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Toying with the Free Market

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Here’s a noteworthy story from the Washington Post last September:

“Toys ‘R’ Us Inc., the world’s largest toy retailer, announced a major restructuring yesterday in an effort to shore up the chain’s sales and profits, which have flagged as a result of growing competition from discounters and changes in the way children play.”

The article goes on to explain that the giant toy retailer would close 90 outlets around the world, 40 of which are in the United States, and revamp its remaining stores.

That news, which played on the business pages of America’s largest newspapers, would not be quite so noteworthy were it not for one interesting fact: in 1996, the Federal Trade Commission complained that Toys “R” Us had engaged in monopolistic practices in order to keep prices high. Specifically, the chain was accused of pressuring top toy manufacturers to stop selling their popular products to discounters and price clubs. The method of pressure, the FTC said, was the firm’s threat not to carry toys that are carried by the discounters.

What can we say about this case? The first thing we may note is that consumers don’t seem much bothered by a firm labeled monopolistic by the government. They go about their business, buying the products they want and ignoring the products they don’t want. No consumer has stepped forward to complain that agents of Toys “R” Us forced him into the store and compelled him to buy a Barbie doll or Star Wars action figure. Because consumers can do what they want and because their tastes change, Toys “R” Us has to make radical adjustments in its business. As the Washington Post put it,

“Toys ‘R’ Us has been losing market share and posting disappointing sales results for several years as it has begun to lose its once formidable grip on the worldwide toy industry. Not only has the company failed to keep up with rapidly evolving technology aimed at kids, but its often dingy and confusing store displays had turned off many parents. That has left the chain vulnerable to competition from discount chains such as Wal-Mart and Target, which have begun making significant inroads into the toy business.”

This story raises an interesting question. If we have free consumers, why on earth do we need the Federal Trade Commission?

An advocate of the FTC would reply that companies must not be allowed to engage in abusive practices. But if “abusive practices” means practices that harm consumers, we can see that consumers are perfectly able to take care of themselves. When they (or their kids) decided that Toys “R” Us did not keep pace with the new toy technology or that the stores were unpleasant, they went to Wal-Mart or Target instead. They didn’t need anyone’s prompting or permission. They didn’t need to petition a government agency. They just found a store they liked better. That sounds like real power to me.

But what about the specific charge: that Toys “R” Us tried to keep toymakers from selling their products to the discounters? Shouldn’t the government prohibit that kind of conduct?

To answer this question, let’s break the issue down to its specifics. When the FTC says that Toys “R” Us tried to get toymakers to stop selling certain toys to discounters, what exactly did the firm threaten? It threatened to abstain from carrying those toys unless its request was complied with. In other words, the retail chain would have refused to buy those toys and place them on its shelves if the manufacturers sold them to the discounters. Toys “R” Us presumably has the right to buy or not buy whatever is offered for sale. At this moment, there are many things that Toys “R” Us does not buy and stock on its shelves. Does anyone believe that violates the law?

But, someone might say, the threat not to buy was intended to prevent the toymakers from doing something they wanted to do and otherwise had a right to do. True enough. But in any transaction, each party is entitled to offer terms. Likewise, each party is entitled to refuse terms offered. Why isn’t Toys “R” Us entitled to offer any terms it believes would be to its advantage? The toymakers were free to reject the terms and renegotiate or to find other outlets for their toys.

We may infer that Toys “R” Us offered terms that it believed were to its advantage. It surely hoped to influence the toy market in an effort to maximize its profits. We can even stipulate that Toys “R” Us, with 25 percent of the toy market, was large enough to make a big impression on the toymakers, who would hate to lose access to the chain’s many customers. But one is hard-pressed to see why those considerations should override the property rights of the Toys “R” Us owners. They have no moral or legal obligation to stock any particular toy. Their reason for not stocking a toy shouldn’t be legally relevant.

Given all that, can we nevertheless conclude that Toys “R” Us’s alleged attempt to persuade toymakers not to sell to discounters was contrary to the interests of its customers? At first glance, it would seem so. If discounters can’t stock popular toys, prices might be higher than otherwise.

But this matter is more complicated than it seems. The discount industry creates problems for regular retailers. The question is whether retailers may use their economic liberty to protect themselves. To illustrate this, imagine two electronics stores, a full-service retailer and a discounter. The full-service store is an electronics showroom, with plenty of trained and knowledgeable salesmen. Several operating models of stereos, televisions, and computers are on display, permitting consumers to sample the products firsthand. The salesmen stand by to answer questions and to demonstrate the merchandise. The store heavily advertises the features of brand-name products.

In contrast, the discounter is not much more than a warehouse. The products are in boxes. The personnel are little more than checkout clerks. They don’t demonstrate products; they can answer only some basic consumer questions.

Since the full-service retailer has higher costs to recoup, it charges more for its products than does the lower-cost discounter. Obviously, the full-service store is at a disadvantage with the discounter. That disadvantage is a consequence of the choices it has made. The full-service store could change its strategy and turn into a discount warehouse if it wished. But the retailer can act to minimize the disadvantage, at least to an extent. It can seek contracts with its suppliers to reduce the discounters’ and customers’ free riding on its services. What free riding? Many consumers sample the products at the retailer, enjoying the showroom atmosphere, and tapping the knowledgeable personnel for information. Then, after deciding what they want to buy, they go across the street and buy the same product at a lower price from the discounter.

Of course, no one’s rights are violated in this scenario. The retailer welcomes potential customers onto the premises, understanding the risk that any customer might end up patronizing another store. The retailer would be foolish to discourage potential customers by, for example, asking them to pledge not to buy from a discounter.

But that doesn’t mean the retailer is powerless to minimize the free riding on his investment. One way to do that is to ask suppliers not to sell their products to discounters. A large enough retailer might have the market clout to win that concession from some suppliers.

Does that hurt consumers? Consumers, of course, always prefer lower prices to higher prices. But we need to recognize that in the scenario described above, consumers can get services – information, access to demonstration products – that they don’t pay for. If that situation were to persist, the full-service stores could go out of business and consumers would lose those services. They would be worse off from their own point of view.

There is a similar free-rider problem in toy retailing. As Donald Boudreaux, the economist and president of the Foundation for Economic Education, has written, Toys “R” Us makes two big investments that benefit consumers and toymakers: it advertises particular toys heavily (providing specific information) and has buildings big enough to hold a full line of toys all year. By stocking virtually every toy, the chain pays to discover which toys are popular and which are not. The discounters free-ride off that investment and confine their inventories to the most popular toys. Thus, consumers might learn about toys from the Toys “R” Us ads, see the toys on Toys “R” Us shelves, but then buy the toys for less at a discounter.

In that light, Toys “R” Us’s attempt to keep certain toys off the discounters’ shelves appears perfectly rational and in harmony with the interests of consumers.

The latest news about Toys “R” Us reminds us, however, that consumers always have the last word.

This post was written by:

Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.