Opinion ID: 4076467
Heading Depth: 3
Heading Rank: 1

Heading: Tying in Antitrust Law

Text: TLI’s antitrust counterclaims against Avaya are based on an allegedly unlawful use of tying to restrain and monopolize the market for PBX and PDS maintenance services. “[A] tying arrangement may be defined as an agreement by a party to sell one product [or service] but only 44 The parties also dispute the propriety of the injunctive relief ordered by the District Court. Because we will vacate the verdict and judgment of liability, we must also vacate the resulting injunction. 80 on the condition that the buyer also purchases a different (or tied) product [or service], or at least agrees that he will not purchase that product [or service] from any other supplier.” Northern Pacific Ry. Co. v. United States, 356 U.S. 1, 5-6 (1958). For a pair of products or services to be distinct, and therefore capable of being tied together, “there must be sufficient consumer demand so that it is efficient for a firm to provide [them] separately.” Kodak, 504 U.S. at 462. Tying can support a Sherman Act claim either under § 1, as an unlawful restraint on trade, or under § 2, as an unlawful act of monopolization or attempted monopolization. See Phillip E. Areeda & Herbert Hovenkamp, Fundamentals of Antitrust Law (“Fundamentals”) § 17.01, at 17-13 (4th ed. Supp. 2015); see also 15 U.S.C. §§ 1-2.45 Under the antitrust theories presented by TLI, Avaya unlawfully tied its PBX and PDS systems to maintenance services by conditioning access to equipment and software on the purchase of such services from Avaya or its Business Partners. Not all ties are illegal, however. To declare otherwise would risk making practically every product the subject of an antitrust suit, because, in theory at least, most any product can be deconstructed into component parts that could be sold separately. For that reason, “[i]t is clear ... that every refusal to sell two products separately cannot be said to restrain 45 TLI secured verdicts against Avaya under both §§ 1 and 2 of the Sherman Act. Section 1 declares illegal “[e]very contract, combination ..., or conspiracy, in restraint of trade or commerce.” 15 U.S.C. § 1. Section 2 makes unlawful any act to “monopolize, or attempt to monopolize, or combine or conspire ... to monopolize any part of the trade or commerce.” 15 U.S.C. § 2. 81 competition.” Jefferson Par. Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 11 (1984) partially abrogated on other grounds by Ill. Tool Works Inc. v. Indep. Ink, Inc., 544 U.S. 28 (2006). Instead, the essential characteristic of an invalid tying arrangement lies in the seller’s exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms. When such “forcing” is present, competition on the merits in the market for the tied item is restrained and the Sherman Act is violated. Id. at 12. Therefore, “[w]hen ... the seller does not have ... the kind of market power that enables him to force customers to purchase a second, unwanted product in order to obtain the tying product, an antitrust violation can be established only by evidence of an unreasonable restraint on competition in the relevant market.” Id. at 17-18. In this case, nobody contends that the primary market for PBX and PDS systems is anything other than competitive, or that Avaya’s main competitors in that market – large firms such as Cisco, Siemens, and Microsoft – cannot use prices to discipline Avaya in that primary market. As to the primary market, then, TLI’s position is not that Avaya’s “share of the market is high” or that it “offers a unique product that competitors are not able to offer.” Id. at 17. Rather, TLI has proceeded under a specialized theory of tying developed in a Supreme Court case called Eastman Kodak Company v. 82 Image Technical Services, Inc., 504 U.S. 451 (1992). Review of the Kodak opinion and our Court’s elaboration of its principles is essential, then, because TLI’s counterclaims rise or fall based on whether they comport with a Kodak theory of antitrust liability.
Tying Liability Kodak presented the Supreme Court with a situation similar to the one before us, consisting of a primary market for complex durable goods and an aftermarket for maintenance service. Kodak sold photocopier equipment, as well as maintenance service and replacement parts. Id. at 455. The parts were of proprietary design and were not interchangeable with other manufacturers’ parts. Id. at 45657. Kodak sold both parts and service, using different contract arrangements to charge different prices to different customers. Id. at 457. When Kodak attempted to prevent the sale of its parts to independent maintenance service providers – thereby restricting their ability to service Kodak machines – a group of those independent providers filed suit, alleging unlawful tying of parts and service in violation of §§ 1 and 2 of the Sherman Act. Id. at 458-59. On ultimate appeal from the district court’s grant of summary judgment for Kodak, the Supreme Court ruled that the plaintiffs had put forward a strong enough case to proceed to trial. The Court accepted Kodak’s argument that the primary equipment market was competitive, id. at 465 n.10, but it nonetheless ruled that the plaintiffs could proceed under a § 1 tying theory of antitrust liability. It refused to endorse Kodak’s assertion that competition in the primary market 83 would necessarily discipline the maintenance aftermarket, preferring not to adopt “[l]egal presumptions that rest on formalistic distinctions rather than actual market realities.” Id. at 466. Instead, the Court insisted on a context-specific factual analysis of whether “the equipment market does discipline the aftermarkets so that [both] are priced competitively overall, or that any anti-competitive effects of Kodak’s behavior are outweighed by its competitive effects.” Id. at 486. “The fact that the equipment market imposes a restraint on prices in the aftermarkets” does not, on its own, “disprove[] the existence of power in those markets.” Id. at 471 (citation omitted). In explaining how a seller facing a competitive primary equipment market could nonetheless exercise market power in the parts and maintenance aftermarkets, the Court expounded a theory whereby high information and switching costs would allow the seller to exploit customers who had already purchased the equipment and were then “locked in” to the aftermarkets. Id. at 476. It explained that “[l]ifecycle pricing of complex, durable equipment is difficult and costly,” and that the information needed for such lifecycle pricing “is difficult – some of it impossible – to acquire at the time of purchase.” Id. at 473. Because “[a]cquiring the information is expensive[, i]f the costs of service are small relative to the equipment price, ... [consumers] may not find it cost efficient to compile the information.” Id. at 474-75. Additionally, competitors may not provide that information, either because they do not have it themselves or because they may wish to collusively engage in the same behavior with their own customers so that “their interests would [not] be advanced by providing such information to consumers.” Id. 84 at 474 & n.21 (citation omitted). Customers’ information limitations could be paired with high switching costs so that consumers who already have purchased the equipment, and are thus “locked in,” will tolerate some level of service-price increases before changing equipment brands. Under this scenario, a seller profitably could maintain supracompetitive prices in the aftermarket if the switching costs were high relative to the increase in service prices, and the number of locked-in customers were high relative to the number of new purchasers. Id. at 476. In other words, tying liability may exist in an aftermarket where the seller can exploit customers who have already purchased the equipment and cannot easily shift to another brand. The Supreme Court also posited that the threat of anticompetitive exploitation of aftermarkets in light of high information and switching costs would be particularly severe in cases where the seller could engage in price discrimination, i.e., charging different prices to different types of consumers. With respect to information costs, “if a company is able to price discriminate between sophisticated and unsophisticated consumers, the sophisticated will be unable to prevent the exploitation of the uninformed.” Id. at 475. With respect to switching costs, “if the seller can price discriminate between its locked-in customers and potential new customers,” it can exploit locked-in customers with supracompetitive aftermarket prices while simultaneously charging low prices to new customers. Id. at 476. Those forms of price 85 discrimination could allow a savvy monopolistic seller to create a market tiered like a pyramid. While charging lower lifecycle prices to sophisticated customers in the primary market, the seller could dupe low-information customers into paying a deceptively low upfront cost for the equipment, to lock them in due to high switching costs and set them up for supracompetitive prices in the aftermarkets for parts and service. In the meantime, it could continue to make a normal competitive profit from sales to sophisticated new customers by charging them lower lifecycle prices through lower-priced long-term contracts. Price discrimination thus allows a seller to run a multi-tier market dividing more sophisticated consumers from less sophisticated ones, while lock-in snares the unsophisticated customers once the proverbial trap has been sprung. Not only was that theory sufficient to support § 1 liability, the Court also held that it could support § 2 liability for unlawful monopolization. In that analysis, the Court incorporated the § 1 analysis for whether the equipment market and the service and parts aftermarkets were distinct for antitrust purposes. Id. at 481. It was comfortable with defining a single-brand market as relevant for antitrust purposes as long as such a market was justified by “the choices available to ... equipment owners,” as “determined ... after a factual inquiry into the ‘commercial realities’ faced by consumers.” Id. at 482 (quoting United States v. Grinnell Corp., 384 U.S. 563, 572 (1966)). A successful plaintiff had to prove more, however, to succeed on a § 2 claim, because simply proving monopoly power in the aftermarket was not enough. A § 2 claim additionally requires showing the use of that monopoly power “to foreclose competition, to gain a competitive advantage, or to destroy a competitor.” Id. at 86 482-83 (quoting United States v. Griffith, 334 U.S. 100, 107 (1948)). Therefore, in defending against a § 2 claim, the seller has the opportunity to justify its actions so that “[l]iability turns ... on whether ‘valid business reasons’ can explain [its] actions.” Id. at 483 (quoting Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585, 605 (1985)). The Court was willing to consider as valid business reasons both controlling inventory costs and ensuring high quality maintenance service, but it did not consider the record in Kodak as sufficient to warrant summary judgment. Id. at 483-86.
Kodak Since Kodak, our Court has had the opportunity to develop that case’s theory of antitrust liability, most notably in a pair of cases called Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430 (3d Cir. 1997), and Harrison Aire, Inc. v. Aerostar International, Inc., 423 F.3d 374 (3d Cir. 2005). In Queen City Pizza, we considered a Kodak-style claim by a group of franchisees against Domino’s Pizza, alleging that Domino’s had used its monopoly power over the market for franchise rights and proprietary pizza dough to restrain trade in the market for approved pizza supplies. 124 F.3d at 434. We affirmed the district court’s dismissal of the claims under Federal Rule of Civil Procedure 12(b)(6) because we did not consider the contractual requirement for franchisees to purchase pizza ingredients from Domino’s to implicate the concerns raised in Kodak. Id. at 444. We observed “that Domino’s approved supplies and ingredients 87 are fully interchangeable in all relevant respects with other pizza supplies” so that they were not unique in the way that Kodak parts were. Id. at 440. The plaintiffs were not, therefore, forced to purchase approved supplies because of the uniqueness of any Domino’s goods, but instead only “because they [were] bound by contract to do so.” Id. at 441. In distinguishing that contractual obligation from the Kodak situation, we explained that, where the defendant’s forcing power “stems not from the market, but from plaintiffs’ contractual agreement ..., no claim will lie.”46 Id. at 443. “If 46 In Queen City Pizza, we talked, in part, of the defendant forcing “plaintiffs to purchase the ... tying product.” 124 F.3d at 443 (emphasis added). That language was a result of the idiosyncratic nature of one of the tying theories alleged in that case. Under that theory, the primary market was for restaurant franchise agreements, which in turn contractually bound franchisees to purchase the alleged “tying” product, fresh dough. The franchisees contended that Domino’s “refused to sell fresh dough to [them] unless [they] purchased other ingredients and supplies from Domino’s,” id. at 434, so that the “other ingredients and supplies” were the “tied” product. The analogy here would be an argument that the primary market was for PBX systems, which “forced” the purchase of ODMCs and MSPs as the “tying” products, which were in turn allegedly used to force purchase of maintenance as the “tied” service. No matter how many intermediate steps are alleged, however, in the end our concern is whether the defendant forced purchases of a tied product using power in some distinct market. Jefferson Parish, 466 U.S. at 12. Queen City Pizza stands for the proposition that if the supposed forcing is entirely the result 88 Domino’s ... acted unreasonably when ... it restricted plaintiffs’ ability to purchase supplies from other sources, plaintiffs’ remedy, if any, is in contract, not under the antitrust laws.” Id. at 441. We also emphasized in Queen City Pizza that “[t]he Kodak case arose out of concerns about unilateral changes in Kodak’s parts and repairs policies.” Id. at 440. Because Kodak’s change in policy against independent maintenance providers “was not foreseen at the time of sale, buyers had no ability to calculate these higher costs at the time of purchase and incorporate them into their purchase decision.” Id. The Domino’s franchisees, on the other hand, “knew that Domino’s Pizza retained significant power over their ability to purchase cheaper supplies from alternative sources because that authority was spelled out in ... the ... franchise agreement,” so the “franchisees could assess the potential costs and economic risks at the time they signed the franchise agreement.” Id. If the franchisees found the contractual requirements “overly burdensome or risky at the time they were proposed, [they] could have purchased a different form of restaurant, or made some alternative investment,” id. at 441, so that the transaction was “subjected to competition at the pre-contract stage,” id. at 440. We thus characterized Kodak as concerned largely with the threat of unfair surprise for customers in the aftermarket, a threat ameliorated if the aftermarket terms were made clear in a primary market contract. of a transparent contractual agreement, then that is not the concern of the antitrust laws. A plaintiff cannot avoid that outcome merely by crafting a complaint to allege intermediate steps. 89 In Harrison Aire, our Court’s second major case elaborating Kodak, we affirmed summary judgment against the Kodak-style claims of a hot air balloon operator that alleged that the balloon manufacturer had monopolized the aftermarket for replacement balloon fabric by tying the purchase of its own branded fabric to its balloons. 423 F.3d at 379, 386. We explained that, in general, “[i]f the primary market is competitive, a firm exploiting its aftermarket customers ordinarily is engaged in a short-run game – for when buyers evaluate the ‘lifecycle’ cost of the product, the cost of the product over its full service life, they will shop elsewhere.” Id. at 382. The Kodak case is an exception to that general rule, based on a “market failure” in which “lifecycle pricing information is particularly difficult or impossible for primary market customers to acquire, as in the case of a unilateral change in aftermarket policy targeting ‘locked in’ customers.” Id. We emphasized that “Kodak does not transform every firm with a dominant share of the relevant aftermarket into a monopolist,” and that a Kodakstyle “plaintiff must produce ‘hard evidence dissociating the competitive situation in the aftermarket from activities occurring in the primary market.’” Id. at 383 (quoting SMS Sys. Maint. Servs., Inc. v. Digital Equip. Corp., 188 F.3d 11, 17 (1st Cir. 1999)). In evaluating the evidence in Harrison Aire, we cautioned that, although “[o]ne important consideration is whether a unilateral change in aftermarket policy exploits locked-in customers,” id. at 383, “an ‘aftermarket policy change’ is not the sine qua non of a Kodak claim,” id. at 384. Other factors to consider include “evidence of (1) supracompetitive pricing, (2) [the seller’s] dominant share of the relevant aftermarket, (3) significant information costs that 90 prevent[] lifecycle pricing, and (4) high ‘switching costs’ that serve[] to ‘lock in’ [the seller’s] aftermarket customers.” Id. Applying those factors to the specific circumstances of the Harrison Aire case, we concluded that “[n]either information costs nor a unilateral change in aftermarket policy prevented [the plaintiff] from shopping for competitive lifecycle balloon prices when it purchased the ... balloon at issue.” Id. at 38485. Without “other evidence dissociating competitive conditions in the primary balloon market from conditions in the aftermarket for replacement fabric,” it was “clear that [the plaintiff] got precisely the balloon and the aftermarket fabric that it bargained for in the competitive primary market.” Id. at 385. Therefore, summary judgment against the monopolization claim was appropriate.47
Law Kodak makes clear that, in certain limited circumstances, a competitive primary market will not insulate a defendant from antitrust liability. But neither that case nor our subsequent case law overturns the more general principle that a plaintiff’s theory of antitrust liability must be economically plausible. Thus, in the summary judgment context, “‘antitrust law limits the range of permissible 47 We also affirmed summary judgment against the § 1 tying claim raised in Harrison Aire because “[t]ying requires appreciable economic power in the tying product market,” and the plaintiff “fail[ed] to produce any evidence of appreciable market power in the tying product market” for hot air balloons. 423 F.3d at 385 (citations and internal quotation marks omitted). 91 inferences’ that can be drawn ‘from ambiguous evidence.’” Harrison Aire, 423 F.3d at 380 (quoting Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 588 (1986)). That “higher threshold” for summary judgment “is imposed in antitrust cases to avoid deterring innocent conduct that reflects enhanced, rather than restrained, competition.” In re Flat Glass Antitrust Litig., 385 F.3d 350, 357 (3d Cir. 2004). As the Supreme Court put it plainly in Kodak itself, “[i]f [a] plaintiff’s theory is economically senseless, no reasonable jury could find in its favor, and summary judgment should be granted.” 504 U.S. at 468-69. The requirement that a plaintiff make out an economically coherent theory of antitrust liability applies just as much to the pleading stage, where, to “make a § 1 claim,” a plaintiff must “identify[] facts that are suggestive enough to render a § 1 [violation] plausible,” with sufficient “context” to “raise[] a suggestion” of unlawful anticompetitive conduct. Bell Atl. Corp. v. Twombly, 550 U.S. 544, 556-57 (2007). The requirement that a plaintiff provide an economically plausible theory for its antitrust claims applies no less at trial than when a case is resolved by summary judgment or on the pleadings. With that in mind, we do not read – and have never read – Kodak to modify the requirement that a plaintiff in a tying case prove that the defendant has market power sufficient “to force a purchaser to do something that he would not do in a competitive market.” Jefferson Parish, 466 U.S. at 14. In general, we expect a vibrant and competitive primary market to discipline and restrain power in related aftermarkets. What Kodak stands for is the principle that there can be some exceptions to that expectation, when a plaintiff can produce a plausible economic theory of market 92 failure, supported by sufficient evidence. In evaluating the issues in this case, we must consider just how broadly that Kodak exception should be read. A leading antitrust treatise seems to suggest that Kodak should be read as confined to the lock-in situation that was that opinion’s focus. As that treatise distills the Kodak analysis: “Kodak could exploit locked-in customers with supracompetitive prices only if it could profitably (1) dispense with sophisticated new customers or (2) could discriminatorily overcharge only those existing customers whose exploitation would not affect new sales.” Areeda & Hovenkamp, Fundamentals, supra, § 5.12, at 5-102 (Supp. 2016).48 Those conditions will rarely obtain, and “[m]uch 48 As that treatise explains those two elements in greater detail: when a defendant has no power in the [primary] market, it cannot profitably charge supracompetitive prices for unique [aftermarket products] to “locked in” users unless: 1. it can profitably abandon selling new machines to sophisticated new customers who would understand that the machine’s cost is the sum of its nominal price plus the excess [maintenance] charges later ...; or