Market power is an important ingredient in most antitrust cases under Section 1 of the Sherman Act and parallel cases under Section 5 of the Federal Trade Commission Act, except those involving certain per se illegal offenses. In Section 1 rule of reason cases, some courts have held that market power is a significant element in the plaintiff's prima facie case. Even in cases involving some per se illegal restraints, such as tying and certain group boycotts, the Supreme Court has held that per se treatment requires the presence of market power.(1) Thus, in cases that involve an assessment of collaborations among competitors, the presence or absence of market power often has the potential to be a dispositive issue.
There is little disagreement among commentators that market power should play a central role in antitrust analysis. As George Hay has explained:
If we accept the notion that the point of antitrust is promoting consumer welfare, then it is clear why the concept of market power plays such a prominent role in antitrust analysis. If the structure of the market is such that there is little potential for consumers to be harmed, we need not be especially concerned with how firms behave because the presence of effective competition will provide a powerful antidote to any effort to exploit consumers.(2)
Inquiry into market power may therefore be useful to courts and agencies in determining whether a firm or group of firms has the ability to harm consumers through conduct, agreements, or other transactions subject to review under the antitrust laws.
Definition and Analytical Approaches
Although most commentators agree that market power is an important issue in antitrust analysis, there is continuing discussion about its precise definition. The Supreme Court has defined market power as the ability to raise prices "above the levels that would be charged in a competitive market."(3) On one end of the spectrum is what can be defined as "classical" market power, which focuses on the ability of a firm or group of firms to raise prices profitably by reducing their own output. On the other end of the spectrum are commentators who argue that the focus of the "classical" market power inquiry is too narrow. According to these commentators, courts and agencies should also assess the ability to exclude competition through cost-raising strategies, because some firms that are unable to raise price solely by reducing their own output may nevertheless acquire market power if they are able to raise costs or reduce output of their competitors.(4) This type of market power has been called "exclusionary" market power.(5)
The primary focus of this paper is how collaborations between actual or potential competitors may create or enhance "classical" market power. "Exclusionary" market power will be examined in a separate memorandum.(6)
Market Power in the Joint Venture Context
The formation and operation of joint ventures may be assessed under § 5 of the Federal Trade Commission ("FTC") Act, § 1 of the Sherman Act, or § 7 of the Clayton Act. In this paper, "joint venture" is used to mean "all collaborations, short of a merger, between or among entities that would have been actual or likely potential competitors in a relevant market absent that collaboration."(7) Given the variety of horizontal arrangements that fall between cartels and mergers, the analysis of market power in joint venture cases can be an extraordinarily complex undertaking.(8) Joint ventures may be formed to set standards, research and develop new products, purchase inputs, produce inputs, integrate production, or distribute, market or sell production. Many ventures will perform more than one (and perhaps several) of those functions. Each of these functions raises different potential competitive harms and may require different assessments of market power in more than one market.
Even when joint ventures are limited to one function, the terms and operation of the joint venture agreement may vary significantly and have a decisive impact on the assessment of the venture's market power. Joint ventures may be exclusive or nonexclusive; they may last one year or twenty years; they may establish price and output jointly or independently; they may permit new members to join, or limit participation to the original participants; they may facilitate the coordination of non-joint venture activities, or they may employ safeguards to prevent the exchange of competitively sensitive information; they may combine a small share of the relevant market at the time of formation, but may acquire a significant share of the relevant market over time without any changes in contractual provisions.
This paper provides a framework for looking at the role of market power in the antitrust analysis of joint ventures. The first part compares economic and legal definitions of market power. The second portion discusses why market power is a central feature of most modern antitrust cases. The third section describes how courts and agencies have used market shares and the Herfindahl-Hirschman Index ("HHI") analysis as proxies for evaluating market power. The fourth portion examines the application of "single-share" analysis(9) to competitor collaborations. The fifth part explores how competition by joint venture members may alter inferences about market power that otherwise might be drawn from single-share analysis of competitor collaborations. The final section discusses the advantages and disadvantages of market-share-based safe harbors for joint ventures.
I. What is Market Power?
As noted earlier, the Supreme Court has defined market power as the ability to raise prices "above the levels that would be charged in a competitive market."(10) The agencies have defined market power as "the ability to maintain prices above competitive levels for a significant period of time."(11) The Intellectual Property Guidelines make explicit that the price increase must be profitable.(12) Thus, three questions should be answered during the market power inquiry: (1) Could a firm increase prices by restricting its output; (2) Would increasing prices be profitable for that firm; (3) Could the prices be maintained above competitive levels for a significant period of time.
The first part of the market inquiry asks whether firms could increase prices in the relevant market by reducing output. The classical model of perfect competition assumes that competitive markets consist of numerous suppliers who compete to set the price of their output at marginal cost. Each firm is too small to affect the market price by itself. If a firm attempts to increase prices above the competitive level (i.e., above its marginal cost), it will lose all its customers and either be forced to lower prices or go out of business. Similarly, if the firm reduces output, it will not affect the market price because the firm's output is too small to significantly reduce the market output. In other theoretical models, firms may set prices above marginal cost, yet still not earn supracompetitive prices due to high fixed costs. In the classical model of monopoly, the monopolist can reduce output and increase prices, but at the cost of losing sales. Similarly, as large firms acquire greater amounts of control over production in a relevant market, they increase their ability to affect prices in the relevant market.
The second part of the market inquiry asks whether a firm with the ability to increase prices has the incentive to set them above competitive levels, i.e., above those levels that would exist in a competitive market. Even though a small-share firm may be able to increase prices, they may lose too many customers for it to be profitable.(13) However, for larger-share firms, it is possible that the firm could profitably increase prices above competitive levels.(14) But how do economists identify competitive price and output levels? One approach would be to return to the assumption that firms in a perfectly competitive market are unable to set prices above their marginal costs. As the difference between price and marginal cost increases, it becomes easier to infer that firms exercise some degree of market power. As a practical matter, many of the markets investigated by the agencies are not perfectly competitive, atomistic markets, so competitive prices sometimes may be somewhat above marginal cost. In those cases, the agencies -- where appropriate -- may use current price levels to serve as a proxy for competitive levels.(15)
The third dimension of market power is temporal: how long must market power last to be significant under the antitrust laws? Many firms could raise their prices above the competitive level for a day, a week, or perhaps even a month. But many would also be forced to rescind the price increase when consumers located cheaper alternative suppliers. Market power implies the ability to maintain prices profitably above competitive levels for a significant period of time.(16) The relevant time frame for antitrust analysis may depend upon the nature of the conduct, the time at which it is evaluated, and the likelihood of timely and successful entry or expansion by actual or potential competitors in the relevant market.(17) In cases under § 7, for example, the agencies require that entry or expansion be likely and sufficient within two years of the transaction. The likelihood of successful entry or expansion under these circumstances should be sufficient to deter the parties from raising price or reducing output in the relevant market. In other cases, however, the relevant time frame will depend on the nature of the conduct.(18) Commentators recognize that the temporal aspect of the market power inquiry entails questions without clear economic answers,(19) but which nonetheless require resolution by courts and agencies.
II. Why Is Market Power Relevant to Antitrust?
The antitrust laws prohibit business practices that harm consumers through higher prices, lower output, or reduced product quality or choice, slowed innovation, or other anticompetitive effects. To unfamiliar observers, the market power inquiry may seem a circuitous route to determining whether conduct, agreements, or transactions have harmed consumers. Why not simply examine whether the conduct has resulted in the effects that the laws are designed to prevent?(20)
There are several reasons. First, courts and agencies routinely assess transactions whose effects will occur in the future and remain unknown at the time of review. There are no actual economic effects to evaluate as of yet. Instead, courts and agencies must resort to less direct methods of determining whether the transaction could harm consumers. They must define product and geographic markets and ascertain the defendants' position in those markets to determine whether, for example, the transaction would give the parties the ability and incentive to raise or maintain prices above levels that would exist in the absence of the transaction. The market power inquiry is thus a valuable tool in predicting the potential anticompetitive effects of transactions.
The market power inquiry is also useful in understanding conduct that has occurred in the past.(21) In some circumstances, the search for actual competitive effects may be expensive and elusive. Price and output data may be incomplete. Even when relevant data are available, interpretation may be difficult. Prices may increase for reasons completely unrelated to the practice or transaction under review. Conversely, prices may have decreased during the relevant period, but they might have been even lower in the absence of anticompetitive conduct. Courts and agencies may therefore use the market power inquiry to determine whether firms have the ability and incentive to increase or maintain prices above the competitive level in the relevant market.(22)
That leads to a third function that the market power inquiry serves: determining whether efficiencies are likely to be passed on to consumers. Although a transaction may increase a firm's market power, it might also create efficiencies that could lead to more intense rivalry in the relevant market. As market power increases, however, it becomes less likely that firms will fully pass on efficiencies to consumers in the form of lower prices. Instead, price levels may increase while the firm's marginal cost decreases. In short, transactions that lower costs may nevertheless increase the ability to exercise market power. Thus, market power is also useful for determining the extent to which consumers will enjoy any procompetitive efficiencies created by the transaction.(23)
Market power, in short, can play a role in determining (1) whether transactions will likely result in future anticompetitive effects; (2) whether ambiguous business practices could have resulted in anticompetitive effects; and (3) whether efficiencies have been or will be passed on to consumers.
1. See Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 26-27 (1984) (hereinafter, Jefferson Parish) (per se illegal tying requires market power in the tying product); Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co., 472 U.S. 284, 296 (1985) (hereinafter, Northwest Wholesale Stationers) (expulsion of competitor from purchasing joint venture per se illegal if group possesses market power and access needed for effective competition).
2. George A. Hay, Market Power in Antitrust, 60 Antitrust L.J. 807, 808 (1992).
3. Jefferson Parish, 466 U.S. at 27 n. 46. See also National Collegiate Athletic Association v. Bd. of Regents of Univ. Of Okla., 468 U.S. 85, 109 n.38 (1984) (hereinafter, NCAA). See also 1992 United States Department of Justice and Federal Trade Commission Horizontal Mergers Guidelines § 0.1 (hereinafter, Merger Guidelines). The agencies have also recognized that the possession or exercise of classical market power may affect innovation competition. See 1995 United States Department of Justice and Federal Trade Commission Guidelines for the Licensing of Intellectual Property §§ 2.2, 3.2.3, 4.1.1 (hereinafter, Intellectual Property Guidelines).
4. See, e.g., Thomas G. Krattenmaker and Steven C. Salop, Anticompetitive Exclusion: Raising Rivals' Costs to Achieve Power Over Price, 96 Yale L.J. 209 (1986).
5. Still other commentators contend that assessments of classical market power, by focusing on allocative efficiency, ignore the anticompetitive potential of other activities that prevent dynamic efficiencies achieved through innovation. See, e.g., Herbert Hovenkamp, Exclusive Joint Ventures and Antitrust Policy, 1995 Columbia Business Law Review 1 (1995) (firms that compete vigorously in the relevant market may exclude innovation that would enhance quality or force prices downward).
6. All subsequent references to market power refer only to "classical" market power.
7. See Comment and Hearings on Joint Venture Project, 62 Fed. Reg. 22945 (April 28, 1997).
8. See Robert Pitofsky, Joint Ventures Under the Antitrust Laws: Some Reflections on the Significance of Penn-Olin, 82 Harv. L. Rev. 1007, 1016 ("Probably the most serious difficulty associated with the law in this area stems from the sheer numbers of different types of joint ventures which may occur and the proliferation and complexity of relevant factors necessary to describe their competitive impact."). Among these factors listed are (1) the number of joint venturers; (2) potential competition in the relevant market; (3) the competitive relationship of the parents with each other and the joint venture; and (4) the market power of the parents and the venture. Id.
9. For purposes of this paper, "single-share analysis" will refer to aggregating the market shares of the joint venture members in the relevant markets into a "single market share."
10. Jefferson Parish, 466 U.S. at 27 n.46. See also NCAA, 468 U.S. at 109 n.38.
11. Merger Guidelines § 0.1.
12. See Intellectual Property Guidelines § 2.2.
13. Hay, supra note 2, at 820; see also William L. Landes and Richard A. Posner, Market Power in Antitrust Cases, 94 Harv. L. Rev. 937 (1981) (market power "refers to the ability of a firm (or a group of firms, acting jointly) to raise price above the competitive level without losing so many sales so rapidly that the price increase is unprofitable and must be rescinded."); Frank H. Easterbrook, The Limits of Antitrust, 63 Tex. L. Rev. 1, 20 (1984) (market power is "the ability to raise prices significantly without losing so many sales that the increase is unprofitable.").
14. As Chief Judge Posner has explained:
Three firms having 90 percent of the market can raise prices with relatively little fear that the fringe of competitors will be able to defeat the attempt by expanding their own output to serve customers of the three large firms. An example will show why. To take away 10 percent of the customers of the three large firms in our hypothetical case, thus reducing those firms' aggregate market share from 90 percent to 81 percent, the fringe firms would have to increase their own output by 90 percent (from 10 to 19 percent of the market). This would take a while, surely, and would force up their costs, perhaps steeply -- the fact that they are so small suggests that they would incur sharply rising costs in trying almost to double their output, and that it is this prospect which keeps them small. So the three large firms could collude to raise price (within limits of course) above the competitive level without incurring the additional transaction costs and risk of exposure that would result from trying to coordinate their actions with those of their competitors. United States v. Rockford Memorial Corp., 898 F.2d 1278, 1283-84 (7th Cir.), cert. denied, 498 U.S. 920 (1990).
15. This approach requires cautious application, since it may lead to errors under certain circumstances. If courts and agencies focus only on the ability to raise prices above current levels, they may infer that firms does not possess market power when, in fact, firms are already exercising it. See, e.g., Mary L. Azcuenaga, Market Power As A Screen in Evaluating Horizontal Restraints, 60 Antitrust L.J. 935, 940 (1992) (focusing on current price levels may lead to inaccurate inferences when firms have already "pushed the price up to an artificially high level just below that of a good substitute."). Economists have labeled this the "Cellophane Fallacy," referring to the Supreme Court's misguided product market definition in du Pont. In other cases, courts and agencies must examine allegations that a firm has prevented firms from entering or expanding in the relevant market. Though the firm may be unable to raise prices above current levels, it may engage in exclusionary conduct that prevents price from falling. See Thomas G. Krattenmaker, Robert H. Lande, and Steven C, Salop, Monopoly Power and Market Power in Antitrust Law, 76 Geo. L.J. 241, 249-55 (1987).
16. See "A Stepwise Approach to Antitrust Review of Horizontal Agreements," Address by Joel I. Klein, Acting Assistant Attorney General, Antitrust Division, United States Department of Justice (November 7, 1996) at 12 ("[W]e require some form of market power to satisfy ourselves that the anticompetitive impact will be enduring rather than transitory.").
17. Temporal questions arise in a broader context as well. Some commentators have suggested that antitrust policy should focus on long-term competitive effects; others have contended that short-run analysis is appropriate. Compare Joseph F. Brodley, Post-Chicago Economics and Workable Legal Policy, 63 Antitrust L.J. 683, 686-87 (1995) (contending that competitive effects analysis should take a longer-run view of potential price increases in the relevant market; conduct which may not result in immediate price increases may nevertheless result in later exercises of market power) with Richard S. Markovits, The Limits to Simplifying Antitrust: A Reply to Professor Easterbrook, 63 Tex. L. Rev. 41, 83 (1984) ("if one examines changes in defendant's market share over a five or even a two-year period, it will be extremely difficult to distinguish the impact of the practice from the impact of other factors that may influence a seller's market share."); see also Easterbrook, supra note 13, at 18 (courts should examine competitive effects of a restraint over a five-year period to determine whether the defendants have gained or exercised market power).
18. Landes and Posner argue that § 7 of the Clayton Act and § 2 of the Sherman Act require long-run analysis to determine whether a transaction or conduct will result in significant market power. Under § 1, "a shorter run perspective seems appropriate, but rarely would the social costs of very short-run supracompetitive pricing be great enough to justify computing an elasticity of demand or supply for a period of less than a year from the date of the challenged conduct or transaction." Landes and Posner, supra note 13, at 959. This may say more about the complexity and cost of economic analysis under their inquiry than the likelihood of significant anticompetitive effects.
19. Hovenkamp, supra note 5, at 80-81 (asserting that the temporal standards for market power in the 1992 Merger Guidelines "are policy judgments, not the result of pure theory.").
20. When there is evidence of actual anticompetitive effects, courts will dispense with a more detailed inquiry into market power. As the Supreme Court has explained, "Since the purpose of the inquiries into market definition and market power is to determine whether an arrangement has the potential for genuine adverse effects on competition, 'proof of actual detrimental effects, such as a reduction of output,' can obviate the need for an inquiry into market power, which is 'but a surrogate for detrimental effects.' P. Areeda, Antitrust Law, ¶ 1511, p.429 (1986)." Federal Trade Commission v. Indiana Federation of Dentists, 476 U.S. 450, 460-61 (1986). See also California Dental Ass'n, 5 Trade Reg. Rep. (CCH) 23,778, 23792 (March 25, 1996) (hereinafter, CDA); Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. 451, 477 (1992) (hereinafter, Kodak) ("It is clearly reasonable to infer that Kodak has market power to raise prices and drive out competition in the aftermarkets, since respondents offer direct evidence that Kodak did so.").
21. Some conduct is so anticompetitive that courts and agencies do not engage in a detailed economic analysis of actual effects, market power, or efficiency justifications. Offenses such as naked price fixing, territorial divisions, and bid rigging are per se unlawful. A discussion of per se treatment will appear in a separate memorandum.
22. See, e.g., Bhan v. NME Hosps., 929 F.2d 1404, 1413 n.10 (9th Cir.) (rule of reason requires plaintiffs to demonstrate "whether the defendant has the power to do what it allegedly wants to do -- that is whether the defendant can actually influence the market."), cert. denied, 502 U.S. 994 (1991); Polk Bros. v. Forest City Enterprises, 776 F.2d 185, 191 (7th Cir. 1985) ("Unless the firms have the power to raise price by curtailing output, their agreement is unlikely to harm consumers, and it makes sense to understand their cooperation as benign or beneficial.").
23. See Revision to the Horizontal Merger Guidelines Issued by the United States Department of Justice and Federal Trade Commission, April 8, 1997 (efficiencies will almost never justify mergers to monopoly); see also NCAA, 468 U.S. at 114 ("If the NCAA's television plan produced procompetitive efficiencies, the plan would increase output and reduce the price of televised games. The District Court's findings [to the contrary] undermine petitioner's position.").