As American as Apple Pie: In Defense of Bundled Rebates

Just about everyone bundles. It’s about as American as apple pie: if you buy more, you get a better price. Most of the time, that’s a good thing. Consumers benefit from lower prices. The question is, can bundling violate the antitrust laws? It can. So, the real question is, how do we determine when a generally good thing – bundling – should be condemned under the sledgehammer that is antitrust? In cases where usually beneficial conduct is challenged as anticompetitive, clear standards and tests are critically important so that a good thing is not stifled by uncertainty.

There is such an objective test, established most prominently perhaps in the Ninth Circuit in a case named Cascade Health Solutions v. PeaceHealth (515 F.3d 883, 906 (9th Cir. 2008)), called the “discount attribution standard,” or “incremental price-cost test.” We’ll call it the “Price-Cost Test.” Under the Test, if a plaintiff can show that the value of bundled rebates exceeds profits (i.e., the aggregated rebates were below cost), and those below-cost rebates excluded rivals from the market, there may be a claim. Put in more technical terms, the Test allocates the “full amount of the discounts given by the defendant on the bundle” to the alleged monopolized product at issue, to see “[i]f the resulting price … is below the defendant’s incremental cost to produce” that product. As the Ninth Circuit recognized, “this standard makes the defendant’s bundled discounts legal unless the discounts have the potential to exclude a hypothetical equally efficient producer.…” Simple, objective, fair.

The Federal Trade Commission (FTC) today, however, doesn’t seem to like this. Earlier this year, it took the somewhat extraordinary step of filing an amicus brief at the motion to dismiss stage in a litigation between rival medical device companies, Applied Medical Resources v. Medtronic (23-cv-00268-CJC-DFM (C.D. Cal. July 3, 2023)). In its brief, the FTC lodged three complaints against the Price-Cost Test, calling it “controversial.” First, the FTC argues, “excluding even a less-efficient rival from a concentrated market can harm competition and consumers.”  Second, it said, the test “gives monopolists free rein to squash nascent, albeit unproven, competitors at will.” And third, a bundled “‘discount’ can be a self-serving, misleading label.”

We’ll address those arguments in turn, but first:

Why Did the FTC File an Amicus on a Motion to Dismiss? 

The FTC is both on the attack and under attack. Since Lina Khan took the reins two years ago, the FTC has been on a mission to expand its purview and the reach of competition law. It wants to challenge more deals and bring more cases. It seemingly wants to do things that prior iterations of the FTC would hardly dream of: abandon the consumer welfare standard of antitrust enforcement, rewrite the rules of merger review and enforcement, and combat consolidation as a matter of course, to name but a few.

At the same time, the very core of the FTC’s constitutional authority is under attack. In April, the Supreme Court held that constitutional challenges to the FTC’s administrative law process need not await completion of the process and can be asserted immediately in federal court. Amgen and Horizon, two pharmaceutical companies, have accepted the Supreme Court’s invitation. They are challenging the constitutionality of the FTC’s challenge to their proposed merger, arguing the FTC’s in-house administrative process is “hopelessly ‘tilted’ in its own favor.”

However that constitutional challenge turns out, the FTC recognizes its power – and particularly its power to shift the law and policy of antitrust – is limited. The law depends on precedent, which depends on judicial decisions. Thus, if the FTC truly wishes to herald a more-than-fleeting new era of antitrust law, it needs judicial decisions. It is playing the long game. But will it succeed? It has strung up a number of relatively high-profile losses in court, most recently in its failed (so far) bid to stop the Microsoft-Activision merger. Amicus briefs fly much further under the radar. They are designed to avoid opinions that could be damaging to the FTC’s mission while planting nuggets that the FTC can later use.

In Medtronic, the FTC took “no position on whether those allegations” of exclusive-dealing and bundling arrangements “are accurate or state a claim,” but wanted to avoid a decision that could require a bundling plaintiff to allege the prices and costs that would satisfy the Price-Cost Test, or would paint a challenge to bundled rebates as simply an attack on low prices. While the court denied the motion to dismiss, it did not address the FTC’s substantive arguments on bundled rebates. We take the opportunity to do so here.

Argument 1: Are Less-Efficient Rivals Really Antitrust’ s Concern?

In arguing the Price-Cost Test “rewards the defendants whose bundling harms rivals the most” because it excludes “less efficient rivals” who “cannot operate at  scale due to the very bundling at issue,” the FTC relies on an academic article by law professor and frequent plaintiffs’ expert, Einer Elhauge. There, Elhauge argued the “equally efficient rival test” does not work because it would allow excluding “a rival that is equally efficient at making the linked product but is less efficient at making the linking product” (the linking product being the one over which the defendant has market power, according to Elhauge).

But antitrust is generally unconcerned with less efficient rivals. The Ninth Circuit has explained: “It is the very nature of competition that the vigorous, efficient firm will drive out less efficient firms. That is not proscribed by the antitrust laws.”  Put another way by the First Circuit, “If a party drives down the cost of its products in the hopes of pummeling a less-efficient competitor into submission, we do not permit the competitor to reach for relief through an antitrust claim. Doing so would thwart the very purposes of the antitrust laws; encouraging efficiency….” And in the words of the perhaps-preeminent antitrust scholar, Herbert Hovenkamp, to wield antitrust law “to harm consumers for the benefit of weaker or less efficient dealers … moves antitrust policy in precisely the wrong direction” (Hovenkamp, The Antitrust Enterprise, 192 (2005)). Consider hot dogs and buns. Company A might be able to offer a lower price to customers who buy hot dogs and buns together. But there may also be bratwurst-eating customers who just need the buns. Company A would charge the profit-maximizing price for buns to those bratwurst customers. That may or may not be good for consumers overall, depending on how the prices relate to costs and other factors. But if Company B is a great hot dog maker but an inefficient bun maker, the antitrust law should not protect the inefficient side of its business because it can’t compete with Company A’s bundle.

Argument 2: Should ‘Unproven’ Competitors Stand In the Way of Lower Prices?

In its brief, the FTC borrows a line from the Microsoft case to argue, monopolists should not be given “free rein to squash nascent, albeit unproven, competitors at will.” See United States v. Microsoft Corp., 253 F.3d 34 (D.C.C. 2001). While protecting potential competition in innovation markets is nothing new to the FTC – it has been bringing potential competition cases since at least the 1970s – the problem with using the Microsoft quote out of context is that very little in law can be “unproven.”  The jilted competitors in Microsoft – Java and Navigator – were not really “unproven.”  In the next sentence, the court recognized the “ample findings that both Navigator and Java showed potential as middleware platform threats.”

The FTC also used the out-of-context Microsoft quote in its 1997 Antitrust Guidelines for the Licensing of Intellectual Property, and in its newly proposed Merger Guidelines. Courts, however, generally require some proof – some “reasonable probability” that the new competitor or technology would have “matured into a competitive force.” E.g., Princo Corp. v. ITC, 616 F.3d 1318 (Fed. Cir. 2010) (quoting United States v. Penn-Olin Chem. Co., 378 U.S. 158 (1964)); F.T.C. v. Steris Corp., 133 F. Supp. 3d 962 (N.D. Ohio 2015) (requiring proof the nascent competitor “probably would have entered the” market “within a reasonable period of time”).

In the bundling context, if a nascent competitor cannot compete with one or more products in the bundle, and the incumbent is pricing above the bundled discounts, it simply means the incumbent is more efficient. There is no reason for the antitrust laws to protect a less-efficient rival from competition just because it’s new, let alone because it’s “unproven.”

Let’s go back to hot dogs and buns. Company A offers its bundled hot dogs and buns at a discount (but not more than the cost of the buns), and also sells buns separately. Company C wants to break into the buns market but can’t profitably price low enough to compete with Company A. That’s simply a result of the competitive process, not a fault of the bundle. The benefit of the Price-Cost Test is that it identifies when the result might be the bundle’s fault – when the discounts are so large, they exceed Company A’s cost to produce buns.

Argument 3: Is a Bundled Discount Ever Not a Discount?  

Finally, the FTC bristled at the suggestion that a challenge to bundled rebates faults “prices that are too low,” arguing a bundling challenge is not to low prices but to the “pricing differential between ‘loyal’ customers who buy the full bundle from the monopolist and ‘disloyal’ customers who do not,” calling the differential a “penalty.” It then provides a hypothetical in which a firm that charges $80 for staples and $40 for bipolar devices decides to raise the price for staples to $100 but offer $20 off for the bundle. But that’s not a challenge to bundled discounts – it’s a challenge to a discount as a sham. That is a fake discount case (where a company inflates prices and then offers a “discount”), not an antitrust bundling case.

An antitrust bundling case is by definition a challenge to prices that are too low – when a monopolist takes advantage of its ability to bundle to lower prices to the point that equally efficient rivals cannot be expected to legitimately compete. That is what the Price-Cost Test measures. Nor does loyalty have anything to do with it. A bratwurst customer that buys buns from Company A is no less “loyal” than the hot dog customer that buys the bundled hot dogs and buns. The bratwurst customer isn’t paying a penalty just because she doesn’t also want hot dogs. It goes the other way. The hot dog customer gets a benefit. Consumer welfare is improved, and the antitrust laws should be happy.

The Future of Bundled Rebates and the Price-Cost Test.

In denying the motion to dismiss in Medtronic, the court applied the Price-Cost Test, simply noting the plaintiff need not allege the defendant’s costs with specificity before there has been any discovery. The case will now proceed into discovery, followed by expert reports applying the Price-Cost Test and, likely, summary judgment briefs. Medtronic’s bundled discounts will either be above or below its costs, and the plaintiff will either be equally efficient or there will be other reasons unrelated to the bundle it is unable to compete. That is as it should be.

Image Source; Deposit Photos
Author: belchonock
Image ID: 186161586