U.S. Antitrust Law: A PrimerU.S. Antitrust Law: A PrimerHoward A. Shelanski, U.C. BerkeleyHoward A. Shelanski, U.C. Berkeley

Nanterre—Paris XNanterre—Paris XNovember 2006November 2006

AgendaAgenda

Sections 1 and 2 of the Sherman ActSections 1 and 2 of the Sherman Act– Collusion and Monopolization Collusion and Monopolization

Section 7 of the Clayton ActSection 7 of the Clayton Act– Merger policyMerger policy

Antitrust and Telecommunications in Antitrust and Telecommunications in the United Statesthe United States

Origins of U.S. Antitrust LawOrigins of U.S. Antitrust Law

Late 19Late 19thth century populist revolt century populist revolt against big businessagainst big business– Small farmers and tradesmen feared the Small farmers and tradesmen feared the

rise of large, powerful “trusts” in key rise of large, powerful “trusts” in key industries like oil, rail transport, and industries like oil, rail transport, and steel.steel.

Sherman Antitrust Act (1890)Sherman Antitrust Act (1890)– U.S. Congress passes the first national U.S. Congress passes the first national

antitrust law in response.antitrust law in response.

Scope of the Sherman ActScope of the Sherman ActTheory behind the Act was to restrain Theory behind the Act was to restrain large business enterprises in 2 ways:large business enterprises in 2 ways:

– Prohibit collusion and coordination among Prohibit collusion and coordination among business enterprises to the detriment of business enterprises to the detriment of consumers and other businesses (Section 1 of consumers and other businesses (Section 1 of the Sherman Act).the Sherman Act).

– Prohibit activities by powerful firms that create Prohibit activities by powerful firms that create or maintain monopoly power for those firms or maintain monopoly power for those firms (Section 2 of the Sherman Act).(Section 2 of the Sherman Act).

Text of Sherman Act Text of Sherman Act §§§§ 1 and 2 1 and 2Section 1Section 1– ““Every contract combination . . . or Every contract combination . . . or

conspiracy in restraint of trade or conspiracy in restraint of trade or commerce . . . is declared to be illegal.” commerce . . . is declared to be illegal.”

Section 2Section 2– ““Every person who shall monopolize, or Every person who shall monopolize, or

attempt to monopolize . . . any part of attempt to monopolize . . . any part of trade or commerce . . . shall be deemed trade or commerce . . . shall be deemed guilty of a felony.” guilty of a felony.”

Problem: Text is Very BroadProblem: Text is Very BroadRead literally, the Act would prohibit much Read literally, the Act would prohibit much beneficial business activitybeneficial business activity

– Examples, Section 1Examples, Section 1: The literal text prohibits : The literal text prohibits professional partnerships, joint R&D, and small professional partnerships, joint R&D, and small purchasing cooperatives.purchasing cooperatives.

– Examples, Section 2Examples, Section 2: Prohibits monopoly itself; could bar : Prohibits monopoly itself; could bar using superior technology or scale economies to under-using superior technology or scale economies to under-price competitors if such conduct could lead to price competitors if such conduct could lead to monopoly, yet this benefits consumers. monopoly, yet this benefits consumers.

Challenge: How to apply the Sherman Act to Challenge: How to apply the Sherman Act to achieve its goals, but without being overly achieve its goals, but without being overly restrictive?restrictive?

Meeting the Challenge: Application Meeting the Challenge: Application of the Sherman Act: Section 1of the Sherman Act: Section 1

U.S. Courts in 1911 determined that U.S. Courts in 1911 determined that Section 1 only means to prohibit Section 1 only means to prohibit “unreasonable” restraints of trade. “unreasonable” restraints of trade.

““Reasonable” restraints of trade are Reasonable” restraints of trade are those that help economic progress those that help economic progress and that lead to more efficient and that lead to more efficient markets.markets.

What Conduct is “Unreasonable” What Conduct is “Unreasonable” Under Section 1?Under Section 1?

Unreasonable restraints of trade are Unreasonable restraints of trade are those that have the overall effect of those that have the overall effect of reducing economic competitionreducing economic competition

How Do Courts and Agencies How Do Courts and Agencies Decide what is “Unreasonable”?Decide what is “Unreasonable”?

Courts have created two classes of Courts have created two classes of conduct:conduct:– Conduct that is always illegal:Conduct that is always illegal: Courts early Courts early

on determined that some conduct is so on determined that some conduct is so inherently harmful to competition that it is inherently harmful to competition that it is presumed illegal, regardless of circumstances. presumed illegal, regardless of circumstances. This conduct is This conduct is illegal illegal per se per se under § 1.under § 1.

Price fixing agreementsPrice fixing agreements

Agreements to divide territoriesAgreements to divide territories

Output restrictionsOutput restrictions

Section 1, Illegal conduct (Cont’d)Section 1, Illegal conduct (Cont’d)

– Conduct that is sometimes illegalConduct that is sometimes illegal: : Other conduct might benefit competition Other conduct might benefit competition under some conditions but be harmful under some conditions but be harmful under other conditions. This conduct is under other conditions. This conduct is not always illegal, but is reviewed case-not always illegal, but is reviewed case-by-case under a by-case under a “rule of reason.”“rule of reason.”

Information exchanges among rivalsInformation exchanges among rivals

Standard setting bodiesStandard setting bodies

Restraints necessary to create a product or Restraints necessary to create a product or allow a market to function.allow a market to function.

Modern Trend in Enforcement of Modern Trend in Enforcement of Section 1 of the Sherman ActSection 1 of the Sherman Act

Per sePer se violations like price fixing are violations like price fixing are prosecuted aggressively, and no prosecuted aggressively, and no justifications or defenses are usually justifications or defenses are usually accepted. Lack of market power, for accepted. Lack of market power, for example, or protection of public safety, example, or protection of public safety, are not allowable defenses.are not allowable defenses.

Rule-of-reason violations are treated more Rule-of-reason violations are treated more deferentially, and the enforcer has a heavy deferentially, and the enforcer has a heavy burden of showing harm to competition. burden of showing harm to competition.

Meeting the Challenge: Application Meeting the Challenge: Application of Section 2of Section 2

The central contradiction of Section 2 The central contradiction of Section 2 is that aggressive competition, the is that aggressive competition, the very conduct the Sherman Act very conduct the Sherman Act wishes to encourage, could lead to wishes to encourage, could lead to monopoly, the very outcome the monopoly, the very outcome the Sherman Act seeks to prevent.Sherman Act seeks to prevent.

– How to distinguish anticompetitive How to distinguish anticompetitive aggression from vigorous competition? aggression from vigorous competition?

Application of Application of § 2, Cont’d§ 2, Cont’dFor several decades, the courts adopted a For several decades, the courts adopted a restricted approach under which conduct that restricted approach under which conduct that harmed competitors was punished, regardless of harmed competitors was punished, regardless of potential benefits to consumers. potential benefits to consumers. – Illustrative case is Illustrative case is U.S. v. Alcoa U.S. v. Alcoa in which the court held in which the court held

Alcoa had broken the law by expanding plant capacity in Alcoa had broken the law by expanding plant capacity in advance of increased customer orders.advance of increased customer orders.

– The court acknowledged that that Alcoa’s plant The court acknowledged that that Alcoa’s plant expansion helped customers by avoiding disruptions in expansion helped customers by avoiding disruptions in supply during a time of growing demand, and that Alcoa supply during a time of growing demand, and that Alcoa gained efficient economies of scale.gained efficient economies of scale.

– Nonetheless, the court held that Alcoa’s actions made Nonetheless, the court held that Alcoa’s actions made market entry difficult for competitors, and hence tended market entry difficult for competitors, and hence tended toward monopoly under Section 2.toward monopoly under Section 2.

Application of Application of § 2, Cont’d§ 2, Cont’dAlcoaAlcoa was later criticized for focusing on the fate was later criticized for focusing on the fate of competitors rather than on the process of of competitors rather than on the process of competition, and for punishing good commercial competition, and for punishing good commercial and competitive behavior. and competitive behavior. But But AlcoaAlcoa was typical of its time: the courts was typical of its time: the courts punished many actions as punished many actions as per seper se ( (i.e. i.e. always always illegal) violations of Section 2. For example:illegal) violations of Section 2. For example:

– Vertical restraints by producersVertical restraints by producers– Tying the sale of two productsTying the sale of two products– Below cost (“predatory”) pricingBelow cost (“predatory”) pricing– Exclusive dealing.Exclusive dealing.

Application of Application of § 2, Cont’d§ 2, Cont’dInterestingly, Interestingly, AlcoaAlcoa also contained the also contained the seeds of more modern enforcement of seeds of more modern enforcement of Section 2. The case is most remembered Section 2. The case is most remembered not for its final decision, but for the court’s not for its final decision, but for the court’s statement that the antitrust laws should statement that the antitrust laws should not punish successful competitors, and not punish successful competitors, and that monopoly obtained through honest that monopoly obtained through honest skill, foresight, and hard work is not illegal skill, foresight, and hard work is not illegal under Section 2.under Section 2.

Modern Enforcement of Modern Enforcement of § 2§ 2From the 1960’s through the 1980’s, many From the 1960’s through the 1980’s, many scholars, enforcement officials, and courts scholars, enforcement officials, and courts began to criticize application of Section 2 began to criticize application of Section 2 as overly aggressive and harmful to as overly aggressive and harmful to competition.competition.

Over time, enforcement shifted from Over time, enforcement shifted from guarding against the risk of monopoly guarding against the risk of monopoly ((AlcoaAlcoa), to guarding against the risk of ), to guarding against the risk of deterring aggressive competition and deterring aggressive competition and beneficial economic arrangments.beneficial economic arrangments.

Modern Enforcement of Modern Enforcement of § 2, Cont’d§ 2, Cont’d

Courts began to move away from Courts began to move away from per seper se illegality under Section 2. They did this in illegality under Section 2. They did this in two ways:two ways:– Treating more conduct under the “rule of Treating more conduct under the “rule of

reason”reason”E.g.E.g. exclusive dealing, vertical non-price restraints, exclusive dealing, vertical non-price restraints, refusals to deal.refusals to deal.

– Making remaining Making remaining per seper se violations harder to violations harder to proveprove

E.g. E.g. predatory pricing, vertical price restraints, tying.predatory pricing, vertical price restraints, tying.

Summary of Current State of the Summary of Current State of the Law under the Sherman ActLaw under the Sherman Act

Section 1 punishes price fixing, territorial Section 1 punishes price fixing, territorial divisions, and output restraints strictly. All other divisions, and output restraints strictly. All other activity is under the rule of reason and is activity is under the rule of reason and is punished only upon strong proof of punished only upon strong proof of anticompetitive effect.anticompetitive effect.

Section 2 is applied cautiously, treating most Section 2 is applied cautiously, treating most conduct under the rule of reason and only conduct under the rule of reason and only punishing actions that unreasonably block entry, punishing actions that unreasonably block entry, and/or foreclose competitors’ access to and/or foreclose competitors’ access to customers or necessary inputs. customers or necessary inputs. Section 2 Section 2 protects the competitive process, not protects the competitive process, not individual competitors.individual competitors.

Lessons from Sherman ActLessons from Sherman ActAntitrust law takes time to evolve. The basic Antitrust law takes time to evolve. The basic principle that competition improves consumer principle that competition improves consumer welfare is sound. But actual business practices welfare is sound. But actual business practices may have ambiguous effects, so “the devil is in may have ambiguous effects, so “the devil is in the details” in deciding where to enforce.the details” in deciding where to enforce.The evolution of antitrust law into specific The evolution of antitrust law into specific enforcement practices and legal precedent will enforcement practices and legal precedent will depend on a country’s unique economic context. depend on a country’s unique economic context. Where the economy is strong and competition is Where the economy is strong and competition is well established, more aggressive conduct can be well established, more aggressive conduct can be allowed. Where monopoly is common or likely, allowed. Where monopoly is common or likely, greater restraint may be required.greater restraint may be required.

Practical Objectives for Antitrust Practical Objectives for Antitrust Law in new MarketsLaw in new Markets

Perfect competition is a textbook fiction. The goal Perfect competition is a textbook fiction. The goal is instead to protect the development of enough is instead to protect the development of enough competition that consumers do not face competition that consumers do not face monopoly.monopoly.Emphasis should be on preventing emerging Emphasis should be on preventing emerging competitors from colluding, and on preventing competitors from colluding, and on preventing any one competitor from foreclosing access to any one competitor from foreclosing access to customers or inputs.customers or inputs.Where competition is not well established, it Where competition is not well established, it might make sense to worry more about the might make sense to worry more about the survival of competitors than about deterring survival of competitors than about deterring vigorously competitive conduct.vigorously competitive conduct.– The institution of the competitive market must be built The institution of the competitive market must be built

before worrying about how freely it operates.before worrying about how freely it operates.

Merger Enforcement in the U.S.Merger Enforcement in the U.S.To understand merger policy in the U.S. it To understand merger policy in the U.S. it is helpful to go back to Section 1 of the is helpful to go back to Section 1 of the Sherman Act. Taken literally, that law Sherman Act. Taken literally, that law would prohibit any merger. would prohibit any merger.

Passage of the Clayton Act in 1914 reflects Passage of the Clayton Act in 1914 reflects the recognition that some mergers are the recognition that some mergers are acceptable. The question for merger law acceptable. The question for merger law is, which ones?is, which ones?

Section 7 of the Clayton ActSection 7 of the Clayton Act

Section 7 is the central merger Section 7 is the central merger statute in the U.S.statute in the U.S.– It prohibits any merger whose effect It prohibits any merger whose effect

“may be substantially to lessen “may be substantially to lessen competition, or to tend to create a competition, or to tend to create a monopoly in any line of commerce.”monopoly in any line of commerce.”

Early Application of Section 7Early Application of Section 7Until the 1970’s, courts interpreted the Until the 1970’s, courts interpreted the text literally, often focusing on the words text literally, often focusing on the words “or tend” to create a monopoly. “or tend” to create a monopoly. – In the In the Brown ShoeBrown Shoe case (1962), the U.S. case (1962), the U.S.

Supreme Court blocked a merger that would Supreme Court blocked a merger that would have given one shoe manufacturer control over have given one shoe manufacturer control over 8% of retail shoe outlets.8% of retail shoe outlets.

– In the In the Von’sVon’s case (1966), the Supreme Court case (1966), the Supreme Court blocked a merger that would have given one blocked a merger that would have given one grocery chain a 7.5% market share.grocery chain a 7.5% market share.

– In the In the Philadelphia National BankPhiladelphia National Bank case, the case, the Supreme Court ruled that mergers to a 30% Supreme Court ruled that mergers to a 30% market share were virtually illegal market share were virtually illegal per seper se..

Early Merger Policy, Cont’dEarly Merger Policy, Cont’dThe emphasis in all the above cases was The emphasis in all the above cases was preventing a tendency toward preventing a tendency toward consolidation. The cases stated clearly consolidation. The cases stated clearly that an important objective of merger that an important objective of merger policy was protecting the place of small policy was protecting the place of small businesses in the American economy,businesses in the American economy,– Efficiency was a secondary concern, and the Efficiency was a secondary concern, and the

cases made clear that increased consolidation cases made clear that increased consolidation was a problem even without evidence of was a problem even without evidence of harmful effects on prices for consumers.harmful effects on prices for consumers.

Modern Merger PolicyModern Merger Policy

Within a decade after Within a decade after VonsVons, the U.S. , the U.S. Supreme Court sharply changed Supreme Court sharply changed direction in its review of merger law.direction in its review of merger law.

In In General Dynamics General Dynamics (1974), the (1974), the Court said that it was necessary for Court said that it was necessary for the government to prove harmful the government to prove harmful effects from a merger, not mere effects from a merger, not mere consolidation.consolidation.

The Merger GuidelinesThe Merger Guidelines

To create a framework for To create a framework for determining competitive effects of determining competitive effects of mergers, the U.S. Federal Trade mergers, the U.S. Federal Trade Commission (FTC) and Department of Commission (FTC) and Department of Justice (DOJ), adopted a set of Justice (DOJ), adopted a set of Horizontal Merger Guidelines in Horizontal Merger Guidelines in 1984. The Guidelines in their current 1984. The Guidelines in their current form set out a 4-step merger review form set out a 4-step merger review process.process.

Merger Guidelines, Cont’dMerger Guidelines, Cont’d4 steps of merger review:4 steps of merger review:– Step 1Step 1: Define the relevant market and : Define the relevant market and

calculate how the merger will affect market calculate how the merger will affect market concentration.concentration.

– Step 2Step 2: If the market concentration is caused : If the market concentration is caused by the merger is high enough to raise concern, by the merger is high enough to raise concern, look at what actual competitive effects of the look at what actual competitive effects of the merger are likely to be.merger are likely to be.

Key questionKey question: Will the merged firm gain market : Will the merged firm gain market power and be able profitably raise prices to the power and be able profitably raise prices to the detriment of consumers? detriment of consumers?

Merger Guidelines, Cont’dMerger Guidelines, Cont’d– Step 3Step 3: If there are likely to be harmful : If there are likely to be harmful

effects, the burden shifts to the merging effects, the burden shifts to the merging parties to show the merger will create parties to show the merger will create efficiencies that cannot otherwise be efficiencies that cannot otherwise be achieved, and that are sufficient to achieved, and that are sufficient to offset competitive harms.offset competitive harms.

Where competitive harms are predicted to Where competitive harms are predicted to be large, efficiency defenses to the merger be large, efficiency defenses to the merger are unlikely to succeed. Efficiencies can tip are unlikely to succeed. Efficiencies can tip the balance where the case for harm is the balance where the case for harm is close, however.close, however.

Merger Guidelines, Cont’dMerger Guidelines, Cont’d

Step 4Step 4: The final step of review under : The final step of review under the guidelines is to determine the guidelines is to determine whether there are remedies for the whether there are remedies for the predicted competitive harms. predicted competitive harms. – For example, can the harm be reduced For example, can the harm be reduced

through divestiture of parts of the through divestiture of parts of the merged firm’s business? Through merged firm’s business? Through licensing of intellectual property? licensing of intellectual property?

Market Share and Market Power Market Share and Market Power under the Guidelinesunder the Guidelines

Much can be said about each of the 4 steps just listed. The Much can be said about each of the 4 steps just listed. The calculation of market share and presumption about market calculation of market share and presumption about market power in step 1 warrant particular mention.power in step 1 warrant particular mention.

The Guidelines use the Herfindahl-Hirschman Index (HHI), The Guidelines use the Herfindahl-Hirschman Index (HHI), which one calculates by taking the individual market share which one calculates by taking the individual market share of each firm in the market, squaring it, and then adding all of each firm in the market, squaring it, and then adding all the squared figures together to get a single index number. the squared figures together to get a single index number.

The HHI communicates two important things: a picture of The HHI communicates two important things: a picture of concentration for the entire relevant market, and a concentration for the entire relevant market, and a measure of the distribution of market shares across all measure of the distribution of market shares across all firms in the market. The HHI is higher where market share firms in the market. The HHI is higher where market share is unevenly distributed across firms than if it is evenly is unevenly distributed across firms than if it is evenly distributed, because a market with five evenly-sized firms distributed, because a market with five evenly-sized firms may be more vigorously competitive than a market with may be more vigorously competitive than a market with one very big firm and several smaller ones. one very big firm and several smaller ones.

Market Share, cont’dMarket Share, cont’dUnder the Guidelines, markets with an HHI Under the Guidelines, markets with an HHI over 1800 are presumed to be non-over 1800 are presumed to be non-competitive, and mergers in such markets competitive, and mergers in such markets are presumed harmful if they increase the are presumed harmful if they increase the HHI by more than 50 points. HHI by more than 50 points. – To provide some perspective, a market with 5 To provide some perspective, a market with 5

equal competitors has an HHI of 2000, and a equal competitors has an HHI of 2000, and a merger of any two of those firms would raise merger of any two of those firms would raise the HHI to 2800, which is presumptively the HHI to 2800, which is presumptively anticompetitive.anticompetitive.

Problems with Inferring Market Problems with Inferring Market Power from Market SharePower from Market Share

The HHI is helpful, but in the end it is The HHI is helpful, but in the end it is just a fancy way to measure market just a fancy way to measure market share. Market share, however, is a share. Market share, however, is a very imperfect proxy for market very imperfect proxy for market power:power:– Market share is backward looking; it Market share is backward looking; it

shows where a firm has been, but not shows where a firm has been, but not where the firm and the market are where the firm and the market are going.going.

Reducing Reliance on Market Reducing Reliance on Market ShareShare

Show competitive effects directly, Show competitive effects directly, without detailed market share without detailed market share calculations, where possible.calculations, where possible.

Enforcement in fact does not happen Enforcement in fact does not happen as often as the Guideline’s 1800 HHI as often as the Guideline’s 1800 HHI presumption would suggest. So less presumption would suggest. So less need for detailed HHI calculations for need for detailed HHI calculations for many mergers.many mergers.

Merger ProcessMerger ProcessWe have so far looked at the substance of U.S. We have so far looked at the substance of U.S. merger review. We now look at Process.merger review. We now look at Process.The FTC and DOJ receive pre-merger notification The FTC and DOJ receive pre-merger notification under the Hart-Scott-Rodino Act (1976) for all under the Hart-Scott-Rodino Act (1976) for all transaction over a particular size threshold (transaction over a particular size threshold (e.g. e.g. $200 Million). $200 Million). The Agencies then decide which (FTC or DOJ) will The Agencies then decide which (FTC or DOJ) will do the review.do the review.The Agency reviews the merger for 90 days. In The Agency reviews the merger for 90 days. In most cases, the merger is approved at this stage.most cases, the merger is approved at this stage.If the merger raises competitive concerns, the If the merger raises competitive concerns, the agency issues a “second request” for information.agency issues a “second request” for information.

Process, Cont’dProcess, Cont’dIt is under a second request that a It is under a second request that a full, detailed review occurs for 6 full, detailed review occurs for 6 months.months.At the end of 6 months, the agency At the end of 6 months, the agency can approve the merger as filed, can approve the merger as filed, move to block the merger, or reach a move to block the merger, or reach a settlement with the merging parties settlement with the merging parties to remedy the harms. to remedy the harms. – Example: SBC/Ameritech mergerExample: SBC/Ameritech merger

Process, Cont’dProcess, Cont’dIf a merger is settled, the settlement If a merger is settled, the settlement must be approved by a U.S. District must be approved by a U.S. District Court as serving the “public Court as serving the “public interest.”interest.”The court retains jurisdiction to The court retains jurisdiction to review the merger later if it becomes review the merger later if it becomes concerned the settlement is not concerned the settlement is not being observed.being observed.– E.g. Verizon/MCI and SBC/Ameritech E.g. Verizon/MCI and SBC/Ameritech

Antitrust in U.S. Antitrust in U.S. TelecommunicationsTelecommunications

Early examples: Challenging the Early examples: Challenging the development of the AT&T monopoly, development of the AT&T monopoly, 1912 to 1960.1912 to 1960.The break-up of AT&T, 1984.The break-up of AT&T, 1984.Merger review and the 1996 ActMerger review and the 1996 ActIncumbents and their competitors, Incumbents and their competitors, the the TrinkoTrinko case. case.New developments, the New developments, the Madison Madison RiverRiver case. case.