Parallel exclusion.

Author:Hemphill, C. Scott
Position:III. Stability A. Interdependent Exclusion 2. The Superior Stability of Parallel Exclusion through Conclusion, with footnotes, p. 1222-1253

2. The Superior Stability of Parallel Exclusion

To this point, we have identified a similar tendency toward defection in parallel pricing and parallel exclusion. We now suggest reasons that exclusion schemes may be less likely to collapse.

Two important challenges for achieving coordination are identifying the coordination point and observing compliance. (174) Both are easier for parallel exclusion than for parallel pricing.

Identifying the coordination point in oligopolistic price elevation is complex. At its simplest, there is a continuum of prices that could be chosen, and the parties have to find some way, often through communication, to choose one of them. Moreover, that optimal price will change as supply or demand conditions change, requiring the parties, who may vary in their perceptions of what if anything has changed, to select a new elevated price. If the product is differentiated, there may be many different prices that must be coordinated. Figuring out how to allocate the gains from price elevation makes the problem even more complex, (175) because direct payments between the firms are obviously disfavored, and alternative mechanisms-taking turns in supplying a customer, or agreeing on the quantity to be sold by each producer-are likely to require forbidden communication. These allocations will also require rebalancing if supply or demand conditions change, or if the parties miscalculate. The need to rebalance increases the fragility of the arrangement.

By contrast, the implementation of parallel exclusion is often simpler. (176) In theory, the action is often binary: each firm either deals or refuses to deal with a new entrant; or either engages or does not engage in tying or exclusive dealing. For example, in Allied Tube, whether a steel manufacturer had voted to exclude plastic pipes from the Code was clear, as the vote was conducted by open ballot. Without a continuum, there is little need for delicate calibration. Moreover, changes in economic conditions are less likely to change the optimal selection. Gains are difficult to reallocate with such a blunt instrument, providing an incentive to stick with the initial allocation. As a result, readjustments in the sharing rule are also unnecessary.

Here, the comparison to predatory pricing conducted by oligopolists is instructive. In Brooke Group, a major predatory pricing case, the Court discussed the significant barriers to successful coordination. The "anticompetitive minuet" that the Court thought was so "difficult to compose and to perform" in the context of oligopolistic predatory pricing (177) is much simpler in the realm of parallel exclusion.

With price-fixing, observing compliance with the elevated price level is difficult. Rivals may secretly extend price cuts to particular customers. This is particularly true for differentiated products, for which comparisons are more difficult. It is also true when demand or supply conditions are uncertain, in which case it is unclear whether an unexpected drop in profits is attributable to a rival's secret price cut or instead to a change in conditions. With parallel exclusion, observing compliance is much easier. It is hard to secretly cut a deal with an innovative entrant or drop out of an industry-wide exclusive dealing arrangement unnoticed.

Beyond these two advantages, there is a third factor, which is that the permanence of the change resulting from accommodation makes parallel exclusion easier to sustain as compared to parallel pricing. Price cuts are reversible. Firms engage in price wars and then stop, raising their price to the old levels. Where the consequences of defection are temporary, firms are tempted to defect. (178) For parallel exclusion, permitting entry is comparatively permanent and thus severe. Once a firm allows an innovative new entrant, the market structure changes permanently. Consumers become used to and come to rely on the new arrangement. Aside from consumer expectations, U.S. antitrust policy makes it harder for an incumbent to reverse course, because cessation of a course of dealing with a rival is a possible basis for liability. (179)

The exclusionary rules imposed by Visa and MasterCard illustrate the stability of parallel exclusion. The rules were not set at the same time. Visa set its rule first, in 1991, while MasterCard lagged by several years. Once Visa had set its rule, MasterCard had a golden opportunity. It could gain at Visa's expense by declining to exclude banks that adopted other cards, and thereby convince banks to leave Visa, in favor of issuing MasterCard and (thanks to MasterCard's openness) Amex. In fact, evidence produced during litigation revealed an extensive internal debate about the merits of an exclusionary rule, in which MasterCard managers argued that openness would help it gain market share at Visa's expense by inducing banks that wanted to issue Amex to abandon Visa. (180)

Ultimately, MasterCard adopted the exclusionary rule-following the counsel of its future CEO-that MasterCard should "make it as hard as possible to have Amex do anything anywhere in the world." (181) Based on the foregoing analysis, it is not hard to see why. The relevant rule was simple and well defined. Compliance was visible and easy to confirm. Unlike a secret price cut, accommodation here would have meant the end of exclusion. Once MasterCard opened the door to Amex, there would have been no going back.

While we expect parallel exclusion to be more durable than parallel pricing, there can be exceptions to this rule. For one thing, we have focused on the simple, canonical example of oligopolistic price elevation, in which firms each select a price in reliance on the optimal price chosen by rivals. As Jonathan Baker has noted, other forms of price elevation may be simpler to establish and sustain, such as the use of focal rules (e.g., raise price by five percent every twelve months). (182) Or, to take another example, firms engaged in geographical market division could each refrain from entering each other's territory. Avoiding certain forms of nonprice competition-a mutual decision not to innovate, for example- may be simpler than setting an elevated price.

There are additional factors that can lead to the failure of parallel exclusion, even where exclusion might be in the collective interest of the excluders. A powerful entrant can undermine its stability, in much the same way that a large enough buyer can disrupt a cartel of sellers. If the outsider seeking interconnection or cooperation owns a must-have application or device, it may be able to dictate terms that disrupt the existing parallel practice. So, while for years, carriers had resisted and blocked various smartphone features like WiFi and Bluetooth, which are valuable to consumers but threatening to carrier revenues, (183) Apple and Google were strong enough to induce the carriers to allow these technologies to operate on the carriers' networks. (184)

Moreover, the powerful outsider can play one oligopolist against another in achieving attractive terms. If AT&T cannot provide what Apple wants, perhaps Verizon Wireless can. There is a possibility of coordination failure among the oligopolists. The failure can be made more likely if the entrant commits to offering a differential benefit to the first defecting incumbent, for example, through exclusivity for a period. (185) This effect grows large as the number of oligopolists increases. In this respect, we see the relative weakness of oligopoly, compared to monopoly, in accomplishing exclusion. (186)

The stability of parallel exclusion has a further important implication.

Interdependent excluders will often not need any agreement-or, more specifically, will not need the communications that are emphasized in some accounts to provide a basis for finding agreement under section 1. (187) The characteristics of parallel exclusionary conduct-simplicity, transparency, and permanence-make it less necessary for communications that define, report, and respond to each firm's actions. (188)

This fact makes "agreement" a particularly poor proxy for determining when interdependent parallel exclusion will be harmful-setting up a paradox of proof of the kind introduced in Part I. Those exclusion schemes that are likely to last the longest and (all else equal) therefore to do the most harm can persist without communication. The easier and more effective parallel exclusion is, the less likely it is to be addressed under antitrust doctrine that focuses on horizontal agreement among the excluders. After all, if parallel exclusion is already easy, and (whatever gives rise to an inference of) agreement merely makes it a little easier, but much rislder legally, then the excluders will simply avoid that particular means of maintaining the oligopoly.

In fact, the paradox may be significantly more severe for parallel exclusion, compared to oligopolistic price elevation. It may be difficult in practice to accomplish price elevation without relying on the forbidden activities, such as communication, that support a finding of agreement. (189) By contrast, parallel exclusion may be relatively easy to accomplish without such activities, and if so, the paradox is more likely to arise in the context of parallel exclusion. Despite this, under current law, the existence of horizontal agreement is sometimes treated as a necessary condition for liability. This problem is taken up in Part IV.

3. Recidivist Exclusion

As argued above, exclusionary schemes may be less prone to collapse than pricing schemes. But the cooperative outcome is just one of many possible equilibria. (190) Why is that particular equilibrium chosen? Our case studies suggest that the particular history and developed customs of the industry, and especially prior episodes of explicit or monopolistic exclusion, may serve to identify a common coordination point and make detecting and punishing deviation easier.

Exclusionary schemes often...

To continue reading