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Resale Price Maintenance: Economic Evidence from Litigation

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""-- . ,, , '.. " , " ..""' , , " , , , - , RESALE PRICE MAINTENANCE Economic Evidence From Litigation Pauline M. Ippolito BUREAU OF ECONOMICS ST'AFF REPORT FEDERAL TRADE COMMISSION APRIL 1988 . FEDERAL TRADE COMMISSION DANIEL OLIVER Chairman PATRICIA P. BAILEY Commissioner TERR Y CAL V ANI Commissioner MAR Y L. AZCUENAGA Commissioner ANDREW J. STRENIO Commissioner BUREA U OF ECONOMICS DA VID T. SCHEFFMAN Director JOHN L. PETERMAN -'\ssociate Director for Policy RONALD S. BOND Deputy Director for Operations and Consumer Protection MARK W. FRANKEN A Deputy Director for Antitrust JAMES A. LANGENFELD Deputy Director for Economic Policy Analysis DENIS A. BREEN Assistant Director for Antitrust II ROBER T D. BROGAN Assistant Director for Antitrust I GERARD R. BUTTERS Assistant Director for Consumer Protection PAUL A. PAUTLER Assistant Director for Economic Policy Analysis This report has been prepared by staff of the Bureau of Economics of the Federal Trade Commission. It has not been reviewed by, nor does it necessarily reflect the views of, the Commission or any of its members. ACKNOWLEDGEMENTS I would like to thank Richard Ippolito, Alan Mathios, Stanley Ornstein, Paul Pautler, George Sweeney, and especially Mark Frankena for helpful comments on earlier versions of this work. I would also like to thank Thomas Overstreet and Michael Knoll who compiled the original listing of cases with funding from the Small Business Administration. 111 EXECUTIVE SUMMARY Resale price maintenance (RPM) is a practice by which a manufacturer limits the retail or wholesale price for its product. RPM is oer illegal under the antitrust laws, but many commentators have suggested that this legal prohibition inappropriate. Minimum RPM occurs when the manufacturer sets a lower limit on resale prices. ' If manufacturers use minimum RPM to facilitate horizontal price- fixing with other manufacturers (by making it easier to detect cheating on the collusion for instance), or if manufacturers are induced by dealers to use RPM to fix retail margins above competitive levels, then RPM is likely to , injure consumers and the legit prohibition of minimum RPM may be beneficiaL However, if individual manufacturers use RPM in order to provide the incentives for dealers to generate a variety of services or selling efforts RPM is likely to benefit consumers under most circumstances. In this case, the legal rules against the use of minimum RPM may reduce the efficiency of retail and wholesale distribution systems and thus injure consumers. The extent to which minimum RPM would be of the collusive type, as opposed to the service-enhancing type, is thus a central Question in determining the most appropriate legal rules on the use of RPM Since the repeal of state Fair Trade laws in 1975, all RPM has been oer se illegal. Thus, the only available evidence for the S. in recent years comes from cases in which firms were alleged to be using RPM. This study examines a large sample of private and government cases that alleged RPM between 1976 and 1982. The analysis of various subsets of these cases suggests that the collusion theories of minimum RPM explain few instances of its use; the collusion theories are possible explanations for more than 15 percent of all the cases and for a smaller portion of the private cases. Moreover most of these potential collusion-type cases were pursued effectively under existing, horizontal price-fixing doctrines, suggesting that the ner rule against RPM may not be important in deterring this type of cond uct. In contrast, virtually all of the cases' appear to be consistent with at least one of the service-enhancing theories of minimum RPM The most prominent of these theories, the "special services theory, in which minimum RPM is used to prevent discounting dealers from "free-riding on pre-sale services provided by other dealers, is found to be a potentially important explanation for ' the practice. However, this theory does not appear to be the explanation for aU uses of RPM At least 30 percent of the cases involve types of products for which the special services" theory is an implausible explanation for the use of RPM The evidence suggests that a quality-control theory, in which the manufacturer uses RPM (and other controls) to protect its Quality reputation by inducing dealers to provide higher Quality pre- .and post-sale services to consumers, may . be ' equally important explanation for the use of RPM. RPM's ability to enhance dealer sales efforts, especially at the wholesale , level is also found to be a potentially important explanation for RPM. The use of RPM' to insure de:alers against demand risk by limiting price reductions in bad markets does not appear to explain many of the cases. Thus, while no individual service-enhancing theory appears able, to explain all uses of RPM, these theories, taken cases.together, do provide potential , explanations for virtually aU of the The study also shows that approximately 30 percent of private RPM litigation, involves maximum rather ' than minimum RPM. ' This, litigation generaUy raises consumer prices without offsetting benefits, and thus, the ner se rule against maximum RPM almost surely injures consumers. Moreover, the prevalence of this type of RPM litigation indicates, that these losses are larger than many have supposed. Finally, several characteristics of the private case sample suggest that many allegations of RPM may, in fact, have little to do with the actual ' practice of RPM Many of the cases appear to be contract disputes or other business disagreemen ts recast as antitrust allegations. If accurate, these findings imply that the oer se illegal standard" for RPM, together with the triple damage awards of private antitrust litigation, may 'deter a variety of manufacturer-dealer business, practices besides RPM itself. doing so, this oer se illegal standard may' have undesirable effects on the efficiency of distribution systems beyond those usually recognized in the policy debate. ' . CONTENTS I. INTRODUCTION AND SUMMARY II. ECONOMIC THEORIES OF RPM A. Basic Issues in the Debate B. RPM as an Aid to Collusion C. RPM and the "Special-Services" Theory D. RPM and Agency Problems Between Manufacturers and Dealers 1. RPM When the Deaier Can Influence Prod uct Quali ty 2. RPM Where Sales Effort by the Dealer the Most Efficient Way to Increase Sales 3. RPM When 'Demand Is Uncertain 4. Summary of RPM's Use to Diminish Agency Problems E. Other RPM Theories and Issues I. When Dealers Have Market Power 2. When Consumers Differ F. Summary III. STUDY DESIGN AND DATA A. Litigated Cases as a Sample for Study 1. Why Examine Litigation? 2. Deterrence and the Decision to Challenge RPM 3. Settlement Versus Litigation 4. Summary B. Description and Summary of the Data: RPM Cases, 1976 - 1982 I. Sample of Cases 2. Nature of the Vertical Price-Fixing Allega tions 3. Origin of Cases 4. Case Outcomes 5. Number of Cases 6. Other Antitrust Allegations 7. Legal Standard 8. Damage A wards IV. EVIDENCE ON THE USE OF MINIMUM RPM A. RPM as an Aid to Collusion B. RPM and the "Special-Services" Theory C. RPM and Principal- Agent Problems 1. QualityWhen Dealers Can Influence Product 2. Where Sales Effort by the Dealer is the Most Effi~ient Way to Increase Sales 3. When Demand is Uncertain 4. Summary of Evidence on Agency Theories of RPM D. RPM and Individual Dealer Market Power E. Summary V. MAXIMUM RPM CASES VI. CONCLUSIONS BIBLIOGRAPHY APPENDIX -- RPM Cases, 1976 - 1982 viii ,...., .. "'.., TABLES Table I Vertical Price-Fixing Cases, By Origin Ta ble 2 Decisions for Vertical Price-Fixing Charges Ta ble 3 Number of Cases With a Vertical Price- Fixing Charge, By Year Ta ble 4 Other Antitrust Charges in Cases With a Vertical Price- Fixing Charge Ta ble 5 Minim um RPM Cases Alleging Horizon tal Collusion Ta ble 6 Minimum RPM Cases Alleging Horizontal Collusion, Adjusted Sample Table 7 Types of Distributors in Minimum RPM Cases Table 8 Products in Minimum RPM Cases, Classified According to Consumer s Pre-purchase Information Needs Ta ble 9 Products in Minimum RPM Cases, Classified According to Dealer s Ability to Influence Consumer Satisfaction Table 10 Products in Independent Wholesaler / Retailer Cases Table Maximum RPM Cases Table Al Cases With a Vertical Price-Fixing Allegation, 1976 - 1982 Ta ble A2 Court and CCH Citations for ' Cases With a Vertical Price-Fixing Allegation 1976 - 1982 I. INTRODUCTION AND SUMMARY There is probably no area of antitrust activity that has generated more controversy than that dealing with vertical restraints. Generally, a manufacturer actions are considered vertical" if they affect the activities of distributors or retailers rather than those of other manufacturers at the same level of productive activity. Typical examples of vertical restraints are franchise arrangements, territorial or customer restrictions, tying arrangements, exclusive dealing requirements, and resale price maintenance (RPM). The economic view of vertical restraints has generally progressed from exclusive concern about their potential anti-competitive use to the current view that recognizes their potential efficiency motivations as well. The legal treatment of vertical restraints has been even more unsettled, moving from general legality, to oer illegality, to legality under state sanction (often with broad enforcement rules), back to Der illegality, and finally to the current standard: vertical non-price restraints are judged under a rule of reason standard, and vertical price restraints under a oer se illegal standard, with For example, a manufacturer might require that an ice cream franchise use particular storage and preparation methods as condition of receiving a franchise (a franchise requirement); that a beer distributor limit sales to a specified geographic area (a territorial restraint); that an auto dealer purchase all replacement parts from the manufacturer (a tying arrangement); or that a tire dealer sell only the manufacturer s brand (an exclusive dealing requirement).
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