In this chapter we’re going to explore the way government, particularly the federal government, regulates business. The government regulates business for many reasons, most of which are focused on providing the most competitive environment possible for business. The intent is to create a business environment that benefits the consumer by providing better goods at a lower cost.

The Supreme Court has held that the federal government may regulate business for any reason as long as it advances the government’s economic needs. States may regulate business as long as the regulations don’t interfere with interstate commerce or the federal government’s activities. States set the limits on what local governments can regulate. So what local governments can do fluctuates from state to state.

In a true free enterprise system, the government would not be involved in business. Instead, it would stand back and allow the market to dictate what actions businesses take. If consumers didn’t like how a business operated, they would take their business to other companies. As a result, the “bad” companies would change their behavior to keep their customers.

In a market economy businesses try to respond to the needs of customers. In real life, the market doesn’t always respond quickly enough to problems. Thus, the federal and state governments step in with regulations that direct the actions of the companies.

Governments cycle through times of regulation and deregulation. When companies abuse their freedom, the government steps in with regulation. When the economy shifts because of new technology, the regulations may be lifted.

For example, in the early 1980s the federal government broke up Ma Bell because it acted in a monopolistic manner that harmed consumers. Ma Bell consisted of 24 companies that provided local phone service, AT&T for long distance, a research and development lab, and a manufacturing company. On January 1, 1984, Ma Bell was broken into seven regional Bells with AT&T keeping the long-distance service. Twenty years later, the face of telecommunications is dramatically different. There is competition for local calls; there are hundreds of providers of long-distance service; and consumers can purchase their phone service through cable providers and other Internet sources. The government is more open to consolidation among telecommunications firms because the market has changed.

The primary goal of government regulation is to protect the public from harm. One way the government protects the public is to regulate false advertising and labeling of products. The Federal Trade Commission (FTC) bears the majority of this burden by preventing fraud, deception, and unfair business practices. The FTC enforces federal laws that protect consumers and provides information that helps consumers avoid fraud and deception.

It also sets health and purity standards for cosmetics, pharmaceuticals, and foods. Let’s look at the U.S. Food and Drug Administration (FDA). The FDA plays the lead role in regulating this area. The FDA regulates under the mandate to improve patient and consumer safety while increasing access to new medical and food products. The FDA also regulates to improve the quality and safety of manufactured products and the supply chain.

Attempts to deregulate are not always successful. In the late 1970s the federal government began deregulating thrifts, organizations like savings and loans that are formed to hold deposits for individuals. This deregulation, in combination with economic factors like falling inflation and collapsing housing prices, in the mid-1980s led to the collapse of the savings and loan industry. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) was enacted to save the savings and loan industry by increasing federal oversight.

The tension between regulation and deregulation ebbs and flows. When several large companies like Enron, WorldCom, and Adelphia imploded in the early 2000s due to accounting irregularities, Congress responded by passing the Sarbanes-Oxley Act (see Chapter 3). Once Congress acts, the agencies create regulations the companies must follow and the oversight to make sure the companies follow those regulations. So expect this cycle to continue.

Antitrust laws are enforced in three basic ways. The federal laws are enforced by civil enforcement actions by the Federal Trade Commission (FTC), criminal and civil enforcement actions by the Antitrust Division of the Department of Justice (DOJ), and lawsuits brought by private parties asserting damages from the anticompetitive behavior. The FTC and DOJ have overlapping jurisdiction, but have developed separate areas of expertise. The agencies also will consult with each other prior to starting an investigation to avoid duplication.

In addition to these two agencies, state attorneys general play a role by bringing suits under federal law on behalf of businesses and consumers from their states. This is in addition to any actions they may bring under state law. Nineteen states joined the Department of Justice in its 1998 suit against Microsoft. Private individuals may also bring suit under the federal laws.

There is also a growing area where international organizations are also involved in antitrust on a multinational level. This can be seen with the ongoing litigation saga Microsoft has endured where it has fought legal battles in the United States and internationally. According to the FTC, there are more than 100 foreign competition agencies. That’s a lot of antitrust law and regulation for businesses to monitor.

The regulation of prices happens at the state and federal levels. It can occur when consumers purchase products, but also by limiting interest rates, or instituting rent controls. Because the state laws vary by state but echo federal principles, here we’ll focus on the federal principles.

Congress passed the Sherman Act in 1890 as a response to the large trusts that had developed in steel, sugar, and other areas of the economy. The Federal Trade Commission (FTC) Act and Clayton Act were passed in 1914 to prevent unlawful mergers and anticompetitive business behavior. The Supreme Court has found that violations of the Sherman Act are automatically violations of the FTC Act. The core purpose of these laws is to protect consumers by encouraging businesses to operate efficiently and keep costs down and quality up.

A key principle in this area is that competitors cannot engage in price-fixing. Price-fixing—any agreement to charge an agreed-upon price or set maximum or minimum prices—is a form of collusion that is prohibited by Section 1 of the Sherman Antitrust Act. Horizontal price-fixing occurs when competitors get together on pricing. Let’s say several competitors are at the same business networking luncheon.

While there, they discuss the prices they charge on a make and model of laptops they all sell. As they talk, they decide they could all make more money if they set the price at the same level. This is horizontal price-fixing and is illegal.

Because price is a sensitive part of competition, if competitors engage in price-fixing, it can also be monopolistic behavior. That’s because if competitors collude to set prices, they are often trying to prevent new competition.

The Clayton Act and Robinson-Patman Act also prohibit price discrimination. Section 2 of the Clayton Act prohibits anyone engaged in commerce to “discriminate in price between different purchasers of commodities of like grade and quality … where the effect of such discrimination may be substantially to lessen competition or tend to create a monopoly in any line of commerce, or to injure, destroy, or prevent competition with any person who either grants or knowingly receives the benefit of such discrimination …”

The key language is “substantially to lessen competition or tend to create a monopoly.” So how does price discrimination accomplish that?

One of my favorite cases that illustrates price discrimination is the Utah Pie Company case. In this case, three outside competitors entered the Utah pie market. Their entries resulted in a price war—not anticompetitive in and of itself. What made this action unconstitutional is that several of these companies charged a higher price for the same pie in other states. Because of that fact, the court determined that the only reason the companies would charge lower prices was to push the Utah Pie Company out of the Utah pie market. That is predatory pricing because the companies intended to harm the Utah Pie Company.

Under the Robinson-Patman Act price discrimination occurs when sellers charge competing buyers different prices for the same commodity or provide different allowances for the competitors. Allowances include items like compensation for advertising or services like repairs. Price discrimination in this context isn’t always illegal, because it may cost more to get a product to one customer over another. For example, the shipping costs may be higher for one. Robinson-Patman applies to commodities and purchases, not services and leases. To be a violation the goods must be of like grade and quality, there must be a likely harm to competition, and the sales must usually be interstate.

Price-fixing also isn’t illegal under Robinson-Patman if the lower price results from the seller attempting to meet a competitor’s price or service offered to that customer. What the pie companies did in the Utah Pie Company case was predatory pricing because they priced below cost with the intent of harming competition by forcing out a competitor. That is never legal. The price difference may also be justified by different costs in the sale, delivery, or manufacture of the goods.

In addition to the two forms of allowable price discrimination under the Robinson-Patman Act, price discrimination is allowed in select circumstances. Those include when the difference in grade, quality, or quantity justifies the price difference. It is also justified when a different method of production is used or the quantity is different. Maybe the goods have deteriorated in a way that justifies the price difference. A close-out sale on a particular line of goods to move the remaining stock can also justify the price difference.

The Sherman Act and Clayton Act do more than address price-fixing. These laws also are designed to prevent monopolies and other forms of unfair competition.

In addition to the price discrimination discussed above, Section 1 of the Sherman Act prevents tying of product and monopolization of markets. Products are tied when the seller conditions the sale or lease of a product the buyer wants on purchase or lease of a second item it doesn’t want. For tying to violate the Sherman Act, the seller must have appreciable economic power in the tying market.

A close cousin to tying is the bundling of products. Bundling occurs when related products are sold as one unit. In a sense newspapers are bundled to consumers. If I purchase a newspaper I pay a fixed rate for the entire paper. I can’t pick and choose the sections I will actually read and pay only for those. The terms bundling and tying are often used interchangeably by the courts.

The distinction is that tying always includes coercion on the part of the seller, and bundling doesn’t. Tying also will often include a slow-selling or unknown product. Bundling can occur because consumers actually want the products bundled. If I purchase a printer, I expect it to come with ink or toner. Those products are bundled together for my convenience. However, if the printer company ensures that nobody can compete with it on the sale of replacement toner, the product may now be tied.

Economists tend to believe that tying and bundling can be good for the economy.

In the Microsoft case that was originally filed in 1998, one charge against Microsoft was that it tied its products. Microsoft required computer manufacturers that wanted to use its software to purchase Internet Explorer. Because Microsoft had a near-monopoly in operating systems, it was in a monopolistic position, and the United States and other plaintiffs successfully argued that Microsoft used the tying to keep competitors out of the market.

A small number of anticompetitive behaviors are per se violations of the antitrust laws. Per se means that it’s a violation just because the act happened. All the plaintiff must do is show the violations occurred and move to a determination of damages. The Supreme Court has held the following are always per se violations:

If a company engages in any of these activities or agreements, they have violated antitrust laws, specifically the Sherman Act. Because they are per se violations and always illegal, these items do not require a trial on the law. However, courts are shifting to require market analysis in tying cases, which is fact intensive, using a rule of reason analysis.

The Sherman Act does not speak to businesses becoming too big unless they take monopolistic action. However, the Clayton Act prohibits companies from merging with or acquiring another if “the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.” The Federal Trade Commission and Antitrust Division of the Department of Justice are charged with reviewing proposed mergers. Periodically you’ll see headlines about mergers that have either been approved or denied by one or both of these agencies. In multinational mergers, the companies will also need to receive approval from foreign governments.

This requirement to give premerger notification to the FTC and DOJ is designed to limit the loss incurred if companies are told to divest postmerger. It also reflects the reality that most mergers benefit the consumer because they increase competition and allow the firms to operate more efficiently. But the government is watching for those mergers that could lead to higher prices, fewer goods and services, or less innovation. The agencies are most concerned about horizontal mergers, those between direct competitors. They review more than 1,000 merger applications a year, and approve more than 95 percent with many of the balance approved once changes are made.

Not all dealings between competitors are illegal. In fact, those interactions can be procompetitive when they allow firms to move into new areas of business both with products or by expanding geographic markets. In addition, competitors often interact in trade associations, joint ventures, and professional groups.

For example, a large pharmaceutical company like Eli Lilly will often form a joint venture with a much smaller pharmaceutical that has a drug it needs help marketing. The smaller company had the expertise and luck to identify a new compound, but it needs assistance with sales and marketing that a large company like Eli Lilly can offer. Because the drug might not be available without the larger company’s involvement, it’s not anticompetitive for two firms in the same industry to join together for the purpose of manufacturing, marketing, and selling that drug.

The problem occurs when these interactions between competitors lead to the companies not acting independently or the competitors are now able to wield market power together that they did not have independently. The key analysis regulators make is whether the agreement brings procompetitive benefits or anticompetitive harms.

The same rule of reason or per se analysis is used to evaluate these agreements between competitors. If the agreement is so likely to cause anticompetitive harm that they violate antitrust laws per se. The harm is so obvious that a fact-finding trial isn’t required. If the harm isn’t as obvious than the rule of reason will be used, requiring fact finding into the overall competitive effect. Remember, rule of reason analysis is flexible and varies depending on the nature of the agreement and market.

There are two different types of remedies for anticompetitive behavior. Sometimes civil remedies of money damages or injunctions will be issued. In other cases, criminal remedies are available.

Plaintiffs can seek an injunction against the defendant for violating the antitrust laws. If the plaintiff is an individual or business, then they can seek treble damages. If the suit is a class-action brought by a state attorney general, then the attorney general can seek damages to reimburse the buyers who have been harmed by the price discrimination or fixing. Structural remedies and injunctions are often the remedies for mergers and acquisitions.

The DOJ can seek criminal remedies under the Sherman Act. Those remedies include a maximum fine of $10 million against a corporation per incident. The maximum fine against an individual is $350,000, but that person can also be sentenced to up to three years in jail or both for the anticompetitive behavior. The DOJ obtained a criminal fine of $250 and $500 million against BASF Ag and F. Hoffmann-La Roche in 1999. In 2003 in 41 criminal cases, it obtained $107 million in fines and an average sentence of 21 months.

One challenge enforcers have today is that the laws they enforce were created to deal with the economy of the late 1800s and early 1900s. That economy was more stagnant than today’s fast-paced, technology-based one. So the question is whether the laws even work. The Microsoft case is a great example of this. The case was fast-tracked from the moment it was filed in May 1998. Yet, by the time the D.C. Court of Appeals issued its decision at the end of June 2001, technology changed. Did the facts that led to the case filing still exist? Was Microsoft a natural monopoly? These questions will likely be asked more in the future as old laws are applied to a rapidly changing economy.