221 F.3d 928 (7th Cir. 2000), 98-4107, Toys "R" Us v Federal Trade Commission

Docket Nº:98-4107
Citation:221 F.3d 928
Party Name:Toys "R" Us, Inc., Petitioner-Appellant, v. Federal Trade Commission, Respondent-Appellee.
Case Date:August 01, 2000
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit
 
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221 F.3d 928 (7th Cir. 2000)

Toys "R" Us, Inc., Petitioner-Appellant,

v.

Federal Trade Commission, Respondent-Appellee.

No. 98-4107

In the United States Court of Appeals, For the Seventh Circuit

August 1, 2000

Argued May 18, 1999

On Petition for Review from a Decision of the Federal Trade Commission. Docket No. 9278.

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[Copyrighted Material Omitted]

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Before Coffey, Kanne, and Diane P. Wood, Circuit Judges.

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 the distribution of its products to low- priced warehouse club stores, on the condition that other manufacturers would do the same. This practice, the Commission found, violated sec. 5 of the Federal Trade Commission Act, 15 U.S.C. sec. 45. It also found that TRU had entered into a series of vertical agreements that flunked scrutiny under antitrust's rule of reason. TRU appealed that decision to us. It attacks both the sufficiency of the evidence supporting the Commission's conclusions and the scope of the Commission's remedial order. It is hard to prevail on either type of challenge the former is fact-intensive and faces the hurdle of the substantial evidence standard of review, while the latter calls into 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 any of its competitors. As one might suspect from these figures alone, TRU is a critical outlet for toy manufac turers. It buys about 30% of the large, traditional toy companies' total output and it is usually their most important customer. According to evidence before the Commission's administrative law judge, or ALJ, even a company as large as Hasbro felt that it could not find other retailers to replace TRU--and Hasbro, along with Mattel, is one of the two largest

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toy manufacturers in the country, accounting for approximately 12% of the market for traditional toys and 10% of a market that includes video games. Similar opinions were offered by Mattel and smaller manufacturers.

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 virtually monopolized by TRU today--that sell at an average 30% mark- up. General discounters like Wal-Mart, K- Mart, and Target are next, with a 22% mark-up, and last are the stores that are the focus of this case, the warehouse clubs like Costco and Pace. The clubs sell toys at a slender mark-up of 9% or so.

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 heart set on a figure of Anakin Skywalker will be disappointed if he receives Jar-Jar Binks, or a truck, or a baseball bat instead. Toy retailers naturally want to have available for their customers the season's hottest items, because toys are also a very faddish product, as those old enough to recall the mania over Cabbage Patch kids or Tickle Me Elmo dolls will attest.

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 could not or did not wish to meet its prices, or from general discounters like Wal-Mart or K-Mart, which could not offer anything like the variety of items TRU had and whose prices were not too far off TRU's mark.

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 competition over service amenities. Nevertheless, the Commission found that the clubs seek to offer name-brand merchandise, including toys. During the late 1980s and early 1990s, warehouse clubs selected and purchased from the toy manufacturers' full array of products, just like everyone else. In some instances they bought specialized packs assembled for the "club" trade, but they normally preferred stocking conventional products so that their customers could readily compare the price of an item at the club against the price of the same item at a competing store.

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 some of its suppliers, including toy manufacturing heavyweights Mattel, Hasbro, and Fisher Price. At the Toy Fair in 1992 (a major event at which the next Christmas season's orders are placed), Goddu informed the manufacturers of a new TRU policy, which was reflected in a memo of January 29, 1992. The policy set forth the following conditions and privileges for TRU

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

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* 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 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 uniqueindividual items or combo packs) that were not offered to anything but a club (and thus of course not to TRU). As the Commission put it, "[t]hrough its announced policy and the related agreements discussed below, TRU sought to eliminate the competitive threat the clubs posed by denying them merchandise, forcing the clubs' customers to buy prod ucts 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 sold to the clubs might gain sales at their expense, given the widespread and increasing popularity of the club format. To address this problem, the Commission found, TRU orchestrated a horizontal agreement among its key suppliers to boycott the clubs. The evidence on which the Commission relied showed that, at a minimum, Mattel, Hasbro, Fisher Price, Tyco, Little Tikes, Today's Kids, and Tiger Electronics agreed to join in the boycott "on the condition that their competitors...

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