- Abstract of the case
Dates: Reargued January 9,10,11,12, 1911; Decided: May 29, 1911.
The objective of the case was to ascertain whether the actions of the defendants amounted to a restraint on the ‘interstate commerce in tobacco’. Drawing precedence to a previous ruling against Standard Oil Co., the court was of the opinion that the company has violated the provisions of the Antitrust Act, 1890 on two grounds, by restraining interstate trade of tobacco and by monopolization of the tobacco business. The court reaffirmed that the actions of the American Tobacco Company was against the public interest as it involved ‘combinations’ that attempted to restrict competition. The court was of the opinion that the American Tobacco Company has violated both section 1 and section 2 of the antitrust act by forming a combination to restrict trade and monopolize the tobacco business. The stock owners, the corporations and foreign corporations involved, all come under the prohibitions of the Act. The combination, with all its constituents, were declared illegal and a lower court was given the responsibility of fixing the penalty and planning the method of dissolution.
- The Provisions of the Anti-trust Act that were violated:
The American Tobacco Company has violated Section 1and Section 2 of the Anti-trust Act. According to section 1 of the Act, any agreement, contract, combination or conspiracy aimed at restricting trade between states or with foreign nations, is illegal, a criminal offence and punishable by the law with a fine and/or imprisonment for maximum 10 years.
According to section 2 of the Anti-trust Act, any act of monopolization or an attempt to monopolization, any contract, agreement or combination or conspiracy to monopolize any part of trade or commerce between states or with foreign nations shall be considered a criminal offence punishable with a fine and/or imprisonment for maximum 10 years.
- The basis of the ruling
The American Tobacco Company was conceived as a trust in 1890. By 1909, the Trust included 86 different companies. It operated on a wide geographical domain including the United States, Cuba, Puerto Rico and 33 other locations. (Crandall, 2001). The products in which the company acquired dominance in included cigars, plug tobacco, smoking tobacco, snuffs and cigarettes. (Crandall, 2001; Crandall & Winston, 2004). The company had a 96.5% share in snuff production, 91.4% share in little cigars. The share in the other products was also considerably high in the range of 86 to 76 percent in 1910. The figure are shown in.
The Company significantly enhanced its market power by acquiring firms like the Union Tobacco Company and the Continental Tobacco Company. The increase in market power is evident from the fact that the Herfindahl Index (shown in table 2) for the cigarette industry was 0.207 before the merger which increased to 0.812 post merger in 1890. (Stigler, 1966).
The sales of this company immensely increased from 2.5 billion cigarettes in 1890 to 10 billion cigarettes in 1910. It received stiff competition from ‘Turkish’ brand of cigarettes in 1900s but recovered its sales to 85% in 1910. The return on tangible assets was also impressive at 54% in 1890 to 16% in 1899 to 35% in 1903. (Crandall, 2001).
The Company resorted to aggressive price cutting which acted as a successful barrier towards entry of other firms in the industry. The price was often below manufacturing costs. (Crandall & Winston, 2004). Obviously, it was an effective barrier to entry and established the firm’s monopoly power. Though, in the lawsuit stress was given to ‘combination’ or the acquisition rather than this aggressive price cutting behavior. Though monopolization was one clause in the lawsuit, it did not explicitly mention the pricing strategy followed.
- The anticompetitive conduct: The firm had taken recourse to price cutting. Though it initially benefited the consumers, but it resulted in monopolization of the market by the Company. It could effectively annex market power from its rivals like the ‘Turkish’ tobacco. Non-price anticompetitive behavior also existed. It increased its market power significantly, as already mentioned, by acquiring some other firms in the industry.
- As we have observed in the previous section, the firm faced stiff competition from ‘Turkish’ tobacco but regained its position by 1903 when it constituted 85% of the total industry production.
- In 1890s, a number of suits were filed against the American Tobacco Company, but the Company won the cases. But in 1904 a reorganization was forced upon the Tobacco Trust.
- No further legal action have been taken after the decree described in this paper.
- In this case, the American Tobacco Company assumed market power by employing dual strategies. In the first place, it was a trust that was a conglomerate of a number of firms and operated in a wide geographical area. Secondly, it acquired few other tobacco companies thereby increasing its market concentration. Finally, it resorted to aggressive pricing strategy that restricted other firms from entering the industry. These strategies established the monopoly power of the company. We have seen that in some products it had around 96% of the share in industry production. This resulted in a monopolistic market structure. The profits were high. Though in 1899 the profits fell due to stiff competition, but subsequent pricing strategy made the company regain its market power as well as profit.
The antitrust suit against the firm led to the formation of an oligopoly structure by dissolving the company and forming three firms. It was converted to a three firm oligopoly. With the change in structure, the firms now resorted to non-price competition like advertising and sales promotion.(Crandall & Winston, 2004). Prices, in fact, rose after the change in structure. The profits also increased for these firms. The change in structure from monopoly to oligopoly did not produce the desired results in terms of consumers’ welfare, but the profits of the firm increased and non-price competition strategy prevailed. So the change in structure resulted in price hike through non-price marketing strategies, by increasing market power, and thereby increasing the profit of the constituent firms. This particular case bears an evidence to the fact that the antitrust law has failed to have an impact upon the conduct and performance of the firms even though the structure of the market have been changed by the decree from monopoly to oligopoly.
References:
Crandall, R.W. (2001). The Failure of Structural Remedies in Sherman Act Monopolization Cases. AEI-Brookings Joint Center for Regulatory Studies. Working Paper 01-05, March 2001.
Crandall, R.W. & Winston, C. (2004). Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence. AEI-Brookings Joint Centre for Regulatory Studies. Related Publication, 04-07, April, 2004.
Stigler, G. J.(1966). The Economic Effects of the Antitrust Laws. Journal of law and Economics, 9(Oct., 1966) 225-258.
