Part 1 of 2: Lessons for Supply Chain Businesses:
Antitrust Implications of Recent Price Squeeze Decision by the U.S. Supreme Court
Randy D. Gordon, Partner, Gardere Wynne Sewell LLP
In 2009, GSA will bring GSA Forum readers a two-part series analyzing legal issues such as antitrust and bankruptcy. These articles will be written by Gardere Wynne Sewell LLP, one of the Southwest's largest full-service law firms providing legal services to private and public companies and individuals in areas of energy, litigation, corporate, tax, environmental, labor and employment, intellectual property, governmental affairs and financial services.
While GSA does not endorse any particular perspective, we believe whether you agree or disagree, these articles will encourage semiconductor companies and their partners to ask and begin identifying answers to some difficult and challenging questions.
Many vertically integrated corporations operate as both wholesalers and retailers of some materials or services. In other words, such a company not only sells some materials or services that are necessary inputs for one of its competitor's finished goods or services, but it also sells the same finished goods or services at retail. What happens, then, if the seller prices its wholesale services so high that its competitor cannot profitably compete with the low price at which the dominant firm sells at retail? This is the question that the United States Supreme Court set out to answer in Pacific Bell Tel. Co. v. linkLine Communications, Inc.
The United States Supreme Court case of Pacific Bell Tel. Co. v. linkLine Communications, Inc. highlights the struggle between small businesses and large corporations that operate at the wholesale or retail levels—or both—in the supply chain. In particular, the smaller firm must protect itself from the possibility of a price squeeze through legal means other than federal antitrust law (e.g., long-term, price-protected contracts) or through careful business planning (e.g., arranging for alternative sources of supply or developing its own substitutes).
Before turning to the specifics of the case, a bit of basic economic background may be helpful. There are two basic ways that a vertically integrated incumbent firm can create a bottleneck for its downstream competitors. In either case, the incumbent firm must control a "facility" (i.e., usually a raw material or component part necessary for the production of finished goods or some sort of infrastructure needed for the delivery of a service). First, the incumbent may simply refuse to deal with its retail competitors. Second, it may agree to sell the desired input, but only on terms that make it impossible for its retail competitors to achieve a reasonable profit. The linkLine case presents an example of the latter scenario, which is commonly referred to as a "price squeeze." There are two key elements to a price squeeze:
- The vertically integrated firm charges its downstream competitors a price for an
essential facility that will not permit them to operate at a reasonable profit, even if
they are equally efficient.
- The vertically integrated firm does not charge its retail arm the same high price
that it charges its competitors.
Against this backdrop, it is clear that a price squeeze can only exist when the dominant firm actually controls the retailer's input market. Put differently, an attempted price squeeze is doomed to failure if there are effective substitutes (in sufficient quantities) for the dominant firm's facility; if there are substitutes, the downstream purchasers will simply buy their inputs from other sources.
linkLine arose in the context of Internet digital subscriber line (DSL) service, which both AT&T (after a merger with Pacific Bell) and several independent service providers (ISPs) offer to consumers. But because the service is offered over telephone lines, competing DSL providers need access to AT&T's land-line facilities. The ISPs filed suit against AT&T, arguing that AT&T violated Section 2 of the Sherman Act by, among other things, subjecting them to a classic price squeeze (i.e., by setting a high wholesale price for DSL transport and a low retail price for DSL Internet service). The district court and the Ninth Circuit Court of Appeals both held that this theory was actionable. However, the U.S. Supreme Court disagreed, despite venerable authority to the contrary. Specifically at issue was Judge Learned Hand's opinion in United States v. Aluminum Co. of America (Alcoa).1 In that case, Alcoa allegedly used its monopoly power in the upstream aluminum ingot market to squeeze the profits of downstream sheet fabricators. Judge Hand held on those facts "That it was unlawful to set the price of 'sheet' so low and hold the price of ingot so high, seems to us unquestionable…" The linkLine Court acknowledged this precedent, but dismissed it based on "developments in economic theory" and more recent decisions of the Supreme Court (discussed in the next paragraph).
The Court's reasoning is twofold and flows from two background sources. First, AT&T has no antitrust duty to deal with the ISPs. (Any duty to deal flowed from Federal Communications Commission (FCC) regulations, not the Sherman Act.) Thus, according to the Court, if there was no duty to sell, there could be no duty to sell to the ISPs at prices they prefer. The Court's analysis was in some sense dictated by its 2004 decision in Communications Inc. v. Law Offices of Curtis V. Trinko, LLP.2 Trinko complained that his telephone carrier, AT&T, had been disadvantaged by certain allegedly anti-competitive conduct by the local incumbent carrier, Verizon, and that he and a putative class of customers had been harmed. Boiled to its essence, Trinko's complaint was that Verizon had a duty to assist its rivals and thereby make the local telephone market more competitive. But the Court found no reason to depart from the general rule that "the Sherman Act does not restrict the long recognized right of a trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal." And so here, in the linkLine Court's view:
There is no meaningful distinction between the 'insufficient assistance' claims we rejected in Trinko and the plaintiff's price squeeze claims in the instant case… The nub of the complaint in both Trinko and this case is identical—the plaintiffs alleged that the defendants (upstream monopolists) abused their power in the wholesale market to prevent rival firms from competing effectively in the retail market. Trinko holds that such claims are not cognizable under the Sherman Act.
Lurking in the shadows of the plaintiff's case in Trinko was Aspen Skiing Co. v. Aspen Highlands Skiing Corp.,3 a 1985 decision of the Supreme Court. That decision has been much criticized and is seen by most courts, commentators and practitioners as something of an outlier. The case arose when the owner of three of four Aspen ski areas broke off a long-running cooperative agreement (to issue joint tickets) with the owner of the fourth. The smaller concern believed that its survival depended on continued issuance of joint tickets and undertook a series of increasingly desperate measures to re-create the joint ticket, including—at one point—an offer to purchase the dominant firm's tickets at retail price. But the dominant firm refused even this, which led to a jury verdict against it and an ultimate affirmance by the Supreme Court: "[t]he jury may well have concluded that [the defendant] elected to forgo these short-run benefits because it was more interested in reducing competition…over the long run by harming its smaller competitor." The Trinko Court was thus forced to make sense of Aspen Skiing in light of the general rule that a party has no duty to aid a competitor. It did so by, in essence, limiting Aspen Skiing to its facts, which thereby reinvigorated the older rule that unilateral refusals to deal are not generally a matter of antitrust concern:
Aspen Skiing is at or near the boundary [of antitrust liability]. The Court there found significance in the defendant's decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anti-competitive end. Similarly, the defendant's unwillingness to renew the ticket even if compensated at retail price revealed a distinctly anti-competitive bent.
Second, because low prices typically benefit consumers, there can be no liability for retail pricing unless that pricing is "predatory." This reasoning is based on a fear of "false positives"—in other words, finding antitrust liability in situations that are actually pro-competitive because (although they may harm individual competitors) they result in consumer savings. Thus, according to the Court, "To avoid chilling aggressive price competition, we have carefully limited the circumstances under which plaintiffs can state a Sherman Act claim by alleging that prices are too low." In practice, then, "to prevail on a predatory pricing claim, a plaintiff must demonstrate that: (1) the prices complained of are below an appropriate measure of its rival's costs; and (2) there is a 'dangerous probability' that the defendant will be able to recoup its 'investment' in below-cost prices." This two-part test assures, as the Court noted in Brooke Group Ltd v. Brown & Williamson Tobacco Corp.,4 that efficient competitors will not be penalized for their ability to deliver low prices:
As a general rule, the exclusionary effect of prices above a relevant measure of cost either reflects the lower cost structure of the alleged predator, and so represents competition on the merits, or is beyond the practical ability of a judicial tribunal to control without courting intolerable risks of chilling legitimate price cutting. To hold that the antitrust laws protect competitors from the loss of profits due to such price competition would, in effect, render illegal any decision by a firm to cut prices in order to increase market share. The antitrust laws require no such perverse result.
Therefore, in linkLine, unless AT&T could be shown to have priced below cost and is likely to "recoup" those losses after driving off the ISPs, then AT&T cannot be liable for its low retail prices. That matter was not squarely before the Court, and it will be left to the district court to sort out on remand. But the Court was clearly skeptical: "For if AT&T can bankrupt the plaintiffs by refusing to deal altogether, the plaintiffs must demonstrate why the law prevents AT&T from putting them out of the market." Given this statement, one can easily posit that the day will come when the Supreme Court altogether vitiates this type of predatory pricing claim.
Summing up, the Court held that the ISPs' price-squeeze claim is "nothing more than an amalgamation of a meritless claim at the retail level and a meritless claim at the wholesale level. If there is no duty to deal at the wholesale level and no predatory pricing at the retail level, then a firm is certainly not required to price both of these services in a manner that preserves its rivals' profit margins."
The takeaway for any business operating at both wholesale and retail levels of the supply chain is this: if there is no generalized duty to deal with a purchaser under the federal antitrust laws and if the business is selling at retail above its cost, then there is no duty to price its wholesale and retail sales at levels assuring a wholesale customer/retail competitor a "fair," "reasonable" or "sufficient" profit. In other words, "[i]f both the wholesale price and the retail price are independently lawful, there is no basis for imposing antitrust liability simply because a vertically integrated firm's wholesale price happens to be greater than or equal to its retail price." For a firm dependent on another firm that is both its supplier and competitor, linkLine teaches that the smaller firm must protect itself from the possibility of a price squeeze through legal means other than federal antitrust law (e.g., long-term, price-protected contracts) or through careful business planning (e.g., arranging for alternative sources of supply or developing its own substitutes).
About the Author
Randy Gordon serves as general counsel for GSA and is a partner at Gardere Wynne Sewell LLP. A member of Gardere's trial section and antitrust group, Mr. Gordon's practice is focused on complex litigation, principally in the areas of antitrust and competition law, with secondary emphases on the Racketeering Influenced and Corrupt Organizations Act (RICO), securities and intellectual property. He has served in leadership roles in numerous class actions, ranging from lead class counsel to chair of a joint defense committee. Mr. Gordon is also immediate past chair of the antitrust section of the State Bar of Texas. You can reach Randy Gordon at 214-999-4527 or rgordon@gardere.com.
Resources
1 148 F. 2d 416 (2d Cir. 1945).
2 540 U.S. 398 (2004).
3 472 U.S. 585 (1985).
4 509 U.S. 209 (1993).
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