Aftermarkets are particularly important to manufacturers of complex technical equipment. The downstream market for maintenance and support of both hardware and software is highly profitable and particularly coveted by proprietary equipment manufacturers, often as a means to recoup their substantial investments in research and development. In many cases these markets are contested by independent service organisations (“ISOs”), which frequently come into conflict with the manufacturers.

In this short article we provide a critical assessment of how US and EU Courts and regulators have developed their thinking on aftermarket issues.

Summary

While there are differences between the way US antitrust and EU competition law is applied, particularly to restrictive agreements, the economic principles set out in the leading US case of Kodak, described below, are widely followed on both sides of the Atlantic.

US antitrust and EU competition laws allow independent service organisations to challenge manufacturers’ conduct in aftermarkets, but only in certain limited circumstances. Although there are no shortage of disputes in this area, ISOs have historically struggled to successfully make their case for judicial and regulatory intervention due to the high legal bar set for establishing exploitative behaviour in aftermarkets.

Background

Aftermarkets often consist of maintaining and supporting hardware and software. ISOs tend to be more active in the supply of hardware support services where few intellectual property barriers exist, although some may provide low-level software support, including helpdesk facilities.

As part of any antitrust/competition analysis in aftermarket cases, it is necessary to decide whether there is one market that includes both the equipment and complementary products or services, or separate markets for each; namely, a “primary market” for equipment and one or more “aftermarkets” or “secondary markets” for complementary products or services supplied by both manufacturers and ISOs. This issue arises regularly, because firms in the primary market are often vertically integrated and supply both the primary equipment and complementary products or services. Those independent downstream firms that supply or wish to supply only the latter often regard the competition from manufacturers as unfair, and manufacturers in turn often resist the supply of aftermarket products (such as spare parts and consumables) and tools (such as training, diagnostics, engineer control orders, and bug fixes or software updates) to ISOs.

The competitive relationship between manufacturers and ISOs has led to a number of important antitrust/competition rulings on both sides of the Atlantic, and we review these below.

US Aftermarket Principles

Under U.S. law, a manufacturer’s efforts to exclude aftermarket competition may be challenged under Section 1 or 2 of the Sherman Act, typically through allegations of unlawful tying, monopolization, or attempted monopolization. In such cases, a plaintiff must prove that, despite robust primary market competition to sell equipment, a manufacturer has market power in an aftermarket for goods or services relating to such equipment.

The U.S. Supreme Court’s opinion in Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451 (1992), paved the way for antitrust plaintiffs to challenge efforts by manufacturers to control the aftermarkets for their own products. 

In Kodak, a group of independent service organizations (“ISOs”) that repaired Kodak copiers, often at lower prices than Kodak, brought an action against Kodak after it decided to cease selling replacement parts to the ISOs. The ISOs alleged that Kodak violated U.S. antitrust laws by tying the sale of parts for its copiers to the sale of Kodak-brand service.  The Supreme Court rejected Kodak’s contention, based solely on economic theory, that the fierce competition Kodak faced from other copier manufacturers in the primary market would act as an effective competitive constraint on Kodak exercising market power in the aftermarket for Kodak parts. The Court allowed the ISOs to proceed to trial on their claims, and they ultimately prevailed.

As a general matter, the Court held that a plaintiff in an aftermarket case must prove that competition in the “primary market” (e.g., for copiers made by Kodak and others) does not discipline competition in the aftermarket (e.g., for service on Kodak copiers).  The Kodak case was a landmark case in US antitrust law, as it rejected economic theory that competition in the primary market would always guarantee that it would be unprofitable for a manufacturer to exploit its own aftermarket customers. Instead, Kodak leaves open the possibility that such exploitation may occur, albeit in rare circumstances.

Since Kodak was decided, litigants and courts have struggled to understand its potentially far-reaching applications.  Although the legacy of Kodak remains uncertain, the courts have fashioned some guiding principles.

Lock-In and Switching Costs. A successful aftermarket claim typically involves complex durable equipment that is costly and difficult to replace (e.g., the copiers in Kodak), causing customers to be “locked in” by high “switching costs.”  When customers are “locked in,” they cannot easily switch to another manufacturer’s equipment if they become dissatisfied with conditions or prices in the aftermarket. If a customer can easily replace its equipment however, competition for the sale of equipment and aftermarket services is inseparable, and an aftermarket claim is likely to fail.

Information Costs and Policy Changes.  In addition, an antitrust plaintiff is usually required to show that “locked in” customers have been exploited, raising the cost of aftermarket goods or services above what they reasonably expected at the time of purchase.  Courts tend to look for evidence of high “information costs” or policy changes that increase aftermarket prices.

Information costs are present when it is difficult for customers to estimate with reasonable accuracy the lifecycle cost or total cost of ownership for a product (i.e., the combined cost of equipment and aftermarket goods or services) at the time of purchase.  When purchasers face high information costs, a manufacturer may exploit customers by charging “supracompetitive” aftermarket prices (i.e., prices that are above competitive levels).

Unexpected policy changes may also unexpectedly increase aftermarket costs, resulting in supracompetitive aftermarket pricing.  In Kodak, for example, Kodak initially sold parts to ISOs and then refused to do so.  Some customers may have factored the availability of lower-cost ISO service into their decision to purchase a Kodak copier, but Kodak’s policy change eliminated that option after they were locked in, increasing their service costs above what they reasonably expected at the time of purchase.  Indeed, Kodak increased its prices after changing its policy.

Restrictions in Purchase Contracts.

When a manufacturer lacks market power in the primary market, an aftermarket restriction set forth in a purchase contract is generally safe from challenge under the antitrust laws.  Numerous courts have rejected aftermarket claims based on contract provisions that exclude competition in an aftermarket.  Because such restrictions are disclosed to customers at the time of purchase, customers can understand and plan for the aftermarket restriction before they are locked in.  In Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430 (3d Cir. 1997), for example, the court dismissed a claim that Domino’s Pizza engaged in anticompetitive conduct by requiring its franchisees to purchase only Domino’s-approved pizza supplies, because the restriction was set forth in franchise agreements and disclosed to franchisees before any lock in.

Conclusion.

It is difficult to prevail on an aftermarket claim under U.S. law.  At a minimum, a plaintiff must show that owners of costly durable goods were locked in and then made to pay supracompetitive prices for goods or services and more than they reasonably anticipated at the time of purchase, as a result of either information costs or an unexpected policy change.  But an aftermarket restriction disclosed in a purchase contract is generally safe from challenge under the U.S. antitrust laws.

EU Treatment of Aftermarkets

Under EU competition law, aftermarket cases can be attacked under Article 101(1) or Article 102 TFEU. Article 101 prohibits restrictive agreements between undertakings which outlaw ,among other things, contractual tying arrangements. Article 102 prohibits abusive market behaviour by companies in a dominant position on the relevant market. Most aftermarket challenges in the EU are based on Article 102, as they usually relate to the implementation of support policies or policy changes rather than restrictive agreements. Therefore, for the complainant seeking to prove his case or a regulator seeking to intervene, defining a market upon which a proprietary manufacturer has dominance is crucial to obtaining jurisdiction.

In the 1980s and 1990s, there was a burgeoning array of claims by ISOs in Europe against proprietary manufacturers for abuses of dominance in downstream support markets. The Commission, the Court of First Instance and the European Court of Justice considered cases based on products where it was appropriate to define the market narrowly, such as for components of a single brand or product. Many of these cases concerned spare parts or consumables for machines (See Hugin Cash Registers v Commission [1979] ECR 1869 and Case 238/87 Volvo v Veng ((1988)) ECR 62/11).

As EU competition law stood at that time, it was relatively easy to show dominance in these cases in an aftermarket where a manufacturer normally had a 90%+ market share of a secondary support market for its own equipment. The technology, skills, spare parts and consumables etc. were all manufacturer specific, so there was little or no substitutability between support of equipment from different proprietary manufacturers. Competition authorities were relatively amenable to assess downstream markets separately from the primary markets. This was the high water mark of ISO claims in Europe.

The Kodak case changed all that. The economic theory behind the case was widely accepted and adopted in Europe, and this severely curtailed regulators’ ability to intervene in aftermarket cases. Effectively, it was no longer enough to show dominance in a secondary market. A complainant now had to show dominance in a primary market, as the prevailing economic theory was that the primary and secondary markets were inseparable. A manufacturer could only have market power in a secondary market distinct from the primary market when the Kodak principles of lock in and informational imperfections at time of purchase were present.

There have been a number of cases at the EU and national Member State level which have charted how the law has developed in the aftermath of the Kodak case.

Digital Undertaking. This was the culmination of a two-year investigation by the EU Commission under Article 85 and 86 of the Treaty of Rome (now Article 101 and 102 TFEU) known as The Digital Undertaking (1998) 10 European Competition Law Review 176. It followed complaints by two leading ISOs regarding the maintenance and support of DEC mid-range systems. The principal contention in the case was that DEC unlawfully tied the provision of hardware to software maintenance services by ensuring the price of software services were considerably more attractive when included in a hardware and software package than when sold on a stand-alone basis. This had the effect of foreclosing ISOs from the market, as it deterred customers from taking hardware maintenance only services other than from DEC. Although DEC contested the Commission’s market definition and allegations of dominance, they agreed to modify their supply and pricing policies by offering undertakings following negotiations with the Commission.

The Commission was persuaded in this case that the relevant market was the supply of maintenance and support services for DEC mid-range systems. DEC had a dominant position in this market. There was a lack of demand and supply substitutability between hardware and software support services provided by other manufacturers of their own equipment and that for DEC equipment due to technological and IP barriers.

It also decided that it was appropriate to define a separate secondary support market as the relevant market in this case (rather than a combined primary and secondary market), as DEC was exploiting its customers in the secondary support market for mid range systems. This was because the customers were locked in (switching costs were high), and it was not possible to whole life cost at time of purchase. The Commission therefore appeared to be persuaded that the special circumstances present in Kodak were present in this case.

Synstar/ICL. In Synstar Computer Services (UK) Ltd v ICL (Sorbus) Limited and International Computers Limited [2001] UKCLR 585/Fujitsu, there were parallel proceedings before the UK competition regulator, the Office of Fair Trading, and in the High Court. The Court proceedings were stayed pending the outcome of the regulatory case.

Synstar, a leading ISO, had alleged that ICL was exploiting its monopoly power under Chapter II of Competition Act 1998 (a provision of UK national competition law similar to Article 102 TFEU) by not providing non-ICL hardware maintenance supported customers with certain diagnostic software. This enabled ICL to prevent third party maintainers (“TPMs”) from competing for hardware maintenance contracts for ICL mainframes. In particular, Synstar alleged that customers were not able to price maintenance services for mainframes at the time of purchase, and customers of ICl mainframes (mainly local Government authorities), were locked in due to the high price of switching to other mainframe solutions.

The OFT concluded that ICL were not in a dominant position in the market for the supply and maintenance of computer equipment with mainframe functionality in the UK. It also concluded that there is no relevant secondary market for hardware maintenance services in the UK for ICL mainframe computers, because customers were able to whole life cost hardware and other support services at the time of purchase. The OFT therefore decided to close the case with a finding that ICL has not infringed the prohibition imposed by Article 102 TFEU or Chapter II of the Competition Act 1998. The OFT was very dismissive of the Commission’s analysis in Digital, claiming that it was bad law.

Pelican/Kyocera. There were further aftermarket cases at an EU level, which closely followed the Kodak judgment in terms of economic analysis.

In Pelikan/Kyocera (1995)/Info-Lab/Ricoh (1999) EFIM complaint (2009), Pelikan claimed that Kyocera was dominant in the market for Kyocera-compatible toner consumables. Kyocera, however, had no significant market power in the relevant printer market. In rejecting Pelikan’s claim, the Commission concluded that the printer market and the consumables market were a single market, as competition in the printer market (the primary market) resulted in effective discipline in the consumables market (the secondary market). In particular, the Commission noted that: (i) consumers were able to make an informed choice, including life-cycle pricing, and (ii) a sufficient number of customers would alter their purchasing behaviour in the primary market in the event of an apparent policy of exploitation in the secondary market. This was because the capital cost of buying a new printer and switching to another make was low.

In Info-Lab/Ricoh, ISOs had complained that Ricoh was refusing to supply empty toner cartridges for its photocopiers in contravention of Article 102 TFEU. ISOs would then fill them with ink at a lower cost to the Ricoh branded variety.

Applying the same criteria in the Pelican case, the Commission found that, like printer customers, photocopier consumers engage in lifecycle pricing, they make informed choices between competing photocopiers based on price per copy, and new customers would adapt their purchasing behaviour within a reasonable timeframe in response to perceived exploitation in the toner aftermarket. The Commission therefore concluded that competition in the primary photocopier market constrained Ricoh’s conduct in the secondary market for toners. Accordingly there was a single market for both primary and secondary products. As such, the Commission found that Ricoh did not have a dominant position and thus could not be required to supply empty toner cartridges.

IBM Commitments

On 20 September 2011, the EU Commission accepted legally binding commitments from IBM regarding the maintenance market for its mainframe computers.

IBM were found to have a dominant position on the secondary market for the maintenance of its own mainframe systems and had abused that position by imposing unreasonable terms on ISOs for the supply of spare parts and the provision of necessary technical information.

In this case the Commission have agreed to accept commitments from IBM to ensure that ISOs:

  • Were provided with access to vital technical information to allow them to support IBM’s mainframe sysyems;
  • received prompt delivery of spare parts; and
  • paid the same price for spare parts as those accorded to self maintainers.

With regard to market definition, the Commission appears to have considered the relevant market to be the secondary market for the maintenance of IBM mainframe systems, a market in which IBM was dominant. This seems to indicate that the Commission takes the view that the secondary market is separate and distinct from the primary market. However, this case was a settlement rather than a formal competition decision, so the description of the Commission’s case is somewhat limited. Regardless, the Commission is likely to have used the presence of high switching costs and a lack of whole life costing according to the Kodak principles to ground its case.

Conclusion. The EU cases show that the Kodak principles are alive and well and actively adhered to by EU and national competition regulators.

ISOs are unlikely to prevail in any case in the EU if they are unable to prove that purchasers are locked into proprietary equipment through high switching costs and an inability to determine whole life cost at time of purchase.

However, from the EU cases, you can deduce certain types of equipment which are more likely to ground successful ISO claims:

  • Equipment with high capital acquisition costs which will make switching costs punitive (Digital).
  • Equipment like printers and photocopiers are likely to be seen as low value items unlikely to inhibit switching (Pelican/Kycoera).
  • Equipment for which the manufacturer is ceasing to produce a new version and will be exiting the primary market, likely removing the manufacturer’s incentive to price competitively in secondary markets (Synstar/ICL).

In contrast, the beneficial treatment accorded to aftermarket restrictions in purchase contracts under US antitrust laws is unlikely to be well received in the EU. Such clauses are likely to be seen as contractual tying obligations which are likely to infringe Article 101(1) TFEU. These clauses are likely to be condemned as unlawful, even if the parties are not in a dominant position and notwithstanding the fact the customer may at the time of purchase agree to the lock in.