Opinion ID: 2994508
Heading Depth: 2
Heading Rank: 3

Heading: Free Riding Explanation

Text: 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 retailer to provide special services or amenities that cost money, such as attractive premises, trained salespeople, long business hours, full- line stocking, or fast warranty service. But the costs of providing some of those amenities (usually pre-sale services) are hard to pass on to customers unless some form of restricted distribution is available. What the manufacturer does not want is for the shopper to visit the attractive store with highly paid, intelligent sales help, learn all about the product, and then go home and order it from a discount warehouse or (today) on-line discounters. The shopper in that situation has taken a free ride on the retailer’s efforts; the retailer never gets paid for them, and eventually it stops offering the services. If those services were genuinely useful, in the sense that the product plus service package resulted in greater sales for the manufacturer than the product alone would have enjoyed, there is a loss both for the manufacturer and the consumer. Hence, antitrust law permits nonprice vertical restraints that are designed to facilitate the provision of extra services, recognizing that a manufacturer in a competitive market who has guessed wrong will eventually be forced by the market to abandon the restrictions. See Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, 724 (1988), quoting Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 52 n.19 (1977). Here, the evidence shows that the free- riding story is inverted. The manufacturers wanted a business strategy under which they distributed their toys to as many different kinds of outlets as would accept them: exclusive toy shops, TRU, discount department stores, and warehouse clubs. Rightly or wrongly, this was the distribution strategy that each one believed would maximize its individual output and profits. The manufacturers did not think that the alleged extra services TRU might have been providing were necessary. This is crucial, because the most important insight behind the free rider concept is the fact that, with respect to the cost of distribution services, the interests of the manufacturer and the consumer are aligned, and are basically adverse to the interests of the retailer (who would presumably like to charge as much as possible for its part in the process). See Premier Electrical Construction Co. v. Nat’l Electrical Contractors Ass’n, 814 F.2d 358, 369-70 (7th Cir. 1987) ([the rationale for permitting restricted distribution policies] depends on the alignment of interests between consumers and manufacturers. Destroy that alignment and you destroy the power of the argument.). What TRU wanted or did not want is neither here nor there for purposes of the free rider argument. Its economic interest was in maximizing its own profits, not in keeping down its suppliers’ cost of doing business. Furthermore, we note that the Commission made a plausible argument for the proposition that there was little or no opportunity to free ride on anything here in any event. The consumer is not taking a free ride if the cost of the service can be captured in the price of the item. As our earlier review of the facts demonstrated, the manufacturers were paying for the services TRU furnished, such as advertising, full-line product stocking, and extensive inventories. These expenses, we may assume, were folded into the price of the goods the manufacturers charged to TRU, and thus these services were not susceptible to free riding. On this record, in short, TRU cannot prevail on the basis that its practices were designed to combat free riding.