Distribution Law Developments At The Federal Trade Commission

Distribution and Dealer Termination, 21st Anniversary Seminar, Law Journal Seminars

New York, N.Y.

Date:
By: 
Thomas B. Leary, Former Commissioner

The Commission has recently taken two enforcement actions with a potentially significant effect on distribution law. The first is a series of consent agreements involving cooperative advertising in the pre-recorded music industry; the second is a consent order resolving Robinson-Patman Act charges against McCormick & Co., the leading supplier of spices. I would like to give you some background on these two cases, along with some personal views that are not necessarily shared by anyone else on the Commission.(1) I would also like to mention in closing a rather controversial issue that the Commission is trying to learn more about: so-called slotting allowances paid by manufacturers to retailers.

I. MINIMUM ADVERTISED PRICE ("MAP") CONSENTS WITH FIVE LARGEST PRE-RECORDED MUSIC DISTRIBUTORS

On May 10th, the Commission entered into proposed settlements with all five of the major pre-recorded music distributors -- Sony, Universal, BMG, Warner-Elektra-Atlantic, and EMI. These five distributors account for approximately 85% of the $13.7 billion domestic sales in the industry. The proposed consent agreements settle FTC charges that the five distributors illegally modified their existing cooperative advertising programs in order to induce retailers to charge consumers higher prices for CDs, which in turn allowed the distributors to raise their own wholesale prices.

As usual, the Commission invited public comments on the proposed consent agreements for a period of 30 days. The Commission is now in the process of reviewing the public comments and deciding whether to make the proposed consent agreements final.

A. Facts:

The factual background is particularly important. The facts stated here are taken from the complaints and Analysis to Aid Public Comment. Some of these facts may well have been disputed, absent settlement, but these are the factual assumptions that underlay the Commission's provisional acceptance of the settlements.

In the early 1990s, major consumer electronic stores such as Best Buy and Circuit City, along with other mass merchandisers, decided to enter the retail sale of music CDs. They started to sell CDs at low prices to gain customers and market share. These new entrants forced more traditional music retailers (such as a Sam Goody or Musicland that you may find in your typical shopping mall), to lower their retail prices to compete. The "price war" led to significantly lower CD prices for U.S. consumers, as prices for popular CDs fell as low as $9.99.

The major music distributors believed this price war had the potential to damage their own margins, because traditional retailers started to demand extra discounts. As an initial response, in 1992 and 1993, the music distributors implemented "minimum advertised price" or "MAP" programs to help forestall the price war. Under these MAP programs, the distributors offered cooperative payments to retailers for certain advertisements that did not mention prices below those suggested by the distributors. The retailers were allowed to advertise prices below the distributors' suggested prices if they paid for the ads with their own funds.

These types of MAP programs are common and generally considered legal, as long as the retailer is free to advertise prices below the manufacturer/distributor suggested price at its own expense. In 1997, the Commission issued a policy statement stating that the Commission would treat such MAP programs pursuant to the Rule of Reason because they may be procompetitive or competitively neutral.(2) The CD price war continued, however, notwithstanding the implementation of the traditional MAP programs by all of the music distributors. The MAP programs did not prohibit major electronic retailers from advertising their CD discounts with their own advertising funds. Some retailers, who could not compete in the price war, again asked the distributors for discounts or more stringent MAP programs to take pressure off their margins.

The distributors introduced stronger MAP policies to stop the price war. Between late 1995 and 1996, all five of the distributors adopted new MAP provisions whereby retailers seeking any cooperative advertising funds were required to observe the distributors' minimum advertised prices in all media advertisements, even in advertisements funded solely by the retailers. In order to get any cooperative funds, retailers were also required to display the distributors' minimum advertised prices on all in-store signs and displays, regardless of whether the distributor contributed to their cost. By defining advertising broadly enough to include all in-store displays and signs, these stronger MAP policies effectively precluded many retailers from communicating prices below MAP to their customers.

Failure to adhere to the respondents' MAP provisions for any particular music title subjected the retailers to a suspension of all cooperative advertising funding offered by the distributor for an extended period, typically 60 to 90 days. The severity of these penalties ensured that even the most aggressive retail competitors stopped advertising prices below MAP.

The effect of the stricter MAP policies was higher CD prices. Wholesale prices increased as well.

B. Legal Theories:

The Commission's consents are based on two different legal theories. First, the Commission found that the more stringent MAP programs individually constituted a vertical restraint in violation of Section 5 of the FTC Act under a rule of reason analysis. The Commission also found that the arrangements were practices that facilitate horizontal collusion among the distributors. The vertical aspect of the cases may be more significant for present purposes.

1. Vertical Restraints Theory:

The Commission determined that the more stringent MAP programs individually constituted an unlawful vertical restraint against competition, under a rule of reason analysis. These MAP programs went well beyond the cooperative advertising programs which the Commission has encountered previously: they prohibited retailers from advertising discounts in all advertising, including advertising paid for entirely by the retailer, and they also applied to in-store advertising, excepting only the smallest price labels affixed to the product. Other MAP programs that the Commission has held lawful in the past involved only advertising paid for in whole or in part by the manufacturer, but did not restrain the dealer from selling at a discount or from advertising discounts when the dealer itself paid for the advertisement.(3)

Moreover, the five distributors that had implemented these more stringent MAP policies together accounted for over 85% of the market, and each individually has some market power because each has its own set of popular artists that no music store can choose not to carry.(4) The effect of the policies was to stabilize retail prices and raise wholesale prices.

The Commission also determined that there was no plausible efficiency rationale for the MAP policies. The new retailers that instigated the price war provided services that were as good as, and in some cases superior to, the services provided by the higher priced traditional retailers. Consequently, there was no "free-riding" on traditional retailers and the standard justification for MAP, and other policies that inhibit discount selling, was inapplicable.

The Commission did not allege that these particular MAP policies constituted per se unlawful minimum resale price maintenance. Retailers were theoretically free to sell at any price, so long as they did not advertise a discounted price, and there was some evidence that on rare occasions they actually did so. There is also a question whether an agreement limited to price advertising would satisfy the requirements of Business Electronics Corp. v. Sharp Electronics Corp., where the Supreme Court held that "a vertical restraint is not illegal per se unless it includes some agreement on price or price levels."(5)

The Commission emphasized, however, that in the future it will view with great skepticism cooperative advertising programs that effectively eliminate the ability of dealers to sell product at a discount.(6) Therefore, counsel in comparable situations should not derive any particular comfort from the fact that a rule of reason analysis was applied.

I voted for the complaint and the consents in these cases, although I had in the past stated that when the appropriate case arises, I believe the Supreme Court should reassess the applicability of the per se rule to resale price agreements.(7) Perhaps some elaboration of my views would be helpful.

Minimum RPM can involve a mixture of procompetitive and anticompetitive effects, like any other vertical restraint, and I question the continuing validity of the per se rule announced almost 90 years ago in Dr. Miles.(8) In the first place, the courts no longer apply the underlying premises of the Dr. Miles decision, which was based on the medieval prohibition against restraints on alienation and the discredited idea that vertical restraints are equivalent to horizontal restraints.

Moreover, courts have attempted to avoid the potentially serious adverse effects of Dr. Miles by application of the so-called Colgate(9)exception, which in my view distorts (for a useful end) ordinary principles of contract law and mandates surreal compliance programs.(10) Dr. Miles has also spawned the so-called "consignment" exception of General Electric,(11) which is based on an essentially artificial inquiry into the locus of "title." In other words, Dr. Miles has cascading adverse effects, which could be eliminated if minimum resale price maintenance were judged under a suitably focused standard of reasonableness.

I have not thought through what those standards might be if Dr. Miles were modified, but I do not think that the traditional concern about "free-riding" dealers should be the only acceptable rationale for a minimum resale price maintenance policy. A manufacturer may also have legitimate concerns about damage to the reputation and goodwill value of its products if dealers, for their own reasons, exploit them as loss leaders -- particularly, if the promotion is part of a "bait-and-switch" strategy. (There are indications that lost-leader selling may have occurred in these music CD cases.) It has also been suggested that manufacturer-imposed minimum resale price maintenance can actually stimulate sales by encouraging dealers to maintain adequate inventories to accommodate uncertain demand conditions.(12)

As long as Dr. Miles continues to be the law, however, I cannot apply these interesting speculations and I am unwilling to distinguish between outright resale price maintenance and a MAP system that is so close to resale price maintenance in its practical effects. Accordingly, I also supported the strong caveat about future conduct. It would send a potentially dangerous message to the business community if we created the impression that far-reaching MAP policies of the kind involved in these cases are ever likely to be acceptable under present legal standards. Sometimes clear cut guidance is better than the most economically precise guidance. (Ultra-sophisticated variations of the Areeda-Turner rule are problematic for the same reason.)

The distinction between a MAP policy that applies to cooperative advertising only and a MAP policy that purports to cover dealer-financed ads as well is relatively clear cut and, in my personal experience, already extensively applied. Business people need solid guidance on what type of conduct is legal and what isn't, and the Commission's MAP consents do provide real world guidance to business people in the cooperative advertising area.

2. Facilitating Practices Theory:

One other aspect of the Commission's MAP consents is worthy of note. The Commission unanimously found that, when considered together, the distributors' adoption of the MAP policies facilitated horizontal collusion, in violation of Section 5 of the FTC Act. Counselors may be concerned about the significance of this development.

The market structure in which the distributors' MAP provisions operated, the fact they were implemented with an intent to stabilize prices, the significant price effects, and the lack of compelling business justifications gave the Commission reason to believe that the practices materially facilitated interdependent conduct.(13) The fact that the wholesale market for prerecorded music is characterized by high entry barriers which limit the likelihood of effective new entry, and the fact that the respondents can easily monitor the pricing and policies of their competition, also added to the Commission's concerns. Note that these structural factors could also be important in conventional vertical analysis, but here they are applied in a horizontal context.

In addition, the Commission found that the history of the MAP policies in the industry indicated a propensity for interdependent behavior among the distributors. All five of the distributors adopted benign MAP policies in 1992 and 1993. Then in 1995 and 1996, all five distributors expanded the restrictions in nearly identical fashion. In one case, the new MAP provisions were announced four months prior to their effective date. During that four month hiatus, two other distributors adopted similar provisions. By the end of 1996, all five distributors had adopted MAP provisions that were virtually identical. Shortly thereafter, several distributors embarked on high profile enforcement actions against major discounters who were discounting prices, and these enforcement actions were widely publicized by the trade press.

Counselors should not over-react. I do not believe that the Commission's endorsement of a facilitating practices theory in these cases signals far reaching use of the theory in different contexts in other relatively concentrated industries. The Commission looked at the totality of the circumstances when approving a facilitating practices theory in the MAP cases, and I personally had "reason to believe" that a horizontal case could be proved at trial. The proof was never put to that test, however, and there may not be many cases that are as extreme as this one appeared to be on the facts before us.

II. MCCORMICK CONSENT

I would also like to discuss the Commission's most recent enforcement action in the Robinson-Patman Act area. On May 2 the Commission accepted as final a consent agreement with McCormick & Co., the leading supplier of spices, that settled charges that it engaged in secondary-line price discrimination in violation of Section 2(a) of the Robinson-Patman Act.(14) Commissioner Swindle and I dissented.

As you know, the Commission very rarely prosecutes a Robinson-Patman case. Although I have reservations about the Robinson-Patman Act, as many antitrust attorneys and economists do, I did not dissent for that reason. In fact, I accept and agree with the majority's objective to bring an appropriate Robinson-Patman case in order to clarify and limit the application of the so-called Morton Salt inference.(15) My problem is that I do not think McCormick was the right case and I do not think Morton Salt was addressed in an appropriate way.

A. Facts:

This is another case that was not tried on the merits, so the facts stated here are based on the complaint and the Analysis to Aid Public Comment, subject to the same caveats mentioned above.

McCormick is by far the leading supplier of spices in the U.S. Its products primarily sold through supermarkets include core and gourmet spice lines, dry seasoning mixes, and so-called "competitive seasonings" such as meat tenderizers, monosodium glutamate (MSG), and garlic and other spice blends. Since the early 1990's, McCormick has faced competition from only one other national firm, Burns Philp, and several much smaller independent regional or local firms.

In the early 1990's Burns Philp started a price war in which both it and McCormick offered increased discounts and other payments to try to win the business of grocery stores. When the price war ended, McCormick remained the dominant spice supplier in the U.S., and Burns Philp's ability to compete may have been impaired.

Commission staff found evidence that in some instances during the price war, McCormick charged some retailers higher net prices for its spices than it charged other competing retailers. The Commission's complaint charged that McCormick extended preferential treatment in a variety of ways, including up-front cash payments similar to slotting allowances, free goods, off-invoice discounts, cash rebates, performance funds, and other financial benefits. The payments that resembled "slotting allowances" typically were for all or a substantial part of the existing McCormick product line and typically were not incentives to accept new McCormick products. McCormick's supply agreements commonly included provisions requiring that the customer allocate to McCormick the large majority (as much as 90%) of the shelf space devoted to spice products.

B. Legal Theory of Majority:

The Commission's complaint charged that in five instances, McCormick discriminated in price between competing grocery stores. Through differing slotting-type payments or other discounts, McCormick sold its products to the favored grocery stores at a lower net price than to the disfavored grocery stores, in violation of Section 2(a) of the Robinson-Patman Act. The complaint is based on threatened injury at the "secondary-line" level of competition, that is, at the level of the favored and disfavored purchasers. The higher prices that the disfavored grocery stores paid McCormick for spices allegedly could harm their ability to compete against other grocery stores for customers.

The Commission relied on the Morton Salt inference of competitive harm to prove the requisite injury. For more than 50 years, courts have used the Morton Salt inference that "injury to competition is established prima facie by proof of a substantial price discrimination between competing purchasers over time."(16) In essence, the Morton Salt inference permits a court to infer injury to a disfavored purchaser from a persistent and substantial discriminatory price in a market where profit margins are low and competition is keen, and then to infer injury to competition from the injury to the disfavored purchaser.

Although the Morton Salt inference has been regularly applied by the courts for the last three decades, it has been the subject of considerable controversy. Overall, the concern has been that the inference makes violations too easy to prove.(17) In apparent recognition of this concern, the Commission majority stated that the Morton Salt inference may not always be sufficient by itself to support a Robinson-Patman Act case.(18)

However, the Commission majority concluded that the use of the Morton Salt inference was strengthened in this case by McCormick's position as the largest supplier of spice products in the U.S. and by the fact that McCormick typically demanded that customers allocate to McCormick the large majority of the space devoted to spice products.(19) The rationale was that these conditions would weaken McCormick's competitors, particularly Burns Philp, thereby reduce alternative supply sources for the disfavored buyers in the secondary-line, and make it more likely that they would be forced to pay higher prices.

C. Dissent:

In our dissent, Commissioner Orson Swindle and I stated that we applaud any effort to limit the use of the Morton Salt inference to situations where secondary-line competitive injury is more plausible, but that the majority had not identified a useful limiting factor.(20)Let me explain.

The case was an atypical secondary-line Robinson-Patman Act case, in the first place. The Robinson-Patman Act was primarily intended to prevent price discrimination in favor of large buyers at the expense of small buyers. Congress was addressing its concern that large buyers could secure a competitive advantage over small buyers solely because of the large buyers' quantity purchasing ability.(21)

When a small buyer pays more than a large buyer in something like the grocery business, with its low profit margins and keen competition, the Morton Salt inference may make sense because it is reasonable to infer that the purchasing power of the large buyer will cause the price discrimination to be repeated across many items, with consequent competitive injury to the small buyer. Prosecutors should not be required to prove the discrimination item by item. That was not the situation in the McCormick case, however. The challenged discriminations occurred, almost fortuitously, in the heat of a spice price war, and there is no reason to suppose that they extended to other items. Moreover, the Commission's complaint does not allege that the favored grocery stores were larger than the disfavored grocery stores, or that they purchased more spices from McCormick. In fact, only one of the disfavored customers could be characterized as a "mom-and-pop" operation, the rest of the disfavored stores were all large or relatively large grocery store chains.

The stated justifications for applying the Morton Salt inference in this case - McCormick's position as the largest supplier of spice products in the U.S. and the fact that McCormick demanded that customers allocate to McCormick the majority of their shelf space - essentially interjects a primary-line injury concept (i.e., injury to competition between sellers) into a case alleging secondary-line injury (i.e., injury to competition between buyers). In the long-run the possible loss of alternative sources for spices could disadvantage both the disfavored grocery stores and the favored grocery stores (once their present contracts expire). This classic consequence of primary-line injury is the principal anticompetitive effect asserted in the McCormick consent, which is ostensibly designed to illuminate standards for secondary-line injury. Moreover, contrary to the apparent assumption in the majority's opinion, there is no particular reason to believe that buyers disfavored by one seller with market power are likely to get better treatment from alternative sources.

Again, I want to emphasize that I believe it is a laudable goal to limit the use of the Morton Salt inference to instances where harm to secondary-line competition is genuinely plausible, and this is precisely what the Commission should be taking into consideration when exercising its prosecutorial discretion. However, I personally do not believe that evidence of seller market power is a significant screen for inferring competitive harm at the buyer level. Evidence of buyer market power would be a far better screen.(22)

The secondary-line complaint in McCormick could be harmful for another reason. As stated above, the case arose out of a battle to the near-death between the two most significant competitors in the spice business. The principal harm, if any, occurred at that primary-line level, and any secondary-line effects occurred almost in passing. The majority's statement in McCormick could convey the impression that the Commission will rely on the permissive Morton Salt standard to salvage a case that may be difficult to prove as a primary-line offense - when there are no sales below cost, for example, or because there is insufficient likelihood of competitive harm under the rigorous "monopolization" standard applied at that level.(23)

Actually, there might be a potentially more promising alternative theory available in a case like McCormick. The price concessions extended by McCormick during the price war involved in some cases payments for shelf space in return for guarantees of near-exclusivity. If the case had been analyzed as an exclusive dealing case rather than as a price discrimination case, it might have been possible to frame a complaint under Section 5 of the FTC Act, without reference to the standards ordinarily required to prove primary-line injury.(24) On the other hand, the problems of proof could still be formidable and the majority would not have had the opportunity to say the things they obviously wanted to say about the Robinson-Patman Act.

III. SLOTTING ALLOWANCES

This brings me to the controversial subject of slotting allowances. The Commission has received a number of complaints about this practice in recent years,(25) and recently held informative hearings on the subject. We heard testimony from numerous industry executives, counsel, and academics. Our staff is expected to prepare a report on the hearings in the coming months -- which should help to inform future Commission action, if any.

My purpose here is not to analyze the pros and cons of slotting allowances, or to predict any Commission response. In particular, you should not interpret the McCormick settlement as related to this issue. As indicated in the discussion above, the consent settlement and associated opinions would not have materially changed if McCormick's selective concessions had been limited to price cuts. The purpose is simply to let you know that we are interested in the issue.

Slotting allowances come in various and ever evolving forms - ranging from simple payments up front to obtain some space for introduction of a new product (a kind of risk sharing between manufacturer and retailer) to payments for preferential or near-exclusive display space (with possible foreclosure effects). Some payments are volume related, and thus may be analogous to price concessions, but others are not, which suggests that something else is going on. Payments are apparently most likely to result from retailer initiatives but not always, and there obviously are different inferences that could be drawn.

My perception at this point is that the Commission is unlikely to recommend hard-and-fast rules. There are too many variables. You may, however, see some cases down the road.

IV. CONCLUSION

There are, of course, many serious issues in the area of distribution law that I have not even touched on today. Some of the most serious problems are created by something that we in the Commission can do very little about, as a practical matter, namely, the continuing proliferation of protectionist franchise laws at the state level. In addition, of course, distribution issues are one of the areas of antitrust that continue to be shaped by private litigation.

The matters that I have mentioned, however, should demonstrate to you that - despite the proliferation of merger matters - the Commission continues to be involved in distribution issues. I am confident it will always be so.

Endnotes:

1. A third recent distribution action against the Nine West Group Inc. also resulted in a consent agreement, but I believe this case is of less general interest. In the Matter of Nine West Group Inc., Dkt. No. C-3937 (April 11, 2000).

2. See Federal Trade Commission Statement of Policy Regarding Price Restrictions in Cooperative Advertising Programs - Rescission, 6 Trade Reg. Rep. (CCH) ¶ 39,057 (April 17, 1997).

3. See, e.g., The Advertising Checking Bureau, Inc., 109 F.T.C. 146, 147 (1987).

4. I do not believe this claim of individual market power, based on the unique appeal of particular entertainment, was crucial to the outcome here. However, an analogous claim could well be significant in a different context.

5. 485 U.S. 717, 735-36 (1988).

6. Statement of Chairman Robert Pitofsky and Commissioners Sheila F. Anthony, Mozelle W. Thompson, Orson Swindle, and Thomas B. Leary, In the Matter of Time Warner Inc.; In the Matter of Sony Music Entertainment Inc.; In the Matter of Capitol Records, Inc., d.b.a. "EMI Music Distribution"; In the Matter of Universal Music & Video Distribution Corp. and UMG Recordings, Inc.; and In the Matter of BMG Music, d.b.a. "BMG Entertainment," file No. 971-0070 at 2 (consent agreements accepted for public comment on May 10, 2000).

7. See Nine West Group Inc., supra n. 1, Statement of Commissioners Orson Swindle and Thomas B. Leary.

8. Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373, 411-12 (1911).

9. United States v. Colgate & Co., 250 U.S. 300 (1919).

10. The Colgate doctrine permits manufacturers unilaterally to establish minimum resale price maintenance and terminate dealers who do not comply, provided they do not solicit "agreements" to comply. Normally, of course, contracts can be accepted by performance. See generally, John D. Calimari and Joseph M. Perillo, Contracts 2-19 (3d ed. 1987). The Nine West case, supra n. 1, was based on the failure to abide by the strictures of this doctrine.

11. United States v. General Electric Co., 272 U.S. 476 (1926).

12. See Raymond Deneckere, Howard P. Marvel, and James Peck, Demand Uncertainty, Inventories, and Resale Price Maintenance, Quarterly Journal of Economics, Vol. III, Issue 3 (August 1996).

13. See E.I. du Pont de Nemours & Co. v. FTC, 729 F.2d 128 (2d Cir. 1984).

14. In the Matter of McCormick & Co., Dkt. No. C-3939 (April 27, 2000).

15. Federal Trade Commission v. Morton Salt Co., 334 U.S. 37 (1948).

16. Falls City Indus., Inc. v. Vanco Beverage, Inc. 460 U.S. 428, 435 (1983) (citing Morton Salt).

17. See, e.g., LaRue, Robinson-Patman Act in the Twenty-First Century: Will The Morton Salt Rule Be Retired?, 48 S.M.U.L. Rev. 1917 (1995).

18. See McCormick & Co., Analysis To Aid Public Comment, at 4.

19. Id.

20. McCormick & Co., Dissenting Statement of Commissioners Orson Swindle and Thomas B. Leary, at 3.

21. See, e.g., H.R. Rep. No. 2287, 74th Cong., 2d Sess. 7 (1936); S.Rep. No. 1502, 74th Cong., 2d Sess. 4-6 (1936).

22. As the dissent stated, however: "We do not suggest that market power of the supplier is irrelevant in a Robinson-Patman Act case - in fact, it is likely to be present in all cases of economic price discrimination. However, supplier market power is not dispositive of whether secondary-line injury is likely to have occurred. Our agreement with the majority that McCormick is the dominant spice seller does not overcome the lack of proof of secondary-line injury in this case." McCormick & Co., Dissenting Statement of Commissioners Orson Swindle and Thomas B. Leary, at 3 n.7.

23. The Supreme Court has stated that "primary-line competitive injury under the Robinson-Patman Act is of the same general character as the injury inflicted by predatory pricing schemes actionable under Section 2 of the Sherman Act." Brooke Group v. Brown & Williamson Corp., 509 U.S. 209, 221 (1993).

24. See, e.g., Instructional Sys. Dev. Corp. v. Aetna Cas. & Sur. Co., 817 F.2d 639, 648 (10th Cir. 1987); McGahee v. Northern Propane Gas Co., 858 F.2d 1487, 1503 (11th Cir. 1988), cert. denied, 490 U.S. 1084 (1989).

25. In the interests of full disclosure, I should mention that I have in the past represented some companies with complaints.