Dr. Miles is dead. Now what? Structuring a rule of reason for evaluating minimum resale price maintenance.

• Author: Lambert, Thomas A.

ABSTRACT

In Leegin Creative Leather Products, Inc. v. PSKS, Inc., the U.S. Supreme Court overruled its 1911 precedent declaring vertical minimum resale price maintenance (RPM) to be per se illegal. The Leegin Court held that the practice should instead be examined on a case-by-case basis under antitrust's rule of reason. The Court further exhorted the lower courts to craft a "structured" rule of reason for evaluating RPM. This Article critiques six proposed approaches for evaluating minimum RPM and offers an alternative approach. The six approaches critiqued are: (1) the Brandeisian, unstructured rule of reason; (2) Judge Posner's rule of per se legality; (3) the approach advocated by twenty-seven states in the recent Nine West case; (4) the approach adopted by the Federal Trade Commission in that case; (5) the approach advocated by economists William Comanor and F.M. Scherer; and (6) the approach proposed in the Areeda & Hovenkamp Antitrust Law treatise. Finding each of these approaches deficient, this Article proposes an alternative evaluative approach that harnesses economic learning and allocates proof burdens in a manner that minimizes the sum of decision and error costs, thereby maximizing the net social benefits of RPM regulation.

TABLE OF CONTENTS INTRODUCTION I. RPM AND COMPETITION A. Potential Anticompetitive Harms 1. Facilitating Dealer Collusion 2. Facilitating Manufacturer Collusion a. Reducing Incentives To Cheat b. Making Cheating More Visible 3. RPM-Augmented Foreclosure B. Potential Procompetitive Benefits 1. Enhancing Distributional Efficiency a. Encouraging Retail Service by Eliminating Free Riders b. Enforcing Unspecified Agreements 2. Facilitating Entry 3. Facilitating the Marketing of Products with Unpredictable Demand II. PROPOSALS FOR EVALUATING RPM UNDER THE RULE OF REASON A. Two Nonstarters: An Unstructured Rule of Reason and a Rule of Per Se Legality 1. An Unstructured Rule of Reason 2. Per Se Legality B. The States' Proposed Approach: Higher Price Places Burden on Defendant To Prove Procompetitive Effect that Could Not Have Been Achieved Less Restrictively C. The FTC Approach: Defendant Can Avoid Burden of Proving Procompetitive Effect of RPM Only if It Proves Absence of "Leegin Factors" D. The Comanor / Scherer Approach: RPM Is Unreasonable if Retailer-Initiated; Otherwise, Focus on Quantitative Foreclosure E. The Antitrust Law Approach III. AN ALTERNATIVE APPROACH A. Principles Governing Rule Selection 1. Likelihood of Incorrect Judgments a. Economic Theory b. Empirical Evidence c. Retailing Trends 2. Magnitude of Losses from Errors 3. Difficulty of Administering the Rule B. The Proposed Rule 1. Plaintiff's Prima Facie Case a. Circumstantial Dealer Collusion Theory b. Circumstantial Manufacturer Collusion Theory c. Foreclosure Theory 2. Defendant's Rebuttal Opportunity 3. Responses Available to Challenger C. Evaluation of the Proposed Rule CONCLUSION INTRODUCTION

The U.S. Supreme Court's decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., (1) marked the end of an era in antitrust. Leegin overruled the Court's 1911 Dr. Miles decision, (2) which had established that minimum vertical resale price maintenance (RPM)--the fixing of minimum downstream prices by upstream firms (3)--is per se unreasonable. (4) Leegin's holding that instances of RPM must instead be evaluated under antitrust's rule of reason (5) was no great surprise. The Court has repeatedly emphasized that per se illegality is reserved for restraints of trade that are always or almost always anticompetitive. (6) Although some of the vast commentary on RPM highlights the practice's anticompetitive potential, (7) numerous economists have demonstrated that RPM may provide important procompetitive benefits. (8) Thus, one thing is clear in the academic literature on RPM: the practice is, at worst, a "mixed bag" in terms of competitive effects. Mixed bags should not be deemed unreasonable per se. (9)

While the academic literature is replete with accounts of RPM's competitive effects, there is little commentary addressing exactly how courts should go about judging the "reasonableness" of any particular instance of RPM. This makes sense, of course, because Dr. Miles precluded courts from inquiring into the reasonableness of specific RPM agreements, and such commentary would have therefore been rather pointless. (10) But in the post-Leegin era, in the face of a proliferation of RPM arrangements, (11) courts must develop means of distinguishing pro- from anticompetitive RPM agreements. Indeed, the Leegin Court expressly contemplated that the lower courts would craft a structured approach for sorting instances of RPM. It explained:

As courts gain experience considering the effects of these [RPM] restraints by applying the rule of reason over the course of decisions, they can establish the litigation structure to ensure the rule operates to eliminate anticompetitive restraints from the market and to provide more guidance to businesses. Courts can, for example, devise rules over time for offering proof, or even presumptions where justified, to make the rule of reason a fair and efficient way to prohibit anticompetitive restraints and to promote procompetitive ones. (12) This Article aims to assist courts with this assignment by proposing a structured rule of reason for evaluating the legality of RPM agreements. Part I lays the foundation by summarizing the economic learning on RPM's competitive effects. Part II then describes and critiques six approaches that have been proposed for evaluating the legality of specific instances of RPM. Part III proposes an alternative evaluative approach. Under this approach, a party challenging an instance of RPM could prevail only if it either (1) produced convincing evidence that the RPM resulted in an output reduction that could not be attributed to another cause or (2) both demonstrated the existence of all the prerequisites to one of RPM's potential anticompetitive harms and rebutted any claim that the RPM was imposed as the most efficient means of securing a procompetitive end. The proposed approach would maximize the net benefits of RPM regulation by minimizing the sum of decision costs and error costs.

1. RPM AND COMPETITION

   Crafting a rational scheme for separating pro- from anticompetitive instances of RPM requires an understanding of how RPM may enhance or diminish competition. We thus begin with a consideration of RPM's competitive effects. Possible anticompetitive harms, examined in Part I.A, include the facilitation of collusion by dealers and manufacturers and the erection of barriers to entry by manufacturers. (13) Potential procompetitive benefits, the focus of Part I.B, include the enhancement of distributional efficiency, the facilitation of entry into the upstream market, and the facilitation of the marketing of products for which consumer demand is uncertain.

   1. Potential Anticompetitive Harms

      RPM's potential anticompetitive harms result from its ability to facilitate collusion and to foreclose new entrants from available marketing outlets. Collusion, which the Supreme Court has dubbed "the supreme evil of antitrust," (14) is, fortunately enough, difficult to accomplish. (15) First, the parties to any collusive arrangement must reach an understanding on how they will limit competition amongst themselves. For example, if the collusive agreement is price fixing, what price will be charged? (16) Agreements of this sort among multiple parties are always a challenge to negotiate, and, because collusion is generally illegal, (17) the parties to any cartel must do so in a clandestine fashion. In addition, the parties to a cartel must somehow police it--that is, they must monitor their coconspirators' compliance with the agreed-upon terms and punish violators. Secretly policing illegal, heavily sanctioned agreements not to compete can be quite difficult.

      RPM may disrupt this fortuitous state of affairs by making collusion easier for both dealers and manufacturers. As Part I.A.1 explains, RPM may facilitate collusion at the dealer level by assisting with both the establishment and the enforcement of a price fixing agreement. Part I.A.2 considers how RPM may facilitate the enforcement of manufacturer-level collusive agreements. Finally, Part I.A.3 considers how manufacturers may employ RPM as an exclusionary device aimed at thwarting competition from new entrants in the manufacturing market.

      1. Facilitating Dealer Collusion

         Dealers can avoid the difficulty of secretly negotiating a fixed supracompetitive resale price for a product if they can convince the manufacturer of that product to require all dealers to charge such a price. They may, for example, complain to the manufacturer--either individually, as a group, or via some trade association--about discounting dealers that are somehow injuring brand equity. The manufacturer might then respond to their complaints by setting minimum resale prices and thereby essentially establishing the retailer cartel. In addition, the manufacturer, which is in constant contact with its dealers and whose interactions with the competing dealers do not typically raise red flags, may take the lead in enforcing the price fixing agreement by punishing (that is, refusing to supply to) dealers that diverge from the fixed price. (18) RPM thus may permit colluding retailers to overcome the two main hurdles to a price fixing conspiracy: establishment and enforcement.

         Of course, manufacturers must agree to participate in this sort of scheme, and it is not immediately obvious why they would do so. The retail markup--the difference between the price the manufacturer collects from the retailer and the price the retailer charges the end user consumer--is the cost the manufacturer must incur to distribute its goods via retailers. (19) A manufacturer would presumably seek to keep that cost as low as possible and would thus refuse retailer...