by Tavashya Kumar
E-commerce may be defined as a mode of conducting business transactions such as purchase and sale of products through electronic means as against the traditional physical means. Recently, this industry has witnessed a phenomenal amount of growth, as evidenced by the rise of industrial conglomerates such as Amazon, Flipkart, etc. These corporations have revolutionized the retail market in India by selling a varied range of products at extremely competitive prices. According to the Draft National E-Commerce Policy, the Indian e-commerce market was worth USD 38.5 billion in 2017 and is estimated to rise to 200 billion by 2026. Owing to its characterisation as an up-and-coming sector, the government is consistently working towards developing a comprehensive legal framework to govern and streamline it. Consequently, this sector has seen a flurry of regulations in the recent past, governed chiefly by concerns of anti-competitive practices. This includes the National E-commerce Policy as well as the FDI Policy (and associated Press Notes).
This two-part series aims to critically analyse the amendments made to the Consolidated FDI Policy 2017 (2017 policy) by the promulgation of Press Note 2 (2018 series) (Press note 2) in context of specific allegations of anti-competitive agreements, namely Exclusive Distribution Agreements (EDA) and ‘arrangements for preferential treatment’ in the e-commerce industry. It shall explore whether the aforementioned agreements/arrangements can be classified as anti-competitive. If so, it shall further analyse whether the amendments made in the new policy are sufficient to restrict such practices. However, if that is not the case, it shall consider the veracity of the amendments and whether they are justified in their object and effect. The first part shall deal with ‘Exclusive Distribution Agreements’, between e-commerce marketplaces and manufacturers of products such as mobile phones.
DEFINITION & CLASSIFICATION
The Competition Act, 2002 (The Act) defines an EDA as “any agreement to limit, restrict or withhold the output or supply of any goods or allocate any area or market for the sale of the goods.” Therefore, an EDA may be understood as a supplier’s commitment to sell his products to a single distributor for resale in a designated territory.
EDAs are one of the 5 types of vertical agreements provided in the Act that may cause an Appreciable Adverse Effect on Competition (AAEC). Vertical agreements are defined as agreements or concerted practices entered into between two or more undertakings each of which operates at a different level of the production/distribution chain, and relating to the conditions, under which the parties may purchase, sell or resell certain goods or services.The effect of such an agreement is to limit the freedom of the manufacturer, who cannot thereafter sell through another distributor in the area granted to the first distributor. Therefore, it represents a ‘vertical’ relationship between the manufacturer and distributor.
The creation of an EDA may preclude other distributors from dealing with the supplier’s product. The resultant (actual or perceived) loss of business has prompted claims of violation of antitrust laws. However, to better understand how and why such concerns have arisen, a theoretical understanding of vertical agreements and the competition concerns that may accompany them is essential.
THEORETICAL UNDERSTANDING OF VERTICAL AGREEMENTS
Goods are produced either for self-consumption or for sale in the market. A producer wishing to sell his products may do so either himself or supply them to a distributor, who would then resell them. A producer is said to be ‘vertically integrated’ if he assumes the function of both producing and distributing goods. However, if the producer chooses to employ a distributor (wholesaler or retailer), a distribution chain is created, moving from the Producer to the Retailer to the Consumer. Competition concerns may arise when these companies, operating at different levels of the distribution chain, enter into certain agreements for exclusive supply, distribution, etc. These are known as vertical agreements.
However, it is an established notion that vertical agreements are only likely to raise legitimate competition concerns when there is a certain degree of concentration of market power either at the upstream or the downstream level or both. Negative effects are likely to accrue only when the agreement between corporations at different levels contributes to the creation or maintenance or exploitation of this power. Therefore, an analysis of the market power of the impugned parties becomes important to ascertain whether there is any concentration and if so, the degree thereof. This approach aligns with that of the EU, which exempts vertical agreements from scrutiny when the market share of the parties is below 30%.
The fundamental objection with regard to vertical agreements is the potential detrimental impact of such agreements on intra- and inter-brand competition. Inter-brand competition refers to the competition between the manufacturer and its competitors, selling similar but slightly differentiated products. Conversely, intra-brand competition refers to the competition between the retailers or distributors of the same brand. EDAs limit intra-brand competition by ensuring that a particular retailer/wholesaler becomes the sole distributor of the products of a manufacturer, thereby precluding others from selling the same products.
LEGISLATIVE FRAMEWORK IN INDIA
Section 3 of the Competition Act, 2002 states that “No enterprise shall enter into any agreement in respect of production & distribution, which causes appreciable adverse effect on competition (AAEC) within India.”
Section 3(3) regulates any agreement entered into by enterprises, who are engaged in identical or similar trade of goods which results in fixing prices, controlling production, supply, etc. By stating ‘identical/similar trade of goods’, the Act refers to firms selling substitutable products. Hence, this section regulates horizontal agreements. Moreover, the sub-section goes on to say that a horizontal agreement shall be presumed to have an AAEC. This approach conforms to the established notion that such agreements are likely to cause competitive constraints and therefore must be per se illegal.
Section 3(4) regulates any agreement amongst enterprises at different levels of the production chain, in respect of production, distribution, etc, shall be deemed anti-competitive if they are likely to cause an AAEC in India.Since it refers to agreements among enterprises at different levels of production, this section regulates vertical agreements. However, there is no presumption of AAEC for vertical agreements and they are subjected to the ‘rule of reason’ approach.
ANALYSIS OF EDAs IN THE E-COMMERCE SECTOR
E-commerce corporations have contended that the agreements with manufacturers do not provide complete exclusivity and the EDAs, in the context of the e-commerce industry, are restricted in their scope as their coverage is limited to online distribution channels. For example- E-commerce entities such as Flipkart and Amazon have been known to enter into agreements with manufacturers of certain products such as smartphones whereby they would launch these products and these products would then be available online exclusively on the marketplace operated by these entities.
In the e-commerce sector, the CCI has examined the allegations of the anti-competitiveness of EDAs most comprehensively in Mohit Manglani v. Flipkart India Pvt. Limited.It was averred that such arrangements cause an AAEC because the consumer is left with no choice regarding terms of purchase and price of the goods and services. He can either accept them in totality or opt not to buy the product. Moreover, the portal operator decides the terms and controls the supply.
However, the CCI contended that it is unlikely for these agreements to create competition concerns as most of the products which are sold by way of exclusivity agreements, such as mobile phones, face competitive constraints. Furthermore, owing to the nascent nature of the e-commerce industry, it is evident that there is no evidence of any retailer having a dominant market share and given the wide range of products, availability of substitutes, etc, no single retailer is in a position to exercise market power resulting in AAEC. By investigating the agreements in the context of these provisions and following a ‘Rule of Reasons’ approach, it concluded that any such EDA would not result in AAEC in the market, as no monopoly or dominance could be established.
Moreover, the CCI has, in other cases, while following this approach, considered market power as the seminal factor in deciding whether an agreement is anti-competitive. For example, In Prime Mag v. Wiley India, it was held that since the arraigned party had a minuscule market share (4.1%), the impugned agreement was unlikely to cause any AAEC.
AMENDMENTS CONTAINED IN PRESS NOTE 2
The agreements entered into by manufacturers of products and the e-commerce marketplaces were intended to ensure exclusivity for the e-marketplace in the online distribution channel. However, this practice was restricted by Press Note 2 with the inclusion of a new provision. It reads as follows- An e-commerce marketplace entity will not mandate any seller to sell any product exclusively on its platform only.A blanket restriction was placed on all agreements that could in any way connote any exclusivity concerning the sale or distribution of any product. Additionally, a presumption of anti-competitiveness was created against such agreements, wherein their mere existence would be deemed to be ‘per se’ illegal.
As established in Mohit Manglani, by reference to the other established case laws, a theoretical understanding of vertical agreements, and an examination of the impugned EDAs, it appears that they are not in violation of Section 3(4). However, that being the case, pertinent questions arise with respect to the objectives behind the promulgation of this provision and the veracity of these objectives. They are examined in the subsequent sections.
FIRST OBJECTIVE: PROTECTING SMALLER VENDORS
Firstly, the idea behind these changes could be that such agreements harm smaller vendors, as they do not have the resources to negotiate such agreements. Furthermore, even though their overall market share is relatively less, the e-commerce entities are still at an advantage over the smaller merchants owing to factors such as foreign investment, network effects, etc. Thus, the purpose behind the new provision is to protect the interests of these small merchants against the big firms, who would still be in a situation to dominate the market to the detriment of the smaller vendors. Statements to this effect have been made by high-level government functionaries such as the Minister for Commerce & Industry, Piyush Goyal.
The nature of these agreements does, on a prima facie level, seem to support the aforementioned argument. However, a deeper examination reveals that this is not the case. Taking the example of the agreement between OnePlus and Amazon, one would assume that Amazon is the sole entity that sells products made by OnePlus. Text messages adduced as evidence in the case of Delhi Vyapar Mahasanghalso seem to indicate the same. However, the actual agreements have not been examined and, as contended in the case of Mohit Manglani, the impugned agreements of exclusivity are limited to the online distribution channel. No manufacturer is prevented, in any manner, from selling the products in physical stores. This is further affirmed by the fact that OnePlus has partnered with offline retailers and opened its stores, rather than selling exclusively online. Therefore, the amendments cannot be justified under the garb of the welfare of smaller vendors, as they are unaffected by these agreements.
SECOND OBJECTIVE: INTRA & INTER-BRAND COMPETITON
As stated previously, any EDA, in its essence, precludes intra-brand competition by making one distributor the sole seller of the products of a particular manufacturer. Therefore, even if the agreements are restricted to the online distribution channel, one distributor would still effectively monopolise the entire market for the product and foreclose the other distributors, thereby limiting competition. This would, in theory, allow for the creation/maintenance of market power and allow manufacturers to charge higher prices for their products since the products would be sold by one seller and consumers wishing to purchase them would have to adhere to the conditions of sale as determined by this distributor. Therefore, it is alleged that such agreements would effectively result in harm to consumer welfare, the protection of which is the central aim and purpose of Competition Law.
A separate concern may be that such agreements also lead to the softening of competition or facilitate active/tacit collusion when most competitors in the market adopt EDAs, thereby restricting inter-brand competition. Consequently, the objective behind the amendments in Press Note 2 could be to address these concerns regarding intra and inter-brand competition.
However, this conceptualisation of anti-competitiveness ignores both the existence and the paramount importance of inter-brand competition in the market. Firms enter into EDAs to limit intra brand competition between distributors only when they are faced with heavy inter-brand competition. As a general principle, intra-brand competition is less important than inter-brand competition. If sufficiently rigorous inter-brand competition exists, any restriction on intra-brand competition may be deemed superfluous and harmless. The US Supreme Court, in Continental T.V. v. Sylvania, reasoned that inter-brand competition would necessarily offset the damages from the restrictions on intra-brand competition. This view was affirmed in the case of Business Electronics v. Sharp Electronics.
The reason behind giving primacy to the inter-brand competition is rooted in economic analysis. An EDA protects the distributors from the competition. However, it does not reduce competition for the producer, who continues to face the same level of inter-brand competition as before. Consequently, EDAs don’t provide the manufacturer with any additional market power. Thus, he cannot restrict output or increase prices arbitrarily, thereby precluding any distortion of competition by an enterprise by the exercise of market power.
In the context of the given industry, even though Amazon and Flipkart may be the sole distributors for OnePlus and Xiaomi in the online channel, fierce inter-brand competition exists between them. Both the manufacturers and e-marketplaces provide goods & services that are slightly differentiated in their features. Thus, there is a high degree of substitutability in the products which they offer. This leads to fierce inter-brand competition. As a result, any restriction upon intra-brand competition becomes relatively insignificant.
As stated previously, a central concern of competition law is that a firm with market power will be able to harm consumer welfare by raising prices. However, the prevailing situation in the Indian e-commerce market is different because, due to the existence of fierce inter-brand competition, the concentration of market power is prevented. As a consequence, there exists a greater choice of substitutes, which, when coupled with lower prices, is beneficial to consumer welfare. Therefore, such agreements have not resulted in any harm to consumer welfare and are not likely to do so. They promote consumer welfare by improving the economic efficiency of the distributors.
With regard to the softening of inter-brand competition, it has been affirmed by the EU that such concerns arise only when the number of competitors is very small. However, this is not the case in the Indian e-commerce market, which already has several entities competing such as Amazon, Flipkart, Snapdeal. Contrarily, the competition only seems to be increasing, with the imminent entry of Reliance and Paytm in the e-commerce space.
For these reasons, it can be concluded that concerns regarding loss of intra-brand & inter-brand competition and consumer welfare are misplaced and therefore, the policy cannot be justified on these grounds.
THIRD OBJECTIVE: ‘PER SE’ ILLEGALITY
Another objective of the amendments could be to prevent e-marketplaces from circumventing the provisions of the 2017 FDI Policy by creating complex agreements with manufacturers, which may not ‘technically’ violate the policy but are, regardless of that, anti-competitive. This is done by imposing a blanket ban on such agreements from the outset. Further, if such agreements were to be concluded, they would be presumed to be violative of competition norms. In other words, such EDAs would be considered as ‘per se’ violations, in a manner akin to the ‘per se’ prohibition of horizontal agreements in India.
While adjudicating upon allegations of anti-competitiveness when it comes to vertical agreements, the CCI has to establish that the impugned agreement results in an AAEC. While establishing this, it has to assess the relevant factors mentioned in Section 19 of the Act. In Automobile Dealers Association v. Global Automobile, the CCI highlighted how this assessment was to be carried out and what weightage the relevant factors were to be given while doing so. From this, we extrapolate that, in Indian competition law jurisprudence, the yardstick for adjudicating the anti-competitiveness (or lack thereof) of vertical agreements has been the ‘Rule of Reasons’.
However, in the USA, the standard of proof has evolved over time from the ‘rule of reason’ approach adopted in White Motor Co. to the ‘per se’ illegality followed (according to widely accepted interpretations) in United States v. Schwinn. Subsequently, in Continental v. Sylvania, the Supreme Court overruled Schwinn and returned to the ‘Rule of Reasons’ as the standard for adjudicating vertical territorial restraints. An examination of this evolution in approach helps in understanding why a rule of ‘per se’ illegality is inappropriate and why a ‘rule of reasons’ approach must be followed.
The evolution of this judicial standard traces the evolution of two schools of thought in the treatment of vertical territorial restraints under competition law. The first school propounds that vertical territorial restraints must follow ‘rule of reasons’ because they promote economic efficiency and have pro-competitive benefits. Conversely, the second school believes that such agreements must be illegal ‘per se’ because they harm intra-brand competition and restrict the independence of enterprises.The former has gained prominence worldwide primarily because it weighs the alleged anti-competitive effects against the potential pro-competitive benefits. Sometimes, vertical arrangements that harm intra-brand competition can simultaneously prove beneficial for inter-brand competition, which is the primary concern of competition law. Some pro-competitive benefits of vertical agreements are- facilitating entry in new markets, quality control, the economics of scale resulting in lower retail prices, etc. Due to such significant potential for pro-competitive impact, it was affirmed in Sylvania that ‘per se’ illegality in vertical agreements will be unjustified and harmful.
In Schwinn, the court did not conduct a proper assessment of the market situation and instead based its decision upon the ‘ancient rule’ against restraints on alienation. Thus, the essential problem with the rule of ‘per se’ illegality is that it seeks to avoid a holistic analysis of all relevant factors while adjudicating by simply proclaiming the agreements to be violative of antitrust laws, regardless of their objective or their effect on the market.
Therefore, in Sylvania, Schwinn was found to be outdated & over-broad and was replaced with a reasonableness standard which considered two factors i.e. if the agreement constituted an unreasonable restriction on competition and if it had any redeeming virtue in the form of economic efficiency. It thus employed a functional economic analysis and required the showing of a demonstrable AAEC before holding the agreements unlawful.
The ‘rule of reasons’ approach is widely accepted because it stipulates that vertical restraints must be examined for both intra and inter-brand effects, as they may, while restricting intra-brand competition, simultaneously promote inter-brand competition & economic efficiency. It, therefore, mandates close economic scrutiny of their effect on competition in the relevant market. This ensures that a criteria-based approach is followed in order to determine whether the harms of an agreement are greater than the benefits it may entail, rather than the imposition of an arbitrary ban which would preclude the potential pro-competitive benefits that may accrue.
Firstly, with regard to the issue of EDAs, it was conclusively established by the CCI in the Mohit Manglani case, that the agreements could not be established as causing an AAEC due to a lack of concentration of market power and hence were not anti-competitive in nature. Furthermore, they only restrict intra-brand competition among the competitors and not an inter-brand competition (for which they may entail certain pro-competitive benefits). Additionally, they do not affect the offline distribution channel in any manner. Therefore, considering the merits of the ‘rule of reason’ procedure, the concomitant demerits of the ‘per se’ illegality approach and the relative importance of inter-brand competition with respect to intra-brand competition, it is reasonable to conclude that this particular amendment to the 2017 FDI Policy, by insertion of Clause 11, is unjustified because it creates a situation wherein these agreements are arbitrarily deemed as ‘per se’ illegal. Thus, this amendment to the rules works to the detriment of both the e-commerce industry and the welfare of consumers.
Views are personal.
Image credits: Disfold
ABOUT THE AUTHOR
Tavashya Kumar is currently pursuing B.A. LLB. (Hons.) from National Law University, Delhi.
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