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Vertical Restraints In Agreements

This week’s article continues on vertical restraints. It highlights the importance of conducts that are restricted under the Fiji Commerce Commission Decree(2010) and the types of vertical restraints.   Types
30 May 2016 12:09
Vertical Restraints In Agreements
Commerce Commission

This week’s article continues on vertical restraints. It highlights the importance of conducts that are restricted under the Fiji Commerce Commission Decree(2010) and the types of vertical restraints.

 

Types of Vertical Restraints

A wide range of vertical restraints can be found in all economies, being very often employed in a bundle. Among the most widely used but not limited to the following:

  1. territorial exclusivity;
  2. tie-in selling;
  3. full line forcing

 

  1. Territorial exclusivity

assigns a portion of the retail market to a specific retailer. No other competing distributor is allowed to supply customers in the same territory, thereby reducing or eliminating intra-brand competition. The territory assigned by the manufacturer to the distributor is usually defined in terms of geographic scope, but the segmentation of the retail market can also be based on the type of customer served, or method of distribution. For example, a distributor may hold exclusive distribution of a given product for orders placed by mail. Manufacturers may simply decide on the specific location of the retail outlets carrying their goods, committing themselves not to allow additional distributors to be set up in those areas, but at the same time allowing shipments from other areas. A stricter version of the territorial exclusivity requires distributors not to sell goods to customers not belonging to the specific territory assigned to them.

Examples of territorial exclusivity include arrangements between:

  1. Competing retailers of groceries not to supply or setup operations in areas where each other already have an existing operation.
  2. The suppliers of fuel to divide the maritime zones into segmented markets for each other not to compete in theses market but to share the markets and concentrate on their allocated geographical market only.

 

  1. Tying-in (or “tied selling”)

This is also known as bundling or conditional selling refers to the situation where a manufacturer will only sell a product to a distributor, or a retailer will only sell a product to a consumer, if the buyer purchases an additional, unrelated product. Such a sale is also called a “tie-in sale”. This can be seen where an importer and distributor of butter and margarine only supplies if both the products are purchased or when a sawmill in Fiji puts a condition that only dressed timber will be supplied if the buyer purchases undressed timber.

 

  1. Full-line forcing

Which can be viewed as a particular form of tie-in involves distributors and retailers being required to hold the whole range of products of a given manufacturer and distributor. This can be noted when a major distributor imposes a condition on the supermarkets that their line items will only be supplied to the retailer if the retailer buys and hold the entire line items distributed by the distributor.

 

The Effects of Vertical Restraints on Competition and Efficiency

Double price mark-up

When downstream distribution firms are in a position to exercise market power, they have an incentive to raise prices and restrict output in order to extract extra profits from the market.

If the upstream manufacturer also enjoys market power and adds up their extra profit margin, then the final price charged to consumers will be subjected to a double mark-up margin.

This double mark-up, sets independently at the two stages of production and distribution will result in a reduction in total welfare for upstream and downstream firms, as well as for consumers.

 

Free-riding in the distribution sector

Once firms have decided on the most suitable wholesale price for their products (which might be higher than the competitive price when market power can be exploited), it will be in their own interest to ensure that the firms handling their goods sell the largest quantity at the lowest price, since this is expected to maximize demand for their products as well as total profits.

They have, therefore, a vested interest in maintaining competition among dealers.

For example by granting them total or partial market exclusivity at a specific location.

The effect is to reduce competition among distributors of a same brand leading to an apparent welfare-reducing outcome from the manufacturer’s point of view (in addition to higher prices for consumers), with fewer goods sold and lower profit levels realized.

 

Free-riding in the manufacturing sector

Another free-rider problem that may arise in the manufacturer-distributor relationship is opportunistic behaviour among upstream firms.

 

Foreclosing markets

When exclusive dealing arrangements tie up a predominant share of existing outlets, competing suppliers are forced to find alternative distributors to build up their own independent networks.

Exclusive dealing arrangements might therefore represent a substantial barrier to entry whenever the share of tied retail outlets is significant.

 

Favouring collusive behaviour

Vertical restraints may play a facilitating role in promoting and maintaining the cartelization of markets when certain structural characteristics prevail.

Resale price maintenance, in particular, may facilitate the task of monitoring effective compliance with a manufacturers’ cartel.

With retail prices fixed, manufacturers have less incentive to undermine cartels and to underprice competitors by offering discounts to retailers, since the latter, in turn, cannot reduce the prices they charge to final consumers.

As a consequence, the solidity of the upstream cartel would be increased.

 

The Analysis of Horizontal Restraints

This week’s article is also on horizontal restraints. It higlights the importance of conducts that are restricted under the Fiji Commerce Commision Decree(2010) and the types of horizontal restraints.

 

What are Horizontal Restraints?

An agreement between potential competitors to restrain their rivalry in some respect is commonly called a “horizontal restraint.” These are restraints between buyers or between sellers at the same level or competing for the same product market and are per se a Restrictive Trade Practice under the Commerce Commission Decree 2010. The Competition laws assume a competitive market place in which rival firms compete with respect to prices, products, and services.  Any arrangement which runs counter to these conducts among competitive entities is accordingly suspect.  Horizontal agreements threaten the achievement of competitive markets by eliminating competition among the participants and thereby allowing them to enhance their collective profits to the detriment of consumers.  Horizontal restraints include collusion and cartels, whether by sellers or buyers in which competitors come together to restrain trade.

 

What are Horizontal Agreements?

A horizontal agreement is made between competing businesses to manipulate competition amongst all competitors in the marketplace. A horizontal agreement can be proven by direct or circumstantial evidence or by existence of unilateral offers that are “accepted” by performance. For example, the circulation of current price lists among competitors, followed by parallel action, may be attacked as an illegal agreement. Horizontal agreements typically include one or more of the following:

n            Joint Venture Agreements

n            Agreements on what Price to charge

n            Facilitating Practices Agreements

n            Market Allocations

n            Group Boycotts

n            Trade Associations

n            Quiet Life Agreements

 

Types of Horizontal Restraints

nJoint Ventures

A joint venture is a temporary business association between two or more persons or organizations for profit without forming a permanent partnership, corporation, or other business entity.

Two companies, through their joint venture, can engage in price fixing creating a market driven not by supply and demand, but by their own desires.For example, an agreement between two competitors in a joint venture to submit a joint bid to build a multi-story building will necessarily contain price fixing elements. The competition between the two contractors is eliminated in securing the construction contract.

nPrice Fixing

Price fixing is a horizontal agreement involving competitors conspiring to raise, decrease, fix or stabilize prices in a specific market. Companies who intentionally engage in price fixing do so primarily to manipulate prices to cause an unfair advantage. This price manipulation creates a situation where, in many cases, competitors set same prices on their products and it negatively affects others in the marketplace.

nFacilitating Practices Agreements

These are agreements that make it easier for competitors to collectively exercise market power and to avoid competing with each other. These may include agreements to share information, adopt a product standard, or adopt a particular contracting or pricing practice. These practices may not directly restrain competition, their use makes it easier for industry participants to reach or maintain tacit or explicit agreements on price or output.

nMarket Allocation

Market allocations are also horizontal agreements and happen when competing companies choose specific territories to sell products and neither company sells to the other company’s customers. What makes this arrangement illegal is it creates a monopoly for each territory.

Agreements among competitors dividing markets by territory or by customers are anticompetitive and hence illegal per se. Thus, competing firms may not divide among themselves the geographical areas in which they sell, nor may they distribute customers or allocate the available market. All such understandings, whether direct or indirect, are unlawful.

nBoycotts

Boycotts are between groups of businesses to stop using a company’s product or services in order to negatively affect their ability to compete in a market. A business has every right to choose whom to do business with.

There is nothing illegal about making prudent product choices. It becomes illegal when it is a concerted and deliberate group effort to push one company to the curb.

nTrade Associations

Trade associations carry out many legitimate, positive functions:

Educating members about technology and other advances in the industry

Identifying potential problems with products

Facilitating training on legal & other administrative issues

Acting as an advocate or lobbyist before the government

Trade associations also can serve as a forum for cartel activities, and trade associations can be used as vehicles for cartels to engage in “facilitating practices” and “quiet life” agreements.

nControlling Output

Competitors also fix prices by controlling an industry’s output. For example, competitors could agree to limit the amount of goods each company makes or by otherwise limiting the amount that comes to market.

To prevent oil prices from dropping, dominant oil companies agreed to and did purchase from independent refiners surplus gasoline that the market was forcing them to sell at distress prices. By buying up this gasoline, the large companies created a price floor for their own product.

nQuite Life Agreements

These are agreements that restrict competition by freeing competitors from some significant aspect of competition that does not directly involve price or output. For example:  Agreements not to advertise; Agreements to limit business hours.

 

The Effects of Horizontal Restraints on Competition and Efficiency

Horizontal co-operation can be a means of sharing risk, saving costs, increasing investments, pooling know how, enhancing product quality and variety, and launching innovation faster-thereby delivering benefits for consumer’s trade, as well as attractive commercial advantages for the companies concerned.

However, Horizontal agreements can lead to competition law issues. For example, where the parties agree to fix prices or output or to share markets, or if the co-operation enables them to maintain, gain or increase market power and, thereby, leads to negative market effects with respect to prices, output, product quality, product variety or innovation.

Accordingly, horizontal agreements should always be carefully reviewed to ensure that any restrictive provisions do not give rise to competition concerns.

 

These are some of the effects, but not limited to the following:

 

Anti-competitive foreclosure of competing purchasers (i.e. by limiting their access to efficient suppliers); and/or a collusive outcome, if they facilitate the coordination of the parties’ behaviour.

restrictive effects on competition on the purchasing and/ or downstream selling market or markets, such as increased prices, reduced output, product quality or variety, or innovation, market allocation

constitute an agreement, a concerted practice, or a decision by an association of undertakings with the object of fixing e.g. prices or quantities-such information exchange would normally be considered and fined as a cartel;

 

Next Week : Cartels

Bobby Maharaj is the chief executive of the Fiji Commerce Commission. This is a regular column from the Commission in the Fiji Sun.

For more information/details on price regulation in Fiji, visit website at www.commcomm.gov.fj or join Facebook  page under Fiji Commerce Commission.

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