There are three principal types of restraints (which are principally characterized as vertical restraints) that are sometimes deemed to be efficient responses to free-riding. The legal treatment of each restraint under competition law typically involves a trade-off between effects on interbrand and intrabrand competition. When applicable law permits a balancing analysis (under the “rule of reason” in US antitrust law and “effects analysis” under EU competition law), courts or regulators may determine that a particular restraint enhances interbrand competition by discouraging free-riding that would otherwise discourage the provision of promotional and other pre-sale services. Those favorable effects on interbrand competition may outweigh adverse effects on intrabrand competition attributable to any such restraint.
Exclusive Dealing
Exclusive dealing arrangements encompass contractual agreements and other vertical restraints through which a producer or supplier elects to distribute its product through a single distributor or limited number of distributors (which may be situated at the retail or wholesale level). These practices inherently raise concerns about potential harms to intrabrand competition. In certain circumstances, however, exclusive dealing arrangements may yield competitive gains by counteracting free-riding that could have adverse effects on Interbrand competition.
For example, when a producer commits to sell exclusively through a single retailer, it shields the retailer to a certain extent from intrabrand competition and, as a result, enhances the retailer’s incentives to invest in efforts to promote the producer’s brand or provide other pre-sale services to consumers. This may be especially important in the case of luxury brands, new products and services, or complex products and services that are difficult for customers to evaluate without the provision of technical or other information by the distributor. Absent an exclusive dealing arrangement, retailers would curtail these pre-sale efforts, the producer’s brand goodwill would be diminished, and interbrand competition would decline.
Resale Price Maintenance
Resale price maintenance (RPM) encompasses contractual provisions or other vertical restraints through which a producer or supplier specifies a fixed price (typically, a minimum price) or price range at which wholesalers or retailers must distribute its products. As a direct intervention in pricing, this practice raises strong concerns over anticompetitive effects. However, RPM may have procompetitive effects if it yields a pricing premium that implicitly compensates distributors for the costs incurred to promote a producer’s brand through marketing and other pre-sale services. Absent an RPM clause, any individual distributor would elect to free ride off the pre-sale efforts undertaken by other distributors. For example, “discount” retailers could offer a lower price for the same product to consumers who had been elicited by “full-service” retailers who had incurred costs to provide marketing, display, and informational services. In anticipation of this outcome, no distributor would have a rational incentive to invest in providing these pre-sale services, the producer’s brand goodwill may be impaired, and interbrand competition would suffer as a result.
Under EU competition law, RPM is a “hardcore” restriction under Article 4 of Commission Regulation (EU) 2022/720 and a “restriction by object” under Article 101(1) of the Treaty on the Functioning of the European Union (TFEU), which would exclude an efficiency defense based on free-riding considerations. However, the Commission’s Guidelines on Vertical Restraints (both as issued in 2010 and updated in 2022) provide that an RPM restraint may nonetheless qualify for an efficiency defense in individual cases under Article 101(3) of the Treaty and specifically address the free-riding considerations that may justify use of an RPM restraint, “in particular where it is supplier driven.”
Territorial Allocation
Territorial allocation encompasses agreements or other practices through which exclusive geographic areas are reserved for certain distributors of a particular product. This type of restraint generally raises strong concerns since, depending on competitive conditions, it may confer pricing power on the firm that is allocated each territory. In certain circumstances, however, territorial allocation may encourage distributors to invest in pre-sale efforts that enhance a producer’s brand goodwill, elicit consumer interest, and, as a result, enhance interbrand competition. Absent territorial allocation, each distributor would have reduced incentives to invest in promoting the producer’s brand since other distributors could free-ride off those services and, not having incurred any or comparable pre-sale costs, offer the same product at a lower price. Territorial allocation enables a producer or supplier to preclude this adverse competitive outcome by enabling each distributor to capture any increase in sales attributable to its pre-sale efforts. When that is the case, territorial allocation can enhance brand goodwill, intensify customer acquisition efforts, and increase interbrand competition, which may outweigh any harms to intrabrand competition within each allocated territory.
Under U.S. antitrust law, any territorial allocation characterized as a horizontal restraint is per se illegal under U.S. v. Topco Associates, 405 U.S. 596 (1972), and any favorable effects on interbrand competition as a result of free-riding considerations would then be ignored. However, if a territorial allocation can be reasonably characterized as a vertical restraint, then some form of the rule of reason standard would apply. Under that standard, courts undertake a balancing analysis that (among other considerations) weighs likely harms to intrabrand competition against likely benefits to interbrand competition. Even if a court finds that territorial allocation efficiently deters free-riding and induces pre-sale efforts by distributors, it may still consider whether free-riding could be reasonably addressed through a “less restrictive” alternative that would cause less harm to intrabrand competition.
Under EU competition law, the legal relevance of free-riding considerations in the context of territorial allocation is treated similarly. Restraints on resales by territory presumptively constitute “hardcore” restrictions under Article 4(b) of the Block Exemption Regulation, which would preclude any efficiency defense based on free-riding considerations. However, any such restraint may qualify for one of the exceptions set forth in Article 4(b), in which case an effects analysis would apply. As provided in the Guidelines on Vertical Restraints, the effects analysis may take into account the extent to which territorial exclusivity may promote interbrand competition by inducing pre-sale efforts that would otherwise be discouraged due to free-riding, offset against adverse impacts on intrabrand competition and taking into account less restrictive alternatives.
Considerations relating to free-riding have also emerged in the still-developing treatment under antitrust law of certain practices in multi-sided platform markets. In particular, the U.S. Supreme Court’s decision in Ohio et al. v. American Express Co., 138 S. Ct. 355 (2017), concerned a practice in which a credit card issuer contractually barred merchants from “steering” consumers to use competitors’ credit cards (which would result in a lower fee for the merchant). The court’s decision upholding this restraint relied substantially on the finding that this practice was necessary to prevent merchants (and, indirectly, other credit card issuers) from free riding on the issuer’s investments in marketing, rewards programs, and other customer services designed to attract higher-income consumers who tend to make larger expenditures. Without the anti-steering restraint, the card issuer’s revenues from merchant fees might decline and it would be compelled to reduce these investments, which the court found had enhanced the quantity and quality of interbrand competition in the relevant market.
