Petition for Review of an order of the Federal Trade Commission entered May 17, 1979 Docket 9080 [93 F.T.C. 764]
Before Fairchild, Chief Judge, Bauer, Circuit Judge and Baker, District Judge.*fn*
The petitioner, Kaiser Aluminum & Chemical Corporation (Kaiser), seeks review of a cease and desist order issued in 1979 by the respondent, Federal Trade Commission (Commission). The order directs Kaiser to divest itself of all the assets, title, properties, interest, rights, and privileges which Kaiser obtained from a 1974 acquisition of the Lavino Division (Lavino) of International Minerals & Chemicals Corporation (IMC). We are asked to set aside that order.
The Commission based its order on conclusions that the acquisition of Lavino by Kaiser might substantially lessen competition in a national market and submarkets for basic refractories and, as a further result, would be an unfair method of competition. The Commission's ruling, therefore, finds a violation of § 7 of the Clayton Act, 15 U.S.C. § 18 (1976),*fn1 and a violation of § 5 of the Federal Trade Commission Act, 15 U.S.C. § 45 (1976).*fn2 The full report of the proceedings before the Commission appears at 93 F.T.C. 764 (1979).
Jurisdiction to review the Commission's order is given by 15 U.S.C. §§ 21(c) and 45(c).*fn3 Since the acquisition of Lavino was consummated at the headquarters of IMC in Illinois and since one of the refractory plants acquired was located in Gary, Indiana, jurisdiction is properly vested in this court.
Both Kaiser and the Commission agree that there are two issues presented for review. Those issues are:
I. Did the Commission properly define the relevant markets within which to measure the effect upon competition of Kaiser's acquisition of Lavino?
II. Did the Commission apply proper legal standards in concluding that, within the markets defined by the Commission, Kaiser's acquisition of Lavino might substantially lessen competition in violation of § 7 of the Clayton Act?
We conclude that the Commission did not define the relevant markets properly and that correct legal principles were not applied in reaching the determination that the effect of the acquisition might be substantially to lessen competition.
Prior to the 1974 acquisition, Kaiser and Lavino were separately engaged in the production of refractories. Refractories are materials that are specifically resistant to the action of heat and are used in the linings of industrial furnaces and kilns. Refractories are sold in shapes or forms such as bricks or may be sold as unformed material known as specialties. Refractories are further differentiated by the chemistry of their ingredients. They are basic (alkaline) or non-basic (acidic) and are intended to correspond with the chemical character of the process with which they will be in contact in order to prevent chemical union or interaction. Refractory linings are consumed over a period of time through wear.
The primary consumer of refractories in the United States is the steel industry. Other consumers include the copper, glass, and cement industries.
Prior to its acquisition, Lavino owned production plants in Plymouth Meeting, Pennsylvania; Gary, Indiana; and Newark, California. Lavino also owned raw material producing facilities a magnesia processing plant in Freeport, Texas and a chrome ore mine in South Africa. In the East and Midwest Lavino sold to major steel producers. In the West Lavino sold refractories to smaller copper, steel, and glass producers.
Lavino commenced business in 1887 under the name of E. J. Lavino & Co. as an importer of mineral ores for sale to the steel industry. During World War I Lavino began to manufacture refractories at its Plymouth Meeting plant. Lavino expanded its refractory manufacturing to plants in California, Indiana, and Texas during the decade 1950-1960. In 1966 the Lavino family sold the business to IMC for 26 million dollars, and the company became the Lavino Division of IMC, whose assets Kaiser acquired in 1974.
Lavino was regarded as a leader in the refractories business and had a reputation as an outstanding supplier of high quality products. Its product line, however, was limited, and Lavino concentrated on the production of refractories for use in the open-hearth method of steel production.
Until the 1960's most steel production was carried on in open-hearth furnaces. During the 1950's the basic oxygen furnace (BOF) was introduced in the steel industry as a more efficient means of steel production. The BOF consumed smaller amounts of refractories than the open-hearth furnace consumed in the production of a ton of steel, and, significantly, the BOF required its own refractories. Steelmakers could not substitute open-hearth refractories, such as those Lavino concentrated on producing, for BOF refractories.
Beginning in 1960 the open-hearth method of steel production began to decline, and the BOF began to replace the open-hearth. In 1960 BOF's produced 3 million tons of steel while open-hearth furnaces produced 86 million tons. In 1970 BOF's produced 77 million tons while open-hearth production fell to 20 million tons.
Lavino made only a half-hearted attempt to enter the BOF refractories market during the early 1960's. But after the company's acquisition by IMC, management pressed for expanded product lines to serve BOF's and electric arc furnaces. IMC increased Lavino's research and development budget, installed new production equipment, and began new marketing projects. These efforts did not meet with great success, however, and in 1970 a slump in the domestic steel industry triggered an IMC decision to leave the refractories business and dispose of Lavino. The Lavino Division embarked on a course of attrition. It deferred physical improvements, made deep cuts in expenditures, allowed its product quality to slip, closed its California plant (thereby abandoning its western market), closed its Texas magnesia plant and bought a long-term supply contract instead, and began to solicit buyers for the business. One firm, Didier-Werke of West Germany, seriously considered the purchase of Lavino but decided against it. In the fall of 1972 Kaiser began to consider the acquisition of portions of Lavino.
Kaiser is a manufacturer of aluminum and is a multinational conglomerate. Kaiser began producing refractories during World War II at three plants in California. Most of Kaiser's production went to Western open-hearth steel producers, but Kaiser also sold to cement and glass producers throughout the United States. In the 1950's Kaiser acquired refractories plants in Missouri, Ohio, Pennsylvania, and Maryland that served the glass, cement, copper, petroleum, and chemical industries. In 1956 Kaiser constructed a refractories plant in Ohio that served steelmakers.
Unlike Lavino, Kaiser had a diverse refractories line as well as the strong support of its management for further expansion into the refractories business. Kaiser had reached the limit of its capacity for production of refractories for steelmakers. Kaiser wanted to penetrate the eastern and midwestern steel industry with a new line of refractories it had developed, and it wanted greater capacity to produce refractories for sale outside the steel industry.
On February 28, 1974, for $17 million, Kaiser purchased Lavino's Plymouth Meeting and Gary plants, most of Lavino's research and development department, and Lavino's long-term supply contract for magnesia. On April 27, 1976, the Commission issued a complaint charging that the acquisition reduced competition between Kaiser and Lavino and in the refractories industry in general; that the acquisition significantly increased concentration in the refractories industry;*fn4 that the acquisition significantly increased the difficulty of entry into the refractories industry; and that the acquisition strengthened the position of Kaiser in that industry.
The Administrative Law Judge found against Kaiser on the issues raised by the complaint and recommended an order of divestiture. The Commission followed that recommendation and in an order of May 17, 1979, ordered divestiture. 93 F.T.C. 855 (1979).
I. The Commission's Market Definitions
Definition of relevant markets is necessary in order to measure the effect upon competition of Kaiser's acquisition of Lavino. The Commission and Kaiser agree that the relevant geographic market for refractories is the United States in its entirety. The market definition dispute in this case centers on the existence of appropriate product markets and submarkets.
The Commission defined an overall product market of basic refractories. That broad classification is founded on the chemical nature of the ingredients of the refractories that are basic, or alkaline, in nature and which are employed in manufacturing processes which are also basic. Steelmaking is a chemically basic process and almost exclusively uses basic refractories.
The overall market of basic refractories was further divided by the Commission into markets for basic bricks and basic specialties. Basic bricks are solid, formed shapes, and are employed in the construction of the floors, walls, and ceilings of industrial furnaces. Basic specialties, on the other hand, are unformed, viscous substances that are used to plaster basic bricks, to repair and protect them, and to extend their useful life. Basic specialties are also used as mortar in between basic bricks when a furnace lining is first constructed. Because basic specialties are used to complement bricks, basic bricks account for a larger share of basic refractories production and consumption than do basic specialties.
The Commission went on to divide the market for basic bricks into a submarket for BOF bricks, which are used in basic oxygen furnace steelmaking, and into a submarket for conventional basic bricks, which are used in open-hearth furnaces and in other industrial processes. The Commission reached its product market definitions by concluding from the evidence that there was substantial interchangeability of use in basic refractories and that, where interchange of use was not indicated, there was sufficient cross-elasticity of supply, or production flexibility, to support the markets defined.
The definition of relevant markets within which to measure the effects on competition of the proposed acquisition is a question of fact. As such, the Commission's findings as to relevant markets are to be accorded great deference and are to be upheld if supported by substantial evidence. 15 U.S.C. §§ 21(e) and 45(c) (1976). Columbia Broadcasting System, Inc. v. Federal Trade Comm'n, 414 F.2d 974, 979 (7th Cir. 1969). See also Beatrice Foods Co. v. Federal Trade Comm'n, 540 F.2d 303, 308 (7th Cir. 1976); Avnet, Inc. v. Federal Trade Comm'n, 511 F.2d 70, 77 (7th Cir. 1975); L. G. Balfour Co. v. Federal Trade Comm'n, 442 F.2d 1, 11 (7th Cir. 1971).
The Supreme Court has held that the concept of economic substitution is the primary means by which to define a product market. "The outer boundaries of a product market are determined by the interchangeability of use or the cross-elasticity of demand between the product itself and substitutes for it." Brown Shoe Co. v. United States, 370 U.S. 294, 325, 82 S. Ct. 1502, 1523, 8 L. Ed. 2d 510 (1962); see Sargent-Welch Scientific Co. v. Ventron Corp., 567 F.2d 701, 710 (7th Cir. 1977). The market need not be limited to products which are identical in nature. Instead, the test is loose and flexible, requiring only that the products be easily substituted in their end-use:
What is called for is an appraisal of the "cross-elasticity" of demand in the trade. (Citations omitted.) The varying circumstances of each case determine the result. In considering what is the relevant market for determining the control of price and competition, no more definite rule can be declared than that commodities reasonably interchangeable by consumers for the same purposes make up that "part of the trade or commerce," monopolization of which may be illegal.
United States v. E. I. du Pont de Nemours & Co., 351 U.S. 377, 394-95, 76 S. Ct. 994, 1006-07, 100 L. Ed. 1264 (1956).
Perhaps the clearest indication that products should be included in the same market is if they are actually used by consumers in a readily interchangeable manner. Id. at 399-400, 76 S. Ct. at 1009; Rosenthal, Continental Can Revisited: Limits Upon the Breadth of a Line of Commerce in a Section 7 Case, 14 Houston L.Rev. 973, 988-93 (1977). While interchangeability of use is a basis for a product market definition, the relevant market need not be extended to include all products that are reasonably interchangeable in their end-use. United States v. Continental Can Co., 378 U.S. 441, 457-58, 84 S. Ct. 1738, 1747, 12 L. Ed. 2d 953 (1964) (upholding definition of a product market composed of glass containers and metal cans but excluding other competing containers).
Cross-elasticity of supply, or production flexibility among sellers, is another relevant factor to be considered in defining a product market for antitrust purposes. Although economic theory would envisage defining a market solely on the basis of cross-elasticity of supply,*fn5 this court has so far adhered to the view that such possibility is not meaningful. Beatrice Foods Co. v. Federal Trade Comm'n, 540 F.2d 303, 307 (7th Cir. 1976); Sargent-Welch Scientific Co. v. Ventron Corp., 567 F.2d 701, 710 (7th Cir. 1977); Cass Student Advertising, Inc. v. National Education Advertising Service, Inc., 516 F.2d 1092, 1095 (7th Cir. 1975); L. G. Balfour Co. v. Federal Trade Comm'n, 442 F.2d 1, 11 (7th Cir. 1971). But cf. Twin City Sportservice, Inc. v. Charles O. Finley & Co., 512 F.2d 1264, 1271-74 (9th Cir. 1975); Telex Corp. v. International Business Machines Corp., 510 F.2d 894, 914-19 (10th Cir. 1975) (production flexibility alone was sufficient to support the definition of a product market).
The problems of market definition are not confined to the determination of an overall product market. Within a broad product market, "well-defined submarkets may exist which, in themselves, constitute product markets for antitrust purposes." Brown Shoe Co. v. United States, 370 U.S. 294, 325, 82 S. Ct. 1502, 1524, 8 L. Ed. 2d 510 (1962). Brown ...