Distribution, Competition, and Antitrust / Intellectual Property (IP) Law

Third Circuit Rules That Long-Term Agreements Featuring Market Share Rebates, Coupled With Other Exclusionary Behavior, Are Not Subject to a Price-Cost Screen

In ZF Meritor, LLC v. Eaton Corp., 2012 U.S. App. LEXIS 20342 (3d Cir. Sept. 28, 2012) (opinion available here), the Third Circuit ruled that long-term supply agreements predicated upon market share rebates or discounts should be evaluated under the Rule of Reason, rather than under the Brooke Group above-cost pricing test. As such, they can be exclusionary even if all of a defendant’s prices are above cost.

The defendant Eaton, a monopolist in the heavy-duty truck transmissions market, had entered into long-term supply agreements with all of the customers (OEMs) in the market. The agreements conditioned rebates on the purchase of a specified percentage of the OEMs’ requirements from Eaton.

The rebates did not reduce Eaton’s prices below cost, and Eaton argued that under a price-cost screen it therefore did not violate the antitrust laws. The Third Circuit conceded that predatory pricing principles, including the price-cost test, would control in cases solely presenting a challenge to pricing practices. “Moreover, a plaintiff’s characterization of its claim as an exclusive dealing claim does not take the price-cost test off the table . . . . [W]hen price is the clearly predominant mechanism of exclusion, the price-cost test tells us that, so long as the price is above-cost, the procompetitive justifications for, and the benefits of, lowering prices far outweigh any potential anticompetitive effects.”

However, the court declined to adopt Eaton’s “unduly narrow” characterization of the case as a “pricing practices” case, i.e., a case in which price is the “clearly predominant mechanism of exclusion.” The court noted other forms of exclusionary behavior, including (i) Eaton’s efforts to make itself the standard offering in the OEMs’ “data books” (which provided product information to end users); (ii) the removal of competitors’ products from two data books; (iii) preferential prices for Eaton products required by the long-term agreements; and (iv) evidence that Eaton’s continued compliance with the long-term agreements was also conditioned on the market penetration targets.

“Accordingly,” the Third Circuit concluded, “this is not a case in which the defendant’s low price was the clear driving force behind the customer’s compliance with purchase targets, and the customers were free to walk away if a competitor offered a better price . . . . Rather, Plaintiffs introduced evidence that compliance with the market penetration targets was mandatory because failing to meet such targets would jeopardize the OEMs’ relationships with the dominant manufacturer of transmissions in the market.”

In a long footnote, the Third Circuit distinguished its decision in LePage’s, while reaffirming its vitality. According to the ZF Meritor Court, LePage’s involved bundled product tying claims. “LePage’s is inapplicable where, as here, only one product is at issue and the plaintiffs have not made any allegations of bundling or tying. The reasoning of LePage’s is limited to cases in which a single-product producer is excluded through a bundled rebate program offered by a producer of multiple products, which conditions the rebates on purchases across multiple different product lines.”

The court went on to find that Eaton’s long-term contracts were, in fact, exclusionary and supported a finding of antitrust injury.

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Is Razor and Blade Pricing a Myth?

A heavy duty style safety razor. This is a fun...

(Photo credit: Wikipedia)

Speaking of razor and blade pricing, I just recently found this 2010 paper by Randal C. Picker entitled “The Razors-and-Blades Myth(s).”  From the abstract:

Gillette’s 1904 patents gave it the power to block entry into the installed base of handles that it would create. While other firms could and did enter the multi-blade market with their own handles and blades, no one could produce Gillette handles or blades during the life of the patents.

From 1904-1921, Gillette could have played razors-and-blades – low-price or free handles and expensive blades – but it did not do so. Gillette set a high price for its handle – high as measured by the price of competing razors and the prices of other contemporaneous goods – and fought to maintain those high prices during the life of the patents. For whatever it is worth, the firm understood to have invented razors-and-blades as a business strategy did not play that strategy at the point that it was best situated to do so.

It was at the point of the expiration of the 1904 patents that Gillette started to play something like razors-and-blades, though the actual facts are much more interesting than that. Before the expiration of the 1904 patents, the multi-blade market was segmented, with Gillette occupying the high end with razor sets listing at $5.00 and other brands such as Ever-Ready and Gem Junior occupying the low-end with sets listing at $1.00.

Given Gillette’s high handle prices, it had to fear entry in handles, but it had a solution to that entry: it dropped its handle prices to match those of its multi-blade competitors. And Gillette simultaneously introduced a new patented razor handle sold at its traditional high price point. Gillette was now selling a product line, with the old-style Gillette priced to compete at the low-end and the new Gillette occupying the high end. Gillette foreclosed low-end entry by doing it itself and yet it also offered an upgrade path with the new handle.

But what of the blades? Gillette’s pricing strategy for blades showed a remarkable stickiness, indeed, sticky doesn’t begin to capture it. By 1909, the Gillette list price for a dozen blades was $1 and Gillette maintained that price until 1924, though there clearly was discounting off of list as Sears sold for around 80 cents during most of that time. In 1924, Gillette reduced the number of blades from 12 to 10 and maintained the $1.00 list price, so a real price jump if not a nominal one. That was Gillette’s blade pricing strategy.

In sum: “Gillette hadn’t played razors-and-blades when it could have during the life of the 1904 patents and didn’t seem well situated to do so after their expiration, but it was exactly at that point that Gillette played something like razors-and-blades and that was when it made the most money. Razors-and-blades seems to have worked at the point where the theory suggests that it shouldn’t have.”

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N.D. Cal. Rejects Retail Shelf Space Discounting Claims

Discounting is usually pro-competitive.  A recent case in the Northern District of California illustrates just how difficult it is to challenge discounts under the antitrust laws.

Church & Dwight Co. (“C&D”), which makes Trojan-branded condoms, uses discounts.  Retailers get “planogram” or “POG” rebates if they dedicate a specified minimum percentage of the available condom “facings” on their in-store displays to C&D condom products.  The C&D POG program has several tiers, ranging from about 7% to 8% discounts, corresponding to about 65% to 75% of the facings.  These discounts are apparently all above cost. 

C&D has a large (>75%) market share, and its much smaller competitor, Mayer Labs, challenged its rebates, and some other practices, in Church & Dwight Co. v. Mayer Laboratories, Inc., 2012 U.S. Dist. LEXIS 51770 (N.D. Cal. Apr. 12, 2012) (Chen, J.).  In a thorough opinion, the Court granted C&D summary judgment on Mayer Lab’s Sherman Act Section 1 and Section 2 claims.

The Court focused on Mayer Lab’s inability to show any actual harm to competition:

  • Mayer failed to obtain evidence from any retailer’s employees or other third parties as to the supposed coercive or anticompetitive effect of C&D’s rebate program.
  • Over 50% of the industry display space is not even covered by C&D’s POG program.
  • C&D does not force retailers to purchase anything, much less a certain percentage, of products from C&D.  Nor do the agreements force retailers to give any specified amount of shelf space to C&D over its rivals.  Instead, retailers are free to give C&D as much or as little shelf space as they want.  The only consequence is that retailers may not receive a rebate based on those decisions.
  • The C&D agreements are terminable at any time, for any reason, on 30 days notice.

Following Allied Orthopedic Appliances, Inc. v. Tyco Healthcare Group LP, 592 F.3d 991 (9th Cir. 2010), the court ruled that Mayer had not shown any actual injury to competition at the retail level as a result of actual and substantial foreclosure of rivals.

The court considered, and rejected, Mayer’s argument that notwithstanding Allied Orthopedic, C&D’s discontinuous rebate structure (where the rebate percentages jumped up or down instantaneously at certain “facing” percentage points) creates “cliffs” whereby retailers face harsh “penalties” (in the form of lost rebates applicable to all sales starting with the first dollar, thus increasing the costs to the retailer) for moving downward on the rate schedule.  Even assuming this argument had merit and could distinguish Allied Orthopedic, the court concluded that Mayer had no evidence that the POG program in fact has such a coercive effect.  A significant number of large retailers do not participate in the POG program; C&D’s average share of sales at non-POG retailers is roughly on par with its share of sales at POG retailers; and C&D’s shelf share rarely exceeds its overall market share.  Other manufacturers (Durex and Lifestyles) have remained in the market despite the POG program.

In short, a foreclosure rate of perhaps 45% to 50%, coupled with the facts above and the easy terminability of the C&D contracts, is not enough to support either a Section 1 or a Section 2 claim — even when the defendant has a monopoly market share.

The court also rejected Mayer’s arguments that C&D, as a category “captain” (i.e., a manager of shelf space for a category of products) had abused its power to harm competition.  It found no evidence similar to that in Conwood Co., L.P. v. U.S. Tobacco Co., 290 F.3d 768 (6th Cir. 2002).

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