Competition Policy on Exclusionary Conduct: Toward an Effects Based Analysis? Gregory J. Werden Senior Economic Counsel Antitrust Division U.S. Department of Justice British Institute of International and Comparative Law February 24, 2006 The views expressed herein are not purported to reflect those of the U.S. Department of Justice

The Problem of False Positives The application of competition policy “can be difficult because the means of illicit exclusion, like the means of legitimate competition, are myriad.” The inevitable “false positives” harm consumers by chilling any legitimate conduct that is sometimes mistakenly found to be exclusionary. A competition agency should allow for the possibility of error in assessing potentially exclusionary conduct.

The Supreme Irony Against any gains from efforts to promote competition, one “must weigh a realistic assessment of its costs.” Zealous efforts to promote consumer welfare can have the opposite effect; denying successful competitors the fruits of their efforts discourages the innovation and risk taking from which consumers derive enormous benefits. A competition agency should account for the impact of its actions on incentives to take risks and innovate.

Best Serving Consumers Consumers are best served by a policy that avoids chilling legitimate competition and discouraging innovation. The best policy features elements that are form based as well as elements that are effects based. Desirable form based elements include a rigorous dominance screen and safe harbors for certain conduct. Desirable effects based elements include the “no economic sense” test.

Common Ground “To say that the law on abuse of dominance should develop a stronger economic foundation is not to say that rules of law should be replaced by discretionary decision making based on whatever is thought to be desirable in economic terms case by case. There must be rules of law in this area of competition policy, not the least for reasons of predictability and accountability.” Sir John Vickers, Abuse of Market Power, 115 Economic Journal F244, F260 (2005).

The Chilling Effect An open ended analysis of the effects of potentially exclusionary conduct is not just problematic; it most likely is counterproductive. “Overreaching the limits of adjudication will increase the rate of error.” “Subjecting a single firm’s every action to judicial scrutiny for reasonableness would threaten to discourage the competitive enthusiasm that the antitrust laws seek to promote.”

The Short Sightedness Problem A purely effects based policy could be fatally short sighted. “The successful competitor, having been urged to compete, must not be turned upon when he wins.” “The opportunity to charge monopoly prices—at least for a short period—is what... induces risk taking that produces innovation and economic growth.”

A Rigorous Dominance Screen Statutory provisions regulating the conduct of single competitors generally make dominance (at least threatened dominance) a jurisdictional prerequisite. There is also a strong policy case for employing a rigorous dominance screen, because the actions of a truly dominant competitor should be “examined through a special lens.”

The Monopoly Power Test An element of the Sherman Act offense most like abuse of dominance is “the possession of monopoly power.” Many courts in the United States have indicated that a share below 50% precludes finding monopoly power and a share of over 70% is required to infer monopoly power. “Monopoly power must be shown to be persistent....“ “In evaluating monopoly power, it is not market share that counts but the ability to maintain market share.”

The Monopoly Power Screen The monopoly power requirement avoids difficult issues in the evaluation of conduct that might possibly be exclusionary, but it most probably is not. This screening process reduces administrative cost and provides cherished certainty to competitors confident they would not be found to possess monopoly power. A rigorous monopoly power screen avoids false positive findings of exclusionary conduct.

Integrating the Dominance Test? A separate dominance test is required because the appropriate effects test depends on whether a competitor was dominant before implementing the subject conduct. It can be exceptionally difficult to determine whether single competitor conduct has the sort of long term adverse effects that would merit its condemnation. Easily observed effects on competitors may imply market power but generally not the substantial and persistent market control required for monopoly power.

Category Based Safe Harbors “A monopolist, no less than any other competitor, is permitted and indeed encouraged to compete aggressively on the merits.” Conduct that can be categorically labeled “competition on the merits” should be placed in a prudential safe harbor and not subjected to any enquiry into actual effects. “[I]mproved product quality, energetic market penetration, successful research and development, cost reducing innovations, and the like” cannot violate the law.

A Cost Cutting Safe Harbor Cost reducing innovations illustrate the need for a safe harbor and the critical difference between protecting competition and protecting competitors. Reducing cost can exclude inefficient competitors, which may harm consumers, but reducing cost nevertheless is competition on the merits, which should be encouraged.

A Price Cutting Safe Harbor The U.S. Supreme Court held that a price cutting is unlawful only if “the prices complained of are below an appropriate measure of [the price cutter’s] costs.” “As a general rule, the exclusionary effect of prices above a relevant measure of cost either reflects the lower cost structure of the alleged predator, and so represents competition on the merits, or is beyond the practical ability of a judicial tribunal to control without courting intolerable risks of chilling legitimate price cutting.”

Other Conduct Safe Harbors The U.S. Supreme Court also created a safe harbor for any litigation that is not “objectively baseless.” Lower U.S. courts have explicitly rejected the possibility of condemning a dominant competitor merely for introducing a new product or for declining to do so.

Limiting Effects Based Analysis Competition agencies and courts should not have “ carte blanche to insist that a monopolist alter its way of doing business whenever some other approach might yield greater competition.” Rather, the conduct of a single competitor should be evaluated under objective standards assuring that only truly exclusionary conduct is condemned.

The “No Economic Sense” Test The Solicitor General of the United States has argued that conduct should not be deemed exclusionary “unless it would make no economic sense for the defendant but for the tendency to eliminate or lessen competition.” The U.S. Department of Justice has consistently advocated this “no economic sense” test in its recent monopoly cases: American Airlines, Dentsply, and Microsoft.

Application of the Test The test is easy to apply to conduct that can benefit the dominant competitor only by eliminating competition. The test can be difficult to apply to conduct that benefits the dominant competitor only partly by eliminating competition, but it should be difficult to find such conduct exclusionary. The test is not always useful; predatory pricing cases instead should compare prices with cost and examine prospects for recoupment.

Conduct Costing Little or Nothing One objection to the “no economic sense” test is that exclusionary conduct may cost little or nothing. It normally is impossible to exclude without incurring some cost, and the “no economic sense” test asks whether the cost sensibly would have been incurred absent the tendency to eliminate competition. Costless exclusion could be dealt with: The test deems conduct exclusionary if it can confer an economic benefit only by eliminating competition.

Conduct Making Little Sense Another objection to the “no economic sense” test is that highly anticompetitive conduct nevertheless may make some economic sense. No real world illustration of such conduct has been cited, nor is there reason to believe that such a scenario could be identified accurately if it did arise. The bar should be set high for any conduct producing significant, immediate consumer benefits.