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LePage’s, Cascade Health Solutions, and a Bundle of Confusion

Jeff Jaeckel, American Bar Association Publications, Antitrust Litigation e-Newsletter, June 28, 2012.

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Discounts on bundled products are commonplace. Consumers value and often expect discounts when purchasing a bundle of products. Sellers use bundled product discounts to compete effectively and maximize sales. As one court has observed, “the world’s largest corporations offer bundled discounts as their product lines expand with the convergence of industries . . . [and] a street corner vendor with a food cart—a merchant with limited capital—might offer a discount to a customer who buys a drink and potato chips to complement a hot dog.” Cascade Health Solutions v. PeaceHealth, 515 F.3d 883, 895 (9th Cir. 2008). Despite the ubiquity of the practice, however, the law in this area is more than just unsettled—it is a mess. Sellers, customers, and antitrust counselors all hope for improvement, and it will surely come, but it is unclear how long we will have to wait.

The Third Circuit’s en banc decision in LePage’s Inc. v. 3M set the stage. 324 F.3d 141 (3d Cir. 2003) (en banc). The LePage’s decision was the first appellate decision to recognize formally a Sherman Act section 2 claim for bundled discounting even if the discounted prices in question are above any reasonable measure of cost. Having opened the door to potential section 2 claims against discounters, however, the decision provides little guidance that sellers, antitrust counselors, or courts could use to differentiate procompetitive bundled discounting from unlawful, exclusionary bundled discounting.

Unfortunately, no consensus has yet coalesced around a clear alternative standard. See, e.g., Richard M. Steuer, “Bundles of Joy,” Antitrust, Spring 2008, at 25; Jonathan M. Jacobson, “Exploring the Antitrust Modernization Commission’s Proposed Test for Bundled Pricing,” Antitrust, Summer 2007, at 23; IIIA Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law ¶ 749a (2008). The Antitrust Modernization Commission (AMC) recommended an alternative three-part test with a below-cost pricing screen, a requirement of proof of likely recoupment, and a rule-of-reason analysis to determine whether bundled discounts violate section 2. AMC Report and Recommendations 99 (2007). The Ninth Circuit’s Cascade Health Solutions decision elevated the below-cost price component of the AMC’s recommended three-part test to a standard for legality rather than just a screen, and rejected the other two elements of the AMC recommendation. Notably, the U.S. antitrust enforcement agencies have not contributed to clarity in this area. The Antitrust Division of the Department of Justice (DOJ) and Federal Trade Commission (FTC) failed to agree on a joint report regarding enforcement of section 2 (which, had they agreed, likely would have included a discussion of product-bundle discounts). The DOJ issued its own report unilaterally and adopted the material points of the AMC recommendation, only to withdraw and disavow the report a mere seven months later.

Against this backdrop of multiple conflicting legal standards and shifting enforcement dynamics, what may a discounter do? One thing is clear—regardless of whether the applicable test is LePage’s, a predatory pricing analysis, Cascade Health Solutions, the AMC recommendation, or the disavowed DOJ test—firms without market power with respect to any of the products in a bundle likely need not worry. But firms with market power do not have it so easy. Any firm that arguably possesses market power in the relevant market for at least one of the bundled products faces the difficult choice of whether and how to discount the bundle in the face of legal standards under which that discounting just might violate the antitrust laws.

What Is Bundled Discounting and Why Does It Matter?
Product-bundle discounts—often referred to generally as “bundled discounts” or “bundling”—are a pricing strategy that sellers often use to offer consumers an attractive package of products and to increase consumption of certain products in the bundle beyond the level that likely would occur if products were priced individually. Both sellers and consumers expect and rely upon bundled discounts, and they are commonplace in markets of all sorts.

The economic and antitrust literature regarding bundled discounts leaves a generally but not universally favorable impression of the actual impact of bundled discounts on competition. See., e.g., Timothy J. Muris & Vernon L. Smith, “Antitrust and Bundled Discounts: An Experimental Analysis,” 75 Antitrust L.J. 399 (2008). As a matter of theory, the literature concludes that bundled discounts are often procompetitive or competitively neutral. For buyers, discounts on product bundles may represent true discounts that reduce prices below the otherwise prevailing unbundled prices and provide a measure of customer convenience. For sellers, bundled discounts can in some instances provide efficiencies such as reduced transaction costs and improved economies of scale. See David S. Evans & Michael Salinger, “Why Do Firms Bundle and Tie?,” 22 Yale J. on Reg. 37, 41 (2005). Moreover, bundled discounts are tools sellers often use to increase sales, by inducing customers to increase consumption of one of the bundled products or try new products. See, e.g., Daniel A. Crane, “Mixed Bundling, Profit Sacrifice, and Consumer Welfare,” 55 Emory L.J. 423, 430–43 (2006). On the other hand, substantial literature acknowledges the potential for bundled discounting to act as an exclusionary tool in some circumstances. See, e.g., Patrick Greenlee, David Reitman & David S. Sibley, An Antitrust Analysis of Bundled Loyalty Discounts (U.S. Dep’t of Justice Econ. Analysis Grp. Discussion Paper, EAG-04-13, Oct. 30, 2006); Barry Nalebuff, “Exclusionary Bundling,” 50 Antitrust Bulletin 321 (2005).

The economic and competitive significance of bundled discounts means that the ideal antitrust standard for evaluating bundled discounts should, to the greatest extent possible, differentiate between the good and the bad while providing clear guidance to businesses and avoiding undue litigation cost. No rule will be perfect in application, however. Therefore, the development of the applicable legal standard raises a policy question of whether the legal rule should tend to err in favor of or against bundled discounting.

Bundled discounts share certain common elements with other vertical practices such as exclusive dealing, tying, and predatory pricing. However, the established literature applicable to those restraints is only modestly helpful because bundled discounts differ from other vertical restraints in fundamental and important ways and therefore present their own unique antitrust challenges:

  • First and foremost, bundled discounts are discounts that generally, though not necessarily always, will result in lower net prices to consumers.
  • Bundled discounts differ from exclusive dealing arrangements because there is no agreement that the consumer would deal exclusively with the relevant seller, though a particularly attractive bundled discount may cause a consumer to choose to purchase exclusively from a discounter.
  • Bundled discounts may differ from tying arrangements because the discount does not necessarily imply or require that the consumer purchase all of the items in the bundle. Assuming the products are sold individually, there may be no coercion at all—though it certainly is possible that a bundled discount could be so substantial as to constitute tying by economic coercion even in the absence of an express requirement that the customer purchase the entire bundle.
  • Bundled discounts differ from traditional predatory pricing simply because of the multi-product nature of the bundle. A seller of a multi-product bundle has the flexibility to spread the bundled discount across all the products in the bundle, whereas a single product seller must allocate any discount to its only product. This flexibility means that a seller of a product bundle potentially could exclude single-product competitors by discounting the bundle to a net price that is above the seller’s aggregate incremental cost for the entire bundle but provides a bundled discount that no equally efficient single-product competitor can match when pricing its individual product.

The choice of analogy matters greatly to the overall legal analysis of bundled discounts. In any event, aside from theoretical discussion in the academic literature of the exclusionary potential of bundled discounts, there are relatively few documented instances of truly anticompetitive bundled discounts. Moreover, it is not entirely clear that anticompetitive effects are likely to occur in the absence of relatively specific market conditions. The legal standard for evaluating bundled discounts under the antitrust laws should take all of this into account to provide clear guidance to sellers, antitrust counselors, and the courts. Unfortunately, we have a long way to go.

Too Many Standards, Not Enough Clarity
There are at least four alternative legal standards for assessing whether a particular bundled discount violates section 2. Two of the alternatives—the Third Circuit’s test first described in LePage’s and the Ninth Circuit’s test first described in Cascade Health Solutions—are controlling law in the respective circuits.

The Third Circuit’s “Exclusionary Effects” Test
In LePage’s¸ the plaintiff charged that 3M had used a bundled rebate program to acquire and maintain a monopoly in the market for transparent tape (which many retail customers associate simply with 3M’s famous Scotch brand tape). 324 F.3d at 147. 3M’s challenged program provided rebates to customers who met specific goals for the growth of their purchases from 3M across multiple product categories and product lines. LePage’s alleged (and 3M did not dispute) that a customer who opted to purchase transparent tape from LePage’s would have faced the loss of 3M’s rebate across all of the 3M product lines that were part of the program and not just the rebates applicable to transparent tape. Id. at 154–55. Moreover, 3M also struggled to offer a compelling procompetitive justification for the rebate program, and some of the company’s internal documents suggested that 3M may have been motivated in part by a desire to prevent private-label tape from gaining momentum in the market. Id. at 164.

After trial, the jury found that 3M’s rebate program was exclusionary and held 3M liable for monopoly maintenance in violation of section 2. The Third Circuit affirmed en banc. In its decision, the Third Circuit held that a multi-product seller with monopoly power in one or more of the products in the bundle violates section 2 when the seller uses a bundled rebate program that (a) has the effect of expanding the monopolist’s share in one or more of the competitive product markets, and (b) lacks a clear and legitimate business justification. Id. at 163–64. The court neither articulated a clear standard to define a permissible bundled discount nor required LePage’s to demonstrate that it could not compete without pricing below cost.

LePage’s has been heavily criticized as lacking clarity and potentially penalizing conduct that actually benefits consumers, and has not been followed by any court outside the Third Circuit.

The Brooke Group Predatory Pricing Test
In stark contrast to the Third Circuit’s analysis in LePage’s, many have advocated a legal standard that would effectively treat a bundle as a single “product” and apply to both the aggregate price and cost of the bundle the predatory pricing test articulated by the Supreme Court in Brooke Group, Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993). 3M advocated this test in LePage’s, and the court rejected the argument. 324 F.3d at 147.

As suggested by 3M and others, the Brooke Group predatory pricing test would compare a bundler’s total incremental cost for the bundle against its total price for the bundle. The bundled discount would be presumptively lawful unless the price of the entire bundle was less than the cost of the entire bundle. Critics maintain that this approach would ignore the “bundling” element of the transaction and treat all of the bundled items as a single product, which they objectively are not. Moreover, it would favor bundles of many products where the aggregation of numerous products would make it easier for a seller to offer above-cost bundled discounts or rebates that are proportionately more difficult for a single-product seller to match. In any event, while this test has some facial appeal, it has not been adopted or endorsed by any court, and the AMC rejected this approach. AMC Report, supra, at 98–99.

The AMC’s Discount Attribution Test
After rejecting both the LePage’s and Brooke Group analyses, the AMC recommended a three-part test that includes a modified predatory-price or price/cost “screen.” The AMC recommended that bundled discounts should be found unlawful only if the plaintiff can show the following three elements:

a. after allocating all discounts and rebates attributable to the entire bundle of products to the competitive product, the defendant sold the competitive product below its incremental cost for that the competitive product;
b. the defendant is likely to recoup its short-term losses; and
c. the bundled discount or rebate program had, has, or is likely to have an adverse effect on competition.

Id. at 99.

The first part of the AMC test is the key differentiator from both LePage’s and Brooke Group. The price/cost screen is a clear and understandable tool for antitrust counselors, sellers, and courts, and may capture for further scrutiny only the universe of bundled discounts that would have the potential effect of excluding equally efficient competitors. Id. at 100. The rationale is that a price that is above cost on an attributed price/cost basis will exclude only those competitors who are unable to produce and sell the competitive product at a cost as low as the defendant’s. Jacobson, supra, at 23, 25.

The price/cost screen is only the first part of the AMC recommendation, however. To establish a claim, a plaintiff would have to demonstrate likely recoupment of losses by showing either that future revenues would offset short-term losses on the bundle as a whole or that the price for the entire bundle is sufficiently above incremental cost for the entire bundle that the seller does not suffer any net loss on the bundle. Id. at 25–26. Finally, a plaintiff who satisfies the first two elements must demonstrate unreasonable harm to competition under a traditional rule-of-reason standard.

Although the AMC recommendation has been widely discussed, no court has incorporated the entire three-part test. The Ninth Circuit adopted the attributed price/cost screen portion of the AMC test, while the DOJ largely adopted, then subsequently withdrew, the AMC recommendation in its section 2 report.

The Ninth Circuit’s Cascade Health Solutions Test
By the time the Ninth Circuit was confronted with the issue of bundled discounts in Cascade Health Solutions, it had the benefit of observing the Third Circuit’s LePage’s decision (and the subsequent criticism of that decision) and the AMC’s analysis and recommendation. With that background, the Ninth Circuit chose a middle course that rejected LePage’s almost entirely and adopted the AMC’s recommendation to use an attributed price/cost test (but rejected the remainder of the AMC recommendation).

The case concerned a relatively straightforward bundled discount. Cascade and PeaceHealth were the only competing hospitals in a county. Cascade offered primary and secondary care services; PeaceHealth offered primary, secondary, and tertiary care services. PeaceHealth offered discounts on tertiary services if purchasers (insurance companies) made PeaceHealth their exclusive provider for primary, secondary, and tertiary services. Apart from the bundled discounts, PeaceHealth also offered less favorable prices generally to insurance companies that contracted with Cascade as a preferred provider for primary or secondary care services. 515 F.3d at 891–93.

The jury found that PeaceHealth’s bundled discount violated section 2, a decision later reversed by the Ninth Circuit. The court concluded first that bundled discounts were too important a part of normal and procompetitive commercial activity to be subject to an antitrust rule without any clear boundaries. Id. at 895–97, 903. Relying on the Supreme Court’s rationale in Brooke Group, the Ninth Circuit held that “the exclusionary conduct element of a claim arising under § 2 of the Sherman Act cannot be satisfied by reference to bundled discounts unless the discounts result in prices that are below an appropriate measure of the defendant’s costs.” Id. at 903. For the “appropriate measure of cost,” the Ninth Circuit endorsed the AMC’s recommended discount-attribution test. Id. at 906.

Although the Ninth Circuit clearly attempted to find a thoughtful middle ground that would avoid the criticisms of LePage’s, the results have been mixed. Some antitrust commentators have criticized Cascade Health Solutions as not going far enough to protect discounting from scrutiny that might harm consumer welfare. See, e.g., Mark S. Popofsky, “Section 2, Safe Harbors, and The Rule of Reason,” 15 Geo. Mason L. Rev. 1265, 1290–94 (Aug. 2008) (approving generally the price/cost screen but criticizing Cascade Health Solutions for its rejection of a recoupment requirement); Dennis W. Carlton & Michael Waldman, “Safe Harbors for Quantity Discounts and Bundling,” 15 Geo. Mason L. Rev. 1231 (Aug. 2008). Others have criticized the decision for creating a safe harbor that may effectively immunize conduct that is exclusionary and that may result in a long-term loss of consumer welfare. See, e.g., Einer Elhauge, “Tying, Bundled Discounts, and The Death of the Single Monopoly Profit Theory,” 123 Harv. L. Rev. 397, 461–75 (Dec. 2009). Unlike LePage’s, however, the Ninth Circuit’s bundled-discount test has been followed in other circuits. See Valassis Commc’ns, Inc. v. News Am. Inc., No. 06-10240, 2011 WL 2413471 (E.D. Mich. June 15, 2011); Peoria Day Surgery Ctr. v. OSF Healthcare Sys., 2010-1 Trade Cas. (CCH) ¶ 76,870 (C.D. Ill. Dec. 30, 2009). Unfortunately, no court has yet taken the opportunity to discuss and reconcile LePage’s and Cascade Health Solutions.

What Are the Implications for Multi-Product Sellers Today?
The bottom line today for any multi-product seller who has market power in the market for one of its products is “bundler beware.” LePage’s remains binding precedent in the Third Circuit, and the U.S. antitrust enforcement agencies have done little (except for the quickly withdrawn DOJ section 2 report) to clarify their view on the law or approach to enforcement.

However, even risk-averse firms can engage in some degree of bundled discounting that would be unlikely to give rise to concerns under any of the potentially applicable legal tests discussed above. But this approach, which is less about finding common ground among the competing standards than finding the “lowest common denominator,” may impair flexibility and may not be workable for every firm. Nonetheless, firms that wish to offer bundled discounts today should consider the following:

  • Does the seller have market or monopoly power in a market for one of the bundled products? If not, the bundled discount is unlikely to give rise to serious issues.
  • What are the conditions in the market for the competitive product(s)? If there are multiple competing sellers, at least one or two of whom are able to offer a competing bundle, the antitrust risk would diminish substantially.
  • Would the bundled discount pass the attributed-cost test adopted by the AMC and the Ninth Circuit? Though this standard is not universally accepted, it is law in the Ninth Circuit, has momentum generally, and appears to be the standard most likely to be adopted in new litigation in circuits that have not yet considered the issue.
  • What is the rationale for offering the bundled discount, and how is it expressed in the business documents? The Third Circuit’s LePage’s decision is partially explained by 3M’s problematic business documents and its failure to articulate a persuasive procompetitive justification for its rebate plan. A seller who can point to true efficiencies resulting from the bundle or other procompetitive justification would be in a much stronger position in any circuit.

Finally, even putting aside the lack of clarity in the law, the DOJ’s withdrawal of the section 2 report and related comments from then-Assistant Attorney General (AAG) Christine Varney raise interesting questions regarding future enforcement plans. In announcing the withdrawal of the report, AAG Varney criticized the report’s reliance on safe harbors and promised “[v]igorous antitrust enforcement action under Section 2 of the Sherman Act.” Assistant Attorney General Christine A. Varney, Antitrust Division, U.S. Department of Justice, Vigorous Antitrust Enforcement in This Challenging Era 5 (May 12, 2009). Varney’s speech did not specifically mention bundled discounts, but in light of the withdrawal of the report and general criticism of the approach that led to the (albeit brief) adoption of an attributed price/cost safe harbor, her silence on the issue is telling. Businesses are left to wonder whether bundled discounts are an enforcement priority for the DOJ or FTC and, if so, what legal standard the enforcement agencies will use internally to screen for appropriate cases and what standard they would advocate in court.

Conclusion
In a decade in which antitrust jurisprudence has been characterized by Supreme Court decisions that have refined and clarified—and some would say narrowed—application of antitrust law to vertical restraints and monopolization claims, bundled discounts remain an outlier. The law is murky, there are competing standards, and the enforcement agencies have not spoken clearly or with one voice. While this uncertainty will not continue indefinitely, in the meantime, bundled discounts remain an area of uncertainty and risk for sellers and an area of opportunity for creative plaintiff’s lawyers.

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