United States: The FTC Sees Red Over 1-800 Contacts' Advertising Agreements With Competitors

A recent challenge by the Federal Trade Commission's (FTC) Bureau of Competition to agreements that 1-800 Contacts entered into with its competitors concerning how those competitors would advertise provides useful insight into the nuts and bolts of Internet advertising, as well as important reminders about how not to deal with your competitors. While agreements to limit advertising competition are not per se illegal, if you are thinking of coming to this sort of agreement, you had better have a really good (i.e., pro-competitive) reason for it.

Background

On August 8, 2016, the FTC alleged in an administrative complaint that 1-800 Contacts, one of the largest online retailers of contact lenses, engaged in anti-competitive practices through its agreements with competitors settling trademark suits. The agreements restricted competitors from showing up when consumers searched for 1-800 Contacts. In early November 2017, Chief Administrative Law Judge D. Michael Chappell upheld the FTC's complaint and ordered 1-800 Contacts to cease and desist enforcing anti-competitive provisions from the settlement agreements, among other remedies.

Many Google searches return two types of results: (1) "organic" and (2) paid advertisements. Organic results return websites the search engine determines to be the most relevant for the user. Paid advertisements are those that Google's algorithm selects, taking into consideration the amount an advertiser bids for a particular key word in the search. One of the main factors incorporated into the algorithm is "cost-per-click," which is how much a company will pay when a consumer clicks on its advertised web-link. Companies bid their cost-per-click amounts on Google AdWords. A company can bid on "broad matches," which matches advertisements for searches of relevant variations of the key words, or "exact matches," which show the website only if the consumer searches for the exact key word. When a consumer enters a search, Google runs its algorithm and determines the placement of the paid advertisements. The algorithm also factors ad relevancy, geographic location, search history, landing page experience, and ad format. Consequently, two consumers could submit the exact same Google search and receive different paid search advertising results. At times, an advertiser will use "negative key words" to stop their advertisement from matching when a consumer searches for those chosen words. For example, to prevent an eyeglasses advertisement displaying when a consumer searches for "wine glasses," the company would use a negative key word when setting up its AdWords campaign.

Prior to 2004, Google restricted bidding on other companies' trademarks. However, Google found that when consumers searched for trademarked words, they also wanted to learn about products and services offered by the trademark holders' competitors. Therefore, Google modified its policy in 2004 to allow bidding on trademarks. Between 2004 and 2013, 1-800 Contacts sued numerous competitors for trademark infringement, based on competitors bidding on the company's trademark to secure advertising in paid search results when consumers searched for 1-800 Contacts. Rather than litigating any of the trademark cases to conclusion, 1-800 Contacts entered into settlement agreements with each of 13 competitors. The agreements prohibited each party from advertising on searches for each other's trademarks, URLs, and certain variations thereof. Nothing prohibited generic key words, such as "contacts" or "contact lens," but the companies were required to use negative key words to prevent matches with 1-800 Contacts' trademark.

The Decision

The FTC's complaint challenged the settlement agreements on three theories, arguing: (1) that the agreements were presumptively anti-competitive; (2) that they had directly harmed competition and consumers; and (3) that the market share of the participants involved was so high that the agreements would likely result in harm to consumers.

Judge Chappell focused on the second of these theories, and chose not to address the other two. According to Judge Chappell, the evidence showed that 1-800 Contacts had used the trademark settlements to limit the ability of competitors to offer cheaper prices in search results. Based on the evidence and the testimony of the FTC's expert witness, the court found it was more likely that the agreements restricted advertising and caused consumers to pay more for contact lenses than they would have absent the restrictions.

Judge Chappell rejected 1-800 Contacts' pro-competitive justifications. One assertion was that the agreements provided trademark protection, which promoted economic efficiency and incentivized investing in brand-building. However, as Judge Chappell pointed out, this justification assumes that what 1-800 Contacts' competitors were doing was, in fact, trademark infringement. 1-800 Contacts' own expert witness was unaware of a U.S. court agreeing that the conduct challenged by 1-800 Contacts constituted infringement. 1-800 Contacts' additional arguments included: (1) the settlement agreements avoided litigation costs; (2) the agreements prevented consumer confusion; (3) the agreements reduced consumers' search costs; and (4) the agreements increased purchases of contact lenses by consumers who searched for 1-800 Contacts' trademarks. Judge Chappell found none of these justifications to be supported by the facts, and concluded that the settlement agreements violated Section 5 of the FTC Act.

Consequently, the judge barred 1-800 Contacts from agreeing with a marketer or seller of any contact lens product to restrict, prohibit, regulate, or otherwise limit that seller's participation in search advertising auctions, and barred 1-800 Contacts from instructing search engines to restrict or prohibit any seller's use of any key word.

The initial decision will become the decision of the Commission 30 days after it is served upon the parties, unless one of the parties files a timely motion to appeal the decision to the Commissioners. Presumably 1-800 Contacts will appeal this to the "full" Commission, and from there one side is likely to seek review by one of the Courts of Appeal.

Takeaways

Agreements between competitors should be scary things that you enter into rarely and always with antitrust counsel involved. Even when you think the agreements simply enforce the rights that you think you should have under the intellectual property laws, you should ensure that any agreement with competitors is backed up by a court order or by a very strong argument that the agreement furthers competition.

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