The Pitfalls of Selective Distribution Agreements
What are the pitfalls of selective distribution agreements?
Producers choose to implement different types of distribution agreements depending on objectives, needs and product characteristics. Selective distribution arrangements are usually adopted in the case of branded products that require special treatment or particular facilities designed to maintain or enhance the product’s brand image. Under a selective distribution regime, dealers can only sell the product if they are authorised to do so by the producer. Authorised dealers can either sell the product to final consumers or to other authorised members of the distribution system. Sales to unauthorised distributors are not permitted.
Selective distribution and competition law: what’s the fuss about?
Competition law aims to protect consumer welfare by prohibiting practices that harm competition in markets. A selective distribution system is, by definition, designed to exclude certain distributors. This can raise competition law issues.
Selective distribution agreements may lead to higher prices by:
- limiting price competition between distributors selling the same product (i.e. intra-brand competition);
- unjustified refusals to supply (i.e. market foreclosure), and;
- facilitating collusion between suppliers or distributors.
Breaching competition rules can lead to hefty fines, high legal costs and serious reputational damage. This is a guide to ensuring that your selective distribution system does not breach EU competition law.
The key: qualitative selective distribution
Competition law draws an important distinction between purely qualitative and quantitative selective distribution systems. Purely qualitative selective distribution agreements will usually fall outside the scope of competition law. To ensure you are on the safe side, aim for a purely qualitative selective distribution system. A system is purely qualitative when the following conditions are satisfied:
- The characteristics of the product merit selective distribution in terms of maintaining quality and ensuring intended use.
- Distributors are chosen on the basis of criteria that are objective and of a qualitative nature. The criteria must apply equally to all and in a non-discriminatory manner.
- The qualitative criteria must not exceed what is necessary to achieve legitimate objectives (proportionality).
The three conditions: a closer look
The first condition: Products that tend to necessitate a selective distribution system in order to maintain quality and secure proper use will, in broad terms, fall within these three categories:
- Products whose brand image is particularly important. Examples include perfumes and luxury products.
- Products that are technically complex and merit a particular after-sales service. Examples include electronic equipment, cars and watches.
- Newspapers are a special third category considering their very short shelf-life.
The second condition: Examples of qualitative criteria are the following:
- The distributor must operate brick and mortar stores.
- The distributor’s staff must be suitably trained to provide assistance.
- The distributor must provide an after sales service.
The criteria must be applied in a non-discriminatory manner. Any distributor or retailer that satisfies the conditions laid down by a given producer must be allowed to sell the product. The law does not allow for a limit on the number of retailers. Such a limit would constitute a quantitative restriction and could attract scrutiny from a competition authority.
The third and final condition: the criteria on the basis of which the suitability of distributors is to be determined must not go beyond what is strictly necessary to achieve the producer’s legitimate objectives. Proportionality is assessed on a case by case basis. Suppliers must be ready to justify the existence of a particular restriction and explain why it is necessary. Pragmatism is key in persuading the authorities.
How to create compliant selective distribution agreements?
Selective distribution agreements make commercial sense for manufacturers that wish to protect their brand image. Producers should ensure that the criteria laid down for selecting their distributors are qualitative as opposed to quantitative in nature. The criteria must be applied fairly, transparently and in a non-discriminatory manner. Be ready to explain why your product merits a selective distribution system and how the criteria are proportionate to your goals. Competition law infringements are costly and may lead to irreparable reputational damage.
The opinions on this page are for general information purposes only and do not constitute legal or financial advice on which you should rely.