1. ANTITRUST POLICY AND REGULATION
Chapter 16
ANTITRUST POLICY AND REGULATION

2. Today’s lecture will:
Explain the difference between the structure and the performance methods of judging competition.
Outline a brief history of U.S. antitrust policy.
Discuss the resolution of the IBM, AT&T, and Microsoft antitrust cases.
Differentiate among horizontal, vertical, and conglomerate mergers.

3. Today’s lecture will:
Discuss the five reasons why unrelated firms would want to merge.
Compare U.S. antitrust policy with antitrust policy of other countries.
Explain three alternatives to antitrust policy that government can use to affect the competitive process.

4. Antitrust Policy
Antitrust policy is the government’s policy toward the competitive process.
There are two views of competition:
Judgment by performance – the competitiveness of markets should be judged by the behavior of the firms in the market.
Judgment by structure – the competitiveness of markets should be judged by the structure of the industry.

5. History of U.S. Antitrust Laws
Americans generally favor laissez-faire, but populist sentiment fears bigness and monopoly.
A trust or cartel is a combination of firms that have not actually merged, but act as a single entity to set common prices and govern the output of individual member firms.
Cartels and trusts, which developed during the late 1800s, led to the passage of the Sherman Act, the Clayton Act, and the Federal Trade Commission Act.

6. The Sherman Antitrust Act
The two main provisions of the Sherman Antitrust Act of 1890 are:
“Every contract, combination, or conspiracy in restraint of trade is illegal.”
“Every person who shall monopolize…shall be guilty of a misdemeanor.”
In the 1890s, economists debated if mergers:
Reflected increased economies of scale.
Were attempts to restrict output and generate monopoly profits.

7. Early Antitrust Cases
A firm is considered a monopoly only if it commits monopolistic abuses.
In 1911 the Supreme Court found Standard Oil and the American Tobacco Company, both structural monopolies, guilty of unfair business practices.
In the 1920 U.S. Steel case, the Court ruled that while the company was a structural monopoly, it was not a monopoly in performance.
U.S. Steel was not required to break up into smaller companies.

8. The Clayton Act
The Clayton Act of 1914 made four monopolistic practices illegal when their effect was to lessen competition:
Price discrimination
Tie-in contracts
Interlocking directorships
Buying stock in a competitor’s company

9. The Federal Trade Commission Act
The Federal Trade Commission Act of 1914 made it illegal:
To use “unfair methods of competition.”
To engage in “unfair or deceptive acts or practices,” whether or not those actions had any effect on competition.
In 1938 the Federal Trade Commission was given the job of preventing false and deceptive advertising.

10. The ALCOA Case
Judgment by performance governed antitrust policy until the ALCOA case of 1945.
The court did not rule that ALCOA had engaged in unfair practices, but that it dominated the market by expanding capacity and keeping prices low.
The court changed its viewpoint to judging markets by structure.

11. Judging Markets by Structure and Performance
Judging by structure is practical though seemingly unfair.
The alleged wrongdoer is doing what it is supposed to be doing, producing the product at the lowest possible price.
With judgment by performance, each action of a firm must be analyzed on a case-by-case basis.

12. Determining the Relevant Market and Industry
Choosing the relevant market when evaluating competitiveness is difficult to do.
The relevant market in the ALCOA case was the aluminum market, not the metals market at large.
The relevant market in the Du Pont case (1956) was flexible wrap, not cellophane.
Du Pont was not considered a monopolist even though it sold 100% of cellophane.

13. Recent Antitrust Enforcement
Since the 1980s, the government has been more lenient in antitrust cases because:
Political pressure for antitrust action waned.
Globalization of the U.S. economy.
The increasing complexity of technology.
There have been three recent important computer and telecommunications cases:
IBM
AT&T
Microsoft

14. The IBM Case
In 1967, the Justice Department sued IBM for violation of antitrust laws:
IBM unfairly bundled hardware, software, and maintenance service.
IBM constantly redesigned its hardware, so that competitors couldn’t keep up.
In its defense, IBM argued:
The market was larger than the government claimed.
Changing technology and customer demand forced it to constantly upgrade its equipment.

15. The IBM Case The government dropped its suit in 1982.
Mainframe computers were replaced by PCs.
Globalization of the computer industry made IBM’s dominance in the U.S. far less important.
The prosecution likely led to IBM’s problems in the 1990s.
IBM didn’t buy the DOS operating system from Microsoft because of the litigation.
PCs replaced mainframes.

16. The AT&T Case Up until 1982, AT&T was a regulated natural monopoly.
It controlled most long-distance and local telephone services.
It produced telephones and other communications equipment.
Satellite transmissions and fiber-optic cable began to compete for long-distance service.
Competitors sued because they felt AT&T was charging too much to access their local lines.

17. Resolution of the AT&T Case
In 1982, AT&T agreed to divest its 22 local operating companies, which merged into the seven Baby Bells.
It kept its long-distance telephone service, manufacturing arm, and Bell Laboratories.
Other firms emerged as long-distance competitors and rates fell.
Local rates doubled and tripled.

18. Developments Since the AT&T Case
By 2005 the Baby Bells had merged into four companies: SBC Communications, Verizon, Bellsouth, and Qwest.
In 1995, AT&T had divided itself into three companies: AT&T, Lucent, and National Cash Register.
In 2005, AT&T and SBC Communications (Cingular Wireless) merged as a new AT&T.
Finally in 2006, the new AT&T was taken over by Bellsouth to become the new, new at&t.

19. The Microsoft Case
Microsoft controls about 50% of the market for software and over 90% of the operating systems market.
In 1998, the Justice Department charged Microsoft with:
Possessing monopoly power in the PC operating systems market.
Tying other of its products to Windows.
Preventing PC manufacturers that install Windows from offering competing software.

20. Is Microsoft a Monopolist?
The software industry is characterized by barriers to entry in the form of
Network externalities
Economies of scale
In a static framework, with its 90% market share, Microsoft is a monopoly.
From a dynamic perspective, there is potential competition from other operating systems and the merging of hardware and software.

21. Is Microsoft a Predatory Monopolist?
The Justice Department argued that Microsoft had acted unfairly in gaining its large shared of the software market and maintaining barriers to entry.
By directing the development of software to favor Windows, Microsoft strengthened the barrier to entry created by network externalities.
Microsoft penalized PC manufacturers that installed Windows if they also installed competing software.

22. Resolution of the Microsoft Case
In 2000 the court ruled that Microsoft violated the Sherman Act by using anti-competitive means to maintain its monopoly power.
In the settlement Microsoft agreed that:
It would not prohibit PC makers from using competing products.
It would release technical information on Windows improvements to software makers.
It could continue to bundle and media players with Windows.

23. Microsoft, the EU, and the Internet
In 2004 the EU fined Microsoft for:
Tying its Windows Media Player to its operating system
Designing server software to give it an unfair advantage over competitors
In 2007 Microsoft faces competition from the free software offered by Google online.

24. Mergers, Acquisitions, and Takeovers
During the 1990s and early 2000s, firms have been breaking up and merging to achieve economies of scope and economies of scale.
A merger, a general term meaning the act of combining two firms, may occur as:
Takeovers
Acquisitions

25. Mergers
Horizontal merger – the merging of two companies in the same industry
Vertical merger – a combination of two companies that are involved in different phases of producing a product
Conglomerate merger – the merging of two companies in relatively unrelated industries

26. Reasons for Mergers Economies of scope To get a good buy
Diversification
Warding off a takeover bid
Strengthening political-economic influence

27. Antitrust Policy in Other Countries
Antitrust legislation in other countries, with the exception of the European Union, is usually much weaker than in the U.S.
In the early 2000s the European Commission, the EU’s antitrust agency, began to block mergers of U.S. companies, such as GE and Honeywell.

28. Regulation, Government Ownership, and Industrial Policies
Governments can affect the competitive process by:
Regulating the activities of firms with:
Price regulations
Social regulations that affect aspects such as working conditions and product quality
Owning and taking direct control of the firms.
Industrial policy that influences firms with laws and taxes.

29. Summary
Antitrust policy is the government’s policy toward the competitive process.
The competitiveness of markets can be judged by:
Performance – behavior of firms in the market
Structure – number of firms in the industry and their market share

30. Summary Important antitrust laws include:
The Sherman Antitrust Act
The Clayton Act
The Federal Trade Commission Act
Important antitrust cases involved:
AT&T
IBM
Microsoft

31. Summary Three types of mergers are:
Horizontal – two firms in the same industry
Vertical – two companies in different industries, one of which is a supplier for the other.
Conglomerate – combination of two companies in relatively unrelated industries
Reasons unrelated firms would want to merge are:
Economies of scope
A good buy
Diversification
Warding off a takeover bid
Strengthening political-economic influence

32. Summary
The increasing internationalization of the U.S. market has changed U.S. antitrust policy from looking at just domestic competition to considering international competition.
Antitrust issues are by nature global, but a country’s antitrust laws are not.
Other than antitrust policy, government affects the competitive process through regulation, government ownership, and industrial policy.

33. Review Question 15-1 What are the two methods of judging the competitiveness of a market?
The performance approach assesses competitiveness based on the behavior of firms in the market, whether they engage in unfair business practices. The structure approach judges the competitiveness of the market based on the number of firms and their market shares.
Review Question In what way is Microsoft a monopolist? In what way is it not a monopolist?
In a static sense, Microsoft is a monopoly because it controls 90% of the market for operating systems with Windows. However, in a dynamic sense, Microsoft faces increasing competition from other operating systems, Linux and Jaguar, and from the merging of software and hardware. PDAs and smart phones run software without Windows.