South Africa: No Certainty For Dual Distribution Relationships

Last Updated: 19 May 2014
Article by Justin Balkin, Kirsty van den Bergh and Michael Mbikiwa

Most Read Contributor in South Africa, September 2018

On 24 March 2014, the Competition Tribunal (the "Tribunal") issued its long-awaited decision in The Competition Commission and South African Breweries and Others. The original complaint against South African Breweries ("SAB") and its Appointed Distributors" ("ADs") was lodged with the Competition Commission (the "Commission") nearly ten years ago, referred to the Tribunal nearly seven years ago, and has been the subject of various interlocutory disputes ever since.

By way of background, the current Liquor Act, unlike its predecessor, imposes no prohibition against a single entity holding both a manufacturing and a distribution liquor license. In this regard, SAB both manufactures and distributes its products: it operates seven breweries in South Africa, each of which is licensed to manufacture and distribute beer, and it operates 40 wholly-owned distribution depots.

However, several years before the current Liquor Act came into effect, SAB began a strategy of outsourcing its distribution in certain rural areas of South Africa. In this regard, it entered into either wholesale or franchise agreements with ADs – a practice which persists today. These agreements (i) limit the operations of each AD to a specific geographic area, (ii) require them to serve all customers of SAB in that region who order above a prescribed minimum quantity, and (iii) prohibit the ADs from selling beer in excess of SAB's recommended selling price. As compensation, ADs are paid a "handling fee" and a "delivery fee", which they receive in the form of a discount from the retail price.

The use of ADs is not, however, SAB's primary method of distribution. SAB distributes 90% of its beer through its wholly-owned depots, which are much larger than the ADs and which are allocated non-overlapping areas of responsibility. The ADs, which account for 10% of SAB's distribution, are confined to those areas in which the wholly-owned depots do not distribute. Effectively, SAB both supplies and competes with the ADs. Such a relationship is referred to in competition law as a dual distribution relationship.

Parties operating in a dual distribution relationship face the danger of their agreements with other downstream players being assessed from a horizontal perspective (rather than a vertical perspective) – that is, they could be seen to be competitor distributors of one another (rather than as providers of services) and could thus fall foul of the "hard core" collusion provisions in section 4(1)(b) of the Competition Act. Indeed, in its complaint, the Commission alleged that SAB's agreements with the ADs contravened both horizontal and vertical prohibitions of the Competition Act.

In this regard, the Commission's first allegation was that SAB and the ADs, as competitors of one another in the downstream market for the distribution of liquor, had engaged in market division in contravention of section 4(1)(b)(ii). In the alternative to this allegation, and to the extent that SAB was considered a supplier rather than a competitor of the ADs, the Commission alleged that SAB had engaged in a vertical restrictive practice which had substantially lessened or prevented competition in contravention of section 5(1).

Section 4(1)(b)(ii), which prohibits market division between competitors through the allocation of "customers, suppliers, territories or specific types of goods or services", is a per se prohibition. This means that it allows for no argument as to the absence of an anti-competitive effect or defence in respect of pro-competitive benefits. Therefore, if the conduct of SAB, qua distributor, amounted to it dividing markets with the ADs, this would be automatically unlawful.

The Commission claimed that there were two ways in which such horizontal conduct occurred: first, although the ADs had not entered into formal agreements with one another, they had, through a "hub and spoke" cartel (using SAB as the hub) divided markets amongst each other; and, second, that each AD separately contracted with SAB qua distributor to effect a division of territories.

The Tribunal accepted that, on face value, the agreements appeared to contravene section 4(1)(b)(ii). However, the Tribunal also noted that an uncritical and rigid application of per se prohibitions can result in counterintuitive and unjust outcomes. Therefore, relying on the Supreme Court of Appeal decision in American Natural Soda Ash Corporation and one other v Competition Commission, the Tribunal embarked on a "characterisation" exercise, to determine whether – in substance if not in form – the character of the impugned conduct coincided with that of the section 4(1)(b)(ii) prohibition.

The Tribunal, in this characterisation exercise, considered a variety of factors which together showed that, but for SAB, the ADs would never have come into existence, and that at no stage did they operate autonomously of SAB. The Tribunal thus held that the ADs could not be considered autonomous economic actors for the purposes of section 4(1)(b). In other words, the Tribunal seems to have found that, because the ADs are not sufficiently independent of SAB they ought not to be regarded as competitors, in the sense that being competitors is a requirement for section 4(1)(b) to apply. Notwithstanding this, the Tribunal then proceeded to consider the effect of the arrangements under section 4(1)(a). This is a strange position, given that section 4(1)(a) and section 4(1)(b) have the same threshold test, namely that the parties involved in the arrangement under investigation are competitors of one another.

Be that as it may, section 4(1)(a) is a "rule of reason" prohibition. It requires the Commission to demonstrate that conduct between firms in a horizontal relationship (i.e. competitors) results in a substantial lessening or prevention of competition, and it allows the offending parties to raise the defence that such anticompetitive effect is outweighed by technological, efficiency or pro-competitive gains. Section 5(1) is similar to section 4(1)(a), except that it applies to parties in a vertical relationship.

The Tribunal undertook a single analysis of whether the impugned agreements resulted in a substantial lessening or prevention of competition, and applied this analysis to its findings in respect of both sections 4(1)(a) and 5(1). Unfortunately, in doing so, the Tribunal did not provide any clarity as regards whether the relationship between the parties was of a fundamentally horizontal or vertical nature.

In attempting to demonstrate a substantial lessening or prevention of competition, the Commission alleged that, but for the territorial exclusivity created by the agreements, distributors would have served customers to whom they were most optimally located, as opposed to those to whom they were restricted, thus reducing costs and time, and enhancing the number of deliveries.

The Tribunal rejected this contention, finding that the Commission had failed to show that SAB was not in fact taking the cheapest route to the customer, or that service would have been optimised in the absence of the agreements. The Commission had thus failed to show a substantial lessening or prevention of competition for the purposes of sections 4(1)(a) or 5(1).

The Commission's second allegation was that SAB had, by providing discounts to its ADs and not to its other customers which also perform a distribution function, engaged in price discrimination. Price discrimination is prohibited conduct by a dominant firm in terms of section 9(1). The Tribunal held that section 9(1) applies only to "equivalent" transactions. SAB's transactions with the ADs – who it gave a discount as consideration for distributing its products – were not equivalent to its transactions with independent customers, as the independent customers were not performing a distribution function for SAB. As a result, the independent customers were not entitled to discounts.

The Commission's final allegation was that SAB had engaged in minimum resale price maintenance in contravention of section 5(2), by imposing a software program on its ADs which prevented them from setting lower prices. Here the Tribunal concluded that it was possible, though not clear from the evidence, that SAB's use of the software was unintended and that, in any event, there were no sanctions for non-compliance. As such, there was insufficient evidence to find that SAB had engaged in minimum resale price maintenance.

This is the first case in which the Tribunal has assessed a potential dual distribution relationship. Unfortunately, however, this decision is very fact-specific. Whilst the decision gives finality and certainty to SAB (pending any appeal) in respect of its method of distribution, other vertically integrated firms should be cautious in attempting to draw from it any principles of general application. In particular, if not for the very specific nature of the relationship between SAB and the ADs, and the ADs lack of autonomy, the Tribunal would likely have found that the agreements were per se prohibited. It would therefore be unwise for firms that operate in both the manufacturing and distributing markets to assume, on this basis that they can safely enter into agreements with distributors which allocate customers or territories.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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