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US Supreme Court Signals Less Scrutiny for Businesses in Two-sided Markets

R ecently, the US Supreme Court decided Ohio v. American Express in which it upheld an American Express (Amex) contractual provision prohibiting merchants that accept Amex cards from "steering" or incentivizing customers to use competing credit cards at the point of sale. Both the Court's holding and its rationale should change the way that companies approach certain strategic opportunities regarding vendors, vendees, and other vertically-oriented entities in the supply or distribution chain (as opposed to direct competitors) and advocate for the legality of their decisions if challenged in court.

Amex charges a higher merchant fee than its competitors and allocates some of those higher fees to higher rewards for its cardholders. Amex's higher rewards and its reputation attract wealthier customers, which is why merchants often agree to accept Amex cards despite the higher fees. If merchants are able to steer customers who have multiple credit cards away from using Amex cards in their stores, they are able to retain a larger percentage of purchases without risking a loss of sales. However, Amex has been aggressive about prohibiting such conduct, arguing that noncompliance violates a valid contract with its merchants and impairs its business model.

Using historical pricing data, the federal government and 17 states argued that Amex's contractual anti-steering provision was a prohibited vertical restraint of trade that led to increased prices in the merchant fee market. The Supreme Court disagreed and instead found that plaintiffs had not even satisfied the first step in the rule of reason analysis — a showing of market power — namely the ability to control prices and/or restrict output.

In doing so, the Court retreated from earlier precedent on anti-competitive effects. The Court also broadened the concept of market division by looking at Amex (as well as Visa, Mastercard, and Discovery) as being part of a "two-sided market" — competing for both merchants and consumers. With such a broad market approach, the likelihood of any single player being found to have a dominant position is low, and therefore this decision should prove very useful to almost any defendant charged with unlawful vertical restraints of trade.

As the dissenting opinion in this case suggests, two-sided markets abound but have never been a category for antitrust jurisprudence. For some examples of how other economic players might be seen as "two-sided," consider the following:

  • Online retailers compete for both vendors and consumers, while search engines compete for both advertisers and users;
  • Movie theater chains compete for films and patrons; and,
  • Airlines compete for airport slots and for the flying public.

A creative lawyer can use this decision to preclude any possibility that an individual market participant has market power, simply by broadening the market definition and showing a low market share. This may be especially true in markets that have inherent, two-sided transaction platforms. The dissent mentions internet retailers who, in addition to selling their own goods, may charge other manufacturers a fee to sell through their site.

A lawyer in the contract drafting stage, or creating a company policy, might consider defining the relevant market as including both sides of a two-sided market. And because the Court did not focus on actual anticompetitive effects, a legal analysis might pass muster even though divorced from consideration of adverse effects in the market in question. This will be a frontier for the lower courts to explore going forward.

Certainly, this decision may be read as inviting such an approach, and perhaps even more broadly than just in the technology sector. Two-sided markets might be found everywhere in commerce, assuming lawyers are creative enough to frame the right arguments.

Plaintiffs brought this case under Section 1 of the Sherman Act, which prohibits contracts that unreasonably restrain trade.1 The reasonableness of a vertical restraint largely depends on how it harms or benefits competition. Often this inquiry requires proof that the restraining party has market power. This is because market power is viewed as a surrogate for showing the likelihood of detrimental effects. However, a showing of market power is not required if a party can show "proof of actual detrimental effects."2

The last 50 years of antitrust law have seen the elimination of per se rules in favor of a more flexible rule of reason test, except as to agreements between horizontal competitors on price or restriction of output. In 1977, the Court held that the majority of vertical restraint cases should be analyzed under the rule of reason unless the particular restraint tended to have a demonstrable negative economic effect.3

Then, in Leegin Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 889 (2007), the Court dispensed with its longstanding application of a per se rule to vertical resale price maintenance because it recognized that vertical restraints often promote inter-brand competition and consumer welfare. The Court made this decision in the face of price surveys, which indicated that vertical restraints were leading to higher prices, stating that it would not rely on pricing effects alone without "a further showing of anticompetitive conduct."4

The Court's decision in Amex to discount the plaintiff's proof of actual detrimental effects is, in a certain sense, consistent with its decision in Leegin. However, the Court has now elevated the issue of market definition above all other competitive considerations. For example, the Court did not focus on whether Amex's anti-steering provision forecloses certain competitive strategies that might have been useful for existing companies or new entrants. The dissent noted that it is already difficult for companies to enter two-sided markets that are prone to network effects because they must rapidly build both a merchant base and a customer base simultaneously.

The dissent also noted that — without the possibility of steering by merchants — consumers will always have incentives to use the cards that offer them the highest rewards. But the majority did not find these points to be compelling, effectively directing the lower courts to look to "market definition" questions broadly, and not in a way necessarily informed by the economic (whether detrimental or otherwise) effects presented.

Because market definition is a threshold question in all rule of reason cases, this shift suggests that far less business conduct will fall under the scope of Section 1 condemnation in the years to come. Again, this is an issue to be fleshed out in the lower courts, and it may suggest the need for reconsideration of antitrust issues in a number of business contexts.

Companies that operate in two-sided markets or that can plausibly argue that they operate in two-sided markets now have enhanced opportunities to avoid antitrust scrutiny. Counsel should be aware of potential multiple sided market platforms that may exist in their client's businesses and whether it is of benefit to define, when drafting contracts and policies, the market as having more than one side.

The Court in Amex has shown that plaintiffs have a substantial initial burden of positing a credible market definition. It is a threshold question — one to be considered before they weigh the competitive benefits and drawbacks of a restraint.

But, equally important, even in the face of significant market share, is the opportunity defendants have to make theory-bound indirect network effects arguments when faced with historical pricing data. As industries become more interconnected, and as companies more heavily rely on technological solutions to match their products to the demands of the market, the prevalence and strength of these arguments will only increase.

Corporate leaders should use this decision as an opportunity to review their operational and litigation strategies. Considerations in light of Amex may include:

  • Merger policy, already liberalized for many years, should become even more business friendly. The Herfindahl-Hirschman Index provides a mechanism for determining whether markets are concentrated or competitive. If markets are to be defined more broadly, the chances of finding market concentration, sufficient to bar a merger, are greatly reduced. And because "actual detrimental effects" are either going to be disregarded or diminished in importance in any analysis of market definition, there becomes a very strong role for creative lawyering in formulating a market analysis.
  • Businesses operating in markets that can be characterized as two-sided (and such markets are far broader than merely credit card issuers, users, and merchants) may review their contractual relationships with vendors and consumers in order to take advantage of the Amex decision. Could an online retailer, for example, insist that a vendor in its marketplace refrain from steering repeat buyers to a separate website? What about a local inn that pays a booking fee on an online travel website?
  • Those bringing antitrust suits have fewer good faith grounds today than they did before Amex was decided. The goal of the plaintiff's bar will be to narrow the idea of what a "two-sided market" is. The defense bar will seek to expand the definition.

Defining what is truly "two-sided" is going to be a major new frontier in litigation. If every market is "two-sided," the effect on antitrust enforcement would be dramatic. The Court seems to be pointing in a direction where internet businesses and financial services are at the core of what they are considering.

The lower courts, at least while the definition of "two-sided" is being hashed out, are likely to continue to examine the consequences of indirect network effects and actual detrimental effects, meaning that this decision should be viewed as an opportunity to reconsider business planning, but not necessarily to make radical changes on an immediate basis.

Expanding on Amex, a relevant market may now be viewable as comprising all of its multiple sides. This expansion will also likely include markets beyond just internet businesses and financial services. For example, applying Amex in a manufacturer/retailer relationship, particularly one where the manufacturer competes with other manufacturers for shelf space at the retailer, may allow counsel to creatively define the relevant market. This may help lend support to a manufacturer's loyalty provisions in their agreements with multi-line resellers.

These are all unsettled questions. How the parties define a relationship, even in a contract negotiated at arm's length, will not necessarily foreclose antitrust scrutiny. However, certainly as between the parties, and perhaps beyond, there is an opportunity to better posture and frame any future analysis before a court.

Also, as is always the case in antitrust and competition policy, a green light under the Sherman Act does not end the inquiry. There is always the possibility that the Federal Trade Commission could bring standalone Section 5 cases to curb some of the more aggressive restraints. State laws will also have to be considered.

While many states construe their competition laws consistently with federal antitrust law and policy, there are key differences. Not all states, for example, follow Leegin. Time will tell how the states construe or apply Amex.

Due to these uncertainties, if your business has not recently looked at antitrust issues, now is an excellent time to revisit what can be done within the bounds of the law. Your competitors will be doing so.

NOTES
1 Nat' Collegiate Athletic Ass'n v. Bd. of Regents of Univ. of Okla., 468 U.S. 85, 98 (1984).
2 FTC v. Indiana Fed. Of Dentists, 476 U.S. 447, 460-61 (1986).
3 Cont'l T.V. v. GTE Sylvania, 433 U.S. 36, 59 (1977).
4 Id. at 895.

About the Authors

Stephen A. LitchfieldStephen A. Litchfield is vice president, associate general counsel at Schneider Electric USA, Inc., a global provider of energy solutions and product offers. He advises the company on competition law and antitrust legal matters, as well as matters relating to product safety. Previously, he managed Schneider's global supply chain legal matters as well as legal teams in the United States, Canada, Mexico, and South America.

Carl J. SchaerfCarl J. Schaerf, a partner at Schnader Harrison Segal & Lewis LLP, chairs the firm's antitrust and trade regulation practice group, which provides antitrust litigation and consulting services to a variety of manufacturing and retail clients. He also focuses his practice on products liability and commercial litigation. He has extensive litigation experience at both the trial and the appellate levels, including several prominent verdicts and published appellate decisions.

Daniel GrossDaniel Gross, an associate at Schnader Harrison Segal & Lewis LLP, is a member of the firm's Litigation Services Department. Prior to law school, he worked at the Federal Trade Commission's Bureau of Competition where he assisted in the review of potential mergers and anticompetitive conduct issues.


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