Vertical Restrictions

The term "vertical restrictions" refers to a range of business practices that are designed to accomplish largely the same objectives as vertical integration--albeit by contractual means. These business practices include:

	Resale price maintenance (RPM)
	Territorial restrictions
	Exclusive dealing
	Tying

Suppose that a manufacturer (such as Poulan Chainsaws or Bose Stereo Equipment) stipulates that a retailer charge a minimum resale price as a condition for carrying the manufacturer's line. This practice is called resale price maintenance (RPM)

RPM is designed to limit intrabrand price competition, but has no obvious implication for interbrand competition. But why would a manufacturer desire to limit intrabrand price competition [e.g., Minolta wants to make sure that a buyer cannot get a huge discount by purchasing a camera at Service Merchandise instead of buying the same camera at a specialty store at Oak Court Mall]?

	Manufacturers (especially of big-ticket , often complex items such as large screen TVs, cameras, lawn mowers, upscale cooking equipment) sometimes depend on retailers to provide professional salesmanship on behalf of their product. By supplying effective display, information about product quality and features, and support after the sale, the retailer takes on a critically important role in differentiating the manufacturer's product from that of rivals. Expressed graphically, the sales effort shifts the demand for the manufacturer's product to the right.
	But professional salesmanship is costly. What if the customers get the benefits of professional salesmanship at the specialty store, then buys the camera at Service Merchandise? This retail free-riding problem creates a disincentive to allocate resources for salesmanship.
	RPM guards against retail free riding because it "creates property rights in the information services provided by the dealers who carry their products" [David Boyd, "From 'Mom and Pop' to Wal-Mart: The Impact of the Consumer Goods Pricing Act of 1975 on the Retail Sector in the U.S." Journal of Economic Issues, March 1997:223-231].
	RPM insures a minimum margin on goods sold and, hence, provides an incentive to salesmanship. See graph

Issue: Does RPM violate the antitrust statutes?

The key early test was Dr. Miles Medical Co. v. John D. Park & Sons 220 U.S. 373 (1911).

	Park and Sons, a drug wholesaling unit, refused to abide the minimum resale price provisions stipulated in contracts signed by marketers of Dr. Miles proprietary drugs. The key issue: did the contracts specifying minimum resale prices fall within the scope of section 1 of the Sherman Act?
	Justice Hughes concluded the majority opinion as follows:"[A]greements or combinations between dealers, having for their sole purpose the destruction of competition and the fixing of prices, are injurious to the public interest and void." The court ruled that RPM , when accomplished by contractual means, is illegal per se.
	The dissent of Oliver Wendell Holmes was noteworthy. An excerpt: "There is no statute covering the case; there is no body of precedent that by ineluctable logic requires the conclusion to which the court has come. The conclusion is reached by extending a certain conception of public policy to a new sphere."

The Supreme Court weighed in again in U.S. v. Colgate & Co. 250 U.S. 300 (1919)

	Colgate enforced minimum resale prices on its soaps and other toiletries by refusing to deal with wholesale and retail units that failed to "tow the line."
	In contrast to the Dr. Miles case, there were no formal contractual agreements between Colgate and its vendors--this turned out to be a key factor in the decision.
	Justice McReynolds: "In the absence of any purpose to create or maintain a monopoly, the act does not restrict the long recognized right of trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to the parties with whom he will deal. And, of course, he may announce in advance the circumstances under which he will refuse to sell. In Dr. Miles the unlawful combination was effected through contracts which undertook to prevent dealers from freely exercising the right to sell."

During the Depression ,many states (including Arkansas) enacted "fair trade" laws to protect small business from retail free riding. These state laws were protected by Miller-Tydings Act of 1937. However, an intense lobbying effort by the giant, mass merchandisers culminated in the Consumer Goods Pricing Act of 1975, which made RPM illegal once again and set the stage for the ascendance of Wal-Mart, Target, and the other retail superstores.

Boyd writes that "Preventing manufacturers from using [RPM] enabled 'no-frills,' discount, corporate retail mega-stores to free ride off the services offered by higher-service, generally smaller, local retail proprietorships. . . .[I]t was this retail free riding problem that, in large measure, led to the demise of the local mom and pop' dealer" [Boyd 1997, p. 224].

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