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One for the little guys.

Conway Pharmacists Win Round 1 With Wal-Mart in Case That Has National Retail Industry Abuzz

IMAGINE A PESKY, PERsistent gnat trying to fight an elephant. Seems ludicrous, doesn't it? But that is how Dwayne Goode, owner of American Drugs Inc. in Conway, compares his successful lawsuit against Wal-Mart Stores Inc., the country's largest retailer.

"After we won, my daughter said, 'That gnat sure bit that elephant pretty hard, didn't it?'" Goode says.

If the Faulkner County Chancery Court ruling is upheld on appeal, the tiny gnat's bite could become much more critical to Wal-Mart and retailers nationwide. While predicting victory by Wal-Mart on appeal, analysts say the precedent could limit competitive pricing practices in the retail industry, change the way retailers do business and prompt a slew of other lawsuits.

Jim Hendrickson, owner of Baker Drug in Conway; Tim Benton, owner of Mayflower Family Pharmacy; and Goode won a $289,407 judgment against Wal-Mart on Oct. 11. That was a token monetary amount for the $55.5 billion retailer but a potentially costly ruling for the long-term.

Chancery Judge David Reynolds of Conway ruled in favor of the pharmacists, finding that Wal-Mart violated Arkansas' Unfair Trade Practices Act. Reynolds ruled that Bentonville-based Wal-Mart violated the 1937 act by selling products at its Conway store at less than cost for the purpose of injuring competitors and destroying competition.

The judgment surprised Wal-Mart, stock analysts, consumers and other retailers.

"I didn't believe that someone would rule against Wal-Mart in Arkansas," says Linda Morris, an analyst who follows Wal-Mart for PNC Bank in Philadelphia.

Many experts believe it will be overturned by the Arkansas Supreme Court in the next six months to a year. If not, Wal-Mart could appeal to the U.S. Supreme Court, says Robert Rhoads, the retailing empire's general counsel.

In the meantime, Wal-Mart has posted a bond and will continue its pricing strategy until the appeal is heard.

Fighting for Market Share

"It is our opinion that the |state~ Supreme Court, when they review the evidence, will see that Wal-Mart had no intent to injure the competitors or the competition," Rhoads says. "There is plenty of evidence to show that our competitors made profit.

"We are fair, tough competitors and we will fight for market share and to be the most customer-pleasing merchant in the world. And if that's a crime, then we're sorry. But we don't believe it's a crime."

But others, including the pharmacists and their attorney, expect the decision to be upheld. Scores of small businesses throughout the country with potentially similar lawsuits also are hoping it's upheld.

Craig Weichmann, an analyst with Morgan Keegan & Co. in Memphis, Tenn., says in a recent stock report on Wal-Mart that the real issue in the case is a potentially dangerous precedent that could limit competitive pricing practices in retailing.

"The free enterprise system is built upon the principle of competition," Weichmann says. "There is no rule that says the inefficient retailer must be subsidized to stay in business."

The concept of selling products below cost is not new. Morris points out that Toys 'R' Us Inc. uses the same strategy as Wal-Mart. The consumer dictates the lower prices, she says.

Grocery stores routinely sell items such as soft drinks and milk as "loss leaders" to attract customers, and other retailers and discount stores do the same. The strategy is that the customer, once in the store, will buy several other normally priced items before leaving, thereby generating an overall profit for the store.

"That's a business strategy, and it's perfectly legal," says Larry Gresham, a marketing professor at Texas A&M University in College Station and former director of the school's nationally recognized Center for Retailing Studies. "But it's not done for the specific intent of driving someone out of business. It's done with the intent to get more customers to come in the Wal-Mart store."

Goode says he does not believe the ruling prohibits using "loss leaders" or other below-cost strategies because they are almost always for the short term. The problem Wal-Mart created for him and the other pharmacists was the seemingly never-ending policy of selling below cost on certain items.

"If Wal-Mart had done this only occasionally, we would never have sued," Goode says.

Judge Reynolds apparently agreed, citing the number and frequency of the below-cost sales.

Gresham says Wal-Mart's policies have been clear for years.

"Its ambition is to drive competitors out of business," says Gresham, who acknowledged he was unfamiliar with the evidence in the case. "That's fine and good. That's the name of all business. That's what businesses do -- attempt to take market share from other businesses.

"Wal-Mart's pricing policies are clearly designed to win as much market share as they can. Yes, a lot of businesses do go out of business. But to say Wal-Mart targeted two or three individual businesses to drive out, I think, is ludicrous."

A New Game

Conway's Wal-Mart opened as the fifth store in the chain in 1966, but it didn't open the pharmacy until 1987. Pharmacies in Faulkner County soon realized the rules of the game had changed.

Wal-Mart sold scores of prescriptions and health and beauty aids below cost to attract more customers. By 1990, Goode began to consider suing the retailing giant.

He sought support from pharmacists in the county, but only Benton and Hendrickson agreed to join him. Many feared possible countersuits from Wal-Mart, Benton says.

"I'll challenge anything that I think is right," Goode says. "If I think it's right, I'll stand up for it."

When Goode questioned Matthew Adlong, a partner in the Conway law firm of Brazil Clawson Adlong Murphy & Osment, his plan to sue was immediately TABULAR DATA OMITTED TABULAR DATA OMITTED rebuffed.

"When he first came to me, I told him I didn't think there was a case," Adlong recalls. "I told him I thought they could sell it for what they wanted to and basically he was barking up the wrong tree.

"He badgered me to dig a little further and to check out some other things. As we got to digging and looking at the federal case law, we felt that what Wal-Mart has actually done with their elaborate plan of pricing is definitely predatory."

Critical Step

Goode investigated Wal-Mart's prices and began comparing them with other stores in Conway. Then, in a step that proved critical to the case, he compared Wal-Mart's prices to those of Wal-Mart stores in different markets.

What he found was that Wal-Mart's prices were lower in competitive markets, such as Conway and the Little Rock area. But in two communities with little competition, Flippin and Clinton, Wal-Mart's prices were higher on the same items.

He then contacted suppliers, including pharmaceutical manufacturers SmithKline Beecham Corp. and Parke Davis, to determine Wal-Mart's actual cost for the items.

"They mailed me their direct cost at that time in volume buying, the largest that you could buy," Goode says. "They assured me that there was no other way that Wal-Mart or anyone else could buy at a lower cost. It would be against the antitrust laws if they did."

Wal-Mart's prices in Conway were below the manufacturers' cost on those items.

"Ben Rand suggested I check the cost of Enfamil baby formula," says Goode, referring to the late chief executive officer of grocery wholesaler Rand's Inc. "He told me if he bought a rail car load of it, or 120,000 pounds, it would cost him $16.98 a case."

Wal-Mart was selling Enfamil for $11.48 a case at the time.

Hendrickson says it was revealed in the trial that Wal-Mart might check a strong competitor's prices weekly. If the competitor's price was lower than Wal-Mart's on a specific product, Wal-Mart would match the price.

If the competitor dropped below that price a week later, Wal-Mart would drop below the competitor's price. If the competitor matched it or beat it again the next week, Wal-Mart would drop that price and many more prices in the department.

"It's like if we're playing poker and I have $50,000 and you have $5," Adlong says. "When I get a good hand, I'll drive you out of the game."

During the first day of the two-day trial in August, Wal-Mart President and CEO David Glass conceded that the company sold products below cost.

But Wal-Mart noted that the number of pharmacies in Faulkner County actually increased, from five in 1967 to 12 in 1981 and 14 in 1992. It also argued that the pharmacists weren't hurt by below-cost pricing judging by the gross margins for all three pharmacists, which increased from 24.9 percent in 1986 to 29.2 percent in 1990.

However, Mayflower Family Pharmacy's Benton says the gross margins were only the difference in what was paid for products and what they sold for. It doesn't include expenses, he says.

Benton doesn't expect he'll be forced out of business in Mayflower, but he admits he is looking for alternatives to supplement or replace his income.

Goode says he's made more money on the stock market than he has at his drugstore.

"Wal-Mart is putting them out of business," Adlong says of the pharmacists. "Their stores are based on sales of prescriptions. If they don't have prescriptions, they close. Their prescriptions are dropping at the rate of from 1,000 to 2,000 prescriptions a year.

"When you see that big a chunk coming out of your business every year, year after year, you've got to stop the bleeding or you will be out of business."

Product Lines Expand

The three also had to put in different product lines to make up for prescription losses, and that's one of the strategies Gresham suggests to small businesses to remain profitable in spite of Wal-Mart's low pricing.

It's impossible to compete on prices, he says. Businesses that have been successful stock different products and better quality products than Wal-Mart and emphasize personalized service.

"In cases where that has happened, businesses have thrived," Gresham says. "While I hurt for the small business that is put out of business, you have got to think about this from the customer's perspective: Is the community in general better off with Wal-Mart there? The answer is absolutely yes."

Adlong says he's heard the comments by analysts and antitrust authorities who have spoken about the case. Most of those support Wal-Mart's position.

"I respect their opinion," Adlong says. "However, they're not privy to what happened at trial, and they didn't see the overwhelming evidence that the judge was able to view. I feel confident if these analysts or experts were made aware of the actual facts proven in this case, their opinion would be different."

Goode says he is certain more lawsuits will be filed against Wal-Mart. There are 22 other states with similar laws.

With the verdict, Goode, Hendrickson and Benton are seen by many small business owners as heroes. There have been appearances on ABC television's "Good Morning, America," and reporters and businessmen from all over the country have called Adlong and each of the pharmacists.

Goode was scheduled to speak to a national meeting of the National Association of Retail Druggists on Oct. 24 in Indianapolis to tell how the victory was won -- at least for now.

Reynolds' Ruling

THE FOLLOWING IS AN EDited version of Faulkner County Chancery Judge David L. Reynolds' ruling in favor of pharmacists Dwayne Goode of American Drugs Inc., Tim Benton of Mayflower Family Pharmacy and Jim Hendrickson of Baker Drug. Reynolds granted the three almost $300,000 in the suit against Wal-Mart Stores Inc.

... Faulkner County has experienced strong population and commercial growth during the past 20 years. The sale of pharmaceuticals and health and beauty aids |the relevant product lines~ has expanded correspondingly. Retail sales in the relevant product lines increased from $5.2 million in 1988 to $9.9 million in 1990.

The number of pharmacies in Faulkner County has increased from five in 1967 to 12 in 1981 and 14 in 1992. Conway Wal-Mart began selling prescription drugs in 1987. ...

... Healthy competition in a market tends to result in lower retail prices, and a competitive marketplace is beneficial to consumers. Prices for relevant product lines in Conway Wal-Mart tend to be the same or slightly higher than in the Little Rock market area Wal-Mart stores (equal or greater competition than Faulkner County) and substantially lower than in the Clinton or Flippin Wal-Mart stores (areas of less competition). ...

After monitoring prices charged by other competitors, the manager of Conway Wal-Mart has reduced the retail prices of some items in its relevant product lines below Wal-Mart's invoice or acquisition cost. Conway Wal-Mart has advertised for sale, in the local market, pharmaceutical items at prices below Wal-Mart's acquisition cost. ...

... The stated purpose of Wal-Mart's pricing policy is to "meet or beat" the retail prices contemporaneously charged by competitors for highly competitive, price-sensitive merchandise; to maintain "low-price leadership" in the local marketplace; and to "attract a disproportionate number of customers into a store to increase traffic." ...

... There is no direct evidence that the purpose of Wal-Mart's pricing policy or Conway Wal-Mart's implementation of the policy is to injure competitors or to destroy competition. However, such purposes may be inferred from the stated policy, the effects of the stated policy and other circumstantial evidence. ...

... The growth in sales and profits experienced by plaintiffs substantially decreased primarily as a result of Wal-Mart's below-cost advertising and pricing in spite of the dramatic increase in sales in the local market.

Conclusions of the Law

Act 253 of 1937, "The Unfair Trade Practices Act," specifically sets out the legislative intent of the act:

"The General Assembly declares that the purpose of this subsection is to ... foster and encourage competition by prohibiting unfair and discriminatory prices by which fair and honest competition is destroyed or prevented."

The purpose of the act is not to protect small business from large business, downtown from malls or to guarantee any business a share of the market, but to encourage "fair and honest competition." The protection afforded by the act is from "unfair competition." ...

... The act makes it unlawful for a business to sell or advertise for sale "any article or product" at less than the "cost thereof." |It~ does not apply to the sale below cost of seasonal, damaged, deteriorated and perishable items; good faith closing business sales; and court ordered sales. ...

... The burden of proof is on the plaintiffs to establish three essential elements: that Conway Wal-Mart sold, offered to sell or advertised to sell products (1) at less than the cost to Conway Wal-Mart, (2) for the purpose of injuring competitors, and (3) for the purpose of destroying competition.

The evidence is clear that Conway Wal-Mart advertised and sold pharmaceutical and health and beauty products below invoice or acquired costs on a regular basis. These below cost sales do not fall within the exemptions set out in the act.

The court finds that purpose to injure competitors and destroy competition cannot be inferred from below cost advertising and sales alone. There must be other proof of intent or purpose. A person's purpose or intent, being a state of mind, ordinarily cannot be proven by direct evidence, but may be inferred from other circumstances.

The court finds from the following circumstances that Conway Wal-Mart advertised and sold pharmaceutical and health and beauty products below cost for the purpose of injuring competitors and destroying competition:

1. The number and frequency of below cost sales.

2. The extent of below cost sales.

3. Wal-Mart's stated pricing policy -- "meet or beat the competition without regard to cost."

4. Wal-Mart's stated purpose of below cost sales -- to attract a disproportionate number of customers to Wal-Mart.

5. The in-store price comparison of products sold by competitors, including plaintiffs.

6. The disparity in prices between Faulkner County prices of the relevant product lines and other markets with more and less competition.
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Article Details
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Title Annotation:includes related article; lawsuit filed by American Drugs Inc. against Wal-Mart Stores Inc.
Author:Smith, David (American novelist)
Publication:Arkansas Business
Date:Oct 25, 1993
Previous Article:Hospitals aim to deliver more.
Next Article:The great sign-up is on.

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