Contributions

Buyers Beware: Lower Prices Can be Harmful to Consumers

by Megan Hare1

Bundling2 is an effective sales strategy with a profound effect on consumer welfare. Buyers generally benefit from bundling because they have the option to purchase more goods for lower costs.3 Sellers are attracted to bundling because it reduces transaction costs and increases consumption of products beyond their individual demand.4 Bundled discounts therefore should presumptively be procompetitive—that is, bundling is among the pricing schemes that the antitrust doctrine aims to promote.

However, bundling can reduce consumer welfare in the long run when firms intentionally price their bundles to eliminate competition.5 In this respect, firms use bundled discounts not to compete in the relevant markets, but to exclude equally or more efficient competitors from those markets. The classic example of this potentially “anticompetitive” behavior involves a firm having a monopoly on a product and pairing it with a second non-monopoly product in a bundle.6 While the aforementioned bundled discount might appear to be a straightforward violation of the Sherman Antitrust Act, the current circuit split between the Third Circuit and the Sixth and Ninth Circuits7 reflects a grave ambiguity about what constitutes an unlawful anticompetitive bundle. The judiciary’s minimal experience with bundled discounts and how bundling affects consumer welfare thus creates a dangerous uncertainty in U.S. markets, ultimately leaving firms without any clear guidance on how to avoid antitrust liability. The legal uncertainty regarding bundled discounts in turn negatively impacts the benefits flowing to consumers from discounted prices while permitting anticompetitive behavior that is harmful to consumers to escape regulation.8

This Contribution will argue first that market foreclosure9 should be the primary consideration for identifying anticompetitive bundling. Second, courts should be suspicious of bundled discounts that link monopoly and non-monopoly products when those bundles are offered by dominate firms, for these discounts frequently exclude competition and harm consumers in the long run.10

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Section 2 of the Sherman Antitrust Act (“Sherman Act”) seeks to prevent firms from destroying competition, and consequently from harming consumers, through exertion of monopoly power in a given market.11 Specifically, § 2 makes it unlawful for a firm to “monopolize, or attempt to monopolize, . . . any part of the trade or commerce among the several [s]tates, or with foreign nations.”12 A firm’s possession of monopoly power combined with its willful wielding of such power by engaging in anticompetitive conduct poses an unlawful threat to competition.13 In short, a monopolist engaging in exclusionary or anticompetitive conduct without a valid business justification violates § 2 of the Sherman Act.14

Anticompetitive conduct impairs the opportunities of rival firms and either does not further competition on the merits or does so in an unnecessarily restrictive way.15 Bundled discounts, while potentially procompetitive, may be anticompetitive where they exclude less diversified but equally efficient sellers. For example, severely discounted bundled products may exclude a competitor who sells only a single product in a bundle (and who produces that single product at a lower cost than the bundled discounter).16 Such a competitor is ultimately excluded from the market because the competitor is unable to match profitably the price created by the multi-product bundled discount.17 Accordingly, it would be inconsistent with § 2 of the Sherman Act to uphold any bundled discounts that substantially foreclose portions of the market to competitors who cannot make comparable offers because of a dominant firm’s conduct.

The threshold issue for courts, then, is to distinguish procompetitive bundled discounts from bundled discounts, offered by firms holding or on the verge of acquiring monopoly power, that harm competition. With no direct guidance from the Supreme Court, the circuit courts are split on the appropriate standard to use for determining when bundled discounts are anticompetitive. The Ninth and Sixth Circuits apply a discount attribution test, while the Third Circuit adopted an exclusionary effects test.18 Not surprisingly, both standards have been widely criticized for failing to discern reliably the anticompetitive effect of bundled discounts on consumer welfare.19

Under the Ninth Circuit’s discount attribution standard, a bundled discount is exclusionary under § 2 if the resulting price of the competitive product, after the full amount of the discount has been allocated to the product, is below the firm’s incremental costs to produce it.20 By requiring the competitive product to be priced below-cost, the court sought to ensure that the only bundled discounts condemned as anticompetitive were those that excluded equally efficient producers of the competitive product.21 Thus, the Ninth Circuit held that bundled discounts priced below-cost will be deemed anticompetitive in violation of § 2.22

 

Whether the Ninth Circuit will continue using the discount attribution standard it set forth in Cascade Health is yet to be determined. Although recent Ninth Circuit decisions have declined to apply the discount attribution standard,23 the Sixth Circuit affirmed the use of the Cascade Health discount attribution test. In Collins Inkjet Corp. v. Eastman Kodak Co., the Sixth Circuit concluded that the discount attribution standard is appropriate for “ties enforced purely through differential pricing,” noting that the Ninth Circuit’s analysis was more compelling than the Third Circuit’s exclusionary effects test.24

 

The Third Circuit’s exclusionary effects test, set forth in LePage’s Inc. v. 3M, is the leading alternative to the cost-based analysis utilized by the Ninth and Sixth Circuits.25 In LePage’s, the Third Circuit held that a bundled discount could be anticompetitive even though the bundle reduced prices for consumers (thus increasing consumer welfare) and even though equally efficient competitors were capable of matching the bundled price.26 In other words, even where post-discount prices are above a firm’s costs, the firm may still threaten competition by driving competitors out of the market using its current monopoly power. For instance, “a firm that enjoys a [dominant] monopoly” power in one market, “but which faces competition” in another market, might unlawfully exclude competitors, even if it prices all of its products above cost.27

However, the LePage’s decision has been challenged in part because the court did not evaluate whether a bundled discount was procompetitive, but simply declared that it was unlawfully anticompetitive for a monopolist to offer bundles with a broader product line than its competitors.28 Despite the widespread comments and criticism, the decision initiated a debate over the proper standard that should be used to determine monopolization in the bundled discount context, given that the anticompetitive effect resulting from bundles resembles both price predation and exclusionary conduct.29

Clearly, courts are struggling to identify the appropriate standard to apply when evaluating the anticompetitive effect of bundled discounts.30 The lack of consensus on the standard required for bundling, along with the Supreme Court’s decision to deny certiorari on the issue,31 makes this common commercial practice one of questionable legality, and that in turn harms both businesses and consumers.

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At first glance, the anticompetitive effect of bundled discounts may be difficult to discern. Bundling allows consumers to “get more for less,” which undoubtedly benefits consumers.32 Consumers benefit when competitors offer discounts through bundling because the competition among rivals creates a race-to-the-bottom effect on market prices.33 To be sure, antitrust laws aim to protect price-cutting discounts precisely because competition encourages lower market prices.34 So how can lower prices ever harm consumers?

Lowering prices can harm consumer welfare by stymieing competition and eliminating competitors from the market.35 Competition in capitalistic markets operates on the assumption that firms will maximize resource efficiencies in order to increase their profits.36 However, firms offering severely discounted bundles temporarily disregard capitalistic principles to gain additional market share or to maintain existing market power.37 The firm is essentially “trad[ing] a part of its monopoly profits, at least temporarily, for a larger market share, by making it unprofitable for other sellers to compete with it.”38 Once the firm achieves market foreclosure, it can then increase the price of its products to the point at which it can guarantee profit maximization.39 Of course, this price is invariably higher than the price determined in a competitive market.40 Consumer welfare therefore suffers in the long run when buyers must pay the higher prices controlled by the dominant firm.

The anticompetitive effect is even more substantial when a bundled discount links monopoly and non-monopoly products. Consider the following example:

Competitor 1 produces a monopoly product, A, and another non-monopoly product, B. Competitor 2 produces another version of product B, but at a lower average variable cost than Competitor 1. Competitor 2 therefore is the more efficient producer of product B. But, with the bundled pricing, Competitor 1 links the price paid for A to the purchase of B. If the stand-alone price of A (the monopoly product) is inflated, then the non-monopoly product, B, will give the false appearance of being a bargain when bundled with A. Competitor 2 will be forced to lower its price enough to compensate buyers for lost discounts on the monopoly product. This may force Competitor 2 to price below-cost, which may eventually exclude Competitor 2 from the market. Thus, a dominant firm can manipulate A’s price so that B appears to be cheaper.41

 

By bundling its monopoly and non-monopoly products, the dominant firm intends not only to maintain its monopoly power in product A’s market, but also to gain market share in product B’s market. The firm’s economic power therefore creates antitrust liability in this scenario, regardless of whether the dominant firm prices the bundle above or below-cost.

Courts should be skeptical of dominant firms linking monopoly and non-monopoly products in bundles. Despite providing consumers with lower prices today, the potential threat to competition in the future is too risky—that is, dominant firms offering these bundles are not simply furthering their current economic interests (i.e. increased profits, lower transaction costs, capitalization of economies of scale), but are attempting to thwart future competition by controlling prices within the market.42 Consequently, courts should condemn these bundles as anticompetitive to the extent that equally efficient competitors of the non-monopoly product are excluded from the market.

The courts’ struggle to ascertain which bundles are anticompetitive stems from the difficulty involved in predicting a bundled discount’s future harm to consumers. Both the Ninth Circuit’s discount attribution test and the Third Circuit’s exclusionary effects test attempt to calculate a bundle’s future threat to consumer welfare.43 The Ninth Circuit uses a cost-based analysis to identify unlawful anticompetitive conduct, recognizing that firms operating below-cost are motivated not by consumer benefit and profit maximization, but by market power.44 Although focusing on the diversification of the firm’s product markets, the Third Circuit similarly acknowledged the threat to competition and consumers when firms drive competitors out of the market using their current monopoly power.45 Despite applying different standards, both circuits articulated the future threat to consumers in terms of the respective bundled discount’s potential to foreclose portions of the related market.46 Concentrating on market foreclosure thus allows courts to regulate anticompetitive pricing schemes without discouraging legitimate price competition.

 

Notably, antitrust laws protect competition and consumers, not competitors.47 But the exclusion of competitors resulting from anticompetitive bundles inevitably harms consumers in the long run. Accordingly, any viable standard for distinguishing between procompetitive and anticompetitive bundled discounts must afford great weight to a bundled discounter’s ability to foreclose substantial portions of the market to less diversified but equally efficient competitors.

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The law on bundled discounts is a “moving target in every jurisdiction.”48 There is an urgent need to understand more fully the economic effects of bundling on consumer welfare. That understanding will allow courts the experience they need to “divine the prevalence and competitive effects of bundled discounts”[49] and make firm judgments about the presence of exclusionary versus procompetitive conduct in a given market. At minimum, courts can therefore better ensure that legitimate price competition will not be prohibited under overbroad liability standards,50 or, conversely, that anticompetitive behavior harming consumers will not escape regulation.

 

The Third and Ninth Circuits have provided some guidance for determining when bundles are anticompetitive. However, whether these circuits will continue to apply the standards they adopted in LePage’s and Cascade Health, respectively, remains unclear. What is clear from the current law is both courts’ emphasis on market foreclosure in determining the exclusionary effect of bundled discounts.51 Accordingly, plaintiffs challenging price-cutting bundled discounts as anticompetitive conduct in violation of § 2 of the Sherman Act should be required to prove that those bundles will exclude equally efficient competitors from the market. Otherwise the court risks enjoining procompetitive discounts, even those offered by dominant firms, that encourage competition on the merits, and thus increase consumer welfare.

Notes:

1. Megan Hare is a 3L at New York University School of Law. This Contribution is a commentary on one of the questions presented during the 2017 Global Antitrust Institute Moot Court Competition in Washington, D.C. The question addressed whether a cloud-based technology firm’s bundled discount for cloud computing and email services was anticompetitive in violation of § 2 of the Sherman Act. The views expressed in this Contribution do not necessarily represent the views of the author on this point of law, but serve as a distillation of the author’s argument as presented during the GAI Moot Court Competition. For another commentary from this competition, see Growing Pains in EU Antitrust Enforcement by Jonathan Hettleman.
2. Bundling is the practice of selling two or more products together (the “bundle”) at a lower price than the seller charges for the products sold separately. See Cascade Health Sols. v. Peacehealth, 515 F.3d 883, 894 (9th Cir. 2008).
3. See id. at 895.
4See Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application 343 (3d ed. 2008) (noting that bundling serves a number of procompetitive purposes, including achievement of economies of scale, quality control, and reduction of transaction costs); see also Timothy J. Muris & Vernon L. Smith, Antitrust and Bundled Discounts: An Experimental Analysis, 75 Antitrust L.J. 399, 404 (2008).
5. See Cascade Health, 515 F.3d at 896; see also Richard A. Posner, Antitrust Law 236 (2d ed. 2001).
6. See Ortho Diagnostic Sys., Inc. v. Abbott Labs., Inc., 920 F. Supp. 455, 467 (S.D.N.Y. 1996).
7Compare LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003), with Collins Inkjet Corp. v. Eastman Kodak Co., 781 F.3d 264 (6th Cir. 2015), and Cascade Health v. Peacehealth, 515 F.3d 883 (9th Cir. 2008).
8. See David S. Sibley, Matthew D. Sibley, & Melanie Stallings Williams, Tying and Bundled Discounts: An Equilibrium Analysis of Antitrust Liability Tests, 13 Berkeley Bus. L.J. 149, 151 (2016) (noting that the “lack of judicial clarity regarding bundled discounts matters because legal uncertainty has its own cost[:] firms may be reluctant to provide bundled discount plans that benefit their customers”).
9. Market foreclosure is a form of exclusionary conduct where a dominant firm acts as an aggressor and expands its market share at the expense of smaller rival firms. See Frank H. Easterbrook, When Is It Worthwhile to Use Courts to Search for Exclusionary Conduct?, 2003 Colum. Bus. L. Rev. 345, 345 (2003). Having lost their market shares to the dominant firm, rival firms either become excluded from the relevant market or attempt to regain market share by seeking injunctive relief from the courts. Id.
10. Because competitive and exclusionary conduct look alike, and because courts must determine whether a firm’s aggressive conduct today will be followed by monopoly tomorrow, courts have widely adopted a wait-and-see approach (i.e. wait to see if monopolistic prices happen later and deal with it then) for resolving exclusionary-practice claims. See Easterbrook, supra note 9, at 346 n.2. This Contribution, however, urges courts to grant injunctive relief sooner for bundled discounts offered by dominate firms that group a product over which the firm has substantial market power with a product that faces more robust competition. As this Contribution will demonstrate, dominant firms may easily employ bundled discounts anti-competitively where the bundled products are insulated with high barriers to entry and where the bundled products experience extremely low marginal costs. See Bradley Polina, False Negatives Under a Discount Attribution Test for Bundled Discounts, 22 CommLaw Conspectus 74, 75 (2014). Such aggressive, exclusionary conduct warrants judicial intervention before the dominant firm controls market prices and excludes rival competitors from the market.
11See Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 458 (1993) (“The purpose of the [Sherman] Act is not to protect businesses from the working of the market; it is to protect the public from the failure of the market. The law directs itself . . . against conduct which unfairly tends to destroy competition itself.”).
12. 15 U.S.C. § 2.
13. See United States v. Grinnell Corp., 384 U.S. 563, 570-71 (1966) (describing the two elements of monopolization as “(1) the possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.”).
14See LePage’s Inc. v. 3M, 324 F.3d 141, 152 (3d Cir. 2003).
15. See Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585, 605 n.32 (1985).
16. See Ortho, 920 F. Supp. at 467.
17. Id.
18. Compare Cascade Health v. Peacehealth, 515 F.3d 883, 906 (9th Cir. 2008) (“[A]s our cost-based rule, we adopt what amici refer to as a ‘discount attribution’ standard.”), and Collins Inkjet Corp. v. Eastman Kodak Co., 781 F.3d 264, 274 (6th Cir. 2015) (“The discount attribution standard thus provides the test for determining whether a plaintiff challenging a competitor’s tie that is enforced through differential pricing has antitrust standing”), with LePage’s Inc. v. 3M, 324 F.3d 141, 162 (3d Cir. 2003) (“The relevant inquiry is the anticompetitive effect of 3M’s exclusionary practices considered together.”).
19. For criticism of the Third Circuit’s exclusionary effects test, see Sibley et. al., supra note 8, at 156; Antitrust Modernization Comm’n, Report and Recommendations 97 (2007), http://govinfo.library.unt.edu/amc/report_recommendation/amc_final_report.pdf. For criticism of the Ninth Circuit’s discount attribution test, see Polina, supra note 10, at 102-07.
20. See Cascade Health, 515 F.3d at 906.
21. Id. at 909.
22. Id. at 903.
23. See Meijer, Inc. v. Abbott Labs., 544 F. Supp. 2d 995, 1002-03 (N.D. Cal. 2008) (“Even if Kaletra represents a bundled discount such that these cases fall within the general purview of Cascade, it does not follow that the Court must mechanically apply the Cascade rule regardless of its effect under the circumstances.”); Aerotec Int’l, Inc. v. Honeywell Int’l, Inc., 4 F. Supp. 3d 1123, 1141 (D. Ariz. 2014) (“While the court finds Honeywell’s arguments against the application of the discount attribution test persuasive, it need not make a determination about whether the test should actually apply.”).
24. Collins Inkjet Corp. v. Eastman Kodak Co., 781 F.3d 264, 273-74 (6th Cir. 2015).
25. See generally Cascade Health, 515 F.3d 895, and Eastman Kodak, 781 F.3d 264; see also Sibley et. al., supra note 8, at 158 (noting that the leading approaches for determining when bundled discounts are anticompetitive are the Third Circuit’s exclusionary effects test and the Ninth Circuit’s discount attribution test); Polina, supra note 10, at 77 (describing the “two dominant schools of thought in antitrust bundling” as the Third Circuit’s decision in LePage’s and the Ninth Circuit’s decision in Cascade Health).
26. See LePage’s Inc. v. 3M, 324 F.3d 141, 154, 156 (3d Cir. 2003); see also Daniel L. Rubinfeld, 3M’s Bundled Rebates: An Economic Perspective, 72 U. Chicago L. Rev. 243, 249-50 (2005).
27. See Ortho Diagnostic Sys., Inc. v. Abbott Labs., Inc., 920 F. Supp. 455, 467 (S.D.N.Y. 1996).
28. See, e.g., Antitrust Modernization Comm’n, supra note 18, at 97; Rubinfeld, supra note 19, at 250.
29. Jonathan B. Baker, Preserving a Political Bargain: The Political Economy of the Non-Interventionist Challenge to Monopolization Enforcement, 76 Antitrust L.J. 605, 614-15 (2010) (“The decision in LePage’s set off a legal controversy over monopolization standards because exclusion arising from bundled rebates or discounts resembles both price predation and exclusionary conduct.”).
30. See, e.g., Cascade Health, 515 F.3d at 903-08 (noting the complexity involved with defining an appropriate cost standard in bundled discount cases and summarizing the alternative cost-based standards rejected by the Ninth Circuit before it adopted the “discount attribution” standard); Sibley et. al., supra note 8, at 158; Thomas A. Lambert, Evaluating Bundled Discounts, 89 Minn. L. Rev. 1688, 1699-1700 (2005) (outlining five possible approaches that courts could use in evaluating bundled discounts); see also Polina, supra note 10, at 77 (“Courts have endeavored to fashion methodologies that can appropriately [solve] [the] ‘puzzle of exclusionary conduct.’” (citing Easterbrook, supra note 9, at 345)).
31. See LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003), cert. denied, 72 U.S.L.W. 3777 (U.S. June 30, 2004) (No. 02-1865). The Department of Justice and the Federal Trade Commission also argued against the Supreme Court’s granting certiorari, urging the Court to wait until the case law and economic analyses regarding bundled discounts were more developed. See Brief for the United States as Amicus Curiae at 19, 3M Co. v. LePage’s Inc., 542 U.S. 953 (2004) (No. 02-1865) (“[A]lthough the business community and consumers would benefit from clear, objective guidance on the application of Section 2 to bundled rebates, this case does not present an attractive vehicle for this Court to attempt to provide such guidance.”).
32. Cascade Health Solutions v. Peacehealth, 515 F.3d 883, 895 (9th Cir. 2008).
33. See id.; Lambert, supra note 30, at 1726 (suggesting that bundled discounts always provide some immediate consumer benefit in the form of lower prices).
34. See Matshushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 594 (1986) (“[C]utting prices in order to increase business often is the very essence of competition.”).
35. See Cascade Health, 515 F.3d at 896; see also Richard A. Posner, Antitrust Law 236 (2d ed. 2001); Barry Nalebuff, Exclusionary Bundling, 50 Antitrust Bull. 321, 321 (2005).
36. See, e.g., The Compact Oxford English Dictionary 497 (2d ed. 1991) (“Capitalists have an interest in economic efficiency, minimizing their factor (labor, capital, materials) costs per unit output, because this increases their profits.”).
37. See Polina, supra note 10, at 75-76, 83 (“[I]ncumbents may use limit-pricing strategies by effectively dropping the price on the competitive product [in the bundle] down to marginal cost – which is often near zero in many industries – to undermine new entry by signaling the unprofitability of entering the competitive product market. . . . Bundling may also be used by dominant firms to protect or maintain a monopoly, or to extend monopoly power into competitive markets.”).
38. Richard A. Posner, Antitrust Law: An Economic Perspective 28 (1976).
39. See LePage’s Inc. v. 3M, 324 F.3d 141, 164 (3d Cir. 2003).
40. Id.
41. Sibley et. al., supra note 8, at 154-55.
42. The advancement of economic interests here represents lawful procompetitive conduct by a dominant firm while the latter attempt to foreclose competition through market price control qualifies as unlawful exclusionary conduct.
43. See generally Cascade Health Solutions v. Peacehealth, 515 F.3d 883 (9th Cir. 2008); LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003).
44. See Cascade Health, 515 F.3d at 909.
45. See LePage’s, 324 F.3d at 155.
46. See Cascade Health, 515 F.3d at 908 (“[T]he primary anticompetitive danger posed by a multi-product bundled discount is that such a discount can exclude a rival who is equally efficient at producing the competitive product”); LePage’s, 324 F.3d at 155 (“The principal anticompetitive effect of bundled rebates as offered by 3M is that when offered by a monopolist they may foreclose portions of the market to a potential competitor”).
47. See Brunswick Corp. v. Pueblo Bowl-O-Mat, 429 U.S. 477, 488 (1977) (“The antitrust laws . . . were enacted for the protection of competition” (internal quotation marks omitted)).
48. Richard M. Steuer, Bundling Beyond Borders, 24-Sum Antitrust 40, 44 (2010).
49. Cascade Health, 515 F.3d at 908.
50. See id. at 895 n.5.
51. See id. at 909; LePage’s, 324 F.3d at 155.