Distribution and supply chains – new competition rules now in force

Dual distribution has become something of a hot topic from a competition law perspective in recent years as increasing numbers of manufacturers have launched their own online stores to sell direct to end customers (thereby placing them in direct competition with their own distributors at the retail level of the supply chain).

The fact that a manufacturer also competes with its customers at the downstream level does not, in itself, take the vertical supply agreement outside the scope of the VBER – and this fundamental principle will not change under either the new UK or EU regimes. However, concerns have been raised about the risk of commercially sensitive information being shared via the downstream/ vertical relationship, which then has the capacity to distort competition between the parties at the retail level of supply.

An obvious example would be where a manufacturer discloses its future pricing strategy for its own online store to a retail customer (or vice versa) who then acts upon the information to adjust its own retail prices – thereby dampening price competition.

The new rules deal with the risk of anti-competitive information exchange in the following ways:

• The VBER now specifically states that the block exemption does not apply to an exchange of information that is “not directly related to the implementation of the vertical agreement or is not necessary to improve the production or distribution of the contract goods or services, or which fulfils neither of those two conditions.” In other words, the VBER does not provide carte blanche for parties to exchange whatever information they please; any information exchange must be strictly limited to the requirements of the “vertical” relationship between the parties and serve a legitimate commercial purpose in that context. The text of the UK VABEO does not include this specific clarification; however, the underlying CMA guidance makes it clear that the same principles apply in the UK.
• Both the CMA and Commission guidelines provide non-exhaustive examples of the types of information exchange that are likely to be permissible in the context of a vertical relationship between competitors. Examples include technical or regulatory information in relation to the contract products, or information relating to production, inventory, stocks, sales volumes and returns.[1] The guidelines also set out some procedural safeguards that can be put in place to enable the exchange of more sensitive information, for example aggregation of sensitive data and internal firewalls.
• The guidelines also give examples of information exchanges that are likely (to be problematic and) fall outside the scope of the VBER/ VABEO, for example information in relation to actual future pricing or customer-specific sales data, including non-aggregated information on the value and volume of sales per customer.[2]
• In addition, in the EU, the dual distribution exemption under the VBER does not extend to “hybrid” online platforms that act both as intermediaries and also sell products and services in direct competition with suppliers who use the platform. The rationale provided in the Commission guidelines is that the “horizontal” risks to competition (i.e. collusion between direct competitors) are too great in these circumstances to merit any kind of safe harbour under VBER. This is consistent with the Commission’s investigation into Amazon, where it was alleged that the platform exploited information received from marketplace sellers to give an unfair advantage to its direct sales offering. It is notable however that the UK’s VABEO does not go as far as carving out online intermediary services from the dual distribution exemption.

Finally, many stakeholders will be relieved to learn that that the final VBER text has dropped the initial proposal to limit the safe harbour for information exchange in dual distribution scenarios to cases where the parties combined market share in the relevant retail market does not exceed 10%. This follows significant feedback during the VBER consultation phase, with respondents arguing the additional market share test would add unnecessary complexity to the self-assessment of agreements. Nevertheless, the Commission’s initial appetite for this 10% combined market share test provides a hint as to the extent of the Commission’s concerns, which may in turn signal the point at which the parties involved in such arrangements should consider more significant procedural safeguards in respect of the handling of the relevant information.

[1] Further examples can be found at paragraph 10.175 of the draft CMA guidelines and paragraph 99 of the Commission guidelines.

[2] See paragraphs 10.176 of the draft CMA guidelines and paragraph 100 of the Commission guidelines for further examples.

The previous VBER did not contain any express provisions relating to restrictions of online sales – although over time it has become established jurisprudence that an outright ban on selling via the internet is a hardcore restriction. Indeed, even indirect or “de facto” bans on internet selling have given rise to significant antitrust fines (see, for example the £1.25m fine imposed on the golf club manufacturer Ping by the CMA in the UK, which related to a mandatory requirement that all distributors offer in-person club fittings).

This principle is now codified in the new VABEO and VBER, which states that a restriction preventing the “effective use of the internet” by the buyer (or its customers) is a hardcore restriction.  This would apply to:

• a direct prohibition on the use of the internet to sell the contract goods or services;

• requiring the buyer to sell the contract goods or services only in a physical space or with physically present personnel;

• prohibiting the buyer from establishing or operating one or more online stores; and

• a blanket prohibition on using an entire online advertising channel (e.g. price comparison websites or search engines).

That said, the CMA and Commission guidelines also recognise that there are circumstances in which suppliers may wish to impose legitimate restrictions, which are designed to foster or preserve an offline/ high street sales presence, which can be critical for certain brands.

Most notably, direct or indirect online marketplace bans are now permissible in principle, even outside of selective distribution networks and for non-luxury goods (building on the principle established in Coty). However, this is subject to the important caveat that a de facto ban on internet selling remains a hardcore restriction, so the marketplace ban must not leave the buyer with no other viable options for selling online.

Other forms of (permitted) restriction that will fall within the scope of the VABEO and VBER include:

• requirements (including on the display of goods or services) to ensure the quality or the particular appearance of the online store;

• the requirement that the buyer operates at least one or more brick and mortar stores; and

• the requirement that the buyer sells a minimum absolute number of products offline.

In addition, the new rules now permit greater flexibility in terms of differential wholesale pricing models (or “dual pricing”) for products intended to be sold via online and offline channels. See below for more information.

The EU and UK rules have now been relaxed for so-called “dual pricing” – i.e. differential wholesale pricing structures for online vs. offline distribution. Under the old VBER, dual pricing was treated as a hardcore restriction.

Under the new regime, both the CMA and Commission guidelines are clear that a requirement for a given buyer to pay a different wholesale price for products intended to be resold offline as opposed to online (and vice versa) can benefit from the block exemption.[1] That is, however, subject to the following important caveats:

• The objective of the pricing structure must be to incentivise or reward the appropriate level of investments respectively made online and offline (e.g. to compensate distributors for the higher costs associated with operating offline sales channels).
• If, in practice, the differential pricing has the objective of preventing internet selling, the pricing model would constitute a hardcore restriction. The CMA and Commission guidelines clarify that this would be the case where the price difference makes the effective use of the internet for the purposes of selling online unprofitable or financially not sustainable.

Accordingly, the rules on dual pricing remain broadly consistent with the underlying principle under the VABEO and VBER that distributors must be free to re-sell online.

The new rules provide much needed clarity on how the concept of a “vertical” agreement applies to digital platforms (referred to as ‘online intermediation service’ providers[1]), which operate in two-sided markets connecting consumers with suppliers. It is not previously been clear whether, in those circumstances, the platform operates upstream or downstream of the third-party suppliers that provide their goods or services through the platform.

Given that the VBER generally applies to downward vertical restrictions imposed on “buyers” by “suppliers”, this has caused considerable uncertainty as to whether or not restrictions imposed by platforms on their B2B partners are caught by the VBER (given the potential assumption that platforms comprise a downstream intermediary of suppliers looking to market their products to end-customers). However, the CMA and Commission guidelines now make it clear that online intermediation services should be categorised as “suppliers” in the sense they supply their services to businesses looking to distribute their products.

In practice, this means that the hardcore restrictions set out in the VBER and VABEO apply in a similar way to online intermediation services.

As the relevant guidelines also clarify that online intermediation services are unlikely to be classified as “agents” for competition law purposes, the scope for digital platforms to argue that they are not caught by established hardcore restrictions under VBER (for example resale price maintenance or customer group restrictions) is considerably reduced.

In addition, as noted above (see “Dual Distribution”) the EU rules tighten the net even further by excluding “hybrid” online intermediation services (i.e. platforms that also offer their own competing goods and services) from the protection of VBER altogether.

Retail price parity obligations (often referred to as Most Favoured Nation, or MFN, clauses) have come under the spotlight in the UK and EU in recent years due to their increasing prevalence in the platform economy – for example in the pan-European investigation into online travel agencies. A classic example is a hotel bookings platform that only allows hoteliers to list rooms on its sales platform if the hotelier agrees not to undercut the platform by offering cheaper prices on the hotelier’s own website (a Narrow MFN) or via any other sales channel (a Wide MFN).

The previous VBER was silent as to the applicability of MFNs (wide or narrow) with competition rules, the obvious inference being that what is not prohibited is exempted. That has now changed to some extent, particularly in the UK.

In the UK, the VABEO specifically states that Wide MFNs (which are referred to as “wide retail parity obligations”) are now to be regarded as a type of hardcore restriction, meaning that, irrespective of the market share of the parties involved, they will no longer potentially benefit from the safe harbour of the block exemption. This reflects the CMA’s hardened position in relation to the use of Wide MFNs in recent years and represents an interesting divergence from the EU position, where the potential of such clauses to give rise to anti-competitive effects is noted, but they are still not treated as presumptively anti-competitive (see further below).

The CMA’s draft guidance on the VABEO makes it clear that this tougher line on Wide MFNs:

• does not just apply to price parity – it can capture restrictions on other benefits that a supplier might seek to offer through third parties and also applies to non-price related parity agreements, for example those that relate to inventory, availability or any other terms or conditions of offer or sale; and

• also applies to indirect parity obligations that do not take the form of a contractual restriction (for example differential pricing or other incentives or measures calculated to achieve the same effect as a Wide MFN).

Narrow MFNs will continue to benefit from the UK’s VABEO safe harbour, provided that the parties’ market shares do not exceed 30%.

By contrast, in the EU under the new VBER, Wide MFNs will only be classified as excluded restrictions if imposed by providers of online intermediation services, which means the clause itself will not benefit from block exemption protection, albeit the wider agreement generally will. When imposed by other businesses, the clauses have the potential to come within the scope of the VBER’s safe harbour. This is suggestive of a slightly softer approach by the Commission, albeit one that should not be interpreted as the Commission giving MFNs a clean bill of health in all scenarios.

One of the core principles of the VBER has always been that suppliers must not impose blanket restrictions that stop distributors from targeting specific customer groups or territories (so-called “active sales” restrictions) or responding to unsolicited sales requests (“passive sales”).

Blanket sales restrictions of this nature have always been classified as hardcore restrictions subject to certain exceptions, noting that the rules have permitted some flexibility/limited exceptions in cases where suppliers operate exclusive or selective distribution networks.

Under the VABEO (and new VBER) the rules in this area have been further refined in some respects, for example:

• Exclusive distribution. Under the old rules, suppliers operating exclusive distribution networks only benefited from certain carve-outs (e.g. the ability to stop an exclusive distributor in one territory from actively selling to customers reserved for an exclusive distributor in another territory^[1]) if a single exclusive distributor was appointed for each territory.

• The new rules introduce the concept of “shared exclusivity”, which means that a manufacturer or supplier could appoint a number of ‘exclusive’ distributors for a territory; moreover, the restriction on active sales into another’s exclusive territory etc. can be passed on to a distributor’s customers.

• Selective distribution. While allowing the combination of certain aspects of exclusive and selective distribution,^[2] the new VBER and VABEO will make it more difficult for manufacturers or suppliers who operate selective distribution networks to restrict distributors from representing specific competing suppliers (although this really just reflects what was previously contained in guidance).

[1] Restrictions on passive or unsolicited sales were not permitted. 

[2] The new VBER and VABEO enable suppliers who operate selective (and exclusive) distribution networks from actively pursuing sales to end customers in territories reserved to the supplier or allocated to other distributors on an exclusive (or shared exclusive) basis.

Strictly speaking, the new VABER and VABEO are, in many respects,^[1] irrelevant to true or ‘genuine’ agency agreements, on the basis that Article 101 and the Chapter I prohibition apply to agreements between independent firms or ‘undertakings’, whereas in a genuine agency, the agent is regarded as part of their principal’s organisation (and not independent).  In other words, a genuine agency does not need block exemption as (with certain exceptions) its terms are not otherwise caught by any competition law prohibition.

That said, guidelines accompanying both the new VABER and VABEO are of critical importance in assessing whether an agency agreement is truly ‘genuine’ and, as a result, any restrictions contained in it (including pricing controls) can escape sanction.

The UK (draft) guidance sets the bar for ‘genuine’ agency at a high level.  It echoes the EU requirement that for a genuine agency agreement to arise, the agent should bear no more than insignificant commercial risk associated with; i) the products in respect of which it has been appointed as agent; ii) the relationship-specific investments it is required to make in support of the sale of its principal’s products; and iii) any other activities linked to its agency appointment that it is required to undertake in the same market for its principal but at the agent’s own risk.  The UK guidance indicates that a genuine agency agreement is one in which, subject to very limited exceptions, the agent:

• does not normally take ownership of the goods bought or sold under the agency agreement and does not itself supply the contract services;

• does not contribute to the costs relating to the supply/purchase of these goods, including the costs of transporting the goods;

• does not maintain at its own cost or risk stocks of the contract goods, including the costs of financing the stocks and can return unsold goods to the principal without charge;

• does not take responsibility for customer bad debt, with the exception of the loss of the agent's commission;

• does not assume responsibility towards customers or other third parties for loss or damage resulting from the supply of the goods, unless, as agent, it is liable for fault in this respect;

• is not, directly or indirectly, obliged to invest in sales promotion, including through contributions to the advertising budget of the principal or to advertising or promotional activities specifically relating to the goods;

• does not make market-specific investments (confined to the contract goods) in equipment, premises or training of personnel;

• does not undertake other activities within the same product market required by the principal under the agency relationship;

• does not undertake responsibility towards third parties for damage caused to the goods sold;

• does not take responsibility for other types of financial risk such as the risk of incurring costs due to deferred payments from credit cards or the risk of customer insolvency; and

• does not make market-specific investments in customer support services, such as after-sales and technical support, to the extent that these services affect the relationship between the agent and the principal in that market, unless these activities are fully reimbursed by the principal.

Interestingly, the guidance also identifies a number of other factors that will militate against a finding of genuine agency.  These factors include:

• Where the agent undertakes a very considerable amount of business on its own account (i.e. as an independent retailer) in the market for the goods in question. This suggests that a partial agency covering only a limited range or type of goods for the principal, where the agent continues to sell similar goods in its own right, will be problematic.^[2]

• Where the agent acts for multiple competing principals. In other words, it is difficult to square the idea of an agent being an integral part of a principal’s organisation (and therefore outside the scope of competition law) if, in fact, it acts in a similar capacity for a number of other ‘principals’.^[3]

Dual-role agents

The guidelines also devote particular attention to the scenario where an independent distributor of some products of a supplier may also be also be considered to act as an agent for other products of that same supplier.

The guidelines stipulate clearly that, in such a scenario, the activities and risks covered by the agency agreement should be effectively delineated and that all relevant risks linked to the sale of the goods covered by the agency agreement must be borne by the principal. The guidelines recognise the difficulties in distinguishing investments and costs that relate to the agency function, including market-specific investments, from those only related to independent activities also conducted in the same market by the agent/distributor.

The guidelines also raise particular concerns where any agency appointment (in a dual role model) is likely to constrain the incentives and decision-making freedom of the distributor/agent in its separate capacity as an independent retailer.  Particular concerns will arise where the pricing policy of the principal for the products sold under the agency agreement limits the incentives of the agent/distributor to price competing products (whether those of the same or different brands) that it sells on its own account independently.

Finally, the guidelines warn that hitherto independent distributors must be genuinely free to enter into agency agreements, and that any new agency arrangement must not be de facto imposed by the principal through a threat to terminate or worsen the terms of the distribution relationship.  That said, it will be interesting to see how competition law enforcers, such as the CMA, apply this aspect of the guidance.

Non-genuine agency

Non-genuine agency is not a concept that is specifically defined in the guidelines; however, one is expected to infer that it captures any type of ‘agency’ agreement that falls short of the strict requirements of genuine agency.  For competition law purposes, it is treated no differently to ordinary distribution arrangements.

Suppliers that do not have the appetite to pursue a genuine agency model and take on the risks and costs involved may see this, superficially, as an attractive alternative; however, they should be warned that any attempt to apply agency style controls over the non-genuine agent’s competitive proposition, including the prices it applies and might seek to advertise, has real potential to contravene competition law. 

Competition is concerned with substance over form, and the guidelines list a wide variety of examples where indirect measures (e.g. restrictions on advertising and other controls) that are used to achieve anti-competitive outcomes, including de facto resale price maintenance, are likely to be prohibited.

Indeed, the draft UK guidelines warn against the “misuse of the agency concept” as “an easy way to control retail prices for those products that allow high resale margins”. They stress that the agency concept should not be misused by suppliers - through the application of agency style controls but without the assumption of risks - to control prices (or apply other anti-competitive restrictions on the non-genuine agent). 

The emphasis placed on agency in the guidelines (both at UK and EU level) and the conditions that need to be met to satisfy genuine agency treatment suggest that competition authorities are alive to the risks to consumer welfare of such practices, and will be minded to intervene if the concept is abused by suppliers (although it should be noted that all parties to agreements that infringe competition law are potentially liable).