Abstract
The seven volumes of The Antitrust Revolution published between 1989 and 2019 include dozens of excellent articles that describe topical antitrust cases and the circumstances that motivated them. Taken together, the volumes provide invaluable insights into the course of antitrust enforcement over more than three decades and the factors that influenced the direction of change. This essay follows the course described in the pages of The Antitrust Revolution for two major components of antitrust enforcement: mergers and vertical restraints. The cases demonstrate that economic analysis profoundly impacted merger decisions, although the trajectory has been anything but linear. The revolution was more dramatic for the treatment of vertical price and nonprice restraints of trade. Courts relied on economic principles to upset decades of legal precedent for these arrangements.
I. Introduction
John Kwoka and Larry White produced the first edition of The Antitrust Revolution in 1989. The book hit the shelves (there were no online purchases then) a decade after Robert Bork challenged the prevailing tenets of antitrust enforcement in The Antitrust Paradox. 1 Judge Bork and his colleagues were the progenitors of the Chicago School of law and economics. A revolution in antitrust policy was underway, and the excellent contributions to the seven volumes of The Antitrust Revolution published between 1989 and 2019 document how the teachings of the Chicago School and its critics took hold in antitrust enforcement.
This essay describes the evolution of antitrust enforcement for two important components of antitrust enforcement: mergers and vertical restraints. I view the evolution through the lens of cases described in the pages of The Antitrust Revolution that were litigated to a decision in a federal court. The restriction to litigated outcomes provides a focal point to study how courts have assimilated economic analysis into their enforcement decisions, although it necessarily omits many outstanding contributions to these volumes.
The law and economics of antitrust enforcement for mergers and vertical restraints experienced dramatic developments over the three decades spanned by the seven volumes of The Antitrust Revolution. In addition to the influence of the Chicago School, these developments include the retreat from market structure as the sole basis for merger evaluations, concerns about the balance of errors of overenforcement and underenforcement, acceptance of efficiency defenses, increased reliance on empirical evidence, sophisticated analysis of unilateral competitive effects, and the replacement of the Chicago School by “Post-Chicago” industrial organization analysis. Some of these developments have had demonstrable impacts on litigation outcomes for mergers and vertical restraints, while others have yet to become part of mainstream antitrust jurisprudence.
The merger cases described in the pages of the seven volumes of The Antitrust Revolution illustrate a gradual and fitful progression in the courts from a structural approach to merger evaluation to an approach that considers the likely effects of mergers on prices and output. This progression has not been without costs for the enforcement agencies. Although economic analysis allows the agencies to focus evaluation on relevant competitive effects, its embrace by the courts also opened a window for defendants to use economic arguments proactively in their defense and to defuse arguments presented by antitrust plaintiffs.
The revolution in the antitrust evaluation of vertical restraints was in many respects even more dramatic than the revolution for merger enforcement. Merger enforcement evolved to place greater emphasis on the role of economic analysis, but it did not change the legal standard for a violation of the Clayton Act, which has always been the likelihood of a substantial lessening of competition. In contrast, courts changed the legal standard to evaluate price and nonprice vertical restraints.
Postsale price and nonprice vertical restraints were per se unlawful violations of the Sherman Act in the decade before Kwoka and White published the first edition of The Antitrust Revolution. The per se rule does not require proof of anticompetitive effects or allow for possible offsetting benefits. In the late 1970s, the Supreme Court ruled that nonprice vertical restraints should be evaluated under the rule of reason, which allows for consideration of potential procompetitive benefits from the restraint along with alleged anticompetitive effects. Postsale vertical price restraints continued to be per se unlawful until 1997 when the Supreme Court ruled that maximum resale price maintenance should be evaluated under the rule of reason. Ten years later, the Supreme Court ruled that all forms of resale price maintenance should be evaluated under the rule of reason.
The revolutions in antitrust policy for mergers and vertical restraints that occurred over the past several decades had their origins in law and economics journals and in the headquarters of the U.S. Federal Trade Commission (FTC) and the Antitrust Division of the Department of Justice (DOJ). The cases in the seven volumes of The Antitrust Revolution provide penetrating insights into whether these revolutions changed the conduct of the courts that enforce the antitrust laws in the United States. Antitrust enforcement is case-specific, and it can be hazardous to draw general conclusions from individual case studies. Nonetheless, the cases reviewed in this essay show that developments in law and economics had significant impacts on decisions by the courts, although with a long lag before their adoption by the judiciary.
II. Merger Enforcement
A. The Early Years: Structure Rules
Section 7 of the 1914 Clayton Act governs mergers and acquisitions that may substantially lessen competition. The 1914 Act contained loopholes that allowed many mergers and acquisitions to escape prosecution, which Congress plugged with the Celler–Kefauver Amendment in 1950. The 1950 amendment also added the qualifier that a merger or acquisition is anticompetitive if it substantially lessens competition in any line of commerce.
The 1950 amendment strengthened merger enforcement by allowing courts and the antitrust authorities to scrutinize mergers that led to an increase in concentration in any relevant antitrust market. In 1966, the U.S. Supreme Court blocked the merger of Von’s Grocery Company, the third largest grocery retailer in the Los Angeles area with 4.7% of regional sales, and Shopping Bag, the sixth largest grocery retailer in the region with 4.2% of sales. 2 Although the retail grocery industry was not concentrated, the Court justified its decision by stating that “Like the Sherman Act in 1890 and the Clayton Act in 1914, the basic purpose of the 1950 Celler-Kefauver Act was to prevent economic concentration in the American economy by keeping a large number of small competitors in business.” 3 In a curious juxtaposition, Richard Posner argued the case to block the merger on behalf of the United States. Posner, who went on to become the chief justice of the seventh circuit court of appeals, is one of the leading proponents of the Chicago School of law and economics, which stresses that the objective of antitrust enforcement should be the enhancement of consumer welfare rather than the protection of small competitors.
The 1968 Merger Guidelines published by the DOJ reflected the low tolerance for mergers that the Supreme Court demonstrated in Von’s Grocery. The 1968 Guidelines state that:
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In a market in which the shares of the four largest firms amount to approximately 75% or more, the Department will ordinarily challenge mergers between firms accounting for, approximately, the following percentages of the market: Acquiring Firm Acquired Firm 4% 4% or more 10% 2% or more 15% or more 1% or more In a market in which the shares of the four largest firms amount to less than approximately 75%, the Department will ordinarily challenge mergers between firms accounting for, approximately, the following percentages of the market: Acquiring Firm Acquired Firm 5% 5% or more 10% 4% or more 15% 3% or more 20% 2% or more 25% 1% or more
Case 1 in the first volume of The Antitrust Revolution describes a merger challenge that occurred when the 1968 Merger Guidelines were in effect and courts presumed that the intent of the Clayton Act was to prevent transactions that led to even modest increases in market concentration. The case is the attempted hostile takeover of Marathon Oil by Mobil in 1981. 5 The relevant market was for sales of motor gasoline and the assumed geographic markets were states, most of which were in the Midwest. Mobil’s share of sales ranged from 2.5% in Indiana to about 8.2% in Wisconsin. Marathon had a larger presence, with shares that varied from about 6% in Tennessee to 14.6% in Indiana. The changes in reported market shares from the proposed acquisition ranged from 2.5% in Indiana to 6.3% in Michigan.
Despite the modest changes in reported market concentration, the court granted Marathon’s request for a preliminary injunction to prevent Mobil from carrying out the proposed acquisition without investigating its likely effects on gasoline prices. 6 The court noted that its decision promoted the purpose of the Clayton Act and was consistent with prior rulings and the 1968 Merger Guidelines. The court quoted a 1962 Supreme Court case, Brown Shoe v. United States, for the proposition that “[w]e cannot avoid the mandate of Congress that tendencies toward concentration in industry are to be curbed in their incipiency, particularly when those tendencies are being accelerated through giant steps striding across a hundred cities at a time.” 7 Mobil appealed the decision, which the court of appeals quickly affirmed. 8
B. The Chicago School and the 1982 Merger Guidelines
The DOJ revised its Merger Guidelines soon after the Mobil-Marathon decision. William Baxter, who led the Antitrust Division at that time, was a brilliant lawyer whose views generally aligned with the teachings of the Chicago School. The Chicago School endorsed the proposition that the objective of the antitrust laws is the promotion of consumer welfare and Baxter wrote that “In my view, the only legitimate objective that can be distilled from the fundamental congressional goals of antitrust law is the enhancement of consumer welfare through increased market and firm efficiency.” 9
The Chicago School also advanced the notion that antitrust enforcement should be more concerned with errors of overenforcement than underenforcement. This enforcement calculation was not based on empirical validation but instead followed from an assumption that market forces can correct failures to contain the exercise of market power, while interventions to prevent innocent conduct can cause persistent disruption. 10 Consistent with this view the 1982 revision of the Merger Guidelines introduced thresholds for merger review that are much more permissive than the thresholds in the 1968 guidelines.
The 1982 revision employed the Herfindahl–Hirschman Index (HHI) for market concentration and the change in the HHI from a merger or acquisition. The 1982 Guidelines stated that the Department is likely to challenge a merger if the postmerger HHI exceeds 1800 and the change in the HHI from the merger exceeds 100. 11 The change in the HHI is 2s 1 s 2 where s 1 is the share of the acquiring firm and s 2 is the share of the acquired firm. The corresponding changes from the 1968 Guidelines in a concentrated market range from thirty to forty. Without regard to which guidance is more correct or whether guidance closely tracked enforcement decisions, it is evident that the 1982 Guidelines indicated a more tolerant attitude toward mergers.
The 1968 Guidelines emphasized a structural approach to merger review and state that “the Department’s enforcement activity under Section 7 is directed primarily toward the identification and prevention of those mergers which alter market structure in ways likely now or eventually to encourage or permit non-competitive conduct.” 12 Although the 1982 Guidelines also emphasized the importance of market structure in merger evaluation, they state that “The unifying theme of the Guidelines is that mergers should not be permitted to create or enhance ‘market power’ or to facilitate its exercise,” 13 which suggests the need for an economic evaluation of merger effects.
Larry White tested the proposition that merger enforcement should focus on competitive effects in his review of the proposed merger of Coca-Cola and Dr. Pepper. 14 The FTC issued a complaint that asked for a preliminary injunction to block the merger. Following the 1982 Merger Guidelines, the Commission buttressed its complaint with an analysis of the proposed merger’s likely anticompetitive effects in addition to the allegation that the merger would cause a significant increase in market concentration.
Coca-Cola challenged the complaint in a federal court. In a 1986 decision the court upheld the challenge by the FTC but emphasized the combination’s effect on market concentration and largely dismissed the competitive analysis. Judge Gerhard Gesell stated: Given [Congress’] dominant legislative desire to curb the economic concentration of power, it is unnecessary to speculate about the economic effects of the proposed acquisition. Without more, substantial mergers of this kind in heavily concentrated industries are presumed illegal.
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At the preliminary injunction hearing economists, drawing on experience in this multi-faceted discipline, flatly disagreed as to the significance of the proposed acquisition upon competition in the market. These sincere professionals are theoreticians in an imprecise field.…The Court should not, in any event, rely on the economic testimony in reaching a conclusion about the probable effects of the proposed acquisition given the concentrated nature of the market just outlined. Section 7 of the Clayton Act was not designed to support a particular economic theory; it was directed at what Congress in the exercise of its own common sense perceived. Congress desired to outlaw substantial increases in concentration through acquisition by a dominant concern in an already concentrated industry by placing a heavy burden of proof upon anyone seeking to justify growth by purchase under such circumstances.
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C. The Government Does Not Always Win
Economic claims regarding the effects of mergers on price and output often played a secondary role in evaluations by courts for most of the twentieth century. Although the courts considered litigants’ different views about the definition of the relevant market and the measurement of market shares, the government usually prevailed in these merger challenges, even if a transaction had only a modest impact on the alleged concentration of the relevant market. In his dissenting opinion in U.S. v. Von’s Grocery, Judge Stewart wrote that “The sole consistency that I can find is that in litigation under § 7 [of the Clayton Act], the Government always wins.” 17
The 1982 Merger Guidelines promoted the policy that antitrust enforcement should prevent mergers that would create or enhance market power or facilitate its exercise. Although this objective aligned with the views of most economists regarding the proper role for merger enforcement, it also created a burden for antitrust authorities to prove that challenged mergers would have adverse effects. The burden on antitrust plaintiffs to demonstrate likely competitive effects implied by the 1982 Merger Guidelines, along with their more tolerant structural presumptions, coincided with a trend in merger enforcement in which the government did not always win.
The FTC and the DOJ made several unsuccessful attempts to challenge hospital mergers in the 1980s and 1990s. The agencies alleged that the mergers would harm health insurers and patients by undermining the ability of payors to bargain for lower health care prices. They would have prevailed in these cases under purely structural presumptions, including the more tolerant presumptions in the 1982 Guidelines, but they failed to convince the courts that the mergers would harm competition. Contemporaneous economic evidence did not clearly demonstrate that hospital mergers raised health care prices. The mixed economic evidence, along with a general belief that hospital managers represented the interests of the community, allowed the courts to reject many of these merger challenges. Economic research has subsequently shown that the agencies correctly anticipated that hospital mergers adversely affect the ability of managed care payors to bargain for lower rates, but that evidence arrived too late to change the outcomes in these cases. 18
An example of a failed merger challenge is U.S. v. Carilion Health System. 19 In 1988 the DOJ attempted to block the proposed merger of Roanoke Memorial Hospital and Community Hospital of Roanoke Valley, two nonprofit hospitals in the city of Roanoke, VA. Roanoke was a subsidiary of the Carilion Health System, which owned three nonprofit hospitals in Virginia and managed six others. Based on the government’s alleged relevant product and geographic markets, the merger would increase the HHI concentration index by approximately 3700 points to a postmerger level of 6050. According to the government’s calculation, the merger would eliminate an important competitor in a highly concentrated market.
Although the defendants disputed the DOJ’s market definition, they focused their defense on the argument that the merger would strengthen rather than reduce competition for hospital services in the relevant geographic territory. The court, in a trial before a jury, considered economic evidence bearing on the likely competitive effects from the merger presented by experts on behalf of the defendants and the DOJ. The government’s economic expert provided statistical evidence that showed a positive correlation between increased market concentration among nonprofit hospitals and higher prices. The defendants offered evidence that showed no correlation and rebutted the government’s economic testimony. The defendants also claimed that the merger would generate substantial savings in capital and operating costs.
The judge accepted a jury verdict that the merger would not have an anticompetitive effect on health care prices. In its opinion the court credited the parties’ efficiency estimates. The judge concluded that as nonprofit entities the cost-savings would be used to lower hospital charges and cited economic evidence that “Hospital rates are lower, the fewer the number of hospitals in an area.” 20 The DOJ appealed the verdict, but the appellate court sustained the district court finding.
In the decade from 1994 to 2004, antitrust authorities litigated and lost seven additional challenges to hospital mergers for reasons similar to those that determined the outcome in U.S. v. Carilion. This dismal record of merger enforcement changed in response to accumulated economic evidence that hospital competition lowers health care prices. The evidence tracked the change in reimbursement practices as hospital payors shifted from fee-for-service compensation to rate schedules that were determined from negotiations in which payors bargained for lower rates by threatening to move patients to hospitals that offered more favorable prices.
Deborah Haas-Wilson documents the evolution of antitrust enforcement for hospital mergers in her discussion of the FTC challenge to the merger of Evanston Northwestern Healthcare Corporation and Highland Park Hospital, which was published in the sixth edition of The Antitrust Revolution. 21 The FTC challenged the merger in 2004. The case is an exception in this survey because it was not litigated in a federal court. Nonetheless, it is noteworthy because the FTC challenged a merger that was completed four years earlier and, relying on actual economic evidence, reversed a string of failed challenges to hospital mergers.
The challenge went before an administrative law judge, who ruled that the merger was anticompetitive and ordered the merged company to divest the acquired hospital. The ruling was supported by economic evidence which showed large increases in rates charged to most payors following the merger. The parties appealed the decision by the administrative law judge to the full Commission. In 2007, the Commission agreed that the merger was anticompetitive, but it rejected the proposed divestiture remedy and instead required Evanston to set up two separate and independent contract negotiation teams to bargain with managed care organizations.
Debra Haas-Wilson concluded that the strong economic evidence of Evanston’s postmerger exercise of market power caused the FTC to double down on its enforcement of hospital mergers. The Commission challenged a merger of Virginia hospitals in 2008, which the hospitals abandoned without turning to litigation. In 2011, the Commission challenged the consummated merger of St. Luke’s Hospital and the ProMedica Health System, which it claimed would lead to higher health care prices for insurers and patients in the Toledo, OH area. The Commission ordered ProMedica to divest St. Luke’s hospital. The merged company appealed. The court of appeals for the sixth circuit agreed with the FTC’s conclusion that the merger was anticompetitive and upheld the Commission’s divestiture order. 22
The FTC challenged two other hospital combinations in 2011. The Commission objected to the proposed joint operation of the only two hospitals in Albany, GA. After a number of appeals, the Commission accepted a remedy that did not require structural relief. The Commission also challenged the proposed merger of two hospitals in Rockford, IL. The parties abandoned their proposed merger in response to the FTC complaint. In 2013, the FTC joined a complaint filed by private plaintiffs that challenged the consummated acquisition of the Saltzer Medical Group by St. Luke’s Health System of Idaho. Both a district court and an appellate court ruled that the acquisition violated Section 7 of the Clayton Act and ordered the acquisition to be unwound. 23
The Evanston Northwestern outcome also energized merger enforcement by the Justice Department in the health care industry. Since 2004, the Department successfully challenged several proposed mergers of health insurance companies. Denrick Bayot et al. discuss the proposed merger of Aetna and Humana in the seventh edition of The Antitrust Revolution. 24 According to the authors, the Department prevailed in court based on economic arguments and econometric evidence, in addition to corporate documents and structural evidence regarding market concentration from the merger. The Department also successfully challenged several noncompete agreements between hospitals and insurance companies. 25
The hospital merger cases discussed in the pages of The Antitrust Revolution demonstrate that economic analysis is a two-edged sword for antitrust enforcers. Economic analysis can reinforce sound enforcement decisions, but economic arguments can also confuse the record and allow courts to reject evidence of anticompetitive effects. The hospital cases show that sound economic arguments prevailed in these cases, although with a substantial lag.
The DOJ and FTC jointly revised the Merger Guidelines again in 1984 and 1992. The 1992 revision brought greater sophistication to merger evaluation by distinguishing between unilateral and coordinated effects of mergers on competition. A unilateral (or noncoordinated) effect from a merger is the exercise of market power that does not rely on the concurrence of other firms in the market or on coordinated responses by those firms. 26
The FTC tested the unilateral effects theory when it opposed the 1997 attempted merger of the two largest office superstores in the U.S., Office Depot and Staples. 27 The case was notable because the market in which the Commission alleged harm from the merger did not identify specific products but instead was “the sale of consumable office supplies through office superstores.” According to the FTC, pens and paper were in the relevant market if they were sold by Office Depot or Staples, but not if they were sold by a corner stationery store. The FTC relied heavily on econometric evidence to substantiate its claim that office supplies sold through office superstores were differentiated from office supplies sold by other retailers.
The parties challenged the FTC complaint. The district court accepted the FTC’s market definition and concluded that the pricing evidence demonstrated a sufficient likelihood of unilateral anticompetitive effects to warrant a preliminary injunction. The parties subsequently abandoned their proposed merger.
The court’s opinion in the 1997 Office Depot–Staples case contrasts with the approach taken by the court in the proposed merger of Coca-Cola and Dr. Pepper, notwithstanding the finding in both cases that the merger violated the antitrust laws. In his discussion of the Coca-Cola case, Larry White lamented that the court dismissed the economic evidence and instead based its decision entirely on market definition and the increase in concentration from the merger. Although market definition and industry concentration also factored in the court’s decision in the 1997 proposed Office Depot–Staples merger, the court accepted economic evidence showing that the merger was likely to raise prices.
The FTC blocked a second attempt by Staples and Office Depot to merge in 2015. The parties also litigated that challenge. The district court found that the plaintiffs met their burden of showing that there is a reasonable probability that the proposed merger would substantially impair competition in the sale and distribution of consumable office supplies to large business-to-business customers. As in the prior attempted merger by the office superstores, the court put great weight on market share and concentration from the proposed merger, but the court also considered economic evidence in support of the allegation that the merger would lead to higher prices. The parties abandoned their proposed merger after the court issued a preliminary injunction. 28
The proposed office superstore mergers show that courts had become more receptive to economic arguments in the decade following the proposed merger of Coca-Cola and Dr. Pepper. However, this trend has not always had favorable consequences for the antitrust authorities.
In 2004, the DOJ and several states challenged the acquisition of PeopleSoft by Oracle. The complaint alleged that the acquisition would increase prices for enterprise planning software (ERP), which enables companies to operate their human resources, finances, supply chains, and customer relations. 29 The plaintiffs claimed that the combination would have adverse unilateral effects by combining firms whose products are close substitutes. They supported their complaint with an auction-based merger simulation model and empirical evidence from procurements in which companies bid to supply ERP software to major clients, in addition to corporate documents and testimony. The empirical evidence showed that Oracle offered significantly larger discounts for its ERP software suite when it competed directly in procurement auctions with PeopleSoft.
Alas, the court rejected the complaint. Judge Vaughn Walker criticized the plaintiffs’ proposed focus on large enterprise customers and their exclusion of alternatives to ERP software. The judge also challenged the discussion in the then current Merger Guidelines regarding the economic analysis of unilateral effects.
The Guidelines noted that: Substantial unilateral price elevation in a market for differentiated products requires that there be a significant share of sales in the market accounted for by consumers who regard the products of the merging firms as their first and second choices, and that repositioning of the non-parties’ product lines to replace the localized competition lost through the merger be unlikely.
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Judge Walker’s opinion included an extensive discussion of profit-maximizing behavior and the distinction between unilateral and coordinated effects, quoting publications by authorities such as Edward Chamberlain, Joan Robinson, Jean Tirole, and Carl Shapiro. 32 The judge correctly noted the possible significance of substitutes for the merging firms’ products. The modern theory of upward pricing pressure identifies the diversion ratio between the merging firms’ products as a determinant, along with product margins, of a likely price increase as a unilateral effect from a merger. The diversion ratio measures the fraction of sales lost from a price increase by one of the merging firms that would be captured by its merger partner if they had not merged. This ratio depends on the presence of other products that are alternatives to the products sold by the merging parties. 33
At one level Judge Walker’s opinion demonstrates that economic analysis can play a central role in courts’ evaluations of likely competitive effects from mergers. However, it is disappointing that the judge rejected empirical evidence of likely higher prices from the loss of competition between Oracle and PeopleSoft in favor of the theoretical possibility that price effects from the elimination of that competition would be absent because there are other close substitutes. In this respect the opinion was not favorable for an evidence-based economic approach to merger evaluation.
At about the same time as the Oracle-PeopleSoft case the FTC challenged the acquisition of the Triton Coal Company by Arch Coal. In contrast to the unilateral effects analysis in Oracle-PeopleSoft, the FTC challenged the Arch Coal-Triton merger based on coordinated effects. 34 The parties agreed that the relevant geographic market for the transaction was the Southern Powder River Basin area of Wyoming. The region had five significant coal producers, of which Arch Coal was the third largest and Triton was the fourth largest. The FTC alleged that the merger would increase the probability that producers in the region would coordinate to increase the price of coal, either explicitly or through tacit coordination. The Commission cited evidence of actual or attempted price coordination in the region and rejected a proposed divestiture as inadequate to prevent a likely price increase.
The FTC asked a district court to grant a preliminary injunction to prevent the merger. The Commission presented various measures of market concentration to the court that indicated postacquisition HHIs of about 2300 with increases from the acquisition that ranged from about 160 to 190. At one time this evidence would have been sufficient to block the merger based on past precedents such as Von’s Grocery. Notwithstanding early statements by the Supreme Court that the Clayton Act was intended to protect small competitors,
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Judge John Bates emphasized that the purpose of the Clayton Act was to protect competition, not competitors.
36
He quoted Judge Posner for the proposition that: …the Supreme Court, echoed by the lower courts, has said repeatedly that the economic concept of competition, rather than any desire to preserve rivals as such, is the lodestar that shall guide the contemporary application of the antitrust laws…. Applied to cases brought under Section 7, this principle requires the district court…to make a judgment whether the challenged acquisition is likely to hurt consumers, as by making it easier for the firms in the market to collude, expressly or tacitly, and thereby force price above or farther above the competitive level.
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The contrast between this case and cases such as Von’s Grocery or the proposed Mobil-Marathon acquisition discussed in the first edition of The Antitrust Revolution is striking. Judges in these early cases presumed that the intent of the Clayton Act was to prevent a significant increase in market concentration and they tended to defer to the judgment of the antitrust authorities in their enforcement decisions.
Judge Bates departed from the past precedents in two major respects. First, he rejected the notion that the Clayton Act was intended to prevent a substantial increase in market concentration and instead adopted an economics-based evaluation of the likely effects of the acquisition on market prices. Second, he did not defer to the judgment of the antitrust authority regarding competitive effects from the merger and instead held that the FTC has a not insubstantial burden to establish an “an appreciable danger of future coordinated interaction based on a predictive judgment.” 38 Judge Bates concluded that the FTC had failed to satisfy this burden and consequently he rejected the Commission’s request for a preliminary injunction to block the merger pending a more comprehensive review of its merits.
D. Efficiency Defenses
A persistent question in merger enforcement is whether courts should consider claimed efficiencies as a defense against allegations of harm from a merger. In 1967, the U.S. Supreme Court ruled that “[p]ossible economies cannot be used as a defense to illegality” in the evaluation of a proposed merger under the antitrust laws. 39 The Merger Guidelines published by the U.S. DOJ in 1968 exclude an efficiency defense for mergers unless there are “exceptional circumstances.” 40
Nevertheless, by the end of the century, the courts and the antitrust authorities acknowledged, albeit grudgingly, an efficiency defense for mergers. The 1997 Horizontal Merger Guidelines include a separate section on efficiencies. The Guidelines recognize that “[M]ergers have the potential to generate significant efficiencies” and state that “The Agency will not challenge a merger if cognizable efficiencies are of the character and magnitude such that the merger is not likely to be anticompetitive in any relevant market.” 41 The most recent version of the Merger Guidelines includes a section on efficiencies that communicates a similar enforcement posture. 42
Courts considered an efficiency defense in several merger challenges, while often questioning at the same time whether such a defense is cognizable under legal precedents. In U.S. v. Carilion the district court found that “Credible testimony at trial satisfies the court the merger will produce capital avoidance and other clinical and administrative efficiencies that will save the two hospitals at least $40 million over the first five years of the affiliation.” 43 The efficiency claim supported the court’s conclusion that “the merger would strengthen the competition between the hospitals in the area because defendant hospitals could offer more competitive prices and services” 44 and its decision to deny the injunctive relief sought by the government. The appellate court that affirmed the district court decision briefly addressed the efficiency claim and only stated that the lower court’s conclusion that substantial cost-savings would be passed on to consumers “was not clearly erroneous.” 45
The proposed merger of Heinz and Beech-Nut, discussed by Jonathan Baker in the sixth edition of The Antitrust Revolution, provided a further test of the efficiency defense. 46 The parties were two of only three significant suppliers of baby food. The FTC challenged the merger in July 2000 as an unlawful merger to duopoly with predictable harm to consumers. The parties took the challenge to court, where they argued that the merger would produce large cost-savings that would lead to greater competition and lower prices.
The district court noted that “the Commission amended its Merger Guidelines in 1997 to provide that ‘efficiencies are properly considered in merger analysis’…if they are merger-specific and cognizable—i.e. verified and not the result of anticompetitive reductions in output and services.” 47 The court concluded that the parties’ claimed efficiencies were substantial and reinforced the parties’ contention that the merger would promote rather than harm competition. Consequently, the district court refused to grant the FTC’s request for a preliminary injunction to block the merger.
The FTC appealed. In 2001, the appellate court reversed the district court. In its decision the court overruled the district court’s judgment regarding the parties’ efficiency defense. Significantly, the appellate court did not prohibit an efficiency defense but rather ruled that the district court relied on evidence that was insufficient to establish the benefits claimed by the parties.
Courts have never endorsed a total economic welfare standard that would allow cost-savings to the merging parties to offset likely actual harm to consumers. Instead, courts have considered whether the alleged efficiencies are of the character and magnitude such that they would prevent an anticompetitive price increase. However, even with this limitation, they have imposed a high bar to a successful efficiencies defense.
III. Vertical Price and Nonprice Restraints
The seven volumes of The Antitrust Revolution document a gradual and uneven evolution in the receptivity of courts to economic evidence that is relevant to predicting adverse price or output effects from mergers and acquisitions. Cases that appear in the pages of The Antitrust Revolution demonstrate more dramatic changes in jurisprudence for vertical price and nonprice restraints.
In 1911, the Supreme Court ruled that resale price maintenance violates the Sherman Act. In the case before the Court, the Dr. Miles Medical Company, a manufacturer of proprietary medicines, had entered into contracts with drug retailers to sell its medicines at fixed prices. The Court held that the agreements between Dr. Miles and drug retailers were designed to maintain prices and to prevent competition among those who trade in them and that “[Dr. Miles] having sold its product at prices satisfactory to itself, the public is entitled to whatever advantage may be derived from competition in the subsequent traffic.” 48
The modern economic approach to vertical restraints considers the trade-off between intrabrand and interbrand competitive effects. Vertical restraints can harm intrabrand competition by limiting the ability of retailers to compete in price or other dimensions. However, they can benefit interbrand competition by facilitating the ability of retailers to profitably engage in actions to promote sales of a manufacturer’s products.
Courts at the beginning of the twentieth century did not frame the debate over vertical restraints using the terminology of intrabrand and interbrand competition. Nonetheless, the Supreme Court was aware of purported justifications for the resale price maintenance arrangement in the Dr. Miles case. The Court acknowledged Dr. Miles’s concern that: [C]ertain retail establishments, particularly those known as department stores, had inaugurated a “cut-rate” or “cut-price” system which had caused “much confusion, trouble and damage” to the complainant’s business and “injuriously affected the reputation” and “depleted the sales” of its remedies; that this injury resulted “from the fact that the majority of retail druggists as a rule cannot, or believe that they cannot realize sufficient profits” by the sale of the medicines “at the cut-prices announced by the cut-rate and department stores,” and therefore are “unwilling to, and do not keep” the medicines “in stock” or “if kept in stock, do not urge or favor sales thereof, but endeavor to foist off some similar remedy or substitute, and from the fact that in the public mind an article advertised or announced at ‘cut’ or ‘reduced’ price from the established price suffers loss of reputation and becomes of inferior value and demand.”
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The legal treatment of price and nonprice vertical restraints evolved from convoluted origins. At the beginning of the twentieth century the Supreme Court treated vertical restraints differently for patented and nonpatented goods. Resale price fixing was per se unlawful following the decision in Dr. Miles. However, in E. Bement & Sons v. National Harrow Co., the Supreme Court did not censure a patent pool that fixed prices for licensed products and required that licensees make or sell only the licensed products. The Court reasoned that the pool was legal because “[T]he general rule is absolute freedom in the use or sale of rights under the patent laws of the United States.…and [t]he fact that the conditions in the contracts keep up the monopoly or fix prices does not render them illegal.” 50
The Court distinguished its ruling in Dr. Miles from its earlier ruling in National Harrow by noting that the proprietary medicines sold by Dr. Miles were not protected by patents, although they were prepared by means of secret methods and formulas and identified by distinctive packages, labels, and trademarks. The Court also distinguished price-fixing of goods sold to retailers from sales at fixed prices of goods for which the manufacturer holds title and the retailer acts as its agent. The Court devoted considerable attention in its Dr. Miles decision to a determination of whether retailers were acting as agents for the manufacturer, without explaining whether the presence or absence of this relationship has an economic significance for the competitive harm from resale price maintenance.
The Supreme Court addressed an additional complication for the legal treatment of vertical restraints a few years after its decision in Dr. Miles. In U.S. v. Colgate, the Court recognized a manufacturer’s right to specify the prices at which its products may be sold and to refuse to sell goods to wholesale and retail dealers who failed to resell the goods at those prices. 51 Thus, the Court drew a distinction between a manufacturer policy to require resale of a good at a fixed price and an agreement between the manufacturer and wholesalers or retailers to resell a good at a fixed price.
The economic effects of a policy that conditions a manufacturer−retailer relationship on compliance with sales at specified prices are similar to the effects of an agreement between the manufacturer and the retailer to sell at the specified prices. Moreover, it can be difficult to distinguish whether sales at specified prices are the consequence of compliance with a policy or are agreements to sell at the specified prices. Nonetheless, the Supreme Court held that a policy to sell at fixed resale prices, enforced by termination of noncompliant dealers or wholesalers, is not unlawful because “In the absence of any purpose to create or maintain a monopoly, the [Sherman] act does not restrict the long recognized right of trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal.” 52
The Supreme Court further muddled the legal landscape for the antitrust treatment of restraints of trade with decisions regarding nonprice vertical agreements. In White Motor v. United States, the Supreme Court considered whether territorial and related customer restrictions imposed by a manufacturer on its dealers violated the Sherman Act. 53 At issue was a summary judgment determination by a district court which held that the manufacturer’s restrictions were per se unlawful. The majority disagreed and remanded the case to the lower court for further analysis.
The majority quoted Chicago Board of Trade v. United States regarding the standard to evaluate restraints of trade under the Sherman Act: Every agreement concerning trade, every regulation of trade, restrains. To bind, to restrain, is of their very essence. The true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition. To determine that question the court must ordinarily consider the facts peculiar to the business to which the restraint is applied; its condition before and after the restraint was imposed; the nature of the restraint and its effect, actual or probable.
54
A vigorous dissent advanced the argument that territorial restrictions have an adverse effect on competition that is the same, if not even more destructive, as resale price maintenance and therefore should be condemned as violations of the Sherman Act without any analysis of effects on interbrand competition. 56 The minority concluded that “The offered justification must fail because it involves a contention contrary to the public policy of the Sherman Act, which is that the suppression of competition is in and of itself a public injury.…No justification, no matter how beneficial, can save it from that interdiction.” 57
The Supreme Court had another opportunity to deliberate the legality of nonprice vertical restraints in United States v. Arnold Schwinn & Co. 58 Schwinn revamped its distribution system in an effort to reverse its declining share of bicycles, which had fallen from 22.5% of sales in 1951 to 12.8% in 1961. The company’s new distribution system assigned exclusive territories to its wholesalers and established a smaller network of franchised dealers that were authorized to sell its bicycles. Franchised dealers could purchase Schwinn bicycles only from their authorized wholesalers and were not permitted to resell Schwinn bicycles to unfranchised dealers.
Schwinn sold some of its bicycles to wholesalers and retailers and also entered into agency arrangements in which the company held title to bicycles that were consigned to distributors. These distinctions proved crucial to the Court’s opinion regarding the legality of the territorial restrictions. The Court ruled that territorial restrictions on the resale of bicycles that Schwinn sold to wholesalers or dealers were per se illegal. The Court allowed restrictions on consignment sales to be evaluated under the rule of reason, which does not presume that restrictions are either lawful or unlawful.
The Court did not justify its distinction between per se condemnation of territorial restrictions for bicycles sold by Schwinn and rule of reason analysis for consigned sales based on an economic evaluation. Instead, the Court cited “the ancient rule against restraints on alienation” for sold goods and held that a less restrictive standard would “open the door to exclusivity of outlets and limitation of territory further than prudence permits.” 59 The Court recognized Schwinn’s argument that the company adopted the challenged distribution program to promote the sales of its bicycles and increase stability of its distributor and dealer outlets. But the Court dismissed these interbrand competitive benefits as irrelevant to its determination of per se illegality for territorial restraints on resales.
The Supreme Court had yet another opportunity to revisit the legality of territorial restraints in Continental T.V. v. GTE Sylvania. 60 Lee Preston discusses this case in the first volume of The Antitrust Revolution. 61 Ten years after the Supreme Court ruled in U.S. v. Schwinn that territorial restraints on resales were per se violations of the Sherman Act, the Court retracted its opinion and held that such restraints should be analyzed under the rule of reason, which permits consideration of the procompetitive benefits of the restraints for interbrand competition.
The decision was a clear break with U.S. v. Schwinn. The Court acknowledged that the territorial restrictions imposed by GTE Sylvania on its dealers were similar to those imposed by Schwinn, which the Court held were per se violations of the Sherman Act when Schwinn parted title with its bicycles. An arguable distinction is that GTE Sylvania’s share of sales of the relevant (televisions) product was even smaller than Schwinn’s share of bicycles, although both companies adopted similar restricted distribution plans to improve their market positions by attracting and maintaining more aggressive and competent retailers.
In U.S. v. Schwinn the Court relaxed the per se rule for territorial restrictions when the manufacturer did not part title with its products. In GTE Sylvania the Court acknowledged that there was no economic basis for this formalistic distinction. The Court observed that vertical restrictions have complicated effects because of their potential for a simultaneous reduction of intrabrand competition and stimulation of interbrand competition. Furthermore, the Court noted its failure to take these opposing costs and benefits into account in its Schwinn decision.
As of 1967, the law of the land was that vertical territorial restrictions were analyzed under the rule of reason, but following precedent first established in Dr. Miles, resale price maintenance remained per se illegal. In GTE Sylvania, Justice White concurred with the majority opinion but separately noted that vertical price and nonprice restrictions have similar economic effects. He quoted Richard Posner, who wrote that “There is no basis for choosing between [price fixing and market division] on social grounds. If resale price maintenance is like dealer price fixing, and therefore bad, a manufacturer’s assignment of exclusive sales territories is like market division, and therefore bad too…” 62
One year after GTE Sylvania, the Supreme Court visited the price–nonprice dichotomy in Albrecht v. Herald. 63 The case involved the fixing of maximum resale prices for the delivery of newspapers on a paper route. The newspaper publisher argued that the maximum resale price restraint was procompetitive because the owner of the paper route enjoyed an exclusive territory, which gave it the ability and incentive to charge high prices that harmed the publisher, its advertisers, and subscribers. The constraint on maximum prices prevented the owner from exercising this incentive. A district court and a court of appeals agreed with this argument. The Supreme Court reversed and instead held that vertical agreements to fix maximum resale prices are per se illegal because, just as agreements to fix minimum prices, they cripple the freedom of traders to sell in accordance with their own judgment.
The Court rejected the notion that maximum resale prices are justified because they limit the exercise of local market power. The Court also argued that maximum resale prices are potentially harmful because they may be fixed too low for dealers to profitably supply essential services or because they may channel distribution through a few large or specifically advantaged dealers who otherwise would be subject to significant price competition. Lee Preston points out in his contribution that these concerns have questionable validity because they imply actions that conflict with the interests of the firm that imposes the maximum price constraint. The Court also suggested that a maximum resale price can provide a focal point that becomes equivalent to fixing a minimum price. This argument has some merit, although it should be possible to identify circumstances in which a maximum resale price is a subterfuge for a minimum price. That situation was not apparent in Albrecht v. Herald.
The Court chose to revisit maximum resale prices almost thirty years later in State Oil v. Khan, which Gustavo Bamberger reviewed in the fourth edition of The Antitrust Revolution. 64 State Oil had entered into a contract with Barkat Khan, the operator of a gasoline station/convenience store in Illinois. The contract included a provision that required Khan to rebate to State Oil any difference between the retail price that Khan charged for gasoline and a price suggested by the oil company. In this way the contract eliminated Khan’s incentive to charge more than a maximum retail gasoline price.
A district court ruled that State Oil’s contract was not anticompetitive. Khan appealed. The appellate court reversed. The opinion, written by Judge Richard Posner, grudgingly and apologetically relied on the Supreme Court’s decision in Albrecht, stating that “the Supreme Court has thus far refused to reexamine the cases in which it has held that resale price fixing is illegal per se regardless of the competitive position of the price fixer or whether the price fixed is a floor or a ceiling.” 65 Judge Posner added that “Albrecht was unsound when decided, and is inconsistent with later decisions by the Supreme Court. It should be overruled. Someday, we expect, it will be.” 66
Judge Posner’s decision was an invitation to the Supreme Court to revisit maximum resale pricing. The Court quickly accepted and in 1997 explicitly overruled its earlier decision in Albrecht and held that maximum resale price maintenance should be evaluated under the rule of reason. In explaining its decision, the Court referenced abundant academic literature that criticized arguments advanced in Albrecht in support of per se illegality for maximum resale price maintenance. The Court also noted that its reversal of Albrecht had a parallel in its reversal of U.S. v. Schwinn for the treatment of nonprice vertical restraints. Curiously, Richard Posner also presented the government’s case in U.S. v. Schwinn that successfully argued for per se illegality for vertical territorial restraints.
As of 1997, vertical price and nonprice restraints were entitled to rule of reason analysis, except for minimum resale price maintenance, which remained per se unlawful. However, just as the economic literature influenced judicial attitudes toward maximum resale price maintenance, similar forces were at work to challenge prevailing jurisprudence for minimum resale price maintenance. After State Oil v. Khan, it seemed inevitable that the Supreme Court would eventually revisit its per se stance regarding minimum resale price fixing.
That opportunity arose ten years after State Oil v. Khan in Leegin Creative Leather Prods. v. PSKS, Inc. 67 Kenneth Elzinga and David Mills reviewed the case in the sixth edition of The Antitrust Revolution. 68 Leegin designs, manufactures, and distributes leather goods and sells belts and other accessories under the Brighton brand. In 1997, Leegin instituted a “Brighton Retail and Promotion Policy” that encouraged sales of its products at high-quality specialty stores, which in turn agreed to sell Brighton products at prices determined by Leegin and not engage in discounting.
PSKS operated Kay’s Kloset, a women’s apparel store in Texas. Brighton was the store’s most important brand and accounted for almost half of its profits. Leegin discovered that PSKS had been discounting the Brighton products and stopped selling to the store after it refused to abide by Leegin’s no-discounting rule. PSKS sued Leegin. The district court rejected Leegin’s Colgate defense that its retail pricing rule was a policy and not an agreement with its retailers. The court held Leegin liable for retail price-fixing without admitting expert testimony because the court concluded that Leegin’s conduct was per se unlawful. A court of appeals affirmed the ruling. Leegin appealed to the Supreme Court and argued that its price and promotion policy deserved to be analyzed under the rule of reason.
Courts have held (minimum) resale price maintenance to be per se unlawful since the 1911 Supreme Court decision in Dr. Miles. In light of this history, Elzinga and Mills described the Leegin appeal as “one of the toughest challenges ever faced by an antitrust defendant.” Yet Leegin prevailed.
The majority opinion and the dissent, taken together, offer a fascinating glimpse into the development of antitrust law at the highest levels. Economics was critical to the majority opinion. The Court noted that “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” 69 In support of this statement, the opinion cited numerous academic studies, law reviews and textbooks, and friend of the court briefs including a brief by several economists 70 and another from the U.S. government signed by the Solicitor General, the Assistant Attorney General for the Antitrust Division of the DOJ, and the General Counsel of the FTC.
Despite the clear break from Dr. Miles, the majority opinion represents that its conclusion that minimum resale price maintenance should be evaluated under the rule of reason is consistent with earlier Supreme Court decisions that reversed per se illegality for vertical restraints. The opinion emphasizes that the primary purpose of the antitrust laws is to promote interbrand competition, which underlined its decision in State Oil v. Khan and justifies the rule of reason analysis for minimum resale price maintenance. The majority also notes that consumer and producer interests are often aligned regarding vertical restraints such as resale price maintenance. “The manufacturer strives to improve its product quality or to promote its brand because it believes this conduct will lead to increased demand despite higher prices. The same can hold true for resale price maintenance.” 71 The majority opinion added a quote from Albrecht v. Herald that “Economists…have argued that manufacturers have an economic interest in maintaining as much intrabrand competition as is consistent with the efficient distribution of their products.” 72
Leegin is a narrow 5-4 decision that was overwhelmingly determined by economic considerations. Judge Breyer presented the minority opinion. Judge Breyer is no stranger to economic analysis, yet his dissent focuses instead on the importance of stable legal precedent: the principle of stare decisis. He acknowledged that: Were the Court writing on a blank slate, I would find these questions difficult. But, of course, the Court is not writing on a blank slate, and that fact makes a considerable legal difference.…We write, not on a blank slate, but on a slate that begins with Dr. Miles and goes on to list a century’s worth of similar cases, massive amounts of advice that lawyers have provided their clients, and untold numbers of business decisions those clients have taken in reliance upon that advice.
73
With regard to stare decisis, the majority noted that the Supreme Court had overruled per se treatment for nonprice vertical restraints established in U.S. v. Schwinn when it decided Continental T.V. v. GTE Sylvania. But Schwinn was arguably inconsistent with the Court’s ruling in U.S. v. White Motor, which preceded the Schwinn decision by only a few years. The Court’s decision in Leegin followed its per se ruling in Dr. Miles by nearly a century and there was no corresponding back-and-forth for minimum resale price maintenance in the intervening years.
V. Concluding Remarks
The antitrust laws provide only vague instructions about conduct and business arrangements that may incur liability. The framers of these laws left clarification of the rules for liability to the courts. The seven volumes of The Antitrust Revolution document how courts have responded to this assignment. In their merger enforcement decisions, courts have generally followed economic developments articulated in the guidelines published by the DOJ and FTC. But several cases described in The Antitrust Revolution illustrate a tendency of courts to adhere to past conventions and to reject or discount economic evidence. When courts have been open to economic analysis in merger enforcement, the results have been mixed for the antitrust authorities. On the one hand, economic analysis has avoided outcomes that are the result of formulaic applications of market shares. On the other hand, courts have sometimes used economic arguments to undermine allegations brought by the antitrust authorities and sometimes without regard to contradictory empirical evidence.
The evolution of antitrust enforcement described in the pages of The Antitrust Revolution is even more dramatic for the evaluation of price and nonprice vertical restraints. The law of the land was once per se illegality for resale price maintenance based on the Supreme Court’s 1911 decision in Dr. Miles. This was unchanged until 1997, when the Court concluded that maximum resale price maintenance should be evaluated under the rule of reason. Ten years later, the court abandoned the presumption of per se illegality for all vertical price restraints. The Court followed a similar evolution for the treatment of vertical nonprice restraints.
Economic arguments ultimately influenced merger enforcement and dominated decision-making by the courts for vertical price and nonprice restraints despite years of legal precedents that adhered to more simplistic rules. Perhaps the Chicago School was instrumental to this evolution. The question remains whether antitrust enforcement will continue to evolve to embrace other revolutions, including “Post-Chicago” enforcement principles, a focus on innovation, and possibly a sensitivity to other societal goals. Herbert Hovenkamp has written extensively about how developments in economic policy have continuously shaped antitrust enforcement. He observed that “[T]he antitrust laws are a tool of economic policymaking. As such, they are eternally wedded to prevailing economic doctrine and forced to change when economic ideology changes.” 74 For an economist, this is encouraging. However, courts have also been committed to methodological approaches such as market definition that do not easily accommodate new considerations. Time will tell. Meanwhile, I look forward to the next volume of The Antitrust Revolution.
Footnotes
Declaration of Conflicting Interests
The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.
Funding
The author(s) received no financial support for the research, authorship, and/or publication of this article.