Retailers Can Benefit From Price Policies

BRANFORD, CT -- Retailer Tim Brockett was frustrated over his inability to price products as he liked. So the owner of Branford Bike, a store front and mail-order business, took his case to a higher court-the public.

In his new catalog, Brockett slammed a supplier's minimum pricing policy. "Any dealer who advertises a lower price than that dictated by Carnac will be completely unable to sell Carnac shoes. We need your help to stand up for your right to purchase products at reasonably discounted prices," read Brockett's editorial. He urged consumers to contact Carnac's distributor, Sinclair Imports.

Brockett said he is aware of about a dozen customers who wrote Sinclair. He received 75 to 100 supportive phone calls. "Many are saying this is the first time they have heard of price setting in the bike industry," Brockett said.

Sinclair received a few letters, said Lance Donnell, Sinclair's sales manager. The policy benefits specialty retailers and has the support of almost all of them, Donnell said.

Minimum pricing policies are common in the industry. Companies such as Answer, Carnac, Litespeed, Mavic, Michelin, Pearl Izumi, RockShox, Specialized and others have announced they will stop selling to outlets that sell or advertise below a certain price.

Most retailers pay little attention. "I don't know how relevant they are. I don't try to have the lowest prices in my area," said Jerry Slack, owner of Cycle Loft in Burlington, Massachusetts.

But the policies have an impact on Brockett, who competes in part, by delivering lower prices than his mail-order competition. "If I have to stick to suggested retail, I'm at a competitive disadvantage," he said.

Industry analysts, economists and even the U.S. Supreme Court offer a mixed view of minimum pricing policies, technically a type of vertical pricing restraint called "resale price maintenance."

Do They Work? Assuming the policies are legal, supporters said they allow specialty retailers to compete with discounters. That benefits the industry because retailers are guaranteed enough margin to adequately promote, sell and service products.

"Discounting lowers service. These policies are a direction we believe in," said Ricky Strawn, Specialized's national sales manager.

But Branford's Brockett said minimum price policies bolster mail-order profits, giving catalog merchants resources to take market share from bike shops. "I don't think the industry should subsidize mailorder in the name of protecting dealers," he said.

Economists judge resale price maintenance by how it affects consumers. So what do economists think about price maintenance? It depends.

Without it, specialty retailers would drop some products rather than compete with discounters. So the policies allow manufacturers to expand distribution to include discounters and traditional retailers, resulting in increased sales volume.

With volume, the supplier manufactures more efficiently and gets lower material costs, translating into lower retail prices in the long run. In this case setting a minimum price eventually benefits consumers. Litespeed, which sells its frames through Colorado Cyclist at full retail, has probably benefited from this process.

What Is Free Riding? Minimum prices also can prevent something economists call "free riding." Free riding occurs when discounters benefit from services provided by full-price retailers. The classic example is when a consumer picks a salesman's brain or tries on shoes, then buys from a mail order discounter. The discounter is free riding on the sales efforts of the specialty retailer.

"Signaling" is a variation on free riding. It occurs when consumers judge quality by the reputation of a retailer. For example, when a specialty store stocks a bike brand, it signals to consumers that it is a quality brand.

If consumers buy bikes from a discounter, based on presumed quality, the discounter is free riding off the specialty store's reputation, which was built at some expense. In the long term, free riding is anti-competitive because specialty retailers will drop products rather than compete with discounters. Consumers are unable to get services specialty retailers provided. Less distribution and decreased customer satisfaction can even cause a manufacturer to leave the market.

But while widening distribution and reducing free riding are pro-consumer aspects, economists point to some cases where it hurts consumers.

The first is where a reliance on the policies, due to risk aversion or pressure from traditional retailers, prevents a product from gaining mass distribution. If the product has mass market potential, discounting could allow an increase in sales volume and eventually lower consumer prices.

If razor manufacturers had relied on pricing policies, for example, traditional drug stores owners might have been happy. But today razors might be less widely available and more expensive.

Price maintenance also can prevent retailers and manufacturers from acting opportunistically, said Francis Bollag, Performance Cycle Products?s president.

"Maybe a dealer says he wants to build up his road business. He's going to sell a bunch of Mavic wheels below cost and get every roadie in the area into his shop. As an independent businessman, he should be allowed to do that," Bollag said.

Economists have difficulty assessing the impact of opportunities like Bollag's example, because they often benefit one part of the distribution channel at the expense of another. The development of a road clientele might benefit the retailer, but harm Mavic and other retailers.

Price maintenance also can take away the incentive for a discounter to buy a manufacturer's closeouts. In this case, price maintenance benefits the traditional retailer but harms the manufacturer.

Is Price Maintenance Legal? Most price policies in the industry are carefully created to comply with the Colgate Doctrine, a legal loophole the U.S. Supreme Court created in ruling on a 1919 case, United States vs. Colgate. The ruling clarified the 1890 Sherman Antitrust Act, which forbids trusts, conspiracies and contracts in restraint of free trade.

"Since Colgate, it?s absolutely legal for a company to announce that they will not do business with discounters, and leave it at that. They can?t negotiate, they can?t sign a contract to that effect, they can simply announce a policy and adhere to it," said Pauline Ippolito, of the Federal Trade Commission's Bureau of Economics.

To remain legal, manufacturers must apply the policy to all their customers, and enforce it immediately and without exception.

"The difficulty is in drawing a line," Ippolito said. "It's very unnatural for most businessmen to just announce a policy and not discuss it, not negotiate, not make exceptions for their better dealers and so on. It's a real control problem," she said.

To avoid the appearance of a conspiracy, manufacturers are unable to accept or act on complaints from one retailer about another store's prices. Policies are often included with dealer agreements and many retailers have them in their files without knowing it.

During the Reagan and Bush administrations, the FTC prosecuted few vertical pricing cases, but the commission has been more aggressive during the Clinton era. Some manufacturers learned the hard way that resale price maintenance under the Colgate Doctrine can be tricky.

For example, in the early 1990s Reebok's policy gave discounters a warning before they were cut off. This, among other aspects of the policy, raised the eyebrows of FTC officials.

A warning could lead to discussion over what the retailer has to do to avoid getting cut off. That would be an unlawful negotiation, in the commission?s view. Without admitting guilt, Reebok settled with the FTC and several state attorneys general for $9.5 million, plus trade practice restrictions.

The Colgate plan only applies to a manufacturer's customer, so manufacturers using distributors are unable to impose a policy on retail prices. Manufacturers often sell directly to potential discounters.

Manufacturers using distributors can impact retail discounters indirectly with a wholesale price policy. This can eliminate "five percenters"?wholesalers who sell to mail-order companies with minimal markup. Park Tool announced a wholesale price maintenance policy in 1996.

The Supreme Court ruled in November that maximum retail price maintenance is not automatically illegal. Lower courts can now analyze maximum price setting cases by judging the case's affect on the economy. Minimum price maintenance remains automatically illegal except when covered by the Colgate Doctrine.

Starting in 1937, resale price maintenance was legal in some states under fair trade laws. Schwinn bicycles were fair trade items in some states. Congress ended the fair trade era in 1975.