Loyalty discounts sound like a great deal for procurement officers. What could be better for a good customer than a discount tied to the volume of goods purchased?
Actually, according to the U.S. Third Circuit Court of Appeals, loyalty discounts could be anti-competitive and violate antitrust laws even if a discount is above manufacturer’s cost.
In a decision handed down almost one year ago, and essentially affirmed in April by the Supreme Court, the Third Circuit Court upheld, by 2-1, a jury’s verdict that Eaton Corp., a manufacturer of heavy-duty truck transmissions, engaged in an illegal monopoly and anti-competitive behavior based on a loyalty discount program.
The Supreme Court declined to review the decision, letting it stand.
Here’s what happened.
Eaton was the dominant supplier of manual heavy-duty truck transmissions in the U.S. In 1989, Meritor Transmission Corp. entered the business and within a decade gained 17 percent market share.
In 1999, Meritor and German company ZF Friedrichshafen formed ZFM to sell ZF’s automated mechanical transmissions in the U.S. Eaton countered by commercializing its own automated mechanical transmissions and initiating long-term supply agreements, which included loyalty discounts, with the four U.S. OEMs of heavy-duty trucks.
The supply agreements provided discounts if the OEMs purchased Eaton transmissions for 65 to 95 percent of sales — new vehicles and, presumably, replacements.
Additionally, the OEMs had to make Eaton’s transmissions either the standard or preferred choice in their databooks (which buyers use when purchasing trucks), price some transmissions preferentially, and sign supply agreements for at least five years — two years longer than agreements Eaton and Meritor had with at least one OEM.
There was also a clause whereby an OEM could exclude an Eaton transmission if a competitive version was of greater quality or lower cost.
As it developed, both Eaton and ZFM had quality problems with their automated mechanical transmissions. ZFM, however, lost market share, while Eaton did not. In 2003, ZFM ended operations and Meritor resumed competing with Eaton. In 2006, Meritor abandoned the heavy-duty transmission business.
Later that year, Meritor and ZF sued Eaton for financial damages, claiming the company monopolized the transmission business and engaged in anti-competitive behavior.
In a case summary on Lexology.com, a website for corporate lawyers, antitrust attorneys Christopher Gordon and Barry Pupkin, both of Squire Sanders, write that the Third Circuit Court’s decision, and the Supreme Court’s decision to not review it, “undercuts the general principle that above-cost pricing practices are not anti-competitive.” The Third Circuit Court’s opinion “is contrary to decisions in a number of other circuits,” but consistent with its previous judgments about “bundled discounts.”
The point here is that procurement officers must consequently be wary of loyalty discounts. Based on recommendations from Gordon and Pupkin, procurement officers should keep the following in mind:
- Loyalty discounts or bundled discounts from suppliers with more than a 30 to 40 percent market share in a product category need to be viewed with extreme caution.
- All product pricing, including discounts and rebates, must be above cost at all times.
- Every loyalty discount program has to be reviewed by company lawyers before making a decision about it.
As noted, the Third Circuit Court’s decision differs from what other courts have determined about discount programs. Nevertheless, write Gordon and Pupkin, the appellate court’s jurisdiction covers Delaware, New Jersey, Pennsylvania, and the U.S. Virgin Islands — home base for many procurement departments and their suppliers. Awareness of this case and the implications it may have for discount programs can save a company the time and expense of defending against a legal action brought by disgruntled suppliers.