August 26, 2020

Antitrust Law 101


  • Antitrust complaints from the political left are often based on the incorrect assumption that antitrust law prohibits all monopolies.
  • Mere possession of monopoly power is not a sign of anticompetitive behavior or a violation of antitrust law —a company also must abuse that power.
  • The Sherman and Clayton Antitrust Acts, the basis of federal antitrust law, require detailed analysis and careful study before the federal government can prosecute antitrust violations.

Antitrust complaints from the political left are often based on the incorrect assumption that antitrust law prohibits all monopolies. This misunderstanding sometimes leads to calls for breaking up companies that have amassed a dominant share of their market. For example, at a hearing in the House of Representatives last month, one top Democrat asserted simply that large tech companies have “too much power.”

Antitrust law prohibits behavior aimed at undermining competition, but it does not prohibit successful companies from naturally outcompeting others. It is not always easy to discern whether a company is behaving in an anticompetitive way or is just better at providing its product, and there are nuanced tests for identifying anticompetitive behavior. Prosecutors for the Department of Justice and federal judges must define the relevant market and analyze it in excruciating detail before rendering a judgment.

Behavior, Not Just Size, Violates Antitrust Law

Antitrust Law 101

Antitrust Theory versus practice

In a perfectly competitive market, many firms would offer the same product and there would be no barriers to new companies entering the business. There would be no chance for anticompetitive behavior — if a firm lowers its prices, selling at a loss to beat out its competition, the competitors could simply stop selling until the firm is forced by economic necessity to raise its prices again. While no market meets this standard of competition, some markets come closer than others. Agricultural products are often cited as an example of an almost perfect market of many producers and consumers, nearly homogeneous products, and thin profit margins.

At the other theoretical extreme are “natural” monopolies, where high fixed costs and barriers to entry mean that the largest supplier has an overwhelming advantage over any possible competitors. Because it would be impractical to have multiple electricity transmission networks and sewer systems in a city, many utilities are natural monopolies. A monopoly in one of these fields could generate almost limitless profits as long as people need the product, leading governments to either directly administer or heavily regulate natural monopolies.

Antitrust law generally concerns itself with situations where there is no natural monopoly but the market is not as competitive as it could be. For example, high barriers to entry could aloow a large company try to drive others out of business – through price wars or other tactics – safe in the knowledge that new competitors won’t appear.

setting legal and regulatory boundaries

The two laws establishing federal antitrust law are the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914. The Department of Justice and the Federal Trade Commission both enforce federal antitrust laws. While their enforcement authorities overlap, the agencies tend to cover different subject areas and try avoid duplicative investigations. FTC generally covers health care, pharmaceuticals, food, energy, and some high-tech industries.

The Sherman Act prohibits agreements in restraint of trade and monopolization or attempted monopolization through anticompetitive behavior. Virtually every agreement between companies can be viewed as restraining trade in some way. Courts have long established that “reasonableness” is the key to discerning which agreements violate the Sherman Act. If a pizza restaurant needs a steady supply of cheese and pays a premium to ensure it is the exclusive recipient of a farm’s output, there is a reasonable explanation for the restraint of trade. But if a pizzeria agreed to set a standard price with all the others within 50 miles so they could maximize collective profits, that would not be reasonable.

A 1958 case involved a railroad that owned millions of acres of land in the northwest. The railroad put clauses in all its contracts with purchasers or lessees of the land saying that they had to use the railroad if its rates were equal to those of competitors. The Supreme Court found that the agreements were an unreasonable restraint of trade under the Sherman Act. By contrast, Microsoft won a landmark case in 2001 where the government claimed that the company’s bundling of Internet Explorer with Windows was anticompetitive.

Courts have created various tests to distinguish between legal acts a business takes to defeat its competitors fairly and illegal monopolistic acts that undermine competition itself. One of these is the “no-economic-sense” test, which asks whether there is any economic purpose to the conduct in question other than to keep out competition. A landmark case on this point involved the Aluminum Company of America in the 1930s. Alcoa originally gained a monopoly over the aluminum ingot market by getting an exclusive license to a patented smelting process. The smelting process required a great deal of electricity. To maintain its market position after the patent expired, Alcoa secured exclusive contracts with many electricity providers. It also entered into a series of cartels with foreign aluminum manufacturers to avoid competition from imports. These practices were found to be unlawful attempts to avoid competition.

The Clayton Act prohibits anticompetitive price discrimination — charging different prices to different customers — and mergers that are likely to harm competition. It also empowers DOJ and the FTC to sue to block anticompetitive mergers.

Mergers can be “horizontal,” between competitors in the same market, or “vertical,” between different levels in a supply chain. FTC guidelines and decades of court cases have identified a greater need for scrutiny in cases of horizontal mergers. The simple reason is that horizontal mergers by definition reduce competition. Whether the result is a harmful monopoly or simply a more efficient business depends on the particular case. The FTC has prohibited several horizontal mergers in recent years, including a proposed acquisition of the cooking oils company Wesson by the parent company of Crisco.

While the Sherman and Clayton Acts provide ample statutory basis for antitrust prosecutions against the exclusionary effect of vertical mergers, economists have often argued that vertical mergers are less worrisome than horizontal. For example, Alcoa could have tried to maintain its monopoly on aluminum by buying part of the electricity market, raising an additional barrier to entry in the aluminum market. But other electricity producers could still sell to other aluminum producers unless Alcoa bought a massive share of the electricity market. That would essentially make the problem one of horizontal market share — Alcoa horizontally acquiring more and more electricity producers — not the vertical integration of electricity into Alcoa. Some scholars have gone so far as to assert that vertical integration is never a problem except through the creation of horizontal market power.

The Problem of Product Market Definition

One problem that arises across several different parts of antitrust law is defining the relevant market. The narrower the defined market, the greater the apparent monopolistic power of a given company. However, a company cannot reap monopolistic profits if there are plenty of substitutes for its product. Court rulings and DOJ guidelines stress that if a monopolist in one kind of product cannot impose a price increase, then the relevant product market should be more broadly defined.

To take a recent example, when the Walt Disney Co. purchased Twenty-First Century Fox, many different markets were affected. Disney had a large share of movie ticket revenue, and Fox also had a substantial share. If regulators defined the relevant market as “theatrically released movies,” it might seem the merger would significantly decrease competition. But if the relevant market is “entertainment,” Disney’s market share is far less consequential. The market of greatest concern to DOJ was ultimately cable sports programming. Disney, which already owned ESPN, addressed the government’s concern by agreeing to sell Fox’s regional sports networks.

While federal antitrust laws have evolved significantly over the past century, they were never intended to harass large businesses simply because they are large. They provide solutions to complex economic problems in some situations, and should not be wielded indiscriminately.  

Issue Tag: Judiciary