FTC’s Latest RPM Investigation: Sound and Fury Signifying Nothing?

Thom Lambert —  24 October 2008

Once again displaying its tenacious devotion to old Dr. Miles, the FTC is investigating whether makers of musical instruments and audio equipment have engaged in illegal resale price maintenance (RPM). Yesterday’s WSJ reported that the Commission has issued subpoenas to a number of prominent musical instrument manufacturers, including Fender, Yamaha, and Gibson, as well as to the retailer, Guitar Center, Inc. The Commission is apparently seeking to determine whether the manufacturers’ minimum advertised price (MAP) programs, which forbid retailers from advertising prices below some minimum level, amount to unreasonable vertical restraints of trade. In the post-Leegin world, even those MAP programs that amount to agreements to set retail prices are not automatically illegal. Instead, a challenger must establish their anticompetitive effect.

Most likely, these arrangements are pro- rather than anti-competitive. To see why, consider the possible anti-competitive harms and pro-competitive benefits that may result from RPM agreements and the pre-conditions for their occurrence.

The potential anti-competitive harms stemming from RPM are (1) facilitation of a cartel at the retailer level [i.e., retailers persuade the manufacturer to establish and enforce a retailer cartel by “requiring” them to adhere to minimum resale prices] and (2) facilitation of a cartel at the manufacturer level [i.e., colluding manufacturers all require their retailers to charge minimum resale prices in order to (a) reduce the manufacturers’ individual incentives to cheat on the fixed price they charge retailers, who can’t enhance total sales of the manufacturer’s brand by passing any price cut on to consumers, and (b) enhance price transparency so that their cartel is easier to monitor].

In order for either of these anti-competitive harms to materialize, a number of structural pre-requisites must be present. For RPM to facilitate a dealer-level cartel, the retail market must be capable of cartelization (e.g., it must be fairly concentrated, with significant entry barriers, etc.). Moreover, because manufacturers would normally want retail mark-ups to be as small as possible and would thus tend to resist requests for RPM, the retailers seeking to enlist manufacturers in establishing/policing their cartel must have some power in the retail market. Given the low barriers to entry in retailing, such retailer market power is rare. For RPM to facilitate a manufacturer-level cartel, the manufacturers’ market must be susceptible to cartelization (e.g., concentrated, subject to entry barriers, etc.) and the use of RPM must be fairly widespread among manufacturers comprising a substantial percentage of the market.

It’s unlikely that the structural pre-requisites to either form of anti-competitive harm exist here. With respect to the dealer cartel possibility, the relevant retailer market is unconcentrated, and entry barriers are low. Retailers couldn’t very well cartelize, and if they tried to do so, retailers offering lower mark-ups would enter the market. It’s therefore unlikely that RPM could facilitate a dealer cartel. I don’t know about the structural pre-requisites to the “facilitation of manufacturer cartel” theory, but the fact that the FTC isn’t (to my knowledge) investigating direct collusion among the instrument manufacturers themselves suggests that there’s no basis for supposing that the RPM here is being used to facilitate any such cartel.

So the potential anti-competitive harms of RPM are unlikely to exist here. What about the pro-competitive benefits?

Well one pro-competitive benefit is pretty darn obvious. A musical instrument is the sort of thing whose attractiveness to consumers will be greatly influenced by point-of-sale services. If a customer can try out a brand of an instrument, ask questions of a knowledgeable salesperson, see the various features demonstrated, maybe take a lesson or two, and be assured that he can return the instrument to the store for occasional servicing, the amount he is willing to pay for that brand will increase. A manufacturer thus has an interest in ensuring that these point-of-sale services remain available. If low-overhead retailers (like Internet retailers) can free-ride off the efforts of high-service dealers, then these output-enhancing point-of-sale services will eventually disappear, to the detriment of the manufacturers. The manufacturers thus have an interest in forbidding the advertising — and even the charging — of low prices by low- (or no-)service retailers. Such restrictions are necessary to promote the services that are desired by consumers and will maximize the total output of the manufacturers’ products.

As Josh has noted a number of times, the free-rider explanation is not the only pro-competitive explanation for RPM agreements. In this case, though, the free-rider story seems pretty plausible. The collusion-facilitation stories, not so much.

It will be interesting to see what the FTC finds and how much proof of pro-competitive effect it requires before it acquits the MAP arrangements at issue. Based on its recent action in the Nine West case, I expect that it will scrutinize the arrangements very closely. I, of course, would recommend that it follow the approach set forth in my forthcoming William & Mary Law Review article, Dr. Miles Is Dead. Now What?: Structuring a Rule of Reason for Evaluating Minimum Resale Price Maintenance.

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.