anti-competitive agreements faculty development … · especially in the case of cartels, the cci...

© Shardul Amarchand Mangaldas

Shardul Amarchand Mangaldas & Co

Faculty Development Programme on

COMPETITION LAW

ANTI-COMPETITIVE AGREEMENTS

10 December 2015

John Handoll

Senior Adviser – European and Competition Law




COMPETITION LAW

ANTI-COMPETITIVE AGREEMENTS: INTRODUCTION

10 December 2015

John Handoll




INTRODUCTION: WHAT ARE WE HERE FOR?

Faculty Development Programme on Competition Law

Capacity Building – “Training the Trainer”

General Objective:

To deepen and broaden knowledge of Competition Law as academic subject

To assist academic development by enhancing teaching

Specific Objective of these Sessions

To assist participants in understanding Legal Analysis and Evidentiary Standards

(1) Horizontal Agreement, Cartel – Price and Non-Price – and Joint Ventures

(2) Vertical Agreements and their Various Forms

Legal Analysis: John Handoll (Shardul Amarchand Mangaldas)

Economic Analysis: John Ramirez (Econ One)

Our job is NOT to give you a three hour lecture which you reproduce to your students, but to provide a framework and ideas for you to develop an structured, informed and effective course on competition law

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INTRODUCTION: SCOPE OF LEGAL SESSIONS

Outline discussion of legal framework and some issues

Followed by economic comment /analysis

Session 1: Horizontal Agreements

Section 3 of Competition Act

AAEC

Cartels

Trade Associations and Information Exchanges

Joint Ventures

Leniency

Session 2: Vertical Agreements

Section 3(4) of Competition Act

Position in EU

“Good” and “Bad” Agreements

Different Types of Vertical Agreements

Establishing an AAEC

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INTRODUCTION: STRUCTURE OF SECTION 3

Section 3(1) prohibits entry into anti-competitive agreements which cause or are likely to cause an appreciable adverse effect on competition (AAEC) within India.

Such agreements are void (Section 3(2))

Covers horizontal, vertical and (arguably) other agreements (Hiranandani Hospital)

CCI is “enforcer”. Makes determination on basis of evidence, applying “negative” and “positive” factors for determining AAEC

- Creation of barriers to new entrants in the market

- Driving existing competitors out of the market

- Foreclosure of competition by hindering entry into the market

+ Accrual of benefits to consumers

+ Improvements in production/distribution of goods/provision of services

+ Promotion of technical, scientific and economic development

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INTRODUCTION: STRUCTURE OF SECTION 3 (CONT.)

Different approach to AAEC for horizontal agreements and vertical agreements

For horizontal agreements, there is a presumption of an AAEC

This presumption does not apply to “any agreement entered into by way of joint ventures if such agreement increases efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services”

The presumption is rebuttable, but it may be more difficult to show there is no AAEC in the case of cartels

For vertical agreements, the onus is on the CCI to show an AAEC

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INTRODUCTION: FACILITATING ENFORCEMENT BY THE CCI

As penalties are administrative not criminal, CCI can apply lower standard of proof than criminal standard of “beyond reasonable doubt”

Horizontal agreements:

“Balance of probability”, “liaison of intention” – later, “preponderance of probabilities” (CCI)

“Strong probability”, but varying application with unlikely or particularly serious events requiring more convincing proof (COMPAT in LPG Cylinders)

Vertical agreements:

CCI has used a fairly low standard of proof: “reasonable tendency to prove”

Broad definition of “agreement” given in Section 2(b) of Competition Act

Agreement includes any agreement or understanding or action in concert

A “nod or a wink“ will do (Lord Denning)

Especially in the case of cartels, the CCI can rely on circumstantial evidence

“the existence of an anti-competitive practice or agreement must be inferred from a number of coincidences and indicia which, taken together, may, in the absence of another plausible explanation, constitute evidence of the existence of an agreement”

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INTRODUCTION: SANCTIONS

Section 27 of the Competition Act sets out wide range of sanctions. CCI may:

Issue a “cease and desist” order

Impose financial penalties on the enterprises and individuals

“Standard”: up to 10% of average of turnover for last three preceding financial years

“Cartel”: up to three times profit, or 10% of turnover, for each year of continuance, whichever is higher

Direct that agreements stand modified

Direct enterprises to abide by orders/directions

Pass “such other order or issue such directions as it may deem fit”

Includes “non-association” orders

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COMPETITION LAW

ANTI-COMPETITIVE AGREEMENTS: HORIZONTAL AGREEMENTS

10 December 2015

John Handoll




HORIZONTAL AGREEMENTS: SECTION 3 COMPETITION ACT

Section 3 of Competition Act

Section 3(1) prohibits entry into agreements with an AAEC

Applies to enterprises, associations of enterprises, persons or associations of persons

Agreement between competitors presumed to have an AAEC where it

Directly/indirectly determines purchase or sale prices

Limits or controls production, supply, markets, technical development, investment or provision of services

Shares the market or source of production or provision of services by way of allocation of geographical area of market, or type of goods or services, or numbers of customers in the market or any other similar way

Directly or indirectly results in bid rigging or collusive bidding

Presumption may be rebutted

“Exception” for efficiency-enhancing JVs

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HORIZONTAL AGREEMENTS: TYPES

Section 3 of Competition Act covers different types of horizontal agreement

Cartels

Joint Ventures

Information Exchanges

Other Horizontal Agreements

Focus on cartels

Brief look at others

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HORIZONTAL AGREEMENTS: CARTELS: THE NATURE OF THE BEAST

What is a “cartel”?

In general terms, an association or combination of competitors who agree to cease to compete while maintaining the illusion of competition

Legal definitions keep balance between legal certainty and suppleness

Why is it so sinister?

Clandestine

Denies customer (and consumers) benefit of lower prices etc.

Adversely affects levels of spending

Puts off necessary industrial/commercial changes

Can have other adverse economic and social effects

Why is it so difficult to detect?

Tends to be secretive and unadvertised

Often no written agreement or arrangement

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HORIZONTAL AGREEMENTS: CARTELS: HOW TO FIGHT THE BEAST

How can an investigation be initiated?

Whistle blowing by disgruntled employee

Leniency (lesser penalty) application

Complaints/exposures of high/similar pricing

How can breach be established?

Wide definition of type of activity – broad definition of agreement (or separate categories of “arrangement” or “concerted practice”)

Evidential presumptions (including of an AAEC)

Evidence from leniency applicant

Standard of proof (depending on criminal or civil liability)

Direct and indirect (circumstantial) evidence

The “forensic” and “econometrics” approach

Sanctions

Especially severe sanctions for cartel behaviour

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HORIZONTAL AGREEMENTS: CARTELS: THE COMPETITION ACT, 2002 “Cartel” includes an association of producers, sellers, distributors, traders

or service providers who, by agreement amongst themselves, limit, control or attempt to control the production, distribution, sale or price of, or, trade in goods or provision of services (Sect. 2(c))

No enterprise or association of enterprises or person or association of persons shall enter into any agreement … which causes or is likely to cause an appreciable adverse effect on competition in India (Sect. 3(1))

Any agreement entered into in contravention of the provisions contained in subsection (1) shall be void (Section 3(2))

“Agreement” includes any arrangement or understanding or action in concert, whether or not such arrangement, understanding or action:

is formal or in writing;

is intended to be enforceable by legal proceedings (Section 2(b))

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HORIZONTAL AGREEMENTS: CARTELS: THE COMPETITION ACT, 2002 (CONT.)

Any agreement entered into between enterprises or associations of enterprise or persons or associations of person or between any person and enterprise or practice carried on, or decision taken by, any association of enterprises or association of persons, including cartels, engaged in similar trade of goods or provision of services, which

Directly/indirectly determines purchase or sale prices

Limits or controls production, supply, markets, technical development, investment or provision of services

Shares the market or source of production or provision of services by way of allocation of geographical area of market, or type of goods or services, or numbers of customers in the market or any other similar way

Directly or indirectly results in bid rigging or collusive bidding

… shall be presumed to have an appreciable adverse effect on competition (Section 3(3))

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HORIZONTAL AGREEMENTS: CARTELS LENIENCY

In US and EU most cartel proceedings result from leniency application

Idea is that confessing to participation in a cartel and helping the competition authority to bring the (other) participants to justice will result in total immunity from, or partial reduction in, penalty

India: Section 46 of the Competition Act & 2009 Lesser Penalty Regulations.

Applicants may get up to a 100%, 50% and 30% reduction in penalty

Marker and prioritisation system (get place in line)

Must satisfy conditions

In principle cease participation in cartel

Provide vital disclosure in respect of violation (first applicant), significant added value (later applicants)

Provide all required relevant information, documents and evidence

Cooperate genuinely, fully, continuously and expeditiously throughout

Not conceal, destroy, manipulate or remove relevant documents

Can be applied for before prima facie opinion, or at investigation stage

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HORIZONTAL AGREEMENTS: CARTELS: BID-RIGGING CASES: WHAT IS BID RIGGING?

Bid rigging (more or less the same as “collusive tendering”)

“A particular form of collusive price-fixing behaviour by which firms coordinate their bids or procurement or project contracts” (OECD)

“any agreement … which has the effect of eliminating or reducing competition for bids or adversely affecting or manipulating the process for bidding” (Explanation to Section 3(3) of Competition Act)

Can take many forms, including:

Identical pricing

Cover bidding (also “complementary”, “courtesy”, “token” or “symbolic” bidding)

Bid rotation

Bid suppression

Market allocation

Collective boycotts

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HORIZONTAL AGREEMENTS: CARTELS: BID-RIGGING CASES: COMPETITION ACT 2002

Section 3(1) No enterprise or association of enterprises or person or association of persons shall enter any agreement … which causes or is likely to cause an appreciable adverse effect on competition in India

Section 3(2) Any agreement entered into in contravention of the provisions contained in subsection (1) shall be void

Section 3(3) Any agreement entered into between enterprises or associations of enterprise or persons or associations of person or between any person and enterprise or practice carried on, or decision taken by, any association of enterprises or association of persons, including cartels, engaged in similar trade of goods or provision of services, which - … (d) directly or indirectly results in bid-rigging of collusive tendering, shall be presumed to have an appreciable adverse effect on competition

Explanation: … “bid rigging” means any agreement, between enterprises or persons … engaged in identical or similar production or trading of goods or provision of services, which has the effect of eliminating or reducing competition for bids or adversely affecting or manipulating the process for bidding

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HORIZONTAL AGREEMENTS: CARTELS: BID-RIGGING CASES: EVIDENCE OF BREACH (I)

Identical (near-identical) pricing

In itself not conclusive evidence of collusion

Collusion inferred where suppliers’ costs differ and no plausible reasons for identical pricing

Distinguish from conscious parallelism where “plus factors” needed

Unless evidence of repeated identical pricing, need for supporting factors

Supporting factors

Contemporaneous meetings between bidders

Trade association giving opportunity to interact and discuss

Common agents to deposit bids, and keep eye on competition

Sharing of confidential documents

Same format, same handwriting, same errors

Bidders visit agency together: same person makes bids

Earning of huge margins: quotes far in excess of costs

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HORIZONTAL AGREEMENTS: CARTELS: BID-RIGGING CASES: EVIDENCE OF BREACH (II)

Market allocation

Total quantity offered by different bidders near quantity stated in tender

Suppliers have capacity well in excess of quantity to be supplied

Cover bidding

Huge differences between bid rates

Common typographical and other errors

Bids contain identical technical deficiencies

Failure to submit essential documents or to accept obligatory clauses

Mismatching dates in bid and supporting documents

COMPAT - not where other qualified bidders: or submitting bids at same time

Collective boycotts

Bidders take similar approach to contracting body/auction

Fact of non-participation in procurement procedure

Consistent practice of making identical bids

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HORIZONTAL AGREEMENTS: CARTELS: BID-RIGGING CASES: EVIDENCE OF BREACH (III)

General industry features tending to collusion (CCI in LPG Cylinder Manufacturers, Vaccines, Bomb Containers)

Market conditions (e.g., fixed/predictable flow of demand)

Small number of suppliers (3, even as many as 37!)

Geographical proximity of suppliers

Few new entrants (barriers to entry)

Active trade associations

Repetitive bidding

Identical or similar products, homogeneous nature of product, stringently standardized product

Few or no substitutes

No significant technological changes

Approach partially endorsed by COMPAT in LPG Cylinder Manufacturers appeal

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HORIZONTAL AGREEMENTS: JOINT VENTURES

Presumption of AAEC in Section 3(3) of Competition Act does not apply to any agreement entered into by way of joint ventures if such agreement increases efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services

Reflects view that JVs may be “good” or “bad” and cannot be per se illegal

Not to date considered by CCI

Unclear whether only formal JVs are covered

Need to demonstrate efficiencies (no clarity what this means)

In practice, JV partners will need to show that there are efficiencies, and hence no AAEC, if arrangements are questioned by CCI

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HORIZONTAL AGREEMENTS: INFORMATION EXCHANGES

Exchanges of information between competitors can breach competition rules even in the absence of a cartel

General principles on the competitive assessment of information exchange set out in European Commission’s 2011 Guidelines on horizontal cooperation agreements

Even once-off exchanges, even if made unilaterally, can amount to breach (T-Mobile)

In EU treated as “object breach”, with no need to show an effect on competition

In India, agreement between competitors, so may be presumption of an AAEC

Look critically at data collection by trade associations: risk reduced where information exchanged on historic/aggregated basis

Information exchanges may be in indirect, using “agents” to message competitors. “Hub and Spoke” cartels recently seen in Indian practice

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HORIZONTAL AGREEMENTS: INFORMATION EXCHANGES A DIGRESSION: TRADE ASSOCIATIONS

Widely recognised that trade associations have a legitimate function, in areas such as standards, industry lobbying, environmental protection, taxation (and even in promoting competition compliance by members!)

However, trade associations can also act as a forum, catalyst or instigator of anti-competitive behaviour

Vehicle for illegal prohibited information exchanges (see above)

Platform for collusion, including price-fixing

Facilitating bid-rigging

Instigating anti-competitive behaviour

Telling members to sell at particular price

Prohibiting discounts

Collective boycotts

Protecting industry structures

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HORIZONTAL AGREEMENTS: OTHERS

Other types of horizontal agreements include

Research and development agreements

Production agreements

Purchasing agreements

Agreements on commercialisation

Standardisation agreements

Rationalisation agreements

Although there is may be presumption of an AAEC (but look at Section 3(3) carefully!), easier to rebut

Little reported practice from CCI

Look at practice from elsewhere:

2000 US Antitrust Guidelines for Collaborations among Competitors

Canadian Competition Bureau Competitor Collaboration Guidelines

European Commission Guidelines on the Applicability of Article 101 TFEU to Horizontal Cooperation Agreements

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9-11 December 2015

HORIZONTAL AGREEMENTS 10 December 2015

John Ramirez Managing Director, Econ One Research Inc. Director, Econ One Research India Pvt. Ltd.

Overview

I. Basic Economics of Cartels

II. Cartel Detection ( Economics of Horizontal Agreements)

III. Optimal Cartel Penalties

IV. Leniency Programs

V. Joint Ventures

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I. Basic Economics of Cartels

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Prohibited Horizontal Behaviour under Sec. 3(3)

• Agreements that:

Determine purchase or sale prices;

Limit the production, supply, markets, technical development, investment or provision of services;

Share the market or source of production or provision of services by way of allocation of geographical area of market, or type of goods or services, or number of customers in the market or any other similar way;

Result in bid rigging or collusive bidding (Competition Act, 2002)

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Why are Cartels Harmful?

Cartels are agreements between firms aimed at reducing the level of competition amongst suppliers to increase the profits of all cartelists

Cartels can be viewed as an attempt to collectively act as a monopolist to exert market power

30

Why are Cartels Harmful? (2)

Efficacious cartelization allows firms to institute supra-competitive prices (i.e., above the level that would prevail in competitive market conditions), thereby increasing profits

There is a negative impact on consumer surplus (the difference between what consumers are willing to pay and what they actually pay) due to increased prices and restricted output

In economic terms, there is deadweight loss as there is reduction in both consumer and producer surplus

Higher prices force some buyers to either lower purchase volume and/or exit the market entirely (“lost volume effect”)

31

What Determines a Successful Cartel?*

Cartels must solve three problems: coordination, cheating, and entry

Successful cartels develop organizations that address these problems

Market concentration (i.e., few market participants) benefits cartel stability both directly (increasing individual profits and easing coordination) and indirectly (concentration is a reflection of barriers to entry)

Cartel organizational characteristics, e.g., industry associations, can allow for cartel formation in less concentrated industries

Demand instability (e.g., demand shocks and rapid growth) can adversely impact cartel stability

Cyclical demand fluctuations that are predicable are more manageable

Successful cartels have mechanisms for sharing information, making decisions and manipulating incentives (“carrots and sticks”)

* For further detail and a survey of empirical analyses of cartels, please see the recommended reading: Levenstein & Suslow, “What Determines Cartel Success?”, 2006.

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Characteristics of Cartels

33

•Agreement on prices and/or price increases

•Agreement to restrict supply or reduce capacity

•Allocate markets, customers, or specific purchases

Mechanism

• Detect any deviation from the agreement

Monitoring

• Punishment of cheaters

• Maintenance of market shares to ensure harmony

Enforcement

Necessary Conditions Desired Effects

Supra-competitive

prices & profits

There is an incentive for

members to cheat on the cartel by

selectively lowering prices to

increase profits

Cartel Examples

Cartel Geography Duration Mechanism Description Enforcement / Monitoring

Reason for Dissolution

Marine Hose Global 12 years (1986-2007)

Allocation of customers / contracts (bid rigging)

The producers operated a worldwide cartel whereby they regularly met to allocate tenders, fix prices, fix quotas, fix sales conditions, share geographic markets and exchange sensitive information on prices, sales volumes and procurement tenders

Appointment of an external consultant to allocate contracts and maintain market shares

Leniency: Full immunity to Yokohama

Paraffin Wax

Europe 14 years (1992-2005)

Mainly price fixing

Nine companies fixed prices for the wax products and allocated both markets and customers for the paraffin waxes

Regular meetings Leniency: Full immunity to Shell

Cathode Ray Tubes (CRTs)

Global 6 years (1999-2004)

Price fixing & supply reduction

Cartel members organised meetings for price coordination activities with the exchange of confidential and sensitive market information

Regular meetings and audits of production facilities to ensure capacity reductions were implemented

Gradual dissolution due to a declining industry

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II. Economic Analysis of Cartels

35

Economic Analysis of Cartels

36

Economic Assessment of Indirect Evidence

37

Industry Structure

Conduct

Performance

Some industry characteristics are more conducive to cartel formation and cartel longevity

Price movements, production/capacity changes, and market share evolutions can yield indicia of cartelization

The purpose of cartels is to fix prices and increase profits

Analyze Why?

Structural Factors

Behavioral Factors

1. Industry Structure: Some Characteristics Conducive to Cartelization

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•The more market participants there are the harder it is to form a cartel and coordinate behaviour Concentrated Industry

•Cartels are easiest to form when price is the determining factor and the number of product variations is small

Homogeneous Product

•It is more difficult to agree on price when underlying cost structures differ Symmetry in Costs

•Super-competitive prices attract new suppliers, so entry barriers must be substantial Barriers to Entry

•Inelastic demand (customers are less price sensitive)

•No close substitutes Demand Characteristics

•Large customers constrain the ability of suppliers to increase price

No Appreciable Countervailing Power

•Makes it easier to detect deviations from cartel agreements

Market Transparency & Cartelist Interactions

1. Industry Structure: Which Industry is More Conducive to Cartelization?

39

Float Glass

• Concentrated industry

• Capital intensive (deters entry)

• Commodity-like product – competition occurs mainly on the basis of price

• Inelastic demand

• Transport of glass over long distances is uneconomical

Cosmetics

• Large number of suppliers

• Product diversity

• Brand loyalty

• Low entry barriers

Some Select “Collusive Markers” Used to Assess Behavioral Conduct Factors

Price

A higher list (or regular) price and reduced variation in prices across suppliers

A series of steady price increases preceded by steep price declines

Prices across firms are strongly positively related

A high degree of uniformity across firms in product prices

Quantity

Market shares are highly stable over time

For a subset of firms, each firm’s share of total supply in that subset is highly stable over time

Source: Huschelrath (2010)/Harrington (2006)

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2. Conduct: Some Cartel Behaviours Can be Observed Provided Data are Available

Prices

• Co-movement across firms

• Reduced variation

• Muted response to changes in demand and costs

Supply

• Capacity/production reductions not explained by market conditions

• Presence of excess capacity/ low capacity utilisation

Market Shares

• Less volatile

• Firms do not change positions in the market

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2. Conduct: Example 1 – Suggestive of Cartelization?

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2. Conduct: Example 2 – More Suggestive of Cartelization?

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Is there evidence that the agreements were implemented?

If there was a price fixing cartel, do actual prices correspond to agreed upon prices (or if targets are unknown, list prices)?

Is there evidence that the cartel successfully increased prices/profit margins?

Caution: not all cartels will result in prices and/or profits that are higher than the non-cartel period

• Hence, more sophisticated economic analysis is advisable when it comes to assessing the performance of a cartel (econometric modelling)

Does the behavior of suspected colluding firms differ from that of competitive firms?

Does a collusive model fit the observed behavior better than a competitive model?

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3. Performance: Was the Cartel Successful?

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3. Performance: Actual Prices Deviate Substantially from List Prices

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Mo.1 Mo.2 Mo.3 Mo.4 Mo.5 Mo.6 Mo.7 Mo.8 Mo.9 Mo.10 Mo.11 Mo.12 Mo.13 Mo.14 Mo.15

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3. Performance: Cartel Increases Prices & Profits

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3. Performance: Cartel Stabilizes Prices & Profits

European Paraffin Wax Cartel: In Which Period Were Prices Cartelized?

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Sep-92 Sep-94 Sep-96 Sep-98 Sep-00 Sep-02 Sep-04 Sep-06 Sep-08

Pri

ce

Period A Period B

Paraffin Wax Price & Upstream Feedstock Price

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Pri

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Cartel Period

Post Cartel Period

Paraffin Wax Price Upstream Feedstock Price

German Cement Cartel: In Which Period Were Prices Cartelized?

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Pri

ce

Period A Period B

Cement Price & Percentage Change in Construction GDP

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-7.0%

-2.0%

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Percentage Change in Construction GDP Cement Price

Cartel Period Post-Cartel Period

Price War

Should Markets be Screened for Cartelization?

Should competition authorities be proactive in screening cartels? Governments are proactive in detecting other white collar crimes (e.g., tax fraud and insider

trading), so why not cartels?

Leniency programs have not stopped cartel formation, and applicants may come mainly from cartels that have become unstable

Profitable cartels are more likely to remain stable (Levenstein & Suslow, 2012); hence, leniency may not catch the cartels that are most detrimental to consumers

However, there are numerous challenges involved with implementing a cartel screening program (for a discussion, see OECD, 2013): Does not provide sufficient proof of cartelization

Can generate false positives and false negatives

A false positive is incorrectly concluding that a cartel may have been operating; a false negative is incorrectly concluding that the market shows no signs of cartelization

Fails to distinguish explicit from tacit collusion. Many of the cartel markers can emerge in non-cartelized markets

Data and resource intensive activity

Risk of firms evading screen detection

Operating cartels may adjust their behavior so that they are not flagged by the screening process

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Information Sharing and Collusion

Communication of information amongst competitors may constitute an agreement, a concerted practice, or a decision of an association of undertakings with the object of fixing prices or sharing markets or customers

Sharing can take different forms:

Direct exchange between competitors

Indirect exchange through the platform of trading associations, publications, etc.

Information sharing can be both pro-competitive (efficiencies/reduction in search cost/better planning) and anti-competitive

Key competition concerns with information sharing:

Can lead to coordination of behaviour by increasing transparency in the market

Can facilitate implementation of a cartel by enabling companies to monitor behaviour and detect deviations

Type of information sharing that can typically be considered problematic:

Strategic information regarding future/current conduct (prices/quantity)

Firm specific rather than industry aggregate information

Shared at short intervals (frequency)

Non-public exchange of information

Whether or not an exchange of information will have restrictive effects depends on both the economic conditions in the relevant markets and the characteristics of information exchanged

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Investigation by the EC in the Container Freight Industry for Price Signaling

The EC initiated an antitrust investigation against several container shipping companies to investigate whether they engaged in concerted practices (2013)

Regular public announcements of price increase intentions conveyed to competitors through press releases on websites were considered as potential evidence of collusion

In most cases, the timing and quantum of the increase were largely similar for all the main carriers, with announcements made by carriers within a few days of each other (Source: Alphaliner)

The EC’s investigation is still ongoing

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0

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Increase as announced by Hapag-Lloyd Increase as announced by MSC

III. Optimal Cartel Penalties

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Cartel penalties play an important role in the prevention of competition law violations

Penalties can be imposed as monetary sanctions (“fines”) and/or criminal sanctions against individuals. Some jurisdictions allow for criminal sanctions; others do not

Imposing fines on cartelists can aid in the prevention of competition law violations in three ways (Wils, 2006):

Deterrence effect

Creates a credible threat of being prosecuted and fined, which is factored into the expected costs and benefits that firms consider while deciding to violate competition law

Moral effect

Sends a message to the law-abiding firms, reinforcing their moral commitment to antitrust prohibitions

Destabilizing effect

Penalties are an expected future loss for cartel members. In combination with leniency programs and other policies, the prospect of penalties can destabilize cartels

Proceeds from cartel fines are normally directed to the public coffers, and are not distributed amongst those affected by the cartel. Victims of cartelization can and do pursue claims against cartelists in civil courts, depending on the jurisdiction

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Cartel Penalties

Approaches to the determination of cartel fines (Allain et. al., 2013):

1. Compensation based approach Focuses on the reparation of the harm that the criminal activities had on society

Under this approach, the optimal fine is set at a level that recoups the net harm caused to individuals or entities

However, the amount to be recouped can be difficult to estimate

2. Deterrence based approach

Focuses on deterring the formation of cartels If the goal is to deter the formation of cartels then the penalty level should be set so that

the expected loss of participating in a cartel is greater than the expected gain

An optimal deterrent fine is set at a level that per se makes cartel formation unprofitable One complication with optimal deterrence based fines is that they may need to be set

very high to deter cartelization

Generally, competition authorities set fines in order to deter the formation of cartels

57

Economic Theory of Fines

IV. Leniency Programs

58

Leniency Programs

Leniency programs offer reduced penalties to cartel participants (firms or individuals) in exchange for cooperating with the enforcement authorities

Depending on their structure, leniency programs can destabilize cartels in two ways:

(1) Deterrence: leniency programs deter cartel formation either by making it unprofitable (depending on the penalty structure), or making collusion unstable

(2) Desistance: leniency programs provide incentives for cartelists to break the cartel agreement through confessions

Most of the economic literature supports the general conclusion that leniency programs can reduce cartel stability

However, the empirical estimation of the impact of leniency programs on cartel formation and longevity is difficult because it is not known how many cartels were operating but not discovered

59

Impact on Competition Law Enforcement

Leniency programs provide a substantial number of new investigative leads to competition authorities, which have finite resources in terms of the number of investigations that can be pursued

As a result, the competition authority may focus on leniency cases at the expense of investigating cases not generated through the leniency program (Chang & Harrington, 2008)

Therefore, there is an interactive effect between leniency programs and other enforcement efforts that can be problematic:

Leniency programs affect the probability that a cartel is discovered, but the probability of discovering a cartel outside of leniency influences a firm’s decision on whether to seek leniency

If cartel members view it as less likely that the cartel will be discovered outside of leniency then they will have a reduced incentive to apply for leniency (Ibid.)

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Select Optimal Leniency Models

An optimal leniency strategy will accomplish two goals (Chen & Rey, 2013):

Destabilize usual collusion (i.e., collude and never report) by providing incentives to firms to deviate from the cartel and denounce it

Discourage firms from exploiting the leniency program (i.e., collude and report)

Chen & Rey find that:

It is always desirable to offer some leniency, at least in the absence of any ongoing investigation

Whether amnesty remains desirable once an investigation starts depends on the frequency of the investigation and its likelihood of success

It is optimal to offer less leniency once an investigation is already underway if the investigation is likely to be successful

It can be desirable to offer more amnesty if the investigation is less likely to be successful to make the investigation more effective

Harrington (2008) finds that offering leniency can trigger a “race to the courthouse” when detection becomes likely and therefore:

It is optimal to restrict eligibility to the first informant

It is often optimal to grant full leniency to the first informant

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V. Joint Ventures

62

Joint Ventures

A Joint Venture (JV) may be defined as any arrangement whereby two or more parties co-operate in order to run a business or to achieve a commercial objective

JVs can be of two types:

Equity/corporate in which the parent undertakings holds voting shares (in a newly incorporated company or an already existing company)

Contractual joint venture is a form of cooperation agreement that defines the activity of the cooperation (but does not centre on a corporate vehicle)

While significant pro-competitive benefits can be achieved through joint ventures, it is nevertheless the case that when competitors collaborate, there is potential for harm

Pro-competitive: Provides a method of organization which enables competitors to join to produce beyond the productive capacity or inclination of its individual members (efficiencies such as economies of scale/R&D/etc.)

Anti-competitive: Threatens to reduce actual or potential competition between rivals by providing a method of operation which engenders collusion (ability and incentive to compete against one another may be compromised). Joint ventures also have the potential to limit participants' independent decision making by combining control of or financial interest in production, key assets, and other competitively sensitive variables.

Given that JVs can have both pro and anti-competitive effects, they are not considered per se illegal

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References (Horizontal Agreements)

Hüschelrath, “How Are Cartels Detected? The Increasing Use of Pro-active Methods to Establish Antitrust Infringements”, Journal of European Competition Law & Practice, Vol. 1, No. 6. , 2010

Joseph E. Harrington, Jr, “How Do Cartels Operate?”, Foundations and Trends in Microeconomics, 2006

Joseph E. Harrington, Jr., “Behavioural Screens and the Detection of Cartels”, 2007

Joseph E. Harrington, Jr., “Detecting Cartels”, Department of Economics, Johns Hopkins University, December 2004

Margaret Levenstein and Valerie Suslow, “Cartels and Collusion – Empirical Evidence”, Ross School of Business, Working Paper No. 1182, November 2012

Organisation for Economic Co-operation and Development, “Roundtable on Ex Officio Cartel Investigations and the Use of Screens to Detect Cartels”, November 2013

Peter Davis and Eliana Garcés, “Quantitative Techniques for Competition and Antitrust Analysis”, Princeton University Press, 2010

Cento Veljanovski , “The Economics of Cartels”, March 2007

John M. Connor and Robert H. Lande, “Cartel Overcharges and Optimal Cartel Fines”, 3 Issues In Competition Law and Policy 2203 (ABA Section of Antitrust Law 2008), Chapter 88, 2007

Marie-Laure Allain et. al., “Are Cartel Fines Optimal? Theory and Evidence from the European Union”, Center for Interuniversity Research and Analysis of Organizations, 2013

Wouter P.J. Wils, “Optimal Antitrust Fines: Theory and Practice”, World Competition, Vol. 29, No.2, June 2006

Khaitan & Co., “Joint Ventures Under India’s Competition Act”

Robins Kaplan LLP, “Antitrust Treatment of Joint Ventures: Analyzing Competitor Collaborations”

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References (Horizontal Agreements)

Georg Clemens and Holger A. Rau, “Do Leniency Policies Facilitate Collusion? Experimental Evidence”, Düsseldorf Institute for Competition Economics”, 2014

Jose Apesteguia et. al., “ Blowing the Whistle”, Economic Theory, 2007

Joseph E. Harrington, Jr., “Optimal Corporate Leniency Programs”, Department of Economics, Johns Hopkins University, October 2004 (revised July 2005)

Joseph E. Harrington, Jr., “Optimal Corporate Leniency Programs”, Journal of Industrial Economics, December 2008

Massimo Motta and Michele Polo, “Leniency Programs and Cartel Prosecution”, International Journal of Industrial Organization, 20

Michael Reynolds et. al., “Antitrust Development : The EU Leniency Programme”, ABA Spring Meeting, March 2009

Michele Polo and Massimo Motta, “Leniency Programs”, 2005

United Nations Conference on Trade and Development, “The Use of Leniency Programmes as a Tool for the Enforcement of Competition Law Against Hardcore Cartels in Developing Countries”, August 2010

Zhijum Chen and Patrick Rey, “On the Design of Leniency Programs”, 2012

65




COMPETITION LAW

ANTI-COMPETITIVE AGREEMENTS: VERTICAL AGREEMENTS

9-11 December 2015

John Handoll




VERTICAL AGREEMENTS: SECTION 3 COMPETITION ACT

Section 3(1) No enterprise or association of enterprises or person or association of persons shall enter any agreement … which causes or is likely to cause an appreciable adverse effect on competition in India

Section 3(2) Any agreement entered into in contravention of the provisions contained in subsection (1) shall be void

Section 3(4) Any agreement amongst enterprises or persons at different stages or levels of the production chain in different markets, in respect of production, supply, distribution, storage, sale or price of, or trade in goods or provision of services, including -

Tie-in arrangement

Exclusive supply agreement

Exclusive distribution agreement

Refusal to deal

Resale price maintenance

shall be an agreement in contravention of sub-section (1) if such agreement causes or is likely to cause an AAEC in India

67



VERTICAL AGREEMENTS: AGREEMENTS COVERED

Agreements “amongst” entities at different stages or levels of the production chain in different markets

In Motor Parts, CCI rejected arguments that “amongst” meant that agreements had to be between more than two parties. Bilateral agreements are covered!

Single economic entity doctrine (Lamborghini and Motor Parts)

Section 3 does not apply to agreements between group companies

Inseparability of economic interest of parties: rebuttable – look at facts and circumstances of each case

“Existence of agreement may be inferred from coercive conduct when level of coercion exerted to impose an apparent unilateral policy, in combination with the number of distributors that are actually implementing the unilateral policy of the supplier would, in practice, point to tacit acquiescence by the other party or parties.” (Snapdeal (prima facie order))

68



VERTICAL AGREEMENTS: BURDEN OF PROOF

No presumption of an AAEC

Vertical agreements have to be proved

In Motor Parts, CCI relied on US Supreme Court in Monsanto case:

“direct or circumstantial evidence that reasonably tends to prove that the manufacturer and others had a conscious commitment to a common scheme designed to achieve an unlawful objective”

No direct or circumstantial evidence to prove that OEMs and (unrelated) overseas suppliers had “understanding or conscious commitment” not to supply to open market

Fairly low standard of proof: “reasonable tendency to prove”

69



VERTICAL AGREEMENTS: COMPARE/CONTRAST EU REGIME (1)

Article 101 TFEU

Prohibits as incompatible with the internal market agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the internal market, and in particular those which:

directly or indirectly fix purchase or selling prices or any other trading conditions;

limit or control production, markets, technical development, or investment;

share markets or sources of supply;

apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;

make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations having no connection with the subject of such contracts.

Agreements or decisions prohibited pursuant to this article automatically void.

70




Art. 101(3): Prohibition may be declared inapplicable in the case of:

any agreement or category of agreements between undertakings, any decision or category of decisions by associations of undertakings, any concerted practice or category of concerted practices, which contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not:

(a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives;

(b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question

EU regime characterised by exemption regime specifying agreements exempted from prohibitions and conditions for such exemption

71




For vertical agreements, European Commission provides some general guidance on when prohibition will not apply at all

De minimis

Agents

Sub-contracting

2010 Block Exemption Regulation for Vertical Agreements

Coverage and exclusions (e.g., agreements between competitors)

Market share threshold of 30% for supplier and customer

Hardcore restrictions (RPM, territorial/customer restrictions (with exceptions))

Excluded restrictions (e.g., long non-compete obligations)

Network effects

2010 Guidelines on Vertical Restraints

Principles for self-assessment, in light of circumstances of each case

Structure completely different from what exists in India

72



VERTICAL AGREEMENTS: SOME RELEVANT CCI CASES - OVERVIEW

Global Automobiles (Case No. 33/2011, 3 July 2002) Exclusive dealership agreement: no AAEC given small size of players

Apple (Case No. 24/2011, 19 March 2013) Mixed Section 3/Section 4 case Contractual tying agreement: no AAEC

Intel (Case No. 48 of 2011, 16 January 2014) Mixed Section 3/Section 4 case No AAEC for incentive scheme, reporting resale prices

Car Parts (Case No. 3/2011, 25 August 2014) Mixed Section 3/Section 4 case CCI found AAEC in relation to restrictions on supply to non-authorised players Opposite parties fined 2% of average of three years’ turnover “Cease and desist” and other specific compliance measures

Hyundai (Case No. 36/2014, PF Order 12 September 2014) Snapdeal (Case No. 61/2014, PF Order 29 December 2014)

Prima facie Orders, both dealing with resale price maintenance

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VERTICAL AGREEMENTS: TYPES OF AGREEMENTS

Section 3(4) gives non-exhaustive list of vertical agreements

Other vertical agreements of the same “nature” are caught

Specified types

Tie-in arrangements

Exclusive supply agreement

Exclusive distribution agreement

Refusal to deal


“As defined”

Only where agreement causes or is likely to cause an AAEC in India

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VERTICAL AGREEMENTS: TIE-IN ARRANGEMENT

Section 3(4), Explanation (a) “tie in arrrangement” includes any agreement requiring a purchaser of goods,

as a condition of such purchase, to purchase some other goods

Apple: need to distinguish between “tying” and “bundling” Tying where, through a contractual or technological requirement, a seller

conditions the sale of lease of one product or service on the customer’s agreement to take a second product or service

Case involved a case of “contractual tying” where the handset manufacturer (Apple) and service provider (Airtel and separately Vodafone) had joined hands to offer a packaged product to a customer

Apple: anti-competitive concerns where: Presence of two separate products or services capable of being tied Seller: sufficient economic power in tying good to restrain competition in tied

good Tying arrangement affects a “not insubstantial” amount of commerce

Intel: no tie where distributors given incentives to sell more low demand goods

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VERTICAL AGREEMENTS: EXCLUSIVE SUPPLY AGREEMENT

Section 3(4), Explanation (b):

“exclusive supply agreement” includes any agreement restricting in any manner the purchaser in the course of his trade from acquiring or otherwise dealing in any goods other than those of the seller or any other person

Motor Parts: dealers required to source spare parts only from OEM or approved vendors

Hyundai (PF case): agreements with dealers prohibiting them from sourcing spare parts other than through approved vendors

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VERTICAL AGREEMENTS: EXCLUSIVE DISTRIBUTION AGREEMENT

Section 3(4), Explanation (c)

“exclusive distribution agreement” includes any agreement to limit, restrict or withhold the output or supply of any goods or allocate any area or market for the disposal or sale of the goods

Global Automobiles: dealer prevented from taking up other dealerships

Motor Parts: arrangement/understanding between OEM and overseas parts suppliers that latter would not supply parts directly to the Indian aftermarket would, if proved, be an exclusive distribution agreement

Motor Parts: agreement between OEM and local OESs preventing latter from supplying to the aftermarket an exclusive distribution agreement

Motor Parts: agreements between OEMs and authorised dealers restricting/ prohibiting OTC sale of spare parts

Hyundai (PF case): dealers required to take prior approval of Hyundai before dealing in competing brands of automobiles

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VERTICAL AGREEMENTS: REFUSAL TO DEAL

Section 3(4), Explanation (d):

“refusal to deal” includes any agreement which restricts, or is likely to restrict, by any method the persons or classes of persons to whom goods are sold or from whom goods are bought

Motor Parts: agreement between OEM and local OESs preventing latter from supplying to the aftermarket a refusal to deal

Motor Parts: agreements between OEMs and authorised dealers restricting/ prohibiting OTC sale of spare parts

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VERTICAL AGREEMENTS: RESALE PRICE MAINTENANCE

Section 3(4), Explanation (e) “resale price maintenance” includes any agreement to sell goods on condition that the

prices to be charged on the resale by the purchaser shall be the prices stipulated by the seller unless it is clearly stated that prices lower than those prices may be charged

In theory, CCI must prove AAEC, but likely to be low threshold In EU, any restriction of buyer’s ability to determine its sale price is seen as a

hardcore restriction (though efficiency defence may be argued). But supplier may impose a maximum sale price or recommend prices provided this does not amount to a fixed or minimum resale price

In US, Supreme Court has seen this as an effects, not per se, breach (Leegin), but some State courts have retained per se approach

Intel: CCI found that Intel was not setting resale price for distributors. Monitoring downstream prices of own products not anti-competitive

Hyundai (PF case): restrictions imposed on maximum permissible discount given by dealer to customer

Snapdeal (PF case): appliance product supplier took exception to S displaying products at prices below MOP (least price determined by manufacturer/seller at which dealer retailer can sell product) 79



VERTICAL AGREEMENTS: AAEC (1)

Unlike Section 3(3), there is no presumption of an AAEC

CCI must establish AAEC applying Section 19(3) factors

At both levels where parties operate (Global Automobiles)

30% market share threshold (Global Automobiles, referring to EU)

Snapdeal: PF case: RPM restrictions problem with 28% of market

“Negative factors” (CCI – normally indicating AAEC)

Creation of barriers to new entrants in the market

Driving existing competitors out of market

Foreclosure of competition by hindering entry into the market

“Positive factors” (CCI – efficiency justifications, normally no AAEC)

Accrual of benefits to consumers

Improvements in production/distribution of goods / provision of services

Promotion of technical, scientific and economic development

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VERTICAL AGREEMENTS: AAEC (2)

Global Automobiles: “The absence of the last three factors alone can neither determine AAEC nor establish

efficiency justifications. In most cases, therefore, it is more prudent to examine all of the above factors together to arrive at a net impact on competition.”

Motor Parts: “An agreement which creates barriers to entry may also induce improvements in

promotion or distribution of goods or vice versa. Thus, whether an agreement restricts the competitive process is always an analysis between the positive and the negative factors listed under section 19(a)-(f).”

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VERTICAL AGREEMENTS: AAEC: GLOBAL AUTOMOBILES

Vehicle dealer prevented from dealing in other vehicles

CCI stated that normally competition at different levels of production-supply chain may possibly be affected where both entities possess some market power in the respective spheres of market. Reference to (supposed) EU rule that both must have at least 30% market share.

Parties had insignificant presence in market and were fringe players. Agreements incapable of causing any AAEC

GA had barely 50 dealers and 1% market share – not in a position to create entry barriers for potential manufacturers, foreclose competition in market, or drive out existing competitors

GA new and small player with teething troubles and unstable operations

Therefore no AAEC

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VERTICAL AGREEMENTS: AAEC: APPLE

“Contractual tying where handset manufacturer (Apple) and telecoms service provider (Vodafone) joined hands to offer packaged product to customer.

CCI found

Market shares of parties in respective markets made AAEC improbable

No exclusivity: multiple choices for purchase of iPhone and service provider

No consumer harm (e.g., customer has choices and can pay to unlock phone)

Parties did not have position of strength to affect market outcome in terms of market foreclosure, deterring entry, creating entry barriers, driving out competitors

Arrangements helped create market for iPhones

Developments elsewhere showed market-building, pro-competitive effects

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VERTICAL AGREEMENTS: AAEC: INTEL

Intel provided more incentives to distributors achieving targets for Intel’s low demand products.

Not a tie-in, as no condition of supplying high demand products only if low demand products bought

Targets and incentive structure seen by CCI as vertical agreement

Plausible business justification/prudent business decision

Anti-trust concern only if AAEC. CCI found no AAEC

No foreclosure of Intel’s competitors

No distortion of competition in downstream distribution business (Informant – a distributor – not at any competitive disadvantage

Intel also monitored resale prices of own products. No AAEC:

No creation of barriers to new entrants in the market

No driving out of existing competitors

No foreclosure of competition into market

84



VERTICAL AGREEMENTS: AAEC: MOTOR PARTS (1)

Agreement between OEM and OES preventing OES from selling spare parts directly into aftermarket

CCI rejected OEMs’ argument that, absent restriction, OEMs could not ensure quality of spare parts – jeopardising safety and health, and goodwill in cars. Restriction not necessary since:

OESs could be contractually required to carry out safety checks, using OEM-licensed safety check methodology

OESs could be required to label products to limits OEM liability

OEMs could limit warranty to exclude faulty/defective parts sold by OESs

Selling finished products in open market does not compromise IPRs: can be addressed by appropriate contractual commitments

OESs can be required to following industry standards and consumer law

OEMs can incentivise use of authorised network, but consumer should choose

Collaboration between independents, multi-brand operators, OEMs and OESs to curb use of spurious parts & give consumers competitive and efficient options

85



VERTICAL AGREEMENTS: AAEC – MOTOR PARTS (2)

Agreements between OEMs and authorised dealers restricting/ prohibiting OTC sale of spare parts, diagnostic tool and repair manuals

CCI rejected arguments that restriction of sales to independent repairers protected owners from buying spurious spare parts/ from botched repairs

Cannot be used to deny consumer choice

Affects multi-brand repairers, who are not unskilled

Restricting access and OEM high pricing result in use of spurious parts!

CCI sought to analyse (short term) efficiencies of selective distribution system in the light of the (longer term) foreclosure effects and barriers to entry resulting from the restrictive clauses

AAEC looked at differently where supplier has monopoly/dominant position

Hardcore restrictions (as set out in EU MV Block Exemption)

Network effects

Frowned upon by competition authorities in mature and developing regimes

86



VERTICAL AGREEMENTS: AAEC AND DOMINANCE

Special application of AAEC test where dominant player

Motor Parts

Each OEMs sole supplier of its genuine spare parts and diagnostic tools in the aftermarket. OEM therefore has a monopoly (and dominant position)

Policy of cancelling warranties if customer goes to non-authorised repairer

Agreements therefore result in total deprivation of consumer choice in aftermarket and OEMs engage in high rent-seeking behaviour

Where an agreement, irrespective of efficiencies, allows an enterprise to completely eliminate competition in the market and thereby become a dominant enterprise and indulge in abusive exclusionary behaviour, “negative” AAEC factors should be prioritised over “positive” factors

Referring to 1983 Michelin judgment of ECJ, dominant undertaking has “a special responsibility not to allow its conduct to impair genuine undistorted competition”

Such priority to be given where restrictive clauses used to create, maintain and reinforce the exclusionary abusive behaviour on part of the dominant entity

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9-11 December 2015

VERTICAL AGREEMENTS 10 December 2015

John Ramirez Managing Director, Econ One Research Inc. Director, Econ One Research India Pvt. Ltd.

Overview

89

Concept of Vertical Agreements

• What are vertical agreements?

• Types of vertical agreements

• Positive effects

• Anti-competitive effects

Implications for Competition Policy

• Treatment different from horizontal agreements

• Competition Act of India

• Balancing the positive and negative effects

• Case example

What are Vertical Agreements?

90

Vertical agreements are formed between firms operating at different levels in the production/distribution chain such as between manufacturers and distributors, manufacturers and retailers, distributors and retailers, etc. • Relate to conditions on the purchase, selling, or reselling of certain goods or services

• Prevalent in industries including television (between channel broadcasters and distributors)

and e-commerce (between manufacturers and platform owners)

• Are also referred to as vertical restraints as they constrain parties under the agreement from operating freely in the market

• Are generally employed to deal with problems arising in vertical relationships as

individual self-interests of the firms may sometimes conflict with their joint interests • vertical agreements can therefore align incentives of the downstream firms with those

of the upstream firms

• However, they may also result in reduction in competition at either level of the supply chain

Types of Vertical Agreements

91


Two-part tariffs

Exclusive distribution – customer or territorial

allocation

Selective distribution

Exclusive dealing

Quantity fixing

Manufacturer

Distributors

Types of Vertical Agreements (2)

92

Resale Price Maintenance: manufacturer restricts the final price that the distributor can charge to end-consumers – could be in the form of a maximum resale price or a minimum resale price, non-binding recommended retail price or advertised price

Exclusive distribution arrangement: manufacturer gives a distributor exclusive rights to sell his products in a particular area (territorial restrictions) or to a particular class of customers (customer allocation)

Exclusive dealing arrangement: restrictions on distributors to engage in activities that directly compete with the manufacturer’s businesses, for example, exclusive purchasing arrangements

Selective distribution: manufacturers lay out certain specifications for distributors to become part of their distribution network

Tying: supply of a product is made conditional on the purchase of another distinct product(s). Tying would classify as a vertical restraint when the products involved are vertically related

Types of Vertical Agreements (3)

93

Two-part tariff: distributor has to pay a fixed amount to the manufacturer irrespective of the quantity bought. In addition, there is a variable component in the form of a per-unit fee

Quantity discounts: distributors can obtain progressive rebates with the increase in quantity they purchase from the manufacturer

Royalty rebates: manufacturers might ask its distributor for payments (royalty) proportional to the sales made by the distributor. But such schemes are effective only when the manufacturer can easily observe and verify the distributor’s sales

Quantity fixing: specification of the quantities to be bought and sold by the distributor

Economic Rationale for Vertical Agreements/ Efficiency Justifications

94

Vertical agreements provide solutions to externalities arising out of producer-distributor relationship, remove distortions in the distribution of products Free-riding by distributors: Some distributors take advantage of the pre-sales

services or advertising done by their rivals by offering a lower price to the customers once they have seen the product. This reduces the incentive for distributors to invest in these services underinvestment in these services Possible solution - Exclusive territorial allocation

Double marginalisation: If both manufacturer and distributor have market power,

they can independently set their respective prices above their marginal costs resulting in the final price being marked up over the marginal cost of production twice higher price and lower quantity (reduced demand) Possible solution - Resale price maintenance, Quantity restriction

Destructive competition between distributors: Distributors may charge less than

optimal prices as high prices could lead to an increase in demand for the products offered by their rivals sub-optimal number of distributors Possible solution - Resale price maintenance, Exclusive territorial allocation

Economic Rationale for Vertical Agreements/ Efficiency Justifications (2)

95

Free-riding by manufacturers: Manufacturers do not have incentive to invest in services such as sales training, financing for distributors, etc. as these services also benefit other brands carried by the distributors, specifically the brands of rival manufacturers who do not invest in these services underinvestment in these services Possible solution - Exclusive dealing

Destructive competition between manufacturers: When a manufacturer increases

the price of his brand, distributors tend to divert sales to the less expensive brands. To avoid this, manufacturers charge less than optimal prices decline in manufacturer’s profits Possible solution - Exclusive dealing

Capturing economies of scale: Manufacturers prefer to supply in bulk to a few distributors over supplying small amounts to a large number of distributors. This could be done by way of quantity restrictions

Anti-Competitive Effects

96

Foreclosure of market Manufacturers could use vertical restraints to foreclose the market to potential or existing rivals by raising the costs of distribution, for example through exclusive dealing arrangements

Softening of competition at both levels

• Reduction in intra-brand competition: resale price maintenance removes price competition between distributors;

• Reduction in inter-brand competition: use of selective distribution by a manufacturer as a means to increase prices could encourage his rivals to follow suit

Facilitating collusion

When various manufacturers simultaneously employ restraints such as resale price maintenance – it is similar to collusion. Resale price maintenance could also be used as a monitoring device for detecting deviation from cartel

Implications for Competition Policy

97

Vertical agreements are generally perceived to be less harmful than horizontal agreements • Parties in a horizontal agreement produce identical/substitutable goods,

therefore horizontal agreements generally reduce competition in that market • Parties in a vertical agreement are involved in complementary activities

o Vertical relationships provides substantial scope for efficiencies

But, one should not overestimate the positive effects

• A firm with market power can use the vertical restraint to increase its profits at the expense of its direct competitors/distributors, and ultimately end consumers

In the European Union, there is a general exemption from antitrust scrutiny if the contracting parties have market shares of less than 30 percent.

One exception is resale price maintenance (RPM) which can be a per se violation

in some jurisdictions; however, there is a movement towards a rule of reason assessment

Vertical Agreements under Sec. 3(4) of the Competition Act, 2002

Section 3(4) of the Competition Act prohibits “an agreement between parties at different levels of production chain including

• tie-ins • exclusive supply or distribution • refusal to deal • resale price maintenance

if the agreement causes (or is likely to cause) an appreciable adverse effect on competition (AAEC) in India”

List of relevant factors for determining AAEC includes both positive and negative effects of vertical agreements • Entry barriers • Market foreclosure • Benefits to consumers

98

Assessment of Vertical Agreements

99

1. Market definition and market power: Define relevant markets and assess if any of the firms under the agreement have market power

2. Examination of anti-competitive effects vis-à-vis efficiency benefits • The two opposite effects are context specific • A holistic analysis is required for evaluation

1. Relevant Market and Market Power

100

Relevant markets are defined as follows under the Competition Act of 2002. Relevant markets are assessed with respect to products and geography:

"relevant product market" means a market comprising all those products or services which are regarded as interchangeable or substitutable by the consumer, by reason of characteristics of the products or services, their prices and intended use "relevant geographic market" means a market comprising the area in which the conditions of competition for supply of goods or provision of services or demand of goods or services are distinctly homogenous and can be distinguished from the conditions prevailing in the neighboring areas

Assessment of market power with any of firms under the agreement • Whether or not there is an adverse effect is strongly influenced by the

participants’ position in the market; in particular, whether they possess market power (i.e., the ability to profitably increase price)

Impact of Behavior is Related to the Firm’s Position in the Market

101

Behaviour

Restrictive contractual

terms

Tying

Example

Loyalty discounts

Must buy ink from printer manufacturer

Impact if firm controls 10% of

the market

Consumers can switch to competitors if discounts are unattractive

Consumers can purchase printers from manufacturers that don’t tie

Impact if firm controls 70% of

the market

Locks up most of the market, making entry difficult

Dominant printer manufacturer may leverage dominance in printer market to dominate ink market

Patents, Market Power, and Tying – Case Study

102

Illinois Tool Works v. Independent Ink (US, 2006)

Background

• Independent Ink asserted an antitrust claim against Illinois Tool Works (ITW) alleging that ITW engaged in unlawful tying. ITW manufactures printing systems for barcodes, and requires its customers to purchase unpatented ITW ink to be used with patented ITW printheads and ink containers

• Independent Ink developed ink that could be substituted for unpatented ITW ink. It claimed that ITW had effectively excluded Independent Ink from the ink market by requiring customers of ITW patented products to also purchase unpatented ITW ink (in violation of the Sherman Antitrust Act)

Basis

• Independent Ink relied on a long-standing (but increasingly criticized) holding that patents confer market power over the patented product

• Independent Ink therefore did not present evidence to establish that ITW held market power

U.S. Supreme Court Holding

• Ruled that there is no such presumption of market power for patented products in a tying claim

• Courts can no longer presume that a patent confers market power over the patented tying product

• The Court concluded:

"Congress, the antitrust enforcement agencies, and most economists have all reached the conclusion that a patent does not necessarily confer market power upon the patentee. Today, we reach the same conclusion, and therefore hold that, in all cases involving a tying arrangement, the plaintiff must prove that the defendant had market power in the tying product."

2. Balancing Negative and Positive Effects

103

Examination of anti-competitive effects

• Loss of product/service variety to the consumers • Reduction in the intensity of competition in the market • Comparison with the counterfactual scenario

Indicators of efficiency benefits

• Cost reduction • Gains to consumers • Other benefits

The net effect of the agreement will depend on which of the two effects is dominant

For instance, tying of less popular channels with more popular channels by broadcasters

(e.g., Sony) when negotiating with distribution platforms (e.g., Tata Sky) may result in economies of scope/scale contributing to better programming. It could also foreclose the market for potential/existing broadcasters by denying them access to distribution platforms (which are capacity constrained in terms of the number of channels they can offer)

Example: Auto Parts Investigation

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In August 2014, the CCI imposed a fine totaling INR 2,544 crore (USD 420 million) on 14 car manufacturers (OEMs) for restricting the sale and supply of genuine spare parts in the open market thereby violating Section 3(4) & Section 4 of the Competition Act, 2002. The CCI concluded: • Agreements between OEMs and authorized dealers requiring authorized

dealers to source spare parts only from OEMs or their approved vendors are anti-competitive

• The OEMs’ restriction of independent repairers’ access to spare parts and diagnostic tools, repair manuals violates Section 3(4) of the Act

• Consumers should be given the option to choose either an authorized dealer of the OEM or an independent repairer to purchase spare parts of repair services

References (Vertical Agreements)

European Commission, “Guidelines on Vertical Restraints”, 2010

Patrick Ray and Thibaud Verge, “The Economics of Vertical Restraints”, March 2005

Paul W Dobson and Michael Waterson, “Vertical Restraints and Competition Policy”, UK Office of Fair Trading, December 1996

Tilottama Raychaudhuri , “Vertical Restraints in Competition Law: The Need to Strike the Right Balance Between Regulation and Competition”, December 2011

Vincet Verouden,“Vertical Agreements: Motivation and Impact”, Chapter 72, Issues in Competition Law and Policy (ABA Section of Antitrust Law 2008)

UNCTAD, “Competition Policy and Vertical Restraints”, January 1999

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anti-competitive agreements faculty development … · especially in the case of cartels, the cci...

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