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1 July 2010

Exclusivity Arrangements: Pros and Cons


Author: Igor Svechkar and Tetiana Vovk
Source: The Ukrainian Journal of Business Law. - 2010. July-August. - p.20-21

Exclusivity arrangements are quite common for a wide range of products and services that a consumer comes across nowadays, especially in distribution (particularly, in such industries as pharmaceuticals, automotive, etc.). Such arrangements are commonly defined as requiring a buyer/distributor to purchase all of its requirements or a large extent thereof from one (dominant) seller/supplier, or a supplier to sell all of its products or services or a large extent thereof to the dominant firm (see Report on Single Branding/Exclusive Dealing of the Unilateral Conduct Working Group of the International Competition Network).

There may be various economic reasons for the parties to engage in exclusivity arrangements. Those would primarily include the supplier's incentive to procure for effective distribution of its products benefiting from optimization of their import and sales, as well as making use of the distributor's developed marketing structure and reduction of transport and other related costs, to implement unified standards with respect to storage, maintenance and presentation of products, etc., all of which would ultimately contribute to safeguarding the supplier' good reputation on the market and bring economic efficiencies. Exclusivity may also serve as a tool to secure confidentiality of the supplier's business secrets and minimize its expenditures on dealing with other distributors. From the distributor's perspective, exclusivity would secure customers' demand for the product and create incentives to offer a better deal to the customer.

On the other hand, exclusivity arrangements may amount to an anti-competitive practice bringing adverse effects for the market, which may be caused by market foreclosure and rise in costs for competitors to enter or maintain their position on the market.

Ukrainian legislation does not contain a precise definition or expressly regulate the issue of exclusive dealing, but it does track down the anti-competitive effects that such arrangements may bring for competition on the market and ultimately, for the end consumer.

Legislative framework

Thus, Economic Competition Protection Act of Ukraine prohibits any anti-competitive concerted practices, i.e. those which resulted or can result in the prevention, elimination or restriction of competition (unless authorized by the Antimonopoly Committee of Ukraine (AMCU) or the Cabinet of Ministers of Ukraine as the last resort).

Such prohibition is pre-qualified by the primary jurisdictional test: the law applies only to the extent an arrangement has or may have an impact on economic competition on the Ukrainian market. This created a form of effects-based defense for the parties to a potentially prohibited practice. However, as the AMCU has exclusive competence to assess and decide whether any impact on the market may occur as a consequence of a particular arrangement and is vested with a rather considerable degree of discretion in qualification of arrangements and determining their potential anticompetitive effects, the possibilities to rely on self-assessment are very limited and the risks of adverse treatment usually remain.

In the worst case scenarios exclusivity arrangements may result in such unlawful practices as market allocation or significant restriction of competitiveness of other undertakings. Furthermore, such arrangements may be treated as actions targeting coordination of competitive behavior on the market and restricting intra-brand competition. They may also contribute to dominant suppliers maintaining unlawful monopoly market power or market foreclosure for competing suppliers, especially if the distributor is unique or represents an important distribution channel.

However, exclusivity does not necessarily have adverse effects on competition and result in consumer harm.

Substantive analysis

Prior to proceeding to the analysis of an exclusivity arrangement on the substance, it is worthwhile analyzing whether the arrangement falls into either of the categories generally exempted from prohibition as incapable of causing significant adverse effects on competition.

The Resolution of the AMCU On the Standard Requirements to Concerted Practices of the Undertakings for the General Exemption from the Requirement to Obtain AMCU Approval, offers
the following exemptions:

— de minimis exemption, i.e. where the aggregate combined market share of the parties to an arrangement on any of the product market(s) concerned is less than 5%;

— market share based exemption, applicable to restraints between non-monopolists (or absent exclusive or privileged rights) if the aggregate combined market share of the parties to an arrangement on any of the product market(s) concerned is less than 20%, provided certain (rather low) financial thresholds
are met.

The above exemptions are, however, not accessible to competitors (at least potential ones) in the event of hard core restrictions, such as market sharing. Another possibility to validate an anti-competitive exclusivity arrangement is to obtain an individual clearance from the AMCU. As a general rule, the AMCU would authorize concerted practices if they contribute to (i) modernization of production, purchase or sale of products, (ii) technological or economic development, and/or (iii) development of small or medium-sized businesses, etc. and do not adversely impact competition on the relevant market. The AMCU is usually reluctant to authorize restrictive arrangements where the beneficiary of the restriction possesses significant market power.

Otherwise, the exclusivity arrangements are generally prohibited, as in essence they represent one of the hard-core restrictions under Ukrainian competition law — market allocation — and reduce intra-brand competition.

In this respect European approaches are more flexible. Thus, exclusive distribution arrangements are generally exempted from prohibition when both the supplier's and the distributor's/buyer's market share do not exceed 30% (see Vertical Block Exemption Regulation). In the view of the European Commission the loss of intra-brand competition (caused by an exclusivity arrangement) can only be problematic if inter-brand competition is limited (see Commission Notice, Guidelines on Vertical Restraints). Thus, it may be concluded that an exclusivity arrangement among the undertakings with a market share of 30% at most are not perceived as posing a serious threat to the competitive market environment. Furthermore, those market players with an even stronger position on the market may still benefit from an individual exemption granted by the European Commission if they prove that the resulting efficiencies would counter-balance the adverse effect of the restrictive arrangement.

Importantly, US and Europe an competition authorities have in recent years tended to employ a more economic-based approach when analyzing the effects of the exclusivity arrangements on competition and adopting rulings on the permissibility of exclusivity arrangements in individual cases. Various factors would be relevant for such analysis:

— market shares of the participating undertakings;

— entry barriers (markets with low entry barriers are normally less sensitive to exclusivity arrangements);

— market position of competitors (adverse effects are less likely when parties to the exclusivity arrangement face strong competition on the market and their competitors do not need to incur significant additional costs to outbalance the effects of such an arrangement);

— the duration and obligatory nature of an exclusivity arrangement (arrangements with shorter duration and/or the possibility for the parties to exit from the arrangement upon notice are generally less harmful as effective competition is preserved);

— price coordination and output control potential of an arrangement (if no such coordination or restriction on output is involved, the arrangement is unlikely to raise concerns over competition);

— need to protect the supplier's good reputation and high value brand, to ascertain protection of its IP rights (these normally justify exclusivity);

— the products' specifics (in certain industries qualified sales personnel and specific market knowledge are required, which normally justifies exclusivity);

— brand preferences of consumers (adverse effects are less likely if consumers have low brand sensitivity);

— other efficiencies (e.g. exclusivity may increase interbrand competition as the exclusive distributor would have more incentives to invest in promoting the product and will be more inclined to offer better terms to the customer to survive in a competitive environment).

Outline

Although prohibited under the general rules of Ukrainian competition law as anti-competitive, exclusive dealing arrangements are not always harmful to competition or infringe upon the interests of the end consumers. The practical risks of exposure and the probability of adverse treatment of an exclusivity arrangement are usually higher if other market players do not pose a serious competitive constraint on the parties to the exclusivity arrangement (e.g., due to limited range of offered products) or if the product is unique and/or there are no alternative sources of supply/distribution. Thus, it is recommended to assess the compliance of a particular arrangement on a case-by-case basis.



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