The Automobile Aftermarket: Crash Parts, Design Patents, and the ...

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The Automobile Aftermarket: Crash Parts, Design Patents, and the Escape from Competition

Norman Hawker *

March 22, 2010

Abstract Automobile manufacturers have increasingly relied on design patents to prevent competition in the aftermarket for collision repair parts. This trend has competitive ramifications for consumers and other stakeholders in a number of related markets, including automobile insurance companies and collision repair services.

The proposed “Access to Repair Parts Act” would create a limited exception to design patent law to promote competition in the collision repair parts aftermarket. This paper provides an overview of design patents, describes the aftermarket, elaborates on the anticompetitive effects design patents when enforced by the OEMs against third party parts distributors, and evaluates the proposal.

Ultimately, this paper concludes that the proposal need not deny automobile manufacturers the profits that a design patent entitles them to receive, although it would shift their collection of that profit away from the aftermarket and toward the primary market. More importantly, the proposal would likely increase price competition in the aftermarket and benefit consumers in a variety ways, including improved transparency in the lifetime costs of different automobiles in the primary market.

Keywords: competition, antitrust, markets, automobile repair, automobile parts, automobile aftermarkets

JEL Classifications: K2 – Regulation and Business Law L1 – Market Structure, Firm Strategy, and Market Performance L2 – Firm Objectives, Organization, and Behavior L4 – Antitrust Policy L62 - Automobiles; Other Transportation Equipment

Author Contact: [email protected] (269) 598-6669

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I. Introduction

Although the “Cash for Clunkers” program proved to be a great success for the automobile

manufacturers, at least temporarily, with the economy just beginning to emerge from a deep

recession, many consumers will likely continue to delay purchase of new cars and seek to extend the

useful life of their current automobiles through the purchase of replacement parts.1 One might

expect that competition from non-OEM manufacturers would limit the ability of original equipment

manufacturers (OEMs) to exploit consumers in the aftermarket.2 However, a number of factors

undermine the ability of non-OEM aftermarket crash parts manufacturers to compete effectively

with OEM parts manufacturers, and there is growing concern that,3 with respect to body parts,

*Professor, Finance and Commercial Law, Haworth College of Business, Western Michigan University, and Senior Fellow, American Antitrust Institute. The AAI makes available on request its list of contributors. Among them are several whose economic interests or public interest concerns accord with the conclusions reached in this working paper. The AAI has long been interested in aftermarkets. See Special Issue: The Future of Aftermarkets in Systems Competition, 52 Antitrust Bull. 1 (2007) (containing papers generated at an AAI symposium on aftermarkets in 2006); Norman Hawker, Under Threat: Competition in the Automotive Service Aftermarket, (Am. Antitrust Inst. Working Paper No. 08-05, 2008), available at http://www.antitrustinstitute.org/Archives/auto_service_working_paper.ashx. The AAI has previously endorsed the Lofgren bill, Letter from Albert A. Foer, President, American Antitrust Institute, to Hon. Zoe Lofgren, United States House of Representatives, (May 6, 2008) http://www.antitrustinstitute.org/archives/files/lofgren letter5.6.08_050620081650.pdf; Letter from Albert A. Foer, President, American Antitrust Institute, and Norman Hawker, Senior Fellow, American Antitrust Institute, to Director of the United States Patent and Trademark Office, (July 14, 2008), http://www.antitrustinstitute.org/archives/files/HR-5638-USPTO_071520081008.pdf. 1 See, e.g., Matthew Dolan and Jeff Bennett, Cruel September for Car Makers, Wall Street J., Oct. 1, 2009, http://online.wsj.com/article/SB125440186148556087.html; Jay Palmer, The Beautiful Side of Car Parts, Barron’s, Jan. 26, 2009, at 49 (“The meltdown of the auto industry last year was vicious and widespread. Amid the gloom, however, there's a notable bright spot: the market for auto parts used for maintenance and repair. The $215 billion ‘aftermarket’ for auto parts hasn't shown the slightest decline, and is likely to hold up well for months to come.”); Mintel; Automobile Aftermarket Yields, But Refuses to Stop, in Face of Economic Slowdown, Transp. Bus. J., Oct. 12, 2008, at 47, available at ProQuest, Doc. Id. No. 1565707381. 2 For a general discussion of monopolization of parts see, Insurance Information Institute, Monopoly and the Generic Auto Parts Controversy - An Economic Perspective , http://www.iii.org/media/presentations/genericautopartspresentation/ (last visited Mar. 6, 2009). 3 This paper focuses on the competitive effects of the expanded use of design patents by OEMs in the aftermarket for automobile crash parts. Non-OEM manufacturers, however, currently face a number of competitive disadvantages. For example, insurance companies have been sued for encouraging body shops to use non-OEM crash parts to repair cars that were in accidents based on alleged inferiority of non-OEM parts. Although the Illinois Supreme Court reversed an award of over a billion dollars in Avery v. State Farm Mutual Automobile Insurance Co., 835 N.E.2d 801 (Ill. 2005), had the

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OEMs could escape the check of competition through the enforcement of design patents, as already

has happened in the case of Ford.

The “Access to Repair Parts Act” would create an exception to design patent law to preserve

competition in the automobile crash parts aftermarket.4 The bill does not mandate the use of non-OEM

parts. Rather, it would simply exempt certain non-OEM parts from design patent infringement. This paper

provides an overview of design patents, describes the automotive aftermarket for crash parts,

elaborates on the anticompetitive effects design patents when enforced by the OEMs against third

party parts distributors, and evaluates the proposal.

II. Overview

Intellectual property has long played an important role in shaping the competitive landscape of

the automobile industry. Indeed, overzealous use of intellectual property almost prevented Henry

Ford’s entry into the market. In 1900, the existing luxury automobile companies had acquired and

lower court decision been affirmed, it would have effectively mandated the use of OEM parts when insurance companies paid for repairs. As one commentator noted, the initial decision in favor of the plaintiffs “sent shock waves through the automobile insurance community.” Matthew W. Rearden, Comment, OEM or Non-OEM Automobile Replacement Parts: The Solution to Avery v. State Farm, 28 Fla. St. U. L. Rev. 543, 544 (2001). Similarly, some states have considered legislation which would limit the use of non-OEM crash parts. Property Casualty Insurers Association of America, Aftermarket Parts 3 (July 2008), http://www.pciaa.net/web/sitehome.nsf/lcpublic/372/$file/Aftermarket_Parts_07-08.pdf (“There have been legislative efforts to limit an insurer’s use of aftermarket crash parts, such as California Senate Bill 1059 which was defeated during the latest legislative session.”).

Non-OEM manufacturers may also face distributional issues. For example, ChoiceParts, an independent “parts locator” filed an antitrust lawsuit against GM, Ford and Chrysler, arguing that the Detroit Three were attempting to prevent ChoiceParts from competing with their jointly owned service, OE Connection, by denying ChoiceParts access to proprietary parts numbers. See ChoiceParts versus General Motors, DaimlerChrysler, and Ford Motor Company: The Case in Brief According to ChoiceParts, Collision Repair Indus. Insight (Jan. 9, 2001), http://www.collision-insight.com/news/20010109-choiceparts.htm; Tina Grady, ChoiceParts Files Antitrust Suit Against Big Three, Automotive Body Repair News, Feb. 2001, at 1. To the extent that OEMs control the software and data used to locate replacement parts, they may be able to make it more difficult for third-party parts manufacturers to sell their parts.

Also, as the Avery v. State Farm case suggests, OEMs appear to enjoy a reputation for better quality crash parts. Finally, consumers may believe that the use of non-OEM parts may create warranty problems.

4 H.R. 3059, 111th Cong. (2009). Senator Sheldon introduced identical legislation in the Senate. S. 1368, 111th Cong. (2009)

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shared with each other a patent on the internal combustion engine, the so-called “Selden Patent.”

The Selden Patent owners denied Ford’s request for a license and then brought a patent-

infringement lawsuit against the fledgling Ford Motor Company shortly after it began operations in

1903. The Selden Patent owners also filed lawsuits against Ford’s customers. After eight years of

litigation, Ford ultimately won but only after years of uncertainty and what in current dollars would

be over $10 million in legal fees.5 Nonetheless, the competitive entry of affordable, mass produced

automobiles into the market ultimately depended on Ford’s successful defense against overreaching

by the Selden Patent owners. As the installed base of automobiles has grown over the past century,

so has the importance of the aftermarket for parts and services,6 including the aftermarket for crash

repair parts.

5 See, G. Richard Shell, Make the Rule or Your Rivals Will 13-16 (2004). The cost of the litigation to Ford Motor Company at the time was estimated at $500,000. Id. at 16. The current dollar amounts were calculated comparing the changes in the value of the U.S. dollar between 1913, the earliest available date, and 2009 using the United States Bureau of Labor Statistics CPI Inflation Calculator, http://www.bls.gov/data/inflation_calculator.htm. 6 See, Morris A. Cohen et al., Winning in the Aftermarket, 84 Harv. Bus. Rev. 129 (2006) (suggesting that the aftermarkets for automobiles and other durable goods “have become four to five times larger than the original equipment businesses.”).

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A. Design Patents

Patents are divided into design patents and utility patents. Design patents provide the creators of

new and original, non-obvious ornamental designs with fourteen years of exclusive use. Those who

would seek to use protected designs are generally subject to the same prohibitions and remedies

against infringement as for the more common twenty-year utility patent protection of inventions.

A single creation or invention cannot be protected by both a design and utility patent. If it is

useful, then the U.S. Patent Act7 allows for a utility patent. Only an “ornamental” design can be

protected by a design patent. A functional design may receive a design patent for its ornamental

appearance provided that its appearance is not driven by, i.e., not the result of, its functionality. One

might expect the overall appearance of a product to be protected by a design patent, but the

ornamental design of component parts of a complex product such as an automobile may qualify for

a design patent under current law.

The number of component parts in automobiles protected by design patents has increased

dramatically in recent years.8 This marks a departure from the past practice in which manufacturers

sought design patents for the overall design of a car.9 Protection of the overall design prevented a

competitor from manufacturing an identical looking automobile, e.g., Toyota was prevented from

building an automobile that looked like a Ford Focus. The newer tactic, however, provides a 7 35 U.S. C. §§ 1, et seq. (2007). 8 See, e.g., Written Comments of LKQ Corporation and the Quality Parts Coalition to United States Patent and Trademark Office Town Hall Meeting on the Protection of Industrial Designs (July 14, 2008), at 4-5, available at http://www.qualitypartscoalition.com/pdfs/072407/Written Comments of LKQ Corporation and QPC FINAL 7.15.08.pdf. 9 Id.

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mechanism which may prevent not only the manufacture of an automobile that looks like a Ford

Focus by a competitor, but also the manufacture of replacement fenders, hoods, etc., for the Ford

Focus.

The practice of patenting designs on multiple, individual component parts has proven effective

insofar as the U.S. International Trade Commission (“ITC”) has blocked the importation of certain

crash parts that infringed on Ford’s design patents.10 The ITC’s decision was appealed, but before

the Federal Circuit Court rendered its decision, the parties settled the dispute on terms that made the

defendant, LKQ, “the sole distributor of new non-Original Equipment aftermarket parts protected

by Ford design patents.”11 Although the specific terms of the agreement remain confidential, it

appears that for a limited period of time, LKQ will pay Ford a royalty and cooperate with Ford in

design patent infringement litigation against other non-OEM manufacturers.12 From this

perspective, it may be fair to characterize the settlement as the grant of an exclusive license by Ford

to LKQ and thus a victory for OEMs seeking to prevent competition from non-OEM

manufacturers.

The threat of using design patents to eliminate competition in the aftermarket for automobile

crash parts is occurring at the same time that a longer useful lifespan for modern automobiles is

enhancing market opportunities for non-OEM aftermarket crash parts manufacturers to reverse

engineer body parts for use in crash repairs. Concerns about the loss of competition in this 10 In the Matter of Certain Automotive Parts, USITC Pub. 4012, Inv. No. 337-TA-557 (June 2008), http://hotdocs.usitc.gov/docs/Pubs/337/Pub4012.pdf (hereinafter “Ford v. Keystone”). 11 Ford and LKQ Settle Patent Disputes, aftermarketNews, Apr. 2, 2009, http://www.aftermarketnews.com/Item/47315/ford_and_lkq_settle_patent_disputes.aspx. 12 Ford and LKQ Settle Patent Disputes, aftermarketNews, Apr. 2, 2009, http://www.aftermarketnews.com/Item/47315/ford_and_lkq_settle_patent_disputes.aspx.

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aftermarket have led to legislative proposals in the European Union and the United States similar to

a law already enacted in Australia.

B. Proposals to Exempt Crash Parts from Design Patent Infringement

1. The Lofgren Bill

On June 25, 2009, Congresswoman Zoe Lofgren (D-Ca.) introduced H.R. 3059. The bill would

amend infringement provisions of the current patent law, 35 U.S.C. § 271, to add the following

provision:

“(j) It shall not be an act of infringement of any design patent to make, use, offer to sell, or

sell within the United States or import into the United States any article of manufacture that

itself constitutes a component part of another article of manufacture, if the sole purpose of

the component part is for the repair of the article of manufacture of which it is a part so as

to restore its original appearance.”13

This provision provides a narrow exception from design patent infringement; specifically, only repair

parts used to restore a product to its original appearance fall within its ambit. Parts manufactured for

any other purpose, including replicating the product or restoring the product’s functional

performance, would fall outside the exemption.

2. The European Union

13 H.R. 3059, 111th Cong. (2009). This is essentially the same bill proposed by Congresswoman Lofgren in the previous Congress. See, H.R. 5638, 110th Cong. (2008).

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The Lofgren bill closely resembles the proposal adopted by the European Parliament in 2007.

The European proposal provides in pertinent part:

“Protection as a design shall not exist for a design that is incorporated in or applied to a

product which constitutes a component part of a complex product and is used … for the

sole purpose of the repair of that complex product so as to restore its original

appearance.”14

The European proposal has met strong resistance from the automobile industry and its ultimate

enactment into law remains in doubt.15 Nonetheless, a number of EU countries, including the

United Kingdom, have already implemented legislation similar to the proposed repair clause.16

3. Australia

Section 72(1) of the Australian Designs Act of 2003 provides that the use of a component part

“which embodies a design that is identical to, or substantially similar in overall impression to, the

registered design” does not constitute infringement provided that the part is used “for purpose of

the repair of the complex product so as to restore its overall appearance.”17

14 European Parliament Legislative Resolution of 12 December 2007 on the Proposal for a Directive of the European Parliament and of the Council Amending Directive 98/71/EC on the Legal Protection of Designs (COM(2004)0582—C6-0119/2004—2004/0203(COD)). 15 Annette Kur, Limiting IP Protection for Competition Policy Reasons — A Case Study Based on the EU Spare-Parts-Design Discussion, in Research Handbook on Intellectual Property Law and Competition Law 313, 314 (Josef Drexl ed., 2008) (“As implementation of the proposal would mean that vehicle manufacturers would lose the exclusionary position I the aftermarket for spares presently enjoyed in a number of member countries, the automobile industry has organized resistance, and receives political support not least in those Member States where it represents a key sector of the domestic economy. [I]t therefore appears doubtful at present whether, and if so, in what form the repairs clause will ever be adopted.”). 16 Id. at 314 n.2. 17 Design Act, 2003, c. 6, § 72(1) (Austl.).

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A review of the legislation released by the Australian government in 2006 concluded that “the

right to repair provision strikes an appropriate balance between the Government’s policy objectives

to encourage innovation by protecting component suppliers in the primary market; [to] open up the

spare parts aftermarket to greater competition; and [to] operate an accessible design registration

system that strikes the appropriate balance between consumer benefits, compliance costs for

business and industry and administrative costs for the Government.”18

C. Participants in the Aftermarket for Crash Repair Parts

1. Consumers

Consumers of parts for the purpose of restoring the automobile to its original appearance are

primarily the victims of automobile accidents. Consumers tend to have insurance to pay for some or

all of the parts and repair service. This creates a third party payer problem, i.e., consumers are

insensitive to the price for repair parts because they do not pay for them directly. Although high

price of parts are passed along to consumers in the form of higher insurance premiums for all

consumers, not just the consumers of crash parts, few consumers seem to make decisions with this

in mind. Non-OEM crash parts are, on average, at least 25% less expensive than OEM parts.19

18 Review of the “Spare Parts” Provision of the Designs Act of 2003 (2006), http://www.ipaustralia.gov.au/media/resources/Report%20-%20%20Review%20of%20Designs%20Spare%20Parts%20Provision.pdf. 19 See Frederick R. Warren-Boulton, Comments for June 16, 2008 USPTO Town Hall Meeting (June 16, 2008), at 2, available at http://www.qualitypartscoalition.com/pdfs/072407/MiCRA.pdf (“Prices from independents are, on average, 26% lower than those from OEMs [and] OEM prices … on those parts are already 8% lower because of competition.”); Remarks of Jack Gillis, Director of Public Affairs, Consumer Federation of America, Before the U.S. Patent and Trademark Office Town Hall Meeting on the Protection of Industrial Designs (June 16, 2008), at 3, available at http://www.uspto.gov/web/offices/pac/dapp/opla/comments/designstownhall/consumerfederationamerica.pdf (“the mere presence of competition reduces the price of car company brand crash parts by 34%-83%.”) (citation omitted); Nationwide Mutual Insurance Company, Position Statement, Design Patent Protection on Exterior Component Parts of an Automobile, and Support of HR 5638, available at http://www.uspto.gov/web/offices/pac/dapp/opla/comments/designstownhall/nationwide.pdf.

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Unlike the consumers of many types of replacement and spare parts, consumers in the crash

aftermarket demand parts that are visually identical to the original.20 A fender that meets or exceeds

the functional characteristics of the automobile manufacturer’s original design has little if any value

to consumers in this aftermarket. Consumers are not seeking to improve upon or alter the

automobile. They are seeking to restore the car to its original appearance.

2. Original Equipment Manufacturers: The Automobile Companies

The original equipment automobile manufacturers (OEMs) design and manufacture new

automobiles for the primary market. As the patent holders of the designs for the parts used in new

cars, OEMs also hold the patents for the replacement parts.

OEMs manufacture some of the parts and license the design of others to independent

manufacturers. For purposes of this analysis, however, whether the parts are manufactured in plants

owned by the OEMs or by their licensees is irrelevant. OEMs are able to extract any monopoly rents

that legitimately come from patent ownership in either case. Licensees may also have contractual

limitations that prevent them from competing independently. Furthermore, the legislative proposals

do not call for compulsory licenses of design patents to OEM competitors. Non-OEM

manufacturers, i.e., those not licensed by OEMs, are not true free riders on the efforts of the OEMs

since they still need to reverse engineer the designs to avoid liability for infringement if the Lofgren

proposal were enacted. Consequently, this analysis does not differentiate between OEMs and their

suppliers.

3. Non-OEM Aftermarket Crash Parts Manufacturers

20 In addition, some state laws prevent insurers from requiring policyholders to accept non-OEM parts unless those parts are the equivalvent to the original equipment. See, e.g., Cal. Code Regs. tit. 10, § 2695.8(g)(1) (2009).

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Non-OEM aftermarket crash parts manufacturers do not manufacture crash replacement parts

under license from OEMs. Rather, they generally reverse engineer OEM parts. Because body parts

are mass produced and fall within a range of tolerances, reverse engineering requires more research

and development than simply creating a die which can stamp out parts that look similar to the

OEMs part to the naked eye. If non-OEM manufacturer parts fall outside the OEMs tolerances,

then the non-OEM parts will not fit the automobile when installed. Without proper fit, the parts are

essentially useless since they will not restore the automobile to its original appearance. Moreover,

parts that “fit” but that do not “fit well” would have a cost disadvantage in the market since they

may be somewhat harder to install than OEM parts. This adds time to the repair process and

increases the costs of repairs.

Innovation, not just in the products themselves, but also in business processes and models to

deliver the products, is one of the benefits of competition. Non-OEM crash parts must have

identical fit, form and finish to OEM parts. Nonetheless, there is still room for innovation brought

about by competition from non-OEM manufacturers. For example, it is conceivable that an OEM

manufacturer might development improvements to in the inventory, financing and distribution

systems for delivery of fenders to body shops even though the non-OEM fender itself is

indistinguishable from the OEM fender.21

21 Confidence in the quality of non-OEM parts appears to be growing as evidenced by the support of consumer groups such as Consumers Union for the bill during the last session of Congress. Hearing on Design Law – Are Special Provisions Needed to Protect Unique Industries? Before the Subcomm. On Courts, the Internet and Intellectual Property of the H. Comm. On the Judiciary, 110th Cong. (2008) (statement of Jack Gillis, Director of Public Affairs, Consumer Federation of America, testifying on behalf of Advocates for Highway and Auto Safety, the Center for Auto Safety, Consumers Union, and Public Citizen as well as the Consumer Federation of America), http://judiciary.house.gov/hearings/pdf/Gillis080214.pdf; c.f., Office of Transportation and Machinery, International Trade Administraion, U.S. Department of Commerce, U.S. Automotive Parts Industry Annual Assessment 14 (2009), http://www.trade.gov/wcm/groups/public/@trade/@mas/@man/@aai/documents/web_content/auto_reports_parts2009.pdf (“many consumers no longer judge replacement/aftermarket parts on anything other than form, fit, and function, since quality parts can and do come from everywhere”), citing, Sativa Ross, Staring Down Commoditization, Aftermarket Business, Dec. 2005. This was not always the case. “The chief problem with the aftermarket crash parts is two-fold: They usually don't fit and they don't stand up in ordinary use. There is also a question of safety when inferior

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4. OEM Automobile Dealers

The competitive nature of the market for new cars places pressure on automobile dealers to use

new automobile sales as a loss leader and to recoup the lost profits in complementary markets,

including repairs.22 It is unclear how an exception to design patent protection for crash repairs

would affect OEM dealers. The complex relationship between dealers and OEMs appears to lock

dealers into OEM parts. Consequently, independent body shops should have a cost advantage over

OEMs to the extent that they can use less expensive non-OEM parts.23 To the extent that

independent body shops pass this cost savings on in the form of lower repair prices, consumers and

their insurers should have a preference for independent body shops. Dealers may respond to this

preference by lowering their prices (and their profit margins) and insofar as insurers have included

dealers in their lists of approved providers, it can be that at least some dealers have cut prices. With

design patent protection, however, OEMs have the ability to insulate their dealers from price

competition by controlling the independent body shops’ access to the protected parts.

body parts are used to make repairs.” John R. White, Consumers Union Finds OEM Parts Are Better, Boston Globe, at D1, Jan. 30, 1999. To the exent the parts don’t fit, non-OEM parts cannot compete with OEM parts and would not even be covered by the Lofgren proposal because a part which cannot be made to fit cannot restore the car to its original appearance. Ultimately, the extent to which a part does not stand up to ordinary use is a consumer protection issue, not an antitrust concern. 22 See John L. Daly, Pricing for Profitability: Activity-Based Pricing for Competitive Advantage 78 (2002) (“Some automobile dealerships view new car sales as a loss leader that attracts customers to their service business. Although the new car business is very price competitive, where customers get their cars serviced is strongly influenced by where they bought them.”); see also Peter Brandow, No Profit in New Cars?, Ward's Dealer Business, Apr. 1, 2005, http://wardsdealer.com/ar/auto_no_profit_new/ (According to one OEM zone manager, “‘the new-car department isn't for making money, it's about setting up the other departments.’”); Ben Klayman, US dealers squeezed on new-car margins-Asbury CEO, Reuters, Sep. 21, 2005, http://www.reuters.com/article/Autos05/idUSDIT17011420050921. 23 Empirical evidence regarding crash parts is needed. A recent study which did not include crash parts, however, suggests the retail price of parts at a dealer are 26.8% higher than the price charged by non-OEMs. Automotive Aftermarket Industry Association, Vehicle Repair Cost Analysis: New Car Dealerships vs. Independent Repair Shops 22 (2009).

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One could argue that design patent protection weakens the incentive that OEMs would

otherwise have to steer crash repair work to dealers since design patent protection ensures that the

OEM receives the monopoly profit regardless of whether a dealer or an independent body shop

performs the repair. Creation of a competitive aftermarket for crash parts could benefit automobile

dealers by creating an incentive for OEM’s to steer repair work toward dealers in order to ensure the

use of OEM parts.

This argument, however, ignores the importance of a strong dealership structure to OEMs.

Regardless of the economics, a dense thicket of contract and franchise protection effectively requires

OEMs to sell their automobiles through their dealerships.24 If the difference between an OEM’s

cost of production of a part and the retail price of the part is $100, then the OEM wants to retain as

much of the $100 profit as possible rather than sharing it with the dealer. The OEM would prefer

that the dealer earn its profit on the labor from installation, and to the extent the OEM can steer

more consumers to the dealer, the dealer’s profits will expand without jeopardizing the OEMs profit

on the parts, i.e., the OEM would prefer that the dealer earn its profits horizontally at the expense of

independent body shops rather than vertically at the expense of the OEM.

OEMs cannot easily prevent the retailers of their parts from marking up the price to consumers.

Again, OEMs would be expected to prefer that their dealers earn this markup rather than

independent body shops. Thus, OEMs typically distribute parts in the aftermarket to independent

body shops through their dealers. This enables the dealers to profit from the repair work done by

24 See, e.g., Peter Valdes-Dapena, Killing Car Brands a Rocky Road: Even Struggling Brands Are Vital to Legions of Dealers and They Don’t Usually Go Down Lightly, CNNMoney.com, Nov. 4, 2008, http://money.cnn.com/2008/10/29/autos/brands_hard_to_kill/index.htm?postversion=2008103116; Jonathan Fahey and Joann Muller, Dealer Surplus, Forbes, Oct. 16, 2006, at 50; Casey J. Dickinson, Crest Sues GM Over Oldsmobile Shutdown, Cent. N.Y. Bus. J., Mar. 11, 2005, available at http://findarticles.com/p/articles/mi_qa3718/is_200503/ai_n13475931/.

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their competitors, and it also ensures that the dealers enjoy a comparative advantage over their

competitors with respect to the cost of parts.

It should be noted that the economic recession and the problems of OEMs have resulted in the

elimination of many dealerships. As the preceding analysis suggests, OEMs likely want to keep their

remaining dealers profitable and as happy as possible, while at the same time keeping their profit

margin on new cars as low as possible, hence there is motivation to favor the dealers over

independent body shops. But if there are too few independent body shops around and a reduced

number of dealerships, OEMs may suffer from the perception that their cars will be increasingly

inconvenient to repair.

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5. Independent Body Shops

Independent body shops are not subject to OEM control outside of intellectual property law.

They have an incentive to provide the highest margin part,25 regardless of price to consumer.

Consequently, they would switch to lower cost non-OEM parts so long as they are visually identical

to OEM parts once installed26 and produce at least the same absolute margin on those parts. To be

sure, an independent body shop would prefer a more expensive part if it simply takes on a

percentage mark up, e.g., the shop would prefer to earn a 25% margin on a $500 (wholesale) part (an

absolute margin of $125) rather a 25% margin on a $200 (wholesale) part (an absolute margin of

$50). If the absolute margin is equal, the body shop would have to base its decision on product

attributes other than price. Independent body shops, however, operate in a competitive

environment. They have an incentive to keep retail prices low compared both to other independent

body shops and to dealers. Consequently, if the competitive retail price for a part is $250, a body

shop would prefer a $200 (wholesale) part with a 25% margin ($250 retail price and a

$50 absolute margin) over a $500 (an absolute margin of -$250) or even $250 (wholesale) (an

absolute margin of $0) part.27 .28

25 To the extent that non-OEM parts are not identical in appearance to OEM parts after installation, the parts are not substitutes. Service providers may be able to modify a non-OEM part so that it obtains the appearance of an OEM part after installation. Whether a service provider has an incentive to do this would depend or use an OEM part would depend on which approach produced the highest absolute margin for the service provider. 26 The analysis used here in this section simplifies the discussion of the service provider’s margin on parts by assuming that inventory, labor, and costs other than the wholesale price of the part are the same for both non-OEM and OEM parts. In practice, this may not be true. If, for example, the inventory costs of an OEM are lower for the service provider than the inventory costs of a non-OEM part, then it is possible that the service provider would enjoy a higher margin on the OEM part even if the OEM part had a higher wholesale price. In that case, the service provider would have an incentive to use the OEM part. The proposed change in design patent law would not mandate the use of non-OEM parts. It would simply allow non-OEM parts to compete against OEM parts. 27 A body shop might sell the part at a loss or without any absolute margin provided that it can still make a profit on the overall job through labor charges, etc. Given the competitive retail market for crash repairs, one issue is how to split the

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6. Non-automotive Design Patent Holders

Although they were not actual or potential participants in the aftermarket for automobile crash

parts, a number of non-automotive design patent holders opposed the Lofgren legislation at a June

2008 Town Hall held by the United State Patent and Trademark Office.The Lofgren bill does not

limit the scope of its exception to design patent protection to automotive parts. Black & Decker, for

example, expressed concern about the impact of the proposal on the design patents for component

parts of its drills.

In theory, a non-OEM could reverse engineer the design of a component part of a hand tool, but

the Lofgren bill is limited to parts for the purpose of restoring the product to its original appearance.

It remains an open question, however, whether such a limited aftermarket exists for any products

other than automobiles. Perhaps private aircraft, boats, and motorcycles are similar markets. It is

also unclear whether consumers in these markets would be beset by the same third party payer

problems and other issues that make it difficult for automobile consumers to factor the cost of crash

repairs into the price of a new car.

7. Automobile Insurance Companies

total profit (the difference between the manufacturer’s cost and the retail price) between the manufacturer and the body shop. Assume, for example, the manufacturer’s cost is $100 and the retail price is $250. The manufacturer would prefer to sell the part to the body shop at a price of $250, a price which the manufacturer might be able to achieve in the absence of competition in the aftermarket for parts. A competing manufacturer, however, might be willing to cut its price to the body shop to $200. The manufacturer’s share of the profit declines and the body shop’s share increases. Since the body shop sells into a competitive retail market, the body shop might lower its retail price to $225 to attract consumers from competing body shops. So it is reasonable to expect that competition in the aftermarket for parts would increase the profits of independent body shops and lower prices to consumers. 28 The American Antitrust Institute submitted testimony in support of the proposal at the Town Hall. See Letter from Albert A. Foer, President, American Antitrust Institute, and Norman Hawker, Senior Fellow, American Antitrust Institute, to Director of the United States Patent and Trademark Office, (July 14, 2008), http://www.antitrustinstitute.org/archives/files/HR-5638-USPTO_071520081008.pdf

17

Forty-eight states and the District of Columbia have mandatory insurance laws, requiring their

resident automobile owners to purchase minimum required levels of automobile insurance before

they are permitted to register and operate their vehicles in those states. All states (including Iowa and

New Hampshire that do not mandate insurance coverage) have financial responsibility laws which

require automobile owners at the time of an accident to prove that they are financially able to pay

for damages caused by an automobile accident. That proof is often provided by exhibiting proof of

automobile insurance covering the vehicle involved in the accident.

Generally speaking, when an accident occurs the insurance company insuring the automobile

driven by the “at fault” driver is responsible for paying some proportion of the damages—including

the crash damages—caused by the accident (assuming the driver was authorized to operate the

vehicle).29 When payment for crash repairs is made by an insurance company on behalf of an

insured driver, the automobile insurance company is considered to be a third party payer. Payment

by the third party insurer to an autobody repairer can include payment for both OEM and non-

OEM crash parts used to repair the vehicles.

A reduction in the cost of replacement crash parts used to repair damages caused by automobile

crashes has the strong potential to produce direct benefits for the consumer. Assuming that

automobile insurance is sold in a competitive market (which varies from state-to-state), the lower

repair costs paid by insurance companies as a result of the use of non-OEM crash parts has the

potential to be passed along to consumers in the form of lower premiums. This is not a simplistic

dollar-for-dollar analysis, however. The pricing of insurance coverage is a very complicated process, 29 Theoretically, one might argue that in a pure “no-fault” state, each insurance company would pay to repair its policyholder’s repairs regardless of whether its policyholder caused the accident. In reality, the states with no-fault insurance have adopted various and complex modifications to the theoretical model of pure no-fault insurance. Thus, for example, things such as the differences in policy types available to consumers in no-fault states and the multiplicity of factors considered in setting premiums, make it dubious at best that consumers in no-fault states could use insurance premiums as a proxy for crash repair costs.

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involving not only an examination of the particular drivers being insured, but also the location and

amount of driving, and the automobile being insured, among many other factors. Projections about

future loss potential and therefore appropriate pricing for the risk underwritten, i.e., the insurance

premium, is based upon previous loss experiences for the driver and the vehicle. Accordingly, if the

use of non-OEM crash parts results in a reduction in the costs of repairs, that loss history could be

projected forward and, all things being equal, might well be reflected in a lower premium for that

coverage.

III. Markets

A. Product

The relevant product market for antitrust analysis could be defined as automobile crash repairs.

This broad definition, however, consists of two submarkets: crash repair parts and crash repair

services. Furthermore, automobile crash repairs occur in an aftermarket for new car sales, the

primary market.

1. Crash Repair (Body) Parts Aftermarket

It seems undisputed that replacement parts must appear to be identical to the original parts.

Consumers seek to have a damaged car restored to its original appearance, and the Lofgren bill’s

exception to design patent protection is expressly limited to parts used for such restoration.

As discussed above, crash repairs are often paid for not by the owner of the automobile directly,

but by an insurance company. The insurance premium paid by a consumer will include consideration

for payment of other vehicles damaged as a result of the negligence of the insured driver, and would

include repair to the insured’s own vehicle as well in the event that first-party crash coverage is

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purchased by the insured. The intricacies of automobile insurance, as discussed earlier, probably

exacerbate the third party payer problem. Consequently, the increased cost of repairing a vehicle

damaged in a crash tends to increase the cost of insurance for all cars.

Automobiles typically undergo design changes every year, hence the term “model year.” Prices

of raw materials, labor, etc., may fluctuate over the life of the car. These changes make it difficult for

consumers to predict the total cost of ownership and future repairs of their vehicles. Arguably, given

the length of union contracts, long term raw material purchase agreements, and design changes they

have instituted, OEM are in the best position to make a reasonable estimate of the cost of crash

repair parts in the future. There does not appear to be much evidence of disclosure of the

anticipated cost of crash repair parts by OEMs to consumers in the primary market.30 The limited

availability of prospective information regarding the anticipated cost of crash repair parts for at least

some consumers inhibits the ability of competition in the market for new cars to ameliorate

anticompetitive behavior in the aftermarket.

This lack of transparency of repair cost (and the associated reduced consideration of these costs

by consumers when they initially purchase a car) is compounded by the fact that the consumer must

discount crash repair costs by the probability of the consumer actually getting into an accident.

Although insurance companies have the expertise to predict the cost of repairs over the life of the

30 There may be correlation across years, and, therefore, reputational effects. Indeed, organizations such as Consumers Union spread information regarding total cost of ownership, increasing the transparency to some extent. See e.g., “When comparing the costs of buying and keeping a car for 225,000 miles over 15 years to buying and financing an identical model every five years, CR found the savings could be more than the original purchase price of the vehicle and even greater if the savings were invested. For example, Consumer Reports estimated the popular Honda Civic EX, with an automatic transmission, could potentially save its owner as much as [$20,500] if properly maintained over 15 years [$1,500] more than its purchase price. In its analysis, CR calculated the costs of purchase price including destination fees, depreciation, maintenance and repairs, finance and interest, fees and taxes, and insurance for 15 years against the same factors for purchasing a new model every five years.” Consumers Union, Make Your Car Last 200,000 Miles, FamilyCar.com, 2007 http://www.familycar.com/Articles/CU/MakeYourCarLast.htm; see also, Pick a Car for the Long Run, Consumer Rep., Oct. 2007, 22.

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automobile and the means of discounting that cost by the probability of an accident, the anticipated

cost of repairs is only one factor used in setting premiums. Simply comparing premiums for

different model cars will not provide the consumer with sufficient information to factor the cost of

repairs into the purchase decision in the primary market.

American antitrust law recognizes that a durable goods manufacturer may be able to monopolize

an aftermarket for repair parts even though the manufacturer lacks monopoly power in the primary

market for the durable good.31 Nonetheless, some antitrust experts dispute the idea of a separate

aftermarket, arguing that consumers will engage in lifecycle cost comparisons such that competition

occurs at the time of the initial purchase.32 This type of abstract economics ignores the way

consumers actually behave, particularly in the absence of full information. Full information is not

possible for crash parts because it is impossible to predict what the price of parts will be several

years in advance and it is impossible to predict what a particular car buyer’s probability of accident

will be during whatever period the car will be owned. Moreover, a growing body of business and

economic literature suggests that as a matter of empirical fact very few consumers have either the

background or the habit of engaging in lifecycle costing when they purchase durable goods such as

automobiles.33

2. Crash Repair Service Aftermarket

31 Eastman Kodak Co. v. Image Technical Services, 504 U.S. 451 (1992); Joseph P. Bauer, Antitrust Implications of Aftermarkets, 52 Antitrust Bull. 31, 43 (2007). 32 See, e.g., Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice 301-302 (3d 2005). 33 See, e.g., Lorenzo Coppi, Aftermarket Monopolization: the Emerging Consensus in Economics, 52 Antitrust Bull. 53, 58 (2007); N. Saccani et al., The Role and Performance Measurement of After-Sales in the Durable Consumer Goods Industry: An Empirical Study, 55 Int’l J. of Productivity and Performance Measurement 259, 260 (2006); Severin Borenstein et al., Exercising Market Power in Proprietary Aftermarkets, 9 J. Econ. & Mgmt. Strategy 157, 187 (2000).

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Insofar as consumers have difficulty determining the total lifecycle cost of ownership for any

given automobile, consumers most likely choose between automobiles based on the purchase price

and other observable product attributes in the primary market, rather than total cost of ownership.

OEMs, therefore, have an incentive to pressure their dealers to reduce their margins on new car

sales, to maximize new car sales, without having to worry about competing on the basis of

consumers’ perception of lifecycle costs. Although OEMs should be equally able to extract a

monopoly profit on design patented parts regardless of whether an independent body shop or an

authorized dealer performs the repair, OEMs have an incentive to shift crash repair work to dealers

so that their dealers can make up the lost margins in the primary market through crash repair work.

To the extent that OEMs give their dealers preferential treatment, e.g., access to training, etc., the

service as well as the parts aftermarket could suffer a reduction in competition. Even if dealers don’t

raise prices, consumers will be harmed by the lack of choice and convenience that is attributable to

the absence of competition.

3. New Automobile Sales Market

OEMs have an additional reason to exploit the aftermarket by charging higher prices for crash

repairs. To the extent that the costs of repair after a crash go up, consumers will tend to purchase

new cars instead of repairing their old cars. In theory, an OEM would not raise prices in the

aftermarket for this reason because the OEM would fear that consumers, upset over the high price

of repairs, would replace their car with a competitor’s product.34

34 See, e.g., Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice 94 (3d ed. 2005) (“In a well functioning market where customers have adequate information,” an automobile company cannot charge an anticompetitive price for parts because the “customer is interested in the package of the automobile-plus-subsequent-maintenance, and the overcharge for subsequent [parts] will show up in her calculus as nothing other than an increase in the price of the package. She will go to another seller who behaves competitively.”).

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The real world, however, “is a less tidy place where the initial competition is imperfect, costs of

subsequent repairs are uncertain … and are probably unknown to the consumer.”35 Empirical

evidence suggests that retail consumers generally do not consider the total cost of ownership when

making a purchase decision.36 In the crash parts aftermarket, this consumer myopia is likely

increased by the lack of transparency stemming from the third party payer effect. As previously

noted, insurance premiums reflect a variety of factors, only one of which may be the cost of

repairing the car purchased by the insured. Insurance cannot serve as proxy for the expected cost of

crash parts.

B. Geographic

Consumers purchase automobiles, insurance and aftermarket services such as crash repairs in

local markets, although for purposes of this analysis there does not appear to be a significant

differences in the local market, although to the extent that a particular state’s law inhibits insurers

from using non-OEM parts, the benefits of competition in the aftermarket for the insurer will

decrease. Neither the Patent Act nor the Lofgren bill extends beyond US borders. Nonetheless, both

OEM and non-OEM parts manufacturers make some of their parts outside the United States.

Consequently, the relevant geographic market should include all parts manufacturers that can

produce parts that can be sold in the US.

35 Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice 94 (3d ed. 2005). 36 Lorenzo Coppi, Aftermarket Monopolization: The Emerging Consensus in Economics, 52 Antitrust Bull. 53, 57-58 (2007) (The “available empirical studies on lifecycle costs seem to contradict” the view that consumers are “fully capable of calculating the lifecycle cost of a given primary product.” The data reveals a “pattern of higher sensitivity to immediate and lump upfront costs as opposed to future and diffuse running costs.”).

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IV. Competitive Effects

A. Crash Repair Part Aftermarket

Although a patent in and of itself does not confer market power within the meaning of the

antitrust laws,37 a design patent for an automobile does confer monopoly power in the aftermarket

for crash repair parts. A design patent prevents a competitor from manufacturing a part that appears

the same as the OEM’s part. Unless the competitor’s part is identical in appearance to the OEM’s,

the consumers will not purchase the competitor’s part regardless of its price or other attributes.38 In

other words, an enforceable design patent means that substitute products cannot compete with the

OEM’s parts. A Ford bumper does not provide any competitive pressure on the price Toyota

charges for its bumpers. Design patents do not merely impede competition in the crash parts

market; they eliminate competition.39

The loss of competition hurts consumers in a variety of ways. Not only are parts from non-

OEM manufacturers less expensive, but competition from non-OEM parts reduces the price of

OEM parts.40 The sale of parts by suppliers in the aftermarket may not provide effective

37 Illinois Tool Works, Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006). 38 Annette Kur, Limiting IP Protection for Competition Policy Reasons — A Case Study Based on the EU Spare-Parts-Design Discussion, in Research Handbook on Intellectual Property Law and Competition Law 313, 327 (Josef Drexl ed., 2008) (“only … a part with an identical shape … will provide consumers with a suitable alternative”). 39 Id. at 328 (“the total blocking of competition in the aftermarket is an automatic and inevitable result simply of the design right being granted”). 40 John C. Bratton and Stephen M. Avila, After-Market Crash Parts: An Analysis of State Regulations, 18 J. Ins. Reg. 150, 169 (1999) (“As a result of competition from after-market suppliers, prices of many OEM parts decreased substantially, while prices in non-competitive markets continued to increase.”); see also Frederick R. Warren-Boulton, Comments for June 16, 2008 USPTO Town Hall Meeting (June 16, 2008), at 2, available at http://www.qualitypartscoalition.com/pdfs/072407/MiCRA.pdf (“Prices from independents are, on average, 26% lower than those from OEMs [and] OEM prices … on those parts are already 8% lower because of competition.”); Remarks of Jack Gillis, Director of Public Affairs, Consumer Federation of America, Before the U.S. Patent and Trademark Office Town Hall Meeting on the Protection of Industrial Designs (June 16, 2008), at 3, available at

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competition with the OEM since the OEM can extract a monopoly profit via royalty payments on

the sales made by suppliers. Although the parts from non-OEM manufacturers must appear

identical once installed on the car, competition may stimulate innovation in the manufacturing

process and marketing of crash repair parts. The industry-wide loss of competition in the

aftermarket does not benefit consumers by providing a necessary incentive to OEMs for creation of

new and innovative designs since OEMs can still recoup the profit to which it they entitled by virtue

of the design patent through the purchase price on the new car.41

To the extent OEMs are already collecting the full profit available to them for their design in the

primary market, the Lofgren bill would simply eliminate their ability to collect what amounts to an

unwarranted “double reward” for their design in the aftermarket.42 In the aftermarket for crash

parts, OEMs have little incentive compared to component manufacturers to engage in any

innovation or other alteration that would require additional investment in design over and above the

investment needed to create the design for the primary market.43 As one commentator stated, to a

http://www.uspto.gov/web/offices/pac/dapp/opla/comments/designstownhall/consumerfederationamerica.pdf (“the mere presence of competition reduces the price of car company brand crash parts by 34%-83%.”) (Citation omitted). 41 Annette Kur, Limiting IP Protection for Competition Policy Reasons — A Case Study Based on the EU Spare-Parts-Design Discussion, in Research Handbook on Intellectual Property Law and Competition Law 313, 324 (Josef Drexl ed., 2008) (“the effect of the repairs clause, namely that gains owed to exclusivity must be collected in their entirety in the primary market, appears as a technicality rather than a reduction of possible gains in their substance.”). This is not to say that an industry-wide competitive aftermarket will result in the same overall competitive outcome. The reason is that a competitor that adopts the “low purchase price, high repair price” strategy will outsell the firm that adopts a P=MC new car purchase price, P=MC repair price strategy. As a result, in a world with incomplete information and no regulatory intervention, one gets a different “competitive” equilibrium than in a world where there is regulation or where competition prevents P>MC in the aftermarket. However, movement from one equilibrium to another will be costly for the car companies that earlier adopted a P>MC in the aftermarket, having sold new cars at P<MC. The implication is that the price of new cars will go up, that dealerships will have to reduce their repair business (shedding workers and perhaps being stuck with underutilized physical assets). The full extent of this impact is an empirical question. Informal discussions with participants in the aftermarket suggest a widespread belief that dealers have increased their capacity to do crash repairs and other body work during the past decade. 42 Cf. Id. at 322-324. 43 Id. at 327 (“in the aftermarket for spare parts, there is neither room for innovation nor a need for the original creator to make specific investments in design efforts that could only be retrieved by the grant of an exclusive right”).

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large extent what “is lost is solely the chance to achieve overly high profit margins.”44 At the very

least, the absence of competition in the crash parts aftermarket may distort the efficient operation of

the primary and secondary markets insofar as too many people are buying new cars and that too

many old cars are being sold for junk prematurely. 45

B. Crash Repair Service Aftermarket

If OEMs deny independent body shops access to design patented parts, they can effectively

force consumers to obtain crash repair services from dealers for most of the car’s life.46 Although

OEMs may be able to extract the full monopoly profit from the sale of patented parts to

independent body shops, OEMs still have an incentive to channel crash repairs to their dealers. By

increasing the revenues available to their authorized dealers in the aftermarket, OEMs may be able

to shrink the margins available to dealers in the primary market without threatening the financial

viability of the dealers. Remember that the OEMs have an incentive to lower the price of the new

cars that they sell to their dealers if this increases the OEMs’ future replacement parts business

(whether sold through dealers or elsewhere). Thus, dealers could make their profit margin at a lower

retail price for new cars. Given that operating a repair shop involves fixed costs and that the OEMs

44 Id. at 324. 45 Hearing on Design Law – Are Special Provisions Needed to Protect Unique Industries? Before the Subcomm. On Courts, the Internet and Intellectual Property of the H. Comm. On the Judiciary, 110th Cong. (2008) (statement of Jack Gillis, Director of Public Affairs, Consumer Federation of America), http://judiciary.house.gov/hearings/pdf/Gillis080214.pdf (“high repair costs will lead to more vehicles being “totaled” because the price of repairing the damage exceeds the value of the vehicle.”) 46 The average life span of an automobile appears to be 8 to 15 years. See Herb Weisbaum, What's the life Expectancy of My Car? MSNBC, Mar. 28, 2006, http://www.msnbc.msn.com/id/12040753/ (citing Consumer Reports). A design patent expires after 14 years.

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are interested in making an investment in their dealerships attractive to potential franchisees, they

have an incentive to support the repair businesses of their dealers.47

C. Offsetting Pro-competitive Benefits

Although it is debatable whether the carrot of design patent protection or the stick of

competition creates a stronger incentive for innovation, design patent protection arguably has the

benefit of creating an incentive for designers to create new designs.48 The characterization of this

incentive as “pro-competitive” is something of a misnomer, however, since the incentive offered is

the exclusion of direct competition. Design patents may result in more innovation (an unproven

assertion), but design patents, no less than other forms of intellectual property, reduce

competition.49

Nonetheless, one could argue that the reduced competition in the aftermarket enhances

competition in the primary market. One way in which this might occur would be through the

OEM’s ability to maintain a uniform level of quality control in the aftermarket for crash parts. This

47 It is entirely possible that OEMs are not as interested in supporting a “crash repair” business as they are in supporting the ordinary maintenance repairs. But the relative importance of “crash repair” to “routine maintenance” is relevant to the question of the relative strength of incentives, not the existence of the incentives. 48 See, e.g., Letter from Steven Miller, President, Intellectual Property Owners Association, to Jon W. Dundas, Undersecretary for Intellectual Property and Director of the U.S. Patent and Trademark Office (July 18, 2008), at 2, available at http://www.ipo.org/AM/Template.cfm?Section=Home&TEMPLATE=/CM/ContentDisplay.cfm&CONTENTID=18806; American Intellectual Property Association, AIPLA Comments on Design Patents (July 15, 2008), at 3, available at http://www.aipla.org/Content/ContentGroups/Issues_and_Advocacy/Comments2/Patent_and_Trademark_Office/20089/DesignPatents.pdf. 49 Although intellectual property “generates substantial costs,” including “direct harm to competition from the granting of exclusive rights that create static inefficiencies in the form of deadweight and wealth-transfer losses,” intellectual property rights are justified to the extent “they promote innovation that would not occur in their absence.” Warren S. Grimes, Making Antitrust and Intellectual Property Policy in the United States: Requirements Tie-Ins and Loyalty Discounts, in Research Handbook on Competition and Intellectual Property Law 258, 259 (Josef Drexl ed., 2008); see also Clifford A. Jones, Patent Power and Market Power: Rethinking the Relationship Between Intellectual Property Rights and Market Power in Antitrust Analysis, in Research Handbook on Competition and Intellectual Property Law 239, 254 (Josef Drexl ed., 2008) (“The classic justification for the right to exclude is of course the incentive given inventors to invent.”).

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would enhance the overall image of the brand thereby enabling the OEM to compete more

effectively against other brands of automobiles. Since the exception to design patents proposed in

the Lofgren bill would apply only to parts capable of restoring the car to its original appearance,

competitors would have to manufacture parts of equal quality in terms of this product attribute. Of

course, non-OEM parts may not be identical to OEM parts in terms of other product attributes. For

example, competitors may manufacture parts that are visually identical but made from different raw

materials.

A somewhat related argument would be that the profits earned in the aftermarket subsidize the

design of new vehicles for the primary market. Although is not clear whether or to what extent

OEMs have relied on sales in the aftermarket to cover the costs of developing new automobiles, if

OEMs have sold new cars at a loss with the expectation of recouping a profit through the sale of

parts, then there is a risk that some OEMs may not be profitable enough to develop new model cars

without supra competitive profits on aftermarket sales. This in turn could lessen competition in the

primary market for new car sales. H.R. 3059, however, avoids this problem since the exception

would apply only to designs created subsequent to the enactment of the proposal. Prospective

application of the exception for aftermarkets would have the beneficial affect competition in the

primary market by reducing the ability of OEMs to shroud the total cost of ownership.

The issue of free riding presents a more difficult problem. Broadly speaking, free riding occurs

when a competitor benefits from the efforts of a firm without compensating the firm. In this sense,

non-OEM manufacturers are free riders on the OEMs’ designs.50 Free riding creates a problem

50 This is not to say that non-OEM manufacturers are simply copying the OEMs’ designs for free. Non-OEM party manufacturers must incur costs to “reverse engineer” the OEMs’ designs. Furthermore, third party manufacturers must invest in their own tools, dies, etc.

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when it prevents a firm from internalizing the rewards of its conduct.51 The fear is that without

design patent protection, OEMs would lack sufficient incentives to compete by creating innovative

designs.52 Since the Lofgren bill does not prevent OEMs from gaining the exclusionary benefit of

their design in the primary market, the free rider problem is minimized.

Furthermore, hiding the design patent profits in aftermarket prices distorts competition in the

new car market by making it difficult for consumers to make a purchase decision based on the initial

purchase price as a part of the expected total cost of ownership.53 Bringing competition to the

aftermarket will not completely eliminate this problem, but to the extent that the monopoly profit

for the design aspect of the car becomes part of the initial purchase price, the distortion should be

reduced.

This is not a safety issue. Although the appearance of functional components may be protected

by a design patent, e.g., the pattern of holes in the ventilation system, the design patent relates to the

ornamental appearance, not structural integrity.54 An OEM’s interest in functional innovations

regarding safety and structural can be protected with a utility patent, and the Lofgren bill would not

create an exception to infringement actions for utility patents. 51 See Lawrence A. Sullivan and Warren S. Grimes, the Law of Antitrust: An Integrated Handbook 842 (2d ed. 2006). 52 See Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice 241 (3d 2005) (“If the innovator cannot effectively exclude others from copying the innovation, then many of the returns to innovation will be lost and we can expect less innovation to occur.”). 53 See, e.g., Lorenzo Coppi, Aftermarket Monopolization: the Emerging Consensus in Economics, 52 Antitrust Bull. 53, 58 (2007); N. Saccani et al., The Role and Performance Measurement of After-Sales in the Durable Consumer Goods Industry: An Empirical Study, 55 Int’l J. of Productivity and Performance Measurement 259, 260 (2006); Severin Borenstein et al., Exercising Market Power in Proprietary Aftermarkets, 9 J. Econ. & Mgmt. Strategy 157, 187 (2000). 54 Special Issue: Cosmetic Repair Parts Irrelevant to Safety (2000), at http://www.iihs.org/sr/pdfs/sr3502.pdf. At least one OEM representative has conceded as much. See, e.g., Remarks of Jack Gillis, Director of Public Affairs, Consumer Federation of America, Before the U.S. Patent and Trademark Office Town Hall Meeting on the Protection of Industrial Designs (June 16, 2008), at 3, available at http://www.uspto.gov/web/offices/pac/dapp/opla/comments/designstownhall/consumerfederationamerica.pdf (“Mr. Porcari of Ford said earlier that this was not safety related.”).

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V. Entry and Efficiencies

A. Productive Efficiencies

All patents create barriers to entry in the sense that a competitor must work around the patent.

Utility patents prevent competitors from duplicating the inventor’s product or using its process

without permission. A would be competitor must overcome this barrier by finding an alternative to

serve the same need or provide the same function as the inventor’s product or process.

Undoubtedly, circumstances exist where a competitor may work around a design patent by

producing a new design with similar aesthetic qualities. A similar design, however, is not close

enough to serve as a substitute for OEM parts in the crash repair aftermarket. A non-OEM’s

replacement part must be identical to the OEM’s for it to restore the product to its original

appearance. Consequently, design patents create an absolute barrier to entry in the automobile crash

repair parts aftermarket.

B. Productive Efficiencies

It can be argued that competition from reverse engineered parts may reduce productive

efficiency in the crash parts market. First, being the sole source of parts enables an OEM to spread

the design cost over more units.55 Second, maximum productive efficiency in the manufacture of

crash parts is probably achieved by getting the greatest number of parts possible from a set of tool

and dies. As with design cost, a single source for a body part increases the likelihood that the die

used to manufacture the part will be fully utilized, i.e., since the cost of the die is fixed, it is possible

that the lowest average cost per part may be achieved by spreading the cost of the die over the

55 See Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice 241 (3d 2005).

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maximum number of parts that the die is capable of producing. These economies of scale could

enhance competition by lowering the average cost of crash parts. Although an OEM might pass

through at least a portion of the savings to consumers through lower prices on new cars, this seems

doubtful since the OEM has at best a only limited ability to forecast how many crash parts will be

sold when the die is first built.

VI. Conclusion

It should come as no surprise that the American Antitrust Institute,56 Consumers Union, the

Consumer Federation of America, the Automotive Aftermarket Industry Association, and the

American Insurance Association, among others, have endorsed the creation of an exception to

design patent protection for crash parts.57 Without legislation such as that proposed by

Representative Lofgren in the last Congress, competition in the aftermarket for body parts, other

than from salvaged parts, cannot exist. There is no demand for a product that looks similar but not

identical to the original body part. While design patents enable OEMs to compete in the primary

market by differentiating their cars, design patents eliminate rather than enhance competition in the

aftermarket.

Given the unique features of this market, the legislation should not deprive the OEMs of the

profits afforded by a design patent protection. Rather, the exception proposed in the Lofgren bill

56 Letter from Albert A. Foer, President, American Antitrust Institute, to the Hon. Zoe Lofgren, United States House of Representatives (May 6, 2008), http://www.antitrustinstitute.org/archives/files/lofgren%20letter5.6.08_050620081650.pdf (supporting the bill introduced in the previous Congress). 57 See USPTO Holds Town Hall Meeting On Industrial Patent Designs, Autobody Online, June 19, 2008, http://www.autobodyonline.com/showstory.cfm?id=9585; Hearing on Design Law – Are Special Provisions Needed to Protect Unique Industries? Before the Subcomm. On Courts, the Internet and Intellectual Property of the H. Comm. On the Judiciary, 110th Cong. (2008) (statement of Jack Gillis, Director of Public Affairs, Consumer Federation of America, testifying on behalf of Advocates for Highway and Auto Safety, the Center for Auto Safety, Consumers Union, and Public Citizen as well as the Consumer Federation of America), http://judiciary.house.gov/hearings/pdf/Gillis080214.pdf.

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would require OEMs to obtain this profit through the sale of new cars. This might have the effect of

slightly raising the price of new cars, but it would reduce the cost of repairs. Assuming the

competitive nature of car insurance in a given jurisdiction, insurance companies may well be able to

pass the cost savings on to consumers in the form of lower premiums.

Furthermore, by including the cost of the design patent in the purchase price of new cars,

consumers will be able to make better informed choices about which cars to buy. Under the best of

circumstances, a consumer faces a difficult, if not impossible, task of forecasting the cost of crash

repairs and then discounting those repairs by the probability that he or she will have an accident

over the eight to fifteen year lifecycle of modern automobiles.58

The proposed “Access to Repair Parts Act” serves the public good by maintaining competition

in the aftermarket for automobile crash repair parts. The failure to enact this legislation could lead to

substantially higher costs to consumers.

58 See Herb Weisbaum, What's the life expectancy of my car? MSNBC, Mar. 28, 2006, http://www.msnbc.msn.com/id/12040753/.

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