Emerging Antitrust Issues in Electronic Commerce
David A. Balto
Assistant Director, Office of Policy and Evaluation
Bureau of Competition, Federal Trade Commission
1999 Antitrust Institute
Distribution Practices: Antitrust Counseling in the New Millennium
November 12, 1999
Thank you for inviting me to discuss the application of the antitrust laws to electronic commerce. (1) This is certainly a vital and timely topic. The very nature of commerce is changing before our eyes, at a speed that is unprecedented in our economic history. When Amazon.com, a company that first sold stock to the public less than three years ago, is capitalized by the stock market at a higher value than Borders and Barnes & Noble combined, despite their thousands of stores (not to mention profits), it is clear that something more than the normal ebb and flow of commerce is occurring. The total size of all electronic commerce already exceeds many major industries. All Internet revenues are projected to exceed $500 billion in 1999 with electronic commerce accounting for 35-40 percent of that total. The electronic commerce total will more than double in 1999 from the 1998 level. Consumers are expected to spend over $12 billion this year, approximately a 59% increase over last year's $7.1 billion. Employment related growth is equally impressive - over 400,000 new electronic commerce-related jobs will be added in 1999. (2) We are in the midst of a revolution in commerce, one that has enormous implications for the way business is transacted and, ultimately, the way society's resources are allocated between businesses and consumers.
When thinking about the role of antitrust enforcement in such a quickly changing market, I am often reminded of a scene from the movie "Hoosiers." As you may recall it is the story of a high school basketball team from a very small town, Milan, Indiana, that wins the state basketball championship in 1954. When the team arrives at the arena in Indianapolis where the championship will be played they are overwhelmed by its size and daunted by their opponents, who are from a much larger school and famous for their speed and unbroken success record. The small town coach takes his team into the empty arena, climbs on a ladder and measures the height of the baskets to show his team that regardless of the size of the arena or talent of the opponent, it is still the same basket.
Ensuring competition in the world of electronic commerce may seem like a similarly daunting task. The markets are evolving rapidly, the number of competitors and amount of commerce are growing at a tremendous pace, and there are novel challenges posed. But antitrust analysis, like the standard measures of a basketball court, provides a framework for prudent competition enforcement, no matter what market is at issue.
The Federal Trade Commission has a vital role to play in electronic commerce markets. The Commission stands in the role of a referee, to protect the process of competition so that such competition occurs on the merits. We want to make sure that innovation in electronic commerce is not compromised by artificial barriers to entry erected by incumbent competitors or established by regulatory fiat. We are there to assure that private forces do not impede the development or growth of the market through exclusionary conduct, either collective or unilateral.
Most of the FTC's experience in the electronic commerce marketplace has been through its consumer protection function. New markets develop best when consumers are confident of the products and services they receive. The FTC has been the leading federal enforcement agency in consumer protection issues on the Internet. The agency has brought over 100 cases to date challenging unfair or deceptive conduct in the online medium. Many well known frauds have migrated to the Internet, including fraudulent prize promotions, credit repair scams, pyramids and other "get-rich-quick" schemes. (3) Maintaining consumers' Internet privacy is also an important FTC consumer protection mission. Just last month, the Commission issued final rules under the Children's Online Privacy Protection Act, designed to ensure that parents control the dissemination and use of personally identifiable information obtained online from children under age 13. (4)
The FTC seeks to understand all facets of commerce, both traditional and any new forms that may arise - how they work, how they are changing, how they might be harmed by collusion or the creation or abuse of market power. We have to understand how electronic commerce works in order to prevent the classic abuses of market power that can occur wherever business is transacted. In this sense, electronic commerce is but another in a long line of alternative methods of commercial transactions. However, electronic commerce, as well as all commerce involving high-tech industries, may be sufficiently different to require a more careful focus from antitrust enforcers. As Chairman Pitofsky has pointed out, the "more subtle problems of antitrust enforcement must adjust to the special circumstances of high-tech industries." (5)
Among these adjustments is that the enforcement agencies need to be able to protect new methods of competition as well as the very process of innovation itself, which provides the stimulus to economic growth and increasing consumer welfare. Equally important, we need to understand the development of electronic commerce so that we will know when to keep hands off and allow new competitive forces to sort themselves out, so that the market can determine the most efficient methods of production, distribution, and retailing. One hundred years of antitrust experience with traditional industries has taught us that market-based competition is almost always preferable to greater private market power or government regulations.
Today, I want to address three topics: (1) how electronic commerce is different than other forms of commerce, (2) what lessons can be learned from other commercial "revolutions" for the proper approach of antitrust enforcement to electronic commerce, and (3) some of the potential competitive concerns that arise in the electronic commerce environment. In that last section, I will focus in particular on distribution restraints, which are of special interest to this audience.
II. How is Electronic Commerce Different?
It is often said that antitrust is an analytical construct which applies equally well to any industry or market. That is only partially true. Antitrust analysis may use principles of general applicability, but these principles must be applied in the context of a particular market environment. If electronic commerce is different, the first question we must answer is, how is it different? There are several reasons why electronic commerce might differ from the kinds of "bricks and mortar" economic activity that we are most familiar with, and many of these differences apply to high-tech industries generally. Thus, the experience the Commission has had in applying the antitrust laws to computers, telecommunications, pharmaceuticals, and other high-tech industries will be invaluable as we analyze electronic commerce issues. Some of the distinguishing features of electronic commerce include:
1. Consumer sovereignty and the role of intermediaries. The most important aspect of the Internet from the consumer's perspective is the increase in choices and especially information on the products and services they desire. A generation ago, a typical consumer may have been limited to choosing among a small number of local banks (perhaps limited to their specific county or state), a few travel agents, some stock brokers, several insurance agents, and a handful of local department stores. Now the consumer may choose from scores of online banks, numerous travel intermediaries (such as travelocity.com) or direct contact with airlines, scores of stockbrokers or online stock traders, a large number of insurance companies, and hundreds of direct marketers and manufacturers of goods.
As important as the breakdown of borders and the growth in the number of competitive alternatives is the tremendous growth in the number of intermediaries that can help ordinary consumers effectively process new sources of information. Some of these intermediaries create new services and markets; in other cases they substitute for and compete against more traditional intermediaries. Using insurance as an example, it is not just that consumers can choose between a much larger number of alternatives; now, there are intermediaries which will provide information on how to comparison shop or will actually do the comparison shopping for the consumer. It is a truism that information is vital to the competitive vigor of the marketplace and this explosion of information can lead to better informed consumers and greater competition.
But it is precisely this potential increase in consumer sovereignty that may also lead to conduct that will raise antitrust concerns. It is inevitable that some businesses may be injured by the growth of electronic commerce, and they may take steps to slow that growth. Some traditional retailers may attempt to boycott new innovative rivals, such as in the Chrysler dealers case I will describe later. In other situations, traditional competitors that control a tool vital to competition, such as a Multiple Listing Service or a Computer Reservation System, may attempt to handicap innovative rivals by denying them access. Or traditional competitors may attempt to bias the information search process, perhaps in the fashion that CRS' were biased by their airline-owners, before the Department of Transportation began to regulate these practices. (6)
2. The rapid growth of an electronic commerce market. Unlike steel, oil, automobiles and other "smokestack" industries that arose in the latter part of the 19th and early part of the 20th centuries, the electronic commerce market has grown from virtually nothing to an economic heavyweight in less than a decade. There are several implications for antitrust policy in this rapid growth. Like other high-tech industries, rapid growth in electronic commerce means that this market may not be conducive to long-term market dominance by a single firm. Rapidly increasing demand and the constant introduction of new products make it harder for a single firm to retain market share year after year. This is a pattern that is consistent across a number of fast-growing industries. For instance, one reason cited for the dismissal of both public and private lawsuits against IBM was its declining market power caused by competitors taking advantage of the huge growth in the computer industry. (7) Explosive growth in computer games destroyed any market power that initially-dominant Atari may have had. Of course, some high-tech firms have managed to remain dominant over time. When firms such as Intel and Microsoft manage to retain market share over several product generations, closer antitrust scrutiny may be warranted when they engage in conduct that may contribute to that dominance in a manner that may not benefit consumers. (8)
Another implication of this rapid growth of electronic commerce is that merger policy becomes even more important. In an industry that is not mature, where market shares are volatile, the antitrust agencies may be better able to prevent the accumulation of market power through the horizontal acquisition of competitors. A strong merger policy can thus prevent the need to bring dominant firm cases later on. (9) A good example of this is in the ATM network area. In the 1980s, a relatively lax policy was applied to ATM mergers, with the result that several dominant networks were formed. (10) Part of the reason for approving these mergers was the perception that the market was "rapidly evolving." These hopes for competitive vigor were overstated and the result was that these firms engaged in exclusionary conduct that was challenged years later in monopolization enforcement actions. (11) Again, it may be the rapidly evolving nature of a market that leads firms threatened by change to employ their residual power to maintain market stability.
3. Barriers to entry. Entry barriers are a critical factor in any antitrust analysis. One might expect that new, fast growing markets that do not yet have dominant firms will likely have low barriers to entry. And the dramatic increase in the number of Internet competitors might suggest that entry barriers are relatively low. New websites are relatively easy to establish. The cost of capital may appear from some perspectives as modest and the heavy reliance on human, as opposed to physical, capital can enable new companies to move quickly.
This initial intuition, however, may not be borne out in many Internet environments. Not all Internet sites are successful and the costs of entry are clearly sunk. Entry to get a site on the web may be relatively easy but commercial success is a very different question. After all, if entry were simple, wouldn't we expect several rivals to Amazon.com to effectively enter the market? And if entry is so simple, why do traditional firms acquire Internet sites, rather than entering with their own site? Not all websites are equal and consumers are reluctant to use sites which do not offer the optimal level of service.
Other segments of the electronic commerce marketplace may have substantial entry barriers. First-movers in high-end markets like Internet Service Providers ("ISPs") may be able to retain market share in the face of attempted entry by seemingly superior products. The ISP market is a good example. ISPs with large subscriber bases have amassed a substantial and sophisticated array of human capital, intellectual property, and contractual relationships with content providers, backbone firms, operating systems owners, and electronic commerce retailers. Moreover, potential ISP entrants must compete on a number of levels, and the difficulty of entry may be substantial. High advertising costs and consequent brand name recognition may give the incumbent firms a critical advantage in selling to consumers. Consumers may be reluctant to switch ISPs, where they have the costs of changing addresses for numerous commercial relationships. It will be difficult for new firms to attack this consumer loyalty and penetrate these markets, particularly when consumers might have to pass through viewing sites of incumbents before connecting with the new competitors.
The entry barrier analysis in electronic commerce is thus a complicated one. Each relevant market must be analyzed separately. Where incumbents have built substantial advantages by being the first to market, we cannot allow the apparent fast growth and low fixed costs to blind us to the fact that potential entrants now face a far different market than existed only a few years ago.
4. Network effects. Certain aspects of the Internet phenomenon are characterized by what economists call "network effects," in which the value of any product increases as others use the same product. These effects can be found in an actual network, such as a telephone or a fax network, or in a "virtual" network such as computer software, which becomes more valuable as more people use the same software and more writers create compatible programs. (12) Networks can be efficient, bringing many users together to create economic products and markets where none existed before. However, the very existence of the network may promote dominance by one firm once the market tips in that firm's favor. Thus, the dominance of the Microsoft PC operating system over several product generations owes much to the network effects inherent in the software market. Once the Microsoft system gained dominance over the Apple and other operating systems, the market tipped in its favor. A large percentage of consumers became locked-in to the Microsoft standard and did not want to pay the switching costs in order to change systems. Also, software writers began to gravitate to the Microsoft system because of the large installed consumer base.
Network effects have potentially contradictory consequences. They may enhance efficiency and innovation and thus contribute to the rapid growth in high-tech industries. At the same time, they may bolster forces that create and sustain single firm market dominance. The antitrust challenge is to take enforcement action where the anticompetitive effects predominate.
5. Standard setting. Closely linked to the issue of network effects is standard setting. In many high-tech industries, collaboration is necessary to share the risks of innovation and to combine technologies and products that may be complementary. As a pure technical matter, without agreement on technical interface standards, such networks cannot be formed. For instance, there could be no electronic commerce without routers and switches compatible with ISPs and their search engines on one side, and the consumers' personal computers on the other. (13)
There are several possibilities for organizing electronic commerce markets to achieve the necessary standardization. A firm monopolizing the entire market would set de facto standards by internalizing the process of interoperability. A second option would be for the government to set the standards and require all participants in the market to produce products compatible with the standards. Finally, competitors could agree on the standards to be met, preserving competition within the network. In the private standard setting scenario, the potential efficiencies of networks may inextricably be linked to collaborative behavior by competitors to set the standards by which the networks can operate.
The antitrust difficulty with private standard setting is that the traditional agency skepticism of joint activities by competitors must be weighed against the potential to enhance efficiency and innovation by agreeing on standards that may make new products, or even new industries, possible. (14) Although the competitive risks of private standard setting in Internet markets is lessened by the necessity of such standards in order for the products to be produced and the fact that the alternative may be de facto monopoly control, antitrust oversight is still necessary to avoid certain anticompetitive outcomes. Private standard setting raises concerns where it is not open to all industry members. (15) The denial of access to the standard setting process might be considered a group boycott, with potential anticompetitive effects where "the boycotting firms possessed a dominant position in the relevant market." (16) Anticompetitive effects can also arise from private standard setting where one or more firms manipulate the process to illegally acquire market power. (17)
III. Similarities with Other Commercial Upheavals
Although electronic commerce evidences numerous differences when compared with traditional commercial transactions, it is not the first change in distribution and retail markets to have widespread competitive effects. Perhaps no area of commerce has changed as much in the last 50 years as retailing. Long before the United States led the world in computers and biotechnology, it set the standards in innovation in retailing. Among the most important innovations have been the creation of supermarkets, shopping malls, discount stores and shopping clubs, category killer stores, and the increase in retailing through catalogues. Each of these retail innovations in turn upset traditional markets and led to significant amounts of antitrust litigation.
As always happens when markets are in transition, market shares may change rapidly and market power may be acquired or dissipated. Markets in flux also generate many calls for antitrust action, from both traditional retailers losing market share and the new competitors seeking access to customers or supply channels. For instance, the early days of discount retailers brought numerous complaints that manufacturers would not sell to these new kinds of stores. (18) On the other side of the market, established retailers were often convinced that discount retailers were consistently engaging in predatory pricing. (19) The growth of shopping malls presented its own antitrust issues, most prominent being complaints of stores denied access to the mall because of an exclusive contract with the mall signed by a competitor or contracts with anchor tenants granting them veto power over other tenant stores. (20)
Antitrust enforcement in new markets tends to be somewhat different than antitrust enforcement generally. Analyzing the history of antitrust complaints arising from new methods of retail competition shows that initially most of them are private lawsuits. The reason for this is that the antitrust laws are designed to protect "competition, not competitors." (21) It is quite natural that the enforcement agencies are more cognizant of this admonition than are the firms that engage in this competition. The agencies recognize innovation as a positive force for competition and have been careful not to stifle it by excess regulatory zeal. The proper response to market turmoil caused by innovative methods of competition is to step back and observe the process, acting only when anticompetitive collusion is occurring or market power is being illegally accumulated or abused.
When the agencies have found clear anticompetitive effects or a serious threat of anticompetitive effects, they have not hesitated to bring cases. The Commission has recently brought two cases in markets where innovators appeared to be acquiring market power in a manner inconsistent with Section 7 of the Clayton Act or abusing existing market power in violation of Section 5 of the FTC Act. In the first case, the Commission moved to block the merger of Staples and Office Depot, two of the three largest office supply superstores. The case turned on the definition of this new kind of retailing market. The respondents urged the District Court to accept a product market definition that would encompass sales of office supplies from discount stores such as Wal-Mart and K-Mart, as well as sales of these products from numerous other retail outlets. The Commission argued that the office supply superstores were a market unto themselves. The respondents' own documents, including advertisements and internal marketing analyses, showed that prices were higher in geographic markets where two rather than three superstores were present, and higher still in markets where only one was located, regardless of the presence of discount or other retailers selling office supplies. The court acknowledged that the respondents were retailing innovators, that they had invented the office supply category killer store, and that they had brought lower prices to consumers. However, once the market was defined as superstores, the court had no choice but to conclude that the merger would result in higher prices, and an injunction was issued. (22)
There is an important lesson from the Staples litigation for the evaluation of Internet commerce competition issues. Staples argued that there were no competitive harms from the merger, because prices would continue to fall post-acquisition. The FTC did not claim that Staples would increase prices. Rather, the FTC argued and the court accepted that the combined firm's prices would be higher after the merger than they would be absent the merger, because prices would simply not decrease as much as they would have absent the merger. Thus, in evaluating competitive effects in Internet commerce, the analysis should focus not only on the likelihood of price increases, but also whether anticompetitive conduct will slow the rate of price decreases.
In the second case, the Commission sued Toys R Us for abusing market power by trying to deny access to the supply of certain popular toys for warehouse club stores such as Costco. Warehouse clubs were new to selling toys but they had begun to take market share from more traditional retailers, including Toys R Us. In the past, Toys R Us had responded to new competition from discounters such as Wal-Mart and Target by lowering prices and improving in-store presentations. When the warehouse clubs entered the market, however, the Commission alleged that Toys R Us, the nation's largest toy retailer and the inventor of the toy store category killer, pressured toy manufacturers to deny popular toys to price clubs or to sell to them only at less favorable terms than it was getting. The Commission alleged that Toys R Us also orchestrated a horizontal agreement among manufacturers to deny products to the warehouse clubs. Toys R Us' market power derived from its status as the nation's largest toy retailer, making access to its shelves a necessity for the success of any toy manufacturer. The Commission held that these actions were illegal under either the per se or the rule of reason. (23)
These cases show that, while the Commission will show deference to innovation, it will draw the line where innovators assume that their initial success entitles them to large market shares for all time. Innovators and first movers deserve the rewards of taking competitive risks - they do not deserve, or get, blanket immunity from the antitrust laws as they try to extend those rewards.
IV. Potential Competitive Concerns in Electronic Commerce
The foregoing suggests that competitive concerns in electronic commerce will be similar to those found in more traditional markets, tempered by a number of special characteristics. By looking at the influence of those characteristics on other high-tech industries, and the record of antitrust enforcement in markets where there were other kinds of commercial upheavals in retailing, we can anticipate that certain patterns of conduct will occur in electronic commerce, and we can give some indication of the analysis we will use when that happens. Some antitrust concerns that are certain to arise in electronic commerce are:
1. Horizontal boycotts. Perhaps the easiest fact pattern for the agencies to analyze in regard to electronic commerce sales is one that we have been familiar with for some time: horizontal collusion to boycott a new form of competition. In a classic case from 1966, the Supreme Court held that a group boycott of discount automobile dealers in the Los Angeles area, orchestrated by full price dealers and acquiesced in by General Motors, was a clear violation of Section 1 of the Sherman Act. (24) The discount dealers were getting their product by buying it from full price dealers. When other full price dealers complained to GM, the manufacturer forced the transhipping dealers to repurchase the cars from the discounters. Thus, the traditional, full price dealers were able to choke off innovative competition in its infancy.
There are many other instances of full-price retailers attempting to collectively force manufacturers to stop dealing with price cutting competitors. (25) When new kinds of competition emerge, one of the first things incumbents may do is to attempt to deny necessary inputs to the innovators by organizing a boycott. (26) Traditional retailers afraid of losing sales to a competitor selling over the Internet similarly might pressure manufacturers to deny product to the Internet seller by threatening a boycott. This is not a difficult antitrust issue. There can be no competitive justification for retailers collectively attempting to choke off this new form of competition. As the Supreme Court has explained, firms violate the antitrust laws where they jointly seek to "disadvantage competitors" by "cut[ting] off access to a supply, facility, or market necessary to enable the boycotted firm to compete." (27)
The Commission recently brought a boycott case in Fair Allocation System. (28) In this case, a group of 25 Chrysler dealers in the Northwest U.S. was losing sales to another dealer that sold at low prices over the Internet. The innovative dealer offered low, "no haggle" pricing, and was among the first dealers nationwide to sell over the Internet. The Internet enabled this dealer to sell to customers over a wide geographic area in eastern Washington, Idaho, and western Montana.
To combat this new form of competition, the full price dealers established the "Fair Allocation System" ("FAS") and threatened to refuse to sell certain Chrysler models and to limit the warranty service they would provide particular customers unless Chrysler limited the allocation of vehicles to the Internet seller. FAS consisted of approximately 25 Chrysler dealers, and they constituted a "substantial percentage" of Chrysler dealers in the relevant market. (29) Chrysler traditionally allocates vehicles based on each dealer's total sales. FAS members wanted Chrysler to allocate vehicles based on the expected number of sales from a dealer's local area, which would have substantially reduced the number of cars available to Internet sellers.
The Commission charged that the agreement to boycott Chrysler was a violation of Section 5 of the FTC Act and would have harmed competition and consumers by reducing competition among automobile dealers and depriving consumers of local access to particular models and warranty work. The order settling the complaint prohibits FAS from participating in, facilitating, or threatening any boycott of, or concerted refusal to deal with, any automobile manufacturer or consumer.
2. Control of Internet access. Manufacturers and retailers have numerous means of accessing the Internet in order to initiate electronic commerce. But on the other side of the potential commercial transaction, consumer access to the Internet initially depends on being able to connect to an Internet Service Provider. That connection in turn, may depend on the various ISPs' ability to access the consumer's home computer through telephone or cable wires. This access is the key for new competitors to enter the market.
Of course, access to broadband Internet service was presaged by similar antitrust issues in the matter of access to cable distribution and programming generally. In Time Warner, the Commission alleged that the merger of Time Warner (with its minority shareholder TCI) and Turner Broadcasting System, two of the country's largest cable programmers and distributors, would limit access to the markets of cable distribution systems and cable programming. (30) Cable operators would find that Time Warner and Turner favored their own distribution systems with programming, while rival programmers would find it difficult to gain access to Time Warner's and TCI's distribution systems. The Commission's consent order preserved competition in both markets by requiring TCI to divest its interest in Time Warner, requiring TCI to cancel its contract to carry certain Turner and Time Warner programming, and preventing Time Warner from bundling its premium HBO channel with Turner channels or Turner's CNN, TNT, or WTBS superstation with Time Warner channels. Time Warner was also prohibited from foreclosing rival programmers from access to its distribution systems. This remedial effort was designed to maintain access for competitors to both programming and distribution markets.
A number of antitrust issues may be raised by the question of access to the Internet, including whether or not certain kinds of access can be considered an "essential facility." Access to the information "pipe" into the consumer's home is the subject of fierce lobbying before the FCC and local cable regulators by telephone, cable, and Internet companies, as well as a recent antitrust suit charging that AT&T and its subsidiary, TCI, tied the sale of its high-speed cable wire to its Internet portal, Excite At Home. (31) Consumers that buy TCI's high-speed cable link may still purchase a different ISP, but they will then be paying for two services. The suit, by GTE, essentially seeks open access to cable's broadband pipe. This is an interesting case in that GTE, which is a local telephone company, already has its own access into the consumer's home, at least in those markets where it delivers telephone service. However, under current technology, which is changing rapidly, cable systems can move more data than telephone systems.
In part because technology is changing so rapidly, the FCC has chosen not to require open access to broadband systems, preferring to let cable and telephone companies fight for consumer dollars in the marketplace. (32) The FCC has taken the position that high-speed cable access to the home does not constitute a monopoly because it competes with telephone companies' DSL high-speed service, as well as satellite delivery systems.
3. Internet mergers. In a new market with fast growth and rapidly changing market shares, most Internet mergers are unlikely to be an immediate competitive problem. However, this will not always be the case. The inevitable consolidation and slower growth will bring the accumulation of market power, and merger oversight will be necessary so that future acquisitions will not lessen competition. Of course, some Internet-related markets have already experienced consolidation. In the merger of Internet backbone providers MCI and WorldCom, the Department of Justice, FCC, and European Union alleged harm to competition and the consent decree settling the case required divestiture of MCI's backbone infrastructure. (33) Other Internet markets, such as Internet Content Providers, are currently relatively unconcentrated.
Acquisitions by incumbents in the traditional markets of Internet participants can also raise competitive concerns. Some flavor of the kinds of activities that might raise competitive merger concerns in Internet markets can be gleaned from the Primestar case. (34) In this case, the joint venture owners of Primestar, including five of the largest cable Multiple System Operators, attempted to acquire the Direct Broadcast System ("DBS") assets of News Corp. and MCI. The Justice Department sued to enjoin the merger, alleging that the cable owners would not use those assets to compete aggressively with their own cable systems, leading to higher cable rates, less innovation, and lower quality in cable markets. The acquisition was dropped after the suit was filed. In Internet markets as well, the agencies must be vigilant to prevent established competitors from attempting to quash new forms of competition through acquisition.
It is also inevitable that the question will arise: can sales on the Internet be a relevant product market? Could a hypothetical monopolist in an Internet market profitably raise Internet prices by 5 or 10 percent? (Or prevent price decreases of a similar degree?). (35) Suppose Amazon.com, Barnes & Noble and Borders gain most of the Internet sales of books, and that Amazon.com then acquires the Internet sales operation of one of the other two. Is that analogous to the Staples case, or are other outlets for books sufficient to keep Amazon.com from raising Internet book prices? The Internet as relevant market is only one of the interesting merger issues that will be answered in the future.
Another intriguing issue is the impact of the ability to price discriminate on Internet market definition. Antitrust markets are traditionally defined by the ability of a hypothetical monopolist to profitably raise prices on a nontransitory basis. In any market, some consumers will exit the market after a significant price increase, but if enough remain to make the increase profitable, a market is defined. The monopolist may not know in advance which consumers will exit the market but will simply adjust its price to the total demand from all consumers.
Certain aspects of electronic commerce may make antitrust market definition more difficult because they will allow the monopolist the ability to discriminate among groups of consumers. A number of factors, including the ability of firms to design pricing and promotion schemes that match customers' willingness to pay, the increasing sophistication of data mining and information retrieval, and even the recent legislative initiative in the financial services industry, may improve the ability of sellers to determine the demand curves of disparate groups of buyers. Internet sellers may be able to determine the incomes of potential buyers, the amount of a product that potential buyers have purchased and at what prices, and even the number and kinds of complementary products recently purchased. For instance, a manufacturer of bicycle clothing and equipment might be able to tell which potential customers on the Internet have recently purchased a bicycle, how much it cost, what the income of the customer is, and even what kinds of products are selling well in the customer's zip code. The seller could then show different prices to different customers, depending on the seller's estimate of the buyer's demand function.
The implications of this technology for antitrust market definition are apparent, even if the answers are not. A hypothetical monopolist may be able to charge a nontransitory 5 percent price increase to some customers and not others. Relevant product markets have often been defined by the ability to price discriminate and this issue will receive serious consideration in future investigations in these markets.
4. Competitor collaborations. Joint ventures, strategic alliances and other collaborations among competitors are already an important component in the emerging electronic commerce market. There are several reasons why these arrangements are formed. Competitor collaborations can bring together firms with complementary skills and expertise. These arrangements also permit firms to share the risks of developing new markets. These collaborations may permit a group of firms to achieve economies of scale and scope that no single firm could achieve.
On October 1, the FTC and Justice Department issued draft "Antitrust Guidelines for Collaborations Among Competitors." These Guidelines do not revise the law, but rather provide a description of the relevant law in a single document. Joint venture guidelines were last issued by the antitrust agencies over a decade ago, and the issuance of new guidelines was quite timely, considering the explosion of these arrangements in the electronic commerce environment over the past few years.
How do the draft guidelines facilitate the creation of these arrangements? First, the guidelines provide a "safe harbor" that these arrangements are unlikely to face challenge where they account for less than 20% of the market. The vast majority of Internet strategic alliances will fall under this safe harbor. Second, where this safe harbor is unavailable, the guidelines make clear that arrangements that fall short of "full integration" will receive rule of reason evaluation. In the past, some suggested that only joint ventures that were fully integrated, in that a separate legal entity was formed, should receive rule of reason treatment. (36) Third, where the agencies apply the rule of reason, they will make an early inquiry as to whether there are likely anticompetitive effects; where these concerns are absent, the joint venture will be quickly approved. Finally, even where competitive concerns otherwise would be raised, if the joint venture members retain the incentive and ability to compete against the venture (a concept known as "insider competition") enforcement action may not be warranted.
That does not mean that competitive concerns are non-existent in these arrangements. (37) Rivals in the more traditional market may use joint ventures (or joint venture rules) to stifle the development of new markets. For example, in 1992 the Justice Department challenged a joint venture known as Primestar, formed by several cable systems including Time Warner, TCI, and others to enter the Direct Broadcast Satellite market. (38) The Department claimed that the joint venture sought to delay the development of DBS, by imposing rules on its members that discouraged them from providing programming to competing DBS systems. The case was settled with the elimination of these rules.
Similar concerns were raised when VISA and Mastercard created a single joint venture to issue debit cards, known as Entree in the mid-1980s. A group of 13 state attorneys general challenged the formation of the joint venture alleging that VISA and Mastercard intended to retard the development of online debit, a payment system which they feared would compete with and erode the profitability of credit cards. In 1990, VISA and Mastercard agreed to abandon the Entree joint venture, and have since created their own independent online debit card networks. (39)
Traditional competitors may use their collaboration to attempt to forestall entry or expansion by attempting to raise the costs of new entrants or participants in new markets. An example of this is the current litigation between ReMax and some real estate broker agencies in Ohio. ReMax alleges that in response to their entry into several Ohio markets, these agencies changed their "commission split" policies so that agents that dealt with ReMax agents would receive a lower rate of commission. Even though these policies did not result in complete network exclusivity, the Sixth Circuit held earlier this year that these arrangements could violate Sections 1 and 2 of the Sherman Act. (40)
5. Exclusive dealing on the Internet. Exclusive dealing in traditional commercial transactions is analyzed under the rule of reason, and there seems to be no reason why the same analysis should not apply to the Internet. Unless a large part of the market is foreclosed to competitors, an exclusive dealing contract usually will not have anticompetitive effects. (41) Amazon.com, for instance, has exclusive dealing contracts with several ISPs to sell books over the Internet. At present, the amount of the Internet foreclosed to other booksellers by these contracts does not raise competitive concerns, even if Internet sales can be considered a relevant antitrust market.
Where significant market share foreclosure does occur, however, exclusive dealing contracts could be an anticompetitive problem. Unlike books, some products have value only in an Internet marketplace, and if they are foreclosed from that market, consumers will have fewer choices. Moreover, when evaluating the degree of foreclosure it is important to recognize that not all Internet competitors are equal. Some ISPs, for example, may be far more essential to effective competition than others. Thus, it is conceivable that exclusive arrangement with even only a handful of some of the largest ISPs may pose significant antitrust risks.
6. Manufacturer nonprice restrictions on Internet distribution. The antitrust laws allow manufacturers wide leeway in establishing their distribution systems. Vertical nonprice restrictions on territories, coop advertising, and mail order sales are analyzed under the rule of reason and usually have been upheld by the courts. (42) Similarly, a manufacturer may reserve to itself the right to sell to certain customers, such as high-volume fleet customers. We have already begun to see manufacturers attach various nonprice restrictions to distributor sales over the Internet. Tupperware is reported to have prohibited all Internet sales by its distributors because it believes personal demonstrations are necessary for proper sales of its products. (43) For a while, Levi Strauss reserved all Internet sales for itself. Nike has appointed one retailer, Fogdog Sports, to be its exclusive Internet seller in return for an ownership stake.
A manufacturer can defend Internet restrictions on two levels. The first is the manufacturer's unilateral Colgate right to deal only with those distributors it wishes. (44) Thus, a manufacturer can refuse to supply product to any dealer that makes Internet sales in the absence of an intent to monopolize. Second, a manufacturer can show that its nonprice restrictive contracts with distributors are procompetitive because they enhance interbrand competition on balance. (45) Thus, Apple Computer's reasons for its refusal to supply computers to distributors that made mail order sales - that point-of-sale and post sale technical service were necessary to protect the brand and to prevent free riding - might also be used to prohibit distributor Internet sales. (46)
This discussion focuses on restraints imposed by manufacturers. But as the Toys R Us discussion suggests, retailers may engage in similar conduct and similar competitive concerns would be presented. In fact, to the extent a retailer has market power, the competitive concerns may raise significant competitive concerns.
7. Manufacturer price restrictions on Internet distribution. A manufacturer retains its Colgate rights, but it cannot make any agreement with distributors on the prices to be charged over the Internet. (47)
Of course, most of the jurisprudence in the resale price maintenance area focuses on the question of whether an agreement has been reached, since agreements to maintain minimum (48) resale price remain per se illegal. Thus, there is relatively little guidance of how to evaluate the economic consequences of resale price maintenance (an issue enforcement officials must consider, if only to evaluate the potential for consumer injury as a guide to prosecutorial discretion). The Internet poses different economic issues than traditional retailing, and thus more careful evaluation of resale price maintenance is appropriate. Consider free-riding, frequently offered as an important justification for a manufacturer's use of resale price maintenance. Manufacturers used to worry that mail-order houses would free-ride on the investments that conventional retailers made in showrooms. That may still be true in some cases: an Internet vendor may take orders from people who have examined the product in their local store first. But now, increasingly, the reverse may also be true: as electronic sales sites become larger and more complete, shoppers may go there first for product information, and then go to their local store for prompt delivery. So in this case the traditional brick-and-mortar store may be free-riding on other firms' websites. Free-riding needs careful scrutiny in this environment.
One particular subheading of resale price maintenance on the Internet that could raise some interesting questions is minimum-advertised-price (or "MAP") agreements. Manufacturers often condition their grant of cooperative advertising allowances on dealers' adherence to certain minimum advertised price levels. In 1987 the Commission rescinded an earlier policy statement to the effect that cooperative advertising programs that refused or restricted reimbursement for the advertising of discounts would be deemed illegal per se. (49) The Commission said that instead it would analyze such restraints under the rule of reason, and simultaneously issued a consent order modification implementing this change. (50) The Commission noted that such programs could often be procompetitive or neutral, stimulating dealer investment in promotion and benefitting interbrand competition, adding that they would not prevent the dealer from "selling at discount prices or even from advertising discount prices at the dealer's own expense." (51)
At that time, of course, electronic commerce was at most a gleam in the eye of most consumers. But as with other issues mentioned, the Internet medium does not alter the rules of the game, though it may affect their application. The first point to bear in mind, of course, is that the Commission did not say it would treat cooperative MAP restraints as per se legal - they remain potentially troublesome, and that potential is realized when they amount to, or play a role in, actual resale price maintenance. (52) For example, some manufacturers may attempt to expand the requirements for cooperative payments to adherence to MAP in all advertisements, including those not coop-supported, and even to in-store price promotions. Or the nature of the retail business involved may be such that there would be no incentive to discount in the store unless the discount price could be advertised. The issue is of course fact-intensive. In an Internet commerce context, suppose a website receives coop-support, and itself contains no prices below MAP, but is linked to pages with discount pricing that do not receive coop-support?
Of course, positing that the discount pages are not supported by cooperative advertising payments may seem to make the question too easy: If it is not coop-supported, the Commission's rule-of-reason carve-out would not seem to apply. But suppose the manufacturer paid a percentage of the cost of the whole website - would it be legal to apply the MAP stricture throughout? If the website is not simply an advertisement, but takes purchase orders as well - the business is true electronic commerce, in other words - the prices listed are both part of the advertising and the equivalent of in-store price stickers, suggesting that the MAP restrictions would be the exact functional equivalent of resale price maintenance.
8. Robinson-Patman. The growth of electronic commerce will also affect and further complicate an already complex area of antitrust law. This is the law governing price discrimination - the Robinson-Patman Act. Reduced to its essentials, the Robinson-Patman Act requires that sellers treat all competing customers on the same basis, unless there is some recognized legal justification for different treatment. So, for example, competing purchasers should be charged the same price. Similarly, competing purchasers should be given promotional support on a proportionately equal basis, for things like advertising and product demonstrators. The Act also contains a number of reasonable affirmative defenses, however, which will justify different treatment if it merely reflects the lower costs of doing business with a large customer, or if it is necessary to meet competition, or for similar reasons.
But consider how electronic commerce will make us re-think the analysis. For example, a bedrock concept of the Robinson-Patman Act is discrimination between competing customers: to oversimplify a little, you could charge different prices to buyers in different parts of the country, but couldn't charge different prices to firms that are across the street from one another, since that would put one at a relative disadvantage in resale. But in electronic commerce, all vendors are, in a sense, right across the street from each other, so long as they don't limit the geographic areas to which they will sell. (53) This suggests that prudent sellers will charge them different prices only if there are other statutory justifications for doing so.
The role of antitrust in the creation of new markets was best summed up by Judge Ryan in a decision earlier this year:
Fundamental canons of antitrust law recognize the legitimacy of permitting the natural economic forces of free enterprise to drive inefficient producers of goods and services out of the market, and replace them with efficient producers. Ordinarily, when an efficient enterprise displaces an inefficient one, we conclude that consumers' economic interests are better served, despite that the inefficient enterprise is injured or even destroyed. Conversely, when inefficiency triumphs over efficiency, consumers lose because they receive lower-quality, higher-priced products and services. (54)
Electronic commerce is a new force for growth in the American economy. The upheaval in distribution and retailing from this force is not unprecedented, having been preceded by such new marketing innovations such as supermarkets, shopping malls and catalogues. However, electronic commerce shares certain special characteristics with other high-tech industries, such as network effects, that may have implications for antitrust policy. These special characteristics warrant a sophisticated and subtle antitrust enforcement policy designed to prevent collusive agreements and the abuse of market power, while allowing the full force of innovation to proceed at its market-determined pace. Although the growth of this market may be unprecedented, traditional antitrust principles still apply.
1. My remarks are my own and do not necessarily reflect the views of the Commission or any individual Commissioner.
3. See FTC News Release at www.ftc.gov/opa/1999/9904/imall1.htm (April 15, 1999) (Internet site and company principals agree to $4 million payment and occupational bans to settle allegations they made false earnings claims for Internet-based businesses in violation of FTC Franchise Rule).
4. 16 C.F.R. Pt. 312 (Oct. 20, 1999).
5. "Antitrust Analysis in High-Tech Industries: a 19th Century Discipline Addresses 21st Century Problems," Prepared Remarks of Robert Pitofsky before the ABA, Antitrust Section, Antitrust Issues in High-Tech Industries Workshop, Feb. 25, 1999 at 1.
6. See Prepared Testimony from Michael Durham, Sabre Group, before the U.S. Congress, Joint Economic Committee, High-Tech Summit, June 15, 1999.
7. See ILC Peripherals Leasing Corp. v. IBM, 458 F.Supp. 423, 430-31 (N.D. Cal. 1978) (declining market share showed IBM did not have monopoly power), aff'd per curiam sub nom. Memorex Corp. v. IBM, 636 F.2d 1188 (9th Cir. 1980).
8. See Intel Corp., Dkt. No. 9288 (Aug. 5, 1999) (consent order); United States v. Microsoft Corp., Civ. Ac. No. 98-1232 (D. D.C. May 18, 1998) (complaint); New York v. Microsoft Corp., Civ. Ac. No. 98-1233 (D. D.C. May 18, 1998) (complaint).
9. See Donald I. Baker, "Government Enforcement of Section Two," 61 Notre Dame L. Rev. 898, 926 (1986) (suggesting that lenient merger enforcement will increase the need to bring monopolization cases at a later date).
10. See David A. Balto, "The Murky World of Network Mergers: Searching for the Opportunities for Network Competition," 42 Antitrust Bulletin 793 (Winter 1998).
11. United States v. Electronic Payments Services, Inc., No. 94-208 (D. Del. Apr. 21, 1994), 59 Fed. Reg. 24711 (May 12, 1994).
12. See Michael Katz and Carl Shapiro, "Network Externalities, Competition, and Compatibility," 75 Am. Econ. Rev. 424 (1985).
13. See Mark A. Lemley, "Antitrust and the Internet Standardization Problem," 28 Conn. L. Rev. 1041, 1046 (1996) ("the Internet can exist in this distributed condition only because each of the participants has agreed-expressly or impliedly-to a set of protocols that allows them to read and pass through messages sent by other participants").
14. De facto standard setting by a monopolist may also raise antitrust issues in the context of the Internet and electronic commerce. Application of Section 2 of the Sherman Act may prove problematic in markets with network effects and declining long run marginal costs (a natural monopoly), but it will be vital to ensure that competition to set the standard, particularly next generation standards, remains vigorous. Id. at 1068-79.
15. See Thomas A. Piraino, Jr., "The Antitrust Analysis of Network Joint Ventures," 47 Hastings L.J. 5, 9 (1995) (suggesting that network joint ventures should be required to have open membership on a nondiscriminatory basis).
16. Northwest Wholesale Stationers Inc. v. Pacific Stationery & Printing, 472 U.S. 284, 295 (1985).
17. See Dell Computer Corp., 121 F.T.C. 616 (1996) (consent order).
18. Golf City, Inc. v. Wilson Sporting Goods Co., 555 F.2d 426, 430-31 (5th Cir. 1977) (manufacturer's refusal to sell high-price golf equipment to a discounter in order to protect the prestige of the brand, if unilaterally made, is a complete defense to a Section 1 claim).
19. See, e.g., Wal-Mart Stores, Inc. v. American Drugs, Inc., 319 Ark. 214 (S.C. Ark. 1995).
20. See, e.g., Dalmo Sales Co. v. Tysons Corner Regional Shopping Center, 429 F.2d 206 (D.C. Cir. 1970).
21. Brown Shoe Co. v. United States, 370 U.S. 294, 320 (1962).
22. Federal Trade Commission v. Staples, Inc., 970 F.Supp. 1066 (D.D.C. 1997).
23. Toys R Us, Inc., Dkt. No. 9278 (Oct. 14, 1998) (final order), on appeal.
24. United States v. General Motors Corp., 384 U.S. 127 (1966).
25. See Monsanto Co. v. Spray-Rite Service Corp., 466 U.S. 994 (1984).
26. See e.g., New England Juvenile Retailer's Ass'n, 119 F.T.C. 79 (1995) (consent order) (attempt to pressure manufacturers of baby furniture to cease selling to discount catalogue retailers).
27. Northwest Wholesale Stationers v.`Pacific Stationery & Printing Co., 472 U.S. 284, 294 (1985).
28. Fair Allocation System, Inc., C-3832 (Oct. 31, 1998) (consent order).
29. Id. (complaint) ¶ 2.
30. Time Warner Inc., 123 F.T.C. 171 (1997) (consent order).
31. Peter S. Goodman, "GTE Files Suit Over Internet Access," Washington Post, Oct. 26, 1999 at E1.
32. Remarks of William E. Kennard, Chairman, Federal Communications Commission, Before the Federal Communications Bar, San Francisco, California (July 20, 1999) at 3. In Portland, Oregon the local cable regulators ruled that AT&T's broadband access was an essential facility and must be opened up to competitors. A federal district court upheld the ruling, which is currently on appeal to the Ninth Circuit. AT&T Corp. v. City of Portland, 43 F.Supp. 2d 1146 (D. Or. 1999), appeal filed.
33. WorldCom, Inc., 13 F.C.C.R. 18,025 (1998).
34. United States v. Primestar, Civ. No. 1:98CV01193(JLG) (complaint). The transaction was abandoned. See Daniel Rubenfeld, "The Primestar Case," Review of Industrial Organization (1999 forthcoming)
35. United States Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines (April 2, 1992), reprinted in 4 (CCH) Trade Reg. Rep. ¶ 13,104.
36. See David A. Balto, "Cooperating to Compete: Antitrust Analysis of Health Care Joint Ventures," 42 St. Louis University Law Review 191 (Winter 1998).
37. In fact, where a competitor collaboration is "not ancillary to any efficiency-enhancing economic activity [it is] subject to per se treatment." GTE New Media Services Inc. v. Ameritech Corp., 21 F. Supp. 2d 27, 44 (D.D.C. 1998)(holding that alleged agreement among Bell Operating Companies to allocate markets in Internet yellow pages market could be per se illegal).
38. See United States v. Primestar Partners, L.P., 58 Fed. Reg. 33944 (June 22, 1993)(proposed final judgment and competitive impact statement).
39. 39See State of New York v. Visa U.S.A., Inc., 1990-1 Trade Cas. (CCH) ¶ 69,016 (S.D.N.Y. 1990).
40. ReMax International, Inc. v. Realty One, Inc., 173 F.3d 995 (6th Cir. 1999), pet. for cert. filed (Aug. 17, 1999).
41. See United States v. Microsoft Corp., 1998 U.S. Dist. LEXIS 14231 at * 61 (suggesting 40% foreclosure may be sufficient).
42. See Richard M. Steuer, "Retailing on the Internet," 12 Antitrust 50 (1998).
43. Melanie Warner, "Can Tupperware Keep a Lid on the Web?," Fortune, Jan 12, 1998 at 144.
44. United States v. Colgate Co., 250 U.S. 300 (1919).
45. GTE Sylvania Inc. v. Continental TV, Inc., 433 U.S. 36 (1977).
46. O. S. C. Corp. v. Apple Computer, Inc., 792 F.2d 1464 (9th Cir. 1986).
47. See Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717 (1988).
48. With regard to rule of reason treatment of vertical maximum price fixing, see State Oil Co. v. Khan, 522 U.S. 3 (1997).
49. Statement of Policy Regarding Price Restrictions in Cooperative Advertising Programs-Rescission, 6 Trade Reg. Rep. (CCH) ¶ 39,057 (May 21, 1987).
50. The Advertising Checking Bureau, Inc., 109 F.T.C. 146, 147 (1987)(order modification).
52. Apart from uses of MAP programs that could be found to be the equivalent of, or play a role in, actual resale price maintenance, such programs might be found to play a less direct, facilitating role in collusive or interdependent pricing at either the wholesale or retail level, and be attacked on that basis.
53. See National Ass'n of College Bookstores v. Cambridge University Press, 990 F. Supp. 245 (S.D.N.Y. 1997).
54. ReMax, 173 F.3d at 995.