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Understanding Market Power and Monopoly Power: A Distinction in Antitrust Law, Lecture notes of Law

The distinction between market power and monopoly power in antitrust law. It explores how courts have struggled to distinguish the two concepts, relying primarily on market share as a determinant. The document also suggests alternative approaches, such as analyzing conduct and performance evidence, to identify monopoly power. It further discusses the limitations of market share as an indicator of market power and the potential for imperfect information to confer market power.

What you will learn

  • What is the difference between market power and monopoly power in antitrust law?
  • How can imperfect information confer market power?
  • What alternative approaches can be used to identify monopoly power?
  • How have courts approached the distinction between market power and monopoly power?
  • What are the limitations of using market share as a determinant of market power?

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*The views expressed are those of the author and Policy Studies’ staff and do not
necessarily reflect the views of the Commission or any individual Commissioner. The
paper derives from early drafts developed in the context of the FTC/Department of
Justice Joint Hearings on Section 2 of the Sherman Act: Single-Firm Conduct as Related
to Competition. Any language that overlaps with other commentaries on the hearings
reflects its origin in the common drafts.
1United States v. Grinnell Corp., 384 U.S. 563, 570–71 (1966) (identifying “the
possession of monopoly power in the relevant market” as an element of the offense of
monopoly).
2Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 456 (1993).
3Verizon Commc’ns Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 407
(2004).
4See Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 225
(1993) (noting that if conduct “could likely produce its intended effect on the target, there
is still the further question whether it would likely injure competition in the relevant
market. . . . ‘[predators] must obtain enough market power to set higher than competitive
WORKING PAPER – December 1, 2008
MONOPOLY POWER: USE, PROOF AND RELATIONSHIP
TO ANTICOMPETITIVE EFFECTS IN SECTION 2 CASES
by Thomas J. Klotz*
I. Introduction
Monopoly power is a key element in the analysis of single-firm conduct. The legal
element for monopolization under section 2 of the Sherman Act requires that the firm possess
monopoly power.1 A dangerous probability of obtaining monopoly power is necessary for
attempted monopolization.2 Yet, while the presence (or probability) of monopoly power is
required to find liability under section 2 of the Sherman Act, “[t]he mere possession of
monopoly power, and the concomitant charging of monopoly prices is . . . not unlawful.”3
Section 2 prohibits improper conduct to acquire or maintain monopoly power; the statute
prohibits improper conduct that has particular effects—the acquisition or maintenance of
monopoly power.
Consequently, the legal requirement—the possession of monopoly power—serves
multiple functions that are analytically related to, but are not explicitly part of, the Sherman
Act’s conduct-based prohibition. To begin with, the monopoly power requirement provides a
useful screen for identifying firms capable of causing competitive harm through their single-firm
conduct. It is only when the firm has sufficient market power that exclusionary conduct can
have an anticompetitive effect on the market and consumers4 by, inter alia, decreasing output,
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  • (^) The views expressed are those of the author and Policy Studies’ staff and do not

necessarily reflect the views of the Commission or any individual Commissioner. The paper derives from early drafts developed in the context of the FTC/Department of Justice Joint Hearings on Section 2 of the Sherman Act: Single-Firm Conduct as Related to Competition. Any language that overlaps with other commentaries on the hearings reflects its origin in the common drafts.

(^1) United States v. Grinnell Corp., 384 U.S. 563, 570–71 (1966) (identifying “the

possession of monopoly power in the relevant market” as an element of the offense of monopoly).

(^2) Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 456 (1993).

(^3) Verizon Commc’ns Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 407

(2004).

(^4) See Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 225

(1993) (noting that if conduct “could likely produce its intended effect on the target, there is still the further question whether it would likely injure competition in the relevant market.... ‘[predators] must obtain enough market power to set higher than competitive

WORKING PAPER – December 1, 2008

MONOPOLY POWER: USE, PROOF AND RELATIONSHIP

TO ANTICOMPETITIVE EFFECTS IN SECTION 2 CASES

by Thomas J. Klotz *

I. Introduction

Monopoly power is a key element in the analysis of single-firm conduct. The legal element for monopolization under section 2 of the Sherman Act requires that the firm possess monopoly power. 1 A dangerous probability of obtaining monopoly power is necessary for attempted monopolization.^2 Yet, while the presence (or probability) of monopoly power is required to find liability under section 2 of the Sherman Act, “[t]he mere possession of monopoly power, and the concomitant charging of monopoly prices is... not unlawful.”^3 Section 2 prohibits improper conduct to acquire or maintain monopoly power; the statute prohibits improper conduct that has particular effects—the acquisition or maintenance of monopoly power.

Consequently, the legal requirement—the possession of monopoly power—serves multiple functions that are analytically related to, but are not explicitly part of, the Sherman Act’s conduct-based prohibition. To begin with, the monopoly power requirement provides a useful screen for identifying firms capable of causing competitive harm through their single-firm conduct. It is only when the firm has sufficient market power that exclusionary conduct can have an anticompetitive effect on the market and consumers 4 by, inter alia , decreasing output,

prices, and then must sustain those prices’” (quoting Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 590–91 (1986))); Frank H. Easterbrook, The Limits of Antitrust , 63 TEX. L. REV. 1, 20 (1984) (“Firms that lack [market] power cannot injure competition no matter how hard they try. They may injure a few consumers, or a few rivals, or themselves... by selecting ‘anticompetitive’ tactics. When the firms lack market power,... they cannot persist in deleterious practices.”).

(^5) Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 488 (1992) (Scalia, J.,

dissenting); see also United States v. Dentsply Int’l, Inc., 399 F.3d 181, 187 (3d Cir.

  1. (“Behavior that otherwise might comply with antitrust law may be impermissibly exclusionary when practiced by a monopolist.”).

(^6) See Dennis W. Carlton, Market Definition: Use & Abuse , COMPETITION POL ’ Y I NT ’ L ,

Spring 2007, at 3, 19 (“[I]f there is no market power after the alleged bad act, then the antitrust inquiry ends.”).

(^7) See id. at 19 (“[T]he central issue in a Section 2 case is whether some alleged bad act

enables additional market power to be exercised, and, if so, whether any exercise of additional market power is offset by the additional provision of valuable services made profitable as a result of the price increase.”).

raising price, or reducing innovation. Stated differently, “Behavior that might otherwise not be of concern to the antitrust laws—or that might even be viewed as procompetitive—can take on exclusionary connotations when practiced by a monopolist.” 5

This screening function provides certainty to the vast majority of firms that their conduct is not unlawful under section 2. It also helps to reduce enforcement costs, keeping many meritless cases out of court and allowing others to be resolved without a trial. When it can be determined that a firm lacks monopoly power, an evaluation of the firm’s conduct may be avoided.^6

For purposes of this screening function, courts traditionally have focused on whether monopoly power is present or likely to be obtained, i.e., they have tried to assess the level of market power. Yet, as discussed below, precise and reliable assessment of the presence of monopoly power is often difficult, and any screening inquiry is likely to be imperfect.

A second function of the monopoly power requirement often is intertwined with the assessment of the challenged conduct’s effects. When the analysis turns to assessing effects, the focus shifts to whether there is a change in the level of market power that results from particular conduct.^7 As a recent commentary phrases it:

[T]he ultimate economic question in antitrust litigation is almost never whether a firm or set of firms have market power. The case almost invariably concerns an economic objection to the challenged conduct... that turns on whether the conduct has increased (in a retrospective case) or is likely to increase (in a

(^13) This section analyzes the meaning of “monopoly power.” Related issues raised by the

attempt offense—requiring a “dangerous probability” of obtaining monopoly power—were not addressed in the hearings and generally are not examined in this paper.

(^14) Alan J. Dashkin & Lawrence Wu, Observations on the Multiple Dimensions of Market

Power , ANTITRUST , Summer 2005, at 53.

(^15) See ABA SECTION OF ANTITRUST LAW , M ARKET POWER HANDBOOK 1 (2005)

(“Economists define ‘market power’ as the ability of a firm or group of firms within a market to profitably charge prices above the competitive level for a sustained period of time.”) (emphasis omitted).

discussed below, to the extent that courts use a variant of market power—an economic concept suitable for assessing anticompetitive effects—for purposes not directly related to that objective, analytical tension and implementation problems result.

This paper reviews relevant case law, scholarship, and presentations at the Federal Trade Commission/Department of Justice Hearings on Section 2 of the Sherman Act to examine the definition of monopoly power, evidence that demonstrates the existence of monopoly power, and conclusions that can be drawn from particular types of evidence. Section II considers the legal and economic definitions of monopoly power and the relationship between monopoly power and market power. Section III examines categories of evidence that courts have used to determine whether a firm possesses monopoly power, including market definition and market share, profitability, and direct evidence of the exercise of monopoly power. The discussion identifies the limitations of these types of evidence. Given those limitations, Sections IV and V present a framework for assessing whether a firm possesses monopoly power based on market share and the presence of anticompetitive effects. Section IV discusses the ability to draw conclusions based on a firm’s market share; it suggests a rebuttable presumption that a firm with less than a 50% share of a properly defined relevant market lacks monopoly power. Section V discusses the inferences that may be supported by a demonstration of actual or likely anticompetitive effects and a causal link between the challenged conduct and anticompetitive harm; it urges recognition of the potential of such evidence to establish the presence of monopoly power. Finally, Section VI summarizes the conclusions.

II. The Definition of Monopoly Power 13

Despite the prominent role of monopoly power in section 2 analysis, its meaning remains “open to much debate and interpretation.” 14 The terms “market power” and “monopoly power” can have varied meanings, and this can generate semantic differences and disputes.

Market power is defined by economists as the ability profitably to price above marginal cost.^15 As a matter of economics, a firm possesses market power when the conditions of perfect competition are absent, so that the firm faces a downward-sloping demand curve. Firms in markets with differentiated products may face downward-sloping demand curves even if they do

(^16) See, e.g. , Sherman Act Section 2 Joint Hearing: Concluding Session Hr’g Tr. 55, May 8,

2007 [hereinafter May 8 Hr’g Tr.] (Sidak) (noting that firms “may have differentiated products that explain the downward slope of their firm demand curves,” and observing, “I don’t think that the downward sloping demand curve itself is a cause for antitrust intervention”); Sherman Act Section 2 Joint Hearing: Monopoly Power Hr’g Tr. 14, Mar. 7, 2007 [hereinafter Mar. 7 Hr’g Tr.] (Nelson) (discussing the distinction between downward-sloping demand curves and antitrust market power); Philip Nelson, Monopoly Power, Market Definition, and the Cellophane Fallacy 1 (Mar. 7, 2007), http://www.ftc.gov/os/sectiontwohearings/docs/0703PhilipNelsonpresentation.pdf (“not all firms with market power have sufficient market power to have ‘market power’ in an antitrust sense”). But cf. William S. Comanor, Is There a Consensus on the Antitrust Treatment of Single-Firm Conduct? , 2008 WIS. L. REV. 387, 391 (2008) (arguing that deviations from perfect competition often provide “[e]xisting degrees of market power

... sufficient for exclusionary actions to be successfully employed”).

(^17) 2B PHILLIP E. AREEDA , HERBERT HOVENKAMP & J OHN L. SOLOW , ANTITRUST LAW

¶ 501, at 111 (3d ed. 2007).

(^18) U.S. Dep’t of Justice & Fed. Trade Comm’n, Horizontal Merger Guidelines § 0.1 (1992)

[hereinafter Horizontal Merger Guidelines] (with Apr. 8, 1997 revisions to section 4 on efficiencies). But cf. Benjamin Klein and John Shepard Wiley, Jr., Competitive Price Discrimination as an Antitrust Justification for Intellectual Property Refusals to Deal , 70 ANTITRUST L.J. 599, 602, 628–33 (2003) (distinguishing as a wholly different concept, antitrust market power, which enables firms to control or influence market outcomes, from economic market power, which enables firms to set their own prices above marginal cost and is reflected by the elasticity of the firm’s demand curve).

not have large shares of the overall market.

Not all departures from the economic model of perfect competition are cause for concern. A small degree of market power is very common and widely understood not to warrant antitrust intervention.^16 Thus, “[m]arket power need not trouble the antitrust authorities unless it is both substantial in magnitude and durable.”^17

The antitrust concept of market power is familiar in other antitrust offenses and enforcement. For instance, the Agencies’ Horizontal Merger Guidelines explain that “[t]he unifying theme of the Guidelines is that mergers should not be permitted to create or enhance market power or to facilitate its exercise. Market power to a seller is the ability profitably to maintain prices above competitive levels for a significant period of time.”^18

A. Monopoly Power Must Be Substantial

The legal requirement for section 2 of the Sherman Act, however, calls for monopoly power, not market power. Monopoly power has no specific, broadly-adopted economic

(^23) See Dickson v. Microsoft Corp., 309 F.3d 193, 199 n.1 (4th Cir. 2002) (citation omitted);

United States v. Microsoft Corp., 253 F.3d 34, 51 (D.C. Cir. 2001) (en banc) (per curiam) (citation omitted); AD/SAT v. Associated Press, 181 F.3d 216, 227 (2d Cir. 1999) (citation omitted).

(^24) See Mar. 7 Hr’g Tr. at 87 (White) (stating that monopoly power is the ability profitably

to charge “a price significantly above marginal cost, sustained for a sustained amount of time... how much and for how long, I do not know.”).

(^25) Andrew I. Gavil, Copperweld 2000: The Vanishing Gap Between Sections 1 and 2 of the

Sherman Act , 68 ANTITRUST L.J. 87, 102 (2000).

(^26) See Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451, 481 (1992)

(concluding, without elaboration that evidence that Kodak “control[led] nearly 100% of the parts market and 80 to 95% of the service market, with no readily available substitutes,” was sufficient to survive summary judgment).

(^27) Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 775 (1984); see supra

notes 11 and 12 and accompanying text. But see George A. Hay, Market Power in Antitrust , 60 ANTITRUST L.J. 807, 818 (1992) (questioning—in light of the emergence of conduct-specific tests to shelter procompetitive activity such as low pricing— the need to adjust the market-power inquiry to avoid erroneously condemning beneficial single-firm conduct).

(^28) See infra Section III.B.

an ability to price “substantially” above the competitive level,^23 this provides no better basis for measuring substantiality.^24

Indeed, while commentators “readily acknowledge that market power will always be a matter of degree, none suggests that there is a meaningful, objective threshold for distinguishing ‘monopoly power’ from ordinary ‘market power’ when the evidence of market power is measured directly.” 25 Consequently, analytical attempts to distinguish monopoly power and antitrust market power have not proved useful.

Although the Supreme Court has stated that monopoly power under section 2 requires “something greater” than power under section 1, it suggested no means for operationalizing that principle.^26 Requiring a higher standard for monopoly power than for market power likely reflects an effort to limit the application of section 2 because of the heightened concern in single- firm contexts with “discourag[ing] the competitive enthusiasm that the antitrust laws seek to promote.” 27 This concern may be sensible in the aggregate, but on the facts of any particular case, courts have found no method to distinguish the concepts apart from market share, which permits only limited inferences regarding economic power. 28 It is not surprising that courts confronting the question typically reach the same conclusion regarding the existence or absence

(^29) See, e.g. , Reazin v. Blue Cross & Blue Shield of Kan., Inc., 899 F.2d 951, 967–72 (10th

Cir. 1990) (finding sufficient evidence that both market and monopoly power were present); Deauville Corp. v. Federated Dep’t Stores, Inc., 756 F.2d 1183, 1192 (5th Cir.

  1. (finding the evidence insufficient for either market power under section 1 or monopoly power under section 2 because there was no finding that the conduct affected competition); cf. U.S. Anchor Mfg., Inc. v. Rule Indus., Inc. 7 F.3d 986, 994 n.12 (11th Cir. 1993) (treating the terms “monopoly power” and “market power” as synonymous); International Distrib. Ctrs., Inc. v. Walsh Trucking, 812 F.2d 786, 791 n.3 (2d Cir. 1987) (same).

(^30) See Thomas G. Krattenmaker, Robert H. Lande & Steven C. Salop, Monopoly Power and

Market Power in Antitrust Law , 76 GEO. L.J. 241, 247 (1987) (“Economists use both ‘market power’ and ‘monopoly power’ to refer to the power of a single firm or group of firms to price profitably above marginal cost.”); Mar. 7 Hr’g Tr. at 32 (White) (“The way I was taught, it is all the same thing... .”); id. at 149–50 (Krattenmaker) (market power and monopoly power are “qualitatively the same”); CARLTON & PERLOFF , supra note 19, at 93 (terms monopoly power and market power typically are used to mean the ability to profitably set price above competitive levels); Hay, supra note 27, at 808 (equating the presence of market power with the potential for competitive harm); cf. Gregory J. Werden, Demand Elasticities in Antitrust Analysis , 66 ANTITRUST L.J. 363, 374 (1998) (“The precise distinction between ‘market power’ and ‘monopoly power’ requires an extended discussion, but the one critical point is that the courts use the term ‘monopoly power’ in a manner compatible with the economic concept of ‘market power.’”).

As discussed in Section II.B., infra , monopoly power invokes the additional consideration of durability. Moreover, in the context of section 1 or other areas of antitrust law, market power includes the ability of a group of firms to maintain price above the competitive level. Many section 1 cases address collusion, where the market power of a group of firms acting together is able to cause competitive harm. In such cases, the group jointly possesses the necessary market power; no single firm may possess sufficient market power. In contrast, under section 2, the concern is the power of a single firm. See Hay, supra note 27, at 818 n.43.

of both monopoly power under section 2 and market power under section 1. 29

In sum, to the extent that market power and monopoly power address the same core policy issue—whether the firm is able profitably to maintain price above a competitive level—there is no clear means for distinguishing between the concepts.^30 To the extent that monopoly power requires “something greater,” as added protection against chilling procompetitive conduct, that increment cannot be derived from competition analysis and will likely be somewhat arbitrary.

(^36) See Mar. 7 Hr’g Tr. at 82–83, 84–85 (Gavil).

(^37) See AREEDA & HOVENKAMP , supra note 21, ¶ 801a, at 383 (“Few cases have paid much

attention to the length of time that market power has been held.”).

(^38) Mar. 7 Hr’g Tr. at 87 (White). But see AREEDA & HOVENKAMP , supra note 21, ¶ 801a, at

383 (proposing a presumption that a firm possesses monopoly when it maintains a market share of more than 70 or 75 percent for a period of five years).

(^39) See May 8 Hr’g Tr. at 41 (Eisenach) (proposing that fact-finders start the monopoly

power analysis with entry, rather than market share).

elaborates on the price inquiry, rather than stating a separate test for monopoly power.^36

There is no broadly accepted standard for defining the period necessary to establish that a firm’s ability to maintain price above a competitive level is durable.^37 One hearing panelist suggested that a two-year period may show sufficient durability to support a conclusion that a firm possesses monopoly power,^38 but the issue was not fully aired.

For purposes of this paper, the term “monopoly power” refers to a substantial degree of market power that enables a firm, acting unilaterally, profitably to maintain price above the competitive level or to produce other market-level effects for a significant period of time.

III. Determining the Existence of Monopoly Power

Determining the existence of monopoly power in section 2 contexts is difficult. Various methodologies and sources of evidence have been proposed to demonstrate that a firm possesses monopoly power. Yet, because of the information constraints that often are encountered, no single method of showing monopoly power can always be applied. Determining whether a firm has monopoly power requires assessing whether particular types of evidence are available; recognizing the limitations or flaws that may be inherent in that evidence; and assessing whether the available information is consistent.

Sometimes the problems can be eased. Several sources of evidence may enable a determination of whether or not a firm possesses monopoly power, and there is no advantage to a rigid, sequential order of assessment. For instance, when entry is easy, a firm’s ability to influence price will not be durable, regardless of market definition or the firm’s market share.^39 In such situations, no further analysis should be necessary. Similarly, the analysis should not invariably require one particular type of evidence if another approach suffices. Given the close relationship between monopoly power and anticompetitive effects, a failure of evidence regarding market definition should not lead to dismissal of a case if there is a sufficient demonstration of monopoly power based on competitive effects. Similarly, delineation of precise market boundaries should be unnecessary if anticompetitive effects are likely under any

(^40) See Mar. 7 Hr’g Tr. at 73–76 (Katz); Sherman Act Section 2 Joint Hearing: Academic

Testimony Hr’g Tr. 148–50, Jan. 31, 2007 [hereinafter Jan. 31 Hr’g Tr.] (Shapiro).

(^41) See United States v. Dentsply Int’l, Inc., 399 F.3d 181, 187 (3d Cir. 2005) (citing United

States v. Microsoft Corp., 253 F.3d 34, 51 (D.C. Cir. 2001) (because evidence of the ability to control prices or exclude competition is “only rarely available, courts more typically examine market structure in search of circumstantial evidence of monopoly power”).

(^42) United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377, 404 (1956)

(“ Cellophane ”); see also Microsoft , 253 F.3d at 51–52 (“Because the ability of consumers to turn to other suppliers restrains a firm from raising prices above the competitive level, the relevant market must include all products reasonably interchangeable by consumers for the same purposes.”) (internal quotations omitted); accord Horizontal Merger Guidelines, supra note 18, § 1.0 (finding that an antitrust market is defined “as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose at least a ‘small but significant and nontransitory’ increase in price, assuming the terms of sale of all other products are held constant.”).

(^43) See Jonathan B. Baker, Market Definition: An Analytical Overview , 74 ANTITRUST L.J.

129, 132 (2007).

(^44) Nelson, supra note 16, at 6. See generally Mark A. Glick, Duncan J. Cameron & David

G. Mangum, Importing the Merger Guidelines Market Test in Section 2 Cases: Potential

of the competing market definitions.^40

A. Market Definition and the Cellophane Fallacy

The existence of monopoly power is most commonly demonstrated indirectly, by defining a relevant market, showing that the firm has a dominant share of that market, and then examining entry and other structural characteristics of the market.^41 The relevant market in a section 2 case, as elsewhere in antitrust, is composed of “products that have reasonable interchangeability for the purposes for which they are produced—price, use and qualities considered.” 42 Thus, the market is defined with regard to demand substitution, which focuses on buyers’ views of which products are acceptable substitutes or alternatives.^43

1. The Cellophane Fallacy

Particular care is required when identifying acceptable alternatives for consumers in cases alleging monopolization. “Undertaking a market definition analysis at monopolistic prices can lead one to define too broad a market and fail to identify market [and monopoly] power when it is present, which is known as the ‘Cellophane Fallacy.’” 44

(^51) See White, supra note 49, at 6–7; Mar. 7 Hr’g Tr. at 35–36 (White).

(^52) Horizontal Merger Guidelines, supra note 18, § 1.11.

(^53) See Gregory J. Werden, Market Delineation Under the Merger Guidelines: Monopoly

Cases & Alternative Approaches , 16 REV. I NDUS. ORG. 211, 212 (2000) (“[T]he issue in many cases arising under Section 2 of the Sherman Act is whether ongoing or threatened conduct, if left unchecked, would create monopoly power—not whether the defendant already possesses monopoly power. Section 2 plaintiffs commonly allege that a rival has (recently) embarked on a course of conduct that constitutes an unlawful ‘attempt to monopolize’ because there is a ‘dangerous probability’ that the conduct, if not enjoined, would create monopoly power.”); see also White, supra note 49, at 13.

(^54) Sherman Act Section 2 Joint Hearing: Section 2 Policy Issues Hr’g Tr. 160–62, May 1,

2007 [hereinafter May 1 Hr’g Tr.] (Willig).

share and incorrectly suggests an absence of monopoly power.

The Cellophane Fallacy presents challenges for analysis in many monopolization contexts. The Court’s error in the Cellophane case can easily arise in a monopoly-maintenance or monopoly-acquisition case if the question posed is whether the defendant has the power profitably to raise price.^51 In fact, the most frequently used analytical approach for defining antitrust markets—described in the Agencies’ Horizontal Merger Guidelines, which, as a general matter, define a relevant market by asking whether a hypothetical monopolist over various groups of products and areas would be able profitably to raise price above the prevailing level 52 — may repeat the error if carried over to the monopolization context absent an appropriate correction.

Although care in defining markets is warranted, the Cellophane Fallacy does not affect all section 2 cases. In particular, when the analysis is prospective, such as in some attempt-to- monopolize cases or other contexts in which the alleged monopolist has not yet exercised monopoly power, the Cellophane Fallacy is not a risk. 53 In such cases, using prevailing prices as the benchmark allows the identification of substitutes at the competitive or but-for-the- conduct price.

2. Proposed Methodologies for Addressing the Cellophane Fallacy

Defining a pre-conduct market. One panelist suggested using past prices that prevailed in the pre-conduct world to define the relevant market as of a time before the challenged conduct began. 54 The resulting market definition would be carried forward to the present to assess whether, after employing the challenged conduct, the firm achieved monopoly power in that market. According to the proponent of this approach, the Cellophane Fallacy need not preclude proper market definition in any monopolization case; even when monopoly power is currently being exercised, he advises, the usual market definition algorithm can be retained, provided that

(^55) Id. (“mentally, we can go back to before the [conduct] and still ask [what was the share

of the defendant in that market, what was the share of the excluded competitors and are there other sources of competitive discipline including entry] and there is a relevant market that’s pertinent for this analysis”).

(^56) See Nelson, supra note 16, at 6 (indicating that to avoid the Cellophane Fallacy, “market

definition must be based on substitution at competitive prices, not monopoly prices”).

(^57) See Mar. 7 Hr’g Tr. at 105 (Katz) (stating that “the competitive effects analysis would

look for a but-for price and would take into account a specific practice”); Werden, supra note 53, at 215 (“[T]he proper benchmark price for purposes of evaluating whether conduct is unlawfully exclusionary is the price that would prevail but for the challenged conduct. That price often is not the competitive price.”).

(^58) Nat’l Econ. Research Assocs., The Role of Market Definition in Monopoly and

Dominance Inquiries 19 (U.K. Office of Fair Trading, Econ. Discussion Paper No. 2, July 2001), http://www.oft.gov.uk/shared_oft/reports/comp_policy/oft342.pdf. (“[I]n practice it is extremely difficult and in most cases impossible to determine the

it is applied to the pre-conduct world.^55

To the extent that conduct is not quickly challenged, however, the exercise may require determining the availability and attractiveness of substitutes in the distant past. This may pose serious practical problems. Further, intervening new product introductions and the demise of competing products, perhaps from causes unrelated to the challenged conduct, may make the pre-conduct market anachronistic.

More important, the approach would still be subject to the Cellophane Fallacy if the challenged conduct was adopted to maintain pre-existing monopoly power, rather than to acquire monopoly power. In monopoly maintenance cases, using pre-conduct prices to define a pre- conduct market will build any pre-existing monopoly power into the market definition process. Consequently, it will distort an inquiry into whether the firm possessed monopoly power that it sought to shelter from erosion.

Using a more competitive benchmark price. A second approach to avoid the Cellophane Fallacy is to substitute a more competitive price for the prevailing price in current market circumstances. The appropriate benchmark price will vary depending upon the inquiry at issue. If the question is the one typically addressed in the case law—whether the firm possesses monopoly power—then a benchmark based on the competitive price is appropriate to identify whether alternative products will constrain the exercise of monopoly power.^56 When the goal is to examine the competitive effects of the allegedly exclusionary conduct—whether the given conduct confers or enhances the ability profitably to raise price, reduce output, or diminish quality—the appropriate benchmark is the price that would have prevailed but for the conduct.^57

Practical problems in determining these benchmarks, however, can be severe, 58 and, for

Guidelines for Collaborations Among Competitors § 3.32(a) (2000) (“[W]hen circumstances strongly suggest that the prevailing price exceeds what likely would have prevailed absent the relevant agreement, the Agencies use a price more reflective of the price that likely would have prevailed.”).

(^64) The Horizontal Merger Guidelines examine a hypothetical monopolist’s ability to raise

its own price ( i.e. , to “impose[] at least a ‘small but significant and nontransitory’... increase in price”), on the assumption that the prices of potential rival products are held constant ( i.e. , on the assumption that “terms of sale of all other products remain[] constant”). Horizontal Merger Guidelines, supra note 18, § 1.11.

(^65) See Mar. 7 Hr’g Tr. at 24–25 (Simons); see also id. at 63 (Gilbert) (arguing that market

definition should be specific to competitive effects analysis; inquiries that explicitly account for the effects of excluded competition tie together competitive effects with market definition and thereby avoid the Cellophane Fallacy); Krattenmaker, Lande & Salop, supra note 30, at 256–57 (urging that market definition methodology be expanded to evaluate effects of conduct on rivals’ costs and the effects of those costs on prices in output markets, and arguing that “this determination... represents the central focus of the analysis, not a threshold inquiry undertaken independently of the analysis of the defendant’s conduct”).

(^66) See Mar. 7 Hr’g Tr. at 127–28 (Bishop); Nelson, supra note 16, at 13 (for

monopolization cases, “[t]here is no ‘cookbook’ methodology for defining markets”).

(^67) Even without a formal algorithm or paradigm, courts often are able to delineate a relevant

market based on observation of the facts and circumstances of the industry. Mar. 7 Hr’g Tr. at 67–68 (Katz) (concluding that market definition and relevant markets are often obvious); id. at 102–03 (Carlton) (arguing that, in many cases, “market definition is just this seat-of-the-pants thing”).

becomes more than a theoretical possibility, at least for allegations of monopoly maintenance.

Moreover, the hypothetical monopolist test may not have the optimal focus for all section 2 issues. It defines the market by considering the profitability of a hypothetical monopolist raising its own price and restricting its own output. 64 In contrast, for many Section 2 cases, the concern is that the firm tries to raise the cost and restrict the output of others; some panelists suggested that the market definition paradigm should reflect such a theory of anticompetitive effect.^65 The proposed methodologies for addressing the Cellophane Fallacy, notably the use of the price that would prevail but for the challenged conduct, recognize that market definition must be specific to the theory of competitive effects.

Unfortunately, there is no accepted alternative to the hypothetical monopolist methodology and no single accepted paradigm for defining relevant markets in all monopolization cases.^66 Market definition is not always difficult,^67 but, as one of the panelists

Moreover, analysts suggest that, despite inherent limitations in many monopolization contexts, the hypothetical monopolist test and the ensuing identification of market participants appropriately focus on demand and supply substitution and thereby help to avoid ad hoc conclusions regarding boundaries of the market and effects of the conduct. See Mar. 7 Hr’g Tr. at 130 (Bishop) (stating that “even just using the SSNIP test as a thought process can actually provide a useful discipline on how to define relevant markets”); Nat’l Econ. Research Assocs., supra note 58, at 19 (“[D]emand and supply substitution—concepts at the heart of the [hypothetical monopolist] test—will always be key and the [hypothetical monopolist] test provides a useful framework on which to build the remainder of the competitive analysis”); Werden, supra note 53, at 214–15 (“[T]he Guidelines’ hypothetical monopolist paradigm might still play a very useful, albeit conceptual, role... provid[ing] the critical insight necessary to decide the case without any need to get into the details of their application.”).

(^68) White, supra note 49, at 16.

(^69) Mar. 7 Hr’g Tr. at 118 (Katz).

(^70) See id. at 24–25, 30 (Simons) (recognizing that the Horizontal Merger Guidelines

approach to market definition may not be optimal for section 2 cases and hoping for development of a new approach that integrates theory of competitive effects); id. at 63 (Gilbert) (“[T]he market definition exercise puts the cart in front of the horse. We should be thinking about where are the competitive effects, how significant can the competitive effects be, and then let the market definition respond to that rather than defining where the competitive effects are.”).

(^71) See, e.g. , id. at 114–18 (Nelson, Simons, White, Gavil, Gilbert, Katz) (advocating greater

reliance on analysis of competitive effects, but recognizing that market definition may be useful in some contexts); Jan. 31 Hr’g Tr. at 150 (Shapiro) (“[W]e need to be careful not to lose sight of what may be a simple or more direct argument that can get us to [the] analysis without... getting tied up particularly in market definition”); id. at 104– (Bresnahan) (“I want us to... think about both the potential for a competitive effect... [and] a causal link between the alleged act and monopoly. I would bring those to the fore. Those would be my framework for thinking about a Section 2 case.”); id. at 168– (Gilbert) (“I do think that the law creates a road map to make [s]ection 2 analysis unnecessarily difficult. You’ve got to... identify the market[.]... In all of these cases,.

has stated, “[T]he absence of a generally accepted market definition paradigm is a genuine problem for monopolization cases.” 68 Another noted, “We have not mapped out... exactly where you could do the hypothetical monopolist test, [and] where we need to do some alternative methodology.... sometimes, the fact that we do not have that has become an obstacle to good decision-making... .” 69 Other panelists voiced similar concerns.^70

Consequently, numerous panelists urged that the role of market definition and evidence derived from market definition, such as market shares, become less central in section 2 cases. 71

component of a monopolization claim” where there is direct evidence of monopoly power); Mar. 7 Hr’g Tr. at 73–74 (Katz) (taking the position that it would be a significant error if a legal requirement led a case involving differentiated products to be dismissed because proof of precise boundaries for one relevant market definition were insufficiently demonstrated when clear anticompetitive effects were shown within each possible definition of relevant market when alternative definitions of relevant markets are offered).

(^77) E.g. , Shoppin’ Bag of Pueblo, Inc. v. Dillon Cos., 783 F.2d 159, 162 (10th Cir. 1986)

(“Market share alone, however, is not enough to determine a firm’s capacity to achieve monopoly.”).

(^78) Carlton, supra note 6, at 12.

(^79) For example, in one a simple, yet common, model, when a dominant firm, in the presence

of smaller, price-taking rivals, sets price to maximize profits, high market shares are correlated with the exercise of market power, but a high market share is not sufficient to prove market power. Algebraically, a firm’s demand elasticity (gF ), which reflects its ability to increase price, depends on three factors— the market’s demand elasticity (gD ), the firm’s market share (S), and its rivals’ supply elasticity (gR):

F

D S R

S

See Landes & Posner, supra note 21, at 939–40, 944– 47 (“Although the... equation... provides an economic rationale for inferring market power from market share, it also suggests pitfalls in mechanically using market share data to measure market power.”). The firm’s demand elasticity, in turn, is inversely related to the Lerner index, a measure

are analyzed in sections III.C. and V., respectively.

B. Market Shares

After a relevant market has been defined, market shares frequently are used as a measure of monopoly power. As in other areas of antitrust, however, courts in section 2 cases typically do not view market shares as dispositive, but rather treat them as the starting point of the analysis.^77

1. Market Shares Provide Incomplete Information

Assuming that the relevant market has been properly defined, using market shares as a measure of monopoly power may nonetheless be misleading. “There is no [economic] model... where market share (or more precisely its change) is the only variable that matters in predicting the change in either price or welfare.” 78 Other factors have bearing on the inquiry.^79

of market power, defined as the firm’s price minus its marginal cost, all divided by its price. Id. at 939–40.

(^80) In addition, some models of competition ( e.g. , Bertrand price competition with

homogeneous goods) yield the competitive result with very few firms. See CARLTON & PERLOFF , supra note 19, at 174.

(^81) See, e.g. , United States v. Syufy Enters., 903 F.2d 659, 666–69 (9th Cir. 1990).

(^82) See, e.g. , Paul L. Joskow & Edward Khan, A Quantitative Analysis of Pricing Behavior

in California’s Electricity Market During Summer 2000 (AEI-Brookings Joint Center for Regulatory Studies, Working Paper 01-01, Jan. 2001) (explaining that in peak power electricity markets, output reductions by firms with relatively small shares may raise price by large amounts because the supply elasticities of other firms are low).

A simple example illustrates the potential pitfalls. Suppose a large firm competes with a fringe of small rivals, all producing a homogeneous product. In this model, the large firm’s market share is a determinant of its power over price. It is, however, only one determinant. Even a huge share does not guarantee substantial power over price for a significant period: if the fringe firms readily can substantially increase production from their existing plants in response to a small increase in the market price (that is, if the fringe supply is highly elastic), a large firm’s output restriction would not be profitable, and hence the firm would not have market power. 80 Similarly, market shares do not take account of potential entrants’ supply. Even when no current rival exists, if barriers to entry are low, an attempt to raise prices anticompetitively may lead to an influx of competitors that would make the price increase unprofitable. 81

On the other hand, conclusions based solely on market share also may underestimate market power. If rivals’ supply is unusually inelastic—such as when all capacity is already in full use—a firm with relatively modest market share may be able to exercise substantial market power. 82 Other factors, such a firm’s ability to exert control over rivals through essential intellectual property holdings, may also contribute to market power beyond what would be expected from market share based on the firm’s sales alone.

2. Market Shares May Provide Inaccurate Information

Obviously, market shares are dependent on market definition. The difficulties encountered in defining relevant markets must be overcome in order for market shares to be accurate and useful in evaluating monopoly power. In some settings, even apart from questions of market definition, reliance on market shares is particularly likely to yield faulty conclusions regarding monopoly power.

In markets characterized by rapid technological change, a high market share based on