2nd Oct 2019
Antitrust/ Competition Law: Vertical Restraints and Exclusive Dealing*
A vertical agreement is an agreement or concerted practice entered into between two or more undertakings each of which operates, for the purposes of the agreement or the concerted practice, at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain goods or services.[i] A vertical agreement between a manufacturer and a distributor can affect competition in two distinct markets: the upstream market where the manufacturer competes with similar firms and the downstream market where retailers compete against other retailers.[ii] The former type of competition is called inter-brand competition as it occurs among various suppliers whose products are mainly identified through the use of specific brands.[iii] Downstream competition may also occur among retailers who sell the products of the same manufacturer; this form of competition is called intra-brand competition.[iv]
Vertical restraints may produce efficiencies or anticompetitive effects. Very often, firms at different stages of the vertical process do not simply rely on spot market transactions, but sign contracts of various types in order to reduce transaction costs, guarantee stability of supplies, and better co-ordinate actions.[v] Vertical restraints also control, if not eliminate, externalities. Internalization of price externalities brought about by vertical restraints between firms with complementary products and services can bring about a reduction in price.
Such restraints can also improve consumer welfare by giving firms incentives to improve their services and efforts since the exclusivity does away with the free-riding problem. This extra effort is rewarded by increase in consumer patronage. If infra-marginal customers (those who do not value extra effort) have the possibility to buy from firms supplying a standard quality of product (i.e. a product which does not incorporate extra services), vertical integration will not reduce welfare.[vi] In fact, if the divergence of interest between marginal and inframarginal consumers is not too large, it is likely that the restraints are welfare enhancing, as consumers will also appreciate the resulting increase in the level of services..[vii]
However, vertical restraints can also engender anticompetitive effects. It can be used as a tool for a dominant firm to leverage its market power to another market. Vertical restraints might increase overall market power in four ways: they might increase market power at a single stage, increase entry barriers, facilitate collusion, or raise rivals’ cost.[viii] Vertical restraints may also enhance retailers’ product differentiation activities and thereby have complex effects on competition and consumers’ welfare.[ix]
Exclusive dealing is a form of vertical restraint. In the Philippines, vertical restraints such as exclusive dealing are not per se illegal. They are only prohibited when the arrangement has the object or effect of substantially preventing, restricting or lessening competition. In view of the dearth of jurisprudence on exclusive dealing in the Philippines, it may be helpful to refer to the experiences of the US and the European Union for guidance.
Exclusive Dealing under US Laws
Exclusive dealing describes a set of practices that have the effect of inducing a buyer to purchase most or all products or services for a period of time from one supplier.[x] In the US, the courts look at both the act of monopolization and the possible procompetitive effects of the exclusive dealing. Thus, the US Department of Justice believes that focusing on whether the exclusive dealing allows a firm to acquire or maintain monopoly power and also taking into account procompetitive effects in those situations where harm to competition is likely—is the appropriate way to determine the legality of exclusive dealing.[xi] Applying the disproportionality test, if there is potential harm to competition and the public as well as procompetitive benefits resulting from the exclusivity, it must be shown that the anticompetitive effects significantly outweigh the procompetitive gains. As for foreclosure, the US Department of Justice provides for a safe harbor when exclusive dealing arrangements foreclose less than thirty percent of effective distribution.[xii] On the other hand, those affecting more than thirty percent should be tested under the rule of reason.
In the earlier years after the passage of the Sherman Act, the laissez faire approach was adopted in the US whereby many exclusive arrangements were held valid. In United States v. United Shoe Machinery Co.[xiii] the US Supreme Court held:
It approaches declamation to say that the lessees were coerced to their making. And, as we have said, there was benefit to the lessee. It is easy to say that the leases are against the policy of the law. But when one tries to be definite, one comes back to the rights and obligations of the parties. There is no question in the case of the use of circumstances to compel or restrain; the leases are simply bargains, not different from others, moved upon calculated considerations, and, whether provident or improvident, are entitled nevertheless to the sanctions of the law.”
Furthermore, in In Re Corning[xiv], the US Court ruled that an agreement between a distillery manufacturer controlling 75% of the market and its distribution agents whereby the latter covenanted to sell only products of the former, was valid since the dominant firm legally acquired its dominant status (three fourths of the market) and did not attempt to control the business of the remaining one fourth. This recognizes a firm’s freedom to conduct business and enter into agreements.
This era came to an end when the US Supreme Court handed down its decision in Standard Fashion Co. v. Magrane-Houston Co.[xv] , where the manufacturer’s claim for breach of contract and damages against its retailers, who subsequently carried garment patterns from other manufacturers, was dismissed. The US Supreme Court, citing and agreeing with the Circuit Court of Appeals, held that “the restriction of each merchant to one pattern manufacturer must, in hundreds, perhaps in thousands, of small communities amount to giving such single pattern manufacturer a monopoly of the business in such community”. Also, in Lorain Journal Co. v. United States[xvi], the Supreme Court struck down a newspaper company’s act of disallowing firms from advertising in its newspaper if the latter also availed of advertising from a new radio station.
However, in the 1961 case of Tampa Electric Co. v. Nashville Coal Co.[xvii], the US court ruled that that one must weigh the probable effect of the contract on competition in the relevant market by taking a look at the relative strength of the parties and volume of commerce involved vis-à-vis its total volume in the relevant market. Thus, the US Court upheld an exclusive twenty-year coal supply contract amounting to US$128 Million. Despite the large amount involved, the contract only accounted for roughly 1% of the sale of coal in the relevant geographic market.
At present, exclusive dealing is now being analyzed under the rule of reason. Furthermore, US cases reduced the focus on foreclosure and placed greater emphasis on the need to prove market power and actual consumer harm.[xviii]
Exclusive Dealing under EU Laws
Exclusive dealing makes, by the express language of the contract or its practical effects, one party fulfil all or practically all its requirements from another party.[xix] Generally, exclusive dealing arrangements are commonly defined as arrangements, which require a buyer to purchase all of its requirements or a large extent thereof only from one (dominant) seller, or, respectively, as arrangements, which require a supplier to sell all of its products or services or a large extent thereof to the dominant firm.[xx]
Historically, the EU has condemned exclusive dealing and considered the same as per se illegal. Over the years, the EU’s form-based approach yielded to an effects-based approach, whereby evidence and economic analysis must show harm to competition, in order to hold an exclusive arrangement violative of Section 102 of the Treaty on the Functioning of the European Union. The conduct, which may be disadvantageous for competition, may be counterbalanced or outweighed by advantages in terms of efficiency, which may also benefit the consumer.[xxi]
Hence, in the case of Intel Corporation Inc. v. European Commission[xxii], the EU Court of Justice held that although dominant firms have a special responsibility not to impair undistorted competition in the market, the efficiencies and lack of foreclosure effects must be considered when put forth by the undertaking. The abusive conduct must also be assessed in light of a possible existence of a strategy aimed at excluding competitors that are at least as efficient.[xxiii] It was further enunciated in the same case that an analysis on the intrinsic capacity of the practice to foreclose equally efficient competitors must first be done, in order to balance the favorable and unfavorable effects of the questioned conduct.
Nevertheless, it is notable in EU decisions that dominant firms are subjected to stricter scrutiny and responsibility. Thus, in 2018, the European Commission fined Qualcomm almost a Billion Euros for its abuse of dominance in the LTE baseband chipsets market by entering into an exclusivity arrangement whereby it paid its key customer Apple, Inc. a hefty sum so that the latter would not buy the same products from the former’s rivals.[xxiv] Furthermore, in the same year, Google LLC was fined more than Four Billion Euros for abusing its dominant position in the general internet search service market when it gave significant payments to device manufacturers and mobile network operators so that they would exclusively pre-install Google search in Android devices thereby blocking rival search engines, among others[xxv].
Nicolas & De Vega Law Offices is a full-service law firm in the Philippines. You may visit us at the 16th Flr., Suite 1607 AIC Burgundy Empire Tower, ADB Ave., Ortigas Center, 1605 Pasig City, Metro Manila, Philippines. You may also call us at +632 4706126, +632 4706130, +632 4016392 or e-mail us at firstname.lastname@example.org . Visit our website www.ndvlaw.com .
* This is part of the papers submitted by NDV Law’s Atty. Norieva “Nikki” de Vega to the University of Melbourne, in partial fulfillment for the completion of a Master of Laws Degree (Global Competition and Consumer Law).
[i] European Union, Guidelines on Vertical Restraints, 2010/C I 30/01, par. 24.
[ii] OECD, Vertical Restraints for On-line Sales, 2013, 10.
[v] Massimo Motta, Competition Policy: Theory and Practice (Cambridge University Press, 2004) 302.
[vi] Ibid 316.
[vii] Vincent Verouden, ‘Vertical Agreements: Motivation and Impact’ (2008), ABA Section of Antitrust Law 1821.
[viii] Alan A. Fisher, Frederick I. Johnson, Robert H. Lande, ‘Do the DOJ Vertical Restraints Guidelines Provide Guidance?’ (1987) 32 Antitrust Bulletin 616.
[x] American Bar Association, Antitrust Law Developments (6th ed. 2007) 210.
[xi] U.S. Department of Justice, ‘Competition and Monopoly: Single-Firm Conduct Under Section 2 of the Sherman Act’ (2008) 136.
[xii] Ibid at 141.
[xiii] 391 US 244 (1968).
[xiv] 51 Fed. 205 (D.C.N.D. Ohio 1892).
[xv] 258 US 346 (1922).
[xvi] 342 US 143 (1951).
[xvii] 365 US 320 (1961).
[xviii] Jonathan Jacobson, ‘Exclusive Dealing, Foreclosure, and Consumer Harm’ (2002) Antitrust Law Journal 311, 323.
[xix] European Commission, Guidelines on Vertical Restraints, 32.
[xxi] British Airways v Commission, C‑95/04 P, (15 March 2007).
[xxii] Case C-413/14 P(6 September 2017) 632.
[xxiv] Case AT.40220 (24 January 2018).
[xxv] Case AT.40099 (18 July 2018).