The Horizontal/Vertical Dichotomy Presented by the Dual Distribution Model

Introduction

Deploying an efficient distribution strategy is essential for enterprises to sell their products / provide services to its customers. Often, a manufacturer’s distribution strategy may involve multiple channels of distribution, i.e., multi-channel distribution. This helps enterprises make their products/services more widely available and concurrently adds to the convenience of the consumers who have multiple options to make their purchases. Manufacturers often choose to sell through a distribution network and simultaneously supply goods to their customers directly – this is referred to as a dual distribution model.

It is common practice for manufacturers of white goods, electronic gadgets, apparel, footwear, accessories, etc., to distribute their products through multiple channels including: (i) company showrooms (directly to consumers); (ii) multi-brand retail stores (through retailers); and (iii) e-commerce platforms. Such strategies are becoming increasingly common for a number of reasons, including developments in e-commerce and third -party logistics, which encourage manufacturers to engage in direct sales in addition to the conventional distribution channel through distributors. Consequently, an enterprise may act as both a supplier and competitor to its distributors. From a competition law perspective, this gives rise to the question whether such arrangements between a manufacturer and its own distributors, which are typically characterized as arrangements across the vertical supply chain, could also be characterized as horizontal arrangements given the competitive nature of their relationship. The characterization of a manufacturer as being both in a horizontal competitive relationship with its own distributors, as well as being part of the vertical supply chain may result in such arrangements being analyzed as a potential cartel arrangements, in addition to vertical restraints. This has obvious repercussions in how these arrangements are reviewed under competition law.

Under the Competition Act, 2002 (‘Act’), certain anti-competitive agreements such as agreements between or among competitors (horizontal agreements, including cartels) and agreements between enterprises or persons at different stages or levels of the production chain (vertical agreements) are prohibited. While horizontal agreements, barring joint efficiency enhancing joint ventures, are presumed to cause an appreciable adverse effect on competition (‘AAEC’), vertical agreements often serve legitimate business purposes and are therefore assessed under the ‘rule of reason’ approach.

For example, consider a case where a manufacturer adopts a dual distribution model, and enters into an exclusive distribution agreement (in terms of territory, customers or products) with its distributors in the vertical supply chain, and simultaneously sells its products directly to customers through its website. Since the exclusive distributor potentially competes with the manufacturer who makes direct online sales to customers, it is possible that an otherwise typical vertical ‘exclusivity’ arrangement, between manufacturer and its distributor, may also be viewed as a horizontal market allocation arrangement and be presumed to cause AAEC. By the same token, if a distributor accepts a resale price suggestion by the manufacturer, it may also be construed as horizontal price-fixing arrangement.

Treatment of Dual Distribution under the Competition Act, 2002

These unique situations give rise to the dilemma of whether to categorize the agreement between the manufacturer and its third-party retailer as a horizontal or vertical agreement.

There is no explicit guidance by the Competition Commission of India (‘CCI’) on the treatment of dual distribution agreements within the framework of regulation of anti-competitive agreements under the Act. While CCI is yet to examine issues arising out of dual distribution arrangements, in a recent decision relating to the zinc chloride batteries segment in India (‘Batteries Case’),[1] CCI found a similar relation between Panasonic (manufacturer-supplier) and Godrej (buyer-reseller) to be an anti-competitive horizontal agreement. Importantly, one of the factors that distinguishes the Batteries Case from a typical dual distribution arrangement was that while Godrej procured batteries from Panasonic, it eventually sold them in the market under its own brand. Hence, CCI noted that from a demand-side perspective, consumers viewed the products of Godrej and Panasonic to be interchangeable and thus considered their relation to be horizontal in nature. Accordingly, it appears that CCI regarded demand-side substitutability as the key determinant in characterizing the nature of their agreement. Notably, the agreement between Godrej and Panasonic was not a typical dual distribution agreement, wherein the reseller merely acts as a distributor and does not sell under its own brand.

Treatment of dual distribution in jurisdictions other than India

In most mature jurisdictions, horizontal restraints are likely to be assessed under the ‘per se’ rule[2]   and vertical restraints, since they often serve legitimate business practices are therefore assessed under the ‘rule of reason’ approach that entails an inquiry of anti-competitive harm. The European Commission (‘EC’) assesses dual distribution agreements under the ‘rule of reason’ approach, as opposed to the assessment of vertical agreements entered into between competitors, which are examined under the Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to horizontal co-operation agreements. The European Commission’s Guidelines on Vertical Restraints (‘EC Vertical Guidelines’) acknowledges that while assessing a ‘dual distribution model, i.e. the manufacturer of particular goods also acts as a distributor of the goods in competition with independent distributors of his goods, any potential impact on the competitive relationship between the manufacturer and retailer at the retail level is of lesser importance than the potential impact of the vertical supply agreement  on competition in general at the manufacturing or retail level.’.

In the United States (‘US’), in a class action antitrust suit against Baskin-Robbins Ice Cream Company (‘BR’)[3], certain franchisees of BR, inter alia, alleged that the dual distribution model adopted by BR involved an unlawful horizontal market allocation. Notably, BR’s distribution model involved licensing its trademarks and formulae to independent area franchisors to produce its ice cream and establish franchised stores, thereby comprising a vertical agreement. At the same time, BR also operated as an area franchisor itself, thereby acting as a competitor vis-à-vis the other area franchisors. The United States Court of Appeals (9th Circuit) (‘USCA-9’) observed that ‘when a manufacturer acts on its own, in pursuing its own market strategy, it is seeking to compete with other manufacturers by imposing what may be defended as reasonable vertical restraints.’ Furthermore, in the absence of a clear precedent on the applicability of the ‘per se’ rule to dual distribution agreements, the USCA-9 examined the actual competitive impact (applying the ‘rule of reason’ approach) of the dual distribution model of BR. Ultimately, the USCA-9 noted that the dual distribution model may have fostered inter-brand competition, resulting in BR’s expansion into new geographic markets as a vigorous competitor. Aligned with this approach, the majority of the courts in the US have classified dual distribution as a form of vertical restraint. However, in 2016, the Federal Trade Commission (‘FTC’) re-initiated the debate when it started an inquiry on the exchange of pricing information (an invitation to collude) between a manufacturer and its distributor in a dual distribution model, alleging it to be a horizontal agreement.[4] Ultimately, the parties entered into a settlement with the FTC and there was no in-depth inquiry into the matter that could have suggested if there was to be a deviation from the ‘rule of reason’ approach being followed in US.

A similar issue was placed before the Competition Appeal Court of South Africa (‘CACSA’) in The Competition Commission v. South African Breweries Limited & Ors.[5] In this case, South African Breweries Limited (‘SAB’) deployed a dual distribution model wherein its products were sold through its wholly owned depots as well as appointed dealers (‘ADs’). The Competition Commission of South Africa contended before the CACSA that by way of this arrangement, SAB had indulged in market allocation, as it had appointed its ADs as exclusive distributors for various territories, while continuing to operate its own depots as well. Interestingly, the CACSA observed that but for the supply agreement between SAB and the ADs, the ADs would not have been able to compete with SAB. In other words, the horizontal element of the arrangement was only incidental to the arrangement. Accordingly, the CACSA noted that ‘the evidence indicates that the relationship between the parties is primarily a vertical one. Although there is also a horizontal component, the latter component is incidental to, and flows from, the vertical agreement.’ Eventually, the CACSA overturned the Competition Commission of South Africa’s decision, which had assumed SAB’s relation with its ADs as anti-competitive and constituting a horizontal agreement.

Conclusion

Clearly, the characterization of an agreement as horizontal or vertical significantly impacts its competition analysis. If CCI were to treat an agreement as horizontal, it will apply the ‘per se’ test and the onus would lie on the defendant to prove its innocence. A vertical agreement would be assessed under the ‘rule of reason’ approach and the onus to examine the effects of the agreement on the market would lie on CCI. It appears that globally, authorities are inclined towards assessing dual distribution models using the ‘rule of reason’ approach. This is because the dual distribution model presents various pro-competitive benefits to the enterprise(s) as well as the consumers, which may not be achievable solely through a single distribution strategy. Most importantly, adopting a dual or multi-channel distribution strategy increases the manufacturer’s ability to compete in the market, thereby promoting inter-brand competition and leading to improved consumer welfare.

Dual and multi-channel distribution models are increasingly common in Indian markets and CCI has already received multiple complaints[6] from distributors of manufactures who sell their products through online channels as well as through independent distributors. CCI is likely to face potential anti-competitive issues emerging from these arrangements and will need to follow an objective approach in assessing dual distribution arrangements. In view of the jurisprudence of more mature antitrust jurisdictions as well as the range of pro-competitive effects arising from dual distribution agreements, CCI should also adopt a similar approach of assessing such agreements under the ‘rule of reason’ approach. Treating dual distribution arrangements as horizontal agreements could potentially result in a legitimate vertical agreement with pro-competitive benefits being treated as a horizontal agreements, thereby leading to adverse consequences for enterprises.

Since CCI’s views on dual distribution remain largely untested, enterprises need to be more careful while entering into agreements with their distributors or contract manufacturers. A key takeaway from the Batteries Case, for enterprises operating a dual or multi-channel distribution model, is that the agreements should unambiguously spell out the vertical relationship with their distributors / suppliers.

[1] Suo Moto Case No. 3 of 2017. This case is presently under appeal before the National Company Law Appellate Tribunal.
[2] The authority presumes anti-competitive harm without an inquiry or analysis.
[3] Krehl v. basin Robbins Ice Cream Company 664 F.2d 1348, (9th Cir 1982).
[4] In re: Fortiline, LLC (FTC Matter/file number 151 0000).
[5] Case No: 129/Cac/Apr14 (2015).
[6] M/s K.C. Marketing v. OPPO Mobiles MU Private Limited (Case No. 34 of 2018); M/s Karni Communication Private Limited & Anr. v. Haicheng Vivo Mobiile (India) Private Limited (Case No. 35 of 2018).

Published In:Inter Alia Special Edition- Competition Law - August 2019 [ English
Date: August 7, 2019