Resale price maintenance and manufacturer competition for retail services

• Published date: 01 March 2017
• DOI: http://doi.org/10.1111/1756-2171.12165
• Author: Johannes Muthers,Matthias Hunold
• Date: 01 March 2017

RAND Journal of Economics

Vol.48, No. 1, Spring 2017

pp. 3–23

Resale price maintenance and manufacturer

competition for retail services

Matthias Hunold∗

and

Johannes Muthers∗∗

We investigate the incentives of two manufacturers with common retailers to use resale price

maintenance (RPM). Retailers provide product-specific services that increase demand and man-

ufacturers use minimum RPM to compete forfavorable retail services for their products.Minimum

RPM increases consumer prices and can create a prisoner’s dilemma for manufacturers with-

out increasing, and possibly even reducing, the overall level of retail services. If manufacturer

market power is asymmetric, minimum RPM may distort the allocation of services toward the

high-priced products of the manufacturer with more market power. These results challenge the

service argument as an efficiency defense for minimum RPM.

1. Introduction

There is a long-standing debate about whether resale price maintenance (RPM) should be

legal. The major concern is that the use of minimum RPM leads to higher consumer prices.1The

economic literature supports this concern by showing that RPM may facilitate collusion among

manufacturers, as well as by arguing that RPM may indirectly support retailer cartels.2

However, if collusion is not a concern, the so-called service argument provides the following

explanation of why minimum RPM benefits consumers: as the direct effectof minimum RPM is a

higher retail price—which normally reduces demand—a monopoly manufacturer only increases

the retail margin with minimum RPM if this indirectlyincreases demand through improved retailer

∗D¨

usseldorf Institute for Competition Economics (DICE) at the Heinrich Heine Universit¨

at D¨

usseldorf;

hunold@dice.hhu.de.

∗∗Julius-Maximilians-Universit ¨

at W¨

urzburg; johannes.muthers@uni-wuerzburg.de.

Hunold gratefully acknowledges support by the Deutsche Forschungsgemeinschaft through SFB TR-15. The views

expressed in this article are the author’s own, and do not necessarily reflect those of the organization to which he is

affiliated. We thank participants at the JEI 2010, the MaCCI 2011 annual conference, the IIOC 2011, the IO Workshop

Lecce 2011, the 2011 annual conferences of the EARIE and the Verein f¨

ur Socialpolitik, as well as at seminars in

D¨

usseldorf, Mannheim, Turunc, and W¨

urzburg; Mark Armstrong, Paul Bridgeland, Firat Inceoglu, Martin Peitz, David

Sauer,Norber t Schulz, Yossi Spiegel, Konrad Stahl, Sebastian Wismer,and two anonymous referees for helpful comments

and suggestions.

1Minimum RPM implies that retailers may not sell below specified price and thus imposes a price floor.

2Wediscuss that literature in the second par t of the Introduction.

C2017, The RAND Corporation. 3

4/THE RAND JOURNAL OF ECONOMICS

incentives. For example, if retailerscan increase demand through costly services, a manufacturer

can use minimum RPM to increase the retail margin, which makes it profitable for retailers to

provide additional services. The use of minimum RPM tends to benefit consumers, at least those

who buy the product because they value these additional services.

In this article, we highlight howthe ser vice argumentcan fail to hold in the context of multiple

manufacturers selling through the same retailers. Qualifying the service argument is important for

competition policy as it is the basis for a recent change, whereby the US Supreme Court assessed

the procompetitive and anticompetitive argumentson minimum RPM i n2007 and overturned the

long-standing per se illegality of minimum RPM with the Leegin decision.3The court followedthe

service argument in stating in its opinion that “ . . . in general, the interests of manufacturersand

consumers are aligned with respect to retailerprofit margins.” Furthermore, the European Union

(EU) Guidelines on Vertical Restraints of 2010 mention as a potential efficiency justification that

extra margins provided by RPM may allow retailers to provide better presales services.4

We provide a theoretical model to show that in markets where multiple manufacturers sell

through common retailers, the interests of each individual manufacturer and the consumers are

misaligned with respect to minimum RPM. We consider this result empirically relevant because

minimum RPM is used for many products where retailers sell competing brands; for example,

books, clothing, contact lenses, hearing devices, and household appliances.5Retailers of such

products frequently offer services such as presales advice. We show that competing manufacturers

individually have incentives to use minimum RPM but collectively can have lower profits when

minimum RPM is used by all manufacturers. Moreover,minimum RPM results in higher consumer

prices without necessarily increasing the service level.

To illustrate this, consider two manufacturers producing differentiated products symmetric

in demand and competing through two retailers. Suppose that each retailer has a fixed amount of

service or influence that can be allocated more to one product or the other. Retailers have a natural

incentive to allocate services in favor of the product that is more profitableto them. Without RPM,

the equilibrium allocation of service at each retailer is symmetric, namely, each product receives

half of each retailer’s service as the products have the same retail margin. However, with RPM, the

allocation of service is also symmetric and thus unchanged. Accordingly, RPM has no impact at

all on retail services. Nonetheless, RPM increases the retail price when competition for retailers’

service is intense, because each manufacturer attempts to obtain marginally greater service for

its product by raising the retail margin of its product. Protection of the retail margin takes the

form, in part, of protecting higher retail prices through minimum RPM. Thus, minimum RPM

raises retail prices but has no impact on the level of services. Minimum RPM is in the individual

manufacturer’s interest, although in this case it makes both manufacturers worse off (a prisoner’s

dilemma effect). Consumers are unambiguously worse off under minimum RPM because prices

are higher with no change in service.

For the previous argument, wehave assumed that each retailer has a fixed amount of service

that can be allocated between the two products. In addition, weinvestigate the effects of RPM on

retailers’ investments in services. The main point of the literature on service and RPM is that with

simple contracts, retailers may fail to providethe (privately) efficient levels of service. The leading

example is that retailers free-ride on other retailers’ presales advice and product presentations.

3Leegin CreativeLeather Products, Inc. v. PSKS, Inc., 551 US, 2007. See Elzinga and Mills (2009) for a discussion

of services in the Leegin case. Elzinga was a testifying expert in Leegin for the pro-rule-of-reason-side.

4Minimum and fixed RPM are still considered core restrictions of competition in the (EU VerticalBlock Exemption

of 2010, Article 4a). Nevertheless an efficiency defense according to 101 (3) Treaty on the Functioning of the European

Union (TFEU) is possible in individual cases (par.223 Vertical Restraints Guidelines; and par. 224 and 225 for efficiency

examples).

5RPM cases with common retailers and products where presales advice potentially matters include the following

cases of the German Federal Cartel Office on contact lenses (fine “Bußgeldbescheid B 3 - 123/08,” 2009), hearing devices

(press release “Bundeskartellamt verh¨

angt Bußgeld gegen H¨

orger¨

atehersteller Phonak GmbH,” 2009), and household

appliances (press release “Bundeskartellamt verh¨

angt Bußgelder wegen unzul¨

assiger Preisbindung,” 2003).

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The RAND Corporation 2017.