By Dr. Gary L. Deel, Ph.D., J.D.
Associate Professor, Dr. Wallace E. Boston School of Business
The Sherman Anti-Trust Act of 1890 is one of our nation’s oldest federal laws aimed at restricting monopolistic business practices and protecting free and fair competition in the marketplace. Since its enactment, the Act has been leveraged countless times to challenge different business arrangements and tactics in different industries all around the country. But one industry which sees a particularly heavy amount of scrutiny over monopolistic activity is entertainment.
Businesses are generally free to innovate and use fair competitive strategies to try to gain an upper hand in the marketplace. However, what competitor businesses cannot do is collaborate or collude in a way that unfairly or unreasonably restricts competition and trade. Enter United States v. Capitol Services, Inc., a 1985 federal appeals court case that shone a spotlight on movie theater collusion for movie exhibition rights acquisition.
Studio Bidding System
The traditional means through which movie theaters would acquire the rights to show a new movie was through a bidding system hosted by the studios that produced the films in question. A studio would send out a brief description of a new film to be released, and then theaters in a given area would all have an opportunity to bid on the rights to show the film.
Generally, the exhibition rights would be awarded to the highest bidder or bidders; the rights were not necessarily exclusive, meaning that a studio could award rights to as many theaters in an area as they like. This system generally resulted in bidding wars between theaters – which of course increased costs to the theaters for rights acquisition.
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Movie Theater Split Agreements
Capitol Services, Inc. was a movie theater operator in the Milwaukee, Wisconsin area. Capitol and several of its competitors in the region – all of whom are named as additional defendants in this case – decided to collaborate on an arrangement that would reduce the costs of purchasing rights to new films for all theaters involved. The theater operators entered a “split agreement,” which essentially involved the following understanding:
- The theaters would take turns selecting which films they wanted to exhibit as they were released on a rotating basis, so that only one theater in any given geographical area of Milwaukee would show a particular film at any given time.
- When the exhibition rights to a new film selected by a particular theater were up for bidding, the other theaters would sit out of the bidding process, meaning only the one theater that selected the film would submit a bid.
Split agreements were explicitly designed to eliminate the competition between theaters that spiked rights acquisition prices. And because film production studios only ever had one bid for each film released in the different regions of Milwaukee (i.e., from the movie theater that selected it), the studios did not have the benefit of free market competition that would have otherwise allowed them a choice among options.
This meant that the theater which selected a particular film could essentially “lowball” the studios in question with minimal bids. And the studios would have no choice but to accept; the only other alternative would be to go without a release of the particular film to the Milwaukee market altogether, which of course would make no financial sense at all.
The arrangement also had a competition-choking effect on the other end of the supply chain as well – moviegoers. Because one and only one theater would ever be showing a particular film in a particular area of Milwaukee, this meant the theater showing a film would enjoy 100% of the market share and could charge premium prices to the consumers for movie tickets. After all, there was nowhere else these patrons could otherwise go, unless they were willing to travel great distances to find another theater showing the film.
Split Agreements Were Deemed Illegal
For these reasons, split agreements substantially reduced rights acquisition costs for the theaters and substantially increased revenues from tickets sold. However, the collusion between them to stifle competition was also a per se violation of the Sherman Act – and as such the United States District Court enjoined the activity.
In doing so, the court recognized that Capitol Services and some of the other defendants were nationwide theater operators, and that they had formed similar arrangements all around the country in different market regions for similar purposes. As such, the Court went a step further and enjoined all split agreements as per se violations as well.
The movie theaters appealed the decision – not on the merits of the reasoning as applied to Milwaukee – but only on the specific issue of the blanket prohibition of split agreements across the entire country. Their lawyers argued that each split agreement entailed different arrangements – and as such a judicial order that enjoined them en masse without first examining each one was improper and an overreach of authority.
The Seventh Circuit Court of Appeals did not agree. The judges opined that, while each one might differ slightly in logistical details, all shared the common general purpose of restricting market competition – and therefore all were per se violations of federal law.
The court noted: “Having found appellants guilty of conduct which was illegal per se under Section 1, it was not an abuse of discretion for the District Court to enjoin appellants from engaging in such conduct anywhere in the United States. Geographical limitations regarding the issues at trial do not alter the court’s broad remedial powers. Appellants have conducted their businesses in a manner forbidden by law. The District Court has large discretion in redressing antitrust violations and in fitting the decree to the special needs of the individual cases.”
So, the lesson to be learned in the Capitol Services case is that competitive innovation is generally fine and even encouraged in the marketplace. However, collusion between competitors that unreasonably restrains or eliminates competition is explicitly prohibited by federal anti-trust law. Businesses should take care to ensure that any cooperation or collaboration between competitors does not cross this bright red line.
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