VERTICAL PRICE FIXING
A. Vertical Price Fixing Defined:
a manufacturer's attempt to control the price of its product at retail
"fair trade" -- practice of setting minimum retail prices
firms have also set maximum retail prices
B. Is this the same issue as horizontal price fixing?
Economist #1: "Clearly not. Horizontal price fixing is an obvious violation of anti-trust statutes. In that case, firms conspire to reduce competition. In the case of vertical price fixing, the firm merely attempts to do what it could if it integrated into the retailing business, i.e. choose the retail price for its product."
Economist #2: "Not so fast my friend. Vertical price fixing could be a surface manifestation of a 'below the surface' horizontal price fixing conspiracy. So allowing it would cause the frequency of horizontal price fixing conspiracies to increase. It makes sense therefore to outlaw the practice. Besides, is there anything socially beneficial in the practice of vertical price fixing that would be lost by banning it?"
C. Legal issues
When manufacturer sell product can it retain any subsequent rights over its distribution or use?
What contracts are allowable between manufacturers, wholesalers, and retailers?
II. The Stacked Monopoly Model
a monopoly manufacturer sells to a retailer that also has market power
assume for simplicity that MC is zero for both manufacturer & retailer
assess retailer's choice of output/price when confronted with wholesale price
Result: retailer sells less than manufacturer wants, at a higher price
potential contracts/restrictions to solve the SM problem:
1. integration by manufacturer into retailing (costly)
2. sales quota
3. set maximum retail price
4. two part tariff with wholesale price = manufacturer's MC + "franchise fee"
the model gives us two insights
1. retailers increase the price above the price that manufacturer wants
2. manufacturers have an interest in contractual restrictions on retailers & these restrictions generally reduce the dead weight losses
III. When Manufacturers Want Fair Trade, or Resale Price Maintenance (RPM)
SM model implies manufacturers might seek price caps to limit retail prices
Q: When and why might a manufacturer want a price floor?
A: When product information is important and brand specific investment is needed
Orvis/Sage fly fishing equipment
Various satellite systems (in early stage before mass market)
Problem: manufacturer needs efficient & informed distribution system
tout the advantages of a Sage fly rod for specific kinds of fishing
whatever is special about Oakley sunglasses
make local installer be knowledgeable about installation & service of sat dishes
this is costly for both
Problem: what if rods & sunglasses are available at discount store, e.g. Wal-Mart ?
Free riding: find out about rod or glasses at specialty store then buy at Wal-Mart
What is wrong with this?
Leads to insufficient investment in information; specialty stores cease to function.
Solution: retail price maintenance or fair trade
Manufacture sells only to distributors that acquire information & don't cut price
gap between WP & RP is a return for brand-specific investment
discount houses would like to free ride on this information but manufacturer won't sell to them
IV. Legal Treatment of Vertical Price Fixing
A. Retail Price Maintenance (RPM)
1. Dr. Miles vs. J.D. Park & Sons (1911)
Dr. Miles set "appropriate retail prices" for proprietary medicines (large markup)
Park was a drug wholesaler
Park undercut these prices and refused to sign contracts with Miles
Miles sued Park
Miles gave up all further rights to product once is sold them at wholesale
"that these agreements restrain trade is obvious"
"the public is entitled to whatever advantage may be derived from competition in the subsequent traffic"
a strict standard, remains controlling to this day - RPM was a per se violation
This case weakened Dr. Miles a bit.
Colgate distributed MSRP lists but did not sign contracts with distributors
Decision: OK for manufacturer to choose the "parties with whom he will deal"
still, no explicit RPM contracts are allowed &
subsequent cases narrowed this loophole: any explicit enforcement or policing
with threat to terminate would be a violation of
Decision: S. Court upheld the Illinois Law, in favor of Seagram.
Departure from Dr. Miles, agreed that cut rates could damage the upstream firm's reputation: "although retailers own the commodity, they do not own the mark (brand) or goodwill that the mark symbolizes. And goodwill is a property in a very real sense, injury to which …..is a proper subject for litigation."
4. Miller Tydings Act (1937)
Fed legislation enabling states to pass Fair Trade laws legalizing RPM
political pressure of small retailers who were being displaced by discounters
by 1948, 41 of 48 states had passed such laws
courts upheld right of firms to cut off violators of RPM contracts
5. Repeal of Miller Tydings (1976)
pendulum had swung in favor of K-Marts & Wal-Marts who wanted pricing freedom
RPM law reverts back to Dr. Miles
5. Current status of RPM
DOJ & FTC don't bring RPM cases
practice is subject to private anti-trust litigation -- firms still can't enforce explicit RPM contracts with retailers
S. Court flirting with reversing Dr. Miles & adopting a rule of reason standard which attaches a per se violation only to agreements which can be proven to be contracts which promote horizontal price fixing (Scalia's decision in Sharp Electronics, 1988)
B. Maximum Retail Prices
1. Albrecht vs. Herald (1968)
Albrecht sold newspapers above the St. Louis Herald's max price and was terminated
Albrecht sues Herald claiming contract unlawful
Why might The Herald want to contain the prices charged by its distributors?
Decision: resting on Dr. Miles, practice is per se violation
2. The Court overturned Albrecht in a 1997 decision: State Oil vs. Kahn
In this decision, the court saw no harm in permitting the upstream firm (State Oil) from containing the market power of local franchisees. The result: an independent gasoline chain can now set the maximum price of gas charged by its franchisees (State Oil vs. Kahn), just like the integrated counterparts can control prices at their outlets. This allows State Oil to establish a reputation for low prices, which is presumably pro-competitive.