The European Commission has adopted a new Regulation that ‘block exempts’ distribution and supply agreements at different levels of the production and distribution chain.
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1. What are vertical agreements?
Vertical agreements are supply and distribution agreements. The term “vertical” emphasises the fact that they are entered into between companies operating at different levels of the production or distribution chain. Distribution agreements between manufacturers and wholesalers or retailers are typical examples of vertical agreements.
2. What are the competition issues associated with vertical agreements? Why do we speak about “vertical restraints”?
For most vertical restraints, competition concerns only arise if there is insufficient competition at one or more levels of trade, that is, if there is some degree of market power at the level of the supplier or the buyer or at both levels. Vertical restraints are generally less harmful than horizontal restraints (between direct competitors) and may provide substantial scope for efficiencies.
A restriction of competition may occur if an agreement between a supplier and a buyer contains “restraints” on the supplier or the buyer. Such restraints can take many forms. For example, agreements whose main element is that the manufacturer sells only to one or to a limited number of buyers (exclusive distribution, selective distribution), may lead to other buyers being excluded from the market and/or to collusion between buyers. Similarly, non-compete obligations which prohibit distributors from purchasing and reselling competing products, may hinder market entry of new manufacturers and reinforce the market positions of incumbent manufacturers.
3. What does it mean that a vertical agreement is “block exempted”?
Where a vertical agreement is concluded between companies that have limited market power (reflected in a market share not exceeding 30%), and providing that it contains no hardcore restrictions of competition, the Commission’s and the national competition authorities’ experience with enforcement shows that the agreement will usually have no anticompetitive effects or, if it does, that the positive effects will outweigh any negative ones. Based on this positive presumption the Commission Regulation exempts them from the prohibition principle set out in Article 101(1) of the EU Treaty.
In contrast, for vertical agreements concluded by companies whose market share exceeds 30%, there is no such exemption, but there is also no presumption that the agreement is illegal: it is necessary to assess the agreement’s negative and positive effects on the market. The Commission’s Guidelines on vertical restraints that accompany the Regulation assist in making this assessment.
4. What are “hardcore restrictions”?
The Regulation does not cover agreements containing hardcore restrictions, such as restraints on the buyer’s ability to determine its sale price (“resale price maintenance”) or certain types of re-sale restrictions, which may create barriers to the internal market.
Under the Regulation manufacturers can, however, implement certain types of distribution system such as exclusive distribution or selective distribution.
Thus, the Regulation allows manufacturers to protect an exclusive distributor from active sales by other distributors, in order to encourage that distributor to invest in the exclusively allocated territory or customer group. But within an exclusive distribution system, the manufacturer cannot restrict its distributor from responding to customer demand and selling its products throughout the internal market (passive sales): any such restriction would be hardcore restriction.
In selective distribution, the Regulation also allows manufacturers to choose their distributors on the basis of specified criteria and to prohibit sales to unauthorised distributors. But distributors can actively sell to other authorised distributors throughout the internal market and to any end consumer. Any other restriction of their freedom regarding where and to whom they may sell would be a hardcore restriction.
The same rules apply to online sales. Since the Internet allows distributors to reach different customers and different territories, restrictions of the use of the Internet by distributors generally are considered as hardcore restrictions. For example, any obligations on distributors to automatically reroute customers located outside their territory, or to terminate consumers’ transactions over the Internet if their credit card data reveal an address that is not within the distributor’s territory, are hardcore restrictions. Similarly, any obligation that dissuades distributors from using the Internet, such as a limit to the proportion of overall sales which a distributor can make over the Internet, or the requirement that a distributor pays a higher purchase price for units sold on-line (“dual pricing”), is also considered as a hardcore restriction. However, as in the offline world, suppliers can set up an exclusive or a selective distribution network, which allow them to restrict active sales into exclusively allocated territories or customer groups, and to require quality standards for the use of an Internet site to sell their products. Where there are hardcore restrictions, the agreement cannot benefit from the block exemption, and it is unlikely they will meet the conditions set out in Article 101(3) which would make them compliant with the competition rules. But as the Guidelines make clear, in individual cases the parties can bring forward evidence that their agreement brings, or is likely to bring efficiencies that outweigh the negative effects.
5. Why did the Commission introduce a buyer’s market share threshold?
Just like suppliers, buyers can use their market power to put in place vertical restraints to the ultimate detriment of consumers. The introduction of a buyer’s market share threshold is particularly beneficial to small and medium sized enterprises, because they are the most likely (as competitors of the powerful buyer or as a supplier unable to countervail the market power of the buyer) to be harmed by buyer-led vertical restraints.
6. To what extent can suppliers impose restrictions on the distribution of their products on the internet?
Suppliers should normally be free to decide on the number and type of distributors they want to have in their distribution systems. They may for example only want to sell to chain stores that provide for a uniform sales environment, or only to shops in exclusive areas which provide a particular quality of service. More generally, suppliers may only want to sell to distributors that have one or more physical points of presence (“brick and mortar” presence) where the suppliers’ goods can be touched, smelled, tried, etc.
However, once a supplier has allowed a distributor into its distribution system, it cannot prevent that distributor from having a website and selling products online. The new Guidelines provide examples of restrictions of online sales that amount to hardcore restrictions of competition, whose object is to segment markets to the detriment of consumers and the internal market. Such restrictions could include an obligation imposed on a distributor to automatically re-route customers to the website of another distributor, or to terminate a sales transaction if the credit card data shows an address outside the area to which a given distributor has been assigned.
However, certain vertical restraints on online sales can be justified because they eventually benefit consumers. For instance a supplier may impose a requirement, as for off-line sales, that, in a selective distribution system, a distributor must not sell online through a website that does not meet the agreed quality standards, or to unauthorised distributors. In the case of exclusive distribution, the supplier may require the distributor not to actively target online customer groups or customers in areas exclusively reserved for another distributor of the supplier. The exclusive distributor must, however, remain free to sell to customers that contact it on their own initiative, i.e., to do “passive sales”.
7. How will the Commission ensure competition in markets which are highly concentrated?
When a majority of the main suppliers in a market have selective distribution systems, the loss of competition at the distribution level can be significant, and it is possible that certain types of distributors could be excluded from the market, as well as there being an increased risk of collusion between these main suppliers. Exclusion (or foreclosure) of potentially more efficient distributors is a risk with selective distribution systems, because these systems allow suppliers to restrict sales by their authorised dealers to non-authorised dealers, thus preventing non-authorised dealers from obtaining supplies.
Pressure by different distribution formats such as price discounters or cheaper online-only distributors is good for competition. Foreclosure of such distribution formats could result either from the cumulative application of selective distribution in a market (the main suppliers all having selective distribution systems) or from the actions of a single supplier with a market share exceeding 30%. In either situation, the lack of competitive pressure from price discounters or cheaper online-only distributors would reduce the possibilities for consumers to take advantage of the specific benefits offered by these alternative formats such as lower prices, more transparency and wider access. In such instances, the Commission may find that there are unjustified restrictions of competition, and may act or withdraw the benefit of the BER.
8. Give examples of individual cases that fall outside the block exemption that the Commission has dealt with?
Since 1999, when the previous rules entered into force, the Commission has dealt with a number of cases in different sectors (e.g., loudspeakers, perfumes, videogames and consoles, musical instruments and Pokémon stickers and cards).
For instance, in 2002 the Commission approved B&W Loudspeakers’ notified1 selective distribution network on the condition that the company remove several hardcore restrictions, such as a disguised resale price maintenance clause and one prohibiting authorised distributors from selling over the Internet. Similarly, in 2001, the Commission approved the agreement notified by Yves Saint Laurent, only after the company agreed to allow its authorised distributors to sell perfumes and luxury items over the Internet.
Also in 2002, the Commission adopted a decision imposing a fine on Nintendo and seven distributors of Nintendo video games and consoles. The investigation showed that Nintendo and its distributors colluded to maintain artificially high price differences in the EU by preventing imports from low-price countries into high-price countries.
In 2003, the Commission adopted a decision concluding that Yamaha violated the competition rules by entering into distribution agreements aimed at partitioning the markets for the provision of traditional and electronic musical instruments and equipment in Europe. The Commission found that the territorial and price restrictions had insulated national markets and maintained different price levels within the EU.
Finally, in 2004, the Commission adopted a decision imposing a fine on Topps, a company producing collectible products, such as stickers or trading cards featuring soccer players or cartoon characters. The Commission found evidence that Topps had developed a strategy to prevent imports from low-price countries into high-price countries.
9. What is Member States’ experience of applying the Regulation and the accompanying Guidelines and to what extent have they been involved in the review of these rules?
Council Regulation 1/2003 empowered the national competition authorities (“NCAs”) in May 2004 to apply Article 101 and 102 of the Treaty. As a result of the decentralisation and the national dimension of the relevant markets, there are more cases dealt with at national level than by the Commission. Coherent enforcement by the NCAs of the competition rules in the field of vertical agreements is ensured by the Regulation and Guidelines and the Commission’s continuous monitoring through the European Competition Network a forum which brings together the Commission and the NCAs.
NCAs have taken an active part in the review of the Regulation and Guidelines, replying to questionnaires about their experience with the current rules and through several official consultations. The NCAs expressed strong support for the maintenance of the system of Block Exemption Regulation and accompanying Guidelines, which is considered to have worked well in practice.
The effects-based rules and the safe harbour provided by the 30% market share threshold have led to a decrease in the number of cases concerning vertical agreements, and have allowed the Commission and NCAs to concentrate their enforcement on the practices of companies with significant market power and hardcore restrictions. Since the decentralisation of the application of the rules, the NCAs have dealt with a number of cases in different sectors, such as fresh tomatoes, petrol stations, perfumes and luxury goods, smart phones, acquisition of sport rights and TV content, and foreign teaching language books.
10. For how long will the new BER and Guidelines apply?
The new Verticals Block Exemption Regulation will be valid for twelve years, but the Commission will constantly monitor the situation, and the application of the Regulation, in cooperation with National Competition Authorities and stakeholders.
Source: European Commission
