Abstract
We briefly review the relevant economic theories and legal treatment of vertical restraints, and especially focus on the 1977 landmark case of Sylvania and its possible influence on China’s antitrust enforcement on vertical restraints. China’s competition policy, and particularly its antimonopoly law, does not explicitly instruct with respect to the enforcement approach (per se versus rule of reason) toward vertical restraints. But from an overview of China’s recent antitrust cases, we find that there is a division in the approaches taken by public versus private enforcement: Even though the administrative enforcement is more inclined to the application of per se prohibitions (or the application of the EU-style prohibition-plus-exemption approach), it seems that a rule of reason is the (increasingly) prevailing approach that is taken by the courts.
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Notes
433 U.S. 36 (1977).
Whinston (2006, p. 133) points out that actually the relationship between two sellers of complementary goods can be viewed as vertical relations as well, since one seller’s sales are interdependent with the supply of the other seller’s good to form a final product demanded by the consumers.
In the literature there is not a universally accepted definition of “competition” for the purpose of competition policy. In line with Lin and Liu (2015), we define competition here as the functioning of the pressure and restraints imposed by the market forces on the behavior of market participants. Malfunctioning or obstructed market pressure and restraints imply the existence of a certain extent of hindrance of competitive forces, and hence a certain degree of market power or monopoly. (In the words of Lin and Liu (2015), market power represents a firm’s sustainable room for pricing freedom in the face of (or lack of) competitive restraints from the market forces.) Following this definition of competition, a pro-competitive (an anti-competitive) conduct is one that enhances (thwarts) the smooth functioning of the competitive pressure and restraints imposed by the market forces on the firms’ behavior in pricing, quality, and service provision, etc. The competitive pressure and market restraints, which include both actual and potential (see Baumol et al. (1982) theory of contestable markets) ones, automatically discipline the behavior of market participants and provide implicit incentives for them to supply good products or services at competitive prices. As for competition policy, Motta (2004) defines it as “the set of policies and laws which ensure that competition in the marketplace is not restricted in a way that is detrimental to society”.
What does “welfare” mean, especially in the context of antitrust? For the Chicago School, it means total surplus: the sum of consumer surplus and producer surplus (see Posner’s (2007) wealth maximization criterion). Other literature on antitrust welfare standards focuses on consumer surplus (see Farrell and Katz (2006) for an analysis on the two welfare measures applied in antitrust). In a more general framework, consumers are the owners (investors) of firms, thus the consumer welfare would encompass, indirectly, the producer surplus. There has been debate on whether antitrust analyses should be conducted in a general or a partial equilibrium framework. Kirkwood and Lande (2008), however, argue that the ultimate goal of antitrust is to protect consumers from exploitation, not to increase efficiency or the total wealth of society. Yet even just for consumer welfare itself, there are various interpretations. Orbach (2011) reviews those interpretations, and he points out the confusion and ironical antitrust paradox that the application of those interpretations in antitrust laws “may hurt consumers and reduce total social welfare”.
As illustrated in the 2010 Horizontal Merger Guidelines by the U.S. Department of Justice and Federal Trade Commission.
127 S. Ct. 2705 (2007).
The ruling states that “A system of contracts between manufacturers and wholesale and retail merchants by which the manufacturers attempt to control not merely the prices at which its agents may sell its products, but the prices for all sales by all dealers at wholesale or retail, whether purchasers or sub-purchasers, eliminating all competition and fixing the amount which the consumer shall pay, amounts to restraint of trade, and is invalid both at common law and, so far as it affects interstate commerce, under the Sherman Anti-Trust Act of July 2, 1890.” See Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911). Also the court applied per se illegality of (vertical) price fixing in White Motor Co. v. United States, 372 U.S. 253, (1963). The defendant did not challenge the price-fixing ruling, but appealed the per se illegality rulings on its territorial and/or customer restraints. The Supreme Court reversed the per se ruling on the non-price vertical restraints by the lower court, remanding the case for a trial on the merits. Later the litigants reached a settlement on the case before such a retrial took place.
State Oil v. Khan, 522 U.S. 3 (1997).
Actually, the potentially oversimplified per se treatment towards vertical pricing restrictions had been heeded shortly after the Dr. Miles case, and some courts had placed qualifications on applying the per se rule. For instance, in United States v. Colgate & Co., 250 U.S. 300, (1919), the Supreme Court affirmed the legality of suppliers’ “refusal to deal” with distributors not complying with their suggested retail prices if the supplier’s action is unilateral and independent, on the grounds that the right to select whom to deal with is fundamental to free enterprise and should be preserved. The United States v. Parke, Davis, & Co., 362 U.S. 29 (1960) decision, though, delimited the bounds of applying the Colgate doctrine. The legality of RPM and refusal to deal is warranted only if they are effectuated through unilateral actions with voluntary compliance, absent multilateral tacit agreements or coordinated actions.
As was ruled in the White Motor Co. v. United States, 372 U.S. 253 (1963).
United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967).
During this period, to challenge non-price vertical restraints a plaintiff was required to prove that the conduct is unreasonable restraint of trade in violation of section 1 of the Sherman Act, as in United States v. Sealy, Inc. [388 U.S. 350, (1967)].
See an early analysis by Spengler (1950).
Mathewson and Winter (1984) show that when the retail sector is imperfectly competitive and retailers have a role of informing consumers about the products, vertical restraints may serve as a remedy to the failure of simple uniform-price contracts to achieve efficient chain coordination.
Just as Ghosh (2010) argued analogously in the case of intellectual properties, licensing restraints form a good substitute for self-manufacturing the patented product.
Though, certainly, the effectiveness of this strategy is conditional on the existence of a credible mechanism to punish noncomplying retailers.
Some services such as hiring sales assistants to reduce consumer waiting time or using warranties to enhance post- sale services are not subject to the spillover problem, but many other services such as advertising or product demonstrations are more exposed to the risk of free-riding.
Using sales data for Sealy mattresses between 1980 and 1985, Mueller and Geithman (1991) rejected the free-rider hypothesis, and supported the market power hypothesis that a reduction of intra-brand competition through territorial allocation leads to increased price and contracted output. See a more detailed analysis of the Sealy case in Martin and Scott (2017) in this issue.
See Comanor (1990) for a more detailed analysis on this.
See Whinston (2006, pp. 137–139) for a detailed illustration of this argument.
Simpson and Wicklegren (2007)) argue, though, that inefficient exclusion could arise only if the buyers are downstream competitors, given that the buyers could opt out of the contracts by paying expectation damages.
Also, many economists warn that the Chicago School approach of justifying most market conduct as efficient market equilibria is “too simplistic and dangerously close to repealing much of antitrust.” (Kwoka and White 2009, p. 4).
Consequentially, it would be a wrong expectation that per se rule is always “prohibitive as is often assumed”, or that the rule of reason is “as hospitable to restraints of trade as is often assumed” (Areeda 1985).
Kaplow (2014) offers a very interesting decision model in the choice of rules using the likelihood ratio test.
Mathewson and Winter (1984, p. 28) prove that price restraints and territorial restrictions could be substitute instruments to curtail vertical inefficiencies in markets with retailer spatial differentiation and informational roles of advertising; hence the asymmetric legal treatment of these restraints (per se illegality of price restraints and rule-of-reason scrutiny of territorial restraints) seems inappropriate. Consistent with their result, Bork (1977, p. 172) pointed out earlier that Sylvania’s shift to the rule of reason signals a fundamental reform “not only in the law of vertical restraints but in antitrust generally”.
The English translation of China’s Anti-Monopoly Law can be found at the Chinese government website: http://www.china.org.cn/government/laws/2009-02/10/content_17254169.htm.
For the EU competition policy on RPM, please see Roundtable on Resale Price Maintenance, European Commission, 2008, DAF/COMP/WD(2008)64, http://ec.europa.eu/competition/international/multilateral/2008_oct_resale_price_maintenance.pdf. Haziroglu and Gokatalay (2016) also provide a short review on EU’s treatments on RPM and minimum resale price maintenance.
China’s AML provides for a private right of action in addition to government agencies’ administrative enforcement. However, there is no procedural guidance in the AML with regard to private antitrust litigations. This could be one of the reasons for the lack of private enforcement of the AML in China.
According to the Financial Times (https://markets.ft.com/data/equities/tearsheet/financials?s=600519:SHH), Moutai’s revenue in 2012 was RMB 26.46 billion.
Though we need to be cautious to attribute the price changes to the previous antitrust decisions, as there was a dramatic price drop of luxury goods since late 2012 when the Xin Jinping administration initiated a harsh anti-corruption campaign against abusive government consumption using public funds, which led to a significant shrinkage of demand for luxury goods and services, especially the demand for luxury liquor such as Moutai and Wuliangye. Therefore, there was a remarkable price drop of Moutai and Wuliangye products in 2013. The price increase in the following year might be deemed as somewhat a rational ex post adjustment to the prior-year’s overreaction to the exogenous political shock, rather than as influenced by the prior-year’s antitrust actions.
For this case, the NDRC did not disclose its decision statement, while it released a news brief at its official website, which contains some facts of the case (in Chinese). See http://zys.ndrc.gov.cn/xwfb/201308/t20130807_552990.html?from=groupmessage&isappinstalled=0.
Some general rules of the leniency program are listed in China’s AML. Article 46 enables enforcement authorities to reduce or waive the sanctions that are imposed on an undertaking for its participation in a monopolistic agreement if the undertaking has voluntarily confessed the relevant facts of the agreement and provided crucial evidence to enforcement authorities.
Note that there was an infant formula scandal in China in 2008. In that scandal Sanlu milk powder was found to contain melamine: a chemical that can cause kidney damage and other injuries. The scandal caused significant damage to the reputation of Chinese brands of infant formula. Afterward, imported brands supplied more than half of the market (A news report (in Chinese) listed the market share in year 2013; see http://baby.163.com/14/0327/15/9OBQCSOU00364MNT.html). However, there is no evidence that the infant formula monopoly agreements case discussed above in this article has any link to the 2008 scandal.
The NDRC did not release the decision statement to the public, but introduced the cases and some facts in its announcement (in Chinese); see http://www.sdpc.gov.cn/gzdt/201405/t20140529_613562.html.
Although the NDRC did not explain how the market shares were derived and what they were.
For the NDRC’s announcement (in Chinese), see http://www.sdpc.gov.cn/gzdt/201405/t20140529_613562.html. Note that the anti-monopoly authorities in China release statements and announcements only in Chinese; all citations in English in this paper are translated by the authors.
See “Lenses price after AML fines” (in Chinese), http://henan.163.com/14/0606/09/9U21V34202270F86.html.
For the NDRC’s decision statement (in Chinese), see http://www.jswjj.gov.cn/office_new/eo_comm_zxnrxs.php.
See the 2014 Deloitte China Auto Dealership Performance Study, http://www2.deloitte.com/content/dam/Deloitte/cn/Documents/manufacturing/deloitte-cn-mfg-2014autodealership-en-150527.pdf.
The decision of the Intermediate Court (in Chinese) can be found at http://www.law-lib.com/cpws/cpws_view.asp?id=200401516720. The decision of the High Court (in Chinese) can be found at http://wenshu.court.gov.cn/content/content?DocID=effe7905-b647-11e3-84e9-5cf3fc0c2c18.
A concise review of China’s judicial system, especially the People’s Courts system, can be found at http://www.olemiss.edu/courses/pol324/chnjudic.htm. China practices a court system of “four levels and two instances of trials”—cases might be brought to any of the three levels of local people’s courts (basic people’s courts, intermediate people’s courts, and higher people’s courts) or the Supreme People’s Court. First instance rulings would be legally effective unless they are appealed to the people’s court at the next higher level (except that any first instance judgment at the Supreme People’s Court is final) for the second instance judgment, which will be final and legally effective.
It seems that the Court drew this conclusion merely on the theory that RPM restricts price competition, because neither the plaintiff nor the defendant provided empirical evidences on RPM’s effects.
Regrettably, neither side provided empirical analyses based on actual data to identify the procompetitive effects of the RPM agreement.
To calculate the compensation, the court highlighted the following two factors: First, the sales target that Rainbow should have completed if J&J had not refused to send supplies to Rainbow in 2008; second, the profitability of Rainbow under the scenario of free competition. Rainbow claimed its profit rate is 23%. However, the court compared the prices of J&J’s stitching products with those of other brands and found that J&J’s prices were 15% higher than other brands. The court thus believed that the profitability of Rainbow under free competition would be comparable to other brands and should thus be adjusted accordingly. Considering these factors, the court ruled that Rainbow is entitled to compensation of 16% of unachieved sales of suture products.
For this analytical approach to be clear, though, one needs to know what courts mean by “competition”, how courts assess the degree of competition in a market, and what degree of competition courts regard as sufficient.
Whether using the degree of concentration or the degree of market power signifies the Court’s differing interpretations of the meaning of competition in the antitrust context: concentration focuses on market structure, while market power concerns market performance. Under either interpretation of competition, it will make the legal standard clearer to have specific thresholds on market structure (i.e., market share) or on market performance (e.g., profit rate or margin) delineated.
See http://www.ceh.com.cn/xwpd/2013/10/255896.shtml, accessed on August 12, 2016.
Especially, note that the Chinese legal system is more similar to the civil law tradition rather than the British/U.S. common law system, which means that in most case statements there was a lack of citations of prior related cases. This makes directly tracing the impact of precedents on the recent cases quite difficult.
Both were involved in the AML’s legislation, and both are current members of the Expert Advisory Board for the Antimonopoly Commission of the State Council.
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Acknowledgements
For their helpful comments, we thank Aditya Bhattacharjea, Liang Lu, and Yudan Sun. We are especially indebted to Jeroen Hinloopen, Steve Martin, and Larry White for their detailed and constructive comments, which led to significant improvement of the paper. We thank Utrecht University School of Economics for their hospitality and financial support during a workshop held there. The second author gratefully acknowledges the financial support from the YSPSDU program of Shandong University. All remaining errors are ours.
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Liu, Z., Qiao, Y. Vertical Restraints, the Sylvania Case, and China’s Antitrust Enforcement. Rev Ind Organ 51, 193–215 (2017). https://doi.org/10.1007/s11151-017-9587-7
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DOI: https://doi.org/10.1007/s11151-017-9587-7
Keywords
- Vertical restraints
- Sylvania
- Antitrust
- Antitrust enforcement
- Competition policy
- Per se rule
- Rule of reason