Exclusive Dealing, the Theory of the Firm, and Raising Rivals' Costs: Toward a New Synthesis

For several decades antitrust courts were extremely hostile to exclusive dealing agreements, banning such contracts, regardless of their benefits, whenever the manufacturer held a significant market share. The FTC went even further, banning such agreements whenever the manufacturer had a non-trivial share of its market. This article attributes the original hostility to exclusive dealing contracts to neoclassical price theory's technological theory of the firm and its derivative model of workable competition. According to price theory, firms existed to allocate resource and realize efficiencies of a technological nature that, by their nature, arose within the firm. At the same time, price theory identified no beneficial explanation for partial contractual integration. The result was the so-called workable competition model, which privileged unilateral competition on the merits over concerted contractual integration, the latter of which was presumed to have market power origins. The article then recounts two responses to this hostility. The first response, from within price theory, came from the Chicago School, which argued that a firm with market power could only realize one monopoly profit, with the result that exclusive dealing contracts could not enhance the power that a firm otherwise possessed. Unlike, say, the Chicago School account of minimum resale price maintenance, this attack on conventional wisdom offered no affirmative wealth-creating reason that firms would adopt such agreements. Instead, Chicagoans simply inferred that such agreements produced benefits because they supposedly could not create harms. The second response  Transaction Cost Economics or TCE  sought to undermine price theory itself, or at least its conception of the firm and other non-standard contracts. Unlike the Chicago School, TCE offered to explain how exclusive dealing within and between firms produced benefits. In particular, TCE argued that complete and partial integration was a method of reducing or eliminating the costs of relying upon unbridled markets to conduct economic activity, particularly costs flowing from anticipated opportunism. Exclusive dealing, it was said, was no exception, and economists have identified several beneficial effects that such contracts can create. Unlike the Chicago School, TCE did not contend that exclusive dealing contracts could never reduce welfare. Still, TCE helped undermine the unmitigated hostility that once characterized antitrust's attitude toward exclusive dealing contracts. Raising Rivals'Costs (RRC) theory, it is shown, filled the void left by price theory's discredited lesson that exclusive dealing agreements were almost always harmful. That is, RRC offered a coherent and plausible theory regarding how such agreements may, in certain circumstances, raise the costs of rivals and facilitate the acquisition or protection of market power. The article ends by attempting to integrate the lessons of TCE and RRC theory with a view toward developing a standard for evaluating exclusive dealing arrangements that reflects the lessons of both paradigms, neither of which purports to exclude the other as a useful tool for interpreting such agreements. The essay critiques certain aspects of modern rule reason analysis as applied to exclusive dealing arrangements. Thus, it is argued, mere significant foreclosure of rivals from portions of the marketplace should not establish a prima facie case requiring the defendant to establish that the restraint produces benefits. Nor should courts allow plaintiffs to establish a prima facie case based simply upon a showing that such contracts result in prices that are higher than those that existed before the restraint. Moreover, if courts allow plaintiffs to establish a prima facie case based upon such showings, then there is no basis for balancing the benefits that the defendant proves against harms that are presumed once a plaintiff makes out a prima facie case, as such balancing depends upon the assumption that benefits coexist with harms, harms not logically presumed once the defendant shows that the restraint produces significant benefits. Instead, the essay concludes, plaintiffs seeking to establish a prima facie case should be required to establish the numerous conditions, including relevant input markets, output markets, and barriers to entry, that are necessary to any raising rivals' costs strategy. Once the plaintiff establishes such a case, the defendant should be allowed to establish that the arrangement produces benefits. Those who embrace a purchaser welfare approach to antitrust have not explained how courts should go about balancing the harms produced by such agreements against their benefits, given that such agreements might harm some consumers while benefitting others. At the same time, those who embrace a social or total welfare approach to antitrust may be content if courts declare lawful any such agreement that produces significant benefits.