Guidelines on vertical restraints

1) OBJECTIVE

To help companies make a case-by-case assessment of the compatibility of agreements with the competition rules by providing a framework of analysis for vertical restraints.

2) ACT

Commission notice of 13 October 2000: Guidelines on vertical restraints

[COM(2000/C 291/01) - Official Journal C 291 of 13.10.2000].

3) SUMMARY

DEFINITION OF VERTICAL RESTRAINTS

Vertical restraints are agreements or concerted practices entered into between two or more companies each of which operates, for the purposes of the agreement, 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. These guidelines set out the principles for the assessment of vertical agreements with a view to determining whether they affect competition between Member States.

SCOPE

The guidelines describe the vertical agreements that generally do not fall within Article 81(1): agreements of minor importance, agreements between small and medium-sized firms and agency agreements

GENERAL FRAMEWORK FOR CASE-BY-CASE ANALYSIS

The guidelines on vertical restraints also describe the general framework of analysis and the policy which the Commission plans to follow in the field.

Analysis of the effects on the market of vertical restraints

The negative effects on the market that may result from vertical restraints which EC competition law aims to prevent are as follows:

• foreclosure of other suppliers or other buyers by raising barriers to entry;
• reduction of inter-brand competition between the companies operating on a market;
• reduction of inter-brand competition between distributors;
• limitations on the freedom of consumers to purchase goods or services in a Member State.

However, vertical restraints often have positive effects, in particular by promoting non-price competition and improved quality of services. Consequently, the application of certain vertical restraints may be justifiable for a limited period where:

• one distributor may "free-ride" on the promotion efforts of another distributor;
• a manufacturer wants to enter a new geographic market, for instance by exporting to another country for the first time. This may involve certain "first-time investments" by the distributor to establish the brand in the market;
• certain retailers in some sectors have a reputation for stocking only "quality" products;
• client-specific investments have to be made by either the supplier or the buyer, such as in special equipment or training;
• know-how, once provided, cannot be taken back, and the provider of the know-how may not want it to be used for or by his competitors;
• in order to exploit economies of scale and thereby see a lower retail price for his product, the manufacturer may want to concentrate the resale of his product on a limited number of distributors;
• the usual providers of capital (banks, equity markets) provide capital sub-optimally when they have imperfect information on the quality of the borrower or there is an inadequate basis to secure the loan;
• a manufacturer increases sales by imposing a certain measure of uniformity and quality standardisation on his distributors. This may enable him to create a brand image and thereby attract consumers. This can be found, for instance, in selective distribution and franchising.

Method of analysis for vertical restraints

In general, the assessment of a vertical restraint involves the following four steps:

• the companies involved need to define the relevant market in order to establish the market share of the supplier or the buyer, depending on the agreement. In order to calculate the market share, the relevant product market (which comprises any goods or services which are regarded by the buyer as interchangeable) and the relevant geographic market (which comprises the area in which the companies concerned are involved in the supply and demand of the relevant goods and services) are taken into account;
• If the relevant market share does not exceed the 30% threshold, the vertical agreement is covered by the Block Exemption Regulation, subject to the conditions set out in Regulation No 2790/1999;
• If the relevant market share is above the 30% threshold, it is necessary to assess whether the vertical agreement distorts competition. The following factors to be taken into consideration are: the market position of the supplier, competitors and the buyer, entry barriers, the nature of the product, etc;
• If the vertical agreement falls within Article 81(1), it is necessary to examine whether it fulfils the conditions for exemption. In that case, the vertical agreement must contribute to improving production or distribution or to promoting technical or economic progress and must allow consumers a fair share of those benefits. At the same time, the vertical agreement must not impose on the companies concerned restraints which are not indispensable to the attainment of those benefits or to eliminate competition.

The most common vertical restraints

The most common vertical restraints are:

• Single branding

Single branding results from an obligation or incentive which makes the buyer purchase practically all his requirements on a particular market from only one supplier. It does not mean that the buyer can only buy directly from the supplier but that he will not buy and resell or incorporate competing goods or services. The possible competition risks are foreclosure of the market to competing and potential suppliers, facilitation of collusion between suppliers in cases of cumulative use and, where the buyer is a retailer selling to final consumers, a loss of in-store inter-brand competition.

• Exclusive distribution

In an exclusive distribution agreement, the supplier agrees to sell his products only to one distributor for resale in a particular territory. At the same time, the distributor is usually limited in his active selling into other exclusively allocated territories. The possible competition risks are mainly reduced intra-brand competition and market partitioning, which may in particular facilitate price discrimination. When most or all of the suppliers apply exclusive distribution, this may facilitate collusion, both at the suppliers' and the distributors' level.

• Exclusive customer allocation

In an exclusive customer allocation agreement, the supplier agrees to sell his products only to one distributor for resale to a particular class of customer. At the same time, the distributor is usually limited in his active selling into other exclusively allocated classes of customer. The possible competition risks are mainly reduced intra-brand competition and market partitioning, which may in particular facilitate price discrimination. When most or all of the suppliers apply exclusive customer allocation, this may facilitate collusion, both at the suppliers' and the distributors' level.

• Selective distribution

Selective distribution agreements, like exclusive distribution agreements, restrict the number of authorised distributors, on the one hand, and the possibilities of resale on the other. The difference vis-à-vis exclusive distribution is that the restriction of the number of dealers does not depend on the number of territories but on selection criteria linked in the first place to the nature of the product. Another difference vis-à-vis exclusive distribution is that the restriction on resale is 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. Selective distribution is almost always used to distribute branded final products. The possible competition risks are a reduction in intra-brand competition and, especially in cases of cumulative effect, foreclosure of a certain type or types of distributor and facilitation of collusion between suppliers or buyers.

• Franchising

Franchise agreements contain licences of intellectual property rights relating in particular to trade marks or signs and know-how for the use and distribution of goods or services. In addition to the licence of IPRs, the franchiser usually provides the franchisee during the life of the agreement with commercial or technical assistance. The licence and the assistance are integral components of the business method being franchised. The franchiser is in general paid a franchise fee by the franchisee for the use of the particular business method. Franchising may enable the franchiser to establish, with limited investments, a uniform network for the distribution of his products. From the competition viewpoint, in addition to provision of the business method, franchise agreements usually contain a combination of different vertical restraints concerning the products being distributed, in particular selective distribution and/or non-compete and/or exclusive distribution or weaker forms thereof.

• Exclusive supply

Exclusive supply means that there is only one buyer inside the Community to which the supplier may sell a particular final product. For intermediate goods or services, exclusive supply means that there is only one buyer inside the Community or that there is only one buyer inside the Community for the purposes of a specific use. For intermediate goods or services, exclusive supply is often referred to as industrial supply. The main competition risk of exclusive supply is the foreclosure of other buyers.

• Tying

Tying exists when the supplier makes the sale of one product conditional upon the purchase of another distinct product from the supplier or someone designated by the latter. The first product is referred to as the tying product and the second is referred to as the tied product. If the tying is not objectively justified by the nature of the products or commercial usage, such practice may constitute an abuse of a dominant position. Agreements of this type, which are designed to make the sale of one product conditional upon the purchase of another distinct product, may be incompatible with the competition rules.

• Recommended and maximum resale prices

The practice consists in recommending a resale price to a reseller or requiring the reseller to respect a maximum resale price. The possible competition risk of maximum and recommended prices is that they will work as a focal point for the resellers and might be followed by most or all of them. They may then facilitate collusion between suppliers.

Last updated: 21.02.2007