Babies-R-Us and the Case Against a Presumption of Illegality for Retailer-Initiated RPM

Thom Lambert —  20 October 2009

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.

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.

4 responses to Babies-R-Us and the Case Against a Presumption of Illegality for Retailer-Initiated RPM

  1. 

    Thanks for clarifying the nature of the original order, Gleklen. I didn’t look at it and should have before assuming it was aimed at RPM. (That wasn’t really the main point of my post, but I should have checked anyway.)

    Yes, Toys-R-Us — and everyone else subject to pre-Leegin consent orders on RPM — could seek modification in light of the changed legal rule. Parties bound by such orders should do so. And the FTC should grant the requested modification without attempting, as it did in the Nine West case, to treat RPM as though it’s presumptively illegal.

  2. 

    The Toys “R” Us case was not a RPM case, and it’s not clear to me that RPM would violate the order in that case (available here: http://www.ftc.gov/os/1998/10/toysrsinord.htm). The order bars TRU from inducing or pressuring a supplier to “limit supply” to a discounter. One wouldn’t normally consider RPM as “limiting supply” given that the context of the order was about exclusive dealing.

    But, assuming that the order actually reaches RPM, you write that “[g]iven the sea change wrought by Leegin, any consent order entered 11 years ago would rest on shaky footing indeed.” I’m not sure whether you mean shaky analytical footing or whether you’re suggesting that there’s a question as to whether the decree binds TRU. Regardless of whether the decree is justified given the state of the law, it’s clear that TRU is bound by it and that if it didn’t like it TRU could, like Nine West, have sought modification.

    DOJ got a $750K civil penalty against Rolex for violating a 46 year old decree that prohibited conduct that is now clearly lawful. Simultaneously with seeking the civil penalty, DOJ asked the court to modify the decree.
    http://www.usdoj.gov/atr/public/press_releases/2006/214821.htm

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