Since 1975, when the debate over monopolistic predation began to boil in courts and universities, most discussion has focused on predatory pricing. And although the allegation of predatory innovation arose in some well-known litigation involving Kodak and IBM, lawyers and economists have produced little credible work explaining how this phenomenon can occur, let alone how it should be identified and remedied if deemed to threaten consumer welfare. This is not surprising: A legal rule defining predatory innovation-if there is to be any rule-is even more problematic to articulate than the optimal predatory pricing rule, for it must balance public policies discouraging monopolistic predation against not only those policies encouraging aggressive competition but also those encouraging innovation.
Now, just when the predation kettle appeared to be simmering again on the back burner, Professors Ordover and Willig have argued that even genuine innovations-new products that in some ways are superior to existing products in the eyes of both engineers and consumers-are in some circumstances anticompetitive. To deal with this perceived antitrust problem, Ordover and Willig propose a model of predatory marketing of product innovations that is flawed in theory and unworkable in practice.
Both the existing law on predatory innovation and the Ordover-Willig model are primarily concerned with the problem of predatory systems rivalry through technological tie-ins. Part I describes first the phenomenon of systems rivalry and then the circumstances under which Ordover and Willig believe it may give rise to an antitrust problem. Parts II and III argue that the Ordover-Willig model overlooks many of the efficiency-enhancing characteristics of technological tie-ins. Many of the points raised have been made by earlier commentators with respect to contractual tie-ins. One major weakness of the Ordover-Willig model is that, by failing to "explore the economic similarities between contractual and technological tie-ins, it overlooks the efficiency-enhancing characteristics common to both.
Part II argues that Ordover and Willig have underestimated the importance of price discrimination as a motive for systems rivalry, and that they have overlooked the beneficial consequences of a price discrimination strategy. Part III discusses other socially desirable characteristics of technological tie-ins, and argues that the Ordover-Willig model fails to consider how the decision to invest in innovation is constrained by legal and economic factors that limit an innovator's ability to exclude others from free-riding on his creation of new information. Part IV discusses various possible antitrust standards for technological tie-ins, and concludes that a rule of per se legality is at least preferable to any rule of reason yet proposed, and probably the socially optimal rule for predatory innovation.
A. Systems Rivalry
A "system" consists of components that must be used together to form a final product. For example, a central processing unit and at least one peripheral unit are needed for many computer systems, and a camera must be used with film in order to take photographs. Although a system may have many components, it is convenient to confine discussion to two-component systems, and I will refer to one component as the main unit and the other as the auxiliary unit.
If a given main unit and auxiliary unit can be used together, they are said to be "compatible." Buyers will be able to assemble a complete system from a main unit and an auxiliary unit made by different manufacturers so long as the two components are compatible. Not uncommonly, however, a firm will purposely redesign its main unit so that it is incompatible with the auxiliary units of other firms. Buyers who wish to purchase the firm's main unit will therefore also have to purchase its auxiliary unit. The resulting situation resembles an old antitrust phemonenon, the tie-in. A contractual tie-in occurs when a seller will sell one product only if the buyer also buys a second product. 10 By contrast, purchases of a technologically-tied product result from that product's unique compatibility with, and complementarity of demand to, the tying product; no explicit buyer consent is necessary. Moreover, the producer's technological tie-in does not last for a contractually prescribed period, but only until another firm can imitate the technologically-tied product. Innovations that result in technological tie-ins have given rise to litigated allegations of predatory innovation; 12 and it is such innovations with which Ordover and Willig are primarily concerned.
B. Ordover and Willig's Analysis
Ordover and Willig argue that redesign of systems components to achieve incompatibility with the components of rivals may be predatory even when the new design is a genuine technological improvement that consumers value. Predation has occurred, they argue, when a firm can be shown both to have had a predatory motive and to have made a predatory profit sacrifice.
1. Predatory Profit Sacrifice. Predation, most generally defined, is conduct by which a firm attempts to increase its own profits not by permanently improving its own performance but by injuring its competitors. IS For its conduct to be predatory, a firm must at a minimum sacrifice short-run profits in hopes of driving its rivals out of the market so that the firm may recoup its lost profits through eventual monopoly pricing. Most commentators believe that predation occurs only if, in the course of driving out rivals, a firm actually incurs short-run losses.'6 Ordover and Willig maintain, however, that even a strategy that merely produces a temporary reduction in profits may be predatory.'7 They suggest that the proper inquiry in cases of alleged predation is whether a firm's conduct would have maximized its profits even if its rivals had remained in the industry. If not, they argue, the conduct must have been motivated by a decision to drive out competitors, and thus gain eventual monopoly profits.
Ordover and Willig then outline a two-stage process for determining whether a dominant innovating firm has made a profit sacrifice, the first stage consisting of an examination of the firm's post-innovation pricing'9 and the second stage consisting of an examination of the firm's research and development investment decision.
2. Predatory Motive. Ordover and Willig argue that a firm has a motive for predatory systems innovation if three conditions are met. First, the market for the auxiliary unit must be horizontally concentrated, and entry and reentry into the market must be difficult. 21 Second, the allegedly predatory firm, or "incumbent," must have some monopoly power in the market for the main unit.22 Third, the incumbent must be unable to set prices on the monopolized main unit so as to extract the available monopoly profit.
Ordover and Willig point to two situations in which the third condition is met. First, a less efficient competitor in the market for the monopolized main unit may prevent the monopolist from charging the full monopoly price on the main unit.24 Second, if not all buyers use the main unit and auxiliary unit in the same proportions, no single monopoly price on the main unit will extract all available monopoly profits. If, however, the firm can force buyers to purchase both its main unit and auxiliary unit, and can price the auxiliary unit above marginal cost, it will be able to price discriminate between various buyers, and increase its monopoly profits considerably.25 Ordover and Willig believe price discrimination to be the less common of the two motives for predation.26 Their analysis of tie-ins motivated by price discrimination will be the major target of my criticism, and the rather compressed explanation just given will be expanded in Part II.
J. Gregory Sidak is an Expert Economist in the fields of Antitrust, Telecommunications Regulation, Commercial and Investment Arbitration, and Intellectual Property Law. Prof. Sidak is the Ronald Coase Professor of Law & Economics at Tilburg University and the Chief Economic Expert at Criterion Economics in Washington, DC. The focus of his research has been regulation of network industries, antitrust policy, the Internet and electronic commerce, intellectual property, and constitutional law issues concerning economic regulation.
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