Distribution, Competition, and Antitrust / IP Law

Patent Tying: Does Price Discrimination Promote Innovation? (Part 3)

Returning to the subject of patent tying, price discrimination, and the promotion of innovation, Christopher Leslie’s recent article comes to the following conclusions:

1. Tying law should apply equally to patent tie-ins as to other tie-ins.

2. Tying law generally should be “fixed” by requiring proof of anticompetitive effects.  In other words, per se treatment should be jettisoned.  (In reality, although many courts still speak of “per se” illegal tying offenses, they often analyze competitive effects.  But there is language in some relatively recent cases suggesting that the offense of per se illegal tying may still exist.)

3. So long as the elements of a tying claim (including anticompetitive effects) are proven, then the fact that the patentee was using the tie-in as a metering device should be irrelevant.

I personally suggest that point no. 2 above makes eminent sense.  Point no. 3 at least has the advantage of simplicity of administration.  But I find, perhaps surprisingly, that point no. 1 is the most interesting one.  For one thing, it may be overbroad.  Patent law, after all, distinguishes between staple products (those that have uses unrelated to the patented product) and non-staple products (which are specially designed for use with the patented product).  Sale of a non-staple product can, at least under certain circumstances, amount to contributory patent infringement.  So if non-staple products are in some sense within the scope of the patent grant, why shouldn’t a patentee be able to engage in metered tying without worrying about tying law?

Additionally, the existence of a patent is probably some evidence of at least some sort of innovation in the patented product.  In the ordinary tying case involving unpatented products, there may be no such presumption.  And although some patentees can directly meter usage instead of using a tie in, as Leslie suggests, in some cases that may not be possible.  For example, suppose a company has a patent on a razor design, which utilizes unpatented blades.  Each consumer may buy only one razor, which lasts many years (or decades).  As a practical matter, it may not be possible to meter the razor usage — but it is relatively easy to meter the blade usage.

So perhaps the rule should be: as to staple products, or as to tied products where metering of the tying, patented product is a practical alternative, the tying rules should be the same.


Patent Tying: Does Price Discrimination Promote Innovation? (Part 2)

In the last post on this topic, I summarized arguments in favor of metered patent tying, as developed in a recent article by Christopher Leslie. There are, of course, arguments against the practice. Leslie summarizes them as follows:

1. The patentee is already rewarded for innovation. The patentee already has the power to charge higher prices for the patented product.

2. Metered tying isn’t calibrated to produce the optimal reward. For most of the 20th century, metered tying constituted (per se) patent misuse, yet firms innovated. The evidence that metered tying is necessary to promote innovation is lacking.

3. Overinvestment. Patent grants produce a “winner-takes-all” reward, which may cause an R&D race by a number of firms. This excessive research activity may be inefficient. Metered tying may exacerbate the problem.

4. Metered tying may not foster innovation. There is an absence of empirical evidence on this point. Additionally, the innovation argument, even if true, has no limiting principle. Why couldn’t companies defend a price-fixing charge on the basis that their activity fostered innovation?

5. Metered tying may reduce innovation in the tied product market. Fewer firms may mean less innovation. A smaller available tied product market provides less incentive for competitors to innovate in that market. The patentee may not have robust incentives to innovate in the tied product market, either. Finally, the tie could force rivals to enter two markets concurrently, impeding competition and innovation.

I’ll finish some thoughts on this in a final post.

Patent Tying: Does Price Discrimination Promote Innovation?

Christopher Leslie has a thoughtful article in this month’s issue of the Antitrust Law Journal entitled “Patent Tying, Price Discrimination, and Innovation.”  I thought I would take a post or two to riff on a few of the ideas presented.

Patents, of course, give their owners certain exclusive rights.  These are thought to foster innovation by allowing firms to recoup their R&D costs.  Absent patents, other firms would free ride on innovators’ efforts, which would reduce the incentive to innovate in the first place.

But patents also create inefficiencies.  Patent owners will likely price their patented products at higher price points.  Some consumers, who would have purchased a product at the competitive price (because they value the product more than it costs at the competitive price), will not buy the higher-priced patented product.  Rivals cannot meet this demand because of the patent.  And so the overall economic system suffers a deadweight loss or inefficiency.

Some commentators have proposed that price discrimination in a tied, metered product is appropriate, efficiency-enhancing, and an antitrust defense to a patented product tie.  Here’s the argument: suppose a manufacturer receives a patent on a sophisticated new type of color copier – one that performs functions no other copiers can perform.  The manufacturer could price its product at a premium, but then some customers who would otherwise buy it will be priced out of the market.  So the manufacturer engages in “metered tying” – it will sell the copier at a lower price point, but only to those customers who buy special, non-patented paper from the manufacturer.  The manufacturer charges for the paper by the page, so that customers who use more paper pay more.  This type of metered tying accomplishes price discrimination – those customers who want the patented product more will pay more for it through the metering.  If the metering is perfectly calibrated, the manufacturer may be able to capture – and thereby eliminate – the entire deadweight loss.

This sort of patent tying may (and often does) violate the patent laws and constitute patent misuse.  But the question is, should there be a special rule for antitrust purposes – should price discrimination through metered tying be allowable under the Sherman and Clayton Acts?

Leslie outlines the arguments that have been advanced in favor of such a defense.  Metered tying rewards past innovation and promotes future innovation.  Also, in the view of some, patentees can price discriminate as to patented products themselves, and so should be able to discriminate as to tied products.  In other words, price discrimination as to tied products is an exercise of the power inherent in the patent grant, not an extension of that power.

There are, of course, responses to these arguments.  I’ll summarize those in the next post.

American Express Can’t Enforce Arbitration Agreement Antitrust Class Action Waiver

The Supreme Court’s recent arbitration decisions have not yet killed the antitrust class action.

Yesterday, in a purported class action brought by merchants against American Express, the Second Circuit ruled that American Express could not enforce an arbitration agreement containing a class action waiver provision.  The Second Circuit distinguished the Supreme Court’s recent decisions in Concepcion and Stolt-Nielsen.  (Concepcion, in particular, had bolstered the enforceability of  arbitration provisions, ruling that the Federal Arbitration Act preempts certain state laws.)  The Second Circuit found that those cases did not address the issue of whether a class-action arbitration waiver clause is enforceable even if the plaintiffs are able to demonstrate that the practical effect of enforcement would be to preclude their ability to vindicate their federal statutory rights.

In so ruling, the Second Circuit relied upon evidence that showed that the cost of individually arbitrating the merchants’ claims would be prohibitive.  (The merchants had alleged that when American Express entered the commodity credit card business, American Express forced merchants to pay “excessive” rates equal to American Express’ more attractive business and personal charge cards by tying the credit and charge cards together.)

The decision is In re American Express Merchants’ Litigation, 2d Circuit Feb. 1, 2012.  A petition for certiorari is likely.

BMW Has To Face Tying Charges

BMW of North America last week failed to dismiss a complaint alleging that it tied certification of body shops as “certified collision repair centers” (CCRCs) to the sale of BMW-branded paint.  The Northern District of California (Judge Illston) analogized the claim brought by a competing paint distributor to a claim brought against a franchisor, and found that the plaintiff had adequately alleged (i) two separate products (the BMW paint might not be an “essential ingredient” of the CCRC branding and thus part and parcel of a single product) and (ii) an unlawful tie.

The tying of products to a franchise always requires careful analysis.  This case again demonstrates the very real possibility that an outsider to the distribution system (an aggrieved, competing supplier of product precluded from selling to franchisees) may complain about a tie.

Nicolosi Distributing, Inc. v. BMW of North America, LLC, No. 3:10-cv-03256SI (N.D. Cal. Apr. 19, 2011).

Don’t Get Tied in a Knot

Franchisors always need to be a bit careful when imposing upon franchisees a requirement to buy products from them. On March 11, in Shamrock Marketing, Inc. v. Bridgestone Bandag, LLC (W.D. Ky. No. 3:10-cv-00074-H), a federal district court refused to dismiss tying claims brought by a competing product supplier against a franchisor. (A “tie” typically exists when a supplier requires someone to purchase product B if she wants product A. Product A is the tying product, and Product B is the tied product.) Bandag, a franchisor with about 300 tire dealerships, did not impose an express tie, but instead allegedly provides strong incentives to purchase certain products from Bandag. Under this program, franchisees receive a credit good towards the purchase of certain products (“curing envelopes”) (the tied product) for every pound of rubber purchased from Bandag (the tying product). All franchisees are required to participate in the incentive program. This program allegedly totally or nearly totally offsets the price for Bandag curing envelopes. Allegedly as a result, the plaintiff saw a 90% decrease in sales of curing envelopes to Bandag franchisees.

The case illustrates a few principles. First, franchisors can be sued by third-party suppliers (as if worrying about franchisees is not enough). Second, a tying claim can be based on something other than a categorical requirement to buy two products together; a tying arrangement can be found where a deal induces all rational buyers of the tying product to accept the tied product (though the court noted the difficulties of actually proving and prevailing on such a claim). And third, franchisors may have to impose less burdensome restrictions to ensure quality. Although Bandag did not expressly assert a quality defense, the court found that it could have defended quality through a less burdensome alternative to tying, i.e., quality specifications.

On the plus side for franchisors, the court refused to allow the plaintiff to proceed on allegations that the relevant market consisted of Bandag rubber (which would, of course, have raised Bandag’s market share considerably – tying is usually not actionable unless the defendant has sufficient economic power in the tying product market). There was no change in policy following the “lock in” of franchisees, because Bandag always had a contractual right to impose its requirements. A policy change is a prerequisite, in the court’s view, to a restricted market definition. However, because Bandag allegedly has a 50% share of the overall market, and the remaining 50% is fragmented, the court found there were sufficient allegations that Bandag has enough market power to commit actionable tying.

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