Keywords: competition, Hong Kong, vertical arrangement
WHAT ARE EXCLUSIVE ARRANGEMENTS?
Exclusive arrangements are a type of vertical arrangement, whereby one party imposes restrictions on the other's ability to choose with whom, in what or where it deals. It is a common business practice and can take many forms. Often, it requires a buyer (whether a reseller or end-user) to deal exclusively with a seller. In most cases it will not harm competition.
For example, a manufacturer may agree to supply a distributor provided it agrees not to carry the products of the manufacturer's competitors. It can also occur between sellers and consumers such as when consumer agrees to purchase all its requirements of a particular product from a single supplier. It can also involve a seller dealing exclusively with a single buyer.
Both the First Conduct Rule and Second Conduct Rule can apply to exclusive arrangements. The Second Conduct Rule is only triggered where one of the parties to the exclusive arrangement has market power.
WHY DEAL EXCLUSIVELY?
Exclusivity may be used by a manufacturer with market power to prevent smaller competitors from succeeding in the market place. For example, by denying a competitor access to retailers without which it cannot make sufficient sales to compete effectively. It can also be used by manufacturers to reduce competition between them. For instance, where exclusive supply contracts between manufacturers and their customers operate like a customer allocation agreement so that the two manufacturers do not need to compete for each other's customers.
WHAT HARM ARISES FROM EXCLUSIVE ARRANGEMENTS?
The main concern with exclusivity is a market "foreclosure" effect. Foreclosure concerns arise because exclusive arrangements by their nature "tie up" certain distributors or suppliers in a manner that precludes other competitors in the market from dealing with those parties. This raises barriers to entry which makes it easier for existing firms to exploit whatever power they have but difficult for existing competitors to compete effectively or potential competitors to entering a market.
The risk of foreclosure is likely heightened where:
- Size of the party: One of the parties has market power, which increases the likelihood a larger share of the market will be foreclosed;
- Network effect: A large part of the market is tied up in other exclusive arrangements (creating a "network effect" of exclusivity arrangements); and
- Duration of exclusivity: The duration of exclusivity is unjustifiably long.
IT'S NOT ALL BAD NEWS
Notwithstanding the above, an exclusivity arrangement can also be pro-competitive and beneficial, for example if it:
- Encourages a distributor to promote and market the manufacturer's brand more vigorously and to offer extra services such as fast warranty service or after-sales services;
- Provides retailers with assured supplies which can allow for longer-term planning and investment;
- Encourages manufacturers to help dealers by providing services or information benefitting consumers; and
- Provides a manufacturer with a reliable and steady outlet of supply enabling it to make investments to increase efficiency.
Whether an exclusive arrangement is likely to be justifiable on efficiency grounds requires careful consideration and must be analysed on a case by case analysis.
Next week, we will take a look at selective distribution agreements.
Originally published 13 May 2015
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