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Resale price maintenance
The Supreme Court will soon consider whether resale price maintenance (RPM) should be per se illegal. Since we don't understand price stickiness well, it is no surprise we also don't understand RPM very well either. My seat of the pants guess is that > 50% of RPM represents a desire to collude and raise prices.
Market-oriented economists often exaggerate the "ancillary services" hypothesis developed by Lester Telser, namely that RPM keeps services flowing ("informative stereo salesman" is the paradigmatic example). Supposedly, without RPM everyone would get sales help at the expensive store but buy at the discount store; in the equilibrium all stores would be discount stores and poor consumers would wander through the world without sales help. In reality RPM has often been used for lots of the small, stupid items you see for sale in drugstores.
I also attach greater credence to the Ben Klein hypothesis that RPM represents a kind of "efficiency wage" to discipline retailers and force them -- through threat of product cut-off -- to present the item in a desirable fashion. (In Telser's hypothesis the services flow automatically after RPM is instituted, through a desire to capture customers and extra profits, but why should the extra services supplied then be the ones subject to the free-rider problem, rather than some other side benefits?)
Even when cartellization is the motive, I do not worry that Colgate will manage to monopolize the market for toothpaste. There just aren't many retail products which don't face lots of competition from alternative manufacturers. I also don't think that so many business decisions should become primarily legal decisions; our government has enough real crimes to look after. So RPM should be close to per se legal (certainly not per se illegal), with some possible exceptions for resource-based monopolies, not that I can think of any offhand in the retail context. Arguably government should not enforce RPM agreements, though product pulling is in any case the major means of implementation.
Here is Greg Mankiw on resale price maintenance. Here is an Econoblog on resale price maintenance. Here is Wikipedia. Here is Aplia. Here is some Supreme Court discussion.
Posted by Tyler Cowen on April 20, 2007 at 07:35 AM in Economics | Permalink
Comments
You're missing a hyperlink to Econoblog, I think.
Posted by: Matthew at Apr 20, 2007 7:39:33 AM
Thanks, fixed.
Posted by: Tyler Cowen at Apr 20, 2007 7:41:39 AM
I worked at a large telecom equipment maker in the early 80's, when a new generation of computerised switches combined with a deregulated market, making for some fun times. But our ability to enforce RPM had a debilitating effect on some consumers.
Because management wanted to get as much market share as possible, they sold to anybody. We had some big and sophisticated dealers; we also had guys who owned a van and a buttset.
Because these guys had low overheads, they would undercut the price of the reputable dealers. But, because their margins were low, they skimped on installation. Since the phone systems last 7-10 years, these cheap dealers weren't looking for repeat business. And, because the installs were shoddy (putting the phone system next to a leaky radiator, and grounding the system by running a piece of speaker wire to the screw that holds the faceplate on the electrical socket were two extreme examples), customers had problems with the system. Again, cheap dealers didn't build enough margin into their prices to support quality warranty service. Typically, if something went wrong, they would replace a circuit board, and send it back to us. Our first few years, more than 50% of all returned boards were "Fault Not Found". This raised our costs and disappointed the end-user.
If we had been able to enforce RPM, we would have been able to ensure the end-user got a good, clean install, and quality warranty service, and the dealers could have competed on hours of service, programming, training, etc., instead of price. For that matter, they would have been able to afford to come for more training themselves.
I agree that competition helps keep prices in check without RPM, and that's fine for Coke and Colgate. Big sophisticated computer systems are a different animal.
Posted by: KevinB at Apr 20, 2007 7:56:57 AM
Sorry, that should be "our INability to enforce RPM". Should have used the preview button!
Posted by: KevinB at Apr 20, 2007 7:58:59 AM
Many instances of manufacturer initiated RPM are to prevent revenue reducing price discounting by retailers, when demand is unknown prior to production and turns out to be lower than expected. For an elaboration of this point see:
Flath, David J. and Nariu, Tatsuhiko, "Demand Uncertainty and Resale Price Maintenance" (April 2000). Contemporary Economic Policy Available at SSRN: http://ssrn.com/abstract=223028 or DOI: 10.2139/ssrn.223028
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Posted by: David Flath at Apr 20, 2007 9:02:27 AM
While in graduate school I worked about 25 hours per week at a golf driving range. We were a classic mom and pop shop. When Dic*'s Sporting Goods built a store a mile away, the only thing which kept our sales of golf equipment from going to zero was the RPM of the golf manufacturers. We then competed on product knowledge and our ability to repair clubs and on avuncular nature.
Being an economist, I never felt quite right about it, although it kept us alive. No doubt Dic*k's could have beat our lowest prices by 10% or more. However, the RPM allowed my employers to NOT find ways to innovate and figure out better ways to sell their products - largely because even though our list prices were the same as at Dic*'s, people would still come to our range, try out the clubs, and purchase them elsewhere.
I am torn about it - but in reality, is there anything really sacred about such a small business?
Posted by: Mike at Apr 20, 2007 9:04:15 AM
If the supplier of a good wants to mandate a minimum price for the good, that's their right, it is after all their product. If a retailer wants to sell at a lower price, that's their right as well. Then it comes down to does the supplier feel there is greater benefit to selling less of the good (since the retailer won't stock it) at the minimum price or more of the good at a lower price. There is absolutely no reason the government should ever get involved in a decision made between the two parties.
Tempur Pedic imposes strict minimum price on their matresses. They pull product from any retailer who breaches the minimum price. They have every right to do so, as they've chosen to brand themselves as a premium product and want it priced as such. Considering the myriad of other matress manufacturers, it's impossible to argue that this harms consumers. In fact, any consumer purchasing a Tempur Pedic is willingly choosing to do so, knowing that they are paying a premium price.
Posted by: joe at Apr 20, 2007 10:14:17 AM
If we had been able to enforce RPM, we would have been able to ensure the end-user got a good, clean install, and quality warranty service, and the dealers could have competed on hours of service, programming, training, etc., instead of price.
I think KevinB makes the same mistake Scalia makes here:
Justice Scalia: So the mere fact that it would increase prices doesn’t prove anything. If in fact it’s giving the consumer a choice of more service at a somewhat higher price, that would enhance consumer welfare, so long as there are competitive products at a lower price, wouldn’t it?
High prices may be necessary to provide good service, but they are not sufficient. The notion that RPM is necessary to give consumers the chance to pay more for good service is silly. They have that chance anyway. Barring RPM does not prevent a retailer from offering a high-price good-service combination, it jut gives consumers the option of choosing that or the low-price no-service option. Why not let the knowledgeable buyer go for the latter?
If the supplier of a good wants to mandate a minimum price for the good, that's their right, it is after all their product.
Once they've sold it to the retailer it's the retailer's product.
Posted by: Bernard Yomtov at Apr 20, 2007 11:38:45 AM
Having been in the distribution bussiness I found many of the retail dealers found ways around these rules. An example would be to sell the Tempur Pedic matress for full price but give you the bed and pillows for just $5 more. The pricing rules usually ended up hurting the smaller retailer that didn't have the buying power to purchase the 'Extras' to give away with the mattress.
Posted by: Dolf at Apr 20, 2007 11:42:49 AM
Maximum/fixed prices are much more interesting than minimum prices. Why do video games and systems cost the exact same amount at every store, even Wal-Mart?
Posted by: Noah Yetter at Apr 20, 2007 12:03:28 PM
What I want to know is, why aren't there "stores" where you just, in essence, "rent" access to the showroom
and knowledgeable people (but not actually be able to buy anything), in order to be able to confidently buy from the super-cheap (online?) discounter?
That way, instead of having to try to bundle different goods (knowledge and the merchandise) into one
overpriced good (merchandise), you pay the marginal cost of the precise good that you really want.
Posted by: Person at Apr 20, 2007 12:04:43 PM
Seems to me that a producer should have the basic, fundamental right to sell at any terms the wish. As long as there is no price collusion across different producers, than you should still end up with a competitive environment. I only see a problem arising if the many producers of a given product all "coincidentally" (wink, wink) set minimum prices at about the same level. Then you've got yourself an anticompetitive cartel (redundant phrase I suppose). Maybe some would argue that it’s very difficult to spot if cartel pricing is occurring, so the safest thing to do is to simply outlaw RPM.
Posted by: Whit Stevens at Apr 20, 2007 12:26:06 PM
Seems to me that a producer should have the basic, fundamental right to sell at any terms the wish.
I think that's a reasonable argument from a "freedom to contract" perspective. But I think it's a stretch to argue that this leads to economic efficiency.
One of my (generally negative) impressions of lots of libertarian arguments is that they are unwilling to accept that there might be a tradeoff between liberty and efficiency. The argument is always that a favored policy is not only morally but also economically correct. I think that's unrealistic.
Posted by: bernard Yomtov at Apr 20, 2007 1:02:18 PM
I think that behavioral economics and bounded rationality tends to push towards allowing RPM. If you believe that people are boundedly rational, then you favor the ability of manufacturers to et contract terms that prevent free-riding off of educative sales staff.
Posted by: Keith at Apr 20, 2007 2:15:18 PM
Supposedly, without RPM everyone would get sales help at the expensive store but buy at the discount store; in the equilibrium all stores would be discount stores and poor consumers would wander through the world without sales help.
Don't think I've ever heard anyone claim that it would happen to that extreme, but perhaps that's not just a straw man and someone does.
Certainly plenty of producers use alternate methods when they're depried of RPM-- a common one being limiting to authorized resellers, and only giving warranty support when the merchandise is bought from authorized resellers. Various premium stereo equipment does this. The argument is simply that that's more inefficient and creates more deadweight loss. Note that limiting to authorized resellers can have the negative cartel affects associated with RPM as well.
Posted by: John Thacker at Apr 20, 2007 5:00:22 PM
If I were a manufacturer with market power and wanted to keep it that way, wouldn't RPM help? By giving retailers part of my monopoly profits, I give them a stake in my ability to exert market power. The added lobbying thus makes my position more difficult to assail politically.
Second, the argument that RPM is necessary to ensure good service is entirely bogus. Product sellers could write minimum service requirements into their contracts directly, rather than using RPM to get at this indirectly. If one argues that minimum service requirements would require monitoring to enforce, the same goes for RPM. The only argument is that violations of RPM are easier to detect. This efficiency, to the extent that it exists, is too minor to justify allowing RPM. The bigger risk is that manufacturers with market power are going to share their monopoly profits to create unbeatable political coalitions.
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