Free Riding on Hot Wheels

• DOI: 10.1177/0003603X0204700403
• Published date: 01 December 2002
• Author: Victor P. Goldberg
• Date: 01 December 2002
• Subject Matter: Domestic Antitrust

The Antitrust Bulletin/Winter 2002

Free riding on

hot

wheels

BY VICTOR P. GOLDBERG*

603

When warehouse clubs

started

making inroads

into

its market,

Toys

"R"

Us (TRU) responded with apolicy designed to limit the

clubs' access to certain toys.

The

FTC successfully challenged the

policy, arguing that TRU had coordinated ahorizontal agreement

amongst the toy manufacturers to eliminate competition from this

new class

of

competitors.'

TRU

defended itself, invoking the free

rider rationale. This the

Commission

rejected as pretext.

TRU's

argument was better than the Commission gave it credit for, but it

failed to press its best argument. That failure stems in part from

the shortcomings of the

standard

free

rider

formulation,

and

in

part from the defendant's

need

to tailor its arguments to ill-fitting

doctrinal constraints.

TRU

attempted to convince the Commission

that its actions were unilateral, within the

Colgate

exception.i Per-

haps they were, although the Commission found to the contrary.

Regardless, the net result was suppression

of

an efficiency ratio-

*Thomas Macioce Professor

of

Law and Co-director

of

the Center

for Law and Economics, Columbia University.

AUTHOR'S NOTE: I would like to thank Dave Butz, Dennis Carlton, Fred

Dunbar, Eleanor Fox, Lou Guth, Ed Iacobucci, Mike Klausner, Damien

Neven, and Dick Rapp

for

helpful comments.

Toys

"Roo

Us, Inc., 126 F.T.C. 415 (1998). Upheld in, Toys

"R"

Us, Inc. v. F.T.C., 221 F.3d 928 (2000).

United States v. Colgate &Co., 250 U.S. 300 (1919).

©2003 by Federal Legal Publications. Inc.

604

The antitrust bulletin

nale that emphasized the benefits

of

cooperation by the toy manu-

facturers.

In this article, I will argue that

TRU

emphasized the wrong

free rider problem. Properly framed, the behavior of TRU and the

toy companies can be seen as consistent with the efficiency goals

of

antitrust policy.

That

aplausible efficiency argument can be

constructed does not mean that the outcome itself was wrong. My

narrow focus here is on showing that the standard formulation led

to asking the wrong question.

Part

I

provides

a

brief

overview

of

the

market

and

TRU's

behavior. Part II summarizes the defense's rationale and the Com-

mission's rejection

of

it. Part III provides an alternative explana-

tion. Part IV concludes.

I.

What

did

TRU

do?

When

the

case

was brought, Toys

"R"

Us was a "category

killer," far and away the largest retailer

of

toys." It accounted for

about 20%

of

the toys sold at retail in the United States and in a

number

of

markets its share was significantly higher. In Chicago,

New York, and Los Angeles its market share exc.eeded 40%. It

faced

competition

from

traditional

toy

retailers,

department

stores, and discounters like Wal-Mart. In the late 1980s a new

retailing innovation, the warehouse club, appeared. Two

of

the

warehouse

clubs,

Sam's

(owned

by

Wal-Mart)

and

Costco,

accounted for over 90%

of

the sales. Warehouse clubs began to

sell toys at prices substantially below

TRU's.

TRU gross margins

were around 30%, while the clubs' margins were in the

9%-12%

range.

TRU

carried

over

11,000 toys

(stock

keeping

units or

SKUs) while the clubs' offerings were much more limited (num-

bering

in

the

low

hundreds).

The

FTC's

complaint

concerned

TRU's

response to the perceived threat

of

increased competition

from the warehouse clubs.

My understanding is that Wal-Mart has recently taken over the

number one spot.