If you read our recent article discussing the allegations of monopolization in the replacement k-cup market, you may have detected a certain measure of skepticism about the antitrust claims’ potential for success. And you’d be correct. But does that skepticism extend to all aftermarkets? Do we mean to suggest that all aftermarket manufacturers are inefficient free-riders unworthy of the protection of the antitrust laws?
To some extent, yes, all aftermarket participants are free riding off the efforts of the original equipment manufacturer. After all, in an aftermarket, a third party is making a part for someone else’s device. But this articulation, if taken to its logical conclusion, would imply that an OEM should never face antitrust liability because all they are doing is driving out inefficient free-riders. That is not what we’re saying. OEMs can face antitrust liability for driving out aftermarket competitors.
The most obvious instance where liability may be appropriate is when the OEM actively encourages an independent aftermarket to develop and then dominates that aftermarket through exclusionary conduct. An independent aftermarket can represent significant value to the OEM and consumers generally. The independent aftermarket manufacturer can create, or significantly expand, the scope and availability of the aftermarket, adding to the value and desirability of the original product. The IAM may be able to manufacture replacement parts more efficiently, thereby reaching price-sensitive consumers that would otherwise go unserved. The IAM can enhance brand value, for example, through advertising and good customer service. Under these, and other, conditions, the OEM could, in fact, be free riding off the IAM’s investment in the product.
But what happens if the OEM does not actively encourage an independent aftermarket? What if the aftermarket develops and it becomes clear later that there are significant problems with it? Perhaps quality is bad, or the IAM is engaging in deceptive practices undermining brand value. These conditions probably would not be present initially. Would excluding these IAMs from the aftermarket constitute actionable exclusionary behavior under the antitrust laws? What happens if the OEM does not actively encourage an independent aftermarket but also does not actively attempt to shut it down? What if the OEM decides later that it does not like the aftermarket and wants to keep control over parts quality and branding? And what about technical innovation after CR Bard? Does the OEM owe a duty to an aftermarket to allow aftermarket competitors to participate in product development? And should the courts be second-guessing technological innovation in the first place?
Kodak and Its Progeny
The Supreme Court addressed some of these issues in its 1992 decision in Kodak. Kodak tied the purchase of replacement parts for its duplicating machines to purchase of service. The tie negatively affected independent service organizations that could not secure replacement parts at rates that would allow them to price competitively. Kodak argued that the proper focus should be on the system—if there was competition in the market for the systems, customers could readily switch systems to defeat any supracompetitive pricing in the parts aftermarket. The Court responded by observing that there was a question of fact whether customers had enough knowledge about the aftermarket when buying the copier in the first place to judge whether the competition that was available in the aftermarket was sufficient. Because the record was not developed on this issue, the Court held that summary judgment for Kodak was improper and remanded.
Interestingly, Justice Scalia, in his dissent, noted that sellers of durable goods had an inevitable power over consumers after those consumers made the purchase. Those customers were in effect “locked in” and would have to pay supracompetitive prices for aftermarket parts and service. Scalia felt that this kind of power was not the type of power with which the antitrust laws should be concerned, however. Instead, market power should be the kind of power that allows the monopolist to extract rents over a more sustained period of time. For Scalia, Kodak’s effort to exploit its buyers would drive those buyers to Kodak’s rivals in the original equipment market when buyers would need to purchase a new piece of equipment. That competition would be sufficient to protect consumers generally.
Ultimately, Kodak can be read to hold that a relevant antitrust market in parts can exist and can be monopolized. Kodak could also be read as holding that it is not possible to monopolize a parts aftermarket if competition in the original equipment market is robust. Notwithstanding the foregoing, plaintiffs have not enjoyed much success pursuing Kodak causes of action in the years following the decision.
Twombly/Iqbal and Kodak
Subsequent to the decision in Kodak, the Court decided two cases that altered what plaintiffs need to plead in order to avoid a motion to dismiss. In Twombly/Iqbal, the Court overruled the long-standing “no set of facts” standard for pleading and held that plaintiffs must plead plausible conspiracies. Arguably, Twombly/Iqbal should not affect what is necessary to plead anticompetitive Kodak conduct. The conduct in Kodak was unilateral, not a conspiracy. Moreover, Kodak was about whether there was a sufficient record to warrant summary judgment. It was not about whether the plaintiffs have stated a sufficiently plausible cause of action to allow discovery. As such, Kodak should remain good law: so long as plaintiffs allege insufficient competition in the market for the original equipment, or, possibly even just high switching costs and informational barriers, exclusionary practices in an existing aftermarket can in fact state a cause of action.
Twombly/Iqbal is not a narrow holding, however. While denying it was doing so, the Court fundamentally changed the standard by which courts may dismiss cases. A plaintiff should expect to have to plead a sufficiently plausible set of facts that would entitle it to discovery. If a plaintiff wanted to pursue a Kodak cause of action today, Twombly/Iqbal would likely require that the plaintiff, among other things, plead (1) the existence of a plausible, relevant antitrust market that consists of the aftermarket parts; (2) activity by the defendant that plausibly excludes the plaintiff from that market; and (3) that customers of the original equipment plausibly do not have sufficient resources with regard to the consumption of the original equipment to discipline a price increase in parts. Indeed, where a plaintiff cannot plausibly allege that a purchaser is locked-in to a particular piece of original equipment for a significant amount of time, the plaintiff most likely will have failed to state a claim. To phrase differently, if a plaintiff cannot allege switching costs are high in the original equipment market, he will have left it open for the defendant to argue switching costs are in fact so low that consumers could easily defeat a price increase in an aftermarket.
Pleading Plausible Kodak Conduct
So, how would one state a claim for anticompetitive exclusion in an aftermarket given Kodak,Twombly/Iqbal and CR Bard?
First, the story of the aftermarket has to be robust. The story cannot just be about a lone maverick coming up with some clever way of defeating an OEM’s pricing regime, however ill-conceived. That story lends itself too well to the free-rider counternarrative. While the IAM may not be able to allege that the OEM actively courted an aftermarket, the IAM should allege that the OEM benefited from the aftermarket. The IAM should consider allegations that its participation has enhanced consumer welfare in ways in addition to discounted pricing—greater scope, greater reach, higher quality, greater brand recognition. These elements undermine the OEM’s inevitable argument that what it was doing was trying to protect its customers and brand. A clever defendant can argue that discounted pricing alone is merely a reflection of the fact that the “maverick” has failed to make the same investment in the part as the OEM made in the whole system and therefore cannot be proof in and of itself of a supracompetitive price (or anticompetitive conduct). The purpose of the pleading should be to demonstrate an active, efficiency- and welfare-enhancing market the monopolization of which will harm consumers. The fact that the OEM encouraged the aftermarket is circumstantial evidence that it is free riding off the IAM investment, and therefore the OEM’s exclusionary efforts in the aftermarket are plausibly inconsistent with any attempt to protect quality and brand.
Second, the story of the OEM’s market power in the market that includes the original equipment must be similarly robust. One shouldn’t simply claim that the parts themselves constitute a relevant market that the OEM is dominating through its exclusionary behavior. In Kodak, Scalia seems to suggest that if there was sufficient competition for the original equipment, lock-in can never be the basis for antitrust liability. If the OEM does not have market power, a customer should be able to switch purchases of the original equipment in response to price increases in the aftermarket. Knowing it will be punished in the original equipment market, the OEM will resist exploiting lock-in in the aftermarket. While that may, or may not, be true (or even justifiable from a policy perspective), a careful plaintiff should be aware of that potential bias in pleading a Kodak cause of action. A plaintiff should therefore plead that the OEM has market power in the market that includes the original equipment.
An original equipment market in which competition occurs at very long intervals raises unique pleading issues. Take a market in which consumers buy a new product every 10 years. On its face, alleging that consumers are stuck with price increases in an aftermarket for 10 years suggests that those customers could suffer real harm. But if competition was robust in the original equipment market, the customers should have included the cost of aftermarket parts over the course of those 10 years in their price calculations. (I personally question the Kodak Court’s conclusion that customers would be unlikely to know or care about the cost of parts. That subjective assumption reminds me of the bald assertion in Matshushita that Japanese electronics manufacturers couldn’t possibly engage in a multi-decade, predatory pricing scheme designed to drive Americans out of the electronics business. To ground the concept, take OEM replacement parts for BMWs which are notoriously expensive. If you buy a BMW, you know you’re going to pay high prices for replacement parts. The fact that you pay those prices doesn’t mean BMW has market power in the market for cars, or luxury cars, or whatever the original equipment market is, or that the antitrust authorities should be clamoring to open up the BMW aftermarket.) In terms of the substantive case, one should assume that lengthy lock-in may be interesting as a rhetorical device designed to add to the “anticompetitive penumbra” of the defendant and so should be included in the complaint. Absent market power in the original equipment market, even in markets with long competitive periods, however, lock-in may not have value as actual proof of market power.
CR Bard and Technical Innovation as Exclusion
Third, if the alleged exclusionary conduct keys off product design, you are going to have to allege that the product changes have no plausible rationale other than exclusion. CR Bard holds that product changes can form the basis of a Sherman Act claim if they exclude competitors. The full scope of potential CR Bard liability is unclear. You may be able to defeat a motion to dismiss by alleging that the product design was motivated in part by the desire to exclude an aftermarket competitor. The more prudent approach, however, from both a pleading perspective and a policy perspective, is to come as close as possible to alleging the sole purpose of the “innovation” was to exclude aftermarket competitors.
From a policy standpoint, one can make a fairly good argument that the courts should not second-guess industry as to whether a particular product change was motivated in part by animus or a genuine effort to improve a product. One of the pillars of the free market is that consumers pick the winners and losers with their checkbooks. Substituting the courts for consumers undermines the market and creates inefficiency. While one can read CR Bard as permitting antitrust liability even if there is some legitimate business rationale, the better rule, particularly in light of Twombly/Iqbal, is that if there is any plausible, legitimate business rationale for the design, the courts should defer to the manufacturer.
I don’t necessarily see this as the best result, but it is the most judicially and economically defensible. In Microsoft, Microsoft “integrated” the entire browser into the operating system, GUI and all. I could see a business justification for moving some functionality to the operating system. For example, a program like WordPerfect could call an O/S protocol to find the web, and then WordPerfect could find the latest version of its dictionary and update it automatically. This approach is more efficient than WordPerfect having to create de novo some mechanism for linking to the web. On the other hand, having the user-interface for the browser tied to the O/S could not be justified on the same lines, I don’t think. A judge could have made the distinction and decided, properly, that the integration of the GUI into the O/S was pretextual. The fact remains, though, that that conclusion is not obvious. And, of course, one would have to show that the GUI integration was the proximate cause of the browser competitor’s exclusion and damage, which could be difficult. And what if there were some benefit to it to consumers? Should they be deprived of their ability to make that choice because a judge believes that the integration is exclusionary?
But plaintiffs must plead the facts they have, and if they cannot plausibly foreclose the possibility that an innovation was, in fact, motivated by legitimate business justification, they should build up the story about how “ridiculous” the innovation was and how it couldn’t possibly be designed to satisfy the needs of any rational consumer.
A Second Look at Coffee
In light of the foregoing, let’s re-examine Coffee. The big problem I see with Coffee is that there appears to be plenty of competition for coffee systems. Most clerks—and judges—will ask themselves, is there really a coffee monopoly? Don’t I have a lot of choice about where I can get my morning coffee? With Coffee, the plaintiffs don’t explain compellingly why I’m stuck with k-cups if I take a free Keurig machine. They don’t explain why if I took one free Keurig machine, I couldn’t take another from a competitor that does not use k-cups and have it sitting next to the Keurig machine. Why couldn’t I dual-source coffee cartridges for these two machines and use that dual sourcing to discipline k-cup prices? Customer inertia certainly plays a role, but I think that’s properly viewed as an explanation as to why one may not see a lot of price movement in a market where customers can readily dual-source rather than defining a fundamental structural problem in the market that requires antitrust’s intervention. Just because someone doesn’t complain about price—and pays more—doesn’t mean that they couldn’t complain and therefore couldn’t enjoy price relief if they really wanted it.
The plaintiffs in Coffee do a better job of explaining the CR Bard issues. Twombly/Iqbal allows judges to impose their subjective views of what’s plausible onto allegations contained in a complaint. No matter how one spins it, plausibility is subjective. (The few cases where the appellate courts have overturned post-Twombly dismissals have been where the lower court imposed an implausible view on what the appeals court felt was an entirely plausible conspiracy.) When pleading, and counterpleading, one has to consider what narratives exist in the market, society and culture in which a judge orbits. The Lexmark case as well as the anti-hacking provisions of the DMCA is a significant specter in Coffee. Lexmark essentially allowed manufactures to require parts compatibility within their systems. OEMs may choose not to require compatibility, but they can. And the DMCA basically says that you can be liable for hacking a protection even if it’s easy to do so, effectively narrowing the scope of permissible reverse engineering. Keurig has announced that it will do precisely what Lexmark did. Again, to a generalist judge, that is not exclusionary conduct. It’s what OEMs can do nowadays. And if a company can create those barriers legally, it is hard to call those barriers anticompetitive even if they do make it hard for an IAM to make generic parts. (I suspect that Keurig’s announcement is like vaporware and that the value of the Plaintiffs’ allegations is more to add to the anticompetitive penumbra and not necessarily there to prove actual exclusion.)
The allegations concerning Keurig’s machines coming off patent are also smoky. Simply because one has a patent for k-cups does not mean that one has a monopoly in the market that includes k-cups or that exclusionary-ish behavior after the patents expire is anticompetitive. Again, what is the competition in the market for the original equipment like? If robust, then the size of the k-cup market share is a reflection of business acumen. I suspect these allegations were inserted also for narrative effect.
At the motion to dismiss stage, litigants use the facts as pleaded to weave a story that suits their litigation goal. For the plaintiff, the market was a “robust aftermarket created by the OEM for the benefit of itself and consumers.” For the defendant, the plaintiff is an input supplier that couldn’t keep up with technology and innovation.
In addition to spinning the story differently, litigants also use facts that are not in the pleadings to enhance their story. This approach can carry risk. Courts don’t like to go outside the four corners of the document. Certainly, you shouldn’t insert outside facts willy-nilly. The suggestion here is to identify implausible assertions and offer only easily verifiable, outside facts. These outside facts should be used sparingly as evidence that the assertion is implausible, and not as facts stated for their truth. Think of it as a “Twombly footnote.” Even if a judge can’t or won’t use the outside fact in her decision, the “fact,” if sufficiently compelling, will, or at least should, make her question the plausibility of the entire complaint. “Is there really a monopoly in coffee?”
Gone are the days when a plaintiff need only make a short, simple statement of the facts to achieve discovery. Now significant thought needs to be paid to drafting a complaint that minimizes the ways the defendant can exploit it and complying with one’s Rule 11 duties. Aftermarkets can play important, procompetitive and pro-consumer roles in developing the original equipment market. But just because they can play those roles doesn’t mean that they always do. Some aftermarkets are ripe for free riding, and OEM efforts to contain aftermarkets can themselves be efficiency-enhancing. A close, skeptical look at the facts is necessary from both the defendant’s perspective as well as the plaintiff’s.