Thousands of sellers, from cable television and Internet service operators to fast food restaurants and book dealers, offer bundled discounts, as do large commercial enterprises that sell to other businesses. But what, if any, risk may a business face if it sells multiple products as a package when the price for that package is less than what the business charges if those products are purchased individually? As matters stand today, there is no clear cut answer to that question. As a result, the practice of offering bundled discount packages can be risky because, at least in some circumstances, the practice may violate federal antitrust law.
To understand why a business should be concerned requires an understanding of the two leading federal antitrust cases that have analyzed the issue of bundled discounts: LePage's Inc. v. 3M Co., 324 F.3d 141 (3d Cir. 2003), cert. denied, 542 U.S. 953 (2004) and Cascade Health Solutions v. PeaceHealth, 502 F.3d 895 (9th Cir. 2007).
3M, the manufacturer and seller of transparent tape under the Scotch brand name, was sued by LePage's, which sold transparent tape, called private label tape, under the names or brands of various retailers, such as Office Depot and Wal-Mart. LePage's tape sold at a lower price than did 3M's branded tape. 3M decided to compete in the private label market, and when it did, it began offering discount, promotional, and cash incentive programs to its customers that purchased other 3M products in addition to Scotch tape. LePage's maintained that, as a result, it lost substantial transparent tape business to 3M.
PeaceHealth operated hospitals that provided a range of services, from basic care to advanced, or tertiary, care in Lane County, Oregon. Cascade Health Solutions operated the only other hospital in that county, and throughout most of its history, that hospital provided only basic care. PeaceHealth began offering discounts of 35-40 percent on tertiary care to health insurance companies if they, in turn, agreed to make PeaceHealth their exclusive provider for all hospital services, including basic care. Because of that, Cascade maintained, it lost substantial business to PeaceHealth.
In LePage's, the Third Circuit Court of Appeals decided that 3M's discount programs violated federal antitrust law (section 2 of the Sherman Act). The court did so even though the bundle was priced above 3M's cost to manufacture the bundled products so that 3M was still earning a profit from those products, including the tape, despite the discount. In effect, the court decided to sweep broadly and concluded that such bundling programs are unlawful whenever a small competitor cannot compete by matching the discount that its competitive rival offers because that smaller competitor does not offer the same range or variety of products as the competitive rival that sells the bundled discount package.
The Ninth Circuit Court of Appeals in PeaceHealth decided not to follow the LePage's decision. Instead, the Ninth Circuit observed that bundled discounts can be beneficial because they can result in lower prices to consumers. Still, the court was not willing to say that bundled discounts are always beneficial because it also recognized that, in some circumstances, such discounts can be anticompetitive if they limit or prevent sales by a more efficient competitor that does not offer as diverse a product line. To determine when bundled discount packages are beneficial, or procompetitive, the court adopted a "discount attribution" test. The test works this way. First, the full amount of all discounts given for the bundle is calculated. Second, that amount is then allocated only to the product that competes with the product offered by the smaller competitor. (Thus, for example, using the LePage's case as an illustration, the total value of all of 3M's discounts, promotions, and other incentives would be allocated to transparent tape.) For purposes of the test, that allocation results in what is called the "competitive price" of the competing product. Third, that competitive price is then compared with the bundled discounter's average variable cost for the competing product, and if the competitive price is above the average variable cost, the bundling does not violate the federal Sherman Act.
So, with both LePage's and PeaceHealth, on the books, where does that leave us? For businesses that are dominant players in a market for one or more products, the answer is this: in a state of uncertainty. (Although what constitutes a "dominant" market position is not clearly defined, it appears that something that at least approaches, if not exceeds, fifty percent is required when a violation of the Sherman Act is alleged.)
For those businesses that operate in states that are located in the Ninth Circuit (Arizona, Nevada, California, Washington, Oregon, Montana, Idaho, Hawaii, and Alaska), PeaceHealth provides at least some comfort because it allows sellers an opportunity to show that their package discounts promote competition. For businesses that operate in the Third Circuit (Pennsylvania, New Jersey, and Delaware), however, it appears that there is a flat prohibition against bundling for businesses that dominate a product's market. For businesses that operate elsewhere, knowing which of those two approaches will gain approval, or whether another approach will be adopted, is at most a guessing game.
As of March 2008, only one reported post PeaceHealth case has dealt with the issue of bundling. Although in Southeast Missouri Hospital v. C.R. Bard, Inc., the court was not required to make a final decision about whether bundling was lawful, the court appeared to indicate that, as the case progressed, it would allow a seller that offered a bundled discount package the opportunity to show that doing so was pro-competitive.
The United States Supreme Court has shown some interest in considering antitrust issues in recent years. The substantially different approaches taken by the Third and Ninth Circuit Courts and the need for certainty may prompt the Supreme Court to consider a bundling case in the near future. Supreme Court Justice Samuel Alito was one of ten members of the Third Circuit panel of judges that decided LePage's in 2003. He voted with the three-judge minority against what many consider a broad, standardless rule prohibiting bundled discounts.
Until then, adding further to the uncertainty is a report by the Antitrust Modernization Commission, which urges an approach that is similar but not identical to the method used in PeaceHealth. Congress established the bipartisan Commission in 2002 to examine whether the federal antitrust laws should be modernized. In its final report, which was submitted in 2007, the Commission proposed a three-part test for bundled discount packages: (i) as in PeaceHealth, determine whether the "competitive price" (as described above) is above or below the incremental cost for the competitive product; (ii) if below, determine whether, in the short term, the seller is likely to recoup its losses; and (iii) determine whether the bundled package has had or will likely have an anticompetitive effect. The Ninth Circuit in PeaceHealth rejected the second part of that test, reasoning that bundled discount packages could be anticompetitive even though the seller may still earn a profit from them, and rejected the third part, reasoning that it was redundant because it amounted only to a restatement of the first part of the test.
Meanwhile, even the PeaceHealth test itself may create uncertainty for a multi product company that wishes to discount some of its products. Before doing so, that company needs to determine which of its products to include in the analysis that produces the hypothetical "competitive price." This becomes especially difficult when the company is faced with several competitors or several competitive products instead of just one, as in PeaceHealth and LePage's. Further, applied literally, PeaceHealth could lead to a determination of illegality when one of several products in a bundle has a competitive price below its average variable cost but accounts for only a small percentage of the company's sales.
In short, whether operating within or outside those states that make up the Ninth Circuit, a business with a significant market position in one or more products that wishes to compete by offering bundled discounts would be well-served to proceed with great caution. That becomes especially true because even if the practice of offering a bundled discount does not violate the Sherman Act, the seller may still be exposed to a claim for a violation of another federal antitrust law, namely unlawful tying under section 3 of the Clayton Act. (The difference between bundled discounts and tying is that, typically, a seller that offers a bundle is also willing to sell the bundled products individually, while a tying arrangement makes the purchase of one product contingent on the purchase of another product, as for example, if the seller of a computer printer requires purchasers to buy the seller's toner or paper as well.)
Concern about being faced with a tying claim cannot be dismissed lightly by business planners because, in at least one way, it may be easier for a small company to succeed in a lawsuit against a large competitor by maintaining that the bundled discount package is really a tying arrangement. That is because the degree of market power possessed by the seller of the package that must be shown is likely to be less when it can be characterized as a tying arrangement rather than a bundled discount. Although an analysis of tying law is beyond the scope of this article, it should be noted that, in PeaceHealth, the court indicated that, even if a bundling arrangement passed the discount attribution test, it might not pass the test for an unlawful tying arrangement should it turn out that only a few customers were choosing not to take the bundle. In other words, the PeaceHealth opinion could be read to mean that, when a bundled discount package is so successful that few purchasers choose to buy the products individually, that may be evidence of a tying arrangement.
This memorandum is provided for informational purposes only and is neither intended to be legal advice nor should be treated as such.