Vertical Restraints Applied for Anticompetitive Motives - Research Paper Example

VERTICAL RESTRAINTS Vertical Restraints Customer Inserts His/Her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name 29, 04, 2012 2506 words Vertical restraints Businesses operate in environments that present diverse challenges that they can take advantage of to remain competitive. The same challenges could however impact negatively on the performance of businesses, if they are not well addressed. Competition is for the market is a common phenomenon among businesses, especially those that operate at the same level. In the struggle to remain competitive and acquire as many customers as possible, businesses may engage in various practices, including use of unfair tactics, to edge out their competitors. It is for this reason that various jurisdictions, including Australia, have come up with competition laws that promote competitive practices and discourage anticompetitive ones. The laws are meant to regulate engagements by companies that operate at similar or different levels of the chain of production or distribution. Firms that operate at different production or distribution levels can enter what is referred to as vertical agreements that define how they will sell or purchase goods or services from each other. An example or a vertical agreement is a distribution agreement entered by a manufacturer and a wholesaler or retailer of his goods or services. When a vertical agreement determines only the quantity and price at which a specific purchase and sale transaction, such an agreement does not constitute a restriction on competition.1 On the other hand, vertical agreements that restrain the buyer or supplier to purchase in certain quantities and sell at certain prices may restrict competition. Such restraints are referred to vertical restraints. Vertical restraints refer to restrictions on competition found in agreements entered by two individuals or firms that operate at different levels in the chain of production and distribution.2 Vertical restraints are different from horizontal restraints found in agreements entered by horizontal competitors3. Vertical restraints are found in agreements that include single branding, exclusive distribution, franchising, customer allocation, exclusive supply, selective distribution and upfront access payments. Others include tying, category management agreements, and resale price restrictions. Various jurisdictions have come up with policies that regulate vertical restraints to make sure they do not hurt competition. The European Union has formulated its guidelines as spelt out under Article 101 of the Functioning of the European Union (TFEU) while Australia has hers in Part IV of the Trade Practices Act 1974 (Chth) (TPA’).4 The next part of this paper explores the position of vertical restraints in line with the Australian competition law. It should, however, be noted that vertical restraints have both positive and negative consequences in the business environment. Under the heading ‘Exclusive Dealing’, Part IV of the Trade Practices Act 1974 (Cth) of the Australian competition law has put prohibitions on vertical restraints. These prohibitions are, however, only applicable if the vertical restraints sole purpose, effect or potential effect of lessening competition to substantial levels. Section 47 of the Australian TPA prohibits vertical agreements that contain non-price related restraints. This is referred to as exclusive dealing. It is, for example, forbidden for a supplier of goods or services to prevail upon the purchaser not to make acquisition of similar goods and services from a competing company. If this happens, the supplier will be seen to have used uncompetitive means to lock his competitors out of the market. A wholesaler or retailer should be given the freedom of choosing the source of his goods and services. In the same vein, the manufacturer is prohibited from compelling a distributor not to resupply goods to certain customers, or geographical locations. This is tantamount to denying the retailers and customers in those areas the opportunity to sample a variety of products from different manufacturers. The purchaser or re-supplier may not be denied goods and services for failure to comply with certain conditions imposed by the supplier5. All these actions have the ultimate purpose of substantially reducing competition, and the competition law frowns upon them. If allowed to continue, they would lead to reduced intrabrand competition, which would work against the customer as far as fair price and variety is concerned. The buyer and supplier enjoy a substantial degree of market power. Similarly a corporation that possesses substantial market power would most likely abuse its market dominance if it enters distribution arrangements that are selective. Related to excusive dealing is the concept of third line forcing and bundling agreements. Third line forcing occurs when goods and services are supplied to a second party only after he has agreed to acquire other goods and services from a third party, a conduct that is prohibited per se. section 47 also prohibits bundling in which the supplier undertakes to supply one product only if the buyer makes an undertaking that he will buy more products from the same supplier. The competition law prohibits this practice only when it substantially lessons competition. The concept of resale price maintenance is dealt with in section 48 of the Trade Practices Act. This occurs when a supplier actually fixes, attempts to fix or declines to supply goods and services because those below him in the chain of distribution have refused to allow him to fix the price. The supplier may express his desire known to the person below him in the chain of distribution that he will not supply the goods and services to him unless he commits himself not to sell the goods and services at below the price the supplier has specified. A supplier may also induce or attempt to induce the person below him in the chain of distribution to refrain from selling the goods and he has supplied to them at a price below that he has specified, regardless of whether the goods and services were sourced from another party or from the supplier himself. RPM may also occur when a supplier enters or offers to enter an agreement to supply goods to another party, in which one of the terms would include prevailing upon the party not to offer for sale the goods and services at a price below that specified by the supplier, or at a price he would specify. The supplier may also withhold the supply of goods and services to the second party because the party has declined to sell the goods and services at a price below that specified by the supplier, has sold, or is likely to offer for sell the supplier’s goods at a price below that he has specified, regardless of whether the goods were supplied by him or by another party who obtained them from the supplier. A supplier may also withhold the supply of goods and services to a second party because a third party who is desirous of getting the goods from the second party has declined not to offer the goods for sale at a lower price than that set by the supplier, has sold, or is likely to offer for sale the goods at a lower price than that specified by the supplier6. A supplier may also indirectly make a hint to the second party that implies that the goods he is being given should not be sold at a price that is lower that a specified price. Generally, the retail price maintenance is a kind of price fixing which is prohibited per se. there is however raging debate in judicial circles as to whether RPM has negative influence to competition. However, under the loss leading selling concept, a supplier may decline to supply his goods to a seller if he establishes the seller has been selling his goods at a price lower than the cost price for purposes of saving the image or reputation of the goods. This is only possible if it happened in the preceding. A case for Vertical Restraints As earlier pointed out, vertical restraints have both merits and demerits. Businesses have various motives for imposing vertical restraints. These can be grouped into efficiency enhancing and market power enhancing motives. Efficiency enhancing motives for the imposition of vertical restraints ignore the fact that there exists market power at whatever level of the vertical chain.7 One of the problems vertical restraints seek to solve is that of free-riding and opportunism. Manufacturers may use their resources to improve retail outlets, promote retail products and offer training to outlet managers. These are massive investments that must be protected by vertical restraints. An upstream firm that uses its resources to improve retail facilities must be given the freedom to enjoy the use of these facilities without interference from competitors. It would not be fair to allow a competitor who did not invest in the improvement of these outlets to enjoy their use. If restraints are absent, the outlets become undesirable. Exclusive dealing therefore protects this investment by excluding competing brands from the outlets, and act as a mechanism by which manufacturers protect their investments while encouraging others to make similar investments. The services offered by the dealer offered at the point of sale have the potential to significantly enhance the demand for a product. As residual claimants, retailers are beneficiaries of the brand that is generated. Such retailers may not fully benefit from these services because some customers who have rated the product highly may opt to buy it from one of the units that sell the product instead to retuning to the initial retail outlet. This is despite the fact that the retailer bore the cost of policy formulation. He will consequently offer the goods at a lower quality product, which will compromise the standards set by the upstream firm. Dealers have the advantage of free riding on the value of the brand they put very little into, as well as the services that other dealers offer. Retailers can be prevented from competing along price lines at the expense of quality and service by minimum price restraints8. The setting of minimum prices would enable retailers to earn good profits and fear losing something of value if their contacts were terminated because of improprieties. This challenge would also be solved by establishing exclusive territories. The fear of business cancellation would motivate retailers to provide quality service that is valued by customers. Customer satisfaction would enhance the volume of sales and profitability for the firm. Some manufacturers compel dealers to invest in certain types of facilities and human resources before they enter agreements with them. This will convince the manufacturer that the dealer has the facilities and resources needed to serve the consumers better. If net well protected, the manufacturer may be opportunistic enough and encroach on the territory that the dealer intends to serve. Vertical restraints that give the dealer exclusive territory are the surest guarantee that his investment will not be lost. Though the dealer acquires some market power from this arrangement, the consumers benefit from the availability of the product, making vertical restraints to have positive effects on the welfare of customers. Another problem that vertical restraints have attempted to solve referred to as succession-of-monopoly. An upstream monopoly may sell a product to a downstream monopoly at a price that is above marginal cost. The downstream monopoly may use its market power to fix a higher price and lower quantity to maximize joint profits. Vertical restraints such as fixing maximum resale price could help overcome the problem of double marginalization. The manufacturer could alternatively use two-part tariff or minimum quantity requirements to solve this problem. When appropriately imposed, vertical restraints have the effect of not only increasing efficiency in the entire vertical structure but also lowering prices for customers. The case against vertical restraints Vertical restraints could also be applied for anticompetitive motives. In this context, market power is enhanced, not created by vertical restraints.9 Though many anticompetitive motives for the imposition of vertical restraints exist, exclusion and collusion take precedence. It is feared that vertical restraints can close out competitors from markets monopolized by certain manufacturers. If a manufacturer, for example, controls most of the retailers in a region and restrains them from retailing goods of his competitors, they can easily exit the industry. The customers are also denied the opportunity to sample competing products on the basis of quality and price. Exclusive dealing also makes entering the retail business quite costly because of economies of scale. Tying is also harmful as it can easily foreclose the entry of firms that could compete in the tied good industry. Vertical restraints can also lead to cartels and monopolies. If a manufacturer imposes a minimum price for his product to retailers whom he controls, he can easily assist dealer cartels to enforce the price in a monopolistic way. Where manufacturers place restraints on the sale of good in certain areas, retailers may feel insulated from competition by the elimination of competitors, or making it difficult for new entrants to venture. Vertical restraints can help in the facilitation of collusion among manufacturers10. Through exclusive dealing, a seller could be tied to a manufacturer, which may eliminate the manufacturer’s temptation to engage in secretive price cuts to steal the customers of his rivals and enhance his market share. This way, cartel stability is enhanced by vertical restraints. Vertical restraints similarly have the effect of softening supplier-competitor competition. In an environment where a number of distributors deal with the distribution of the supplier’s brand, when competition between them is reduced, intra-brand competition will also reduce. This will lead to a reduction in sales volumes and hence, profitability. Collusion can also involve buyers and suppliers where vertical restraints exist. They also create new obstacles to the process of market integration. Conclusion Vertical restrains, as part of the competition law in Australia, has played a very important role in protecting businesses against anticompetitive practices that would have driven them out of business. Even then, vertical restraints can be considered to be valuable on the basis of enhancing collective welfare of the citizens more than any other aspect of the competition law. The types of vertical restraints that apply to branded products are harsher than those that apply to non-branded products. It is generally hoped that the Australian jurisdiction, together with may others, will seek to amend and domesticate this important piece law so that it is better able to serve the needs of the ever changing business environment. Bibliography Bowman, Ward Jr, `Tying Arrangements and the Leverage Problem' (1957) 67 Yale Law Journal 19, 19-20. Bruce, A, Restrictive Trade Practices Law in Australia (LexisNexis Butterworths, 2010). Comanor, William, `The Two Economics of Vertical Restraints' (1992) 21 Southwestern University Law Review 1265. Corones, SG, Competition Law in Australia (Thomson Reuters, 5th ed, 2010). Clough, Daniel, ‘Law and Economics of Vertical Restraints in Australia’ (2001) 25 Melbourne. University Law Review 551, 553. Gal-Or, Esther, ‘Duopolistic vertical restraints’ (1991) 35(6) European Economic Review 1237–1253. Hovenkamp, Herbert, `Vertical Restrictions and Monopoly Power' (1984) 64 Boston University Law Review 521, 557. Miller, RV, Miller's Australian Competition Law and Policy (Thomson Reuters, 2nd ed, 2012). Scherer FM , `The Economics of Vertical Restraints' (1983) 52 Antitrust Law Journal 687, 693. Read More