Tying and the Rule of Reason: Understanding Leverage, Foreclosure, and Price Discrimination

Abstract

Many tying arrangements are used by firms that do not have substantial market power in either of the two markets linked together by the tie. Their function must be something other than the enlargement or perpetuation of power. A few ties do involve fairly explicit exercises of market power, but they need not be used for a different purpose than the ties imposed by more competitive firms. This paper considers firms’ use of ties to exploit whatever power they already have over the tying product. The leverage theory sees ties as exploiting customers as a group via higher prices, whether or not the tie excludes any rival. By contrast, the foreclosure theory of ties is concerned with exclusion of rivals, mainly in the tied product market, with extension or perpetuation of monopoly as a long term goal. The dominant explanation for variable proportion ties is price discrimination, although it explains some fixed proportion ties as well. Like leveraging, price discrimination results in some customer exploitation. However, while some customers are injured, most price discrimination ties benefit an even larger number of customers and by a greater amount. As a result they are beneficial under both general welfare and consumer welfare antitrust tests. Also like leveraging, a tying firm can profit from price discrimination without foreclosing any rival. Indeed, even firms with small amounts of tying product market power can use price discrimination ties. Although a price-discriminating tie might cover most purchasers of a tied product and thus foreclose a substantial share of the tied market, effective price discrimination neither requires nor typically generates a significant foreclosure or other impairment of the tied market's structure or performance. Indeed, in many litigated cases the tying product was a common commodity such as dry ice, salt, or ordinary printing ink. The least warrant for antitrust intervention occurs when higher tied product prices fail to result from foreclosure of rivals and are not reflected in customer prices that are not higher overall. For example, most ties of complementary products (1) fail to foreclose any rival from anything because the tied product is a common ingredient or other common expendable input; and also (2) fail to result in higher consumer prices for the tying/tied combination because the firm is in competition with other firms and could not assess a monopoly price increase. The last conclusion is true even though a price discrimination tie typically results in higher prices for the tied product alone. Finally, an even stronger case for lower prices results in situations where the tied product is a manufactured good sold at prices above cost. In those cases tying can eliminate double marginalization, thus benefiting both consumers and the tying seller.