3. InnovationINTRODUCTORY NOTE

I. Overview: An important form of competition is innovation in the design of products and in the provision of services. Better products and services create advantages in the market for the innovative firm and spur competitors to improve their own products and services in response. Indeed, one of the concerns Learned Hand expressed in Alcoa is that the absence of competition “deadens initiative.”

When a monopolist continues to improve the products and services it provides, con-sumers obviously benefit in the short run from these innovations. However, some inno-vations can create or strengthen barriers to entry and thus help maintain monopoly power, keeping prices above competitive levels for longer than might otherwise be true. When, if ever, should this concern about extending monopoly conditions be sufficient to justify treating particular innovations as violations of Sherman Act §2? II. U.S. v. United Shoe Machinery, 110 F. Supp. 295 (D.Mass. 1953, aff’d U.S. 1954)

A. Background.1. §2 suit by the government against the leading maker of machines used to make shoes. The court defined the market as all shoe machinery. 2. Although a complete shoe factory could be assembled w/o any United ma-chines, United had 75-85% of US market as defined.

B. Challenged Practice: United allowed customers to obtain its more complicated machines only through leases (not purchases).

1. Others in industry do the same. 2. Customers were happy with the system:

a. Uniform rates of payment (v. large occasional one-time purchases) b. Repair service fast & efficient w/o separate charge.

C. Court enjoined the leasing system, finding that it created barriers to entry:1. Incentives in leases to use machines for whole 10-yr period of lease2. Requirement that if work available, had to use machine to full capacity3. More favorable terms if replaced one United machine with another. 4. Repair process meant that independent repair services have not arisen.

$ $ $ $ $ $ $BERKEY PHOTO, INC. v. EASTMAN KODAK CO.

603 F.2d 263 (2d Cir. 1979)

IRVING R. KAUFMAN, Chief Judge: INTRODUCTION: … Founded over a cen-tury ago by George Eastman, the Eastman Kodak Company has long been the preeminent firm in the amateur photographic industry. It provides products and services covering ev-ery step in the creation of an enduring photographic record from an evanescent image. … The firm has rivals at each stage of this process, but in many of them it stands, and has long stood, dominant. …

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This action, one of the largest and most significant private antitrust suits in his-tory, was brought by Berkey Photo, Inc., a far smaller but still prominent participant in the industry. Berkey competes with Kodak in providing photofinishing services the con-version of exposed film into finished prints, slides, or movies. Until 1978, Berkey sold cameras as well. It does not manufacture film, but it does purchase Kodak film for resale to its customers, and it also buys photofinishing equipment and supplies, including color print paper, from Kodak.

The two firms thus stand in a complex, multifaceted relationship, for Kodak has been Berkey’s competitor in some markets and its supplier in others. In this action, Berkey claims that every aspect of the association has been infected by Kodak’s monop-oly power in the film, color print paper, and camera markets, willfully acquired, main-tained, and exercised in violation of §2 of the Sherman Act. ... A number of the charges arise from Kodak’s 1972 introduction of the 110 photographic system, featuring a “Pocket Instamatic” camera and a new color print film, Kodacolor II….

After more than four years of pretrial maneuvering, the trial got under way in July 1977 before Judge Marvin E. Frankel of the Southern District of New York. Despite the daunting complexity of the case the exhibits numbered in the thousands Kodak demanded a jury. Accordingly, the trial was conducted in two parts, one to determine liability and the other to measure damages. It ran continuously, except for a one-month hiatus between the two segments, until the final verdict was rendered on March 22, 1978. The liability phase of the trial by itself consumed more than six months, and the damages aspect re-quired approximately another month. Except for a few specific questions relating primar-ily to market definitions, the jury was asked to render what was essentially a general ver-dict on each count.

After deliberating for eight days on liability and five on damages, the jury found for Berkey on virtually every point, awarding damages totaling $37,620,130. Judge Frankel upheld verdicts aggregating $27,154,700…. Trebled and supplemented by attor-neys’ fees and costs pursuant to §4 of the Clayton Act, Berkey’s judgment reached a grand total of $87,091,309.47, with interest, of course, continuing to accrue. Kodak now appeals this judgment…. It challenges virtually every aspect of the district court proceed-ings, from the theories of liability and damages presented to the jury to the sufficiency of the evidence to sustain them. …

Resolution of these competing claims requires us to settle a number of important and novel issues concerning §2 of the Sherman Act. We believe that the district court committed several significant errors as it charted its course through the complexities of this case, and we are therefore compelled to reverse the judgment below in certain major respects. …

I. THE AMATEUR PHOTOGRAPHIC INDUSTRY: … It is, of course, a basic prin-ciple in the law of monopolization that the first step in a court’s analysis must be a defini-tion of the relevant markets. See, e.g., duPont. Although Kodak does not now challenge the jury’s delineation of the markets, a survey of this terrain remains essential. …

The principal markets relevant here, each nationwide in scope, are amateur con-ventional still cameras, conventional photographic film, photofinishing services, photofinishing equipment, and color print paper. The numerous technological interactions

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among the products and services constituting these markets are manifest. To take an obvi-ous example, not only are both camera and film required to produce a snapshot, but the two must be in compatible “formats.” This means that the film must be cut to the right size and spooled in a roll or cartridge that will fit the camera mechanism. Berkey charges that Kodak refused to supply on economical terms film usable with camera formats de-signed by other manufacturers, thereby exploiting its film monopoly to obstruct its rivals in the camera market. …

A. The Camera Market. The “amateur conventional still camera” market now consists almost entirely of the so-called 110 and 126 instant-loading cameras. … Small, simple, and relatively inexpensive, cameras of this type are designed for the mass market rather than for the serious photographer.

Kodak has long been the dominant firm in the market thus defined. Between 1954 and 1973 it never enjoyed less than 61% of the annual unit sales, nor less than 64% of the dollar volume, and in the peak year of 1964, Kodak cameras accounted for 90% of mar-ket revenues. Much of this success is no doubt due to the firm’s history of innovation. In 1963 Kodak first marketed the 126 “Instamatic” instant-loading camera, and in 1972 it came out with the much smaller 110 “Pocket Instamatic.” Not only are these cameras small and light, but they employ film packaged in cartridges that can simply be dropped in the back of the camera, thus obviating the need to load and position a roll manually. Their introduction triggered successive revolutions in the industry. Annual amateur still camera sales in the United States averaged 3.9 million units between 1954 and 1963, with little annual variation. In the first full year after Kodak’s introduction of the 126, industry sales leaped 22%, and they took an even larger quantum jump when the 110 came to mar-ket. Other camera manufacturers, including Berkey, copied both these inventions but for several months after each introduction anyone desiring to purchase a camera in the new format was perforce remitted to Kodak.

Berkey has been a camera manufacturer since … 1966…. In 1968 Berkey began to sell amateur still cameras made by other firms, and the following year … commenced manufacturing such cameras itself. From 1970 to 1977, Berkey accounted for 8.2% of the sales in the camera market in the United States, reaching a peak of 10.2% In 1976. In 1978, Berkey sold its camera division and thus abandoned this market.

B. The Film Market. The relevant market for photographic film comprises color print, color slide, color movie, and black-and-white film. Kodak’s grip on this market is even stronger than its hold on cameras. Since 1952, its annual sales have always ex-ceeded 82% of the nationwide volume on a unit basis, and 88% in revenues. Foreign competition has recently made some inroads into Kodak’s monopoly, but the Rochester firm concedes that it dominated film sales throughout the period relevant to this case. In-deed, in his summation, Kodak’s trial counsel told the jury that “the film market . . . has been a market where there has not been price competition and where Kodak has been able to price its products pretty much without regard to the products of competitors.”

… Of special relevance … is the color print film segment of the industry, which Kodak has dominated since it introduced “Kodacolor,” the first amateur color print film, in 1942. In 1963, when Kodak announced the 126 Instamatic camera, it also brought out a new, faster color print film Kodacolor X which was initially available to amateur pho-

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tographers only in the 126 format. Nine years later, Kodak repeated this pattern with the simultaneous introduction of the 110 Pocket Instamatic and Kodacolor II film. For more than a year, Kodacolor II was made only for 110 cameras, and Kodak has never made any other color print film in the 110 size. …

II. §2 OF THE SHERMAN ACT: … In passing the Sherman Act, Congress recog-nized that it could not enumerate all the activities that would constitute monopolization. Section 2, therefore, in effect conferred upon the federal courts “a new jurisdiction to ap-ply a ‘common law’ against monopolizing.” 3 P. AREEDA & D. TURNER, ANTITRUST LAW 40 (1978). … To provide a framework for deciding the issues presented by this case, therefore, we begin by stating what we conceive to be the fundamental doctrines of §2.

A. Monopoly Power as the Essence of the §2 Violation … [E]xistence of monop-oly power, “the power to control prices or exclude competition,” du Pont, is “the primary requisite to a finding of monopolization.” 1 M. HANDLER, TWENTY-FIVE YEARS OF ANTITRUST 691 (1973). The Supreme Court has informed us that “monopoly power, whether lawfully or unlawfully acquired, may itself constitute an evil and stand con-demned under §2 even though it remains unexercised.” U.S. v. Griffith, 334 U.S. 100, 107 (1948). This tenet is well grounded in economic analysis. There is little disagreement that a profit-maximizing monopolist will maintain his prices higher and his output lower and the socially optimal levels that would prevail in a purely competitive market. …

Because, like all power, it is laden with the possibility of abuse; because it en-courages sloth rather than the active quest for excellence; and because it tends to damage the very fabric of our economy and our society, monopoly power is “inherently evil.” U.S. v. United Shoe Machinery Corp., 110 F.Supp. 295, 345 (D.Mass.1953), aff’d per cu-riam, 347 U.S. 521 (1954). If a finding of monopoly power were all that were necessary to complete a violation of §2, our task in this case would be considerably lightened. Ko-dak’s control of the film and color paper markets clearly reached the level of a monopoly. And, while the issue is a much closer one, it appears that the evidence was sufficient for the jury to find that Kodak possessed such power in the camera market as well. But our inquiry into Kodak’s liability cannot end there.

B. The Requirement of Anticompetitive Conduct. … [W]hile proclaiming vigorously that monopoly power is the evil at which §2 is aimed, courts have declined to take what would have appeared to be the next logical step declaring monopolies unlawful per se unless specifically authorized by law. To understand the reason for this, one must comprehend the fundamental tension one might almost say the paradox that is near the heart of §2. This tension creates much of the confusion surrounding §2. It makes the cryptic Alcoa opinion a litigant’s wishing well, into which, it sometimes seems, one may peer and find nearly anything he wishes.

The conundrum was indicated in characteristically striking prose by Judge Hand [in Alcoa], who was not able to resolve it. Having stated that Congress “did not condone ‘good trusts’ and condemn ‘bad’ ones; it forbad all,” he declared with equal force, “The successful competitor, having been urged to compete, must not be turned upon when he wins.” Hand, therefore, told us that it would be inherently unfair to condemn success when the Sherman Act itself mandates competition. Such a wooden rule, it was feared,

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might also deprive the leading firm in an industry of the incentive to exert its best efforts. Further success would yield not rewards but legal castigation. The antitrust laws would thus compel the very sloth they were intended to prevent. We must always be mindful lest the Sherman Act be invoked perversely in favor of those who seek protection against the rigors of competition.

In Alcoa the crosscurrents and pulls and tugs of §2 law were reconciled by noting that, although the firm controlled the aluminum ingot market, “it may not have achieved monopoly; monopoly may have been thrust upon it.” In examining this language, which would condemn a monopolist unless it is “the passive beneficiary of a monopoly,” id., we perceive Hand the philosopher. As an operative rule of law, however, the “thrust upon” phrase does not suffice. It has been criticized by scholars, and the Supreme Court appears to have abandoned it. Grinnell instructs that after possession of monopoly power is found, the second element of the §2 offense is “the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.” … Thus the statement in Alcoa that even well-behaved monopolies are forbidden by §2 must be read carefully in context. Its right-ful meaning is that, if monopoly power has been acquired or maintained through im-proper means, the fact that the power has not been used to extract improper benefits pro-vides no succor to the monopolist.

But the law’s hostility to monopoly power extends beyond the means of its acqui-sition. Even if that power has been legitimately acquired, the monopolist may not wield it to prevent or impede competition. Once a firm gains a measure of monopoly power, whether by its own superior competitive skill or because of such actions as restrictive combinations with others, it may discover that the power is capable of being maintained and augmented merely by using it. That is, a firm that has achieved dominance of a mar-ket might find its control sufficient to preserve and even extend its market share by ex-cluding or preventing competition. … Even if the origin of the monopoly power was in-nocent, therefore, the Grinnell rule recognizes that maintaining or extending market con-trol by the exercise of that power is sufficient to complete a violation of §2. …

A firm that has lawfully acquired a monopoly position is not barred from taking advantage of scale economies by constructing, for example, a large and efficient factory. These benefits are a consequence of size and not an exercise of power over the market. Nevertheless, many anticompetitive actions are possible or effective only if taken by a firm that dominates its smaller rivals. A classic illustration is an insistence that those who wish to secure a firm’s services cease dealing with its competitors. See, e.g., Lorain Jour-nal. Such conduct is illegal when taken by a monopolist because it tends to destroy com-petition, although in the hands of a smaller market participant it might be considered harmless, or even “honestly industrial.” Alcoa.

Nor is a lawful monopolist ordinarily precluded from charging as high a price for its product as the market will accept. True, this is a use of economic power…. But high prices, far from damaging competition, invite new competitors into the monopolized mar-ket. …

In sum, although the principles announced by the §2 cases often appear to con-flict, this much is clear. The mere possession of monopoly power does not ipso facto con-

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demn a market participant. But, to avoid the proscriptions of §2, the firm must refrain at all times from conduct directed at smothering competition. This doctrine has two branches. Unlawfully acquired power remains anathema even when kept dormant. And it is no less true that a firm with a legitimately achieved monopoly may not wield the result-ing power to tighten its hold on the market.

C. Monopoly Power as a Lever in Other Markets. … [W]e must determine whether a firm violates §2 by using its monopoly power in one market to gain a competi-tive advantage in another, albeit without an attempt to monopolize the second market. We hold, as did the lower court, that it does.

This conclusion appears to be an inexorable interpretation of the antitrust laws. We tolerate the existence of monopoly power, we repeat, only insofar as necessary to pre-serve competitive incentives and to be fair to the firm that has attained its position inno-cently. There is no reason to allow the exercise of such power to the detriment of compe-tition, in either the controlled market or any other. That the competition in the leveraged market may not be destroyed but merely distorted does not make it more palatable. Social and economic effects of an extension of monopoly power militate against such conduct.

The Griffith case confirms this view. There, a chain of motion picture exhibitors operated the only theaters in a number of towns, and used its concomitant buying power to extract from distributors certain exclusive rights in other localities where it faced chal-lengers. The Court ... admonished that “the use of monopoly power, however lawfully ac-quired, to foreclose competition, to gain a competitive advantage, or to destroy a com-petitor, is unlawful.” 334 U.S. at 107. …15

Accordingly, the use of monopoly power attained in one market to gain a compet-itive advantage in another is a violation of §2, even if there has not been an attempt to monopolize the second market. It is the use of economic power that creates the liability. But, as we have indicated, a large firm does not violate §2 simply by reaping the competi-tive rewards attributable to its efficient size, nor does an integrated business offend the Sherman Act whenever one of its departments benefits from association with a division possessing a monopoly in its own market. So long as we allow a firm to compete in sev-eral fields, we must expect it to seek the competitive advantages of its broad-based activ-ity more efficient production, greater ability to develop complementary products, reduced transaction costs, and so forth. These are gains that accrue to any integrated firm, regard-less of its market share, and they cannot by themselves be considered uses of monopoly power.

We shall now apply to the case at bar the principles we have set forth above.

III. THE 110 SYSTEM: We turn now to the events surrounding Kodak’s introduction of the 110 photographic system in 1972. … We commented earlier on the camera revolu-tion sparked by Kodak’s introduction of the 126 Instamatic in 1963. Ben Berkey, chair-15 We cannot accept Kodak's argument that, read literally, §2 prevents a plaintiff from recovering unless there was at least an attempt to monopolize the market in which it claims to have been in-jured. Since monopoly power itself is the target of §2, it is unreasonable to suggest that a firm that possesses such power in one market and uses it to damage competition in another does not “monopolize” within the meaning of the statute.

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man of Berkey Photo, described the camera’s cartridge-loading feature as “foolproof” and remarked that the new simple system gave the industry “a great boost.” Even before the 126 was introduced, however, Kodak had set its sights on a new, smaller line of Insta-matic cameras. The aim of Kodak’s Project 30, or P-30, as it was often called, was a cam-era barely one inch thick but capable of producing photographs as clear and large as its bulkier cousins.

Kodak’s desire to produce large, high-quality snapshots from a small camera cre-ated successive ripples in a number of ponds. As camera size decreases, so does the area of film exposed when the shutter is opened. Thus the negative must be substantially en-larged to produce a print, and the P-30 group was concerned that the Kodak color print film then in use, Kodacolor X, might not be equal to the task. There was fear that it was too “grainy” that full-size photographs printed from tiny Kodacolor X negatives would have an unacceptably speckled, pebbly appearance, reflecting the extreme magnification of the small light-sensitive grains constituting the film.

The early view at P-30 had been that despite this problem Kodacolor X would prove “quite adequate” for the new format. By 1966, however, the Kodacolor Future Sys-tem Committee, considering Kodak’s film sales in the 126 size as well as in the format being created by Project 30, began actively to consider the possibility of developing a new type of Kodacolor film. This engendered the second set of ripples, for the committee realized that basic changes in the film would require a new photofinishing process, con-ducted at temperatures higher than those used in the so-called C-22 method by which prints were made from Kodacolor X. Some committee members, therefore, expressed concern about the effect that a new process might have on independent photofinishers, who developed Kodak film and were purchasers of Kodak equipment and supplies. These concerns were shared by a number of Kodak scientists, such as D. M. Zwick, who feared an “unethical” attempt to create a “deliberate . . . incompatibility with systems other than Kodacolor.”

Nevertheless, on May 10, 1967, the committee recommended that Kodak proceed with the development of the new film and finishing process, tentatively labeled P-118. This recommendation was adopted at a meeting of the Kodak management on September 20. Although management believed that many of the film improvements were desirable without regard to the P-30 program,” it decided that Kodak should consider marketing the new film in the P-30 size for approximately one year before introducing it in the 126 for-mat. A firm date was not set at that time for introduction of P-118, but by 1969 Kodak decided that P-118 should be used to help launch the P-30 camera system in March 1972. This decision appears to have been influenced by the views of those Kodak officers who believed that “[w]ithout a new film, the [camera] program is not a new advertisable sys-tem….”

To meet this self-imposed deadline for P-118, Kodak was required to act in great haste. … Not surprisingly, then, as the target date approached, Kodak realized that its new film was plagued by a number of difficulties.

Shortly after initial production runs began in October 1971, Kodak recognized that “several product deficiencies” would exist in the film, now called Kodacolor II, at the time of introduction. Indeed, just eight days before the joint announcement of the new

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camera, film, and photofinishing process, a technical committee listed eleven “presently identified” problems that could affect “the customer’s ultimate quality.” Not only did Ko-dacolor II have a significantly shorter shelf life than had been anticipated, but it also proved grainier than Kodak had originally hoped. This problem was highly significant, of course, because low graininess was supposedly the quality that made Kodacolor II espe-cially suitable for the Pocket Instamatic cameras.

Despite these deficiencies, Kodak proceeded with its plans for introduction of the 110 system, of which Kodacolor II had become an integral part. On March 16, 1972, amid great fanfare, the system was announced. Finally, said Kodak, there was a “little camera that takes big pictures.” Kodacolor II was “a remarkable new film” indeed, the best color negative film Kodak had ever manufactured. There had long been other small cameras, Kodak explained: “But they weren’t like these. Now there are films fine enough, and sharp enough, to give you big, sharp pictures from a very small negative.”

In accord with Kodak’s 1967 plan, Kodacolor II was sold only in the 110 format for eighteen months after introduction. It remains the only 110-size color print film Ko-dak has ever sold.

As Kodak had hoped, the 110 system proved to be a dramatic success. In 1972 the system’s first year the company sold 2,984,000 Pocket Instamatics, more than 50% of its sales in the amateur conventional still camera market. … Rival manufacturers hastened to market their own 110 cameras, but Kodak stood alone until Argus made its first shipment of the “Carefree 110” around Christmas 1972. The next year, although Kodak’s competi-tors sold over 800,000 110 cameras, Kodak retained a firm lead with 5.1 million. Its share of 110 sales did not fall below 50% until 1976. Meanwhile, by 1973 the 110 had taken over most of the amateur market from the 126, and three years later it accounted for nearly four-fifths of all sales.

Berkey[ ] … was a late entrant in the 110 sweepstakes, joining the competition only in late 1973. Moreover, because of hasty design, the original models suffered from latent defects, and sales that year were a paltry 42,000. With interest in the 126 dwin-dling, [Berkey] thus suffered a net decline of 118,000 unit sales in 1973. The following year, however, it recovered strongly, in large part because improvements in its pocket cameras helped it sell 406,000 units, 7% of all 110s sold that year.

Berkey contends that the introduction of the 110 system was both an attempt to monopolize and actual monopolization of the camera market. … Because the jury re-turned what amounted to general verdicts for the plaintiff … , we are bound in the fol-lowing discussion to construe the evidence and the possible inferences in the light most favorable to Berkey. …

A. Attempt to Monopolize and Monopolization of the Camera Market. There is little doubt that the evidence supports the jury’s implicit finding that Kodak had mo-nopoly power in cameras. The principal issues presented to us regarding the effect of the 110 introduction in the camera market are whether Kodak engaged in anticompetitive conduct and, if so, whether that conduct caused injury to Berkey.

It will be useful at the outset to present the arguments on which Berkey asks us to uphold its verdict:

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(1) Kodak, a film and camera monopolist, was in a position to set industry standards. Ri-vals could not compete effectively without offering products similar to Kodak’s. More-over, Kodak persistently refused to make film available for most formats other than those in which it made cameras. Since cameras are worthless without film, this policy effec-tively prevented other manufacturers from introducing cameras in new formats. Because of its dominant position astride two markets, and by use of its film monopoly to distort the camera market, Kodak forfeited its own right to reap profits from such innovations without providing its rivals with sufficient advance information to enable them to enter the market with copies of the new product on the day of Kodak’s introduction. This is one of several “predisclosure” arguments Berkey has advanced in the course of this liti -gation.

(2) The simultaneous introduction of the 110 camera and Kodacolor II film, together with a campaign advertising the two jointly, enabled Kodak to garner more camera sales than if it had merely scaled down Kodacolor X to fit the new camera. The jury could conclude that Kodacolor II was an inferior product and not technologically necessary for the suc-cess of the 110. In any event, Kodak’s film monopoly prevented any other camera manu-facturer from marketing such a film-camera “system” and the joint introduction was therefore anticompetitive.

(3) For eighteen months after its introduction, Kodacolor II was available only in the 110 format. Thus it followed that any consumer wishing to use Kodak’s “remarkable new film” had to buy a 110 camera. Since Kodak was the leading and at first the only manu-facturer of such devices, its camera sales were boosted at the expense of its competitors.

For the reasons explained below, we do not believe any of these contentions is sufficient on the facts of this case to justify an award of damages to Berkey. We therefore reverse this portion of the judgment.

1. Predisclosure. Through the 1960s, Kodak followed a checkered pattern of predisclosing innovations to various segments of the industry. Its purpose on these oc-casions evidently was to ensure that the industry would be able to meet consumers’ de-mand for the complementary goods and services they would need to enjoy the new Ko-dak products. But predisclosure would quite obviously also diminish Kodak’s share of the auxiliary markets. It was therefore, in the words of Walter Fallon, Kodak’s chief ex-ecutive officer, “a matter of judgment on each and every occasion” whether predisclosure would be for or against Kodak’s self-interest. Thus, well before the 1965 introduction of Super-8 movie films, Kodak, which had a relatively small share of the movie camera market, provided sufficient information to companies such as Keystone and Bell & How-ell to enable them to make cameras to use the new film. It also released processing infor-mation so that photofinishers could develop the film. But in 1963, when Kodak came out with Kodacolor X and the 126 Instamatic, it kept its own counsel until the date of intro-duction.

As early as 1968, some Kodak employees urged that advance warning of the P-30 system would be needed, at least to film processors and manufacturers of photofinishing equipment, to give them time to prepare for Kodacolor II and the new high-temperature finishing process, which was eventually labeled C-41. One memorandum noted that “P-30 will require more changes in photofinishing techniques than were required for P-13 (the 126 system). These differences . . . seem to indicate a minimum 6 month advance disclosure to other firms.” Nevertheless, Kodak decided not to release advance informa-

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tion about the new film and format. The decision was evidently based on the perception of Dr. Louis K. Eilers, Kodak’s chief executive officer at that time, that Kodak would gain more from being first on the market for the sale of all goods and services related to the 110 system than it would lose from the inability of other photofinishers to process Kodacolor II. An important factor in Eilers’s thinking may have been that Kodak had al-ready decided to manufacture the new film initially in the 110 format only. Since Koda-color II could not be used in any pre-existing cameras, the demand for photofinishing ser-vices and equipment in the first several months would be within the capacities of [Ko-dak’s photofinishing units].

Although Kodak had most seriously considered divulging advance information of the 110 system to processors and equipment manufacturers, it was a rival camera maker that forced a small breach in its wall of secrecy. In the summer of 1971, Bell & Howell, implicitly threatening legal action, began to pressure Kodak “to notify photographic equipment manufacturers in advance of its introduction of new films or film formats which require changes in equipment design.” … Kodak determined to avoid litigation if it could, and it proposed an experimental predisclosure arrangement with the 110 system. On January 3, 1972, [Kodak] informed Bell & Howell that Kodak would soon introduce “a new cartridge-loading still camera and (slide) projector to accommodate a new film format.” More information, Brereton explained, would be forthcoming only for a fee, necessary to compensate Kodak for its “very considerable research and development ex-penses” and to represent the value of such knowledge to the recipient.

…[W]ithin the next two weeks Kodak explained the offer to Berkey. For a fee of $10,000 Kodak would provide a general description of the new film format and cartridge, a view of the cartridge and sample prints and slides, the anticipated dates of announce-ment and commercial introduction, and an outline of the terms on which Kodak would further disclose “such information as we believe will enable you to design and manufac-ture cameras to accept our new cartridge and film format.” Berkey paid the $10,000 fee and also the supplemental fees, totaling $50,000 for eleven sheets of specifications and notes. For the $60,000 Berkey gained somewhat less than two months advance knowl-edge of information it needed to compete with Kodak in the sale of 110 cameras. The jury could unquestionably conclude that this was far from adequate to permit Berkey to be “at the starting line” when the 110 was introduced.

Judge Frankel did not decide that Kodak should have disclosed the details of the 110 to other camera manufacturers prior to introduction. Instead, he left the matter to the jury, instructing them as follows:

Standing alone, the fact that Kodak did not give advance warning of its new products to competitors would not entitle you to find that this conduct was exclusionary. Ordinarily a manufacturer has no duty to predisclose its new products in this fashion. It is an ordinary and acceptable business practice to keep one’s new developments a secret. However, if you find that Kodak had monopoly power in cameras or in film, and if you find that this power was so great as to make it impossible for a competitor to compete with Kodak in the camera market unless it could offer products similar to Kodak’s, you may decide whether in the light of other conduct you determine to be anticompetitive, Kodak’s fail-ure to predisclose was on balance an exclusionary course of conduct.

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We hold that this instruction was error and that, as a matter of law, Kodak did not have a duty to predisclose information about the 110 system to competing camera manu-facturers.

As Judge Frankel indicated, and as Berkey concedes, a firm may normally keep its innovations secret from its rivals as long as it wishes, forcing them to catch up on the strength of their own efforts after the new product is introduced. It is the possibility of success in the marketplace, attributable to superior performance, that provides the incen-tives on which the proper functioning of our competitive economy rests. If a firm that has engaged in the risks and expenses of research and development were required in all cir-cumstances to share with its rivals the benefits of those endeavors, this incentive would very likely be vitiated.

Withholding from others advance knowledge of one’s new products, therefore, or-dinarily constitutes valid competitive conduct. Because, as we have already indicated, a monopolist is permitted, and indeed encouraged, by §2 to compete aggressively on the merits, any success that it may achieve through “the process of invention and innovation” is clearly tolerated by the antitrust laws. United Shoe Machinery Corp.

The Supreme Court’s language in U.S. v. National Lead Co., 332 U.S. (1947), is instructive on this score. There, National Lead and du Pont were found to have engaged in an illegal patent pool that restrained commerce in titanium products. As part of its de-cree, the district court ordered the firms to make licenses available at reasonable fees and also to make available for a period of three years and at a reasonable fee certain informa-tion on processes exploiting these patents. The Supreme Court upheld these requirements as a reasonable remedy for the antitrust violations. It squarely rejected, however, the Government’s attempt to extend the decree by requiring the defendants to furnish again for only three years and at a reasonable fee all information desired by any applicant relat-ing to the methods and processes for manufacturing titanium pigments:

The attempt of the Government to throw the field of technical knowledge in the titanium pigment industry wide-open would reduce the competitive value of the independent re-search of the parties. It would discourage rather than encourage competitive research.

Moreover, enforced predisclosure would cause undesirable consequences beyond merely encouraging the sluggishness the Sherman Act was designed to prevent. A signifi-cant vice of the theory propounded by Berkey lies in the uncertainty of its application. Berkey does not contend, in the colorful phrase of Judge Frankel, that “Kodak has to live in a goldfish bowl,” disclosing every innovation to the world at large. However pre-dictable in its application, such an extreme rule would be insupportable. Rather, Berkey postulates that Kodak had a duty to disclose limited types of information to certain com-petitors under specific circumstances. But it is difficult to comprehend how a major cor-poration, accustomed though it is to making business decisions with antitrust considera-tions in mind, could possess the omniscience to anticipate all the instances in which a jury might one day in the future retrospectively conclude that predisclosure was war-ranted. And it is equally difficult to discern workable guidelines that a court might set forth to aid the firm’s decision. For example, how detailed must the information con-veyed be? And how far must research have progressed before it is “ripe” for disclosure? These inherent uncertainties would have an inevitable chilling effect on innovation. They go far, we believe, towards explaining why no court has ever imposed the duty Berkey seeks to create here.

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An antitrust plaintiff urging a predisclosure rule, therefore, bears a heavy burden in justifying his request. Berkey recognizes the weight of this burden. It contends that it has been met. Kodak is not a monolithic monopolist, acting in a single market. Rather, its camera monopoly was supported by its activity as a film manufacturer. Berkey therefore argues that by not disclosing the new format in which it was manufacturing film, Kodak unlawfully enhanced its power in the camera market. Indeed, Kodak not only participates in but monopolizes the film industry. The jury could easily have found that, when Kodak introduced a new film format, rival camera makers would be foreclosed from a substan-tial segment of the market until they were able to manufacture cameras in the new format. Accordingly, Berkey contended that Kodak illegitimately used its monopoly power in film to gain a competitive advantage in cameras. Thus Berkey insists that the jury was properly permitted to consider whether, on balance, the failure to predisclose the new for-mat was exclusionary. We disagree.

We note that this aspect of Berkey’s claim is in large measure independent of the fact that a new film, Kodacolor II, was introduced simultaneously with the new format. It is primarily introduction of the format itself the size of the film and the cartridge in which it is packaged of which Berkey complains. Indeed, at oral argument counsel for Berkey contended that predisclosure would have been required even had Kodak merely cut down Kodacolor X to fit the new 110 camera and cartridge.

We do not perceive, however, how Kodak’s introduction of a new format was rendered an unlawful act of monopolization in the camera market because the firm also manufactured film to fit the cameras. The 110 system was in substantial part a camera de-velopment. After all, P-30 existed long before the P-118 film project began, and much of the creative energy behind it was consumed by efforts to produce the camera itself. In-deed, Berkey not only argues that a new film was not necessary to introduce the new pocket cameras; it also concedes that the early models of its own 110 cameras, brought to market some eighteen months after it first learned of the new format, suffered because of the haste with which they were designed.

Clearly, then, the policy considerations militating against predisclosure require-ments for monolithic monopolists are equally applicable here. The first firm, even a mo-nopolist, to design a new camera format has a right to the lead time that follows from its success. The mere fact that Kodak manufactured film in the new format as well, so that its customers would not be offered worthless cameras, could not deprive it of that reward. Nor is this conclusion altered because Kodak not only participated in but dominated the film market. Kodak’s ability to pioneer formats does not depend on it possessing a film monopoly. Had the firm possessed a much smaller share of the film market, it would nev-ertheless have been able to manufacture sufficient quantities of 110-size film either Ko-dacolor X or Kodacolor II to bring the new camera to market. It is apparent, therefore, that the ability to introduce the new format without predisclosure was solely a benefit of integration and not, without more, a use of Kodak’s power in the film market to gain a competitive advantage in cameras. …

Our analysis, however, must proceed beyond the conclusion that introduction of film to meet Kodak’s new camera format was not in itself an exercise of the company’s monopoly power in film. Berkey contends that Kodak in the past used its film monopoly to stifle format innovations by any other camera manufacturer. Accordingly, it argues that

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Kodak was barred from reaping the benefits of such developments without making pre-disclosure to allow its rivals to share from the beginning in the rewards.

There is, indeed, little doubt that the jury could have found that Kodak, by refus-ing to make film available on economical terms, obstructed sales of cameras in compet-ing formats. Thus, Kodak has never supplied film to fit the Minox, a small camera that uses a cartridge similar to that of the Instamatics and that has been on the market since the 1930s, or similar cameras by Minolta and Mamiya that were also introduced before the Kodak 126. Merchants of these cameras, including Berkey, made numerous requests that Kodak sell film packaged in their formats, with or without the Kodak name. As an al-ternative, they asked Kodak to sell bulk film rolls large enough to permit the camera manufacturers economically to cut the film down to the appropriate size and spool it. Ko-dak denied all such appeals. Some of the miniature cameras did survive but, as even Ko-dak’s own economic expert testified, its policy drastically reduced the ability of rival manufacturers to compete by introducing new camera formats.

We accept the proposition that it is improper, in the absence of a valid business policy, for a firm with monopoly power in one market to gain a competitive advantage in another by refusing to sell a rival the monopolized goods or services he needs to compete effectively in the second market. Indeed, Kodak itself was the defendant in the leading case establishing this point. Eastman Kodak Co. v. Southern Photo Materials Co., 273 U.S. 359, 375 (1927). Moreover, as indicated by our discussion of §2 principles, such a use of power would be illegal regardless of whether the film monopoly were legally or il-legally acquired. It may be that Kodak violated the Sherman Act when it refused to sell Berkey bulk film for use in the Minolta camera, and Berkey might well have recovered for its loss of Minolta sales and for any additional expenses incurred because of Kodak’s conduct.

But Berkey did not sue Kodak then for its refusal to sell film, and it concedes that it is not now claiming a right to damages on this basis. Rather, it contends that Kodak’s past offenses created a continuing duty to disclose its new formats to competing camera manufacturers, and that its violation of that obligation supports the jury’s verdict. For two reasons, however, we decline to recognize such a duty.

First, the benefits that would flow to Kodak’s rivals in the camera market from such a rule bear no relationship to the injury caused them by the monopolist’s refusal to sell films for their competing camera formats. There is no reason to suppose, for exam-ple, that the loss suffered by Berkey because Kodak undercut Minolta sales was at all comparable to the boon Berkey would have received had Kodak given it the opportunity to participate from the beginning in the 110 revolution. Indeed, some of the camera man-ufacturers who would be benefited by predisclosure might not have participated in or even contemplated entering the market at the time Kodak committed its alleged viola-tions. For them, predisclosure would be pure windfall.

Second, it would be inappropriate to hold that Kodak should spontaneously have recognized a duty to release advance information of its new products to its competitors. It is important to note that Berkey, which no longer sells cameras, does not advance its pre-disclosure argument as part of a demand for equitable relief. Where a firm has engaged in monopolistic practices, a court is not limited, in fashioning prospective remedies, to an

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injunction against future violations of law. Hence the function of the court includes “un-doing” what the monopoly achieved by its illegal acts. U.S. v. Paramount Pictures, 334 U.S. 131, 171 (1948).

Accordingly, if Berkey were still a camera maker, it might be able to demand that Kodak, to nullify the effect of its monopolistic obstruction of new formats for competing cameras, be required to allow its rivals to share from the start in the business created by its own changes in format. Even in the equitable context, National Lead would caution against a decree that might stifle future innovations. But Berkey, in any event, does not demand prospective relief. Instead it asks us to condemn Kodak retrospectively, holding that it violated §2 and so is liable for damages, because it did not decide on its own initia-tive to take unusual, self-abnegatory actions as a corrective for unadjudicated prior of-fenses. This is without justification.

Conclusion. We have held that Kodak did not have an obligation, merely because it introduced film and camera in a new format, to make any predisclosure to its camera-making competitors. Nor did the earlier use of its film monopoly to foreclose format in-novation by those competitors create of its own force such a duty where none had existed before. … [T]he jury clearly based its calculation of lost camera profits on Berkey’s cen-tral argument that it had a right to be “at the starting line when the whistle blew” for the new system. The verdict, therefore, cannot stand.

2. Systems Selling: Berkey’s claims regarding the introduction of the 110 camera are not limited to its asserted right to predisclosure. The Pocket Instamatic not only initiated a new camera format, it was also promoted together with a new film. As we noted earlier, the view was expressed at Kodak that “(w)ithout a new film, the (cam-era) program is not a new advertisable system.” Responding in large measure to this per-ception, Kodak hastened research and development of Kodacolor II so that it could be brought to market at the same time as the 110 system. Based on such evidence, and the earlier joint introduction of Kodacolor X and the 126 camera, the jury could readily have found that the simultaneous release of Kodacolor II and the Pocket Instamatic was part of a plan by which Kodak sought to use its combined film and camera capabilities to bolster faltering camera sales. Berkey contends that this program of selling was anticompetitive and therefore violated §2. We disagree.

It is important to identify the precise harm Berkey claims to have suffered from this conduct. It cannot complain of a product introduction simpliciter for the same reason it could not demand predisclosure of the new format: any firm, even a monopolist, may generally bring its products to market whenever and however it chooses.30 Rather, Berkey’s argument is more subtle. It claims that by marketing the Pocket Instamatics in a system with a widely advertised new film, Kodak gained camera sales at Berkey’s ex-pense. And, because Kodacolor II was not necessary to produce satisfactory 110 photo-graphs and in fact suffered from several deficiencies, these gains were unlawful.

30 This is not to say, of course, that new product introductions are ipso facto immune from an-titrust scrutiny, and we do not agree with Kodak’s argument that they are; in all such cases, how-ever, it is not the product introduction itself, but some associated conduct, that supplies the viola-tion.

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It may be conceded that, by advertising Kodacolor II as a “remarkable new film” capable of yielding “big, sharp pictures from a very small negative,” Kodak sold more 110 cameras than it would have done had it merely marketed Kodacolor X in 110-size cartridges. The quality of the end product a developed snapshot is at least as dependent upon the characteristics of the film as upon those of the camera. It is perfectly plausible that some customers bought the Kodak 110 camera who would have purchased a com-petitor’s camera in another format had Kodacolor II not been available and widely adver-tised as capable of producing “big, sharp pictures” from the tiny Pocket Instamatic. Moreover, there was also sufficient evidence for the jury to conclude that a new film was not necessary to bring the new cameras to market. Walter Fallon testified that in 1967, as manager of Kodak’s Film Emulsion and Plate Organization, he expressed the view that Kodacolor X “would give satisfactory pictures, satisfactory customer results” in the P-30 format. Documents introduced at trial indicated that this opinion was shared by at least two Kodak research scientists.

But necessity is a slippery concept. Indeed, the two scientists, Zwick and Groet, conceded that improvements in the quality of Kodacolor X would be “most welcome.” Even if the 110 camera would produce adequate snapshots with Kodacolor X, it would be difficult to fault Kodak for attempting to design a film that could provide better results. The attempt to develop superior products is, as we have explained, an essential element of lawful competition. Kodak could not have violated §2 merely by introducing the 110 camera with an improved film.

Accordingly, much of the evidence at trial concerned the dispute over the relative merits of Kodacolor II and Kodacolor X. There was ample evidence that for some months following the 110 introduction, Kodacolor II was inferior to its predecessor in several re-spects. Most notably, it degenerated more quickly than Kodacolor X, so that its shelf life was shorter. It is undisputed, however, that the grain of Kodacolor II, though not as fine as Kodak had hoped, was better than that of the older film.

In this context, therefore, the question of product quality has little meaning. A product that commends itself to many users because superior in certain respects may be rendered unsatisfactory to others by flaws they considered fatal. Millions of consumers, for example, evidently found the 110 camera highly attractive because of its “pocketabil-ity.” Others, perhaps more concerned over the quality of their flash pictures, found the original models unsatisfactory because of the high incidence of “red-eye.” Similarly, some individuals would, if given the option and aware of the relevant factors, select Ko-dacolor II over Kodacolor X because of its superior grain, which was especially useful for a small camera; others might choose Kodacolor X because the original variety of Ko-dacolor II had to be used more quickly to produce attractive pictures.

It is evident, then, that in such circumstances no one can determine with any rea-sonable assurance whether one product is “superior” to another. Preference is a matter of individual taste. The only question that can be answered is whether there is sufficient de-mand for a particular product to make its production worthwhile, and the response, so long as the free choice of consumers is preserved, can only be inferred from the reaction of the market.

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When a market is dominated by a monopolist, of course, the ordinary competitive forces of supply may not be fully effective. Even a monopolist, however, must generally be responsive to the demands of customers, for if it persistently markets unappealing goods it will invite a loss of sales and an increase of competition. If a monopolist’s prod-ucts gain acceptance in the market, therefore, it is of no importance that a judge or jury may later regard them as inferior, so long as that success was not based on any form of coercion. Certainly the mere introduction of Kodacolor II along with the Pocket Instamat-ics did not coerce camera purchasers. Unless consumers desired to use the 110 camera for its own attractive qualities, they were not compelled to purchase Kodacolor II especially since Kodak did not remove any other films from the market when it introduced the new one. If the availability of Kodacolor II spurred sales of the 110 camera, it did so because some consumers regarded it as superior, at least for the smaller format.39

Of course, Kodak’s advertising encouraged the public to take a favorable view of both Kodacolor II and the 110 camera, but that was not improper. A monopolist is not forbidden to publicize its product unless the extent of this activity is so unwarranted by competitive exigencies as to constitute an entry barrier. And in its advertising, a producer is ordinarily permitted, much like an advocate at law, to bathe his cause in the best light possible. Advertising that emphasizes a product’s strengths and minimizes its weak-nesses does not, at least unless it amounts to deception, constitute anticompetitive con-duct violative of §2.

We conclude, therefore, that Kodak did not contravene the Sherman Act merely by introducing Kodacolor II simultaneously with the Pocket Instamatic and advertising the advantages of the new film for taking pictures with a small camera.

3. Restriction of Kodacolor II to the 110 Format: There is another aspect to Berkey’s claim that introduction of Kodacolor II simultaneously with the Pocket Insta-matic camera was anticompetitive. For eighteen months after the 110 system introduc-tion, Kodacolor II was available only in the 110 format. Since Kodak was the first to have the 110s on the market, Berkey asserts it lost camera sales because consumers who wished to use the “remarkable new film” would be compelled to buy a Kodak camera. This facet of the claim, of course, is not dependent on a showing that Kodacolor II was inferior in any respect to Kodacolor X. Quite the opposite is true. The argument is that, since consumers were led to believe that Kodacolor II was superior to Kodacolor X, they were more likely to buy a Kodak 110, rather than a Berkey camera, so that the new film could be used.

Where a course of action is ambiguous, “consideration of intent may play an im-portant role in divining the actual nature and effect of the alleged anticompetitive con-duct,” U.S. v. U.S. Gypsum Co., 438 U.S. 422, 436 n.13 (1978); We shall assume ar-guendo that Kodak violated §2 of the Sherman Act if its decision to restrict Kodacolor II 39 Thus, the situation might be completely different if, upon the introduction of the 110 system, Kodak had ceased producing film in the 126 size, thereby compelling camera purchasers to buy a Kodak 110 camera. Or had Kodak shifted production in all formats from Kodacolor X to Koda-color II before other photofinishers could process the new film, it would force photographers to procure their photofinishing services from CP&P. In such a case the technological desirability of the product change might bear on the question of monopolistic intent.

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to the 110 format was not justified by the nature of the film but was motivated by a desire to impede competition in the manufacture of cameras capable of using the new film. This might well supply the element of coercion we found lacking in the previous section. We shall assume also that there was sufficient evidence for the jury to conclude that the ini-tial decision to market Kodacolor II exclusively in the 110 format during its introductory period was indeed taken for anticompetitive purposes.

But to prevail, Berkey must prove more, for injury is an element of a private tre-ble damages action. Berkey must, therefore, demonstrate that some consumers who would have bought a Berkey camera were dissuaded from doing so because Kodacolor II was available only in the 110 format. This it has failed to establish. The record is totally devoid of evidence that Kodak or its retailers actually attempted to persuade customers to purchase the Pocket Instamatic because it was the only camera that could use Kodacolor II, or that, in fact, any consumers did choose the 110 in order to utilize the finer-grained film.

To be sure, some of Kodak’s advertisements emphasized the superior qualities of Kodacolor II, but the gist of these messages was merely that Kodacolor II, unlike previ-ous films, would yield, “big, sharp pictures” from a small camera. In short, Kodak simply claimed to have achieved its goal of truly developing a Pocket Instamatic system whose color prints would be “as close as possible to the prints currently obtained from 126-size Kodacolor X.” Stressing the “pocketability” of the 110 format, Kodak did not emphasize Kodacolor II as an independent reason to choose a photography system. Little of the ad-vertising mentioned Kodacolor II by name. Of even greater weight is the fact that none in any way implied that the new film was available only in the 110 size. Accordingly, the content of Kodak’s publicity, standing alone, would not permit a jury rationally to infer that Berkey was injured by the restriction of Kodacolor II to the 110 format.

The abstract possibility nevertheless remains that there might have been some customers who would have purchased a Berkey camera in one of the pre-existing formats but decided to select a Kodak 110 instead because they were aware that there was no al-ternative means of using Kodacolor II, even in the absence of advertising to that effect. Yet, although millions of amateur photographers bought Pocket Instamatics, Berkey did not produce anyone at the trial to testify that he was so motivated. Nor did Berkey present the testimony of camera dealers, or evidence of any kind, to establish that such customers existed. …

To summarize our conclusions on the 110 camera claims, we hold:

1. Kodak was under no obligation to predisclose information of its new film and format to its camera-making competitors.

2. It is no basis for antitrust liability that Kodacolor II, despite certain deficiencies com-pared to Kodacolor X, may have encouraged sales of the 110 camera.

3. Finally, although the restriction of Kodacolor II to the 110 format may have been un-justified, there was no evidence that Berkey was injured by this course of action.

We, therefore, reverse so much of the judgment as awarded Berkey damages based on the introduction of the 110 camera. …

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The IBM Cases: OverviewI. Background

A. The Computer Industry in the early 1960s:

1. Computers sold as entire units; incompatible with other brands’ machines.

2. IBM 70% of market; others divided 30%.

3. Brand loyalty b/c incompatible; expensive to switch.

4. Independent components priced to maximize system as a whole.

B. Late 1960: Compatible Parts Developed

1. Entry barriers much lower; could come into market w just 1 product.

2. By early 1970, some erosion of IBM market share.

II. IBM Three-Part Response (drastically reduced profits of competitors)

A. PRICE CUTS ON PERIPHERALS: E.g., sold disk drives at prices below its esti-mate of minimum price competitors could afford. No evidence new prices were be-low its own costs.

B. FIXED TERM PLAN: Switched from one-month to long-term leases on most products with discounts for longer leases. Peripherals only available on long-term leases. Simultaneously, increases price of CPUs.

C. BUNDLING OF SEPARATE UNITS: IBM restructured new disc drives to be part of CPU & lowered price for leasing them together.

III. Lawsuits:

A. Several competitors (and U.S.) sued IBM in mid-70s re "extent to which a domi-nant firm can take explicit actions to protect itself from the attacks of competitors" w/o violating §2.

B. IBM won all cases. Sample points from cases:

1. Telex (10th Cir. 1975) describes as "aggressive skillful businessman, seeking to market a product cheaper and better than that of their competitors"

2. California Computer Products (9th Cir. 1979)

a. No duty to help competitors by providing info re products.

b. No need to constrict product development to facilitate rival's sales

c. IBM can redesign as long as plausible technical rationale (e.g., lower cost or price or improve performance).

3. TransAmerica (9th Cir. 1983): making product worse to protect it from com-petition would be no good.

$ $ $ $ $ $ $CM350

4. Other Exclusionary/Predatory Conducta. Non-Predatory Pricing

(i) Monopoly Pricing: USFL (2d Cir 1988): monopoly pricing is not bad conduct(A) not anticompetitive; rather invites competition(B) can be evidence of market power

(ii) Limit Pricing: (A) Price above marginal cost but low enough to scare off most likely entrant(B) (C) Arises in IBM Cases and in American Prof. Testing Servs. (below)(C) Legal Treatment

(1) Suggestion in some lower ct. cases that can violate §2(2) Language in Brooke Group suggests otherwise(3) May be more plausible if one of several types of questionable conduct

(iii) Price Squeeze (Form of Limit Pricing)(A) Firm with monopoly power over a raw material also makes some finished prod-ucts using that raw material as input

(1) Monopolist sets price of raw material high; finshed products’ price low(2) Rivals re finished product have trouble meeting monopolist’s price

(B) Some cases find liability E.g., Bonjorno (3d Cir. 1984)(C) Today courts might allow if low price isn’t predatory.

(iv) Supplemental Reading: AK422-25; H300-02, 340-43; SH297, 318-19

b. Exclusive Dealing Contracts(i) contracts with suppliers or purchasers require they only do business with monopolist (A) conduct raises rivals’ costs by foreclosing some business opportunities

(B) if widespread, may be difficult for rivals to do business at all(ii) Alcoa pre-1912 (contracts with power companies)(iii) Lorain Journal (US 1951): Newspaper had essential monopoly of news & advertis-ing in Ohio City. Radio station opens nearby; paper refuses to run print ads for those ad-vertising w radio station. SCt finds attempt to monop. Co. has right to select own cus-tomers (like Colgate), but only as long as no intent to maintain or create monopoly(iv) PepsiCo. v. Coca-Cola Co. (S.D.N.Y. 1998): Pepsi stated a cause of action by alleg-ing that Coke, which already has 90% of market for soft drink sales to movie theaters and restaurants for use in fountain-dispensers, tried to enforce contracts with vendors requir-ing that they not do business with Pepsi as well.(v) Supplemental Reading:AK526-28; GR482-84; H293, 302-03, 322-23

c. “Predatory Hiring”

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(i) Monopolist hires away key employees or potential employees of rivals(A) Effect is to make it harder for rivals to do business (B) Claim is a subset of exclusive dealing

(ii) 2d & 9th Circuits: Difficult Tests to Meet for §2 Liability(A) MacNeal-Schwendler (9th Cir 1990) :

(1) Stealing employee just to frustrate competition might be actionable conduct. (2) Not violation where primary motivation was to get productive employee. (3) Test: Either

(a) must harm rival without helping monopolist –OR-(b) monopolist must not really use services

(B) Walsh Trucking (2d Cir. 1987)(1) simply hiring rival’s ees is insufficient(2) can be violation in conjunction w other wrongful acts(3) Natsource (SDNY 2004) follows Walsh; finds no AT violation from hiring where no evidence of harm to consumers through hi prices or lower quantity

(iii) Wichita Clinic v. Columbia/HCA Healthcare Co. (D.Kansas 1997): (A) Defendant Columbia runs the largest hospital in the Wichita area. (B) Plaintiff clinic alleges that after it refused D’s merger overtures, D hired away 20% of its doctors with the intent to monopolize the Wichita health care market. (C) The court found the allegations stated a cause of action.

(iv) Supplemental Reading: GR542-43; H321-22

d. Other Forms of Predation(i) Theory in Alcoa: Predatory Expansion (ii) Exclusion Cases Sometimes Seem to Require Predation for Liability

(A) Aspen/Trinko(B) Predatory Hiring

(iii) Photovest v. Fotomat (7th Cir. 1979)(A) Fotomat directly owned & franchised kiosk photofinishing services(B) Photovest Corp. set up to run Fotomat franchises; gets contract for 15. (C) Fotomat decided to eliminate own franchises b/c discovered kiosks it ran directly were more profitable than franchises(D) Among conduct held to violate §2: predatory placement of new kiosks:

(1) F flooded market with their own kiosks to reduce value of franchises so F could buy back. (2) F placed 14 kiosks in P’s city; more than 1/2 on overlapping sites(3) Evidence that new kiosks operating at below break-even point

(iv) Supplemental Reading: GR407-08, 541-42; H290-91; SH286e. False Advertising and Other Illegal or Immoral Conduct:

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(i) False advertising designed to discourage purchasers from using competitor’s products(A) 9th Cir.: Violation only if “significant and enduring impact on competition” (B) 2d Cir. Defense to claim if no harm OR customers wouldn’t believe ads(C) E.g., Nat’l Ass’n of Pharmaceutical Mfrs (2d Cir 1990): Sufficient allegation: Monopolist sent letter to pharmacists making false claims about worth of its product v. generic version

(ii) Caribbean Broadcasting System (D.C.Cir. 1998): Court held that P radio station stated cause of action under §2 where it alleged that D, a rival station:

(A) made false statements to advertisers about D’s broadcast range to discourage them from advertising with P(B) filed sham objections to P’s application for a broadcast license; and(C) conspired to have P’s telephone number listed incorrectly in the phone book.

(iii) Dooley v. Crab Boat Owners Assoc. (N.D. Cal. 2004)(A) §2 claim by small rival ag. Ass’n w 96% of boats used for crabbing in region(B) Conduct reqmt met by evidence that, to protect hi prices, D tried to exclude Ps by:

(1) using threats and violence ag. Ps(2) boycotting customers who purchased from Ps (3) tortious acts like cutting more than 2/3 of Ps crab pot lines

$ $ $ $ $ $ $REVIEW PROBLEM #5: BAR REVIEW COURSES

Instructions: Below you will find an old exam problem that is roughly based on the fascts of the Ninth Circuit decision in American Professional Testing Service, which fol-lows. Read through the problem and then prepare answers to the questions listed at the end. You may find it helpful to try to answer the questions before reading the Ninth Cir-cuit case, basing your initial answers on the rest of the material covered so far in Unit III. You then could add in any insights you glean from reading the case afterward. While an-swering the questions, keep in mind the following: To the extent the facts in the problem differ from those in the case, you should use the facts

of the problem.

The problem is set in the U.S. Supreme Court, so lower court cases are not binding but can be used as persuasive authority.

Trinko and some of the lower court cases we discussed were decided after the Ninth Circuit case and after the exam problem was given.

Problem: American states generally require that attorneys-to-be pass a state-adminis-tered bar exam after they complete law school. Most state bar exams incorporate some multiple choice questions that are simultaneously administered nationwide. However, every state reserves at least half of the exam for questions it creates and administers itself, often on peculiarities of its own statutory and common law. Thus, studying for the bar exam differs to some extent in each state.

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A number of private firms offer review courses that prepare students to take the various state bar exams. Generally, the courses include a review of the subjects tested by the state in question, exam-taking tips, and practice questions and answers. Almost every student who takes a bar exam purchases one of these courses. The firms sell the courses to law students in association with a variety of promotional activities at the law schools. Industry practice is to give substantial discounts to students purchasing courses early in their law school careers. Because each state bar is different, many of the firms that pro-vide review courses only operate in a single state. However, firms can achieve some economies of scale by preparing materials geared toward the national portion of the bar exam and using them in several states.

Between 1993 and the present, only two firms have operated bar courses in every state. BarGreed, established in the 1970’s, currently sells 63% of the bar review courses purchased in the U.S. Its closest rival, Eastbar, only in existence since 1993, sells 11% of the courses purchased nationwide. Both BarGreed and Eastbar hire famous professors from top 20 law schools to travel the country lecturing on the national portions of the bar. These professors also do videotaped supplemental lectures that are tailored to the state portions of the exams. BarGreed and Eastbar compete with a variety of local and re-gional firms that vary greatly in popularity from state to state.

As of Summer 1993, BarGreed sold 88% of the courses geared to the Florida bar. In that year, it was joined in the market both by Eastbar and by a local firm called Robyn, Rodriguez & Rosenblatt, which did business under the trade name “3R’S.” 3R’S, a sub-sidiary of the educational testing firm Learning Limited, tried to distinguish its course from BarGreed by using popular local law professors. Its marketing included the slogan, “Back to Basics with 3R’S: Let Florida’s Best Prep You For Florida’s Bar.” By Summer 1996, this campaign had succeeded sufficiently that 3R’S sold 17% of the bar review courses for the Florida Bar compared to 65% for BarGreed and 9% for Eastbar. In addi -tion, 3R’S had sold even greater percentages of the Florida courses for 1997 and 1998 purchased at a discount by first and second year students. In light of this success, 3R’S began exploring the possibility of applying its strategy in other states.

In the late Spring of 1996, worried by the decline in its share of the sales of Flor -ida bar review courses, BarGreed launched an intensive investigation of 3R’S and of the Florida market. As a result, it developed a marketing plan for Florida courses that it im-plemented during the 1996-97 school year. The plan, known internally as “Operation Kill-R’S,” had three components:

(1) Hiring: BarGreed hired five popular professors who had taught major sub-jects for 3R’S’ courses in prior years. None of the five was yet under contract with 3R’S for Summer 1997. BarGreed continued to use its regular teachers to teach the national portions of the bar courses and contracted with the new hires only to teach the Florida portions. Although their contracts contained no exclu-sivity provisions, the five Florida professors were effectively precluded from working for other bar review courses by the time needed to meet their contractual commitments to BarGreed.

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(2) Advertising: BarGreed’s investigations revealed that 3R’S’ parent company, Learning Limited, had fairly serious financial problems and had entered bank-ruptcy in the spring of 1996. However, the investigations also revealed that the bankruptcy would not affect 3R’S, which was in good shape financially and easily was able to meet its obligations to its employees and students. BarGreed passed out flyers on law school campuses that emphasized Learning Limited’s problems and suggested, without actually saying so, that 3R’S would be affected. For ex-ample, one flyer read:

Federal Judge Appoints Receiver To Run Parent of 3R’S:

CAN 3R’S AFFORD TO KEEP THE LIGHTS ON?

None of the advertising was untrue and BarGreed never violated state laws re-garding false advertising or defamation.

(3) Discounting: During the 1996-97 school year BarGreed lowered prices only on sales of its Florida courses. The sale price was above BarGreed’s own costs, but below the costs of 3R’S. BarGreed was aware of 3R’S’ cost structure be-cause of its investigations.

Operation Kill-R’S was highly successful for BarGreed. During the 1996-97 school year, it sold 80% of Florida bar review courses. Eastbar sold 10%, and 3R’S share declined to just 6%.

3R’S sued BarGreed in federal court, claiming that its implementation of Opera-tion Kill-R’S had monopolized the market for Florida bar review courses in violation of Sherman Act §2. After a trial at which 3R’S introduced evidence supporting the facts laid out above, the jury found for 3R’S. On appeal, the 11 th Circuit Court of Appeals re-versed. It characterized each of the components of Operation Kill-Rs as “robust competi-tion” and thus held that there was insufficient evidence of bad conduct to support a Sec-tion 2 claim. 3R’S petitioned for certiorari. The Supreme Court granted the petition.

Questions:

(1) Based on the problem and your own knowledge of the operation of bar review cour-ses, what barriers to entry arguably exist in the market for Florida bar review courses? What are the best arguments for each side as to whether these barriers are significant?

(2) Based on the authorities in Unit III, antitrust policy, and your own knowledge of the operation of bar review courses, and assuming for this question that BarGreed has mo-nopoly power in the relevant market, identify the best arguments for each side as to whether the following aspects of BarGreed’s conduct violate §2 of the Sherman Act, and be ready to state which position is stronger (and why).

(a) The hiring of the five Florida law professors.

(b) The misleading advertising about 3R’S’ financial condition.

(c) The discounts on sales of Florida courses.

(d) The three types of conduct taken together.

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AMERICAN PROFESSIONAL TESTING SERVICE v. HARCOURT BRACE JOVANOVICH LEGAL AND PROFESSIONAL

PUBLICATIONS108 F.3d 1147 (9th Cir. 1997)

O’SCANNLAIN, Circuit Judge: We must decide whether the sponsor of BAR/BRI, the nation’s dominant bar review course, violated the Sherman Act by distributing dis-paraging fliers about, and hiring a faculty member away from, the sponsor of Barpassers, one of its competitors.

I. … American Professional Testing Service, Inc. (“American”) provides full service bar review courses under the name Barpassers, offers supplemental bar review courses under the name APTS Multistate Maximizer, and publishes legal study aids under the name Sum & Substance. Harcourt Brace Jovanovich Legal and Professional Publications, Inc. (“Harcourt”) provides full service bar review courses under the name BAR/BRI, offers supplemental bar review courses under the name Gilbert Multistate Workshop, and pub-lishes legal study aids under the name Gilbert Legal Summaries.

Harcourt offers its BAR/BRI course in 46 states and enrolls far more students than its nearest competitor. Harcourt owns and operates BAR/BRI bar review courses in 26 jurisdictions and has license agreements with licensees in another 20 states.1

Barpassers was first offered in California in preparation for the Winter 1986 bar examina-tion. Barpassers has been offered continuously in California since that time, in Arizona since 1992, and in Nevada and Florida since 1993.

In September 1991, American became a wholly-owned subsidiary of College Bound, Inc. (“CBI”). Seven months later, a receiver was appointed for CBI in an action commenced by the U.S. Securities and Exchange Commission. CBI, under fire from fed-eral regulators for overstating revenue and earnings by millions of dollars, filed for bank-ruptcy protection and was subsequently placed under the control of a Chapter 11 Trustee. In July 1992, CBI disposed of its entire interest in American.

According to American, Harcourt seized on CBI’s troubles to “launch a campaign to forestall competition from American” through the distribution on law school campuses of anonymous advertising fliers that suggested that American was implicated in the SEC investigation and might not be able to continue to offer its bar review courses because of CBI’s bankruptcy. However, American and its officers were never the subject of the SEC investigation or even accused of fraud or securities violations. Nonetheless, Ameri-

1 In 1967, the Bar Review Institute, Inc. (“BRI”) bar review course was founded in Illinois by Richard Conviser and others. In the early 1970s, Bay Area Review, Inc. (“BAR”) offered a bar review course in California. In 1974, Harcourt Brace Jovanovich, Inc., acquired BAR and BRI. BAR and BRI merged into Harcourt and began doing business under the trade name “BAR/BRI.” By 1974, BAR and BRI were offering full service bar review courses in various jurisdictions. BRI was offering full service bar review courses in Illinois, Arizona, Colorado, Washington D.C., Georgia, New Jersey, Texas, Pennsylvania, Virginia, and Maryland (as a joint venture). BAR was offering full service bar review courses in California and other Western states. BAR and BRI, as part of a joint venture, began offering a bar review course in New York in 1973 under the name BAR/BRI.

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can allegedly suffered “a tremendous drop in enrollments and concomitant loss of prof-its.” American claims Harcourt offered its courses at below-cost prices, provided gratu-ities to law school administrators to obtain preferential treatment, and ripped down Amer-ican’s advertising materials. American also maintains that Harcourt’s alleged predatory hiring of American Professor Robert Jarvis, who also taught at BAR/BRI, “crippled American’s effort to compete in the Florida market.”

… American filed this action alleging that Harcourt engaged in actual and at-tempted monopolization under Section 2 of the Sherman Act; unlawful mergers and ac-quisitions in violation of Section 7 of the Clayton Act; price discrimination in violation of the Robinson-Patman Act; false advertising in violation of Section 43(a) of the Lan-ham Act; unfair competition; tortious interference with contractual relations; trade libel; and violations of California’s Unfair Practices Act. …

[T]he case was tried before a jury, which returned special verdicts for American on its claims under §2, the Lanham Act, tortious interference and unfair competition, but against American and for Harcourt on its claims that American had violated the Lanham Act and had engaged in tortious interference and unfair competition. Trial testimony lasted 11 days, during which the jury heard 29 witnesses and the court admitted over 140 exhibits into evidence. The jury was given a detailed 37-page special verdict form to guide its deliberations. After finding injury proximately caused by Harcourt’s exclusion-ary conduct, the jury awarded American damages (before trebling) of $784,753 for injury in California, $121,000 for injury in Florida, and $110,000 for injury in New York.

The district court subsequently granted Harcourt’s motion for judgment as a mat-ter of law (“JMOL”) on the Sherman Act claim, concluding that there was insufficient evidence that Harcourt either (i) engaged in exclusionary conduct in violation of the Sherman Act or (ii) possessed monopoly power or a dangerous probability of obtaining monopoly power in any market. The district court also denied a motion for a new trial. American and Harcourt each filed timely notices of appeal. After the jury verdicts, the parties settled all claims except for American’s §2 allegation ….

II. … [W]e must determine whether the district court erred in overturning the jury’s fac-tual findings that: (a) Harcourt’s disparagement of American constituted exclusionary conduct in California; (b) Harcourt’s predatory hiring of American’s faculty member constituted exclusionary conduct in Florida; and (c) Harcourt’s anti-competitive conduct in the relevant markets resulted in a dangerous probability of monopolization.

While the disparagement of a rival or compromising a rival’s employee may be unethical and even impair the opportunities of a rival, its harmful effects on competitors are ordinarily not significant enough to warrant recognition under §2 of the Sherman Act. See, e.g., Brown & Williamson (“Even an act of pure malice by one business competitor against another does not, without more, state a claim under the federal antitrust laws; those laws do not create a federal law of unfair competition or ‘purport to afford remedies for all torts committed by or against persons engaged in interstate commerce.’”); Spec-trum Sports (“The law directs itself not against conduct which is competitive, even se-verely so, but against conduct which unfairly tends to destroy competition itself.... Thus, this Court and other courts have been careful to avoid constructions of §2 which might chill competition, rather than foster it.”) … We therefore insist on a “preliminary show-

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ing of significant and more-than-temporary harmful effects on competition (and not merely upon a competitor or customer)” before these practices can rise to the level of ex-clusionary conduct. 3 P. AREEDA & D. TURNER, ANTITRUST LAW ¶737b at 278 (1978).

To succeed on its claim for actual monopolization under §2, American must prove Harcourt: (i) possessed monopoly power in the relevant markets; (ii) willfully acquired or maintained its monopoly power through exclusionary conduct; and (iii) caused an-titrust injury. American urges that it has made a preliminary showing of two grounds of exclusionary conduct and a dangerous probability of monopolization.2

A. American first argues that the district court erred in overturning the jury’s fac-tual determination that Harcourt’s implementation of a campaign designed to disparage American’s bar review courses … through the distribution of anonymous, false, and de-ceptive advertising fliers on law school campuses constituted exclusionary conduct. We disagree.

While false or misleading advertising directed solely at a single competitor may not be competition on the merits, the fliers in question must have a significant and endur-ing adverse impact on competition itself in the relevant markets to rise to the level of an antitrust violation.

False statements about rivals can obstruct competition on the merits and possess no off-setting redeeming virtues. But distinguishing false statements on which buyers do, or ought reasonably to, rely from customary puffing is not easy. … More importantly, the effects upon a rival would usually be very speculative, especially when disparage-ment is not systematic. Many buyers, moreover, recognize disparagement as non-objec-tive and highly biased. Although hardly a justification for falsehood, buyer distrust of a seller’s disparaging comments about a rival seller should caution us against attaching much weight to isolated examples of disparagement. …

To prove that Harcourt’s false and misleading advertising constituted exclusion-ary conduct, the disparagement must overcome a presumption that the effect on competi-tion of the fliers was de minimis. National Ass’n of Pharmaceutical Mfrs. v. Ayerst Labs., 850 F.2d 904, 916 (2d Cir.1988). “[A] plaintiff may overcome de minimis pre-sumption ‘by cumulative proof that the representations were [1] clearly false, [2] clearly material, [3] clearly likely to induce reasonable reliance, [4] made to buyers without knowledge of the subject matter, [5] continued for prolonged periods, and [6] not readily susceptible of neutralization or other offset by rivals.’” Id. American must satisfy all six elements to overcome [the] de minimis presumption. …

2 American alleged that Harcourt intended to monopolize the full service bar review market of those states in which it possesses monopoly power. BAR/BRI allegedly enjoyed a complete mo-nopoly or control, either by itself or through an affiliation, of over 70% of the full service bar re-view markets in Georgia, Minnesota, Alabama, Nevada, Hawaii, North Carolina, Colorado, Ken-tucky, Mississippi, Tennessee, South Carolina, Wyoming, Florida, New Jersey and Pennsylvania. In those states where it has substantial competition, Harcourt allegedly has pursued a policy of of -fering students substantial discounts from the price which they would pay for a full service bar re -view course if they contracted for the course at a time early in their education.

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Assuming American’s testimony and evidence at trial is correct, the entire dispar-agement claim hinges on [the following] fliers:

SEC Sues BARPASSERS’ Parent Company, Questions Its Enrollment, Financial Health

CAN BARPASSERS AFFORD TO KEEP THE LIGHTS ON?Federal Judge Appoints Receiver To Run Parent of APTS, Barpassers

BARPASSERS’, APTS’ parent files for BANKRUPTCYThese fliers were distributed on law school campuses during a two-month period.

American also relied on a survey … to demonstrate how the fliers suggested to law stu-dents that American was in “financial trouble, might be unable to operate its bar review courses, and had been accused of fraud by the SEC.” For example, 53 percent of the sur-vey respondents had some belief in or agreed with the statement that “because of its fi-nancial circumstances, I would expect the Barpassers course in the future to be less bene-ficial to me.” Furthermore, the district court found that the “fliers came at a bad time for [American]; they surfaced at California (also Arizona and Florida) law schools during the time third year law students had to make financial decisions and pay the tuition for bar re-view courses, and there is evidence that the usual increase in sign-ups for [American’s] course did not occur for that year, substantially injuring profitability for that year.”

However, American presented little evidence, other than the survey, that law stu-dents were “clearly likely” to rely on the fliers or that Harcourt’s false advertising was not readily susceptible to neutralization or other offset by American. The argument that its neutralization efforts were not completely successful is unavailing; the test refers to “susceptible to neutralization” not “successful in neutralization.” … [W]e conclude that the district court did not err in its judgment as to the disparagement of rival issue.

B. American next argues that the jury properly found Harcourt guilty of preda-tory conduct in Florida for hiring Professor Robert Jarvis, a well-known Florida law pro-fessor, away from American. Jarvis, who began working for American in March 1992, agreed to teach Florida constitutional law for Barpassers in August 1992. In 1991 and 1992, Jarvis also taught for BAR/BRI. After Jarvis accepted American’s offer to teach the Florida Barpassers course, Harcourt countered with an offer that precluded Jarvis’ continued work for American or any other bar review course. Jarvis accepted Harcourt’s offer which included increased compensation and greater lecturing and administrative du-ties.

American does not allege that Harcourt hired any other Barpassers instructor. Ab-sent a continued pattern of compromising American’s employees, this one-time hiring of Jarvis by Harcourt is not sufficient to constitute an antitrust violation: “Nor should the actual compromising of rival employees be grounds for §2 liability in the absence of a continued pattern of such behavior or of reason to believe that the actual effect was prob-ably significant.” ANTITRUST LAW, ¶737b at 281.

Most importantly, this court’s decision in Universal Analytics, Inc. v. MacNeal-Schwendler Corp., 914 F.2d 1256 (9th Cir.1990) is controlling on these facts. There, we reviewed whether there were any genuine issues of material fact with respect to Univer-sal’s claim that MacNeal’s hiring of five of Universal’s six key technical employees in

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1986 and 1987 was predatory in violation of §2. This was the first reported case of a claimed §2 violation as a result of alleged employee raiding or predatory hiring. Univer-sal Analytics held that an internal memo of the producer referring to “wounding” of a competitor by hiring key technical employees showed at most that a secondary motiva-tion of the hirings was to disadvantage competition and was insufficient to show preda-tory conduct in violation of the Sherman Act. “Unlawful predatory hiring occurs when talent is acquired not for purposes of using that talent but for purposes of denying it to a competitor. Such cases can be proved by showing the hiring was made with such preda-tory intent, i.e. to harm the competition without helping the monopolist, or by showing a clear nonuse in fact.” Id. at 1258. Absent either of those circumstances, the court agreed with Professors Areeda and Turner that the hiring should not be held exclusionary:

Acquiring talent not to use it but to deny it to possible rivals is exclusionary. Such an ar-rangement has the same harmful tendency and the same lack of redeeming virtue as the promise by a non-employee that he will not compete with the monopolist. But unlike the latter agreement whose existence or nonexistence is a rather clear-cut question, exclu-sionary employment would be hard to identify. A monopolist would probably use impor-tant talent once acquired. And the court should not try to judge whether the acquired tal -ent was used more effectively than readily available alternative personnel. Nor should it try to do so when the defendant pursues a hard-to-match, if not unmatchable, program of recruiting, say, young researchers in his field. In the absence, therefore, of the monopo-list’s proved subjective intent to hire talent preclusively or of clear nonuse in fact, em-ployment should not be held exclusionary.

Id. (quoting from ANTITRUST LAW, ¶702b at 110). Because American failed to meet the two-prong test set forth in Universal Analytics (harm American without helping Harcourt or Harcourt did not use Jarvis’ services), we conclude that the district court did not err in its judgment as to the predatory hiring issue.

C. American next argues that the district court erred in overturning the jury’s fac-tual finding that Harcourt’s anti-competitive conduct resulted in a dangerous probability of monopolization. To establish a §2 violation for an attempt to monopolize, American must show, inter alia, that there is a dangerous probability that Harcourt will achieve mo-nopoly power. See Spectrum Sports. … Mere proof of exclusionary conduct is not suffi-cient to prove Harcourt’s dangerous probability of success; other proof of market power is required. [Id.]

Even if Harcourt has a high market share, neither monopoly power nor a danger-ous probability of achieving monopoly power can exist absent evidence of barriers to new entry or expansion. … The only entry barrier upon which American relies on appeal is Harcourt’s reputation for offering high quality courses. Contrary to American’s argu-ment, reputation alone does not constitute a sufficient entry barrier in this Circuit. See Syufy Enterprises (“We fail to see how the existence of good will achieved through effec-tive service is an impediment to, rather than the natural result of, competition.”). More-over, the existence of 29 bar review courses in California suggests that any barriers to en-try may not be that significant. … [W]e conclude that there was insufficient evidence of a dangerous probability of monopoly power in the relevant markets. …

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C. Aside: The State Action Doctrine

1. Private Conduct Authorized by the StatesCALIFORNIA LIQUOR DEALERS v. MIDCAL ALUMINUM

445 U.S. 97 (1980)

JUSTICE POWELL delivered the opinion of the Court. In a state-court action, re-spondent Midcal Aluminum, Inc., a wine distributor, presented a successful antitrust challenge to California’s resale price maintenance and price posting statutes for the wholesale wine trade. The issue in this case is whether those state laws are shielded from the Sherman Act by … the “state action” doctrine of Parker v. Brown….I. Under … the California Business and Professions Code, all wine producers, whole-salers, and rectifiers must file fair trade contracts or price schedules with the State. If a wine producer has not set prices through a fair trade contract, wholesalers must post a re-sale price schedule for that producer’s brands. No state-licensed wine merchant may sell wine to a retailer at other than the price set “either in an effective price schedule or in an effective fair trade contract… .”

The State is divided into three trading areas for administration of the wine pricing program. A single fair trade contract or schedule for each brand sets the terms for all wholesale transactions in that brand within a given trading area. Similarly, state regula-tions provide that the wine prices posted by a single wholesaler within a trading area bind all wholesalers in that area. A licensee selling below the established prices faces fines, li-cense suspension, or outright license revocation. The State has no direct control over wine prices, and it does not review the reasonableness of the prices set by wine dealers.

Midcal Aluminum, Inc., is a wholesale distributor of wine in southern California. In July 1978, the Department of Alcoholic Beverage Control charged Midcal with selling 27 cases of wine for less than the prices set by the effective price schedule of the E. & J. Gallo Winery. The Department also alleged that Midcal sold wines for which no fair trade contract or schedule had been filed. Midcal stipulated that the allegations were true and that the State could fine it or suspend its license for those transgressions. Midcal then filed a writ of mandate in the California Court of Appeal … asking for an injunction against the State’s wine pricing system.

The Court of Appeal ruled that the wine pricing scheme restrains trade in viola-tion of the Sherman Act. The court relied entirely on the reasoning in Rice v. Alcoholic Beverage Control Appeals Bd., 579 P.2d 476 (Cal. 1978), where the California Supreme Court struck down parallel restrictions on the sale of distilled liquors. In that case, the court held that because the State played only a passive part in liquor pricing, there was no Parker v. Brown immunity for the program:

In the price maintenance program before us, the state plays no role whatever in setting the retail prices. The prices are established by the producers according to their own economic interests, without regard to any actual or potential anticompetitive effect; the state’s role is restricted to enforcing the prices specified by the producers. There is no control, or “pointed re-examination,” by the state to insure that the policies of the Sherman Act are not “unnecessarily subordinated” to state policy.” …

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In the instant case, the State Court of Appeal found the analysis in Rice squarely controlling. The court ordered the Department of Alcoholic Beverage Control not to en-force the resale price maintenance and price posting statutes for the wine trade. The De-partment … did not appeal the ruling in this case. An appeal was brought by the Califor -nia Retail Liquor Dealers Association, an intervenor.5 The California Supreme Court de-clined to hear the case, and the Dealers Association sought certiorari from this Court. We granted the writ and now affirm the decision of the state court.II. … This Court has ruled consistently that resale price maintenance illegally re-strains trade. In Dr. Miles, the Court observed that such arrangements are “designed to maintain prices…, and to prevent competition among those who trade in [competing goods].” See Albrecht; Parke, Davis. For many years, however, the Miller-Tydings Act of 1937 permitted the States to authorize resale price maintenance. The goal of that statute was to allow the States to protect small retail establishments that Congress thought might otherwise be driven from the marketplace by large-volume discounters. But in 1975 that congressional permission was rescinded. … Consequently, the Sherman Act’s ban on resale price maintenance now applies to fair trade contracts unless an industry or program enjoys a special antitrust immunity.

California’s system for wine pricing plainly constitutes resale price maintenance in violation of the Sherman Act. The wine producer holds the power to prevent price competition by dictating the prices charged by wholesalers. As Mr. Justice Hughes pointed out in Dr. Miles, such vertical control destroys horizontal competition as effec-tively as if wholesalers “formed a combination and endeavored to establish the same re-strictions … by agreement with each other.”7 …

Thus, we must consider whether the State’s involvement in the price-setting pro-gram is sufficient to establish antitrust immunity under Parker v. Brown. That immunity for state regulatory programs is grounded in our federal structure.

In a dual system of government in which, under the Constitution, the states are sovereign, save only as Congress may constitutionally subtract from their authority, an unexpressed purpose to nullify a state’s control over its officers and agents is not lightly to be attrib-uted to Congress.

In Parker v. Brown, this Court found in the Sherman Act no purpose to nullify state pow-ers. Because the Act is directed against “individual and not state action,” the Court con-cluded that state regulatory programs could not violate it.

Under the program challenged in Parker, the State Agricultural Prorate Advisory Commission authorized the organization of local cooperatives to develop marketing poli-cies for the raisin crop. The Court emphasized that the Advisory Commission, which was appointed by the Governor, had to approve cooperative policies following public hear-ings:

5 The California Retail Liquor Dealers Association, a trade association of independent retail liquor dealers in California, claims over 3,000 members.7 In Rice, the California Supreme Court found direct evidence that resale price maintenance re-sulted in horizontal price fixing. Although the Court of Appeal made no such specific finding in this case, the court noted that the wine pricing system “cannot be upheld for the same reasons the retail price maintenance provisions were declared invalid in Rice.”

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It is the state which has created the machinery for establishing the prorate program… . [I]t is the state, acting through the Commission, which adopts the program and enforces it… .

In view of this extensive official oversight, the Court wrote, the Sherman Act did not ap-ply. Without such oversight, the result could have been different. The Court expressly noted that “a state does not give immunity to those who violate the Sherman Act by au-thorizing them to violate it, or by declaring that their action is lawful… .”

Several recent decisions have applied Parker’s analysis. In Goldfarb v. Virginia State Bar, 421 U.S. 773 (1975), the Court concluded that fee schedules enforced by a state bar association were not mandated by ethical standards established by the State Supreme Court. The fee schedules therefore were not immune from antitrust attack. “It is not enough that … anticompetitive conduct is ‘prompted’ by state action; rather, anticom-petitive activities must be compelled by direction of the State acting as a sovereign.” Similarly, in Cantor v. Detroit Edison Co., 428 U.S. 579 (1976), a majority of the Court found that no antitrust immunity was conferred when a state agency passively accepted a public utility’s tariff. In contrast, Arizona rules against lawyer advertising were held im-mune from Sherman Act challenge because they “reflect[ed] a clear articulation of the State’s policy with regard to professional behavior” and were “subject to pointed re-ex-amination by the policymaker – the Arizona Supreme Court – in enforcement proceed-ings.” Bates v. State Bar of Arizona, 433 U.S. 350, 362 (1977).

Only last Term, this Court found antitrust immunity for a California program re-quiring state approval of the location of new automobile dealerships. New Motor Vehicle Bd. Of Cal. V. Orrin W. Fox Co., 439 U.S. 96 (1978). That program provided that the State would hold a hearing if an automobile franchisee protested the establishment or re-location of a competing dealership. In view of the State’s active role, the Court held, the program was not subject to the Sherman Act. The “clearly articulated and affirmatively expressed” goal of the state policy was to “displace unfettered business freedom in the matter of the establishment and relocation of automobile dealerships.”

These decisions establish two standards for antitrust immunity under Parker v. Brown. First, the challenged restraint must be “one clearly articulated and affirmatively expressed as state policy”; second, the policy must be “actively supervised” by the State itself. City of Lafayette v. Louisiana Power & Light Co., 435 U.S. 389, 410 (1978) (opin-ion of BRENNAN, J.). The California system for wine pricing satisfies the first standard. The legislative policy is forthrightly stated and clear in its purpose to permit resale price maintenance. The program, however, does not meet the second requirement for Parker immunity. The State simply authorizes price setting and enforces the prices established by private parties. The State neither establishes prices nor reviews the reasonableness of the price schedules; nor does it regulate the terms of fair trade contracts. The State does not monitor market conditions or engage in any “pointed reexamination” of the program.9

The national policy in favor of competition cannot be thwarted by casting such a gauzy cloak of state involvement over what is essentially a private price-fixing arrangement. As

9 The California program contrasts with the approach of those States that completely control the distribution of liquor within their boundaries. E.g., Va. Code 4-15, 4-28 (1979). Such comprehen-sive regulation would be immune from the Sherman Act under Parker v. Brown, since the State would “displace unfettered business freedom” with its own power. New Motor Vehicle Bd.

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Parker teaches, “a state does not give immunity to those who violate the Sherman Act by authorizing them to violate it, or by declaring that their action is lawful… .” …

The judgment of the California Court of Appeal … is Affirmed.

$ $ $ $ $ $ $T he Supervision Requirement After Midcal

A. Hoover v. Ronwin (U.S. 1984): Challenge to Arizona bar admission practices. Claim that purpose was just limiting entry into market, not checking competence. Bar examin-ers administered test at direction of State Supreme Court. IMMUNE. State Supreme Court completely controlled policy in question.

B. Southern Motor Carriers Rate Conference v. US (U.S. 1985): Several states autho-rized, but did not require, truckers to discuss and agree on rates in "rate bureaus". IM-MUNE. Although no compulsion, fact that the states set up rate bureaus showed intent to eliminate competition and states actively supervised.

C. 324 Liquor Corp v. Duffy (U.S. 1987): State mandated that retail liquor prices be 112% of wholesale prices, did no monitoring of wholesale prices. NOT IMMUNE. In-adequate supervision.

D. Patrick v. Burget (U.S. 1988): Oregon mandated peer review by physicians. State monitored hospital privileges generally and may have provided judicial review of peer re-view process in certain circumstances. Doctors use peer review process to exclude com-petitor from hospital. NOT IMMUNE. Inadequate supervision.

E. FTC v. Ticor Title Ins. (U.S. 1992): State statutes allowed title ins. cos. to jointly pro-pose rates to be reviewed by state agency; if no action w/in 30 days, became law. Lots of evidence that agency review was perfunctory at best. NOT IMMUNE. Inadequate super-vision. Mere potential supervision insufficient; needs to be substantial state participation in rate setting.

$ $ $ $ $ $ $2. Conduct by Municipalities

TOWN OF HALLIE v. CITY OF EAU CLAIRE471 U.S. 34 (1985)

JUSTICE POWELL delivered the opinion of the Court. This case presents the ques-tion whether a municipality’s anticompetitive activities are protected by the state action exemption to the federal antitrust laws established by Parker v. Brown when the activities are authorized, but not compelled, by the State, and the State does not actively supervise the anticompetitive conduct.

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I. Petitioners … (the Towns) - are four Wisconsin unincorporated townships located ad-jacent to respondent, the City of Eau Claire (the City). … The Towns filed suit against the City … alleging that the City violated the Sherman Act by acquiring a monopoly over the provision of sewage treatment services … and by tying the provision of such services to the provision of sewage collection and transportation services. Under the Federal Wa-ter Pollution Control Act, the City had obtained federal funds to help build a sewage treatment facility within the Eau Claire Service Area, that included the Towns; the facil-ity is the only one in the market available to the Towns. The City has refused to supply sewage treatment services to the Towns. It does supply the services to individual landowners in areas of the Towns if a majority of the individuals in the area vote by ref-erendum election to have their homes annexed by the City and to use the City’s sewage collection and transportation services.

Alleging that they are potential competitors of the City in the collection and trans-portation of sewage, the Towns contended in the District Court that the City used its mo-nopoly over sewage treatment to gain an unlawful monopoly over the provision of sewage collection and transportation services, in violation of the Sherman Act. They also contended that the City’s actions constituted an illegal tying arrangement and an unlawful refusal to deal with the Towns.

The District Court ruled for the City. It found that Wisconsin’s statutes regulating the municipal provision of sewage service expressed a clear state policy to replace com-petition with regulation. The court also found that the State adequately supervised the municipality’s conduct through the State’s Department of Natural Resources, that was au-thorized to review municipal decisions concerning provision of sewage services and cor-responding annexations of land. The court concluded that the City’s allegedly anticom-petitive conduct fell within the state action exemption to the federal antitrust laws, as set forth in Community Communications Co. v. Boulder, 455 U.S. 40 (1982), and Parker v. Brown. Accordingly, it dismissed the complaint.

The U.S. Court of Appeals for the Seventh Circuit affirmed. It ruled that the Wis-consin statutes authorized the City to provide sewage services and to refuse to provide such services to unincorporated areas. The court therefore assumed that the State had contemplated that anticompetitive effects might result, and concluded that the City’s con-duct was thus taken pursuant to state authorization within the meaning of Parker v. Brown. The court also concluded that in a case such as this involving “a local government performing a traditional municipal function,” active state supervision was unnecessary for Parker immunity to apply. Requiring such supervision as a prerequisite to immunity would also be unwise in this situation, the court believed, because it would erode tradi-tional concepts of local autonomy and home rule that were clearly expressed in the State’s statutes. We granted certiorari, and now affirm.

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II. The starting point in any analysis involving the state action doctrine is the reason-ing of Parker v. Brown. In Parker, relying on principles of federalism and state sovereignty, the Court refused to construe the Sherman Act as applying to the anticom-petitive conduct of a State acting through its legislature. Rather, it ruled that the Sherman Act was intended to prohibit private restraints on trade, and it refused to infer an intent to “nullify a state’s control over its officers and agents” in activities directed by the legisla-ture.

Municipalities, on the other hand, are not beyond the reach of the antitrust laws by virtue of their status because they are not themselves sovereign. Lafayette v. Louisiana Power & Light Co., 435 U.S. 389 (1978) (opinion of BRENNAN, J.). Rather, to obtain exemption, municipalities must demonstrate that their anticompetitive activities were au-thorized by the State “pursuant to state policy to displace competition with regulation or monopoly public service.” Id.

The determination that a municipality’s activities constitute state action is not a purely formalistic inquiry; the State may not validate a municipality’s anticompetitive conduct simply by declaring it to be lawful. Parker. On the other hand, in proving that a state policy to displace competition exists, the municipality need not “be able to point to a specific, detailed legislative authorization” in order to assert a successful Parker defense to an antitrust suit. Rather, Lafayette suggested, without deciding the issue, that it would be sufficient to obtain Parker immunity for a municipality to show that it acted pursuant to a “clearly articulated and affirmatively expressed ... state policy” that was “actively su-pervised” by the State. The plurality viewed this approach as desirable because it “pre-serv[ed] to the States their freedom ... to administer state regulatory policies free of the inhibitions of the federal antitrust laws without at the same time permitting purely parochial interests to disrupt the Nation’s free-market goals.” …

… [I]n Boulder, we … held that Colorado’s Home Rule Amendment to its Consti-tution, conferring on municipal governments general authority to govern local affairs, did not constitute a “clear articulation” of a state policy to authorize anticompetitive conduct with respect to the regulation of cable television in the locale. Because the city could not meet this requirement of the state action test, we declined to decide whether governmen-tal action by a municipality must also be actively supervised by the State.

It is therefore clear from our cases that before a municipality will be entitled to the protection of the state action exemption from the antitrust laws, it must demonstrate that it is engaging in the challenged activity pursuant to a clearly expressed state policy. We have never fully considered, however, how clearly a state policy must be articulated for a municipality to be able to establish that its anticompetitive activity constitutes state action. Moreover, we have expressly left open the question whether action by a munici-pality - like action by a private party - must satisfy the “active state supervision” require-ment. We consider both of those issues below.

III. The City cites several provisions of the Wisconsin code to support its claim that its allegedly anticompetitive activity constitutes state action. We therefore examine the statutory structure in some detail.

A. Wisconsin Stat. §62.18(1) grants authority to cities to construct, add to, alter, and repair sewage systems. The authority includes the power to “describe with reasonable

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particularity the district to be [served].” This grant of authority is supplemented by Wis. Stat. §66.069(2)(c), providing that a city operating a public utility

may by ordinance fix the limits of such service in unincorporated areas. Such ordinance shall delineate the area within which service will be provided and the municipal utility shall have no obligation to serve beyond the area so delineated.

With respect to joint sewage systems, Wis. Stat. §144.07(1) provides that the State’s De-partment of Natural Resources may require a city’s sewage system to be constructed so that other cities, towns, or areas may connect to the system, and the Department may or-der that such connections be made. Subsection (1m) provides, however, that an order by the Department of Natural Resources for the connection of unincorporated territory to a city system shall be void if that territory refuses to become annexed to the city.4

B. The Towns contend that these statutory provisions do not evidence a state policy to displace competition in the provision of sewage services because they make no express mention of anticompetitive conduct. As discussed above, the statutes clearly con-template that a city may engage in anticompetitive conduct. Such conduct is a foreseeable result of empowering the City to refuse to serve unannexed areas. It is not necessary, as the Towns contend, for the state legislature to have stated explicitly that it expected the City to engage in conduct that would have anticompetitive effects. Applying the analysis of Lafayette, it is sufficient that the statutes authorized the City to provide sewage ser-vices and also to determine the areas to be served. We think it is clear that anticompeti-tive effects logically would result from this broad authority to regulate. See New Motor Vehicle Board v. Orrin W. Fox Co., 439 U.S. 96, 109 (1978) (no express intent to dis-place the antitrust laws, but statute provided regulatory structure that inherently “dis-place[d] unfettered business freedom”). Accord, 1 P. AREEDA & D. TURNER, ANTITRUST LAW ¶212.3, p. 54 (Supp. 1982).

Nor do we agree with the Towns’ contention that the statutes at issue here are neutral on state policy. The Towns attempt to liken the Wisconsin statutes to the Home Rule Amendment involved in Boulder, arguing that the Wisconsin statutes are neutral because they leave the City free to pursue either anticompetitive conduct or free-market competi-tion in the field of sewage services. The analogy to the Home Rule Amendment involved in Boulder is inapposite. That Amendment … allocated only the most general authority to municipalities to govern local affairs. We held that it was neutral and did not satisfy the “clear articulation” component of the state action test. The Amendment simply did not address the regulation of cable television. Under home rule the municipality was to be free to decide every aspect of policy relating to cable television, as well as policy relating to any other field of regulation of local concern. Here, in contrast, the State has specifi-cally authorized Wisconsin cities to provide sewage services and has delegated to the cities the express authority to take action that foreseeably will result in anticompetitive effects. No reasonable argument can be made that these statutes are neutral in the same way that Colorado’s Home Rule Amendment was.

The Towns’ argument amounts to a contention that to pass the “clear articulation” test, a legislature must expressly state in a statute or its legislative history that the legisla-ture intends for the delegated action to have anticompetitive effects. This contention em-

4 There is no such order of the Department of Natural Resources at issue in this case.

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bodies an unrealistic view of how legislatures work and of how statutes are written. No legislature can be expected to catalog all of the anticipated effects of a statute of this kind.

Furthermore, requiring such explicit authorization by the State might have delete-rious and unnecessary consequences. Justice Stewart’s dissent in Lafayette was con-cerned that the plurality’s opinion would impose this kind of requirement on legislatures, with detrimental side effects upon municipalities’ local autonomy and authority to govern themselves. In fact, this Court has never required the degree of specificity that the Towns insist is necessary.7

In sum, we conclude that the Wisconsin statutes evidence a “clearly articulated and affirmatively expressed” state policy to displace competition with regulation in the area of municipal provision of sewage services. These statutory provisions plainly show that “the legislature contemplated the kind of action complained of.” Lafayette This is sufficient to satisfy the “clear articulation” requirement of the state action test.

C. The Towns further argue that the “clear articulation” requirement of the state action test requires at least that the City show that the State “compelled” it to act. In so doing, they rely on language in Cantor v. Detroit Edison Co., 428 U.S. 579 (1976), and Goldfarb v. Virginia State Bar, 421 U.S. 773 (1975). We disagree with this con-tention for several reasons. Cantor and Goldfarb concerned private parties - not munici-palities - claiming the state action exemption. This fact distinguishes those cases because a municipality is an arm of the State. We may presume, absent a showing to the contrary, that the municipality acts in the public interest.9 A private party, on the other hand, may be presumed to be acting primarily on his or its own behalf.

None of our cases involving the application of the state action exemption to a mu-nicipality has required that compulsion be shown. Both Boulder and Lafayette spoke in terms of the State’s direction or authorization of the anticompetitive practice at issue. This is so because where the actor is a municipality, acting pursuant to a clearly articu-lated state policy, compulsion is simply unnecessary as an evidentiary matter to prove that the challenged practice constitutes state action. In short, although compulsion affir-matively expressed may be the best evidence of state policy, it is by no means a prerequi-site to a finding that a municipality acted pursuant to clearly articulated state policy.

IV. Finally, the Towns argue that as there was no active state supervision, the City may not depend on the state action exemption. The Towns rely primarily on language in

7 Requiring such a close examination of a state legislature’s intent to determine whether the fed -eral antitrust laws apply would be undesirable also because it would embroil the federal courts in the unnecessary interpretation of state statutes. Besides burdening the courts, it would undercut the fundamental policy of Parker and the state action doctrine of immunizing state action from federal antitrust scrutiny. See 1 P. AREEDA & D. TURNER, ANTITRUST LAW ¶12.3(b) (Supp. 1982).9 Among other things, municipal conduct is invariably more likely to be exposed to public scru -tiny than is private conduct. Municipalities in some States are subject to “sunshine” laws or other mandatory disclosure regulations, and municipal officers, unlike corporate heads, are checked to some degree through the electoral process. Such a position in the public eye may provide some greater protection against antitrust abuses than exists for private parties.

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Lafayette. It is fair to say that our cases have not been entirely clear. The plurality opinion in Lafayette did suggest, without elaboration and without deciding the issue, that a city claiming the exemption must show that its anticompetitive conduct was actively super-vised by the State. In Midcal, a unanimous Court held that supervision is required where the anticompetitive conduct is by private parties. In Boulder, however, the most recent relevant case, we expressly left this issue open as to municipalities. We now conclude that the active state supervision requirement should not be imposed in cases in which the actor is a municipality.10

As with respect to the compulsion argument discussed above, the requirement of active state supervision serves essentially an evidentiary function: it is one way of ensur-ing that the actor is engaging in the challenged conduct pursuant to state policy. In Mid-cal, we stated that the active state supervision requirement was necessary to prevent a State from circumventing the Sherman Act’s proscriptions “by casting . . . a gauzy cloak of state involvement over what is essentially a private price-fixing arrangement.” Where a private party is engaging in the anticompetitive activity, there is a real danger that he is acting to further his own interests, rather than the governmental interests of the State. Where the actor is a municipality, there is little or no danger that it is involved in a pri -vate price-fixing arrangement. The only real danger is that it will seek to further purely parochial public interests at the expense of more overriding state goals. This danger is minimal, however, because of the requirement that the municipality act pursuant to a clearly articulated state policy. Once it is clear that state authorization exists, there is no need to require the State to supervise actively the municipality’s execution of what is a properly delegated function.

V. We conclude that the actions of the City of Eau Claire in this case are exempt from the Sherman Act. They were taken pursuant to a clearly articulated state policy to replace competition in the provision of sewage services with regulation. We further hold that active state supervision is not a prerequisite to exemption from the antitrust laws where the actor is a municipality rather than a private party. We accordingly affirm….

$ $ $ $ $ $ $CITY OF COLUMBIA v. OMNI OUTDOOR ADVERTISING

499 U.S. 365 (1991)

Justice Scalia delivered the opinion of the Court. This case requires us to clarify the application of the Sherman Act to municipal governments and to the citizens who seek action from them. I. Petitioner Columbia Outdoor Advertising, Inc. (COA) … entered the billboard busi-ness in the city of Columbia, South Carolina (also a petitioner here), in the 1940’s. By 1981 it controlled more than 95% of what has been conceded to be the relevant market. COA was a local business owned by a family with deep roots in the community, and en-joyed close relations with the city’s political leaders. The mayor and other members of

10 In cases in which the actor is a state agency, it is likely that active state supervision would also not be required, although we do not here decide that issue. Where state or municipal regulation by a private party is involved, however, active state supervision must be shown, even where a clearly articulated state policy exists. See Southern Motor Carriers Rate Conference., 471 U.S. at 62.

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the city council were personal friends of COA’s majority owner, and the company and its officers occasionally contributed funds and free billboard space to their campaigns. Ac-cording to respondent, these beneficences were part of a “longstanding” “secret anticom-petitive agreement” whereby “the City and COA would each use their [sic] respective power and resources to protect . . . COA’s monopoly position,” in return for which “City Council members received advantages made possible by COA’s monopoly.”

In 1981, respondent Omni Outdoor Advertising … began erecting billboards in and around the city. COA responded to this competition in several ways. First, it redou-bled its own billboard construction efforts and modernized its existing stock. Second — according to Omni — it took a number of anticompetitive private actions, such as offer-ing artificially low rates, spreading untrue and malicious rumors about Omni, and at-tempting to induce Omni’s customers to break their contracts. Finally (and this is what gives rise to the issue we address today), COA executives met with city officials to seek the enactment of zoning ordinances that would restrict billboard construction. COA was not alone in urging this course; a number of citizens concerned about the city’s recent ex-plosion of billboards advocated restrictions, including writers of articles and editorials in local newspapers.

In the spring of 1982, the city council passed an ordinance requiring the council’s approval for every billboard constructed in downtown Columbia. This was later amended to impose a 180-day moratorium on the construction of billboards throughout the city, ex-cept as specifically authorized by the council. A state court invalidated this ordinance on the ground that its conferral of unconstrained discretion upon the city council violated both the South Carolina and Federal Constitutions. The city then requested the State’s re-gional planning authority to conduct a comprehensive analysis of the local billboard situ-ation as a basis for developing a final, constitutionally valid, ordinance. In September 1982, after a series of public hearings and numerous meetings involving city officials, Omni, and COA (in all of which, according to Omni, positions contrary to COA’s were not genuinely considered), the city council passed a new ordinance restricting the size, lo-cation, and spacing of billboards. These restrictions, particularly those on spacing, obvi-ously benefited COA, which already had its billboards in place; they severely hindered Omni’s ability to compete.

In November 1982, Omni filed suit against COA and the city in Federal District Court, charging that they had violated §§1 and 2 of the Sherman Act … as well as South Carolina’s Unfair Trade Practices Act. Omni contended, in particular, that the city’s bill-board ordinances were the result of an anticompetitive conspiracy between city officials and COA that stripped both parties of any immunity they might otherwise enjoy from the federal antitrust laws. In January 1986, after more than two weeks of trial, a jury returned general verdicts against the city and COA on both the federal and state claims. It awarded damages, before trebling, of $600,000 on the §1 Sherman Act claim, and $400,000 on the §2 claim.2 The jury also answered two special interrogatories, finding specifically that

2 The monetary damages in this case were assessed entirely against COA, the District Court hav-ing ruled that the city was immunized by the Local Government Antitrust Act of 1984, 15 U.S.C. §§34-36, which exempts local governments from paying damages for violations of the federal an-titrust laws. Although enacted in 1984, after the events at issue in this case, the Act specifically provides that it may be applied retroactively if “the defendant establishes and the court deter-

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the city and COA had conspired both to restrain trade and to monopolize the market. Peti-tioners moved for judgment notwithstanding the verdict, contending among other things that their activities were outside the scope of the federal antitrust laws. In November 1988, the District Court granted the motion. A divided panel of the Court of Appeals … reversed the judgment of the District Court and reinstated the jury verdict on all counts. ..

II. In the landmark case of Parker v. Brown, … we held that the Sherman Act did not apply to anticompetitive restraints imposed by the States “as an act of government.” Since Parker emphasized the role of sovereign States in a federal system, it was initially unclear whether the governmental actions of political subdivisions enjoyed similar pro-tection. In recent years, we have held that Parker immunity does not apply directly to lo-cal governments, see Hallie; Boulder; Lafayette. We have recognized, however, that a municipality’s restriction of competition may sometimes be an authorized implementa-tion of state policy, and have accorded Parker immunity where that is the case.

The South Carolina statutes under which the city acted in the present case autho-rize municipalities to regulate the use of land and the construction of buildings and other structures within their boundaries.3 It is undisputed that, as a matter of state law, these statutes authorize the city to regulate the size, location, and spacing of billboards. It could be argued, however, that a municipality acts beyond its delegated authority, for Parker purposes, whenever the nature of its regulation is substantively or even procedurally de-fective. On such an analysis it could be contended, for example, that the city’s regulation in the present case was not “authorized” by S. C. Code §5-23-10 (1976), see n.3, supra, if it was not, as that statute requires, adopted “for the purpose of promoting health, safety, morals or the general welfare of the community.” As scholarly commentary has noted, such an expansive interpretation of the Parker-defense authorization requirement would have unacceptable consequences.

To be sure, state law “authorizes” only agency decisions that are substantively and proce-durally correct. Errors of fact, law, or judgment by the agency are not “authorized.” Erro-neous acts or decisions are subject to reversal by superior tribunals because unauthorized.

mines, in light of all the circumstances . . . that it would be inequitable not to apply this subsec-tion to a pending case.” 15 U.S.C. §35(b). The District Court determined that it would be, and the Court of Appeals refused to disturb that judgment. Respondent has not challenged that determina-tion in this Court, and we express no view on the matter. 3 S. C. Code §5-23-10 (1976) (“Building and zoning regulations authorized”) provides that “[f]or the purpose of promoting health, safety, morals or the general welfare of the community, the leg-islative body of cities and incorporated towns may by ordinance regulate and restrict the height, number of stories and size of buildings and other structures.” …S. C. Code §6-7-710 (1976) (“Grant of power for zoning”) provides that “[f]or the purposes of guiding development in accordance with existing and future needs and in order to protect, pro-mote and improve the public health, safety, morals, convenience, order, appearance, prosperity, and general welfare, the governing authorities of municipalities and counties may, in accordance with the conditions and procedures specified in this chapter, regulate the location, height, bulk, number of stories and size of buildings and other structures... . The regulations shall ... be de-signed to lessen congestion in the streets; to secure safety from fire, panic, and other dangers, to promote the public health and the general welfare, to provide adequate light and air; to prevent the overcrowding of land; to avoid undue concentration of population; to protect scenic areas; to facilitate the adequate provision of transportation, water, sewage, schools, parks, and other public requirements.”

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If the antitrust court demands unqualified “authority” in this sense, it inevitably becomes the standard reviewer not only of federal agency activity but also of state and local activ-ity whenever it is alleged that the governmental body, though possessing the power to en-gage in the challenged conduct, has actually exercised its power in a manner not autho-rized by state law. We should not lightly assume that Lafayette’s authorization require-ment dictates transformation of state administrative review into a federal antitrust job. Yet that would be the consequence of making antitrust liability depend on an undiscrimi-nating and mechanical demand for “authority” in the full administrative law sense.

P. AREEDA & H. HOVENKAMP, ANTITRUST LAW ¶212.3b, p. 145 (Supp. 1989). We agree with that assessment, and believe that in order to prevent Parker from

undermining the very interests of federalism it is designed to protect, it is necessary to adopt a concept of authority broader than what is applied to determine the legality of the municipality’s action under state law. … It suffices for the present to conclude that here no more is needed to establish, for Parker purposes, the city’s authority to regulate than its unquestioned zoning power over the size, location, and spacing of billboards.

Besides authority to regulate, however, the Parker defense also requires authority to suppress competition — more specifically, “clear articulation of a state policy to au-thorize anticompetitive conduct” by the municipality in connection with its regulation. Hallie. We have rejected the contention that this requirement can be met only if the dele-gating statute explicitly permits the displacement of competition. It is enough … if sup-pression of competition is the “foreseeable result” of what the statute authorizes, id. That condition is amply met here. The very purpose of zoning regulation is to displace unfet-tered business freedom in a manner that regularly has the effect of preventing normal acts of competition, particularly on the part of new entrants. A municipal ordinance restricting the size, location, and spacing of billboards (surely a common form of zoning) necessar-ily protects existing billboards against some competition from newcomers.4

4 The dissent contends that, in order successfully to delegate its Parker immunity to a municipal-ity, a State must expressly authorize the municipality to engage (1) in specifically “economic reg-ulation,” (2) of a specific industry. These dual specificities are without support in our precedents, for the good reason that they defy rational implementation. If, by authority to engage in specifically “economic” regulation, the dissent means authority specifically to regulate competition, we squarely rejected that in Hallie…. Seemingly, however, the dissent means only that the State authorization must specify that sort of regulation whereun-der “decisions about prices and output are not made by individual firms, but rather by a public body.” But why is not the restriction of billboards in a city a restriction on the “output” of the lo-cal billboard industry? It assuredly is — and that is indeed the very gravamen of Omni’s com-plaint. It seems to us that the dissent’s concession that “it is often difficult to differentiate eco -nomic regulation from municipal regulation of health, safety, and welfare,” is a gross understate-ment. Loose talk about a “regulated industry” may suffice for what the dissent calls “antitrust par -lance,” but it is not a definition upon which the criminal liability of public officials ought to de-pend. Under the dissent’s second requirement for a valid delegation of Parker immunity — that the au-thorization to regulate pertain to a specific industry — the problem with the South Carolina statute is that it used the generic term “structures,” instead of conferring its regulatory authority industry-by-industry (presumably “billboards,” “movie houses,” “mobile homes,” “TV antennas,” and every other conceivable object of zoning regulation that can be the subject of a relevant “mar-ket” for purposes of antitrust analysis). To describe this is to refute it. Our precedents not only fail

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The Court of Appeals was therefore correct in its conclusion that the city’s restric-tion of billboard construction was prima facie entitled to Parker immunity. The Court of Appeals upheld the jury verdict, however, by invoking a “conspiracy” exception to Parker that has been recognized by several Courts of Appeals. That exception is thought to be supported by two of our statements in Parker: “[W]e have no question of the state or its municipality becoming a participant in a private agreement or combination by oth-ers for restraint of trade, cf. Union Pacific R. Co. v. U.S., 313 U.S. 450.” Parker (empha-sis added). “The state in adopting and enforcing the prorate program made no contract or agreement and entered into no conspiracy in restraint of trade or to establish monopoly but, as sovereign, imposed the restraint as an act of government which the Sherman Act did not undertake to prohibit.” Id. (emphasis added). Parker does not apply, according to the Fourth Circuit, “where politicians or political entities are involved as conspirators” with private actors in the restraint of trade.

There is no such conspiracy exception. The rationale of Parker was that, in light of our national commitment to federalism, the general language of the Sherman Act should not be interpreted to prohibit anticompetitive actions by the States in their govern-mental capacities as sovereign regulators. The sentences from the opinion quoted above simply clarify that this immunity does not necessarily obtain where the State acts not in a regulatory capacity but as a commercial participant in a given market. That is evident from the citation of Union Pacific, which held unlawful … certain rebates and conces-sions made by Kansas City, Kansas, in its capacity as the owner and operator of a whole-sale produce market that was integrated with railroad facilities. These sentences should not be read to suggest the general proposition that even governmental regulatory action may be deemed private — and therefore subject to antitrust liability — when it is taken pursuant to a conspiracy with private parties. The impracticality of such a principle is evi-dent if, for purposes of the exception, “conspiracy” means nothing more than an agree-ment to impose the regulation in question. Since it is both inevitable and desirable that public officials often agree to do what one or another group of private citizens urges upon them, such an exception would virtually swallow up the Parker rule: All anticompetitive regulation would be vulnerable to a “conspiracy” charge. See AREEDA & HOVENKAMP, supra, ¶203.3b, at 34, and n.1; Elhauge, The Scope of Antitrust Process, 104 HARV. L. REV. 667, 704-705 (1991).5

to suggest but positively reject such an approach. “The municipality need not “be able to point to a specific, detailed legislative authorization” in order to assert a successful Parker defense to an antitrust suit.” Hallie, (quoting Lafayette).5 The dissent is confident that a jury composed of citizens of the vicinage will be able to tell the difference between “independent municipal action and action taken for the sole purpose of carry-ing out an anticompetitive agreement for the private party.” No doubt. But those are merely the polar extremes, which like the geographic poles will rarely be seen by jurors of the vicinage. Or-dinarily the allegation will merely be (and the dissent says this is enough) that the municipal ac-tion was not prompted “exclusively by a concern for the general public interest,” (emphasis added). Thus, the real question is whether a jury can tell the difference — whether Solomon can tell the difference — between municipal-action-not-entirely-independent-because-based-partly-on-agreement-with-private-parties that is lawful and municipal-action-not-entirely-independent-because-based-partly-on-agreement-with-private-parties that is unlawful. The dissent does not tell us how to put this question coherently, much less how to answer it intelligently. “Independent municipal action” is unobjectionable, “action taken for the sole purpose of carrying out an anti-

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Omni suggests, however, that “conspiracy” might be limited to instances of gov-ernmental “corruption,” defined variously as “abandonment of public responsibilities to private interests,” “corrupt or bad faith decisions,” and “selfish or corrupt motives.” Ulti-mately, Omni asks us not to define “corruption” at all, but simply to leave that task to the jury: “[a]t bottom, however, it was within the jury’s province to determine what consti-tuted corruption of the governmental process in their community.” Omni’s amicus es-chews this emphasis on “corruption,” instead urging us to define the conspiracy excep-tion as encompassing any governmental act “not in the public interest.” Brief for Associ-ated Builders and Contractors, Inc. as Amicus Curiae.

A conspiracy exception narrowed along such vague lines is similarly impractical. Few governmental actions are immune from the charge that they are “not in the public in-ter- est” or in some sense “corrupt.” The California marketing scheme at issue in Parker itself, for example, can readily be viewed as the result of a “conspiracy” to put the “pri-vate” interest of the State’s raisin growers above the “public” interest of the State’s con-sumers. The fact is that virtually all regulation benefits some segments of the society and harms others; and that it is not universally considered contrary to the public good if the net economic loss to the losers exceeds the net economic gain to the winners. Parker was not written in ignorance of the reality that determination of “the public interest” in the manifold areas of government regulation entails not merely economic and mathematical analysis but value judgment, and it was not meant to shift that judgment from elected of-ficials to judges and juries. If the city of Columbia’s decision to regulate what one local newspaper called “billboard jungles” is made subject to ex post-facto judicial assessment of “the public interest,” with personal liability of city officials a possible consequence, we will have gone far to “compromise the States’ ability to regulate their domestic com-merce,” Southern Motor Carriers Rate Conference. v. U.S., 471 U.S. 48, 56 (1985).

The situation would not be better, but arguably even worse, if the courts were to apply a subjective test: not whether the action was in the public interest, but whether the officials involved thought it to be so. This would require the sort of deconstruction of the governmental process and probing of the official “intent” that we have consistently

competitive agreement for the private party” is unlawful, and everything else (that is, the known world between the two poles) is unaddressed. The dissent contends, moreover, that “the instructions in this case, fairly read, told the jury that the plaintiff should not prevail unless the ordinance was enacted for the sole purpose of interfer-ing with access to the market.” (emphasis added). That is not so. The sum and substance of the jury’s instructions here was that anticompetitive municipal action is not lawful when taken as part of a conspiracy, and that a conspiracy is “an agreement between two or more persons to violate the law, or to accomplish an otherwise lawful result in an unlawful manner.” Although the Dis -trict Court explained that “[i]t is perfectly lawful for any and all persons to petition their govern-ment,” the court immediately added, “but they may not do so as a part or as the object of a con-spiracy.” These instructions, then, are entirely circular: an anticompetitive agreement becomes unlawful if it is part of a conspiracy, and a conspiracy is an agreement to do something unlawful. The District Court’s observation, upon which the dissent places so much weight, that “if by the evidence you find that [COA] procured and brought about the passage of ordinances solely for the purpose of hindering, delaying or otherwise interfering with the access of [Omni] to the mar-keting area involved in this case . . . and thereby conspired, then, of course, their conduct would not be excused under the antitrust laws” is in no way tantamount to an instruction that this was the only theory upon which the jury could find an immunity-destroying “conspiracy.”

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sought to avoid.6 “[W]here the action complained of ... was that of the State itself, the ac-tion is exempt from antitrust liability regardless of the State’s motives in taking the ac-tion.” Hoover v. Ronwin, 466 U.S. 558, 579-580 (1984).

The foregoing approach to establishing a “conspiracy” exception at least seeks (however impractically) to draw the line of impermissible action in a manner relevant to the purposes of the Sherman Act and of Parker: prohibiting the restriction of competition for private gain but permitting the restriction of competition in the public interest. An-other approach is possible, which has the virtue of practicality but the vice of being unre-lated to those purposes. That is the approach which would consider Parker inapplicable only if, in connection with the governmental action in question, bribery or some other vi -olation of state or federal law has been established. Such unlawful activity has no neces-sary relationship to whether the governmental action is in the public interest. A mayor is guilty of accepting a bribe even if he would and should have taken, in the public interest, the same action for which the bribe was paid. (That is frequently the defense asserted to a criminal bribery charge — and though it is never valid in law, it is often plausible in fact.) When, moreover, the regulatory body is not a single individual but a state legisla-ture or city council, there is even less reason to believe that violation of the law (by brib-ing a minority of the decisionmakers) establishes that the regulation has no valid public purpose. To use unlawful political influence as the test of legality of state regulation un-doubtedly vindicates (in a rather blunt way) principles of good government. But the statute we are construing is not directed to that end. … “Insofar as [the Sherman Act] sets up a code of ethics at all, it is a code that condemns trade restraints, not political activity.” Noerr.

For these reasons, we reaffirm our rejection of any interpretation of the Sherman Act that would allow plaintiffs to look behind the actions of state sovereigns to base their claims on “perceived conspiracies to restrain trade,” Hoover. We reiterate that, with the possible market participant exception, any action that qualifies as state action is “ipso facto ... exempt from the operation of the antitrust laws,” id.. This does not mean, of course, that the States may exempt private action from the scope of the Sherman Act; we in no way qualify the well established principle that “a state does not give immunity to those who violate the Sherman Act by authorizing them to violate it, or by declaring that their action is lawful.” Parker, 317 U. S., at 351. III While Parker recognized the States’ freedom to engage in anticompetitive regula-tion, it did not purport to immunize from antitrust liability the private parties who urge them to engage in anticompetitive regulation. However, it is obviously peculiar in a democracy, and perhaps in derogation of the constitutional right “to petition the Govern-ment for a redress of grievances,” U. S. Const., Amdt. 1, to establish a category of lawful state action that citizens are not permitted to urge. Thus, beginning with Noerr, we have developed a corollary to Parker: the federal antitrust laws also do not regulate the con-duct of private individuals in seeking anticompetitive action from the government. …

6 We have proceeded otherwise only in the “very limited and well-defined class of cases where the very nature of the constitutional question requires [this] inquiry.” U.S. v. O’Brien, 391 U.S. 367, 383, n.30 (1968) (bill of attainder). See also Arlington Heights v. Metropolitan Housing De-velopment Corp., 429 U.S. 252, 268, n.18 (1977) (race- based motivation).

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Noerr recognized, however, what has come to be known as the “sham” exception to its rule:

There may be situations in which a publicity campaign, ostensibly directed toward influ-encing governmental action, is a mere sham to cover what is actually nothing more than an attempt to interfere directly with the business relationships of a competitor and the ap-plication of the Sherman Act would be justified.

The Court of Appeals concluded that the jury in this case could have found that COA’s activities on behalf of the restrictive billboard ordinances fell within this exception. In our view that was error.

The “sham” exception to Noerr encompasses situations in which persons use the governmental process — as opposed to the outcome of that process — as an anticompeti-tive weapon. A classic example is the filing of frivolous objections to the license applica-tion of a competitor, with no expectation of achieving denial of the license but simply in order to impose expense and delay. See California Motor Transport. A “sham” situation involves a defendant whose activities are “not genuinely aimed at procuring favorable government action” at all, Allied Tube, not one “who genuinely seeks to achieve his gov-ernmental result, but does so through improper means,” id. at n.10.

Neither of the Court of Appeals’ theories for application of the “sham” exception to the facts of the present case is sound. The court reasoned, first, that the jury could have concluded that COA’s interaction with city officials “was ‘actually nothing more than an attempt to interfere directly with the business relations [sic] of a competitor.’”. This anal-ysis relies upon language from Noerr, but ignores the import of the critical word “di-rectly.” Although COA indisputably set out to disrupt Omni’s business relationships, it sought to do so not through the very process of lobbying, or of causing the city council to consider zoning measures, but rather through the ultimate product of that lobbying and consideration, viz., the zoning ordinances.

The Court of Appeals’ second theory was that the jury could have found “that COA’s purposes were to delay Omni’s entry into the market and even to deny it a mean-ingful access to the appropriate city administrative and legislative fora.” But the purpose of delaying a competitor’s entry into the market does not render lobbying activity a “sham,” unless (as no evidence suggested was true here) the delay is sought to be achieved only by the lobbying process itself, and not by the governmental action that the lobbying seeks. “If Noerr teaches anything it is that an intent to restrain trade as a result of government action sought ... does not foreclose protection.” Sullivan, Developments in the Noerr Doctrine, 56 ANTITRUST L. J. 361, 362 (1987). As for “deny[ing] ... meaning-ful access to the appropriate city administrative and legislative fora,” that may render the manner of lobbying improper or even unlawful, but does not necessarily render it a “sham.” We did hold in California Motor Transport that a conspiracy among private par-ties to monopolize trade by excluding a competitor from participation in the regulatory process did not enjoy Noerr protection. But California Motor Transport involved a con-text in which the conspirators’ participation in the governmental process was itself claimed to be a “sham,” employed as a means of imposing cost and delay. (“It is alleged that petitioners ‘instituted the proceedings and actions ... with or without probable cause, and regardless of the merits of the cases.’”) The holding of the case is limited to that situ-ation. To extend it to a context in which the regulatory process is being invoked gen-

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uinely, and not in a “sham” fashion, would produce precisely that conversion of antitrust law into regulation of the political process that we have sought to avoid. Any lobbyist or applicant, in addition to getting himself heard, seeks by procedural and other means to get his opponent ignored. Policing the legitimate boundaries of such defensive strategies, when they are conducted in the context of a genuine attempt to influence governmental action, is not the role of the Sherman Act. In the present case, of course, any denial to Omni of “meaningful access to the appropriate city administrative and legislative fora” was achieved by COA in the course of an attempt to influence governmental action that, far from being a “sham,” was if anything more in earnest than it should have been. If the denial was wrongful there may be other remedies, but as for the Sherman Act, the Noerr exemption applies.

Omni urges that if, as we have concluded, the “sham” exception is inapplicable, we should use this case to recognize another exception to Noerr immunity — a “conspir-acy” exception, which would apply when government officials conspire with a private party to employ government action as a means of stifling competition. We have left open the possibility of such an exception, see, e. g., Allied Tube, at n.7, as have a number of Courts of Appeals. …

Giving full consideration to this matter for the first time, we conclude that a “con-spiracy” exception to Noerr must be rejected. … [O]ur reasons … are largely the same as those set forth in Part II above for rejecting a “conspiracy” exception to Parker. …. The same factors which … make it impracticable or beyond the purpose of the antitrust laws to identify and invalidate lawmaking that has been infected by selfishly motivated agree-ment with private interests likewise make it impracticable or beyond that scope to iden-tify and invalidate lobbying that has produced selfishly motivated agreement with public officials. … IV Under Parker and Noerr, therefore, both the city and COA are entitled to immu-nity from the federal antitrust laws for their activities relating to enactment of the ordi-nances. … The judgment of the Court of Appeals is reversed, and the case is remanded for further proceedings consistent with this opinion. Justice Stevens, with whom Justice White and Justice Marshall join, dissenting. … [T]he Court today … decid[es] that agreements between municipalities, or their officials, and private parties to use the zoning power to confer exclusive privileges in a particular line of commerce are beyond the reach of §1. History, tradition, and the facts of this case all demonstrate that th[is] … is ill advised.

I. … [O]ne of the classic common-law examples of a prohibited contract in restraint of trade involved an agreement between a public official and a private party. The public of-ficial — the Queen of England — had granted one of her subjects a monopoly in the making, importation, and sale of playing cards in order to generate revenues for the crown. A competitor challenged the grant in The Case of Monopolies, 11 Co. Rep. 84, 77 Eng. Rep. 1260 (Q. B. 1602), and prevailed. Chief Justice Popham explained on behalf of the bench:

The Queen was . . . deceived in her grant; for the Queen . . . intended it to be for the weal public, and it will be employed for the private gain of the patentee, and for the prejudice of the weal public; moreover the Queen meant that the abuse should be taken away,

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which shall never be by this patent, but … the abuse will be increased for the private ben-efit of the patentee, and therefore ... this grant is void….

In the case before us today, respondent alleges that the city of Columbia, South Carolina, has entered into a comparable agreement to give respondent a monopoly in the sale of billboard advertising. After a three-week trial, a jury composed of citizens of the vicinage found that, despite the city fathers’ denials, there was indeed such an agreement, presumably motivated in part by past favors in the form of political advertising, in part by friendship, and in part by the expectation of a beneficial future relationship — and in any case, not exclusively by a concern for the general public interest. Today the Court ac-knowledges the anticompetitive consequences of this and similar agreements but decides that they should be exempted from the coverage of the Sherman Act because it fears that enunciating a rule that allows the motivations of public officials to be probed may mean that innocent municipal officials may be harassed with baseless charges. The holding evi-dences an unfortunate lack of confidence in our judicial system and will foster the evils the Sherman Act was designed to eradicate.

II. There is a distinction between economic regulation, on the one hand, and regulation designed to protect the public health, safety, and environment. … Economic regulation of the motor carrier and airline industries was imposed by the Federal Government in the 1930s; the “deregulation” of those industries did not eliminate all the other types of regu-lation that continue to protect our safety and environmental concerns.

The antitrust laws reflect a basic national policy favoring free markets over regu-lated markets. In essence, the Sherman Act prohibits private unsupervised regulation of the prices and output of goods in the marketplace. That prohibition is inapplicable to spe-cific industries which Congress has exempted from the antitrust laws and subjected to regulatory supervision over price and output decisions. Moreover, the so-called “state ac-tion” exemption from the Sherman Act reflects the Court’s understanding that Congress did not intend the statute to preempt a State’s economic regulation of commerce within its own borders.

The contours of the state action exemption are relatively well-defined in our cases. Ever since our decision in Olsen v. Smith, 195 U.S. 332 (1904), which upheld a Texas statute fixing the rates charged by pilots operating in the Port of Galveston, it has been clear that a State’s decision to displace competition with economic regulation is not prohibited by the Sherman Act. Parker v. Brown, the case most frequently identified with the state action exemption, involved a decision by California to substitute sales quotas and price control — the purest form of economic regulation — for competition in the market for California raisins.

In Olsen, the State itself had made the relevant pricing decision. In Parker, the regulation of the marketing of California’s 1940 crop of raisins was administered by state officials. Thus, when a state agency, or the State itself, engages in economic regulation, the Sherman Act is inapplicable. Hoover v. Ronwin; Bates v. State Bar of Arizona, 433 U.S. 350, 360 (1977).

Underlying the Court’s recognition of this state action exemption has been respect for … federalism. As we stated in Parker, “In a dual system of government in which, un-der the Constitution, the states are sovereign, save only as Congress may constitutionally

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subtract from their authority, an unexpressed purpose to nullify a state’s control over its officers and agents is not lightly to be attributed to Congress.”

However, this Court recognized long ago that the deference due States within our federal system does not extend fully to conduct undertaken by municipalities. … Unlike States, municipalities do not constitute bedrocks within our system of federalism. And also unlike States, municipalities are more apt to promote their narrow parochial interests “without regard to extraterritorial impact and regional efficiency.” Lafayette; see also The Federalist No. 10 (J. Madison) (describing the greater tendency of smaller societies to promote oppressive and narrow interests above the common good). … Indeed, “[i]n light of the serious economic dislocation which could result if cities were free to place their own parochial interests above the Nation’s economic goals reflected in the antitrust laws, ... we are especially unwilling to presume that Congress intended to exclude anti-competitive municipal action from their reach.” Lafayette.

Nevertheless, insofar as municipalities may serve to implement state policies, we have held that economic regulation administered by a municipality may also be exempt from Sherman Act coverage if it is enacted pursuant to a clearly articulated and affirma-tively expressed state directive “to replace competition with regulation.” Hoover. How-ever, the mere fact that a municipality acts within its delegated authority is not sufficient to exclude its anti-competitive behavior from the reach of the Sherman Act. …

Accordingly, we have held that the critical decision to substitute economic regula-tion for competition is one that must be made by the State. That decision must be articu-lated with sufficient clarity to identify the industry in which the State intends that eco-nomic regulation shall replace competition. The terse statement of the reason why the municipality’s actions in Hallie, was exempt from the Sherman Act illustrates the point: “They were taken pursuant to a clearly articulated state policy to replace competition in the provision of sewage services with regulation.” 5 5 Contrary to the Court’s reading of Hallie, our opinion in that case emphasized the industry-spe-cific character of the Wisconsin legislation in explaining why the delegation satisfied the ‘clear articulation’ requirement. At issue in Hallie was the town’s independent decision to refuse to pro-vide sewage treatment services to nearby towns — a decision that had been expressly authorized by the Wisconsin legislation. We wrote:

Applying the analysis of Lafayette…, it is sufficient that the statutes authorized the City to pro- vide sewage services and also to determine the areas to be served. … The Towns’ attempt to liken the Wisconsin statutes to the Home Rule Amendment involved in Boulder, arguing that the Wisconsin statutes are neutral because they leave the City free to pursue either anticompetitive conduct or free-market competition in the field of sewage services. The analogy to the Home Rule Amendment involved in Boulder is inapposite. … Under home rule the municipality was to be free to decide every aspect of policy relating to cable television, as well as policy relating to any other field of regulation of local concern. Here, in contrast, the State has specifically authorized Wisconsin cities to provide sewage services and has delegated to the cities the express authority to take action that foreseeably will result in anticompetitive effects. No rea-sonable argument can be made that these statutes are neutral in the same way that Colorado’s Home Rule Amendment was.

We rejected the argument that the delegation was insufficient because it did not expressly men-tion the foreseeable anticompetitive consequences of the city of Eau Claire’s conduct, but we surely did not hold that the mere fact that incidental anticompetitive consequences are foreseeable is sufficient to immunize otherwise unauthorized restrictive agreements between cities and pri-

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III. Today the Court adopts a significant enlargement of the state action exemption. The South Carolina statutes that confer zoning authority on municipalities in the State do not articulate any state policy to displace competition with economic regulation in any line of commerce or in any specific industry. As the Court notes, the state statutes were ex-pressly adopted to promote the “health, safety, morals or the general welfare of the com-munity.” Like Colorado’s grant of “home rule” powers to the city of Boulder, they are simply neutral on the question whether the municipality should displace competition with economic regulation in any industry. There is not even an arguable basis for concluding that the State authorized the city of Columbia to enter into exclusive agreements with any person, or to use the zoning power to protect favored citizens from competition. Never-theless, under the guise of acting pursuant to a state legislative grant to regulate health, safety, and welfare, the city of Columbia in this case enacted an ordinance that amounted to economic regulation of the billboard market; as the Court recognizes, the ordinance “obviously benefited COA, which already had its billboards in place . . . [and] severely hindered Omni’s ability to compete.”

Concededly, it is often difficult to differentiate economic regulation from munici-pal regulation of health, safety, and welfare. “Social and safety regulation have economic impacts, and economic regulation has social and safety effects.” D.HJELMFELT, ANTITRUST AND REGULATED INDUSTRIES 3 (1985). It is nevertheless important to deter-mine when purported general welfare regulation in fact constitutes economic regulation by its purpose and effect of displacing competition. “An example of economic regulation which is disguised by another stated purpose is the limitation of advertising by lawyers for the stated purpose of protecting the public from incompetent lawyers. Also, economic regulation posing as safety regulation is often encountered in the health care industry.” Id.

In this case, the jury found that the city’s ordinance — ostensibly one promoting health, safety, and welfare — was in fact enacted pursuant to an agreement between city officials and a private party to restrict competition. In my opinion such a finding neces-sarily leads to the conclusion that the city’s ordinance was fundamentally a form of eco-nomic regulation of the billboard market rather than a general welfare regulation having incidental anticompetitive effects. Because I believe our cases have wisely held that the decision to embark upon economic regulation is a nondelegable one that must expressly be made by the State in the context of a specific industry in order to qualify for state ac-tion immunity, I would hold that the city of Columbia’s economic regulation of the bill-board market pursuant to a general state grant of zoning power is not exempt from anti- trust scrutiny.7

Underlying the Court’s reluctance to find the city of Columbia’s enactment of the billboard ordinance pursuant to a private agreement to constitute unauthorized economic regulation is the Court’s fear that subjecting the motivations and effects of municipal ac-tion to antitrust scrutiny will result in public decisionmaking being “made subject to ex

vate parties.7 A number of Courts of Appeals have held that a municipality which exercises its zoning power to further a private agreement to restrain trade is not entitled to state action immunity. …

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post-facto judicial assessment of ‘the public interest.’” That fear, in turn, rests on the as-sumption that “it is both inevitable and desirable that public officials often agree to do what one or another group of private citizens urges upon them.”

The Court’s assumption that an agreement between private parties and public offi-cials is an “inevitable” precondition for official action, however, is simply wrong. In-deed, I am persuaded that such agreements are the exception rather than the rule, and that they are, and should be, disfavored. The mere fact that an official body adopts a position that is advocated by a private lobbyist is plainly not sufficient to establish an agreement to do so. Nevertheless, in many circumstances, it would seem reasonable to infer — as the jury did in this case — that the official action is the product of an agreement intended to elevate particular private interests over the general good.

In this case, the city took two separate actions that protected the local monopolist from threatened competition. It first declared a moratorium on any new billboard con-struction, despite the city attorney’s advice that the city had no power to do so. When the moratorium was invalidated in state court litigation, it was replaced with an apparently valid ordinance that clearly had the effect of creating formidable barriers to entry in the billboard market. Throughout the city’s decisionmaking process in enacting the various ordinances, undisputed evidence demonstrated that Columbia Outdoor Advertising had met with city officials privately as well as publicly. As the Court of Appeals noted: “Im-plicit in the jury verdict was a finding that the city was not acting pursuant to the direc-tion or purposes of the South Carolina statutes but conspired solely to further COA’s commercial purposes to the detriment of competition in the billboard industry.”

Judges who are closer to the trial process than we are do not share the Court’s fear that juries are not capable of recognizing the difference between independent municipal action and action taken for the sole purpose of carrying out an anticompetitive agreement for the private party.9 … Indeed, the problems inherent in determining whether the ac-tions of municipal officials are the product of an illegal agreement are substantially the same as those arising in cases in which the actions of business executives are subjected to antitrust scrutiny.

The difficulty of proving whether an agreement motivated a course of conduct should not in itself intimidate this Court into exempting those illegal agreements that are proven by convincing evidence. Rather, the Court should, if it must, attempt to deal with these problems of proof as it has in the past — through heightened evidentiary standards rather than through judicial expansion of exemptions from the Sherman Act. See, e. g., Matsushita (allowing summary judgment where evidence of a predatory pricing conspir-

9 The instructions in this case, fairly read, told the jury that the plaintiff should not prevail unless the ordinance was enacted for the sole purpose of interfering with access to the market. Thus, this case is an example of one of the “polar extremes,” see ante at n.5, that juries — as well as Solomon — can readily identify. The mixed motive cases that concern the Court should present no problem if juries are given instructions comparable to those given below. When the Court de-scribes my position as assuming that municipal action that was not prompted “exclusively by a concern for the general public interest” is enough to create antitrust liability, it simply ignores the requirement that the plaintiff must prove that the municipal action is the product of an anticom -petitive agreement with private parties. …

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acy in violation of the Sherman Act was founded largely upon circumstantial evidence); Monsanto (holding that a plaintiff in a vertical price-fixing case must produce evidence which “tends to exclude the possibility of independent action”).

Unfortunately, the Court’s decision today converts what should be nothing more than an anticompetitive agreement undertaken by a municipality that enjoys no special status in our federalist system into a lawful exercise of public decision- making. Although the Court correctly applies principles of federalism in refusing to find a “conspiracy ex-ception” to the Parker state action doctrine when a State acts in a nonproprietary capac-ity, it errs in extending the state action exemption to municipalities that enter into private anticompetitive agreements under the guise of acting pursuant to a general state grant of authority to regulate health, safety, and welfare. Unlike the previous limitations this Court has imposed on Congress’ sweeping mandate in §1, which found support in our common-law traditions or our system of federalism, the Court’s wholesale exemption of municipal action from antitrust scrutiny amounts to little more than a bold and disturbing act of judicial legislation which dramatically curtails the statutory prohibition against “every” contract in restraint of trade.

IV. Just as I am convinced that municipal “lawmaking that has been infected by selfishly motivated agreement with private interests,” is not authorized by a grant of zoning au-thority, and therefore not within the state action exemption, so am I persuaded that a pri-vate party’s agreement with selfishly motivated public officials is sufficient to remove the antitrust immunity that protects private lobbying under Noerr and Pennington. Although I agree that the “sham” exception to the Noerr-Pennington rule exempting lobbying activi-ties from the antitrust laws does not apply to the private petitioner’s conduct in this case for the reasons stated by the Court in Part III of its opinion, I am satisfied that the evi-dence in the record is sufficient to support the jury’s finding that a conspiracy existed be-tween the private party and the municipal officials in this case so as to remove the private petitioner’s conduct from the scope of Noerr-Pennington antitrust immunity. Accord-ingly, I would affirm the judgment of the Court of Appeals as to both the city of Colum-bia and Columbia Outdoor Advertising. I respectfully dissent.

$ $ $ $ $ $ $D. Tying1. Generally

INTRODUCTION TO TYINGI. OVERVIEW

A. DEFINITIONS1. Producer sells product only to those who agree to buy 2d product. (E.g. can only buy can-closing machines if also buy cans from same mfr.2. Desired product (can-closing machine) is "tying" product3. Forced products (cans) are "tied" product

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B. RELEVANT STATUTES1. Clayton Act §3:

a. Limited to goods (not services)b. Conduct only violates act if “the effect … may be to substantially lessen competition or tend to create a monopoly in any line of commerce.”

2. Sherman Act §1: a. Only thing available for ties between services or goods/servicesb. SCt has read ShAct§1 to have same standards as ClAct§3c. issue whether coerced tying agreement = §1 concerted action

i) Circuits say yes ii) E.g., Systemcare (10th 1997)

C. BUSINESS JUSTIFICATIONS FOR TYING 1. attain monopoly/increase market share in tied product2. more favorable joint pricing of products3. price discrimination (charge more to those who use more)

a. counting device (hard to do without tie)b. Note debate re whether price discrimination is badc. If in context where horizontal producer cartel seems possible, industry wide-use could indicate horizontal agreement

4. Achieve efficienciesa. packaging in bundlesb. force dealers to put full line before public

5. quality control: tying service/parts/complementary prodsa. insures successful operation of productb. creates consumer goodwill

II. ECONOMIC ANALYSIS OF TYINGA. Traditional Arguments Against

1. Attempt to spread monopoly from 1 market to anothera. harms competition in market for tied productb. competitors lose opportunities for customersc. “leverage”

2. limits buyers’ freedom of choiceB. Chicago Critique

1. fixed sum: can get only so much leverage out of monopolya. doesn't matter where you take it.b. no possible harm if 2 products used in fixed proportions

2. most ties benign/pro-competitive3. if there is monopoly, should attack it directly

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C. Responses to Chicago1. fixed sum is static analysis; over time may lead to loss in comp:

a. discourage innovationb discourage entry (have to come in at 2 levels)

2. Concerns with counting justification a. can use less restrictive alternatives (metering) b. must have market power to do price discrimination.

3. Concerns with “just attack the monopoly directly”a. breaking up monopoly complex and expensive b. maybe better to permit monopoly; control behavior

4. Alternative Managerial motivationsa. people believe they can “leverage” even if they can'tb. sales & growth maximization (cf. mergers)

III. EARLY TYING CASES: A. International Salt (1947): patented salting machines tied to sale of salt

1. Gov’t suit under ShAct1 & ClAct3a. DCt: Summary Judgment for Govt.b. D claim: need trial on either:

i) “unreasonable” (ShAct1) ORii) “tends to create monopoly/lessen competition” (ClAct3)

2. SCt says NO. a. Unreasonable per se to foreclose competitors from a substantial market b. tendency to monopoly "obvious"c. immaterial that tendency "is a creeping one rather than one that proceeds at full gallop; nor does the law await the arrival of the goal before condemning the direction of the movement."

3. Court rejects proposed defensesa. D will meet price, so consumers not harmed?

i) competitors have to beat IS salt prices to sell = restraint of tradeb. quality control defense: keeps impurities out

i) Can require specs instead: ii) “It is not pleaded, nor is it argued, that the machine is allergic to salt of equal quality produced by anyone except International."

B. Northern Pacific Ry. (1958)1. RR owned lots of land. In lease/sale provisions:

a. require grantee/lessee to ship over its lines all commodities produced or manufactured on landsb. guaranteed rates as low as competing carriers.

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2. SCt: tying arrangements per se illegala. pernicious effect on comp; lack of any redeeming valueb. Denies competitors free access to customers c. Buyers forced to forego free choice among competing products.

3. Two Requirements for Per Sea. sufficient economic power in tying product to appreciably restrain free competition for tied product; no monopoly/market dominance necessaryb. not insubstantial amount of interstate commerce affected.

4. Northern Pacific contains famous stmt of per se illegality: a. price fixing, boycotts, tying are per se b. because little redeeming value, avoid costly Rule of Reason inquiry

C. Leaves 3 issues as basic structure of tying law1. 2 products: (i.e., not left and right shoes)2. Economic power in tying product3. Substantial commerce in tied product affected

a. Fortner (1969) makes this insignificantb. look at $ value, not % of market c. $190,000 = substantial, so effectively no bottom limit

$ $ $ $ $ $ $JEFFERSON PARISH HOSPITAL DISTRICT NO. 2 v. HYDE

466 U.S. 2 (1984)

Justice STEVENS delivered the opinion of the Court: At issue in this case is the va-lidity of an exclusive contract between a hospital and a firm of anesthesiologists. We must decide whether the contract gives rise to a per se violation of §1 of the Sherman Act because every patient undergoing surgery at the hospital must use the services of one firm of anesthesiologists, and, if not, whether the contract is nevertheless illegal because it un-reasonably restrains competition among anesthesiologists.

… [R]espondent Edwin G. Hyde, a board certified anesthesiologist, applied for admission to the medical staff of East Jefferson Hospital. The … hospital board denied the application because the hospital was a party to a contract providing that all anesthesi-ological services required by the hospital’s patients would be performed by Roux & As-sociates…. Respondent then commenced this action seeking a declaratory judgment that the contract is unlawful and an injunction ordering petitioners to appoint him to the hos-pital staff. After trial, the District Court denied relief, finding that the anticompetitive consequences of the Roux contract were minimal and outweighed by benefits in the form of improved patient care. The Court of Appeals reversed because it was persuaded that the contract was illegal “per se.” We granted certiorari, and now reverse.

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I. In February 1971, shortly before East Jefferson Hospital opened, it entered into an “Anesthesiology Agreement” with Roux & Associates (“Roux”)…. The hospital agreed to “restrict the use of its anesthesia department to Roux & Associates and [that] no other persons, parties or entities shall perform such services within the Hospital for the term of this contract.”

The 1971 contract provided for a one-year term automatically renewable for suc-cessive one-year periods unless either party elected to terminate. In 1976, a second writ-ten contract was executed containing most of the provisions of the 1971 agreement. Its term was five years and the clause excluding other anesthesiologists from the hospital was deleted; the hospital nevertheless continued to regard itself as committed to a closed anesthesiology department. Only Roux was permitted to practice anesthesiology at the hospital. At the time of trial the department included four anesthesiologists. The hospital usually employed 13 or 14 certified registered nurse anesthetists.

The exclusive contract had an impact on two different segments of the economy: consumers of medical services, and providers of anesthesiological services. Any con-sumer of medical services who elects to have an operation performed at East Jefferson Hospital may not employ any anesthesiologist not associated with Roux. No anesthesiol-ogists except those employed by Roux may practice at East Jefferson.

There are at least 20 hospitals in the New Orleans metropolitan area and about 70 per cent of the patients living in Jefferson Parish go to hospitals other than East Jefferson. Because it regarded the entire New Orleans metropolitan area as the relevant geographic market in which hospitals compete, this evidence convinced the District Court that East Jefferson does not possess any significant “market power”; therefore it concluded that petitioners could not use the Roux contract to anticompetitive ends. The same evidence led the Court of Appeals to draw a different conclusion. Noting that 30 percent of the res-idents of the Parish go to East Jefferson Hospital, and that in fact “patients tend to choose hospitals by location rather than price or quality,” the Court of Appeals concluded that the relevant geographic market was the East Bank of Jefferson Parish. The conclusion that East Jefferson Hospital possessed market power in that area was buttressed by the facts that the prevalence of health insurance eliminates a patient’s incentive to compare costs, that the patient is not sufficiently informed to compare quality, and that family con-venience tends to magnify the importance of location.

The Court of Appeals held that the case involves a “tying arrangement” because the “users of the hospital’s operating rooms (the tying product) are also compelled to pur-chase the hospital’s chosen anesthesia service (the tied product).” Having defined the rel-evant geographic market for the tying product as the East Bank of Jefferson Parish, the court held that the hospital possessed “sufficient market power in the tying market to co-erce purchasers of the tied product.” Since the purchase of the tied product constituted a “not insubstantial amount of interstate commerce,” under the Court of Appeals’ reading of our decision in Northern Pac. R. Co. v. U.S., 356 U.S. 1, 11 (1957), the tying arrange-ment was therefore illegal “per se.”

II. Certain types of contractual arrangements are deemed unreasonable as a matter of law. The character of the restraint produced by such an arrangement is considered a suffi-cient basis for presuming unreasonableness without the necessity of any analysis of the

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market context in which the arrangement may be found. A price fixing agreement be-tween competitors is the classic example of such an arrangement. It is far too late in the history of our antitrust jurisprudence to question the proposition that certain tying ar-rangements pose an unacceptable risk of stifling competition and therefore are unreason-able “per se.”12 The rule was first enunciated in International Salt Co. v. U.S., 332 U.S. 392, 396 (1947), and has been endorsed by this Court many times since. The rule also re-flects congressional policies underlying the antitrust laws. In enacting §3 of the Clayton Act, Congress expressed great concern about the anticompetitive character of tying ar-rangements.15 While this case does not arise under the Clayton Act, the congressional

12 The District Court intimated that the principles of per se liability might not apply to cases in -volving the medical profession. The Court of Appeals rejected this approach. In this Court, peti -tioners “assume” that the same principles apply to the provision of professional services as apply to other trades or businesses. See generally Professional Engineers.15 … For example, the House Report on the Clayton Act stated:

The public is compelled to pay a higher price and local customers are put to the inconve-nience of securing many commodities in other communities or through mail-order houses that can not be procured at their local effect. Where the concern making these contracts is already great and powerful, such as the United Shoe Machinery Co., the American To-bacco Co., and the General Film Co., the exclusive or ‘tying’ contract made with local dealers becomes one of the greatest agencies and instrumentalities of monopoly ever de-vised by the brain of man. It completely shuts out competitors, not only from trade in which they are already engaged, but from the opportunities to build up trade in any com-munity where these great and powerful combinations are operating under this system and practice. By this method and practice the Shoe Machinery Co. has built up a monopoly that owns and controls the entire machinery now being used by all great shoe-manufac-turing houses of the United States. No independent manufacturer of shoe machines has the slightest opportunity to build up any considerable trade in this country while this con-dition obtains. If a manufacturer who is using machines of the Shoe Machinery Co. were to purchase and place a machine manufactured by any independent company in his estab-lishment, the Shoe Machinery Co. could under its contract withdraw all their machinery from the establishment of the shoe manufacturer and thereby wreck the business of the manufacturer. The General Film Co., by the same method practiced by the Shoe Machin-ery Co. under the lease system, has practically destroyed all competition and acquired a virtual monopoly of all films manufactured and sold in the United States. When we con-sider contracts of sales made under this system, the result to the consumer, the general public, and the local dealer and his business is even worse than under the lease system.

Similarly, Rep. Mitchell said that monopoly has been built up by these ‘tying’ contracts so that in order to get one machine one must take all of the essential machines, or practically all. Independent companies who have sought to enter the field have found that the markets have been preempted .... The manufacturers do not want to break their contracts with these giant monopolies, be-cause, if they should attempt to install machinery, their business might be jeopardized and all of the machinery now leased by these giant monopolies would be removed from their places of business. No situation cries more urgently for relief than does this situa -tion, and this bill seeks to prevent exclusive ‘tying’ contracts that have brought about a monopoly, alike injurious to the small dealers, to the manufacturers, and grossly unfair to those who seek to enter the field of competition and to the millions of consumers.

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finding made therein concerning the competitive consequences of tying is illuminating, and must be respected.

It is clear, however, that every refusal to sell two products separately cannot be said to restrain competition. If each of the products may be purchased separately in a competitive market, one seller’s decision to sell the two in a single package imposes no unreasonable restraint on either market, particularly if competing suppliers are free to sell either the entire package or its several parts.17 For example, we have written that “if one of a dozen food stores in a community were to refuse to sell flour unless the buyer also took sugar it would hardly tend to restrain competition if its competitors were ready and able to sell flour by itself.” Northern Pac. R. Co., 356 U.S. at 7. Buyers often find pack-age sales attractive; a seller’s decision to offer such packages can merely be an attempt to compete effectively–conduct that is entirely consistent with the Sherman Act. See Fortner Enterprises v. U.S. Steel Corp. (Fortner I), 394 U.S. 495, 517-518 (1969) (White, J., dissenting); id., at 524-525 (Fortas, J., dissenting).

Our cases have concluded that the essential characteristic of an invalid tying ar-rangement lies in the seller’s exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms. When such “forcing” is present, competition on the merits in the market for the tied item is restrained and the Sherman Act is violated. Accordingly, we have condemned tying arrangements when the seller has some special ability–usually called “market power”–to force a purchaser to do some-thing that he would not do in a competitive market. When “forcing” occurs, our cases have found the tying arrangement to be unlawful.

Thus, the law draws a distinction between the exploitation of market power by merely enhancing the price of the tying product, on the one hand, and by attempting to impose restraints on competition in the market for a tied product, on the other. When the seller’s power is just used to maximize its return in the tying product market, where pre-sumably its product enjoys some justifiable advantage over its competitors, the competi-tive ideal of the Sherman Act is not necessarily compromised. But if that power is used to impair competition on the merits in another market, a potentially inferior product may be insulated from competitive pressures. This impairment could either harm existing competitors or create barriers to entry of new competitors in the market for the tied prod-uct and can increase the social costs of market power by facilitating price discrimination, thereby increasing monopoly profits over what they would be absent the tie.23 And from the standpoint of the consumer–whose interests the statute was especially intended to serve–the freedom to select the best bargain in the second market is impaired by his need to purchase the tying product, and perhaps by an inability to evaluate the true cost of ei-ther product when they are available only as a package. …

17 “Of course where the buyer is free to take either product by itself there is no tying problem even though the seller may also offer the two items as a unit at a single price .” Northern Pac. R. Co. 356 U.S. at 6, n.4.23 Sales of the tied item can be used to measure demand for the tying item; purchasers with greater needs for the tied item make larger purchases and in effect must pay a higher price to ob-tain the tying item.

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Per se condemnation–condemnation without inquiry into actual market condi-tions–is only appropriate if the existence of forcing is probable. Thus, application of the per se rule focuses on the probability of anticompetitive consequences. Of course, as a threshold matter there must be a substantial potential for impact on competition in order to justify per se condemnation. If only a single purchaser were “forced” with respect to the purchase of a tied item, the resultant impact on competition would not be sufficient to warrant the concern of antitrust law. It is for this reason that we have refused to condemn tying arrangements unless a substantial volume of commerce is foreclosed thereby. Simi-larly, when a purchaser is “forced” to buy a product he would not have otherwise bought even from another seller in the tied product market, there can be no adverse impact on competition because no portion of the market which would otherwise have been available to other sellers has been foreclosed.

Once this threshold is surmounted, per se prohibition is appropriate if anticompet-itive forcing is likely. For example, if the government has granted the seller a patent or similar monopoly over a product, it is fair to presume that the inability to buy the product elsewhere gives the seller market power. Any effort to enlarge the scope of the patent monopoly by using the market power it confers to restrain competition in the market for a second product will undermine competition on the merits in that second market. Thus, the sale or lease of a patented item on condition that the buyer make all his purchases of a separate tied product from the patentee is unlawful.

The same strict rule is appropriate in other situations in which the existence of market power is probable. When the seller’s share of the market is high, or when the seller offers a unique product that competitors are not able to offer, the Court has held that the likelihood that market power exists and is being used to restrain competition in a separate market is sufficient to make per se condemnation appropriate. Thus, in Northern Pac. R. Co., we held that the railroad’s control over vast tracts of western real estate, al-though not itself unlawful, gave the railroad a unique kind of bargaining power that en-abled it to tie the sales of that land to exclusive, long term commitments that fenced out competition in the transportation market over a protracted period. When, however, the seller does not have either the degree or the kind of market power that enables him to force customers to purchase a second, unwanted product in order to obtain the tying prod-uct, an antitrust violation can be established only by evidence of an unreasonable restraint on competition in the relevant market.

In sum, any inquiry into the validity of a tying arrangement must focus on the market or markets in which the two products are sold, for that is where the anticompeti-tive forcing has its impact. Thus, in this case our analysis of the tying issue must focus on the hospital’s sale of services to its patients, rather than its contractual arrangements with the providers of anesthesiological services. In making that analysis, we must con-sider whether petitioners are selling two separate products that may be tied together, and, if so, whether they have used their market power to force their patients to accept the tying arrangement.

III. The hospital has provided its patients with a package that includes the range of facili-ties and services required for a variety of surgical operations. At East Jefferson Hospital the package includes the services of the anesthesiologist. Petitioners argue that the pack-age does not involve a tying arrangement at all–that they are merely providing a function-

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ally integrated package of services. Therefore, petitioners contend that it is inappropriate to apply principles concerning tying arrangements to this case.

Our cases indicate, however, that the answer to the question whether one or two products are involved turns not on the functional relation between them, but rather on the character of the demand for the two items.30 … [The] cases make it clear that a tying ar-rangement cannot exist unless two separate product markets have been linked.

The requirement that two distinguishable product markets be involved follows from the underlying rationale of the rule against tying. The definitional question depends on whether the arrangement may have the type of competitive consequences addressed by the rule. The answer to the question whether petitioners have utilized a tying arrangement must be based on whether there is a possibility that the economic effect of the arrange-ment is that condemned by the rule against tying–that petitioners have foreclosed compe-tition on the merits in a product market distinct from the market for the tying item. Thus, in this case no tying arrangement can exist unless there is a sufficient demand for the pur-chase of anesthesiological services separate from hospital services to identify a distinct product market in which it is efficient to offer anesthesiological services separately from hospital services.

Unquestionably, the anesthesiological component of the package offered by the hospital could be provided separately and could be selected either by the individual pa-tient or by one of the patient’s doctors if the hospital did not insist on including anesthesi-ological services in the package it offers to its customers. As a matter of actual practice, anesthesiological services are billed separately from the hospital services petitioners pro-vide. There was ample and uncontroverted testimony that patients or surgeons often re-quest specific anesthesiologists to come to a hospital and provide anesthesia, and that the choice of an individual anesthesiologist separate from the choice of a hospital is particu-larly frequent in respondent’s specialty, obstetric anesthesiology. The District Court found that “[t]he provision of anesthesia services is a medical service separate from the other services provided by the hospital.” The Court of Appeals agreed with this finding, and went on to observe that “an anesthesiologist is normally selected by the surgeon, rather than the patient, based on familiarity gained through a working relationship. Obvi-ously, the surgeons who practice at East Jefferson Hospital do not gain familiarity with any anesthesiologists other than Roux and Associates.” The record amply supports the conclusion that consumers differentiate between anesthesiological services and the other hospital services provided by petitioners.

30 The fact that anesthesiological services are functionally linked to the other services provided by the hospital is not in itself sufficient to remove the Roux contract from the realm of tying arrange-ments. We have often found arrangements involving functionally linked products at least one of which is useless without the other to be prohibited tying devices. See … Morton Salt Co. v. Sup-piger Co., 314 U.S. 488 (1942) (salt machine and salt); … International Business Machines Corp. v. U.S., 298 U.S. 131 (1936) (computer and computer punch cards); … FTC v. Sinclair Refining Co., 261 U.S. 463 (1923) (gasoline and underground tanks and pumps)…. In fact, in some situa-tions the functional link between the two items may enable the seller to maximize its monopoly return on the tying item as a means of charging a higher rent or purchase price to a larger user of the tying item. See n.23 supra.

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Thus, the hospital’s requirement that its patients obtain necessary anesthesiologi-cal services from Roux combined the purchase of two distinguishable services in a single transaction.40 Nevertheless, the fact that this case involves a required purchase of two ser-vices that would otherwise be purchased separately does not make the Roux contract ille-gal. … Only if patients are forced to purchase Roux’s services as a result of the hospi-tal’s market power would the arrangement have anticompetitive consequences. If no forcing is present, patients are free to enter a competing hospital and to use another anes-thesiologist instead of Roux.41 …

IV. … Respondent’s only basis for invoking the per se rule against tying and thereby avoiding analysis of actual market conditions is by relying on the preference of persons residing in Jefferson Parish to go to East Jefferson, the closest hospital. A preference of this kind, however, is not necessarily probative of significant market power.

Seventy per cent of the patients residing in Jefferson Parish enter hospitals other than East Jefferson. Thus East Jefferson’s “dominance” over persons residing in Jefferson Parish is far from overwhelming. The fact that a substantial majority of the parish’s resi-dents elect not to enter East Jefferson means that the geographic data does not establish the kind of dominant market position that obviates the need for further inquiry into actual competitive conditions. The Court of Appeals acknowledged as much; it recognized that East Jefferson’s market share alone was insufficient as a basis to infer market power, and buttressed its conclusion by relying on “market imperfections” that permit petitioners to charge noncompetitive prices for hospital services: the prevalence of third party payment for health care costs reduces price competition, and a lack of adequate information ren-ders consumers unable to evaluate the quality of the medical care provided by competing hospitals. While these factors may generate “market power” in some abstract sense,46

they do not generate the kind of market power that justifies condemnation of tying.

40 This is not to say that §1 of the Sherman Act gives a purchaser the right to buy a product that the seller does not wish to offer for sale. A grocer may decide to carry four brands of cookies and no more. If the customer wants a fifth brand, he may go elsewhere but he cannot sue the grocer even if there is no other in town. However, in such a case the customer is free to purchase no cookies at all, while buying other needed food. If the grocer required the customer to buy an un -wanted brand of cookies in order to buy other items which the customer needs and cannot readily obtain elsewhere, then a tying question arises. … Here, the question is whether patients are forced to use an unwanted anesthesiologist in order to obtain needed hospital services.41 An examination of the reason or reasons why petitioners denied respondent staff privileges will not provide the answer to the question whether the package of services they offered to their pa -tients is an illegal tying arrangement. As a matter of antitrust law, petitioners may give their anesthesiology business to Roux because he is the best doctor available, because he is willing to work long hours, or because he is the son-in-law of the hospital administrator without violating the per se rule against tying. Without evidence that petitioners are using market power to force Roux upon patients there is no basis to view the arrangement as unreasonably restraining compe-tition whatever the reasons for its creation. Conversely, with such evidence, the per se rule against tying may apply. Thus, we reject the view of the District Court that the legality of an ar-rangement of this kind turns on whether it was adopted for the purpose of improving patient care.46 As an economic matter, market power exists whenever prices can be raised above the levels that would be charged in a competitive market.

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Tying arrangements need only be condemned if they restrain competition on the merits by forcing purchases that would not otherwise be made. A lack of price or quality competition does not create this type of forcing. If consumers lack price consciousness, that fact will not force them to take an anesthesiologist whose services they do not want–their indifference to price will have no impact on their willingness or ability to go to an-other hospital where they can utilize the services of the anesthesiologist of their choice. Similarly, if consumers cannot evaluate the quality of anesthesiological services, it fol-lows that they are indifferent between certified anesthesioligists even in the absence of a tying arrangement–such an arrangement cannot be said to have foreclosed a choice that would have otherwise been made “on the merits.”

Thus, neither of the “market imperfections” relied upon by the Court of Appeals forces consumers to take anesthesiological services they would not select in the absence of a tie. It is safe to assume that every patient undergoing a surgical operation needs the services of an anesthesiologist; at least this record contains no evidence that the hospital “forced” any such services on unwilling patients.47 The record therefore does not provide a basis for applying the per se rule against tying to this arrangement.

V. In order to prevail in the absence of per se liability, respondent has the burden of proving that the Roux contract violated the Sherman Act because it unreasonably re-strained competition. That burden necessarily involves an inquiry into the actual effect of the exclusive contract on competition among anesthesiologists. This competition takes place in a market that has not been defined. The market is not necessarily the same as the market in which hospitals compete in offering services to patients; it may encompass competition among anesthesiologists for exclusive contracts such as the Roux contract and might be statewide or merely local.48 There is, however, insufficient evidence in this

47 Nor is there an indication in the record that respondents’ practices have increased the social costs of its market power. Since patients’ anesthesiological needs are fixed by medical judgment, respondent does not argue that the tying arrangement facilitates price discrimination. Where vari-able-quantity purchasing is unavailable as a means to enable price discrimination, commentators have seen less justification for condemning tying.

While tying arrangements like the one at issue here are unlikely to be used to facilitate price discrimination, they could have the similar effect of enabling hospitals “to evade price con-trol in the tying product through clandestine transfer of the profit to the tied product....” Fortner I, 394 U.S. at 513 (WHITE, J., dissenting). Insurance companies are the principal source of price restraint in the hospital industry; they place some limitations on the ability of hospitals to exploit their market power. Through this arrangement, petitioners may be able to evade that restraint by obtaining a portion of the anesthesioligists’ fees and therefore realize a greater return than they could in the absence of the arrangement. This could also have an adverse effect on the anesthesi-ology market since it is possible that only less able anesthesiologists would be willing to give up part of their fees in return for the security of an exclusive contract. However, there are no find -ings of either the District Court or the Court of Appeals which indicate that this type of exploita-tion of market power has occurred here. …48 While there was some rather impressionistic testimony that the prevalence of exclusive con-tracts tended to discourage young doctors from entering the market, the evidence was equivocal and neither the District Court nor the Court of Appeals made any findings concerning the con-tract’s effect on entry barriers. Respondent does not press the point before this Court. It is possi-ble that under some circumstances an exclusive contract could raise entry barriers since anesthesi-

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record to provide a basis for finding that the Roux contract, as it actually operates in the market, has unreasonably restrained competition. The record sheds little light on how this arrangement affected consumer demand for separate arrangements with a specific anes-thesiologist. The evidence indicates that some surgeons and patients preferred respon-dent’s services to those of Roux, but there is no evidence that any patient who was so-phisticated enough to know the difference between two anesthesiologists was not also able to go to a hospital that would provide him with the anesthesiologist of his choice.50

In sum, all that the record establishes is that the choice of anesthesiologists at East Jefferson has been limited to one of the four doctors who are associated with Roux and therefore have staff privileges.51 Even if Roux did not have an exclusive contract, the range of alternatives open to the patient would be severely limited by the nature of the transaction and the hospital’s unquestioned right to exercise some control over the iden-tity and the number of doctors to whom it accords staff privileges. If respondent is ad-mitted to the staff of East Jefferson, the range of choice will be enlarged from four to five doctors, but the most significant restraints on the patient’s freedom to select a specific anesthesiologist will nevertheless remain.52 Without a showing of actual adverse effect on competition, respondent cannot make out a case under the antitrust laws, and no such showing has been made.

VI. Petitioners’ closed policy may raise questions of medical ethics, and may have in-convenienced some patients who would prefer to have their anesthesia administered by someone other than a member of Roux & Associates, but it does not have the obviously unreasonable impact on purchasers that has characterized the tying arrangements that this Court has branded unlawful. There is no evidence that the price, the quality, or the sup-ply or demand for either the “tying product” or the “tied product” involved in this case has been adversely affected by the exclusive contract between Roux and the hospital. It

oligists could not compete for the contract without raising the capital necessary to run a hospital-wide operation. However, since the hospital has provided most of the capital for the exclusive contractor in this case, that problem does not appear to be present.50 If, as is likely, it is the patient’s doctor and not the patient who selects an anesthesiologist, the doctor can simply take the patient elsewhere if he is dissatisfied with Roux. The District Court found that most doctors in the area have staff privileges at more than one hospital. 51 The effect of the contract has, of course, been to remove the East Jefferson Hospital from the market open to Roux’s competitors. Like any exclusive requirements contract, this contract could be unlawful if it foreclosed so much of the market from penetration by Roux’s competitors as to unreasonably restrain competition in the affected market, the market for anesthesiological ser-vices. See generally Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320 (1961); U.S. v. Standard Oil Co., 337 U.S. 293 (1949). However, respondent has not attempted to make this showing.52 The record simply tells us little if anything about the effect of this arrangement on price or quality of anesthesiological services. As to price, the arrangement did not lead to an increase in the price charged to the patient. As to quality, the record indicates little more than that there have never been any complaints about the quality of Roux’s services, and no contention that his ser-vices are in any respect inferior to those of respondent. Moreover, the self interest of the hospital, as well as the ethical and professional norms under which it operates, presumably protect the quality of anesthesiological services.

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may well be true that the contract made it necessary for Dr. Hyde and others to practice elsewhere, rather than at East Jefferson. But there has been no showing that the market as a whole has been affected at all by the contract. Indeed, as we previously noted, the record tells us very little about the market for the services of anesthesiologists. Yet that is the market in which the exclusive contract has had its principal impact. There is sim-ply no showing here of the kind of restraint on competition that is prohibited by the Sher-man Act. Accordingly, the judgment of the Court of Appeals is reversed and the case is remanded to that court for further proceedings consistent with this opinion.

Justice BRENNAN, with whom Justice MARSHALL joins, concurring: As the opin-ion for the Court demonstrates, we have long held that tying arrangements are subject to evaluation for per se illegality under §1 of the Sherman Act. Whatever merit the policy arguments against this longstanding construction of the Act might have, Congress, pre-sumably aware of our decisions, has never changed the rule by amending the Act. In such circumstances, our practice usually has been to stand by a settled statutory interpre-tation and leave the task of modifying the statute’s reach to Congress. See Monsanto (BRENNAN, J., concurring). I see no reason to depart from that principle in this case and therefore join the opinion and judgment of the Court.

Justice O’CONNOR, with whom Chief Justice BURGER, Justice POWELL, and Justice REHNQUIST join, concurring in the judgment: … I concur in the Court’s decision to reverse but write separately to explain why I believe the Hospital-Roux con-tract … is properly analyzed under the Rule of Reason.

I. … Under the usual logic of the per se rule, a restraint on trade that rarely serves any purposes other than to restrain competition is illegal without proof of market power or anti-competitive effect. In deciding whether an economic restraint should be declared il-legal per se, “the probability that anticompetitive consequences will result from a practice and the severity of those consequences [is] balanced against its pro-competitive conse-quences. Cases that do not fit the generalization may arise, but a per se rule reflects the judgment that such cases are not sufficiently common or important to justify the time and expense necessary to identify them.” Sylvania. Only when there is very little loss to soci-ety from banning a restraint altogether is an inquiry into its costs in the individual case considered to be unnecessary.

Some of our earlier cases did indeed declare that tying arrangements serve “hardly any purpose beyond the suppression of competition.” Standard Oil Co. of California v. U.S., 337 U.S. 293, 305-306 (1949) (dictum). However, this declaration was not taken literally even by the cases that purported to rely upon it. In practice, a tie has been illegal only if the seller is shown to have “sufficient economic power with respect to the tying product to appreciably restrain free competition in the market for the tied product....” Northern Pacific R. Co., 356 U.S. at 6. Without “control or dominance over the tying product,” the seller could not use the tying product as “an effectual weapon to pressure buyers into taking the tied item,” so that any restraint of trade would be “insignificant.” Id. The Court has never been willing to say of tying arrangements, as it has of price-fix-ing, division of markets and other agreements subject to per se analysis, that they are al-ways illegal, without proof of market power or anticompetitive effect.

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The “per se” doctrine in tying cases has thus always required an elaborate inquiry into the economic effects of the tying arrangement. As a result, tying doctrine incurs the costs of a rule of reason approach without achieving its benefits: the doctrine calls for the extensive and time-consuming economic analysis characteristic of the rule of reason, but then may be interpreted to prohibit arrangements that economic analysis would show to be beneficial. Moreover, the per se label in the tying context has generated more confu-sion than coherent law because it appears to invite lower courts to omit the analysis of economic circumstances of the tie that has always been an necessary element of tying analysis.

The time has therefore come to abandon the “per se” label and refocus the inquiry on the adverse economic effects, and the potential economic benefits, that the tie may have. The law of tie-ins will thus be brought into accord with the law applicable to all other allegedly anticompetitive economic arrangements, except those few horizontal or quasi-horizontal restraints that can be said to have no economic justification whatsoever.2

This change will rationalize rather than abandon tie-in doctrine as it is already applied.

II. … Tying may be economically harmful primarily in the rare cases where power in the market for the tying product is used to create additional market power in the market for the tied product.4 The antitrust law is properly concerned with tying when, for example, the flour monopolist threatens to use its market power to acquire additional power in the sugar market, perhaps by driving out competing sellers of sugar, or by making it more difficult for new sellers to enter the sugar market. But such extension of market power is unlikely, or poses no threat of economic harm, unless the two markets in question and the nature of the two products tied satisfy three threshold criteria.

First, the seller must have power in the tying product market. Absent such power tying cannot conceivably have any adverse impact in the tied-product market, and can be only pro-competitive in the tying product market.7 … 2 Tying law is particularly anomalous in this respect because arrangements largely indistinguish-able from tie-ins are generally analyzed under the rule of reason. For example, the “per se “ anal-ysis of tie-ins subjects restrictions on a franchisee’s freedom to purchase supplies to a more searching scrutiny than restrictions on his freedom to sell his products. Compare, e.g., Siegel v. Chicken Delight, 448 F.2d 43 (9th Cir 1971), cert. denied, 405 U.S. 955 (1972), with Sylvania. And exclusive contracts, that, like tie-ins, require the buyer to purchase a product from one seller, are subject only to the rule of reason.4 Tying might be undesirable in two other instances, but the Hospital-Roux arrangement involves neither one. In a regulated industry a firm with market power may be unable to extract a super-competitive profit because it lacks control over the prices it charges for regulated products or ser-vices. Tying may then be used to extract that profit from sale of the unregulated, tied products or services. … Tying may also help the seller engage in price discrimination by “metering” the buyer’s use of the tying product. … Price discrimination may be independently unlawful, see 15 U.S.C. §13. Price discrimination may, however, decrease rather than increase the economic costs of a seller’s market power. …7 A common misconception has been that a patent or copyright, a high market share, or a unique product that competitors are not able to offer suffice to demonstrate market power. While each of these three factors might help to give market power to a seller, it is also possible that a seller in these situations will have no market power: for example, a patent holder has no market power in any relevant sense if there are close substitutes for the patented product. Similarly, a high market

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Second, there must be a substantial threat that the tying seller will acquire market power in the tied-product market. No such threat exists if the tied-product market is oc-cupied by many stable sellers who are not likely to be driven out by the tying, or if entry barriers in the tied product market are low. If, for example, there is an active and vibrant market for sugar–one with numerous sellers and buyers who do not deal in flour–the flour monopolist’s tying of sugar to flour need not be declared unlawful. If, on the other hand, the tying arrangement is likely to erect significant barriers to entry into the tied-product market, the tie remains suspect.

Third, there must be a coherent economic basis for treating the tying and tied products as distinct. … For products to be treated as distinct, the tied product must, at a minimum, be one that some consumers might wish to purchase separately without also purchasing the tying product. When the tied product has no use other than in conjunction with the tying product, a seller of the tying product can acquire no additional market power by selling the two products together. If sugar is useless to consumers except when used with flour, the flour seller’s market power is projected into the sugar market whether or not the two products are actually sold together; the flour seller can exploit what market power it has over flour with or without the tie. The flour seller will therefore have little incentive to monopolize the sugar market unless it can produce and distribute sugar more cheaply than other sugar sellers. And in this unusual case, where flour is monopolized and sugar is useful only when used with flour, consumers will suffer no further economic injury by the monopolization of the sugar market.

Even when the tied product does have a use separate from the tying product, it makes little sense to label a package as two products without also considering the eco-nomic justifications for the sale of the package as a unit. When the economic advantages of joint packaging are substantial the package is not appropriately viewed as two prod-ucts, and that should be the end of the tying inquiry. The lower courts largely have adopted this approach.10

share indicates market power only if the market is properly defined to include all reasonable sub-stitutes for the product. …10 The examination of the economic advantages of tying may properly be conducted as part of the Rule of Reason analysis, rather than at the threshold of the tying inquiry. This approach is con-sistent with this Court’s occasional references to the problem. The Court has not heretofore had occasion to set forth any general criteria for determining when two apparently separate products are components of a single product for tying analysis. In Times-Picayune Co., the Court held that advertising space in a morning newspaper was the same product as advertising space in the evening newspaper—access to readership of the respective newspapers--because the subscribers had no reason to distinguish among the readers of the two papers. 345 U.S., at 613-616. In Fort-ner I, the Court, reversing the grant of a motion for summary judgment, rejected the contention that credit could never be separate from the product for whose purchase credit was extended. 394 U.S., at 506-507. The Court disclaimed any determination of “the standards for determining ex-actly when a transaction involves only a single product.” Id., at 507. These cases indicate that consideration of whether a buyer might prefer to purchase one component without the other is one of the factors in tying analysis and, more generally, that economic analysis rather than mere conventional separability into different markets should determine whether one or two products are involved in the alleged tie.

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These three conditions–market power in the tying product, a substantial threat of market power in the tied product, and a coherent economic basis for treating the products as distinct–are only threshold requirements. Under the Rule of Reason a tie-in may prove acceptable even when all three are met. Tie-ins may entail economic benefits as well as economic harms, and if the threshold requirements are met these benefits should enter the Rule of Reason balance.

Tie-ins ... may facilitate new entry into fields where established sellers have wedded their customers to them by ties of habit and custom. ... They may permit clandestine price cutting in products which otherwise would have no price competition at all because of fear of retaliation from the few other producers dealing in the market. They may protect the reputation of the tying product if failure to use the tied product in conjunction with it may cause it to misfunction. ... And, if the tied and tying products are functionally re-lated, they may reduce costs through economies of joint production and distribution.

Fortner I, 394 U.S. at 514 n.9 (Justice WHITE, dissenting).

The ultimate decision whether a tie-in is illegal under the antitrust laws should de-pend upon the demonstrated economic effects of the challenged agreement. It may, for example, be entirely innocuous that the seller exploits its control over the tying product to “force” the buyer to purchase the tied product. For when the seller exerts market power only in the tying product market, it makes no difference to him or his customers whether he exploits that power by raising the price of the tying product or by “forcing” customers to buy a tied product. On the other hand, tying may make the provision of packages of goods and services more efficient. A tie-in should be condemned only when its anticom-petitive impact outweighs its contribution to efficiency.

III. Application of these criteria to the case at hand is straightforward. Although the is-sue is in doubt, we may assume that the Hospital does have market power in the provi-sion of hospital services in its area…. Second, in light of the Hospital’s presumed market power, we may also assume that there is a substantial threat that East Jefferson will ac-quire market power over the provision of anesthesiological services in its market. …

But the third threshold condition for giving closer scrutiny to a tying arrangement is not satisfied here: there is no sound economic reason for treating surgery and anesthe-sia as separate services. Patients are interested in purchasing anesthesia only in conjunc-tion with hospital services,12 so the Hospital can acquire no additional market power by selling the two services together. Accordingly, the link between the Hospital’s services and anesthesia administered by Roux will affect neither the amount of anesthesia pro-vided nor the combined price of anesthesia and surgery for those who choose to become the Hospital’s patients. In these circumstances, anesthesia and surgical services should probably not be characterized as distinct products for tying purposes.

Even if they are, the tying should not be considered a violation of §1 of the Sher-man Act because tying here cannot increase the seller’s already absolute power over the volume of production of the tied product, which is an inevitable consequence of the fact that very few patients will choose to undergo surgery without receiving anesthesia. The Hospital-Roux contract therefore has little potential to harm the patients. On the other

12 While the record appears to be devoid of factual findings on this point the assumption is a safe one, and certainly one that finds no contradiction in the record.

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side of the balance, the District Court found, and the Court of Appeals did not dispute, that the tie-in conferred significant benefits upon the hospital and the patients that it served.

The tie-in improves patient care and permits more efficient hospital operation in a number of ways. From the viewpoint of hospital management, the tie-in ensures 24 hour anesthesiology coverage, aids in standardization of procedures and efficient use of equip-ment, facilitates flexible scheduling of operations, and permits the hospital more effec-tively to monitor the quality of anesthesiological services. Further, the tying arrangement is advantageous to patients because, as the District Court found, the closed anesthesiol-ogy department places upon the hospital, rather than the individual patient, responsibility to select the physician who is to provide anesthesiological services. The hospital also as-sumes the responsibility that the anesthesiologist will be available, will be acceptable to the surgeon, and will provide suitable care to the patient. In assuming these responsibili -ties–responsibilities that a seriously ill patient frequently may be unable to discharge–the hospital provides a valuable service to its patients. And there is no indication that pa-tients were dissatisfied with the quality of anesthesiology that was provided at the hospi-tal or that patients wished to enjoy the services of anesthesiologists other than those that the hospital employed. Given this evidence of the advantages and effectiveness of the closed anesthesiology department, it is not surprising that, as the District Court found, such arrangements are accepted practice in the majority of hospitals of New Orleans and in the health care industry generally. Such an arrangement, that has little anti-competi-tive effect and achieves substantial benefits in the provision of care to patients, is hardly one that the antitrust law should condemn. This conclusion reaffirms our threshold deter-mination that the joint provision of hospital services and anesthesiology should not be viewed as involving a tie between distinct products, and therefore should require no addi-tional scrutiny under the antitrust law. …

$ $ $ $ $ $ $EASTMAN KODAK CO. v. IMAGE TECHNICAL SERVICES

504 U.S. 451 (1992)

Justice BLACKMUN delivered the opinion of the Court: This is yet another case that concerns the standard for summary judgment in an antitrust controversy. The principal issue here is whether a defendant’s lack of market power in the primary equipment mar-ket precludes–as a matter of law–the possibility of market power in derivative aftermar-kets. Petitioner Eastman Kodak Company manufactures and sells photocopiers and mi-crographic equipment. Kodak also sells service and replacement parts for its equipment. Respondents are 18 independent service organizations (ISO’s) that in the early 1980’s be-gan servicing Kodak copying and micrographic equipment. Kodak subsequently adopted policies to limit the availability of parts to ISO’s and to make it more difficult for ISO’s to compete with Kodak in servicing Kodak equipment.

Respondents instituted this action … alleging that Kodak’s policies were unlawful under both §1 and §2 of the Sherman Act…. [T]he District Court granted summary judg-ment for Kodak. The Court of Appeals for the Ninth Circuit reversed. The appellate court found that respondents had presented sufficient evidence to raise a genuine issue

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concerning Kodak’s market power in the service and parts markets. It rejected Kodak’s contention that lack of market power in service and parts must be assumed when such power is absent in the equipment market. Because of the importance of the issue, we granted certiorari.

I. A. … Kodak manufactures and sells complex business machines–as relevant here, high-volume photocopiers and micrographic equipment. … Kodak parts are not compati-ble with other manufacturers’ equipment, and vice versa. Kodak equipment, although ex-pensive when new, has little resale value.

Kodak provides service and parts for its machines to its customers. It produces some of the parts itself; the rest are made to order for Kodak by independent original-equipment manufacturers (OEM’s). Kodak does not sell a complete system of original equipment, lifetime service, and lifetime parts for a single price. Instead, Kodak provides service after the initial warranty period either through annual service contracts, which in-clude all necessary parts, or on a per-call basis. It charges, through negotiations and bid-ding, different prices for equipment, service, and parts for different customers. Kodak provides 80% to 95% of the service for Kodak machines.

Beginning in the early 1980’s, ISO’s began repairing and servicing Kodak equip-ment. They also sold parts and reconditioned and sold used Kodak equipment. Their customers were federal, state, and local government agencies, banks, insurance compa-nies, industrial enterprises, and providers of specialized copy and microfilming services. ISO’s provide service at a price substantially lower than Kodak does. Some customers found that the ISO service was of higher quality. Some ISO customers purchase their own parts and hire ISO’s only for service. Others choose ISO’s to supply both service and parts. ISO’s keep an inventory of parts, purchased from Kodak or other sources, pri-marily the OEM’s.

In 1985 and 1986, Kodak implemented a policy of selling replacement parts for micrographic and copying machines only to buyers of Kodak equipment who use Kodak service or repair their own machines. As part of the same policy, … Kodak and the OEM’s agreed that the OEM’s would not sell parts that fit Kodak equipment to anyone other than Kodak. Kodak also pressured Kodak equipment owners and independent parts distributors not to sell Kodak parts to ISO’s. … Kodak intended, through these policies, to make it more difficult for ISO’s to sell service for Kodak machines. It succeeded. ISOs were unable to obtain parts from reliable sources, and many were forced out of business, while others lost substantial revenue. Customers were forced to switch to Ko-dak service even though they preferred ISO service.

B. In 1987, the ISO’s filed the present action … alleging, inter alia, that Kodak had unlawfully tied the sale of service for Kodak machines to the sale of parts, in viola-tion of §1 of the Sherman Act, and had unlawfully monopolized and attempted to monop-olize the sale of service for Kodak machines, in violation of §2 of that Act. Kodak filed a motion for summary judgment….[and] the District Court granted summary judgment in favor of Kodak.

As to the §1 claim, the court found that respondents had provided no evidence of a tying arrangement between Kodak equipment and service or parts. The court, however, did not address respondents’ §1 claim that is at issue here. Respondents allege a tying ar-

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rangement not between Kodak equipment and service, but between Kodak parts and ser-vice. As to the §2 claim, the District Court concluded that although Kodak had a “natural monopoly over the market for parts it sells under its name,” a unilateral refusal to sell those parts to ISO’s did not violate §2.

The Court of Appeals for the Ninth Circuit … reversed. With respect to the §1 claim, the court first found that whether service and parts were distinct markets and whether a tying arrangement existed between them were disputed issues of fact. Having found that a tying arrangement might exist, the Court of Appeals considered a question not decided by the District Court: Was there “an issue of material fact as to whether Ko-dak has sufficient economic power in the tying product market [parts] to restrain compe-tition appreciably in the tied product market [service].” The court agreed with Kodak that competition in the equipment market might prevent Kodak from possessing power in the parts market, but refused to uphold the District Court’s grant of summary judgment “on this theoretical basis” because “market imperfections can keep economic theories about how consumers will act from mirroring reality.” Noting that the District Court had not considered the market power issue, and that the record was not fully developed through discovery, the court declined to require respondents to conduct market analysis or to pinpoint specific imperfections in order to withstand summary judgment. “It is enough that [respondents] have presented evidence of actual events from which a reason-able trier of fact could conclude that ... competition in the [equipment] market does not, in reality, curb Kodak’s power in the parts market.” …

As to the §2 claim, the Court of Appeals concluded that sufficient evidence ex-isted to support a finding that Kodak’s implementation of its parts policy was “anticom-petitive” and “exclusionary” and “involved a specific intent to monopolize.” It held that the ISO’s had come forward with sufficient evidence, for summary judgment purposes, to disprove Kodak’s business justifications. …

II. A tying arrangement … violates §1 of the Sherman Act if the seller has “appreciable economic power” in the tying product market and if the arrangement affects a substantial volume of commerce in the tied market. Fortner Enterprises, Inc. v. U.S. Steel Corp., 394 U.S. 495, 503 (1969). Kodak did not dispute that its arrangement affects a substan-tial volume of interstate commerce. It, however, did challenge whether its activities con-stituted a “tying arrangement” and whether Kodak exercised “appreciable economic power” in the tying market. We consider these issues in turn.

A. For respondents to defeat a motion for summary judgment on their claim of a tying arrangement, a reasonable trier of fact must be able to find … that service and parts are two distinct products… For service and parts to be considered two distinct products, there must be sufficient consumer demand so that it is efficient for a firm to provide ser-vice separately from parts. Jefferson Parish. Evidence in the record indicates that service and parts have been sold separately in the past and still are sold separately to self-service equipment owners.5 Indeed, the development of the entire high-technology service in-dustry is evidence of the efficiency of a separate market for service.

5 The Court of Appeals found: “Kodak’s policy of allowing customers to purchase parts on con-dition that they agree to service their own machines suggests that the demand for parts can be separated from the demand for service.”

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Kodak insists that because there is no demand for parts separate from service, there cannot be separate markets for service and parts. By that logic, we would be forced to conclude that there can never be separate markets, for example, for cameras and film, computers and software, or automobiles and tires. That is an assumption we are unwill-ing to make. “We have often found arrangements involving functionally linked products at least one of which is useless without the other to be prohibited tying devices.” Jeffer-son Parish.

Kodak’s assertion also appears to be incorrect as a factual matter. At least some consumers would purchase service without parts, because some service does not require parts, and some consumers, those who self-service for example, would purchase parts without service. Enough doubt is cast on Kodak’s claim of a unified market that it should be resolved by the trier of fact. …

B. Having found sufficient evidence of a tying arrangement, we consider the other necessary feature of an illegal tying arrangement: appreciable economic power in the tying market. Market power is the power “to force a purchaser to do something that he would not do in a competitive market.” Jefferson Parish. It has been defined as “the ability of a single seller to raise price and restrict output.” Fortner, 394 U.S. at 503; duPont. The existence of such power ordinarily is inferred from the seller’s possession of a predominant share of the market.

1. Respondents contend that Kodak has more than sufficient power in the parts market to force unwanted purchases of the tied market, service. Respondents pro-vide evidence that certain parts are available exclusively through Kodak. Respondents also assert that Kodak has control over the availability of parts it does not manufacture. According to respondents’ evidence, Kodak has prohibited independent manufacturers from selling Kodak parts to ISO’s, [and] pressured Kodak equipment owners and inde-pendent parts distributors to deny ISO’s the purchase of Kodak parts….

Respondents also allege that Kodak’s control over the parts market has excluded service competition, boosted service prices, and forced unwilling consumption of Kodak service. Respondents offer evidence that consumers have switched to Kodak service even though they preferred ISO service, that Kodak service was of higher price and lower quality than the preferred ISO service, and that ISO’s were driven out of business by Ko-dak’s policies. Under our prior precedents, this evidence would be sufficient to entitle re-spondents to a trial on their claim of market power.

2. Kodak counters that even if it concedes monopoly share of the relevant parts market, it cannot actually exercise the necessary market power for a Sherman Act violation … because competition exists in the equipment market. Kodak argues that it could not have the ability to raise prices of service and parts above the level that would be charged in a competitive market because any increase in profits from a higher price in the aftermarkets at least would be offset by a corresponding loss in profits from lower equipment sales as consumers began purchasing equipment with more attractive service costs. Kodak does not present any actual data on the equipment, service, or parts mar-

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kets. Instead, it urges the adoption of a substantive legal rule that “equipment competi-tion precludes any finding of monopoly power in derivative aftermarkets.”…11

Legal presumptions that rest on formalistic distinctions rather than actual market realities are generally disfavored in antitrust law. This Court has preferred to resolve an-titrust claims on a case-by-case basis…. In determining the existence of market power, and specifically the “responsiveness of the sales of one product to price changes of the other,” duPont, this Court has examined closely the economic reality of the market at is-sue.

Kodak contends that there is no need to examine the facts when the issue is mar-ket power in the aftermarkets. A legal presumption against a finding of market power is warranted in this situation, according to Kodak, because the existence of market power in the service and parts markets absent power in the equipment market “simply makes no economic sense,” and the absence of a legal presumption would deter procompetitive be-havior. Matsushita. …

The Court’s requirement in Matsushita that the plaintiffs’ claims make economic sense did not introduce a special burden on plaintiffs facing summary judgment in an-titrust cases. The Court did not hold that if the moving party enunciates any economic theory supporting its behavior, regardless of its accuracy in reflecting the actual market, it is entitled to summary judgment. Matsushita demands only that the nonmoving party’s inferences be reasonable in order to reach the jury, a requirement that was not invented, but merely articulated, in that decision. If the plaintiff’s theory is economically senseless, no reasonable jury could find in its favor, and summary judgment should be granted.

Kodak, then, bears a substantial burden in showing that it is entitled to summary judgment. It must show that despite evidence of increased prices and excluded competi-tion, an inference of market power is unreasonable. To determine whether Kodak has met that burden, we must unravel the factual assumptions underlying its proposed rule that lack of power in the equipment market necessarily precludes power in the aftermar-kets.

The extent to which one market prevents exploitation of another market depends on the extent to which consumers will change their consumption of one product in re-sponse to a price change in another, i.e., the “cross-elasticity of demand.” See Du Pont. Kodak’s proposed rule rests on a factual assumption about the cross-elasticity of demand in the equipment and aftermarkets: “If Kodak raised its parts or service prices above competitive levels, potential customers would simply stop buying Kodak equipment. Perhaps Kodak would be able to increase short term profits through such a strategy, but at a devastating cost to its long term interests.”16 Kodak argues that the Court should ac-

11 Kodak argues that such a rule would be per se, with no opportunity for respondents to rebut the conclusion that market power is lacking in the parts market. … As an apparent second-best alter-native, Kodak suggests elsewhere in its brief that the rule would permit a defendant to meet its summary judgment burden…; the burden would then shift to the plaintiffs to “prove ... that there is specific reason to believe that normal economic reasoning does not apply.” This is the United States’ position.16 The United States as amicus curiae in support of Kodak echoes this argument:

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cept, as a matter of law, this “basic economic realit[y],” that competition in the equip-ment market necessarily prevents market power in the aftermarkets.17

Even if Kodak could not raise the price of service and parts one cent without los-ing equipment sales, that fact would not disprove market power in the aftermarkets. The sales of even a monopolist are reduced when it sells goods at a monopoly price, but the higher price more than compensates for the loss in sales. Kodak’s claim that charging more for service and parts would be “a short-run game,” is based on the false dichotomy that there are only two prices that can be charged–a competitive price or a ruinous one. But there could easily be a middle, optimum price at which the increased revenues from the higher priced sales of service and parts would more than compensate for the lower revenues from lost equipment sales. … Thus, contrary to Kodak’s assertion, there is no immutable physical law–no “basic economic reality”–insisting that competition in the equipment market cannot coexist with market power in the aftermarkets.

We next consider the more narrowly drawn question: Does Kodak’s theory de-scribe actual market behavior so accurately that respondents’ assertion of Kodak market power in the aftermarkets, if not impossible, is at least unreasonable?

To review Kodak’s theory, it contends that higher service prices will lead to a dis-astrous drop in equipment sales. Presumably, the theory’s corollary is to the effect that low service prices lead to a dramatic increase in equipment sales. According to the the-ory, one would have expected Kodak to take advantage of lower priced ISO service as an opportunity to expand equipment sales. Instead, Kodak adopted a restrictive sales policy consciously designed to eliminate the lower priced ISO service, an act that would be ex-pected to devastate either Kodak’s equipment sales or Kodak’s faith in its theory. Yet, according to the record, it has done neither. Service prices have risen for Kodak cus-tomers, but there is no evidence or assertion that Kodak equipment sales have dropped.

Kodak and the United States attempt to reconcile Kodak’s theory with the con-trary actual results by describing a “marketing strategy of spreading over time the total cost to the buyer of Kodak equipment.” In other words, Kodak could charge subcompeti-tive prices for equipment and make up the difference with supra-competitive prices for service, resulting in an overall competitive price. This pricing strategy would provide an explanation for the theory’s descriptive failings–if Kodak in fact had adopted it. But Ko-dak never has asserted that it prices its equipment or parts subcompetitively and recoups its profits through service. Instead, it claims that it prices its equipment comparably to its competitors and intends that both its equipment sales and service divisions be profitable. Moreover, this hypothetical pricing strategy is inconsistent with Kodak’s policy toward

The ISOs’ claims are implausible because Kodak lacks market power in the markets for its copier and micrographic equipment. Buyers of such equipment regard an increase in the price of parts or service as an increase in the price of the equipment, and sellers recognize that the revenues from sales of parts and service are attributable to sales of the equipment. In such circumstances, it is not apparent how an equipment manufacturer such as Kodak could exercise power in the aftermar-kets for parts and service.

17 It is clearly true, as the United States claims, that Kodak “cannot set service or parts prices without regard to the impact on the market for equipment.” The fact that the cross-elasticity of demand is not zero proves nothing; the disputed issue is how much of an impact an increase in parts and service prices has on equipment sales and on Kodak’s profits.

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its self-service customers. If Kodak were underpricing its equipment, hoping to lock in customers and recover its losses in the service market, it could not afford to sell cus-tomers parts without service. In sum, Kodak’s theory does not explain the actual market behavior revealed in the record.

Respondents offer a forceful reason why Kodak’s theory, although perhaps intu-itively appealing, may not accurately explain the behavior of the primary and derivative markets for complex durable goods: the existence of significant information and switch-ing costs. These costs could create a less responsive connection between service and parts prices and equipment sales.

For the service-market price to affect equipment demand, consumers must inform themselves of the total cost of the “package”–equipment, service, and parts–at the time of purchase; that is, consumers must engage in accurate lifecycle pricing. Lifecycle pricing of complex, durable equipment is difficult and costly. In order to arrive at an accurate price, a consumer must acquire a substantial amount of raw data and undertake sophisti-cated analysis. The necessary information would include data on price, quality, and availability of products needed to operate, upgrade, or enhance the initial equipment, as well as service and repair costs, including estimates of breakdown frequency, nature of repairs, price of service and parts, length of “downtime,” and losses incurred from down-time. Much of this information is difficult–some of it impossible–to acquire at the time of purchase. During the life of a product, companies may change the service and parts prices, and develop products with more advanced features, a decreased need for repair, or new warranties. In addition, the information is likely to be customer-specific; lifecycle costs will vary from customer to customer with the type of equipment, degrees of equip-ment use, and costs of down-time.

Kodak acknowledges the cost of information, but suggests, again without eviden-tiary support, that customer information needs will be satisfied by competitors in the equipment markets. It is a question of fact, however, whether competitors would provide the necessary information. A competitor in the equipment market may not have reliable information about the lifecycle costs of complex equipment it does not service or the needs of customers it does not serve. Even if competitors had the relevant information, it is not clear that their interests would be advanced by providing such information to con-sumers.21

Moreover, even if consumers were capable of acquiring and processing the com-plex body of information, they may choose not to do so. Acquiring the information is ex-pensive. If the costs of service are small relative to the equipment price, or if consumers

21 To inform consumers about Kodak, the competitor must be willing to forgo the opportunity to reap supracompetitive prices in its own service and parts markets. The competitor may anticipate that charging lower service and parts prices and informing consumers about Kodak in the hopes of gaining future equipment sales will cause Kodak to lower the price on its service and parts, canceling any gains in equipment sales to the competitor and leaving both worse off. Thus, in an equipment market with relatively few sellers, competitors may find it more profitable to adopt Kodak’s service and parts policy than to inform the consumers. … Even in a market with many sellers, any one competitor may not have sufficient incentive to inform consumers because the in-creased patronage attributable to the corrected consumer beliefs will be shared among other com-petitors.

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are more concerned about equipment capabilities than service costs, they may not find it cost efficient to compile the information. Similarly, some consumers, such as the Federal Government, have purchasing systems that make it difficult to consider the complete cost of the “package” at the time of purchase. State and local governments often treat service as an operating expense and equipment as a capital expense, delegating each to a differ-ent department. These governmental entities do not lifecycle price, but rather choose the lowest price in each market.

As Kodak notes, there likely will be some large-volume, sophisticated purchasers who will undertake the comparative studies and insist, in return for their patronage, that Kodak charge them competitive lifecycle prices. Kodak contends that these knowledge-able customers will hold down the package price for all other customers. There are rea-sons, however, to doubt that sophisticated purchasers will ensure that competitive prices are charged to unsophisticated purchasers, too. As an initial matter, if the number of so-phisticated customers is relatively small, the amount of profits to be gained by supracom-petitive pricing in the service market could make it profitable to let the knowledgeable consumers take their business elsewhere. More importantly, if a company is able to price discriminate between sophisticated and unsophisticated consumers, the sophisticated will be unable to prevent the exploitation of the uninformed. A seller could easily price dis-criminate by varying the equipment/parts/service package, developing different war-ranties, or offering price discounts on different components.

Given the potentially high cost of information and the possibility that a seller may be able to price discriminate between knowledgeable and unsophisticated consumers, it makes little sense to assume, in the absence of any evidentiary support, that equipment-purchasing decisions are based on an accurate assessment of the total cost of equipment, service, and parts over the lifetime of the machine.

Indeed, respondents have presented evidence that Kodak practices price discrimi-nation by selling parts to customers who service their own equipment, but refusing to sell parts to customers who hire third-party service companies. Companies that have their own service staff are likely to be high-volume users, the same companies for whom it is most likely to be economically worthwhile to acquire the complex information needed for comparative lifecycle pricing.

A second factor undermining Kodak’s claim that supracompetitive prices in the service market lead to ruinous losses in equipment sales is the cost to current owners of switching to a different product. If the cost of switching is high, consumers who already have purchased the equipment, and are thus “locked in,” will tolerate some level of ser-vice-price increases before changing equipment brands. Under this scenario, a seller profitably could maintain supracompetitive prices in the aftermarket if the switching costs were high relative to the increase in service prices, and the number of locked-in cus-tomers were high relative to the number of new purchasers.

Moreover, if the seller can price discriminate between its locked-in customers and potential new customers, this strategy is even more likely to prove profitable. The seller could simply charge new customers below-marginal cost on the equipment and recoup the charges in service, or offer packages with lifetime warranties or long-term service agreements that are not available to locked-in customers.

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Respondents have offered evidence that the heavy initial outlay for Kodak equip-ment, combined with the required support material that works only with Kodak equip-ment, makes switching costs very high for existing Kodak customers. And Kodak’s own evidence confirms that it varies the package price of equipment/parts/service for different customers.

In sum, there is a question of fact whether information costs and switching costs foil the simple assumption that the equipment and service markets act as pure comple-ments to one another.24

We conclude, then, that Kodak has failed to demonstrate that respondents’ infer-ence of market power in the service and parts markets is unreasonable, and that, conse-quently, Kodak is entitled to summary judgment. It is clearly reasonable to infer that Ko-dak has market power to raise prices and drive out competition in the aftermarkets, since respondents offer direct evidence that Kodak did so. It is also plausible, as discussed above, to infer that Kodak chose to gain immediate profits by exerting that market power where locked-in customers, high information costs, and discriminatory pricing limited and perhaps eliminated any long-term loss. Viewing the evidence in the light most favor-able to respondents, their allegations of market power “mak[e] ... economic sense.” Cf. Matsushita.

Nor are we persuaded by Kodak’s contention that it is entitled to a legal presump-tion on the lack of market power because, as in Matsushita, there is a significant risk of deterring procompetitive conduct. Plaintiffs in Matsushita attempted to prove the an-titrust conspiracy “through evidence of rebates and other price-cutting activities.” Be-cause cutting prices to increase business is “the very essence of competition,” the Court was concerned that mistaken inferences would be “especially costly” and would “chill the very conduct the antitrust laws are designed to protect.” Id. But the facts in this case are just the opposite. The alleged conduct–higher service prices and market foreclosure–is facially anticompetitive and exactly the harm that antitrust laws aim to prevent. In this situation, Matsushita does not create any presumption in favor of summary judgment for the defendant. Kodak contends that, despite the appearance of anti-competitiveness, its behavior actually favors competition because its ability to pursue innovative marketing plans will allow it to compete more effectively in the equipment market. A pricing strat-egy based on lower equipment prices and higher aftermarket prices could enhance equip-ment sales by making it easier for the buyer to finance the initial purchase.26 It is undis-puted that competition is enhanced when a firm is able to offer various marketing op-tions, including bundling of support and maintenance service with the sale of equipment.

24 The dissent disagrees based on its hypothetical case of a tie between equipment and service. “The only thing lacking” to bring this case within the hypothetical case, states the dissent, “is concrete evidence that the restrictive parts policy was ... generally known.” But the dissent’s “only thing lacking” is the crucial thing lacking–evidence. Whether a tie between parts and ser-vice should be treated identically to a tie between equipment and service, as the dissent and Ko-dak argue, depends on whether the equipment market prevents the exertion of market power in the parts market. Far from being “anomalous,” requiring Kodak to provide evidence on this fac-tual question is completely consistent with our prior precedent. 26 It bears repeating that in this case Kodak has never claimed that it is in fact pursuing such a pricing strategy.

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Nor do such actions run afoul of the antitrust laws.27 But the procompetitive effect of the specific conduct challenged here, eliminating all consumer parts and service options, is far less clear.28

We need not decide whether Kodak’s behavior has any procompetitive effects and, if so, whether they outweigh the anticompetitive effects. We note only that Kodak’s service and parts policy is simply not one that appears always or almost always to en-hance competition, and therefore to warrant a legal presumption without any evidence of its actual economic impact. In this case, when we weigh the risk of deterring procompet-itive behavior by proceeding to trial against the risk that illegal behavior will go unpun-ished, the balance tips against summary judgment. Cf. Matsushita. …29

27 See Jefferson Parish (“Buyers often find package sales attractive; a seller’s decision to offer such packages can merely be an attempt to compete effectively–conduct that is entirely consistent with the Sherman Act”). …28 Two of the largest consumers of service and parts contend that they are worse off when the equipment manufacturer also controls service and parts. See Brief for State Farm Mutual Auto-mobile Insurance Co. et al. as Amici Curiae; Brief for State of Ohio et al. as Amici Curiae.29 The dissent urges a radical departure in this Court’s antitrust law. It argues that because Kodak has only an “inherent” monopoly in parts for its equipment, the antitrust laws do not apply to its efforts to expand that power into other markets. The dissent’s proposal to grant per se immunity to manufacturers competing in the service market would exempt a vast and growing sector of the economy from antitrust laws. Leaving aside the question whether the Court has the authority to make such a policy decision, there is no support for it in our jurisprudence or the evidence in this case.Even assuming, despite the absence of any proof from the dissent, that all manufacturers possess some inherent market power in the parts market, it is not clear why that should immunize them from the antitrust laws in another market. The Court has held many times that power gained through some natural and legal advantage such as a patent, copyright, or business acumen can give rise to liability if “a seller exploits his dominant position in one market to expand his empire into the next.” Times-Picayune Publishing Co. v. U.S., 345 U.S. 594, 611 (1953). Moreover, on the occasions when the Court has considered tying in derivative aftermarkets by manufacturers, it has not adopted any exception to the usual antitrust analysis, treating derivative aftermarkets as it has every other separate market. Our past decisions are reason enough to reject the dissent’s pro-posal. … Nor does the record in this case support the dissent’s proposed exemption for aftermar-kets. The dissent urges its exemption because the tie here “does not permit the manufacturer to project power over a class of consumers distinct from that which it is already able to exploit (and fully) without the inconvenience of the tie.” Beyond the dissent’s obvious difficulty in explaining why Kodak would adopt this expensive tying policy if it could achieve the same profits more conveniently through some other means, respondents offer an alternative theory, supported by the record, that suggests Kodak is able to exploit some customers who in the absence of the tie would be protected from increases in parts prices by knowledgeable customers. At bottom, whatever the ultimate merits of the dissent’s theory, at this point it is mere conjecture. Neither Kodak nor the dissent have provided any evidence refuting respondents’ theory of forced unwanted purchases at higher prices and price discrimination. While it may be, as the dissent predicts, that the equipment market will prevent any harms to consumers in the aftermarkets, the dissent never makes plain why the Court should accept that theory on faith rather than requiring the usual evidence needed to win a summary judgment motion.

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III. Respondents also claim that they have presented genuine issues for trial as to whether Kodak has monopolized, or attempted to monopolize, the service and parts mar-kets in violation of §2 of the Sherman Act. “The offense of monopoly under §2 of the Sherman Act has two elements: (1) the possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or his-toric accident.” Grinnell.

A. The existence of the first element, possession of monopoly power, is eas-ily resolved. As has been noted, respondents have presented a triable claim that service and parts are separate markets, and that Kodak has the “power to control prices or ex-clude competition” in service and parts. duPont. Monopoly power under §2 requires, of course, something greater than market power under §1. Respondents’ evidence that Ko-dak controls nearly 100% of the parts market and 80% to 95% of the service market, with no readily available substitutes, is, however, sufficient to survive summary judgment un-der the more stringent monopoly standard of §2. Cf. Grinnell (87% of the market is a mo-nopoly); American Tobacco Co. v. U.S., 328 U.S. 781, 797 (1946) (over two-thirds of the market is a monopoly).

Kodak also contends that, as a matter of law, a single brand of a product or ser-vice can never be a relevant market under the Sherman Act. We disagree. The relevant market for antitrust purposes is determined by the choices available to Kodak equipment owners. See Jefferson Parish. Because service and parts for Kodak equipment are not interchangeable with other manufacturers’ service and parts, the relevant market from the Kodak equipment owner’s perspective is composed of only those companies that service Kodak machines. See Du Pont (“The market is composed of products that have reason-able interchangeability”). This Court’s prior cases support the proposition that in some instances one brand of a product can constitute a separate market. See NCAA; Interna-tional Boxing Club of New York v. U.S., 358 U.S. 242, 249-252 (1959). The proper mar-ket definition in this case can be determined only after a factual inquiry into the “com-mercial realities” faced by consumers. Grinnell.

B. The second element of a §2 claim is the use of monopoly power “to foreclose competition, to gain a competitive advantage, or to destroy a competitor.” U.S. v. Grif-fith, 334 U.S. 100, 107 (1948). If Kodak adopted its parts and service policies as part of a scheme of willful acquisition or maintenance of monopoly power, it will have violated §2. Grinnell; [Alcoa]; Aspen Skiing.32

As recounted at length above, respondents have presented evidence that Kodak took exclusionary action to maintain its parts monopoly and used its control over parts to strengthen its monopoly share of the Kodak service market. Liability turns, then, on whether “valid business reasons” can explain Kodak’s actions. Aspen Skiing; Alcoa. …

Kodak first asserts that by preventing customers from using ISO’s, “it [can] best maintain high quality service for its sophisticated equipment” and avoid being “blamed for an equipment malfunction, even if the problem is the result of improper diagnosis,

32 It is true that as a general matter a firm can refuse to deal with its competitors. But such a right is not absolute; it exists only if there are legitimate competitive reasons for the refusal. See As-pen Skiing.

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maintenance or repair by an ISO.” Respondents have offered evidence that ISO’s pro-vide quality service and are preferred by some Kodak equipment owners. This is suffi-cient to raise a genuine issue of fact. …

Moreover, there are other reasons to question Kodak’s proffered motive of com-mitment to quality service; its quality justification appears inconsistent with its thesis that consumers are knowledgeable enough to lifecycle price, and its self-service policy. Kodak claims the exclusive-service contract is warranted because customers would other-wise blame Kodak equipment for breakdowns resulting from inferior ISO service. Thus, Kodak simultaneously claims that its customers are sophisticated enough to make com-plex and subtle lifecycle-pricing decisions, and yet too obtuse to distinguish which break-downs are due to bad equipment and which are due to bad service. Kodak has failed to offer any reason why informational sophistication should be present in one circumstance and absent in the other. In addition, because self-service customers are just as likely as others to blame Kodak equipment for breakdowns resulting from (their own) inferior ser-vice, Kodak’s willingness to allow self-service casts doubt on its quality claim. In sum, we agree with the Court of Appeals that respondents “have presented evidence from which a reasonable trier of fact could conclude that Kodak’s first reason is pretextual.” …

Nor does Kodak’s final justification entitle it to summary judgment on respon-dents’ §2 claim. Kodak claims that its policies prevent ISO’s from “exploit[ing] the in-vestment Kodak has made in product development, manufacturing and equipment sales in order to take away Kodak’s service revenues.” Kodak does not dispute that respondents invest substantially in the service market, with training of repair workers and investment in parts inventory. Instead, according to Kodak, the ISO’s are free-riding because they have failed to enter the equipment and parts markets. This understanding of free-riding has no support in our case law. To the contrary, as the Court of Appeals noted, one of the evils proscribed by the antitrust laws is the creation of entry barriers to potential competi-tors by requiring them to enter two markets simultaneously. Jefferson Parish. …

IV. In the end, of course, Kodak’s arguments may prove to be correct. It may be that its parts, service, and equipment are components of one unified market, or that the equip-ment market does discipline the aftermarkets so that all three are priced competitively overall, or that any anti-competitive effects of Kodak’s behavior are outweighed by its competitive effects. But we cannot reach these conclusions as a matter of law on a record this sparse. Accordingly, the judgment of the Court of Appeals denying summary judg-ment is affirmed.

Justice SCALIA, with whom Justice O’CONNOR and Justice THOMAS join, dis-senting: This is not, as the Court describes it, just “another case that concerns the stan-dard for summary judgment in an antitrust controversy.” Rather, the case presents a very narrow–but extremely important–question of substantive antitrust law: whether, for pur-poses of applying our per se rule condemning “ties,” and for purposes of applying our ex-acting rules governing the behavior of would-be monopolists, a manufacturer’s conceded lack of power in the interbrand market for its equipment is somehow consistent with its possession of “market,” or even “monopoly,” power in wholly derivative aftermarkets for that equipment. In my view, the Court supplies an erroneous answer to this question, and I dissent.

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I. … The concerns … that have led the courts to heightened scrutiny both of the “exclu-sionary conduct” practiced by a monopolist and of tying arrangements subject to per se prohibition, are completely without force when the participants lack market power. … The Court today finds in the typical manufacturer’s inherent power over its own brand of equipment–over the sale of distinctive repair parts for that equipment, for example–the sort of “monopoly power” sufficient to bring the sledgehammer of §2 into play. And, not surprisingly in light of that insight, it readily labels single-brand power over aftermarket products “market power” sufficient to permit an antitrust plaintiff to invoke the per se rule against tying. In my opinion, this makes no economic sense. The holding that mar-ket power can be found on the present record causes these venerable rules of selective proscription to extend well beyond the point where the reasoning that supports them leaves off. Moreover, because the sort of power condemned by the Court today is pos-sessed by every manufacturer of durable goods with distinctive parts, the Court’s opinion threatens to release a torrent of litigation and a flood of commercial intimidation that will do much more harm than good to enforcement of the antitrust laws and to genuine com-petition. … [N]either logic nor experience suggests, let alone compels, application of the per se tying prohibition and monopolization doctrine to a seller’s behavior in its single-brand aftermarkets, when that seller is without power at the interbrand level.

II. … A. We must assume, for purposes of deciding this case, that petitioner is without market, much less monopoly, power in the interbrand markets for its micrographic and photocopying equipment. In the District Court, respondents did, in fact, include in their complaint an allegation which posited the interbrand equipment markets as the relevant markets; in particular, they alleged a §1 “tie” of micrographic and photocopying equip-ment to the parts and service for those machines. Though this allegation was apparently abandoned in pursuit of §§1 and 2 claims focused exclusively on the parts and service af-termarkets (about which more later), I think it helpful to analyze how that claim would have fared under the per se rule.

Had Kodak–from the date of its entry into the micrographic and photocopying equipment markets–included a lifetime parts and service warranty with all original equip-ment, or required consumers to purchase a lifetime parts and service contract with each machine, that bundling of equipment, parts, and service would no doubt constitute a tie under the tests enunciated in Jefferson Parish. Nevertheless, it would be immune from per se scrutiny under the antitrust laws because the tying product would be equipment, a market in which (we assume) Kodak has no power to influence price or quantity. The same result would obtain, I think, had Kodak–from the date of its market entry–consis-tently pursued an announced policy of limiting parts sales in the manner alleged in this case, so that customers bought with the knowledge that aftermarket support could be ob-tained only from Kodak. The foreclosure of respondents from the business of servicing Kodak’s micrographic and photocopying machines in these illustrations would be undeni-ably complete–as complete as the foreclosure described in respondents’ complaint. Nonetheless, we would inquire no further than to ask whether Kodak’s market power in the equipment market effectively forced consumers to purchase Kodak micrographic or photocopying machines subject to the company’s restrictive aftermarket practices. If not, that would end the case insofar as the per se rule was concerned. The evils against which the tying prohibition is directed would simply not be presented. Interbrand competition would render Kodak powerless to gain economic power over an additional class of con-

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sumers, to price discriminate by charging each customer a “system” price equal to the system’s economic value to that customer, or to raise barriers to entry in the interbrand equipment markets.

I have described these illustrations as hypothetical, but in fact they are not far re-moved from this case. The record below is consistent–in large part–with just this sort of bundling of equipment on the one hand, with parts and service on the other. …[A]ll post-1985 purchasers of micrographic equipment, like all post-1985 purchasers of new Kodak copiers, could have been aware of Kodak’s parts practices. The only thing lacking to bring all of these purchasers (accounting for the vast bulk of the commerce at issue here) squarely within the hypotheticals we have described is concrete evidence that the restric-tive parts policy was announced or generally known. Thus, under the Court’s approach the [lack of] existence … of such evidence is determinative of the legal standard (the per se rule versus the rule of reason) under which the alleged tie is examined. In my judg-ment, this makes no sense. It is quite simply anomalous that a manufacturer functioning in a competitive equipment market should be exempt from the per se rule when it bundles equipment with parts and service, but not when it bundles parts with service. This vast difference in the treatment of what will ordinarily be economically similar phenomena is alone enough to call today’s decision into question.

B. …[R]espondents sought to sidestep the impediment posed by interbrand com-petition to their invocation of the per se tying rule by zeroing in on the parts and service “aftermarkets” for Kodak equipment. By alleging a tie of parts to service, rather than of equipment to parts and service, they identified a tying product in which Kodak unques-tionably held a near-monopoly share: the parts uniquely associated with Kodak’s brand of machines. The Court today holds that such a facial showing of market share in a sin-gle-brand aftermarket is sufficient to invoke the per se rule. The existence of even vi-brant interbrand competition is no defense. I find this a curious form of market power on which to premise the application of a per se proscription. It is enjoyed by virtually every manufacturer of durable goods requiring aftermarket support with unique, or relatively unique, goods.1 Under the Court’s analysis, the per se rule may now be applied to single-brand ties effected by the most insignificant players in fully competitive interbrand mar-kets, as long as the arrangement forecloses aftermarket competitors from more than a de

1 That there exist innumerable parts and service firms in such industries as the automobile indus-try … does not detract from this point. The question whether power to control an aftermarket ex-ists is quite distinct from the question whether the power has been exercised. Manufacturers in some markets have no doubt determined that exclusionary intrabrand conduct works to their dis -advantage at the competitive interbrand level, but this in no way refutes the self-evident reality that control over unique replacement parts for single-branded goods is ordinarily available to such manufacturers for the taking. It confounds sound analysis to suggest, as respondents do, that the asserted fact that Kodak manufactures only 10% of its replacement parts, and purchases the rest from original equipment manufacturers, casts doubt on Kodak’s possession of an inherent advan-tage in the aftermarkets. It does no such thing, any more than Kodak’s contracting with others for the manufacture of all constituent parts included in its original equipment would alone suggest that Kodak lacks power in the interbrand micrographic and photocopying equipment markets. The suggestion implicit in respondents’ analysis–that if a seller chooses to contract for the manu-facture of its branded merchandise, it must permit the contractors to compete in the sale of that merchandise–is plainly unprecedented.

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minimis amount of business. This seems to me quite wrong. A tying arrangement “forced” through the exercise of such power no more implicates … concerns behind the per se tying prohibition than does a tie of the foremarket brand to its aftermarket deriva-tives, which–as I have explained–would not be subject to per se condemnation.2 …

In the absence of interbrand power, a seller’s predominant or monopoly share of its single-brand derivative markets does not connote the power to raise derivative market prices generally by reducing quantity. As Kodak and its principal amicus, the United States, point out, a rational consumer considering the purchase of Kodak equipment will inevitably factor into his purchasing decision the expected cost of aftermarket support. … If Kodak set generally supracompetitive prices for either spare parts or repair services without making an offsetting reduction in the price of its machines, rational consumers would simply turn to Kodak’s competitors for photocopying and micrographic systems. True, there are–as the Court notes –the occasional irrational consumers that consider only the hardware cost at the time of purchase (a category that regrettably includes the Federal Government, whose “purchasing system,” we are told, assigns foremarket purchases and aftermarket purchases to different entities). But we have never before premised the appli-cation of antitrust doctrine on the lowest common denominator of consumer.

The Court attempts to counter this theoretical point with a theory of its own. It says that there are “information costs”–the costs and inconvenience to the consumer of acquiring and processing life-cycle pricing data for Kodak machines–that “could create a less responsive connection between service and parts prices and equipment sales.” But this truism about the functioning of markets for sophisticated equipment cannot create “market power” of concern to the antitrust laws where otherwise there is none. “Informa-tion costs,” or, more accurately, gaps in the availability and quality of consumer informa-tion, pervade real-world markets; and because consumers generally make do with “rough cut” judgments about price in such circumstances, in virtually any market there are zones within which otherwise competitive suppliers may overprice their products without losing appreciable market share. We have never suggested that the principal players in a market with such commonplace informational deficiencies (and, thus, bands of apparent con-sumer pricing indifference) exercise market power in any sense relevant to the antitrust laws. …

Respondents suggest that, even if the existence of interbrand competition prevents Kodak from raising prices generally in its single-brand aftermarkets, there remain certain consumers who are necessarily subject to abusive Kodak pricing behavior by reason of their being “locked in” to their investments in Kodak machines. The Court agrees; in-2 Even with interbrand power, I may observe, it is unlikely that Kodak could have incrementally exploited its position through the tie of parts to service alleged here. Most of the “service” at is-sue is inherently associated with the parts, i.e., that service involved in incorporating the parts into Kodak equipment, and the two items tend to be demanded by customers in fixed proportions (one part with one unit of service necessary to install the part). When that situation obtains, “ ‘no revenue can be derived from setting a higher price for the tied product which could not have been made by setting the optimum price for tying product.’” P.AREEDA & L. KAPLOW, ANTITRUST ANALYSIS ¶426(a), at 706 (4th ed. 1988) (quoting Bowman, Tying Arrangements and the Lever-age Problem, 67 YALE L.J. 19 (1957)). These observations strongly suggest that Kodak parts and the service involved in installing them should not be treated as distinct products for antitrust tying purposes. …

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deed, it goes further by suggesting that even a general policy of supracompetitive after-market prices might be profitable over the long run because of the “lock-in” phenome-non. “[A] seller profitably could maintain supracompetitive prices in the aftermarket,” the Court explains, “if the switching costs were high relative to the increase in service prices, and the number of locked-in customers were high relative to the number of new purchasers.” In speculating about this latter possibility, the Court is essentially repudiat-ing the assumption on which we are bound to decide this case, viz., Kodak’s lack of any power whatsoever in the interbrand market. If Kodak’s general increase in aftermarket prices were to bring the total “system” price above competitive levels in the interbrand market, Kodak would be wholly unable to make further foremarket sales–and would find itself exploiting an ever-dwindling aftermarket, as those Kodak micrographic and photo-copying machines already in circulation passed into disuse.

The Court’s narrower point, however, is undeniably true. There will be con-sumers who, because of their capital investment in Kodak equipment, “will tolerate some level of service-price increases before changing equipment brands,” ibid.; this is neces-sarily true for “every maker of unique parts for its own product.” AREEDA & HOVENKAMP, ANTITRUST LAW ¶525.1b, at 563. But this “circumstantial” leverage cre-ated by consumer investment regularly crops up in smoothly functioning, even perfectly competitive, markets, and in most–if not all–of its manifestations, it is of no concern to the antitrust laws. The leverage held by the manufacturer of a malfunctioning refrigerator (which is measured by the consumer’s reluctance to walk away from his initial invest-ment in that device) is no different in kind or degree from the leverage held by the swim-ming pool contractor when he discovers a 5-ton boulder in his customer’s backyard and demands an additional sum of money to remove it; or the leverage held by an airplane manufacturer over an airline that has “standardized” its fleet around the manufacturer’s models; or the leverage held by a drill press manufacturer whose customers have built their production lines around the manufacturer’s particular style of drill press; or the leverage held by an insurance company over its independent sales force that has invested in company-specific paraphernalia…. Leverage, in the form of circumstantial power, plays a role in each of these relationships; but in none of them is the leverage attributable to the dominant party’s market power in any relevant sense. …

The Court correctly observes that the antitrust laws do not permit even a natural monopolist to project its monopoly power into another market…. However, when a man-ufacturer uses its control over single-branded parts to acquire influence in single-branded service, the monopoly “leverage” is almost invariably of no practical consequence, be-cause of perfect identity between the consumers in each of the subject aftermarkets (those who need replacement parts for Kodak equipment and those who need servicing of Ko-dak equipment). When that condition exists, the tie does not permit the manufacturer to project power over a class of consumers distinct from that which it is already able to ex-ploit (and fully) without the inconvenience of the tie.

We have never before accepted the thesis the Court today embraces: that a seller’s inherent control over the unique parts for its own brand amounts to “market power” of a character sufficient to permit invocation of the per se rule against tying. As the Court observes, we have applied the per se rule to manufacturer ties of foremarket equipment to aftermarket derivatives–but only when the manufacturer’s monopoly power

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in the equipment, coupled with the use of derivative sales as “counting devices” to mea-sure the intensity of customer equipment usage, enabled the manufacturer to engage in price discrimination, and thereby more fully exploit its interbrand power. That sort of en-during opportunity to engage in price discrimination is unavailable to a manufacturer–like Kodak–that lacks power at the interbrand level. A tie between two aftermarket de-rivatives does next to nothing to improve a competitive manufacturer’s ability to extract monopoly rents from its consumers.3 …

We have recognized in closely related contexts that the deterrent effect of inter-brand competition on the exploitation of intrabrand market power should make courts ex-ceedingly reluctant to apply rules of per se illegality to intrabrand restraints. For in-stance, we have refused to apply a rule of per se illegality to vertical nonprice restraints “because of their potential for a simultaneous reduction of intrabrand competition and stimulation of interbrand competition,” Sylvania, the latter of which we described as “the primary concern of antitrust law,” id. We noted, for instance, that “new manufacturers and manufacturers entering new markets can use the restrictions in order to induce com-petent and aggressive retailers to make the kind of investment of capital and labor that is often required in the distribution of products unknown to the consumer,” and that “[e]sta-blished manufacturers can use them to induce retailers to engage in promotional activities or to provide service and repair facilities necessary to the efficient marketing of their products.” Id. The same assumptions, in my opinion, should govern our analysis of ties alleged to have been “forced” solely through intrabrand market power. In the absence of interbrand power, a manufacturer’s bundling of aftermarket products may serve a multi-tude of legitimate purposes: It may facilitate manufacturer efforts to ensure that the equipment remains operable and thus protect the seller’s business reputation; it may cre-

3 The Court insists that the record in this case suggests otherwise, i.e., that a tie between parts and service somehow does enable Kodak to increase overall monopoly profits. Although the Court does not identify the record evidence on which it relies, the suggestion, apparently, is that such a tie facilitates price discrimination between sophisticated, “high-volume” users of Kodak equip-ment and their unsophisticated counterparts. The sophisticated users (who, the Court presumes, invariably self-service their equipment) are permitted to buy Kodak parts without also purchasing supracompetitively priced Kodak service, while the unsophisticated are–through the imposition of the tie–compelled to buy both.While superficially appealing, at bottom this explanation lacks coherence. Whether they self-ser-vice their equipment or not, rational foremarket consumers (those consumers who are not yet “locked in” to Kodak hardware) will be driven to Kodak’s competitors if the price of Kodak equipment, together with the expected cost of aftermarket support, exceeds competitive levels. This will be true no matter how Kodak distributes the total system price among equipment, parts, and service. Thus, as to these consumers, Kodak’s lack of interbrand power wholly prevents it from employing a tie between parts and service as a vehicle for price discrimination. Nor does a tie between parts and service offer Kodak incremental exploitative power over those consumers–sophisticated or not–who have the supposed misfortune of being “locked in” to Kodak equip-ment. If Kodak desired to exploit its circumstantial power over this wretched class by pressing them up to the point where the cost to each consumer of switching equipment brands barely ex-ceeded the cost of retaining Kodak equipment and remaining subject to Kodak’s abusive prac -tices, it could plainly do so without the inconvenience of a tie, through supracompetitive parts pricing alone. Since the locked-in sophisticated parts purchaser is as helpless as the locked-in un-sophisticated one, I see nothing to be gained by price discrimination in favor of the former. …

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ate the conditions for implicit consumer financing of the acquisition cost of the tying equipment through supracompetitively-priced aftermarket purchases; and it may, through the resultant manufacturer control of aftermarket activity, “yield valuable information about component or design weaknesses that will materially contribute to product im-provement,” 3 AREEDA & TURNER ¶733c, at 258-259. Because the interbrand market will generally punish intrabrand restraints that consumers do not find in their interest, we should not–under the guise of a per se rule–condemn such potentially procompetitive ar-rangements simply because of the antitrust defendant’s inherent power over the unique parts for its own brand.

I would instead evaluate the aftermarket tie alleged in this case under the rule of reason, where the tie’s actual anticompetitive effect in the tied product market, together with its potential economic benefits, can be fully captured in the analysis. Disposition of this case does not require such an examination, however, as respondents apparently waived any rule-of-reason claim they may have had in the District Court. I would thus reverse the Ninth Circuit’s judgment on the tying claim outright.

III. These considerations apply equally to respondents’ §2 claims. An antitrust defen-dant lacking relevant “market power” sufficient to permit invocation of the per se prohi-bition against tying a fortiori lacks the monopoly power that warrants heightened scrutiny of his allegedly exclusionary behavior. Without even so much as asking whether the pur-poses of §2 are implicated here, the Court points to Kodak’s control of “100% of the parts market and 80% to 95% of the service market,” markets with “no readily available substitutes,” and finds that the proffer of such statistics is sufficient to fend off summary judgment. But this showing could easily be made, as I have explained, with respect to virtually any manufacturer of differentiated products requiring aftermarket support. By permitting antitrust plaintiffs to invoke §2 simply upon the unexceptional demonstration that a manufacturer controls the supplies of its single-branded merchandise, the Court transforms §2 from a specialized mechanism for responding to extraordinary agglomera-tions (or threatened agglomerations) of economic power to an all-purpose remedy against run-of-the-mill business torts.

In my view, if the interbrand market is vibrant, it is simply not necessary to enlist §2’s machinery to police a seller’s intrabrand restraints. In such circumstances, the inter-brand market functions as an infinitely more efficient and more precise corrective to such behavior, rewarding the seller whose intrabrand restraints enhance consumer welfare while punishing the seller whose control of the aftermarkets is viewed unfavorably by in-terbrand consumers. Because this case comes to us on the assumption that Kodak is with-out such interbrand power, I believe we are compelled to reverse the judgment of the Court of Appeals. I respectfully dissent.

$ $ $ $ $ $ $POST- KODAK CASELAW

A. Many claims re franchises (Dairy Queen; Jiffy-Lube, etc.)1. Nature of claims:

a. franchisee must use specific product brands to get franchise

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b. big investment in franchise arguably locks in franchisee as in Kodak 2. Cases split

a. some cts: Kodak doesn’t apply once franchise agreement signed. E.g., Queen City (3d Cir 1997): Franchisees purchase tied products because bound by contract, not forced by market power b. other cts: more expensive than switching costs at issue in Kodak, so can force franchisee to buy fungible stuff from manufacturer at market or above-market pricec. distinctions from Kodak:

i) franchisee effectively acting as dealers of common productii) franchisee not consumer; market can discipline bad ties

B. Kodak distinguished where purchasers know of policy in advance1. Several Circuits & S.D. Fla (E.g., Honeywell (6th Cir. 1997))2. Facts similar to Kodak except policy in place before all sales3. Can’t succeed on Kodak claim w/o market power in product market unless tie is change in policy or policy hidden

C. Kodak on remand1. 9/95 jury verdict for Ps: $23.9million (trebled)2. 9th Cir largely affirms in 1997

a. about ½ of verdict affirmed; most of rest remandedb. affirms market definition put forward by ISO’sc. affirms jury finding of monopoly power d. §2 violation for refusal to deal

i) rejects claim that monopolist only liable for refusal to deal if it denies ac-cess to essential input ii) violation if w/o business justification

A) here: Kodak claimed protecting patents in partsB) possible defense but here only 65 of 1000s of parts patented

D. Illinois Tool Works (U.S. 2006): Overturns longstanding presumption that if the tying product is patented, the patent holder has market power for purposes of tying analysis.

2. Complexities of High-Tech Markets: The Microsoft Litigation

U.S. v. MICROSOFT CORPORATION(D.C. Cir. 2001) (en banc)

PER CURIAM: Microsoft Corporation appeals from judgments of the District Court finding the company in violation of §§1 and 2 of the Sherman Act and ordering various remedies. … The District Court determined that Microsoft had maintained a monopoly in the market for Intel compatible PC operating systems in violation of §2; attempted to gain a monopoly in the market for internet browsers in violation of §2; and illegally tied two purportedly separate products, Windows and Internet Explorer (“IE”), in violation of

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§1. … To remedy the Sherman Act violations, the District Court issued a Final Judgment requiring Microsoft to submit a proposed plan of divestiture, with the company to be split into an operating systems business and an applications business. The District Court’s re-medial order also contains a number of interim restrictions on Microsoft’s conduct. …

After carefully considering the voluminous record on appeal--including the Dis-trict Court’s Findings of Fact and Conclusions of Law, the testimony and exhibits submit-ted at trial, the parties’ briefs, and the oral arguments before this court--we find that some but not all of Microsoft’s liability challenges have merit. Accordingly, we affirm in part and reverse in part the District Court’s judgment that Microsoft violated §2 of the Sher-man Act by employing anticompetitive means to maintain a monopoly in the operating system market; we reverse the District Court’s determination that Microsoft violated §2 of the Sherman Act by illegally attempting to monopolize the internet browser market; and we remand the District Court’s finding that Microsoft violated §1 of the Sherman Act by unlawfully tying its browser to its operating system. …

We also find merit in Microsoft’s challenge to the Final Judgment embracing the District Court’s remedial order. There are several reasons supporting this conclusion. First, the District Court’s Final Judgment rests on a number of liability determinations that do not survive appellate review; therefore, the remedial order as currently fashioned cannot stand. Furthermore, we would vacate and remand the remedial order even were we to uphold the District Court’s liability determinations in their entirety, because the District Court failed to hold an evidentiary hearing to address remedies-specific factual disputes.

Finally, we vacate the Final Judgment on remedies, because the trial judge en-gaged in impermissible ex parte contacts by holding secret interviews with members of the media and made numerous offensive comments about Microsoft officials in public statements outside of the courtroom, giving rise to an appearance of partiality. Although we find no evidence of actual bias, we hold that the actions of the trial judge seriously tainted the proceedings before the District Court and called into question the integrity of the judicial process. We are therefore constrained to vacate the Final Judgment on reme-dies, remand the case for reconsideration of the remedial order, and require that the case be assigned to a different trial judge on remand. We believe that this disposition will be adequate to cure the cited improprieties. …

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I. INTRODUCTION

A. Background. In July 1994, officials at the Department of Justice (“DOJ”), on behalf of the U.S., filed suit against Microsoft, charging the company with, among other things, unlawfully maintaining a monopoly in the operating system market through anti-competitive terms in its licensing and software developer agreements. The parties subse-quently entered into a consent decree, thus avoiding a trial on the merits. (“Microsoft I”). Three years later, the Justice Department filed a civil contempt action against Microsoft for allegedly violating one of the decree’s provisions. On appeal from a grant of a pre-liminary injunction, this court held that Microsoft’s technological bundling of IE 3.0 and 4.0 with Windows 95 did not violate the relevant provision of the consent decree. (“Microsoft II”). We expressly reserved the question whether such bundling might inde-pendently violate §§1 or 2 of the Sherman Act.

… [S]hortly before issuance of the Microsoft II decision, the U.S. and a group of State plaintiffs filed separate (and soon thereafter consolidated) complaints, asserting an-titrust violations by Microsoft…. Relying almost exclusively on Microsoft’s varied ef-forts to unseat Netscape Navigator as the preeminent internet browser, plaintiffs charged four distinct violations of the Sherman Act: (1) unlawful exclusive dealing arrangements in violation of §1; (2) unlawful tying of IE to Windows 95 and Windows 98 in violation of §1; (3) unlawful maintenance of a monopoly in the PC operating system market in vi-olation of §2; and (4) unlawful attempted monopolization of the internet browser market in violation of §2. …

The District Court scheduled the case on a “fast track.” The hearing on the pre-liminary injunction and the trial on the merits were consolidated…. The trial was then scheduled to commence … less than four months after the complaints had been filed. In a series of pretrial orders, the District Court limited each side to a maximum of 12 trial witnesses plus two rebuttal witnesses. It required that all trial witnesses’ direct testi-mony be submitted to the court in the form of written declarations. …

After a 76-day bench trial, the District Court issued its Findings of Fact. This trig-gered two independent courses of action. First, the District Court established a schedule for briefing on possible legal conclusions, inviting Professor Lawrence Lessig to partici-pate as amicus curiae. Second, the District Court referred the case to mediation to afford the parties an opportunity to settle their differences. The Honorable Richard A. Posner, Chief Judge of the U.S. Court of Appeals for the Seventh Circuit, was appointed to serve as mediator. The parties concurred in the referral to mediation and in the choice of me-diator.

Mediation failed after nearly four months of settlement talks between the parties. … [W]ith the parties’ briefs having been submitted and considered, the District Court is-sued its conclusions of law. The District Court found Microsoft liable on the §1 tying and §2 monopoly maintenance and attempted monopolization claims, while ruling that there was insufficient evidence to support a §1 exclusive dealing violation. …

Having found Microsoft liable on all but one count, the District Court then asked plaintiffs to submit a proposed remedy. Plaintiffs’ proposal for a remedial order was subsequently filed within four weeks, along with six supplemental declarations and over 50 new exhibits. In their proposal, plaintiffs sought specific conduct remedies, plus

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structural relief that would split Microsoft into an applications company and an operating systems company. The District Court rejected Microsoft’s request for further evidentiary proceedings and, following a single hearing on the merits of the remedy question, issued its Final Judgment…. The District Court adopted plaintiffs’ proposed remedy without substantive change. …

B. Overview. Before turning to the merits of Microsoft’s various arguments, we pause to reflect briefly on two matters of note, one practical and one theoretical. The practical matter relates to the temporal dimension of this case. The litigation timeline in this case is hardly problematic. Indeed, it is noteworthy that a case of this magnitude and complexity has proceeded from the filing of complaints through trial to appellate de-cision in a mere three years. …

What is somewhat problematic, however, is that just over six years have passed since Microsoft engaged in the first conduct plaintiffs allege to be anticompetitive. As the record in this case indicates, six years seems like an eternity in the computer industry. By the time a court can assess liability, firms, products, and the marketplace are likely to have changed dramatically. This, in turn, threatens enormous practical difficulties for courts considering the appropriate measure of relief in equitable enforcement actions, both in crafting injunctive remedies in the first instance and reviewing those remedies in the second. Conduct remedies may be unavailing in such cases, because innovation to a large degree has already rendered the anticompetitive conduct obsolete (although by no means harmless). And broader structural remedies present their own set of problems, in-cluding how a court goes about restoring competition to a dramatically changed, and con-stantly changing, marketplace. That is just one reason why we find the District Court’s refusal in the present case to hold an evidentiary hearing on remedies--to update and flesh out the available information before seriously entertaining the possibility of dramatic structural relief--so problematic. We do not mean to say that enforcement actions will no longer play an important role in curbing infringements of the antitrust laws in technologically dynamic markets, nor do we assume this in assessing the merits of this case. Even in those cases where forward-looking remedies appear limited, the Government will continue to have an inter-est in defining the contours of the antitrust laws so that law-abiding firms will have a clear sense of what is permissible and what is not. And the threat of private damage ac-tions will remain to deter those firms inclined to test the limits of the law. The second matter of note is more theoretical in nature. We decide this case against a backdrop of significant debate amongst academics and practitioners over the ex-tent to which “old economy” §2 monopolization doctrines should apply to firms compet-ing in dynamic technological markets characterized by network effects. In markets char-acterized by network effects, one product or standard tends towards dominance, because “the utility that a user derives from consumption of the good increases with the number of other agents consuming the good.” Michael L. Katz & Carl Shapiro, Network Exter-nalities, Competition, and Compatibility, 75 AM. ECON. REV. 424, 424 (1985). For ex-ample, “[a]n individual consumer’s demand to use (and hence her benefit from) the tele-phone network ... increases with the number of other users on the network whom she can call or from whom she can receive calls.” Howard A. Shelanski & J. Gregory Sidak, An-titrust Divestiture in Network Industries, 68 U. CHI. L. REV. 1, 8 (2001). Once a product

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or standard achieves wide acceptance, it becomes more or less entrenched. Competition in such industries is “for the field” rather than “within the field.” See Harold Demsetz, Why Regulate Utilities?, 11 J.L. & ECON. 55, 57 & n.7 (1968) (emphasis omitted). In technologically dynamic markets, however, such entrenchment may be tempo-rary, because innovation may alter the field altogether. See JOSEPH A. SCHUMPETER, CAPITALISM, SOCIALISM AND DEMOCRACY 81-90 (Harper Perennial 1976) (1942). Rapid technological change leads to markets in which “firms compete through innovation for temporary market dominance, from which they may be displaced by the next wave of product advancements.” Shelanski & Sidak at 11-12 (discussing Schumpeterian compe-tition, which proceeds “sequentially over time rather than simultaneously across a mar-ket”). Microsoft argues that the operating system market is just such a market. Whether or not Microsoft’s characterization of the operating system market is correct does not appreciably alter our mission in assessing the alleged antitrust violations in the present case. As an initial matter, we note that there is no consensus among com-mentators on the question of whether, and to what extent, current monopolization doc-trine should be amended to account for competition in technologically dynamic markets characterized by network effects. Compare Steven C. Salop & R. Craig Romaine, Pre-serving Monopoly: Economic Analysis, Legal Standards, and Microsoft, 7 GEO. MASON L. REV . 617, 654-55, 663-64 (1999) (arguing that exclusionary conduct in high-tech net-worked industries deserves heightened antitrust scrutiny in part because it may threaten to deter innovation), with Ronald A. Cass & Keith N. Hylton, Preserving Competition: Economic Analysis, Legal Standards and Microsoft, 8 Geo. Mason L. Rev. 1, 36-39 (1999) (equivocating on the antitrust implications of network effects and noting that the presence of network externalities may actually encourage innovation by guaranteeing more durable monopolies to innovating winners). Indeed, there is some suggestion that the economic consequences of network effects and technological dynamism act to offset one another, thereby making it difficult to formulate categorical antitrust rules absent a particularized analysis of a given market. See Shelanski & Sidak at 6-7 (“High profit margins might appear to be the benign and necessary recovery of legitimate investment returns in a Schumpeterian framework, but they might represent exploitation of customer lock-in and monopoly power when viewed through the lens of network economics.... The issue is particularly complex because, in network industries characterized by rapid innovation, both forces may be operating and can be difficult to isolate.”).

Moreover, it should be clear that Microsoft makes no claim that anticompetitive conduct should be assessed differently in technologically dynamic markets. It claims only that the measure of monopoly power should be different. For reasons fully dis-cussed below, we reject Microsoft’s monopoly power argument. …

II. MONOPOLIZATION. … The District Court … found that Microsoft possesses monopoly power in the market for Intel-compatible PC operating systems. Focusing pri-marily on Microsoft’s efforts to suppress Netscape Navigator’s threat to its operating sys-tem monopoly, the court also found that Microsoft maintained its power not through competition on the merits, but through unlawful means. Microsoft challenges both con-clusions. We defer to the District Court’s findings of fact, setting them aside only if clearly erroneous. We review legal questions de novo.

We begin by considering whether Microsoft possesses monopoly power, see in-

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fra Section II.A, and finding that it does, we turn to the question whether it maintained this power through anticompetitive means. Agreeing with the District Court that the company behaved anticompetitively, see infra Section II.B, and that these actions con-tributed to the maintenance of its monopoly power, see infra Section II.C, we affirm the court’s finding of liability for monopolization.

A. Monopoly Power. … The District Court … concluded that Microsoft possesses monopoly power in a relevant market. Defining the market as Intel-compatible PC oper-ating systems, the District Court found that Microsoft has a greater than 95% share. It also found the company’s market position protected by a substantial entry barrier. … Microsoft argues that the District Court incorrectly defined the relevant market. It also claims that there is no barrier to entry in that market. Alternatively, Microsoft argues that because the software industry is uniquely dynamic, direct proof, rather than circum-stantial evidence, more appropriately indicates whether it possesses monopoly power. Re-jecting each argument, we uphold the District Court’s finding of monopoly power in its entirety.

1. Market Structure

a. Market definition. … In this case, the District Court defined the market as “the licensing of all Intel-compatible PC operating systems worldwide,” find-ing that there are “currently no products—and ... there are not likely to be any in the near future—that a significant percentage of computer users worldwide could substitute for [these operating systems] without incurring substantial costs.” … Microsoft argues that the District Court improperly excluded three types of products: non-Intel compatible op-erating systems (primarily Apple’s Macintosh operating system, Mac OS), operating sys-tems for non-PC devices (such as handheld computers and portal websites), and “middle-ware” products, which are not operating systems at all.

We begin with Mac OS. Microsoft’s argument that Mac OS should have been in-cluded in the relevant market suffers from a flaw that infects many of the company’s mo-nopoly power claims: the company fails to challenge the District Court’s factual find-ings, or to argue that these findings do not support the court’s conclusions. The District Court found that consumers would not switch from Windows to Mac OS in response to a substantial price increase because of the costs of acquiring the new hardware needed to run Mac OS (an Apple computer and peripherals) and compatible software applications, as well as because of the effort involved in learning the new system and transferring files to its format. The court also found the Apple system less appealing to consumers because it costs considerably more and supports fewer applications. Microsoft responds only by saying: “the district court’s market definition is so narrow that it excludes Apple’s Mac OS, which has competed with Windows for years, simply because the Mac OS runs on a different microprocessor.” This general, conclusory statement falls far short of what is re-quired to challenge findings as clearly erroneous. Microsoft neither points to evidence contradicting the District Court’s findings nor alleges that supporting record evidence is insufficient. And since Microsoft does not argue that even if we accept these findings, they do not support the District Court’s conclusion, we have no basis for upsetting the court’s decision to exclude Mac OS from the relevant market.

Microsoft’s challenge to the District Court’s exclusion of non-PC based competi-

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tors, such as information appliances (handheld devices, etc.) and portal websites that host server-based software applications, suffers from the same defect: the company fails to challenge the District Court’s key factual findings. In particular, the District Court found that because information appliances fall far short of performing all of the functions of a PC, most consumers will buy them only as a supplement to their PCs. The District Court also found that portal websites do not presently host enough applications to induce con-sumers to switch, nor are they likely to do so in the near future. Again, because Microsoft does not argue that the District Court’s findings do not support its conclusion that infor-mation appliances and portal websites are outside the relevant market, we adhere to that conclusion.

This brings us to Microsoft’s main challenge to the District Court’s market defini-tion: the exclusion of middleware. Because of the importance of middleware to this case, we pause to explain what it is and how it relates to the issue before us.

Operating systems perform many functions, including allocating computer mem-ory and controlling peripherals such as printers and keyboards. Operating systems also function as platforms for software applications. They do this by “exposing”—i.e., mak-ing available to software developers—routines or protocols that perform certain widely-used functions. These are known as Application Programming Interfaces, or “APIs.” For example, Windows contains an API that enables users to draw a box on the screen. Soft-ware developers wishing to include that function in an application need not duplicate it in their own code. Instead, they can “call”—i.e., use--the Windows API. Windows contains thousands of APIs, controlling everything from data storage to font display.

Every operating system has different APIs. Accordingly, a developer who writes an application for one operating system and wishes to sell the application to users of an-other must modify, or “port,” the application to the second operating system. This process is both time consuming and expensive.

“Middleware” refers to software products that expose their own APIs. Because of this, a middleware product written for Windows could take over some or all of Win-dows’s valuable platform functions—that is, developers might begin to rely upon APIs exposed by the middleware for basic routines rather than relying upon the API set in-cluded in Windows. If middleware were written for multiple operating systems, its im-pact could be even greater. The more developers could rely upon APIs exposed by such middleware, the less expensive porting to different operating systems would be. Ulti-mately, if developers could write applications relying exclusively on APIs exposed by middleware, their applications would run on any operating system on which the middle-ware was also present. Netscape Navigator and Java—both at issue in this case—are mid-dleware products written for multiple operating systems.

Microsoft argues that, because middleware could usurp the operating system’s platform function and might eventually take over other operating system functions (for instance, by controlling peripherals), the District Court erred in excluding Navigator and Java from the relevant market. The District Court found, however, that neither Naviga-tor, Java, nor any other middleware product could now, or would soon, expose enough APIs to serve as a platform for popular applications, much less take over all operating system functions. Again, Microsoft fails to challenge these findings, instead simply as-

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serting middleware’s “potential” as a competitor. The test of reasonable interchangeabil-ity, however, required the District Court to consider only substitutes that constrain pricing in the reasonably foreseeable future, and only products that can enter the market in a rela-tively short time can perform this function. … Whatever middleware’s ultimate potential, the District Court found that consumers could not now abandon their operating systems and switch to middleware in response to a sustained price for Windows above the com-petitive level. Nor is middleware likely to overtake the operating system as the primary platform for software development any time in the near future.

Alternatively, Microsoft argues that the District Court should not have excluded middleware from the relevant market because the primary focus of the plaintiffs’ §2 charge is on Microsoft’s attempts to suppress middleware’s threat to its operating system monopoly. According to Microsoft, it is “contradict[ory]” to define the relevant market to exclude the “very competitive threats that gave rise” to the action. The purported con-tradiction lies between plaintiffs’ §2 theory, under which Microsoft preserved its monop-oly against middleware technologies that threatened to become viable substitutes for Windows, and its theory of the relevant market, under which middleware is not presently a viable substitute for Windows. Because middleware’s threat is only nascent, however, no contradiction exists. Nothing in §2 of the Sherman Act limits its prohibition to ac-tions taken against threats that are already well-developed enough to serve as present sub-stitutes. Because market definition is meant to identify products “reasonably interchange-able by consumers,” du Pont, and because middleware is not now interchangeable with Windows, the District Court had good reason for excluding middleware from the relevant market.

b. Market power. Having thus properly defined the relevant mar-ket, the District Court found that Windows accounts for a greater than 95% share. The court also found that even if Mac OS were included, Microsoft’s share would exceed 80%. Microsoft challenges neither finding, nor does it argue that such a market share is not predominant. Cf. Grinnell, (87% is predominant); Eastman Kodak (80%); du Pont (75%). Instead, Microsoft claims that even a predominant market share does not by itself indicate monopoly power. Although the “existence of [monopoly] power ordinarily may be inferred from the predominant share of the market,” Grinnell, we agree with Microsoft that because of the possibility of competition from new entrants, looking to current mar-ket share alone can be “misleading.”

In this case, however, the District Court was not misled. Considering the possi-bility of new rivals, the court focused not only on Microsoft’s present market share, but also on the structural barrier that protects the company’s future position. That barrier—the “applications barrier to entry”--stems from two characteristics of the software market: (1) most consumers prefer operating systems for which a large number of applications have already been written; and (2) most developers prefer to write for operating systems that already have a substantial consumer base. This “chicken-and-egg” situation ensures that applications will continue to be written for the already dominant Windows, which in turn ensures that consumers will continue to prefer it over other operating systems.

Challenging the existence of the applications barrier to entry, Microsoft observes that software developers do write applications for other operating systems, pointing out that at its peak IBM’s OS/2 supported approximately 2,500 applications. This misses the

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point. That some developers write applications for other operating systems is not at all inconsistent with the finding that the applications barrier to entry discourages many from writing for these less popular platforms. Indeed, the District Court found that IBM’s dif-ficulty in attracting a larger number of software developers to write for its platform seri-ously impeded OS/2’s success.

Microsoft does not dispute that Windows supports many more applications than any other operating system. It argues instead that “[i]t defies common sense” to suggest that an operating system must support as many applications as Windows does (more than 70,000 …) to be competitive. Consumers, Microsoft points out, can only use a very small percentage of these applications. As the District Court explained, however, the ap-plications barrier to entry gives consumers reason to prefer the dominant operating sys-tem even if they have no need to use all applications written for it:

The consumer wants an operating system that runs not only types of applications that he knows he will want to use, but also those types in which he might develop an inter -est later. Also, the consumer knows that if he chooses an operating system with enough demand to support multiple applications in each product category, he will be less likely to find himself straitened later by having to use an application whose fea -tures disappoint him. Finally, the average user knows that, generally speaking, appli-cations improve through successive versions. He thus wants an operating system for which successive generations of his favorite applications will be released--promptly at that. The fact that a vastly larger number of applications are written for Windows than for other PC operating systems attracts consumers to Windows, because it reassures them that their interests will be met as long as they use Microsoft’s product.

Thus, despite the limited success of its rivals, Microsoft benefits from the applications barrier to entry.

Of course, were middleware to succeed, it would erode the applications barrier to entry. Because applications written for multiple operating systems could run on any op-erating system on which the middleware product was present with little, if any, porting, the operating system market would become competitive. But as the District Court found, middleware will not expose a sufficient number of APIs to erode the applications barrier to entry in the foreseeable future.

Microsoft next argues that the applications barrier to entry is not an entry barrier at all, but a reflection of Windows’ popularity. It is certainly true that Windows may have gained its initial dominance in the operating system market competitively—through superior foresight or quality. But this case is not about Microsoft’s initial acquisition of monopoly power. It is about Microsoft’s efforts to maintain this position through means other than competition on the merits. Because the applications barrier to entry protects a dominant operating system irrespective of quality, it gives Microsoft power to stave off even superior new rivals. The barrier is thus a characteristic of the operating system market, not of Microsoft’s popularity, or, as asserted by a Microsoft witness, the com-pany’s efficiency. Finally, Microsoft argues that the District Court should not have considered the applications barrier to entry because it reflects not a cost borne disproportionately by new entrants, but one borne by all participants in the operating system market. According to Microsoft, it had to make major investments to convince software developers to write for

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its new operating system, and it continues to “evangelize” the Windows platform today. Whether costs borne by all market participants should be considered entry barriers is the subject of much debate. …

We need not resolve this issue, however, for even under the more narrow defini-tion it is clear that there are barriers. When Microsoft entered the operating system mar-ket with MS-DOS and the first version of Windows, it did not confront a dominant rival operating system with as massive an installed base and as vast an existing array of appli-cations as the Windows operating systems have since enjoyed. Moreover, when Microsoft introduced Windows 95 and 98, it was able to bypass the applications barrier to entry that protected the incumbent Windows by including APIs from the earlier ver-sion in the new operating systems. This made porting existing Windows applications to the new version of Windows much less costly than porting them to the operating systems of other entrants who could not freely include APIs from the incumbent Windows with their own.

2. Direct Proof. Having sustained the District Court’s conclusion that circumstantial evidence proves that Microsoft possesses monopoly power, we turn to Mi-crosoft’s alternative argument that it does not behave like a monopolist. Claiming that software competition is uniquely “dynamic,” the company suggests a new rule: that mo-nopoly power in the software industry should be proven directly, that is, by examining a company’s actual behavior to determine if it reveals the existence of monopoly power. According to Microsoft, not only does no such proof of its power exist, but record evi-dence demonstrates the absence of monopoly power. … Microsoft’s argument fails because, even assuming that the software market is uniquely dynamic in the long term, the District Court correctly applied the structural ap-proach to determine if the company faces competition in the short term. Structural mar-ket power analyses are meant to determine whether potential substitutes constrain a firm’s ability to raise prices above the competitive level; only threats that are likely to materialize in the relatively near future perform this function to any significant degree. The District Court expressly considered and rejected Microsoft’s claims that innovations such as handheld devices and portal websites would soon expand the relevant market be-yond Intel-compatible PC operating systems. Because the company does not challenge these findings, we have no reason to believe that prompt substitutes are available. The structural approach, as applied by the District Court, is thus capable of fulfilling its pur-pose even in a changing market. Microsoft cites no case, nor are we aware of one, re-quiring direct evidence to show monopoly power in any market. We decline to adopt such a rule now. Even if we were to require direct proof, moreover, Microsoft’s behavior may well be sufficient to show the existence of monopoly power. Certainly, none of the conduct Microsoft points to—its investment in R&D and the relatively low price of Windows—is inconsistent with the possession of such power. The R&D expenditures Microsoft points to are not simply for Windows, but for its entire company, which most likely does not possess a monopoly for all of its products. Moreover, because innovation can increase an already dominant market share and further delay the emergence of competition, even monopolists have reason to invest in R&D.

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Microsoft’s pricing behavior is similarly equivocal. The company claims only that it never charged the short-term profit-maximizing price for Windows. … [But] a price lower than the short-term profit-maximizing price is not inconsistent with posses-sion or improper use of monopoly power. Cf. Berkey Photo (“[I]f monopoly power has been acquired or maintained through improper means, the fact that the power has not been used to extract [a monopoly price] provides no succor to the monopolist.”). Microsoft never claims that it did not charge the long-term monopoly price. Microsoft does argue that the price of Windows is a fraction of the price of an Intel-compatible PC system and lower than that of rival operating systems, but these facts are not inconsistent with the District Court’s finding that Microsoft has monopoly power. See Findings of Fact (“Intel-compatible PC operating systems other than Windows [would not] attract[ ] significant demand ... even if Microsoft held its prices substantially above the competi-tive level.”). More telling, the District Court found that some aspects of Microsoft’s behavior are difficult to explain unless Windows is a monopoly product. For instance, … the company set the price of Windows without considering rivals’ prices, something a firm without a monopoly would have been unable to do. The District Court also found that Microsoft’s pattern of exclusionary conduct could only be rational “if the firm knew that it possessed monopoly power.” It is to that conduct that we now turn.

B. Anticompetitive Conduct. … In this case, after concluding that Microsoft had monopoly power, the District Court held that Microsoft had violated §2 by engaging in a variety of exclusionary acts (not including predatory pricing), to maintain its monopoly by preventing the effective distribution and use of products that might threaten that mo-nopoly. …

Whether any particular act of a monopolist is exclusionary, rather than merely a form of vigorous competition, can be difficult to discern: the means of illicit exclusion, like the means of legitimate competition, are myriad. The challenge for an antitrust court lies in stating a general rule for distinguishing between exclusionary acts, which re-duce social welfare, and competitive acts, which increase it.

From a century of case law on monopolization under §2, however, several princi-ples do emerge. First, to be condemned as exclusionary, a monopolist’s act must have an “anticompetitive effect.” That is, it must harm the competitive process and thereby harm consumers. In contrast, harm to one or more competitors will not suffice. …

Second, … [i]n a case brought by a private plaintiff, the plaintiff must show that its injury is “of the type that the statute was intended to forestall,” Brunswick Corp. v. Pueblo Bowl-O-Mat, 429 U.S. 477, 487-88, (1977) ; no less in a case brought by the Government, it must demonstrate that the monopolist’s conduct harmed competition, not just a competitor.

Third, if a plaintiff successfully establishes a prima facie case under §2 by demonstrating anticompetitive effect, then the monopolist may proffer a “procompetitive justification” for its conduct. If the monopolist asserts a procompetitive justification—a nonpretextual claim that its conduct is indeed a form of competition on the merits be-cause it involves, for example, greater efficiency or enhanced consumer appeal—then the burden shifts back to the plaintiff to rebut that claim.

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Fourth, if the monopolist’s procompetitive justification stands unrebutted, then the plaintiff must demonstrate that the anticompetitive harm of the conduct outweighs the procompetitive benefit. In cases arising under §1 of the Sherman Act, the courts rou-tinely apply a similar balancing approach under the rubric of the “rule of reason.” …

Finally, in considering whether the monopolist’s conduct on balance harms com-petition and is therefore condemned as exclusionary for purposes of §2, our focus is upon the effect of that conduct, not upon the intent behind it. Evidence of the intent behind the conduct of a monopolist is relevant only to the extent it helps us understand the likely effect of the monopolist’s conduct.

With these principles in mind, we now consider Microsoft’s objections to the Dis-trict Court’s holding that Microsoft violated § 2 of the Sherman Act in a variety of ways.

1. Licenses Issued to Original Equipment Manufacturers. The District Court condemned a number of provisions in Microsoft’s agreements licensing Windows to OEMs, because it found that Microsoft’s imposition of those provisions (like many of Microsoft’s other actions at issue in this case) serves to reduce usage share of Netscape’s browser and, hence, protect Microsoft’s operating system monopoly. The reason market share in the browser market affects market power in the operating system market is com-plex, and warrants some explanation.

Browser usage share is important because … a browser (or any middleware prod-uct, for that matter) must have a critical mass of users in order to attract software devel-opers to write applications relying upon the APIs it exposes, and away from the APIs ex-posed by Windows. Applications written to a particular browser’s APIs, however, would run on any computer with that browser, regardless of the underlying operating sys-tem. “The overwhelming majority of consumers will only use a PC operating system for which there already exists a large and varied set of ... applications, and for which it seems relatively certain that new types of applications and new versions of existing applications will continue to be marketed....” If a consumer could have access to the applications he desired—regardless of the operating system he uses—simply by installing a particular browser on his computer, then he would no longer feel compelled to select Windows in order to have access to those applications; he could select an operating system other than Windows based solely upon its quality and price. In other words, the market for operat-ing systems would be competitive.

Therefore, Microsoft’s efforts to gain market share in one market (browsers) served to meet the threat to Microsoft’s monopoly in another market (operating systems) by keeping rival browsers from gaining the critical mass of users necessary to attract de-veloper attention away from Windows as the platform for software development. …

In evaluating the restrictions in Microsoft’s agreements licensing Windows to OEMs, we first consider whether plaintiffs have made out a prima facie case by demon-strating that the restrictions have an anticompetitive effect. In the next subsection, we conclude that plaintiffs have met this burden as to all the restrictions. We then consider Microsoft’s proffered justifications for the restrictions and, for the most part, hold those justifications insufficient.

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a. Anticompetitive effect of the license restrictions . The restric-tions Microsoft places upon Original Equipment Manufacturers are of particular impor-tance in determining browser usage share because having an OEM pre-install a browser on a computer is one of the two most cost-effective methods by far of distributing brows-ing software. (The other is bundling the browser with internet access software distributed by an IAP.) The District Court found that the restrictions Microsoft imposed in licensing Windows to OEMs prevented many OEMs from distributing browsers other than IE. In particular, the District Court condemned the license provisions prohibiting the OEMs from: (1) removing any desktop icons, folders, or “Start” menu entries; (2) altering the initial boot sequence; and (3) otherwise altering the appearance of the Windows desktop.

The District Court concluded that the first license restriction—the prohibition upon the removal of desktop icons, folders, and Start menu entries—thwarts the distribu-tion of a rival browser by preventing OEMs from removing visible means of user access to IE. The OEMs cannot practically install a second browser in addition to IE, the court found, in part because “[p]re-installing more than one product in a given category ... can significantly increase an OEM’s support costs, for the redundancy can lead to confusion among novice users.” That is, a certain number of novice computer users, seeing two browser icons, will wonder which to use when and will call the OEM’s support line. Support calls are extremely expensive and, in the highly competitive original equipment market, firms have a strong incentive to minimize costs.

Microsoft denies the “consumer confusion” story; it observes that some OEMs do install multiple browsers and that executives from two OEMs that do so denied any knowledge of consumers being confused by multiple icons. Other testimony, however, supports the District Court’s finding that fear of such confusion deters many OEMs from pre-installing multiple browsers. Most telling, in presentations to OEMs, Microsoft itself represented that having only one icon in a particular category would be “less confusing for end users.” Accordingly, we reject Microsoft’s argument that we should vacate the District Court’s Finding of Fact … relate[d] to consumer confusion.

As noted above, the OEM channel is one of the two primary channels for distribu-tion of browsers. By preventing OEMs from removing visible means of user access to IE, the license restriction prevents many OEMs from pre-installing a rival browser and, therefore, protects Microsoft’s monopoly from the competition that middleware might otherwise present. Therefore, we conclude that the license restriction at issue is anticom-petitive. We defer for the moment the question whether that anticompetitive effect is outweighed by Microsoft’s proffered justifications.

The second license provision at issue prohibits OEMs from modifying the initial boot sequence—the process that occurs the first time a consumer turns on the computer. Prior to the imposition of that restriction, “among the programs that many OEMs inserted into the boot sequence were Internet sign-up procedures that encouraged users to choose from a list of IAPs assembled by the OEM.” Microsoft’s prohibition on any alteration of the boot sequence thus prevents OEMs from using that process to promote the services of IAPs, many of which—at least at the time Microsoft imposed the restriction--used Navi-gator rather than IE in their internet access software. Microsoft does not deny that the prohibition on modifying the boot sequence has the effect of decreasing competition against IE by preventing OEMs from promoting rivals’ browsers. Because this prohibi-

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tion has a substantial effect in protecting Microsoft’s market power, and does so through a means other than competition on the merits, it is anticompetitive. Again the question whether the provision is nonetheless justified awaits later treatment.

Finally, Microsoft imposes several additional provisions that, like the prohibition on removal of icons, prevent OEMs from making various alterations to the desktop: Microsoft prohibits OEMs from causing any user interface other than the Windows desk-top to launch automatically, from adding icons or folders different in size or shape from those supplied by Microsoft, and from using the “Active Desktop” feature to promote third-party brands. These restrictions impose significant costs upon the OEMs; prior to Microsoft’s prohibiting the practice, many OEMs would change the appearance of the desktop in ways they found beneficial. See, e.g. … March 1997 letter from Hewlett-Packard to Microsoft (“We are responsible for the cost of technical support of our cus-tomers, including the 33% of calls we get related to the lack of quality or confusion gen-erated by your product.... We must have more ability to decide how our system is pre-sented to our end users. If we had a choice of another supplier, based on your actions in this area, I assure you [that you] would not be our supplier of choice.”).

The dissatisfaction of the OEM customers does not, of course, mean the restric-tions are anticompetitive. The anticompetitive effect of the license restrictions is, as Microsoft itself recognizes, that OEMs are not able to promote rival browsers, which keeps developers focused upon the APIs in Windows. … This kind of promotion is not a zero-sum game; but for the restrictions in their licenses to use Windows, OEMs could promote multiple IAPs and browsers. By preventing the OEMs from doing so, this type of license restriction, like the first two restrictions, is anticompetitive: Microsoft reduced rival browsers’ usage share not by improving its own product but, rather, by preventing OEMs from taking actions that could increase rivals’ share of usage.

b. Microsoft’s justifications for the license restrictions . Microsoft argues that the license restrictions are legally justified because, in imposing them, Microsoft is simply “exercising its rights as the holder of valid copyrights.” Microsoft also argues that the licenses “do not unduly restrict the opportunities of Netscape to dis-tribute Navigator in any event.”

Microsoft’s primary copyright argument borders upon the frivolous. The com-pany claims an absolute and unfettered right to use its intellectual property as it wishes: “[I]f intellectual property rights have been lawfully acquired,” it says, then “their subse-quent exercise cannot give rise to antitrust liability.” That is no more correct than the proposition that use of one’s personal property, such as a baseball bat, cannot give rise to tort liability. As the Federal Circuit succinctly stated: “Intellectual property rights do not confer a privilege to violate the antitrust laws.” In re Indep. Serv. Orgs. Antitrust Litig., 203 F.3d 1322, 1325 (Fed.Cir.2000) .

Although Microsoft never overtly retreats from its bold and incorrect position on the law, it also makes two arguments to the effect that it is not exercising its copyright in an unreasonable manner, despite the anticompetitive consequences of the license restric-tions discussed above. In the first variation upon its unqualified copyright defense, Microsoft cites two cases indicating that a copyright holder may limit a licensee’s ability to engage in significant and deleterious alterations of a copyrighted work. … The only li-

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cense restriction Microsoft seriously defends as necessary to prevent a “substantial alter-ation” of its copyrighted work is the prohibition on OEMs automatically launching a sub-stitute user interface upon completion of the boot process. We agree that a shell that auto-matically prevents the Windows desktop from ever being seen by the user is a drastic al-teration of Microsoft’s copyrighted work, and outweighs the marginal anticompetitive ef-fect of prohibiting the OEMs from substituting a different interface automatically upon completion of the initial boot process. We therefore hold that this particular restriction is not an exclusionary practice that violates § 2 of the Sherman Act.

In a second variation upon its copyright defense, Microsoft argues that the license restrictions merely prevent OEMs from taking actions that would reduce substantially the value of Microsoft’s copyrighted work: that is, Microsoft claims each license restriction in question is necessary to prevent OEMs from so altering Windows as to undermine “the principal value of Windows as a stable and consistent platform that supports a broad range of applications and that is familiar to users.” Microsoft, however, never substanti-ates this claim, and, because an OEM’s altering the appearance of the desktop or promot-ing programs in the boot sequence does not affect the code already in the product, the practice does not self-evidently affect either the “stability” or the “ consistency” of the platform. Microsoft cites only one item of evidence in support of its claim that the OEMs’ alterations were decreasing the value of Windows. That document, prepared by Microsoft itself, states: “there are quality issues created by OEMs who are too liberal with the pre-install process,” referring to the OEMs’ installation of Windows and addi-tional software on their PCs, which the document says may result in “user concerns and confusion.” To the extent the OEMs’ modifications cause consumer confusion, of course, the OEMs bear the additional support costs. Therefore, we conclude Microsoft has not shown that the OEMs’ liberality reduces the value of Windows except in the sense that their promotion of rival browsers undermines Microsoft’s monopoly—and that is not a permissible justification for the license restrictions.

Apart from copyright, Microsoft raises one other defense of the OEM license agreements: It argues that, despite the restrictions in the OEM license, Netscape is not completely blocked from distributing its product. That claim is insufficient to shield Microsoft from liability for those restrictions because, although Microsoft did not bar its rivals from all means of distribution, it did bar them from the cost-efficient ones.

In sum, we hold that with the exception of the one restriction prohibiting automat-ically launched alternative interfaces, all the OEM license restrictions at issue represent uses of Microsoft’s market power to protect its monopoly, unredeemed by any legitimate justification. The restrictions therefore violate § 2 of the Sherman Act.

2. Integration of IE and Windows. Although Microsoft’s license restric-tions have a significant effect in closing rival browsers out of one of the two primary channels of distribution, the District Court found that “Microsoft’s executives believed ... its contractual restrictions placed on OEMs would not be sufficient in themselves to re-verse the direction of Navigator’s usage share. Consequently, in late 1995 or early 1996, Microsoft set out to bind [IE] more tightly to Windows 95 as a technical matter.”

Technologically binding IE to Windows, the District Court found, both prevented OEMs from pre-installing other browsers and deterred consumers from using them. In

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particular, having the IE software code as an irremovable part of Windows meant that pre-installing a second browser would “increase an OEM’s product testing costs,” be-cause an OEM must test and train its support staff to answer calls related to every soft-ware product preinstalled on the machine; moreover, pre-installing a browser in addition to IE would to many OEMs be “a questionable use of the scarce and valuable space on a PC’s hard drive.”

Although the District Court, in its Conclusions of Law, broadly condemned Mi-crosoft’s decision to bind “Internet Explorer to Windows with ... technological shackles,” Conclusions of Law, at 39, its findings of fact in support of that conclusion center upon three specific actions Microsoft took to weld IE to Windows: excluding IE from the “Add/Remove Programs” utility; designing Windows so as in certain circumstances to override the user’s choice of a default browser other than IE; and commingling code re-lated to browsing and other code in the same files, so that any attempt to delete the files containing IE would, at the same time, cripple the operating system. As with the license restrictions, we consider first whether the suspect actions had an anticompetitive effect, and then whether Microsoft has provided a procompetitive justification for them.

a. Anticompetitive effect of integration . As a general rule, courts are properly very skeptical about claims that competition has been harmed by a dominant firm’s product design changes. In a competitive market, firms routinely innovate in the hope of appealing to consumers, sometimes in the process making their products incom-patible with those of rivals; the imposition of liability when a monopolist does the same thing will inevitably deter a certain amount of innovation. This is all the more true in a market, such as this one, in which the product itself is rapidly changing. Judicial defer-ence to product innovation, however, does not mean that a monopolist’s product design decisions are per se lawful.

The District Court first condemned as anticompetitive Microsoft’s decision to ex-clude IE from the “Add/Remove Programs” utility in Windows 98. Microsoft had in-cluded IE in the Add/Remove Programs utility in Windows 95, but when it modified Windows 95 to produce Windows 98, it took IE out of the Add/Remove Programs utility. This change reduces the usage share of rival browsers not by making Microsoft’s own browser more attractive to consumers but, rather, by discouraging OEMs from distribut-ing rival products. Because Microsoft’s conduct, through something other than competi-tion on the merits, has the effect of significantly reducing usage of rivals’ products and hence protecting its own operating system monopoly, it is anticompetitive; we defer for the moment the question whether it is nonetheless justified.

Second, the District Court found that Microsoft designed Windows 98 “so that us-ing Navigator on Windows 98 would have unpleasant consequences for users” by, in some circumstances, overriding the user’s choice of a browser other than IE as his or her default browser. Plaintiffs argue that this override harms the competitive process by de-terring consumers from using a browser other than IE even though they might prefer to do so, thereby reducing rival browsers’ usage share and, hence, the ability of rival browsers to draw developer attention away from the APIs exposed by Windows. Microsoft does not deny, of course, that overriding the user’s preference prevents some people from using other browsers. Because the override reduces rivals’ usage share and protects Microsoft’s monopoly, it too is anticompetitive.

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Finally, the District Court condemned Microsoft’s decision to bind IE to Win-dows 98 “by placing code specific to Web browsing in the same files as code that pro-vided operating system functions.” Putting code supplying browsing functionality into a file with code supplying operating system functionality “ensure[s] that the deletion of any file containing browsing-specific routines would also delete vital operating system rou-tines and thus cripple Windows....” As noted above, preventing an OEM from removing IE deters it from installing a second browser because doing so increases the OEM’s prod-uct testing and support costs; by contrast, had OEMs been able to remove IE, they might have chosen to pre-install Navigator alone. … [W]e conclude that such commingling has an anticompetitive effect; as noted above, the commingling deters OEMs from pre-installing rival browsers, thereby reducing the rivals’ usage share and, hence, developers’ interest in rivals’ APIs as an alternative to the API set exposed by Microsoft’s operating system.

b. Microsoft’s justifications for integration . Microsoft proffers no justification for two of the three challenged actions that it took in integrating IE into Win-dows—excluding IE from the Add/Remove Programs utility and commingling browser and operating system code. Although Microsoft does make some general claims regard-ing the benefits of integrating the browser and the operating system, it neither specifies nor substantiates those claims. Nor does it argue that either excluding IE from the Add/Remove Programs utility or commingling code achieves any integrative benefit. Plaintiffs plainly made out a prima facie case of harm to competition in the operating sys-tem market by demonstrating that Microsoft’s actions increased its browser usage share and thus protected its operating system monopoly from a middleware threat and, for its part, Microsoft failed to meet its burden of showing that its conduct serves a purpose other than protecting its operating system monopoly. Accordingly, we hold that Micro-soft’s exclusion of IE from the Add/Remove Programs utility and its commingling of browser and operating system code constitute exclusionary conduct, in violation of §2.

As for the other challenged act that Microsoft took in integrating IE into Windows—causing Windows to override the user’s choice of a default browser in certain circum-stances—Microsoft argues that it has “valid technical reasons.” Specifically, Microsoft claims that it was necessary to design Windows to override the user’s preferences when he or she invokes one of “a few” out “of the nearly 30 means of accessing the Internet.” According to Microsoft:

The Windows 98 Help system and Windows Update feature depend on ActiveX controls not supported by Navigator, and the now-discontinued Channel Bar utilized Microsoft’s Channel Definition Format, which Navigator also did not support. Lastly, Windows 98 does not invoke Navigator if a user accesses the Internet through “My Computer” or “Windows Explorer” because doing so would defeat one of the purposes of those fea-tures--enabling users to move seamlessly from local storage devices to the Web in the same browsing window.

The plaintiff bears the burden not only of rebutting a proffered justification but also of demonstrating that the anticompetitive effect of the challenged action outweighs it. In the District Court, plaintiffs appear to have done neither, let alone both; in any event, upon appeal, plaintiffs offer no rebuttal whatsoever. Accordingly, Microsoft may not be held liable for this aspect of its product design.

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3. Agreements with Internet Access Providers. The District Court also condemned as exclusionary Microsoft’s agreements with various IAPs. The IAPs in-clude both Internet Service Providers, which offer consumers internet access, and Online Services (“OLSs”) such as America Online (“AOL”), which offer proprietary content in addition to internet access and other services. …

The District Court condemned Microsoft’s actions in (1) offering IE free of charge to IAPs and (2) offering IAPs a bounty for each customer the IAP signs up for ser-vice using the IE browser. In effect, the court concluded that Microsoft is acting to pre-serve its monopoly by offering IE to IAPs at an attractive price. Similarly, the District Court held Microsoft liable for (3) developing the IE Access Kit (“IEAK”), a software package that allows an IAP to “create a distinctive identity for its service in as little as a few hours by customizing the [IE] title bar, icon, start and search pages,” and (4) offering the IEAK to IAPs free of charge, on the ground that those acts, too, helped Microsoft pre-serve its monopoly. Finally, the District Court found that (5) Microsoft agreed to provide easy access to IAPs’ services from the Windows desktop in return for the IAPs’ agree-ment to promote IE exclusively and to keep shipments of internet access software using Navigator under a specific percentage, typically 25%. We address the first four items—Microsoft’s inducements—and then its exclusive agreements with IAPs. Although offering a customer an attractive deal is the hallmark of competition, the Supreme Court has indicated that in very rare circumstances a price may be unlawfully low, or “predatory.” Plaintiffs argued before the District Court that Microsoft’s pricing was indeed predatory; but instead of making the usual predatory pricing argument … plaintiffs argued that by pricing below cost on IE (indeed, even paying people to take it), Microsoft was able simultaneously to preserve its stream of monopoly profits on Win-dows, thereby more than recouping its investment in below-cost pricing on IE. The Dis-trict Court did not assign liability for predatory pricing, however, and plaintiffs do not press this theory on appeal.

The rare case of price predation aside, the antitrust laws do not condemn even a monopolist for offering its product at an attractive price, and we therefore have no war-rant to condemn Microsoft for offering either IE or the IEAK free of charge or even at a negative price. Likewise, as we said above, a monopolist does not violate the Sherman Act simply by developing an attractive product. See Grinnell (“[G]rowth or develop-ment as a consequence of a superior product [or] business acumen” is no violation.). Therefore, Microsoft’s development of the IEAK does not violate the Sherman Act.

We turn now to Microsoft’s deals with IAPs concerning desktop placement. Microsoft concluded these exclusive agreements with all “the leading IAPs,” including the major OLSs. The most significant of the OLS deals is with AOL, which, when the deal was reached, “accounted for a substantial portion of all existing Internet access sub-scriptions and ... attracted a very large percentage of new IAP subscribers.” Under that agreement Microsoft puts the AOL icon in the OLS folder on the Windows desktop and AOL does not promote any non-Microsoft browser, nor provide software using any non- Microsoft browser except at the customer’s request, and even then AOL will not supply more than 15% of its subscribers with a browser other than IE. The Supreme Court most recently considered an antitrust challenge to an exclu-sive contract in Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320 (1961) . That

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case, which involved a challenge to a requirements contract, was brought under §3 of the Clayton Act and §§1 and 2 of the Sherman Act. The Court held that an exclusive contract does not violate the Clayton Act unless its probable effect is to “foreclose competition in a substantial share of the line of commerce affected.” … [T]he Court in Tampa Electric examined the record and, after defining the relevant market, determined that the contract affected less than one percent of that market. After concluding, under the Clayton Act, that this share was “conservatively speaking, quite insubstantial,” the Court went on sum-marily to reject the Sherman Act claims. “[I]f [the contract] does not fall within the broader prescription of §3 of the Clayton Act it follows that it is not forbidden by those of the [Sherman Act].” ….

Though what is “significant” may vary depending upon the antitrust provision un-der which an exclusive deal is challenged, it is clear that in all cases the plaintiff must both define the relevant market and prove the degree of foreclosure. … Because an ex-clusive deal affecting a small fraction of a market clearly cannot have the requisite harm-ful effect upon competition, the requirement of a significant degree of foreclosure serves a useful screening function.

In this case, plaintiffs challenged Microsoft’s exclusive dealing arrangements with the IAPs under both §§1 and 2 of the Sherman Act. The District Court, in analyzing the §1 claim, stated, “unless the evidence demonstrates that Microsoft’s agreements excluded Netscape altogether from access to roughly forty percent of the browser market, the Court should decline to find such agreements in violation of §1.” The court recognized that Microsoft had substantially excluded Netscape from “the most efficient channels for Navigator to achieve browser usage share,” and had relegated it to more costly and less effective methods (such as mass mailing its browser on a disk or offering it for download over the internet); but because Microsoft has not “completely excluded Netscape” from reaching any potential user by some means of distribution, however ineffective, the court concluded the agreements do not violate §1. Plaintiffs did not cross-appeal this holding. Turning to §2, the court stated: “the fact that Microsoft’s arrangements with vari-ous [IAPs and other] firms did not foreclose enough of the relevant market to constitute a §1 violation in no way detracts from the Court’s assignment of liability for the same ar-rangements under §2.... [A]ll of Microsoft’s agreements, including the non-exclusive ones, severely restricted Netscape’s access to those distribution channels leading most ef-ficiently to the acquisition of browser usage share.” On appeal Microsoft argues that “courts have applied the same standard to alleged exclusive dealing agreements under both Section 1 and Section 2,” and it argues that the District Court’s holding of no liability under §1 necessarily precludes holding it liable un-der §2. ... [H]owever, we agree with plaintiffs that a monopolist’s use of exclusive con-tracts, in certain circumstances, may give rise to a §2 violation even though the contracts foreclose less than the roughly 40% or 50% share usually required in order to establish a §1 violation. In this case, plaintiffs allege that, by closing to rivals a substantial percentage of the available opportunities for browser distribution, Microsoft managed to preserve its monopoly in the market for operating systems. The IAPs constitute one of the two major channels by which browsers can be distributed. Microsoft has exclusive deals with “four-teen of the top fifteen access providers in North America[, which] account for a large ma-jority of all Internet access subscriptions in this part of the world.” By ensuring that the

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“majority” of all IAP subscribers are offered IE either as the default browser or as the only browser, Microsoft’s deals with the IAPs clearly have a significant effect in preserv-ing its monopoly; they help keep usage of Navigator below the critical level necessary for Navigator or any other rival to pose a real threat to Microsoft’s monopoly. Plaintiffs having demonstrated a harm to competition, the burden falls upon Microsoft to defend its exclusive dealing contracts with IAPs by providing a procompeti-tive justification for them. Significantly, Microsoft’s only explanation for its exclusive dealing is that it wants to keep developers focused upon its APIs—which is to say, it wants to preserve its power in the operating system market. That is not an unlawful end, but neither is it a procompetitive justification for the specific means here in question, namely exclusive dealing contracts with IAPs. Accordingly, we affirm the District Court’s decision holding that Microsoft’s exclusive contracts with IAPs are exclusionary devices, in violation of §2 of the Sherman Act.

4. Dealings with … Independent Software Vendors, and Apple Com-puter. The District Court held that Microsoft engages in exclusionary conduct in its dealings with … ISVs, which develop software and Apple, which is both an OEM and a software developer. … The District Court described Microsoft’s deals with ISVs as fol-lows:

In dozens of “First Wave” agreements signed between the fall of 1997 and the spring of 1998, Microsoft has promised to give preferential support, in the form of early Windows 98 and Windows NT betas, other technical information, and the right to use certain Microsoft seals of approval, to important ISVs that agree to certain conditions. One of these conditions is that the ISVs use Internet Explorer as the default browsing software for any software they develop with a hypertext-based user interface. Another condition is that the ISVs use Microsoft’s “HTML Help,” which is accessible only with Internet Ex-plorer, to implement their applications’ help systems.

The District Court further found that the effect of these deals is to “ensure [ ] that many of the most popular Web-centric applications will rely on browsing technologies found only in Windows,” and that Microsoft’s deals with ISVs therefore “increase[ ] the likeli-hood that the millions of consumers using [applications designed by ISVs that entered into agreements with Microsoft] will use Internet Explorer rather than Navigator.” The District Court did not specifically identify what share of the market for browser distribution the exclusive deals with the ISVs foreclose. Although the ISVs are a relatively small channel for browser distribution, they take on greater significance be-cause, as discussed above, Microsoft had largely foreclosed the two primary channels to its rivals. In that light, one can tell from the record that by affecting the applications used by “millions” of consumers, Microsoft’s exclusive deals with the ISVs had a sub-stantial effect in further foreclosing rival browsers from the market. … Because, by keeping rival browsers from gaining widespread distribution (and potentially attracting the attention of developers away from the APIs in Windows), the deals have a substantial effect in preserving Microsoft’s monopoly, we hold that plaintiffs have made a prima fa-cie showing that the deals have an anticompetitive effect. Of course, that Microsoft’s exclusive deals have the anticompetitive effect of pre-serving Microsoft’s monopoly does not, in itself, make them unlawful. A monopolist, like a competitive firm, may have a perfectly legitimate reason for wanting an exclusive arrangement with its distributors. Accordingly, Microsoft had an opportunity to, but did

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not, present the District Court with evidence demonstrating that the exclusivity provisions have some such procompetitive justification. On appeal Microsoft likewise does not claim that the exclusivity required by the deals serves any legitimate purpose…. Microsoft having offered no procompetitive justification for its exclusive dealing ar-rangements with the ISVs, we hold that those arrangements violate §2 of the Sherman Act.

Finally, the District Court held that Microsoft’s dealings with Apple violated the Sherman Act. Apple is vertically integrated: it makes both software (including an oper-ating system, Mac OS), and hardware (the Macintosh line of computers). Microsoft pri-marily makes software, including, in addition to its operating system, a number of popu-lar applications. One, called “Office,” is a suite of business productivity applications that Microsoft has ported to Mac OS. The District Court found that “ninety percent of Mac OS users running a suite of office productivity applications [use] Microsoft’s Mac Of-fice.” Further, the District Court found that:

In 1997, Apple’s business was in steep decline, and many doubted that the company would survive much longer.... [M]any ISVs questioned the wisdom of continuing to spend time and money developing applications for the Mac OS. Had Microsoft an-nounced in the midst of this atmosphere that it was ceasing to develop new versions of Mac Office, a great number of ISVs, customers, developers, and investors would have in-terpreted the announcement as Apple’s death notice.

Microsoft recognized the importance to Apple of its continued support of Mac Office. [Internal e-mail in evidence included the following:] “[We] need a way to push these guys[, i.e., Apple] and [threatening to cancel Mac Office] is the only one that seems to make them move.”; “[Microsoft Chairman Bill] Gates asked whether Microsoft could conceal from Apple in the coming month the fact that Microsoft was almost finished de-veloping Mac Office 97.”; “I think ... Apple should be using [IE] everywhere and if they don’t do it, then we can use Office as a club.”.

In June 1997 Microsoft Chairman Bill Gates determined that the company’s nego-tiations with Apple “‘have not been going well at all.... Apple let us down on the browser by making Netscape the standard install.’ Gates then reported that he had already called Apple’s CEO ... to ask ‘how we should announce the cancellation of Mac Office....’” The District Court further found that, within a month of Gates’ call, Apple and Microsoft had reached an agreement pursuant to which

Microsoft’s primary obligation is to continue releasing up-to-date versions of Mac Office for at least five years.... [and] Apple has agreed ... to “bundle the most current version of [IE] ... with [Mac OS]”... [and to] “make [IE] the default [browser]”.... Navigator is not installed on the computer hard drive during the default installation, which is the type of installation most users elect to employ.... [The] Agreement further provides that ... Apple may not position icons for non-Microsoft browsing software on the desktop of new Macintosh PC systems or Mac OS upgrades.

The agreement also prohibits Apple from encouraging users to substitute another browser for IE, and states that Apple will “encourage its employees to use [IE].”

This exclusive deal between Microsoft and Apple has a substantial effect upon the distribution of rival browsers. If a browser developer ports its product to a second oper-ating system, such as the Mac OS, it can continue to display a common set of APIs.

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Thus, usage share, not the underlying operating system, is the primary determinant of the platform challenge a browser may pose. Pre-installation of a browser … is one of the two most important methods of browser distribution, and Apple had a not insignificant share of worldwide sales of operating systems. Because Microsoft’s exclusive contract with Apple has a substantial effect in restricting distribution of rival browsers, and be-cause (as we have described several times above) reducing usage share of rival browsers serves to protect Microsoft’s monopoly, its deal with Apple must be regarded as anticom-petitive.

Microsoft offers no procompetitive justification for the exclusive dealing arrange-ment. It makes only the irrelevant claim that the IE-for-Mac Office deal is part of a mul-tifaceted set of agreements between itself and Apple; that does not mean it has any pro-competitive justification. Accordingly, we hold that the exclusive deal with Apple is ex-clusionary, in violation of §2 of the Sherman Act.

5. Java. Java, a set of technologies developed by Sun Microsystems, is another type of middleware posing a potential threat to Windows’ position as the ubiqui-tous platform for software development. The Java technologies include: (1) a program-ming language; (2) a set of programs written in that language, called the “Java class li-braries,” which expose APIs; (3) a compiler, which translates code written by a devel-oper into “bytecode”; and (4) a Java Virtual Machine (“JVM”), which translates byte-code into instructions to the operating system. Programs calling upon the Java APIs will run on any machine with a “Java runtime environment,” that is, Java class libraries and a JVM.

In May 1995 Netscape agreed with Sun to distribute a copy of the Java runtime environment with every copy of Navigator, and “Navigator quickly became the principal vehicle by which Sun placed copies of its Java runtime environment on the PC systems of Windows users.” Microsoft, too, agreed to promote the Java technologies—or so it seemed. For at the same time, Microsoft took steps “to maximize the difficulty with which applications written in Java could be ported from Windows to other platforms, and vice versa.” Specifically, the District Court found that Microsoft took four steps to ex-clude Java from developing as a viable cross-platform threat: (a) designing a JVM in-compatible with the one developed by Sun; (b) entering into contracts, the so-called “First Wave Agreements,” requiring major ISVs to promote Microsoft’s JVM exclu-sively; (c) deceiving Java developers about the Windows-specific nature of the tools it distributed to them; and (d) coercing Intel to stop aiding Sun in improving the Java tech-nologies.

a. The incompatible JVM. The District Court held that Microsoft engaged in exclusionary conduct by developing and promoting its own JVM. … In or-der to violate the antitrust laws, the incompatible product must have an anticompetitive effect that outweighs any procompetitive justification for the design. Microsoft’s JVM is not only incompatible with Sun’s, it allows Java applications to run faster on Windows than does Sun’s JVM. Microsoft’s faster JVM lured Java developers into using Micro-soft’s developer tools, and Microsoft offered those tools deceptively, as we discuss be-low. The JVM, however, does allow applications to run more swiftly and does not itself have any anticompetitive effect. Therefore, we reverse the District Court’s imposition of liability for Microsoft’s development and promotion of its JVM.

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b. The First Wave Agreements . The District Court also found that Microsoft entered into First Wave Agreements with dozens of ISVs to use Microsoft’s JVM. (“[I]n exchange for costly technical support and other blandishments, Microsoft induced dozens of important ISVs to make their Java applications reliant on Windows-specific technologies and to refrain from distributing to Windows users JVMs that com-plied with Sun’s standards.”). Again, we reject the District Court’s condemnation of low but non-predatory pricing by Microsoft. To the extent Microsoft’s First Wave Agreements with the ISVs conditioned re-ceipt of Windows technical information upon the ISVs’ agreement to promote Micro-soft’s JVM exclusively, they raise a different competitive concern. The District Court found that, although not literally exclusive, the deals were exclusive in practice because they required developers to make Microsoft’s JVM the default in the software they devel-oped. While the District Court did not enter precise findings as to the effect of the First Wave Agreements upon the overall distribution of rival JVMs, the record indicates that Microsoft’s deals with the major ISVs had a significant effect upon JVM promotion. As discussed above, the products of First Wave ISVs reached millions of consumers. … Moreover, Microsoft’s exclusive deals with the leading ISVs took place against a back-drop of foreclosure: the District Court found that “[w]hen Netscape announced in May 1995 [prior to Microsoft’s execution of the First Wave Agreements] that it would include with every copy of Navigator a copy of a Windows JVM that complied with Sun’s stan-dards, it appeared that Sun’s Java implementation would achieve the necessary ubiquity on Windows.” As discussed above, however, Microsoft undertook a number of anticom-petitive actions that seriously reduced the distribution of Navigator, and the District Court found that those actions thereby seriously impeded distribution of Sun’s JVM. Because Microsoft’s agreements foreclosed a substantial portion of the field for JVM distribution and because, in so doing, they protected Microsoft’s monopoly from a middleware threat, they are anticompetitive. Microsoft offered no procompetitive justification for the default clause that made the First Wave Agreements exclusive as a practical matter. Because the cumulative effect of the deals is anticompetitive and because Microsoft has no procompetitive justification for them, we hold that the provisions in the First Wave Agreements requiring use of Mi-crosoft’s JVM as the default are exclusionary, in violation of the Sherman Act. c. Deception of Java developers . Microsoft’s “Java implementa-tion” included, in addition to a JVM, a set of software development tools it created to as-sist ISVs in designing Java applications. The District Court found that, not only were these tools incompatible with Sun’s cross-platform aspirations for Java—no violation, to be sure—but Microsoft deceived Java developers regarding the Windows-specific nature of the tools. Microsoft’s tools included “certain ‘keywords’ and ‘compiler directives’ that could only be executed properly by Microsoft’s version of the Java runtime environ-ment for Windows.” As a result, even Java “developers who were opting for portability over performance ... unwittingly [wrote] Java applications that [ran] only on Windows.” That is, developers who relied upon Microsoft’s public commitment to cooperate with Sun and who used Microsoft’s tools to develop what Microsoft led them to believe were cross-platform applications ended up producing applications that would run only on the Windows operating system.

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When specifically accused by a PC Week reporter of fragmenting Java standards so as to prevent cross-platform uses, Microsoft denied the accusation and indicated it was only “adding rich platform support” to what remained a cross-platform implementation. An e-mail message internal to Microsoft, written shortly after the conversation with the reporter, shows otherwise:

[O]k, i just did a followup call.... [The reporter] liked that i kept pointing customers to w3c standards [ (commonly observed internet protocols) ].... [but] he accused us of being schizo with this vs. our java approach, i said he misunderstood [--] that [with Java] we are merely trying to add rich platform support to an interop layer.... this plays well.... at this point its [sic] not good to create MORE noise around our win32 java classes. instead we should just quietly grow j++ [ (Microsoft’s development tools) ] share and assume that people will take more advantage of our classes without ever realizing they are building win32-only java apps.

Finally, other Microsoft documents confirm that Microsoft intended to deceive Java developers, and predicted that the effect of its actions would be to generate Win-dows-dependent Java applications that their developers believed would be cross-plat-form; these documents also indicate that Microsoft’s ultimate objective was to thwart Java’s threat to Microsoft’s monopoly in the market for operating systems. One Microsoft document, for example, states as a strategic goal: “Kill cross-platform Java by grow[ing] the polluted Java market.”

Microsoft’s conduct related to its Java developer tools served to protect its mo-nopoly of the operating system in a manner not attributable either to the superiority of the operating system or to the acumen of its makers, and therefore was anticompetitive. Un-surprisingly, Microsoft offers no procompetitive explanation for its campaign to deceive developers. Accordingly, we conclude this conduct is exclusionary, in violation of §2 of the Sherman Act.

d. The threat to Intel . The District Court held that Microsoft also acted unlawfully with respect to Java by using its “monopoly power to prevent firms such as Intel from aiding in the creation of cross-platform interfaces.” In 1995 Intel was in the process of developing a high performance, Windows-compatible JVM. Microsoft wanted Intel to abandon that effort because a fast, cross-platform JVM would threaten Micro-soft’s monopoly in the operating system market. At an August 1995 meeting, Micro-soft’s Gates told Intel that its “cooperation with Sun and Netscape to develop a Java run-time environment ... was one of the issues threatening to undermine cooperation between Intel and Microsoft.” Three months later, “Microsoft’s Paul Maritz told a senior Intel executive that Intel’s [adaptation of its multimedia software to comply with] Sun’s Java standards was as inimical to Microsoft as Microsoft’s support for non-Intel microproces-sors would be to Intel.”

Intel nonetheless continued to undertake initiatives related to Java. By 1996 “In-tel had developed a JVM designed to run well ... while complying with Sun’s cross-plat-form standards.” In April of that year, Microsoft again urged Intel not to help Sun by dis-tributing Intel’s fast, Sun-compliant JVM. And Microsoft threatened Intel that if it did not stop aiding Sun on the multimedia front, then Microsoft would refuse to distribute Intel technologies bundled with Windows.

Intel finally capitulated in 1997, after Microsoft delivered the coup de grace.

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[O]ne of Intel’s competitors, called AMD, solicited support from Microsoft for its “3DX” technology.... Microsoft’s Allchin asked Gates whether Microsoft should support 3DX, despite the fact that Intel would oppose it. Gates responded: “If Intel has a real problem with us supporting this then they will have to stop supporting Java Multimedia the way they are. I would gladly give up supporting this if they would back off from their work on JAVA.”

Microsoft’s internal documents and deposition testimony confirm both the anti-competitive effect and intent of its actions. [One] Microsoft executive … included among Microsoft’s goals for Intel: “Intel to stop helping Sun create Java Multimedia APIs, especially ones that run well ... on Windows.” [The same executive later testified that,] “We were successful [in convincing Intel to stop aiding Sun] for some period of time.”

Microsoft does not deny the facts found by the District Court, nor does it offer any procompetitive justification for pressuring Intel not to support cross-platform Java. Microsoft lamely characterizes its threat to Intel as “advice.” The District Court, how-ever, found that Microsoft’s “advice” to Intel to stop aiding cross-platform Java was backed by the threat of retaliation, and this conclusion is supported by the evidence cited above. Therefore we affirm the conclusion that Microsoft’s threats to Intel were exclu-sionary, in violation of §2 of the Sherman Act. …

C. Causation. As a final parry, Microsoft urges this court to reverse on the mo-nopoly maintenance claim, because plaintiffs never established a causal link between Mi-crosoft’s anticompetitive conduct, in particular its foreclosure of Netscape’s and Java’s distribution channels, and the maintenance of Microsoft’s operating system monopoly. … Microsoft points to no case, and we can find none, standing for the proposition that, as to §2 liability in an equitable enforcement action, plaintiffs must present direct proof that a defendant’s continued monopoly power is precisely attributable to its anticompetitive conduct. …

To require that §2 liability turn on a plaintiff’s ability or inability to reconstruct the hypothetical marketplace absent a defendant’s anticompetitive conduct would only encourage monopolists to take more and earlier anticompetitive action. We may infer causation when exclusionary conduct is aimed at producers of nascent competitive tech-nologies as well as when it is aimed at producers of established substitutes. Admittedly, in the former case there is added uncertainty, inasmuch as nascent threats are merely po-tential substitutes. But the underlying proof problem is the same—neither plaintiffs nor the court can confidently reconstruct a product’s hypothetical technological development in a world absent the defendant’s exclusionary conduct. To some degree, “the defendant is made to suffer the uncertain consequences of its own undesirable conduct.” 3 AREEDA & HOVENKAMP, ANTITRUST LAW ¶ 651c, at 78.

[Thus,] the question in this case is not whether Java or Navigator would actually have developed into viable platform substitutes, but (1) whether as a general matter the exclusion of nascent threats is the type of conduct that is reasonably capable of contribut-ing significantly to a defendant’s continued monopoly power and (2) whether Java and Navigator reasonably constituted nascent threats at the time Microsoft engaged in the an-ticompetitive conduct at issue. As to the first, suffice it to say that it would be inimical to the purpose of the Sherman Act to allow monopolists free reign to squash nascent, al-

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beit unproven, competitors at will—particularly in industries marked by rapid technologi-cal advance and frequent paradigm shifts. As to the second, the District Court made am-ple findings that both Navigator and Java showed potential as middleware platform threats. Counsel for Microsoft admitted as much at oral argument:

There are no constraints on output. Marginal costs are essentially zero. And there are to some extent network effects. So a company like Netscape founded in 1994 can be by the middle of 1995 clearly a potentially lethal competitor to Windows because it can supplant its position in the market because of the characteristics of these markets.

Microsoft’s concerns over causation have more purchase in connection with the appropriate remedy issue, i.e., whether the court should impose a structural remedy or merely enjoin the offensive conduct at issue. … Absent some measure of confidence that there has been an actual loss to competition that needs to be restored, wisdom counsels against adopting radical structural relief. But these queries go to questions of remedy, not liability. In short, causation affords Microsoft no defense to liability for its unlawful ac-tions undertaken to maintain its monopoly in the operating system market.

III. ATTEMPTED MONOPOLIZATION. Microsoft further challenges the District Court’s determination of liability for “attempt[ing] to monopolize ... any part of the trade or commerce among the several States. To establish a §2 violation for attempted monopo-lization, “a plaintiff must prove (1) that the defendant has engaged in predatory or anti-competitive conduct with (2) a specific intent to monopolize and (3) a dangerous proba-bility of achieving monopoly power.” Spectrum Sports. Because a deficiency on any one of the three will defeat plaintiffs’ claim, we look no further than plaintiffs’ failure to prove a dangerous probability of achieving monopoly power in the putative browser mar-ket. …

To establish a dangerous probability of success, plaintiffs must as a threshold matter show that the browser market can be monopolized, i.e., that a hypothetical monop-olist in that market could enjoy market power. This, in turn, requires plaintiffs (1) to de-fine the relevant market and (2) to demonstrate that substantial barriers to entry protect that market. Because plaintiffs have not carried their burden on either prong, we reverse without remand.

A. Relevant Market. A court’s evaluation of an attempted monopolization claim must include a definition of the relevant market. Such a definition establishes a context for evaluating the defendant’s actions as well as for measuring whether the challenged conduct presented a dangerous probability of monopolization. The District Court omitted this element of the Spectrum Sports inquiry.

Defining a market for an attempted monopolization claim involves the same steps as defining a market for a monopoly maintenance claim, namely a detailed description of the purpose of a browser—what functions may be included and what are not—and an ex-amination of the substitutes that are part of the market and those that are not. The Dis -trict Court never engaged in such an analysis nor entered detailed findings defining what a browser is or what products might constitute substitutes. In the Findings of Fact, the District Court … stated only that “a Web browser provides the ability for the end user to select, retrieve, and perceive resources on the Web.” Furthermore, in discussing at-tempted monopolization in its Conclusions of Law, the District Court failed to demon-

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strate analytical rigor when it employed varying and imprecise references to the “market for browsing technology for Windows,” “the browser market,” and “platform-level browsing software.”

Because the determination of a relevant market is a factual question to be resolved by the District Court, we would normally remand the case so that the District Court could formulate an appropriate definition. A remand on market definition is unnecessary, how-ever, because the District Court’s imprecision is directly traceable to plaintiffs’ failure to articulate and identify evidence before the District Court as to (1) what constitutes a browser (i.e., what are the technological components of or functionalities provided by a browser) and (2) why certain other products are not reasonable substitutes (e.g., browser shells or viewers for individual internet extensions, such as Real Audio Player or Adobe Acrobat Reader). Indeed, when plaintiffs in their Proposed Findings of Fact attempted to define a relevant market for the attempt claim, they pointed only to their separate prod-ucts analysis for the tying claim. However, the separate products analysis for tying pur-poses is not a substitute for the type of market definition that Spectrum Sports requires. … Furthermore, in their brief and at oral argument before this court, plaintiffs did nothing to clarify or ameliorate this deficiency.

B. Barriers to Entry. Because a firm cannot possess monopoly power in a mar-ket unless that market is also protected by significant barriers to entry, it follows that a firm cannot threaten to achieve monopoly power in a market unless that market is, or will be, similarly protected. … Plaintiffs must not only show that barriers to entry protect the properly defined browser market, but that those barriers are “significant.” Whether there are significant barriers to entry cannot, of course, be answered absent an appropriate mar-ket definition; thus, plaintiffs’ failure on that score alone is dispositive. But even were we to assume a properly defined market, for example browsers consisting of a graphical interface plus internet protocols, plaintiffs nonetheless failed to carry their burden on bar-riers to entry. …

In contrast to their minimal effort on market definition, plaintiffs did at least offer proposed findings of fact suggesting that the possibility of network effects could poten-tially create barriers to entry into the browser market. The District Court did not adopt those proposed findings. However, the District Court did acknowledge the possibility of a different kind of entry barrier in its Conclusions of Law:

In the time it would have taken an aspiring entrant to launch a serious effort to compete against Internet Explorer, Microsoft could have erected the same type of barrier that pro-tects its existing monopoly power by adding proprietary extensions to the browsing soft-ware under its control and by extracting commitments from OEMs, IAPs and others simi-lar to the ones discussed in [the monopoly maintenance section].

Giving plaintiffs and the District Court the benefit of the doubt, we might remand if the possible existence of entry barriers resulting from the possible creation and ex-ploitation of network effects in the browser market were the only concern. That is not enough to carry the day, however, because the District Court did not make two key find-ings: (1) that network effects were a necessary or even probable, rather than merely pos-sible, consequence of high market share in the browser market and (2) that a barrier to entry resulting from network effects would be “significant” enough to confer monopoly power. Again, these deficiencies are in large part traceable to plaintiffs’ own failings. …

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Simply invoking the phrase “network effects” without pointing to more evidence does not suffice to carry plaintiffs’ burden in this respect. …

Because plaintiffs failed to make their case on attempted monopolization both in the District Court and before this court, there is no reason to give them a second chance to flesh out a claim that should have been fleshed out the first time around. Accordingly, we reverse the District Court’s determination of §2 liability for attempted monopoliza-tion.

IV. TYING. ... The facts underlying the tying allegation substantially overlap with those set forth in Section II.B in connection with the §2 monopoly maintenance claim. The key District Court findings are that (1) Microsoft required licensees of Windows 95 and 98 also to license IE as a bundle at a single price; (2) Microsoft refused to allow OEMs to uninstall or remove IE from the Windows desktop; (3) Microsoft designed Windows 98 in a way that withheld from consumers the ability to remove IE by use of the Add/Re-move Programs utility; and (4) Microsoft designed Windows 98 to override the user’s choice of default web browser in certain circumstances. The court found that these acts constituted a per se tying violation.

Microsoft does not dispute that it bound Windows and IE in the four ways the District Court cited. Instead it argues that Windows (the tying good) and IE browsers (the tied good) are not “separate products,” and that it did not substantially foreclose competing browsers from the tied product market. …

We first address the separate-products inquiry, a source of much argument be-tween the parties and of confusion in the cases. Our purpose is to highlight the poor fit between the separate-products test and the facts of this case. We then offer further rea-sons for carving an exception to the per se rule when the tying product is platform soft-ware. In the final section we discuss the District Court’s inquiry if plaintiffs pursue a rule of reason claim on remand.

A. Separate-Products Inquiry Under the Per Se Test. … The first case to give content to the separate-products test was Jefferson Parish [,which] resolved the matter in two steps. First, it clarified that “the answer to the question whether one or two products are involved” does not turn “on the functional relation between them....” In other words, the mere fact that two items are complements, that “one ... is useless without the other,” does not make them a single “product” for purposes of tying law. Second, rea-soning that the “definitional question [whether two distinguishable products are involved] depends on whether the arrangement may have the type of competitive consequences ad-dressed by the rule [against tying],” the Court decreed that “no tying arrangement can ex-ist unless there is a sufficient demand for the purchase of anesthesiological services sepa-rate from hospital services to identify a distinct product market in which it is efficient to offer anesthesiological services separately from hospital service.” Id. (emphasis added). The Court proceeded to examine direct and indirect evidence of consumer de-mand for the tied product separate from the tying product. Direct evidence addresses the question whether, when given a choice, consumers purchase the tied good from the tying good maker, or from other firms. .. Indirect evidence includes the behavior of firms with-out market power in the tying good market, presumably on the notion that (competitive) supply follows demand. If competitive firms always bundle the tying and tied goods,

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then they are a single product. … To understand the logic behind the Court’s consumer demand test, consider first the postulated harms from tying. The core concern is that tying prevents goods from competing directly for consumer choice on their merits, i.e., being selected as a result of “buyers’ independent judgment.” With a tie, a buyer’s “freedom to select the best bargain in the second market [could be] impaired by his need to purchase the tying product, and perhaps by an inability to evaluate the true cost of either product....” Direct competition on the merits of the tied product is foreclosed when the tying product either is sold only in a bundle with the tied product or, though offered separately, is sold at a bundled price, so that the buyer pays the same price whether he takes the tied product or not. In both cases, a consumer buying the tying product becomes entitled to the tied product; he will therefore likely be unwilling to buy a competitor’s version of the tied product even if, making his own price/quality assessment, that is what he would prefer. But not all ties are bad. Bundling obviously saves distribution and consumer transaction costs. This is likely to be true, to take some examples from the computer in-dustry, with the integration of math co-processors and memory into microprocessor chips and the inclusion of spell checkers in word processors. Bundling can also capitalize on certain economies of scope. A possible example is the “shared” library files that perform OS and browser functions with the very same lines of code and thus may save drive space from the clutter of redundant routines and memory when consumers use both the OS and browser simultaneously. Indeed, if there were no efficiencies from a tie (including econo-mizing on consumer transaction costs such as the time and effort involved in choice), we would expect distinct consumer demand for each individual component of every good. In a competitive market with zero transaction costs, the computers on which this opinion was written would only be sold piecemeal—keyboard, monitor, mouse, central process-ing unit, disk drive, and memory all sold in separate transactions and likely by different manufacturers. Recognizing the potential benefits from tying, the Court in Jefferson Parish forged a separate-products test that, like those of market power and substantial foreclo-sure, attempts to screen out false positives under per se analysis. The consumer demand test is a rough proxy for whether a tying arrangement may, on balance, be welfare-en-hancing, and unsuited to per se condemnation. In the abstract, of course, there is always direct separate demand for products: assuming choice is available at zero cost, consumers will prefer it to no choice. Only when the efficiencies from bundling are dominated by the benefits to choice for enough consumers, however, will we actually observe con-sumers making independent purchases. In other words, perceptible separate demand is inversely proportional to net efficiencies. On the supply side, firms without market power will bundle two goods only when the cost savings from joint sale outweigh the value consumers place on separate choice. So bundling by all competitive firms implies strong net efficiencies. If a court finds either that there is no noticeable separate demand for the tied product or, there being no convincing direct evidence of separate demand, that the entire “competitive fringe” engages in the same behavior as the defendant, then the tying and tied products should be declared one product and per se liability should be rejected.

Before concluding our exegesis of Jefferson Parish’s separate-products test, we

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should clarify two things. First, Jefferson Parish does not endorse a direct inquiry into the efficiencies of a bundle. Rather, it proposes easy-to-administer proxies for net effi-ciency. In describing the separate-products test we discuss efficiencies only to explain the rationale behind the consumer demand inquiry. To allow the separate-products test to become a detailed inquiry into possible welfare consequences would turn a screening test into the very process it is expected to render unnecessary. Second, the separate-products test is not a one-sided inquiry into the cost savings from a bundle. Although Jefferson Parish acknowledged that prior lower court cases looked at cost-savings to decide separate products, the Court conspicuously did not adopt that approach in its disposition of tying arrangement before it. Instead it chose proxies that balance costs savings against reduction in consumer choice. With this background, we now turn to the separate products inquiry before us. The District Court found that many consumers, if given the option, would choose their browser separately from the OS. Turning to industry custom, the court found that, al-though all major OS vendors bundled browsers with their OSs, these companies either sold versions without a browser, or allowed OEMs or end-users either not to install the bundled browser or in any event to “uninstall” it. …

Microsoft does not dispute that many consumers demand alternative browsers. But on industry custom Microsoft contends that no other firm requires non-removal be-cause no other firm has invested the resources to integrate web browsing as deeply into its OS as Microsoft has. … Microsoft contends not only that its integration of IE into Windows is innovative and beneficial but also that it requires non-removal of IE. In our discussion of monopoly maintenance we find that these claims fail the efficiency balanc-ing applicable in that context. But the separate-products analysis is supposed to perform its function as a proxy without embarking on any direct analysis of efficiency. Accord-ingly, Microsoft’s implicit argument—that in this case looking to a competitive fringe is inadequate to evaluate fully its potentially innovative technological integration, that such a comparison is between apples and oranges—poses a legitimate objection to the opera-tion of Jefferson Parish’s separate- products test for the per se rule.

In fact there is merit to Microsoft’s broader argument that Jefferson Parish’s con-sumer demand test would “chill innovation to the detriment of consumers by preventing firms from integrating into their products new functionality previously provided by stand-alone products—and hence, by definition, subject to separate consumer demand.” The per se rule’s direct consumer demand and indirect industry custom inquiries are, as a general matter, backward-looking and therefore systematically poor proxies for overall efficiency in the presence of new and innovative integration. The direct consumer demand test fo-cuses on historic consumer behavior, likely before integration, and the indirect industry custom test looks at firms that, unlike the defendant, may not have integrated the tying and tied goods. Both tests compare incomparables—the defendant’s decision to bundle in the presence of integration, on the one hand, and consumer and competitor calculations in its absence, on the other. If integration has efficiency benefits, these may be ignored by the Jefferson Parish proxies. Because one cannot be sure beneficial integration will be protected by the other elements of the per se rule, simple application of that rule’s sepa-rate-products test may make consumers worse off.

In light of the monopoly maintenance section, obviously, we do not find that Mi-

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crosoft’s integration is welfare-enhancing or that it should be absolved of tying liability. Rather, we heed Microsoft’s warning that the separate-products element of the per se rule may not give newly integrated products a fair shake.

B. Per Se Analysis Inappropriate for this Case. We now address directly the larger question as we see it: whether standard per se analysis should be applied “off the shelf” to evaluate the defendant’s tying arrangement, one which involves software that serves as a platform for third-party applications. There is no doubt that “[i]t is far too late in the history of our antitrust jurisprudence to question the proposition that certain ty-ing arrangements pose an unacceptable risk of stifling competition and therefore are un-reasonable ‘per se.’” Jefferson Parish (emphasis added). But there are strong reasons to doubt that the integration of additional software functionality into an OS falls among these arrangements. Applying per se analysis to such an amalgamation creates undue risks of error and of deterring welfare-enhancing innovation.

The Supreme Court has warned that “‘[i]t is only after considerable experience with certain business relationships that courts classify them as per se violations....’” BMI. Yet the sort of tying arrangement attacked here is unlike any the Supreme Court has con-sidered. … In none of these cases was the tied good physically and technologically inte-grated with the tying good. Nor did the defendants ever argue that their tie improved the value of the tying product to users and to makers of complementary goods. In those cases where the defendant claimed that use of the tied good made the tying good more valuable to users, the Court ruled that the same result could be achieved via quality stan-dards for substitutes of the tied good. See, e.g., Int’l Salt.

Here Microsoft argues that IE and Windows are an integrated physical product and that the bundling of IE APIs with Windows makes the latter a better applications platform for third-party software. It is unclear how the benefits from IE APIs could be achieved by quality standards for different browser manufacturers. We do not pass judg-ment on Microsoft’s claims regarding the benefits from integration of its APIs. We merely note that these and other novel, purported efficiencies suggest that judicial “expe-rience” provides little basis for believing that, “because of their pernicious effect on com-petition and lack of any redeeming virtue,” a software firm’s decisions to sell multiple functionalities as a package should be “conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their use.” N. Pac. Ry. (emphasis added).

Nor have we found much insight into software integration among the decisions of lower federal courts. …While the paucity of cases examining software bundling suggests a high risk that per se analysis may produce inaccurate results, the nature of the platform software market affirmatively suggests that per se rules might stunt valuable innovation. We have in mind two reasons.

First, as we explained in the previous section, the separate-products test is a poor proxy for net efficiency from newly integrated products. Under per se analysis the first firm to merge previously distinct functionalities (e.g., the inclusion of starter motors in automobiles) or to eliminate entirely the need for a second function (e.g., the invention of the stain-resistant carpet) risks being condemned as having tied two separate products be-cause at the moment of integration there will appear to be a robust “distinct” market for

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the tied product. Rule of reason analysis, however, affords the first mover an opportu-nity to demonstrate that an efficiency gain from its “tie” adequately offsets any distortion of consumer choice.

The failure of the separate-products test to screen out certain cases of productive integration is particularly troubling in platform software markets such as that in which the defendant competes. Not only is integration common in such markets, but it is common among firms without market power. We have already reviewed evidence that nearly all competitive OS vendors also bundle browsers. Moreover, plaintiffs do not dispute that OS vendors can and do incorporate basic internet plumbing and other useful functionality into their OSs. Firms without market power have no incentive to package different pieces of software together unless there are efficiency gains from doing so. The ubiquity of bundling in competitive platform software markets should give courts reason to pause before condemning such behavior in less competitive markets.

Second, because of the pervasively innovative character of platform software markets, tying in such markets may produce efficiencies that courts have not previously encountered and thus the Supreme Court had not factored into the per se rule as originally conceived. For example, the bundling of a browser with OSs enables an independent software developer to count on the presence of the browser’s APIs, if any, on consumers’ machines and thus to omit them from its own package. It is true that software developers can bundle the browser APIs they need with their own products, but that may force con-sumers to pay twice for the same API if it is bundled with two different software pro-grams. It is also true that OEMs can include APIs with the computers they sell, but dif-fusion of uniform APIs by that route may be inferior. First, many OEMs serve special subsets of Windows consumers, such as home or corporate or academic users. If just one of these OEMs decides not to bundle an API because it does not benefit enough of its clients, ISVs that use that API might have to bundle it with every copy of their program. Second, there may be a substantial lag before all OEMs bundle the same set of APIs--a lag inevitably aggravated by the first phenomenon. In a field where programs change very rapidly, delays in the spread of a necessary element (here, the APIs) may be very costly.

Of course, these arguments may not justify Microsoft’s decision to bundle APIs in this case, particularly because Microsoft did not merely bundle with Windows the APIs from IE, but an entire browser application…. A justification for bundling a component of software may not be one for bundling the entire software package, especially given the malleability of software code. Furthermore, the interest in efficient API diffusion obvi-ously supplies a far stronger justification for simple price-bundling than for Microsoft’s contractual or technological bars to subsequent removal of functionality. But our qualms about redefining the boundaries of a defendant’s product and the possibility of consumer gains from simplifying the work of applications developers makes us question any hard and fast approach to tying in OS software markets.

There may also be a number of efficiencies that, although very real, have been ig-nored in the calculations underlying the adoption of a per se rule for tying. We fear that these efficiencies are common in technologically dynamic markets where product devel-opment is especially unlikely to follow an easily foreseen linear pattern. Take the fol-lowing example from ILC Peripherals, 448 F.Supp. 228, a case concerning the evolution

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of disk drives for computers. When IBM first introduced such drives in 1956, it sold an integrated product that contained magnetic disks and disk heads that read and wrote data onto disks. Consumers of the drives demanded two functions--to store data and to access it all at once. In the first few years consumers’ demand for storage increased rapidly, outpacing the evolution of magnetic disk technology. To satisfy that demand IBM made it possible for consumers to remove the magnetic disks from drives, even though that meant consumers would not have access to data on disks removed from the drive. This componentization enabled makers of computer peripherals to sell consumers removable disks. Over time, however, the technology of magnetic disks caught up with demand for capacity, so that consumers needed few removable disks to store all their data. At this point IBM reintegrated disks into their drives, enabling consumers to once again have im-mediate access to all their data without a sacrifice in capacity. A manufacturer of remov-able disks sued. But the District Court found the tie justified because it satisfied con-sumer demand for immediate access to all data, and ruled that disks and disk heads were one product. A court hewing more closely to the truncated analysis contemplated by Northern Pacific Railway would perhaps have overlooked these consumer benefits. These arguments all point to one conclusion: we cannot comfortably say that bundling in platform software markets has so little “redeeming virtue,” N. Pac. Ry., … that “an inquiry into its costs in the individual case [can be] considered [ ] unnecessary.” Jefferson Parish (O’Connor, J., concurring). We do not have enough empirical evidence regarding the effect of Microsoft’s practice on the amount of consumer surplus created or consumer choice foreclosed by the integration of added functionality into platform soft-ware to exercise sensible judgment regarding that entire class of behavior. … [W]e will heed the wisdom that “easy labels do not always supply ready answers,” Broad. Music, and vacate the District Court’s finding of per se tying liability under Sherman Act §1. We remand the case for evaluation of Microsoft’s tying arrangements under the rule of rea-son. … Our judgment regarding the comparative merits of the per se rule and the rule of reason is confined to the tying arrangement before us, where the tying product is software whose major purpose is to serve as a platform for third-party applications and the tied product is complementary software functionality. While our reasoning may at times ap-pear to have broader force, we do not have the confidence to speak to facts outside the record, which contains scant discussion of software integration generally. … C. On Remand. Should plaintiffs choose to pursue a tying claim under the rule of reason, we note the following for the benefit of the trial court:

First, on remand, plaintiffs must show that Microsoft’s conduct unreasonably re-strained competition. Meeting that burden “involves an inquiry into the actual effect” of Microsoft’s conduct on competition in the tied good market, the putative market for browsers. To the extent that certain aspects of tying injury may depend on a careful defi-nition of the tied good market and a showing of barriers to entry other than the tying ar-rangement itself, plaintiffs would have to establish these points. … Of the harms left, plaintiffs must show that Microsoft’s conduct was, on balance, anticompetitive. Microsoft may of course offer procompetitive justifications, and it is plaintiffs’ burden to show that the anticompetitive effect of the conduct outweighs its benefit.

Second, the fact that we have already considered some of the behavior plaintiffs

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allege to constitute tying violations in the monopoly maintenance section does not resolve the §1 inquiry. The two practices that plaintiffs have most ardently claimed as tying vio-lations are, indeed, a basis for liability under plaintiffs’ § 2 monopoly maintenance claim. These are Microsoft’s refusal to allow OEMs to uninstall IE or remove it from the Windows desktop, and its removal of the IE entry from the Add/Remove Programs utility in Windows 98. In order for the District Court to conclude these practices also constitute §1 tying violations, plaintiffs must demonstrate that their benefits … are out-weighed by the harms in the tied product market. …

[W]e also considered another alleged tying violation--the Windows 98 override of a consumer’s choice of default web browser. We concluded that this behavior does not provide a distinct basis for §2 liability because plaintiffs failed to rebut Microsoft’s prof-fered justification by demonstrating that harms in the operating system market outweigh Microsoft’s claimed benefits. On remand, however, although Microsoft may offer the same procompetitive justification for the override, plaintiffs must have a new opportunity to rebut this claim, by demonstrating that the anticompetitive effect in the browser market is greater than these benefits. …

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