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Maintaining competition in online advertising: the US FTC’s 1-800 Contacts decision

In an important case on the intersection of IP and antitrust, the US Federal Trade Commission (FTC) issued an Opinion on 7 November 2018 holding that 1-800 Contacts, the largest online retailer of contact lenses in the US, entered into a series of anti-competitive settlement agreements with its online rivals in violation of Section 5 of the FTC Act.  The decision provides useful insight into the mechanics of keyword search advertising and emphasises that such advertising is fundamental to competition between retailers in an e-commerce context.  The case also serves as a reminder – if any were needed – that companies cannot rely on IP settlements to immunise their conduct from competition law scrutiny.

Background
Internet search engines such as Google and Bing typically generate two types of results in response to search queries: ‘organic’ results and ‘sponsored’ links.  The latter are advertisements, which are often displayed above or beside the organic results. As the name suggests, advertisers have to pay to have their sponsored links appear on a search engine results page.  To determine which ads appear (and in which order), search engines use auctions to sell advertising positions.  Advertisers bid on ‘keywords’ – words or phrases that trigger the display of ads when they are deemed to match a user’s search.  Advertisers can also specify ‘negative’ keywords. For instance, a retailer of eye-glasses might bid on ‘glasses’ but list ‘wine’ as a negative keyword to prevent its ad from appearing in response to a query for wine glasses.

Between 2004 and 2013, 1-800 Contacts sent cease and desist letters alleging trade mark infringement to a number of its competitors whose online search advertising displayed in response to queries involving ‘1-800 Contacts’ and similar terms.  It subsequently filed suit against a number of these online retailers (even if the retailers had not been bidding on the keyword ‘1-800 Contacts’ but on more generic terms such as ‘contact lenses’).  Rather than litigating the trade mark disputes to conclusion, 1-800 Contacts settled with each of the competitors.  The settlement agreements prevented the competitors from bidding for search advertising involving ‘1-800 Contacts’ and similar terms. They also required the competitors to use negative keywords to prevent their ads appearing whenever a search included the ‘1-800 Contacts’ trade mark. The agreements were reciprocal: 1-800 Contacts agreed to the same bidding restrictions and negative keyword requirements in respect of its rivals’ trade marks.

The FTC’s decision
Anti-competitive restraints
The FTC held that the settlement agreements prevented online contact lens retailers from bidding for online search ads that would inform consumers about the availability of identical products at lower prices.  According to the FTC, the agreements:
  • harmed competition in bidding for search engine key words, artificially reducing the prices that 1-800 Contacts paid for search advertising, as well as reducing the quality of online ads delivered to consumers; and
  • resulted in price-conscious consumers paying more for contact lenses that they would have absent the restrictions. 
Whilst the FTC did not suggest that all advertising restrictions are necessarily anti-competitive, it emphasised that the restrictions in this case prevented the display of ads that would enable consumers to learn about alternative sellers of contact lenses and to make price comparisons at a time when they would be considering a purchase.  Significantly, the restrictions in the settlement agreements were not merely “limitations on the content of an advertisement a consumer would otherwise see”; they were restrictions on a “consumer’s opportunity to see a competitor’s ad in the first place”.  The restrictions were particularly harmful to retail price competition because the suppressed ads “often emphasise[d] lower prices”.

1-800 Contacts’ efficiency justifications
1-800 Contacts put forward two efficiency justifications for the restrictions: (i) avoidance of litigation costs though settlement and (ii) trade mark protection.  The FTC found that whilst these justifications were plausible, they were insufficient to outweigh the restrictions’ anti-competitive effects.  Further, the claimed pro-competitive benefits could have been achieved through less restrictive means.  In the agency’s analysis, “when an agreement limits truthful price advertising on the basis of trade mark protection, it must be narrowly tailored to protecting the asserted trade mark right”.  The settlement agreements in this case were not: they restricted advertising regardless of whether the ads were likely to cause consumer confusion (a key element of the test for trade mark infringement) and regardless of whether competitors actually used the trade mark term.

The FTC was also unconvinced by 1-800 Contacts’ argument that a trade mark settlement requiring non-use is immune from antitrust review because a prohibition on use is within a trade mark’s exclusionary potential.  Citing the US Supreme Court’s 2013 ruling in Actavis, the FTC emphasised the importance of considering “both antitrust and intellectual property policies”.  According to the agency, the “crux” of the Actavis decision was that there could be antitrust liability for settlement of litigation, regardless of whether the agreement’s anti-competitive effects fall within the scope of the exclusionary potential of the IP right in question.  1-800 Contacts’ argument “look[ed] only to half of the equation, i.e. trade mark policies, and did not withstand a thorough understanding of Actavis”.

Comment
The decision sends a clear signal that the FTC takes a dim view of agreements between competitors that restrict online search advertising to the detriment of consumers.  Whilst agreements to limit advertising are not per se illegal in the US, it seems that such agreements will likely fall foul of the antitrust rules unless the parties can establish robust pro-competitive justifications for the restrictions.  The FTC’s position is clear: online search advertising plays a crucial role in the effective functioning of retail competition in the modern internet economy.

Competition authorities on this side of the Atlantic have also shown an interest in the links between competition and online advertising in recent years. The European Commission’s Final Report in the E-Commerce Sector Inquiry of May 2017 noted that almost one in ten retailers were contractually restricted from advertising online.  Just under a year later, the French competition authority published a report on the functioning of the online advertising sector.  And in the German Asics case, the Bundeskartellamt found that the sports equipment manufacturer’s prohibitions on the use of price comparison websites and Asics brand names in online advertisements amounted to a hardcore restriction of competition under the Vertical Agreements Block Exemption.  That decision was ultimately upheld by Germany’s highest court, the Federal Court of Justice.  Given the continuing growth of e-commerce, it wouldn’t be surprising to see further cases in this area in the future.

By Sophie Lawrance and Edwin Bond