Kodak Company Case Study
Hyun Lee Eastman Kodak v.Image Technical Services — Plaintiff This is yet another case that concerns the standard for summary judgment in an antitrust controversy.The principal issue here is whether a defendant’s lack of market power in the primary equipment market precludes — as a matter of law — the possibility of market power in derivative aftermarkets.
Eastman Kodak Company manufactures and sells photocopiers and micrographic equipment. Kodak also sells service and replacement parts for its equipment.
Respondents are 18 independent service organizations (ISOs) that in the early 1980s began servicing Kodak copying and micrographic equipment. Kodak subsequently adopted policies to limit the availability of parts to ISOs and to make it more difficult for ISOs to compete with Kodak in servicing Kodak equipment. Respondents instituted this action in the United States District Court for the Northern District of California alleging that Kodak’s policies were unlawful under both §§ 1 and 2 of the Sherman Act, 1 and 2.
After truncated discovery, the District Court granted summary judgment for Kodak. The Court of Appeals for the Ninth Circuit reversed. The appellate court found that respondents had presented sufficient evidence to raise a genuine issue concerning Kodak’s market power in the service and parts markets. It rejected Kodak’s contention that lack of market power in service and parts must be assumed when such power is absent in the equipment market. Kodak manufactures and sells complex business machines — as relevant here, high volume photocopier and micrographics equipment.
Kodak equipment is unique; micrographic software programs that operate on Kodak machines, for example, are not compatible with competitors’ machines. Kodak parts are not compatible with other manufacturers’ equipment, and vice versa. Kodak equipment, although expensive when new, has little resale value. Kodak provides service and parts for its machines to its customers. It produces some of the parts itself; the rest are made to order for Kodak by independent original equipment manufacturers (OEMs).
Kodak does not sell a complete system of original equipment, lifetime service, and lifetime parts for a single price. Instead, Kodak provides service after the initial warranty period either through annual service contracts, which include all necessary parts, or on a per call basis. It charges, through negotiations and bidding, different prices for equipment, service, and parts for different customers. Kodak provides 80% to 95% of the service for Kodak machines. Beginning in the early 1980s, ISOs began repairing and servicing Kodak equipment.
They also sold parts and reconditioned and sold used Kodak equipment. Their customers were federal, state, and local government agencies, banks, insurance companies, industrial enterprises, and providers of specialized copy and microfilming services. ISOs provide service at a price substantially lower than Kodak does. Some customers found that the ISO service was of higher quality. In 1985 and 1986, Kodak implemented a policy of selling replacement parts for micrographic and copying machines only to buyers of Kodak equipment who use Kodak service or repair their own machines.
As part of the same policy, Kodak sought to limit ISO access to other sources of Kodak parts. Kodak and the OEMs agreed that the OEMs would not sell parts that fit Kodak equipment to anyone other than Kodak. Kodak also pressured Kodak equipment owners and independent parts distributors not to sell Kodak parts to ISOs. In addition, Kodak took steps to restrict the availability of used machines. Kodak intended, through these policies, to make it more difficult for ISOs to sell service for Kodak machines. It succeeded.
ISOs were unable to obtain parts from reliable sources, and many were forced out of business, while others lost substantial revenue. Customers were forced to switch to Kodak service even though they preferred ISO service. In 1987, the ISOs filed the present action in the District Court, alleging, inter alia, that Kodak had unlawfully tied the sale of service for Kodak machines to the sale of parts, in violation of § 1 of the Sherman Act, and had unlawfully monopolized and attempted to monopolize the sale of service for Kodak machines, in violation of § 2 of that Act.
Kodak filed a motion for summary judgment before respondents had initiated discovery. The District Court permitted respondents to file one set of interrogatories and one set of requests for production of documents, and to take six depositions. Without a hearing, the District Court granted summary judgment in favor of Kodak. As to the § 1 claim, the court found that respondents had provided no evidence of a tying arrangement between Kodak equipment and service or parts. The court, however, did not address respondents’ § 1 claim that is at issue here.
Respondents allege a tying arrangement not between Kodak equipment and service, but between Kodak parts and service. As to the § 2 claim, the District Court concluded that although Kodak had a “natural monopoly over the market for parts it sells under its name,” a unilateral refusal to sell those parts to ISOs did not violate § 2. Noting that the District Court had not considered the market power issue, and that the record was not fully developed through discovery, the court declined to require respondents to conduct market analysis or to pinpoint specific imperfections in order to withstand summary judgment.
The court then considered the three business justifications Kodak proffered for its restrictive parts policy: (1) to guard against inadequate service, (2) to lower inventory costs, and (3) to prevent ISOs from free riding on Kodak’s investment in the copier and micrographic industry. The court concluded that the trier of fact might find the product quality and inventory reasons to be perpetual and that there was a less restrictive alternative for achieving Kodak’s quality related goals.
The court also found Kodak’s third justification, preventing ISOs from profiting on Kodak’s investments in the equipment markets, legally insufficient. As to the § 2 claim, the Court of Appeals concluded that sufficient evidence existed to support a finding that Kodak’s implementation of its parts policy was “anticompetitive” and “exclusionary” and “involved a specific intent to monopolize. ” It held that the ISOs had come forward with sufficient evidence, for summary judgment purposes, to disprove Kodak’s business justifications.
The dissent in the Court of Appeals, with respect to the § 1 claim, accepted Kodak’s argument that evidence of competition in the equipment market “necessarily precludes power in the derivative market. ” With respect to the § 2 monopolization claim, the dissent concluded that, entirely apart from market power considerations, Kodak was entitled to summary judgment on the basis of its first business justification because it had “submitted extensive and undisputed evidence of a marketing strategy based on high quality service. A tying arrangement is “an agreement by a party to sell one product but only on the condition that the buyer also purchases a different (or tied) product, or at least agrees that he will not purchase that product from any other supplier. ” Such an arrangement violates § 1 of the Sherman Act if the seller has “appreciable economic power” in the tying product market and if the arrangement affects a substantial volume of commerce in the tied market. Kodak did not dispute that its arrangement affects a substantial volume of interstate commerce.
It, however, did challenge whether its activities constituted a “tying arrangement” and whether Kodak exercised “appreciable economic power” in the tying market. We consider these issues in turn. For the respondents to defeat a motion for summary judgment on their claim of a tying arrangement, a reasonable trier of fact must be able to find, first, that service and parts are two distinct products, and, second, that Kodak has tied the sale of the two products.
For service and parts to be considered two distinct products, there must be sufficient consumer demand so that it is efficient for a firm to provide service separately from parts. Jefferson Evidence in the record indicates that service and parts have been sold separately in the past and still are sold separately to self service equipment owners. Indeed, the development of the entire high technology service industry is evidence of the efficiency of a separate market for service.
Kodak insists that because there is no demand for parts separate from service, there cannot be separate markets for service and parts. By that logic, we would be forced to conclude that there can never be separate markets, for example, for cameras and film, computers and software, or automobiles and tires. That is an assumption we are unwilling to make. “We have often found arrangements involving functionally linked products at least one of which is useless without the other to be prohibited tying devices. Kodak’s assertion also appears to be incorrect as a factual matter.
At least some consumers would purchase service without parts, because some service does not require parts, and some consumers, those who self service for example, would purchase parts without service. Finally, respondents have presented sufficient evidence of a tie between service and parts. The record indicates that Kodak would sell parts to third parties only if they agreed not to buy service from ISOs. Having found sufficient evidence of a tying arrangement, we consider the other necessary feature of an illegal tying arrangement: appreciable economic power in the tying market.
Market power is the power “to force a purchaser to do something that he would not do in a competitive market. ” It has been defined as “the ability of a single seller to raise price and restrict output. ” The existence of such power ordinarily is inferred from the seller’s possession of a predominant share of the market. Respondents contend that Kodak has more than sufficient power in the parts market to force unwanted purchases of he tied market, service. Respondents provide evidence that certain parts are available exclusively through Kodak.
Respondents also assert that Kodak has control over the availability of parts it does not manufacture. According to respondents’ evidence, Kodak has prohibited independent manufacturers from selling Kodak parts to ISOs, pressured Kodak equipment owners and independent parts distributors to deny ISOs the purchase of Kodak parts, and taken steps to restrict the availability of used machines. Respondents also allege that Kodak’s control over the parts market has excluded service competition, boosted service prices, and forced unwilling consumption of Kodak service.
Respondents offer evidence that consumers have switched to Kodak service even though they preferred ISO service, that Kodak service was of higher price and lower quality than the preferred ISO service, and that ISOs were driven out of business by Kodak’s policies. Under our prior precedents, this evidence would be sufficient to entitle respondents to a trial on their claim of market power. To review Kodak’s theory, it contends that higher service prices will lead to a disastrous drop in equipment sales. Presumably, the theory’s corollary is to the effect that low service prices lead to a dramatic increase in equipment sales.
According to the theory, one would have expected Kodak to take advantage of lower priced ISO service as an opportunity to expand equipment sales. Instead, Kodak adopted a restrictive sales policy consciously designed to eliminate the lower priced ISO service, an act that would be expected to devastate either Kodak’s equipment sales or Kodak’s faith in its theory. Yet, according to the record, it has done neither. Service prices have risen for Kodak customers, but there is no evidence or assertion that Kodak equipment sales have dropped.
Respondents offer a forceful reason why Kodak’s theory, although perhaps intuitively appealing, may not accurately explain the behavior of the primary and derivative markets for complex durable goods: the existence of significant information and switching costs. These costs could create a less responsive connection between service and parts prices and equipment sales. For the service market price to affect equipment demand, consumers must inform themselves of the total cost of the “package” — equipment, service and parts — at the time of purchase; that is, consumers must engage in accurate life cycle pricing.
Lifecycle pricing of complex, durable equipment is difficult and costly. In order to arrive at an accurate price, a consumer must acquire a substantial amount of raw data and undertake sophisticated analysis. The necessary information would include data on price, quality, and availability of products needed to operate, upgrade, or enhance the initial equipment, as well as service and repair costs, including estimates of breakdown frequency, nature of repairs, price of service and parts, length of “downtime” and losses incurred from downtime. Much of this information is difficult — some of it impossible — to acquire at the time of purchase.
During the life of a product, companies may change the service and parts prices, and develop products with more advanced features, a decreased need for repair, or new warranties. In addition, the information is likely to be customer specific; lifecycle costs will vary from customer to customer with the type of equipment, degrees of equipment use, and costs of downtime. Indeed, respondents have presented evidence that Kodak practices price discrimination by selling parts to customers who service their own equipment, but refusing to sell parts to customers who hire third party service companies.
Companies that have their own service staff are likely to be high volume users, the same companies for whom it is most likely to be economically worthwhile to acquire the complex information needed for comparative lifecycle pricing. A second factor undermining Kodak’s claim that “supracompetitive” prices in the service market lead to ruinous losses in equipment sales is the cost to current owners of switching to a different product.
If the cost of switching is high, consumers who already have purchased the equipment, and are thus “locked in,” will tolerate some level of service price increases before changing equipment brands. Under this scenario, a seller profitably could maintain “supracompetitive” prices in the aftermarket if the switching costs were high relative to the increase in service prices, and the number of locked in customers were high relative to the number of new purchasers. Moreover, if the seller can price discriminate between its locked in customers and potential new customers, this strategy is even more likely to prove profitable.
The seller could simply charge new customers below marginal cost on the equipment and recoup the charges in service, or offer packages with life time warranties or long term service agreements that are not available to locked-in customers. Respondents have offered evidence that the heavy initial outlay for Kodak equipment, combined with the required support material that works only with Kodak equipment, makes switching costs very high for existing Kodak customers.
And Kodak’s own evidence confirms that it varies the package price of equipment/parts/service for different customers. In sum, there is a question of fact whether information costs and switching costs foil the simple assumption that the equipment and service markets act as pure complements to one another. We conclude, then, that Kodak has failed to demonstrate that respondents’ inference of market power in the service and parts markets is unreasonable, and that, consequently, Kodak is entitled to summary judgment.
It is clearly reasonable to infer that Kodak has market power to raise prices and drive out competition in the aftermarkets, since respondents offer direct evidence that Kodak did so. It is also plausible, as discussed above, to infer that Kodak chose to gain immediate profits by exerting that market power where locked in customers, high information costs, and discriminatory pricing limited and perhaps eliminated any long term loss. The alleged conduct — higher service prices and market foreclosure — is facially anticompetitive and exactly the harm that antitrust laws aim to prevent.
Respondents also claim that they have presented genuine issues for trial as to whether Kodak has monopolized or attempted to monopolize the service and parts markets in violation of § 2 of the Sherman Act. “The offense of monopoly under § 2 of the Sherman Act has two elements: (1) the possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident. ” The existence of the first element, possession of monopoly power, is easily resolved.
As has been noted, respondents have presented a triable claim that service and parts are separate markets, and that Kodak has the “power to control prices or exclude competition” in service and parts. Monopoly power under § 2 requires, of course, something greater than market power under § 1. Respondents’ evidence that Kodak controls nearly 100% of the parts market and 80% to 95% of the service market, with no readily available substitutes, is, however, sufficient to survive summary judgment under the more stringent monopoly standard of § 2.
The second element of a § 2 claim is the use of monopoly power “to foreclose competition, to gain a competitive advantage, or to destroy a competitor. ” If Kodak adopted its parts and service policies as part of a scheme of willful acquisition or maintenance of monopoly power, it will have violated § 2. As recounted at length above, respondents have presented evidence that Kodak took exclusionary action to maintain its parts monopoly and used its control over parts to strengthen its monopoly share of the Kodak service market.
Liability turns, then, on whether “valid business reasons” can explain Kodak’s actions. Kodak contends that it has three valid business justifications for its actions: “(1) to promote interbrand equipment competition by allowing Kodak to stress the quality of its service; (2) to improve asset management by reducing Kodak’s inventory costs; and (3) to prevent ISOs from free riding on Kodak’s capital investment in equipment, parts and service. ” Factual questions exist, however, about the validity and sufficiency of each claimed justification, making summary judgment inappropriate.
As respondents argue, Kodak’s actions appear inconsistent with any need to control inventory costs. Presumably, the inventory of parts needed to repair Kodak machines turns only on breakdown rates, and those rates should be the same whether Kodak or ISOs perform the repair. More importantly, the justification fails to explain respondents’ evidence that Kodak forced OEMs, equipment owners, and parts brokers not to sell parts to ISOs, actions that would have no effect on Kodak’s inventory costs.
None of Kodak’s asserted business justifications, then, are sufficient to prove that Kodak is “entitled to a judgment as a matter of law” on respondents’ § 2 claim. In the end, of course, Kodak’s arguments may prove to be correct. It may be that its parts, service, and equipment are components of one unified market, or that the equipment market does discipline the aftermarkets so that all three are priced competitively overall, or that any anticompetitive effects of Kodak’s behavior are outweighed by its competitive effects.. Accordingly, the judgment of the Court of Appeals denying summary judgment is affirmed.