In my last blog, I explained how the prices of grand pianos are created. Three pianos of different sizes might only differ in price by a few hundred dollars when you order a quantity from the manufacturer. After the importing distributor establishes the wholesale price, followed by the retailer setting the retail price, the difference in price grows significantly. In my Piano Buying Guide (found on this blog) I explained that consumer perceptions drive price points. Consumers expect a grand piano to cost around $10,000. If the distributor saves money by locating a manufacturer who can make the piano for less money, the distributor can realize a windfall profit. A retailer would be foolish to lower the price of a grand piano to $9,000 if the consumer was willing to pay $10,000. Likewise, a distributor would be foolish to pass savings to a retailer who was willing to buy a piano at a higher price. For the consumer, this means that the cheaper products that are coming out of China do not automatically guarantee consumer savings.
I want to expand on this subject of pricing. I need to review some history in order to explain some of the problems the musical instrument manufacturing industry has encountered. This historical view will eventually help you understand one of the most controversial decisions by our Supreme Court – one which is rarely discussed in the media.
A History of Minimum Advertised Price (MAP) Pricing
Before the internet – before Big Box retailers – before catalog sales; the market of discounts was served by businesses that marketed their goods through 1-800 telephone numbers. American retail was rapidly changing in the 70s and 80s. Downtown areas were unable to compete with the mall concept. Populations were locating to the suburbs, and malls catered to young consumers who favored convenient locations. The suburbs did not have the traffic congestion that was found in city centers. Malls and strip centers offered better parking, modern and cleaner amenities, access to a broader selection of products and the promise of cheaper prices.
Consumers end up hurting themselves, like so many rats that are attracted to the sweet music of cheap prices.
That wasn’t good enough for the American consumer. Any retailer could advertise in a distant market and offer spectacular prices to anyone who didn’t mind ordering over the telephone. Large retailers, who could take advantage of quantity discounts from distributors and manufacturers, could undercut the prices of retailers in smaller towns. The smaller retailer had lower overhead. Rents were not as high in the smaller towns, but even if the large retailer did not cause the smaller dealer to go out of business, he still caused the smaller retailer a high amount of frustration and irritation.
Small Dealers Lost Sales and Profits
In those days, a small retailer might spend an hour or two showing a product to a customer, like a synthesizer or trumpet, and later find that his price was undercut which resulted in a lost sale. The larger retailers were quite arrogant about their practices. As a territory sales rep, I was once introduced to the owner of a large retail store in Atlanta. I worked the Texas area, and was paid commissions on sales to dealers in Texas. When I spoke with the owner of the discount operation in Atlanta, he said, “There are some very good salespeople in Texas. We get a lot of sales from that area.”
He got a lot of sales, but he did not do anything other than advertise a 1-800 number in order to get that business. The dealers and sales people in Texas did the work. The dealer in Atlanta made the sale. The Texas dealers lost profit to an out-of-state dealer. I lost commissions to the Atlanta rep.
Retailers complained bitterly about the loss of profit margin due to the increase of discounters.
Small retailers quickly found that there was nothing they could do to compete with the large discounters. Some of them placed similar ads with their own 1-800 number. Within a few years, the number of discounters grew dramatically. Retail changed. Products that could be shipped to customers became scarce in the stores of the smaller retailers. Pianos were not affected (because of their size and shipping weight) but sales of digital pianos and synthesizers greatly suffered.
With fewer stores offering the popular shippable products, there were fewer dealers to educate the public about new products. Sales to smaller dealers dropped. When consumers purchased products thru 1-800 numbers, the local dealer might later refuse to service the product, or offer the consumer any after-sale services, such as an invitation to training clinics.
Discounters vs. Brick and Mortar Stores
These smaller dealers are referred to as “Mom and Pop” dealerships. They are usually owned by a family, and run by the husband and wife. They are also referred to as “brick and mortar” stores. Discounters who sell over the telephone exclusively do not have to locate their store in a high rent district. In fact, a store is not necessary at all. You could buy products and put them in your house or garage. The name “brick and mortar” implies overhead costs and a physical retail location.
As the years advanced, a lawsuit soon made its way to the Supreme Court.
In the late 80s, there were about 10,000 music stores in the U.S. I do not have figures on what that number is today, but it is probably similar. In the early 90s, a new type of discounter emerged. As the internet market grew, discounters could reach a wider audience for less money. By the end of the decade, consumers had easy access to catalog sales, internet sales and 1-800 discounters. This created a very big problem for wholesalers. Retailers complained bitterly about the loss of profit margin due to the increase of discounters. The buying advantages given to large retailers, many of whom had multiple store locations, often enabled those retailers to set retail prices at near, or just above the smaller retailer’s wholesale cost.
Wholesale Pricing Schemes
The large retailers could also buy products that would soon be discontinued. Distributors might sell single units to smaller retailers (without informing them about their intent to discontinue the product), and then sell all of the remaining stock to one or two large retailers by informing them the product would soon be discontinued.
This happened to the extreme when I worked for Kurzweil Music Systems Inc. The company needed to sell hundreds of rack-mount synthesizers that were no longer competitive. The prices of the units were $1,197 – $1,497 with suggested retails of $1,995 – $2,495.00, respectively. During our national trade show, where retailers can receive additional discounts through “Show Specials”, the national sales force was charged to sell all of the remaining units. We sold quite a few, but we did not sell all of them. On the last day of the show we learned that the remaining units, about 300 total; had been sold to a large retailer. The price paid was $250 per unit.
Within two weeks, ads appeared in local classified sections offering these units for as little as $500.00. The local dealers, who had paid $1,197 – $1,497 just two weeks earlier, were furious to learn that the large retailer had made such a purchase. They asked why they had not been offered that price. In time, everyone sold their units, but the actions of the distributor/manufacturer were not soon forgotten.
In the 2000s internet discounters started offering pianos for sale. These pianos were usually Chinese “no-name” pianos. A no-name piano is made without a brand name. The purchaser buys decals and applies one to the piano fallboard. These pianos are often similar to the brands you would find in a piano store. Piano stores must charge higher prices in order to cover higher overhead for staff and facilities. Discounters pitched their pianos as the “same” as those found in piano stores. This statement was not always false. With such competition, a Brick and Mortar dealer could not build brand name recognition or differentiate a brand by selling the value-added product attributes the piano store could offer.
Discussions of Price Protections
What emerged from the pricing disparities which existed at the end of the 90s was born in the minds of sales reps in untold numbers of companies who insisted that price protections must be implemented in order to protect the interests of the Mom and Pop stores. Distributors and manufacturers needed to protect the population of stores; otherwise the ranks of the retailers would shrink and ruin the strength of the industry. Fewer stores in smaller markets meant less support for educators, schools and local consumers. Profit margins were being decreased because of discounters, but also because of the unethical and incompetent management practices of manufacturers such as Kurzweil Music Systems, Inc.
MAP pricing – Minimum Advertised Price
As sales reps bantered in home office sales meetings about pricing, rumors emerged that a few larger manufacturers had embraced the idea of setting the lowest permissible price that could be advertised. This scheme became known as MAP pricing – Minimum Advertised Price. Each dealer would soon be required to agree to MAP pricing in order to continue to be an authorized dealer. The requirement was placed in Dealer Agreements; those contracts that set the conditions for business practices. Some manufacturers even limited the territory that a dealer could advertise in. For instance, a Yamaha piano dealer in Oklahoma cannot advertise for customers in Florida. By limiting the retailer to territories (often in exchange for local exclusivity), the manufacturers were able to decrease the impact of discounters, 1-800 number retailers, internet companies and catalog marketers.
MAP pricing became the catch-all solution for more and more distributors and manufacturers. This is why pricing on the internet is so similar today. Consumers do not realize that products can be sold for less. Retailers are permitted to sell for lower prices; they just can’t advertise that they are able and willing to do so. This practice interferes with any consumer’s ability to negotiate with a seller of goods, a key feature of free market economics. It also reinforces strategies that create higher prices for consumers.
Free Market Economics
MAP pricing interferes with free market economics. It creates an artificial obstacle which hinders the evolution of the marketplace, and favors the interests of retailers and distributors over the buying preferences of consumers. The story of the Pied Piper comes to mind. Consumers do not realize that by consistently selecting the retailer who offers the lowest price, they are slowly destroying the industry and eliminating all the non-sale related services that ultimately support those same consumers. Consumers end up hurting themselves, like so many rats that are attracted to the sweet music of cheap prices. However, if the emergence of new marketing strategies are supported by consumers, then the principles of free market economics would oppose artificial strategies that alter the force of consumer preferences in the evolution of the marketplace.
When the topic of MAP pricing was being introduced, I argued among associates that it was illegal price setting. Retailers are not permitted to enter into agreements with other retailers in an effort to set prices of similar products. MAP pricing enabled manufacturers to set those prices. Manufacturers were not known to actually meet and secretly discuss their prices with competitors, but the pricing schemes could soon be known by acquiring confidential price lists. Confidential price lists are easy to attain from retailers. Typically, a national sales manager will ask a rep for a competitor’s price list: “Can you get me one?” The rep then “trades” with the retailer. The rep offers the retailer a confidential price list of a competitive brand in trade for the desired one. The desired price list is then faxed to the national sales manager. The same is true for dealer agreements. By this method (and others) manufacturers and distributors are able to gain first-hand information about the pricing and dealer agreements of competitors.
While MAP pricing became the industry-wide solution to the problem, the question of legality remained relevant. As the years advanced, a lawsuit soon made its way to the Supreme Court. The decision in that case may be of interest to you. I will tell that story in my next blog.