Product manufacturers are always looking to increase revenue by tapping into new markets. In recent years, they’ve begun to focus their efforts on driving sales in Asia. In particular, the People’s Republic of China (“China” or “PRC”) offers a unique opportunity for manufacturers to expand their business; while much of the world’s consumer sales growth has slowed, China’s consumer market continues to grow at a steady pace.

In 2000, less than 1 percent of households in China were considered middle class. [1] A snapshot of the country today offers a stark contrast: the modern Chinese market is comprised of a rapidly growing mass of middle class consumers, poised and ready to engage with the international marketplace. In fact, China boasts the largest middle class population in the entire world, surpassing the United States in 2015. [2] In 2017, China’s online retail sales approached US $1 trillion, solidifying the country as the world’s largest e-commerce market. [3] Undoubtedly, China’s market promises profitable gains and untapped growth for product manufacturers willing to establish distribution channels in this region. [4]

However, product manufacturers too often delegate control to third-party distributors in this region. Instead of relying on Chinese distributors, manufacturers must proactively establish and monitor direct control over their brands. China’s market may be different, but it presents the same dangers of price erosion that product manufacturers face in the United States and the EU. Potential online price erosion in the PRC could have negative impacts on manufacturers both regionally and globally.

To succeed in China, product manufacturers must develop effective and lawful distribution strategies. Most competition law enforcement in China is carried out under the country’s Anti-Monopoly Law (“AML”), which was first implemented in 2008. This article aims to address the potential distribution and pricing policies that manufacturers may adopt to combat price erosion under China’s newly established regulatory framework.

Adopting Key Distribution Strategies in China

While the PRC offers consistent sales growth for product manufacturers, the nuances of product distribution remain the same: narrow margins, price erosion, and shrinking product life cycles may pose disastrous implications for manufacturers on a global scale. Product manufacturers can combat these risks by implementing thoughtful, tailored distribution strategies that comply with Chinese law. Specifically, this article discusses loss-minimizing distribution and pricing strategies that product manufacturers can use to prevent and offset price erosion. There are three essential components to an effective distribution program: an authorized reseller network, a price maintenance policy, and monitoring and enforcement.

Authorized Dealer Program

By adopting an authorized dealer program, product manufacturers can limit which dealers are permitted to sell their products. This allows manufacturers to increase control over the manner in which their products are sold. Similarly, through internet authorization, product manufacturers can further control the websites and e-commerce platforms that authorized dealers use to sell their products. Product manufacturers in the United States and Europe routinely use authorized dealer programs and selective distribution strategies to gain control of their online presence and mitigate price erosion. In the United States, manufacturers have the ability to choose who they authorize to sell their products and where those authorized resellers can sell their products. In the EU, manufacturers may implement authorized dealer networks, albeit with limitations – manufacturers must use objective criteria when selecting distributors; compared to the United States, manufacturers in the EU have far less control over distributors’ sales methods. The recent case of Coty Germany GmbH v. Parfümerie Akzente GmbH(commonly known as the “Coty” case), decided by the European Court of Justice (“ECJ”) in December 2017, suggests that manufacturers of luxury products in the EU may be permitted to prohibit authorized dealers from selling products through third-party internet platforms, so long as policies of this nature are executed uniformly, fairly, and in the least-restrictive manner possible. [5]

There is no prohibition on the use of selective distribution networks or authorized dealer programs in China. China’s Anti-Monopoly Law and Anti-Unfair Competition Law (“AUCL”) suggests that manufacturers will be able to execute these strategies more liberally in the PRC, like we see in the United States currently. [6]

Price Maintenance

Resale price maintenance, or “RPM,” allows a product manufacturer to obtain a certain level of control over the price at which its products are advertised and sold. Generally, RPM is achieved through an agreement between a manufacturer and its resellers, or by way of a manufacturer’s announcement of a unilateral pricing policy. The AML prohibits “undertakings” that “fix or change commodity prices,” “restrict the amount of commodities manufactured or marketed,” or “restrict the lowest prices for commodities resold to a third party.” [7] In practice, Chinese enforcement agencies have scrutinized resale price maintenance practices under the AML with considerable censure. However, Chinese courts have issued several key decisions suggesting that the use of resale price maintenance agreements in the region is permissible, subject to the court’s flexible inquiry.

When the Shanghai Higher People’s Court ruled on China’s very first vertical monopolistic agreement action – Rainbow Medical Equipment v. Johnson & Johnson – onlookers analogized the case to the groundbreaking U.S. antitrust decision, Leegin Creative Leather Products, Inc. v. PSKS, Inc. [8] Before Leegin, vertical price restraints had long been held “per se” illegal in the United States. Leegin revolutionized the U.S. antitrust framework by establishing that the legality of such restraints should be evaluated under a flexible “rule of reason” analysis. [9] Johnson & Johnson appears to establish a similar shift in China, suggesting that courts will employ a fact-specific “rule of reason” approach when analyzing the legality of resale price maintenance agreements. [10] Still, the use of resale price maintenance agreements carries some risk due to the infancy of China’s competition law. [11]

Courts are likely to be less critical of unilateral policy implementation, especially in instances where a product manufacturer does not have a dominant market share. [12] Thus, if product manufacturers are inclined to adopt a pricing policy in China, the safest and most effective strategy available is a unilateral pricing policy. Under a unilateral policy, a manufacturer can announce a minimum advertising or resale price for selected products and refuse to work with resellers who do not acquiesce with the policy. Unilateral policies are not “per se” illegal in China. In fact, because unilateral policies involve only one actor, it seems that they may fall entirely outside the scope of the AML, which focuses on bilateral agreements. As such, the implementation of a unilateral policy appears to be the most attractive resale price maintenance strategy available to manufacturers. [13] As with any pricing policy, manufacturers must ensure that unilateral polices are implemented and enforced properly in order to maintain legality.

Monitoring and Enforcement

Even the greatest authorization programs and resale price maintenance policies are useless without consistent monitoring and enforcement. Once product manufacturers establish their authorized dealer networks, they must take the necessary steps to monitor and remove unauthorized resellers. Authorized dealer networks provide manufacturers with the tools to remove unauthorized resellers on the market, and resale price maintenance policies enable manufacturers to have additional control over their brand.

Conclusion

Competition law in China continues to evolve; however, a variety of options are available for product manufacturers who wish to establish control over their online brand presence today. Manufacturers would be wise to adopt flexible global distribution and pricing strategies that enable growth not just in China, but throughout the world.