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Professor Drake
Team Seven (M. Srour, N. Istiani, J. Goldberg, A. Kvarnström, F. Gui, J. Emans)
November 24, 2009
Case Study 7 Memo – MassApparel, Inc.
I. Issues Presented
a. Are MassApparel’s (“Mass”) contractual restraints valid under antitrust law?
b. Assuming the restraints are valid, can Mass terminate its contract with Sports Unlimited
(“SU”)?
c. Can Mass modify its contractual restraints to prohibit advertising in other geographic areas?
II. Executive Summary
Based on our research, we have concluded that all vertical restraints currently imposed by Mass
on SU are reasonable and therefore legal under U.S. antitrust law. Our analysis indicates that
pro-competitive effects of the vertical restraints on interbrand competition outweigh
anticompetitive effects on intrabrand competition. This conclusion is based on assumptions that:
(1) the relevant market in question is the MLB-logo cap and jacket market; and (2) Mass'
restraints are subject to rule of reason analysis and not per se analysis.
We further conclude that Mass may lawfully terminate its contract with SU. The justification for
termination should not be based on a violation of the "spirit of the deal", but rather on the fact
that SU has clearly violated the contract by selling to resellers. An additional argument could be
made that SU is 'always' discounting at least some portion of its Mass-MLB merchandise below
the suggested MSRP and is therefore not making a good-faith effort to keep prices above MSRP
during the season.
Lastly, we conclude that Mass may be able to contractually restrict
marketing efforts based on geographic territory, but it may not be in their best interest so long as
the company can effectively enforce retailer minimum price restraints.
III. Facts
MLB Inc. controls the merchandising rights to all Major League Baseball teams in the United
States. They company has gross revenues of $90 million annually on the licensing of all logo
merchandise. $30 million of revenue is attributed to sales in the "cap and jacket market." MLB
does not manufacture logo products itself, but instead licenses manufacturers to produce
merchandise.
While MLB has 105 total licensed manufacturers, it authorizes only 4 manufacturers to produce
caps and jackets - A, B, C, and Mass. MLB considers four to be the optimal number of
manufacturers as it ensures sufficient diversity between products and that licensed manufacturers
are sufficiently incentivized by demand to prioritize the manufacturing of MLB-logo cap and
jackets. In exchange for the license to produce its logo products, MLB requires all cap and jacket
licensees to (1) pay 10% royalties on revenue (10% on wholesale prices); (2) be honest and
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reputable in their business dealings; and (3) use the MLB logo in accordance with graphic
standards imposed by MLB. Mass is an LA-based manufacturer of sporting goods and distinguishes itself from the competing
MLB cap and jacket manufacturers by being more 'high-end' - producing high quality, high
price, well-designed MLB products. While individual customers are attracted primarily to the
logo and quality, retailers place value on carrying Mass products because Mass' reputation of
being up-scale has positive effects on retailer perception. Most buyers want the MLB logo in
their products, and are willing to pay a premium to have them.
MLB-cap and jackets make up a full 25% of Mass' total annual sales. Although Mass has 581
retail customers selling its products worldwide and has an aggregate market share for MLB cap
and jackets of 26% (based on volume of sales), it places particular focus to the Southwestern
United States and, as a result, has a 37% market share in the overall region as well as in the
metropolitan markets of LA, Las Vegas, Salt Lake City, and San Diego.
Mass requires that all retailers of its MLB caps and jackets to sign a contract with the following
five major requirements: (1) Specifies the location where a retailer can inventory and sell MLB
merchandise; (2) Restricts sales to end-users (no resellers are allowed to purchase); (3) Requires
all retailers to train their staff on MLB merchandise and establish a marketing plan for MLB
products; (4) Prohibits retailers from selling products for more than 110% of suggested retail
price published by Mass; and (5) requires all retailers to use 'best efforts' to not sell MLB
merchandise below the published MSRP anytime during the regular baseball season. (It should
be noted that Mass does not restrict Internet sales, but it does see in-store sales as integral to its
business.) The company believes these restrictions are necessary to maintain brand integrity and
drive impulse sales within brick and mortar retail locations and have the sales data to support the
claim. Sales data supports a conclusion that the vertical restraints have had a positive effect on Mass
sales. Data shows that since imposing vertical restraints on retailers, sales have been up, retailers
have done better job of capturing demand through impulse buying, and retailer spending on
marketing, brand maintenance and training have increased. Furthermore, Mass' market share has
increased since the vertical restrictions have been put in place.
Mass has recently received complaints from 10 of its retailers in Las Vegas and Salt Lake that
Sport Unlimited ("SU"), a Mass-MLB retailer licensed to inventory and sell from only its
flagship San Diego store, has been violating the contract by marketing in its satellite stores (in
Las Vegas, Tucson, Palm Springs and Salt Lake) that it has the largest selection of MLB
merchandise and lowest prices at its online store. SU further advertises that it can ship from its
San Diego store to a customer’s doorstep within two days. Complaints further allege that SU has
been selling old inventory to resellers well below MSRP, marking up prices to an 'insanely high
level", (assuming this is above 100%, but we will need further clarification) and slashing prices
year-round. Currently, the sale of Mass products accounts for 11% of SU's total sales. In the cap
and jacket area, 90% of SU's sales are from Mass MLB caps and jackets. When Mass inquired about the allegations, a representative for SU flew off the handle and
accused the complaining retailers of not being able to take a little competition. The SU
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representative also stated they had to 'dump' product to buy more, and were unable to control
sales to resellers because they 'have no way of knowing what buyers do with the product.' While
Mass has had issues with contract breach in the past, they have always been able to solve the
issues simply by contacting the alleged violator. Mass is concerned that SU's conduct in selling
outside the price collars amounts to free riding, and if allowed to continue will tarnish Mass'
reputation, and reduce or eliminate incentives for brick-and-mortar retailers - the core of Mass'
business strategy.
IV. Market Analysis: Market Definition and Power
Relevant product and geographic markets must be defined in order to analyze the vertical
restraints imposed by Mass and ascertain the existence of any market power. We conclude the
relevant product market to be MLB licensed caps and jackets. Since sales of Mass' product are
driven by in-store impulse purchases, the product market is subjected to segmentation around
retail centers, most likely to be in larger metropolitan areas.
The relevant market is determined by consumer preference - it consists of all products that are
"reasonably interchangeable" for the same purpose. United States v E.I. Du Pont De Nemours &
Co., 351 U.S. 377 (1956). One would need to consider the cross-elasticity of demand between
these products in order to ascertain the likelihood of a reasonable consumer making the switch
between them. When a consumer decides to purchase a good, she has an intention, or desire. To
the extent this desire can be satisfied by purchasing a different product, the relevant product
market expands. When the consumer has exhausted her choices of products that will satisfy her
initial intention or desire behind the purchase, the relevant product market has been defined.
The sports merchandising market in the United States is enormous. MLB merchandise forms
only 20% of a market, which consists of among other things, hats, jackets, buttons, books,
pennants and more. Defining the relevant product market as all sports merchandise would be
inappropriate for two reasons. First there are many differentiable products within the realm of
merchandise. For instance, a fan going to a sporting event will often want to show her team
spirit. However, this desire would rarely be expressed by her going to Borders to buy an official
MLB fact book to bring to the game. Second, individuals tend to dislike some sports. Sorry
hockey. Furthermore, the popularity of a sport or team can be affected by seasonality, tradition,
current win loss record, or other factors. For instance, a mother whose son just got into UW is
not going to buy a Detroit Redwings jersey to show her Husky pride, even though the Redwings
are a storied franchise will have a far better season than the UW football team. Therefore, it is
necessary and proper to delineate the sports merchandising market very narrowly - not just
between leagues, but also within actual merchandise offered - ie, to MLB caps and jackets.
Mass has a license to produce MLB caps and jackets. In this case we will specifically analyze
vertical restraints placed on sales of their MLB caps and jackets. One may reasonably presume
that a consumer in the market will not consider any other merchandise reasonably
interchangeable with MLB caps and jackets. We note that more pointed questions would be
needed concerning the cross-elasticity of demand of other MLB apparel in order to determine if
the relevant product market should be expanded.
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There are two relevant geographical markets for Mass produced merchandise. Mass sells MLB
licensed caps and jackets to over five hundred retailers worldwide. Therefore the relevant market
could be widely cast to encompass the aggregate. However, the behavior of consumers buying
Mass merchandise, and the nature of Mass’ promotional efforts directed at specific retailers in
the Southwest, suggest that the relevant geographical market for Mass' product should be sized
down.
The first geographical market is one largely based on the purchasing habits of impulse buyers.
Fans often enter sporting retailers and are persuaded by retail staff and in-store advertising
displays to purchase MLB products. The consumer's desire to purchase the product is generated
inside the retail outlet. This type of sale accounts for a tremendous amount of Mass' MLB cap
and jacket sales. Since a vast amount of sales are created by impulse buying, which is reliant on
local retailers, we feel one relevant geographic market is limited to the area in which a
reasonable consumer will travel to shop in person. Under this theory, the hundreds of Mass
retailers are broken down into many different submarkets, probably associated with metropolitan
hubs. This conclusion is supported by the tendencies of the average consumer described above
and Mass' business strategy.
Vertical restraints, which will be discussed in the next section, embody Mass' belief that retailers
must be protected. The assurance of adequate sales volumes through such protection serves to
provide retailers with the incentive to promote impulse buying. In the Southwest, Mass’ sales
force is able to infiltrate the different metro areas and helps its licensed retailers located there, to
establish optimal marketing strategies and sales techniques. This would explain why Mass'
market share is 37% in the Southwest, while only 26% in the broader geographical market.
Accordingly, our market analysis will begin by being geographically limited to southwestern
United States.
This analysis would ignore other buyers in the relevant product market - viz, non-impulse
shoppers. Some consumers know exactly what products they want. These individuals are more
price-sensitive than impulse buyers and are willing to shop around. Again a narrow market
definition is appropriate because even a non-impulse shopper will be unwilling to go outside of
her surrounding cosmopolitan area for sports merchandise because higher transportation costs
would likely negate any arbitrage. There are also shoppers who value convenience in addition to
low prices and only purchase products via the internet. The internet opens up narrowly defined
retail oriented markets and enables consumers to get MLB caps and jackets from other locales.
Mass does not have a blanket prohibition against retailers selling its merchandise online. It is in
this respect that the broader geographical market can be defined.
However, it should be noted that the internet is not an effective impulse buying tool. Customers
use the internet to shop for a product they know they want. Mass' business strategy is largely
dependent on business derived from impulse-buying consumers. To the extent that internet-based
marketing and sales permits free riding and cannibalizes impulse retails sales, Mass' business
strategy is undermined. Since this is the very effect of SU advertising in its satellite stores in
other Southwestern markets, we will focus our analysis below to the effects on select retail
markets and not the macro picture.
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Mass does not have market power in either case - that is, regardless of whether or not the market
is defined more narrowly in geographical terms. Courts normally take the share of the market a
company has presently captured as the principal sign of market power. As seen in Alcoa, a
market share in excess of 70% was considered indicative of monopoly power by the court.
However, below a 40% market share is usually insufficient to show any actual market
power. See Dupont. Even in the Southwest, where Mass has focused the operations of its sales
force, Mass has captured only 37% of the total MLB cap and jacket market and faces
competition from the other three manufacturers of MLB caps and jackets all of whom have
substantial market shares. Therefore, Mass likely does not have market power - notwithstanding
the existence of barriers to entry in the form of the need for an MLB license.
V. Are Mass’ Contractual Restraints Valid Under Antitrust Law?
a. Rule of Reason vs. Per Se
Justice Kennedy in Leegin noted that minimum price maintenance in a vertical restrain is no
longer per se, provided the conduct does not serve to disguise certain other types of restraint.
Kennedy postulated three scenarios in which an exemption may apply: Manufacturer Cartel,
Retailer Cartel, and Dominant Actor Scenario (manufacturer or retailer.)
The vertical restraints imposed by Mass are not related to a disguised manufacturer cartel.
Retailers of the four MLB manufacturers are distributed everywhere in the United States and
around the world, and each of them offers somewhat different prices. Mass is well-known for
having higher quality and higher prices, thus differentiating their products from competitors.
Even though there are only four players in the MLB world, which makes the MLB market prone
to collusion, the MLB is in constant competition with NBA, NFL and other entertainment (Mass
also imposes the same vertical restraints on retailers of its other licensed merchandise). There is
no evidence that the other three manufacturers are imposing the same vertical restrains. Some do
not impose any.
The vertical restraints are not related to a retailer-level cartel. The manufacturer establishes the
restraints to stimulate services and to promote its brand, not to give inefficient retailers higher
profits. It is the manufacturer who wants these restraints, not the retailers. There is no evidence
of volume incentives.
This is not a Microsoft/ Dominant Actor scenario either. There is neither a giant manufacturer
nor a giant retailer. On the manufacturer level, Mass, in its strongest market area, only has a
37% market share and arguably lacks the power to dominate the market for caps and jackets.
There is no indication that Mass is trying to use its market power to incentivize the retailers not
to sell the products of the other three manufacturers who are trying to penetrate Mass’ territory.
In fact, retailers are generally aware of Mass' high-end quality and see it as a component of sales,
but certainly not the only game in town.
For the retailer perspective, there is no indication that a dominant retailer is attempting to
dominate. Complaints against SU were independent actions and did not even involve Mass’
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largest MLB retailer in the Southwest region. Besides, retailers are able to purchase and display
MLB products from other manufacturers without sanction or repercussions by Mass. For
example, SU buys from others direct via phone calls to fill in select lower cost and lower quality
models. The other three manufacturers should worry about retail domination when Mass retailers
discount Mass MLB products below MSRP, because it will penetrate their market (high quality,
lower price).
Finally, the restraints do not disguise price-fixing across different MLB teams. Each retailer has
some latitude to charge relatively higher prices for “hot-team” merchandise and relatively lower
prices for dog team merchandise. Hot-teams differ from time to time and from area to area.
Moreover, according to American Needles, MLB is likely to be considered as single entity for
antitrust purpose. Accordingly, a rule of reason analysis would apply.
b. Territorial Restraints
Every Mass MLB retailer contract specifies the location from which the designated retailer can
inventory and sell MLB merchandise. It would be appropriate to apply a rule of reason analysis
to this provision, as it is a vertical, non-price restraint having the evident potential to stimulate
interbrand competition in the relevant market: Continental T.V., Inc. v GTE Sylvania Inc., 433
U.S. 36 (1977). This provision would likely survive a rule of reason analysis and be found not to
violation of §1 of the Sherman Act.
The provision has an important pro-competitive effect in that it enhances interbrand competition
in the relevant market. Mass encourages its retailers to invest in in-store promotion of, and
customer service relating to, Mass-produced MLB caps and jackets in the absence of a risk that
such investment would be taken advantage of by free riders. It does so by limiting the number of
sellers of a particular product competing for the business of a given group of buyers. Without
this provision, Mass’ retailers would have little or no incentive to invest in product promotional
efforts as new retailers entering the market could free ride by: (1) taking sales away from
existing retailers without investing in product promotion; (2) generating relatively higher profit
margins per unit of product sold; and/or (3) stealing market share from existing retailers by
lowering their prices in line with cost-savings.
Increased product promotion (in-store advertising and customer service) benefits consumers by
enhancing product information and consumer choice. Importantly, in the present case, product
promotion is integral to Mass’ apparent business strategy in encouraging impulse buying by
consumers once they enter the retailers’ stores. Attracting competent retailers is consistent with
Mass’ brand image and necessary for the successful distribution of products with which
consumers are largely unfamiliar. In this way, the vertical restraint essentially facilitates Mass’
capacity to effectively compete with other MLB-licensed cap and jacket manufacturers by
protecting and promoting its brand - that is, it facilitates interbrand competition.
Although it is true that retailers (not consumers) value Mass’ brand, the relevant competition
here consists of competition between the MLB cap and jacket manufacturers for retailer shelf
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space and eye-catching marketing to maximize the consumer’s response in a context where
impulse purchases a sought.
It is likely that the provision will adversely affect intrabrand competition, especially in those
regions where only one retailer exists. However, the elimination of free-riding on retailers’
investments in product promotion, as well as the achievement of efficiencies in the distribution
of Mass’ product to a smaller number of competent retailers, define the relevant restraint as a
reasonable and legitimate one (as reflected, in fact, by the increase in MLB’s volumes and
profitability since the imposition of this restraint). Additionally, there is no evident alternative
means by which this result can be achieved.
In any case, it is likely that the pro-competitive effect on interbrand competition would outweigh
any anticompetitive effect on intrabrand competition. Therefore, there is likely no violation of §1
of the Sherman Act in this respect. It is important that Mass be firm in upholding/enforcing this
provision of its retailer contracts, in order to ensure that existing retailers continue to procompetitively promote Mass-produced MLB products and provide effective customer service in
relation to them.
c. Reseller Restrictions
Reseller restraints on Mass’ MLB caps and jackets have both pro-competitive and anticompetitive effects. Ultimately however, these restraints are essential to maintaining the output
of Mass’ business by protecting the incentive of licensed retailers to encourage impulse buying,
which sustains the market for caps and jackets.
By limiting the number of locations selling Mass’ MLB caps and jackets, reseller restraints are
potentially anti-competitive. Theoretically, more sellers would promote intrabrand competition,
and margins would be squeezed in a relatively more competitive retail market. However, in order
for resellers to be profitable, retailers must ignore seasonal minimum price restraints that are not
per se illegal (See minimum price restraints section). As such, resellers would presumably have
to buy product in between minimum and maximum price restraints. Therefore, reseller prices
would on average be higher than licensed retailers.
In the off-season no minimum price restraints exist. Therefore, reseller restraints could
potentially prevent resellers from buying super discounted product and keeping it for the
seasonal demand and selling at an ordinary price later. This assumes resellers would be willing to
buy discounted merchandise to hold for the following season in order to make more money. This
could only occur without price gouging, if reseller inventory costs are low. Furthermore, a
reseller may still choose to gouge customers in the offseason and even more so with hot-team
merchandise during the season. Therefore it cannot be assumed having more outlets will actually
benefit consumers via more competitive prices.
Forgoing reseller restraints will most likely hurt the consumer. Any volume resellers take away
from licensed retailers of Mass’ product would diminish retailer incentives to stock and try to
push Mass’ product. Resellers would be effectively free riding on the efforts of the licensed
retailers. Without a reliable expectation of volume because of reseller cannibalization, aggregate
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volume within a metropolitan market may actually decline. This scarcity would encourage higher
prices for all Mass-produced products and have a chilling effect on the marketplace.
Free riding is a legitimate concern for Mass. Since it sells higher quality merchandise, its price
point on the retailer’s shelves is higher than its competitors. Individuals do not know about Mass
on their own. Retail staff and displays must highlight Mass’ higher quality product, to make up
for the difference in price seen by the consumer, in order to sell more product. In the Southwest,
where Mass has a sales force to help retailers optimize marketing and training strategies, Mass
has over 30% of the market share for caps and jackets. Elsewhere, Mass’ market share is barely
over 20%. Therefore, it is quite evident that reseller restrictions are good business practices for
Mass and, indeed, necessary for the company to effectively compete in the market.
d. Training and Advertisement Requirements
Mass-produced MLB caps and jackets differ from those of other MLB cap and jackets
manufacturers in terms of quality, design, and price points. Mass' products are more expensive,
of higher quality, with more superior designs and finishes. Mass differentiates itself in this way
to play hard in high-end markets. At the customer level, Mass' brand is no big deal because the
customer is just concerned with the product's quality and its logo.
To nurture the Mass-MLB high-end quality image in customers' minds, Mass tries to strengthen
its promotional efforts by having provisions in its retailer contract requiring each retailer to train
all its staff on MLB merchandise and adopt a comprehensive plan to advertise MLB merchandise
in its market. Mass wants to capture impulse buyers (a key driver of its sales volume) by creating
effective retail outlets that promote product sales.
Mass' retailer contract does not restrain other MLB products produced by other manufacturers
from retail advertising, but Mass wants its product to have key shelf positioning to maximize
customer response. Retailers who give maximize shelf space and use displays and other eyecatching marketing to capture impulse buyers will generate big volumes and preserve the highend quality brand image of Mass. This is pro-competitive because competing in quality and
brand image building naturally creates market differentiation and niche areas for new market
entrants.
This provision increases retailers' costs, which may be passed along to the customer through
higher prices. However, the maximum price restraint provision makes it impossible for retailers
to completely gouge customers. Furthermore the SRP itself is two and half times the retailer's
cost (which is common for specialized logo merchandise), training and advertisement cost have
no significant impact on retailer profit margins. Therefore, this provision survives the rule of
reason test.
e. Maximum Resale Price Maintenance Provision
This provision is essentially vertical price-fixing at a maximum level. Like other vertical
restraints, the legality of maximum price-fixing is to be determined by a rule of reason analysis
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(Leegin v. FSKS.) A provision that amounts to maximum price-fixing, prevents prices from being
set only by the market. This seems extremely anticompetitive at face value, but the procompetitive effects that come with a legitimate business justification of maximum price
restraints, outweigh these negative effects.
Risk of Predatory Prices
The purpose of a maximum price fixing provision is to keep prices at a lower level. Low prices
benefits consumers regardless of how they are set and according to KHAN and ARCO, they do
not threaten competition as long as the prices are above a predatory level. The suggested retail
price published by Mass equals two and one-half times the retailer’s cost. This retail pricing is
not uncommon for specialized logo merchandise, which indicates that the pricing is not
predatory. The provision does not state that the retailers can only sell for the exact suggested
retail price, it does allow for some flexibility in setting prices higher, which also indicates that
the prices are not predatory. As for the risk of predatory pricing, according to KHAN, a supplier
cannot squeeze his dealer’s margin below a competitive level unless the supplier is a
monopsonist. Any attempt my Mass to squeeze dealer margins would not have a consolidating,
anti-competitive effect, but would likely make dealers turn to competing suppliers. Mass is not
the only manufacturer, nor is the MLB cap and jacket market inelastic. Retailers can turn to other
manufacturers if margins on Mass products become too narrow.
Risk of Monopoly Prices
When retailers are given exclusive territories or placed sufficiently far apart to limit competition
between them, there is a risk of them developing monopoly power. If a retailer has monopoly
power in its area, a supplier generally will want to prevent the retailer from taking advantage of
this power to charge monopoly prices. According to KHAN, trying to prevent monopoly pricing
is a legitimate business justification for wanting to put a roof on prices. The higher the price at
which a product is sold, the smaller the potential volume sold.
Pro-Competitive v Anti-Competitive
Since Mass' business strategy to compete more efficiently in the interbrand market relies heavily
on their retailers being geographically spread, they have a legitimate business justification to
impose a vertical restraint in the form of maximum pricing in order to minimize the risk of
monopoly pricing. This is especially true in smaller retail market segments containing few stores
that sell Mass produced merchandise. The purpose of the restraint could probably not have been
accomplished with less restrictive means. Mass does open up the possibility for the retailers to
sell the products for 10% higher than the suggested price, which allows for some flexibility.
Combined with the fact that the purpose of the restraint is to keep prices down and output up,
which is good for the consumers, the pro-competitive effects of this restraint outweighs the
anticompetitive and allows this restraint under a rule of reason analysis.
f. Minimum Resale Price Maintenance Provision
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Under Leegin v. FSKS, a minimum price maintenance vertical restraint is not per se invalid
unless it falls into the three per se exceptions. Mass' minimum price restraint has passes the per
se test, therefore it will be examined under rule of reason.
SU has spent a lot on advertisement, however, it seems SU does not spend the money the way
Mass prefers. Mass wants advertisements focused on capturing impulse buyers, not non-impulse
buyers lured by cheap prices. By discounting its “not-hot” team merchandise all the time, even
in season, it seems SU only bothers to make the easy sale (i.e., to promote impulse buying for
“hot team” merchandise). Essentially SU is skimming the market for the low hanging fruitselling cheap, and free riding on other retailers in satellite markets who take the effort to
promote impulse buying.
SU’s cold-team inventory in its San Diego retail outlet might be hot merchandise in Las Vegas
and Salt Lake. Retailers there will have to compete extremely hard to capture impulse buyers
because of SU’s strategy of drawing people to its website and selling cheap. SU's strategy does
not help in any way to generate impulse buying, while such strategy does have the effect of
attracting plenty of “ma & pa” stores from Las Vegas and Salt Lake to buy online. The
prevalence of “ma & pa” stores will unavoidably discourage the retailers in proximity to
comprehensive advertising and eventually tarnish the brand. The minimum price provision has
the pro-competitive virtue of mitigating free riding, if not completely eliminating it, and
preserving the brand.
Selling online is not a horrible idea if Mass can effectively enforce the minimum price
provision. A reseller purchasing Mass' product at a discount may mark the product up from 10%
to 50%. If SU does not so easily sell Mass merchandise below the minimum price, let alone as
low as 50% of suggested retail, especially in season, a reseller will not find it profitable enough
to purchase merchandise from SU’s website and then resell the goods, especially if SU charges a
shipping fee for orders online.
For “ma & pa” resellers who buy “hot team” merchandise at suggested retailer prices and then
charge impulse buyers “insanely” high prices, the minimum price provision will not directly curb
such highway robbery, but if authorized retailers are doing their job of advertising and sale
promotion, they should be more capable and well equipped to capture those impulse buyers with
“sane” prices. Therefore, the minimum provision helps to prevent highway robbery of consumers
by “ma & pa” resellers and at the same time helps to prevent Mass from looking like a gangster,
and helps to preserve the brand. Instead of a categorical bar of online sales, another less
restrictive means to discipline SU would be restraining the amount of merchandise each
customer can buy per transaction from the website, say 10 or 20 items per transaction per
customer. Presumably, such restriction would increase the transaction costs for resellers, while
not having a big impact on real end buyers.
The other pro-competitive benefit associated with this provision is the increase in efficiency. SU
grumbled about its “lousy excess inventories” of Mass' product. SU should blame itself at least
in part. Mass is set up to quickly handle small retailer orders so retailers can easily control
inventories with smart buying programs. Excessive inventories are not an excuse for selling
cheap to get ride of them, because SU does not need to over store as much in the first place. The
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provision thus can incentivize the retailers to buy smartly, and to be more sensitive to
consumers’ preference.
Retailers who commit to the sale promotion of Mass' product will want the enforcement of the
minimum provision. Otherwise, Mass knows other retailers would love to ignore this covenant,
to discount heavily slower-moving MLB merchandise at all times and to dump excess
inventories to unauthorized resellers in other markets. On the other hand, Mass does want this
provision. Because through this provision, together with other provisions, Mass is able to
preserve strong retailer commitment and place priority on in-store service. If SU can ignore
limits, then others may follow and the discipline of all retailers may be lost.
Usually, a manufacturer’s interest is aligned with that of consumers, especially where, like here,
the manufacturer is not a monopolist. In the short term, consumers would be happy with the
discounted product they can get from “ma & pa”, but eventually, if the brand is tarnished or
degraded, consumers will lose the choice of high-end merchandise, which is not a good for the
market.
SU’s claim that “those other pansies just can’t handle a little competition; they want all the sales
in their markets without having to do any advertising” is demonstrably false. Promoting impulse
buying is substantially more difficult than advertising cheap and dumping (intentionally or not)
to resellers and is focused on the sustainability of the business – a benefit to consumers in the
long-term. The victim retailers’ effort to promote impulse sale will be frustrated by a “ma & pa”
at the gas station down the block who sells the same thing at a big discount.
The minimum resale provision does have some potential anticompetitive effects. For one, prices
are higher. This is not surprising since discounting is discouraged and impulse buying is
promoted. As discussed by Justice Kennedy in Leegin, “ price surveys indicate that resale price
maintenance in most cases increased the prices of products sold,” but the phenomenon itself
doesn’t mean the provision is illegal per se; anti-competitive conduct has to be shown before a
provision can be outlawed under rule of reason.
The other potential anticompetitive effect is the discouraging of innovation in sale. Presumably
SU innovated this kind of sale strategy– advertising in satellite stores and selling online. If SU is
able to sell cheap merely because it achieved lower distribution costs through this innovation, it
is anti-competitive to disallow SU from benefiting from its innovation by setting the minimum
price. However, it’s unlikely to be the case here – SU is mainly free riding and running the risk
of tarnishing the brand. Even with more serious enforcement of the provision, technically, SU is
free to sell cheap off-season. Henceforth, SU can still possibly benefit from the innovation
during the off-season.
Another anticompetitive concern would be the narrowing of consumer’s choice. If each retailer
buys smartly, instead of storing the whole collection of MLB-Mass merchandise, some
consumers with unique preference would not be able to find what they want. Such loss of
consumer choice is likely to be small, because 1) it’s unlikely to be the case for impulse buyers
and 2) for non-impulse buyers, they can always find the merchandise they want online.
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Last but not least, the provision is not an across-the-board prohibition; it’s a “best effort”
provision. Retailers can still sell below the suggested price on season if that’s only way to sell
cold-team merchandise, but they need to put good faith effort to try to promote the sale first,
before they can resort to easier route. In sum, the minimum resale price maintenance provision
passes muster under a rule of reason analysis.
VI. Assuming the restraints are valid, can Mass terminate its contract with SU?
Mass' business reason for wanting to terminate SU
The restraints imposed by Mass on its retailers are important because Mass wants its retailers to
be committed to promoting product sales in a way that captures impulse buyers, which is crucial
for making sales and big volumes in the high end cap and jacket market. A retailer who gives
strong shelf space and uses displays and eye-catching marketing to capture impulse buyers will
generate big volumes for Mass. By giving retailers territorial and price protection, Mass
incentivizes optimal product placement and sales treatment.
Mass' business plan has proven to be crucial in order to build up its brand and efficiently
compete in the interbrand market against the other MLB manufacturers. The MLB retailers now
associate the Mass brand with high quality and high prices. Since imposing vertical restraints on
retailers, Mass' MLB business has grown steadily and become more profitable. Both prices and
profits have stayed high and Mass has found that they will sell more and achieve high profits
when dealing with a lower number of retailers that are committed to Mass merchandise and their
business plan, instead of the retailers that only want to make an easy sale.
In Mass' business plan, retailers are the key. It is a priority for Mass to preserve strong
commitment and service of all its MLB retailers. The sales plan will not work if not all of its
retailers follow the provisions because of intermediary devices such as the internet and selling to
resellers. If Mass ignores limits, retailers may go rogue and then the discipline of the entire
program may be lost. In order to continue to be a strong interbrand competitor, it is therefore
crucial for Mass to make sure that SU complies with the provisions or try to get rid off SU as a
retailer. Since through our analysis it seems the vertical restraints imposed are legal, Mass could
consider terminating SU in order to save its business model.
The right to termination according to the contract
The contract between Mass and its retailers containa a termination clause stating two possibilities
for Mass to terminate the contract on 30 days notice. These possibilities are if a retailer, in Mass'
judgment, does not produce adequate volume, or if it does not follow the rules of the contract.
Terminating due to inadequate volume would be a difficult argument to make. SU is probably
producing more volume than before with the internet sales and advertisement about it. The only
possibility to terminate in accordance with the contract is if SU has broken a rule in the contract.
Assuming complaints against SU are legitimate, there may be sufficient grounds to terminate for
breach of contract. Despite the fact that SU's contract with Mass specifies that the flagship store
in San Diego is the only SU store that can inventory and sell MLB merchandise, SU has huge
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displays in all its satellite stores advertising their website. The advertisement states that they
have “the largest selection” of MLB merchandise at the “lowest prices” and that the merchandise
will be delivered to the customer's door within two days from SU’s flagship San Diego store.
SU has also sold discontinued or dated MLB merchandise to unauthorized “ma and pa” retailers
in the satellite markets. Some of these “ma and pa” stores heavily discount the merchandise at all
times and others charge “insanely” high prices for “Hot-team” merchandise. SU itself is always
discounting its huge inventories of “not-hot” MLB merchandise at prices far below suggested
retail.
If the sales over the internet are to be seen as sales from the San Diego store, SU is not breaching
the provision of only selling from the flagship store. Mass thinks that SU’s advertisement in
other markets, might not technically be in violation of specific contract language, but well
outside the “spirit of deal”. Mass considers the spirit of the deal to be staying close to the market
area where a retailer is authorized to maintain inventory. Even though SU's behavior might be in
violation of the “spirit of the deal”, such a violation is not a substantial breach of contract that
gives Mass a contractual right to terminate the contract. We would not recommend Mass to
terminate the contract on that basis. Instead, it is possible that SU's conduct can be seen as a
breach of one of the other contractual provisions.
Sales to unauthorized resellers
The contract clearly states that the retailer may only sell MLB merchandise to end consumers
and not resellers. The fact that SU has been selling Mass MLB products to resellers such as the
“ma and pa” stores is a clear violation of the contract. Having resellers sell the Mass-MLB
merchandise tarnishes the Mass brand and discourages retailers from doing their job. The
resellers can sometimes discount the merchandise up to 50%. These impacts on the Mass brand
means that it is a crucial part in Mass business plan to prevent sales to unauthorized resellers.
However, SU has never knowingly broken the provision by dumping stuff to an unauthorized
player. Even though SU did not know this, it did nothing to prevent from selling to resellers. SU
even claims that they encourage large ticket orders, which reasonably should wake some kind of
suspicion that there might be a risk of reselling. Not asking purchasers of large orders if they
have an intention to resell could be seen as anti-loyal and maybe as proof of intent to ignore the
terms of the contract. This is the provision that SU is most likely to be in violation of.
Discounted sales
The contract requires the retailer to use its “best efforts” not to sell MLB merchandise below the
published suggested retail prices at anytime during the regular baseball season. “Best efforts” is
not defined by the contract, however an argument could be made that SU is always discounting
at least some portion of its Mass-MLB merchandise below the suggested retail price and is
therefore not making a good-faith effort to keep prices above minimum suggested retail prices
during the season. Most retailers do go below the suggested retail price when it is necessary to
get rid of excess merchandise. However, for SU it seems to be more of a habit.
On average, SU's internet prices for Mass merchandise are 82% of suggested retail, with some
being as low as 50% of suggested retail. These averages are the same as SU's in-store sales. In
totality, there is a good chance that a judge or jury would conclude that SU has failed to make its
best effort.
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There is also very little need for SU to have large stock of excess merchandise. The retailers only
have 2 days of delivery from placing an order from Mass. The contract does not impose an
obligation on the retailers to order a certain amount of merchandise per time period, they are free
to order any amount they wish. This means that SU really cannot blame any excess stock on
Mass – it was their own bad business decision to buy that much merchandise and Mass should be
allowed to impose restrictions that prevents SU from making a bad business decision go out over
Mass. Never the less, it is still only a “best effort” provision, and even if SU really is not making
its best effort, it is hard to prove that this is a breach of contract.
Termination even without a breach of contract
Our analysis above shows that the restraints in the contract will most likely survive the antitrust
regulation under a rule of reason analysis due to the fact that intrabrand restraints are necessary
and justified to make Mass a stronger competitor in the interbrand market.
A termination of the contract might be in violation of Mass' contractual obligations, but
considering the harm that SU's behavior may cause Mass' entire business plan, Mass need to take
action in order to make sure that the other retailers do not follow SU's lead. If a termination does
not impose antitrust liability, but only contractual liability, it would be wise to terminate SU
anyway due to the risk of having its entire business plan destroyed. It is possible that other
retailers also play the “don't ask, don't tell game” and allow large ticket orders without
questioning the possible resell intention. If Mass sets a standard by terminating SU's contract
even if they cannot prove that SU intentionally sold to resellers, it would certainly make Mass
retailers consider cracking down on reseller sales and imposing some kind of policy to prevent
resellers from getting to the Mass-MLB products in order to avoid having their own contracts
terminated. Even though SU is Mass' second largest retailer, it is only a small part of Mass-MLB
sales. Possible damages due to unjust termination of contract would be minimum and potentially
worth it in order to protect the business plan.
VII. Can Mass modify its contractual restraints to prohibit advertising in other geographic
areas?
Mass considers the spirit of the contract with its retailers to be to stay close to the market area
where retailer is authorized to maintain inventory. Therefore, it believes that SU’s advertisement
in other markets is far outside the “spirit of deal.” To prevent this from happening again, Mass
would like to change the contract language into prohibiting any such advertising in other
geographic markets and wants to know if such a provision would be valid under antitrust
regulation.
A geographical restriction on advertisement is another form of vertical territorial restraint subject
to a rule of reason analysis according to our previous analysis. By prohibiting advertising in
other geographic markets than the one the retailers has been assigned, Mass makes the existent
geographical division more explicit.
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Since the restraint is a vertical, non-price restraint, it also has potential to stimulate interbrand
competition in the relevant market. (Continental T.V., Inc. v GTE Sylvania Inc) The geographical
division of retailers is critical to Mass' business plan which makes Mass a strong competitor in
the interbrand market.
A territorial restraint on advertisement limits customer information, which could be
anticompetitive. However, the relevant output for antitrust purposes is not the amount of
advertising, but the amount of merchandise, so the restriction does not limit output. (California
Dental Associates v FTC)
There is no provision in the contract that concerns sales through the internet specifically. The
contract ought to cover all of the retailers sales regardless of whether its done in their respective
stores or over the internet. It would be hard for Mass to modify the contract into a provision that
restrains the retailers from selling over the internet, since that would effectively be limiting
output of merchandise.
A good solution might be to allow internet sales, but only to consumers within retailers
designated territory. Mass should also clarify that the all the other provisions for normal sales
also apply for sales through the internet. A retailer has to use the same price points for internet
and in store price. (With delivery cost, the total price a customer would pay through an internet
purchase is higher than in store purchase. It will create competition, and in the other hand protect
territorial exclusivity of the retailer because customer who lives near the retailer store will rather
go to nearest store rather than purchase from other retailer store through the internet.
This provision will impose some complications for the retailers in the intrabrand market, but the
purpose of the provision is to make Mass a stronger competitor in the interbrand market which
essentially is anticompetitive. These pro-competitive effects in the interbrand market outweigh
any harm in the intrabrand market and allow this restriction under a rule of reason analysis.
VIII. Conclusion
While Mass’ vertical restraints on SU are clearly anticompetitive within the context of
intrabrand competition, the Supreme Court has interpreted antitrust regulation to be geared
towards competition on the interbrand market. Therefore, most intrabrand restraints can be
justified so long as they produce improved competition in the interbrand market. Mass’ vertical
restraints clearly do produce such interbrand benefits and therefore should be interpreted under
rule of reason analysis and deemed justified.
Additionally, Mass should be able to terminate the contract with SU and modify existing
contracts to limit extra-territorial advertising. While Mass will likely strike out with the
argument that SU’s conduct is in violation of the ‘spirit of the deal’, SU is weak to attack in that
it has clearly made a habit of selling to resellers, and has done so consistently at prices
substantially below MSRP.
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