VERTICAL RESTRAINTS

1. VERTICAL RESTRAINTS by Philippe Brusick

2. PRODUCTION-DISTRIBUTION CHAIN Firm A Suppliers Manufacturer A Wholesalers Retailers Firm B Suppliers Manufacturer B Wholesalers Retailers

3. VERTICAL RESTRAINTS • Vertical restraints include restrictive agreements between suppliers and a manufacturer (upstream) and between a manufacturer and his distributors (downstream), as can be viewed on the figure above. • The agreement is vertical, while an agreement between manufacturers A and B would be horizontal. • Numerous cases of vertical restraints exist in business life.

4. VERTICAL RESTRAINTS (Cont’d) • Upstream, between suppliers and manufacturers, exclusivity agreements; • Downstream, between manufacturers and wholesalers, resale price maintenance, exclusive distribution contracts and fixed margins; • Between manufacturers/wholesalers/importers and retailers, resale price maintenance, discount prohibition, tied selling, reciprocal exclusivity contracts, etc.

5. MAIN VERTICAL RESTRAINTS • Territorial exclusivity agreements • Reciprocal exclusivity arrangements • Year-end rebates • Resale price maintenance • Tied sales; full-line forcing • Transfer-pricing (over- or under-invoicing) • Below-cost sales (dumping) • Refusal to deal (boycot).

6. EXCLUSIVITY AGREEMENTS • Most often, these are normal business relations, such as territorial exclusivity, which are not anti-competitive. • They stem from the desire of the manufacturer to ensure the quality of service and after-sales services for his brand of products • The distributor, or agent, will require exclusivity so that he can make important investments for the brand he represents, with assurances he will not be cheated by « free-riders » selling the same brand nearby without having incurred heavy investments. • Competition problems occur especially in case of abuse of dominance.

7. END-OF-YEAR REBATES • An oft- used arrangement concerns end-of year rebates given on the condition the retailer does not sell any competing goods • In case the supplier is a dominant firm, such a practice might result in eliminating competition.

8. RESALE PRICE MAINTENANCE (RPM) • The manufacturer fixes the price his products must be sold by retailers • He thus controls resale margins and prohibits rebates • RPM is often prohibited by competition law but exceptions exist in some countries, for example in the fields of books, medicines and luxury products such as perfumes.

9. RPM AND PARALLEL IMPORTS • When prices vary from one country to another, independent resellers are tempted to import and sell at lower price than official agent • The manufacturer (or his agent) can apply trademark law to block such unauthorised imports • For expensive products (eg cars) it can attempt to block private parallel imports • Problem in case of dominance….

10. TIED SELLING • A manufacturer obliges his distributors to hold minimum stocks or even all his product line (Full-line-forcing) • A distributor refuses to sell one product indipendently from another (eg selling a computer without software included). • Reseller may impose large quantities sale on concumer • Problem in case of dominance…

11. TRANSFER-PRICING • Involves over-invoicing imported inputs from a subsidiary or mother firm of a TNC in order to declare less profit and evade remittances and tax. • Otherwise, involves under-invoicing imported inputs from a sister company to reduce cost and sell at lower price than competitors in order to eliminate them (see predatory practices and loss-selling).

12. LOSS-SELLING • Dominant firms may apply predatory prices (similar to dumping) to harm their competitors • Under-invoicing is one of the predatory practices used by multinationals to this effect • In international trade relations dumping is challenged by anti-dumping duties.

13. REFUSAL TO DEAL • Vertical restraints such as those described above are usually imposed under the threat of reusal to deal anymore in case of breach by the resaler. • An exclusivity agreement involves such a refusal to deal with competitors • As for most vertical restraints refusal to deal is usually anti-competitive when applied by a dominant firm or a monopoly.

14. VERTICAL INTEGRATION • It is clear that different stages of the production-distribution chain can be owned by a single vertically integrated firm, giving that firm increased dominant power which may turn to be anti-competitive • Vertical restraints can be imposed by a dominant firm upstream (essential input), by a manufacturer, or downstream (eg large retail chain imposing restraints on suppliers).

15. CONCLUSION • Except for RPM, which always pose anti-competitive problems (although opinions diverge on this matter, see Chicago School)… • Most vertical restraints have anti-competitive effects only when applied by a dominant firm or by a monopoly.

16. ANALYSIS OF VERTICAL RESTRAINTS • Does the agreement restrain competition by: Increasing barriers to entry? Facilitating price-discrimination? Monopolising another product? Facilitating an agreement between producers or distributors? Increasing costs of competitors? • Does the agreement have any pro-competitive aspects? • One must weigh pros & cons before deciding.

17. THANK YOU FOR YOUR KIND ATTENTION philippe.brusick@gmail.com www.prbrusick.org