The expanded economics of free-riding: How exclusive dealing prevents free-riding and creates undivided loyalty

Antitrust Law Journal

Volumn 74, Issue 2, 2007, Pages 473-519

  Klein, Benjamin ^a,b   Lerner, Andres V ^a,b  

^a UNIVERSITY OF CALIFORNIA   (United States)

^b LECG ^*

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EID: 34548129589     PISSN: 00036056     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (161)

1. "The recent decisions uniformly favor defendants where foreclosure levels are 40 percent or less . . . ." Jonathan M. Jacobson, Exclusive Dealing "Foreclosure," and Consumer Harm, 70 ANTITRUST L.J. 311, 362 (2002) (citing cases at 325 n. 85). Moreover, exclusive dealing arrangements covering even greater shares of the market have been routinely upheld if the contracts are relatively short-term, with a number of courts concluding that exclusive contracts covering one year or less are presumptively lawful. See, e.g., Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039, 1059 (8th Cir. 2000); Omega Envtl. Inc. v. Gilbarco, Inc., 127 F.3d 1157, 1163-64 (9th Cir. 1997); Roland Mach. Co. v. Dresser Indus., 749 F.2d 380, 392-95 (7th Cir. 1984).
2. United States v. Microsoft Corp., 87 F. Supp. 2d 30 (D.D.C. 2000), aff'd in part, rev'd in part, 253 F.3d 34 (D.C. Cir. 2001) (en banc).
3. Microsoft, 87 F. Supp. 2d at 52. The D.C. Circuit signaled its disagreement, noting that "The District Court appears to have based its holding with respect to §1 upon a 'total exclusion test' rather than the 40% standard drawn from the caselaw."
4. Microsoft, 253 F. 3d at 70. But the D.C. Circuit did not reverse the Section 1 ruling, which was not appealed by the plaintiffs.
5. "Microsoft's only explanation for its exclusive dealing is that it wants to keep developers focused upon its APIs [Windows application program interfaces]-which is to say, it wants to preserve its power in the operating system market. . . . That is not an unlawful end, but neither is it a procompetitive justification for the specific means here in question, namely exclusive dealing contracts with IAPs [Internet access providers]." Microsoft, 253 F. 3d at 71.
6. Id. at 70-71.
7. The D.C. Circuit defined "competition on the merits" as competition that "involves, for example, greater efficiency or enhanced consumer appeal." Id. at 59.
8. United States v. Dentsply Int'l, Inc., 277 F. Supp. 2d 387 (D. Del. 2003), rev'd, 399 F.3d 181 (3d Cir. 2005),
9. cert. denied, 126 S. Ct. 1023 (2006).
10. Dentsply, 277 F. Supp. 2d at 423.
11. For consistency of exposition throughout the article we refer to the supplier of the product in question as "the manufacturer," and, in most cases, the purchaser/distributor of the manufacturer's product as "the dealer."
12. Specifically, the court concluded that Dentsply's exclusive contracts did not have an anticompetitive effect because "direct distribution is viable, non-Dentsply dealers are available, and Dentsply dealers may be converted at any time." Dentsply, 277 F. Supp. 2d at 453.
13. Dentsply, 399 F.3d at 193, 196-97. The court of appeals discounted the possibility that rival manufacturers could compete effectively by relying on direct sales to dental laboratories, noting that direct distribution was "'viable' only in the sense that it is 'possible,' not that it is practical or feasible in the market as it exists and functions," as evidenced by the fact that total sales by Dentsply's two primary direct-selling competitors comprised only 8 percent of the market.
14. Id. at 193.
15. Moreover, the court held that, although dealers legally could terminate their relationship with Dentsply "at will" and switch to a competing line of artificial teeth, "dealers have a strong economic incentive to continue carrying Dentsply's teeth." Id. at 193-94.
16. Jonathan Jacobson lists seven additional economic justifications for exclusive dealing that have sometimes been accepted by courts. Jacobson, supra note 1, at 357-60. Some of these additional justifications, however, are analytically similar to the prevention of free-riding or the creation of dedicated dealers. For example, the use of exclusive dealing to assure quality and to prevent dealers from passing off an inferior product in place of the manufacturer's product (discussed infra note 28) or to reduce the costs of monitoring dealer performance (discussed infra note 70) are shown to be economic variants of the prevention of free-riding, and the use of exclusive dealing to increase dealer incentives to stock inventories and thereby decrease "out-of-stocks" (discussed infra note 57) is shown to be an economic variant of the use of exclusive dealing to increase dealer incentives to promote by creating dedicated dealers.
17. Howard P. Marvel, Exclusive Dealing, 25 J.L. & ECON. 1 (1982).
18. Dentsply, 277 F. Supp. 2d at 442-46.
19. Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 55 (1977).
20. See, e.g., infra notes 75, 79, and 80.
21. Dentsply, 277 F. Supp. 2d at 441 (referring to Marvel, supra note 13).
22. Id.
23. Marvel, supra note 13, at 2, 6-8.
24. Beltone Elecs. Corp., 100 F.T.C. 68 (1982).
25. Id. at 270. Beltone's exclusive territories were enforced in part by refusing to issue warranties submitted by dealers on sales to consumers outside their assigned territories.
26. See Howard P. Marvel, Vertical Restraints in the Hearing Aids Industry, in IMPACT EVALUATIONS OF FEDERAL TRADE COMMISSION VERTICAL RESTRAINT CASES 270, 280 (Ronald N. Lafferty, Robert H. Lande & John B. Kirkwood eds., 1984).
27. Beltone, 100 F.T.C. at 90, 180-81. The FTC began an investigation in 1970 of these distribution arrangements, used by a number of hearing aid manufacturers, that resulted in a series of actions brought in 1973 against several of the leading hearing aid manufacturers, including Dahlberg Electronics, Maico Hearing Instruments, Sonotone Corporation, and Radioear Corporation, in addition to Beltone Electronics. All the other companies reached consent agreements between 1973 and 1976. Beltone, the largest manufacturer with approximately a 20 percent market share, chose not to enter into a consent agreement and litigated to a successful conclusion in 1982.
28. Ryko Mfg. Co. v. Eden Servs., 823 F.2d 1215 (8th Cir. 1987).
29. Id. at 1218.
30. Id. at 1219-20.
31. Id. at 1220.
32. Id. at 1220-21, 1230.
33. Jacobson, supra note 1, at 358.
34. In addition to the loss of profit to the manufacturer on any sales that are switched, in these circumstances the manufacturer also may bear the cost of a loss to its reputation (and reduced future sales) if the customer receives an inferior product that fails to perform as expected that the customer believes is the manufacturer's product. In cases such as this, the manufacturer may find it economic to sue the dealer for commercial fraud, and not merely terminate the dealership.
35. Marvel, supra note 13, at 7.
36. Beltone, 100 F.T.C. at 215-18. The FTC also found that there was significant interbrand competition and that Beltone's exclusive contracts did not foreclose distribution to competitors.
37. Id. at 290-91.
38. Ryko, 823 F.2d at 1234-35 n.17. In addition to finding Ryko's exclusive contracts procompetitive, the court found that the exclusive did not foreclose competition since there was "no evidence suggesting that Ryko's exclusive dealing provisions generally prevent Ryko's competitors from finding effective distributors for (or other means of promoting and selling) their products."
39. Id. at 1234.
40. "There are 'zero examples' in the record of these dealers steering customers from one brand to another." United States v. Dentsply Int'l, Inc., 277 F. Supp. 2d 387, 443-45 (D. Del. 2003), rev'd, 399 F.3d 181 (3d Cir. 2005),
41. cert, denied, 126 S. Ct. 1023 (2006).
42. Dentsply, 277 F. Supp. 2d at 445. The court cited Marvel's article, supra note 13, stating that "[t]he term 'purely brand-specific' is derived from Prof. Marvel's 1982 paper describing his theory, where he wrote: 'This argument does not apply if the promotional investment is purely brand-specific. In such cases, the dealer will not be in a position to switch customers from brand to brand.'"
43. Id.
44. Marvel argued that Dentsply was making brand-specific investments that were not "purely" brand-specific in this sense. The example he uses is Dentsply's promotion of "Portrait" and other new premium products. Marvel argued that without exclusive dealing it would not have been profitable for Dentsply to undertake the promotional investments required to introduce these new products because dealers could then switch customers to an alternative premium product from another manufacturer. Id. at 442.
45. In Ryko, the court noted that "the distributors' promotional efforts can be essential to the completion of individual (NAP) [National Account Program] sales . . . [w]hile an oil company might designate Ryko an approved equipment supplier as the result of a national sales presentation, many NAP sales cannot be completed until the distributor has convinced the local purchaser that installing Ryko car-wash equipment at his location is a profitable idea."
46. Ryko, 823 F.2d at 1220.
47. In Beltone, dealers were supposed to follow up on sales leads with "a personal call upon the responding customer and to provide him or her with testing and information about hearing impairment and hearing aids. The dealer also requests that the person come to his shop for more thorough fitting of a suitable Beltone hearing aid."
48. Beltone, 100 F.T.C. at 180-81.
49. Dentsply, 277 F. Supp. 2d at 441.
50. The avoidance of this type of inter-dealer free-riding is the primary economic rationale for vertical restraints in antitrust law and economics. For example, exclusive territories reduce the ability of consumers to free-ride in this way since limited-service dealers are not conveniently available. See Continental TV., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 55 (1977). Similarly, resale price maintenance is claimed to reduce the incentive of consumers to free-ride in this way since a lower priced dealer is not available. See Lester G. Telser, Why Should Manufacturers Want Fair Trade?, 3J.L. & ECON. 86 (1960).
51. Marvel, supra note 13, at 4.
52. "The free-rider problems facing exclusive and multiline dealers are identical." Id. at 5.
53. Dentsply, 277 F. Supp. 2d at 441.
54. A more formal statement of the following analysis is provided in Benjamin Klein & Joshua Wright, The Economics of Slotting Contracts,].L. & ECON. (forthcoming 2007),
55. which extends the original analysis of inadequate dealer incentives to promote (and the economic role of vertical restraints in solving this dealer incentive problem by creating a dealer profit premium stream that facilitates manufacturer self-enforcement) that is presented in Benjamin Klein & Kevin M. Murphy, Vertical Restraints as Contract Enforcement Mechanisms, 31 J.L. & ECON. 265 (1988).
56. This does not imply that such manufacturers possess any antitrust market power, in the sense of the ability to affect market prices. Almost every firm operating in the economy, except perhaps the wheat farmer described in introductory economics textbooks, faces a negatively sloped demand because it is producing a differentiated product and, hence, charges a price greater than marginal cost. See Benjamin Klein, Market Power in Antitrust: Economic Analysis After Kodak, 3 S. CT. ECON. REV. 43 (1993).
57. In fact, because infra-marginal consumers who would purchase the product without dealer provision of brand-specific promotion are unlikely to receive much, if any, value from the dealer's promotion, the dealer may find it profitable to decrease price in response to increased promotion. The provision of the brand-specific promotion can be thought of as shifting demand out only for marginal consumers, and, by increasing the marginal elasticity of demand, may result in a decrease in the dealer's profit-maximizing price and profit margin. See Gary Becker & Kevin M. Murphy, A Simple Theory of Advertising as a Good or Bad, 108 Q.J. ECON. 941 (1993), where a firm's price change is shown to depend upon the change in its elasticity of demand and whether the increased supply of promotion increases marginal cost.
58. This example is used because it is a clear case of purely brand-specific promotion. However, manufacturers can, and often do, explicitly contract for desired supermarket promotional shelf space with slotting fee contracts (Klein & Wright, supra note 42). Therefore, when shelf space contracts include exclusive dealing terms, it is not likely it is to prevent supermarkets from free-riding by using a manufacturer's purchased space to sell another manufacturer's product, as exclusive dealing is used in the cases analyzed in this article. Instead, exclusive dealing often can be explained in shelf space cases by competitive retailer commitments to transfer loyal customers to a particular manufacturer in return for more favorable purchase prices. See Benjamin Klein & Kevin M. Murphy, Exclusive Dealing Intensifies Competition for Distribution (unpublished manuscript 2007) (on file with authors).
59. Whether the dealer's price will increase is indeterminate. See Becker & Murphy, supra note 44.
60. Of course, if all dealers lower price, an individual dealer's actual demand increase will not exceed the manufacturer's demand increase. The sum of all dealer demand increases and decreases will always equal the manufacturers' demand increase. However, if dealers price independently, each dealer will perceive substantially larger demand changes from price changes, expecting an increase in sales as consumers switch their purchases from other dealers in response to a price decrease or to lose sales as consumers switch purchases to other dealers in response to a price increase.
61. In competitive equilibrium the dealer's quantity response to its price reduction multiplied by its lower profit margin will exactly equal the manufacturer's quantity response to a lower price multiplied by its larger profit margin. This is because the manufacturer and dealers, given their respective price elasticities of demand, will both adjust their prices so that, in equilibrium, their respective profit margins multiplied by the demand response will be equal. See Klein Sc Wright, supra note 42, equation (5).
62. Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 AM. SOC. REV. 55 (1963), documents the common use of self-enforcement, that is, termination rather than court-enforcement, as the mechanism by which transactor performance is assured in many business arrangements. We assume in what follows that the manufacturer has the legal ability to terminate dealers at will or according to the minimum notice requirement in its dealer contracts. In some industries this ability is regulated by statute. For example, automobile dealers can sue in federal court for damages caused by an automobile manufacturer's failure to act in good faith in terminating or not renewing them under the Automobile Dealer Franchise Act, 15 U.S.C. §§ 1221-1225, and gasoline dealers are protected against petroleum company terminations or non-renewals other than for certain specific reasons by the Petroleum Marketing Practices Act, 15 U.S.C. §§ 2801-2806. Moreover, a number of state laws impose a "good cause" requirement for terminations or non-renewals of franchisees, with some statutes also requiring the franchisor to give the franchisee notice of default and an opportunity to cure the defect.
63. See supra note 36.
64. Evidence that Beltone terminated non-performing dealers is mentioned in Beltone Electronics Corp., 100 F.T.C. 68, 226 (1982).
65. Similar self-enforcement is described in United States v. Dentsply International, Inc., 277 F. Supp. 2d 387, 414-15, 420 (D. Del. 2003),
66. rev'd, 399 F.3d 181 (3d Cir. 2005),
67. cert. denied, 126 S. Ct. 1023 (2006).
68. Ryko Manufacturing Co. v. Eden Services, 823 F.2d 1215 (8th Cir. 1987),
69. involved termination of a dealer, Eden Services, that violated the exclusive dealing requirement, as did Roland Machinery Co. v. Dresser Industries, 749 F.2d 380 (7th Cir. 1984),
70. discussed infra text accompanying notes 71-76, where the manufacturer terminated a dealer after it moved to non-exclusive dealing. Standard Fashion Co. v. Magrane-Houston Co., 258 U.S. 346 (1922), did not involve manufacturer termination of a dealer, but dealer termination of the manufacturer.
71. Standard Fashion involved the attempt by Magrane-Houston (a dry-goods retailer in Boston) to substitute the dress patterns of another pattern manufacturer, McCall, for Standard Fashion's dress patterns. Standard's exclusive contracts were not an economic obstacle to other manufacturers competing for distribution since the contracts were two years in duration and the particular contract with Magrane-Houston had already been running for four years. Standard Fashion sued to enforce its exclusive contract solely because Magrane-Houston had failed to provide the contractually required three-month notice of termination. 258 U.S. at 351-54.
72. Although Standard Fashion had a 40 percent share of sales (id. at 357), it is not necessary for manufacturers to possess any market power for them to desire increased dealer promotion.
73. See supra note 43.
74. The desire for increased dealer promotion by firms without any market power is vividly illustrated by the fact that Royal Crown Cola, which possessed only 5 percent of cola sales (and a corresponding much smaller share of soda sales), desired increased promotion by its bottlers and used exclusive dealing to facilitate enforcement of this expectation. See Joyce Beverages v. Royal Crown Cola Co., 555 F. Supp. 271 (S.D.N.Y. 1983); see also discussion infra note 77.
75. Standard Fashion, 258 U.S. at 351-52.
76. Id. Pis. Ex. 7, Contract, Nov. 25, 1914, R. at 131.
77. Butterick Publ'g Co. v. William G. Fisher, 203 Mass. 122, 131 (1909). Butterick was the owner of Standard Fashion.
78. The required minimum inventory level involved a commitment by MagraneHouston to purchase and have on hand at all times $1,000 worth of Standard patterns, measured at net invoice prices, which were 50 percent of retail prices. This amounted to in excess of 10,000 patterns. Standard Fashion, 258 U.S. at 352. Dealer supply of adequate inventories is analytically similar to a type of promotional service in that inventory availability induces incremental manufacturer sales and, because dealers do not earn the full profit on such incremental sales, dealers will not have the incentive to bear the additional costs to carry the optimal level of inventories desired by the manufacturer. In addition to contractually specifying a minimum level of inventories and using exclusive dealing to prevent dealers from switching consumers to another brand when the manufacturer's product is not available, manufacturers often will directly subsidize dealer inventory levels. For example, Standard Fashion credited Magrane-Houston at 90 percent of its cost for unsold, returned patterns that were exchanged for new stock.
79. Id.
80. Moreover, as we shall see infra Part IVA., an economic incentive exists for retailers to use even the contractually specified promotional inputs that were paid for by the manufacturer, such as the "lady attendant" stationed on the ground floor, to sell alternative products, and such free-riding can be prevented by exclusive dealing.
81. See, e.g., Benjamin Klein & Keith B. Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. POL. ECON. 615 (1981).
82. Klein & Murphy, supra note 42.
83. See also Benjamin Klein, Distribution Restrictions Operate by Creating Dealer Profits: Explaining the Use of Maximum Resale Price Maintenance in State Oil v. Khan, 7 S. CT. ECON. REV. 1, 7-8 (1999).
84. Klein & Murphy, supra note 42. This role of resale price maintenance as a way for the manufacturer to provide sufficient compensation to dealers for supplying increased promotion explains the use of resale price maintenance in the distribution of products where the standard explanation for resale price maintenance as a way to prevent interdealer free-riding described in Telser, supra note 38, is not applicable. For example, Robert Pitofsky uses the examples of cosmetics, over-the-counter pharmaceuticals, blue jeans, and men's underwear as products where resale price maintenance has been used but where consumers do not require the pre-purchase demonstration and explanation such as is required for complicated audio and video equipment that the standard interdealer free-riding model uses to justify resale price maintenance.
85. Robert Pitofsky, Are Retailers Who Offer Discounts Really "Knaves"?: The Coming Challenge to the Dr. Miles Rule, 61 ANTITRUST, Spring 2007, at 63. However, these products require the supply of retailer brand-specific promotional services, including shelf space display, to induce profitable increased manufacturer sales. For example, prominent display of men's underwear will cause some consumers to purchase the displayed product who would not otherwise do so. But since the inter-retailer effects of such retailer promotion are likely to be relatively small (consumers are unlikely to choose a department store because it prominently displays men's underwear), retailers will not have the correct incentive to supply the desired, profit-maximizing quantity of the promotion from the manufacturer's point of view. Therefore, manufacturers must effectively compensate retailers for supplying additional promotion, which is the economic purpose served by resale price maintenance in these and other cases.
86. Standard Fashion, 258 U.S. at 352.
87. This problem where price competition for infra-marginal consumers competes away the manufacturer's compensation of retailers for supplying increased promotion occurs even if discounting retailers are supplying desired promotional services and infra-marginal consumers do not go to a full-service retailer before purchasing the product at discount, low-service retailers, as in standard inter-dealer free-riding described in Sylvania, supra note 15. Dealers that supply the desired quantity of promotional services but lower price are free-riding on the manufacturer's compensation arrangement and on other dealers because they increase their sales to infra-marginal consumers who would have purchased the product from other dealers. Dealers that reduce price, therefore, are overcompensated for supplying the desired level of promotion, while other dealers that have lost these infra-marginal sales will be under-compensated for supplying the desired promotion. Therefore, dealers are free-riding on other dealers not in the Sylvania sense of using the services provided by other dealers without paying for them, but by taking the compensation the manufacturer has provided to other dealers for supplying services, leading other dealers to either reduce their promotional efforts below the desired level or to stop marketing the manufacturer's products.
88. This likely explains the use of resale price maintenance in Leegin Creative Leather Products, Inc. v. PSKS, Inc., 171 F. App'x 464 (5th Cir.), 2006 WL 690946 (unpublished opinion),
89. cert. granted, 127 S. Ct. 763 (2006) (U.S. Dec. 7, 2006) (No. 06-480).
90. Resale price maintenance had the effect of preserving Leegin's extensive distribution network. The preservation of an adequate retail distribution network, and the fact that a majority of retail druggists had dropped (or ignored) its products as unprofitable, was a primary stated rationale for Dr. Miles' institution of resale price maintenance. Dr. Miles Med. Co. v. John D. Park & Sons Co., 220 U.S. 373, 375 (1911).
91. Howard Marvel justifies exclusivity in Standard Fashion by focusing on the intellectual property investments made by Standard Fashion in the initial creation of dress pattern designs. Marvel, supra note 13. If popular designs easily could have been copied by rival manufacturers that had not made these investments, this explains why lower cost alternative products would have been available to retailers that engaged in free-riding, either type one or type two free-riding. Exclusive dealing prevented retailers that were selling Standard Fashion patterns from engaging in free-riding, but exclusive dealing would not have prevented other pattern manufacturers (either full-line manufacturers, such as McCaIl, or groups of limited-line manufacturers that together can supply retailers with a full line of patterns) from copying Standard's successful patterns.
92. A systematic historical survey of exclusive dealing contracts indicates that resale price maintenance has frequently been used in conjunction with exclusive dealing. See Thomas R. Overstreet, Jr., Resale Price Maintenance: Economic Theories and Empirical Evidence, Bureau of Economics Staff Report to the Federal Trade Commission 84-101 (1983). This is because those products for which exclusive dealing was required to prevent dealer switching of promotional efforts to the sale of alternative products were also products for which manufacturers demanded and compensated dealers for additional promotional efforts.
93. Full internalization of increased distribution costs assumes that exclusive dealing produces no anticompetitive effects that benefit the manufacturer and, therefore, will influence its contractual choice. We modify this assumption of no anticompetitive effects of exclusive dealing in the discussion of Dentsply's exclusive dealing contracts, infra Part V.D.
94. See, for example, Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039, 1045 (8th Cir. 2000),
95. which involved purchase share discounts provided by Brunswick, the maker of MerCruiser brand stern drive boat engines, to induce its dealers to promote its engines. Price discounts may be offered on a sliding scale for additional units purchased. Alternatively, discounts may go back to the first unit purchased, which implies low effective prices on the particular unit at which a purchase share necessary for a price discount is reached. These contracts are described as de facto or partial exclusive dealing in Willard Tom, David A. Balto & Neil W. Averitt, Anticompetitive Aspects of Market-Share Discounts and Other Incentives to Exclusive Dealing, 68 ANTITRUST L.J. 615 (2000).
96. Supra note 63.
97. Dealers also have the incentive under sliding-scale price discount arrangements to purchase increased quantities at lower prices and transship to other dealers that are sharing the discounts.
98. N, and hence reduces the required premium stream the manufacturer must pay the dealer in order to assure dealer performance. Therefore, exclusivity reduces the costs to Beltone of self-enforcing dealer performance by decreasing the amount of profit it must share with dealers, for example, by granting dealers larger or otherwise more profitable dealerships. See Benjamin Klein & Lester Saft, The Law and Economics of Franchise Tying Contracts, 28 J.L. & ECON. 345 (1985), for a discussion of this reduced monitoring cost rationale for exclusive input requirements contracts in franchise arrangements.
99. Roland Mach. Co. v. Dresser Indus., 749 F.2d 380 (7th Cir. 1984).
100. Id. at 381.
101. Id. at 381-82.
102. The appeals court in Roland Machinery held that there was no evidence of an exclusive dealing agreement between Dresser and Roland (or any other distributor). Although the evidence indicates a clear preference by Dresser for distributor exclusivity, the fact that Roland openly obtained a Komatsu dealership indicated to the court that Roland did not believe it had made a commitment to exclusivity. While Dresser desired distributor exclusivity and, in fact, was extremely hostile to nonexclusive arrangements, as evidenced by its termination of Roland, the court held that there was no "meeting of minds" and, therefore, no agreement.
103. Id. at 392-93.
104. In addition to denying the existence of an exclusive dealing agreement, the court concluded that, even if such an agreement existed, it would not have been anticompetitive since Dresser Industries manufactured only 16 or 17 percent of the construction equipment sold in Roland's territory of central Illinois. Id. at 382. Furthermore, the court concluded that Dresser's contracts were short term and could not foreclose Komatsu, the second-largest manufacturer of construction equipment in the world, from the market. In fact, Komatsu had already obtained effective distribution and become a major factor in the U.S. market.
105. Id. at 393-95.
106. Id. at 395.
107. Id.
108. Joyce Beverages, Inc. v. Royal Crown Cola Co., 555 F. Supp. 271 (S.D.N.Y. 1983).
109. Id. at 273.
110. Id. at 278. Royal Crown Cola bottlers were partially paid for supplying extra promotional efforts with the grant of a valuable exclusive territory that would have been lost if Royal Crown terminated a bottler for failure to adequately "compete for shelf space, display racks, promotional rotations and the placement of feature advertising."
111. Id. at 275.
112. The exclusive dealing requirement clearly had nothing to do with anticompetitive foreclosure because Royal Crown Cola had only a 5 percent share of U.S. cola sales. Id. at 273.
113. Hendricks Music Co. v. Steinway, Inc., 689 F. Supp. 1501, 1514, 1545-48 (N.D. 111. 1988).
114. PHILLIP KOTLER, MARKETING MANAGEMENT 513 (11th ed., 2003).
115. Marvel, supra note 13, at 3-5. 83 Id.
116. "The free-rider problems facing exclusive and multiline dealers are identical." Id. at 5. Marvel, therefore, concludes that "exclusive dealing is not an efficient means by which to promote increases in dealer services."
117. Id. at 4.
118. Id. at 3-5.
119. An indication of the impact of Marvel's rejection of the undivided loyalty rationale for exclusive dealing can be obtained by examining the changes over time in industrial organization textbooks on this issue. For example, an undivided loyalty rationale for exclusive dealing was included in the 1980 edition of F.M. Scherer's popular textbook, Industrial Market Structure and Economic Performance, which states (at 886) that "[f]or manufacturers, exclusive dealing arrangements are often appealing, because they ensure that their products will be merchandised with maximum energy and enthusiasm." F.M. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 886 (2d. ed. 1980). This rationale for exclusive dealing was removed from later editions of the same textbook.
120. See EM. SCHERER & DAVID ROSS, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE (3d. ed. 1990).
121. United States v. Dentsply Int'l, Inc., 277 F. Supp. 2d 387 (D. Del. 2003), rev'd, 399 F.3d 181 (3d Cir. 2005),
122. cert. denied, 126 S. Ct. 1023 (2006).
123. Dentsply claimed that in its experience, "the greater the number of competing tooth lines carried, the less likely that a dealer will be able to sustain all of the desired services and promotional elements at a high competitive level. In short, service and promotional support for a particular line is likely to suffer the greater the number of lines carried." GX 157 at Interrogatory Response No. 13 (cited in Dentsply, 277 F. Supp. 2d, United States' Brief in Support of its Proposed Findings of Fact and Conclusions of Law at par. 332).
124. Dentsply, 277 F. Supp. 2d at 441. This is why an undivided loyalty rationale for exclusive dealing was not presented by Marvel in his testimony, but in Dentsply answers to interrogatories (GX 157 at Interrogatory Response No. 13) and by a Dentsply executive (D.I. 429 at 1719-20).
125. Id.
126. Roland Mach. Co. v. Dresser Indus., 749 F.2d 380, 395 (7th Cir. 1984).
127. Id.
128. Id.
129. Id. (citing Sulmeyer v. Coca-Cola Co., 515 F.2d 835, 840 n.2 (5th Cir. 1975)).
130. While many consumers may comparison shop at multiple dealers before purchasing because of the significant size of the purchase, profitable after-sale service (including warranty work) will often be supplied by the most conveniently located dealer. Therefore, the grant of a limited exclusive territory will be a profitable asset.
131. Automobile dealer termination is subject to federal regulation. See supra note 49.
132. The assumption that the customer is leaning towards a Honda before he enters the dealership is made for expositional clarity. The analysis does not depend on a customer having an ex ante preference for one brand relative to another. For instance, a customer may be uninformed regarding the benefits of each brand before entering the dealership.
133. The shape of this curve is likely to be convex, which will be the case if, for example, there is declining effectiveness of promotional expenditures, p″(S) < 0, and the marginal cost of S is linear, so that C″(S) = 0.
134. Dentsply's "Dealer Criterion Six" states that "in order to effectively promote Dentsply-York products, authorized dealers . . . 'may not add further tooth lines to their product offering.'" United States v. Dentsply Int'l, Inc., 399 F.3d 181, 185 (3d Cir. 2005).
135. Dentsply, 277 F. Supp. 2d at 440-41 (citing GX 157 at Interrogatory Response No. 13 and D.I. 429 at 1719-20).
136. The President of Vident, Vita's distributor in the United States, stated that he "considers the exclusivity agreement Vident has with Vita beneficial because it permits Vident's sales representatives to focus completely
137. Id. at 441 (referring to Marvel, supra note 13).
138. "Dealers are an important conduit for supplier's promotional message." Id. United States' Brief in Support of its Proposed Findings of Fact and Conclusions of Law ¶ 85. "Dealers can assist suppliers in generating incremental business by promoting the manufacturer's product . . . ."
139. Id. ¶ 90. "Although each supplier employs sales representatives, dealer sales representatives add another 'voice in the marketplace.'"
140. Id. ¶ 85. "Dealers refer new lab customers to supplier representatives."
141. Id. ¶ 88. ". . . [D]ealers know about new customers and can provide valuable leads to its suppliers, leads that the suppliers would not have if they were selling teeth directly."
142. Id. The significant role of dealers in promoting Dentsply's products also was highlighted by the Department of Justice's economic expert.
143. Id. Expert Report of David Reitman, Ph.D., February 29, 2000, at 11-12.
144. Dentsply, 399 F.3d at 192-93. In addition to promoting Dentsply products to laboratories, an important "promotional" service provided by dealers was the maintenance of an adequate inventory of Dentsply teeth. As we have seen (supra note 57), dealer maintenance of adequate inventories is analytically similar to dealer supply of promotional services in that it induces incremental sales of the manufacturer's products. Artificial teeth come in a wide variety of shades, shapes, moulds, qualities, and other attributes. With exclusive dealing, dealers have the incentive to incur increased costs of maintaining an adequate level of inventories of the manufacturer's products because the dealer cannot substitute a competing manufacturer's product when a particular type of teeth is demanded by a lab.
145. Dentsply, 277 F. Supp. 2d at 447-48;
146. Dentsply, 399 F.3d at 197.
147. In fact, the largest Dentsply dealer, Zahn, was claimed to be the "most aggressive" dealer in the United States, according to Dentsply executives, despite its carrying competing brands. Id. at 448.
148. Dentsply, 277 F. Supp. 2d at 448;
149. Dentsply, 399 F.3d at 185.
150. However, we do know that "Dentsply rebuffed attempts by those particular [grandfathered] distributors to expand their lines of competing products beyond the grandfathered ones." Dentsply, 399 F.3d at 185.
151. Id. at 192.
152. Id. at 194.
153. Therefore, the appeals court distinguished Dentsply from other shortduration exclusive contract cases,
154. including Ryko and Roland Machinery. Id. at n.2.
155. Id. at 185.
156. Id. at 194-96.
157. Id. at 192-93: "Criterion 6 imposes an 'all-or-nothing' choice on the dealers. The fact that dealers have chosen not to drop Dentsply teeth in favor of a rival's brand demonstrates that they have acceded to heavy economic pressure."
158. Dentsply, 277 F. Supp. 2d at 442-46.
159. Id. at 445-46.
160. A former Dentsply manager testified that the purpose of Dentsply's exclusive dealing contracts was to "block competitive distribution points. Do not allow competition to achieve toeholds in dealers; tie up dealers; do not 'free-up' key players." Dentsply, 399 F.3d at 189.
161. This is related to one variant of the "no economic sense" test, advocated by some as a necessary condition for anticompetitive exclusionary conduct. See, e.g., Gregory J. Werden, Identifying Exclusionary Conduct Under Section 2: The "No Economic Sense" Test, 73 ANTITRUST L.J. 413 (2006). Our statement refers to this as a sufficient, not a necessary, condition for anticompetitive exclusionary conduct.