.
For example, in analyzing a supermarket merger, should one count the sales generated within the
geographic market by an e-grocer such as Peapod.com? Or do the on-line grocery merchants
constitute a separate market? As brick and mortar companies try to combine with each other or
indeed as they combine with Internet companies, antitrust enforcers will increasingly be required
to answer this fundamental type of market definition question. To date, the e-commerce
companies have been viewed as too small to have a substantial impact on traditional markets, but
as they grow in sales volume, their role will be examined with more and more care.
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An important case for analyzing markets in this light may be the failed acquisition of
Office Depot by Staples. The merging parties argued that the relevant market included all
channels that distributed office supplies at the retail level. The FTC successfully argued that
Office Depot, Staples, and Office Max were the only three companies in a super office store
market whose characteristics set it off as a separate market for purposes of antitrust analysis.
(Dalkir and Warren-Boulton 1999, p. 143) The FTC’s victory rested on a market definition which
at first seemed questionable (there being so many retailers of office supplies), but the careful
marshalling of price data and other empirical evidence showed that office superstores constituted
a separate market. This type of hard-nosed emphasis on facts is one characteristic of postChicago antitrust analysis.
The second step, after defining the relevant market, is to ascertain whether the purported
monopolist or dominant firm in fact has a dominant position. Unfortunately, this has not proved
to be something that can be done by a simple numerical test, such as “You are not a monopolist if
you control less than 60% of the relevant market.” Other factors beside market share, including
the potential of entry by new competitors, must be analyzed. Incidentally, it is generally easier to
be crowned as a dominant firm in Europe than a monopolist in the U.S., a fact that may be
relevant to an international electronic commerce network.
In most traditional industries, monopoly has not been deemed necessary as a condition of
efficient operation. In other words, while there are often efficiencies of scale, most industries are
subject to diminishing returns and the minimum efficient scale is generally small enough for an
industry to have room for multiple efficient performers. (Scherer and Ross 1990, pp. 97-106)
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Most industries, therefore, are oligopolies. Where economies of scale are so great that there is
room for only one supplier, as in electricity transmission, we term the situation a “natural
monopoly.” Typically, a natural monopoly has been subjected to direct governmental regulation,
as an alternative to regulation by the competitive market that could not be present.
The Internet provides a new paradigm. Richard B. McKenzie elaborates from what
appears to be a libertarian perspective on the differences between the old paradigm and the new,
concluding, “The efficacy of antitrust law enforcement has been on trial. The Microsoft case has
been the first large-scale antitrust proceedings of the digital age; it has tested the appropriateness
of new economic concepts such as ‘network effects,’ ‘tipping,’ ‘path dependency,’ and ‘lock-ins’
and has forced us to ask whether nineteenth-century antitrust law, combined with twentiethcentury enforcement norms, are applicable to twenty-first-century problems of business
organization.” (2000, p. 2)
The Internet has brought us a sudden abundance of network industries that move
information from one place to another. In these networks, there are both supply-side scales and
demand-side externalities: often, the more consumers who participate, the greater the overall
value of the net and the lower the marginal cost of production. In a network industry, the concept
of diminishing returns is replaced by increasing returns. Frequently, this leads to a “tipping
point” and winner-take-all competition, in which case the market share will be so high that
monopoly status will be attained.
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Critics of antitrust question whether this type of monopoly should be considered the same
as a monopoly in a traditional industry. One question they raise relates to market definition:
supposing Peapod.com were the only web-based retail grocery company in a community, would
it be a monopolist? Or would it be considered a relatively small competitor in a market defined
to include the incumbent supermarket chains? While not necessarily an easy question, defining
markets has a long and increasingly sophisticated history, and answers can be found based on
detailed factual analysis.
Perhaps a more fundamental question is whether network monopolists should be
attacked by antitrust. Critics argue that in the New Economy, monopolies are temporary and
monopolists, always threatened by potential competitors, tend to act more competitively than
traditional monopolists. “Indeed, some firms with high market shares might act more like
competitors than other firms in markets where they have much smaller market shares,”
McKenzie posits. “The reason is that the threat posed by potential competitors in a highly
concentrated market can be more constraining than the competitive threat of actual competitors
in less-concentrated markets.” (2000, p. 34) This may be more a profession of faith than an
empirically-based generalization. After deregulation of the air transportation industry, many
airline mergers were permitted on the basis of “contestable markets” theory, which assumed
that new entry by potential competitors would render increasing concentration irrelevant.
Things have not worked out this way. To the contrary, as demonstrated by airlines and
Microsoft, monopolists tend to find ways to maintain their status over time by using their
power to make new entry extremely difficult.
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One characteristic of network industries having entry barrier implications is the ubiquity
of “lock-in,” which means that once a consumer or business is attached to the network, the costs
to switch to a different network are so great that for practical purposes any new competitor is
foreclosed from this customer. From an antitrust perspective, lock-in makes it less likely that a
new competitor will enter the market, even if it offers a superior product or service. A firstmover thus has an advantage that may not only lead to total domination of the market in the
short-run, but the inability of a newcomer to challenge the monopoly in the long-term. Critics
respond that lock-in is a myth.
Some Implications of the Network Model: Predation
I want to call attention to several of the consequences for antitrust analysis of the
information network model, beginning with the concept of predation. Price predation was one
of the monopolistic abuses that led to the breakup of Standard Oil in 1911. The idea is that a
monopolist can wipe out its smaller competitors by using its deeper pockets to undercut the
competitors’ prices, thereby taking away their customers. Once this has been accomplished, the
monopolist can raise his prices and reap the benefits of monopoly status. This conception of
predation came under attack by what is known as the Chicago School of Law and Economics.
The Chicago School dominated federal antitrust enforcement during the years of the Reagan
administration, and still has substantial influence on the course of antitrust. The Chicago point is
that price predation probably occurs so rarely that government is better advised to not challenge
episodes of price-cutting, for fear that their action would undermine legitimate aggressive price
competition. Moreover, Chicagoists set out a standard for identifying predation that is very
difficult to meet: the price must be so low as to be below the company’s own marginal costs and
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the investment in low-pricing must be likely to be recouped in the same market after competitors
leave. Chicagoists also postulate that entry into markets is typically easy, so that they would
rarely find a situation where the investment is likely to be recouped.
In recent years, a post-Chicago approach to predation has evolved, based largely in game
theory and strategic thinking, and it finds predation much more likely to occur. Even if one
accepts the idea that predation can only occur when price is below marginal cost, it must be said
that this was formulated in a context where marginal cost was usually near average cost. There is
substantial question whether price-below-marginal-cost represents a realistic test in an industry
where marginal costs approach zero.
With that necessary background, let’s turn to information networks. Listen to these quotes
from a leading text on strategies in a network industry:
When trying to estimate the benefits of price-cutting, it is important to realize that
you are investing not only in eliminating a potential competitor but also in
establishing a reputation as a formidable opponent. This investment will be amply
repaid down the road by discouraging potential entrants…
A credible threat of price cuts after entry may be enough to convince would-be
competitors that they won’t be able to recover their sunk costs and thus
discourage them from entering the market in the first place…
In some cases, especially for software with a zero marginal cost, you can go
beyond free samples and actually pay people to take your product… The player in
a standards battle with the largest profit streams from related products stands to
win the war. (Shapiro and Varian 1999, pp. 31, 274, 275)
In other words, competition in an information network industry might turn on first-mover
advantage, exploiting that advantage by pricing far below current average costs and even below
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marginal costs, and obtaining recoupment at some later point in time, with reputation for
aggression being one of the desired returns. Will this strategy be permitted? Should it be deemed
predatory or merely appropriately aggressive?
After a full generation during which concepts of predation were moribund, the Justice
Department is currently and in my view correctly attempting to reinvigorate the idea that
monopolists can obtain and maintain their position through predatory pricing. Two current cases
involve predation within network industries. The airline industry operates through a network of
routes and many of the airlines have created transportation hubs as a central node for their routes.
The airlines tend to dominate their own hubs and often use various tactics described as predatory
to keep new low-cost entrants from operating out of these hubs. Typically, when a new entrant
tries to come in, the dominant firm lowers its prices on competing routes and makes available
additional seats on its flights. When the new entrant eventually gives up, which doesn’t take very
long, the dominant firm raises its prices.
The Justice Department is suing American Airlines in a test of its ability to deal with this
behavior. It is fairly typical of predation cases that the predator picks off a specific target, usually
a new entrant or maverick. American is alleged to have picked off three low-cost competitors
(Vanguard Airlines, Sun Jet International, and Western Pacific) on the occasions when they tried
to enter the Dallas-Fort Worth International Airport. When Vanguard entered, it is alleged,
American cut prices and added flights on nearly all of Vanguard’s Dallas routes, including the
one to Wichita. Two months later, Vanguard abandoned its routes and soon after that American
reduced its capacity on the Wichita route by 30% and raised the one-way fare by more than 50%.
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(Labaton 1999; U.S. v. AMR et al.) It is fairly typical of predation cases that the predator picks
off a specific target, usually a new entrant or maverick. American is alleged to have picked off
three low-cost competitors (Vanguard Airlines, Sun Jet International, and Western Pacific) on the
occasions when they tried to enter the Dallas-Fort Worth International Airport. When Vanguard
entered, it is alleged, American cut prices and added flights on nearly all of Vanguard’s Dallas
routes, including the one to Wichita. Two months later, Vanguard abandoned its routes and soon
after that American reduced its capacity on the Wichita route by 30% and raised the one-way fare
by more than 50%.
One of the allegations by the Justice Department in the Microsoft case was that Microsoft
bundled the Internet Explorer (its browser product) with Windows (its monopolistic operating
system), and in effect sold the browser at a price of zero, i.e., Microsoft gave away the browser
to anyone who purchased the Windows operating system. This type of tying practice, if
permitted, would make it extremely difficult for another business to enter (or remain in) the
browser market. Justice took the position that recoupment in this case should not be measured in
terms of a later intention to raise the price of the browser, but rather that Microsoft believed it
needed to destroy Netscape, lest it become a platform for a competing operating system. (Foer
1999) The first Microsoft case led to a consent decree. (Gilbert 1995) In the Plaintiffs’ Joint
Proposed Conclusions of Law filed December 6, 1999, the Department argued that “Microsoft’s
zero pricing and vast spending for distribution of Internet Explorer, by contrast [to earlier
holdings regarding the recoupment element of predatory pricing], did not require for its
anticompetitive effect an ability to raise the price of Internet Explorer in the future. It achieved
20
an anticompetitive effect simply by perpetuating Microsoft’s monopoly in the market for another
product, the Windows operating-system.” (U.S. v. Microsoft Corp.)
The trial court found that “Viewing Microsoft’s conduct as a whole...reinforces the
conviction that it was predacious. Microsoft paid vast sums of money, and renounced many
millions more in lost revenue every year, in order to induce firms to take actions that would help
enhance Internet Explorer’s share of browser usage at Navigator’s expense…[This] can only
represent a rational investment if its purpose was to perpetuate the applications barrier to entry.”
(U.S. v. Microsoft Corp.)
These two cases indicate that the Antitrust Division under Assistant Attorney General
Joel Klein intended to attack what it understands to be predatory pricing practices by dominant
firms in network industries. Now the courts will have to clarify whether this approach will
prevail and a new Administration will have to determine what policy it will adopt with regard to
network monopolists.
Implications of the Network Model: Tying and Exclusive Dealing
Predation is not the only type of behavior that may get a New Economy monopolist into
trouble. For example, monopolists cannot engage in tying arrangements or exclusive dealing
arrangements that lead to a lessening of competition. Microsoft has tried to argue that its
exclusive dealing contracts with original equipment manufacturers were just good aggressive
competition, of the sort engaged in by other companies. This did not persuade the Justice
Department or the District Court.
21
Vertical foreclosure or exclusion may be the result of tying or exclusive dealing by a
company with market power, and it has many times been challenged, including in network
industries. For example, when a dominant ATM network required participating banks to use
certain data processing services provided by the network, the Justice Department successfully
challenged it. (U.S. v. Electronic Payment Services) When FTD, the floral delivery network,
prohibited member florists from participating in competing floral delivery services, it was forced
to stop. Later, after this was prohibited, it offered financial incentives to induce its members not
to collaborate with other networks, and this, too, was stopped. (U.S. v. FTD) We can summarize
in the words of FTC policy planner David Balto:
Exclusive dealing in traditional commercial transactions is analyzed under the
rule of reason, and there seems to be no reason why the same analysis should
not apply to the Internet. Unless a large part of the market is foreclosed to
competitors, an exclusive dealing contract usually will not have anticompetitive
effects. (1999)
Implications of the Network Mode l: Denial of Access
A new book by Jeremy Rifkin is called The Age of Access. (2000) It describes what
Rifkin sees as an emerging world in which markets are making way for networks, and ownership
is steadily being replaced by access. We do not have to go this far in order to recognize the
importance of non-discriminatory access to competitors. Indeed, antitrust has in a variety of
situations required a monopolist to provide access to a network. For example, in the Realty
Multi-List case, a real estate listing service in effect refused to permit would-be competitors to
join the network. The Reagan administration obtained an injunction that enabled competitors to
take advantage of the network economies. (U.S. v. Realty Multi-List) I mention the Reagan
administration as a hint that a change in administrations may not necessarily have a great deal of
22
effect on how antitrust will approach many e-commerce issues. Access through antitrust may be
the alternative to the regulated duty to serve the public which was traditionally imposed on
natural monopolies.
The FTC’s chairman, Robert Pitofsky, has thoughtfully examined the question of how
antitrust should address access. (1999) After discussing the differences between traditional
industries and the high-tech sector (Balto and Pitofsky 1998), he pondered the circumstances under
which antitrust authorities should seek mandatory access to a network monopoly. (A 1999 speech
by David Balto, Assistant Director of the FTC’s Bureau of Competition Office of Policy and
Evaluation, provides an excellent introduction to the subject.) Pitofsky provided no conclusions,
other than that “antitrust enforcers should proceed cautiously in breaking up or mandating access to
an existing network, even when that network is dominant.” He then suggested three approaches in
those “unusual” situations in which antitrust enforcement might be required.
The first approach was where the facility is “essential” to the existence of competition.
The Supreme Court’s decision in Associated Press v. United States (1945) required access to a
newspaper wire service when the network confers a significant competitive advantage and there
was no good business reason to exclude. The second approach would be to put the burden of
explaining exclusionary behavior on the party or parties controlling the network. If they could
assert a plausible efficiency and if there were no evidence of a primary purpose to exclude, access
would be denied. And the third approach would be to balance several factors — essentiality, intent,
efficiency, and the exclusionary effect of denying access. It is typical of the FTC’s caution in
approaching e-commerce and the Internet that the Chairman has not suggested that a network
23
monopolist holds the equivalent of a natural monopoly, with the historic linkage that term has to
economic regulation. But this question hangs like a sword of Damocles over e-commerce.
Implications of the Network Model: Lock-in and Antitrust
The implications of high switching costs and lock-in have been growing in significance
ever since a Supreme Court case called Eastman Kodak v. Image Technical Services. (1992) This
involved the ability or rather inability of Kodak’s copier customers to obtain aftermarket service
from independent service organizations. Under the purchase contract, they were bound to buy
aftermarket service from Kodak. While Kodak did not have a huge share of the copier market,
the Supreme Court held that it did have market power from the point of view of its customers,
who had no practical ability to turn to other copiers. In effect, they were locked-in to Kodak and
Kodak had no right to treat them abusively.
It has been said that “a whole cottage industry has sprung up in which customers are
suing manufacturers under the antitrust laws via class actions, alleging that the manufacturers
have impeded their ability to obtain aftermarket service from independent service organizations.”
(Shapiro and Varian 1999, p. 120) Indeed, similar cases are springing up in another network
industry, franchising, where franchisees are claiming, with — at best — only mixed success in
the courts, that Kodak entitles them to antitrust protection from abuse by franchisors who have
them locked-in to their franchise systems. (Grimes 1999; Sullivan and Grimes 2000, chapter 8)
On the one side of the argument is contract law: the locked-in party voluntarily agreed to be
bound. On the other side is the unfairness of taking advantage of the party that has become
24
locked-in, particularly if circumstances change or more complete information becomes known
over time.
Shapiro and Varian argue that everyone, businesses and antitrust authorities alike, should
look at these issues from the perspective of a whole life-cycle. For example, a dominant firm in
an information network may invest in building up the network, perhaps by charging low prices
while the system is under construction, on the anticipation that it will be permitted to recoup the
investment later on, perhaps by making a profit on aftermarket services. These profits, they say,
should be considered quasi-profits rather than real profits, when viewed over a life-cycle.
(Shapiro and Varian 1999, p. 147) But one can’t help wondering what this would mean in
practice. Shapiro and Varian don’t want this network builder to be deemed a monopolist, and
perhaps they have a point for so long as this builder is merely recouping an investment and
making what would be a competitive return on the investment (including a return for risk). After
a while, however, if all goes well and the quasi-profits keep flowing in, the return really will be
much more like a monopoly rent than a competitive return.
Intellectual Property and Antitrust
A similar issue arises in the context of intellectual property, which is often an extremely
important asset in the New Economy. Copyright and patent law provide a monopoly to the holder
of intellectual property. For a statutory term (17 years for a patent), the owner has the right to
recoup monopoly profits, and these need bear no relationship to a reasonable return on
investment over a life cycle. The trade-off to the public, in return for the opportunity to earn
monopoly profits, is that there is a strong incentive to invest in innovation and that the
25
innovation must be disclosed to the public. In the network context, outside of intellectual
property, there is no time limit for monopoly profits and no duty to disclose.
Because of the importance of intellectual property in the New Economy, the relationship
between antitrust and intellectual property is coming under increased scrutiny. In keynote
remarks to the American Antitrust Institute’s first national conference, FTC Chairman Pitofsky
chose to focus on this topic. He summarized that
[T]he history of the last 110 years has treated antitrust and intellectual property as
complementary regimes, both designed to encourage innovation within
appropriate limits. As a matter of policy, we are comfortable rewarding
innovation through patents and copyrights so long as the compensation is not
significantly in excess of that necessary to encourage investment in innovation,
and the market power that results is not used to distort competition in, for
example, related product or service areas. But because intellectual property is now
a principal, if not the principal, barrier to new entry in high tech markets, we are
also concerned that it be interpreted in a way that does not distort the traditional
balance between intellectual property and antitrust. (2000a)
Pitofsky raised an antitrust alarm about recent cases, particularly the Federal Circuit’s
opinion in the “Xerox” case. (Independent Service Organizations Antitrust Litigation) Xerox is
very similar to the Kodak case (Eastman Kodak Co. v. Image Technical Services, Inc. 1992),
except that it contains an intellectual property defense. In Kodak, independent service
organizations (ISOs) challenged Kodak policies designed to limit the availability of parts to ISOs
and to make it more difficult for them to compete with Kodak in servicing Kodak equipment.
The Supreme Court held that this could be construed to include an illegal tie-in sale as well as
monopolization or an attempt to monopolize the service and parts markets. On remand, Kodak
raised the argument (for the first time) that its parts enjoyed patent and copyright protection. This
was rejected by the Ninth Circuit. (Image Technical Services, Inc. v. Eastman Kodak Co. 1997)
26
In the Xerox case three years later, the Federal Circuit (which has jurisdiction over
intellectual property cases) explicitly rejected the Ninth Circuit’s approach in Kodak, holding:
“In the absence of any illegal tying, fraud in the Patent and Trademark Office, or sham litigation,
the patent holder may enforce the statutory right to exclude others from making, using or selling
the claimed invention free from liability under the antitrust laws.” (Independent Service
Organizations Antitrust Litigation, pp. 1327-28) As Chairman Pitofsky writes, the Federal
Circuit dismissed evidence of anticompetitive purpose “in sweeping language that exalts patent
and copyright rights over other considerations and throws into doubt the validity of previous
lines of authority that attempted to strike a balance between intellectual property and
antitrust...[the three exceptions to absolute immunity] appear to be extremely narrow limits
on a virtually unfettered right of a patent holder to refuse to deal in order to achieve an
anticompetitive objective.” (2000a)
In the Microsoft case, Microsoft argued that even if its fusion of Windows and Internet
Explorer software code were to constitute an illegal tie in any other context, its contractual
restrictions on original equipment manufacturers which forbade them from attempting to
separate its bundled products are absolutely immune from Sherman Act liability by reason of the
Copyright Act, since both its operating system and its browser are copyrighted works. This view
was twice rejected by Judge Jackson. If the Federal Circuit is right and the Ninth Circuit is
wrong, not only might the Microsoft case be affected, but countless refusal to deal cases may
well have been wrongly decided. (Crew)
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Working out the relationship between intellectual property and antitrust will clearly be a
fundamental challenge in the New Economy.
Standards and Certification
Antitrust has longstanding principles applicable to collective standard setting. When
competitors come together, as they must in standard setting, there is always the risk of collusion.
To avoid antitrust liability, companies and associations must follow rules that ensure procedural
due process, maximum openness to all interested parties, “consensus” decision making,
impartiality and objectivity in both the development process and in post-adoption certification
and interpretation processes. All standards must be voluntary rather than collectively enforced. In
general, the rules are well-understood. A problem arises in that dynamic high-tech industries
depend on rapid development of and widespread adherence to standards that ensure compatibility
across disparate systems and interoperability with complementary products. While it has been
suggested that the traditional rules and procedures are too slow and cumbersome to meet the
needs of high-tech markets, some practical solutions have been found to facilitate more rapid
movement. Robert Skitol identifies solutions including committing in advance to open access to
the end-product of the development process and reasonable licensing terms to all interested
parties; inclusion of the consumer and user communities in the process; and utilizing the
Department of Justice Business Review Procedure or the FTC equivalent. (1999)
Problems have arisen when firms in network industries engage in anticompetitive tactics
to give themselves preferential access to controlling standards. For instance, the FTC stopped a
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firm that misled a standards-setting group by denying that it had any patent rights that might give
it exclusive or preferred ability to exploit a proposed standard. (Federal Trade Commission 1995)
Perhaps the most important antitrust issue for networks is the question of access, which
we described earlier. Who will be allowed to interconnect and on what terms? As we write, the
FTC is negotiating with AOL and Time Warner regarding conditions that would be required as a
basis for permitting their merger. According to press reports, the principal issue is how to assure
fair and nondiscriminatory access of competing Internet content providers to cables that will be
controlled by the merged entity.
Mergers and Joint Ventures
Collective standard setting is one way in which competitors overcome their natural
rivalry for cooperative ends. Another way is by joint venturing. And of course the most
permanent and complete way is by merger or acquisition. From an antitrust perspective, joint
ventures and other forms of collaboration are certainly favored over mergers. Congress has
granted protection from private treble damage awards for research and development joint
ventures. The National Cooperative Research and Production Act, 15 U.S.C. sections 4301-4306,
does not expressly cover standard setting ventures.
In October 1999, the FTC and DOJ issued their proposed Antitrust Guidelines for
Collaborations among Competitors, a generally well-received document that provides an analytic
framework for evaluating joint ventures. (The proposed Collaboration Guidelines do not cover
standard setting.) One important feature of the Guidelines is their recognition of a “safe harbor”
29
for joint ventures that account for less than 20% of the market. The vast majority of Internet
strategic alliances will fall within this safe harbor. Even outside of the safe harbor, most
collaborative arrangements will receive rule of reason treatment.
Although we are in the midst of an unprecedented merger wave, the vast majority of
mergers have no antitrust consequences. Mergers are analyzed within a framework created by
the Federal Horizontal Merger Guidelines. (1992, revised 1997) Merger review by the federal
antitrust agencies is also structured by the Hart-Scott-Rodino Premerger Notification Act
(15 U.S.C. section 17), a 1976 law that requires mergers and certain other transactions above a
threshold size to report specified information to the agencies and then wait 30 days before
consummating the transaction. The agency that is assigned to the transaction may within that
period make a “second request” for additional information, which delays consummation until 20
days (30 days, effective February 1, 2001) after the supplemental information is received. Prior
to 2001, when a merger transaction was valued at over $15 million, the merging parties were
required to file a pre-merger notification with the FTC and DOJ. Special treatment was given to
acquisitions involving a company with less than $10 million of assets in annual revenue. By an
amendment to the Hart-Scott-Rodino premerger notification law, effective February 1, 2001, the
transaction-size threshold for making a filing rose to $50 million, cutting in half the more than
5,000 annual HSR filings. At the same time, the legislation expands the reporting requirement
for high-technology deals and leveraged buy outs by raising the “size of person” exemption to
deals valued at less than $200 million. This is a legislative response to regulators’ recognition
that major technology firms often pay enormous sums for dot-com startups with little assets or
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revenues, resulting in the acquisition of potential competitors before they get large enough for
the premerger notification process to cover them. (Sieberg 2001)
In approximately 97 percent of the reported transactions reported each year, the review is
completed within 20 days and the deal can go forward without further antitrust involvement. The
other three percent get what are called “second requests.” About half of these are eventually
stopped or restructured. No doubt the vast majority of e-commerce mergers go through without
antitrust concern. Several software mergers have been challenged and then either abandoned or
modified. Shapiro and Varian provide these examples: Adobe/Aldus in graphics software;
Microsoft/Intuit in personal financial software; Silicon Graphics/Alias/Wavefront in high-end
software for graphics workstations; Computer Associates/Legent in utility software for IBM
mainframes; and Cadence/CCT in electronic design automation software. (1999, p. 305) In
dynamic markets where entry barriers are low and any monopoly power would likely be
transitory, there is little likelihood of antitrust involvement.
On the other hand, we’ve already seen some Internet-related mergers where antitrust was
relevant. In the merger of Internet backbone providers MCI and WorldCom, a consent decree
resulted in the divestiture of MCI’s backbone infrastructure. The AOL-Time Warner merger
pending in the FTC may raise questions about access for Internet Service Providers to cable,
owned by a competitor, which may be essential to the ability to compete.
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B2B Electronic Marketplaces
As noted above, one of the most explosive new features of the New Economy has been
the advent of the business-to-business electronic marketplace. Although it is too soon to know
which B2B ventures, if any, will succeed, there is widespread agreement on their potential
dramatically to change how business is conducted. Recognizing this potential and already
experiencing the need to review particular ventures, the Federal Trade Commission hosted a
public workshop on June 29 and 30, 2000. The resultant staff report is essential reading for
anyone interested in this subject. (Federal Trade Commission 2000)
The FTC Staff Report recognizes that B2Bs are “remarkably diverse” and that market
forces are continuing to sort out many of the factual questions that need to be answered for
specific antitrust analyses. The Report also recognizes that B2B marketplaces “have the potential
to generate significant efficiencies, winning lower prices, improved quality and greater
innovation for consumers.” At the same time, B2Bs may raise a variety of antitrust issues.
Workshop panelists tended to agree that these issues are not new and are amenable to traditional
antitrust analysis. Moreover, says the Report, “it appears that many potential concerns could be
eliminated through well-crafted B2B operating rules.”
As of this writing, the FTC has reviewed only one B2B, Covisint. When the FTC opened
an investigation of the plan by Ford, General Motors and Daimler-Chrysler to create a massive
online parts bazaar, speculation had it that they were looking at whether the structure and
procedures of this venture will facilitate unlawful price “signalling” or coordination among
32
buyers or sellers. (Wilke and White, 2000, p. A6) The venture came to the FTC under its
premerger notification procedures and thus was subject to review deadlines.
Ultimately, the Commission found no action warranted “at this time” but stated:
Because Covisint is in the early stages of its development and has not yet adopted
bylaws, operating rules, or terms for participant access, because it is not yet
operational, and in particular because it represents such a large share of the
automobile market, we cannot say that implementation of the Covisint venture
will not cause competitive concerns. (Covisint, Inc., In Re 2000)
Thus, it would be a mistake to say that the FTC gave a “green light” to this venture.
Rather, given the situation at the time a decision had to be made, it was premature for the
Commission to take action. Informally, the staff describes this as a “yellow light.”
When the FTC terminated its investigation, after a six-month review, the Chairman of
General Motors, John F. Smith, Jr., complained that during the delay, Covisint was unable to hire
staff or operate as a business, although “dot-coms from nowhere can do whatever they please.”
Smith went on to say, “Government cannot react in government time to new-economy initiatives”
from Old Economy companies without handicapping them competitively. (Lundegaard 2000)
As we write, two additional governmental investigations of B2Bs have received press
coverage. The European Commission cleared MyAircraft.com, a joint venture launched by the
U.S. companies Honeywell, United Technologies, and 12 Technologies, after a routine onemonth probe. The Financial Times reported that the Commission said that a B2B platform would
not qualify for merger review if the parent groups did not exercise control over its strategic
commercial decisions. (Buckley 2000)
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This was the European Commission’s first action with respect to a B2B venture, and is
reflective of the important fact that B2Bs are likely to be of interest to multiple antitrust
reviewers.
The U.S. Justice Department has not indicated whether it is investigating
MyAircraft.com, but there are reports that it is investigating Homestore.com, Inc., the leading
online realty-services site. The investigation is said to be focusing on “exclusionary conduct and
monopolization of Internet realty sites in the United States; and Homestore.com’s acquisition of
Move.com from Cendant.” (Guidera 2000) The company has created the only truly national
property-listing service based on its exclusive contracts with many of the local Multiple Listing
Services that Realtors and brokers (who have an ownership interest in Homestore) use to post
homes for sale. The concern about Homestore.com’s acquisition of Move.com is reported to
focus on whether this would allow Homestore to extend its reach to the off-line sector.
B2B Antitrust Issues
There are at least four types of antitrust problems that need to be looked at in the
B2B context.
1. Price Fixing and Other Information Sharing Agreements
Certainly the Internet permits the rapid exchange of information that could allow
competitors not only to know exactly and immediately all prices in the market, but to make
adjustments immediately so that no one can reap an advantage by cutting a price. An enormous
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amount of coordination can take place right out in public view, without the need for secret
meetings or complex phases of the moon conspiracies. (Baker 1996)
The problem for antitrust enforcement is that it may be perfectly normal and it is
perfectly legal for firms to set their prices based on other peoples’ prices. Parallel behavior alone
is not unlawful. To find a conspiracy in pricing, the law holds that there must be “plus factors.”
Antitrust’s first attempt to deal with price-fixing in cyberspace resulted in a Justice Department
consent agreement with the leading U.S. airlines. (U.S. v. Airline Tariff Publishing Co. and
related cases cited in Baker 1996, note 20) Working through a joint venture, they set up a
computer reservation system used by travel agents. The government’s evidence of a conspiracy
focused on the large amount of communication among the airlines involving fares that were
mostly unavailable to consumers until a consensus was reached; the complexity of their conduct,
which made sense only in terms of facilitating a process of negotiation and exchange of
assurances; and the lack of convincing legitimate business justification for much of what they
were doing.
“Depending on the operating rules,” the FTC Staff Report says, “participants in a B2B
could learn in real time, for example, the identities of the purchaser and seller in a transaction,
the quantity purchased, the date and time of the transaction, and the purchase price… [This]
might injure competition by facilitating price or other anticompetitive coordination.” The Report
identifies many possible mechanisms for handling these concerns, including erecting firewalls
within the B2B, segmenting catalogs, and other measures. It observes that “sharing contingent or
future pricing information is generally more troubling than sharing information about past
35
transactions, and sharing competitively sensitive information that is uniquely and readily found
on the B2B is generally more likely to raise concern than sharing such information that can
easily be found elsewhere.” (Federal Trade Commission 2000, p. 3)
Because illegal coordination is difficult to detect and prove, it is important for the federal
agencies to provide this sort of guidance at this early stage of development, when joint ventures
are just being conceptualized and shaped, to help design the architecture in a way that will
minimize later problems. Lawrence Lessig in Code and Other Laws of Cyberspace (1999) argues
that in cyberspace, code is law, and government needs to be involved in designing the
architecture that embeds choices of substantive values.
2. Competition to Control the Electronic Marketplace
Boats.com is one of many Internet sites that arranges for sales, financing and insurance
for recreational crafts. Before launching its site, it lined up exclusive endorsements of the
industry’s two biggest trade groups, representing manufacturers and retailers. The endorsers
received stock warrants. Boats.com also received a significant investment from a major boat
manufacturer. Competing Internet sites are claiming that it is inappropriate for neutral trade
groups to favor one enterprise over another and take a financial stake in the business. A
spokesman for the retail association explained why he favors an industry-controlled electronic
marketplace: “We don’t want to see two dozen dot-com companies out there trying to sell
directly to consumers and disenfranchising the distribution system that we have built over a lot
of years.” (Associated Press 2000)
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Initially, B2B electronic marketplaces were being created by independent start-up
companies (“dot-coms”). Before long, however, the largest established companies in an industry
began announcing joint ventures of their own. Antitrust has often been concerned about joint
ventures that include so much of an industry that competition is not feasible. We faced this
potential 30 years ago with the invention of automated teller machines, when there was a push for a
single national network. Antitrust intervention, however, assured that there are multiple electronic
fund transfer networks, which compete with each other and assure a continued motivation for
generating better products and new services. Today, we read about “navigators” that pose a threat
to an industry by being aligned with consumers rather than industry participants and consulting
firms urge existing companies to develop their own electronic marketplaces so as to deny “critical
mass” to independent competitors. (Evans and Wurster 2000)
There is also a potential problem of a B2B that improperly requires or encourages buyers
or sellers to deal with it to the exclusion of other B2Bs. The FTC Staff Report says that the
antitrust inquiry in this regard “would ask whether the exclusivity practices leave available
sufficient buying, selling, or other support to sustain alternative marketplaces capable of
maintaining competition…Indeed, exclusivity practices could exacerbate potential effects from
network or other scale economies that may make it difficult for an entrant to start small, attract
the necessary volume, compete effectively, and grow to become a significant factor in the
market.” (Federal Trade Commission 2000, p. 4) Inquiry into these issues is highly factintensive. The Report does not suggest that industry consortia B2Bs are presumptively illegal,
but “high levels of industry ownership or substantial minimum purchase requirements will likely
draw a closer look.” (2000, p. 6)
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3. Exclusionary Practices
The FTC Staff Report noted concerns about the potential for exclusionary operating rules
and the possibility that some B2Bs would discriminate against, if not overtly exclude, the rivals
of its owner-participants. (2000, pp. 3-4; Foer 2000) For instance, the joint venture could charge
high transaction fees to all users, while rebating part of the fees (in the form of profits) to the
owners — a strategy known as “raising rivals’ costs.” In analyzing the legality of such a strategy,
it would be necessary to know how easy or difficult it is for participants to switch out of one
marketplace into another (if an alternative exists). Even if anticompetitive harm were likely, the
FTC Staff Report says that the analysis would ask whether the exclusion was reasonably
necessary to achieve procompetitive benefits that likely would offset the anticompetitive harm.
4. Joint Purchasing Issues
Buyer power is the mirror image of seller power. Although the vast majority of antitrust
cases have involved sellers who gained market power, the fact that buyer power can be
anticompetitive has been recognized in several recent cases and is increasingly mentioned by the
enforcement agencies in speeches. While buyer power can be used to create true efficiencies and
reduce purchasing costs, with savings passed on to consumers, this does not always occur.
Moreover, from the point of view of overall allocative efficiency, which is one of the objectives
of the antitrust laws, it is just as bad for suppliers to be deprived of a competitively set price as
for consumers. Finally, a squeeze on suppliers will probably result in consolidation of supplier
industries, which at some point cannot be good for consumers.
38
The author recently participated in a convention of purchasing managers. A spokesman for
Covisint, the auto joint venture, was asked if the auto manufacturers intend to aggregate their
purchasing power. “No way,” he replied, stating that this was one conclusion that became clear from
negotiations with the FTC. While not all B2B marketplaces will be capable of facilitating buying
groups, it is safe to predict that aggregation of demand, an area in which there is relatively little
precedent, will be a focal point of many future conversations involving e-commerce and antitrust.
A Final Note on B2Bs
It is certainly extraordinary to see so many industries undertake apparently similar joint
ventures simultaneously, all with the potential for radically restructuring relationships with
customers, competitors, and suppliers. If the government stands back to watch passively, great
harm can be done. If the government intervenes improvidently, great harm can also be done.
Given the suddenness with which these changes are arriving, we are still in the phase of trying to
ask the right questions. Should public policy support legacy-controlled joint ventures into ecommerce? Should it prefer neutral players running the marketplaces? Should it require open
ventures that permit all competitors to share in ownership and control? Should it preclude
exclusion of unfavored suppliers? Should there be firewalls to protect against leakage of certain
types of competitively-sensitive information? And so on. What kinds of competitive problems
can be fixed later, after the architecture is in place, and which will be relatively unfixable? The
FTC Workshop represents an intelligent first step in asking questions and providing the most
preliminary type of guidance to those who are building the New Economy.
39
Price Discrimination
Mythically if not necessarily actually, Americans used to live in a predominantly oneprice world. Today, increasingly, different customers pay different prices for the same product.
Price discrimination that lessens competition is illegal under the Robinson-Patman Act
(15 U.S.C. section 13), unless it can be defended as cost-justified or necessary to meet the
competition. But Robinson-Patman does not cover end-use consumers and in business-tobusiness situations it has not been aggressively enforced for many, many years. But be aware that
the FTC recently concluded a consent order on Robinson-Patman grounds with the McCormick
Spice Company. (Skitol 2000)
Network industries such as the airlines have accustomed us to the idea that different
consumers may be charged different prices. To price discriminate successfully, one needs a
certain amount of market power and enough information about the buying habits and motivations
of customers to be able to place them in different pricing categories. The airlines do it primarily
by separating business travelers from leisure travelers.
E-commerce generates much more information about customers than was previously
available, making it much more likely that price discrimination will be practiced. In the fall of
2000, Amazon.com tested out “dynamic pricing,” a fancy way of saying that it charged different
customers different prices for the same DVDs. This became known to consumers, whose
bulletins of unhappiness were sprayed over the Internet, forcing Amazon to back down. A
spokesman for the company said that the test was to explore how customer demand for the
DVDs was affected by different prices and to determine whether a product’s price or display on
40
the site is a bigger factor in customer demand. (Wolverton 2000) Observers describe dynamic
pricing as an effort to sort customers into different price zones, based on sophisticated estimates
of the buyer’s demand function.
Amazon’s experiment demonstrates both the potential implicit in the Internet for
sophisticated price discrimination and the Internet’s potential for helping consumers to fight back
when they feel discriminated against. While the Robinson-Patman Act would not seem to be
involved in dynamic pricing where it is the ultimate consumer who is discriminated against, it is
possible that price discrimination will affect market definition in Internet merger cases. For
instance, if a seller is sufficiently able to place customers into price zones, based on sophisticated
estimates of the buyer’s demand function, this may indicate a separate market exists.
Conclusion
An existing trend towards consolidation within e-marketplaces will continue and the FTC
needs to keep on top of it, according to half of the business-to-business executives surveyed by
Ernst & Young LLP recently. “A comfortable majority — 71% — of the B2B respondents
believe that collusion is a legitimate concern for the FTC with 68% believing that some type of
independent third party verification of neutrality would be the bet way to tackle the problem.
One quarter thought that regulation is needed. Sixty percent predicted that there will be fewer
than 500 B2B exchanges by 2004, while one third thought the number would be less than 100.”
(FTC:WATCH 2000)
41
Congress has invited the Federal Trade Commission to focus on the Internet and it is
likely that the FTC will utilize an ever-increasing portion of its staff to monitor e-commerce,
coordinating its consumer protection and antitrust functions and gaining confidence as it gains
knowledge and experience. On the whole, this is positive for the e-commerce industry in its
emergent phase, because the FTC is well situated to assist it to deal with issues of fraud, privacy,
and security, which could be major obstacles to the industry’s development. At the same time, by
protecting the emerging industry from the unfair competition that could be unleashed by legacy
industries, it can give e-commerce a better chance for moving forward. Finally, by utilizing
antitrust oversight to help steer a still-malleable dynamic industry away from monopolistic
practices and abuses of market power, it keeps open the channels for creative start-ups and
smaller rivals who can continue to generate innovations and refinements.
42
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