U.S. Antitrust Law: A Primer
Howard A. Shelanski, U.C. Berkeley
Nanterre—Paris X
November 2006
Agenda
Sections 1 and 2 of the Sherman Act
– Collusion and Monopolization
Section 7 of the Clayton Act
– Merger policy
Antitrust and Telecommunications in
the United States
Origins of U.S. Antitrust Law
Late 19th century populist revolt
against big business
– Small farmers and tradesmen feared the
rise of large, powerful “trusts” in key
industries like oil, rail transport, and
steel.
Sherman Antitrust Act (1890)
– U.S. Congress passes the first national
antitrust law in response.
Scope of the Sherman Act
Theory behind the Act was to restrain
large business enterprises in 2 ways:
– Prohibit collusion and coordination among
business enterprises to the detriment of
consumers and other businesses (Section 1 of
the Sherman Act).
– Prohibit activities by powerful firms that create
or maintain monopoly power for those firms
(Section 2 of the Sherman Act).
Text of Sherman Act §§ 1 and 2
Section 1
– “Every contract combination . . . or
conspiracy in restraint of trade or
commerce . . . is declared to be illegal.”
Section 2
– “Every person who shall monopolize, or
attempt to monopolize . . . any part of
trade or commerce . . . shall be deemed
guilty of a felony.”
Problem: Text is Very Broad
Read literally, the Act would prohibit much
beneficial business activity
– Examples, Section 1: The literal text prohibits
professional partnerships, joint R&D, and small
purchasing cooperatives.
– Examples, Section 2: Prohibits monopoly itself; could
bar using superior technology or scale economies to
under-price competitors if such conduct could lead to
monopoly, yet this benefits consumers.
Challenge: How to apply the Sherman Act to
achieve its goals, but without being overly
restrictive?
Meeting the Challenge: Application
of the Sherman Act: Section 1
U.S. Courts in 1911 determined that
Section 1 only means to prohibit
“unreasonable” restraints of trade.
“Reasonable” restraints of trade are
those that help economic progress
and that lead to more efficient
markets.
What Conduct is “Unreasonable”
Under Section 1?
Unreasonable restraints of trade are
those that have the overall effect of
reducing economic competition
How Do Courts and Agencies
Decide what is “Unreasonable”?
Courts have created two classes of
conduct:
– Conduct that is always illegal: Courts early
on determined that some conduct is so
inherently harmful to competition that it is
presumed illegal, regardless of circumstances.
This conduct is illegal per se under § 1.
Price fixing agreements
Agreements to divide territories
Output restrictions
Section 1, Illegal conduct (Cont’d)
– Conduct that is sometimes illegal:
Other conduct might benefit competition
under some conditions but be harmful
under other conditions. This conduct is
not always illegal, but is reviewed caseby-case under a “rule of reason.”
Information exchanges among rivals
Standard setting bodies
Restraints necessary to create a product or
allow a market to function.
Modern Trend in Enforcement of
Section 1 of the Sherman Act
Per se violations like price fixing are
prosecuted aggressively, and no
justifications or defenses are usually
accepted. Lack of market power, for
example, or protection of public safety,
are not allowable defenses.
Rule-of-reason violations are treated more
deferentially, and the enforcer has a heavy
burden of showing harm to competition.
Meeting the Challenge: Application
of Section 2
The central contradiction of Section 2
is that aggressive competition, the
very conduct the Sherman Act
wishes to encourage, could lead to
monopoly, the very outcome the
Sherman Act seeks to prevent.
– How to distinguish anticompetitive
aggression from vigorous competition?
Application of § 2, Cont’d
For several decades, the courts adopted a
restricted approach under which conduct that
harmed competitors was punished, regardless of
potential benefits to consumers.
– Illustrative case is U.S. v. Alcoa in which the court held
Alcoa had broken the law by expanding plant capacity in
advance of increased customer orders.
– The court acknowledged that that Alcoa’s plant
expansion helped customers by avoiding disruptions in
supply during a time of growing demand, and that Alcoa
gained efficient economies of scale.
– Nonetheless, the court held that Alcoa’s actions made
market entry difficult for competitors, and hence tended
toward monopoly under Section 2.
Application of § 2, Cont’d
Alcoa was later criticized for focusing on the fate
of competitors rather than on the process of
competition, and for punishing good commercial
and competitive behavior.
But Alcoa was typical of its time: the courts
punished many actions as per se (i.e. always
illegal) violations of Section 2. For example:
–
–
–
–
Vertical restraints by producers
Tying the sale of two products
Below cost (“predatory”) pricing
Exclusive dealing.
Application of § 2, Cont’d
Interestingly, Alcoa also contained the
seeds of more modern enforcement of
Section 2. The case is most remembered
not for its final decision, but for the court’s
statement that the antitrust laws should
not punish successful competitors, and
that monopoly obtained through honest
skill, foresight, and hard work is not illegal
under Section 2.
Modern Enforcement of § 2
From the 1960’s through the 1980’s, many
scholars, enforcement officials, and courts
began to criticize application of Section 2
as overly aggressive and harmful to
competition.
Over time, enforcement shifted from
guarding against the risk of monopoly
(Alcoa), to guarding against the risk of
deterring aggressive competition and
beneficial economic arrangments.
Modern Enforcement of § 2, Cont’d
Courts began to move away from per se
illegality under Section 2. They did this in
two ways:
– Treating more conduct under the “rule of
reason”
E.g. exclusive dealing, vertical non-price restraints,
refusals to deal.
– Making remaining per se violations harder to
prove
E.g. predatory pricing, vertical price restraints, tying.
Summary of Current State of the
Law under the Sherman Act
Section 1 punishes price fixing, territorial
divisions, and output restraints strictly. All other
activity is under the rule of reason and is
punished only upon strong proof of
anticompetitive effect.
Section 2 is applied cautiously, treating most
conduct under the rule of reason and only
punishing actions that unreasonably block entry,
and/or foreclose competitors’ access to
customers or necessary inputs. Section 2
protects the competitive process, not
individual competitors.
Lessons from Sherman Act
Antitrust law takes time to evolve. The basic
principle that competition improves consumer
welfare is sound. But actual business practices
may have ambiguous effects, so “the devil is in
the details” in deciding where to enforce.
The evolution of antitrust law into specific
enforcement practices and legal precedent will
depend on a country’s unique economic context.
Where the economy is strong and competition is
well established, more aggressive conduct can be
allowed. Where monopoly is common or likely,
greater restraint may be required.
Practical Objectives for Antitrust
Law in new Markets
Perfect competition is a textbook fiction. The goal
is instead to protect the development of enough
competition that consumers do not face
monopoly.
Emphasis should be on preventing emerging
competitors from colluding, and on preventing
any one competitor from foreclosing access to
customers or inputs.
Where competition is not well established, it
might make sense to worry more about the
survival of competitors than about deterring
vigorously competitive conduct.
– The institution of the competitive market must be built
before worrying about how freely it operates.
Merger Enforcement in the U.S.
To understand merger policy in the U.S. it
is helpful to go back to Section 1 of the
Sherman Act. Taken literally, that law
would prohibit any merger.
Passage of the Clayton Act in 1914 reflects
the recognition that some mergers are
acceptable. The question for merger law
is, which ones?
Section 7 of the Clayton Act
Section 7 is the central merger
statute in the U.S.
– It prohibits any merger whose effect
“may be substantially to lessen
competition, or to tend to create a
monopoly in any line of commerce.”
Early Application of Section 7
Until the 1970’s, courts interpreted the
text literally, often focusing on the words
“or tend” to create a monopoly.
– In the Brown Shoe case (1962), the U.S.
Supreme Court blocked a merger that would
have given one shoe manufacturer control over
8% of retail shoe outlets.
– In the Von’s case (1966), the Supreme Court
blocked a merger that would have given one
grocery chain a 7.5% market share.
– In the Philadelphia National Bank case, the
Supreme Court ruled that mergers to a 30%
market share were virtually illegal per se.
Early Merger Policy, Cont’d
The emphasis in all the above cases was
preventing a tendency toward
consolidation. The cases stated clearly
that an important objective of merger
policy was protecting the place of small
businesses in the American economy,
– Efficiency was a secondary concern, and the
cases made clear that increased consolidation
was a problem even without evidence of
harmful effects on prices for consumers.
Modern Merger Policy
Within a decade after Vons, the U.S.
Supreme Court sharply changed
direction in its review of merger law.
In General Dynamics (1974), the
Court said that it was necessary for
the government to prove harmful
effects from a merger, not mere
consolidation.
The Merger Guidelines
To create a framework for
determining competitive effects of
mergers, the U.S. Federal Trade
Commission (FTC) and Department
of Justice (DOJ), adopted a set of
Horizontal Merger Guidelines in
1984. The Guidelines in their current
form set out a 4-step merger review
process.
Merger Guidelines, Cont’d
4 steps of merger review:
– Step 1: Define the relevant market and
calculate how the merger will affect market
concentration.
– Step 2: If the market concentration is caused
by the merger is high enough to raise concern,
look at what actual competitive effects of the
merger are likely to be.
Key question: Will the merged firm gain market
power and be able profitably raise prices to the
detriment of consumers?
Merger Guidelines, Cont’d
– Step 3: If there are likely to be harmful
effects, the burden shifts to the merging
parties to show the merger will create
efficiencies that cannot otherwise be
achieved, and that are sufficient to
offset competitive harms.
Where competitive harms are predicted to
be large, efficiency defenses to the merger
are unlikely to succeed. Efficiencies can tip
the balance where the case for harm is
close, however.
Merger Guidelines, Cont’d
Step 4: The final step of review
under the guidelines is to determine
whether there are remedies for the
predicted competitive harms.
– For example, can the harm be reduced
through divestiture of parts of the
merged firm’s business? Through
licensing of intellectual property?
Market Share and Market Power
under the Guidelines
Much can be said about each of the 4 steps just listed. The
calculation of market share and presumption about market
power in step 1 warrant particular mention.
The Guidelines use the Herfindahl-Hirschman Index (HHI),
which one calculates by taking the individual market share
of each firm in the market, squaring it, and then adding all
the squared figures together to get a single index number.
The HHI communicates two important things: a picture of
concentration for the entire relevant market, and a
measure of the distribution of market shares across all
firms in the market. The HHI is higher where market share
is unevenly distributed across firms than if it is evenly
distributed, because a market with five evenly-sized firms
may be more vigorously competitive than a market with
one very big firm and several smaller ones.
Market Share, cont’d
Under the Guidelines, markets with an
HHI over 1800 are presumed to be noncompetitive, and mergers in such markets
are presumed harmful if they increase the
HHI by more than 50 points.
– To provide some perspective, a market with 5
equal competitors has an HHI of 2000, and a
merger of any two of those firms would raise
the HHI to 2800, which is presumptively
anticompetitive.
Problems with Inferring Market
Power from Market Share
The HHI is helpful, but in the end it
is just a fancy way to measure
market share. Market share,
however, is a very imperfect proxy
for market power:
– Market share is backward looking; it
shows where a firm has been, but not
where the firm and the market are
going.
Reducing Reliance on Market
Share
Show competitive effects directly,
without detailed market share
calculations, where possible.
Enforcement in fact does not happen
as often as the Guideline’s 1800 HHI
presumption would suggest. So less
need for detailed HHI calculations for
many mergers.
Merger Process
We have so far looked at the substance of U.S.
merger review. We now look at Process.
The FTC and DOJ receive pre-merger notification
under the Hart-Scott-Rodino Act (1976) for all
transaction over a particular size threshold (e.g.
$200 Million).
The Agencies then decide which (FTC or DOJ) will
do the review.
The Agency reviews the merger for 90 days. In
most cases, the merger is approved at this stage.
If the merger raises competitive concerns, the
agency issues a “second request” for information.
Process, Cont’d
It is under a second request that a
full, detailed review occurs for 6
months.
At the end of 6 months, the agency
can approve the merger as filed,
move to block the merger, or reach a
settlement with the merging parties
to remedy the harms.
– Example: SBC/Ameritech merger
Process, Cont’d
If a merger is settled, the settlement
must be approved by a U.S. District
Court as serving the “public interest.”
The court retains jurisdiction to
review the merger later if it becomes
concerned the settlement is not
being observed.
– E.g. Verizon/MCI and SBC/Ameritech
Antitrust in U.S.
Telecommunications
Early examples: Challenging the
development of the AT&T monopoly,
1912 to 1960.
The break-up of AT&T, 1984.
Merger review and the 1996 Act
Incumbents and their competitors,
the Trinko case.
New developments, the Madison
River case.