The Supreme Court's recent decision in Eastman Kodak Co v. Image Technical Services, Case No. 90-1029, has sweeping implications for both manufacturers of high-tech equipment and those companies which service that equipment. Since the ascendancy of the Chicago School of antitrust economics began with Continental T.V. v. GTE Sylvania, 433 U.S. 35 (1977), manufacturers had enjoyed wide latitude in imposing vertical restraints on their products.
The Chicago School theory embraced three tenets which have now been rejected in Kodak: (1) that economic theory unsupported by facts was sufficient to determine the existence of markets, (2) that markets are determined before customers purchase products rather than after, (3) that a market cannot be defined by a single brand of a product.
The Supreme Court's recent antitrust cases, particularly in regard to summary judgment, seemed to indicate that Kodak's argument that markets could be determined by economic theory alone had some credence. Kodak relied on the antitrust summary judgment opinion in Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) for this proposition. However, the Supreme Court declined to read Matsushita as mandating summary judgment simply because the plaintiff's argument may not conform to economic theory.
Without Sylvania and Matsushita, the Chicago School is greatly weakened. Kodak has returned antitrust to tis fact-based roots, which means more trials and fewer summary judgment.
THE FACTS AND COMMERCIAL CONTEXT OF THE KODAK CASE
Maintenance was not always an important aspect of selling equipment. When the high-tech industry began to flourish, manufacturers of high-tech equipment such as computers, copiers and medical equipment first on manufacturing the equipment, and left service to independent service companies. They fostered growth of an independent repair and maintenance industry by providing the new service companies such services as training, parts, and diagnostic software. In turn, the ISOs recommended the brand they serviced to their customers, which fostered brand loyalty.
Then the economics of the industry changed. The price of computers dropped, and the demand for high quality and reliable service rose. Instead of most of the profits being in manufacturing, profits were found in the maintenance of the equipment. As a result of this change in economics, manufacturers sought to regain the market share they had fostered for the ISOs. By taking away the benefits they had provided, manufacturers succeeded in driving many ISOs out of business.
A similar pattern developed with regard to the plaintiffs in the Kodak case. In Kodak, the plaintiffs , a group of eighteen ISOs, alleged that Kodak unlawfully tied the sale of its replacement parts to the purchase of service of Kodak copiers directly from Kodak. For years, Kodak sold unique replacement parts for its copiers to anyone who wanted to purchase them. As a result, independent service organizations (ISOs) began purchasing replacement parts in order to service Kodak equipment themselves.
After the ISOs began to compete successfully with Kodak, Kodak revised its policy and refused to sell parts to ISOs or customers who used ISOs.
The district court, after very little discovery and no expert testimony, granted Kodak's motion for Summary Judgment. On the tying claim, the district court held that Kodak did not "condition the sale of one product on the buyer's purchase of another product" because the two could be bought separately. Image Technical Services v. Eastman Kodak Co., 1989-1 Trade Cas. ¶ 68,402 (N.D.Cal. 1988).
The Court of Appeals reversed on both the tying and monopolization claims. Image Technical Services v. Eastman Kodak Co., 903 F.2d 612, 615, 620. The Ninth Circuit held that a material issue of fact existed as to whether parts and service constituted separate products, id. at 615, and then went on to consider the market power issue, which was not decided by the district court. Id. at 616. Although the Ninth Circuit recognized that Kodak's arguments might have merit, it nonetheless found that "market imperfections" might exist so that market power was possible.
Citing Jefferson Parish Hosp Dist. No.2 v. Hyde, 466 U.S. 2 (1984), the court stated that "market imperfections can keep economic theories about how consumers will act form mirroring reality." Id. at 617. The court echoed Jefferson Parish in holding that "[s]ome strength in the interbrand market, although short of actual market power, can combine with other factors to yield power in an after-market." Id. at 618. This implicit rejection by the Ninth Circuit of economic theory advanced by the Chicago School was followed by the Supreme Court.
MATSUSHITA AND THE STANDARD FOR SUMMARY JUDGMENT
Kodak claimed that Matsushita entitled it to a summary judgment because Kodak offered a coherent economic theory that explained its behavior. According to Kodak, it was entitled to a legal presumption that it did not have market power over Kodak parts because it did not have a large share of the market for copiers generally.
Many lower courts had interpreted Matsushita to hold that when a plaintiff's theory in an antitrust case does not make economic sense, a defendant is entitled to summary judgment. Some courts found that Matsushita imposed a greater burden on plaintiffs in antitrust cases in the summary judgment context than in other cases. The Supreme Court, however, clarified that a plaintiff's burden of proof in an antitrust case is no different from that in any other case.
The Court stated: "The Court's requirement in Matsushita that the plaintiffs' claims make economic sense did not introduce a special burden on plaintiffs facing summary judgment in antitrust cases....Matsushita demands only that the nonmoving party's inferences be reasonable in order to reach a jury, a requirement that was not invented, but merely articulated, in that decision." Contrary to Kodak's assertions, the Court found that Matsushita "did not hold that if the moving party enunciates any economic theory supporting its behavior, regardless of its accuracy in reflecting the actual market, it is entitled to summary judgment."
Instead of placing a heavier burden of proof on a plaintiff in an antitrust case, the Court found that a defendant, seeking to foreclose a plaintiff from presenting his case based on an economic theory, "bears a substantial burden in showing that it is entitled to summary judgment." The Court specifically held that "...[i]n this situation, Matsushita does not create any presumption in favor of summary judgment for the defendant."
THE CHICAGO SCHOOL AND GTE SYLVANIA
The Sylvania case involved a suit by a franchised retailer of Sylvania televisions which claimed that Sylvania had violated the antitrust laws by permitting a franchise to sell Sylvania products only from specific locations. According to Sylvania, it was necessary to limit the number of franchises and adopt a practice of limiting locations from which merchandise could be sold because of fierce competition in the market for the sale of television sets generally.
The Court, relying on Chicago School theory, including an article by Richard Posner[2] (then a professor at the University of Chicago Law School, and now a federal judge on the Seventh Circuit), held that vertical restraints which were not price related were not governed by a per se rule of illegality. Instead, such claims had to be governed by the rule of reason standard, which is more difficult for plaintiffs to prove.
In analyzing the allegations in Sylvania, the Court found that although vertical restrictions reduce intrabrand competition (competition among sellers of the same brand of product) by constraining the number of distributors, such restrictions also promote interbrand competition (competition among sellers of the same generic product) by permitting the manufacturer to control the distribution of its product. GTE Sylvania, 433 U.S. at 54. Because "interbrand" competition is the concern of the antitrust laws, the Court held that non-price vertical restraints were legal.
The Court looked to economic theory to determine the outcome of the Sylvania case. "Economists have identified a number of ways in which manufacturers can use such restrictions to compete more effectively against other manufacturers." Id. at 54-55. The Court examined the relationship between service and repair of products and a manufacturer's position in the interbrand market.
- Service and repair are vital for many products, such as automobiles and major household appliances. The availability and quality of such services affect a manufacturer's goodwill and the competitiveness of his product. Because of market imperfections such as the so-called "free rider" effect, these services might not be provided by retailers in a purely competitive situation, despite the fact that each retailer's benefit would be greater if all provided the services than if none did.
Id. at 55 (citing Posner, n.13 at 285). Relying solely on economic theory, the Court found that a manufacturer's limitation of intrabrand competition actually aided that manufacturer in the interbrand market. Id. at 56.
INTERBRAND V. INTRABRAND COMPETITION
The Supreme Court defined interbrand and intrabrand competition in Sylvania, 433 U.S. 36, 52 n.19: "Interbrand competition is the competition among the manufacturers of the same generic product . . .. In contrast, intrabrand competition is the competition between the distributors . . . of the product of a particular manufacturer."
Employing the same arguments considered in the Sylvania case, Kodak asked the Supreme Court to find that, as a matter of law, it could not have market power in an aftermarket because it did not have power in the market for copiers generally. The Court declined the invitation to invoke pure economic theory in an antitrust case, and held that it was possible for a plaintiff to prove that a defendant had power over an aftermarket even in the absence of monopoly power in the general market.
Kodak relied on the reasoning in Sylvania which stated that "when interbrand competition exists...it provides a significant check on the exploitation of intrabrand market power because of the ability of consumers to substitute a different brand of the same product."
Kodak, joined by the Solicitor General, claimed that the Court should rule against the plaintiffs on the ground that their theory did not make economic sense. The Court did not find Kodak's reliance on Sylvania for this proposition to be persuasive.
- Although Kodak repeatedly relies on Continental T.V. as support for its factual assertion that the equipment market will prevent exploitation of the service and parts markets, the case is inapposite....Unlike Continental T.V., this case does not concern vertical relationships between parties on different levels of the same distribution chain....Despite [Kodak's] best effort, repeating the mantra "intraband competition" does not transform this case into one over an agreement the manufacturer has with its dealers that would fall under the rubric of Continental T.V.
Kodak, slip op. at 18 n.16.
Under the Court's definition of interbrand and intrabrand competition, the competition among companies that service Kodak copiers and micrographic equipment is interbrand competition. The Court found that the "generic product" was service of Kodak copiers and micrographic equipment: "In the relevant market, service, Kodak and the ISOS are direct competitors; their relationship is horizontal. The interbrand competition at issue here is competition over the provision of services." Slip op. at 18, n. 16.
The Court implicitly found that companies that service Kodak copiers and micrographic equipment are not in a similar position to the distributors of Sylvania television sets in Sylvania. Those distributors dealt with selling Sylvania television sets as Sylvania produced them. Thus, they were competing against other distributors which sold the exact same product. In Kodak, however, the ISOs which service Kodak copiers and micrographic equipment have their own brand of service, and do not sell a Kodak product.
Although Sylvania is still applicable to non-price vertical integration cases, the Court refused to extend the economic reasoning used in Sylvania to situations where different companies are competing for the service of a single brand of high-tech equipment.
The Supreme Court declined to adopt Kodak's economic argument. Instead, contrary to Chicago School theory, the Court examined the realities faced by consumers:
- Legal presumptions that rest on formalistic decisions rather than actual market realities are generally disfavored in antitrust law. This Court has preferred to resolve antitrust claims on a case by case basis, focusing on the "particular facts disclosed by the record." In determining the existence of market power, and specifically the "responsiveness of the sales of one product to price changes of the other," this Court has examined closely the economic reality of the market at issue.
EX POST V. EX ANTE: MARKET DEFINITION
At the heart of Kodak's economic-based argument was that it could not force owners of Kodak copiers to choose Kodak for service and then charge supracompetitive prices for service because owners would switch to another manufacturer's brand of copier. Kodak argued, as Chicago School economists do, that markets must be determined before a consumer has made a choice, and not after. The Court rejected this blanket economic argument in favor of determining the facts of each individual case.
Prior to the Supreme Court's decision in Kodak, only one Circuit, the Ninth Circuit, had embraced the "lock-in" theory, which states that once a consumer has invested a great deal of money in a piece of high-tech equipment, that customer will not easily switch to another brand of equipment.[3] The Supreme Court explicitly recognized the validity of that theory, holding that a relevant market for antitrust purposes may be limited to a single manufacturer's brand of equipment under the lock-in theory.
- If the cost of switching is high, consumers who already have purchased the equipment, and are thus "locked-in" will tolerate some level of service price increases before changing equipment brands. Under this scenario, a seller profitably could maintain supracompetitive prices in the aftermarket if the switching costs were high relative to the increase in service prices, and the number of locked-in customers were high relative to the number of new purchasers.
Slip op. at 23.
Kodak, following the Chicago School, contended that as a matter of law a single brand of a product can never constitute a relevant market for antitrust purposes. The Supreme Court disagreed, stating that "[t]he relevant market for antitrust purposes is determined by the choices available to Kodak equipment owners." Slip op. at 28.
The Court recognized the uniqueness of parts and service for each manufacturer's brand of high-tech equipment: "Because service and parts are not interchangeable with other manufacturers' service and parts, the relevant market from the Kodak-equipment owner's perspective is composed of only those companies that service Kodak machines." Slip op. at 28-29. The Court was unwilling to adhere to economic principles which made blanket statements about relevant markets, and instead stated that "[t]he proper market definition in this case can be determined only after a factual inquiry into the 'commercial realities' faced by consumers." Slip op. at 29.
The dissent was especially critical of the Court's ruling that markets could be determined both before and after a consumer had made a choice. Relying on a recent Sixth Circuit decision, Virtual Maintenance v. Prime Computer, 957 F.2d 1318 (6th Cir. 1992), the dissent argued that recognizing a market limited to the product of a single manufacturer made no economic sense. The import of the majority opinion, however, is that economics are not determinative in antitrust cases where reality may not correlate with economic theories.
LIFECYCLE COSTS AND MARKET POWER
Closely related to Kodak's argument that it did not make economic sense that it would have market power over an aftermarket if it did not have power over the market for copiers was its contention that consumers are aware of lifecycle costs of high-tech equipment. Thus, Kodak's argument went, because consumers were armed with this knowledge they would not purchase Kodak equipment if they knew Kodak would be charging supracompetitive prices for service. Economically speaking, Kodak would not be able to exact monopoly profits because they would be foreclosed from doing so by the consumer's knowledge of lifecycle costs.
Again the Supreme Court rejected the invitation to adopt a per se economic stance. Instead, the Court found that "[l]ifecycle pricing of complex, durable equipment is difficult and costly. In order to arrive at an accurate price, a consumer must acquire a substantial amount of raw data and undertake sophisticated analysis." Slip op. at 20. The Court did not find it reasonable to assume that a manufacturer's policies would remain constant over time and therefore that lifecycle costs would remain constant. The Court also found that lifecycle costs would vary from customer to customer, depending on each customer's needs. Id.
Finally, the Court found that the mere fact that a plaintiff was alleging that an aftermarket existed did not foreclose the finding of a relevant market. "[O]n the occasions when the Court has considered tying in derivative aftermarkets by manufacturers, it has not adopted any exception to the usual antitrust analysis, treating derivative aftermarkets as it has every other separate market." The Court rejected both Kodak's and the Solicitor General's adoption of the Chicago School argument that relevant markets should be determined only before a consumer has made a purchase, not after. According to the Supreme Court, the analysis of determining a relevant market is the same whether it is examined before a purchase is made or after.
BUSINESS JUSTIFICATIONS WILL NOT AUTOMATICALLY
ENTITLE MANUFACTURERS TO SUMMARY JUDGMENT
Kodak proffered three separate business justifications which it contended entitled it to summary judgment. First, Kodak claimed that its policy was necessary to insure that customers received quality service so that Kodak could compete effectively in the interbrand market. Kodak feared "finger pointing" by consumers who used ISOs for service and then were not satisfied with Kodak equipment as a result of that service. However, the Court found that the ISOs presented evidence that they provided higher quality service than Kodak in some instances, and that Kodak was not entitled to summary judgment on that point.
Kodak also claimed that its policy was necessary to control and reduce inventory costs; the Court found this justification to be pretextual because inventory costs are driven by how often machines break rather than on who fixes them. Kodak's final justification was that it was entitled the eliminate "free riders," so disliked by the Chicago School. Kodak claimed that the ISOs had taken advantage of Kodak's investment in the development and manufacturing of its product rather than manufacturing a product themselves.
The Supreme Court found that "[t]his understanding of free-riding has no support in our case law." Slip op. at 32. Again the Court rejected Kodak's reliance on the Sylvania case for its justification of the elimination of free riders. In Sylvania the Court found that elimination of "free riders" was a legitimate business justification because manufacturers would not be able to ensure that competent retailers would make the necessary investment without resorting to vertical integration.
The Court in Kodak found that this justification did not apply to the ISOs in the service market.
- In Continental T.V., the relevant market level was retail sale of televisions and in Monsanto retail sales of herbicides. Some retailers were investing in those markets; others were not, relying, instead, on the investment of the other retailers. To be applicable to this case, the ISOs would have to be relying on Kodak's investment in the service market; that, however, is not Kodak's argument.
Slip op. at 32. Indeed, the Court found that the purpose of the prohibition against illegal tying was to insure that a potential entrant to one market would not have to enter two markets.
CONCLUSION
Had it not been for the Supreme Court's rejection of the rigid economic theory of the Chicago School, ISOs for high-technology equipment would have ceased to exist or would have existed only at the sufferance of manufacturers. Because of the Supreme Court's ruling, however, the end result is that competition for service will exist and consumers will have greater choice and will pay lower prices. The demonstrated demand by consumers for independent companies which service high-tech equipment will thus be met.
It is not likely, as the dissent states, that there will be more litigation as a result of the Kodak decision. It is more likely that manufacturers will conform their conduct to the teachings of Kodak. There will be greatly increased demand for antitrust compliance programs tailored to Kodak.
If manufacturers are permitted to maintain their control of the parts necessary to service their equipment, the result will be that hundreds of ISOs, which came into existence based on the availability of those parts, will be driven out of business. By denying ISOs access to parts, manufacturers effectively reserve the market of maintenance of their systems to themselves. Without parts it is impossible for ISOs to service equipment. Because parts are unique to a particular machine, manufacturers are usually the only source of those parts.
In fact, the manner in which the ISOs flourished and then suffered is similar to Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985). In Aspen Skiing, the owner of three of four mountains in a destination ski resort cooperated for many years with the owner of the other mountain in the area. Id. at 589. When the venture no longer suited its purposes, the three-mountain owner cut off its competitor. Id. at 594. This Court unanimously held that this conduct violated the antitrust laws. Id. at 611.
This Court recognized the well-established maxims that a business has the right to select its own customers and a competitor need not cooperate with other competitors. Id. at 600. This Court also acknowledged that those rights are not unqualified. Id. at 601. The Court stated: "[In Aspen Skiing], the monopolist did not merely reject a novel offer to participate in a cooperative venture that had been proposed by a competitor. Rather, the monopolist elected to make an important change in a pattern of distribution that had originated in a competitive market and had persisted for several years." Id. at 603.[4]
ENDNOTES
1. The authors are attorneys with Coudert Brothers in San Francisco, co-counsel for the respondents in the Kodak case, and counsel for two groups of independent service organizations which filed amicus briefs in the Kodak case.
2. Posner, Antitrust Policy and the Supreme Court: An Analysis of the Restricted Distribution, Horizontal Merger and Potential Competition Decisions, 75 Colum. L. Rev. 282 (1975).
3. Other circuits have specifically held to the contrary. See, e.g., Virtual Maintenance v. Prime Computer, 957 F.2d 1318 (6th Cir. 1992) ; A.I. Root Co. v. Computer Dynamics, Inc., 806 F.2d 673 (6th Cir. 1986) ; Grappone v. Subaru of New England, 858 F.2d 792 (1st Cir. 1988).
4. The Court elaborated on this point by quoting from Robert Bork's book The Antitrust Paradox, 156: "In any business, patterns of distribution develop over time; these may reasonably be thought to be more efficient than alternative patterns of distribution that do not develop. The patterns that do develop and persist we may call the optimal patterns. By disturbing optimal distribution patterns one rival can impose costs upon another, that is, force the other to accept higher costs." Id. at 604, n.31.