Discounts Upheld - Reversing the district court, the Tenth Circuit Court of Appeals held on April 25 that a supermarket can sell gasoline below cost under Colorado law when the sale is contingent on purchasing groceries above cost, and the price of the total bundle is above cost. See Parish Oil Co. v. Dillon Cos., No. 07-1032, 2008 WL 1837228, __ F.3d __ (10th Cir. 2008).
Defendant Dillon Companies, a subsidiary of Kroger, operates grocrery stores that include retail gasoline filling stations on the same premises. The stores offered discounts of up to 20 cents a gallon when customers satisfied minimum purchase requirements from the grocery stores. The profit margin on qualifying grocery sales, in the aggregate, exceeded the discounts.
Colorado Unfair Practices Act - Competing gas stations in Colorado brought suit under the Colorado Unfair Practices Act, complaining that the gasoline was sold below cost and hurt their sales. The Act prohibits below-cost product sales, and prohibits the sale of a bundle of products if the "selling price [is] below the cost of all articles . . . included in such transactions."
The district court held that the statute should not be read literally, and that the price of each item in the bundle should be considered separately. The district court found that this reading was supported by the stated purpose of the Act, which was to prevent evasion of the Act's prohibition on below-cost single-product pricing through multi-product sales.
Reliance on Aggregate Costs and Pricing - The Tenth Circuit disagreed, reading the text of the statute literally. The Court recognized that the purpose of many state unfair practices act statutes was to prohibit the use of loss leaders, and the practice at issue does not involve the use of a loss leader, which normally is used to lure buyers to purchase other products at the store under the false assumption that they are similarly low-priced.
The Court also recognized that stores often offered products below cost as part of a bundle, citing the example of a discounted cell phone offered with a service contract, and citing to an example of a customer loyalty card offering a free product discussed in an episode of Jerry Seinfeld:
JERRY: "Atomic Sub"? Why are you eating there?
ELAINE: I got a card, and they stamp it every time I buy a sub. Twenty-four stamps, and I become a Submarine Captain!
JERRY: What does that mean?
ELAINE (embarrassed): Free sub.
Id. at __ (quoting Seinfeld: The Strike (NBC television broadcast Dec. 18, 1997)).
Thus, the Tenth Circuit reversed the lower court's ruling, finding that because the aggregate price of the bundle exceeded the cost, the practice was permissible under the Colorado Uniform Practices Act.
Above-Cost Aggregate Pricing Can Be Anti-Competitive - While the Court's ruling appears to be a correct reading of the statute, the statute fails to take into account potential scenarios in which an above-cost bundled price can be anticompetitive. For example, even if the competing gas stations were the most efficient providers of gasoline, Dillon's practices could potentially exclude them from the market because they cannot compete with the bundled product, harming consumers in the long run.
Peacehealth Decision - A recent Ninth Circuit ruling suggests that, if Dillon's had a monopoly over groceries in the relevant market, then its gasoline discounting scheme would be illegal under the antitrust laws. See Cascade Health Solutions v. Peacehealth, 515 F.3d 883 (9th Cir. 2008), superseding and amending 502 F.3d 895.
Discount Attribution Approach - The Peacehealth court examined whether a bundled discount constituted attempted monopolization under the Sherman Act. The court rejected the aggregate pricing approach that "condemns bundled discounts as anticompetitive only in the narrow cases in which the discounted price of the entire bundle does not exceed the bundling firm's incremental cost to produce the entire bundle." Id. at 904. Instead, the court adopted a "discount attribution" standard under which "the full amount of the discounts given by the defendant on the bundle are allocated to the competitive product or products." Id. at 906. (The Peacehealth decision explicitly disagreed with the Third Circuit's standard in LePage's Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003), which did not require any evidence of below-cost pricing).
The Peacehealth court gave the example of two shampoo producers, one of which also makes conditioner. Id. at 897, 906 n.14. Hypothetically, producer A offers shampoo for $3 and conditioner for $5, but as a bundle for $2.25 and $3. Producer B only makes shampoo and not conditioner. In order to match the bundled price, B must price its shampoo at 25 cents, which combined with A's individual conditioner product price of $5 achieves the combined price of $5.25. Thus, if Producer B's variable costs exceeded 25 cents, it would likely be driven out of business by A even if B were the more efficient producer. Under the Peacehealth standard, the entire discount for the bundle would be allocated to the competitive product – shampoo – and the court would find producer A's practice anticompetitive if its variable costs exceeded 25 cents.
In the context of the Dillon's case, if a supermarket with a monopoly on grocery sales offered a discount on gasoline sales, then the discounted price of gasoline must exceed its costs, regardless of whether the store achieved an aggregate profit.
Conclusion - In sum, retailers offering bundled product pricing must be careful that their practices comply with federal and state laws, which can vary significantly by jurisdiction. They should be especially cautious if they have market power in any of the relevant product markets or if their discounting could be seen as pricing one of the products in the bundle below cost.