Toys "R" US, Inc. v. Federal Trade Commission ( 2000 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 98-4107
Toys "R" Us, Inc.,
Petitioner-Appellant,
v.
Federal Trade Commission,
Respondent-Appellee.
On Petition for Review from a
Decision of the Federal Trade Commission.
Docket No. 9278.
Argued May 18, 1999--Decided August 1, 2000
Before Coffey, Kanne, and Diane P. Wood,
Circuit Judges.
Diane P. Wood, Circuit Judge. The
antitrust laws, which aim to preserve and
protect competition in economically
sensible markets, have long drawn a sharp
distinction between contractual
restrictions that occur up and down a
distribution chain--so-called vertical
restraints--and restrictions that come
about as a result of agreements among
competitors, or horizontal restraints.
Sometimes, however, it can be hard as a
matter of fact to be sure what kind of
agreement is at issue. This was the
problem facing the Federal Trade
Commission ("the Commission") when it
brought under its antitrust microscope
the large toy retailer Toys "R" Us (more
properly Toys "R" Us, but to avoid debate
we will abbreviate the company’s name as
TRU, in keeping with the parties’ usage).
The Commission concluded, upon an
extensive administrative record, that TRU
had acted as the coordinator of a
horizontal agreement among a number of
toy manufacturers. The agreements took
the form of a network of vertical
agreements between TRU and the individual
manufacturers, in each of which the
manufacturer promised to restrict the
distribution of its products to low-
priced warehouse club stores, on the
condition that other manufacturers would
do the same. This practice, the
Commission found, violated sec. 5 of the
Federal Trade Commission Act, 15 U.S.C.
sec. 45. It also found that TRU had
entered into a series of vertical
agreements that flunked scrutiny under
antitrust’s rule of reason. TRU appealed
that decision to us. It attacks both the
sufficiency of the evidence supporting
the Commission’s conclusions and the
scope of the Commission’s remedial order.
It is hard to prevail on either type of
challenge: the former is fact-intensive
and faces the hurdle of the substantial
evidence standard of review, while the
latter calls into question the
Commission’s exercise of its discretion
to remedy an established violation of the
law. We conclude that, while reasonable
people could differ on the facts in this
voluminous record, the Commission’s
decisions pass muster, and we therefore
affirm.
I
TRU is a giant in the toy retailing
industry. The Commission found that it
sells approximately 20% of all the toys
sold in the United States, and that in
some metropolitan areas its share of toy
sales ranges between 35% and 49%. The
variety of toys it sells is staggering:
over the course of a year, it offers
about 11,000 individual toy items, far
more than any of its competitors. As one
might suspect from these figures alone,
TRU is a critical outlet for toy manufac
turers. It buys about 30% of the large,
traditional toy companies’ total output
and it is usually their most important
customer. According to evidence before
the Commission’s administrative law
judge, or ALJ, even a company as large as
Hasbro felt that it could not find other
retailers to replace TRU--and Hasbro,
along with Mattel, is one of the two
largest toy manufacturers in the country,
accounting for approximately 12% of the
market for traditional toys and 10% of a
market that includes video games. Similar
opinions were offered by Mattel and
smaller manufacturers.
Toys are sold in a number of different
kinds of stores. At the high end are
traditional toy stores and department
stores, both of which typically sell toys
for 40 to 50% above their cost. Next are
the specialized discount stores--a
category virtually monopolized by TRU
today--that sell at an average 30% mark-
up. General discounters like Wal-Mart, K-
Mart, and Target are next, with a 22%
mark-up, and last are the stores that are
the focus of this case, the warehouse
clubs like Costco and Pace. The clubs
sell toys at a slender mark-up of 9% or
so.
The toys customers seek in all these
stores are highly differentiated
products. The little girl who wants
Malibu Barbie is not likely to be
satisfied with My First Barbie, and she
certainly does not want Ken or Skipper.
The boy who has his heart set on a figure
of Anakin Skywalker will be disappointed
if he receives Jar-Jar Binks, or a truck,
or a baseball bat instead. Toy retailers
naturally want to have available for
their customers the season’s hottest
items, because toys are also a very
faddish product, as those old enough to
recall the mania over Cabbage Patch kids
or Tickle Me Elmo dolls will attest.
What happened in this case, according to
the Commission, was fairly simple. For a
long time, TRU had enjoyed a strong
position at the low price end for toy
sales, because its only competition came
from traditional toy stores who could not
or did not wish to meet its prices, or
from general discounters like Wal-Mart or
K-Mart, which could not offer anything
like the variety of items TRU had and
whose prices were not too far off TRU’s
mark.
The advent of the warehouse clubs
changed all that. They were a retail
innovation of the late 1970s: the first
one opened in 1976, and by 1992 there
were some 600 individual club stores
around the country. Rather than earning
all of their money from their mark-up on
products, the clubs sell only to their
members, and they charge a modest annual
membership fee, often about $30. As the
word "warehouse" in the name suggests,
the clubs emphasize price competition
over service amenities. Nevertheless, the
Commission found that the clubs seek to
offer name-brand merchandise, including
toys. During the late 1980s and early
1990s, warehouse clubs selected and
purchased from the toy manufacturers’
full array of products, just like
everyone else. In some instances they
bought specialized packs assembled for
the "club" trade, but they normally
preferred stocking conventional products
so that their customers could readily
compare the price of an item at the club
against the price of the same item at a
competing store.
To the extent this strategy was
successful, however, TRU did not welcome
it. By 1989, its senior executives were
concerned that the clubs were a threat to
TRU’s low-price image and, more
importantly, to its profits. A little
legwork revealed that as of that year the
clubs carried approximately 120-240 items
in direct competition with TRU, priced as
much as 25 to 30% below TRU’s own price
levels.
TRU put its President of Merchandising,
a Mr. Goddu, to work to see what could be
done. The response Goddu and other TRU
executives formulated to beat back the
challenge from the clubs began with TRU’s
decision to contact some of its
suppliers, including toy manufacturing
heavyweights Mattel, Hasbro, and Fisher
Price. At the Toy Fair in 1992 (a major
event at which the next Christmas
season’s orders are placed), Goddu
informed the manufacturers of a new TRU
policy, which was reflected in a memo of
January 29, 1992. The policy set forth
the following conditions and privileges
for TRU:
The clubs could have no new or
promoted product unless they carried
the entire line.
All specials and exclusives to be sold
to the clubs had to be shown first to
TRU to see if TRU wanted the item.
Old and basic product had to be in
special packs.
Clearance and closeout items were
permissible provided that TRU was
given the first opportunity to buy the
product.
There would be no discussion about
prices.
TRU was careful to meet individually with
each of its suppliers to explain its new
policy. Afterwards, it then asked each
one what it intended to do. Negotiations
between TRU and the manufacturers
followed, as a result of which each
manufacturer eventually agreed that it
would sell to the clubs only highly-
differentiated products (either
uniqueindividual items or combo packs)
that were not offered to anything but a
club (and thus of course not to TRU). As
the Commission put it, "[t]hrough its
announced policy and the related
agreements discussed below, TRU sought to
eliminate the competitive threat the
clubs posed by denying them merchandise,
forcing the clubs’ customers to buy prod
ucts they did not want, and frustrating
customers’ ability to make direct price
comparisons of club prices and TRU
prices." FTC opinion at 14.
The agreements between TRU and the
various manufacturers were, of course,
vertical agreements, because they ran
individually from the
supplier/manufacturer to the
purchaser/retailer. The Commission found
that TRU reached about 10 of these
agreements. After the agreements were
concluded, TRU then supervised and
enforced each toy company’s compliance
with its commitment.
But TRU was not content to stop with
vertical agreements. Instead, the
Commission found, it decided to go
further. It worked for over a year and a
half to put the vertical agreements in
place, but "the biggest hindrance TRU had
to overcome was the major toy companies’
reluctance to give up a new, fast-
growing, and profitable channel of
distribution." FTC opinion at 28. The
manufacturers were also concerned that
any of their rivals who broke ranks and
sold to the clubs might gain sales at
their expense, given the widespread and
increasing popularity of the club format.
To address this problem, the Commission
found, TRU orchestrated a horizontal
agreement among its key suppliers to
boycott the clubs. The evidence on which
the Commission relied showed that, at a
minimum, Mattel, Hasbro, Fisher Price,
Tyco, Little Tikes, Today’s Kids, and
Tiger Electronics agreed to join in the
boycott "on the condition that their
competitors would do the same." FTC
opinion at 28 (emphasis added).
The Commission first noted that internal
documents from the manufacturers revealed
that they were trying to expand, not to
restrict, the number of their major
retail outlets and to reduce their
dependence on TRU. They were specifically
interested in cultivating a relationship
with the warehouse clubs and increasing
sales there. Thus, the sudden adoption of
measures under which they decreased sales
to the clubs ran against their
independent economic self-interest.
Second, the Commission cited evidence
that the manufacturers were unwilling to
limit sales to the clubs without
assurances that their competitors would
do likewise. FTC opinion at 29. Goddu
himself testified that TRU communicated
the message "I’ll stop if they stop" from
manufacturer to competing manufacturer.
FTC opinion at 30. He specifically
mentioned having such conversations with
Mattel and Hasbro, and he said more
generally "We communicated to our vendors
that we were communicating with all our
key suppliers, and we did that I believe
at Toy Fair 1992. We made a point to tell
each of the vendors that we spoke to that
we would be talking to our other key
suppliers." Id. at 31.
Evidence from the manufacturers
corroborated Goddu’s account. A Mattel
executive said that it would not sell the
clubs the same items it was selling to
TRU, and that this decision was "based on
the fact that competition would do the
same." Id. at 32. A Hasbro executive said
much the same thing: "because our
competitors had agreed not to sell loaded
[that is, promoted] product to the clubs,
that we would . . . go along with this."
Id. TRU went so far as to assure
individual manufacturers that no one
would be singled out.
Once the special warehouse club policy
(or, in the Commission’s more pejorative
language, boycott) was underway, TRU
served as the central clearinghouse for
complaints about breaches in the
agreement. The Commission gave numerous
examples of this conduct in its opinion.
See id. at 33-37.
Last, the Commission found that TRU’s
policies had bite. In the year before the
boycott began, the clubs’ share of all
toy sales in the United States grew from
1.5% in 1991 to 1.9% in 1992. After the
boycott took hold, that percentage
slipped back by 1995 to 1.4%. Local
numbers were more impressive. Costco, for
example, experienced overall growth on
sales of all products during the period
1991 to 1993 of 25%. Its toy sales
increased during same period by 51%. But,
after the boycott took hold in 1993, its
toy sales decreased by 1.6% even while
its overall sales were still growing by
19.5%. The evidence indicated that this
was because TRU had succeeded in cutting
off its access to the popular toys it
needed. In 1989, over 90% of the Mattel
toys Costco and other clubs purchased
were regular (i.e. easily comparable)
items, but by 1993 that percentage was
zero. Once again, the Commission’s
opinion is chock full of similar
statistics.
The Commission also considered the
question whether TRU might have been
trying to protect itself against free
riding, at least with respect to its
vertical agreements. It acknowledged that
TRU provided several services that might
be important to consumers, including
"advertising, carrying an inventory of
goods early in the year, and supporting a
full line of products." FTC opinion at
41-42. Nevertheless, it found that the
manufacturers compensated TRU directly
for advertising toys, storing toys made
early in the year, and stocking a broad
line of each manufacturer’s toys under
one roof. A 1993 TRU memorandum confirms
that advertising is manufacturer-funded
and is "essentially free." FTC opinion at
42. In 1994, TRU’s net cost of
advertising was a tiny 0.02% of sales, or
$750,000, out of a total of $199 million
it spent on advertising that year. As the
Commission saw it, "[a]dvertising . . .
was a service the toy manufacturers
provided for TRU and not the other way
around." Id. (emphasis in original). TRU
records also showed that manufacturers
routinely paid TRU credits for
warehousing services, and that they
compensated it for full line stocking. In
short, the Commission found, there was no
evidence that club competition without
comparable services threatened to drive
TRU services out of the market or to harm
customers. Manufacturers paid each
retailer directly for the services they
wanted the retailer to furnish.
Based on this record, the Commission
drew three central conclusions of law:
(1) the TRU-led manufacturer boycott of
the warehouse clubs was illegal per se
under the rule enunciated in Northwest
Wholesale Stationers, Inc. v. Pacific
Stationery & Printing Co., 472 U.S. 284
(1985); (2) the boycott was illegal under
a full rule of reason analysis because
its anticompetitive effects "clearly
outweigh[ed] any possible business
justification"; and (3) the vertical
agreements between TRU and the individual
toy manufacturers, "entered into seriatim
with clear anticompetitive effect,
violate section 1 of the Sherman Act."
FTC opinion at 46. These antitrust
violations in turn were enough to prove a
violation of FTC Act sec. 5, which for
present purposes tracks the prohibitions
of the Sherman and Clayton Acts. After
offering a detailed explanation of these
conclusions (spanning 42 pages in its
slip opinion), it turned to the question
of remedy and affirmed the order the ALJ
had entered.
In the Commission’s words, its order:
. . . prohibits TRU from continuing,
entering into, or attempting to enter
into, vertical agreements with its
suppliers to limit the supply of, or
refuse to sell, toys to a toy discounter.
See para. II.A. The order also prohibits
TRU from facilitating, or attempting to
facilitate, an agreement between or among
its suppliers relating to the sale of
toys to any retailer. See para. II.D.
Additionally, TRU is enjoined from
requesting information from suppliers
about their sales to any toy discounter,
and from urging or coercing suppliers to
restrict sales to any toy discounter. See
para.para. II.B, C. These four elements
of relief are narrowly tailored to stop,
and prevent the repetition of, TRU’s
illegal conduct.
FTC opinion at 88. TRU complained that
the order trampled on its ability to
exercise its rights under United States
v. Colgate & Co., 250 U.S. 300 (1919), to
choose unilaterally the companies with
which it wanted to deal. The Commission
rejected the point, because it found that
TRU had repeatedly crossed the line from
unilateral to concerted behavior in
illegal ways, and that it was entitled to
include remedial provisions that were
necessary to prevent recurrence of the
illegal behavior, citing FTC v. National
Lead Co., 352 U.S. 419, 430 (1957).
Commissioner Swindle concurred in part
and dissented in part. He agreed with the
majority’s determination that TRU had
engaged in a series of anticompetitive
vertical agreements, and he thus agreed
with the remedial provisions designed to
proscribe those practices and their
effects. He was unconvinced, however,
that TRU had orchestrated a horizontal
combination as well, believing that the
evidence was too thin to support that
conclusion. TRU appealed from the
Commission’s final order of October 13,
1998, to this court, under 15 U.S.C. sec.
45(c), as it carries on business in this
circuit (as well as every other circuit,
to the best of our knowledge).
II
On appeal, TRU makes four principal
arguments: (1) the Commission’s finding
of a horizontal conspiracy is contrary to
the facts and impermissibly confuses the
law of vertical restraints with the law
of horizontal restraints; (2) whether the
restrictions were vertical or horizontal,
they were not unlawful because TRU has no
market power, and thus the conduct can
have no significant anticompetitive
effect; (3) the TRU policy was a
legitimate response to free riding; and
(4) the relief ordered by the Commission
goes too far. We review the Commission’s
legal conclusions de novo, but we must
accept its findings of fact if they are
supported by such relevant evidence as a
reasonable mind might accept as adequate
to support a conclusion. FTC v. Indiana
Fed’n of Dentists, 476 U.S. 447, 454
(1986).
A. Horizontal Conspiracy
As TRU correctly points out, the
critical question here is whether
substantial evidence supported the
Commission’s finding that there was a
horizontal agreement among the toy
manufacturers, with TRU in the center as
the ringmaster, to boycott the warehouse
clubs. It acknowledges that such an
agreement may be proved by either direct
or circumstantial evidence, under cases
such as Matsushita Electric Indus. Co. v.
Zenith Radio Corp., 475 U.S. 574 (1986)
(horizontal agreements), Monsanto Co. v.
Spray-Rite Service Corp., 465 U.S. 752
(1984) (vertical agreements), and
Interstate Circuit, Inc. v. United
States, 306 U.S. 208 (1939). When
circumstantial evidence is used, there
must be some evidence that "tends to
exclude the possibility" that the alleged
conspirators acted independently.
Monsanto, 465 U.S. at 764, quoted in
Matsushita, 475 U.S. at 588. This does
not mean, however, that the Commission
had to exclude all possibility that the
manufacturers acted independently. As we
pointed out in In re Brand Name
Prescription Drugs Antitrust Litigation,
186 F.3d 781 (7th Cir. 1999), that would
amount to an absurd and legally unfounded
burden to prove with 100% certainty that
an antitrust violation occurred. Id. at
787. The test states only that there must
be some evidence which, if believed,
would support a finding of concerted
behavior. In the context of an appeal
from the Commission, the question is
whether substantial evidence supports its
conclusion that it is more likely than
not that the manufacturers acted
collusively.
In TRU’s opinion, this record shows
nothing more than a series of separate,
similar vertical agreements between
itself and various toy manufacturers. It
believes that each manufacturer in its
independent self-interest had an
incentive to limit sales to the clubs,
because TRU’s policy provided strong
unilateral incentives for the
manufacturer to reduce its sales to the
clubs. Why gain a few sales at the clubs,
it asks, when it would have much more to
gain by maintaining a good relationship
with the 100-pound gorilla of the
industry, TRU, and make far more sales?
We do not disagree that there was some
evidence in the record that would bear
TRU’s interpretation. But that is not the
standard we apply when we review
decisions of the Federal Trade
Commission. Instead, we apply the
substantial evidence test, which we
described as follows in another case in
which the Commission’s decision to stop a
hospital merger was at issue:
Our only function is to determine whether
the Commission’s analysis of the probable
effects of these acquisitions on hospital
competition in Chattanooga is so
implausible, so feebly supported by the
record, that it flunks even the
deferential test of substantial evidence.
Hospital Corp. of America v. F.T.C., 807
F.2d 1381, 1385 (7th Cir. 1986). There,
as here, the Commission painstakingly
explained in a long opinion exactly what
evidence in the record supported its
conclusion. We need only decide whether
the inference the Commission drew of
horizontal agreement was a permissible
one from that evidence, not if it was the
only possible one.
The Commission’s theory, stripped to its
essentials, is that this case is a modern
equivalent of the old Interstate Circuit
decision. That case too involved actors
at two levels of the distribution chain,
distributors of motion pictures and
exhibitors. Interstate Circuit was one of
the exhibitors; it had a stranglehold on
the exhibition of movies in a number of
Texas cities. The antitrust violation
occurred when Interstate’s manager,
O’Donnell, sent an identical letter to
the eight branch managers of the
distributor companies, with each letter
naming all eight as addressees, in which
he asked them to comply with two demands:
a minimum price for first-run theaters,
and a policy against double features at
night. The trial court there drew an
inference of agreement from the nature of
the proposals, from the manner in which
they were made, from the substantial
unanimity of action taken, and from the
lack of evidence of a benign motive; the
Supreme Court affirmed. The new policies
represented a radical shift from the
industry’s prior business practices, and
the Court rejected as beyond the range of
probability that such unanimity of action
was explainable only by chance.
The Commission is right. Indeed, as it
argues in its brief, the TRU case if
anything presents a more compelling case
for inferring horizontal agreement than
did Interstate Circuit, because not only
was the manufacturers’ decision to stop
dealing with the warehouse clubs an
abrupt shift from the past, and not only
is it suspicious for a manufacturer to
deprive itself of a profitable sales
outlet, but the record here included the
direct evidence of communications that
was missing in Interstate Circuit. Just
as in Interstate Circuit, TRU tries to
avoid this result by hypothesizing
independent motives. 306 U.S. at 223-24.
If there were no evidence in the record
tending to support concerted behavior,
then we agree that Matsushita would
require a ruling in TRU’s favor. But
there is. The evidence showed that the
companies wanted to diversify from TRU,
not to become more dependent upon it; it
showed that each manufacturer was afraid
to curb its sales to the warehouse clubs
alone, because it was afraid its rivals
would cheat and gain a special advantage
in that popular new market niche. The
Commission was not required to disbelieve
the testimony of the different toy
company executives and TRU itself to the
effect that the only condition on which
each toy manufacturer would agree to
TRU’s demands was if it could be sure its
competitors were doing the same thing.
That is a horizontal agreement. As we
explain further below in discussing TRU’s
free rider argument, it has nothing to do
with enhancing efficiencies of
distribution from the manufacturer’s
point of view. The typical story of a
legitimate vertical transaction would
have the manufacturer going to TRU and
asking it to be the exclusive carrier of
the manufacturer’s goods; in exchange for
that exclusivity, the manufacturer would
hope to receive more effective promotion
of its goods, and TRU would have a large
enough profit margin to do the job well.
But not all manufacturers think that
exclusive dealing arrangements will
maximize their profits. Some think, and
are entitled to think, that using the
greatest number of retailers possible is
a better strategy. These manufacturers
were in effect being asked by TRU to
reduce their output (especially of the
popular toys), and as is classically true
in such cartels, they were willing to do
so only if TRU could protect them against
cheaters.
Northwest Stationers also demonstrates
why the facts the Commission found
support its conclusion that the essence
of the agreement network TRU supervised
was horizontal. There the Court described
the cases that had condemned boycotts as
"per se" illegal as those involving
"joint efforts by a firm or firms to
disadvantage competitors by either
directly denying or persuading or
coercing suppliers or customers to deny
relationships the competitors need in the
competitive struggle." 472 U.S. at 294
(internal citations omitted). The
boycotters had to have some market power,
though the Court did not suggest that the
level had to be as high as it would
require in a case under Sherman Act sec.
2. Here, TRU was trying to disadvantage
the warehouse clubs, its competitors, by
coercing suppliers to deny the clubs the
products they needed. It accomplished
this goal by inducing the suppliers to
collude, rather than to compete independ
ently for shelf space in the different
toy retail stores. See also NYNEX Corp.
v. Discon, Inc., 525 U.S. 128 (1998);
Klor’s, Inc. v. Broadway-Hale Stores,
Inc., 359 U.S. 207 (1959).
B. Degree of TRU’s Market Power
TRU’s efforts to deflate the
Commission’s finding of market power are
pertinent only if we had agreed with its
argument that the Commission’s finding of
a horizontal agreement was without
support. Horizontal agreements among
competitors, including group boycotts,
remain illegal per se in the sense the
Court used the term in Northwest
Stationers. We have found that this case
satisfies the criteria the Court used in
Northwest Stationers for condemnation
without an extensive inquiry into market
power and economic pros and cons: (1) the
boycotting firm has cut off access to a
supply, facility or market necessary for
the boycotted firm (i.e. the clubs) to
compete; (2) the boycotting firm
possesses a "dominant" position in the
market (where "dominant" is an undefined
term, but plainly chosen to stand for
something different from antitrust’s term
of art "monopoly"); and (3) the boycott,
as we explain further below, cannot be
justified by plausible arguments that it
was designed to enhance overall
efficiency. 472 U.S. at 294. We address
the market power point here, therefore,
only in the alternative.
TRU seems to think that anticompetitive
effects in a market cannot be shown
unless the plaintiff, or here the
Commission, first proves that it has a
large market share. This, however, has
things backwards. As we have explained
elsewhere, the share a firm has in a
properly defined relevant market is only
a way of estimating market power, which
is the ultimate consideration. Ball
Memorial Hospital, Inc. v. Mutual
Hospital Insurance, 784 F.2d 1325, 1336
(7th Cir. 1986). The Supreme Court has
made it clear that there are two ways of
proving market power. One is through
direct evidence of anticompetitive
effects. See FTC v. Indiana Fed’n of
Dentists, 476 U.S. 447, 460-61 (1986)
("the finding of actual, sustained
adverse effects on competition in those
areas where IFD dentists predominated,
viewed in light of the reality that
markets for dental services tend to be
relatively localized, is legally
sufficient to support a finding that the
challenged restraint was unreasonable
even in the absence of elaborate market
analysis."). The other, more conventional
way, is by proving relevant product and
geographic markets and by showing that
the defendant’s share exceeds whatever
threshold is important for the practice
in the case. See, e.g., United States v.
E.I. duPont de Nemours & Co., 351 U.S.
377 (1956); United States v. Grinnell
Corp., 384 U.S. 563 (1966); United States
v. Aluminum Co. of America, 148 F.2d 416
(2d Cir. 1945) (suggesting that more than
90% is enough to constitute a monopoly
for purposes of Sherman Act sec. 2 and
33% is not); Jefferson Parish Hospital
Dist. No. 2 v. Hyde, 466 U.S. 2 (1984)
(indicating that something more than 30%
would be needed to show the kind of power
over a tying product necessary for a
violation of Sherman Act sec. 1).
The Commission found here that, however
TRU’s market power as a toy retailer was
measured, it was clear that its boycott
was having an effect in the market. It
was remarkably successful in causing the
10 major toy manufacturers to reduce
output of toys to the warehouse clubs,
and that reduction in output protected
TRU from having to lower its prices to
meet the clubs’ price levels. Price
competition from conventional discounters
like Wal-Mart and K-Mart, in contrast,
imposed no such constraint on it, or so
the Commission found. In addition, the
Commission showed that the affected
manufacturers accounted for some 40% of
the traditional toy market, and that TRU
had 20% of the national wholesale market
and up to 49% of some local wholesale
markets. Taking steps to prevent a price
collapse through coordination of action
among competitors has been illegal at
least since United States v. Socony-
Vacuum Oil Co., 310 U.S. 150 (1940).
Proof that this is what TRU was doing is
sufficient proof of actual
anticompetitive effects that no more
elaborate market analysis was necessary.
C. Free Riding Explanation
TRU next urges that its policy was a
legitimate business response to combat
free riding by the warehouse clubs. We
think, however, that it has fundamentally
misunderstood the theory of free riding.
Briefly, that theory is as follows. The
manufacturer of a product, say widgets,
has an incentive to distribute as many
widgets as it can, while keeping its
costs of distribution down as low as
possible. In many instances, this means
that the manufacturer will want to sell
its widgets for a particular wholesale
price and it will want its retailer to
apply as low a mark-up as possible (i.e.
put the product on the market for as
little extra expense as possible).
Sometimes, however, the manufacturer will
want the retailer to provide special
services or amenities that cost money,
such as attractive premises, trained
salespeople, long business hours, full-
line stocking, or fast warranty service.
But the costs of providing some of those
amenities (usually pre-sale services) are
hard to pass on to customers unless some
form of restricted distribution is
available. What the manufacturer does not
want is for the shopper to visit the
attractive store with highly paid,
intelligent sales help, learn all about
the product, and then go home and order
it from a discount warehouse or (today)
on-line discounters. The shopper in that
situation has taken a "free ride" on the
retailer’s efforts; the retailer never
gets paid for them, and eventually it
stops offering the services. If those
services were genuinely useful, in the
sense that the product plus service
package resulted in greater sales for the
manufacturer than the product alone would
have enjoyed, there is a loss both for
the manufacturer and the consumer. Hence,
antitrust law permits nonprice vertical
restraints that are designed to
facilitate the provision of extra
services, recognizing that a manufacturer
in a competitive market who has guessed
wrong will eventually be forced by the
market to abandon the restrictions. See
Business Electronics Corp. v. Sharp
Electronics Corp., 485 U.S. 717, 724
(1988), quoting Continental T.V., Inc. v.
GTE Sylvania Inc., 433 U.S. 36, 52 n.19
(1977).
Here, the evidence shows that the free-
riding story is inverted. The
manufacturers wanted a business strategy
under which they distributed their toys
to as many different kinds of outlets as
would accept them: exclusive toy shops,
TRU, discount department stores, and
warehouse clubs. Rightly or wrongly, this
was the distribution strategy that each
one believed would maximize its
individual output and profits. The
manufacturers did not think that the
alleged "extra services" TRU might have
been providing were necessary. This is
crucial, because the most important
insight behind the free rider concept is
the fact that, with respect to the cost
of distribution services, the interests
of the manufacturer and the consumer are
aligned, and are basically adverse to the
interests of the retailer (who would
presumably like to charge as much as
possible for its part in the process).
See Premier Electrical Construction Co.
v. Nat’l Electrical Contractors Ass’n,
814 F.2d 358, 369-70 (7th Cir. 1987)
("[the rationale for permitting
restricted distribution policies] depends
on the alignment of interests between
consumers and manufacturers. Destroy that
alignment and you destroy the power of
the argument.").
What TRU wanted or did not want is
neither here nor there for purposes of
the free rider argument. Its economic
interest was in maximizing its own
profits, not in keeping down its
suppliers’ cost of doing business.
Furthermore, we note that the Commission
made a plausible argument for the
proposition that there was little or no
opportunity to "free" ride on anything
here in any event. The consumer is not
taking a free ride if the cost of the
service can be captured in the price of
the item. As our earlier review of the
facts demonstrated, the manufacturers
were paying for the services TRU
furnished, such as advertising, full-line
product stocking, and extensive
inventories. These expenses, we may
assume, were folded into the price of the
goods the manufacturers charged to TRU,
and thus these services were not
susceptible to free riding. On this
record, in short, TRU cannot prevail on
the basis that its practices were
designed to combat free riding.
D. Remedy
Last, we consider TRU’s challenge to the
remedial provisions the Commission
ordered. TRU’s basic point here is that
the Commission has commanded it to do
things that it would have been free to
refuse, and conversely to refrain from
actions it would have been free to take,
in the absence of its violation of FTC
Act sec. 5. So that its arguments can be
fully understood, we set forth Section II
of the decree in its entirety here:
IT IS ORDERED that respondent, directly
or indirectly, through any corporation,
subsidiary, division or other device, in
connection with the actual or potential
purchase or distribution of toys and
related products, in or affecting
commerce, as "commerce" is defined in the
Federal Trade Commission Act, forthwith
cease and desist from:
A. Continuing, maintaining, entering
into, and attempting to enter into any
agreement or understanding with any
supplier to limit supply or to refuse to
sell toys and related products to any toy
discounter.
B. Urging, inducing, coercing, or
pressuring, or attempting to urge,
induce, coerce, or pressure, any supplier
to limit supply or to refuse to sell toys
and related products to any toy
discounter.
C. Requiring, soliciting, requesting or
encouraging any supplier to furnish
information to respondent relating to any
supplier’s sales or actual or intended
shipments to any toy discounter.
D. Facilitating or attempting to
facilitate agreements or understandings
between or among suppliers relating to
limiting the sale of toys and related
products to any retailer(s) by, among
other things, transmitting or conveying
complaints, intentions, plans, actions,
or other similar information from one
supplier to another supplier relating to
sales to such retailer(s).
E. For a period of five years, (1)
announcing or communicating that
respondent will or may discontinue
purchasing or refuse to purchase toys and
related products from any supplier
because that supplier intends to sell or
sells toys and related products to any
toy discounter, or (2) refusing to
purchase toys and related products from a
supplier because, in whole or in part,
that supplier offered to sell or sold
toys and related products to any toy
discounter.
PROVIDED, however, that nothing in this
order shall prevent respondent from
seeking or entering into exclusive
arrangements with suppliers with respect
to particular toys.
TRU makes a perfunctory, one-paragraph
argument that paragraphs II(B), II(C),
II(D), and II(E)(1) impose a "gag order"
that contravenes the Supreme Court’s
recognition in Monsanto Co. v. Spray-Rite
Corp., supra, that manufacturers and
distributors have a legitimate need for a
free flow of information between them.
This order, they claim, will create an
irrational dislocation in the market to
the detriment of toy suppliers,
retailers, and consumers. With respect to
paragraph II(E)(2), it argues that the
five-year restriction on refusals to deal
impermissibly cabins its Colgate rights
to choose the suppliers with which it
wants to deal. In effect, it claims, the
decree will force it to purchase all toys
that are offered to anyone, unless it can
somehow prove that its refusal was
because of a safety defect or other
similar flaw.
We consider first TRU’s challenges to
parts II(B) through II(D) of the order.
(It has not mentioned II(A) in its brief,
and thus it has waived any challenge to
that part of the order.) In general, if a
retailer had some kind of restricted
distribution arrangement with a
manufacturer, Monsanto holds that it is
permissible for the retailer to urge the
manufacturer to respect the limits of
that agreement. The retailer may
communicate complaints about the
provision of product to discounters, if
that runs afoul of the promises in the
distribution agreement. Colgate indicates
that the retailer would also be within
its rights to tell the manufacturer that
it will no longer stock the
manufacturer’s product, if it is unhappy
with the company it is keeping (i.e. if
the manufacturer is sending too many
goods to discounters, stores with a
reputation for rude and sloppy service,
or other undesirables).
Two facts distinguish these general
rules from the situation in which TRU
finds itself. First, unilateral actions
of the sort protected by Monsanto and
Colgate are not the same thing as a
retailer’s request to the manufacturer to
change the latter’s business practice.
Under paragraph II(B) of the decree, TRU
must not tell the manufacturer what to
do; it is still permitted to decide which
toys it wants to carry and which ones to
drop, based on business considerations
such as the expected popularity of the
item. Second, to the extent paragraph
II(B) might indirectly inhibit TRU from
exercising its unilateral judgment, TRU
must confront the fact that the FTC is
not limited to restating the law in its
remedial orders. Such orders can restrict
the options for a company that has
violated sec. 5, to ensure that the
violation will cease and competition will
be restored. See National Lead Co.,
supra, 352 U.S. at 430; FTC v. Cement
Institute, 333 U.S. 683, 726-27 (1948);
Corning Glass Works v. FTC, 509 F.2d 293,
303 (7th Cir. 1975). See also FTC v.
Colgate-Palmolive Co., 380 U.S. 374, 392
(1965) (making the same point, in context
of the Commission’s deceptive practices
authority).
The second point also applies to TRU’s
objections to paragraphs II(C) and II(D).
In addition, we note that the retailer
should not have any reason to obtain its
suppliers’ business records about
shipments to the retailer’s competitors.
That is the supplier’s concern. TRU is
protected as long as it can ensure that
it receives what was promised to it.
Also, of course, the decree preserves
TRU’s right to enter into exclusive
arrangements with respect to particular
toys. In so doing, it also implicitly
allows TRU to engage in communications
that are necessary for the implementation
and enforcement of such agreements.
Paragraph II(D) directly addresses the
Commission’s finding of a horizontal
agreement, and it orders TRU not to go
out and create a new one. The Commission
was certainly acting within the bounds of
its discretion when it included these
provisions.
Paragraph II(E) appears to be the one
that causes the greatest concern to TRU.
This strikes us as a closer call, but in
this connection the standard of review
becomes important. The Commission has
represented in its brief to this court
that the decree "leaves [TRU] free to
make stocking decisions based on a wide
range of business reasons; it must simply
make those decisions--for a period of
five years--independent of whether clubs
or other discounters are carrying the
same item." FTC Brief at 58. The attempt
to use its market clout to harm the
warehouse clubs lies at the heart of this
case, and so it is easy to see why the
Commission chose to prohibit reliance on
the supplier’s practices vis e vis the
clubs as a reason for TRU’s own
purchasing decisions. At bottom, TRU is
really just worried that it will be
difficult to prove that any particular
purchasing decision was free from the
prohibited taint. It will be easy to
refrain from announcements or
communications about refusals to deal,
which is what II(E)(1) prohibits. With
respect to II(E)(2), if TRU implements
adequate internal procedural safeguards,
it should be possible to demonstrate that
its buying decisions were not influenced
by anything the manufacturers were doing
with discounters like the clubs. These
refusals to deal were the means TRU used
to accomplish the unlawful result, and as
such, they are subject to regulation by
the Commission. See National Lead, 352
U.S. at 425. Under the abuse of
discretion standard that governs our
review of the Commission’s choice of
remedy, see Siegel Co. v. FTC, 327 U.S.
608, 612-13 (1946), this does not appear
to be a remedy that "has no reasonable
relation to the unlawful practices found
to exist." We therefore have no warrant
to set it aside. If, however, it becomes
clear in practice that this provision is
unworkable, TRU is free to return to the
Commission to petition for a modification
of the order.
III
We conclude that the Commission’s
decision is supported by substantial
evidence on the record, and that its
remedial decree falls within the broad
discretion it has been granted under the
FTC Act. The decision is hereby Affirmed.