Bundled Pricing and Loyalty Discounts

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Bundled Pricing and Loyalty Discounts

• Penelope Preovolos,
• Morrison Foerster LLP
• Harvey Saferstein,
• Mintz Levin
• Anita Stork,
• Covington Burling LLP

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What Are Bundled Discounts and Loyalty Rebates?
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Bundled Discounts

• Discounts for buying both Product A and Product B
  together (where both are still available to be
  bought singly).

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Loyalty Rebates

• Discounts for increasing purchases by a
  particular percentage or buying a particular
  share of needs from seller (market share
  discount).
• Typically, the discounts applies to both the
  marginal and the prior purchases--i.e., discount
  applies to all purchases.

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Legal Pigeonholes for Analyzing Antitrust
Implications of Bundled Pricing and Loyalty
Discounts

• Harvey I. SafersteinMintz Levin

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Sherman Act Section 2 -- Monopolization or
Attempted Monopolization

• At least two different forms of analysis under
  Section 2
• Predatory Pricing--Cost?
• Exclusionary Practice.

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Sherman Act Section 1--Agreement or Conspiracy

• At least three different forms of analysis under
  Section 1
• Tying
• Exclusive Dealing
• General Rule of Reason

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Robinson-Patman Act--Price Discrimination

• Predatory Below Cost Pricing?
• Discriminatory?
• Functional Availability?

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Bundled Discounts Evolution and Continuing
Conflict

• Penelope A. Preovolos
• Morrison Foerster LLP

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Early Price/Cost Analysis Cases
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SmithKline Corp. v. Eli Lilly(3rd Cir. 1978)

• Lilly had monopoly power in 4 products
• SmithKline was a new entrant with a single
  product
• Lilly added 5th product and changed its
  volume-based rebate plan to require purchase of
  multiple products
• SmithKline would have had to offer 20 discount
  to compete
• Lilly violated section 2 because its pricing
  would have eliminated equally efficient
  competitor
• SmithKline was slightly less efficient
  competitor

12
Ortho Diagnostic Systems v. Abbott Labs (S.D.N.Y.
1996)

• Equally efficient competitor -- subjective
  standard
• Abbott had monopoly on some but not all blood
  assays in discounted bundle price above AVC on
  all
• Plaintiff (Ortho) could win buy showing either
• Price below AVC or
• It was equally efficient producer but could not
  remain in market because of Abbotts pricing
• No violation because Ortho did not claim it could
  not remain in the market.

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Virgin Atlantic Airways v. British Airways (2d
Cir. 2001)

• First case to apply discount attribution
  standard
• Applied all discounts to competitive products
  (airline routes where there was competition)
• If resulting price on competitive products is
  below AVC, 2 is violated
• Virgin did not have evidence to meet this standard

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Subjective Bundled Discount Analysis (Divorced
from Price/Cost)
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LePages v. 3M(3rd Cir. 2003)

• 3M was monopolist in transparent tape
• Discounts required purchases spanning 6 product
  lines (target growth rates in each product line)
• No price/cost analysis
• Sufficient for 2 violation if jury found
  defendants conduct made it difficult or
  impossible for competitors to engage in fair
  competition

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Antitrust Modernization Commission Analysis
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Antitrust Modernization Commission Test

• Safe harbor if after allocating all discounts
  to competitive products, price for all products
  is above incremental cost
• If plaintiff meets first prong of test, must meet
  recoupment standard
• If first two prongs met, must still show adverse
  effect on competition

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The Post-3M Price/Cost Decisions
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Cascade Health Solutions v. PeaceHealth (9th Cir.
2008)

• PeaceHealth provided primary, secondary and
  tertiary care services and had high market share
  in tertiary
• Cascade did not compete in tertiary
• Ninth Circuit adopted first prong of AMC test
  (discount allocation analysis)
• Did not require plaintiff to meet other two
  prongs of AMC test

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Information Resources v. Dun Bradstreet
(S.D.N.Y. 2004)

• Followed discount allocation analysis rejected
  LePages
• Defendant bundled discounts in first and second
  (competitive) markets
• All discounts allocated to second market
• If resulting prices not below AVC, no violation

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Masimo Corp. v. Tyco Health Care(C.D. Cal. 2006)

• Tyco offered bundled rebates across several
  product markets Masimo competed only in one
• Masimo argued that to compete against bundled
  pricing it would have been required to price
  below cost
• Court overturned jury verdict for plaintiff
  because no showing of predatory pricing or tying
  (addressed only Sherman 1 and Clayton 3, not
  Sherman 2)

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DOJ Report

• Where bundle-to-bundle competition is reasonably
  possible (i.e., all products in bundle are
  offered by a competitor or combination of
  competitors), pure predatory pricing analysis
  (i.e., lawful if cost of entire bundle not below
  AVC)
• Bundle-to-bundle competition is not reasonable
  possible
• Discount allocation safe harbor
• If outside safe harbor, plaintiff must show
• (a) bundled discount has no procompetitive
  benefits
• (b) if there are procompetitive benefits,
  discount produces harm substantially
  disproportionate to those benefits

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FTC Criticism of DOJ Analysis

• Commissioners Harbour, Liebowitz and Rosch
• Supreme Court has not blessed price-cost test
  for any practice other than predatory pricing
• DOJ is sole author of disproportionality
  safety net
• Should have treated as exclusive dealing and
  analyzed under traditional rule of reason
  foreclosure analysis

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Loyalty DiscountsNo True Answer

• Anita F. Stork
• Covington Burling LLP

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Basics of Loyalty Discounts

• Rebates are offered on single product
• Discounts conditioned upon level of purchase
• Referred to as all-units or first-dollar
  discounts
• Price break applies to all items, not just items
  beyond level of requisite purchase
• Can be based on volume or market share

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Early Price/Cost Analysis Cases
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Barry Wright Corp. v. ITT Grinnell Corp. (1st
Cir. 1983)

• Pacific Scientific had 80 market share in
  snubbers
• Customer Grinnell wanted Barry Wright as
  alternate supplier
• Pacific Scientific offered Grinnell large
  discounts for purchasing high percentage of needs
  for two years
• Predatory pricing analysis applied
• Discount not predatory because it was above any
  relevant measure of Pacifics cost
• No firm rule by court
• Acknowledged that above-cost loyalty discounts
  could still harm competition

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Concord Boat v. Brunswick(8th Cir. 2000)

• Brunswick had 75 share in stern drive engine
  market
• Offered discounts to buyers under market share
  program
• Boat builders who agreed to buy a certain
  percentage (typically 60 or more) of their
  engine needs received all-units discount
• Brunswicks discount prices were above cost, so
  no violation of Section 2
• Court noted that buyers could purchase 40 of
  needs from other sellers, and still receive
  Brunswick discounts
• Sellers could compete by offering better
  discounts
• Court found Brunswicks discounts were not
  exclusive dealing arrangements

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Virgin Atlantic Airways Ltd. v. British Airways
PLC(S.D.N.Y. 1999), affd (2d Cir. 2001)

• British Airways offered incentive programs
  (commissions for travel agencies, discounts for
  corporate customers) for threshold purchase of
  tickets
• Virgin alleged below-cost pricing
• British Airways prevailed, because Virgin failed
  to show below-cost pricing

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Recent Loyalty Discount Cases
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Masimo Corp. v. Tyco Health Care Group,
L.P.(C.D. Cal. 2006)

• Tyco offered market share discounts for hospitals
  that purchased high levels of sensors
• E.g., 40 off all sensors if hospital bought over
  90 of its requirements from Tyco
• Court did not analyze Tycos cost and prices
• Accepted Masimos argument that the discounts
  were illegal exclusive dealing under Section 1
• Discounts also maintained Tycos monopoly power
  in violation of Section 2

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J.B.D.L. Corp. v. Wyeth-Ayerst Laboratories,
Inc.(S.D. Ohio 2005), affd on other grounds
(6th Cir. 2007)

• Wyeth conditioned all rebates paid on Premarin
  under contracts with pharmacy benefit managers on
  the drug being listed as the exclusive offering
  in formulary
• Plaintiff alleged that loyalty rebates were
  anticompetitive and illegal exclusive dealing
  under Section 1 and Section 2
• Relying on Concord Boat, the court found that
  Wyeths prices were not below cost
• Nor did Wyeths pricing plus the contract violate
  Section 2
• Court found that plaintiff could not establish
  substantial foreclosure due to exclusive dealing
  no Section 1 violation

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Benefits of Loyalty Discounts

• Can reduce prices
• Increase output
• Encourage marketing efforts by retailers
• Allow manufacturer to produce more efficiently

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Downsides of Loyalty Discounts

• Sometimes below-cost selling
• Can lead to full-line forcing
• Market foreclosure for smaller rivals

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DOJ Report

• Analyzed numerous approaches, including
  cost-based and foreclosure analyses
• Focus is defendant covering its costs on all
  units sold, or just the cost of the additional
  sales induced by the discount?
• Additional question at what level the quantity
  of sales induced by the practice will likely have
  an anticompetitive effect
• Likely to apply standard predatory-pricing
  analysis
• Additional study of real-world impact of
  discounts necessary

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FTC Dissent from DOJ Approach

• Critiqued DOJ Report for applying predatory
  pricing safe harbor even where weaker rival
  prevented from reaching minimum viable scale
• Also criticized conclusion that even where a
  defendant fell outside safe harbor, a crippled
  rival in market constituted evidence that loyalty
  discounts were legal
• FTC View Analyze loyalty discounts as a form of
  exclusive dealing

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Hypothetical No. 1

• Your client has a 70 market share in in the
  relevant product and geographic markets for
  Product X.
• You client tells you it wants to give its best
  price, a 20 discount off list price, to
  customers who buy 70 of their total requirements
  from your client.
• Legal or illegal? What else do you need to know?
  

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Hypothetical No. 2

• The same client now tells you it want to give its
  best price to customers who also buy at two other
  products from it (discount will be 20 off list
  on all purchases).
• Legal or illegal? What else do you need to know?
  

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Hypothetical No. 3

• Your client comes to you and tells you it is
  about to release a product that is highly
  anticipated in the market place and that it
  believes will be very successful.
• The client tells you it wants to offer a 30
  discount on the new product to resellers who
  agree also to purchase two other, older products.
  
• Legal or illegal? What else do you need to know?

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Hypothetical No. 4

• Same facts as hypothetical No. 2, but you learn
  that there are e-mails that suggest the purpose
  of the discounting is to eliminate a competitor.
• How does this affect your analysis?
• What else do you need to know?
• What about state law?
• What about the Robinson-Patman Act?