Breaking a Monopoly: Vigilante Justice or the Sort of Innovative Approach We Celebrate?

• Publication year: 2015
• Author: By Ryan McCauley

BREAKING A MONOPOLY: VIGILANTE JUSTICE OR THE SORT OF INNOVATIVE APPROACH WE CELEBRATE?

By Ryan McCauley¹

The Second Circuit's recent decision in United States v. Apple, Inc. (the "Opinion"),² like Judge Denise Cote's decision and judgment in the district court, paints a scintillating conspiracy story of Apple and five of the nation's largest book publishers ganging up to take on Amazon and, as the majority argues, raising consumer prices. There are numerous factual aspects of the district court's judgment that Apple will undoubtedly continue to dispute in its recently announced appeal to the Supreme Court, but the real policy question is whether relatively short term concerted action that is designed to facilitate entry into a monopolized market should be illegal per se, particularly where the monopolist is likely undertaking a preemptory price cutting regime to prevent entry.³

One of my antitrust professors offered what I find to be a helpful analogy when thinking about per se rules and the "rule of reason" standard in the antitrust realm: he analogized that a per se rule is like a numerical speed limit while the "rule of reason" was comparable to the state of Montana's widely publicized former "reasonable and prudent" standard for judging whether a driver was speeding.⁴ Per se rules are incredibly efficient for our legal system—there is very little analysis when it comes to the question of whether a driver exceeded a numeric speed limit—but the necessary trade-off is that cases deserving deeper analysis are quickly categorized along a bright line and justice is meted out roughly without respect to unique circumstances. To their credit, per se rules provide certainty and deter conduct that falls on the wrong side of the bright line. At the other end of the spectrum, rule of reason analyses take account of each cases' unique aspects and, therefore, result in more accurate judgments, but require a significant dedication of parties' and judicial resources. That antitrust law has long employed, depending on the circumstances, either per se or rule of reason analyses to efficiently adjudicate cases is one of the most interesting aspects of this body of law. But as economic thinking about certain types of conduct has grown more sophisticated and nuanced, the natural evolution for our legal regime has been to reduce the types of conduct judged illegal per se to only those types that are clearly anticompetitive.⁵

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We are now sixteen years past Justice Souter's famous invocation of "an enquiry meet for the case" when endorsing the use of the rule of reason to analyze horizontal agreements among a trade group⁶ and almost a decade past Justice Kennedy's declaration that vertical price fixing requires a rule of reason review.⁷ Those decisions built on more than a century of experience, which though uneven, has arrived at the consensus that few agreements are easily categorized as so pernicious or damaging to consumer welfare that they should be labeled per se illegal. The Apple case brings the question of the right test to the last significant circumstance where the per se rule has been essentially unquestioned: concerted conduct. The answer for the typical cartel scenario is that the per se rule bars concerted action among horizontal competitors because it is presumed to be designed to attain monopoly power. But the twists in this case—the largest being the presence of an overwhelming monopolist in the relevant retail market—is important. To put the question slightly differently, should there be a per se prohibition on concerted action that involves a non-integrated retailer agreeing on a new business model with upstream distributors in an attempt to enter a monopolized retail market? Is that a resort to socalled "marketplace vigilantism" as the Second Circuit majority saw it,⁸ or is that a competitor finding an efficient and innovative path into the marketplace?

Some will cast this as a question of whether any conduct should continue to be adjudged per se, rather than by the searching rule of reason analysis or even some middle-ground "quick look" analysis. But the question is actually much narrower: Is concerted action so obviously detrimental when used to take on a monopolist exercising monopoly power? If not, the district court and Second Circuit have erred and this case should be retried applying some variant of a rule of reason analysis. That does not mean that Apple and the publishers are off the hook—the result may well be the same after that analysis is genuinely undertaken—but it does mean that the trial court needs to look at the full set of facts in this unique case.⁹

This comment addresses three concepts stemming from the Second Circuit's Opinion. First, how does the Supreme Court's evolving jurisprudence, most recently the Leegin decision, guide this case? Second, the Opinion effectively articulates the anticompetitive rationales attendant to concerted action and, in keeping with a per se analysis, dismissed any potential procompetitive rationales. Are there really no procompetitive rationales in this circumstance? Third, and following from the first two, does a per se rule have a place when analyzing concerted action against a monopolist?

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A. Leegin's Reverberations

The majority and dissenting opinions at the Second Circuit each invoke Leegin, which reversed a century-long per se ban on vertical price fixing, to support their arguments that Apple should or should not be tried under a per se regime. In the eight years since it was handed down, Leegin has been widely regarded as the near-final word on the Supreme Court's evolution about the application of per se rules in antitrust. The earliest case, Dr. Miles Medical Co. v. John D. Park & Sons Co.,¹⁰ effectively held that vertical price restraints—minimum resale price maintenance ("RPM") agreements—were per se illegal.¹¹ For the remainder of the Twentieth Century, the Supreme Court, Congress and the states wrote a lurching novel which vacillated between high and low points for vertical agreements.¹² Bolstered by the economic rationales supporting the valuable, but often intangible, services that producers seek for retailers to provide to their ultimate customers, Leegin overturned the per se rule against RPM and declared that vertical pricing agreements must be evaluated using a rule of reason analysis. The Supreme Court left it to the lower courts to fashion the appropriate analysis under the circumstances.¹³

1. The Economic Rationale for Analyzing Vertical Agreements Between Producers and Retailers By the Rule of Reason.

The basic purpose of vertical agreements among producers and retailers is to forsake intra-brand competition among retailers (e.g., Target and Walmart) in favor of more aggressive inter-brand competition among rival producers (e.g., Colgate and Crest). One way to visualize the relationship between retailers and manufacturers is to view retailers as a means to distribute finished products from manufacturers into the hands of consumers.¹⁴ This analogy, though imperfect, is a good starting point for considering pro-competitive benefits that flow from vertical agreements between producers and retailers: Retail distribution is an input that adds value to manufacturers' goods by delivering them to consumers.¹⁵ In theory, the value added by a retailer should reflect the value that the manufacturer places in a particular distributional scheme.¹⁶ If the costs to transport and promote the products are low and the profit margins charged by retailers are low, then the product price will reflect these lower costs of distribution. Producers compete on numerous levels, but price competition is undoubtedly important. Thus, lower retail mark-ups (and lower prices generally) will result in more sales for producers. In contrast, if the costs of distribution are high and the retailers charge large mark-ups on each good sold, the higher prices will reduce the quantity of goods sold and cause the manufacturer's total revenue to shrink.¹⁷ As a result, manufacturers rationally desire to deliver their goods via the least expensive distribution channel.

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But if manufacturers want cheap distribution, why would they set minimum resale prices, and more importantly for the legal question, why would the courts allow manufacturers to eliminate intra-brand price competition among retailers? The basic answer is that manufacturers compete for sales on many factors besides price. A major competitive factor is distribution—be it by the internet or in-store sales. By guaranteeing retailers a particular margin on every sale, producers gain some control over the retailers as a means of distribution. In return for those guaranteed profits, manufacturers can require retailers to offer particular services. And beyond this idea of direct control over retailers (dictating how a retailer will display a product, how it will market that product, or which services the retailer must provide), the manufacturers establish indirect control by creating an incentive for retailers to push their products instead of competitors' goods. So, if manufacturers believe that increasing their retailers' margins will cause more units to be sold, then the manufacturers would choose to be less competitive on price in order to be more competitive in point-of-sale services that add value to the purchased product. RPM accomplishes its goal of increased services related to distribution by eliminating intra-brand price competition through a price floor. From an economic perspective, the theory behind RPM is that there is a "bargain" being struck—consumers pay higher prices for increased services related to a particular brand, all the while there remains price competition between brands.¹⁸

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2. What Does Leegin Tell Us About Apple?

All of this discussion about vertical price fixing is important background to understand what is really happening in distributional chains. The big...