Resale Price Maintenance – Established Thinking & New Ideas
Roman Inderst, Zlata Jakubovic, Sebastian Pfeil1
Talk given at: Annual MaCCI Conference, Mannheim February 2013
1. Introduction and Background
Resale Price Maintenance agreements are treated as vertical restraints by scholars and practitioners
of antitrust law and economics. The most contentious RPMs prescribe that dealers must sell at or at
least not below a fixed price. This is also called a “minimum RPM”. We will thus not deal with the
case of a „maximum RPM“, which leaves retailers free to set any price below a pre-specified level.
RPM agreements are different from horizontal agreements – that is, agreements between
enterprises that are in direct rivalry. While also the latter may give rise to efficiency gains, amongst
economists there is clearly a stronger presumption that such horizontal agreements are likely to
dampen competition and cause consumer detriment. Instead, a fair share of economists has argued
over the last decades that vertical restraints, including RPM, should receive a more benign treatment
by antitrust law. In particular, a majority of commentators from the economics profession have
argued against a per se prohibition, advocating instead a treatment under a rule-of-reason approach.
If we could ignore the practicalities of costly resources and those of the benefits of legal certainty,
surely many more would agree that a rule-of-reason approach was preferable. In practice, however,
these are the key constraints that economists cannot ignore. Advocating a rule-of-reason approach is
thus only the first step. The much more onerous task is then that of designing a workable rule-ofreason approach. This must bring together the various anti- and pro-competitive effects of RPM that
have been identified in the literature, as well as the respective evidence both from published
empirical studies and from case work.
A workable rule-of-reason approach must also be open to arguments that have not yet been
sufficiently grounded in theoretical or empirical work, possibly as they escape the standard textbook
tools of economists. In what follows, our aim is to both review the received literature and to add
some novel insights and ideas. Being two-handed economists, our new ideas will add to both the
pros and the cons of RPM. However, as much as this is possible in this short time, we will try to
discuss when they are more and when they should be less applicable for a particular industry.
2. The Argument against RPM
In what follows, for convenience only we will use the terms manufacturers and retailers for the
respective two agreeing parties in the vertical chain.
Price Fixing
The economics literature has long recognized the role, at least in principle, of RPM to facilitate both
explicit collusion and implicit coordination - both at the upstream and at the downstream levels.2
1
All from Goethe University Frankfurt. Contact: [email protected]
1
Among manufacturers, RPM can increase transparency and facilitate coordination on a higher price.
This is so when wholesale prices are not easily observable. Then, cartel members will find it difficult
or even impossible to distinguish between the various reasons that may have caused retail prices to
vary, in particular changes in cost and demand, on the one hand, and an undercutting of an agreed
wholesale price, on the other hand. RPM, instead, allows conditioning the collusive agreement or the
focus point of any implicit coordination directly on the retail price. Deviations from the collusive
strategy are then much easier to detect.3
In many instances, however, RPM may be a very costly, in terms of inefficiency, and also a very
ineffective way to stabilize a manufacturer cartel, for instance as retailers may reward secret
discounts in many other ways, such as preferable display or promotion.
Also in theory, RPM can facilitate retailer coordination. In this case, manufacturers would be
pressured into RPM by the joint action of retailers, who thereby wish to prevent manufacturers from
inducing sales by would-be price-cutters.4 Then, however, we should clearly not see retailers
defending their freedom to set prices.
Market Structure
Vertical agreements and also RPM can be used to exclude more efficient rivals. In particular, it has
been argued that an incumbent manufacturer can use RPM to exclude potential competitors.
Through RPM the incumbent supplier can, as it is argued, dampen downstream competition and then
allow retailers to share in the thereby obtained supra-competitive rents. Instead, when contracting
with a new, different supplier, retailers may fear that this leads to fierce competition and the
breakdown of RPM.5
In addition, when RPM establishes a uniform price level, this may protect inefficient retailers that
would otherwise leave the market. To the extent that RPM, however, fosters non-price competition,
as discussed below, this argument seems not convincing.
Softening of Competition
The previous theories of harm mainly rely either on repeated interactions to establish coordination
or to support outright collusion or they require significant market power as in the case of exclusion. A
more recent strand of the literature has shown, instead, that RPM can soften competition in a static
setting and when no firm enjoys a particularly strong position, provided that there is a network of
contracts.6
2
Economic theory frequently does not distinguish between explicit collusion and implicit coordination. In
particular, with the exception of a few, mostly recent contributions, communication, which is a key legal
ingredient of collusion, is not considered explicitly in these theories of coordination.
3
Cf. Telser (1960), Mathewson and Winter (1998), Jullien and Rey (2007).
4
Cf. Yamey (1954), Gammelgaard (1958), Overstreet (1983).
5
This argument has recently been formalized by Asker and Bar-Isaac (2011).
6
Cf. Hart and Tirole (1990), O’Brien and Shaffer (1992), Rey and Vergé (2004, 2010) or Inderst and Shaffer
(2010). Another theory is that of Dobson and Waterson (2007), which relies on linear contracts, though. When
wholesale prices are restricted to be linear, any shift of profits between manufacturers and retailers has an
impact on wholesale prices and thus also retail prices. In such setting, RPM has an immediate positive effect of
reducing double-marginalization, which is treated further below.
2
RPM can dampen intrabrand competition when manufacturers face a so-called problem of
opportunistic behavior. This arises when a manufacturer cannot credibly communicate to all retailers
the terms and conditions under which it supplies their respective rivals. Then, the manufacturer is
tempted to offer a given retailer a discount as neither the manufacturer nor this retailer internalizes
the profit loss of a rival. At least in theory, abstracting particularly from reputational concerns that
would arise under frequent interaction, this temptation can be so large so as to drive marginal
wholesale prices down to marginal costs.
By resorting to this so-called “non-observability” of wholesale contracts, the economic model also
clarifies why it is not feasible for firms to achieve the same objective, namely to sustain higher prices,
by simply increasing the marginal wholesale price, which would then be passed-through into a higher
retail price. In fact, take a benchmark setting with a monopolistic supplier and competing retailers.
Firms could then simply maximize total industry profits, namely through eradicating downstream
rivalry, by agreeing on sufficiently high marginal wholesale prices for all rivals - and then splitting up
profits through additional transfers. Non-observability of wholesale contracts prevents this
mechanism to work. RPM provides a solution.
Take now another benchmark: That with a monopolistic retailer that stocks substitute products from
different manufacturers. Total industry profits are then maximized when each manufacturer supplies
the retailer at marginal cost, while agreeing on a transfer or, more generally, on a positive profit
margin on “infra-marginal” units. This scheme clearly no longer maximizes industry profits when
retails compete: Retail prices would then be too low from firms’ perspective as, once again,
intrabrand competition across retailers is not sufficiently dampened. A combination of RPM and
suitably chosen marginal wholesale prices can, instead, allow firms to sufficiently dampen both interand intrabrand competition. The reason is that this ensures both a high retail margin on each product
and a high retail price. The latter is not to the detriment of manufacturers when profits can be
shared through other means but the marginal wholesale price. In this setting, one equilibrium
outcome is now that where each manufacturer sets its RPM price (or price floor) at the price that
maximizes total industry profits, anticipating that all other manufacturers do the same.
In this setting there are, however, multiple equilibrium outcomes. When all other manufacturers
follow this strategy, then it is privately optimal for each individual manufacturer to do the same.
However, if not all other manufacturers are expected to adopt RPM, then at first it is not clear
whether an individual manufacturer can still enhance his profits by using RPM to induce higher retail
prices.7 This is where an extension of this theory can come in. This is presently formalized by Greg
Shaffer and one of us.
To see why it is also unilaterally optimal to adopt RPM even if this is not done so by a rival
manufacturer, note first that one manufacturer – call him A – can then adopt the following strategy:
Under RPM he can set a retail price equal to the price that would prevail without RPM, but now set a
wholesale price strictly lower than the one that would be required to otherwise induce the
respective retail price. What is the effect of this strategy? As a rival retailer – call him retailer B –
does, by assumption, not use RPM, the higher margin on product A would induce the retailer to set a
higher price for product B. Overall, this increases the joint profits of manufacturer A and the retailers
7
Shaffer (2012) calls this, consequently, a top-down theory of RPM.
3
at the expense of the rival manufacturer B. In sum, there is now clearly an incentive to be even the
first firm to adopt RPM. This thus provides a “bottom-up” view of RPM.
What is more, under the now adopted RPM, manufacturer A should have an incentive to raise its
retail price compared to the outcome without RPM, given that in the latter case all retail prices were
strictly below the level at which industry profits are highest.
3. RPM as an Efficient and Pro-competitive Contractual Choice
Service Provision, Non-Price Competition, and Free Riding
As we focus attention to the case of a “minimum resale price”,8most likely the most prominent
argument in favor of RPM, at least among economists, is that it can induce beneficial non-price
competition among retailers.9 When the downstream market is competitive, then even a high retail
price will not lead to high retailer profits provided retailers can compete also on non-price attributes
such as services.
To the extent that these services risk being underprovided, most notably through a free-riding
problem among retailers, RPM can increase welfare. While also exclusive arrangements could serve
the same purpose, in many markets this is not feasible as manufacturers need sufficient scope and
scale of distribution. On the other hand, in many markets, most notably fast-moving consumer goods
and groceries, services such as advice may be of limited relevance. There, however, an efficiency
rationale for RPM may be that by maintaining retailers’ margins, a broad range of retailers can be
induced to carry sufficient inventory. Higher inventories are then chosen for two reasons: First, lost
sales from running out-of-stock become more costly also to retailers; second, RPM protects
inventory holders against a melt-down of the value of their stock.10
A free-riding argument among retailers, however, may also be applied more broadly. For instance,
retailers that must invest to help promoting a product may expect to be compensated through future
sales at a higher price. The margin generated through RPM can allow for such compensation, while
otherwise discounting late-followers would erode the profits of the “pioneering” retailers. Likewise,
the idea that the margins protected by RPM can allow manufacturers to induce sales-enhancing
behavior applies clearly more generally. In particular, in repeated interaction RPM can provide a rent
stream that can be revoked for unsatisfactory performance. The margin ensured through RPM allows
a manufacturer to compete with rivals for special services and preferential treatment by a retailer.
8
It should be noted that various efficiency rationales for RPM are not prominently considered in this note as
they pertain (more) to a “maximum resale price” rather than a “minimum resale price”. To single out only one,
consider the argument of double marginalization (cf. Posner 1976). A problem of double-marginalization is best
illustrated in the framework of a sequential monopoly. When a manufacturer is constrained to set a linear
price, i.e., a uniform per-unit wholesale price, then the ultimate retail price is strictly higher than the price that
would obtain under vertical integration. Both firms, i.e., the monopolistic retailer and the monopolistic
manufacturer, charge a strictly positive margin, which ultimately pushes the retail price above the level that
would maximize industry profits. As is easily seen, a maximum resale price provides a means for the
manufacturer to control also the final price, so that ultimately the uniform wholesale price only serves the
purpose of distributing joint profits. Clearly, also the addition of other contractual means, e.g., a fixed transfer
or more generally a non-linear price schedule, would serve the same purpose, however.
9
Cf. Telser (1960), Matthewson and Winter (1984, 1998).
10
Cf. Deneckere et al. (1996).
4
All of these pro-competitive or efficiency-based theories presume that RPM is essential to achieve
the desired effect. For this it is, however, necessary to show, for instance, that supplying different
retailers at different wholesale prices or safeguarding margins through the judicious use of non-linear
tariffs are both not feasible. This is, however, not what most of these theories accomplish. Again, to
rescue the argument that RPM is necessary to achieve these effects, theorists must invoke additional
assumptions, such as manufacturer opportunism through non-observability of wholesale contracts.
Quality, Price Ownership and Vertical Competition
For many branded products the aforementioned pro-competitive effects or efficiency rationales for
RPM may not be very convincing, for instance as high turnover reduces the need for large inventory
holding or as they require little advice or alternative services of retailers. Or these services can be
contracted explicitly and thus need not be incentivized through higher margins – or such margins can
be provided more efficiently through the right choice of wholesale terms rather than through RPM.
The marketing literature, in particular, has, however, recognized that to establish and to keep the
value of a brand, it is not sufficient to develop a product of given characteristics, as described in
much of economic theory. Instead, the different instruments of marketing must play together to
develop and sustain such a recognizable brand image. Price is recognized to be a key instrument in
this respect.
But why should, in particular, a low price indicate low quality and destroy brand value? Why are
retailers’ and manufacturers’ incentives not aligned in this respect? And why should RPM be
necessary, in this light, to achieve benefits for consumers? According to one theory, quality
certification is provided only indirectly through a high price, as it is associated with the decision of
certain retailers to stock the product.11 These retailers may have invested heavily in their own image
and may uphold this through extensively screening products they carry. When they have higher costs
compared to discounters that do not provide these services and when a manufacturer can set
wholesale prices only uniformly, they may end up with a too low market share and margin. They are
then unwilling or unable to provide this “certification service”, from which both other retailers and
the manufacturer would benefit. RPM levels the playing field and ensures a sufficiently high margin
to widen the distribution to retailers that provide this service.
A high price may also provide incentives for the manufacturer to ensure a continuing high level of
quality. This concerns both the essential features of a product and the way it is handled along the
distribution channel. To illustrate this, consider first a monopolist that sells directly to consumers.
There are many reasons for why often the choice of a targeted price level represents a long-term
strategy, for instance as it must be consistently communicated to consumers through all marketing
channels. Once a price level is set, there is then a robust relationship between a higher price and
higher incentives of the manufacturer to sustain high quality. In fact, we can identify three effects
pointing in the same direction.
To see this, consider the following short formalization. [See picture.] Here, the price is denoted by p
and the quality by q. Both influence demand as captured by the function D. Constant marginal costs
are denoted by c and are higher when a higher quality is chosen, for instance more care with
handling the product. The resulting profit of the monopolistic manufacturer is given by π. The next
line denotes the first-order condition to determine the optimal quality level q-star for a given price p.
11
Cf. Marvel andMcCafferty (1984).
5
The first term captures the effect of quality on demand, which is clearly assumed to be strictly
positive. The second term captures the resulting higher costs per unit.
When we now ask how a higher price affects optimal quality choice, then this depends on the crossderivative of profits with respect to both price and quality. This is depicted next. There are, as already
mentioned, three effects. They all lead to higher quality when the price is higher in case the
respective terms in this expression are positive. This is immediate for the first effect: It captures the
fact that when the price is higher, a loss of sales due to a lower quality is more costly to the
manufacturer. The second effect works through the per-unit cost change. A higher price reduces
demand and makes per-unit costs less important in the firm’s overall trade-off.
The third and final term is now a bit more subtle and for an intuition it is best to build up the demand
function from primitives, that is from the aggregation of individual consumers’ preferences. The term
is then exactly zero when all consumers care equally about quality. But it is strictly positive when
those consumers who have the highest valuation for the product put also a higher value on quality. It
is for this case, in fact, that we find overall the most extreme results.
That is, to be precise, for the simplest, “workhorse” demand functions, we find that even when a
monopolist sells directly to consumers, quality is underprovided from a total welfare perspective.
What is more, in the same settings both efficiency and consumer surplus would often, but not
always, be higher at a price that exceeds that chosen by the monopolist. Such an extreme result is,
however, not needed for the subsequent argument to hold.
In an admittedly stark interpretation, we now think of a world with RPM as one where the
manufacturer keeps ownership of the final retail price. In modeling terms, we let the manufacturer
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communicate to consumers a final retail price, based on which the wholesale price is then
determined through negotiations with retailers. Instead, without RPM it is the retailer that
determines how to position a product in terms of its price, for instance, to use it as a loss-leader or to
charge a premium. Retailers and manufacturers may now have quite different interests in setting
high versus low prices and thus raising or lowering incentives to provide high quality and the
respective brand image.
When a high price communicates high quality, thereby raising the product’s brand value, this raises
the outside option of the manufacturer and decreases that of the retailer. In other words, the
particular product becomes less and the retailer more substitutable. What is more, when consumers
multi-home at different retailers, the price perception at one retailer can provide a brand image that
boosts sales also at other retailers. This spill-over is in the interest of the manufacturer, but not in the
interest of retailers. In fact, a retailer would rather prefer to free-ride on the image and quality
incentives that high prices at other retailers provide.
Also, as long as a lower price does not too severely affect consumers’ perception of quality, a retailer
may want to sustain a low price when this attracts more shoppers to the store, who then also buy
other, higher-margin products. Instead, the supplier does not fully share in the benefits from these
additional sales.
Overall, this suggests that there are various reasons for why, in their own interest and not necessarily
that of consumers, retailers may strictly prefer a lower retail price than that favored by
manufactures. And by the preceding remarks, a lower price, as preferred by retailers, may not be in
the interest of all consumers, in particular not of those placing a high value on quality.
4. Concluding Remarks
What our last stylized modeling example, which we presently formalize fully, suggests is to consider
RPM also in light of a potential conflict of interest between manufacturers and retailers, which
extends beyond the distribution of a fixed margin along the chain. In fact, such a conflict may also be
framed much wider.
Over the last decades we have seen a substantial shift in functions away from manufacturers and
towards retailers. Powerful retailers increasingly assume the function of certifying quality through
their own brand image, they innovate and compete with manufacturers through own brands, they
control a large fraction of marketing expenditures, or – to name one more – capture a larger share of
the value chain in terms of storage and shipping. One may capture this through the term “vertical
competition” over functions and, thereby, over a larger share of the total value-added in the vertical
chain.
A per se prohibition of RPM essentially grants retailers an unquestioned ownership of the retail price.
It sanctions attempts of manufacturers to communicate or even negotiate a targeted price level, for
instance one that would, in the eyes of the manufacturer, better conform to its overall brand
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strategy. In the light of the discussed conflict of interest, to the extent that this truly applies to a
particular industry, one may ask whether this still allows for a “level playing field”.12
Having reviewed the key pros and cons of RPM from the perspective of economic theory, our final
remarks and the particular example of price, quality and brand image serve one purpose. We think
that it may be necessary to review some of the received theories or to widen our thinking when
applied to industries that have undergone a substantial shift in bargaining power towards large and
powerful retailers. Instead, most of the received theories do not incorporate powerful dealers that
assume functions that also a manufacturer would or even did perform. In fact, economic modeling is
often still dominated by the view that retailing just provides a veil through which manufacturers sell
to final consumers. Whether this is the case and what implications the distribution of power and
functions in the vertical chain should have on our view of RPM, remains, however, not only a
theoretical question, but must be informed also by ongoing empirical work. 13
5. References
Asker, J. and Bar-Isaac, H. (2011). “Exclusionary Minimum Resale Price Maintenance,” mimeo, New
York University.
Deneckere, R., Marvel, H. and Peck, J. (1996). “Demand Uncertainty, Inventories, and Resale Price
Maintenance,” Quarterly Journal of Economics, vol. 111, pp. 885-914.
Dobson, P. and Waterson, M. (2007). “The Competition Effects of Industry-Wide Vertical Price Fixing in
Bilateral Oligopoly,” International Journal of Industrial Organization, vol. 25, pp. 935-962.
Gabrielsen, T.S. and Johansen, B.O. (2013). “Resale Price Maintenance and Up-front Payments:
Achieving Horizontal Control under Seller and Buyer Power,” mimeo.
Gammelgaard, S. (1958). “Resale Price Maintenance,” Project No. 238, Paris: The European
Productivity Agency of the OEEC.
Hart, O. and Tirole, J. (1990). “Vertical Integration and Market Foreclosure,” Brooking Papers on
Economic Activity: Microeconomics, 205-276.
Inderst, R. and Shaffer, G. (2010). “Market-Share Contracts as Facilitating Practices,” The Rand Journal
of Economics, vol. 41, pp. 709-729.
Jullien, B. and Rey, P. (2007). “Resale Price Maintenance and Collusion,” The Rand Journal of
Economics, vol. 38, pp. 983-1001.
Marvel, H. and McCafferty, S. (1984). “Resale Price Maintenance and Quality Certification,” Rand
Journal of Economics, vol. 15, pp. 346-359.
Mathewson, G. and Winter, R. (1984). “An Economic Theory of Vertical Restraints," RAND Journal of
Economics, vol. 15(1), pp. 27-38.
Mathewson, G. and Winter, R. (1998). “The Law and Economics of Resale Price Maintenance,”
Review of Industrial Organization, vol. 13, 57-84.
12
Somewhat complementary, a recent strand of the literature analyzes which vertical restraints, including
RPM, would be imposed when proposed by sellers („seller power“) or when proposed by buyers („buyer
power“). Cf. Gabrielsen (2013) and the references therein.
13
For German readers, a recent and detailed discussion of the sparse literature is provided by Schwalbe (2011).
8
Overstreet, T. (1983). “Resale Price Maintenance: Economic Theories and Empirical Evidence,”
Bureau of Economics Staff Report to the U.S. Federal Trade Commission.
O’Brien, D.P. and Shaffer, G. (1992). “Vertical Control with Bilateral Contracts,” The Rand Journal of
Economics, vol. 23, pp. 299-308.
Posner, R. (1976). “Antitrust Law and Economics Perspective,” Chicago: University of Chicago Press.
Rey, P. and Vergé, T. (2010). “Resale Price Maintenance and Interlocking Relationships,” Journal of
Industrial Economics, vol. 58, pp. 928-961.
Schwalbe, U. (2011). “Preisgestaltung in vertikalen Strukturen – Preisbindung und Preisempfehlung
aus ökonomischer Sicht,“ WuW 12, 1197-1216.
Shaffer, G. (2012). “Anti-Competitive Effects of RPM (Resale Price Maintenance) Agreements in
Fragmented Markets,” Draft Report, University of Rochester.
Telser, L. (1960). “Why Should Manufacturers Want Fair Trade,” Journal of Law and Economics, vol.
3, pp. 86-105.
Yamey, B.S. (1954). “The Economics of Resale Price Maintenance,” London: Sir Isaac Pitman & Sons,
LTD.
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