1985 federal vertical restraints guidelines: Requiescat in pace, The

Antitrust is a prohibiting set of arrangements-laws, courts, and enforcement agencies-that indicate the "rules of the game" designed for business decision makers to follow in their quest for profits or other goals. However, these three arrangements may be in conflict with one another. This author discusses the sources and nature of this conflict in a particular antitrust situation. Laws, Courts, and Enforcement Agencies

Laws U. S. antitrust policy is based on three principal laws. The Sherman Act of 1890 prohibits any agreements in restraint of trade (e.g., collusion) or any attempt to monopolize a market. The Clayton Act of 1914 outlaws certain kinds of market conduct such as price discrimination, tying contracts and exclusive dealerships, horizontal mergers, and interlocking directorates. The Federal Trade Commission Act of 1914 established the administrative agency, the Federal Trade Commission (hereinafter FTC), to investigate "unfair methods of competition." In general terms, the Sherman Act operates in a curative manner, whereas the Clayton and FTC Acts operate in a preventive manner (and as correctives of the Sherman Act). The general intent of the U. S. Congress in passing the antitrust laws is a matter of dispute. Two broad classifications of economic explanations are offered for why these laws were passed.' The first approach suggests that U. S. antitrust laws were designed to promote the public interest. According to this approach, the antitrust laws, by facilitating greater competition, reduce, if not eliminate, the wedge or gap between price and marginal cost and reduce or eliminate any discrepancy between marginal rates of substitution of consumers and the marginal rate of transformation of producers. The purpose is not to eliminate monopolists' profits, which may not even exist if costs are high and demand is weak. Thus, public-interest theory emphasizes that the antitrust laws attempt to improve market performance by regulating market structure and conduct (behavior) and by protecting, preserving, and promoting competition crucial to the success of a market economy in promoting efficiency and delivering the ensuing benefits to consumers. That is, competition generally forces producers to contain costs and respond to consumer demands by developing innovative products that are distributed at low prices. However, if significant externalities are' involved, society may be worse off if competition is pushed, in which case regulations are needed.2 Thus, the problem may not be just a lack of competition.

The second, or private-interest approach, argues that U. S. antitrust laws were designed to help some special-interest group other than consumers' Since the government, like the market, is imperfect, the passage and enforcement of antitrust laws may be controlled or guided by private interests. Thus, when businesses use the political marketplace for their own goals, their rentseeking worsens the public interest in the classic prisoners' dilemma sense.3 While proponents of the U. S. antitrust acts claim they serve the public interest, some empirical results suggest that they appear as susceptible to the influence of special-interest groups as is any public policy. This same possibility of private-interest domination applies to the courts and antitrust enforcement agencies.

Courts' The three-tiered structure of the federal courts consists of district courts, courts of appeals, and the Supreme Court. The decisions of the Supreme Court are binding on all federal courts in the United States. Each state has a court system that is usually tripartite, also. These generally consist of trial courts, appellate courts, and state supreme courts. The decisions of state supreme courts are binding on all the courts in that state.

Some antitrust cases are restricted to state jurisdictions since the laws are state-createdand-enforced statutes and these cases are not treated uniformly throughout the nation. However, more important decisions result from opinions in the federal courts, especially the appellate courts and the Supreme Court. Moreover, specialized courts deal with subjects such as administrative agencies, customs, and taxes. The special-interest group theory opines that judicial decisions may also be influenced by the private interests of the court.

Enforcement Agencies At the federal level, the FTC enforces the antitrust laws in partnership with the Department of Justice (hereinafter DOJ). However, unlike the DOJ, the FTC litigates the antitrust cases (known as "administrative complaints") it prosecutes before its own administrative law judges .and then hears the appeal itself. The Antitrust Division is under the direct administrative authority of the President inasmuch as the head of the DOJ is a member of the President's cabinet. The FTC is an independent administrative agency composed of five commissioners appointed for terms of seven years by the President, with the advice and consent of the Senate. No more than three of the five commissioners may belong to the same political party. Until 1950, the chairship of the FTC rotated annually among its members. Since that time the chair has been designated by the President and has been made responsible for administration of the FTC's activities. The public-- choice theory of antitrust claims that the behavior of federal antitrust enforcement agencies is systematically influenced by such external factors as the Congress, the executive branch, and various private-interest groups.s Over the years, the U. S. federal antitrust enforcement agencies have promulgated and issued various guidelines that do not coincide with the intent of the antitrust laws and with the actual case law. One reason for this incongruity is that federal antitrust enforcement agencies' promulgating guidelines are as susceptible to the influence of special-interest groups as the legislators passing the antitrust laws. This author discusses the lack of harmony between the federal antitrust laws, courts, and antitrust enforcement agencies that have existed and the guidelines, standards, or principles pertaining to vertical restraints that the DOJ has recently recanted. Department of

Justice Withdrawal The role of the U. S. Department of Justice in enforcing vertical restraints has varied dramatically in the past 15 years. Assistant Attorney General William Baxter pushed for the explicit strategy of nonenforcement in the Vertical Restraints Guidelines (hereinafter Guidelines) issued January 23, 1985. The election of the Democratic Clinton Administration in 1992 precipitated the withdrawal of the Guidelines and ushered in an apparent new phase of enforcement, although few cases have been brought as yet. On August 10, 1993, Anne K. Bingaman, assistant attorney general for the Department of Justice's Antitrust Division, in a press release and in an address before the Antitrust Section of the American Bar Association, announced that the Division was withdrawing the Guidelines. In a nutshell, vertical restraints are restrictive agreements or relationships imposed on buyers by sellers as conditions of sale, such as boycotts, exclusive dealings, resale price maintenance, territorial and customer limitations, tying arrangements, vertical integration, etc. These Guidelines were designed to assist the business community

( 1 ) by providing information about the law so efficiency enhancing arrangements would not be delayed over antitrust concerns; and (2) by reducing uncertainty by setting out clear guidelines as to the DOJ's antitrust enforcement intentions in various nonprice vertical restraints circumstances that could be in violation of Sections 1 and 2 of the Sherman Act and Section 3 of the Clayton Act. The Guidelines, following the Chicago School, held that vertical restraints should be legal per se. This withdrawal action by the DOJ has received very little attention in the economic or legal community. Yet it is potentially very profound.

Putative Basis for Withdrawal

In announcing the rescinding, Ms. Bingaman said, The Vertical Restraints Guidelines do not set forth the Division's current analysis of vertical practices and are not consistent with judicial interpretations of the antitrust laws. They are misleading both to practitioners attempting to counsel clients as well as businesses attempting to conform with the law. For these reasons, it is appropriate to withdraw the Vertical Restraints Guidelines (1993,

p. 2). In contrast to the Horizontal Merger Guidelines issued by the DOJ and FTC, separately in 1982 and 1984 and jointly by the DOJ and FTC in 1992 and 1997, the Vertical Restraints Guidelines were controversial from the outset. The Congress, the National Association of Attorneys General, and non-Chicago School attorneys and economists challenged the relationship of the Guidelines to the existing federal law or intent of the antitrust laws. In fact, the State Attorneys General issued their own tougher guidelines (these guidelines are in the process of revision) that indicated the Guidelines' efficiency interpretation of vertical restraints was no more universally accepted by law enforcement agencies than by economists. Moreover, the FTC was not a signatory to the Guidelines as it was to the Horizontal Merger Guidelines in 1992. One of the leading textbooks on antitrust economics put the situation this way:

In 1985 the justice Department's Antitrust Division, having been captured by Chicago school attorneys, published "Vertical Restraints Guidelines" adopting a more permissive posture toward vertical restraints than was embodied in the standing judicial precedents (Scherer & Ross, 1990, p. 569). The DOJ made it clear that it was not revoking the Guidelines because of the opposition of Congress and state Attorneys General but because it believed that the Guidelines were in opposition to case law and factual analysis. The DOJ made it clear that there was merit in some aspects of the Guidelines, but it was not specific as to what sections were meritorious, instead merely indicating that it was "cognizant of the potential pro-competitive effects of some vertical nonprice restraints in a variety of circumstances" (Bingaman, 1993, p. 9). Apparently, two extreme Chicago School beliefs are no longer acceptable to the DOJ: (1) product differentiation is not a source of market power, and (2) since entry is almost always free and easy (absent government blockage), the market in interfirm relationships makes socially harmful restraints unsustainable.

Vertical Restraints Vertical restraints involve arrangements that restrict the price, other terms, and other forms of behavior between nonvertically integrated firms operating at different levels in the distribution chain of a product, e.g., between a manufacturer and its wholesaler or a wholesaler and its retailers.b These vertical restrictions on the conditions under which firms may purchase, sell, or resell (such as territorial and customer restraints, exclusive dealing arrangements, and resale price maintenance) are quite complex and have complex economic consequences.' Depending on the factual circumstances, the restraints sellers impose on their downstream customers and on their customers' conduct toward buyers may increase, decrease, or leave essentially unchanged economic efficiency.

In the Guidelines, the DOJ adopted an efficiency view of vertical restraints:

The competitive consequences of restraints that affect interbrand competition are different from those that only affect intrabrand competition. Restraints on interbrand competition may have a significant negative impact on economic welfare. By contrast, vertical restraints that only affect intrabrand competition generally represent little anticompetitive threat and involve some form of economic integration between different levels of production or distribution that tend to create efficiencies (1985, p. 4). The DOJ opined in the Guidelines that the efficiencies of vertical restraints were so great that it is appropriate to treat constraints that have every appearance of being horizontal as vertical.

If a single manufacturer complies with a request of its dealers, the resulting restraint would be properly characterized as a vertical restraint imposed by the manufacturer . . . the fact that a supplier also engages in distribution does not make a restraint "horizontal" (1985, p. 4). Thus, a dealer's cartel restricting competition in the distribution of the differentiated product of a major brand through the manufacturer was treated as not imposing a horizontal restraint on competition. Moreover, a distributor could restrain distribution of its product if it was also a manufacturer. Although the Guidelines dealt largely with nonprice restraints, it stated . . . if a supplier adopts a bona fide distribution program embodying both nonprice and price restrictions, the Department will analyze the entire program under the rule of reason if the nonprice restraints are plausibly designed to create efficiencies and if the price restraint is merely ancillary to the nonprice restraints (1985, p. 4). This rule-of reason approach flies in the face of the Supreme Court decision in Monsanto Co. v.

Spray-Rite Service Corp. (1984) that explicitly distinguished price from nonprice vertical restraints and declined to reverse the per se rule against vertical price-fixing. The Guidelines listed the

efficiencies that may flow from vertical restraints. The Guidelines stated that the "vertical restraints generally have a procompetitive or competitively neutral effect" (1985, p. 6). But the Guidelines did list possible anticompetitive effects of vertical restraints. However, these dealer, supplier, and bilateral collusions and anticompetitive exclusion possibilities were felt to be unlikely unless sellers' concentration in the restrainer's market (that is, the source of the restraint) was high, sellers' concentration in the restrained market was high, and significant barriers to entry into the restrainer's market existed. The Guidelines did not admit that a single firm might use vertical restraints to cultivate product differentiation to restrict competition and worsen market performance. Finally, the Guidelines described a two-stage process for evaluating exclusive dealing and other vertical restraints involving first structure and then conduct and performance. For instance, if a firm has a market share of 30% or less in the tying market, a tie-in is not per se illegal, and even if its market share is greater than 30%, the tie-in may be legal if competition is not "significantly blunted" in the tied market. However, during the first five years of the Reagan administration, the DOJ filed no vertical restraints cases and, by the second term, the FTC was not enforcing vertical restraints cases.

The DOJ, in its withdrawal, suggested that it had specific problems with the following features of the now-defunct Guidelines. (1) The almost complete discounting of the anticompetitive potential of vertical interbrand restraints because of their alleged inevitable efficiencyenhancing effects;

(2) The treatment of all agreements between distribution of a single manufacturer under a more lenient vertical agreement rather than the harsher horizontal agreement; and (3) The predisposition to handle vertical price fixing under a rule of reason if ancillary to nonprice agreements. In the DOJ's present view, the Congress and the Supreme Court treat vertical price fixing as per se illegal (i.e., it is necessary only for the complainant to prove that certain conduct occurred because it fell within the class of practices so plainly anticompetitive that they are illegal on their face, A la Monsanto and Sharp cases), and nonprice-fixing restraints according to a rule of reason (i.e., whereby the trier of fact undertakes a broad inquiry into the facts peculiar to, the reasons implemented, the competitive significance, and the welfare effects of the contested practices). It is interesting that the withdrawal did not specifically reject the Guidelines' treatment of tying arrangements. Under a tying agreement, a seller requires that a buyer of a tying product also purchase a second, distinct, tied product on unfavorable terms.e According to the Guidelines, "Tying arrangements often serve procompetitive or competitively neutral

purposes . . . Tying agreements generally do not have a significant anticompetitive potential" (1985, p. 11). Because the Guidelines position on tying arrangements was not specifically discussed in the withdrawal, it may be that the DOJ does not find this opinion inappropriate. If so, many economists would concur. Other vertical restraints have the potential for far greater anticompetitive consequences than tying arrangements.9 To be sure, mainstream economists do recognize that situations in which tying agreements are

anticompetitive have existed and will continue to exist. Conclusions Despite rejecting, in general in 1993, the Vertical Restraints Guidelines (1985), the Antitrust Division of the DOJ correctly recognizes, in the author's opinion, the potential competitive as well as anticompetitive effects of some vertical nonprice restraints in a variety of factual circumstances. This more balanced look at vertical restraints should be applauded by lovers of economic theory, factual evidence, and competition. The U. S. Supreme Court admonished Americans long ago to focus on promoting, protecting, and preserving competition and not just the prerogatives of competitors.

This significant change in position has strong, important managerial (practical) implications for market behavior that avoid antitrust violations. For instance, businesspeople must be more cautious about adopting vertical restraints as they are not as immune from an antitrust violation as the previous Guidelines suggested. The almost complete lack of recognition by business communities, and even some academicians, of this apparently profound shift is curious. Perhaps this manuscript can serve as a bridge between the academic and business communities in recognizing this change. One reason this change may have gone largely unrecognized is that some portions of the Guidelines were so contrary to extant case law that many thought that such conduct challenged by the DOJ would never be approved by the courts. In fact, Gellhorn and Fenton (1988) document that the Reagan-Bush administration chose not to enforce, or failed to find, any violations so that no case law existed on vertical restraints under the Guidelines when it was repealed. Another reason may be that only portions of the Guidelines are now specifically singled out as wrong. That the DOJ remained silent and did not specifically castigate some of the more important passages in the Guidelines, such as tying arrangements, can be interpreted, in the most hospitable light, as approval or at least non-disapproval. Acknowledgment Once again, the author is indebted to David B. Robinson for his helpful comments and suggestions.

Endnotes

1. See DeLorme, Frame & Kamerschen (1996, 1997) for extensive references.

2. Externalities, spillover, or neighbor effects occur when the decisions of an economic agent impose direct costs or benefits on consumers and producers other than the decision maker.

3. Rentseeking is defined as economic agents influencing government policy defined as economic agents increase their own welfare. government policy to increase their two own welfare. Prisoners' dilemma occurs when two or more economic agents, by attempting to choose the best stratoegy for whatever other(s) are likely to do, end up in a worse position than if they cooperated.

4. See, e.g., Clarkson & Miller (1982).

5. See e.g., Shughart (1997, p. 444).

6. See Kamerschen (1993, 1994), Cartwright, Kamerschen & Huang (1989), and Kamerschen & Kohler (1993), for the various approaches to defining a market.

7. See Carlton & Perloff (2000), Church & Ware (2000), Kamerschen & Kamerschen (1994), Martin (1988, 1993, 1994), Pepall, Richards, & Norman (1999), and Waldman & Jensen (1998).

8. See Kamerschen Fd Kamerschen (1994).

9. See, e.g., Kamerschen (1999).

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David R. Kamerschen, Ph.D., is distinguished professor and Jasper N. Dorsey chair in the Department of Economics, The University of Georgia, Athens, GA 30602.

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