Presentation on vertical agreements

1. Vertical agreements
Julija Jerneva

2. • Vertical restraints are generally less harmful than horizontal
restraints and may provide substantial scope for efficiencies

3. De minimis
• vertical agreements entered into by non- competing
undertakings whose individual market share on the relevant
market does not exceed 15 % are generally considered to fall
outside the scope of Article 101(1)
• But:
• subject to cumulative effect and hardcore restrictions

4. Exceptions to Article 101 (1)
• Genuine agency agreements
• Subcontracting agreements
• Franchise agreements

5. Block Exemption Regulation
• For most vertical restraints, competition concerns can 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.
• Supplier market share less than 30%
• Buyer market share less than 30%
• No hardcore restrictions

6. Hardcore restrictions
(a) the restriction of the buyer's ability to determine its sale price,
without prejudice to the possibility of the supplier to impose a
maximum sale price or recommend a sale price, provided that
they do not amount to a fixed or minimum sale price as a result
of pressure from, or incentives offered by, any of the parties;

7. Hardcore restrictions
(b) the restriction of the territory into which, or of the customers to
whom, a buyer party to the agreement, without prejudice to a
restriction on its place of establishment, may sell the contract
goods or services, except:
(i) the restriction of active sales into the exclusive territory or to an
exclusive customer group reserved to the supplier or allocated by the
supplier to another buyer, where such a restriction does not limit sales
by the customers of the buyer,

8. Active/passive sales
• ‘Active’ sales mean actively approaching individual customers
by for instance direct mail, including the sending of unsolicited
e-mails, or visits;
• ‘Passive’ sales mean responding to unsolicited requests from
individual customers including delivery of goods or services to
such customers
• Internet?

9. Sales through internet: hardcore restrictions
(a) an agreement that the (exclusive) distributor shall prevent
customers located in another (exclusive) territory from viewing
its website or shall automatically re-rout its customers to the
manufacturer's or other (exclusive) distributors' websites.

10. Sales through internet: hardcore restrictions
(b) an agreement that the (exclusive) distributor shall terminate
consumers' transactions over the internet once their credit card
data reveal an address that is not within the distributor's
(exclusive) territory

11. Sales through internet: hardcore restrictions
(c) an agreement that the distributor shall limit its proportion of
overall sales made over the internet.

12. Sales through internet: hardcore restrictions
(d) an agreement that the distributor shall pay a higher price for
products intended to be resold by the distributor online than for
products intended to be resold offline.
• Unless it can be objectively justified

13. Free riding
• A distributor which will be the first to sell a new brand or the first
to sell an existing brand on a new market
+ substantial investments (often sunk investments)
= restrictions of passive and active sales can be necessary
during the first two years

14. Hardcore restrictions
(b) the restriction of the territory into which, or of the customers to
whom, a buyer party to the agreement, without prejudice to a
restriction on its place of establishment, may sell the contract
goods or services, except:
(ii) the restriction of sales to end users by a buyer operating at the
wholesale level of trade,

15. Hardcore restrictions
(b) the restriction of the territory into which, or of the customers to
whom, a buyer party to the agreement, without prejudice to a
restriction on its place of establishment, may sell the contract
goods or services, except:
(iii) the restriction of sales by the members of a selective distribution
system to unauthorised distributors within the territory reserved by the
supplier to operate that system, and

16. Hardcore restrictions
(b) the restriction of the territory into which, or of the customers to
whom, a buyer party to the agreement, without prejudice to a
restriction on its place of establishment, may sell the contract
goods or services, except:
(iv) the restriction of the buyer's ability to sell components, supplied for
the purposes of incorporation, to customers who would use them to
manufacture the same type of goods as those produced by the
supplier;

17. Hardcore restrictions
(c) the restriction of active or passive sales to end users by
members of a selective distribution system operating at the
retail level of trade, without prejudice to the possibility of
prohibiting a member of the system from operating out of an
unauthorised place of establishment;

18. Hardcore restrictions
(d) the restriction of cross-supplies between distributors within a
selective distribution system, including between distributors
operating at different level of trade, unless:
• appointed wholesalers located in different territories are obliged to
invest in promotional activities in ‘their’ territories to support the sales
by appointed retailers

19. Hardcore restrictions
(e) the restriction, agreed between a supplier of components and
a buyer who incorporates those components, of the supplier’s
ability to sell the components as spare parts to end-users or to
repairers or other service providers not entrusted by the buyer
with the repair or servicing of its goods.

20. Excluded (from exemption) restrictions
(a) any direct or indirect non-compete obligation, the
duration of which is indefinite or exceeds five years;
• more than 80 % of the buyer's total purchases
• Unless the contract goods or services are sold by the buyer from
premises and land owned by the supplier or leased by the supplier
from third parties not connected with the buyer, provided that the
duration of the non-compete obligation does not exceed the period of
occupancy of the premises and land by the buyer

21. Excluded (from exemption) restrictions
(b) any direct or indirect obligation causing the buyer,
after termination of the agreement, not to manufacture,
purchase, sell or resell goods or services, unless:
a) the obligation relates to goods or services which compete with
the contract goods or services;
(b) the obligation is limited to the premises and land from which
the buyer has operated during the contract period;
(c) the obligation is indispensable to protect know-how
transferred by the supplier to the buyer;
(d) the duration of the obligation is limited to a period of one year
after termination of the agreement.

22. Excluded (from exemption) restrictions
(c) any direct or indirect obligation causing the members
of a selective distribution system not to sell the brands
of particular competing suppliers.

23. Block Exemption Regulation
• Regulation may be non-applicable where:
• competition is significantly restricted by the cumulative effect of parallel
networks of similar vertical agreements practised by competing
suppliers or buyers
• Regulation is non-applicable where:
• networks of similar vertical restraints cover more than 50 % of a
relevant market

24. If block exemption does not apply
• No presumption of illegality
• Object or effect?
• Even if by either object or effect the agreement restricts
competition, additional analysis must be performed on the basis
of Article 101(3) rules (see Commission guidelines for the
assessment of standard vertical restraints)

25. Object or effect?
• “hardcore restrictions” (as opposed to “excluded restrictions”) are
“object cases”
• Hardcore restrictions: Article 4 of the Commission regulation
• Excluded restrictions: Article 5 of the Commission regulation
• Object cases = it is enough to establish the “fact” = violation of Article
101(1)
• All other cases to be analysed on the basis of the “effects” of the
agreement on the market(s)

26. Assessment
• For vertical agreements to be restrictive of competition
by effect:
• they must affect actual or potential competition to such an extent that on
the relevant market negative effects on:
• prices,
• output,
• innovation,
• or the variety or quality of goods and services
• such effects should be expected with a reasonable degree of probability.
• the likely negative effects on competition must be appreciable

27. Likelihood of negative appreciable effects
• at least one of the parties has or obtains some degree of
market power and the agreement contributes to the creation,
maintenance or strengthening of that market power or allows
the parties to exploit such market power

28. Market power
• Market power is the ability to maintain prices above competitive
levels or to maintain output in terms of product quantities,
product quality and variety or innovation below competitive
levels for a not insignificant period of time.
• (market power ≠ dominance)

29. Frequent negative effects
• anticompetitive foreclosure of other suppliers or other buyers by
raising barriers to entry or expansion

30. Frequent negative effects
• softening of competition between the supplier and its
competitors and/or facilitation of collusion amongst these
suppliers, often referred to as reduction of inter- brand
competition

31. Frequent negative effects
• softening of competition between the buyer and its competitors
and/or facilitation of collusion amongst these competitors, often
referred to as reduction of intra-brand competition if it concerns
distributors' competition on the basis of the brand or product of
the same supplier

32. Frequent negative effects
• the creation of obstacles to market integration, including, above
all, limitations on the possibilities for consumers to purchase
goods or services in any Member State they may choose

33. Inter-brand and intra-brand competition
• if inter-brand competition is fierce, it is unlikely that a reduction
of intra-brand competition will have negative effects for
consumers

34. Branded and non-branded goods
• Branding tends to increase product differentiation and reduce
substitutability of the product, leading to a reduced elasticity of
demand and an increased possibility to raise price
• Vertical restraints for non-branded goods and services are in general
less harmful

35. Effects: which markets?
• Both downstream and upstream markets!

36. • A manufactures luxury goods and is willing to enter the Belgian
market
• In Belgium certain retailers (B, C and D) have a reputation for
stocking only ‘quality’ products
• Other retailers do not have such a reputation
• However, B, C and D have already entered into various
distribution agreements with the competitors of A and therefore
have no possibility to accept A’s goods anymore

37. Methodology of analysis
• nature of the agreement
• market position of the parties
• market position of competitors
• market position of buyers of the contract products
• entry barriers
• maturity of the market
• level of trade (which level of production/distribution)
• nature of the product

38. Most common vertical restraints
• Single branding
• Exclusive distribution
• Exclusive customer allocation
• Selective distribution
• Exclusive supply
• Upfront access payments
• Category Management Agreements
• Tying
• Resale price restrictions

39. Single branding
• an obligation or incentive scheme which makes the buyer
purchase more than 80% of its requirements on a particular
market from only one supplier
• minimum purchase requirements, stocking requirements or non-linear
pricing, such as conditional rebate schemes or a two-part tariff (fixed
fee plus a price per unit)
• ‘English clause’ requires the buyer to report any better offer and
allowing him only to accept such an offer when the supplier does not
match it

40. Exclusive distribution
• the supplier agrees to sell its products to only one distributor for
resale in a particular territory
• risks: reduced intra-brand competition and market partitioning,
which may facilitate price discrimination; foreclosure of other
distributors and therewith reduce competition at that level
• But if strong competitors: the reduction in intra-brand
competition is outweighed by sufficient inter-brand competition

41. Exclusive customer allocation
• the supplier agrees to sell its products to only one distributor for
resale to a particular group of customers
• mainly applied to intermediate products and at the wholesale level
when it concerns final products, where customer groups with
different specific requirements concerning the product can be
distinguished
• may lead to efficiencies, especially when the distributors are
required to make investments in for instance specific equipment,
skills or know-how to adapt to the requirements of their group of
customers
• risks: reduced intra-brand competition and market partitioning, which
may facilitate price discrimination; foreclosure of other distributors
and therewith reduce competition at that level

42. Selective distribution
• not a restriction on active selling to a territory but a restriction
on any sales to non-authorised distributors, leaving only
appointed dealers and final customers as possible buyers
• purely qualitative selective distribution and quantitative selective
distribution
• The characteristics of the product must be such as to require
selective distribution

43. Purely qualitative selective distribution
• Purely qualitative selective distribution selects dealers only on
the basis of objective criteria required by the nature of the
product such as training of sales personnel, the service
provided at the point of sale, a certain range of the products
being sold etc.
= no direct limit on the number of distributors

44. Quantitative selective distribution
• Quantitative selective distribution: further criteria for selection
that more directly limit the potential number of dealers by, for
instance, requiring minimum or maximum sales, by fixing the
number of dealers, etc

45. Exclusive supply
• the supplier is obliged or induced to sell the contract products
only or mainly (quantity forcing) to one buyer, in general or for a
particular use
• The main competition risk of exclusive supply is anticompetitive
foreclosure of other buyers

46. Upfront access payments
• fixed fees that suppliers pay to distributors in the framework of
a vertical relationship at the beginning of a relevant period, in
order to get access to their distribution network
• may have the same downstream foreclosure effect as an exclusive
supply type of obligation
• are likely to increase the price charged by the supplier for the contract
products

47. Category Management Agreements
• within a distribution agreement, the distributor entrusts the
supplier (the ‘category captain’) with the marketing of a
category of products including in general not only the supplier's
products, but also the products of its competitors

48. Tying
• customers that purchase one product (the tying product) are
required also to purchase another distinct product (the tied
product) from the same supplier or someone designated by him
• Whether products will be considered as distinct depends on customer
demand
• may lead to anticompetitive foreclosure effects on the tied market, the
tying market, or both at the same time
• may lead to less competition for buyers interested in buying the tied
product, but not the tying product

49. Resale price restrictions
• ResalePriceMaintenance:
• Prohibited: fixed and minimum
• Allowed: maximum and recommended (but genuinely recommended!)
• RPM can still be exempted under Article 101(3)
• New product (to allow the distributors increase marketing efforts without
being under pressure from each other)
• franchise system
• a coordinated short term low price campaign (2 to 6 weeks in most
cases) which will also benefit the consumers

50. ‘hold-up problem’
• A is a manufacturer of widgets
• B is a manufacturer of widgetetts, which generally
requires widgets to produce
• B is willing to start production of new improved version of
widgetetts, which requires seriously improved widgets
• A agrees to invest into the production of new type of
widgets, but requires exclusivity of purchase from B for
the period of 10 years (A will recover the costs of
investment within 8 years)
• B’s competitor C is also considering the new improved
version of widgetetts but will not start manufacturing
earlier than in 3 years’ time

51. ‘know-how hold-up problem’
• A is a manufacturer of midgets
• B is willing to start the production of midgetetts, which
would require midgets
• Usage of midgets in the production is complicated and
requires substantial know-how passing from A to B
• A offers to produce midgetetts himself, but B in turn
offers exclusive purchase obligation from A for 10 years

52. ‘vertical externality issue’
• A manufactures cositas and the varied costs drop substantially
when the sales are up
• B is the distributor of cositas in UK
• A imposes on B maximum retail price on cositas to ensure that
the sales are up
• B asks in return exclusive distribution in UK
• Another distributor C is willing to start selling cositas in UK, so A
is choosing between exclusive and selective distribution

53. Other positive effects
• See Commission guidelines (para 107)

54. Thank you!
• Julija Jerneva
• Mobile: +371 29131597