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Retailer Initiated Vertical Restraints: Toys “R” US. Case Author: F.M. Scherer Presented 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.

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retailer initiated vertical restraints toys r us

Retailer Initiated Vertical Restraints: Toys “R” US

Case Author: F.M. Scherer

Presented by: Janel Bass

Yash Shah

Chad Sykes

  • 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
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
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
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
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
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
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
  • 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
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
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
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
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
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
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
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
Post Trial
  • Additional class action antitrust suits
    • Settlement
  • Declining market share to warehouse clubs and hypermarkets
  • Acquisitions over concerns for viability