Be careful what you ask for: How a Supreme Court victory for manufacturers helped Amazon
Contributor David Rodnitzky takes a look at a decade-old ruling and explains how it helped Amazon become a commerce behemoth and what it means for manufacturers and advertisers.
Less than 10 years ago, the Supreme Court ruled that manufacturers could dictate pricing terms to retailers, much to the delight of manufacturers. Today, Amazon is doing the same thing to manufacturers.
Do a search on Amazon for “Leegin Creative Leather,” and you’ll find two very nice leather belts:
A search online, however, for “Leegin Creative Leather” will likely lead you to a Supreme Court case of far greater significance. In 2007, the court ruled in Leegin Creative Leather Products Inc. v. PSKS Inc. that manufacturers could enforce “minimum advertised pricing” (or MAP) against retailers. Unlike the manufacturer’s suggested retail price (MSRP) — which was just guidance — MAP is an enforceable floor. Sell below MAP, and you risk getting your contract with the manufacturer terminated.
Prior to the Leegin ruling, MAP policies were consider per se illegal under the Sherman Anti-Trust Act. With Leegin, however, the court switched to a “rule of reason” test to determine if future “vertical price restraints” like MAP were antitrust violations. Thus, before a court invalidated a MAP policy, it would have to consider a wide range of factors, like “the number of manufacturers using the practice, the restraint’s source, and a manufacturer’s market power.”
Obviously, manufacturers were happy about the ruling, as MAP was a way to maintain more control of brand and prevent “race to the bottom” price competition. Deep in the court’s ruling, however, was a prescient note about how this case could end up hurting the very manufacturers who advocated for it:
[blockquote] A dominant retailer, for example, might request resale price maintenance to forestall innovation in distribution that decreases costs. A manufacturer might consider it has little choice but to accommodate the retailer’s demands for vertical price restraints if the manufacturer believes it needs access to the retailer’s distribution network. [/blockquote]
When this ruling was announced in 2007, Amazon revenue was around $15 billion. By comparison, Amazon’s first quarter alone of 2017 came in at almost $36 billion). Today, Amazon accounts for 43 percent of all online retail sales — and online retail is about 12 percent of all retail sales in the US, which means that Amazon is about 5 percent of all retail in the US (and growing). For many verticals, Amazon’s market share is far greater — for example, Amazon now owns 17 percent of the electronics market — up from only 6.3 percent in 2010.
So it’s an understatement to say that Amazon has a lot of power these days. While the court was likely referring to Walmart or Toys “R” Us in 2007, the balance of power between Amazon and sellers is vastly more one-sided today than anything that existed in 2007.
Amazon and the new MAP
And Amazon is using that power to effectively create its own version of MAP. When a merchant sells products on Amazon, the merchant must sign a seller agreement with Amazon. In Section S-4 of the agreement, Amazon demands pricing, customer service and product detail parity:
[blockquote] Subject to this Section S-4, you are free to determine which of Your Products you wish to offer on a particular Amazon Site. You will maintain parity between the products you offer through Your Sales Channels and the products you list on any Amazon Site by ensuring that : (a) the Purchase Price and every other term of offer or sale of Your Product (including associated shipping and handling charges, Shipment Information, any “low price” guarantee, rebate or discount, any free or discounted products or other benefit available as a result of purchasing one or more other products, and terms of applicable cancellation, return and refund policies) is at least as favorable to Amazon Site users as the most favorable terms upon which a product is offered or sold via Your Sales Channels (excluding consideration of Excluded Offers); (b) customer service for Your Products is at least as responsive and available and offers at least the same level of support as the most favorable customer services offered in connection with any of Your Sales Channels (this requirement does not apply to customer service for payment-related issues on Your Transactions, which we will provide); and (c) the Content, product and service information, and other information under Section S-1.1 regarding Your Products that you provide to us is of at least the same level of quality as the highest quality information displayed or used in Your Sales Channels. [/blockquote]
To be clear, Amazon is not telling manufacturers what price to charge, or even setting MAP or MSRP. Instead, it’s simply demanding parity: If you sell on Amazon, you can’t undersell us or out-service or out-market us — on your own site or with another channel partner.
The price of success on Amazon
But here’s where this gets tricky for manufacturers: Selling on Amazon may result in significant additional costs above what it costs to sell something on the manufacturer’s own website. Amazon charges merchants a myriad of fees to list products on Amazon. The primary fees include:
- selling plan fees (monthly membership fee to sell on Amazon).
- referral fees (commission to Amazon).
- variable closing fees (basically shipping fees).
- shipping and handling fees (more shipping fees).
- fulfillment by Amazon fees (fees for Amazon to fulfill your order if you decide to use this service. This is known as FBA).
The biggest hit to manufacturers comes in the referral fees, which range from 6 percent to 15 percent of the order amount (but it’s 15 percent for most items).
In other words, to sell on Amazon, a manufacturer needs to give up 15 percent of its margin and provide content equal to the content it uses on their own site to sell the product (and given Amazon’s dominance, you can bet that Amazon is frequently going to outrank the actual manufacturer on the natural search rankings).
And Amazon is continuing to find new ways to extract additional revenue out of merchants. For example, Amazon offers Prime Shipping, which gives customers expedited and often free shipping of items. At last count, Amazon had 66 million Prime subscribers. Having products available for Prime increases sales by upwards of 50 percent, according to some merchants. To be eligible for Prime, a product must be either “sold by Amazon . . . [or] fulfilled by Amazon.”
To get Prime, manufacturers must use FBA or let Amazon take items into inventory. Items sold by Amazon are bought by Amazon at wholesale prices from manufacturers.
Items using FBA require manufacturers to ship products to Amazon at their expense and then pay an additional set of fulfillment fees to Amazon. So essentially, Prime shipping is being paid for by the manufacturer, while simultaneously giving customers a reason to buy from Amazon instead of directly from the manufacturer’s website.
Amazon also has introduced advertising on its site. Merchants who want maximum sales on Amazon now have the option to buy ads right on Amazon. The program may generate Amazon up to $5 billion by 2018. While it may seem optional to buy ads on Amazon, the Amazon ecosystem has some nuances that may eventually force manufacturers to invest in them.
When a consumer sees an item for sale on Amazon, he will often see a “buy now” box that enables him to click and immediately add the item to his cart. The buy-now box sometimes sends the consumer directly to Amazon (if the item is in inventory), and sometimes to a merchant (and usually a merchant with Prime shipping enabled). Merchants fight each other for this coveted position and describe this competition as “winning the buy box.”
Winning the buy box is based on a variety of factors that are controlled by the merchant (price, customer satisfaction, shipping times and so forth) and Amazon’s algorithms to maximize sales. Like many algorithms used in e-commerce and ad tech, the algorithm appears to reward merchants with more historical sales with greater buy-box wins. This makes sense, because the more data Amazon has about a merchant, the more it can predict returns.
So the more historical sales a merchant drives for a particular product, the more likely that merchant will win the buy box. Prime shipping is one way to tweak the algorithm in your favor, and it stands to reason that advertising will also have the same effect. Hence, in the future, merchants who refuse to advertise on Amazon may see their sales plummet and their buy-box wins decline.
Welcome to the jungle
To be clear, merchants sell products on Amazon because it helps their bottom line. And I am not suggesting that Amazon is doing anything illegal or even unethical. Indeed, Amazon has dominated commerce because it is an amazingly well-run, innovative company. And for many merchants, Amazon is virtually the primary driver of success.
But Amazon has a lot of power these days, and it makes merchants nervous. So it’s worth looking at the Leegin case in hindsight and wondering: If it had come out differently, would merchants have a better case to suggest regulation to keep Amazon in check? Be careful what you wish (or litigate) for!