WRITE-UP OF REVIEW PROBLEM #2: TOYS ‘R’ US

Assume that you are counsel for Toys ‘R’ Us immediately after the FTC Opinion is handed down. Devise the best arguments you can to challenge each of the following elements of the FTC opinion and identify the FTC’s likely responses.

(1) The finding that there was a horizontal agreement.

TRU: No explicit evidence of agreement among toy mfrs. Each mfr had an independent incentive to limit sales to the clubs in order to satisfy TRU & maintain sales. (FTC dissent)

FTC:

  • Participation by mfrs doesn’t make sense if most aren’t doing it (or they’d lose business to each other). This is supported by evidence that mfrs made their agreement contingent on agreement by others (AR379)
  • Motive to enter (threats from TRU)
  • Evidence of discussions that provided info on other mfrs: Complaints by one mfr against others as enforcement device. TRU talks to mfrs about other mfrs, not just about other retailers.

CtApp: Upholds finding

(1) Mfrs’ decision to stop dealing with warehouse clubs abrupt shift from past

  • companies wanted to diversify from TRU, not to become more dependent upon it
  • suspicious for a manufacturer to deprive itself of a profitable sales outlet

(2) Direct evidence of communications

(3) Reliance on competitor behavior: 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. (testimony of the different toy company executives and TRU itself)

Bottom Line: Pretty Weak Ground for Appeal. Challenge to factual finding. Some evidence supports.

(2) The Commission’s reliance on Klor’s. Not clear how much of Klor’s survives NWWS, Sharp, Discon & Leegin, although the case keeps getting cited. Klor’s facts not inconsistent with per se under NWWS (Prototype I boycott; cutting off elements necessary to compete; no efficiencies). However, Court might be skeptical of claim because it’s so unlikely to affect prices or output in the market. TRU might argue that Klor’s shouldn’t be per se illegal where it’s so clear it would not violate Rule of Reason.

Good ground for appeal. Klor’s is questionable precedent and a court could decide against TRU without affirming this aspect of FTC ruling.

(3) The ruling that the case should be judged under the per se rule under Northwest Wholesale Stationers.

Literal language: One argument accepted by both the FTC and the Seventh Circuit was that the case fit the literal language used by the Supreme Court to describe the sort of case that usually was per se.: “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." TRU would have to respond that the case did not really meet the three factors laid out in the case to elaborate on this statement. These factors are market power, denying the target of the boycott an element necessary to compete, and lack of plausible efficiencies.

Market Power: TRU argued that its market share (19.4% share of national toy market) was too small to provide market power and was declining. Arguments supporting market power include:

  • TRU had a share over 30% in most local markets it participated in
  • TRU had power dealing with its suppliers because it was so much bigger than any other toy seller and it was more than 30% of business of big toy cos.
  • TRU priced key products lower in markets where it faced competition from Wal-Mart and others.
  • The manufacturers who participated in the agreement collectively had market power
  • Evidence of harmful effects in market can be sufficient to show market power (IFD) & here evidence of harm to clubs’ ability to get key toy products

CtApp: Enough market power to meet NWWS standards: the share a firm has in a properly defined relevant market is only a way of estimating market power; evidence of harmful effects (present here) can be enough.

Necessity: Obviously warehouse clubs don’t need toys to stay in business, but they cannot effectively participate in the retail toy market without the products of the leading toymakers.

Efficiencies. See free-rider arguments discussed in (4) below.

  • less restrictive ways to address;
  • timing suggests post-hoc justification;
  • no evidence of other efficiencies

NWWS is pretty weak ground for appeal; unless court insists on large market share to show market power, solid evidence on all the factors.

(4) The rejection of TRU’s free-rider arguments.

  • TRU: TRU advertising helps market product; clubs don’t pay for
  • BUT mfrs paid TRU for the advertising, so TRU not spending for benefit of clubs plus not clear that TRU ads help clubs)
  • TRU: Clubs have low overhead and get money from membership fees,
  • BUT this is not free-riding, but efficiency.
  • TRU: Our choice of which products to sell/highlight identifies key products for rest of market
  • BUT finding of fact that clubs did not rely on other retailers’ advertising or sales in choosing a product
  • Not clear that we should be concerned about “free-riding” on product choice (not really investment by TRU)
  • FTC: No evidence TRU cared about free-riding prior to litigation

CtApp: Manufacturers didn’t want to employ TRU strategy to limit access to clubs, which shows they didn’t think services in question were valuable

I think weak ground for appeal; very sketchy free-rider arguments.

(5) The finding that the horizontal agreement violated the Rule of Reason

TRU would argue that the challenged agreement cannot harm consumers because of the very large number of toy retailers and its own lack of market power (see discussion above). It also would try to use its free-rider claims (discussed above) to show that there were pro-competitive effects of the agreements.

FTC: Besides responding (as above) to the market power arguments and the free-rider claim, the FTC would note that there was no evidence that the agreement furthered any marketing plan of the manufacturers. Indeed, the manufacturers would have preferred to sell more to the clubs. In addition, the following evidence suggested that consumers were harmed:

  • Club prices were lower.
  • Club shares of toy sales declined, even while other sales increased.
  • Best-selling/highly advertised toys become unavailable to clubs
  • TRU lowered its prices where it had local competition
  • TRU was concerned about the clubs’ low prices and its image as a discounter.
  • Terms of the agreement made it harder for consumers to compare prices.
  • TRU would have lowered prices on best-selling items absent agreement.

Weak ground for appeal; finding of fact supported by lots of evidence.

(6) The implicit rejection of the argument that TRU was simply exercising its rights under Colgate to refuse to deal with mfrs who sold to clubs.

  • Under Monsanto, sufficient evidence of agreements between TRU & mfrs; did more than just refuse to deal;

- negotiated terms

- Monsanto fn.9: sought & received assurances of compliance

- monitoring & enforcement mechanisms

  • Related point: Termination because choosing the bigger distributor over smaller ones can be seen as an independent decision by mfr even if bigger distributor issues threats. Some lower courts have held this although Sharp treats similar facts as agreement (without ruling on).

Might be plausible ground to appeal because of lower court cases noted in last point.

(7) The decision to consider the effects of all the vertical agreements in the aggregate when judging them under the Rule of Reason.

TRU: Vertical restraints should be considered individually. Since, according to Sylvania, the primary harms of non-price vertical restraints are to intra-brand competition, it makes no sense to aggregate the claims, because each intra-brand market must be evaluated separately. TRU also might argue that there are no cases where the Supreme Court aggregated vertical claims in the way the FTC did here.

FTC: On the other hand, the strongest claim here is really that the agreements drove important players out of the inter-brand market. To demonstrate this harm, you need to aggregate the vertical claims. Sylvania’s lenient treatment of vertical restraints rests on the assumption that inter-brand competition limits the significance of intra-brand market power. It would undercut the reasoning of Sylvania to look only at the intra-brand markets when the aggregate affect may be to eliminate inter-brand competition.

This is a solid ground for appeal because it really is an undecided question.

Thus, my guess is that strongest grounds for appeal are 2, 6, 7.