Petition for Writ of Certiorari — Baughans, Inc. v. Domino's Pizza, Inc.

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up Court, U.S,

No. 97-_9 1184 ys 1998’

In The OFFICE OF THE CLERK

Supreme Court of the United States

October Term, 1997

BAUGHANS, INC.; BLUE EARTH ENTERPRISES, INC.;

KEVIN BORES; CHARLES F. BUCK; DAVIS PIZZA ENTER-

PRISES, INC.; DIANE A. DAVIS; FISHER PIZZA, INC.; JAMES

B. FISHER, JR.; JRW PIZZA, INC.; LUGENT PIZZA, INC.;

JOSEPH J. LUGENT; SCALE PIZZA, INC.; SPRING GARDEN

PIZZA, INC.; BRAD L. WALKER; JAMES R. WOOD; INTER-

NATIONAL FRANCHISE ADVISORY COUNCIL, INC.,

Petitioners,

DOMINO’S PIZZA, INC.,

Respondent.

On Petition For A Writ Of Certiorari To The United States

Court Of Appeals For The Third Circuit

PETITION FOR A WRIT OF CERTIORARI

é&

SHERYL G. SNYDER

400 West Market Street

Suite 3200

Louisville, Kentucky 40202-3363

(502) 589-5400

Counsel of Record

Of Counsel:

Barry D. HunNrTER

Rosert W. Disert

Amy D. CusBBaGE

Brown, Topp & HeryvsurN PLLC

400 West Market Street

Suite 3200

Louisville, Kentucky 40202

(502) 589-5400

‘Attorneys for Petitioners

QUESTION PRESENTED

This case involves the derivative aftermarket in

which franchisees of Domino’s Pizza, Inc. (“Domino's”)

purchase the ingredients and supplies which they use to

make Domino’s brand pizza. Although the Domino’s

offering circular promised an aftermarket policed by

price competition among several approved suppliers,

Domino’s acquired a 90% share of this aftermarket. Using

that market power to obtain exclusive dealing arrange-

ments with customers and requirements contracts from

suppliers, Domino’s changed its policy of approving

alternate suppliers, and excluded a franchisee coopera-

tive from competing with Domino’s in this aftermarket.

The franchisees’ substantial investments in their fran-

chises, coupled with noncompetition covenants, make

switching to a different franchise financially impossible.

Consequently, Domino’s continues to reap supracompeti-

tive profits on the sale of approved ingredients and sup-

plies. The sharply divided Court of Appeals immunized

these acts and affirmed the Rule 12(b)(6) dismissal of the

franchisees’ antitrust claim, which the District Court had

entered without permitting any discovery at all. ‘

—

This petition presents the following question:

Whether the derivative aftermarket for ingredients

and supplies which the franchisees use to make the prod-

uct sold in the franchised business format, may be a

relevant market for analyzing under the antitrust laws

the franchisor’s willful acquisition and maintenance of a

monopolistic share of that derivative aftermarket?

TABLE OF CONTENTS

Page

QUBRTIONS PRMD. gk Ks eins i

TASER GP MEPTIIe. .. 555s. css iv

OPINIONS AND ORDERS BELOW ................ 1

CI oe se a 1

STATUTES (HVORFED © 5 i 2

STATEMENT OF THE CASE...............00000e0: 2

SUD SE TS ask a Wn kick occ dose ceks dexons 2

The Precontings Behe <.« «x s<n0n <kise Jsengnaicn nsec 6

REASONS FOR GRANTING THE WRIT ........... 10

I. The Court of Appeals’ decision is in conflict

with antitrust precedent from other circuits in

franchise tying and monopolization claims .. 10

II. The Third Circuit misapplied the legal and

economic framework of Kodak............... 16

A. The Third Circuit misconstrued the eco-

nomic underpinnings of Kodak.......... 16

B. The Third Circuit ignored this Court's

admonition to examine the facts and eco-

nomic realities of each case and to avoid

broad legal rules concerning the defini-

tion of relevant markets ................ 19

C. The Third Circuit decision is in conflict

with the Sixth and Seventh Circuits’ inter-

Po Be ere 21

iii

TABLE OF CONTENTS - Continued

Page

III. The Court of Appeals’ decision presents sig-

nificant questions concerning the application

of the antitrust laws to business format fran-

chises, which compose a significant sector of

We I aid wba cae Vi wc cdes cand ui dodo cen 24

oe gh eg a BN EE SEIS i al AL pe area a a he 27

TABLE OF AUTHORITIES

Page

Cases

Casey v. Diet Center, Inc., 590 F.Supp. 1561 (N.D.

Cah, TOD ih wi Cie 6 tte kcnes Cr sae Syn neaes ce 12

Collins v. International | Dairy Queen, Inc., 939

F.Supp. 875 (M.D. Ga. 1996) ....... cece cence eens 8

Collins v. International Dairy Queen, Inc.,

F.Supp. __, 1997 WL 627504 (M.D. Ga. 1997). capes 15

Digital Equipment Corp. v. Uniq Digital Technologies,

FNC. FS Fee FOO C7 Re TI och ob ccceissevpeees 22

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

i ee He ee. Pe ee rere passim

Grappone, Inc. v. Subaru of New England, Inc., 858

F.2d 792 (lat Cissy T9GS) «cence ccc cccccsvreccncecs 14

Heatransfer Corp. v. Volkswagenwerk A.G., 553 F.2d

S66 CO CUS BOTT Fic va sivns's teins true sibs cosa vneds 12, 24

Image Technical Services v. Eastman Kodak Co., 125

F.3d 1195, 1997 U.S. App. LEXIS 22608 (9th Cir.

FONG a ss Kaa ke bekk hon ote KAT Rea eRe Cmte Sones 9

International Boxing Club of New York, Inc. v. United

Stahes, SOG WG. FOR CFSE) oie cc cic cv vsieveevgquiceres 16

International Business Machines Corp. v. United

States, 296 U.S. 131 (U9SG) 2... ccc ccccciccdeccccees 16

Kentucky Fried Chicken Corp. v. Diversified Packag-

ing Corp., 549 F.2d 368 (Sth Cir. 1977)............. 10

Krehl v. Baskin-Robbins Ice Cream Co., 664 F.2d 1348

COU: GO, FIIs oo bk odd ca rchtsh sere a eden ks bonhenes 7

Lee v. Life Ins. Co. of N. Am., 23 F.3d 14 (1st Cir.

199 0 ESTAS aC he CRRA Ei 23

Little Caesar Enterprises Co., Inc. v. Smith, Bus.

Franchise Guide (CCH) { 11 (E.D. Mich. 1996) ..... 7

TABLE OF AUTHORITIES - Continued

Metrix Warehouse, Inc. v. Daimler-Benz

Aktiengeselleschaft, 828 F.2d 1033 (4th Cir.

Pag BEE BA SS ER ae RO ne Dat. eh am 11,

Midwestern Waffles, Inc. v. Waffle House, Inc., 734

Rod 705 Clith Civ 1980), &.. 20. eeoke ke...

Mozart Co. v. Mercedes-Benz of N. Am., 833 F.2d

1342 (9th Cir. 1987), cert. denied, 488 U.S. 870

te) FET IT ar pA ey ee. | Me Rg 13,

National Collegiate Athletic Ass'n v. Board of Regents

of Univ. of Okla., 468 U.S. 85 (1984)............

Northern v. McGraw-Edison Co., 542 F.2d 1336 (8th

Cir. 1976), cert. denied, 429 U.S. 1097 (1976) ....

Perma Life Mufflers v. International Parts Corp., 392

We BO MIN co occcl a a ee

Photovest Corp. v. Fotomat Corp., 606 F.2d 704 (7th

Cir. 1979), cerr. denied, 445 U.S. 917 (1980) .....

PSI Repair Services v. Honeywell, Inc., 104 F.3d 811

(6th Cis), cort. denied, = «US... 117 S.Ct.

one seca NES Ie Sara Ai wae Se aon

Redd v. Shell Oil Co., 524 F.2d 1054 (10th Cir. 1975) .

Siegel v. Chicken Delight, Inc., 448 F.2d 43 (9th Cir.

ig) Cpr onanen DOR BB tin T cain any Cogn. ites: Seema

NE te pig ipa lag ae i Ee

Tominaga v. Shepherd, 682 F. Supp. 1489 (C.D. Cal.

OU ian Anca ha Baa Ab sae tor ackuweas vanadess rcs

Page

12, 13

14, 15

TABLE OF AUTHORIT IES — Continued

Page

Valley Products Co., Inc. v. Landmark, 128 F.3d 398

(GG Che 29BF) cikivinn Finis cing Hed te eV ietinens vs 15, 24

Virtual Maintenance, Inc. v. Prime Computer, Inc., 11

F.3d GOO (Gtk Cin. LOGS. oii ye i:sgiticcowiindas soma rinss 24

Wilson v. Mobil Oil Corp., 940 F.Supp. 944 (E.D. La.

SU 5 u's len £50 GRINS bo we oR Ee a Eee as 8

STATUTES

19 CBA Od 6 ik cede tiene eee tees 2, 6, 11

1S USE 2s cA NRG ROTA a 6,41

1S USGS FOS he ki ek IE ie 2

BO TE BD EMME) 6 ce ksccdusevervebadevaaeiavenyens 1

MISCELLANEOUS CITES

Areeda and Hovenkamp, Antitrust Law { 510

(1GD7: UPS so oan’ «Spies Siale's isn 0'e'e 6 bun e's be T Ree wre ee 5

Baer, Lockerby, Wieczorek, Domino's Pizza Deliv-

ers ...@ Blow to Franchisee Tying Claims, 17

PRAMS Lie Gr CEP TET we ch 8550 ca N A wae chbeeas canes 5

Cantor, Tying, Exclusive Dealing and Franchising

[gguses; GHG FASE Ge CAPM OE 8 8a eae aw Week ee ek ov 6

Grimes, When Do Franchisors Have Market Power?

Antitrust Remedies For Franchisor Opportunism,

65 Anurrauer’ 1.5. 105: (IGS). oe is ee eve cee 3, 8, 25

Guerin-Califert, Assessing the Implications of Kodak

for Franchise Market Power Issues, Assessing Mar-

ket Power in the Post-Kodak World (ABA Section

of Antitrust Law Spring Meeting, March 27,

SGC ss chine y030 caHere pee hy ues Wed CORRES Ute eos oho 6

vii

TABLE OF AUTHORITIES - Continued

Page

Hadfield, Problematic Relations: Franchising and

Law of Incomplete Contracts, 42 Stan L. Rev. 927

Hovenkamp, Market Power in Aftermarkets: Anti-

trust Policy in the Kodak Case, 40 UCLA L.Rev.

cnet te tate CREEP AS PE EEA i EC, eae 5, 18

Klein and Saft, The Law and Economics of Franchise

Tying Contracts, 28 J. Law & Econ. 345 (1985) ..... 13

Lande, Chicago Takes it on the Chin: Imperfect Infor-

mation Could Play a Crucial Role In The Post-

Kodak World, 62 Antitrust OR. wo. | 14

Lazaroff, Reflections On Eastman Kodak Co. v. Image

Technical Services, Inc.: Continued Confusion

Regarding Tying Arrangements and Antitrust

Jurisprudence, 69 Wasu. L.Rev. 101 cant oss a 5

McDavid, Kodak Decision Revitalizes Tying Claims,

cadcses seme cen che +. | ERIE I ue ites 5

Meese, Antitrust Balancing in a (Near) Coasean

World: The Case of Franchise Tying Contracts, 95

WS SA REE COO oo os ccc ee obec ccc... 5

Selden, Franchise Market Power in a Post-Kodak Uni-

verse (ABA Section of Antitrust Law Spring

MO ae OO sees. 6

Silberman, The Myths of Franchise “Market Power,”

nt cozy vant ee | TR IE GG er 5

Solish, A Survey of the Antitrust Consequences of

Franchise Sourcing Limitations at the Millennium,

Alive and Kicking: “Encroachment” and Tying

Claims in Franchising, 1 (ABA Section of Anti-

trust Law Annual Meeting, August 3, 1997)........ 8

viii

TABLE OF AUTHORITIES - Continued

Page

Solish, Market Power in Per Se Franchise Tying

Claims: Virtual Maintenance Decision Addresses

“Locked In” Buyers, 13 Francnise L.J. 73 (1994)...... 6

VonKalinowski, Sullivan and McGuirl, ANrtrirrust

Laws AND TRADE REGULATION (1996) .........0000 00: 20

OPINIONS AND ORDERS BELOW

The majority and dissenting opinions of the Court of

Appeals are reported at 124 F.3d 430 (3d Cir. 1997), and

reprinted at Petitioner's Appendix (“Pet. App.”) 1. The

order of the Court of Appeals denying Petitioners’

(“Franchisees’”) petition for rehearing and suggestion

for rehearing en banc, and the opinion for the five judges

who would have granted rehearing, is reported at 129

F.3d 724 (3d Cir. 1997), and is reprinted at Pet. App. 46.

The order of the United States District Court for the

Eastern District of Pennsylvania granting Respondent

Domino’s Pizza, Inc.’s (“Domino’s”) motion to dismiss

pursuant to Rule 12(b)(6) is published at 922 F. Supp.

1055 (E.D. Pa. 1996), and is reprinted at Pet. App. 51. The

opinion of the District Court denying Plaintiffs’ motion to

file an amended complaint is not reported and is

reprinted at Pet. App. 70.1

JURISDICTION

The Court of Appeals entered judgment on August

27, 1997. It denied a timely petition for rehearing and

suggestion for rehearing en banc on October 27, 1997. This

Court has jurisdiction to review the judgment by writ of

certiorari under 28 U.S.C. § 1254(1).

’ Pursuant to Supreme Court Rule 29.6, Petitioners state

that none of the incorporated Petitioners has a parent or

subsidiary corporation.

STATUTES INVOLVED

The statutory provisions involved are Sections 1 and

2 of the Sherman Act, 15 U.S.C. §§ 1-2, and Section 3 of

the Clayton Act, 15 U.S.C. § 14. (reprinted in full at Pet.

App. 167).

STATEMENT OF THE CASE

The sharply divided Court of Appeals held, as a

matter of law, that franchisors are wholly immune from

antitrust liability where the victims of their monopolistic

behavior are the franchisor’s own franchisees. With the

panel divided 2-1, and the full Court divided 7-5, the

Court affirmed a Rule 12(b)(6) dismissal of the Fran-

chisees’ well pleaded antitrust claims, immunizing from

antitrust scrutiny a section of the economy which the

panel acknowledged encompasses more “than one-third

of all dollars spent in retailing transactions in the United

States. ...” 124 F.3d at 441, Pet. App. 23. As the dissent

cogently demonstrated, Pet. App. 33-45, the Rule 12(b)(6)

dismissal reflects a misunderstanding and misapplication

of this Court’s opinion in Eastman Kodak Co. v. Image

Technical Services, Inc., 504 U.S. 541 (1992), and conflicts

with several decisions of other Courts of Appeals that

franchisees’ antitrust claims against their franchisors do

state a claim for which relief may be granted.

Statement of Facts

This case involves the $500,000,000 per year market

in which Domino’s franchisees purchase the ingredients

which they use to make Domino’s brand pizza, which

they sell in the business format franchised by Domino’s.

Domino's has 100% of the market for fresh dough bought

by the franchisees and 90% of the market for other ingre-

dients and supplies bought by the franchisees (“Ingre-

dients and Supplies”). Except for fresh dough, Domino’s

does not manufacture those Ingredients and Supplies.

Rather, Domino’s buys the Ingredients and Supplies from

approved suppliers, and then resells them to the fran-

chisees at a marked up price. Pet. App. 5.

In an effort to bring price competition to this after-

market, the association of Domino’s franchisees

approached a franchisee cooperative to enter the market

in competition with Domino’s. This franchisee coopera-

tive was already successfully competing, for example,

with PepsiCo Foodservice selling ingredients and sup-

plies to Kentucky Fried Chicken franchisees and Taco Bell

franchisees. Pet. App. 86.

Domino’s did not disapprove the franchisee coopera-

tive as a competing supplier. Rather, Domino’s responded

to this potential competition with the classic market

manipulations of a monopolist, using its market power to

force the franchisee cooperative out of the market for

Ingredients and Supplies.

Using its 90% share of the $500,000,000 Ingredients

and Supplies aftermarket - not its contractual approval

prerogatives - Domino’s offered predatory, discrimina-

tory rebates to its largest franchisees to induce them to

enter into exclusive dealing arrangements with Domino’s,

thereby foreclosing them as potential customers of the

franchisee cooperative. Pet. App. 91-96. Domino’s also

used its market power to coerce the sole supplier of

ready-made parbaked dough, the primary supplier of

thin-crust shells, and all the suppliers of sauce, to con-

tract to sell their entire output to Domino’s, thereby

foreclosing the franchisee cooperative from access to the

essential ingredients it would need to enter the market

for distributing Ingredients and Supplies to franchisees.

Pet. App. 91-93.

By these willful uses of its monopolistic share of the

aftermarket for Ingredients and Supplies — not merely its

contractual power to approve the suppliers - Domino’s

has excluded the franchisee cooperative from competing

in that market. By foreclosing interbrand competition in

the aftermarket for Ingredients and Supplies, Domino’s

has reaped supracompetitive profits in that market. Pet.

App. 102-03.

These market conditions are in marked contrast to

what Domino’s promised the Franchisees when they pur-

chased their franchises. Domino’s promised the Fran-

chisees an aftermarket policed by price competition. In the

premarket in which the Franchisees purchased their fran-

chises, the Domino’s Offering Circular indicated that it

would approve several sources of Ingredients and Sup-

plies, thereby insuring price competition in this after-

market. Pet. App. 82. After the Franchisees purchased

their franchises, Domino’s failed to adhere to this repre-

sentation, and erected barriers to entry by potentially com-

peting suppliers of Ingredients and Supplies. Those

barriers to entry enabled Domino’s to gain a 90% share of

this aftermarket. Domino’s then used the market power

arising from its 90% market share — not merely its contrac-

tual prerogatives — to raise prices and exclude competition

in this market. Pet. App. 87-99.

The Franchisees are economically locked in to their

franchises not only by their substantial monetary invest-

ments, but also by substantial restrictions on their ability

to sell their franchises and noncompetition covenants

which preclude the Franchisees from purchasing a com-

petitor’s fast food franchise. Pet. App. 152-54. These

information costs, sunk costs and switching costs pre-

clude the Franchisees from responding to Domino's mar-

ket manipulations by returning to the premarket in which

fast food franchises are sold. The Franchisees are locked

into the aftermarket, which therefore is the relevant mar-

ket for antitrust analysis of Domino’s restraints of trade.2

2 The decision in this case to immunize the franchisor-

franchisee relationship from antitrust scrutiny, despite this

Court’s economic analysis of locked in aftermarkets in Kodak, is

an issue which permeates current antitrust commentary:

The debate among courts and commentators as to

whether the Supreme Court’s decision in Eastman

Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451

(1992), breathed new life into franchise tying claims

has, at times, had all the back and forth characteristics

of a tennis match.

Baer, Lockerby, Wieczorek, Domino's Pizza Delivers .. . a Blow to

Franchisee Tying Claims, 17 Francnise L.J. 65 (1997). See e.g.,

Areeda and Hovenkamp, Antitrust Law { 510 (1997 Supp.);

Grimes, When Do Franchisors Have Market Power? Antitrust

Remedies for Franchisor Opportunism, 65 Antrrrust L.J. 105 (1996);

Meese, Antitrust Balancing in a (Near) Coasean World: The Case of

Franchise Tying Contracts, 95 Micn. L.Rev. 111 (1996); Silberman,

The Myths of Franchise “Market Power,” 65 Anrtrrrust L.J. 181

(1996); Lazaroff, Reflections On Eastman Kodak Co. v. Image

Technical Services, Inc.: Continued Confusion Regarding Tying

Arrangements and Antitrust Jurisprudence, 69 Wasn. L.Rev. 101

(1994); Hovenkamp, Market Power in Aftermarkets: Antitrust

Policy in the Kodak Case, 40 UCLA L.Rev. 1447 (1993); McDavid,

Those allegations - which must be assumed to be

true in the Rule 12(b)(6) posture of this case — formed the

crux of the Complaint that was dismissed without any

discovery being permitted.

The Proceedings Below

Based upon the foregoing factual allegations — which

are assumed to be true when reviewing a dismissal for

failure to state a claim - the Franchisees pleaded that

Domino's has willfully acquired the power to increase

prices and exclude competition in the market for Ingre-

dients and Supplies, and that it has willfully maintained

and used that monopoly power in that market, in viola-

tion of Section 2 of the Sherman Act. Pet. App. 103.5

Kodak Decision Revitalizes Tying Claims, 12 Francuise L.J. 3 (1992);

Solish, Market Power in Per Se Franchise Tying Claims: Virtual

Maintenance Decision Addresses “Locked in” Buyers, 13 FRANCHISE

L.J. 73 (1994); Solish, A Survey of the Antitrust Consequences of

Franchise Sourcing Limitations at the Millennium, Alive and

Kicking: “Encroachment” and Tying Claims in Franchising, 1 (ABA

Section of Antitrust Law Annual Meeting, August 3, 1997);

Cantor, Tying, Exclusive Dealing and Franchising Issues, 890 PLI

869 (1995); Selden, Franchise Market Power in a Post-Kodak

Universe (ABA Section of Antitrust Law Spring Meeting, March

17, 1996); Guerin-Califert, Assessing the Implications of Kodak for

Franchise Market Power Issues, Assessing Market Power in the Post-

Kodak World, 1 (ABA Section of Antitrust Law Spring Meeting,

March 27, 1996).

3 The Franchisees also pleaded that, after they acquired

their Domino’s franchises, Domino’s imposed two separate

unlawful tie-in arrangements in violation of Section 1 of the

Sherman Act and Section 3 of the Clayton Act: (1) requiring

Franchisees to buy Ingredients and Supplies from Domino’s as a

condition to being able to acquire fresh dough from Domino’s

Refusing to permit any discovery at all, the District

Court dismissed the Franchisees’ complaint for failure to

state a claim under Rule 12(b)(6). 922 F. Supp. at 1064,

Pet. App. 69. The District Court held, as a matter of law,

that a derivative aftermarket in which a business format

franchisee buys Ingredients and Supplies which the fran-

chisee uses to make the finished product, can never be a

relevant market for antitrust purposes, under any set of

facts. The District Court held, as a matter of law, that

competition in the premarket for franchises inherently

polices the aftermarket for Ingredients and Supplies, and

that a franchisor’s abuse of power in the aftermarket is

therefore only a concern of contract law, and is never a

concern of antitrust law. Disregarding this Court's rejec-

tion of the same, formalistic economic analysis in Kodak,

the District Court held that the relevant market is always

and (2) requiring Franchisees to buy Ingredients and Supplies

from Domino’s as a condition to continuing as a Domino’s

franchisee. Pet. App. 104. The District Court had original subject

matter jurisdiction under 28 U.S.C. § 1331.

* A business format franchise, such as Domino’s, is

different from a franchised distributor of finished products

manufactured by the franchisor, such as Baskin-Robbins. In a

business format franchise, the franchisee pays a fee for a

method of doing business, not a product to be resold; it is the

franchisees who are responsible for the production and

preparation of the product sold in connection with the

franchised trademark. Accordingly, it is business format

franchisees who purchase goods in the kind of derivative

aftermarket at issue in this case. See Redd v. Shell Oil Co., 524 F.2d

1054, 1056-57 (10th Cir. 1975). Compare Little Caesar Enterprises

Co., Inc. v. Smith, Bus. Franchise Guide (CCH) ¥ 11, 163 (E.D.

Mich. 1996), with Krehl v. Baskin-Robbins Ice Cream Co., 664 F.2d

1348 (9th Cir. 1982).

the premarket in which the franchise is purchased, never

the aftermarket in which the Ingredients and Supplies are

purchased. 922 F. Supp. at 1062, Pet. App. 64. The District

Court’s brightline test, and its misapprehension of this

Court’s antitrust analysis in Kodak, was rejected by other

courts® and criticized by the commentators.®

Without adopting the premarket vs. aftermarket

dichotomy on which the District Court’s judgment was

premised, the Court of Appeals nevertheless affirmed, 2-1.

The majority held that in no circumstances could a fran-

chise derivative aftermarket be a relevant antitrust market.

The majority reasoned that the absence of cross-elasticity

of demand between approved and nonapproved Ingre-

dients and Supplies results solely from Domino’s contrac-

tual approval prerogatives, and that the relevant market

therefore is the premarket in which the Franchisees pur-

chased their franchises. The majority rejected the Fran-

chisees’ contention that the derivative franchise

aftermarket was consistent with this Court’s decision in

Kodak. Rather than reading Kodak as premised upon the

substantial economic lock-in experienced by Kodak copier

owners in that case, and Kodak’s change in policy after the

5 Wilson v. Mobil Oil Corp., 940 F.Supp. 944 (E.D. La. 1996);

Collins v. International Dairy Queen, Inc., 939 F.Supp. 875 (M.D.

Ga. 1996) (“This Court declines to accept the view of the Queen

City court”).

6 See, e.g., Grimes, When Do Franchisors Have Market Power?

Antitrust Remedies For Franchisor Opportunism, 65 Antitrust L.J.

105 (1996); Solish, A Survey of the Antitrust Consequences of

Franchise Sourcing Limitations at the Millennium, Alive and

Kicking: “Encroachment” and Tying Claims in Franchising 1 (ABA

Section of Antitrust Law Annual Meeting, August 3, 1997).

copier owners made their investment, the majority held

that Kodak turned on the uniqueness of Kodak spare parts.

In the majority’s view, Kodak was therefore inapplicable to

the Franchisees’ claim since the Ingredients and Supplies

were not physically unique from other pizza ingredients

and supplies. In the majority’s view, the degree to which

the Franchisees are locked into their franchise by the infor-

mation costs, sunk costs and switching costs is irrelevant

to the proper application of Kodak.

Judge Lay’s dissent correctly read Kodak as turning on

the economic lock-in, which clearly applied to Domino’s

change in policy after the Franchisees made substantial

investments in franchises they could not easily sell.

“Whether the product is unique was not the key compo-

nent of the Kodak opinion.” 124 F.3d at 447, Pet. App. 397.

Judge Lay also recognized that the District Court and the

panel majority rested their decision on pre-Kodak case law

and commentary that was “simply irreconcilable with the

Supreme Court’s analysis of information and switching

costs in Kodak.” 124 F.3d at 445 n.1, Pet. App. 34.

By a vote of 7-5, the Court of Appeals denied the

Franchisees’ petition for rehearing. Dissenting from the

denial of rehearing, Judge Becker echoed the analysis in

Judge Lay’s dissent, emphasizing that the panel’s inter-

pretation of Kodak would mean “that the franchisor /fran-

chisee relationship is virtually rendered immune from

7 Indeed, the branded parts at issue in Kodak were “unique”

only because Kodak’s contracts with third party suppliers

prevented sales of the parts to anyone but Kodak. See Image

Technical Services, Inc. v. Eastman Kodak Co., 125 F.3d 1195, 1997

U.S. App. LEXIS 22608, *3-4 (9th Cir. 1997).

antitrust scrutiny.” 129 F.3d 724, Pet. App. 48. Criticizing

the majority for resolving factual disputes on a motion to

dismiss, judge Becker said: “even if the majority’s legal

position is correct, it can only be sustained if it were an

affirmance of a summary judgment on a full record,

which is how the opinion seems to read. It cannot stand

under its actual procedural status - review of a Rule

12(b)(6) dismissal.” 129 F.3d at __, Pet. App. 50.

REASONS FOR GRANTING THE WRIT

I. The Court of Appeals’ decision is in conflict with

antitrust precedent from other circuits in franchise

tying and monopolization claims.

As the dissenting opinions recognized, antitrust has

long been concerned with franchisors’ abuse of their eco-

nomic power in franchisee aftermarkets, perhaps because

too many franchisors have been unable to resist the temp-

tation to monopolize these captive markets. 124 F.3d at

449, Pet. App. 44-45. See, e.g., Standard Oil Co. v. United

States, 337 U.S. 293 (1949); Perma Life Mufflers v. Interna-

tional Parts Corp., 392 U.S. 134 (1968). In Standard Oil, this

Court squarely held that otherwise anticompetitive tying

arrangements are not justified by the franchisor’s ostens-

ible need to control quality unless they are the least

restrictive alternative available.®

8 Accord Kentucky Fried Chicken Corp. v. Diversified Packaging

Corp., 549 F.2d 368, 376 (Sth Cir. 1977) (“The franchisor is free to

demonstrate that the tie constitutes a necessary device for

controlling the quality of the end product sold to the consuming

public. As part of this defense, however, the franchisor must

For decades, the Courts of Appeals uniformly

applied these precedents to franchisor tying arrange-

ments, explicitly recognizing the derivative aftermarket

as the relevant market for analyzing franchisor tying

arrangements under Section 1 and franchisor monopoliz-

ation claims under Section 2. For example, in Metrix

Warehouse, Inc. v. Daimler-Benz Aktiengeselleschaft, 828 F.2d

1033, 1036-39 (4th Cir. 1987), the Fourth Circuit recog-

nized a relevant aftermarket in Mercedes-Benz brand

replacement parts. Affirming a jury verdict for the fran-

chised dealer, the Fourth Circuit squarely held that the

franchisor’s use of its contractual powers to compel the

franchisee dealers to purchase only replacement parts

manufactured by Mercedes-Benz constituted an illegal

tying arrangement under the Sherman Act, 828 F.2d at

1040-42.

The Fourth Circuit held that the franchisor’s business

justification for requiring franchisees to use only “genu-

ine” replacement parts, and the business justification for

the franchisor’s refusal to permit its franchisees to pur-

chase replacement parts from indepe .“jent suppliers, pre-

sented a question of fact for the trier of fact. The Fourth

Circuit’s decision in Metrix echoes uecisions of the Fifth,

Seventh and Eighth Circuits.?

establish that the tie constitutes the method of maintaining

quality that imposes the least burden on commerce. If there are

less burdensome alternatives, a franchisor is obligated to

employ them rather than the tie”). See also Midwestern Waffles,

Inc. v. Waffle House, Inc., 734 F.2d 705, 712-13 (11th Cir. 1984).

9 In Photovest Corp. v. Fotomat Corp., 606 F.2d 704, 721-24

(7th Cir. 1979), cert. denied, 445 U.S. 917 (1980), the Seventh

Circuit recognized a derivative aftermarket in the franchisor’s

photo processing services, holding that the franchisor’s use of

The Third Circuit’s decision in this case is in direct

conflict with the Fourth Circuit’s decision in Metrix. The

Third Circuit created a rule of per se legality for the

franchisor’s quality control claims. The majority held that

Domino’s approval prerogatives are essential to “prevent

franchisees from free riding — offering products of sub-

standard quality insufficient to maintain the reputational

value of the franchise product while benefiting from the

its contractual approval powers to compel the franchisees to

purchase Fotomat processing services from Fotomat as a

condition of retaining their franchise constituted an unlawful

tying arrangement. 606 F.2d at 721-24. In Heatransfer Corp. v.

Volkswagenwerk A.G., 553 F.2d 964, 979-81 (5th Cir. 1977), the

Fifth Circuit recognized a relevant antitrust market in air

conditioners that could be installed only in Volkswagen

automobiles. Affirming a jury verdict for an independent

supplier of automobile air conditioners, the Fifth Circuit

squarely held that Volkswagen’s requirement that its franchised

dealers buy only air conditioners manufactured by Volkswagen

constituted an illegal tying arrangement and monopolization of

the derivative aftermarket. Accord Northern v. McGraw-Edison

Co., 542 F.2d 1336, 1345 (8th Cir. 1976), cert. denied, 429 U.S.-1097

(1976) (Arnold Palmer dry cleaning franchisor’s use of its

contractual approval powers to compel the franchisees to

purchase franchisor’s dry cleaning equipment constitutes an

unlawful tie-in arrangement). See also Siegel v. Chicken Delight,

Inc., 448 F.2d 43 (9th Cir. 1971) (contractual requirement by a fast

food franchisor that its franchisees purchase equipment and

supplies from the franchisor held to constitute an illegal tie-in

arrangement). The decision in Chicken Delight was criticized for

attributing to the franchised trademark the kind of economic

power ordinarily inferred from patents and copyrights. See

Tominaga v. Shepherd, 682 F. Supp. 1489, 1493-95 (C.D. Cal. 1988);

Casey v. Diet Center, Inc., 590 F. Supp. 1561, 1564-66 (N.D. Cal.

1984). However, the other cited cases did not rely on that

rationale. Moreover, in this case, the Franchisees have relied

exclusively upon Kodak’s analysis of aftermarket lock-ins.

quality control efforts of other actors in the franchise

system.” 124 F.3d at 440-41; Pet. App. 23. Ironically, the

majority also held that Kodak’s aftermarket analysis is

inapplicable to this case because the ingredients

approved for use in making Domino’s pizza are not suffi-

ciently “unique” to invoke the Kodak analysis. The major-

ity opinion would thus establish an anomalous precedent

which immunizes franchisor “quality control” restrictions

where they are least warranted.

The decisions of the Fourth, Fifth, Seventh and

Eighth Circuits were criticized by devotees of the Chicago

School of antitrust analysis, who argued that competition

in the premarket for franchises should adequately police

the franchisor’s power in the derivative aftermarket. See,

e.g., Klein and Saft, The Law and Economics of Franchise

Tying Contracts, 28 J. Law & Econ. 345 (1985). In this

theoretical economic model, the relevant antitrust market

should always be the premarket in which franchises are

sold, and never the derivative aftermarket for the equip-

ment, ingredients and supplies used by business format

franchisees.

In Mozart Co. v. Mercedes-Benz of N. Am., 833 F.2d 1342

(9th Cir. 1987), cert. denied, 488 U.S. 870 (1988), the Ninth

Circuit adopted the Klein and Saft economic model, and

expressly rejected the precedents from the other circuits.

The Ninth Circuit’s decision involved the identical issue

decided by the Fourth Circuit in Metrix: whether Mer-

cedes-Benz’s restrictions on replacement parts is an ille-

gal tying arrangement. Since Mercedes-Benz did not have

a substantial share of the premarket for franchises to sell

automobiles, the Ninth Circuit held the franchisees failed

to state a tying claim. Id. at 1345-47. Mozart was followed

;

by Tominaga v. Shepherd, 682 F. Supp. 1489 (C.D. Cal. 1988)

which applied Klein and Saft’s theory to a fast food

franchisee’s tying claim. Id. at 1493-95. Both courts

expressly acknowledged their decisions were in direct

conflict with prior case law. See Mozart, 833 F.2d at 1346 &

n.4; Tominaga, 682 F. Supp. at 1494-95.10

However, the notion that competition in the pre-

market always adequately polices anticompetitive behav-

ior in the aftermarket was expressly rejected by this

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

504 U.S. 541 (1992). See Lande, Chicago Takes it on the Chin:

Imperfect Information Could Play a Crucial Role In The Post-

Kodak World, 62 Antitrust L.J. 193 (1993).

In Kodak, independent service organization (“ISOs”)

offered service to Kodak copier and micrographics

owners. In order to perform this service, ISOs needed

replacement parts, some of which were only available

from suppliers approved by Kodak. In a change of policy,

Kodak refused to permit its suppliers to sell replacement

parts to the ISOs, and permitted them to sell parts only to

copier owners who contracted with Kodak for service.

This policy was implemented only after the Kodak

owners made their initial investments in the durable

goods. Id. at 456-58.

The trial court granted Kodak summary judgment on

the ISOs antitrust claims, but the Ninth Circuit reversed,

stating that the ISOs had defined a relevant aftermarket

10 See also Grappone, Inc. v. Subaru of New England, Inc., 858

F.2d 792 (1st Cir. 1988).

in Kodak’s own goods that withstood summary judg-

ment. Id. at 459-61. This Court affirmed the Ninth Circuit,

holding that Kodak’s unilateral change in policy, coupled

with switching and informational costs, created a genuine

issue of material fact whether the aftermarket in Kodak

parts and service was the relevant market. Id. at 477-78,

481-86. Clearly, Kodak vitiated Mozart's rationale.

The Third Circuit’s decision in this case is in direct

conflict with both Kodak and the decisions of the Fourth,

Fifth, Seventh and Eighth Circuits. Rejecting those prece-

dents, the Third Circuit chose to adopt the Ninth Circuit's

rationale in Mozart, which expressly acknowledged its

conflict with the decisions of other circuits. 833 F.2d at

1346 n.4. See also Valley Products Co., Inc. v. Landmark, 128

F.3d 398, 405-07 (6th Cir. 1997) (noting conflict between

Third Circuit’s decision in this case and prior decisions of

other circuits). At least one District Court has expressly

refused to follow the decision of the Third Circuit. Collins

v. International Dairy Queen, Inc., __ F. Supp. __, 1997

WL 627504 (M.D. Ga. 1997).

The Ninth Circuit’s decision in Mozart predates Kodak

and therefore contains no analysis of the information

costs, sunk costs and switching costs which are essential

to determining whether the economic lock-in of the fran-

chisee makes the derivative aftermarket a relevant anti-

trust market. Under Kodak, the franchisee derivative

aftermarket recognized by the Fourth, Fifth, Seventh and

Eighth Circuits may be the relevant antitrust market,

depending upon the facts of the case. That determination

is for the trier of fact, not a Rule 12(b)(6) dismissal. The

Third Circuit’s reliance on Mozart, and its holding that

the aftermarket may never be the relevant market, under

any set of facts, clearly conflict with Kodak.

This Court should grant the writ in order to resolve

this clear and acknowledged conflict in this circuits,

which relates to the proper application of the antitrust

laws to a significant sector of the American economy.

II. The Third Circuit misapplied the legal and eco-

nomic framework of Kodak.

A. The Third Circuit misconstrued the economic

underpinnings of Kodak.

In Kodak, this Court specifically approved a relevant

market defined as an aftermarket derived from one man-

ufacturer’s products, as distinguished from the pre-

market for the primary product from which the

aftermarket is derived. 504 U.S. at 477-79.11 In Kodak, this

Court emphasized the economic realities of market

behavior, holding that significant switching costs, cou-

pled with information imperfections, can make a deriva-

tive aftermarket the relevant market for antitrust

analysis.

The factual situation of copier owners in Kodak is

plainly parallel to the situation of the Franchisees in this

11 Kodak noted that prior decisions of this Court have

recognized relevant markets in a single brand. 504 U.S. at 482

(citing National Collegiate Athletic Ass'n v. Board of Regents of

Univ. of Okla., 468 U.S. 85, 101-02, 111-12 (1984); International

Boxing Club of New York, Inc. v. United States, 358 U.S. 242, 249-52

(1959); International Business Machines Corp. v. United States, 298

U.S. 131 (1936)

case. Indeed, the relevant market realities are identical.

As the dissent recognized, the Franchisees’ substantial

investments, Domino’s fraudulent misrepresentation of

effective aftermarket competition and the noncompetition

covenants which exact prohibitive switching costs, com-

bine to insulate the aftermarket from the competition in

the premarket for franchises. Accordingly, the question

whether the aftermarket is the relevant antitrust market

is, under Kodak, a question of fact for the trier of fact.

The Third Circuit majority nevertheless applied a

bright line test and held the derivative franchisee after-

market may never be a relevant antitrust market, under

any set of facts. The majority’s errors arise from the funda-

mental misperception that Kodak rested primarily on the

“uniqueness” of the Kodak parts. 124 F.3d at 439-40, Pet.

App. 16-21. But Kodak did not hold the uniqueness of spare

parts was dispositive. Instead, the Court emphasized the

effect of Kodak’s change in policy combined with the lock-

in effect of purchasers’ sunk costs:

It is .. . plausible . . . to infer that Kodak chose

to gain immediate profits by exerting that mar-

ket power where locked-in customers, high

information costs, and discriminatory pricing

limited and perhaps eliminated any long term

loss. Viewing the evidence in the light most

favorable to respondents, their allegations of

market power “makife] . . . economic sense.”

504 U.S. at 477-78 (citations omitted).!2 Because Kodak

customers did not reasonably anticipate the change in

12 The Third Circuit majority’s reliance upon the ostensible

uniqueness of the Kodak replacement parts is the mistaken

application of Kodak predicted by the dissent in that case. As the

Kodak dissent stated, recognizing aftermarkets based solely on

policy, it made “economic sense” to recognize after-

markets in parts and service. Domino’s fraudulent mis-

representation, combined with the Franchisees’ sunk

costs and switching costs, is squarely within Kodak's anal-

ysis. As the dissent said:

[T]he Supreme Court's clear direction in Kodak

[is] that information and switching costs are

relevant to the ultimate determination of market

power. . . . The reality of the aftermarket for

unique products or supplies would potentially subject every

equipment and parts manufacturer or supplier to antitrust

claims based on an aftermarket whenever that manufacturer or

supplier refused to sell to a willing buyer. See 504 U.S. at 493 (“I

find this a curious form of market power on which to premise

the application of a per se proscription. It is enjoyed by virtually

every manufacturer of durable goods requiring aftermarket

support with unique, or relatively unique, goods.”) (Scalia, J.,

dissenting). See also Hovenkamp, Market Power in Aftermarkets:

Antitrust Policy in the Kodak Case, 40 UCLA L.Rev. 1447, 1454-55

(1993). Furthermore, approved ingredients are not

interchangeable with nonapproved ingredients for the same

reason that Kodak authorized service was not reasonably

interchangeable with independent photocopier service. Kodak

does not manufacture replacement parts, and Domino’s does

not manufacture ingredients; they are manufactured for them

by third parties. The only reason independent service

organizations could not obtain parts for Kodak copiers was that

Kodak contractually required the manufacturers of the

replacement parts to refuse to deal with the independent service

organizations. Similarly, the only reason the Franchisees cannot

obtain the nonapproved ingredients is that Domino’s refuses to

approve those manufacturers’ products for use by its

Franchisees, despite the majority’s presumption that those

manufacturers’ ingredients meet all of Domino’s quality

specifications and are therefore interchangeable with the

approved ingredients.

ingredients and supplies faced by these plain-

tiffs, according to the pleadings, is that alterna-

tive suppliers do not restrain DPI’s ability to

increase price, and information and switching

costs lock-in the franchises thereby preventing

any competitive response to the price increases

from DPI.

124 F.3d at 449 (Lay, J., dissenting), Pet. App. 45. There-

fore, the Third Circuit’s distinction between the unique

parts in Kodak and the allegedly fungible ingredients in

this case, is not a meaningful distinction, especially in

light of this Court’s admonition that “[t]he proper market

definition . . . can be determined only after a factual

inquiry into the ‘commercial realities’ faced by con-

sumers.” 504 U.S. at 482 (citation omitted). If the ingre-

dients approved by Domino’s were fungible with

nonapproved ingredients, Domino’s would have no basis

for withholding its approval. The reality is that the Fran-

chisees are at least as locked-in as the photocopier pur-

chasers in Kodak, so that a derivative aftermarket is the

relevant market in this case.

B. The Third Circuit ignored this Court’s admoni-

tion to examine the facts and economic realities

of each case and to avoid broad legal rules

concerning the definition of relevant markets.

In Kodak, this Court recognized that antitrust cases

are fact-intensive, and are therefore not good candidates

for resolution on summary judgment, much less on a Rule

12(b)(6) motion, based on economic presumptions con-

cerning the functioning of the market:

Legal presumptions that rest on formalistic dis-

tinctions rather than actual market realities are

generally disfavored in antitrust law. This Court

has preferred to resolve antitrust claims on a

case-by-case basis, focusing on the “particular

facts disclosed by the record.” In determining

the existence of market power, and specifically

the “responsiveness of the sales of one product

to price changes of the other,” this Court has

examined closely the economic reality of the

market of issue.

504 U.S. at 466-67 (citations omitted). Consequently, eco-

nomic theory is a useful tool to evaluate antitrust claims,

but cannot be the end of the inquiry into how markets in

fact behave.

Instead of ruling on a full record, the Third Circuit

created a rule of per se legality with no consideration of

economic reality. According to the panel, if it were “to

accept Plaintiffs’ relevant market, virtually all franchise

tying agreements requiring the franchisee to purchase

inputs such as ingredienis and supplies from the fran-

chisor would violate antitrust law.” 124 F.3d at 440, Pet.

App. 23. Even if this were a legitimate concern for the

courts instead of Congress!*, years of applying the Sher-

man Act to franchise relationships show that the panel’s

13 To the extent that Congress has spoken, its statutory

language encourages instead of discourages application of the

antitrust laws to franchisor-franchisee dealings: “Section 3 of

the Clayton Act was designed specifically to prohibit restrictive

methods of competition which prevent a buyer or lessee from

dealing in the goods of his seller’s or lessor’s competitors.” 16A

VonKalinowski, Sullivan and McGuirl, Antrrrust Laws AND

TRADE REGULATION § 66.03[1] (1996).

concern about the “chilling effect” on the franchise for-

mat is wholly misguided. Recognizing and applying the

logic of Kodak simply means that a franchisor is subject to

antitrust liability where its actions create information and

switching costs such that the market cannot respond to

supracompetitive pricing or other anticompetitive condi-

tions.

C. The Third Circuit decision is in conflict with

the Sixth and Seventh Circuits’ interpretation

of Kodak.

The Third Circuit’s decision explicitly limited Kodak

to markets involving “physically unique” products, com-

pletely discounting the roles of information costs, sunk

costs and switching costs that create an economic lock-in.

See 124 F.3d at 439-40, Pet. App. 20-21. This interpretation

of Kodak is in direct conflict with the Sixth Circuit’s

application of Kodak in PSI Repair Services v. Honeywell,

Inc., 104 F.3d 811 (6th Cir.), cert. denied, __ U.S. __, 117

S.Ct. 2434 (1997).

In that case, the plaintiff, PSI, was an independent

computer repair service that desired to service Honey-

well-brand circuit boards. Defendant Honeywell did not

manufacture its own board components, but had restric-

tive agreements with the manufacturers who made com-

ponents specific to Honeywell boards. In addition,

Honeywell offered to replace any defective or worn-out

boards for 50% of the list price, if the consumer would

return the boards to Honeywell. These policies served to

insure that PSI and other independent service organiza-

tions could not get enough spare board parts to offer

service on Honeywell boards. Id. at 813-14.

Analyzing Kodak, the Sixth Circuit stated that: “the

change in policy in Kodak was the crucial factor in the

Court’s decision.” Id. at 820. When information is expen-

sive or otherwise difficult to obtain, unexpected changes

in policy could not have been evaluated by the consumer

when determining whether to enter the initial transaction

in the premarket. In the view of the Sixth Circuit,

[b]y changing its policy after its customers were

“locked in,” . . . [Kodak] took advantage of the

fact that its customers lacked the information to

anticipate this change. Therefore, it was Kodak’s

own actions that increased its customers’ infor-

mation costs. In our view, this was the evil

condemned by the Court and the reason for the

Court’s extensive discussion of information

costs.

Id. PSI’s claim failed because there was no change in

policy. Honeywell’s parts policy was well-known at the

time of manufacture and sale.

Similarly, the Seventh Circuit held that Kodak’s

change in policy is the key to this Court’s antitrust anal-

ysis. Digital Equipment Corp. v. Uniq Digital Technologies,

Inc., 73 F.3d 756 (7th Cir. 1996). In that case, Judge East-

erbrook held that “[t]he material dispute that called for a

trial [in Kodak] was whether the change in policy enabled

Kodak to extract supracompetitive prices from customers

who had already purchased its machines.” Id. at 763.14

The Third Circuit’s interpretation of Kodak directly

conflicts with the Sixth and Seventh Circuit’s recognition

that Kodak's change in policy is the key to the decision in

that case. The Third Circuit explicitly limited Kodak to

derivative aftermarkets in “unique” parts, and com-

pletely discounted this Court’s analysis concerning the

information and switching costs that create an economic

lock-in: “Kodak does not hold that the existence of infor-

mation and switching costs alone, such as those faced by

the Domino’s franchisees, renders an otherwise invalid

relevant market valid.” 124 F.3d at 439, Pet. App. 20.

But Domino’s changed its policy at least as much as

Kodak changed its policy. For purposes of the motion to

dismiss, it is presumed true that the Domino’s Offering

Circular promised to approve an adequate number of

suppliers to ensure price competition in the aftermarket

for Ingredients and Supplies, and it is presumed true that

Domino’s failed to adhere to that policy after the Fran-

chisees were locked into their franchises. The Third Cir-

cuit decision therefore directly conflicts with the Sixth

14 Accord Lee v. Life Ins. Co. of N. Am., 23 F.3d 14 (1st Cir.

1994). In that case, the First Circuit declined to apply Kodak toa

group of University of Rhode Island students’ claim that URI

had impermissibly tied an education at URI to the purchase of

University health services. The court refused to apply Kodak on

the grounds that the “tie” was fully disclosed at the time the

students “purchased” their educations (i.e., paid their tuition),

and that there was no appreciable long-term lock-in since

students were free to leave at the end of any semester. Id. at

17-20.

and Seventh Circuit’s interpretation of Kodak's analysis of

derivative aftermarkets.'5

III. The Court of Appeals’ decision presents signifi-

cant questions concerning the application of the

antitrust laws to business format franchises, which

compose a significant sector of the economy.

The Court of Appeals held, as a matter of law, that

the aftermarket for Ingredients and Supplies, which these

business format Franchisees are locked into, can never be

the relevant market in which to analyze the antitrust

implications of the franchisor’s monopolistic behavior in

that market. The Court of Appeals created a rule of per se

legality for franchisor abuses, and held that a franchisee’s

only remedy is for breach of the franchise contract.1®

15 See also Virtual Maintenance, Inc. v. Prime Computer, Inc.,

11 F.3d 660, 663 (6th Cir. 1993). (Kodak held summary judgement

improper where plaintiffs proof showed “information and

switching costs,” and “that certain parts were available

exclusively through Kodak, that Kodak had control over the

availability of parts it didn’t manufacture, and that Kodak’s

control over its parts market had excluded service competition,

boosted service prices, and forced unwilling consumption.”)

16 Under the Court of Appeals’ analysis, the franchisee

cooperative which was foreclosed from entering the Domino’s

aftermarket for Ingredients and Supplies has no remedy at all,

even though the cooperative is in the same market position as

were the ISOs in Kodak. Compare Valley Products Co., Inc. v.

Landmark, 128 F.3d 398 (6th Cir. 1997), with Heatransfer Corp. v.

Volkswagenwerk A.G., 553 F.2d 964 (5th Cir. 1997). Furthermore,

the inequality of bargaining power between franchisor and

franchisee usually leaves the franchisee without an adequate

contractual remedy. See generally Hadfield, Problematic

Ne ae Ne on ne ee

This sweeping pronouncement immunizes a huge

sector of the American economy from antitrust scrutiny.

As the panel majority acknowledged, “one third of all

dollars spent in retailing transactions in the United States

are paid to franchise outlets.”!7 Indeed, the market in this

case involves a franchisor “with revenues in excess of

$1.8 million per year”! and franchisees which purchase

$500 million in Ingredients and Supplies each year.

The majority opinion leaves this huge sector of the

economy “virtually immune from antitrust scrutiny.” 129

F.3d at __, Pet. App. 48. As Judge Becker wrote, even if

such blanket immunity were appropriate fos a “nascent”

industry, it is completely inappropriate for the very

mature fast food franchising industry:

But now the food franchisors are leviathans, and

I am underwhelmed by the suggestion that they

may be permitted with impunity to perpetrate

the type of arrangements pled in the complaint.

These arrangements are clearly quite onerous to

the average franchisee, a relatively small busi-

nessperson whose sunk costs in the franchise

represent all or most of his or her assets and

who lacks the considerable resources necessary

to switch or defranchise.

129 F.3d at __, Pet. App. 50.

Relations: Franchising and Law of Incomplete Contracts, 42 Stan L.

Rev. 927 (1990).

17 124 F.3d at 441, Pet. App. 23 (citing Grimes, When Do

Franchisors Have Market Power? Antitrust Remedies for Franchisor

Opportunism, 65 Antrrrust L.J. 105, 105 n.1 (1996)).

18 124 F.3d at 433, Pet. App. 3.

In conferring this grant of immunity, the Court of

Appeals relied upon economic theories predicting how

markets should behave, rather than assuming as true the

complaint’s factual allegations how those markets have

actually behaved. The Court of Appeals’ holding that all

franchisee derivative aftermarket cases should be dis-

missed at the pleading stage, without any discovery, vio-

lates a central holding of Kodak:

Legal presumptions that rest on formalistic dis-

tinctions rather than actual market realities are

generally disfavored in antitrust law. This Court

has preferred to resolve antitrust claims on a

case-by-case basis, focusing on the “particular

facts disclosed by the record... . ”

Kodak, 504 U.S. at 466.

Because of the great importance of this issue to the

proper application of the antitrust laws to so large a

sector of the economy, the writ should be granted.

CONCLUSION

For the foregoing reasons, the petition for a writ of

certiorari should be granted.

Respectfully submitted,

SHERYL G. SNYDER

400 West Market Street

Suite 3200

Louisville, Kentucky 40202-3363

Telephone: (502) 589-5400

Facsimile: (502) 581-1087

Counsel of Record

Of counsel:

Barry D. HuNTER

Rosert W. Disert

Amy D. CusBBAGE

Brown, Topp & Heysurn PLLC

400 West Market Street

Suite 3200

Louisville, Kentucky 40202-3363

Telephone: (502) 589-5400

Facsimile: (502) 581-1087

Attorneys for Petitioners

Dated: December 31, 1997

App. 1

Filed August 27, 1997

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 96-1638

QUEEN CITY PIZZA, INC.; THOMAS C. BOLGER;

SCALE PIZZA, INC.; BAUGHANS, INC.; CHARLES F.

BUCK; F.M. PIZZA, INC.; ROBERT S. BIGELOW; BLUE

EARTH ENTERPRISES, INC.; KEVIN BORES; DAVIS

PIZZA ENTERPRISES, INC.; DIANE A. DAVIS; FISHER

PIZZA, INC.; JAMES B. FISHER, JR.; SEPCO, INC.; S&S

PIZZA CORP.; G&L PIZZA CO.; STEPHEN D. GALLUP;

LUGENT PIZZA, INC.; JOSEPH J. LUGENT; BILLIO’S

PIZZA, INC.; WILLIAM J. MURTHA; SPRING GARDEN

PIZZA, INC; BRAD L. WALKER; JRW PIZZA, INC.;

JAMES R. WOOD, Individually and as Class Representa-

tives of a Class Consisting of All Present and Certain

Former Domino’s Franchisees in the United States; Inter-

national Franchise Advisory Council, Inc.,

Vv.

DOMINO’S PIZZA, INC.; Queen City Pizza, Inc.; Thomas

C. Bolger; Scale Pizza, Inc.; Baughans, Inc.; Charles F.

Buck; F.M. Pizza, Inc.; Robert S. Bigelow; Blue Earth

Enterprises, Inc.; Kevin Bores; Davis Pizza Enterprises,

Inc.; Diane A. Davis; Fisher Pizza, Inc.; James B. Fisher,

Jr.; SEPCO, Inc.; S&S Pizza, Inc.; G&L Pizza, Inc.; Stephen

D. Gallup; Lugent Pizza, Inc.; Joseph J. Lugent; Billio’s

Pizza, Inc.; William J. Murtha; Spring Garden Pizza, Inc.;

Brad L. Walker; JRW Pizza, Inc.; James R. Wood; and

International Franchise Advisory Council, Inc.,

Appellants

On Appeal from the United States District Court for the

Eastern District of Pennsylvania

(D.C. Civil Action No. 95-cv-03777)

App. 2

Argued February 28, 1997

Before: SCIRICA, ALITO and LAY,” Circuit Judges;

(Filed August 27, 1997)

SHERYL G. SNYDER, ESQUIRE

(ARGUED)

Brown, Todd & Hayburn

3200 Providian Center

Louisville, Kentucky 40202

Attorney for Appellants

DANIEL F. KOLB, ESQUIRE

(ARGUED)

THOMAS P. OGDEN, ESQUIRE

Davis, Polk & Wardwell

450 Lexington Avenue

New York, New York 10017

LAURENCE Z. SHIEKMAN, ESQUIRE

Pepper, Hamilton & Scheetz

18th and Arch Streets

3000 Two Logan Square

Philadelphia, Pennsylvania 19103-2799

Attorneys for Appellee

OPINION OF THE COURT

SCIRICA, Circuit Judge.

In this appeal, we must decide whether certain fran-

chise tying restrictions support a claim for violation of

federal antitrust laws. Eleven franchisees of Domino’s

Pizza stores and the International Franchise Advisory

* The Honorable Donald P. Lay, United States Circuit Judge for

the Eighth Judicial Circuit, sitting by designation.

App. 3

Council, Inc. filed suit against Domino’s Pizza, Inc., alleg-

ing violations of federal antitrust laws, breach of contract,

and tortious interference with contract. The district court

dismissed the antitrust claims under Fed. R. Civ. P.

12(b)(6) for failure to state a claim for which relief can be

granted, because the plaintiffs failed to allege a valid

relevant market. The district court declined to exercise

supplemental jurisdiction over the plaintiffs’ remaining

common law claims. Queen City Pizza, Inc. v. Domino’s

Pizza, Inc., 922 F. Supp. 1055 (E.D. Pa. 1996). We will

affirm.

I. Facts and Procedural History

Domino’s Pizza, Inc. is a fast-food service company

that sells pizza through a national network of over 4200

stores. Domino’s Pizza owns and operates approximately

700 of these stores. Independent franchisees own and

operate the remaining 3500. Domino’s Pizza, Inc. is the

second largest pizza company in the United States, with

revenues in excess of $1.8 billion per year.

A franchisee joins the Domino’s system by executing

a standard franchise agreement with Domino's Pizza, Inc.

Under the franchise agreement, the franchisee receives

the right to sell pizza under the “Domino’s” name and

format. In return, Domino’s Pizza receives franchise fees

and royalties.

The essence of a successful nationwide fast-food

chain is product uniformity and consistency. Uniformity

benefits franchisees because customers can purchase

App. 4

pizza from any Domino’s store and be certain the pizza

will taste exactly like the Domino’s pizza with which they

are familiar. This means that individual franchisees need

not build up their own good will. Uniformity also bene-

fits the franchisor. It ensures the brand name will con-

tinue to attract and hold customers, increasing franchise

fees and royalties.?

For these reasons, section 12.2 of the Domino’s Pizza

standard franchise agreement requires that all pizza

ingredients, beverages, and packaging materials used by

a Domino’s franchisee conform to the standards set by

Domino’s Pizza, Inc. Section 12.2 also provides that Dom-

ino’s Pizza, Inc. “may in our sole discretion require that

ingredients, supplies and materials used in the prepara-

tion, packaging, and delivery of pizza be purchased

exclusively from us or from approved suppliers or dis-

tributors.” Domino’s Pizza reserves the right “to impose

reasonable limitations on the number of approved sup-

pliers or distributors of any product.” To enforce these

rights, Domino’s Pizza, Inc. retains the power to inspect

franchisee stores and to test materials and ingredients.

Section 12.2 is subject to a reasonableness clause provid-

ing that Domino’s Pizza, Inc. must “exercise reasonable

judgment with respect to all determinations to be made

by us under the terms of this Agreement.”

Under the standard franchise agreement, Domino’s

Pizza, Inc. sells approximately 90% of the $500 million in

1 See the analysis of the economics of franchising in Warren

S. Grimes, When Do Franchisors Have Market Power?, 65 Antitrust

L.J. 105, 107-110 (1996).

App. 5

ingredients and supplies used by Domino’s franchisees.2

These sales, worth some $450 million per year, form a

significant part of Domino's Pizza, Inc.’s profits. Fran-

chisees purchase only 10% of their ingredients and sup-

plies from outside sources. With the exception of fresh

dough, Domino’s Pizza, Inc. does not manufacture the

products it sells to franchisees. Instead, it purchases these

products from approved suppliers and then resells them

to the franchisees at a markup.

The plaintiffs in this case are eleven Domino’s fran-

chisees and the International Franchise Advisory Council,

Inc. (“IFAC”), a Michigan corporation consisting of

approximately 40% of the Domino’s franchisees in the

United States, formed to promote their common inter-

ests. The plaintiffs contend that Domino’s Pizza, Inc. has

a monopoly in “the $500 million aftermarket for sales of

supplies to Domino’s franchisees” and has used its

monopoly power to unreasonably restrain trade, limit

* Domino’s Pizza, Inc. sells ingredients and supplies

through its division, Domino’s Pizza Distribution Division,

“DPDD.” DPDD was formerly a subsidiary of Domino’s Pizza,

Inc.

° Domino’s Pizza, Inc. argued before the district court that

IFAC is without standing in this case. Queen City Pizza, Inc. v.

Domino's Pizza, Inc., 922 F. Supp. 1055, 1057 (E.D. Pa. 1996). The

district court apparently found it unnecessary to address this

issue in light of its order dismissing the case for failure to state a

claim.

App. 6

competition, and extract supra-competitive profits. Plain-

tiffs point to several actions by Domino’s Pizza, Inc. to

support their claims.

First, plaintiffs allege that Domino’s Pizza, Inc. has

restricted their ability to purchase competitively priced

dough. Most franchisees purchase all of their fresh dough

from Domino’s Pizza, Inc. Plaintiffs here attempted to

lower costs by making fresh pizza dough on site. They

contend that in response, Domino’s Pizza, Inc. increased

processing fees and altered quality standards and inspec-

tion practices for store-produced dough, which elimi-

nated all potential savings and financial incentives to

make their own dough. Plaintiffs also allege Domino’s

Pizza, Inc. prohibited stores that produce dough from

selling their dough to other franchisees, even though the

dough-producing stores were willing to sell dough at a

price 25% to 40% below Domino’s Pizza, Inc.’s price.

Next, plaintiffs object to efforts by Domino’s Pizza,

Inc. to block IFAC’s attempt to buy less expensive ingre-

dients and supplies from other sources. In June 1994,

IFAC entered into a purchasing agreement with FoodSer-

vice Purchasing Cooperative, Inc. (FPC). Under the agree-

ment, FPC was appointed the purchasing agent for IFAC-

member Domino’s franchisees. FPC was charged with

developing a cooperative purchasing plan under which

participating franchisees could obtain supplies and ingre-

dients at reduced cost from suppliers other than Dom-

ino’s Pizza, Inc. Plaintiffs contend that when Domino’s

Pizza, Inc. became aware of these efforts, it intentionally

issued ingredient and supply specifications so vague that

potential suppliers could not provide FPC with meaning-

ful price quotations.

App. 7

Plaintiffs also allege Domino’s Pizza entered into

exclusive dealing arrangements with several franchisees

in order to deny FPC access to a pool of potential buyers

sufficiently large to make the alternative purchasing

scheme economically feasible. In addition, plaintiffs con-

tend Domino’s Pizza, Inc. commenced anti-competitive

predatory pricing to shut FPC out of the market. For

example, they maintain that Domino’s Pizza, Inc. lowered

prices on many ingredients and supplies to a level com-

petitive with FPC’s prices and then recouped lost profits

by raising the price on fresh dough, which FPC could not

supply. Further, plaintiffs contend Domino’s Pizza, Inc.

entered into exclusive dealing arrangements with the

only approved suppliers of ready-made deep dish crusts

and sauce. Under these agreements, the suppliers were

obligated to deliver their entire output to Domino’s

Pizza, Inc. Plaintiffs allege the purpose of these agree-

ments was to prevent FPC from purchasing these critical

pizza components for resale to franchisees.

Finally, plaintiffs allege Domino’s Pizza, Inc. refused

to sell fresh dough to franchisees unless the franchisees

purchased other ingredients and supplies from Domino’s

Pizza, Inc. As a result of these and other alleged prac-

tices, plaintiffs maintain that each franchisee store now

pays between $3000 and $10,000 more per year for ingre-

dients and supplies than it would in a competitive mar-

ket. Plaintiffs allege these costs are passed on to

consumers.

As noted, eleven Domino’s franchisees and IFAC

filed an amended complaint in United States District

App. 8

Court for the Eastern District of Pennsylvania against

Domino’s Pizza, Inc. seeking declaratory, injunctive, and

compensatory relief under §§ 1 and 2 of the Sherman Act,

15 U.S.C. §§ 1 and 2. The plaintiffs also sought damages

for breach of contract, breach of implied covenants of

good faith and fair dealing, and tortious interference with

contractual relations.*

Domino’s Pizza, Inc. moved to dismiss the antitrust

claims for failure to state a claim, contending the plain-

tiffs failed to allege a “relevant market,” a basic pleading

requirement for claims under both § 1 and § 2 of the

Sherman antitrust act. They maintained that the relevant

market defined in the complaint - the “market” in Dom-

ino’s-approved ingredients and supplies used by Dom-

ino’s Pizza franchisees — was invalid as a matter of law

because the boundaries of the proposed relevant market

were defined by contractual terms contained in the fran-

chise agreement, and not measured by cross-elasticity of

demand or product interchangeability.

The district court granted defendant’s motion to dis-

miss with prejudice plaintiffs’ federal antitrust claims.

The district court observed that “in order to state a Sher-

man Act claim under either § 1 or § 2, a plaintiff must

identify the relevant product and geographic markets and

allege that the defendant exercises market power within

those markets.” Queen City Pizza, Inc. v. Domino’s Pizza,

4 The plaintiffs originally filed the complaint on behalf of

themselves and a purported class of all present and future

Domino’s franchisees in the United States. Their amended

complaint abandoned their claim to represent all Domino’s

franchisees.

App. 9

Inc., 922 F. Supp. 1055, 1060 (E.D. Pa. 1996). Noting that

plaintiffs did “not explicitly identify the relevant product

and geographic markets in their amended complaint,” the

court said that “it is clear from the context, and con-

firmed in their memorandum in opposition to the instant

motion, that Plaintiffs consider the relevant product mar-

ket to be the market for ingredients and supplies among

Domino’s franchisees.” Id. at 1061. Rejecting this concept

of the relevant market, the court held that “antitrust

claims predicated upon a ‘relevant market’ defined by the

bounds of a franchise agreement are not cognizable.” Id.

at 1063. The court noted that Domino’s Pizza, Inc.’s

power to force plaintiffs to purchase ingredients and

supplies from them stemmed “not from the unique nature

of the product or from its market share in the fast food

franchise business, but from the franchise agreement.” Id.

at 1062. For that reason, plaintiffs’ claims “implicate prin-

ciples of contract, and are not the concern of the antitrust

laws.” Id. The district court also held plaintiffs had failed

adequately to allege harm to competition, “a bedrock

premise of antitrust law.” Id. at 1063. Because plaintiffs

failed to assert a cognizable antitrust claim and there was

neither diversity among the parties nor special circum-

stances justifying exercise of supplemental jurisdiction,

the court dismissed without prejudice plaintiffs’ common

law claims for lack of subject matter jurisdiction. Id. at

1063-64.

The district court granted plaintiffs leave to file an

amended complaint to cure the jurisdictional pleading

deficiencies in their state law claims. Plaintiffs decided

not to replead their state law claims. Instead, they sought

to amend their complaint for a second time in an attempt

App. 10

to state a valid federal antitrust claim. The district court

denied their motion, noting that though the plaintiffs’

proposed second amended complaint would cure the fail-

ure to plead harm to competition, it would not cure the

failure to allege a valid relevant market. The court stated:

“Plaintiffs do not and cannot purchase ingredients and

supplies from alternative suppliers not because Domino’s

dominates the ingredient and supply market or because

Defendant is the market’s only supplier, but because the

franchisee-plaintiffs are contractually bound to purchase

only from suppliers approved by Defendant. It is eco-

nomic power resulting from the franchise agreement,

therefore, and not market power, that defines the ‘rele-

vant market’ Plaintiffs allege in support of their antitrust

claims.” The district court rejected plaintiffs’ argument

that a different result was required under the Supreme

Court’s decision in Eastman Kodak Co. v. Image Technical

Services, Inc., 504 U.S. 451 (1992). This appeal followed.

II. Jurisdiction and Standard of Review

The district court had jurisdiction over the antitrust

counts under 15 U.S.C. §§ 15 and 26 and 28 U.S.C. §§ 1331

and 1337. It declined to exercise supplemental jurisdic-

tion over the common law counts. We have jurisdiction

under 28 U.S.C. § 1291. Our review of the district court's

dismissal under Fed. R. Civ. P. 12(b)(1) and 12(b)(6) is

plenary. Stehney v. Perry, 101 F.3d 925 (3d Cir. 1996).

III. Discussion

Plaintiffs assert six distinct antitrust claims on

appeal. First, plaintiffs allege Domino’s Pizza, Inc. has

App. 11

monopolized the market in pizza supplies and ingre-

dients for use in Domino’s stores, in violation of § 2 of the

Sherman Act, 15 U.S.C. § 2. In support of this contention,

plaintiffs allege Domino’s Pizza, Inc. has sufficient mar-

ket power to control prices and exclude competition in

this market. Second, plaintiffs contend Domino’s Pizza,

Inc. has attempted to monopolize the market for Dom-

ino’s pizza supplies and ingredients, in violation of § 2 of

the Sherman Act. Third, plaintiffs allege Domino's Pizza,

Inc.’s exclusive dealing arrangements have unreasonably

restrained trade in violation of § 1 of the Sherman Act, 15

U.S.C. § 1. Fourth, plaintiffs allege Domino’s Pizza, Inc.

imposed an unlawful tying arrangement by requiring

franchisees to buy ingredients and supplies from them as

a condition of obtaining fresh dough, in violation of the

Sherman Act § 1, 15 U.S.C. § 1. Fifth, plaintiffs allege

Domino’s Pizza, Inc. imposed an unlawful tying arrange-

ment by requiring franchisees to buy ingredients and

supplies “as a condition of their continued enjoyment of

rights and services under their Standard Franchise Agree-

ment,” in violation of § 1 of the Sherman Act, 15 U.S.C.

§ 1. Sixth, plaintiffs allege Domino’s Pizza, Inc. has

monopoly power in a relevant “market for reasonably

interchangeable franchise opportunities facing prospec-

tive franchisees,” in vioiation of § 2 of the Sherman Act,

15 U.S.C. § 2. This last claim was not raised before the

district court.

> “In a tying arrangement, the seller sells one item, known

as the tying product, on the condition that the buyer also

purchases another item, known as the tied product.” Allen-

Myland, Inc. v. International Business Machines Corp., 33 F.3d 194,

200 (3d Cir. 1994).

App. 12

As we have noted, the district court held that none of

the plaintiffs’ antitrust claims was cognizable under fed-

eral law. We will analyze each claim in turn.

As a threshold matter, plaintiffs argue that “relevant

market determinations are inherently fact intensive, and

therefore are inappropriate for disposition on a Rule

12(b)(6) motion.” (Appellant’s brief at 16). It is true that

in most cases, proper market definition can be deter-

mined only after a factual inquiry into the commercial

realities faced by consumers. See Eastman Kodak Co. v.

Image Technical Services, Inc., 504 U.S. 451, 482 (1992).

Plaintiffs err, however, when they try to turn this general

rule into a per se prohibition against dismissal of antitrust

claims for failure to plead a relevant market under Fed. R.

Civ. P. 12(b)(6).

Plaintiffs have the burden of defining the relevant

market. Pastore v. Bell Telephone Co. of Pennsylvania, 24 F.3d

508, 512 (3d Cir. 1994); Tunis Bros. Co., Inc. v. Ford Motor

Co., 952 F.2d 715, 726 (3d Cir. 1991). “The outer bound-

aries of a product market are determined by the reason-

able interchangeability of use or the cross-elasticity of

demand between the product itself and substitutes for it.”

Brown Shoe Co. v. U.S., 370 U.S. 294, 325 (1962); Tunis

Brothers, 952 F.2d at 722 (same). Where the plaintiff fails

to define its proposed relevant market with reference to

the rule of reasonable interchangeability and cross-elas-

ticity of demand, or alleges a proposed relevant market

that clearly does not encompass all interchangeable sub-

stitute products even when all factual inferences are

App. 13

granted in plaintiff’s favor, the relevant market is legally

insufficient and a motion to dismiss may be granted. See,

e.g., TV Communications Network, Inc. v. Turner Network

Television, Inc., 964 F.2d 1022, 1025 (10th Cir. 1992) (affirm-

ing district court’s dismissal of claim for failure to plead a

relevant market; proposed relevant market consisting of

only one specific television channel defined too nar-

rowly); Tower Air, Inc. v. Federal Exp. Corp., 956 F. Supp.

270 (E.D.N.Y. 1996) (“Because a relevant market includes

all products that are reasonably interchangeable, plain-

tiff’s failure to define its market by reference to the rule

of reasonable interchangeability is, standing alone, valid

grounds for dismissal.”); B.V. Optische Industrie De Oude

Delft v. Hologic, Inc., 909 F. Supp. 162 (S.D.N.Y. 1995)

(dismissal for failure to plead a valid relevant market;

plaintiffs failed to define market in terms of reasonable

interchangeability or explain rationale underlying narrow

proposed market definition); Re-Alco Industries, Inc. v.

Nat'l Center for Health Educ., Inc., 812 F. Supp. 387

(S.D.N.Y. 1993) (dismissal for failure to plead a valid

relevant market; plaintiff failed to allege that specific

health education product was unique or explain why

product was not part of the larger market for health

education materials); E. & G. Gabriel v. Gabriel Bros., Inc.,

No. 93 Civ. 0894, 1994 WL 369147 (S.D.N.Y. 1994) (dis-

missal for failure to plead valid relevant market; pro-

posed relevant market legally insufficient because it

clearly contained varied items with no cross-elasticity of

demand). -

App. 14

Plaintiffs allege Domino’s Pizza, Inc. has willfully

acquired and maintained a monopoly in the market for

ingredients, supplies, materials and distribution services

used in the operation of Domino’s stores, in violation of

§ 2 of the Sherman Act, 15 U.S.C. § 2. Section 2 sanctions

those “who shall monopolize, or attempt to monopolize,

or combine or conspire with any other person or persons,

to monopolize any part of the trade or commerce among

the several states, or with foreign nations.” “The offense

of monopoly under § 2 of the Sherman Act has two

elements: (1) the possession of monopoly power in the

relevant market and (2) the willful acquisition or mainte-

nance of that power as distinguished from growth or

development as a consequence of a superior product,

business acumen, or historic accident.” Aspen Skiing Co. v.

Aspen Highlands Skiing Corp., 472 U.S. 585, 596 n. 19 (1985)

(quoting United States v. Grinnell Corp., 384 U.S. 563,

570-71 (1966)). See also Ideal Dairy Farms, Inc. v. John

Labatt, Ltd., 90 F.3d 737, 749 (3d Cir. 1996) (same); Bon-

jorno v. Kaiser Aluminum & Chemical Corp., 752 F.2d 802,

808 (3d Cir. 1984) (same).

The district court dismissed plaintiffs’ § 2 monopoly

claims for failure to plead a valid relevant market. Plain-

tiffs suggest the “ingredients, supplies, materials, and

distribution services used by and in the operation of

Domino’s pizza stores” constitutes a relevant market for

antitrust purposes. We disagree.

As we have noted, the outer boundaries of a relevant

market are determined by reasonable interchangeability

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

App. 15

504 U.S. 451, 482 (1992); Brown Shoe Co. v. U.S., 370 U.S.

294, 325 (1962); Tunis Brothers Co., Inc. v. Ford Motor Co.,

952 F.2d .715, 722 (3d Cir. 1991). “Interchangeability

implies that one product is roughly equivalent to another

for the use to which it is put; while there may be some

degree of preference for the one over the other, either

would work effectively. A person needing transportation

to work could accordingly buy a Ford or a Chevrolet

automobile, or could elect to ride a horse or bicycle,

assuming those options were feasible.” Allen-Myland, Inc.

v. International Business Machines Corp., 33 F.3d 194, 206

(3d Cir. 1994) (internal quotations omitted). When assess-

ing reasonable interchangeability, “[fJactors to be consid-

ered include price, use, and qualities.” Tunis Brothers, 952

F.2d at 722. Reasonable interchangeability is also indi-

cated by “cross-elasticity of demand between the product

itself and substitutes for it.” Brown Shoe Co. v. U.S., 370

U.S. 294, 325 (1962). As we explained in Tunis Brothers Co.,

Inc. v. Ford Motor Co., 952 F.2d 715, 722 (3d Cir. 1991),

“products in a relevant market [are] characterized by a

cross-elasticity of demand, in other words, the rise in the

price of a good within a relevant product market would

tend to create a greater demand for other like goods in

that market.” Tunis Brothers, 952 F.2d at 722.6

interchangeability. As one treatise observes: “The economic tool

most commonly referred to in determining what should be

included in the market from which one then determines the

defendant’s market share is cross-elasticity of demand. Cross-

elasticity of demand is a measure of the substitutability of

products from the point of view of buyers. More technically, it

measures the responsiveness of the demand for one product to

changes in the price of a different product.” E. Thomas Sullivan

App. 16

Here, the dough, tomato sauce, and paper cups that

meet Domino’s Pizza, Inc. standards and are used by

Domino’s stores are interchangeable with dough, sauce

and cups available from other suppliers and used by

other pizza companies. Indeed, it is the availability of

interchangeable ingredients of comparable quality from

other suppliers, at lower cost, that motivates this lawsuit.

Thus, the relevant market, which is defined to include all

reasonably interchangeable products, cannot be restricted

solely to those products currently approved by Domino’s

Pizza, Inc. for use by Domino’s franchisees. For that

reason, we must reject plaintiffs’ proposed relevant mar-

ket.

Of course, Domino’s-approved pizza ingredients and

supplies differ from other available ingredients and sup-

plies in one crucial manner. Only Domino’s-approved

products may be used by Domino’s franchisees without

violating section 12.2 of Domino’s standard franchise

agreement. Plaintiffs suggest that this difference is suffi-

cient by itself to create a relevant market in approved

products. We disagree. The test for a relevant market is

not commodities reasonably interchangeable by a particu-

lar plaintiff, but “commodities reasonably interchange-

able by consumers for the same purposes.” United States

v. E.I. du Pont de Nemours & Co., 351 U.S. 377, 395 (1956);

Tunis Brothers, 952 F.2d at 722. A court making a relevant

market determination looks not to the contractual

restraints assumed by a particular plaintiff when deter-

mining whether a product is interchangeable, but to the

and Jeffrey L. Harrison, Understanding Antitrust and its Economic

Implications 217 (1994).

App. 17

uses to which the product is put by consumers in general.

Thus, the relevant inquiry here is not whether a Domino’s

franchisee may reasonably use both approved or non-

approved products interchangeably without triggering

liability for breach of contract, but whether pizza makers

in general might use such products interchangeably.

Clearly, they could. Were we to adopt plaintiffs’ position

that contractual restraints render otherwise identical

products non-interchangeable for purposes of relevant

market definition, any exclusive dealing arrangement,

output or requirement contract, or franchise tying agree-

ment would support a claim for violation of antitrust

laws. Perhaps for this reason, no court has defined a

relevant product market with reference to the particular

contractual restraints of the plaintiff.7 Indeed, the only

cases we have found involving similar claims rejected

plaintiffs’ position as a matter of law. See United Farmers

Agents Ass’n, Inc. v. Farmers Ins. Exchange, 89 F.3d 233 (5th

Cir. 1996) (“Economic power derived from contractual

arrangements such as franchises or in this case, the

agents’ contract with Farmers’, has nothing to do with

market power, ultimate consumers’ welfare, or anti-

trust.”) (internal citation and quotation omitted), cert.

denied, __ U.S. __, 117 S. Ct. 960 (1997); Ajir v. Exxon

7 In Mozart Co. v. Mercedes-Benz of North America, 833 F.2d

1342 (9th Cir. 1987), the Court of Appeals for the Ninth Circuit

observed that market power exists in three circumstances:

where the government has granted a seller a patent or similar

monopoly, where the seller possesses a unique product, or

where the seller possesses a high market share. Id. at 1345-1346.

The court made no mention of contractual limitations as a

source of market power.

App. 18

Corp., No. C 93-20830, 1995 WL 429234, *3 (N.D. Ca.)

(“Just because Exxon’s direct serve dealers may contrac-

tually purchase gasoline from only one source — Exxon -

does not mean that the relevant market is Exxon gas-

oline”; the correct relevant market is all gasoline). See also

Seagood Trading Corp. v. Jerrico, Inc., 924 F.2d 1555, 1570 n.

39 (11th Cir. 1991) (declining to reach issue but noting the

district court rejected plaintiffs’ claim that proposed mar-

ket for sales of supplies to Long John Silver’s fast food

stores was a relevant market for antitrust purposes).

Plaintiffs argue that the Supreme Court’s decision

defining relevant markets in Eastman Kodak Co. v. Image

Technical Services, Inc., 504 U.S. 451 (1992) requires a dif-

ferent outcome. We disagree.

In Kodak, the Supreme Court observed that a market

is defined with reference to reasonable interchangeability.

Kodak, 504 U.S. at 482. The Court held that the market for

repair parts and services for Kodak photo-copiers was a

valid relevant market because repair parts and services

for Kodak machines are not interchangeable with the

service and parts used to fix other copiers. Id. Plaintiffs

suggest that Kodak supports its proposed relevant market

because it indicates that in some circumstances, a single

brand of a product or service may constitute a relevant

market. This is correct where the commodity is unique,

and therefore not interchangeable with other products.

But here, it is uncontested that contractual restraints

aside, the sauce, dough, and other products and ingre-

dients approved for use by Domino’s franchisees are

interchangeable with other items available on the market.

App. 19

Plaintiffs contend that they face information and

switching costs that “lock them in” to their position as

Domino’s franchisees, making it economically impractica-

ble for them to abandon the Domino’s system and enter a

different line of business. They argue that under Kodak,

the fact that they are “locked in” supports their claim that

an “aftermarket” for Domino’s-approved supplies is a

relevant market for antitrust purposes. We believe plain-

tiffs misread Kodak.

The defendants in Kodak argued that there was no

relevant market in Kodak repair parts, even if they were

unique and non-interchangeable with other repair parts,

because of cross-elasticity of demand between parts

prices and copier sales. If the price of parts were raised

too high, defendants contended, it would decrease

demand for copiers.* The Court held that whether there

was cross-elasticity of demand between parts and copiers

was, in this case, a factual question that could not be

determined as a matter of law. The Court reached this

conclusion because switching and information costs arise

when one purchases an expensive piece of equipment like

a copier. In some circumstances, these costs might create

8 In a typical antitrust case, plaintiffs assert that the

products or services in their proposed relevant market are

reasonably interchangeable because they possess positive cross-

elasticity of demand: a rise in the price of one product in the

market will increase demand for the other items in the market.

By contrast, in Kodak the defendants argued that Kodak copier

parts, though not reasonably interchangeable with the copiers

themselves, were not a relevant market because of negative

cross-elasticity between parts and copiers: an increase in the

price of parts would, they argued, decrease demand for copiers

using those parts.

App. 20

an economic lock-in that could reduce or eliminate the

cross-elasticity of demand between copiers and the repair

parts for those copiers.

Kodak, we believe, held that a plaintiff’s proposed

relevant market in a unique and non-interchangeable

derivative product or service cannot be defeated on sum-

mary judgment by a defendant's assertion that the pro-

posed derivative market is cross-elastic with the primary

market, if there is a reasonable possibility that the defen-

dant’s assertion about cross-elasticity is factually incor-

rect. But Kodak does not hold that the existence of

information and switching costs alone, such as those

faced by the Domino’s franchisees,’ renders an otherwise

invalid relevant market valid.!° In Kodak, the repair parts

and service were unique and there was a question of fact

about cross-elasticity. Judgment as a matter of law was

therefore inappropriate. Here, it is uncontroverted that

° A franchisee considering exiting one franchise system

faces information costs associated with researching alternative

investment opportunities and switching costs stemming from

the loss of invested funds that may not be recovered if it

abandons its current business and start-up costs associated with

the new venture.

10 If Kodak repair parts had not been unique, but rather,

could be obtained from additional sources at a reasonable price,

Kodak could not have forced copier purchasers to buy repair

parts from Kodak. This would be true even if the copier

purchasers faced information and switching costs that locked

them into to use of Kodak copiers. This fact indicates that

switching and information costs alone cannot create market

power. Rather, it is the lack of a competitive market in the object

to be purchased - for instance, a competitive market in Kodak

parts — that gives a company market power.

App. 21

Domino’s approved supplies and ingredients are fully

interchangeable in all relevant respects with other pizza

supplies outside the proposed relevant market. For this

reason, dismissal of the plaintiffs’ claim as a matter of

law is appropriate.

Kodak is distinguishabie from the present appeal in

other important respects. The Kodak case arose out of

concerns about unilateral changes in Kodak's parts and

repairs policies. When the copiers were first sold, Kodak

relied on purchasers to obtain service from independent

service providers. Later, it chose to use its power over the

market in unique replacement parts to squeeze the inde-

pendent service providers out of the repair market and to

force copier purchasers to obtain service directly from

Kodak, at higher cost. Because this change in policy was

not foreseen at the time of sale, buyers had no ability to

calculate these higher costs at the time of purchase and

incorporate them into their purchase decision. In con-

trast, plaintiffs here knew that Domino's Pizza retained

significant power over their ability to purchase cheaper

supplies from alternative sources because that authority

was spelled out in detail in section 12.2 of the standard

franchise agreement. Unlike the plaintiffs in Kodak, the

Domino’s franchisees could assess the potential costs and

economic risks at the time they signed the franchise

agreement. The franchise transaction between Domino's

Pizza, Inc. and plaintiffs was subjected to competition at

the pre-contract stage. That cannot be said of the conduct

challenged in Kodak because it was not authorized by

contract terms disclosed at the time of the original trans-

action. Kodak’s sale of its product involved no contrac-

tual framework for continuing relations with the

App. 22

purchaser. But a franchise agreement regulating supplies,

inspections, and quality standards structures an ongoing

relationship between franchisor and franchisee designed

to maintain good will. These differences between the

Kodak transaction and franchise transactions are compel-

ling."

Plaintiffs also contend that Virtual Maintenance, Inc. v.

Prime Computer, Inc., 11 F.3d 660 (6th Cir. 1993), supports

their claim that the boundaries of a relevant market may

be defined by contract. In Virtual Maintenance, Ford

Motor Co. granted Prime Computer an exclusive right to

market Ford-designed software and software revisions

that automobile design companies must use to design

cars for Ford. Prime Computer sold the software revi-

sions only in a package with uncompetitive hardware

maintenance services. The Court of Appeals for the Sixth

Circuit held that Prime could not legally exercise its

monopoly power over software revisions to force cus-

tomers to buy unwanted hardware maintenance con-

tracts. Plaintiffs note that Prime’s de facto monopoly

power over software stemmed from a contract with Ford,

which they argue implies that the boundaries of a market

may be defined by contract. But Prime had a monopoly

because it possessed a unique product that no one else

sold. Since the product was unique, and not interchange-

able with any other products, it constituted its own rele-

vant market for antitrust purposes. By contrast, Domino’s

does not sell a unique product or service. Franchisees

must buy Domino’s-approved supplies and ingredients

11 See Alan Silberman, The Myths of Franchise “Market

Power”, 65 Antitrust L.J. 181, 217 (1996).

App. 23

not because they are unique, but because they are obli-

gated by contract to do so.

Were we to accept plaintiffs’ relevant market, vir-

tually all franchise tying agreements requiring the fran-

chisee to purchase inputs such as ingredients and

supplies from the franchisor would violate antitrust law.

Courts and legal commentators have long recognized that

franchise tying contracts are an essential and important

aspect of the franchise form of business organization

because they reduce agency costs and prevent franchisees

from freeriding - offering products of sub-standard qual-

ity insufficient to maintain the reputational value of the

franchise product while benefitting from the quality con-

trol efforts of other actors in the franchise system.12 Fran-

chising is a bedrock of the American economy. More than

one third of all dollars spent in retailing transactions in

the United States are paid to franchise outlets.13 We do

not believe the antitrust laws were designed to erect a

serious barrier to this form of business organization.'4

12 See Mozart Co. v. Mercedes-Benz of North America, Inc., 833

F.2d 1342, 1349-50 (9th Cir. 1987); Alan J. Meese, Antitrust

Balancing in a (Near) Coasean World: The Case of Franchise Tying

Contracts, 95 Mich. L.Rev. 111, 117-119 (1996); Warren S. Grimes,

When Do Franchisors Have Market Power?, 65 Antitrust L.J. 105

145-47 (1996); Benjamin Klein and Lester F. Saft, The Law and

Economics of Franchise Tying Contracts, 28 J.L. & Econ. 345, 346-48

(1985).

13 Warren S. Grimes, When Do Franchisors Have Market

Power?, 65 Antitrust L.J. 105, 105 n.1 (1996).

14 See United States v. Arnold, Schwinn & Co., 388 U.S. 365,

387 (1967) (Stewart, J., concurring in part and dissenting in part)

(“Indiscriminate invalidation of franchising arrangements

would eliminate their creative contributions to competition and

9 np: sitaciaaall

App. 24

The purpose of the Sherman Act “is not to protect

businesses from the working of the market; it is to protect

the public from the failure of the market.” Spectrum

Sports, Inc. v. McQuillan, 506 U.S. 447, 458 (1993). Here,

plaintiffs’ acceptance of a franchise package that included

purchase requirements and contractual restrictions is con-

sistent with the existence of a competitive market in

which franchises are valued, in part, according to the

terms of the proposed franchise agreement and the avail-

ability of alternative franchise opportunities. Plaintiffs

need not have become Domino’s franchisees. If the con-

tractual restrictions in section 12.2 of the general fran-

chise agreement were viewed as overly burdensome or

risky at the time they were proposed, plaintiffs could

have purchased a different form of restaurant, or made

some alternative investment.!5 They chose not to do so.

Unlike the plaintiffs in Kodak, plaintiffs here must pur-

chase products from Domino’s Pizza not because of Dom-

ino’s market power over a unique product, but because

they are bound by contract to do so. If Domino’s Pizza,

Inc. acted unreasonably when, under the franchise agree-

ment, it restricted plaintiffs’ ability to purchase supplies

force suppliers to abandon franchising and integrate forward to

the detriment of small business. In other words, we may

inadvertently compel concentration by misguided

zealousness.”) (internal quotations omitted). The majority’s

opinion in Arnold was later overturned. See Continental T.V., Inc.

v. GTE Sylvania Inc., 433 U.S. 36 (1977).

15 As one scholar has noted, there are thousands of

franchise opportunities available to investors and disclosure

laws to help them make informed choices about these

alternatives. George A. Hay, Is the Glass Half-Empty or Half-Full?:

Reflections on the Kodak Case, 62 Antitrust L.J. 177, 188 (1993).

App. 25

from other sources, plaintiffs’ remedy, if any, is in con-

tract, not under the antitrust laws.16

For these reasons, we agree with the district court

that plaintiffs have not pleaded a valid relevant market.!7

¢..

Plaintiffs’ claim for attempt to monopolize fails for

the same reasons. To prevail on an attempted monopoliz-

ation claim under § 2 of the Sherman Act, “a plaintiff

16 The dissent contends Domino’s has acted ina “predatory

way.” But plaintiffs may have a right to sue for breach of

contract.

17 The reasoning adopted by the district court in this case

has been criticized recently by two other district court decisions.

See Wilson v. Mobil Oil Corp., 940 F. Supp. 944 (E.D. La. 1996);

Collins v. International Dairy Queen, Inc., 939 F. Supp. 875 (M.D.

Ga. 1996). In Wilson, the court disagreed with the district court's

interpretation of Kodak, arguing that under Kodak information

and switching costs alone, absent a unique product or service,

may create a relevant market for antitrust Purposes. As noted

above, we disagree with this interpretation, for the Supreme

Court specifically found that the copier parts involved in the

case were unique. The basis of the Collins court's criticism of the

district court’s decision here is less clear, though it appears the

court believed that the district court’s holding was too

expansive. The Collins court apparently wished to reserve

judgment whether some franchise tying arrangements might be

deemed anti-competitive in the future. The approach taken by

the district court in this case has received support in recent

scholarly literature. See Alan J. Meese, Antitrust Balancing in a

(Near) Coasean World: The Case of Franchise Tying Contracts, 95

Mich. L. Rev. 111, 128 (1996) (“economic theory suggests . . . that

tying contracts that actually reduce free riding are unrelated to

any exercise of market power”); Alan H. Silberman, The Myths of

Franchise “Market Power”, 65 Antitrust L.J. 181 (1996).

App. 26

must prove that the defendant (1) engaged in predatory

or anticompetitive conduct with (2) specific intent to

monopolize and with (3) a dangerous probability of

achieving monopoly power.” Spectrum Sports, Inc. v.

McQuillan, 506 U.S. 447, 456 (1993). Ideal Dairy Farms, Inc.

v. John Labatt, Ltd., 90 F.3d 737, 750 (3d Cir. 1996); Advo,

Inc. v. Philadelphia Newspapers, Inc., 51 F.3d 1191, 1197 (3d

Cir. 1995). In order to determine whether there is a dan-

gerous probability of monopolization, a court must

inquire “into the relevant product and geographic market

and the defendant’s economic power in that market.”

Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 459 (1993);

Ideal Dairy Farms at 750; Pastore v. Bell Telephone Co. of

Pennsylvania, 24 F.3d 508, 512 (3d Cir. 1994).

Plaintiffs’ attempted monopoly claim is predicated

on the identical proposed relevant market underlying its

monopoly claim: a market in the ingredients, supplies,

and materials used by Domino’s pizza stores. Because the

products within this proposed market are interchange-

able with other products outside of the proposed market,

the claim was properly dismissed.

Plaintiffs allege exclusive dealing arrangements

entered into by Domino’s Pizza, Inc. have unreasonably

restrained trade in violation of § 1 of the Sherman Act, 15

U.S.C. § 1. Section 1 of the Sherman Act provides: “Every

contract, combination in the form of trust or otherwise, or

conspiracy, in restraint of trade or commerce among the

several states, or with foreign nations, is declared to be

illegal.” 15 U.S.C. § 1.

App. 27

To establish a section 1 violation for unreasonable

restraint of trade, a plaintiff must prove (1) concerted

action by the defendants; (2) that produced anti-competi-

tive effects within the relevant product and geographic

markets; (3) that the concerted action was illegal; and (4)

that the plaintiff was injured as a proximate result of the

concerted action. Mathews v. Laxicaster General Hospital, 87

F.3d 624, 639 (3d Cir. 1996); Orson Inc. v. Miramax Film

Corp., 79 F.3d 1358. 1246 (3d Cir. 1996); Petruzzi’s IGA

Supermarkets, Inc. v. Darling-Delaware Co., Inc., 998 F.2d

1224, 1229 (3d Cir. 1993). :

Plaintiffs allege defendant’s actions caused anticom-

petitive effects within the market for ingredients and

supplies used by Domino’s pizza stores. Again, this claim

fails because the products within the proposed market

are interchangeable with products outside the proposed

market.18

18 Monopoly power under § 2 requires “something greater”

than market power under § 1. Kodak, 504 U.S. at 481. This does

not imply, however, that the analyses employed in the two types

of cases to define relevant markets differ. In the past, we

intimated that the relevant market analysis required under § 2

of the Sherman Act was “instructive” in § 1 cases, though

perhaps not identical. See Tunis Bros., 952 F.2d at 724 n. 3. The

Supreme Court and lower courts have consistently held that

relevant markets under both sections are defined by the same

two factors: reasonable interchangeability of use and cross-

elasticities of demand. See, e.g., Allen-Myland, 33 F.3d at 201 and

201 n. 8 (applying Brown Shoe relevant market test of reasonable

interchangeability and cross-elasticity of demand in § I tying

case). In this case, we see no difference in the relevant market

analyses required under the two provisions.

—EEeee

App. 28

Plaintiffs allege Domino’s Pizza, Inc. imposed an

unlawful tying arrangement by requiring franchisees to

buy ingredients and supplies from them as a condition of

obtaining Domino’s Pizza fresh dough, in violation of § 1

of the Sherman Act, 15 U.S.C. § 1. “In a tying arrange-

ment, the seller sells one item, known as the tying prod-

uct, on the condition that the buyer also purchases

another item, known as the tied product.” Allen-Myland,

Inc. v. International Business Machines Corp., 33 F.3d 194,

200 (3d Cir. 1994). “[T]he antitrust concern over tying

arrangements is limited to those situations in which the

seller can exploit its power in the market for the tying

product to force buyers to purchase the tied product

when they otherwise would not, thereby restraining com-

petition in the tied product market.” Id. “Even if a seller

has obtained a monopoly in the tying product legit-

imately (as by obtaining a patent), courts have seen the

expansion of that power to other product markets as

illegitimate and competition suppressing.” Town Sound

and Custom Tops, Inc. v. Chrysler Motors Corp., 959 F.2d 468,

475 (3d Cir. 1992). “The first inquiry in any § 1 tying case

is whether the defendant has sufficient market power

over the tying product, which requires a finding that two

separate product markets exist and a determination pre-

cisely what the tying and tied products markets are.”

Allen-Myland, 33 F.3d at 200-201.

Here, plaintiffs allege Domino’s Pizza, Inc. used its

power in the purported market for Domino’s-approved

dough to force plaintiffs to buy unwanted ingredients

and supplies from them. This claim fails because the

proposed tying market — the market in Domino’s-

App. 29

approved dough - is not a relevant market for antitrust

purposes. Domino’s dough is reasonably interchangeable

with other brands of pizza dough, and does not therefore

constitute a relevant market of its own. All that distin-

guishes this dough from other brands is that a Domino’s

franchisee must use it or face a suit for breach of contract.

As we have noted above, the particular contractual

restraints assumed by a plaintiff are not sufficient by

themselves to render interchangeable commodities non-

interchangeable for purposes of relevant market defini-

tion. If Domino’s had market power in the overall market

for pizza dough and forced plaintiffs to purchase other

unwanted ingredients to obtain dough, plaintiffs might

possess a valid tying claim. But where the defendant's

“power” to “force” plaintiffs to purchase the alleged

tying product stems not from the market, but from plain-

tiffs’ contractual agreement to purchase the tying prod-

uct, no claim will lie. For that reason, plaintiffs’ claim was

properly dismissed.

Plaintiffs allege Domino’s Pizza, Inc. imposed an

unlawful tie-in arrangement by requiring franchisees to

buy ingredients and supplies “as a condition of their

continued enjoyment of rights and services under their

Standard Franchise Agreement,” in violation of § 1 of the

Sherman Act, 15 U.S.C. § 1. This claim is meritless.

Though plaintiffs complain of an illegal tie-in arrange-

ment, they have failed to point to any particular tying

product or service over which Domino’s Pizza, Inc, has

market power. Domino’s Pizza’s control over plaintiffs’

“continued enjoyment of rights and services under their

App. 30

Standard Franchise Agreement” is not a “market.”

Rather, it is a function of Domino’s contractual powers

under the franchise agreement to terminate the participa-

tion of franchisees in the franchise system if they violate

the agreement. Because plaintiffs failed to plead any rele-

vant tying market, the claim was properly dismissed.

On appeal, the plaintiffs advance a new claim based

on a different relevant market theory — that Domino’s has

a monopoly in a relevant market comprised of pizza

franchise opportunities of the type that Domino’s Pizza,

Inc. offers. Plaintiffs raise this new theory, which the

district court did not address, in the hopes of obtaining a

remand.

Plaintiffs’ argument that Domino’s Pizza has monop-

olized a relevant market comprised of franchise oppor-

tunities of a particular sort was not raised or mentioned

in their complaint, first amended complaint, memoran-

dum of law in support of their motion for leave to file a

second amended complaint, or in the “claims for relief”

section of the proposed second amended complaint.

When the district court denied plaintiffs leave to file a

second amended complaint, on grounds of futility, it had

no idea that plaintiffs intended or desired to raise such a

claim. “This court has consistently held that it will not

consider issues that are raised for the first time on

appeal.” Harris v. City of Philadelphia, 35 F.3d 840, 845 (3d

Cir. 1994).

App. 31

Nonetheless, plaintiffs argue that this claim was

raised before the district court. In support of this conten-

tion, they note that facts which might support such a

claim were pleaded in paragraphs 60 and 65 of their

proposed second amended complaint. Though we con-

strue pleadings liberally, plaintiffs have a duty to make

the district court aware that they intend to rely on a

particular relevant market theory. This is particularly true

in a complex case like this one, where plaintiffs bring

multiple antitrust claims based on multiple and alterna-

tive relevant market theories. See Pastore v. Bell Telephone

Co. of Pennsylvania, 24 F.3d 508, 513 (3d Cir. 1994) (plain-

tiff bound by relevant market theory raised before district

court); TV Communications Network, Inc. v. Turner Network

Television, Inc., 964 F.2d 1022, 1025 (10th Cir. 1992) (same);

Edward J. Sweeney & Sons, Inc. v. Texaco, Inc., 637 F.2d 105,

117 (3d Cir. 1980) (same). We do not believe a fleeting

reference in a proposed second amended complaint to

facts that might support a proposed relevant market is

sufficient, on its own, to preserve that relevant market

theory for appellate review. See Frank v. Colt Industries,

Inc., 910 F.2d 90, 100 (3d Cir. 1990) (issues not raised

before district court are waived on appeal; fleeting refer-

ence to issue before district court insufficient to preserve

it for appellate review). “Particularly where important

and complex issues of law are presented, a far more

detailed exposition of argument is required to preserve

an issue.” Id. at 100. Because this claim was not properly

raised before the district court and is not properly before

us, we decline to address it. See generally Salvation Army v.

Department of Community Affairs of State of N.J., 919 F.2d

183, 196 (3d Cir. 1990) (“The matter of what questions

App. 32

may be taken up and resolved for the first time on appeal

is one left primarily to the discretion of the courts of

appeals, to be exercised on the facts of each case.”).

Plaintiffs also contend the district court held that the

availability of contract remedies prohibited recovery

under antitrust laws. But this misstates the district court’s

holding. The district court held that Domino’s Pizza’s

ability to block franchisees from purchasing ingredients

from other sources stemmed from its exercise of contrac-

tual powers, not market power, and the remedy for this

problem lies, if at all, under contract law. The court did

not say that as a matter of law the availability of common

law remedies prohibits recovery under an antitrust the-

ory. We see no error.

The district court declined to exercise supplemental

jurisdiction over the plaintiffs’ remaining state law con-

tract claims. This decision is committed to the sound

discretion of the district court. Stehney v. Perry, 101 F.3d

925, 939 (3d Cir. 1996); Growth Horizons, Inc. v. Delaware

County, Pa., 983 F.2d 1277, 1284-85 (3d Cir. 1993). Because

all federal claims were correctly dismissed and dismissal

of the remaining contract claims would not be unfair to

the litigants or result in waste of judicial resources, we

see no abuse of discretion.

App. 33

IV.

For the foregoing reasons, we will affirm the judg-

ment of the district court.

LAY, Circuit Judge, dissenting.

I respectfully dissent.

The district court, at the pleading stage, dismissed

plaintiffs’ complaint alleging violations under § 1 and § 2

of the Sherman Antitrust Act holding that plaintiffs failed

to allege a relevant market. The issue is complex. Judge

Scirica’s opinion is logically reasoned. Our differences lie

in the interpretation and application of the Supreme

Court’s recent opinion in Eastman Kodak Co. v. Image

Technical Servs., Inc., 504 U.S. 451 (1992). I respectfully

submit, for the reasons that follow, that the district

court’s opinion in this case rests on several incorrect

hypotheses. To the extent that the majority adopts the

district court’s rationale, I dissent.

The district court rejected as a matter of law the

plaintiffs’ alleged relevant market, that of the derivative

aftermarket for ingredients and supplies among Dom-

ino’s Pizza, Inc. (“DPI”)’s franchisees. The district court

found that “[t]he economic power DPI possesses results

not from the unique nature of the product or from its

market share in the fast food franchise business, but from

the franchise agreement.”!

? The district court relied on “two influential

commentators,” Benjamin Klein and Lester F. Saft, The Law and

Economics of Franchise Tying Contracts, 28 J.L. & Econ. 345, 356

(1985) and two pre-Kodak cases, Mozart Co. v. Mercedes-Benz of

App. 34

The plaintiffs allege that DPI has harmed the compet-

itive process by “foreclos[ing] interbrand competition in

the market for distributing approved Ingredients and

Supplies to Domino’s franchisees.” The plaintiffs argue

that DPI prevented a franchise cooperative and other

distributors of ingredients and supplies from entering

that market. By stopping any interbrand competition for

ingredients and supplies for DPI franchisees, DPI, accord-

ing to the pleadings, has excluded other potential distrib-

utors, and thereby preempted market forces from

disciplining the sale of ingredients and supplies.

Interchangeability

In adopting the district court’s approach to relevant

market definition, the majority reasons that all ingre-

dients and supplies, whether or not approved by DPI, are

North America, Inc., 833 F.3d 1342 (9th Cir. 1987), and Tominaga v.

Shepherd, 682 F. Supp. 1489 (C.D. Cal. 1988). The district court

adopted the Ninth Circuit’s analysis from Mozart that an alleged

economic-lock-in is irrelevant to the determination of a

defendant’s market power. See Tominaga, 682 F. Supp. at 1494

(quoting Mozart, 833 F.2d at 1346-47). This reasoning is simply

irreconcilable with the Supreme Court’s analysis of information

and switching costs in Kodak. See Kodak, 504 U.S. at 473-77.

It should also be noted Professor Klein recognized, contrary

to his original thesis, that Kodak permits the recognition of

market power in a derivative aftermarket “despite the absence

of market power in the equipment market, by taking advantage

of imperfectly informed consumers that become ‘locked-in’ to

their existing Kodak equipment.” See Benjamin Klein, Market

Power in Antitrust: Economic Analysis After Kodak, 3 Sup. Ct.

Econ. Rev. 43, 48 (1993).

App. 35

interchangeable for making pizzas generally and there-

fore must be included within the relevant market. Kodak

made a similar argument. As in Kodak, this ignores the

reality that there are no substitutes for ingredients and

supplies sold only by DPI. The majority’s approach to the

interchangeability concept is not faithful to the purpose

of interchangeability analysis or the Supreme Court's

understanding of market definition and power. The pur-

pose of analyzing interchangeability is to find competing

products which are reasonable substitutes and thereby

prevent market power.? In Kodak, the question was

whether the cross-elasticity of demand between the

equipment market and the derivative aftermarkets for

parts and service was sufficient to deprive Kodak of

market power. Our question is whether the inter-

changeability of, or cross-elasticity of demand between,

DPI-approved ingredients and supplies and other ingre-

dients and supplies is sufficient to make the alleged

relevant market invalid. The issue, whether under the

framework of market power as it was in Kodak, or as

market definition as here, is whether competition from

other providers of ingredients and supplies for pizzas

will restrain the power of DPI over ingredients and sup-

plies it sells to franchisees. See Kodak, 504 U.S. at 469 n.15.

The plaintiffs allege not only that they are limited to

buying ingredients and supplies from DPI, but also that

information and switching costs prevented them from

? The basic definition of market power is “the power to

raise prices above competitive levels without losing so many

sales that the price increase is unprofitable.” Herbert

Hovenkamp, Federal Antitrust Policy: The Law of Competition and

its Practice § 3.1, at 79 (1994) (footnote omitted).

App. 36

anticipating and being able to respond to DPI’s power to

substantially raise price for the ingredients and supplies.

They allege that competition from independent providers

of ingredients and supplies does not restrain DPI’s power

in the aftermarket for ingredients and supplies, and

therefore ingredients and supplies not approved by DPI

need not be included in the relevant market.?

3 The majority, in footnote 17, ante at 20, states that the

district court’s approach has “received support in recent

scholarly literature,” citing Alan J. Meese, Antitrust Balancing in

a (Near) Coasean World: The Case of Franchise Tying Contracts, 95

Mich. L. Rev. 111, 128 (1996). However, Professor Meese does

not argue that the approach taken is correct under current

antitrust law. In fact, on page 126 he concedes that the Kodak

decision “found that the existence of relationship-specific

investments can confer ‘market power’ ”, and at 152-55 he

states that “under current law” franchisors may have market

power over derivative aftermarkets due to “lock-in” of the

franchisees, and because of this he proposes a new framework

for analyzing such claims. He argues that “the focus on market

power and less restrictive alternatives, though perfectly natural

given the partial equilibrium framework that dominates

antitrust law and the premises that underlie tying

jurisprudence,” does not properly apply to the franchise tying

context. Id. at 128. Professor Meese argues that tying contracts

that reduce free riding, a form of opportunistic behavior taken

at the expense of the franchise system, should be prima facie

legal. Whatever the value of Professor Meese’s argument, he

presupposes that “under current law” from the Supreme Court

the district court in this case may have erred. Id. at 152. In

addition, it is not even clear that Professor Meese would find the

plaintiffs’ allegations insufficient as a matter of law because

they allege that DPI charged supracompetitive prices for the

ingredients and supplies. See id. at 155.

App. 37

Information and Switching Costs

A closely related problem with the district court's

opinion is its scant treatment of information and switch-

ing costs and their relevance to defining a valid relevant

market. The plaintiffs argue that they have experienced

information and switching costs which have prevented

them from anticipating or responding to the price

increases for ingredients and supplies from DPI. They

argue that these information and switching costs create a

“lock-in” which makes the aftermarket for DPI-approved

ingredients and supplies the relevant market. Specifically,

the imperfect information they proffer is that the fran-

chisees “could not foresee that Domino’s would not fol-

low the policy represented in its Offering Circular and

would, instead, commence excluding potential suppliers

in order to foreclose competition in the aftermarket.”

They suggest switching costs arise from sunk costs in the

franchise, limits on franchisees’s ability to sell their fran-

chise, and noncompetition covenants in the Standard

Franchise Agreement.

An important part of the Supreme Court's decision in

Kodak that the plaintiffs presented a triable claim was that

“there is a question of fact whether information costs and

switching costs foil the simple assumption that the equip-

ment and service markets act as pure complements to one

another.” Kodak, 504 U.S. at 477. In fact, other circuit

courts have held that the presence of these market imper-

fections was the crucial factor in Kodak, and that had

Kodak’s policy been known at the time businesses bought

App. 38

copiers from Kodak, the result would have been differ-

ent.4 See PSI Repair Servs., Inc. v. Honeywell, Inc., 104 F.3d

811, 820 (6th Cir. 1997) (“We likewise agree that the

change in policy in Kodak was the crucial factor in the

Court’s decision. By changing its policy after its cus-

tomers were ‘locked in,’ Kodak took advantage of the fact

that its customers lacked the information to anticipate

this change.”), cert. denied, 1997 WL 195257; see also Digital

Equip. Corp. v. Unig Digital Techs., Inc., 73 F.3d 756, 763

(7th Cir. 1996); Lee v. Life Ins. Co. of North America, 23 F.3d

14, 20 (1st Cir. 1994). Several commentators have

described how the analysis from Kodak could mean that

franchisors’ derivative aftermarkets may be relevant anti-

trust markets. Meese, 95 Mich. L. Rev. at 152 (“Under

current law, [post-contract market power] can arise once

the cost to the franchisee of switching to a different

franchise is significant. . ..”); Warren S. Grimes, When Do

Franchisors Have Market Power? Antitrust Remedies For

Franchisor Opportunism, 65 Antitrust L.J. 105, 112 (1996)

(“A franchisor has market power if it can, without losing

substantial sales, raise the price of a good or service sold

to a franchisee above the level at which an equivalent

good or service is available from other suppliers.”); see

* This conclusion seems quite sensible. If Kodak

customers knew about Kodak’s subsequent parts-and-service

policy when they bought the copiers, or were not economically

restricted from switching to other copiers, then Justice Scalia’s

dissent, which assumes a perfect competition/perfect

information world, should be right. Kodak is merely a

concession to fact that markets do not always work perfectly,

and sometimes, but not always, these imperfections can create

sufficient market power to justify possible antitrust liability.

App. 39

also Robert H. Lande, Chicago Takes It On The Chin: Imper-

fect Information Could Play A Crucial Role In The Post-Kodak

World, 62 Antitrust L.J. 193, 195 (1993) (“Another impor-

tant lesson of Kodak is that imperfect information can be a

crucial factor in defining relevant markets.”). But see Alan

Silberman, The Myths of Franchise “Market Power”, 65 Anti-

trust L.J. 181, 217 (1996).

Uniqueness

In rejecting the plaintiffs’ theory that the information

and switching costs they face justify the alleged relevant

market under Kodak, the majority states: “Kodak does not

hold that the existence of information and switching costs

alone, such as those faced by the Domino’s franchisees,

renders an otherwise invalid relevant market valid.” Ante

at 16 (footnotes omitted). Both the district court and the

majority make a more difficult argument, that a necessary

factor in Kodak was that the repair parts were “unique.”

They state that this uniqueness is what gave Kodak mar-

ket power, and that the lack of this factor herein warrants

rejecting the plaintiffs’ alleged relevant market. The basis

for not applying Kodak in this case lies in two arguments:

(1) the aftermarket ingredients and supplies are not

unique, and (2) the franchisees knew of the policy

because it was contained in the franchise agreement.

The first argument fails as a matter of law. Whether

the product is unique was not the key component of the

Kodak opinion. Even if the Court was somehow preoc-

cupied with the “uniqueness” of the Kodak replacement

parts, the opinion itself as well as economic theory sug-

gest that uniqueness was not a sine qua non in finding a

App. 40

triable claim of market power. Justice Blackmun describes

the plaintiffs’ allegations regarding the market realities,

including the facts that Kodak had excluded independent

parts distributors and service competition and then

boosted prices above prior levels. After this discussion,

Justice Blackmun states: “Under our prior precedents,

this evidence would be sufficient to entitle respondents to

a trial on their claim of market power.” 504 U.S. at 465.5

The term unique seems to be important for antitrust

purposes only in describing a product which has no

reasonable substitutes.° The fact that Kodak parts were

unique was important only because it limited the choices

available to Kodak equipment owners seeking to replace

worn out parts. The Court stated: “The relevant market

for antitrust purposes is determined by the choices avail-

able to Kodak equipment owners.” 504 U.S. at 481-82.

Here, the plaintiffs’ choices are limited to DPI-approved

ingredients and supplies, and therefore the alleged rele-

vant market is identical in kind to that involved in Kodak.

5 In Market Power in Aftermarkets: Antitrust Policy and the

Kodak Case, 40 U.C.L.A. L. Rev. 1447 (1993), Professor

Hovenkamp argues that whether a product requires “unique”

replacement parts is absolutely irrelevant to whether the

manufacturer of that product has market power. He states that

the portion of the Kodak opinion about unique parts is wrong,

but that the evidence cited of increased prices was relevant to

the question of market power. Id. at 1454-55.

6 For example, if someone patented a new material for

bottling soft drinks, it would certainly be true that there were no

other materials just like it. But, provided glass and plastic were

still reasonable substitutes, the description “unique” would not

be meaningful for antitrust analysis.

App. 41

In Wilson v. Mobil Oil Corp., 940 F. Supp. 944 (E.D. La.

1996), the district court analyzed the relevance of the

Kodak opinion to the franchise context. The defendants

argued that Kodak does not apply to the franchisor/fran-

chisee relationship and cited the district court opinion

from this case for support. Wilson, 940 F. Supp. at 951. The

court rejected the argument that the lack of unique prod-

ucts, like Kodak parts, makes Kodak inapplicable to the

franchise relationship:

This Court is not convinced that a principled

distinction can be drawn as a matter of law

between the franchise context and the durable

equipment market involved in Kodak. No facts

have been adduced to indicate that a business

format franchise cannot create a derivative

aftermarket for the purchase and sale of prod-

ucts that must be used in the franchise operation

by the franchise network. Nor have facts been

adduced that such an aftermarket could not be

subject to the same economic dislocations that

permitted market power to be possible in Kodak.

The Kodak court did not purport to base its

market power analysis solely on the fact that

Kodak’s machines were unique, nor did it limit

the application of its reasoning to durable

equipment markets. If anything, Kodak cautions

against making economic assumptions on a

blank factual record. See Kodak, 504 U.S. at

466-67.

Id. at 951-52. This analysis is compelling because it incor-

porates the understanding that a unique product does not

App. 42

itself confer market power and then analyzes the work-

ings of the market in question.”

The majority also distinguishes Virtual Maintenance,

Inc. v. Prime Computer, Inc., 11 F.3d 660 (6th Cir. 1993), on

the basis of the importance of a unique product. In Virtual

Maintenance, the Sixth Circuit was directed by the

Supreme Court, in light of its opinion in Kodak, to recon-

sider the Sixth Circuits’ earlier rejection of the plaintiff's

antitrust claims. Upon reconsideration in light of Kodak,

the court upheld the alleged relevant market for “the sale

of software revisions and support of software necessary

to do business with Ford Motor Company.” Id. at 664

(citation omitted). In upholding the derivative after-

market as a relevant market, the court held: “Like Kodak,

Prime is able to exercise control over the sale of software

support because of its exclusive distribution license from

Ford, and Ford’s requirement that its automotive design

7 The majority cities United Farmers Agents v. Farmers Ins.

Exchange, 89 F.3d 233 (Sth Cir. 1996), cert. denied, 117 S. Ct. 960

(1997), for the argument that a derivative aftermarket defined

by contractual restraints must be rejected. However, this case

does not stand for the proposition for which it is cited. In United

Farmers, the 5th Circuit does cite the statement from Professors

Klein and Saft, that the economic power derived from

contractual agreements has nothing to do with market power

for purposes of antitrust. 89 F.3d at 236-7. However, the court

proceeded to expressly address whether there were sufficient

information and switching costs to justify invoking Kodak and

upholding the plaintiffs’ alleged relevant market. The district

court in Wilson addressed the importance of the United Farmers

opinion and concluded: “If anything, this decision suggests that

when parties seek to invoke Kodak, issues of information costs

and switching costs must be addressed before tying claims can

be rejected out of hand.” Wilson, 940 F. Supp. at 952.

App. 43

suppliers use the most current version of Prime’s soft-

ware support.” Id. at 666. The majority in the present case

rejects application of Virtual Maintenance to this case: “But

Prime had a monopoly because it possessed a unique

product that no one else sold. Since the product was

unique, and not interchangeable with any other products,

it constituted its own relevant market for antitrust pur-

poses. By contrast, Domino’s does not sell a unique prod-

uct or service.” Ante at 18. However, this misstates the

facts; Prime’s product was not unique. In fact, the plain-

tiffs in Virtual Maintenance made products that were rea-

sonably interchangeable with that of Prime. Thus, this

analysis slights the significance of Prime’s distribution

license from Ford and Ford’s requirement that suppliers

use the latest version of Prime’s product. The Sixth Cir-

cuit analyzed the market realities, including evidence of

price manipulation and an economic lock-in, and con-

cluded that under Kodak the alleged relevant market was

valid.

The Franchise Agreement

The second argument, that the alleged relevant mar-

ket fails because franchisees knew of the policy, fails as a

matter of fact. Adopting the district court’s position, the

majority states that the franchisees knew the potential

costs and economic risks of DPI forcing them to buy

ingredients and supplies only from DPI at supracompeti-

tive prices because the franchise agreement gave DPI the

power to do so. Ante at 17. This statement is illusory for

two reasons. First, it ignores the information in the Offer-

ing Circulars: the plaintiffs are supposed to have antici-

pated these actions despite the fact that they are directly

App. 44

contrary to what DPI told them. The plaintiffs argue that

the Offering Circulars DPI presented when they were

considering a DPI franchise stated that there would be

alternative suppliers for the ingredients and supplies.

Second, it would be illogical for the franchisees to expect

that the franchisor’s right to sell ingredients and supplies

coupled with its approval power in the franchise agree-

ment, included for the very legitimate purpose of fran-

chise quality control, would be applied in such an odd

and predatory way.’ It seems hard for DPI to argue that

the franchise agreement justifies its actions when all it’s

doing is buying the ingredients and supplies, marking up

the prices, and then reselling them to the franchisees.?

Conclusion

Concern is expressed about the possible impact on

the franchise industry from adopting plaintiffs’ theory of

relevant market definition. However, plaintiffs still have

to prove the arguments they present for the alleged rele-

vant market, and seek more discovery in order to do so.

There are many defenses, which have not been argued,

which may be applicable in this case or other franchisor /

® It is alleged the DPI’s Offering Circular represented to

prospective franchisees that DPI would approve a sufficient

number of suppliers to ensure a competitive aftermarket for

ingredients and supplies, and that it would only utilize its

approval power to maintain quality control.

% Moreover, the majority’s analysis, that what the

plaintiffs knew when they entered the franchise agreement is an

important distinguishing factor, concedes that imperfect

information is a crucial factor in determining relevant market

definition.

App. 45

franchisee antitrust disputes. My main concern with

affirming the district court’s opinion is the broad rejec-

tion of the basis for any antitrust claims by franchisees

against franchisors in derivative aftermarkets. See

Grimes, 65 Antitrust L.J. at 125-26 (describing several

types of post-contract franchisor opportunism which may

lead to antitrust claims if the franchisor has market

power). There may be other problems, which are not

before the court, with the plaintiffs’ allegations of monop-

olization and illegal tying in the derivative aftermarkets

by a franchisor, but the Supreme Court's clear direction

in Kodak that information and switching costs are relevant

to the ultimate determination of market power is honored

by the district court only in the breach. The reality of the

aftermarket for ingredients and supplies faced by these

plaintiffs, according to the pleadings, is that alternative

suppliers do not restrain DPI’s ability to increase price,

and information and switching costs lock-in the fran-

chisees thereby preventing any competitive response to

the price increases from DPI.

For the reasons set forth, I would reverse the district

court's 12(b)(6) dismissal of plaintiffs’ complaint.

A True Copy:

Teste:

Clerk of the United States Court of Appeals for the Third

Circuit

App. 46

Filed October 27, 1997

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 96-1638

QUEEN CITY PIZZA, INC.; THOMAS C. BOLGER;

SCALE PIZZA, INC.; BAUGHANS, INC.; CHARLES F.

BUCK; F.M. PIZZA, INC.; ROBERT S. BIGELOW;

BLUE EARTH ENTERPRISES, INC.; KEVIN BORES;

DAVIS PIZZA ENTERPRISES, INC.; DIANE A. DAVIS;

FISHER PiZZA, INC.; JAMES B. FISHER, JR.; SEPCO,

INC.; S&S PIZZA CORP.; G&L PIZZA CO.; STEPHEN

D. GALLUP; LUGENT PIZZA, INC.; JOSEPH J.

LUGENT; BILLIO’S PIZZA, INC.; WILLIAM J.

MURTHA; SPRING GARDEN PIZZA, INC.; BRAD L.

WALKER; JRW PIZZA, INC.; JAMES R. WOOD,

Individually and as Class Representatives of a

Class Consisting of All Present and

Certain Former Domino’s Franchisees in the

United States INTERNATIONAL FRANCHISE

App. 47

Brad L. Walker; JRW Pizza, Inc.;

James R. Wood; and International

Franchise Advisory Council, Inc.,

Appellants

(D.C. Civ. No. 95-cv-03777)

SUR PETITION FOR REHEARING

Present: SLOVITER, Chief Judge,

BECKER, STAPLETON, MANSMANN, GREENBERG,

SCIRICA, COWEN, NYGAARD, ALITO,

ROTH, LEWIS, McKEE and LAY,* Circuit Judges

ORDER

The petition for rehearing filed by appellants in the

above-entitled case having been submitted to the judges

who participated in the decision of this Court and to all

the other available circuit judges of the circuit in regular

active service, and no judge who concurred in the deci-

sion having asked for rehearing, and a majority of the

circuit judges of the circuit in regular service not having

voted for rehearing, the petition for rehearing by the

panel and the Court in banc, is denied. Chief Judge

* The Honorable Donald P. Lay. United States Circuit Judge

for the Eighth Judicial Circuit, who sat by designation, as to

panel rehearing only.

App. 48

Sloviter and Judges Becker, Mansmann, Nygaard and

Roth would grant rehearing.

BY THE COURT,

/s/ Anthony J. Scirica

Circuit Judge

Dated: October 27, 1997

BECKER, Circuit Judge, Statement Sur Denial of the Petition

for Rehearing.

The majority opinion’s interpretation of the Supreme

Court’s decision in Eastman Kodak Co. v. Image Technical

Servs., Inc., 504 U.S. 451 (1992) has serious consequences

for our future examination of franchisor/franchisee rela-

tionships in the context of the antitrust laws. The majority

states that

Kodak does not hold that the existence of infor-

mation and switching costs alone, such as those

faced by the Domino’s franchisees, renders an

otherwise invalid relevant market valid.

Queen City Pizza, Inc., et al. v. Domino's Pizza, Inc., No.

96-1638. Slip op. at 16. Instead the majority believes that

the ratio decidendi of the Kodak case is that the aftermarket

commodity or service alleged to constitute a single brand

market must be unique. Slip op. at 15-16. When this view

is combined with the majority’s further holding that

uniqueness must come from the nature of the product,

not the franchise agreement, slip op. at 13-14, the result is

that the franchisor/franchisee relationship is rendered

virtually immune from antitrust scrutiny.

App. 49

Judge Lay’s splendid dissenting opinion fully

exposes the flaws in the majority’s relevant product mar-

ket analysis, and I need not labor the point. I do, how-

ever, write separately to elucidate a concern about the

majority’s approach to antitrust policy in the franchising

area that Judge Lay discusses only briefly, slip op. at

34-35, but which also strongly counsels that this case be

heard en banc.

I have long believed that “The way you come out in

[a] case depends on how you go in.” See Larry Muko, Inc.

v. Southwestern Pa. Bldg. & Constr. Trades Council, 609 F.2d

1368, 1377 (3d Cir. 1979) (Aldisert, J., dissenting). The

majority’s holdings stem, I believe, from how it has gone

into the case, i.e. from the fact that the majority has

bought into the oft-heard paeans of praise for franchis-

ing:

Franchising is a bedrock of the American econ-

omy. More than one third of all dollars spent in

retailing transactions in the United States are

paid to franchise outlets. We do not believe the

antitrust laws were designed to erect a serious

barrier to this form of business organization.

Queen City Pizza, Inc., et al. v. Domino's Pizza, Inc., No.

96-1638. Slip op. at 18. It also has endorsed the question-

able theory that the kind of tying arrangements involved

here “are an essential and important aspect of the fran-

chise form of business organization.” Id. But these theo-

ries are also flawed.

I believe that the approach endorsed by the majority

might have been acceptable two decades ago, see Ungar v.

Dunkin’ Donuts, 531 F.2d 1211 (3d Cir. 1976), when fran-

chising was in its nascent, or at least its growing stage.

App. 50

But now the food franchisors are leviathans, and I am

underwhelmed by the suggestion that they may be per-

mitted with impunity to perpetuate the type of arrange-

ments pled in the complaint. These arrangements are

clearly quite onerous to the average franchisee, a rela-

tively small business person whose sunk costs in the

franchise represent all or most of his or her assets and

who lack the considerable resources necessary to switch

or defranchise. Moreover, the amount of commerce that

the franchisors are foreclosing in the tied product market

- for the pizza sauce, flour and other supplies (for which

non-franchisor dominated suppliers, be they individual

firms or a franchise cooperative, could easily meet quality

control specifications) is enormous.

Additionally, to the extent that the plaintiffs have

alleged coercion in connection with their acceptance of a

burdensome tie, a Rule 12(b)(6) dismissal would be

inconsistent with Ungar. Indeed, even if the majority's

legal position is correct, it can only be sustained if it were

an affirmance of a summary judgment on a full record,

which is how the opinion seems to read. It can not stand

under its actual procedural status - review of a Rule

12(b)(6) dismissal.

For all the foregoing reasons, I dissent from the

denial of rehearing en banc.

A True Copy:

Teste:

Clerk of the United States Court of Appeais

for the Third Circuit

App. 51

IN THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

QUEEN CITY PIZZA, INC., et al., :

Plaintiffs,

v. : No. 95-CV-3777

DOMINO’S PIZZA, INC.,

Defendant.

MEMORANDUM AND ORDER

(Filed April 30, 1996)

Joyner, J.

The plaintiffs in this antitrust action are eleven

owners and operators of Domino’s Pizza franchises

located in Delaware, Florida, Illinois, Minnesota, Missis-

sippi, New Hampshire, North Carolina, Pennsylvania and

South Carolina, as well as International Franchise Advi-

sory Council, Inc. (“IFAC”), a Michigan corporation

whose members include approximately 40% of the Dom-

ino’s Pizza franchisees located in the United States. IFAC

brings this suit on its own behalf and on behalf of its

member franchisees. On September 25, 1995, Plaintiffs

filed an amended complaint against Domino’s Pizza, Inc.

(“DPI”), also a Michigan corporation, seeking (1) declara-

tory, injunctive and compensatory relief under §§ 1 and 2

of the Sherman Act, 15 U.S.C. §§ 1 and 2; and (2) damages

for DPI’s alleged breach of contract, breach of the implied

covenant of good faith and fair dealing, and tortious

interference with contractual relations. DPI has since filed

the instant motion for summary judgment as to the claims

App. 52

brought by IFAC in both its individual and representative

capacities on the grounds that IFAC lacks standing. More-

over, DPI contends that the breach of contract, breach of

covenant of fair dealing, and antitrust claims should be

dismissed for failure to state a claim on which relief can

be granted. We conclude that the facts set forth in the

amended complaint do not give rise to causes of action

cognizable under the federal antitrust laws. Accordingly,

we will dismiss the anti-trust claims pursuant to Fed. R.

Civ. P. 12(b)(6) and dismiss the remaining claims in accor-

dance with Rule 12(b)(1).

FACTUAL BACKGROUND

The facts giving rise to this action, as recited in the

amended complaint, are as follows. The Domino’s pizza

business is comprised of a network of stores that sell

pizza and other food products largely on a take-out or

delivery basis. The Domino’s network consists of approx-

imately 700 stores owned and operated by DPI and 3,500

stores owned and operated by Domino’s franchisees. In

order to acquire a Domino’s franchise, a franchisee must

enter into a franchise agreement! with DPI, pursuant to

which the franchisee is entitled to market food products

under DPI’s business format and trade and service marks

in exchange for franchise fees and royalties. The franchise

1 Plaintiffs state that while the terms of the franchise

agreement have varied over the years, the material provisions of

the franchise agreements at issue here are substantially the

same for each of the franchisee plaintiffs. Thus, Plaintiffs refer

in their complaint amended to a “Standard Franchise

Agreement.”

App. 53

agreement is crafted so as to maintain uniformity and

consistency of quality throughout the network. Fran-

chisees must therefore purchase ingredients, materials,

and supplies from either DPI or a DPI-approved supplier.

The relevant provision of the franchise agreement reads

as follows:

12.2 Pizza Ingredients, Supplies and Materials.

All pizza ingredients, beverage products, cook-

ing materials, containers, packaging materials,

other paper and plastic products, utensils, uni-

forms, menus, forms, cleaning and sanitation

materials and other supplies and materials used

in the operation of the Store must conform to

the specifications established by us [DPI] from

time to time. You [franchisee] must use in the

operation of the Store boxes, containers and

other paper products imprinted with the Marks

as prescribed from time to time by us. We may

in our sole discretion require that ingredients,

supplies and materials used in the preparation,

packaging, and delivery of pizza be purchased

exclusively from us or from approved suppliers

or distributors. Any ingredient, supply or mate-

rial not previously approved by us as conform-

ing to our specifications and quality standards

must be submitted for examination and/or test-

ing prior to use. We reserve the right from time

to time to examine the facilities of any approved

supplier or distributor, including the commiss-

ary, if any, operated by you, and to conduct

reasonable testing and inspection of ingredients,

materials or supplies to determine whether they

meet our standards and specifications. We also

reserve the right to charge fees for testing and

evaluating proposed suppliers or distributors

and examining or inspecting operations and to

App. 54

impose reasonable limitations on the number of

approved suppliers of any product. Approval of

a supplier or distributor may be conditioned on

requirements relating to frequency of delivery,

standards of service including prompt attention

to complaints and the ability to service and sup-

ply stores within areas designated by us.

Moreover, DPI is required “to exercise reasonable judg-

ment with respect to all determinations to be made by us

under the terms of [the franchise agreement].” Franchise

Agreement § 22.9.

The franchisees purchase the great majority of the

required ingredients and supplies from Domino’s Pizza

Distribution Division (“DPDD”), formerly a subsidiary

and now a division of DPI. The nub of the amended

complaint is that DPI employs the above-quoted fran-

chise agreement provisions unreasonably, so that fran-

chisees are effectively precluded from purchasing

ingredients and supplies in a competitive market. For

example, Plaintiffs contend that when they initiated

efforts to produce fresh pizza dough at the store level,

DPI arbitrarily increased the processing fees and altered

the standards and inspection practices so as to eliminate

any savings the franchisees may have realized, in an

effort to protect DPDD from competition. Moreover, the

franchisees producing fresh dough in approved commiss-

aries were prohibited by DPI from selling the dough to

other franchisees, even though the dough-producing

franchisees could deliver the dough to other franchisees

at a cost 25% to 40% less than DPDD’s price.

In 1993, IFAC began to pursue alternative means of

acquiring ingredients and supplies at more competitive

App. 55

prices for its member franchisees. To that end, IFAC

entered into a purchasing affiliation agreement (“pur-

chasing agreement”) with FoodService Purchasing Coop-

erative, Inc. (“FPC”) on June 15, 1994. Pursuant to the

purchasing agreement, FPC was appointed to act as pur-

chasing agent for the IFAC-member franchisees and to

develop a cooperative purchasing plan for franchisees

seeking to purchase ingredients and supplies from a

source other than DPDD. Plaintiffs contend that once DPI

became aware of IFAC’s efforts, it initiated a campaign to

prevent FPC from establishing a cooperative purchasing

program that would compete with DPDD. Thus, when

IFAC and FPC requested that DPI provide specifications

so that FPC could solicit bids from potential suppliers,

DPI eventually issued specifications so vague that sup-

pliers could not furnish FPC with meaningful price quo-

tations. Further, Plaintiffs assert that in response to IFAC

and FPC’s efforts, DPI entered into exclusive dealing

arrangements with a broad base of Domino’s franchisees

for the purpose of denying FPC a pool of purchasers

sufficiently large to make the alternative purchasing

effort feasible.

Plaintiffs allege that DPI has engaged in other anti-

competitive conduct for the purpose of shielding DPDD

from competition. DPI’s alleged activity includes: (1)

entering into an exclusive dealing arrangement with the

only approved supplier of deep-dish pizza crusts, thereby

effectively preventing FPC from arranging for the pur-

chase of this ingredient from an alternative source; (2)

effectively denying FPC access to approved pizza sauce

suppliers and refusing to consider approving a low-cost

alternative supplier for many months, even though the

App. 56

alternative supplier’s product met DPI’s standards for

quality; and (3) commencing a “predatory pricing” effort,

whereby DPI lowered prices on most ingredients and

supplies to a level competitive with the prices FPC was

expected to offer, while raising prices on fresh dough, an

ingredient over which DPI maintained almost exclusive

control, and tying the purchase of fresh dough to the

purchase of other ingredients and supplies.

Finally, Plaintiffs contend that when it solicited them

to become Domino's franchisees, DPI represented that

DPDD was but one of a number of approved suppliers

and that the terms of the franchise agreement would

provide for a competitive purchasing environment. They

claim that DPI reneged on this promise in the manner

described above, forcing them to pay an additional $3,000

to $10,000 per store annually for ingredients and sup-

plies. Moreover, Plaintiffs allege that they are effectively

“locked in” to the franchises in view of their investments,

and since DPI must approve any sale of a franchise and

applies an unreasonably restrictive approval policy. Thus,

any franchisee desiring to switch its investment to an

alternative franchise system is likely to incur a significant

financial loss.

ANALYSIS

A. The Antitrust Claims

As noted above, Plaintiffs seek injunctive relief and

treble damages as a result of DPI’s alleged violation of

§§ 1 and 2 of the Sherman Act. In Count One, Plaintiffs

contend that the facts set forth in the amended complaint

constitute an unreasonable restraint on trade and a tying

App. 57

arrangement that is per se unlawful under § 1. Plaintiffs

allege in Count Two that DPI has unlawfully monopo-

lized the relevant market in violation of § 2. DPI contends

that the antitrust claims should be dismissed pursuant to

Rule 12(b)(6). Specifically, DPI argues that the amended

complaint must be dismissed in light of Plaintiffs’ failure

to allege a relevant product market, and that to the extent

Plaintiffs contend that the relevant market is the market

for ingredients and supplies among Domino’s fran-

chisees, such a market definition must be rejected as a

matter of law. We turn now to evaluate these arguments.

1. Standard of Review

We first address DPI’s argument that the antitrust

claims should be dismissed on the grounds that Piaintiffs

have failed to allege a relevant market. DPI has thus

challenged the legal sufficiency of Plaintiffs’ antitrust

claim. Accordingly, we must examine whether Plaintiffs

have set forth facts which state a claim as a matter of law.

Taha v. I.N.S., 828 F. Supp. 362, 364 (E.D. Pa. 1993). In so

doing, the court must accept as true all of the factual

averments in the complaint and extend to the plaintiff the

benefit of every favorable inference that can be drawn

from those allegations. Schrob v. Catterson, 948 F.2d 1402,

1405 (3d Cir. 1991); Markowitz v. Northeast Lane Co., 906

F.2d 100, 103 (3d Cir. 1990). Thus, a complaint is properly

dismissed only if it appears certain that the plaintiff

cannot prove any set of facts in support of his claim

which would entitle him to relief. Ransom v. Marrazzo, 848

F.2d 398, 401 (3d Cir. 1988).

App. 58

2. Relevant Market

As stated above, Plaintiffs allege that DPI’s conduct

amounts to both an unreasonable restraint of trade and

an unlawful tying arrangement under § 1. Section 1 pro-

vides that “[e]very contract, combination in the form of

trust or otherwise, or conspiracy, in restraint of trade or

commerce among the several States, or with foreign

nations, is declared to be illegal.” 15 U.S.C. § 1. A vertical

non-price restraint, such as the one at issue in the instant

case, is governed by the rule of reason, which requires an

examination of whether the restraint had an anti-competi-

tive effect in the relevant market. Muenster Butane, Inc. v.

Stewart Co., 651 F.2d 292, 295 (5th Cir. 1981) (citing Conti-

nental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 58-59

(1977)).

A plaintiff contending that defendant employed an

unlawful tying arrangement must likewise identify the

relevant market. A tying arrangement is an agreement by

one party to sell a product (the tying product) to a buyer,

but only on the condition that the buyer also purchase

from the seller a different product (the tied product).

Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S.

451, 461 (1992); Advo, Inc. v. Philadelphia Newspapers, Inc.,

854 F. Supp. 367, 377 (E.D. Pa. 1994), aff'd, 51 F.3d 1191

(3d Cir. 1995). The “essential characteristic” of a tying

arrangement violative of § 1 “lies in the seller’s exploita-

tion of its control over the tying product to force the

buyer into the purchase of a tied product that the buyer

either did not want at all, or might have preferred to

purchase elsewhere on different terms.” Jefferson Parish

Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 12 (1984). Thus, there

cen be no Sherman Act violation in the absence of the

App. 59

seller’s ability to “force” the buyer to act in a manner

different from the way he would behave in a competitive

market. Id. at 13-14. This ability is termed “market

power” in the tying market — the ability of the seller to

raise price and restrict output. Kodak, 504 U.S at 464.

Plaintiffs further contend that DPI is liable under § 2

for its monopolization or attempted monopolization of

the relevant market. Section 2 sanetions those “who shall

monopolize, or attempt to monopolize, or combine or

conspire with any other person or persons, to monopolize

any part of the trade or commerce among the several

States, or with foreign nations.” 15 U.S.C. § 2. In order to

sustain a claim for monopolization, a plaintiff must show

that the defendant (1) possessed monopoly power in the

relevant product and geographic markets; and (2)

acquired and maintained that power wilfully, as distin-

guished from having developed its business as a result of

a superior product, business acumen, or historic accident.

Borough of Lansdale v. Philadelphia Elec. Co., 692 F.2d 307,

311i (1982) (citing United States v. Grinnel Corp., 384 U.S.

563, 570-71 (1966)). As for attempted monopolization, a

plaintiff must show (1) that defendant has engaged in

predatory or anti-competitive conduct with (2) a specific

intent to monopolize and (3) a dangerous probability of

achieving monopoly power, an inquiry requiring an

examination of the relevant market and the defendant's

ability to affect competition in that market. Spectrum

Sports, Inc. v. McQuillan, 506 U.S. 447, 456 (1993). Monop-

oly power, like market power in the § 1 context, is gener-

ally defined as the ability to control price and exclude

competition within the relevant product and geographic

markets, and is usually determined by examining the

App. 60

extent of the alleged monopolist’s market share. Pennsyl-

vania Dental Ass'n v. Medical Serv. Ass'n of Pennsylvania,

745 F.2d 248, 260 (3d Cir. 1984), cert. denied, 471 U.S. 1016

(1985); Lansdale, 692 F.2d at 313.

Thus, in order to state a Sherman Act claim under

either § 1 or § 2, a plaintiff must identify the relevant

product and geographic markets and allege that the

defendant exercises market power within those markets.

Brader v. Allegheny General Hosp., 64 F.3d 869, 877 (3d Cir.

1995); Tunis Bros. Co., Inc. v. Ford Motor Co., 952 F.2d 715,

726 (3d Cir. 1991), cert. denied, 505 U.S. 1221 (1992).2 The

relevant product market is defined as “those ‘commodi-

ties reasonably interchangeable by consumers for the

same purposes.’” Tunis Bros., 952 F.2d at 722 (quoting

United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377,

395 (1956)). In determining the relevant product market,

the court examines the cross-elasticity of demand; that is,

the court considers, in light of the product’s characteris-

tics and price, the extent to which a rise in price of the

product creates a rise in demand for like products in that

market. Id. The relevant geographic market consists of the

area in which customers would look to purchase the

product. Id. at 726.

2 This is not to say that the degree of the defendant's

dominance of the relevant market that would trigger liability

under § 1 would necessarily raise a § 2 claim. The Supreme

Court has long held that “[mJonopoly power under § 2 requires,

of course, something greater than market power under § 1.”

Kodak, 504 U.S. at 481 (citing Fortner Enterprises, Inc. v. United

States Steel Corp., 394 U.S. 495, 502 (1969)).

App. 61

While they do not explicitly identify the relevant

product and geographic markets in their amended com-

plaint, it is clear from the context, and confirmed in their

memorandum in opposition to the instant motion, that

Plaintiffs consider the relevant product market to be the

market for ingredients and supplies among Domino’s

franchisees. Further, Plaintiffs argue that the franchisees

are “consumers” for purposes of this litigation, and that

the relevant geographic market encompasses the entire

nation. Thus, in support of its tying claim, for example,

Plaintiffs assert that DPI enjoys monopoly power over

pizza dough, and uses it both to exclude other potential

sellers from the market and to charge super-competitive

prices for other ingredients and supplies. Moreover,

Plaintiffs allege that DPI possesses monopoly power in

the market comprised of Domino’s franchisees, and that

it improperly uses that power to exclude DPDD’s poten-

tial competitors from the market.

For its part, DPI contends that as a matter of law, a

relevant market cannot arise from a franchise agreement.

Thus, this case presents the issue of whether the antitrust

laws are implicated where a franchisor dominates a “mar-

ket” created by virtue of franchise agreements. In the

past, courts have concluded that an illegal tying arrange-

ment can arise in the franchise context where franchisees

are compelled to purchase equipment or other tied prod-

ucts from the franchisor in order to obtain the franchise.

Photovest Corp. v. Fotomat Corp., 606 F.2d 704, 722 (7th Cir.

1979), cert. denied, 445 U.S. 917 (1980); Northern v.

McGraw-Edison Co., 542 F.2d 1336, 1345 (8th Cir. 1976),

cert. denied, 429 U.S. 1097 (1977); Siegel v. Chicken Delight,

448 F.2d 43, 49 (9th Cir. 1971), cert. denied, 405 U.S. 955

App. 62

(1972). In these cases, the courts concluded that the

defendants possessed market power as a result of the

unique nature of the franchise’s trademark, a basis for

market power that has since been discredited. See Mozart

Co. v. Mercedes-Benz of N. Am., Inc., 833 F.2d 1342, 1346

(9th Cir. 1987), cert. denied, 488 U.S. 870 (1988) (“[W]hile

many individual purchasers of automobiles undoubtedly

regard a Mercedes as unique, it is by no means clear that

franchisees (dealers) view the Mercedes in the same man-

ner. To them it is an article that is purchased at wholesale

and sold at retail.”). Still, these cases illustrate the key

distinction to be drawn in defining market power in the

franchise context: that between a franchisor’s pre-

contractual market power versus the post-contractual

economic power it possesses under the contract. Two

influential commentators describe the distinction as fol-

lows:

The important economic distinction that must be

made is between pre- and postcontract eco-

nomic power. Precontract, competition among

franchisors (such as McDonald’s or Kentucky

Fried Chicken) to sign up franchisees prevents

{a single franchisor] from exercising any eco-

nomic power in setting contract terms with

potential franchisees. [The franchisor], although

it possesses a trademark, does not possess any

economic power in the market in which it oper-

ates — the fast food franchising (or perhaps,

more generally, the franchising) market.

Postcontract, on the other hand, a franchisor

can use the threat of termination to “hold up” a

franchisee that has made a specific investment

in the marketing arrangement. However, this

potential economic power has nothing to do with

App. 63

market power, ultimate consumers’ welfare, or anti-

trust.

Benjamin Klein & Lester F. Saft, The Law and Economics of

Franchise Tying Contracts, 28 J. Law & Econ. 345, 356

(1985) (emphasis added). Thus, market power in the pre-

contractual setting derives not from the trademark or

from the franchisor’s power to award a franchise, but

instead focuses on the product, and is defined by the

extent to which the franchisor is able to force a potential

franchisee to purchase a tied product rather than acquire

a franchise to sell a competing brand. Mozart, 833 F.2d at

1346.

As we noted above, Plaintiffs here do not allege that

DPI enjoyed market power in the fast food franchise

business such that it could force potential franchisees to

purchase a tied product. Instead, they contend that DPI

has employed its contractual power to coerce existing

franchisees to purchase ingredients and supplies from

DPDD. Accordingly, they assert that the relevant market

is the market for ingredients and supplies among Dom-

ino’s franchisees. The court in Tominaga v. Shepherd, 682 F.

Supp. 1489 (C.D. Cal. 1988), rejected just such an attempt

to define the relevant market in the post-contractual con-

text when presented with facts similar to the ones at issue

here:

Plaintiff’s implicit argument is that the relevant

market is the “Pizza Man” franchising market.

This market definition is erroneous as a matter

of law. No reasonable argument can be made

that Pizza Man possesses the power to coerce

potential franchisees to purchase the tied prod-

uct rather than sell a different brand of fast food

App. 64

(the tying product). The analysis must take

place at the “pre-contract” stage. Klein & Saft,

supra, at 356. Plaintiff, however, engages in

“post-contract” analys

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