CASE STUDIES

for

FEDERAL TRADE COMMISSION PUBLIC WORKSHOP

on

EMERGING ISSUES FOR COMPETITION POLICY IN THE WORLD OF E-COMMERCE

INTRODUCTORY NOTE

Policy Planning staff of the Federal Trade Commission have developed the following two case studies for discussion at the first day of the FTC's May 7-8, 2001 workshop, entitled "Emerging Issues For Competition Policy in The World of E-Commerce." It is our hope that these case studies will focus, but not limit, the discussion. The case studies are not based on any particular industries, but rather use generic terms (e.g., the market for widgets). We have worked with business analysts, attorneys, and economists in the private sector to ensure that the case studies reflect possible real-world business situations, but we have also simplified the hypotheticals in certain respects in order to more easily focus on particular antitrust issues. Thus, these case studies should be viewed as hypotheticals that may not reflect the full complexity of real-world circumstances and that are intended to elicit, but not constrain, a discussion of the relevant competition issues.

CASE STUDY ONE

PANEL ONE
9:15 A.M. TO NOON
MAY 7, 2001

BASIC FACTS

Three B2Bs - A, B, and C - propose to merge into a single B2B called ABC, and your advice is sought about the competitive consequences of the proposed merger.

Widgets are parts that 1,000 widget buyers nationwide ("buyers") insert into machines that they manufacture and sell. There are 25 widget manufacturers ("sellers") nationwide, each of about the same size. Buyers have traditionally bought widgets through wholesalers. There are only two such wholesalers in today's market, X and Y, and all sellers use them. Recently, however, four new B2Bs - A, B, C and D - have been established. A, B, C, and D each have websites that let buyers nationwide view certain sellers' offerings and place orders with the sellers directly. A, B, and C sell first-quality widgets through online catalogs; D also sells some first-quality widgets through online catalogs, but much of its business derives from an online auction service that offers widgets that have been slightly malformed in the manufacturing process, discontinued lines of widgets, and widgets languishing in excess inventory.

X and Y's procurement process has a ten percent error rate. A, B, C, and D, by contrast, all have lower error rates due to their improved communications technology. A, B, C, and D each have different error rates, however, with D recording the lowest rate of error. Purchasers using D also receive their widgets more quickly than purchasers using A, B, or C.

The mark-up on price that X and Y pass on to buyers is ten percent. A, B, C and D charge buyers either transaction or subscription fees, and they also charge buyers for optional value-added services. Different value-added services are important to different buyers, and A, B, C, and D each offer different packages of such services. A buyer using the most popular value-added services on A, B, C, or D will generally pay less than the ten percent mark-up charged by X and Y.

A, B, and C each receive 10% of the widget buying volume; D receives 20% of the widget buying volume; and X and Y each receive 25% of the widget buying volume. Sellers 1, 2, 3, 4 and 5 -- five of the 25 widget manufacturers in this market -- founded A, and these are the only sellers now selling through A. Sellers 6-10 founded B and are the only sellers that trade on B. Sellers 11-15 founded C and are the only sellers that trade on C. D is used by Sellers 16-25. A, B, C, D, X and Y are open to all buyers and sellers who wish to use them, and no exclusive contracts bind any seller or buyer to A, B, C, D, X or Y.

The merger's proponents state that B2Bs such as A, B, and C that each process only 10% of the widget purchasing volume are not as likely to succeed as those with more volume. Given the expense of the necessary hardware and software, supply-side scale economies demand more volume, they say. Furthermore, they report that buyers are frustrated that they can access only 5 sellers through A, and that they must go to the trouble of working through other exchanges to access other sellers. (They have the same complaints about their inability to access more than 5 sellers when working through B and C.) The buyers want to be where the sellers are, or at least where more of them are, and this demand-side scale economy is also driving the merger, A, B, and C state. Assuming that ABC remains at least as attractive to buyers as A, B, and C did individually, ABC will bring 30% of the buying volume and 60% of the sellers together in a single B2B.

Questions

1) Other than the market for widgets, what is the relevant product market in this case? The market for online widget marketplaces? The market for widget marketplaces, whether online or off? Another market? What factors should be considered in assessing the competitive significance of the wholesalers? What additional facts are needed to address these questions?

2) Who are the participants in the relevant market? Should X and Y be considered participants on the basis of current operations? Should X and Y or any other firms be considered uncommitted entrants within the meaning of the Horizontal Merger Guidelines? What factors should be considered in analyzing that issue? What additional facts would be needed to address these questions?

3) What are the relevant market shares?

4) Are there any likely potential adverse competitive effects of the merger? (a) Is the merger likely to diminish competition by enabling coordinated interaction among marketplaces? Does it make a difference if the relevant market is determined to be only online widget marketplaces? (b) Is ABC likely to find it profitable to unilaterally raise its fees to buyers, reduce the services it offers, or otherwise diminish competition? If so, how? What additional facts are needed to address these questions?

5) Assume that capital for new B2Bs dried up considerably after A, B, C, and D were established, but that X and Y could extend their wholesaling infrastructure and expertise to perform online transactions like A, B, C and/or D's. Given such facts, is committed entry likely? Would it be timely and sufficient to deter or counteract any competitive effects of concern?

6) If there are concerns about potential adverse competitive effects, what efficiencies are likely to be accomplished through the proposed merger? Are they merger-specific efficiencies? Would an interoperability plan also achieve these efficiencies? (See Variation One, below.)

7) Suppose that A, B, C, and D have all shown losses of varying degrees and that none has yet turned a profit. Are the financial pressures faced by A, B, and C likely to affect the analysis of the merger? What additional facts are needed to address this issue?

8) Would your answers to these questions change if it were assumed that A, B and C (and D) were encountering serious difficulties with the technology behind their B2Bs and were thus afraid of losing market share as disappointed buyers look elsewhere?

VARIATION ONE:

A, B, and C choose not to merge. Instead, they agree to implement an interoperability plan. Absent the interoperability plan, a buyer using A could only access price quotes and order from Sellers 1-5; a buyer using B could only access Sellers 6-10; and a buyer using C could only access Sellers 11-15. Under the interoperability plan, however, a buyer using A, B, or C will be able to access price quotes and order from Sellers 1-15.

To implement the interoperability plan, A, B, and C - which charge transaction fees (not transaction or subscription fees, as posited in the Basic Facts above) - agree to split the fees with each other when buyers take advantage of this interoperability. If, for example, a buyer using A placed an order with Seller 6, a seller ordinarily linked with B, then A would receive 75% of the fee, and B would receive 25%. Each B2B would still receive 100% of the fee when a buyer used it to purchase from one of its own sellers. Thus, if a buyer used A to purchase from Seller 1, A would collect 100% of the fee, and B and C would collect nothing. In addition, as part of the interoperability arrangement, A, B, and C have agreed to use the same shipping service to ship widgets from sellers to buyers, and A, B, and C have agreed that they will each provide a common minimum set of value-added services on their websites.

Questions

1) What factors are relevant to ascertaining the effect of the interoperability plan on the ability and incentive of A, B, and C to compete on price, service, innovation, or any other competitive variables? What additional facts do you need to know in order to address this issue?

2) Is entry likely? Would it be timely and sufficient to deter or counteract any competitive effects of concern?

3) What are the procompetitive benefits of the collaboration? Are there practical, significantly less restrictive means to achieve these benefits?

4) What is the overall competitive effect of the interoperability plan?

VARIATION TWO:

Assume again that A, B, and C intend to merge. Assume also that 100 buyers use A, 100 use B, 100 use C, 200 use D, 250 use X and 250 use Y, and that each buyer purchases about the same volume.

A has developed an intellectual property-protected technology that allows buyers to integrate their internal processes with A's, streamlining the procurement process. Buyers who use this integration package are particularly loyal clients of A's. These features have saved them considerable sums; moreover, once they have integrated their internal systems with A's technology, abandoning A's technology and installing another comparable system would be very costly.

Through a research-and-development joint venture, B and C have developed and were about to introduce a similar technology for the users of their B2Bs. The technology would have allowed B's buyers to integrate their internal processes with B's and would have allowed C's buyers to integrate their internal processes with C's. B and C's technology would have been "open" and would not have been protected by intellectual property law.

ABC will allow buyers now using A, B, or C to integrate their internal processes with a B2B that connects to Sellers 1-15, something they cannot now do. In support of their proposed merger, A, B, and C state that their buyers want to be able to connect seamlessly with more sellers, and that the merger will facilitate that. The parties' documents indicate plans to connect the merged firm with all three sets of buyers using A's proprietary technology.

Questions

1) Do these facts affect the definition of the relevant market? How?

2) Do these facts affect the likelihood of timely and successful entry, whether committed or uncommitted? Do network effects play a role in the analysis?

3) Do these facts affect the analysis of the potential adverse competitive effects of the merger? Is the merger likely to affect competition to set integration standards of the sort that A, and B and C, have created? Is broader adoption of the proprietary technology likely to affect competition in the market for marketplaces?

4) If there are concerns about potential adverse competitive effects, what efficiencies are likely to be accomplished through the proposed merger? Are they merger-specific efficiencies? Could such efficiencies be achieved if A licensed its technology to B and C, or if ABC adopted the open technology of B and C? Must anything additional be known about the merits of the two integration technologies in order to answer this question?

CASE STUDY TWO

PANEL TWO
2:00 P.M. TO 5:00 P.M.
MAY 7, 2001

BASIC FACTS

Acme, Apogee, Bottom, and Base are the four largest purchasers of X, a non-differentiated commodity with few close substitutes, that is used in the manufacture of commercial goods. There are also a number of smaller purchasers of X: Zenith, the largest; Center; Core; and Cross. The remaining purchasing volume is split equally among the 6 smallest buyers. The share of X that each buyer purchases is reflected in the chart below. The HHI for this market is 1834.

In the past, buyers have purchased X in established offline marketplaces. That changed two years ago, when a B2B for trading X, called IndyX, was established. It was founded without the backing of any of the buyers but with the hope of attracting their business. Soon thereafter, Acme and Apogee founded a B2B called XMarket in which to buy X. XMarket is open to all buyers, and within days of its founding, two other buyers - Zenith, and one of the 6 smallest buyers - joined the B2B as participants. As a result, XMarket handles 57% of the purchases of X. Finally, the last surviving traditional marketplace converted its business to an online B2B model and renamed itself ECommX. It has since attracted the business of Base and Bottom and five of the smallest buyers, giving it 35% of the X buying volume. The success of XMarket and ECommX has come at IndyX's expense: it has retained only Center, Core, and Cross, and thus serves only 8% of the X buying volume. Today, all purchases of X are made through one of these three B2Bs.

Questions

Information Sharing.

1) Acme and Apogee each have two seats on the seven-member board of directors of XMarket. The other three board seats are reserved for non-industry-participants. By express XMarket policy, the board confines itself to making broad decisions about the direction of the B2B. Day-to-day decisions are left to senior management. Is XMarket's policy limiting the role of its board sufficient to address the risk of improper information-sharing between Acme and Apogee, given that each has seats on the board? How much and what types of information must be shared with the board to enable its members to make broad decisions? What considerations must be weighed to answer this and other related questions?

2) On XMarket, senior management staff comes from three sources: so-called "seconded employees," i.e., employees of Acme and Apogee who are being loaned to the B2B; former seconded employees who have chosen not to return to Acme or Apogee; and businesspeople with no ties to Acme or Apogee. Does the presence of seconded or former Acme and Apogee employees in XMarket's senior management affect the potential for improper information-sharing? What additional facts are necessary to address this question?

3) Assume for these questions only that another component, Y, goes into the product that the buyers make and sell, and that XMarket facilitates the buying and selling of Y as well. Acme owns a Y manufacturer, Yellow. Acme uses XMarket's online catalog to review prices for Y posted by Yak, Yolanda, and Yosemite, other manufacturers of Y.

• Should firewalls be constructed to prevent sellers of Y from learning about the prices offered by their competitors? Can they be constructed?

• How will the fact that Acme owns Yellow impact the effectiveness of such firewalls? Can additional firewalls, policies, or other measures be instituted to account for the fact that Acme owns Yellow?

4) ECommX has strict policies forbidding sellers from reviewing the prices offered or amounts sold by competing sellers, and forbidding buyers from reviewing the prices paid and quantities acquired by competing buyers. As a practical matter, ECommX's firewalls do not make it technologically difficult to review this forbidden information. However, violations of ECommX's information policies can be detected by the "e-paper trail" left on ECommX computer systems. A computerized notation of almost all activity on the B2B is preserved automatically. As a result, each time that a seller requests a screen that allows it to review prices or quantities offered by other sellers (or each time that a buyer requests a screen that allows it to review the details of other buyers' transactions), a computerized notation of the request is preserved. These computerized notations are preserved for 6 months.

• Are ECommX's policies against reviewing certain information about rivals, combined with the e-paper trail, sufficient safeguards against the possibility of collusion? Must ECommX establish more secure technological safeguards as well? What additional facts might be relevant to such an analysis? For example, does it matter whether - and how often - ECommX is audited for compliance with its internal policies?

5) For this question only, assume that XMarket used to compile monthly transaction reports that reflected the quantity and price of every purchase of X made through XMarket that month. The names of the buyers and sellers for each transaction were not listed in the report. Because the reports were issued in the middle of the following month, the information they contained was always 2 weeks to 6 weeks old. XMarket issued these reports to its purchasers and sellers for free, and made them available to anyone else for a substantial fee.

• What effect could XMarket's monthly transaction reports have had on competition? What factors are relevant to this analysis? In particular, what factors are relevant to deciding whether the information in the reports is timely enough to possibly affect competition?

• Suppose XMarket's monthly transaction reports reflected not the quantity and price of every purchase of X made through XMarket, but instead reflected the amount of inventory each seller using XMarket had on hand. Suppose further that the reports were daily and that they identified sellers by name. What effect could such daily transaction reports have had on competition? What additional facts would be needed to address this question?

6) Assume for purposes of this paragraph only that XMarket has structured its exchange on a model that resembles a peer-to-peer ("P2P") network. Information from XMarket's participants about their inventories, production schedules, and projected needs for X may be accessed by all XMarket participants through a central directory on XMarket. Does this affect the risk of improper information-sharing? If so, what safeguards would you recommend be adopted? Are any additional facts needed to address these questions?

Compliance.

7) Assume that Acme and Apogee, wishing to satisfy sellers, other buyers, and the public that XMarket is a fair and neutral marketplace, have commissioned an auditor to periodically examine XMarket's management's assertions regarding the B2B's operational practices and controls. The auditor examined XMarket 18 months after its founding and gave it an unqualified opinion letter stating that XMarket had made accurate representations about its information-handling policies and controls. Future audits have been scheduled at 12-month intervals.

• How much weight should antitrust enforcement officials, XMarket's buyers and sellers, or the public place upon such auditors' reports? What factors make auditors' reports more reliable? Less reliable?

• Suppose that XMarket's computer systems retain an "e-paper trail" (of the sort described above in connection with ECommX), and that the trail is archived for 6 months. Does that factor affect the reliability of the auditor's report? How?

Monopsony and Exclusion

8) Assume that ECommX provides services to facilitate the ability of its buyers to aggregate their purchases, that approximately 90% of the purchases on ECommX involve some aggregation among buyers, and that as a result, ECommX's buyers pay rather low prices for their inputs.

• What factors are relevant to determining whether the buyers on ECommX are practicing efficient joint purchasing, or exercising monopsony power? What additional facts would be needed to address this issue?

• Suppose that the three small buyers who currently use IndyX would like to abandon IndyX and join ECommX in order to take advantage of these favorable prices. ECommX has refused to let them join, however, stating that it is concerned that the extra buying volume that they will bring - eight percent - will render ECommX's market share too big and will put it at risk for monopsony. ECommX's current members also state that admitting the three buyers now would allow them to free-ride on the expense and effort that the current members have devoted to building a successful joint buying program. The three buyers complain that an improper exclusionary strategy, not a conscientious avoidance of antitrust harms, is motivating ECommX's members to influence ECommX to keep them out. How should the dispute between the three buyers and ECommX be resolved? How would it be likely to affect competition if ECommX admitted, or excluded, the three buyers? In what market(s) would competition likely be affected? The market for marketplaces? The market for X? Other markets?

9) For this question only, suppose that ECommX permits joint buying but provides no services designed to facilitate it, such as pooling its participants' individual purchase orders. Suppose further that the buyers using ECommX agree (perhaps over the telephone or in a meeting) that they will coordinate their purchases made through the B2B in ways that depress output and lower the price they must pay. In such a case, could ECommX itself be deemed to have violated the antitrust laws? What factors are relevant to such an analysis? What additional facts would be needed to address this question?

VARIATION:

Sellers offer Xs in a variety of weights, sizes, colors, strengths, and other characteristics. Before the rise of B2Bs, buyers and sellers would communicate with each other (sometimes through intermediaries like wholesalers) and eventually would come to an understanding of the weight, size, color, strength, and other characteristics of the X that would be sold. But sellers are discovering that communication through B2Bs requires use of more precise taxonomies, and that those taxonomies sometimes differ. For example, XMarket directs buyers requesting a 5-pound X to order a "large" X; ECommX directs such buyers to order an "extra-large X," and IndyX directs them to order an "industrial-strength" X. As a result, each seller has had to create a customized, compatible online catalog for each of the three B2Bs in order to sell there. Customizing online catalogs for each of three B2Bs has proved expensive.

Fifteen of the sixteen sellers of X hope to cut those costs by establishing standards to define X in all its variations. (The sixteenth seller, by far the largest seller of X, is not a member of the group.) The group's members believe that the arrangement may have benefits for buyers, too, by allowing them to easily compare different sellers' offerings. They also state that it will reduce the transaction costs of both buyers and sellers: once all parties know that 5-pound Xs are called "large," for example, the costs of negotiating each individual transaction for 5-pound Xs will decrease.

Questions

1) What efficiencies do the group's standard-setting activities appear to provide? What factors might affect their magnitude?

2) Suppose that the fifteen sellers have excluded the sixteenth seller from their standard-setting effort. Does this exclusion affect competition? If so, how? What additional facts are needed to address this issue?

3) Assume that the group's work is still in progress, but that it has already established a few standards that are now in use. One such standard identifies the "breakage rate" of a grade of X, i.e., how likely it is that a grade of X will break under the ordinary pressures that Xs are expected to bear. The standard does not identify when that breakage is likely to occur: early in the life of the X, or late. A few sellers in the group protest that this standard puts them at a competitive disadvantage, since they offer Xs that break, if at all, only late in the X's expected lifespan. Buyers care when Xs break, these sellers say, and the standard describing the breakage rate conceals that critical information. What factors are relevant to ascertaining the competitive effects of this scenario? Would the analysis change if some buyers were among the members of the standard-setting group?

4) Suppose that all Xs have traditionally had five handles. Thus, the group established a standard that allows buyers to order five-handled Xs through B2Bs. Buyers have since determined, however, that six-handled Xs would last far longer than five-handled Xs and would save buyers money in the long run. The buyers are frustrated that it appears to be impossible to order six-handled Xs through a B2B from any of the group's members, since the standard does not accommodate them. The group states that it is seeking to change the standard now to accommodate five-handled and six-handled Xs, but it explains that changing standards takes time. Buyers suspect that the group is not eager to establish a standard for six-handled Xs because they will last longer and sellers will therefore lose money on them. Are such facts likely to affect competition? What are the relevant factors to examine in answering this question? Would the analysis change if some buyers were among the members of the standard-setting group?

5) Suppose that the standard-setting group claims intellectual property rights in the standards. Does that alter the analysis of how the group's activities are likely to affect competition? If so, how?