Distribution Restrictions Operate by Creating Dealer Profits: Explaining the Use of Maximum Resale Price Maintenance in State Oil v. Khan

The Supreme Court in State Oil Company v. Khan focused on the control of "successive monopoly" problems as the sole pro-competitive rationale for maximum vertical resale price maintenance. This article shows that the circumstances that lead a manufacturer to use maximum resale price maintenance are much more complex than the presence of a negatively sloped dealer demand curve and that these more complex conditions must be considered in order to explain Khan. The analysis first demonstrates that there are important reasons other than the "classic dealer free riding" emphasized in economics and case law for why an incentive incompatibility may exist between a manufacturer and its dealers. Therefore, to enforce dealer performance distribution arrangements must create and preserve a dealer profit premium. This explains why maximum resale price maintenance is not ubiquitous and suggests that to understand Khan we must examine other pro-competitive reasons for maximum resale price maintenance. Maximum resale price maintenance was used in Khan to prevent gasoline dealers from taking advantage of the fact that regular gas sales, but not premium gas sales, are related to convenience store sales. Hence, unconstrained dealers have the incentive to shift their demand away from the supplier's higher margin premium gas towards regular gas. This analysis illustrates the difficulties courts would have if they were required to undertake a full rule of reason analysis of every distribution arrangement that used maximum resale price maintenance. Instead, the article recommends that rule of reason analysis should employ a manufacturer market power screen.