Search Results For RPM

The law and economics of RPM have been a frequent topic of discussion here for Thom and I especially, ranging from the empirical evidence on RPM, to competitive resale price maintenance without free riding, to the inappropriate use of the term “price-fixing” by journalists some who should know better to describe RPM,  to the Commission’s recent musical instruments investigation, and of course, Leegin.

Thom’s latest entry into the RPM wars deserves a close read by all who are interested in this subject.  Dr. Miles Is Dead, Now What?  Structuring a Rule of Reason for Minimum Resale Price Maintenance is now available in published form in the William and Mary Law Review (SSRN version available here).  Thom crafts a rule of reason approach to for evaluating RPM in a Post-Leegin (for now!) world.  Thom, I hope that you’ll be submitting this for the record to the FTC hearings.  My testimony at the FTC hearings took an approach very similar to Thom’s in attempting to structure a rule of reason inquiry around the available theory and evidence on competitive effects of vertical restraints and RPM specifically.

In any event, as the RPM battles rages on (and I hope it does, as the consumer welfare upside for the pending legislation is likely negative in my view), Thom’s article is worth the investment.

I’ve recently finished reading Jonathan Baker’s Preserving a Political Bargain: The Political Economy of the Non-Interventionist Challenge to Monopolization Enforcement, forthcoming in the Antitrust Law Journal.

Baker’s central thesis in Preserving a Political Bargain builds on earlier work concerning competition policy as an implicit political bargain that was reached during the 1940s between the more extreme positions of laissez-faire on the one hand and regulation on the other.  The new piece tries to explain what Baker describes as the “non-interventionist” critique of monopolization enforcement within this framework.  The piece is motivated, at least in part, by the Section 2 Report debates.  Baker’s basic story is fairly straightforward.  Under Baker’s account, competition policy is the outcome of the political bargaining process described above.  The “competition policy bargain” was then successfully modified in the 1980s in response to the Chicago School critique.  According to Baker, during the 1970s and 80s, “the Supreme Court revised many if not most of aspects of antitrust law along the lines suggested by legal and economic commentators loosely associated with the University of Chicago,” though this revolution changed the antitrust laws “dramatically but not fundamentally” and reflected a “bipartisan consensus in favor of reforming antitrust rules to enhance the efficiency gains arising from competition policy.”

Baker applies his “political bargain” framework to argue that the “modern non-interventionist critique,” unlike the successful attempt to modify the “terms” of the bargain in the 1980s, is highly likely to fail.  Baker defines the non-interventionist critique as relying on a particular series of legal and economic arguments.  For example, Baker describes the economic arguments deployed by the non-interventionists as that “markets are self-correcting,” “monopoly fosters economic growth,” “there is a single monopoly profit,” “excluded fringe rivals may not matter competitively,” “courts cannot reliably identify monopolization,” and so on.  Animated by the Section 2 Hearings, Report, its withdrawal, and the subsequent controversy, Baker begins from the assumption the non-interventionists are trying to modify an existing bargain, since non-interventionists are “the primary source of recent criticism of monopolization standards.”  From there, Baker argues that this concerted effort to modify the competition bargain in favor of less intervention is unlikely to succeed because such an attempted modification is unlikely to mobilize broader political support in the current social environment.

Let me start by saying that I agree entirely with the ultimate conclusion in so far as I don’t think there is any doubt that, in the current environment,  it is unlikely that the implicit “policy bargain” will be modified in a way that makes it more difficult for monopolization plaintiffs.  I have much more trouble with the premise of the exercise, and on how one knows a deviation from the current policy bargain when he sees one, and so will focus my critique on those issues.

Baker paints the picture of a dramatic and fundamental attack by non-interventionists on monopolization enforcement.  My response to the premise of the paper was: What non-interventionist effort to further relax monopolization standards?” To be sure, there are plenty of folks who have cautioned against expansive use of Section 2.  It strikes me that the fundamental weakness in Baker’s analysis is that his starting point – the “terms” of the current political bargain — derives from  assumptions that don’t seem to square with reality.    In other words, rather than envisioning the current debates around Section 2 as an assault by non-interventionists, there is a much more compelling case that it is the interventionists attempting to “deviate” from whatever implicit political bargain exists with respect to competition policy.  Christine Varney’s declaration that there is “no such thing as a false positive” – the presence of such being a seminal observation since The Limits of Antitrust (in 1984, no less) immediately leaps to mind.  I will turn to making the case that it is the interventionists making the offer for modification below.

But first note that Baker leaves out of his list of “economic arguments” against Section 2 both error costs and that there is little empirical evidence that aggressive monopolization enforcement generates consumer benefits.  This is, in my view, an important omission since Baker makes the point that all of the other economic arguments have attracted rebuttals.  If there has been a rebuttal of the argument that the empirical evidence suggests that instances of anticompetitive exclusive dealing, RPM, tying and vertical integration are quite rare, or an empirical demonstration that monopolization enforcement has generated consumer welfare gains bet of error and administrative costs, I’d like to see it.  Further, note that the original Chicago School argument, a la Director & Levi, against monopolization enforcement was not that anticompetitive exclusion was impossible, but rather that it was sufficiently rare in the world as an empirical matter as to be irrelevant to policy formation.  Baker ignores this empirical, evidence-based non-interventionist critique, which, for example, has been the core of the position taken by modern academic skeptics of monopolization enforcement like myself, Dan Crane, Tim Muris, Bruce Kobayashi, Luke Froeb, and David Evans.

What is the evidence that there is a non-interventionist attack on the current competition policy bargain as it exists with respect to monopolization? Not much.  The first is that the non-interventionists are the “source of criticism of recent monopolization standards.”  In parts of the paper, Baker equates the non-interventionists with business interests.  But under that formulation, there is not much evidence to support this proposition.  If anything, and as Baker readily acknowledges in a footnote, the headlines seem to tell a story of AMD, Google, Microsoft, Adobe and others expending resources to instigate antitrust enforcement against rivals not to restrict the scope of Section 2.

Baker cites more generally the recent monopolization controversy as driven by the non-interventionist attempt to deviate from the status quo.  But this part of the analysis reads to me as driven entirely by assertion that the competition policy preferences that Baker appears to prefer are in the “political bargain” and deeming opposition to those (interventionist) policies attempted “deviations.”  Perhaps this is a problem of hammers and nails.  Baker’s more interventionist than I and so sees obstacles between his ideal vision of antitrust law and reality as caused by non-interventionists.  But I’ve got a different hammer and see different nails.  For example, I read the Section 2 Report as largely (but not entirely) limited to a description of Section 2 law as it exists and the vigorously dissenting voices coming from the interventionist crowd.  As George Priest has put it:

It’s fair enough for a succeeding administration to reject policies of its predecessor. But the Justice Department report was not authored by John Yoo or Alberto Gonzales. It was the work of a year-long study that considered recommendations from 29 panels and 119 witnesses, most of them critical of the minimalist Chicago School approach to antitrust law. The report’s conclusions basically track Supreme Court law with modest extensions in areas where the Supreme Court has not ruled. Ms. Varney denounced the report in its entirety.

Finding the evidence lacking of some strong non-interventionist attempt to impose dramatic change on Section 2 that deviates from the current political bargain, I offer an alternative hypothesis: it is the interventionists that are attempting to deviate from the current political bargain and propose change.

For starters, I think that Baker and I would agree that there actually is a “stable” competition policy bargain with respect to monopolization that has drawn bipartisan over the last twenty years – at least in the courts.  Note that even restricting attention to decisions during the George W. Bush administration from 2004-08, the total vote count of these decisions was 86-9, with 7 of 11 decisions decided unanimously, and only Leegin attracted more than two votes of dissent (and more likely, as others have pointed out, for its implications with respect to abortion jurisprudence than anything to do with the antitrust analysis of vertical restraints!).  The monopolization-related decisions of the modern era, including Trinko, Linkline, Credit Suisse, and Brooke Group have all made lift more difficult for plaintiffs in one way or another.  But as I’ve written on this blog over and over again, the error-cost analysis embedded in these decisions is a key feature of modern Section 2 jurisprudence that is part of the current bargain.  So as I understand it, these decisions must be part of the current bargain.  It would be difficult, in fact, to find another area of law in which the Court has articulated principles with such overriding unanimity despite persistent attempts by some scholars to advocate for an alternate overarching legal framework.  I think there is a much more compelling story – and one backed by greater evidence than Baker’s narrative — to tell about the modern attempt of the interventionists to renegotiate terms.    Let’s discuss some of the evidence.

For starters, the strongly-toned dissents from the Section 2 Report from both Agencies after Hearings with witnesses and testimony from all possible sides of debate — even the parts that merely describe the law — suggest dissatisfaction with the terms of the modern bargain Baker describes and that are represented by the monopolization case law created over the past several decades by supermajority Supreme Court decisions.  It is AAG Varney who recently, as Baker acknowledges in the paper, minimized the importance of Trinko under Section 2 in favor of “tried and true” cases like Aspen Skiing.  This is, of course, to say nothing of AAG Varney’s endorsement of an antitrust policy free of error-cost considerations.

Further, it is the interventionists at the Federal Trade Commission that have turned to an expanded vision of Section 5 to evade the constraints imposed by Section 2.  In fact, the Commission has explicitly announced that it does not think that the constraints imposed on plaintiffs under Section 2 should apply to the antitrust agencies!  If this is not an attempt to deviate from the existing political bargain in an interventionist direction, I’m not sure what is.  Put another way, interventionists are currently attempting to re-write existing Section 2 law – the “political bargain” – through Section 5. Given the Complaint in Intel and promised use of Section 5 in broad circumstances previously covered under the Section 2 law envisioned under the “stable” bargain that Baker describes as generating bipartisan support from Democrats and Republicans, surely this is an attempt to deviate from the prior bargain.

It is the interventionists that have provided new economic arguments in favor of greater antitrust enforcement.  For example, the recent trend towards reliance on behavioral economics endorsed by the agencies emerges out of dissatisfaction with Chicago and Post-Chicago School theories that adopt rational actor models and, presumably, inability to get substantial traction in the federal courts from existing interventionist models provided by the Post-Chicago School.

The interventionist assault on the current implicit competition policy bargain goes further than the agencies though.  Congress currently has in front of it pending legislation to take out of the courts the development of a rule of reason standard for minimum RPM, a Twombly-repealer, legislation to make reverse payments in pharmaceutical patent settlements illegal, and legislation to regulate interchange fees.  Every one of these proposals represents an interventionist reaction attempting to overturn a judicial application of current competition law and suggest that perhaps the interventionists do not trust the courts to oversee the political bargain.

The premise of Baker’s analysis (that the non-interventionists are strongly challenging the current status quo) is either false to begin with or practically irrelevant in light of the much more important interventionist challenge.  Note again that Baker’s claim is that the non-interventionists would fail in any attempt to reduce the scope of monopolization enforcement because they will not be able to generate more broad political support in the current environment.  No doubt that is true.  But what about the interventionists chances for success?  Baker’s analysis provides a very interesting lens to analysis evaluate questions like whether the interventionists will be successful in renegotiating the terms of the competition policy bargain.  At the moment, though things may be changing, they seem to have greater political support.  I think the most interesting conflict arising out of Baker’s interesting conception of competition between stakeholders in antitrust policy is that it illuminates what might be a battle for supremacy in governing the bargain between agencies and courts.  As Baker notes, the courts have been a critical part of establishing the terms of the bargain and adjudicating attempts to “re-negotiate” by private plaintiffs and agencies over time.  Recently, interventionists have attempted to shift antitrust (and consumer protection) enforcement away from courts and towards administrative agencies, such as with Section 5 and the proposed CFPA.   To me, these present more important and interesting policy questions than whether non-interventionists will be successful in further shrinking Section 2 law.  I believe that the prediction emerging from Baker’s model depends on what happens with the political environment in the next few years.

My prediction, for what its worth, is that the current policy bargain will certainly hold together in the courts.  The remarkable strength of the current Section 2 status quo is held together by a combination of the intuitive appeal of price theory for generalist judges relative to more interventionist Post-Chicago and Behavioral economic alternatives, the relative explanatory power of the so-called Chicago School theories relative to contenders.  Nothing there has changed.  I have less of a sense about the impact of Congressional changes, judicial nominations, and the rise of the EU as monopolization enforcer have on monopolization in the US.

A new law in Maryland will take effect on October 1 and will re-instate the Dr. Miles rule for minimum RPM. The Wall Street Journal reports that it is a “move that could lead to lower prices for consumers across the country.” I doubt it. There are quite a few reasons to believe that shifts back to Dr. Miles will not result in lower retail prices, much less higher output (recall that the price effects are less interesting here from a consumer welfare perspective because both cartel theories and pro-competitive theories under which RPM facilitates demand-enhancing promotional services predict upward price movement). For instance, the most likely outcome of the move to per se illegality (whether at the state or federal level through legislation) is that firms contract around the rule with more costly contractual arrangements or vertical integration. To the extent that these alternative arrangements are indeed less efficient, those costs will be passed on to consumers. And of course, the empirical evidence tells us that RPM is generally output-enhancing, not anticompetitive.

Nonetheless, I suspect the WSJ article is right that we will see a number of states moving this direction. When the dust settles, and the state and federal legislation passes, I’d be willing to wager that the evidence will continue to show that prohibitions on RPM do not generate lower prices or higher output. Coincidentally, I will be a panelist at the May 21st FTC Hearings on Resale Price Maintenance discussing rule of reason analysis of RPM post-Leegin along with a representative of the Maryland State AG’s office amongst others.

Ill preview my prepared remarks here a few days in advance.

Varney on RPM

Josh Wright —  4 March 2009

I just saw this very good piece in The Deal from Sean Gates and Tej

During her tenure at the FTC, Varney advocated greater enforcement against vertical restraints. In a speech before the American Bar Association in early 1995, she explained her thoughts on resale price maintenance cases: “Our enforcement agenda today is that resale price maintenance agreements are unlawful per se and the commission will enforce the law in this area.” This was a clear change from Reagan administration antitrust enforcement. Even though the Supreme Court had long held RPM to be per se unlawful, the Reagan administration enforcers did not challenge these types of restraints. In fact, they did not bring a single pure vertical restraint challenge.

True to her word, Varney joined in several important RPM challenges, including cases that expanded the scope of the per se rule in RPM cases. In a case against American Cyanamid, Varney joined the majority in inferring the existence of a per se illegal RPM agreement despite the fact that the defendants had never announced resale prices nor sought a commitment from distributors to sell at or above a certain price level. In a case against Reebok, Varney joined the Commission in condemning an RPM policy, enjoining Reebok from using “structured terminations” to effect RPM even though such terminations “falls into the ‘gray’ area of RPM jurisprudence.” Varney also joined in a number of other cases challenging vertical price fixing agreements.

The Bush administration, however, did not bring a single challenge to an RPM policy. Instead, the Bush administration urged the Supreme Court to overturn the per se rule against RPM, which the Court did in Leegin Creative Products v. PSKS Inc. Since then, there has been much speculation regarding when, under a rule of reason analysis, RPM is unlawful. Given her prior positions in this area, Varney’s antitrust division may lead the charge in testing the boundaries set in Leegin by bringing challenges to vertical price restraints.

If past is prologue, Varney’s appointment suggests that Obama is looking to make good on his campaign promise to pursue a more aggressive and active antitrust enforcement agenda.

Varney’s speeches are available here. And I’ve previously noted my disappointment about a recent statement from the future AAG that “there is no such thing as a false positive.” Here is a speech from 1996 on vertical restraints. It is difficult to know what to make of the speech in terms of predictive power since it was made during the Dr. Miles era. Though my own view is that P(Dr. Miles Return) = .53. But it will be interesting to watch. As readers of the TOTM know, my own view on RPM is that the theoretical and empirical evidence do not warrant an aggressive antitrust enforcement approach.

FTC RPM Workshops This Week

Josh Wright —  15 February 2009

Tuesday and Thursday this week the FTC will be hosting the first two in a series of workshops on Resale Price Maintenance.  Presentation materials, slides, and papers are available on the website.

I’ve been reading the papers for the FTC RPM Workshops, though I cannot attend.  On the procompetitive side, I especially recommend Ben Klein’s explanation of how RPM facilitates the supply of promotional services in the absence of dealer free-riding.  Critics of RPM, in my view, generally do not understand the fundamental economic point that retailer competition alone is not sufficient to guarantee the supply of promotional services because of incentive conflicts between manufacturers and retailers.  Klein and Wright (JLE, 2007) explains this incentive conflict in great detail, and how fixed per unit time payments (slotting contracts) can be used to solve this common incentive problem and are part of the normal competitive process.  Klein’s newest RPM explains how RPM contracts can be used to achieve the same effect, that is, solving the incentive conflict between manufacturers and retailers to facilitate the supply of efficient promotional services.

The most common argument raised by defenders of the Dr. Miles rule, including Justice Breyer in Leegin, is that Telser’s (1960) classic discount dealer free-riding story for RPM (RPM solves the problem of consumption of promotional services at the full service retailer before buying the product at the discounter — and thus unraveling the supply of services in equilibrium) does not apply to a number of products where we observe RPM used.  This is where Klein & Murphy’s (1988) seminal explanation comes into play, documenting how the incentive conflict is a real economic problem solved by these vertical restraints, and part of the normal competitive process.  The Klein’s RPM Workshop piece builds on and updates that analysis.

One of the other issues that I’ve been keeping my eye on during the hearings is the evaluation of the current empirical evidence.  I’ve written before that in my own evaluation of the evidence, “the evidence overwhelmingly shows (see also here) [that RPM agreements] are highly likely to make consumers better off in practice.”  I also wrote that I hoped the RPM Workshops would take a hands on and rigorous approach to evaluating the state of evidence in order to design appropriate antitrust enforcement approaches to RPM and vertical restraints generally:

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…. 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.

In this light, it caught my eye that Patrick Rey’s slides and paper, which offers yet another possibility theorem of how RPM “could” result in anticompetitive outcomes.   The possibility theorem paper is nothing new in the sense that there are a ton of these around.  But the claim of empirical support is.  Indeed, my views on this matter are well known that there is not much empirical support at all for the anticompetitive theories of vertical restraints including RPM (see also the Lafontaine & Slade and Cooper et al literatuer surveys).  So I did some digging.  Here’s the claim from Rey’s paper with Thibaud Verge:

Our analysis supports this claim and shows that RPM can actually eliminate competition, not only among competing fascias, but also among competing brands. This possibility has been validated by recent empirical studies. Using data about retail prices of food products in French retail chains during the period 1994-1999, Biscourp, Boutin and Vergé (2008) find that the correlation between retail prices and the concentration of local retail markets was important before 1997 and no longer significant after that date. This suggests that the price increases that occurred after 1997 were indeed due to the impact of the new legislation on intrabrand competition.

So what does the Biscourp et al. study actually analyze?  You might think from the context that BBV (2008) studies Minimum RPM contracts.  But you would be wrong.  What did they actually study?  Get this: a set of French laws that make it illegal for retailers to sell “below cost.”  The Loi Galland came into force in 1997 and clarified a pre-existing ban on below-cost sales.  In other words, the Loi Galland set mandatory government enforced minimum price floors that apply to all retailers.  Boutin & Guerrero provide some details on the 1996 Loi Galland:

The Loi Galland gave a simple, precise definition of the actual purchase price and hence of the below-cost retail price floor: `The actual purchase price is the unit price stated on the invoice plus taxes on sales, specific taxes applied to the resale, and transportation costs.’  Since 1997, the definition of purchase price has thus been restricted to the price stated on the invoice, with no deductions such as year-end discounts. The Act also tightened official verification and raised fines. Only the margins formally applied at the invoice date and shown on the invoice the “upfront margins” can be passed on to final consumers through reductions in the final selling price. By contrast, all other discounts are described as “hidden margins” and therefore excluded from the below-cost retail price floor. Examples include margins linked to an annual sales volume, to the retailer’s display of the product on a minimum shelf length, to business cooperation, or simply to the respect of mutual commitments over a certain period. Consequently, hidden margins can in no way be passed on to consumers.

The law in other words, is similar to sales below costs laws i the US that are designed to anticompetitive raise prices, are binding on all sellers, and enforced by the government with significant fines.  Unsurprisingly, a law designed to prevent price-cutting achieves its intended effect and is found to have an anticompetitive effect.  But I’m frankly lost as to how Rey & Verge claim from this study of government imposed sales below cost laws that there is empirical support for the proposition that voluntary, privately negotiated RPM contracts are likely to be anticompetitive.  Note that Lafontaine & Slade’s leading survey of the literature argues that this distinction is quite important — concluding that mandatory restraints are far more likely to generate anticompetitive outcomes.

There is more.

Rey and Verge also claim that another paper from Bonnet and Dubois (2008) “supports his analysis of RPM.”  Curious, I took a closer look at this paper.  Does this second paper actually study RPM agreements?  Again, the answer is no.  B&D (2008) do something different: (1) they get retail prices and quantities for branded and unbranded bottles of water, (2) estimate a random coefficients logit model for the demand for bottled water (no data on costs or markups except for general input price indices), (3) infer wholesale and retail markups under a variety of assumptions about the nature of wholesale and retail competition which amount to 12 different models, and (4) from these estimated markups, estimate marginal costs (e.g. 12 different cost equations).  From these cost equations, they conduct a series of non-nested hypothesis tests, comparing the 12 different models against each other (table7, p. 34 at link above).  The authors conclude that “the results finally show that the best model appears to be model 10, that is the case where manufacturers use two part tariffs with resale price maintenance.”  From this series of assumptions and steps, the authors conclude that the branded water sellers are actually using RPM and two-part tariffs (“Our empirical analysis allows it to be concluded that manufacturers and retailers use nonlinear pricing
contracts and in particular two part tariff contracts with resale price maintenance.”)!  Further, the authors simulate the effect of moving from model 10 to other models of pricing and find that pricing is lower in other models and therefore conclude that RPM has anticompetitive effects.

There are some problems with this analysis.  First, suffice it to say that it is difficult to make confident policy statements about the effects of RPM contracts without studying actual RPM contracts.  There is no actual evidence that the water sellers are using RPM.  Indeed, RPM is illegal in France.  The inference is generated because the non-nested hypothesis test (which is notoriously weak) implies the model best fits the data.   Second, my understanding of merger simulations at the FTC is that when marginal costs are inferred from equilibrium conditions, attempts are made to verify the validity of the inference by comparing the inferred level to some actual measure (so that the model can be tossed if they don’t correspond to one another).

Evaluating the empirical evidence in favor of the various pro- and anti-competitive theories is an incredibly important step in the process of identifying the appropriate legal test to apply to resale price maintenance (and other vertical restraints). While the Rey & Verge piece offers an interesting theoretical effect of RPM, the key issue identified by Justice Breyer’s Leegin dissent is understanding how RPM contracts work in practice. In my view, Rey & Verge’s claim that there is empirical support for their model is unfounded. To the contrary, neither the BBV or BD papers add any empirical contribution to the debate over the appropriate antitrust treatment of privately and voluntarily adopted RPM contracts.

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.

Dear Mr. Toobin

Josh Wright —  3 June 2009

Jeff Toobin has an interesting profile on John Roberts in the New Yorker (HT: Jonathan Adler who also takes issue with Toobin’s description of Leegin, but goes on to challenge Toobin’s general account of Roberts as a “stealth nominee”).   Toobin’s column has very little to do with antitrust.  with the exception of one sentence describing the Leegin decision where he writes:

That same day, the Justices overturned a ninety-six-year-old precedent in antitrust law and thus made it harder to prove collusion by corporations.

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.

UPDATE: A reader reminds me that the Antitrust Section at the American Bar Association, which I don’t believe can fairly be characterized as a “conservative” (if that’s a useful label at all in this context) antitrust group, has made an official statement in support of the Roberts Court’s analysis in Leegin:

The ABA supports the position that under the federal antitrust laws—and analogous state and territorial antitrust law—agreements between a buyer and seller setting the price at which the buyer may resell a product or service purchased from the seller should not be illegal per se. Instead, these agreements should be analyzed under a rule of reason analysis. The ABA also believes that the Supreme Court’s recent decision in Leegin is consistent with that position.

Thom answers this question in the affirmative in his excellent post about the Ninth Circuit’s analysis in Masimo and is disappointed that the Ninth Circuit rejected the discount attribution standard as the sole test for Section 2 in favor of a separate inquiry as to whether the bundled discount arrangement resulted in a substantial foreclosure of distribution and competitive harm.  Thom describes this reasoning as “sorely disappointing.”  I’m tentatively not convinced things are as bad as Thom sees them and want to explain why.  Maybe Thom can persuade me that I ought to be more upset about Masimo than I am.

Let me start with two preliminary points.

First, I agree that bundled discounts are generally pro-competitive for all of the reasons Thom states as well as some others.  While there is some empirical evidence that bundled discounting appears in highly competitive markets where anticompetitive theories do not apply, suggesting pro-competitive efficiencies, but little empirical verification of a high likelihood of competitive harms.

Second, despite our agreement about the generally efficiency of bundled discounting, Thom’s claim that a bundled discount distribution arrangement cannot result in anticompetitive effect is overstated as a matter of economic theory.  My basic point is that it is possible, as a matter of economic theory, for distribution arrangements involving bundled discounts that satisfy the PeaceHealth safe harbor to result in anticompetitive effects.  Despite this economic point, I’m not sure that Thom and I disagree on the ultimate appropriate legal treatment of bundled discounting.  I’ll get back to that.

Now, to defend my claim.

Let’s start with Thom’s position that, contra the Ninth Circuit, a bundled discount scheme that satisfies PeaceHealth’s discount attribution test (i.e. prices are still above cost after the discount is fully attributed to the competitive product in the bundle) should be immune from Section 2 liability even if the arrangement results in the “foreclosure” of a sufficient share of distribution to deprive rivals of the opportunity to have access to a critical input (such as shelf space) required to achieve minimum efficient scale.

What is the anticompetitive story in these “bundled discount as de facto exclusive dealing” set of cases?  Put simply, the anticompetitive theories are based on the notion that the monopolist’s distribution arrangement will deprive the rival of the opportunity to reach minimum efficient scale through the foreclosure of access to some critical input do not depend on offering distributors a price that fails the discount attribution standard.  A broad set of “exclusionary distribution” cases allege that various forms of marketing arrangements between manufacturers and retailers result in a situation where the monopolist is purchasing exclusion + distribution rather than just distribution.

The economic literature giving rise to these anticompetitive theories of exclusive dealing as “raising rival’s costs” is about the conditions under which manufacturers will be able to purchase exclusion from downstream firms and the price that they will have to pay to do so.  Manufacturers make payments to distributors for access to shelf space in a lot of ways: lump sum payments such as slotting fees, rebates, loyalty discounts, bundled discounts, RPM, cooperative marketing dollars, trade promotions, and more.  But the key question should not turn on the form of those payments.  It should turn on whether the contracts satisfy the conditions necessary for anticompetitive harm: are rivals foreclosed from a sufficient share of distribution that they cannot achieve minimum efficient scale?

This begs the question: is a price that fails the discount attribution test a necessary condition for the above set of theories to operate?  I don’t think so as a matter of theory.  One can think of the raising rivals’ costs theories of distribution as the manufacturer paying a set of distributors to join the manufacturer’s cartel.  What payment would be sufficient to sustain that agreement without defection (distributors would all have the standard incentive to cheat)?  The answer to that question depends on a lot of things: upstream and downstream entry conditions, switching costs, number of distributors, the existence and magnitude of economies of scale or scope, etc.  But I don’t think that there is any reason to believe that economic theory provides a linkage between passing the discount attribution test and failure to satisfy the necessary conditions for standard raising rivals’ cost-based exclusion theories.  Thus, in theory one suspects that there are distribution arrangements that could logically survive PeaceHealth but also potentially create anticompetitive effects because they satisfy the conditions of the exclusion theories.  Let’s call that set of agreements X.

The existence of X doesn’t necessary mean that I disagree with Thom about the appropriate legal rule.  If X is very small such that it would be more costly to identify these agreements and prosecute them, one could justify Thom’s rule on those grounds.  If enforcement actions against X would lead to substantially greater error costs than Thom’s rule, one could also justify his position on those grounds.  The existing empirical evidence, to my knowledge, is insufficient to make such fine grained determinations.  However, the same evidence also tells us that manufacturer arrangements to pay for distribution and promotion are incredibly common, provide benefits to consumers, and occur in competitive markets.  Indeed, I’ve written a great deal about the set of conditions under which the normal competitive process generates payments for distribution. As such, I agree with Thom that it is incredibly important to establish workable and broad safe harbors in this area that minimize error costs. What I reject is the strong economic claim that appears in Thom’s post:

When it comes to bundled discounts, which generally reflect (or promote) cost-savings and which provide an immediate benefit to consumers, there can be no anticompetitive harm in the form of predation, unreasonable exclusion, or foreclosure if the competitive product is priced above the defendant’s cost once the entire discount is attributed to that product.

If the plaintiff is making a predation claim involving bundled discounts, I think the PeaceHealth standard is workable and useful and we should keep it.  A potential case might even be made, as discussed, to justify PeaceHealth as the universal standard for bundled discount claims even when they alleged exclusionary deprivation of scale because we think X is sufficiently small or unimportant or especially susceptible to Type I error.  But I don’t read Thom as making that case.  Perhaps he is and I hope he’ll clarify.

To repeat: I just don’t think that there is any reason to believe that exclusion in the sense defined here is not theoretically possible as a matter of economics because we observe a price that passes PeaceHealth.  As such, I don’t want to throw out foreclosure analysis as an important and relevant part of the antitrust inquiry.  Let me end with a few words in defense of foreclosure analysis which I think gets a bad rap nowadays.

There are costs to keeping the foreclosure analysis, and having two standards for two different allegations of anticompetitive harm.  Beyond that, of course, foreclosure analysis is full of its own complications, e.g. foreclosure of what? does duration of contract matter? what about staggered expiration dates?  But despite its complications and the potential for abuse, the foreclosure analysis asks the right question in deprivation of scale questions and the one that we know is explicitly linked to an important necessary condition of a very large set of the theories of harm alleged in monopolization cases.  Getting a legal standard reasonably tied to the necessary conditions for anticompetitive harm, as Thom knows from his important work in the RPM area, is not always an easy thing to do in antitrust.

By the way, I think that my objection here survives Thom’s “Hydra critique” that the mode of antitrust analysis should be a function of economic substance rather than form.  I agree that the critical question is whether the conduct is likely to impair the competitive process to the detriment of consumers.   The point here is that the the deprivation of scale claims are or at least can be, as a matter of economic substance, different than pure price predation claims.

The critical economic point is that the set of distribution arrangements must, as the literature says, raise a rival’s cost of operating or impair his ability to exist.  Those arrangements that do not should not trigger antitrust violations.  And of course, those that do not satisfied a necessary but not sufficient condition for competitive harm.  The key point is that in cases involving allegations of deprivation of scale, the economic consensus is that those claims require allegations of exclusion require foreclosure sufficient to deprive rivals the opportunity to compete for minimum efficient scale.  If we are ready to accept that this is the state of economic consensus, then we ought to explicitly include this showing in the part of the plaintiff’s burden.  The antitrust law currently attempts to get at this inquiry through foreclosure analysis, requiring something around 40 percent foreclosure share in de facto exclusionary cases.  That seems sensible to me.

Antitrust can handle different standards.  If the plaintiff is alleging deprivation of scale, lets make substantial foreclosure a necessary (but not sufficient) condition.  If the plaintiff is alleging a price predation argument that does not depend on deprivation of scale, PeaceHealth is a safe harbor.  Would that be so bad?  And one more question for discussion purposes, if Thom is right about PeaceHealth in the context of bundled discounts, doesn’t this also apply to any payment distribution?  For example, I think the logic clearly applies that single product loyalty discounts ought to be analyzed the same way, i.e. we should use discount attribution to apply the discount on so-called non-contestable units to the contestable ones and apply the same filter.  But if that’s true, exclusive dealing with discounts is a loyalty discount where the threshold volume is set to 100% of the distributor purchases.  If that’s right, Thom are you arguing that we should get rid of all exclusive dealing law whenever there is a discount scheme?

Geoff recently highlighted AAG Christine Varney’s closing remarks at the Horizontal Merger Guidelines workshop and was fairly critical.   Thom intervened to suggest that we at TOTM, while fairly critical of the agencies from time to time, also give credit where it is due — highlighting AAG Varney’s RPM article.  OK, that’s enough credit for now.

Now, I’d like to highlight another portion of the speech Geoff mentioned that, as Commissioner Rosch has done in earlier remarks of his own, takes a shot at the Chicago School in order to justify greater intervention and a “reinvigorated” antitrust enterprise.  On the one hand, it sure is nice to see convergence between the agencies compared to the days when Commissioner Kovacic described the sister agencies as “an archipelago of policy makers with very inadequate ferry service between the islands” and “too many instances when you go to visit those islands the inhabitants come out with sticks and torches and try to chase you away.”  Ah.  Nothing like attacking a vaunted enemy of interventionist antitrust policy like the Chicago School bogeyman to create warm feelings between the agencies.   On the other hand, convergence would seem like a less impressive feat if what is converged upon is an embarrassing error that demonstrates a lack of understanding about the Chicago School in the first instance, and even still less impressive if the error is bootstrapped into justifications for policy changes.

What is all this about?  In leveraging discussion of the financial crisis as the basis of an argument that microeconomic theory that forms the basis of industrial organization economics has been turned on its head, the chiefs of both antitrust agencies have now made the same error.  I’ve criticized Commissioner’s Rosch’s error in declaring the Chicago School “on life support, if not dead” in great detail elsewhere.  Antitrust is getting a little bit depressing.  While the US enforcement agencies would have the Chicagoans on life support, or at least retired, of course, Professor Elhauge goes the whole way to “death of the single monopoly profit theorem.”  All this talk about the Chicago School’s death, retirement, general malaise and otherwise fragile state and one almost forgets the state of Supreme Court jurisprudence, much less the actual empirical evidence.

Let’s turn to AAG Varney’s statement:

The evolution of antitrust law needs to keep pace with the advancement of economic thinking. Judge Posner convincingly made this case for reassessing economic beliefs in his recent, thought-provoking piece entitled “How I Became a Keynesian: Second Thoughts in a Recession,” wherein he questioned some of the theoretical assumptions that had previously guided his work. In an even more recent interview, he is quoted to say that “‘the term “Chicago School” should be retired.'” Theoretical assumptions that market forces naturally and inevitably correct for market failures clearly need to be reconsidered. In the context of the Horizontal Merger Guidelines, the most relevant aspect of this reassessment involves explicit or implicit assumptions that entry will erode market power otherwise enhanced by a merger.

Here’s the link to the interview.  Varney clearly wants to use Posner’s quote about the retirement of the Chicago School to support the next sentence, that is, that we ought to reconsider our priors about markets working and reevaluate antitrust priorities in a way that supports greater intervention.  I mean, if Chicago’s own Richard Posner says the Chicago School should be retired — well, I leave the rest of the proof as an exercise for the reader.

So did Posner And here’s what Posner actually said:

Ronald (Coase) is alive, but he’s very, very old. He’s not active. Stigler is dead. Friedman is dead. There’s Gary (Becker) of course. But I’m not sure there’s a distinctive Chicago School anymore. Except there are probably a higher percentage of conservative people here, but not all. Jim Heckman—not particularly conservative at all. He’s very distinguished. Steve Levitt—he’s very famous. I don’t think he’s conservative. You’ve got people like (Richard) Thaler. So probably the term “Chicago School” should be retired.

There were people—people like Stigler and Coase, Harold Demsetz, Reuben Kessel, and people at other schools like Armen Alchian. They were people rebelling against the very liberal economics of the nineteen-fifties—very Keynesian, very regulatory, very aggressive anti-trust, little faith in the self-regulating nature of markets. Francis Bator, who’s a very distinguished Harvard economist, he wrote a famous essay entitled “The Anatomy of Market Failure.” And he gave so many examples of market failure that you couldn’t believe a market could exist. You have to have an infinite number of competitors, full information, you can’t have any economies of scale, and so on. It was too austere. That was what the Chicago people, with their more informal approach, rebelled against. So we had our moment in the sun, but by the nineteen-eighties the basic insights of the Chicago School had been accepted pretty much worldwide.

Posner did not make the point that the Chicago School ought to be retired because it is outdated, incorrect, or led to antitrust policy that provided inadequate protection for consumers because of misguided notions about market failures.  Posner was making the point, as he has made elsewhere time and time again, that the Chicago School as applied to regulation, antitrust, and industrial organization economics, had been so broadly adopted into mainstream economic thought that it no longer made sense to describe a distinctive “Chicago School.”  This is the point he also makes in the speech.   Posner, actually goes so far as to reject the assertion Varney invites the reader to make, i.e. that the financial crisis should undermine faith in markets in a sense relevant to regulation and antitrust generally.

When asked “Has the financial crisis undermined your faith in markets and the price system outside of the financial sector?”

Here is Judge Posner’s answer:

No. But of course one of the more significant Chicago (positions) was in favor of deregulation, based on the notion that markets are basically self-regulating. That’s fine. The mistake was to ignore externalities in banking. Everyone knew there were pollution externalities. That was fine. I don’t think we realized there were banking externalities, and that the riskiness of banking could facilitate a global financial crisis. That was a big oversight. It doesn’t make me feel any different about the deregulation of telecommunications, or oil pipelines, or what have you.

It really can’t be made more clear than that can it?  I understand that it is tempting to use figures like Greenspan and Posner to play “gotcha.”  I’m quite sure its even an effective rhetorical device at times with those who do not follow the debates closely or do not read the language carefully.  But in both cases, the AAG and the Commissioner do a disservice to those lawyers and economists in their agencies who are dedicated to getting the answer right by hard economic analysis and not by sloganeering.  For a serious and intellectually powerful discussion from a public antitrust enforcement official discussing the Chicago School’s role, along with contributions from Harvard, in forming the intellectual basis of modern antitrust jurisprudence, see Commissioner and former Chairman Kovacic’s seminal article on the subject.

As I’ve written on this topic previously:, at that time motivated by the declaration out of the Federal Trade Commission that the Chicago School was either on life support or dead:

I had always thought that the “Chicago School” stood for the proposition that microeconomic theory should be applied rigorously, with care and attention to institutional detail, and with an eye towards producing testable implications.  These are qualities, especially empiricism, that do not lend themselves to a reflexive “faith” that markets will produce only efficient behavior.  That faith, where it exists, is earned by persuasive theory and evidence.

And with all due respect to the Commissioner, an intellectually honest survey of the state of evidence concerning the actual competitive effects of antitrust-relevant business practices reveals that the Chicago School isn’t close to dead.  In fact, Chicago School principles are alive as ever in the Supreme Court’s jurisprudence.  Perhaps this disappoints the Commissioner and others who might like economics (and particularly Chicago School antitrust economics) to be a lesser constraint on antitrust enforcement decisions.  But it’s the state of play in both the federal courts and in the empirical antitrust literature.  The debate over whether to deviate from the state of play should be determined by the quality of theory and evidence.   A rigorous review of the empirical evidence suggests not only that the Chicago School of antitrust is alive, but in my view, that it is the “best available” mode of analysis for understanding many business practices relevant to antitrust enforcement.

The search for evidence-based antitrust cannot be conducted by assertion.  Instead, if it is to be fruitful, it must take a more scientific approach.

If the Chicago School’s influence on antitrust policy is going to be defeated — let it be by strong theoretical and empirical evidence that its insights give less predictive power than alternative theories and result in policies that provide fewer benefits to consumers than alternatives.  T-shirt slogans are not going to reverse Supreme Court decisions or win Section 2 cases — though perhaps acts of Congress and expanded use of Section 5 will leave a dent.  Still, here’s to authorities and leading voices in the antitrust community, and particular those at the antitrust enforcement agencies, using their podiums to encourage productive and intellectually honest debate and not cheap, deceptive, and misleading rhetorical tricks.

Speaking of, let’s have new Section 2 hearings!

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.

I want to second Josh’s commendation of Ben Klein’s submission to the recent FTC Hearings on Resale Price Maintenance. Klein’s paper, which bears the same title as this post, is lucidly written (blissfully free of equations, Greek letters, etc.) and makes a point that, at this juncture in antitrust’s history, is absolutely crucial.

In the pre-Leegin era, commentators who were critical of Dr. Miles‘s per se rule (including yours truly) usually emphasized the so-called free-rider rationale for minimum RPM. According to that rationale, manufacturers frequently set minimum resale prices for their products in order to encourage demand-enhancing point-of-sale services upon which retailers could free-ride. Golf club manufacturer Ping, for example, tried to control its dealers’ resale prices because it wanted dealers to expend great effort helping customers find the perfect set of highly customizable clubs. It worried that the ability to compete on resale price would lead some dealers to cut their own customizing services (and thus their costs), direct their customers to high-service dealers for the necessary customization, and then offer a discount to those customers on the clubs selected by the high service (and thus higher cost) dealers, who couldn’t afford to match the discount. If such free-riding were pervasive, Ping dealers would eventually stop providing the sort of customizing services that enhance demand for Ping clubs.

In the pre-Leegin era, it made sense for critics of Dr. Miles to emphasize the free-rider rationale because (1) it’s easy to explain, and (2) it applies often enough that we can say with confidence that RPM — often motivated by a desire to avoid free-riding on output-enhancing services — is not “always or almost always anticompetitive.” That, of course, is all we Dr. Miles critics needed to establish in order to undermine the per se rule against minimum RPM. (Per se illegality is appropriate only for practices that are always or almost always anticompetitive.)

It’s now a new day in antitrust. Dr. Miles is dead, and the key question for courts, commentators, and the regulatory agencies is how particular instances of RPM should be evaluated to determine their legality. Answering that question requires more than a simple showing that RPM can, under a fairly common set of circumstances, lead to higher output. Indeed, if our rule of reason focuses exclusively on the free-rider rationale for RPM, it may well lead to condemnation of procompetitive instances of RPM in circumstances in which the free-rider rationale does not apply. For example, the highly influential Areeda-Hovenkamp treatise proposes a rule of reason that would automatically condemn RPM arrangements on “homogeneous products,” for which there are unlikely to be any point-of-sale services that are susceptible to free-riding. (See par. 1633c of the Second Edition.) The assumption here is that RPM’s only significant procompetitive effect is the elimination of free-riding.

Fortunately, the Supreme Court’s Leegin decision recognized that RPM may be output enhancing even in the absence of free-riding. The Court explained (page 12):

Resale price maintenance can also increase interbrand competition by encouraging retailer services that would not be provided even absent free riding. It may be difficult and inefficient for a manufacturer to make and enforce a contract with a retailer specifying the different services the retailer must perform. Offering the retailer a guaranteed margin and threatening termination if it does not live up to expectations may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services.

The idea here — developed fully in Klein & Murphy (1988) — is that RPM, which guarantees retailers a healthy margin on sales of the product at issue, can be used to generate retailer services that are hard to secure contractually. Exhaustively specifying ex ante all the services a retailer should provide would be quite difficult for a manufacturer. In addition, monitoring and enforcing a dealer’s performance obligations along multiple service dimensions would require substantial effort. RPM coupled with a liberal right of termination can provide an alternative means of securing the retailer services(attractive product placement, etc.) that enhance demand for the manufacturer’s products. If the manufacturer generally observes its retailers’ performance, retains an unfettered right to terminate underperformers, and provides an attractive retail margin as an incentive to avoid termination, then the manufacturer can motivate its retailers to provide demand-enhancing point of sale services without specifying them exhauastively.

While the Leegin majority nicely explained how RPM can be used to enhance demand-enhancing retailer services even when those services are not subject to free-riding, it failed to address one crucial question: Why would a manufacturer need to use RPM to encourage these services, since retailers themselves would also benefit from increasing the sales of their manufacturers’ products?

Justice Breyer pounced on this omission in his Leegin dissent. Referring to the majority’s contention that RPM “may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services,” Justice Breyer stated (pages 14-15):

…I do not understand how, in the absence of free-riding (and assuming competitiveness), an established producer would need resale price maintenance. Why, on these assumptions, would a dealer not “expand” its “market share” as best that dealer sees fit, obtaining appropriate payment from consumers in the process? There may be an answer to this question. But I have not seen it.

Klein’s submission to the FTC’s RPM hearings provides a straightforward answer to Justice Breyer’s question. RPM may be necessary, Klein contends, because a manufacturer and its dealers often have divergent incentives when it comes to services that expand demand for the manufacturer’s products. Frequently, a manufacturer will stand to gain much more from its dealers’ promotional efforts than the dealers themselves. Thus, “RPM plus a liberal right of termination” may be needed to incentivize dealers to provide the services that will maximize sales of the manufacturer’s products. Klein points to three commonly present economic factors that create the sort of incentive divergence that warrants RPM:

(1) Manufacturers often enjoy a larger per-unit profit margin than do their retailers. Because manufacturers’ products tend to be more highly differentiated than the services retailers provide, and because the ability to charge prices in excess of one’s costs is a function of the uniqueness of whatever one is providing, manufacturers will generally earn higher per-unit profits on their products than will the retailers who resell those products. Accordingly, manufacturers stand to gain more from incremental sales of their products than do their retailers, and they may therefore need a way to give their retailers an extra incentive to promote their products.

(2) Many manufacturer-specific retailer promotional efforts lack significant inter-retailer demand effects. While some retailer promotional efforts, such convenient free parking or extended store hours, would provide competitive benefits for both the manufacturers whose products are carried by the retailer and the retailer itself, other retailer promotional efforts, such as prominent placement of the manufacturer’s product within the “impulse buy” section of the retailer’s store, would really benefit only the manufacturer without enhancing demand for the retailer’s services over those of its competitors. Absent some nudge from the manufacturer, retailers won’t be adequately incentivized to perform these sorts of services. RPM can provide the needed nudge.

(3) Manufacturer-specific retailer promotional efforts may cannibalize a multi-brand retailer’s sales of other brands. Many retailer services that would promote a manufacturer’s brand of a product would merely reduce the retailer’s sales of competing brands of the same product and would thus provide little, if any, net benefit to the retailer. Granting favored shelf space to one brand, for example, may require moving a competing brand to less favorable shelf space, thus reducing the sales of that brand. A manufacturer can induce its retailers to provide it with “cannibalizing” promotional services by employing RPM to guarantee the retailer a higher markup on sales of the manufacturer’s brand.

These sources of divergence between manufacturers’ and retailers’ incentives are discussed in more detail in Josh’s 2007 collaboration with Klein, The Economics of Slotting Contracts, 50 J. L. & Econ. 421 (2007). Taken together, the various sources of divergence make it in the interest of many manufacturers to adopt some sort of RPM policy, even when the product at issue is not one that is sold along with services that are susceptible to free-riding. The RPM policies manufacturers adopt to address incentive divergence enhance the manufacturers’ overall output and should thus be assumed to be procompetitive. Accordingly, liability rules such as that proposed in the Areeda-Hovenkamp treatise, which maintains that “[p]roduct homogeneity is an easily observable fact that is inconsistent with known legitimate uses of RPM” (Par. 1633c, at 334 (2d ed.)), are unsound and should be rejected.