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Allen-Myland, Inc. v. International Business Machines Corp.

filed: August 12, 1994.

ALLEN-MYLAND, INC., APPELLANT
v.
INTERNATIONAL BUSINESS MACHINES CORPORATION



ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA. (D.C. Civil Action No. 85-06166).

Before: Mansmann and Nygaard, Circuit Judges and Seitz, Senior Circuit Judge.

Author: Nygaard

Opinion OF THE COURT

NYGAARD, Circuit Judge.

Allen-Myland, Inc. ("AMI") appeals from the district court's judgment in favor of IBM in this intricate antitrust tying case. We conclude that the district court erred and will vacate its judgment and remand the cause for further proceedings.*fn2

I. FACTS and PROCEDURE

A. Mainframes and Upgrades

The facts underlying this nine-year-old dispute are minutely detailed and quite voluminous. The district court has set forth these facts in great detail in its forty-four page opinion, Allen-Myland, Inc. v. IBM Corp., 693 F. Supp. 262 (E.D. Pa. 1988), and we will present only a brief summary here.

IBM is the world's largest manufacturer of large-scale mainframe computers. These machines have the capacity to process millions of records at a time and manage a tremendous volume of information, making modern operations possible for large corporations, public utilities and government agencies. Without them, business would soon slow or halt. Mainframes are physically large machines, generally occupying significant floor space and requiring a full-time staff to keep them in operation. Needless to say, they are quite expensive, with prices commonly in excess of $1 million.

Mainframes are available in a wide range of computing capacities, to fit the needs of each individual customer. One common measure of capacity is computing speed, measured in millions of instructions per second ("MIPS"). IBM mainframes may also be upgraded, as its customers' computing needs change over time, in what is known as a MIPS upgrade.

Many IBM mainframes are not purchased outright from IBM by their end users, but are instead leased through third-party leasing companies such as CMI and Comdisco.*fn3 A mainframe will typically be leased to several end users during its life cycle, and then when obsolete will be scrapped. Often, when the lease term expires and the mainframe returns to the lessor, the computer will need to be reconfigured to meet the needs of the next lessee.

Companies like AMI found a profitable market reconfiguring mainframe computers such as the IBM 303X series.*fn4 Lessors could not afford to have their machines idle and generating no revenue while waiting for a reconfiguration, yet IBM often took months to install an upgrade. AMI, on the other hand, would turn the job around in a matter of only a few days. Either AMI or the leasing company would buy the required parts outright from IBM for inventory on what were known as SWRPQ terms, meaning that IBM installation was not included. It would then install the parts in the user's computer, set up the appropriate software and test the system. Old parts could often then be used on another computer. Because the 303X series of computers was based on "MST" circuit board technology, which required significant technical skill and time to reconfigure, AMI was in a position to add considerable value in terms of its labor. As a result, AMI grew into a company with $50 million in annual revenue.

In 1980, however, IBM introduced its next generation of mainframe computers, the 308X series, which caused a major erosion in AMI's reconfiguration business. These machines used a new technology, the thermal conduction module, or TCM. A TCM is essentially a water-cooled can containing a much greater density of circuits than the system it replaced. Because more circuitry can be placed in a TCM, there are fewer TCMs to replace; hence, there is much less labor involved in performing an upgrade on a TCM-based computer than on earlier models.

In marketing its 308X series, IBM used a policy known as net pricing. Under this policy, IBM installation labor was bundled in with the price of the parts for TCM-based MIPS upgrades; SWRPQ pricing was either eliminated or was priced prohibitively high. In addition, any old TCMs recovered from a mainframe during reconfiguration became IBM's property. As a result, customers desiring non-IBM installation of upgrades were required to pay IBM's labor charge anyway. And because the net pricing policy limited the supply of the TCMs on the open market, acquiring parts from sources other than IBM became impractical.

IBM contended that net pricing's purpose was to insure that the old TCMs recovered from reconfigured machines were returned to IBM. TCMs are extremely durable and can easily be refurbished to "equivalent to new" condition. IBM, faced with a manufacturing capacity shortage, stated that it merely wanted to refurbish TCMs that were returned for later reuse in a future upgrade or in a brand-new machine. As for bundling the labor charge, IBM contended its purpose was to ensure that it got its TCMs back, which was enhanced when IBM personnel performed the labor.

B. Procedural History

AMI, however, soon found that much of its reconfiguration business was drying up and filed this action. AMI's four-count complaint alleged that IBM violated sections 1 and 2 of the Sherman Act, 15 U.S.C. §§ 1, 2, and also asserted state law unfair competition and tortious interference claims. IBM counterclaimed for copyright infringement of its software programs and documentation manuals; IBM also asserted state law counterclaims for breach of contract and tortious interference.

AMI's section 1 claim was tried in a bench trial, contending that IBM had tied its upgrade installation services to the parts needed to perform the upgrades.*fn5 AMI alleged that this tying arrangement constituted a per se violation of the Sherman Act; alternatively, it asserted that the tie was still a section 1 violation under the rule of reason.

The district court found that IBM's net pricing structure did not constitute a per se section 1 violation, for two reasons: first, that IBM's share of the relevant market was not high enough to impose per se liability, id. at 270-83; and second, that net pricing did not foreclose AMI from a "viable business opportunity," id. at 283-93. The court also found that net pricing did not violate section 1 under a rule of reason analysis because sufficient procompetitive reasons existed for it.*fn6 Id. at 293-98.

Later, the district court tried most of the remaining claims and counterclaims, and concluded that AMI was liable to IBM for copyright infringement and violations of the Lanham Act. Allen-Myland, Inc. v. IBM Corp., 746 F. Supp. 520 (E.D. Pa. 1990).*fn7 The court also entered judgment for IBM on AMI's Sherman Act section 2 claim, concluding that such a claim could not possibly succeed unless its earlier ruling on market power were reversed. Id. at 525 n.1, 559.

Meanwhile, IBM had filed another Lanham Act action against AMI in the United States District Court for the Northern District of Illinois, which was transferred to the Eastern District of Pennsylvania. Moreover, certain issues concerning IBM's relief against AMI on its counterclaims remained unresolved. On AMI's motion, the district court issued an order under Fed. R. Civ. P. 54(b) declaring that its 1988 opinion resolving the antitrust issues constituted a final judgment. Allen-Myland, Inc. v. IBM Corp., 1993-1 Trade Cas. (CCH) P 70,244, 25 Fed. R. Serv. 3d

(Callaghan) 1353, 1993 WL 169849 (E.D. Pa. May 14, 1993). This appeal followed.

II. OVERVIEW of the LAW of TYING ARRANGEMENTS

The overarching issue in this appeal is AMI's claim that the district court erred when it found that net pricing was not a per se violation of section 1 of the Sherman Act. In a tying arrangement, the seller sells one item, known as the tying product, on the condition that the buyer also purchases another item, known as the tied product. Town Sound & Custom Tops, Inc. v. Chrysler Motors Corp., 959 F.2d 468, 475 (3d Cir.) (in banc), cert. denied, 121 L. Ed. 2d 139, 113 S. Ct. 196 (1992). Section 1 of the Sherman Act declares only contracts in restraint of trade illegal. Thus, the antitrust concern over tying arrangements is limited to those situations in which the seller can exploit its power in the market for the tying product to force buyers to purchase the tied product when they otherwise would not, thereby restraining competition in the tied product market. Market power is defined as the ability "to raise prices or to require purchasers to accept burdensome terms that could not be exacted in a completely competitive market." United States Steel Corp. v. Fortner Enters., Inc. ("Fortner II "), 429 U.S. 610, 620, 97 S. Ct. 861, 867-68, 51 L. Ed. 2d 80 (1977).

On the other hand, if the seller does not have sufficient power in the tying product market, buyers wanting to purchase the tied product from another source will simply avoid the tie by buying the tying product from another supplier. See Town Sound, 959 F.2d at 476 (discussing Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 11-14, 104 S. Ct. 1551, 1558-59, 80 L. Ed. 2d 2 (1984)). Such a tie will not restrain an appreciable amount of trade, and accordingly, will not constitute an antitrust violation.

The first inquiry in any section 1 tying case is whether the defendant has sufficient market power over the tying product, which requires a finding that two separate product markets exist and a determination of precisely what the tying and tied product markets are. See Jefferson Parish, 466 U.S. at 21, 104 S. Ct. at 1562-63. If the defendant is found to have sufficient market power in the tying product market, then the tie may be a "per se" violation of the Sherman Act. This tie is condemned if the probability that the contractual arrangement improperly restrains trade is so high that a judicial inquiry into the actual prevailing market conditions, including possible procompetitive justifications for the tie, is deemed unprofitable. Id. at 15-18 & n.25, 104 S. Ct. at 1560-61 & n.25; Town Sound, 959 F.2d at 477.

Assuming the court finds sufficient market power, it must then decide whether "a substantial amount of interstate commerce" has been affected by the tie. See, e.g., Town Sound, 959 F.2d at 477. The Supreme Court has defined "substantial" in absolute dollar terms as an amount which is not de minimis in terms of the "total volume of sales tied by the sales policy under challenge . . . ." Fortner Enters., Inc. v. United States Steel Corp.

("Fortner I "), 394 U.S. 495, 501-02, 89 S. Ct. 1252, 1257-58, 22 L. Ed. 2d 495 (1969) ($190,000 sufficient).

Finally, to have standing to bring a private antitrust action, the plaintiff must show "fact of damage," defined as some harm flowing from the antitrust violation. Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S. 100, 114 n.9, 89 S. Ct. 1562, 1571-72 n.9, 23 L. Ed. 2d 129 (1969); Pitchford v. Pepi, Inc., 531 F.2d 92, 98-99 (3d Cir. 1975), cert. denied, 426 U.S. 935, 96 S. Ct. 2649, 49 L. Ed. 2d 387 (1976). The amount of the damage is not important for antitrust standing; it is sufficient that some damage has occurred. There must, however, be some causal link between the damage and the violation of the antitrust laws. Put another way, the harm must be one that the antitrust laws were designed to prevent. Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 488-89, 97 S. Ct. 690, 697, 50 L. Ed. 2d 701 (1977).

III. SCOPE of the RELEVANT MARKET

A. Introduction

AMI asserts that the tying product is the "large-scale mainframe computer," defined as computers that are "among the largest in memory capacity, the fastest in computing speed, and the most expensive of computers available." Allen-Myland, 693 F. Supp. at 270-71. Alternatively, it sets forth two submarkets consisting of the parts and services required for the conversion and upgrade of either IBM mainframes or all manufacturers' mainframes. AMI defines the tied product as the labor required to install upgrades.

The district court found AMI's proposed market definition and submarkets to be too narrow. When the court broadened the market to include various substitutes that it believed shared cross-elasticity of demand*fn8 with large-scale mainframes, IBM's market share dropped from as high as 79% to under 34.4%, too low to impose per se liability. See Jefferson Parish, 466 U.S. at 26-27, 104 S. Ct. at 1566 (30% market share insufficient); Times-Picayune Publishing Co. v. United States, 345 U.S. 594, 611-12, 73 S. Ct. 872, 882, 97 L. Ed. 1277 (1953) (33-40% market share insufficient). The court stated:

Standing alone, AMI's market share evidence tends to show that IBM enjoys substantial economic power. However, AMI's definitions of large scale mainframes and the relevant market are flawed in several respects and tend to overstate IBM's market share and power.

Allen-Myland, 693 F. Supp. at 271. The district court defined the relevant market to include not only large-scale mainframes, but also added upgrades to large-scale mainframes, leased and smaller capacity computers, peripheral products and software, "box swaps," and upgrades using customer-provided parts to the relevant market. To the extent that the district court's alleged errors were in formulating or applying legal principles, our review is, of course, plenary. We review the district court's findings of fact, however, under the clearly erroneous standard of review.

B. Leasing Companies

The district court first added leasing companies into AMI's proposed market definition. It reasoned as follows:

Leasing companies, such as Comdisco and CMI, purchase computer equipment from manufacturers and lease it to users. From a consumer's standpoint, they are an alternative source of computer equipment. They compete with IBM. Leasing companies own approximately 40 percent of all large scale mainframe computers, as defined by AMI. Prof. Levin testified that IBM's share of the market would be reduced by an amount he was unable to determine if leasing companies were taken into account in AMI's market definition. If leasing company transactions involving computers comparable and in many cases identical to the large scale mainframes marketed by IBM are included in the relevant market, and the market is measured on a "transaction basis," IBM's share of the market, according to Prof. Almarin Phillips, who testified for IBM as an expert economist, drops to 34.4 percent. Prof. Phillips testified that such a share would not reflect "overwhelming" activity in the market on IBM's part.

Allen-Myland, 693 F. Supp. at 273-74 (footnote and record citations omitted). We cannot affirm the district court's finding that leasing companies form a part of the relevant market.

First, the district court relied on the testimony of Professor Levin, AMI's own expert, as an admission that IBM's market share would have to be reduced if leasing companies were added to the relevant market. This reliance is misplaced. Although Professor Levin did affirmatively answer the tautological question whether "leasing companies are competitors of IBM when they market IBM manufactured equipment in competition with IBM," this and our review of the trial transcript indicate

that he neither addressed the issue of market share reduction nor made an admission about it.

More importantly, we think that the opinion reveals an analytical flaw. Leasing companies lease both new and used computers. They purchase new mainframes from IBM and lease them to end users; when the lease term is up, if the mainframe is not obsolete and can be leased again, the leasing company will place it with another end user. In addition, leasing companies deal in both IBM and non-IBM computers. There are important legal and competitive distinctions between the various types of equipment in which the leasing companies deal, so they cannot be lumped together.

New computers are, of course, already in the relevant market as defined by AMI. It was therefore incorrect to add them in again when end users lease new computers rather than purchase them outright. In this situation, leasing companies provide nothing more than an alternate way of financing a new computer, but do nothing to increase the supply of new machines. See Transamerica Computer Co. v. IBM Corp. (In re IBM Peripheral EDP Devices Antitrust Litig.), 481 F. Supp. 965, 979 (N.D. Cal. 1979), aff'd, 698 F.2d 1377 (9th Cir.), cert. denied, 464 U.S. 955, 104 S. Ct. 370, 78 L. Ed. 2d 329 (1983). They do not increase the number of new mainframes, as leasing companies still must purchase them from their manufacturers. Thus, to the extent that IBM had the power to set prices, that power would not be diminished, or at most would only be slightly diminished,*fn9 by its sales to leasing companies rather than end users. Since these purchases are already in the relevant market, it was double counting to also include them as part of the leasing market. Cf. id.

With respect to leases of used computers, there is a significant difference whether those machines were made by IBM or by some other manufacturer. Where used IBM computers are leased, we think that United States v. Aluminum Co. of America ("Alcoa "), 148 F.2d 416 (2d Cir. 1945)*fn10 is apposite. There, Alcoa controlled 90 percent of the market for virgin aluminum ingot. It sought to reduce its market share for antitrust purposes by arguing that secondary ingot derived from scrap competed with virgin ingot for sales. The court held that because all secondary ingot was ultimately derived from virgin ingot, Alcoa, by properly exercising its power over the supply of virgin, could indirectly control the supply of secondary as well. Id. at 425.

Alcoa 's analysis is persuasive. Indeed, we think the case is even stronger here for excluding the secondary market. Refined aluminum can be melted down and reused repeatedly, and in any event, products made with it may last for decades before they are scrapped and the aluminum is recycled. It therefore may have been quite difficult for Alcoa to estimate future supply and demand for aluminum ingot over a long period of time with sufficient accuracy to maximize its profits by manipulating the supply of virgin ingot it produced. See 2 Phillip Areeda & Donald F. Turner, Antitrust Law § 530c (1978).

Computers, however, have considerably more limited lives than aluminum ingot. Technology and price/performance ratios have been advancing so rapidly in the computer industry that used machines cannot be re-leased indefinitely.*fn11 Accordingly, a powerful manufacturer like IBM was in a position to maximize its profits by carefully controlling the number of mainframes that would later appear on the used leasing market. This is particularly true when, as here, that control was enhanced by IBM's policy of recapturing old parts that could otherwise have been used to extend the useful service lives of existing used mainframes by allowing them to be upgraded and placed with new customers. We therefore conclude that the district court erred when it added leases of used IBM mainframes into the relevant market.*fn12

On the other hand, to the extent that leasing companies deal in used, non-IBM mainframes that have not already been counted in the sales market, these machines belong in the relevant market for large-scale mainframe computers. Unlike IBM, there is no allegation that the manufacturers of these computers possess the market power to control prices, much less that they would do so in concert with IBM.*fn13 When these computers are placed in service by leasing companies, they provide an alternative that limits IBM's power in the market.*fn14

Accordingly, we conclude that the district court erred when it included all leasing company transactions in the relevant market. On remand, the court should include only leases of used, non-IBM mainframes and determine ...


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