Appellate Court Affirms FTC’s Finding of Illegal Exclusive Dealing Program

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Appellate Court Affirms FTC’s Finding of Illegal Exclusive Dealing Program

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On April 15, 2015, a panel of the 11th Circuit affirmed a decision by a divided Federal Trade Commission that McWane, Inc. violated FTC Act Section 5 with a partial exclusive dealing program adopted to combat a rival. In doing so, the court afforded great deference to the FTC’s factual determinations and analysis. The case is a reminder that common marketing practices like loyalty pricing programs adopted by entities found to have market power can violate antitrust law, even if any resulting exclusivity is de facto and any foreclosure of competitors is incomplete. (See our earlier alert on McWane in the FTC here).

McWane is the only U.S. producer of ductile iron pipe fittings and one of a small number of U.S. sellers of such products. It was accused of excluding one of its few rivals from a market for domestically produced fittings through a loyalty rebate program that was effectively an exclusive dealing arrangement. Because that foreign-based rival, Star Pipe Products, had not yet developed a full line of domestic fittings from its supplier foundries, many distributors chose to purchase only from McWane to ensure access to a complete line of domestically-produced fittings. According to Star, that loss of sales prevented it from generating enough sales to justify purchasing its own foundry and matching McWane’s costs. In a 3-1 vote, Commissioner Josh Wright dissenting, the FTC found such actions constituted illegal exclusion.

The Commission found that McWane had monopoly power in a properly-defined market for domestic fittings. (Commissioner Wright did not join in that finding but assumed McWane had monopoly power.) Next, the Commission found this "modest short term rebate" was a de facto exclusive dealing program because of numerous internal and external statements by McWane that, with some exceptions, it would not sell domestic fittings to distributors who purchased such fittings from Star (Commissioner Wright explicitly agreed with this characterization.)

Finally, the Commission found that such exclusive dealing was, on balance, anticompetitive. Several major distributors decided not to buy any domestic fittings from Star for fear that McWane would not sell them any of its full line of domestic fittings. This "substantial foreclosure" prevented Star from obtaining the sales it said it needed to achieve what it described as minimum efficient scale (MES). Achieving such scale would allow Star to purchase its own domestic foundry and compete more effectively with McWane. The level of foreclosure here and when it became "substantial" were not clear from the opinion, although the Commission did mention two major distributors who chose not to purchase from Star and whose combined shares of distribution added up to more than 50 percent.

In dissent, Commissioner Wright agreed that the majority articulated a coherent theory of competitive harm but argued that the evidence was insufficient to support that theory. In particular, Wright asserted that the majority simply calculated the percentage of distributors from which Star was foreclosed (and miscalculated the percentage at that) and declared it “substantial.” They did not sufficiently link that foreclosure to Star’s failure to achieve MES and effectively challenge McWane, mostly because the evidence of MES in this industry was weak. Other evidence in the record, especially Star’s initial success in selling domestic fittings made at others’ foundries, supported the opposite conclusion. As a result of this evidentiary failure, Wright dissented.

McWane challenged three findings of the Commission. The 11th Circuit applied a deferential “substantial evidence” standard to all three and found them adequately supported by the evidence.

First, McWane challenged the “domestically-produced fittings” product market definition because it was “unsupported by an expert economic test.” The court acknowledged that some of its earlier opinions could be read to require non-conclusory expert testimony. Here, however, the FTC did have an expert who considered the interchangeability between domestic and imported fittings, though without an econometric cross-elasticity of demand analysis. The FTC’s reliance on qualitative evidence, such as persistent price differences between domestic and imported fittings, met the court’s deferential standard.

Second, the court agreed with the Commission’s finding that McWane had monopoly power in that market. McWane claimed that Star’s entry and capture of 10 percent of the market precluded such a finding: “[A]ctual entry of a new competitor or expansion by an existing competitor precludes a finding that exclusive dealing is an entry barrier of any significance.” While the court acknowledged the importance of such entry, it found that McWane’s continuing 90 percent share, substantial barriers to any other new entry and McWane’s continued high and profitable pricing of domestic fittings were enough to support the Commission’s finding.

The court also agreed with the Commission’s finding that the pricing program harmed competition. McWane first argued that the program was “presumptively legal” because the program lasted only four months and was easily and immediately terminable. The court acknowledged the relevance of the program’s short duration but rejected any “formalistic distinctions” that would stop a review of all “market realities,” especially given that some McWane distributors thought the program was still in effect months later.

Next, McWane pointed to Star’s gain of 10 percent market share to rebut any finding that the program resulted in “substantial foreclosure” as required by case law. The court rejected that argument, finding the Commission’s implicit finding of at least 50 percent foreclosure (through its vague references to McWane’s agreements with two key customers) to be sufficient to comport with earlier cases recognizing 40 percent foreclosure as anticompetitive. More generally, the court explained that “monopolists [can be] liable for anticompetitive conduct where, as here, the targeted rival gained market share -- but less than it likely would have absent the conduct … [E]xclusive dealing measures that slow a rival’s expansion can still produce consumer injury.” The court also quickly found sufficient the Commission’s evidence of MES. As a result, the court agreed with the Commission’s finding that the “probable effect” of McWane’s program was to harm competition.

This opinion shows that exclusive dealing programs that are only partial and de facto can cause antitrust problems for monopolists. It also shows that companies need not be huge to have monopolies in narrowly defined markets. McWane has vowed to petition for Supreme Court review so we might learn more about when such common marketing programs violate the antitrust laws. In the meantime, companies considering loyalty pricing programs should discuss them before implementation with a trusted antitrust adviser like Steve Cernak, Bill Hannay, or any of the attorneys in Schiff Hardin’s Antitrust and Trade Regulation Group.