United States: Ninth Circuit Adopts Clear Cost-Based Standards to Evaluate Antitrust Liability of "Bundled Discounts"

On September 4, 2007, the Ninth Circuit issued its opinion in Cascade Health Solutions (f/k/a McKenzie-Willamette Hospital) v. PeaceHealth¹, ruling that bundled discounts violate antitrust law only if the discounts results in below-cost pricing. PeaceHealth involved the controversial issue of whether a dominant player's bundled discounts constitute attempted monopolization that violates Section 2 of the Sherman Act. PeaceHealth is significant because it rejected the ambiguous approach adopted by the Third Circuit in LePage's Inc. v. 3M². The Court instead endorsed a cost-based test to determine when bundled discounts constitute attempted monopolization, an analysis recently set forth in the report of the Antitrust Modernization Commission.

Background

PeaceHealth was an appeal from a final award of $16.2 million by the district court in favor of plaintiff McKenzie and against defendant PeaceHealth.

PeaceHealth and McKenzie are the only two hospital care providers operating hospitals in Lane County, Oregon. PeaceHealth provides basic care and more advanced "tertiary care" services whereas McKenzie only provided basic care service. PeaceHealth has a market share of more than 90% for the advanced service and 75% for the basic service in Lane County.

McKenzie sued PeaceHealth for violating Section 2 of the Sherman Act by offering bundled discounts. McKenzie alleged, among others, that PeaceHealth offered insurers 35% to 40% discount on tertiary care if the insurers made PeaceHealth their exclusive preferred provider for all hospital care services. McKenzie further alleged that it could provide basic care services at a lower cost than PeaceHealth but because of the bundled discounts offered by PeaceHealth, McKenzie was driven out of the market for those services. After a trial, the district court instructed the jury that "[b]undled price discounts may be anticompetitive if they are offered by a monopolist and substantially foreclose portions of the market to a competitor who does not provide an equally diverse group of services and who therefore cannot make a comparable offer."

As a result, the jury rendered a $5.4 million award in favor of McKenzie, which the district court trebled for a final award of $16.2 million.

The Ninth Circuit’s Opinion

The Ninth Circuit first addressed the issue of when a bundled discount can constitute attempted monopolization, noting that bundled discounts generally benefit buyers because the discounts allow buyers to get more for less. However, the court also recognized that bundled discounts may be misused to exclude a competitor and reduce consumer welfare in the long run especially when a competitor with one product in the bundle cannot match profitably the price created by the multi-product bundled discount.

In deciding when a bundled discount is anticompetitive, the court rejected an open-ended approach adopted by the Third Circuit in LePage's. The Third Circuit in LePage's did not consider whether the bundled discounts constitute competition on the merits, but simply concluded that all bundled discounts offered by a monopolist are anticompetitive with respect to its competitors who do not manufacture an equally diverse product line. The LePage's standard does not require a cost-based analysis and allows the jury to find bundled discounts exclusionary merely upon a showing that a competitor could not offer the same bundle as the defendant. The PeaceHealth court found that this punished more efficient competitors who were able to offer customers lower prices.

In addressing the measurement of costs in a multi-product discount context, the court adopted a "discount attribution" standard, under which the full amount of the discounts given by the defendant of the bundle are allocated to the competitive product or products. Under this standard, the plaintiff must establish that "after allocating the discount given by the defendant on the entire bundle of products to the competitive product or products, the defendant sold the competitive product or products below its average variable cost of producing them."

With this reasoning, the court held that the jury was improperly instructed to follow the standard borrowed from LePage's and reversed the jury verdict for further proceedings.

The court also reversed summary judgment in favor of PeaceHealth on its tying claim, dismissed prior to trial, because a genuine issue of material fact existed whether insurers were "coerced" into purchasing bundled hospital care services. Tying occurs when a seller conditions the sale of one product (the tied product) on the purchase of another (the tying product). McKenzie had alleged that PeaceHealth illegally tied primary and secondary hospital service to its provision of tertiary service in the relevant geographic market, where PeaceHealth was the only tertiary service provider.

Implications: Clearer Guidance for Business

PeaceHealth is a positive refinement to the LePage's view on the issue of when discount bundling will violate Section 2 of the Sherman Act. The ruling helps to form a more solid foundation in this muddled area of antitrust law and it provides clearer guidance for sellers offering bundled discounts because they can readily calculate the costs and prices of products and determine whether it is unlawful or not.

However, plaintiffs will still try to test the boundaries of this standard, as PeaceHealth only inquires into potential effects on a "hypothetical" equally efficient producer rather than the party who is actually bringing the claim. As a practical matter, multi-product sellers who have similar multi-product competitors may face challenges in discounting depending on the level of the discount and breadth of products to which the discount is applied. However, because a significant market share or level of dominance in the market is a prerequisite for a finding of attempted monopolization, the bundled discounter is in a position to know what types of bundling practices may raise competition concerns vis à vis other discounters. Sellers should also pay attention to potential tying claims that may be raised.

The divergence in views between the Third and Ninth Circuits now creates an interesting circuit split. Given the U.S. Supreme Court's recent penchant for antitrust cases during last term's rulings in Weyerhaeuser³ and Leegin⁴, this sets the stage for the Supreme Court to possibly weigh in on this issue in the future. While LePage's still remains good law in the Third Circuit, it remains uncertain how other circuits will rule on multi-product discounting. Thus, firms selling bundled products in other regions should pay close attention to see how the other circuit's jurisprudence on this issue develops.