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A new tool for antitrust investigators

How operations management can strengthen a well-intended but controversial anti-collusion regulation from the 1970s

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Public policy often has to balance specific objectives, but few decisions can be said to be as contentious and a focus for debate as Illinois Brick Co. v. Illinois (1977). It is a US Supreme Court ruling that has had an impact well beyond construction.

The decision has proved contentious not only because of ambiguity around its interpretation but also because of concerns regarding its effectiveness in curtailing collusion.

Even this year lawyers for Apple’s App Store cited the precedent of Illinois Brick in an attempt to have an anti-trust case against them dismissed. In May, the US Supreme Court split 5-4 over the interpretation of Illinois Brick in Apple Inc. v. Robert Pepper et al.

The justices agreed by the narrowest margin that the plaintiff did have a case against Apple’s App Store because they had a direct relationship with the tech giant. Apple unsuccessfully argued the consumer relationship was with the App makers.

"There is a fresh perspective that can cut through the complexity for antitrust investigators"

Pepper and four other iPhone owners can now sue Apple, alleging that the company has unlawfully monopolised the aftermarket for iPhone apps.

In order to understand why the relationship between Apple and its consumers mattered, we must understand the original thinking behind Illinois Brick.

The original decision

Very simply, the judgement is designed to reduce an excess of antitrust cases. The judges decided that only direct purchasers of a firm should be allowed to sue and recover antitrust damages.

The principle behind the judgment is that anti-trust cases based on ‘pass-on’ claims by an indirect purchaser could easily balloon “into massive multiparty litigations involving many distribution levels and including large classes of ultimate consumers remote from the defendant”. After Illinois Brick, only retailers, and not consumers, can file antitrust claims against manufacturers.

The trade-off to reducing the case load by barring the indirect purchasers is that there are greater need for enforcement. That is to say, if the colluding manufacturers can neutralise the threat of a lawsuit arising from retailers, they can use Illinois Brick as a shield to avoid prosecution. Curtailment of such cases requires greater enforcement efforts.

However, there is a fresh perspective that can cut through the complexity for antitrust investigators and help mitigate the trade-off, without rewriting the law.

“Taking an operations perspective can make regulations tighter, more effective and make their administration more effective”

An operations perspective

In a research paper Supply Chains and Antitrust Governance, I set out, with Sameer Hasija, Associate Professor of Technology and Operations Management at INSEAD, and Serguei Netessine, Professor at the Operations, Information and Decisions Department at the Wharton School, University of Pennsylvania, how to identify cartels hiding behind Illinois Brick and how to find the evidence to make an antitrust prosecution.

Using an operations management lens, the paper compares prevalent contracts between manufacturers and retailers. The evidence points to one type of contract that does facilitate collusion. This involves a fixed payment term in addition to the wholesale price term.

In the other contracts we studied, which were wholesale price, quantity discount, revenue-sharing and minimum order quantity, retailers have incentives to take private legal action, thus making manufacturer cartels impossible to form.

In a wholesale price plus fixed fee structure the fixed payment term enables the manufacturer to neutralise the retailer’s incentives to sue.

Therefore, this payment, sometimes referred to as a ‘slotting fee’ allows a cartel to form and to flourish.

The slotting fee is a payment to retailer for a product to be placed in a certain premium location in a shop. We found that within the context of Illinois Brick these payments may facilitate collusion.

We also found that when product demand is unpredictable, the likelihood of collusion formation is even more likely. Moreover, though the increased competition among the retailers aid collusion formation, increased competition among the manufacturers surprisingly deters collusion formation.

The research gives antitrust enforcement a four step evidence based focus for public investigators:

  1. Are manufacturers using wholesale price plus fixed fee contracts?
  2. Is there high demand uncertainty?
  3. Is there high retailer competition?
  4. Is there low manufacturer competition?

With a slotting fees the manufacturer buys access to the best retail spots. While this is standard practice it can enable collusion. Could it be that the manufacturers are buying the retailer’s silence? If an investigator sees them being used heavily then they should investigate those contracts first.

The EU is contemplating a similar ruling to Illinois Brick where ‘pass-on’ claims are barred but with a better balance between efficiency in the courts and a deterrence against collusion.

The hope is this research can inform government policy. We also hope to demonstrate that taking an operations perspective can make regulation more effective and that in the short term, this work will mitigate the side effects of Illinois Brick while retaining its legal and administrative benefits.

Nitish Jain is an Assistant Professor of Management Science and Operations at London Business School.

A summarised version of Dr Jain’s paper has been circulated in the White House through the Wharton Public Policy Initiative.



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