DISTRIBUTION
THE NEWSLETTER OF THE
DISTRIBUTION AND FRANCHISING
COMMITTEE
Antitrust Section — American Bar Association
Vol. 20, No. 1 — March 2016
In this Issue
Message from the Chair.................................................................................... 1
Franchise Law Developments in Germany: Appellate Court
Recognizes Claim for Damages Based on Pre-Contract
Information Provided by Franchisor................................................................. 3
California Assembly Bill 525: A Resounding Win for
Franchisees or a Source for Further Dispute.............................................................. 5
Resale Price Maintenance and Dual Distribution............................................. 8
The 2016 Auto Distribution Workshop: An Insider’s Take..............................14
Summary of FTC Workshop: Auto Distribution: Current
Issues and Future Trends.................................................................................16
Distribution and Franchising Committee: ABA Section of Antitrust Law
THE HIGHLIGHT ZONE:
MESSAGE FROM THE CHAIR
Submitted for your consideration … the first issue of DISTRIBUTION
in the 2015-2016 ABA year. On behalf of the Distribution & Franchising
Committee, I hope you’ll find its contents thought-provoking and
educational.
This issue will be of special interest to practitioners with clients involved
in franchise relationships. We are grateful to authors Marcus Schriefers and
Michaela Schwuchow for their update entitled, Franchise Law Developments
in Germany: Appellate Court Recognizes Claim for Damages Based on Pre-Contract Information Provided by Franchisor.
Several times zones to the west of Germany, Anthony Marks and Kazim Naqvi comment on California
Assembly Bill 525: A Resounding Win for Franchisees or a Source for Further Dispute?
Reuben Arnold, Neill Norman, and Daniel Schmierer take a look at Resale Price Maintenance and Dual
Distribution. And in the aftermath of the FTC’s day-long workshop on the state of motor vehicle distribution
in the U.S., the intrepid Anna Aryankalayil provides a useful Summary of the FTC Workshop: Auto Distribution:
Current Issues and Future Trends, while industry veteran Steven Cernak offers valuable insights in his piece, The
2016 Auto Distribution Workshop: An Insider’s Take.
As we develop the contents of our next issue of this newsletter, we invite you to contact the editors about
contributing an article, book review, commentary, practice tips, case note, or interview. Good articles come
in all shapes and sizes!
We hope to see many readers at the Section of Antitrust Law Spring Meeting in early April. Our Committee
is the sponsor of a Spring Meeting panel discussion entitled, Spinning Our Wheels: Clarifying Liability in Huband-Spoke Conspiracies, and co-sponsor of no fewer than three other programs with a focus on distribution
issues: Price War: Reconciling Conflicting National Pricing Restraints, International Perspectives on Online Vertical
Restraints and Marijuana, Twenty-Three States and Counting…. If you are looking for excellent speakers and
fascinating topics, look no further.
Later this year, the Committee looks forward to the publication of the second edition of The Law and
Economics of Product Distribution, a compilation of legal and economic approaches to antitrust issues arising in
the context of distribution relationships.
We invite you to join the Distribution & Franchising Committee if you have not already done so.
Membership is free to all Section members. All you have to do is enter the Section website, go to the
Committees page, click on “JOIN A COMMITTEE” and follow the instructions.
Enjoy this newsletter and join us soon for another episode of … The Highlight Zone.
Warmest regards,
Alicia L. Downey
Chair, Distribution and Franchising Committee
Copyright Notice
©Copyright 2016 American Bar Association. All rights reserved. The contents of this publication may not be reproduced, in whole or in
part, without written permission of the ABA. All requests for reprints should be sent to www.americanbar.org/utility/reprint.
March 2016
1
Distribution and Franchising Committee: ABA Section of Antitrust Law
DISTRIBUTION is published by the Distribution
and Franchising Committee of the American Bar
Association Section of Antitrust Law. The views
expressed in Distribution are the authors’ only and
not necessarily those of the American Bar Association,
the Section of Antitrust Law, or the Distribution and
Franchising Committee. If you wish to comment on
the contents of DISTRIBUTION, please write to the
American Bar Association, Section of Antitrust Law,
321 North Clark, Chicago, IL 60610.
Submission of Materials:
DISTRIBUTION welcomes submissions of articles,
and case summaries involving significant or interesting
decisions, trials, or developments in antitrust law
affecting all types of distribution arrangements.
Please send all submissions to:
Craig G. Falls, Vice Chair
Dechert LLP
1900 K Street, NW
Washington DC 20006-1110
202.261.3373
craig.falls@dechert.com
Celeste C. Saravia, Vice Chair
Cornerstone Research
Two Embarcadero Center, 20th Floor
San Francisco, CA 94111-3922
415.339.8116
csaravia@cornerstone.com
Jeff L. White, Vice Chair
Weil Gotshal & Manges LLP
1300 I Street, NW, Suite 900E
Washington, DC 20005-3348
202.682.7059
Jeff.white@weil.com
THE DISTRIBUTION AND FRANCHISING
COMMITTEE LEADERSHIP
Alicia L. Downey, Chair
Downey Law LLC
155 Federal Street, Suite 300
Boston, MA 02110
617.444.9811
alicia@downeylawllc.com
Katrina M. Robson, Vice Chair
O’Melveny & Myers LLP
1625 Eye Street, NW
Washington DC 20005
202.220.5052
krobson@omm.com
Craig G. Falls, Vice Chair
Dechert LLP
1900 K Street, NW
Washington DC 20006-1110
202.261.3373
craig.falls@dechert.com
Joy K. Fuyuno, Vice Chair
Microsoft
One Marina Boulevard
#22-01
Singapore 018989
SGP
65.6568887475
joyf@microsoft.com
Celeste C. Saravia, Vice Chair
Cornerstone Research
Two Embarcadero Center, 20th Floor
San Francisco, CA 94111-3922
415.339.8116
csaravia@cornerstone.com
Jeff L. White, Vice Chair
Weil Gotshal & Manges LLP
1300 I Street, NW, Suite 900E
Washington, DC 20005-3348
202.682.7059
Jeff.white@weil.com
Melanie A. Hallas, Young Lawyer Representative
Sidley Austin LLP
1501 K Street, NW
Washington, DC 20005
202.736.8029
mhallas@sidley.com
March 2016
2
Distribution and Franchising Committee: ABA Section of Antitrust Law
Franchise Law Developments in Germany: Appellate Court
Recognizes Claim for Damages Based on Pre-Contract
Information Provided by Franchisor
by Marcus Schriefers and Michaela Schwuchow
In a September 5, 2015 judgment, the Higher Regional
Court of Hamburg, Germany ruled that a franchisee
of the Tom Tailor apparel franchise system was entitled
to recover damages based on unreliable and inaccurate
data in documents Tom Tailor provided to the franchisee
prior to the parties’ entering into their franchise
agreement. Based on this ruling, any franchisor that
provides incorrect information to a franchisee in
the pre-contract/negotiation phase is potentially
liable for damages where the franchisee bases
their decision to join the franchise system on the
incorrect information. This decision is in line with the
recent approach of German courts to the franchisorfranchisee relationship. German courts have a tendency
to protect the “smaller” business, and particularly so in
distribution relationships like franchises.
Franchising in Germany has developed steadily since
first appearing in the 1960s. Germany is now one of
the fastest growing markets for franchises in the EU.
In Germany today, franchises are present in a wide
variety of business markets, from food and other service
providers, to do-it-yourself retailers, to fashion apparel
stores like Tom Tailor. As the number of German
franchise systems and franchisees has grown, the
application of German law to franchise relationships has
become increasingly important.
Despite the rapid growth and current prominence of
franchise businesses in Germany, there is only limited
statutory German law specifically addressing franchising.
Rather, German franchise law has developed in the
courts through the application of general legal principles.
Although the European Union (“EU”) published a
group exemptions regulation in 1999 dealing specifically
with franchises, that regulation was focused specifically
on antitrust considerations. In 2010, the EU’s 1999
regulation was overruled by a new, more general group
exemption regulation addressing vertical restraints—
March 2016
again with an antitrust focus. The 2010 regulation is the
only current statutory provision specifically directed at
franchise contracts under German law. All other aspects
of franchise law are governed by general German legal
principles.
German case law addressing franchise relationships
provides for an enhanced protection of franchisees and,
in particular, provides that a franchisor is obliged to
correctly and fully inform the potential franchisee about
the profitability of the franchise system during contract
negotiations prior to the execution of a franchise
contract (cf. Higher Regional Court of Düsseldorf, judgment of
25 October 2013).
The judgment of the Higher Regional Court of
Hamburg of September 5, 2014 regarding the Tom
Tailor fashion group is in line with this established case
law but further substantiates the concept of franchisor
liability for faulty information provided in the precontract phase of the parties’ relationship. Tom Tailor,
a franchise chain established in Germany in 1962 that
has seen its popularity grow significantly in the past
decade, sells medium-priced fashion apparel to teens
and young adults. In the recently decided case, a Tom
Tailor franchise sued for damages, contending that prior
to entering into the franchise agreement, Tom Tailor had
supplied the franchisee with unsubstantiated and false
information regarding the performance of other Tom
Tailor stores.
In the judgment of the court of first instance dated
January 17, 2014, the Regional Court of Hamburg
ordered Tom Tailor to pay damages in the amount of
€ 156,450.17 (approx. $ 175,742) based on its finding
that the franchisor had provided the franchisee with
an inventory turnover forecast in investment proposals
during contract negotiations that did not correspond
to the average inventory turnover of all other existing
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Distribution and Franchising Committee: ABA Section of Antitrust Law
Tom Tailor Stores or to the actual inventory turnover in
existing Tom Tailor Stores that were comparable to the
size and location of the store the franchisee intended
to establish. The court of the first instance also found
that the target figure regarding the expected increase in
inventory turnover in the investment proposals supplied
by the franchisor was based only on assumptions and
hopes about how the inventory turnover would develop
in the future. The investment proposal provided by the
franchisor stated, inter alia, that an inventory turnover of
€ 3,000 (approx. $ 3,370) per square meter of sales area
and an increase in turnover of 5% within the first five
years of business was to be expected. The franchisee
claimed to have relied on those figures in deciding to
sign the franchise agreement. However, from the outset
the franchisee’s store experienced inventory turnover far
behind the turnover forecast supplied by the franchisor
and the franchisee’s inventory turnover was not even
sufficient to cover the operations costs of the store.
The court of first instance offered some other
noteworthy pronouncements and observations in
its ruling. For example, the court declared that a
franchisor is not allowed to create false impressions
about profitability by – without explicitly informing the
franchisee about this – using incorrect data or using
data that is not based on a thorough investigation of the
market and therefore only has the nature of an estimate.
The court further determined that a forecast lacks a
realistic factual basis if the forecast is based on figures
that are in fact only reached by few franchisees, as such a
forecast can create the false impression that the forecast
figures can be reached “normally” or by an “average
franchisee” or “during the normal course of business.”
As the Higher Regional Court of Hamburg pointed out
in its Judgment, the burden of proof to demonstrate
that the pre-contractual information provided by the
franchisor is correct lies with the franchisor.
The Tom Tailor case is in line with the general tendency
of German courts to protect the “smaller” partner in
any kind of distribution system. This general principle is
March 2016
akin to German law governing sales agency relationships,
where the sales agent has for a long time enjoyed special
legal rights and protections against the principal. These
protections were initially extended to distributors in
distribution relationships and, subsequently, franchisees
in franchise systems.
The Tom Tailor case offers some important lessons and
cautions for franchisors who are looking to do business
in Germany. For example, during contract negotiations
with a potential German franchisee a franchisor should:
•
Only provide inventory turnover forecasts,
profitability calculations, or other similar data
that are determined using a comprehensible and
realistic factual basis or experience based on the
size and type of location under consideration;
and
•
Affirmatively advise the franchisee where the
franchisor lacks the factual basis to deliver such
a forecast due to the fact that there are no stores
established that are comparable to the size and/
or location of the store the franchisee intends
to establish or due to the fact that the franchise
system does not have sufficiently comparable
figures.
•
If a franchisor does provide the franchisee with
data that is not from comparable locations,
the franchisor should specifically indicate in
writing on the face of the data that such data
is from locations that are not comparable to
the prospective franchisee’s location and is
not meant to be a forecast or projection of
the future performance of the prospective
franchisee’s location.
Marcus Schriefers is a partner with Heussen
Rechtsanwaltsgesellschaft mbH in Stuttgart, Germany and
serves as head of the firm’s distribution and logistics practice
group, Michaela Schwuchow an associate with Heussen
Rechtsanwaltsgesellschaft mbH in Stuttgart.
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Distribution and Franchising Committee: ABA Section of Antitrust Law
California Assembly Bill 525: A Resounding Win
for Franchisees or a Source for Further Dispute?
by Anthony Marks1 and Kazim Naqvi2
On October 11, 2015, California Governor Jerry Brown
approved Assembly Bill Number 525 (“AB 525”), since
dubbed the “Franchise Bill of Rights.” AB 525 proposes
three notable changes that shift the dynamics within the
franchisor/franchisee relationship.
First, franchisors previously were prohibited from
terminating a franchise prior to the expiration of its term
except for good cause, which was defined as “the failure
of the franchisee to comply with any lawful requirement
of the franchise agreement after being given notice
and a reasonable opportunity to cure the failure within
30 days.”3 Now, the definition of good cause has been
changed to “the failure of the franchisee to substantially
comply with any lawful requirement of the franchise
agreement,”4 and the time to cure has been extended to
60 days.
Second, AB 525 states that franchisees cannot be
restricted from transferring assets or interest in a
franchise, provided that the transferee is qualified under
the operative franchise agreement and the franchisor’s
then-existing and reasonable standards for approving
new or renewing franchisees.5
Lastly, AB 525 requires a franchisor, upon a lawful
termination or nonrenewal of a franchisee, to purchase
certain of franchisee’s resalable equipment, inventory,
and supplies at “the value of price paid, minus
depreciation.”6
Although these three changes seek to provide
further clarity and limitation on franchisor control
and discretion, they also present several unanswered
questions. This article seeks to provide possible
interpretations, answers, and best practice tips to
franchisors and franchisees alike when complying with
AB 525’s new requirements.
A Different Standard for Termination
The new provisions of AB 525 have undoubtedly
caused both franchisors and franchisees alike to seek
guidance as to what “substantially comply” actually
means. Before, franchisors could technically pursue
termination if franchisees violated any provision of the
franchise agreement, no matter how minor. Now, the
required level of non-compliance by franchisees has been
changed. Is “failure to substantially comply” a brand
new standard introduced by AB 525 or have similar
standards been employed by tribunals when governing
contract disputes?
Although not directly applicable to contract
interpretation, several California courts have tried
to specify the meaning of “substantial compliance”
in the context of statutes. Again, in the context of
statutory compliance, courts have stated that “substantial
compliance means actual compliance with respect to
the substance essential to every reasonable objective
of the statute, as distinguished from simple technical
1
Tony Marks [https://www.bryancave.com/en/people/anthony-j-marks.html] is the Co-leader of the Franchise and Distribution Law Team of Bryan Cave LLP. He is located in
Los Angeles, California where he counsels clients in all industry areas in the full spectrum of franchise and distribution law matters.
2
Kazim Naqvi [https://www.bryancave.com/en/people/kazim-a-naqvi.html] is an associate in the Los Angeles office of Bryan Cave LLP. He practices in the commercial litigation
and franchise and distribution areas where he represents franchisors in various industries, including transportation, education, and food and beverage services.
3
http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201520160AB525.
4
Id.
5Id.
6
Id.
7
Hoffmaster v. City of San Diego, 55 Cal. App. 4th 1098, 1103 (1997).
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
imperfections of form.”7 “Substance prevails over form.
When the plaintiff embarks on a course of substantial
compliance, every reasonable objective of the statute at
issue has been satisfied. The court’s primary concern is
the objective of the statute.”8 This may or may not be
the result when a California court considers substantial
compliance of a franchise agreement.
Other courts have invoked a doctrine of substantial
compliance in contract law. “The doctrine of substantial
compliance or substantial performance is well-established
in contract law, dating back to Justice Cardozo’s holding
that a deficiency in performance may not be considered
a breach as long as it is not ‘so dominant or pervasive
as in any real or substantial measure to frustrate the
purpose of the contract.’”9 “To determine questions of
substantial compliance, a court generally considers the
promised performance, the purpose of the contract, and
the extent to which any defects in performance have
frustrated the purpose of the contract.”10
Under the above authorities, Courts generally employ a
broad, holistic analysis of to determine whether a party
has substantially complied with the contract’s purpose.
On the contrary, the determination of what constitutes
a “material breach,” which many are familiar with, tends
to focus on an isolated key term of the contract, such
as payment of royalties. “Normally the question of
whether a breach of an obligation is a material breach,
so as to excuse performance by the other party, is a
question of fact. Whether a partial breach of a contract
is material depends on the importance or seriousness
thereof and the probability of the injured party getting
substantial performance.”11 When determining whether a
breach is “material” or “immaterial,” courts may look at
whether the isolated breach impacts the core nature of a
particular product or service, or if it is merely ancillary to
the franchisee’s brand and business.
For example, the Ninth Circuit held that “hours of
operation are material to the franchise agreement”
and a “franchisee’s willful noncompliance with a court
order to be significant to the determination of whether
termination was proper.”12 Similarly, the Seventh Circuit
held that where the franchisee was found to have
actually cheated the franchisor out of money due to the
franchisor, termination was proper under the franchise
agreement.13 Other courts have held that failure to pay
required fees and royalties constitutes a material breach
of a franchise agreement.14
Conversely, where a franchisor sought termination based
on a franchisee’s failure to report and pay its state sales
tax, the Ninth Circuit held that “[t]his is not a term that
is fundamental to the franchise relationship, nor does the
term have real importance or great consequence to the
relationship.”15
AB 525 inserts a new uncertainty into terminations of
franchise agreements. The judiciary will have to tell us
if and how a failure to substantially comply is different
from the statutory requirements before AB 525. The
amendments by AB 525 invite more subjectivity and
likely more disputes over franchise terminations.
Transfers Must Meet “Then-Existing” Standards
Many franchise agreements reserve the franchisor’s
right to approve a proposed transfer of the franchise
agreement, either by providing the franchisor with
8
Malek v. Blue Cross of California, 121 Cal. App. 4th 44, 45 (2004).
9
Wapato Heritage, LLC v. United States, 2008 U.S. Dist. LEXIS 117185, at *16 (E.D. Wash. Nov. 21, 2008).
10
J.K. v. Humble, 2013 U.S. Dist. LEXIS 95454, at *5 (D. Ariz. May 17, 2013) (“the first task in resolving questions of substantial compliance is to define the nature of the promised
performance. When a party’s promised performance relates to a qualitative term of a contract that affords the party discretion in performance, the analysis of whether the party
has breached that contractual term typically turns on whether the party has breached the covenant of good faith and fair dealing.”).
11
Brown v. Grimes, 192 Cal. App. 4th 265, 266 (2011).
12
Chevron, U.S.A., Inc. v. Mebtahi, 148 F. Supp. 2d 1019, 1025 (C.D. Cal. 2000) (discussing Texaco Refining and Marketing, Inc. v. Davis, 835 F. Supp. 1223 (9th Cir. 1994)).
13
Baker v. Amoco Oil Co., 956 F.2d 639 (7th Cir. 1992).
14
See Tolle Furniture Group, LLC v. La-Z-Boy, Inc., 2009 U.S. Dist. LEXIS 64965, at *7-8 (W.D. Wash. July 17, 2009); Era Franchise Sys. v. Brager & Assocs., 2007 U.S. Dist. LEXIS 56418,
at *24 (E.D. Cal. Aug. 1, 2007).
15
Chevron, U.S.A., Inc., 148 F. Supp. 2d at 1025.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
the sole discretion to do so, or that the franchisor’s
approval will not be unreasonably withheld. As revised,
a franchisor may no longer withhold its approval
unless the proposed transferee does not meet its “thenexisting standards for the approval of new or renewing
franchisees.” This requirement does not preclude a
franchisor from exercising its contractual right of first
refusal, but the franchisor’s offer must be equal to the
franchisee’s bona fide offer.
Now, franchised owners cannot prevent the transfer
of a franchise if the transferee otherwise meets the
then existing standards and the criteria set forth in
the franchise agreement. Franchisors must also apply
its transfer discretion consistently across its franchise
brand. Further, the franchisor must make available to the
franchisee its standards and requirements for transfer.
Required Repurchase of Franchisee’s Business
Previously, upon a lawful termination or nonrenewal of a
franchise, many franchisors had discretion as to whether
it wanted to purchase back the inventory, equipment,
supplies, and furnishings of the franchisee. And, the
valuation of those assets would have been established by
the applicable contract. Now, in the context of a lawful
termination or nonrenewal, the franchisor is obligated to
repurchase the franchisee’s resalable current inventory,
supplies, equipment, fixtures and furnishings at the price
paid less depreciation. The required repurchase is limited
to those items that are purchased or paid for under the
terms of the franchise agreement by the franchisee to
the franchisor or its approved suppliers and sources.
Naturally, there will be dispute as to the depreciated value
of the items repurchased.
Another point of dispute is to determine which of the
many methods of depreciation to employ. Although
there are several methods of calculating depreciation, and
AB 525 is silent as to how depreciation is determined, a
simple procedure would be to use a method permitted
for federal income tax purposes. There are four
different methods generally employed by California and
9th Circuit courts. The simplest method is straightline depreciation, which charges an equal amount of
depreciation to each accounting period.16 The unit-ofproduction method assigns an equal amount of expense
to each unit produced or service rendered by the asset.17
The sum-of-the-years digits method determines annual
depreciation by multiplying the asset’s depreciable cost
by a series of fractions based on the sum of the asset’s
useful life digits.18 Lastly, the double-declining balance is
a type of accelerated depreciation method that calculates
a higher depreciation charge in the first year of an asset’s
life and gradually decreases depreciation expense in
subsequent years.19
To avoid dispute and ensure clarity, the parties may be
best serviced to identify a depreciation method in the
franchise agreement.
Franchisor/Franchisee Relationships Moving
Forward
Many of the new issues raised by AB 525 will
undoubtedly be the subject of litigation between
franchisors and franchisees. Specific examples of what
constitutes a “failure to substantially comply” will help
both franchisors and franchisees understand where the
threshold for termination lies. Further, examples of
how to quantify depreciated value of saleable assets will
help franchisors and franchisees understand the best way
to conduct the buy-back procedure. Until such issues
are raised in an appropriate forum, one can only take
an educated guess as to how to appropriately comply
with AB 525. However, until the interpretive authority
is further fleshed out, franchisors and franchisees are
advised to be proactive, as opposed to reactive, in
thinking through these issues before entering into a
franchise agreement.
16
San Francisco v. Public Utilities Com., 6 Cal. 3d 119, 123 (1971) (“Straight line depreciation provides for essentially uniform annual write-offs of a depreciable asset over the life of the
asset.”).
17
Mohawk Petroleum Co. v. Commissioner, 148 F. 2d 957, 958 (9th Cir. 1945).
18
Portland General Electric Co. v. United States, 1964 U.S. Dist. LEXIS 9939, at *9 (D. Or. Mar. 16, 1964).
19
Pacific Power & Light Co. v. United States, 644 F. 2d 1358, 1361 (9th Cir. 1981).
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
Resale Price Maintenance and Dual Distribution
by Reuben Arnold, Neill Norman, and Daniel Schmierer 1
Several recent antitrust cases brought by both direct and
indirect purchasers have challenged minimum resale price
maintenance (“RPM”) policies imposed by manufacturers
engaged in dual distribution or multi-channel
distribution.2 These cases are frequently dismissed
because plaintiffs fail to establish a relevant market or
fail to demonstrate that the defendant has market power
in that market.3 While these are appropriate threshold
tests, dismissal on these grounds means that the court
does not reach the central economic issue in the case,
namely whether the procompetitive benefits of an
RPM policy that supports dual distribution outweigh
any harm to competition. In this article, we discuss the
positive impact of dual distribution and multi-channel
distribution on interbrand competition, review the
economic analysis of RPM, and demonstrate that RPM
plays a key role in facilitating the competitive benefits
that can arise from dual distribution and multi-channel
distribution.
“Dual distribution” describes the distribution strategy
of a manufacturer that sells to customers both directly
and through third-party distributors or retailers. “Multichannel distribution” describes a distribution strategy
in which a manufacturer sells through multiple types of
retailers, such as online vs. bricks-and-mortar stores, or
big box stores vs. specialist stores, etc. In this article we
focus on RPM as it applies dual distribution although
the analysis applies to multi-channel distribution as well,
except where noted.
Dual distribution and multi-channel distribution are
common practices across many industries, including
information technology, consumer electronics, cosmetics,
apparel, and home furnishings, among many others.
As one Harvard Business School case study puts it,
“[i] practice, most producers and resellers are usually
members of multiple—often, competing—channels
systems. Producers often sell through a number of
intermediaries, while resellers often carry the products
of competing manufacturers as well as the lines of many
other suppliers in different product categories.”4
For example, Levi Strauss, a manufacturer of blue
jeans and other clothing, sells a variety of product lines
through different channels targeting different segments
of the market, including its own retail stores, high-end
stores like Neiman Marcus, department stores like Macy’s
and Sears, and discount retailers like Wal-Mart.5 Coach,
a manufacturer of luxury handbags and accessories,
markets products to its consumers through a variety of
channels, such as retail stores, factory outlets, concession
counters within larger stores (shop-in-shops), online
channels, and specialty stores.6
1
Reuben Arnold is a senior analyst, Neill Norman is a principal, and Daniel Schmierer is a manager at Cornerstone Research. The opinions expressed are those of the authors, who
are responsible for the content, and do not necessarily reflect the views of the Cornerstone Research.
2
See, e.g., Complaint, Costco Wholesale Corp. v. Johnson & Johnson Vision Care, Inc., 3:15-cv-00941 (N.D. Cal. Mar. 2, 2015); Corrected Consolidated Class Complaint, In re:
Disposable Contact Lens Antitrust Litig. 1:15-md-2626-HES (M.D. Fla. Nov. 23, 2015); People of the State of New York v. Tempur-Pedic Int’l, Inc., 916 N.Y.S.2d 900 (N.Y. Sup.
Ct. 2011); Jacobs v. Tempur-Pedic Int’l, Inc.,No. 4:07-cv-02-RLV (N.D. Ga. Dec. 11, 2007); and House of Brides, Inc. v. Alfred Angelo, Inc., No. 11 C 07834 (N.D. Ill. Dec. 4,
2014).
3In House of Brides, Inc. v. Alfred Angelo, Inc., the plaintiff failed to allege facts that plausibly suggested that a single wedding dress brand constituted a cognizable product market. In
People of the State of New York v. Tempur-Pedic Int’l Inc; the state court ruled that RPM provisions are unenforceable but not unlawful under New York state law. In Jacobs v. TempurPedic International, Inc., the federal court concluded that plaintiffs had not identified a relevant market as required under the rule of reason standard that had to be applied after
Leegin Creative Leather Prods., Inc. v. PSKS, 551 U.S. 877 (2007). Costco Wholesale Corporation v. Johnson & Johnson Vision Care Inc., and In Re: Disposable Contact Lens Antitrust Litigation are
ongoing.
4
Frank V. Cespedes, Channel Management, Harvard Business School Case Study No. 9-590-045, 3–6, 8 (rev. Nov. 2006).
5
S. C. Jain and G. T. Haley, Marketing Planning and Strategy 339 (8th ed. 2009).
6
P. Kotler and K. L. Keller, Marketing Management 495 (15th ed. 2016).
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
I. Competitive Benefits from Dual and MultiChannel Distribution
Dual distribution and multi-channel distribution can
expand a manufacturer’s output, reduce distribution
costs, and thereby yield pro-competitive benefits that
would not be realized under single-channel distribution.
First, multi-channel and dual-channel distribution
may allow suppliers to reach a wider array of demand
segments within a broad market. In markets for many
differentiated consumer goods, preferences for pointof-sale service vary.7 By providing a product through a
variety of channels that offer differing levels of service
at the point of sale, a manufacturer can cater to a wider
range of consumer preferences and penetrate different
market segments.8 This expands output, and increases
competition between brands. For example, a consumer
purchasing a computer may value the ability to use the
product on a trial basis buying it and or the transfer
of their data and settings from an old computer to the
new computer; a small business purchasing the same
computer may value the availability of local repair
services and procurement advice; and a large corporation
with dedicated IT staff purchasing the computer may
need none of these services. Different distribution
channels tailored to different demand segments allow
a manufacturer to efficiently satisfy these varied needs
and desires. In many cases, this segmentation would not
be possible were a manufacturer to sell entirely through
distributors or entirely directly to consumers, or entirely
through a single type of reseller.9
Aside from product and service specifications, dual and
multi-channel distribution also allow manufacturers
to optimize across location and delivery method while
minimizing costs.10 For example, it may be most efficient
for a company to sell directly to consumers in a dense
urban area and to sell through a distributor in a more
thinly-populated rural area.11 Again, this distribution
strategy has a pro-competitive impact: a supplier
reaches certain market segments at a lower cost than it
can attain on its own, and thereby increases the degree
of competition between brands in the marketplace.
Additionally, the nature of a given product or market
segment may require a company to take direct control
of a particular channel, while other channels are more
efficiently shared with intermediaries.12 For example, if a
manufacturer of auto parts sells some proportion of its
product to an auto manufacturer that uses the product
as an intermediate input, the auto parts manufacturer
may wish to control distribution directly to minimize
the possibility of supply interruption. In contrast,
the parts manufacturer may find it simpler to allow an
intermediary to distribute that same part to its auto parts
store and auto mechanic customers.
Second, and relatedly, multi-channel distribution allows
different channels to focus on marketing and selling
efforts in which they have a comparative advantage.
In many cases, local retailers have an informational
advantage that allows them to more effectively engage
in local advertising and selling efforts than a national
manufacturer. However, a national brand may be
able to run large advertising campaigns and target
market segments that are difficult for a local retailer
to reach. For example, a local HVAC retailer that
sells Trane products likely has a better strategy for
targeting and selling to local small businesses than
Trane does. However, Trane itself can produce and run
large advertising campaigns more effectively, and can
compete for large corporate procurements. This sort of
dynamic exists in many areas; distributors provide many
services such as order processing, customer support, and
7
See Frank Mathewson and Ralph Winter, The Law and Economics of Resale7 Price Maintenance,” 13 Rev. Indus. Org. 67 (1998) (“Additional demand factors include: the number of
outlets or availability of the product, the convenience of the outlet’s location, the information provided to customers at the point of sale, the sales effort and talent of dealers, the
reputation of the product for quality, the prominence of the display of the product and so on.”).
8
Jain, supra note 5 at 338.
9Id.
10
Kotler, supra note 6 at 494.
11
Jain, supra note 5 at 340.
12
“Channel Management,” Cespedes, supra note 4 at Harvard Business School, Case Study No. 9-590-045, pp. 3–6, 8.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
customer education that a manufacturer may be wellpositioned to deliver to some segments of the market but
poorly-positioned to deliver to other segments.13 Indeed,
in many cases, manufacturers add channels when they
realize there are customers or market segments that they
cannot effectively satisfy with existing channels.14
While product distribution through third-party
retailers may be the most efficient solution for many
manufacturers, others choose to integrate forward into
direct sales to consumers for a number of reasons.
First, a manufacturer-operated retail store allows the
manufacturer to shape its brand image by controlling
the shopping experience more closely and providing
a broader selection of its goods. Nike and Apple are
notable examples of this approach.15 Many large firms
and brands have also decided to manage Internet sales
of their products for the same reason. Estee Lauder, for
example, decided to launch an Internet channel for its
Clinique products as an alternative distribution method
to traditional sales via department store cosmetics
counters.16 Similarly, Apple manages its own online
storefront and prohibits its bricks-and-mortar resellers
from selling over the Internet.17
Second, a manufacturer that integrates forward into retail
may be able to generate higher profit margins and expand
output by eliminating double marginalization.18 Finally,
direct selling provides closer contact with customers
and customer information, improving supply chain
efficiency by giving the manufacturer a better picture
of market demand.19 Manufacturers that choose a dual
distribution strategy are able to realize these benefits
while simultaneously enjoying the benefits of third-party
distribution in other market segments. This efficient
13
combination of distribution methods increases the
manufacturer’s competitiveness in the market which, in
turn, promotes inter-brand competition and improves
consumer welfare.
II. Resale Price Maintenance Can Facilitate
Dual - and Multi-Channel Distribution and
Enhance Interbrand Competition
As part of a dual or multi-channel distribution strategy,
manufacturers frequently impose vertical restraints, i.e.,
policies that limit the conduct of both the manufacturer
and its downstream trading partners. These include
policies such as resale price maintenance, minimum
advertised prices, exclusive territories, and exclusive
dealing. Minimum resale price maintenance (RPM)20 in
particular can play a key role in facilitating successful
dual and multi-channel distribution, as it provides the
manufacturer with an instrument with which it can elicit
the level of retail promotion services consistent with its
objectives for its brand.
First, manufacturers may use RPM to correct a wellknown market failure — the free rider problem — that
can otherwise frustrate attempts to elicit competition in
retail services to promote its products. A free rider is an
economic agent who appropriates the benefits of another
agent’s (costly) economic endeavors. The classic example
involves a complex consumer durable good whose sale
requires a knowledgeable salesperson to inform and
persuade a consumer of the product’s merits. Suppose
that, upon receiving the requisite information from the
full-service retailer, the shopper leaves the store without
making a purchase, travels to a discount operation that
stocks the product the consumer now knows she wants,
A. A. Tsay and N. Agrawal, Modeling Conflict and Coordination in Multi-Channel Distribution Systems: A Review, in Handbook of Quantitative Supply Chain Analysis: Modeling in
the E-Business Era 558 (2004).
14
Jain, supra note 5 at 340.
15
Kevin Lane Keller, Brand equity management in a multichannel, multimedia retail environment. 24:2 J. Interactive Marketing 58-70 (2010).
16 Tsay, supra note 13 at 559.
17
Steve Tobak, How to Sell Like Apple, CBS News Moneywatch (May 13, 2010), available at http://www.cbsnews.com/news/how-to-sell-like-apple/.
18
Jean Tirole, The Theory of Industrial Organization, MIT Press (1988), pp. 174-175.
19
Tsay, supra note 13 at 558.
20
A minimum resale price maintenance agreement between a manufacturer and a retailer sets a minimum price that a retailer may charge for the manufacturer’s products. See Dennis
W. Carlton and Jeffrey M. Perloff, Modern Industrial Oorganization 423 (4th ed 2004).
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
and buys it for a lower price. The lower price is possible
because the buyer and ultimate seller can free-ride on
(i.e., appropriate the benefits of) the full-service retailer’s
costly investment in pre-sale service.
In markets in which free-riding is common, sellers may
reduce the level of services they provide because they
do not receive adequate compensation in the form of a
sufficient retail margin. Consumers in turn may reduce
their participation in such markets because they do not
receive adequate pre- or post-sale services. The upshot is
a reduction of output, consumer welfare, and interbrand
competition. In the extreme, the market for a desirable
good (i.e., a good whose value exceeds its opportunity
cost) can simply dissolve because of free-riding.
RPM corrects the free-rider problem by requiring
retailers of a manufacturer’s products to charge a
minimum price that provides a profit margin sufficient to
justify investment in pre-sale service, thereby thwarting
discounters that seek to free-ride on other retailers.21
The effect of the policy is to enhance intrabrand service
competition, limit intrabrand price competition, and
increase interbrand competition.
The use of RPM is not confined to markets for
information-intensive consumer goods vulnerable
to free-riding. Manufacturers also implement RPM
pricing policies for goods that do not require detailed
information or extensive product demonstration
at the point of sale, or significant post-sale service
commitments. Economics offers two theories to explain
this phenomenon. Under the “quality certification”
view of RPM, retailers may use protected margins to
invest in greater services (e.g., longer hours of operation,
nicer store furnishings, additional sales force training)
that signal or certify the quality of their merchandise
and increase demand for the manufacturer’s product.22
A second view explains RPM as a contract enforcement
mechanism that a manufacturer adopts to assure that
retailers supply non-contractible retail service that
increases the demand for the manufacturer’s product.
Where incomplete information and monitoring costs
make writing and enforcing a complete and explicit
performance contract with a retailer impractical,
manufacturers may instead use RPM to elicit
performance by retailers who are eager to retain the
protected retail margin it affords.23
The problem of free-riding can be a particular concern
in cases where there is dual distribution. The fact
that the retailer and the manufacturer have different
incentives, business models, and cost structures can
increase the likelihood of conflict between the retailer
and manufacturer and increase the incentives to free-ride.
Therefore, to have an effective dual distribution system,
a manufacturer can use RPM to reduce conflicts and
eliminate free-riding.
A. Manufacturers Selling Directly to Consumers
Have Incentives Consistent with Interbrand
Competition
Manufacturers who sell directly to consumers do not
have the same incentive to free-ride as non-affiliated
retailers. This is because the manufacturer internalizes
the impact of its actions on the brand as a whole. While
any individual third-party retailer has an incentive to
reduce its provision of service and reduce its price to
undercut other retailers of the manufacturer’s products,
the manufacturer will not engage in such behavior itself
because it recognizes that this behavior is inconsistent
with the long-term competitiveness of its brand. This
is one reason why some manufacturers, particularly
those who are concerned with the provision of service
or the consistency of their brand image, may choose to
control the online sales of their products: whereas thirdparty Internet retailers have an incentive to free ride on
the services provided by bricks-and-mortar stores, the
manufacturer does not.
21
Lester G. Tesler, Why should manufacturers want fair trade? 3 J. Law and Econ. 86-105 (1960).
22
See Howard P.Marvel and Stephen McCafferty, Resale price maintenance and quality certification, 15 RAND J. Econ. 346-359 (1984).
23
See Benjamin Klein and Kevin M. Murphy, Vertical restraints as contract enforcement mechanisms, 31 J. Law and Econ. 265-297 (1988); Benjamin Klein, Competitive Resale Price Maintenance
in the Absence of Free Riding, 76 Antitrust L.J. 431-481 (2009).
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Distribution and Franchising Committee: ABA Section of Antitrust Law
This distinction between the incentives of the
manufacturer (in its role as a direct-to-consumer seller)
and third-party retailers is perhaps best illustrated
through examples. As the following examples show,
RPM policies can be useful to manufacturers with
different retail strategies. However, in both examples,
an RPM policy allows the manufacturer to implement
a dual distribution strategy that increases interbrand
competition.
and education. Since the manufacturer is concerned
with the long-term profitability and strength of its brand,
it prices its online sales at a level that internalizes the
impact of online sales on service. In doing so, it may,
for example, choose to sell online only at MSRP. By
supporting the provision of service and education, this
arrangement may strengthen the competitiveness of
the cosmetic manufacturer’s brand and thereby enhance
inter-brand competition.
B. Example: Dual Distribution Online and
Through Specialty Stores
C. Example: Multi-Channel Distribution through
Online and Retail Direct Channels and Multiple
Third-Party Retail Channels
As a first example, consider a manufacturer of high-end
cosmetics that sells products both through beauticians
(specialty bricks-and-mortar stores) and through its own
website. This manufacturer sells (offline) only through
beauticians because it wants to make sure that customers
are provided with the service and education needed to
properly use the manufacturer’s products.
Suppose the manufacturer sells its products to beautician
retailers at prices substantially below the manufacturer’s
suggested retail price (MSRP). The gap between the
wholesale price and MSRP is meant to cover the costs
that retailers will incur in providing service related to
the manufacturer’s products. However, in this situation,
each individual retailer has an incentive to set up an
online storefront and sell the manufacturer’s products at
discounted prices below MSRP, because the retailer does
not incur the costs of service and education in sales to
online customers. To protect against this type of free
riding, the manufacturer may put in place an RPM policy
to keep retailers from selling online at deep discounts.
At first blush, the need to prohibit retailers from selling
at deep discounts online (and therefore not providing
in-store service) may seem inconsistent with the
manufacturer itself selling its products online. But the
key difference is that the manufacturer, when it sells
online, does not have the same incentive to free ride on
the service and education provided by the bricks-andmortar retailers. When pricing its own online sales, the
manufacturer weighs the direct profits from online sales
against the broader impact of those sales on the ability
of the bricks-and-mortar beauticians to provide service
March 2016
As a second example, consider a manufacturer of
computers and electronics that sells its products to
consumers directly both online and in manufactureroperated retail stores, and indirectly through a variety of
third-party retailers, including big-box electronics stores
and small businesses that focus on repair and sales of
the manufacturer’s products. Much like the cosmetics
manufacturer described above, this manufacturer chooses
to sell through vendors that it believes will adequately
convey its brand and educate consumers about its
products.
As part of its retail strategy, this manufacturer also
introduces an RPM policy to eliminate the possibility of
discounted online sales by third parties. This policy is
meant to prevent third parties from free-riding on the
brand-building activity conducted by the manufacturer.
Since the manufacturer has a strong incentive to ensure
a positive customer experience that will generate repeat
purchases, and since it benefits from customer purchases
regardless of channel, the manufacturer has chosen
to invest substantial capital in the development of its
website, with professionally-produced videos explaining
its products and beautifully-designed interfaces that
generate a premium shopping experience. A third-party
online seller does not share the manufacturer’s incentive
to create a premium online shopping experience,
because it cannot completely internalize the return
from that investment. Instead, it has an incentive to
minimize its costs associated with the online sale of
the manufacturer’s brand and free-ride on the positive
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Distribution and Franchising Committee: ABA Section of Antitrust Law
brand image and national marketing conducted by the
manufacturer. By setting a minimum resale price, the
manufacturer removes the ability of third party online
retailers to free ride on the manufacturer’s brand building
activities by undercutting the manufacturer on price.
The RPM policy also incentivizes third party online
sellers to compete, both with each other and with the
manufacturer, on the quality of the online shopping
experience, which benefits consumer welfare. The RPM
policy therefore helps the manufacturer eliminate online
customer experiences that would damage its brand, thus
improving its ability to compete in the long term against
other consumer electronics manufacturers.
III. Conclusion
differentiated goods and services to different customer
segments efficiently and permit them to delegate
tasks such as order processing and customer support
that may be difficult for them to complete in a cost
effective manner. However, retailer free-riding and
difficulty in obtaining non-contractible retail services
can compromise these benefits and undermine dual
and multi-channel distribution. RPM policies can
support dual and multi-channel distribution and increase
interbrand competition. Thus, when analyzing RPM
under the rule of reason, the presence of dual and
multi-channel distribution — and its attendant benefits
to consumers and competition — should be taken into
account.
Dual and multi-channel distribution strategies, when
working as intended, allow manufacturers to deliver
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
The 2016 FTC Auto Distribution Workshop:
An Insider’s Take
by Steven Cernak
On January 19, 2016, the FTC held a workshop on how
auto distribution trends might impact current or potential
regulation. While some of the issues covered were
unique to this industry, many apply to all industries. Here,
I offer a few comments based on my years dealing with
these laws. These comments do not necessarily represent
the views of any past, present, or future client, employer,
or colleague.
Background – These laws and other government
involvement date back decades
FTC Chairwoman Edith Ramirez kicked off the
workshop by describing the FTC’s long history of
review of the auto industry, pointing to the FTC’s 1939
report on the industry (the report is now available on the
workshop’s website—the section on distribution begins
on p. 106).1
While it is correct that the FTC been involved in the
industry for decades, I think the government review
of the industry that had a more direct influence on
regulation of car distribution is the 1955 Senate Judiciary
Committee investigation into the antitrust laws that
ended up focusing on General Motors.2 Many GM
business practices were reviewed, including alleged
mistreatment of its car dealers. During the hearings,
GM announced that it would change the length of its
standard dealer sales and service agreement from 1
year to 5 years, a move that soon became an industry
standard. That change was in response to complaints that
GM and others used the threat of non-renewal to drive
dealer behavior. In 1956, the federal Dealer Day in Court
Act (15 U.S.C. § 1222) was passed. The Act imposed
a good faith requirement on manufacturers when
performing or terminating their agreements with dealers.
As dealers determined that the federal law did not
provide enough protection, they turned to the states.
While some state laws governing the manufacturer/
dealer relationship date back to the 1930s, many more
and stronger laws were passed beginning in the 1960s
and 1970s. It is those laws that the FTC workshop
covered. Those laws vary, but they all impose limitations
on when and how a manufacturer can decide to
terminate, move, or fail to renew an existing dealer.
In some cases, they also allow the dealer to appoint a
successor.
The laws also regulate other aspects of the
manufacturer’s relationship with a dealer, including how
the dealer is compensated for performing warranty
repairs. As has been publicized recently, some of these
laws also prevent an end run around the regulation by
forbidding any sales of cars to consumers except through
dealers.
“Dealers: Good or Bad?” is not the right question
to ask
Before the event, I feared the debates would devolve
into “dealers are good and so the state laws protecting
them are good” and its opposite. Unfortunately, I think
most of the dealer and state law defenders did just
that. Fortunately, the others (especially the economists)
focused on the more relevant question: Whether or not
1
https://www.ftc.gov/news-events/events-calendar/2016/01/auto-distribution-current-issues-future-trends.
2
http://www.autonews.com/article/20060925/SUB/60919020/government-tips-scales-for-dealers-automakers.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
auto dealers are good or bad, what is unique about them
to justify state laws that override their agreements with
manufacturers and require manufacturers to only sell
through them?
Future technology—and its implications for
regulations—are still in the, uh, future
If you read press releases from the recent Consumer
Electronics Show or Detroit Auto Show, then you might
think that it is only a matter of months before we will
all be pushing a button on a smartphone and calling up
some Jetsons-like car. Thankfully, the panel on future
trends in the industry was much more realistic about
the pace of technological change. (For my own part, I’ll
point out that the research joint venture on advanced
batteries for electric vehicles that I helped negotiate is
nearly twenty-five years old.)3 Yes, change is coming, and
maybe more quickly than in the past, but there still are
technical and, especially, customer acceptance hurdles to
leap.
have been tried in the past and abandoned as too
complex for mass market vehicles. That does not mean
that state laws should prevent such efforts or that they
are doomed to fail again—but hopefully others have
learned from those who went before them (or are at least
aware of their efforts).
You could have held this conference ten (or more)
years ago
Very few of the topics—warranty reimbursement, add
points, dealer terminations, even direct distribution —
have anything to do with electric vehicles, autonomous
vehicles, or ride-sharing. Heck, I debated warranty
reimbursement in New Jersey with one of the panelists
before either one of us had grey hair. Many industry
lawyers, now long-retired, spent entire careers working
on these issues. I’m glad newcomers to the industry have
sparked interest in the issues by the FTC, academics and
even mainstream media,4 but I can’t help wondering:
What took you so long?
More relevant to the workshop, the implications of those
technological changes are not certain, and so the proper
policies and regulations are not clear either. For instance,
one speaker pointed out that autonomous vehicles will
reduce the cost (at least in terms of time) of driving, and
so those vehicles probably will be driven more miles—
but whether those vehicles will be owned and operated
by individuals, fleets, the government, or some peerto-peer company isn’t clear. These panelists just urged
regulators to understand what they know—and don’t
know—about new technology before regulating.
Great job by the FTC
The automotive industry didn’t start in 2003
Steve Cernak was on the General Motors Legal Staff from 19892012. Since then, he has been Of Counsel in the Ann Arbor
Office of Schiff Hardin. He is a Council Member of the ABA
Antitrust Section.
It was helpful to hear industry veterans like Maryann
Keller and Jim Anderson remind the audience that
building vehicles to order and distributing them directly
The FTC does a fine job of advocating on behalf of
competition and consumers in front of state legislatures
and international enforcers. Sometimes, the methods5
chosen lead to unintended consequences.6 But efforts
like this workshop to bring together industry participants
and experts to “prompt meaningful dialogue” (as
Chairwoman Ramirez said) go a long way to “protect
consumers and promote competition” without any new
regulation.7
3
http://uscar.org/guest/teams/12/U-S-Advanced-Battery-Consortium-LLC.
4
http://www.usnews.com/opinion/economic-intelligence/2015/01/19/laws-protecting-auto-franchises-are-bad-for-consumers-and-innovation.
5
http://antitrustconnect.com/2015/04/13/phoebe-putney-nc-board-winning-legal-battles-not-hearts-and-minds/.
6
http://antitrustconnect.com/2015/08/19/slower-crony-capitalism-the-immediate-aftermath-of-nc-board/.
7
https://www.ftc.gov/about-ftc/what-we-do.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
Summary of FTC Workshop Auto–Distribution:
Current Issues and Future Trends
by Anna Aryankalayil 1
On January 19, 2016, the Federal Trade Commission
(“FTC”) hosted an all day workshop to discuss issues
related to the regulation of motor vehicle distribution in
the United States. The workshop was organized around
four panels that presented the perspectives of attorneys,
economists, and representatives of auto manufacturers
and dealers. The panels addressed the rationale for state
regulation of the manufacturer/dealer relationship, the
impact of that regulation on competition and consumers,
and how emerging technologies and distribution
practices may affect the current regulatory regime. FTC
Chairwoman Edith Ramirez and former FTC Bureau
of Economics director Francine Lafontaine opened the
workshop by providing a historical perspective on the
FTC’s role in auto distribution dating back to 1939. And,
Professor Dennis Carlton delivered the Keynote Address,
in which he provided an economic perspective on the
“state action doctrine.” This article summarizes the key
issues and the opposing viewpoints expressed in each
of the four panels and briefly summarizes the respective
remarks by Chairwoman Ramirez, Dr. Lafontaine, and
Dr. Carlton.
The workshop demonstrated that there continues to
be substantial disagreement on the need for regulation
of the manufacturer/dealer relationship, with battle
lines clearly drawn between dealers and manufacturers.
Panelists advocating for the dealers expressed concern
about an imbalance of power in a relationship in which
dealers are locked in to certain manufacturers as a result
of relationship-specific investments. Those advocating
for the manufacturers expressed concern with the effect
of regulation on manufacturers’ ability to address dealer
performance and to customize their distribution practices
in a dynamic industry where potentially revolutionary
1
developments like autonomous cars are already on the
horizon. Economists recognized merit in both sides’
positions, but tended to be skeptical overall that the
problems presented in auto distribution were unique or
unsolvable by contract. Ultimately, the workshop was a
productive forum for interested parties to express their
views, to challenge their adversaries’ arguments, and to
sharpen their own, but little consensus was reached, and
FTC signaled no clear change in policy.
I. Opening Remarks
In her opening remarks, FTC Chairwoman Edith
Ramirez explained that the current system of auto
distribution has remained essentially unchanged for
the past 80 years. The current state regulatory regime
is a result of dealers turning to their state legislatures
for protection against what they believed were abusive
and coercive practices by manufacturers. Dealers who
had made large, manufacturer-specific investments
became concerned that they would be at the mercy
of their affiliated manufacturers-- especially with few
manufactures available as alternatives prior to entry of
foreign competitors.
Chairwoman Ramirez noted that while some regulation
may be beneficial and necessary, regulation can also
have detrimental consequences for consumers if it
harms competition or stifles innovation. She called
on the FTC to continue to consider whether the state
laws are necessary to protect dealers against abuses by
manufacturers.
Former FTC Bureau of Economics director Francine
Lafontaine noted that there are today about half as many
automobile dealerships as thirty years ago, which she
Anna Aryankalayil is an Antitrust Associate in Dechert LLP’s Washington, D.C. office. The statements in this article do not necessarily represent the views of the author, Dechert
LLP, or its clients.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
attributed primarily to the loss of smaller dealerships
that may have sold gasoline and other things in addition
to vehicles. Dr. Lafontaine further noted that most
laws concerning dealer termination and non-renewal/
continuation were not in place until about 1979, and
that even at that time, only about half of the states
had laws that provided dealers with ability to object to
establishment of a new nearby dealership. By 2009,
however, all 50 states had laws governing termination and
non-renewal, and all but three states had laws regulating
establishment of new dealerships.
Dr. Lafontaine discussed a study she conducted with
Fiona Scott-Morton in 2009, in which she compared
GM’s dealer network, which was put in place before state
regulation, and the network of newer entrant Toyota,
which was put in place after such laws were already on
the books. Her study found that GM dealerships were
located closer to each other, were not necessarily located
near to areas of population growth, and were selling
on average about a half to a third as many cars as the
Toyota dealerships. Dr. Lafontaine suggests that these
results could support the view that state regulation may
make dynamic adjustments in the franchise system too
difficult. She queried whether there is a way that dealer
investments can be protected while also providing for
dynamic adjustments to the dealer network.
Teeing up issues for later panels, Dr. Lafontaine
expressed interest in empirical results of recent changes
in regulation on warranty reimbursement, and asked
why manufacturers would find it beneficial to outsource
distribution, why they would choose to do so under
a franchise system, and why any law should prevent a
manufacturer from dealing direct if the manufacturer
found that model beneficial.
II. Panel 1: State Regulation of Dealer Networks
Moderated by James Frost and Patrick Roach of the
FTC, the first panel featured Jim Anderson of Urban
Science, Carl Chiappa of Hogan Lovells, Aaron Jacoby
of Arent Fox, Joseph Roesner or Fontana Group, and
2
Professor Henry Schneider of Cornell.2 The panelists
debated why state regulation of dealer networks is
necessary and what effects such regulation has on
competition and consumers. The panel noted that all 50
states regulate the manufacturer/dealer relationship, with
the three most litigated issues being: dealer terminations,
establishing a new dealership, and re-locating an existing
dealer. These laws override private contracting, permit
dealers to obtain stays without a showing otherwise
required of plaintiffs seeking a preliminary injunction,
and permit government oversight over manufacturer
actions under a “good cause” standard that also includes
considerations of consumer convenience and public
welfare.
In this contentious debate, Carl Chiappa, representing
the dealer perspective, argued that existing “one-size-fitsall” regulations are too blunt an instrument for a dynamic
industry in which manufacturers are often growing at
different rates and in which they have differentiated
competitive strategies (e.g., luxury vs. high-volume).
Mr. Chiappa also noted that the laws have not changed
over the years to reflect changing circumstances such as
the effect of dealer consolidation or the impact of the
internet on retail.
Mr. Chiappa further argued that, instead of serving to
promote dealer investments, the state laws can have
the opposite effect as manufacturers lack the means to
reward dealers that invest in better service or facilities,
or deter poor performance by dealers. He further
noted that the process to resolve disputes is so lengthy
that it ends in settlements in which the manufacturer
effectively has to pay a tax to incumbent dealers in order
to take the steps necessary to be competitive with other
manufacturers.
On the other side of the debate, Aaron Jacoby noted that
the auto industry is an important economic sector similar
to health care, telecom, shipping, and transportation, all
of which are regulated. He noted that the auto industry
can act as a substantial drag on the economy, as it did
James Frost, Office of Policy & Coordination, FTC; Patrick Roach, Office of Policy Planning, FTC; Jim Anderson, Founder, President & CEO, Urban Science; Carl Chiappa, Partner,
Hogan Lovells; Aaron Jacoby, Partner, Arent Fox; Joseph Roesner, President, Fontana Group; Professor Henry Schneider, Cornell University.
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Distribution and Franchising Committee: ABA Section of Antitrust Law
during the Great Recession, or substantially bolster the
economy in better times. Reading the legislative intent
from the California laws, Mr. Jacoby further noted that
regulation ensures a well-organized distribution system in
which warranty, recall, and repair facilities are available to
maintain vehicles.
Mr. Jacoby also argued that regulation was necessary
to curb abuses by manufacturers and to deal with
unequal bargaining power because dealers are small and
are prohibited by antitrust from collective bargaining.
He rejected the idea that consolidation had changed
this imbalance of bargaining power because even
consolidators negotiate each dealership agreement
separately.
Mr. Jacoby further emphasized that state regulation
merely provides objective third party oversight by
experienced state boards and does not give any dealer
absolute veto rights. And Mr. Roesner added that
state franchise laws merely create a process to analyze
manufacturer decisions on termination, add-points
and relocation, but do not prohibit such actions.
Manufacturers need only show “good cause,” and
oversight prevents arbitrary behavior by manufacturers.
Jim Anderson of Urban Science noted that the franchise
system works relatively well for dealers, manufacturers
and consumers, and that a dispute resolution system
is necessary, but expressed concern that the current
process is too slow and expensive. Professor Schneider
acknowledged that dealers have some legitimate
concerns, but opined that long term contracts could
address them. From an economic perspective, state
regulations impose serious costs and make it harder to
for manufacturers to adjust to a change in demand (i.e.,
relocating a dealership in response to demographic shifts)
and it becomes harder to reach economies of scale (i.e.,
consolidating dealerships).
3
III. Panel 2: Warranty Reimbursement
Regulation
The second panel discussed the merits of state laws
governing the rates by which dealers are reimbursed for
services the dealers provide to consumers pursuant to
manufacturer warranties. These state laws can require
manufacturers to pay the same retail prices for parts and
labor that individual consumers pay for non-warranty
work. The panel discussed whether such regulation was
necessary and how it impacted prices that consumers pay
for cars.
The session was moderated by Nathan Wilson and
James Frost of the FTC and the panelists were James
Appleton of the New Jersey Coalition of Automotive
Retailers; attorneys Daniel L. Goldberg of Morgan,
Lewis & Bockius, and Richard Sox of Bass Sox Mercer,
and Professor David Sappington of the University of
Florida.3
Panelists reflecting the dealer perspective took the
position that state regulation is necessary because of the
imbalance in bargaining power between manufacturers
and dealers and that state regulation merely assures
that the dealer is paid the market rate. Mr. Appleton
argued that regulation encourages investments necessary
to ensure that dealers provide adequate warranty
services that consumers need. He further noted
that manufacturers view warranty work as only an
expense while dealers see it as a revenue opportunity
that encourages them to compete for that work. If
manufacturers were permitted to pay less than retail for
warranty work, it would result in increased consumer
costs of non-warranty work or decrease the quality
of dealer’s service. Mr. Appleton further noted that,
in states where reimbursement rates are regulated,
manufacturers already impose surcharges on dealers that
Nathan Wilson, Bureau of Economics, FTC; James Frost, Office of Policy & Coordination, FTC; James Appleton, President, New Jersey Coalition of Automotive Retailers; Daniel L.
Goldberg, Partner, Morgan, Lewis & Bockius LLP; Professor David Sappington, University of Florida; Richard Sox, Partner, Bass Sox Mercer.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
more than cover their costs of reimbursing dealers for
warranty work.
Mr. Sox added that manufacturers had capped
reimbursement on warranty repairs during a period of
time in which manufacturers were increasing dealer
overhead costs through certain demands for facilities
upgrades and requirements to keep fleets of loaner
vehicles, and that repair costs had also increased due
to the need to obtain specialized technician training
and specialized diagnostic equipment to repair more
sophisticated vehicles. Mr. Sox noted that dealers
cannot refuse warranty work, and thus must incur these
overhead costs without knowing how much warranty
work they will actually get. Because a dealer must cover
all of this overhead, it is incorrect to think of a dealer
markup on warranty services as profit.
Dan Goldberg, representing the manufacturers’
perspective argued that it is unusual for states to set
minimum pricing for any good or service. He queried
why a manufacturer should have to pay any markup,
much less retail, on a part that the manufacturer was
itself providing to the dealer for the warranty repair. The
natural solution should be that the manufacturer would
just provide the part for free so that neither side is paying
any markup on the part. Mr. Goldberg further argued
that manufacturers would not offer warranties unless it
provided them an advantage in competing for car buyers,
and so they have a competitive incentive to ensure that
dealers are properly incented to do the warranty work.
Mr. Golberg pushed back on the imbalance of power
argument, noting that dealers, on average, net $1 million
in profit a year and there are very large dealer entities
making billions of dollars a year. Although there
are some small dealers, because manufacturers adopt
nationwide policies, he argued that small dealers are
being protected by the large dealers. He was troubled
by the notion that dealers are victims of warranty
obligations when it is a profit center for them and helps
to drive repeat business that could translate into new
4
car sales. Regarding balance of power, he suggested
that the dealers have influence with local legislatures due
to their local presence and local employment whereas
manufacturers have facilities only in distant states. He
even suggested that perhaps the real reason for warranty
reimbursement regulation was to maintain the revenue
stream to dealers that had otherwise been declining due
to better performing cars that needed fewer repairs.
Professor Sappington, offering an economic perspective,
was skeptical of the argument that an imbalance of
power created a market failure necessitating regulation.
He saw manufacturers and dealers working more
cooperatively as a team in competition with other
manufacturers and dealers. He saw this team-based
competition as providing sufficient incentives for
manufacturers and dealers to agree on mutually beneficial
warranty reimbursement terms that serve their joint
competitive efforts. He further noted that regulation
could create perverse incentives such as encouraging
dealers to raise non-warranty rates so that their
reimbursements are higher on warranty rates.
IV. Panel 3: Direct Distribution
The third panel debated why state regulation should
prohibit direct distribution or direct service by
manufacturers. Patrick Roach and Paolo Ramezzana of
the FTC moderated the panel, which featured Professor
Dan Crane, consultant Maryann Keller, Todd Maron of
Tesla Motors, Joel Sheltrown of Elio Motors, and private
attorneys Steven McKelvey of Nelson Mullins and Paul
Norman of Boardman & Clark.4
Mr. Maron explained that Tesla prefers direct distribution
because its stores are located in urban, high foot traffic
areas, while traditional dealers are located in out-ofthe way suburban locations, and Tesla does not need
inventory because each vehicle is built to the buyer’s
specifications. While dealers tend to make high-volume,
fast-paced deals, buying a Tesla is a more time-intensive
process that requires Tesla to educate the customer about
Patrick Roach, Office of Policy Planning, FTC; Paolo Ramezzana, Bureau of Economics, FTC; Professor Dan Crane, University of Michigan; Maryann Keller, Managing Partner, Maryann
Keller & Associates; Todd Maron, General Counsel, Tesla Motors; Steven McKelvey, Partner, Nelson Mullins; Paul Norman, Partner, Boardman & Clark; Joel Sheltrown, Vice President of
Government Affairs, Elio Motors.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
the unique circumstance of owning an electronic vehicle.
Tesla vehicles have fewer parts than gas-powered vehicles
and Tesla does not finance the purchase, so the typical
profit centers for dealers are not available. Tesla also
does not advertise and would not be able to co-fund
dealer advertising. Thus, there is little for Tesla to offer
a franchised dealer, and little for Tesla to gain from the
relationship.
Mr. Maron noted that very few states prohibit direct
distribution, but remarked that these prohibitions only
exist in the United States. He saw opposition to direct
distribution coming from dealer groups and from
traditional manufacturers and saw both as protectionist.
Joel Sheltrown of Elio Motors described how his
company’s autocycles are different from other vehicles
due to their low $6,800 target price, and next-day
delivery model. Elio found that 25% of retail price is
in advertising and dealer network, and Elio wants to
cut those costs through by using 60 retail centers with
servicing provided by Pep Boys.
Maryan Keller provided her perspective as an industry
participant for over 30 years, and noted that there is
nothing new about direct distribution. Manufacturers
like Ford previously tried the model and found that a
franchise system provided better value. She disputed
the argument that direct distribution necessarily is
lower cost, noting that Ford increased costs through
its retail network, and that respective specialization
on manufacturing and sales can be efficient. She also
expressed skepticism that made-to-order assembly could
compete with the engineering involved in traditional
manufacturing, and noted the benefits of dealers
competing in intra-brand competition in which they have
more flexibility to meet consumer needs than a one-sizefits-all manufacturer model.
Paul Norman also spoke in support of such state laws
based on the principles of federalism. He noted that
state franchise laws should be given much deference
5
by federal agencies such as the FTC. He also credited
the state franchise laws for promoting intra-brand
competition.
Professor Crane explained that there is no need for
public policy to favor a certain method of distribution
over another. The method of distribution itself is
a component of competition. Laws that entrench
incumbents chill innovation because new technologies
may require new methods of distribution. Professor
Crane called existing laws “dealer protection” and not
consumer protection. In fact, vertical integration means
lower prices for consumers because, at the very least, it
avoids double marginalization.
V. Panel 4: Future Trends
The final panel was moderated by Ellen Connelly and
Patrick Roach of the FTC, and the panelists were Avery
Ash, Ashwini Chhabra, Robbie Diamond, Professor
Fiona Scott-Morton, Professor Bryant Walker Smith, and
Peter Welch.5 The panelists considered whether existing
regulatory regimes need to change to accommodate
new technologies such as autonomous vehicles and car
sharing services like Uber and Lyft that have become
more prevalent. Panelists opined that accelerated trends
may shift purchasing of automobiles from individuals to
fleet purchasers. This may negate some of the historical
reasons for state regulations as fleet purchasers may
choose to deal with manufacturers directly. On-air
repairs directly from the manufacturer could minimize
the need for warranty reimbursement regulation.
Panelists generally agreed that given the uncertainty
of the scope of new technologies, a regulatory regime
built for the future must be flexible enough to both
accommodate new technology and not chill yet further
innovation. Dr. Scott-Morton noted that we already are
having trouble permitting direct distribution, which does
not bode well for the flexibility that will be required for
new technologies. Panelists expressed concerns about
interest group capture of regulations to deter innovation,
Ellen Connelly, Office of Policy Planning, FTC; Patrick Roach, Office of Policy Planning, FTC; Avery Ash, Director of Federal Relations, American Automobile Association; Ashwini
Chhabra, Head of Policy Development, Uber Technologies; Robbie Diamond, Founder, President and CEO, Securing America’s Future Energy; Professor Fiona Scott Morton, Yale
University; Professor Bryant Walker Smith, University of South Carolina; Peter Welch, President, National Automobile Dealers Association.
March 2016
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Distribution and Franchising Committee: ABA Section of Antitrust Law
but Mr. Welch expressed his faith in state regulators to
develop good public policy.
VI. Keynote Address
Professor Dennis Carlton6 presented the keynote
address on the broader topic of “state action” immunity,
which he described as a doctrine that allows states to take
actions that would violate the antitrust laws if conducted
by individuals. Dr. Carlton suggested certain economic
justifications for the doctrine: such as the rationale
that, if everyone is participating in the political process,
the state’s action must be the right result, or that if a
state makes a mistake, citizens can move to a different
state that offers better policy. He characterized this
rationale as “flimsy” because there are significant costs
to moving, legislation often reflects influence of special
interests, and because the policy of one state may have
externalities on citizens in another state who have no
ability to participate in the first state’s legislative process.
Dr. Carlton warned that the real danger of state action is
that it may be an invitation for special interest legislation.
Special interest legislation distorts the competitive
process by favoring one group over others, leading
to inefficiency. Dr. Carlton suggested that, if legally
possible, the state action should be modified such that it
6
does not apply to state action that harms a person in a
different state nor to state action that has no cognizable
benefits.
He observed that the FTC is on the right track by
restricting the application of state action doctrine to
circumstances where there is clear articulation by the
state and close state supervision. He also invited the
FTC to study the incidence of how special interest
legislation is affected by corruption and campaign
contributions. He observed that it would be useful to
explicitly evaluate the effect of special interest legislation
on consumers’ prices and the quality of their goods.
Although he had not planned on addressing auto
distribution specifically, Dr. Carlton responded to the
first two panels by disputing the argument that regulation
is required because an industry is important or that
regulation is rendered harmless because there will be a
neutral fact-finder reviewing disputes. He also rejected
the argument that regulation is necessary to make things
fair between manufacturers and dealers since the concept
of fairness has no guiding principle. Moreover, he did
not see any market failure or other special circumstance
that would require regulation of auto distribution as
opposed to any other industry.
David McDaniel Keller Professor of Economics, Booth School of Business, University of Chicago.
March 2016
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