An Analysis of Trident v. Independent Ink

Wenjia Sheng, Minyi ZhuApril, 2016

Summary Introduction Background Presumption Result From the Case to Economic Analysis Economic Analysis Our Views Q & A

In 2006, the Supreme Court used Trident v. Independent Ink case to overturn a line of cases that had recognized a presumption of market power for patented tying products.

Introduction

Background Trident Independent Ink

DescriptionA subsidiary of Illinois Tool Works, which is a leading manufacturer of printheads (patented)

a small but reputable manufacturer and its ink is compatible with Trident printheads

Price of equivalent

ink$325/per bottle $125 - $189/per bottle

Lawsuits Between Two Companies

In 1997 Sued Independent Ink for patent infringement;But, was dismissed for lack of personal jurisdiction

In 1998Found Trident’s patents were invalid to show that they did not infringe the patents

Background

Trident Independent Ink

Countersued for patent infringement

Amended its complaint to include claims of monopolization and illegal tying

Federal District Court: dismissed the patent infringement claimMeanwhileThe District Court: granted summary judgment because of no economic analysis demonstrating that Trident had market power

The District Court: refused to apply the presumption of market power and reserved itAfter 2004, The Court of Appeals for the Federal Circuit: agreed with the district court and acknowledged the criticism of the presumption only Congress or the Supreme Court could alter it

PresumptionCases according to the presumption(the precedent from the Supreme Court):International Salt (1947) – patented machine and saltLoews (1962) – blocking book of moviesJefferson Parish (1984) – hospital

The presumption was open to the obvious criticism that most patents have little or no value, and therefore cannot obtain or possess significant market power by themselves.

Result

Besides,Independent Ink was given an opportunity to demonstrate that Trident did indeed have market power and thus violated §1 of the Sherman Act through its tying contract.

§ 1:“Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."

From the Case to Economics Analysis

The ability of a firm to exercise and extend market power via tying is the biggest conflict between Trident and Independent Ink. Tying creates an opportunity to meter usage and thereby increase profits.

We will focus on tying in the economic analysis part.

Economic Analysis

1. Concepts1) Tying Instrument2) Bundling Instrument3) Metering4) Direct Metering5) Indirect Metering

2. Modeling Tying: Indirect Metering Device

1.1 Tying Instrument

Tying occurs when a seller requires to purchase not only a certain good, but also all the units a consumer wishes to buy of another good: here the two goods are sold together in variable proportions.

Instances: mobile phone set + phone calls copy machine + toner

1.2 Confusable Concept: Bundling Instrument

A product is offered by a seller under the condition that another product is also bought. The different goods are sold together in fixed proportions.

Instances: plane ticket + hotel accommodation computers + application software car + tires, air-conditioning, engine and seats shoes + strings …

1.3 Metering

Metering, a major requirements tying device, is a practice under which a customer is charged a price based on his or her use of the product.

This allows the seller to raise its profits by charging more to high-value customers while still making sales at lower prices to low-value customers, which can be understood as a useful price discrimination tool.

1.4 Direct Metering

Under direct metering, the customer is charged a per-use or metered fee.

For example, Monsanto (a sustainable agriculture company that delivers agricultural products that support farmers all around the world) charged a per-acre technology use fee for its patented Roundup ready seeds.

Summit (an ambulatory surgery center) charged doctors a per-use fee for its patented laser eye surgery device.

1.5 Indirect Metering

Under indirect metering, the fee is based on the use of a complementary product, as with printheads and ink in our case.

There are three salient features of a requirements tying used for indirect metering:

First, the two products are essential complements in that the original product is of no value without the tied product.

Second, the value of the original product is related to its intensity of use as measured through consumption of the complement. More frequent use of original product requires more complementary products, thereby allowing the seller to charge more to and earn more from high-value customers.

The final ingredient of indirect metering is that the tied aftermarket product is sold at a price premium. The price premium is how the firm profits from additional usage. As a result, the customer would prefer to buy the tied product elsewhere but is prevented from doing so either by contract, technology constraints, or lack of alternatives.

The ability to engage in price discrimination via metering is evidence of market power.

In the case of Trident v Independent Ink, customers who were the largest volume users of the ink jet printers were the most profitable. Were a rival to have offered an equivalent printer at a higher price combined with ink sold at marginal cost, this would have been attractive to the large-volume customers. The fact that a firm could profitably enter with a single-price contract (but none did) is evidence that Trident was exercising market power.

2. Modeling Tying: Indirect Metering Device Assumptions:

• A consumer of type i = l, h (indicating low-value and high-value customers respectively)

• One unit of product A (the original good)• q units of product B (a complementary good)• Utility function: Ui = q – q2/2vi

• Consuming the goods separately gives zero utility.• Buying more than one unit of good A does not add to

utility.• Type-l consumers have lower intensity of demand (vl < vh)

• A share λ of the population (of size 1 for simplicity), 1-λ being the share of type-h consumers.

• Good A is monopolized by firm 1.• Several firms having identical technology - including firm

1-are involved in the production of good B. (There is price competition in the B market.)

• The cost of producing one unit of the product are respectively cA and cB < 1.

• No fixed costs.

No tying (if all consumers buy):

• Maxq Ui – pA– pBq• Setting dUi /dq = 0, we have:

qi = vi (1– pB)• Given that CSi = Ui – pA – pBqi is non-negative, after

substitution, we have:CSi = vi (1– pB)2 /2 – pA ≥ 0

• Price competition on B market implies that pB = cB.• Firm 1 chooses prices so that all consumers buy:

pANT = vl (1– cB)2/2 (vl < vh)

• In this case, type-l consumers will have zero surplus, whereas type-h consumers will have a surplus :

CShNT=(vh–vl)(1–cB)2/2

• Producer surplus equals firm 1’s profits from good A:πNT= vl (1– cB)2/2 – cA

• Therefore, welfare will be equal to:

Tying :

• Firm 1 requires consumers who want to buy good A also to buy good B from it.

• It is a strong assumption, that it is endowed with some technology that allows firm 1 to monitor consumers’ purchases of good B, and to prevent them from addressing competitors to buy good B after having bought one unit of good A with a symbolic quantity of B.

• From equation qi = vi (1– pB), firm 1’s profits are:π = (pB– cB)(λvl(1 – pB) + (1 – λ)vh(1 – pB)) + pA – cA

• From dπ/dpB = 0, we have:

> > > cB

• Since pBT > cB, it is crucial that firm 1 is able to prevent

consumers from buying good B from competitors.• Consumers will buy both goods as long as:

CSi = vi (1 – pBT)2/2 – pA ≥ 0

• After replacement, we obtain:

, which can either be bigger or smaller than cA.

• Here tying works in a very similar way as a two-part tariff scheme T + pq that segments consumers according to their intensity of demand. The fixed fee part of the tariff, T, corresponds to pA

T , whereas the variable part of the

tariff corresponds to pBT.

• The lower the intensity of demand of a consumer the lower the number of units of good B he will buy from the monopolist, as qi = vi (1 – pB

T), and therefore the lower the total amount paid to it.

• Firm 1’s profits under tying are:

• Type-l consumers have zero surplus, whereas type-h consumer surplus is:

• Welfare can be computed:

- - CA

Comparisons of equilibria : both types are served

• Tying is profitable:

• It allows the monopolist to impose higher payments from consumers who have a higher intensity of demand.

• Tying is detrimental to welfare: WNT – WT=

> 0

• We can notice that welfare should be lower under tying. Indeed, if there is no tying, consumers buy at marginal cost, and welfare is therefore the highest possible, whereas tying introduces a source of allocative inefficiency as good B is sold above marginal cost. We are therefore in the usual case where a higher price decreases CS (CSh, since CSl=0 in either regime)more than it increases PS.

Our Views Efficiency reasons for tying

• Natural Efficiency RationaleIn many cases the principles of scale economies imply that it is more efficient that certain components are marketed together rather than separately.

• Company Incentives Preservation of Quality and Reputation Risk Allocation Efficiencies Leveraging Market Power …

Alternative Explanations

• As the monopolist uses metering to capture more surplus from large customers, this may lead to small and medium customers’ being excluded entirely from the market.

• Furthermore, firms will find resistance to their attempts to impose tying. This resistance leads to an often-overlooked inefficiency: Firms spend significant resources to impose tying, while consumers spend resources to avoid being subject to tying.

• A third reason is that no firm has a perfect monopoly. Consumers can find ways to create substitutes. Thus, high-value customers distort their behavior, which ends up being costly.

Q&A

Thanks for your listening!