Vertical Practices and the Exclusion of Rivals Post Eaton

Posted by D. Daniel Sokol

John Asker (Stern School of Business, NYU) & Shannon Seitz (Analysis Group, Inc.) discuss Vertical Practices and the Exclusion of Rivals Post Eaton

ABSTRACT: In the wake of the ZF Meritor v. Eaton decision, there is new uncertainty regarding the kinds of vertical contracting practices that will attract antitrust scrutiny under U.S. law. In this case, the market share and loyalty rebates Eaton Corporation offered to truck manufacturers were found to violate antitrust law despite the fact that there was no evidence of pricing below cost. The court of appeals determined that the price-cost test, which, since Matsushita v. Zenith (1986) has been applied in cases in which predatory pricing is alleged, did not apply in Eaton. Elements of Eaton’s agreements had more in common with exclusive dealing than predatory pricing, the court said.

Vertical agreements frequently include a variety of price and non-price restrictions, including market share and loyalty discounts, pre-specified sales territories, retail price restrictions (such as resale price maintenance), rebates, and product placement requirements. The Eaton decision, as well as several other recent cases involving exclusive dealing, illustrates the piecemeal fashion in which the courts have dealt with vertical agreements. It has been argued that decisions like Eaton, which move away from the broad application of the price-cost test, may discourage suppliers from offering non-predatory loyalty or market share discounts, as there may be no safe harbor, particularly when such discounts are part of a multidimensional vertical agreement.

In this article we describe recent academic research that provides a coherent framework for the analysis of a host of vertical agreements with price or non-price restraints, thereby helping courts and economic experts to determine the potential exclusionary impact of these arrangements. In truth, many vertical contracting practices share the same underlying economics: The vertical structure allows an upstream supplier and a downstream retailer to share industry profits gained through the supplier’s increased market power. As a result, the retailer has an incentive to protect these profits by serving as a “gatekeeper,” potentially limiting market access by upstream rivals. If an upstream rival cannot access the market without some help from the gatekeeper, then vertical-contracting practices may result in exclusion.

Later in the article, we focus on potential anticompetitive aspects of vertical arrangements. We consider the choice between framing a case as predation or exclusive dealing and compare the economics of predatory pricing practices to those of exclusive deals within vertical agreements. We look more closely at exclusive-dealing settings and propose several screens for the detection of antitrust harm, regardless of whether the vertical practice involves price or non-price restraints. And, finally, we weigh potential pro-competitive benefits of vertical agreements against the anticompetitive harm of exclusion in the specific context of resale price maintenance. In particular, we focus on one of the pro-competitive justifications for resale price maintenance raised in the majority judgment in Leegin v. PSKS (2007), the provision of retail services that may promote interbrand competition.