Amicus Curiae Brief — Eastman Kodak Co. v. Image Technical Services, Inc.

FILED

Supreme Court, U.S. |

SEP 20 199] |

No. 90-1029“ OFFKE OF Th:

In The

Supreme Court of the United States

October Term, 1991

EASTMAN KODAK COMPANY,

Petitioner,

VS.

IMAGE TECHNICAL SERVICES, INC. et ai.,

Respondents.

7

On Writ Of Certiorari To The United States Court

Of Appeals For The Ninth Circuit

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BRIEF OF AMICI CURIAE NATIONAL

ASSOCIATION OF STATE PURCHASING

OFFICIALS AND NATIONAL INSTITUTE OF

GOVERNMENTAL PURCHASING, INC.

IN SUPPORT OF RESPONDENTS

sd

RicHarRD D. MONKMAN*

Ditton & FINDLEY

One Sealaska Plaza

Juneau, Alaska 99801

Telephone: (907) 586-4000

*Counsel of Record

COCKLE LAW BRIEF PRINTING CO., (800) 225-4964

OR CALL COLLECT (402) 342-2831

|

TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES....... ii

INTEREST OF AMICI ........ l

SUMMARY OF ARGUMENT... 2

PE os cceusenseecs< 3

B.

D.

F.

The Issue of Market Power in Aftermarkets is a Fact

Question That Cannot Be Resolved on This Record

by a “Per Se” Rule of Competitiveness

Governments are Major Purchasers of Photo

copiers and Micrographic Equipment

A Competitive Service Aftermarket Provides the

ETO a ae a rea

Procurement Rules Result in Market Imperfec-

Ea Pat Se eee ee ea eee ae eee rage

Separation of Purchasing and Operating Func-

tions in Government Results in Market Imperfec-

RC Oe ee Pre

The “Lock-In” Effect Results in Market Imperfec-

PE Sb Seat acsecdeuaceesecnes

The Matsushita Standard Applied.

NEE bd Goo bbe 0006's oes 066s

JT

NJ

ii

TABLE OF AUTHORITIES

Page

CASES:

Image Technical Services, Inc. v. Eastman Kodak Co.,

oe &® Be. Ee Be Sr er 4

Jefferson Parish Hospital Dist. No. 2 v. Hyde, 466 U.S.

ot, ere 4,7, 14

Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio

Coop., G75 US. GFE GIRGEc oc cvccscusuccssuusens 13, 14

NCAA uv. Board of Regents, 468 U.S. 65 (1984)......... 2

Parts and Elec. Motors, Inc. v. Sterling Elec., Inc., 866

wy B- By, ge | ewer 8

Llnited States v. E.I. DuPont deNemours & Co., 351

US. S7F CHBGS occ cccconsecdesbvaseeeee 4

STATUTES:

1S USL. Gostiom § .cccccvccceuueceesn ee 2

Alsene Siatute DOSS «occ cece seccess eee 10

Alaska Statute SE.S0. OEP ous ccccvccevcescssene 2

Alaska Ghatwhe BE.Fe. Bae. occ ck cvcescececsenuee q

Aliases Siatube FE.Fe. TT ccc vcecscessesssesee 8

1991 Session Laws of Alaska, Chapter 73 ........... 10

1991 Session Laws of Alaska, Chapter 96, Sec. 163 .... 10

RULEs:

Federal Rule of Civil Procedure 56...................

INTEREST OF AMICI

The National Association of State Purchasing Offi-

cials and the National Institute of Governmental Purchas-

ing, Inc. file this brief as amici curiae in support of

Respondents, Image Technical Services, Inc., et al.

The National Association of State Purchasing Offi-

cials (“NASPO”) is a non-profit affiliate of the Council of

State Governments. NASPO is comprised of the heads of

the purchasing agencies of all fifty States, the District of

Columbia, Puerto Rico, the Virgin Islands, Guam, Ameri-

can Samoa, and the Northern Mariana Islands.

The National Institute of Governmental Purchasing,

Inc. (“NIGP”) is a non-profit educational and technical

organization of State and local governmental buying

agencies. The members of NIGP include over 1,300 gov-

ernmental purchasing agencies of the United States, the

fifty States, the Provinces of Canada, and many county,

city and municipal governments.

The members of NASPO and NIGP purchase a com-

bined total of about $550 billion in goods and services

annually on behalf of State and local taxpayers. State

governments alone purchase more than $200 billion

annually. These purchases include Kodak photo-copiers

and micrographic equipment, and related purchases of

supplies, replacement parts and repair services for those

machines.

This case arises under the Sherman Act, 15 USC § 1 et

seq. (1982), intended by Congress to encourage competi-

tion and protect the interests of consumers. See NCAA uv.

Board of Regents, 468 U.S. 65, 107 (1984). NASPO and

NIGP have strong interests in promoting competition

among suppliers of goods and services to governmental

consumers. The members of both organizations seek to

obtain the best quality product, at the lowest price, for

the taxpayers. “More value for the tax dollar” is NIGP’s

informal motto.

The goals of NASPO and NIGP are firmly embedded

in established public policy. Virtually every State and

local government in the United States is required, by law,

to use competitive processes to purchase goods and ser-

vices. See e.g., Alaska Stat. 36.30.100 (. . . unless specifi-

cally exempted by law, an agency contract shall be

awarded by competitive sealed bidding”). Long experi-

ence has shown that vigorous competition among multi-

ple suppliers is essential to obtaining the best product

while protecting the public fisc.

The members of NASPO and NIGP are in a unique

position to address the practical effects of the issues

raised in this case.

SUMMARY OF ARGUMENT

Governments routinely buy expensive pieces of

micrographic and photocopier equipment, including

Kodak’s machines. This equipment must be maintained

and serviced on a regular basis. Without constant atten-

tion from skilled technicians, much of today’s “high tech”

equipment will not function for very long - if at all.

Public agencies are easily locked-in by budget con-

straints to a particular type of equipment. There are legal

constraints on public purchasers which make total cost

pricing of equipment difficult. Vigorous competition

among multiple service providers is essential for the

members of NASPO and NIGP to obtain the “most value

for the tax dollar.”

Monopolization of aftermarket for parts, and the con-

sequent elimination of competition in the aftermarket for

service, is injurious to the public fisc. Tying sales of parts

to service leaves the equipment manufacturer free to

charge the public agency higher prices for less service

than could be obtained in a competitive market.

The factual record in this case is almost nonexistent.

The Court of Appeals correctly held that remand was

appropriate.

ARGUMENT

THE ISSUE OF MARKET POWER IN AFTERMARKETS

IS A FACT QUESTION THAT CANNOT BE

RESOLVED ON THIS RECORD BY A “PER SE” RULE

OF COMPETITIVENESS

The issue of Kodak’s market power is central to the

correct resolution of this case. Respondents’ tying claims

require a showing of “some special ability - usually

called ‘market power’ — to force a purchaser to do some-

thing that he would not do in a competitive market.”

Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 27

(1984). Similarly, respondents’ claims of monopolization

require proof that Kodak enjoyed the “power to control

prices or exclude competition in the relevant market.”

United States v. E.1. DuPont deNemours & Co., 351 U.S. 377,

391 (1956).

Kodak argues that a manufacturer that lacks market

power in the “interbrand” original equipment market

cannot, as a matter of law, wield market power in the

aftermarkets for parts and repair services. See Petitioner’s

Br., 16-27. In an area of particular interest to NASPO and

NIGP, Kodak argues that it cannot succeed in overcharg-

ing its customers in these aftermarkets: “[a] lock-in strat-

egy works only if Kodak can make more total profit by

overcharging its existing customers for service than it

will lose as its new and repeat product sales dry up.”

Petitioner’s Br. at 25.

Given the constraints on public purchasing agencies,

the members of NASPO and NIGP believe that an equip-

ment manufacturer with market power in the after-

markets is quite able to make a “lock-in strategy” work in

the public sector, regardless of whether the manufacturer

has market power in the interbrand equipment market.

This is precisely the sort of “market imperfection” the

Court of Appeals held can “keep economic theories about

how consumers will act from mirroring reality.” Image

Technical Services, Inc. v. Eastman Kodak Co., 903 F.2d 612,

617 (9th Cir. 1990).

A.

Governments Are Major Purchasers of Photocopiers

and Micrographic Equipment.

State, county and local governments are among the

nation’s largest purchasers of copiers and micrographic

equipment. This equipment is necessary to perform

essential governmental services at a manageable cost.

Court records in the State of Alaska, for example, are

transferred to microfiche for permanent storage and easy

retrieval. Land records, once kept in rows and rows of

dusty books, are maintained in easily accessed microfiche

files. With the assistance of computers, these records can

be searched quickly, accurately and inexpensively by the

public.

Similarly, photocopiers (low, medium, and high vol-

ume) are fixtures in virtually every State and local gov-

ernmental office in the nation. It may well be, as some

say, that the invention of the photocopier was the greatest

advance in printing since moveable type. Combined with

the desktop publishing capacities of personal computers,

photocopiers have become essential in government oper-

ations.

A Competitive Service Aftermarket

Provides the Best Value.

Micrographic equipment and photocopiers are

expensive to buy and to operate. The initial capital outlay

is substantial, not only for the machines themselves but

for their associated “systems” — data retrieval software,

for example, and employee training. To amortize the cost

of these expensive machines at an affordable level, State

and local governments need to keep them in operation

for as long as possible. As the District Court observed,

“customers who have purchased Kodak equipment in a

competitive market will tend to retain that equipment for

its economic life.” Pet. App. 34B. Put another way, once

the equipment purchase is made, the public agency is “on

the hook” for parts and service until the equipment wears

out.

Where can the governmental agency turn for parts

and service? Its interest is in obtaining the best value for

the least cost to the taxpayer. This combination is not

always found in the cumbersome bureaucracies of equip-

ment manufacturers like Kodak. In response to demand

for better (and cheaper) service than that provided by

manufacturers, independent service organizations have

sprung up to provide specialized and aggressive service

for the owners of many types of equipment, including

copiers and micrographic equipment. See, e.g., JA 420,

425-27, 474-75 and 482-84.

An independent service organization may not be able

to manufacture a microfiche machine, but it is likely to do

a quicker, cheaper and often better job of servicing that

machine than the original manufacturer.! The members

' The Court of Appeals accurately found that evidence in

the record of Kodak’s own conduct suggests that “the demand

for parts can be separated from the demand for service.” 903

F.2d at 616. In the view of the more than 1,300 public purchas-

ing agencies which make up NASPO and NIGP, this conclusion

(Continued on following page)

of NASPO and NIGP have found that a competitive envi-

ronment, where independent service organizations com-

pete fiercely among themselves and with manufacturers,

results in lower prices and better customer service. The

challenge from independent organizations sharpens the

manufacturers’ response to its customer’s problems; the

smaller, more flexible independent organizations adapt

quickly to new market needs. The record confirms the

experience of NASPO and NIGP members. See, e.g., JA

420 4 30, JA 424-35 4] 42-47, JA 451 7 5 and JA 536 74

5-7.

To effectively compete, these independent service

entrepreneurs need parts. As any owne’ of a photocopier

can aver, high technology equipment needs maintenance

and repair ceaselessly - and virtually every service call

requires parts. By exploiting its control over parts, and

starving the independent service organizations, a manu-

facturer can force the public agency to buy service from

it: “a tied product that the buyer. .. might have preferred

to purchase elsewhere on different terms.” Jefferson Parish

Hosp., 466 U.S. at 12.

Cc.

Procurement Rules Result in Market Imperfections.

Kodak argues that an equipment manufacturer which

uses this power to overcharge its customers will soon

(Continued from previous page)

is correct. The development and early success of Respondents’

businesses is additional evidence from which it may be

inferred that parts and service are separate markets in the

photocopier and micrographic industries. Fed. R. Civ. Pro. 56.

find its sales of new equipment declining. Petitioner’s Br.

at 26. Thus, it argues, overcharging in the aftermarkets is

an “implausible strategy,” or in Judge Posner’s pithy

phrase, “a short-run game.” Id., citing Parts and Elec.

Motors, Inc. v. Sterling Elec., Inc., 866 F.2d 228, 236 (7th Cir.

1988) (Posner, J., dissenting). Kodak’s economic theory is

largely irrelevant to the real world of public purchasing.

Government agencies face restrictions not found in

the private sector. One of these is the requirement of

competitive bidding. As a matter of public policy, State

and local governments almost uniformly use competitive

bidding to obtain the lowest price. Where more than one

supplier exists (i.c., where there is “interbrand” competi-

tion), most public agencies are required by law to buy

equipment from the lowest bidder. See, e.g., Alaska Stat.

36.30.170(a) (“the procurement officer shall award a con-

tract . . . to the lowest responsible and responsive bid-

der”). A rational bidder can “low-ball” the price for its

equipment, and make up for lost profits by higher service

costs once the agency is locked-in.

To avoid this, Kodak argues, the consumer will “con-

sider” service costs at the time of purchase. The type of

analysis required by Kodak’s economic theory — estimat-

ing the total (or “life-cycle”) cost of a given piece of

equipment - is notoriously difficult and imprecise. This is

particularly the case for high technology, where there

may not be enough data to estimate the cost of maintain-

ing newly developed equipment over the term of its

useful life. Long term service contracts covering the use-

ful life of new equipment, at a fixed cost, are generally

not available at the time of purchase.

Consequently, Kodak’s approach to purchasing is

disfavored by State and local governments. In the State of

Alaska, for example, life-cycle costing is only allowed

upon a special showing:

A contract based on total or life cycle costs may

be awarded only when the chief procurement

officer or, for construction contracts or procure-

ment for the state equipment fleet, the commis-

sioner of transportation and public facilities,

determines in writing at the time of the contract

solicitation that the contract promotes overall

economy for the purposes intended, encourages

competition, is not unduly restrictive, and is in

the best interests of the state.

Alaska Stat. 36.30.150(b).

It takes a courageous purchasing officer to certify

that all these factors are present on a bid for untested

equipment. Government officials know they are not

omniscient in purchasing decisions. The public interest

and closely drawn procurement regulations demand that

they err on the side of caution. This generally means

taking vendors’ claims with the proverbial grain of salt,

and relying on empirically verifiable specifications rather

than the rosy projections of an eager salesman. The “per-

fectly omniscient consumer,” as posited by Kodak, does

not exist in the public purchasing sector.

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D.

Separation of Purchasing and Operating Functions

In Government Results in Market Imperfections.

Kodak’s theory also ignores institutional barriers to

evaluation of service costs at the time a competitive bid is

issued. A central procurement officer may be charged

with buying equipment, but is rarely charged with oper-

ating, maintaining, or servicing the equipment. See e.g.,

Alaska Stat. 36.30.005 (centralized procurement author-

ity). Equipment purchased en masse, at a quantity dis-

count, may be delivered far and wide across the State,

locking-in operating agencies regardless of the availabil-

ity (or cost) of manufacturer service. The interests of the

centralized procurement officer in obtaining the lowest

possibile cost for equipment may not take into account the

total cost to the operating agency, as measured by the cost

of parts and service.

Additionally, State and local budgets are subject to a

variety of constraints which Kodak’s economic theory

does not take into consideration. For example, the State of

Alaska has different budgets for capital appropriations

and for operating expenses. The capital budget funds

one-time costs of purchasing equipment, funding con-

struction projects, condemning land, and the like. See e.g.,

1991 Session Laws of Alaska, Chapter 96, § 163 (appropri-

ates $450,000 for purchase of “duplicating equipment”).

The operating budget gives agencies the funds needed for

the day-to-day-operations of government, including

funds to repair and service equipment. See e.g., 1991

Session Laws of Alaska, Chapter 73 (appropriates funds

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for “the operating expenses . . . of state government” on

an agency basis).

A central procurement officer charged with buying

$450,000 of duplicating equipment will measure success

by the number of copiers purchased. Capital funds can-

not be used to service the machines, and if not spent will

lapse back into the State’s general fund. After the copiers

are delivered, the recipient agencies use funds from the

operating budget to obtain the best quality service at the

lowest price to the taxpayer.

Where a competitive aftermarket exists, these goals

are complementary. The central procurement officer pur-

chases the maximum amount of equipment for the

amount budgeted, possibly obtaining quantity discounts

and attracting more bidders by the large scale of the

purchase. The operating agency is able to obtain the best

value for its budget among competing service organiza-

tions.

However, when a manufacturer eliminates competi-

tion in the aftermarkets, either through monopolization

or by tying parts to service, the public purchasing mecha-

nism does not operate effectively. A central purchasing

officer, required by law to seek the lowest bid for equip-

ment, using funds which if not spent will lapse, and

facing uncertainty in estimating life-cycle costs, is going

to award the purchase contract to the lowest bidder. This

decision provides a manufacturer with market power in

the aftermarkets an opportunity to charge higher prices

for service than it could charge in a competitive situation.

The net result is less value for the taxpayer dollar.

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E.

The “Lock-In” Effect Results in Market Imperfections.

The lock-in effect noted by Respondents in their brief

is of special concern to governments. It is not simply the

cost of replacing the primary equipment, but associated

costs which must be taken into account when analyzing

the lock-in effect of an equipment purchase.

For example, governments are major consumers of

micrographic equipment. Libraries microfilm books, peri-

odicals, newspapers, and government publications. State

archives contain masses of documents, from deeds to

birth certificates, which are transferred to microfiche both

to save storage costs and to preserve fading or disin-

tegrating paper records from oblivion. Court systems use

micrographic systems to record the contents of closed

case files, wills, and judicial decisions.

Micrographic systems generally include a computer

assisted information retrieval system. A retrieval system

can include equipment to record documents on micro-

fiche, a means of encoding data on documents so that it

can be read by computer, computer hardware, a software

program to tie the whole package together, and terminals

so that the public and government employees can access

the data. Such a system can cost several hundred thou-

sand dollars in fixed costs, not including the labor needed

to design the system so that it meets the needs of the

government and the public.

These systems are integrated. That is, the component

elements of one element are designed to work together

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with those of another. Before a governmental purchaser

of Kodak micrographic equipment can rationally consider

changing brands, it must consider costs of the entire

system. These costs include retraining personnel and

recoding data. “Industry standards” for data transfer not-

withstanding, changing from one micrographic system to

another is fraught with expense and peril. See, e.g., JA

424-425.

In practical terms, the lock-in effect of an initial deci-

sion by a public agency to purchase a certain brand of

equipment is substantial. This results in market imperfec-

tions that, as the Court of Appeals noted, “can keep

economic theories about how consumers will act from

mirroring reality.” 903 F.2d at 617.

F.

The Matsushita Standard Applied.

The members of NASPO and NIGP have vast experi-

ence in public purchasing. They strongly disagree with

Kodak’s view that it “simply makes no economic sense”

that a manufacturer with market power in the parts mar-

ket will use that power to earn monopoly profits in the

service market. Petitioner’s Br., at 29; Matsushita Elec.

Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587

(1986). The nature of public purchasing, budgetary con-

straints, and the lock-in effect make it quite likely that

such an equipment manufacturer - even without market

power in the interbrand market - can reap monopoly

profits in service through a judicious use of its power

over parts.

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Kodak’s theory that consumers accurately project the

lifetime costs of high technology equipment at the time of

purchase, accurately weigh the possibility of monopoly

rents for parts and service, and take these factors into

account when making an initial equipment purchase is

simply unrealistic when applied to the public sector. This

is not a perfect market, and cannot be examined using

theory alone.

If the record were complete, this Court could make

an informed decision on the anti-competitive effects of

the conduct involved. But the record is not complete. As

other amici and Respondents note, the District Court

drastically truncated discovery. The Court of Appeals

was correctly reluctant to decide this case on a “theoreti-

cal basis.” 903 F.2d at 617.

Respondents have raised disputed issues of material

fact, and - as shown above - their arguments “make[]

economic sense.” Matsushita, 475 U.S. at 587. The public

interest is best served by a vigorous, competitive business

environment in the aftermarkets for parts and service.

When market power over parts is used to restrain compe-

tition in service, both competitors and consumers suffer.

Jefferson Parish Hosp., 466 U.S. at 15.

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CONCLUSION

The judgment of the Court of Appeals should be

affirmed.

Respectfully submitted,

RicHarD D. MONKMAN

Ditton & FINDLEY

One Sealaska Plaza

Juneau, Alaska 99801

(907) 586-4000

Attorneys for the National Associa-

tion of State Purchasing Officials and

the National Institute of Govern-

mental Purchasing, Inc.