Opinion ID: 185418
Heading Depth: 2
Heading Rank: 1

Heading: Separate-Products Inquiry Under the Per Se Test

Text: 195 The requirement that a practice involve two separate products before being condemned as an illegal tie started as a purely linguistic requirement: unless products are separate, one cannot be tied to the other. Indeed, the nature of the products involved in early tying cases--intuitively distinct items such as a movie projector and a film, Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502 (1917)-led courts either to disregard the separate-products question, see, e.g., United Shoe Mach. Corp. v. United States, 258 U.S. 451 (1922), or to discuss it only in passing, see, e.g., Motion Picture Patents, 243 U.S. at 508, 512, 518. It was not until Times-Picayune Publishing Co. v. United States, 345 U.S. 594 (1953), that the separate-products issue became a distinct element of the test for an illegal tie. Id. at 614. Even that case engaged in a rather cursory inquiry into whether ads sold in the morning edition of a paper were a separate product from ads sold in the evening edition. 196 The first case to give content to the separate-products test was Jefferson Parish, 466 U.S. 2. That case addressed a tying arrangement in which a hospital conditioned surgical care at its facility on the purchase of anesthesiological services from an affiliated medical group. The facts were a challenge for casual separate-products analysis because the tied service--anesthesia--was neither intuitively distinct from nor intuitively contained within the tying service--surgical care. A further complication was that, soon after the Court enunciated the per se rule for tying liability in International Salt Co. v. United States, 332 U.S. 392, 396 (1947), and Northern Pacific Railway Co. v. United States, 356 U.S. 1, 57 (1958), new economic research began to cast doubt on the assumption, voiced by the Court when it established the rule, that  'tying agreements serve hardly any purpose beyond the suppression of competition,'  id. at 6 (quoting Standard Oil of Cal. v. United States, 337 U.S. 293, 305-06 (1949)); see also Jefferson Parish, 466 U.S. at 15 n.23 (citing materials); Fortner Enters. v. U.S. Steel Corp., 394 U.S. 495, 524-25 (1969) (Fortas, J., dissenting) (Fortner I). 197 The Jefferson Parish Court resolved the matter in two steps. First, it clarified that the answer to the question whether one or two products are involved does not turn on the functional relation between them.... Jefferson Parish, 466 U.S. at 19; see also id. at 19 n.30. In other words, the mere fact that two items are complements, that one ... is useless without the other, id., does not make them a single product for purposes of tying law. Accord Eastman Kodak, 504 U.S. at 463. Second, reasoning that the definitional question [whether two distinguishable products are involved] depends on whether the arrangement may have the type of competitive consequences addressed by the rule [against tying], Jefferson Parish, 466 U.S. at 21, the Court decreed that no tying arrangement can exist unless there is a sufficient demand for the purchase of anesthesiological services separate from hospital services to identify a distinct product market in which it is efficient to offer anesthesiological services separately from hospital service, id. at 21-22 (emphasis added); accord Eastman Kodak, 504 U.S. at 462. 198 The Court proceeded to examine direct and indirect evidence of consumer demand for the tied product separate from the tying product. Direct evidence addresses the question whether, when given a choice, consumers purchase the tied good from the tying good maker, or from other firms. The Court took note, for example, of testimony that patients and surgeons often requested specific anesthesiologists not associated with a hospital. Jefferson Parish, 466 U.S. at 22. Indirect evidence includes the behavior of firms without market power in the tying good market, presumably on the notion that (competitive) supply follows demand. If competitive firms always bundle the tying and tied goods, then they are a single product. See id. at 22 n.36; see also Eastman Kodak, 504 U.S. at 462; Fortner I, 394 U.S. at 525 (Fortas, J., dissenting), cited in Jefferson Parish, 466 U.S. at 12, 22 n.35; United States v. Jerrold Elecs. Corp., 187 F. Supp. 545, 559 (E.D. Pa. 1960), aff'd per curiam, 365 U.S. 567 (1961); 10 Phillip E. Areeda et al., Antitrust Law p 1744, at 197-201 (1996). Here the Court noted that only 27% of anesthesiologists in markets other than the defendant's had financial relationships with hospitals, and that, unlike radiologists and pathologists, anesthesiologists were not usually employed by hospitals, i.e., bundled with hospital services. Jefferson Parish, 466 U.S. at 22 n.36. With both direct and indirect evidence concurring, the Court determined that hospital surgery and anesthesiological services were distinct goods. 199 To understand the logic behind the Court's consumer demand test, consider first the postulated harms from tying. The core concern is that tying prevents goods from competing directly for consumer choice on their merits, i.e., being selected as a result of buyers' independent judgment, id. at 13 (internal quotes omitted). With a tie, a buyer's freedom to select the best bargain in the second market [could be] impaired by his need to purchase the tying product, and perhaps by an inability to evaluate the true cost of either product.... Id. at 15. Direct competition on the merits of the tied product is foreclosed when the tying product either is sold only in a bundle with the tied product or, though offered separately, is sold at a bundled price, so that the buyer pays the same price whether he takes the tied product or not. In both cases, a consumer buying the tying product becomes entitled to the tied product; he will therefore likely be unwilling to buy a competitor's version of the tied product even if, making his own price/quality assessment, that is what he would prefer. 200 But not all ties are bad. Bundling obviously saves distribution and consumer transaction costs. 9 Phillip E. Areeda, Antitrust Law p 1703g2, at 51-52 (1991). This is likely to be true, to take some examples from the computer industry, with the integration of math co-processors and memory into microprocessor chips and the inclusion of spell checkers in word processors. 11/10/98 pm Tr. at 18-19 (trial testimony of Steven McGeady of Intel), reprinted in 9 J.A. at 5581-82 (math co-processor); Cal. Computer Prods., Inc. v. IBM Corp., 613 F.2d 727, 744 & n.29 (9th Cir. 1979) (memory). Bundling can also capitalize on certain economies of scope. A possible example is the shared library files that perform OS and browser functions with the very same lines of code and thus may save drive space from the clutter of redundant routines and memory when consumers use both the OS and browser simultaneously. 11/16/98 pm Tr. at 44 (trial testimony of Glenn Weadock), reprinted in 9 J.A. at 5892; Direct Testimony of Microsoft's James Allchin p p 10, 97, 100, 106116, app. A (excluding p p f, g.vi), reprinted in 5 J.A. at 3292, 3322-30, 3412-17. Indeed, if there were no efficiencies from a tie (including economizing on consumer transaction costs such as the time and effort involved in choice), we would expect distinct consumer demand for each individual component of every good. In a competitive market with zero transaction costs, the computers on which this opinion was written would only be sold piecemeal--keyboard, monitor, mouse, central processing unit, disk drive, and memory all sold in separate transactions and likely by different manufacturers. 201 Recognizing the potential benefits from tying, see Jefferson Parish, 466 U.S. at 21 n.33, the Court in Jefferson Parish forged a separate-products test that, like those of market power and substantial foreclosure, attempts to screen out false positives under per se analysis. The consumer demand test is a rough proxy for whether a tying arrangement may, on balance, be welfare-enhancing, and unsuited to per se condemnation. In the abstract, of course, there is always direct separate demand for products: assuming choice is available at zero cost, consumers will prefer it to no choice. Only when the efficiencies from bundling are dominated by the benefits to choice for enough consumers, however, will we actually observe consumers making independent purchases. In other words, perceptible separate demand is inversely proportional to net efficiencies. On the supply side, firms without market power will bundle two goods only when the cost savings from joint sale outweigh the value consumers place on separate choice. So bundling by all competitive firms implies strong net efficiencies. If a court finds either that there is no noticeable separate demand for the tied product or, there being no convincing direct evidence of separate demand, that the entire competitive fringe engages in the same behavior as the defendant, 10 Areeda et al., Antitrust Law p 1744c4, at 200, then the tying and tied products should be declared one product and per se liability should be rejected. 202 Before concluding our exegesis of Jefferson Parish's separate-products test, we should clarify two things. First, Jefferson Parish does not endorse a direct inquiry into the efficiencies of a bundle. Rather, it proposes easy-toadminister proxies for net efficiency. In describing the separate-products test we discuss efficiencies only to explain the rationale behind the consumer demand inquiry. To allow the separate-products test to become a detailed inquiry into possible welfare consequences would turn a screening test into the very process it is expected to render unnecessary. 10 Areeda et al., Antitrust Law p p 1741b & c, at 180-85; see also Jefferson Parish, 466 U.S. at 34-35 (O'Connor, J., concurring). 203 Second, the separate-products test is not a one-sided inquiry into the cost savings from a bundle. Although Jefferson Parish acknowledged that prior lower court cases looked at cost-savings to decide separate products, see id. at 22 n.35, the Court conspicuously did not adopt that approach in its disposition of tying arrangement before it. Instead it chose proxies that balance costs savings against reduction in consumer choice. 204 With this background, we now turn to the separateproducts inquiry before us. The District Court found that many consumers, if given the option, would choose their browser separately from the OS. Findings of Fact p 151 (noting that corporate consumers ... prefer to standardize on the same browser across different [OSs] at the workplace). Turning to industry custom, the court found that, although all major OS vendors bundled browsers with their OSs, these companies either sold versions without a browser, or allowed OEMs or end-users either not to install the bundled browser or in any event to uninstall it. Id. p 153. The court did not discuss the record evidence as to whether OS vendors other than Microsoft sold at a bundled price, with no discount for a browserless OS, perhaps because the record evidence on the issue was in conflict. Compare, e.g., Direct Testimony of Richard Schmalensee p 241, reprinted in 7 J.A. at 4315 ([A]ll major operating system vendors do in fact include Web-browsing software with the operating system at no extra charge.) (emphasis added), with, e.g., 1/6/99 pm Tr. at 42 (trial testimony of Franklin Fisher of MIT) (suggesting all OSs but Microsoft offer discounts). 205 Microsoft does not dispute that many consumers demand alternative browsers. But on industry custom Microsoft contends that no other firm requires non-removal because no other firm has invested the resources to integrate web browsing as deeply into its OS as Microsoft has. Appellant's Opening Br. at 25; cf. Direct Testimony of James Allchin p p 262-72, reprinted in 5 J.A. at 3385-89 (Apple, IBM); 11/5/98 pm Tr. at 55-58 (trial testimony of Apple's Avadis Tevanian, Jr.), reprinted in 9 J.A. at 5507-10 (Apple). (We here use the term integrate in the rather simple sense of converting individual goods into components of a single physical object (e.g., a computer as it leaves the OEM, or a disk or sets of disks), without any normative implication that such integration is desirable or achieves special advantages. Cf. United States v. Microsoft Corp., 147 F.3d 935, 950 (D.C. Cir. 1998) (Microsoft II).) Microsoft contends not only that its integration of IE into Windows is innovative and beneficial but also that it requires non-removal of IE. In our discussion of monopoly maintenance we find that these claims fail the efficiency balancing applicable in that context. But the separate-products analysis is supposed to perform its function as a proxy without embarking on any direct analysis of efficiency. Accordingly, Microsoft's implicit argument--that in this case looking to a competitive fringe is inadequate to evaluate fully its potentially innovative technological integration, that such a comparison is between apples and oranges--poses a legitimate objection to the operation of Jefferson Parish's separate-products test for the per se rule. 206 In fact there is merit to Microsoft's broader argument that Jefferson Parish's consumer demand test would chill innovation to the detriment of consumers by preventing firms from integrating into their products new functionality previously provided by standalone products--and hence, by definition, subject to separate consumer demand. Appellant's Opening Br. at 69. The per se rule's direct consumer demand and indirect industry custom inquiries are, as a general matter, backward-looking and therefore systematically poor proxies for overall efficiency in the presence of new and innovative integration. See 10 Areeda et al., Antitrust Law p 1746, at 224-29; Amicus Brief of Lawrence Lessig at 24-25, and sources cited therein (brief submitted regarding Conclusions of Law). The direct consumer demand test focuses on historic consumer behavior, likely before integration, and the indirect industry custom test looks at firms that, unlike the defendant, may not have integrated the tying and tied goods. Both tests compare incomparables--the defendant's decision to bundle in the presence of integration, on the one hand, and consumer and competitor calculations in its absence, on the other. If integration has efficiency benefits, these may be ignored by the Jefferson Parish proxies. Because one cannot be sure beneficial integration will be protected by the other elements of the per se rule, simple application of that rule's separate-products test may make consumers worse off. 207 In light of the monopoly maintenance section, obviously, we do not find that Microsoft's integration is welfare-enhancing or that it should be absolved of tying liability. Rather, we heed Microsoft's warning that the separate-products element of the per se rule may not give newly integrated products a fair shake. 208