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A company that dominates its industry or the market for a particular product within that industry must tread lightly when it takes any action that could interfere with its competitors’ efforts to develop an efficient distribution network. The 3d U.S. Circuit Court of Appeals hammered this point home this past February in an antitrust case brought by the federal government against the nation’s largest false teeth manufacturer, Dentsply International Inc. The 3d Circuit held that Dentsply had monopolized sales of false teeth to dental laboratories and dealers in violation of federal antitrust laws by prohibiting its distributors from carrying competing lines of false teeth-a practice commonly known as exclusive dealing. U.S. v. Dentsply, 399 F.3d 181 (3d Cir. 2005). According to the 3d Circuit, Dentsply’s exclusive-dealing policy effectively denied competitors access to the most efficient and effective channel of distribution, which as a practical matter meant that the competitors could not possibly mount any serious challenge to Dentsply’s dominant position in the market. Indeed, the primary antitrust concern with exclusive dealing arrangements is foreclosure, i.e., that they may be used in certain circumstances to wrap up vital outlets to the marketplace or necessary product inputs without which others cannot effectively compete. Notwithstanding this concern, exclusive-dealing arrangements often result in pro-competitive benefits and, therefore, in the majority of circumstances, usually raise no antitrust concerns. But Dentsply stands as a recent example of cases decided over the last several years in which courts have struck down exclusive-dealing arrangements under the antitrust laws. The primary antitrust statutes applicable to exclusive-dealing arrangements are �� 1 and 2 of the Sherman Act and � 3 of the Clayton Act. Section 1 generally prohibits any agreement, including an agreement by a distributor to deal exclusively with a particular manufacturer, that has an overall adverse effect on competition in a relevant market. In contrast to � 1, � 2 covers single-firm conduct and makes it unlawful to acquire or maintain through willful means monopoly power in any relevant market. As with � 1, however, to establish a claim under � 2, the conduct in question must have an anti-competitive effect in a relevant market. In other words, conduct having a legitimate business justification cannot support a � 2 claim for monopolization unless the anti-competitive effects flowing from the conduct outweighs the pro-competitive benefits. Section 3 of the Clayton Act, unlike �� 1 and 2 of the Sherman Act, applies only to sales of commodities, not to services, and condemns those exclusive-dealing arrangements that “may . . . substantially lessen competition or tend to create a monopoly.” 15 U.S.C. 14. The ability to invoke � 3 to attack exclusive-dealing arrangements in their incipiency, before they inflict any meaningful harm to competition, arguably stands as a significant distinction between the reach of the Clayton Act compared to that of the Sherman Act. These statutory provisions applicable to exclusive-dealing arrangements also have other fundamental differences (such as the need to establish varying degrees of market power), which, depending on the particular case, could result in disparate outcomes. But the competitive-effects inquiry under each statute generally focuses on essentially the same factors, namely not only a quantitative evaluation of the amount of market foreclosure but also a qualitative assessment of how important those things in the foreclosed segment of the market are to competition. As the U.S. Supreme Court noted, exclusive-dealing arrangements raise antitrust concerns “only when a significant fraction of buyers or sellers are frozen out of a market by the [arrangement].” Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2, 45 (1984) (O’Connor, J., concurring). Pro-competitive benefits Notwithstanding the antitrust precedent condemning exclusive dealing arrangements as anti-competitive devices, numerous cases and commentators have recognized the legitimate business justifications for, and the pro-competitive benefits flowing from, such exclusivity arrangements. Indeed, exclusive-dealing arrangements offer a broad array of efficiencies and may actually enhance competition in several ways. For instance, a distributor that sells only a single brand often will have a much greater incentive than a distributor carrying multiple brands to take the time to learn about the unique attributes of that brand, try to distinguish the brand from others and spend the resources necessary to promote that brand (e.g., by advertising and discounting) over other competing brands. Moreover, a manufacturer can use exclusive-dealing arrangements to prevent rivals from free riding on its efforts to develop an efficient and effective distribution chain and thereby give the manufacturer greater incentive to invest resources to support its distributors, for example, by engaging in cooperative advertising programs with its distributors. These things can greatly enhance the level of interbrand competition. These potential competitive benefits, coupled with the rather substantial degree of market foreclosure required under the modern cases, have made it relatively difficult to prove an antitrust violation resulting from an exclusive-dealing arrangement. Nevertheless, several cases since 2000-some slightly controversial-have found antitrust violations flowing from exclusive-dealing arrangements. These unlawful arrangements took many forms and spanned widely different industries. For instance, the exclusionary rules imposed by Visa and MasterCard that prevented their issuing banks from also issuing American Express or Discover cards failed to survive a challenge by the U.S. Department of Justice (DOJ) under Sherman Act � 1. U.S. v. Visa U.S.A. Inc., 344 F.3d 229 (2d Cir. 2003). The DOJ also successfully challenged, under � 2 of the Sherman Act, among other conduct, Microsoft Corp.’s exclusive-dealing provisions with Internet service providers that required the ISPs to promote Microsoft’s Internet browser software and prevented or limited the ISPs from using the competing Netscape browser. U.S. v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001). And in another 3d Circuit case predating Dentsply, a private-label tape manufacturer prevailed on its Sherman Act � 2 claim against 3M Co. for using a bundled discounting strategy to persuade dominant retailers, such as Wal-Mart, to deal exclusively with 3M for purchases of various products, including 3M’s well-known Scotch brand tape. LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003). Although the exclusive-dealing arrangements in these cases assumed many forms, they all exhibited a few common threads: A company having market power, in most cases monopoly power, over a particular product used that power to foreclose its rivals from access to a critical channel of distribution. The 3d Circuit found that Dentsply engaged in essentially these same tactics and achieved the same anti-competitive ends as found in the other cases. The anti-competitive conduct that took center stage in Dentsply came in the form of a distribution policy known as “Dealer Criterion 6,” which Dentsply adopted in the early 1990s. Dealer Criterion 6 prohibited dealers from adding any new lines of artificial teeth to their product offerings. Dealers that had carried competing lines of teeth prior to enactment of the policy were “grandfathered” and could continue to carry those competing product lines. Dentsply’s stated purpose behind the policy was to ensure that its authorized dealers would effectively promote its products. A finding of monopoly power The 3d Circuit and the district court had no problem finding that Dentsply had obtained a monopoly in the artificial tooth market-an essential fact for establishing a Sherman Act � 2 violation. Dentsply controlled a dominant share of artificial teeth sales, roughly 75% to 80% of total revenues and 67% of all units sold. In addition to its substantial market share, the court of appeals noted that Dentsply had the ability through its anti-competitive acts to exclude certain competitors from the market and also seemingly set its prices without regard to its competitors’ prices. These factors provided the 3d Circuit with additional support for its finding that Dentsply possessed monopoly power. Dentsply’s exclusivity policy severely hampered competition, according to the 3d Circuit. Indeed, the court of appeals found that manufacturers in this market must distribute through dealers to be able to compete effectively. Dealers provide numerous benefits to dental labs-the primary customers in the market-that cannot be achieved through a manufacturer’s direct sales. For example, dealers provide extensive credit to laboratories, economies of scale and the convenience of one-stop shopping. Economies of scale translate into discounts for customers, while one-stop shopping provides a significant reduction in transaction costs. Dealers also allow laboratories to return teeth to a single source-an important consideration in an industry where approximately 30% of all purchases are returned for exchange or credit. Finally, by selling to a few dozen dealers as opposed to selling directly to thousands of individual labs, dealers reduce the manufacturers’ credit risks and transaction costs, thereby lowering the ultimate cost of the teeth. For these reasons, the 3d Circuit disagreed with the district court’s finding that a direct-to-customer sales approach represented a viable alternative to sales through established dealers. According to the court of appeals, a direct sales strategy might be possible but it is not economically feasible. Dealer Criterion 6 had been particularly effective in foreclosing competitors from the market. Although Dentsply operated on a purchase-order basis, meaning that either the dealers or Dentsply could terminate their distribution arrangements “at will,” the 3d Circuit found that dealers had no choice but to carry Dentsply’s products, given Dentsply’s dominance in the market. Dealers therefore were forced to acquiesce to Dealer Criterion 6. Under these circumstances, the policy was just as effective and binding on the dealers as if it were written into a formal distribution agreement. Evidence in the record also showed that the policy severely limited the dealer’s choice in the marketplace. One dealer declined to add a competitor’s line of teeth after Dentsply threatened to cut off the dealer from access to Dentsply’s teeth-a product that constituted more than 90% of that dealer’s revenue from tooth sales. The policy, coupled with the economic realities of the market, presented dealers with an “all or nothing” decision, and the dealers chose the only economically viable option-sticking with Dentsply. Without access to a viable distribution network, the other false teeth competitors were only able to make an anemic showing in the market, no one competitor achieving a market share of more than 5% and most capturing a share of 3% or less. This poor showing further supported the 3d Circuit’s finding that manufacturers could not compete effectively without access to established distributors and that Dentsply’s tactics had succeeded in stifling competition. Rejecting business justification Dentsply argued that it had a legitimate business justification for its exclusivity policy, namely to encourage its dealers to promote its product more vigorously. But both the 3d Circuit and the district court rejected that justification as a mere pretext. Dentsply had used its exclusivity policy to fence off from its competitors a large percentage of the significant distributors in the market, with devastating competitive effects. Under these circumstances, Dentsply’s claim that it merely sought to engage in legitimate, but aggressive, competition rang hollow with the court. Notwithstanding the pro-competitive benefits that may result from exclusive dealing arrangements, the 3d Circuit’s Dentsply decision, as well as other recent exclusive dealing cases, increase the antitrust risks to dominant firms that choose to use such arrangements to boost sales. These decisions show that, as a general matter, any conduct on the part of a dominant firm that interferes with its smaller rivals’ efforts to distribute their products may expose the dominant firm to antitrust liability, even if the smaller rivals are not entirely foreclosed from the market. These cases demonstrate that strategies that may be pro-competitive in one circumstance, if implemented by a firm without market power, may violate the antitrust laws under other circumstances, if undertaken by a firm with monopoly power. Companies with large market shares therefore must carefully consider any strategy that may adversely affect their competitors’ access to a commonly used method of distribution. Peter M. Boyle is a partner, and Svetlana S. Gans is an associate, in the antitrust practice group of Kilpatrick Stockton, in the firm’s Washington office.

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