Opinion ID: 4076467
Heading Depth: 4
Heading Rank: 1

Heading: The Kodak Theory of Antitrust

Text: 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.