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Legal Update - Internet Sales

Legislative Issue Update - June 2008

Manufacturer Limitations on Internet Sales

In the mid-1980’s, Apple Computer instituted a ban on mail order sales of its products. Dealers who continued to sell Apple products by mail were warned they would be terminated as authorized dealers. Several dealers who specialized in mail order sales sued Apple claiming the mail order ban violated antitrust laws. Apple prevailed. (O.S.C. Corp. v. Apple Computer, Inc., 792 F.2d 1464 (CA 9th 1986)).

Mail order sales and internet sales have a lot in common, so this case is of interest today. Often a customer may consult with a local wholesaler-distributor to obtain product specifications, valuable advice on selecting the right product, product demos and other services – then bypass the wholesaler-distributor and shop the product on the Internet.

“Free-riding” on the investments made by a full service, value-add wholesaler-distributor is not a new practice. It is, nevertheless, potentially harmful to the manufacturer and its distribution network that supplies the services and expertise demanded by customers.

In the Apple case, the court of appeals found that Apple had an entirely plausible and justifiable explanation for its sales policy that was consistent with proper business practice. The mail order sales prohibition was imposed to insure Apple’s products were sold in face-to-face transactions, which was consistent with Apple’s marketing strategy - - to require sales support by its dealers, “such as assessing the needs of prospective purchasers, assembling the particular package to met those needs, hands-on instruction, education and training, and follow-up servicing.” Mail order sales do not supply this necessary support.

Apple’s policy was intended to protect the financial health of its distribution network. Here’s what the appeals court said on this point:

The district court found that Apple’s only concern with prices pertained to its dealers’ capacity to withstand erosion of profit margins caused by having to carry “free riding” mail order dealers. Such a concern is both legitimate and lawful. See Monsanto, 465 U.S. at 762-63 (manufacturer may lawfully ensure that distributors earn sufficient profits to pay for product service programs and to “see that ‘free riders’ do not interfere”); Continental T.V., Inc. v. GTE Sylvania, Inc. 433 U.S. 36, 54-59 (1977) (manufacturer can impose service and repair responsibilities on retailers, which because of “free rider” effect, retailers might not otherwise perform); JBL Enterprises, Inc. v. Jhirmack Enterprises, Inc. 698 F.2d 1011, 1015 (9th Cir.) (dealers more likely to promote or service product if not worried about other dealers taking a “free ride” on their efforts), cert. denied. 464 U.S. 829 (1983); Computer Place, Inc. v. Hewlett-Packard Co., 607 F.Supp. 822, 830-31 (C.D.Cal. 1984) (manufacturer’s ban on mail order sales of computers was held justified by the manufacturer’s concern over free riding by mail order dealers).

Clearly, a manufacturer’s distribution policy that is designed to protect the well-being of its distribution network can be implemented in a manner that is consistent with the antitrust laws.

Finally, the court also found that Apple’s policy was not anticompetitive. In fact, competition was intense before and increased after the mail order ban was adopted.