March 5, 2007 On February 27, 2007, the U.S. Court of Appeals for the Sixth Circuit issued
decisions in two related cases, Smith Wholesale Co., Inc., et al. v. R.J. Reynolds Tobacco Co.,
No. 05-6053 (“RJR”), and Smith Wholesale Co., Inc., et al. v. Philip Morris USA, Inc., No.
05-6481 (“PM”), in which it affirmed grants of summary judgment in favor of the defendants on
claims of price discrimination under Section 2(a) of the Robinson-Patman Act, 15 U.S.C. Sec.
13(a) (“RPA”). These decisions provide important guidance regarding the applicability of the
RPA, and in particular the ‘functional availability” doctrine, to market share incentive discount
programs.
In RJR, plaintiffs were 18 wholesale distributors who distributed RJR cigarettes to grocery and
convenience stores and other retail outlets. Cigarettes are divided into four different price
categories or tiers: first tier or premium brands produced by major manufacturers like RJR and
PM; second-tier and third-tier brands sold at a substantial discount in comparison to first-tier
cigarettes that also are produced by major manufacturers; and fourth-tier brands that sell at prices
below third-tier brands but are produced by smaller manufacturers. RJR produced second-tier
and third-tier brands but did not sell fourth-tier brands. Following the cigarette industry’s 1998
Master Settlement Agreement, which settled smoking litigation by requiring established cigarette
manufacturers to make payments per carton of cigarettes sold to settling states, RJR experienced
declining market share (to 22% by 2004), while sales of fourth-tier brands, which were not
subject to the settlement agreement, expanded rapidly from a market share of less than 1% in
1998 to 15% by 2003.
In April 2000, RJR attempted to address its declining market share by creating the Wholesale
Partners Program (“WPP”), which provided wholesalers with an incentive to increase purchases
of RJR’s discount or “savings” brands. The program provided multiple levels of discounts and
rebates, ranging from Level 1 (smallest discount) to Levels 2A to 2H (larger discounts), to Level
3 (largest discount), depending on the share of the wholesaler’s total sales of savings brands
accounted for by RJR savings brands. Wholesalers could achieve the higher level discounts by
exceeding certain market share targets set by RJR on a state-by-state basis. Because the
discounts were based on RJR share of sales or market share for each distributor, not on sales
volume, small wholesalers were ostensibly treated the same as large wholesalers.
Some wholesalers participated at higher levels than others, meaning they paid a lower price for
RJR discount cigarettes than others. Although many of the plaintiffs participated at Levels 2 and
3 for some period of time, they all were classified at Level 1 of the WPP for some or all of the
relevant period. Plaintiffs alleged they could not practically and realistically achieve the highest
level discount market share targets (which were achieved by only 8% of all distributors) because
they serviced retailers in lower income areas in which there was a high demand for fourth-tier
brands not sold by RJR. Plaintiffs claimed this put them at a competitive disadvantage vs.
distributors who qualified for the higher level discounts.
Smith Wholesale filed suit in the U.S. District Court for the Eastern District of Tennessee on
January 31, 2003, alleging the WPP violated Section 2(a) of the RPA. The complaint
subsequently was amended to add the other wholesaler plaintiffs. The States of Tennessee and
Mississippi also were permitted to intervene on behalf of consumers, wholesalers and
manufacturers and the economies of their states. After the conclusion of discovery, RJR filed a
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motion for summary judgment that the court referred to a magistrate. The magistrate issued a
Recommendation and Report advising the motion be granted, which was adopted and approved
by the court on the grounds that the WPP discounts were “functionally available” to plaintiffs.
The court’s analysis focused on whether plaintiffs had satisfied the requirements for a secondaryline price discrimination claim, in particular whether plaintiffs had provided evidence of a
“difference in price” that had injured competition (citing Volvo Trucks North America, Inc. v.
Reeder-Simco GMC, Inc., 546 U.S. 164 (2006)). In determining whether there was an actionable
difference in price, numerous courts had employed the “functional availability” doctrine, which
negates the “difference in price” element of a plaintiff’s secondary-line claim.
The court explained the doctrine stemmed from the Supreme Court’s decision in Morton Salt, in
which the Court deemed a volume discount program to be illegal because the manufacturer set
the minimum purchase requirements so high that it was impossible for small buyers to obtain the
discounts received by large buyers. FTC v. Morton Salt Co., 334 U.S. 37, 42 (1948). (RJR
Opinion, “RJR Op.,” at 10). After acknowledging the “dearth” of case law regarding the legality
of market share discount programs, the court reviewed a number of cases from the Sixth Circuit
and other circuits applying the functional availability doctrine to quantity discount cases, see
e.g., Shreve Equipment, Inc. v. Clay Equip. Corp., 650 F.2d 101 (6th Cir. 1981), and Bouldis v.
U.S. Suzuki Motor Corp., 711 F.2d 1319 (6th Cir. 1983). The court noted that “courts have
refused to find price discrimination under [Section] 13 (a) when the purchaser’s decision or
capacity to take advantage of the best discount . . . was determined by elements within its
control . . . “ such as marketing strategies or a decision to promote a competitor’s product, rather
than “disproportionately small purchasing power or the pricing structure itself.” (RJR Op., at 9,
16).
The plaintiffs alleged that the higher level WPP discounts were not practically available to them
because, unlike other RJR distributors, they operate largely in rural, low-income areas in which
there is a high demand for fourth-tier cigarette brands not sold by RJR. The WPP thus “places
plaintiffs in a no-win situation—either accede to RJR and destroy their business or meet
customer demands and attempt to absorb RJR’s discriminatory price differences while suffering
debilitating lost profits.” (RJR Op., at 17-19).
The court rejected this argument and found that, assuming plaintiffs allegations were true, the
facts supported that the best discounts under the WPP were functionally available to plaintiffs on
an equal basis. “We initially note that the WPP does not bear any of the obvious hallmarks of a
discriminatory pricing program. RJR developed a share-based program, not a quantity-based
program of the sort condemned by the Supreme Court in Morton Salt.” In addition, the court
found the program was administered in an “evenhanded manner” under which “small
wholesalers were treated the same as large wholesalers.” (RJR Op., at 21)
Further, the court pointed out that plaintiffs failed to present any evidence that they sold only in
low income areas or in areas of the state in which there was a higher demand for fourth-tier
cigarettes than in other areas, while RJR presented evidence that incomes in areas served by
plaintiffs were higher than in other areas. Plaintiffs also failed to show they were disadvantaged
by any alleged improper market share calculations by RJR. “In any event, there is no evidence
that anything other than plaintiffs’ marketing decisions [and brand prioritization] impacted their
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ability to obtain the WPP’s best prices . . . . As long as defendant offered the same best price to
plaintiffs as to their competitors, using a non-discriminatory pricing formula, defendant did not
violate the Robinson-Patman Act.” (RJR Op., at 22).
In PM, the court reached the same conclusion based on similar facts. Plaintiffs were 29
distributors and the States of Tennessee and Mississippi. Like RJR, PM’s market share declined
(from 51.6% in 2001 to 48% in 2001-2002) as a result of the Master Settlement Agreement and
subsequent entry into the market by fourth-tier cigarette manufacturers. In response, in 2003 PM
established the Wholesale Leaders discount program (“WL”), under which it offered wholesalers
Level 1, 2 or 3 discounts, depending on whether their share of PM products as a percentage of
their total cigarette sales was below, met or exceeded certain targets. Like RJR, PM did not sell
any fourth-tier priced cigarettes. As a result, sales of fourth-tier cigarettes produced by
competing manufacturers reduced a wholesaler’s PM market share.
In June 2003, a group of 16 wholesalers brought the PM suit in the U.S. District Court for
Eastern Tennessee (later amended to add the other plaintiffs), alleging the WL program violated
Section 2(a) of the RPA because the highest discounts under the program were not realistically
achievable by plaintiffs. To move from Level 1, where most of the plaintiffs were situated, to
Level 3 required plaintiffs to increase their PM share from 27.8% to 49.2%, which plaintiffs
claimed they could not do because they sold a significant amount of fourth-tier cigarettes in
response to customer demand. Only 27% of PM’s distributors achieved Level 3 discounts, and
none of the plaintiffs had done so on all of its PM purchases. The WL program thus
discriminated in favor of wholesalers who sold a smaller percentage fourth-tier cigarettes.
Plaintiffs also alleged an attempt to monopolize under Section 2 of the Sherman Act. PM moved
for summary judgment on both claims, which was granted by the district court.
The Sixth Circuit affirmed, incorporating and employing its analysis from RJR. The court
determined the WL program was “functionally available to plaintiffs pursuant to a market-share
based pricing formula that is uniformly applied to all of PM’s approximately 700 direct
distributors operating throughout the country.” (PM Opinion, “PM Op.,” at 13). The court found
that market share targets were set below or, in the case of Level 3, slightly above PM’s overall
market share, and that at these levels approximately one-half of the distributors qualified for
Level 3 discounts to some extent. (PM Op., at 14-15).
The court rejected plaintiffs’ claims they were disadvantaged by selling in areas where there was
a higher demand for fourth-tier cigarettes, citing evidence that plaintiffs were selling non-PM
cigarettes in excess of the market share of those cigarettes in the relevant areas. “Here, in the
absence of evidence of discriminatory application of market-share incentives, and in light of
deposition testimony of plaintiffs’ representatives consistently indicating that brand prioritization
and marketing strategy governed their level of participation in the WL, we can only conclude
that it is these choices, not PM’s formula, that determine whether plaintiffs’ will earn PM’s
higher discounts.” To find otherwise and mandate equal incentive payments, the court found,
would “undermine the competitive purpose behind the market-share incentive program.” (PM
Op., at 17-18). Given the applicability of the functional availability doctrine and plaintiffs’
consequent failure to establish a discrimination in price, its RPA claim was properly dismissed.
The court also affirmed dismissal of the attempt to monopolize claim, finding the evidence did
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not support a finding that PM had monopoly power, including that PM had reduced its prices in
response to entry by fourth-tier cigarette manufacturers.
Together, RJR and PM support the proposition that market share discount programs that are
administered in an even-handed manner, and that set thresholds that can reasonably be achieved
by customers of all sizes, do not violate Section 2(a), even if certain purchasers choose to pursue
marketing strategies that result in their not achieving the highest level of discounts available
under these programs. As such, these decisions provide useful guidance to firms that have such
programs or are considering adopting them.
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