Functionalism and Systems Theory and the Supreme Court's Upcoming Review of American Needle

(If you need background on the case, skip to the * * * * * below.)

For proponents of functionalism and systems theory, there is no more important case before the Supreme Court right now.

Robert Ellickson is perhaps most famous for showing how the Coase Theorem does not hold among ranchers in rural Shasta County in California. His explanation is that shared cultural values are more important than legal rules in many particular social contexts. What the Seventh Circuit has done in American Needle is prevent antitrust law from interfering with privately evolved social norms of cooperation. The theory that individuals can evolve into groups with common norms is part of the sociological theory of functionalism.

In an earlier post on Robert Ellickson's Order Without Law, I pointed out how Ellickson's reasons and evidence for dismissing functionalism as a useful and valid part of systems theory are no longer sound. First, Ellickson rejected functionalism because of a fight among evolutionary biologists that was going on contemporaneous with his publication of Order Without Law. Functionalism is enjoying a resurgence among some evolutionary biologists, notably including E.O. Wilson, whom Ellickson cites in Order Without Law as an opponent of group selection theory. Wilson and Holldobler recently published, The Superorganism, which lays out a functionalist theory of group selection for how cooperation evolved among insects.

Second, there are now better theoretical tools for getting quantitative about functionalism. In particular, associating a group with a network, and individuals with nodes therein, permits evolution of group behavior to be modeled using mathematical models for network growth and decay, or phase transitions. Such models help to eliminate much of the conceptual circularity to which Ellickson objects in this passage.

The upshot is that social norms can evolve to facilitate group cooperation. These norms, in turn, can play a huge role in promoting health and economic growth. The case of IP licensing by the NFL is an easy example of the economic benefits of cooperation. Competition among the teams for licensing revenue -- which I understand is the norm among MLB teams -- leads to less social benefit for consumers and less revenue for the league. In many contexts, cooperation creates wealth that competition would destroy.

This is not to say that there is no role for antitrust regulation. The point is that regulators should not rely on the prescription of methodological individualists (including, most notoriously, neoclassical economists) that competition is a uniform good. Neither perfect competition nor perfect cooperation is optimal for a society. We must find a balance in which enough competition is permitted to allow existing relationships to be broken so that new experiments with resources, capital, and people can be tried. But we should remember that these experiments have an opportunity cost of stability and efficiency, which is too expensive when there is no theory tested by the experiments.

The Seventh Circuit's ruling on the "single-entity" doctrine should be upheld by the Supreme Court. It is a sophisticated answer to the question of how functional groups should be defined. The Seventh Circuit refuses to accept the oversimple definition of a group as a particular group of people. Rather, the group is defined (as W. Edwards Deming suggests it must be) by its shared purpose. Each individual has many goals, but a group of individuals will have only as many as are shared by each individual within it. This counterintuitive fact accounts, to a considerable extent, for the success of neoclassical theory -- only a handful of goals are shared by large groups of people over long periods of time, with the rational pursuit of happiness being the most obvious.

Long time readers will appreciate why I feel this decision is so important for the future prospects of our country. But to give just one illustration, refer back to the description of the effects of individual versus group competition described in this earlier post on executive compensation:

Chickens have always lived in groups, and in the modern egg production industry they are crammed inhumanely into cages usually containing nine to twelve hens. [Biologist William Muir] wanted to increase egg production by selective breeding, and he tried to do it in two ways. The first method involved selecting the most productive hen from each of a number of cages to breed the next generation of hens. The second method involved selecting all the hens from the most productive cages to breed the next generation of hens. You might think that the difference between the two methods is slight and that the first method should work better. After all, it is individuals who lay eggs, so selecting the best individuals directly should be more efficient than selecting the best groups, which might include some individual duds. The results told a completely different story.

When Bill presented his results at a scientific conference that I attended several years ago, he showed a slide of hens selected by the first method after six generations.The audience gasped. Inside the cage were only three hens, not nine, because the other six hens had been murdered. The three survivors had plucked each other during their incessant attacks and were now nearly featherless... What happened? The most productive individuals had achieved their success by suppressing the productivity of their cagemates.

By contrast, the second method resulted in higher production, and a cage that looked almost happy. If group selection could have such a dramatic impact on egg production, what impact might they have on the characteristics of individuals and groups in other situations in which group selection criteria are at work?

What kind of world do we want to live in? There is more at stake in how the Supreme Court decides this case than seems to be apparent to most people.

* * * * *

Here's how the Seventh Circuit summarized the facts and record on appeal (see here for links):

For those who do not know, the NFL is an unincorporated association of (now) 32 separately owned and operated football teams that collectively produce an annual series (or “season”) of over 250 interrelated football games. Each season culminates in a championship game—a game better known as the Super Bowl. As such, the product that the teams produce jointly—NFL football—requires extensive coordination and integration between the teams. After all, NFL football is produced only when two teams play a football game. Thus, although each team is a separate corporate entity or partnership unto itself, no team can produce a game—the product of NFL football—by itself, much less a full season of games or the Super Bowl. Likewise, the teams’ individual success is necessarily linked to the success of the league as a whole; to put it another way, it makes little difference if a team wins the Super Bowl if no one cares about the Super Bowl.

Realizing that the success of the NFL as a whole was in their best interests, in the early 1960’s the individual teams sought to collectively promote the NFL Brand—that is, the intellectual property of the NFL and its member teams—to compete against other forms of entertainment. With this promotional effort in mind, in 1963 the NFL teams formed NFL Properties: a separate corporate entity charged with (1) developing, licensing, and marketing the intellectual property the teams owned, such as their logos, trademarks, and other indicia; and (2) “conduct[ing] and engag[ing] in advertising campaigns and promotional ventures on behalf of the NFL and [its] member [teams].” Among other things, the NFL teams authorized NFL Properties to grant licenses to vendors so the vendors could use the teams’ intellectual property to manufacture and sell various kinds of consumer products that bear the teams’ logos and trademarks—products such as team jerseys, shirts, flags, and, as pertinent here, headwear, like baseball caps and stocking hats.

For a while after its establishment, NFL Properties granted headwear licenses to a number of different vendors simultaneously; one of those vendors was American Needle, which held an NFL headwear license for over 20 years. But then in 2000, the NFL teams authorized NFL Properties to solicit bids from the vendors for an exclusive headwear license. Reebok won the bidding war, and in 2001 the NFL teams allowed NFL Properties to grant an exclusive license to Reebok for ten years. NFL Properties thus did not renew American Needle’s headwear license, or the licenses of the other headwear vendors.

American Needle responded to the loss of its headwear license by filing an antitrust action against the NFL, NFLProperties, the individual NFL teams, and Reebok. As relevant here, American Needle claimed that the exclusive headwear licensing agreement between NFL Properties and Reebok violated § 1 of the Sherman Antitrust Act, which outlaws any “contract, combination . . . or conspiracy, in restraint of trade.” 15 U.S.C. § 1. As American Needle saw it, because each of the individual teams separately owned their team logos and trademarks, their collective agreement to authorize NFL Properties to award the exclusive headwear license to Reebok was, in fact, a conspiracy to restrict other vendors’ ability to obtain licenses for the teams’ intellectual property. American Needle also contended that, by authorizing NFL Properties to award the license to Reebok, the NFL teams monopolized the NFL team licensing and product wholesale markets in violation of § 2 of the Sherman Antitrust Act. See id. § 2.

And here's how the Seventh Circuit ruled on the question of whether the NFL can be considered a "single entity":

American Needle first contends that the district court erred by granting the NFL defendants’ summary judgment on its § 1 claim. Specifically, American Needle argues that the district court incorrectly concluded that the NFL teams constitute a single entity under Copperweld when collectively licensing their intellectual property. American Needle’s argument leads us into murky waters. We have yet to render a definitive opinion as to whether the teams of a professional sports league can be considered a single entity in light of Copperweld. The characteristics that sports leagues generally exhibit make the determination difficult; in some contexts, a league seems more aptly described as a single entity immune from antitrust scrutiny, while in others a league appears to be a joint venture between independently owned teams that is subject to review under § 1. See Brown v. Pro-Football, Inc., 518 U.S. 231, 248-49 (1996) (“[T]he clubs that make up a professional sports league are not completely independent economic competitors . . . . In the present context, however, that circumstance makes the league more like a single bargaining employer . . . .”); Bulls II, 95 F.3d at 597-99 (“To say that the league is ‘more like a single bargaining employer’ than a multi-employer unit is not to say that it necessarily is one, for every purpose.”); see also Super Sulky, Inc. v. U.S. Trotting Ass’n, 174 F.3d 733,741 (6th Cir. 1999) (“[T]he notion of concerted action liability in the field of professional sports is at best confusing.”). For instance, from the perspective of fans, a professional sports league can be seen as “a single source” of entertainment that produces “one product,” even though the league’s member teams are distinguishable. Bulls II, 95 F.3d at 599. Yet at the same time, individuals seeking employment with any of the league’s teams would view the league as a collection of loosely affiliated companies that all have the independent authority to hire and fire employees. See Brown, 518 U.S. at 249 (noting that professional football players “often negotiate their pay individually with their employers,” NFL teams); Bulls II, 95 F.3d at 599 (“[F]rom the perspective of college basketball players who seek to sell their skills, the teams [in the National Basketball League (NBA)] are distinct . . . .”).

That being said, we have nevertheless embraced the possibility that a professional sports league could be considered a single entity under Copperweld. Bulls II, 95 F.3d at 598. But see Fraser v. Major League Soccer, L.L.C., 284 F.3d 47, 55-56 (1st Cir. 2002) (citing Sullivan v. Nat’l Football League, 34 F.3d 1091, 1099 (1st Cir. 1994), to note that Bulls II has not yet been adopted by United States Court of Appeals for the First Circuit). But because of the many and conflicting characteristics that professional sports leagues generally exhibit, we have expressed skepticism that Copperweld could provide the definitive single-entity determination for all sports leagues alike. See id. at 599-600. This skepticism, in turn, has led us to opine that the question of whether a professional sports league is a single entity should be addressed not only “one league at a time,” but also “one facet of a league at a time.” Id. at 600. Thus, in reviewing the district court’s decision, we will limit our review to (1) the actions of the NFL, its members teams, and NFL Properties; and (2) the actions of the NFL and its member teams as they pertain to the teams’ agreement to license their intellectual property collectively via NFL Properties.

With this compartmentalization of Copperweld in mind, we turn to American Needle’s challenge to the district court’s single-entity determination. According to American Needle, the district court applied the wrong legal standard when concluding that the NFL teams were a single entity. As American Needle sees it, the district court concluded “that the NFL [t]eams are a single entity because they ‘act’ as a single entity in licensing their intellectual property.” American Needle asserts that this approach undercuts the Supreme Court’s central teaching in Copperweld: that the Sherman Antitrust Act was designed to combat the deprivation of independent sources of economic power in the marketplace. See 467 U.S. at 469-71.

Therefore, American Needle continues, instead of asking whether the NFL teams merely “ ‘act’ ” as a single entity, the district court should have inquired into whether the NFL teams’ agreement to license their intellectual property collectively deprived the market of sources of economic power that control the intellectual property. That question, the company contends, can be answered by looking to whether the teams could compete against one another when licensing and marketing their intellectual property. If so, American Needle posits, then it is the individual teams who actually control their intellectual property, meaning that they cannot be considered a single entity for the purposes of licensing their intellectual property.

We agree with American Needle that the Supreme Court in Copperweld was concerned about the anti-competitive effects that collective action might introduce into the market. We further agree that when making a single-entity determination, courts must examine whether the conduct in question deprives the marketplace of the independent sources of economic control that competition assumes.

But we are not convinced that the NFL’s single-entity status in the present context turns entirely on whether the league’s member teams can compete with one another when licensing and marketing their intellectual property. American Needle’s proposed approach is one step removed from saying that the NFL teams can be a single entity only if the teams have “a complete unity of interest”—a legal proposition that we have rejected as “silly.” Bulls II, 95 F.3d at 598. As we have explained, “Copperweld does not hold that only conflict-free enterprises may be treated as single entities”; “[e]ven a single firm contains many competing interests.” Id. at 598 (discussing Robert G. Eccles, Transfer Pricing as a Problem of Agency, in Principals and Agents: The Structure of Business 151 (1985)). Thus, though the several NFL teams could have competing interests regarding the use of their intellectual property that could conceivably rise to the level of potential intra-league competition, those interests do not necessarily keep the teams from functioning as a single entity. Id. at 597-98. We therefore cannot fault the district court for not considering whether the NFL teams could compete against one another when licensing and marketing their intellectual property.

And with that said, American Needle’s assertion that the NFL teams have deprived the market of independent sources of economic power unravels. Certainly the NFL teams can function only as one source of economic power when collectively producing NFL football. Asserting that a single football team could produce a football game is less of a legal argument then it is a Zen riddle: Who wins when a football team plays itself? See Nat’l Collegiate Athletic Ass’n v. Bd. of Regents, 468 U.S. 85, 101 (1984)(“‘[Some] activities can only be carried out jointly. Perhaps the leading example is league sports. When a league of professional lacrosse teams is formed, it would be pointless to declare their cooperation illegal on the ground that there are no other professional lacrosse teams.’ ” (quoting Robert Bork, The Antitrust Paradox 278 (1978))); Bulls II, 95 F.3d at 599 (“[T]he NBA has no existence independent of sports. It makes professional basketball; only it can make ‘NBA Basketball’ games . . . .”). It thus follows that only one source of economic power controls the promotion of NFL football; it makes little sense to assert that each individual team has the authority, if not the responsibility, to promote the jointly produced NFL football. Indeed, the NFL defendants introduced uncontradicted evidence that the NFL teams share a vital economic interest in collectively promoting NFL football. After all, the league competes with other forms of entertainment for an audience of finite (if extremely large) size, and the loss of audience members to alternative forms of entertainment necessarily impacts the individual teams’ success. See Bulls II, 95 F.3d at 597; see also Brown, 518 U.S. at 248 (“[T]he [teams] that make up a professional sports league are not completely independent economic competitors, as they depend upon a degree of cooperation for economic survival.”); Nat’l Football League v. N. Am. Soccer League, 459 U.S. 1074, 1077 (1982) (Rehnquist, J., dissenting) (“The NFL . . . competes with other sports and other forms of entertainment in the entertainment market. Although individual NFL teams compete with one another on the playing field, they rarely compete in the market place.”).

But most importantly, the record amply establishes that since 1963, the NFL teams have acted as one source of economic power—under the auspices of NFL Properties—to license their intellectual property collectively and to promote NFL football. Tellingly, American Needle does not dispute that the NFL teams collectively license their intellectual property to promote NFL football; in fact, when opposing the NFL defendants’ motion for summary judgment, American Needle relied on NFL Properties’s Articles of Incorporation, which state that the teams formed NFL Properties “[t]o conduct and engage in advertising campaigns and promotional ventures on behalf of the [NFL] and the member [teams].” And our review of the record reveals no evidence that requires us to question the purpose of the teams’ licensing agreement.

Simply put, nothing in § 1 prohibits the NFL teams from cooperating so the league can compete against other entertainment providers. Indeed, antitrust law encourages cooperation inside a business organization—such as, in this case, a professional sports league—to foster competition between that organization and its competitors. See Bulls II, 95 F.3d at 599. Viewed in this light, the NFL teams are best described as a single source of economic power when promoting NFL football through licensing the teams’ intellectual property, and we thus cannot say that the district court was wrong to so conclude.

Moving on, the failure of American Needle’s § 1 claim necessarily dooms its § 2 monopolization claim. As a single entity for the purpose of licensing, the NFL teams are free under § 2 to license their intellectual property on an exclusive basis, see Cook Inc. v. Boston Scientific Corp., 333 F.3d 737, 740 (7th Cir. 2003), even if the teams opt to reduce the number of companies to whom they grant licenses, see Bulls II, 95 F.3d at 598 (“To say that participants in an organization may cooperate is to say that they may control what they make and how they sell it: the producers of Star Trek may decide to release two episodes a week and grant exclusive licenses to show them, even though this reduces the number of times episodes appear on TV in a given market . . . .”); Gregory J. Werden, Antitrust Analysis.

of Joint Ventures: An Overview, 66 Antitrust L.J. 701, 730-31 (1998) (“An antitrust claim based solely on a single firm’s denial of a license to a trademark would readily be dismissed . . . .”). As such, American Needle has no colorable claim that the NFL teams and NFL Properties created a monopoly by awarding Reebok the exclusive headwear licensing contract. See Cook Inc., 333 F.3d at 740 (discussing competitive effects of exclusive-licensing agreements); Bulls II, 95 F.3d at 598. The district court was therefore correct to grant summary judgment to the NFL defendants on American Needle’s § 2 monopolization claim.