Limited distribution: a self-assessment exercise

Transcription

1 Limited distribution: a self-assessment exercise Jan Peter van der Veer Partner, RBB Economics jan.peter.vanderveer@rbbecon.com 20 Oc tober 2011

2 About RBB Economics Largest independent competition consultancy in Europe Worked on many high profile mergers and behavioural investigations Example of current cases: lead economic advisers in EC investigation of Google and in Google/Motorola merger Extensive experience in Eastern Europe and CIS countries In the last year, cases undertaken in countries including Romania, Hungary, Serbia, Russia and Ukraine 2

3 Today s Topics Limited distribution Selective distribution Exclusive distribution Efficiency rationale for selective/exclusive distribution Impacts of selective/exclusive distribution on competition Self assessment Concluding remarks 3

4 Limited distribution 4

5 Limited distribution Producer Distributor Distributor Distributor 5

6 Limited distribution Selective distribution: Producer sells only to distributors meeting certain criteria Examples: volume of purchases, quality, location Any distributor meeting these criteria will be supplied Exclusive distribution: Producer sells only to one distributor For example, one distributor in a particular area or in a particular distribution channel Selective and exclusive distribution can also be applied in combination 6

7 Efficiency rationale for selective/exclusive distribution 7

8 Efficiency rationale for selective/exclusive distribution (1) A producer in principle has an incentive for its products to be as widely available as possible The more outlets a product is available, the higher expected sales will be (all else equal) A producer in principle also has an incentive to stimulate competition between its retailers If competition at the retail level is weak, retailers will have market power and will be able to apply a high margin on top of the manufacturer margin Such an increase in retailer s market power hurts the manufacturer s profit So why may producers have an incentive to limit the distribution of their products? 8

9 Efficiency rationale for selective/exclusive distribution (2) When applied, selective/exclusive distribution will in most cases be a source of economic efficiencies Examples of efficiencies of selective/exclusive distribution include (see next slides): eliminating free-riding problems protecting brand value achieving cost savings 9

10 Eliminating free-riding problems (1) Free-riding: the idea that certain firms bear less than their fair share of costs, possibly leading to under-provision of services Example 1: Electronic stores provide highly trained staff and demonstration facilities Consumers after acquiring product knowledge could buy the same product at a no-frills store or over the internet Free-riding problem limits the incentive of retailers to offer point-of-sales service The free-riding problem could be overcome by minimum retail prices (RPM) or selective/exclusive distribution Selective/exclusive distribution may be considered a less restrictive way of achieving this objective than RPM 10

11 Eliminating free-riding problems (2) Free-riding: the idea that certain firms bear less than their fair share of costs, possibly leading to under-provision of services Example 2: A manufacturer who wishes to enter a new market may require distributor A to make first time investments to promote the brand Distributors B and C may subsequently be able to free-ride on the investments made by distributor A As a result, distributor A may be unable to earn a return on its investment Anticipating this, distributor A may not want to make the investment This free-riding problem could be overcome by giving the distributor making the investment a degree of (temporary) protection For example, an exclusive territory 11

12 Protecting brand value In certain industries, manufacturers invest great sums in developing a brand A brand represents a combination of attributes valued by consumers such as: quality, range, service, reputation and image. Distributors cannot always be relied on to maintain brand value May take actions that promote their own profit at the expense of the brand owner (e.g. the under-provision of service, quality, range, and presentational efforts) This is because distributors do not take account of any adverse impacts of their actions on the brand owner (they do not suffer from these themselves) Negative externality Selective distribution addresses this issue Distribute only through retailers meeting certain criteria Widely employed mechanism e.g. in luxury goods industries 12

13 Cost savings Selective distribution might reduce transaction costs between firms Limit the number of retailers in a distribution network in order to gain from lower distribution and contracting costs lower costs of monitoring any promotional efforts required of its retailers 13

14 Impacts of selective/exclusive distribution on competition 14

15 Possible effects of vertical restraints on competition Competition authorities should intervene if vertical restraints limit competition and if this leads to harm to consumers E.g. higher prices, reduced choice etc. What really matters is protecting an effective competitive process and not simply protecting competitors. This may well mean that competitors who deliver less to consumers in terms of price, choice, quality and innovation will leave the market. [EC Art 102 Guidance Paper, par. 6] How can vertical restrains harm the competitive process? 15

16 Possible effects of vertical restraints on competition Some vertical restraints eliminate intra-brand competition, others eliminate inter-brand competition at point of sales Intra-brand competition: competition among retailers for the same manufacturer s brand Inter-brand competition: competition among manufacturers different brands 16

17 Possible effects of vertical restraints on competition Restricting intra-brand competition is often not a competition concern in itself A producer in principle has no incentive to limit competition between its retailers Increase in retailer s market power hurts the manufacturer s profit => double margin Any lessening of intra-brand competition should in general only be a concern when it serves manufacturers to restrict inter-brand competition Subject to some exceptions (see below) 17

18 Possible effects of vertical restraints on inter-brand competition There are two principal ways in which vertical restraints can adversely impact on inter-brand competition: Foreclosure: keep retailers exclusive to brand A to prevent brand B from gaining access to viable distribution Collusion/softening of competition: make producer coordination easier to achieve, e.g., by increasing transparency Of these, foreclosure is normally the more important concern 18

19 Possible effects of vertical restraints on inter-brand competition: foreclosure Single-branding arrangements can reduce inter-brand competition by foreclosing rival producers Distributors are prevented from selling other brands either as a result of exclusivity of as a result of the operation of rebate schemes Competing producers access to market may be reduced when the producer has a large share of the market and there is no comparable quality of distributors or location By contrast, selective/exclusive distribution arrangements generally do not keep buyers exclusive to one brand (see next slides) Selective/exclusive distribution arrangements are unlikely to give rise to foreclosure of rival producers 19

20 Single branding can reduce inter-brand competition by foreclosing competing suppliers Competing producer Producer Distributor Distributor 20

21 Limited distribution cannot reduce inter-brand competition by foreclosing competing suppliers Producer Distributor Distributor Distributor 21

22 Limited distribution cannot reduce inter-brand competition by foreclosing competing suppliers Competing producer Producer Distributor Distributor Distributor 22

23 Limited distribution can limit inter-brand competition in other ways: softening of competition Selective/exclusive distribution may dampen inter-brand competition between upstream producers Producers delegate the pricing decision to selected distributors Facing less price competition (reduction in intra brand competition), the distributors set higher retail prices Retail prices of competing products may also increase Rival brand retailers will react by increasing prices By delegating the pricing decision, the producer has a weaker incentive to lower prices A lower producer price is less likely to be passed on by authorised distributors Rival producers understand and anticipate this effect by not lowering their prices themselves Result: dampening of inter brand competition But: quite speculative! 23

24 Can limited distribution reduce intra-brand competition by foreclosing distributors? Competing producer Producer Low-cost distributor Online channels Distributor Distributor 24

25 Can limited distribution reduce intra-brand competition by foreclosing distributors? If the producer s market share is low, distributors will be able to obtain supplies from competing producers Selective/exclusive distribution unlikely to foreclose distributors in that case However, if most/all suppliers employ selective/exclusive distribution systems, cumulative effects can occur E.g. low-cost distributors or online-only retailers may not have access to supplies European rules provide for possible withdrawal of Block Exemption if such cumulative effects occur Although this possibility is largely theoretical European rules comprise specific provisions stipulating that distributors must always be able to rely on online sales 25

26 Can limited distribution give rise to price discrimination concerns? Exclusive territories are sometimes associated with concerns about market partitioning and price discrimination Exclusive distribution and exclusive customer allocation limit arbitrage and allow price differential Price differentials implies that some consumers pay more while others pay less for the same product But: if these restraints enable the supply chain to set different prices for different customers, this is not necessarily harmful Allow market expansion (e.g. poorer economic regions) Recoupment of high fixed cost investments (e.g. R&D in pharmaceuticals) 26

27 Self assessment 27

28 Self-assessment: market power Selective/exclusive distribution is unlikely to raise competition concerns in the absence of market power. So what is market power? Market power arises where competitive constraints are not effective at the relevant level of the supply chain. Competitive constraints are market factors that prevent an undertaking from profitably sustaining (quality adjusted) prices above competitive levels: Existing competition: firms already in the market (effectiveness of existing competition gauged by, inter alia, market shares and ease of expansion) Potential competition: firms that may enter the market and prevent exercise of market power in the long run (effectiveness of potential competition gauged by entry barriers) Buyer power: strategic actions by buyers to avoid suffering worse terms of supply, e.g. credible threats to switch to new suppliers or sponsor new entry and growth. 28

29 Self-assessment: market shares Where neither the upstream nor the downstream firm has market power, a vertical agreement is most unlikely to be harmful Provides an economic justification for de minimis threshold and legal safe harbour for vertical restraints between firms with low shares Under the European framework, agreements exempt when both parties to the agreement have a market share below 30% Even if one or both of the contracting parties has market power, vertical restraints must be assessed on a case-by-case basis. What is the scope for rivals to compete given the vertical restraint? Can any claimed efficiencies be substantiated? (See example on next slides.) 29

30 Self-assessment: substantiating the free-rider problem Low price sales channel (e.g. internet) competes with higher priced sales channel (e.g. brick and mortar physical store, B&M), where valuable, and costly to provide, nonprice features are offered. Low price sales channel does not offer certain non-price features (and so has lower costs). B&M channel has reduced incentive to invest in non-price features valued by consumers (e.g. pre-sales service) if consumers obtain service from B&M and then buy (e.g. online) from a different distributor. Brand owner wants pre-sales service delivered at point of sale but cannot enforce contract to ensure optimal service levels. Brand owner employs a measure to restrict degree of price competition between low price sales channel and B&M stores to maintain B&M incentives to offer non-price services. This can benefit consumers. 30

31 Self-assessment: substantiating the free-rider problem Checklist conditions: costly to provide pre-sales service; new/complex product, reputation a major determinant of demand, reasonably high value product; non-contractible services. 31

32 Self-assessment: substantiating the free-rider problem Possible sources of evidence with which the free rider problem can be substantiated include: Consumer surveys: do consumers value pre-sales (or other) service provided at least as much as price? Would sufficient consumers trade off higher price for higher quality? What % of online purchasers first obtained service in a different B&M store? Internal documents recording retailer feedback is this systematically recorded? Internal documents may demonstrate such feedback influences decision to adopt the vertical restraint. Evidence of inappropriate choices being made in low price channel. Greater % of returns or counterfeit purchases in low price channel? Before and after / benchmarking: are service levels higher while the restriction is in place (or in other countries where the restriction is permitted)? 32

33 Concluding remarks 33

34 Concluding remarks An assessment of market power is a critical starting point in the competitive assessment of vertical restraints No market power no problem! Selective distribution and exclusive distribution systems are often justified by efficiency improvements Harm to competition as a result of these practices only occurs in very specific cases 34

35 Locations and contact London Brussels The Connection Bastion Tower 198 High Holborn Place du Champ de Mars 5 London WC1V 7BD B 1050 Brussels Telephone Telephone: london@rbbecon.com brussels@rbbecon.com The Hague Melbourne Lange Houtstraat Rialto South Tower, Level CV Den Haag 525 Collins Street The Netherlands Melbourne VIC 3000 Telephone: Telephone: thehague@rbbecon.com melbourne@rbbecon.com Johannesburg Augusta House, Inanda Greens 54 Wierda Road West Sandton, 2196, Johannesburg Telephone: johannesburg@rbbecon.com 35