Laurel Price If youre not familiar with this building_ the

Document Sample
 Laurel Price If youre not familiar with this building_ the Powered By Docstoc
					>> Laurel Price: If you're not familiar with this building, the restrooms are just outside of this room.
If you go out of the room, the men's room is to the immediate left, and they ladies' room is out past
the elevator bank and then to the left. In the unlikely event that an alarm goes off, it will be either
an announcement to evacuate the building or to shelter in place, and you simply follow the
instructions you will receive over the loudspeaker system. If it is to evacuate the building, we will
simply exit this room, go around the hallway to the right, take the stairway down to the street, and
then follow the FTC personnel to the sculpture garden across Constitution Avenue at Seventh Street.
In the event of a shelter and place, you'll simply go into the hallway away from the exterior
windows. Today's first panel will look at the legal and business history of the use of RPM in the
United States. RPM and issues relating to channel management are actually as old or older than the
antitrust laws themselves, and many of the issues they give rise to haven't changed fundamentally
over the years, but the doctrine and the way we look at it has shifted from time to time, and that's
true both as a matter of legal theory and doctrine and business-marketing theory and practice. So,
we're starting this morning with two professors -- Professor Rudolph Peritz of the New York Law
School, and he will be our first speaker. He specializes in antitrust intellectual property, but he also
teaches contracts, property, cyber law, and jurisprudence. He is a senior fellow of the American
Antitrust Institute and director of a computer-assisted enforcement program funded by the
Department of Justice some years ago at the antitrust division of the state of Texas. He has two
books which are of note and interest for the purpose of this program -- "Competition Policy in
America: History, Rhetoric, and Law," a '66 and 2001 versions, and "U.S. Antitrust in the Global
Context," which is a 2004 publication. And, so, with that, I will turn the program over to Professor

>> Rudolph Peritz: Thanks, Laurel. I appreciate the invitation. Of course, the occasion for our
gathering today is the Supreme Court's recent decision in Leegin Creative Leather Products.
Leegin overruled a century-old doctrine in Dr. Miles Medical vs. John D. Park & Sons, the
doctrine that resale price maintenance, at least the manufacturers' setting of minimum prices, is
illegal as a matter of law. Now, since Leegin RPM, resale price maintenance, is to be judged
somewhere along California Dental's spectral rule of reason. I've been invited to discuss the
antitrust treatment of vertical restraints on competition since Dr. Miles, to tell a history of how we
got here from there. So, what can I add to the law and the economics so many of you already know
and understand? My intent is to shift your perspective to nudge you off center by addressing the
following question. What are the legal dynamics that have shaped the shifting judicial attitudes
toward vertical restraints over the past century? Here is the history in a nutshell. The dynamic has
been an ongoing tension between competing logics of property rights. To make sense of the swings
-- thank you -- in vertical restraints doctrine over the past century, it is necessary to recognize the
enormous pressures produced by conflicting commitments to the property rights of manufacturers
and dealers that have defined the relationship between them with respect to branded goods. In this
view, much of what we entertain -- I hope there are some economists in the audience. Much of
what we entertain as antitrust economics is epiphenomenal. Antitrust economics is a second-order
effect of the primary phenomenon of property-rights logics. In short, property rights are the
engines that drive vertical restraints doctrine. Antitrust economics is the caboose. Well, now that
you have the punch line, I'll tell you the story. It has four chapters. Each one reflects a cluster of
property logics that have pushed and pulled each other to produce the shifting treatment of
manufacturers' restraints on distribution of goods. First, this story, like most stories, has an
introduction. Certainly, a lot has changed in the 100 years since Dr. Miles. Coca-Cola no longer
contains cocaine and is no longer advertised as brain tonic and intellectual beverage under the name
"Moxie Nerve Food." Bayer pain pills no longer contain heroin. After federal statutes banned over-
the-counter sales of cocaine and morphine derivatives, virtually all patent medicines were
comprised of alcohol, typically between 35 and 55 proof, sometimes as high as 80 proof. Despite
the idiom, patent medicines, also called proprietary medicines, were not actually patented. To the
contrary, the ingredients were kept secret until the Pure Food and Drug Act of 1906 required their
listing in product labels. Still, much remains the same. The patent medicine industry, together with
alcohol distillers, were the first to have business models driven by massive advertising and public
relations -- farmers almanacs, calendars, children's storybooks, and pamphlets for "women's
troubles." Long after Dr. Miles became Miles Laboratories and then a subsidiary of Bayer AG,
advertising remains paramount in today's pharmaceutical industry, whether for Robitussin cough
syrup or Viagra, just as it was for Kickapoo Indian Cough Cure or Lydia Pinkham's vegetable
compound for ladies. Like their patent medicine predecessors, today's branded manufacturers use
the same business model of product differentiation to avoid price competition like the plague, and
industry trade associations remain influential. As for the legal doctrine, it was the Dr. Miles case
that spun the three doctrinal threads running through the past century of Supreme Court treatment
of vertical restraints. In short, here are the three threads. First, the Sherman Act section one
requirement of an agreement, which I won't discuss today. Next, the second thread. The court
considered and rejected a series of explicitly property-based arguments made to justify resale price
maintenance, arguments that a property owner should be permitted to determine the conditions of
sale for her own goods. I will pay particular attention to this thread of property logics, whose
power to produce vertical restraints doctrine has never waned despite its changing fiber content.
The third thread was spun by counsel for Dr. Miles who argued that RPM was necessary to protect
the profit margins of their retailers from price discounters to assure that the retailers would continue
to promote Dr. Miles products. Today, of course, we recognize this argument as the free-rider
rationale for vertical restraints. The Supreme Courts White Motor in 1963 would weave the latter
two threads, a property-based argument with the free-rider rationale, in to the logic that supports
the entire weight of modern vertical restraints jurisprudence, that logic is the efficiency of inter-
brand competition, which the Gte Sylvania decision would firmly establish in 1977 as the
incontestable rationale for justifying manufacturers' restraints on inter-brand competition. In that
case, non-price restraints. After Sylvania, i contend, Leegin was just a matter of time. Despite the
competition rhetoric, the free-rider rationale is a property logic in the fundamental sense that the
very distinction as well as the hierarchy between inter-brand and intra-brand competition derived
from trademark ownership. With that introduction, I turn to the first chapter in the history of
property logics as the driving force behind vertical restraints doctrine. The story begins in Elkhart,
Indiana, where Dr. Franklin Miles opened his grand dispensary in 1890 to offer free medical
advice and to sell the patent medicines he concocted. By the turn of the century, Dr. Miles' patent
medicines were sold by druggists around the country. Price competition was fierce because market
entry was cheap, and so fringe firms came and went almost daily. Advertising became the industry
lifeline to sustain success, and the larger firms, including Dr. Miles, formed the Proprietary
Association, the industry trade association which provided members with standard-form contracts
for product sales to distributors and retailers. The standard sales contracts all included RPM
provisions. John D. Park & Sons, the defendant, had grown in to one of the early discount chain
stores and, along the way, gained experience in cases brought by patent medicine producers. The
RPM issue raised in the Dr. Miles case had been litigated many times before in both state and
federal courts, and so both Miles and Park were seasoned veterans. In the Dr. Miles case, Miles
sued Park in tort for malicious interference with contractual relations, asserting that Park
wrongfully induced wholesalers to sell below the stated prices. Park filed an antitrust counterclaim
asserting a contract in restraint of trade. So, what was different in this case was the new standard-
form contract written by the Proprietary Association and used by Dr. Miles. The new form
contract was a consignment-sale agreement rather than the old straight sales agreement. Why the
change? Well, into the first decade of the 20th Century, courts permitted patent copyright as well
as trade-secret owners to set resale prices in straight sales contracts for goods embodying their
intellectual-property rights. But this IP logic was falling out of favor. As the Dr. Miles case was
making its way through the lower federal courts, the Supreme Court declared that a copyright
ownership itself did not permit the setting of resale prices. Closer to home, the six-circuit court of
appeals had just rejected the very IP arguments that had succeeded in the early patent-medicine
cases. The six-circuit decision was doubly important. First, because the winning defendant was
John D. Park & Sons, and second because the Dr. Miles case was filed in the sixth circuit. The
Proprietary Association recognized that their standard-form contract was risky business, given the
recent decisions, and the attorneys representing Dr. Miles realized they would likely need a new
argument to justify RPM, though they determined to try the IP arguments all the way up to the
Supreme Court. Well, in a flash of lawyerly ingenuity, the Proprietary Association attorneys
decided to put the age-old consignment contract to new use. The logic was impeccable. Though
the manufacturer gave up physical possession of the patent medicine, it retained title under the
consignment, and so the RPM provision only set prices for the sale of its own goods. Retailers
were not independent entrepreneurs. They were merely selling agents for the producer. And so Dr.
Miles would be the test case for the patent-medicine industry to determine whether the new
consignment contract would pass the test -- with the RPM provision -- would past the test, antitrust
legality. Both the trial court and the six-circuit panel rejected all the property arguments to justify
RPM, both the old and the new, as did the Supreme Court. Or so it seemed, anyway. First, the
Supreme Court rejected the old IP argument that Dr. Miles' trade secrets should have the same
immunizing force as patents because, according to Justice Charles Evans Hughes, who wrote the
opinion, the patent statue created unique rights to restrain trade that did not obtain to common-law
property rights. Second, counsel for Dr. Miles made what we would call a free-rider argument but
dressed it in property-sounding claims that Park & Sons not only harmed the products reputation,
the Dr. Miles brand, by selling on the cheap, but mutilated its property by scraping off the
identifying information from the labels and the boxes. The court rejected, out of hand, Miles' free-
rider argument that protecting dealer profits from discounters was the incentive necessary to
promote its product. Finally, the new argument, that Dr. Miles' retention of title under
consignment meant the RPM provision involved nothing more than setting prices for its own goods.
The court rejected the new argument, too, but not on its merits. Rather, Justice Hughes found that
the particular consignment contract was defective and concluded that Park could therefore have
gained title to the goods. And so Miles was seen as trying to set the prices of goods owned by Park
& Sons. So, Dr. Miles lost the battle, but it's important to recognize that the Proprietary
Association won the war. As dissenting Justice Oliver Wendell Holmes pointed out, it would be a
simple matter to close the loophole and scriven an effective consignment agreement whose RPM
provision would pass muster under the antitrust laws, and that's precisely what happened. So ends
the first chapter. One property argument fell -- the IP argument -- and another, the consignment,
rose in its place. In practical terms, there was no change. RPM provisions remained impervious to
any trust attack, and competition policy had nothing to do with it. In contrast to the first, the
second chapter is lengthy in time span but requires little narrative detail. The 50 years following Dr.
Miles saw federal courts accept the simple and powerful property logic justifying RPM provisions
in consignment agreements. Although retailers had physical possession and the right to sell the
goods, the courts did not treat them as the property owners. Retailers were treated as mere selling
agents for the principle of the manufacturer who held title and was treated as the owner for antitrust
purposes. In the 1926 General Electric decision, Chief Justice William Howard Taft reaffirmed the
powerful property logic of retained title to hold that vertical restraints ancillary consignment
agreements were legal as a matter of law. Again, this decision had nothing to do with competition
policy. It was a matter of common-law property rights. Chapter three opens in the 1960s when GE
consignment rationale, its safe harbor for RPM provisions, was shaken by two Supreme Court
decisions. One of them, Simpson vs. Union Oil, characterized as coercive the Oil Industry's
standard consignment contract with its service-station owners, and the court held the RPM
provision illegal, per se. The other decision, White Motor, rejected entirely the logic of
consignment in favor of dressing an old argument in new clothes. The court outfitted the old free-
rider argument rejected by Dr. Miles in a new analytical framework for evaluating the power of
property rights to restrain competition. The framework resulted from subdividing the unitary
concept of competition. Indeed, subdividing it in two ways. First, the court split competition in to
price and non-price components, characterizing the White Motor restraints as non-price, and thus as
something different in kind from restraints on price competition, the court was not confined to its
RPM precedent of, per se, legality. Second, the court split competition in to the subcategories of
inter- and intra-brand, opening the anomalous possibility that a restraint of competition could be an
antitrust virtue. White Motor, a small manufacturer of trucks, argued that restraints on something
called intra-brand competition was necessary to direct the efforts of its dealers towards something
called inter-brand competition against its large rivals and, at that time, powerful rivals -- General
Motors, Chrysler, and Ford. Where did this distinction between inter-brand and intra-brand
competition come from, and why should it justify White Motor's imposition of territorial and
customer restraints on its dealers, who, after all, had purchased the vehicles in straight sales
contracts? They had possession. They held title. Why shouldn't they be able to sell their trucks to
all comers? It was White Motor's trademark ownership -- trademark ownership -- that underlay the
court's approval of restraints on dealers. Indeed, brand ownership defines the very logic for the
entire conceptual scheme. Brand ownership is the logical condition for defining separate categories
of inter- and intra-brand competition as well and thus for making a free-rider argument. It's a
simple property logic. Next, what might explain the court's revealed preference for White's
trademark ownership over the dealer's goods ownership to define their relationship with respect to
the goods and with it the primary importance explicitly accorded inter-brand competition? In
White Motor, there seems to be good reason. A small, struggling manufacturer of trucks would not,
could not, compete on price against the big three with their economies of scale. Without an
effective plan for non-price competition, White Motors would fail. In these circumstances, the
property rights of dealers as title holders to trucks were clearly secondary because their value
depended on the strength of the White Motor brand, which was failing. Without a stronger White
Motor brand, the dealer's property rights would be worthless. And, so, there was no real conflict in
property rights in this case. The logic and the outcome served the private-property interests of both
manufacturers and dealers as well as the public interest in promoting competition. Still, the court
could not give up the powerful property logic of consignment. In the Schwinn decision a few years
later, the court withdrew White Motor's free-rider rationale and revived the logic of consignment.
All vertical restraints in straight sales contracts were once again illegal, per se. In this series of
decisions, the court flip-flopped between two property logics of trademark ownership and retention
of title to define the relationship between branded manufacturers and their retailers and thus
between inter-brand and intra-brand competition. This era of equivocation came to a close in 1977
with the Gte Sylvania decision. Like Schwinn and White Motor, Sylvania was a small and
struggling company that devised a national plan for non-price competition calling for restraints on
its dealers. Here, location clauses. The court rejected Schwinn's consignment logic. Instead, it
revived the White Motor opinion's trademark logic of restraining free riders to enhance inter-brand
competition. Sylvania actually did more than revive White Motor's trademark logic. It
universalized the logic with the categorical statement that inter-brand competition is the primary
concern of antitrust law. Henceforth, the free-rider rationale no longer depended on competitive
conditions on market circumstances. It became a formality. In effect, price discounters were
treated as free riders, per se. And, so, Sylvania was the tipping point in vertical-restraints doctrine.
With a formalized free-rider rationale, all the changes in vertical-restraints doctrine that followed,
Sharp Electronics, Kahn, and Leegin were just a matter of time. Sylvania opened the door to what
we have today -- the fourth chapter of the history. Branded manufacturers, both weak and strong,
both small and large, are permitted to restrain dealers from exercising their own property rights to
engage in what is usually price competition, restrain them in the presumed service of inter-brand
competition that is presumably harmed by price discounters that are presumed to be free riders.
That's the economic caboose being pulled by the engine of property logic, by a naturalized right of
trademark owners. And, so, I conclude my story with a short afterward. Economics is the policy
voice of antitrust doctrine, but the courts don't have the degrees of freedom that economists enjoy.
Judges have to make decisions, and so economics must serve the judicial function of deciding cases.
This institutional mandate has consistently changed the very substance of economics as it entered
antitrust analysis. In the 1960s, Donald Turner took Edward Chamberlain's dynamic theory of
monopolistic competition and turned it into a structuralist logic of oligopoly. In the 1970s, Ward
Bowman's Chicago school comrades, including those who now sit as judges, took his fixed sum
theory of tying and stretched it beyond the very strict boundary conditions he defined. In the 1980s,
first Chicago school acolytes and then federal judges took the theory of contestable markets and
similarly overextended it by removing the rigorous conditions that...defined for its application.
Each of these logics, oligopoly, fixed sum, contestable markets, as well as free riding, has followed
the same path -- the path from limited theory to universalized formalistic application that betrays
the competition antitrust is intended to promote. I asked my barber, Stanley, whether his suppliers
of hair product were telling him what prices to charge these days. He laughed and said that if they
did, he would buy from someone else. But my question would likely get different responses in a
Burlington Coat Factory or maybe a Chevrolet dealership. That's just a small, silly anecdote to
illustrate a large point -- the point that there is no universal competition logic or economic theory
that justifies the categorical primacy accorded inter-brand competition. Rather, its relationship with
intra-brand competition in the production of economic welfare depends on commercial
circumstances. In many markets, intra-brand competition by dealers would be the only source of
price competition. Certainly, antitrust policy regarding vertical restraints should not derive from
formalistic conceptions derived from implicit property logics. Practical difficulty in all of this, of
course, is that should a dealer get past the presumptions, the next step is expensive litigation under
a rule of reason that amounts to defacto legality. How this evidentiary inquiry should be structured,
whether the strong presumption should be flipped in a way that opens the courthouse door to
terminated dealers and the discount store to consumers, is our topic in the next workshop. And, so,
as we proceed this afternoon, I think we must recognize that the Supreme Court has treated
property rights in these cases as a self-evident, unexamined concept rather than a cluster of public
policies, including competition policies, that should inform the adjudication or relationships
between branded manufacturers and their dealers with respect to the distributed goods. Thank you.
[ Applause ]

>> Laurel Price: Our next speaker is Professor William Trombetta. He is a professor of
pharmaceutical marketing at St. Joe's University in Philadelphia. In addition to being a professor
of marketing and a PhD in marketing, Bill's also a lawyer, indeed. He and I worked together as
deputy attorney generals more years ago than we'd like to remember in the New Jersey division of
criminal justice doing state antitrust enforcement work. So, at this point, I'd like to turn it over to
Bill Trombetta.

>> William Trombetta: Thank you, Laurel. It's an honor to be here. Let me pull this up so I can
see what I'm doing. Sorry about that. Okay. I teach at St. Joe's University, and I'm in healthcare,
pharmaceuticals, and devices, and the interesting thing is, this topic is now coming in to healthcare
big-time, as to control and channel support and evolution. So I see it every day, and I'm gonna try
to put a little flesh on some of the things that relate to how retailing has evolved. Starting off, just
milestones in retailing, and, yeah, it's another PowerPoint presentation, or as my students would
refer to it as "death by PowerPoint," but nonetheless, we go on. Starting off with the mom and pop
individual one stores, you had one owner, one operator, chief cook, and bottle washer. They new
everything about their customers, knew their customers by name, were on top of inventory 18 hours
a day, 7 days a week. Then a big change -- the emergence of chains, multi-store operations that
started to hit around the 1950s through the 1960s. And another aspect of the chains that came
along a little bit later -- some were, again, in the mid-'60s or so -- channel systems and vertical
marketing systems. The big difference there is the difference between a channel of distribution
versus a channel system. Channel of distribution is a manufacturer versus a wholesaler versus a
retailer and then a consumer. It's inefficient, it's adversarial, it's duplicative, and it's possible to say,
"Can we have another way to do this? Can we form a system where somebody is powerful enough
to make this intermediary channel network work as a system?" So, we started to see that evolved,
and then something more interesting came along called category captain management, and this is
something that deals with a powerful entity, no matter who he is -- a category captain -- who knows
how to use and leverage technology, and they know how to do merchandising scientifically, and
they can do profitability analytics. Underline profitability analytics. And we see today where we
are. We certainly have category captain management, but we also have multiple channels evolving
in the 1990s to the present, including things like selling things through ATMs, kiosks, vending
machines, online. We also have drugs now being sold in kiosks in doctors' offices, and they're
primarily generic drugs. Just an example, a quick example, of how diverse it can be, this is an
orderless Bowflex, and they do direct marketing with TV ads with an 800 number. They have
inbound, outbound call centers. They use the Internet. UPS is their delivery channel, just like UPS
and FedEx are now inventory captain managers for the drug industry, and they have local service
contracted out, so when the consumer buys the product, if there's a problem. And they also delve in
to commercial, retail, and specialty channels, as well. So that's pretty comprehensive and covers
quite a bit of range of retailers. Good example is Apple. When Apple decided to go in to their own
retail stores, and people said, "This is a dumb idea. Steve Jobs, what are you thinking about?" And
this is what has happened with their Manhattan showcase store. Their sales are 4,000 bucks a
square foot compared to Tiffany's at $2,600, Best Buy at $930, and Saks Fifth Avenue at $362.
The reason why Apple decided to go against the grain was they just were frustrated with the kind of
retail service that they found in the stores up to that point. Let's take a look now at this notion of
channel systems and vertical systems as to how retailing has evolved. We talked about the
conventional channel distribution and a lot of the negatives that comes with it, and we talked about
channel systems, or, as it's also called, vertical marketing systems, that act as a unified system. It's
not one business unit versus another unit. In fact, it's not brand against another brand. It's network
systems going up against each other, and the three main manifestations of how this has evolved are
corporate administered and contractual. A corporate vertical marketing system is an entity that
owns everything from "A" to "Z." Sears is maybe a good example. They do retailing, they do their
own wholesaling, and they control a lot of their private brands, like Kenmore and some of the other
names. An administered VMS is the more analytically intriguing. They don't own anything, but
they're smart enough and powerful enough to make that channel work as a system, and the best
example that I see every day is GE Healthcare. Nobody better at it than GE Healthcare. One
magnetic resonance imaging unit is just like another one. They all cost $2.5 million, but the
package that GE Healthcare puts together is a powerful, competitive force that sets them apart, and
a contractual vertical marketing system is literally that -- a way to handle channel arrangements on
a contract basis. An example of this would be co-ops, like food co-ops, like IGA, hardware co-ops,
like True Value, and franchising, like McDonalds, would be a quintessential contractual vertical
marketing system. When we talk about channel members and how to control through vertical
marketing systems, there are five basic ways. One would be coercive -- the ability to threaten or
terminate or withdraw resources. In my opinion, my way of thinking, RPM is more of a coercive
mechanism. "This is how you will price, and if you don't price that way, this is what will happen to
you." Reward? There are ways that you can reward what might smack of non-price competition
opportunities, like exclusive dealing and some things like that, territories that are exclusive.
Contractual, which is straight out. "Here's what we're gonna do. Here's the deal between us." And
then the two other intriguing ones that tie in a little bit more with, I think, the way channel captain
management, or category captain management, is going. Expert -- the ability to hook up with
somebody that is really good at what they do, and that halo effect rubs off on you and all the other
kinds of things you offer. And in healthcare, a good example of that these days would be the Mayo
Clinic. That's as powerful enough to go up against major health plans and not toe the line. And
then referent power. A firm like Caterpillar that's just a great company to work for and deal with.
So, some angles as to how we can incentivize its channel members. Some key concepts that, for
me, explain where things are going and how they might have evolved. Value added. If you take a
heretical approach and assume that, yes, as was mentioned, brands are powerful. Another cynic
might say, "One product is physically the same as another." It's really tough to differentiate. So,
the next question then becomes, "How do I add value? What more can I do for you that you didn't
expect?" And just a mundane example, I'm a college professor. You walk into my classroom, and
there's a blackboard or, I guess, a PowerPoint projector, and there's a text, and you expect grades,
and you expect to try to sit through an hour and 15 minute lecture. Whatever. So, what more can I
do to add value to my course? I know my students on a first-name basis. I know the companies
they work for. I program those companies in to my sessions so we can just customize the course.
And, again, it's the same course. It's the same grade. Not much different from the guy that teaches
it right next door. But I try to add value, a very profound way to think strategically. What more
can I do for you? This is what you expected from me. What more can I do? Sustainable
competitive advantage, easy to say but tough to pull off. I consider RPM a tactic. It's a short-term
tactic. I can change it today, I can change it tomorrow, but a sustainable competitive advantage,
I've got to earn that. Takes a lot of time to do it. Quintessential example would be a patent.
Having a patent doesn't mean that you win the game. Just talk to the folks in the drug industry.
But other things being equal, I'd rather have the patent than not have the patent -- sustainable
competitive advantage. Brand equity -- the most admired and respected drug company in the world,
J&J, worth its weight in gold. Fly the friendly skies. So, sustainable competitive advantage, and I
believe that a category captain management rationale that has evolved is that kind of a sustained
competitive advantage. Ties that bind in switching costs, in marketing, it's an old chestnut, that
most of the marketing dollar is spent getting new customers. 80% of the marketing's spent. So,
what do we do with our present customers? We take them for granted. They're our customers.
You don't have to worry about them. We got them in fold. Let's go out and get new customers.
What can I do, though, to put switching costs in place? How can I make it tougher for you to leave
me? What can I put in place? Classic example a few years ago used to be installed computer
systems that had proprietary language. So, if you wanted to come in and compete on a low price,
somebody would say, "Wait, you know, it's not compatible with our architecture." And, of course,
Apple and Windows broke that down some years back. Interesting notion strategically as to how
things have evolved, customer intimacy. That's a typo worm, and it should be treat the... That was
a book that came out in the mid-'80s, not too unlike Michael Porter. But the one thing that caught
my eye was customer intimacy. The more I know about my customer's business, the more valuable
I'm gonna be to him -- the more I can become a strategic partner, not just a supplier, to my
customer. And then we talked about channel of distribution verses a channel system. Shifts of
power to the retailers. We see an example here that Walmart accounts for $9 billion of Procter &
Gamble's spend, or 28% of P&G's revenue, but P&G's $9 billion only account for 4% of Walmart
sales. So, we see who we can check to the power with here. Private labels, 19% versus 14% 10
years ago, and going up. In Europe, even stronger. In the United Kingdom, private labels are 43%
of all brands, indicating again the power of the retailer, the shift the power of the retailer. Great
example of tying channel systems, evolution, and category captain management -- this was
McKesson, but this was McKesson like we wouldn't recognize today. They were present at the
creation. It's a great site. Seymour Freedgood's article in "Fortune," 1962. McKesson realized in
the late '50s and early '60s that their bread-and-butter customer was mom and pop drug store, and
these guys were getting killed by the chains -- CVS, Rite Aid, Walgreens, et cetera. So, they sat
down with their customers and said, "What can we do to keep you alive? Because if you go, we're
not gonna be around much longer." And the obvious thing that hit was, "We can't compete with the
chains on price." So, McKesson said, "How about if we organize you and put you into a buying co-
op, and then we can take sales minus, of course, the goods sold, and we can increase the gross
margin or markup that you get." Okay, that worked well. It worked so well that McKesson said,
"What more can we do for you?" So, McKesson came out and found out things like the following.
"We can find suppliers that can bring you displays and merchandise, and you don't have to pay
anybody to take them down, and that'll save you 10% of your operating spent. We can do
automated inventory analysis." And this is 1962. Automated inventory analysis. "We can collect
and analyze market data -- what's moving and what's not moving on the shelves. We can do shelf-
management planning -- what should go at the end of the aisle and what should go eye level. We
can do safety management. You've got all these people coming in, especially older people, taking
drugs that are interacting with each other, and they could kill themselves, and guess who they're
gonna sue? We can try to help you minimize that kind of liability. And the no-brainer, group co-
op purchasing power. And we can also help you with co-op advertising. What do you know about
co-op advertising? You're carrying 30,000 items. We can take that expertise, take those coupons
and programs and cash them for you, and all you have to do is put the money in the bank." I saved
the best for last. The mom and pop guy is doing well. He's thinking about opening up a second
store. He goes to the bank, and the bank says, "Yeah, we'd lend you money, but we'd like to see a
business plan," and the mom and pop guy says, "A business plan? What's that?" And McKesson
says, "We'd be only too happy to help you with that, because if you open up a second store, we do
better." Notice the thread that's coming here. I don't have to punish or force anybody. I just have to
be a smart strategic partner, and good things will happen to the both of us. Everything I said before
impacts either costs of goods sold going down, either raising the gross margin. My marketing costs
can go down because I can focus on fewer larger customers. My selling costs can go down because
I can segment better. My administrative costs go down because on scale I can consolidate more.
My sales to asset can drop. Who wants to carry excessive inventory? Inventory costs money. If
you've got a million bucks in inventory, 15% of that is the cost to carry it -- $150,000. What if I
could put a dent in some of that $150,000 and put it in your pocket without selling one more item?
Collecting accounts receivable sooner. I'll use the money. Why should I leave it out there 45 or 60
days? And bad debt expenses go down because I'm dealing with better customers. Everything I
said before hits and impacts that. Now let's see an example in action. This is an actual company
that's a small, midsized food supermarket chain. So it's not an ACME or a Wegmans, and it's not a
small boutique. It's somewhere in the middle. And here are two suppliers that are co-ops that want
the business of this chain. The one on the left is Splendid, and the one on the right is New Guy
who comes in to town, and he wants to get the business away from Splendid. Notice the price off
the top. Splendid's price is 21.6% markup, and New Guy's is 20%. So, right off the top, the New
Guy's got an advantage of a 1.6% price edge, and if this company does about $10 million to $20
million in sales, that's quite a bit of money in their pocket without selling one more item.
Interesting. Stock buy in. Stock buy in. Splendid has no stock buy in. You know, come on.
"Deal with us. We're friendly guys. We've been working with you all these years." New Guy
requires $50,000 up front of a stock buy in. What's going on here? They want you to have skin in
the game. It's not gonna be a fly by night, you know, at hock thing. Come and deal with us when
you want. "We want to tie you to us and give you sweat equity in what we're doing." And what
kind of stock is this? It's closed-corporation stock, not the kind of stock you're gonna sell on Wall
Street. But, oh, boy, if they pull it off right, what if they go public? What if they did what the
Connecticut Medical Society did in the late 1990s, where the state medical society formed its own
independent practice association, a for-profit medical group practicing medicine, and a health plan
out on the west coast said, "We like the way you guys are practicing medicine. We would like to
buy you out," and each of the docs walked away with a $600,000 capital-gains walkaway gift. So,
again, it's stock, but notice the purpose of the stock. They're looking for special customers.
Splendid has salesmen. Salesmen take orders. New guy has a merchandise counselor. What's a
merchandise counselor do? They analyze inventory, what's moving, where you're making most of
your money, how are the demographics of your market changing. Again, impact on operating
expenses and asset turnover. Rebates. Real simple with Splendid. 5%. But notice 4% to 6% for
new guy. Get an extra 1% based on volume, and the guys that we're looking for do volume. We
don't want the fly by night guy. Ship delivery. Interesting. Splendid ships anytime. "Give us a
call. We'll send it right over." Less than truckload, less than carload. New Guy says, "We only
take your order once a week, and you better have your order right, and our merchandise counselor
will help you put your order together, and, therefore, we can give you full truckload and carload
rates, which means we've got a price edge of 6 to 8 times cheaper than shipping less than truckload
or less than carload." Seminars, none. Splendid says, "Hey, what's seminars?" New guy says,
"You're gonna go four times a year and learn how to practice business, and if we don't see you at
those seminars, if there's not a good reason, we can terminate you and give you your $50,000 back,
plus interest." Inventory. Splendid carries 38,000 items. New guy only carries 24,000, but those
24,000 items are flying out of the store. They don't even get a chance to gather dust in the
warehouse. And notice the interesting thing. Gross margin times sales times sales to inventory at
retail, New Guy can come in and analyze the dollar investment of everything you've got in
inventory and measure your profitability and compare that against what Splendid does. Minimum
purchase, none. New Guy has a minimum purchase of $10,000 a month, which is like falling out of
bed for the kind of clients New Guy wants. And, again, that gets them the rebate, and it also gets
them the additional discounts. At the end of the day, that $50,000 stock buy in is tripled. Not a bad
return getting back 150,000 bucks on a $50,000 investment. Little bit better than I'm getting on my
certificate of deposit these days. We talk about retailing, but we're way off base. There's
something going on out there that started to happen before the financial implosion in August and
September. I did a talk for a Pharmaceutical Market Association about a year and a half ago in
Philadelphia, and I followed one of the executives from Novo Nordisk, who is the Danish firm that
does diabetes. That's their franchise. And this was a pharmaceutical group. He was preaching to
the choir -- drug and street people, publications, whatever. The guy spoke for about 40 minutes.
Of the 40 minutes, 10 minutes had to do with diabetes drugs and what's coming in the pipeline.
The other 30 minutes had to do with, "We use the right kind of lightbulbs in our manufacturing
plants. Oh, and all our sales reps drive hybrid cars." I thought I was listening to Al Gore. I wanted
to go up and hug the guy at the end. And I'm thinking to myself, "Wow. What is going on here?
What kind of a company are you? What do you stand for? The triple bottom line -- people, planets,
and profits. How many plants did you shut down in your community? How many jobs did you
outsource, and what's the golden parachute packages like on your companies when your execs
destroy shareholder value but you walk away with $100 million to $200 million in gold
parachutes?" Interesting. So, we take that and connect a couple dots. The incredible "Business
Week" studies that started to emerge in 2006 on who the innovators are, it's a must read to tie down
where things are going, not just in retailing. So, we see that innovation can certainly be a physical
product, but it can also be a process master, like Toyota. Nobody better at dealing with the chain
and suppliers than Toyota. I have a Toyota. It's the greatest car I ever earned. But when I have
trouble sleeping, I walk outside, look at my Toyota Camry, and I fall right asleep. Except there's
nobody better strategically at how they work with their suppliers. They don't try to ratchet down
every possible penny from their suppliers. They try to make it a strategic partner relationship. And
we see how to revolutionize a business model -- Southwest Airlines, Virgin, Netflix. And we see a
great quote from a professor at Amos Tuck. "Innovation does not have anything to do with
technology." This is an interesting study that just came out. This notion of strategic competitive
advantage, sustainable competitive advantage. There's a fellow that teaches at Wake Forest named
Dr. James Harrison. He was working with the Institute for the Study of Business Markets at Penn
State in Happy Valley, and they have come up with studies across the board to show that the key
now to success is gonna be a supplier's ability to reduce distributor customers' costs to serve his
customers and the ability to align with customer solutions. "How can I help you solve your
problem? And if I can do that, I think we'll both make out in the end." Category captain
management. Let's take a quick look at it. A great site. [ Speaks indistinctly ] the "Journal of
Public Policy and Marketing." But this is the essence of it. A supplier/retailer process for
managing an entire product category as an SBU, strategic business unit, and, yeah. Yeah, let's say
it. This guy also handles his competitors' products. And if you read this great article, you'll find
out that the key issue here was the antitrust concern. Do you have the ability to preclude a
competitor from getting in to that store or retail outlet. In healthcare, the concern isn't so much
antitrust as it is fraud and abuse and antikickback. But still, the essence of the article was mainly
antitrust. And notice the category leader takes a significant role in organizing the way this product
gets through as well as competing products. Kraft, real exciting products. I think their most recent
blockbuster innovation was string cheese. Kraft controls more of the aisles in the supermarket than
any of its competitors, and the Kraft rep, the distributor, has only one goal -- "Make money for the
supermarket. Then I make money." Again, what do they do? Here's Kraft. They have a three-step-
category builder. They can take a category apart and analyze data. They can create a management
plan in two days versus one that usually takes about 200 hours. They can figure out which product
to move to eye level and then to the aisle, where to position in-house brands, and in-house brands
make more profit than the national brand. So, retailers love generic, in-house brands. And price
analysis for each brand. How can we make this product more profitable. So, that's how they
operate strategically. The best that ever there was -- GE. There's the GE guy. And let's talk about
plain vanilla GE, not GE Healthcare. This is the plain vanilla GE guy, and he walks in to a plant,
and the plant guy sees him come, and he figures, "Okay, here comes the sales pitch," but it's a little
bit different. The GE guy says, "By the way, what are your yield numbers on your plant floor?
You've got so many workers on the floor, and what are your sales per productive whatever, and the
plant guy says, "I don't even know what you're talking about. I have no idea what that information
is." "What are your biggest operational problems? Do you have any downtime?" "Oh, yeah. We
have downtime, and all hell breaks loose." "What plant capacity?" "Oh, we're about 68%. Could be
better, but, you know, we're at 68%." "How much capital tied up in trucks and logistics?" What an
interesting sales pitch, right? "And at the end of the day, how can I make you money with a plan
that impacts positively those three or four strategic metrics?" So, three ways to make money. You
can make it through margin management by controlling your sales minus cost of goods sold and
operating expenses, and you can make money by asset management -- sales to assets. Nobody's in
business to carry or use assets, especially excess inventory. We'll leave that to net worth and
financial management out of the picture for a minute. And we'll wrap up with some powerful
strategic statements to show you where things are going. This is cardinal, the number-one drug
wholesaler in the country. I just made a mistake. I called them a drug wholesaler. They're
probably one of the most sophisticated information-technology companies in the world. They don't
just move drug from "A" to "B." They're much more involved than that. But this is an interesting
quote. Our goal is to be an essential partner with our customers and help them solve their most
pressing issues. The problem in the past has been bonuses and career advancement have been too
much tied to how much I can sell you versus not how much can we help our customers. And I've
saved the best for last. Are you ready for this one? Here's Wendy's, a hamburger joint, making a
statement about Coca-Cola, a syrup supplier. "We definitely believe Coke is a source of
competitive advantage for us." I mean, what are they talking about? It's a hamburger joint, and it's
a soda supplier, right? Let's dig down. Coke can come in and understand the nuances of how
Wendy's does its business in each local market. They have their power to work with them on joint
marketing campaigns. They can understand and analyze different market segments with their
computer program they call Solver. And here's my favorite one. They went in, and Coke said,
"You know, you're supposed to be a fast-food place, but it's noon, and the soccer team is outside
with 28 kids ordering hamburgers. I think you're slow food. How about if we work with you and
take a look at your items on menu, and if we find out that 20% of those items give you 90% of your
noontime traffic and that drives your profit and makes you fast food again -- If it was a fight, they
would have stopped it a long time ago. So, to end things up and open it up for discussion if you
like, the way things have evolved now have moved more in to, "I want to be your strategic partner.
I want to tie myself to you. I want to think of myself so valuable to you that you have no option but
to deal with me." And when I do this talk for the drug industry, I have a 7-point Likert scale. Go
back to your customers, your doctors, your hospitals, your drug stores, and ask them one question --
"Please tell me, am I a supplier to you?" One, two, three. "Or do you consider me a source of
competitive advantage?" Five, six, seven. I haven't found too many five, six, sevens, but notice
what I didn't say. If people say you're a strong one and a strong two, I didn't say your products
aren't excellent. I didn't say that your sales reps aren't top guns. That's not the same thing as saying,
"You are a source of competitive advantage to us." So, that's the way I see things going, and you
can fit the RPM into that notion as best you like. Thank you. [ Applause ]

>> Laurel Price: Any questions?

>> William Trombetta: Thanks.

>> Laurel Price: [ Laughs ] Where does RPM fit in, in your mind, Bill, in terms of building
strategic partnerships?
>> William Trombetta: I just feel, just based on what I see and do every day, working on the
industry, as well, as a professor, that there's more to be had by saying, "I want to work with you. I
want to do the kind of things that make you successful, and I really don't have to do those kinds of
things, let's say, if you don't do this, then I'll have to take action that will sort of punish you or
dissuade you from that." So, I just don't see -- I never even think of it. I just don't see the need for
it in the kind of stuff that I see every day and do.

>> Laurel Price: So, in the marketing side, you're seeing more alignment of incentive through joint
analysis rather than through other means.

>> William Trombetta: There's an article in the current issue of "Business Week" about Cisco.
Not the S-Y-S-C-O Sysco -- the number-one food distributor in the country. And they now work
with their customers. They actually teach restaurants how to prepare meals for various ethnic
groups. They work with them on profitability analysis. And I think you'll appreciate the quote
from the CEO as to why they've done this and they keep on doing it. Here's a quote. "We feel that
competing this way is likely to result in one of our customers not leaving us, as likely as they would,
if we had done it the old way and had just been a supplier of physical products.

>> Laurel Price: Rudy.

>> Rudolph Peritz: I've got a question. It seemed to me that the examples that you were giving are
examples of companies that are not producing commodities but produce services, really, and, so,
the question that I have is do you think that the marketing approaches and the relationships between
firms that you described in your talk are ones that would apply to Leegin Creative Leather Products
or to Levis or to manufacturers of goods that are trying to maximize their profit margins? I mean,
is that a different ball game?

>> William Trombetta: No. I think the strategy can apply to both, and I use two words -- generic
drugs -- as a way to differentiate by these kinds of partnership or arrangements rather than just
trying to always compete on price, and you see it now in healthcare specifically with vaccines,
especially pediatric vaccines. What's the difference between one pediatric vaccine and another?
The difference is that a pediatrician has got to give a kid 30 vaccinations by the time the kid's 5
years old, and they're getting paid less to do the vaccines. So, what a smart drug company that
comes in and says, "Here's a product that's not physically different from the next guy's, but we can
help you avoid the insane place that it is for you when trying to keep track of who got it, getting
parent releases, going to the schools, et cetera." So, I think it could be applicable to both situations.

>> Rudolph Peritz: But that's still different from selling blue jeans, I think, you know?

>> William Trombetta: It may be. It may be. But in the stuff I do and what I've read, the notion of
this way to compete, it could work even for branded goods, as well.

>> Laurel Price: Burt?

>> Female Speaker: You need to state your name, please.

>> Burt Fluor: Burt Fluor, American Antitrust Institute and co-author of the paper he was so nice
to compliment.

>> William Trombetta: I keep it under my pillow at night.

>> Burt Fluor: It's not that good.

>> William Trombetta: You'd be surprised.

>> Burt Fluor: Reminds me of the way you described the Toyota. But anyway...

>> William Trombetta: Touche.

>> Burt Fluor: It looked to me as if two of the Wendy's comments up on the screen are directly
relevant to RPM. Understand the nuances of Wendy's business, okay. What's more nuance than
how to psych out your local customers and set the price, something that would typically be in the
scope of the local retailer's knowledge more than a central databank, although the databank might
have useful information to provide. Understand different market segments. Same thing. Because
what's at stake here, largely, is where will these pricing decisions be made? Will they be made
centrally, or will they be made at the periphery by the local retailer?

>> William Trombetta: That's a great question. I think it's truly a combination of the two. First of
all, most of the franchises, unless it's, like, a master franchise agreement, these are just average
guys who really might not know that much about business, and that's why they're paying Wendy's
or McDonald's a franchise fee of a million bucks to get into the system. But I think it's a little bit
more complicated than that. It's not so much how to price, but what are the local demographics?
So, is there a market that's changing in terms of demographics? Older people moving in, yuppies,
certain ethnic groups, whatever? Some psycho-graphic variables. For example, Burger King, with
the macho male supreme guy, may have upset a lot of women buyers who take their kids to those
kinds of chains. So, I think it can be as complicated and sophisticated as moving beyond just price
and raw, basic demographics. You're a man, you're a woman, you're young, you're old. Getting in
to more things like psycho-graphic variables and lifestyle, and these firms are excellent at that. Just
like the supermarket chains now have evolved to -- When you and I go in and we swipe our little
credit card to pay for our food, they know more about us than the CIA knows. They're in a position
to analyze what worked and what didn't as a promotion. The manufacturer could do that kind of
research, but he'd have to sample about 10,000 people at random, pay an arm and a leg for it, and
how good would that research be compared to the databank that's been accumulated by the
supermarket chain, which reflects now increasing power on their part? So, I think that it may have
RPM aspects to it, as you suggest, but I think it goes beyond that in terms of some of the classic
marketing principles having to do with psycho-graphic and lifestyle segmentation.

>> Laurel Price: Last question.

>> Ryan MacAlly: Thank you. My name is Ryan MacAlly. Is there something that we can draw
from the firms that are using RPM? Your basic thesis is that retailing is moving away from
coercive methods towards cooperative methods, and so where we see RPM, either by industry or
just, in particular, individual instances, what can we draw from that?
>> William Trombetta: You're asking the wrong person. I don't mean to pass myself off as an
RPM expert. I can't even spell RPM. So, it's just, in my world, when I deal with doctors and
drugstores and things like that, it just is a new breath of fresh air saying, "How can I work with you?
I don't want to punish you. I've got the same stake in this as you do. If you grow and become
profitable, then I will do the same thing." And if RPM could play a role in that, I wouldn't discount
it. My own experience, I've never seen the need for it.

>> Ryan MacAlly: If I might. Your general thesis, though, is that coercive methods are giving
way to more cooperative methods.

>> William Trombetta: From what I see, absolutely.

>> Ryan MacAlly: And where we would continue to see coercive methods, is it just firms you
think that are behind the times, or is it something else?

>> William Trombetta: This is my best example. Somebody paid 2 bucks or 3 bucks for this, and
this is tap water, but somebody's done a hell of a good job convincing somebody that this brand is
better than tap water. And I made a big mistake as soon as I called this tap water or bottled water.
I flunked marketing 101. Because you know what this really is? It could be status. So when I'm
out at dinner with my big-time buddies, like Laurel, and the guy comes around and says, "What
would you like, sir?" "Evian, please. Oh, you don't have Evian? Perrier, please." And Laurel goes
back and says, "Bill's a big-time guy. Look at what he drinks." He doesn't see me when I'm home
alone with my dog and I'm drinking out of the toilet 'cause I wouldn't be dopy enough to be paying
2 or 3 bucks for a bottle. What else is this? It's lifestyle, right? I'm gonna change my unhealthy
ways. I'm gonna get away from that carbonated soda and start to be healthy, and, by God, I'm
gonna carry around a bottle of water so I can have eight helpings a day and stay in the bathroom
every hour. So, for me, I could even use it for something like this, but I don't see the need for RPM
if I can get across that my brand -- If you need RPM, then there must be something vulnerable
about your brand.
>> Laurel Price: Okay, thank you. We'll take a short break, and we'll reconvene at 2:15.

Shared By: