SELECTED THEMES FROM THE FTC’s HEARINGS ON GLOBAL AND INNOVATION-BASED COMPETITION
Director, Policy Planning
Federal Trade Commission
The 1996 Antitrust Conference: Antitrust Issues in Today’s Economy
The Conference Board
New York, New York
March 7, 1996
I am very pleased to be here today to discuss new directions in antitrust and competition policy. This topic goes to the very heart of the Federal Trade Commission’s hearings this past fall on “Global and Innovation-Based Competition.” Those hearings were initiated to assess whether changes in the nature of competition require any adjustments to current antitrust enforcement policies. Let me start by describing the purpose of the hearings, and then I will discuss some of the themes that evolved during the hearings. As is customary, my remarks reflect only my views and do not necessarily represent the views of the Commission or any Commissioner.
The FTC’s Hearings on Global and Innovation-Based Competition
It would be fair to characterize the recent FTC hearings as the “brainchild” of our new Chairman, Robert Pitofsky, who presented the idea of public hearings as a way for the FTC to take a closer look at how the many competitive changes of the last few decades might have implications for antitrust and consumer protection enforcement policies. It is also fair to note that the Federal Trade Commission has a long and honored tradition of public hearings that have assisted enforcers and legislators in keeping up with new issues in the U.S. economy. For example, in the late 1920's, the FTC’s review of securities abuses led to enactment of the 1933 Securities Act. After World War II, the FTC’s examination of business trends led Congress to impose more stringent limitations on mergers.
The FTC’s “Global and Innovation-Based Competition” hearings were intended to address a more limited, although still formidable, set of topics related to changes in the nature of competition. Although many competitive changes were noted, most participants underscored the continuing vitality of the core principles of consumer protection and antitrust enforcement as the best means for ensuring that U.S. consumers have accurate information and competitive markets in which to select their purchases. The Commissioners, and others during the course of the hearings, reaffirmed the critical value of these core principles in safe-guarding the competitiveness of U.S. markets.
The hearings instead provided an opportunity to listen and learn about how competition in U.S. markets has changed during the last twenty years and what adjustments might be required to consumer protection and antitrust enforcement policies in order to keep pace with those changes. More than 50 businesses and business organizations participated, as well as many consumer protection advocates. We also received testimony from lawyers, economists, and academicians.
The Commission initiated the hearings on the basis of two assumptions: (1) Global competition (imports, exports, cross-border investments, and international joint ventures) is expanding at a rapid rate; and (2) In some markets, competition on innovation, as well as price, is of central importance. The hearings statements and testimony clearly confirmed both assumptions.
Twenty-five years ago, U.S. firms tended not to consider foreign competition and thrived by fighting to produce better and cheaper products than their domestic rivals in a common economic climate. This is no longer the case. Today, U.S. companies report that they increasingly find that their toughest competitors are foreign firms. Conversely, U.S. businesses are finding themselves able to compete in more markets abroad than ever before. By 1994, the trade across our borders was equal to over one quarter of the value created within the U.S. domestic economy.
At the hearings, business witnesses unanimously affirmed that, in order to become and remain competitive with foreign companies in the emerging global marketplace, innovation and efficiency-enhancing measures are essential to their businesses. Nowhere is this more evident than in manufacturing-intensive industries like steel and auto that, more than twenty years ago, began encountering tremendous competition from Europe and Japan. Several studies, sponsored by the Sloan Foundation, reported the adjustments that industries such as these have made to become more competitive. For example, U.S. auto makers have re-emerged as strong competitors in large part by replacing American systems of mass production with more efficient, lower-cost Japanese-honed lean production techniques.(1) Similarly, foreign competition in the steel industry led to changes in processes and capacity rationalization that has substantially restored much of the competitiveness of U.S. steel producers.(2)
Business participants also emphasized that competition is a primary incentive for innovation, and continual innovation is critical for success in increasingly global markets. At the hearings, William Coyne of 3M explained 3M’s innovation philosophy, which appears similar to how many other firms view the nexus between competition and innovation, as follows:
[U]nless you can continue to innovate, even though first on the market, you may lose your competitive position. . . . [I]nnovation can give you a market position, but it’s fleeting, and unless you continue to innovate, you cannot maintain your market position in any market.(3) Lew Platt of Hewlett Packard emphasized that to be successful, Hewlett Packard “must continually invest in newer, cutting-edge technology.(4) He observed that competition has dramatically shortened product life cycles in the high-tech industries. The typical product life cycle today, he suggested, is 6-to-12 months, where five years ago the average was 3-to-5 years.(5) Marshall Phelps of IBM echoed this sentiment of intense industry competition, reporting that from 1985 to 1995, the number of software competitors worldwide increased by more than ten-fold, and the number of hardware vendors worldwide more than tripled.(6) In discussing how companies compete, Phelps stated: “[I]t should be obvious  that innovation is the preeminent factor.(7)
With this backdrop of global competition and innovation, let me now turn to a few themes from the hearings. I will limit myself today to three: (1) the role of efficiencies in merger analysis; (2) access issues regarding networks; and (3) the relationship between antitrust and intellectual property. Although the hearings were not designed to address the international harmonization of antitrust policy, I also will briefly discuss some business testimony that we received on this issue.
Perhaps one of the most significant themes from the hearings relates to efficiencies. Business witnesses asserted that, with increased foreign competition, mergers are an important means for capturing efficiencies. For example, Ben Heineman of General Electric testified that, because of global competition, it is “essential to ring out all the excesses, to get to efficient, low cost, high quality products . . . .(8) Mergers, he explained, are preferred when they enable GE “to ring out efficiencies, to be more productive, to make unilateral decisions in terms of manufacturing [and] sourcing . . . .(9) Similarly, Norm Augustine of Lockheed-Martin testified that “combinations are encouraged . . . to reduce cost, to become more efficient, [and to] eliminate duplicative expenditures” in the defense industry.(10) He reported that, through two mergers, Lockheed-Martin has generated over $2 billion in savings.(11)
There was strong, consistent support among hearing participants for the proposition that efficiencies are generally procompetitive and should play an enhanced role in merger, as well as non-merger, analysis.(12) Support for this began the very first day of the hearings when James F. Rill, the former Assistant Attorney General for Antitrust and a principal author of the 1992 Guidelines, urged that, particularly with the expansion of global competition, “the time is ripe” to address and more fully articulate how to handle efficiencies in the context of merger analysis.(13)
Most witnesses agreed that the agencies should take efficiencies into account in analyzing a merger’s likely competitive effects,(14) because the likelihood of merger-created efficiencies may affect the net impact of a transaction on competition in a market.(15) Some stated that likely efficiencies from a merger may help to explain the business rationale for a transaction.(16) In this context, let me note that FTC staff at the hearings did ask business witnesses to share with us the types of business documents on efficiencies that they prepare in deciding whether to pursue a merger. Although some explained to us generally some efficiency considerations,(17) it was frequently difficult for business witnesses to articulate how they assess a merger’s likelihood of creating efficiencies.
A few witnesses thought that efficiencies were best analyzed as an affirmative defense(18) to an otherwise anticompetitive transaction.(19) Supporters of this approach generally thought that it was most logical to consider efficiencies only after an anticompetitive effect had been established.(20) To the extent that efficiencies were considered an affirmative defense, most witnesses advocated retaining a “merger-specific” requirement.(21) In addition, some witnesses cautioned that, as an affirmative defense, efficiencies should not be considered where markets are highly concentrated.(22)
Intellectual Property and Antitrust
It may be helpful to begin with two dichotomies that are probably familiar to many of you. The first dichotomy is that both intellectual property protection and competition are necessary in order to spur innovation efforts,(23) but they each achieve that result through different means. Intellectual property law focuses on providing inventors and creators with a return on their work that is intended to remedy various “public good” problems that may arise in connection with intellectual property, such as the ease with which others may copy and thereby appropriate the originator’s intellectual property. Antitrust law, by contrast, focuses on maintaining competitive markets in which competition among inventors and creators provides the spur to innovation.
The second dichotomy is between first-generation and second- (or successive-) generation innovators. On one hand, the first-generation innovators emphasize their need for broad and strong intellectual property protection in order to reward their innovation efforts appropriately. On the other hand, follow-on innovators emphasize their need for access to the intellectual property of the first-generation innovators, so that follow-on innovators can develop the improvements to and next generation of the first-generation’s invention or creation.
For public policy purposes, these two dichotomies require a difficult and delicate balancing of the value to innovation incentives that intellectual property protection and competition each provide. The tensions in this balancing exercise were addressed by the very first speaker at the hearings, Joseph Stiglitz, Chairman of the Council of Economic Advisors. Among other things, his opening remarks pointed out that firms may impede innovation by making overbroad assertions of intellectual property rights, and he explained this point as follows:
We often talk about how important patents are to promote innovation, because without patents, people don’t appropriate the returns to their innovation activity, and I certainly very strongly subscribe to that. . . . It was so important that it was included in the Constitution, so it gives you a sense of how important it was. On the other hand, some people jump from that to the conclusion that the broader the patent rights are, the better it is for innovation, and that isn’t always correct, because we have an innovation system in which one innovation builds on another. If you get monopoly rights down at the bottom, you may stifle competition that uses those patents later on, and so . . . the breadth and utilization of patent rights can be used not only to stifle competition, but also have adverse effects in the long run on innovation. We have to strike a balance.(24)
As the hearings continued, other participants had views and ideas about how best to achieve the balance between competition and intellectual property protection that Chairman Stiglitz had addressed on the first day. Those witnesses also addressed important issues, such as the value of intellectual property in promoting initial innovation, the scope of intellectual property protection and competition necessary to induce follow-on innovation, and the overall role of antitrust in stimulating innovation.
In considering the value of intellectual property, most participants focused on patents. As you know, a patent gives an inventor exclusive property rights to an invention that meets the criteria for patentable subject matter and that satisfies statutory conditions of novelty, utility, and nonobviousness. Last year, the patent term was increased from 17 to 20 years in order to bring the U.S. patent term into conformity with that of foreign countries.
Testimony by Professor F.M. Scherer of Harvard University discussed studies that have examined, in various ways, the extent to which incentives derived from patent protection actually are the primary motivators of innovation efforts.(25) Such studies generally assessed the value of patents in inducing initial innovation. Interestingly, the results of several studies have shown that the majority of industries do not consider patents to be very important assets. In a study published by Richard Levin in 1987,(26) firms in 130 lines of business reported that patents were the least important means of securing competitive advantages from new products.(27) These industries placed a higher value on business strategies like secrecy, being first with an innovation, the ability to move quickly down the learning curve, and sales or service efforts. In fact, 80 percent viewed investments in complementary sales and service efforts as a highly effective strategy for capturing a competitive edge from their research and development activities.(28)
However, in the Levin study, certain industries did perceive patents as being valuable to their innovation efforts. In pharmaceutical, inorganic and organic chemistry, and plastic materials industries, participants in the study considered patents to be an effective means of protecting new products. Hearings testimony from industry representatives corroborated those findings. In particular, representatives of the pharmaceutical and biotechnological industries emphasized the importance of patents to their respective industries.(29) In those industries, a patent is viewed as protecting the large, up-front investments necessary to the research and development of new drugs and biotechnologies.(30)
Professor Scherer also cited a 1986 study by Edwin Mansfield,(31) who, in a survey of firms from 12 industries, found that only 14 percent of innovations overall (in a period from 1981-83) would not have been developed without patent protection.(32) By contrast, Mansfield further concluded that 65 percent of pharmaceutical inventions and 30 percent of chemical inventions would not have been developed absent patent protection.(33) He also found that patent protection had no impact at all in four industries (office equipment, motor vehicles, rubber products, and textiles).
Based on all of the research in this area (including his own), Professor Scherer concluded that large corporations generally have many incentives, other than the potential for patent protection, to engage in research and development. He characterized the most basic incentive as: “If you don’t keep running on the treadmill, you’re going to be thrown off.(34) He offered the caveat, however, that “the spectacular successes that sometimes come from patented products may provide a sort of demonstration effect and lure to other smaller firms that would like to make it big.(35) This means that the distribution effect of rewards to technical innovations will be highly skewed, because “a relatively few winners offset the losses of large numbers of losing R&D investments.(36)
We also heard testimony from industry representatives on the role of intellectual property in innovation. The Licensing Executives Society conducted a survey of its members to elicit their views on various intellectual property and antitrust issues.(37) LES is comprised of over 3900 professionals in the U.S. and Canada who are engaged in the transfer and licensing of technology and industrial and intellectual property. According to the LES survey, respondents believe that intellectual property is a valuable asset that helps U.S. companies to compete and that provides a competitive advantage.(38) Eighty-eight percent of respondents agreed that intellectual property adds value to a company. Others concurred. For example, Max Frankel of the American Intellectual Property Law Association testified that intellectual property protection is essential to promoting innovation and investment in new technologies.(39) Dr. William Coyne reported that 3M Corporation has built a strong intellectual property portfolio in each of its product areas, because patents are necessary to protect its innovation efforts.(40)
Another area of interest involved patent breadth and its potential effect on follow-on innovation. Like Stiglitz, some commentators have argued that overly broad patents will deter other firms from pursuing follow-on innovations, thereby making new entry more difficult and stifling competition.(41) In testimony at the hearings, Professor John Barton of Stanford Law School discussed this issue in the context of antitrust.(42) He asserted that the 1970's pattern of weak patent law and strong antitrust law has been replaced in the 1990's with a pattern of strong patent law and weak antitrust law. Professor Barton suggested that fundamental changes in the PTO’s issuance of patents and the Federal Circuit’s enforcement of patents have led to increasingly broad patents and to certain patent claims that cover basic research tools.
These changes have intensified two related problems, according to Professor Barton. First, broad patents and patents covering basic research may discourage incremental and follow- on research. Moreover, the negotiation of patent rights for the incremental or follow-on innovation could be difficult, because there would be only one monopoly rent to be split between the initial and the follow-on innovators.(43) Second, according to Professor Barton, when broad patents and basic research patents are at issue, cross-licensing that is the equivalent of patent pooling is likely to be encouraged.(44) This raises similar concerns regarding disincentives for follow-on innovation.
Professor Carey Heckman of Stanford Law School highlighted the problems that high- technology industries encounter in trying to achieve a balance between initial and follow-on innovation. In high-technology industries, many of the products and services are combinations of more than one company’s technology.(45) According to Professor Heckman, technology is multi-faceted and multi-dimensional; “it doesn’t come in nice, neat sequences.(46) He explained that “we have all stood on the top of the shoulders of our predecessors, as Newton said;” early developers do not want their technology ripped off, but “new developers  would say that it’s really ridiculous to have to start from scratch.(47)
Another theme of the hearings involved networks. Networks were discussed in a variety of contexts, but there was no consensus on any of the issues. One of the contexts concerned issues arising when direct competitors in a market create a network joint venture. Credit cards and automatic teller machines (“ATMs”) are two examples of such networks. One question is whether and under what circumstances antitrust should mandate access to the network joint venture for an excluded competitor. Some witnesses emphasized that competition would likely benefit if antitrust law did not mandate access. For example, inter-system competition might be increased because excluded competitors might develop their own competing network joint venture;(48) incentives to develop network joint ventures would be maintained because joint ventures would know that they would not be forced to share their gains with “free-riders.(49)
On the other hand, others stressed that competition would likely suffer if access were denied. They argued there might be less intra-system competition,(50) possibly no increase in inter-system competition (if the excluded firm(s) cannot form a competing network),(51) and a slowing of innovation (due to the costliness of innovating outside the network joint venture).(52)
Witnesses identified a variety of analytical frameworks to evaluate whether and how access should be mandated. On the difficult question of how to price access, some argued that a newcomer should pay a fully compensatory fee that would compensate the network “not only for the direct and immediate costs of conferring access on an outsider, but also terms that will compensate the network for the lost mark-up, the lost contribution, or even the lost profits that the entry of the new player would cause those who are previously or currently members of the network.(53) Others pointed out that applicants to a new joint venture should pay the same price as other new members; in other circumstances, an applicant should pay a “risk-adjusted cost.(54)
In the single-firm context, most witnesses addressed whether a single firm could leverage its control over a standard in one market into market power in a complementary market. The most likely technique would be to deny access to the standard’s interface code to potential competitors in the complementary market. Those who found this a credible scenario generally supported some form of compulsory licensing of the interface code as a remedy.(55) Other witnesses were very skeptical that such leveraging could ever occur and found procompetitive reasons for denying compulsory licensing claims.(56) Several witnesses debated how to address the pricing of access to a single firm’s assets, which raises potentially even more difficult issues than those of how to price access to a joint venture (where joint venturers at least have reached agreement on initial price). Some witnesses suggested that joint standard setting by private parties might be a better remedy than compulsory licensing.(57) Others raised concerns about the potential for exclusionary practices by incumbents and the possibility of settling on a standard too early.(58)
Harmonization of International Antitrust Enforcement Policy
The hearings were not designed to study issues relating to the harmonization of international antitrust enforcement policy. However, in light of the over-arching theme of global competition, some witnesses addressed harmonization concerns in part. Ben Heineman of GE called for “a more level playing field” for U.S.-based companies.(59) He described the situation as follows:
The emphasis that has been placed on market concentration in U.S. merger analysis has resulted in merger standards that are significantly more restrictive than those applied elsewhere in the world. The different merger standards create an unequal global playing field that has the potential to disadvantage U.S.-based firms seeking to achieve the benefits of enhanced scale and globalizing technology-intense industries.(60)
Heineman further explained that as compared to the EC and Canada, only U.S. merger analysis focuses “both on single firm market power and on market concentration that may facilitate the collusive or coordinated exercise of market power.(61)
Others expressed similar thoughts. Addressing differences between EC and U.S. merger policy, one antitrust practitioner stated the following:
[I]s commonality, convergence a good thing? Should we have the same standards or not? I would [say], as somebody who represents parties on both sides of the Atlantic, the answer is, yes, at least in the sense of not having wildly different approaches.(62) He urged that although EC and U.S. merger analysis may have some differences, they should at least have common market share cut-offs. In his view, it is “strange” that the U.S. market share cut-off is 35 percent while the EC cut-off is 45 percent.(63) Professor Kenneth Dam warned that “simply applying [U.S.] antitrust law . . . is [not] a solution that will maximize the competitiveness of the world economy.(64) He suggested that the U.S. try to “change the foreign law to make it more pro-competitive.(65)
Finally, on the very first day of hearings, Joseph Stiglitz, Chairman of the Council of Economic Advisors, affirmed the importance of “energetic” U.S. antitrust enforcement policy.(66) While recognizing that “energetic” U.S. enforcement must not place U.S. firms at a competitive disadvantage with foreign rivals, Stiglitz asserted that there is no compelling evidence of this result.(67) Indeed, he concluded the following:
Far from creating competitive disadvantage for U.S. firms, antitrust enforcement is one of the most important reasons for the success of domestic producers in America in the global markets. Domestic competition makes U.S. firms leaner, more agile, more responsive and more innovative, and therefore, stronger global competitors.(68)
He further noted that others, including Michael Porter, agree that “vigorous domestic competition makes firms stronger global competitors.(69)
In conclusion, let me say that I have touched on only some of the themes from the FTC hearings on “Global and Innovation-Based Competition.” A staff report on the hearings is being prepared, and will be issued in late spring. I would be happy to take any questions.
(1)Roos (Sloan Foundation Auto Study).
(2)Fruehan (Sloan Foundation Steel Study).
(3)Coyne at 211-13.
(4)” Platt at 35.
(6)Phelps (Stmt) at 6.
(7)” Id. at 3.
(8)” Heineman at 186.
(9)” Id. at 194.
(10)Augustine at 1316-17.
(12)Collins at 1415; Muris at 1669; Calvani at 1644-45; Goldschmid at 3991-94.
(13)Rill at 138-40.
(14)Arquit at 3965; Egan at 1409, 1458-60; Fox at 4232-34, 4237-39.
(15)Id.; Salop at 1434-35, 1455; Collins 1423-27.
(16)E.g., McDavid at 3948-50.
(17)E.g., Platt at 44-45.
(18)Witnesses generally treated efficiencies as a “defense” or under a “competitive effects” analysis. It was not always entirely clear in the testimony, however, that every witness attached the same meaning to these terms.
(19)Some witnesses suggested that efficiencies could be considered when analyzing competitive effects and/or as a separate affirmative defense. Calvani at 1698; Muris at 1701-02; Kattan at 1958; Goldman at 4257-58. One commentator proposed that, due to difficulties in their prediction, efficiencies should be taken into consideration by increasing the HHI thresholds for highly concentrated markets in the Merger Guidelines. Lande at 1947.
(20)Muris at 1692; Jones 1399.
(21)E.g., Arquit at 3968.
(22)Jones at 1405-06; Brodley at 1679.
(23)Some have noted that the theoretical and empirical economics literature is still undecided on whether increased market power or concentration results in decreased innovation efforts. Carlton at 930-31; Rapp at 918; Sohn at 993. However, none of the business witnesses at the FTC hearings questioned that competition had a role in fostering innovation; indeed, many business witnesses (and others) addressed the need to maintain competition in order to ensure innovation.
(24)Stiglitz at 24-25.
(25)Scherer at 3301-11.
(26)The Levin study is being replicated by Wesley Cohen at Carnegie Mellon University, and the results should be available shortly. This time, the study will include businesses in other countries such as Japan, Germany, and England, as well as the United States, and will use more recent data. Scherer at 3315-17.
(27)See Wesley M. Cohen and Richard C. Levin, Empirical Studies of Innovation and Market Structure, in Handbook of Industrial Organization 1059, 1092 (Richard Schmalensee & Robert D. Willig eds., 1989); Levin, Klevorick, Nelson & Winter, Appropriating the returns from industrial R&D, Brookings Papers on Economic Activity 783 (1987); Richard C. Levin, A New Look at the Patent System, 76 Am. Econ. Rev. 199 (1986).
(28)Cohen & Levin, supra note 27, at 1092.
(29)Schafer at 718-19; Bloom at 719-20; Green at 721; Cooney at 722.
(30)Scherer at 3301-17.
(31)Id. at 3304.
(32)Edwin Mansfield, Patents and innovation: An empirical study, 32 Management Science 173 (1986). See Cohen & Levin, supra note 27, at 1091-92.
(33)See Cohen & Levin, supra note 27, at 1091-92.
(34)” Scherer at 3308.
(37)Nunnenkamp at 3374 et seq.
(39)Frankel at 3385.
(40)Coyne at 205.
(41)See, e.g., Robert P. Merges & Richard R. Nelson, Market Structure and Technical Advance: the Role of Patent Scope Decisions, in Antitrust, Innovation, and Competitiveness 186 (Thomas Jorde & David Teece eds., 1992); Kenneth W. Dam, The Economic Underpinnings of Patent Law, 23 J. Legal Stud. 247 (1994); Robert P. Merges & Richard R. Nelson, On the Complex Economics of Patent Scope, 90 Colum. L. Rev. 839 (1990).
(42)Barton at 3409-20.
(43)See Suzanne Scotchmer, Standing on the Shoulders of Giants: Cumulative Research and the Patent Law, 5 J. Econ. Persp. 29 (1991). See also Suzanne Scotchmer & Jerry Green, Novelty and disclosure in patent law, 21 Rand J. Econ. 131 (1990).
(44)Barton at 3417 -20.
(45)Heckman at 1835.
(48)Katz at 1126; Opper at 3674-76; MacDonald at 3708; Schmalensee at 3736-38.
(49)” MacDonald at 3692, 3694; Schmalensee at 3737-38; Willig at 3877-79.
(50)Besen at 3719; Salop at 3862.
(51)Ordover at 3822, 3824-25.
(52)Hovenkamp (Stmt) at 2-5; Katz at 1139-41; Edwards at 3763.
(53)” E.g., Willig at 3877-80.
(54)” E.g., Salop at 3868, 3906, 3916.
(55)Poppa at 91-92; America Online (Stmt) at 3-5; Software Publishers Assoc. (Stmt) at 11.
(56)Baxter at 3506-07; Bresnahan at 3550-51; Simon at 3571-72; Phelps at 3594-95.
(57)Teece at 3807-08; Cutler at 3639; Katz at 1134.
(58)Gellhorn at 1170-72; Nunnenkamp at 3453-54; Edwards at 3772, 3776; Katz at 1182; Heckman at 1850; Miller at 1180-81.
(59)Heineman at 171-72.
(60)Id. at 172.
(62)Griffin at 4005.
(63)Id. at 4006-07.
(64)” Dam (Stmt) at 12.
(66)Stiglitz at 18-19.