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Industrial Organization

by: Hailee Rowe DVM

Industrial Organization ECON 410

Hailee Rowe DVM
Cal State Fullerton
GPA 3.76


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This 19 page Class Notes was uploaded by Hailee Rowe DVM on Wednesday September 30, 2015. The Class Notes belongs to ECON 410 at California State University - Fullerton taught by Staff in Fall. Since its upload, it has received 13 views. For similar materials see /class/217077/econ-410-california-state-university-fullerton in Economcs at California State University - Fullerton.

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Date Created: 09/30/15
CASE 9 Collusive Predation Matsushita v Zenith 1986 Kenneth G Elzinga INTRODUCTION Within a few months of the Supreme Court s 5to4 opinion in Matsushita V Zenith1 the case had become a widely cited and widely discussed deci sion of the Court What the Supreme Court decided in only seventeen pages of written text came after millions of pages of documents had been examined and thousands of hours of labor had been expended before the litigation got to the nation s highest court By antitrust standards Mat Sushita V Zenith was what lawyers call a big case Justice Lewis Powell s Supreme Court opinion recognized that eco nomic analysis merited an important role in the Court s reasoning process Indeed it is rare for the Court to place reliance on economic analysis to the extent that it did in this case Four principles from the economists tool kit have particular usefulness in assessing this case They are the economic theory of predation the theory of the cartel cheater the law of one price and the principle of alternative opportunity cost THE BACKGROUND OF THE LITIGATION Some antitrust cases involve allegations of conspiracy Some entail alle gations of predatory pricing Matsushita v Zenith hereafter M v Z was Kenneth G Elzringa served as a consultant to the Japanese television manufacturers in this case Gratitude is expressed to David E Mills for his input on this case stu y 1The case originally was Zenith v Matsushita at the district court Zenith Radio Corp et al v Mat sushita Electric Industrial Corp Ltd et al 513 F Supp 1100 1981 Upon the defendants initial legal victory the case was appealed by the plaintiffs Zenith Radio Corp et al v Matsushita Elec tric Industrial Corp Ltd etal 723 F2d 238 1983 After Zenith s victory at the initial appellate 220 Case 9 Matsushita V Zenith 1986 about both conspiracy and predatory pricing The plaintiffs charged that several companies that were supposed to be independent competitors entered a conspiracy to charge predatory prices in one market while collu sively charging supracompetitive prices in another Several laws were said to be violated by the defandants behaviorZ but the Sherman Act charges of a conspiracy to restrain trade and a collective attempt to monopolize were the focus of the action The Players Matsushila v Zenith was born in 1970 when National Union Electric Cor poration NUE brought suit against a number of Japanese rms NUE was the former Emerson Radio Company a US pioneer in the manufacture of radios and television receivers Four years later Zenith Radio Corporation led a similar lawsuit against the same Japanese rms The two actions were consolidated The principal defendants were seven Japanese rms Matsushita Toshiba Hitachi Sharp Sanyo Sony and Mitsubishi here after the Japanese rms3 They are among the largest business corporations in the world In 1974 the seven rms had combined sales of over 20 bil lion Zenith and NUE are not Mom and Pop operations either Zenith had sales of 910 million in 1974 and NUE had sales of 140 million The charges in M v Z embrace the entire consumer electronics prod ucts industry television receivers radios tape players and stereo equip ment But the case was fought primarily over the relevant market of televi sion receivers hereafter televisions in the United States Televisions are a consumer durable familiar to everyone Originally the product of American and European inventors the US industry was the world leader in production volume and quality until the mid1960s The birth of the Japanese industry came largely through licensing arrange ments and technical assistance from US companies American rms such as GE RCA Westinghouse Western Electric and Zenith along with Eu ropean rms such as Philips were prominent exporters of licensed tech nology to Japan The basic charge against the Japanese rms was that they were engaged in a massive global conspiracy lasting more than two decades whose purpose was to destroy the American television industry The al leged strategy had two prongs l charging monopoly prices in Japan the level mm M t I hit W m In I m 39Cor LtdetalvZmith Radio Corp at 11 475 US 574 1986 Throughout this anicle the term plainti s refers to the original plaintiffs in the lawsuit Zenith and National Union Electric Corporation 2Sections 1 and 2 of the Sherman Act Section 73 of the Wilson Tariff Act Section 7 of the Clay ton Act the Robinsoanatman Act and the Wilson Antidumping Act The last law did not involve any conspiracy allegations 3There were seveml other defendants including subsidiaries of the Japanese rms and some American rms such as Sears Roebuck Sony was one of the original principal defendants It setr tled with Zenith but remained a defendant in the NUE half of the case 221 TH E ANTITRLIST REVOLUTION defendants home market through a price xing conspiracy among the de fendants there and 2 using the monopoly pro ts made in Japan to subsi dize belowcost predatory pricing on export sales to the United States Zenith and NUE claimed that in the short run US producers like them selves were economically harmed by the predatory pricing and in the long run American consumers would end up paying monopoly prices on televi sions after domestic competition was eliminated Predatory Pricing in the United States Using monopoly pro ts made in one market to gain a monopoly position in another is a strategy often associated with some of the notorious trusts of an earlier industrial era In M V Z the alleged predators were Japanese rms and their war chest supposedly was derived from a cartelized home market largely shut off from outside competition The Mechanics of Predatory Pricing in Matsushz ta v Zenith Two Japanese organizations were said to form the heart of the export por tion of the conspiracy MlTl theMinistry of International Trade and lndus try and the JMEA Japanese Machinery Exporters Association Through MlTl an arm of the Japanese government minimum prices called check or reference or benchmark prices were established governing the sale to the United States of consumer electronic products including televisions Through the JMEA the defendants allegedly adopted a Five Company Rule that limited each Japanese seller to only ve wholesale customers in the United States Under the Sherman Act it would be illegal for a group of competitors to agree upon minimum prices and to agree not to compete against each other for particular customers4 The plaintiffs contended that not only were agreements made by the Japanese rms on the check prices but there were additional agreements to go below the checkprice minimums This disregard of the check prices was done according to the plaintiffs through secret rebates and discounts to US customers Zenith and NUE complained that these prices or at least some of them were arti cially depressed and predatory There are then two antitrust issues running concurrently here prices that are predatory in the US television market and a collusive agreement to put them there The economic theory of predation sheds light on the rst issue the economic theory of cartels sheds light on the second AWhile both xing minimum prices and dividing markets are Sherman Act offenses it is not clear how rivals of rms adopting such behavior would be affected adversely by these practices In fact Zenith and NUE should have been the bene ciaries of such tactics had they been carried out If xing minimum prices and dividing markets had constituted the plaintiffs entire case the district court would have denied them standing to sue because they would not have been injured parties but rather economic bene ciaries 513 F Supp 114771148 1981 222 Case 9 Matsushita V Zenith 1986 THE ECONOMIC THEORY OF PREDATION AND THE EVIDENCE Predatory pricing is a conscious strategy of pricing below cost on a sus tained basis to eliminate or discipline one s rivals in order to maintain or establish monopoly power When this strategy is successful rivals expire or cede pricing leadership to the predator The upshot of successful preda tory pricing is the monopolization of a market to the detriment of con sumers of that product or service The topic of predatory pricing has been widely discussed in academic circles and has been a central allegation in several important antitrust cases that did not reach the Supreme Court in the decade prior to M V In many antitrust cases involving predatory pricing courts typically examine evidence comparing a defendant s prices with its costs The most famous methodology for comparing prices and costs considered by courts is adopted from the economic theory of the rm and was promoted in a 1975 article in the Harvard Law Review5 This method now called the AreedaTurner test entails comparing an alleged predator s price with its average variable cost as a proxy for marginal cost and rests on the as sumption that no seller normally will produce output if the market price is below the rm s outof pocket costs7 In the economic theory of the rm the average variable cost curve is associated with the rm s shutdown point In a mechanical application of this theory a price below the shut down point should cause the rm to cease operations8 If the rm chooses not to shut down the inference is explored or drawn that the rm is en gaging in predatory pricing 1 erent in predatory pricing is that the predator must incur a short run loss in order to impose losses on its prey Zenith and NUE claimed that the Japanese defendants sold televisions in the United States at prices below cost Partly because of the dif culty in estimating defendants vari able costs and partly because there was not a full trial on the merits an 5The litemture on predatory pricing is too large to cite comprehensively here For a selective in troduction to the topic and the ongoing debate see Joskow and Klevorick 1979 Brodley and Hay 1981 Calvani and Lynch 1982 Isaac and Smith 1985 Shepherd 1986 Fisher 1987 Boudreaux Flzinga and Mills 1995 and Areeda and Hovenkamp 1996 pp 221465 as well as the references to the articles on price predation in footnote 20 5Areeda and Turner 1975 7As Areeda and Turner 1975 p 733 put it Recognizing that marginal cost data are typically unavailable we conclude that a a price at or above reasonably anticipated avemge variable cost should be conclusively presumed lawful and b a price below reasonably anticipated avemge variable cost should be conclusively presumed unlawful 8There are benign reasons a rm may price below average variable cost The rm may be unloadr ing inventory at distress prices it may be a new seller engaging in promotional pricing it may be rm whose output does not yet exploit expected lower costs due to a learning curve pher nomenon and its avemge 39 L may a 39 39 make pricing below this measure of cost pro table on a posttax basis 723 TH E ANTITRLIST REVOLUTION AreedaTurner type test was never used by the Court to examine the pre dation allegation9 Predation as an Investment In economic analysis predation can be seen as having an investmentlike character One incurs signi cant costs in the form of losses during the pe riod of predation These losses are an investment in prospective monopoly pro ts Justice Powell recognized this subtle facet of economic analysis when he wrote the following The forgone pro ts of predation may be considered an investment in the future For the investment to be rational the conspirators must have a rea sonable expectation of recovering in the form of later monopoly pro ts more than the losses suffered10 Figure 91 illustrates and compares a predator s losses during pre dation and its pro ts during recoupment Assume that the competitive prepredation price is at a level of 100 and is represented by the distance OH The total quantity sold per year at this price is also 100 and is repre sented by DC Now suppose that the alleged predatory price of the Japa nese sellers was equal to the distance 0E and assume that this unremu nerative price caused some US sellers to leave the industry and others to cut back their output such that US sales were only 0A Assume further that the demand curve remains unchanged The total number of televisions consumers will buy during each year of predation is 0D Since US producers have elected to produce only 0A under the predatory conditions the Japanese must produce the balance D This means the Japanese rms loss on each unit produced and sold is FH the difference between the average competitive price 0H which is a proxy for longrun average costs including a normal pro t and the preda tory price 0F Thus the predators losses in every year of predation are de picted by the product of HF gtlt AD the shaded rectangle Figure 91 can be used to assess the prospects for recoupment by the defendants Assume that when predation is over the US competition is beaten back and continues to produce only 0A units This means the Japanese rms cannot consider the total demand curve as their own They will raise prices during recoupment to maximize pro ts over the 9An economic expert for the plaintiffs opined that four of the Japanese rms had sold televisions in the United States at prices at least below avemge cost The district courtjudge for reasons not assessed here ruled that this pricercost evidence was inadmissible on the grounds that the cone struction of the cost and price data was unreliable 10475 US 574 5887589 1986 Case 9 Matsushz ta v Zenith 1986 FIGURE 9 1 Predator s Predation Losses and Recoupment Gains Price recoupment pro ts N o o predation losses vlo39o39vovo39 394 oo o 9 o o o q o 4 ammuti w p o 9 0 A B C D Output residual demand curve which is that portion of the demand curve south east of point K11 The predators pro t maximizin g monopolistic price during recoup ment is OI their level of output is AB which is the difference between the total demand OB at the recoupment price and the output 0A of their US rivals The pro t on each set is IH The pro t during each year of recoup ment would be the product of H X AB the cross hatched area On the basis of Figure 9 1 a predatory pricing strategy would seem rational only if the value to the rm of the recoupment rectangle exceeded the cost to the rm of the loss rectangle In the example shown visually this does not occur but the rectangles represent only an annual bene t and cost The predatory strategy in its loss stage and recoupment stage may take several years Figure 9 1 therefore is a heuristic device A simple comparison of the rectangles by itself cannot reveal the full costs and bene ts of preda tion because of the tactic s intertemporal dimension But Figure 9 1 does illustrate key parameters of a predation strategy 11The pro tmaximizing price for the predators will be the midpoint of the segment K for a linear demand curve Any price southeast of J on the demand curve could not be a recoupment 0p tion for the Japanese sellers if they were predators since J itself shows the competitive price level A price higher than K on the demand curve is not an option either With the US rms sup plying OA already nobody would pay such a price 225 TH E ANTITRLIST REVOLUTION Present Value and Predation Economic analysis teaches that a dollar tomorrow is worth less than a dollar today Consequently a rational predator recognizes that the pro t rectangle during recoupment must more than offset the loss rectangle during preda tion in order to compensate the rm for the timevalue of the funds em ployed In a more careful analysis of predation the discounted character of the losses would be compared with the future stream of monopoly pro ts 12 Whether the returns to investment in predation are suf ciently great to warrant the cost depends on how long and how far prices are below costs during the predation period the rate of return the predator uses in making its investment decision the reentry rate of rivals during the re coupment period and the length of the recoupment period In addition the more inelastic is demand in the market the better the prospects for a predator to be successful Using this analysis Table 91 shows a series of conditions derived from the economic studies submitted by plaintiffs in M v Z The predatory price is expressed as a percentage of the prices that plaintiffs alleged would have prevailed absent predation For example in column one for color televisions the entry 62 re ects the plaintiffs contention that the average prices charged by Japanese rms during the period 1968 to 1975 were 62 percent of the butforpredation price Column two shows the same calculation for blackandwhite receivers Both columns re ect the deep discounting allegedly engaged in by the Japanese Column one adopts plaintiffs position that the period of predation ran at least from 1965 when the Japanese rst gained 5 of the market to 1975 the year after the cases were consolidated Column two indicates that predation in TABLE 9 1 Predation in Televisions Color Sets BlackWhite Sets Predatory price 62 58 Years of predation 10 13 Growth in demand 5 72 Japanese beginning market share 5 5 Japanese ending market share 42 17 Recoupment price range 1197138 100106 Years of recoupment co of nonrJapanese imports and stable US production levels would shrink Japanese sa1es to Zero at pnoes above 100 pen m 12This approach has been developed in Elzinga and Mills 1989 For a comparison of this ape proach with the AreedarTurner test see Elzinga and Mills 1994 226 Case 9 Matsushita V Zenith 1986 blackandwhite sets purportedly endured for at least thirteen years Given such deep discounting for such a long period the losses or magnitude of the investment in predation would be enormous It would be unrealistic for the defendants to expect the output of US television producers to fall immediately to zero under conditions of preda tory pricing if only because some consumers may prefer particular fea tures of US producers such as cabinet styling and some retailers who carry a full line of appliances made by a particular US manufacturer may be slow to substitute a Japanese brand of television sets For these reasons and others there would be some lag before US rms drastically reduced or ceased their television production because of predatory price levels But if prices were in fact predatory predators at a minimum could reasonably expect the output of US rms not to expand during the predation period If domestically produced output remained constant as column one of Table 91 assumes the Japanese would capture all television sales stem ming from demand growth This would have given the defendants 42 per cent of the color market by 1975 The demand for blackandwhite sets was declining during the period under consideration Column two s calculations ascribe to the Japanese producers their actual share of the blackandwhite segment at the end of the predation periodil7 percent Japanese rms in the manufacturing sector at that time earned an average 122percent rate of return on assets Holland 1984 Table 13 p 9 If this approximates the alternative op portunity cost for the defendants of an investment in predatory pricing and if 12 is a reasonable estimate of the price elasticity of demand for televi sions in the United States Houthakker and Taylor 1966 p 130 the size of the putative losses of the Japanese rms can be compared with the prospective returns supposedly available to offset them From this one can estimate how long and at what level remunerative recoupment prices would have to be for predation to be worthwhile Table 91 shows the range of prices the Japanese could have expected to charge during the recoupment period and the duration of payment to make predation worth the candle The analysis assumes that the rivals of the Japanese defendants sell the same number of televisions during the years of attempted recoupment as they did at the end of the predatory pe riod This assumption favors the prospect of the predation strategy s being successful in that it means that the rivals of the predators do not expand their output even if monopoly prices were being charged by the Japanese producers The table suggests that even under this assumption recoup ment is impossible for the Japanese rms in either of the television seg ments lf recoupment could go on for in nity it would not pay off for the Japanese rms in color televisions because the huge initial losses swamp the modest price enhancement possible during recoupment In the black andwhite segment prospects are even worse Because of declining de mand charging the best price it can for blackandwhite sets essentially 227 TH E ANTITRLIST REVOLUTION the competitive price shuts the Japanese rms out of the market in ten years By the analysis re ected in Table 91 the pricing strategy imputed to the Japanese rms by the plaintiffs in M V Z requires that the defendant rms act irrationally Because the investment characteristics of the market do not support a predation theory this suggests some other explanation of the events described such as lower costs for the Japanese rms Market Power Prerequisite for Recoupment Economic theory characterizes successful predation as a twostep se quence The rst step involves belowcost pricing to drive out or discipline rivals exercise of the second step recoupment requires monopoly power In antitrust enforcement a rm s market share often serves as a proxy for its market power A seller with a low market share in a market with several sellers cannot dictate market price unilaterally A rm or group of rms acting collusively with a large market share may not have signi cant mar ket power either if customers perceive other products or services as close substitutes or if entry into the market is easy Notwithstanding the economic devastation supposedly in icted upon US rms the Japanese defendants combined market share in terms of unit sales of blackandwhite and of color sets made to US dealers never exceeded 50 percent13 Japanesemade color sets exported to the United States went from fewer than 700000 units in 1968 to almost 4 million units by 1976 The numbers are impressive but not overwhelming In 1965 the Japanese defendants supplied only about 10 percent of US purchases of televisions by 1970 the percentage had grown but was still under 30 per cent14 If there were no collusion on export sales a fortiori the low market shares of individual Japanese rms would suggest that the defendants indi vidually had no signi cant control over price lndeed Mitsubishi in its biggest volume year in the United States sold less than 1 percent of the blackandwhite and color sets purchased in this country 15 While NUE and other US television producers did exit the business Zenith remained a prominent seller In 1973 the year before the NUE and Zenith cases were consolidated Zenith had 238 percent of the color television market selling more sets in the United States than any other seller Zenith was followed by RCA another US producer which at that time had 201 percent of the US color market15 Plaintiffs had dif culty 13513 F Supp 1100 1322 1981 14513 F Supp 1100 1251 1981 15513 F Supp 1100 1285 1981 Mitsubishi owned no manufacturing facilities in Japan so it is not evident under the plaintiffs theory of the case how it bene ted from a predatory export cartel It could not use gains from Japanese production to nance losses in the United States In fact it is a buyer of televisions which it resells it has no incentive to see the Japanese home market mor nopolized or to drive US manufacturers out of business 15513 F Supp 1100 1255 1981 228 Case 9 Matsushita V Zenith 1986 persuading the court that the Japanese rms even collectively ever gained monopoly power or had the prospect of gaining it to accomplish predation s second step Economic reasoning persuaded the lower court that there was no reason to study or ascertain the height of any entry barriers in the televi sion industry because of the low market shares held by the defendants Cheating in a Predatory Cartel In the economic theory of the cartel one of the most powerful concepts is that of the cheater Cartel theory teaches that when a group of rivals collu sively establishes price at the joint pro tmaximizing level it will be eco nomically advantageous for any one seller to operate outside the cartel rather than within Outside the cartel a sellerithe cheaterican enjoy the high cartel price but not be subject to the output limitation imposed on in siders that makes the high price possible Most cartels seek to maintain high prices So the cheater typically is the rm that tries to sneak outside shade prices and clandestinely sell larger outputs But in a predatory cartel the cheater does the reverse lf rms have agreed to charge prices below cost the cheater s incentive is to sell less than its share of the jointly mandated amount considered neces sary to drive out the rivals The cheater concept has powerful applicability in analyzing M v Z Plaintiffs maintained that under the auspices of MlTl Japanese sell ers collusively set check prices The checkprice minimums were to show the Us government that Japan wanted fair competition and should not be subject to tariffs and quotas that would be even more restrictive Then to circumvent the check prices the Japanese sellers offered US cus tomers secret price cuts and rebates below these prices Plaintiffs devoted some 2000 pages in their Final Pretrial Statement describing details of this rebate scheme The documentation is a powerful showing of the many ways by which buyers pay transaction prices lower than list prices Zenith and NUE alleged that the prices the Japanese sellers netted after violating the checkprice minimum were unremunerative The factual record surrounding the checkprice violations actually is powerful evidence that these reference prices were not predatory because sellers sought additional sales at levels below them It would be irrational as a matter of economics to want to sell more than your share at prices below cost especially when such sales involved falsifying purchase or ders shipping documents export validation forms and US Customs in voices entailed keeping double sets of books and involved other types of concealment 17The Japanese sellers would secretly rebate to the customer the difference between the nominal price declared for export and import purposes and the actual tmnsaction price quoted to the cusr tomer These activities did not violate the antitrust laws but they did expose the Japanese produce ers to other legal action by the Us Bureau of Customs and the Us Treasury Department 229 TH E ANTITRLIST REVOLUTION It is logical to ask whether the secret rebates and clandestine dis counts might not have been part of a concerted effort by the Japanese to move transaction prices downiperhaps without MlTl s knowledgeito predatory levels What is dif cult to reconcile with such a conjecture is the eagerness with which Japanese sellers sought to expand their sales at prices below the checkprice level a level that allegedly was below pro duction and marketing costs18 For example an importer told Sharp one of the seven principal defendants that Sharp s competitors were rebating off the check prices and that if Sharp wanted any business it must be pre pared to lower its prices as well Sharp obliged When Matsushita was planning to acquire Motorola a US rm to which Sharp had sold televi sions Sharp requested Motorola executives not to tell Matsushita of its past rebates and deviations from the check prices19 The only economic rationale for an eagerness to expand one s share of belowcost sales in a truly predatory cartel would be if a seller viewed its product line as being highly differentiated If there were great customer inertia against switching brands a cheating member of a predatory cartel might covet additional sales even during the period of predation know ing or believing that its new customers will not switch suppliers when prices are raised later to monopolistic levels Such a prospect does not square with consumer behavior in the tele vision industry at the time of the alleged predation in M v Z Only Sony among all the defendants had signi cant brand recognition and it sold at relatively high prices not low prices Largescale buyers of Japanese tele visions and other consumer electronics products such as a KMart or a Woolco who frequently attach their own house brand name to a prod uct do not become wedded to a particular manufacturer Moreover Japa nese television manufacturers witnessed rsthand that American con sumers were not locked in to their rst television brand Many switched from US rms like Philco and Admiral to rms like Hitachi and Sanyo when they purchased their second television sets or replaced their rst The Economic Literature on Predatory Pricing Legal opinions usually have many footnotes But rarely are they refer ences to economists In M v Z the Supreme Court to an extent not often seen relied on economic studies of predation to in uence its decision Jus tice Powell mentioned the consensus among commentators that predatory pricing schemes are rarely tried and even more rarely successful 2 18Cartelization also implies not only concerted behavior but also similar behavior Rebates were not offered to all customers and the amount of rebates when offered varied between defendants and between customers of the A f A Such quot r 39 quam 39 39 rivalry more thanjoint conduct 513 F Supp 1180 1249 1981 19513 F Supp 1100 1247 1278 1981 20475 US 574 589 1986 Some of the scholarly articles the Court cited are Easterbrook 1981 Koller 1971 and McGee 1958 1980 230 Case 9 Matsushita V Zenith 1986 The word consensus is an apt one unanimity would not have been Most of the historical studies of alleged episodes of predatory pricing have shown the charges to be unfounded They tend to support the prediction of economic theory that predatory pricing will be dif cult because of the large losses a successful predator must somehow offset Nonetheless there are some economists who remain persuaded that predatory pricing is in particular markets a matter of serious antitrust concern THE LAW OF ONE PRICE The economist s law of one price says that in competitive markets sales of the same product will be at identical prices Plaintiffs in M V Z essen tially argued If a television set sells for 200 in yen equivalent in Japan and the same set sells for 150 in the United States sellers should increase supply in Japan and decrease supply in the United States on the assump tion that transportation costs are not substantial In the process by com petitive arbitrage only one price will result If prices do not equilibrate the argument continues there must be a reason Japanese sellers do not ex pand sales in Japan the home market conspiracy theory and reduce sales in the United States the predation theory Capping off the argument is the closed Japanese market for which there is much evidence which pre vents US producers from accomplishing the arbitrage by increasing their shipments to Japan The dif culty of obtaining retail and wholesale distri bution appeared to be one of the main barriers to entry Plaintiffs offered evidence that compared defendants home market prices for televisions with prices for US export and argued that Japanese prices exceeded US prices Defendants claimed this evidence was marred because the economists ceteris paribus conditions were not met in making the comparison The sets were not identical in their engineering speci ca tions they were sold at different levels of distribution and they bore dif ferent warranty and distribution costs in the two countries The lower court agreed with the defendants economic analysis that these differences made the law of one price inapplicable In fact Japanese export sales to the United States did not have a lockstep relationship either to their own or to US prices Some of the defendants notably Sony charged relatively high prices in the United States21 Some charged rela tively low prices Moreover relative prices varied among different models among the Japanese defendants themselves and in comparison with their US rivals That Japanese rms often undercut established prices in the United States does not itself prove predation since the Japanese were new entrants 21Sony was an awkward choice of rms for plaintiffs to group with the others The prices charged by its pro table American distribution arm Sonam were considerably higher than both the check prices and the prices of Zenith and NUE sets See 513 F Supp 1100 1282 1981 How Sony s high prices could injure American rms was never speci ed 231 TH E ANTITRLIST REVOLUTION in the US market and the market is one where longterm cost reductions led price levels downward over time In markets where economies of scale and learningbydoing result in cost reductions economic theory teaches that prices will trend downward Frequently such trends are led by the newer rms who are seeking to use low prices to help gain brand recogni tion goodwill and company reputation22 Economists and Inferential Evidence In the United States price xing conspiracies often do not leave smoking guns idirect evidence in the form of a written agreement to charge joint p 39 39 39 price or a 394 t p h 1 39 Antitrust enforce ment agencies often must use indirect or circumstantial evidence to prove price xing But in M v Z there was direct evidence that the Japanese rms had signed a document determining minimum export prices on television sales to the United States Indeed over time there were more than a dozen such agreements covering both blackandwhite and color televisions This is the language of Article 8 of one such agreement The Manu facturers Agreements The parties to this agreement shall not offer for sale make a contract for sale or deliver to export businessmen goods at prices lower than the prices speci ed in attached Schedule 2 23 Signato ries could sell at or above the check prices The defendants claimed that these agreements were mandated by the Japanese government through MlTl and therefore were immune from US antitrust prosecution by the act of statequot and sovereign compulsion doctrines The plaintiffs contended that MlTl did not compel joint action by the Japanese sellers and that MlTI at best gave subsequent approval to business strategy initiated by the defendants Using economic reasoning the district court recognized that Zenith and NUE and other US producers of televisions could not be harmed by foreign rms setting minimum prices Zenith for example should have been delighted if Hitachi were hamstrung by legal minimums All Zenith would need to do to compete assuming comparable quality and other terms was charge a price less than the minimum to which Hitachi was bound24 Moreover jointly setting minimum prices does not t gracefully with the theory that prices are predatory quot39 39 mm 1w quot r r t on um r r 4 39 Innaquot Together they controlled almost 95 percent of the Japanese market but there is no credible evidence that tmnsaction prices at the hmquotn 391 1v TL LI ofe tahli hed hmnd recognition A c A United States probably are explained by higher distribution costs in Japan than in the United States 23513 F Supp 1100 1188 1981 2AParadoxically MlTI and the defendants claimed that the mtionale behind the minimums was to limit the number of televisions exported to the United States and thus the agreements represented a stmtegy by the Japanese to limit or prevent even more severe USrimposed tmde restrictions on Japanese goods through tariffs and quotas 232 Case 9 Matsushita V Zenith 1986 The Five Company Rule limiting each favored seller to only ve US wholesalers also was not compelling as evidence of predatory pric ing First the rule did not always holdiseveral large American buyers such as J C Penney Sears Roebuck and Western Auto purchased televi sions from more than one of the seven Japanese sellers Second the rule was easily circumventedia defendant could make its American sub sidiary one of the ve and sell to anyone in the United States through that subsidiary Moreover the rule could not have injured Zenith and NUE or other US producers Indeed if the Five Company Rule had constrained Japanese sellers it should have made it easier for Zenith and NUE to sell to any particular domestic buyer since that buyer allegedly was limited in its Japanese supply alternatives From an economic perspective the Five Company Rule runs contrary to the hypothesis of a low price export con spiracy An organizer of a predatory cartel might have to say you must sell to these ve but not you are limited to these ve The Home Market Conspiracy Price xing in Japan supposedly was the means by which the Japanese sellers nanced the sales of televisions at depressed prices in the United States As sometimes happens in antitrust cases as litigation commences from complaint to discovery legal theories change The district court noted early in its opinion that the war chest theory which formed an im portant part of the plaintiffs original charge began to wane as the case progressed By the time of the summary judgment the judge wrote Little is said at this stage about warchesting apparently because plaintiffs nally recognized that there is no evidence of it in the record 25 Earlier in a controversial move the lower court judge had rejected much of the written opinion of the plaintiffs economic experts who con tended that a home market conspiracy existed These economists reviewed written materials that persuaded them circumstantially that a conspiracy existed Much of this evidence was held to be untrustworthy and inadmis sible For example one JMEA document contained this statement Thus the businessmen involved have decided that acting as one body they will strive to maintain export order and furthermore to aim for steady expan sion of exportation 26 Economists for the plaintiffs saw such documents as evidence of conspiratorial intent But the lower court judge interpreted 25513 F Supp 1100 1129 1981 Indeed after surveying many of the documents concerning the meetings of Japanese executives about home market prices Judge Becker concluded that discus sions about home market prices were often discussions about how to maintain retailer margins which may have lowered manufacturers prices and conversations about how prices were dropr ping in Japan to levels too low to enable manufacturers to break even These were facts Judge Becker found dif cult to square with the war chest theory See 513 F Supp 1100 120371204 1981 25513 F Supp 1100 1231 1981 233 TH E ANTITRLIST REVOLUTION the document merely as expressing an intent to reduce trade friction be tween the United States and Japan Moreover he ruled that making judg ments about conspiracy based on circumstantial evidence of this sort is not the task of an expert economist Judges and juries are supposed to make such decisions He dismissed much of the work ofplaintiffs economic ex perts as that of conspiracyologists and not the work of economists qua economists27 The plaintiffs contended that parallel price discrimination was such strong inference of conspiracy that a trial was merited The defendants ar gued that to go from a fact of sustained high prices in Japan and lower prices in the United States to the conclusion of conspiracy is not inference but speculation The plaintiffs it should be noted never submitted any evi dence of the rates of return made by Japanese defendants on home market sales They argued that it should be suf cient to show a price difference28 War Chests and Alternative Opportunity Costs Economic analysis often proceeds from assumptions At this juncture let us assume that the Japanese rms had cartelized their home market and were making monopoly pro ts there Let us assume too that the Japanese rms are considering a predation strategy in the United States Plaintiffs in M v Z argued that there is a connection or nexus between the circum stances in the two sets of assumptions A successful television cartel in Japan renders more likely the adoption of a predatory campaign against the television industry in America The pro ts from one market subsidize the other This is the war chest theory of predation Economic analysis cautions against a quick adoption of such a theory War chests like everything else in the world of economics do not come free Their cost is the forgone pro ts that could have been earned by in vesting the purported monopoly pro ts made in Japan in some alternative endeavor The alternative would include relatively riskless opportunities for the funds such as government bonds No rational rm would forgo a more certain and immediate stream of income for a riskier and more long term prospect of gain unless the opportunities for the future gains are very attractive lf predation were an attractive strategy that is if it were nancially at tractive as an investment relative to other riskadjusted alternatives then potential predators would adopt this strategy of export pricing independent of their home market position In other words if a predatory strategy in volving shortterm losses is apro table investmentbecause of an expected future monopoly position it is attractive regardless of whether cartelizing in the home market or any other market also has proved pro table 27513 F Supp 1100 1138 1981 28513 F Supp 1100 1205 1981 234 Case 9 Matsushita V Zenith 1986 THE DISTRICT COURT DECISION Judge Edward R Becker at the time serving on the US District Court for the Eastern District of Pennsylvania was the trial judge who in March of 1981 rst decided M V Z It was his opinion that eventually was appealed to the Supreme Court His decision was extraordinarily long a re ection of the Brobdingnagian number of documents put before him In 1980 alone 114 briefs and memoranda were led in M v Z In reaching his de cision Judge Becker relied heavily on his own economic analysis and the economic arguments placed before him He ruled that despite years of discovery the plaintiffs have failed to uncover any signi cant probative evidence that the defendants entered into an agreement or acted in concert with respect to exports to the United States in any manner which could in any way have injured plaintiffs 29 Judge Becker could nd no evidence of admissible caliber that refers or relates to the setting or coordination of export prices or any other aspect of the export component of the unitary conspiracy claimed by plaintiffs 30 There were many documents that revealed meetings about home mar ket conditions But very few of these even contained reference to exports those that did were to exports in general not exports that were United States speci c There was some evidence that a Japanese trade association the Electronic Industries Association of Japan gathered and disseminated average prices of televisions sold for export but no record of exchanges of current price information much less agreement on prices or quantities of export Absent evidence of this character the plaintiffs predation case be comes one requiring proof of predatory pricing by individual defendants But none of these rms had enough market power nor even the prospect of suf cient market power to prey successfully in a unilateral fashion Notwithstanding the resources poured into this case there never was a full trial on the merits Judge Becker decided the case for the defendants on summary judgment Summary judgment means that the judge read the pleadings in the case heard oral argument studied particularly the plain tiffs Final Pretrial Statement and determined what evidence of the plain tiffs would have been admissible if a trial were held He then determined that even if all of this admissible evidence were accepted as true and unre butted by the defendants the plaintiffs did not have a suf cient case and there was no genuine need for a trial CONCLUSION The US Third Circuit Court of Appeals was unpersuaded that Zenith and NUE did not merit a trial Essentially the appellate court would have 29513 F Supp 1100 1117 1981 30513 F Supp 1100 1209 1981 235 TH E ANTITRLIST REVOLUTION admitted much of the evidence that Judge Becker held to be inappropriate including the opinions and studies of economists employed by Zenith and NUE The Supreme Court thought otherwise albeit by a narrow majority While the predation strategy of the Japanese television producers does not make economic sense for monopolizing the television market alone in theory one cannot rule out that a rm might prey in one market because the tactic generates spillover consequencesior reputational ef fectsiin other markets For example if a rm operates in two markets and adopts a predation strategy in one its behavior may deter new entry or supply expansion by rivals in the other market If such a rm can establish a reputation as a reckless pricecutter in one market and thereby deter oth erwise prospective entrants from another market where it already has mar ket power then the payoff from entry deterrence in the second market must be weighed against the cost of predation in the rst31 When assessing predation strategies that seem in hindsight irra tional one also cannot dismiss the possibility that the wouldbe predator was mistaken like the child whose eyes were bigger than his stomach A rm that is pricing below cost may not realize how long it will take to push rivals from the market and once having started may keep trying perhaps overestimating the amount of time it will then have in the recoupment pe riod before monopoly prices attract new entry again In the case of the television market not only is it clear that the payoff matrix did not support a predation theory for that market there is no evi dence that any reputation effects carried over into other markets for con sumer electronic products In the television market itself concentration actually declined during the Matsushila litigation and continued to de crease The Her ndahlHirschman Index in 1976 was 1389 it was 1249 in 1985 and it was only 1027 in 1992 Retail prices for television sets have continued to decline in the postMalsushita period as well Matsushila v Zenith from a purely legal perspective is about the suit ability of summary judgmentiavoiding a full trial on the meritsiin an an titrust case If the facts about a case as they are put forward by a plaintiff prior to a full trial on the merits are not in accord with economic analysis or make no economic sense as the Supreme Court put it bluntly then a plaintiff s case may be dismissed without burdensome and costly trials being imposed on the defendants This puts economic theory in the role of a lter sorting out inappropriate cases from those worthy of a court s full consideration M v Z adds weight to the view that in antitrust econo mic analysis matters Moreover M v Z strengthens the view that vigorous price competition is so desirable and predatory pricing so rare that courts to 31For a summary of reputation effects in the economic theory of predation see Ordover and Say loner 1989 pp 55556 For an empirical critique of reputation effects see Lott and Opier 236 Case 9 Matsushita V Zenith 1986 ensure more of the former should set a high standard of proof for allega tions of the latter32 REFERENCES Areeda Phillip E and Herbert Hovenkamp Antitrust Law Boston Little Brown Vol III 1996 Areeda Phillip E and Donald F Turner Predatory Pricing and Related Practices Under Section 2 of the Sherman Act Harvard Law Review 88 February 1975 6977733 Boudreaux Donald J Kenneth G Elzinga and David E Mills The Supreme Court s tion Odyssey From Fruit Pies to Cigarettes Supreme Court Economic Re view 4 1995 5793 Brodley Joseph F and George A Hay Predatory Pricing Competing Theories and the Evolution of Legal Standards Cornell Law Review 66 April 1981 7387803 Calvani Terry and James M Lynch Predatory Pricing Under the RobinsonPatman and Sherman Acts An Introduction Antitrust Law Journal 51 1982 3757400 Easterbrook Frank Predatory Strategies and Counterstrategies University of Chicago Law Review 48 Spring 1981 2637337 Elzinga Kenneth G and David E Mills Testing for Predation Is Recoupment Feasi ble Antitrust Bulletin 34 Winter 1989 8697893 Elzinga Kenneth G and David E Mills Trumpng the AreedaTurner Test The Re coupment Standard in Brooke Group Antitrust law Journal 62 Spring 1994 5597584 Fisher Franklin M On Predation and Victimless Crime Antitrust Bulletin 32 Spring 1987 8592 Holland Daniel M ed Measuring Pro tability and Capital Costs Lexington Mass Lexington Books 1984 Houthakker H S and Lester D Taylor Consumer Demand in the United States Cam bridge Mass Harvard University Press 1966 Isaac R Mark and Vernon L Smith In Search of Predatory Pricing Journal ofPo litiealEeonomy 93 April 1985 3207345 Joskow Paul L and Alvin K Klevorick A Framework for Analyzing Predatory Pric ing Policy Yale Law Journal 89 December 1979 2137269 32It Was this concern that provoked the Antitrust Division of the Department of Justice to be a party to this litigation ling a brief as a friend of the Court At the request of Zenith and NUE the Antitrust Division in 1977 and 1978 investigated the plaintiffs claims and found them Without any titrust merit Brief for the United States as Amicus Curiae Supporting Petitioners 1985 p 3 Charles F Rule who Was Deputy Assistant Attorney Geneml of the Antitrust Division in 1985 appeared h F m quotourt in M n ted the Antitnl t Divi inn s fears that ifJudge Becker s opinion were not upheld the case would offer strong encouragement to be e r guered competitors seeking protection from the ri ors of competition and that s precisely the Wrong thing that the antitrust laws should do Rule 1985 pp 21722 237 TH E ANTITRLIST REVOLUTION Koller Roland H The Myth of Predatory Pricing An Empirical Study Antitrust Law amp Economic Review 4 Summer 1971 1057123 Lott John R and Tim C Opier Testing Whether Predatory Commitments Are Credi ble Journal ofBusiness 69 July 1996 3397382 McGee John S Predatory Price Cutting The Standard Oil NJ Case Journal of Law A zEeonomies 1 October 1958 1377169 McGee John S Predatory Pricing Revisited Journal of Law amp Economics 23 Octo ber 1980 289330 Ordover Janusz A and Garth Saloner Predation Monopolization and Antitrust ln Handbook of Industrial Organization vol I edited by Richard Schmalensee and Robert Willig Amsterdam Elsevier 1989 pp 537596 Rule Charles F Oral Argument Of cial Transcript Proceedings Before the Supreme Court of the United States DocketjCase No 832004 November 12 1985 Shepherd William G Assessing Predatory Actions by Market Shares Antitrust Bulletin 31 Spring 1986 1728 US Department of Justice Antitrust Division Brieffor the United States as Amieus Curiae Supporting Petitioners Matsushita Electric Industrial Co Ltd et al v Zenith Radio Corp etal June 1985 238


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