Vertical restraints (or restrictions)

 

Author Definition

 

Definition

The term vertical restraints refers to the restrictions of competition vertical agreements may contain. These agreements take place between companies (or “undertakings”) operating at different levels of the production or distribution chain. The most common types are those for the supply, distribution, production, purchase and sale of goods, and research and development agreements. They tend to include restrictions relating to,inter alia, the number of buyers a seller will trade with within a specified territory, the number of providers a buyer is allowed to purchase from, and the conditions (price, location, customers) under which the goods can be resold.

 

Commentary

Whether vertical restraints may be anticompetitive remains a highly-debated matter. In many instances, the restrictions can be justified. When a distributor is required to invest in advertising, she will likely seek protection from “free-riders” who could profit from the expenses she incurred and sell the same product for less. The protection might be granted via exclusivity over a specific territory or customer group, or by imposing a resale price.

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 an 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. A recent report by Oxera Consulting (2016) further suggests that vertical restraints may be used to limit the expansion of e-commerce.

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. In this context, 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). The current Guidelines on Vertical Restraints (2010) point out that “for most vertical restraints competition concerns can only arise if there is insufficient competition at one or more levels of trade”. While in most cases an effects analysis will be required to determine whether the restrictions may bear an impact on competition, certain restraints are considered anticompetitive by object, such as minimum RPM and those that confer absolute territorial protection. The inclusion of the latter in the “by object” category relates in part to the potential threat territorial restraints pose for market integration, the main goal of the TFEU.

The basic EU rules are contained in the block exemption regulation (BER) for vertical agreements, Regulation 330/2010. To be applicable, the market share of each of the parties to the agreement cannot exceed 30%. Moreover, agreements must not contain hardcore restrictions, that is: 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 BER, 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.

Subsequent EU case law has clarified the conditions under which different kinds of vertical restraints will be lawful. With regard to selective distribution, resellers much be chosen on the basis of objective criteria which have a genuine relationship to the product and are not applied in a discriminatory manner (Metro I, 1966). A total ban on Internet sales in a selective distribution system is considered an object restriction (Pierre Fabre, 2011). However, it is legal to limit online sales in order to preserve the luxury image of the goods, as long as the requirements are not applied in a discriminatory manner, and are proportionate to the objectives pursued (Coty, 2017). Franchising agreements can contain restrictions aiming to prevent the use of know-how and assistance provided by the franchisor to benefit competitors, and those necessary to maintain identity and reputation of the brand (Pronuptia, 1986).

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, a shift has taken place, 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 do not apply (Yutai). It also encouraged the SAMR to issue guidance in this respect.

 

Bibliography

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

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 2022)

This article is being reviewed by the Editors of the Dictionary.

Author

Quotation

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

Visites 6741

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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