When GTE Sylvania discovered it was losing market share to other television manufacturers, it developed a franchise plan that limited the number of retailers selling its product in each area. Moreover, it established the location in each area where the stores could be located. Sylvania required that each franchise sell only Sylvania products.
Sylvania became unhappy with its sales in San Francisco, so it established another location that would be in competition with the existing franchise, Continental T.V. Continental was upset by GTE’s action, so it canceled a large order of televisions and ordered a competing brand. Sylvania terminated Continental’s franchise and sued for money owed. Continental filed a cross-claim, arguing Sylvania had violated Section 1 of the Sherman Act by restricting the location of retailers that could sell its product. The district court ruled in favor of Continental, while the court of appeals reversed the decision in favor of Sylvania.
Continental appealed.
JUSTICE POWELL The [Schwinn] Court articulated the following “bright line” per se rule of illegality for vertical restrictions: “Under the Sherman Act, it is unreasonable without more for a manufacturer to seek to restrict and confine areas or persons with whom an article may be traded after the manufacturer has parted with dominion over it.” But the Court expressly stated the rule of reason governs when “the manufacturer retains title, dominion, and risk with respect to the product and the position and function of the dealer in question are, in fact, indistinguishable from those of an agent or salesman of the manufacturer.”
In essence, the issue before us is whether Schwinn’s per se rule can be justified under the demanding standards of Northern Pac. R. Co. The Court’s refusal to endorse a per se rule in White Motor Co. was based on its uncertainty as to whether vertical restrictions satisfied those standards. Addressing this question for the first time, the Court stated:
We need to know more than we do about the actual impact of these arrangements on competition to decide whether they have such a “pernicious effect on competition and lack … any redeeming virtue” (Northern Pac. R. Co. v. United States, supra, p. 5) and therefore should be classified as per se violations of the Sherman Act. 372 U.S., at 263.
Only four years later the Court in Schwinn announced its sweeping per se rule without even a reference to Northern Pac. R. Co. and with no explanation of its sudden change in position.
The market impact of vertical restrictions is complex because of their potential for a simultaneous reduction of intrabrand competition and stimulation of interbrand competition…. Vertical restrictions reduce intrabrand competition by limiting the number of sellers of a particular product competing for the business of a given group of buyers…. Vertical restrictions promote interbrand competition by allowing the manufacturer to achieve certain efficiencies in the distribution of his products. These “redeeming virtues” are implicit in every decision sustaining vertical restrictions under the rule of reason. Economists have identified a number of ways in which manufacturers can use such restrictions to compete more effectively against other manufacturers.
Economists also have argued manufacturers have an economic interest in maintaining as much intrabrand competition as is consistent with the efficient distribution of their products. Although the view that the manufacturer’s interest necessarily corresponds with that of the public is not universally shared, even the leading critic of vertical restrictions concedes Schwinn’s distinction between sale and nonsale transactions is essentially unrelated to any relevant economic impact.
We conclude the distinction drawn in Schwinn between sale and nonsale transactions is not sufficient to justify the application of a per se rule in one situation and a rule of reason in the other. The question remains whether the per se rule stated in Schwinn should be expanded to include nonsale transactions or abandoned in favor of a return to the rule of reason. We have found no persuasive support for expanding the per se rule. As noted above, the Schwinn Court recognized the undesirability of “prohibit[ing] all vertical restrictions of territory and all franchising….” And even Continental does not urge us to hold all such restrictions are per se illegal.
Accordingly, we conclude the per se rule stated in Schwinn must be overruled. In so holding we do not foreclose the possibility that particular applications of vertical restrictions might justify per se prohibition under Northern Pac. R. Co. But we do make clear that departure from the rule-of-reason standard must be based upon demonstrable economic effect rather than—as in Schwinn—upon formalistic line drawing.
In sum, we conclude the appropriate decision is to return to the rule of reason that governed vertical restrictions prior to Schwinn. When anticompetitive effects are shown to result from particular vertical restrictions they can be adequately policed under the rule of reason, the standard traditionally applied for the majority of anticompetitive practices challenged under 1 of the Act. Accordingly, the decision of the Court of Appeals is affirmed.
CRITICAL THINKING:
The Court in this case overturned the previous decision made by the Supreme Court in the Schwinn case. Why did the Court decide to overrule the Schwinn decision? Do you agree with the Court’s overruling?
ETHICAL DECISION MAKING:
Suppose you were a business manager at GTE Sylvania who wished to open a store near the Continental store. If you were guided by the universalization test, would your actions have been different? Why?