Retailer Initiated Vertical Restraints: Toys R US

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Retailer Initiated Vertical Restraints Toys R
US

• Case Author F.M. Scherer
• Presented by Janel Bass
• Yash Shah
• Chad
  Sykes

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Players

• Toy Manufacturers
• Ex Mattel, Nintendo, Sega
• Toys R US (TRU)
• Warehouse Clubs
• Ex Costco, Sams Club, BJs
• Federal Trade Commission

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Things to Consider

• Role of econometric vs. investigatory evidence
• Interaction between vertical restraint and
  horizontal collusion Management of agreement
• Bertrand competition model with regard to prices
  and supply of information
• Structure of Trial Fair process,
  Deterrence/Punishment concerns

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Evolution in Retailing (1/2)

• General or Mom and Pop Stores
• Department stores and mail-order houses
• Ex Sears, Roebuck
• Mass consumption stores
• Chain Stores (Walgreens)
• Supermarkets
• Hypermarket Chains (Walmart, Kmart)
• Category Killer Chains (Home Depot, Staples)
• 1. Reductions in percentage retail margin (PRM)
• 2. Price as strategic variable for consumer

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Evolution in Retailing (2/2)

• Rise of TRU as category killer discount chain
• Broad line of toys 16,000 items by 1990s
• Realized PRM below traditional 40-50 range
• 1992 497 US stores, 126 abroad

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Warehouse Clubs

• Ex Costco, Sams Club, BJs ,etc.
• Late 1980s opened to individual customers
• By 1992, 576 clubs in US
• Shopping experience
• PRM
• 9-12

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Pricing in Toy Market

• Price competition on hit items
• Low PRM for TRU as sales strategy
• Clubs stock 100 to 250 items at low PRM as well
• Threat to TRU inverse pricing
• TRU response downward price adjustments, maximum
  estimate of 55 million per year

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New York Toy Fair, February 1992

• TRU policy towards manufacturer sales to
  warehouse clubs
• Penalty for violations
• Effect on Market Share
• 1.9 of Toy Sales in 1992, 1.4 by 1995
• By 1993, TRU did not set PRM for hit items in
  response to club competition

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Antitrust

• Clubs threatened legal action, informed FTC, FTC
  formal complaint in May 1996
• Protecting competition vs. processes of
  competition
• Political dimension of FTC activism
• Trial in front of FTC Administrative Law Judge,
  September 1997
• Appeal in front of FTC Commission members
• Set precedent on Retailer Instigated Restraints

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Violations Vertical Restraint

• Definition
• Unilateral vs. Bilateral Agreements
• Type of Evidence
• Violation of Sherman Act, Section 1
• Act that prohibits agreements, conspiracies,
• or trusts in restraint of trade

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Violations Horizontal Collusion

• Need for cooperation between manufacturers
• Product differentiation
• TRU as a hub and spoke
• Ensured level playing field
• Hub and spoke implies unilateral vertical
  restraint
• Limitations of both vertical and horizontal
  agreements

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Market Power (1/2)

• Inference of illegality
• Methods
• Definitions
• Intermediate concentration amongst manufacturers
• Four suppliers produced 34-45 of toy market
• Further concentration in relevant market of
  nationally advertised toys
• TRU accounted for 20 of US toy sales
• 32 in local market

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Market Power (2/2)

• TRU economists, regression between PRM and
  significant rivals in local markets
• PRM uniform with or without competition
• FTC response hot items vs. entire inventory
• TRU economists, ability to raise prices limited
• FTC response Policy intended to avoid reductions
  in prices

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Free Riding (1/2)

• Lemons Problem in presale services
• Bertrand equilibrium in supply of effort
• Vertical integration as solution
• TRU presale services and early stocking decisions
• Rebuttal
• No actual product demonstration
• Price of toys did not warrant consumer
  free-riding
• Costs were compensated by manufacturers
  retroactive wholesale discounts, advertising
  allowances (90)
• Free-riding, even if it occurred, would not
  eliminate services.

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Free Riding (2/2) Regressions

• TRU economist, retailers experienced sales
  increases as a result of TRU advertising
• FTC response unobserved heterogeneity, selection
  issues in April 2, 1995 catalogue as sample
• Re-estimation showed negative impact
• FTC no evidence of free-riding defense during
  Toy Fair deliberations

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Trial Outcome

• Found violation in vertical restraints and
  horizontal collusion, rejected free-riding
  defense
• Prospects for fair trial
• 7th Circuit Court of Appeals, Chicago. Judges
  were faculty of University of Chicago Law School.
• Finding

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Post Trial

• Additional class action antitrust suits
• Settlement
• Declining market share to warehouse clubs and
  hypermarkets
• Acquisitions over concerns for viability

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The End