Law of Marketing and Antitrust

Abstract

Every company must market their products to make a profit; however, the allowable methods of marketing are limited. The United States and other market economies are committed to the principle of competition because it protects consumers, encourages efficiency and innovation in producers, and maximizes overall wealth. Society, in the form of the antitrust law, has announced its strong policy against monopolies, cartels, and other arrangements that threaten competition. The company seeking to market its products is well advised to steer clear of any practices that hamper competition. Excessive market power, tying agreements, and cartel violations can all attract the attention of government regulators seeking to enforce antitrust law. This article reviews these concepts and the criminal penalties for violation of the antitrust law.

Overview

All businesses operate by offering some good or service within some market. The basic forces that drive those markets economies are supply, demand, and competition. Market economies are dedicated to the principle that people are in the best position when they can make voluntary exchanges of goods and services at prices controlled by competitive markets. When exchanges are made in competitive markets, society will be better off because markets remain open and output can expand, thereby maximizing national wealth. Antitrust laws are designed to control private economic power by preventing monopolies, punishing cartels, and otherwise ensuring competitive markets. A market is competitive if goods are priced at the cost of production giving sellers and producers enough profit to maintain their investment in the industry and if all consumers willing to pay that price are able to purchase those goods (Hovenkamp, 1985).

As an economic model, a perfectly competitive market is characterized by the existence of several factors. First, sellers would produce identical products such that consumers are indifferent regarding which supplier they buy from. Second, each supplier is so small as compared to the overall market that fluctuations in their output, or their withdrawal from the market, would not affect the decisions of other sellers. Third, all sellers would have the same access to the material required to produce their goods. Fourth, all participants in the market would have perfect knowledge about prices, output, and other market information. The closer a market comes to meeting all of the four standards, the more competitively that market will perform (Hovenkamp, 1985).

A monopoly is essentially the opposite of perfect competition. Monopolies seek to maximize profits through substantial or total market power and restrict output in a way that limits supply and causes prices to rise. This practice reduces overall production and likely relieves the producer from competitive market pressures to be innovative and efficient. Monopoly markets are characterized by three factors. First, a single seller occupies the entire market. Second, that dominant seller sells a unique product. Third, there are substantial barriers to entry for other firms and exiting the market is also difficult. This third factor is likely the most important to monopolistic behavior. Without such barriers, other firms would be likely to enter the market when the monopolist raises prices or lowers quality from the competitive norm (Hovenkamp, 1985).

The Development of Antitrust Law. The law has developed over the years in order to protect markets from monopolies and anti-competitive behavior. Courts in England, dating back to 1414, sought to protect fair commercial activity by declaring void clauses in agreements between master and apprentice whereby the apprentice was prevented from entering the trade for a certain period of time or in a given location. Courts were, and are, hesitant to deprive a person of the ability to use their skills to earn a living and to deprive the public of the advantages of competition. However, the principle of freedom of contract held that people should be able to make agreements and courts should enforce those freely entered agreements without dictating how a person can or should dispose of the property or effort. The competing principles of market regulation and freedom of contract came to a head in the famous English case of Mitchell v. Reynolds in 1711. The case laid down the doctrinal principles to determine the enforceability of a restraint on trade. General restraints on trade were invalid because their only purpose was to limit competition. Society was justified in intervening in an agreement in order to protect a person who agreed to such a general restraint before the person became a burden to the state or deprived the public of the benefits of competition. Particular or specific restraints may be valid if they are limited in duration and scope and otherwise reasonable. The common law view was that the public was protected if the legal right to trade was guaranteed.

The inadequacy of the safeguard provided by the common law became apparent in the railroad industry where high capital expenditures to enter the market made competition sparse, even though all potentially interested parties had a legal right to enter the market. The concern was that a railroad could inflate rates on routes where it enjoyed a monopoly and then unfairly cut rates on competitive routes. In the United States, during the second half of the ninetieth century, rising public concern about the abusive practices of railroads and corporate giants led to antitrust legislation. Congress first responded with the Interstate Commerce Act and the Sherman Antitrust Act, both passed in 1890. The Sherman Act enjoyed overwhelming support and passed in Congress with only one vote cast against the measure. However, continuing corporate abuse along with disappointing judicial interpretation of the acts fueled continued public pressure for additional regulation. The antitrust issue dominated the 1912 presidential election and led to the Clayton Act and the Federal Trade Commission Act of 1914.

The operative provisions of Sherman Antitrust Act of 1890 are few and brief. Section 1 of the Sherman Act declares illegal all contracts, combinations, or conspiracies that unreasonably restrain interstate or foreign trade. The act applies to agreements among competitors that attempt to fix prices, rig bids, and allocate customers. Section 2 of the act declared illegal any monopoly or attempt to monopolize any part of trade. The violation of either section is punishable as a criminal felony. The Sherman Act did not create authority for active regulation of business. On the other hand, the general prohibition on monopolies and restraints of trade was more restrictive than the common law approach that only refused to enforce offensive contracts. The main effect of the Sherman Act was to bring the enforcement of antitrust law within the executive branch of government. The initial judicial reaction was to give the Sherman Act a very narrow reading followed by a very broad reading that made it unworkable. Eventually, the courts settled on the "rule of reason" and condemned only unreasonable conduct under the act (Hovenkamp, 1985).

Under the "rule of reason" businesses had little guidance as to what was illegal and courts had no specific mandate to enforce. To provide some guidance, in 1914 Congress passed the Clayton Act, which declared four restrictive or monopolistic activities against the law but not criminal offenses: Price discrimination (selling the same product at different prices to similar buyers); exclusive dealing contracts (selling on the condition that the buyer would not deal with seller’s competition); corporate mergers (acquisition of competing companies), and interlocking directors (common board members among competing companies). Each of these practices was illegal only when their effect was to considerably lessen competition or when they tended to create a monopoly in any line of commerce. The Federal Trade Commission Act of 1914, as amended in 1938, declared unlawful unfair methods of competition and deceptive trade acts (Hovenkamp, 1985).

Applications

The application of the antitrust law, for example section 2 of the Sherman Act, requires the finding that a company has monopolistic power. As a general matter, courts describe market power as the ability to raise prices or eliminate competition. When a firm raises prices to sell at higher than competitive price, that firm will lose customers. Market power refers to a firm's ability to raise prices without losing so many sales that the price increase becomes unprofitable. Monopolistic power is a high degree of market power. Therefore, a monopolist can deviate significantly from competitive or marginal cost and pricing and will enjoy increased profits. To determine market power, courts rely on the positive correlation between market share and market power. For example, suppose that a market is composed of ten firms each with 10 percent market share. If the competitive price is $1.00 and Firm X attempts to raise its price to $1.25, Firm X's customers will look to the competition to purchase the item at the competitive price. If each of those competitors can raise output by a little over 10 percent, Firm X will lose all of it sales. However, if Firm X has an 80 percent market share, Firm X's customers will still look to competitors but those competitors will have to substantially raise their output to take all of Firm X's sales. Firm X's increased prices would encourage other new firms to enter the market and cause current competitors to increase competition. While Firm X's position would eventually erode, it would be able to charge the higher price for quite some time. The firm with a large market share has market power because it may raise prices and, at least for a while, charge higher than competitive prices (Hovenkamp, 1985).

To infer the market power deemed illegal by the antitrust law, a court will typically determine the relevant product market and geographic area and then compute the firm's output in that relevant market. A particular company may have a number of product markets but many of those potential markets are not relevant for antitrust purposes. The relevant market is the smallest for which a firm with 100 percent of the market could profitably reduce output and raise prices. Consider the product market of "Ford cars," of which Ford does have 100 percent of the market. If Ford raised prices of Ford cars, then customers would likely turn to some other manufacturer; "Ford cars" is therefore not a relevant market. If the holder of 100 percent market share of "American passenger cars" raised prices, once again consumers would likely turn to manufactures from another country. However, if the holder of 100 percent of the market for "passenger cars" raised prices, consumers would have to switch to trucks, bicycles, or simply do without cars. In reality, because the demand for cars is sufficiently inelastic, a large percentage of consumers would pay the higher price. The elasticity of demand is the relationship between a change in the price for a product and the corresponding change in demand for that product. While the price increase would motivate related manufacturers to enter the market, causing GM to lose its monopolistic pricing, it would likely take several years. Of the examples listed above, the "passenger car" market is the smallest market that could result in monopoly pricing given 100 percent market share and it is therefore likely to be the relevant product market (Hovenkamp 1985).

The above analysis is focused upon the ability, or likelihood, that consumers would substitute one product for another. That concept of substitution of alternative products is known as the cross elasticity of demand. For two products that are close substitutes, a raise in the price of one will encourage consumers to buy the other. For example, corn and wheat are often used interchangeably for many purposes and the products would have a high cross elasticity of demand. For antitrust purposes, those two products would be in the same relevant market.

In addition to evaluating the cross elasticity of demand, antitrust law also evaluates the elasticity of supply. The elasticity of supply is the relationship between the changes in price and the amount of the product produced. As a general rule, as prices increase more companies will produce the products to earn those higher prices. Therefore, if producers of a product have a large amount of excess production capacity, the holder of a large percentage of the market would not be able raise prices. A price increase would prompt other producers to flood the market with those same products at the lower price.

Goal of Antitrust Policy. The overall goal of antitrust policy is assure the efficiency of market economies by protecting competition, and the law accomplishes this goal by prohibiting a number of activities. Although breaking up a massive company’s market power is certainly a popular notion, another practice called a tie-in can catch the attention of the antitrust law. A tie-in or tying arrangement may be illegal under the Sherman Antitrust Act, as an act in restraint of trade, or the Clayton Act, as an act that substantially lessens competition. A tying arrangement is the sale of one product on the condition that the consumer take another product as well. Generally, the practice of tying is illegal where the seller has sufficient economic power in one market to force the sale of the tied product and where the seller coerces the buyer to take the tied product. Many products are and may be legally tied or bundled; the law of tying agreements is aimed at those forced sales that are anti-competitive or cause injury to the seller's customers. However, that does not mean that the law seeks a solution that makes every consumer better off in every instance. The law seeks to make most consumers better off most of the time.

According to US Department of Justice (DOJ), cartel violations are the worst antitrust violations. Cartel violations include price fixing, bid rigging, and customer allocation. Price fixing happens when two or more competitors agree on a price to charge as when they agree to raise prices by a certain amount or agree not to sell below a certain price. Bid rigging occurs when two or more companies agree to bid so that a predetermined firm receives the contract. Bid rigging typically occurs in contracts for government work. Customer allocation agreements split customers between companies to reduce or eliminate competition. The allocation may be by geographic area or some other method. These types of cartel agreements are usually secret and the participants defraud consumers by pretending to be competitors even though they have made an agreement not to compete. These agreements harm consumers by forcing them to pay more for products and services and by removing the usual benefits of competition, such as innovation. It has been estimated that cartel arrangements can raise the price of products by 10 percent or more. The Department of Justice considers people that take consumer money by using one of these methods to be thieves (U.S. Dept. of Justice).

Enforcement of Antitrust Law. Antitrust laws are enforced by the Antitrust Division of the United States Department of Justice (both civil and criminal actions), the Federal Trade Commission (civil actions only), and by private parties asserting damage claims. DOJ attorneys investigate cases with the help of the Federal Bureau of Investigation and other investigative agencies. Most states also have antitrust laws very similar to the federal laws that are applied to antitrust violations that occur entirely within one state. State antitrust laws are generally enforced through the office of the state attorney general. Currently, the penalties for violations of the federal acts are fines up to $1 million and up to ten years in prison for each offense committed by an individual and fines up to $100 million for each corporate offense. In certain circumstances, the fine can exceed these maximums and go to twice the actual gain or loss.

Cartel violations are the Department of Justice's top antitrust priority. The DOJ has prosecuted and convicted many cartel violation cases in a number of industries, including soft drink, vitamins, trash hauling, auto parts, road building, and electrical contracting. Industries producing fax paper, display materials, explosives, plumbing supplies and doors, among others, have been investigated for possible violations. In the late 1990s, the DOJ began an investigation into a large-scale vitamin cartel that was affecting more than $5 billion in US commerce. The cartel had agreements on the production for each company, on the amount they should charge, and on the customer who they should serve. The victims of the cartel companies included such corporations as General Mills, Kellogg, Coca Cola, Tyson Foods, and Procter & Gamble. The effects of the cartel conspiracy were eventually felt in the form of higher prices for a decade by all Americans who took vitamins, drank milk, or ate cereal. The DOJ investigations led to the condemnation of Swiss, German, Canadian, Japanese, and US firms and many top executives from those companies went to prison and paid unprecedented fines of $850 million in 1999 alone (U.S. Dept. of Justice).

Conclusion

Every company must market their products to make a profit; however, the allowable methods of marketing are limited. The United States and other market economies are committed to principle of competition because competition protects consumers, encourages efficiency and innovation from producers, and maximizes overall wealth. The US government, in the form of the antitrust law, has announced its strong policy against monopolies, cartels, and other arrangements that threaten competition. The company seeking to market products is well advised to steer clear of any practices that prevent competition. Excessive market power, tying agreements, and cartel violations can all attract the attention of government investigators seeking to enforce the antitrust law.

Terms & Concepts

Bid rigging: When two or more companies make an agreement to bid so that a predetermined firm wins the contract, typically occurs in contracts for government work.

Competitive markets: When goods are priced at the cost of production giving sellers and producers enough profit to maintain their investment in the industry and all consumers willing to pay that price are able to purchase those goods.

Cartel: "An arrangement among supposedly independent corporations or national monopolies in the same industrial or resource development field organized to control distribution, set prices, reduce competition, and sometimes share technical expertise. Often the participants are multinational corporations which operate across numerous borders and have little or no loyalty to any home country, and great loyalty to profits. The most prominent cartel is OPEC (Organization of Petroleum Exporting Countries), which represents all of the oil producing countries in the Middle East, North Africa and Venezuela. Many cartels operate behind a veil of secrecy, particularly since under American antitrust laws (the Sherman and Clayton Acts) they are illegal" (www.dictionary.law.com).

Cross elasticity of demand: The measure of how the change in demand for one product affects the demand for another product.

Customer allocation: Agreements to split customers between companies to reduce or eliminate competition, often by geographic area.

Elasticity of supply: The relationship between the changes in price and the amount of the product produced.

Inelastic: A condition where a change in price does not cause a corresponding change in demand.

Monopoly: "A business or inter-related group of businesses which controls so much of the production or sale of a product or kind of product as to control the market, including prices and distribution. Business practices, combinations and/or acquisitions which tend to create a monopoly may violate various federal statutes which regulate or prohibit business trusts and monopolies or prohibit restraint of trade. However, limited monopolies granted by a manufacturer to a wholesaler in a particular area are usually legal, since they are like ‘licenses.’ Public utilities such as electric, gas and water companies may also hold a monopoly in a particular geographic area since it is the only practical way to provide the public service, and they are regulated by state public utility commissions" (www.dictionary.law.com).

Price fixing: When two or more competitors agree on a price to charge as when they agree to raise prices by a certain amount or agree not sell below a certain price.

Tie-in or tying arrangement: The sale of one product on the condition that the consumer takes another product as well.

Bibliography

Gates, B. (2000). The case for Microsoft. Time, 155, 57. Retrieved June 14, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=3074549&site=ehost-live

Gellhorn, E., Kovacic, W. E., & Calkins, S. (2004). Antitrust law and economics in nutshell (5th ed.). St. Paul, MN: Thomson/West.

Giving the invisible hand a helping hand. (2002). Economist, 365(8298), 14-15. Retrieved June 14, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7799641&site=ehost-live

Haw Allensworth, R. (2016). The commensurability myth in antitrust. Vanderbilt Law Review, 69(1), 1-69. Retrieved February 14, 2018, from EBSCO online database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=112363798&site=ehost-live&scope=site

Hovenkamp, H. (1985). Economics and federal antitrust law (Hornbook series student ed.). St. Paul, MN: West Publishing.

Kwoka, J. E., & Moss, D. L. (2012). Behavioral merger remedies: evaluation and implications for antitrust enforcement. Antitrust Bulletin, 57, 979–1011. Retrieved November 19, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=85404112

Levy, S., Sandberg, J., Stone, B., & Thomas, R. (1999). Bill takes it on the chin. Newsweek, 134, 52. Retrieved June 14, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=2457810&site=ehost-live

Markham, J. W. (2012). Sailing a sea of doubt: a critique of the rule of reason in U.S. antitrust law. Fordham Journal of Corporate and Financial Law, 17, 591–664. Retrieved November 19, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=77931207

McDonald, M. (2013). Antitrust immunity up in smoke: pre-emption, state action, and the master settlement agreement. Columbia Law Review, 113, 97–137. Retrieved November 19, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=84955965

U.S. Department of Justice Antitrust Enforcement and the Consumer Brochure, available at http://www.usdoj.gov/atr/public/div%5fstats/211491.htm

Suggested Reading

Brannon, I. (2016). When does antitrust activity stifle innovation? Regulation, 39(4), 6-7. Retrieved February 14, 2018, from EBSCO online database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=120433042&site=ehost-live&scope=site

Dassiou, X. & Glycopantis, D. (2006). The economic theory of price discrimination via transactions bundling: An assessment of the policy implications. Review of Law & Economics, 2, 323-348. Retrieved July 11, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=22934555&site=ehost-live

Dvorak, J. (2000). Not a monopoly, marketing. PC Magazine, 19, 69. Retrieved July 11, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=2639439&site=ehost-live

Peritz, R. J. R. (2013). Taking antitrust to patent school” the instance of pay-for-delay settlements. Antitrust Bulletin, 58, 159–171. Retrieved November 19, 2013 from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=88876653

Ulanoff, L. (2007). Google? A monopoly? PC Magazine, 26, 56-56. Retrieved July 11, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=25425988&site=ehost-live