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Retailer Initiated Vertical Restraints: Toys “R” US

Retailer Initiated Vertical Restraints: Toys “R” US. Case Author: F.M. Scherer Presented by: Janel Bass Yash Shah Chad Sykes. Players. Toy Manufacturers Ex: Mattel, Nintendo, Sega Toys “R” US (TRU) Warehouse Clubs Ex: Costco, Sam’s Club, BJ’s Federal Trade Commission.

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Retailer Initiated Vertical Restraints: Toys “R” US

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  1. Retailer Initiated Vertical Restraints: Toys “R” US Case Author: F.M. Scherer Presented by: Janel Bass Yash Shah Chad Sykes

  2. Players • Toy Manufacturers • Ex: Mattel, Nintendo, Sega • Toys “R” US (TRU) • Warehouse Clubs • Ex: Costco, Sam’s Club, BJ’s • Federal Trade Commission

  3. 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

  4. 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

  5. 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

  6. Warehouse Clubs • Ex: Costco, Sam’s Club, BJ’s ,etc. • Late 1980s: opened to individual customers • By 1992, 576 clubs in US • Shopping experience • PRM • 9-12%

  7. 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

  8. 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

  9. 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

  10. 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”

  11. 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

  12. 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

  13. 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

  14. 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.

  15. 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

  16. 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

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

  18. The End

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