The Eleventh Circuit recently affirmed a Federal Trade Commission finding that a manufacturer’s rebate program requiring exclusivity from its distributors was an unlawful maintenance of monopoly power under Section 5 of the FTC Act.  McWane, Inc. v. Fed. Trade Comm., No. 14-11363 (11th Cir. April 15, 2015).  The Court found that the rebate program’s practical effect was to make it economically infeasible for distributors to switch from defendant McWane to its only competitor, Star Pipe Products (“Star”).  Unable to attract sales, Star was therefore incapable of generating enough revenue to become an efficient and effective competitor to challenge McWane’s near 100% monopoly over domestic water-pipe fittings.

McWane’s Rebate Program:

Before 2009, McWane enjoyed monopoly power as the only supplier of domestic water-pipe fittings.  In 2009, however, Star (an importer of pipe fittings) announced that it would enter the domestic fittings market in response to significant federal funding for waterworks projects that used domestic pipe fittings.

In response to Star’s impending entry, McWane announced its “Full Support Program,” informing all distributors that those who purchased domestic fittings from any other company would lose their rebates or be cut off from purchasing McWane’s domestic fittings for up to three months.  The Full Support Program had two limited exceptions permitting purchase of a competitor’s domestic fittings: (1) where McWane fittings were not readily available; and (2) where a customer bought domestic fittings along with another manufacturer’s iron pipe.

Contemporaneously-created internal documents revealed that McWane’s express design in implementing the Full Support Program was to prevent domestic prices from falling by preventing Star from becoming a viable competitor.

Distributors abided by McWane’s program to avoid the devastating result of being cut off from its supply.  The two largest distributors, for example (with a collective 40-50% market share), prohibited their branches nationwide from purchasing fittings from Star, unless the purchases fell within one of the two exceptions outlined above, and even canceled pending orders with Star.  And McWane enforced its program by in fact cutting off supply and rebates to all branches of a distributor when one branch violated its rebate program.

While McWane claimed that it ended its rebate program in early 2010, the FTC did not find any evidence of a public announcement or other notification to distributors of the program’s termination.

Substantial Evidence Supported FTC’s Conclusion that the Rebate Program Violated Section 5

The Eleventh Circuit agreed with the FTC’s opinion that McWane’s rebate program was an unlawful exclusive dealing arrangement that foreclosed a competitor’s access to distributors and harmed competition, thereby contributing significantly to the maintenance of McWane’s monopoly power in the relevant market.

In affirming the FTC opinion, the Eleventh Circuit rejected each of McWane’s grounds for appeal:

First, McWane challenged the FTC’s finding that the relevant product market consisted of domesticfittings, arguing that domestic and imported fittings had identical specifications and were completely interchangeable.  The Court sided with the FTC’s position that because regulations required many projects to use only domestic fittings, imported fittings were not reasonable substitutes.  The Court also found that the fact that McWane charged notably higher prices for domestic (as opposed to imported) fittings supported a separate domestic market.

Second, although McWane did not dispute that it enjoyed 100% and 90% market share in 2009 and 2011, respectively, it argued that the successful entry and growth of its competitor refuted any inference of monopoly power from McWane’s high market shares.  While the Court noted some authority in other circuits seemingly supporting McWane’s argument, it concluded that given McWane’s high market share and significant barriers to entry, Star’s entry did not foreclose a finding of McWane’s monopoly power.

Third, McWane argued that its program was presumptively legal because it was short-term and voluntary, and that there was insufficient evidence of harm to competition.  In rejecting the first of these arguments, the Court explained that while exclusive dealing arrangements are not per seillegal, and in fact, common and often procompetitive, they can violate the antitrust laws when used by a dominant firm to maintain its monopoly.  An exclusive dealing arrangement, for example, can be harmful when “it allows a monopolist to maintain its monopoly power by raising its rivals’ costs sufficiently to prevent them from becoming effective competitors.”  The Court further noted that McWane’s exclusive dealing lacked the traditional procompetitive benefits of such contracts, i.e., the initial competition for exclusivity by offering lower prices and/or better services.  Instead, McWane’s program was imposed unilaterally on all distributors, without any discount, rebate, or other consideration offered in exchange for exclusivity  With respect to harm to competition, the Court found direct evidence of such harm given that McWane’s prices and profit margins for domestic fittings was notably higher than for imported ones, which faced greater competition.  Furthermore, there was evidence that McWane’s rebate program impeded Star’s growth, barring it from making the necessary capital investments to become an efficient and effective competitor.

Finally, McWane asserted procompetitive justifications, arguing that the rebate program was necessary to: (1) retain enough sales to keep McWane’s domestic foundry operational; and (2) prevent Star from “cherrypicking” the business by pursuing only the top few dozen fittings that account for 80% of sales.  The Court rejected the first as a viable justification, noting that McWane did not ensure sufficient sales by lower prices or improving quality, but rather, by restricting a rival’s output.  Similarly, the Court agreed with the FTC that McWane could have accomplished the second justification by competing more aggressively for the core business rather than imposing full-line forcing.  Lastly, the Court emphasized the significance of McWane’s internal documents which belied any notion that McWane’s rebate program was designed for procompetitive benefit: “McWane’s damning internal documents seem to be powerful evidence that its procompetitive justifications are merely pretextual.”

The insights for vertical counselling concerning widely used loyalty discounts are straightforward, but important.  First, companies that can be plausibly alleged to have market power in a domestic product market involving the product that is subject to a loyalty discount need to be very careful in implementing such vertical arrangements.  Second, as a practical matter, counsel should be appropriately skeptical that high market shares can be countered by arguments about potential entry by new competitors undercutting existing pricing power.  Third, loyalty discounts coupled with what amounts to a seller requirement of exclusive dealing for some period of time pose separate and additional antitrust risk, and unilaterally imposed exclusive dealing agreements in exchange for discounts are riskier still if market power clearly exists.  Fourth, although procompetitive impacts from vertical agreements are theoretically always available to defend a vertical arrangement in a rule of reason balancing, such procompetitive effects do not include simply being able to sell more of whatever product is being discounted.  Finally, as is true in every antitrust context, from mergers to all varieties of vertical Section 1 agreements, protestations of countervailing efficiencies will never survive contemporaneous internal documents to the contrary, and effective vertical counseling must include a thorough search for, and review of, internal documents describing the economic motivation for the conduct being examined.