Fixing Antitrust’s Indirect Purchaser Rule

Font Size:

A recent Supreme Court case allows end users to sue for antitrust violations.

Font Size:

In Apple v. Pepper, the U.S. Supreme Court held that consumers who claim to have overpaid for apps sold on Apple’s App Store could sue Apple for damages. The case involved a class action by iPhone users alleging antitrust violations against Apple. The underlying claim, which the Supreme Court did not resolve, was that the Apple App Store was a bottleneck through which iPhone users had to purchase apps, for which Apple received a 30% commission. The app purchasers challenged the lack of competition as a form of exclusive dealing. The consumers alleged that the result was an “overcharge” that greater competition on the Apple platform might have remedied.

The decision reflects some bizarre complexities that resulted from the Supreme Court’s 1977 decision in Illinois Brick, when the Court held that only direct purchasers could sue for overcharge injuries under federal antitrust laws. Apple argued essentially that it was merely a broker and that the true direct sellers were the app makers themselves. That would make the iPhone users “indirect” purchasers from Apple, and under U.S. antitrust law they would not be entitled to sue for damages. The Supreme Court majority sided with the customers, however, ruling that the decisive issue was who paid the money to whom. In this case the customers paid Apple directly, who then reimbursed the app makers after taking out its commission. That made the customers direct purchasers.

The Illinois Brick decision that framed Apple v. Pepper was factually straightforward, but its reasoning sparked controversy. Makers of construction blocks fixed their prices and sold them to contractors who built buildings for the state of Illinois. No one seriously doubted that when a cartel like the construction block manufacturers sold something at a higher price to an intermediary, such as a contractor, that contractor would pass on some of the price increases to its customers. The legal question was how damage recoveries should reflect that fact.

Purchaser damages in antitrust cases are ordinarily measured by the amount of the price increase, or “overcharge.” Illinois Brick held that indirect purchasers could not collect such damages. It restricted the opportunity to sue for overcharges to the first purchaser in line, even though that firm might have passed most of the price increase on to others.

The indirect purchaser rule was problematic from the beginning. First, it was plainly inconsistent with the antitrust damages statute, which gives an action to “any person who shall be injured in his business or property” by an antitrust violation. That hardly sounds like a limitation to direct purchasers.

Second, the Court exaggerated the difficulty of “tracing” indirect purchaser damages. Computing passed-on damages requires “incidence theory,” which is used primarily to estimate how a tax is passed along through the economy. For example, if a farmer is taxed on wheat she may absorb part of that tax but pass a portion on to the wholesale bread baker, who in turn may pass some on to the grocer, who will then pass part of it to the consumer. The technical quantification of pass-on is quite demanding. In most cases, however, experts can assess damages without computing pass-on. For example, under the “yardstick” method of estimating damages, the expert compares the price in the market where the violation is occurring with the price in some reasonably similar “yardstick” market not affected by the violation.

For example, suppose that dairies are fixing prices, raising the wholesale price of milk from $2.00 to $3.00 per gallon. The milk is sold to distributors, who sell it to grocers, who finally sell it to consumers. Suppose we can identify a “yardstick” market, similar to the cartel market but without price fixing. In that market the wholesale price is $2.00 as it should be. We also observe that retail prices in the cartel market are $3.75, but only $2.90 in the competitive market. We do not need to know how much of the overcharge was passed on at each level. These numbers tell us that, although not all of the overcharge was passed on, consumers in the cartel market paid 85 cents more for their milk. This represents their overcharge, regardless of how much was absorbed at each link along the way.

Third, the indirect purchaser rule has always been problematic because, if we were going to give the overcharge to a single set of buyers, it should be the end users, not the direct purchasers. The end user is the only person in the distribution chain who is unable to pass anything on. Often the largest losses are those absorbed by end users, because many intermediaries use standardized markup formulas. Consider the dairy example. Suppose that Kroger, a retailer, routinely computes a 10% markup on its dairy products. If it pays $2.50 at wholesale, it adds 25 cents. However, if it pays $3.50, it adds 35 cents. Instead of “absorbing” part of the overcharge, Kroger actually exacts a higher markup when the milk is price-fixed. The consumer gets hit even harder.

This is not to say that Kroger is not injured by the price fixing. Its injury results mainly from lost volume. When suppliers collude to fix prices, retail sales volume goes down. This suggests an important principle: the real injury to direct purchasers and other intermediaries in the distribution chain is not from the overcharge per se; rather, it is from the loss of sales volume.

If we really want to award damages based on injury, as the statute requires, we should compute damages differently for intermediaries and consumers. We should award lost profits for all intermediaries, including the direct purchaser. Only the final purchaser, or consumer, should obtain overcharge damages.

Finally, the Illinois Brick rule is excessively subject to manipulation when defining the direct purchaser. A case in point was Campos v. Ticketmaster, a 1998 case decided by the U.S. Court of Appeals for the Eighth Circuit with facts resembling those of Apple. In that case, the defendant Ticketmaster was accused of monopolizing event ticket sales through its online marketplace. The purchasers were eventgoers who bought their tickets directly from Ticketmaster, paying high processing and handling fees. Ticketmaster itself set the final ticket price. The court held, however, that the concert promoters were direct purchasers of “distribution services” from Ticketmaster, and that the actual ticket buyers were only indirect purchasers of these services. Significantly, the concert promoters behaved as intermediaries: they passed on Ticketmaster’s high markups by charging higher prices for the tickets. The final purchasers, who used the tickets, were the only ones unable to pass anything on. The Apple decision effectively overruled Ticketmaster.

Although Apple reached the right decision in this case, it did not address the indirect purchaser rule’s many other problems, including its very narrow interpretation of a statute that clearly was intended to give damages actions to all of those injured by an antitrust violation. A better rule would be to permit all purchasers to recover, with damages measured by lost profits to all intermediaries, and by the final overcharge to consumers.

The Apple dissenters—Justices Gorsuch, Roberts, Thomas, and Alito—adopted a distinctively non-economic approach that dispensed with the pass-on problem entirely. They reasoned that only the direct purchaser had an injury that was “proximately caused” by the defendant’s antitrust violation. This view harkens back to a nineteenth century tort law concept that was widely used by courts to limit tort liability, particularly in railroad cases. Under this rule, only a single entity could be said to have an injury that was proximately caused by the defendant’s conduct. That rule was properly abandoned in tort cases and should be laid to rest. It makes even less sense in antitrust cases.

Herbert Hovenkamp

Herbert Hovenkamp is the James G. Dinan University Professor at the University of Pennsylvania Law School and the Wharton School of the University of Pennsylvania.

This essay is part of a series, entitled The Supreme Court’s 2018-2019 Regulatory Term.