Competition Bureau submission to the OECD Competition Committee roundtable on Vertical Restraints for On-Line Sales

February 27, 2013

1. Introduction

  1. Canada’s Competition Bureau (the "Bureau") is pleased to provide this submission to the OECD Competition Committee’s 27 February 2013 roundtable on "Vertical Restraints for On‑line Sales". The Bureau, headed by the Commissioner of Competition (the "Commissioner"), is an independent law enforcement agency responsible for the administration and enforcement of the Competition Act (the "Act") and certain other statutes.Footnote 1 In carrying out its mandate, the Bureau strives to ensure that Canadian businesses and consumers have the opportunity to prosper in a competitive and innovative marketplace.
  2. The digital economy is a vital sector in Canada, given the country’s large size and dispersed population. The development of advanced wireline and wireless communications networks and the services enabled by those networks, including e‑commerce, has allowed Canadian consumers to reap the benefits of lower prices, greater choice, and innovation. The digital economy has also introduced new challenges for antitrust authorities: how to strike the appropriate balance between vigorous competition law enforcement and encouraging investment in networks and platforms; how to establish access to networks in the face of gatekeepers such as vertical search providers, electronic payment networks, and broadband infrastructure operators; and, in the case of e‑commerce, how to assess the increasing use of vertical restraints.
  3. An increasingly important enforcement priority for the Bureau is ensuring that consumers are able to enjoy the competitive benefits of e‑commerce. There is no doubt that the introduction and rapid growth of e‑commerce in Canada over the last 15 years has had a pronounced effect on competition. Once the domain of a small niche of early adopters and of little competitive significance to bricks‑and‑mortar retailers, many online merchants are now fully‑fledged competitors to their traditional counterparts in nearly every respect, selling an expected $21.5 billion of goods and services in 2012. The ease with which consumers can now compare prices has in some cases driven margins razor‑thin; in other cases, it has motivated retailers to abandon price competition and instead switch to high‑quality, high‑service business models. Low barriers to entry in online retail have allowed innovative sales models to establish themselves, allowed traditional retailers to extend their brands online to compete directly, and in some cases required suppliers to choose between the two. And important as innovation and entry have been, both online and bricks‑and‑mortar retailers have experienced widespread consolidation and exit, as vigorous competition makes scale and scope economies more crucial and business more volume‑driven.

2. Vertical restraints in e‑commerce

  1. It is in the disruptive retail environment created by the introduction and rapid growth of e‑commerce that the use of vertical restraints is becoming increasingly prevalent, as retailers and suppliers seek to preserve efficient distribution systems and service incentives, or alternately, to protect their margins against tough, innovative competition. This is exemplified by the Bureau’s recent litigation in the Toronto Real Estate Board ("TREB") case, in which the Bureau seeks to ensure that online realtors can use the same electronic databases as their bricks‑and‑mortar competitors to inform customers online.Footnote 2
  2. The pro‑and anti‑competitive theories of vertical restraints are well‑known, and their application to online sales is now being tested much as they have been with traditional retail. A supplier, faced with highly transparent price competition between a number of retailers, may consider imposing resale price maintenance or minimum advertised price schemes in the face of loss leadering. Another supplier with different distribution networks in different countries may impose territorial restrictions that prevent cross‑border sales. A third may impose asymmetries between online and traditional retailers, in terms of product options, marketing support, or pricing restrictions. These practices may be attempts to insulate suppliers from competition or they may be valid online distribution management strategies, which highlights the importance of rule of reason analysis.
  3. The Bureau’s view is that these types of vertical restraints in online sales are generally no different in their operation from those that have historically been imposed in traditional retail, in terms of how suppliers distribute to and discriminate between retailers with different cost structures, sales models, and territories. In that respect, assessing the impact of these vertical restraints does not require specific new rules or changes to the law; indeed, the Act’s vertical restraint provisions are technologically neutral, in that they can be applied to potentially anti‑competitive conduct regardless of the means of sale or distribution. Consequently, the Bureau already possesses the enforcement tools required to address anti‑competitive vertical restraints and pricing practices in the online sales channel, and is and will continue to use them. The challenge lies in assessing the rationales and effects of these restraints, when a supplier is faced with distribution decisions between low‑cost, high‑volume online retailers that may offer little in the way of service or support, and higher‑cost traditional retailers that continue to offer consumers hands‑on benefits. Suppliers in homogeneous industries may seek to distribute their products as widely as possible, at as low a price as possible, to capture market share; suppliers concerned with product differentiation, reputation, or aftermarkets may not.
  4. There are, however, some distinctions between online sales and traditional retail models, an obvious one being the use of digital communications networks which enable consumers to shop, place orders and pay for goods from a computer, tablet or smartphone. The extensive use of these networks gives rise to some unique economic features which must be taken into account when assessing the use of vertical restraints in online sales. Where network effects are very strong, they may result in supplier monopolies, which may be the most efficient market outcome — network effects can still create efficiencies that drive prices down in online markets, such as streamlined distribution and sales networks, centralized operations, and information gathered from consumer data collection. Care must be taken, however, to ensure that this market power is not maintained by vertical restraints that discipline or eliminate rivals.
  5. Network effects can also exacerbate the effects of vertical restraints that accompany access to platforms and information networks (as in the TREB case) or to electronic payment networks that facilitate online sales. For example, in 2010 the Bureau commenced litigation to strike down restrictive and anti‑competitive rules that Visa and MasterCard impose on merchants who accept their credit cards, whether through traditional sales channels or online. The Bureau believes these rules have effectively eliminated competition between Visa and MasterCard for merchants’ acceptance of their credit cards, resulting in increased costs to businesses and, ultimately, consumers.Footnote 3 The outcome of the litigation is pending.
  6. Many electronic networks, including the electronic payment networks that drive online sales in Canada, are two‑sided in nature, which can give rise to complex pricing and discrimination issues. Where network firms are vertically integrated, incentives may exist for them to harm non‑integrated competitors through leveraging, squeezing or denial of access. One of the Bureau’s first e‑commerce cases involved the Interac debit network, which allows for shared cash withdrawals at any member financial institution and direct debit payments at any participating merchant.Footnote 4 A consent order issued in 1996 prohibits the members of Interac, who include most of the large deposit‑taking institutions in Canada, from discriminating against rivals wishing to use the network. More recently, in 2012 the Bureau commenced legal proceedings against Canadian wireless telecommunications carriers and a wireless industry association, alleging that they were making, and permitting others to make, false or misleading representations for the purposes of promoting digital content (such as ring tones) and wireless products.Footnote 5 The Bureau’s investigation concluded that the companies and their association established and exercised control over the mechanism by which the wireless companies profited from their representations. The outcome of the litigation is pending.

3. Bureau enforcement against anti‑competitive vertical restraints in the online sales channel

3.1 Rule of reason analysis

  1. The Bureau will ordinarily review online vertical restraints under the civil provisions in Part VIII of the Act, regardless of whether the restraint is imposed at the initiative of the supplier or at the behest of a retailer, or as a result of any vertical agreement or arrangement.Footnote 6 Under Part VIII, vertical restraints are not per se illegal, in recognition that they are not always anti‑competitive and, in fact, can be pro‑competitive in some cases. Because the competitive effects of vertical restraints are case‑specific, a common element of the Act’s vertical restraint provisions is the requirement that the restraint result in an anti‑competitive effect in a market. Depending on the specific provision, the Bureau must establish that a vertical restraint has resulted, is resulting or is likely to result in either an "adverse effect on competition in a market" or a "substantial prevention or lessening of competition in a market".
  2. Case law has established that "adverse" is a somewhat lower threshold than "substantial".Footnote 7 However, under either standard, the Bureau must demonstrate that the vertical restraint creates, preserves or enhances market power. Generally, this can occur where the restraint erects or strengthens barriers to entry or expansion, thus inhibiting competitors or potential competitors from challenging the market power of firm(s) imposing the restraint. In examining the effect of a vertical restraint on entry barriers, the Bureau focuses its analysis on determining the likely state of competition in the market in the absence of the restraint. If, for example, it can be demonstrated that but for the vertical restraint, an effective competitor or group of competitors would likely emerge within a reasonable period of time to challenge the market power of the firm(s) imposing the restraint, the Bureau will likely conclude that this conduct creates, preserves or enhances market power.

3.1.1 Market definition

  1. Defining relevant product and geographic markets is important in cases under Part VIII of the Act in order to assess whether the impugned conduct satisfies the requisite competitive effects test.Footnote 8 In vertical restraint cases, for example, the Bureau may consider whether the online sale of a particular product is in the same relevant product market as the sale of that product through a bricks‑and‑mortar retailer. Where there is differentiation between these products, such as with respect to particular product features, warranty, or availability, the Bureau may assess whether, from a consumer demand perspective, the online and bricks‑and‑mortar sales channels are most accurately viewed as substitutes or as complements. Similarly, an online sales channel may be able to supply a wider geographic market than a locally‑based bricks‑and‑mortar sales channel, and markets that would traditionally be defined around the locations of bricks‑and‑mortar retailers may need to be viewed more broadly where an online sales channel is considered to compete within the same product market.
  2. No matter how the market is defined, however, generally, a vertical restraint will not raise issues under the Act where it covers products or services that would not constitute a relevant product market; for example, a single brand in a market with several competing brands of similar products. In these circumstances, any restriction of competition at the brand level is generally unlikely to create, preserve or enhance market power in the broader relevant product market, depending on the disciplining effect of inter‑brand competition. However, where vertical distribution and pricing practices do have an exclusionary effect in a market, the Bureau will not hesitate to use its enforcement tools under the Act, where appropriate, to preserve and enhance competition. How the relevant market is defined in these cases may impact the Bureau’s assessment of these effects, in terms of whether an online vertical restraint has effects only in the online sales channel, or in a market that includes the bricks‑and‑mortar sales channel as well.

3.2 Vertical non‑price restraints

  1. Two types of non‑price online vertical restraints are commonly brought to the Bureau’s attention: suppliers prohibiting bricks‑and‑mortar retailers of their products from also selling the products online; and suppliers refusing to distribute their products through retailers that only have an online presence (i.e., that do not additionally operate bricks‑and‑mortar stores). While these restraints could serve to preserve exclusive retailer distribution territories, they may also be imposed for pro‑competitive reasons, such as to ensure retailers provide an appropriate level and quality of service that the supplier believes cannot be offered through an online sales channel, particularly if the supplier is concerned about free‑riding.
  2. In the Bureau’s experience, when these types of restraints apply to products in respect of which effective competition remains at the supplier and/or retailer level, it is unlikely a restraint will create, preserve or enhance market power, thus precluding the Bureau from showing an adverse effect on competition in a market or a substantial prevention or lessening of competition in a market. In these cases, non‑price restraints, such as exclusive distribution territories, are often used to limit intra‑brand competition in order to stimulate inter‑brand competition. However, the TREB case reflects a situation where non‑price vertical restraints raise serious competition concerns.

3.2.1 The TREB Case — Abuse of dominance

  1. In 2011, the Bureau filed an application with the Competition Tribunal (the "Tribunal")Footnote 9 against TREB under section 79 of the Act, seeking to prohibit TREB from abusing a dominant market position through its implementation of certain rules and policies that prevent realtors using online business models from using the same electronic databases as their bricks‑and‑mortar competitors to inform customers online.
  2. Under section 79 of the Act, abuse of dominance occurs when:
    1. a dominant firm or a dominant group of firms in a market;
    2. engages in a practice of anti‑competitive acts;
    3. with the result that competition has been, is being or is likely to be prevented or lessened substantially. Where the Bureau establishes each of the required three elements, the Tribunal may issue an order:
      1. prohibiting the practice of anti‑competitive acts;
      2. directing the respondent(s) to take actions that are reasonable and necessary to overcome the anti‑competitive effects of the practice, including the divestiture of assets or shares; and/or
      3. requiring the respondent(s) to pay an administrative monetary penalty of up to $10 million on a first order, and up to $15 million for each subsequent order.Footnote 10
  1. TREB is the largest real estate board in Canada, with more than 30,000 members. It owns and operates the Toronto Multiple Listing Service system (the "Toronto MLS System"), an electronic database that contains current property listings and historical information about the purchase and sale of residential real estate in Toronto and the surrounding area. The vast majority of local real estate transactions make use of the Toronto MLS System, which is a key input in the supply of residential real estate brokerage services in the greater Toronto area. Information in the Toronto MLS System is controlled by TREB and is only accessible to those authorized by TREB, primarily its members. By controlling access to this input, TREB is dominant in the market for the provision of residential real estate services in the Toronto area.
  2. The overwhelming majority of TREB’s members operate traditional bricks‑and‑mortar real estate brokerages. TREB’s rules permit these members to have full access to the Toronto MLS System, and to provide detailed property listing information from the system to customers by hand, mail, fax or e‑mail. However, TREB’s rules and policies effectively prohibit real estate agents from providing this same listing information to customers in innovative new ways, such as through password‑protected websites (also called virtual office websites, or "VOWs"Footnote 11). As such, real estate agents who would prefer to operate through an online model, rather than a bricks‑and‑mortar model, are effectively precluded from carrying on business due to their inability to provide information from the Toronto MLS System to their customers in an online environment. TREB’s restrictive rules and policies therefore constitute a practice of anti‑competitive acts.
  3. The Bureau submitted in its section 79 application that TREB’s Toronto MLS System access restrictions result in a substantial prevention and lessening of competition in the market for residential real estate brokerage services in the greater Toronto area. TREB’s access restrictions protect and perpetuate the traditional bricks‑and‑mortar business model used by a majority of its member brokers. But for TREB’s restrictions, the Bureau believes that innovative and lower‑cost brokerage models, such as VOWs, would enter and expand in the relevant market, allowing consumers to access new and higher quality services at lower prices.
  4. A hearing on the Bureau’s section 79 application against TREB was held in the fall of 2012. The Tribunal’s decision is pending.

3.2.2 Other non‑price vertical restraint provisions of the Act

  1. In addition to the Act’s abuse of dominance provisions, the Bureau can also address online vertical restraints under other civil provisions of the Act, including the refusal to deal (section 75) and exclusive dealing, tied selling and market restriction (section 77) provisions. Under these provisions, the Bureau generally takes the same analytical and enforcement approach to restraints in the online sales channel as it does to restraints in the bricks‑and‑mortar channel. That is, the Bureau will follow a rule of reason analysis to evaluate whether, as a result of the imposition of the restraint, the supplier is likely to obtain, preserve or enhance its market power in the relevant product and geographic market.
  2. Under section 75 of the Act, the Tribunal may order one or more suppliers of a product to accept a person as a customer within a specified time period and on usual trade terms, provided each of the following five elements is established:
    • a person is substantially affected in his/her business or is precluded from carrying on business due to his/her inability to obtain adequate supplies of a product anywhere in a market on usual trade terms;
    • the person is unable to obtain adequate supplies of a product because of insufficient competition in the market among suppliers of the product;
    • the person is willing and able to meet the supplier’s usual trade terms;
    • the product is in ample supply; and
    • the refusal to deal is having or is likely to have an adverse effect on competition in a market.Footnote 12
  3. For purposes of the application of this section, the Act provides that a product is not to be considered a separate product in a market only because it is differentiated by its brand name, trade‑mark or the like, unless the product, so differentiated, occupies such a significant position in the market as to substantially affect the ability of a person to carry on business in that class of products unless that person has access to the product. Consequently, the refusal to supply a particular brand of product to a retailer will not ordinarily satisfy the required elements of section 75 where the retailer may obtain other brands within the market.
  4. Section 77 of the Act permits the Tribunal to issue a remedial order in respect of exclusive dealing, tied selling or geographic market restriction that occurs between non‑affiliated entities. Where the Tribunal finds that the conduct is engaged in by a major supplier of a product or is widespread in a market, is likely to have an exclusionary effect in a market (in the case of exclusive dealing or tied selling) and is likely to substantially lessen competition, the Tribunal may prohibit the conduct and order any other action necessary to overcome the anti‑competitive effects of the practice or to restore or stimulate competition in the market.Footnote 13
  5. The effectiveness of exclusive dealing and market restriction as potentially exclusionary practices in the bricks‑and‑mortar sales channel can be enhanced by the use of other vertical restraints, such as price maintenance or refusal to deal, in the online sales channel. For example, a supplier’s refusal to permit retailers to engage in online sales, or the supplier’s requirement that retailers engaging in online sales price the supplier’s products at manufacturer suggested retail prices ("MSRP"), can be used to preserve the exclusive distribution franchises of bricks‑and‑mortar retailers. However, in recognition that exclusive dealing and market restriction may also sometimes have pro‑competitive effects, no order may be issued under the Act in respect of the practices if they are engaged in only for a reasonable period of time to facilitate entry of a new supplier of a product into a market or of a new product into a market. Moreover, where these restraints are used online to reinforce restraints in the traditional retail channel, it is unlikely the restraint will create, preserve or enhance market power where it applies to a product or service that is not itself a relevant product market.

3.3 Vertical price restraints

  1. Price maintenance has been the most common vertical price restraint brought to the Bureau’s attention. In most price maintenance cases, a manufacturer requires a retailer of its products to price them at MSRP in the online sales channel (and sometimes in the bricks‑and‑mortar sales channel as well). Less frequently, manufacturers induce retailers to price at MSRP in the online sales channel (and again, sometimes also in the bricks‑and‑mortar sales channel) by threatening to increase wholesale prices. As discussed previously, price maintenance policies may be implemented for both pro‑competitive and anti‑competitive reasons. However, similar to non‑price vertical restraints, and for the same reasons, vertical price restraints will satisfy the requisite competitive effects test under the Act only in certain circumstances.
  2. In some cases, vertical price restraints may be a manifestation of an underlying competitor collaboration. For example, a group of retailers may agree to induce a manufacturer to impose a price maintenance policy or to assign exclusive sales territories so that the retailers need not compete on price or service. At the supplier level, a group of suppliers may agree to implement a price maintenance policy as a mechanism to monitor enforcement of a collusive wholesale pricing arrangement.
  3. Where a vertical restraint is imposed as a result of an agreement or arrangement between competing suppliers, competing retailers or a supplier that competes with a retailer (i.e., in a dual‑distribution context), the Bureau may review such an agreement or arrangement under the Act’s civil competitor collaboration provision or criminal cartel provision. Agreements between competitors to fix prices, allocate markets or restrict output that constitute "naked restraints" on competition (restraints that are not implemented in furtherance of a legitimate collaboration, strategic alliance or joint venture) will be examined under section 45, the per se criminal cartel provision, unless a defence applies.Footnote 14 Where an agreement or arrangement is not in respect of conduct prohibited by section 45, or a defence under that section applies, the Bureau may examine the collaboration under section 90.1 of the Act, the civil competitor collaboration provision, which requires the Bureau to show that the collaboration is likely to substantially prevent or lessen competition in a market.

3.3.1 Price maintenance

  1. In 1951, Canada became the first country to impose a statutory ban on price maintenance.Footnote 15 As a result of amendments to the Act in 2009, the per se criminal price maintenance prohibition (in the former section 61) was repealed and replaced with a new civil provision, in section 76, which includes a competitive effects test.Footnote 16 under section 76, the Tribunal may prohibit price maintenance or require a person to do business with a customer or supplier on usual trade terms, where the Tribunal finds that the conduct adversely affects competition in a market and no statutory exceptions apply.Footnote 17 The intent of section 76 is to circumscribe the ability of one market participant to exercise control over, or dictate, the pricing practices of another, to the extent this conduct is harmful to competition. In the Bureau’s view, market power is likely a prerequisite for a person’s price maintenance to result in anti‑competitive effects. That said, section 76 does not prohibit the mere exercise of market power, such as may occur when a supplier increases wholesale prices.Footnote 18
  2. In some circumstances, vertical price restraints in the online sales channel are likely to result in an adverse effect on competition in a market or a substantial prevention or lessening of competition in a market. In one such case, the Bureau is currently investigating certain e‑commerce vertical price restraints imposed by a critical mass of suppliers. Because the restraints in this case are imposed against all major retailers in the relevant market, the Bureau believes these restraints may substantially prevent and lessen retail price competition in the online sales channel. The Bureau’s investigation in this case is ongoing.
  3. Section 76 encompasses three forms of price maintenance. First, subparagraph 76(1)(a)(i) prohibits a person from using an agreement, threat, promise or any like means to directly or indirectly influence upward or discourage the reduction of the price at which the person’s customer or any other person to whom the product comes for resale supplies or offers to supply or advertises a product within Canada. For purposes of this provision, prices are deemed to be influenced upward by the use of manufacturer suggested resale prices or minimum resale prices, unless the manufacturer makes it clear to the retailer that the retailer is under no obligation to accept the suggested price and would in no way suffer in its business relations with the manufacturer if it failed to follow the suggested price. Similarly, prices are deemed to be influenced upward by a manufacturer’s advertisement that mentions a resale price, unless the price is expressed in a way that makes it clear that the product may be sold at a lower price (such as, for example, by accompaniment with the phrase "dealer may sell for less").
  4. The Bureau may analyze platform parity agreements as an example of this first form of price maintenance. A supplier’s requirement that an online retailer price at a level that is not less than that charged in a bricks‑and‑mortar store could influence upward prices in the online sales channel, as well as the overall price across sales channels. At the same time, however, there could be legitimate reasons for the agreements, including preventing online retailers from free‑riding on the investments in retail experience and service quality of bricks‑and‑mortar retailers. Regardless, absent market power by the supplier, the use of a platform parity agreement is not likely to meet the requisite anti‑competitive effects test under section 76 of the Act.
  5. Subparagraph 76(1)(a)(ii) of the Act prohibits the second form of price maintenance, namely directly or indirectly refusing to supply a product to a person or otherwise discriminating against a person engaged in business in Canada because of that person’s low pricing policy.Footnote 19 However, in recognition that there can be legitimate reasons why a manufacturer may not wish to supply a discounting retailer, various statutory exceptions provide that the Tribunal cannot issue an order under this provision where the retailer was: using the relevant product(s) as a loss‑leader; using the relevant product(s) for bait‑and‑switch marketing; engaging in misleading advertising; or not providing the level of service that purchasers of the product(s) might reasonably expect.
  6. Finally, subsection 76(8) prohibits a person from using an agreement, threat, promise or any like means to induce a supplier, as a condition of doing business with the supplier, to refuse to supply a product to a particular person because of that person’s low pricing policy. Thus, for example, the Bureau would examine under this provision a retailer’s threats to boycott a manufacturer unless the manufacturer discontinued supplying a competitor of the retailer. As with price maintenance engaged in by suppliers, some degree of monopsony power on the part of the retailer(s) would likely be necessary to adversely affect competition.

4. Conclusion

  1. This submission has provided an overview of Canada’s competition law framework for addressing potentially anti‑competitive vertical restraints. In the Bureau’s experience, the Act provides the Bureau with the tools to examine online vertical restraints in the same manner as those in the bricks‑and‑mortar sales channel, and the enforcement issues with respect to both are generally the same. That said, where an online vertical restraint does create, preserve or enhance market power, the Bureau will not hesitate to use its enforcement tools under the Act, where appropriate, to preserve and enhance competition.
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