Concepts in Industrial Organization: Tying Agreements and Antitrust Cases Regarding Them

Tying agreements bundle two products together - typically a more desirable product and a less desirable one. Tying occurs most frequently in the intermediate stages of the hierarchy of production. That is, producers between the stage of raw resource extraction and the stage of retail will often bundle products together as a condition of selling them to their buyers in the next stage of production.

The conventional wisdom regarding tying is that it can sometimes bring about undesirable consequences but is acceptable and harmless in most cases. Under current antitrust laws, there exists a rule of reason approach to tying. Courts have often condoned tying agreements when either of the following conditions held.

1. Tying was considered necessary for technological reasons.

2. Tying was necessary to maintain the high quality of a particular brand name.

Three major cases in antitrust history have dealt with tying agreements.

The American Can Company Case (1950)

The American Can Company and Continental Can Company manufactured can-closing machinery and, via tying agreements, mandated that their customers purchase cans from them as a condition of purchasing the can-closing machinery. The courts ruled against this practice due to worries regarding the prospect of foreclosure, where firms "downstream" the structure of production in this market would have trouble finding suppliers of their inputs or where firms "upstream" the structure of production would have difficulty finding buyers for their products. The courts feared that the practices of American and Continental would foreclose the market to either buyers or sellers.

The American Can Company did not sell its can-closing machinery; it only leased it. The only way for a firm to lease the can-closing machinery was to agree to get its entire supply of cans from the American Can Company. The courts argued that this practice foreclosed the can market to new entrants, because anybody who wished to manufacture cans and sell them would also need to produce and lease or sell can-closing machinery. The courts thus ruled that the tying practices of American and Continental were illegal and needed to cease.

Within ten years of this ruling, many more producers of cans emerged on the market - along with new producers of can-closing machinery. By the courts' definition, which often equated competition with the number of competitors, the market had indeed become more "competitive" - but this does not necessarily mean that consumers were better off, as many paid higher prices in the aftermath of the ruling.

After this ruling, courts generally judged tying agreements to be illegal per se until the 1960 Jerrold case set a different precedent.

The Jerrold Case (1960)

The Jerrold Case involved a cable company that bundled its cable service with a cable box. It mandated its customers to rent its cable box as a condition of purchasing its cable service. The courts ruled that this practice was acceptable due to technological reasons - as the cable company could not count on other producers to make cable boxes that worked as well with the company's cable service as the boxes that the company itself produced. However, the courts also ruled that this tying could not continue forever and that the cable company must stop the tying practice eventually - though the courts did not specify the term.

The Hyde Case (1984)

The Hyde case involved an anesthesiologist, Dr. Hyde, who wanted to start providing anesthesiology services to a local hospital which was already doing business with a surgeons' collective and had an exclusive contract for anesthesiology services with said collective. Dr. Hyde accused the hospital of tying its surgeries with this particular group of doctors.

The courts decided that the hospital had the right to tie its services to the surgeons' collective so as to "guarantee the quality of its brand name."

Today, courts approach tying cases using a limited per se rule: tying is allowed as long as there exists no market power sufficient to force buyers to purchase the tied products. For example, in the Hyde Case, there existed other hospitals in the area where consumers could go if they were unsatisfied with the work of the surgeons' collective in the hospital in question. Thus, the hospital's tying practices were not deemed anti-competitive.

Firms accused of making illegal tying agreements have several ways to defend themselves in court. They can claim that they do not have enough market power, that the tying is necessary for technological reasons, or that the tying is necessary for quality reasons.

Source

Pongracic, Ivan. Lecture on Alternatives to Vertical Integration. Hillsdale College. Hillsdale, MI. November 27, 2007.

All lecture material is used with explicit permission.