In 2009, following passage of federal legislation that provided a large infusion of money for U.S. waterworks projects that required domestic ductile iron pipe fittings, Star Pipe Products (Star) entered the domestic fittings market. In response, McWane, Inc., which since 2006 was the only U.S. producer of domestic pipe fittings, announced to distributors that (with limited exceptions) unless they bought all of their domestic fittings from McWane, they would lose their rebates and be cut off from purchases for 12 weeks. Last month, the Eleventh Circuit upheld an FTC ruling that the actions constituted an illegal exclusive dealing policy used to maintain monopoly power in the domestic fittings market, in violation of Section 5 of the FTC Act.1 In doing so, the circuit court adopted the FTC’s factual and economic conclusions—that McWane had monopoly power in a product market for domestic fittings produced for domestic-only projects, and that its exclusivity program harmed competition. Specifically, the court held that the FTC’s findings were supported by substantial evidence in the record, “as required by our deferential standard of review,” and that the Commission’s legal conclusions were supported by the governing law under the Federal Trade Commission Act, applying the monopolization standards of Section 2 of the Sherman Act.2
Ductile iron pipe fittings join together pipes and help direct the flow of pressurized water in pipeline systems. They are sold primarily to municipal water authorities by distributors. Although there are thousands of unique configurations, approximately 80 percent of the demand is for about 100 commonly used fittings.3 While more than 80 percent of fittings are imported, a 2009 federal statute provided more than $6 billion to fund water infrastructure projects with domestic-only specifications, and some state laws require domestic materials in public projects, as do certain federal programs.4 Prior to passage of the 2009 federal statute, competition from lower-priced imports drove most domestic producers out of the market, and by 2008 three major suppliers—McWane, Star, and Sigma—accounted for 90 percent of the fittings sold in the United States.5 Moreover, two national distributors accounted for 60 percent of the overall waterworks distribution market.6 Of most significance, from April 2006 until the federal legislation prompted Star to enter the domestic fittings market in late 2009, McWane was the only producer of domestic fittings.7 Star did not at the outset open a foundry in the United States. Instead, while it sought to build up its business sufficiently to justify opening a foundry, Star contracted with six third-party foundries in the U.S. to produce fittings to its specifications.8
In response to Star’s entry into the domestic fitting market, McWane implemented its “Full Support Program” to protect its market position. In a September 2009 letter to distributors, McWane declared that if they did not “fully support McWane branded products for their domestic fitting . . . requirements,” they “may forgo participation in any unpaid rebates for domestic fittings . . . or shipment of their domestic fitting” of McWane products for up to 12 weeks.”9 The record indicated, however, that the Program was enforced only once, but apparently other distributors feared being cut off from McWane domestic fittings, and the two largest waterworks distributors, with more than 50 percent of distribution, refused to buy fittings from Star.10
Nevertheless, Star gained 5 percent of the domestic fittings market in 2010 and 10 percent in 2011.11 It expected to do even better by the following year—which is when the FTC instituted suit. Star estimated that but for the McWane program its sales would have been greater by a multiple of three by 2011.12 Star never built or bought a domestic foundry, the FTC finding that this was because Star believed its sales level was insufficient to justify doing so, adding that Star’s costs would have been much lower if it had done so.13 Star’s average prices were higher than McWane’s in several states.14
McWane’s production costs for domestic fittings were flat, but it raised its prices despite Star’s entry into the market, and increased its gross profits.15 The duration of the Full Support Program was in dispute, McWane declaring that it ended in early 2010 and the FTC finding that it had never “publicly” withdrew the policy, and some distributors believed it remained in effect at least until the FTC brought suit in 2012.16
Based on the above summarized evidence, the FTC ruled 2-1 that McWane’s Full Support Program unlawfully enabled it to maintain its monopoly of the domestic fittings market, which was a separate product market because of the higher prices charged for such products than imported fittings, and because imported fittings were not a substitute for domestic fittings in domestic-only waterwork projects.17
The Eleventh Circuit Opinion
A very important factor in the Eleventh Circuit opinion affirming the FTC decision was its view that it was required to review the FTC’s findings of fact and economic conclusions under the “substantial evidence” standard that applies to the review of federal agency decisions. Under that standard, the agency’s findings as to the facts are conclusive if the evidence is such that “a reasonable mind might accept as adequate to support a conclusion,” even though it is less than a preponderance of the evidence. Moreover, although the court reviews de novo the legal conclusions and the application of the facts to the law, “we afford the FTC some deference as to its informed judgment that a particular commercial practice violated the Federal Trade Commission Act.”18
After supporting the FTC’s narrow market definition,19 the Eleventh Circuit affirmed the Agency’s monopoly power determination because the 90 percent market share McWane retained in 2011 far exceeded the levels courts typically require to support a prima facie showing of monopoly power, and the fact that McWane was able to raise its prices for domestic fittings and “earned significantly higher gross profits than for non-domestic fittings,” despite Star’s entry and growth, supported the conclusion that it had the “ability to control prices.”20 The court also affirmed the Commission’s finding that significant barriers to entry existed in the domestic market because Star did not have business sufficient for it to build or purchase its own foundry, and, because McWane had tied up distributors accounting for more than 50 percent of the market, Sigma, the other major producer, had not entered the domestic fittings market.21
After opining that McWane still had monopoly power despite Star’s two-year market share growth, the Eleventh Circuit ruled that the Full Support Program helped McWane maintain its monopoly power.22 The court accepted the FTC’s view that the program was an exclusive dealing policy that foreclosed Star’s access to necessary distributors, which contributed significantly to Star’s inability to purchase its own foundry.23 Recognizing that the program was short-term and voluntary, and that exclusive dealing arrangements generally are lawful, the court concluded that the program nevertheless contributed to key distributors “freezing out” Star, and deprived it of distribution sufficient to achieve effective scale, thereby raising its costs and slowing or even preventing its successful market entry.24 Moreover, McWane’s prices were not adversely affected by Star’s market entry, and it actually raised prices and increased its gross profits.25 Finally, the court referred to the fact that there was considerable documentary evidence that the Full Support Program was designed to harm competition, and there was substantial evidence that it was successful in achieving that aim.26 Accordingly, the Eleventh Circuit ruled in favor of the FTC, concluding that the Agency’s factual and economic conclusions were supported by substantial evidence, and its legal conclusions comported with the governing law.27
Assuming the Eleventh Circuit was correct in limiting the relevant market to domestic pipe fittings, although 80-85 percent of fittings sold are lower priced imported fittings, it is questionable whether its determination that McWane had monopoly power in the domestic market was correct. Star was able to enter the market and obtain a 10 percent share in two years, and was continuing to expand despite McWane’s Full Support Program, which may have ended by 2011. True, McWane still had a 90 percent market share, but it lawfully controlled 100 percent of the market in 2009, and its share was going down despite the fact that Star was a less efficient competitor. Star did not attempt to build or buy a domestic foundry, and distributors were wary of the six foundries Star had contracted to produce fittings for it, questioning their quality control and unreliability. While McWane did increase its prices during the period, the Eleventh Circuit did not indicate that Star’s business was unprofitable, and its prices actually were above McWane’s in a few geographic areas. These facts do not appear to be consistent with a conclusion that McWane nevertheless had monopoly power.
It is important to keep in mind, however, that the FTC’s McWane decision was reviewed by the Eleventh Circuit under the “substantial evidence” standard for judicial review of federal agency decisions. According to the Eleventh Circuit, that standard does not require a court of appeals to ascertain whether an agency’s factual and economic conclusions are supported by a preponderance of the evidence. Instead, the court merely determines whether there is “such relevant evidence as a reasonable mind might accept as adequate to support a conclusion.” Throughout the opinion, the court ruled in favor of the FTC because it concluded there was “substantial evidence” to support the FTC’s factual conclusions, although the record contained evidence to the contrary which the court may have found persuasive under a preponderance of the evidence standard. For that reason, the decision may not be very persuasive authority in a Sherman Act challenge to a monopolist’s exclusive dealing arrangement by a private party–or even by the U.S. Department of Justice–as distinguished from an FTC suit under Section 5 of the Federal Trade Commission Act, which can only be enforced by the FTC.