James has pretty much nailed it.
Protos, demonstrators, artist loaners, and overstocks; those are the guitars that sell at Friends & Family.
What's the impact on local dealers? Well, they'll say that the F&F Sale is just about the end of the world. Having been a San Diego dealer, though, I can tell you that the impact is actually pretty minimal. There wasn't a F&F Sale in 2010, and I don't recall any San Diego area dealers talking about how much stronger their Taylor sales were because of that.
Are guitars sold below normal dealer pricing? Yeah, many are. But if someone pays "X" amount at F&F for an 814ce, they probably wouldn't be going into a local dealer and paying the "Y" street price for an 814ce, simply because the price a local retailer is going to sell it for is just too high.
Friends & Family happens, at the most, once a year; normally the second Saturday in December. If retailers, who stock guitars year round, have a problem competing with that, they really need to find another line of work...