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Toys "R" Us Distribution Policies Ruled Illegal

The court of appeals has affirmed an FTC decision against a dominant buyer who imposed unreasonable distribution policies on toy manufacturers and orchestrated a group boycott of competing warehouse clubs.

Toys "R" Us Distribution Policies Ruled Illegal

In 1998, the Federal Trade Commission ordered Toys "R" Us ("TRU"), the nation's largest toy retailer, to stop announcing or enforcing restrictive distribution policies with major toy manufacturers which prohibit or limit the manufacturer's sale of toys to warehouse clubs. The complaint alleged that TRU took action in the late 1980s and throughout the 1990s to have the major toy manufacturers disfavor warehouse clubs, an emerging rival that threatened TRU's market share, which ranged from 35% to 50% in some metropolitan areas.

On appeal, the U.S. Court of Appeals in Chicago unanimously affirmed the FTC order and remedial measures, some of which will be binding upon TRU for five years. (Toys "R" Us, Inc. v. Federal Trade Commission, No. 98-4107).

The antitrust laws, which aim to preserve and protect competition, have long drawn a sharp legal distinction between contractual restrictions that occur up and down the distribution channel - - so-called vertical restraints - - and restrictions that come about as a result of agreements among competitors, or horizontal restraints. Vertical restraints are unlawful only if their anticompetitive effects clearly outweigh any possible business justification and pro-competitive effects, while horizontal restrictions are unlawful without any need to analyze their effect on competition. This case involves vertical agreements between TRU and the toy manufacturers, which led to the formation of a horizontal agreement among toy manufacturers and TRU to boycott the warehouse clubs.

Background

In 1992, TRU announced its new "warehouse club policy" to its key toy suppliers:

• The clubs could have no new or promoted product unless they carried the entire line.

• All specials and exclusives to be sold to the clubs had to be shown first to TRU to see if TRU wanted the item.

• Old and basic product had to be in special packs.

• Clearance and closeout items were permissible provided that TRU was given the first opportunity to buy the product.

• There would be no discussion about prices.

TRU held separate meetings with each manufacturer to discuss the policy. Eventually, agreements were reached with 10 manufacturers to adhere to the policy, after which TRU enforced each company's compliance with its commitment.

TRU went further. It also orchestrated a horizontal conspiracy among 7 manufacturers to adhere to their respective vertical agreements - - by fielding complaints about non-compliance and pressuring the deviating manufacturer to comply in the future. A promise to comply was then relayed by TRU to the complaining manufacturers to bolster collective adherence to the boycott.

The FTC rejected TRU's argument that each toy manufacturer acted independently, not collectively or in agreement with TRU, based on testimony from manufacturers that no manufacturer was willing to limit its sales to this new distribution channel unless there was assurance that its competitors would do likewise. In fact, manufacturers were eager to do business with the warehouse clubs and their decision to stop dealing with them was an abrupt shift from the past.

FTC Ruling Affirmed

Based on an extensive evidentiary record, the FTC concluded that: (1) the TRU-led manufacturer boycott of the warehouse clubs was per se illegal under the antitrust laws, (2) the boycott was also illegal because its anticompetitive effects clearly outweighed any business justification, and (3) the vertical agreements entered into by TRU and the individual toy manufacturers were illegal as clearly producing anticompetitive effects.

On appeal, TRU denied there was sufficient evidence to prove a horizontal conspiracy among the toy manufacturers, with TRU as the ringmaster. It hypothesized an independent motive for each manufacturer to agree to stop selling the warehouse clubs. The court disagreed, citing testimony from toy company executives and TRU that each toy manufacturer would agree to TRU's demands only if its competitors were doing the same. There was sufficient circumstantial evidence that excluded the possibility that the conspirators acted independently.

TRU also argued that it had no market power and thus its conduct could not possibly produce any significant anticompetitive effects. The court found that even though TRU did not possess a large market share (20% of the US market), market power can be shown through direct evidence of anticompetitive effects. TRU's remarkable success in causing 10 major toy manufacturers to halt sales to TRU competitors was sufficient proof without a more elaborate market analysis.

Finally, the court upheld the FTC's cease-and-desist order which prohibits TRU from agreeing with its suppliers to limit sales to toy discounters, or facilitating such agreements among suppliers, or from urging or coercing suppliers to restrict sales to any toy discounter.

 

Keeley, Kuenn & Reid, a Chicago based law firm with government relations affiliates in Washington, D.C., is engaged in the practice of business law, commercial litigation, employment law, taxation, antitrust, product liability, estate planning and legislative matters. Through its affiliates, the firm also meets its clients' needs in protecting intellectual property rights and international commercial law matters.

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