TYING, BUNDLED DISCOUNTS, AND

THE DEATH OF THE SINGLE

MONOPOLY PROFIT THEORY

Professor Elhauge
Harvard Law School
 The Attack on Current Tying Doctrine
• Existing quasi-per se rule in US/EU. Tying illegal if
– Have tying market power/dominance
– No offsetting efficiency
• Chicago School
– Only a single monopoly profit.
– Thus tying must be efficient & cannot injure buyers.
– Should be per se legal.
• Some Harvard School scholars
– Only a single monopoly profit absent a substantial tied
foreclosure share.
– Should overrule quasi-per se rule and base liability on
substantial tied foreclosure share and lack of offsetting
efficiencies.
 Both Attacks Misguided
• Without a substantial foreclosure share, ties with tying market
power and no offsetting efficiencies increase monopoly profits in
three ways:
– Extracting Individual Consumer Surplus. If buyers purchase
varying amounts of the tying product, tying can profitably
extract consumer surplus from individual buyers.
– Inter-Product Price Discrimination. Without strong positive
demand correlation, tying can profitably permit price
discrimination across buyers of both products.
– Intra-Product Price Discrimination. If buyers use varying
amounts of the tied product, tying can profitably allow price
discrimination among buyers of the tying product.
• U.S. Supreme Court expressly deems each effect anticompetitive.
• Each effect generally reduces consumer welfare (the correct legal
standard) and total welfare.
 Extracting Individual Consumer Surplus
P
• Buyers who buy multiple tying
units enjoy consumer surplus at
monopoly price. (CSM). CSM

• If CSM > consumer surplus lost

from buying tied product at
monopoly price, buyers will accept
a tie requiring purchase of both
products at monopoly price. Q

•Otherwise can extract even more consumer surplus (all of CSM) with
combination of supracompetitive prices below monopoly levels.
•In either case tying
•Increases monopoly profits.
•Reduces consumer welfare.
•Reduces ex post total welfare if buyers subject to tie spend or
value tying product significantly more than tied product, which is
typically true for ties.
 Inter-Product Price Discrimination
•Suppose A & B cost $0, buyers
value A or B from $0 to $200
and value A + B at $200.
•Without bundling, price for
each $100, buyers who value A
or B above $100 enjoy consumer
surplus (CSA + CAB).
•With bundling, price for bundle
$200, buyers get zero consumer
surplus.
• More generally, if buyer valuations for A & B have a normal
distribution and no strong positive correlation, bundling will
– increase monopoly profits
– reduce consumer welfare, and
– reduce ex post total welfare unless allocation inefficiencies are
offset by output-increasing efficiencies.
 Intra-Product Price Discrimination

• Buyer valuations of tying product correlate to

usage of tied product.
• Tie with supracompetitive tied product price
can achieve price discrimination among buyers
of tying product, which
– Increases monopoly profits
– Reduces consumer welfare & ex post total welfare
absent an offsetting output-increasing efficiency
because such tying reallocates some output to
buyers who put less value on it.
 Power Effects Generally Reduce Welfare
• Clearly reduce consumer welfare, which is US/EC legal standard.
• Consumer welfare standard supported by sound policy
– Aids International Coordination – Importing nations are decisive
regulators & have incentives to accurately apply a consumer
welfare standard.
– Distributional benefits.
– If conduct increases total welfare, can generally restructure to
improve consumer welfare. Consumer welfare trust.
• Ties barred by quasi-per se rule generally reduce total welfare
– Tying with market power generally reduce ex post total welfare
unless the inefficiencies are offset by output-increasing
efficiencies.
– Even when tying increases ex post total welfare and reduces
consumer welfare, it likely reduces overall total welfare because
additional monopoly profits dissipated ex ante.
– Total welfare ironically measured better by consumer welfare
than by ex post total welfare.
 Foreclosure Share Effects
• Increasing Tied Market Power. Without fixed tied
market competitiveness, tying can impair tied rival
competitiveness in ways that increase tied product
prices and profits.
• Increasing Tying Market Power. Without fixed tying
market competitiveness, tying can increase the degree
of tying market power.
• Because tying profitable without high foreclosure
share, neither effect requires profit-sacrifice.
• Neither effect requires complete elimination of rivals.
• Both effects exacerbate power effects by reducing the
consumer surplus available to buyers who reject tie.
• Foreclosure share effects necessary for §2 or Article 82
exclusionary abuse, but not for §1, Article 81, or
Article 82 exploitative abuse.
 Increasing Tied Market Power
• Impairing rival efficiency by denying rivals
network effects or economies of scale, scope,
learning, distribution, or research.
• Impairing rival aggressiveness by
– Reducing Cournot competition by encouraging
rivals to decrease output.
– Reducing Bertrand competition by effectively
differentiating tied market (because buyer
valuations for the tying product vary)
• Impairing rival expandability by lowering its
market share.
 Increasing Tying Market Power

• Tying can increase the degree of tying market

power in various ways.
• (1) Foreclosing enough of the tied market to
deter or delay later entry into the tying market
by tied rivals or other possible entrants.
• (2) Raising the costs of a partial substitute that
constrains tying market power.
• (3) Transferring market power from a waning
technology to the next-generation technology.
 The Death of the Single Monopoly Profit Theory
Assumption of Frequent Reality Profit-Increasing
Theory Effect
Unvarying Tied Varying Tied Product Intra-Product Price
Product Usage Usage Discrimination
Strong Positive No Strong Positive Inter-Product Price
Demand Correlation Demand Correlation Discrimination
Unvarying Tying Varying Tying Extracting Individual
Product Usage Product Usage Consumer Surplus
Tied Market Tied Foreclosure Can Increased Tied
Competitiveness Reduce Tied Rival Market Power
Fixed Competitiveness
Tying Market Tied Foreclosure Can Increased Tying
Competitiveness Protect Tying Market Market Power
Fixed Power
 Quasi-Per Se Rule Should Not Be Overruled
• Burden of proof is, given stare decisis, on those who might
claim that existing law and modern economic theory are
undermined by empirical evidence, error costs, or administrative
costs.
• Empirical evidence must focus on ties banned by the quasi-per
se rule, not all ties. We wouldn’t test drunk driving laws by
examining whether driving is generally desirable.
• Error costs support quasi-per se rule because it allows
defendants to prove efficiencies and really is a rule of reason
test for judging power effects. Without it, power effects would
be categorically ignored, amounting to a rule of per se legality
for ties with power effects, no matter how adverse they were.
• Administrative costs support quasi-per se rule because
experience shows it is administrable and because market power
is easier to ascertain than foreclosure shares and effects.
• Exception. Quasi-per se rule shouldn’t apply if products are
bundled in fixed ratio & lack separate utility, because those two
conditions negate power effects. Explains Microsoft exception.
Cf. technological ties.
 Bundled “Discounts” Can Be Penalty
• Need Not Involve True Discount – Just a Price Difference
• If unbundled price > but-for price, then difference is a penalty and
has same power effects as tying.
• If unbundled price > choke
price (Pu > Pch), effects same as
tying for all buyers.
•If Pch>Pu’>Pm=Pbut-for, effects
same as tying for purchases
valued between unbundled and
but-for price.
•Substitution to rivals or other
products already reflected in
demand curve.
•Same price-taker assumption as
monopoly pricing.
 Bundled Discount Foreclosure Share Effects
• If bundled discounts foreclose substantial share of linked
market, same foreclosure share effects as tying, whether
unbundled price > or < but-for price. Can also be profitable
either way, so requires no profit-sacrifice.
• Bundled loyalty discounts can also perversely discourage
discounts because cutting prices to disloyal buyers lowers prices
to loyal buyers.
• When power effects exist, buyers have incentives to agree
whether or not they get a true discount.
• Otherwise, buyers still have incentives to agree for discount
from future prices, even if marketwide foreclosure inflates those
prices, because the price effects from their contribution to
marketwide foreclosure are mainly externalized to other buyers
in same market or downstream.
 Legal Implications for Bundled “Discounts”
• None of anticompetitive effects depends on bundled or
effective price being < cost. To contrary, those effects
raise prices well above cost.
• Cost-based tests thus wrong & perversely exempt worst
bundled discounts. Also contrary to SCT precedent.
• Tests focused on proportion bought in bundle also
wrong because overinclusive & underinclusive.
• If unbundled price > but-for price, bundled discounts
should be governed by quasi-per se rule (i.e., illegal if
market power & no offsetting efficiencies) unless the
products have a fixed ratio and lack separate utility.
• Otherwise, should be governed by rule of reason: illegal
if substantial foreclosure share or effects absent
offsetting efficiencies.