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Horizontal and Vertical Agreements that Violate the Sherman Act

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  • 1:13 Price Fixing
  • 2:58 Market Allocations
  • 3:59 Boycotts
  • 5:58 Monopolies
  • 7:32 The Rule of Reason
  • 8:15 Lesson Summary
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Lesson Transcript
Instructor: Kat Kadian-Baumeyer

Kat has a Master of Science in Organizational Leadership and Management and teaches Business courses.

There are two types of restrictions under the Sherman Anti-Trust Act. A horizontal agreement between competing businesses includes price fixing, and a vertical agreement between sellers and buyers includes engaging in resale price maintenance. Learn about both types of agreements in this lesson.

Sherman Anti-Trust Act of 1890

The Sherman Anti-Trust Act of 1890 was enacted to disband monopolies and cartels to prevent unfair competition. The purpose of the act was to ensure that all businesses that engage in interstate commerce retain their right to fair competition. The Sherman Anti-Trust Act Section 1 states 'no company may engage in interstate commerce with the intention to scheme between competitors to level the competition or gain market control.' Said a different way, it is illegal to unreasonably restrain trade amongst competitors, and these agreements can be either horizontal or vertical.

A horizontal agreement is made between competing businesses to manipulate competition amongst all competitors in the marketplace. In contrast, a vertical agreement is made between a seller and a buyer in where a retailer can buy products from one manufacturer but in the agreement is restricted from buying from a competing manufacturer. Here are some examples of both types of agreements:

  • Price fixing
  • Market allocations
  • Boycotts
  • Tying agreements
  • Monopolies

Price Fixing

Price fixing is a horizontal agreement involving competitors conspiring to raise, decrease, fix or stabilize prices in a specific market. It sounds confusing, but it is really quite simple. Companies who intentionally engage in price fixing do so primarily to manipulate prices to cause an unfair advantage. This price manipulation creates a situation where, in many cases, competitors set same prices on their products and it negatively affects others in the marketplace.

For example, Stone's Filling Station is located on the eastbound side of Route 1, and Hillbilly Millie's Gas N' Go is located on the westbound side of the same highway. Both Stone and Millie may set the same price of $1.68 per gallon. There is nothing illegal about it. However, if one can prove that the owners made the decision to sell at the exact same price in order to affect the natural market fluctuation that results from supply and demand, it would be illegal.

Both Stone and Millie know that there is going to be a big concert in town. People will be traveling from the east and west to arrive at the destination. The destination, coincidentally, only has two filling stations: one owned by Millie and one by Stone. There is no other place to get gas for up to at least 100 miles in either direction.

If Millie and Stone conspire to raise gas prices to $3.98 per gallon, they are messing with the natural ebb and flow of supply and demand. In other words, customers may need to fill up when they arrive or before they leave the concert. They are given no choice but to pay a gouged, or unfairly inflated price, for their fuel.

Market Allocations

Market allocations are also horizontal agreements and happen when competing companies choose specific territories to sell products and neither company sells to the other company's customers. What makes this arrangement illegal is it creates a monopoly for each territory. Let's see if we can break this down. Suppose there were only two manufacturers of office copy machines, Conglom Copier Co. and Comp-U-Copiers, Inc. and both make very similar products.

If the two companies decide to split the country into two, say north and south, with Conglom selling copiers to the lower states and Comp-U-Copiers selling to the upper states, they will create a monopoly in where the businesses in their territory have only one choice, which is to buy from the company that sells exclusively in their location. With this type of illegal agreement between the two companies, they have the ability to fix prices to whatever they desire because the businesses that need to buy from them have no choice.

Boycotts

Boycotts are illegal vertical agreements between a group of businesses to stop using a company's product or services in order to negatively affect their ability to compete in a market. Don't get me wrong. A business has every right to choose whom to do business with. There is nothing illegal about making prudent product choices. It becomes illegal when it is a concerted and deliberate group effort to kick one company to the curb.

Let's say We Care Insurance Company decides to increase their payouts to doctors in a certain territory only if they accept their insurance exclusively. We Care Insurance may contact all of the doctors in the area to tell them about the new payment schedule. Since most doctors take several insurances, there is built-in competition. However, by making an attractive offer to several hundred doctors in one region, it could wipe out business for all other insurance carriers. On a side note, it would be awfully inconvenient for patients who do not subscribe to We Care as well.

Tying Agreements

Tying agreements are vertical agreements where a manufacturer sells a product and the necessary complementary products needed to use the tying product and forces the customer to buy all complementary products exclusively from the manufacturer. Let's use Conglom Copier Co. Suppose Conglom sells several hundred copiers to a major law firm. In the agreement to purchase the copiers at a specific price, they require that the law firm also purchase paper from Conglom exclusively.

In other words, regardless of whether paper is available at an office supply wholesaler for less money, the law firm must only purchase paper from Conglom. This creates market domination for Conglom on the sale of copiers and paper. Competing copy paper sellers cannot sell to those who purchased copiers from Conglom.

Monopolies

Of the horizontal and vertical agreements we reviewed, monopolies are probably the most dangerous. They involve one or very few companies who dominate a particular market, leaving no room for others to compete. This domination could be market-based or even product-based.

Keep in mind, exclusive rights to sell in a specific venue is not really a monopoly. For example, a ballpark may only sell a certain brand hot dog. Other hot dog companies cannot say that they are being forced out of a market because a stadium has a right to choose one brand over another. Where it gets a little sketchy is when only one company has a stranglehold on the market.

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