Tuesday, April 19, 2011

You and Antitrust: A BCS Primer

(the enemy)

“Antitrust” is one of those words where a few people know what it means, and everyone else nods knowingly whenever the subject comes up. It is a verbal trump card. You can be in an argument about anything—anything at all—with an ordinary person, and if you say “well, of course you have to consider the antitrust ramifications” you will win the argument. Try it later today:
Honey, what are we having for dinner? 
Pork chops. 
I’d prefer meat loaf. 
But have you considered antitrust?
Uh…pork chops it is.
Etc. I was once one of those persons. Now I am the other of those persons. Part of the confusion is because proving an antitrust case is usually hard. Many of the top attorneys in the world are antitrust experts. Trials on antitrust can take an unusually long time, even by the standards of our tortoise-like judicial system, and both sides hire economists with PhDs from expensive schools to prove their cases.

Just because proving an antitrust case is hard, however, doesn’t mean that the entire subject is inscrutable. In fact, much of the subject is surprisingly easy, and understanding what people mean when they say “antitrust” is becoming increasingly important for college football fans. This won't be an exhaustion of the subject, but it should be enough of an introduction that you are no longer forced to submit to unwanted pork chops.

What does antitrust even mean? What is a trust? Why are we against them?

Don’t worry about the “trust” part of antitrust; it is just a product of the early history of the subject, when large conglomerates of would-be competitors arranged themselves as “trusts” to avoid competition against one another. This isn’t so much of a concern anymore; nowadays you are more likely to encounter a trust as a way of passing money to someone else, sort of like a will. Think of the topic as “anti-monopoly” rather than “antitrust” and you will be better served.

Then why are we anti-monopoly?

Monopolies are bad for a few reasons. Free competition is good because it leads to lower prices and more of the product being sold. Those two things are actually the same thing; the scarcer the supply, the more the thing will cost. Price goes up as supply shrinks (think about groceries just before a hurricane).

A monopoly company raises its prices. It can do that because there are no other competitors (or few competitors) to drive prices down. When it raises its prices, some people stop buying the product, while others pay more for it. This is bad, because under competition more people would have the product, and we want people to have things. There’s some economics involved here, but just trust me when I say there’s more societal good as a whole (to both the consumers and the companies) in competition than there is in a monopoly, where lots of beneficial transactions are not performed. In other words, I would have bought a pound of bananas at 50 cents, but because the monopoly raised prices, I can no longer afford the bananas.

So, being a monopoly is illegal?

Not exactly. The reason people go into business is to become a monopoly, or at least to have market power. Classic economic theory says that in perfectly free competition, no company will make any profits beyond what they would make doing their next best option. This isn’t good enough for most people to enter business; entrepreneurs want profit. This is why they invent new products, try to make existing products cheaper, etc. We want to encourage these things, so we don’t make being successful in business illegal by itself. (We see this in patents and copyrights, where we actually give creators monopoly rights; we want new products and works to exist more than we are concerned about competition, at least for a little while).

Then what is illegal?

One thing that is especially bad is when lots of companies group together and mimic a large monopoly (this is what the original business trusts did, among other things). For example, if you and I own the only two gas stations for fifty miles, we would be expected to compete against each other for customers. If I went to you and said “let’s both raise our prices by 50 cents a gallon; we’ll both make more money,” and you agree, our two competing companies would be acting like a monopoly. This is just as bad as if a monopoly existed naturally. That is illegal under the Section 1 of the Sherman Act, which forbids unreasonable behavior such as price fixing.

Wait, I see gas stations right next to one another with the same price all the time! Isn’t that an antitrust violation?

Probably not. There are two possibilities here. The first is that the market is very competitive and companies in the same area are just charging the market rate. This is a strong possibility in the gas market, since all gasoline is pretty much the same. Prices might change based on geography or taxes, but if two gas stations are in the same location and otherwise similar, neither one can afford to charge less than the other gas station, since even a penny difference might lead motorists to go to the other station.

There’s a less wholesome possibility as well. Perhaps I do not go to you and ask you to raise your prices; that would be illegal, and I don't want to break the law. Instead, one morning I post my prices on my giant electronic sign as 50 cents higher than yours. You are wise to my plan and raise your prices as well. We’ve never even spoken with one another, but we’ve silently agreed to raise prices in parallel. Courts have decided that telling this situation from the first situation is too difficult and so this is allowed as well, even though the result is the same as the illegal scenario above. The legal looks just like the illegal, so we can't risk punishing the former.

Luckily, silent cartel arrangements are very unstable. If I raise my prices 50 cents, you could raise your prices 49 cents, make a great profit, and still get most of the business since you have cheaper gas. This is even a problem when we actually discuss creating a cartel (OPEC countries cheat on their cartel agreement all the time to make a little more money); when we don’t speak, the cartel is very hard to maintain. Things tend back towards competition.

What else is illegal?

All the secondary signs that a cartel has been created are also illegal. For example, punishing a company for not maintaining high prices is illegal (craftmen’s unions sometimes run into this problem by refusing to accredit workers who are not charging high enough rates). Tying a product that you have a monopoly in to a product in which you do not have a monopoly is also illegal. (If you want my printer, where I have a monopoly, you’ll have to spend more money on my ink, which is otherwise a competitive market).

Another common example is splitting areas by geography. If Pepsi and Coca-Cola agreed to stop competing nationally, with instead Pepsi agreeing to compete only west of the Mississippi River and Coca-Cola only east of the river, this would be an antitrust violation, since each company is acting as a monopoly in its own area. The Department of Justice website provides a helpful checklist of some other things that are potentially illegal.

Interestingly, just being a monopoly is not illegal. If my company does well, drives my competitors out of business, and thereby becomes a monopoly, this is fine (eventual monopoly status is the carrot we use to get people to go into business). But companies are not allowed to use that monopoly power to fight unfairly against new competitors. For example, let’s say I’m the only airplane company. Running an airline is expensive, but I’ve done well and have become a monopoly. Thus, I am making tremendous profits. Every time a new company spends the money to enter the market, I lower my prices so much that I am temporarily losing money. Once the new company folds, I go back to my old, high prices. Discouraging competition like this is illegal, though telling apart normal competition from predatory pricing is very difficult (that’s why the attorneys and the experts make so much money).

Don’t sports leagues do some of the things you’ve described?

Yes, kind of. There are three different possibilities at play here. Some sports leagues are set up as a single business (this is true of the MLS, which did this specifically to avoid antitrust problems). Major League Soccer can create whatever rules and regulations they want because the teams are separate several companies, and there cannot be a one-company cartel.

Th MLS is arrangement is unusual, however, and it only exists because the MLS was actually thinking about antitrust when it was formed. In most leagues, every team is a separately owned company. The NFL does not own the Browns, the NBA does not own the Cavaliers, and MLB does not own the Indians. Yet those competing companies have to agree on some things, like how big the field will be. There literally cannot be a game if both teams can’t agree how many bases go on a diamond; even negotiating this before each game would be a massive annoyance. Better for all the teams to just agree in advance. This sounds silly, but most companies cannot define the boundaries of their competition in such a way (hey Pepsi, we're only going to sell cola and root beer, and only in plastic bottles, OK?)

Field dimensions are the easy examples; many are more difficult. Are salary caps an antitrust violation? A salary cap is an agreement by all teams to only pay their employees so much; this would be illegal in almost any other sector. But salary caps are arguably needed in sports leagues because competitive balance is needed for the league, as a whole, to be successful. Everyone in the NFL benefits when all the teams are competitive. (Salary caps are also OK because the union has agreed to them and labor law governs some of this area, but set that aside). Teams want to compete against one another on the field, but they are not trying to drive one another out of business; competition in sports leagues is friendlier than on Wall Street.

One league, the MLB, has a judicially-granted antitrust exemption. The reasons for this are quirky and not particularly sound, either legally or economically, but this has been true for almost a century and is just the way things are. The other professional sports leagues do not have this total exemption, but between the labor agreements and the necessity of running a sports league, these leagues have far more leeway than other sectors. They also often have limited exemptions in some areas, such as television agreements; these exemptions have been granted by Congress, not the courts.

As an added complication, competition could mean many things for sports leagues. First, there is competition within the league (the Bears vs. the Packers). Second, there is competition against other sports leagues (NFL vs. NBA), or against other forms of entertainment (NFL vs. other television shows, or NFL vs. opera). Defining the market is tricky; does the NFL compete in the professional football market (definitely a monopoly), the football market (split with college football), the television market (a major player), or the entertainment market (one of thousands or perhaps millions of choices)? Just how “unique” is the NFL or football that it makes its own separate market? That is, to what extent do fans replace professional football with other forms of entertainment (how many football fans would become opera fans if the NFL was too expensive? How many would become college football fans?)

Where does the NCAA fit into all of this?

There is no college football antitrust exemption from either Congress or the courts. Because the NCAA is a sports league, however, the competitors within the NCAA can reach more agreements than, say, Pepsi and Coke, so long as those agreements make college football more competitive as a whole. Thus the NCAA decide how long the field should be and whether you need one foot down or two for a completed pass. The NCAA can also set prices (i.e., amateurism) because keeping amateurism in college sports is arguably necessary for college football to retain their competitiveness with other forms of entertainment (this is more controversial). Yet the NCAA doesn't have carte blanche; the Supreme Court held in the 1980s that the NCAA could not limit the number of college football games shown on television, because by limiting the games, the NCAA was acting like a monopoly within the televised college football market.

How about the BCS?

The BCS is not the NCAA. The NCAA has almost nothing to do with the NCAA, beyond giving certification to the bowl games that make up the BCS games. Instead, the BCS is a separate arrangement reached by the six major college football conferences.

You can probably see where this is tricky. The BCS is an agreement amongst competitors, which is always a little fishy, yet it is being done in a sports league, where a little extra leeway is always provided since some agreements are necessary. Not all teams are treated the same under the BCS, so there is a fear that the BCS is acting like a certification that is only sparingly given so that the chosen few retain a monopoly over quality college football.

But the case against the BCS isn’t a slam dunk. The quantity of college football playoff games has gone up, not down, since the BCS was put in place (from zero playoff games to one). If the BCS was removed, there’s a good chance the number of playoff games would go down (from one to zero). Supply usually increases when cartel restrictions are removed—that’s what happened in the college football television market. Remember, when supply increases, prices go down, and we almost always want supply to increase, all else being equal.

There’s also the argument that no teams are excluded from the games governed by the BCS. About 10% of the teams playing in BCS games have been from outside the BCS conferences. One of those teams, Utah, has even obtained BCS membership. As for the restrictions, there is a plausible argument that those restrictions are necessary to preserve the value of the BCS; not all conference championships automatically earn games, but no one cares about the best MAC or Sun Belt team, while (arguably) lots of people care about the best Big East or ACC team, even when those teams are mediocre. Every conference gets a payment from the BCS (even when no teams take the BCS games), and conferences that place teams get fairly large payments. On the whole, the size of these payments has reflected the popularity of the conferences (Big Ten and SEC first, other major conferences next, then the mid-major conferences). Popularity is what drives value, after all, so this is a reasonable arrangement (so the argument goes).

So, antitrust is complicated, despite what you said?

I never said it wasn’t complicated, just that the ideas underpinning it are simple. Describing the economic concepts is one thing; finding evidence in the real world is difficult, since there is all sorts of random noise that needs to be filtered out. Unless you have a document that says “let’s conspire to fix prices” (and you do find those sometimes), the case will be a tough one. There is no smoking gun in the BCS case because everyone agrees on the facts; the disagreement is on the economic effect. Without dismantling the BCS, we don’t know what would happen if we dismantled the BCS.

Last week, a group of professors—mostly business school professors but some law professors—wrote a letter to the DOJ that won’t do anything arguing the BCS runs afoul of the antitrust laws. Lester Munson says the case is a no brainer. Maybe, but the bulk of the academic literature (though not all of it) says the BCS is probably legally OK. Someday, we may find out. But now you at least have an idea of what everyone is talking about.