The antitrust division of the Department of Justice (DOJ), the Federal Trade Commission (FTC) and state attorneys general are responsible for enforcing nonmerger government antitrust issues. The DOJ has the exclusive authority to enforce the provisions of the Sherman Act, and the FTC has the authority to challenge “unfair methods of competition” under Section 5 of the FTC Act.
The language of Section 5 of the FTC Act is broader than that of Section 2 of the Sherman Act. Until recently, however, Section 5 of the FTC Act did not play a significant role in single-firm antitrust enforcement. Federal enforcement policy between the 1940s and the 1970s took an expansive view of liability under Section 2 of the Sherman Act in challenging anticompetitive single-firm conduct. Consequently, there was less need for the broader language of Section 5.
In addition, previous cases alleging independent Section 5 violations were rejected by the courts. In the early 1980s, the FTC brought three cases under independent Section 5 theories—Official Airline Guides, Boise Cascades, and Ethyl Corp.—all resulting in adverse appellate decisions. In each case, the court criticized the FTC for failing to explain the limiting principles that justify departure from the Sherman Act.
It is by now apparent that the FTC’s efforts to expand its Section 5 authority to challenge anticompetitive conduct are well under way. One area that the FTC has singled out for expanded Section 5 application is exclusionary practices. FTC Commissioner Rosch, for example, noted that Section 5 would have its broadest application “in cases involving ostensibly exclusionary practices by firms with monopoly power where those practices have an anticompetitive effect, which may include preventing a rival from constraining the use of monopoly power.”
In the last three years, the FTC filed claims against Transitions Optical Inc., Pool Corp. and McWane Inc. and Sigma Corp. In each of these cases, the FTC focused on the practice of vertical restraints as a means to exclude rivals.
The FTC alleged that Transitions Optical, which manufactures photochromic treatments for corrective eyeglass lenses, forced lens casters and wholesale labs into exclusive dealing arrangements to foreclose its rivals. The FTC accused Pool Corp., the largest nationwide wholesale distributor of pool products, of engaging in exclusionary practices by refusing to deal with any manufacturer that sold its products to new distribution businesses. In the matter involving McWane and Sigma Corp., the FTC claimed that the companies excluded their rivals in the domestic ductile iron pipe fittings market by adopting duplicate exclusive dealing policies with distributors. All three cases settled with parties entering into consent decrees with the FTC. Private actions asserting Sherman Act Section 2 claims have been filed in all three matters.
The vertical practices involved in these cases can have procompetitive or anticompetitive explanations depending on the particular facts and circumstances of each situation. Exclusive dealing—the practice the FTC alleged was anticompetitive in the cases involving Transitions Optical and McWane and Sigma—is an arrangement that prevents a distributor from selling another manufacturer’s products. Exclusive distributorship, which was the focus of the case involving Pool Corp., is an arrangement that prevents a manufacturer from selling its products through a different distributor.
A procompetitive logic for both these arrangements is to prevent free riding that would otherwise reduce competition. A free-riding problem for manufacturers is created if a dealer uses a manufacturer’s investment, such as salesperson training or advertising that brings customers to the dealer, to sell a rival manufacturer’s product. Unchecked, the effect of this conduct would be to reduce the procompetitive investment by the manufacturer. Similarly, a free-riding problem for dealers is created if a manufacturer allows other dealers to benefit from a dealer’s investments that increase the demand for the manufacturer’s products (e.g., brand promotion, customer service, etc.). These practices also can have an anticompetitive impact if the exclusivity restrictions are applied when these efficiency justifications are absent or weak.
The DOJ also recently has focused on the potential anticompetitive impact of vertical restraints. The DOJ brought its first Sherman Act Section 2 action in more than a decade against United Regional Hospital, alleging that the hospital imposed exclusive dealing on private insurers to exclude its rivals. The DOJ also currently is investigating vertical relationships between Apple Inc. and book publishers.
The focus on vertical restraints may continue for a while, given the conflict between big-box stores and online retailers over “showrooming.” Big-box stores, such as Target and Best Buy, increasingly are complaining that customers use their stores as showrooms by visiting the store to check out a product and get more information about the product’s features and performance from store associates, and then purchasing the same product from an Internet retailer at a lower price.
Big-box stores are claiming that they incur the costs of displaying and promoting the products while Internet retailers are reaping the benefits. It would not be surprising if big-box retailers decide to take action in the form of vertical restraints that could affect online discounting. Whether the FTC and the DOJ would challenge such conduct remains to be seen.
The views expressed in this article are solely those of the authors, who are responsible for the content, and do not necessarily represent the views of Cornerstone Research.