In A Fix

You can fix your car. You can fix your cat. But you can't fix your prices.
Magazine Contributor
6 min read

This story appears in the May 2000 issue of Entrepreneur. Subscribe »

The frustrating part of setting prices for goods and services is figuring out what competitors are going to charge. Will your price be so low that you attract customers but can't make a decent profit? Will you be the only place in town charging so much for the item? How can you find out what your competitors are charging so you can adjust your prices slightly higher or lower?

The traditional method is to read your competitors' sale ads or send someone over to scope out their prices. Wonder why you can't save the hassle and just pick up the phone to chat with your competitors about it? Because that would be a direct violation of the Sherman Antitrust Act, a federal law adopted in 1890. The Sherman Act was designed to encourage healthy competition and keep any one company from monopolizing a whole industry. It's the law under which the Justice Department is pursuing Microsoft, but it can apply to even the smallest store. The law forbids competing companies of any size from entering "contracts, combinations or conspiracies" in restraint of trade.

That's what got a group of gas station owners in trouble in Dothan, Alabama. Motorists noticed a pattern: After prices at most gas stations in this town of 50,000 had remained the same for weeks, suddenly they would all change. Major brand dealers charged the same as independents, consistently higher than in surrounding communities. Of course, it's easy for gas station owners to keep tabs on what the competition is charging, since current prices are typically posted on large signs out front. Still, in this town, the sudden changes looked suspicious.

Four consumers filed a class-action lawsuit under the Sherman Act against a dozen gasoline retailers and their owners. During the trial, employees testified that they had overheard conversations and phone calls in which one owner asked another to "go along" because "everyone" in Dothan was about to increase prices. Those who refused sometimes received angry visits from competitors. The jury concluded that five of the station owners had engaged in illegal price fixing.

Violation of the Sherman Act is a felony, subject to fines of up to $1 million and jail terms of up to three years. Injured competitors or customers may sue and recover up to three times the dollar amount of their damages. Just defending such a lawsuit can easily cost $50,000 in attorneys' fees, and bad publicity from a price-fixing case can last a lifetime. But the defendants in Dothan lucked out; the court only assessed a nominal fine and issued an injunction not to do it again.

Steven C. Bahls, dean of Capital University Law School in Columbus, Ohio, teaches entrepreneurship law. Freelance writer Jane Easter Bahls specializes in business and legal topics.

What's Safe?

Does this mean you can't engage in "parallel pricing," adjusting prices to reflect those of your competitors? No. Courts recognize that when there's a limited number of companies competing in an industry, prices will tend to be the same. If the industry leader lowers prices, competitors will do the same if they want to survive. If the leader raises prices but the others don't follow suit, the leader's prices will soon drop. No firm will stay out of line for long. Courts have ruled that it's not illegal for businesses to keep their prices parallel as long as they don't consult with each other about it. There's no sense in outlawing a practice that's inevitable.

The problem is determining whether parallel prices stem from independent decisions or from owners cutting a deal. Merely asserting that your price decisions were independent probably won't persuade the jury if the evidence points the other way. In one Utah case, 14 distributors of eggs were accused of price fixing when they all offered egg farmers the same depressed price for their eggs. The distributors denied they'd agreed on prices, but the jury didn't believe them because company representatives met regularly at a cafe and constantly made phone calls to each other.

The Sherman Act also outlaws agreements between competitors on other matters besides pricing. For instance, you can't sit down with your competitors and agree to standardize your products, refuse certain credit cards or charge a standard interest rate on financing packages. You can't divide territories with your competitors or agree on who gets which customers. If an agreement tends to limit competition, it's illegal.

Know Your Rights

One exception concerns manufacturers who sell through dealerships. While competing companies may not conspire together to set prices or standardize products and services, it's not illegal for a manufacturer to set a suggested retail price and offer incentives for following it. The U.S. Supreme Court established this principle in 1919 in a case called United States v. Colgate & Co., ruling that the Sherman Act "did not restrict the long-recognized right of trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal; and of course, he may announce in advance the circumstances under which he will refuse to sell." Later case law would decide what manufacturers may and may not do in this area. In general, though, if a dealer refuses to follow a suggested retail price, the manufacturer is free to terminate the dealership.

For example, in one case decided last November, a manufacturer of products for horses told its dealers that it would stop working with any dealer who sells its products for less than 90 percent of the established retail price. When a dis-tributor issued a catalog listing the company's horse blankets and sheets for less, the manufacturer promptly sent a letter terminating the dealership. The distributor filed a complaint accusing the manufacturer of price-fixing. But the U.S. District Court for the Middle District of Alabama, southern division, ruled in favor of the manufacturer because it stated in its letter to dealers that it had established the pricing policy unilaterally, and was not seeking either the approval or agreement of the dealers. When customers called with complaints, company employees would listen but explain that they could not debate the policy. The company would help dealers work out the math if requested, but wouldn't discuss it. And when the terminated dealer tried to talk with someone at the company to "work something out," they refused. The manufacturer knew its legal obligations and was very careful not to get on the wrong side of the Sherman Act.

What's the lesson? Don't talk about prices or policies with your competitors. If you sell through dealers, you may establish a pricing policy and terminate those who fail to comply, but don't discuss it or debate it with your dealers. Otherwise, you risk legal trouble for conspiring to restrain trade.


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