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A recent article argues “65 percent of today’s elementary aged kids may end up doing work that hasn’t even yet been invented.” This is a thought provoking number and it points to the disruptive nature of innovation and its impact on a variety of labor markets. There is a portion of the downturn in legal hiring that is associated with the business cycle. When economic conditions improve – there should be a rebound. However, starting even before the recession, it is reasonably clear that a serious structural change was underway. Expect this broader trend to continue. As Bruce H. Kobayashi & Larry E. Ribstein have argued, we are at the very beginning of Law’s Information Revolution. Whether we like it or not, informatics, computing and technology are going to change both what it means to practice law and to “think like a lawyer.”
Yesterday’s Fast is Today’s Slow: For better or for worse, when it comes to building software, there is nothing deeply exceptional about a subset of tasks undertaken by lawyers. In this vein, law is like other industries. The bundle of skills associated with the practice of law falls on a continuum – where a number of basic tasks have already been displaced by computation / automation / “soft” artificial intelligence. Faced with cost pressures, legal information technology is being leveraged to either automate or semi-automate tasks previously performed by teams of lawyers. Namely, a series of first generation innovations such as e-discovery and automated document generation have already imposed significant consequences on the legal services market. Like many industries before it – the march of automation, process engineering, informatics, supply chain management and quantitative prediction will continue to operate and transform the industry. In fact, when it comes to the application of the leading ideas in computation, informatics and other allied disciplines, the market for legal services lags behind many other sectors. In other words, this is only the beginning.
As I have mentioned previously, what is very much in play is the infamous line from There Will be Blood – “I Drink Your Milkshake.” In this metaphor, technology is the straw and the legal information engineer is Daniel Day Lewis.
The Scandal of the Profession: Legal Service Provision at the Retail Level: Technology is a disruptive force but it can also be a force for good. At the retail level, legal services are simply too expensive. For years, the outright inability to provide reasonably priced legal services for even simple tasks has forced millions of Americans to go it alone.
Companies such as LegalZoom have admirably tried to fill this gap. However, various regulatory limits such as the bar on corporate law firm ownership and limits on the unauthorized practice of law have prevented a real solution to the problem of the unlawyered population. With respect to corporate law firm ownership, both Renee Knake and Gillian Hadfield highlight the significant potential upside for the consumer. The ability to apply process engineering, leverage supply chain techniques and analyze queueing data should allow for the unlawyered to become lawyered at an affordable price point.
Although the job will likely come with a lower salary, a service delivery model at the lower end of the market should help create net jobs for lawyers. When it comes to deregulation, I would consider myself to be a pragmatist. Given just how bad the current model of legal service delivery actually serves the average consumer – we should be prepared to usher in the age of reasonably regulated corporate law firms (i.e. the age of WalMart Law / Google Law/ etc.).
London Calling: I would like to also highlight at least one additional upside of a rapid move toward corporate law firm ownership – the ability of U.S. non-firm firms to be global competitive. As has been mentioned by others, the UK has recently modified their Legal Services Act such that WH Smith Law / Tesco Law / etc. will likely go live in the coming months. Given this rule change, it is likely that the UK is going to generate the service delivery model and ultimately export that model to the United States (not the other way around). The future is likely to have fewer lawyers (as we traditionally understand them today). However, the future will also give birth to completely different job sub-sectors.
The center of the legal world may very well shift toward London. I am quite concerned that presence of the ban on corporate law firm ownership will cause the United States to be left out of a significant portion of the new jobs created during this new era of legal service delivery. London (and not somewhere in United States) may become the Silicon Valley of the Law’s Information Revolution.
Why? Because the UK is going to develop the business model, the UK is going to develop the internal logistics and the UK is going to develop the legal information technologies that will allow it to become the center of the 21st Century legal universe.
Product Differentiation in the Market for Legal Education and Being Part of the Solution: Professor Campos has asked us to be part of the solution. I agree we should be part of the solution. However, what is the solution? What is the positive agenda? How can legal education be reoriented to help increase the chances that our students are able to secure employment?
Across the entire economy as well as within the law business, there is a great skills mismatch. Thus, the question that should be asked is what class of skills an individual needs to be successful in the 21st Century law practice.
If our students are going to survive (thrive) in this market, they need to be trained to efficiently leverage information technology and in some cases develop a new class of information products. This is an age of technology – an age of information – so you might wonder – where is the MIT School of Law? As Larry Ribstein has argued, we need product differentiation in the market for legal education. Arbitrage opportunities abound – the question is who is going to be Billy Beane.
In this conversation, it is important not to be fatalistic and to instead emphasize how individuals and institutions can respond. Students with a background in science and technology (rather than say the humanities, etc.) are likely to have a significant advantage in law’s information revolution. Institutions can help level this playing field by offering their students the requisite skills training necessary to be competitive within this new ordering. At Michigan State University – College of Law, I am currently developing a series of potential courses that I believe can aid my students in being Legal Information Engineers and 21st Century Lawyers. (1) Quantitative Methods for Lawyers (which is part Statistical Methods and part Legal Information Technology) (2) Legal Informatics, Legal IT and Legal Supply Chain Mgmt. (3) Law 3.0 – Yeah There is an App for That (Building Legal informatics Software including IPhone/Android Apps). Expect other institution to follow suit.
Yes – There is Going to be Math on the Exam: In closing let me offer these thoughts. Markets are not pretty places and all one can do is try to adapt to changing circumstances. The pathology of attending law school to avoid math/science simply must give way to a new reality. In other words, if the real world is the ultimate test — then — yes — there is going to be math (and computing) on the exam.
Last month the New York Times ran an editorial with the headline “Addressing the Justice Gap,” observing that “the poor need representation and thousands of law graduates need work.” The piece proposed several solutions, but notably absent was the reform most likely to deliver legal services to those in need and to create jobs for unemployed lawyers: corporations should be able to own law practices and provide legal representation. It’s not only a matter of managing the justice gap in America in the face of an enduring economic recession and increased global competition; it’s also a matter of First Amendment concern.
Corporations like Google and Wal-Mart are expert in the delivery of goods, information, and services to the public. They have the capacity to make significant financial outlays into innovative mechanisms for legal representation and await a delayed return on that investment. Wal-Mart already offers financial and medical services to its customers. It is not difficult to imagine other alternative law delivery processes or tools that might be developed if a company like Google could take the next step to directly own a law practice, or if Wal-Mart could add a legal assistance window next to the bank or health care provider in its stores. (Indeed, in the wake of deregulation through the Legal Services Act, London-based WHSmith stores will host legal access points through a partnership with QualitySolicitors, a British legal services provider.)
Attorney professional conduct rules should be reformed to permit corporations to own law practices and deliver legal services. This deregulation has the potential to increase competition, drive down prices, encourage inventive methods for providing legal representation to those who cannot access or afford it, and create new jobs for lawyers.
The American Bar Association historically opposed nonlawyer ownership citing concerns of professionalism and client protection, though the Ethics 20/20 Commission recently approved the drafting of a proposed change to ABA Model Rule 5.4 allowing minority nonlawyer ownership (see here). But corporations still would be banned from owning the entire law practice. Minority nonlawyer ownership is unlikely to generate the revolutionary change necessary for providing meaningful legal representation on a mass scale.
This summer, the law firm Jacoby & Meyers (J&M) filed litigation challenging Rule 5.4. J&M raised a number of constitutional challenges, but most intriguing is the First Amendment claim. Admittedly, I’m especially interested in this aspect because the regulation of lawyer speech is a scholarly interest of mine, especially free speech protection for advice from an attorney to her client (for my thoughts on this topic see here and here). But if one looks at recent decisions from the Roberts Court, it appears that a majority might be receptive to the idea that the First Amendment protects the delivery of legal services by a corporation, a subject I’ve written about in Democratizing the Delivery of Legal Services: On the First Amendment Rights of Corporations and Individuals.
I see the corporation’s right to own a law practice and deliver legal representation as stemming from NAACP v. Button, a 1963 decision in which the Supreme Court held that states cannot ban the delivery of legal services by the NAACP (a nonprofit corporation) because of the First Amendment interests involved. The Court extended Button to situations beyond civil rights in a series of cases from the 1960s and 1970s: Brotherhood of Railroad Trainmen v. Virginia State Bar (the First Amendment protects the rights of union members to “maintain and carry out their plan for advising workers who are injured to obtain legal advice”); United Mine Workers of America, Dist. 12 v. Illinois State Bar Association (the First Amendment “give[s] . . . the right to hire attorneys . . . to assist . . . in the assertion of . . . legal rights” for union members’ workers compensation claims); and United Transportation Union v. State Bar of Michigan (“collective activity undertaken to obtain meaningful access to the courts is a fundamental right within the protection of the First Amendment”). The union cases build upon Button in two important ways. One, the First Amendment is now understood to protect legal advice and advocacy not only about political and civil rights but also other matters. Two, it is clear that the First Amendment protects collective activity by a corporate entity undertaken to deliver legal services.
Another relevant line of First Amendment decisions are the advertising and solicitation cases from the 1970s. In Bates v. State Bar of Arizona, the Court held that Arizona’s ban on lawyer advertising violated the First Amendment. The Bates majority rejected the very same arguments levied against corporate ownership of law practices. For example, the Court found the Arizona State Bar’s “postulated connection between advertising and the erosion of true professionalism to be severely constrained,” and similarly rejected the Bar’s concern about the “adverse effect on the administration of justice.” The Court also noted that the advertising ban (much like the corporate ownership ban) “likely has served to burden access to legal services, particularly for the not-quite-poor and the unknowledgeable.”
Two other lawyer solicitation cases deserve mention. In 1978, the Court decided Ohralik v. Ohio State Bar and In re Primus on the same day. In Ohralik, the Court determined that the state could ban an ambulance chaser from in-person solicitation but in Primus the Court held that the state could not ban an ACLU lawyer from informing potential litigants about their constitutional rights. One might reconcile these decisions by looking to the fact that Ohralik solicited for pecuniary gain, whereas the ACLU lawyer offered services free of charge (though still received salary from the ACLU). And, so the argument might go, it follows that corporations, in seeking a profit when offering legal services, should be treated more like an ambulance chaser than an ACLU lawyer. I disagree. A Wal-Mart law type delivery mechanism, for all practical purposes, need not be anything like the proverbial ambulance chaser. Rather than rushing in to prey on the vulnerable accident victim, we instead would have access to a de-mystified legal services provider, where customers could learn about services in a neutral atmosphere as they conduct everyday shopping.
In Part II, I’ll discuss two recent decisions from the Roberts Court that offer insight about the First Amendment interests of corporations in the delivery of legal representation.
FTC v. Staples is a seminal case in modern antitrust analysis of horizontal mergers. Judge Posner has described it as the economic “coming of age” of merger analysis. It is also a landmark decision in the development of unilateral effects theories. Despite the fact that Judge Hogan did not explicitly rely upon the econometric evidence presented to demonstrate that a post-merger combination of Staples and Office Depot would be able to increase prices, it is also often discussed as having particular importance for the role of econometrics in antitrust analysis. As Jonathan Baker observes:
Judge Hogan’s hidden opinion supports the government’s use of econometric evidence, though the court did not trumpet doing so. The opinion never uses the term, presumably in a conscious effort to downplay novelty in order to avoid creating an issue for appeal. Yet Judge Hogan demonstrably relied on econometric evidence in one instance,(14) when he stated that “in this case the defendants have projected a pass through rate of two-thirds of the savings while the evidence shows that, historically, Staples has passed through only 15-17%.”(15) The sole basis in the record for the 15-17% figure is the testimony of the FTC’s econometric expert as to the conclusions of his statistical analysis of the pass-through rate.
The district court was persuaded by the FTC’s pricing evidence, and evidence that entry would not timely, likely and sufficient to counter any price increase. Part of that entry analysis was rejecting the defendant’s claim that firms like Walmart would discipline any attempt to increase prices. In any interesting turn of events, nearly 15 years later, it looks like we are heading toward another significant merger between office superstores:
Office Depot Inc. (ODP) and OfficeMax Inc. (OMX) may need to merge after heightened competition for office-supply sales and a 26-year high in the U.S. unemployment rate helped wipe out almost $13 billion of shareholder value.
Office Depot, the second-largest U.S. office-supply chain, has plunged 90 percent to $1.16 billion in the last five years, more than any American retailer that still has a market value greater than $500 million, according to data compiled by Bloomberg. OfficeMax was valued at $664 million yesterday after plummeting 78 percent, the third-steepest drop. Both trade at 10 cents or less per dollar of sales — one-tenth of the industry average and ranking in the bottom five of 126 retailers.
Interestingly, competitive pressure from Wal-Mart and Target, among others, appears to have developed into a significant force in the market.
With businesses spending less on paper and printers as the U.S. jobless rate hovers at 9 percent, combining Office Depot with OfficeMax may reduce costs by almost $500 million, said KeyBanc Capital Markets Inc. Regulatory approval won’t be a hurdle because of more competition from Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT) since Staples Inc. (SPLS) was blocked from buying Office Depot in 1997, said BB&T Capital Markets. Money-losing Office Depot of Boca Raton, Florida, hired interim Chief Executive Officer Neil Austrian in May after a seven-month search.
“Office Depot needs OfficeMax,” said Anthony Chukumba, an analyst with BB&T in New York. “They need to combine so they can scale up to better compete with Staples. For them to bring in a guy who’s been on the board forever and who has been CEO twice before on an interim basis, that just smacked of them saying, ‘We’re going to try to sell the company.’”
Of course, the ex post expansion of Wal-Mart and others into this territory does not mean that the FTC or Judge Hogan were wrong ex ante. Indeed, the strength of the economic evidence in the case suggested that entry would be difficult — and indeed, perhaps it was. Nonetheless, a merger of the the second and third largest office superstores is surely to attract some attention at the agencies. Indeed, it may well be the case that the sale of consumable office supplies through office superstores in no longer a relevant antitrust product market. However, the markets have changed in ways other than the emergence of significant pricing discipline from Wal-Mart and others. The story notes that Office Depot’s market value has decreased by over $10,3 billion ($2.3 billion for OfficeMax since June 2006).
Given the growth of Wal-Mart and others, I suspect that even a replay of the Staples-Office Depot transaction of the late 1990s would have a significantly better chance of approval today than it did then. Those in the industry appear to be expecting a merger announcement, but describe government approval as “certainly not a given.” In any event, a Office Depot – Office Max merger will provide a good opportunity to go back and look at the predictions of the agencies at the time, to evaluate those predictions against the development of the market, and perhaps to learn something useful about competitive dynamics and entry in the retail sector.
What happens when Wal-Mart comes to town? One thing is for sure, the line for jobs is long:
In contrast, a new Walmart in Cleveland recently received 6000 applicants for 300 positions, and, not long ago, two Walmart stores in the Chicago area received 25,000 and 15,000 applications. The Cleveland store hired one in twenty applicants. The Chicago hiring rates were far more modest.
HT: (American Thinker).
We are not interested in negotiating the terms of Wal-Mart’s arrival. We know the harmful impact that Wal-Mart always has, from thousands of case studies around the country, and around the world. We believe in our hearts, and in our minds, that DC must continue to be Wal-Mart Free.
Other labor-backed anti-Walmart groups are insisting on a community benefits agreement extracting concessions from Walmart, including, apparently, reduced hours of operation (see, e.g. here).
One need not look at the long list of job applicants to figure the social benefits. But often left out when the policy discussion is framed as unions versus corporations are consumers. Consider Hausman & Ephraig’s (a version of the paper here) analysis of the impact of Wal-Mart on consumer welfare, finding (looking at the benefits of food prices alone) the following:
We find that an appropriate approach to the analysis is to let the choice to shop at
Wal-Mart be considered as a “new good” to consumers when Wal-Mart enters a
geographic market. Some consumers continue to shop at traditional supermarkets while other consumers choose to shop at Wal-Mart. Many consumers shop at both types of stores. Thus, we specify a utility consistent two level model of choice among types of shopping destinations. We then estimate a fixed effects binomial logit choice model to estimate the parameters of the utility model that differs across households. We use the estimated parameters to calculate the exact compensating variation that arises from the direct variety effect of the entry and expansion of supercenters and find the average estimate to be 20.2% of average food expenditure. We similarly estimate the exact compensating variation from the indirect price effect that arises from the increased competition that supercenters create. We find this average effect to be 4.8%. Thus, we estimate the average effect of the total the compensating variation to be 25% of food expenditure, a sizeable estimate.
Since we find that lower income households tend to shop more at these low priced
outlets and their compensating variation is higher from supercenters than higher income households, a significant decrease in consumer surplus arises from zoning regulations and pressure group tactics that restrict the entry and expansion of supercenters into particular geographic markets.
Note again that these are significant benefits in terms of consumer welfare — and just for food. Further, these gains are disproportionately enjoyed by low-income households. Hausman & Ephraig find that household incomes below $10,000 benefit by approximately 50 percent more than average.
[T]hat’s a huge savings for households in the bottom quintile, which, on average, spend 26 percent of their income on food. In fact, it is equivalent to a 6.5 percent boost in household income—unless the family lives in New York City or one of the other places that have successfully kept Wal-Mart and its ilk away.
That’s some pretty low-hanging fruit in terms of policy wouldn’t you say? Consumers do not have a loud voice in the relevant policy and political debate. And the anti-Wal-Mart crowd seems to be laboring under the unfortunate assumption that their preferred policy amounts to a mere wealth transfer between Wal-Mart and workers. Hausman & Ephraig’s results demonstrate the magnitude of the cost to consumers of this economic naivete. The relative silence of consumer interests should not be confused with the notion that the consumer welfare losses imposed by deterring Wal-Mart entry are not real — or pretending that they are not concentrated precisely on low-income households.
Recent coverage of the A&P bankruptcy has alluded to its era of “dominance” in grocery retail, describing it as “the Wal-Mart of its day.” See this earlier post on the unconvincing antitrust case against Wal-Mart. However, what the A&P bankruptcy brings to mind for me is Justice Stewart’s famous dissent in Von’s Grocery. The famous line from Stewart’s powerful dissent objecting to the majority’s analysis, devoid of economic analysis and full of now well known contradictions, is his description of the merger law: “the only consistency is that the government always wins.”
I have a different passage in mind with implications for antitrust analysis not only in grocery retail, but with respect to innovation generally:
Section 7 was never intended by Congress for use by the Court as a charter to roll back the supermarket revolution. Yet the Court’s opinion is hardly more than a requiem for the so-called “Mom and Pop” grocery stores – the bakery and butcher shops, the vegetable and fish markets – that are now economically and technologically obsolete in many parts of the country. No action by this Court can resurrect the old single-line Los Angeles food stores that have been run over by the automobile or obliterated by the freeway. The transformation of American society since the Second World War has not completely shelved these specialty stores, but it has relegated them to a much less central role in our food economy. Today’s dominant enterprise in food retailing is the supermarket. Accessible to the housewife’s automobile from a wide radius, it houses under a single roof the entire food requirements of the family. Only through the sort of reactionary philosophy that this Court long ago rejected in the Due Process Clause area can the Court read into the legislative history of Section 7 its attempt to make the automobile stand still, to mold the food economy of today into the market pattern of another era.
For related thoughts on antitrust and innovation, check out Manne and Wright on Innovation and the Limits of Antitrust.
Last week Josh discussed the American Booksellers’ Association’s effort to get the Justice Department to pursue antitrust charges against Walmart, Target, and Amazon for engaging in a vigorous, consumer-benefiting price war. In today’s Boston Globe, Jeff Jacoby has a nice piece highlighting a bit more of the Association’s tortured logic. (HT: Don Boudreaux.) Apparently, these low prices are “devaluing the very concept of the book” and may actually discourage reading and the “sharing of ideas in the culture.” Go figure.
Here’s the Association’s letter to the DOJ in all its glory.
The WSJ Reports that the American Booksellers Association has knocked on Christine Varney’s door at the Antitrust Division to complain about the new low prices resulting from the price war between Amazon, Target and Wal-Mart. The complaint?
In a letter dated Oct. 22, the ABA said it believes that the discount pricing—which has led to 10 of the most anticipated hardcover titles being priced as low as $8.98 on Walmart.com—amounts to such an act and that it is “damaging to the book industry and harmful to consumers.” The letter said while it may appear that the prices will generate “more reading and a greater sharing of ideas in the culture,” many of the independent stores that belong to the ABA won’t be able to compete. “The net result will be the closing of many independent bookstores and a concentration of power in the book industry in a very few hands,” the letter said.
Of course, one can violate the Sherman Act with predatory pricing. But because of the obvious and palpable benefits generated by consumers for low prices, the costs of false positives throughout the economy that would arise from chilling pro-competitive discounting, and the speculative nature of the future harms associated with such claims, the antitrust law has sensibly developed a standard that makes successful predatory pricing claims very rare. But the ABA is arguing here that any single firm will lower price until rivals go under and exit and then raise price in the future. Rather, it is basically arguing that low prices will run higher cost independent booksellers out of business — resulting in higher market concentration.
The claim calls to mind Justice Potter Stewart’s famous dissent in Vons Grocery, in which Supreme Court prohibited a merger of two supermarkets controlling less than 10 percent of the market, which offered a nice 1-2 combination to the notion that antitrust could protect both competitors and competition simultaneously. Justice Stewart reminded the majority that “The Clayton Act was never intended by Congress for use by the Court as a charter to roll back the supermarket revolution” and made the obvious economic point that “the numerical decline in the number of single-store owners is the result of transcending social and technological changes that positively preclude the inference that competition has suffered because of the attrition of competitors.”
So yes, the dog-eat-dog competition between Amazon, Wal-Mart, Target and others will be messy, chaotic, and will produce winners and losers. Independent bookstores might well lose. It will depend on how much consumers value those stores relative to the combination of price and other amenities offered by the Amazon’s of the world and other competitors. This is something the market can and will figure out whether we like it or not — especially if we’ve learned our lesson from Von’s Grocery and no longer use the antitrust rules to roll back innovation in the book business.
Antitrust basics tell us there is not going to be much to the ABA complaint. Low price to consumers for books are a good thing. Complaints from competitors without complaints from customers are a good sign that antitrust authorities should stay away. The likelihood that the ABA can convince the DOJ that there is a convincing case for recoupment in the retail sale of books through the internet or anywhere else is very close to zero. The antitrust argument is outdated, harmful to consumers, and out of touch with modern antitrust analysis.
But I don’t really blame the ABA for trying. Why not?
Consider the Obama Administration’s recent White Paper on innovation which I blogged about here previously. Unfortunately, the Obama Administration’s White Paper appears to explicitly endorse the exclusion of small businesses as an objective of the antitrust laws:
Protect small businesses from unfair business practices. In many industries, small companies are critical innovators, bringing enormous benefits to consumers while putting competitive pressure on incumbent firms. The Obama Administration is committed to enforcing the antitrust laws to insure that innovative entrepreneurs are not excluded from the market by anti-competitive conduct. The Department of Justice actively investigates allegations of exclusionary conduct as part of its law enforcement mission to keep markets open and competitive.
As I wrote then:
This language is hearkens to an era of antitrust where the protection of small businesses and individual competitors was an acceptable antitrust goal. From an economic perspective, this view was long ago rejected on the basis of the new learning in industrial organization economics during the 1960s and 1970s. The last sentence is rather unobjectionable. Nobody is surprised that the Administration is interested in bringing more monopolization cases based on allegations of exclusionary conduct. But I am a little bit surprised to see the open and explicit appeal to using antitrust as a weapon to protect small businesses. Perhaps this is the product of a failure to communicate? Maybe the administration antitrust crew ought to sit down and have a talk with the administration intellectual property folks and tell them that protection of small businesses (rather than the competitive process and consumers) is no longer considered a legitimate goal of antitrust in the courts, agencies, or by antitrust economists.
But if the Administration has signaled its willingness to hear these types of arguments, why not give it a shot?
According to the Wall Street Journal, the FTC is investigating whether retailer Toys-R-Us has violated the antitrust laws by inducing certain manufacturers to set minimum resale prices for their products (i.e., to engage in resale price maintenance, or “RPM”).
The Journal first reports that the Commission “is investigating whether [Toys-R-Us] may have violated an 11-year-old order to abstain from [RPM].” That seems a bit odd, for the law on RPM changed radically in 2007, when the U.S. Supreme Court’s Leegin decision held that the practice, which since 1911 had been deemed automatically illegal, would be subject to antitrust’s more lenient rule of reason. Given the sea change wrought by Leegin, any consent order entered 11 years ago would rest on shaky footing indeed.
[UPDATE: As the first comment below explains, the 11 year-old consent order was not aimed at RPM. I didn't take a look at the order before drafting this post. I should have done so. Mea culpa. This oversight doesn't alter my argument in the rest of this post.]
More notably, the Journal reports that the FTC may issue a new complaint against Toys-R-Us “for allegedly trying to fix the price of baby products” sold through its Babies-R-Us unit (“BRU”). This past summer, a federal district court certified a consumer class action against Toys-R-Us based on these same allegations. According to the Journal, the FTC has demanded emails from the discovery record in that action (the “BRU case”).
I’m not surprised that the FTC would want to get involved in the BRU case. The legal standard for evaluating instances of RPM is currently pretty unclear (as I explained in this article), and the FTC has a definite opinion on the issue. In considering whether to modify a pre-Leegin consent order entered in another RPM case (Nine West), the FTC took the position that any RPM initiated by retailers, rather than by the manufacturer, should be presumed illegal. If that’s the standard, then the RPM in the BRU case (which was apparently initiated by retailer BRU) should be illegal, at least presumptively. The FTC probably wants to jump into the case to procure a precedent adopting an “illegal if retailer-initiated” liability rule for RPM.
The court hearing the consumer action against BRU has already endorsed a version of that rule. BRU had argued, consistent with well-accepted economic theory and empirical evidence, that RPM may promote competition, even if it raises consumer prices, because it may induce retailers to provide demand-enhancing, output-increasing services (especially those that might be subject to free-riding by cut-rate dealers). The district court concluded, though, that no such procompetitive benefits can follow from retailer-initiated RPM. Crediting the testimony of plaintiffs’ expert William Comanor, the court reasoned that “when a dominant distributor coerces a manufacturer to implement resale price maintenance — rather than the manufacturer adopting it unilaterally — the restraint has only anticompetitive effects.” Such reasoning would seem to entail a rule of per se illegality for dealer-initiated RPM.
As the BRU court explained, the intuition behind its “illegal if retailer-initiated” rule is that whereas “[m]anufacturer interests may be associated with procompetitive effects (creating demand for their products), … distributor interests are associated only with anticompetitive effects (restricting price competition).” But that intuition is mistaken.
Contrary to the BRU court’s assertion, distributor interests in RPM are not “associated only with anticompetitive effects” like facilitating a retailer-level cartel. High-service retailers, who must charge higher prices to cover the costs of the demand-enhancing services they provide, are the most direct victims of free-riding by low-service, low-cost dealers. While the manufacturer, who wants to ensure point-of-sale services, certainly has an interest in preventing free-riding, so do high-service retailers, who bear the immediate costs of providing the demand-enhancing services. Moreover, such retailers are likely to discover free-riding more quickly than the manufacturer; they will immediately notice when they are losing sales to no-frills dealers. Thus, it should not be surprising that retailers would request RPM to prevent free-riding by low-service dealers and that the manufacturer, seeking to ensure that all dealers earn a margin sufficient to finance desired services, would grant their request.
Consider the retailer-initiated RPM in the BRU case. Because (1) manufacturers make more money as more units are sold to consumers and (2) more units typically will be sold to consumers as the retail price is reduced, BRU’s manufacturers had no interest in having a retail mark-up higher than that necessary to motivate effective retail service. Yet, according to the court’s recitation of the facts, every manufacturer asked by BRU to forbid Internet discounting complied with the retailer’s request. Why did the manufacturers give in to BRU’s demand?
The plaintiffs’ theory, which the district court accepted, was that the manufacturers were “forced” to do so because of BRU’s market power in the retailing of baby products. But that is hardly plausible. Each of the products on which BRU sought RPM is, or easily could be, sold by discount retailers like Walmart, Target, and Kmart. While there are currently fewer than 270 Babies-R-Us stores in the United States, Walmart alone boasts 4,300 domestic outlets. The claim that BRU’s allegedly put-upon manufacturers would be unable to get their products to consumers absent BRU’s cooperation is simply incredible.
A far more plausible theory is that the manufacturers at issue gave in to BRU’s demands because they wanted their products to bear the prestige that comes from being sold at a trendy Babies-R-Us store. That “prestige stamp” is a service that BRU provides — a service that is conferred at considerable expense and that can be easily appropriated by low-cost dealers like Internet retailers.
It thus makes perfect sense that BRU would try to protect itself from no-frills dealers seeking to free-ride off its costly prestige stamp and that the manufacturers at issue would give in to BRU’s demands, expecting that the value-increase in their products resulting from the BRU prestige stamp would offset the higher price occasioned by the requested RPM and would enhance total output. This output-enhancing theory is significantly more plausible than the competing theory that the manufacturers were forced to give into a relatively small retail chain’s demands because of its market power in retailing.
If the FTC does decide to bring its own case against BRU, it will probably advocate the same “illegal if retailer-initiated” rule it set forth in its Nine West order. Judicial adoption of such a rule would be unfortunate. The identity of RPM’s instigator (retailer or manufacturer) says nothing about the RPM’s dominant rationale (to facilitate retailer collusion or to protect manufacturer and retailer interests in avoiding free-riding), and the fact that an instance of RPM was retailer-initiated by no means suggests that it was imposed for an illicit purpose.
As regular readers know, we have covered this case extensively on this blog, including most recently this great, lengthy post from Thom on the proper standard of review. I wouldn’t be surprised if Thom is disappointed with the standard adopted by the DC Circuit in its appeal, and I look forward to his thoughts.
I’m sure all of us will have more to say about the case in due course. For now I want to highlight one incredible aspect of the decision: The claim that relevant market definition can turn on average or “core” customer effects. Yes, throw out 30-odd years of antitrust economics and the very concept of the marginal consumer. Here’s the court’s theory: If a bunch of inframarginal consumers really like products X and Y but not similar-but-slightly-different-and-cheaper product Z, a merger between X and Y would enable the combined firm to gouge the inframarginal consumers, regardless of the effect on the marginal folks. Sure the marginal guys will shop at Safeway if the price rises too much–but who cares? There’s always a “core” of super premium and organic supermaket addicts to take advantage of–folks who just can’t resist all those free samples and faux-wood floors!
OK. Except–correct me if I’m wrong–if price discrimination were possible before the merger as well as after (and there’s no reason why this would change), the core folks were already being gouged! Effective product differentiation may make the market price higher for a subset of goods–but this higher market price would prevail even with lots of competition.
The court here claims that the real damage will occur in prices of perishables, because organic produce bought at a Whole Foods is qualitatively different than organic produce bought at Safeway, and this is what the core shoppers bought at the premium stores. But if that were true post-merger, it would be tru pre-merger, as well, right? There aren’t any merger-specific effects that I am aware of. Again–correct me if I’m wrong–but I don’t think any of the evidence in the case suggested that there could be a significant non-transitory effect on the price of “PNO” produce. Yes, some evidence suggests produce prices are higher at PNOS’s than at typical grocery stores, but is there evidence that the price could be even higher if Wild Oats exited a market? The concurrence points to the FTC’s supposition that enough people would be diverted from Wild Oats to Whole Foods to sustain a 5% price increase, but I’m not sure that there was any evidence to support this claim (particularly since the FTC’s economist didn’t look at prices, but rather at profit margins).
Manwhile, if price discrimination is not possible, way more than 30 years of economics tells us that the seller will price to the marginal consumer–the ones who would decamp to Product Z if prices rise too much. The claim here, however, is that, even if evidence indicates that Whole Foods and Wild Oats compete not only with each other but also many other stores, they are each other’s only competitor for some consumers. Yes, Virginia, there are inframarginal consumers. So what? Did the court forget its Econ 101? Profit is maximized where marginal revenue equals marginal cost. Absent price discrimination, it’s a bummer the seller can’t capture the surplus from all those inframarginal shoppers, but profit is still maximized by pricing to the marignal consumer. There is no reason (other than a new ability to price discriminate) that the post-merger entity would sacrifice profits by jettisoning the marginal shopper just to gouge its regular clientelle.
Perhaps even more fundamentally–as we have pointed out on this blog before–the differential effect via price discrimination story (if true) suggests a far, far simpler solution: Better relevant market definition. If the inframarginal consumers at the grocery store are consuming radically different products than the marginal consumers, perhaps the relevant market is not “premium natural and organic supermarkets” but rather “organic foods,” for example. In other words, perhaps the relevant market is the products being consumed, not the channel of distribution. But I would guess that this market definition would have condemned the case from the start given Walmart’s extensive entry into this market, so it wasn’t in the cards.
“But wait!,” you say. Some people have idiosyncratic preferences. They preferer buying organic tomatoes, zucchini and grapes from premium natural stores–it’s a combination, you see, not only of the food being consumed but also the channel of distribution. These poor sots will be gouged without competition between Whole Foods and Wild Oats, because they don’t want to shop for produce at Safeway. And Whole Foods without Wild Oats would easily overcharge these 17 or 18 people in any given market.
Yes, indeed. One can always define a market by focusing on idiosyncratic preferences or product variations. This is what Justice Fortas decried in his dissent in Grinnell:
The trial court’s definition of the “product” market even more dramatically demonstrates that its action has been Procrustean – that it has tailored the market to the dimensions of the defendants. It recognizes that a person seeking protective services has many alternative sources. It lists “watchmen, watchdogs, automatic proprietary systems confined to one site, (often, but not always,) alarm systems connected with some local police or fire station, often unaccredited CSPS [central station protective services], and often accredited CSPS.” The court finds that even in the same city a single customer seeking protection for several premises may “exercise its option” differently for different locations. It may choose accredited CSPS for one of its locations and a different type of service for another.
But the court isolates from all of these alternatives only those services in which defendants engage. It eliminates all of the alternative sources despite its conscientious enumeration of them. Its definition of the “relevant market” is not merely confined to “central station” protective services, but to those central station protective services which are “accredited” by insurance companies.
There is no pretense that these furnish peculiar services for which there is no alternative in the market place, on either a price or a functional basis. The court relies solely upon its finding that the services offered by accredited central stations are of better quality, and upon its conclusion that the insurance companies tend to give “noticeably larger” discounts to policyholders who use accredited central station protective services. This Court now approves this strange red-haired, bearded, one-eyed man-with-a-limp classification.
Tailoring market definition to inframarginal consumers who may be willing to pay more than market prices for certain product characteristics is neither sound economics nor sound antitrust doctrine.
UPDATE: A great post from Manfred Gabriel at Antitrust Review makes much the same case. A couple of really good parts:
Maybe I shouldn’t be surprised by this. But the passage does more than accept that, given the difficulties of economic analysis, we can supplement it with some common-sense heuristic insights to come up with markets. This approach seems to undermine the acceptance of the theoretical foundations of economic analysis.
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I read this to mean that the “practical indicia” have become the trump card to beat economic analysis.
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The only economic evidence of price discrimination between core and marginal customers cited in the opinion is the fact that Whole Foods stores enjoyed lower margins (not prices!) in cities where they competed with Wild Oats stores. One would have hoped for a discussion of how Whole Foods identifies core customers (the ones in Birkenstocks, perhaps?) and manages to charge them higher prices than the marginal customers (in wingtips and high heels).