Conditional Pricing: The Next Frontier of Antitrust Enforcement?

Economists Ink: A Brief Analysis of Policy and Litigation


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Su Sun has worked on merger, pricing fixing and abuse of dominance cases, including those involving conditional pricing. He has expertise in China’s antitrust issues and has made presentations before China’s Ministry of Commerce (MOFCOM).

 

Conditional pricing includes two types of pricing discounts: (1) discounts or rebates offered on a bundle of multiple products but not available on separate purchases of products in the bundle; and (2) loyalty discounts or rebates given on single product purchases that exceed a specified share or volume. Conditional pricing is a common business practice, but it is controversial, and different U.S. courts have used different criteria in judging its legality. Recently, the Federal Trade Commission and the Antitrust Division of the Department of Justice held a one-day public workshop to explore the economics and legal policy implications of conditional pricing.

There is no consensus in analyzing bundled or loyalty discounts in U.S. case law. In LePage’s, Inc. v. 3M (2003), 3M had a dominant share in the market for transparent tapes, but private label products were emerging as a competitive threat. 3M responded by making its own private label tapes. Since 3M also made other office products, including its branded Scotch tapes, it offered discounts to stores that purchased bundles that included its private label tape. LePage’s could not match that strategy due to its limited product variety. The 3rd Circuit found that 3M’s bundled pricing strategy was to exclude LePage’s from the transparent tape market by leveraging 3M’s monopoly power in other products. The 3rd Circuit ruled against 3M on the basis of exclusion, not predation.

This exclusion-based standard adopted by the 3rd Circuit was much criticized. In 2007, the Antitrust Modernization Commission (AMC) suggested a different test that focused more on predation than exclusion. The AMC’s test required a plaintiff to show three things. First, the defendant sold the competitive product below its incremental cost after all discounts and rebates attributable to the bundle of products were allocated to the competitive product. Second, the defendant likely would recoup the losses from the below-cost pricing. Third, the bundled discounts likely would harm competition.

The AMC’s price-cost test was adopted in the 9th Circuit’s decision in Cascade Health Solutions v. PeaceHealth (2007). McKenzie and PeaceHealth were the only providers of hospital care in Lane County, Oregon. Both offered primary and secondary care, but only PeaceHealth offered tertiary care. McKenzie claimed that it was more efficient in providing primary and secondary care and it could not compete because PeaceHealth offered discounts on tertiary care to insurers only if they made PeaceHealth their sole preferred provider for all three services. The 9th Circuit adopted the first prong of the AMC’s three-pronged test to allocate total discounts to the competitive product. The 9th Circuit’s requirement of a showing of below cost pricing in this case is consistent with the Supreme Court’s decision in Brooke Group v. Brown & Williamson Tobacco Corp. (1993) that a plaintiff must show that a rival’s discounted price falls below an appropriate measure of its costs.

Loyalty discounts are given to single product purchasers that satisfy specified share or volume requirements. In ZF Meritor, LCC v. Eaton Corp. (2012), Eaton had long-term agreements involving loyalty discounts with all the customers in the heavy-duty “Class 8” truck transmissions market. The 3rd Circuit considered these arrangements to be exclusive dealing and thus exclusionary. The 3rd Circuit rejected a price-cost test proposed by Eaton. In contrast, in Eisai Inc. v. Sanofi Aventis U.S. LLC (2014), the district court found the practices that the plaintiff alleged were exclusionary all came down to price, and a price-cost test was appropriate.

U.S. antitrust authorities are not the only ones scrutinizing conditional pricing. For example, the EU General Court affirmed the European Commission’s (EC) decision against Intel’s practice of offering rebates to PC manufacturers and to a PC retailer that were conditional on buying all or almost all of their microprocessors from Intel. While the EC performed a rule of reason analysis of Intel’s pricing practice, the General Court went further to find loyalty rebates by a dominant firm, like Intel, a per se violation.

Chinese antitrust authorities are also dealing with conditional pricing. One of the three Chinese antitrust agencies, the State Administration of Industry and Commerce (SAIC), has been investigating Tetra Pak’s bundled pricing of its packaging machines, packaging materials and service. Another Chinese antitrust agency, the National Development and Reform Commission (NDRC), has recently investigated Qualcomm’s patent licensing practices.Part of the investigation focuses on Qualcomm’s bundled pricing of its chips and patent licenses. (The Korean Fair Trade Commission (KFTC) fined Qualcomm in 2009 for bundled pricing.) The third Chinese antitrust agency, the Ministry of Commerce (MOFCOM), has imposed conditions on a recent merger prohibiting post-merger cross bundling of the merging parties’ products.

Economists recognize that the use of conditional pricing as a competitive strategy often results in lower prices for customers, especially when firms adopting that pricing strategy do not possess market power. Economists also recognize that in some circumstances when firms have market power, such pricing may exclude competitors, even when competitors are more efficient, and may strengthen a firm’s market dominance or extend market power from one market to another.

There appears to be no bright-line test that would distinguish between competitive conditional pricing and anticompetitive discounts. Currently, the most frequently cited test is the price-cost test. The main benefits of the price-cost test include the underlying principle that only discounts that do not allow equally efficient rivals to compete may be considered a violation of the antitrust law. However, skeptics say price is not the only dimension for competition, especially in a differentiated product market. Firms may also compete through marketing and quality. Some critics of this test argue that even less efficient competitors help lower prices for consumers, so that excluding them may be anticompetitive.

From a practical perspective, because the price-cost test is relatively straightforward, it is easier for businesses to comply with and for courts to rely on in adjudicating such disputes. Still, application of such a test may be difficult. For example, a large number of products may be included in the bundle, the pricing schemes of different bundles may be very complex, and rivals may form their own bundles in response to a dominant firm’s bundling. For single product loyalty discounts, it is often difficult to determine the level of purchases the customer would have to buy from the defendant, i.e., its incontestable demand.

In general, there is a need to balance all these considerations in finding a proper test for analyzing conditional pricing. Such a test needs to be based on sound economics, and it should also be clear and administrable.