To Whom It May Concern: Please Stop Calling RPM Agreements Cartels (or Price-Fixing)

Josh Wright —  11 February 2009

The headline of this Bloomberg story on the Swiss Competition Authority’s complaint against Bayer, Pfizer and Lilly announces that the firms operated an “Erection Drug Cartel.” I read a bit further to learn something about what I suspected, from the title of the story, would be a horizontal agreement between the firms — that is an agreement between rivals to set prices. Then I read this:

Pfizer, which makes Viagra; Lilly, the maker of Cialis; and Bayer, which sells Levitra, made “inadmissible vertical competition agreements” by maintaining a recommended public selling price for the drugs, the panel said today. “The recommended public selling price covered the drugmakers, pharmacies and physicians,” Olivier Schaller, a spokesman for the commission, said in a telephone interview. “It was widely followed.”

So, instead of a horizontal conspiracy between pharmaceutical firms, it looks like Pfizer, Lilly and Bayer were independently entering into agreements with distributors to adhere to a suggested price. In other words, these were the analytical equivalent to the Minimum Resale Price Maintenance (RPM) agreements recently held to be properly evaluated under the Rule of Reason in the United States. These are two very different things. I wish that reporters doing antitrust stories would convey more information about the nature of the complaint. A few things could be going on here:

  1. There could be a horizontal price fixing cartel between Pfizer, Lilly and Bayer.
  2. There could be a horizontal agreement between Pfizer, Lilly and Bayer to institute these vertical agreements with their distributors.
  3. There could be a horizontal agreement between distributors or pharmacies and the pharmaceutical companies which is enforced through the vertical agreements.
  4. There could be the common presence of these vertical RPM agreements which are “widely followed” through much of the market but do not involve any horizontal component (e.g. an agreement between the firms).

These are very different agreements for antitrust purposes. At least in the US. RPM agreements (at least for now!) are evaluated under the rule of reason in the United States. Cartels involving horizontal agreements to fix price are per se illegal. Further, they are different on the economics. VERY different. Naked horizontal agreements to fix price reduce consumer welfare and output. RPM agreements, the evidence overwhelmingly shows (see also here), are highly likely to make consumers better off in practice.

Now, what is likely going on here is that minimum RPM is the analytical equivalent to per se illegal under Swiss competition law. That’s fine. But its still not a cartel without the horizontal agreement. My complaint here is not technical, its descriptive. One can read the headline and story and be left completely in the dark about what the complained about conduct is.

Further, this confusion about horizontal and vertical agreements infects reporting on these issues in the United States where the legal important of the distinction really is important. While Min RPM remains per se illegal in some states, and there is pending legislation to overturn Leegin and restore the Dr. Miles rule, the current state of affairs is that both Min and Max RPM are evaluated under the rule of reason under the Sherman Act. A horizontal agreement may be per se illegal, condemned in a much more cursory fashion, and may even involve criminal penalties! And again, the economic effects of purely vertical RPM agreements and cartels are strikingly different.

In the United States where the difference is not only economic but also legal, there is simply no excuse to use the words “cartel” or “price-fixing” to describe RPM. Yes, a vertical agreement “fixes prices” but this is a fairly transparent attempt to obfuscate the economic issues (empirically RPM generally increases consumer welfare and does not have cartel-like effects) by analogizing it to a cartel. I hesitate to describe this as a mistake in labeling because in some cases it is not a mistake. For example, the learned antitrust scholars at the American Antitrust Institute released the following statement after Leegin:

Antitrust experts from the government, legal and academic communities joined retailers, “e-tailers” and consumer advocates in Washington, D.C. today to discuss the sweeping anti-consumer effect that newly legal price-fixing, also known as ‘resale price maintenance’ (RPM), has had on the cost of consumer products. Despite widespread discounting in parts of the market where competition is being allowed to work, holiday shoppers are finding fewer discounts this season on price-fixed products ranging from toys to baby strollers.

Later in the press release we’re told by AAI President Bert Foer that:

The Supreme Court underplayed the magnitude of the anticompetitive risks of price-fixing. The Court did not account for the fact that it leads to higher prices, reduced efficiency and lost innovation in retailing. They failed to recognize how those risks have grown with increasing retail concentration.

They know better. The evidence simply doesn’t support the assertion that RPM leads to losses of consumer welfare. Read Lafontaine & Slade (linked above) which surveys the literature. The evidence overwhelmingly points the other direction. That doesn’t mean that RPM cannot be anticompetitive. Just that there’s no evidence that it is systematically anticompetitive and deserves legal treatment like a horizontal conspiracy to fix prices. Its frankly not even close. Buy by invoking the “price-fixing” label, the hope is to win in the court of public opinion, in the press, and perhaps with policy makers.

It may be working. Joseph Pereira in the Wall Street Journal echoes the AAI stance (“Manufacturers are embracing broad new legal powers that amount to a type of price-fixing — enabling them to set minimum prices on their products and force retailers to refrain from discounting”), though his piece a few months later is far more objective. Antitrust scholars like to use the same rhetorical / marketing strategy to group in RPM with cartels in order to justify more aggressive antitrust intervention against the practice.

There is no question they are winning the marketing game. But a serious analysis of RPM and its appropriate antitrust treatment demands an evidence-based approach. This is, indeed, the approach called for by Leegin. While I have written about some of my qualms with Leegin’s approach to the economic and empirical evidence (by both the majority and the dissent), as has Thom, there is a lot of room to talk about sensible approaches to the appropriate rule of reason analysis. It is my hope that these discussions take an evidence based approach. In my view, while there is still a lot to learn about precisely how RPM works, when and by whom it is adopted, and to what effect, there is simply no empirical evidence that its effects warrant per se illegality. Consider the following. Nobody seems to be arguing that predatory pricing is per se illegal. But is the empirical evidence of the competitive effects of RPM really that different than the literature on predatory pricing. Its true its easier to intuitively grasp the competitive benefits of low prices than the increased point of sale services (and thereby, output) facilitated by RPM contracts. But antitrust economists and lawyers know better than to ignore the possible pro-consumer effects of vertical restraints.  And they argely agree that an evidenced based approach is that is sensitive to both Type 1 and 2 errors is the right way to design antitrust policy. Its my sincere hope that the policy debate to be had on RPM with the pending legislation and FTC Workshops upcoming will be fought on this margin rather than on marketing.

3 responses to To Whom It May Concern: Please Stop Calling RPM Agreements Cartels (or Price-Fixing)

  1. 

    Ha! I tried four versions of some such joke in the draft post but couldn’t get it quite right. I’m glad somebody did …

  2. 

    Looks like the Bloomberg folks made a serious boner. But c’mon, Josh. Were you really surprised that the erection drug arrangement turned out to be vertical rather than horizontal?

Trackbacks and Pingbacks:

  1. TRUTH ON THE MARKET » Dear Mr. Toobin - September 17, 2009

    […] Mr. Toobin clearly did not get this memo.  Descriptions of resale price maintenance agreements between manufacturers and retailers are not collusion in the antitrust sense, a label that connotes horizontal price-fixing between competitors.   Toobin’s explanation implies that what the Roberts court did was make it more difficult to prove a price-fixing agreement that harms consumers.  In the United States where the difference is not only economic but also legal, there is simply no excuse to use the words “cartel” or “price-fixing” to describe RPM.  Yes, a vertical agreement “fixes prices” but this is a fairly transparent attempt to obfuscate the economic issues (empirically RPM generally increases consumer welfare and does not have cartel-like effects) by analogizing it to a cartel.  If one was not paying attention, or knew nothing about antitrust economics, they could take the wrong impression from Toobin’s description that the Court reached an anti-consumer and pro-business result.  That’s a silly way to think about RPM as discussed here. […]