On June 28, the Supreme Court of the U.S. issued a groundbreaking decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., 2007 WL 1835892 (June 28, 2007). This decision has the potential to have a large-scale effect on consumers, manufacturers, and resellers in the United States. The Leegin decision overruled Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911), the case that established vertical price fixing as per se illegal for almost one hundred years.
Leegin has instituted a rule of reason analysis for vertical price agreements making it possible for a manufacturer and a reseller to legally agree on a resale price. While the focus of this decision may seem narrow, its potential impact on distribution and how we buy products in the United States is broad.
For the manufacturer the current marketplace is littered with obstacles to successful distribution; antiquated distribution practices, growth in internet sales, rampant counterfeiting and the international movement of gray market goods have hastened traditional margin erosion rates to an unstable pace. These factors have combined to create a perfect storm opposing margin stability, forcing the manufacturer to react to market forces, rather than strategically plan for them.
While these four forces appear to act independently, problems arising from the last three are symptomatic of choices made in the first. Whether it is free-riding internet dealers driving down resale price, the manufacturer's 'partners' in China running their own midnight production shift, or national dealers selling internationally, each problem can be curbed once the manufacturer takes more control over how its products are sold, through strategic distribution and resale price maintenance ("RPM").
A manufacturer needs to know who it is selling to and how those dealers are in turn selling its products. It is not enough to place a product in the stream of commerce and hope for the best. The manufacturer must grab the helm and help steer the product's course. Through long-term distribution planning, a manufacturer can slow and even control the storm of unsustainable margin erosion. A manufacturer must recognize that long term means more than deciding you intend to be in business a decade from now, it means determining a path that can increase market share and profitability. Understanding that while some partners and opportunities may be profitable in the immediate term, they can become destructive over time is essential to long-term distribution planning.
While it might seem contradictory to say that not every sale is a good sale, in this modern market, where the value of a product is tied so heavily to branding, it is often true. Eroding the value of the brand is akin to eroding the quality of the product. If a manufacturer's products are always on clearance or available online at liquidation prices, how can one expect dealers and consumers to recognize its products as quality goods worth a premium? Poorly chosen distribution channels can have profound effects on the market internationally, manifesting when the manufacturer realizes that a handful of dealers are destroying the market.
Facing this storm in distribution, how does the manufacturer begin to maintain margin, and where does the recent U.S. Supreme Court decision in Leegin fit into the equation? The manufacturer must carefully examine how it is currently selling its products versus how it wishes its products were being sold. If the manufacturer's dealers fail to correspond to the manufacturer's goals it must examine its distribution network to determine how each dealer relates to margin stability.
Putting partners in a position to succeed does not happen by chance; quality partners should be paired with premium products, while commodity sellers should be paired with commodity products. Staging distribution according to these parameters allows products to sustain margin initially and then commoditize as needed. While predetermining a product's ideal life-cycle and which distribution channels are appropriate, examining whether RPM can help facilitate that life-cycle is vital.
While RPM can take many forms from MSRP to MAP, from unilateral policies, to now maybe price agreements, each must be weighed carefully. As a general rule, the more effective the method of sustaining margin, the more legal risk it carries. Unilateral policies have always carried legal risk, but when administered properly, that risk becomes manageable. It is when the manufacturer's conduct changes from unilateral to bilateral, it then crosses to illegality.
After Leegin, the rule that bilateral action equals illegality is no longer. While it is true that Leegin created the possibility of a legal agreement as to price, it has not guaranteed that every agreement will be legal. Leegin has provided a second tier of defense to manufacturers who employ unilateral policies under the landmark ruling in U.S. v. Colgate, 250 U.S. 300, 39 S.Ct. 465 (1919). The first being, that the action was unilateral, therefore lawful under Colgate, and second, that even if the conduct was bilateral it was legal under Leegin. This distinction will have a profound effect on how products are sold, by making unilateral activity a more attractive option.
While agreement on price has allure, the beauty of unilateral policies is the manufacturer's ability to act without the consent of the other party and the ability to amend the policy without approval from dealers. This flexibility, tied to a strong distribution strategy, allows the manufacturer to anticipate the market and seamlessly react to market conditions. The manufacturer can adjust the resale price of its products according to factors it deems relevant, while cycling products on and off its policy as the market demands.
Control over these forces grants the manufacturer a degree of control over its products after they leave production. When a product line is examined with the manufacturer's goals in mind, and distribution channels are examined under the same criteria, distinctions in function can be made. Combined with margin goals, RPM can then be employed to maintain goals on specific products while market forces can drive other products.
Assessing current distribution and applying restrictions where necessary enables the manufacturer to control the number of internet resellers who are eroding margin and restrict the international gray market sale of its goods. Controlling a product's price allows for precise market timing, allowing the manufacturer to look beyond its current products to the next product's life-cycle. Combining strong distribution strategy with appropriate RPM can enable a manufacturer to compete in an international commodity marketplace.
Christopher S. Finnerty is a corporate attorney in the Boston office of WolfBlock. Finnerty focuses on national and international distribution issues. He can be reached at [email protected].