THE LEGAL ENVIRONMENT FOR STRATEGIC VERTICAL MARKETING SYSTEM DESIGN DISSERTATION FOR THE DEGREE or i ' DOCTOR OF PHILOSOPHY _ 7, ' ' If : TMICHIGANSTATEUNIVERSITY H H I JAMES’RDBERT BURLEY 1974 ‘7 err-T55“s Date 0-7639 -- LIBRARY This is to certify that the thesis entitled The Legal Environment for Strategic Vertical Marketing System Design presented by James Robert Burley has been accepted towards fulfillment of the requirements for Ph . D. degree in Marketing Major professor \ 11/1/74 ABSTRACT THE LEGAL ENVIRONMENT FOR STRATEGIC VERTICAL MARKETING SYSTEM DESIGN BY James Robert Burley The use of the vertical marketing system (VMS) has been suggested by many authorities in the fields of market- ing and distribution. The hypothesis of this research is that the use of the control variables in a VMS can create legal problems because attempts to restrain or control com- petition are in opposition to the basic premise of the fed— eral antitrust legislation. This research evaluates the present legal environment to determine to what extent each of forty-nine strategic policy alternatives may or may not create legal problems for the firm. These alternatives fall in the general categories of price concessions, finan- cial assistance, inventory protection, price protection and territorial protection. The research evaluates the legal environment of vertical marketing systems of an ad— ministered or contractual form, and not vertical marketing systems which are owned by a manufacturer. The research is descriptive in nature. Sources of information utilized to determine the present legal environ— ment include federal judicial interpretations, statutory James Robert Burley material, advisory material from federal administrative agencies and scholarly opinions from legal and business publications. After evaluating the information obtained from the search process the inductive method was employed to determine basic legal positions with respect to each of the forty—nine suggested control variables. The research indicated that price concessions are potentially powerful strategic variables in a VMS but are restricted in their use due to the requirement that equal treatment be given to all of the firm's competing customers. Particular care must be exercised by the firm attempting to use price concessions which favor direct buyers over in— direct buyers. The application of the statutes governing price concessions, the Robinson-Patman Act and the Federal Trade Commission Act create questions due to inconsistencies which occur in the interpretations. This leads to the con— clusion that the use of price concessions as a strategic control variable in a VMS is a policy decision which may create legal difficulty for the firm. Financial assistance is often used in distribution networks as a control device as well as a mechanism to assist new or struggling dealers. Recent decisions have created difficulty for the firm considering the granting of credit in exchange for purchases of their product. The controversy over these decisions is not likely to be settled immediately; as a result, firms utilizing financial assistance variables James Robert Burley should exercise care to insure that the variables are not used in a manner which could create a tying arrangement, and that the assistance is not granted in a discriminatory way to favored dealers. Protective programs designed to assist the dealers in price, inventory and territorial protection are also offered as powerful strategic variables in a VMS. The power of these variables has been dissipated by decisions which prohibit tampering with or conSpiring to fix prices or ter— ritories in vertically oriented distribution systems. In addition, state legislation coupled with the continual over— view of the FTC create additional difficulties for suppliers who attempt to shield members of their channels from the rigors of the competitive environment through policies designed to inhibit or restrain competition. The research indicates that administered and con— tractual vertical marketing systems require the use of control variables which are illegal in certain circumstances. Firms considering the use of a VMS should be aware of these legal problems. THE LEGAL ENVIRONMENT FOR STRATEGIC VERTICAL MARKETING SYSTEM DESIGN BY James Robert Burley A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Marketing & Transportation Administration 1974 ACKNOWLEDGMENTS I would like to thank my Dissertation Committee Chairman, Professor Richard J. Lewis, for his guidance and encouragement during the preparation of this dissertation. I would also like to thank Professor Donald J. Bowersox and Professor Hendrik Zwarensteyn for their helpful criti— cisms, support and assistance. Other members of the Michi- gan State University faculty have been of assistance in ways too numerous to mention but for which I shall be for— ever grateful. I am also indebted to fellow graduate students E. Link Beck and Robert L. Pou for their assistance in helping me to understand the legal technicalities which developed during the research. Finally, special thanks to my wife, Nancy, for her support and encouragement throughout my graduate education. ii TABLE OF CONTENTS List of Figures . . . . . . . . . . . . . . . . . I. II. INTRODUCTION. . . . . . . . . . . . . . . Statement of problem . . . . . . Scope of problem . . . . . . . . Background . . . . . . . . . . . Methodology. . . . . . . . . . . Limitations. . . . . . . . . . . Contribution of the research . Order of presentation. . . . . . PRICE CONCESSIONS AS STRATEGIC VARIABLES. Introduction. . . . . . . . . . Defenses To Price Discrimination Actions. . . . . . . . . . . "Meeting competition' defense. . "Changing market conditions" defense. . . . . . . . . . . . . "Cost justification' defense . . Discount Structure. . . . . . . . . . Trade (functional) discounts Quality discounts. . . . . . . . Cash discounts. . . . . . . Anticipation allowances. . . . . iii Vii ll l3 14 15 l7 17 20 22 24 25 28 28 37 43 45 iv Free goods. . . . . . . . . . . . Prepaid freight — freight allow- ances. . . . . . a . . . . . . . New product display and advertis— ing allowances . . . . . . . . . Seasonal discounts. . . . . . . Mixed carload privilege . . . . . Drop shipping privilege . . . . . Trade deals. . . . . . . . . . . Discount substitutes . . . . . . Display materials. . . . . . . . Premarked merchandise . . . . Inventory control programs Catalogs and sales promotion literature. . . . . . . . . . Training programs . . . . . . . . Shelf stocking programs . . . . . Ad matrices. . . . . . . . . . . Management consulting services. . Merchandising programs. . . . . . Sales "spiffs" . . . . . . . . . Technical assistance. . . . . . . Payment of sales personnel and demonstrator salaries . . . . . Promotional and advertising allow— ances with performance require— ments. . . . . . . . . . . . . Conclusions . . . . . . . . . 46 50 54 58 61 64 66 68 68 70 71 73 76 77 80 81 83 85 86 87 90 97 III. IV. FINANCIAL ASSISTANCE AS STRATEGIC VARIABLES. . . . V Conventional Lending Arrangements. Term loans. Inventory floor plans Notes payable financing . Accounts payable financing. Installment financing of fix— tures and equipment. Lease and note guarantee programs Accounts receivable financing Extended Dating. PROTECTIVE PROVISIONS AS STRATEGIC VARIABLES. . . . Price Protection Pre—marked merchandise Fair trade. Franchise pricing . Agency agreement. Inventory Protection . Consignment selling Memorandum selling. 0 Liberal returns allowances. Rebate programs. Reorder guarantees Guaranteed support of sales events. . o 101 102 102 107 109 112 115 117 119 120 123 124 125 132 142 156 161 161 164 166 167 169 170 vi Maintenance of spot" stocks and fast delivery. . . . . . . . . 171 Territorial Protection. . . . . . . . . 173 Selective distribution . . . . . . 174 Exclusive distribution . . . . . . 176 Exclusive dealing. . . . . . . . . 179 Territorial restraints on resale . 183 Exclusive territories — restraints on resale. . . . . . . . . . . . . 198 V. SUMMARY, CONCLUSIONS AND RECOMMENDATIONS. . 201 Summary. . . . . . . . . . . . . . . . 201 Conclusions. . . . . . . . . . . . . . 202 Recommendations For Further Research. . 213 Bibliography. . . . . . . . . . . . . . . . . . . 215 [El . . . . . . . . Innifnsh SVL‘MEQXE alsssw no r rierjasz Iei;n;ixtuz -~T‘E;*= ' -=Lfirftwr % LIST OF FIGURES vii Page 56 100 138 192 CHAPTER I INTRODUCTION Statement of problem The purpose of this research is to examine the legal environment with which firms seeking to develop planned ver- tical marketing systems (VMS) of the administered or contrac— tual form must deal. The legal environment for corporate ver— tical marketing systems is determined primarily by interpre- tations of Section 7 of the Clayton Act. There is a vast amount of literature regarding the probable boundaries that firms should consider prior to attempting ownership of the intermediary as a means to accomplish the product market commitment they seek. A similar description of the boundaries firms at- tempting administered or contractual vertical arrangements can expect to encounter does not exist. Questions exist re— garding the restrictions which a firm might legally utilize to develop reseller confidence or cooperation in marketing programs. Scope of the problem The government has sought to protect the competitive process from the effects of economic concentration of power. 1 2 In addition, in certain instances, that policy has been in— terpreted as protecting competitors. To accomplish the government's objectives legislation has been passed with the intent to protect either the competitive system or a com— petitor. The strategic channel mechanisms which have been described, could have a tremendous impact on the competitive system or on an individual competitor. For this reason, much of the antitrust legislation in this country has direct bearing on these control strategies. Legislation which can be considered as having an effect on strategic planning of vertical marketing systems would be the Sherman Act (1890), Clayton Act (1914), Fed— eral Trade Commission Act (1914), Robinson—Patman Act (1936), Miller Tydings Act (1937), and the Anti—Merger Act (1952). These Federal laws have an impact on many direct and indirect strategic actions which the distribution planner might con— template. Background As the search for differential advantage and competi— tive efficiency has intensified in recent years, the impor- tance of the distribution process as a controllable manage— ment tool has increased. The distribution process operates to solve the problem of matching homogeneous supply for the 3 manufacturer and heterogeneous demand at the consumer level. The application of the systems concept to the dis— tribution of goods and services led to the development of the physical distribution concept. Recent refinements of this theory on a micro basis have led many distribution chan— nels to adopt the theory of the vertical marketing system. The vertical marketing system offers increased efficiency and control for the manufacturer. Bowersox and McCarthy de- fine the vertical marketing system as "one in which both the manufacturer and the middleman (or middlemen) have made a commitment to jointly provide something to some target market." Strategies may be defined as "top management deci— sions regarding corporate mission or commitment - that is what markets the firm is going to try to serve and what will be offered to gain a differential advantage." McCammon points out that planned vertical marketing systems "are rationalized and capital—intensive networks de— signed to achieve technological, managerial and promotional economies through the integration and synchronization of mar- keting flows from point of production to points of ultimate lW. Alderson, Marketing Behavior and Executive Action 195-227 (I957). 2D. Bowersox and E. J. McCarthy, Strategic Develop- ment of Planned Vertical Marketing Systems in Vertical Marketing Systems 58 (L. Bucklin ed. 1970). 3 _I_d. at 52. 4 use."4 He classifies planned vertical marketing systems into three basic types. These three types are corporate, contractual, and administered systems. According to McCammon corporate systems "achieve operating economies and market impact by combining successive stages of production and dis— tribution under a single ownership."5 The key distinction between corporate systems and administered and contractual systems is one of ownership. Administered and contractual systems are composed of business units independently owned, but operated to achieve a collectively defined goal. Administered systems are the least structure form of planned vertical marketing systems. They rely upon a single or limited number of members of the distribution channel to coordinate the programs developed for the channel. The direc— tion and coordination of the marketing activities of an ad— ministered system can come from either the manufacturer or a strong reseller. For these reasons administered systems are usually considered to be the most complex and difficult or— ganizational form of planned vertical marketing systems to study.6 The third form of planned vertical marketing systems is the contractual system. These systems are formed when independent firms at various levels in the distribution 4B. McCammon, Perspective for Distribution Program— ming in Vertical Marketing Systems 43 (L. Bucklin ed. 1970). 5I_d_. at 45. 6E. 5 channel integrate their marketing programs on a contractual basis in hopes of attaining economies and market impact which separately could not be-achieved. There are three forms of contractual systems according to McCammon. These principle forms are the voluntary, cooperative and franchise form of systems. He points out that contractual systems accounted for approximately 118 billion dollars of aggregate sales in 1967, comprising the most significant form of vertical marketing system measured in dollar sales.7 The planned vertical marketing system as described by Bowersox and McCarthy would include all three basic types of distribution systems described by McCammon, provided, how— ever, that a product market commitment existed in all the systems.8 They suggest that for strategic purposes, firms should utilize planned vertical marketing systems. This strategic decision will allow the channel system to reach peak performance in a shorter time period and at lower cost than could be expected from normal evolutionary development of the channel.9 Questions of efficiency and measurements of that factor have been undertaken by many individuals. Whether absolute measures of efficiency will ever be possible is questionable because of the complexity of the systems under 7g. at 46. 8E. J. McCarthy, Basic Marketing 488 (4th ed. 1971). Bowersox and McCarthy, supra note 2, at 55. 6 study. Baligh and Richartz suggest that dynamic studies will be necessary to answer these questions directly because "vertical market structures are dynamic, slef—adaptive, goal changing, and learning systems. They are in effect, of the highest order of development in terms of general system complexity and capacity. Determination of absolute economic efficiency may be very difficult, but there are other meas- ures of efficiency.10 The capacity to achieve goals or to implement programs with greater speed or effectiveness than competing systems, all other factors equal, would establish temporal advantage in the marketplace at a minimum. Thus, efficiency of the vertical marketing system, though not measurable in dollars, in many instances, may be measured through increased effectiveness of strategic programs or through some temporal advantage, both of which lead toward establishing differential advantage in the marketplace. The firm might develop a strategic program around a vertical marketing system for two basic reasons. The first would be as a means of more effective control, coordination and utilization of member intermediaries in maintaining a present or "core" market. A second rationale for the desire to develop a strategic program around a vertical marketing system would be the attempt to secure new or "fringe" mar— kets or customers. 10H. Baligh and L. Richartz, Vertical Market Struc- tures 233 II967). 11 Alderson, supra note 1 at 56. 7 The strategic use of vertical marketing systems is a logical extension of the power—seeking activity of members within a distribution channel. Because vertical relation- ships of the distribution channel which are removed from the actual consumer market, many classical economic concepts tend not to operate. Scholars examining channel behavior recognized this phenomena many years ago. Joseph C. Pala— mountain, Jr. said "It is apparent that a principal factor differentiating vertical conflicts from horizontal and in— tertype competition is that it is so directly a power con— flict." He further went on to describe the logic behind the increasing use of vertical integration when he said: The very essence of the newer marketing media is their integration of a series of market func— tions which formerly were executed from both ends of the distributive chain. Both manufacturers and retailers have acted on the premise that distribu— tion is a process, and have organized it as such, much in the manner that different phases of the manufacturing process are more and more conducted under integrated control and organization. The conflict created in the vertical relationships may be resolved in a number of ways. Economic interaction alone may determine the resolution of many conflicts. Other conflicts may only be resolved through coercion or the use of force. Palamountain described the most potent form of force in a vertical relationship as the boycott. 12J. Palamountain, The Politics of Distribution 52 (1955). 13Id. at 53. 8 Certainly the most efficient means for resolving the conflict would occur through the process of negotiation. Alderson points out that "Negotiation is a manifestation of competitive articulation or of the effort of various partici- pants in a process such as marketing to organize the process to their own advantage."14 The sharpest conflicts often de- velop among those who feel obliged to cooperate with each other. While accepting this common necessity, each may in— sist that the cooperation be carried on in terms which suit his own convenience. Negotiation enter as a means of sol— ving these conflicts.15 Alderson also points out that "nego— tiation may be regarded as a strategic aspect of business, since it is an attempt to restore balance in the action sys- tem as a whole."16 Through this logic it may be seen that conflict in the vertical marketing system may be resolved through the strategic process of negotiation, where mutual understanding is developed and a common goal is defined as the objective. It should be apparent that the amount of conflict in a corporate vertical marketing system should be lower than in administered or contractual systems since the corporate system should have well defined consistent objectives. This is not always the case, but does remove many corporate 14Id. at 52. 15Alderson, supra note 1, at 134. 16E. 9 systems from conflict resolution activities, particularly the negotiation problem as it has been described. There exist a number of strategic factors which firms utilizing or developing administered or contractual marketing systems might choose as strategic variables to control other members of the system. Certainly, most variables in the mar- keting mix could, under certain circumstances, be used as control techniques. One possible description of the key ne- gotiation or control variables is offered by McCammon. He includes three fundamental groupsings: (1) price concessions, (2) financial assistance, and (3) protective provisions in his framework.l7 Price concessions would include direct alterations in the price paid or indirect alterations via expense reduc- ing factors. McCammon's complete list of "Price Concessions" includes:18 A. Discount Structure: 1) Trade (functional) discounts 2) Quantity discounts 3) Cash discounts 4) Anticipation allowances 5) Free goods 6) Prepaid freight 7) New product, display, and advertising allow— ances (without performance requirements) 8) Seasonal discounts 9) Mixed carload privilege 10) Drop shipping privilege 11) Trade deals AAA/\AAA AAAA l7McCammon, supra note 4, at 33-37. 18E. at 36. 10 B. Discount Substitutes: (12) Display materials (13) Premarked merchandise (14) Inventory control programs (15) Catalogs and sales promotion literature (16) Training programs (17) Shelf—stocking programs (18) Advertising matrices (19) Management consulting services (20) Merchandising programs (21) Sales "spiffs" (22) Technical assistance (23) Payment of sales personnel and demonstrator salaries (24) Promotional and advertising allowances (with performance requirements) The second major category of strategic control mech— anisms are financial pricing programs aimed at financing the channel member's inventory, assisting intermediary capital- ization or creating larger field inventories. A complete list of Financial Assistance variables would include:19 A. Conventional Lending Arrangements: (25) Term loans (26) Inventory floor plans (27) Notes payable financing (28) Accounts payable financing (29) Installment financing of fixtures and equipment (30) Lease and note guarantee programs (31) Accounts receivable financing B. Extended Dating: (32) E.O.M. dating (33) Seasonal dating (34) R.O.G. dating (35) "Extra" dating (36) Post dating The third major form of control strategy, Protective Provisions, may be broken into three general areas; price protection, inventory protection, and territorial protection. 19E. at 36-37. 11 Each variable is designed to help protect channel members from risks associated with the business. A complete list of McCammon's protectiveprovisions would include:20 A. Price Protection: (37) Premarked merchandise (38) Fair trade (39) "Franchise" pricing (40) Agency agreements B. Inventory Protection: (41) Consignment selling (42) Memorandum selling (43) Liberal returns allowances (44) Rebate programs (45) Reorder guarantees (46) Guaranteed support of sales events (47) Maintenance of "spot" stocks and fast delivery C. Territorial Protection: (48) Selective distribution (49) Exclusive distribution The strategic factors described are not collectively exhaustive of all possible strategies which might be utilized by a strategic planner in a vertical marketing system, but they do represent a reasonable structure under which most strategic actions could be considered. Methodology The research will utilize the strategic structure as described by McCammon. Although this structure is certainly not the only set of key marketing system variables, it is a fairly thorough structure encompassing most of the major strategic considerations firms utilizing or establishing a vertical marketing system might consider. It is useful to Id. 12 the research in that it provides a structure within which the legal investigation can take place. In discussions with Dr. McCammon regarding his structure, it was found that the variables he identified were not defined in an operational way but rather are terms generally understood by trade inter— mediaries. Each variable will be briefly defined in the section relating to it. The definitional process is valuable as an academic activity but pragmatically may lose its value since the be- havior of the legal agencies involved in the study is inter- pretive; that is, behavior is analyzed and the law is applied in each individual situation, irrespective of labels or defi- nitions which are on strategic programs. The courts look at behavior in order to evaluate the variable and seldom define any of these variables, because to do so might limit the reach of the legislation. The framers of the various anti- trust 1aws allowed the wordings to be somewhat imprecise so that the most comprehensive inclusion could occur under in— terpretation by the courts and administrative agencies. The value of the operational definition is that it allows the distribution planners to interpret the legal en— vironment regarding each of the strategic variables. This action will permit planners to utilize the results of this research to avoid difficulty with the legal agencies, pro— vided no changes in interpretation occur. Each variable will be analyzed under a triple search l3 technique. First, the applicable Federal judicial case ma- terials relating to the variable will be analyzed to deter- mine the line of reasoning or boundaries which the courts have applied to the variable. The second phase of the search will be an analysis of the relevant hearings and decisions of the Federal Trade Commission pertaining to the variable. Finally, the opinion of the legal and scholarly community as found in sources such as the Harvard Law Review, Yale Law Journal, Michigan Law Review, MSU Business Topics, Business Horizons, and the Journal of Marketing will be analyzed to shed additional light on the boundaries or conditions which a firm considering the variable would deem important. Following the three phase search process, conclu- sions will be generated in an attempt to describe the present condition of the legal environment for each variable, and a graphic representation of the process will be developed. Limitations There are several limitations to the research pre- sented in this dissertation. Among the major limitations of the work are: l. The material presented will be descriptive in nature rather than predictive. The study will be current in terms of present case material but could be outdated at any time by a shift in philosophical position of the Court, Federal 14 Trade Commission or other organization of similar impact. 2. The research pertains only to planned vertical marketing systems of an administrative or con- tractual nature as defined in the Introduction and cannot be viewed as pertinent to other forms of distribution systems. 3. The structure utilized is not completely ex— haustive of vertical marketing system control strategies, and there may therefore, be situa- tions to which this research will not apply. 4. There is a great deal of historical information behind each court and administrative decision which could not be discussed due to limitations in time for both the reader and the researcher. 5. The author, being non—legal in academic back— ground, may have made errors in interpretations of legal principles or readings presented in the research. Contribution of the research During the past decade, the business community has become increasingly aware of vertical marketing systems as a means of increasing effectiveness at the market level. The implementation of a vertical marketing system requires a 15 21 The competitive commitment between the channel members. willingness of these members to commit themselves to the product market strategy can create legal difficulties for firms utilizing the strategy. The literature that exists regarding vertical mar- keting systems, particularly Vertical Marketing Systems ed- ited by Louis P. Bucklin, contain little or no mention of the potential legal difficulties with which a firm utilizing or establishing a vertical marketing system might contend. The information to develop the environmental structure is presently available primarily in legal publications and doc— uments, and therefore, not generally accessible to the busi— ness community. This research, subject to the limitations previously mentioned, will hopefully develop some insight into the legal environment within which the firm must operate. The overall contribution of the research will hopefully be to increase the business community's awareness of the increas— ingly important role which the legal environment plays in strategic planning of vertical marketing systems. Order of presentation The first chapter is the introduction to the study. Chapter II, "Price Concessions as Strategic Variables" ex— amines the legal factors surrounding pricing decisions Bowersox and McCarthy, supra note 2, at 59. 16 within a vertical marketing system context, and draws con- clusions about the present environment for various pricing actions. Chapter III, "Financial Assistance Activities as Strategic Variables,l examines the legal questions regard— ing the use of financial assistance programs in vertical marketing systems. Chapter III ends with conclusions re— garding the present legal environment as it relates to fi- nancial assistance as a management tool. Chapter IV, "Pro— tective Provisions as Strategic Variables,l evaluates the legal questions regarding protective provisions and draws conclusions regarding the current "state of the law" in the area. Chapter V, "Summary and Conclusions, describes the results of the research in general, and any conclusions of general interest regarding the various aspects of legal significance associated with vertical marketing systems. .1. CHAPTER II PRICE CONCESSIONS AS STRATEGIC VARIABLES Introduction One of the primary means the developer of a Vertical Marketing System has at his disposal when establishing con- trol strategies is the immediately felt variable of price adjustment. Price adjustments allow a firm to reward or dis- courage members of a channel for the adherence to channel goals which have been previously established. Price advantages which a manufacturer might offer to a member of the distribution channel would fall into two major categories; direct discounts or discount substitutes. Alteration of the discount structure through activities such as prepaid freight, trade or functional discounts, quantity discounts, cash discounts, seasonal discounts, etc., have a direct effect on the cost of goods sold. Discount substitutes are also desirable for strate— gic purposes. Examples of substitutes which might be util— ized by the distribution planner would include display ma- terials, inventory control programs, payment of demonstrator lMcCamon, "Perspectives for Distribution Program- ming" in Vertical Marketing Systems 37 (L. Bucklin ed. 1970). 17 l8 salaries, sponsorship of training programs, furnishing cata— logs and sales promotion literature and many others. Dis— count substitutes do not affect the channel member's cost of goods sold as do the discount items, but do act to alter ex- pense items, thereby having the same effect on profits. Price concessions which would be utilized by a manu— facturer to obtain cooperation from channel members can be an extremely important tool in the continuing effort to gen- erate and maintain channel continuity. The use or misuse of price concessions creates a body of legal inquiry centering around the area of price discrimination. Price discrimination legislation originally was based on Section 2 of the Clayton Act which stated: That it shall be unlawful for any person engaged in commerce, in the course of such commerce, either directly or indirectly; to discriminate in price be- tween different purchasers of commodities, which com— modities are sold for use, consumption or resale . . . where the effect of such discrimination may be to substantially lessen competition or tend to create a monopoly in any line of commerce: provided, that nothing herein contained shall prevent discrimina— tion in price between purchasers of commodities on account of differences in the grade, quality, or quantity of the commodity sold, or that makes only due allowances for difference in the cost of selling or transportation, or discrimination in price in the same or different commodities made in good faith to meet competition . . . In its original wording the law makers left a loop— hole in the statement "on account of differences in the quantity of the commodity sold." Nearly all business trans- actions occur with variations in quantities sold. Only cases directed at "first line" competition (at the suppliers level) 19 were brought under this provision so that by 1929 when the Supreme Court said other levels of competition were affected by the provision, the statute was considered a dead issue. In 1936 Congress passed the Robinson—Patman Act, a bill designed to strengthen price discrimination legisla— tion primarily aimed at large chain buyers who received sub— stantial price reductions through their economic power. The Robinson—Patman Act replaced section 2 of the Clayton Act and focused on practices other than low prices charged by a manufacturer on a local basis to exclude competitors from markets. Now, large buyers at the retail level were no longer able to secure an advantage over the smaller competitor by using buying power pressure to gain discounts not available to other buyers. A summary of the provisions of the Act follows: Section 2(a) embodies the Act's basic prohibition, forbid- ding sellers to discriminate in price between customers en- gaged in interstate commerce unless a seller can show that a price difference resulted from the lower costs of doing business with a particular customer, or that market condi— tions had changed creating a change in the value of the merchandise. Section 2(b) provides a third defense - that the price dif— ferential was granted in good faith to meet the price of a competitor. Section 2(c) forbids the granting or receiption of a broker- age payment by a buyer or his agent. Sections 2(d) and 2(e) respectively forbid the granting of discriminatory allowances or payments for promotional ser— vices or facilities furnished by the customer, and the dis— criminatory furnishing of promotional service of facilities to a customer. 20 Section 2(f) is aimed at powerful buyers, and prohibits a knowing reception by a buyer of a discriminatory price for— bidden by Section 2(a). Section 3 of the Robinson—Patman Act, which is an indepen— dent enactment makes it a criminal offense for a seller to charge different prices or unreasonably low prices for his products in different geographic areas "for the purpose of destroying competition or eliminating a competitor." It also declares it a criminal offense "to be a party to or assist in" enumerated discriminatory treatment of competing buyers. Defenses To Price Discrimination Actions Under the provisions of the Act certain defenses are allowed for actions taken. These may be defined in three broad categories: (a) meeting competition, (b) changing mar- ket conditions, (c) cost justification. Enforcement of the price discrimination legislation takes place in two general forms. The first deals with pri— vate civil actions seeking to reclaim damages suffered as a result of primary competition (horizontal in nature) or sec- ondary competition (between vertical levels in the distribu- tion system). The Federal Trade Commission may also initi— ate actions dealing with discrimination at all levels within the distribution structure. Discrimination cases are diffi— cult to analyze because private suits often fail when "dam- ages" cannot be established even though discrimination clearly exists. The Federal Trade Commission allows for the most complete coverage of the provisions because the Commission need not establish damages to win its action. Other laws also infringe on the clear determination of price discrimination situations. The Sherman Act, which _.1 1 21 prohibits contracts, combinations, or conspiracies, in re- straint of trade or attempts at monopoly or combination, may be used under practices condemned by Sections 2(a), 2(b), 2(d), or 2(e) of the Clayton Act. The Federal Trade Commis- sion Act also prohibits unlawful or unfair methods of com- petition and therefore may apply as well as Section 3 of the Robinson—Patman Act which establishes the criminal portion of the statute. The laws operating in the price discrimination area are the Sherman Act, Clayton Act, Robinson—Patman Act (Sec- tion 2), and the Federal Trade Commission Act. Under present judicial interpretations there are a number of initial tests to establish a price discrimination situation. The courts (or Commission) will attempt to deter- mine if sales have taken place between two sellers at com— petitive levels or whose customers are in competition. Sec- ondly, the period of time of the sale is used to determine whether the sale meets the test of a contemporaneous trans— action. Next, there will be an examination to determine if the goods are of like grade and quality under the evolved definition of that characteristic. Finally, there needs to be proof that the sales in question occurred in interstate commerce. If all the previous conditions can be shown, a prima facie or "on the face of it" case of discrimination exists and the responsibility of proving the discrimination to be justi— fied rests on the person granting the discriminatory price. 22 An additional condition necessary for a Section 2(a) case is the test of competitive injury. This is not neces— sary in cases involving Sections 2(c), 2(d), or 2(e) as these sections prohibit all discriminations, not just injurious ones. The burden of proof of charges which are brought under Clayton Act prohibitions is on the grantor of the dis- criminatory price. Thus a firm that chooses to discriminate in price between buyers, in the presence of proof that dis- crimination has occurred, is then obliged to prove that dis— crimination was allowable under one of the three defenses available. 'Meeting competition" defense The "meeting competition defense has been rather strictly interpreted by the courts such that meeting compe— tition means matching or just equalling the price of the com— petitor. An acceptable defense under the "meeting competi— tion" framework was discussed by the Supreme Court, in re- jecting a Federal Trade Commission decision, when they said that a complete defense under provisions of the Robinson— Patman Act would be the proof that a lower price charged to a customer was made to meet an equally low price offer of a competitor, whether or not injury to competition was the re— sult. The Court explained that to allow otherwise would tie the hands of the competitive system and prevent a firm from protecting its customer markets from predatory price cutting 23 by competitors.2 A further View of this defense occurred when a firm "beat" the lower price of a competitor. In a situation where identical requirements contracts were being granted on a sealed bid basis, the bidder had been léd to believe that its competitor would bid a certain low price. The competitors actually bid a higher price. The defense was allowed because the firm had been acting in good faith to meet what it had been led to believe was the competi— tor's bid.3 Low prices offered to prospective customers which are designed to beat their present suppliers prices are al— lowable, since, if they were not allowed, once a firm had a relationship established, barring other factors, future price competition would be stifled.4 The meeting competition defense can be used to jus— tify price discrimination in meeting equally low competitor prices. It is the practice of the courts to review each lowered price on a situational rather than systematic basis; that is, lower prices which might harm competitors must be reactionary rather than anticipatory. 2Standard Oil v. F.T.C., 34o U.S. 231 (1951). 3Beatrice Foods Co. v. F.T.C., 1966 Trade Cases para 71,733 (D.C. Cir. 1966). 4Sunshine Biscuit v. F.T.C., 306 F.2d 48 (7th Cir. 1962). | E J 24 “Changing market conditions" defense Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act expressly exempts from violation price changes which are made periodically to account for changing conditions in the market, or as a result of such conditions as spoilage or deterioration of periShable commodities, or obsolescence of seasonal goods, or distress sales under court surveillance, or sales for going out of business. Generally accepted fluctuations in sales rates which are normal parts of an industry's pattern of operation can— not be used as justification for a "changing market" defense. The additional discounts granted to auto retailers in the fall of the year have been upheld because of the depreciation which these products encounter if they are held past new model in- troduction.5 In addition, units of a past selling season need not be offered to all retailers on an equal basis. Discriminatory prices offered to sellers of shower curtains were not allowable under a "slow moving" defense be- cause the mere "slow movement," as distinguished from "pro— nounced and serious deterioration or alteration in the mar— ket conditions," was not enough defense, under the present 6 interpretation of the F.T.C. The Commission seems to have taken a harder line in determination of these cases than the courts. 5Valley Plymouth v. Studebaker—Packard Corp. 219 F. Supp. 608 (S.D. Cal. 1963). 6Joseph H. Kaplan & Sons, 347 F.2d 785 (D.C. Cir. 1965). 25 Finally, discounts continued for extended periods of time, and discounts offered on a regularly recurring basis do not qualify for exemption under the changing conditions defense,7 although price reductions which are made in response to a general loss of sales have been found to be reasonable under the changing market defense. In twenty—five discrimination cases under Section 2(a) within the automotive after—market the changing market conditions defense was not offered once, leading to the con- clusion that it is a defense which is useful only when mar— ket conditions become substantially different than normal. "Cost justification" defense Cost justification can be used as a defense in price discrimination cases only in cases where Section 2(a) is in— volved. The Clayton Act states that a price differential be— tween two purchasers is not unlawful under the statute if it is designed to reflect differences in the cost of manufacture, sale, or delivery resulting from the differing methods or quantities in which such commodities are to such purchasers sold or delivered. Under this situation, discounts based upon actual 7D & N Auto Parts Co., 55 F.T.C. 1279 (1959). 8Balian Ice Cream Co., Inc. v. Arden Farms Co. 231 F.2d 356 (9th Cir. 1955). 9 S. Nelson, An Economic Analysis of Industry Prac- tices and Anti—Trust Po icy in e u 0 ar 5 n us ry, 26 direct cost savings for freight, packaging, etc., may legally be reflected in the discount structure by granting lower prices unless the categories established preclude a great number of competitors. Again, in any action under Section 2(a) of the Clay— ton Act, once a harmful discrimination has been proven, the rationale for the practice becomes the defense if one of the 10 three defenses can be established. The burden of proof, therefore, rests on the part of the firm charged with the . . . . 11 discrimination. Since customer classes can be important strategically to the firm when developing marketing plans, it is also im— portant to evaluate cost justification with respect to these groups. In the "Advisory Committee on Cost Justification, Report to the Federal Trade Commission,I general accounting principles are developed for firms seeking to utilize the cost justification defense. Allocation of the fixed costs of preparing the gen- eral sales catalog across all purchasers equally has been held to be reasonable since the catalog would be necessary 10Ronald M. Copeland, Accounting strategies for De- fenses of Discriminatory Pricing Under the Robinson—Patman Act, 1966 (unpublished dissertation in the Michigan State University Library) at 114-15. An analysis of cost justi- fication actions points out that the cost justification de— fense may be effective in blocking a price discrimination action. llF.T.C. v. Morton Salt Co., 334 U.S. 37 (1948). 27 for all purchasers regardless of volume,12 while variable costs could reasonably be related to sales volume. Allowable cost justifications have been obtained in cases where delivery costs were identifiably greater13 or where geographical factors led to differentials in the cost of serving the customers. Sellers of private labeled goods also must consider the function of the Robinson—Patman Act. The interpretation of the requirement that products be of like grade and quality is one of the most contested points of antitrust law. In both the Borden case and a similar case involving whiskey sales in Florida, the Courts have held that labeling is of no significance in establishing price discounts. The only allowable test is of chemical and physical properties of a product. In the Hartley Parker case the attorney argued "Four Roses by any other name still swills the same."15 The general conclusions regarding cost justification defenses may be summarized by saying that except for direct costs of primarily sale or delivery, little latitude is 12F.T.C. v. Standard Motor Products, Inc., 371 F.2d 613. l3Nachman v. Shell Oil Company, Inc. 1944-1945 Trade Cases para. 57,631. 4National Nut Company of California v. Kelling Nut Co. 1944—1945 Trade Cases para. 57,405. 15F.T.C. v. Borden, 383 U.S. 637 (1965) and Hartley- Parker, Inc. v. Florida Beverage, 307 F.2d 916 (5th Cir. 1962). -14, 1 :lgnkinnn-L éznngunjlg igflnnn, ha resin. l” : 4'21,» Pan §A hijf 28 granted or accepted by the F.T.C. for price discrimination defense. An identifiable long run costing system, of the type suggested by distribution cost and revenue theorists, appears to be the best chance which a firm has in using cost justification as the means of justifying price differentials amongst different purchasers, channels, territories, or pri— vate labeled products. Discount Structure The following variables comprise the collection of strategic price discounts which may be utilized in a VMS. These variables will have a direct effect upon the price which a buyer will pay. Trade (functional) discounts Functional discounts are a general category of dis— counts from list price given for the performance of specific activities within a distribution channel. Historically func— tional discounts were based on how individuals resold the product in question. This system resulted in discounts based upon predominantly institutional definitions such as wholesaler and retailer. As long as customer classes are clear, distinct and well defined, there is little difficulty in justifying discounts given different intermediaries based upon activities which they perform. The difficulty in inter- preting functional discounts has arisen as distribution sys— tems have become more complex, overlapping (from a functional standpoint) and more integrated. Pfii‘f-T '- A '...' .- "-'r .asirojr'nszi .eI-‘x: ' .' . ' '..- 3.59mi; l '2‘ .551 915v 29 Functional discounts need not be directly tied to justifiable differences in the cost of dealing, as is the case with quantity discounts, because they do not deal with direct competitive injury, but rather with allowances for the performance of functions which may be difficult to quan- tify in absolute terms. The most important rule with respect to functional discounts deals with the behavior of the reseller and the level of competition involved. If a wholesaler is in com— petition at the retail level, that is, competing with retail— ers for dollar sales, his discount will be determined as equivalent to the discount granted the retailer. In Advisory Opinion No. 202 (1968), the Federal Trade Commission has said: The controlling element in your problem, however, as in similar problems arising under the amended Clay- ton Act, is whether or not resale competition actually exists as between and among these various resellers rather than the names they use to describe themselves. If in fact a so-called wholesaler competes with a so— called jobber in the redistribution of goods, the dif- ference in namef6is of no consequence; the fact of the competition is. The prerequisite of competitive injury has been im- portant in the determination of many complaints. Where two separate buyers were involved in the purchase of the same product for different trade channels, one as an industrial component part and the other as a retail service part, the Court said differing discounts were not incorrect since 16Advisory Opinion, No. 202 73 F.T.C. 1314 (1968). uvljifieqmou Ell --.-'--': 'roldw afield-mu] 30 s:rr:r.u'~u=".9q all: 1- ., ”it: 30 there was no competitive buying between competitors or cus- tomers of the firm as a result of the discount structure.l7 An automotive replacement parts manufacturer was ordered to cease its pricing practice of selling at lower prices to the manufacturer as original equipment, than to its own distributors, because the car manufacturer resold the parts to its franchised dealers at prices which the parts distributors could not compete with.18 In the Doubleday case, the Federal Trade Commission considered the problems of a dual distribution system in conjunction with integrated ownership of one channel. The distribution of gooks was accomplished through retail book— sellers, some privately owned by the company, and through book clubs, one of which was owned by the company. The ques- tion involved was whether the two distribution formats were in competition. Lower prices were allowed on book club se- lections while normal publisher's editions of the same book were under "fair trade" price maintenance. In addition, three extremely large customers received a larger functional discount (46%) than other competitors doing business at the same competing level (40%). The Commission found that the differing functional discounts given in the Doubleday case were allowable since 7Minneapolis Honeywell Regulator Co. V. F.T.C., 344 U.S. 206 (1952). 18Thompson Products, Inc., 55 F.T.C. 1252 (1959). 31 they increased the market acceptance levels of the product. In that decision the Commission described the problems as— sociated with analysis of intermediaries when they said: Wholesalers and retailers no longer comprised clean cut separate links between the producer and the ultimate consumer, each responsible for a clearly defined set of duties. Marketing functions became scrambled, with many permutations and Combinations. Many jobbers and brokers contributed genuine and important services, through assuming only a part of the traditional full time wholesaler's job . . . . Manu— facturers created their own outlets. Retailers inte- grated into wholesaling, and wholesaling into retail— ing, either by outright ownership or by COOperative arrangements. The number of patterns was legion and diverse. This proliferation of modern marketing meth- ods defigs definition neat nomenclautre or descriptive labels. The Commission then described the method of estab— lishing discounts based upon functional performance by say- ing: In our View, to relate functional discounts solely to the purchaser's methods of resale without recogni- tion of his buying function thwarts competition and efficiency in marketing, and inevitably leads to higher consumer prices. It is possible, for example, for a seller to shift to customers a number of distributional functions which the seller himself ordinarily performs. Such functions ghould, in our opinion, be recognized and reimbursed. The Commission described the test of the discounts reason— ableness as: Only to the extent that a buyer actually performs certain functions, assuming all the risks and costs involved, should he qualify for a compensating discount. 1952 F.T.C. 169, 208 (1956). 2052 F.T.C. 169, 209 (1956). 32 The amount of the discount should be reasonably re- lated to the expenses assumed by the buyer. This viewpoint has been essentially overruled by the decision in the General Foods case where the Commission again considered the problem of the functional discount granted in situations where various distributional roles were assumed in the channel. In that case General Food's system of distributing institutionally packaged goods and consumer packaged goods came under scrutiny. The company distributed its institutional products through Institution Contract Wagon Distributors (ICWD), conventional wholesalers dealing in institutional as well as consumer goods, and wholesalers dealing exclusively in institutional goods. During the five year period examined by the F.T.C. the sales volume for ICWD customers increased 645.7 per cent while sales through non-ICWD wholesalers de- clined 13.7 per cent, a decline which the commission attri— buted to the ability of the ICWD to grant lower prices be- cause of greater discounts which they received. These dis- counts amounted to additional discounts below the conventional wholesale price list of two cents per pound on coffee and 10 per cent on all commodities, and were given payment for performance of services which were not generally provided by wholesalers. The Commission finding points out that since ICWD and conventional wholesalers were in direct competition, the 211d. 33 discounts offered to both should be identical. The Commis— sion did not dispute a similar payment given for delivery from ICWD or wholesaler stock to direct buying large accounts. The chief contention was the problem of discriminatory dis_ counts given over goods which had been purchased by private intermediaries for resale purposes. The confusion which General Foods created was dis- cussed in the Yale Law Journal as a potential form of dis- couragement to firms interested in trying new distribution systems (such as the ICWD). The comment pointed out: Apply all of section 2(d)'s requirements as con— strued in prior cases can be justified only by a de— sire to insulate distributors from the challenge of new methods of distribution. These requirements would invalidate nearly all service functional discounts, and certainly all those offered for new services. If a producer is required to grant functional discounts to distributors who can perform new and valuable ser— vices and equally to those who cannot perform, he is hardly likely to adopt a method of distributiga, how- ever efficient, based on that service The Federal Trade Commission and the courts should not interpret General Foods as overruling Doubleday, for only by reconciling the two cases can vertical integration among distributors be encouraged where it promotes efficiency. The middle ground, granting service functional discounts a pro- tected status under Section 2(a), provided some of the con— ditions of 2(d) are met, is in itself sound. However, the prohibitions of Section 2(d) should not be rigidly adhered 2‘2Note, Robinson—Patman Curtailment on Distribution Innovation: A Status Sought for Functional Discounts, 66 Yale L.J. 243 (1956). 34 to in applying the General Foods holding to future 2(a) cases involving genuine innovations in distribution.23 The matter of functional discounts has been fairly well resolved by General Foods and a more recent Federal Trade Commission decision in Chemical Associates, Inc. in which the Commission reaffirmed the rules of General Foods and Standard Oil by saying it is prohibited to: . . . discriminate directly or indirectly in the price of any merchandise of like grade and quality by selling to any purchaser at net prices higher than the net prices charged any other purchaser who com- petes in the resale or distribution of such products with the purchaser paying the higher price, this argu— ment notwithstanding other justifiable disggunts in the cost of manufacturer sale or delivery. The decision points out the exact same conditions with respect to the terms or conditions of sale at the pur— chaser level; a point to be considered in depth elsewhere. The great difficulty for the vertical marketing sys— tem planner arises when considering the indirect purchaser doctrine. The doctrine, and the decisions based thereon, have looked at control as the key element in determining whether a transaction is one made under the indirect purchaser doctrine. A long line of cases has developed the point that ownership of the wholesaler and retailer by one individual 23 66 Yale L.J. 255—56 (1956—1957). 24Chemical Associates, Inc., 77 F.T.C. 1512—13 (1970). 253., 1513. 35 will disallow a wholesale discount because the competitive resale level is the price to be considered in evaluating discriminatory situations. In the situation where the manufacturer extends con— trol through the channel, not by ownership, but through be— havior, such as operating a sales force at the retail level, maintaining rigid wholesale price control through fair trade mechanisms, or approving of wholesalers to whom distributors may sell, the determination is less clearcut. This practice could possibly be interpreted to be in violation of the Sher— man Act or Section 5 of the Federal Trade Commission Act and has made the indirect purchaser doctrine applicable without ownership. The doctrine points out: Where the prices to be charged the indirect pur— chaser are effectively established by the manufac— turer, and where virtually all the conditions and terms upon which the sale is to be consummated are fixed by the manufacturer or are subject to its ap- proval, the predicate for finding that the indirect purchaser is a purchaser from the manufacturer has been constructed. Other factors to be considered in arriving at the conclusion are instances of direct contact between the indirect purchaser and the manu- facturer, such as direct solicitation of orders by the manufacturer's salesmen even though the orders filled by the intermediary for payment, direct nego— tiations for changes in price, direct policing of the indirect purchaser's resale prices, direct pro- vision of advertising materials, and inspection by the manufacturer to insure that the direct purchaser is fulfilling the terms of its agreemeag with the manufacturer's distributor wholesaler. The automotive jobbers and distributors have been the focus of a great deal of attention on this issue, and it 26Purolator Products, Inc. V. F.T.C., 352 F.2d 874, 881 (7th Cir. 1965). nniiaudil ad: a! find .cjjirsnvo {d inn (lard-r1 and uptoafiJ 10:3 36 appears that recent commission rulings have begun to clear up many of the uncertainties that exist with regard to func- tional discounts. In the National Parts Warehouse case, individual job— bers who had formed a buying organization turned back their stock in the company and received long term promissory notes in the company, the interest and principal of which are pay- able only out of wholesaler profits. Due to low margins in that industry it is likely that the return to note holders may be as great as it was to stockholders. The key issue which led to the situation was the problem of ownership amounting to control, therefore making the functional discount unavailable to the wholesaler because of retail selling under the indirect purchaser doctrine. The indirect purchaser doctrine has found support at the Supreme Court level in the Purolator case in which an automotive aftermarket parts manufacturer was found guilty of discriminating by selling to warehouse distributors with branches at lower prices than it sold to similar competitive WD's who did not have branches. The Justice Department filed a memorandum as stating that the indirect purchaser doctrine was not meant for comparing customers at different distribu- tion levels. The argument presented was based on the language supporting functional discounts in Doubleday. The Supreme 27National Parts Warehouse V. F.T.C., 346 F.2d 311 (7th Cir. 1965). 37 Court, in refusing to review the case as appealed by Puro— lator, essentially rejected the argument of the Justice De— partment. The element of most critical importance to the VMS planner becomes control, as it is utilized at various func- tional levels. Firms exercising control over intermediaries will be found in violation of the Robinson—Patman Act under the current viewpoint of the indirect purchaser doctrine. The only way to justify discounts under the present status of interpretation would be through actual agency contracts with integrated intermediaries which specify payments for specific functional activities performed by these individuals such as warehousing or selling. When dealing with buyers who operate at more than one level, the manufacturer may justify the granting of functional discounts on that proportion of sales which represents non- retail sales. By requiring a statement of volumes sold at retail and at wholesale, the manufacturer can reasonably al- low the functional discount on non-retail sales volume. Quantity discounts Quantity discounts are discounts from list price granted for purchasing specified quantities of a good. Quan— tity discounts, of both cumulative and non—cumulative nature have been a prime consideration of firms, administrative agencies, and the courts since the Clayton Act (1914) included 28purolator Products v. F.T.C., 389 U.S. 1045 (1966). 50 isolate an! *5nui anotusv 51 fissiliiu at J} rm .1 trues asmouad Isnnslq r—zwnzhnms-ini - r--.~-;.--r.._-. -. 'r .. r-srr‘.I::.t I l' 38 the provision "on account of differences in . . . quantity," hereby opening the way for quantity discount programs devel- oped by many firms. When the Robinson-Patman Act amended Section 2 of the Clayton Act in 1936, the "quantity" proviso was deleted, allowing discounts to be based only on justifi- able grounds of cost saving, competitive conditions, or chang— ing market conditions. One of the most basic problems in quantity discount determination revolves around aggregated purchases of a sin— gle buyer, such as a chain, for purposes of determining the discount which should apply. A chocolate manufacturer al— lowed a drug chain to aggregate annual purchases for discount class determination, against similarly sized independent out- lets, and received discounts of up to 10 per cent additional on sales volume,29 which were violative of the Act. Similar situations, where department stores have ag— gregated purchases at all branches for billing purposes, but have received separate sales calls and deliveries have been found in violation of the Act.30 A manufacturer who operated a cumulative discount program which allowed pooling of volumes for multi-plant cus- tomers was found in Violation because the volume discounts were available only to approximately 1 per cent of the cus— tomers and many of the separate plants used as much as 29Pangburn Co., Inc., 56 F.T.C. 57 (1960). 30James Lees and Sons Co., 59 F.T.C. 418 (1961). 39 members of the multi—plant firm, but were unable to take advantage of the discount.31 The establishment of quantity discount categories can be difficult, as was found in the Morton Salt case.32 An interesting version of the competitive problem in cate- gory determination occurred in Callaway Mills v. F.T.C. Be— cause Callaway had a line which was less complete than a competitors, the quantities necessary for various discounts were lowered to allow for the same impact at the market level as the quantity discounts given (on a relative percentage basis) to buyers of the limited line.33 An entire group of cases revolving around quantity discounts deals with sales of automotive parts in the auto— motive aftermarket. They originate in the early fifties with organizations of automotive jobbers who formed buying organ- izations or COOperatives to gain the advantages of quantity discounts offered to large purchasers of replacement parts. The Federal Trade Commission in condemning this prac— tice looked to the actual behavior of the organization to determine whether the discounts were justified. In all the early cases (decided during the fifties) the Commission found drop shipments being made by manufacturers direct to member lAmerican Can Co. V. Bruces' Juices, Inc., 190 F.2d 73 (5th Cir. 1951). 32Morton Salt, 334 U.S. 37 (1948). 33Callaway Mills Co. v. F.T.C. 362 F.2d 435 (5th Cir. 1966). 40 jobbers, with the billing going to the buying group office in order that quantity discounts be based on cumulative pur— chases of all the members, rather than the individual volume generated by the separate jobbers. The Commission pointed out that since the discounts did not reflect actual saving to the manufacturer, they could not be cost justified and were therefore prohibited under the Robinson—Patman Act. In the "automotive parts" cases, the Commission laid down quite explicit rules forbidding the formation of buying groups as a means of aggregating purchases to qualify for vol— ume or quantity discounts. The problems created by not receiving quantity dis— counts led many firms to attempt to receive functional dis— counts as wholesale distributors supplying the individual job— bers. It was this action which led the Commission in the Whitaker Products case to conclude that contractual arrange- ments between wholesale distributors, authorized jobbers and the factory were extensions of control and that: . . . the degree of control exercised by respondent over sales to the wholesale distributor accounts was such that the sales were in all essential respects sales by respondent and that the wholesale distributors were, therefore, purchasers3£rom respondent within the meaning of the Clayton Act. Further evolution of the problem has led to the de- signing of quantity discounts in favor of functional dis— counts for buying cooperatives. The major test becomes the 34Whitaker Cable Corp. 51 F.T.C. 958, 972-73 (1955). 41 degree of ownership and control and the reality of functional performance. A variation of quantity discounts based upon an in- centive programs which tied the discount to increased per— centa e erformance over a revious ear's uarterl urchases P Y P was not allowed. The Commission in an advisory opinion pointed out that the discounts would not make due allowance for differences in cost of dealing because firms doing a small volume with a large percentage increase would receive a larger discount than a large volume buyer having only a small in— crease. A quantity discount plan proposed by Knoll Interna— tional, an office furniture manufacturer, was judged to be in Violation of the Act since it was a systematic plan of discrimination. In an attempt to meet competitive prices on bids for large purchases, Knoll proposed quantity discounts of: 10 - 20 pieces 5 per cent 21 — 49 pieces 7 per cent 50 pieces or more 10 per cent Knoll felt these discounts would allow their dealers to be more competitive in bidding on office contract jobs. In an advisory opinion, the Commission pointed out that the problem with the plan was that if it were universally 35Scott Publishing Co., F.T.C. Advisory Opinion No. 479, CCH Transfer Binder 1970—73 para. 20,196 (1973). 42 available to dealers all the time, it would be impossible to determine when the discounts were made to gain a bid job. If on the other hand, dealers could certify that the lower prices were necessary to get a particular contract, the dis- counts might be allowed under the meeting competition de— fense.36 To the vertical marketing system designer there are two apparent conclusions. The first is that cumulative dis— counts will receive a very thorough analysis by the Commis— sion, particularly if they are established to be available only to the very large customers such as in the classic Morton Salt case. If extremely limited availability is a condition of the discount program, or if the effect of the discounts may be to substantially lessen competition it is unlikely that the courts will allow the program. The second major conclusion deals with non—cumulative discounts. If a firm grants a non—cumulative quantity dis— count, it must be justifiable through cost savings (the cost justification defense) or be made in good faith to meet com— petition.37 Discount structures can be based on different volumes so long as the competitive impact is the same at the resale level. The third conclusion deals with the tendency to form 36Knoll International, Inc., Advisory Opinion C—l643, August 10, 1971. 37F.T.C. v. Morton Salt Co., 334 U.S. 37 (1948). 38Callaway Mills Co. v. F.T.C. 362 F.2d 435 (5th Cir. 1966). 43 integrated buying organizations to gain discounts. Buying organizations formulated to gain such quantity discounts for members will not be successful, unless certain functions are performed by the organization and the discounts which are received can be reasonably cost justified. Cash discounts Cash discounts, reductions from the list price of— fered for payment within a specified period, are another con- trol variable suggested by McCammon. These discounts are treated under the law as reductions in price affecting the “net" price paid by the buyer, and any discrimination in the use of cash discounts may violate Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act. National Grain Yeast Corp. and Federal Yeast Corp. were found guilty of violating the Act by exercising selec— tive application of cash discounts of between 1 per cent and 2 per cent to preferred customers.39 Similarly, Borden Co. was found guilty of giving only certain retail firms cash discounts of 2 per cent on their purchases. In a situation where a firm offered cash discounts to two classes of customers, wholesale buyers and drop ship- ment buyers, discrimination was found against the third class 39National Grain Yeast Corp., 33 F.T.C. 684 (1941), and Federal Yeast Corp., 33 F.T.C. 1372 (1941). 40The Borden Company, 54 F.T.C. 563 (1958). 44 of buyers, regular independent retailers, because all three classes were in competition with one another.41 Finally, when a trade association inquired about the legality of recommending standardized cash discounts in the clothing industry because of the confusion and errors created by dissimilar behavior of the manufacturers in the industry, the Commission said that recommendations by the association: . . . even if unaccompanied by any intent to force the manufacturer to adopt the policies set forth therein, there was implicit in such resolutions by the retailers too grave a danger that they would serve as a device whereby the concerted power of the members of the association was brought to bear to coerce the manufacturers to conform their dis— count policies to the restrictive standards of the resolutions, or, at the very least, as an invitatio to enter into agreements among themselves to do so. There is danger for the retail marketing system plan— ner in the use of cash discounts if they are not made avail- able to all buyers at each resale level in equivalent amounts. The indirect purchaser doctrine will hold in determination of discount effect; therefore, where different buyers oper— ating at different levels, such as a direct buying retailer and a retailer buying through wholesalers, are in competition (in goods of like grade and quality in interstate commerce), it will be the responsibility of the manufacturer or seller to insure that cash discounts which he offers direct buying retailers are also passed through to buyers dealing with 41Albert Ehlers, Inc., 56 F.T.C. 1316 (1960). 42Advisory Opinion No. 281 (1968) 74 F.T.C. 1663. 5035915 8101‘s bus noianinos ad# in gnibuaunooo1 to C- I. 1;." ”'5. .- 9.111"; 1' E-nhflolfi _- 'i'i'.=.-."‘- yd 45 wholesalers, such that the net price paid by both resellers is identical. Anticipation allowances Anticipation can be defined as a discount for ad— vance payment of a bill for goods or services where not cash discount is specified in the terms of sale. From this defi— nition the character of the discount situation can be infer— red; that is, that discounts may be taken for advance pay— ment or for early payment. These anticipation allowances would have the same impact on the net price paid by the re— sellers as would cash discounts, the only difference being the amount of the discount. It is sensible to conclude that the courts would in— terpret anticipation allowances essentially the same as they do cash discounts. In practice, however, it is the purchaser and not the seller who takes anticipation on an invoice which is paid prior to the due date. In that situation, Section 2(f) of the Clayton Act as amended by the Robinson-Patman Act becomes controlling. A buyer might induce an unlawful discrimination by taking anticipation when he was aware that competitors were not doing the same.43 This would violate Section 2(f). Thus, the vertical marketing system planner should treat anticipation allowances as price adjustments under the 3Automatic Canteen Company of America v. F.T.C., 346 U.S. 61 (1953). 46 Clayton Act, and seek to make the allowances, if being of- fered by the manufacturer, available to all buyers operating at competitive reseller levels, as well as insuring that buyers taking anticipation are not gaining an advantage over other buyers of goods of like grade and quality. Free goods Free goods are defined as merchandise which is re— ceived for no payment. Generally free goods are elements of promotionally oriented programs. The practice of granting free merchandise can be considered as a potentially effective variable in a vertical marketing system. The practice can result in violation of Sections 2(a), 2(d), or 2(e) of the Clayton Act as amended by the Robinson—Patman Act. Specifi- cally, certain forms of free merchandise will be treated as a reduction in the net price, while other forms may be treated as promotional allowances. In the National Dairy case a program offering one free case of fruit spread for each case purchased during a particular period was found to be discriminatory in that the actual impact of the one—for—one offer was a reduction by one—half in the "net" purchase price paid for the goods. A change in the net purchase price paid by a buyer brings the 44 discrimination under Section 2(a) of the Clayton Act. A similar situation occurred when a Texas bean packager 44National Dairy Products Corp. v. F.T.C., 412 F.2d 605 (7th Cir. 1969). sham: 3m 7'4 47 developed a program offering one free bag of beans with each ten bags purchased. The plan was available only to favored retailers and wholesalers. The Commission treated the pro— gram as a reduction in the net price paid by the favored buy— ers, and therefore illegal.45 A different construction occurs when the free mer— chandise is given to the firm, not for resale as in the pre— vious situations, but as part of a promotional campaign or introductory campaign. In those situations Sections 2(d) and 2(e) will be the governing statutory sections. The practice of furnishing small trial sizes only to favored customers has been found to be illegal, because the free merchandise was not offered to all customers on propor— tionately equal terms (based on units or dollars or volume) as required by the Act.46 A program where free electric razors were given as prizes for dealer salesmen was found to be in Violation of Sections 2(d) and 2(f) because the free merchandise was only offered to salesmen of favored purchasers at wholesale and retail levels.47 Finally, free merchandise utilized in in—store demonstrations was prohibited when the demonstrations were not made available to all customers of the seller in prOportionally equal amounts. 45Arrow Food Products, 61 F.T.C. 504 (1962). 46Diaperwite, Inc., 60 F.T.C. 1771 (1962). 47North American Philips Company, Inc., 55 F.T.C. 682 (1959). 48Knomark Manufacturing Co., Inc., 51 F.T.C. 879 (1955). 48 The distribution system planner must be aware that the use of free merchandise may be treated in different ways depending upon the way the merchandise is given, either as merchandise for resale or as part of a promotional program offering merchandise for resale or as part of a promotional program offering merchandise or prizes as rewards. Prior to the decision in the Fred Meyer case,49 there would have been great significance to this breakdown because promotional a1- lowances and services had been viewed as applicable only on a regional level and only at a specific functional level. The Meyer decision expanded the scope of inquiry in promotion— ally related cases to include the "indirect purchaser doc— trine for promotional activities, as it had already been ap— plied under Section 2(a) for price related issues. The Fed— eral Trade Commission, because of the confusion created by the broadening effect of the Meyer case, issued in 1969 "Guides for Advertising Allowances and Other Merchandising Payments and Services"50 in an attempt to clarify the actions which a manufacturer might take that would be unlawful under the new interpretation of the statutes. Under the guides a custom— er was defined as "someone who buys for resale directly from the seller, the seller's agent or broker; and in addition, a 'customer' is any buyer of the sellers product who pur- chases from or through a wholesaler or other intermediate 49F.T.c. v. Fred Meyer, Inc., 390 U.S. 341 (1968). 5034 Fed. Reg. 8285—89 (May 29, 1969) [hereinafter cited as FTC Guides]. 49 reseller." This definition of customer, that is, one which makes the customer of the manufacturer someone who buys from an independent wholesaler, has placed additional burdens on the manufacturer such as the necessity to inform all cus— tomers" of the availability of promotional programs or as— sistance, i.e., free merchandise.51 One significant legal question appears when the guides are considered in terms of the control which a manufacturer might use to insure his compliance. Too much COOperation be— tween members of the distribution channel, or too much price policing (or fixing) may cause a violation of the Sherman Act Section 1, by constituting a form of conspiracy. The issue has created controversy, but is not atypical of the problems with antitrust enforcement being separated amongst different branches in the government. Discussing Justice Harlan's dissenting opinion, there is potential danger in the Meyer interpretation because when manufacturers must evaluate the resale level to be legal in granting promotional allowances, then the wholesalers may justifiably claim a manufacturer-retailer conspiracy against them. A conspiracy constitutes a violation of Section 1 of the Sherman Act. Adherence to the Meyer decision may be dis— astrous to the firm. Further criticism was levelled at the possibility 51g. at 8286. 52Note, The Fred Meyer Case & Section 2(d) of the Robinson—Patman Act, 43 St. John's L.R. 254, 270 (1968). 50 that the new interpretation may have the effect of cutting out many promotional programs as manufacturers elect not to assume the additional responsibilities which the decision 53 has placed upon them. The Meyer decision has placed additional burdens on the manufacturer withing to develop promotional programs and has brought about stricter enforcement of price discrimina— tion situations. Manufacturers contemplating various pro— motional programs dealing with free goods need to determine the legal environment on a stricter basis than before. Prepaid freight — freight allowances Prepaid freight is defined as a purchase which in— cludes in the price paid, freight charges to the point of destination. Freight allowances are allowances to be received in lieu of the receipt of prepaid freight. The use of prepaid freight might certainly be con- sidered as a strategic variable in a vertical marketing sys— tem, particularly where it would be utilized to extend mar— ket areas by offering customers farther from the plant loca— tion, prices comparable or equivalent to prices of competi- tors closer to the production location. This position es- sentially describes the character of legislation and deci- sions governing delivered pricing systems, but some confu- sion exists over recent advisory opinions offered by the Federal Trade Commission. The original intent of the writers of the Robinson- 51 Patman Act may have been to encourage F.O.B. plant pricing systems in order to overcome basing point and phantom freight problems. The Attorney General's Report in 1955 pointed out that delivered prices should be allowed enabling "sellers to be free to meet competition in distant markets by quot— ing delivered prices to equalize the freight advantages of more favorably situated competitors."54 Pricing practices with respect to delivery are eval— uated under Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act. This factor means that competitive injury is a necessary part of the cause of action. Attempts have been made to read transportation into Sections 2(d) and 2(e) where competitive injury is not necessary, but they have been unsuccessful. Transportation charges are treated as direct discrimination in price. "As a general rule the pertinent statutory price is the total delivered price paid by the buyer regardless of the place or method of delivery."55 Uniform delivered prices have been upheld as acceptable in a recent advisory opinion even though some buyers will receive more freight included in their final "net" purchase price than others. The practice of establishing lower "invoice" prices, which, when added to common carrier charges, equal the uniform delivered price, Report of the Attorney General's National Commit- tee to Study Efie Anfifrusf flaws, 2I9 (I935TT““"“__“_“_____ 55Guyott Co. v. Texaco, Inc., 261 F. Supp. 942, 948 (D. Conn. 1966). 52 has been approved.56 This practice would allow the seller to transfer title and payment administration to the buyer, while maintaining the equality of final market prices. Confusion over freight payment plans exists because of an advisory opinion dealing with the desire of a firm to grant "back haul" allowances in order that customer's empty trucks, returning near the plant, could pick up shipments and receive an allowance equal to the cost of shipping to the customer on a common carrier. The Commission initially stated that the plan would probably result in a violation of the 57 law. The Commission attempted to explain this viewpoint when it said: While this conclusion may seem unreasonable from one point of view, since the allowance would be for no more than the actual freight saved, it seemed to the Commission to be a necessary result of using a delivered pricing system. Whenever such a seller departs from his delivered prices for the benefit of one customer, he leaves himself open to a charge of discriminating against his other competing cus- tomers who order in the same quantitggs and hence fall within the same pricing market. This statement created confusion since the request was viewed as reasonable by many people. This statement has helped to clear up the confusion created by the advisory opin— ion which was pointed out in Anti-trust Developments. The seller may grant to customers freight allow— ances equal to the sellers actual common carrier 56Advisory Opinion, No. 194 (1968) 73 F.T.C. 1309-10. 57Advisory Opinion, No. 147 (1967) 72 F.T.C. 1051. 58Advisory Opinion, No. 147 (1967) 72 F.T.C. 1051. 53 freight cost savings to enable such customers to apply the applicable freight directly to a com— mon carrier performing the transportation ser- vice, and yet the seller may not grant to custom- ers pick up allowances equal to the outbound com— mon carrier freight cost even though such custom— ers perform the same transporggtion service as a common carrier would perform. The Cost of Living Council requested the F.T.C. to review the original opinion and in a clarification, issued in December of 1973, the Commission pointed out that: Questions properly would not arise under the laws it administers if sellers using valid uniform, zone delivered pricing systems, offer to all customers, on a non-discriminatory basis, in lieu of a deliv- ered price, the option of pugfihasing at a true F.O.B. shipping point price. The clarification has not completely cleared up the issue of freight allowances, but it appears that the Commis- sion is not anxious to attack the practice, the results of which should be substantially similar prices in most market areas where zone pricing systems are in use. A national uni- form delivered price would need to have various F.O.B. factory prices so that the net delivered prices would be fairly simi— lar as suggested in Advisory Opinion No. 194. To vertical marketing system planners, the essential point becomes the confusion over granting back haul privileges in conjunction with a system utilizing delivered prices. Cer- tainly control of the flow of goods can be maintained in a more suitable fashion if all shipments are arranged by the 59Anti-trust Developments, 1955-1968, 165 (1969). 60Fed. Reg., 1260 (Jan. 7, 1974). 54 seller, but administrative burdens increase with that stra- tegy. If the VMS strategist elects to have allowances for back haul available, the present rule of thumb would appear to be that allowances must be equal to an amount which will create uniform delivered prices among resellers at the vari- ous functional levels. New product display and advertising allowances New products can be defined as products which are not presently available in a market area, or which have been newly developed from a technical standpoint. New product introduction programs will be of inter— est to the vertical marketing system designer in most indus- tries. In that regard, the promotional allowances and ser- vices to be furnished will be an important part of the in- troductory program. There have been no directly applicable cases revolving around this issue, but many cases dealing with component elements in the introduction have been de- cided. All actions dealing with displays and allowances would fall under Sections 2(d) and 2(e) of the Clayton Act as amen- ded by the Robinson—Patman Act. Governing all promotional services and allowances are the "guides for Advertising Al— 61 lowances and Other Merchandising Payments and Services," which were issued by the Federal Trade Commission after the 61FTC Guides. 55 Fred Meyer62 decision to clarify the decision and discuss the broadened powers which the decision conferred upon the Com— mission in policing the Act. Display materials such as cabinets, wire racks, etc. given to a seller, have been found to be included under the provisions of Section 2(d).63 If these forms of promotional assistance are given, they must be provided on proportionally equal terms to all buyers. Other items covered under this provision which a seller might furnish his customers to stim- ulate demand are advertising, catalogs, demonstrators, spec— ial packaging or package sizes, accepting returns for credit, prizes or merchandise for contests, etc.64 In addition to covering services and furnishings of— fered to buyers, the Guides also prescribe behavior for firms in establishing allowances to be paid for promotional activ— ities that a seller might provide such as cooperative ad— vertising, handbills, window and floor displays, special sales efforts, "push money" programs, demonstrators, etc. The critical issue in the Guides is the expanded re— quirement to make available to all buyers at a particular functional level, whether direct or indirect customers, pro- portionally equal payments for services rendered. This means that even if the seller deals through wholesalers to retailers, 62Fred Meyer, Inc. v. F.T.C., 39o U.S. 341 (1968). 63Day's Tailor-D Clothing, Inc., 55 F.T.C. 1584 (1959). 64FTC Guides at 8286. 56 and also directly to retailers, he is responsible for inform— ing the retailers who buy through wholesalers, of services, allowances, or furnishings which are available. The duty of the seller has been expanded as shown in Figure l. MANUFACTURER WHOLESALER DIRECT BUYING RETAILER RETAILER CUSTOMER Figure l The duty of the seller to inform customers is stated in the Guides: The seller should take reasonable action, in good faith, to inform all his competing customers of the availability of his promotional program. Such notification should include all the relevant details of the offer in time to enable customers to mag? an informed judgment whether to partici— page. Many new product introductions will occur on a regional basis as opposed to national basis, and the relative nature of the market area will be important in determining the ac— ceptability of the program. The competing customers can be Id. 57 in any area as long as all competing sellers (at any level) have access to the plan, and the area can be distinctly drawn as described by the Commission: "Assuming that you selected a reasonable trading area, even though limited . . . we do not believe that your action would run afoul of any law ad— ministered by this Commission."66 Thus, regional introductions in which all competi- tive resellers have available on a proportionally equal basis allowances, services, or furnishing should be acceptable under the current interpretation of the law. If a Violation is found in a competitive program there will be a significant difference in the defenses avail— able. Under a Section 2(a) case, it has already been shown that cost justification is an available defense. Cost justi— fication of a promotional program is not allowed under Sec- tions 2(d) and 2(e).67 The only defense to an action brought regarding ad— vertising allowances or services furnished is the good faith defense.68 In this defense, showing how specific actions were taken to meet a competitors program or offer will be al— lowed by the Commission. Of questionable success will be a defense based on general "competitive conditions." The 6Advisory Opinion Digest No. 157, CCH Transfer Binder 1967—70 para. 18,147 (1970). 67F.T.c. v. Simplicity Pattern Co., 360 U.S. 55 (1959). 68Exquisite for Brassier, Inc. v. F.T.C., 301 F.2d 499 (D.C. Cir. 1961). 58 Commission and courts have been quite explicit in allowing only a directly equivalent program or one with directly com— petitive impact to be acceptable. The possibility does exist for action to be brought under Section 2(a), as a reduction in price, if it can be shown that promotional allowances exceeded the cost of the buyer performing those services. The Commission has treated situations such as this as a reduction in the "net" price paid for the merchandise. Since Sections 2(e) and 2(e) have fewer defenses available, the Commission will generally at— tack all the discrimination under the promotional provisions. Seasonal discounts Seasonal discounts are reductions in the net price paid to account for diminished value of the goods due to the time of the year in which they are sold. Seasonal discounts for analysis purposes can be of two forms, either direct re— ductions in price, or allowance programs offered to speed the sale of merchandise of a seasonal nature. Because of this fact, there are different problems under the law which must be resolved. If the allowances are for promotional activities or service, the "proportionally equal" provisions of Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson— Patman Act will govern the determination of the legality of the discount. That is, promotional allowances made avail— able to one buyer must be made available to all buyers on a 59 proportionally equal basis. In addition to previous consid— erations, the only defense open to a firm under Sections 2(d) and 2(e) is the meeting competition defense, which would necessitate having a competitor involved in a very similar program.69 More realistically, seasonal discounts will be direct reductions in the price which a buyer pays for the goods, and as such will be treated under Section 2(a) of the Act. Under this portion of the statute there are potential defenses which a seller might utilize to escape a finding of discrim— ination. As in the previous section, the meeting competi— tion defense would be available to the firm. The defense for seasonal discounts which has had the most success is the changing market conditions defense. The critical issue that has appeared in these actions is the "ob- solescence" question, that is, whether the value and salabil— ity of the goods are affected by the passage of time. This question coupled with the concept of a "season," has allowed the courts to determine that there are many products which are susceptible to "seasonal obsolescence," and may be elig- ible for the changing market conditions defense. One of the classic cases in this area deals with discounts granted to a car dealer on previous model year automobiles, at a time well into the current selling season. The court, in reaching 69Joseph A. Kaplan & Sons, Inc. v. F.T.C., 347 F.2d 785 (D.C. Cir. 1965). 60 their decision, pointed out that because market conditions had changed the manufacturer had been left with a large number of automobiles at the close of the model year and had to discount the cars in successively greater amounts, as time passed, in order to get rid of them. The court explained: The word 'season' also signifies the period of the year in which something is more in vogue than at others, as when a particular trade, business, or profession is in itsogreatest state of activity, as the holiday season. This statement in conjunction with the facts led the court to conclude: A normal change in car models, made in good faith, as in the instant case would come within the ex— ception of this Fourth Proviso, (the seasonal ob— solescence condition) and that it, therefore fol— lows that the sale by Studebaker . . . did not constitute a violation of the Clayton Actlas supplemented by the Robinson-Patman Act. In a more recent decision this principle was upheld where a manufacturer of Christmas decorations granted "off— season discounts to dealer who purchased the entire inven- tory of last season's merchandise in the slow selling season. The court said: There are at least two distinct selling seasons in the calendar year. The first part of the year is Mr. Christmas primary selling season, its 'peak' season. The latter part of the year is the slow season, in which close-out sales are made. Prices are lowered during the slow season in order to 70219 F. Supp. 608, 612 (S.D. Cal. 1963). 71;g. at 613. 61 induce retailers to 'soak up' goods not bought during the peak season, i.e., merchandise whose marketability has decreased . . . . The Plaintiff, which insisted on 'early season' delivery was Op— erating in a different market from Treasure Island. 72 The major difficulty in any seasonal discount case based upon changing market conditions, or good faith meeting of competition is that the burden of proof rests on the de- fendant in a case of this kind.73 Seasonal discounts can be a valuable and justifiable aid to the vertical marketing system planner when used as a result of changing marketabil— ity to meet competitive pressure or to enhance the salability of goods which have a seasonal pattern of value attached to them. Mixed carload privilege Mixed carload privilege is a privilege granted to a buyer which allows the buyer to receive carload quantity dis- counts or carload freight rates for the goods being purchased. The mixed carload privilege may have a number of potential uses in a vertical marketing system such as allowing buyers to mix various models to take advantage of quantity discounts, to delay shipments in order that carload quantities can ac— cumulate, or where prices are based on delivered prices, quoting lower delivered prices based upon apparent cost sav- ings which result from the privilege. 72Willow Run Garden Shop, Inc. v. Mr. Christmas, Inc., para. 74,816 5 Trade Reg. Rep. (1973). 73Huber, Inc. v. Pillsbury Flour Mills Co., 30 F. Supp. 108 (S.D.N.Y. 1939). 62 The rules which apply to quantity discounts would apply in a program where "mixing" of models was allowed in order to take advantage of quantity discount categories which are often based on unit purchases, such as in the ap- pliance industry. The Commission will look at the categori— cal discounts on a cost justification basis to determine if they are justified, and secondly, that they are available to all buyers of similar quantities.74 Difficulties would occur if a firm maintained single model quantity discounts for some buyers, and allowed model mixing for other buyers. This prac- tice would not be allowed under Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act. A program allowing aggregating purchases, such as an early sales program, to allow the buyer to attain carload quantities in an F.O.B. factory shipping plan, would be a1— lowable under the conditions established in the FTC Guides. Since this program would constitute the furnishing of a ser- vice connected with the handling and sale of goods, then Sec— tions 2(d) and 2(e) of the Clayton Act would be the binding provisions. These provisions state that if a program is furnished to one buyer, it must be furnished to all buyers on a proportionately equal basis.75 This would be a diffi— cult situation for the seller to defend since to aggregate a 74Informal Opinion of Commission, 81 Congressional Record Appendix, Part 10, p. 2336. 75FTC Guides at 8287. 63 carload shipment for some customers may take a great deal of time, indeed may never occur for smaller accounts. The Com— mission has been very strict in interpreting this section of the statute, and it would become the sellers responsibility in this situation to have some service of " equivalent" value available to small buyers unable to avail themselves of the program. In the situation where a manufacturer would allow mixed carload privilege for sales which were priced on a uniform delivered basis, there is a bit of confusion. In an Advisory Opinion dealing with a 5 per cent discount on truck— load quantity purchases, the Commission said that since the 5 per cent prepresented an average of the savings to all customers, the discount may result in discrimination to some since the actual carload discount may be greater or lesser than 5 per cent for a particular customer. The Commission said: . . . the alleged cost savings depend upon aver— aging the savings in the freight rates for truckload — lot shipments to all of the manufacturer's truckload customers in the United States, and that, all through the freight savings increase with the distance of cus- tomers from the manufacturers plant, the freight sav- ings on sales to nearby truckoad gustomers is con- siderably less than five percent. The previous opinion appears to be in conflict with an opinion regarding uniform delivered prices released just 76Advisory Opinion No. 198 (1968) 73 F.T.C. 1312. 771%- 64 ten days earlier in which the Commission advised: . . it would not be illegal to use either a con— ventional uniform delivered pricing system based on average cost factors or a uniform delivered pricing system which will be effected by granting so-called freight allowances to be deductgd from the manufacturer's f.o.b. factory price. The confusion probably rests with the historical be— havior of the Commission in viewing any price differential with a much more difficult attitude. In the Advisory Opin- ion No. 194, the Commission is permitting a system which re— sults in a nationwide uniform price which is based on aver- aging. The averaging technique is not allowed as a means of justifying a price difference in Advisory Opinion No. 198. The vertical marketing system designer should exer- cise care in the use of the mixed carload privilege since justification may be difficult and some forms of the priv- ilege may be difficult to offer to all competitors on a proportionally equal basis. Drop shipping privilege Drop shipments are shipments made directly from the manufacturer to the final reseller. A firm might utilize a drop shipping privilege in a vertical marketing system as a means of increasing customer service. A large chain of food stores may prefer to have drop shipments made directly to its individual stores rather than to the warehouse. To 78Advisory Opinion No. 194 (1968) 73 F.T.C. 1309. 65 the extent that a seller grants such a privilege some prob— lems with the law may occur. A problem would occur if the seller of goods grants wholesale or brokerage allowances on sales made by drop ship— ments, which result in lower prices to certain customers com- peting at the same level with higher priced customers. In this case the Commission and the courts have been very ex- plicit in not allowing the additional brokerage discount since the level of competitive resale is the test to deter— mine what prices will be viewed as discriminatory.79 Sellers are not allowed to establish different prices to buyers of the same good purchased in different ways (un- less subject to other defenses) for resale in competitive situations. A company which gave the highest discount to firms taking warehouse delivery, a slightly lower discount to customers taking drop shipments, and the lowest discount to small retail buyers was required to cease and desist from its practice even though it would create inefficiency in the distribution system. The functional discounts discussed represent a di— rect usage of drop shipments to receive lower prices either because of actual savings, or by attempting to establish "mail slot" jobbers; those which do nothing more than place 79Mid-South Distributors v. F.T.C., 287 F.2d 512 (5th Cir. 1961). 80A1bert Ehlers, Inc., 56 F.T.C. 1316 (1960). 66 orders and pay bills but have all merchandise drop shipped to the individual customers. This practice was very common in many industries until the Commission began its enforce- ment of the Act in the manner discussed. Additional problems could be encountered if the firm uses drop shipments as a program of special service' for large quantity buyers. The provision of Sections 2(d) and 2(e) requires such services be made available on a propor- tionally equal basis to all buyers. It becomes difficult to conceive of a system that would be proportionally feasible for drop shipping in small quantitites to smaller buyers, but it would not be improbable to offer other services of pro- portionally equal value" to the small buyers.8l This type of program would generally make such a program allowable under the 2(d) and 2(e) guides and current court decisions. DrOp shipment can be potentially dangerous to the seller because it may signal the attempt of a dummy broker or intermediary to receive additional functional discounts. In addition, if used as a tool to expand marketing and dis- tribution services for large customers the test of propor— tional availability must be met. Trade deals A trade deal can be defined as a combination of spe- cial terms or offers given as a custom in certain lines of 8lFTc Guides at 8287. 67 business. Within this meaning would fall many programs which the vertical marketing system designer might utilize for per— formance or control purposes. For analytical purposes, the majority of trade deals would be combinations of specific discounts, allowances, or financing programs discussed else- where in this dissertation. As such, the "package" will be bound by the legality of the various components of the pro— gram since the Commission and courts will evaluate each as- pect of the program to determine its impact. Of special interest is the special support which can be given to a new dealer in the distribution channel. In an advisory opinion issued in 1968, the Commission stated that proposed program to offer new retail dealers special one— time packages consisting of additional discounts off list price and in—store display materials not offered to exist- ing dealers would be permitted since "it is unlikely that injury could result from this one shot offer in view of its nature and the start up costs which new dealers are apt to experience. In the special case of the opening of new dealers, it appears that "special" trade deals may be available to the firm expanding or redesigning its distribution system. For existing dealers, an evaluation of each variable making up the trade deal must be undertaken to determine the col- lective legality of the entire program. 82Advisory Opinion No. 384 (1969) 76 F.T.C. 1115. 68 Discount substitutes Discount substitutes will be important to the dis— tribution programmer because of their immediate impact. That is, just as price concessions had the immediate impact of driving up the profitability of the firm by cutting the cost of merchandise, discount substitutes have the same impact on profitability accomplished through a cut in the resellers expenses. Display materials Display materials are items which are furnished to Show, highlight, or hold goods being offered for sale. Dis— play materials can be used by the vertical marketing system planner to induce channel members to follow or utilize pro- motional materials designed to enhance consumption of the product. The rules which govern the use of display mater— ials will be found in Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson-Patman Act. The classic case in the area of display materials is Simplicity Patterns. Simplicity, a manufacturer of tissue patterns for dressmaking, furnished to large retail variety stores pattern storage cabinets and other promotional ma- terials which they did not furnish to their smaller custom— ers — fabric shops. The Supreme Court found Simplicity guilty of violation of Sections 2(d) and 2(e) because they had not furnished the display materials, etc. on a proportionally 69 equal basis to all buyers of their patterns who competed in their resale.83 The Commission has included in the description of "display" materials such articles as point of purchase racks for candy, window displays, shelf displays, and exhibit space. The guidelines for furnishing of many promotional services and facilities were well described in the recent FTC Guides for Advertising Allowances and Other Merchandis- ing Payments and Services, which were necessitated by the Fred Meyer decision expanding the administrative power of the FTC in promotional program evaluation. The Meyer decision creates the necessity for the sel— ler to make available to all who compete in the resale of the product display materials (as well as other services and fa— Cilities) in proportion to the sales volume they represent, regardless of whether they are a direct customer of the sel- ler, or if they buy the sellers product through an indepen— dent wholesaler. The seller must therefore create more ex— tensive communication systems to inform all resellers, both direct and indirect, of the availability of materials, ser— vices and allowances.84 The vertical marketing system designer may use dis- play materials in a number of ways to insure uniform appeal, to create a solidified image, etc. The duties of informing 83F.T.C. v. Simplicity Patterns Co., 360 U.S. 55 (1969). 84F.T.C. v. Frey Meyer, Inc., 390 U.S. 341 (1968). 70 all resellers have been expanded by the Fred Meyer decision, and this places further burdens on the planner if this stra— tegic variable is to be utilized. Premarked merchandise Premarked merchandise is merchandise to which has been affixed a label, price tag, or other identifying mark by the seller. Premarking is a service which will fall under the jurisdiction of Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson-Patman Act. The key issue will be whether the service is offered to all resellers on a proportionally equal basis.85 In a recent advisory opinion the Commission discussed the pre— marking of imported candles. They said: If the service of affixing an individual custom— er's pricing labels on packages is not generally available on proportionally equal terms to all other of an importer's customers competing in the resale of imported candles, the providing of such a service to one customer may constitute a §%olation of Section 2(e) of the amended Clayton Act. The furnishing of premarking service to buyers may be one way to accomplish uniform resale prices and a way to cut expenses for the reseller. However, the distribution planners must be aware of the expanded responsibility in these situations as explained in the FTC Guides. 85FTC Guides at 8285. 86Advisory Opinion No. 422 (1970) 77 F.T.C. 1712. 71 Inventory control programs Inventory control programs are defined as processes or procedures which determine optimum inventory levels, given some set of criteria. Inventory control programs can be a valuable tool to the distribution programmer in managing field inventory levels while lowering expenses for the re- seller by relieving him of the task of inventory control. This strategic measure may pay off in much higher sales, profitability, and customer satisfaction by reducing stock outs and rush orders that require extra time and expense. These are basic legal dangers with inventory control programs. Like many other activities, the inventory control system would constitute the furnishing of a service. Be— cause of this service, Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson—Patman Act will be binding. Current interpretations of these sections have been quite strict in their viewpoint. The best statement of the gen- eral characteristics of the provision are detailed in the FTC Guides.87 A service plan to computerize sales data and project inventory needs promoted by a third party was approved by the Commission in an Advisory Opinion when they placed con— ditions on the program saying: The Commission does not object to the proposal, subject to two safeguards for nonparticipating 87FTC Guides. 72 dealers; first, that the suppliers 'will continue to provide personal salesman service or some non- computerized equivalent to those dealers who do not participate', and second, that supplier's 'make the results of the computer analysis of sales trends and other general market informa- tion availggle to nonparticipants if and as they desire it. A more complex problem occurs when examining a very popular technique of inventory control at the retail level; that is, the use of a rack jobber. This form of distribu- tion is generally made available in conjunction with the leas- ing or lending of display equipment where the merchandise will be stored or displayed. The legal problems that arise involve the Sherman Act and possible restraints of trade im— posed as part of a rack jobbing agreement. The courts have said that agreements which forbid the use of the rack for other than the suppliers goods are acceptable as long as the agreement does not "prohibit the retailer from dealing in the same or similar goods."89 If the agreement requires that the line be the only one which the retailer carries, Section 1 of the Sherman Act and Section 3 of the Clayton Act may be violated due to sub— stantial foreclosure of competition from the market place as a result of the contracts. Arguments that a rack jobber is providing a service90 have been overturned when the court 88Advisory Opinion No. 306 (1968) 74 F.T.C. 1679-80. 9Perryton Wholesale, Inc. v. Pioneer Distributing Co., 353 F.2d 618 (10th Cir. 1965). 90;§. at 624. 73 said "the services performed are but incidental to the sale of the merchandise." Thus, the vertical marketing system planner should be aware that inventory control provisions utilized in the distribution of a product may violate Sections 2(d), 2(e), or 3 of the Clayton Act or Section 1 of the Sherman Act, de- pending on the competitive nature and restrictions placed on those participating in the system. Catalogs and sales promotion literature Catalogs are defined as descriptive collections of merchandise. Other literature relating to sales promotion would be handbill, handout, circular or other printed docu— ments used to enhance the sale of a product. Manufacturers may wish to utilize reseller's assistance in promoting pro- ducts through catalogs or sales promotional literature as a means of achieving more effective market coverage. A num- ber of variations of sales promotional literature will be available such as circulars, handbills, coupons, shopping bags, etc. The law does not discriminate among these pro- motional formats, thus making analytical problems somewhat less difficult. The classic case of furnishing catalogs to some sel- lers, but not to all resellers, is the Simplicity Pattern case in which a dress pattern manufacturer was found guilty Id. 74 of violating Section 2(e) of the Clayton Act as amended by the Robinson—Patman Act by furnishing large volume customers with free pattern catalogs while charging smaller volume pur- chasers for the same catalogs.92 Another program of interest is the promotional pro- gram sponsored by Fred Meyer, Inc. in Portland. The program revolved around a once a year, four week coupon book sale to customers. Each customer would buy the coupon books for ten cents. The books were said to be worth in excess of $50 if all coupons were utilized, and they were good for one month. Meyer charged suppliers $350 for each coupon page of adver— tising. The Court found this practice violated Section 2(d) of the Clayton Act because similar payments were not made to competing resellers in the Portland area. A trade catalog published by a wholesaler's associ— ation was an acceptable place for a seller's promotion on the condition that: . . . (l) the publication is to be published by a separate corporate subsidiary, (2) the advertis— ing rates to be charged will be no higher than necessary to realize a normal profit for such a publication, and (3) in any event, the profits resulting from the publication will begdonated annually to a charitable organization. In the previous advisory opinion, a manufacturer con- templating advertising in the catalog was told that buying 92F.T.C. v. Frey Meyer, Inc., 390 U.S. 341 (1968). 93Advisory Opinion No. 16 (1966) 69 F.T.C. 1204. 94E- 75 space in a publication such as this: . . . is in effect furnishing through the inter- mediary of the publisher, a promotional service to those wholesalers who make use of the publica— tion. In order to assure compliance with Sec— tion 2(e) of the amended Clayton Act, the sup~ plier should ascertain whether in a practical busi— ness sense the publication is available for use by all of his wholesale customers who are in competi- tion with the wholesale customers who do in fact use it; if it is not so available for use by some cus— tomers, the supplier mufig offer those customers a reasonable alternative. In a somewhat different situation where a toy cata- log was being published by an unaffiliated, independent pro— moter was generally available to all toy jobbers and was not designed to be used by certain jobbers or classes of jobbers, the Commission said: Payments for advertising in a catalog published by a firm which is not owned or controlled by, or in anyway directly or indirectly affiliated with, any customer of the advertiser or group or class of such customers, do not violate Section 2(d) of the Clayton Act where no discriminatory benefit is con— ferred by such payments on a particular customer96 or class or group of customers over competitors. Thus, the independence of the catalog producer and the gen— eral availability have become central tests of the acceptance of catalog payments. In a related situation, a paper bag manufacturer who sold bags with product advertising printed on them to food stores was found to Violate Section 2(a) of the Act by attach- ing non—cost justified discounts for various quantities of Id. 96Advisory Opinion No. 3 (1956) 68 F.T.C. 1267. 76 bags which participants purchased. Here the important is- sue was that manufacturers who had paid for advertising space on the bags were probably in violation of Section 2(e) since a realistically available alternative had not been of— fered to customers who did not use the bags.97 Other forms of sales promotional assistance granted by the manufacturer would be covered under the FTC Guides. This document spells out the condition a manufacturer (or customer attempting inducement) should adhere to in conjunc- tion with the furnishing of or payment for promotional assis— tance such as catalogs, circulars, and in—store promotional literature, etc.98 Training programs A training program can be defined as systematic in— struction in skills related to the operation of the firm. Training programs can play a vital role in the accomplish— ment of channel system objectives by carrying product know- ledge, managerial information or sales techniques to the resellers organization. Training programs furnished by the seller will fall under the provisions of Section 2(e) of the Clayton Act as amended, making it unlawful to furnish to a favored purchaser facilities or services connected with the handling, sale or offering for sale of commodities. The 97Advisory Opinion No. 57 (1966) 69 F.T.C. 1232. 98FTC Guides. 77 seller may also pay or grant allowances for the reseller's personnel to attend training schools or seminars. In this situation Section 2(d) will govern service payments that are involved. A training program was found to violate Section 2(e) by furnishing training to personnel in the "fieldcrest Shop" at favored retail locations.99 In a similar case, the use of the manufacturer's "missionary" salesmen to assist and train the reseller's field sales force was found to discrim- inate because the training services were not made available to all competitive resellers on proportionally equal terms.100 Thus, training is another area where the FTC Guides can be of value in determining the present attitude of the Commission in the enforcement of Sections 2(d) and 2(e). To the vertical marketing system planner, this must be heeded due to the importance of sales and service training programs to the reseller. Shelf stocking programs A shelf stocking program can be defined as any sales situation where the seller stocks the shelves of the reseller. Shelf stocking programs can be of value as a means of cutting the expenses of the retailer by providing an inventory man- agement system and cutting his direct labor expenses. Since 99Fieidcrest Mills, Inc., 56 F.T.C. 1306 (1960). looGojer, Inc., 57 F.T.C. 1228 (1960). 78 the stocking activity would be connected with the handling or sale of goods, and would be a service or allowance to the retailer, Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson-Patman Act will be the applicable law govern— ing these activities. In a situation where a company gave stocking allow- ances to vending machine operators for stocking the company's brand of cigarettes, the Commission ruled them in violation of Section 2(d) because the allowances were not made avail- 101 The Com- able to competing resellers at the same level. mission pointed out that to classify automatic retailing machines as operating at a different competitive level than traditional retail sellers such as drug and tobacco stores would not be reasonable. Another major form of shelf stocking activity would be that of the rack jobber. These intermediaries lend their basic existence in the distribution process to their stock— ing activity. The rack jobers become guilty of violation if they do not provide essentially similar service (and facili— ties) to all buyers on proportionally equal terms.102 Another form of shelf stocking program that could be utilized in the distribution of a product would be the en— couragement for a dealer to "stock" a product gained by lOlLiggett & Myers Tobacco Co., 56 F.T.C. 215 (1959). 2Perryton Wholesale, Inc. v. Pioneer Distributors Co., 353 F.2d 618 (10th Cir. 1965). 79 paying a stocking allowance or by granting lower prices to the dealers who stock the product in some minimum quantities. In an advisory Opinion regarding a plan with lower prices to the stocking dealers, the Commission concluded that the discounts would probably result in price discrimination and would therefore necessitate one of the defenses available under Sections 2(a) and 2(b) of the Statute, with principle relevance on cost justification.103 If the manufacturer elects to pay an allowance for services (such as stocking) which a reseller provides, Sec— tion 2(d) becomes the applicable portion of the Statute. The Commission pointed out that "compensation for such services, if made available on proportionally equal terms to other cus— tomers of that manufacturer who compete with the favored cus— tomer in the sale of the manufacturer's products are allow- able under the Act."104 Thus, the question of creating stocking programs be- comes one of determining what form the stocking program should take, whether it be a program aimed at cost justifying additional functional discounts, or whether it be based on allowances made available to all dealers for stocking the product. The more conventional forms of shelf stocking pro— grams such as the wagon distributor and rack jobber must a1- so be viewed as falling under the provisions of 2(d) and 103Advisory Opinion No. 263 (1968) 74 F.T.C. 1649. 10419- 80 2(e) and that service must be offered to all resellers in proportionally equal amounts if difficulties are to be avoided. Ad matrices Advertising matrices can be defined as mode devices used in reproducing prepared advertisements. Advertising matrices which are furnished to a reseller in the distribu— tion system would be valuable means of assisting dealers in obtaining maximum competitive impact for their promotional expenditures. Matrices would be classified under the anti—trust statutes as services and facilities furnished to the buyer and, as such, would have direct evaluation under Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson— Patman Act. The Federal Trade Commission's guidelines issued in 1969 would be the applicable environmental constraints regarding ad matrices.105 No cases at the Federal level have specifically evaluated the furnishing of matrices, al— though other promotionally related items have been evaluated under the strict test of proportional equality for all re— sellers, direct or indirect. Additionally, the furnishing of advertising allowances and other promotional items will be discussed later in this chapter. 105FTC Guides. 81 Management consulting services Management consulting services can be defined as ex- pert services which are performed to solve managerially re— lated problems. The use of management consulting service to disseminate information about more efficient sales techniques, material handling equipment, technical servicing, etc., can be a very valuable tool to the vertical marketing system de- signer. Elimination of inefficiency improvement of communi— cations, more efficient inventory management and many other benefits are the direct impact of consultation between the manufacturer and his resellers. Additionally, membership in trade associations can be a valuable source of managerial in— formation and advice. Problems will arise under Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson—Patman Act if the manufacturer or seller makes available his consulting ser— vice only to certain "favored" direct or indirect resellers of his product. Since consulting services would be classi— fied as services connected with the handling, sale or proc— essing for sale, the statute will apply and the test of pro— portional equality will be utilized to determine if a viola— tion is evident.106 Membership in a trade association, on the other hand, can also be a means for a reseller to gain market (and to a certain extent competitor) behavior data without securing it 82 directly from the seller. The Commission has approved a trade association program for sharing information regarding new production materials and experiences which individual producers have had with those materials.107 On the other hand, the Commission has been very much opposed to any proposals by trade associations which would communicate information regarding prices to be charged, dis- counts, margins, or even recommended selling periods for cer— tain merchandise.108 The Commission stated that these prac— tices may have a tendency to lessen competition among re— sellers. Indeed, a proposal for a service flat rate manual for automotive repairmen would be a per se violation of price fixing legislation and therefore not allowed.109 Management consulting services rendered by a manu- facturer or seller on a unilateral basis will be allowed under the pr0portional equality test of the FTC Guides. Col- lective organizations, such as dealer groups or trade asso— ciations, may be allowed to disseminate information as long as it does not contribute to price fixing or have the ten— dency to restrain competition by creating concerted action against a seller, etc. 107Advisory Opinion No. 85 (1966) 70 F.T.C. 1867. 108Advisory Opinion No. 281 (1968) 74 F.T.C. 1661. 109Advisory Opinion No. 201 (1968) 73 F.T.C. 1314. 83 Merchandising programs Merchandising programs are rather difficult strategic variables to define. The term relates to a variety of com- binations of product or promotionally oriented variables used in the merchandising of a particular good such as the LEGGS hosiery program which includes systematic stocking, packaging, and display components. For analytical purposes, since the various individual promotional services are dis— cussed elsewhere in this dissertation, merchandising programs will relate to the special situation where unique products are merchandised; that is, where a specific alteration in the brand, size, or characteristics of the product gives it a unique position in the competitive array of goods being of- fered the consumer. Private label goods have been a constant problem in anti—trust decisions. This was finally settled (at least it appears so) by the Supreme Court's holding that for the test of like grade and quality the technical characteristics or physical properties will be the major deciding factors.110 In a case where special merchandising programs were developed around private label goods which had been sold to competitive resellers at different prices, the court found the canning company in violation of Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act. Because of this situa— tion, any private label purchases must be based on an ll0F.T.c. v. Borden Co., 383 U.S. 637 (1966). 84 allowable defense under 2(a). Thus, in order for the firm to allow different prices on the same good sold under a na- tional brand as well as private label, a cost justification, meeting competition or changing market conditions defense must be established.111 Merchandising programs based upon special packaging have received the attention of the Federal Trade Commission under jurisdiction of Sections 2(d) and 2(e) of the Clayton Act as amended. Small packages of cosmetics called "juniors" made available only to dime stores were found to be violative of the Act since the packages were widely accepted and the variety stores were in resale competition with non-variety store resellers of the regular size. The Commission pointed out that special size packages should be available to all buyers.112 Similarly, in a grocery supply situation, General Foods was guilty of violating Section 2(e) by not furnishing to all competitive wholesale buyers institutional packages which were available to institutional jobbers, even though both types of intermediaries competed for the institutional 113 sales. A bean manufacturer's special "Sugar Bowl" pro— motional packaging, made available only to certain buyers lllTri Valley Growers v. F.T.C. 411 F.2d 985 (9th Cir. 1969). 112 Luxor, Ltd., 31 F.T.C. 658 (1940). 113 General Foods, Inc., 52 F.T.C. 798 (1956). 85 during football season, was also found to violate Section 2(e) of the Act.114 Special merchandising programs based upon private label merchandise or merchandise which is specially packaged, can have substantial impact in the marketplace. These prod— ucts can be very valuable tools in accomplishing market im— pact for a retailer. The problems with programs based on such products revolve around two issues. The first is pric— ing and the latitude available to establish prices. The second difficulty involves an evaluation of the amount of services offered and their availability to various customers. Sales "spiffs" Sales spiffs or push money are extra amounts paid in addition to normal commission or compensation for the sale of specially designated items. They can be an effective tool in the maintenance of adequate inventory amounts at various levels in the distribution channel by encouraging sales personnel to push slow moving items. The payment of push money to a retailer's sales personnel has been upheld as a valid trade practice under the Federal Trade Commision Act, provided the dealer is aware 15 of the payments being made to his sales representatives. Under evaluation for violating Section 2(d) of the 114Arrow Food Products, Inc., 60 F.T.C. 1771 (1962). l15Kinney Rome Co. v. F.T.C., 275 F. 665 (1921). 86 Clayton Act as amended by the Robinson—Patman Act, push money was considered a promotional payment; that is, one subject to the test of proportional equality for all resellers. A cosmetics manufacturer was in Violation of the Section since he required customer recipients to meet different standards and furnish different amounts of reciprocal services, etc., in order to receive the promotional payments. 16 In addition to the previous difficulties in making spiff programs work, the Meyer Guides have placed additional burdens on sellers contemplating the use of push money or prize spiffs, because of the necessity for the program to be available to indirect customers as well as direct customers on equal terms. Technical assistance Technical assistance can be defined as any assistance given which is of a technical nature regarding the design, implementation or control of business systems. The furnishing of technical assistance can be a valu- able aid in building cooperative relationships with members of a distribution channel. Just as in the case of manage— ment consulting services, the furnishing of or paying for technical assistance will fall under the jurisdiction of Sec— tions 2(d) and 2(e) of the Clayton Act as amended by the Robinson—Patman Act. 116Bourjois, Inc., 53 F.T.C. 751 (1957). 87 The furnishing of technical personnel to assist in the opening of a new distributorship which was in competi— tion with an existing distributor was held to be in viola- tion of Section 2(e) of the Act since the technical service was not made available to all resellers on a proportionally equal basis.117 The Commission, in an advisory opinion, cautioned a supplier who was making available a computerized fore- casting and inventory service through an independent con— sultant to make sure that some sales forecasting assistance was made available to customers who did not subscribe to the computer service.118 Technical assistance to the sales force of a distri— butor must be made available on a proportionally equal basis to all competitive distributors. Furnishing such services to only favored customers may result in a violation of Sec— tion 2(e).119 Payment of sales personnel and demonstrator salaries Payment of sales personnel and demonstrator salaries refers to payments by the seller to pay the salaries of per— sonnel involved in sales or demonstration work on the buyer's 117M. O. Dantzler v. Dictograph Products, Inc., 272 F.2d 172 (4th Cir. 1959). 118Advisory Opinion No. 306 (1969) 74 F.T.C. 1679. 119Gojer, Inc., 57 F.T.C. 1228 (1960). 88 premises. The use of demonstrators and sales personnel can be a valuable tool to a vertical marketing system planner. Indeed, the training and payment of skilled salespeople at the retail level can do a great deal to enhance the sales of a particular product. This competitive strategy has been upheld as a legitimate promotional device and not one which would constitute "unfair competition" under Section 5 of the Clayton Act.120 If payments are only made available to certain "fa— vored" dealers, then a violation of Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson—Patman Act may result. In a case where a cosmetic manufacturer only paid half the salary of an in—store demonstrator for one customer, and the entire salary for a competitor, the court found a 121 The court was pres- violation of Sections 2(d) and 2(e). sed with the argument by the company that a payment of salary was outside Section 2(e). The court said that it really didn't matter if the service was furnished by direct or in— direct payment; the fact of importance was the outcome of the discriminatory practice.122 This decision has allevi— ated a technical point in the law; that is, which section of the Act applies in which situations. After the Arden 120Kinney Rome Co. v. F.T.C., 275 F. 665 (1921). 121Elizabeth Arden Sales Corp. V. Gus Blass Co., 150 F.2d 988 (8th Cir. 1945). 122Id. 89 ruling it became immaterial and it would be decided on the facts in each case. 23 Demonstration payments to sales personnel at a large New York department store were violative of the Act since these payments were not made available to all resellers on proportionally equal terms.124 But, a plan whereby a manu— facturer paid a sales commission of 2.5 per cent to a re- tailer on the retail jewelry sales volume, an amount sup— posedly passed on to the retail sales personnel, was a vio- lation of Sections 2(d) and 2(e) since similar payments were not made to all competitive dealers.125 The payment of salaries via direct payment, through sales commissions or through promotional allowances must be made available to all competitive resellers on prOportionally equal terms. The Fred Meyer guides spelled out the nature of any allowances and the care the program operator must take to insure equivalent treatment of all buyers, either direct or indirect.126 There is an additional defense available under Sec- tions 2(d) and 2(e), the "meeting competition" defense. A company which employed "stylists" dispatched from a district 124The Regina Corp., 60 F.T.C. 241 (1962). 125United Cigar-Whelan Stores Corp. v. H. Weinreich Co., 107 F. Supp. 89 (S.D.N.Y. 1952). 126FTC Guides. 90 sales office and assigned to various retail locations, as the district manager saw fit, was not found to violate Sec» tion 2(d) or 2(e) because of a meeting competition defense. Since the legislative intent of the two sections was to plug any loopholes that manufacturers might attempt to squeeze through, the defense was equally applicable under either type action.127 The payment or granting of allowances for sales per- sonnel or demonstration services can be a valuable promo- tional strategy when a retailer carries many competitive brands. These payments to a merchant's personnel or to per— sonnel employed by the sellers, as long as they are made to meet competitive conditions or are equally available to all sellers, will be allowable under the current interpretation of the Commission and the courts. Promotional and advertising allowances with performance requirements One of the most popular and traditional forms of channel strategy development revolves around advertising pro- grams and other forms of promotion which are conditional or have performance requirements attached; that is, the adver— tising must meet certain minimum standards and specifications, and the amount of participation will be based upon some set of performance criteria such as sales volume. 127Exquisite Form Brassier, Inc. v. F.T.C., 301 F.2d 499 (D.C. Cir. 1961). 91 Allowances and payments for cooperative advertising and promotion, the most common form of performance oriented allowances, fall under the jurisdiction of Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson—Patman Act. The courts have interpreted Section 2(f) on buyer in— ducement of discrimination as also being tested under the same relationship as a seller granted allowance since the buyer—seller relationship is a two way street.128 The Commission has struck down allowances paid for newstand space by distributors of magazines. In a rather extensive program the Commission found Select Magazines, Inc. (a subsidiary of "McCall's," "Life," "Time," "Popular Science Monthly," "Charm," "Reader's Digest," "Mademoiselle," and others), Curtis Publishing Co. (publishers of "Ladies Home Journal,’ "The American Home," and others), Cowles Magazines, Inc. (publishers of "Look" and other magazines, pocketbooks, etc.), Esquire, Inc., New Yorker Magazine, Inc., Newsweek, Inc., United States News Publishing, Inc., The Hearst Cor- poration and many others guilty of violating the Act. The Commission did not allow the negotiated method of establish- ing various allowances for space to be a "proportionally equal" method, particularly since only the largest retail operators of newstands received these allowances.129 128Grand Union Co. v. F.T.C., 300 F.2d 92 (2d Cir. 1962). 129The Cases mentioned are found sequentially begin- ning with Select Magazines, Inc., 57 F.T.C. l, continuing through Pocket Books, Inc., 57 F.T.C. 75 (1960). 92 A program of cooperative advertising which was based on a percentage of sales was violative of the Act because the buyers had to "qualify" for the program with such large purchases that only two buyers in Philadelphia received al— lowances under the program.130 However, a program under which all resellers were paid one—half of their proven adver— tising expenditures, at no time allowing the amount to ex— ceed 10 per cent of a single sale invoice, and not allowing the cumulative refund on an annual basis to exceed 2.5 per cent of the total annual purchases, was allowable under the Act.l3l Cooperative advertising programs, as well as other promotional programs, need to conform to the Guides issued 132 by the FTC in 1969. In discussing some of the difficulty the Meyer Guides have created, Carla Hills said: . . . It is almost impossible at this juncture to advise a client with both direct buying and in— direct buying retailers who wishes to initiate a cooperative seller—buyer advertising program. Most suppliers would find it very difficult to ascertain the number and names of all in direct buying retailers who compete with direct buying retailers in order to notify them of their pro— motional program . . . . The problem of satis- fying the 'proportional equality' requirement in this context also poses tough questions to the supplier who has no way of computipg3the pur— chase volume of each unknown retailer. 130Simmons Company, 58 F.T.C. 277 (1961). l3lAdvisory Opinion No. 39 (1966) 69 F.T.C. 1221. 132FTC Guides. 133 C. A. Hills, The Anti—Trust Advisor, 274 (1971). 96 Thus, the problems associated with insuring proportional equality may be more difficult than the potential benefits to be derived. Promotional programs will adhere to the same basic tests as cooperative advertising. A program in which a large grocery retailer rented space on a flashing sign to its sup- pliers was not allowed since it was a discriminatory allow- ance having a favored affect on the retailer over his competi- tors.134 Additionally, if the promotional allowances re- ceived by the buyer surpass the amount the buyer has expended, the Court has viewed the additional allowance as a discrim- inatory price granted under Section 2(a). The measure of the discrimination is equal to the amount by which the allow— ance exceeds the expenditure.135 A promoter's program of store give—aways and coupons was not allowed. The promoter wished to mark the coupons "Available at your local pharmacy," but since some of the merchandise was handled by food and variety stores the Com- mission objected to the plan.136 Another coupon book pro— motion was not allowed since under the redemption plan large retailers would be allowed to redeem partial and full books, while small retailers could only redeem filled books. The 134Grand Union Co. v. F.T.C., 300 F.2d 92 (2d Cir. 1962). l35F.T.C. v. Fred Meyer, Inc., 390 U.S. 341 (1968). 136Advisory Opinion No. 92 (1966) 70 F.T.C. 1875. i . I'd I'.J' r-" '-‘ -_-. . - 97 plan also violated Sections 2(d) and 2(e) because of the participation rate having a quantity discount associated with the number of books purchased. They said: . . our concern with this prOposal stemmed just from the fact that the retailers will be charged different prices for these books depending upon the quantities ordered. In one sense this could be viewed simply as a sale from the promoter to the retailers and thus subject to cost justification defense which the statute makes vailable to one charged with a discrimination in price. However, the Commission found it conceptually impossible to lift this transi- tion out of the whole and view it as a separate price discrimination program. The proposal involves one essentially promotional program in which the parts cannot be separated from the whole.137 This interpretation eliminates quantity discount provisions from any purchases associated with promotional or advertising pro— grams. There are many difficulties associated with maintain- ing a "legal" posture in promotional and advertising programs, particularly for the firm with more than one form of channel system. The functional approach described by the Commission in the previous Advisory Opinion, coupled with the Meyer Guides appears to define the present environment for the use of this variable. Conclusions Price and price related variables are a complex stra— tegic variable when examined from a legal perspective. Many 137Advisory Opinion No. 135 (1967) 72 F.T.C. 1038. 98 laws have application to pricing cases including the Sherman Act, Clayton Act, Federal Trade Commission Act and the Robin— son—Patman Act. The majority of price related cases will be based on the Robinson—Patman Act and will center on the issue of the effect of the discrimination. That is, does the dis- crimination result in a reduction in the net price of the good or does the discrimination involve the furnishing of services or facilities which lower the reseller's expenses. This basic determination will lead to the portion of the statute which applies Section 2(a) to direct price changes and Sections 2(d) and 2(e) which apply to indirect price re- ductions such as services and allowances. Price discounts will be evaluated under three basic criteria. First is the determination of whether the goods are of like grade and quality. Second will be a test to determine if the goods are involved in interstate commerce. Third will be the test to determine if competitive injury has or will probably result from the practice. Three defenses are available for Section 2(a) actions: (1) cost justifica— tion, (2) meeting competition, and (3) changing market con— ditions. Discount substitutes generally will be evaluated under three criteria. First is the like grade and quality test. Second is the test for interstate commerce. Third is the test of proportional equality. The general guidelines 99 for determining proportional equality are described in the FTC Guides.138 Although the Meyer decision has been controversial, support for the position is evident. The Vanderbilt Law Review supported the Court by saying: The Court's decision to enforce Section 2(d) by requiring proportionately equal treatment of all competing retailers correctly reflects the purpose of the Robinson—Patman Act to protect small retailpga from promotional allowance dis- crimination. The only defense, once a violation is determined under this Section, is the meeting competition defense. The indirect purchaser doctrine and the enlargement of responsibility under the Meyer decision have allowed the various legal agencies to examine direct or indirect cus— tomers under the statutes. For these reasons, an awareness by the vertical marketing system planner of the legal environment surround— ing each of the strategic variables is imperative. Figure 2 attempts to put into perspective the major difference between the most common forms of discriminatory actions. 138FTC Guides. 139Recent Cases, Vand. L. Rev. 1129, 1134 (1968). ZOHBHBHASOO GZHBfiHE 100 ZOHBHQZOU HEM IMGS UZHUZGMO ZOHBHBWMSOU UZHBWHE ZOHBflUHmHBme BmOU mumzmhfin HAMdQHfl>¢ .H N oudmflm wqu¢pam qaonemomomm moMmzzoo mamammmazH waHuapa n24 madmw MMHQ amnnzH m>HaHsmmzoo mommzzoo mamammmazH wquana 92¢ moamu mMHq ZOHBUfl mom Emma BOWMHQZH m0 BUHmHQ BUHMHQZH MO BUHMHQ MMDbZH m0 qm>mq MMBDEHBmmDm BZDOUmHQ .N mBZDOOMHQ mUHmm .H ZOHBflZHZHMUmHQ m0 Emom CHAPTER III FINANCIAL ASSISTANCE AS STRATEGIC VARIABLES Financial assistance can be an extremely important tool in the administration of a vertical marketing system. It is probably the category of variables that account for most of the success of franchise forms of distribution, by creating strong financial backing for small investor-opera- tors whose own capital and reputations might not be substan- tial enough to secure a loan to establish a small business. With national firms behind the franchise, or other interme- diaries in the various forms of vertical marketing systems, lending institutions have responded much more favorably to financing requests. Indeed, some vertical systems have in- ternally available capital which allows the manufacturer to offer financial support to the dealers for a number of pur— poses. General Motors Corporation operates a subsidiary de— signed to finance the inventory of their dealers, as well as the purchases of new cars for the final customers. Still another division of the company is responsible for loans to dealers for the establishment or improvement of their facil- ities. Thus, by using internal capital, assistance to inter- mediaries may be given in many instances allowing closer con- trol or observation of the operations of the intermediary. 101 102 Financial assistance can be of two major forms ac— cording to Professor McCammon: conventional lending arrange— ments and extended dating. This chapter will develop the legal environment surrounding the use of these strategic variables in a vertical marketing system. ‘Conventional"Lending’Arrangements Lending arrangements can be broadly defined as activ— ities by the manufacturer associated with securing or estab- lishing financial assistance for the intermediary. As such, there are many forms which these loans can take from mort— gages on a facility to floor plan financing programs for inventory. Each specific variable for McCammon's structure as discussed in Chapter I will be evaluated for the present legal environment. Term loans Term loans can be defined as loans made for periods of time greater than ninety days (the general trade credit period). They would include loans for operation of a firm, expansion, acquisition, etc. The environment for firms contemplating the establishment of loan arrangements for intermediaries has become less desirable as a result of the Fortner case. 1B. McCammon, Perspectives for Distribution Program- ming in Vertical Marketing Systems 43 (L. Bucklin ed. 1970). 2Fortner Enterprises v. U.S. Steel Corp., 394 U.S. 495 (1969). 103 The Fortner decision determined that monies which ‘were acquired in conjunction with the sale of another prod— uct might fall under the antitrust laws regarding tying contracts. In that case, the purchase of homes from the home building division of U. S. Steel was a necessary con— dition for receiving a 100 per cent loan on a housing devel— opment. In a very close decision (5-4) which had strong dissent, the Court said the fact that the loan was for a greater amount than the products being purchased indicated that it, too, was a separate product. In order to receive the loan, Fortner had to agree to erect present housing purchased from U. S. Steel on the lots. The sales situa— tion represented a tying arrangement under the antitrust statutes. This decision altered a number of previously held notions that credit granted on the sale of merchandise was allowable in varying quantities. In a very strong dissenting opinion, Justice Fortas argued that the situation in Fortner was nothing more than the sale of a product with incidental provisions for finan— cing, not really a sale of credit as a tying position would require. He said: Provision of credit financing by the seller of a commodity to its buyer is a very common event in the American economy. Often the seller is not will- ing to supply credit generally for the business and personal needs of the public at large, but restricts his credit to the purchasers of the commodity which he is principally in business selling. In all such cases, the commodity may be viewed as tied to the credit. But in all such cases, under the majority 104 opinion, the mere fact that the credit is offered on uniquely advantageous terms makes the trans- action a violation of Section 1 of the Sherman Act . . . . The logical of the majority opinion then, casts doubt on credit financing by sellers. In discussing some of the difficulties created by the Fortner decision, and the dissent, Professor Kenneth Dam points out that the Court utilized conventional legal prin— ciples to reach an unexpected result.4 He points out that the confusion created by the decision may lead to situations such as that: When the courts have enough per se principles available to them to find both anti—competitive and pro-competitive practices illegal, it is un— likely that all courts will readily use those prin— ciples on all occasions. Some judges will choose not to find illegality in arrangements that, to them, make sense for the economy as a wh 1e. Deci— sions will thus become less predictable. The treatment by the Court of the credit granted to Fortner as a separate product was not entirely aimed at traditional types of credit. The Court, in the majority decision said: In the usual sale of credit the seller, a single individual or corporation, simply makes an agreement determining when and how much he will be paid for his product. In such a sale the credit may consti— tute such an inseparable part of the purchase price for the item that the entire transaction could be considered to involve only a single product. It will be time enough to pass on the issue of credit sales when a case involving it actually arises. 31d. at 515—16. 4K. Dam, Neither A Borrower or A Lender Be 1, 1969 Supreme Court Review. 5 Id. at 2. 6Fortner Enterprises v. U.S. Steel Corp., 394 U.S. 495, 507 (1969). 105 The apparent conclusion with respect to the Fortner decision appears to be that firms attempting to tie the sale of one product to the substantial grant of credit, possibly in amounts greater than the value of the products involved, may be courting the danger of having a per se violation of the Sherman Act decided against them. The Supreme Court has pointed out that the "normal" type of trade credit remains to be decided. The question the majority opinion raises is what constitutes a normal credit sale. If the amount is directly related to the present sale, then it may pass as justifiable. If it exceeds the amount of the present purchase, it may become a separate good under the new position, and as such may create a tying problem for a firm. Another problem associated with term loans involves the situation where a loan is induced beyond the amount given to competitors. In a situation where a large bus company induced more favorable credit terms, along with other factors, the company was found guilty of violating Section 1 of the Sherman Act.7 Thus, the credit element in a transaction in— volving a relatively large company may be construed as a technique to gain monopolistic control. A term loan program offered to new retailers in inner- city and ghetto areas, whereby the new dealer would receive 7United States v. Greyhound Corp., 1957 Trade Cases para. 68,756 (N.D. Ill. 1957). 106 one year trade terms on purchases during the first month of operation was allowable under the Clayton Act because an insubstantial amount of commerce would be involved. Term loans appear to be an area of confusion because of the many problems created by the Fortner decision and the number of different antitrust actions that may be in— volved in each case. They need not be so confusing to the vertical marketing system planner. Term loans which are made for amounts larger than the value of merchandise involved, and which are tied to the sale of another product will not be allowed. Traditional forms of term loans which are directly related to the sale of a particular product appear to be allowable based upon the majority decision in the Fortner case and Justice Fortas' strong dissent based on the same argument. Term loans of- fered to new or struggling firms will be allowable, even though they appear to be discriminatory, if the amount of commerce affected is relatively insubstantial. Financing packages which are offered as part of a franchising arrange— ment will be allowed provided that the package is available to all franchisees of the firm. Term loans can be a valuable device in building re— seller confidence in the distribution channel, but care must be taken that loan programs not be overly "forcing" in their provision or tie themselves to other specified behavior. 8Advisory Opinion No. 253 (1968) 73 F.T.C. 1337. 107 Inventory floor plans Inventory floor plan programs can be defined as pro- grams designed to finance the wholesale purchase of the prod— uct while in the dealer's inventory. Floor plan programs can be a valuable tool to the distribution planner because they allow the planner to develop inventory programs which do not become burdensome to the intermediary from a capitalization standpoint. A number of very large firms in this country have established finance subsidiaries to serve this purpose. Among large companies operating such subsidiaries are Ford Motor, General Motors, General Electric, Westinghouse, and many others. The legal environment surrounding floor plan programs is determined by the automobile cases of the early 1950's. In that series of cases, the procedure of forcing the dealer to finance wholesale purchases and retail sales through a company owned finance subsidiary was condemned as a viola- tion of Section 1 of the Sherman Act. Similarly, a program which "coerced" dealers into financing through approved independent finance companies was also violative of the Sherman Act. The coercive behavior of franchise cancellation, slow or incorrect model deliveries, or withholding of other services constituted violations even 9United States v. General Motors Corp., 1952 Trade Cases para. 67,324 (N.D. Ill. 1952). 108 though the finance companies were not owned by the firms. An expansion of the problems of a firm convicted of violation occurred in the Emich Motors case where the prior conviction of coercion under Section 1 of the Sherman Act coupled with the proof of the damages which the conspiracy has caused, was enough to prove a violation of Section 5 of the Clayton Act. The decision meant that when a private in— dividual was damaged because of the practices of coercion (in credit or otherwise) a guilty verdict in the criminal case plus proof of damages would allow a prima facie case to be established and treble damages awarded to the damaged firm.11 In addition to criminal violation of the Sherman Act and private treble damage suits under the Clayton Act, the Robinson-Patman Act may be violated if advantageous credit arrangements are withheld from a class or group of purchasers. In a situation where credit was denied to a beer distributor who had not maintained suggested resale prices, the court entertained argument that the withholding of credit to qual- ified (having a good credit rating) purchasers may constitute a Violation of Section 2(a) of the Clayton Act as amended by the Robinson-Patman Act.12 10United States v. Ford Motor Co., 1953 Trade Cases para. 67,437 (N.D. Ill. 1953). —_—___—“”_ llEmich Motors v. General Motors, 340 U.S. 558 (1951). 12Clausen & Sons, Inc. v. Theo. Hamm Brewing Co., 284 F. Supp. 148 (D.C. Minn. 1967). 1:5 -. 109 The previous decision did not overrule a long stand- ing principle that if a particular customer has been diffi— cult to collect from or has had a bad credit rating, denial of credit may simply indicate sound business practice.13 Thus, the credit rating of a firm will have a tremendous impact on the range of credit services, such as floor plans, which a supplier must make available. Floor plan programs can be a valuable aid in estab— lishing sound dealer relations and adequate inventory levels in the distribution channel. There are potential legal dif— ficulties if the floor plan program requires additional be— havior on the part of the firm. Financing programs cannot be the basis of coercive or prohibitive business practices. Secondly, if advantageous credit arrangements are only of— fered to certain favored customers, the action may involve a violation of the Robinson-Patman Act. Notes payable financing Notes payable financing is defined as the payment or support for long-term debt which a firm has incurred. Notes payable financing finds its major application in franchise distribution channels. In the automobile industry the major manufacturers operate Special long-term financing subsidi— aries to enable dealers to obtain the necessary capital to build or expand facilities. General Motors operates such a subsidiary known as Motors Holding Company l3Secatore's, Inc. v. Esso Standard Oil, 171 F. Supp. 665 (D.C. Mass. 1959). 110 There are a number of problems which a firm may en— counter as a result of their extension of financing. Firms in the franchising field or manufacturers utilizing franchized forms of distribution may be guilty of violating Section 1 of the Sherman Act due to tying problems or may be violative of Section 5 of the Federal Trade Commission Act prohibiting un- fair methods of competition. In the Fortner case the grant of credit was tied to the purchase of another product. When considering the impact of that decision on notes payable financing, it becomes ap- parent that long-term debt received as a result of an agree- ment to purchase a product may be in violation of Section 1 of the Sherman Act.14 In a similar situation where more favorable financial arrangements were available to firms which signed franchise agreements, a violation of Section 5 of the Federal Trade Commission Act was found.15 The fact that was significant for the Section 5 violation was that fi- nancial terms were available only on condition that competi- tion in a competitor's products carried at the resale points be restricted or eliminated in favor of products of the Brown Shoe Co. Further difficulties with long term financing arrange— ments are possible under the Robinson-Patman Act. As the l4Fortner Enterprise v. U.S. Steel, 394 U.S. 495 (1960). l5F.T.c. v. Brown Shoe Co., 384 U.S. 316 (1966). 111 courts become more sophisticated in their approach to anti- trust cases, there is no reason to believe that the intro— duction of the present value of money concept is far off.16 That is, it is very likely that the Federal Trade Commission or the courts will apply the "present value" theory to ad- vantageous credit terms granted some buyers in order to ar— rive at an indirect price discrimination under Section 2(a) of the Clayton Act as amended by the Robinson—Patman Act. There is no apparent problem with the practice of withholding credit where the previous payment history experi— enced by the firm indicates a substantial risk.17 The Com— mission accepted a program where a trade association supplied credit information to member firms, provided that no recom— mendations were made regarding the information. Where support for the loan application of an inter- mediary is used to secure credit arrangements from a third party certain potential problems become apparent. When man— ufacturers use their economic power to secure assistance for 16The present value may be defined as the value at present of future payments discounted by the compound cur— rent interest rate or cost of capital. A mathematical ex- pression of the concept would establish the present value of one dollar received at the end of year n as: _ l _ P. V. — TI_I—RT n, where K — the cost of capital or the current interest rate 7Secatore's, Inc. v. Esso Standard Oil Co., 171 F.2d 665 (D.C. Mass. 1959). 18Advisory Opinion No. 361 (1969) 76 F.T.C. 1100. 112 intermediaries a Sherman Act violation alleging conspiracy may result if only certain finance companies are utilized in the plan.19 This situation presents problems for the franchisor or manufacturer who wishes to use his influence to support loan availability for his customers. If a sub- stantial foreclosure of competition from the financing market can be established a violation of the Sherman Act will prob— ably occur. If the power of the manufacturer to obtain fi— nancing gives the individual dealers a favored position in the local markets a violation of Section 5 of the FTC Act may be determined. The differing forms of long-term note financing which a firm utilizes for the benefit of their intermediaries is a potentially dangerous problem in antitrust regulation, made particularly confusing by the number of statutes which a fi- nancing program, direct or indirect (through third parties), may violate. The firm considering notes payable financing for their vertical marketing system needs to be particularly careful due to the potential difficulties they may encounter. Accounts payable financing Accounts payable financing may be defined as programs offered to assist in the payment of short term credit obliga- tions. The most common form of account payable financing 19United States v. Ford Motor Co., 1953 Trade Cases para. 67,437 (N.D. Ill. 1953). 113 would be the traditional form of trade credit. Trade credit has become a variable used by a very large percentage of firms in order to simplify bookkeeping and collection by al— lowing more orderly payment of accounts. This form of credit extension is not without risk to the seller since in many industries bankruptcy, business failures, or other problems will generally create bad debt expenses for the selling firm. The usefulness of payment periods to the vertical marketing system planner is great. Extension of trade terms allows for an expansion of sales to raise volume during slow moving periods or to get rid of close—out merchandise. In addition, advantageous trade terms can be an effective vari- able in securing new customers for a firm. There are many uses of trade terms in the vertical marketing system, but the VMS planner must be careful to consider the potential legal problems he may encounter. The extension of traditional trade credit may be vi— olative of Section 2(a) of the Clayton Act as amended by the Robinson—Patman Act. The refusal to grant credit to pur— chasers whose credit ratings show a good record may be con— strued by the courts as an effective reduction in price for the customers receiving credit.20 An attempt to have credit brought under the stricter provisions of Sections 2(d) and 2(e) of the Clayton Act as amended by the Robinson-Patman Act was unsuccessful. The court held that trade credit is 20Clausen & Sons, Inc. v. Theo. Hamm Brewing Co., 284 F. Supp. 48 (3d Cir. Minn. 1967). 114 not a promotional service under the Sections 2(d) and 2(e) provisions of the Act. In a case where a manufacturer cut off the normal 30-day credit he offered to one of his custom- ers because of slow payment the court said: The conclusion must be that the extension of credit is not one of the services or facilities covered by Section 13(e) and . . . if under any circumstances differentiation between customers as to credit terms might constitute a violation of Section 13(e), a justifiable denial of credit such as that which occpfred in this case would not be such a violation. The Commission has been somewhat lenient in allowing a manufacturer to establish extended terms to new dealers in inner-city and ghetto locations. An extension of one year terms on first month purchases has been determined as accept— able since the program would probably not have a detrimental effect on competition. The most difficult situation which may arise in ac— counts payable financing would occur if a firm loaned a cus- tomer amounts greater than the value of the goods which they had purchased, and if the loan were conditioned upon pur- chase of other goods or at the expense of a competitor's product. In that situation the Fortner rules would apply and a violation of the Sherman Act may be the result. Trade credit or accounts payable financing can be a valuable strategic variable for stimulating purchase in the lSecatore's, Inc. v. Esso Standard Oil, 171 F. Supp. 665, 668 (D.C. Mass. 1959), 13(e) designates Section 2(e) of the Act. 22Advisory Opinion No. 253 (1968) 73 F.T.C. 1337. 115 vertical marketing system. The VMS planner must exercise ll caution that credit terms be made available to all quali— fied" purchasers and that conditions not be attached to the credit which might allow the courts to construe a tying arrangement. Installment financing of fixtures and equipment Installment financing of fixtures and equipment can be defined as the grant of money to dealers for the purchase of furnishings and equipment for their business which is re— paid in a systematic pattern. Financial assistance of this kind can be a valuable source of capital to dealers in the distribution channel. Installment financing programs are quite common in franchising situations where the franchisor establishes stan- dards for the business and 'packages" the franchise for the franchisee. Often credit of the installment type will be arranged through a third party. The environment with re— spect to these programs will involve the factors discussed in the Term Loans section of this chapter. A variation of fixture and equipment financing of particular interest occurred in Jones v. Borden. The Borden Milk Company desired to increase their market penetration in Odessa, Texas. In assessing the market they found the chief competitor to be the Metzger Dairies which were owned by Tilden A. Jones. In order to be competitive with Jones and others, Borden found it necessary to grant additional 116 discounts off the list price to compensate for favorable al— lowances or terms on refrigeration equipment which were being provided by the competitors. The court allowed the price discount under the meeting competition defense of the Clayton Act as amended by the Robinson—Patman Act.23 The classic problem of tying the purchase of fixtures and equipment to other factors such as credit availability or a franchise are considered in the Chicken Delight case. Chicken Delight developed a franchise program that granted the franchise at no charge provided that all equipment, fur- nishings and supplies were purchased from the franchisor. The court held that this situation amounted to a classic form of tying arrangement even though it was just another way of receiving a franchising fee.24 The exception of the tying problems of the Fortner and Chicken Delight cases occurred in a situation where a dairy often established 100 per cent requirements contracts in exchange for installment loans. The court said that since the practice was not uncommon in the dairy industry, and that since competition in the relevant market had not been effec— ted, the exclusive relationship was allowed. The conclusion must be reached that the extension of 23Jones v. Borden Co., 430 F.2d 568 (5th Cir. 1970). 24siegei v. Chicken Delight, Inc., 448 F.2d 43 (9th Cir. 1971). 5Curly's Dairy, Inc. v. Dairy Cooperative Assn., 202 F. Supp. 481 (D.C. Ore. 1962). 117 installment credit in a vertical marketing system may be a valuable strategy enabling the establishment of a greater amount of channel coordination, but there are potential legal problems associated with that strategy. The tying problems discussed in the Fortner case and the potential price dis— crimination problems under the Clayton Act create a very dubi— ous position for financing strategy. The only apparent mechanism to avoid difficulty ap— pears to be the substantial commerce test in the relevant market area. If the firm can prove no substantial impact in the relevant market associated with the installment program, the plan will probably be allowed under the present interpre* tation of the courts. Lease and note guarantee programs Lease and note guarantees may be defined as guaran- tees provided by a seller or franchisor to assume a financial obligation in the event that the party making the obligation defaults. These agreements are quite common in franchise distribution system where the franchisor uses his capacity to secure the original credit and subleases to the franchisee, or where a direct line of credit is established by the fran— chisor through large financial sources. This practice gen— erally allows the acquisition of large sums of capital at more economical rates than might be obtained if each poten— tial location were to capitalize individually. The general financial provisions discussed earlier ,_A_ .‘ 118 in the chapter establish the basic guidelines for any finan- cing arrangement of the typical note format. Leasing situ- ations present a different approach. The lease of machinery as well as property leases have been determined not to be "goods" within the description of the Clayton Act's provi- sions.27 Therefore, the only statutes which the firm must be concerned with are the Federal Trade Commission Act, Sec- tion 5, and in broader terms the Sherman Act.28 Practices which favored one class of customers over others by allowing them to receive more favorable loan terms because their loans were guaranteed, while other customers were not, would represent a potential violation of Section 5 of the FTC Act. Provided that guarantee provisions were available to all qualified customers, no apparent problems would be connected with the practice of guaranteeing loans for customers. Other problems may arise under Section 5 of the FTC Act if a leasing program or note guarantee program is used as a device to allow dealer termination in cases where sub- stantial investments areinvolved. The Commission has adopted the stance of protecting the smaller individual, the fran— chisee, from the stronger firm, the franchisor, and has been 26United States v. United Shoe Machinery Co., 264 F. 138 (E.D. Mo. 1920). 7Gaylord ShOps, Inc. v. Miracle Mile Town & Country Shopping Center, Inc., 219 F. Supp. 400 (W.D. Pa. 1963). 28F.T.C. v. Brown Shoe Co., U.S. 316 (1966). 119 quite insistent upon having reasonable grounds for cancella- tion of franchise and dealership agreements. Lease and note guarantee programs can be a valuable means of allowing a manufacturer or franchisor to maintain control over his distribution system. Most guarantee pro— grants include provisions allowing some amount of inspection of operating documents, etc. There are danger in develop— ing programs which may include provisions that might be construed as "unfair competition." In addition, guarantees on leases appear to have fewer potential antitrust problems associated since leases have been traditionally held not to be "goods" as described in the Clayton Act. Accounts receivable financing Accounts receivable financing may be defined as the payment to the holder of credit documents by another party. Accounts receivable can be viewed pragmatically as credit cards, credit slips or other forms of credit agreements which are available to ultimate consumers. Generally, independent financing arrangements of this form involve the discounting of the credit receipt when presented. Familiar financing plans would include Master Charge, American Express, Bank Americard, and others. These services will have an agree- ment which each prospective user of their service will sign outlining charges for and responsibilities of the service. In situations where a manufacturer develops his own credit card or sales financing program, other problems with 120 credit sales as most credit regulation is based upon State statutes. If a nationwide seller were to institute the re- quirement that all dealers utilize his financing program, and if the costs were not related to other competitive systems, a potential violation of the FTC Act, Section 5, may result. The use of credit sales financing programs, such as those operated by the major petroleum companies or indepen— dent agencies, can be a valuable tool in channel system pro— motion. If all requirements for participants are reasonable there are apparently no problems in utilizing the variable, provided the various state laws are observed in each case. Extended Dating Extended dating may be defined as the granting of a longer time period for payment of invoices. Extended terms can be a valuable strategic variable in the vertical market— ing system. Among the forms of extended dating suggested as valuable variables in the VMS are: l. E. O. M. dating — This form of extension starts the discount period at the end of the month during which the invoice was written. 2. Seasonal dating - Seasonal dating involves the postponement of the payment cycle until the selling season for the merchandise arrives. 3. R. O. G. dating — A version of terms extension which starts the payment cycle upon receipt of the goods. 4. "Extra" dating - A form of time description which allows extra time for the payment of the invoice. 5. Post dating — A version of invoicing which alters the date on the invoice to some future date to 121 move the payment cycle without altering the payment terms. All the various forms of extended payment variables described can be aggregated for legal evaluation because the courts and Commission treat the various terms as differences in price or methods of competition. The environment which exists for one variable will also apply to other time period extensions. The essentials character of these various extended term variables has been described in Chapter II under the Cash Discount section or in the Accounts Payable portions of this chapter. The Robinson—Patman Act will apply in all situations where cash discounts are coupled to the time statement on the invoice, since differentials involve an effective dif- ference in the price paid by different buyers. When no cash discounts are allowed, Section 5 of the FTC Act may be util— ized if a differential in the length of time is granted to comparable buyers. The courts have allowed the seller to selectively determine who will receive terms due to variations in cus- tomer credit.29 Additionally, to establish new accounts in marginal areas of risk, the Commission allowed a plan for extending the terms to one year for the new customer. 29Secatore's, Inc. v. Esso Standard Oil Co., 171 F. Supp. 665 (D.C. Mass. 1959). 30Advisory Opinion No. 253 (1968) 73 F.T.C. 1337. 122 The nature of the competitive situation in an indus- try will generally act as an important input to the strategic planning of trade terms. Because cash discounts would be regarded as direct discrimination in price Section 2(a) of the Clayton Act as amended by the Robinson—Patman Act will be the important statute to consider. That section allows the broadest range of defenses to a charge of discrimination in- cluding meeting competition, changing market conditions, and cost justification. The granting of different terms to customers which include extended payment cycles is an important strategic variable to the vertical marketing system planner. Care must be taken to observe industry standards and avoid differen— tials which are indefensible under the Robinson—Patman Act. CHAPTER IV PROTECTIVE PROVISIONS AS STRATEGIC VARIABLES In many vertical marketing systems the relative strength of the manufacturer or weakness of the intermedi— aries may create the desire to shield the intermediary from the rigor of the competitive environment. Protective behav— ior allows the intermediary members to strengthen their com— petitive capability while it builds cohesiveness in the channel. The problem with protective behavior is that it runs contrary to the fundamental thrust of the antitrust laws. The legislature and the courts, in the majority of cases, have attempted to instill a positive attitude toward individual initiative and competitive spirit in the legis- lation governing business behavior. These are characteris— tics which are inconsistent with the concept of protection when exercised within a protected distribution channel. Protective programs aimed at assisting dealers in inventory protection, territorial protection, or price pro- tection have been suggested by McCammon as viable strategic alternatives in a VMS. The justification for such policies may be evident from a business standpoint, but they can cre- ate great legal difficulty for the businessman. 123 124 Price Protection Pricing stategy, one of the central strategies of any distribution system, is an extremely important variable to the VMS planner. Pricing decisions Operate on the funda- mental success indicators of a distribution channel, revenue, and profit. Price protection activities undertaken by the VMS planner can play a major role in minimizing competitive price pressure, particularly on the intrabrand level. Price protection programs and activities have met harsh resistance from the legislative and judicial organiza— tions which enforce the antitrust laws of this country. The Supreme Court pointed out this attitude when it said in United States v. Socony-Vacuum Oil Co.: Whatever economic justification particular price—fixing agreements may be thought to have, the law does not permit an inquiry into their reasonableness. They are all banned because of their actual or potential threit to the central nervous system of the economy. Any tampering with the pricing strategy at the horizontal level has been declared per se illegal under the Sherman Act. Pricing making activities within an agency relationship do not receive per se judgment, but require a test of the reason- ableness of the strategy in each and every situation. A dif— ficulty with pricing stragegy occurs because the judicial decisions have narrowed the boundary of what constitutes a legitimate agency relationship in a business situation. 1United States v. Socony—Vacuum Oil Co., 310 U.S. 150, 226 n.59 (1939). 125 The VMS planner must be aware of the position of the courts and administrative agencies with regard to pricing strategies in order to avoid legal difficulties under the Sherman Act, Clayton Act, and Federal Trade Commission Act. The pricing strategies suggested by McCammon will be exam— ined to determine the present legal environment regarding each strategy. Pre-marked merchandise Pre—marking merchandise is defined as the affixing by the manufacturer of a price ticket showing a suggested retail price for a particular piece of merchandise. This procedure can be valuable as a protective provision for chan— nel members because a uniform price is displayed to custom- ers. The procedure of pre-marking (pre—ticketing) is not without potential legal difficulty. Pre-ticketing may involve violation of Section 1 of the Sherman Act, Section 5 of the Federal Trade Commission Act, or Section 2(e) of the Clayton Act as amended by the Robinson—Patman Act. Certain situations involving the affix- ing of price labels will create legal difficulties for the VMS planner. The pre—marking activity, first and foremost, may encourage a price fixing action against the firm or its deal— ers. In a situation where a group of Plymouth auto dealers utilize price stickers which displayed uniform prices which 126 had been jointly agreed upon, the court found a per se viola— tion of the Sherman Act.2 The showing that the fixed prices were not the actual sale prices was irrelevant since the col— lective action to attempt to control prices established the violation. Automobile suggested list prices, because of problems similar to the previous case are now required to be affixed by the manufacturer. This is required by the Disclosure of Automobile Information Act, sometimes referred to as the Monroney Bill, which became effective October 1, 1958. A second potential problem may occur if pre-ticketing or pre-marking service is not made available to all dealers on a proportionally equal basis. The Commission has held that Section 2(e) of the Robinson—Patman Act applies to pre- ticketing service and therefore is subject to the test of proportional equality. There need be no proof of competitive injury or damage; the simple act of furnishing the service preferentially to some dealers will be violative of the Act. In a case where a manufacturer-importer affixed price tags for dealers, the Commission said: . . . if the service of affixing an individual customer's pricing labels on packages is not gen- erally available on proportionally equal terms to all . . . the providing of such service to one customer may constitute a violation of Section 2(e) of the amended Clayton Act. 2Plymouth Dealers Assn. of No. Cal. v. United States, 279 F.2d 128 (9th Cir. 1960). 3Advisory Opinion No. 422 (1970) 77 F.T.C. 1712, 1713. 127 The major difficulty would appear to be the appli— cability of the Fred Meyer decision and the necessity to make the pre-marking service available to all buyers, direct or indirect,4 as outlined in the FTC Guides for Advertising Allowances and Other Merchandising Payments and Services. Additional problems may develop in pre—ticketing situations if the price which is attached to a product is not the price at which a substantial amount of sales occur within a trad— ing area. If the price tag reflects an inflated or deceptive price, it may constitute a violation of Section 5 of the FTC Act prohibiting unfair and deceptive competitive practices. When a manufacturer attached suggested retail price tags to luggage which was being sold below that price by approximately one—third of the dealers, the Commission found a violation of Section 5 of the FTC Act because the price tags had the ten- dency to "mislead members of the purchasing public."6 Similarly, another luggage manufacturer was found to be in violation of the FTC Act because fictitious price tags were attached to catalog distributor's purchases which were not intended to sell at the suggested price. The Commission relied on the volume of merchandise sold below the suggested 4F.T.C. v. Fred Meyer, Inc., 390 U.S. 341 (1968). 534 Fed. Reg. 8285—89 (May 29, 1969). 6The Baltimore Luggage Co., 58 F.T.C. 451, 455 (1961). 128 prices and the catalog pages furnished by the manufacturer to the catalog dealers bearing the fictitious prices.7 In addition, the Commission grouped any price representations such as tags, catalog pages or promotional circulars together as evidence of display of retail price for analytical pur- poses under Section 5 of the FTC Act. The Commission pointed out that competitive damage was unnecessary for a Section 5 action when it said: We think it clear that such a representation may well induce a person to purchase a product. It is well settled that the use of a fictitious and excessive price on a ticket or tag attached to a product has a tendency to deceive the public as to the usual and customary retail price of the product and as to the savings afforded by the purchase there— of. Section 5 of the Federal Trade Commission Act declares such deceptive practices unlawful without regard to their actual effect on competition. More- over, the courts have repeatedly held that injury to competition may be inferred from the use of such practices. In a case where the price affixed to watches was marked up 400 per cent to allow direct sellers to cover busi- ness expenses, the fact that the discount stores normally sold the watches at a price far below that figure did not constitute a valid defense.9 The Commission pointed out that where a substantial amount of sales occurred below the price on the merchandise, the price was fictitious and de— ceptive. 7Leeds Travelwear, Inc., 61 F.T.C. 152 (1962). 8;g. at 166. 9Heibros Watch Co., 59 F.T.C. 1377 (1961). 129 There are certain situations where sales below the tagged price do not constitute a Section 5 violation. Where products are sold at different pre—ticketed prices in dif- ferent trade areas, the courts have allowed the practice and the Second Circuit stated: Pre-ticketing at one price within one trade area and at another price in another area is not deceptive if, in fact, the product is sold at the pre-tisketed price within the applicable trade area. Additionally, sales in the off—season below the pre— ticketed price are allowable if the normal season sales were made at the pre-ticketed price. Extended periods of sales below the pre—ticketed price may constitute a violation of Section 5.11 The F.T.C. has issued guides for pre-ticketing ac- tivities and other price related representations which may be pre-marked by a manufacturer, such as "cents off" or "specials," and they point out that a manufacturer may also be subject to liability in addition to the sellers of the merchandise, if he joins in the deception or if the ordin- ary business "facts of life" would give reason to believe that the prices may be used as deceptive information. The Commission has spelled out responsibility quite well in the ' s A ainst Dece tive Pricin which define retailer and loRayex Corp. v. F.T.C., 317 F.2d 290, 293 (2d Cir. 1963). 111d. 130 manufacturer responsibilities. The Guides point out: (a). Many members of the purchasing public be— lieve that a manufacturer's list price, or suggested retail price, is the price at which an article is generally sold. Therefore, if a reduction from this price is advertised, many people will believe that they are being offered a genuine bargain. To the extent that list or suggested retail prices do not in fact correspond to prices at which a substantial number of sales of the article in question are made, the advertisement of a reduction may mislead the consumer. (b). There are many methods by which manufactur— er's suggested retail or list prices are advertised: large scale (often nationwide) mass-media advertising by the manufacturer himself; pre-ticketing by the man— ufacturer; direct mail advertising; distribution of promotional material or price lists designed for dis— play to the public. The mechanics used are not of the essence. (c). There would be little problem of deception in this area if all products were invariably sold at the retail price set by the manufacturer. However, the widespread failure to observe manufactuer's sug— gested or list prices, and the advent of retail dis- counting on a wide scale, have seriously undermined the dependability of list prices as indicators of the exact prices at which articles are in fact gen- erally sold at retail. Changing competitive condi- tions have created a more acute problem of deception than may have existed previously. Today, only in the rare case are all sales of an article at the manu— facturer's suggested retail or list price. (d). But this does not mean that all list prices are fictitious and all offers of reductions from list, therefore, deceptive. Typically, a list price is a price at which articles are sold, if not everywhere, then at least in the principal retail outlets which do not conduct their business on a discount basis. It will not be deemed fictitious if it is the price at which substantial (that is, not isolated or insignifi- cant) sales are made in the advertiser's trade area (the area in which he does business). Conversely, if the list price is significantly in excess of the highest price at which substantial sales in the trade area are made, there is a clear and serious danger of the consumer being misled by an advertised reduc- tion from this price. 131 (e). This general principle applies whether the advertiser is a national or regional manufacturer (or other non-retail distributor), a mail—order or catalog distributor who deals directly with the consuming pub- lic, or a local retailer. But certain differences in the responsibility of these various types businessmen should be noted. A retailer competing in a local area has at least a general knowledge of the prices being charged in his area. Therefore, before adver— tising a manufacturer's list price as a basis for comparison with his own lower price, the retailer should ascertain whether the list price is in fact the price regularly charged by principal outlets in his area. (f). In other words, a retailer who advertises a manufacturer's or distributor's suggested retail price should be careful to avoid creating a false im— pression that he is offering a reduction from the price at which the product is generally sold in his trade area. If a number of the principal retail outlets in the area are regularly engaged in making sales at the manufacturer's suggested price, that price may be used in advertising by one who is selling at a lower price. If however, the list price is being followed only by, for example, small suburban stores, house—to—house canvassers, and credit houses, account- ing for only an insubstantial volume of sales in the area, advertising of the list price would be decep- tive. (g). On the other hand, a manufactuer or other distributor who does business on a large regional or national scale cannot be required to police or in- vestigate in detail the prevailing prices of his articles throughout so large a trade area. If he advertises or disseminates a list of pre—ticketed price in good faith (i.e., as an honest estimate of the actual retail price) which does not appreciably exceed the highest price at which substantial sales are made in his trade area, he will not be chargeable with having engaged in a deceptive practice. (h). It bears repeating that the manufacturer, distributor or retailer must in every case act hon— estly and in good faith in advertising a list price, and not with the intention of establishing a basis, or creating an instrumentality, for a deceptive com— parison in any local or other trade area. For in— stance, a manufactuer may not affix price tickets con- taining inflated prices as an accommodation to 132 particular retailers who intend to use such prices as the basis for advertifing fictitious price re- ductions. (Guide 111). The procedure of pre-ticketing or pre-marking the price on merchandise can be a useful practice in the VMS provided that the price tickets do not lead to collusive behavior on the part of intermediaries, that the service is made available to all buyers on a proportionally equal basis and that the pre-ticketed prices are not used as a deceptive device. Fair trade Fair trade programs for price protection may be de- fined as programs in which the minimum or absolute resale price is established by the seller and adhered to by channel members. Thus, the nature of fair trade pricing is similar to price fixing problems under the Sherman Act and FTC Act. There are specific differences between fair trade programs and per se price fixing programs. Fair trade programs are exempt from antitrust price fixing action by virtue of Federal enabling legislation. The enabling legislation is comprised of the Miller—Tydings Act and the McGuire Act. Both of these statutes expressly allow the individual states to determine the nature of any fair trade programs in their state. When individual states pass legislation allowing fair trade or resale price 12The entire text of these Guides may be found in Part 233 of the Federal Rules and Regulations at pages 15534-36. 133 maintenance, the enabling legislation exempts firms oper- ating in that state from coverage under the federal anti- trust provisions which prohibit price fixing. The policy behind fair trade programs is generally one of maintaining goodwill for owners of trademarked prod- ucts by not allowing their products to be used as discount or loss leader items in advertising or promotional programs. The Justice Department and Federal Trade Commission opposed enactment of the McGuire Act and have continuously recom— mended repeal of the federal enabling legiSlation because it allows dealers to escape the competitive atmosphere of free price competition and encourages horizontal price fixing. Fair trade has also been criticized by many legal scholars because of the apparent price fixing problems asso- ciated with the activity. One scholar points out: Fair Trade thus stands out plainly as a major departure from the most elementary assumptions of a free competitive enterprise economy and as a serious compromise of the federal antitrust policy. Among the freedoms which businessmen are normally thought to possess in a free enterprise order are two fundamental ones, both of which are engulfed by Fair Trade. One is that the owner of goods should be reasonably free to dispose of his property for whatever consideration he may obtain; this is the simple expectation of any entrepreneur in a capitalist system and interference with this ex- pectation has traditionally been regarded as tol- erable only under conditions of paramount public necessity such as war or other national emergency. Fair Trade is a rude compromise of this freedom without even the color of governmental supervision. Second, businessmen are supposed to be free to complete and are expected to compete with all fair means. Price competition is one of the most 134 meaningful forms of competition, both in its direct benefits to the consumer and in its pervasive im- portance in the automatic adjustment of economic forces; the Supreme Court has called the free price mechanism the 'central nervous system' of the economy. Each instance of Fair Trade saps a little of the strength of this presumably vital force, and if Fair Trade existed on a majority scale, serious doubt as to the continued existence of the free competition system would necessarily arise. In recognition of these facts, the United States Supreme Court has repeatedly held resale price maintenance agreements and nonsignor control to be no different from ordinary price-fixing and to be in clear violation of the Sherman Antitrust Act, punishable by criminal fine or imprisonment, unless plainly exempted by Congress. No amount of argument would seem effective to reconcile Fair Trade with antitrust policy in the face of these decisions. 13 The first test to determine the validity of a fair trade program is accomplished by examining the nature of the competitive situation. Only vertical relationships between firms at non—competitive levels are permissible under the Federal enabling legislation. This creates a problem for the integrated distributor if he also has traditional dis— tribution channels because intermediaries which he owns or controls may be in competition with other independent cus— tomers at the same level of distribution. In a case where an integrated drug manufacturer and wholesaler stipulated fair trade prices to independent wholesalers the Court found a per se violation of Section 1 of the Sherman Act since competitors at the same level (wholesale) were involved in setting prices. l3J. Rahl, The Case Against Fair Trade, 44 Ill.B.J. 754, 766-67 (1956). 14United States v. McKesson & Robbins, Inc., 351 U.S. 305 (1956). 135 Other provisions of the enabling legislation require that the product involved in the fair trade program be a "commodity which bears the trademark, brand or name of the "15 producer or distributor of such commodity. Enforcement of the provisions of the state programs, however, are not limited to the owners of the brand or trademark. Finally, the commodity involved in the fair trade program must be in free and open competition with other com— modities of the same general class or description. The free and open requirement was tested in the Eastman Kodak Co. v. F.T.C.l6 case in which Kodak was the only manufacturer of color film in a market area. The court said the product was not in the same class as black and white film and there- fore did not meet the free and open test. In a case where technological differences in cigarette lighters accounted for design differences, the function of the product was such that butane lighters were judged to be in free and open competi- tion with wick lighters as well as other forms of lighters. The free and open competitive requirement is the basis of Walter Adams' argument in favor of fair trade. He points out that other techniques used to accomplish resale price maintenance such as agency agreements, refusal to deal 15McGuire Act, 15 U.S.C. 45(a)(2) (1970). 16158 F.2d 592 (2d Cir. 1946). l7Ronson Patents Corp. v. Sparklets Devices, Inc., 112 F. Supp. 676 (D.C. Mo. 1953). 136 with price cutters or vertical integration which leads to monopolistic power are more dangerous to competition than "vigorous enforcement of the statutory requirement that price fixed commodities be in free and open competition."18 He further points out that "it seems wiser to demand exten— sion of the free and open competition proviso to other forms of resale price maintenance rather than to urge repeal of the only laws of which it is now an explicit part."19 The individual state laws will play an important role in determining the specific nature of fair trade pricing pro— grams. For instance, in Massachusetts a company has the right to establish resale prices without a specific fair trade agreement. A program to pay rebates to service sta- tions which adhered to suggested prices was lawful under the McGuire Act because the Massachusetts law does not define the form or content for resale price maintenance agreements. A Florida fair trade agreement which created a loss sharing policy between dealers was in violation of the McGuire Act since it was not consistent with the spirit of the Florida statute. Where state fair trade laws do not allow a prac— tice, the practice will also be condemned by Federal law. l8W. Adams, Resale Price Maintenance: Fact and Fancy, 64 Yale L.J. 967, 990 (1955). 19 a 20United States v. Socony Mobil Oil Co., 150 F. Supp. 202 (D.C. Mass. 1957). 137 One basic problem of fair trade programs centers on dealers who refuse to sign fair trade agreements. Some states allow a firm to enforce fair trade policies against dealers who have not signed such agreements. These states have nonsigner clauses in their fair trade statutes. If the provisions of resale are attached to the product or carton, some states infer agreement with those terms by the accep— tance of the product. The individual state programs will determine the nature of enforcement of fair trade provisions against dealers who refuse to sign agreements. Such statutes should be of decreasing importance to VMS planners because they are being declared unconstitutional in many states (see Figure 3). Certain attempts at circumventing the manufacturer's fair trade price policy have occurred. These situations generally involve the granting of excessive trade in allow— ances, the use of trading stamps or the combination sales of a fair traded product with other products in a "package deal." When a company established fixed trade-in amounts and specified the nature of allowable trade—ins, the Com- mission found a violation of Section 5 of the FTC Act.21 Trading stamp programs, because of their acceptance in super- market merchandising programs, have been held to be insig- nificant as price discounts in some states, but where the 21Walter E. Schwanhausser, 52 F.T.C. 28 (1955). Am if“ A. A . 138 wusH0mQ< EDEHcaz ou5H0mQ¢ ODDHOmQ< OUDHOmnm ESEflcHz Edeflcflz ESEHcfiz ODDHOmbm Esaflcflz EDEHcflz ou5H0mQ¢ ODDH0mQ¢ EDEHCAZ mp5H0QO mp5H0mQ¢ EDEHcflZ EDEAQHE EBEHCME ESEACHZ ESEfiCflZ EDEACHS mudeomna nuance: ponauoeuoa woeum Howsw> an Hopsw> Hopco> H0pcw> Hopcw> i. Hoocw> Hopcm> .1 Hopcw> Hopcw> Howam> .1 Howcm> .1 .1 .<. .1 k. HwHme Hotcw> at Honawm wnp an pmmmcmflmmp on Hafiz “mummwumsv Housnfluumflt pmuflnosusm can Mums mo Hoszo HO©Gm> counm ruuannu 1mm 0p thHHo Inudm cowuwm coummu uoz HMGOfluDUHumcoo HocOeusueumcoo HOGOHuspfiumqoosb Hocoaudueuucoo HMCOHusuHumcoo HMQOflusuflumcoocD Hmcoflpsufiumcoocb quoflusuflpmcooca HDGOfiusuflumcoo Hmcoapsuflumcooca HMQOHuSDAumcooQD HMGOAHSUHumcoucD Hoqoeusueumcoo Hocoeusueuncoo Hmcoflmsuflumcoocb HMCOfluDuflpmcoosa HMCOHudufiumcoocb HMGOADDUHumCOU HDQOflusuHumcou HOGOHDDDHDMGOUQD Hmcoeusuupmcoo HMGOAHSHflDM¢OOCD HMQOflusuflumsou mmsmao mumsmflmaoz MO muaHOGOHupuflumcoo mmoxmo sunoz mmflaoumo Quuoz xuow 3oz coaxmz 3oz mwmuwb 3oz OHH£mmEmm 3oz muommccflz cadence: mupmmsaommwmz pcmawumz DQMHMHDOH mxosucwx DBOH mcmfich MHOCHaHH OQMUH ummHowU NMUHHOHM mumsmaoo usuauowccoo Opmuoaoo mwcuowfiamo N mmmcmxud N OQONHH< ucmwwum pm mea wpwue Hamm HMQOflusqum Icoo Spas mouwpm 139 m mudmflm .Amnmav avow .mumm .mwm .mom opmHB N "onSOm .HOuLDQflHuvmflU UONHHOQUDQ UCM MHME MO MOQ3O um .pwpmou soon #0: mm: QOADOHmfiwwH mcmup Hamm mcHDMwa map mo muHHOCOHDSDflumsOO 039 N .mpusoo Hosea Ga tmuusooo w>m£ muHHmCOAHDDflpmsoo mo mummy mmwzea manaombd Hopcw> HMCOflpspHpmcou CachUMHB EDEHCHS * HOQOdepflumcooca DHchHfl> uwwz mu5H0mn< Hopqm> HMQOflusuflumsooca coumsflnmmz ESEHSHE « HDQOflusuflpmcoo macflmufl> wu5H0mQ¢ Hopnw> Hmcoflpsufipmcoo wmmmwcch ESEHQHE * Hmcoflpfipfluwcooca upoxma fludom EDEHCHZ Htho> HmcoflDDUHDMQOOCD mafiaoumo sudom mp5a0m£< Hopcw> Hmcoflwsuflumcoocb H macm>ammccmm EDEHCHZ r Hmcofipsuflbmcoocb comwuo ESEACHE HOpcw> thOHpgpflpmsOOCD maosmaxo EUEHCHZ Acomuwm N pmNflHosusm can MHME mo HOCBOV Houmflumonm Hwnoflusuflumaoo pom mmma Esaflsflz Hopcw> HMQOfipsuflpmGOOCD pom omma oaro 3333 moanm [mo 0p Umnnuo mo momma Hamm HOGOHUSH Igusfl somnwm muflHMGOHusuHumsoo Iflpmcoo Sues wopmum 140 stamps are granted above and beyond normal amounts the ef- fect may be a reduction in price which creates a violation of the manufacturer's fair trade policy.22 A unique approach to avoiding fair trade occurred where a grocery company al- lowed customers to purchase goods with a combination of cash and stamps. Because the value of the stamps was not a trade secret, as in other trading stamp company situations, and because the combined net price was far below the established fair trade price, the court allowed the manufacturer to cease dealing with the grocery company.23 Enforcement of the fair trade program is one of the chief reasons why such programs appear to be diminishing in importance. The establishment of a fair trade program by a manufacturer creates a burden of equal enforcement of the provisions of the program. If a firm selectively adminis— ters the program, the courts may invalidate the program as an unfair method of competition. Any party who is damaged because an agreement has been broken or because prices were not observed in states with nonsigner clauses may bring an action to recover dam— ages or to halt the practice. In addition, many states re- quire the manufacturer to enforce his program upon notice 22Colgate Palmolive v. Max Dichter & Sons, 142 F. Supp. 454 (D.C. Mass. 1956). 23Vornado, Inc. v. Corning Glass Works, 388 F.2d 117 (3d Cir. 1968). 141 by any intermediary that a dealer is not observing the sug- gested resale prices. The confusion over what is required in each individual state, the responsibilities of enforcement, and the insistence of the Federal Trade Commission and the Justice Department to keep fair trade contracts as competitive as possible have led to the difficulties which fair trade programs presently find confronting them. The VMS designer must also make certain that any at- tempts at integrating the distribution channel do not invali- date the fair trade program under the horizontal price fix— ing rule. Thus, a fair trade program may be a means of re— quiring individual members of the distribution channel to ad- here to defined functional responsibilities in an effort to avoid McKesson—Robbins type price fixing actions against the firm. Because of the many problems which confront the firm contemplating the use of fair trade as a price protection mechanism appears to be on the decline. This can be attri- buted to the fact that slightly more than half the states have effective fair trade legislation at present and contin— ual erosion of price maintenance programs is occurring through judicial interpretation and legislative repeal. The VMS planner who feels that uniform resale prices are necessary for national promotional success or other strategic reasons may find alternative means to enforce resale 142 price maintenance. Agency agreements or refusals to deal may offer effective resale price control without the prob— lems of individual state fair trade laws. A summary of the basic provisions of the individual state fair trade statutes appears in Figure 3. Franchise pricing Before an analysis of the current legal environment surrounding franchise pricing programs can be undertaken, it is necessary to define the term franchise. Gladys Glickman says: In its simplest terms a franchise is a license from the owner of a trademark or trade name per— mitting another tg4sell a product or service under the name or mark. This is consistent with the judicial View that a trademark or trade name is necessary for a franchise and may be the "cornerstone of a franchise system."25 Other forms of fran— chises may deal with entire marketing programs which have been successful. The key element in every franchise distri— bution program involves the permission by the owner of the brand or trade name to sell a specific product, a product line, or furnish a specific service. In any franchise where permission to use the brand name or trademark is granted by the franchisor control techniques will be necessary to 2415 G. Glickman, Franchising in Bus. Organizations, Section 2.01 TI???T?==== 25Sussex v. Carvel Corp., 206 F. Supp. 636 (S.D. N.Y. 1962). 143 insure adherence by the franchisee to the standards estab— lished by the franchisor.26 Elaborate franchise mechanisms assist the franchisee in location analysis, design, inventory management, and product procurement in addition to promotional assistance and other traditional marketing variables. Con— versely, simple franchise systems exist whereby a dealer re- ceives the right to sell a particular line of merchandise. Franchise pricing may be defined as a protective pricing program whereby the manufacturer or franchisor sug— gests resale prices to channel members or franchisees and utilizes control techniques to insure compliance. Pragmatic— ally, most franchisors will utilize the threat of refusal to deal or franchise termination to maintain control over the resale price of their products. This procedure may be neces- sary from the standpoint of the manufacturer to insure that his national promotion program is received or perceived properly and/or that images or values he wishes to create or impart on the product are not destroyed by ruinous price cut- ting or the use of the product as a loss leader. Indeed, protection of the firm's market demand may be at issue since undesirably high prices may limit, at the manufacturer's ex- pense, the volume of business which the franchisees, and 26Such control techniques may involve a tying arrange- ment which could constitute additional Violations of the Sherman Act. For a discussion of tying arrangements in a franchise situation, and the defenses available, see M. L. Erickson, Siegel v. Chicken Delight: Continued Erosion of Defenses to Tying Arrangements, 9 Am.Bus.L.J. 21 (1971). 144 consequently the manufacturers, are able to generate. In such a situation, excessive margins at the retail level may create substantial profit for the retailer at the expense of the manufactuer's total sales volume. In a recent deci- sion in the First Circuit, Judge Coffin pointed out: ". . . in the case of a single manufactuer's policy to set ceilings above which resale prices shall not rise, the mo— tive and the pressure must be, in the great generality of cases, the manufacturer's desire to maximize his profits."27 This proposition is at the root of demand analysis situa- tions when applied to vertical marketing systems. There are, however, dangers in exerting force over resale prices in a distribution channel except where the privilege is granted by statute such as in states that have fair trade laws which allow the manufactuer and his dealers to enforce minimum resale prices. Where fair trade laws do not exist, many controlling and coercive strategic ac— tions to insure price adherence will constitute violations of Section 1 of the Sherman Act. The Court in the Socony case enumerated the differ— ent types of activities that would be considered to be price fixing when they pointed out: Under the Sherman Act a combination formed for the purpose and with the effect of raising, depressing, fixing, pegging, or stabilizing the 27Quinn v. Mobil Oil Co., 375 F.2d 273 (lst Cir. 1967). 145 price of a commodity in intfigstate or foreign commerce is illegal per se. The key element again appears to be the agreement by members in the chain, which constitutes a combination in violation to the Sherman Act. The classic case in resale price establishment and dealer selection is United States v. Colgate & €0.29 case the position of the Court was described in the now famous "Colgate doctrine" which points out: In the absence of any purpose to create or main- tain a monopoly, the act does not restrict the long recognized right of trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal. And, of course, he may announce in advance the garcumstances under which he will refuse to sell. The Colgate doctrine, then, spells out the rights of the seller, on a strictly unilateral basis, to determine the conditions of resale and with whom he will deal. Subsequent decisions have eroded this position in certain areas. In United States v. Parke—Davis & €0.31 the Court held that a program of resale price maintenance involving wholesaler support, discussions with retailers to gain other retailer's support, and other factors were clearly outside 28United States v. Socony-Vacuum Oil Co., 310 U.S. 150, 223 (1939). 29250 U.S. 300 (1919). 3°;g. at 307. 31 362 U.S. 29 (1959). In that 146 the allowable bounds of Colgate, and that the practices were in violation of Section 1 of the Sherman Act because: What Parke-Davis did here by entwining the wholesalers and retailers in a program to pro- mote general compliance with its price maintenance policy went beyond mere customer selection and cre— ated combinations or cogfipiracies to enforce re— sale price maintenance. The strength of the Colgate doctrine was further eroded when the Court found that because the dealer had agreed to the price structure there was enough to constitute the elements of conspiracy necessary for a violation under Section 1 of the Sherman Act.33 Thus, the original strength of the Colgate doctrine, allowing a range of expectations which the seller or fran— chisor could establish, has been gradually eroded to the point where many scholars and legal authorities believe it has become ineffectual. The extension of control beyond the simple refusal to deal has become the major difficulty. Professor Pitofsky believes the Colgate doctrine is dead because: . . . exceptions have been piled upon exceptions to the point where it is now impossible in this day of complex business Siansactions not to over- step limits on the rule. Thus, because there are so many conditions which create the 32Id. at 37-38. 33R. Pitofsky & K. Dam, Is the Colgate Doctrine Dead?, 37 Antitrust L.J. 772, 779 (1968). 34 m- 147 overstepping of that simple refusal, many scholars believe the doctrine is dead. Professor Dam, on the other hand, believes the doc— trine is still alive even if somewhat weaker. He points out: It is true that the Supreme Court has in the past ten years steadily tightened the noose about Colgate's neck. But it is highly significant that the Supreme Court has been careful to find every case an agreement of some kind, whether it be called a contract, combination or conspiracy, as a pre— requisite to liability . . . . as long as that re— quirement still §§ands, one cannot fairly say that Colgate is dead. The key issue appears to be the existence of an agree— ment between the manufacturer and seller, between sellers, between other sellers and the manufacturer, etc. If agree- ment does not exist, at least for the present, the Colgate doctrine still applies. In a situation where a manufacturer pre—ticketed his luggage and suggested that dealers observe the suggested prices, the court did not find a violation when the manufacturer terminated a discounter for not observing suggested prices.36 The Court said that the unilateral de- cision to cease dealing with a dealer in violation of its policies was acceptable provided there was no showing of an agreement or conspiracy. The Court went on to point out that the use of behavior as circumstantial evidence of agreement is not enough to constitute a violation since sound business 351d. at 784. 36Klein v. American Luggage Works, Inc., 323 F.2d 787 (3d Cir. 1963). 148 practice would dictate the similar behavior of dealers in many cases. The Court said: This Court has never held that proof of parallel business behavior conclusively establishes agreement or, phrased differently, that such behavior itself constitutes a Sherman Act offense. Circumstantial evidence of consciously parallel behavior may have made heavy inroads into the traditional judicial attitude toward conspiracy; but 'conscious' parallelism has not ygt read conspiracy out of the Sherman Act entirely. Agreement becomes the central issue in franchise pricing because "the statutory scheme relfects a philosophy that exalts the liberty and initiative of the individual en- terprise and looks with suspicion on collective action." The probing for agreements, express or substantially implied, becomes the key issue in determining the present legal environment for franchise price decisions. Because agreement is a requisite element for a violation of Section 1 of the Sherman Act, some evaluation of the techniques the authorities will utilize to test for agreement becomes neces— sary because "the troublesome distinction between unilateral and conspiratorial acts was not invented by Colgate but by Congress when it framed the language of Section 1 of the Sherman Act."39 37Theater Enterprises, Inc. v. Paramount Film Dist., 346 U.S. 537, 540—41 (1954). 38C. Fulda, Individual Refusals to Deal: When Does Single Firm Conduct Become Vertical Restraint?, 30 Law & Contemp. Prob. 590, 603 (1965). 391d. at 597. 149 The courts will utilize a number of evaluative devices in an attempt to determine whether conspiracy or agreement exists in a given situation. Among these, it has been sug— gested, can be over announcement, under enforcement and over policing. Over announcement problems involve situations where manufacturers go beyond the simple announcement of policies by continuously sending out price lists, or by circulating cancelled dealer lists, or by any other means which could be construed as being more than is required to communicate the firm's policies. Where such announcements are used to solicit agreement with the policy, the Sherman Act will be violated. Obtaining assurances of price maintenance from pros— pective customers would constitute agreement. Pre—ticketing which is very difficult or impossible to remove, in the ab— sence of fair trade legislation, may constitute over announce- ment since the dealer would not be free to set prices above the ticketed amount.41 The practice of gaining assurances a priori, bonbarding the dealers with notices or threats of cancellation, or other over announcement policies may con— stitute enough to find an agreement or conspiracy which is not a simple unilateral action on the part of a manufacturer. 40H. Halper, Individual Refusals to Deal: Customer Selection or Dealer Protection?, A.B.A. Sect. on Antitrust Law 49 (1963). lKiefer-Stewart Co. v. Joseph E. Seagram & Sons, Inc., 340 U.S. 211 (1951). 150 Donald Turner points out: If a manufacturer induces acquiescence by his distributors in a policy of resale price maintenance, he has created a series of tacit vertical agreements, and it seems wholly irrelevant to that conclusion that he obtained these tacit agreements by threats of refusal to deal, cggried out against those who refused to acquiesce. Simple adherence to suggested prices may constitute enough for the court to construe an agreement. Indeed in a famous footnote43 to a recent Supreme Court case dealing with newspaper carriers and their adherence to suggested prices, the Court stated: Petitioner could have claimed a combination between respondent and himself, at least as of the day he unwillingly complied with respondent's adver— tised price. Likewise, he might successfully have claimed that respondent had combined with other carriers because the firmly enforced price policy applied to all carriers, most of whom acquiesced in it. If a manufacturer repeatedly warns a channel member regarding his policy, and then terminates the franchise, a violation may result.45 A petroleum company which was successful at getting the dealer to adjust his prices was held to be in violation 42D. Turner, The Definition of Agreement Under the Sherman Act: Conscious Parallelism & Refusals to Deal, 75 Harv. L. Rev. 665, 689 (1962). 43R. Kamenshine, Competition Versus Fairness in Franchising, 40 Geo. Wash. L. Rev. 197, 201 (1971). 44Albrecht v. Herald Co., 390 U.S. 145, 150 n.6 (1967). 5Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134 (1968). 151 of the Sherman Act because the procedure was found to con- stitute a conspiracy to fix resale prices.46 Compliance after a complaint by the seller will probably constitute enough to find a violation. It can be concluded that there is a great deal of evidence to support the concept that acquiescence to sug- gested prices due to over announcement or over enforcement may constitute a violation of Section 1 of the Sherman Act. However, this argument, draws criticism because: The notion that any retailer who accepts goods for distribution with knowledge of the manufac— turers announcement as to observance of retail prices gives an implied promise to comply may be logical, but, as a general proposition, it is irreconcilable with Colgate, which allows advance announcements of the circumstances undir which the manufacturer would refuse to deal. The conclusion must be reached that the current status of the Colgate doctrine is precarious at best if a seller utilizes any tactice to announce prices other than the most simplistic ones. Over policing of dealers in a franchise system may be enough to constitute the "something more" which creates agreement. In Parke—Davis,47 where the wholesalers were used to police retail prices, the Court found a violation saying that the combination went beyond the simple refusal to deal in Colgate. 46Simpson v. Union Oil Co., 377 U.S. 13 (1964). 47Fulda, supra note 37, 595. 48United States v. Parke—Davis & Co., 362 U.S. 29 (1960). 152 The use or assistance of other distribution channel members to police a resale price program is allowable only in states which have fair trade legislation allowing such activity. In the absence of such legislation policing pro- grams utilizing intermediaries create a combination, the necessary element for violation under the terms of Section 1 of the Sherman Act. In a case where General Motors enlisted the aid of dealers and customers in Los Angeles to identify dealers who were selling below suggested prices, the Court declared that an agreement existed in violation of Section 1 of the Act.49 In addition, blacklists or recurrent lists of auth— orized dealers which are used to identify those cancelled because they did not adhere to the suggested prices may constitute enough to find coercion under Section 1 of the Sherman Act. Under enforcement or selective enforcement of the suggested price policy may constitute "something more" neces— sary to find the boundaries of Colgate have been exceeded. Selective enforcement creates a potential violation because it results in different standards being applied to the firm's customers. The requirement of a simple unilateral refusal is not met when some customers are allowed to violate the policy while others are cancelled immediately if price cut- ting is discovered. 49United States v. General Motors, 384 U.S. 127 (1966). 153 If salesmen or sales representatives are utilized as the firms "checking up" individuals, there is a natural conflict present in the situation because of the salesmen's desire to maintain a large number of dealers and sales vol— ume. If in such a situation, one salesman is very diligent in reporting price cutting and cancellation of offending dealers results, while another salesman continually warns the dealer but does not report the offender, agreement be- tween the manufacturer and dealer may be inferred and viola- tion of the Act may result.50 For this reason, enforcement procedures must be equally applied if safety of the pricing program is to be retained. The safe area for design of a franchise pricing sys— tem appears to hinge on the very narrow recent interpreta— tions of the eroding Colgate doctrine. In a case where a manufacturer suggested prices to a dealer, and terminated his lease for not observing the prices the court found that because the dealer had not acquiesced, no agreement had oc- curred and the cancellation was an allowable refusal to deal under the Colgate doctrine. The Court has left little room for error under the Colgate doctrine, but only enough so that the simplest of franchise pricing programs may be successful. The Court of 50Klein v. American Luggage Works, Inc., 323 F.2d 787 (3d Cir. 1963). 51Quinn v. Mobil Oil Co. 375 F.2d 273 (lst Cir. 1967). 154 Appeals in the Second Circuit summed the situation very nicely when they pointed out: The Supreme Court has left a narrow channel through which a manufacturer may pass even though the facts would have to be of such Doric simplicity as to be somewhat rag? in this day of complex buSiness enterprise. The concept of "Doric simplicity" has been described by many legal scholars as the only remaining safe area under the Sherman Act. That is, if a manufacturer engages in a program of pricing which includes announcement of suggested prices and a policy statement which indicates that refusal to sell at suggested prices will be grounds for termination, it appears that a unilateral cancellation is permissible under the Colgate doctrine. Any activity which creates less than "Doric simplicity" in the program such as over announc— ing, over policing, or under enforcing will render the pric- ing program violative of the Act. In addition to the thin line of Doric simplicity under the Sherman Act, Section 5 of the Federal Trade Com- mission Act may create problems for the firm because of un— fair business practices. In a situation where resale price maintenance was accomplished through a policing plan of checking invoices, the Commission held that they would not be able to "discontinue or threaten to discontinue distri- butorships for the purpose of or with the effect of causing George W. Warner & Co. v. Black & Decker Manufac— turing Co., 277 F.2d 787, 790 (2d Cir. 1960). 155 adherence to any prices, terms, or conditions of resale."53 Thus, it appears that the Commission will consider price maintenance programs under the jurisdiction of Section 5 of the FTC Act. In conclusion, it appears that the legal environ— ment is hostile to the establishment of protective franchise pricing systems. Additionally, to attain the Doric simplic— ity standard may be impossible given the complexity of re- lationships in most distribution channels. The general rules resulting from such characterizations of the legal climate would have to be stated as: l. The firm may suggest prices through price tickets, price lists, advertising or other . . . . . . 54 information which is not over informative. 2. Only in states permitting Fair Trade pro- grams may price listgsbe included in the franchise agreement. 3. The firm may state the conditions under which they will refuse to deal. 4. Policing must be on a unilateral basis with no assistance from other members of the dis— tribution channel, competitors, or customers. If these guidelines are followed, the firm's pricing policy may pass through the "narrow channel" left by the courts and find itself sheltered under the Colgate doctrine.56 53The Roberts Co., 56 F.T.C. 1569, 1591 (1960). 54Engbrecht v. Dairy Queen Co. of Mexico, Miss., 203 F. Supp. 714 (D.C. Kan. 1962). 55Advisory Opinion No. 382 (1969) 76 F.T.C. 1113. 56For a seminar discussion of the applicability of present law to different situations see Marketing and 156 The reality of resale price fixing presents a differ— ent picture. Even though the present status of resale price programs is precarious, 97 per cent of those franchisors studied by Gillespie suggested resale prices, of which 41 per cent included control of the resale price in the fran— chise contract, which quite clearly constitutes agreement.57 This data strongly suggests one important factor with respect to resale price maintenance programs: the agencies respon- sible for policing the Sherman Act (The Antitrust Division of the Justice Department) and_the Federal Trade Commission are seriously under funded if total control is the objective. It is likely that a manufacturer in violation due to his pricing program may not be identified. On the other hand, the VMS planner when determining the nature of the franchise pricing program must be aware of the illegality of the ac- tions, since violation of the Sherman Act carriers criminal as well as civil penalties. Agency agreement Agency is primarily a legal concept which has been applied to business relationships of specified characteristics. Agency has been defined as "the fiduciary relation which Franchising: Antitrust Prognosis for the 70's 39 Antitrust L.J. 502 (1970). 57S. Gillespie, An Analysis of Control in Franchise Distribution Systems (1966), in D. Thompson, Franchise Operations and Antitrust, 46 (1971). 157 results from the manifestation of consent by one person to another that the other shall act on his behalf and subject "58 The to his control, and consent by the other so to act. pragmatic definition of agency is a relationship where one party, by agreement, acts in behalf of another party. In vertical marketing systems there are a number of situations where an agency relationship will be desirable. It must be recognized that establishment of such a relationship may impose serious financial burdens upon the firm. In order to maintain title, dominion, and risk, the manufacturer will find it necessary to finance his agent's inventory. Legal problems may also arise when agency is used as a means of effecting resale price maintenance. Long ago the Court ruled that the use of the term "agency" could not cover up a system of essentially indepen- dent resellers being controlled in their resale prices. An actual agency relationship was discussed by the Court in the United States v. General Electric Co.60 case when they said: We are of opinion, therefore, that there is nothing as a matter of principal, or in the authori— ties, which requires us to hold that genuine con— tracts of agency like those before us, however com- prehensive as a mass or whole in their effect, are 58Restatement (Second) of Agency Section 20 (1957). 59Dr. Miles Medical Co. v. John D. Park & Sons, 220 U.S. 373 (1911). 60272 U.S. 476 (1926). "5.545 158 violations of the Antitrust Act. The owner of an article, patented or otherwise, is not violating the Common law, or the Antitrust law, by seeking to dispose of his article directly to the consumer and fixing the price by which his agents giansfer the title from him directly to such consumer. The decision in General Electric allowed a firm, if it es— tablished a genuine agency relationship with its channel members, to establish the resale price on the commodities which it consigned to the dealers or agents. The ruling was based on the concept that since the product was not sold to the agent, the manufacturer still had the right to estab— lish the price at which it would be sold. The General Electric guidelines on agency relation- ships as a price maintenance mechanism existed until 1964 when the Supreme Court substantially limited the power of price establishment in an agency relationship in the case of Simpson v. Union Oil Co.62 Simpson was a retail gasoline dealer for Union Oil. A lease, renewable on a yearly basis, was cancelled because Simpson had not adhered to the sug— gested prices on gasoline consigned to him under the “agency" relationship of Union Oil. The Court said: Dealers, like Simpson, are independent busi— nessmen; and they have all or most of the indicia of entrepreneurs, except for price fixing. The risk of loss of the gasoline is on them, apart from acts of God. Their return is affected by the rise and fall in the market price, their commissions declining as retail prices drop. Practically the only power they have to be wholly independent business— men whose service depends on their own initiative 611d. at 488. 62377 U.S. 13 (1964). 159 and enterprise is taken from them by the proviso that they must sell their gasoline at prices fixed by Union Oil. By reason of the lease and 'consign— ment' agreement dealers are coercively laced into an arrangement under which their supplier is able to impose noncompetitive prices on thousands of persogg whose prices otherwise might be competi— tive. It is clear that the Court was concerned that true agency relationships be maintained if resale price maintenance was an element of the strategic marketing program. The Court went on to point out that the General Electric decision could be applied only to patented products.64 The decision represented an indirect attack on the General Electric deci— sion in the sense that the decision was not overruled, but was severely undercut as a matter of legal principle. Sub— sequent decisions have upheld the Simpson doctrine, that un- patented goods may not be part of a price maintenance con— signment distribution plan, but have not been eager to apply it on a retroactive basis. The confusion in the legal66 and scholarly community over the Simpson decision was pointed out by Milton Handler when he said, "There is a puzzling schizophrenic quality to 63;g. at 20. 64;g. at 24. 5Lyons v. Westinghouse Electric Corp., 235 F. Supp. 526, 537 (S.D.N.Y. 1964). 66C.B.S. Business Equipment Corp. v. Underwood Corp., 240 F. Supp. 413, 425 (S.D.N.Y. 1964). 160 the Court's opinion in Simpson."67 The position of estab— lishing each decision on the special facts in each case ap- pears to be the present posture of the courts.68 The con— fusion over Simpson has not allowed the development of guid- ing principals but forces a unique determination in each case. Additional consideration of the Simpson decision raises the question of the indirect purchaser. If a firm may not, through agency, control the resale price of a product, how are they to insure that indirect purchasers receive the same price as the large direct buyers which the Robinson— Patman interpretations require? Still unclear is the case of the very clearcut agency situation which is not viewable as a sham as was the agency in Dr. Miles and as it was sug— gested in Simpson. The current legal environment for VMS design using agency as a means to establish and maintain resale prices produces difficulties for the distribution planner. Agency no longer provides protection for a resale price maintenance scheme in the absence of a patented product. Indeed, one decision where sales of patented and unpatented products were mixed together declared the relationship unlawful.69 67M. Handler, Recent Antitrust Developments--1964, 63 Mich. L. Rev. 59, 62 (1964). 68Sun Oil Co. v. F.T.C. 350 F.2d 624 (7th Cir. 1965). 69United States v. General Electric Co., 303 F. Supp. 1131 (S.D.N.Y. 1969). 1 161 It appears that the value of agency has been eroded substantially as a method of achieving price maintenance in the distribution channel. Further interpretation may define the necessary elements to achieve a "genuine" agency rela- tionship, and resolution of the effect of agency on the market will be determined by further court decisions on the issue. Until that resolution occurs, potential users of the agency device should exercise caution because of the poten- tial problems to be encountered with the Sherman Act and Federal Trade Commission Act. Inventory Protection Inventory protection can be a valuable tool in the VMS, particularly in industries having seasonal or cyclical sales patterns or where perishability or salability of the goods changes very quickly. Protection of the value of the inventory in the hands of dealers can do a great deal to build reseller confidence and maintain adequate field inven— tory levels. The present legal environment regarding inven- tory protection programs will be examined in the following sections. Consignment selling Consignment selling is a term used to indicate the distribution process whereby merchandise is placed in the hands of the reseller, but payment for the merchandise is delayed until it is sold. The practice of consignment 1&1 ‘ 5:; . 162 selling is often used where capital is unavilable to retail dealers, new lines are attempting to secure distribution, or control of the product to the point of resale is desired. The VMS planner must be aware of the potential problems which may occur as a result of a consignment sales program. The basic doctrine with respect to such programs allows the firm substantial discretion in the actions which they wish to take, with the exception of price fixing activities on unpatented products. Indeed, the provisions of the Robinson— Patman Act do not apply to some agency—consignment plans since no sale or purchaser is involved.70 For this reason, pricing programs which wish to differentiate between pur- chasers may attempt to establish an agency relationship which will remove the practice from the jurisdiction of the Robinson-Patman Act. Although no cases have directly dealt with this question, if the outcome of such strategies results in a restraint of trade, the courts or Commission may abandon the requirement of sale to create "purchasers" in an effort to bring the practice under the jurisdiction of the Robin— son—Patman Act.71 Further problems revolve around the question of 7OLoren Specialty Mfg. Co. v. Clark Mfg. Co., 360 F.2d 913 (7th Cir. 1966). 71All Books, Inc., 67 F.T.C. 1073, 1118 n.10 (1965). 163 Agency since return privileges automatically pertain to consignments under a principal-agent relationship, but can also be created by a return policy on merchandise which has been sold.72 Problems dealing with return privileges under a sales contract will be dealt with in a later section in this chapter. The use of consignment selling as a device to gain additional sales also presents potential problems under the FTC Act which prohibits unfair methods of competition. Where a manufacturer secured new sales by supplying equipment such as cabinets, purchased inventory in competitors products, and set dealers up on consignment programs, the court found no violation of the Robinson—Patman Act since the case was brought by a competitor of the firms' customer. The court cautioned that the practice appears to be "more in the na— ture of unfair competition than a violation of the antitrust laws."73 These actions plus the court's statements would indicate that the use of consignment selling as a means of competing for new customers must be utilized with great care in order that Section 5 of the FTC Act not be violated. Consignment selling programs can be valuable tools to the VMS designer in establishing field inventories, assist— ing dealer financing programs and gaining new dealers, but 72Students Book Co. v. Washington Law Book Co., 232 F.2d 49 (D.C. Cir. 1956). 73Ludwig v. American Greetings Corp., 264 F.2d 286 (6th Cir. 1969). 164 care must be taken that false agency relationships not be created which will bring the agreements under the shadow of the Robinson-Patman, thus creating problems of the agree- ments being viewed as additional discounts or merchandising services. Memorandum selling Memorandum selling may be used in a VMS to replenish stocks which have been delivered by a retailer to direct buy- ing customers of a manufacturer or supplier and as such can be a valuable tool for the firm because of its market proxim— ity. Memorandum selling can be defined as a technique of sale whereby the manufacturer solicits the order but deliv— ery is made from the stock of an intermediary who receives a credit against purchases for the merchandise delivered plus some reasonable allowance for the service provided. This type of transaction is a variable of importance to manufacturers in industries which have characteristics of high inventory turnover such as the food industry. Many manufactuers will have retailers designated as supply points for emergency replenishments of customers. In a situation where General Foods utilized certain distributors for such deliveries, and gave the distributors special payments, the Commission found no violation since the wholesale distribu- tors had provided special services for the manufacturer in order to receive the payments, and, in addition, the 165 distributors were not 'purchasers" for purposes of Section 2(a) of the Clayton Act as amended by the Robinson—Patman 74 Act The Commission did point out that the favored use of certain distributors may constitute an unfair method of competition under Section 5 of the FTC Act.75 Another legal problem which may be encountered when using credit memoranda involves the use of the memoranda to conceal a discrimination under Section 2(d) of the Robinson— Patman Act. A firm issued credit memoranda only to certain customers who were advertising its products and assisting in the delivery of the product to their competitors.76 Because the payments by memoranda were available only to certain cusomters the Commission found a violation of Section 2(d) of the Clayton Act as amended by the Robinson-Patman Act and pointed out that the memorandum could not be used as a device to mask a discriminatory practice. In addition, price discounts on quantity purchases which were issued by memor- andum created a violation of Section 2(a) of the Act.77 In conclusion, the use of a credit memorandum may be valuable in the VMS to maintain stocks to key customers, but when the variable is used as a selective technique to 74Generai Foods Corp. 52 F.T.C. 798 (1956). 75;g. at 815. 76c. F. Sauer Co., 33 F.T.C. 812 (1941). 77;g. at 828. 166 grant additional discounts or payments to favored customers, a violation of the Clayton Act as amended by the Robinson— Patman Act, Section 2(a) or 2(d), or the FTC Act, Section 5, may result. Liberal returns allowances One means of accomplishing inventory protection for members of a VMS can be the establishment of a return-for- credit policy for merchandise which has lost its salability due to seasonal factors, or where the demand fluctuates for other reasons. In order to insure adequate dealer stocks, it is often necessary to guarantee repurchase or credit for all unsold merchandise. Certain uses of a liberal returns allowance have been found to be violations of the antitrust laws. A greeting card company which utilized a return for full credit policy on seasonal greeting card sales was in violation of Section 2(e) of the Clayton Act as amended by the Robinson—Patman Act because the service was only avail- able to certain favored customers, and not to all customers on a proportionally equal basis as the law requires. A percentage return plan which a publisher utilized was also in violation of the Clayton Act because it was avail- able only to bookstores which generally sold new books, and was withheld from stores which did substantial volume in 78American Greetings Corp., 49 F.T.C. 440 (1952). 167 used texts. The fact that the bookstores were in competi— tion for sales of books to students meant that the propor- tional test of Section 2(e) did apply to the policy.79 A further problem under the Clayton Act may result if percentage allowances are established for returned mer— chandise which are not equal to the original cost of the goods and which represent different percentages for differ— ent purchasers. The Commission could view such practice as a reduction in the effective price paid by the favored cus- tomers and draw the practice under Section 2(a) of the Act. The general legal environment regarding return poli- cies appears to be one which will evaluate the strategy under the merchandising services provisions of Section 2(e) of the Clayton Act as amended to determine if the practice meets the current defined standards discussed in the FTC Guides on 80 The key merchandising services as described in Chapter II. issue for the VMS planner appears to be the problem in estab- lishing a return program which will be proportionally avail- able to all purchasers, direct or indirect. Rebate programs Rebate programs may be used in a VMS to encourage dealers to purchase additional quantities or take on new lines. Both of these results will have an impact on 79Appleton—Century--Crofts, Inc., 47 F.T.C. 1371 (1951). 8034 Fed. Reg. 8285—89 (May 29, 1969). 168 inventory levels. Rebate programs are defined as programs which make payments of money or additional goods conditioned upon purchases of Specified products. In general, any rebate program which is not available to all customers on propor— tionally equal terms will be a violation of the Robinson—Pat— man Act as discussed in the Free Goods section of Chapter II. A stiuation directly related to the use of rebated occurred in Viviano Macaroni Co. v. F.T.C.81 A macaroni manufacturer, in order to secure the business of a large new account, offered (as an incentive) to replace on a one—for one basis every unit ordered on the first two orders. The court found that since there were no similar offers from competitors the program resulted in discrmination to the other buyers of Viviano's macaroni; such discrimination constituting a violation of Sec- tion 2(a) of the Robinson—Patman Act. Even if no competitors are in the trading area, and the practice thus cannot be in violation of the Robinson—Patman Act, a further danger still exists. The use of a rebate program may be declared an un— fair method of competition under Section 5 of the FTC Act. This possibility is extremely great if the firm offering the rebate is large and the competing sellers of similar products are smaller by comparison. The use of rebateprograms has potential value in the VMS. There are specific situations, such as new dealer open- ings, where such practices are condoned. However, in most 81411 F.2d 255 (3d Cir. 1969). 169 cases, the use of rebates, unless available to all customers, will constitute a violation of the Robinson-Patman Act and may involve unfair competition under Section 5 of the FTC Act. Reorder guarantees Reorder guarantees play an important role in the distribution of goods which are being newly introduced to the market or require extensive expenditures on demand cre— ation activities. Reorder guarantees may be defined as con— tractual guarantees granted by a seller specifying minimum quantities of a good which must be available over some spec— ified period. The concept of the reorder guarantee, when evaluated from a legal perspective, is one of both contract and the grant of a merchandising service. Under contract law three elements must be present to have a valid contract specifying the reorder program. These elements include offer, accep— tance, and consideration. The questionable element in a re— order program would be the presence of consideration. Consideration is what one party gives up in return for something from the other party. In distribution channels something may be given up for the guaranteed right to re— purchase. That something may not necessarily be dollars or prices, but may be shelf space, or the planned expenditure of large amounts of money to introduce a new product. Such benefits relinquished by a buyer can constitute consideration ‘.":’l .u 170 and a binding contract can thus be formed. A buyer who has been granted a reorder guarantee, but whose guarantee has not been honored, may institute a suit for breach of contract. Additional legal difficulty may occur if reorder guarantees are offered only to certain customers in a partic— ular market area. The inventory replenishment service would be under the operation of Section 2(e) of the Clayton Act which requires that the guarantee contracts be made available on a preportionally equal basis to all buyers. Reorder guarantees can be useful strategic variables, particularly in times of expanding demand for a product, but care must be taken by the VMS planner to insure that breach of contract or actions under Section 2(e) of the Clayton Act do not occur due to the characteristics of the program. Guaranteed support of sales events Guaranteed support of sales events deals with the willingness of the manufacturer to support the dealers' pro- motional expenditures with backup inventories. Thus, if a promotional event is extremely successful additional merchan— dise may be necessary to replenish depleted dealer inven— tories. To the extent that a manufacturer makes this service available to one retailer or buyer in a particular market, it must be made available to all dealers on a proportionally equal basis since this activity will be defined by the Com— mission as a merchandising service and subject to Section 171 2(e) of the Robinson-Patman Act. The availability of the service to all buyers, direct or indirect, is a necessary element of the program under the FTC Guides for such ser— vices. In conclusion, guaranteed inventory support for dealer sales events may be utilized in a VMS, but it must be made available to all buyers, direct or indirect, on a pro— portionally equal basis, consequently, the practicality of such a strategy is severely limited. Maintenance of "spot" stocks and fast delivery Maintenance of "spot" stocks and fast delivery can be of value in the VMS by allowing better service for pur— chasing customers, and thereby establishing better channel relations. Spot stocks may be defined as small inventories held near markets to service unexpected demand. In a case where General Foods used the inventories of eealers to back up the factory shipments to institutional direct buying customers, the Commission determined that the payment to distributors for providing the service was not discriminatory since it was not a purchase under the Robinson— Patman Act provided that all the distributors had equal prob- abilities of receiving such payments.83 The Commission said that the use of distributors' stocks to service direct 8234 Fed. Reg. 8285—89 (May, 29, 1969). 83General Foods Corp., 52 F.T.C. 798 (1956). 172 buying customers was "not the kind of practice which is with— in the prohibitions contemplated by Section 2(d) of the Act."84 If the buyer of the goods receives faster delivery than competing buyers another problem may occur under Sec- tion 2(d) of the Robinson-Patman Act. Where the services are received by "purchasers, the Commission may find a vio- lation since delivery programs are one of the merchandising services discussed in the FTC Guides. If delivery terms are used to acquire sales another potential problem exists. if fast deliveries, which make one product more desirable than competitive products, are the basis of orders being secured in favor of competitors, the practice of falsely promising rapid delivery may consti— tute an unfair and deceptive practice at both the customer and competitor level,85 under Section 5 of the FTC Act. The opposite case of fast delivery, slow delivery, presents other problems for the VMS planner. When the speed of deliveries is used as a device to encourage a specified form of dealer behavior the practice has been declared to be an unfair method of competition because of the coercive char- acteristics involved which constitute the necessary elements of a Sherman Act, Section 1, violation.86 A similar finding 84lg. at 814. 85c. H. Stuart & Co., 56 F.T.C. 715 (1960). 86United States v. Ford Motor Co., 1958 Trade Cases para. 67,437 (N.D. Ill. 1953). 173 is possible under Section 5 of the FTC Act if the coercive behavior is strictly unilateral in nature. The use of spot stocks and fast delivery can be a valuable inventory maintenance activity in a VMS, but care must be exercised in the operator of such a plan that cer- tain dealers do not become favored by receiving proportion— ally more of the desirable service than their competitors. If power is to be used to encourage cooperation with channel strategies, the withholding or slowing of deliveries to dealers in question may encourage antitrust actions under the Sherman Act or FTC Act. Territorial Protection Territorial protection programs are extremely im- portant strategic mechanisms in a VMS. They can serve as the rationale for dealers to invest substantial amounts of money in support of a manufacturer's product. Indeed, many firms may find it difficult to add additional dealers to the distribution channel without creating some form of territor- ial protection for their intermediaries. Territorial programs have been segmented by McCammon to include selective distribution and exclusive distribution. The differences are a matter of degree, not kind, under the antitrust laws since territorial protection is offered to the dealers in both cases. For this reason the section titled Selective Distribution will be quite brief and will lay the groundwork for the Executive Distribution section which will 174 cover the majority of current legal development in territor- ial protection situations. Selective distribution Selective distribution is used to describe a distri— bution policy in which potential distributors must meet es— tablished standards in order to qualify as a dealer for the product. A selective distribution policy might be useful in a VMS that deals in products which are susceptible to instal- lation, service or selling difficulties. If other facets of the dealers characteristics play an important perceptual role in the total product image a selective distribution policy may also be useful. In a case in which an air conditioner component man- ufacturer established a policy to sell only to manufacturers of complete air conditioning systems, a firm which brought an action against the component manufacturer was unsuccess- ful.87 The court said the manufacturer could determine the conditions and persons to whom it would sell; such selection constitutes behavior under the Colgate doctrine. The court pointed out that "Aeroquips' activities which included no attempt to control prices, were limited solely to its refus- ing to deal with manufacturers who did not qualify under its pre-existing sales policy."88 Thus, a manufacturer might 87Weather Wise Co. v. Aeroquip Corp., 468 F.2d 716 (5th Cir. 1972). 88;g. at 718. 175 selectively limit those to whom it will sell by establishing policies and standards which only desirable dealers or dis- tributors can meet. In a different situation a manufacturer or outboard motors terminated the franchise of one of its dealers because of squalor and poor organization of the dealership coupled with failure to render adequate service and failure to main- tain an accurate accounting system.89 The court determined that the acceptability of the retailer as a distributor of the product had deteriorated and that the termination con— stituted unilateral action because the firm had decided that the retailer was no longer acceptable as a distributor of the product. Pre-determined policy statements which are used to qualify dealers for distribution rights may be necessary in certain states due to the individual state anti—trust statutes which often prevent exclusive dealing. The State of Texas has such a statute. It prohibits the establishment of any exclusive arrangement between two parties, thus leaving se— lective distribution as the only means of controlling distri- bution. The Texas statute states: It is a conspiracy in restraint of trade for two or more persons engaged in buying or selling tangible personal property to agree not to buy from oposell to another person tangible personal property. 89Amplex of Maryland, Inc. v. Outboard Marine Corp., 380 F.2d 112, 114 (4th Cir. 1967). 90Tex. Bus. & Comm. Code Ann., Section 15.03(a)(l) (1968). 176 Selective distribution policies, though generally interpreted under the name of exclusive dealing in antitrust proceedings, may be a means of establishing greater distri- bution for a manufacturer's product or avoiding the specific antitrust statues of some of the states. The majority of territorial protection provisions will be discussed in the next section entitled "Exclusive Distribution." Exclusive distribution Exclusive distribution policies used for territorial protection may be defined as policies which allow only a specified number of dealers in a product for a specified pop- ulation or area. That is, a firm may define the necessary population or geographic base necessary to adequately support the existence of a dealer or distributor. The use of exclu- sive distribution is an important variable in a VMS since the dealer can be assured that a substantial investment in sales fixtures, service training or inventory will not be negated by the establishment of a competitive dealer in the immediate area. The procedure of utilizing exclusive distri- bution is one that has been widely utilized by the manufac— turers and has long been recognized as permissible under the Federal antitrust laws, although it has not been permitted by all the state statutes (see Selective Distribution sec— tion). Exclusive distribution can be discussed under three basic formats. 177 The first type of exclusive distribution would be the policy of exclusive dealing. In this context exclusive dealing refers to a basic policy of a manufacturer to ap- point only one dealer in a specific geographical, population or political area. This form of distribution may also be ac- complished through termination of existing dealers. Such practices might become necessary in order to create a large enough segment of the market to allow a reasonable return on investment for a dealer, or to allow for increased chances of success in markets which have declining sales volumes. A second form of exclusive distribution policy is one which places restraints on the resale procedures which a dealer may utilize. Included in this category would be poli- cies which limit the territories in which a dealer may resell. Professor C. Stone points out the distinction between simple exclusive distribution and restricted exclusive distribution: In exclusive territorial distribution, the manufacturer divides his marketing area into dis- tricts, covenanting with one distributor in each district not to permit his product to be distri— buted by anyone else having a place of business located within the specified territory. Closed territory distribution goes a step further in that the distributor selected from each territory is, in terms, forbidden even to send salesmen or detail men into the territory of the neighboring distributors, mpgh less to establish a place of business there. Closed distribution policies therefore go beyond the 91C. Stone, Closed Territorial Distribution: An Opening Question in the Sherman Act, 30 U. Chi. L. Rev. 286 (1963). 178 establishment of basic exclusive dealers, to assist in ter- ritorial protection to a greater extent. Similarly, restric- tions placed upon a dealer regarding the types of customers to whom he may resell will accomplish similar protective characteristics. Many companies which have different types of customers may utilize such restrictions to enable the manufacturer to service large industrial buyers. Where sub— stantial technical capacity is involved a similar policy might be established. There are many sound strategic reasons for a manufacturer to establish such policies in a VMS, such as the technical expertise necessary to sell the product to some customers, the substantial volume of some purchases, or the long established relationship which exist outside a newly formed distribution network. Some firms will elect to combine the basic provisions of exclusive distribution along with resale restrictions to establish the third and most controllable form of exclusive distribution system. Such a system would include both the description of geographic or political boundaries within which other competitive distribution points would not be es- tablished along with some specifications of the territorial Operational limits or the type of allowable customers for dealer. This form of dealer may be highly controlled by the manufacturer. All three forms of exclusive distribution may be justifiable from a business efficiency or orderly marketing 179 standpoint. Under various circumstances these distribution programs may have elements which cause the system to be in violation of various federal laws including Sections 1 and 2 of the Sherman Act, Section 3 of the Clayton Act, and Sec- tion 5 of the Federal Trade Commission Act. Exclusive dealing The first form of exclusive distribution policies, the exclusive dealership, has had long standing in the distri- bution network in the United States. It has been held to be a lawful competitive strategy provided that the structure of the system does not contain certain fatal elements. Among these elements would be exclusion of a competitor's product, conSpiracy to boycott a competing dealer or tying require- ments. The general legal justification for exclusive dealing may be traced to the Colgate decision in which the Court said: In the absence of any purpose to create or maintain a monopoly, the act does not restrict the long recognized right of trader or manufac— turer engaged in an entirely private business, freely to exercise his own independengzdiscretion as to parties with whom he will deal. Thus, in the early part of the century, the Supreme Court established the basic doctrine which allows the exis- tence of a simple exclusive distribution to be established 92United States v. Colage & Co., 250 U.S. 300, 307 (1918). 180 by a manufacturer. Where more is involved, additional tests will be necessary. In the Packard case an auto manufacturer found it necessary to cancel all of its dealers except the largest one in the Baltimore area, was not in violation of the Sher— man Act since the action was not an attempt to restrain trade in the area.93 The declining market position of the manufac— turer caused the dealer to insist that the only way he would continue his distribution of the product was under an exclu- sive dealing arrangement. Two significant procedures were established in this case: distribution arrangements would be tested for their reasonableness, and restraints would be evaluated with respect to their effect upon a relevant market area. Where the exclusive distribution situation was devel- oped at the insistence of a large retailer who was attempting to eradicate a small competitor by soliciting exclusive con— tracts from all the suppliers who dealt with the small buyer, the Court found an unreasonable restraint of trade in viola- tion of the Sherman Act.94 The procedure was too systematic and amounted to a group boycott, a per se illegal conspiracy. A similar finding occurred in the Los Angeles area when dealer location clauses were the basis of an attempt by area 93Packard Motor Car Co. V. Webster Motor Car Co., 243 F.2d 418 (D.C. Cir. 1957). 94Klor's v. Broadway Hale Stores, 359 U.S. 207 (1959). 2» 181 Chevrolet dealers to gain the manufacturers' support in iden— tifying and terminating supply to dealers who were selling automobiles at discounts to customers located in other deal" ers primary selling areas. The Court, again, found a hori— zontal conspiracy to stifle competition and declared the prac~ 95 The decision to refuse tice violative Of the Sherman Act. to deal resulting from the insistence of a large retailer which utilized a number of manufacturers to effectively boy- :ott the competitor is not permissible under the Colgate doc— :rine. Similarly, cooperation between retailers to restrain :ompetitive behavior of other dealers is not allowed under :he doctrine. If a large purchaser requires that he be the only (urchaser of a product, and that action substantially limits ompetition in the market, a violation of Section 5 of the TC Act as unfair competition may be found. The practice ay be an allowable refusal to deal under the Sherman Act, ut may not escape the more general provisions of the FTC ct.96 Where the receipt of an exclusive dealership is con— Ltioned upon the purchase of specified other products, prob- ams with Section 3 of the Clayton Act may result. Tying :rangements which have forced the sale of one product with 95United States v. General Motors Corp. 384 U.S. E7 (1966). 96Hershey Chocolate Corp. v. F.T.C., 121 F.2d 968 1d (Sir. 1941). 182 nothmthave clearly been established as violative practices. shMlar violation of the Act occurred where a gasoline mufiacturer's sales representatives forced their individual ealers, upon threat of termination, not to deal in or dis- lay a competitors car wax.97 In a situation where a new 1tomobile dealer was required to purchase the companies ser— .ce and replacement parts, the court found a violation of :ction 3.98 In summation, a grant of the distribution reement or franchise conditioned upon the exclusion of mpetition or competirors will not be allowed under the titrust laws. Finally, the practice of granting the exclusive deal— ;hip if conditioned upon a program involving price fixing -1 not be allowed. The attempt to cancel a distributor 1C8 he had not followed the manufacturer's suggested prices .er insistent threats of cancellation was not allowed with- more justification, since the cancellation would involve onspiracy to fix prices. However, the cancellation of one distributor's con— :t after another had been appointed was nothing more than aasonable business decision on the part of the manufac— 217, and was not in violation of the Sherman Act because 97Richfield Oil Corp. v. Karseal Corp., 271 F.2d (9th Cir. 1959) . 98Englander Motors, Inc. v. Ford Motor Co., 267 F.2d 6tfli Cir. 1959). 9Interphoto Corp. v. Minolta Corp., 295 F. Supp. (S.]D.N.H. 1969). a?!“ e 183 100 O nmtraint of competition occurred. The court said: The Stroh Brewery Company had one distributor tithe territory under consideration before it terminated plaintiff's franchise. It continued to have only one distributor thereafter . . . . Un- less it can be that the refusal to deal with plaintiff had the result of suppressing competition and thus constituted 'restraint of trade' within the meaning of Section of the Sherman Act, there is no violation of the Act. We do not think the substitution of Stroh Brewery Company galone distributor for an- other had this result. ms, the legality of restrictive dealer selection, even ough a single competitor may be damaged in that process, 3 been upheld as a reasonable business practice102 pro- ded that the practice does not tend to restrain competi- On, create fixed prices or establish a monopoly. The general rules regarding exclusive dealing allow a establishment of designated exclusive dealers as a uni— :eral determination by the seller. In addition, dealer icellations may occur, even at the insistence of one sel- ', where the effect of such action does not substantially sen competition in the relevant market. ritorial restraints on resale Territorial restraints on the resale of a product a a different problem than simple exclusive dealing 100Ace Beer Dist., Inc. V. Kohn, Inc., 318 F.2d 283 1 Cir. 1963). lOlIg. at 287. 102Weather Wise Co. V. Aeroquip Corp., 468 F.2d (5th.Cir. 1972). 184 :rmmements. Exclusive dealing is allowable under the uni— Lteral refusal to deal doctrine of the Colgate decision. w vertically imposed restraint will involve an agreement ‘the attempt to establish such an agreement between firms the distribution channel. For this reason legal problems th respect to the Sherman Act, which forbids "contracts, mbinations, or conspiracies in restraint of trade," are a ry great possibility. The legal interpretation of the rtical restraint area has developed only recently and is present one of the most unsettled areas of antitrust law. The desire of the firm to encourage efficiency in : VMS by imposing territorial restraints is often apparent. .ocation of sales territories to distributors, assignment primary areas of responsibility and assignment of custom— classifications with whom the distributor or dealer may 1 are all offered as strategies which will increase the ect of the expenditure of marketing dollars. The problem 1 territorial and customer restraints is that they are remely vulnerable to antitrust attack under Section 1 of Sherman Act or Section 5 of the FTC Act. Because the sent legal environment regarding vertical restraints on Lle has developed recently, and, as many feel, is still 1 to interpretation, the historical development of the ent: situation is in order. In 1963 the Supreme Court decided White Motor Co. v. edl States the first case involving a vertical restraint 185 103 the distributors of the firm. The case was a motion rsummary judgment by the United States declaring White's actice of allocating specific territories and customer mses to be illegal per se. The Court pointed out that: We do not know enough of the economic or busi- ness stuff out of which these arrangements emerge to be certain. They may be too dangerous to sanction or they may be allowable protections against ag— gressive competitors or the only practicable means a small company has for breaking into or ifiiying in business and within the 'rule of reason.‘ :Court, in that statement, laid the foundation for test— ‘Vertical restraints under the rule of reason to deter— e if the vertical confinement was a reasonable restraint er the meaning of the Sherman Act. The Court would not ow the practice to be ruled a per se Violation of the as horizontal territorial agreements had been many years are in the Timken case. 05 The F.T.C. declared similar territorial restrictions tool dealers who sold to mechanics from trucks to be un- sonable restraints. Subsequently, the court of appeals Lied the White Motor doctrine of the rule of reason to 1 the practices reasonable methods of competition and not riolation of Section 5 of the FTC Act.106 The 103372 U.S. 253 (1963). 104gg. at 263. 105 Timken Roller Bearing Co. V. United States, 341 593 (1951). 106Snap—On Tools Corp. v. F.T.C., 321 F.2d 825 Cir. 1963). 186 stribution of tools required a great deal of personal con— ct between the mechanic and the sales representative to ex— ain the use of new tools and to provide adequate service. cause the tools were sold from trucks, it became necessary limit the geographic territory over which the dealers uld Operate. There was no evidence that such restrictions re inhibitory or had "pernicious" effects on competition ich horizontal restraints of this type would have. In the subsequent Sandura case, another F.T.C. ac- >n, the court held that Sandura's practice of assigning >sed sales territories, those which were exclusive and in .ch other dealers were not permitted to sell, was a neces- 'y restraint due to Sandura's inability to finance an ade- .te promotional campaign.107 The dealers argued that the .y rationale to justify their making the promotional ex— ,ditures would be if they were certain no intraband com- itor would take advantage of their individual expendi- es by attempting to sell in their territory. The court lared that the closed territories constituted a reason- e restraint because of the strong possibilities Of dura's failure as a firm if the practice was not allowed. decision may have signaled the establishment of the iling company" doctrine, even though it was not specifi— Ly discussed in the decision. 107Sandura Co. v. F.T.C., 339 F.2d 847 (6th Cir. l). 187 The apparent direction of the decisions on vertical straints appeared to be based on the rule of reason test determine if the restraints created detriment to competi- ML Then, in 1967, the Supreme Court decided United States Arnold Schwinn & Co.108 and established new principles r determining vertical restraint cases. The company employed two basic forms of distribu— >n. This first involved the sale of the product from the lufacturer to franchised distributors to approved retail— n The second method involved consignment distribution, ; sale, to authorized agents. The Schwinn Court held that ' restraints upon the product after it had been sold were egal per se. The Court made this statement on post—sale traints: "to allow this freedom where the manufacturer parted with dominion over the goods——the usual marketing uation—-would Violate the ancient rule against restraints alienation and Open the door to exclusivity of outlets limitation of territory further than prudence permits."109 5 effectively overruled the test for reasonableness which been established in the White Motor case. The Court, by voiding the agency distribution method did allow a means territorial protection. The use of agency relationships was not included as 108388 U.S. 365 (1967). loggg. at 380. 188 rt of the per se Violation. The Court indicated that ency agreement restrictions which impose reasonable straints on distribution channel members would be allowed en it stated: Where the manufacturer retains title, dominion, and risk with respect to the product and the posi— tion and function of the dealer in question are, in fact, indistinguishable from those of an agent or salesman of the manufacturer, it is only if the impact of the confinement is 'unreasonably' re- strictive of competition that a violation of Section 1 results from such confingmfint, unen— cumbered by culpable price fixing. IS, the Court established the position that reasonable ;traints could be utilized if an agency relationship with :ermediaries was established, provided that such relation- .ps were not used as a means of fixing prices. The de- Lion created a great deal of controversy in the legal and .olarly community because it represented a significant ft in the Court's position on vertical restraints. One very interesting discussion of the Schwinn de— ion contrasts it with United States vs. Sealy, Inc.lll h were decided on the same day, and both involved terri- ial allocations to various distributors. Sealy was a poration which had been formed and was owned by a number nattress distributors. Sealy, Inc. licensed these dis— Dutors and allocated sales territories to them. Since 111388 U.S. 350 (1967). 189 1e territorial assignments were made by the member distri— 1tors who constituted the ownership of Sealy, the Court >und it to be a horizontal conspiracy even though the ter— _tories were allocated in a vertical manner by the licensor. 1e Court declared the practice to be illegal per se because 1ey were horizontal divisions of the market even though aaly argued the allocations were vertical confinements. irl Pollock points out that: . . . The two decisions can be easily summarized: Sealy stands for the proposition that in anti— trust cases substance is more important than form. On the other hand, the teaching of Schwinn is that in antitruifzcases form is more important than substance. 1e apparent contradiction involves the declaration that aninements after sale are per se illegal, while the same aninements under the agency format need to be tested for easonableness, a dichotomy which he criticizes. "What the curt did is to create 'a bicycle built for two', but the NO sets of handle bars are aimed in precisely opposite irections." Additional difficulties with the decision occurred ver the price fixing factors involved. The facts did in- icate that price maintenance may have been utilized by chwinn, even though the Court determined there must be an bsence of price fixing before the reasonableness of other 112E. Pollock, Alternative Distribution Methods fter Schwinn, 63 Northwestern L. Rev. 595 (1968). 190 :strictions can be decided.113 The tests for reasonable- :ss include: 1. Other reasonably similar products must be available to dealers and distributors. 2. Exclusive dealing contracts not be present. 3. The restrictions to no further than competi— tive pressure requires. 4. The restrictions tend to preserve or increase competition. 5. Price fixing not be present. 1ese factors appear to constitute the requirements which .11 create reasonable restraint situations if agency rela— Lonships are present.114 Other defenses also were recognized in the Schwinn acision. Among the defenses to a per se finding of viola— Lon was the "newcomer defense and the "failing company" afense. Both defenses contain a reasonable basis for re— traints. 15 One major problem which occurs with the fail— ig company defense is the potential failure of a firm which ay occur if distribution restraints are not allowed. The newcomer defense is even more problematic since Dme decisions or policies must be developed to determine at iat point a firm ceases to be a newcomer and becomes a 113L. Averill, Jr., Sealy, Schwinn and Sherman One: n Analysis and Prognosis, 15 N.Y.L.F. 39 (1969). 114United States v. Arnold Schwinn & Co. 388 U.S. 65, 381 (1967). llSE- at 374. 191 ad. dealer. An economist discussing the problem said: . . . The difficult problem remains of determin— ing how long the restrictive agreements should be allowed to continue. Too long a period would encourage excessive product differentiation and permit monopoly returns which exceedlghose required for these SOCial purposes. necessity for judicial decisions and the problems of tance versus form have caused substantial interpretive ulems with the Schwinn decision. Many subsequent lower court decisions (see Figure Lave not followed the Schwinn per se rule but have dis— )uished their arguments in some particular point. The >rity of distinguishing decisions deal with the loophole :he per se ruling which describes the reasonable defenses llable to failing companies or newcomers. That loophole been expanded to include other reasonable exceptions to Schwinn rules and the Supreme Court has not acted to se the gap in interpretation. This factor may be a func— n of the Court's makeup, which, as most authorities would ee, has become more conservative than the Court which ided the Schwinn case. The narrowed View of the Schwinn ision is discussed in a number of legal journals. Among .journals discussing the decision are the George Washing- .Law Review and the Journal of Public Law.117 In those 116 W. Comanor, Vertical Territorial Customer Restric- )ns: White Motor and Its Aftermath, 81 Har. L. Rev. 1419, S8 1968 . ============ ll7Comment, Territorial and Customer Restrictions: Trend Toward a Broader Rule of Reason?, 40 Geo. Wash. 192 v wusmflh QDEHOEE¢ coumcacoom comuwpc< OCflonm HOHHomSM .oxm denuded umhflm wuommm aeodaue mEsm OUDHOHOU osflugmflq EDOchm was» .cowmm McEEOHU awash pmsoaaom UOSMHSOCHpmHD COMMOH mo wads I mocwwfl Hmmwaafi mm Mom ssflw:om mHDpcmm solmmsm when: mZOHBUHMBmmm HMQ Qflwmq ODOQQMOUGH .monm “Honor HOHOSM wuoqu QSOHU Oxmaw UOBOHHOM oamm 193 articles the commentators point out the range Of lower court decisions expanding the loopholes in the per se doctrine and also the tests of what constitute reasonable restraints. It is unclear whether the lower courts are confused by the Schwinn decision or are simply reluctant to follow its doc- trine. The first group of exceptions to the per se rule can be classified as those involving firms which are not "firm and resolute" in their policy of refusing to deal with dealers that do not adhere to territorial restrictions. In a case where no proof was offered that the firm had ever en— forced their territorial sales restrictions, the court found the practice needed to be tested under the rule of reason and was not per se illegal, even though the situation in— 118 volved the sale Of a product. In a similar situation where sales territories were assigned but not enforced, the court said "assignment of territories or customers, even in a contract, is insufficient to establish a per se violation; some element Of enforcement of the restriction on the part 19 Of the manufacturer is required." Finally, a similar L. Rev. 123 (1971); Comment, Vertical Territorial and Cus— tomer Restrictions Under the Sherman Act: Decisions Since United States V. Arnold Schwinn & Co., 22 J. Pub. L. 483 1973). 118Janel Sales Corp. v. Lanvin Parfums, Inc., 396 F.2d 398 (2d Cir. 1968), 393 U.S. 938 (1968). 119United States V. Eaton, Yale & Towne, Inc., 1972 Trade Cases para. 73,889 (D. Conn. 1972). \— \— 194 holding was developed in a case where the territories were assigned but not enforced.120 Thus, the imposition of ter— ritorial restraints, even in the presence Of sale, may not constitute a per se violation of the Sherman Act if the firm has not been firm and resolute in forcing compliance with the assignment by cancelling franchises or other techniques. A second exception of the Schwinn rules deals with dangerous products. In a case where special application procedures were necessary to prevent blindness and other equally undesirable affects resulting from improper applica— tion, the court held that the restraints which allowed sales only to qualified applicators were reasonable.121 Another case suggested that safety factors may be justification for territorial restrictions as well as customer restriction.122 Exception to the per se rule has occurred where the products are dangerous or have inherent safety characteristics which require qualified dealers or distributors. A third exception to the Schwinn rule has occurred in the definition in franchise agreements of "areas of pri— mary responsibility." Such agreements designate the geo— graphic region within which the dealer is to make his 120Colorado Pump & Supply CO. v. Febco, Inc., 472 F.2d 637 (10th Cir. 1973) 411 U.S. 987 (1973). 121Tripoii v. Wella Corp., 425 F.2d 932 (3d cir. 1970), 400 U.S. 831 (1970). 122United States v. Safety First Products Corp., 1972 Trade Cases para. 74,223 (S.D.N.Y. 1972). 195 primary sales effort, but do not preclude the dealer from selling outside that territory.123 Another case involving primary trading areas dealt with the profit passover activ— ity. Profit passover clauses are used to compensate a dealer for sales which are made within his assigned territory by another dealer. The justification for such clauses rests upon the argument that the demand in the dealers territory may be affected by his advertising and promotion and he is therefore entitled to some compensation as the party respon- sible for generating the demand which another dealer has serviced. Profit passover clauses will be evaluated to de— termine their reasonableness since such clauses are not per 124 A similar ruling under the Automobile Deal— se illegal. ers' Day in Court Act was utilized to allow the cancellation of a dealer's franchise. The dealer had been neglectful of his responsibilities to the manufacturer in his primary area while actively seeking sales outside his area.125 The as- signment of primary areas of responsibility appears to be a reasonable exception to Schwinn, provided that the dealers are free to sell outside their assigned territories. 123Plastic Packaging Materials, Inc. v. Dow Chemi- cal Co., 327 F. Supp. 213 (E.D. Pa. 1971). 124Superior Bedding CO. V. Serta Associates, Inc., 353 F. Supp. 1143 (N.D. Ill. 1972). 125Frank Chevrolet Co. V. General Motors Corp., 419 F.2d 1054 (6th Cir. 1969). 196 The fourth exception to the per se principle in Schwinn occurred where the sale of a service rather than a good was involved. The court reasoned that since the per se rule applied to the sale of a good in the Schwinn language, the sale of services, with territorial restraints, need to be tested under the rule of reason.126 This decision points out one of the confusing aspects of Schwinn; the sale of services do not receive the same treatment as the sale of goods. If the purpose of the anti—trust laws is to protect competition, then there should be no basis for differentia— tion of competition in the sale of goods and competition in the sale of services. Other cases have departed from the basic Schwinn rules for a number of reasons. One exception occurred where a firm was allowed to sell goods at a lower price with the provision that the goods not be resold in the United States, thereby escaping the duty on the goods.127 In another action involv- ing the sale of home cleaning products combined with terri— torial restrictions the court, rather than following Schwinn and declaring a per se violation requested a test of the reasonableness of the territorial restrictions. This 126Anderson v. American Automobile Assoc., 454 F.2d 1240 (9th Cir. 1972). 127Paddington Corp. v. Major Brands, Inc., 359 F. Supp. 1244 (W.D. Okla. 1973). This decision is consistent with the immunity granted to exporters under the Webb— Pomerene Act, 15 U.S.C. 61—65 (1918). .11,” 197 constitutes an effective recognition of exceptions to the Schwinn doctrine.128 Thus, expansion of the loopholes in the Schwinn case have occurred outside the previously iden— tified major areas. At the same time, a number of cases have upheld the Schwinn doctrine. In a sales situation the court found a per se violation of the Sherman Act consistent with the 129 Schwinn doctrine. A similar ruling was applied to a news- paper which assigned carriers specific territories. The court said: I find that by inference from the exclusive territory provisions of the carrier agreements, the plaintiffs have not been permitted to sell the News outside their own territories. This is E3Ber se violation of Section 1 of the Sherman Act. In a pyramid distribution structure which specified that each dealer could buy only from his supplier, and could only sell to his own organization, the court found the territorial and customer restraints to be per se illegal.131 Another case which followed the Schwinn doctrine involved a moving com- pany agent who was not allowed to solicit business inside 128Ammerman v. Bestline Products, Inc., 352 F. Supp. 1077 (E.D. Wis. 1973). 129United States v. Glaxo Group Ltd., 302 F. Supp. 1 (D.D.C. 1969). 130Lepore v. New York News, Inc., 347 F. Supp. 755, 761 (S.D.N.Y. 1972). l3lKugler V. Koscott Interplanetary, Inc., 293 F.2d 682 (N.J. 1972). 198 another agent's territory. The territorial restrictions were reasonable when applied in this agency situation.132 Another case which followed Schwinn overturned an argument of reasonableness because of the need for orderly marketing and the confusion of the firm's retail dealers which resulted when more than one distributor solicited sales from them. The court held the restrictions to be per se violations of the Sherman Act. Indeed, in this particular situation, since the manufacturer was also a competiting dis- tributor, a potential Sherman violation might be argued un- der the horizontal division of the market as in Sealy.133 Exclusive territories - restraints on resale In the previous sections development of the environ— mental situation regarding exclusive distributorships and restraints regarding territories have been developed. What conditions appear available to the manufacturer wishing to exercise restraint on his product throughout the VMS? The most likely method for maintaining control in distribution at present would appear to be through the use of exclusive agency relationships coupled with territorial protection and no price fixing. In the presence Of the agency relationship, resale restraints which do not stifle 132Clemmer v. North American Van Lines, 1969 Trade nggg para. 72,936 (E.D. Pa. 1969). 133Interphoto Corp. V. Minolta Corp., 295 F. Supp. 711 (S.D.N.Y. 1969) . 199 competition will be allowable under the Schwinn doctrine and the test of the rule of reason as originally discussed in White Motor. Where agency relationships are not utilized, the restraint may qualify as one of the exceptions to the Schwinn per se rule; that it is a new product, a failing company, a service, a dangerous product, that restraints are not en— forced, or that the territorial protection merely defines an area of responsibility. If one of the exceptions is avail— able the restraint will still be tested under the rule of reason. In conclusion, territorial protection may be accom— plished in a VMS through the long standing right to select the dealers with whom the firm will deal, provided a monopoly does not exist, and by the simple refusal to deal with deal— ers in the area which do not meet the standards or which will have a negative effect on other distributors. If additional control is necessary on resale territories or customers, agency relationships will allow reasonable distribution re- strictions to exist.134 The development of the present structure in terri— torial protection is shown in Figure 4, and points out the confusion which reigns as some courts follow and other courts distinguish the Schwinn rules of legality in agency situations 134Top—All Varieties, Inc. V. Hallmark Cards, Inc., 301 F. Supp. 703 (S.D.N.H. 1969). 200 and per se illegality in sales situations. The fact that no Supreme Court decisions on territorial restrictions have oc- curred since Schwinn may indicate that the confusion over vertical restrictions, which must exist in the minds of VMS members, may also exist in the minds of the members of the Court. The fact that the Supreme Court has declined to hear many of the decisions which take exception to the Schwinn doctrine indicates that until the right decision is on ap— peal, no further decisions in vertical restrictions at the Supreme Court level are likely.135 135This conclusion is based on the presumption that where the Court has denied certiorari, it was because of the Court's desire to have the lower court's further evaluate "the business and economic stuff" of legal guidelines laid down by Schwinn. CHAPTER V SUMMARY, CONCLUSIONS AND RECOMMENDATIONS Summary In Chapter I the basic usefulness of the vertical marketing system (VMS) was discussed, from both a theoreti— cal and pragmatic standpoint. The use of this concept as a valuable strategic tool for the distribution planner was also described. The basic hypothesis of the research is that many activities suggested as means to achieve price, inventory or territorial protection are illegal under fed— eral antitrust laws. A structure utilizing forty—nine con— trol policies, which are niehter collectively exhaustive nor mutually exclusive, was selected as the framework for evalu- ation. Chapter II evaluated the present legal environment regarding price concession programs in a VMS. The legality Of Financial Assistance programs was examined in Chapter III. The fourth chapter evaluated the legal environment for ter— ritorial, price, and inventory protection programs which a manufacturer could utilize in a VMS. 201 202 Conclusions Price concessions are potentially powerful strategic variables in a VMS but are restricted in their use due to the general requirement that equal treatment be given to all of the firm's customers who compete at the same level in the distribution channel. Functional discounts which are granted to integrated intermediaries performing wholesale and retail functions who are in competition with other retailers present a special problem. The wholesale discount may only be granted to the integrated intermediary on the proportion of the mer— chandise which he sells to other retailers, not on all the merchandise which he purchases. Similarly, retailers who purchase direct from the manufacturer may not receive a wholesale discount on their purchases since that discount might result in a favored price below the price retailers with whom the store competes must pay to the wholesalers from whom they purchase. The efficiency of such a position has been questioned by many but the present interpretation upholds the requirement that those who compete pay identical prices regardless of their functional inputs to the VMS. The Robinson—Patman Act requires that all customers at the same competitive level be charged the same price. Firms which have both direct and indirect distribution chan— nels must oversee the prices charged by independent whole- salers to insure that independent retailers are charged prices equal to those which the firm charges their direct 203 buying stores. In so doing, however, the firm falls under the indirect purchaser doctrine which may disallow some wholesale discounts to independent distributors because of the inter— pretations of that doctrine which prohibit the extension of control down the channel at the risk of the discount being Viewed as false. In addition, problems may result if the manufacturer seeks to maintain price equality by requiring independent wholesale intermediaries to charge certain prices to independent retail buyers. This form of control has been prohibited as price fixing by the decision in the Simpson case. That decision pointed out that the prices which inde— pendent intermediaries charged could not be controlled by the seller once title to the product had passed to the independent intermediary. If price control was exercised, the firm would be in violation of the Sherman Act because such control has been equated with conspirational price fixing. Such behavior, however, is necessary if all buyers are to receive uniform prices under the Robinson-Patman Act. The apparent contra- diction between these pieces of legislation and the agencies charged with their enforcement is one of the major difficul- ties for the businessman contemplating such distribution pol— icies. The firm which operates a VMS having both direct buy- ing retailers as well as retailers which buy from wholesale intermediaries must exercise care that price concessions of— fered to competing customers be equivalent in order to avoid a potential Violation of the Robinson—Patman Act, and that 204 the administration of the strategy not place the firm in jeopardy of a price fixing action. Price discounts granted on quantity purchases may create legal problems for the firm. There are three basic conclusions which the VMS planner must consider when devel- oping his price strategy. First, quantity discounts which are established so that only the largest buyers may qualify for the discount will probably be found to be violative of the Robinson-Patman Act. Second, cost justification for cum- ulative discounts will be most difficult to establish there— fore noncumulative discounts appear to be the only potentially justifiable discounts. Finally, discounts to cooperatives and integrated buying organizations whose function is to achieve such discounts will not be allowed. Quantity dis— counts offered to members of the VMS should meet these cri— teria if the strategies are to avoid legal difficulty. Price discounts such as cash discounts, seasonal allowances, anticipation and other such allowances which af- fect the net price which a buyer pays will be evaluated to determine whether the discounts convey a "favored" buyer status upon any purchasers. If the discounts are found to favor certain buyers, the discounts will not be allowed under current Robinson-Patman interpretations. Since no single antitrust organization exists within the government, the requirements which one piece of legisla— tion, such as the Robinson—Patman Act, place upon the busi- nessman may be in direct conflict with behavior covered 205 under the Sherman Act. Until either one agency, or a co— ordination program between agencies is established the busi- nessman may be confused regarding which course of behavior will be legally acceptable. The end product of such confusion is likely to be legal difficulty for the firm because compli— ance with one statute may create violation of another. For example, extension of control to insure uniform prices at various competitive levels, a requirement of the Robinson— Patman Act may constitute price fixing under the Sherman Act. It must be concluded that pricing decisions made by a firm will need to consider both the strategic price control tech— niques which have been condemned per se, as well as those price concessions which may cause the firm to be in viola— tion of the laws due to inconsistencies in the statutes as well as the interpretations of such statutes. Discount substitutes such as allowances for advertis- ing and promotion, merchandising services, inventory assis— tance, and technical assistance which lower a buyers costs of doing business have been severely damaged as desirable con- trol strategies because of the requirements imposed by the Fred Meyer decision. Discount substitutes fall under Section 2(d) and 2(e) of the Robinson—Patman Act. To insure compli— ance with the statute, the legal requirements imposed on the seller are quite Specific. For instance, services and allow— ances must be offered on a proportionally equal basis to all buyers including indirect customers of the firm. Thus, the 206 extension of control over wholesalers to insure that they pass on such allowances or make available such services is a requisite under this decision. Such control procedures may constitute unfair competition under Section 5 of the FTC Act or may be in Violation of the Simpson doctrine since dis— counts direct or indirect, may effectively change the net price paid by the buyer. These apparent inconsistencies make the use of discount substitutes such as cooperative ad— vertising allowances, drop shipment privileges or promotional displays, etc., a dangerous practice unless every buyer is dealt with directly or unless the distribution channel is organized in such a manner that uniform behavior is easily achieved without collusive or conspiratorial overtones. Financial assistance is often used in distribution networks as a strategic control device as well as a mechan— ism to assist new or struggling dealers. Financial assis— tance programs of a long term nature such as term loans, equipment financing, loan guarantees, and notes payable fi— nancing create potential problems for the firm because of the Fortner decision. In that decision the extension of long term credit arrangements were found to be in violation of the antitrust laws which prohibit tying arrangements; agreements which force the purchase of one product in order to obtain the second product. Long term credit has therefore been construed as a product for this test, and any firm which re— quires buyers to sign requirements contracts in order to gain credit from the supplier will be in violation of the law. 207 The Fortner decision created great controversy by changing the status of long term assistance to a "product" rather than a service as it had previously been Viewed, and by not dealing with the problem of short term trade credit. The controversy over the Fortner decision is not likely to be settled immediately; as a result, firms utilizing finan— cial assistance variables should exercise care to insure that the variables are not used in a manner which could create a tying arrangement, and that the assistance is not granted in a discriminatory way to favored dealers. If care is not exercised over long term financial assistance variables, a per se violation of the Sherman Act may result. Short term financial assistance such as inventory floor plan programs, accounts payables financing and extended dating programs are interpreted under other statutes and therefore have different elements which determine their 1e— gality. Short term credit arrangements are treated as ef— fective price reductions in many situations, and therefore the rules regarding price discounts under the Robinson— Patman Act apply to such short term financial assistance. The only exceptions to the requirement that financial assis— tance be available to all dealers on an equal basis involves new dealers or situations where the granting of credit has an insubstantial effect on commerce. In addition, financial assistance programs which force independent channel members to use nationwide credit programs may be in violation of the 208 FTC Act if the requirement imposes an unfair restraint upon competition or upon the individual dealers. Also, any co— ercive activity which forces a dealer to utilize a particu— lar source of financial assistance may be in Violation of the Sherman Act. Protective programs designed to assist the dealers in price, inventory and territorial protection have been de— scribed as powerful strategic variables in a VMS. The power of these variables has been dissipated by decisions which prohibit tampering with or conspiring to fix prices or ter— ritories in vertically oriented distribution systems. In addition, the concept of a VMS may be in direct contradiction to the general thrust of United States antitrust policy which is designed to foster unrestrained competitive behavior. Also, state legislation coupled with the continual overview of the FTC create additional difficulties for suppliers who attempt to shield members of their channels from the rigors of the competitive environment through policies designed to inhibit or restrain competition. Price protection programs which have elements that contain potentially false or misleading information regard- ing specials or regular prices may violate Section 5 of the FTC Act. Price markings which show list prices substantially above what the product is normally sold for may also violate the Act. The firm contemplating the use of labels to es— tablish resale prices for dealers in a VMS in order to 209 eliminate some price competition must ensure that the prices are not misleading or fallaceous. Specific price protective programs designed to achieve resale price maintenance such as Fair Trade, although still allowable, are under fire in the individual states which determine the character of such programs, as well as at the Federal level where the antitrust agencies continu— ously observe such programs to insure that nothing other than price maintenance takes place under such programs. The pro- grams are also monitored to insure that they remain competi— tor protecting devices and do not become price fixing con- spiracies. The non-signers clause, a provision which allows a great deal of control, has now been declared unconstitu— tional by a majority of the states.1 In these states, the extra burden of insuring compliance with the price mainten- ance program falls on the seller who must Obtain a signed agreement from every reseller in such situations. In multi— state distribution systems the problems of maintaining resale prices between states which do and states which do not have Fair Trade have caused a continual erosion in the value of such programs as a means to achieve price protection in a VMS. Price protection programs designed to allow the man— ufacturer to control resale prices absent Fair Trade have 1See Figure 2 for a complete list of the individual state statutes. 210 also been severely limited such that the right to cease dealing with buyers who do not adhere to the sellers estab- lished policies, as described in the Colgate doctrine, may not be available if the decision to cease dealing is de— termined strictly on the basis of the buyers refusal to ad- here to resale prices. Any informational input from inter— mediaries or other competitors, overpolicing of prices, or selective enforcement of the firms policies may be enough to constitute a conspiracy to fix prices under the Sherman Act. In today's complex distribution situations, simple unilateral refusals to deal which are used to control resale prices will be difficult, if not impossible, to maintain from a legal standpoint. The use of agency agreements are often suggested as techniques which will allow resale price maintenance. Under present judicial interpretation a resale price may only be controlled in cases where the manufacturer holds a patent on the article. Resale prices on unpatented articles, even in the presence of agency agreements, may not be controlled without risking a price fixing action under the Sherman Act. Inventory protection programs such as consignment selling, spot stock maintenance, and sales support, etc., have been construed generally as promotional and merchandis— ing assistance and therefore fall under Sections 2(d) and 2(e) of the Robinson—Patman Act, which require that such services be made available on a proportionally equal basis to all buyers. As a result the strict provisions of these 211 sections severely limit the ability to use such a variable as a control device in a VMS. Territorial programs designed to define areas of sales and distribution responsibility are widely used in present distribution channels. Protective programs designed to shield channel members from competitive pressures will meet with legal difficulty under the Sherman Act unless certain conditions are met. Under the Colgate doctrine the manufacturer has the right to determine with whom he will deal. The decision must be made on a strictly unilateral basis however, if a conspiracy action is to be avoided. In— put from other channel members, or even customers, may be enough to show a conspiracy if a dealer who has not observed his assigned territories is terminated. Additional problems may occur if a manufacturer uses his sales representatives to report on dealer behavior. If the manufacturer terminates any dealer as a result of such reports, the need for uniform evaluation criteria is vital. Otherwise, the salesmen who has been very critical of one dealer, and very lenient with another may be engaging in a conspiracy with the favored dealer. The Schwinn decision declared territorial control programs illegal per se if the title to the merchandise had passed from the manufacturer to an intermediary. Resale territorial restrictions in agency situations were still allowed provided that such restrictions were reasonable. 212 The following factors will be considered to determine the reasonableness of the territorial restriction: l. 4. 5. Other similar products be available to the intermediaries. Exclusive dealing contracts not be involved. The restrictions go no further than competitive pressure requires. The restrictions tend to preserve competition. Price fixing not be involved. Thus, territorial control of intermediaries is possible pro— vided there is an agency relationship with reasonable terri- torial restrictions. The Schwinn doctrine has been eroded by decisions in which the courts have recognized various exceptions to the basic per se doctrine. Exceptions to the Schwinn rules on territorial restraints have occurred in cases involving the sale of: Dangerous products. New products entering the market. Products of failing companies. Territorial control programs which assign areas of primary responsibility but do not prohibit sales outside the assigned territory. Thus, the method that the manager may use to avoid antitrust problems which might be created by territorial restraint programs will depend upon the distribution relationship 213 involved. In an agency relationship the territorial re— strictions must meet the test of reasonableness. In a sales situation, however, one of the judicially recognized excep— tions to the Schwinn doctrine must be met. The volatility of this area of the law has precluded accurate prediction of the outcome of antitrust litigation. For instance, General Electric has been overruled by Simpson; and White Motor has been overruled by Schwinn. Meanwhile, the growth in the number of legal doctrines, some of which are contradictory means that a well defined legal structure upon which the businessman can base distribution decisions is not available. The general conclusion of the research must be that control strategies have a great deal of potential value to the manager operating a VMS. To make the strategies operate, and at the same time maintain their legality with respect to the antitrust laws, requires that the strategies be developed by a skilled manager and a well versed antitrust attorney. Recommendations For Further Research This research has attempted to establish the legal environment regarding forty—nine policy variables which a VMS designer might utilize. Because the law is constantly changing, statutory development as well as judicial inter— pretations which occur in the future will modify the results of the research. 2See Figure 4, page 192. 214 Additional further study could occur by expanding the list of forty-nine variables as other control techniques are identified or suggested by distribution planners. The pragmatic value of a strategic variable might be determined based upon some measure of the absence of legal difficulties associated with the strategy. Further research evaluating various product—market distribution networks might be conducted to determine to what extent operators of a VMS are aware of the legal diffi— culties which they may encounter when using certain strategic variables. Finally, research which leads to the development of information systems designed to inform businessmen of the legal constraints regarding distributions systems design is needed to eliminate the lack of understanding of the anti- trust laws. 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