United States District Court, N.D. California
ORDER GRANTING MOTION TO DISMISS FIFTH AND SIXTH CAUSES OF ACTION IN THIRD AMENDED COMPLAINT RE: DKT. NO. 237
WILLIAM H. ORRICK, District Judge.
On April 25, 2014, I granted defendant SanDisk Corporation's motion to dismiss plaintiff PNY Technologies, Inc.'s Fifth and Sixth Causes of Action in the Second Amended Complaint ("SAC") because PNY failed to adequately allege that SanDisk's short-term, easily terminable exclusivity agreements with retailers unlawfully foreclosed competition in, or constituted an illegal attempt to monopolize, the market for Secure Digital cards ("SD cards"). Dkt. No. 218 ("Order"). I also granted PNY leave to amend its pleading. Id. On May 5, 2014, PNY filed a Third Amended Complaint ("TAC"). Dkt. Nos. 224, 250.
Because the TAC suffers from the same fundamental deficiency as the SAC, SanDisk's motion to dismiss PNY's Fifth Cause of Action for attempted monopolization and Sixth Cause of Action for exclusive dealing in the TAC is GRANTED.
PNY alleges the following new facts in its TAC:
SanDisk has entered into agreements with retailers making it their exclusive supplier of S.D. cards for sale to consumers. Many retailers enter these agreements because the agreements contain significant incentives in exchange for exclusivity. SanDisk's competitors, including PNY, are thus unable to reach consumers and competition is thereby harmed. SanDisk has attempted to monopolize the S.D. card market through these exclusive-dealing arrangements.
The United States retail channel is dominated by a limited number of retailers, such as Best Buy, RadioShack, Verizon, CVS, Target, and Costco. TAC ¶ 173. Of 16 major retailers, SanDisk has exclusive arrangements with 11. TAC Table 7. Of the five retailers where PNY is present, SanDisk is the only other competitor. TAC Table 7. "[O]n information and belief SanDisk has never lost an exclusive arrangement once it has been established." TAC ¶ 98. "[O]n information and belief, SanDisk has been known to threaten retaliation in the event [retailers] terminate their arrangements." TAC ¶ 184.
All of SanDisk's contracts with retailers identified in the TAC had terms ranging from one year to three years, with only one contract lasting three years. See, e.g., TAC ¶¶ 204, 220, 225, 235, 246. "SanDisk's exclusive arrangements, in practice and effect, are long-term" because retailers almost always renew those arrangements. See TAC ¶ 179. For example, SanDisk has had an exclusive agreement with Costco since 2001. TAC ¶ 179. Costco, however, has previously tested carrying the products of a competing manufacturer, Kingston; it is also currently testing products from Lexar. TAC ¶¶ 214-15.
SanDisk's agreements with retailers have "massive hard dollar incentives, corresponding penalties for non-exclusivity, and economic investments that make no sense for any rational economic action except to create a monopoly." TAC ¶ 168. For example, an internal SanDisk email from September 2012 shows that it was prepared to offer Rite Aid nearly [REDACTED/] dollars in marketing development funds and markdown funding in exchange for exclusivity (though there is no allegation that SanDisk actually presented such an offer). TAC ¶ 168. Similarly, SanDisk has offered up to [REDACTED/] in marketing funds and rebates for a 19-month exclusivity period. TAC ¶¶ 190-96. RadioShack's 2013 agreement included a [REDACTED/] marketing development fund contingent on exclusivity. TAC ¶ 206.
"Some of SanDisk's written exclusive dealing agreements have provisions that make it very difficult or expensive for retailers to terminate the arrangement." TAC ¶ 180. For example, through the use of "co-op funding, " a retailer can accrue advertising funds based on its purchases from a manufacturer, but if the funds are not fully used by the end of a contract term, the retailer will be "leaving unused funding on the table" if it does not extend its agreement. TAC ¶ 180. Another "practical" impediment to ending an exclusive agreement is retailers' use of "planograms, " i.e., schedules for arranging product displays, which occur on pre-determined cycles that may not coincide with the term of a supply contract. TAC ¶ 181. "To the extent the end of an exclusive dealing agreement and the end of the planogram cycle do not align, it may not be possible for a competing seller of S.D. cards to persuade a retailer to terminate the exclusive arrangement." TAC ¶ 181. Finally, SanDisk's S.D. cards are considered a "must-have" product for retailers. TAC ¶ 182.
"SanDisk's exclusive arrangements with retailers are reflected in written agreements but may also be based on oral or informal understandings, not found in the written agreements.... Accordingly, the terms and conditions of SanDisk's exclusive arrangements may not be determined solely from SanDisk's written agreements." TAC ¶ 178. Staples's agreement does not have an exclusivity requirement, but it is "economically motivated to maintain the exclusive arrangement." TAC ¶ 248.
"PNY has made numerous attempts to compete with SanDisk at retailers at which SanDisk has established an exclusive arrangement. These attempts have been unavailing." TAC ¶ 185. For example, Costco once rejected PNY's offer of pricing on S.D. cards "that was below PNY's cost on a special promotion." TAC ¶ 185. Similarly, RadioShack, CVS, and Walgreens have "expressly communicated to PNY that it is precluded from even entertaining a proposal from PNY because of its exclusive arrangement with SanDisk." TAC ¶ 157; see also TAC ¶¶ 183, 186.
SanDisk's internal documents reflect that it targeted PNY in its drive for exclusivity. TAC ¶ 170. A November 2012 SanDisk email chain shows that while SanDisk was negotiating an exclusive agreement with Best Buy, Best Buy said that "while [SanDisk] sell[s] more, PNY provides more margins." TAC ¶ 188 (original brackets). In response, SanDisk prepared a spreadsheet showing a benefit of [REDACTED/] to Best Buy premised on replacing PNY's lower-priced products with SanDisk's higher-priced products. TAC ¶ 188. SanDisk and Best Buy also discussed selling SanDisk products under another brand name so that consumers would not know that "one vendor manages the entire category, " though there is no allegation that this was done. TAC ¶ 189. Another email from April 2011 shows that SanDisk hoped that PNY would be out at Walgreens. TAC ¶ 234.
In 2007, SanDisk's market share in retail sales of S.D. cards was 32 percent. TAC ¶ 162. In July 2011, SanDisk's market share was 47 percent; by December 2013, after entering into exclusive agreements with Best Buy, CVS, Walgreens, and BJ's, its market share reached 66.1 percent. TAC ¶ 172. Concurrently, PNY's market share dropped from 22.3 percent to 11 percent. TAC ¶ 172. During the same period, Lexar's share grew from 5.8 to 6.4 percent; Sony's share fell from 4.7 to 3.9 percent, Transcend's share fell from 4.3 to 2.6 percent, and other retailers fell from 15.8 to 10 percent. TAC Table 6. In March 2014, SanDisk accounted for over 60 percent of S.D. card sales. TAC ¶ 95. SanDisk "recently enticed" Walmart to enter into an exclusive agreement with it - if Walmart accepts, SanDisk will control over 75 percent of the retail distribution channel for S.D. cards. TAC ¶ 251.
Despite the fact that the price of flash memory (a component of S.D. cards) has dropped by 45 to 52 percent, SanDisk's prices on S.D. cards at Best Buy have been "nearly level" and have not been reduced since July 2013, when SanDisk entered an exclusive agreement with Best Buy. TAC ¶¶ 278-80 & Tables 14, 15. Though the components of an S.D. card and a USB flash drive are very similar and thus their costs are similar (though USB flash drives cost slightly more because they require additional outer housing), Best Buy has been charging over 50 percent more for 16 gigabyte S.D. cards - for which SanDisk has an exclusive agreement with Best Buy - than it charges for similarly sized USB flash drives - for which PNY competes with SanDisk on Best Buy's shelves. TAC ¶ 282. A similar trend has occurred at Staples, where SanDisk dropped its price for a short time when PNY competed against it, then raised its prices when it reached an exclusive deal. TAC ¶¶ 281 & Tables 16, 17.
Over the course of 2011, "brick and mortar" retailers accounted for approximately 81 to 87 percent of S.D. card sales while "e-tail" sales - which include direct sales by manufacturers - accounted for approximately 13 to 19 percent. TAC ¶ 105 & Table 5. PNY's own experience with direct sales "confirms that the direct sales channel is not a viable alternative to the retail channel": PNY has invested heavily in promoting its products online, offering better prices than retailers, yet its direct-channel sales in - were less than one percent of its total S.D. card sales. TAC ¶ 102. SanDisk's internal documents show that it "places an emphasis on driving the retail business." TAC ¶ 161.
"On information and belief, no other major manufacturer of S.D. cards - including giants like Toshiba, Samsung, and Micron - has had any meaningful success in building a direct sales channel." TAC ¶ 103. One "likely" reason is that S.D. cards are often purchased at the point of sale along with devices such as cameras and cell phones since consumers would rather not wait for S.D. cards to be delivered through the mail a few days later. TAC ¶ 103. Because S.D. cards are often purchased as part of a bundle, "customers are often insensitive to the price of S.D. cards, do not consider alternative sources for S.D. cards, and are willing to pay an inflated price at retail for their S.D. card." TAC ¶ 104. "Because of the need for personalized service and product demonstrations, established brick and mortar retailers have a substantial advantage over internet sales" and online sales have been stagnant, at least from January to December 2011. TAC ¶¶ 103-04 & Table 5.
"On information and belief, " it has become considerably more expensive and difficult for a new market entrant to develop the necessary distribution network, relationships, and brand recognition to become a meaningful competitor in the S.D. card market. TAC ¶ 100. Other constraints prevent expansion by existing firms, including: SanDisk's ability to deprive a firm of its license from SD-3C ("an entity combining certain SanDisk, Panasonic, and Toshiba intellectual property"); the ...