Selective distribution agreements are often beneficial for competition but risk breaching the Hong Kong Competition Ordinance (Ordinance) where they harm competition. The nature and application of your selection criteria is very important in ensuring compliance of your selective distribution strategy with the Ordinance.
What is selective distribution?
Selective distribution is commonly used by suppliers of complex or technical consumer products or luxury products. It allows the supplier to control the resale process to ensure a high level of customer service or to protect and promote the brand image.
Selective distribution arises where the manufacturer appoints a limited number of 'authorised distributors' on the basis of a set of criteria. It often includes a restriction on the resale of the contract goods to third party resellers who are not part of the selective distribution system, but unlike exclusive distribution arrangements, allows the authorised distributor to sell to any customer.
When will a selective distribution agreement give rise for concern under the Ordinance?
The First Conduct Rule (FCR) prohibits an agreement, a decision by an association of undertakings or a concerted practice that has the object or effect of harming competition in Hong Kong. However, an anti-competitive restriction may be exempted from the prohibition where it can be shown that the agreement enhances overall economic efficiency.
For the selective distribution strategy to fall outside the scope of the FCR, selection should be based on purely qualitative criteria and where the following apply:
- the product warrants a selective distribution network to preserve its quality and proper use;
- the distributors are selected solely on the basis of non-discriminatory, qualitative criteria which are applied consistently, such as those that relate to their technical ability to handle the goods and the suitability of their premises; and
- the selection criteria do not go beyond what is necessary.
Qualitative criteria includes matters such as training and qualification of staff, type of equipment available in the retail outlet, that the products be sold in a specialist shop or form part of a separate display, that the sales outlet has a particular appearance, opening hours or after sales service.
The selective distribution strategy is more likely to raise concerns where the supplier or authorised distributor has market power because it increases the risk of a selective distribution excluding entry of more efficient retailers. Further, if there is a high degree of concentration in the market, selective distribution can assist in facilitating collusion among suppliers or distributors.
You can read more about the FCR here.
Penalties for breaching the FCR
There are two possible enforcement approaches the Competition Commission can take depending on the seriousness of the alleged offence:
- issue a warning notice, providing an opportunity to cease or alter the offending conduct; or
- institute proceedings in the Competition Tribunal without first issuing a warning.
If the Competition Tribunal finds an offence has been committed, it can issue a fine of up to 10 per cent of its group turnover in Hong Kong for duration of the infringement (with a three-year cap) for each offence.