Appendix — American Telephone & Telegraph Co. v. MCI Communications Corp.

No. 82- —

In The

Supreme Court of the United States

October Term, 1982

AMERICAN TELEPHONE AND TELEGRAPH

COMPANY,

Petitioner,

\

MCI COMMUNICATIONS CORPORATION and

MCI TELECOMMUNICATIONS CORPORATION,

Respondents

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES

COURT OF APPEALS FOR THE SEVENTH CIRCUIT

APPENDIX TO PETITION FOR WRIT OF CERTIORARI

HOWARD J. TRIENENS*

GEORGE L. SAUNDERS, JR.

Of Counsel THEODORE No MILLER

Jim G. KiLPatRee

RAYMOND BRENNER One First National Plaza

Siptky & AUSTIN Chicago, Illinois 60603

(312) 83-7000

alte K. 1983

Dated July d Counsel for Petitioner

*Counsel of Record

TABLE OF CONTENTS

PAGE

Appendix A Opinion of Court of Appeals for the

Seventh Circuit ..c.cccecssceceseser la

Appendix B Order of Court of Appeals Denying Pet-

tions for Rehearing, With Suggestions for

Rehearing En Banc ..... cece eeeeeees 239a

la

APPENDIX A

OPjinion of Court of Appeals

for the Seventh Circuit

2a

iu the

United States Court of Appeals

For the Seventh Cirenit

Nos. 80-2171 and 80-2288

MCI COMMUNICATIONS CORPORATION and

MCI TELECOMMUNICATIONS CORPORATION,

Plaintiffs-A ppellees,

Uv.

AMERICAN TELEPHONE AND TELEGRAPH COMPANY,

Defendant-A ppellant.

Appeal from the United States District Court for the

Northern District of Illinois, Eastern Division

No. 74-C-633—John F. Grady, Judge.

ARGUED APRIL 19, 1982%*—DECIDED JANUARY 12, 1983

* This case was originally argued on April 30, 1981, before a

panel consisting of Circuit Judge Harlington Wood, Jr., Senior

Circuit Judge Thomas FE. Fairchild, and Senior District Judge

Inzer B. Wyatt, of the United States District Court for the

Southern District of New York. Judge Wyatt subsequently was

forced to withdraw from the case on his physician's orders, and

Circuit Judge Richard D. Cudahy was selected by lot from the

judges of this court not disqualified from hearing this case to

replace him. The case was then reargued on April 19, 1982,

before Judges Wood, Cudahy and Fairchild.

3a

TABLE OF CONTENTS

OPINION OF THE COURT

4

II.

III.

IV.

PRI ITEE sett sincakvbdsadohvhanlohatsekeusiininndeceyesrsaviaamvanees

A. Background and Initial Entry of MCI ...

B. The Interconnection Disputes ................

C. The Execunet Decision ............00. one

D. The Pricing Controversies Between

I a sted

E. MCI’s Damage Evidence ...........ccccccee

Rig TTE ils cicsintannitsosensesvaryseestteonsistéusltanctesiaveye>

A. The Federal Regulatory Scheme for

TelecomMmMunications .....cccccccccccceceeseeeees

Be, WUENE BUMMIINNIIIIED sciceeconcccvsnsvesesoseascivcsssses

C. The Impact of Regulation ...........0..00

PREDATORY PRICING .......ccccccsssssscsessseens

ii sis ecient bcssnsnaseias

I SA UII vcocsccsesscissvvesscssssssvecsese

Defining Measures of Cost ..........6ccc0008

The Proper Cost Standard ................06

CKOSS-BUDBIGIZACION .....0..ccccccrescssscsccccecceeeess

Insufficiency of the Evidence ................

Pre-ANNOUNCEMENT ...........cccccccsssssersssserseees

LOMB OOMD>

INTERCONNECTIONS. .......csccssssssesssesseesess

A. FX-CCSA Interconnections ..............060:

1. The Essential Facilities Doctrine .......

2. The Meaning of the Specialized

Common Carrier Decision ............

3. “Retroactive” Application of

| Br is ECT

4a

ii

4. Instructions on Regulatory Policy ......

5. Insufficient Evidence ............cccccceeeeee

6. Evidentiary Rulings ............cccccccceeeee

7. Substantial Impact ..........ccoccccccssssscsess

TSI cinceicindninictsiaemesaneieseeaniadinieale

SII, sscicicensnnscasncasacbeaiaones

Denial of Interconnections for Service

Outside of Local Distribution Areas ...

Multipoint Service ........c.cccccscoccrsecsssesssees

Inappropriate or Inefficient Inter-

CURD | uicecnccsocacntntamacamenaens

=m DOW

V. BAD FAITH NEGOTIATIONS AND

NOERR-PENNINGTO! | eisasakececniaemniaaal

A. The State Tariff Filings ..............cceee

B. Bad Faith Negotiations ...........cccccccceeeees

Oi. RI SIS: scsccncsisscensevenccsoicnecciadenasin

Vi. CARTERS eicniieinsinenicnannniaian

A. MCI’s Proof of Damages ..............6.0000008

B. Causation of Damages .............cccccceceeeeeees

C. The Flawed Assumptions of the Lost

FUER TN =. ccsistscrcionnaicemenaccnuanena

D. Remand for a Partial New Trial ..........

VII. THE CONDUCT OF THE TRIAL ...........

Be. OR BOE vcicccntsnnceitnutiadinnnaenne

ee. OU BS Cer ees

WEEE. CARP INT ccissistrsrmeinenninaameae

iii

D AEROS ORAS Rene er cape arEr TEEN eN rae 164

I. HI-LO AND PREDATORY PRICING ...... 166

A. The Inappropriateness of Exclusively

Cost-Based Standards ...........ccccccceees 166

1. The History and Goals of the

IID TINIE od ncsiertadnenbepuennenveassinns 170

2. LRIC and Consumer Welfare in the

Monopoly Context .......cccccceccsceeeseceees 176

B. Evidence of AT&T’s Predatory

3 ne en a UE en 183

II]. PRE-ANNOUNCEMENT OF HI-LO ........ 187

BE, RPMS IIE veccesecniciscsnssreressunsesnesenenbeis 189

ic I a sank pacesalanmebeusanes 190

is + III 1:2 sieentesa guestebecasibiaiiiasemmersionane 199

1. The Revenue Assumption. ...............0. 200

hs HERETO i ea CN OPE 205

Be. SUEY TRAP UCEIOIG vevccvvevscsscccceeiecsesciivesesnses 207

Ss SEE. SUE III --osrasnsncnetinsiesecnbvccsevteiaoeantaee 230

NOTE

Throughout the opinion the following abbreviations are

used: Trial Transcript — Tr., Plaintiff's Exhibit — PX,

Defendant’s Exhibit — DX, and Appendix of this Opin-

ion — App.

Nos. 80-2171 & 80-2288 1

Before Woop and CUDAHY, Circuit Judges, and FAIR-

CHILD, Senior Circuit Judge.

CUDAHY, Circuit Judge. In this extraordinary anti-

trust case,! defendant American Telephone and Tele-

graph Company (“AT&T”) appeals from a judgment in

the amount of $1.8 billion, entered on a jury verdict, ina

treble damage suit brought by plaintiffs MCI Communij-

cations Corporation and MCI Telecommunications Cor-

poration (collectively “MCI”) under section 4 of the

Clayton Act, 15 U.S.C. § 15 (1976)?

I. FACTS

MCI’s original complaint, filed March 6, 1974, con-

tained four separate counts: monopolization, attempt to

monopolize, and conspiracy to monopolize—all under sec-

tion 2 of the Sherman Act'—and conspiracy in restraint

' The author of this opinion recognizes his debt and expresses

his appreciation to Judge Wood, whose draft of this opinion

me ot important ground and formed a basis for what has

become the majority opinion. Although Judge Wood and the

author disagree on some of the points at issue here, we agree

fully about the Herculean joint efforts required to produce

such a “weighty” finished product. Further, we both recognize

the important contributions of Judge Fairchild to this product.

Section 4 of the Clayton Act, 15 U.S.C. § 15 (1976), provides

as follows:

Any person who shall be injured in his business or

roperty by reason of anything forbidden in the antitrust

aws may sue therefor in any district court of the United

States in the district in which the defendant resides or is

found or has an agent, without respect to the amount in

controversy, and shall recover threefold the damages by

him sustained, and the cost of suit, including a reasonable

attorney's fee.

* Section 2 of the Sherman Act, 15 U.S.C. § 2 (1976), provides

in relevant part: “Every person 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 com-

— among the severa! States .. . shall be deemed guilty of a

elony... .”

2 Nos. 80-2171 & 80-2288

of trade—under section 1 of the Sherman Act. MCI al-

leged that AT&T had committed twenty-two types of

misconduct, classifiable into several categories includ-

ing predatory pricing, denial of interconnections, negoti-

ation in bad faith and unlawful tying. MCI claimed at

trial, on the basis of a lost profits study originally pre-

pared in part for financing purposes, that it had suffered

damages of approximately $900 million as a result of

AT&T's allegedly unlawful! actions.‘

The case was tried to a jury between February 6 and

June 13, 1980. After completion of MCI’s case in chief,

the district court directed a verdict in favor of AT&T on

seven of the twenty-two alleged acts of misconduct.’ The

remaining fifteen charges—all based on section 2 of the

Sherman Act—were submitted to the jury. A special

verdict form required the jury to make a separate find-

ing of liability as to each of the fifteen charges, but per-

mitted the jury to award damages in a single lump sum,

without apportioning MCI’s claimed financial losses

4 AT&T also filed a counterclaim against MCI alleging that

MCI attempted and conspired to monopolize the om Baer

market and actually monopolized the St. Louis-Chicago seg-

ment, conspired to restrain trade in the relevant market, and

wrongfully acquired stock or share capital of other cor-

porations, which substantially lessened competition. The dis-

trict court did not permit any of these allegations to go to the

jury, and AT&T does not challenge the propriety of that action

on appeal.

5 The district court directed a verdict in favor of AT&T on the

following seven allegations: (1) inducing Western Union to file

a tariff which mirrored the St. Louis-Chicago charges of MCI;

(2) increasing AT&T's capacity to conduct business in data

communications for the purpose of destroying competition; (3)

introducing experimental service to discourage tential

customers from dealing with MCI; (4) disparaging MCI; (5)

bringing sham proceedings before certain administrative and

judicial bodies; (6) participating in a massive public propa-

ganda campaign conducted against MC]; and (7) refusing to

provide Joint Telpak (a special tariff) to MCI. MCI does not

challenge the propriety of the district court's directed verdict

on any of these issues.

8a

Nos. 80-2171 & 80-2288 3

among AT&T’s various lawful and unlawful acts. The

jury found in favor of MCI on ten of the fifteen charges

submitted, and awarded damages of $600 million—a sum

equal to two thirds the total damage figure claimed in

MCI’s aggregated lost profits study.* The district court

trebled this damage award, as required by section 4 of

the Clayton Act, resulting in a judgment of $1.8 billion,

exclusive of costs and attorneys’ fees.

AT&T filed motions for judgment notwithstanding the

verdict or, in the alternative, for a new trial on June 23,

1980. These motions were denied without opinion on July

29, 1980. On August 25, 1980, AT&T filed its notice of

appeal. On September 8, 1980, MCI filed a notice of

cross-appeal.’ In this opinion, we reject challenges to

certain jury findings upon which AT&T's liability was

based, sustain other challenges, and remand for a new

trial on the issue of damages.

A. Background and Initial Entry of MCI

Prior to 1969, the telecommunications industry was

regulated as a lawful monopoly. Local exchange service

was and still is provided exclusively by one of the twenty-

three Bell System operating companies or by one of some

1600 independent telephone companies, depending upon

the geographical area involved.* Long distance service

6 i” Special Verdict is reprinted in the Appendix. See infra,

p.

’ Because we hold that Judge Grady did not err in refusing to

admit evidence alleging destruction of documents by ATT.

we do not reach a motion filed by AT&T to strike a portion of

MCI’s reply brief on this issue.

* Local exchange telephone service is the ordinary service

provided in nearly all homes and businesses. From a technical

standpoint, it involves a wire connection between the telephone

set and a switching machine in a nearby telephone company

central office which is connected by transmission trunks to the

switching machines in other central offices within the ex-

change area. When the telephone is taken off the hook—or in

the case of multiple telephones behind a private branch ex-

(Footnote continued on following page)

9a

4 Nos. 80-2171 & 80-2288

was provided by the Long Lines Department of AT&T in

partnership with these operating companies.’ The net-

work of long distance transmission facilities was owned

in substantial part by Long Lines; however, the inter-

exchange facilities of the local telephone companies, in-

cluding both transmission and switching facilities, were

used in conjunction with Long Lines facilities whenever

efficiency required. The local exchange facilities and

switching machines belonging to the local companies

were also used at each end of a regular long distance call.

This same nationwide network was used as well by

AT&T to provide other intercity telephone services, in-

cluding point-to-point private lines, foreign exchange

lines (“FX”), and common control switching arrange-

ments (“CCSA”). Point-to-point private lines (also called

tie lines) are connections between two locations that do

not require the use of local switching machines because

the lines are available to the customer on a continuing

and exclusive basis. FX and CCSA, although classified

for tariff purposes as private line services, do require

interconnection with local switching machines.'®

* continued

change, when a designated access code such as “9” is dialed—a

signal is sent to the central office. The switching machine in

the central office responds to this signal by sending a dial tone

that enables the calling party to dial any telephone connected

yg switched network within that exchange area. See DX

* Long distance service operates in a manner similar to local

exchange service but typically involves a two-step process in

which the user first gains access to the local switching machine

through a dial tone and then a access to the long dis-

tance toll switching machine < ialing an area code plus the

number of the telephone the calling — wishes to reach. If a

circuit is available to handle the call, it is routed through the

calling party’s central office to a toll office nearby, over an in-

tercity circuit to a toll office in the city that is being called, and

finally through the central office that serves the called

telephone to that telephone. Wade, Tr. 3903-04; Marshall, Tr.

4893; DX 1828, 1833.

0 From a technical standpoint, FX and CCSA services are

similar to local exchange service in that they provide a connec-

(Footnote continued on following page)

10a

Nos. 80-2171 & 80-2288 5

In 1963, Microwave Communications, Inc., the prede-

cessor corporation to MCI,'! requested permission from

the Federal Communications Commission (“FCC”) to con-

struct and operate a long distance telephone system be-

tween Chicago and St. Louis. The proposed system con-

sisted of a terminal in each city and microwave radio

relay towers connecting the terminals. Through this sys-

tem, MCI intended to provide long distance, private line

telephone service to business and industria! subscribers

whose needs justified the exclusive or semi-exclusive use

of a long distance telephone line. MCI also sought inter-

connections from its terminals to ordinary local telephone

facilities, principally telephone wires running in conduits

beneath the street. These interconnections were essential

to MCI’s ability to do business, since they provided the

telephone or computer linkage between MCI’s terminals

and its individual customers in each city.

In 1969, after lengthy administrative proceedings in

which AT&T and the other general service carriers op-

1° continued

tion into a switching machine in a telephone company central

office which responds to requests for network access by send-

ing a dial tone. The distinguishing aspect of FX service is that

the switching machine to which the telephone is connected is

not located in the nearby telephone company central office but

is in a distant office, as, for example, where a telephone located

in Chicago is connected to a switching machine in New York

City. Such an arrangement permits the user to make and

receive calls in the distant city as though they were local calls,

i.e., aS if the subscriber had a local telephone in the distant

city. For this reason, FX service is frequently used by such

businesses as airlines and hotel reservation agents.

CCSA service offers a similar advantage to large subscribers

who wish to link far flung branches or offices to each other via

private telephone lines connected through switches in the local

telephone company office. In essence, CCSA service allows a

large subscriber to obtain a personal mini version of the

nationwide telephone network. The FTS line that connects

federal government offices is one example of a CCSA-type ser-

vice.

‘In this opinion, Microwave Communications, Inc., as well as

its successor corporations, are collectively referred to as MCI.

lla

6 Nos. 80-2171 & 80-2288

posed MCI’s application, the FCC approved MCI’s pro-

posal. Microwave Communications, Inc., 18 F.C.C.2d 953,

966 (1969); 21 F.C.C.2d 190 (1970).'* The FCC's decision

specifically authorized MCI to provide only point-to-point

private line service not requiring connection to the nation-

wide switched network—that is, tie lines that would

connect two or more locations without the use of switch-

ing machines. 18 F.C.C.2d at 953-54. The FCC also

retained jurisdiction to order appropriate local inter-

connections.

The MCI decision resulted in a deluge of new appli-

cations to the FCC for authority to construct and oper-

ate facilities for specialized common carrier services.

MCI filed applications for authority to provide special-

ized services among more than 100 cities. Other com-

panies filed similar applications, creating a situation in

which, in many instances, more than one carrier was seek-

ing to provide specialized services over the same route.

To deal with this situation, the FCC instituted a broad

rulemaking inquiry designed to permit consideration in

one proceeding of the policy questions raised by these

numerous applications. Specialized Common Carriers, 24

F.C.C.2d 318 (1970) (Notice of Inquiry).

In June 1971, the FCC handed down its Specialized

Common Carriers decision, approving in principle the

entry of specialized carriers into the long distance tele-

communications field, and declaring as a matter of policy

that there should be open competition in the specialized

The general service carriers argued that the entry of

specialized common carriers into the telecommunications in-

dustry would be contrary to the public interest because

telecommunications services could provided more eco-

nomically by a oe 7 because additional micro-

wave systems would be duplicative and wasteful; and be-

cause specialized carriers without general service respon-

sibilities would “cream-skim” the existing averaged rate struc-

ture by selectively competing only along the most profitable

long distance routes, thus imposing a heavier rate burden on

low density and local telephone users.

Nos. 80-2171 & 80-2288 7

services to which the decision applied. 29 F.C.C.2d 870

(1970). Because AT&T, reversing its earlier position,

agreed to negotiate with MCI and other new entrants for

local interconnections, the FCC elected to defer consider-

ation of MCI’s claim that AT&T was misusing its power

over local telephone service to gain a competitive advan-

tage over potential specialized competitors.

The FCC’s Specialized Common Carriers decision was

hardly a model of clarity.'* The decision did not define

the specialized services to which it referred, nor did it

define the corresponding obligations that the FCC ex-

pected the general carriers (primarily AT&T) to assume

in order to assist the new carriers. AT&T contended, both

at the time of the FCC decision and throughout the

pendency of this lawsuit, that the Specialized Common

Carriers decision authorized only point-to-point private

line services not requiring switched network connections,

and that the obligations of the Bell System extended only

to providing local distribution facilities for these point-to-

point private line services. MCI, by contrast, has con-

sistently taken the position that the Specialized Common

Carriers decision authorized it to provide FX and CCSA

type services, as well as point-to-point private lines, and

that AT&T had a corresponding obligation to provide it

with the switched network connections required for these

services. MCI also contended, both before and after the

Specialized Common Carriers decision, that AT&T was

obligated to provide it with loca! distribution facilities at

the same rate at which AT&T provided such facilities to

Western Union, under a longstanding contract between

those two carriers. AT&T disagreed, claiming that the

contract then in effect with Western Union did not re-

flect AT&T's current costs, and that the price charged to

MCI for local! distribution facilities should be set so as to

recover AT&T's costs on a current basis.

‘Indeed, the district judge in this case characterized the

decision as an “abomination” and “one of the worst examples of

legal draftsmanship | have ever seen.” Tr 2785

}3a

8 Nos. 80-2171 & 80-2288

In September 1971, AT&T entered into interim con-

tracts with MCI defining the kinds of interconnections

that AT&T would provide for MCI’s initial Chicago-St.

Louis route and establishing the price for those inter-

connections. These contracts did not permit switched net-

work connections for FX or CCSA type services, nor was

the price set by the contracts for local distribution

facilities comparable to that charged to Western Union.

During this same time period, the original MCI in-

vestors joined forces with William McGowan, an experi-

enced business executive and engineer, to form a venture

that envisioned the eventual construction and operation

of a nationwide long distance telephone system. After

scrutiny of the market it believed had been opened by the

Specialized Common Carriers decision, MCI created a

plan contemplating sales of 74,000 circuits (leased tele-

phone lines) having an average length of 500 miles per

circuit, or approximately 37 million circuit miles’ by

the end of 1975. According to this plan, MCI expected its

revenues to average $1.00 per circuit mile excluding

AT&T's local connection charges, which MCI intended to

pass on to its customers. Projected annual revenues for

1975 were approximately $350 million. Armed with these

projections, MCI proceeded to raise $110 million by June

1972, making it one of the largest start-up ventures in the

history of Wall Street. The funds were raised after re-

view and analysis by leading lenders and large equip-

ment suppliers who were either lending the funds or

underwriting or guaranteeing the financing.

MCI commenced operations over its Chicago-St. Louis

route on January 1, 1972. In the fall of 1972, MCI began

construction of the first segment of its nationwide sys-

tem, extending east and south from the original Chicago-

St. Louis route. MCI initially expected to complete

the first portion of its national network and commence

customer service over major parts of the system by

“ Circuit miles measure the total distance covered by all lines

leased by customers in a given month. Mctiowan, Tr. 355-56

Ida

Nos. 80-2171 & 80-2288 9

late summer 1973. Expansion to a second and a third

group of smaller cities was to follow over the next three

years. MCI planned to fund these capital expenditures

from its initial $110 million capitalization, from substan-

tial additional anticipated financing, and from operating

revenues.

B. The Interconnection Disputes

During late 1972, while construction was progressing,

MCI entered into negotiations with AT&T over the pro-

vision by AT&T of interconnections and local distribu-

tion facilities on the expanded MCI system. Because MCI

had previously experienced difficulty obtaining satis-

factory interconnections for its Chicago-St. Louis seg-

ment, MCI hired an experienced lawyer-negotiator to

secure a national interconnection agreement with AT&T

that would permit MCI to serve the entire market it

believed the FCC had opened. These negotiations began

in September 1972, and continued with little progress for

the next nine months.

During this same period, MCI appealed to the FCC for

help in breaking down what it viewed as AT&T's unrea-

sonable negotiating stance. Through a series of informal

complaints and conferences with FCC staff, MCI charged

that AT&T was treating it unfairly, on the question of

interconnections, in at least three respects:

(1) MCI claimed that AT&T was unlawfully deny-

ing it interconnections to the switched network for

FX and CCSA services and for point-to-point service

to customers located outside a local distribution

area,’® including multipoint service;'*

The dispute over local distribution areas related to the

geographic boundaries within which AT&T was obhgated to

provide ocal facilities to MCL See infra. pp. 107-110

Multipoint service involves a situation in which a customer

has an AT&T private line between Cities A and B, and an MCI

private line between Cities 2 and © MCI claimed that it was

entitled to an interconnection between tts terminal and the

tnot ntinued following page)

15a

10 Nos. 80-2171 & 80-2288

(2) MCI claimed that it was being charged exces-

sive and discriminatory prices for the local distri-

bution facilities provided by the Bell System; and

(3) MCI claimed that it was being harassed by Bell

System employees in the provision of local distribu-

tion facilities through delays, improper installation,

improper maintenance and other similar practices.

AT&T denied each of these charges. Both in its direct

dealings with MCI and in its responses to FCC staff

members, AT&T adhered to the position that the Special-

ized Common Carriers decision authorized only private

line service not requiring switched network connections.

AT&T also contended that it was providing MCI with all

the interconnections to which MCI was entitled and that

the prices it was charging for those interconnections

were not excessive or unfair.

In August 1973, with negotiations still pending, and

without informing MCI, AT&T decided to file with forty-

nine of the state utility commissions interconnection tar-

iffs that would be equally applicable to all carriers—in-

cluding MCI and Western Union. By filing interconnec-

tion tariffs with the state commissions rather than with the

FCC, AT&T made it more difficult for MCI to oppose the

tariffs, since, in the words of one AT&T official, the inter-

connection “controversy would spread to 49 jurisdictions.”

PX 2148 at 2031. Even after making this unilateral tariff

decision, AT&T continued to “negotiate” with MCI. After

MCI accidentally learned of the state tariff plan, how-

ever, AT&T formally broke off all contract negotiations.

In early October 1973, several top MCI officials met

with Bernard Strassburg, Chief of the FCC Common

(arnier Bureau, to discuss a plan designed to resolve the

interconnection controversies between MC'l and AT&T.

‘6 continued

AT&T terminal in City B so that the customer could obtain

direct, MC] provided service between City A and City ©

Revenues for the City A to City B segment would, of course,

redound to AT&T. See infra, pp. 111-116

l6a

Nos. 80-2171 & 80-2288 1

Pursuant to this plan, FCC Chairman Burch, on October

4, 1973, issued a letter on behalf of the Commission,

rejecting AT&T's resort to state regulatory agencies as

unlawful and asserting exclusive F.C.C. jurisdiction over

the interconnection dispute. Shortly thereafter, MCI

wrote to Mr. Strassburg, inquiring as to the nature and

scope of the services that MCI was authorized to pro-

vide and for which AT&T was obliged to supply inter-

connections under the Specialized Common Carriers

decision. Mr. Strassburg replied by letter dated October

19, 1973, that these services included FX and CCSA, as

well as services outside local distribution areas and

multipoint services. On November 2, 1973, MCI filed a

complaint in federal district court under section 406 of

the Communications Act asking that AT&T be ordered to

provide interconnections for these services.

On December 31, 1973, the United States District Court

for the Eastern District of Pennsylvania issued a prelimi-

nary injunction ordering AT&T to provide all of the in-

terconnections sought by MCI, on the theory that such

interconnections were contemplated and required by the

FCC's Specialized Common Carriers decision. MCI Com-

munications Corp. v. AT&T, 369 F. Supp. 1004 (E.D. Pa.

1973). AT&T provided the required interconnections, but

immediately appealed the district court’s injunction.

Meanwhile, the FCC, on December 13, 1973, issued its

own order requiring AT&T to show cause why it should

not be held to have violated the Specialized Common

Carriers decision by refusing to provide the intercon-

nections requested by MCI.

On April 15, 1974, the Third Circuit reversed the pre-

liminary injunction issued against AT&T. MCI Com-

munications Corp. v. AT&T, 496 F.2d 214 (3d Cir. 1974).

On April 16, 1974, despite assurances that the FCC's

“show cause” decision was expected “any day now,” and

despite FCC warnings that disconnection of MCI’s cus-

tomers would violate the Communications Act, AT&T

ordered its local operating companies to disconnect MCI’s

customers on twenty-four hours notice. MCI alleged that

the resulting disconnections caused turmoil among its

17a

12 Nos. 80-2171 & 80-2288

customers and seriously damaged its reputation for re-

liable service. On April 23, 1974—eight days after the

Third Circuit had vacated the injunction obtained by

MCI—the FCC issued a decision ordering AT&T to pro-

vide the disputed interconnections. Bell System Tariff

Offerings of Local Distribution Facilities for Use by Other

Common Carriers, 46 F.C.C.2d 4138, affd sub nom. Bell

Telephone Co. v. FCC, 503 F.2d 1250 (3d Cir. 1974), cert.

denied, 422 U.S. 1026 (1975). The FCC held that it had

intended to include both FX and CCSA services within

the terms “specialized” or “private line” services as those

terms were used in the Specialized Common Carriers

decision. 46 F.C.C.2d at 425-27. AT&T provided the re-

quested interconnections within ten days of the FCC's

order.

C. The Execunet Decision

In October 1974, MCI filed a tariff with the FCC for

what the tariff referred to as metered use private line

services, principally a service called “Execunet.” Al-

though the FCC did not immediately perceive it as such,

this tariff was apparently designed to permit MCI to

provide ordinary switched long distance service to users

in any city to which its microwave system extended. See

MCI Telecommunications Corp., 60 F.C.C.2d 25, 40-43

(1976) (the “Exrecunet decision”). When the FCC dis-

covered the nature and purpose of the new tariff, it

declared the tariff unlawful and ordered MCI to dis-

continue providing ordinary long distance message serv-

ice on the ground that the Specialized Common Carriers

decision limited MCI’s authorization to the provision of

private line services. 60 F.C.C.2d at 35-44, 58.

MCI appealed the FCC’s E-recunet decision to the Court

of Appeals for the District of Columbia Circuit and, in

July 1977, the Court of Appeals set the decision aside.

MCI Telecommunications Corp. v. FCC, 561 F.2d 365

(D.C. Cir. 1977), cert. denied, 434 U.S. 1040 (1978). In its

opinion, the Court of Appeals assumed, without deciding,

that “a service like Execunet was not within the contem-

plation of the [FCC] when it made the Specialized Com-

l8a

Nos. 80-2171 & 80-2288 13

mon Carriers decision,” 561 F.2d at 378, but held that the

FCC had not conducted a sufficient hearing—either dur-

ing the Specialized Common Carriers proceeding or at

any subsequent time—to justify any limitation on the

operating authority of MCI and the other new special-

ized carriers. Jd. at 378-80.

This decision by the District of Columbia Circuit—

handed down long after the events involved in the in-

stant case occurred—rendered virtually meaningless the

debate between MCI and AT&T over the proper inter-

pretation and definition of the specialized private line

services to which the Specialized Common Carriers de-

cision applied. AT&T also claims that it was only by

virtue of this Court of Appeals decision that MCI was

able to achieve profitability since, according to AT&T,

MCI’s costs for private line services (including FX and

CCSA) substantially exceeded the rates AT&T was then

charging its large users under the Telpak tariff. See

infra, pp. 15-17.

D. The Pricing Controversies Between MCI and AT&T

From the time of MCI’s entry into the telecommunica-

tions field, AT&T's prices for specialized long distance

services had been a significant source of controversy.

Initially the principal controversy centered on AT&T's

Telpak tariff. The Telpak tariff, which accounted for

most of AT&T's private line circuits at the time MCI

commenced operations, offered private line service to

large users under two schedules: (1) the user could obtain

the right to up to 60 circuits between any two points for

$30 per mile per month, or an average of $.50 per circuit

mile per month if all circuits were being used; or (2) the

user could obtain the right to up to 240 circuits between

any two points for $85 per mile per month, or an average

of $.35 per circuit mile per month if all 240 circuits were

being used. PX 821.

AT&T originally instituted its Telpak tariff in 1961 as

a competitive response to the FCC's decision to permit

large telephone users to construct and operate their own

19a

14 Nos. 80-2171 & 80-2288

private microwave systems.'’ At the time MCI entered

the industry, in 1969, a number of microwave manu-

facturers were contending in proceedings before the FCC

that Telpak rates were too low and unfairly hindered

efforts to interest large users in building their own

microwave systems. At the same time, however, a num-

ber of large users, including the federal government,

were resisting any efforts to increase the Telpak tariff

and, indeed, were contending that Telpak rates were

already too high.

In 1968, shortly before MCI obtained its first author-

ization to enter the telecommunications industry, AT&T

was permitted to increase its Telpak rates on an interim

basis. During the period 1969-1972, AT&T was able—

over the strenuous objections of some Telpak users—to

obtain FCC approval for two additional rate increases.

Although MCI contended strongly before the FCC that

AT&T's Telpak tariff did not cover its fully distributed

costs and was therefore predatory, the FCC, in 1977,

ae rejected all of the attacks upon the Telpak

tariff.'*

Concurrent with MCI’s entry into the telecommuni-

cations field, AT&T also initiated studies to consider

nationwide deaveraging of its rates for individual private

line service. Pursuant to these studies, AT&T formu-

lated a plan known as the Hi-Lo tariff, which provided

for the deaveraging of AT&T’s individual private line

'' For a detailed description of Telpak and how it works, see

American Trucking Ass'ns, v. FCC, 377 F.2d 121, 124-27 (D.C.

Cir. 1966), cert. denied, 386 U.S. 943 (1967).

'* AT&T, Revisions ef Taryff F.C.C. No. 260 Private Line Ser-

vices, Series 5000 (TELPAK), 64 F.C.C.2d 971, 983-89 (1977).

This holding was affirmed by the Court of Appeals for the Dis-

trict of Columbia Circuit after the completion of the trial in the

instant case. Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221,

1223 (D.C. Cir. 1980), cert. denied, 541 U.S. 920 (1981).

Nos. 80-2171 & 80-2288 15

service into two principal rate categories.'* Under Hi-Lo,

AT&T would lower its rates on certain “high density”

long distance routes, many of which MCI planned to

serve. At the same time, AT&T would increase its rates

between so-called “low-density” cities, most of which MCI

was not planning to serve. In February 1973, the month

after MCI had announced its plans and prices for nation-

wide service, AT&T announced Hi-Lo to the public and

sought permission from the FCC to file the new tariff.

AT&T did not actually receive permission to file its Hi-

Lo tariff until November 15, 1973, and the new tariff

finally became effective on June 13, 1974.

E. MCI’s Damage Evidence

Faced with unproductive negotiations, a “chilled” mar-

ket caused by AT&T's early announcement of Hi-Lo, and

curtailed sales commitments stemming in part from

customer awareness of MCI’s interconnection difficulties,

MCI in mid-1973 began to pare down its construction

program. Because the company’s revenues were sub-

stantially lower than originally anticipated, MCI de-

cided to defer construction on fifteen of the thirty-four

routes contained in its original plan. In addition, MCI

terminated almost one-third of its employees and re-

negotiated its bank loans to secure permission to use loan

proceeds for working capital rather than for additional

construction. Although MCI survived and eventually

prospered, it alleges in the instant lawsuit that by the

'* AT&T had initiated studies to consider a deaveraged rate

structure as early as 1970. shortly after the FCC's approval of

MCIl's Chicago-St. Louis line. The initial proposal resultin

from those studies was a so-called “exception tariff” which

would have matched M(l's rate over the Chicago-St. Louis

route as soon as MC! commenced operations. Warned by its

economic advisors that such an exception tariff oad be

perceived as violative of the antitrust laws, AT&T decided

inst this approach and opted, instead, for the development

of a broadly deaveraged national rate structure. deButts, Tr

4038-39

2la

16 Nos. 80-2171 & 80-2288

time the interconnection dispute was finally resolved, in

May 1975, it had a far smaller system, slower growth

rate and related lower net cash flows and profits than it

would have had absent AT&T’s unlawful interference.

At trial, MCI’s proof of damages was based almost

entirely on a lost profits study authored by MCI’s former

controller, Mr. Uhl. This study compared the profits that

a hypothetical MCI—undamaged by AT&T’s allegedly

unlawful actions—would have enjoyed with MCI’s actual

and projected profit figures for the years 1973-1984.”

The revenues posited for the “undamaged” MCI were

based upon projections made by MCI in 1971-1972 and

previously used for financing purposes. Among other pre-

sumptions, these revenue projections assumed that

AT&T’s Telpak service—which the jury in this case

found to be lawfully priced and marketed—would not be

in existence during the relevant time period. Costs for the

“undamaged” MCI were derived from MCI’s actual oper-

ating experience. These revenue and cost projections

were then used to compute MCI’s “lost profits,” measured

in net cash flow, for each of the years 1973-1994.2'! These

computations resulted in an aggregated before-tax dam-

age claim of $900,468,000.

AT&T, at trial, sharply disputed the accuracy of MCI’s

revenue projections. AT&T argued that MCI’s own lost

profits study demonstrated that MCI could never have

achieved profitability in the private line business, even

including FX and CCSA services, since MCI’s costs for

such services substantially exceeded the rates AT&T was

then charging its large business users under the Telpak

tariff. According to AT&T, MCI’s lost profits study

showed MC I's costs to be $.63 per circuit mile per month

2% =6The revenue projections for the “undamaged” MCI were ad-

justed Paced to account for some delays and uncertainties

that MC1 officials felt were not fairly attributable to AT&T

See Uhl, Tr. 3228-37; PX 12038

“) MCI assumed that the effects of AT&T's allegedly unlawful

conduct would be completely eliminated as of 1995

ty

ty

Nos. 80-2171 & 80-2288 17

assuming that it could obtain local distribution facilities

at the Western Union contract rates and $.74 per circuit

mile per month, if it had to pay for those facilities on the

basis of the current prices charged by AT&T. On either

basis, AT&T argued that MCI’s costs were substantially

in excess of the Telpak rates and, hence, that MCI could

not have undercut these rates and still have covered its

costs.22 AT&T also argued that because its ordinary long

distance rates are averaged on a nationwide basis, and

because state and federal regulatory policy has tradi-

tionally required AT&T to set its long distance rates high

enough to subsidize its less profitable local telephone

service, MCI and other specialized carriers, by com-

peting exclusively in the most lucrative long distance

markets, could easily undercut AT&T's artificially ele-

vated long distance rates.

Il. REGULATION AND THE ANTITRUST LAWS

A. The Federal Regulatory Scheme for

Telecommunications

The first venture of the federal government into the

regulation of telecommunications was section 7 of the

Mann-Elkins Act of 1910,*° which added telephone and

telegraph companies to the list of common carriers regu-

lated by the Interstate Commerce Commission (“ICC”).

The Mann-Elkins Act imposed upon the newly designated

common carriers the obligation to provide service upon

request at just and reasonable rates, without unjust

discrimination or undue preference“ The Act did not,

# MCI countered this contention by arguing. inter alia, that

AT&T's Telpak rate computations did not include applicable

termination charges and that they failed to account for the

percentage of base capacity actually used by a customer (the

“fill factor”). See infra, pp. 146.147

= Mann-Elkins Act of 1910, ch 309. § 7. 46 Stat 580 544

(1910)

* See Mann-Elkins Act of 1910. ch. 309 §§ 7. 12. 86 Stat 539,

544, 551 (1910)

18 Nos. 80-2171 & 80-2288

however, subject the telecommunications industry to the

broad tariff and regulatory jurisdiction enjoyed by the

ICC over railroads. See Essential Communications Sys-

tems v. AT&T, 610 F.2d 1114, 1117-19 (8d Cir. 1979)

(detailing early regulation of telecommunication and rail-

road industries).

Competition among telephone services in the same geo-

graphic area was, in the early part of the century, a fact

of life. Thus, the enactment, in 1914, of the Clayton Act's

antimerger provisions™ presented a serious obstacle to

the development of an integrated national telephone net-

work. The Willis-Graham Act addressed this problem by

authorizing the ICC to approve the consolidation of tele-

phone company properties into single companies if such

consolidation was “of advantage to the persons to whom

service is to be rendered and in the public interest.”

WillisGraham Act of 1921, ch. 20, 42 Stat. 27 (1921)

(current version at 47 U.S.C. § 221(a)(1976)). The statute

granted express immunity from the antitrust laws for

such consolidations. /d.

Thus, as of 1921, federal law recognized the telecom-

munications industry as a common carrier, subject to the

consumer protection and non-discrimination provisions of

the Mann-Elkins Act and exempt from antitrust liability

for consolidations of competing local service systems. In

other respects, however, the industry was subject to the

antitrust laws. Indeed, in 1914, a government antitrust

suit produced a consent decree against AT&T. See Es-

sential Communications, 610 F.2d at 1119 & n.19. Aside

from the ICC’s jurisdiction to enforce AT&T's common

carrier obligations, AT&T was free to determine its own

rates, return on investment and service obligations. Fed-

eral law did not even impose upon AT&T an obligation

to interconnect with other communications common

carriers, although AT&T's local subsidiaries were sub-

ject to regulation at the state level. /d. at 1119.

% Clayton Act, ch. 323, § 7, 38 Stat. 731 (1914) (current ver-

sion at 15 U.S.C. § 18 (1976).

24a

Nos. 80-2171 & 80-2288 19

In 1934, Congress enacted the Federal Communications

Act, 47 U.S.C. § 151 et seg. (1976), which constitutes the

primary federal regulatory mechanism for the telecom-

munications industry today. The 1934 Act severed regu-

lation of the telephone, telegraph and radio industries

from the ICC, and vested regulatory jurisdiction over

those industries in the newly created Federal Communi-

cations Commission. The Act carried forward, almost

verbatim, many provisions of the Mann-Elkins Act of

1910—for example, the just and reasonable tariff require-

ment and the prohibition against unjust or unreasonable

discrimination. The 1934 Act also imposed certain

new obligations on the telecommunications industry—for

example, the requirement that regulated carriers inter-

connect or establish through routes with other common

carriers. See 47 U.S.C. § 201(a) (1976).

With respect to tariffs, the 1934 Act continued the

prior practice that tariffs be generated, at least in the

first instance, by the carriers themselves. Under section

20% a) of the Act, these tariffs must be filed with the

FCC, and carriers must give the FCC and the public

ninety days notice of any proposed changes. 47 U.S.C.

§ 20%a) (1976); 47 U.S.C.A. § 203(b) (West Supp. 1982).

No charge may be demanded or collected, or any service

rendered, except in accordance with a filed tariff. Jd.

20%c). Section 204 of the Act further authorizes the

CC, either sua sponte or upon request, to conduct a

hearing concerning the lawfulness of the rates embodied

in a proposed tariff and to suspend operation of the tariff

for up to five months. /d. § 204. If the Commission deter-

mines that the new tariff does not meet the requirements

of the Act, it may prescribe a “just and reasonable” sub-

stitute, or set maximum and/or minimum charges to be

observed. /d. § 205; see American Broadcasting Com-

panies v. FCC, 643 F.2d 818, 822 (D.C. Cir. 1980). Any

* Compare Mann-Elkins Act of 1910, ch. 309, §§ 7, 12, 36

Stat. 539, 554, 551 (1910) uith Communications Act of 1934, ch.

652, §§ 201, 202, 43 Stat. 1064, 1070 (1934) (current version at

47 U.S.C. §§ 201(b), 202(a) (1976)).

20 Nos. 80-2171 & 80-2288

carrier which knowingly fails to obey an FCC order

issued under this section is liable for a fine of $1000 per

violation per day. In addition, any common carrier which

does or causes to be done any act prohibited or declared

unlawful by the Communications Act shall be liable “to

the person or persons so injured thereby for the full

amount of damages,” plus attorneys’ fees. 47 U.S.C. § 206

(1976).

B. Implied Immunity

AT&T contends that the district court should have dis-

missed this suit on its motion because the FCC's regu-

latory control over AT&T's conduct renders AT&T im-

mune from antitrust liability.*’ The trial court denied the

motion in a well-reasoned memorandum opinion. MC]

Communications Corp. v. AT&T, 462 F. Supp. 1072 (N.D.

Ill. 1978). Judge Grady traced the legislative history of

the Federal Communications Act, and concluded that

while AT&T is subject to considerable regulatory con-

trol and supervision, there is no indication that the Act

was meant to immunize a carrier such as AT&T from the

antitrust laws. 462 F. Supp. at 1086-87. Moreover, he

concluded, the regulatory scheme to which AT&T is sub-

ject is not so wholly inconsistent with the antitrust laws

as to require immunity. AT&T is not subject to conflict-

ing requirements, nor would it be held liable for deci-

sions which were not its own business judgment. The

district court noted that the FCC did not sanction AT&T's

conduct with regard to interconnections nor dictate its

tariffs. Thus, while certain actions might ultimately have

been subject to agency review, the initial decisions were

the product of AT&T's private business judgment, and

were not so heavily regulated as to remove them from

AT&T's control.

On appeal, AT&T contends that the district court's

decision incorrectly focused on blanket immunity rather

“We acknowledge the brief on this issue of the United States

as amicus curiae,

26a

Nos. 80-2171 & 80-2288 21

than immunity for the particular actions of which MCI

complained. Thus, AT&T argues that the critical ques-

tion left unconsidered by the district court is “whether

the charges in this case do in fact relate to matters basic

to the pervasive regulatory scheme to which AT&T is

subject.” Appellant’s Br. at 188. Our reading of the dis-

trict court’s opinion, however, convinces us that it did not,

as AT&T insists, miss the point now raised on appeal.

While the district court did address the question of

“blanket immunity” (7.e., whether regulation by the FCC

under the public interest standard contained in the Com-

munications Act is wholly inconsistent with the antitrust

laws), 462 F. Supp. at 1074, 1080-82, it also fully con-

sidered AT&T's “fall back position. . . that even though

all of AT&T’s conduct may not be immunized, the FCC,

in its pervasive regulation, has approved each of the

allegedly anticompetitive activities of which MCI com-

plains and that therefore AT&T should obtain at least ad

hoc immunity from antitrust laws.” Jd. at 1078, 1082-

1102. For the reasons largely set forth in the district

court’s memorandum opinion denying AT&T’s motion to

dismiss, we reject AT&T's assertion of implied immunity.

As the district court recognized, the Communications

Act of 1934 does not expressly grant AT&T immunity

from the antitrust laws for the conduct challenged in the

instant case. Nor does the legislative history of the Com-

munications Act indicate how Congress intended that the

Act and the antitrust laws were to be reconciled. See

United States v. AT&T, 461 F. Supp. 1314, 1321 (D.D.C.

1978); Comment, AT&T and the Antitrust Laws: A Strict

Test for Implied Immunity, 85 Yale L. J. 254, 269 (1975).

It is well established, however, that regulated industries

“are not per se exempt from the Sherman Act.” Georgia

v. Pennsylvania R.R., 324 U.S. 439, 456 (1945). “Repeal

of the antitrust laws by implication is not favored and not

casually to be allowed. Only where there is a ‘plain

repugnancy between the antitrust and regulatory pro-

visions’ will repeal be implied.” Gordon v. New York

Stock Exchange, 422 U.S. 659, 682 (1975) (quoting United

States v. Philadelphia National Bank, 374 U.S. 321, 350-

51 (1963)). As a further limitation, repeal is to be re-

22 Nos. 80-2171 & 80-2288

garded as implied only where necessary to make the

regulatory scheme work, and even then, only to the mini-

mum extent necessary. Silver v. New York Stock Ex-

change, 373 U.S. 341, 357 (1963); see National Gerimedi-

polars dg & Gerontology Center v. Blue Cross, 452 U.S.

(1981).

Application of these general principles to a particular

claim of implied immunity requires an evaluation of the

specific regulatory scheme involved and the administra-

tive authority exercised pursuant to that scheme. North-

eastern Telephone Co. v. AT&T, 651 F.2d 76, 83 (2d Cir.

1981), cert. denied, 102 S.Ct. 1438 (1982); see National

Gerimedical Hospital! & Gerontology Center v. Blue Cross.

Thus, in our case, the inquiry must focus upon (1) whether

the activities that are the subject of MCI’s complaint were

required or approved by the Federal Communications

Commission, pursuant to its statutory authority, in a way

that is incompatible with antitrust enforcement, see, e.g.,

Goraon v. New York Stock Exchange, 422 U.S. 659 (1975);

Pan American World Airways, Inc. v. United States, 371

U.S. 296 (1963), or (2) whether these activities are so per-

vasively regulated “that Congress must be assumed to

have forsworn the paradigm of competition.” Northeastern

Telephone, 651 F.2d at 82; see United States v. AT&T, 461

F. Supp. 1314, 1324 (D.D.C. 1978).

With respect to interconnections, we conclude, as did

the district court, that the FCC’s regulatory authority

under the Communications Act does not preclude appli-

cation of the Sherman Act. See 462 F. Supp. at 1089-

96. The mere pervasiveness of a regulatory scheme

does not immunize an industry from antitrust liability

for conduct that is voluntarily initiated. Otter Tail Power

Co. v. United States, 410 U.S. 366, 374 (1973); see Com-

ment, The Application of Antitrust Law to Telecommunt-

cations, 69 Calif. L. Rev. 497, 509 (1981). Although the

FCC has authority to compel interconnection under sec-

tion 201(a) of the Act, the initial decision whether to in-

terconnect rests with the utility, and the record shows

that the FCC did not control or approve of AT&T's ac-

Nos. 80-2171 & 80-2288 23

tions here. Nor has the FCC supervised AT&T's inter-

connection practices so closely that the FCC’s approval

could be inferred. Cf. Gordon v. New York Stock Ex-

change, 422 U.S. 659 (1975)

Other circuits that have considered AT&T's implied

immunity in interconnection-type disputes have uniform-

ly rejected arguments the same as or similar to those

made by AT&T in the instant case. See, e.g., North-

eastern Telephone Co. v. AT&T, 651 F.2d 76 (2d Cir.

1981), cert. denied, 102 S.Ct. 1438 (1982); Phonetele, Inc. v.

AT&T, 664 F.2d 716 (9th Cir. 1981), cert. denied, 51

U.S.L.W. 3533 (1983); Mid-Texas Communications Sys-

tems v. AT&T, 615 F.2d 1372, 1377-82 (5th Cir.), cert.

denied, 449 U.S. 912 (1980); Sound, Inc. v. AT&T, 631

F.2d 1324, 1327-31 (8th Cir. 1980) (citing with approval

Judge Grady’s memorandum opinion); Essential Com-

munications Systems v. AT&T, 610 F.2d 1114 (3d Cir.

1979); see also United States v. AT&T, 461 F. Supp. at

1320-30. But see Southern Pacific Communications Co. v.

AT&T, No. 78-0545 (D.D.C. Dec. 21, 1982). We agree with

the reasoning of these decisions and are not persuaded

that a contrary result is warranted here.

AT&T relies heavily on Hughes Tool Co. v. Trans World

Airlines, Inc., 409 U.S. 363 (1973), and Pan American

World Airways, Inc. v. United States, 371 U.S. 296 (1963),

to support its claim that “matters at the heart of a per-

vasive scheme of common carrier, or public utility, regu-

lation [here, presumably, AT&T's interconnection and

pricing policies] are immune from antitrust liability.”

Appellant’s Br. at 183. In both of these cases, however,

the Supreme Court found that the transactions chal-

lenged as violative of the antitrust laws fell precisely

within the detailed scheme of administrative oversight

established by Congress. Thus, in Hughes Tool, the Court

held that where the Civil Aeronautics Board (CAB) had

specifically authorized certain transactions between a

parent and its subsidiary, those transactions were im-

munized from antitrust liability by section 414 of the

Federal Aviation Act, 49 U.S.C. § 1378 (1976). Similarly,

29a

24 Nos. 80-2171 & 80-2288

in Pan American Airways, the Court held that section

411 of the Federal Aviation Act granted to the CAB the

very jurisdiction over the division of territories and allo-

cation of air carrier r utes that was the subject of the

government’s antitrust complaint. In the instant case, by

contrast, neither AT&T’s interconnection decisions nor

its price structure policies are dictated, in the first in-

stance, by the FCC (although, of course, AT&T's overall

rate of return is subject to continuing surveillance).

Moreover, to the extent that any FCC decisions are rele-

vant to AT&T's claim of implied immunity, those deci-

sions disapprove of, rather than condone, AT&T's actions.

Thus, this is not a case like Hughes Tool or Pan Ameri-

can Airways, where the refusal to grant antitrust im-

munity could subject AT&T to conflicting and potentially

irreconcilable liability standards. See also Phonetele, Inc.,

664 F.2d at 732-34.

AT&T also cites the case of FCC v. RCA Communica-

tions, Inc., 346 U.S. 86 (1953), for the proposition that the

public interest standard embodied in the Communica-

tions Act is inconsistent and thus presumably irreconcil-

able with the policy of the antitrust laws favoring com-

petition. However, the Third Circuit, in Sound, Ine. v.

AT&T, 631 F.2d 1324 (3d Cir. 1980), recently rejected

precisely this irreconcilability argument. In Sound, /nc.,

AT&T argued that it was exempt, by virtue, inter alia, of

the public interest standard contained in the Communi-

cations Act, from antitrust liability arising out of its rate

structure and marketing practices for terminal telephone

equipment. In rejecting AT&T's assertion that the public

interest standard of the Communications Act was neces-

sarily inconsistent with the pro-competition standard of

the antitrust laws, the Third Circuit noted that the FCC

had exercised its supervisory authority so as to encourage

rather than discourage competition in the terminal equip-

ment market. In light of this policy, the court concluded

that “the maintenance of an antitrust suit will not conflict

with the operation of the regulatory scheme authorized

by Congress but will supplement that scheme.” 631 F.2d

at 1330. Similarly, in the instant case, the interconnec-

tion policies adopted by the FCC during the time period

30a

Nos. 80-2171 & 80-2288 25

relevant to this litigation appear designed to promote

rather than inhibit competition in the specialized tele-

communications field. Thus, the allowance of antitrust

liability is likely to complement rather than undermine

the applicable statutory scheme.

AT&T's assertion of implied immunity with respect to

MCI’s predatory pricing allegations presents a closer

question. Because section 201(b) of the Communications

Act requires that AT&T’s rates be “just and reasonable,”

and because both AT&T’s rates and rate making method-

ology are subject to continuing supervision by the FCC, it

is probable that AT&T enjoys less flexibility in setting

rates than it does, for example, in making initial inter-

connection decisions. Moreover, it can be argued that the

hearing and enforcement provisions of the Communica-

tions Act itself afford competitors such as MCI an adequate

opportunity to contest and seek relief from tariffs they

consider unreasonable or unfair. Although these argu-

ments are not entirely without merit, we believe that,

under the particular circumstances of this case, AT&T is

not entitled to antitrust immunity for the competitive

rate filings which form the basis of MCI’s predatory

pricing claims.

Although the Communications Act grants the FCC

potentially broad authority over interstate and foreign

telephone rates, in practice, this authority is consider-

ably more circumscribed. First, as the district court in

this case noted, the Act gives the carrier sole responsi-

bility for filing a tariff, and a carrier may file a new or

revised tariff at any time. See 47 U.S.C. § 204 (1976).

Thus, it is AT&T, not the FCC, that has the primary re-

sponsibility for initiating and setting both regular and

private line telephone rates. See Sound, Inc., 631 F.2d at

1330. “When [such decisions] are governed in the first

instance by business judgment and not regulatory

* But see Essential Communications, 610 F.2d at 1120 (Com

munications Act intended for the benefit of customers, not

com petitors ).

3la

26 Nos. 80-2171 & 80-2288

coercion, courts must be hesitant to conclude that

Congress intended to override the fundamental national

licies embodied in the antitrust laws.” Otter Tail, 410

S. at 374.79

Moreover, although the Communications Act gives the

FCC the right to conduct hearings on proposed tariffs, a

new tariff automatically goes into effect after 90 days

unless acted upon by the FCC in its discretion. See 47

U.S.C. § 203(bX1) (Supp. 1981). Thus, the FCC does not

expressly approve or adopt as agency policy every tariff

it permits to become effective. “By permitting a tariff to

go into effect, the FCC does not assert that it has

examined the content of the tariff and found it necessary

or appropriate to effectuate the regulatory program, nor

does it have an obligation under the Act to make such a

finding.” Phonetele, 644 F.2d at 733; see Essential Com-

munications, 610 F.2d at 1124; MCT Telecommunications

Corp. v. FCC, 561 F.2d 365, 374 (D.C. Cir. 1977), cert.

denied, 434 U.S. 1040 (1978).

The less than comprehensive nature of the FCC's au-

thority over tariffs is further reinforced by the huge

volume of tariff filings received by the Commission.

During the twelve month period between September

1974 and August 1975, for example, the FCC received

1,371 tariff filings, totaling 11,491 pages. Because of this

volume, it was able to investigate only a small percentage

of the tariffs filed. See United States v. AT&T, 461 F.

Supp. at 1326. Recognizing these practical limitations on

its regulatory jurisdiction, the FCC has acknowledged, in

an antitrust case involving implied immunity questions

similar to those at issue here, that “rate filings generally

proceed from the carrier's independent judgment... .”

Id. at 1326 (quoting Memorandum of FCC, filed Decem-

ber 30, 1975, pp. 19-20). Moreover, the FCC has consis-

“

But we believe that FCC regulation of AT&T's rates may

be more pervasive than Federal Power Commission (now

Federal Energy Regulation Commission) regulation of the

wholesale rates of electric utilities Cf Otter Tail Power Co. v.

l'mted States, 410 US. 366 (1973)

Nos. 80-2171 & 80-2288 27

tently maintained—in contrast to the SEC in the stock

exchange cases relied upon by AT&T—that antitrust en-

forcement is not precluded in this area.*® United States v.

AT&T, 461 F. Supp. at 1326. Finally, as is the case in the

interconnection context, the actual FCC decisions rele-

vant to the pricing policies challenged as predatory in the

instant case have tended to disapprove of, rather than

support, those policies.*! We thus conclude that where, as

here, the — decisions complained of are more the

result of business judgment than regulatory coercion,

and the FCC has neither dictated nor approved of those

decisons, the challenged rate filings are not immune from

antitrust scrutiny.®? See City of Kirkwood v. Union Elec-

tric Co., 671 F.2d 1173, 1176-79 (8th Cir. 1982), petition

for cert. filed, 51 U.S.L.W. 3141 (U.S. June 11, 1982) (No.

81-2278) (no immunity for rate filing under similar pro-

visions of Federal Power Act); City of Mishawaka v.

Indiana & Michigan Electric Co., 560 F.2d 1314, 1318-21

(7th Cir. 1977), cert. denied, 436 U.S. 922 (1978) (denying

” The FCC maintains, however, that when it has prescribed

or specifically approved a tariff, its judgment must control. See

United States v. AT&T, 461 F. Supp. at 1327 n.39; ef. Jeffrey v.

Southwestern Bell Tel. Co., 518 F.2d 1129 (5th Cir. 1975) (state

action immunity from antitrust laws granted where challenged

rate had been approved by municipality after thorough

hearings).

See, e.g. AT&T, Charges, Regulations, Classifications and

Practices For Voie Grade/Private Line Service (High Density -

Low Density), 55 F.C.C.2d 224, 244 (1975) (Interim Decision);

58 F.C.C.2d 362, 364, 370 (1976) (Final Decision) (finding

Hi-Lo tariff “unlawful” because AT&T had not submitted suf-

ficient cost data to justify the tariff); AT&T, Revisions of Tari

FCC No. 260 Private Line Services, Series 5000 (TELPA kK),

61 F.C.C.2d 587, 651-62 (1976) (overall rate levels for AT&T's

private line telephone service unlawful because not set in ac-

cordance with fully distributed cost methodology), affd in

part, rev'd in part sub nom. Aeronautical Radw, Inc. v. FCC,

642 F.2d 1221 (D.C. Cir. 1980), cert. denied, 451 U.S. 920

(1981).

* AT&T's claim that its tariff filings with state commis-

sions are immune from antitrust liability under the Noerr-

Pennington doctrine is analyzed separately infra, at pp. 122-133.

33a

28 Nos. 80-2171 & 80-2288

immunity for price squeeze claim arising out of relation-

ship between electric utility’s filed wholesale and retail

rates); cf. Cantor v. Detroit Edison Co., 428 U.S. 579

(1976) (denying state action immunity for light-bulb-

exchange program contained in tariff approved by state

public utility commission).

C. The Impact of Regulation

Our conclusion that AT&T is not entitled to antitrust

immunity in the instant case does not mean that AT&T's

status as a regulated common carrier is irrelevant to our

evaluation of AT&T’s conduct. On the contrary, an in-

dustry’s regulated status is an important “fact of market

life,” the impact of which on pricing and other competi-

tive decisions “is too obvious to be ignored.” JTT v.

General Telephone and Electronics Corp., 518 F.2d 913,

935-36 (9th Cir. 1975) (footnote omitted). For this reason,

the Supremie Court has repeatedly recognized that con-

sideration of federal and state regulation may be proper

even after the issue of antitrust immunity has been re-

solved. United States v. Marine Bancorporation, 418 U.S.

602, 627 (1975) (application of antitrust doctrine to bank

mergers “must take into account the unique federal and

state restraints on [defendant's conduct]. Failure to do so

would produce misconceptions that go to the heart of the

doctrine itself.”); see Silver v. New York Stock Exchange,

373 U.S. 341, 360-61 (1963) (although applicable stat-

utory scheme not sufficiently pervasive to create anti-

trust immunity, particular acts of self regulation—even if

in restraint of trade—may be justified with reference to

that scheme); Otter Tail, 410 U.S. at 381 (court, in fashion-

ing antitrust remedy, “should [not] be impervious to

[regulated utility’s] assertion that compulsory intercon-

nection or wheeling will erode its integrated system and

threaten its capacity to serve adequately the public”).

Similarly, several recent decisions of the courts of ap-

peals involving regulated industries have emphasized the

“continuing significance of regulation” in evaluating al-

leged antitrust violations. Mid-Teras Communications

Systems v. AT&T, 615 F.2d 1372, 1385 (5th Cir. 1980),

34a

Nos. 80-2171 & 80-2288 29

cert. denied, 449 U.S. 912 (1980) (antitrust laws “are not

so inflexible as to deny consideration of government regu-

lation.”); Almeda Mall, Inc. v. Houston Lighting & Power

Co., 615 F.2d 343, 354 (5th Cir.), cert. denied, 449 U.S.

870 (1980) (“Monopolization cases involving .. . regu-

lated industries are special in nature and require close

scrutiny.”); Jacobi v. Bache & Co., 520 F.2d 1231, 1237-39

(2d Cir. 1975), cert. denied, 423 U.S. 1053 (1976) (reject-

ing application of per se liability rule in light of regula-

tion of stock exchange); TT, 518 F.2d at 935-36 (impact

of regulations must be assessed as fact of market life). As

Professors Areeda and Turner have stated:

[A]ntitrust courts can and do consider the particular

circumstances of an industry and therefore adjust

their usual rules to the existence, extent, and nature

of regulation. Just as the administrative agency

must consider the competitive premises of the anti-

trust laws, the antitrust court must consider the

peculiarities of an industry as recognized in a regu-

latory statute.

1 P. Areeda & D. Turner, Antitrust Law 223d (1978).

Whether in a regulated context or not, the broad out-

line of the offense of monopolization is well understood.

Most recently, the Supreme Court has stated:

The offense of monopoly under § 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 distin-

guished from growth or development as a conse-

quence of a superior product, business acumen, or

historic accident.

United States v. Grinnell, 384 U.S. 563, 570-71 (1966); see

Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d 263,

274-76 (2d Cir. 1979), cert. denied, 444 U.S. 1093 (1980).

Cases dealing with non-regulated industries have de-

veloped a number of analytic tools designed to aid courts

in identifying each of these elements. In many instances,

however, these tools are of only limited value in resolving

monopolization charges against regulated monopolies.

30 Nos. 80-2171 & 80-2288

See Watson & Brunner, Monopolization by Regulated

“Monopolies”: The Search for Substantive Standards, 22

Antitrust Bull. 559, 563 (1977). In particular, the

presence of a substantial degree of regulation, although

not sufficient to confer antitrust immunity, may affect

both the shape of “monopoly power” and the precise

dimensions of the “willful acquisition or maintenance” of

that power. Jd.

According to the Supreme Court, monopoly power

may be defined as “the power to control prices or exclude

competition” in a relevant market. United States v. E. I.

duPont de Nemours & Co., 361 U.S. 377, 391 (1956). In

many cases involving unregulated industries, however,

courts have eschewed examination of the ostensible

monopolist’s actual degree of control over prices or com-

petition, and have relied solely on statistical data con-

cerning the accused firm’s share of the market. Where

that data reveals a market share of more than seventy to

eighty percent, the courts have inferred the existence of

monopoly power. See, e.g., United States v. Grinnell, 384

U.S. at 571, American Tobacco Co. v. United States, 328

U.S. 781, 797 (1946); Standard Oil Co. v. United States,

221 US. 1, 33 (1911).

Such a heavy reliance on market share statistics is

likely to be an inaccurate or misleading indicator of

“monopoly power” in a regulated setting. In many regu-

lated industries, each purveyor of service, regardless of

absolute size, is in a monopoly position with regard to its

customers. Indeed, while a regulated firm's dominant

share of the market typically explains why it is subject to

regulation, the firm’s statistical dominance may also be

the result of regulation. See United States v. Marine

Bancor poration, 418 U.S. at 633. For these reasons, the

size of a regulated company’s market share should con-

stitute, at most, a point of departure in assessing the

existence of monopoly power. Ultimately, that analysis

must focus directly on the ability of the regulated com-

pany to control prices or exclude competition—an assess-

36a

Nos. 80-2171 & 80-2288 31

ment which, in turn, requires close scrutiny of the regu-

latory scheme in question.”

In the instant case, the district court properly instructed

the jury that, in determining whether AT&T possessed

monopoly power in the relevant market,

you may consider the effect of the FCC's exercise of

regulatory authority over prices and entry, includ-

ing interconnection. Similarly, you may consider the

effect of the exercise by state regulatory agencies of

regulatory authority over prices and entry in connec-

tion with the provision of local services and facilities.

That AT&T may have had the largest share or the

entire share of the telephone business in certain

areas would not be sufficient to establish that AT&T

possessed monopoly power if in fact regulation by

regulatory agencies prevented AT&T from having

the power to restrict entry or control prices.

App. 215.

Although the district court’s instructions in this area

might have been more helpful if they had described, in

more detail, the specific regulatory scheme to which

AT&T was subject, see Mid-Teras, 615 F.2d at 1386-87,

we believe the instructions, taken as a whole, adequately

apprised the jury of its duty “to take into account the

unique federal and state regulatory restraints” to which

AT&T was subject. /d. at 1387. We, therefore, reject

% See, eg., Travelers Insurance Co. v. Blue Cross, 361 F.

Supp. 774, 780 (W.D. Pa. 1972), affd, 481 F.2d 80 (3d Cir.),

cert. denied, 414 US. 1093 (1973) (company was not a monopoly

since it lacked control over rate-making mechanism), Nankin

Hospital v. Michigan Hospital Service, 361 F. Supp. 1199,

1209-10 & n.33 (B.D. Mich. 1973) (company did not

monopoly power since rates were controlled and actively

reviewed by state insurance commission). Cf /nternatwnal

Railways of Central America v. United Brands Co., 532 F.2d

231, 240 (2d Cir.), cert. denied, 429 U.S. 835 (1976) (consent

decree which fixed freight rates removed ability of banana

grower to coerce lower freight rates from rai!road and thus

negated finding of monopoly power).

37a

32 Nos. 80-2171 & 80-2288

AT&T's contention that the trial court’s instructions on

this issue left the jury without any meaningful way to

assess the impact of regulation on the existence or non-

existence of AT&T’s monopoly power (and constituted

reversible error).

AT&T's status as a regulated public utility also bears

on the second element of a monopolization offense: the

willful acquisition or maintenance of monopoly power.

The precise dimensions of the “willfulness” standard have

been the subject of considerable litigation and varying

formulations even in cases involving unregulated indus-

tries. Some courts, building upon Judge Learned Hand’s

noted opinion in United States v. Aluminum Co. of

America, 148 F.2d 416 (2d Cir. 1945), have concluded

that monopolistic conduct can be presumed from the

possession of monopoly power unless the accused firm

affirmatively demonstrates that its monopoly position has

been “thrust upon it.” /d. at 432; see American Tobacco

Co. v. United States, 328 U.S. at 813-14. Under this

analysis, if the ordinary business conduct of a dominant

firm leads to the acquisition or maintenance of monopoly

power, that conduct is presumed to reflect the requisite

willful monopolistic intent. Whatever merit this pre-

sumption may have in other contexts,"4 we believe it is a

“ Although many cases make reference to Alcoa's innovative

presumption, in the more than three decades since that case

was decided, courts have consistently found monopolization

only in circumstances where predatory or exclusionary conduct

was proven. Watson & Brunner, supra, at 590 n.83; see Hanover

Shoe, Ine. v. United Shoe Machine Corp., 392 U.S. 481, 485-86

(1968); United States v. L'nited Shoe Machine Corp., 110 F.

Supp. 295, 343-44 (D. Mass. 1953), affd per curiam, 347 US.

521 (1954). In most successfully prosecuted section 2 monopoli-

zation cases, predatory or exclusionary practices held to consti-

tute a violation of section | of the Sherman Act have also been

resent. See, ¢.g., United States » Grinnell, 384 US. 563 (1966):

‘nited States » Griffith, 334 US. 100, 106-07 (1948), Amerwean

Tobacco Co. United States, 328 US. 781 (1946), United States

1. Reading Co, 258 U.S. 26 (1920), ef Berkey Photo Inc». East

man Kodak Co. 608 F.2d 263, 278-76 (2d Cir. 1979), cert

(Footnote continued on following page)

38a

Nos, 80-2171 & 80-2288 33

particularly inappropriate means of identifying monopo-

listic conduct by a regulated utility or common carrier.

For these industries, anticipating and meeting all rea-

sonable demands for service is often an explicit statu-

tory obligation. See, e.g., 47 U.S.C. § 201(a) (1976) (“It

shall be the duty of every common carrier. . . to furnish

such communication service upon reasonable request

therefor.”). To apply the Alcoa presumption to such con-

duct would be tantamount to holding that adherence to a

firm's regulatory obligation could, by itself, constitute

improper willfulness in a section 2 monopolization case.

This circuit has already declined to endorse such an

anomalous result. In City of Mishawaka v. American

Electric Power Co., 616 F.2d 976, 985 (7th Cir. 1980), cert.

denied, 449 U.S. 1096 (1981), we specifically held that

“{iJn the particular circumstances of a regulated utility

. , entitled to recover its cost of services and provide its

investors with a reasonable rate of return, we believe that

something more than general intent should be required

to establish a Sherman Act violation.” See also Watson &

Brunner, supra, at 574-79 (willfulness by a regulated

monopoly should be demonstrable only by evidence of

predatory conduct or other exclusionary acts contrary to

public policy). We reaffirm our holding in Mishawaka

and, therefore, reject MCI's contention on cross-appeal

that the trial court erred in requiring MCI to prove that

each allegedly anticompetitive act or practice attributed

to AT&T was done with the intent to maintain a monopoly

in the relevant market.”

4“ continued

denied, 444 US. 1098 (1980) (integrated monopolist’'s failure to

predisclose innovations and its ability to sell monopolized and

competitive products as a system are not unlawful uses of

monopoly power, but legitimate advantages of size and integra-

twn), Teles Corp. + 1AM 510 F 2d 894, 927-28 (10th Cir ), cert

dismissed, 424 US 802 (1975) (reversing finding of section 2

lability in the absence of predatory conduct)

* We reject MC I's suggestion that our holding in Mushawaka

is limited to the unique situation of an alleged price squeeze by

an electric utility subject to both federal and state rate regula

tion

394

34 Nos. 80-2171 & 80-2288

The impact of regulation was also an important ele-

ment of AT&T's defense in the instant case. Particularly

with regard to the interconnection controversy, AT&T

argued that its dealings with MCI were reasonable and

that they represented a good faith attempt to comply with

AT&T's regulatory obligations under section 201 of the

Communications Act. AT&T claims that the trial court's

instructions improperly prevented the jury from con-

sidering this defense, in that the instructions were fatally

“silent concerning the overall structure of the Communi-

cations Act, the public interest standards under which

the provisions of that Act are administered by the FCC

and to which common carriers are required to conform

their conduct, and the requirements set forth in the Act

relating to the particular interconnection and pricing

controversies presented to the jury for resolution.” Ap-

pellant’s Br. at 138.

MCI, by contrast, argues in its cross-appeal that the

district court gave too much credence to AT&T's regu-

latory defense. In particular, MCI claims that the district

court improperly held it to an “over-rigorous burden of

proof” by instructing the jury that, if AT&T believed in

good faith that interconnection with MCI would have

violated established regulatory policies, then AT&T's

refusal to interconnect could not be considered anticom-

petitive conduct. We reject both parties’ contentions. The

district court in this case properly allowed AT&T to

assert a defense based on good faith adherence to its

regulatory obligations. See Mid-Teras, 615 F.2d at 1388-

90. The district court also properly articulated this de-

fense in its instructions to the jury. Thus the district

court instructed the jury that

MCI must prove more, however, than the fact that

AT&T refused to provide the interconnections. As

you know, AT&T contends that it refused to provide

the connections because it believed that it had not

been ordered to do so, that MCI was not authorized

to provide the service, and that it would have vio-

lated established regulatory policies for MCI to re-

ceive the connections. If AT&T refused the inter-

40a

Nos. 80-2171 & 80-2288 35

connections because of such reasons, believing in

good faith that they justified the refusal, then the

refusal to provide the interconnections was not anti-

competitive conduct and cannot be considered con-

duct engaged in for the purpose of maintaining a

monopoly.

MCI has the burden of proving that in refusing the

FX and CCSA interconnections AT&T acted with

anti-competitive intent, for the purpose of maintain-

ing a monopoly, rather than for what it in good faith

regarded as legitimate reasons.

App. 217-18.

Similarly, with respect to the charge that AT&T un-

lawfully pre-announced its Hi-Lo tariff, the jury was told

to consider AT&T’s contention that the time interval

involved was reasonable and required by applicable

regulations. In addition, the district court instructed the

jury that:

With respect to those facilities and interconnections

which AT&T did not provide, its position is that its

failure to do so was based upon a good faith belief

that it would have violated established regulatory

policies and therefore that it acted reasonably in all

the circumstances.”

App. 216.

We believe these instructions adequately conveyed to

the jury the substance of AT&T's regulatory defense and,

% Moreover, the trial court assured the jury that

the Sherman Act allows a regulated firm with monopoly

power to compete vigorously whenever it may be faced

with competition. So long as the defendant's competitive

responses to plaintiffs were based on legitimate business

decisions and on the merits of defendant's services, defen-

dant cannot be found to have unlawfully maintained a

monopoly. This is so even if plaintiffs were hurt by the

competition and defendant sought to retain as much of its

business as possible.

App. 214.

4la

36 Nos. 80-2171 & 80-2288

thus, allowed the jury to “consider the effect of regula-

tion in ascertaining whether Bell misused its monopoly

power.” Mid-Teras, 615 F.2d at 1389. We reject AT&T’s

contention that the trial court’s failure to provide a more

detailed exposition of the standards contained in the

Communications Act constituts reversible error. We also

reject MCI’s counter-argument that the district court’s

instructions in this area improperly placed upon MCI the

burden of disproving AT&T’s subjective good faith. See

California Computer Products, Inc. v. IBM Corp., 613

F.2d 727, 736 (9th Cir. 1979) (holding that a verdict must

be directed in favor of defendant when plaintiff's evi-

dence is insufficient to establish that defendant acted

unreasonably). In the particular context of an industry

subject to extensive and rapidly changing regulatory

demands, we believe that an antitrust defendant is en-

titled both to raise and to have the jury consider its good

faith adherence to regulatory obligations as a legitimate

antitrust defense. See Mid-Teras, 615 F.2d at 1389-90;

City of Mishawaka, 616 F.2d at 985.

Finally, we believe the fact of FCC regulation is rele-

vant to our analysis of antitrust principles in another,

more subtle way. AT&T, as the dominant firm in a regu-

lated industry recently opened in part to competition, is

subject to dual, and sometimes conflicting, principles of

regulatory and antitrust law. As already indicated, we

believe the trial court properly reconciled these bodies of

law by allowing AT&T to present evidence as to its good

faith belief in its compliance with regulatory require-

ments. In addition, the fact of FCC regulation to some

extent affects our view of the appropriate purposes and

proper scope of antitrust law in the present context—

specifically, whether we should focus our examination on

economic efficiency and consumer benefit or whether we

should more expansively consider the political and social

consequences of bigness or concentration of economic

power. Compare R. Bork, The Antitrust Paradoz (1978)

and R. Posner, Antitrust Law (1976) with L. Sullivan,

Handbook of the Law of Antitrust § 2 (1977) and Pitofsky,

The Political Content of Antitrust, 127 U. Pa. L. Rev. 1051

42a

Nos. 80-2171 & 80-2288 37

(1979) and Schwartz, “Justice” and Other Non-Economic

Goals of Antitrust, 127 U. Pa. L. Rev. 1076 (1979).

Certain factors may tend to distinguish this from ordi-

nary monopolization cases. AT&T is a public utility sub-

ject to public regulation, occupying a unique place in the

American industrial scene. To the extent that it may

have enjoyed economies of scale and significant techno-

logical resources, the political and regulatory judgment,

until recently, has been to tolerate the political and social

consequences of its size in the ostensible interest of reli-

able, effective and economic telecommunications service.

Now this regulatory judgment has been drastically modi-

fied, and competiton—with all its economic, political and

social consequences—is transforming the telecommuni-

cations industry.

Certainly this transformation, carried out at the behest

of regulatory authorities, is meeting the broadest objec-

tives of the antitrust laws at least as effectively as they

might be pursued by this court in this case. The FCC has

exercised its powers under the Communications Act and

has instituted sweeping pro-competitive changes in the

telecommunications industry to accommodate the broad

demands of national communications policy. We also note

the role of the Justice Department, AT&T itself, and the

federal district court in the consent decree entered re-

cently between AT&T and the government in the District

Court for the District of Columbia. See United States v.

AT&T, 43 Antitrust & Trade Reg. Rep. (BNA) No. 1077

(Spec. Supp. Aug. 12, 1982). The massive restructuring of

AT&T accomplished in that decree is an additional ave-

nue through which the issues of the concentration of

economic power in the Bell System, as well as its political

power, are being addressed.

We acknowledge with approval the populist origins of

the antitrust laws as well as the preeminent role of the

Sherman Act as a charter of economic freedom.” But we

"See Northern Pacific Ry. Co. v. United States 9356 U.S. 1,4

(1958).

43a

38 Nos. 80-2171 & 80-2288

also believe that, as we have pointed out, larger concerns

about broad pro-competitive policy, economic concentra-

tion and political power have been, and are being at this

very moment, effectively addressed by the regulators,

and possibly by the Congress. Hence, we have tended

to believe it appropriate to focus at this time and in

this case upon the specific issues of economic efficien-

cy and consumer benefit which are directly presented.

Thus, our resolution of the allegations of predatory

pricing and unlawful failure to interconnect MCI to

Bell’s local distribution facilities has centered on the

questions whether prices cover costs and whether the

denied facilities are essential. We are, of course, not in-

sensitive to broader social and political issues, but as in-

dicated, we think that our principal task is to deal in

depth with the specific questions presented.

Ill. PREDATORY PRICING

At trial MCI alleged that AT&T had engaged in preda-

tory pricing of both its Telpak and Hi-Lo services for

long distance business communications. The jury found

that Telpak was lawfully priced, but that Hi-Lo was

priced below its fully distributed costs and was preda-

tory. We disapprove this finding with 4 pe to Hi-Lo

because of erroneous instructions, the use of an improper

cost standard and insufficiency of the evidence. We also

disapprove the jury’s finding that AT&T unlawfully pre-

announced its Hi-Lo tariff. Further, we reject MCI’s

cross-appeal on Telpak’s marketing plan and sustain the

jury’s finding that Telpak was lawfully priced and

marketed.

A. Jury Instructions

One of the crucial issues presented at trial concerned

the proper standard for determining predatory pricing.

Both parties presented expert testimony on this issue.

AT&T argued that unless its prices for a particular

service failed to cover that service's long-run incremental

costs the price could not be found predatory. MCI con-

44a

Nos. 80-2171 & 80-2288 39

tended that proof of price below fully distributed cost

was sufficient to establish predation.

At trial Judge Grady refused to instruct the jury as to

which cost measure was the correct legal standard to

determine predatory pricing. Instead, he left the choice

of a cost-based standard for predation —in this case fully

distributed costs (“FDC”) or long-run incremental costs

(“LRIC”)—for the jury to decide as a question of fact.

Judge Grady instructed the jury:

{[Y]Jou’re going to have to decide whether it should

be fully distributed costs on the one hand, or incre-

mental costs on the other hand; and in doing that

you'll have to look at all the evidence and decide

which is the cost that truly reflects the actual cost

of producing the service.

The test for determining whether Hi-Lo was pred-

atory is the same as for Telpak. Again, it is a ques-

tion of whether the price covered what you con-

sider the applicable cost. If it did, you may not

infer predatory intent. If it did not, you may infer

predatory intent.

Tr. 11486-87.* As a result, the special verdict required

the jury to check which cost standard it felt was appro-

riate and then decide whether AT&T's prices were

low that measure of cost: either LRIC or FDC.

This we hold to be error. The choice of a cost-based

standard for evaluating claims of predatory pricing is a

question of law to be decided by the trial judge. Thus,

while several courts have stated that the appropriate

cost-based standard for predation may differ depending

“ In the course of instructing the jury, Judge Grady noted

that the term “average costs” had also been referred to at

trial as “fully distributed costs” or “embedded costs,” and the

term “marginal costs” had also been used neers

with “incremental” or “long-run incremental costs.” Tr. 11485.

This arguably imprecise terminology, see infra, was repeated

in the special verdict. App 230-33.

45a

40 Nos. 80-2171 & 80-2288

on the facts of the case, see, e.g., Chillicothe Sand &

Gravel Co. v. Martin Marietta Corp., 615 F.2d 427 (7th

Cir. 1980), both courts and commentators are united in

regarding the selection of that standard as a question of

law. Indeed, the entire judicial and academic struggle

to enunciate an appropriate definition of predatory pric-

ing reflects the legal rather than factual nature of the

question. Since a finding of below-cost pricing permits

the jury to infer, or even presume, anticompetitive

intent, it is imperative thet the judge instruct the jury

on the relevant cost standard to compare with defend-

met prices. See 2 P. Areeda & D. Turner, supra, at

315.

MCI relies on Greenville Publishing Co. v. Daily Re-

flector, Inc., 496 F.2d 391 (4th Cir. 1974), to support the

proposition that the jury may select the appropriate cost

standard to evaluate a predatory pricing claim. MCI’s

reliance here reflects an overly broad interpretation of

that case. In Greenville Publishing the Fourth Circuit

reversed a grant of summary judgment for the defend-

ant in a case charging monopolization and attempted

monopolization. On the issue of predatory pricing the

court took note of affidavits by the defendant purport-

ing to show that the operation of the advertising guide

in question was profitable and that prices covered aver-

age variable costs. Plaintiffs challenged both the actual

calculation of these costs and the failure of the defend-

ant to include in its cost calculations “any portion of the

—" fixed expenses or personnel costs.” /d. at 397

n.10.

The court in Greenville Publishing reversed the grant

of summary judgment in favor of the defendant stating

“(t]he sum of this evidence presents an issue of disputed

fact.” /d. at 398. It is misleading, however, in the con-

text of the instant case, to place much reliance on this

sentence. The court in Greenville Publishing was not

concerned with which entity—judge or jury—is em-

powered to select the proper cost-based standard for

determining predation. Rather, the Greenville Publish-

ing court was addressing the much more general issue

of the propriety of summary judgment in a complex

46a

Nos. 80-2171 & 80-2288 41

antitrust case. At the summary judgment stage, the

plaintiffs in Greenville Publishing had presented no evi-

dence on the issue of anticompetitive intent other than

the pricing policies of the defendant. Hence, the propri-

ety of summary judgment on plaintiffs’ monopolization

and attempted monopolization claims turned entirely on

whether any inferences of intent could be drawn from

the relationship between the defendant’s prices and

costs. The Fourth Circuit's refusal to uphold the grant

of summary judgment in Greenville Publishing merely

represents the traditional view that summary judgment

is generally inappropriate in complex antitrust cases

where intent may be difficult to discern. /d. at 398 (cit-

ing Poller v. Columbia Broadcasting System, 368 U.S.

464 (1962)).

There is no support in the cases for the proposition

that a jury may simply choose the cost-based standard it

feels is most appropriate. Indeed, the only other pur-

portedly apposite case cited by MCI in its brief, the dis-

trict court’s opinion in Northeastern Telephone Co. v.

AT&T, 497 F. Supp. 230 (D.Conn. 1980), has been re-

versed on this very point, with the Second Circuit stating

that the cost standard used to determine whether a

monopolist’s prices were predatory was a legal question.

651 F.2d 76, 87 (2d Cir. 1981), cert. denied, 102 S.Ct.

1438 (1982), rev'g in part 497 F. Supp. 230, 240-41

(D. Conn. 1980). Judge Grady himself acknowledged

that it is inappropriate for the jury to consider all possi-

ble economic theories of predation in ruling that MCI’s

originally proffered profit-maximizing theory was in-

adequate as a matter of law.

B. Below Cost Pricing

Liability for predatory pricing represents an excep-

tion to the general antitrust regime which contemplates

that no limits on price competition shall be imposed.

Predatory pricing is prohibited because of the fear that

a monopoly or dominant firm will deliberately sacrifice

present revenues for the purpose of driving rivals from

the market and then recoup its losses through higher

profits earned in the absence of competition. See North-

47a

42 Nos. 80-2171 & 80-2288

eastern Telephone Co. v. AT&T, 651 F.2d 76, 86 (2d Cir.

1981), cert. denied, 102 S.Ct. 1438 (1982); Areeda &

Turner, Predatory Pricing and Related Practices Under

Section 2 of the Sherman Act, 88 Harv. L. Rev. 697, 698

(1975) [hereinafter cited as Areeda & Turner, Predatory

Pricing].

There is at present, in cases such as the one before us,

no reliable way to determine whether predatory pricing

has occurred without some comparison between the

prices charged and a properly defined measure of the

cost of production. A subjective test based wholly upon

intent is almost incapable of distinguishing between

pro- and anticompetitive price cuts by a monopolist.

Areeda, Predatory Pricing (1980), 49 Antitrust L. J.

897, 899 (1980); R. Posner, supra, at 188. Nor is a sub-

jective test capable of identifying whi . pricing strate-

gies represent rational business decisions and which

have no legitimate business purpose and are designed

only to injure competition.

In addition, a test based wholly on intent is unwork-

able.” Even if it were possible to identify those persons

within a firm whose intentions are relevant, the mean-

ing of the evidence will usually be obscure. After all,

competition consists of winning business from rivals.

The intent to preserve or expand one’s market share is

presumptively lawful. To encourage judges and juries to

rely overly on nonprobative data allegedly bearing on a

firm's “state of mind” invites the twin mischiefs of (1)

burdening litigation with thousands of documents about

the firm's motives and calculations; and (2) encouraging

inconsistent and quixotic results. Areeda, Predatory

Pricing (1980), 49 Antitrust L. J. 897, 899 (1980); see R.

Posner, supra, at 189-90.”

*” We do not mean to imply that direct probative evidence of

a defendant's intent is inadmissible. See infra, note 58.

“” Early antitrust cases could define predatory pricing only

in vague verbal formulations relating to predatory intent and

ruinous competition. See Moore v. Mead’s Fine Bread Co., 348

U.S. 115, 118 (1954); Forster Mfg. Co. v. FTC, 335 F.2d 47,

52-53 (Ist Cir. 1964), cert. denied, 380 U.S. 906 (1965); Porto

(Footnote continued on follewing page)

48a

Nos. 80-2171 & 80-2288 43

In the absence of an objective standard, firms making

ahage decisions in the presence of competition would

unable to ascertain what price reductions rnay be

legally undertaken. Because the antitrust laws are de-

signed to encourage vigorous competition, as well as to

promote economic efficiency and maximize consumer

welfare, such uncertainty seriously undermines the goals

of antitrust enforcement. As one commentator has re-

cently emphasized:

It is imperative that courts timely establish objec-

tive and understandable pricing standards which

bring into sharp focus the line which separates

commendable price reductions from predatory pric-

ing practices. Such standards are necessary for the

guidance of businessmen . . . . Businessmen should

not be put into the position where they must either

forego competitive price decreases or risk treble

damages in Sherman Act suits.

Sherer, Predatory Pricing: An Evaluation of its Poten-

tial for Abuse Under Government Procurement Contracts,

6 J. Corp. L. 531, 539 (1981).

Within the past decade, both economists and lawyers

have recognized the need for an objective standard to

evaluate predatory pricing claims.*' Advocates of an

objective test agree that price cuts by a dominant firm

or monopolist are nothing more than lawful competition

© continued

Rico Am. Tobacco Co. ». American Tobacco Co., 30 F.2d 234,

236 (2d Cir.), cert. denied, 279 U.S. 858 (1929). Such -

definitions resulted in erratic application of the law as we

lengthy and complex inferences of intent, which were of litele

predictive or precedential value, See Brodley & Hay, Preda-

tory Pricing: Com mpeting Economic Theories and the Evalua-

tion of Legal Standards, 66 Cornell L. Rev. 738, 765-67 (1981)

{hereinafter cited as Brodley & Hay, Predatory Pricing}

Areeda & Turner, Predatory Pricing at 699.

‘| See, “a5 3 P. Areeda & D. Turner, supra, at 1711-15

1978); R. Posner, supra, at 189; Areeda & Turner, oe ay 4

icing at 709-13; Joskow & Klevorick, A Framework

Analyzing Predatory Pricing Policy, 89 Yale L. J. 213 (1 9).

49a

44 Nos. 80-2171 & 80-2288

on the merits if prices remain above costs. Since such

price cuts benefit consumers by providing greater out-

put of desired goods at lower prices, they are pro-com-

petitive and cannot result in the elimination of equally

efficient competitors.

Similarly, the courts have nearly unanimously adopted

some form of a cost-based standard in deciding ques-

tions of predation. afi Northeastern Telephone Co. v.

AT&T, 651 F.2d 76 (2d Cir. 1981), cert. denied, 102 S.Ct.

1438 (1982); Chillicothe Sand & Gravel Co. v. Martin

Marietta Corp., 615 F.2d 427, 430-32 (7th Cir. 1980);

California Computer Products, Inc. v. IBM Corp., 613

F.2d 727, 742-43 (9th Cir. 1979); Janich Bros. v. Ameri-

can Distilling Co., 570 F.2d 848, 857 (9th Cir. 1977),

cert, denied, 439 U.S. 829 (1978); Pacific Engineering &

Production Co. v. Kerr-MceGee Corp., 551 F.2d 790, 797

(10th Cir.), cert. denied, 434 U.S. 879 (1977); National

Association of Regulatory Utility Commissioners v. FCC,

525 F.2d 630, 637-38 & n.34 (D.C. Cir.), cert. denied, 425

U.S. 992 (1976).

MCI nonetheless argues in its cross-appeal that the

district court erred in requiring it to prove that AT&T

priced its Hi-Lo service below any measure of cost. MCI

contends that, if AT&T knowingly sacrificed revenue

(i.e, failed to maximize its profits) with the intent to

injure competition, this court should hold that behavior

to constitute unlawful predatory pricing. In support of

this “profit maximization” theory, MCI cites a trio of

cases. Hanson v. Shell Oil Co., 541 F.2d 1352, 1358 n.5

(9th Cir. 1976), cert. denied, 429 U.S. 1074 (1977); Jnter-

national Air Industries, Inc. v. American Excelsior Co.,

517 F.2d 714, 724 (5th Cir. 1975), cert. denied, 424 U.S.

943 (1976); JLC Peripherals Leasing Corp. v. IBM Corp.,

458 F. Supp. 423, 432 (N.D. Cal. 1978), affd per curiam

sub nom. Memorex Corp. v. IBM Corp., 636 F.2d 1188

(9th Cir. 1980), cert. denied, 452 U.S. 972 (1981).

Each of these cases contains language to the effect

that a price may be predatory if it is below the short-

run profit-maximizing price and barriers to new entry

are great. Assuming, arguendo, that these statements

are more than mere dicta, we must reject such a “profit

SOa

Nos, 80-2171 & 80-2288 45

maximization” theory as incompatible with the basic

principles of antitrust. The ultimate danger of monopoly

power is that prices will be too high, not too low. A rule

of predation based on the failure to maximize profits

would rob consumers of the benefits of any price reduc-

tions by dominant firms facing new competition. Such

a rule would tend to freeze the prices of dominant firms

at their monopoly levels and would prevent many pro-

competitive price cuts beneficial to consumers and

other purchasers. In addition a “profit maximization”

rule would require extensive knowledge of demand

characteristics—thus adding to its complexity and un-

certainty. Another, and related, effect of adopting the

“profit maximization” theory advocated by MCI would

be to thrust the courts into the unseemly role of moni-

toring industrial prices to detect, on a long term basis,

an elusive absence of “profit maximization.” Such super-

vision is incompatible with the functioning of private

markets. It is in the interests of competition to permit

dominant firms to engage in vigorous competition, in-

cluding price competition. See Berkey Photo, Inc. v.

Eastman Kodak Co., 603 F.2d 263, 273 (2d Cir. 1979),

cert. denied, 444 U.S. 1093 (1980). We therefore reject

MCI’s “profit maximization” theory, and reaffirm this

Circuit’s holding that liability for predatory pricing

must be based upon proof of pricing below cost. Chillt-

cothe Sand & Gravel Co. v. Martin Marietta Corp., 615

F.2d 427 (7th Cir. 1980).

C. Defining Measures of Cost

The first commentators to propose a specific cost-

based standard for predatory pricing were Professors

Areeda and Turner, who argued that pricing below a

firm's short-run marginal cost should be deemed unlaw-

ful, and that prices above that level should be deemed

lawful. Areeda & Turner, Predatory Pricing at 709-13.

*# It should also be noted that AT&T is a regulated public

utility. A dominant purpose of public utility regulation is to

deny AT&T profits attributable to its monopoly power. It

would be anomalous indeed in this context to require AT&T,

as a matter of antitrust law, to maximize its profits.

Sla

46 Nos. 80-2171 & 80-2288

See also 3 P. Areeda & D. Turner, supra, at 711-15.

In economic terms, short-run marginal cost represents

the increment to total cost that results from producing an

additional unit of output, where some inputs of produc-

tion are variable and others are fixed. 3 P. Areeda & D.

Turner, supra, at 712 at 155. Because short-run margi-

nal cost is an economic concept that cannot be derived

by conventional accounting methods, Areeda and Turner

advocate the use of “average variable cost” (“AVC”) as a

proxy in predatory pricing cases. Variable costs, as the

name implies, are costs that vary with changes in out-

put. They typically include such items as materials,

fuel, maintenance, and labor directly used to produce

the product. /d. A product’s average variable cost is the

sum of all its variable costs divided by the number of

units of output.

The Areeda-Turner rule has engendered much discus-

sion about whether short-run marginal (or, its proxy,

average variable) cost represents the proper cost stand-

ard for evaluating predatory pricing claims.** Much of

the economic literature, as well as the case law, has

examined whether average variable cost or some meas-

ure of average total cost (which includes “fixed” as well

as variable costs) represents the better cost standard for

measuring predatory pricing.

It is unfortunate that in the course of trial the case

before us was characterized as a contest between the

“3 See Scherer, Predatory Pricing and the Sherman Act: A

Comment, 89 Harv. L. Rev. 868 (1976); Areeda & Turner,

Scherer on Predatory Pricing: A Reply, 89 Harv. L. Rev. 891

(1976); Scherer, Some Last Words on Predatory Pricing, 89

arv. L. Rev. 901 (1976); Williamson, Predatory Pricing: A

Strategic and Welfare Analysis, 87 Yale L. J. 284 (1977);

Areeda & Turner, Williamson on Predatory Pricing, 87 Yale

L. J. 1337 (1978); Williamson, A Preliminary Res , 87

Yale L. J. 1353 (1978); Williamson, Williamson on Predatory

Pricing I], 88 Yale L. J. 1183 (1979); Greer, A Critique of

Areeda and Turner's Standard for Predatory Practices, 24

Antitrust Bull. 233 (1979); Koller, When is Pricing Preda-

et Ne aaa Bull. 283 (1979). See also R. Posner, supra,

at -196.

Nos. 80-2171 & 80-2288 47

supporters and opponents of the Areeda-Turner rule. At

trial long-run incremental cost was incorrectly equated

with average variable cost while fully distributed cost

was incorrectly equated with average total cost. In fact,

the validity of the Areeda-Turner rule, based on short-

run marginal costs, is not at issue in this case because

neither party ever argued for a short-run cost standard.

Rather, AT&T introduced evidence, unrefuted by MCI,

showing that its prices for both Telpak and Hi-Lo were

above those services’ long-run incremental costs.

There are important economic differences between

long-run incremental cost and short-run marginal cost.

First, incremental costs (LRIC) represent the average

cost of adding an entire new service or product rather

than merely the last unit of production. Professor Al-

fred Kahn has highlighted this distinction by stating:

bed orice cost, strictly speaking, refers to the

additional cost of supplying a single, infinitesimally

small additional unit, while “incremental”. . . re-

fer({s] to the average additional cost of a finite and

possibly a large change in production or sales.

1 A. Kahn, The Economics of Regulation 66 (1970)

(emphasis in original).

Second, and more important, long-run incremental

cost differs from average variable cost in that it is a

long-run rather than a short-run cost measure. Because

variable costs, by definition, are associated with the

limited time period in which a firm cannot replace or

increase its plant or equipment, the cost of plant and

equipment is regarded as fixed and is not included in

the calculation of a product's short-run marginal, or

average variable, cost. Long-run incremental cost, by

contrast, measures all the costs of adding a new product

or service—“fixed” as well as variable costs (and “capi-

tal” as well as “operating” items). Essentially, the

“ Professor William Baumol! has defined long-run incre-

mental costs of product X as “total — cost minus what

the total cost of the company would be in the absence of pro-

(Footnote continued on following page)

S3a

48 Nos. 80-2171 & 80-2288

LRIC approach assumes that all costs become variable

in the long run. Hence, a number of the criticisms that

have been leveled against the choice of a short-run mar-

ginal cost standard are not applicable to the use of long-

run incremental cost. The use of long-run cost analysis

may be particularly appropriate to capital-intensive

processes where growth of plant and equipment is

marked.

In addition to incorrectly equating long-run incremen-

tal cost with short-run marginal (or average variable)

cost, the district court (without adequate guidance from

the parties) incorrectly equated fully distributed cost

(“FDC”) with average tota tal cost. Both these notions are

= because LRIC and FDC can be viewed as

different ways of defining the average total cost

("A are) of a particular product or service for a firm that

produces multiple products or services.”

For a single product firm, average total cost can be

easily defined as the sum of all costs, both fixed and

variable, divided by the total units of output produced

by the firm. Such simple concepts of average total cost,

however, lose their meaning when one considers a multi-

service firm such as AT&T. Joint and non-joint common

costs shared among products of the same firm render it

impossible to calculate ATC simply by adding up costs

and dividing by the number of units of output. This is

possible only in a firm which produces a single product.

One cannot proceed in this fashion for multiproduct

“continued

duction of X, all divided by the quantity of X being pro-

5 om Baumol, Quasi-Permanence of Price Reductions: A

a cy for, Prevention of Predatory Pricing, 89 Yale L. J. 1, 9

n.

** “Average total cost” as we use it here refers to average

total economic cost, as the term is employed by economists in

predatory erie ng analysis, See steerer rodley & Hay, Pred-

atory Prieci e term “average total costs” is also some-

times wed ¢ in utility ratemaking to refer to the revenue

required to meet al] the accounting costs of an entire utility

enterprise. See infra, note 51.

54a

Nos. 80-2171 & 80-2288 49

firms because the total number of units produced in-

clude many different products each with different costs

and different price and sales data. It is therefore neces-

sary, in the multiproduct context, to determine what

costs are «7used by which products and services, and

this requ some sort of differential (e.g., incremental)

methodolo,,y.

In an antitrust context, fully distributed cost is not an

economically relevant definition of average total cost

and must be rejected as determinative.” First, FDC is a

quite arbitrary allocation of costs among different classes

of service. There are countless FDC methods, each allo-

cating costs by a different mathematical formula.” De-

“No objection has been made in the instant case to the

introduction of fully distributed cost evidence. Thus, nothin

in this opinion should be construed as reflecting on the

missibility of fully distributed cost evidence. Under some cir-

cumstances—for example, the operation of a single product

enterprise in a stable economy —average balance sheet costs

may provide an acceptable proxy for LRIC. See R. Posner,

supra, at 190. The use of C, as a proxy, in various con-

texts, is always open to examination.

Thus, various FDC methods will normally produce quite

different calculations of the cost of a product or service. In

one electric utility rate case one witness testified to the exist-

ence of at least 29 different methods of apportioning costs

among services. J. Bonbright, Principles of Public Utility

Rates 351 (1961). The FCC itself has required AT&T to sub-

mit at least seven different FDC cost studies. In the instant

case, cost studies — these seven different FDC methods

were introduced at trial. Not surprisingly, each method yielded

a significantly different cost profile.

A simple example helps to highlight the arbitrariness of

FDC methodology. Imagine a railroad line that simultane-

ously transports three different products: gold, lead and

feathers. If the railroad attempted to calculate, on a fully dis-

tributed cost basis, the cost of shipping each of these prod-

ucts, it would reach radically different results depending on

whether it allocated joint and common costs on the basis of

the value, weight, or bulk of the respective commodities

shipped.

5Sa

50 Nos. 80-2171 & 80-2288

spite trenchant criticism on economic grounds,** FDC

continues to be widely used for reguiatory purposes, inter

alia, because of its ease of application in dividing an

authorized total revenue requirement among individual

Cg oe or services—much as a pie is divided into slices.

ut FDC cannot purport to identify those costs which

are caused by a product or service, and this is funda-

mental to economic cost determination.

FDC also fails as an economically relevant measure of

cost for antitrust purposes because it relies on historical

or embedded costs. For it is current and anticipated

cost, rather than historical cost that is relevant to busi-

ness decisions to enter markets and price products. The

business manager makes a decision to enter a new

market by comparing anticipated additional revenues

(at a particular price) with anticipated additional costs.

If the expected revenues cover all the costs caused by

the new product, then a rational business manager has

sound business reasons to enter the new market. The

historical costs associated with the plant already in

place are essentially irrelevant to this decision since

those costs are “sunk” and unavoidable and are unaf-

fected by the new production decision. This factor may

be particularly significant in industries such as telecom-

munications which depend heavily on technological in-

novation, and in which a firm’s accounting, or sunk,

costs may have little relation to current pricing deci-

sions.*9

In particular, FDC fails as a relevant measure of cost

in a competitive market. FDC is, at best, a rough indi-

“ See erally 1 A. Kahn, supra, at 150; J. Bonbright,

supra; Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221, 1236-

47 (D.C. Cir. 1980) (Wilkey, J., dissenting), cert. denied, 451

U.S. 920 (1981).

* This decision path illustrates that LRIC analysis is not, as

the dissent suggests, a solely theoretical view of the question,

but is, in fact, a meaningful representation of the implicit

issues considered in the making of business decisions in the

real world.

56a

Nos. 80-2171 & 80-2288 51

cator of an appropriate rate ceiling for regulatory pur-

poses and should not be used as a measure of the

minimum price permissible in a competitive market.

The justifiable fear of monopoly, and the basis of section

2 of the Sherman Act, is that a firm enjoying monopol

power will not be constrained by market forces; it will

raise prices and decrease output in such a manner that

its own profit will be maximized but that consumers

will be subject to higher prices and a less efficient allo-

cation of resources than would be the case in a competi-

tive market. A standard making predatory pricing il-

legal and subject to treble damages must be carefully

structured to fit the needs of the Sherman Act and its

encouragement of competition on the merits. See Janich

Bros. v. American Drilling Co., 570 F.2d 848, 855 (9th

Cir. 1977), cert. denied, 439 U.S. 829 (1978). When a

price floor is set substantially above marginal or incre-

mental cost a price “umbrella” is created which allows

less efficient rivals to remain in the market sheltered

from full price competition. A fully distributed price

floor may thus misallocate resources and force con-

sumers to pay more for less production than competition

would dictate.

The economic literature that has considered the prob-

lem of predatory pricing has rejected almost entirely

the notion that fully distributed costs are a relevant

measure of ATC.” To the contrary, long-run incremen-

tal cost has been approved as an economically relevant

5% MCI has cited no economic authority beyond the testimony

of its own expert, Dr. Melody, which supports fully distrib-

uted cost as a measure of average total cost. Similarly, MCI

has cited no economic authority supporting the use of fully

distributed cost in an antitrust context. But cf. Noll & Rivlin,

Regulating Pricea in Competitive Markets, 82 Yale L. J. 1426

(1973) (use of incremental cost methods in — oe

prices may invite predatory ma, See ly ae

lic Utility Pricing

Comment, in New Dimensions in

(H. Trebing ed. 1976) (discussing the problems of —

cost information in regulatory contexts); rage fi The wi 1

nal Utility of Marginal Analysis in Public cy Formula-

tion, 8 J. Econ. Issues 287 (1974).

57a

52 Nos. 80-2171 & 80-2288

measure of average total cost for one product produced

by a multiproduct firm. Professor Baumol has stated in

reply to the sloppy use of the term “average total cost”:

By average total cost, [one] surely does not mean

fully allocated cost, which is a mare’s nest of arbi-

trary calculations parading as substantive informa-

tion . . . . Consequently, I assume that when [one]

requires the price of a good in the long-run to ex-

ceed its “average total cost,” [one] defines the latter

to mean the average incremental cost of the prod-

uct including any fixed cost outlays required by

the item.

Baumol, Quasi-Permanence of Price Reductions: A Pol-

icy for Prevention of Predatory Pricing, 89 Yale L. J. 1,

9 n.26 (1979). Professors Joskow and Klevorick agree

with this critique of fully distributed cost as a measure

of average total cost:

For a single-product firm, average total cost is

easily defined. In the more likely multiproduct con-

text, we are using “average total cost” to signify the

average incremental cost of the commodity of con-

cern and not any arbitrary “fully allocated cost

measure.”

Joskow & Klevorick, A Framework for Analyzing Pred-

atory Pricing Policy, 89 Yale L. J. 213, 252 n.79 (1979).

Since all costs are variable in the long run it is long-run

incremental costs (including return on investment) which

most closely measure anticipated average total cost. 3 P.

Areeda & D. Turner, supra, at 7712 at 156. Cf R.

Posner, supra, at 190.°!

51 Unfortunately the terms “average total cost” or “average

total costs” have been used ambiguously. As we use “average

total cost” in this ee. we mean average total economic

cost, i.¢., costs on a forward-looking basis. See generally 1 A.

Kahn, supra, at 73-74, 130-33. For a particular product or

service of a multiproduct business “average total cost” is de-

fined differentially as the average long-run incremental! cost

of the product or service in question. The term “average total

costs” has also been used in quite a different sense in a utility

(Footnote continued on following page)

58a

Nos. 80-2171 & 80-2288 53

A simplified example of some of these cost relation-

ships can be found in Judge Wilkey’s dissenting opinion

in Aeronautical Radio, Inc. v. FCC, 642 F.2d 1221, 1236

(D.C. Cir. 1980), cert. denied, 451 U.S. 920 (1981) (Wil-

key, J., dissenting).6* In Judge Wilkey’s example, a

judge accepts an invitation to participate in a law school

moot court, with the school paying for his hotel room

costing $125 per night. He later decides to bring his

wife along even though the school’s moot court represent-

ative cannot assure him that his wife’s expenses will

also be paid. Judge and Mrs. X attend the moot court,

and their hotel bill for two is $150 per night. Upon his

return, Judge X sends the moot court board his item-

ized expenses, noting that if the board has decided to

pay for his wife’s => he should be reimbursed at $150

a day; if not, he should receive $125 a day, the amount it

would have cost him had he attended the moot court

alone. The moot court board sends back a check for $75,

noting that it is unable to absorb the expenses of Mrs.

X, and explaining that, using a fully distributed cost

methodology, it has allocated one half of the couple’s

daily $150 hotel bill to Judge X and the other half to his

wife. Judge X is understandably both annoyed and con-

fused; he knows that if he had attended the moot court

alone, he would have been reimbursed at $125 a day, be-

5! continued

ratemaking setting to refer to the revenues required to meet

all the accounting, historical or embedded costs of the entire

utility enterprise. See Bonbright, supra, at 300. This latter

usage of “average total costs” is not ——— here since we

are concerned with the economic cost of a particular service of

a multiservice business. Such a cost must be one which is

caused by the particular service in seers. * Brodley and

} an

Hay, Predat Pricing at 780-86; Cudah Malko, Elec-

tric Peak- Pricing: Madison Gas and Beyond, 1976 Wis.

L. Rev. 47, 62.

%? In Aeronautical Radio, the District of Columbia Circuit

held that the FCC did not act arbitrarily and copermenty in

adopting a form of fully distributed cost methodo for pur-

poses of evaluating propessd telephone rates. Judge Wilkey

dissented, arguing that FDC was irrational, arbitrary and

capricious even as applied to regulatory ratemaking.

59a

54 Nos. 80-2171 & 80-2288

cause this is what his actual hotel charge would have

been, and because the moot court board's original invi-

tation had been extended on this basis. Judge X is also

angry because, had he known that the moot court board

was going to penalize him in this manner, he would not

have asked Mrs. X to accompany him, but would have

come by himself at the agreed all-expenses paid rate of

$125 a day. Thus, both practical considerations and eco-

nomic theory dictate that the relevant cost of Mrs. X’s

stay is $25 and that a marginal cost methodology should

be used to analyze the judge’s travel expenses and other

real world problems.™

53 Judge wd eh Base on to draw the parallel between this

example and AT&T's pricing decisions:

The parallel with the AT&T situation is obvious. The cost

for monopoly services is fixed, and will be the same

whether the competitive services are added by AT&T or

not. The cost for the monopoly services is the equivalent of

the $125 which would have been the hotel charge for

Judge X; the cost for the competitive services would be

the additional $25 which would be added if Mrs. X

enjoyed the use of the same services. From the hotel's

point of view, the additional cost for Mrs. X's presence is

only the additional linens and food, and therefore the

incremental cost for her presence is a relatively small

amount compared to the basic cost of providing that one

room and facilities for one person. (The hotel might calcu-

late that the presence of Mrs. X would generate sales in

the shops on the hotel premises and thus add a small

amount to hotel revenues, and thus the hotel could encour-

age her presence by charging even less than the cost of

the linens and food and still make a profit on the incre-

mental services. Similar comparisons might be made to

AT&T services.)

To apply fully distributed costs to the stay of the couple

at the hotel is economic nonsense; it is unquestionably true

that considered ah initio the cost of Arey the room

and food for the two persons can be divided equally, $75

apiece, but this bears no relation to the economic logic of

the way to conduct a hotel business or to conduct a moot

court board's business either. What the moot court board

was faced with from the start was paying the total

expenses of Judge X, which amounted to $125 at the price

(Footnote continued on following page)

60a

Nos. 80-2171 & 80-2288 55

D. The Proper Cost Standard

This case, insofar as predatory pricing is concerned, is

truly one of first impression for this circuit. The case

law in this and most other circuits has thus far largely

addressed the merits of short-run marginal cost (or its

proxy, average variable cost) as compared with average

total cost; the cases have not discussed the choice be-

tween long-run incremental cost and fully distributed

cost as a way to measure average total cost. See, e.g.,

3 continued

charged by the hotel. Similarly, the cdg charged by the

hotel for Judge X individually was what it cost to put one

person in the room and provide meals and all services,

with a reasonable profit.

Both the hotel and the moot court board should logically

and sensibly run their business on an incremental cost

basis, just as is advocated by AT&T and the Antitrust

Division in our case. The basic cost of having Judge

come to the moot court is going to be $125 a day whether

Mrs. X comes or not. The board is logically forced to pay

this price. The advent of Mrs. X is something entirely

within the control of Judge X; she can come or not, and if

she does come, there is no moral or economic right of the

moot court board to profit by the incremental service the

hotel is providing for Mrs. X by yee the cost allo-

cated to Judge X's presence, which logically still remains

at $125 a day and is not either economically or equitably

reducible to $75.

Similarly, the charges which the monopoly customers of

AT&T have been paying and which have been previous!

determined as fair, based on the costs of AT&T in provid-

ing these services, should not necessarily be reduced

simply because AT&T can inaugurate other services in

the competitive market. The costs properly allocated to

the new competitive services of AT&T are incremental

costs, not fully distributed costs, because the costs of the

monopoly services should remain the same irrespective of

whether AT&T enters competitive markets or not. (Actu-

ally, as shown by the detailed economic exposition above,

there is hope that the competitive services of AT&T, with

incremental cost pricing, will definitely contribute to a

lowering of costs for the monopoly service customers.)

642 F.2d at 1245-47 n.52.

6la

56 Nos. 80-2171 & 80-2288

Chillicothe Sand & Gravel Co. v. Martin Marietta Corp.,

615 F.2d 427 (7th Cir. 1980); Borden, Inc. v. FTC, 674

F.2d 498, 515 (6th Cir. 1982), petition for cert. filed, 51

U.S.L.W. 3271 (U.S. Aug. 25, 1982) (No. 82-328); O.

Hommel Co. v. Ferro Corp., 659 F.2d 340 (3d Cir. 1981),

cert. denied, 102 S.Ct. 1711 (1982); Americana Industries

v. Wometco de Puerto Rico, Inc., 556 F.2d 625 (1st Cir.

1977); International Air Industries v. American Excel-

sior Co., 517 F.2d 714 (5th Cir. 1975), cert. denied, 424

U.S. 943 (1976). Cf. Northeastern Telephone Co. v. AT&T,

651 F.2d 76, 89-90 (2d Cir. 1981), cert. denied, 102 S.Ct.

1438 (1982) (rejecting use of fully distributed cost stand-

ard). The Supreme Court has not spoken on the entire

issue of predatory pricing except to note a firm’s below

cost pricing in a price discrimination case. Utah Pie Co.

v. Continental Baking Co., 386 U.S. 685, 698-99 (1967).

Recently, several courts have questioned whether

short-run marginal cost should be the exclusive stand-

ard for predatory pricing and have expressed a willing-

ness to consider other factors. William Inglis & Sons

Baking Co. v. ITT Continental Baking Co., 668 F.2d

1014 (9th Cir. 1981), cert. denied, 103 S.Ct. 58 (1982);

International Air Industries v. American Excelsior Co.,

517 F.2d 714 (5th Cir. 1975), cert. denied, 424 U.S. 943

(1976); see generally Note, Predatory Pricing: The Re-

treat from the AVC Rule and the Search for a Practical

Alternative, 22 B.C.L. Rev. 467 (1981) (hereinafter cited

as Note, Retreat from AVC). Exclusive reliance on AVC

(a proxy for short-run marginal cost) has been criticized

primarily on the grounds that it focuses on short-run

rather than long-run price cost comparisons, a criticism

which, as noted earlier, is not fairly applicable to LRIC.

See Note, Retreat from AVC at 484-85, 489-94.

This court in Chillicothe Sand & Gravel Co. v. Martin

Marvetta Corp., 615 F.2d 427 (7th Cir. 1980), affirmed

the use of an incremental cost methodology as the start-

ing point for predatory pricing analysis. In that case,

the Areeda-Turner standard based upon short-run mar-

ginal cost was cited as “both a relevant and an extremely

useful factor” in identifying predatory conduct. 615

F.2d at 432. We are now required to move away from

62a

Nos. 80-2171 & 80-2288 57

the Areeda-Turner rule because we are faced with a

choice between two different cost standards—LRIC or

FDC—each of which may be argued to measure average

total cost. If average total cost is the objective (and the

principle of cost causation is to be honored), we think

that LRIC is and FDC is not an appropriate method of

getting at it." We, of course, do not close the door on

such other methods—as yet undeveloped and undis-

closed—as may be firmly based on the relation of cause

and effect between the product or service involved and

the costs it produces.

It is not surprising that no court has ever adopted

fully distributed cost as the appropriate cost standard in

a predatory pricing case. Most recently, the Second Cir-

cuit rejected fully distributed cost and adopted margi-

nal cost as the test for predation in a case involving

AT&T. In Northeastern Telephone Co. v. AT&T, 651

F.2d 76 (2d Cir. 1981), cert. denied, 102 S.Ct. 1438

(1982), the court considered allegations that a Bell Sys-

tem affiliate had engaged in predatory pricing in the

equipment market. The Second Circuit, in reversing the

— of the judgment relating to predatory pricing,

stated:

Adopting marginal costs as the proper test of

predatory pricing is consistent with the pro-com-

petitive thrust of the Sherman Act. When the price

of a dominant firm's product equals the product’s

marginal costs, “only less efficient firms will suffer

larger losses per unit of output; more efficient

firms will be losing less or even operating profit-

ably.” ... Marginal cost pricing thus fosters compe-

% We regard this case as being tried under a stipulation

that a form of average total cost would be used to determine

predation. Thus, we analyze whether LRIC or FDC is the

most meaningful economic measure of average total cost. This

analysis should not be construed as a rejection of the Areeda-

Turner rule using average variable costs. We affirm our pre-

vious holding in Chillicothe that pricing below average vari-

able cost is normally one of the most relevant indications of

predatory pricing.

63a

58 Nos. 80-2171 & 80-2288

tition on the basis of relative efficiency. Establish-

ing a pricing floor above marginal cost would

encourage underutilization of productive resources

and would provide a price “umbrella” under which

less efficient firms could hide from the stresses and

storms of competition.

Id. at 87 (citation omitted).

The Second Circuit explicitly rejected the trial court’s

reasoning that because AT&T was a multiservice regu-

lated utility the use of fully distributed cost was appro-

priate. Jd. at 89-90. The Second Circuit reiterated its

conclusion that maintaining a price floor above margi-

nal cost provided a haven for inefficient competitors. It

then detailed the perverse effects of FDC pricing on

consumer welfare and the competitive process itself.

Finally, the court examined and rejected the argument

that FDC was required to prevent cross-subsidization,

explaining that if prices were above marginal cost no

subsidies could exist and in fact contributions would be

made to the overhead of the other Bell services. /d. at

90. See also Southern Pacific Communications Co. v.

AT&T, No. 78-0545 (D.D.C. Dec. 21, 1982).

The Eighth Circuit has also rejected the use of fully

allocated costs, although in a less definitive manner

than the Second Circuit. In Superturf, Inc. v. Monsanto

Co., 660 F.2d 1275 (8th Cir. 1981), the court held that

pricing below fully allocated cost but above average

variable cost was not predatory, particularly in the ab-

sence of predatory intent or other conduct sufficient to

render the pricing unreasonable.

Nor has FDC gained any adherents among district

courts in the Sixth Circuit, which has not decided the

validity of the Areeda-Turner short-run marginal cost

approach. See Borden, Inc. v. FTC, 674 F.2d at 515

(affirming violation of section 5 of the FTC Act where

monopolist had engaged in selective price cutting and

romotional allowances in competitive markets only); ef.

rodley and Hay, Predatory Pricing at 780-86. In Hill-

side Dairy Co. v. Fairmont Foods Co., 1980-2 Trade

Cas. 1 63,313 (N.D. Ohio 1980), the Northern District of

64a

Nos. 80-2171 & 80-2288 59

Ohio considered a meeting competition defense to a

price discrimination charge where the facts indicated

that the defendant had inadvertently beaten rather than

met its competitor’s dairy prices. The court held that

such a defense would still prevail if the defendant had

made substantial efforts to verify the actual price offered

by its competitor, and did not operate at a loss in sup-

lying the product. /d. at p. 75,625. The court, in holding

or the defendant, explicitly chose average variable cost

over aa allocated cost as the proper standard. /d. at p.

75,626.

The other circuits have been virtually unanimous in

their endorsement of a marginal cost standard for pred-

atory pricing. The Third Circuit stated recently in O.

Hommel Co. v. Ferro Corp., 659 F.2d 340 (3d Cir. 1981),

cert. denied, 102 S.Ct. 1711 (1982), that although the

record before it obviated the need to choose explicitly

among competing economic theories of predation, it was

“inclined to accept the basic premise of the Areeda and

Turner thesis that predatory intent may not be inferred

from sales at or above average variable cost.” 659 F.2d

at 352.% Similarly, in /nternational Air Industries v.

American Excelsior Co., 517 F.2d 714 (5th Cir. 1975),

cert. denied, 424 U.S. 943 (1976), the Fifth Circuit held

that, except where barriers to entry are “extremely

high,” a plaintiff claiming predatory pricing must show

6 The trial court in Hommel, relying on the Supreme Court's

decision in Utah Pie Co. v. Continental Baking Co., 386 U.S.

685 (1967), had allowed the jury to hear evidence of defend-

ant’s pricing below total cost. See 472 F. wens 793, 795-97

(W.D. Pa. 1979). On this evidence the jury found for the plain-

tiff on a Robinson-Patman violation, but not on a section 2

Sherman Act violation. Hence, on appeal, the Third Circuit

faced only the issue of the appropriate pricing standard in

price discrimination cases. Without ruling on the question

whether the standards for predatory pricing were the same

for both price discrimination and monopolization, the Third

Circuit reversed the district court and entered judgment for

the defendant, in part because of the absence of any evidence

o- prices were below average variable cost. 659 F.2d at 350-

6Sa

60 Nos. 80-2171 & 80-2288

that the defendant “is charging a price below his aver-

age variable cost in the competitive market.” 517 F.2d

at 724 & n.31.% The First, Tenth and District of Colum-

bia Circuits have also expressed their approval of the

Areeda-Turner marginal cost test. See Americana In-

dustries v. Wometco de Puerto Rico, Inc., 556 F.2d at

628; Pacific Engineering & Production Co. v. Kerr-

McGee Corp., 551 F.2d 790, 797 (10th Cir.), cert. denied,

434 U.S. 879 (1977); AT&T v. FCC, 602 F.2d 401, 410

n.49 (D.C. Cir. 1979); National Association of Regulatory

Utility Commissioners v. FCC, 525 F.2d 630, 638 n.34

(D.C. Cir.), cert. denied, 425 U.S. 992 (1976); Southern

Pacific Communications Co. v. AT&T, No. 78-0545

(D.D.C. Dec. 21, 1982).

% An important, but presently theoretical, issue not directly

before this court is the propriety of using short-run marginal

cost (as opposed to some measure of average total cost) in pred-

atory pricing cases involving industries with high entry bar-

riers. Several courts have suggested that exceptions to the

Areeda-Turner rules may be appropriate where entry barri-

ers are high—one of the circumstances in which true preda-

tory pricing is more likely to occur. See, e.g., /nternational

Air Industries v. American Excelsior Co., 517 F.2d at 724;

Hanson v. Shell Oil Co., 541 F.2d 1352, 1358 n.5 (9th Cir.

1976), cert. denied, 429 U.S. 1074 (1977); cf. Northeastern Tele-

phone, 651 F.2d at 89 (barriers to entry into business tele-

phone equipment market “relatively low”).

There is some evidence that barriers to entry may be high

in the long distance telecommunications field. There is also

evidence, however, that the development of microwave tech-

nology has of may lowered those barriers. See Note,

Recent Federal Actions Affecting Long Distance Telecommuni-

cations: A Survey of Issues Affecting the Microwave Special-

ized Common pal Be jo Baye 43 Geo. Wash. L. Rev. 878,

894 (1975). Because both parties here have argued for meas-

ures of average total cost, we do not reach this question

except to note that one of the principal barriers to entry in

the telecommunications industry is the need for FCC permis-

sion to enter the field. Since the FCC has extensive powers to

open up the telecommunications industry to new competition

and to “fine tune” the permissible competitive prices by

lation, any such barriers to entry may not be of overriding

concern in an antitrust context.

66a

Nos. 80-2171 & 80-2288 61

Only one circuit has ever permitted a jury to hear evi-

dence of predation based on pricing above average vari-

able but below average total cost. In William Inglis &

Sons Baking Co. v. ITT Continental Baking Co., 668

F.2d 1014 (9th Cir. 1981), cert. denied, 103 S.Ct. 58

(1982), the Ninth Circuit held that it was permissible

for a jury to find predation based on evidence that dem-

onstrated pricing above average variable cost, if accom-

panied by intent. In J/nglis the trial court had entered

judgment n.o.v. for the defendant as a result of plain-

tiffs failure to introduce evidence that prices were

below marginal costs. Jd. at 1026.

The Ninth Circuit reversed, noting its reluctance to

adopt the Areeda-Turner rule as the exclusive test for

=" pricing. /d. at 1032. In place of Areeda-

urner, the court stated a new rule:

[W]e hold that to establish predatory pricing a

plaintiff must prove that the anticipated benefits of

defendant's price depended on its tendency to disci-

pline or eliminate competition and thereby enhance

the firm’s long-term ability to reap the benefits of

monopoly power. If the defendant’s prices were

below average total cost but above average variable

cost, the plaintiff bears the burden of showing

defendant's pricing was predatory. If, however, the

acreage proves that the defendant’s prices were

elow average variable cost, the plaintiff has estab-

lished a prima facie case of er er pricing and

the burden shifts to the defendant to prove that the

prices were justified without regard to any antici-

pated destructive effect they might have on compet-

itors.

Id. at 1035-36. See also D & S Redi-Mizx v. Sierra Redi-

Mix and Contracting Co., No. 81-5493 (9th Cir. Nov. 2,

1982).

Nothing in this statement supports the use of fully

distributed cost in a predatory es case. The Ninth

Circuit established a rule which allows a jury to hear

evidence of pricing between ATC and AVC without any

67a

62 Nos. 80-2171 & 80-2288

reference to FDC at all. The court in Jnglis defined

average total cost as the “portion of the firm’s total

cost—both fixed and variable—attributable on an aver-

age basis to each unit of output.” Jd. at 1035 n.30. This

definition is consistent with the use of long-run incre-

mental cost as a measure of ATC, as advocated by Pro-

fessors Baumol, Joskow and Klevorick; it does not sup-

rt the use of non-economic cost measures such as

DC. Moreover, the J/nglis rule must be read narrowly

to avoid conflict with prior Ninth Circuit decisions

endorsing a marginal cost standard and with the spe-

cific reason given by the Ninth Circuit in J/nglis for

reversing the district court. See id. at 1032-33, 1036.

It is important to understand that the “average total

cost,” to which some courts and commentators refer,

should not be equated with FDC; it is, when properly

understood, best measured in the multiproduct context

by average long-run incremental cost. Essentially, this is

the case because LRIC, unlike FDC, only measures costs

which are causally related to the service or product in

question.’

This is not an economist’s quibble or a theoretical

musing; it is a matter of principled analysis and practi-

cal reality in the market place. Pricing at or above long-

run incremental cost in a competitive market is a

rational and profitable business practice. Because there

are legitimate, and in fact compelling, business reasons

for pricing products at or above their long-run incre-

mental cost, no predatory intent should be presumed or

inferred from such conduct.™

57 How practically to compute LRIC (including the possible

use of proxies, where saerrerete, cf. Brodley and Hay, Pred-

atory cing at 780-86) is a matter which we believe to be

quite manageable and capable of development on an ongoing

is.

% We do not intend to imply that in a// cases and in all cir-

cumstances we would only examine the price-cost relationship

of a product or service. Our test merely suggests that a judge

(Footnote continued on following page)

68a

Nos. 80-2171 & 80-2288 63

E. Cross-subsidization

MCI makes one final argument to support the use of

fully distributed cost. MCI argues at considerable length

that an FDC methodology is required to prevent AT&T

from subsidizing its competitive services with revenues

derived from services in which it retains a monopoly.

MCI claims that such “cross-subsidization” injures

AT&T’s competitors as well as AT&T’s local monopoly

customers, who must pay higher rates in order to “sub-

sidize” the company’s less profitable private line serv-

ices. Nowhere does MCI define precisely what it means

by a “cross-subsidy,” although it presented evidence at

trial that different AT&T services earned differing

rates of return. In particular, MCI noted that AT&T's

Telpak and other private line long distance services,

although showing a positive rate of return, earned on an

allocated rate base a lower rate of return than did cer-

tain other AT&T long distance services.

Such differing rates of return, however, even if cor-

rectly and meaningfully derived, do not support the

imposition of antitrust liability. The fact that different

services may earn different rates of return largely re-

flects the realities of a competitive market.°® Where a

% continued

or jury may not infer predatory intent unless price is below

long-run incremental! cost. Thus, we agree, at least in princi-

ple, with Judge Wood's advocacy of the use of non-economic

(or less rigorous economic) evidence in some cases. Consider-

ing, however, among other things, the extent of regulatory

control over entry and prices in the present case, and the

highly ambiguous nature of the non-economic evidence which

has been submitted, we think the price-cost relationship must

be determinative. But, of course, some future case may admit

more scope for “other factors.” Chillicothe, 615 F.2d at 432. In

any event a strong presumption of lawfulness must attach

when price is shown in a case like this one to be above an

appropriately derived measure of long-run incremental cost.

I has offered no credible direct evidence of intent that, in

our view, directly rebuts this presumption.

** The implication of MCI’s theory would be that a multi-

service firm must earn a rate of return for each service at

(Footnote continued on following page)

69a

64 Nos. 80-2171 & 80-2288

firm faces competition, demand is more elastic—that is,

more sensitive to changes in prices—because of the pres-

ence of other firms producing substitute products to

which buyers may turn. Lower returns on investment

are to be expected in competitive markets because each

firm, in accordance with classical competitive theory

and practice, will be forced to lower prices toward mar-

ginal costs in order to maintain its market share.

MCI’s argument presumes that customers of monop-

oly services will have to pay higher prices if AT&T

prices below FDC in markets where competition is pres-

ent. See In Re American Telephone & Telegraph Co., 61

F.C.C. 2d 587, 624, 652 (1976). Such arguments ignore

the nature of costs and revenues in a multi-service

enterprise. AT&T’s unattributable overhead costs do not

increase when AT&T offers a new service, nor do they

decrease when such a service is discontinued. When a

multiproduct firm prices a competitive service above its

long-run incremental cost, no cross-subsidy can occur

because the additional revenues produced exceed all

additional costs associated with the competitive service

and provide a contribution to the unallocable common

costs otherwise borne by the firm’s existing customers.

For this very reason the Second Circuit in Northeastern

Telephone Co. v. AT&T rejected a cross-subsidization

argument identical to that advanced by MCI here:

(The plaintiff's] argument in favor of the fully dis-

tributed cost test is based on a misunderstanding of

the economic notion of subsidization. [The plaintiff]

59 continued

least equal to its overall cost of capital for the firm. Such a

requirement is illogical since a firm's overall cost of capital is

based on the level of risk in investing in the firm and not in

an individual service faced with particulari risks and com-

petitive conditions. Also, to the extent all the services face

competition, a demand that in the aggregate they earn the

overall cost of capital —— that, to the degree some serv-

ices exceed this figure, others will fall short and thus arbitrar-

ily appear “predatory.” In any event, rate of return calcula-

tions must be based on a host of arbitrary apportionments of

plant and expenses.

70a

Nos. 80-2171 & 80-2288 65

seems to believe that whenever a product’s price

fails to cover fully distributed costs, the enterprise

must subsidize that product’s revenues with rev-

enues earned elsewhere. But when the price of an

item exceeds the costs directly attributable to its

production, that is, when price exceeds marginal or

average variable cost, no subsidy is necessary. On

the contrary, any surplus can be used to defray the

firm’s non-allocable expenses.

651 F.2d 76, 90 (2d Cir. 1981), cert. denied, 102 S.Ct.

1438 (1982). See also Southern Pacific Communications

Co. v. AT&T, No. 78-0545 (D.D.C. Dec. 21, 1982).

Judge Wilkey of the District of Columbia Circuit ampli-

fied this point in his dissent in Aeronautical Radio, Ince.

v. FCC, 642 F.2d 1222 (D.C. Cir. 1980), cert. denied, 451

U.S. 920 (1981):

AT&T’s common or joint unattributable costs will

exist whether or not it offers services in the com-

petitive market. These costs existed and were borne

by AT&T’s monopoly service customers before

AT&T entered the competitive market, and would

again be borne fully by them if AT&T were forced

out of the competitive market.

When AT&T considers whether to enter or to

expand sales in a competitive market the old mo-

nopoly service customers stand to benefit so long as

the new customers bear any part of the common or

joint costs. To determine whether monopoly custom-

ers will benefit from the firm's operations in the

competitive market, one need only calculate whether

the revenues from the new competitive market

operations pay fully for the incremental or addi-

tional costs the firm incurs for these operations. If

revenues cover these costs (including cost of capital

as measured by LRIC or any similar variant of

marginal cost measurement) then ANY additional

revenue earned above the LRIC level! is a bonus for

the monopoly customers.

642 F.2d at 1240 (Wilkey. J.. dissenting). See also 2 P.

Areeda & [). Turner, supra, at *719 1 A. Kahn, supra,

at 150-58.

7la

66 Nos. 80-2171 & 80-2288

If AT&T were forced to price at FDC levels in com-

petitive markets, its monopoly customers would proba-

bly be worse rather than better off. Because of the

elasticity of demand in competitive markets, any rate

substantially above LRIC would cause AT&T to lose

business against an equally efficient competitor and,

hence, decrease AT&T's total revenue from competitive

markets. There would thus be less revenue available

from competitive services to contribute to the firm’s

joint or common costs, and monopoly customers would

be required to provide a greater share of these costs.”

For a regulated utility such as AT&T, fully distrib-

uted cost methodology may be used to establish a regu-

latory rate ceiling, in order to provide no more than a

“fair rate of return” for the enterprise as a whole. If

FDC is adopted as a floor for predatory pricing pur-

poses, as well as a ceiling for ratemaking purposes, the

regulated utility will be effectively prohibited from

materially raising or lowering prices to engage in com-

petition. This result flies in the face of a major objective

of the antitrust laws—the promotion of price competi-

tion. It is also inconsistent with the BCC's explicit

endorsement of price competition in its Specialized

Common Carriers decision. An antitrust rule requiring

a dominant firm to price at or above FDC in competi-

tive markets may effectively require the firm to forego

price competition and gradually abandon its market

share, i.e., lose its business. Constraining AT&T to FDC

pricing of its competitive services thus runs the risk of

permitting actually or potentially less efficient competi-

tors to serve a growing segment of the telecommunica-

tions market and thus deprive consumers of the benefits

of price competition.”

# We recognize. of course, that under the consent decree

approved in ['nited States » AT&T, 43 Antitrust & Trade

Rep. (BNA) No 1077 (Spee Supp Aug 12, 1982), Bell's

local operating companies w i no longer be corporately linked

to AT&f's long distance telephone service

* Of course. quite apart from antitrust pricing standards in

this regulated industry. the regulatory agencies can evaluate

(Footnote continued on following page)

72a

Nos. 80-2171 & 80-2288 67

F. Insufficiency of the Evidence

In addition to reliance on an incorrect cost standard,

the jury’s finding that Hi-Lo was predatory is disap-

proved and must be set aside because MCI failed to pro-

duce sufficient evidence to create a jury question that

Hi-Lo was priced below cost under any standard. The

testimony of Dr. William Melody, a regulatory econo-

mist, accompanied by certain documents, constitutes the

only evidence MCI presented on the issue of predatory

pricing. Dr. Melody testified twice, first in the latter

part of February 1980 and again on June 3 and 4, 1980.

On neither occasion did his testimony produce evidence

sufficient to sustain a jury verdict that Hi-Lo was

priced below cost under any standard.

Testifying the first time, Dr. Melody presented no evi-

dence whatsoever that Hi-Lo was priced below any meas-

ure of cost. Dr. Melody introduced a chart, Plaintiff's

Exhibit 933, which purported to prove that Telpak was

predatory by comparing its price with the costs asso-

ciated with Hi-Lo service. Dr. Melody argued that the

costs attributable to both services were identical because

each service was simply a different marketing plan for

the same private lines. This chart shows the cost of the

Hi Density (Hi-D) circuits to be $.65 per circuit mile.

Thus, MCI’s own proof on this issue establishes that

6! eontinued

competitive prices by whatever standards ag hy economi-

cally or socially desirable, including FDC. See Aeronautical

Radio, Ine. v. FCC, 642 F.2d 1222 (D.C. Cir. 1980), cert.

denied, 451 U.S. 920 (1981).

In this connection, although there may be some merit to the

courts’ fashioning an antitrust rule of liability addressing

limit pricing (or other “strategic” practices) as discussed by

the dissent, administration might be difficult. See infra, pp.

178-81. Further, Prof. Baumol’s proposal of a quasi-permanent

pricing approach (and other like proposals) may have promise

if apparent problems of administration can be solved. See

Baumol, Quasi-Permanence of Price Reductwns. A Policy for

Prevention of Predatory Pricing, 89 Yale L.J. 1 (1979). In any

event, no evidence was presented based on such theories in

this case

73a

68 Nos. 80-2171 & 80-2288

AT&T's Hi-D circuits**, which were sold for $.85 per

circuit mile, were priced $.20 above even their fully dis-

tributed costs.

This admission was reinforced on cross-examination

' an exchange between counsel for AT&T and Dr. Mel-

y:

Q: Now turning back to Hi-Ls, you are not con-

tending, are you, that the high density portion of

the Hi-Lo tariff is below cost by any measure?

A: I have not contended that the high density

rate is below cost. I have not assessed the high den-

sity rate in terms of costs.

Tr. 2593. Despite expressing misgiving about the costs

reflected in PX 933, Dr. Melody repeatedly adopted

these costs, including the $.65 figure, as the best evi-

dence available. Tr. 2576, 10481. Dr. Melody also stated

that, in examining Bell’s cost data, he was unable to

make the adjustments necessary to demonstrate that Hi-

D costs were any greater than $.65. Tr. 2594.

On rebuttal, Dr. Melody purported, for the first time,

to suggest that Hi-D was below cost. MCI introduced

PX 3915, reproduced below, which is a table computed

by Dr. Melody showing various alleged revenue defi-

ciencies for AT&T's entire private line telephone service.

*2 MCI belatedly argues that it was not required to prove that

the Hi-D circuits were priced below cost but that Hi-Lo as a

whole was priced below cost. This argument defies logic as

well as MCI’s proof. The Hi-D circuits were the only portion

of the long distance market in which AT&T lowered its price.

The Lo-D and short haul portions of the market were subject

to substantial “lage increases. Further, Dr. Melody's testi-

mony bolsters the notion that only the | cuts for the Hi-D

circuits are relevant for purposes of determining predatory

pricing. Dr. Melody stated that this decrease in the high den-

sity rates was AT&T's competitive response to MCI and,

therefore, the only relevant price to be examined. Tr. 2617.

74a

Nos. 80-2171 & 80-2288 69

AT&T PRIVATE LINE TELEPHONE SERVICE

(IN $ MILLIONS)

197119721973 19741975

REVENUE

NECESSARY TO

CoveR AT&T's

Cost OF

CAPITAL $109 $120 $153 $164 $172

REVENUE

AVAILABLE $ 37 $ 47 $ 65 $ 68 $ 73

DEFICIENCY

Or REVENUE

BELow Cost ($ 72) ($ 73) ($ 88) ($ 96) ($ 99)

Dr. Melody explained the preparation of his chart as

follows:

On the basis of Mr. Johnson's [sic] [an AT&T wit-

ness] study, what I did was I examined every

revenue that would be available after deducting all

of the normal operating expenses of business. .. .

What I did was I calculated the revenue that

would be available for paying the cost of capital on

the basis of Mr. Johnson's [sic] studies. . . .

I then calculated the revenue that would be

necessary to cover AT&T's cost of capital as earned

by the business as a whole. That is indicated by the

first row. The revenues that would be necessary if

private line telephone service were to provide suffi-

cient revenue to pay the cost of capital.

I then subtracted the revenue necessary from the

revenue available and was able to calculate the

deficiency of revenue below costs for private line

telephone service.

Tr. 10474-76.

Neither Dr. Melody’s testimony nor his private line

telephone chart reflect the sort of analysis and presenta-

tion necessary to support a claim of predatory pricing.

75a

70 Nos. 80-2171 & 80-2288

The summary nature of Dr. Melody’s chart would make

it very difficult for the jury to determine the basis of his

calculations. Dr. Melody purports to be making adjust-

ments to a series of fully distributed cost exhibits intro-

duced by AT&T. Each of these exhibits consisted of

voluminous cost studies (using several different methods

of cost distribution), or summaries of such studies,

which on their face stated that private line telephone

service and Telpak earned positive rates of return®

under each FDC method used in the studies. Dr. Melody

provides us with no calculation (or even specification) of

AT&T's overall cost of capital (including, presumably,

embedded cost of debt), which establishes a deficiency

in contribution by private line telephone to that cost.™

Thus, Dr. Melody’s testimony is deficient as to the

reasons why he selected one of the FCC's at least seven

cost methods or how he may have adjusted AT&T's cost

studies to produce the revenue deficiencies derived on

his chart. Dr. Melody does not state what percentage he

used to calculate AT&T's cost of capital rate, nor what

plant items he attributed to private line services for pur-

poses of calculating these capital costs. Similarly, there is

no definition or description of AT&T's “normal operating

expenses of business.” Thus, we do not know if, or how,

Dr. Melody allocated capital costs and normal operating

expenses.® More importantly, Dr. Melody’s chart fails to

° These were expressed in the studies as a ratio of net oper-

ating earnings to net investment.

* Dr. Melody also testified that the “revenue deficiency”

shown in his chart was “greater after Hi-Lo went into effect.”

Tr. 10477. Considered in the context of the other deficiencies

in the evidence and the many variables involved, we do not

consider this observation as evidence that Hi-Lo or Hi-D was

“below cost.”

ss It appears from our review of the record that Dr. Melod

used the plant and expense allocations produced by AT&T's

FDC “Method 1” as applied to the various years. See supra,

note 47, for a discussion of FDC methodologies. Thus AT&T's

“net operating earnings” under that method turns out for

each of the years (with the possible exception of 1974) to be

(Footnote continued on following page)

76a

Nos. 80-2171 & 80-2288 71

isolate Hi-D circuits or even Hi-Lo service as a whole;

instead it calculates alleged revenue deficiencies for

AT&T's entire private line sector. As Dr. Melody ac-

knowledged, this sector includes many services besides

Hi-D, as well as several types of switching equipment.®

Dr. Melody’s chart, together with his testimony, is

therefore an insufficient basis for a jury verdict that the

Hi-D portion of the Hi-Lo rate is “below cost.” We

assume that Dr. Melody’s testimony was designed to

demonstrate that, during the years in question, under

some FDC method (presumably Method 1, see supra,

note 65), “private line telephone” was returning less

than AT&T's overall cost of capital. Whatever the mer-

its of such a demonstration as a measure of predation, see

supra, text and note at note 47, we think the attempted

demonstration is defective for lack of specificity and ex-

planation of key elements and because “private line tele-

phone” is inadequately related to the high density por-

tion of the Hi-Lo rate.*’ This evidence falls below the

6 continued

egual to the “revenue available” in Dr. Melody’s chart. Dr.

elody did not testify that he in fact followed “Method 1” or

why he selected that method if in fact he did. Of course,

neither Method 1 nor any other method was espoused, or had

its probative value attested to, by Mr. Johnston, who mere]

stated that these FDC studies were required by the FCC,

* Dr. Melody attempted to address this problem by testify-

ing that “Mr. Johnson [sic] [in his testimony} indicated that

the other services were .. . providing a profit.” Tr. 10477.

What Mr. Johnston actually said was that the other services

“were making a significant contribution to the earnings of the

Bell System.” Tr. 6868. This statement might mean that the

other services were contributing on an incremental cost basis

or earning a positive rate of return on a fully distributed cost

basis. The stateinent says nothing about whether the rate of

return of the other services was greater or less than the over-

all cost of capital of the Bell Sys

This text is long and has been trimmed here. Open the source document for the complete record.