Communication from the Commission on the application of the Community competition rules to vertical restraints - Follow-up to the Green Paper on vertical restraints
26. 11. 98 EN Official Journal of the European Communities C 365/3 Communication from the Commission on the application of the Community competition rules to vertical restraints (FollowÜup to the Green Paper on Vertical Restraints) (98/C 365/03) (Text with EEA relevance) SECTION I - INTRODUCTION 1. Shortcomings of current policy Thirdly, as the BEs only cover vertical agreements concerning the resale of final goods and not intermediate goods or servicesØ(ˇ) a significant part of all vertical agreements are not covered by the current BEs, even when the parties involved have no market power. This means that an unnecessarily large number of vertical restraints could in principle be scrutinised, resulting in legal uncertainty and unnecessary enforcement costs. concerning competition policy Community vertical restraints has a history of nearly forty years. Although this policy has been successful a review is necessary. The reasons for this review were amply described in the Green Paper on Vertical RestraintsØ(˛). The Green Paper in current identified a number of shortcomings has policy, which can be summarised as follows. First, the current BlockÜExemption Regulations (BEs) comprise rather strict form based requirements and as a result are considered too legalistic and work as a straitÜ jacket. This is especially awkward in the light of the major changes in methods of distribution that have taken place and still are the vertical agreements that, sometimes with difficulty, do fall within the current BEs a compliance burden is created through legal uncertainty. Companies without unnecessary significant market power suffer unnecessary regulation and may even be prevented from using vertical restraints to improve their competitive position in the market. taking place. For Secondly, for those agreements that fall within the BEs there is the real risk that the Commission is exempting agreements that distort competition. As the BEs are form based instead of effect based and do not contain any market share limit, companies with significant market power can benefit from them. The sanction of withdrawal is in this respect not seen as a real deterrent because it works only with effect for the future. Thus, the present BEs exempt for instance, non compete obliÜ gations up to 100Ø% market share although these may cause serious foreclosure effects and allow the charging of exorbitant prices on the market to the detriment of consumers. 2. Need for a more economics based approach in their market context. It To remedy these three shortcomings and better protect the primary objective of Community competition, competition policy, a more economics based approach is required. Such an approach should be based on the effects on the market; vertical agreements should be is only when analysed inter brand competition is weak and market power exists that it becomes important to control vertical agreements. This should facilitate a relaxation of the form based requirements, ensure that fewer agreements are covered scrutiny of by Article 85(1) and afford a better agreements of companies having substantial market power. This can be depicted as follows. Market Power Individual Scrutiny significant market power BlockÜExempted/de minimis All types of Vertical Restraints Most markets are fairly competitive, the companies not having market power. Therefore, the number of cases (˛) Green Paper on Vertical Restraints in Community Competition Policy, COM(96) 721 final, adopted by the Commission on 22. 1. 1997. (ˇ) Only under the Franchise Block Exemption Regulation (No 4087/88 of 30 November 1988) are services covered. C 365/4 EN Official Journal of the European Communities 26. 11. 98 that may need scrutiny, as depicted below, will be relatively low. This is confirmed by an analysis of recent merger casesØ(˛). the Commission will have the burden of proof that the agreement in question infringes Article 85(1) and will have to examine whether the agreement does or does not fulfil the conditions of Article 85(3). Number of Vertical Restraints Individual Scrutiny BlockÜExempted/de minimis All types of Vertical Restraints In reforming Community competition policy in the field the of vertical restraints, following objectives: the Commission pursues - the protection of competition, which is the primary it objective of Community competition policy, as enhances consumer welfare and creates an efficient allocation of resources; - market integration, light of enlargement, the which remains a second important objective when assessing competition issues. in covering regulation The proposed safe harbour consists of one broad umbrella BlockÜExemption all vertical restraints for the distribution of goods and servicesØ(ˇ). This regulation uses market share thresholds to distinguish between agreements that are or are not block exempted. By being based primarily on a blackÜ clause approach, i. e. defining what is not block exempted instead of defining what is exempted, it avoids the straitÜ jacket effect and facilitates the simplification of the applicable rules. The policy will ensure that the vast majority of vertical agreements where no significant net negative effect can be expected no longer require indiÜ vidual scrutiny. It will thereby allow the Commission and national competition authorities to concentrate on the important cases. It treats different forms of vertical agreements having similar effects in a similar way, preventing unjustified differentiation in policy between forms or sectors and avoiding a policy bias in the choice companies make concerning their formats of distribution. In order to maintain a sufficient level of legal certainty the BlockÜExemption regulation will be supplemented by guidelines detailing the Commission’s policy concerning individual share the BlockÜ thresholds and possible withdrawal of Exemption below the thresholds. the market examination above In addition, the effects on the overall level of legal certainty for business, the enforcement costs to business and competition authorities, and the possibilities for improving decentralisation have to be taken into account. 3. Structure of the present communication The policy proposal set out in this Communication is based on a more economic approach. This is required, as was explained above, to remedy the shortcomings of current policy. For situations without significant market power a safe harbour needs to be created, thus providing a presumption of legality for those vertical restraints that likely to have no net negative effects. Vertical are restraints falling outside the safe harbour will not be presumed to be illegal but may need individual examÜ individual examination, ination. the context of In (˛) In more than 80Ø% of the merger cases dealt with under the Merger Regulation in 1997, the market shares of the indiÜ vidual parties were below 25Ø%. As these merger cases only concern large companies and often the most narrow market definition is looked at in the first phase of investigation in order to clear the merger, it can be expected that in the economy as a whole, market shares will be even lower. This Communication has the following structure: - Section II summarises the comments the Commission received on the Green Paper; - Section III provides an economic assessment of vertical restraints and their effects; - Section IV discusses the issues of market share thresholds and legal certainty; (ˇ) Motor vehicle distribution is the only sector not covered by this exercise, see Green Paper on Vertical Restraints in Community Competition Policy, p. 2, footnote No 2. 26. 11. 98 EN Official Journal of the European Communities C 365/5 - Section V describes the proposed new policy; - Section VI describes the procedural steps which will be followed to adopt the proposed policy. Most commentators however pointed out the difficulties of defining markets and assessing market shares. These difficulties were said to give rise to a high degree of legal uncertainty and the majority of those who commented did not favour a market share cap. In the course of the consultation exercise, the support for the use of a market share test increased, but companies asked the Commission to adopt sufficient flanking measures so as to make the market share test operable. SECTION II - SUMMARY OF REACTIONS TO THE GREEN PAPER In the Green Paper, five options were described, namely: 1. Written submissions on the Green Paper associations representing companies. Only The consultation exercise launched by the Green Paper produced 227 written submissions. A large majority (64Ø%) of the submissions came from either companies or 6 submissions were received from consumer organisations. Of the companies and associations of companies who made submissions, a large percentage (31Ø%) came from either the beer or petrol sector. The primary concern of most submissions was (37Ø% of all submissions). Only 41 submissions (18Ø%), mainly from academics and national authorities, placed their primary emphasis on the protection of competition. legal certainty Most submissions believe the current system to be too legalistic and favour a more economic approach. It is felt that an economic, effects based approach rather than a clause based approach would be more suitable for dealing with a dynamic sector such as distribution. The current system tends to produce negative effects on the evolution of distribution, preventing undertakings from introducing new and innovative distribution formats which could lead to substantial gains in terms of effiÜ ciency. Of those who commented on this issue 95Ø% favour a more economic approach, while 97Ø% believe that the current system has too much of a strait jacket effect. Of those who commented on the competition effects of vertical restraints, 42Ø% view vertical restraints as having primarily a positive effect on competition, while 50Ø% are of the view that vertical restraints may have both positive and negative effects on competition. As possible negative effects, foreclosure and dampening of competition were mentioned, with the former being seen as the main problem. While there is general consensus on the need for a more economic based approach, there is no agreement on how to implement such an approach. Nearly half (41Ø%) of those that commented on market share tests believe market shares to be a good indicator of market power. 1. Option I: maintain the current system; 2. Option II: wider block exemptions without a market share cap; 3. Option III: more focused block exemptions with a market share cap of [40Ø%ü; 4. Option IVÜI: negative clearance presumption up to [20Ø%ü and above wider block exemptions without a market share cap; and 5. Option IVÜII: negative clearance presumption up to [20Ø%ü and above wider block exemptions with a market share cap of [40Ø%ü. It was stated clearly in the Green Paper that the list of options proposed was not exhaustive. It is therefore not surprising that three other options have been proposed by several interested partiesØ(˛), namely: 6. An umbrella block exemption: one wide blockÜ exemption based on a blacklist approach and without market shares; 7. Guidelines: no block exemption but only guidelines indicating how the Commission would apply Article 85 in individual cases; 8. A control of abuse system: all vertical restraints the would be presumed a priori Commission having the power to suspend the positive presumption only with effect for the future. lawful, with (˛) A number of other individual options were proposed, such as a foreclosure test based on market shares. C 365/6 EN Official Journal of the European Communities 26. 11. 98 Set out below is a statistical breakdown of support for the various options referred to above: Options In favour Not in favour No comment 1. Option I (maintain current system): 16,6Ø% 51,6Ø% 31,8Ø% 2. Option II (wider block exemptions without a market share cap) 46,2Ø% 23,3Ø% 30,5Ø% 3. Option III (more focused block exemptions with a market share cap of [40Ø%ü) 6,7Ø% 59,6Ø% 33,7Ø% 4. Option IVÜI (negative clearance presumption up to [20Ø%ü and above wider block exemptions without a market share cap) 20,2Ø% 59,5Ø% 20,3Ø% 5. Option IVÜII (negative clearance presumption up to [20Ø%ü and above wider block exemptions with market share cap of [40Ø%ü) 8,1Ø% 82,4Ø% 9,5Ø% 6. Umbrella BlockÜexemption without market shares 17Ø Ø% 4,9Ø% 78,1Ø% 7. Guidelines only 1,8Ø% 10,8Ø% 87,4Ø% 8. Control of abuse system 10,8Ø% 6,3Ø% 82,9Ø% 2. Public hearing commentators stressed that a market share test would be feasible and is the best possible indicator of market power available. No alternatives were provided. On 6 and 7 October 1997, the Commission organised a public hearing for industry and other interested parties on the Green Paper. Companies, associations, law firms, consumer organisations etc. who had made a written submission were invited to come to the hearing. Most Member States also sent observers, as did the EFTA Surveillance Authority, Norway, a Iceland, the Central and Eastern considerable number of European countries. and There was a large element of consensus that market power and a reduction in inter brand competition are the circumstances under which vertical restraints may have negative effects. There was similar consensus that the Commission sould adopt a more economic approach to get away from the current legalistic strait jacket. Most also considered that there is a link between market power and market share but stressed that they are not synonymous. In the light of the increased legal uncertainty that a market share test would bring to those who currently benefit from existing BE Regulations, a large majority were against introduction of such a test to limit the applicability of block exemptions. A limited number of On the question of which vertical restraints should remain per se prohibited there was consensus that resale price maintenance and absolute territorial protection should not be covered by any block exemption and should in most cases also not qualify for individual exemption. However, individual exemption should not be completely excluded. At the hearing support was expressed to allow true maximum resale price maintenance, it being recognised that it is difficult to identify what a true maximum price is. it was argued that On the argument that vertical restraints can help to solve free rider problems, i. e. to ensure that the one who makes an effort is able to appropriate all the benefits the effort engenders, opinions were divided. At the hearing some argued that free rider problems occur quite often, especially through the actions of retailers outside the official dealer network. This was argued by represenÜ tatives from amongst others the car, perfumes, petrol, consumer electronics and toy industries. They favoured action to stop "leakage’ from the system, including the power to ban parallel imports. However, it was not explained whether real free rider problems were at the 26. 11. 98 EN Official Journal of the European Communities C 365/7 heart of the problem - that is that the outside retailers truly profit from the investments made by the network - or whether the issue was really one of trying to shut out certain retailers in order to reduce competition and increase prices. The latter argument was mentioned by large several participants, retailers. These vital importance of parallel imports to enable them to make use of price differences between Member States. including distributors and the commentators stressed It was recognised that in order to achieve a more economic approach, a compromise has to be found between such an approach and legal certainty. A number of participants were of the opinion that most vertical agreements are innocuous from a competition point of view or are even pro competitive. They therefore favoured either option II (wider block exemptions), Option IVÜI (the same to a negative clearance presumption) or one very wide blockÜ exemption, preferably with only black clauses. A few were in favour of a future policy using market share thresholds as in Option IVÜII (block exemptions with a market share cap) or a foreclosure test based on market shares. in addition It was stressed that, in the event market share tests were introduced, the Commission should provide as many flanking measures as possible to protect legal certainty. In particular, it was mentioned that the Commission should 1. provide guidelines on the application of the rules above the market share thresholds, 2. solve the problem of automatic nullity under Article 85(2) where a it company has failed to notify because incorrectly introduce a share, 3. possibly assessed non opposition procedure, and 4. reduce the burden of notification. its market 3. Opinions of the Community Institutions and of the Member States The European Parliament to is opposed its Resolution of 18 July 1997 the European In Parliament notes that, apart from the de minimis notice, business the use of a market share approach and that this approach is not always the most efficient indicator of market power. It therefore calls on the Commission to examine the possibility of using other parameters. It stresses the need to secure legal certainty for SMEs so that voluntary retail chains are put on the same footing as large integrated groups, particularly in terms of a common pricing strategy. It also calls on the Commission to examine whether it is necessary to draw up a block exemption regulation for selective distribution the special and asks for attention to be paid to commercial or financial advantages in beer supply and service station agreements. The Parliament expresses a preference for a system in which the vertical agreements of companies having less than 10Ø% market share fall outside Article 85(1). Above this threshold, block exemptions should leave more room for flexibility without disturbing the balance between the contracting parties. Above a certain market share threshold the benefit of a block exemption should be easy to withdraw. Only if such an easy withdrawal procedure the Commission consider creating block exemptions that do not apply above a certain market share threshold, and then only for companies with a significant turnover. is not possible should The Economic and Social Committee In its Opinion of 4 June 1997 the Economic and Social Committee recognises that the current block exemption regulations are too rigid and often difficult to interpret. Emphasis should be placed on the importance of market structure in assessing the effects of vertical restraints, together with the need to focus on the market impact, rather than the formal content of agreements. The Committee the blockÜ exemptions to apply to upstream linkages in the supply chain between producers and suppliers of necessary inputs. The wider the coverage of the block exemptions, the less the need for individual notifications of vertical agreements. It would also welcome the addition of a non opposition procedure. favour of expanding in is While not opposed to Option II (wider block exemptions without a market share cap) the Committee strongly recommends Option IV, Variant I (Option II with a negative clearance presumption up to [20Ø%ü). It has reservations about Option IV, Variant II (Option IVÜI with a market share cap of [40Ø%ü). However, if the Commission were able to introduce Option IV, Variant I, combined with extremely wide block exemptions, then the Committee could see a case for a procedural mechanism distribution agreements with high market shares. for monitoring vertical Committee of the Regions In its Opinion of 12 June 1997 the Committee of the Regions considers that the multi faceted nature of the question of vertical restraints makes it difficult to select a single option which is not highly debatable for one sector or another. Whichever option is selected, agreements - such as those for beer - must be safeguard. Views other than those of manufacturers and distributors should be brought into the process of assessing consumer benefit. C 365/8 EN Official Journal of the European Communities 26. 11. 98 In relation to Options III and IV, the introduction of market share thresholds only makes sense if these are expressed in terms of the entire Community market. The Committee believes that ultimately the option which should be selected is Option I. Member States the Green Paper. Many of All but one of the fifteen Member States made written submissions on these submissions were made on a preliminary basis. There was no clear consensus on the format of future policy in this area. With regard to the options set out in the Green Paper, none of the Member States expressed a prefÜ erence for Option I or III, four gave a preference for Option II, three gave a preference for Option IV, Variant I, and two gave a preference for Option IV, Variant II. The remaining five Member States put forward other substantive options of their own. These may be summarised as follows: 1. a negative clearance regulation providing that almost all vertical restraints would be deemed a priori lawful, irrespective of market share, with the Commission, national authorities and national judges having the power to declare the regulation inapplicable with retroactive effect if there is no effective competition or if there are high barriers to entry in the market; 2. a single block exemption for all vertical agreements, with a market share threshold of [25Ø%ü. Above this market share, agreements would be covered by the individual exemption system. Below this threshold, the Commission would have the power of withdrawal for problematic cases; level above which a company 3. a negative clearance regulation with two market share thresholds. The first (25Ü40Ø%) to indicate the market likely to share second substantial market power. The exercise (60Ü80Ø%) to indicate the possible restrictions caused by companies with at least a 10Ü15Ø% market share in case of a cumulative effect of parallel network agreements; is to the need to change The first element of general consensus amongst the Member States relates the Commission’s current policy on vertical restraints. It is recognised that the adoption of a more economic based approach would of necessity result in a system with less legal certainty for companies with market power who currently benefit from existing BE Regulations. The second element of consensus relates to the most recent vertical according economic restraints should only be considered as capable of harming competition when they are linked to some degree of market power. The third element of consensus relates to the need for maintaining the importance given to the market integration objective in the assessment of vertical restraints, particularly light of future enlargement. to which literature, in the As a follow up to this consensus there appear to be two trends of thought. The first tends to simply promote the introduction of a level of flexibility within the existing system by reducing the regulatory approach of the current block exemption regulations. A second approach is based on the need to adopt a real change in policy. This second approach has two major hypotheses. The first is based on maintaining the current prohibition system of Article 85. This system could be adjusted by the introduction of market share thresholds. The aim of these thresholds would be to determine, on the basis of the market power level, both the absence of grounds for the application of Article 85(1) and field of application of a single, wide block exemption covering all vertical restraints. The second hypothesis is based on a switch from a prohibition to a control of abuse system. This system would in effect grant almost all vertical restraints an a priori presumption of compatibility with Article 85(1), with the possibility for the Commission to withdraw this positive presumption with effect only for the future. the In the course of the consultation exercise, the positions expressed by the Member States on the Green Paper have evolved and led to a greater consensus on the policy proposal set out in this communication, i. e. one broad BlockÜExemption regulation limited by one/two market share threshold(s). irrespective of market 4. a single black clause block exemption. The exemption share. The would apply Commission would be able to ask for individual notifications. The block exemption would confer provisional validity upon vertical agreements, which could be withdrawn only with effect for the future; SECTION III - ECONOMICS OF VERTICALS 1. Vertical restraints and market power 5. broader and more the application of which would be controlled, a posteriori by the national competition authorities. flexible block exemptions, As indicated in the introduction, economics tells us that in the field of vertical restraints competition concerns can only arise inter brand competition, i. e. if there exists a certain degree of market insufficient there is if 26. 11. 98 EN Official Journal of the European Communities C 365/9 the other hand, power. On the one hand, the fiercer the inter brand competition is, the more likely it is that vertical restraints have no negative effect or at least a net positive effect. On inter brand competition, the more likely it is that vertical restraints have a net negative effect. This means that the same vertical restraint can have different effects depending on the market structure and on the market power of the company applying the vertical restraint. the weaker the In economics, market power is usually defined as the power to raise price above the competitive level (in the short run marginal cost, in the long run average total cost). In other words, a company has market power if it has a perceptible influence on the price against which it can sell and if by charging a price above the competitive level it is able, at least in the short term, to obtain supraÜ normal profits. Most economists would agree that there exists market power below the level of dominance as defined by the Court of Justice. This view was also expressed in the Green PaperØ(˛), to indicate that vertical restraints can harm competition below the level of dominance and therefore that Article 86 and merger control will not suffice. Article 85 needs to be applied to vertical restraints, in particular in oligopolistic markets where none of the individual companies hold a dominant position. It is also generally recognised that vertical restraints are less harmful than horizontal competition on average restraints. The main reason treating a vertical for restraint more leniently than a horizontal restraint lies in the fact that the latter may concern an agreement between competitors producing substitute goods/services while the former concerns an agreement between a supplier and a buyer of a particular product/service. In horizontal situations the exercise of market power by one company (higher price of its product) will benefit its an competitors. This may provide to incentive competitors to behave antiÜ induce each other competitively. In vertical situations the product of the one is the input for the other. This means that the exercise of market power by either the upstream or downstream company would normally hurt the demand for the product of the other. The companies involved in to the agreement may prevent the exercise of market power by the other (so called self policing character of vertical restraints). therefore have an incentive to can only try to increase its profits by optimising its manufacturing and distribution processes, with or without the help of vertical restraints. However, when it does have market power it can also try to increase its profits at the expense of its direct competitors by raising their costs and at the expense of its buyers/consumers by trying to appropriate some of their surplus. This can happen when the upstream and downstream company share the extra profits or when one of the two imposes the vertical restraint and thereby appropriates all the extra profits. 2. The negative effects 2. 1. Individual vertical restraints The negative effects on the market that may result from anti competitive vertical agreements and that Community competition law aims at preventing are the following: - foreclosure, either of other suppliers or of other buyers; - the deterioration of price and non price conditions available to consumers, either for one particular brand (reduction of intra brand competition) or between different brands (reduction of inter brand competition); - collusion amongst suppliers or buyers facilitated by vertical restraints; - the creation of obstacles integration, including, most of all, limitations on the freedom of the European consumers to purchase a good or service in any Member State they may choose. to market Such negative effects may result from various vertical restraints. Special care is needed due to the fact that agreements which are different in form may have the impact on competition. To analyse same substantive these possible negative effects it is appropriate to divide four groups: an exclusiveÜ vertical distribution a resale price maintenance group and a market partiÜ tioning group. The vertical restraints within each group seem to have similar negative effects on competition. single branding into a restraints group, group, However, this self restraining character should not be over estimated. When a company has no market power it (˛) Green Paper on Vertical Restraints in Community Competition Policy, point 303. Before describing the four groups a number of general points need to be made. First, the analysis applies to both goods and services, although certain restraints are mainly C 365/10 EN Official Journal of the European Communities 26. 11. 98 used in the distribution of goods. This is why throughout this text the term good(s) means both good(s) and service(s) unless otherwise stated. Secondly, vertical agreements can be concluded for intermediate and final goods and services. Unless otherwise stated the analysis and arguments in the text apply to all levels of trade and the neutral terms supplier and buyer are used. When only a specific indicated. Thirdly, the classification is based upon what could be described as the basic components of vertical restraints. In practice many vertical agreements make use of more than one of these components. To give an example, exclusive distribution usually limits the number of buyers the supplier can sell to and often at the same time limits the area where the buyers can be active. The first component may lead to foreclosure of other buyers while the second component may lead to market partitioning. implicated this level is is ExclusiveÜdistribution group Under the heading of exclusive distribution come those agreements/components that have as their main element that the manufacturer is selling only to one or a limited number of buyers. This may be to restrict the number of buyers for a particular territory or group of customers, or to restrict the kind of buyers. This group comprises amongst others exclusive distribution and exclusive customer allocation as the supplier limits its sales to only one buyer for a certain territory or class of customers. It also comprises exclusive supply and quantity forcing on the supplier, where an obligation or incentive scheme agreed between the supplier and the buyer makes the former to sell on a particular market only or mainly to one buyer. This group selective distribution, where the conditions imposed on or agreed with the selected dealers may limit their number. comprises also is concerned, since it will also There are two main effects on competition: 1. certain buyers within that market can no longer buy from this particular supplier, i. e. it leads, in particular in the case of exclusive supply, to foreclosure, and 2. as far as the less distribution of final goods distributors will offer this good lead to reduced intra brand competition. In the case of wide exclusive territories or in case of exclusive customer alloÜ cation the result may be total elimination of intra brand competition. In addition, when a selective distribution agreement is used rather strictly, i. e. not many stores can less carry in store competition. competition Furthermore, selective distribution contains a limitation on resale since approved dealers may only sell to end consumers and other approved dealers. to inter brand the product, reduced it also leads and SingleÜbranding group those the heading of single branding come Under agreements/components that have as their main element that the buyer is induced to concentrate his orders for a particular type of good with one supplier. The group comprises amongst others non compete and quantity forcing on the buyer, where an obligation or incentive scheme agreed between the supplier and the buyer makes the latter purchase its requirements for a particular good or service and its substitutes only or mainly from one supplier. There are two main effects on competition: 1. other suppliers in that market cannot sell to the particular buyers, i. e. foreclosure of competing suppliers, and 2. as far as the distribution of final goods is concerned, the particular retailers will only sell one brand, therefore there will be no in store competition in their shops. Both effects may inter brand competition. reduction to a lead in in inter brand competition may be The reduction mitigated by stronger ex ante competition between suppliers to obtain the single branding contracts, but the longer the duration the more likely it will be that this effect will not be strong enough to fully compensate for the lack of inter brand competition. ResaleÜprice maintenance group Under the heading of resale price maintenance (RPM) come those agreements/components that have as their main element that the buyer is obliged or induced to resell not below a certain price, at a certain price or not above a certain price. This group comprises minimum, resale prices. fixed, maximum and Maximum and resale prices, while unlikely to have negative effects, may work as fixed RPM. As RPM relates to the resale price it is mainly relevant for the distribution of final goods. recommended recommended There are two main effects of minimum and fixed RPM longer on competition: 1. the distributors can no 26. 11. 98 EN Official Journal of the European Communities C 365/11 compete on price for that brand, leading to a total elimiÜ nation of intra brand price competition, and 2. there is increased transparency on price and responsibility for price changes, making horizontal collusion between manufacturers or distributors easier, at least in concenÜ trated markets. The reduction in intra brand competition may, as it leads to less downward pressure on the price for the particular good, have as an indirect effect a reduced level of inter brand competition. MarketÜpartitioning group the heading of market partitioning come Under agreements/components that have as their main element that the buyer is restricted as to where it either sources or resells a particular good or that the supplier is restricted to whom it may sell its good. This group includes exclusive purchasing, where an obligation or incentive scheme agreed between the supplier and the buyer makes the latter purchase its requirements for a particular good or service exclusively from the supplier, but leaving the buyer free to buy and sell competing territorial sales goods or services. It also restrictions, customer sales restrictions, after market sales restrictions, prohibitions of resale and tying. includes The main effect on competition is a reduction of intra brand competition that may help the supplier or the buyer (in case of after market sales restrictions) to partition the market and thus hinder market integration. This may facilitate price discrimination. Tying is slightly the odd one out. Its main effect is that the buyers may pay a higher price for the tied good than they would otherwise do but it may also lead to foreclosure of other suppliers and reduced in the market of the tied good. inter brand competition 2. 2. Combinations of vertical restraints The next question to be considered is whether a combiÜ nation of different vertical restraints the negative effects. In the Green Paper a rather prominent place is given to the argument that certain combinations of vertical restraints are better for competition than their use in isolation from each otherØ(˛). Although this may occasionally be the case, it does not appear to be the increases (˛) Green Paper, point 67. general rule. In general the opposite seems true, a combiÜ nation usually aggravates the possible negative effects. a combines reduction distribution For example, a combination of single branding with exclusive of inter brand competition with a reduction of intra brand competition. In the case of final goods a market is created with local brand monopolists without in store competition. Also, to foreclosure at manufacturer level is added foreclosure at the retail level. This means that not only may it be difficult for a manufacturer to sell a new brand as stores are tied to one brand, but also that new entrants the retail market may have difficulty obtaining some of the leading brands. This results in a situation where it may be both difficult to find outlets and unprofitable to set up new outlets. to Another example is the combination of one of the restraints of the exclusive distribution group like selective distribution with RPM. To the reduction of intra brand competition of the first is added the elimination of intra brand price competition of the second. This quickly leads to a total elimination of intra brand competition. This elimination of intra brand competition may also help tendencies between manuÜ facturers facilitated by RPM. In general, this combiÜ nation does also not make sense from an efficiency point of view as both protect the margin of the retailer. One of these restraints would normally suffice to overcome, for example, a free rider problem between retailers. to sustain collusive A combination of one of the restraints of the single branding group with RPM may combine a reduction of inter brand competition resulting from a lack of in store competition with a facilitation of collusive behaviour between the manufacturers induced by RPM. Collusive behaviour may become easier as the lack of in store competition takes away some of the competitive pressure. In addition, the reduction of inter brand competition is combined with a loss of intra brand price competition resulting from RPM. Finally, all combinations of vertical restraints which make arbitrage either by final customers or by distributors more difficult, if not impossible, are negative from a market integration perspective. Examples include the combination of: 1. restriction combined with selective distribution at the same level of distribution, 2. exclusive distribution combined with exclusive purchasing, and 3. selective distribution combined with exclusive purchasing. territorial sales C 365/12 EN Official Journal of the European Communities 26. 11. 98 Certain combinations may however be viewed more positively, because it can be argued that one of the vertical restraints limits the possible negative effects of the other. In the combination of exclusive distribution with maximum RPM the latter restraint may help the supplier to limit possible price increases the buyer may want to implement under the protection of the territorial exclusivity obtained. The same reasoning can be applied selective distribution and to maximum RPM. Also the combination of exclusive distribution with quantity forcing on the buyer may work in the same way as the latter may prevent the distributor from raising his prices. combination of the 3. The positive effects It is said that in a number of situations the usual arm’s length dealings between manufacturer and retailer, determining only price and quantity of a certain transÜ action, lead to a sub optimal level of investments and sales. The following generalisations can be made about this: 1. The this - level of investments and sales - first and main reason why i. e. a sub optimal is supposed to happen is the existence of some form of free rider problem. The person who makes an effort may not be able to appropriate all the benefits his or her effort engenders and may therefore be inclined to invest sub optimally. This may be the result of free riding by one retailer on the promotion efforts of similar another retailer. Exclusive distribution or restrictions or RPM may be helpful in avoiding such free riding. FreeÜriding can also occur between manuÜ facturers where one invests in promotion in the shops for its brand, thereby also attracting customers for its competitors. NonÜcompete type restraints can help to overcome this latter type of free riding. the retailers effective service requirements concerning the pre sales servicesØ(˛). FreeÜriding between manufacturers is also limited by rather strict conditions. Where a product is promoted by the manufacturer through national advertising there seems to be little scope for a free rider issue to arise that could be addressed through non compete obligations imposed on the distributors. Only in case the promotion takes place in certain retail outlets could a non compete type agreement help capture the full benefits. In addition, it can only occur on pre sales service, it must not be possible to make the promotion brand specific and likely for relatively new and complex products as customers may otherwise already very well know what they want. is only suppose a real 2. A second general point that needs to be made is concerns the possible divergence between what privately efficient and what is efficient from a total welfare/consumer point of view. What is privately efficient is not always good for total welfare. To go back to the free riding between retailers or between manufacturers. Let us free rider problem exists and sales can be expanded by inducing more pre sales services although this would also lead to higher prices. When these extra services are valued equally by the majority of consumers this may very well lead to higher total welfare. But when the infraÜ marginal consumers (that is those who are already buying at the current price/service level) know what they want and do not appreciate the extra service, they only suffer from the higher price, especially if there is insufficient inter brand competition. It may be privately efficient to level to attract more marginal consumers and thereby increase sales, but total welfare may nonetheless suffer. increase the service issue, something that For there to be a problem there needs to be a real free rider is not always so obvious. FreeÜriding between retailers can only occur on pre sales services and not on after sales services. The good needs to be relatively new or technically complex as the customer otherwise may very well know what he wants from past purchases. And the good must be of a reasonably high value as it is otherwise not attractive for a customer to go to one shop for information and to another to buy. On top of this, when all these conditions are fulfilled it must not be practical for the manufacturer to agree with 3. A special form of free riding is the certification free rider issue. The hypothesis is that certain retailers perform a valuable service by "good’ products. The fact that these retailers sell a certain identifying (˛) The standard argument against contractability of service requirements is that the costs of monitoring and the contract costs may be prohibitive for the manufacturer in case of a large number of small retailers. 26. 11. 98 EN Official Journal of the European Communities C 365/13 its introduction may fail. If this product signifies to the consumer that it is a good buy. This hypothesis may sometimes be useful for explaining the introduction of new products. New and complex products are first stocked by highÜ quality, high margin stores where they are bought by avant garde consumers. Gradually reputation becomes established and demand grows enough for it to be sold through low price chains. If the manuÜ facturer cannot initially limit its sales to the premium stores, it runs the risk of being delisted and the product is true, a problem analogous to invention patent protection exists. It may be necessary to provide temporary protection against price discounters to help the introÜ duction of the product. However, a period of protection which is too long may only delay the into the mature, price competitive product moving stages of the disadvantage of consumers. This means, at best, that there may be a reason to allow for a limited duration a restriction of the exclusive distribution or RPM kind; enough to guarantee introduction, but not so long as to hinder large scale dissemination. life cycle, its to there are 4. Yet another special form of free riding is the so called "hold up’ problem. Sometimes specific investments to be made by either the supplier or the buyer, such as in special equipment or training. In such a case, after the investments have been made the investor becomes to a certain extent prisoner to the other side. The balance of power will shift. In fear of this the necessary investments may not be made, unless ex ante supply arrangements can be fixed. The investor fears that the other side will free ride on its investment. However, as in the free riding example between retailers, there are a number of conditions which have to be met before such a risk is real. First, the investment must be sunk and specific to deal with that other party only. Secondly, it must be a long term investment which is not recouped in the short run. And thirdly, the investment must be asymÜ metric; i. e. one invests more than the other. Only when these conditions are met can there be a real limited reason to have a vertical restraint for a the duration, of investment the exclusive distribution or exclusive supply type when the investment is made by the buyer. type when the supplier and of the non compete is made by a final price that even exceeds the monopoly price an integrated company would charge, to the detriment of their collective profits and consumers. In this case quantity forcing on the buyer or maximum RPM could help the manufacturer bring the price down to monopoly level. large measure of substitutability between 6. In the economic literature it is explained that there is a the different vertical restraints. This means that the same inefficiency problem can be solved by different vertical restraints. For example, as explained above, the problem of free riding between retailers or the certification free rider problem can be solved by means of exclusive distribution or fixed or minimum RPM. This is of importance as the negative effects on competition may differ between the various vertical restraints. This plays a role when indispensability is discussed under Article 85(3). As RPM is generally considered to be less acceptable from a competition point of view this is a reason only to allow exclusive distribution or other less serious restraints and not RPM. 4. General rules for the evaluation of vertical restraints In evaluating vertical restraints from a competition policy perspective, some general rules can be formulated. intra brand it can be said that vertical As a first general rule restraints which reduce inter brand competition are generally more harmful than vertical restraints that only reduce example, non compete obligations are likely to have more net negative effects than exclusive distribution. The former, by foreclosing other brands, may prevent these brands from reaching the market. The latter, while foreclosing certain buyers, does not, in general, prevent the good from reaching the final consumer. competition. For 5. The last reason for sub optimal sales that should be mentioned, is the problem of "double marginalisation’. In case both the manufacturer and the retailer have market power each will set its price above marginal cost. They both add their margin that exceeds the one that would exist under competition. This may result in A second general rule is that exclusive agreements are generally worse than non exclusive for competition agreements. Exclusive agreements make, by the express C 365/14 EN Official Journal of the European Communities 26. 11. 98 language of the contracts or their practical effects, one party fulfil all or practically all its requirements from another party. For example, a non compete obligation makes that the buyer purchases only one brand, while leaves the buyer scope to purchase quantity forcing competing goods. The degree of foreclosure is therefore different, while often the efficiencies are remarkably similar. a somewhat less serious restriction. It concerns the possible extension of market power from one market into another. Possible efficiency arguments ("need to assure the buyer uses the right sort of input for the fragile machine we sold him as breakdowns may hurt our products image’ or "joint delivery is cost saving’) may be limited. Exclusive purchasing, i. e. the obliÜ gation to source directly from one supplier without a restriction on selling competing brands, is the last serious restriction within this group. A third general rule that can be formulated is that the possible negative effects of vertical restraints are reinÜ forced when not just one supplier with its buyers practies a certain vertical restraint but when also other suppliers and their buyers organise their trade in a similar way. These so called cumulative effects may be a problem in a number of sectors. To make a valid assessment of the effects of a cumulation of vertical agreements requires a sector wide investigation and overview. The issue of withdrawal of the proposed BE Regulation is reviewed in the section VÜ3 and will be further developed guidelines. in In addition to these three general rules some further points can be made: - RPM is usually considered to be more restrictive than the other vertical restraints. In case of efficiencies it can often be replaced by less competition distorting restraints with is in most countries reflected by the current policy which tends to be very strict on RPM while allowing exclusive distribution in certain market conditions. similar positive effects. This - Community competition policy, with its emphasis on the necessity to protect arbitrage and the general prohibition on resale restrictions, reflects the concern to further market integration. - Restraints agreed for intermediate goods are in general less harmful than restraints affecting the distribution of final goods. As intermediate goods are not sold to final consumers but are used as an input, brand and image are less important. This makes a less intra brand possible important. This distinction between intermediate and final goods and in guidelines. services will be competition taken up loss of - Within the RPM group, fixed and minimum price maintenance are serious restraints. Maximum and recommended prices, when really maximum or recommended, are not considered to be restrictive of competition. SECTION IV - MARKETÜSHARE THRESHOLDS AND LEGAL CERTAINTY 1. Existing block exemptions regulations The present block exemption (exclusive distribution, exclusive purchasing and franchising) follow a legalistic clause based approach where the focus is on the freedom of action of dealers and on intra brand competition between dealers belonging the same distribution system. Apart from the withdrawal system and the possible application of Article 86, the exemptions are granted for all companies irrespective of market power. to - Within the market partitioning group restriction of resale and after market sales restrictions seem the worst as they allow market partitioning without clear possible efficiencies. "Tying’ is in general considered system exempts This from Article 85(1), without distinction, companies with 1Ø% and 100Ø% market share even for non compete obligations and certain combinations of vertical restraints such as exclusive and selective distribution (see franchising regulation). It leads to the result that small operators (the vast majority of companies) suffer unnecessarily strict regulation while 26. 11. 98 EN Official Journal of the European Communities C 365/15 companies with significant market power can protect themselves simply by drafting the contract clauses so as to fit within the existing block exemption regulations. The Commission can withdraw the benefit of these exemption regulations only with effect for the future. Companies with market power can apply the most serious restrictions until the Commission adopts a prohibition decision. There is no pressure on companies to change their agreements or conduct because they effectively enjoy provisional validity for their contracts. Therefore, the preventive effect of the prohibition system of Article 85(1) to lost. competition can be caused without any remedy for the past (e. g. market foreclosure through exclusive dealings). At the same time, smaller operators are prevented from using vertical restraints in an innovative way to improve their competitive position on the market. This hinders the development of new dynamic forms of distribution. Therefore regulations the cannot be carried forward. existing block exemption Irreparable damage is 2. Economic approach and market share thresholds Two policy conclusions can be drawn from the economic learning described in the previous section: firstly, in the absence of market power, a presumption of legality for for certain vertical restraints can be made except hardcore restrictions; secondly, when market power exists, no general presumption of legality can be made. Therefore, it makes economic sense to use market share thresholds to limit the application of a block exemption regulation. It is clear that market share is not a substitute for market power. In an individual case the establishment of an infringement in respect of a particular vertical restraint can normally only be assessed by looking at all aspects of market structure and market behaviour. However, such a market analysis imposes significant enforcement costs on the competition authority and cannot be applied to every single case. It is possible to make two policy assumptions that assist in this market analysis. First, in the majority of cases a market share of 20Ø% is normally insufficient to bring about net negative effects on competition that would result from vertical restraints practised by a single firm. Secondly, for certain vertical restraints in the light of significant efficiencies a block exemption up to 40Ø% market share, which is the level at which a risk of dominance starts, can be envisaged. Above that level there is a risk that the last condition of Article 85(3) is no longer fulfilled. Accordingly, the use of market share thresholds in a block exemption regulation does not establish an infringement but serves to exclude certain categories of vertical restraints from the application of Article 85(1) by applying Article 85(3). the By working with these two policy assumptions based on market share only, the Commission is aware that it may exempt certain agreements that do not justify exemption. The higher the market shares used the higher that risk will be. The Commission considers that the market share thresholds of 20Ø% and 40Ø% linked to the nature of the vertical restraint and importance of efficiencies levels for a future blockÜ involved are appropriate exemption regulation. However, the exact level of the market share thresholds and the question of whether one should only work with one threshold instead of two will be reconsidered by the Commission in the course of the consultation on the BE and the guidelines (see explaÜ nation following hereafter). The Commission intends to maintain the withdrawal mechanism for the rare cases where a serious competition problem may arise below these levels of market shares. The withdrawal mechanism will in particular be applied in cumulative effect cases (see Section V for further details). Nobody has been able to suggest a better single indicator than market share for use in a block exemption reguÜ lation. The only alternative would be to only work with guidelines that would make it possible to use the full set of market factors for the assessment of vertical restraints. The Commission considers the present stage, represent too radical a change and afford industry a lower level of legal certainty than the use of a block exemption with market share thresholds. this would, at that involve a certain degree of Competition rules are economic rules that by their very nature legal uncertainty. Companies holding market power are exposed to the risk of violating the competition rules. The Commission pursues the objective to create a reasonable level of legal certainty for industry that is compatible with the efficient protection of competition. The use of market share thresholds makes it possible to create the link between a more economic approach and legal certainty. C 365/16 EN Official Journal of the European Communities 26. 11. 98 Market shares are not an unknown phenomenon in the Community competition rules. Industry has been living for many years with market share thresholds which dispense with notification (see the 15Ø% market share in Article 4(2) of Council Regulation No 17), create a presumption of negative clearance (see the 10Ø% market share in the Notice on agreements of minor importance or the 25Ø% market share threshold in the Merger ReguÜ lation) or grant a block exemption (see the 10Ø% and 20Ø% market share thresholds in Regulations (EEC) No 417Ø85Ø(˛) and (EEC) No 418/85Ø(ˇ). This has not created an legal uncertainty for level of industry. intolerable 3. Market share cap a condition for a wider blockÜ exemption for for cars, the present system intermediate goods or the majority of vertical Under agreements are not covered by any block exemption regulation. Only goods for resale are covered as far as exclusive distribution, exclusive purchasing and franÜ selective chising are concerned. Except distribution is not covered by any block exemption. There is no block exemption for services (except for franchising), for goods undergoing processing. To the extent that a blockÜ exemption applies, it sets out which clauses are exempted (white list that everything else is not exempted. This approach limits the scope of application of the existing block exemptions and results in excessive regulation for industry. At the moment, the majority of companies are not covered by any block exemption and thus either take the risk of not notifying or of notifying and accepting in most cases a comfort letter from the Commission. approach) with consequence the The Commission wants to correct this situation by considerably widening the existing block exemptions to include services, intermediate goods, goods for resale combined with transformation and selective distribution. It also wants to largely replace the present white list approach by a black list approach. The Commission considers that this will ultimately give legal certainty to more companies than the present narrow clause based block exemption approach. With a much wider blockÜ to continue exemption, is, however, impossible it (˛) Commission Regulation (EEC) No 417/85 of 19 December 1984 on the application of Article 85(3) of the Treaty to categories of specialisation agreements (OJ L 53, 22. 2. 1985, p. 1). (ˇ) Commission Regulation (EEC) No 418/85 of 19 December 1984 on the application of Article 85(3) of the Treaty to categories of research and development agreements (OJ L 53, 22. 2. 1985, p. 5). irrespective power. The exempting Commission therefore its future in BlockÜExemption Regulation with two parameters: the nature of the vertical restraint and the level of market power involved. of market intends to work 4. No presumption of illegality above the market share cap that recognises The Commission the use of a market share cap will create a certain degree of uncerÜ tainty for companies as to the application of the BE is due to the difficulty of defining regulation. This markets and assessing a company’s position on the relevant product and geographic market. It also results from the volatility of market shares that change over time. However, this following two elements: legal uncertainty is mitigated by the - The use of market share thresholds does not create a presumption of illegality above the market share cap. The market share threshold will only operate as a safe harbour, to distinguish the agreements that are presumed to be legal from those which may require individual examination. In respect of the latter, the Commission will continue to bear the burden of proof that the agreement in question does violate Article 85(1) and will have to examine whether the agreement does fulfil the conditions of Article 85(3). This is the normal situation of an agreement not covered by a block exemption regulation. Above the threshold, three situations can thus arise: negative clearance, individual exemption or a prohibition ex if the conditions of Article 85(3) are not tunc fulfilled. - Companies will need to know what policy the Commission is going to apply above the thresholds. The Commission therefore intends to issue a set of guidelines which should basically cover three issues: the scope of Article 85(1) above the market share cap, the Commission’s policy under Article 85(3) and its policy of withdrawal of the benefit of the blockÜ exemption, particularly in cumulative effect cases. These guidelines should set out clear and simple rules so as to allow companies to make in most cases their own assessment under Article 85(1) and (3). The objective must be to reduce the enforcement cost for 26. 11. 98 EN Official Journal of the European Communities C 365/17 industry and to eliminate as far as possible notifiÜ cations of agreements that do not raise any serious competition problem. a more Since the BE regulation uses market share thresholds combined with to vertical restraints, less agreements will be covered by Article 85(1). A consistent application of the guidelines and the publication of leading decisions will further increase the level of legal certainty for industry. economic approach a real doubt about the applicability of Article 85(3); this reduction in notifications is very likely to occur, as is evident from those agreements already covered by Article 4(2) of Regulation No 17 which are not normally notified. This will allow the Commission to reduce the advance control system based on notifiÜ cations and the competition authorities of Member States on the more important cases, thereby increasing the effiÜ ciency of the Community competition rules. The objective is to reduce the enforcement costs to industry and to eliminate as far as possible notifiÜ cations which do not raise any serious competition problems. to concentrate, together with 5. Revision of Article 4(2) of Regulation No 17 Legal certainty will be further enhanced by the following additional elements: If a company makes a mistake in assessing its market share, it should not be punished for the fact that it has not notified its agreement. At present the Commission can only exempt back to the date of notification. Therefore, if a contract infringed Article 85(1) and has not been notified, a national judge may declare the contract null and void for the sole reason that it has not been notified, even if all the conditions of Article 85(3) are fulfilled. To change that situation it will be necessary to modify Article 4(2) of Council Regulation No 17 so that all vertical distribution agreements can be exempted retroÜ actively when notification takes place at a later date. Such a change will have several beneficial effects: - where a company has made a mistake the assessment of its market share and is not covered by the block exemption, the Commission will be able to exempt retroactively provided all the conditions of Article 85(3) were fulfilled from the beginning; in - it will eliminate artificial litigation before national courts, where the competition rules are often invoked to escape from contractual obligations even though there this will strengthen the civil enforceability of contracts by putting the emphasis on protection of competition instead of protection of private interests often unrelated to competition; is no real competition problem; - it will reduce the number of notifications presently occurring with a view to obtaining legal certainty; companies will not have to notify in advance to obtain the benefit of an individual exemption, but can make their own assessment under Article 85(1) and (3) and avoid the cost of notification unless they have - cumulative effects resulting from networks of vertical restraints will only be subject to the withdrawal system, with effect for the future; - in the event of a dual threshold the agreements of SMEs will be subject to the higher market share cap. However, they will remain subject to withdrawal and hardcore restrictions; system - for the calculation of the market share thresholds, the following rules will apply: (i) coverage by the future block exemption will be based on the relevant antitrust market as explained in the Commission Notice on market definitionØ(˛); (ii) the market share will be based on data for the preceding financial year; (iii) the market share can be calculated on the basis of sales volume where there is insufficient data on sales value; (iv) agreements the blockÜ remain covered by exemption regulation for a period of two years as long as the threshold is not exceeded by more than 5Ø% market share; (v) if the threshold is exceeded, including the 5Ø% increase referred to in point (iv), a grace period of one year will apply during which period (˛) Commission Notice on the definition of relevant market for the purposes of Community competition law (OJ C 372, 9. 12. 1997, p. 5). C 365/18 EN Official Journal of the European Communities 26. 11. 98 the block exemption regulation will continue to apply; the grace period would start in the year following the financial year the threshold was exceeded; in which - in general, it will only be necessary to estimate the market share of the supplier, as it is this market share that decides whether an agreement is block exempted or not. However, in cases of exclusive supply the market share of the buyer may have to be used as the relevant indicator. In addition, the guidelines will address the issue of how the Commission will take account of the buyer’s market position in the analysis of individual cases. is recognised that these measures will not create It absolute legal certainty. However, a more economic approach is incompatible with absolute legal certainty. The aim of the present revision exercise is to bring about a new balance between a more economic approach and a reasonable level of legal certainty. This new approach is ultimately to the benefit of smaller operators without market power which are the vast majority of companies. It will also be to the benefit of bigger companies operating in competitive markets. However, companies with significant market power which would practice antiÜ competitive vertical restraints will be subjected to stricter control to the benefit of competition, other competitors and finally consumers. 6. Increased decentralisation Under the existing BE regulation, there is very little scope for decentralised application of the Community competition rules. If a company drafts its agreement in accordance with the BE regulations there is no scope for the application of Article 85(2) by the national competition authorities or the national courts, because all companies are covered up to 100Ø% market share and only the Commission has the power to withdraw the benefit of those BE regulations. Therefore, while the existing block exemptions apply third parties have no other course of action than to bring a complaint to the Commission. competition authorities the benefit of the BE regulation in their territory if the conditions of Article 85(3) are no longer fulfilled. to withdraw the power The Commission will closely cooperate with national competition authorities and courts to assist them in the increased application of Article 85. This cooperation is already operational since the adoption of the notices on cooperation with national competition authoritiesØ(˛) and national courtsØ(ˇ). SECTION V - POLICY PROPOSAL 1. Different options During the Green Paper exercise the policy options described in Section II (see in particular the Table in II. 1) were reviewed. Most of these are not acceptable as they would not solve the three major shortcomings of current policy: regulation, neglect of market power and block exemptions which are too narrow. strait jacket form based Option I of the Green Paper retains all these shortÜ comings. Options II and IVÜI reduce the strait jacket effect but increase the neglect of market power. The umbrella block exemption without market shares takes the neglect of market power to the extreme. Option III and Option IVÜII do take account of market power but do stay too much with narrow block exemptions with a strait jacket effect. Two other options, fundamentally different from the one that is proposed below, would not solve the main drawbacks of the current policy. The first, which relies single black clause block exemption without on a confer provisional market share validity upon vertical agreements, subject only to withÜ drawal with effect for the future. This solution would lead to the elimination of the preventive effect which is inherent in the prohibition system provided for by Article 85 and based on the ex tunc nullity of anti comÜ thresholds, would Under the new proposed BE regulation, decentralised is application of opened up for national competition authorities and courts above the market share threshold(s) of the BE regulation. In addition it is proposed to give national the Community competition rules (˛) Notice on cooperation between national competition authÜ orities and the Commission in applying Articles 85 and 86 of the EC Treaty (OJ C 313, 15. 10. 1997, p. 3). (ˇ) Notice on cooperation between national courts and the Commission in applying Articles 85 and 86 of the EC Treaty (OJ C 39, 13. 2. 1993, p. 6). 26. 11. 98 EN Official Journal of the European Communities C 365/19 petitive practices. It should be recalled that such a preventive effect plays a fundamental role in ensuring effective compliance by the companies and, ultimately, sound competition conditions. (subject that vertical restraints The second option that is not acceptable is to start from to the presumption hardcore) are in general not anti competitive and thus can be covered by a wide negative clearance regulation, the benefit of which can be taken away with retroactive effect in cases where competition is distorted without any offsetting gains in efficiency. This general positive presumption is supported neither by economic thinking nor enforcement experience. Furthermore, it would result in increased legal uncertainty for industry. In fact, as there would be no market share limits that would create a safe harbour the national courts, the national competition authorities and the Commission could all retroactively declare the negative clearance inapplicable at any level of market power. 2. The proposed new policy in the introduction, future policy As was explained should avoid the three major shortcomings of current policy. The new policy should first and foremost protect competition and market integration. It should also provide a reasonable level of legal certainty for business, result in acceptable enforcement costs for industry and the competition authorities and increase decentralisation. In order to avoid the shortcomings and strike the right balance between these different objectives, a profound change of policy is necessary. The main characteristics of the proposed policy are the following: - The basis is one, very wide, BlockÜExemption reguÜ lation ("the BlockÜExemption’) that covers all vertical restraints concerning intermediate and final goods and services, except for a limited number of hardcore restraints. This solves the shortcoming of blockÜ exemptions which are too narrow. - It makes use of market share caps to in link the exemption to market power. The issue of whether one or two market share thresholds should be used has not yet been decided. A single threshold system has advantages in terms of clarity and simplicityØ(˛). A dual threshold system allows an economically justified gradation treatment of vertical the restraints reflecting differences in their likely antiÜ is competitive effects. Below assumed that vertical restraints have no significant net negative effects. This means that the agreements either fall outside Article 85(1) or, when falling within Article 85(1), with the hardcore restraints, may be block exempted. The hardcore restraints are mainly related to resale price maintenance and to restrictions on resale which are deemed not to justify block exemption in the light of the market integration objective. the exception of thresholds such it - In case of a single threshold system the threshold would lie in the range of 25Ü35Ø% market share, clearly below what is usually perceived as the level of dominance. In case of a dual threshold system the first and main market share cap would be around 20Ø%. Above the 20Ø% threshold there is room to exempt certain vertical restraints up to a higher level of around 40Ø%. Such an approach with market share(s) takes away the shortcoming of neglect of market power and, by eliminating the vast majority of notifications, probably 80 to 90Ø% of all cases, it the national the Commission and will allow competition authorities the important cases. concentrate on to - It will create a safe harbour to distinguish the agreements that are presumed to be legal from those which may require individual examination. Vertical restraints falling outside the safe harbour will not be presumed to be illegal but may need individual examÜ ination. In respect of agreements that fall outside the BE the Commission will continue to bear the burden of proof that the agreement in question does infringe Article 85(1) and will have to examine whether the agreement does fulfil the conditions of Article 85(3). - It is based mainly on a black clause approach, i. e. defining what instead of defining what is exempted. This removes the straitÜ jacket effect. is not block exempted (˛) In the course of consultation on this document a majority of the Member States expressed a preference for a singleÜ threshold system. C 365/20 EN Official Journal of the European Communities 26. 11. 98 three This is the normal situation for an agreement not covered by a block exemption regulation. Above the threshold, situations may arise: negative clearance, individual exemption or prohibition if the conditions of Article 85(3) are not fulfilled. The proposed policy will provide for guidelines detailing the Commission’s policy individual negative clearance, exemption or prohibition above the market share thresholds and possible withdrawal of the BlockÜExemption below the thresholds. concerning - There will be a number of flanking measures as outlined in the previous section. The most important one is the extension of Article 4(2) of Regulation 17 to all vertical distribution agreementsØ(˛). Taken together as a package with the other elements of the proposal, i. e. the fact that this very wide BlockÜ Exemption will cover many agreements that are not presently covered by a block exemption, the possible gradation in exemption, and guidelines, the overall level of legal certainty for industry will be improved. - It will be compatible with improved decentralisation. National courts and national competition authorities will be able to apply the BlockÜExemption, and, with the help of guidelines, apply Article 85(1) above the market share thresholds. Furthermore, if Article 85(1) is not applicable because there is no appreciable effect on trade between the Member States or on competition, the BE will not apply. It is also proposed that the national competition authÜ orities, on the basis of clear and well specified criteria, would have the power to withdraw the in respect of their benefit of the BE Regulation territory. This more economic approach is based upon the investiÜ gations made for the Green Paper, a careful analysis of all the comments received on the Green Paper, the Commission’s experience in past vertical cases, Court judgments and study of the relevant economic and legal literature. 3. Specific points The following specific points can be made about the proposed new policy: - The proposal will contain a list will fall outside that always in any event list of hardcore the BlockÜ restrictions Exemption. This include agreements concerning minimum and fixed resale prices and absolute territorial protection. In addition, the Commission proposes to protect the possibility of arbitrage by intermediate and final purchasers to a to blacklist more greater extent and therefore generally resale restrictions these far as restrictions result from factors under the control of the parties. The following may then be defined as hardcore restrictions that would fall outside the BlockÜExemption: so in 1. fixed resale prices or minimum resale prices; 2. maximum resale prices or recommended resale fixed or in reality amount prices which minimum resale prices as a result of a pressure exercised by any of the parties; to 3. the prevention or restriction of active or passive resales, imports or exports to final or non final buyers, other than (a) the restriction on active sales in the territory of an exclusive distributor, (b) to exclusively the restriction on active allocated restriction on (c) members of a selective distribution system from selling to unauthorised distributors, and (d) the restriction on the buyer of intermediate goods and/or services from selling these to other direct or indirect buyers of the supplier; customers, sales the 4. the prevention or restriction of cross supplies between distributors at the same or different levels of distribution selective distribution system or between distributors of these different i. e. exclusive or selective distribution combined with exclusive purchasing; systems of distribution: in an exclusive or 5. the combination, at the same level of distribution, of selective distribution and exclusive distribution containing a prohibition or restriction on active selling; (˛) A draft of the required Council Regulation is jointly submitted with this Communication. 6. the combination, at the same level of distribution, of selective distribution and exclusive customer allocation; 26. 11. 98 EN Official Journal of the European Communities C 365/21 7. an obligation on the supplier of an intermediate good not to sell the same good as a repair or replacement good to the independent aftermarket. which the buyer operates or in equivalent situations. The guidelines will take account of the particular relationship between investments and long duration limits. term - Where a single threshold system is chosen, all the non hardcore vertical restraints are covered below this threshold. - There are a number of vertical agreements that are in the future be generally considered or would considered to fall outside Article 85. These include qualitative selective distribution, service requirements and maximum and recommended resale prices if they do not amount to fixed RPM. - Where a dual threshold to system is chosen, lead to a form of exclusivity the non hardcore vertical restraints including the more serious ones are subject the first and main threshold of 20Ø% market share. These include the like restraints that exclusive supply, exclusive customer allocation and non compete. As explained in section III, exclusive vertical restraints are in general more likely to have significant anti competitive effects than non exclusive restraints, while the latter may often achieve the same efficiencies. To the extent that selective distribution falls within Article 85(1), it is also subject to this threshold in view of its considerable potential to reduce both intra and inter brand competition. Tying also falls under this threshold. The first threshold covers all possible vertical restraints and combinations of vertical restraints unless otherwise stated. - Again assuming a dual threshold system, the second threshold of 40Ø% would cover vertical restraints that, on the basis of the economic thinking or past policy experience, lead to less serious restrictions of competition. Firstly, one finds here the non exclusive type of agreements such as quantity forcing on buyer or supplier. As they leave room for dealing with others they are less serious than their exclusive counterparts. Two exclusive types of agreement are also exclusive distribution, as it does not directly harm inter brand competition and often has efficiencies, and 2. exclusive purchasing, as it does not lead to foreÜ closure or a direct inter brand competition. Lastly, this threshold would also apply to agreements between SMEs. reduction of threshold: subject this to 1. - It to effects foreclosure is proposed impose a duration limit on in view of the possible non compete agreements with serious connected non compete obligations. The Commission is also considering imposing a duration limit for exclusive purchasing combined with quantity forcing on the buyer. The Commission further considering dispensing with the duration limits in the particular cases where the supplier owns the premises from is - As was indicated at the end of Section III the possible negative effects of vertical restraints are reinÜ forced when a number of suppliers and their buyers practice a certain vertical restraint. These cumulative effects may be a problem in a number of sectors. Making a valid assessment of the effects of such a cumulation of vertical agreements may require a sector wide investigation and overview. In general only a competition authority can be expected to gather such sector wide information, as it may not be readily available to individual companies. It also seems fair to treat all companies the same if they add significantly to the total effect. Such cases of cumuÜ lative effect, where individual suppliers are covered by the BlockÜExemption, will be addressed by withdrawal of the BlockÜExemption with effect for the future. It is proposed that not only the Commission but also the national competition authÜ orities will have the power to withdraw the benefits of the BE. the The Commission will indicate when withdrawal is unlikely and when withdrawal is likely. It is proposed that withdrawal would be unlikely when less than a certain proportion of foreclosed the market through similar agreements and would also be unlikely when the individual firm’s market share is below a certain level. is to the Commission’s experience, According the possible negative outcome resulting from the cumuÜ lative effect of the same type of vertical restraints are especially at issue in the field of selective distribution. To address this problem, it is proposed that the inapplicable to BlockÜExemption may be declared companies operating a selective distribution system on a market where more than two thirds of the total sales is channelled through parallel networks of selective distribution. As the companies concerned in possession of such a sector wide may not be information, it is proposed that this condition would future BlockÜ not operate automatically. The the that Exemption Regulation would provide C 365/22 EN Official Journal of the European Communities 26. 11. 98 Commission would, at its own initiative, establish that the aforesaid condition is fulfilled in respect of a specific market and fix a transition period at the expiry of which the BlockÜExemption would no selective distribution longer agreements relating to that market. Such a transiÜ tional period should not be shorter than six months. The Commission will publish a decision to this effect in the Official Journal of the European Communities. applicable be to The subject matter of the 1979 Notice on subconÜ tractingØ(ˇ) also remains outside the scope of the BE regulation. However, vertical agreements relating to the supply of goods, produced on the basis of specifiÜ cations given by the buyer to the supplier, but not involving the use of know how or patent rights of the buyer for the manufacture of these goods, will be covered. - The choice has been made to propose one wide block exemption regulation instead of different reguÜ lations for specific forms of vertical restraints or sectors. It thus treats different forms of vertical restraints having similar effects in a similar way, preventing unjustified differentiation between forms or sectors. In this way it is avoided, to the greatest extent possible, to have a policy bias in the choice formats of concerning companies make distribution. The company’s choice should be based on commercial merit and not on unjustified differences in exemptability. This has a number of consequences that are spelled out in the next points. their - It is proposed to cover selective distribution in the BlockÜExemption regulation. Care has been taken to stay as close as possible to the current policy as formulated in past Commission decisions and Court judgments. This means that the supplier, in order to be covered by the BE, may not exclude a priori certain forms of distribution and may only apply selective distribution on condition that the nature of type of the good or distribution and the selection criteria are impleÜ mented objectively and in a non discriminatory manner. The supplier may also not specify the identity of competing brands to be sold by the authÜ orised distributor. service requires such a - Vertical agreements relating to the manufacture of goods, in particular when they involve the use of know how or patents, are not covered. Licence (EEC) No agreements covered by Regulation 240/96Ø(˛) on the transfer of technology will be future BE regulation. the outside the scope of - As it relating regards vertical agreements the to is distribution or supply of goods or services, proposed that the BE regulation cover intellectual property rigths to the extent that these do not relate to the manufacture of goods and are 1. indispensable for and complementary to those agreements which are exempted, and 2. contain obligations which are not more restrictive of competition than those vertical restraints which are exempted under the draft BE Regulation. This relates to restrictions on the use and application of the context of vertical agreements covered by the future block exemption regulation. intellectual property rights in - Agreements where the buyer of software on sells this software to the final consumer without obtaining any copyright over it are considered as agreements for the supply of goods for resale for the purposes of this BE. The treatment of software agreements beyond this requires further consideration. - Franchising, while being covered, will not be given any preferential treatment in the BlockÜExemption regulation as it is a combination of vertical restraints. is a combination of selective Usually franchising distribution and non compete obligations in relation to goods which are the franchise. Sometimes, other elements like a location clause or territorial exclusivity are added. These combinations will be treated according to the general criteria set forth in the BE. the subject matter of the involve - Certain distribution forms - in particular franchising - licensing of Intellectual Property Rights (IPR). In franchising, the transfer of IPR is an essential element of this distribution format and is used to assimilate the commercial practises of the franchisee as closely as possible to those of the franÜ (˛) Commission Regulation (EC) No 240/96 of 31 January 1996 on the application of Article 85(3) to certain categories of technology transfer agreements (OJ L 31, 9. 2. 1996, p. 2). (ˇ) Notice on subcontracting agreements (OJ CØ1, 3. 1. 1979, p. 2). 26. 11. 98 EN Official Journal of the European Communities C 365/23 to chisor. This licensing may include restrictions which are necessary or complementary the vertical restraints placed on the sale of the goods or services. While vertical restraints on the goods or services are important from a competition perspective and may result in a franchise agreement falling within the scope of Article 85(1), these necessary or compleÜ mentary restraints must be examined in the light of the need to protect the know how provided or the maintenance of the network’s identity and repuÜ tationØ(˛). - The BlockÜExemption Regulation will not cover vertical agreements between actual or potential competitors, except where is a non reciprocal one and no party has an annual turnover exeeding ECU 100 million. the agreement - A transitional period for the adaptation of existing agreements to the BE is anticipated but remains to be determined. 4. Conclusions The proposed new policy will create a more efficient protection of competition by allowing the competition authorities to concentrate their efforts on those cases involving market power. It will do away with the straitÜ jacket effect of current regulation and will reduce the industry. The smaller enforcement costs operators, especially, will benefit from this and from the enhanced level of legal certainty. imposed on There are four pillars on which this new policy is based: - It is further proposed that the BlockÜExemption Regulation will cover the vertical agreements of associations of independent retailers when the indiÜ vidual members of the association are SMEs as defined in the Annex to Commission RecommenÜ dation 96/280/EC. In the case of a dual threshold system these agreements would fall under the lower threshold. What is contemplated here are retailers who associate themselves under a common format to sell to final consumers. It is recognised that there are horizontal aspects the coverage by the BE is subject to the proviso that these horizontal aspects do not infringe Article 85. these associations and to - For reasons of coherence and unity of policy it is proposed not to retain sector specific rules for beer and petrolØ(ˇ). There are insufficient economic or legal reasons to continue to have a special regime for these sectors. In as far as sector specific treatment is in the justified this will be taken guidelines. into account - It is proposed not to apply the rule of severability but to make the exemption of agreements dependent on all the provisions in the BE being complied with. - one broad umbrella BlockÜExemption Regulation services with goods applying market share threshold(s) and a black list approach; both and to - guidelines detailing the policy above the thresholds and possible withdrawal of the BE; - the adjustment of Article 4(2) of Regulation 17 to reduce the number of notifications, to stop artificial litigation before national courts and strengthen the civil enforceability of contracts; - an increase in the role of national competition authÜ in the application of orities and national courts Article 85(1) above the market share thresholds and the withdrawal of the BE below the thresholds. SECTION VI - PROCEDURE 1. Legislative changes the policy proposal outlined Implementation of in Section V will require three new legislative texts, namely two Council amending the Commission’s powers under Regulation No 19/65/ EECØ(˛) and amending Article 4(2) of Regulation No 17, and a Commission block exemption regulation covering all vertical restraints in almost all sectors of distribution. regulations extending (˛) See Pronuptia v. Schillgalis, Case 161/84, [1986ü ECR 353, paras 23Ü24. (ˇ) The BlockÜExemption regulation on car distribution, which expires in 2002, is not covered by the current proposal. (˛) OJ 36, 6. 3. 1965, p. 533/65. C 365/24 EN Official Journal of the European Communities 26. 11. 98 The first Council amending regulation is required to grant the Commission the power to declare by way of a block exemption regulation that Article 85(1) shall not apply to certain categories of vertical agreements entered into between economic operators. This is because the current enabling regulation (Regulation No 19/65/EEC) is restricted to a limited number of vertical restraints, namely, exclusive distribution of goods for resale, exclusive purchase of goods for resale, obligations in respect of exclusive supply and exclusive purchase for resale, and restrictions the assignment or use of industrial property rights. It is also limited to agreements entered into between two parties. in relation imposed to The second Council amending regulation relates to the amendment of Article 4(2) of Regulation No 17, the First Regulation implementing Articles 85 and 86 of the Treaty. This is necessary because under the current system the date upon which an exemption can enter into effect cannot precede the date of notification. The Commission wants to change that system so as not to punish those companies which under the new more system working with market share economic based thresholds may make mistakes in the assessment of their market position. Section IV. 5 of this policy paper outlines a number of measures which are necessary to create a reasonable level of legal certainty for economic operators. The proposed amendment to Article 4(2) of Regulation No 17 is the most important of the measures identified. This is because under Regulation No 17, as currently worded, the earliest date upon which an indiÜ vidual exemption can have effect, subjet to certain limited exceptions, is the date of notification and not the date of that many vertical agreements falling under Article 85(1), despite fulfilling the requirements for exemption under Article 85(3), are automatically void under Article 85(2) until they have been notified to the Commission. The fact such agreements are automatically void, pending notification, has two negative effects. First, it results in an unnecessarily high number of notifications and secondly, it results in the competition rules being used as a strategic tool to avoid the enforcement of contracts, rather than as a means to address competition problems. The objective of the draft amending text is to enable the Commission to exempt retroactively when the notification takes place at a later date. The practical effect of such a legislative amendment is that companies would no longer have to notify vertical agreements which they do not believe to cause competition concerns, simply to ensure legal certainty. Instead, companies will place greater weight on their own analysis of the economic effects of issue, knowing that in the event of subsequent litigation it the agreement. This has the vertical restraints at the effect that would not be too late to apply for an exemption under Article 85(3). The current Commission block exemption regulations in the field of distribution, adopted pursuant to Regulation No 19/65/EEC, are limited to exclusive distributionØ(˛), franchisingØ(—), and motorÜ exclusive purchasingØ(ˇ), vehicle distributionØ(Ñ). These the regulations, with the block exemption on motor vehicle exception of distribution which has been excluded from the scope of the current review, cannot be satisfactorily amended to provide for the change in this Communication. Therefore, subject to the adoption of the two Council Regulations outlined above, a new Commission Regulation will be proposed. The ReguÜ lation will extend to all vertical restraints in all sectors of distribution other than motor vehicles, covering, inter alia, selective distribution, services, intermediate goods and agreements between more than two parties each operating at different levels in the distribution chain. In the light of the new regulation the de minimis notice may need to be reviewed. in policy proposed 2. Procedural steps and timing The first procedural step will be the adoption by the Council of the two new Council Regulations. It is only following adoption of these two Regulations that work can commence on the procedural steps leading to the adoption by the Commission of a new group exemption regulation and a set of guidelines in the field of vertical restraints. The Commission will two submit documents for consultation with Member together States, industry and other third parties. This being the case, all the legislative changes required to implement the policy proposals outlined in this Communication are envisaged to be in place by the year 2000. these (˛) Commission Regulation (EEC) No 1983/83 of 22 June, 1983 on the application of Article 85(3) of the Treaty to categories of exclusive distribution agreements (OJ L 173, 30. 6. 1983, p. 1). (ˇ) Commission Regulation (EEC) No 1984/83 of 22 June 1983 on the application of Article 85(3) of the Treaty to categories of exclusive purchasing agreements (OJ L 173, 30. 6. 1983, p. 5). (—) Commission Regulation (EEC) No 4087/88 of 30 NoÜ vember 1988 on the application of Article 85(3) of the Treaty to categories of franchise agreements (OJ L 359, 28. 12. 1988, p. 46). (Ñ) Commission Regulation (EC) No 1475/95 of 28 June 1995 on the application of Article 85(3) of the Treaty to certain categories of motor vehicle distribution and servicing agreements (OJ L 145, 29. 6. 1995, p. 25)