A June 2007 ruling gave manufacturers greater leeway to set retail prices. That’s set off a free-for-all as online retailers seek creative ways to compete—including on price.
By Don Davis
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.
In another lawsuit, e-retailers BabyAge.com and BabyCatalog.com are suing the Babies ‘R’ Us subsidiary of retail chain Toys ‘R’ Us Inc. and six manufacturers of baby products alleging that the retailer forced the manufacturers to impose minimum prices to prevent price-cutting by online retailers. Before Leegin, about a dozen baby products suppliers had minimum pricing rules; now it’s around 100, says Jacob Weiss, president of BabyAge.com. Those price-setting rules have cost BabyAge.com tens of millions of dollars in sales, says Jack Kiefer, CEO.
Their suit is in federal court and has been combined with a consumer suit against minimum pricing policies. A trial could occur late in 2009. Toys ‘R’ Us and the manufacturers have denied wrongdoing in legal filings.
Higher profit margins
Other web retailers, however, say MAP policies have little if any impact on sales. “If a consumer wants a product, they’re going to buy from somebody,” says Randy Kremer, president of online-only retailer Rugs Direct. Meanwhile, profit margins go up. MAP policies, which cover about 75% of the sales at Rugs Direct, have improved the retailer’s profit margins by 10% to 15%, says David Craig, CEO
“What happens on the Internet when there’s not a MAP policy in place, it takes retail prices down to unacceptable margins,” Craig says.
That makes MAP beneficial to online retailers, even if sales are lower, says Donal Michael Gleeson, managing director of AOIFE Co. LLC, operator of KitchenSource.com. “Sales decrease, but profits increase,” he says.
And it’s not just the biggest players who benefit. Price controls can help small retailers compete against e-commerce heavyweights, says Jeff Bradshaw, president of Totalvac.com. When there is no price floor, Bradshaw says, a big online retailer like Amazon.com might price a vacuum cleaner that wholesales for $150 at $159, while Bradshaw must sell it at $189 or more to make a profit.
But why should consumers buy online when they can get the same price in a store? Convenience and selection, says Bradshaw, echoing other retailers who defend MAP programs. “Why drive 50 miles to get a Miele vacuum if you can get it online at the same price?” he asks.
MAP pricing just means e-retailers must differentiate themselves in other ways besides price, Craig says.
He says Rugs Direct competes by offering 75,000 SKUs, far more than a typical rug store can stock. The company also provides free shipping on most orders, matches competitors’ prices and lets consumers try out a rug at home for 30 days at no charge. Other e-retailers note there’s no sales tax on most online purchases, giving the consumer an automatic price break. (While shoppers are supposed to pay sales tax on their own, few do.)
Oops, sorry!
And price competition is far from dead. Even when manufacturers mandate minimum prices, some retailers ignore those rules, relying on competing merchants to blow the whistle. “We spend a huge amount of time watching what our competitors are doing and going to the manufacturers telling them when competitors are off MAP pricing,” says Wagner of Touchboards.com.
Wagner says some competitors abide by MAP prices most of the time, but then drop prices at crucial times, such as when schools or government agencies get budget allotments. He says competitor CDW Corp. posted sub-MAP prices on many audio-visual products used by schools in June, just as school districts were planning how to spend the new funds they receive July 1. Given the timing, and the fact that CDW dropped prices on products from several manufacturers, Wagner is convinced it was intentional.
Wagner notified the suppliers, but saw little action, likely because CDW is a big retailer, he believes. “So when they weren’t reacting quickly enough I just matched all of CDW’s prices,” Wagner says. “And when they told me to raise my prices, I said just as soon as CDW raises its prices, and not a second before.”
“CDW supports its business partners and understands the purpose of their Minimum Advertised Price guidelines,” Matt Troka, vice president of product and partner management at CDW, said in an e-mail response to Wagner’s comments. “It is our policy at CDW to take into consideration these guidelines when making our own independent pricing decisions.”
Getting creative
Other retailers are offering discounts in various guises, and waiting to see if manufacturers slap their wrists.
An increasingly common practice is to post a price along with a link saying customers can get a lower price by adding the item to their shopping cart. Retailers argue that this is equivalent to a store marking down a price on a shelf, without advertising it.
Some retailers say such offers generate good results. But Bradshaw of Totalvac.com says it was a lot of work because he had to make sure those product pages did not show up in site search results and were not sent to comparison shopping engines—lest manufacturers complain he was advertising a below-MAP price. He discontinued the practice.
Wagner of Touchboards.com also stopped making such offers after a manufacturer complained. Now Wagner places on his sites banners encouraging visitors to click for a quote, and even has a pop-up figure appear on certain pages to explain that, while manufacturers prevent the retailer from advertising lower prices, visitors can get a better price by clicking on the “Send me a quote” link. About 50% of customers who click provide the requested e-mail address, allowing him to offer a lower price.
On some products, instead of listing a price he displays a “click here for price” link next to a product; when the visitor clicks, he sees a below-MAP price. Visitors also can click on a “why isn’t the sale price shown?” link that explains why the site can’t display prices below those set by manufacturers.
Discount coupons
EHobbies sends customers a 20% off coupon good for their next purchase, even on items that are covered by minimum price rules. Manufacturers have not objected, says Brian Carlevato, senior buyer.
And Rugs Direct sends American Express gift cards worth $25 to $100 to some customers following a purchase. “None of our suppliers have said that’s unacceptable because we’re not discounting the product,” Craig says.
But suppliers have objected to another online rug dealer, Rugs USA, e-mailing coupons to customers that could reduce the prices of MAP-priced items. “Previously, as long as you didn’t have it advertised on your web site you were in the clear,” says CEO Koorosh Yaraghi. “Now many of them get on our e-mail lists, and when we send out an e-mail offering a coupon they make complaints about it.”
Instead, he offers a free pad with price-controlled rugs. “As long as you offer a product, they don’t seem to mind.”
Yaraghi also was dropped by one supplier because a Rugs USA affiliate offered a 5% discount coupon for purchases on Rugs USA that could reduce prices to below manufacturer-specified levels.
In order to offer low prices in this new environment, Yaraghi has begun importing his own rugs or buying stock from liquidators, enabling him to set his own prices. Although that requires him to warehouse his own inventory, instead of relying on drop shippers, he says, “It puts us in control of the product.”
Pushback
Some online retailers are pressing suppliers for more leeway to make offers to customers.
For instance, Xtremez.com, an e-commerce site operated by Paintball Online Inc., sometimes offers a second item for free or at a discount when a customer buys a MAP-protected product. Adam Stites, president, says he lets manufacturers know that if they do not offer him that kind of flexibility their products will not show up as prominently in his marketing materials or search engine advertising. “They’re going to be left behind if they don’t give us any flexibility to market their products,” he says.
The next few years are likely to see more of that kind of push and pull between e-retailers and suppliers over pricing rules, at least until courts, or Congress, clarify how much power manufacturers have to set prices on the web.
don@verticalwebmedia.com
The law on minimum price programs is all over the MAP
For decades, an agreement between a manufacturer and a retailer to fix minimum prices was a per se violation of antitrust law. The agreement was automatically illegal—no proof of harm was necessary.
That changed in June 2007 when a 5-4 majority made up of the generally more conservative U.S. Supreme Court justices ruled that such pricing agreements should be judged on a case-by-case basis. The ruling came in a lawsuit brought by retailer PSKS Inc. against the minimum pricing policies of Leegin Creative Leather Products Inc., a manufacturer of women’s accessories. An agreement to maintain prices above a certain level, the majority said, could in some circumstances expand consumer choice, for instance by enabling retailers a sufficient profit margin to offer valuable services with complex products or to allow a newcomer to break into the market.
Many manufacturers have taken this decision as license to impose price-maintenance agreements. And Christopher S. Finnerty, an attorney with WolfBlock LLP who advises manufacturers on such issues, thinks that’s a risky course.
The high court ruling does not mean pricing agreements are automatically legal, and defending an antitrust lawsuit can be expensive, Finnerty says. Even if the manufacturer wins, it could be sued again later if it gains market share, he says.
A legally safer alternative for manufacturers, Finnerty says, is to set a unilateral policy that states it will not sell to dealers who sell below specified prices. That way there is no agreement between manufacturer and retailer, and no antitrust violation.
Such unilateral policies have always been legal, but hard to implement for long, Finnerty says. “The difficulty is that manufacturers engage in fluid conversations with their dealers on a regular basis,” he says. “It’s difficult to interact with someone more than once and not form an agreement.”
Further complicating the legal picture is the fact that 38 states have laws that make price-fixing agreements per se illegal. New York State has made clear its intent to enforce its law, and in March reached a settlement with Herman Miller Inc., a manufacturer of office chairs, which imposed a $750,000 penalty on the manufacturer and required it to refrain from mandating minimum prices.
In addition, 26 other states signed on to a petition drafted by New York to oppose footwear manufacturer Nine West’s appeal to the Federal Trade Commission to be freed from previously imposed restrictions on fixing retail prices. Nine West argues in its petition that the Leegin decision makes such pricing mandates legal.
And in yet another reaction to the Leegin decision, U.S. Sen. Herb Kohl, R-Wis., chairman of the Senate’s antitrust subcommittee, last fall introduced a bill entitled the Discount Pricing Consumer Protection Act that would reverse the impact of the Leegin decision by restoring a ban on manufacturers setting minimum prices. That bill has not emerged from committee.
