Vertical restraints (or restrictions)

 

Author Definition

 

Definition

The term vertical restraints refers to the restrictions of competition contained in vertical agreements. These agreements take place between firms operating at different levels of the production or distribution chain. The most common vertical restraints relate to the supply, distribution, production, purchase and sale of goods; however vertical restraints will also be found in the services sector. Typical vertical restraints concern the number of buyers a seller will trade with within a specified territory, the suppliers a buyer is allowed to purchase from, and the conditions (price, location, customers) under which the goods can be resold.

 

Commentary

The extent to which vertical restraints may be anticompetitive is a highly-debated matter. In many instances the restrictions in a vertical agreement are justifiable: indeed they may be pro-competitive. For example when a distributor is required to invest in stocking, promoting and advertising a particular brand of goods, it will likely seek protection from “free-riders” who could profit from the expense incurred by the distributor by selling the same product for less. In principle the distributor could be protected from the free rider by a grant of exclusivity over a specific territory or customer group, or by the imposition of minimum resale prices.

An advantage of these restraints is that, in the absence of market power, they may boost inter-brand competition (for example, between a Canon printer and a HP printer), even though intra-brand competition (between providers of the same Canon printer) might be lessened. The Chicago School of economics generally sees these restrictions as efficient. Nonetheless, their efficiency is not always guaranteed. For instance, if consumers do not benefit from the additional advertising costs, because they are already familiar with the product, they might prefer to pay less and skip the promotional expenses.

While even exclusive dealers will not have control over price if providers of competing goods from other brands cover the same market, concerns arise in situations where market power exists and there is little or no price competition. The most controversial restriction is minimum resale price maintenance (RPM), where sellers impose a price below which their buyers are not allowed to re-sell. In addition to having a direct impact on consumer prices, it may also help implement a price-fixing cartel. Competition authorities tend to take a strict line on RPM, and many examples of fines for this practice can be found. In 2018 four electronics manufacturers were recently fined by the European Commission for imposing minimum prices on their online retailers (Commission decisions Asus, Denon & Marantz, and Pioneer, 2018).

In the EU, the Court of Justice has confirmed that vertical restraints might fall foul of Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) (Consten and Grundig, 1996). While in most cases an effects analysis is required to determine whether vertical restraints have an anti-competitive impact on competition, certain restrictions are considered to be anti-competitive ‘by object’, examples being minimum RPM and provisions that confer absolute territorial protection on a distributor. The inclusion of the latter in the “by object” category is because of the threat territorial restraints pose for single market integration, the main goal of the TFEU.

The basic EU rules are contained in the block exemption regulation for vertical agreements (the ‘VBER’), Regulation 2022/720 which entered into force on 1 June 2022 and replaced Regulation 330/2010. For the block exemption to apply, the market share of each of the parties to the agreement must not exceed 30%. Moreover, agreements must not contain what are referred to as ‘hardcore restrictions’: these are set out in Article 4 of the VBER and include minimum RPM; territorial restrictions (although it is possible, under certain circumstances, to prohibit active sales outside the buyers’ allotted territories, and to prevent wholesalers from selling to end customers); restrictions of cross-supplies in selective distribution systems; and restrictions on the sale of components (suppliers of these should be allowed to sell to end users, repairers and other service providers). If a vertical agreement does not meet the conditions of the VBER, and falls within the scope of Article 101(1) TFEU, then it must comply with the requirements of the legal exception contained in Article 101(3) TFEU to be lawful. The VBER is accompanied by Guidelines on vertical restraints which were published on the Official Journal of the European Union on 30 June 2022. These extensive guidelines (and the VBER itself) reflect adaptations required to the rules on vertical restraints to accommodate the widespread digitalisation of markets in recent years and the crucial role of e-commerce in the modern economy.

In 1911 the US Supreme Court confirmed that contracts between non-competitors could fall within the scope of Section 1 of the Sherman Act (Dr Miles). Certain restrictions, such as exclusive dealing or RPM, were considered per se illegal. Over the years, the analysis shifted, spurred principally by the acceptance of the postulates of the Chicago School of economics. In 1977, the case GTE Sylvania introduced a reasonableness test for non-price territorial restraints. Twenty years later, maximum RPM was placed under the rule of reason analysis following Khan. The landmark Leegin case did the same for minimum RPM in 2007, proclaiming that “[v]ertical price restraints are to be judged according to the rule of reason.” However, the laws of some US states still consider minimum RPM to be per se illegal. While the reasonableness assessment does not equate to per se legality, it has become remarkably difficult for plaintiffs to win cases in which the lawfulness of vertical restraints is in dispute.

In the People’s Republic of China, the Anti-Monopoly Law (AML) expressly prohibits agreements that “[fix] the price of commodities for resale to a third party”, or “[restrict] the minimum price of commodities for resale to a third party” (Article 14). However, Article 15 AML contains a significant list of broadly construed exemptions. Originally, the approach towards minimum RPM was somewhat incoherent. The administrative agencies—the State Administration for Market Regulation (SAMR) and its predecessors, as well as some regional watchdogs—treated minimum RPM as illegal unless it fell within one of the exemptions of the AML (Kweichow Maotai, or Wuliangye). The courts however appeared to apply a rule of reason-style analysis before coming to a conclusion as to their compatibility with Article 14 (Johnson & Johnson, 2013, and Gree, 2018). In 2019, the Supreme People’s Court finally confirmed that these restrictions should generally be regarded as illegal, provided the exemptions of the law do not apply (Yutai). The parties may however show that the practice bore no anticompetitive effects and escape illegality. The amendments to the Anti-Monopoly Law that entered into force in August 2022 largely follow the Yutai approach.

 

Bibliography

Louis Kaplow, ‘The Meaning of Vertical Agreement and the Structure of Competition Law’ (2016) 80 Antitrust Law Journal 563.

Marina Lao, ‘Free Riding: An Overstated, and Unconvincing, Explanation for Resale Price Maintenance’, in Robert Pitofsky (ed.), How the Chicago School Overshot the Mark: The Effect of Conservative Economic Analysis on U.S. Antitrust (Oxford University Press 2008) 199.

Sandra Marco Colino, Competition Law of the EU and UK (8th edn, Oxford University Press 2019), chapters 8, 9 and 10.

Sandra Marco Colino, Vertical Agreements and Competition Law: A Comparative Study (Hart 2010 – new edition expected in 2023).

Sandra Marco Colino, Building a Coherent Legal Framework for Vertical Price Restrictions in China, Competition Policy International, 30 September 2022.

William S Comanor, ‘Vertical Price-Fixing, Vertical Market Restrictions, and the New Antitrust Policy’ (1985) 98 Harvard Law Review 983.

Author

Quotation

Sandra Marco Colino, Vertical restraints (or restrictions), Global Dictionary of Competition Law, Concurrences, Art. N° 85423

Visites 10486

Publisher Concurrences

Date 1 January 1900

Number of pages 500

 

Institution Definition

Refers to certain types of practices by manufacturers or suppliers relating to the resale of their products. The usual practices adopted in this regard are resale price maintenance (RPM), exclusive dealing and exclusive territory or geographic market restrictions. Under exclusive dealing and/or exclusive territory, a single distributor is the only one who obtains the rights from a manufacturer to market the product. A significant debate exists in the economic literature as to whether this confers monopoly power on the distributor. Usually, the distributor’s market power is limited by inter-brand competition. The manufacturer’s purpose is normally to provide incentives to the distributor to promote the product and provide better service to customers. © OECD

See also Resale Price Maintenance

 
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