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More Pros and Cons of Vertical Restraints

This year's theme, as well as year 2008, was the Pros and Cons of Vertical Restraints. Researchers and experts shared their point of view of the topic.

2019 year's Pros and Cons seminar addressed the issue of Vertical Restraints.

Contributors (from back, left): Björn Axelsson, Rikard Jermsten, Anton Hartl, Arvid Fredenberg, Bjørn Olav Johansen, Andrea Amelio. (Front, left): David S. Evans, Max Engels, Helene Andersson, Thomas K. Cheng, Csaba Kovács, Joanna Goyder.

Summary of the seminar

Vertical restraints 10 years on: the e-commerce earthquake

Joanna Goyder, Senior Knowledge Lawyer from Freshfields Bruckhaus Deringer, held a presentation on the topic “Vertical restraints 10 years on: the e-commerce earthquake”. Goyder summarized the events that had occurred in vertical restraints over the past ten years.

Similarly to how an earthquake changes the landscape, e-commerce has changed how we think of vertical restraints. One such change is the use of price algorithms that make coordination between manufacturers and/or retailers easier. Moreover, when price algorithms are created with artificial intelligence (AI) the program can teach itself to behave anti-competitive. Goyder also talked about dual distribution which occurs when a manufacturer simultaneously sell their products to retailers as well as directly to end-users. With the growth of e-commerce, the cost for suppliers to sell their products directly to end-users is much lower and as a result dual distribution is becoming increasingly common. Goyder went on to explain that the e-commerce has made more manufacturers feel like they do not have control of where and how their product is sold. There are a number of ways that manufacturers try to limit the way retailers sell their products online, also known as selective distribution, i.e. forbidding the use of third party sellers and price comparison websites.

Concerning e-commerce and agency Goyder pointed out that there has been two developments that go in the opposite direction. On the one hand, it is easier for manufacturer to sell their product directly to end-users without retailers. On the other hand, there has been a rise of platforms that act as middlemen for hundreds and thousands of sellers. She continued by questioning whether it is reasonable to view platforms as agents.

With regard to platforms, Joanna brought up the well-known investigations of online travel agencies Booking.com and Expedia. The online travel agencies set up terms that prohibited the hotels that wanted to sell their services through their website to offer lower prices through other, competing online travel agencies, so called wide MFN clauses. Moreover, the terms also prohibited the hotels to offer lower prices via the hotel's own website, so called narrow MFN clauses. Here, she believes that there is some ambiguity about whether narrow MFN clauses are anti-competitive as the national competition authorities came to different decisions. For that reason, she expressed a desire for more clarity.

Goyder concluded by stating that the earthquake is not over, the landscape will continue to change. In another ten years things will yet again be more different than we could ever have imagined today.

Discussant Max Engels, deputy head of chief economist unit from The Bundeskartellamt, commented on the topics of online restrictions, dual distribution, national divergence and categorization of platforms.

Engels commented on why suppliers are increasingly in competition with their retailers, especially on the internet. The internet increases price transparency through price comparison websites which in turn increases price competition and can lead to reduced profits. Therefore, there is an increasing attempt from producers to take control of the online distribution. In regards to the competitive effects, the assessment strongly depends on additional factors such as market structure, market shares and product attributes. According to Engels, the assessment on “online restrictions” is complex and time consuming and is made even more difficult from uncertainty on earlier judgements. However, the vertical guidelines has in his opinion been helpful.

Engels went on the address why he thinks national competition authorities came to different decisions in regards to the online hotel booking cases. The narrow MFNs in the hotel booking case were about the assessment of the potential for free riding. Free riding, Engels explained, occurs when hotels use the platform to divert customers to their own homepage. According to Engels, large hotel chains have the potential to divert customers with their websites whereas smaller independent hotels in most cases will not. In effect, when the hotel market is dominated by smaller independent hotels, as is the case in Germany, free riding is unlikely to be an issue. The hotel markets differ in Europe and it is therefore reasonable that national competition authorities came to different decisions.

In regards to the categorisation of platforms, Engels put forth that platforms differ strongly regarding business model, market power and bargaining position or the relevant network effects. He therefore feels that a standardised treatment is inappropriate. Furthermore, many platforms bear significant commercial risk so it is implausible that they can qualify as genuine agents.

The consumer in vertical restraints

Associate Professor Thomas K. Cheng, University of Hong Kong University, held a presentation on the topic ”The consumer in vertical restraints”. Cheng’s presentation focused on a particular consumer behaviour, namely free riding in the context of resale price maintenance (RPM). Cheng challenged free riding as a defence for RPM, since it often relies on assumptions of consumer behaviour that is not realistic.

Free-riding occurs if, for example, a consumer make use of a brick-and-mortar retailer’s investment in knowledgeable staff and possibilities to test the product, and then purchase the product at a cheaper price in an online store that did not undertake such investments. In these cases, brick-and-mortar retailers will be less incentivized to make the investment and investments on the retailer level will be too low. RPM may remedy this problem by providing the retailer with a sufficient margin to afford the investment.

Professor Cheng distinguished between three models of consumer behaviour, namely the Interbrand primacy model, the Inter-retailer primacy model, and the Impulse purchase model. In the interbrand primacy model consumers choose brand first then shop around different retailers, and this model is typically associated with heavily advertised brands and in situations where brand preferences are strong. In the inter-retailer primacy model, the situation is reversed so that the consumer first choose retailer then choose brand. In the impulse purchase model, the consumers purchase is based on an unplanned impulse to buy and the purchase tends to be product specific, for example ice-cream on a sunny day.

Professor Cheng argued that the free riding defence was only valid in the first of the three models, the interbrand primacy model, and only so in specific circumstances.

One argument to this point was that the free riding defence relies on five different assumptions and these are not all met under the two last models. One example is the assumption it is worth the consumers while to go to other retailers. In the impulse purchase model, such an assumption may not be realistic. Further, Cheng pointed to marketing scholars that find that this assumption is often not met in reality. Another argument is that there is no intrabrand competition in the other two models and, consequently, free riding is not an issue.

Though the conclusions were based on two articles professor Cheng wrote on brick-and-mortar retailers, Cheng argued that the concepts and analytical framework applies equally to online sales.

Professor Cheng then proceeded to present other academics research on the topic.

Cheng demonstrated, firstly, that the literature finds that free riding is relatively uncommon, that RPM leads to cannibalization between different retail channels and may increase adverse effects of free-riding such as less service and price differentiation, and that free riding could lead to beneficial crowding as research shows that human crowding in store affects shopping satisfaction.

Secondly, Cheng pointed out that the emergence of e-commerce has changed the patterns of consumer behaviour and this raises further questions in relation to the effectiveness of RPM to mitigate free riding. Cheng pointed out that free-riding may go in both directions, i.e. online-offline or offline-online and that there are more effective ways other than RPM to provide the right service incentives to retailers.

Anton Hartl of the Austrian Federal Competition Authority provided comments to professor Cheng. Hart pointed out that knowledge about consumer behaviour can indeed inform on issues of free-riding. However, consumer behaviour may not be stable and consumers may sort more or less under one category depending on situation. Hart said that the Authority is often presented with free riding arguments but that it is often difficult to observe and measure. Typically, it would like micro-data on individual consumers but this is difficult to obtain. Hart also pointed out that RPM may lead to competition on quality but that free riding can also occur in this context.

Current ideas on resale price maintenance

The third topic of the day was resale price maintenance (RPM). Bjørn Olav Johansen, associate professor at the university of Bergen, held a presentation with the title “Current Ideas on Resale Price Maintenance”. The presentation started with a review of the treatment of RPM in competition law and in economic literature. In Europe, RPM is in practice per se illegal (although not per se illegal in principle). In the US, there is a “rule of reason” approach since the ruling in Leegin. In the economic literature, there are pro-competitive theories, e.g. RPM promoting retail services, and anti-competitive theories, e.g. RPM facilitating collusion.

Johansen then asked what the appropriate policy should be, e.g. should we adopt a rule of reason towards fixed and minimum RPM, or should we adopt a stricter policy towards maximum RPM?

In order to address those questions, Johansen went on to present two papers written by Johansen and co-authors regarding RPM (Gabrielsen and Johansen, 2017, and Gabrielsen, Johansen and Lømo, 2018).

The first paper explores RPM in a setting where contracts between manufacturer and retailers are secret. The paper finds that minimum industry-wide RPM is bad for welfare in that setting, while maximum RPM is good.

The second paper looks at RPM on a two-sided market where competing platforms sell directly to one side of the market and through an agent on the other side of the market. The paper finds that minimum RPM is bad for welfare in this setting, and that maximum RPM is good for welfare.

Johansen thus concluded that the two papers give support to the current legal treatment of RPM, which treats minimum and fixed RPM as worse than maximum RPM.

After Johansen, the discussant Andrea Amelio from DG Comp at the European Commission took the stage. He summarized and complimented the papers that Johansen had presented and emphasised the setting in the first paper, namely that the contracts between manufacturers and retailers are secret. This setting is a more realistic setting than if public contracts are assumed, according to Amelio. In regard to the second paper, that deals with two-sided markets, Amelio made the point that secret contracts would have been an interesting approach in that setting as well.

Amelio then moved on to talk about an analysis of RPM cases that have been investigated at national competition authorities in the EU, which shows that none of the cases included arguments of RPM creating efficiencies. Empirical studies of RPM in the economic literature also seem to suggest negative effects of RPM, according to Amelio. The second part (ca 6:00) of Amelios presentation concerned the evaluation of the Vertical block exemption and Vertical Guidelines which is currently being conducted at DG Comp. There is now in an evaluation phase which will end Q2/2020, in which, inter alia, different stakeholders are asked to provide their points of view. From Q3/2020 until the expiry of the current VBER in 2022, there will be an impact assessment phase.

Vertical restraints in a digital world

The last session of the 2019 edition of Pros and Cons was held by David S. Evans, Chairman, Global Economics Group who spoke about vertical restraints in a digital world, focusing on two main topics; what’s new and different about digital that matters for an antitrust analysis of vertical restraints and the specific analysis of vertical practices of digital platforms related to abusing platform governance systems, exclusive contracts and MFNs. Evans started off by identifying the specific features of digital markets. Firstly, the digital economy result in more platforms acting as intermediaries, facilitating interaction. Nowadays, digital platforms cover most of the economy and has displace many of the traditional intermediaries. For example, shopping malls are being replaced by online marketplaces. Secondly, many of the core services are software based and rely on internet to connect services and users. This combination results in a dramatic drop in start-to-scale costs. Thirdly, network effects give increases in value if a company can become large. This has resulted in many platforms being large and global. They often start local and expand global in a short time. Another central feature of digital platform highlighted by Evans is the gathering and analysis of user data. By using data driven algorithms, platforms can provide multiple services to users such as search and discovery tools, recommendations and targeted advertising.

According to Evans, because of the network effects in the platform markets, the growth of digital platforms is characterised by the so called hen-and-egg problem. This means that a platform has to reach a critical mass of users on both sides to provide interaction and a valuable service to either side. Reaching this critical mass is a challenge for most platforms. Whether network effects lead towards few companies possessing market power and possibly creating to bottlenecks may depend on the level of multihoming (consumers use multiple platforms and switch between them) or single homing in the market. Evans draws the conclusion that if multihoming is possible on both sides, this makes entry easier.

Evans concluded the first part of his presentation by pointing out that digital platforms are different from traditional offline platforms, but it is matter of degree, not kind.

The second part of the presentation focused on potential antitrust issues related to the practice of digital platforms. Although digital platforms offer efficiencies, they can also possibly offer an increased incentive and ability to foreclose. As described by Evans, antitrust issues may arise horizontally when platform imposes vertical restraints on participants on one side to deter competition by rival platforms, and vertically when platforms impose vertical restraints on participants on one side to advantage platform-sponsored participants. An analysis of the competitive effects of a conduct on price, output, choice, innovation will have to take into account the effects on welfare on both sides of the platform.

To finish Evans zoomed in on some of the conducts previously and currently under investigation by the European Commission and national competition authorities including platform governance structures, exclusivity contracts and MFN:s. Evans concluded the presentation by sending the message that digital platform markets should maintain an active area for competition authorities and private litigants, but, due to the many efficiencies of certain conducts, cases must be underpinned by fact-based balanced analysis.

The discussant, Csaba Kovács, Deputy Head of the Chief Economist Section at the Hungarian Competition Authority, brought an additional perspective to vertical restraints in a digital world. Firstly by pointing out that vertical restraints in itself, regardless of the digital evolution, is an ever-evolving policy and will not go away. In addition vertical restraints play an important role in the digital era.

Kovács sided with Evans that challenging features of the digital world are network effects, big data and the two sidedness of platform markets. But added zero pricing as an additional feature that is prevalent on platforms. Zero price platforms have complicated the antitrust analysis by making inapplicable several analytical methods and benchmarks such as the SSNIP-test, price effects.

Kovács advanced by proposing a number of solutions to these digital challenges. For example, the competitive effect of a conduct on zero price markets could be measured through a quality benchmark, SSNDQ, instead of a price related benchmark, where privacy and data gathering could be used as important quality aspects. Furthermore, market shares can be assessed based on number of transactions or clicks. Moreover, big data to be taken as an important asset or input in vertical foreclosure theories.

Kovács invited the audience to observe caution in interfering in markets with strong self-correction capabilities and demonstrate more activism where substantial consumer welfare is at stake and in market where the ability to self-correct is weak and there is a risk for tipping effects. Finally Kovács called for more research on vertical restraints in digital markets. Including ex-post evaluations.

Presentations from the seminar