As many have expected, the new members of the Supreme Court are making big headlines, and their June 28th decision lifting the many-years-old “ban” on what are known as “price floors” (a form of price-fixing) is no exception. It is now legal, thanks to this ruling, for manufacturers to require resellers of their goods to charge at least a minimum price for those goods.
Further, although the repercussions are not completely clear, the court’s opinion is definitely going to have a significant impact on manufacturers’ strategic pricing decisions, reseller relationships with those manufacturers, the way the law interacts on pricing-related antitrust issues, and consumers. Put another way, a previously-accepted “law of nature” governing how a business ecosystem operates is now, for the foreseeable future, dramatically changed.
This reverses a policy going back almost 100 years, to a Supreme Court decision passed down in 1911 known as the “Dr. Miles Precedent”, named after a seller of patent medicines. In that case and in decisions reinforcing it since that time, the “law of the land” has always been that suppliers cannot constrain their resellers by requiring a minimum price on their goods. The legal basis for these decisions was connected to antitrust and monopoly concerns, with at least part of the concern in the judicial proceedings being that manufacturers and resellers should not be allowed to collude to set prices. The result of the original decision was, in effect, an “automatic ban” on setting of price floors by a supplier.
Brighton Polishes Up Its Legal Strategy
The current case is titled “Leegin Creative Leather Products, Inc. vs. PSKS, Inc.” Leegin is a successful manufacturer of custom leather products, and known better by its “Brighton” brand of belts, handbags, watches, footwear, watches, jewelry, fragrance, and other fashion accessories. It also sells products under the Silver Creek, Tony Lama, and Justin labels, and private label distribute to companies such as Eddie Bauer, Land’s End, L.L. Bean, and J. Crew. A key to its strategy is selling to smaller retailers (as opposed to major store chains and/or discounters), where Leegin feels, as it states on the Brighton website, there is the opportunity for “excellent customer service”. Leegin sells through over 6,000 retailers, and had 2006 revenues of around $250 million.
Its opponent in this case is PSKS, Inc., the operator of Kay’s Kloset, a boutique privately-held women’s retailer in Lewisville, Texas and former seller of the Brighton handbag product line. Kay’s Kloset, a Brighton “Heart Store” reseller with the Brighton handbag line being at one time its biggest-selling product category, with Brighton’s product lines sometimes accounting for between 40% and 50% of its profits. It did so through aggressive promotion of the Brighton brand, holding special “Brighton Days”, and repeatedly discounted the Brighton line by as much as 20% over suggested prices. It became, as the Supreme Court opinion notes, “the destination retailer in the area to buy Brighton products”. In 2002, Leegin discontinued business with Kay’s Kloset because of its continued selling of products below pricing Leegin had suggested, and Kay’s Kloset’s sales dropped by half. PSKS sued Leegin under the “vertical” (sales channel) price-fixing argument above, won a judgment against Leegin, Leegin appealed, and the case made it up to the Supreme Court.
The Decision
The decision, as passed down this week, held in favor of Leegin, on the grounds that price-fixing “per se” is not, by itself, evidence of “restraint of trade”, the actual underlying legal issue in the case. As the court noted in its written opinion this past week:
“The rule of reason is the accepted standard for testing whether a practice restrains trade in violation of §1. See Texaco, supra, at 5. “Under this rule, the fact finder weighs all of the circumstances of a case in deciding whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition.” Continental T. V., Inc. v. GTE Sylvania Inc., 433 U. S. 36, 49 (1977). Appropriate factors to take into account include “specific information about the relevant business” and “the restraint’s history, nature, and effect.” Khan, supra, at 10. Whether the businesses involved have market power is a further, significant consideration. See, e.g., Copperweld Corp. v. Independence Tube Corp., 467 U. S. 752, 768 (1984) (equating the rule of reason with “an inquiry into market power and market structure designed to assess [a restraint’s] actual effect”); see also Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U. S. 28, 45–46 (2006). In its design and function the rule distinguishes between restraints with anticompetitive effect that are harmful to the consumer and restraints stimulating competition that are in the consumer’s best interest.”
So effectively what the court decided was that Leegin wasn’t creating “an unreasonable restraint on competition” by insisting on minimum prices from its resellers. So-called “horizontal” price-fixing, such as when a group of retailers might agree together to set a minimum price level for a product, is still explicitly against the law according to the ruling. But the change in this ruling, that “vertical” price restraints of the kind noted here, which are enforced “vertically” through the distribution channel, says that assuming vertical price restraints are anticompetitive “per se” is not valid. As the decision explains further:
“To justify a per se prohibition a restraint must have “manifestly anticompetitive” effects, GTE Sylvania, supra, at 50, and “lack . . . any redeeming virtue,” Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co., 472 U. S. 284, 289 (1985) (internal quotation marks omitted).
“As a consequence, the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue, see Broadcast Music, Inc. v. Columbia Broadcasting System, Inc., 441 U. S. 1, 9 (1979), and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason, see Arizona v. Maricopa County Medical Soc., 457 U. S. 332, 344 (1982).”
The Strategic Implications for Business
As I mentioned earlier in this essay, one of the more significant rules guiding Business Ecosystem behavior has now changed. It’s okay now, up to a point, to require minimum pricing into the vertical selling chain. In the old marketing concept of the “4 Ps”, where the “Ps” were Product, Pricing, Promotion, and “Placement” (or the distribution channel), pricing could not be controlled via the sales channel, although the choice of where to sell could sometimes effectively help maintain a given price level (because if you sell only to high-end retailers, you’re going to tend to encourage “high-end” prices). Now, however, you can control the low end of the pricing, which of course is all that truly matters. Further, although distribution matters, a manufacturer can now more comfortably sell through a wider variety of resellers – because it can be assured its prices are being upheld to a minimum standard.
The decision does make clear that if the pricing controls have the effect of antitrust or anticompetitive “restraints of trade”, the courts are still against those kind of effects. But the powerful change here is that where any kind of pricing controls used to be considered anticompetitive more or less automatically (the “per se” argument noted above), now they aren’t. So anyone who feels a pricing action is anticompetitive will now have to slog through the courts to prove its case, where in the past it was relatively straightforward to get summary judgments issued just on the simple facts of the case.
To me, the strategic shift offered by this decision is extremely significant. In all markets, when one reseller begins to lower a price for a given product, others selling the same product may feel the pressure to lower the prices themselves – as a competitive move. In the early days of the “designer jeans” craze in the United States, for example, this resulted in some drastic discounting of some of the hottest-selling brands, which in turn damaged the original carefully crafted “high-priced image” of those brands. The end result in that case was that the bottom fell out of these markets faster than the manufacturers would ever have wanted, with consumers being the winner in the long run. Under the present ruling, this would never have happened this way because no “high-priced image” manufacturer would have resisted the opportunity to require a minimum selling price for the distributors’ goods.
What it means for manufacturers, then, is an interesting strategic opportunity. Early in a product cycle, especially in highly innovative markets such as we discuss here at Stranova, manufacturers will have a better chance at their fledgling products not being used as “loss leaders” to get a customer into a store, or, for a “hot” new product, to dramatically shift market share from one store to another (which was exactly the situation with Kay’s Klosets in this Supreme Court Case) using low-ball pricing. Later in a product cycle, if the product stays differentiated in important ways, maintaining price floors will help sustain profit margins longer, even in a dwindling market for the same goods, as they will no longer be able to be discounted by those resellers who want (or need) to sell the goods. In effect, then, manufacturers will tend to have more control on their markets, and more ways “to become essential to their business ecosystem” using pricing floors as a competitive weapon.
The Effect on Consumers
Unfortunately, the effect of this decision on consumers isn’t particularly rosy, in my opinion. Once the court decisions have been analyzed thoroughly by corporate lawyers on all sides of this argument, I believe many manufacturers will begin installing price floors for their products in many categories sold in the United States. Because discounting will be discouraged, prices will slowly rise on these products, and some sales channels for certain product categories will begin to shrink. Inflation will also rise because of this as well, although it will be hard to show the direct link.
Some will argue that the selling power of companies such as Wal-Mart, Target, and others will tend to mitigate the ability of original manufacturers to set price floors, and so this decision won’t really have major consequences. I disagree, especially in markets where those kind of retailers aren’t really the dominant force. In particular, I expect the impact on discounting to be felt most in those areas where operating costs are held the lowest, such as with mass-market discounters and internet retailers.
It will also be argued that consumers will benefit because, thanks to higher prices, resellers will be able to provide more customer service support in their stores, allowing consumers to make better purchasing decisions. Perhaps. But for most products that we buy, enhanced customer service isn’t really all that specific to a given product line, and in many cases customers don’t necessarily need better-trained and available sales personnel to help decide what to buy.
Finally, because, when a true anticompetitive situation does begin to emerge because of setting price-floors, this decision now requires an individual court fight for each case. Since legal battles have high expenses of their own, the need for such court fights to settle such an issue will discourage the smaller manufacturers (as well as smaller resellers) who are being hurt – from pursuing their grievances. There will be more abuses, both because of the appearance of legality of a particular action and because of the difficulty in seeking legal relief from the wrongful ones.
What to Do, What to Do
As with all decisions on Strategic Innovation, for us what’s important as a result of this court decision is for a company to act based on an understanding of its strategic aims and a firm grounding in the values it holds close at hand. For example, in our strategic resource services we provide to clients, we emphasize the concept of Business Ecosystems from the standpoint of becoming essential to one’s ecosystem while ensuring that the whole ecosystem continues to thrive.
We need to realize that the business ecosystem is indeed an interactive enterprise in its own right, and, just as it is with nature, using one’s power to manipulate one part of the network in what seems appropriate logic at the time may eventually come back and harm not only your company but the entire ecosystem. Implementing such price floors should therefore be done sparingly and with conscious thought about exactly what “value-adding” there is to the system by (effectively) requiring a higher gross margin from your resellers. Ideally that higher gross margin should indeed support some other value-adding capacity that definitely supports not only the retailer but also the consumers, in order for the customers to see the value.
Finally, a company should never forget that price floors only protect the price of its own product, not all products. So, again as with all competition, if a competitor can provide a value that you cannot – at the same price or lower – at least some customers will move to that competitor’s service. It should never be considered a safe action to put a price floor in place to help prop up your products across its distribution channels, since your product may indeed be vulnerable to substitution (of one sort or another) from other suppliers.
As a resource, if you’re interested, the full text of the Supreme Court’s Decision can be found here:
“Leegin vs. PSKS, Inc.”
business ecosystems law Strategic Innovation News & Reflections
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To understand more about this, we spoke with Israeli serial entrepreneur Shai Schiller, CEO of Modula, Ltd., a strategic investment firm, about some of the forces behind why this is happening and how the continuing evolution of Israeli high-tech ventures and outside forces such as foreign Venture Capital firms are stimulating business change on many levels.
