UK: OFT Publishes Full Tobacco Retail Pricing Decision

Last Updated: 12 July 2010
Article by Susan Hankey and Caroline Hobson

The OFT has published its full decision on the tobacco investigation, in which it found that two tobacco manufacturers and ten retailers had engaged in unlawful retail pricing conduct, breaching the Chapter I prohibition of the Competition Act 1998 (the Act).  On 15 April 2010 the OFT announced its decision and handed down fines totalling £225 million on the parties involved in the infringements.  This is the largest fine that the OFT has imposed to date for breaches of UK competition law.  

The OFT's decision follows a lengthy investigation into the retail pricing actions of manufacturers and retailers, which began in 2003. 

The infringing agreements

A series of agreements was found to exist between each manufacturer and each retailer (the infringing agreements).  The infringing agreements enabled the manufacturers and retailers to co-ordinate the setting of retail prices for the tobacco products.  This was done in order to achieve certain "parity" and "differential" requirements that were set by each manufacturer in pursuit of its retail pricing strategy.  That strategy was based on maintaining certain price differences between the relevant manufacturer's brands and the linked brands of a competing manufacturer.

"Parity" requirements broadly required that the relevant manufacturer's brand X would be priced the same as a competing manufacturer's brand Y.  "Differential" requirements (expressed either as a fixed or maximum differential) broadly required that certain price differentials be applied between the manufacturer's brand X and a competing manufacturer's brand Y.  Together these were aimed at achieving the manufacturer's desired pricing relativities between its brands and competing brands.

The infringing agreements contained a number of different elements:

  • The manufacturer's strategy in relation to the retailer's retail prices (i.e. to achieve its parity and differential requirements).
  • Written trading agreements between a manufacturer and a retailer, under which the retailer agreed that it would price a number of the manufacturer's brands according to the parity and differential requirements stipulated by the manufacturer.
  • Contacts between the manufacturer and retailer regarding i) the retail prices for the manufacturer's brands; ii) the retail prices for the manufacturer's competitors' brands; iii) the retail prices charged by the retailer's competitors.
  • The payment or withdrawal of bonuses and other incentives by the manufacturer to incentivise the retailer to set its retail prices in accordance with the manufacturer's retail pricing strategy.
  • Frequent and detailed monitoring, complaints by the manufacturer and subsequent alignment of the retailer's retail prices to ensure compliance with the manufacturer's retail pricing strategy.

The OFT found evidence that the retailers accepted and/or indicated a willingness to implement the manufacturer's parity and differential requirements.

OFT decision

The OFT found that the infringing agreements comprised an agreement and/or concerted practice between each manufacturer and retailer.  The infringing agreements were found to restrict the retailer's ability to determine its retail prices for competing tobacco products.  Each agreement was found to have the object of restricting competition in the supply of tobacco products in the UK in breach of competition law. 

The OFT determined that the manufacturers' retail pricing strategies took the retailers' pricing policies and desired pricing position into consideration.  The changes in retail prices were made so as to avoid significantly affecting the retailers' margins.  The parity and differential requirements had the effect of removing uncertainty for the manufacturers, enabling them to predict retail pricing movements more accurately.  The OFT also believed that the manufacturers had knowledge of each other's pricing requirements as agreed with the retailers. 

Taking into account the legal and economic context (and in particular the manufacturers' combined share of the relevant market by volume), the infringing agreements enabled the manufacturers to achieve a degree of stability in relation to inter-brand competition.  The OFT believes that this stability is similar to that which could have been achieved from horizontal price co-ordination between competitors.

As both tobacco manufacturers (covering a significant part of the market) had similar infringing agreements with the same retailers, there was found to be a prevalence of similar vertical agreements across the tobacco retail sector.  The OFT treated the infringing agreements as a series of bilateral vertical agreements between each manufacturer and retailer.  The OFT noted the similarities between the two manufacturers' agreements, the manufacturers' "parallel and symmetrical" pricing requirements and stated that each manufacturer must have been aware of the requirements of the other.  It considered that these factors reinforced and increased the restrictive nature of each infringing agreement.  However, the OFT does not appear to have found any evidence of a "hub and spoke" arrangement, which is where vertical arrangements are converted to a horizontal cartel arrangement between competitors.

No exclusion/exemption available

At the time of the infringing agreements, vertical agreements were excluded from the Chapter I prohibition pursuant to the Competition Act 1998 (Land and Vertical Agreements Exclusion) Order 2000.  However, this exclusion could not be applied where an agreement had the object or effect of restricting the buyer's ability to determine its sale price.  In this case, the OFT determined that the infringing agreements did restrict the retailers' ability to set retail prices for competing tobacco brands.  In particular, this was because the restrictive nature of the agreements involved linking the retail price of competing brands, and was not due to the imposition of a maximum resale price.  As such, the exemption did not apply.

A number of parties made representations that the infringing agreements might benefit from individual exemption pursuant to section 9 of the Act.  In order to benefit from this exemption, an agreement must:

  • contribute to improving production or distribution, or promoting technical or economic progress; 
  • not impose restrictions which are not indispensable to the attainment of the efficiencies created by that agreements; 
  • allow consumers a fair share of the resulting benefit; and 
  • not create the possibility of eliminating competition. 

The OFT concluded that the infringing agreements did not meet these requirements.  In particular the OFT was not persuaded that the first condition was met, and did not consider that the restrictions of competition were indispensable.  Therefore, the OFT found that the exemption could not apply.

Appeals

Six parties have lodged appeals with the Competition Appeal Tribunal against the OFT's decision.  The parties seek an annulment of the decision or a reduction in the fine imposed.  They dispute the substance of the decision on various bases.  Grounds for appeal include that the agreements in question did not have the object of restricting competition, that the OFT's evidence was insufficient or mischaracterised, and that the exclusion under the Competition Act 1998 (Land and Vertical Agreements Exclusion) Order 2000 should have applied. 

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 09/07/2010.

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