Tuesday, March 27, 2007

Resale Price Maintenance

A classic topic in Industrial Organization is in the news. From today's Wall Street Journal (subscription required):

MSRP Case Seems to Split Justices
Rule Barring Manufacturers From Dictating Prices To Retailers Is Challenged

Hearing arguments in a case about retail prices, the Supreme Court's justices seemed divided over whether to overturn a 96-year-old antitrust ruling intended to promote competition.

In yesterday's case, Leegin Creative Leather Products of Industry, Calif., challenged the ruling, which prohibits manufacturers from requiring retailers to sell their products for a set minimum price. A Texas federal district court cited the 1911 precedent in tossing out the "resale price maintenance" policy Leegin had imposed on Kay's Kloset, a Dallas-area boutique.

Kay's Kloset, owned by PSKS Inc., brought the suit so it could sell Leegin's Brighton line of women's accessories at a discount.

Leegin's attorney, Theodore Olson, argued in briefs that discount prices "degrade" the Brighton brand. And yesterday he said forcing retailers to charge higher prices could benefit consumers by helping ensure the stores would have enough money to provide attractive services to shoppers.

Justice Antonin Scalia agreed. If the set prices give "the consumer a choice of more service at a somewhat higher price, that would enhance consumer welfare, so long as there are competitive products at a lower price," he said. Later, he said overturning the 1911 precedent could solve the "free rider problem," when "customers shop at the place that has the big showroom" to learn about a product, but then buy it at a lower price from somebody else who has not incurred that expense."

The precedent, known as Dr. Miles for the manufacturer that sought to fix retail prices of its patent medicines, helped shape the 20th-century marketplace....

The Bush administration, along with the National Association of Manufacturers and other business groups, backed Leegin. But 37 states, represented by New York, and the Consumer Federation of America urged the court to retain Dr. Miles.

Here is what my favorite economics textbook says about the topic:

Resale Price Maintenance

One example of a controversial business practice is resale price maintenance, also called fair trade. Imagine that Superduper Electronics sells DVD players to retail stores for $300. If Superduper requires the retailers to charge customers $350, it is said to engage in resale price maintenance. Any retailer that charged less than $350 would have violated its contract with Superduper.

At first, resale price maintenance might seem anticompetitive and, therefore, detrimental to society. Like an agreement among members of a cartel, it prevents the retailers from competing on price. For this reason, the courts have often viewed resale price maintenance as a violation of the antitrust laws.

Yet some economists defend resale price maintenance on two grounds. First, they deny that it is aimed at reducing competition. To the extent that Superduper Electronics has any market power, it can exert that power through the wholesale price, rather than through resale price maintenance. Moreover, Superduper has no incentive to discourage competition among its retailers. Indeed, because a cartel of retailers sells less than a group of competitive retailers, Superduper would be worse off if its retailers were a cartel.

Second, economists believe that resale price maintenance has a legitimate goal. Superduper may want its retailers to provide customers a pleasant showroom and a knowledgeable sales force. Yet, without resale price maintenance, some customers would take advantage of one store's service to learn about the DVD player's special features and then buy the item at a discount retailer that does not provide this service. To some extent, good service is a public good among the retailers that sell Superduper products. As we discussed in Chapter 11, when one person provides a public good, others are able to enjoy it without paying for it. In this case, discount retailers would free ride on the service provided by other retailers, leading to less service than is desirable. Resale price maintenance is one way for Superduper to solve this free-rider problem.

The example of resale price maintenance illustrates an important principle: Business practices that appear to reduce competition may in fact have legitimate purposes. This principle makes the application of the antitrust laws all the more difficult. The economists, lawyers, and judges in charge of enforcing these laws must determine what kinds of behavior public policy should prohibit as impeding competition and reducing economic well-being. Often that job is not easy.

Update: Here is the NY Times article on the case.