Consignment & Resale Price Maintenance

Karl Note: Those lines in this color are either the page number references or the footnotes on the various pages. In reading this page careful attention to this color designation will be necessary to follow the flow of the text as contrasted with a flow of the footnotes. In a few cases a footnote is carried forward to continue on the next page. I have also added some images to the article -- which contained none.

Reference to "consignment" is here. [This link takes you to the section that indicates that "consignment sales" is a method of "getting around" the per se illegality of price fixing arrangements.

The authors also cite a US Supreme Court Case that would SEEM to make a Resale Price Maintenance legal, but it is from a case decided in 1919 and even these authors suggest it could be risky. More information on this reference is here.

Karl Note: Although this was published on the net it was marked "not for quotation." The lead author is a professor of economics at . Read about his personal teaching philosophy here.

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NOT FOR QUOTATION OR CITATION
Forthcoming in American Bar Association, Antitrust Section
Issues in Competition Law and Policy
(Wayne D. Collins, editor)

A resale price maintenance (RPM) agreement is a contract in which a manufacturer and a downstream distributor (hereafter a retailer) agree to the price the retailer will charge its customers (hereafter consumers).2

One might wonder why a manufacturer, having sold a product to retailers, would want to exert any influence over resale prices. It might seem, at first glance, that the manufacturer could set wholesale prices expecting that competition among retailers would hold retail prices in check. But there is much more to the story. This paper explains why a manufacturer might establish and maintain a minimum or maximum retail price, and what the consequences are for consumer welfare when this pricing practice is deployed. [Image is of the lead author, Kenneth G. Elzinga]

It turns out there are several reasons why a manufacturer might try to maintain resale prices. Some of the reasons indicate that RPM enhances consumer welfare; others indicate the opposite. This means any economic assessment of a particular case must interpret the facts in that situation with competing theories in view.

1 The authors thank Tyler A. Baker, Roger D. Blair, Frank Mathewson, Howard P. Marvel, and Ralph A. Winter for helpful comments.

Manufacturers selling undifferentiated products in perfectly competitive markets would never use RPM as a pricing practice. In such markets, manufacturers have no unilateral influence over prices at either wholesale or retail levels. But in many transactions involving branded products, RPM can have a constructive role. To understand why, two economic concepts must be understood: (1) consumer demand for a differentiated product can depend on retail “service” as well as the product’s price; (2) retail service can be an occasion for what economic theory calls “market failure.” [The image is a pile of salt.]

In markets for differentiated consumer products, demand is a function of product features and quality as well as the price of a product. Demand also can be

affected by retail service, defined broadly to include pre-sale display, product-specific information, store hours, adequate inventory, post-sale service, the reputation of the retailer as a certifier of product quality, and other shopping amenities. Consumers value retail service, so better retail service raises consumer demand. In some instances, an increase in demand caused by increased retail service can increase unit sales and make consumers better off, even if accompanied by a price increase. [Image of a Bose Sound System -- Bose has a very good reputation for quality -- mostly sold direct from the manufacturer in order to maintain prices and quality of service and product]

If consumers value retail service such that better service raises consumer demand, should we not expect retailers to

provide adequate retail service without being nudged by the manufacturer? The answer is “no” where one retailer’s service invites a competing retailer to become a free rider. A free rider is someone who enjoys the benefits of someone else’s investment without having to pay compensation. [Image: There are still cheats in the world!]

[Karl Note: Is THIS not the central problem of the internet? Millions of "browser cheats" look for the information they MUST HAVE TO SURVIVE, but then do NOT exchange with the source of that information -- they cheat and buy from the other cheats who freeride on that "free information" and sell cheap! Is this not the central ruin of a health food store where the staff are well educated and give good information to the customer -- some of whom duck out to buy at Costco?]

The iconic free riding example in the RPM literature is the high-tech, information-intensive consumer durable (think of high-end audio equipment), where pre-sale assistance by a knowledgeable salesperson at a retail establishment is

Upon getting the requisite information from the full-service retailer, the shopper leaves the store, without making a purchase, and visits a discount store to buy the product for a lower price. The discount store, which can offer the lower price because it does not employ knowledgeable salespersons, gets a free ride from the full-service retailer who pays those salespersons.

The state of affairs just described is unsustainable for the full-service retailer. It cannot continue to employ knowledgeable salespersons and still match the discounter’s low price. The full-service retailer must curtail service to survive. In the end, the free rider prevents consumers from having access to retail services for which they are willing to pay. Those consumers must decide what brand of good to buy, or whether to buy a good at all, with less than optimal information about their choice set. Products that require retail service may not be available.4 The consequences are bad for consumers and bad for the manufacturer.5

3 What is high-tech depends upon the time of reference.

In the early days of the automobile industry, Henry Ford used RPM to protect the retail margins of automobile dealers who needed to teach customers how to drive. Economists should be aware that Alfred Marshall’s classic text, Principles of Economics, was the first product “ in the English speaking world to be sold under a scheme of resale price maintenance.” See William Breit, “Resale Price Maintenance: What do Economists Know and When did They Know it?” 147 Journal of Institutional and Theoretical Economics 72 (1991) (emphasis in original).

4 The free rider problem could be circumvented if those aspects of retail service that build demand for the manufacturer’s product can be separated from other retailer activities and “sold” to consumers, or the manufacturer, on a stand-alone basis. Transaction costs appear to prevent separate service sales from eliminating all free riding.

5 Technically, it makes no difference to perfectly competitive retailers whether retail service is provided since, in the long run, perfect competition allots them normal profits either way.

Manufacturers with RPM policies that establish retail price floors may be trying to remedy a market failure.6

[Karl Note: Is there any greater failure than the drug company patents which allow them monopoly control over prices and the linked laws that make it illegal for a vitamin company to make a claim for cure? We do fight the good fight here!]

That is, by selling its brand to retailers on the condition that each retailer’s price not fall below some minimum level, the manufacturer prevents any retailer from taking sales away from another by charging a lower price. Also, by exerting control over the retail price of its brand, as well as the wholesale price, the manufacturer can affect the amount of retail service by providing the necessary retail “margin” to pay for it. With retail price competition for the product thwarted, once retail prices settle to the minimum level specified in the RPM agreement, retailers compete with each other for sales by offering valuable retail service to consumers.

The free rider problem is not confined to high-tech, information-intensive consumer durables.

RPM occurs in markets where goods do not require detailed information, extensive product demonstration, or significant post-sale service commitments. Such products might include women’s fashion accessories, shoes, candy, and designer jeans. In the case of such products, retailers may use RPM-protected margins to invest in retail services like longer hours of operation, more attractive store furnishings, and other amenities that owe nothing to specialized information. Besides shopping amenities, retailers with reputations for selling high-quality merchandise provide what has been called a “quality certification” service to manufacturers.7

A manufacturer may use RPM to insure that reputable retailers – those who help

6 Lester G. Telser offered this explanation for RPM in his path-breaking article on protected retail margins. See “Why Should Manufacturers Want Fair Trade,” 3 Journal of Law & Economics 86 (1960), especially p. 91.

7 See Howard P. Marvel and Stephen McCafferty, “Resale Price Maintenance and Quality Certification,” 15 Rand Journal of Economics 346 (1984).

the manufacturer build and maintain a good reputation for its brand – carry its brand by affording those retailers protection from free-riding discounters.8

RPM also may be used to induce efficient retail services when the source of market failure is not a free-riding discounter. Klein and Murphy interpret RPM not so much as a method to foil free riders but rather as a device to make retailers comply with incomplete performance contracts aimed at stimulating and securing retail services that build demand for the manufacturer’s product.9

Economic theory indicates that a manufacturer cannot rely on the retailer to provide optimal retail service when the manufacturer captures some of the benefits of that service. The manufacturer, hypothetically, might enter into a contract with the retailer that specifies exhaustively what services the retailer must provide – how the product is to be displayed, hours of operation, sales presentations, inventory levels, etc.

But asymmetric information makes writing and enforcing such thorough contracts problematic. RPM spares the manufacturer the task of specifying and monitoring the retailer’s performance along these various dimensions. This is because RPM induces retail services without their being specified exhaustively. The retailer provides the sought-after, but difficult-to-specify, retail services to avoid termination and to capture the protected retail margin.

The economic logic of using RPM to induce efficient retail service is for the manufacturer to impose a price floor to restrain downstream price competition in order to foster service competition. The motivation of a manufacturer using RPM is not to enable retailers to

8 Obviously, a product whose quality is low cannot survive long in the marketplace just because it carries a high retail price and appears in reputable retail stores. An RPM policy does not enable a manufacturer to make a silk purse out of a sow’s ear.

9 See Benjamin Klein and Kevin M. Murphy, “Vertical Restraints as Contract Enforcement Mechanisms,” 31 Journal of Law & Economics 265 (1988).

raise prices and gouge consumers. Indeed, a manufacturer has no incentive to overcompensate its retailers; doing so would reduce the manufacturer’s profits and would make the manufacturer’s product line less competitive in the marketplace. Instead, the manufacturer wants its retailers to make just enough money to market its brand effectively, and no more.

By redirecting retailers’ competitive activities from prices to retail service, RPM limits intrabrand competition in prices. But this limitation has the effect of enhancing interbrand competition because retail service affects consumers’ choices among competing brands.10

It is interbrand competition that disciplines a manufacturer who has adopted an RPM policy and ultimately establishes retail prices in the marketplace. In this respect, the appearance that RPM restrains retail price competition at the expense of consumers is deceiving.

Having set forth the standard economic explanation of RPM, it is appropriate at this juncture to consider conditions where RPM does not increase consumer welfare.

Economic analysis suggests three ways in which RPM can contravene antitrust’s fundamental goal of promoting consumer welfare. Two ways in which RPM might have anticompetitive effects involve the formation and maintenance of cartels.

in the second, the cartel is formed among manufacturers. In both cases, of course, the use of RPM to organize and operate a cartel is unlawful under the antitrust laws.12

10 Intrabrand competition means competition among retailers for sales of the same brand. Interbrand competition means competition among manufacturers and retailers alike for sales of different brands.

11 By “retailers,” we really mean horizontally arranged firms anywhere “downstream” from the manufacturer. The analysis would not change if we were to use wholesalers or other agents located anywhere in the distribution channel between the manufacturer and consumers.

12 The likelihood of RPM being used to fix prices in an industry with many competitors is not high, absent evidence of formal cartel mechanisms.

In the case of a cartel among retailers, those firms conspire to get manufacturers to set resale prices at monopoly levels. Because it is the manufacturer who appears to be setting retail prices, this kind of collusion diverts attention from the collective price-setting by the retailers. Furthermore, by inducing manufacturers to “impose” an RPM policy upon them, retailers in effect deter themselves from cheating on the agreement and discounting prices.

In this scenario, retailers use manufacturers’ RPM policy as a cover for their own price-fixing shenanigans. Retailers thereby delegate both the implementation and the enforcement of the cartel to the manufacturer so they need not enter into a direct price fix.13 The manufacturer merely becomes the cat’s paw for the retail cartel. Consumers are made worse off, the same as they would be if the cartel were operated directly by retailers without the participation of a manufacturer.

For RPM to arise in this manner, retailers must possess monopsony power, either unilaterally or by means of a common agency (like a trade association), to make the manufacturer go along even though this practice reduces its sales. The story is easy enough to tell, but finding real world examples is not so easy. If retailers must get together to induce manufacturers to engage in RPM, they should leave the same trail of evidence as a direct price fix. The textbook example of an RPM-induced retailer cartel involves retail druggists who, working through a trade association, cajoled a manufacturer of toothpaste to implement RPM. But there is no evidence that retailer-induced cartels are common.

13 This explanation does not account for how retailers could avoid their cartel being undermined by other forms of competition, such as non-price rivalry.

In the usual manufacturer cartel, sellers collude on the price they charge their customers and do not endeavor to set the resale price of their product.14

Nonetheless, a cartel of manufacturers might use RPM to help monitor and enforce the cartel’s agreement. Once cartelists reach an agreement to raise prices, each of them has a strong incentive to cheat on that agreement by shading price and expanding output. Incremental sales that stem from furtive discounts can be very remunerative if the cartel has jacked up prices well above incremental costs.

To rein in this kind cheating, the manufacturers in this scenario agree among themselves to implement RPM policies with retailers to reduce the incentives to cheat. Here is how it would work.

RPM agreements, if they are enforced, take away the profitability of secret discounts by manufacturers because retailers are not able to pass those discounts on to consumers in the form of lower retail prices. Without lower retail prices, retailers sell no more of the cheating manufacturer’s product than before. By secretly cutting its prices below the cartel level, the manufacturer merely sells the same quantity at a lower price, which is not a recipe for making money. The only way the price-chiseling manufacturer could profit from lower prices would be if the firm did not enforce its RPM policy so that retail sales would increase. But this would be visible to the other cartelists and could elicit an unfriendly response. This is not a recipe for making money either.

In short, manufacturers agree to fix prices to their customers and then, to make cheating on that agreement unprofitable or more easily detectable, they agree to fix retail prices as well.15

14 For example, in the international vitamins cartel, participants agreed upon the prices they charged, but they did not try to influence prices their customers charged.

15 This type of cartel works best when the products are homogeneous. Product differentiation engenders all kinds of non-price competition among the cartel members that would be difficult

Just as real world examples of retailer cartels stitched together by RPM are not common, real world examples of manufacturer cartels that used RPM to curtail cheating are uncommon. Indeed, the economic nexus between cartels and RPM is not robust. Pauline Ippolito’s study of RPM litigation found that fewer than 10% of private cases involve even the allegation of collusion among manufacturers or retailers. Andrew Kleit’s research into cases before the legal status of RPM was clear found no evidence of RPM as a cartelization strategy.16 17

The main economic objection to RPM is when it is used to enable or facilitate cartelization of markets. But even where RPM is used to stimulate retail service, the effects on consumers can be mixed. Mathewson and Winter observe that “the general ‘service hypothesis’ is that the increase in demand resulting from enhanced service, elicited through a protected retail margin, will more than offset a negative impact on demand of a higher . . . retail price.”18

But if RPM raises retail prices to finance enhanced service, and if that service is more valuable to some for a cartel to squash, especially in an environment where contracts cannot be enforced in a court of law.

16 Pauline M. Ippolito, “Resale Price Maintenance: Empirical Evidence from Litigation,” 34 Journal of Law & Economics, 263 (1991); Andrew N. Kleit, “Efficiencies without Economists: the Early Years of Resale Price Maintenance,” 59 Southern Economic Journal 597 (1993).

17 There is another theory as to how RPM might have anticompetitive effects. This is a theory of RPM-augmented foreclosure. Since RPM permits a manufacturer to control its retailers’ profit margins, this practice might facilitate an implicit contract between the manufacturer and those retailers of the following nature.

18 Frank Mathewson and Ralph Winter, “The Law and Economics of Resale Price Maintenance,” 13 Review of Industrial Organization 57, 67 (1998), internal footnote omitted.

consumers and less valuable to others, the result may be that some consumers gain when RPM is imposed while others lose.

Although the net effect of RPM on consumers is no doubt positive in many instances, there is no assurance that the net effect is necessarily positive whenever a manufacturer finds it profitable to implement RPM. The reason, as Marvel and McCafferty explain, is that “[m]anufacturers, in their desire to maximize profits, focus on the margin, while allocative efficiency incorporates effects on inframarginal customers . . . . The additional customers attracted by the services must be better off as a result of the service provision. But if some of the additional receipts are derived from higher prices charged to inframarginal customers who do not value the services, the benefits to society of the services provided need not justify their cost.”19

Consider a simple example in which there are two kinds of consumers: those who value enhanced retail service, because they are ill informed about the manufacturer’s product, and those who are already knowledgeable and do not value enhanced service.20

If the manufacturer implements RPM to bring about better retail service, and if the retail price increases as a result, the only beneficiaries of RPM are ill informed consumers who buy the firm’s product. Some of these might not have bought the product had they remained ill informed, while others might have bought it, but underutilized it for lack of specialized knowledge. Knowledgeable consumers who buy the product are harmed because the price increase is not accompanied by anything they value. In fact, some knowledgeable consumers might be deterred by the price increase.

19 Howard P. Marvel and Stephen McCafferty, “The Welfare Effects of Resale Price Maintenance,” 28 Journal of Law and Economics 363, 370 (1985). In general, market failure can arise whenever the welfare effects of prices, quality, or retail services on the marginal consumer do not represent the welfare effects on inframarginal consumers. See A. Michael Spence, “Monopoly, Quality and Regulation,” 6 Bell Journal of Economics 417 (1975).

20 This example is intended to illustrate a trade-off between RPM’s two separate effects on consumers that applies more generally.

In a market with lots of knowledgeable consumers, and few consumers who are ill informed, RPM can reduce overall consumer welfare. On the other hand, if most consumers are ill informed, RPM can increase overall consumer welfare. Weighing the impact of RPM upon consumers becomes, in this example, a matter of counting noses.21

This example exaggerates the likelihood that a manufacturer would implement an RPM policy that reduces overall consumer welfare. Unless the manufacturer was a monopolist, consumers would continue to have the benefit of interbrand competition even if RPM curtails intrabrand competition. To the extent one manufacturer’s RPM policy induces retailers to provide costly retail service that knowledgeable consumers do not value, an opportunity is created for other manufacturers to sell “plain vanilla” merchandise at lower prices to attract knowledgeable consumers.22

The main reason a manufacturer would implement RPM to induce retail service is that enhanced service increases product sales. The incremental sales come from consumers who value those services, not consumers who gain nothing from them. If putting an RPM policy in place boosts sales noticeably, this strongly suggests that consumers, on net, have benefited. One

21 See William B. Comanor, “Vertical Price-Fixing, Vertical Market Restrictions, and the New Antitrust Policy,” 98 Harvard Law Review 983 (1985). See also Don Boudreaux and Robert B. Ekelund, Jr., “Inframarginal Consumers and the Per Se Legality of Vertical Restraints,” 17 Hofstra Law Review 137 (1988). Counting noses becomes moot if the manufacturer’s implementation of RPM does not increase the retail price of its product, but only the quantity of sales. Marvel and McCafferty explain that if the effect of RPM-induced retail service is an isoelastic shift in market demand, and if the cost of providing service is fixed rather than variable in the long run, then the retail price the manufacturer would seek to impose is the same as without RPM and enhanced services. Op. cit. (Journal of Law & Economics) p. 371.

22 Using antitrust to curtail RPM because of its consequences for inframarginal consumers is a strained application of trade regulation. Manufacturers who buy media advertising impose costs on customers who are already persuaded; manufacturers who upgrade product features impose costs on customers who prefer (but are no longer offered) the older, less expensive model. But antitrust does not challenge these policies. See Frank R. Easterbrook, “Vertical Arrangements and the Rule of Reason,” 53 Antitrust Law Journal 135 (1984).

antitrust authority considers this to be the key indicator of procompetitive RPM. Richard A. Posner explains:

“If [the defendant firm’s] output expanded, the restriction must have made the firm’s product more attractive on balance, thereby enabling the firm to take business from its competitors. This is an increase in interbrand competition and hence in consumer welfare, which is the desired result of competition. The increase must exceed any net reduction in intrabrand competition considered in both its price and service aspects. Any reduction in intrabrand competition, viewed by itself, would increase the price to the consumer and hence make the product less attractive to him. If, on balance, the product is more attractive to consumers, as demonstrated by the fact that more of it is sold, the net effect of the restriction on competition must be positive.”23

There is a non-economic argument against RPM, one rooted in what Thorstein Veblen called “conspicuous consumption.” This argument attributes to RPM the financing of retail service that appeals to consumers merely because it is expensive and extravagant. That is, RPM-induced service costs a lot of money but does not enhance the instrumental value of the product. This kind of service only appeals to consumers who are in search of ways to signal their elite status. Critics of RPM who object to conspicuous consumption might grant the case for RPM when used to sell information-impacted goods like audio equipment, but not for status goods such as designer jeans or athletic shoes. If mass merchandisers could sell designer jeans at discount prices in a world without RPM, then consumers purportedly would be better off. What would be lost would be the boost in status enjoyed by those who flaunt expensive clothing in front of people who cannot afford the high, RPM-enhanced prices. Whether this argument has merit is outside the scope of this article, since judging the praiseworthiness of different kinds of consumer benefits is not the task antitrust has taken on.

23 Richard A. Posner, “The Next Step in the Antitrust Treatment of Restricted Distribution: Per Se Legality,” 48 University of Chicago Law Review 6, 21 (1981), emphasis in original.

Antitrust law applies to situations where there has been a distortion in market outcomes that harms consumers. In economic parlance, consumer harm means consumer welfare is reduced.24

For some business practices, the harm to consumers is so transparent that courts consider the conduct to be per se illegal. Economic logic suggests that the per se category of antitrust offense should be for business conduct so unlikely to ever confer consumer benefits that a full-blown “rule of reason” inquiry into the practice is not worth the candle.

At one time a number of vertical practices were thought to be so unlikely to generate consumer benefits that they were considered per se violations of antitrust law. Exclusive territory25 and RPM agreements are examples. As courts discovered the procompetitive benefits associated with exclusive territories, this practice was removed from the per se bin and placed in the rule of reason bin.26 Today, all non-price vertical arrangements are sorted into the rule of reason bin, leaving only price-related vertical arrangements like RPM in the per se bin.

If prevailing antitrust law governing non-price vertical arrangements is properly calibrated, this means that a per se rule against RPM fails to apply the economic logic of GTE

24 An economist measures consumer welfare as the difference between the most consumers would pay for a product, rather than do without it, and the product’s price. By this definition, any reduction in a product’s price, other things remaining unchanged, adds to consumer welfare. Similarly, higher quality and easier availability, at the same price, add to consumer welfare. To monetize the value of higher quality or easier availability, an economist calculates the price reduction on the unenhanced product that would be necessary to make the consumer indifferent to getting the enhanced product at the original price.

25 Assigning dealers to exclusive geographic territories is another vertical arrangement some manufacturers use to curtail free riding and assure downstream service. Exclusive territory agreements prevent a dealer in one territory from undercutting the prices of a dealer in a nearby territory.

26 The decision by the Supreme Court that accomplished this move was Continental T.V., Inc. et al. v. GTE Sylvania, Inc., 433 U.S. 36 (1977).

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Sylvania to price-related vertical arrangements. In other words, if the per se rule is reserved for conduct that is nearly always anticompetitive, then why should it apply to RPM? Just as economic analysis is required to distinguish those circumstances when territorial restraints reduce or increase consumer welfare, it also is required to tell when RPM reduces or increases consumer welfare. The economics of RPM does not warrant the presumption that RPM nearly always causes antitrust injury.
In the early days of antitrust, RPM was viewed as nothing more than an attempt to fix retail prices at monopoly levels.27

Precisely why a self-interested manufacturer would want to constrain retailers to raise retail prices instead of just setting wholesale prices at profit-maximizing levels (and relying on intrabrand competition among retailers to set the retail price) was a question that went ignored.28

To square the status of RPM with that of other vertical practices, RPM should be subjected to a rule of reason inquiry like non-price vertical arrangements.29

Notwithstanding the per se illegality of RPM agreements, the Supreme Court recognized a manufacturer’s unilateral right to implement RPM in Colgate.30

The Colgate doctrine affords a manufacturer the option to announce a take-it-or-leave-it policy of selling only to downstream

27 This doctrine was especially perverse in the case of “maximum RPM,” where the manufacturer imposes a price ceiling on its retailers.

28 The common law doctrine against restraints on alienation also helps account for the early hostility to RPM. RPM agreements never were given the opportunity to be assessed on the basis of their effects on consumers.

29 A rule of reason inquiry need not be an expensive, time-consuming task for the court if the manufacturer using RPM does not possess enough market power to trigger antitrust concern (i.e., where there is abundant interbrand competition). Unless such a firm is in cahoots with its rivals, it could not use RPM to cause antitrust injury.

vendors whose retail price adheres to the manufacturer’s suggested resale price (SRP).

Here the manufacturer proposes a resale price and may use practices short of private contract enforcement to establish and maintain that downstream price. Colgate allows a manufacturer to enforce its SRP policy by refusing to do business with retailers who undercut that price.

The reason a manufacturer may implement RPM unilaterally is that such a policy does not comprise an agreement between the manufacturer and its retailers, or the retailers among themselves. The fact that a group of retailers behaves in the same way does not mean they have collectively agreed to behave that way. The distinction between a coincidence of action and an agreement is prominent in economic theory31 and is a basic principle of antitrust analysis.32

When a manufacturer unilaterally announces its intention to terminate retailers who do not abide by its retail price requirement, and retailers unilaterally follow suit, this result is not due to an agreement.

For a manufacturer to implement RPM unilaterally, the firm must make good on its threat to terminate retailers who sell the firm’s products at discount prices. If the manufacturer continued to supply discounters, adherence to its pricing policy could erode. Where the purpose of the manufacturer’s requirement is to elicit enhanced services from retailers, those services could be curtailed if intrabrand price competition breaks out.

The distinction between unilateral action and an agreement is clear in the abstract, but often unclear in ordinary business dealings. Invoking the Colgate doctrine carries with it risks

31 Parallel behavior is not necessarily collective behavior. In the economic model of perfect competition, sellers all charge the same price, but not as the result of an agreement. The same holds in other theories of price determination where firms’ products are homogeneous. Economists call this the “law of one price.”

32 See Philip E. Areeda and Herbert Hovenkamp, Antitrust Law, 2nd edition, 2003, vol. VI, pp. 59-66 and following.

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for a manufacturer that some aspect of its dealing with its customers could be construed as an agreement. Consequently, the Colgate doctrine does not provide a reliably safe harbor for the manufacturer who wants to induce retail services through RPM.

To implement an RPM policy in compliance with the Colgate doctrine means the manufacturer must take care to avoid any appearance of sponsoring an “agreement” among its downstream retailers. Indirect methods include inter alia using consignment sales with specified downstream prices, buy-back deals to purchase unsold inventory, markdown allowances offered to retailers whenever demand is unexpectedly low, meeting competition price guarantees to retailers, printing SRP on packaging or sales tags, and making extensive use of buydowns and slotting allowances, all to influence downstream retail prices. If antitrust law acknowledged that explicit minimum price RPM agreements, sans indications of a horizontal conspiracy, are mainly procompetitive, many such work-arounds would fade away.

[Karl Note: The significance of this highlighted paragraph is that in all my searching on the internet for "thoughtful" articles or data about "consignment sales" I found virtually none. This article, with the origin being a prominent full professor of economics and providing legal citations and viewpoint, suggests that he, and others, who may have looked at the problem of price competition damaging the quality of service in a retail store -- those who have looked at it have accepted the apparent per se illegality of "price fixing" and found "work-arounds" such as are mentioned in this paragraph. I accept this paragraph as the most fruitful source of good data on this subject -- and find that "consignment sales" have been and are used as a "work-around" to avoid the charge of illegal price fixing. This article, furthermore, provides the philosophical underpinning of the morality of a marketing arrangement which helps consumers rather than damages them. This article can be and is the primary philosophical justification for using a "consignment sales" arrangement to avoid destructive price competition.]

The inadequacy of the Colgate doctrine as a substitute for enforceable agreements to induce retail services, and the asymmetric treatment of RPM and non-price vertical arrangements, both augur for changing the legal status of RPM. Antitrust law reserves the category of per se offense for business practices that nearly always create antitrust injury. RPM does not qualify for per se treatment by that criterion. If RPM were to come under the rule of reason, many benign applications of RPM could go unchallenged and the procompetitive effects of RPM would not have to be achieved by other means.33

33 There is probably not a starker example of antitrust diverting a company from an efficient marketing strategy than Coors. Coors once purchased very little media advertising. Instead the company used resale price maintenance and exclusive territories to preserve the freshness of its non-pasteurized beer and to induce downstream promotion and regular product rotation by its distributors. When the Federal Trade Commission successfully attacked Coors for these distribution arrangements, Coors had more difficulty insuring product freshness -- something that

For years, under Albrecht, the Supreme Court treated minimum and maximum resale price agreements with the same lack of enthusiasm.34

It should be evident, however, that using RPM to establish a downstream price floor is quite different than using RPM to establish a downstream price ceiling. Although the presumption of harm to competition will rarely be justified for RPM-imposed price floors, it is even more unlikely that “maximum” RPM -- the imposition of a retail price ceiling – could harm consumers. The most compelling explanation for a manufacturer restraining retailers from charging high retail prices is one that couples consumers’ interests with those of the manufacturer.

When a manufacturer distributes its product to consumers via a perfectly competitive retail market, competition among retailers will keep retail prices as low as possible, given retailers’ costs and the manufacturer’s wholesale prices.35 If retailers who distribute the manufacturer’s product have substantial market power, the manufacturer cannot rely on competition to discipline retail prices. The imposition of price ceilings keeps such retailers from raising retail prices and reducing quantities sold at the manufacturer’s expense. Putting a cap on retail prices also prevents harm to consumers. Ironically, Albrecht stood in the way of a business practice with procompetitive consequences.

In November 1997, the Supreme Court overturned Albrecht and held that maximum RPM agreements were to be assessed under a rule of reason. In explaining this change in direction,

was not as great a concern to its major rivals who pasteurized their beer. In the end, Coors altered its product differentiation strategy and turned to media advertising like its major rivals.

35 In fact, it is the dependability of price competition among retailers that gives rise to a manufacturer’s using “minimum” RPM to prevent price competition from extinguishing efficient retail service.

Justice O’Connor’s opinion (for a unanimous Court) in Khan v. State Oil stated that the “Court finds it difficult to maintain that vertically imposed maximum prices could harm consumers or competition to the extent necessary to justify their per se invalidation.”36

The plaintiff Khan (a retail gasoline dealer) challenged its wholesale gasoline distributor State Oil’s supply contracts. In effect, State Oil’s supply contract established the maximum retail prices at which Kahn could sell premium and regular gasoline. It did so by pegging the margin between the wholesale and retail price. For example, if Kahn were to raise its pump price 2 cents/gallon on premium gasoline, but not on regular, State Oil would raise its wholesale price on premium gasoline the same amount. Maximum RPM was important to State Oil to deter its gasoline dealers from changing the relative prices of premium versus regular gasoline by raising the price of premium disproportionately. Consumers were beneficiaries of the Court’s decision to allow State Oil to limit the mark-ups of its downstream retailers, since this limitation kept premium gasoline prices in check.

The generally recognized purpose of antitrust economics is to distinguish procompetitive business conduct, which promotes consumer welfare, from anticompetitive behavior, which reduces consumer welfare.37 Procompetitive conduct by sellers benefits consumers by lowering

36 State Oil Co. v. Kahn, 118 S. Ct. 275, 282 (1997). Two scholars whose earlier criticism of Albrecht was cited by the Court have criticized Kahn for not simply making maximum RPM per se legal. See Roger Blair and John Lopatka, “The Albrecht Rule after Kahn: Death Becomes Her,” 74 Notre Dame Law Review 123 (1998).

37 Some would argue that advancing consumer welfare is the only goal of antitrust. See Robert Bork, The Antitrust Paradox. Basic Books, 1978, p. 89. See also Kenneth G. Elzinga, “The Goals of Antitrust: Other Than Competition and Efficiency, What Else Counts?” 125 University of Pennsylvania Law Review 1191 (1977); Philip E. Areeda and Herbert Hovenkamp wrote “Today it seems clear that the general goal of the antitrust laws is to promote ‘competition’ as the economist understands that term. Thus we say that the principal objective of antitrust policy

market prices and/or raising product quality. Anticompetitive conduct harms consumers by raising prices or reducing product quality. Except for instances where it becomes a tool for cartelization, the practice of RPM appears to be procompetitive.38

Imposing minimum retail prices generally elicits efficient retail service and sharpens interbrand competition. It is hard to see how imposing maximum retail prices could be anything other than beneficial to consumers. When there is no remotely plausible (or even alleged) horizontal conspiracy, keeping RPM under the per se rule mainly condemns a procompetitive practice.

Bringing RPM agreements that impose maximum retail prices under the rule of reason is a welcome development. One hopes for a similar future development with respect to minimum price RPM agreements. Continuing to treat RPM agreements that impose minimum retail prices as a per se offense puts manufacturers in a peculiar position. Since using enforceable contracts with retailers to influence retail prices is off limits, manufacturers must use indirect and less efficient arrangements to exert that influence. Either the per se rule about RPM should be reformulated (requiring proof of a manufacturer or retailer cartel, or significant market power on
is to maximize consumer welfare by encouraging firms to behave competitively, while yet permitting them to take advantage of every available economy that comes from internal or jointly created production efficiencies, or from innovation producing new processes or new or improved products.”

Antitrust Law. vol. 1, p. 4 (2000). A former chairman of the Federal Trade Commission, testifying before the House Judiciary Committee, put the matter this way: “It is virtually undisputed today that the purpose of antitrust is to protect consumers, that economic analysis should guide decisions, and that horizontal cases involving mergers and agreements among competitors are the mainstays of antitrust.” Timothy J. Muris, Prepared Statement of July 24, 2003, available at www.ftc.gov/os/2003/07/antitrustoversighttest.htm.

38 There is another potentially procompetitive use of RPM. This is where a manufacturer imposes a minimum price on retailers to prevent “destructive competition” from breaking out during periods of unexpected slack demand when retailers are prone to use drastic markdowns. In extreme cases, RPM may even prevent distribution of the manufacturer’s product from imploding. See Raymond Deneckere, Howard P. Marvel, and James Peck, “Demand Uncertainty and Price Maintenance: Markdowns as Destructive Competition,” 87 American Economic Review 619 (1997).

the part of the manufacturer) or RPM should be treated under a rule of reason test which could take the existence of these conditions into account.

Personal Statement of Teaching Philosophy
Kenneth G. Elzinga

Professor of Economics
University of Virginia

My colleagues in the Department of Religious Studies might contend that the most prominent image or picture of the Christian faith is the crucifix. For me, as a teacher, it is the picture of Jesus washing the feet of his disciples. The scene illustrates the upside-down and paradoxical biblical principle of leadership: the one who leads should be willing to serve; if you want to be first, you line up last.

I endeavor to apply that picture to my teaching: if I want best to lead a class of students, I should be willing to serve them. My authority as a teacher is linked to my willingness to serve my students.

This principle is not void of content. Rather, it is practical (and sobering). For example, it seems clear that one way a teacher serves is by thorough class preparation. For me, this has meant not scheduling any substantive activities before my lectures, so I can focus my attention solely on the material and its presentation; it means mining an entire book for one small nugget: a useful classroom illustration.

A teacher serves by being available. For me, this has meant setting my schedule to have no commitments immediately after a lecture; to be generous with office hours; and to make myself available to my students at home.

A servant-teacher is not a pal, but can be a friend. The servant-teacher is an educator who succeeds because his or her students succeed.

Teaching does not come readily to me. Year after year, my stomach reminded me before each class that standing before students was not a normal, biological activity. I have never believed good teaching is a natural gift, like good hand-eye coordination. Nor am I persuaded it requires acting talents, comedy skills, or a personality of extroversion. Instead, I have looked to models, mentors, written sources, and taping of lectures to improve and develop my own classroom endeavors.

At the University of Virginia, a number of students know me as the teacher of the institution's largest class, Econ 201, Principles of Microeconomics. Because of the size of the class, and the regularity with which I have taught it in the fall semester, students might conjecture that I enjoy teaching the course. My relationship with Econ 201 is more complex. It mimics the relationship a faithful servant has to a demanding taskmaster. I "enjoy" Econ 201 the way a servant might "enjoy" completing demanding assignments.

My preferred manner of teaching is socratic dialogue, a teaching style I adopt in the spring semester with smaller, upper level courses. Here there can be electricity in the classroom. Students know they are expected to be prepared each day; there is give and take, a matching of wits; sometimes there is tension and often laughter. And each semester I witness a handful of young women and men who are almost "speechless" at the start of the term and yet they blossom into people who -- while not yet ready to appear on Firing Line -- are able to take on my questioning (and even my badgering) with a measure of confidence and clarity that surprises even them. When this occurs, I experience what I would dare call the joy of teaching and not simply the satisfaction of the task.

When I came to the University of Virginia I was encouraged to think of my job as primarily research. Teaching was going to be a sideline, the payment vehicle for the research. I have been blessed in my research and pursue it more actively now than as an assistant professor; I am grateful for the freedom to pursue my own research agenda. But I am grateful as well for four teachers I had in my lifetime, and one faculty mentor I encountered in my department at the University of Virginia, who modeled out for me the practice of excellence in teaching.

After more than twenty years, when one might expect boredom to set in, or at least the law of diminishing marginal utility to take its toll, teaching continues to be fresh, challenging, scary, and rewarding. And I have come to experience, haltingly and with many shortcomings, the paradox of the teacher who leads by service.

This has been important because it now gives us a reference, in addition to the one from within our Hubbard Management System, for doing what seems right to do. In other words, Mr. Hubbard has written about the destructive nature of price competition, yet price competition is usually seen as the vital core of our global business model. Among "ethical" producers, however, price competition would be destructive and competition on terms of service and quality would be the moral thing to do. Among UNETHICAL producers, price competition may be the only hammer society has found to keep the immorality at bay!

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The link below is a 20 page article by a professor of economics. The article is apparently soon to be published by the American Bar Association. At the top of this page there is a comment and link to the exact paragraph where the author refers to "consignment sales."

Reading the entire article would be very useful in understanding the different types of "price fixing" and the moral justification for making some illegal while others should not be (even though they are), EVEN NOW DURING A TIME WHEN THE MAJORITY OF BUSINESS FIRMS DON'T YET ADOPT OUR DEFINITION OF "PRODUCT."

Karl Note: The significance of this highlighted paragraph is that in all my searching on the internet for "thoughtful" articles or data about "consignment sales" I found virtually none. This article, with the origin being a prominent full professor of economics and providing legal citations and viewpoint, suggests that he, and others, who may have looked at the problem of price competition damaging the quality of service in a retail store -- those who have looked at it have accepted the apparent per se illegality of "price fixing" and found "work-arounds" such as are mentioned in this paragraph. I accept this paragraph as the most fruitful source of good data on this subject -- and find that "consignment sales" have been and are used as a "work-around" to avoid the charge of illegal price fixing. This article, furthermore, provides the philosophical underpinning of the morality of a marketing arrangement which helps consumers rather than damages them. This article can be and is the primary philosophical justification for using a "consignment sales" arrangement to avoid destructive price competition.

Personal Statement of Teaching Philosophy Kenneth G. Elzinga

Professor of Economics University of Virginia

Personal Statement of Teaching Philosophy
Kenneth G. Elzinga

Professor of Economics
University of Virginia