The US Federal Trade Commission recently issued a consent decree that brings into focus the risks of requiring exclusivity. While In the Matter of Pool Corporation, FTC File No. 101 0115 (Nov. 21, 2011), involves unique facts, we believe that the FTC is investigating a number of exclusive arrangements, and that there may be other consent decrees to follow.
According to the FTC’s complaint, Pool Corporation (PoolCorp) is the world’s largest distributor of pool products and, in some local areas, has a market share that exceeds 80 percent. The FTC complaint alleges that when a new distributor attempted to enter a local area, PoolCorp threatened not to deal with manufacturers that also supplied the new entrant. PoolCorp would threaten not only to terminate the purchase and sale of the manufacturer’s pool products in that area, but for all of PoolCorp’s distribution centers nationwide. The loss of sales to PoolCorp could be “catastrophic” to manufacturers, the FTC claimed, because no other distributor could replace the large volume of potential lost sales. The entering distributors could not offer any economic incentive to manufacturers that would offset the risks imposed by PoolCorp’s threats.
The FTC concluded that there were no efficiency justifications for the policy, and that the policy had real, adverse effects on competitors. Notably, the one Republican Commissioner currently serving on the FTC dissented, concluding that there was insufficient evidence that PoolCorp’s policies actually harmed competition because, among other things, many manufacturers explained that they were not interested in adding new distributors regardless of PoolCorp’s conduct.
This decision should not be taken as a broad attack on exclusive arrangements. Exclusive dealing arrangements are common in the United States and serve important functions that help competition. For example, a manufacturer may want a distributor to commit to not handle a competitor’s products to ensure that the distributor stays loyal and will aggressively sell the manufacturer’s products. Similarly, a distributor may request the exclusive right to distribute a product in a given territory to ensure that the distributor’s efforts to interest customers in the manufacturer’s product are rewarded. In the absence of exclusivity, it is possible that a competing distributor will not invest, but instead will “free ride” and make sales because of interest generated by competing distributors.
There are limits, however. In the United States, it is important to consider the following factors when assessing the competition risks from exclusive arrangements:
- How large is the market share of each party to the exclusive arrangement? If one or more parties have large market shares, a court or an enforcer could find that the exclusivity will unlawfully enhance market power.
- How long is the exclusive arrangement? An exclusive arrangement that is short in duration is generally less risky. Assessing the risks associated with the length of the agreement will vary from industry to industry.
- Who is insisting on the exclusivity? If the party requesting exclusivity does not have a large market share, then it is less likely to be found to have anticompetitive effects.
- What is the reason that exclusivity is being requested? In many instances, if there are good, pro-competitive reasons for the exclusivity, the antitrust risks are minimized. The FTC decided in Pool Corporation that there were no valid justifications for the exclusivity.
- Where is the harm? In assessing whether an existing exclusive arrangement is at risk, it is important to consider how much foreclosure rivals have actually suffered. If competitors have not been excluded from the market, exclusive arrangements are not likely to raise significant competition concerns.
The issue of exclusivity is also analyzed in a similar way in other parts of the world. For example, in Europe, exclusive distribution agreements between businesses that do not compete will not be challenged so long as the supplier and buyer/distributor each have market shares below 30 percent. Where the parties have greater than a 30 percent market share, the analysis will consider a variety of factors, including the position of the supplier and its competitors, the type of distribution system operated by the supplier, the buying power and the maturity of the market and the level of trade—i.e., whether the exclusive distribution is applied to the wholesale or the retail level.
If the market share of one of the companies exceeds 40 percent, the European Commission will typically deem that company to have a dominant position. Under these circumstances, the European Commission—conceptually similar to exclusive purchasing cases where the supplier (and not the distributor) forecloses its competitors by hindering them from selling to customers—will analyze whether the exclusive arrangement further weakens residual competition by foreclosing fringe competitors, making exclusive arrangements particularly risky.
To take another example, in China, there is very limited authority or guidance as to the limits on exclusive dealing. We believe that Chinese authorities most likely would analyze exclusive arrangements under an “abuse of dominance” standard similar to the one employed in Europe. Accordingly, it is generally considered that reference to compliance standards in other antitrust jurisdictions, such as the European Union, is the most appropriate starting point for risk management. We believe that there will be heightened risk of scrutiny or challenge in more politically or economically sensitive sectors in China, such as sectors relating to key natural resources, new technologies, significant intellectual property, or involving China-owned enterprises as key participants. We expect to see more abuse of dominance investigations in 2012, and exclusive arrangements may be key to these investigations.