Wednesday, March 28, 2007

Clearing out inventory in the United States: a problem

A friend of mine sent me this news story last week. And I was so shocked; I had to share it with you.

The story reads: "If you own a mom & pop store and can't get rid of some of your inventory, you can always clear out some shelf space by holding a sale. If the Supreme Court sides with business interests in a case they heard today, however, such sales may no longer be possible. Since 1911 it has been illegal for manufacturers to force retailers into setting a price floor for products — individual retailers get to decide how much they sell products for."

The article continues to say "But today the Supreme Court heard oral arguments in a case seeking to overturn this longstanding rule. Should the Court do so, it would drive up consumer prices across the board. This case is particularly salient in the era of Internet shopping: consumers are now easily able to shop around to multiple retailers to find the best price. The Court could wipe out this advantage."

What is a 'price floor'? Let me explain. A price floor allows manufacturers to set a price below which a retailer cannot sell their products - like a gun manufacturer telling Wal-Mart to sell their pistol no lower than $29.99 ("stop rollin' back prices on my pistol"). The above graph shows the the implication of this price floor. I don't think this will even get pasted ... but what if it did? Implications? Yes, there are two questions we need to answer: (a) What will be the impact on demand and supply? (b) Which markets could be affected?

(a) On the above graph, the floor price floor is represented by the green line. The quantity demanded at the price floor is given by the interception of the blue line - which is the demand cure - and the green line (the price floor). The quantity supplied at this price is given the interception of the red and green lines. What this tells us is that manufacturers will supply the market more than what the market will demand at the new 'price floor' price; that is, the producer will make more because they can get a better price for it.

(b) What does this mean for the market? Well, it will give manufacturers more power of the final sale price of their market and it could prevent 'clearance sales'. Retailers, therefore, will have less power to move inventory. If retailers misjudge the demand at the new 'price floor' price they will have to carry more inventory. Is this a big concern? No.

Most markets are very competitive. Production in China of everything from TVs to furniture suggests that the manufactures the try to put price floor in place will loose - thus there is little incentive to do so. Unless firms collaborate, prices will not rise. Who might do this? Maybe the makers of seven jeans might be concerned that their customers believe 'price means quality' and they would like to keep prices near $200 a pair (no more buy these at Winners for you). For them, never allowing retailers to sell their jeans for less might be part of their strategy (as a Dollar Store lover, clearly, I am not very concerned).

Here is a link to another version of the story: here

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