Ideoblog

Microhoo

For somebody who’s been writing about the devolution of the large corporation (e.g.), MS’s huge bid Yahoo is an arresting development. Obviously the 62% premium reflects an assumption of significant synergy. But where does this supposed synergy come from? Ballmer’s “bear hug” letter to Yang begins with

Scale economics: This combination enables synergies related to scale economics of the advertising platform where today there is only one competitor at scale. This includes synergies across both search and non-search related advertising that will strengthen the value proposition to both advertisers and publishers. Additionally, the combination allows us to consolidate capital spending.

This makes some superficial sense. It points to the fact that today’s megafirm differs from that of a previous era. Now it’s about scale economies of marketing rather than of making products. It’s possible (I’m agnostic on this) that only a combination, and not contracting, could yield these economies given the risk of opportunism by contracting parties.

I’m less convinced that a combination is necessary to achieve Ballmer’s other stated objectives: "expanded R&D capacity," "operational efficiencies," and "emerging user experiences." How much of this is eyewash for the antitrust review? Operational efficiencies? It’s already evident that combining these two huge firms will be a logistical nightmare. With respect to expanded R & D: do the firms have complementary patents that can’t otherwise be licensed? And about “emerging user experiences,” Ballmer says:

Our combined ability to focus engineering resources that drive innovation in emerging scenarios such as video, mobile services, online commerce, social media, and social platforms is greatly enhanced.

Hunh?

Some thoughts on BellSouth-ATT

Two questions about the ATT/BellSouth deal. First, will it go through? WSJ's Law Blog neatly summarizes the latest thinking. One would think that with all of the changes wrought by satellite, internet, cable and wireless technologies, and the continuous reshaping of the telecom industry, the trustbusters wouldn't have the hubris/chutzpah to intervene. Would they?

Second, was it worth it? Tom Kirkendall wonders if the price was "delusional," as I did about Comcast/Disney.

I don't know, but there's an interesting theoretical question. One aspect of the deal is that it eliminates the Cingular joint venture between ATT and BellSouth. A Cingular spokesman is quoted as saying that "having one owner makes governance simpler, and makes decision-making simpler."

That's clearly true, and it's not just decision-making, but also sticky issues about fiduciary duties, which significantly complicate contracting. Indeed, for this reason I have suggested eliminating the need to form a business association in joint ventures, among other contexts. See Limited Liability Unlimited, 24 Delaware Journal of Corporate Law 407 (1999). It would be interesting to try to quantify how much of the 67 billion is intended to deal with this sticky little problem.

On Bundling and Price Discrimination

Friday's WSJ includes Ronald Cass' insightful commentary on the South Korea Fair Trading Commission's recent decision to force Microsoft to sell modified versions of Windows that strip out its Instant Messenger and Media Player technologies.  Cass emphasizes the potential dangers of several nations dictating separate product configurations:

We live in a global market. If each nation asserts the right to dictate the composition of products sold there, producers will need different products for every nation. Suppose, in addition to the EU and Korea, that Japan, India, China and Brazil regulate products like Windows, each requiring different features. The efficiency of global production will not be totally eliminated, but it would be very significantly eroded.

I share Cass' concern in this regard, and what appears to be his general sense that tying is efficient and not likely to harm consumers.  Cass rejects the leverage theory, which hypothesizes that a dominant firm can extend monopoly power from one market to the next by bundling, and also emphasizes the production or distribution efficiencies associated with bundling (shoes with shoelaces and such).  To my mind, however, the $64,000 antitrust question is about neither leverage theory nor distribution costs, but how antitrust law will treat practices that increase firm profits by linking a complementary good to the tying good, i.e. metering the intensity of demand.

Metering is a form of price discrimination, which despite its nasty label and disfavored position in antitrust, is quite often good for consumers.  The static welfare effects of price discrimination are generally ambiguous as some consumers gain and others lose, but likely to be positive if the metering device allows accurate measurement of the intensity of demand since output will increase.  When one also accounts for dynamic consumer welfare gains, price discrimination is likely to benefit consumers unless linked to some independent antitrust wrong.  So what should antitrust law do about these practices?  Ben Klein and John Wiley have argued that price discrimination of this type should amount to a business justification defense (70 Antitrust LJ 599 (2003)).  Others have argued that antitrust should strictly prohibit metering.  It is in light of this debate that I find the following passage from Cass' analysis puzzling:

In rare cases, bundling doesn't promote efficiency. Early tying cases probably were examples of firms trying to exploit a monopoly -- not by extending it to another product, but by using a complementary product (ink, punch cards) to distinguish among buyers based on how much they value the base product (mimeo machines, computers). Those who buy more ink or more punch cards presumably would be willing to pay more for the mimeo or computer. Tying the complementary good allows the producer to extract some of that extra value. Newer theories, depending on very peculiar assumptions, posit that tying can harm competition. Yet, while competition hurts individual businesses, consumers almost never suffer from a firm's decision to bundle products together. In reality, bundling doesn't hurt competition.

Cass appears to take the position that metering is the "rare case" in which bundling does not promote efficiency.  In my view, this is incorrect for two reasons.  First, metering and other forms of price discrimination are extremely common in well-functioning, competitive markets.  Second, metering does promote efficiency for the reasons described above and in greater detail in the Klein and Wiley piece.  My colleague Bruce Kobayashi has posted a comprehensive survey of the expansive bundling literature on SSRN.

I do not mean to minimize the problems, which Cass highlights, associated with divergent international standards.  These are serious issues, and Cass is certainly correct that the South Korea Fair Trade Commission's decision is a blow against efficiency.  However, if it is true that international authorities often follow the United States' lead on substantive antitrust issues, it is increasingly important that domestic antitrust jurisprudence sensibly addresses the ubiquitous practices of bundling, metering, and price discrimination more generally.  The forthcoming SCOTUS opinion in Independent Ink is a valuable opportunity to clarify the law in this area.

Alito & Antitrust

From The Legal Intelligencer comes Carl Hittinger's essay, Alito's Conservative Views on Antitrust, summarizing Judge Alito's antitrust track record in the hopes of discerning his views on substantive antitrust question (the American Antitrust Institute also summarizes Alito's antitrust record here).  Hittinger focuses on the two Third Circuit decisions authored by Judge Alito, Miller v. Indiana Hospital and Barton & Pittinos v. SmithKline, and the dissent he joined in LePage's v. 3M authored by Judge Greenberg.  Hittinger's primary conclusion is that:

Alito interprets precedent strictly and narrowly applies the reaches of the antitrust laws.  He does not appear to give private antitrust plaintiffs the benefit of the doubt, particularly as to issues of standing or injury, even in the context of summary judgment . . .. [H]e often appears to be saying that the plaintiff was not the proper plaintiff to bring the case, not that there were no antitrust violations at play.  Based on his joining of the Brader, it appears he is willing to give a plaintiff the chance to develop a discovery record if the essential elements are plead.

This is all to the good.  Earlier in the essay, however, Hittinger makes a statement that I find to be more troublesome:

"in many [of Alito's cases], the antitrust claims were dismissed on a motion for summary judgment despite what seemed to be disputed factual and related expert issues concerning antitrust market and injury questions."

My suspicion is that this passage is largely in reference to Alito's opinion in SmithKline, which Hittinger goes on to discuss, and describes (correctly, in my view) as the best available example of Alito's antitrust jurisprudence.  The opinion is worth a closer look.

The plaintiff (B&P) marketed SmithKline's Hepatitis-B vaccine to nursing homes until terminated.  The termination appeared to be brought on by complaints by pharmacists who had traditionally supplied nursing homes with vaccines and pharmaceutical products.  The Third Circuit unanimously affirmed the district court's ruling that no Section 1 violation of the Sherman Act had taken place on the grounds that the plaintiff was lacking antitrust standing.  Specifically, the district court noted that the plaintiff's alleged injury was not "the type for which the antitrust laws were designed to protect."

Affirming the district court, Judge Alito points out that B&P clearly fails the antitrust standing requirement on the basis of their complaint alone, which alleges that competition has been injured in the markets to sell and distribute the vaccine while B&P readily admits that it does not participate in either of these activities (and in fact, is prohibited from doing so by law).  Judge Alito also considered B&P's modified claim, raised at oral argument and in their briefs, that the relevant market was the competition between B&P and the pharmacists.  Judge Alito carefully rejected this argument by considering the cross-elasticity of demand between the services offered B&P and the pharmacists.  Because B&P's role was limited to marketing the vaccine, nursing homes were not choosing between B&P and the pharmacists because the former would be worthless without the entire package offered by SmithKline, a licensed seller, and B&P.  Namely, B&P would me missing the vaccine! Judge Alito concludes that:

"[c]onsequently, there was no elasticity of demand as between the pharmacists' offerings and B&P's offerings; no matter how much the pharmacists raised the price of the package of the goods and services offered, the nursing homes would not have switched to B&P."

Judge Alito also notes that B&P's president described his own company as an advertising and marketing agency which did not compete with wholesalers and pharmacists.  While I do not have the benefit of the entire record, nothing in this opinion strikes me as justifying any concern that Judge Alito cavalierly dismissed the motion for summary judgment despite genuine factual disputes.  To the contrary, the facts underlying the analysis were plainly undisputed.

While I share Hittinger's view that Judge Alito will strictly apply the antitrust standing precedent, I do not share his concern that he may eschew careful legal and factual analysis in order to limit opportunities for private antitrust plaintiffs.  On this point, my sense of Judge Alito's antitrust opinions is quite the opposite.  I find that what little Judge Alito has written on antitrust issues is properly described as fastidious analysis complemented by strict application of doctrine.

BAR/BRI's potential competition

The blawgosphere is abuzz with comments on the recent New York Times article (first brought to my attention by Bill -- Thanks, Bill) about BAR/BRI's antitrust troubles.  See Kaimi Wenger (who handily wins the award for best blog post title), Dan Solove (commenting on Kaimi's post and linking to a collection of relevant articles at lawschool.com), Ethan Lieb, and my colleague Joe Miller (riffing off of Ethan's post).  The actual complaint is here.

In the first instance, I agree with Dan:  We should ban the bar.  I don't actually agree with all of his reasoning, but . . . close enough.             

But let's assume, for the sake of propping up legal fees -- er, for the sake of argument -- that we keep the bar.  What about the merits of the antitrust suit?

There's actually a lot more to this case than meets the eye, and the plaintiffs' attorneys have made some creative points.  Let me highlight one or two here (and maybe I'll point out others in subsequent posts).

The plaintiffs claim that the nature of exam prep course marketing impedes entry by potential competitors.  The claim is that, because many students sign up for bar classes as first years, before they know in which jurisdiction they will take the exam, any potential competitors would have to offer courses in every jurisdiction to compete with BAR/BRI.  At the same time, because West advertises for BAR/BRI through its Westlaw service (to which all law students are freely and repeatedly exposed), a potential competitor would have a hard time promoting its exam prep.

These are nice arguments, suggesting the pool of potential competitors that could effectively correct the complained-of effects is small.  It is important for the plaintiffs to make these arguments because, in the absence of claims like these, it's hard to see how potential competition in this market is structurally limited in any way.  But at the end of the day I think the arguments are weak. 

Every state's bar exam (except two) includes the MBE, and I would guess that the majority of students do know which bar exam they intend to take, even in their first year.  In most law schools, a single- or couple-jurisdiction competitor would be quite viable, as long as it offered MBE prep and one or two jurisdictions' worth of essay prep.  In fact, competitors of this sort already exist (see, for example, Celebration Bar Review, Supreme Bar Review, Gallagher Bar Exam School and MicroMash (admittedly, also owned by Thomson)).   

Moreover, antitrust law doesn't require that potential competitors adopt precisely a monopolist's business model.  An effective competitor could certainly recruit students from among third year students, offering, in fact, a compelling deal like, "first-year prices for third-year students!"  There are likewise a near-infinite number of other advertising outlets than pop-up screens on Westlaw, and links through Westlaw are hardly necessary for effective bar prep.

At the end of the day, the complaint alleges little more on this score than that BAR/BRI offers something valuable to law students -- valuable things a new competitor might have a hard time matching.  Certainly BAR/BRI offers an excellent product that can (and does) command Ricardian rents.  This is the very definition of competition, not its antithesis.  In the Internet age, for a business like this one, start-up costs are low and high-quality teachers abundant.  It's hard to believe BAR/BRI could maintain real monopoly pricing for long.

More Politics and Price-Fixing

While on the topic of state-facilitated collusion, I should mention that Eliot Spitzer's campaign against the recording industry and payola is not the only example of this phenomenon.  In California,for example, the state legislature is currently considering a bill that would require retailers to disclose shelf space payments (aka "slotting fees") to rival manufacturers.  Senator Figeuroa recently introduced Senate Bill No. 582 (see the amended bill here), which mandates that:

A retailer shall, upon the request of a qualified supplier or manufacturer, disclose the placement fees or arrangements that the retailer assesses other suppliers or manufacturers for placement of similar products." 

Under SB 582, a retailer must also disclose "all trade information" (defined as "all retail pricing, sales volume, and promotional information for similar products within specific stores, a grouping of stores, or stores owned by either the retailer or other parties") for placement of a similar product if the retailer has previously shared that information with other manufacturers.  Violations would allow competing manufacturers to recover a $10,000 civil penalty and attorney's fees from a retailer who fails to comply.

SB 582 is embarassingly misguided policy, and obviously bad for California consumers, who are the ultimate beneficiary of payments to retailers for valuable shelf space.  The root cause of this misguided proposal (and perhaps the payola investigation) is a failure to understand the role of slotting fees and other payments for distribution in the competitive process, the subject of my recent work with Benjamin Klein (earlier draft available here).  I can only hope that the California legislature does not fall victim to the temptation popular among economists, to attach a monopoly explanation to business practices that they do not understand.  When legislative bodies fall victim to this temptation and respond by "fixing" the problem, consumers are inevitably injured.  This will certainly be the case if SB 582 passes.

Payola, Politics, and Price-Fixing

Pseudonym raises the interesting question of why Eliot Spitzer might be pursuing payola cases in lieu of more pressing matters.  I am sure that I do not have the complete answer to that question.  But I think some economics might shed a bit of light on some of the political interests in play, and at least spice up the calculation.  I do not mean some economics of payola.  I have explained previously why payola payments are an important (and efficient) part of the competitive process, and an attempt to contractually resolve an incentive incompatability betweem music publishers and radio stations.  The important point is that payola payments are part and parcel of price competition (read the whole prior post for details).

Instead, I want to talk about the economics of collusion, and in the process, propose a speculative but sinister theory of the payola investigation.  Here's the simple economics: collusion is very difficult.  The incentives to deviate from cartel agreements are powerful.  Music publishers sell products (CDs) with very high profit margins (do you know how small the marginal cost of a CD is?), strengthening the incentive to cheat on the cartel.  One need only read Coase's seminal account of the many failed (and documented) attempts at collusion by music publishers in 1890, 1916-17, 1933, 1960, and 1986, to garner some appreciation for the difficulty of the task.  Importantly, each of these attempts was initiated by the music industry.  Many of these collusive endeavors failed because cartel members could not credibly commit to reducing output. 

So what are wanna be price-fixers to do?  Would be colluders often seek a third party to police and punish parties that might cheat on the cartel.  This strategy is not foreign to the music industry.  Fortunately for consumers, those attempts have failed in the past.  After Sony BMG "settled," I mentioned the possibility that Mr. Spitzer's office may succeed where the recording industry has failed for over a century in deterring compliance with the cartel's competitive restrictions.  After all, the AG's office is not just any third party.  They are a cartel-enforcer with big guns (criminal sanctions, fines, etc.). 

Now that Warner has joined Sony for a mere $5 million donation (cheap, relative to the prospect of monopoly profits for several years), with other industry "victims" likely to follow, perhaps consumers will be less fortunate.  By the way, has anybody else noticed that the payola laws only require disclosure of pay for play but the industry settlements prohibit it altogether?  Maybe I am just being paranoid.  The music industry doesn't donate to political campaigns, do they?

The SEC, Antitrust Immunity and Eliot Spitzer

Courtesy of Bill, I have just been reading the Second Circuit’s recent opinion in Billing v. Credit Suisse First Boston Ltd., 436 F.3d 130 (2005) (unformatted version available here).  The issue in the case is succinctly set out by Judge Wesley in the first lines of the opinion:

Plaintiffs allege an epic Wall Street conspiracy. They charge that the nation’s leading underwriting firms entered into illegal contracts with purchasers of securities distributed in initial public offerings (“IPOs”). Through these contracts and by other illegal means, the underwriting firms allegedly executed a series of manipulations that grossly inflated the price of the securities after the IPOs in the so-called aftermarket. Plaintiffs contend that the firms capitalized on this artificial inflation, profiting at the expense of the investing public.

It’s an issue we all know and love.  But the Plaintiffs here add a twist:  They claim that the underwriters’ coordinated actions violate Section 1 of the Sherman Act.  The Defendants argue (and the district court agreed) that only the securities laws provide a remedy (assuming the allegations are true), and thus that the securities laws offer implied antitrust immunity for the conduct alleged.  The Second Circuit rejects the argument.  The particular conduct in question in this case involves a variety of quid pro quo tie-in arrangements between underwriters and prospective customers.  See the case for more details.

Basically, the court takes a doctrinal approach to the analysis of implied antitrust immunity and holds that the requirements (thwarting of a pervasive regulatory regime, Congressional intent, Congressional awareness of the potentially-anticompetitive implications of the regulatory regime, etc.) were not met here, in part because the SEC could still prohibit the behavior in question absent antitrust immunity, and had never explicitly permitted it.

But the core question not really addressed by the courts is this:  Where conduct directly affecting the securities markets is concerned, are we better off with enforcement (and the threat of enforcement) by private antitrust plaintiffs along with the SEC, or just the SEC? The district court plainly thought the SEC should have complete authority here, and the appellate court argues for enforcement by both (with the implicit realization that some enforcement by antitrust plaintiffs could effectively preclude some forms of regulation by the SEC). Seen this way, the question is really one of regulatory turf, and it’s not surprising to find the SEC uncomfortably on the Defendants’ side here, supporting its own broad regulatory authority, but going to great pains to distance itself from the specific conduct being defended.

While I’m generally in favor of regulatory competition, this seems like a bad holding (as a policy matter; it may be exactly right as a doctrinal matter).  Plaintiffs firms will be chomping at the bit to get at the IPO underwriters (in fact the class actions are already under way).  Without getting to the merits of the conduct in question, all signs point to SEC prohibition anyway (the SEC once proposed a rule prohibiting these tie-ins, but then retracted it, saying existing law already prohibited them).  Now we’ll get the same result, but we’ll get massive litigation costs along with it.

Even worse, the case sets a fairly high bar for antitrust immunity – but it’s one that can be met by anticipatory agency rule-making (read: claim staking).  That seems like a bad idea.  The last thing we need is to give the SEC more incentive to issue hasty rules in an effort to stake out its regulatory turf.

Not coincidentally, Eliot Spitzer weighed in on the Plaintiffs’ side against the SEC and the Defendants.  The complained-of conduct is precisely the sort that Spitzer would probably like to (threaten to) regulate on his own, perhaps using the very antitrust laws at issue in this case, and this is another skirmish in the ongoing turf war between federal and state regulation of the securities markets.  Chalk this one up as another victory for Spitzer.