1. Retailer Initiated Vertical Restraints: Toys “R” US
Case Author: F.M. Scherer
Presented by: Janel Bass
Yash Shah
Chad Sykes

2. Players Toy Manufacturers Toys “R” US (TRU) Warehouse Clubs
Ex: Mattel, Nintendo, Sega
Toys “R” US (TRU)
Warehouse Clubs
Ex: Costco, Sam’s Club, BJ’s
Federal Trade Commission

3. 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

4. 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

5. 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

6. 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%

7. 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

8. 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

9. Antitrust
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

10. 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”

11. 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

12. 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

13. 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

14. 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.

15. 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

16. 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

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

18. The End