The US Supreme Court recently held that vertical resale price maintenance (RPM) should be reviewed under the rule of reason standard, overruling the 96-year-old case law establishing the per se illegality of minimum resale price maintenance. Since RPM can have both pro-competitive and anti-competitive effects, Korean laws and courts should also evaluate RPM by the rule of reason standard.

On June 28 2007, the US Supreme Court overturned – in Leegin Creative Leather Products, Inc. v. PSKS Inc. (No. 06-480) – the per se rule of Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U. S. 373 (1911), which it has, for the past 96 years, maintained as the basis for determining the illegality of fixing minimum resale prices.

PSKS, a retail women’s clothing store, brought an action against Leegin Creative Leather Products, a manufacturer of women’s accessories including "Brighton" brand products, claiming that Leegin engaged in vertical price fixing of Brighton products. The lower courts found that Leegins policy constituted a per se violation of the Sherman Act §1.

Summary of the Ruling

The US Supreme Court held that a vertical RPM agreement between manufacturers and their retailers are not, per se, anti-competitive and must instead be evaluated under the rule of reason standard. The rule of reason is the accepted standard for evaluating whether a certain practice restrains trade in violation of the Sherman Act. In enacting the Sherman Act, the US Congress intended §1 to give courts the ability to develop governing principles of law as new circumstances evolve. Vertical RPM can have both pro-competitive and anti-competitive effects, depending upon the circumstances in which it is applied. The majority in Leegin upheld the view that RPM can have pro-competitive as well as anti-competitive effects in the market.

Implications of Leegin

As stated by the dissenting opinion in Leegin, because of the difficulty for courts to identify when benefits are likely to outweigh the potential harms, applying the rule of reason may create more confusion and uncertainty. The rule of reason itself does not legalize nor make illegal the practice of RPM as a whole. The new rule of reason analysis may initiate controversies and induce more litigation but may be an inevitable step in the development of a standard that evolves with economic development.

Vertical Restraints in Korea

(i) Types of Vertical Restraints. Restraints are either horizontal or vertical; horizontal restraints refer to those restraints taking place among competitors, while vertical restraints occur between business operators at different levels of the distribution channel. Vertical restraints are subdivided into intrabrand restraints in distribution and vertical foreclosure restricting interbrand competition. Intrabrand restraints in distribution can be further divided into: (a) RPM, which relates to prices, and (b) non-price resale maintenance. RPM refers to the practice whereby a manufacturer requires its retailers to sell the former’s product at or above a price floor (minimum RPM) or at or below a price ceiling (maximum RPM). Non-price resale maintenance restricts the territory, target customers, or method or means of resale. Vertical foreclosure includes tying and exclusive dealing.

(ii) Regulation of RPM in Korea.

  • Statutes. The Monopoly Regulation and Fair Trade Act currently in effect (MRFTA) prohibits an enterprise from implementing RPM (Article 29(1) and (2)). Elements of RPM are: (i) fixed resale price and (ii) binding effect of the fixed resale price. Since the MRFTA is silent on the examination of anti-competitive effects of the fixed resale price, these requirements are the sole criteria for determining a violation under the MRFTA, except that a maximum RPM is permitted "if reasonably justified" (Article 29(1)). This appears to have reflected the US Supreme Court’s case law applying the per se rule to a minimum RPM and the rule of reason standard to a maximum RPM (State Oil Co. v. Khan, 522 U. S. 3 (1997)).

    However, RPM is allowed with respect to such literary works as provided by the Enforcement Decree of the MRFTA or, if designated in advance, in accordance with such procedures as set by the Korea Fair Trade Commission (KFTC).
  • Case Law. In a minimum RPM case, the Korean Supreme Court observed that, if a manufacturer unilaterally determines a resale price of its products and instructs that retailers should sell the products at the notified resale price, it should not be illegal as long as the resale price is offered merely as a reference or proposed price. It then held that, if the offer is accompanied by any means of forcing the instruction into practice, i.e., any binding force, the offer should constitute RPM and therefore be illegal (Supreme Court Judgment 99 Du 11141, dated December 24 2001).

In other words, the Korean Supreme Court has applied the per se rule in determining the illegality of minimum RPM. However, it has alleviated the requirements for RPM in effect by strictly construing the "binding force" element. Consistent with the Korean Supreme Court’s position and the disposition of the legislation, the KFTC has applied the per se rule to minimum RPM cases.

(iii) Economic Effects of RPM. However, the uniform application of the per se rule to minimum RPM cases has repeatedly met a convincing dissent that minimum RPM may have pro-competitive as well as anti-competitive effects, as discussed below, and that its illegality should be judged by balancing the two. Leegin illustrates that the formerly dissenting opinion has now represented the majority of the highest US court.

Anti-competitive Effects

  • Restriction of Intrabrand Competition. RPM is likely to reduce intrabrand competition and thereby discourage retailers from carrying out competition-stimulating sales activities. It also renders readily identifiable a change in resale price set by a particular retailer, easily causing collusion. The likelihood of collusion is high, particularly in a market gravitating toward either manufacturers or retailers.
  • Cartel Among Manufacturers. Where manufacturers form a cartel and fix the supply price for their retailers higher than a normally competitive level, if the manufacturers agree to maintain their respective resale prices, any manufacturer’s reducing, in secrecy, its supply price to retailers would bring no benefits to the manufacturer. Because the retailers are prevented from selling products below the set resale price, there would be no increase in the sales volume that has an effect on the benefits of the manufacturer that deviated from the cartel. Therefore, RPM would prevent potential withdrawals and, if a withdrawal occurs, make it readily identifiable.

    On the other hand, the retailers may still increase the sales volume through non-price competition, and the more the manufacturers lower their supply price, the larger the margins the retailers have. If there are multiple similar manufacturers, the retailers may have a tendency to select another offering a lower supply price. As a result, the manufacturers are induced to withdraw from the cartel. In this regard, the existence of RPM cannot be said to preclude the likelihood of a withdrawal from the cartel.

  • Cartel among Retailers. Retailers may form a cartel and demand manufacturers maintain a certain level for resale prices in order to block entry of new distribution forms of greater efficiency, such as discount stores or mail-order sale. In these circumstances, the development at the distribution level will be impeded and RPM will likely be utilized as a means for retailers to reap monopoly profits.

    However, the recent empirical researches have found that diversified distribution channels would reduce the effect of RPM to block the entry of new retailers.

Pro-Competitive Effects: the Efficiency-Enhancing Theory

  • Avoiding Free Rides; in Point-of-Sale Services. To increase demand for the products they sell, retailers may provide consumers with information, manuals and training related to the products. Such point-of-sale service involves costs, and retailers who do not provide point-of-sale services can save such costs and sell their products at relatively lower prices. Then, rather than providing point-of-sale services directly to customers, retailer A is induced to pursue a "free ride" strategy, whereby customers receive point-of-sale services provided by other retailers and then buy their products from no-frill retailer A at a lower price.

    If RPM is in place, however, products of the same type cannot be sold at a lower price, and consumers cannot buy from no-frill retailers. For the same prices, consumers would rather buy products from retailers providing point-of-sale services. As such, manufacturers can now maintain their resale prices and thereby induce all retailers to provide certain point-of-sale services to customers.
  • Increased Demand from Point-of-Sale Services. In general, reduced prices lead to rising demand and more profits to manufacturers and an increase in consumer surplus, given that consumers can buy products at lower prices. However, in respect of certain products, the sale or demand of which largely depends on certain services (e.g., complicated electronic products and machines), an increase in price due to higher costs incurred by retailers in providing point-of-sale services may be offset by the consequent increase in demand for the product. This would bring extra profits to retailers and more demand on the manufacturers side. As such, RPM may increase the profits of both manufacturers and retailers and thereby increase social benefits.
  • Intensified Interbrand Competition. In particular, RPM would stimulate interbrand competition while reducing intrabrand competition. The likelihood of a cartel may depend upon market conditions. In a market with a number of competing manufacturers or retailers and with low trade barriers, RPM is least likely to encourage cartel formation and, rather, enhance efficiency by fostering interbrand competition. Consumers, among others, enjoy more benefits in the form of diversified product lines, through competition between manufacturers.

Implications of Leegin

The implications of Leegin are not that a minimum RPM is free of anti-competitive aspects but that the illegality of RPM should be determined under the rule of reason by balancing pro-competitive and anti-competitive effects of the RPM. Prior to Leegin, the US Supreme Court, the Korean Supreme Court and Korean law had applied the per se rule in minimum RPM cases, disregarding the fact that minimum RPM may stimulate interbrand competition much more than it restricts intrabrand competition.

However, it is uncertain whether Leegin would lead to amendments to Korean law and change the Korean Supreme Court’s position. Even if it will, it would take a significant period of time before it could be put into practice. However, we can expect that, even before any significant change in laws and precedents, the KFTC would determine its illegality under the rule of reason, just as in maximum RPM cases.

Still, it should be kept in mind that, in determining the pro-competitiveness of RPM under the rule of reason, the determination should not be made by reference to the resale price. That is, a higher resale price would not necessarily render the RPM anti-competitive. Since the resale price is often fixed by reflecting the costs of point-of-sale services, the resale price itself can be higher than a purely competitive level.

Therefore, to determine the pro-competitiveness or anti-competitiveness of RPM under the rule of reason, one should begin with an output analysis, rather than a price analysis. If RPM was implemented for the sole purpose of forming a cartel, the output would likely decrease after the RPM was in place. If it were adopted for pro-competitive purposes, the output would likely increase overall.

However, since increased output does not always lead to an increase in consumer surplus, the output analysis should be balanced against an analysis of this surplus. By applying these two analyses, the pro-competitive benefits of the RPM could be properly analyzed under the rule of reason.

It will not be easy to analyze the pro-competitiveness or anti-competitiveness of RPM. For this analysis, economists are expected to have a greater role in the future. If a distributor brings an RPM case before the KFTC alleging that a manufacturers RPM is illegal, citing reduced output after the RPM is in place, one of the main tasks will be to find out whether the reduced output was caused by the RPM’s anti-competitive effects or other factors of the RPM.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.