Managing your distributors in the anti-trust new dawn

A manufacturer’s relationship with distributors is generally considered a vertical relationship, i.e. one of upstream and downstream companies in the supply chain of the market. Restrictions on vertical relationships are common tools used by manufacturers to manage their distributors, but few have realised that they need to make changes to set their companies on the right path in the new enforcement environment.

Most companies that manage traders and distributors by controlling price and dividing markets are too small to attract the anti-trust authorities’ attention. However, companies are still vulnerable to anti-trust claims, especially multinational companies with a substantial market share in China, because they are likely to become the target of complaints or reports lodged by their competitors, whistle-blowers, or even customers.

1. Price restraints
a) Resale Price Maintenance
Article 14 of the AML prohibits a company from fixing the price of commodities for resale to a third party, restricting the minimum price of commodities for resale to a third party, or reaching other monopoly agreements as recognised by the enforcement agency. This is the only clause under Chapter 2 (monopoly agreement) regulating vertical relationships. Judging from the criteria set forth by this clause, many companies that manage a distributor or channel network by setting minimum or fixed resale prices have already committed anti-trust violation.

Setting maximum resale price seems to be safe, but the catch-all clause of Article 14 vests the enforcement agency with power to regulate any other unlisted monopoly agreements if such practice restricts or eliminates competition. Besides, if the maximum price is set below the cost of the commodity, the practice may be deemed ‘dumping’ in the context of the fair competition law.

b) Recommended price
Efforts to circumvent Article 14 never stop since the NDRC’s investigation into the famous Chinese liquor producers, Wuliangye and Moutai, became well-known to the public in early 2013. A common practice is to change the mandatory pricing policy for distributors to a suggestion of ‘recommended price’. Recommended price, however, is only good if it is truly nothing but a recommendation. Whenever recommended price comes with coercive factors, such as supervision by the company or by other organisations controlled by the company, warnings or penalties, such behavior in fact deprives a distributor of any other option, and is likely to be considered resale price maintenance (RPM) in a disguised form by the enforcement agency.

2. Territory and location restrictions
In regulating vertical relationships, the AML only expressly prohibits RPM, while all the other monopoly agreements which are vertical in nature are dealt with under Chapter 3 (abuse of market dominance). In other words, practice of imposing various non-price restrictions upon distributors is allowed from the perspective of vertical restraints in China, though some of them might be problematic under the regulations on abuse of market dominance. In rare cases, it could also become a cross-border issue involving both horizontal and vertical restraints, discussed below.

a) Restrictions imposed by the company
Territory or location restrictions, such as exclusivity arrangements by region, channel restrictions, and restrictions by the location of reseller or customer are typical methods of regulating distributors on the basis of market division. As mentioned above, the application of such a restriction itself does not violate the AML in the vertical context. In the event that the company which manages distributors is a large company with dominant market power, it is possible that such practice might constitute exclusive dealing (i.e. restrict the company’s trading party so that it may conduct deals exclusively with the company or with its designated companies without any justifiable causes) or other unreasonable trade conditions which are prohibited under Chapter 3 of the AML.

b) Restrictions imposed by the distributors
Sometimes it is the distributor rather than the company that has the incentive and takes the initiative to regulate the relationship with other distributors. An example being distributors in a city voluntarily meeting and dividing the cities into several areas with reference to the locations of the distributors, where each distributor should only sell the commodities in its own area. By dividing the areas, a distributor eliminates competition in its own territory. This scheme, formed among competing distributors, is likely to be considered a horizontal conspiracy among the distributors. Moreover, if such a scheme is taken upstream by the distributors to the company for its support or recognition, the company will find itself also in danger of committing anti-trust violations.

c) Parallel channels
It is a common strategy of business development that a company develops its own sales channel while using distributors to further increase its sales volume. For example, a manufacturer usually provides in its distribution agreement that the sales activity of a distributor is limited in its designated region (usually called the authorised region), while the manufacturer expressly reserves the rights to directly sell into said region designated to the distributor. This creates a competitive relationship between the manufacturer and the distributor in the region, which in turn brings in the risk of a horizontal monopoly.

3. Loyalty programme
Manufacturers usually offer a loyalty programme to their distributors. In some loyalty programmes, the price of purchasing commodities is associated with the volume of purchase. The more a distributor buys, the more it saves on the unit price of the commodity. The benefit might be provided in the form of a discount on the spot, or rebates or refunds given after a certain threshold is met.

The AML does not expressly regulate on loyalty programme. Whether a specific loyalty programme is legitimate is also a controversial issue even in jurisdictions where anti-trust laws are well developed. Considering the various and creative forms that a programme could take, it is suggested that a company seek legal advice before implementing a loyalty programme in any major anti-trust jurisdiction.

One unique type of loyalty programme worthy of discussing is retroactive rebate. Retroactive rebate refers to a rebate provided to the distributor on all the quantities purchased if a certain volume threshold is met. This rebate is retroactive because it is applied retroactively up to the threshold. It would not make any significant difference for distributors to purchase from the company offering the rebate or from its competitors if the purchase does not meet the threshold. However, the fact that a rebate kicks in when the purchase reaches a certain threshold will give great attraction to the distributor, and render small competitors impossible to compete with the rebate provider on large-scale transactions.

Such rebate might be deemed a disguised penalty against those not buying enough, and a distributor who could have diversified its procurement without such a rebate will now stick to the rebate provider for all of its demand to meet the threshold and receive the benefit. A manufacturer using a volume threshold is in fact squeezing out smaller competitors by inducing the distributors to buy more from the manufacturer, resulting in a serious decrease in the purchase from rival companies. In this scenario, if the manufacturer possesses a dominant market share, the discount might be seen by the enforcement agency as a potential risk involving abuse of market dominance.

In addition to the exclusionary effect of the retroactive rebate, the reduction in unit price of the commodities as a result of the provision of such rebate could also cause price-related issues for large companies. By taking advantage of their operational scale, large companies are able to bring down the cost of commodities while output keeps increasing. In some cases, however, companies go too far by granting rebate higher than the decrease in cost, resulting in the unit price dropping below the cost of the commodity. It is likely to be considered predatory pricing (i.e. selling commodities at prices below cost without any justifiable cause that drives the competitors out of the market) when the company possesses a dominant market position.