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Monopolization, Exclusion, and the Theory of the Firm Alan J College of William & Mary Law School William & Mary Law School Scholarship Repository Faculty Publications Faculty and Deans 2005 Monopolization, Exclusion, and the Theory of the Firm Alan J. Meese William & Mary Law School, [email protected] Repository Citation Meese, Alan J., "Monopolization, Exclusion, and the Theory of the Firm" (2005). Faculty Publications. 58. https://scholarship.law.wm.edu/facpubs/58 Copyright c 2005 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository. https://scholarship.law.wm.edu/facpubs Article Monopolization, Exclusion, and the Theory of the Firm Alan J. Meeset Introduction .............................................................................. 744 I. Definition of "Monopolize" Under Section 2 .................. 750 A. General Monopolization Standards ........................ 750 B. The Early Years: The Intent Test ........................... 753 C . M odern L aw .............................................................755 D. Application: The Microsoft Case ............................. 762 II. Price Theory, Competition on the Merits, and Contractual Exclusion .................................................... 771 A. Workable Competition, Exclusion, and the Theory of the Firm ................................................... 772 B. Price Theory and Workable Competition in the C ourts ........................................................... 793 1. Early Influence ................................................... 793 2. United Shoe Machinery and "Competition on the M erits" ............................. ............................ 797 C. Price Theory's Continuing Influence on M onopolization Doctrine .......................................... 808 III. Transaction Cost Economics and the Theory of th e F irm .......................................................................... 812 A. A Revolution in Economic Theory ........................... 812 B. TCE's New Version of (Contractual) Competition.. 822 C. TCE's New Model of Competition ........................... 827 D. TCE's Influence over Antitrust: Section 1 .............. 830 IV. TCE and Monopolization Doctrine ................................. 831 A. How TCE Undermines Modern M onopolization Law ................................................. 832 t Ball Professor of Law, William and Mary School of Law. J.D., The University of Chicago; A.B., The College of William and Mary. The William and Mary School of Law provided a generous summer research grant in sup- port of this project. Della Harris assisted in preparation of the manuscript, and Susan Billheimer provided diligent research assistance. 744 MINNESOTA LAW REVIEW [89:743 B. Toward a New Definition of Unlawful Contractual Exclusion ............................................. 842 C onclu sion ................................................................................. 846 Section 2 of the Sherman Act penalizes those firms that "monopolize" or "attempt to monopolize" any relevant market.1 Unfortunately, the term "monopolize" does not define itself. In one sense "monopolization" is any conduct that leads to or pro- tects monopoly. Still, the statute does not purport to forbid the mere status of monopoly, and such a definition of "monopolize" would sweep quite broadly. After all, firms may take over a market, or protect a monopoly they already have, in a variety of ways. At one extreme, firms can murder their competitors or destroy their factories. At the other extreme, firms can build a better mousetrap or reduce the cost of building an average mousetrap. Finally, a firm that produces a better mousetrap can devise some method for minimizing the cost of distributing the trap to consumers. Each of these tactics can create or protect monopoly. In that sense, then, each such tactic "monopolizes" the market in question. Nonetheless, any rational society would want to dis- tinguish between the various tactics that might produce or pro- tect a monopoly. The innovative firm that invents the better mousetrap may harm its rivals, but at the same time, also does society a great service. The injured rival that burns down the innovator's factory or slanders its product does not. A defensi- ble definition of "monopolize" would presumably distinguish be- tween the two. For nearly a century, antitrust courts have maintained just such a distinction.2 In particular, early decisions held that ''normal" or "ordinary" conduct does not offend the Sherman Act, including section 2, even if such conduct leads to or pro- tects a monopoly. 3 More recently, courts have relied upon a 1. See Sherman Antitrust Act, ch. 647, § 2, 26 Stat. 209 (1890) (codified as amended at 15 U.S.C. § 2 (2004)). 2. See Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 223 (1993) (noting that section 2 does not forbid aggressive pricing by a monopolist that preserves its dominant position); United States v. Am. Tobacco Co., 221 U.S. 106, 178-81 (1911) (concluding that section 2 only for- bids monopoly obtained or maintained by unnatural means). 3. See United States v. Int'l Harvester Co., 274 U.S. 693, 708 (1927) (stating that section 2 does not make mere size an offense); United States v. United Shoe Mach. Co. of N.J., 247 U.S. 32, 64-66 (1918) (holding that section 2 does not forbid normal conduct that preserves a monopoly); Am. Tobacco, 2005] MONOPOLIZATION 745 slightly different formulation, condemning only that conduct which they deem "exclusionary."4 Neither formulation is particularly illuminating on its face. For one thing, business practices do not announce themselves as "normal" or "abnormal." Moreover, an inquiry into whether a practice is "exclusionary" merely restarts the inquiry into the meaning of "monopolize." After all, the firm that invents a bet- ter mousetrap "excludes" its competitors from the market just as surely as the firm that employs force or other tortious tac- tics. Current law seeks additional precision by drawing a dis- tinction between two different sorts of conduct that can "ex- clude" rival firms from the marketplace. On the one hand, "in- ternal" conduct, including decisions on product design, marketing strategies, refusals to buy or sell, and pricing and output, are treated as "competition on the merits" and pre- sumed lawful, even if they drive competitors from the market- place. This presumption is extremely robust: plaintiffs can only rebut it by showing that, for instance, a particular price is be- low some measure of cost, or that the practice produces no plausible benefits. Thus, the vast majority of internal conduct, including above-cost pricing, is simply lawful per se, even if such conduct has led, or will lead, to a monopoly by excluding rivals. On the other hand, "external" conduct, that is, agree- ments or other practices that contractually constrain other firms, are presumed unlawful whenever they impair or tend to impair significantly the opportunities of rivals. While this pre- sumption is rebuttable, defendants that seek to do so face a heavy burden. Not only must defendants show that the chal- lenged arrangement produces significant benefits; they must also show that the practice is no broader than necessary to achieve those benefits. Thus, even where such conduct produces more benefits than harm, courts will still condemn it if plain- tiffs establish that there is a "less restrictive means" of achiev- 221 U.S. at 178-81 (holding that section 2 only forbids "undue" restraints that lead to or protect monopolies); see also Standard Oil Co. v. United States, 221 U.S. 1, 62 (1911) (holding that the Sherman Act forbids only unreasonable re- straints of trade and does not forbid "monopoly in the concrete"); United States v. Joint Traffic Ass'n, 171 U.S. 505, 566-68 (1898) (holding that section 1 of the Sherman Act does not forbid "indirect" restraints of trade or "ordinary con- tracts and combinations"); infra notes 10-19 and accompanying text. 4. See Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. 451 (1992); United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001); see also infra notes 37-42 and accompanying text. MINNESOTA LAW REVIEW [89:743 ing the objective in question. This distinction between "inter- nal" and "contractual" exclusion corresponds roughly to a dis- tinction between property and contract. While conduct that takes place "within" the firm and excludes rivals involves the exercise of a single entity's property rights, contractual exclu- sion involves agreements with one or more other firms. This Article offers a critique of antitrust's distinction be- tween "internal" and "contractual" exclusion as well as the preference for property-based "competition on the merits" on which this distinction rests. In particular, the Article shows that antitrust's modern distinction between "competition on the merits" and contractual exclusion reflects the undue influence of neoclassical price theory, the economic paradigm that domi- nated the study of industrial organization for most of the twen- tieth century. Price theory, it is shown, produced a theory of the firm and related model of "workable competition" that natu- rally gave rise to a distinction between "internal" and "contrac- tual" exclusion. Built on the perfect competition model, price theory treats the business firm as a sort of "black box," an impersonal entity that takes in inputs and transforms them into outputs. In this way, the firm performs a crucial function: the allocation of re- sources from input markets
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