This book provides a wide-ranging review of the European rules relating to distribution: exclusive purchase and exclusive supply, exclusive and selective distribution, motor vehicle distribution, franchises, commercial agents.

French Distribution Law

Even before the economists did so, lawyers have always made a clear distinction between horizontal agreements between competitors at the same stage of the production and distribution chain, and vertical agreements , between undertakings that are not at the same stage of the chain - a typical example being agreements concluded between suppliers and distributors. Horizontal agreements may carry the  …

Economic distinction between horizontal and vertical restraints.

Even before the economists did so, lawyers have always made a clear distinction between horizontal agreements between competitors at the same stage of the production and distribution chain, and vertical agreements , between undertakings that are not at the same stage of the chain - a typical example being agreements concluded between suppliers and distributors. Horizontal agreements may carry the seeds of illegal restrictive agreements insofar as there is a risk that, by their existence, competition is restricted when they concern competitive data such as prices or quantities. Vertical agreements have on the contrary always been regarded with a certain indulgence in that, unlike horizontal agreements, they do not lead to any harm to competition between the parties but only the possibility of such harm between one of them and a third party.

Rather than making the distinction between horizontal and vertical agreements, which places the focus on the situation of the parties to the agreement, economists prefer to put vertical restraints in opposition to horizontal restraints which directly relates to the localization of effects on the market . For economic analysts, the essential difference resides in the fact that, in the context of a horizontal relationship undertakings sell substitutable products, whereas in a vertical relationship they are selling complementary products. It is generally accepted that demand for a product decreases when the price of a substitute product falls, and that demand increases when the price of a complementary products falls. In a horizontal relationship relative to substitutable goods, each undertaking wants its competitors' prices to rise so that there is less price competition between them. Under that assumption, the exercise of the market power of an undertaking increasing its prices will be of benefit to its competitors as they will be mutually encouraged to increase their prices. On the other hand, in the presence of complementary products where the product is sold by an upstream undertaking to a downstream undertaking, it is in the interests of each undertaking that the other reduces the price of its product in order to increase demand, and this increase is beneficial to both undertakings. This creates an incentive to lower retail prices, which is positive for consumers: vertical restraints therefore appear on the face of it to be pro-competitive.

The Commission distinguishes vertical agreements and vertical restraints, a horizontal agreement may determine in certain case a vertical restraint and vice versa (see Guidelines on Vertical Restraints of 19 May 2010 (OJEU 2010/C 248/01) of 30 June 2022, pt 88 et seq. For vertical agreements between competitors and Nos 69 et seq. for associations of retailers).

Even though the two definitions - legal and economic -  are not always reconcilable, they overlap to a great extent.

1) Internalization of externalities generated by double marginalization.

The phenomenon of double marginalization was formally expressed for the first time by Spengler in a bilateral monopoly situation. If hypothetically, the supplier and the distributor both find themselves in a situation of monopoly on their respective markets, the supplier will fix the price level of the product at a monopoly level on the upstream market in accordance with his/her own objectives of maximizing profits as a monopoly-holder, independently of the decisions of the distributor. The distributor, with a monopoly in his/her own market, will also set a monopoly price which will have integrated the monopoly price of the product purchased from the supplier to which his own monopoly margin will be added. These non-coordinated decisions thus produce negative vertical externalities which are then simultaneously translated into negative effects on profits all along the supply chain (supplier and distributor) and on the retail price levels to consumers since, when setting their prices, all the undertakings will apply a monopoly margin on the basis of their costs. The retail price will incorporate two monopoly margins - the supplier's and the distributor's bringing an addition of competitive distortions.

Where two undertakings coordinate their behavior, the negative externalities generated by this double margin piling phenomenon can be internalized and the efficiency of the vertical relationship is improved. The easiest way of achieving it consists in integrating the two undertakings so that the retail price now only incorporates that one margin. When the two operators are not integrated, vertical cooperation can lead to the same result. All it takes is for supplier and distributor to agree on a maximum sale price that corresponds to the price of the integrated structure (fully internalizing the negative externalities), as the wholesale price will then regulate the share of profit generated between the two operators. This economic theory is at the origin of the case law favorably disposed to resale price maintenance. Another solution consists in the supplier imposing a purchasing quota on the distributor at the same level as would push the retail price down to the level of the marginal costs of the downstream undertaking, as the minimum sales or purchasing quota set by the supplier would impel the distributor to lower prices in order to reach it.

2) Reduction of inefficiencies and the free-rider phenomenon.

A classic example of the positive effect of vertical restraints which is systematically cited in economic theory is that of products requiring a specific level of service. Intra-brand competition can, in such cases lead to a tricky situation where negative horizontal externalities are added to the negative vertical externalities which we dealt with previously. A negative horizontal externality may arise when the effort involved in the service is of direct benefit to the distributor's competitors. In that case, the distributor increases his costs and therefore his prices by offering a service to the customer (qualified sales staff, demonstration products, catalogues etc.). If competing retailers do not offer this service and therefore do not bear the costs, they can still sell the product in question at a lower price and make greater profits than the distributor providing the service. The customer can obtain all the information on the product from one retailer and then purchase it from another retailer able to offer it at a lower price because there is no additional service. Because of the level of negative horizontal externalities created, this free-riding phenomenon leads distributors across the board to stop providing such services, which is detrimental to the interests of both consumers and manufacturers.

A vertical restraint between the supplier and his distributors can be a way of resolving this inefficiency problem. If the supplier only supplies to distributors offering the service and prohibits them from reselling to retailers not offering the service, the free-riding phenomenon is eliminated. Use of a system of selective distribution based on those two vertical restraints thus increases the benefit to consumers and suppliers. The free-rider theory was developed almost exclusively within the context of the sale of products from brick and mortar outlets, but applies mutatis mutandis in the case of the coexistence of a brick and mortar outlet with pre-sales, sales and after-sales services included, and distribution via the internet.

3) Other examples of the positive effects of vertical restraints.

Various other situations may justify vertical restraints. A supplier who invests in training for his distributor's sales staff will not want those staff to benefit from the investment by selling competing products and will demand brand-exclusivity in return. This is also legitimate where the supplier subsidizes the payment of the distributor's rent for city center premises.

Positive effects of vertical restraints.

Economic analysis finds that the use of vertical restraints can have anticompetitive effects where inter-brand competition is weak. In such cases, an operator with strong market power may be tempted to use restraints by foreclosing the market to new suppliers, for example by signing exclusive agreements with all the distributors.

The analysis of the impact of vertical restraints on competition and efficiency must therefore be pursued taking into account the conditions of competition, the state of markets and the specific nature of the products. The intensity of inter-brand competition is a crucial element in assessing the effects of vertical restraints. The existence on the market of sufficiently strong inter-brand competition will be a sufficient guarantee of efficiency.

More generally, the impact analysis should take into account the relative upstream/downstream degree of concentration, the conditions of entry to the markets, the nature of the competition, the importance of constraints related to the capacities of production and distribution and the existence of a countervailing buyer power.

French Distribution Law

6. Economic distinction between horizontal and vertical restraints.

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Les notions juridiques connexes

6. Economic distinction between horizontal and vertical restraints.

Demandez un accès gratuit au contenu exclusif Livv – juristes d’entreprise

Les notions juridiques connexes

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