Chapter 5
GOVERNMENT REGULATION OF COMPETITION AND PRICES
RESTATEMENT
Under the U.S. Constitution, the federal and state governments are given “police power” or the power to regulate
commercial and other activities. At all levels of government, there are regulations of business activity. While there
has been a significant trend toward deregulation, a great many laws still impact businesses such as those that
regulate worker safety, food purity and the sale of pharmaceuticals. In some industries, such as the savings and loan
industry, deregulation has not been effective or has caused harm, and government has stepped back in with
additional regulation. Currently, telecommunications and electric utilities are in a deregulation phase. Government
regulation is broad and diverse. The financing of a business is regulated in many ways from the method by which
interests are sold to investors to the regulations on loans to businesses.
Government regulation of competition is really regulation designed to prevent unfair competition. The Federal Trade
Commission (FTC) was given the authority by Congress to regulate “unfair” competition which has been defined to
include everything from deceptive ads or labels to industrial espionage to market restrictions. Price discrimination
between different buyers of like commodities is also prohibited. Monopolistic practices by businesses are prohibited.
Monopolies can exist but must be the result of a better product, price or service and not the result of driving
competitors out of business with unfair tactics. Mergers and other combinations are regulated to prevent
monopolization. Anticompetitive behavior carries both civil and criminal sanctions.
STUDENT LEARNING OUTCOMES
LO.1: Explain the powers the government has to be sure free markets are working efficiently.
LO.2: List the federal statutes that regulate horizontal markets and competition and give examples of each.
LO.3: Describe the federal statutes that regulate the supply chain and vertical markets.
LO.4 Discuss the remedies available to protect business competition.
INSTRUCTOR’S INSIGHTS
Break the chapter into four components – related Learning Outcomes are indicated in ( ):
1. What power and authority do governments have to regulate business? (LO.1)
Cover the concept of free enterprise
Discuss the movements toward deregulation
Present the areas of business where government regulation is most extensive
2. How does the government regulate and protect markets and competition? (LO.2)
Review the concept of fairness in commerce and the role of the Federal Trade Commission in creating a
level playing field for competitors
Discuss the types of price discrimination and delineate those types that are illegal
Define monopolies and cover the types of monopolies and monopolistic conduct that are illegal
List the types of mergers and requirements for undertaking such combinations
3. How does the government regulate the supply chain and vertical markets? (LO.3)
4. What are the penalties and remedies available when there is anticompetitive behavior? (LO.4)
CHAPTER OUTLINE
I. What Power and Authority do Governments Have to Regulate Business?
A. Free enterprise system – market with its demands controls behavior
B. Sometimes markets don’t move quickly enough to stop harms or provide remedies
1. Use example of Savings and Loan deregulation, then re-regulations
2. See also telecommunications, cable TV pricing, and market and regulation of pricing
3. Use example of electricity and shortage issues in California
C. Government may also regulate the production, distribution, and financing of goods and services
D. Power to regulate unfair competition (See Figure 5-1)
1. FTC has authority – created by Congress
2. Given broad authority to stop deceptive trade practices
3. Name appropriation
4. Deceptive ads
5. Deceptive labels, boycotting disparagement
II. How Does the Government Regulate and Protect Markets and Competition?
A. Regulation of horizontal markets and competitors
1. Prohibition on price fixing
a. Horizontal price fixing violates the Sherman Act
b. Price fixing is a per se violation
B. Prevention of monopolies and combinations
1. The Federal Antitrust Act and Sherman Antitrust Act – prevent monopolies
2. Conduct prohibited under Sherman Act
DISCUSSION POINTS: Ethics & the Law
Toys Я Us and Horizontal/Vertical Controls on Distribution
Here is the Court of Appeals decision on this case:
TOYS “R” US, INC., Petitioner-Appellant, v. FEDERAL TRADE COMMISSION, Respondent-Appellee
221 F.3d 928 (2000)
DIANE P. WOOD, Circuit Judge.
The antitrust laws, which aim to preserve and protect competition in economically sensible markets, have long drawn
a sharp distinction between contractual restrictions that occur up and down a distribution chain-so-called vertical
restraints, and restrictions that come about as a result of agreements among competitors, or horizontal restraints.
Sometimes, however, it can be hard as a matter of fact to be sure what kind of agreement is at issue. This was the
problem facing the Federal Trade Commission (“the Commission”) when it brought under its antitrust microscope the
large toy retailer Toys “R” Us (more properly Toys “R” Us, but to avoid debate we will abbreviate the company’s name
as TRU, in keeping with the parties’ usage).
The Commission concluded, upon an extensive administrative record, that TRU had acted as the coordinator of a
horizontal agreement among a number of toy manufacturers. The agreements took the form of a network of vertical
agreements between TRU and the individual manufacturers, in each of which the manufacturer promised to restrict
question the Commission’s exercise of its discretion to remedy an established violation of the law. We conclude that,
while reasonable people could differ on the facts in this voluminous record, the Commission’s decisions pass muster,
and we therefore affirm.
I.
TRU is a giant in the toy retailing industry. The Commission found that it sells approximately 20% of all the toys sold
in the United States, and that in some metropolitan areas its share of toy sales ranges between 35% and 49%. The
variety of toys it sells is staggering: over the course of a year, it offers about 11,000 individual toy items, far more than
Toys are sold in a number of different kinds of stores. At the high end are traditional toy stores and department stores,
both of which typically sell toys for 40 to 50% above their cost. Next are the specialized discount stores, a category
The toys customers seek in all these stores are highly differentiated products. The little girl who wants Malibu Barbie
is not likely to be satisfied with My First Barbie, and she certainly does not want Ken or Skipper. The boy who has his
What happened in this case, according to the Commission, was fairly simple. For a long time, TRU had enjoyed a
strong position at the low price end for toy sales, because its only competition came from traditional toy stores who
The advent of the warehouse clubs changed all that. They were a retail innovation of the late 1970s: the first one
opened in 1976, and by 1992 there were some 600 individual club stores around the country. Rather than earning all
of their money from their mark-up on products, the clubs sell only to their members, and they charge a modest annual
membership fee, often about $30. As the word “warehouse” in the name suggests, the clubs emphasize price
To the extent this strategy was successful, however, TRU did not welcome it. By 1989, its senior executives were
concerned that the clubs were a threat to TRU’s low-price image and, more importantly, to its profits. A little legwork
revealed that as of that year the clubs carried approximately 120-240 items in direct competition with TRU, priced as
much as 25 to 30% below TRU’s own price levels.
TRU put its President of Merchandising, a Mr. Goddu, to work to see what could be done. The response Goddu and
other TRU executives formulated to beat back the challenge from the clubs began with TRU’s decision to contact
• 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.
TRU was careful to meet individually with each of its suppliers to explain its new policy. Afterwards, it then asked
each one what it intended to do. Negotiations between TRU and the manufacturers followed, as a result of which
each manufacturer eventually agreed that it would sell to the clubs only highly differentiated products (either unique
products they did not want, and frustrating customers’ ability to make direct price comparisons of club prices and TRU
prices.” FTC opinion at 14.
The agreements between TRU and the various manufacturers were, of course, vertical agreements, because they
ran individually from the supplier/manufacturer to the purchaser/retailer. The Commission found that TRU reached
about 10 of these agreements. After the agreements were concluded, TRU then supervised and enforced each toy
company’s compliance with its commitment.
But TRU was not content to stop with vertical agreements. Instead, the Commission found, it decided to go further. It
worked for over a year and a half to put the vertical agreements in place, but “the biggest hindrance TRU had to
overcome was the major toy companies’ reluctance to give up a new, fast-growing, and profitable channel of
distribution.” FTC opinion at 28. The manufacturers were also concerned that any of their rivals who broke ranks and
The Commission first noted that internal documents from the manufacturers revealed that they were trying to expand,
not to restrict, the number of their major retail outlets and to reduce their dependence on TRU. They were specifically
interested in cultivating a relationship with the warehouse clubs and increasing sales there. Thus, the sudden
adoption of measures under which they decreased sales to the clubs ran against their independent economic
Evidence from the manufacturers corroborated Goddu’s account. A Mattel executive said that it would not sell the
clubs the same items it was selling to TRU, and that this decision was “based on the fact that competition would do
the same.” Id. at 32. A Hasbro executive said much the same thing: “because our competitors had agreed not to sell
loaded [that is, promoted] product to the clubs, that we would … go along with this.” Id. TRU went so far as to assure
individual manufacturers that no one would be singled out.
Once the special warehouse club policy (or, in the Commission’s more pejorative language, boycott) was underway,
TRU served as the central clearinghouse for complaints about breaches in the agreement. The Commission gave
numerous examples of this conduct in its opinion. See id. at 33-37.
Last, the Commission found that TRU’s policies had bite. In the year before the boycott began, the clubs’ share of all
toy sales in the United States grew from 1.5% in 1991 to 1.9% in 1992. After the boycott took hold, that percentage
slipped back by 1995 to 1.4%. Local numbers were more impressive. Costco, for example, experienced overall
The Commission also considered the question whether TRU might have been trying to protect itself against free
riding, at least with respect to its vertical agreements. It acknowledged that TRU provided several services that might
be important to consumers, including “advertising, carrying an inventory of goods early in the year, and supporting a
full line of products.” FTC opinion at 41-42. Nevertheless, it found that the manufacturers compensated TRU directly
for advertising toys, storing toys made early in the year, and stocking a broad line of each manufacturer’s toys under
Based on this record, the Commission drew three central conclusions of law: (1) the TRU-led manufacturer boycott of
the warehouse clubs was illegal per se under the rule enunciated in Northwest Wholesale Stationers, Inc. v. Pacific
Stationery & Printing Co. , 472 U.S. 284, 105 S.Ct. 2613, 86 L.Ed.2d 202 (1985); (2) the boycott was illegal under a
full rule of reason analysis because its anticompetitive effects “clearly outweigh[ed] any possible business
justification”; and (3) the vertical agreements between TRU and the individual toy manufacturers, “entered into
seriatim with clear anticompetitive effect, violate section 1 of the Sherman Act.” FTC opinion at 46. These antitrust
violations in turn were enough to prove a violation of FTC Act § 5, which for present purposes tracks the prohibitions
of the Sherman and Clayton Acts. After offering a detailed explanation of these conclusions (spanning 42 pages in its
slip opinion), it turned to the question of remedy and affirmed the order the ALJ had entered.
In the Commission’s words, its order:
… prohibits TRU from continuing, entering into, or attempting to enter into, vertical agreements with its suppliers to
limit the supply of, or refuse to sell, toys to a toy discounter. See ¶ II.A. The order also prohibits TRU from facilitating,
or attempting to facilitate, an agreement between or among its suppliers relating to the sale of toys to any retailer.
FTC opinion at 88. TRU complained that the order trampled on its ability to exercise its rights under United States v.
Colgate & Co ., 250 U.S. 300, 39 S.Ct. 465, 63 L.Ed. 992 (1919), to choose unilaterally the companies with which it
wanted to deal. The Commission rejected the point, because it found that TRU had repeatedly crossed the line from
unilateral to concerted behavior in illegal ways, and that it was entitled to include remedial provisions that were
necessary to prevent recurrence of the illegal behavior, citing FTC v. National Lead Co. , 352 U.S. 419, 430, 77 S.Ct.
502, 1 L.Ed.2d 438 (1957).
Commissioner Swindle concurred in part and dissented in part. He agreed with the majority’s determination that TRU
had engaged in a series of anticompetitive vertical agreements, and he thus agreed with the remedial provisions
designed to proscribe those practices and their effects. He was unconvinced, however, that TRU had orchestrated a
II.
On appeal, TRU makes four principal arguments: (1) the Commission’s finding of a horizontal conspiracy is contrary
to the facts and impermissibly confuses the law of vertical restraints with the law of horizontal restraints; (2) whether
the restrictions were vertical or horizontal, they were not unlawful because TRU has no market power, and thus the
A. Horizontal Conspiracy
As TRU correctly points out, the critical question here is whether substantial evidence supported the Commission’s
finding that there was a horizontal agreement among the toy manufacturers, with TRU in the center as the ringmaster,
to boycott the warehouse clubs. It acknowledges that such an agreement may be proved by either direct or
circumstantial evidence, under cases such as Matsushita Electric Indus. Co. v. Zenith Radio Corp. , 475 U.S. 574, 106
S.Ct. 1348, 89 L.Ed.2d 538 (1986) (horizontal agreements), Monsanto Co. v. Spray-Rite Service Corp. , 465 U.S. 752,
In TRU’s opinion, this record shows nothing more than a series of separate, similar vertical agreements between itself
and various toy manufacturers. It believes that each manufacturer in its independent self-interest had an incentive to
limit sales to the clubs, because TRU’s policy provided strong unilateral incentives for the manufacturer to reduce its
sales to the clubs. Why gain a few sales at the clubs, it asks, when it would have much more to gain by maintaining a
good relationship with the 100-pound gorilla of the industry, TRU, and make far more sales?
We do not disagree that there was some evidence in the record that would bear TRU’s interpretation. But that is not
the standard we apply when we review decisions of the Federal Trade Commission. Instead, we apply the substantial
evidence test, which we described as follows in another case in which the Commission’s decision to stop a hospital
merger was at issue:
Our only function is to determine whether the Commission’s analysis of the probable effects of these acquisitions on
hospital competition in Chattanooga is so implausible, so feebly supported by the record, that it flunks even the
deferential test of substantial evidence.
Hospital Corp. of America v. F.T.C. , 807 F.2d 1381, 1385 (7th Cir.1986). There, as here, the Commission
painstakingly explained in a long opinion exactly what evidence in the record supported its conclusion. We need only
decide whether the inference the Commission drew of horizontal agreement was a permissible one from that
evidence, not if it was the only possible one.
The Commission’s theory, stripped to its essentials, is that this case is a modern equivalent of the old Interstate
Circuit decision. That case too involved actors at two levels of the distribution chain, distributors of motion pictures
and exhibitors. Interstate Circuit was one of the exhibitors; it had a stranglehold on the exhibition of movies in a
number of Texas cities. The antitrust violation occurred when Interstate’s manager, O’Donnell, sent an identical letter
to the eight branch managers of the distributor companies, with each letter naming all eight as addressees, in which
The Commission is right. Indeed, as it argues in its brief, the TRU case if anything presents a more compelling case
for inferring horizontal agreement than did Interstate Circuit, because not only was the manufacturers’ decision to
stop dealing with the warehouse clubs an abrupt shift from the past, and not only is it suspicious for a manufacturer to
deprive itself of a profitable sales outlet, but the record here included the direct evidence of communications that was
missing in Interstate Circuit. Just as in Interstate Circuit, TRU tries to avoid this result by hypothesizing independent
That is a horizontal agreement. As we explain further below in discussing TRU’s free rider argument, it has nothing to
do with enhancing efficiencies of distribution from the manufacturer’s point of view. The typical story of a legitimate
vertical transaction would have the manufacturer going to TRU and asking it to be the exclusive carrier of the
manufacturer’s goods; in exchange for that exclusivity, the manufacturer would hope to receive more effective
Northwest Stationers also demonstrates why the facts the Commission found support its conclusion that the essence
of the agreement network TRU supervised was horizontal. There the Court described the cases that had condemned
boycotts as “per se” illegal as those involving “joint efforts by a firm or firms to disadvantage competitors by either
directly denying or persuading or coercing suppliers or customers to deny relationships the competitors need in the
competitive struggle.” 472 U.S. at 294, 105 S.Ct. 2613 (internal citations omitted). The boycotters had to have some
B. Degree of TRU’s Market Power
TRU’s efforts to deflate the Commission’s finding of market power are pertinent only if we had agreed with its
argument that the Commission’s finding of a horizontal agreement was without support. Horizontal agreements
among competitors, including group boycotts, remain illegal per se in the sense the Court used the term in Northwest
Stationers. We have found that this case satisfies the criteria the Court used in Northwest Stationers for
[5] TRU seems to think that anticompetitive effects in a market cannot be shown unless the plaintiff, or here the
Commission, first proves that it has a large market share. This, however, has things backwards. As we have
explained elsewhere, the share a firm has in a properly defined relevant market is only a way of estimating market
power, which is the ultimate consideration. Ball Memorial Hospital, Inc. v. Mutual Hospital Insurance , 784 F.2d 1325,
1336 (7th Cir.1986). The Supreme Court has made it clear that there are two ways of proving market power. One is
through direct evidence of anticompetitive effects. See FTC v. Indiana Fed’n of Dentists , 476 U.S. 447, 460-61, 106
S.Ct. 2009, 90 L.Ed.2d 445 (1986) (“the finding of actual, sustained adverse effects on competition in those areas
The Commission found here that, however TRU’s market power as a toy retailer was measured, it was clear that its
boycott was having an effect in the market. It was remarkably successful in causing the 10 major toy manufacturers
to reduce output of toys to the warehouse clubs, and that reduction in output protected TRU from having to lower its
prices to meet the clubs’ price levels. Price competition from conventional discounters like Wal-Mart and K-Mart, in
C. Free Riding Explanation
TRU next urges that its policy was a legitimate business response to combat free riding by the warehouse clubs. We
think, however, that it has fundamentally misunderstood the theory of free riding. Briefly, that theory is as follows. The
manufacturer of a product, say widgets, has an incentive to distribute as many widgets as it can, while keeping its
costs of distribution down as low as possible. In many instances, this means that the manufacturer will want to sell its
widgets for a particular wholesale price and it will want its retailer to apply as low a mark-up as possible (i.e. put the
product on the market for as little extra expense as possible). Sometimes, however, the manufacturer will want the