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Introduction
Agreements that infringe the Chapter I prohibition of the Competition Act 1998 are void and unenforceable and can lead to fines of up to 10% of total group turnover.
The Competition Appeal Tribunal (“CAT”) is rarely required to opine on vertical agreements, particularly, those that do not involve retail price maintenance. However, in a recent case, Up & Running v Deckers, involving the supply of HOKA branded running shoes, the CAT has provided a detailed analysis of its approach to analysing the potential anti-competitiveness of selective distribution systems.
The case highlights the substantial competition law risks in seeking to operate selective distribution systems without clear, objectively justifiable, qualitative criteria. As a result of the findings in the case, Deckers is now facing a substantial claim for damages.
Pros and cons of selective distribution from a competition law perspective
Selective distribution systems restrict the number of authorised distributors and the possibilities of resale and thus reduce competition at the distribution level.
In a selective distribution system, distributors must meet certain qualitative and/or quantitative criteria to be supplied. Qualitative criteria require distributors to be able to provide particular levels of service. Quantitative criteria simply limit the number of distributors. Quantitative restrictions can also be imposed indirectly, for example, by requiring minimum levels of purchasing.
The competition risk is that these systems potentially reduce competition in the distribution of products and services. That is, they reduce ‘intra-brand’ competition between retailers.
In particular, selective distribution forecloses different types of distributors who do not meet the specified qualitative or quantitative criteria. In theory, this potentially facilitates collusion between distributors due to the requirement of similarity and hence likely business models and costs, and if there are quantitative limits as well, this will limit the number of distributors further facilitating collusion.
However, at the same time, selective distribution can increase competition between brands, ‘inter-brand’ competition – improving competition in relation to factors other than price (as opposed to the guarantee of a high profit margin for distributors). For example, by ensuring a higher quality of service by distributors to offset any reduction in price competition.
Competition law assessment
Relevant Competition law background points
Before getting to the detail of the assessment of selective distribution, there are a couple of basic competition law points that are important to establish.
First, in competition law matters, the term ‘agreement’ is interpreted broadly and includes not just written contracts but also any meeting of minds that it is possible to infer from the behaviour of the parties and, importantly for selective distribution type cases, includes the tacit acceptance of terms by a distributor.
Second, there is a distinction in competition law between agreements which have the ‘object’ of restricting competition and those which may have the ‘effect’ of restricting competition. Where agreements contain ‘object’ restrictions of competition, the anti-competitive effects can be assumed. There is no need for detailed economic analysis of the actual effects. However, where agreements do not clearly have the ‘object’ of restricting competition, it is necessary to conduct a detailed economic analysis of their effects and this is a much more onerous exercise (for regulators and private actions).
Agreements that do not raise competition law issues
There is a substantial body of EU caselaw specifically concerning selective distribution systems and competition law. While there remain gaps, this has broadly established a methodology for conducting competition law assessments of selective distribution systems. Selective distribution systems that comply with what are known as the ‘Metro‘ criteria, are considered not to raise competition law issues at all. the Metro criteria are that:
- The nature of the products necessitates a selective distribution system (e.g. ‘luxury’ goods, examples being perfume and high quality/high technology products)
- Distributors must be chosen on objective qualitative criteria
- The criteria are laid down uniformly for all potential resellers and not applied in a discriminatory fashion
- The criteria must not go beyond what is necessary
Where Metro criteria are not met, this does not necessarily mean there’s a restriction by ‘object’, it is still necessary to consider the question. However, it is difficult to envisage many practical circumstances where this will not be the case. In particular, the absence of a clear framework (transparent, objective, precise, non-discriminatory and proportionate) for the proper exercise of discretion by the distributor will point to an ‘object’ restriction of competition.
Agreements that raise issues but may be exempt
Agreements that do restrict competition (even by ‘object’) can benefit from ‘exemption’ from the competition law prohibitions. Agreements may be ‘exempt’ because they fall within the Vertical Agreements Block Exemption Order (VABEO) or because they qualify for ‘individual exemption’. In both cases, the thinking is essentially that on balance the positive benefits outweigh the detriment to competition.
Broadly speaking, the VABEO can cover selective distribution systems (irrespective of the nature of the product and the nature of the selection criteria) provided the market shares of the parties are below 30% on their respective markets and they do not contain ‘hardcore’ restrictions of competition. ‘Hardcore’ restrictions include those relating to onward sale pricing and selling other than to end users.
Where the VABEO does not apply, individual exemption is theoretically possible. However, it is likely to be difficult to establish that the benefits outweigh the detriments where there are high market shares, hardcore restrictions or the relevant market contains a number of selective distribution networks and there is a cumulative anti-competitive effect as a result.
Internet sales
A contentious area can be restrictions on online sales.
In a UK case involving Ping golf clubs, Ping had tried to prevent resellers from selling online as it argued that its golf clubs required personalised fitting in store. The CMA, CAT and Court of Appeal, however, were all of the view that such a restriction went beyond what was reasonable in the circumstances.
On the other hand, in an EU case involving perfumes, Coty successfully argued that it should be allowed to prevent resellers from selling its perfumes through online marketplaces as these did not fit the luxury image of its products.
The dividing lines between these approaches are not entirely clear.
Up & Running v Deckers
The facts were that Up & Running operated bricks and mortar stores and an associated online sales platform. Deckers supplies HOKA running shoes in the UK. Up & Running sought to start selling residual/out of season HOKA products through a new discount online sales platform (runningshoes.co.uk). Deckers required that a retailer had specific permission to make online sales, that the website had an identical or similar name to associated bricks and mortar stores or that Deckers was notified if the retailer wished to sell HOKA products from a website with a different name and that Deckers approved the contents of the website.
Deckers refused permission, ostensibly because there was no clear ‘signposting’ from the running.co.uk website back to Up & Running. In the CAT, Deckers sought to justify this restriction, but Up & Running proceeded to sell HOKA products through the running.co.uk website. Deckers served notice on Up & Running, terminating its supply agreement.
The CAT found that Deckers operated a multi-channel selective distribution system. This included a ‘Main Retail Channel’, which included Up & Running was categorised and a ‘Clearance Channel’ involving other retailers such as Sport Pursuit.
The CAT also found that: “There was no further guidance given and no criteria formulated, let alone published, to indicate the basis on which Deckers would give approval for any website with a different name from any bricks and mortar operation. These provisions were therefore in the nature of conferring a very wide discretion upon Deckers to make decisions permitting or not permitting such an activity, without any accountability for the reasons for those decisions.”
The CAT’s conclusion, based on these facts, was that the: “general purpose of the contractual provision is to promote the selective distribution model envisaged by Deckers by preventing the emergence of competing business models or channels for distribution. The discretion and vague wording enabled Deckers to pursue two discernible sub-purposes…:
- To restrict entry into the Clearance Channel, being the additional channel for the online clearance of residual stock, so that Deckers is largely able to determine when and what volumes are sold through this channel
- To prevent retailers in Deckers’s selective distribution system who sell HOKA product in the Main Retail Channel from accessing the Clearance Channel, so that discounting of residual stock is inhibited by only taking place within, and subject to the commercial and practical constraints of, the Main Retail Channel.”
The CAT found that despite the market shares of Up & Running and Deckers being below the 30% thresholds in the VABEO, it did not apply because the refusal to approve the runningshoes.co.uk website because of the likely discounting of HOKA products amounted to the ‘hardcore’ restrictions of:
- the restriction of active or passive sales to end users; and
- a restriction on the buyer’s ability to set prices.
The CAT concluded with the following description of the facts that had given rise to the competition law issues in the case: “The selective distribution system implemented by Deckers was incomplete and flawed in its design and operation. The criteria for admission into the system were not properly recorded or kept in writing. Those criteria were, moreover, applied inconsistently on a piecemeal basis at best and in a discretionary, if not arbitrary, manner at worst. It is also striking to see the virtual absence of anything resembling a framework for treatment of separate channels.”
Conclusion
Selective distribution systems can be viewed as pro-competitive or as falling within the VABEO in many circumstances. However, where the qualitative criteria are not clearly specified and/or they clearly operate to restrict price competition or provide wide discretion to distributors to limit the channels through which retailers can sell, there are likely to be significant competition law risks arising.
Distributors operating selective distribution systems should therefore be careful to ensure that these systems are clearly specified, on the basis of objective qualitative criteria as far as possible. While there can be discretion for distributors in how they specify relevant criteria and thus define their selective distribution systems, the systems cannot be designed to allow continuing wide discretion (subject to a system redesign).
Failing to set up a clear selective distribution system could lead to agreements being void and unenforceable, fines of up to 10% of group turnover and private actions for damages.
If you have queries about any of the issues raised in this article, please contact Noel Beale or your usual Michelmores contact for further information. We have extensive experience in helping clients mitigate the potential competition law risks in these types of scenarios and ensuring that our clients have effective and robust distribution systems that optimise their commercial positions.
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