Knoch, Senior Circuit Judge, and Kiley and Kerner, Circuit Judges. Kiley, Circuit Judge, dissenting.
The Federal Trade Commission issued a complaint on June 25, 1962, against Columbia Broadcasting System, Inc. (CBS) charging CBS and its subsidiary, Columbia Record Club, Inc. (Club) with violation of Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45.*fn1 Hearings were held and the hearing examiner entered an order on September 30, 1964, dismissing the complaint. On July 25, 1967, the Commission, Commissioner Elman not concurring, reversed the examiner's findings and from this decision CBS appeals.
Columbia Broadcasting System, Inc., is a corporation organized under the laws of New York with its principal place of business in New York City. One of its operating divisions, Columbia Records (Columbia), manufactures and sells phonographic records. In 1961 this division produced 20% of CBS' total sales.
Total sales in the record industry were $521 million in 1960. Columbia Records, the leading producer and seller accounted for 21% of the industry's total sales. The "Big Three" record manufacturers, Columbia, R.C.A. and Capitol, produced 48% of total sales. Most of the records sold are LPs (long playing) and singles: in 1961 the breakdown in dollar volume was LPs, 75%; singles, 24%; and EPs (extended play) 1%. Columbia's share of LP sales was 25.4% while the Big Three together, shared 56.5% of the LP market.
Columbia has two main channels of record distribution: (1) the records are sold to distributors, either Columbia owned or independent, who sell them to subdistributors and independent retailers; or (2) the records are sold directly by the Columbia Record Club to the consumer through the use of a "subscription" form of mail order business. In 1961 and 1962, Club sales were 50% of Columbia's total record dollar sales.
Columbia entered the mail order subscription sale of records by forming the Columbia Record Club in 1955 in response to a threat of competition from other companies. The Club's method of mail order sale was to induce the consumer to join the Club and agree to purchase a minimum number of records during the year by offering a certain number of records at below cost prices. For example, in 1963, the Club's offer consisted of six records for an aggregate price of $1.89 plus 55 cents postage provided the new member agreed to buy another six records in the next twelve months at the list price of $3.98 each plus 35 cents postage per record. In the second year of membership, for every two records a member purchased, he received one free. The first year the member paid an average of $2.37 per record and in the second year the average price was $2.88 per record.
From 1955-58, the Club only sold Columbia records. However, in 1958, the Club decided to sell records of competitors. To acquire a more diversified catalog, the Club entered into licensing agreements with some of the small record manufacturers.*fn2 The agreements had a duration of from one to three years with options to renew. Columbia guaranteed the sale of a certain number of records in return for an agreement by the licensor not to sell any of its catalog to another club. The licensor could still sell to wholesalers who could in turn sell to other clubs or retailers.
The licensing agreements also provided that the licensors should make every effort to reduce royalties paid to artists on records sold through the Club. Columbia's practice was to pay an artist only 50% of his royalty on records sold by the Club and no royalty on free bonus records offered by the Club. The licensing agreements contained a provision requiring the licensor to follow the same policy wherever it was practicable. In certain contracts Columbia only agreed to be liable for royalties paid at these reduced rates and any royalty paid by the licensor above these rates was to be absorbed by the licensor.
In 1960, Columbia's share of record club sales was 56% while the Big Three together accounted for 90.6% of total sales through clubs. Columbia Club was the only club offering outside labels to its members. In 1961, Columbia's licensors accounted for 11% of total record sales. Of the 150 largest selling monaural LPs on March 24, 1962, 103 of these records were on Columbia, Columbia licensors, R.C.A. or Capitol labels. Columbia and its licensors, alone, accounted for 65 of the "hits" or 43.3%, while the licensors themselves had 33 of the records on the listing or 22%.
The total acquisition cost to the club of a record produced under a licensing agreement was 87.5 cents. The Club's cost of marketing these records is $1.255 and when added to the acquisition cost, the total cost is $2.13.*fn3 The acquisition cost to a competitor, either retailer or club, ranges from $1.60 to $2.47 for the same record. The average cost to Columbia retailers was $2.12 in 1961. The competitors' additional operating cost would raise their total cost above $2.13. In 1961, 30% of the records sold by the Club were produced under these licensing agreements.
While the number of companies that have entered the business of manufacturing records has grown substantially during the 1950s and early 1960s, the number of entries into the club market has been small. According to the evidence presented to the Commission, aside from the entry of R.C.A. and Capitol after 1955, there have been no significant entries into the club business. However, after the examiner closed the hearings, Record Club of America, Longine, Dot and Starday have all entered the club business with the Record Club of America claiming to be the second largest club in the industry.*fn4
The Commission, in reversing the hearing examiner, found that the exclusive licensing agreements violated Section 5 of the Federal Trade Commission Act in that the exclusive provision of the contract had the effect of barring new entrants into the record club market and that the artist royalty agreements constituted a form of price fixing which is also violative of Section 5. The Commission entered a cease and desist order prohibiting exclusive licensing agreements and agreements fixing artist royalty payments.
To determine whether the exclusive licensing provision is an unfair method of competition under Section 5 of the Federal Trade Commission Act, the relevant market within which to measure the effect on competition must be defined. The relevant product market is the area of effective competition. The area of effective competition depends on the degree of substitutability which may be measured by the cross-elasticity of demand. CBS argues that since all records are the same whether distributed through retail dealers or mail order sellers because artists record the same material on both LPs and singles, there is complete interchangeability and, therefore, the relevant market is the entire record market. However, the Supreme Court in United States v. Philadelphia National Bank, 374 U.S. 321, 356-57, 10 L. Ed. 2d 915, 83 S. Ct. 1715 (1963), found that commercial banking as compared to other forms of ...