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21.6 Sherman Act, Section 2: Concentrations of Market Power

Learning Objectives

  1. Understand the ways in which monopoly power can be injurious to competition.
  2. Explain why not all monopolies are illegal under the Sherman Act.
  3. Recognize the importance of defining the relevant market in terms of both geography and product.
  4. Describe the remedies for Sherman Act Section 2 violations.

Introduction

Large companies, or any company that occupies a large portion of any market segment, can thwart competition through the exercise of monopoly power. Indeed, monopoly means the lack of competition, or at least of effective competition. As the Supreme Court has long defined it, monopoly is “the power to control market prices or exclude competition.”United States v. Grinnell Corp., 384 U.S. 563, 571 (1966). Public concern about the economic and political power of the large trusts, which tended to become monopolies in the late nineteenth century, led to Section 2 of the Sherman Act in 1890 and to Section 7 of the Clayton Act in 1914. These statutes are not limited to the giants of American industry, such as ExxonMobil, Microsoft, Google, or AT&T. A far smaller company that dominates a relatively small geographic area or that merges with another company in an area where few others compete can be in for trouble under Sections 2 or 7. These laws should therefore be of concern to all businesses, not just those on the Fortune 500 list. In this section, we will consider how the courts have interpreted both the Section 2 prohibition against monopolizing and the Section 7 prohibition against mergers and acquisitions that tend to lessen competition or to create monopolies.

Section 2 of the Sherman Act reads as follows: “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a [felony].”

We begin the analysis of Section 2 with the basic proposition that a monopoly is not per se unlawful. Section 2 itself makes this proposition inescapable: it forbids the act of monopolizing, not the condition or attribute of monopoly. Why should that be so? If monopoly power is detrimental to a functioning competitive market system, why shouldn’t the law ban the very existence of a monopoly?

The answer is that we cannot hope to have “perfect competition” but only “workable competition.” Any number of circumstances might lead to monopolies that we would not want to eliminate. Demand for a product might be limited to what one company could produce, there thus being no incentive for any competitor to come into the market. A small town may be able to support only one supermarket, newspaper, or computer outlet. If a company is operating efficiently through economies of scale, we would not want to split it apart and watch the resulting companies fail. An innovator may have a field all to himself, yet we would not want to penalize the inventor for his very act of invention. Or a company might simply be smarter and more efficient, finally coming to stand alone through the very operation of competitive pressures. It would be an irony indeed if the law were to condemn a company that was forged in the fires of competition itself. As the Supreme Court has said, the Sherman Act was designed to protect competition, not competitors.

A company that has had a monopoly position “thrust upon it” is perfectly lawful. The law penalizes not the monopolist as such but the competitor who gains his monopoly power through illegitimate means with an intent to become a monopolist, or who after having become a monopolist acts illegitimately to maintain his power.

A Section 2 case involves three essential factors:

  1. What is the relevant marketFor a court to determine if a firm has a dominant market share, it must first define the relevant market, which consists of two elements: a relevant product market and a relevant geographic market. for determining dominance? The question of relevant market has two aspects: a geographic market dimension and a relevant product marketThe market that includes all products that have identical attributes or are reasonably interchangeable. If customers treat different products as acceptable substitutes for one another, the products are reasonably interchangeable. dimension. It makes a considerable difference whether the company is thought to be a competitor in ten states or only one. A large company in one state may appear tiny matched against competitors operating in many states. Likewise, if the product itself has real substitutes, it makes little sense to brand its maker a monopolist. For instance, Coca-Cola is made by only one company, but that does not make the Coca-Cola Company a monopoly, for its soft drink competes with many in the marketplace.
  2. How much monopoly power is too much? What share of the market must a company have to be labeled a monopoly? Is a company with 50 percent of the market a monopoly? 75 percent? 90 percent?
  3. What constitutes an illegitimate means of gaining or maintaining monopoly power?

These factors are often closely intertwined, especially the first two. This makes it difficult to examine each separately, but to the extent possible, we will address each factor in the order given.

Relevant Markets: Product Market and Geographic Market

Product Market

The monopolist never exercises power in the abstract. When exercised, monopoly power is used to set prices or exclude competition in the market for a particular product or products. Therefore it is essential in any Section 2 case to determine what products to include in the relevant market.

The Supreme Court looks at “cross-elasticity of demand” to determine the relevant market. That is, to what degree can a substitute be found for the product in question if the producer sets the price too high? If consumers stay with the product as its price rises, moving to a substitute only at a very high price, then the product is probably in a market by itself. If consumers shift to another product with slight rises in price, then the product market is “elastic” and must include all such substitutes.

Geographic Market

A company doesn’t have to dominate the world market for a particular product or service in order to be held to be a monopolist. The Sherman Act speaks of “any part” of the trade or commerce. The Supreme Court defines this as the “area of effective competition.” Ordinarily, the smaller the part the government can point to, the greater its chances of prevailing, since a company usually will have greater control over a single marketplace than a regional or national market. Because of this, alleged monopolists will usually argue for a broad geographic market, while the government tries to narrow it by pointing to such factors as transportation costs and the degree to which consumers will shop outside the defined area.

Monopoly Power

After the relevant product and geographic markets are defined, the next question is whether the defendant has sufficient power within them to constitute a monopoly. The usual test is the market share the alleged monopolist enjoys, although no rigid rule or mathematical formula is possible. In United States v. Aluminum Company of America, presented in Section 21.8.3 "Acquiring and Maintaining a Monopoly" of this chapter, Judge Learned Hand said that Alcoa’s 90 percent share of the ingot market was enough to constitute a monopoly but that 64 percent would have been doubtful.United States v. Aluminum Co. of America, 148 F.2d 416 (2d Cir. 1945). In a case against DuPont many years ago, the court looked at a 75 percent market share in cellophane but found that the relevant market (considering the cross-elasticity of demand) was not restricted to cellophane.

Monopolization: Acquiring and Maintaining a Monopoly

Possessing a monopoly is not per se unlawful. Once a company has been found to have monopoly power in a relevant market, the final question is whether it either acquired its monopoly power in an unlawful way or has acted unlawfully to maintain it. This additional element of “deliberateness” does not mean that the government must prove that the defendant intended monopolization, in the sense that what it desired was the complete exclusion of all competitors. It is enough to show that the monopoly would probably result from its actions, for as Judge Hand put it, “No monopolist monopolizes unconscious of what he is doing.”

What constitutes proof of unlawful acquisition or maintenance of a monopoly? In general, proof is made by showing that the defendant’s acts were aimed at or had the probable effect of excluding competitors from the market. Violations of Section 1 or other provisions of the antitrust laws are examples. “Predatory pricing”—charging less than cost—can be evidence that the defendant’s purpose was monopolistic, for small companies cannot compete with large manufacturers capable of sustaining continued losses until the competition folds up and ceases operations.

In United States v. Lorain Journal Company, the town of Lorain, Ohio, could support only one newspaper.United States v. Lorain Journal Company, 342 U.S. 143 (1951). With a circulation of twenty thousand, the Lorain Journal reached more than 99 percent of the town’s families. The Journal had thus lawfully become a monopoly. But when a radio station was set up, the paper found itself competing directly for local and national advertising. To retaliate, the Journal refused to accept advertisements unless the advertiser agreed not to advertise on the local station. The Court agreed that this was an unlawful attempt to boycott and hence was a violation of Section 2 because the paper was using its monopoly power to exclude a competitor. (Where was the interstate commerce that would bring the activity under federal law? The Court said that the radio station was in interstate commerce because it broadcast national news supported by national advertising.)

Practices that help a company acquire or maintain its monopoly position need not be unlawful in themselves. In the Aluminum Company case, Alcoa claimed its monopoly power was the result of superior business skills and techniques. These superior skills led it to constantly build plant capacity and expand output at every opportunity. But Judge Hand thought otherwise, given that for a quarter of a century other producers could not break into the market because Alcoa acted at every turn to make it impossible for them to compete, even as Alcoa increased its output by some 800 percent. Judge Hand’s explanation remains the classic exposition.

Innovation as Evidence of Intent to Monopolize

During the 1970s, several monopolization cases seeking huge damages were filed against a number of well-known companies, including Xerox, International Business Machines (IBM), and Eastman Kodak. In particular, IBM was hit with several suits as an outgrowth of the Justice Department’s lawsuit against the computer maker. (United States v. IBM was filed in 1969 and did not terminate until 1982, when the government agreed to drop all charges, a complete victory for the company.) The plaintiffs in many of these suits—SCM Corporation against Xerox, California Computer Products Incorporated against IBM (the Calcomp case), Berkey Photo Incorporated against Kodak—charged that the defendants had maintained their alleged monopolies by strategically introducing key product innovations that rendered competitive products obsolete. For example, hundreds of computer companies manufacture peripheral equipment “plug-compatible” with IBM computers. Likewise, Berkey manufactured film usable in Kodak cameras. When the underlying products are changed—mainframe computers, new types of cameras—the existing manufacturers are left with unusable inventory and face a considerable time lag in designing new peripheral equipment. In some of these cases, the plaintiffs managed to obtain sizable treble damage awards—SCM won more than $110 million, IBM initially lost one case in the amount of $260 million, and Berkey bested Kodak to the tune of $87 million. Had these cases been sustained on appeal, a radical new doctrine would have been imported into the antitrust laws—that innovation for the sake of competing is unlawful.

None of these cases withstood appellate scrutiny. The Supreme Court has not heard cases in this area, so the law that has emerged is from decisions of the federal courts of appeals. A typical case is ILC Peripherals Leasing Corp. v. International Business Machines (the Memorex case).ILC Peripherals Leasing Corp. v. International Business Machines, 458 F.Supp. 423 (N.D. Cal. 1978). Memorex argued that among other things, IBM’s tactic of introducing a new generation of computer technology at lower prices constituted monopolization. The court disagreed, noting that other companies could “reverse engineer” IBM equipment much more cheaply than IBM could originally design it and that IBM computers and related products were subject to intense competition to the benefit of plug-compatible equipment users. The actions of IBM undoubtedly hurt Memorex, but they were part and parcel of the competitive system, the very essence of competition. “This kind of conduct by IBM,” the court said, “is precisely what the antitrust laws were meant to encourage.…Memorex sought to use the antitrust laws to make time stand still and preserve its very profitable position. This court will not assist it and the others who would follow after in this endeavor.”

The various strands of the innovation debate are perhaps best summed up in Berkey Photo, Inc. v. Eastman Kodak Company, Section 21.8.4 "Innovation and Intent to Monopolize".

Attempts to Monopolize

Section 2 prohibits not only actual monopolization but also attempts to monopolize. An attempt need not succeed to be unlawful; a defendant who tries to exercise sway over a relevant market can take no legal comfort from failure. In any event, the plaintiff must show a specific intent to monopolize, not merely an intent to commit the act or acts that constitute the attempt.

Remedies

Since many of the defendant’s acts that constitute Sherman Act Section 2 monopolizing are also violations of Section 1 of the Clayton Act, why should plaintiffs resort to Section 2 at all? What practical difference does Section 2 make? One answer is that not every act of monopolizing is a violation of another law. Leasing and pricing practices that are perfectly lawful for an ordinary competitor may be unlawful only because of Section 2. But the more important reason is the remedy provided by the Sherman Act: divestiture. In the right case, the courts may order the company broken up.

In the Standard Oil decision of 1911, the Supreme Court held that the Standard Oil Company constituted a monopoly and ordered it split apart into separate companies. Several other trusts were similarly dealt with. In many of the early cases, doing so posed no insuperable difficulties, because the companies themselves essentially consisted of separate manufacturing plants knit together by financial controls. But not every company is a loose confederation of potentially separate operating companies.

The Alcoa case (Section 21.8.3 "Acquiring and Maintaining a Monopoly") was fraught with difficult remedial issues. Judge Hand’s opinion came down in 1945, but the remedial side of the case did not come up until 1950. By then the industry had changed radically, with the entrance of Reynolds and Kaiser as effective competitors, reducing Alcoa’s share of the market to 50 percent. Because any aluminum producer needs considerable resources to succeed and because aluminum production is crucial to national security, the later court refused to order the company broken apart. The court ordered Alcoa to take a series of measures that would boost competition in the industry. For example, Alcoa stockholders had to divest themselves of the stock of a closely related Canadian producer in order to remove Alcoa’s control of that company; and the court rendered unenforceable a patent-licensing agreement with Reynolds and Kaiser that required them to share their inventions with Alcoa, even though neither the Canadian tie nor the patent agreements were in themselves unlawful.

Although the trend has been away from breaking up the monopolist, it is still employed as a potent remedy. In perhaps the largest monopolization case ever brought—United States v. American Telephone & Telegraph Company—the government sought divestiture of several of AT&T’s constituent companies, including Western Electric and the various local operating companies. To avoid prolonged litigation, AT&T agreed in 1982 to a consent decree that required it to spin off all its operating companies, companies that had been central to AT&T’s decades-long monopoly.

Key Takeaway

Aggressive competition is good for consumers and for the market, but if the company has enough power to control a market, the benefits to society decrease. Under Section 2 of the Sherman Act, it is illegal to monopolize or attempt to monopolize the market. If the company acquires a monopoly in the wrong way, using wrongful tactics, it is illegal under Section 2. Courts will look at three questions to see if a company has illegally monopolized a market: (1) What is the relevant market? (2) Does the company control the market? and (3) How did the company acquire or maintain its control?

Exercises

  1. Mammoth Company, through three subsidiaries, controls 87 percent of the equipment to operate central station hazard-detecting devices; these devices are used to prevent burglary and detect fires and to provide electronic notification to police and fire departments at a central location. In an antitrust lawsuit, Mammoth Company claims that there are other means of protecting against burglary and it therefore does not have monopoly power. Explain how the Justice Department may be able to prove its claim that Mammoth Company is operating an illegal monopoly.
  2. Name the sanctions used to enforce Section 2 of the Sherman Act.
  3. Look at any news database or the Department of Justice antitrust website for the past three years and describe a case involving a challenge to the exercise of a US company’s monopoly power.