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A critical discussion of the pro and anti-competitive effects of vertical restraints and the extent to which EU Competition Law is in line with, or diverges from, Bork’s statement.

This article, written by Laura Rankin (4th Year LLB ), criticises Robert Bork’s view of vertical agreements and why, in light of the modernisation process of the Euorpean Commission, undertakings are still reluctant to incorporate such agreements. It is clear that the current law diverges significantly from the view of Bork owed particularly to the ambiguity of what is to be considered the primary aim of EU Competition Law.

 ‘We have seen that vertical price fixing (resale price maintenance), vertical market division (closed dealer territories), and indeed, all vertical restraints are beneficial to consumers and should for that reason be completely lawful.’ (Robert Bork)

A critical discussion of the pro and anti-competitive effects of vertical restraints and the extent to which EU Competition Law is in line with, or diverges from, Bork’s statement.

 

Vertical agreements can be defined as the relationship between firms that trade with each other along a chain that moves upstream to downstream.[1] In its’ approach, the European Union holds that a blacklisted group of hardcore restraints, are more problematic than others – notably Resale Price Maintenance (RPM) and Absolute Territorial Protection (ATP). This can be seen to diverge from the opinion of academics such as Bork who argue for the legality of such restraints. In order to assess whether the EU is correct in its approach, the pro and anti-competitive arguments for vertical restraints will be considered. However, ambiguity remains as to what the main goal of EU Competition Law appears to be – whether it is consumer welfare or single market. This may have a potential impact in determining the accuracy of Bork’s argument given his restrictive view of consumer welfare.

 

   The roots of pro-competitive theories can be traced back to the Chicago school – they contended that vertical restraints increase sales whilst lowering distribution. Bork went further holding that restrictions on output are anti-competitive whilst an increase in input is pro-competitive[2] - arguing for per se legality for vertical restraints. His analysis led many to consider the potential benefits of vertical restraints on intra brand competition, particularly where RPM may be required in order to encourage retailers to compete on non price criteria such as aiding the entry of a new product onto the market.[3] The end result is correlation between the interests of the manufacturer and consumers.[4]

 

   Furthermore, the free rider explanation has been described as the cornerstone of the pro competitive debate regarding vertical restraints.[5] The concept was developed by WS Bowman and refined by Lester Telser.[6] Free riding exists where retailers can offer point of sale product specific services that can lead to an increase in total sales of the particular product.[7]

 

   Telser justified the existence of RPM by virtue of the pre- sale services theory, owed to the extra margin that the restraint provides.[8] Thus, RPM can clearly allow dealers to promote the products of a manufacturer, shielding them from free riders that seek to benefit from the promotional services whilst maintaining lower prices. Evading the costs of the extra services is of clear benefit to the free rider, allowing them to gain an advantage over competitors. Moreover, the allocation of exclusive territories could also prevent free riding whilst allowing promote of goods and services.[9]

 

   Additionally, free riding occurs in relation to the sale of high quality products. Leegin[10] highlighted that while RPM can ensue a reduction in intra brand competition, it can promote inter brand. It does so by providing quality certification and allowing a reduction of free riding at the distribution level on areas such as provision of services. Those in favour of such restraints such as Rey and Stiglitz, believe that exclusive territories can help to create and maintain reputation.[11]

 

   The European Commission is more than aware of the benefits that Vertical Restraints promote[12], particularly in light of the free rider problem and the opening of new markets. If vertical restraints seek to enhance these particular issues then this is in parallel with the Commission’s wider goal of consumer welfare. However, the Commission contends that free riding can be used as a justification to enforce vertical restraints but only where pre-sale services and promotional activities in are in question. This has been met with some criticism, particularly from those who believe that free riding has a positive effect of lowering prices and increasing innovation.[13]

 

  Whilst vertical restraints have many pro-competitive benefits, they are not always justified or per se beneficial for competition.[14] Kneepkens argues that RPM and VTR can have the equivalent effect of a cartel.[15] Arguably, the enforcement of RPM will be anti competitive in that manufacturers will face significant pressure from dealers to impose RPM.[16] Furthermore, exclusive territories can limit the number of dealers, meaning they can engage in tacit collusion. Dealers will seek to soften competition to increase profit.

 

   In a price fixing cartel, every participant can present a product at a price lower than the mandated price. If the remaining members adhere to the cartel price, the member who chooses not to comply will enjoy an increase in market power, to the detriment of its’ competitors. In contrast, there may be an allocation territories - meaning that each individual dealer can charge those consumers at higher prices.[17] However, where territorial restraints were used in the US to restrict intra brand competition, this negatively impacted inter brand competition as manufacturers increased their prices, whilst there was no clear impact on demand by the consumers.[18]

 

   Furthermore, manufacturer cartels can benefit from RPM as it allows wholesale and retail prices to remain constant. Arguably, an upstream level cartel may utilise RPM as an incentive management tool.[19] In order for RPM to be efficient in its’ role in such a cartel, manufacturers must be allocated specific territories. Whilst academics have regarded the imposition of RPM as a facilitating tool as implausible[20] it has previously been enforced to sustain long- term cartels of this kind. However, Bork holds the view that RPM is not required for manufacturer cartels – this is owed to the justifications for cheating inside a cartel. [21]

 

   In addition, where producers have significant market power, they can tie distributors by enforcing exclusive distribution agreements. Ultimately, this provokes foreclosure for competitors at the distribution level by increasing the entry standards for new entrants and undeniably the level of investment necessary in order to enter the market.[22] This could lead to the partitioning of national markets - contrary to the EU objective of market integration.[23] This is particularly prominent where there are economies of scale or scope at distribution level. [24]

 

   Thus, whilst vertical restraints can be pro-competitive, it would appear many academics fail to agree with Bork in his analysis. Comanor holds the view that the preferences exercised by all consumers must be considered – not just those at the margin.[25] Prices may increase, and RPM can be used to eradicate all effective inter brand and intra brand competition – yielding a monopoly outcome if applied with franchise fees.[26]

 

  Under EU Competition Law, vertical restraints must undertake two stages of examination under Article 101 Treaty of the Functioning of the EU (TFEU).[27] It must be ascertained if the restraint restricts competition by object or effect  - capable of hindering trade between states. If so, the restraint must be assessed under Article 101(3) to decide whether individual exception can be sought.

 

  In the early nineties, the Commission received intense criticism as it tended to deal with vertical agreements by category leading to inconsistency. It responded in 1999 with a Block Exemption for vertical agreements which fall under Article 101(1)[28] accompanied by a coherent set of Guidelines.[29]

 

  In adopting this modern approach, the Commission aligned itself with the view of the courts in that many agreements will not infringe Article 101(1).[30] If they do, then Article 101(3) promotes a flexible approach allowing a fuller economic analysis. This means that undertakings should seek to ascertain if the agreement could benefit from the ‘safe haven’[31] before seeking economic analysis by virtue of the Treaty articles –a more sensible approach. The Regulation was reconsidered in 2010[32] and arguably, the amendments align with the modernisation process conducted by the Commission – inclusive of some overdue clarifications.[33]

 

   A key aspect of the 1999 and 2010 BER is that firms with less than 30% market share can benefit from vertical restraints. However, a crucial change introduced in 2010, in response to the changing behavior of the markets, is that the 30% cap now applies to not only the supplier but the buyer. This is owed to the fact that the latters market share could foreclose a supply market as the result of an agreement. Undertakings may also seek to benefit from the De Minimis notice where the restraint does not restrict competition by object.[34] 

 

   However, what has remained unchanged is the Article 4 Hardcore Restrictions. There is a presumption that these four restrictions have, by their object, the aim of restricting or distorting competition and therefore are per se illegal. Thus, the safe haven offered by the block exemption will not be extended to agreements which such black listed restraints.

 

   Minimum RPM imposed by distributors are treated as restrictive by object as price competition is so important that it can never be eliminated.[35] There is a strong presumption on the part of the Commission that at the distribution level, intra-brand competition is vital to the competitive process[36] and that minimum retail pricing can provoke horizontal effects. The Commission have imposed significant fines where agreements have been found to include such restraints.[37] However, Maximum RPM is not categorised as a hardcore restriction.

 

In light of the ruling of Leegin it was thought that this would encourage the EU to eliminate hardcore restrictions from its’ regulations. Reindl[38], on the one hand, is of the belief that the EU missed an opportunity to move towards an analytical approach to vertical restraints which is in line with the more economic approach as a whole. However, Van Doorn whilst acknowledging the benefits posed by RPM, in particular, feels that it should remain within the ambit of Article 4.[39]

 

   Whilst the BER accepts limited territorial exclusivity, it is wary of the repercussions of exclusive distribution – particularly the partitioning of national markets. However, whilst protection may be granted for active sales, the same cannot be said where a retailer may wish to be protected from passive sales of a competitor – ATP. The Commission is of the view that ATP, like RPM, will not satisfy Article 101(3) and has in the past imposed fines where agreements which have been inclusive of such restrictions.[40] Both Consten [41]and Société La Technique Minière [42], highlighted that where an exclusive distributor is allocated a specific territory it will not invoke Article 101(1). However, if the agreement can be perceived to have been concluded on the basis that the end result would partition the markets of a member state, then this will amount to an infringement of Article 101(1) by object. Both cases provide a key example of the court aiming to balance pro competitive efficiency gains against the wider EU competition goal of market integration. A similar situation was found to have occurred in Yamaha[43] and JCB.[44] Consten, in particular, highlighted that an exemption will only be granted if benefits of such a restraint show appreciable object advantages which neutralise any anti-competitive effects - in line with Article 101(3).

 

   That being said, in accordance with the Vertical Guidelines, it is possible in the case of ATP, that an exemption from Article 101(1) can be sought for two years where a manufacturer requires significant investment from retailers to enter a new market.[45] This runs contrary to Consten, where the justification to enforce such restrictions was not considered.

 

  Paradoxically, it may be the belief of at least one party to the agreement that the restraint in question is essential to achieve efficiency and benefit consumers. B&W Loudspeakers, highlights that the Commission has previously failed to consider that restraints inclusive of RPM or ATP can benefit from Article 101(3).[46] Instead, it was concluded that they were anti-competitive and not beneficial for consumers.[47] Indeed, in Nintendo[48], the Commission held that agreements, which included ATP, could not meet the criteria of Article 101(3).

 

However, GlaxoSmithKline[49] offers some clarity here in that it is not impossible for a hardcore vertical restraint to be considered pro-competitive by EU courts.[50] The General Court held that prohibition of parallel trade would not amount to an infringement of Article 101(1).  By not granting an exemption to a dual pricing system controlled by GSK meant parallel trade ceased was held by the General Court to be fundamentally flawed.[51] However, it was later stated by the CJEU that the General Court had erred in law in holding that the welfare of consumers was a necessary consideration. The court conducted a competitive analysis and relied on Consten to conclude that the prevention of parallel imports was illegal. This serves to reinforce the uncertainty surrounding what qualifies as the fundamental goal of EU Competition policy as the General Court was in favour of consumer welfare –whereas the CJEU opted in favour of market integration.

 

  The modern approach shown by the Commission and the EU courts, mean that the 2010 Guidelines are now more open to the idea that where Article 101(1) has been infringed – individual exemptions can be granted by virtue of Article 101(3) where efficiencies can be proven.[52] If the undertaking wishes to succeed, it has the burden of proof in showing that the agreement fulfills Article 101(3), which has been described as a virtually insurmountable obstacle. [53]

 

   There has yet to be convincing evidence that Commission has accepted that hardcore restraints can be beneficial to competition – therefore firms may not wish to incorporate such restraints. This is due to the absence of empirical evidence which clearly highlights, for example, whether the benefits of RPM outweigh the problems it can cause. [54] The Commission has maintained the view that there is an alternative to restrict competition by virtue of less restrictive measures.  

 

   Ergo, it is readily apparent that vertical restraints provoke a great deal of benefits – notably the ability to solve the free riding problem. Further analysis highlights the severe anti competitive effects of vertical restraints where RPM and ATP – which fall foul of the fundamental objectives of EU competition policy. However, problems lie in the fact that the pro competitive benefits tend to focus on consumer welfare, whereas the anti competitive problems are based on the goal of market integration. Therefore, it is not clear which goal the Commission and the courts is seeking to protect. Even though there is evidence that ATP is treated with greater leniency than RPM – there seems to be no convincing argument which would mean either restraint is ever likely to not be regarded as per se illegal. To follow the US approach in such cases would increase both regulatory costs and the burden on the Commission, contrary to what the Regulation seeks to achieve.   Therefore, it is apparent that the EU approach diverges significantly from the argument proposed by Bork.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

[1] Vettas, N, ‘Developments in Vertical Agreements’, The Antitrust Bulletin (2010) 55(4), 843-874.

[2] Bork, R, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division – Part II’, (1966) ,Yale L.J, 75(3), 377- 475

[3] Jones, A and Sufrin, B (2016). EU Competition Law. 6th ed. Oxford: Oxford University Press

761

[4] Comanor, W, ‘Vertical Price-Fixing, Vertical Market Restrictions, and the New Antitrust Policy’, (1985), Harvard L.R, 98(5), 983-1002

[5] Paldor, I, ‘The Vertical Restraints Paradox: Justifying the Different Legal Treatment of Price and Non- Price Vertical Restraints’, (2008) The University of Toronto L.J, 58(3), 317-353

[6] Telser, L, ‘Why Should Manufacturers want Fair Trade?, (1960), Journal of Law and Economics 3(1), 86-105

[7] Paldor, I, ‘The Vertical Restraints Paradox: Justifying the Different Legal Treatment of Price and Non- Price Vertical Restraints’

[8] Zevgolis, N, ‘Resale Price Maintenance (RPM) in European competition law: legal certainty versus economic theory?’ (2013), E.C.L.R 34(1), 25-32

[9] Marvel, H.P, ‘Resale Price Maintenance and Resale Prices: Paying to Support Competition in the Market for Heavy Trucks’, (2010), Antitrust Bulletin 55(2), 79-99

[10] Leegin Creative Leather Products Inc v PSKS Inc (1997) 522 US 3

[11] Rey, P and Stiglitz, J,  ‘The Role of Exclusive Territories in Producers Competition’, (1995), RAND Journal of Economics ,26(3), 431

[12] Guidelines on vertical restraints [2010] O. J. C 130/1 , para. 106-109

[13] Consumer Focus, Consumer Focus Response to Vertical Restraints Block Exemption Regulation, (September 2009), 11-12

[14] European Commission, Green Paper on Vertical Restraints in EC Competition Policy, COM (96) 721, para. 54

[15] Kneepkens, M,’Resale Price Maintenance: Economic Call for A More Balanced Approach’, (2007) 28(12) E.C.L.R, 660-661

[16] Comanor, W, ‘Vertical Price-Fixing, Vertical Market Restrictions, and the New Antitrust Policy, Harvard Law Review’

[17] Herbert J. Hovenkamp. Economics and Federal Antitrust Law. St. Paul, MN: West Publishing Co. 1985, xvii, 592 pages (Hornbook Series Lawyer’s Edition);  Jay Palmer v BRG of Georgia (2010) 498 U.S. 46 illustrates the reality of a price increase by horizontal territorial market division

[18] B. Durand, “On the Efficiency of VTR” (thesis, Boston College, The Department of Economics, U.S.A., May 2000).

[19] Iacobucci, E, ‘The Case for Prohibiting Resale Price Maintenance’, (1995) 19(2) World Comp.L. & Econ.Rev. 71

[20] Sullivan, E.T and Jeffrey, L (2014). Understanding Antitrust and Its Economic Implications . 6th ed. Newark: Mathew Bender & Co. 227

[21] Jedličková, Barbora (2012) The law of vertical territorial and price restraints in the EU and in the USA: a critical analysis of vertical territorial and price restraints - an argument against legalisation. PhD thesis.

[22] Organisation for Economic Co-operation and Development (‘OECD’), Competition Policy and Vertical Restraints: Franchising Agreements (1994) 192–3. The EC believes that inter-brand competition is a crucial indicator of workable competition: European Commission, Green Paper on Vertical Restraints in EC Competition Policy, COM(96)721, 20

[23] European Commission, Green Paper on Vertical Restraints in EC Competition Policy, COM(96) 721, para. 70 and 78

[24] Comanor, W, ‘Vertical Arrangements and Antitrust Analysis’, (1987) 62(5), N.Y.U L. Rev. 1153

[25] Comanor, W, ‘Vertical Price-Fixing, Vertical Market Restrictions, and the New Antitrust Policy’

[26] Bennett, M et al., Resale Price Maintenance: Explaining the Controversy, and Small Steps Towards a More Nuanced Policy, (2010), MPRA Paper No. 21121, Online at www.mpra.ub.uni-muenchen.de/21121 [Accessed 20 December 2016]

[27] Treaty on the Functioning of the European Union, O.J. C 83 of 30.3.2010

[28] Regulation 2790/99 Vertical Restraints [1999] O.J. L336/21

[29] Guidelines on Vertical Restraints [2000] OJ C291/1

[30] Jones, A and Sufrin, B (2016). EU Competition Law, 768

[31] Guidelines, para 110

[32] Commission Regulation 330/2010 on the application of Article 101(3) of the Treaty

on the Functioning of the European Union to categories of vertical agreements and

concerted practices, O.J. L 1021

[33] Brenning –Louko, M et al., ‘Vertical Agreements: New Competition Rules for the Next Decade’, (2010) 2 Competition Policy Newsletter, 15

[34] Notice on agreements of minor importance which do not appreciably restrict

competition under Article 81(1) of the Treaty establishing the European Community (“de minimis Notice”) [2001] OJ C 368/13

[35] Case 26/76 Metro – SB – Großmärkte GmbH v Commission (Metro I), [1977] ECR 1875, para.21

[36] Jones, A,. ‘Resale Price Maintenance: A Debate About Competition Policy in Europe’, (2009), European Competition Journal, 5(2), 479-514

[37] Case C -167/04 JCB Service v Commission [2006] ECR I-8935; Yamaha, IP/03/1028, 16 July 2003

[38] Bennett, M et al., Resale Price Maintenance: Explaining the Controversy, and Small Steps Towards a More Nuanced Policy, (2010)

[39] Van Doorn, F, Resale Price Maintenance in EC Competition Law: The Need for  Standardised approach, (November 6 2009). Online at www.ssrn.com/abstract=1501070 [Last Accessed 23 December 2016]

[40] Case C-74/04 P Commission v. Volkswagen AG [2006] ECR I-6585

[41] Cases 56/64, 58/64 Établissements Consten S.à.R.L. and Grundig-Verkaufs-GmbH v. Commission of the European Economic Community [1966] ECR 299

[42] Case 56/65, Société La Technique Minière v Maschinenbau Ulm GmbH [1966] ECR 235,

[43] Yamaha, IP/03/1028, 16 July 2003

[44] Case C -167/04 JCB Service v Commission [2006] ECR I-8935

[45] Guidelines, para 61

[46] IP/02/916, Commission clears B&W Loudspeakers distribution system after company deletes hard-core violations, 24 June 2002

[47] COMP/3344 Grundig, 23 September 1964

[48] Case T-13/03, Nintendo and Nintendo Europe v Commission [2009] ECR II-975

[49] Joined cases C-501/06 P, C-513/06 P and C-519/06 P GlaxoSmithKline Services Unlimited v Commission of the European Communities [2009] I-09291

[50] A similar conclusion was drawn in Case 243/83 Binon & Cie v SA Agence et Messageries de la Presse [1985] ECR 2015

[51] Jones, A and Sufrin, B (2016). EU Competition Law. 817

[52] Guidelines, para 47

[53] Maci, M, ’The assessment of RPM under EU Competition rules: certain inconsistencies based on a non-substantive analysis’, (2014) E.C.L.R, 35(3), 103-109

[54] Kyprianides, G.P, ‘Should Resale Price Maintenance be per se illegal?’, (2012), E.C.L.R, 33(8),  376-385

 

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