October 30, 2008, 12:00 AM

How the Supreme Court Fractured Online Pricing

A Supreme Court decision changed the ground rules, and online retailers are scrambling to adapt.

Just as millions of consumers are turning to the web to find the lowest prices, online retailers in many categories find they no longer can compete on price. That’s because a growing number of manufacturers are setting minimum prices on their goods, and in some cases cutting off retailers who sell below those prices.

They are taking advantage of a June 2007 U.S. Supreme Court decision known as Leegin Creative Leather Products Inc. vs. PSKS Inc. that gives greater legal protection to such minimum pricing policies. While these policies are largely aimed at preventing online retailers from undercutting manufacturers’ traditional distribution channel, bricks-and-mortar stores, opinion is divided among online retailers. Some vigorously oppose these pricing policies because they reduce sales while others favor them because they improve profit margins.

Whatever their opinion, many online retailers are finding suppliers mandating minimum prices, particularly on higher-priced goods with strong brands. But manufacturers’ enforcement of these policies-often referred to as MAP, for minimum advertised price-has been uneven. Many online retailers complain that, while they abide by MAP pricing, their competitors do not.

“We lose sales to those guys who sell for less, and we inevitably lower our prices so we can compete with them,” says Richard Wagner, president of InterWorld Highway LLC, operator of Touchboards.com and other e-commerce sites. “Then other direct distributors lower their prices and everyone’s pointing fingers. It turns out to be a big headache because instead of selling product, you’re worrying about who’s at MAP and who isn’t.”

Beyond simply ignoring MAP prices, online retailers have come up with creative ways to offer discounts, such as by e-mailing coupons to customers, or offering free shipping or a discount on a product not covered by a MAP policy. Some manufacturers object, and others do not, further adding to the uncertainty created by the change in the legal landscape.

And that legal landscape could change again in coming years. While the high court in the Leegin decision said minimum pricing policies could be legal, it did not say all are. Some online retailers already are suing, claiming their suppliers’ MAP programs illegally prevent them from using low prices to woo consumers away from better-known retail chains. Until those cases go through the courts, legal questions will remain.

“Not a lot of this is tested yet,” says Christopher S. Finnerty, an attorney with WolfBlock LLP who advises manufacturers on pricing issues. “Leegin is just a year old.”

While those lawsuits play out, online retailers in categories where MAP policies have become prevalent will be testing the boundaries of what suppliers will allow in terms of creative discounting. And they also will be gauging consumer reaction to the disappearance of discounts on many popular items.

Among the big questions raised by minimum price policies is whether consumers will continue to shop the web if they can’t get a better deal online than in a store.

Surveys suggest low price is one reason consumers shop online, but not the most important one. In a Forrester Research Inc. survey early this year 49% of respondents cited convenience as a reason to shop online, 46% selection and 43% value. A more recent consumer survey by The E-Tailing Group found price to rank only fifth among the benefits of shopping online, although it was important to 80% of those surveyed.

Studies by Carnegie-Mellon University professor Michael Smith have shown consumers derive far more value from greater online selection than from lower prices on the web, and that online consumers would pay $1.72 more on average to buy books from brand-name retailers than from merchants they do not know.

That leads Smith to conclude that less freedom to discount will affect some e-retailers more than others. “I don’t see it leading to a mass exodus from the Internet, because lower price isn’t the dominant reason people get value from the Internet,” says Smith, associate professor of information technology and marketing at Carnegie-Mellon and co-director of the Center for Digital Media Research. “But taking away the little guys’ pricing advantage will strengthen the hand of the large players.”

Merchants and manufacturers

Indeed, some manufacturers state explicitly that their minimum-price policies are aimed at cut-rate online retailers. For instance, lighting supplier Kichler says in a letter to retailers outlining its policy, “Due to the growth of the Internet channel of commerce, we are seeing more and more of our distributors losing sales to these low price Internet web sites.” The letter goes on to say that Kichler will stop taking orders from retailers advertising Kichler products below specified prices.

Before the Leegin decision, any agreement between manufacturers and retailers to set prices was automatically illegal. (For more on the legal issues, see story on page 24.) But it was legal to create minimum advertised price programs in which a manufacturer subsidizes advertising costs for retailers that sell at or above minimum prices.

Since Leegin, many manufacturers have converted MAP programs into strict minimum price policies that make clear the suppliers will withhold orders from retailers selling below specified prices or cut them off altogether.

While MAP policies in theory only govern advertised prices, manufacturers generally interpret those rules to cover any price posted on a web site. That heightens the rules’ impact on web retailers.

Wasting no time

Not all retail categories have been affected, but retailers of many types of goods report a sharp increase in manufacturers setting minimum prices since the Leegin decision.

For Ergo on Demand Inc., a web-only retailer of ergonomic office accessories, about half of the items it sells are covered by minimum pricing policies, versus perhaps 10% two years ago; for eHobbies it’s gone up from around 15% to close to 75%; and at HomeCenter.com, it’s now 40%, up from 20%

Do these price policies hurt sales? Web retailers disagree.

Brian Okin, president of HomeCenter.com, says many of the plumbing and lighting products he sells are price-sensitive, and not being able to offer discounts on MAP-covered items has cost him millions of dollars in sales. For instance, on certain lines he sells more than $150,000 per month when he offers discounts and $10,000 when he’s forced to sell at the manufacturer’s recommended price. HomeCenter.com is one of the retailers that has taken legal action over pricing rules, suing Kichler in a New York state court.

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