Retailer Initiated Vertical Restraints: Toys “R” US

Case Author: F.M. SchererPresented 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

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

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

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

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%

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

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

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

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”

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

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

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

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.

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

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

Post Trial

Additional class action antitrust suits– Settlement

Declining market share to warehouse clubs and hypermarkets

Acquisitions over concerns for viability

The End