Vertical Integration and Media Regulation in the New Economy interest.Consistent with the spirit of the day, the Court did not subject the economic rationales underlying the rules to any significant scrutiny opting instead to defer to the agency in this regard. The Court later relied heavily on this decision in subsequently upholding the national ownership In 1946. the fcc extended the chain broadcasting rules to television without conducting any specific analysis of their applicability to the new medium. This action was clearly prophylactic, as there were only six television stations on the air in the entire u.s. at the time t the fcc has since largely eliminated the Chain Broadcasting Rules with respect to adio, so, as a practical matter, their only remaining relevance is with respect to television 3. The Economic Theory Underlying the Chain Broadcasting rules The Chain Broadcasting Rules reflected the FCc s belief that the networks were using vertical integration and vertical contractual restraints to harm competition in two ways. First, the FCC was concerned that the use of such provisions allowed networks to use their dominant positions to reduce the local broadcast stations' freedom to choose. a concern analogous to the concern in antitrust theory that a dominant firm might leverage'" its market power over one stage of production to reduce competition in an adjacent stage that otherwise would be competitive Second, the FCC was also concerned that allowing networks to tie up local broadcast stations tended to obstruct the growth of new networks, a concern analogous to modern concerns about" foreclosure 43ld.at215-19 44 See, eg-, JAMES LANDIS, THE ADMINISTRATIVE PROCESS 95-103, 132-40(1938). For general descriptions of the courts deferential attitude towards agency policymaking, see Thomas w 1997); Reuel E. Schiller, Enlarging the Administrative Polity: Administrative Law and the Changing Definition of Pluralism, 1945-1970, 53 VAND. L REV. 1389, 1417-19(2000); Richard B. Stewart, The Reformation of American Administrative Law, 88 HARV. L REV. 1669, 1677-78(1975), and Keith Werhan, The Neoclassical Revival in Administrative La, 44 ADMIN. L REV. 567, 574-75(1992) 45 319 U.S. at 218-19; see also id. at 224-25(rejecting the argument that the Chain Broadcasting Rules were arbitrary and capricious). 46 United States v. Storer Broad Co., 351 U.S. 192(1956) Amendment to Part 3 of the Comm'n's Rules, Il Fed. Reg. 33(1946) 48 See Review of the Comm'n's Regulations Governing Television Broad, 10 F.C. C R. 4538, 4539,15(1995)(Report and Order). 49 Review of Comm'n Rules and Regulatory Policies Concerning Network Broad. by Standard(AM) and FM Broad Stations, 63 F.C. C2d 674(1977)(Report, Statement of Policy, and Order ). See REPORT ON CHAIN BROADCASTING, supra note 31, at 4, 52, 65-67 51 See id. at 51-52, 54, 59, 62, 67. It should be noted that the fCc also based its report in part on considerations unrelated to competition policy. For example, at times, the Report on Chain roadcasting also relies in part on concerns more closely allied with the First Amendment, such as the rceived need to encourage locally produced programming. See id. at 4, 63, 65 185
Vertical Integration and Media Regulation in the New Economy 185 interest.43 Consistent with the spirit of the day,44 the Court did not subject the economic rationales underlying the Rules to any significant scrutiny, opting instead to defer to the agency in this regard.45 The Court later relied heavily on this decision in subsequently upholding the national ownership rules.46 In 1946, the FCC extended the Chain Broadcasting Rules to television without conducting any specific analysis of their applicability to the new medium.47 This action was clearly prophylactic, as there were only six television stations on the air in the entire U.S. at the time.48 The FCC has since largely eliminated the Chain Broadcasting Rules with respect to radio,49 so, as a practical matter, their only remaining relevance is with respect to television. 3. The Economic Theory Underlying the Chain Broadcasting Rules The Chain Broadcasting Rules reflected the FCC’s belief that the networks were using vertical integration and vertical contractual restraints to harm competition in two ways. First, the FCC was concerned that the use of such provisions allowed networks to use their dominant positions to reduce the local broadcast stations’ freedom to choose,50 a concern analogous to the concern in antitrust theory that a dominant firm might “leverage” its market power over one stage of production to reduce competition in an adjacent stage that otherwise would be competitive. Second, the FCC was also concerned that allowing networks to tie up local broadcast stations tended to obstruct the growth of new networks,51 a concern analogous to modern concerns about “foreclosure.” 43 Id. at 215-19. 44 See, e.g., JAMES LANDIS, THE ADMINISTRATIVE PROCESS 95-103, 132-40 (1938). For general descriptions of the courts’ deferential attitude towards agency policymaking, see Thomas W. Merrill, Capture Theory and the Courts: 1967-1983, 72 CHI.-KENT L. REV. 1039, 1048-50, 1056-59 (1997); Reuel E. Schiller, Enlarging the Administrative Polity: Administrative Law and the Changing Definition of Pluralism, 1945-1970, 53 VAND. L. REV. 1389, 1417-19 (2000); Richard B. Stewart, The Reformation of American Administrative Law, 88 HARV. L. REV. 1669, 1677-78 (1975); and Keith Werhan, The Neoclassical Revival in Administrative Law, 44 ADMIN. L. REV. 567, 574-75 (1992). 45 319 U.S. at 218-19; see also id. at 224-25 (rejecting the argument that the Chain Broadcasting Rules were arbitrary and capricious). 46 United States v. Storer Broad. Co., 351 U.S. 192 (1956). 47 Amendment to Part 3 of the Comm’n’s Rules, 11 Fed. Reg. 33 (1946). 48 See Review of the Comm’n’s Regulations Governing Television Broad., 10 F.C.C.R. 4538, 4539, ¶ 5 (1995) (Report and Order). 49 Review of Comm’n Rules and Regulatory Policies Concerning Network Broad. by Standard (AM) and FM Broad. Stations, 63 F.C.C.2d 674 (1977) (Report, Statement of Policy, and Order). 50 See REPORT ON CHAIN BROADCASTING, supra note 31, at 4, 52, 65- 67. 51 See id. at 51-52, 54, 59, 62, 67. It should be noted that the FCC also based its report in part on considerations unrelated to competition policy. For example, at times, the Report on Chain Broadcasting also relies in part on concerns more closely allied with the First Amendment, such as the perceived need to encourage locally produced programming. See id. at 4, 63, 65
Yale Journal on Regulation Vol.19:171.2002 The Chain Broadcasting Rules' reliance on the perceived dangers posed by leveraging and foreclosure was an apt reflection of the prevailing economic wisdom of the day. At the time, the Harvard School of Industrial Organization(Harvard School), associated with the work of economist oe Bainand legal scholars Carl Kaysen and Donald Turner, dominated antitrust law. The Harvard School based its hostility towards vertical integration on three central tenets. First, it readily accepted the leverage theory of vertical integration, believing that firms with as little as five percent of the market could use vertical integration to exert market power against upstream and downstream markets. Second, the Harvard Scho also believed that vertical integration allowed firms to foreclose enti ither by tying up the supply of necessary inputs or by forcing new entrants to enter at two different levels of production. Third, Harvard School scholars believed that vertical integration provided few efficiency benefitsand was more often motivated by the desire to create barriers to ent From the 1950s through the early 1970s, the Harvard School swept the field and became the orthodox position on the Supreme Court. In 52 For helpful overviews of the Harvard School approach, see HERBERT HOVENKAMP, AL ANTITRUST POLICY 1.7, at 42-46, 22a, at 60(2d ed. 1999), F M. SCHERER, INDUSTRI STRUCTURE AND ECONOMIC PERFORMANCE 4-6(1970); Peter C Carstensen, Antitrust Law Paradigm of Industrial Organiation, 16 U.C. DAVIS L REv. 487, 493-501(1983); Robert J ECONOMICS AND ANTTTRUST POLICY 179, 180-91(Robert J. Larner James W. Meehan, Jr. eds 1989); Leonard w. Weiss, The Structure-Conduct-Performance Paradigm and Antitrust, 127 U PA L. REV. 1104, 1104-23(1979), and Oliver E. williamson, Antitrust Enforcement: Where It's Been, Where It' s Going,27sT. LOUIS L.L.J.289,290-92,312-13(1983) 53 JOE S BAIN, BARRIERS TO NEW COMPETTTION 155-56( 1956); JOE S BAIN, INDUSTRIAL ORGANIZATION179,360-64,381(2ded.1968) 54 CARL KAYSEN DONALD F. TURNER, ANTITRUST POLICY: AN ECONOMIC AND LEGAL ANALYSIS (1959); CARL KAYSEN, UNITED STATES V UNITED SHOE MACHINERY CORPORATION:AN ECONOMIC ANALYSIS OF AN ANTI-TRUST CASE (1956): Donald Turner, The validity of lying Arrangements Under the Antitrust Laws, 72 HARV. L. REV. 50(1958). In fact, Kaysen was able to influence doctrine directly when he served as a law clerk to Judge Wyzanski in one of the leading antitrust cases of its time. See Carl Kaysen, In Memoriam: Charles e. Wy=anski, Jr, 100 HARV. L REV.713,713-15(1987) 55 See kaysen TURNER, supra note 54, at 132(arguing that firms"can, through the leverage effects of firms in one market n another to which they stand in the relation of supplier or customer, enhance existing p able it to be applied in a new market") 56 See id. at 121 (Vertical backward over limited raw material supplies or forward over limited market outlets may provide either the basic sources of the market power of the firm or important buttresses to it. See id at 120 58 See BAIN, BARRIERS TO NEW COMPETTTION, supra note 53, at 155-56: BAIN, INDUSTRIAL ORGANIZATION, supra note 53, at 179, 360-64, 381 BAIN, BARRIERS TO NEW COMPETITION, supra note 53, at 144-47 60 In fact, at the time the harvard School counted even such future critics as George Stigler Ward Bowman, and Milton Friedman among its adherents. See GEORGE STIGLER, MEMOIRS OF AN UNREGULATED ECONOMIST 97, 99-100(1988), Ward S Bowman, Jr, Toward Less Monopoly, 101 U PAL.REV.577,589,641(1953) 186
Yale Journal on Regulation Vol. 19:171, 2002 186 The Chain Broadcasting Rules’ reliance on the perceived dangers posed by leveraging and foreclosure was an apt reflection of the prevailing economic wisdom of the day. At the time, the Harvard School of Industrial Organization52 (“Harvard School”), associated with the work of economist Joe Bain53 and legal scholars Carl Kaysen and Donald Turner,54 dominated antitrust law. The Harvard School based its hostility towards vertical integration on three central tenets. First, it readily accepted the leverage theory of vertical integration, believing that firms with as little as five percent of the market could use vertical integration to exert market power against upstream and downstream markets.55 Second, the Harvard School also believed that vertical integration allowed firms to foreclose entry either by tying up the supply of necessary inputs56 or by forcing new entrants to enter at two different levels of production.57 Third, Harvard School scholars believed that vertical integration provided few efficiency benefits58 and was more often motivated by the desire to create barriers to entry.59 From the 1950s through the early 1970s, the Harvard School swept the field60 and became the orthodox position on the Supreme Court.61 In 52 For helpful overviews of the Harvard School approach, see HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY § 1.7, at 42-46, § 2.2a, at 60 (2d ed. 1999); F. M. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 4-6 (1970); Peter C. Carstensen, Antitrust Law and the Paradigm of Industrial Organization, 16 U.C. DAVIS L. REV. 487, 493-501 (1983); Robert J. Larner & James W. Meehan, Jr., The Structural School, Its Critics, and Its Progeny: An Assessment, in ECONOMICS AND ANTITRUST POLICY 179, 180-91 (Robert J. Larner & James W. Meehan, Jr. eds., 1989); Leonard W. Weiss, The Structure-Conduct-Performance Paradigm and Antitrust, 127 U. PA. L. REV. 1104, 1104-23 (1979); and Oliver E. Williamson, Antitrust Enforcement: Where It’s Been, Where It’s Going, 27 ST. LOUIS U. L.J. 289, 290-92, 312-13 (1983). 53 JOE S. BAIN, BARRIERS TO NEW COMPETITION 155-56 (1956); JOE S. BAIN, INDUSTRIAL ORGANIZATION 179, 360-64, 381 (2d ed. 1968). 54 CARL KAYSEN & DONALD F. TURNER, ANTITRUST POLICY: AN ECONOMIC AND LEGAL ANALYSIS (1959); CARL KAYSEN, UNITED STATES V. UNITED SHOE MACHINERY CORPORATION: AN ECONOMIC ANALYSIS OF AN ANTI-TRUST CASE (1956); Donald Turner, The Validity of Tying Arrangements Under the Antitrust Laws, 72 HARV. L. REV. 50 (1958). In fact, Kaysen was able to influence doctrine directly when he served as a law clerk to Judge Wyzanski in one of the leading antitrust cases of its time. See Carl Kaysen, In Memoriam: Charles E. Wyzanski, Jr., 100 HARV. L. REV. 713, 713-15 (1987). 55 See KAYSEN & TURNER, supra note 54, at 132 (arguing that firms “can, through the leverage effects of firms in one market on those in another to which they stand in the relation of supplier or customer, enhance existing power, or enable it to be applied in a new market”). 56 See id. at 121 (“Vertical integration backward over limited raw material supplies or forward over limited market outlets may provide either the basic sources of the market power of the firm or important buttresses to it.”). 57 See id. at 120. 58 See BAIN, BARRIERS TO NEW COMPETITION, supra note 53, at 155-56; BAIN, INDUSTRIAL ORGANIZATION, supra note 53, at 179, 360-64, 381. 59 See BAIN, BARRIERS TO NEW COMPETITION, supra note 53, at 144-47. 60 In fact, at the time, the Harvard School counted even such future critics as George Stigler, Ward Bowman, and Milton Friedman among its adherents. See GEORGE STIGLER, MEMOIRS OF AN UNREGULATED ECONOMIST 97, 99-100 (1988); Ward S. Bowman, Jr., Toward Less Monopoly, 101 U. PA. L. REV. 577, 589, 641 (1953)
Vertical Integration and Media Regulation in the New Economy case after case, the Court struck down vertical mergers by firms controlling as little as five percent of the market. The Court followed a arallel pattern with respect to vertical contractual restraints, either holding them illegal per se on the grounds that the restraint at issue evinced such a ernicious effect on competition"and such a" lack of any redeeming virtue" that little would be lost if they were"presumed to be.,. illega without elaborate inquiry as to the precise harm they have caused or the business excuse for their use or striking them down at such low levels of concentration as to be tantamount to the same thing. The harvard School approach also became enshrined in the initial Merger Guidelines issued by the Justice Department in 1968, which disfavored any vertical merger involving a firm holding as little as six to ten percent of its market. Given the prevailing hostility towards vertical integration, it seemed quite natural for the FCC to impose categorical regulations that in essence made vertical integration in the broadcast industry illegal per se B. The Basic Economics of vertical Integration 1. The Chicago School's Rejection of Per Se Illegality The academic and doctrinal consensus in place at the time the FCC established the Chain Broadcasting Rules would not prove to be lasting. A new body of economic scholarship, spearheaded by a group of economists associated with the University of Chicago,unleashed a critique of the Harvard Schools approach to vertical integration that remains one of the central influences in competition policy to this day 515,516-/> See Louis Kaplow, Extension of Monopoly Power Through Leverage,85 COLUM.LREv 62 See Ford Motor Co. v United States, 405 U.S. 562, 578(1971)(striking down merger resulting in 10% foreclosure); Brown Shoe Co. v. United States, 370 U.S. 294, 328-34 (striking down vertical merger resulting in 5% and 1% foreclosure); United States v E.L. d Nemours Co, 353 U.S. 586(1956)(striking down vertical merger resulting in 6%to 7% foreclosure) 3 N Pac Ry Ce les, also United States v Loews, Inc, 371 U.S. 38, 45(1962)(same); Fortner Enters, Inc. v. United States Steel Corp, 394 U.S. 495, 498-99(1968)(same); United States v. Arnold, Schwinn Co, 388 U.S. 5(1966)(holding territorial restrictions illegal ) White Motor Co v. United States, 372 U.S See, e.g., Standard Oil Co. v United States, 337 U.S. 293, 314(1948)(striking down exclusive dealing contract that foreclosed 16% of the market) 65 U.S. Department of Justice Merger Guidelines 8 12, 33 Fed. Reg. 23, 442(1968), reprinted in 4 Trade Reg. Rep ( CCH)1 13, 66 Readers already familiar with the basic economics of vertical integration might prefer to 67 For a useful overview of the Chicago School, see Richard A. Posner, The Chicago School of Antitrust Analysis, 127U. PA. L REV. 925(1979) 187
Vertical Integration and Media Regulation in the New Economy 187 case after case, the Court struck down vertical mergers by firms controlling as little as five percent of the market.62 The Court followed a parallel pattern with respect to vertical contractual restraints, either holding them illegal per se on the grounds that the restraint at issue evinced such a “pernicious effect on competition” and such a “lack of any redeeming virtue” that little would be lost if they were “presumed to be . . . illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their use”63 or striking them down at such low levels of concentration as to be tantamount to the same thing.64 The Harvard School approach also became enshrined in the initial Merger Guidelines issued by the Justice Department in 1968, which disfavored any vertical merger involving a firm holding as little as six to ten percent of its market.65 Given the prevailing hostility towards vertical integration, it seemed quite natural for the FCC to impose categorical regulations that in essence made vertical integration in the broadcast industry illegal per se. B. The Basic Economics of Vertical Integration66 1. The Chicago School’s Rejection of Per Se Illegality The academic and doctrinal consensus in place at the time the FCC established the Chain Broadcasting Rules would not prove to be lasting. A new body of economic scholarship, spearheaded by a group of economists associated with the University of Chicago,67 unleashed a critique of the Harvard School’s approach to vertical integration that remains one of the central influences in competition policy to this day. 61 See Louis Kaplow, Extension of Monopoly Power Through Leverage, 85 COLUM. L. REV. 515, 516-17 (1985). 62 See Ford Motor Co. v. United States, 405 U.S. 562, 578 (1971) (striking down vertical merger resulting in 10% foreclosure); Brown Shoe Co. v. United States, 370 U.S. 294, 328-34 (1961) (striking down vertical merger resulting in 5% and 1% foreclosure); United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586 (1956) (striking down vertical merger resulting in 6% to 7% foreclosure). 63 N. Pac. Ry. Co. v. United States, 356 U.S. 1, 5 (1957) (holding tying illegal per se); see also United States v. Loew’s, Inc., 371 U.S. 38, 45 (1962) (same); Fortner Enters., Inc. v. United States Steel Corp., 394 U.S. 495, 498-99 (1968) (same); United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1966) (holding territorial restrictions illegal per se); White Motor Co. v. United States, 372 U.S. 253 (1962) (same). 64 See, e.g., Standard Oil Co. v. United States, 337 U.S. 293, 314 (1948) (striking down exclusive dealing contract that foreclosed 16% of the market). 65 U.S. Department of Justice Merger Guidelines § 12, 33 Fed. Reg. 23,442 (1968), reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,101. 66 Readers already familiar with the basic economics of vertical integration might prefer to skip directly to infra Section I.C. 67 For a useful overview of the Chicago School, see Richard A. Posner, The Chicago School of Antitrust Analysis, 127 U. PA. L. REV. 925 (1979)
Yale Journal on Regulation Vol.19:171.2002 The Chicago School systematically called into question each of the three central propositions that underlay the Harvard Schools hostility towards vertical integration. First, the Chicago School argued that the leverage theory of vertical integration provided neither the incentive nor the ability to harm competition. Second, the Chicago School attacked the notion that vertical integration could foreclose entry. Third, Chicagoan offered plausible arguments that vertical integration could lead to more significant efficiency benefits than the Harvard School thought possible. I will discuss each in turn a. The Critique of leverage The Chicago school leveled a twofold attack on the notion that firms could use vertical integration to gain leverage over another market. One attack focused on the structural preconditions required to state a coherent leveraging claim. The other attack was more radical: it argued that. even when the structural preconditions identified in the first attack were met, vertical integration did not provide firms with any additional market power. As a result, the Chicagoans argued, firms will generally find leverage to be unnecessary Beginning with the first attack, Chicagoans pointed out that it is impossible to state a coherent theory of leverage unless two structural preconditions are met. First, the merging firm must have monopoly power n its primary market since, without such power, any attempt to charge supra-competitive prices would simply induce customers to obtain the goods they need from other sources. In short, a firm that lacks market power has nothing to leverage in the first place. Second, the market into which the firm seeks to vertically integrate(called the secondary market) must also be concentrated and protected by barriers to entry. If no such barriers to entry exist, any attempt to raise price in the secondary market will simply attract new competitors until the price drops back down to competitive levels. Unless these two structural preconditions are met, it is impossible to see how vertical integration could provide any firm with the ability to extract any profit from either market. In addition, the Chicago School pointed out that, although firms with monopoly power may have the ability to exercise leverage over upstream and downstream markets, those firms typically lack the incentive to do so 68 See RICHARD A, PoSner FRANK H. EASTERBROOK, ANTTTRUST 870-71(2d ed. 1982) ("Firms that are competitive cannot impose coercive restrictions on their suppliers or their c.(1956) Edward H. Levi, Law and the Future: Trade Regulation, 51 Nw. U. L REv. 281, 290 as a means of obtaining a monopoly. They lack the power to do this effectively. " 69 See RICHARD A POSNER, ANTITRUST LAW: AN ECONOMIC PERSPECTIVE 172-73(1976)
Yale Journal on Regulation Vol. 19:171, 2002 188 The Chicago School systematically called into question each of the three central propositions that underlay the Harvard School’s hostility towards vertical integration. First, the Chicago School argued that the leverage theory of vertical integration provided neither the incentive nor the ability to harm competition. Second, the Chicago School attacked the notion that vertical integration could foreclose entry. Third, Chicagoans offered plausible arguments that vertical integration could lead to more significant efficiency benefits than the Harvard School thought possible. I will discuss each in turn. a. The Critique of Leverage The Chicago School leveled a twofold attack on the notion that firms could use vertical integration to gain leverage over another market. One attack focused on the structural preconditions required to state a coherent leveraging claim. The other attack was more radical; it argued that, even when the structural preconditions identified in the first attack were met, vertical integration did not provide firms with any additional market power. As a result, the Chicagoans argued, firms will generally find leverage to be unnecessary. Beginning with the first attack, Chicagoans pointed out that it is impossible to state a coherent theory of leverage unless two structural preconditions are met. First, the merging firm must have monopoly power in its primary market since, without such power, any attempt to charge supra-competitive prices would simply induce customers to obtain the goods they need from other sources. In short, a firm that lacks market power has nothing to leverage in the first place.68 Second, the market into which the firm seeks to vertically integrate (called the secondary market) must also be concentrated and protected by barriers to entry. If no such barriers to entry exist, any attempt to raise price in the secondary market will simply attract new competitors until the price drops back down to competitive levels.69 Unless these two structural preconditions are met, it is impossible to see how vertical integration could provide any firm with the ability to extract any profit from either market. In addition, the Chicago School pointed out that, although firms with monopoly power may have the ability to exercise leverage over upstream and downstream markets, those firms typically lack the incentive to do so. 68 See RICHARD A. POSNER & FRANK H. EASTERBROOK, ANTITRUST 870-71 (2d ed. 1982) (“The leverage theory . . . is beside the point if the integrated firm lacks a monopoly.”); Aaron Director & Edward H. Levi, Law and the Future: Trade Regulation, 51 NW. U. L. REV. 281, 290 (1956) (“Firms that are competitive cannot impose coercive restrictions on their suppliers or their customers as a means of obtaining a monopoly. They lack the power to do this effectively.”). 69 See RICHARD A. POSNER, ANTITRUST LAW: AN ECONOMIC PERSPECTIVE 172-73 (1976)
Vertical Integration and Media Regulation in the New Economy This is because there is only one monopoly profit in any chain of production, and any monopolist can capture all of that profit without having to resort to vertical integration. All it has to do is simply price its goods at the monopoly level A simple numerical example will help illustrate the point. Suppos that a monopolist refines ore into copper ingot and sells it to a downstream firm that fabricates the ingot into copper pipe that is sold into a competitive market. Suppose further that the cost of refining ore into ingot is $40, that the cost of fabricating the ingot into pipe is $35, and that the monopoly price of the final good is $100. If the monopolist were to vertically integrate into fabrication, it could charge $100 for the final good and thereby earn a profit of $25 per unit (i.e, $100-$40-$35).The monopolist need not vertically integrate to capture this profit, however. All it needs to do is price the ingot at $65, which would allow it to earn the same profit of $25 per unit (i.e, $65-$40). Since the downstream firm faces competition, it will simply set its markup equal to its costs. This results in the price of the final good also being set at its profit-maximizing price of $100 (i. e, $65+$35). Thus, as a general matter, the monopolist gains nothing by vertically integrating into fabrication. All it needs to do to capture all of the available profit is simply price the input so that the final good is priced at the monopoly lev Chicago School scholars did note two relevant exceptions to their critique of leveraging. First, they pointed out that leverage might be profitable if the monopolist controls an input that can be used in variable proportions with other competitively supplied inputs. The logic is straightforward: A firm with monopoly control over an input will price it supra note 69, at 173, 197; POSNER& EASTERBROOK, supra note 802-03,870; Ward s Bowman, Jr, 7) gements and the Leverage Problem, 67 YALE LJ. 19, 20-21(1957); Director 71 The example is taken from Town of Concord v. Boston Edison Co., 915 F2d 17, 32(1st Cir. 1990)(Breyer, CJ), cert. denied, 499US. 931(1991) See boRk, note 70, at 229-31; POSNER, supra note 69, at 201; POSNER EASTERBROOK, supra note 68, at 874: Bowman, supra note 70, at 25-27, ML Burstein, A Theory of Full-Line Forcing, 55 Nw. U. L REV. 62, 68, 76-83(1960); John S. McGee Lowell R. Bassett, Vertical Integration Revisited, 19 J.L.& ECoN. 17, 22-32, 38(1976); Posner, supra note 67, at 937. For the seminal economic articles, see L w. McKenzie, Ideal Output and the Interdependence Firms, 61 ECON. J. 785(1951); and John M. Vernon Daniel A. Graham, Profitability Monopolization by Vertical Integration, 79 J. POL. ECON. 924(1971). For useful reviews ap the economic literature, see blair KASERMAn, supra note 24, at 31-35: F.M. SCherer david RosS, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 522-27(3d ed. 1990) niro Abiru, Vertical Integration, Variable Proportion cessive Oligopolies, 36 J. INDUS. ECON. 315, 324(1988); and Martin K. Perry, vertical Integration: Determinants and Effects, in 1 HANDBOOK OF INDUSTRIAL ORGANIZATION 183, 191-92 Richard Schmalensee Robert D. willig eds, 1989). For n the l HOVENKAMP, supra note 52,$9.3a, at 377-78: Chen Hylton, supra note 24, at 598-99, 627-2 and David eiffen Michael Vita, Is There New Thinking on Vertical Mergers 63 ANTTTRUST LJ 917,922-24(1995) 189
Vertical Integration and Media Regulation in the New Economy 189 This is because there is only one monopoly profit in any chain of production, and any monopolist can capture all of that profit without having to resort to vertical integration. All it has to do is simply price its goods at the monopoly level.70 A simple numerical example will help illustrate the point.71 Suppose that a monopolist refines ore into copper ingot and sells it to a downstream firm that fabricates the ingot into copper pipe that is sold into a competitive market. Suppose further that the cost of refining ore into ingot is $40, that the cost of fabricating the ingot into pipe is $35, and that the monopoly price of the final good is $100. If the monopolist were to vertically integrate into fabrication, it could charge $100 for the final good and thereby earn a profit of $25 per unit (i.e., $100 - $40 - $35). The monopolist need not vertically integrate to capture this profit, however. All it needs to do is price the ingot at $65, which would allow it to earn the same profit of $25 per unit (i.e., $65 - $40). Since the downstream firm faces competition, it will simply set its markup equal to its costs. This results in the price of the final good also being set at its profit-maximizing price of $100 (i.e., $65 + $35). Thus, as a general matter, the monopolist gains nothing by vertically integrating into fabrication. All it needs to do to capture all of the available profit is simply price the input so that the final good is priced at the monopoly level. Chicago School scholars did note two relevant exceptions to their critique of leveraging. First, they pointed out that leverage might be profitable if the monopolist controls an input that can be used in variable proportions with other competitively supplied inputs.72 The logic is straightforward: A firm with monopoly control over an input will price it 70 See ROBERT H. BORK, THE ANTITRUST PARADOX 226-31, 372-73, 375 (1978); POSNER, supra note 69, at 173, 197; POSNER & EASTERBROOK, supra note 68, at 802-03, 870; Ward S. Bowman, Jr., Tying Arrangements and the Leverage Problem, 67 YALE L.J. 19, 20-21 (1957); Director & Levi, supra note 68, at 290. 71 The example is taken from Town of Concord v. Boston Edison Co., 915 F.2d 17, 32 (1st Cir. 1990) (Breyer, C.J.), cert. denied, 499 U.S. 931 (1991). 72 See BORK, supra note 70, at 229-31; POSNER, supra note 69, at 201; POSNER & EASTERBROOK, supra note 68, at 874; Bowman, supra note 70, at 25-27; M.L Burstein, A Theory of Full-Line Forcing, 55 NW. U. L. REV. 62, 68, 76-83 (1960); John S. McGee & Lowell R. Bassett, Vertical Integration Revisited, 19 J.L. & ECON. 17, 22-32, 38 (1976); Posner, supra note 67, at 937. For the seminal economic articles, see L.W. McKenzie, Ideal Output and the Interdependence of Firms, 61 ECON. J. 785 (1951); and John M. Vernon & Daniel A. Graham, Profitability of Monopolization by Vertical Integration, 79 J. POL. ECON. 924 (1971). For useful reviews appearing in the economic literature, see BLAIR & KASERMAN, supra note 24, at 31-35; F.M. SCHERER & DAVID ROSS, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 522-27 (3d ed. 1990); TIROLE, supra note 24, at 179-81; Masahiro Abiru, Vertical Integration, Variable Proportions, and Successive Oligopolies, 36 J. INDUS. ECON. 315, 324 (1988); and Martin K. Perry, Vertical Integration: Determinants and Effects, in 1 HANDBOOK OF INDUSTRIAL ORGANIZATION 183, 191-92 (Richard Schmalensee & Robert D. Willig eds., 1989). For overviews appearing in the legal literature, see HOVENKAMP, supra note 52, § 9.3a, at 377-78; Chen & Hylton, supra note 24, at 598-99, 627-28; and David Reiffen & Michael Vita, Is There New Thinking on Vertical Mergers?, 63 ANTITRUST L.J. 917, 922-24 (1995)