Price Fixing and Minimum Resale Price Restrictions Are Two Different Animals

The world of minimum resale price maintenance (RPM) has been in flux in recent years. In 2007, the U.S. Supreme Court relaxed antitrust restrictions on the practice, and in response, legislation was introduced in the U.S. Senate to change the antitrust laws and re-strengthen regulation in this area.[1] This article informs managers about the differences between price fixing and minimum RPM; the potential risks and rewards of employing a minimum RPM strategy; and the state of the economic, legal, and political environment with respect to minimum RPM. Consequently, managers should be able to make better decisions regarding “one of the hottest issues in retailing: whether manufacturers can force retailers to charge customers a minimum . . . price.”[2]

Horizontal Conspiracy among Competitors

Classic price fixing is typically referred to as horizontal price fixing in supply chain terminology, horizontal arrangements are those between competitors operating at the same level of distribution, and vertical arrangements are those between businesses operating at distinct levels of distribution. Horizontal price fixing is an agreement among competitors to restrain price competition in some way. Two examples of such agreements were in the mid-1990s, when Archer Daniels Midland executives were caught on FBI surveillance tapes fixing the price of lysine, a feed additive, with competitors across the globe, and in 2007, when multiple airlines were fined more than $1 billion for colluding to fix fuel surcharges from 2004 to 2006.[3]

Price-fixing arrangements are agreements among competitors to compete less vigorously; they can affect prices, price formulas, margins, discounts, or wages. They also can allocate customers or sales volume across competitors without explicit discussion of prices. One company’s unilateral conduct, which involves no explicit or implicit agreement among competitors, does not constitute price fixing.

Social Harm

An economic analysis of price fixing is relatively simple. In a quest for enhanced profits, conspirators agree to set prices above levels obtained in a competitive environment, thereby minimizing competition and reducing output. This harms both consumers and overall economic wellbeing there are no consumer or social benefits from price fixing.

Legal Status of Price Fixing

Typical of antitrust legislation, economic analysis of conduct is the impetus for law. The U.S. Supreme Court has long held that price fixing agreements are “per se” unlawful; that is, they are illegal “without elaborate inquiry as to the precise harm they have caused or the business excuse for their use.”[4] According to the Court, per se rules should be confined to business conduct “that would always or almost always tend to restrict competition and decrease output.”[5] Price-fixing agreements do exactly this and pose an “actual or potential threat to the central nervous system of the economy.”[6] The free-market competitive process in the United States is the foundation of the enormous growth in standard of living over the past 200-plus years. As price fixing threatens that process, it is taken very seriously and punished strictly.

Businesspeople should expect legal repercussions, even incarceration, if they engage in price fixing. Businesspeople with advanced degrees, such as MBAs, should expect more severe penalties, such as longer prison sentences, as they “should know better.” The rule of thumb is to never discuss prices with competitors do not even appear to discuss prices. Price fixing should be painstakingly avoided in business.

Minimum RPM is Vertical and is Not an Agreement among Competitors

Minimum RPM is a vertical price restriction imposed by an upstream manufacturer on downstream distributors, dealers, or retailers (henceforth, all will be referred to as “retailers”). Typically, a manufacturer specifies a minimum price above which its retailers must sell its product(s). The manufacturer monitors the retailers or employs a monitoring agent[7] to ensure their performance. If retailers are discovered pricing below the specified minimum price, they are terminated or threatened with termination.

Sony, LeapFrog, Black & Decker, Cisco Systems, JVC, Samsung, and Panasonic have all employed minimum RPM strategies.[8] Other examples include:

• In 1997, Leegin Creative Leather Products instituted a “Brighton Retail Pricing and Promotion Policy” for retailers selling their women’s fashion accessories. Leegin terminated retailers who priced below the suggested level.[9]
• From 1988 to 1999, Nine West Group used minimum RPM to restrict the retail prices of their women’s shoes and their dealers’ promotional periods.

Minimum RPM is frequently referred to by politicians, members of the media, and sometimes lawyers as vertical price fixing;[10] but that terminology is inaccurate and misleading as it imparts the negative connotation of horizontal price fixing conspiracies on a non-conspiratorial practice that often has legitimate business purposes and consumer benefits.[11] While use of minimum RPM is sometimes alleged in the operation of price-fixing conspiracies,[12] in and of itself no other competitors are involved in the decision. Minimum RPM is a vertical price restriction, not a price-fixing arrangement.

Uses and Abuses of Minimum RPM

Possible Benefits

Minimum RPM arrangements can prevent consumers from “free-riding” on retailers’ provision of special services. For example, take the case of a high-tech camera manufacturer. Full-service retailers providing well-trained sales personnel, well-staffed sales floors, product demonstrations, and other promotional services are unlikely to be able to compete on price with discount retailers who provide few or no services. If the price difference is large enough, consumers have an incentive to obtain services at a full-service retailer before buying the camera from a discount retailer. Over the long run, this discourages full-service retailers from providing special services, and consequently, harms the manufacturer via lost incremental sales and competitive disadvantage.  Minimum RPM can prevent this type of consumer free-riding by restricting the ability of discount retailers to undercut full-service retailers.

Minimum RPM can mitigate problems between manufacturers and retailers even when consumers are unlikely to free-ride. For example, when retailers decide on the level and types of services and sales effort to provide for a product, they consider their own markup, not the manufacturer’s. Suppose that Levi Strauss & Co, a popular denim wear manufacturer, has a $50 wholesale markup on a brand of women’s jeans while its retailer has a $10 retail markup. The retailer would not spend $15 on promotional displays or extra sales efforts that would induce one additional consumer to buy; however, Levi’s profits would increase, so it is in Levi’s interest to motivate the retailer to invest and compete for incremental sales.[13] This example illustrates just how easily the private interests of retailers and manufacturers can be misaligned, especially when there is a large difference in markups. In stark contrast to price-fixing arrangements, promotional, brand image, or sales-effort investments are competitive and geared towards incremental sales.

To address the incentive problem, minimum RPM arrangements would offer larger discount-restricted markups to retailers; convey the types of services, effort, and brand image desired;[14] monitor retail prices, and terminate retailers who do not comply. They serve as a “premium-termination” contract enforcement mechanism by restricting price at the retail level in order to enhance other forms of non-price competition.[15] If a manufacturer were interested in using its market power to raise consumer prices, it could simply increase its wholesale prices to retailers. In the end, minimum RPM yields a larger markup for retailers as opposed to manufacturers. This is a common phenomenon in economics: a business practice that appears to harm competition actually has a legitimate, competitive justification when analyzed more exhaustively.[16]

In price-fixing conspiracies, the initiators are competitors who realize that they will be better off if they minimize group competition. With minimum RPM, a single manufacturer influences downstream retailers’ behavior through an increased markup, so they will compete more aggressively on non-price dimensions; meanwhile, competition amongst manufacturers is not affected. This enhances intra-brand non-price competition and overall inter-brand competition via a non-conspiratorial restriction of intra-brand price competition. The net effect on consumers and social wellbeing requires a deeper analysis and more careful consideration than is currently provided by those who label minimum RPM “vertical price fixing.”[17]

Possible Harm

The common scenarios in which minimum RPM purportedly harms the market involve price fixing and exclusion of rivals. Minimum RPM is sometimes alleged to support a price-fixing conspiracy between competing manufacturers or a price-fixing conspiracy between retailers who collectively pressure the manufacturer to implement minimum RPM. A 1991 study in the Journal of Law & Economics estimated that only 13 percent of minimum RPM cases filed over a seven-year period included allegations of horizontal price fixing.[18] Even so, price fixing should never be undertaken, whether or not the conspiracy involves minimum RPM. If a businessperson’s retailers apply pressure to implement minimum RPM or increase minimum prices, the businessperson may be accused of facilitating a retail price fixing conspiracy. Do not take part in this. Immediately seek legal counsel.

Another scenario in which minimum RPM may harm the competitive process is when attractive retail markups, provided by minimum RPM, induce retailers not to stock the products of a manufacturer’s competitors. Such exclusion is similar to a manufacturer using exclusive contracts at the retail level to exclude rivals from “retail space” critical to competition. This scenario requires that a manufacturer have a substantial market share.

Legal Status of Minimum RPM

In 1911, the U.S. Supreme Court held that minimum RPM arrangements are per se illegal when a manufacturer agrees with retailers on a minimum retail price.[19] A loophole was created in 1919 when the Court allowed manufacturers to unilaterally impose minimum RPM, provided there was no agreement with retailers. In what is known as the “Colgate Doctrine,” the Court noted that antitrust law, in particular the Sherman Act, “does not prevent a manufacturer engaged in a private business from announcing in advance the prices at which his goods may be resold and refusing to deal with wholesalers and retailers who do not conform to such prices.”[20] Passed in 1890, the Sherman Act was the first U.S. federal antitrust statute.  It was designed to promote competition by limiting the monopolistic restraint of trade and certain types of monopolization of markets.

Over time, antitrust laws evolve as economic knowledge and research progress and new insights are gleaned into procompetitive reasons for hard-to-understand business practices. Since “the economics literature is replete with procompetitive justifications”[21] for minimum RPM, the practice can offer business and consumer benefits, and does not “always or almost always” restrict competition. The Supreme Court determined that minimum RPM agreements should be judged according to the “rule of reason” in a landmark June 2007 decision (Leegin Creative Leather Products, Inc. v. PSKS, Inc., i.e. the Leegin decision).[22]

“Rule of reason” determines illegality on a case-by-case basis, whereby “the factfinder weighs all of the circumstances of a case in deciding whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition.”[23] This rule not only examines circumstances, but also weighs likely harm as well as legitimate business justifications and consumer benefits (i.e., procompetitive justifications). Thus, minimum RPM is not always legal or illegal, but each case will be analyzed on an individual basis, taking all relevant factors into consideration. It is worth noting that a significant amount of U.S. state law and legislation conforms to the new federal standard, but not all do.[24]

Recent Developments in Minimum RPM

In 2007, U.S. senators sponsored the Discount Pricing Consumer Protection Act as a bill “to correct the Supreme Court’s mistaken interpretation of the Sherman Act in the Leegin decision.”[25] The bill did not pass by the end of the 110^th Congress, but has already been re-sponsored in the current 111^th Congress. It would amend the antitrust laws to restore the rule that minimum RPM agreements violate the Sherman Act.[26] The attorneys general of 35 states support the bill, while the Department of Justice and the Federal Trade Commission (FTC) support the Leegin decision.[27]

The Leegin decision is already affecting business practices in the United States. In March 2000, Nine West settled its use of minimum RPM agreements with the FTC. In May 2008, after the Leegin decision, the FTC modified its order and allowed Nine West to use minimum RPM agreements, subject to periodic reports. Relying on the rule of reason rationale, the FTC evaluated the merits of this particular case, and determined that Nine West’s use of minimum RPM agreements did not “pose any potential competitive concerns” because of “among other things, ‘its modest market share.'”[28] Because of the Leegin decision, the courts and the FTC are not forced to prohibit business decisions that are competitive in nature and they can study those that fall into a shade of gray.

Summary and Conclusions

To associate minimum RPM with the term “price fixing” is improper and flat-out wrong. Minimum RPM is a business practice that can benefit companies and consumers in stark contrast to price-fixing conspiracies. With the Leegin decision, federal law conformed to economic analysis, recognizing minimum RPM’s potential benefits and the reality that it does not “always or almost always” restrict competition. Thus, managers should treat minimum RPM as any other strategic business practice that has potential benefits but can be abused, such as exclusive contracts, tie-in sales, exclusive territories, and maximum RPM.

Minimum RPM arrangements should be carefully analyzed to predict and weigh all of the risks and rewards. If a manager has a competitive interest in a minimum RPM strategy, expert antitrust legal advice should be obtained, especially considering the pending bill (which will affect agreements, as opposed to unilateral conduct, if passed) and the different state laws that may be inconsistent with federal law.

Remember, minimum RPM is not price fixing in the economic sense, no matter what politicians say or the media writes. If fully informed and strategically employed, minimum RPM can solve a company’s incentive problems with retailers, enabling it to more effectively compete against rival brands by better managing its brand image and providing desired promotional services and sales effort.

[1] Joseph Pereira, “Group Hits Manufacturers’ Minimum Pricing,” The Wall Street Journal, December, 4, 2008, at A4; GovTrack.us, S. 2261: Discount Pricing Consumer Protection Act, http://www.govtrack.us/congress/bill.xpd?bill=s110-2261; and Joseph Pereira, “Discounters, Monitors Face Battle on Minimum Pricing,” The Wall Street Journal, December, 4, 2008, at A1.

[2] Joseph Pereira, John R. Wilke, “Instruments, Audio Gear Scrutinized In Price Probe,” The Wall Street Journal, October, 23, 2008, at B1.

[3] The Associated Press, “British Airways and Korean Air Lines Fined in Fuel Collusion,”The New York Times, August, 2, 2007, at 6.

[4] Northern Pacific R. Co. v. United States, 356 U.S. 1 at 5 (1958).

[5] Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717 at 723 (1988).

[6] United States v. Socony-Vacuum Oil Co., Inc., 310 U.S. 150 at 224 (1940).

[7] For examples of monitoring agents, see Joseph Pereira, “Discounters, Monitors Face Battle on Minimum Pricing,” The Wall Street Journal, December, 4, 2008, at A1.

[8] Joseph Pereira, “Why Some Toys Don’t Get Discounted,” The Wall Street Journal, December, 24, 2008, at D1; Joseph Pereira, “Discounters, Monitors Face Battle on Minimum Pricing,” The Wall Street Journal, December, 4, 2008, at A1.

[9] Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007).

[10] Joseph Pereira, “Price-Fixing Makes Comeback After Supreme Court Ruling,” The Wall Street Journal, August, 18, 2008, at A1; Andrew Noyes, “Senate Judiciary Starting To Build Agenda For Next Session,” CongressDaily/P.M., December 8, 2008; and J.L. Himes, “New York’s Prohibition of Vertical Price-Fixing,” New York Law Journal, 239, no. 19 (2008).

[11] In fact, in the Supreme Court’s 2007 Leegin decision, they used the terminology “vertical price fixing” twice, while using the terminology “vertical price restraint”and “resale price maintenance” numerous times.

[12] P. Ippolito, “Resale Price Maintenance: Empirical Evidence from Litigation,” Journal of Law & Economics, 34, no. 2 (1991): 263–294.

[13] Notice that this is similar to the real estate agent incentive incompatibility described in Steven D. Levitt, Stephen J. Dubner, Freakonomics, (New York: HarperCollins, 2005).

[14] For example, the “Brighton Retail Pricing and Promotion Policy” of the Leegin case.

[15] B. Klein, K.M. Murphy, “Vertical Restraints as Contract Enforcement Mechanisms,” Journal of Law & Economics, 31, no. 2 (1988): 265–296 at 295.

[16] For more information on the economics of minimum RPM, see Kenneth G. Elzinga, David E. Mills, “The Economics of Resale Price Maintenance,” in ABA Section of Antitrust Law, Issues in Competition Law and Policy, Wayne D. Collins (Ed.) (Chicago: ABA Book Publishing, 2008); B. Klein, K.M. Murphy, “Vertical Restraints as Contract Enforcement Mechanisms,” Journal of Law & Economics, 31, no. 2 (1988): 265–296; H.P. Marvel, S. McCafferty, “The Welfare Effects of Resale Price Maintenance,” Journal of Law & Economics, 28, no. 2 (1985): 363–379; and L.G. Telser, “Why Should Manufacturers Want Fair Trade?” Journal of Law & Economics, 3 (1960): 86–105.

[17] See, for example, R.A. Posner, “The Next Step in the Antitrust Treatment of Restricted Distribution: Per Se Legality,” University of Chicago Law Review, 48, no. 1 (1981): 6–26 at 21; B. Klein, K.M. Murphy, “Vertical Restraints as Contract Enforcement Mechanisms, “Journal of Law & Economics, 31, no. 2 (1988): 265–296 at 291.

[18] Supra note 12 at 281.

[19] Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911).

[20] See Syllabus of United States v. Colgate & Co., 250 U.S. 300 (1919). Note that the legal distinction between an agreement with retailers and unilateral conduct can be a very thin line. If a unilateral minimum RPM policy is being considered, one should obtain expert antitrust legal advice, before the policy is implemented.

[21] Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 at 2714 (2007).

[22] Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007).

[23] Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36 at 49 (1977).

[24] For state-by-state information on resale price maintenance legislation and litigation, see M.A. Linsey, “Overview of State RPM (Complete),” Antitrust, 22, no. 1 (2007).

[25] GovTrack.us, S. 148: Discount Pricing Consumer Protection Act, http://www.govtrack.us/congress/bill.xpd?bill=s111-148.

[26] Note that the act intends to restore the Dr. Miles decision, with respect to agreements between manufacturers and retailers. It does not attack minimum RPM arrangements that are unilaterally imposed by a manufacturer, within the parameters of the Colgate Doctrine. This distinction is more of a legal issue, as the economic benefits of minimum RPM do not hinge on its unilateral imposition relative to an agreement with retailers, so long as a horizontal price fixing conspiracy is not involved.

[27] Supra note 22 at 2721.

[28] “FTC Modifies Order in Nine West Resale Price Maintenance Case,” press release, Federal Trade Commission, May 6, 2008. For more information on Nine West’s use of minimum RPM and the FTC’s lawsuit, settlement, and subsequent modification, see “In the Matter of Nine West Group Inc.,” Federal Trade Commission, File No. 981 0386, Docket No. C-3937.