Feature Articles
How the Chicago School Overshot the Mark
Economic Analysis of Exclusionary Vertical Conduct: Where Chicago Has Overshot the Mark
Excluding Less Efficient Competitors:
The Equally Efficient Entrant Standard
The analysis of exclusionary conduct and competition for exclusives is related to the question of whether antitrust should apply an equally efficient entrant (“EEE”) standard, usually tied to conservative analysis, in antitrust exclusion cases other than predatory pricing. That is, are entrants and other competitors that are less efficient than the excluding firm deserving of the protection of the antitrust laws?
The use of an EEE standard often is motivated by a concern with administrability. That is, a rationale for the use of the Brooke Group below-cost pricing prong for predatory pricing is that this price level is the only one that is practically administrable by antitrust courts. This is a controversial issue and deserving of further analysis. But, for the purposes of this paper, the proper rules for predatory pricing are beyond the scope of the analysis. Instead, the analysis here will focus on the question of whether the EEE standard is appropriate for vertical RRC exclusion cases. In my view, it is not.
The predatory pricing paradigm and its price/cost comparison motivates the EEE standard. It is argued that if the dominant firm is pricing above its costs, then an equally efficient competitor would not be forced to exit from the market. In this sense, the below-cost pricing standard for predatory pricing is said to protect equally efficient competitors from being excluded from the market. This prong of the antitrust standard in principle could be mechanically applied to all exclusionary conduct, including RRC conduct. For example, Judge Posner has suggested applying this standard to all exclusionary conduct, not just predatory pricing. Under the equally efficient competitor standard, the plaintiff would need to prove that the conduct “is likely in the circumstances to exclude from the defendant’s market an equally or more efficient competitor.”
The equally efficient entrant standard is a very permissive standard with respect to exclusionary vertical conduct, even naked RRC behavior. For example, suppose that exclusionary conduct would only be condemned if it would cause the exit or deter the entry of an equally efficient firm. That is, the conduct would only be condemned if it leads the dominant firm to set a price below its costs — a price that could not be profitably matched by equally efficient competitors.
For example, under this standard, payments to input suppliers to induce them to refuse to deal with rivals would be allowed unless the payments were so large that the defendant’s overall profits turned negative. This would be true even if the sole purpose of the payments were to raise the costs and marginalize competitors. As shown in the competition for exclusives numerical example, the winning bid for the monopolist would place the entrant at a loss if it wins, but would not place the monopolist at a loss if it wins.
Similarly, burning down a rival’s factory would not violate the antitrust laws as long as the arsonist’s fee was modest and the predator charged such a high output price that its price remained above its costs. Conduct that was used to maintain an existing monopoly would be treated more permissively than conduct used to achieve dominance because the defendant’s initial price would be at the more highly profitable monopoly level.
The fundamental flaw in applying the equally efficient entrant standard to RRC conduct is that the unencumbered (potential) entry of less efficient competitors often raises consumer welfare and efficiency. For example, consider the simplest example of limit pricing by a monopolist that has obtained its monopoly legitimately with superior skill, foresight, and industry. Suppose that this monopolist has variable costs of $20, and initially charges the unconstrained monopoly price of $50, because the monopolist faces no threat of entry.
Now suppose that there is a new entry threat by a less efficient firm, for example, a firm with variable costs of $40. Facing this threat, the monopolist would have the incentive to reduce its price to the “limit price” of $39 in order to deter the entry into the monopolized market. This limit pricing conduct clearly benefits consumers. Even though the potential entrant does not produce any output itself, it serves as a perceived potential entrant and constrains the monopolist’s price by waiting in the wings. Its potential for entry reduces price, increases market output, and raises both consumer welfare and total economic welfare.
Suppose instead that the monopolist engages in naked RRC conduct that raises the entrant’s costs above the unconstrained monopoly price of $50. For example, suppose that it raises the entrant’s costs by $12 to a cost of $52. As a result, the entrant would no longer have the ability to constrain the monopolist from charging the monopoly price of $50. Consumers would be harmed by this RRC conduct, and total economic welfare would fall too.
But, no antitrust liability would attach to this RRC conduct under the EEE standard. This is because a $12 cost increase would not deter an equally efficient potential entrant (i.e., an entrant with costs of $20). If the monopolist were to maintain its price at the $50 monopoly price, such an equally efficient entrant would still be able to enter successfully even if its costs increased from $20 to $32.
The fact that the EEE standard fails to catch and deter this obvious type of anticompetitive conduct demonstrates the fundamental flaw in the standard. The idea that a perceived potential entrant can constrain the pricing of a monopolist is a central idea in the analysis of entry barriers, potential competition and market power. If the EEE standard fails in this simple RRC example, then it obviously also would be deficient for other, more complex non-price exclusionary conduct.
This analysis also means that using the EEE standard would underdeter anticompetitive conduct. A better antitrust standard would be one that found liability when the following two prongs both are satisfied: (1) when the defendant’s conduct significantly raises the costs of competitors — even less efficient competitors — for example, when the competitors do not have access to cost-effective alternatives; and (2) when, as a result, the exclusionary conduct permits the defendant to achieve or maintain monopoly power. Of course, if the conduct leads to consumer and efficiency benefits as well as these harms, then the net effect on consumers must also be evaluated. This type of analysis can be carried out in the context of a rule of reason analysis that does not include an EEE prong.
A policy of adopting a standard that finds liability for conduct that harms consumers by raising the costs of competitors, whether or not they are equally efficient, is not one that is at odds with the view of all Chicago School commentators. As discussed earlier, Robert Bork explicitly took the position that eliminating competitors’ access to the most efficient distribution pattern could be viewed as anticompetitive. That section of the Antitrust Paradox has been cited with approval in Aspen Ski. And, a similar formulation was used in Microsoft.
Conclusion
In light of this analysis, it is clear that the strong economic foundations — and economic implications — claimed by Chicago-school commentators like Robert Bork do not hold up to careful economic analysis. The concepts of anticompetitive foreclosure and anticompetitive leverage are not empty and illogical. Competition for exclusives is not a panacea for all vertical exclusion claims. Nor is the predatory pricing paradigm the appropriate framework for analyzing and judging exclusionary vertical conduct. Instead, a more refined analysis must be applied. This analysis implies that the better legal standard would be the rule of reason with its focus on consumer harm, not a proxy rule like the equally efficient entrant standard.
