Maximum Vertical Price Fixing from Albrecht Through Brunswick to Khan: an Antitrust Odyssey

Publication year2000
CitationVol. 24 No. 02


Maximum Vertical Price Fixing from Albrecht Through Brunswick to Khan: An Antitrust Odyssey

James M. Fesmire (fn*)


The imposition of a maximum resale price by a manufacturer on her distributors has long received harsh judicial treatment.(fn1) At the same time, for many years, a majority of economists have viewed maximum vertical price fixing as a practice that is not only benign, but, indeed, one that results in an increase in consumer welfare, a primary goal of antitrust.(fn2) Further, maximum resale price restraints have been seen by some as not only leading to an enhancement of consumer welfare, but also as promoting every other suggested goal of antitrust policy.(fn3) Consequently, the Supreme Court's declaration of the per se illegality of these restraints in Albrecht v. Herald Co. was met by a chorus of criticism from economists and legal scholars alike.(fn4) But, even as many in the judiciary came to recognize the benefits of maximum vertical price fixing, its per se illegality stubbornly persisted because of the Court's reluctance to violate the precedent of previous decisions.

The conflict between the benefits of maximum vertical price fixing and its harsh legal treatment was aggravated further in Brunswick Corp. v. Pueblo Bowl-O-Mat, where the Court introduced a requirement that a plaintiff in a private action show he has suffered an "antitrust injury" in order for his damages to be compensable.(fn5) "Antitrust injury" is defined as an injury that results from some anticompetitive aspect of the offending conduct.(fn6) The Court's clear purpose was to bring antitrust law into conformity with the goals of antitrust. The Court admonished the appellate court's holding because it "divorces antitrust recovery from the purposes of the antitrust laws without a clear statutory command to do so."(fn7) As a result, in the post-Brunswick world, courts were left to address a practice that most agreed was procompetitive (as we shall see, the anticompetitive effects detected by some were not convincing), but a practice that was nonetheless illegal. Worse, once courts determined the illegality of a defendant's seemingly procompetitive behavior, they then had to somehow find that the plaintiff was injured by some anticompetitive aspect of a procompetitive practice.

Brunswick cast in stark relief the tension between maximum price fixing's per se illegality under Albrecht on the one hand, and the goals of antitrust on the other, setting in motion a judicial odyssey that ended when, in State Oil v. Khan,(fn8) the Supreme Court finally corrected its error. The Court ruled that maximum vertical price fixing is no longer per se illegal, but it stopped short of declaring the practice per se legal.(fn9) Rather, the Court held that maximum price fixing is now subject to a rule of reason analysis.(fn10)

This result is a great improvement, albeit one not completely satisfying to all. Vertical maximum price fixing is a procompetitive policy that almost always leads to an increase in consumer welfare. The reversal of its per se illegality and the substitution of a rule of reason analysis is a positive result for the competitive process and for consumers.

The road from Albrecht to Khan was a long and confusing one. This Article attempts to sort out some of this confusion by portraying that long road as a successful example of the antitrust injury doctrine's ability to bring substantive antitrust law into compliance with the goals of antitrust. To this end, this Article first shows how the existence of successive monopoly provides an incentive for maximum vertical price fixing and how maximum vertical price fixing leads to an increase in consumer welfare. Second, it examines manufacturer alternatives to vertical price restraints, finding them less attractive in terms of social welfare. Third, this Article analyzes other competitive concerns raised by the Albrecht Court, finding them largely baseless. Next, it looks at how the prohibition of maximum vertical price fixing frustrates every one of the suggested goals of antitrust. Finally, this Article analyzes the antitrust injury doctrine and shows how its application to maximum resale price fixing forced substantive antitrust law into conformance with the goals of antitrust.

II. Successive Monopoly and Maximum Vertical Price Fixing

Let us now turn to an analysis of how vertical integration can be profitable in the presence of successive monopoly.(fn11) Successive monopoly occurs when a monopoly producer of some product sells it to a distributor who is the only reseller of the product to final consumers.(fn12) Once it is understood why successive monopolists might want to integrate, it is easy to appreciate why maximum vertical price fixing might be an attractive alternative.(fn13)

A. A Single Monopolist

First, let's examine what happens when both the production and the distribution of a product are controlled by a single monopolist. Assume that a manufacturer has obtained a patent for a product for which he is the sole producer. Because the monopolist owns a patent, the monopoly is perfectly legal, and antitrust concerns can be ignored.(fn14) Assume also that the manufacturer has chosen to be the only distributor of the product.(fn15)

In Figure 1, D is the demand by consumers for the manufacturer's product and MR is the associated marginal revenue curve.(fn16) Let MCR represent the marginal cost of retailing (distributing) the product, and let MCP represent the marginal cost of production. For simplicity, assume both MCP and MCR are constant and are therefore equal to average costs.(fn17) Profits are maximized for the monopolist by producing and selling Q, units, where marginal revenue (MR) equals the marginal cost of production and retailing (MR - MCP + MCR).(fn18) Therefore, the monopolist will charge the price P,, resulting in maximum profits equal to (P, - MO)Q,.(fn19) No other combination of price and quantity can result in greater profits for the firm with these demand and cost curves.

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Because the monopolist has the ability to choose the price and resulting quantity of his good rather than being forced to accept some price dictated by competitive forces, there is a resulting social welfare loss. We can see this by contrasting our monopoly results with those that would occur in a competitive industry. Suppose that we do have a competitive industry, populated by many small firms, each of which is subject to exactly the same production and distribution costs as our monopolist.(fn20) Competition among the many small firms in such an environment would drive price to P2, where price is equal to average and marginal cost MC.(fn21) Because price is equal to average cost, firms in this industry will earn a competitive rate of return.(fn22) In a competitive industry, then, the result would be a price P2, and Q2 units of production and consumption. With a monopolist, who faces no competition from rivals, we have seen the result would be a price P1 and a restriction of output to Q1.

In Figure 1, area ABC represents the loss in social welfare resulting from the monopolist's ability to restrict output. This loss is equal to the area between the demand curve, which measures what consumers would have been willing to pay, and the marginal cost curve, which measures the cost of the resources for the lost output (Q2- Q1).(fn23) While our concern here is with social welfare, others would argue that this loss in social welfare understates the degree of antitrust concern.(fn24)

B. Successive Monopolists

Now that we have examined the differences in output and welfare results in the polar cases of monopoly and competitive markets, we next turn to the case where a monopoly producer, rather than performing both the production (upstream) and the distribution (downstream) functions, grants exclusive (monopoly) territories to a system of independent distributors to whom he sells a product. This is a case of successive monopoly. As described above, the objection to monopoly arises from the loss of social welfare that results from the monopolist's restriction of output.(fn25) In successive monopoly, both the upstream and the downstream monopolists have an incentive to restrict output in order to bring about a higher price and greater profits, thereby compounding the problem. These successive output restrictions, one upon the other, bring about an even higher price and lower output than that which results when a single monopolist controls both the production and the retailing stages.

A monopolist who controls both production and distribution faces a straightforward problem. He chooses that price that leads consumers to buy the profit-maximizing quantity, the quantity at which marginal revenue and marginal cost are equal. In a successive monopoly, however, there are two decision variables. The retailer chooses the final price for consumers and the producer chooses the price that the retailer must pay for each unit of the product, called the "transfer price," T. It is the producer's task to choose the transfer price that will lead the retailer, in turn, to charge a final price that will generate maximum producer profits. Then, faced with the transfer price selected by the producer, the retailer...

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