SECTION 5 VERTICAL RESTRAINTS

1. SECTION 5VERTICAL RESTRAINTS • Section 5 of the Competition Act, regulates both price and non-price related restraints.It states: • “(1) An agreement between parties in a vertical relationship is prohibited if it has the effect of substantially preventing or lessening competition in a market, unless a party to the agreement can prove that any technological, efficiency or other pro-competitive, gain resulting from that agreement outweighs that effect. • (2) The practice of minimum resale price maintenance is prohibited. • (3) Despite subsection (2), a supplier or producer may recommend a minimum resale price to the reseller of a good or service provided – • (a) The supplier or producer makes it clear to the reseller that the recommendation is not binding; and • (b) If the product has its price stated on it, the words “recommended price” appear next to the stated price.”

2. (i) SECTION 5(1) REQUIREMENTS • an agreement between firms • in a vertical relationship • onus on complainant to show substantially lessening/preventing of competition • onus on respondent to show technological efficiency and other pro-competitive gains. • Balance between SLC and Efficiency gains. • Rule of Reason approach.

3. (ii) LESSENING/PREVENTING Competition • Identifying the competitive harmNational Association of Pharmaceutical Wholesalers and Others/Glaxo Welcome (pty) Ltd and others (case 45/CR/Jul01) • In a vertical agreement, there will always be two relevant markets (upstream market and downstream market). • The nature of competition in the respective markets. • An analysis of the structure of the market and the relative position of the parties in these respective markets • The maturity of the market • The level of trade

4. (iii) Interbrand & intrabrand competition • Inter-brand competition refers to competition between different brands. • Intra-brand competition takes place when competing wholesalers and/or retailers sell the same brand

5. (iv) Agreements that Benefit Competition • Lowering transaction costs • Assuring a steady supply of a key input • Eliminating negative externalities • Preventing “free riding”

6. (v) Agreements that Restrict Competition • Eliminating Competition through Foreclosure • Raising rivals costs • Tying Arrangements • Exclusive dealing

7. (vi) Efficiency Arguments • In order to ensure that all resellers are equally incentivised to push their brands by investing in efforts that enhance the marketing and branding of a particular product or service, suppliers award exclusive territories to each reseller. • Exclusivity of supply is sometimes afforded to some resellers or distributors in order to reward them for specific investments. • The rule of reason test with regard to the vertical agreements is one where the loss of intra-brand competition (the anti-competitive effect) must be weighed against any potential gain in inter-brand competition (the pro-competitive benefit).

8. (vii) Franchise agreements • A franchise agreement generally limits intra-brand competition between francisees- for eg, restricting the number of franchisees that operate in a particular area, or by confining franchisees to specific territories or customer classes.

9. (vii) Franchise agreements (cont..) Cancun Trading No24 CC v Seven-Eleven Corp SA Case I8/IR/Dec99. • The respondent argued that the franchise operation should be viewed as a single business entity or association and that it is not a vertical relationship as contemplated by the Competition Act. • The Competition Tribunal did not accept this view and confirmed that a franchise agreement should be assessed as a contractual means of vertical integration. • The Competition Tribunal also confirmed that, given the vertical relationship between franchisee and franchisor, the prohibition against minimum resale price maintenance was also applicable to franchising agreements.

10. Section 5(2) Minimum Resale Price Maintenance • What is minimum RPM? • May a supplier dictate margins or discounts to resellers? • What evidence is required to prove minimum RPM? • Should the SA Competition Act impose a per se prohibition on Minimum RPM? • CASES: • Federal Mogul, • Toyota SA (consent Order) • Leegins (US).

11. Minimum Resale Price Maintenance • Minimum Resale Price Maintenance (RPM) refers to any attempt by an upstream supplier to control or maintain the minimum price at which the product is resold by its customer. • These rules prevent resellers from competing too fiercely and by drive down profits. • Minimum RPM is regarded as a form of vertical price fixing.

12. May a supplier dictate margins or discounts to resellers? • Insisting that a product be resold at a specific margin, or limiting the discounts that a reseller may offer, in essence restricts the reseller’s ability to set a price and is accordingly prohibited. • CUM Christian Book Stores v Maranatha Record Company- Consent order During 2003, Maranatha, a recording company and distributor of Christian/Gospel music, admitted to the Competition Tribunal that its retailers were not allowed to deviate by more than 10% from the recommended retail price. This practice was found to amount to minimum resale price maintenance.

13. Minimum RPM-Evidence required: • The practice showing the minimum RPM is implemented. • A minimum resale price is relevant. • Measures in place to enforce or maintain the practice of minimum RPM.

14. RPM-PER SE ILLEGAL • Dr. Miles Medical Co v John D Park & Sons Co. 220 U.S 373. • Leegin Creative Leather Products. Inc v PSKS, Inc d/b/a Kay’s Kloset, No 06-480 (June 28, 2007)

15. Leegin’s case • Leegin did not deny the existence of an RPM agreement. • Instead, Leegin argued that its agreement requiring retailers to sell at minimum prices should have been analysed under the rule of reason and that it should have been allowed to submit evidence tending to show the policies anticompetitive benefits.

16. Leegin’s case- cont… • In overruling its 1911 decision in Dr Miles Medical co v John D Park & Sons Co 220 US 373 (1911), the court stated that it could not reconcile Dr Miles per se treatment of resale price maintenance (“RPM”) with the Court’s “traditional” rule of reason analysis applied in Section 1 cases. • The court stated that over the course of 30 years it had “progressed away from [the dr miles] rationale, and that it no longer made sense to analyse vertical non-price restraints and maximum resale agreements under the rule of reason, while continuing to treat RPM agreements as per se unlawful. (referring to cases such as Continental TV Inc. GTE Sylvania Inc. 433 US 36. 57-59 (1977) and State Oil Co v Khan 522 US , 22 (1997), which allowed non-price vertical restraints and maximum price restraints to be analysed under the rule of reason respectively.

17. Leegin’s case- cont… • pro-competitive benefits • RPM may increase interbrand competition by encouraging retailers to invest and promote a particular manufacturer’s products, thus increasing competition at the manufacturer level. • RPM may encourage new entry by allowing manufacturers of new product to incentivize retailers to promote a new or unknown product to consumers. • RPM may lead retailers to improve their performance if the margins guaranteed by RPM could be revoked should the retailer fail to meet the manufacturer’s expectations.

18. Leegin’s case- cont… • Anticompetitive effects However, the Court also acknowledged that RPM could be used for anticompetitive purposes to harm consumer welfare. • First, the Court expressed concern about firms with market power using RPM agreements.The court stated that manufacturers with market power could use RPM to discourage retailers from selling or promoting competing products by smaller rivals. The Court also noted that retailers with market power could use RPM agreements “to forestall innovation in distribution that decreases costs. • Second, the Court acknowledged that RPM could be used to facilitate a horizontal cartel at the manufacturer level by making it easier to detect “cheating” because prices at the retail level are more transparent than prices at the wholesale level).RPM could also be used to facilitate a retailer cartel, and therefore, RPM arrangements that are requested by retailers would raise concerns. • Finally, the Court stated that RPM agreements may be anticompetitive if they are used by a majority of firms in a market. Under such circumstances, the RPM agreements could “deprive consumers of a meaningful choice between high-service and low-service outlets”.

19. RPM IN SOUTH AFRICA • Should the SA Competition Act impose a per se prohibition on Minimum RPM? • Should the Act be amended?

20. Section 5(3) Recommended Retail price • 5(3) a supplier or producer may recommend a minimum resale price to the reseller of a good or service provided – • The supplier or producer makes it clear to the reseller that the recommendation is not binding; and (b) If the product has its price stated on it, the words “recommended price” appear next to the stated price.”