* Professor of Law, University of California, Los Angeles; A.B. 1975, University of California, Davis; M.A. 1980, University of California, Berkeley; J.D. 1980, University of California, Berkeley.

** Assistant Professor of Business Economics, Anderson Graduate School of Management, University of California, Los Angeles; B.A. 1980, M.A. 1980, Yale University; Ph.D. 1984, Massachusetts Institute of Technology.

*** Professor of Law, University of California, Los Angeles; B.A. 1976, Goshen College; A.M. 1978, University of Michigan; J.D. 1982, Harvard University.

We thank Stephen Breyer, William Comanor, Frank Easterbrook, Franklin Fisher, William Klein, Thomas Krattenmaker, and Stanley Ornstein for helpful comments. Copyright 1990 Wiley, Rasmusen, and Ramseyer.

ABSTRACT

The United Shoe case banned lease-only policies by monopolists. But the court erred in believing that monopoly pricing could explain United Shoe Machinery's complex of leasing policies. At best, this explanation only accounts for a few details of the case. The bulk of the company's conduct seems simply efficient -- suggesting that the Shoe decision was wrong and its later precedential consequences pernicious. The Coase Conjecture might seem to make some sense of Shoe's ban on monopoly leasing, and suggests that the Shoe rule may have been too narrow. At the same time, however, the Conjecture dictates that the Shoe rule be confined ways the opinion did not suggest that are unacceptably costly to accomplish. Courts would do well to accept that Coase describes a problem that is real. But they would also do well to accept it as a problem not worth solving.

INTRODUCTION

Antitrust law regulates the behavior of monopolists by branding some acts as "bad conduct." To define this key notion, every antitrust casebook includes the United Shoe Machinery decision, a classic district court opinion that condemned a monopoly firm's practice of only leasing and never selling its shoe manufacturing equipment. n1 The Supreme Court has never questioned its approval of the case, and Shoe has provided the authority for later and successful government attacks on leasing policies in the computer and copier markets. n2 Nonetheless, because the Shoe court never correctly  [*694]  evaluated the economic impact of leasing, the decision remains highly unsatisfactory. Although the court condemned leasing because of its exclusionary effects, most leasing arrangements are no more exclusionary than sales.
 
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n1 United States v. United Shoe Mach. Corp., 110 F. Supp. 295 (D. Mass. 1953), aff'd, 347 U.S. 521 (1954).

n2 For example, in 1956 IBM complied with a Justice Department consent decree requiring it to offer its computers for sale. Nonetheless, most consumers continued to rent. See J. SOMA, THE COMPUTER INDUSTRY 35, 61-62 (1976). The Department of Justice again attacked IBM's rental policies in a suit that the Reagan administration eventually dismissed. See F. FISHER, J. McGOWAN & J. GREENWOOD, FOLDED, SPINDLED, AND MUTILATED: ECONOMIC ANALYSIS AND U.S. v. IBM 191-96 (1983). In 1975, the Federal Trade Commission entered a consent decree with Xerox that declared that the firm had followed "a lease only policy" that was among its violations of federal antitrust law. In re Xerox Corp., 86 F.T.C. 364, 367-68 (1975) Cf. United States v. Am. Can Co., 1950-1 Trade Cas. (CCH) P62,679, at p. 63, 963, 63,968 (1950) (final judgment finding antitrust violation expresses policy favoring customer ownership of defendant's products "as compared with the continued leasing of them").
 
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If the defendant United Shoe Machinery Corporation did not lease in order to exclude its competitors, the question remains why it did insist that its customers lease. Perhaps leasing was incidental to particular United practices that were in fact exclusionary, that bore no necessary relationship to leasing, and that caused the Shoe court to err by condemning leasing generally. Or perhaps both United and its customers preferred leases and United's various other practices for benign reasons, and antitrust law ought to discard Shoe altogether. But an idea of Ronald Coase, from an article written some twenty years after the Shoe decision, suggests that leases may enable monopolists to earn monopoly returns where sales would not. Although the Shoe court had no chance to consider Coase's later insight, prominent commentators have noted the connection between that case and the "Coase Conjecture" -- a theory that explains why leasing can be attractive to a monopolist that makes goods which are durable. n3
 
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n3 Coase, Durability and Monopoly, 15 J.L. & ECON. 143 (1972). We acquiesce in the conventional label for this Coase insight -- which he expressed entirely in English -- without endorsing the condescension that mathematical economists might imply by their use of the label.

For reasons different from Coase's, the durability of a good may make any competition that does exist more intense than otherwise. See Carlton & Gertner, Market Power and Mergers in Durable-Goods Industries, 32 J.L. & Econ. S203 (1989).
 
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Coase's logic is brilliantly counterintuitive. Usually a firm's products are complements of each other because greater output enhances the value of production by creating a reputation in customers' minds. But a monopolist that makes long-lived goods -- like diamonds, paintings, or aluminum ingots -- faces an unusual situation. Customers can accelerate or delay their purchases in anticipation of changing prices, but when customers do buy, they leave the market until their good wears out. As a result, each future unit of output potentially is a substitute for every present unit.

The fact that some customers value the good more highly than others tempts the monopolist to price-discriminate through time: to sell at a high price to willing buyers today, and then to discount in the future for customers further down the demand curve who were  [*695]  unwilling to pay the initial price. The initial high-valuation customers (the "Highs") would be willing to pay a high price rather than not obtain the good at all. But they would not be willing to pay the high price if they foresaw a price drop. Hence, the monopolist cannot succeed in having a high price today and a low price tomorrow.

Unfortunately for the monopolist, while it cannot price-discriminate, neither can it credibly claim that it will maintain its high price forever. After the Highs have made their purchases, a rational monopolist has no reason not to try to sell to the low-valuation customers (the "Lows") left in the market. As the Highs have already bought, the monopolist may as well lower its price and sell to the Lows. But foreseeing that price drop, the Highs will not buy in the first place. The only outcome that does not create a logical contradiction is for the price to be low today and low tomorrow. The Coase Conjecture is a paradox: the durability of the monopolist's goods denies it its monopoly profit.

Coase also showed that the monopolist can escape this unprofitable paradox by leasing instead of selling. By selling the good at a high price, the monopolist removes the high-valuation customers from the market and encounters the temptation to lower the price. But when the monopolist leases the good at a high rental charge, the high-valuation customers remain in the market, and the monopolist has no incentive to lower the future rental charge. Leasing enables the monopolist essentially to switch from selling a durable good to selling the nondurable service flow that a durable good produces. By thus retaining an incentive to maintain high rental charges, the monopolist can convince customers willing to pay those charges to do so immediately -- because they have no reason to expect a future drop in charges -- and can thereby earn a supracompetitive profit. n4
 
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n4 Coase also explained that a monopolist can take two other steps to gain its monopoly profit: make the product less durable or offer to repurchase the machines at a set price. Coase, supra note 3, at 149.
 
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In the last ten years, the Coase Conjecture has become an important part of industrial organization theory, n5 and prominent economists have continued to produce increasingly sophisticated elaborations on it. Faruk Gul, Hugo Sonnenschein, and Robert Wilson made Coase's intuitive discussion precise with mathematical  [*696]  game theory. n6 Jeremy Bulow constructed a simpler but classic two-period model of a durable-goods monopoly and explored how durable a monopolist would choose to make the product it sells. n7 Eric Bond and Larry Samuelson discussed what happens if buyers eventually replace the "durable" goods. n8 Sam Bucovetsky, John Chilton, and Valerie Suslow asked how Coase's logic affected the way a monopolist would choose to exclude potential competitors. n9 Nancy Stokey explored what happens if a seller cannot change prices quickly. n10 Faruk Gul n11 and Lawrence Ausubel and Raymond Deneckere n12 extended the Coase Conjecture to oligopolistic durable-goods sellers. Charles Kahn asked what would happen if marginal costs increased with output. n13
 
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n5 Note, for example, the extensive discussion of the Conjecture in a recent text, J. TIROLE, THE THEORY OF INDUSTRIAL ORGANIZATION 72-74, 79-87, 91-92 (1988).

n6 Gul, Sonnenschein & Wilson, Foundations of Dynamic Monopoly and the Coase Conjecture, 39 J. ECON. THEORY 155 (1986).

n7 Answer: Not very. Bulow, Durable-Goods Monopolists, 90 J. POL. ECON. 314 (1982) [hereinafter Bulow, Monopolists]; Bulow, An Economic Theory of Planned Obsolescence, 101 Q.J. ECON. 729, 733 n.10 (1986) [hereinafter Bulow, Planned Obsolescence]. For a numerical example of the Bulow model, see E. RASMUSEN, GAMES AND INFORMATION 276-80 (1989). See also Rust, When is it Optimal to Kill off the Market for Used Durable Goods?, 54 ECONOMETRICA 65 (1986) (when consumers can choose when to scrap the product, the monopolist may make it of either socially excessive or socially deficient durability).

n8 Answer: The monopolist may be able to sell the product at a monopoly price after all. Bond & Samuelson, Durable Good Monopolies with Rational Expectations and Replacement Sales, 15 RAND J. ECON. 336 (1984). K. Sridhar Moorthy found the same result follows if the monopolist is able to trick consumers into believing that its actually high rate of future production instead will be low. Moorthy, Consumer Expectations and the Pricing of Durables, in ISSUES IN PRICING 99 (T. Devinney ed. 1988).

n9 Answer: By selling rather than by leasing. See Bucovetsky & Chilton, Concurrent Renting and Selling in a Durable-Goods Monopoly Under Threat of Entry, 17 RAND J. ECON. 261 (1986); Suslow, Commitment and Monopoly Pricing in Durable Goods Models, 4 INT'L J. INDUS. ORG. 451 (1986). When a potential competitor considers challenging a monopolist, the competitor first asks whether the monopolist would be willing to wage a price war. Because a leasing monopolist owns the durable goods in use, a price war would reduce the capital value of the monopolist's own assets -- hence, the lessor-monopolist will hesitate to cut prices. By contrast, the seller-monopolist will cut prices more willingly, as any decline in the value of the existing assets falls on consumers who have already bought the assets. The same point appears in Bulow, Planned Obsolescence, supra note 7, at 743-46.

n10 Answer: The monopolist may be able to charge monopoly prices to some buyers. Stokey, Rational Expectations and Durable Goods Pricing, 12 BELL. J. ECON. 112 (1981).

n11 Gul, Noncooperative Collusion in Durable Goods Oligopoly, 18 RAND J. ECON. 248 (1987). Gul's model yields a curious result: "For the durable goods model, monopoly is more competitive than oligopoly: higher total profits and prices can be sustained under oligopoly than under monopoly." Id. at 249.

n12 Ausubel & Deneckere, One Is Almost Enough for Monopoly, 18 RAND J. ECON. 255 (1987). This model yields results similar to those in Gul, supra note 11.

n13 Answer: The Coase Conjecture is less applicable. Kahn, Durable Goods Monopolist and Consistency with Increasing Costs, 54 ECONOMETRICA 275 (1986).
 
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 [*697]  As hostile as Chicago economists usually are toward efforts by judges to intervene in the market, Ronald Coase has apparently invented a widely accepted theory that requires just such intervention. Richard Posner, author of a classic Chicago antitrust monograph and now a distinguished federal judge, has adopted exactly this tack. After explaining flaws in the Shoe court opinion, Posner cites the Coase Conjecture as a possible motivation for the lease-only policy: "Professor Coase has argued that the lease-only policy of a monopolist of a durable good, such as United Shoe Machinery Corporation, may be designed to overcome the difficulties encountered in trying to charge a monopoly price for a durable good." n14 Yet if antitrust law aims to force sellers to price at competitive levels, then the Coase Conjecture implies that judges should embrace the Shoe ban on lease-only monopoly. Posner makes just this suggestion: "Perhaps the lease-only policy should have been forbidden on that ground . . . ." n15
 
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n14 R. POSNER, ANTITRUST LAW: AN ECONOMIC PERSPECTIVE 184 (1976); see also R. POSNER & F. EASTERBROOK, ANTITRUST: CASES, ECONOMIC NOTES AND OTHER MATERIALS 627 (2d ed. 1981); Froeb, Evaluating Mergers in Durable Goods Industries, 34 ANTITRUST BULL. 99 (1989).

n15 R. POSNER, supra note 14, at 184.
 
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In delightful irony, however, it is not Posner's Coase-based suggestion but rather the usual Chicago reluctance to interfere in the market that gives the right result in this case. True enough, in one respect the Coase Conjecture does support the Shoe rule; indeed, it suggests that courts should broaden the rule significantly. In other ways, though, the Conjecture implies that judges ought to narrow the Shoe rule, for the Conjecture applies only under stringent qualifications -- and the rule certainly was not appropriate in the Shoe case itself. These qualifications imply that courts should either bound Shoe's proscription with a large number of inevitably arbitrary lines, or scrap the Shoe rule altogether. We argue the latter. In no event should a court consider Shoe's ban on lease-only conduct to be sensible law.

I. THE SHOE CASES

The United Shoe Machinery Corporation may be the most popular antitrust defendant of all time. Plaintiffs have taken it from district courts to the Supreme Court six times in one century. The federal government first (and unsuccessfully) claimed a criminal violation of the Sherman Act by five individuals who in 1899 merged their companies to create the United Shoe Machinery Company.  [*698]  Holmes's unanimous 1913 opinion upheld the district court's dismissal of the attack on the merger. n16 Again using the Sherman Act, the government sued the corporate entity United Shoe Machinery Company for the same merger, n17 as well as for a number of its standard leasing clauses (which Justice Louis Brandeis had drafted in private practice). n18 In 1918, the Supreme Court upheld the merger against this second challenge and approved United's leasing practices for the first time. n19 On a third try in 1922, invoking the Clayton Act of 1914, the government finally succeeded in winning Supreme Court condemnation of specific lease clauses although not of United's general leasing policy. n20
 
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n16 United States v. Winslow, 227 U.S. 202 (1913). In addition to the merger, the government also sought to attack the merged defendants' practice of

ceasing to sell shoe machinery to the shoe manufacturers. Instead, they only let machines, and on the condition that unless the shoe manufacturers use only machines of the kinds mentioned furnished by the defendants, or if they use any such machines furnished by other machinery makers, then all machines let by the defendants shall be taken away. This condition they constantly have enforced.

(1) the restricted use clause, which provides that the leased machinery shall not . . . be used upon shoes . . . upon which certain other operations have not been performed on other machines of the defendants; (2) the exclusive use clause, which provides that if the lessee fails to use exclusively machinery of certain kinds made by the lessor, the lessor shall have the right to cancel the right to use all such machinery so leased; (3) the supplies clause, which provides that the lessee shall purchase supplies exclusively from the lessor; (4) the patent insole clause, which provides that the lessee shall only use machinery leased on shoes which have had certain other operations performed upon them by the defendants' machines; (5) the additional machinery clause, which provides that the lessee shall take all additional machinery for certain kinds of work from the lessor or lose his right to retain the machines which he has already leased; (6) the factory output clause, which requires the payment of a royalty on shoes operated upon by machines made by competitors; (7) the discriminatory royalty clause, providing lower royalty for lessees who agree not to use certain machinery on shoes lasted on machines other than those leased from the lessor.

complex of obligations and rights [that] deter a shoe manufacturer from disposing of a United machine and acquiring a competitor's machine. He is deterred more than if he owned that same United machine, or if he held it on a short lease carrying simple rental provisions and a reasonable charge for [cancellation] before the end of the term. n25

Until Alcoa lost its case in 1945, there was no significant reason to suppose that United's conduct violated � 2 of the Sherman Act. . . . What United is now doing is similar to what it was then doing, but the activities which were similar stood uncondemned, -- indeed, one ought to go further and say they were in part endorsed.

It has been easy for a person with modest capital and of something less than superior efficiency to become a shoe manufacturer. He can get machines without buying them; his machines are serviced without separate charges; he can conveniently exchange an older United model for a new United model; he can change from one process to another . . . .

[A] large number of shoe manufacturers . . . expressed their preference for leasing rather than buying machines. How deeply rooted is this preference might be disputed; but it cannot be denied that virtually all the shoe manufacturers who took the stand, and the 45 shoe manufacturers who were selected as a sample by the Court, expressed a preference for the leasing system.

The testimony also shows that the advantage of the leases was and is that manufacturers of not large means were able to obtain machinery which they were without capital to buy. They helped, indeed, the big and the little. One manufacturer whose output was 5,000 pairs of shoes a day testified that if his company had been compelled to buy outright the machinery necessary to equip its factory, it could not have developed as it had.

Despite its express terms, the full capacity clause is not considered by United to have been violated unless the lessee fails to use the machine on work for which the machine is capable of being used, and instead performs such work by using a competitor's machine. In other words, it is not treated as a violation if the lessee fails to use United's machines because he performs the work by hand, or because he discontinues the type of operation for which the machine is capable of being used.

To this defense the shortest answer is that the law does not allow an enterprise that maintains control of a market through practices not economically inevitable, to justify that control because of its supposed social advantage. . . . It is for Congress, not for private interests, to determine whether a monopoly, not compelled by circumstances, is advantageous.