Do Bundled Discounts Violate the Antitrust Laws? LaPage’s, PeaceHealth, and the Discount-Attribution Test

Bundling-antitrust-300x200

Author: Jarod Bona

Let’s pretend that you sell three different types of protein powder: Whey Protein, Casein Protein, and Pea Protein. You sell them each for $10 per container. But for someone—like myself—that likes to include several types of protein in their morning smoothie, you offer a special deal of $25 total for purchasing all three types of protein at once (compared to $30 at the regular price).

Congratulations, you just offered a bundled discount, the subject of this article.

Should you worry that your bundled discount breached the antitrust laws?

Let’s dig in.

You probably recognized the maneuver above because bundled discounts are pervasive in a market system. Companies like it when customers purchase several products and may thus offer a discount—a reduction in margin—when customers do so. At the same time, customers like discounts, so they may purchase a second, third, or fourth product from the same company to obtain the discount.

So what is the problem?

Well, like many pricing policies, there exist a set of conditions such that certain bundled discounts create anticompetitive harm that exceeds their procompetitive benefits.

That sounds too formal, so let’s try this: Sometimes a big company that sells lots of different products can eliminate its competitors that sell fewer types of products by manipulating the prices of their bundles.

How does that work?

If your company has market or monopoly power, your profits are at least a little extra. This is sometimes called supra-competitive pricing or monopoly profits (or monopoly rents if you prefer economist-speak). If that is your world, you worry about not just competing, but also about maintaining your extra level of profits that only exist with market or monopoly power.

Because these extra profits can be so significant, those that have market or monopoly power will burn extraordinary resources to hold onto that power. This, of course, is one of the wasteful aspects of monopoly—the resources that go into maintaining it.

You must keep feeding the monopoly beast or it may grow weak and competition will kill it.

Anyway, monopolists are brilliant at manipulating pricing to exclude their competitors. And even though bundled discounts are usually pro-competitive, a monopolist in certain situations can employ them to exclude competition and protect their market power and, thus, their outsized profits.

In what situation can a monopolist manipulate bundled discounting to maintain or extend their monopoly?

Let’s turn to an actual case that made it to the Third Circuit a couple years after I graduated from law school: LePage’s, Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003).

You’ve probably heard of 3M—Minnesota Mining and Manufacturing Company. They are based in Saint Paul, Minnesota and they are important to the community. I am from Minnesota, originally, and as a local, you hear a lot of good about this innovative company. (Bona Law also has a Minnesota office).

3M makes many products, but relevant to this Third Circuit case, they manufacturer transparent tape (under the Scotch brand)—just like their upstart competitor, LePage’s. I am speaking, of course, from the time perspective of the lawsuit. I am certain that 3M still makes transparent tape, but I haven’t kept up with LePage’s.

Anyway, unlike LePage’s, 3M also made many other products that they sold to major customers that purchased their Scotch tape. Importantly, 3M had monopoly power in the market for transparent tape.

So, according to the lawsuit, here is what 3M did: They offered discounts to major customers (retailers, etc.) conditioned on those customers purchasing products from each of six of 3M’s product lines. 3M linked the size of the rebate to the number of product lines in which the customer met purchasing targets. And the number of targets (i.e. minimum purchases in separate product lines) would determine the rebate that the customer would receive on all of its purchases. So each customer had a substantial incentive to meet targets across all product lines, to maximize the discounts/rebates.

LePage’s sold transparent tape, but not all of the other products. So they didn’t stand a chance to compete because the customers for transparent tape would purchase from 3M because by doing so, they receive substantial discounts on a bunch of other products too.

The Third Circuit explained that “[t]he principal anticompetitive effect of bundled rebates as offered by 3M is that when offered by a monopolist, they may foreclose portions of the market to a potential competitor who does not manufacture an equally diverse group of products and who therefore cannot make a comparable offer.” (155).

Of course, if there were a competitor of 3M, even separate from LePage’s, that could offer these product lines, the Court may have held that there wasn’t anticompetitive harm or antitrust injury.

If you are inclined toward numbers, you might spit out your drink and say—“Gosh darn it! Hold on a Second! How do we know whether the discount forecloses the market or is even anticompetitive without getting into the actual prices and discounts? If LePage’s is super inefficient or insists on crazy-high prices, should they really be able to utilize the machinery of the federal government to stop a benevolent monopolist from reducing their prices?”

Good instincts!

LePage’s was a controversial decision for that reason. While 3M’s bundling could have been anticompetitive, the Court didn’t go deep enough into the analysis to really understand if they were.

For some number crunching, let’s travel west to the Ninth Circuit and see what they did a few years later in Cascade Health Solutions v. PeaceHealth, 515 F.3d 973 (updated Feb. 1, 2008).

The Discount-Attribution Test for Bundled Discounts

In PeaceHealth, the Ninth Circuit overturned a jury verdict against defendant for violating Section 2 of the Sherman Act by bundling (among other conduct). The trial court erred in providing the jury with a LePage’s instruction on bundling that didn’t include specific price-cost requirements.

This case was a dispute between the only two providers of hospital care in Lane County, Oregon. The relevant market was the market for primary and secondary acute care hospital services in Lane County. PeaceHealth—the defendant—had three hospitals, and McKenzie—the plaintiff—had one. PeaceHealth, but not McKenzie, provided tertiary care, which are more complex services like invasive cardiovascular surgery and intensive neonatal care.

Do you see where this is going?

We won’t get into the complexities of a health care market (which commonly create antitrust issues), involving insurers, hospitals, and patients, but as you probably predicted, PeaceHealth found a way to utilize the fact that it was the only tertiary care provider in the market.

More specifically, plaintiff’s theory was that “PeaceHealth engaged in anticompetitive conduct by offering insurers ‘bundled’ or ‘package’ discounts. McKenzie asserted that PeaceHealth offered insurers discounts of 35% to 40% on tertiary services if the insurers made PeaceHealth their sole provider for all services—primary, secondary, and tertiary.”

Just like in LePage’s, a monopolist for one product/service offered a substantial discount to purchasers among a range of products/services that was conditioned upon the customer purchasing the entire bundle of products/services from the monopolist. If no competitors offer the entire range of product/services, it is possible that such pricing could have anticompetitive effects on the market by foreclosing competition.

The Ninth Circuit described bundling as “the practice of offering, for a single price, two or more goods or services that could be sold separately. A bundled discount occurs when a firm sells a bundle of goods or services for a lower price than the seller charges for the goods or services purchased individually.”

The court also acknowledged that bundled discounts are pervasive and usually procompetitive—beneficial for both buyers and sellers.

But “it is possible, at least in theory, for a firm to use a bundled discount to exclude an equally or more efficient competitor and thereby reduce consumer welfare in the long run.” The antitrust doctrine of bundled discounts is a search to define when, exactly, this occurs, and thus, when the antitrust laws should forbid it.

The Ninth Circuit’s attempt to fashion the rule that fits the theory, which has had decent staying power, is called the discount-attribution test.

The appellate court explains:

“Under this standard, the full amount of the discounts given by the defendant on the bundle are allocated to the competitive product or products. If the resulting price of the competitive product or products is below the defendant’s incremental cost to produce them, the trier of fact may find that the bundled discount is exclusionary for the purpose of § 2. This standard makes the defendant’s bundled discounts legal unless the discounts have the potential to exclude a hypothetical equally efficient producer of the competitive product.” (slip 1607).

As you can see, the purpose here is for a court to examine whether the bundle excludes a “hypothetical equally efficient competitor,” not the actual plaintiff. This approach eliminates the difficulty of proving that the plaintiff itself is as equally efficient as the defendant, which is practically complicated.

Notably, Peacehealth is a monopoly case, which requires a plaintiff to show that defendant has monopoly power. Bundling can also apply to a straight Section 1 conspiracy case—the agreement is the bundle purchase—but the plaintiff should show that the defendant that offers the bundle has some level of market power. The law isn’t well-established on this point, but I’d be surprised to see it end up anywhere but at the point that some level of market power is necessary for a bundling antitrust claim.

Also, let’s say you own a small company that was excluded by the bundle, even applying the discount attribution test. If there is another competitor in the market that offers the full variety of products in the bundle and/or was not excluded if applying the discount attribution test, you are unlikely to have a claim because you won’t be able to show antitrust injury. You were injured, sure, but competition itself didn’t likely suffer. I say likely because it really does depend upon the circumstances.

Antitrust Doctrine and Labels

If you are a regular reader of The Antitrust Attorney Blog, you might notice that bundling looks like a cross between tying and predatory pricing.

Bundling is like tying because it involves multiple products and some level of coercion or opportunity (depending upon your perspective) for the customers to purchase the multiple products. For tying, the customer can only purchase multiple products together, not separately. For bundling, the customer receives a discount by purchasing multiple products together, not separately.

Bundling is like predatory pricing in that our concern is when a company with market power can utilize that market power to exclude an equally efficient competitor. Predatory-pricing doctrine digs into price-cost tests, just like bundling does. But the multiple-product aspect of bundling led to a different test because a bundler with market power that sells many products can exclude competitors that sell fewer products, even if the offered post-discount prices for individual products are not each below the bundler’s costs.

And if you read the court opinions of early treatment of bundling (including LePage’s and Peacehealth), you will notice that the courts examine both of these doctrines when trying to develop the right test for bundling, which is a practice that the courts had not dealt with quite as often.

Antitrust doctrine develops as different types of practices confront the courts in specific cases. As the same type of practice—tying, for example—arises again and again, courts create a doctrine of law, evolving similarly to the common law, that they utilize to address the practice when it comes up in the future. These decisions also provide the raw materials for the antitrust counseling that we provide to clients.

But sometimes conduct arises that seems like it could be anticompetitive, but it doesn’t fit into an obvious doctrine, like bundling, loyalty discounts, tying, predatory pricing, etc. What do you do then?

Well, you go back to the basics, perhaps the start of a law school antitrust class. What does it mean for something to be anticompetitive? And what are pro-competitive aspects of the same conduct? Are the anticompetitive aspects greater or the pro-competitive ones?

From both an antitrust counseling and antitrust litigation perspective, when the conduct in question does not fit cleanly into a particular doctrine, there is greater uncertainty about how courts or the antitrust agencies will handle it. You will see antitrust attorneys use doctrines for other types of conduct to help explain or categorize the questioned conduct, but, in the end, you must add a larger error factor into the analysis, whether you are the victim or perpetrator of the conduct.

Before LePage’s and especially before Peacehealth, bundling was an example of a type of conduct with this antitrust uncertainty. But the doctrine developed such that we now have a ballpark sense of how a court is likely to address it. Of course, the US Supreme Court has not yet spoken and I suspect the federal appellate courts are going to continue playing around with the doctrine until they do.

So bundle with care!

Image by Peter H from Pixabay

Contact Information