Intellectual Property Enforcement Guidelines

 

 

 

TABLE OF CONTENTS

Part 1:  Introduction......................................................................................................................... 3

 

1.1       Purpose of Guidelines............................................................................................................ 3

 

1.2       Organization of Guidelines...................................................................................................... 4

 

Part 2:  The Competition Law / Intellectual Property Interface............................................................. 5

 

2.1       Intellectual Property Laws...................................................................................................... 5

 

2.2       Competition Law................................................................................................................... 7

 

2.3       Competition Law/IP Law Interface: Enforcement Principles.................................................... 9

The Bureau applies the same general competition law principles to business arrangements involving IP as it applies to conduct involving other forms of property..................................... 10

The Bureau will not assume that IP rights confer market power................................. 12

The Bureau will generally consider the licensing of intellectual property rights to be pro- competitive       13

 

Part 3: Application of the Competition Act to Intellectual Property................................................... 13

 

3.1  General Issues........................................................................................................................ 14

3.1.1   Market Definition..................................................................................................... 14

3.1.2    Market Power......................................................................................................... 17

(i) Market Concentration......................................................................................... 18

(ii)        Supply Side Substitution.............................................................................. 19

(iii)       Ease of Entry............................................................................................... 20

3.1.3    Competitive Effects Analysis.................................................................................... 21

(i) The Horizontal and Vertical Distinction................................................................. 21

3.1.4 Efficiency Analysis...................................................................................................... 22

3.2       Analysis Applied to Specific Conduct: Hypothetical Case Examples...................................... 25

Mergers Involving IP........................................................................................................... 25

Conspiracy Involving IP....................................................................................................... 29

Abuse of Dominance Involving IP........................................................................................ 30

Exclusive Licensing.............................................................................................................. 31

Exclusive Dealing and Market Restriction............................................................................. 34

Output Royalties.................................................................................................................. 36

Price Maintenance............................................................................................................... 38

Tied Selling.......................................................................................................................... 38

Cross-Licensing and Pooling Arrangements.......................................................................... 40

Refusals to License.............................................................................................................. 41

Standard for Liability........................................................................................................... 42

Essential Facility.................................................................................................................. 42

Background on Network Industries...................................................................................... 44

Network Access..................................................................................................... 45

Foreclosure of Complementary Products.................................................................. 47

Denying Access to Complementary Product Suppliers.............................................. 48

 

Policy Advocacy and the Role of section 32..................................................................................... 50

 

 

Part 1:  Introduction

1.1       Purpose of Guidelines

 

                        With the growth of the knowledge‑based economy, intellectual property ("IP")^[1]  has become an increasingly important competitive asset.  Firms have new opportunities to use their IP strategically.  As with any private property, owners of IP generally have the right to exclude others from using their property and to profit from its exchange.  Given the intangible nature of IP, it is necessary in many instances to provide a statutory mechanism for owners to enforce their ownership rights in IP comparable to those given other kinds of private property. 

 

                        Property laws, such as IP laws, which protect owners' rights in their private property, in general encourage the efficient allocation and use of such property.  However, no property rights are absolute, and as with any other property rights, there are limits on the manner in which IP rights can be exercised.  In particular, limits may be imposed by the Competition Act where necessary to protect and facilitate competitive markets. The Bureau views IP laws and competition laws as complementary ‑ IP laws establish and protect the existence of IP rights and the Competition Act imposes limits on the exercise of these right to ensure that IP is valued and traded efficiently.

 

                        While IP laws and competition laws have the same overall objective ‑ the efficient operation of markets ‑ firms may be unclear about the interface between IP laws and competition laws.  This uncertainty may lead firms to avoid arrangements that are pro‑competitive, or unknowingly base future business plans on arrangements that could be found to be anti‑competitive under the Competition Act.

 

                        The purpose of these Guidelines is to articulate the Competition Bureau's (the "Bureau") enforcement policy as it applies to the assignment, licensing and general use of IP, so as to alleviate any uncertainty that the business community may be facing in this regard.  These Guidelines explain how the Bureau will assess business arrangements involving IP.  The approach elaborated in these Guidelines is dictated by the fundamental principle that the Competition Act applies to IP as it applies to other forms of property.  As with other private property rights, there can be circumstances where intervention under the Competition Act would impose constraints on the exercise of IP rights.  These Guidelines discuss the circumstances in which the Bureau will likely seek to impose limits on the exercise of IP rights in order to promote competitive markets. 

 

                        However, these Guidelines cannot possibly review how discretion will be applied in every situation.  The circumstances of each alleged violation of the Competition Act will determine how the Bureau will apply its enforcement discretion.  Therefore, individuals should either consult with qualified counsel or contact the Bureau when evaluating the competition law risk associated with any contemplated business arrangement involving IP.  The final interpretation of the law rests with the courts and the Competition Tribunal  (the "Tribunal").

 

                        In developing these Guidelines, the Bureau has considered the approach taken in the 1995 Antitrust Guidelines for the Licensing of Intellectual Property issued by the U.S. Department of Justice and the Federal Trade Commission, and the approach taken in other jurisdictions, including the European Community.  These Guidelines are consistent with the North American Free Trade Agreement and the World Trade Organization Agreement on Trade‑Related Intellectual Property Rights, which recognize a country's right to address the anti‑competitive exercise of IP rights.

 

1.2       Organization of Guidelines

 

                        The remainder of these Guidelines is organized in two parts.  Part 2 is divided into three subsections.  The first subsection discusses the general purpose of IP laws.  The second subsection discusses the general purpose of competition law and describes the basic analytic approach used in applying the competition law.  The third subsection presents how the Bureau views the interface between competition law and IP laws and explains the three general enforcement principles the Bureau will apply when dealing with IP.  Part 3 outlines the specific approach adopted by the Bureau in the enforcement of the Competition Act to business arrangements involving IP.  This Part also illustrates the general application of the enforcement approach of the Guidelines to previous case law and discusses a series of hypothetical situations.

 

Part 2: The Competition Law / Intellectual Property Interface

2.1       Intellectual Property Laws

 

                        Private property rights are the foundation of a market economy, facilitating the creation of wealth and prosperity.  Private property is granted legal protection, either by common law or by statute, in order to create incentives for investment and trade.  Property rights provide incentive for owners to invest in the creation and development of property by allowing owners to benefit from their ownership of that property.  The economic incentives underlying ownership are fundamentally the same for all types of private property.  Owners profit from their property through exchange, by receiving payment from those who make use of it.  This is only possible when owners can control others' access to their property.

 

                        IP has unique characteristics which make it difficult for owners to exclude others and profit from their IP.  First, IP is typically non‑rivalrous; two or more persons can simultaneously make use of an IP.  For example, the fact that a firm is using a novel production process does not prevent another firm from simultaneously using the same process.  In contrast, for an input like steel ingots use by one firm prevents concurrent use by another.  Second, intellectual property is typically non‑excludable; it is impossible or at least very costly for owners of IP to exclude others from its use without legal recourse.  Whereas its owner can physically restrict access to steel ingots, it would be difficult, if not impossible, for the creator of a work of art to prevent it from being copied once the work has been shown or distributed.  Lastly, while IP is often expensive to develop, it is easy and inexpensive to copy.  As a result, the task of establishing private property rights in IP is more difficult than for other kinds of property and the common and civil law alone has not proven sufficient to protect most IP rights^[2].  Accordingly, legislation has been enacted to provide a mechanism for owners to protect and enforce their rights in their IP.  This legislation allows owners to more efficiently participate in market exchanges relating to their IP rights.^[3]

 

                        In these Guidelines, "intellectual property rights" (“IPR”) refers to the rights granted under the Copyright Act, the Patent Act, the Trade‑Marks Act, the Industrial Design Act, the Integrated Circuit Topography Act, and other industry‑specific legislation^[4].  The Copyright Act confers upon the creator of a work exclusive rights to produce, reproduce or communicate that work.  The Patent Act protects an innovator by granting, for a fixed term, the exclusive right to use or to sell the right to use the invention.  The Trade‑Marks Act allows the registration of distinctive marks and confers upon the owner the exclusive right to use its mark.  Finally, upon registration of a design the Industrial Design Act confers the right to limit the production and sale of articles that incorporate the design.  The Integrated Circuit Topography Act confers similar rights for a topography, which is a design for the disposition of an integrated circuit product.  The term "intellectual property rights" also encompasses the protection of IP provided under the common law and the Quebec Civil Code, including the protection given to trade secrets.

 

2.2       Competition Law

 

                        The principle underlying competition law is that the public interest is best served when markets are competitive.  Competitive markets are socially desirable because they lead to an efficient allocation of resources.  However, if competition is imperfect and firms are able to exercise market power, resources may be allocated inefficiently to the detriment of consumers.  Market power refers to the ability of firms to profitably cause one or more facets of competition, such as price, quality, variety, services, advertising, or innovation to significantly deviate from competitive levels for a sustainable period of time^[5].  Competition law seeks to prevent the creation, enhancement or maintenance of market power where this would undermine competition without offsetting economic benefits.

 

                        However, since strong property rights are necessary conditions for open and efficient competitive markets, the enforcement of the Competition Act strives to respect basic property rights and does not routinely interfere with their exercise. The Competition Act will infringe on these rights only in circumstances where a remedy is necessary to preserve the public interest through competitive markets.

 

                        The Competition Act contains two types of provisions which define the circumstances where intervention in a business arrangement is warranted in order to protect competition: criminal offences and reviewable matters.  The most egregious conduct is prohibited under the criminal conspiracy provisions in section 45 of the Competition Act, punishable by fines and imprisonment.  Under that section, it is a criminal offence for two or more persons to agree or arrange to prevent or lessen competition unduly.^[6] 

 

                        The reviewable matters provisions deal with conduct that is generally neutral or pro‑competitive but which may in certain economic circumstances significantly constrain competition.  Under these provisions, the Tribunal may order remedial relief if the conduct leads to the specified anti‑competitive effects.  Reviewable matters include abuse of dominant position (section 79), exclusive dealing, tied selling and market restriction (section 77), refusal to deal (section 75) and mergers (section 92).

 

                        Under the abuse provisions, the Tribunal may issue an order if one or more persons who substantially or completely control a class of business in Canada engage in a practice of anti‑competitive acts which has had, is having, or is likely to have the effect of preventing or lessening competition substantially in a market.  Similarly, the exclusive dealing, tied selling, and market restriction provisions authorize remedial orders where the result or likely result of any of those practices is a substantial lessening of competition.  The refusal to deal provisions address the refusal by one or more suppliers to supply a person with a product where the refusal precludes the refused person from carrying on business or substantially affects his business.  In these circumstances, if the product is in ample supply and the person is unable to obtain supply due to insufficient competition among suppliers, the Tribunal may order one or more suppliers to supply product to the refused person.  Lastly, under the merger provisions the Tribunal may, among other things, prohibit a merger or order a divestiture of assets if it finds that a merger or proposed merger prevents or lessens, or is likely to prevent or lessen, competition substantially in a market.

 

                        In most cases, enforcement of the Competition Act entails an evaluation of whether the conduct in question has resulted in, or is likely to result in, the harm to actual or potential competition provided for in the particular provision.  Conduct is deemed to harm competition when the firm under scrutiny can affect market outcomes through the exercise of market power.  The assessment of the likelihood that a firm will be able to exercise market power usually begins with defining the relevant product market.  A relevant market consists of the firm(s) under scrutiny and all actual and potential competitors that sell products that consumers consider to be acceptable substitutes.  In general, market power will be associated with situations where there is a small number of acceptable substitutes and where entry into the market is either slow or particularly costly.

 

                        If it is found that a firm does, or as a result of the transaction is likely to, possess market power, the challenged conduct must be shown to have the prescribed anti‑competitive effects before enforcement action is taken.  The effects that must be shown to result from the conduct vary with the offense and thus with the applicable section of the Competition Act.

 

                        If the courts determine that there is a violation of the Competition Act, they can impose sanctions in the case of criminal provisions, or order remedies under the civil provisions.  This can involve placing constraints on the exercise of private property rights.  For instance, if the Tribunal concludes that a proposed merger is likely to result in a substantial lessening of competition, then it could order a divestiture of assets.  In this case, the rights of property owners to acquire or dispose of their private property are overridden.  Similarly, remedies under the abuse of dominant position provisions can involve (and have involved)^[7]  the modification of contracts that were deemed to have the stipulated anti‑competitive consequences.   Since such contracts govern the exchange of private property, such a remedy imposes constraints on the exercise of property rights.

 

2.3       Competition Law/IP Law Interface: Enforcement Principles

 

                        The Bureau approaches the competition law/intellectual property laws interface from the broad perspective that both legal frameworks are necessary components to the efficient operation of the marketplace and the enhancement of social welfare.  IP laws provide incentives for owners to invest in the creation and development of their property and encourage the efficient use and dissemination of this property within the marketplace.  IP laws merely provide a mechanism for owners to establish and enforce their ownership rights for IP comparable to those given other kinds of private property.  Once IP is provided a comparable level of protection, society benefits from the application of the Competition Act to IP for the same reasons it benefits from the application of the Competition Act to other forms of property.  Competition law facilitates the objectives underlying IP laws by preventing restrictive commercial practices that impede the efficient production and diffusion of goods and technologies.

 

                        Based on this perspective, the Bureau takes the following approach in applying the Competition Act to intellectual property:

a.         The Bureau applies the same general competition law principles to business arrangements involving IP as it applies to conduct involving other forms of property

b.         The Bureau will not assume IP rights confer market power

c.         The Bureau will generally consider the licensing of intellectual property rights to be pro‑competitive

 

                        (a)       The Bureau applies the same general competition law principles to business arrangements involving IP as it applies to conduct involving other forms of property.

 

                        Since IP is exchangeable property, it falls within the scope of the Competition Act, which aims to promote the efficient exchange of property.  Therefore, in considering business arrangements involving IP, the Bureau will apply the same general competition law principles that it applies to conduct involving other forms of property.  In assessing the potential anti‑competitive effects of conduct involving IP, the Bureau will apply the following four‑step analytic framework:  (i) define the relevant market or relevant markets, (ii) determine if the firm(s) under scrutiny posses market power in the relevant market(s), (iii) determine if the transaction or conduct has had or will have an anti-competitive effect in the relevant market(s) that results in either an undue lessening or a substantial lessening (prevention) of competition, and (iv) where appropriate, consider any efficiency rationales that may offset the lessening (prevention) of competition.  Even though there are some differences between the characteristics of IP and other kinds of property, the Competition Act and the analysis applied in its enforcement are sufficiently flexible to account for these differences.  IP does not require fundamentally different enforcement principles.

 

                        For example, a firm enjoying a degree of market power in a goods market faced with the possible entry of a close substitute may attempt to preserve its market power by signing a large number of the buyers to long term exclusive contracts.  As a result, there may be an insufficient level of sales for the new firm to cover its entry costs, and entry is deterred.  The incumbent's contracts may well have a social cost.  By preventing entry, the contracts reduce the variety of goods available to consumers and preserve the higher prices charged to those consumers not covered by the contracts.  Competition law could intervene to protect society's interest by seeking to restrict the incumbent's ability to contract in this manner.  This example could just as well apply to a situation where the market power enjoyed by the incumbent is the result of an IP right.   The incumbent having a patent about to expire, for instance, could be trying to extend the life of the patent through these long‑term exclusive contracts.  The justification to apply competition law is the same whether the market power comes from an IP right or from another source.

 

                        In enforcing the Competition Act with respect to IP, the Bureau will respect the role of the IP, as it respects the role of other private property laws, in providing property owners with the proper incentives to invest in the creation and development of their property.  It is not the intention of the Bureau to use the enforcement of the Competition Act to tailor the level of protection granted to a specific property by a specific IP^[8].   Nevertheless, when conduct involving IP is deemed to be anti‑competitive, the Bureau may, as it does with other kinds of property, petition the courts to limit the manner in which owners may exercise their IP rights, in order to correct any harm caused by the anti‑competitive conduct.

 

                        (b) The Bureau will not assume that IP rights confer market power.

 

                        While an IP owner has the exclusive right to use its property, this does not necessarily give the owner market power.  In competition analysis, market power is always defined with respect to the availability of substitutes within a relevant market.  Intellectual property laws grant IP holders the right to exclude others from the use of a specific idea, innovation, product, or process.  In this sense, the IP holder is granted  exclusive rights over the use of the specific property.  However, there often exist a number of actual and potential close substitutes for the specific product so that the IP holder is not the sole supplier in a relevant market.  For instance, a firm that has a patent on an analgesic may be the sole producer of a particular drug formulation but the presence of both over‑the‑counter and prescription analgesics means that the firm is not the sole producer in the relevant antitrust market.   Moreover, there may be a sufficient number of substitutes so that the IP holder is incapable of exercising any market power in the relevant market.  Therefore, the Bureau will not presume that an IP right always grants market power.  Any assessment of the competitive effects of conduct involving IP will be based on a full market power analysis.

 

                        Furthermore, if an IP right does confer market power, this by itself does not warrant enforcement action.  A firm is not in violation of the Competition Act if it possesses market power attained solely through a superior quality product, process, the introduction of an innovative business practice, or for exceptional performance.

 

                        (c) The Bureau will generally consider the licensing of intellectual property rights to be pro‑ competitive.

 

                        Licensing agreements dealing with IP are a common business practice.  Licensing represents a means by which IP is traded and it signals the willingness of IP holders to participate in the marketplace.  To the extent that licensing increases the pool of agents that use the IP, licensing will distribute and diffuse an innovation or creative work.  This ability to exchange and transfer IP can enhance its value and increase the incentive for its creation and use.  Licensing arrangements also promote the efficient use of IP by facilitating the integration of IP with other components of production, such as manufacturing and distribution.

 

                        Although, simple licensing arrangements could reduce rival firms' incentives to innovate, without other restrictions this conduct would not likely raise concerns under the Competition Act.  The licensing of intellectual property, therefore, should generally be considered to contribute positively to the competitive market process and be viewed as being pro‑competitive.

 

Part 3: Application of the Competition Act to Intellectual Property

 

                        As with other kinds of property, the assignment, licensing (or non-licensing) and use of IP is generally considered to contribute positively to the efficient operation of the market place and is therefore viewed as being pro-competitive.  Under certain circumstances however, the assignment, licensing (or non-licensing) and use of IP can have anti-competitive effects. 

 

                        There are a number of factors, many of which are applicable to all investigations, that the Bureau may consider when assessing the potential anti-competitive harm of a particular conduct involving IP.  These factors are described in section 3.1.  Other factors, specific to the type of conduct or arrangement under investigation, are illustrated in hypothetical scenarios discussed in section 3.2.

 

3.1  General Issues

 

                        The Bureau’s enforcement analysis of the potential anti-competitive harm of a particular transaction or conduct involving IP can be described generically as follows: (i) define the relevant market or relevant markets, (ii) determine if the firm(s) under scrutiny posses market power by examining the level of concentration, the supply substitution factors and entry conditions in the relevant market(s), (iii) determine if the transaction or conduct has had or will have an anti-competitive effect in the relevant market(s) that results in either an undue lessening or a substantial lessening (prevention) of competition, and (iv) where appropriate, consider any efficiency rationales that may offset the lessening (prevention) of competition.

 

3.1.1   Market Definition

 

                        The first stage of the Bureau’s analysis involves defining the relevant market or markets in which there is an anti-competitive concern.  Defining a relevant market provides an economically meaningful tool for measuring market power.  The market definition exercise focuses solely on demand substitution factors – i.e., possible consumer responses.  The potential constraining influence of firms that can participate in the market through a supply response - i.e, a possible production response - is considered subsequent to an initial market definition.  Supply substitution is discussed below in section 3.1.2.

 

                        Concerns about anti-competitive effects can be prospective, where the transaction or conduct is likely to have a future anti-competitive effect, or retrospective, where the transaction or conduct has already had an anti-competitive effect.  In cases where the anti-competitive concern is prospective, as is generally the case in a merger, relevant markets are normally defined through the use of the “hypothetical monopolist” test. Under this test, a relevant market is the smallest group of products and the smallest geographic area such that a sole supplier of these products could profitably maintain a small but significant, non-transitory price increase above what would prevail absent the transaction or conduct.  In conducting the hypothetical monopolist test, the Bureau considers a number of evaluative criteria  that provide indirect evidence of substitutability.^[9]  In many situations, the results of the analysis of each of these criteria are not consistent with a single conclusion, in which case, the market definition that is most supportable by the available information is used.

 

                        When the anti-competitive concern is retrospective, as is generally the case of an alleged abuse of dominant position or illegal conspiracy, the hypothetical monopolist test for market definition may not be fully applicable because the monopolization may be real not hypothetical.  Prices may already have been increased above competitive levels.   Therefore, asking whether an additional price increase could be sustained would be irrelevant; applying the hypothetical monopolist test would lead to the erroneous conclusion that there are available substitutes and there is an absence of market power.   Accordingly, in the course of determining the relevant market definition in such cases, the Bureau will take into account the impact of the alleged anticompetitive conduct underlying the investigation.  The market definition and competitive effects stages of the Bureau’s analysis will proceed simultaneously. 

 

                        In general, the definition of the relevant market is likely to be based on functional characteristics of the product and on consumers’ behavior, measured qualitatively in terms of: (i) the views, strategies, behaviour and identity of buyers, (ii) trade views, strategy and behaviour, (iii) end use of products, (iv) physical and technical characteristics of products, (v) the costs incurred by buyers in switching from one product to another, and (vi) other factors.

 

                        For transactions or conduct involving IP, the Bureau is likely to assess the competitive effects within the relevant market defined around one of the following: (i) the intangible knowledge or know-how underlying the IP, (ii) the tangible product or process (i.e. the technology) created from the knowledge or know-how, or (iii) the final or intermediate goods resulting from or including the tangible or intangible IP inputs.

 

                        The Bureau will generally not define markets specifically around R&D activity or innovation efforts with the aim of determining solely whether a transaction or arrangement leads to a reduction in this activity.  The Bureau will instead focus only on those innovation-related anticompetitive effects that appear as direct price or output effects in the markets outlined above.  More specifically, the Bureau’s analysis will focus on determining whether a transaction or arrangement would eliminate the “actual potential competition” or “perceive potential competition” of an existing innovation effort directed toward producing knowledge or know-how, a tangible technology, or a final or intermediate good to compete in a current or future relevant market.^[10]  The appropriate market definition will depend specifically on the knowledge or know-how, tangible technology, or final or intermediate good toward which the current innovation effort was directed.

 

                        Defining a  market around intangible knowledge or know-how is likely to be important when the rights to the IP are marketed separately from any technology or product in which the knowledge or know-how is used.  For example, consider a merger between two firms that individually license the right to use the underlying know-how of a patented process technology to various independent downstream firms that use this know-how to develop their own firm-specific process technologies.  Such a merger may reduce competition in the relevant market for the know-how if the know-how underlying the two firms patented technologies are close substitutes for the downstream firm, there are no (or few) alternative technologies for which the underlying know-how represents a close substitute for that of the merging firms, and there are sufficient barriers preventing the development of new alternative conceptual approaches that would replace the merging firms approaches.  This last condition may be the case if the scopes of the two patents protecting the know-how are defined sufficiently broad to prevent the downstream firms from patenting around the technologies.  It may also be the case if the development of such know-how requires certain specialized knowledge of assets for which only the two merging firms possess.

 

                        In cases involving the licensing of IP, the Bureau will generally treat the license as the terms of trade under which the licensee is entitled to use the IP.  The Bureau will not define a relevant market around a licence, but rather will focus on what is actually being protected by the legal rights being granted to the licensee as the starting point in defining the relevant market.

 

3.1.2    Market Power

 

 

                        The second stage of the Bureau’s analysis consists of an assessment of the degree to which the firm(s) under scrutiny possess market power in the relevant market.  This stage of the analysis involves, among other things,^[11] an examination of the level of concentration, the degree of supply side substitution and the entry conditions in the market.

 (i) Market Concentration

 

In assessing the likelihood for competitive harm for any arrangement, the Bureau will examine the degree of market concentration in the relevant market.  The degree of concentration in a relevant market often provides a preliminary measure of the competitiveness of that market.  In general, the more firms that are included as competitors in a relevant market, the less likely it is that any one firm acting unilaterally, or any group of firms acting interdependently, could increase or preserve its market power through a transaction or through potentially anti-competitive business conduct. Although the fact that concentration is or will be high in a relevant market is not sufficient to justify the conclusion that a transaction or business conduct will lead to an increase or preservation of market power; it is a necessary pre-condition to such a finding. Market concentration measures simply serve to distinguish transactions or business conduct that are unlikely to have anti-competitive consequences from those that require a more qualitative analysis before a conclusion can be reached.

 

The Bureau’s approach to measuring market concentration typically involves a calculation of the market shares of the firms identified as actual participants in the relevant market.^[12]  Market shares may be calculated in terms of the firms’ (i) entire actual output, (ii) total capacity (used and unused), or (iii) total sales (dollar sales or unit sales). The Bureau will generally not challenge a transaction or a potentially anti-competitive conduct if the firm or group of firms under scrutiny possess less than a 35% market share in the relevant market.  Additionally, in the case of mergers,  the Bureau will generally not challenge a merger on the basis that the interdependent exercise of market power by two or more firms in the relevant market will be greater than in the absence of the merger where the post-merger market share of the largest four firms would be less the 65% or the post-merger market share of the merged entity would be less than 10 %.

 

Determining accurate market shares on the foregoing basis may be difficult in cases involving IP.  Accordingly, the Bureau’s assessment of market power is likely to focus on qualitative factors indicating the competitive significance of market participants, particularly the conditions of entry into the relevant market.  In such cases, the Bureau will examine market factors such as the views of buyers and market participants to qualitatively assess competitive significance.

 

(ii)        Supply Side Substitution 

 

Firms that are likely to respond to a price increase in the relevant market within one year with minimal investments are considered at the market share stage of analysis.  Firms that are unable to respond within the one year time frame or whose entry requires considerable investment are considered when analysing barriers to entry.

 

The following factors are relevant to determining if a firm will divert sales within one year in response to a price increase: (i) the cost of substituting production in the relevant market for current production ("switching cost”), (ii) the extent to which the firm is committed to producing other products or services, and, (iii) the profitability of switching from current production.

 

In general, the Bureau will determine whether a firm not currently supplying the relevant product can profitably respond to a small but significant increase in the price of this product within one year.  Only the volume of output that is likely to be supplied in the relevant market at this price will be included in market share calculations.

 

(iii)       Ease of Entry

 

The Bureau also examines the ease of entry into the market to determine whether an arrangement could increase or preserve market power.   If entry into the market is sufficiently easy so that the firm(s) under scrutiny could not profitably maintain a price increase above competitive levels (i.e., those existing before the transaction or those that would exist absent the business practice) for a significant period of time, then the transaction or business practice is not likely to cause anti-competitive harm.

 

When assessing effects in markets involving IP, conditions of entry are often more important than market concentration or supply side substitutability.  IP can contribute to heightening barriers to entry through enhancing incumbents’ cost advantages, augmenting the sunk costs of entry, or by reducing the likelihood of profitability of entry in a variety of ways.

 

In examining the effects of a particular arrangement involving IP, the Bureau will also consider the extent to which the practice itself erects or has erected barriers to entry or alternatively, induces or has induced competitors to exit the market.  For example, the need to have access to intellectual property or the possession of critical R&D facilities and know-how can make entry difficult.  In addition, high switching costs caused by the presence of an intellectual property or a licensing arrangement could create substantial barriers to entry.  IP may also provide incumbents with important first mover advantages or network effects may foreclose the market to all but one major supplier, including potential entrants.  For example, an incumbent enjoying network effects^[13] may temporarily reduce prices, preventing the adoption of alternative technologies until its established base is large enough to foreclose the market from future competition or use its IP in strategic preemptive cost reduction or research and development initiatives that discourage entry.  An incumbent may also deter new entry by introducing new systems or components that are incompatible with those of potential competitors or exclude potential competitors by making pre-announcements of pending new products or updates, encouraging customers to delay purchases, and discouraging them from testing existing new products.

 

However, in contrast to these possible entry deterring effects, the presence of IP may require the development and adoption of compatibility standards which can facilitate entry as a new competitor may be able to enter by supplying a single component rather than a complete system.

 

3.1.3    Competitive Effects Analysis

 

The principal focus of the Bureau’s competitive effects analysis is to determine the extent to which a transaction or a certain conduct increases or preserves market power within a relevant market.  In evaluating the competitive effects of any transaction, licensing arrangement, or other form of implicit or explicit contractual arrangement among firms that involves an IP, the Bureau will assess whether the arrangement is primarily horizontal or vertical in nature or whether it has substantial aspects of both.  The positive finding that an arrangement is horizontal in nature is a necessary condition for concluding an arrangement has increased or preserved or is likely to increase or preserve market power within the market.

 

(i) The Horizontal and Vertical Distinction

 

An arrangement is vertical if it creates a relationship between parties involved in complementary production activities.  Examples include: the acquisition of retail shoe outlets by a shoe manufacturer, the licensing of the copyright of a song’s lyrics by a song writer to a singing artist, and the sale of aspartame produced by a company that owns the patent protecting the know-how to a soft drink company that uses aspartame as a sweetener.  Alternatively, an arrangement is horizontal if it creates a relationship between parties involved in substitute production activities.  Examples include a merger between two national running shoe manufacturers or an agreement between competing compressed gas companies to fix prices.

 

All arrangements, whether vertical or horizontal, can have horizontal effects in a relevant market (i.e., can lead to an increase or preservation of market power).   While IP licensing arrangements, inasmuch as they involve one firm selling the right to use an IP to another, are inherently vertical arrangements, the Bureau will treat such an arrangement as horizontal if the licensor and licensee would have been actual or potential competitors in a relevant market in the absence of the licence.  If the arrangement is horizontal, the Bureau will analyse whether the arrangement facilitates a firm’s ability to exercise market power, either unilaterally or in a coordinated manner, with respect to pricing, output, or other aspects of competition.  If the arrangement is vertical, the Bureau will look for horizontal effects among firms at either the level of the seller of the product or the level of the buyer of the product.  Horizontal effects may occur in a vertical relationship if the arrangement anti-competitively forecloses access to, or increases competitor’s costs of obtaining important inputs, or if it facilitates coordinated pricing among firms in a horizontal relationship.

 

3.1.4 Efficiency Analysis

 

A fundamental objective of competition law is to ensure the efficient use of resources through vigorous competition.  However, there may be instances in which apparent restrictions of competition can lead to a more efficient use of resources.  This may be particularly true of arrangements and transactions involving IP which are inherently vertical arrangements involving the integration of economic activity.

 

Transactions or arrangements involving IP may often incorporate procompetitive restrictions.  For example, an arrangement among competitors which establishes a product standard may act to increase the size of the market thereby attracting more competitors and aiding the development of new markets for complementary products.  A licensing arrangement between an IP owner and a distributor may restrict intra brand competition but at the same time enhance the brand and further inter brand competition.   A licensing arrangement between two potential competitors may result in the development of a new product.  While either firm could develop the product independently, neither one would if there were competition from the other.  In these instances, the transaction or arrangement is unlikely to have horizontal effects (increase market power) and therefore, should not raise antitrust concern.

 

Alternatively, transactions and arrangements involving IP may often result in a restriction of competition that represents an undue or  substantial lessening of competition but at the same time results in a more efficient use of resources.  For example, the merger of two competitors in a technology market may permit the new merged entity to realize economies of scale in production.  While the merger leads to higher product prices, production costs are lower (inputs are used more efficiently).  A licensing arrangement between two multi product competitors permits the two firms to specialize production with each supplying the needs of the other.  Both firms save resources by avoiding change-over and inventory costs and by using more specialized equipment and personnel.  However, the arrangement, since it requires the exchange of production cost information, facilitates coordinated pricing between the two firms.

 

Certain provisions of the Competition Act permit the consideration of efficiency rationales for a transaction or business practice in those instances in which it is determined that there has been a lessening of competition.  For example, the  abuse of dominance and merger provisions of the Competition Act explicitly allow for the consideration of efficiency rationales.^[14]  In such cases, if the Bureau concludes that a particular transaction or business practice is likely to lead to anti-competitive harm, it will consider whether the transaction or practice is necessary to achieve any pro-competitive efficiencies.  If it is determined that the transaction or practice does achieve certain efficiencies, the Bureau will then determine the net effect on competition in the relevant market, by assessing whether the pro-competitive efficiency benefits are sufficient to offset the anti-competitive harm. 

 

In measuring the efficiency benefits of a transaction or arrangement involving IP, the Bureau will consider both static and dynamic efficiency gains.  Static efficiency gains are one-time increases in productivity or one-time reductions in unit cost.  Dynamic efficiency gains can include improvements in annual productivity growth or the rate of unit-cost reduction as well as the consumer welfare created from the development of new markets.

 

The balancing of the anticompetitive and procompetitive effects of a transaction or arrangement may be partially quantitative and partially qualitative.  The balancing may involve a quantitative comparison of the anticompetitive effects  measured as the deadweight loss and non-neutral wealth transfers from the exercise of market power and the efficiency gains in terms of fixed cost and unit cost savings.  This is generally the consideration of the static efficiency analysis.  Additionally, the balancing may consider qualitatively the benefits to consumers that would result from the realization of a new product or innovation.  Longer-term or dynamic efficiencies gains, as they are often difficult or impossible to quantify, are almost necessarily considered qualitatively.

 

In measuring the net effect of a transaction or business practice, the Bureau will also consider whether there exists a less restrictive means of achieving the pro-competitive efficiencies.  If a less restrictive alternative exists, the anti-competitive harm of the transaction or conduct will be compared  relative to this alternative.  In conducting this comparison, the Bureau will not attempt to uncover all of the theoretically possible alternatives for achieving the pro-competitive efficiencies.  It will only consider those means that are practical to the business at hand.  The Bureau will also consider the impact that any less restrictive means would have on the firm’s statutory ability to exercise its property rights.

 

In evaluating allegations of anti-competitive harm involving IP, the Bureau will generally follow the four step approach outlined  above, including conducting a full efficiency analysis.  Nonetheless, if the Bureau determines that a horizontal arrangement which explicitly restricts the output or increases the prices of firms results in a undue lessening of competition with no off-setting efficiency rationales, the Director is likely to seek prosecution under the criminal provisions of the Competition Act (i.e., section 45).  All other arrangements will be investigated under the civil provisions of the Competition Act (section 77, 79 or 92).  As is discussed below, the burden of proof for these sections provide for efficiency considerations.

 

3.2       Analysis Applied to Specific Conduct: Hypothetical Case Examples                    

 

Mergers Involving IP

 

The outright acquisition of a firm and its IP by another or the merger of two or more firms’ respective IPs in a horizontal competitive relationship can have anti-competitive effects similar to the acquisition of tangible assets by direct competitors.  Moreover, the amalgamation of IP among firms that are in a vertical relationship can have anti-competitive effects in a variety of markets by creating exclusionary effects through the raising of rivals’ costs.  Either type of merger would have such anti-competitive effects if the merger resulted in a substantial lessening of competition due to an enhanced ability to exercise market power either unilaterally or through interdependent behavior.  In analysing mergers or acquisitions involving IP, the Bureau will continue to follow the analysis outlined in the MEGs.

 

A horizontal merger for example, between two firms developing competing herbicides using separately patented active ingredients could be found to be anti-competitive if the merged entity had market power and the merger prevented competition between the alternative formulations of herbicide.  Market power would exist if there were few alternatives to the herbicide, if there were less effective formulations of the herbicide remaining in the market after the merger, or if each party to the merger was each other’s most direct and effective rival in the market.  Furthermore, entry into developing and bringing alternative formulations of herbicide to market must be difficult.  This would likely be the case for instance, if the two firms were the only firms currently possessing the requisite technological capabilities or R&D facilities which could not be easily or quickly replicated by a potential competitor.  Alternatively, the merger may not raise an issue if the herbicide market is characterized by a number of firms developing similar competing products using alternative but potentially equally, effective, patented formulations.

 

Situation: Two producers of biodegradable plastic containers that use competing substitutable technologies propose to merge.  The transaction will combine the competing technologies creating one product and the largest supplier of biodegradable plastic containers.  The market is currently characterized by a number of alternative biodegradable products, such as Styrofoam, and by non-biodegradable but recyclable materials, such as glass and standard plastic.

 

Discussion: If purchasers of containers would quickly and easily switch to these alternative container products and if these alternative suppliers had adequate capacity to accommodate this additional business, then it would be unlikely that the merged firm could profitably sustain increase  prices.   This merger would not raise an issue under the Competition Act.

 

Typically, vertical mergers are either pro-competitive or competitively neutral mergers which often enhance overall economic efficiency through improved co-ordination of production and design.  This can reduce costs, improve product quality or encourage more efficient input usage.  However, a vertical merger, may create market power in either the upstream (input) market, the downstream (output) market, or in an ancillary market.  These effects can be the result of the vertically merged firm successfully raising its rivals’ costs by foreclosing the input market from its downstream (output market) competitors or by foreclosing the output market from its upstream (input market) competitors.  Such exclusionary behavior can harm consumers through higher prices in any or all of these markets.

 

For example, the merging of a computerized relationship medical patient tracking and monitoring software package with one of its computer software input suppliers of medical databases could have anti-competitive effects in a variety of markets.  If the post-merger market for medical data bases was sufficiently concentrated to now allow unilateral exercise of market power by the merged integrated firm or encourage more interdependent behavior among the remaining database suppliers the price of database software could increase.  Increased medical database prices increase the input costs to unintegrated providers of competing tracking and monitoring software packages, allowing the integrated merged firm to raise prices in that market.  In addition, if the medical databases were used as an important input into the production of electronic medical diagnostic packages, the merger, through raising the price of this input, could raise the prices in the ancillary market for electronic medical diagnostic packages. 

 

Alternatively, if the patient tracking and monitoring software producer altered its previous behavior of purchasing database products from a variety of suppliers to purchasing it exclusively from its newly acquired company, then this may cause other database suppliers to incur higher costs or force some to exit.  This could harm competition by making these other database suppliers less formidable competitors and allow the integrated firm to increase prices for the database products or raise prices in either the patient tracking and monitoring software market or the ancillary electronic medical diagnostic market.

 

A number of factors must be assessed to determine whether a vertical merger will have all or any of these competitive impacts.  These would include:

- the availability of alternatives in both the medical database (input/upstream) and the computerized relationship medical patient tracking and monitoring software (output/downstream) markets

- the presence of competition by other integrated firms

- the elasticity of demand in the input market

- the availability of other patient tracking and monitoring software suppliers to sell database products to

- the cost structure of the database providers

 

Situation:  The major supplier of computer operating systems that purchases software applications that are integrated into its operating system proposes a vertical merger with three of the largest software suppliers.  The operating system supplier dominates this market with upwards of 70% of the market and as such it is a major purchaser of software.  It has traditionally purchased software applications from a variety of suppliers.  After the merger it will be the only integrated supplier in the operating systems market.

 

Discussion:  This merger could potentially harm competition in both the operating systems and the software applications markets.  If ownership of the largest software developers allowed the merged firm to unilaterally increase the prices in the software market, this would increase the costs that its rivals in the operating system market will have to pay to integrate software applications into their respective systems.  This would allow the merged firm to increase the price of its operating system.  Entry at this level is less profitable for an unintegrated firm or will be more costly as it would require entry at both levels to effectively compete with the merged entity.  The higher prices in the software applications market may not attract entry as the integrated merged firm’s operating platform is foreclosed to the unintegrated software developers making entry less profitable and more unlikely.  

 

Conspiracy Involving IP

 

Price fixing cartels or market allocation schemes involving IP can have anti-competitive effects similar to agreements involving tangible property.  Firms selling IP imbedded technologies who form a cartel to fix the price at which they sell their respective technologies to others will raise concerns under the conspiracy provisions of the Act.  As there is no exchange or licensing of IP between the co-conspirators and therefore unlikely to be any efficiency or pro-competitive benefits often associated with the licensing of IP, such an agreement would be treated as any other conspiracy to fix prices.

 

The conspiracy provisions prohibit firms from entering into an agreement which, inter alia, prevents or lessens competition unduly or is likely to have this effect.  As with other conspiracy allegations, the determination of whether an agreement involving IP unduly lessens competition, applies the two stage approach suggested by the Supreme Court of Canada^[15] that requires a consideration of the combination of market power associated with the agreement and the degree of injurious behavior engaged in by the alleged co-conspirators.  Many combinations are possible to establish an undue lessening of competition, for example, a particularly injurious behavior in combination with a small degree of market power could draw liability as could the converse.

 

Situation: Three firms offering a competing corrective medical procedure each employing an alternative patented technique agree on a minimum price at which they will perform the procedure as well as a minimum licensing fee to license the procedure to third parties.  The procedure that has a very high success rate is effected by four two-hour visits to a medical clinic over a six month period and produces no side effects.  The only existing substitute for the procedure is control of the condition through a prolonged medicinal treatment than can require frequent visits to a hospital.  Prior to entering the agreement the procedure was performed for a price that averaged $5,000.  After the agreement prices averaged in the $8,000 range.  If competition had continued among the three firms at least one of the firms offering the procedure would likely have been driven out of business.

 

Discussion: Given the superiority of the procedure in terms of its effectiveness over its only existing substitute, the corrective medical procedure would likely be considered the relevant product market.  Therefore, the three firms together would have clear market power.  Given that one of the firms which would have gone out of business is saved by way of the agreement suggests that the agreement is not based on any efficiency rationale.  In this example, this agreement would be treated as a conspiracy to fix prices. 

 

Not all agreements between competitors contravene the conspiracy provisions of the Act.  Co-operative standards setting and co-operative research and development initiatives among competitors that require agreements between competitors are of particular importance with regards to IP.  The conspiracy provisions of the Act provides a defense specifically for such types of arrangements.  However, limits exist on the these defenses and it will be lost if, for example,  standard setting negotiations extended beyond defining product standards to include agreeing on prices or the terms at which products will be sold.  Agreements that promote a common standard are most often associated with patent and technology sharing arrangements, such as cross-licenses, grant-backs and patent pools, are dealt with elsewhere with in the guidelines.

 

Abuse of Dominance Involving IP

 

IP may be the source of abusive practices by a dominant firm that leads to increased market power.  For example, a dominant component supplier could entrench its overall market dominance if it were able to use its IP to manipulate the compatibility of an existing industry standard.  Reduced compatibility can deny other competitors access to an industry installed base placing them at a competitive disadvantage in the relevant market.  This in turn, entrenches the dominant firm’s position by protecting its component operation from competition.  Alternatively, a dominant firm may be able to use IP to extend its dominant position through time or to another market, particularly if the second market exhibits a first mover advantage in the form of network effects.  The dominant firm may be able to do this by engaging in behavior that could hinder or deter the adoption of competing technologies.  For instance, the firm may rely on its dominance in one market to temporarily reduce its price in another market to prevent the adoption of alternative technologies until its installed base or first mover advantage is so well established that the market is foreclosed from any effective competitive alternatives.

 

Situation: SPICE Incorporated has legitimately established a dominant position in the worldwide market for Megasalt, a unique food additive that has effectively replaced salt in prepared foods. The patent for use of SPICE’s Megasalt has expired in Canada but is still in force in the United States.  SPICE has signed contracts involving exclusive requirement restrictions placed on buyers not to combine either Megasalt produced by other manufacturers or other salt substitutes with SPICE’s Megasalt in the same product line.  The principal buyers of SPICE’s Megasalt are two companies that use it as an input into specially prepared foods for hospitals.  Both of these companies negotiated worldwide contracts with SPICE.  A new fledgling Megasalt producer in Canada files a complaint with the Director claiming that it is excluded from supplying the two principal buyers in Canada because SPICE threatened to cease supplying those two companies in the United States unless their worldwide demand for Megasalt was met through SPICE.

 

Discussion:

Exclusive Licensing

 

A licensee is granted an exclusive licence if the licensor is restricted from granting additional licenses to other parties.  Often, a prospective licensee will insist on being granted an exclusive license when it must make specific investments to exploit and develop the technology being licensed.  Without exclusivity, other firms that may be given subsequent access to the technology would be able to free-ride off the investments made by the initial licensee.  For example, suppose a company developed and patented a new type of digital watch design and it wanted to license its technology to another company.  The licensee in this case would be a company that wanted to manufacture a watch using the new design, arrange its distribution, and sale to final customers.  Given that the licensee would find it necessary to promote the watch through significant advertising expenditures, it may insist on being granted an exclusive license; otherwise, any other company which also received a license could sell the watch without having to incur any advertising expenses of its own. 

 

In contrast to its efficiency benefits, an exclusive licensing arrangement may pose a competitive concern in those situations where it forecloses a technology to other buyers or it prevents competition among actual competitors or potential competitors.  In these instances the Bureau will weigh the anti-competitive effects of the exclusive license against its efficiency-enhancing benefits.

 

Situation: LINC Incorporated has recently developed a new lens for digital cameras.  Two other manufacturers compete with LINC in the lens-for-digital-camera market.  These three firms manufacture several varieties of lenses and are engaged in R&D to improve digital technologies.  LINC does not have the capability to manufacture digital cameras so it grants licenses for use of its patented lenses to manufacturers of digital cameras.  The market for digital cameras contains three large firms producing differentiated products, accounting for an 80% market share, plus a half dozen smaller firms.  LINC has just granted CINC, the largest digital camera firm with a 30% market share, an exclusive license to use its new patented lens in its cameras.  CINC does not own or have the capability to develop lens technology.  Although LINC’s newest lens has superior features over the current products, the demand for cameras with the new features is uncertain.  Therefore, significant investment must be incurred to promote and develop the product embodying the new lens.  Other camera manufacturers have requested a license but have been refused.

 

Discussion: LINC and CINC are clearly in a vertical relationship since they are neither actual or potential competitors in the market for lenses or in the market for digital cameras.  This implies that competition between the two firms is not affected by the exclusive license.  The exclusive licensing arrangement was undertaken to encourage CINC to incur the set-up costs of adopting the technology and for product promotion.  Although LINC’s newest lens is not available to CINC’s two rivals and both markets for lens and cameras are concentrated, LINC’s rivals in the digital lens market are not foreclosed from selling to CINC.  Furthermore, the other digital camera manufacturers have access to other lens suppliers and alternative technologies are expected to be available in the future.  Consequently, the Competition Bureau is not likely to challenge this contract.

 

Situation: Consider the situation described above but now suppose that LINC is vertically integrated into the market for digital cameras and is, therefore, a direct competitor with CINC.  Market studies indicate that the new patented lens in a LINC camera would result in a product that would be in close competition with a CINC camera.  LINC grants CINC an exclusive license to use its new lens which prevents LINC from selling its newest lens in its own cameras.

 

Discussion: In this case, an exclusive contract to CINC would create anti-competitive concerns since LINC and CINC would be horizontal competitors in the absence of the license.  There may be efficiency benefits from CINC manufacturing a new camera that incorporates LINC’s new lens but these would need to be weighed against the negative effects of a reduction in competition.  Since an exclusive contract in this case is not unlike an acquisition of a potential competitor, merger analysis would be applied.

 

Situation: Consider the situation described in the first example above but now suppose that CINC acquires an exclusive license for the use of all LINC’s lenses as well as the lenses for both of LINC’s rivals.  CINC offers a variety of cameras which incorporate the lenses of the three input suppliers.  The other two digital camera manufacturers attempt to bid for the same set of exclusive contracts but CINC succeeds in securing all three.  Although future technologies for lenses are in the development stage, their date of introduction is uncertain.

 

Discussion: In this case, CINC has succeeded in having the three digital lens manufacturers deal exclusively with itself and not with the other camera manufacturers, thus creating a monopoly in the digital camera market.  Bidding for the exclusive rights to the suppliers’ inputs inevitably results in a single firm securing all the rights, with the rents from reduced competition in the camera market shifted to the suppliers.  The exclusive licensing arrangement clearly forecloses CINC’s rivals from the input market, thus harming competition in the camera market.  If there are efficiency-enhancing reasons for integrating the use of all lenses under one entity, these would need to be weighed against the restriction on competition under a section 77 (or 78, 79) challenge of the exclusive licensing arrangement.  This example, while appearing to be a typical foreclosure case with anti-competitive effects, is interesting as an IP case.  From the suppliers’ points of view, the exclusive licensing arrangement simply may be the outcome of the licensors’ independent decisions to exercise their right to license to a single firm.  While patentees generally have the right to grant an exclusive license to a firm, especially when in a vertical relationship, it would likely be constrained from doing so when the potential licensee has effectively contracted with horizontal competitors of the patentee, thus integrating all input activity under one firm.

 

Exclusive Dealing and Market Restriction

 

Exclusive dealing refers to the practice whereby a supplier as a condition of supplying a product to a customer requires that customer to deal only or primarily in the product supplied by the supplier.  Market restriction refers to the practice whereby a supplier as a condition of supplying a product to a customer requires that customer to supply the product only in a defined market.  Both exclusive dealing and market restriction are practices usually used by suppliers to induce retailers to undertake a sufficient level of effort to sell their product.  For example, a company that has developed and patented a new type of video cassette recorder may only licence retailers to sell the recorder if the retailers agree not to sell other types of recorders or may give each retailer an exclusive geographic territory into which to sell the new recorder.  The company may do this in order to encourage the retailers to provide potential customers with the necessary information about the recorder and exert sufficient sales effort into selling the recorder.  In this way the use of exclusive dealing and market restriction is efficiency enhancing.

 

Exclusive dealing and market restriction can also raise competitive concerns if they foreclose a relevant market to other input suppliers or if they facilitate anti-competitive pricing or other practices.  When determining whether a case of exclusive licensing or market restriction should be challenged, the Bureau will weigh the competitive concerns against any pro-competitive benefits.

 

Situation: Consider the situation described previously where LINC Incorporated has recently developed a new lens for digital cameras.  Two other manufacturers compete with LINC in the lens-for-digital-camera market.  These three firms manufacture several varieties of lenses and are engaged in R&D to improve digital technologies.  LINC does not have the capability to manufacture digital cameras so it grants licenses for use of its patented lenses to manufacturers of digital cameras.  The market for digital cameras contains three large firms producing differentiated products, accounting for an 80% market share, plus a half dozen smaller firms.  LINC offers a contract to CINC, the largest digital camera firm with a 30% market share, on the condition that CINC deal exclusively with LINC, constraining CINC from incorporating lenses from other suppliers into its cameras.  CINC does not own or have the capability to develop lens technology.  It is expected that CINC’s cameras with LINC’s new lens would become CINC’s dominant product line if CINC were not constrained from purchasing other lenses.  LINC claims that it has incurred significant investment to develop the lens specifically for installation into CINC’s camera.

 

Discussion: An efficiency rationale for this exclusive dealing arrangement is provided by the specific costs LINC incurred to make its product compatible with CINC’s cameras.  Moreover, in the absence of the restriction, other cameras sold by CINC would represent a small proportion of its total sales.  However, since the market is concentrated, this restriction may facilitate anti-competitive pricing (since only two lens manufacturers compete for the two remaining camera manufacturers) and there may be a reduction in potential competition in the technology market since foreclosure of the largest camera manufacturer may reduce the incentive to continue research in the input market for components.  Whether the latter would be a serious threat depends on the geographic market - if the market for LINC’s new lens is the world, then an exclusive dealing arrangement in Canada is not likely to deter investment in future research.

 

These efficiency and anticompetitive effects would be evaluated under section 77 (or 78, 79).

 

Output Royalties

 

A common practice in licensing arrangements is to have the licensee pay an amount to the licensor based on the use or sale of the innovation.  In many cases however, it is difficult for the licensor to observe the use of the innovation and therefore determine the appropriate amount of royalties that it is owed.  In order to overcome this problem, a licensor may issue a license with a royalty based on the licensee’s sales regardless if the innovation was incorporated in the product or not.  However, this raises another issue, a royalty based on output effectively imposes an implicit tax on the licensee for using an alternative technology and in this way acts similarly to an exclusive dealing arrangement.  As discussed previously, exclusive dealing arrangements can pose anti-competitive risks in certain circumstances.  Therefore, in any given situation where output royalties are used or proposed, the Bureau will assess whether it is in fact justified or instead is just a pretext for an exclusive dealing arrangement.

 

Situation: LINC Incorporated produces multiple components of digital cameras and has recently developed a new lens which is the most valuable component.  LINC faces significant competition in the market for all components except lenses; two other manufacturers compete with LINC in the lens-for-digital-camera-market.  These three firms manufacture several varieties of lenses and are engaged in R&D to improve digital technologies.  LINC does not have the capability to manufacture digital cameras so it grants licenses for use of its components to manufacturers of digital cameras.  The market for digital cameras contains three large firms producing differentiated products, accounting for an 80% market share, plus a half dozen smaller firms.  LINC has just granted a nonexclusive licence for its entire portfolio of patents to all digital camera manufacturers but specifies a royalty on every camera sold, whether or not it included any or all patented components.

 

Discussion: This example illustrates two types of restrictions: bundling of patented components and the use of a royalty not related directly to the IP.  While the latter restriction does not prohibit explicitly the sale of products embodying competing components, the implicit tax imposed on such sales discourages digital camera manufacturers from selling such products.  In this case there may be efficiency reasons for using an output royalty, distinct from those that motivate exclusive dealing.  In particular, a royalty on each component may be infeasible if metering the use of various components is too costly.  Moreover, charging an output royalty may result in a more efficient combination of the various components relative to the combination that would be used if the individual components were priced above their marginal cost, although this is less likely to matter in this case since components are used in fixed proportions (e.g., one lens is used per camera).  Despite the economic justifications for the bundling-output royalty scheme, it may also be a disguise for an exclusive dealing arrangement on its lens which is the most valuable component in the bundle.  These tradeoffs would likely be evaluated under section 77 (or 78, 79).

 

Price Maintenance

 

Section 61 of the Act, explicitly states that those who possess patent, trademark, copyright or registered industrial design protection are prohibited from attempting by agreement, threat, promise or like means to influence upward the price at which a firm supplies a product.  Furthermore, they are also prohibited from refusing to deal with a firm because of that firm’s low pricing policy.  Importantly, section 61 does not say that market power needs to be demonstrated in order for price maintenance to be found unlawful.

 

From an economic standpoint, price maintenance can be anti-competitive if it facilitates cartel pricing at either the manufacturer or the retail level.  Conversely, price maintenance can be pro-competitive if it motivates retailers to provide customers with an appropriate level of service for a given product. Section 61(10) of the Act outlines several exemptions from the price maintenance provisions dealing with refusal to supply.  In particular, price maintenance is permitted in the case of a “loss-leaders” defense, a “bait-and-switch” defense, a misleading advertising defense, and a service defense.