Exclusive dealing

Test: Exclusive dealing is analyzed under the rule of reason (no per se test) for Sherman Act Section 1 and Clayton Act Section 3 (Jefferson Parish, O'Connor concurrence)

• (1) P's prima facie case: exclusive dealing is illegal if it forecloses a substantial share (maybe ~25% or more, above 40% is safe) of a product and geographic market (Tampa Electric)
  • A "substantial share" is one where there is a substantial likelihood of anticompetitive harm ("probable effect of the contract on the relevant area of effective competition")
  • Foreclosures are usually shown through circumstantial evidence of market shares through exclusive dealing contracts
  • P usually does not have to show direct evidence of anticompetitive effects, although some courts will require a showing of harm (e.g., Gilbarco)
• (2) Burden shifts to D to demonstrate procompetitive benefits or reasons why P's evidence overstates the anticompetitive potential of the restraint
• (3) Burden shifts to P to show that the anticompetitive effects outweigh any procompetitive benefits

Sherman Act Section 2: test is the same with an additional requirement in P's prima facie case to make a showing of monopoly power (D has >70% share)

• Market power can be proved with very few facts (e.g., McWane: apply Cellophane test and show the large price difference)

Definition: exclusive dealing occurs when

• (1) A firm limits its customers/distributors or suppliers from dealing with its competitors
• (2) Vertical, across-brand restraint
• (3) Potential exclusion of rival sellers

Important factors: consider these together

• Foreclosure share (market definition)
• Exclusive contract features (length/termination)
• Switching costs (for exclusive suppliers/distributors)
• Other non-exclusive suppliers/distributors
• New suppliers/distributors
• Other entry/expansion barriers
• Anticompetitive intent
• Direct and/or circumstantial evidence of likely and/or actual harm
• Procompetitive justifications

Common defenses (McWane):

• Contracts were presumptively legal because they were nonbinding and short term (weighs heavily in D's favor, but look at switching costs)
• Exclusive dealing didn't harm competition, it just harmed a competitor (but look at intent of exclusive dealing in but-for world)

Anticompetitive effects of and potential justifications for exclusive dealing: McDonald's franchise example. McDonald's decides what kind of food the franchise will sell (won't sell rivals' food), so franchisee is in an exclusive dealing contract with McDonald's.

Potential justifications:

• Reduce transaction costs: franchise owner has a fixed set of standardized requirements they must meet, which streamline operations and allow lower costs to be passed to consumers
• Create relationship-specific investments: exclusive dealing creates trust between parties that can incentivize greater investment
• Prevent inter-brand freeriding: people won't invest if they think returns will be taken by a third party (e.g., unknown muffin seller inside McDonald's)
• Competition for exclusive contracts: there is competition between franchises (e.g., McDonald's vs. Burger King)
• Capture market share on the basis of cost or quality advantages: improves ability to compete on the merits
• Initial investments only profitable if exclusive

Anticompetitive effects:

• Firms with substantial market share and suppliers/distributors who are essential to function in the market, exclusive relationships can bar competitors from the market

Takeaway: because there are so many conceivable benefits from exclusive dealing contracts, there is not a presumption that they are illegal per se, so the test is rule of reason from the start.

• P rarely wins unless there is no good procompetitive justification for the exclusive dealing.

Caselaw

Standard Oil v. United States (1949) ("Standard Stations")

• Holding:
  • P must show "proof that competition has been foreclosed in a substantial share of the line of commerce affected"
  • Distinguishes exclusive dealing from tying: exclusive dealing has recognized commercial benefits
  • Court condemns the exclusive dealing arrangements under Clayton Act Section 3 (6.7% foreclosure)
  • Contracts foreclosed independent distributors from buying from D's rivals
• Facts: D accounts for 23% of all gasoline sales in the western U.S., where 6.8% of gas is sold through D's own stations and 6.7% to independent dealers through exclusive contracts. Only 1.6% of retail outlets are "split-pump" (more than one supplier). Government challenges the exclusive contracts (D shouldn't be allowed to tell independent distributors not to purchase gas from anyone else).
• Prof. Note: today, 6.7% foreclosure would not be enough to get a court to find a violation for exclusive dealing
  • Today, would need something closer to 25% of the market to be foreclosed
  • Distinction between tying and exclusive dealing not as clear today: most courts recognize benefits from tying like they did of exclusive dealing
  • Unclear if there was any actual harm here: competitors like Exxon could likely still access consumers through independent distributors or other channels, so the foreclosure here isn't really having meaningful anticompetitive effects

Tampa Electric v. Nashville Coal (1961)

• Holding: the contract does not violate the Clayton Act
  • The exclusive dealing contract foreclosed less than 1% of coal supply in the southeastern region.
  • Doctrinal formulation: (1) define a product and geographic market in which D's share is substantial and (2) show foreclosure is likely going to lead to anticompetitive effects
• Facts: electric utility (D) contracts with coal supplier (P) and agrees to a 20-year requirements contract before D constructs two coal-fired power plants. After the plants are completed, P informs D that it will not deliver any coal because the contracts are unenforceable under Clayton Act Section 3.
• Prof. Note: real reason that P challenged the contract was that the price of coal had risen, so the requirements contract was no longer favorable to them.
  • The contract excludes coal sellers from selling to D, which is such a small portion of the market that there isn't a meaningful anticompetitive effect.

McWane v. FTC (11th Cir. 2015)

• Holding:
  • Section 2 case so P must show D had market power in a relevant product and geographic market
  • Market definition: domestic pipe fittings
    • Other product market for "open" pipe fittings: these pipe fittings were sold internationally (same fittings, just labeled for the international market)
    • Why aren't domestic and open pipe fittings part of the same market?
      • Contracts were only for buying fittings produced in the U.S.
      • There was a large difference in price between the open ($2) and domestic ($5) fittings: since companies were still buying the $5 fittings, they must not be reasonable substitutes (otherwise companies would flip their contracts and buy the cheaper fitting)
  • Market power: clear monopoly power, D had 100% of the domestic market.
    • Court rejects D's argument that P was able to enter the market and get a 10% share before exiting.
    • Court rejects D's argument that P had no expert testimony to support their argument for the geographic and product market: few facts are needed to prove market power
  • Exclusive dealing: the Full Support Program foreclosed P from entering the market
    • Even though P entered the market, they did so at a higher cost and with less success than they would have absent the exclusive dealing
    • D's failed counterarguments:
      • Contracts were presumptively legal because they were nonbinding and short term: but switching costs for distributors were high (D cut switching distributors off from their products, forcing distributors to rely on P's offerings, which weren't able to supply the whole market)
      • There wasn't harm to competition, just harm to a competitor: but we don't know if P would have entered the market at a higher scale absent exclusive dealing
        • Clear intent evidence that D introduced exclusivity to prevent P from entering at scale with its own foundries
        • The way D should have competed with P is by developing better fittings, not by entering exclusive dealing contracts
      • Exclusivity is needed to have a domestic foundry: Court dismisses (prof. thinks it's a good argument)
• Facts: 3 manufacturers account for 90% of pipe fittings in the U.S. D accounts for 100% of the domestic specification market. In 2009, Star entered the domestic-specification market, producing fittings with 3rd party foundries. D responded with the Full Support Program, which forced non-exclusive distributors to lose all accrued rebates and be cut off from purchases for 12 weeks.
  • Two distributors account for 60% of the distribution market. Internal evidence from D indicates it intended to prevent Star from achieving critical market mass to force Star to develop a full line of fittings before securing distribution. Despite these efforts, Star's domestic-only market share grew to 10% over the next 2 years.
• Prof. Note: in 2008, there was a ton of stimulus money but a requirement that goods were purchased from the domestic market.

Omega Environmental v. Gilbarco (9th Cir. 1997) (exclusion of party other than competitor)

• Holding: cutting off P and entering exclusive dealing contracts with other dealers is not anticompetitive
  • 38% foreclosure (70% of 55%) overstates the anticompetitive effects of the exclusive dealing: competitors can still sell directly to P and sell to P through distributors
    • No evident anticompetitive harm: evidence of past entry, increasing output, falling prices, and fluctuating market shares
    • Exclusive dealing is not a way these companies are maintaining an oligopoly
• Dissent: the majority was too lenient
  • Evidence that exclusivity helped avoid price competition
  • Accuses majority of elevating the standard of proof from probable harm to actual harm
• Facts: Gilbarco (D) is the leading manufacturer of petroleum dispensing equipment in the U.S. (55% share). Omega (P), a distributor (i.e., not one of D's competitors), plans to provide one-stop shopping for multiple manufacturers' product lines.
  • P buys two of D's authorized distributors. D responds by terminating the two distributors and adopts exclusivity with all other distributors (70% of D's shares). P sues under Section 3 of the Clayton Act.
• Prof. Note:
  • Usually, exclusive dealing cases exclude a company's competitor. Here, the distributor, which wants to be a one-stop shop where smaller gas stations can comparison shop gas dispensers, is the one excluded.
  • Case illustrates the difficulty of winning a modern exclusive dealing case.
  • There is good reason to side with P here: it looks a lot like oligopoly (but court not sympathetic)
    • Exclusive distributors can help competitors tacitly collude
    • Once a customer (think a small gas station) has developed a relationship with a distributor, they might be reluctant to switch
    • P introduces competition to the market: encourage customers to comparison shop, result in lower prices
  • Tough case to win for P: not like McWane, where the evidence of anticompetitive intent and effect was very strong.