September/October 2000
The Curtain Rises on Competition Concerns & B2B Marketplaces
WorldLink
Based in the Washington D.C. office of Arnold & Porter, Mr. Baer heads the firm's antitrust practice group and was Director of the U.S. Federal Trade Commission's Bureau of Competition from 1995 to1999. Mr. Frazer heads the competition group at Arnold & Porter's London office and is the author of a number of books and articles, most recently "The Competition Act 1998: A Practical Guide"; he is co-editor of the UK Competition Law Reports.
Like attendees at an opening night cast party waiting for the first edition reviews to roll off the presses, the business community has been waiting to digest competition regulators' initial reviews of the on-line B2B and B2C exchanges that are being formed at a fevered pitch as companies and industry groups race to capture efficiencies made available by Internet technology. The reviews are starting to roll in and they seem to be favorable, but answers to most of the difficult competition questions about on-line marketplaces will be only come as the industry matures.
Competition regulators are busy investigating on-line marketplaces. For example, the U.S. Federal Trade Commission and the German Cartel Office are reportedly investigating Covisint, a business-to-business ("B2B") procurement exchange planned by Ford Motor Corp., General Motors Corp., and Daimler Chrysler A.G. Press reports indicate that the U.S. Justice Department's Antitrust Division is investigating both a B2B venture among meatpacking firms and Orbitz, a planned business-to-consumer ("B2C") exchange among five major airlines. The European Commission has been monitoring the large numbers of new Internet exchanges and is now starting to take action. On 7 August the Commission cleared a B2B Internet exchange operated by Honeywell International Inc., United Technologies Corp. and i2Technologies Inc. known as MyAircraft.com. This was the first such exchanges to be notified under EC Merger Control rules. In addition to these venture specific actions, the EU Commission is working on guidelines for B2B e-commerce and the FTC recently concluded a two-day workshop designed to explore the ways in which B2B ventures operate, what efficiencies they offer, and what antitrust risks they present.
While all this government attention has caused some to worry whether the collaborations involved in on-line exchanges pose too much antitrust risk, our view and the clear message from the FTC workshop and the recent EU Commission clearance of MyAircraft.com is that B2B ventures are not inherently suspect under competition laws. Indeed, given the enormous efficiencies touted by proponents of on-line exchanges, government regulators are likely to be very reluctant to take precipitous actions that might discourage these ventures without solid evidence of relatively immediate threats to competition. For that reason, exchanges that have minimized competitive risks by paying close attention to structure, information flow and membership criteria are unlikely to face roadblocks to their start-up operations.
Managing vast amounts of information is a key to the success of on-line marketplaces, but that information is also the source of the most obvious competitive risks. Companies buying and selling through B2B ventures may be direct competitors, and in processing transactions the venture may obtain detailed information about competitive activities of those companies. This could include information about customers, suppliers, prices, costs, sales volumes and inventory. Fortunately, participants in B2B ventures seem to be aware of the need to establish firewalls and confidentiality rules to protect competitively sensitive information.
The basic guidance marketplaces are receiving in this area is simple - competitively sensitive information should be provided and be accessible only on a need-to-know basis for the reasonable functioning of the venture. But managers have found that there is more to worry about besides technical firewalls such as password protecting access to transaction specific data. In order to avoid the possibility that these ventures might be seen as facilitating collusive behavior, managers of industry controlled exchanges have had to limit board and investor access to the venture's records and limit the use of temporary employees seconded from investor companies. Some business models have had to be reworked as limitations have been placed on the ability of these ventures to mine and disseminate the data they will generate. But most information control issues raised by competition laws are relatively straightforward and these ventures have not found them to be material impediments.
The more interesting developments from a competition lawyer's perspective will come as winners and losers emerge and the victors assess their maturing operations. As with any venture, in creating an on-line exchange and planning for its operations, the joint venture partners will have to establish rules about who can join and what participation, either in equity or non-equity positions, implies about participation in other similar ventures. But the competitive implications of those rules can change as circumstances change, and de facto rules can sometimes emerge from other features of an exchange. Navigating this transition is a task for which exchanges are most likely to need legal counsel.
When evaluating whether certain competitors can be excluded from or can be allowed to join an exchange, companies need to be sensitive to the possibility that the exchange might be a vehicle for the exercise of market power. Controlling the creation and exercise of market power - roughly the ability to raise prices or exclude competition - is the goal of competition law. The business models of many B2B exchanges recognize that the exchange becomes more useful as a greater percentage of the target audience participates. In some of these "network" situations, access to the exchange's network (or the lack of access) can affect the viability of a competitor in that industry. Ventures need to be careful about membership decisions in these situations. When access to an exchange has little affect on the viability of a competitor, the exchange has far greater leeway in determining who may join.
The existence of market power is also relevant to the question of a venture's exclusivity rules. Exchanges, especially new exchanges, will often have valid business reasons for seeking commitments from participants that they will conduct all or a certain portion of their business through the exchange. But commitments by participants to use one exchange means they are not available as potential customers for the promoters of other exchanges. When the first exchange is so successful that it becomes the "dominant" exchange (with some arguable degree of market power), antitrust concerns may arise regarding exclusive dealing requirements that hamper the development of other exchanges.
In addition to explicit rules about membership and exclusivity, companies also need to be aware that other features of an exchange, for example its fee structure, can create de facto rules regarding membership and exclusivity. Fee structures could create entry barriers for start-up enterprises trying to compete against an exchange's existing members. Fee structures could also reduce incentives for current members to use competing exchanges or to compete through non-exchange methods.
The difficulty with all these concerns is that they normally arise only after an exchange has achieved some level of market power - until that time the practices are usually legitimate and reflect aggressive competition. However, determining whether such market power exists is a difficult, fact-intensive inquiry best undertaken with antitrust counsel. The necessary interplay between "bricks and mortar" sales channels and Internet sales has only complicated that inquiry. But given the network effects that characterize these types of businesses (the exchange is more valuable as its user base expands), companies should realize that if the start-up exchange of today is successful, it may eventually be the only exchange operating in a particular area.
The potential that network effects will lead to a situation where only one or a very few exchanges serve individual markets creates a heightened need for exchanges to plan for the possibility of transitioning away from membership and exclusivity rules that could raise concerns in a more mature phase of their operations. Statements at the FTC workshop indicate regulators are aware that the proper focus in analyzing conduct in this area is whether the conduct harms competition itself, not individual competitors. But if the controversy over the Microsoft litigation is any indication, the issue of if, when and how any transition needs to take place is likely to be subject to different views within the enforcement agencies and the antitrust bar.
Adding to the complexity, the questions surrounding that transition are not likely to be left solely to government regulators. As winners emerge, so will losers. There will be competing exchanges that failed to capture industry support. There will also be industry members that lost out in the race to take advantage of the new technology. Without prejudging the merits, both types of parties will have incentives to find fault in the competitive actions of the winners.
Looking at other structural issues, exchanges that intend to aggregate the purchases of multiple buyers have been a special focus of potential antitrust concerns. The issue presented - monopsony, or buyer side market power - is not new, but it has attracted special attention because much of the talk about potential B2B efficiencies has been devoted to the enhanced opportunity that the Internet creates for buyers to aggregate their purchases in order to lower procurement costs. For many exchanges this will not be a concern; but those that do intend to aggregate purchasing power should keep in mind that antitrust enforcers will be unlikely to credit procurement cost savings that are the result of the exercise of buyer market power. Where aggregated purchases could account for more than about twenty percent of sales of a particular good or service in a relevant geographic area, exchanges need to assess whether such aggregation is appropriate from an antitrust perspective. Finally, because of concerns over the facilitation of coordinated behavior, buyer aggregation sites also need to be alert to situations where jointly purchased goods or services account for more than about twenty percent of the input costs of buyers that compete against each other downstream.
As a result of the rapid evolution of on-line marketplaces, the marketplaces and their counselors have been navigating competition law issues with little direct indication of how government regulators were going approach this new field. Along with most commentators, we agree that existing laws are robust enough to address the issues presented by this new industry. But now, as the curtain begins to rise on regulators' enforcement decisions, we will begin to see how they balance the twin goals of protecting consumers and avoiding stunting the efficiencies promised by this emerging technology.
Like attendees at an opening night cast party waiting for the first edition reviews to roll off the presses, the business community has been waiting to digest competition regulators' initial reviews of the on-line B2B and B2C exchanges that are being formed at a fevered pitch as companies and industry groups race to capture efficiencies made available by Internet technology. The reviews are starting to roll in and they seem to be favorable, but answers to most of the difficult competition questions about on-line marketplaces will be only come as the industry matures.
Competition regulators are busy investigating on-line marketplaces. For example, the U.S. Federal Trade Commission and the German Cartel Office are reportedly investigating Covisint, a business-to-business ("B2B") procurement exchange planned by Ford Motor Corp., General Motors Corp., and Daimler Chrysler A.G. Press reports indicate that the U.S. Justice Department's Antitrust Division is investigating both a B2B venture among meatpacking firms and Orbitz, a planned business-to-consumer ("B2C") exchange among five major airlines. The European Commission has been monitoring the large numbers of new Internet exchanges and is now starting to take action. On 7 August the Commission cleared a B2B Internet exchange operated by Honeywell International Inc., United Technologies Corp. and i2Technologies Inc. known as MyAircraft.com. This was the first such exchanges to be notified under EC Merger Control rules. In addition to these venture specific actions, the EU Commission is working on guidelines for B2B e-commerce and the FTC recently concluded a two-day workshop designed to explore the ways in which B2B ventures operate, what efficiencies they offer, and what antitrust risks they present.
While all this government attention has caused some to worry whether the collaborations involved in on-line exchanges pose too much antitrust risk, our view and the clear message from the FTC workshop and the recent EU Commission clearance of MyAircraft.com is that B2B ventures are not inherently suspect under competition laws. Indeed, given the enormous efficiencies touted by proponents of on-line exchanges, government regulators are likely to be very reluctant to take precipitous actions that might discourage these ventures without solid evidence of relatively immediate threats to competition. For that reason, exchanges that have minimized competitive risks by paying close attention to structure, information flow and membership criteria are unlikely to face roadblocks to their start-up operations.
Managing vast amounts of information is a key to the success of on-line marketplaces, but that information is also the source of the most obvious competitive risks. Companies buying and selling through B2B ventures may be direct competitors, and in processing transactions the venture may obtain detailed information about competitive activities of those companies. This could include information about customers, suppliers, prices, costs, sales volumes and inventory. Fortunately, participants in B2B ventures seem to be aware of the need to establish firewalls and confidentiality rules to protect competitively sensitive information.
The basic guidance marketplaces are receiving in this area is simple - competitively sensitive information should be provided and be accessible only on a need-to-know basis for the reasonable functioning of the venture. But managers have found that there is more to worry about besides technical firewalls such as password protecting access to transaction specific data. In order to avoid the possibility that these ventures might be seen as facilitating collusive behavior, managers of industry controlled exchanges have had to limit board and investor access to the venture's records and limit the use of temporary employees seconded from investor companies. Some business models have had to be reworked as limitations have been placed on the ability of these ventures to mine and disseminate the data they will generate. But most information control issues raised by competition laws are relatively straightforward and these ventures have not found them to be material impediments.
The more interesting developments from a competition lawyer's perspective will come as winners and losers emerge and the victors assess their maturing operations. As with any venture, in creating an on-line exchange and planning for its operations, the joint venture partners will have to establish rules about who can join and what participation, either in equity or non-equity positions, implies about participation in other similar ventures. But the competitive implications of those rules can change as circumstances change, and de facto rules can sometimes emerge from other features of an exchange. Navigating this transition is a task for which exchanges are most likely to need legal counsel.
When evaluating whether certain competitors can be excluded from or can be allowed to join an exchange, companies need to be sensitive to the possibility that the exchange might be a vehicle for the exercise of market power. Controlling the creation and exercise of market power - roughly the ability to raise prices or exclude competition - is the goal of competition law. The business models of many B2B exchanges recognize that the exchange becomes more useful as a greater percentage of the target audience participates. In some of these "network" situations, access to the exchange's network (or the lack of access) can affect the viability of a competitor in that industry. Ventures need to be careful about membership decisions in these situations. When access to an exchange has little affect on the viability of a competitor, the exchange has far greater leeway in determining who may join.
The existence of market power is also relevant to the question of a venture's exclusivity rules. Exchanges, especially new exchanges, will often have valid business reasons for seeking commitments from participants that they will conduct all or a certain portion of their business through the exchange. But commitments by participants to use one exchange means they are not available as potential customers for the promoters of other exchanges. When the first exchange is so successful that it becomes the "dominant" exchange (with some arguable degree of market power), antitrust concerns may arise regarding exclusive dealing requirements that hamper the development of other exchanges.
In addition to explicit rules about membership and exclusivity, companies also need to be aware that other features of an exchange, for example its fee structure, can create de facto rules regarding membership and exclusivity. Fee structures could create entry barriers for start-up enterprises trying to compete against an exchange's existing members. Fee structures could also reduce incentives for current members to use competing exchanges or to compete through non-exchange methods.
The difficulty with all these concerns is that they normally arise only after an exchange has achieved some level of market power - until that time the practices are usually legitimate and reflect aggressive competition. However, determining whether such market power exists is a difficult, fact-intensive inquiry best undertaken with antitrust counsel. The necessary interplay between "bricks and mortar" sales channels and Internet sales has only complicated that inquiry. But given the network effects that characterize these types of businesses (the exchange is more valuable as its user base expands), companies should realize that if the start-up exchange of today is successful, it may eventually be the only exchange operating in a particular area.
The potential that network effects will lead to a situation where only one or a very few exchanges serve individual markets creates a heightened need for exchanges to plan for the possibility of transitioning away from membership and exclusivity rules that could raise concerns in a more mature phase of their operations. Statements at the FTC workshop indicate regulators are aware that the proper focus in analyzing conduct in this area is whether the conduct harms competition itself, not individual competitors. But if the controversy over the Microsoft litigation is any indication, the issue of if, when and how any transition needs to take place is likely to be subject to different views within the enforcement agencies and the antitrust bar.
Adding to the complexity, the questions surrounding that transition are not likely to be left solely to government regulators. As winners emerge, so will losers. There will be competing exchanges that failed to capture industry support. There will also be industry members that lost out in the race to take advantage of the new technology. Without prejudging the merits, both types of parties will have incentives to find fault in the competitive actions of the winners.
Looking at other structural issues, exchanges that intend to aggregate the purchases of multiple buyers have been a special focus of potential antitrust concerns. The issue presented - monopsony, or buyer side market power - is not new, but it has attracted special attention because much of the talk about potential B2B efficiencies has been devoted to the enhanced opportunity that the Internet creates for buyers to aggregate their purchases in order to lower procurement costs. For many exchanges this will not be a concern; but those that do intend to aggregate purchasing power should keep in mind that antitrust enforcers will be unlikely to credit procurement cost savings that are the result of the exercise of buyer market power. Where aggregated purchases could account for more than about twenty percent of sales of a particular good or service in a relevant geographic area, exchanges need to assess whether such aggregation is appropriate from an antitrust perspective. Finally, because of concerns over the facilitation of coordinated behavior, buyer aggregation sites also need to be alert to situations where jointly purchased goods or services account for more than about twenty percent of the input costs of buyers that compete against each other downstream.
As a result of the rapid evolution of on-line marketplaces, the marketplaces and their counselors have been navigating competition law issues with little direct indication of how government regulators were going approach this new field. Along with most commentators, we agree that existing laws are robust enough to address the issues presented by this new industry. But now, as the curtain begins to rise on regulators' enforcement decisions, we will begin to see how they balance the twin goals of protecting consumers and avoiding stunting the efficiencies promised by this emerging technology.
