For more than a decade, public policymakers, competition agencies, courts, and government authorities around the world have been developing an increasingly detailed set of rules governing and defining fair, reasonable, and nondiscriminatory (FRAND) terms for the licensing of standard-essential patents (SEPs). It is time to take a step back, to think hard about where we are, and to recognize that some core propositions need to be reconsidered to better align FRAND analysis and policy with good public policy.

Unlike in a competitive marketplace, and unlike in the markets for any other component in an implementer’s product, in a market for patented technology, implementers are free to “take” the technology goods (the patented technologies) and incorporate them into their products, without having first agreed to a price—in fact, without having agreed to pay at all.

This anomaly—the inability of the patent holder to prevent an implementer from taking and using the technology without having agreed to pay—has significant ramifications for both the patent holder and the implementer regardless of whether the patents are SEPs. For all patents, if and when the implementer is finally tracked down and asked to pay, the implementer can refuse to pay, requiring the patent holder to spend significant resources in time, effort, and money, to sue the implementer in an effort to force the implementer to pay. The implementer will be free to increase the patent holder’s cost to enforce its patents by challenging both whether its products infringe the patents, and whether the patents are valid. This is the issue of “holdout.” From a public policy perspective, holdout is troubling, because far from simulating the outcomes of a competitive market, it incentivizes conduct that is contrary to what would be obtained in a competitive market.

The ramifications of holdout are even more troubling and contrary to public policy when the patents at issue are SEPs. An implementer engaged in holdout when the patents are not SEPs runs the risk of being found liable for willful infringement, and therefore subject to enhanced penalties.  By contrast, an implementer engaged in holdout when the patents are SEPs runs no such risk: the only “penalty” the holdout implementer will face is being required to pay FRAND royalties, the same royalties it would have paid had it not engaged in holdout and – even more to the point – the same royalties that its competing good-faith implementers have been paying all along. The term “efficient infringement” is an apt description and explains the strong incentive to engage in such conduct.

Holdout thus creates exactly the effect that FRAND, as a public policy, was intended to prevent. In effect, it permits the holdout implementer to award itself a subsidy not available to the good-faith implementer. And the effect on the good-faith implementer is the same as if the holdout implementer were permitted to raise its rivals’ costs directly. Thus, “efficient infringement” harms the good-faith implementer both directly and indirectly.

There is an additional distortion that has developed in implementing FRAND: the ability of implementers to engage in holdout distorts the notion of what is a “reasonable” rate. The common view that the price to be paid by the implementer for the intellectual property (IP) is an externality, a “tax,” invariably does not recognize that, as with any other component, the cost of the IP should have been factored into the bill of materials, as part of the total cost of goods sold. Not only does this approach distort the determination of the appropriate price to be paid for the IP, but also calibrating that price to the implementer’s “margin” encourages courts to determine FRAND rates on a basis that ignores the very IP costs at issue, rewarding implementers for ignoring their obligation to pay for the IP they use. And it can lead courts to conclude that implementers with the lowest margins should pay the least, with the result that the least-efficient producer gets the best outcome, a reward for inefficiency that is certainly contrary to public policy.

After a decade of evolving FRAND policies, it is time to take a step back, to think hard about where we are, and to recognize that some core propositions need to be reconsidered to better align FRAND analysis and policy with good public policy.

(A longer version of this discussion is available here.)

Regarding John W. Mayo and Mark Whitener’s March 22 Outlook essay, “Five Myths: Antitrust law”:

The authors concluded by noting that “enforcers and courts tend to take competitors’ complaints about their rivals’ behavior with a grain of salt.” That is true, and, in my view, more unfortunate the more true it is.

Competitors are the first ones to notice that other, usually bigger, companies are abusing their market power, and they often notice that by observing that they are being hurt by the anticompetitive conduct of those companies. So while some competitors’ complaints may not be true, one would hope that enforcers and courts have become sophisticated enough to look carefully and not just take all competitors’ complaints with a grain of salt.

Click here to view the complete text.

This material first appeared in the April 3, 2020, edition of The Washington Post. © 2020 The Washington Post. All Rights Reserved. Further duplication without permission is prohibited.

The Organization of Petroleum Exporting Companies (OPEC) is one of the longest-running and most successful price-fixing cartels in history.

It proved its power in the 1970s by drumming up a “shortage” of oil that resulted in gasoline rationing in the U.S. Here in Washington, D.C. and the surrounding region, you could buy gas for your car only on alternate days, according to whether your license plate ended with an even or odd number. Lines stretched around the block, and people waited for hours.

The oil industry fueled and rolled out a fleet of economists and analysts to “instruct” us that the shortage was due not to agreement among the OPEC cartelists, but rather to ordinary market forces of supply and demand. The world was running out of oil reserves, they said, and we were finally in the last days of exhausting the supply of melted dinosaurs that had long given us plentiful and cheap oil products.

And of course, that was not true. Here we are, nearly 50 years later, and we still have enough oil to burn (literally) and to be partly responsible for climate change.

Price fixing is an instinct, for the simple reason that businesses hate competition. Competition makes life difficult for businesses by creating uncertainty:

Have my competitors figured out a way to become more efficient, so they can lower their prices and still be profitable? How much business will that take away from me? Will that force me to lower my prices? If I do, can my business survive? I need to work on becoming more efficient so that I can lower my prices and take business from my competitors, or at least not lose business to them.

Will my competitors innovate, making my products less desirable? If they do, how much business will I lose to them? Will my business survive? I need to work on innovating so that I can differentiate my products from my competitors’ and take business away from them, or at least not lose business to them.

And no businesses hate competition more than those whose products are homogeneous, essentially indistinguishable from each other.

Milk (adjusted for graded quality) is an example. Grade A milk is Grade A milk; it all tastes the same. We have seen how this has driven innovation and differentiation: whole milk, 2% milk, skim milk, organic milk, vitamin-enhanced milk, and lactose-free milk.

Oil (adjusted for graded quality) is another example. Oil refined by any company for a particular purpose is the same as the oil refined by any other company for that purpose.

But innovating and becoming more efficient are painful and expensive. And both have their limits. So we have seen milk price-fixing cartels, and we have seen oil and gasoline price-fixing cartels.

There are two fundamental ways to fix prices.

The first is just to get together with your competitors and agree on prices. A recent dramatic example is the lysine price-fixing cartel, made famous in the movie “The Informant” starring Matt Damon. Three executives from Archer Daniels Midland each went to jail for three years, and the company paid a fine of $70 million. And the lysine cartel was just one of several similar cartels in additives and ingredients.

The second way to fix prices is to get together with your competitors and agree to limit production or otherwise reduce supply. This works because the demand for the product will drive up the price when the supply of product is reduced (assuming demand for the product has not decreased).

And this second approach is the key to OPEC’s power.

Historically–meaning, for as long as OPEC has existed–the United States has recognized that the OPEC cartel hurts the American economy by driving up prices for a commodity that is an essential input all across that economy. More recently, when the Saudis broke with the cartel by ramping up production, that action boosted the American economy by making gasoline and other petroleum products cheaper. And it significantly hurt the economy of Russia, which is not an OPEC member, but is highly dependent on selling its oil above a certain price.

So it was quite a shock to see that President Donald Trump jumped into this dispute first by arranging talks between Russia and the Saudis; second, by pressuring Mexico (also not an OPEC member) to agree to cut back production to help move prices higher; and third, by agreeing to cut back U.S. oil production to make up the difference when Mexico would not agree to the full production limits asked of it.

We will leave it to others to analyze the politics and incentives behind this historical about-face in American economic policy. Instead, let’s look at the antitrust issue: If American oil companies limit their production, with the effect of raising prices, will that violate U.S. antitrust laws?

Let’s start by asking this obvious question: Does OPEC’s control of oil production, which raises prices, violate U.S. antitrust laws? The answer is no, but perhaps not for the reason you are thinking.

It is not because the OPEC members are not U.S.-based, or are not in the United States when they are agreeing on implementing production quotas; for over a century, it has been clear that U.S. antitrust law reaches illegal activity conducted outside the U.S. when it has a direct, foreseeable effect on the U.S. market. Rather, it’s because the actors in the OPEC cartel are sovereign nations, which cannot be subjected to U.S. antitrust laws. In other words, if the OPEC cartel were made up of private companies, even non-U.S. companies, that agreed to fix prices for oil–including the oil they export to the United States–they would violate U.S. antitrust law. The companies and their executives could be prosecuted and fined, and the executives sent to jail, even if they had never entered the United States.

And a particularly interesting feature of U.S. antitrust law is that those companies and their executives would violate the law simply by the act of agreeing, even if they did not carry through by actually limiting production. The agreement itself is illegal.

That brings us to the hard question: Would private U.S. oil companies violate antitrust law if they agreed to limit oil production at the “request” of the President? That may depend on what form that request takes.

The answer would be no if Congress passes legislation that specifically requires private companies to reduce production.

In addition, the federal government and its agencies are not subject to the antitrust laws, and courts have extended this immunity to conduct by private parties acting individually or together when the collaboration is compelled by an agreement with a federal agency or a clearly defined federal government policy and a federal agency supervises the conduct.  This immunity was recently cited by the Antitrust Division as the core rationale for approving a proposed collaboration by to medical supply distributors supporting FEMA’s “Project Airbridge” to help the agencies to expedite and increase manufacturing, sourcing, and distribution of personal protective equipment (PPE) and coronavirus-treatment-related medication.  So if the “request” takes the form of a properly authorized and structured program, closely supervised by an authorized federal agency, then the cooperating private companies would be protected from antitrust liability, so the answer would be no.

But the answer would be yes, the private companies would be subject to antitrust scrutiny and potentially liability if they go beyond the strict bounds of what they are required to do. And the answer also may be yes if the private companies agree to limit production under any government influence short of a legislated mandate, or one imposed by a federal agency in a way that extends the federal government’s immunity to the cooperating private companies.

Moreover, under U.S. antitrust law, companies can ask the U.S. government to order them to fix prices or limit production, without risking antitrust prosecution, under the First Amendment right to petition the government. But the companies violate U.S. antitrust law if they actually engage in the conduct they are petitioning the government to require while waiting for the government to respond, or if the government fails to act or refuses their request.

Future blog posts will consider how this new chapter in U.S. economic policy and antitrust law is playing out.

Sunday’s CNBC headline reads, “OPEC and allies finalize record oil production cut after days of discussion.”

One normally would interpret that headline to mean that OPEC agreed with non-OPEC members Russia, Venezuela, and Mexico on the production cut. One would not assume that the word “allies” refers to the United States. After all, we have for decades attacked the OPEC cartel for collusively raising oil prices, and Congress has enacted laws authorizing lawsuits against OPEC for precisely that collusive conduct.

Yet, there is this from the Washington Post:

Mexico had balked at a 10 million-barrel-a-day compact the Saudis and Russians were pushing and refused to agree to its share of cuts. That threatened to upend the proposal … but to keep the Mexican stand from undermining the fragile and tentative agreement, Trump announced that the United States would ‘pick up the slack’ so Mexico would not have to scale back too deeply.

In other words, President Donald Trump offered to reduce United States production of oil, and that reduction will be equal to the difference between the reduction Russia and Saudi Arabia are demanding of Mexico and the reduction Mexico is willing to make.

Abetting OPEC’s collusive conduct certainly represents a historic change in policy.

Yet it is not clear how the President could effectuate that policy. Private actors produce oil in the United States, and they make production decisions based largely on supply and demand considerations. So how could President Trump represent that the “United States” will reduce its oil output when the government does not control production?

He apparently will do so through a sleight of hand. He will count as reductions preexisting production cuts United States oil producers already made in response to declining demand. What caused that declining demand? The decision by many governors to put their states’ economies in an induced coma in response to the coronavirus; from the Washington Post: “‘We’d make up the difference,’ [President Trump] said at a White House briefing, then immediately added, ‘Now, the U.S. production has already been cut.’”

The Post reports that despite much grumbling in the Kremlin, Russia will accept the United States’ offer so that a global deal cutting oil production may be signed.

One has to ask whether this action is in the long-term interests of the United States. The President worries that declining oil prices will make oil production unprofitable for United States producers, which may threaten jobs in oil-producing regions. Job losses would concern any president, but should the United States (potentially) preserve those jobs by facilitating a collusive agreement by an oil cartel that has imposed billions of dollars of higher prices on consumers? And does the President’s action deprive the United States of any legitimate basis going forward for declaring illegal collusive conduct by the cartel?

Over the past several decades, antitrust analysis has become tightly focused on the prices consumers pay as the sole, or at least the primary, measure of consumer welfare. The focus on prices to consumers has in turn led to too narrow a focus on efficiency as a proxy for consumer welfare because regulators assume that greater efficiency results in lower consumer prices.

This approach was described by William Kolasky, then Deputy Assistant Attorney General of the Antitrust Division, in a 2002 speech he delivered in Japan titled “The Role of Competition in Promoting Dynamic Markets and Economic Growth”:

In the United States, we believe that the sole objective of competition policy is consumer welfare. This means, to repeat one of my favorite sayings, that “efficiency is the goal, competition is the process.”

To oversimplify, the argument is essentially that companies in a competitive market seek to differentiate themselves from their competitors either by increasing the quality of their product without raising the price, or by lowering the price of their product without reducing the quality, in both cases increasing the ratio of quality to price in their product. A company facing competition must become more efficient in order to do either of those.

But efficiency is a proper proxy for lower prices, and thus consumer welfare, only if companies share with consumers the benefits of their increased efficiency.

Historically, competition has forced producers to share some of their increased efficiency with consumers in the form of lower prices, and lower prices have benefited consumers and the economy in general by enabling a given amount of disposable income to purchase a larger volume of products, just as antitrust theory would predict.

Historically, it also was true that labor unions forced producers to share some of their increased efficiency with employees in the form of higher wages, which benefited consumers and the economy in general by giving consumers more spending power–that is, putting more money into the hands of employees–the consumers most likely to spend it (rather than save it)–thus spurring growth in the economy.

But more recently, the increase in concentration across broad swaths of the economy has resulted in producers keeping more of their efficiency gains for themselves. We have seen more and more companies use their increased profits from efficiency gains not to lower prices, but to buy back stock and pay large bonuses to senior management. And of course, those two actions are linked: stock buybacks increase earnings per share–a main criterion of management compensation plans–not by increasing earnings but by decreasing the number of shares outstanding.

Similarly, the decrease in the number and role of labor unions and other collective bargaining mechanisms has resulted in producers keeping more of their efficiency gains for themselves rather than paying higher wages. This is captured in the statistics over the past decades showing that dramatic increases in production efficiency have not been accompanied by increases in wages. Interestingly, the experience in professional sports stands in sharp contrast, as players’ unions have been successful in forcing team owners to share profits through higher player salaries.

William Kolasky neatly summarized the view that efficiency was the most important value in antitrust analysis in the speech quoted above, saying: “We should never use the antitrust laws to restrain efficient conduct or transactions.”

The current coronavirus pandemic is shining a spotlight on how this overreliance on efficiency as the primary proxy of consumer welfare has had negative consequences in many segments of our economy, which, I suggest, would not have obtained if we as a society–and if the antitrust agencies–had taken a broader view of the benefits of competition, rather than focusing relentlessly, and primarily, on price, and more particularly on efficiency, as a proxy for consumer welfare.

Future blog posts will explore how this narrow focus on efficiency has played out in various ways, and how by “never restraining efficient conduct or transactions” we have allowed conduct and transactions that have produced outcomes that do not enhance the welfare of consumers or society.

Welcome to our “Big Thoughts/Quick Reads” Antitrust Blog. This will be an irregular series. Some posts will be triggered by current issues. Some posts will be triggered by long-settled issues that we think need to be unsettled and reconsidered. All will be issues interesting to us, and we hope to you as well. We welcome your thoughts and look forward to generating interesting conversations.

The new coronavirus is a heat-seeking missile headed straight for our health care system. The virus threatens to infect a segment of our population so large that an influx of patients will overwhelm the relatively few open beds that hospitals have to treat the seriously ill. Estimates vary, but it is possible that hospitals will run out of available beds in the coming weeks, and certainly well before summer arrives. How did we get ourselves into this dire situation, and what role did the antitrust laws play in that process? More pointedly, should we change the way the Federal Trade Commission (FTC) evaluates hospital consolidation to ensure our health care system is more prepared to withstand a shock like COVID-19?

The number of hospital beds in the United States has decreased dramatically over the past 45 years, even as the population has increased over 50 percent. Since 1975, the number of hospitals has decreased 13 percent and the number of hospital beds has decreased 37 percent. Most of this decrease came prior to 2000 as our health care system moved to a managed care model. The traditional fee-for-service model posited a relatively simple transaction in which a patient (or an insurance company) paid a doctor for medical care. Under the managed care model, health maintenance organizations (HMOs) determined the fixed amount doctors and hospitals would be paid for particular services. Managed care was designed to eliminate waste and encourage preventive care.

As HMOs forced down health care spending, hospitals suddenly had to reduce their costs to remain financially viable. Their natural response was to consolidate into large hospital systems that created economies of scale, which allowed them to reduce cost by, among other things, negotiating deeper discounts from suppliers. The new hospital systems also brought new analytical models to the industry, which increased efficiency in the provision of care, increased outpatient service, and reduced the need for overnight stays.

Large reductions in hospital beds followed. Between 1980 and 2000, hospitals across the country decreased their inventory of beds by a whopping 28 percent. Improving hospital balance sheets was reason enough to encourage consolidation, but there were other good reasons for the FTC to approve hospital mergers. Large capital investments were needed to pay for the innovations in medical technologies, treatments, and pharmaceuticals that increased the efficiency of care and decreased the need for overnight hospital stays.

Yet these new economics had, by the turn of the century, exposed the hospital industry to the threat of shocks, and COVID-19 is the latest threat to our health care system. Again, estimates vary, but it appears that hospitals have fewer than 500,000 beds available, a number that everyone agrees is far too low to accommodate the likely volume of seriously ill patients. The situation is so extreme that governors and mayors across the country are shutting down large segments of the economy to slow the progress of the virus and thereby reduce the number of patients who need a hospital bed.

So, while there are good arguments that the FTC reasonably concluded that a lenient approach to reviewing hospital mergers created procompetitive efficiencies, it is equally clear that the review did not account for the negative consequences consolidation would have on our health care system. The problem, of course, is that the FTC is not competent to consider those larger public policy issues. Rather, other entities in the executive branch, such as the Food and Drug Administration and the Department of Health and Human Services, routinely consider those policy issues. Perhaps it is time for us to consider enlarging the scope of the FTC’s review of hospital mergers to include the input of experts who can anticipate the likely effect of consolidation on the ability of our health care system to respond to sudden shocks that threaten the quality of patient care.

What would that expanded review look like? We will explore that issue later this week.