In June, a high-profile Supreme Court case held the attention of retailers and manufacturers alike. In a five-to-four ruling, the high court overturned a lower-court decision to award $1.2 million to a Dallas-area clothing store that was cut off by a supplier, Leegin Creative Leather Products, because the retailer refused to abide by the manufacturer’s retail price maintenance (RPM), or no-discount policy. The decision means that manufacturers no longer face a blanket prohibition against implementing an RPM policy. The case has spurred concern among consumer groups, who claim it overturns a century of precedent and will lead to price fixing and unjustifiably higher prices. But Wharton faculty and others suggest that any changes will be gradual, and may ultimately benefit consumers.
Supreme Court Justice Stephen Breyer, who authored a dissent signed by three other justices, said that the ruling could mean price hikes of more than $1,000 per year for the average American family. That’s likely to be “the tip of the iceberg,” according to a statement released by Gene Kimmelman, vice president of federal and international affairs of Consumers Union, an advocacy organization. “The long-run effect [of the Leegin decision] will be to undermine innovation in the distribution and marketing of goods in America.”
Leegin and other manufacturers, particularly in the fashion segment, argue that a minimum pricing floor enhances their brand image. “[W]e want consumers to get a different experience than they get in [discounters like] Sam’s Club or in Wal-Mart,” Leegin’s court statement read. “You can’t get that kind of experience or support or customer service from a store like Wal-Mart.”
According to Z. John Zhang, a Wharton marketing professor, statements like these indicate a potential upside of RPM for consumers. “Previous legal treatment of retail price maintenance meant that specialty stores had diminishing incentive to offer informational and other services, since consumers were likely to purchase goods at discounters after tapping specialty stores for data about the goods,” he says. “Now, with fewer obstacles to retail price maintenance, more retailers may be encouraged to provide service.”
A Century-Old Approach
For nearly a century before the Leegin ruling, however, courts did not buy manufacturers’ arguments about brand control. The precedent was set in a 1911 case, Dr. Miles Medical Co. v. John D. Park & Sons Co., when the Supreme Court concluded that under the Sherman Antitrust Act, it was illegal for a manufacturer and distributor to set a minimum retail price for its products. Such an attempt, said the court, was illegal “per se” — that is, without regard to the individual facts of the case.
With the June Supreme Court decision, however, price maintenance plans will be decided on an individual basis, and courts will consider whether a particular plan is likely to increase or decrease consumer welfare.
It sounds like a dramatic change, one which the dissenting justices suggest overturns the principle that decisions arrived at by previous courts should be followed by successive courts. But in fact the new approach does not constitute a wholesale change of philosophy, according to Gérard P. Cachon, Wharton professor of operations and information management.
“In its recent ruling, the court simply said that a retail pricing agreement between an upstream supplier and a downstream distributor is not necessarily illegal,” says Cachon. “That’s not the same as saying that such a pricing agreement is always legal. Instead, each case will be judged on its unique circumstances. That means retail pricing agreements can be viewed as legal when they promote inter-brand competition, even if they reduce intra-brand competition.”
A similar point is made by Quentin Riegel, vice president for litigation and deputy legal counsel for the National Association of Manufacturers, which represents small and large manufacturers in every industrial sector across the United States. “The court is not legalizing all instances of retail price maintenance. [The decision] makes RPM legal in some situations if there is pro-competitive justification, and will primarily affect commodity-like products, where pricing is the only significant difference. Today, there is a great deal of competition, so any effect is likely to be limited.”
“Right now our people are in a ‘wait and watch’ mode,” says Nate Herman, director of international trade at the American Apparel & Footwear Association, a national trade organization. “There was some hope that the Leegin decision would enable apparel and footwear manufacturers to better support their brands by establishing and maintaining minimum prices on their products, but the fact is that retailers [still] have a lot of control.”
Noting the increased level of competition driven by international manufacturers, Herman adds that retailers may simply walk away from a manufacturer that tries to impose a minimum pricing program. “Some luxury brands such as the Coach line and Manolo Blahnik shoes might be able to maintain minimum pricing. But for most footwear and apparel manufactures, the Supreme Court ruling isn’t likely to be much help.”
Fair Trade and Pricing Restraints
In 1937, in the name of consumer protection, Congress passed an amendment to the Sherman Act commonly referred to as the “Fair Trade Law,” which exempted interstate price-fixing agreements from antitrust law if the agreements concerned trademarked or brand-name products. The amendment “essentially gave states the right to allow retail price maintenance schemes,” says Cachon. Allowing manufacturers limited ability to set a floor on retail prices was seen as a way to prevent large chain stores from utilizing loss leader pricing, or the practice of selling commodity items at cost or below cost to eliminate the chain stores’ small retail rivals.
The Fair Trade Law was repealed in 1975 and replaced by the Consumer Goods Pricing Act. Until the high court’s recent decision, the act generally restricted price maintenance agreements to a manufacturer’s suggested list price, which was essentially no restriction since suggested list prices could not be legally enforced.
Cachon notes that a long history of case law exists which addresses vertical price restraints between manufacturers and retailers. Over time, however, the courts have chipped away at the ban. In 1967, in United States v. Arnold, Schwinn & Co., a Supreme Court case involving exclusive dealer territories, the court acknowledged that some vertical restrictions, such as the conferral of territorial rights or franchises, could have pro-competitive benefits by allowing smaller enterprises to compete. In that case, however, the court drew the line at permitting manufacturers to control product marketing once the goods had passed to dealers.
But in a 1997 ruling, which involved retail price restraints in the gasoline distribution industry and was quoted in the Leegin decision, the Supreme Court took direct aim at the concept of per se price fixing — in this case, restrictions were placed on maximum prices. In State Oil Company, Petitioner V. Barkat U. Khan and Khan & Associates, Inc., the high court noted that “…we find it difficult to maintain that vertically-imposed maximum prices could harm consumers or competition to the extent necessary to justify their per se invalidation.”
Cachon points out that during the Fair Trade era (1935 to 1975), some states allowed RPM and, overall, 10% of goods were sold with some kind of RPM. “Manufacturers want to protect their brand and ensure widespread distribution. If they cannot use RPM, they will use some other means to achieve those goals, such as buy-back agreements, exclusive territories or minimum advertised price agreements. Unfortunately, those other means may not be as efficient as RPM. Where RPM would be more efficient, we would expect firms to begin to implement RPM … now that it is no longer per se illegal — assuming a pro-competitive argument can be made.”
The Case for RPM
Initially, economists were puzzled by manufacturers’ desire to institute retail price maintenance structures, according to Cachon. “Why would a supplier wish to limit its sales? After all, one would think that a retail price maintenance program would actually diminish a manufacturer’s profits, because higher retail prices are likely to reduce overall sales.”
But in the 1960s, as discounters multiplied, researchers realized that in such categories as consumer electronics and fashion goods, an increasing number of consumers would first go to a high-end store where trained salespeople would educate them about the product. Armed with that knowledge, consumers would then go to a discounter (or today, simply log onto a web site) that doesn’t offer service, but does offer the same product at a lower price.
“Unrestricted retail discounting led retailers to abandon providing consumers with value-added services, like product demos, thereby lowering overall demand,” Cachon says.
There is another problem with unrestricted discounting, Cachon notes. “Retailers that face the prospect of a price war are likely to be conservative with their initial product purchase because no retailer wants to be forced to sell a lot of merchandize at a cheap price. This cautious behavior is clearly a problem for the manufacturer, but it can become a problem for consumers because the products they want might be in short supply. In contrast, a price maintenance agreement gives manufacturers the ability to reduce the likelihood of costly price wars, thereby encouraging retailers to better support their products.
“The Supreme Court has essentially recognized the right of manufacturers to protect their brand,” Cachon says. “Whether the most efficient way of doing that is retail price maintenance or other approaches is something that will have to be determined in the marketplace.”
In the meantime, there may be some losers, Zhang says, particularly smaller discount fashion, consumer electronics and other retailers that have depended on a pure price play to attract customers. But even so, he does not expect consumers will be affected appreciably, since mass discounters like Wal-Mart and Target have enough channel power that they’re more likely to dictate terms to manufacturers, rather than the reverse. But suppliers may still have some options, he adds.
“As a distribution channel, the mass discounters are too big to be ignored or excluded by manufacturers,” says Zhang. “But the manufacturers may instead differentiate the merchandise they sell to full-retail stores by supplying Wal-Mart and similar stores with specific, private label products. This strategy would enable manufacturers to support their brands without disrupting their sales. Discounters will always have a niche, especially in product lines where full service is not a necessity.”