Federal Trade Commissioner Pamela Jones Harbour has sent the U.S. Supreme Court justices an “open letter” regarding the pending Leegin case. [HT: Danny Sokol.]
Leegin, as regular TOTM readers know, will test the continued vitality of Dr. Miles, the 1911 decision making it per se illegal for manufacturers and retailers to agree on minimum retail prices for the manufacturers’ products. I have previously argued (here and here) that such “vertical resale price maintenance,” or “VRPM”, should not be automatically illegal and that Dr. Miles should be overruled. Based on his upcoming eCCP presentation, I believe Josh agrees. He may, however, be reluctant to go head-to-head with a commissioner since he’s now a scholar-in-residence at the FTC.
I have no such qualms.
Putting aside any procedural impropriety here (Is it kosher for a commissioner to send an open letter to the Supreme Court regarding a pending appeal? I have no idea, but it seems fishy to me….), Commisioner Harbour’s letter is substantively off base.
To see why, first consider what overruling Dr. Miles would and would not do. By overruling Dr. Miles, the Court would effectively direct courts to afford VRPM agreements the same treatment they give most restraints of trade: courts should apply the rule of reason, under which they look at things like market structure and the nature of the restraint to assess the restraint’s effect on competition. If this investigation reveals a likely anticompetitive effect, the agreement should be declared illegal; if not, the agreement should be permitted. Overruling Dr. Miles would not render VRPM agreements per se legal. Any such agreements that, upon investigation, would seem to pose a significant competitive threat would still be subject to condemnation. Thus, the only legal effect of overruling Dr. Miles would be to eliminate the rule of automatic illegality for VRPM agreements.
With that in mind, let’s analyze Commissioner Harbour’s open letter. The letter consists of four parts, which argue, respectively, that overruling Dr. Miles is “bad as a matter of law,” “bad as a matter of economic policy,” “expressly contrary to Congressional findings and intent,” and “unsupported by the facts of the case itself.”
I. BAD AS A MATTER OF LAW?
Commissioner Harbour’s “bad law” argument essentially amounts to an assertion that Dr. Miles is a “longstanding precedent, having celebrated its 95th birthday” and should therefore not be overruled. As I previously argued, this notion of “superprecedent” is (if ever valid) entirely misplaced in the antitrust context. Our entire Section One jurisprudence contemplates that courts will adjust the intensity of their investigation of particular trade restraints in accordance with their growing understanding of the effect of those restraints. When courts have had enough experience to know that a practice is almost always anticompetitive, per se treatment should be appropriate. By the same token, when experience and economic learning have shown that practices once deemed per se illegal are actually pro-competitive most or much of the time, courts should shift to a more probing rule of reason analysis. That latter situation is what we have with VRPM.
Commissioner Harbour also argues in the “bad law” section that the restraint in Dr. Miles itself actually involved a horizontal restraint because the manufacturer in that case was essentially acting as the policeman for a price-fixing conspiracy at the retail level. That may be right (the record supports that theory), but if so, no per se rule would have been required to establish illegality — the agreement would have been condemned under the rule of reason. This argument thus seems inapposite.
II. BAD AS A MATTER OF ECONOMIC POLICY?
I’m not going to rehash the policy argument for jettisoning Dr. Miles since I’ve already done so twice on this blog (again, here and here). I will, though, make two points that rebut most of Commissioner Harbour’s economic arguments.
First: Manufacturers want distribution costs to be as low as possible because such costs get embedded in the retail price of goods, so that higher distribution costs result in higher retail prices and thereby reduce the number of units sold. If the manufacturers can provide distribution services most efficiently, they’ll do so (they’ll “vertically integrate”). If it’s more efficient to outsource to dealers, manufacturers will take that tack (they’ll buy distribution services on the market). VRPM gives manufacturers a middle-ground between vertical integration and a pure market approach. It allows them to exercise some control over their distributors without bringing those distributors within the boundaries of the firm. Manufacturers will choose this middle-ground option only if it offers the lowest (quality-adjusted) cost of distribution and thereby maximizes total sales of the manufacturers’ products.
So why might VRPM lead to the lowest cost of distribution? That’s my second point.
Second: VRPM can encourage retailers to provide point-of-sale services that make their manufacturers’ products more valuable and thereby increase sales of those products. As I previously explained:
Dealers hoping to maximize their sales will normally provide [point-of-sale] services [such as] fancy showrooms, product advertising, customer education, etc. — unless they can free-ride off the efforts of other dealers. For example, the dealer of a certain make of dishwasher will normally try to maximize his sales by providing consumer-friendly displays and a knowledgeable sales staff. But if a nearby dealer provides such services, the first dealer may cut his own, knowing that many consumers will go to his neighbor for information and then head to his more bare-bones operation (which has lower costs and can thus offer lower prices) to make the actual purchase. If dealers know such free-riding is a possibility, they will be less likely to provide the point-of-sale services that maximize sales of the manufacturer’s product. Manufacturers may eliminate the free-riding possibility and consequent reduction of point-of-sale services by forbidding sales without the desired services or by separating retailers’ sales territories so that free-riding is difficult. As an alternative to imposing such “non-price restraints,†manufacturers might dictate the minimum price for which their dealers can sell the product at issue. Such RPM forces dealers to compete with each other on terms other than price, and they are most likely to do so by competing on the sort of point-of-sale services that maximize the manufacturer’s total sales.
With those two points in mind, consider Commissioner Harbour’s arguments for why affording VRPM rule of reason treatment is “bad as a matter of economic policy.” According to the commissioner, more prevalent VRPM will result in the following laundry list of maladies:
“higher prices set by manufacturers” [Really? If manufacturers set higher prices without receiving enhanced point-of-sale services worth more than those price hikes, total sales will fall — to the detriment of manufacturers.]
“reduced efficiency in distribution and retailing” [Why would a manufacturer impose a scheme that reduces the efficiency of distribution and retailing, since such will result in higher retail mark-ups and reduced sales of his product?]
“lower levels of retail sales per outlet” [If total sales fall, the manufacturer will not pursue a VRPM strategy.]
“higher rates of business failure” [I don’t know the basis for the commissioner’s claim here. She cites a Senate report comparing rates of firm failure in “fair trade” states (states that had legislatively preempted Dr. Miles, as they were permitted to do for a period) with those in other states. Unless some study controlled for lots of other variables, this comparison is meaningless.]
“reduced opportunities for effective entry by new competitors and products” [This seems inconsistent with the higher prices assertion above. Higher prices invite entry. Perhaps the commissioner is arguing that new retailers will not be able to gain a foothold by underpricing (i.e., free-riding off of) full-service retailers…I’m not sure.]
“distortion of retailer incentives to provide objective comparisons of competing brands on their shelves” [Does anyone really think retailers do (or should do) this??? If so, slotting fees would certainly seem to present some problems.]
“diminished levels of competition between competing brands of goods” [Not if VRPM is being used to combat the free-rider problem discussed above. If it is, it works to enhance the quality of the manufacturer’s product, thereby enhancing interbrand competition.]
AND
“increased competition by manufacturers for the loyalty of their dealers, the costs of which will be borne by consumers” [In the footnote accompanying this statement, the commissioner refers to “upward-spiraling price escalations to attract dealer loyalty.” Any manufacturer that sought dealer loyalty by raising the retail mark-up on his products in excess of the value added by the dealer would be shooting himself in the foot. Manufacturers thrive by selling lots of products (which they won’t do if the retail mark-up is too high), not by winning their dealers’ affections.]
III. CONTRARY TO CONGRESSIONAL FINDINGS AND INTENT?
Commissioner Harbour maintains that overruling Dr. Miles would effectively “repeal the Consumer Goods Pricing Act of 1975, in which Congress expressed its clear support for a per se rule against vertical minimum price fixing.” The statute to which the commissioner refers repealed the 1937 Miller-Tydings Act, which permitted states to authorize certain forms of VRPM. In repealing Miller-Tydings, the argument goes, Congress implicitly endorsed a per se rule against VRPM.
While this is probably Commissioner Harbour’s strongest argument, even it fails. The 1975 statute did not legislate a per se rule. Rather, the statute was, in the words of the House Report on the legislation, “a simple repealer of the Miller-Tydings and McGuire exemptions.” In repealing the exemption but not legislating a per se rule against VRPM, Congress was returning the law to the status quo in which courts, guided by experience and evolving economic insight, develop appropriate rules. The 1975 statute thus does not imply that the Court should decline to modernize the rule governing this particular trade restraint. As the Areeda-Hovenkamp treatise explains (paragraph 1629c):
Neither the hearings nor the reports [on the 1975 statute] address the distinct issue of whether the courts that created the Dr. Miles rule should or should not be free to alter it. There certainly was no indication that even the proponents of repeal meant to single out Dr. Miles from all other judge-made antitrust rules to freeze it or any related rules in place. With the issue not posed as such, repeal of fair trade reflected no legislative consensus that the process by which judges make and revise antitrust rules should thereafter be constricted, either generally or for resale price maintenance alone. The 1975 statute neither says nor implies that the courts will thereafter be less free to alter Dr. Miles than they are to alter any other judicially created antitrust rule.
Moreover, if Congress does intend for the per se rule against VRPM to remain in place, it could certainly respond to the overruling of Dr. Miles by enacting a statute that would reinstate the per se rule.
IV. OVERRULING UNSUPPORTED BY THE FACTS OF THE LEEGIN CASE ITSELF?
Commissioner Harbour’s final argument is that the specific facts of the Leegin case cannot support a decision overruling Dr. Miles. While she quibbles over a number of factual matters, the crux of her argument is that Leegin is engaged in a “substantially horizontal” restraint because it operates its own retail stores that compete with its independent dealers. Thus, she says, “Leegin adopted its vertical minimum price fixing regime to insulate its own stores from competition from its other dealers.”
Even if the commissioner’s factual assertion is accurate, that does not mean the Court should refrain from overruling Dr. Miles. In the lower court, Leegin was precluded from defending its pricing constraints because the per se rule applied. The Supreme Court could resolve this appeal by ruling (1) that Leegin’s conduct is not illegal per se (i.e., that Dr. Miles is overruled), and (2) that remand is necessary to consider whether Leegin’s conduct passes muster under the rule of reason. If Commissioner Harbour’s assertions are correct, then Leegin’s conduct may well violate the rule of reason — in which case it should be condemned. But the mere fact that Leegin’s conduct might be unreasonable does not imply that the Court should deny Leegin the right to litigate the issue of reasonableness.
***
I said before that I’ll eat my hat if the Court does not overrule Dr. Miles. If Commissioner Harbour’s arguments represent the best the per se advocates have got, I’m even more confident than when I made that statement.
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Phil: I suggest the Cooper et al (2005) or Lafontaine & Slade (2005) surveys of the empirical literature with respect to RPM and consumer welfare studies. P.S. the studies that find 18-27% price effects control for virtually nothing. You can read about far better studies in those surveys.
As to whether the antitrust laws exist to foster price competition — yes, of course, but not price competition ALONE. They exist to protect consumer welfare, which may be improved by various forms of competition which are generally best left up to the unilateral decisions of manufacturers to determine. Of course, if that proposition is wrong it should show up in the empirical studies showing that RPM harms consumers.
The bottom line empirically is that virtually nobody who has read the literature agrees that RPM “always or almost always harms consumers” — which is the standard for application of the per se rule.
Joshua–more questions. Is there any proof (rather than just theory) that HIGHER PRICES with RPM actually benefits consumer’s ? Everything I have read shows that Fair Trade Laws produced an average of 18-27 percent higher prices. Is PRICE the central nervous system of the economy ? Is PRICE COMPETITION the driving force that makes a market economy possible ? If I am forced to pay more with RPM, Who gets my 18-27 percent more in Price ? A 27 percent increase needs to be explained How that benefits a Consumer ? An item today at 100 bucks–Supreme Court overturns–that same item is 127 bucks. Who got my extra 27 bucks and Why ? Has any economist ever succeeded (emperical study rather than thoery) in showing that consumer’s of a product sold subject to RPM were benefitted by paying higher prices ? Is it well accepted that Congress, not the courts, “IS THE ULTIMATE ANTITRUST POLICYMAKER”, and in the realm of antitrust “there is probably no area” ***where Congress has displayed such an explicit and abiding intent to set policy for the courts and enforcement agencies as in the area of RESALE PRICE MAINTENANCE ? Is discouraging a price cut sound antitrust policy ? Do antitrust laws exist to foster price competetion and to insure that consumer’s pay lower prices for products ? My extra 27 bucks of questions–thanks.
Phil,
You raise an interesting issue. Thanks.
I’m not so convinced the title of the statute can do as much work as you would like it to here. In particular, I don’t think that Congressional action in 1975, which merely put an end to special ability of states to make RPM per se LEGAL, was designed to mandate a particular welfare standard for these practices.
Rather, the most plausible interpretation (the FTC/DOJ brief makes a similar argument around p. 22) is that Congress did not intend to deprive courts of the ability to interpret the Sherman Act’s language in a manner consistent with growing economic knowledge about the actual effects of these restraints in the marketplace.
Those market realities demonstrate that where RPM increases price, it is generally increases output as well. So it is a bit misleading to cite only the price effect. However, the combined output/price effect is consistent with promotional services theories of RPM. It would be quite a stretch, I think, to argue that Congress’ actions in 1975 mandated a particular mix of price and non-price competition or to prohibit manufacturers from solving incentive incompatibility problems designed to induce output increasing (and usually consumer welfare enhancing) activities.
A question concerning RPM and Congressional intent. In 1975 Congress responded to Fair Trade Laws when it Passed “an Act to amend the Sherman Antitrust Act to PROVIDE LOWER PRICES FOR CONSUMERS” more commonly known as the Consumer Goods Pricing Act of 1975. The long title of the act demonstrated Congress’s overriding policy goal: “TO PROVIDE LOWER PRICES FOR CONSUMERS”. President Ford wrote in his signing statement that the Act would “MAKE IT ILLEGAL FOR MANUFACTURERS TO FIX THE PRICES OF CONSUMER PRODUCTS SOLD BY RETAILERS.” If empirical studies show that “RPM INCREASES PRICES” to consumers and The Consumer Goods Pricing Act is “TO PROVIDE LOWER PRICES FOR CONSUMERS”–Is it Congressional intent that retailers compete on price ?
Your suspicion that I will not comment directly on the Commissioner’s letter, nor on the facts of Leegin is absolutely warranted. But I do have some general comments on the tenor of the pro-per se briefs I have been reading, most of which echo basically the same arguments as the letter.
1. I think the empirical evidence here is rather overwhelming in favor of a rule of reason approach. I had suspected that I would be reading arguments in favor of the per se rule that read something more like: “yes, the evidence is not in our favor but it is too inconclusive to change the rule yet because ….” Of course, this argument would not be persuasive because the modern per se approach tells us that we condemn under the per se rule if and only if we know the restraint always or almost always has anticompetitive effects. Instead, the argument is being made that the literature affirmatively demonstrates that RPM meets this standard. This surprises me. Maybe it shouldnt. But that is not how I, and many others, read this literature.
2. The FTC/ DOJ Amicus brief, which was written well before my appointment and thus I had nothing to do with, I think covers the issues and summarizes the economic literature quite nicely (as does, of course, the Economists’ Brief).
3. One point that I wish received more attention in the discussion of vertical restraints more generally is that the “discount dealer” free-riding explanation is not the only explanation for the use of vertical restraints. Incentive problems regarding promotion exist between manufacturers and dealers even without any inter-dealer externalities and RPM is one method of solving them. See, e.g. Klein and Murphy. Many of the pro-per se crowd cite to this paper for exposing some shortcomings in the discount free-riding story, but greatly misundertand the economics in that paper and with respect to “free-riding” in the absence of discount dealer problems more generally.