Queen Cty Pizza Inc v. Dominos Pizza Inc , 124 F.3d 430 ( 1997 )

Opinions of the United
1997 Decisions States Court of Appeals
for the Third Circuit
8-27-1997
Queen Cty Pizza Inc v. Dominos Pizza Inc
Precedential or Non-Precedential:
Docket
96-1638
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Recommended Citation
"Queen Cty Pizza Inc v. Dominos Pizza Inc" (1997). 1997 Decisions. Paper 210.
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Filed August 27, 1997
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 96-1638
QUEEN CITY PIZZA, INC.; THOMAS C. BOLGER; SCALE
PIZZA, INC.; BAUGHANS, INC.; CHARLES F. BUCK; F.M.
PIZZA, INC.; ROBERT S. BIGELOW; BLUE EARTH
ENTERPRISES, INC.; KEVIN BORES; DAVIS PIZZA
ENTERPRISES, INC.; DIANE A. DAVIS; FISHER PIZZA,
INC.; JAMES B. FISHER, JR.; SEPCO, INC.; S&S PIZZA
CORP.; G&L PIZZA CO.; STEPHEN D. GALLUP; LUGENT
PIZZA, INC.; JOSEPH J. LUGENT; BILLIO'S PIZZA, INC.;
WILLIAM J. MURTHA; SPRING GARDEN PIZZA, INC;
BRAD L. WALKER; JRW PIZZA, INC.; JAMES R. WOOD,
Individually and as Class Representatives of a Class
Consisting of All Present and Certain Former Domino's
Franchisees in the United States; INTERNATIONAL
FRANCHISE ADVISORY COUNCIL, INC.
v.
DOMINO'S PIZZA, INC.
Queen City Pizza, Inc.; Thomas C.
Bolger; Scale Pizza, Inc.; Baughans,
Inc.; Charles F. Buck; F.M. Pizza, Inc.;
Robert S. Bigelow; Blue Earth
Enterprises, Inc.; Kevin Bores; Davis
Pizza Enterprises, Inc.; Diane A. Davis;
Fisher Pizza, Inc.; James B. Fisher, Jr.;
SEPCO, Inc.; S&S Pizza, Inc.; G&L
Pizza, Inc.; Stephen D. Gallup; Lugent
Pizza, Inc.; Joseph J. Lugent; Billio's
Pizza, Inc.; William J. Murtha; Spring
Garden Pizza, Inc.; Brad L. Walker;
JRW Pizza, Inc.; James R. Wood; and
International Franchise Advisory
Council, Inc.,
Appellants
On Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. Civil Action No. 95-cv-03777)
Argued February 28, 1997
Before: SCIRICA, ALITO and LAY,* Circuit Judges
(Filed August 27, 1997)
SHERYL G. SNYDER, ESQUIRE
(ARGUED)
Brown, Todd & Hayburn
3200 Providian Center
Louisville, Kentucky 40202
Attorney for Appellants
DANIEL F. KOLB, ESQUIRE
(ARGUED)
THOMAS P. OGDEN, ESQUIRE
Davis, Polk & Wardwell
450 Lexington Avenue
New York, New York 10017
LAURENCE Z. SHIEKMAN, ESQUIRE
Pepper, Hamilton & Scheetz
18th and Arch Streets
3000 Two Logan Square
Philadelphia, Pennsylvania 19103-
2799
Attorneys for Appellee
_________________________________________________________________
*The Honorable Donald P. Lay, United States Circuit Judge for the
Eighth Judicial Circuit, sitting by designation.
2
OPINION OF THE COURT
SCIRICA, Circuit Judge.
In this appeal, we must decide whether certain franchise
tying restrictions support a claim for violation of federal
antitrust laws. Eleven franchisees of Domino's Pizza stores
and the International Franchise Advisory Council, Inc. filed
suit against Domino's Pizza, Inc., alleging violations of
federal antitrust laws, breach of contract, and tortious
interference with contract. The district court dismissed the
antitrust claims under Fed. R. Civ. P. 12(b)(6) for failure to
state a claim for which relief can be granted, because the
plaintiffs failed to allege a valid relevant market. The
district court declined to exercise supplemental jurisdiction
over the plaintiffs' remaining common law claims. Queen
City Pizza, Inc. v. Domino's Pizza, Inc., 922 F. Supp. 1055(E.D. Pa. 1996). We will affirm.
I. Facts and Procedural History
A.
Domino's Pizza, Inc. is a fast-food service company that
sells pizza through a national network of over 4200 stores.
Domino's Pizza owns and operates approximately 700 of
these stores. Independent franchisees own and operate the
remaining 3500. Domino's Pizza, Inc. is the second largest
pizza company in the United States, with revenues in
excess of $1.8 billion per year.
A franchisee joins the Domino's system by executing a
standard franchise agreement with Domino's Pizza, Inc.
Under the franchise agreement, the franchisee receives the
right to sell pizza under the "Domino's" name and format.
In return, Domino's Pizza receives franchise fees and
royalties.
The essence of a successful nationwide fast-food chain is
product uniformity and consistency. Uniformity benefits
franchisees because customers can purchase pizza from
3
any Domino's store and be certain the pizza will taste
exactly like the Domino's pizza with which they are familiar.
This means that individual franchisees need not build up
their own good will. Uniformity also benefits the franchisor.
It ensures the brand name will continue to attract and hold
customers, increasing franchise fees and royalties.1
For these reasons, section 12.2 of the Domino's Pizza
standard franchise agreement requires that all pizza
ingredients, beverages, and packaging materials used by a
Domino's franchisee conform to the standards set by
Domino's Pizza, Inc. Section 12.2 also provides that
Domino's Pizza, Inc. "may in our sole discretion require that
ingredients, supplies and materials used in the preparation,
packaging, and delivery of pizza be purchased exclusively
from us or from approved suppliers or distributors."
Domino's Pizza reserves the right "to impose reasonable
limitations on the number of approved suppliers or
distributors of any product." To enforce these rights,
Domino's Pizza, Inc. retains the power to inspect franchisee
stores and to test materials and ingredients. Section 12.2 is
subject to a reasonableness clause providing that Domino's
Pizza, Inc. must "exercise reasonable judgment with respect
to all determinations to be made by us under the terms of
this Agreement."
Under the standard franchise agreement, Domino's Pizza,
Inc. sells approximately 90% of the $500 million in
ingredients and supplies used by Domino's franchisees.2
These sales, worth some $450 million per year, form a
significant part of Domino's Pizza, Inc.'s profits.
Franchisees purchase only 10% of their ingredients and
supplies from outside sources. With the exception of fresh
dough, Domino's Pizza, Inc. does not manufacture the
products it sells to franchisees. Instead, it purchases these
products from approved suppliers and then resells them to
the franchisees at a markup.
_________________________________________________________________
1. See the analysis of the economics of franchising in Warren S. Grimes,
When Do Franchisors Have Market Power?, 65 Antitrust L.J. 105, 107-
110 (1996).
2. Domino's Pizza, Inc. sells ingredients and supplies through its
division, Domino's Pizza Distribution Division, "DPDD." DPDD was
formerly a subsidiary of Domino's Pizza, Inc.
4
B.
The plaintiffs in this case are eleven Domino's franchisees
and the International Franchise Advisory Council,
Inc. ("IFAC"), a Michigan corporation consisting of
approximately 40% of the Domino's franchisees in the
United States, formed to promote their common interests.3
The plaintiffs contend that Domino's Pizza, Inc. has a
monopoly in "the $500 million aftermarket for sales of
supplies to Domino's franchisees" and has used its
monopoly power to unreasonably restrain trade, limit
competition, and extract supra-competitive profits. Plaintiffs
point to several actions by Domino's Pizza, Inc. to support
their claims.
First, plaintiffs allege that Domino's Pizza, Inc. has
restricted their ability to purchase competitively priced
dough. Most franchisees purchase all of their fresh dough
from Domino's Pizza, Inc. Plaintiffs here attempted to lower
costs by making fresh pizza dough on site. They contend
that in response, Domino's Pizza, Inc. increased processing
fees and altered quality standards and inspection practices
for store-produced dough, which eliminated all potential
savings and financial incentives to make their own dough.
Plaintiffs also allege Domino's Pizza, Inc. prohibited stores
that produce dough from selling their dough to other
franchisees, even though the dough-producing stores were
willing to sell dough at a price 25% to 40% below Domino's
Pizza, Inc.'s price.
Next, plaintiffs object to efforts by Domino's Pizza, Inc. to
block IFAC's attempt to buy less expensive ingredients and
supplies from other sources. In June 1994, IFAC entered
into a purchasing agreement with FoodService Purchasing
Cooperative, Inc. (FPC). Under the agreement, FPC was
appointed the purchasing agent for IFAC-member Domino's
franchisees. FPC was charged with developing a cooperative
purchasing plan under which participating franchisees
_________________________________________________________________
3. Domino's Pizza, Inc. argued before the district court that IFAC is
without standing in this case. Queen City Pizza, Inc. v. Domino's Pizza,
Inc., 922 F. Supp. 1055, 1057 (E.D. Pa. 1996). The district court
apparently found it unnecessary to address this issue in light of its
order
dismissing the case for failure to state a claim.
5
could obtain supplies and ingredients at reduced cost from
suppliers other than Domino's Pizza, Inc. Plaintiffs contend
that when Domino's Pizza, Inc. became aware of these
efforts, it intentionally issued ingredient and supply
specifications so vague that potential suppliers could not
provide FPC with meaningful price quotations.
Plaintiffs also allege Domino's Pizza entered into exclusive
dealing arrangements with several franchisees in order to
deny FPC access to a pool of potential buyers sufficiently
large to make the alternative purchasing scheme
economically feasible. In addition, plaintiffs contend
Domino's Pizza, Inc. commenced anti-competitive predatory
pricing to shut FPC out of the market. For example, they
maintain that Domino's Pizza, Inc. lowered prices on many
ingredients and supplies to a level competitive with FPC's
prices and then recouped lost profits by raising the price on
fresh dough, which FPC could not supply. Further,
plaintiffs contend Domino's Pizza, Inc. entered into
exclusive dealing arrangements with the only approved
suppliers of ready-made deep dish crusts and sauce. Under
these agreements, the suppliers were obligated to deliver
their entire output to Domino's Pizza, Inc. Plaintiffs allege
the purpose of these agreements was to prevent FPC from
purchasing these critical pizza components for resale to
franchisees.
Finally, plaintiffs allege Domino's Pizza, Inc. refused to
sell fresh dough to franchisees unless the franchisees
purchased other ingredients and supplies from Domino's
Pizza, Inc. As a result of these and other alleged practices,
plaintiffs maintain that each franchisee store now pays
between $3000 and $10,000 more per year for ingredients
and supplies than it would in a competitive market.
Plaintiffs allege these costs are passed on to consumers.
C.
As noted, eleven Domino's franchisees and IFAC filed an
amended complaint in United States District Court for the
Eastern District of Pennsylvania against Domino's Pizza,
Inc. seeking declaratory, injunctive, and compensatory
relief under SS 1 and 2 of the Sherman Act, 15 U.S.C. SS 1
6
and 2. The plaintiffs also sought damages for breach of
contract, breach of implied covenants of good faith and fair
dealing, and tortious interference with contractual relations.4
Domino's Pizza, Inc. moved to dismiss the antitrust
claims for failure to state a claim, contending the plaintiffs
failed to allege a "relevant market," a basic pleading
requirement for claims under both S 1 and S 2 of the
Sherman antitrust act. They maintained that the relevant
market defined in the complaint -- the "market" in
Domino's-approved ingredients and supplies used by
Domino's Pizza franchisees -- was invalid as a matter of
law because the boundaries of the proposed relevant
market were defined by contractual terms contained in the
franchise agreement, and not measured by cross-elasticity
of demand or product interchangeability.
The district court granted defendant's motion to dismiss
with prejudice plaintiffs' federal antitrust claims. The
district court observed that "in order to state a Sherman
Act claim under either S 1 or S 2, a plaintiff must identify
the relevant product and geographic markets and allege
that the defendant exercises market power within those
markets." Queen City Pizza, Inc. v. Domino's Pizza, Inc., 922
F. Supp. 1055, 1060 (E.D. Pa. 1996). Noting that plaintiffs
did "not explicitly identify the relevant product and
geographic markets in their amended complaint," the court
said that "it is clear from the context, and confirmed in
their memorandum in opposition to the instant motion,
that Plaintiffs consider the relevant product market to be
the market for ingredients and supplies among Domino's
franchisees." Id. at 1061. Rejecting this concept of the
relevant market, the court held that "antitrust claims
predicated upon a `relevant market' defined by the bounds
of a franchise agreement are not cognizable." Id. at 1063.
The court noted that Domino's Pizza, Inc.'s power to force
plaintiffs to purchase ingredients and supplies from them
stemmed "not from the unique nature of the product or
_________________________________________________________________
4. The plaintiffs originally filed the complaint on behalf of themselves
and
a purported class of all present and future Domino's franchisees in the
United States. Their amended complaint abandoned their claim to
represent all Domino's franchisees.
7
from its market share in the fast food franchise business,
but from the franchise agreement." Id. at 1062. For that
reason, plaintiffs' claims "implicate principles of contract,
and are not the concern of the antitrust laws." Id. The
district court also held plaintiffs had failed adequately to
allege harm to competition, "a bedrock premise of antitrust
law." Id. at 1063. Because plaintiffs failed to assert a
cognizable antitrust claim and there was neither diversity
among the parties nor special circumstances justifying
exercise of supplemental jurisdiction, the court dismissed
without prejudice plaintiffs' common law claims for lack of
subject matter jurisdiction. Id. at 1063-64.
The district court granted plaintiffs leave to file an
amended complaint to cure the jurisdictional pleading
deficiencies in their state law claims. Plaintiffs decided not
to replead their state law claims. Instead, they sought to
amend their complaint for a second time in an attempt to
state a valid federal antitrust claim. The district court
denied their motion, noting that though the plaintiffs'
proposed second amended complaint would cure the failure
to plead harm to competition, it would not cure the failure
to allege a valid relevant market. The court stated:
"Plaintiffs do not and cannot purchase ingredients and
supplies from alternative suppliers not because Domino's
dominates the ingredient and supply market or because
Defendant is the market's only supplier, but because the
franchisee-plaintiffs are contractually bound to purchase
only from suppliers approved by Defendant. It is economic
power resulting from the franchise agreement, therefore,
and not market power, that defines the `relevant market'
Plaintiffs allege in support of their antitrust claims." The
district court rejected plaintiffs' argument that a different
result was required under the Supreme Court's decision in
Eastman Kodak Co. v. Image Technical Services, Inc., 504
U.S. 451 (1992). This appeal followed.
II. Jurisdiction and Standard of Review
The district court had jurisdiction over the antitrust
counts under 15 U.S.C. SS 15 and 26 and 28 U.S.C.
SS 1331 and 1337. It declined to exercise supplemental
jurisdiction over the common law counts. We have
8
jurisdiction under 28 U.S.C. S 1291. Our review of the
district court's dismissal under Fed. R. Civ. P. 12(b)(1) and
12(b)(6) is plenary. Stehney v. Perry, 101 F.3d 925 (3d Cir.
1996).
III. Discussion
Plaintiffs assert six distinct antitrust claims on appeal.
First, plaintiffs allege Domino's Pizza, Inc. has monopolized
the market in pizza supplies and ingredients for use in
Domino's stores, in violation of S 2 of the Sherman Act, 15
U.S.C. S 2. In support of this contention, plaintiffs allege
Domino's Pizza, Inc. has sufficient market power to control
prices and exclude competition in this market. Second,
plaintiffs contend Domino's Pizza, Inc. has attempted to
monopolize the market for Domino's pizza supplies and
ingredients, in violation of S 2 of the Sherman Act. Third,
plaintiffs allege Domino's Pizza, Inc.'s exclusive dealing
arrangements have unreasonably restrained trade in
violation of S 1 of the Sherman Act, 15 U.S.C.S 1. Fourth,
plaintiffs allege Domino's Pizza, Inc. imposed an unlawful
tying arrangement5 by requiring franchisees to buy
ingredients and supplies from them as a condition of
obtaining fresh dough, in violation of the Sherman Act S 1,
15 U.S.C. S 1. Fifth, plaintiffs allege Domino's Pizza, Inc.
imposed an unlawful tying arrangement by requiring
franchisees to buy ingredients and supplies "as a condition
of their continued enjoyment of rights and services under
their Standard Franchise Agreement," in violation of S 1 of
the Sherman Act, 15 U.S.C. S 1. Sixth, plaintiffs allege
Domino's Pizza, Inc. has monopoly power in a relevant
"market for reasonably interchangeable franchise
opportunities facing prospective franchisees," in violation of
S 2 of the Sherman Act, 15 U.S.C. S 2. This last claim was
not raised before the district court.
As we have noted, the district court held that none of the
_________________________________________________________________
5. "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." Allen-Myland, Inc. v. International Business
Machines Corp., 33 F.3d 194, 200 (3d Cir. 1994).
9
plaintiffs' antitrust claims was cognizable under federal law.
We will analyze each claim in turn.
A.
As a threshold matter, plaintiffs argue that "relevant
market determinations are inherently fact intensive, and
therefore are inappropriate for disposition on a Rule
12(b)(6) motion." (Appellant's brief at 16). It is true that in
most cases, proper market definition can be determined
only after a factual inquiry into the commercial realities
faced by consumers. See Eastman Kodak Co. v. Image
Technical Services, Inc., 504 U.S. 451, 482 (1992). Plaintiffs
err, however, when they try to turn this general rule into a
per se prohibition against dismissal of antitrust claims for
failure to plead a relevant market under Fed. R. Civ. P.
12(b)(6).
Plaintiffs have the burden of defining the relevant market.
Pastore v. Bell Telephone Co. of Pennsylvania , 24 F.3d 508,
512 (3d Cir. 1994); Tunis Bros Co., Inc. v. Ford Motor Co.,
952 F.2d 715, 726 (3d Cir. 1991). "The outer boundaries of
a product market are determined by the reasonable
interchangeability of use or the cross-elasticity of demand
between the product itself and substitutes for it." Brown
Shoe Co. v. U.S., 370 U.S. 294, 325 (1962); Tunis Brothers,
952 F.2d at 722 (same). Where the plaintiff fails to define
its proposed relevant market with reference to the rule of
reasonable interchangeability and cross-elasticity of
demand, or alleges a proposed relevant market that clearly
does not encompass all interchangeable substitute
products even when all factual inferences are granted in
plaintiff 's favor, the relevant market is legally insufficient
and a motion to dismiss may be granted. See, e.g., TV
Communications Network, Inc. v. Turner Network Television,
Inc., 964 F.2d 1022, 1025 (10th Cir. 1992) (affirming
district court's dismissal of claim for failure to plead a
relevant market; proposed relevant market consisting of
only one specific television channel defined too narrowly);
Tower Air, Inc. v. Federal Exp. Corp., 956 F. Supp. 270(E.D.N.Y. 1996) ("Because a relevant market includes all
products that are reasonably interchangeable, plaintiff's
failure to define its market by reference to the rule of
10
reasonable interchangeability is, standing alone, valid
grounds for dismissal."); B.V. Optische Industrie De Oude
Delft v. Hologic, Inc., 909 F. Supp. 162 (S.D.N.Y. 1995)
(dismissal for failure to plead a valid relevant market;
plaintiffs failed to define market in terms of reasonable
interchangeability or explain rationale underlying narrow
proposed market definition); Re-Alco Industries, Inc. v. Nat'l
Center for Health Educ., Inc., 812 F. Supp. 387 (S.D.N.Y.
1993) (dismissal for failure to plead a valid relevant market;
plaintiff failed to allege that specific health education
product was unique or explain why product was not part of
the larger market for health education materials); E.& G.
Gabriel v. Gabriel Bros., Inc., No. 93 Civ. 0894, 1994 WL
369147 (S.D.N.Y. 1994) (dismissal for failure to plead valid
relevant market; proposed relevant market legally
insufficient because it clearly contained varied items with
no cross-elasticity of demand).
B.
Plaintiffs allege Domino's Pizza, Inc. has willfully acquired
and maintained a monopoly in the market for ingredients,
supplies, materials and distribution services used in the
operation of Domino's stores, in violation of S 2 of the
Sherman Act, 15 U.S.C. S 2. Section 2 sanctions those "who
shall monopolize, or attempt to monopolize, or combine or
conspire with any other person or persons, to monopolize
any part of the trade or commerce among the several
states, or with foreign nations." "The offense of monopoly
under S 2 of the Sherman Act has two elements: (1) the
possession of monopoly power in the relevant market and
(2) the willful acquisition or maintenance of that power as
distinguished from growth or development as a
consequence of a superior product, business acumen, or
historic accident." Aspen Skiing Co. v. Aspen Highlands
Skiing Corp., 472 U.S. 585, 596 n. 19 (1985) (quoting
United States v. Grinnell Corp., 384 U.S. 563, 570-71
(1966)). See also Ideal Dairy Farms, Inc. v. John Labatt,
Ltd., 90 F.3d 737, 749 (3d Cir. 1996) (same); Bonjourno v.
Kaiser Aluminum & Chemical Corp., 752 F.2d 802, 808 (3d
Cir. 1984) (same).
11
The district court dismissed plaintiffs' S 2 monopoly
claims for failure to plead a valid relevant market. Plaintiffs
suggest the "ingredients, supplies, materials, and
distribution services used by and in the operation of
Domino's pizza stores" constitutes a relevant market for
antitrust purposes. We disagree.
As we have noted, the outer boundaries of a relevant
market are determined by reasonable interchangeability of
use. Eastman Kodak Co. v. Image Technical Services, Inc.,
504 U.S. 451, 482 (1992); Brown Shoe Co. v. U.S. , 370 U.S.
294, 325 (1962); Tunis Brothers Co., Inc. v. Ford Motor Co.,
952 F.2d 715, 722 (3d Cir. 1991). "Interchangeability
implies that one product is roughly equivalent to another
for the use to which it is put; while there may be some
degree of preference for the one over the other, either would
work effectively. A person needing transportation to work
could accordingly buy a Ford or a Chevrolet automobile, or
could elect to ride a horse or bicycle, assuming those
options were feasible." Allen-Myland, Inc. v. International
Business Machines Corp., 33 F.3d 194, 206 (3d Cir. 1994)
(internal quotations omitted). When assessing reasonable
interchangeability, "[f]actors to be considered include price,
use, and qualities." Tunis Brothers, 952 F.2d at 722.
Reasonable interchangeability is also indicated by"cross-
elasticity of demand between the product itself and
substitutes for it." Brown Shoe Co. v. U.S., 370 U.S. 294,
325 (1962). As we explained in Tunis Brothers Co., Inc. v.
Ford Motor Co., 952 F.2d 715, 722 (3d Cir. 1991), "products
in a relevant market [are] characterized by a cross-elasticity
of demand, in other words, the rise in the price of a good
within a relevant product market would tend to create a
greater demand for other like goods in that market." Tunis
Brothers, 952 F.2d at 722.6
_________________________________________________________________
6. Cross-elasticity is a measure of reasonable interchangeability. As one
treatise observes: "The economic tool most commonly referred to in
determining what should be included in the market from which one then
determines the defendant's market share is cross-elasticity of demand.
Cross-elasticity of demand is a measure of the substitutability of
products from the point of view of buyers. More technically, it measures
the responsiveness of the demand for one product to changes in the
price of a different product." E. Thomas Sullivan and Jeffrey L. Harrison,
Understanding Antitrust and its Economic Implications 217 (1994).
12
Here, the dough, tomato sauce, and paper cups that meet
Domino's Pizza, Inc. standards and are used by Domino's
stores are interchangeable with dough, sauce and cups
available from other suppliers and used by other pizza
companies. Indeed, it is the availability of interchangeable
ingredients of comparable quality from other suppliers, at
lower cost, that motivates this lawsuit. Thus, the relevant
market, which is defined to include all reasonably
interchangeable products, cannot be restricted solely to
those products currently approved by Domino's Pizza, Inc.
for use by Domino's franchisees. For that reason, we must
reject plaintiffs' proposed relevant market.
Of course, Domino's-approved pizza ingredients and
supplies differ from other available ingredients and supplies
in one crucial manner. Only Domino's-approved products
may be used by Domino's franchisees without violating
section 12.2 of Domino's standard franchise agreement.
Plaintiffs suggest that this difference is sufficient by itself to
create a relevant market in approved products. We
disagree. The test for a relevant market is not commodities
reasonably interchangeable by a particular plaintiff, but
"commodities reasonably interchangeable by consumers for
the same purposes." United States v. E.I. du Pont de
Nemours & Co., 351 U.S. 377, 395 (1956); Tunis Brothers,
952 F.2d at 722. A court making a relevant market
determination looks not to the contractual restraints
assumed by a particular plaintiff when determining whether
a product is interchangeable, but to the uses to which the
product is put by consumers in general. Thus, the relevant
inquiry here is not whether a Domino's franchisee may
reasonably use both approved or non-approved products
interchangeably without triggering liability for breach of
contract, but whether pizza makers in general might use
such products interchangeably. Clearly, they could. Were
we to adopt plaintiffs' position that contractual restraints
render otherwise identical products non-interchangeable for
purposes of relevant market definition, any exclusive
dealing arrangement, output or requirement contract, or
franchise tying agreement would support a claim for
violation of antitrust laws. Perhaps for this reason, no court
has defined a relevant product market with reference to the
13
particular contractual restraints of the plaintiff.7 Indeed,
the only cases we have found involving similar claims
rejected plaintiffs' position as a matter of law. See United
Farmers Agents Ass'n, Inc. v. Farmers Ins. Exchange, 89
F.3d 233 (5th Cir. 1996) ("Economic power derived from
contractual arrangements such as franchises or in this
case, the agents' contract with Farmers', has nothing to do
with market power, ultimate consumers' welfare, or
antitrust.") (internal citation and quotation omitted), cert.
denied, ___ U.S. ___, 117 S. Ct. 960 (1997); Ajir v. Exxon
Corp., No. C 93-20830, 1995 WL 429234, *3 (N.D. Ca.)
("Just because Exxon's direct serve dealers may
contractually purchase gasoline from only one source--
Exxon -- does not mean that the relevant market is Exxon
gasoline"; the correct relevant market is all gasoline). See
also Seagood Trading Corp. v. Jerrico, Inc., 924 F.2d 1555,
1570 n. 39 (11th Cir. 1991) (declining to reach issue but
noting the district court rejected plaintiffs' claim that
proposed market for sales of supplies to Long John Silver's
fast food stores was a relevant market for antitrust
purposes).
Plaintiffs argue that the Supreme Court's decision
defining relevant markets in Eastman Kodak Co. v. Image
Technical Services, Inc., 504 U.S. 451 (1992) requires a
different outcome. We disagree.
In Kodak, the Supreme Court observed that a market is
defined with reference to reasonable interchangeability.
Kodak, 504 U.S. at 482. The Court held that the market for
repair parts and services for Kodak photo-copiers was a
valid relevant market because repair parts and services for
Kodak machines are not interchangeable with the service
and parts used to fix other copiers. Id. Plaintiffs suggest
that Kodak supports its proposed relevant market because
it indicates that in some circumstances, a single brand of
_________________________________________________________________
7. In Mozart Co. v. Mercedes-Benz of North America, 833 F.2d 1342 (9th
Cir. 1987), the Court of Appeals for the Ninth Circuit observed that
market power exists in three circumstances: where the government has
granted a seller a patent or similar monopoly, where the seller possesses
a unique product, or where the seller possesses a high market share. Id.
at 1345-1346. The court made no mention of contractual limitations as
a source of market power.
14
a product or service may constitute a relevant market. This
is correct where the commodity is unique, and therefore not
interchangeable with other products. But here, it is
uncontested that contractual restraints aside, the sauce,
dough, and other products and ingredients approved for
use by Domino's franchisees are interchangeable with other
items available on the market.
Plaintiffs contend that they face information and
switching costs that "lock them in" to their position as
Domino's franchisees, making it economically impracticable
for them to abandon the Domino's system and enter a
different line of business. They argue that under Kodak, the
fact that they are "locked in" supports their claim that an
"aftermarket" for Domino's-approved supplies is a relevant
market for antitrust purposes. We believe plaintiffs misread
Kodak.
The defendants in Kodak argued that there was no
relevant market in Kodak repair parts, even if they were
unique and non-interchangeable with other repair parts,
because of cross-elasticity of demand between parts prices
and copier sales. If the price of parts were raised too high,
defendants contended, it would decrease demand for copiers.8
The Court held that whether there was cross-elasticity of
demand between parts and copiers was, in this case, a
factual question that could not be determined as a matter
of law. The Court reached this conclusion because
switching and information costs arise when one purchases
an expensive piece of equipment like a copier. In some
circumstances, these costs might create an economic lock-
in that could reduce or eliminate the cross-elasticity of
_________________________________________________________________
8. In a typical antitrust case, plaintiffs assert that the products or
services in their proposed relevant market are reasonably
interchangeable because they possess positive cross-elasticity of
demand: a rise in the price of one product in the market will increase
demand for the other items in the market. By contrast, in Kodak the
defendants argued that Kodak copier parts, though not reasonably
interchangeable with the copiers themselves, were not a relevant market
because of negative cross-elasticity between parts and copiers: an
increase in the price of parts would, they argued, decrease demand for
copiers using those parts.
15
demand between copiers and the repair parts for those
copiers.
Kodak, we believe, held that a plaintiff's proposed
relevant market in a unique and non-interchangeable
derivative product or service cannot be defeated on
summary judgment by a defendant's assertion that the
proposed derivative market is cross-elastic with the primary
market, if there is a reasonable possibility that the
defendant's assertion about cross-elasticity is factually
incorrect. But Kodak does not hold that the existence of
information and switching costs alone, such as those faced
by the Domino's franchisees,9 renders an otherwise invalid
relevant market valid.10 In Kodak, the repair parts and
service were unique and there was a question of fact about
cross-elasticity. Judgment as a matter of law was therefore
inappropriate. Here, it is uncontroverted that Domino's-
approved supplies and ingredients are fully interchangeable
in all relevant respects with other pizza supplies outside the
proposed relevant market. For this reason, dismissal of the
plaintiffs' claim as a matter of law is appropriate.
Kodak is distinguishable from the present appeal in other
important respects. The Kodak case arose out of concerns
about unilateral changes in Kodak's parts and repairs
policies. When the copiers were first sold, Kodak relied on
purchasers to obtain service from independent service
providers. Later, it chose to use its power over the market
in unique replacement parts to squeeze the independent
_________________________________________________________________
9. A franchisee considering exiting one franchise system faces
information costs associated with researching alternative investment
opportunities and switching costs stemming from the loss of invested
funds that may not be recovered if it abandons its current business and
start-up costs associated with the new venture.
10. If Kodak repair parts had not been unique, but rather, could be
obtained from additional sources at a reasonable price, Kodak could not
have forced copier purchasers to buy repair parts from Kodak. This
would be true even if the copier purchasers faced information and
switching costs that locked them into to use of Kodak copiers. This fact
indicates that switching and information costs alone cannot create
market power. Rather, it is the lack of a competitive market in the object
to be purchased -- for instance, a competitive market in Kodak parts --
that gives a company market power.
16
service providers out of the repair market and to force
copier purchasers to obtain service directly from Kodak, at
higher cost. Because this change in policy was not foreseen
at the time of sale, buyers had no ability to calculate these
higher costs at the time of purchase and incorporate them
into their purchase decision. In contrast, plaintiffs here
knew that Domino's Pizza retained significant power over
their ability to purchase cheaper supplies from alternative
sources because that authority was spelled out in detail in
section 12.2 of the standard franchise agreement. Unlike
the plaintiffs in Kodak, the Domino's franchisees could
assess the potential costs and economic risks at the time
they signed the franchise agreement. The franchise
transaction between Domino's Pizza, Inc. and plaintiffs was
subjected to competition at the pre-contract stage. That
cannot be said of the conduct challenged in Kodak because
it was not authorized by contract terms disclosed at the
time of the original transaction. Kodak's sale of its product
involved no contractual framework for continuing relations
with the purchaser. But a franchise agreement regulating
supplies, inspections, and quality standards structures an
ongoing relationship between franchisor and franchisee
designed to maintain good will. These differences between
the Kodak transaction and franchise transactions are
compelling.11
Plaintiffs also contend that Virtual Maintenance, Inc. v.
Prime Computer, Inc., 11 F.3d 660 (6th Cir. 1993), supports
their claim that the boundaries of a relevant market may be
defined by contract. In Virtual Maintenance, Ford Motor Co.
granted Prime Computer an exclusive right to market Ford-
designed software and software revisions that automobile
design companies must use to design cars for Ford. Prime
Computer sold the software revisions only in a package
with uncompetitive hardware maintenance services. The
Court of Appeals for the Sixth Circuit held that Prime could
not legally exercise its monopoly power over software
revisions to force customers to buy unwanted hardware
maintenance contracts. Plaintiffs note that Prime's de facto
monopoly power over software stemmed from a contract
_________________________________________________________________
11. See Alan Silberman, The Myths of Franchise "Market Power", 65
Antitrust L.J. 181, 217 (1996).
17
with Ford, which they argue implies that the boundaries of
a market may be defined by contract. But Prime had a
monopoly because it possessed a unique product that no
one else sold. Since the product was unique, and not
interchangeable with any other products, it constituted its
own relevant market for antitrust purposes. By contrast,
Domino's does not sell a unique product or service.
Franchisees must buy Domino's-approved supplies and
ingredients not because they are unique, but because they
are obligated by contract to do so.
Were we to accept plaintiffs' relevant market, virtually all
franchise tying agreements requiring the franchisee to
purchase inputs such as ingredients and supplies from the
franchisor would violate antitrust law. Courts and legal
commentators have long recognized that franchise tying
contracts are an essential and important aspect of the
franchise form of business organization because they
reduce agency costs and prevent franchisees from free-
riding -- offering products of sub-standard quality
insufficient to maintain the reputational value of the
franchise product while benefitting from the quality control
efforts of other actors in the franchise system. 12 Franchising
is a bedrock of the American economy. More than one third
of all dollars spent in retailing transactions in the United
States are paid to franchise outlets.13 We do not believe the
antitrust laws were designed to erect a serious barrier to
this form of business organization.14
_________________________________________________________________
12. See Mozart Co. v. Mercedes-Benz of North America, Inc., 833 F.2d
1342, 1349-50 (9th Cir. 1987); Alan J. Meese, Antitrust Balancing in a
(Near) Coasean World: The Case of Franchise Tying Contracts, 95 Mich.
L. Rev. 111, 117-119 (1996); Warren S. Grimes, When Do Franchisors
Have Market Power?, 65 Antitrust L.J. 105 145-47 (1996); Benjamin
Klein and Lester F. Saft, The Law and Economics of Franchise Tying
Contracts, 28 J.L. & Econ. 345, 346-48 (1985).
13. Warren S. Grimes, When Do Franchisors Have Market Power?, 65
Antitrust L.J. 105, 105 n.1 (1996).
14. See United States v. Arnold, Schwinn & Co., 388 U.S. 365, 387 (1967)
(Stewart, J., concurring in part and dissenting in part) ("Indiscriminate
invalidation of franchising arrangements would eliminate their creative
contributions to competition and force suppliers to abandon franchising
and integrate forward to the detriment of small business. In other words,
we may inadvertently compel concentration by misguided zealousness.")
(internal quotations omitted). The majority's opinion in Arnold was later
overturned. See Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36(1977).
18
The purpose of the Sherman Act "is not to protect
businesses from the working of the market; it is to protect
the public from the failure of the market." Spectrum Sports,
Inc. v. McQuillan, 506 U.S. 447, 458 (1993). Here, plaintiffs'
acceptance of a franchise package that included purchase
requirements and contractual restrictions is consistent with
the existence of a competitive market in which franchises
are valued, in part, according to the terms of the proposed
franchise agreement and the availability of alternative
franchise opportunities. Plaintiffs need not have become
Domino's franchisees. If the contractual restrictions in
section 12.2 of the general franchise agreement were viewed
as overly burdensome or risky at the time they were
proposed, plaintiffs could have purchased a different form
of restaurant, or made some alternative investment.15 They
chose not to do so. Unlike the plaintiffs in Kodak, plaintiffs
here must purchase products from Domino's Pizza not
because of Domino's market power over a unique product,
but because they are bound by contract to do so. If
Domino's Pizza, Inc. acted unreasonably when, under the
franchise agreement, it restricted plaintiffs' ability to
purchase supplies from other sources, plaintiffs' remedy, if
any, is in contract, not under the antitrust laws. 16
For these reasons, we agree with the district court that
plaintiffs have not pleaded a valid relevant market.17
_________________________________________________________________
15. As one scholar has noted, there are thousands of franchise
opportunities available to investors and disclosure laws to help them
make informed choices about these alternatives. George A. Hay, Is the
Glass Half-Empty or Half-Full?: Reflections on the Kodak Case, 62
Antitrust L.J. 177, 188 (1993).
16. The dissent contends Domino's has acted in a "predatory way." But
plaintiffs may have a right to sue for breach of contract.
17. The reasoning adopted by the district court in this case has been
criticized recently by two other district court decisions. See Wilson v.
Mobil Oil Corp., 940 F. Supp. 944 (E.D. La. 1996); Collins v.
International
Dairy Queen, Inc., 939 F. Supp. 875 (M.D. Ga. 1996). In Wilson, the
court disagreed with the district court's interpretation of Kodak, arguing
that under Kodak information and switching costs alone, absent a
unique product or service, may create a relevant market for antitrust
purposes. As noted above, we disagree with this interpretation, for the
Supreme Court specifically found that the copier parts involved in the
19
C.
Plaintiffs' claim for attempt to monopolize fails for the
same reasons. To prevail on an attempted monopolization
claim under S 2 of the Sherman Act, "a plaintiff must prove
that the defendant (1) engaged in predatory or anti-
competitive conduct with (2) specific intent to monopolize
and with (3) a dangerous probability of achieving monopoly
power." Spectrum Sports, Inc. v. McQuillan , 506 U.S. 447,
456 (1993). Ideal Dairy Farms, Inc. v. John Labatt, Ltd., 90
F.3d 737, 750 (3d Cir. 1996); Advo, Inc. v. Philadelphia
Newspapers, Inc., 51 F.3d 1191, 1197 (3d Cir. 1995). In
order to determine whether there is a dangerous probability
of monopolization, a court must inquire "into the relevant
product and geographic market and the defendant's
economic power in that market." Spectrum Sports, Inc. v.
McQuillan, 506 U.S. 447, 459 (1993); Ideal Dairy Farms at
750; Pastore v. Bell Telephone Co. of Pennsylvania, 24 F.3d
508, 512 (3d Cir. 1994).
Plaintiffs' attempted monopoly claim is predicated on the
identical proposed relevant market underlying its monopoly
claim: a market in the ingredients, supplies, and materials
used by Domino's pizza stores. Because the products within
this proposed market are interchangeable with other
products outside of the proposed market, the claim was
properly dismissed.
D.
Plaintiffs allege exclusive dealing arrangements entered
into by Domino's Pizza, Inc. have unreasonably restrained
_________________________________________________________________
case were unique. The basis of the Collins court's criticism of the
district
court's decision here is less clear, though it appears the court believed
that the district court's holding was too expansive. The Collins court
apparently wished to reserve judgment whether some franchise tying
arrangements might be deemed anti-competitive in the future. The
approach taken by the district court in this case has received support in
recent scholarly literature. See Alan J. Meese, Antitrust Balancing in a
(Near) Coasean World: The Case of Franchise Tying Contracts, 95 Mich.
L. Rev. 111, 128 (1996) ("economic theory suggests . . . that tying
contracts that actually reduce free riding are unrelated to any exercise
of market power"); Alan H. Silberman, The Myths of Franchise "Market
Power", 65 Antitrust L.J. 181 (1996).
20
trade in violation of S 1 of the Sherman Act, 15 U.S.C. S 1.
Section 1 of the Sherman Act provides: "Every contract,
combination in the form of trust or otherwise, or
conspiracy, in restraint of trade or commerce among the
several states, or with foreign nations, is declared to be
illegal." 15 U.S.C. S 1.
To establish a section 1 violation for unreasonable
restraint of trade, a plaintiff must prove (1) concerted action
by the defendants; (2) that produced anti-competitive
effects within the relevant product and geographic markets;
(3) that the concerted action was illegal; and (4) that the
plaintiff was injured as a proximate result of the concerted
action. Mathews v. Lancaster General Hospital , 87 F.3d
624, 639 (3d Cir. 1996); Orson Inc. v. Miramax Film Corp.,
79 F.3d 1358, 1366 (3d Cir. 1996); Petruzzi's IGA
Supermarkets, Inc. v. Darling-Delaware Co., Inc., 998 F.2d
1224, 1229 (3d Cir. 1993).
Plaintiffs allege defendant's actions caused anti-
competitive effects within the market for ingredients and
supplies used by Domino's pizza stores. Again, this claim
fails because the products within the proposed market are
interchangeable with products outside the proposed
market.18
E.
Plaintiffs allege Domino's Pizza, Inc. imposed an unlawful
_________________________________________________________________
18. Monopoly power under S 2 requires "something greater" than market
power under S 1. Kodak, 504 U.S. at 481. This does not imply, however,
that the analyses employed in the two types of cases to define relevant
markets differ. In the past, we intimated that the relevant market
analysis required under S 2 of the Sherman Act was "instructive" in S 1
cases, though perhaps not identical. See Tunis Bros., 952 F.2d at 724 n.
3. The Supreme Court and lower courts have consistently held that
relevant markets under both sections are defined by the same two
factors: reasonable interchangeability of use and cross-elasticities of
demand. See, e.g., Allen-Myland , 33 F.3d at 201 and 201 n. 8 (applying
Brown Shoe relevant market test of reasonable interchangeability and
cross-elasticity of demand in S 1 tying case). In this case, we see no
difference in the relevant market analyses required under the two
provisions.
21
tying arrangement by requiring franchisees to buy
ingredients and supplies from them as a condition of
obtaining Domino's Pizza fresh dough, in violation of S 1 of
the Sherman Act, 15 U.S.C. S 1. "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." Allen-Myland, Inc. v.
International Business Machines Corp., 33 F.3d 194, 200
(3d Cir. 1994). "[T]he 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." Id. "Even if a seller has
obtained a monopoly in the tying product legitimately (as by
obtaining a patent), courts have seen the expansion of that
power to other product markets as illegitimate and
competition suppressing." Town Sound and Custom Tops,
Inc. v. Chrysler Motors Corp., 959 F.2d 468, 475 (3d Cir.
1992). "The first inquiry in any S 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 precisely what the tying
and tied products markets are." Allen-Myland, 33 F.3d at
200-201.
Here, plaintiffs allege Domino's Pizza, Inc. used its power
in the purported market for Domino's-approved dough to
force plaintiffs to buy unwanted ingredients and supplies
from them. This claim fails because the proposed tying
market -- the market in Domino's-approved dough-- is not
a relevant market for antitrust purposes. Domino's dough
is reasonably interchangeable with other brands of pizza
dough, and does not therefore constitute a relevant market
of its own. All that distinguishes this dough from other
brands is that a Domino's franchisee must use it or face a
suit for breach of contract. As we have noted above, the
particular contractual restraints assumed by a plaintiff are
not sufficient by themselves to render interchangeable
commodities non-interchangeable for purposes of relevant
market definition. If Domino's had market power in the
overall market for pizza dough and forced plaintiffs to
purchase other unwanted ingredients to obtain dough,
22
plaintiffs might possess a valid tying claim. But where the
defendant's "power" to "force" plaintiffs to purchase the
alleged tying product stems not from the market, but from
plaintiffs' contractual agreement to purchase the tying
product, no claim will lie. For that reason, plaintiffs' claim
was properly dismissed.
F.
Plaintiffs allege Domino's Pizza, Inc. imposed an unlawful
tie-in arrangement by requiring franchisees to buy
ingredients and supplies "as a condition of their continued
enjoyment of rights and services under their Standard
Franchise Agreement," in violation of S 1 of the Sherman
Act, 15 U.S.C. S 1. This claim is meritless. Though plaintiffs
complain of an illegal tie-in arrangement, they have failed
to point to any particular tying product or service over
which Domino's Pizza, Inc, has market power. Domino's
Pizza's control over plaintiffs' "continued enjoyment of
rights and services under their Standard Franchise
Agreement" is not a "market." Rather, it is a function of
Domino's contractual powers under the franchise
agreement to terminate the participation of franchisees in
the franchise system if they violate the agreement. Because
plaintiffs failed to plead any relevant tying market, the
claim was properly dismissed.
G.
On appeal, the plaintiffs advance a new claim based on
a different relevant market theory -- that Domino's has a
monopoly in a relevant market comprised of pizza franchise
opportunities of the type that Domino's Pizza, Inc. offers.
Plaintiffs raise this new theory, which the district court did
not address, in the hopes of obtaining a remand.
Plaintiffs' argument that Domino's Pizza has monopolized
a relevant market comprised of franchise opportunities of a
particular sort was not raised or mentioned in their
complaint, first amended complaint, memorandum of law in
support of their motion for leave to file a second amended
complaint, or in the "claims for relief" section of the
proposed second amended complaint. When the district
23
court denied plaintiffs leave to file a second amended
complaint, on grounds of futility, it had no idea that
plaintiffs intended or desired to raise such a claim. "This
court has consistently held that it will not consider issues
that are raised for the first time on appeal." Harris v. City
of Philadelphia, 35 F.3d 840, 845 (3d Cir. 1994).
Nonetheless, plaintiffs argue that this claim was raised
before the district court. In support of this contention, they
note that facts which might support such a claim were
pleaded in paragraphs 60 and 65 of their proposed second
amended complaint. Though we construe pleadings
liberally, plaintiffs have a duty to make the district court
aware that they intend to rely on a particular relevant
market theory. This is particularly true in a complex case
like this one, where plaintiffs bring multiple antitrust
claims based on multiple and alternative relevant market
theories. See Pastore v. Bell Telephone Co. of Pennsylvania,
24 F.3d 508, 513 (3d Cir. 1994) (plaintiff bound by
relevant market theory raised before district court); TV
Communications Network. Inc. v. Turner Network Television,
Inc., 964 F.2d 1022, 1025 (10th Cir. 1992) (same); Edward
J. Sweeney & Sons, Inc. v. Texaco, Inc., 637 F.2d 105, 117
(3d Cir. 1980) (same). We do not believe a fleeting reference
in a proposed second amended complaint to facts that
might support a proposed relevant market is sufficient, on
its own, to preserve that relevant market theory for
appellate review. See Frank v. Colt Industries, Inc., 910 F.2d
90, 100 (3d Cir. 1990) (issues not raised before district
court are waived on appeal; fleeting reference to issue
before district court insufficient to preserve it for appellate
review). "Particularly where important and complex issues
of law are presented, a far more detailed exposition of
argument is required to preserve an issue." Id. at 100.
Because this claim was not properly raised before the
district court and is not properly before us, we decline to
address it. See generally Salvation Army v. Department of
Community Affairs of State of N.J., 919 F.2d 183, 196 (3d
Cir. 1990) ("The matter of what questions may be taken up
and resolved for the first time on appeal is one left
primarily to the discretion of the courts of appeals, to be
exercised on the facts of each case.").
24
H.
Plaintiffs also contend the district court held that the
availability of contract remedies prohibited recovery under
antitrust laws. But this misstates the district court's
holding. The district court held that Domino's Pizza's ability
to block franchisees from purchasing ingredients from other
sources stemmed from its exercise of contractual powers,
not market power, and the remedy for this problem lies, if
at all, under contract law. The court did not say that as a
matter of law the availability of common law remedies
prohibits recovery under an antitrust theory. We see no
error.
I.
The district court declined to exercise supplemental
jurisdiction over the plaintiffs' remaining state law contract
claims. This decision is committed to the sound discretion
of the district court. Stehney v. Perry, 101 F.3d 925, 939
(3d Cir. 1996); Growth Horizons, Inc. v. Delaware County,
Pa., 983 F.2d 1277, 1284-85 (3d Cir. 1993). Because all
federal claims were correctly dismissed and dismissal of the
remaining contract claims would not be unfair to the
litigants or result in waste of judicial resources, we see no
abuse of discretion.
IV.
For the foregoing reasons, we will affirm the judgment of
the district court.
25
LAY, Circuit Judge, dissenting.
I respectfully dissent.
The district court, at the pleading stage, dismissed
plaintiffs' complaint alleging violations under S 1 and S 2 of
the Sherman Antitrust Act holding that plaintiffs failed to
allege a relevant market. The issue is complex. Judge
Scirica's opinion is logically reasoned. Our differences lie in
the interpretation and application of the Supreme Court's
recent opinion in Eastman Kodak Co. v. Image Technical
Servs., Inc., 504 U.S. 451 (1992). I respectfully submit, for
the reasons that follow, that the district court's opinion in
this case rests on several incorrect hypotheses. To the
extent that the majority adopts the district court's
rationale, I dissent.
The district court rejected as a matter of law the
plaintiffs' alleged relevant market, that of the derivative
aftermarket for ingredients and supplies among Domino's
Pizza, Inc. ("DPI")'s franchisees. The district court found
that "[t]he economic power DPI possesses results not from
the unique nature of the product or from its market share
in the fast food franchise business, but from the franchise
agreement."1
_________________________________________________________________
1. The district court relied on "two influential commentators," Benjamin
Klein and Lester F. Saft, The Law and Economics of Franchise Tying
Contracts, 28 J.L. & Econ. 345, 356 (1985) and two pre-Kodak cases,
Mozart Co. v. Mercedes-Benz of North America, Inc. , 833 F.3d 1342 (9th
Cir. 1987), and Tominaga v. Shepard, 682 F. Supp. 1489 (C.D. Cal.
1988). The district court adopted the Ninth Circuit's analysis from
Mozart that an alleged economic-lock-in is irrelevant to the
determination of a defendant's market power. See Tominaga, 682 F.
Supp. at 1494 (quoting Mozart, 833 F.2d at 1346-47). This reasoning is
simply irreconcilable with the Supreme Court's analysis of information
and switching costs in Kodak. See Kodak, 504 U.S. at 473-77.
It should also be noted Professor Klein recognized, contrary to his
original thesis, that Kodak permits the recognition of market power in a
derivative aftermarket "despite the absence of market power in the
equipment market, by taking advantage of imperfectly informed
consumers that become `locked-in' to their existing Kodak equipment."
See Benjamin Klein, Market Power in Antitrust: Economic Analysis After
Kodak, 3 Sup. Ct. Econ. Rev. 43, 48 (1993).
26
The plaintiffs allege that DPI has harmed the competitive
process by "foreclos[ing] interbrand competition in the
market for distributing approved Ingredients and Supplies
to Domino's franchisees." The plaintiffs argue that DPI
prevented a franchise cooperative and other distributors of
ingredients and supplies from entering that market. By
stopping any interbrand competition for ingredients and
supplies for DPI franchisees, DPI, according to the
pleadings, has excluded other potential distributors, and
thereby preempted market forces from disciplining the sale
of ingredients and supplies.
Interchangeability
In adopting the district court's approach to relevant
market definition, the majority reasons that all ingredients
and supplies, whether or not approved by DPI, are
interchangeable for making pizzas generally and therefore
must be included within the relevant market. Kodak made
a similar argument. As in Kodak, this ignores the reality
that there are no substitutes for ingredients and supplies
sold only by DPI. The majority's approach to the
interchangeability concept is not faithful to the purpose of
interchangeability analysis or the Supreme Court's
understanding of market definition and power. The purpose
of analyzing interchangeability is to find competing
products which are reasonable substitutes and thereby
prevent market power.2 In Kodak, the question was whether
the cross-elasticity of demand between the equipment
market and the derivative aftermarkets for parts and
service was sufficient to deprive Kodak of market power.
Our question is whether the interchangeability of, or cross-
elasticity of demand between, DPI-approved ingredients and
supplies and other ingredients and supplies is sufficient to
make the alleged relevant market invalid. The issue,
whether under the framework of market power as it was in
Kodak, or as market definition as here, is whether
_________________________________________________________________
2. The basic definition of market power is "the power to raise prices
above competitive levels without losing so many sales that the price
increase is unprofitable." Herbert Hovenkamp, Federal Antitrust Policy:
The Law of Competition and its Practice S 3.1, at 79 (1994) (footnote
omitted).
27
competition from other providers of ingredients and
supplies for pizzas will restrain the power of DPI over
ingredients and supplies it sells to franchisees. See Kodak,
504 U.S. at 469 n.15. The plaintiffs allege not only that
they are limited to buying ingredients and supplies from
DPI, but also that information and switching costs
prevented them from anticipating and being able to respond
to DPI's power to substantially raise price for the
ingredients and supplies. They allege that competition from
independent providers of ingredients and supplies does not
restrain DPI's power in the aftermarket for ingredients and
supplies, and therefore ingredients and supplies not
approved by DPI need not be included in the relevant market.3
Information and Switching Costs
A closely related problem with the district court's opinion
is its scant treatment of information and switching costs
and their relevance to defining a valid relevant market. The
plaintiffs argue that they have experienced information and
switching costs which have prevented them from
_________________________________________________________________
3. The majority, in footnote 17, ante at 20, states that the district
court's
approach has "received support in recent scholarly literature," citing
Alan J. Meese, Antitrust Balancing in a (Near) Coasean World: The Case
of Franchise Tying Contracts, 95 Mich. L. Rev. 111, 128 (1996). However,
Professor Meese does not argue that the approach taken is correct under
current antitrust law. In fact, on page 126 he concedes that the Kodak
decision "found that the existence of relationship-specific investments
can confer `market power' ", and at 152-55 he states that "under current
law" franchisors may have market power over derivative aftermarkets
due to "lock-in" of the franchisees, and because of this he proposes a
new framework for analyzing such claims. He argues that "the focus on
market power and less restrictive alternatives, though perfectly natural
given the partial equilibrium framework that dominates antitrust law
and the premises that underlie tying jurisprudence," does not properly
apply to the franchise tying context. Id. at 128. Professor Meese argues
that tying contracts that reduce free riding, a form of opportunistic
behavior taken at the expense of the franchise system, should be prima
facie legal. Whatever the value of Professor Meese's argument, he
presupposes that "under current law" from the Supreme Court the
district court in this case may have erred. Id. at 152. In addition, it is
not even clear that Professor Meese would find the plaintiffs' allegations
insufficient as a matter of law because they allege that DPI charged
supracompetitive prices for the ingredients and supplies. See id. at 155.
28
anticipating or responding to the price increases for
ingredients and supplies from DPI. They argue that these
information and switching costs create a "lock-in" which
makes the aftermarket for DPI-approved ingredients and
supplies the relevant market. Specifically, the imperfect
information they proffer is that the franchisees "could not
foresee that Domino's would not follow the policy
represented in its Offering Circular and would, instead,
commence excluding potential suppliers in order to
foreclose competition in the aftermarket." They suggest
switching costs arise from sunk costs in the franchise,
limits on franchisees's ability to sell their franchise, and
noncompetition covenants in the Standard Franchise
Agreement.
An important part of the Supreme Court's decision in
Kodak that the plaintiffs presented a triable claim was that
"there is a question of fact whether information costs and
switching costs foil the simple assumption that the
equipment and service markets act as pure complements to
one another." Kodak, 504 U.S. at 477. In fact, other circuit
courts have held that the presence of these market
imperfections was the crucial factor in Kodak, and that had
Kodak's policy been known at the time businesses bought
copiers from Kodak, the result would have been different.4
See PSI Repair Servs., Inc. v. Honeywell, Inc., 104 F.3d 811,
820 (6th Cir. 1997) ("We likewise agree that the change in
policy in Kodak was the crucial factor in the Court's
decision. By changing its policy after its customers were
`locked in,' Kodak took advantage of the fact that its
customers lacked the information to anticipate this
change."), cert. denied, 1997 WL 195257; see also Digital
Equip. Corp. v. Uniq Digital Techs., Inc., 73 F.3d 756, 763
(7th Cir. 1996); Lee v. Life Ins. Co. of North America, 23
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4. This conclusion seems quite sensible. If Kodak customers knew about
Kodak's subsequent parts-and-service policy when they bought the
copiers, or were not economically restricted from switching to other
copiers, then Justice Scalia's dissent, which assumes a perfect
competition/perfect information world, should be right. Kodak is merely
a concession to fact that markets do not always work perfectly, and
sometimes, but not always, these imperfections can create sufficient
market power to justify possible antitrust liability.
29
F.3d 14, 20 (1st Cir. 1994). Several commentators have
described how the analysis from Kodak could mean that
franchisors' derivative aftermarkets may be relevant
antitrust markets. Meese, 95 Mich. L. Rev. at 152 ("Under
current law, [post-contract market power] can arise once
the cost to the franchisee of switching to a different
franchise is significant. . . ."); Warren S. Grimes, When Do
Franchisors Have Market Power? Antitrust Remedies For
Franchisor Opportunism, 65 Antitrust L.J. 105, 112 (1996)
("A franchisor has market power if it can, without losing
substantial sales, raise the price of a good or service sold to
a franchisee above the level at which an equivalent good or
service is available from other suppliers."); see also Robert
H. Lande, Chicago Takes It On The Chin: Imperfect
Information Could Play A Crucial Role In The Post-Kodak
World, 62 Antitrust L.J. 193, 195 (1993) ("Another
important lesson of Kodak is that imperfect information can
be a crucial factor in defining relevant markets."). But see
Alan Silberman, The Myths of Franchise "Market Power", 65
Antitrust L.J. 181, 217 (1996).
Uniqueness
In rejecting the plaintiffs' theory that the information and
switching costs they face justify the alleged relevant market
under Kodak, the majority states: "Kodak does not hold
that the existence of information and switching costs alone,
such as those faced by the Domino's franchisees, renders
an otherwise invalid relevant market valid." Ante at 16
(footnotes omitted). Both the district court and the majority
make a more difficult argument, that a necessary factor in
Kodak was that the repair parts were "unique." They state
that this uniqueness is what gave Kodak market power,
and that the lack of this factor herein warrants rejecting
the plaintiffs' alleged relevant market. The basis for not
applying Kodak in this case lies in two arguments: (1) the
aftermarket ingredients and supplies are not unique, and
(2) the franchisees knew of the policy bec