Hub and Spoke arrangements a comparative view Monday

Hub and Spoke arrangements: a comparative view Monday 15 November 2010, 17. 00 – 19. 00 Chair: Michael Hutchings, OBE Speakers: Javier Berasategi, Berasategi & Abrogados Thomas Lübbig, Freshfields Bruckhaus Deringer Alastair Gorrie, Counsel to SC Johnson, Counsel to Orrick Mario Siragusa, Cleary Gottlieb Steen & Hamilton LLP www. biicl. org

HUB AND SPOKE BIICL 15 NOVEMBER 2010 MICHAEL HUTCHINGS INTRODUCTION

TWO PREVIOUS SEMINARS • 19 October 2009 – Legal Analysis – UK Focused • 19 April 2010 – EU Proposals – Various NCA cases – UK Supermarkets Code

RESEARCH PROJECT • BRIEF: Legal analysis of hub and spoke agreements under UK competition law • RESEARCHER: Peter Whelan • OUTPUT: Article in European Competition Journal December 2009 • FUTURE WORK: Explore themes from other EU countries

THEMES FROM WHELAN RESEARCH • Innocuous information exchanges may be anticompetitive • Parallel cases in numerous EU countries • “Hub & Spoke” collusion is a feature of UK milk and tobacco cases • Vertical information flows can be deemed to be “horizontal” • High legal hurdle to establish unlawful horizontal collusion

THEMES FROM SEMINARS • Horizontal collusion requires higher standard of proof than vertical restrictions • Conditional participation not enough – the vertical agreement must be unlawful (e. g. RPM) • RPM is easier to nail than H&S (e. g. UK Tobacco) • Margin protection practices = RPM? ? • Compliance requirements for trading partners including category management

Hub & spoke is dead: welcome to the era of retailer power Javier Berasategi Torices BIICL Hub & Spoke Conference London, 15. 11. 2010

“We used to live in a world where brand power was everything, but slowly and inexorably it is being replaced by retail power. . . The mountain here is the shelf: a shelf in the supermarket, a shelf in a concept store or a shelf on the internet. Once the shelf was the place we proudly displayed our brands. Now it’s the place we fight to stay on. Now it’s the place we can be evicted from on the smallest whim…We believe this squeeze has taken us to a new type of world. It’s clear that this new world has some big fish and some little fish. The biggest fish of them all is the global retailer. This new breed of super retailer increasingly gets its own way. It can decide to swim with the small fish or simply gobble them up and spit them out. The little fish are of course the brands. ” Thomassen, Lincoln, & Aconis, Retailization – Brand survival in the age of retailer power, 2006 “As retailers have grabbed power around the globe, they’ve transformed private labels from price purchases into powerful brands with their own cachet. As a result, one powerful brand manufacturers like Nestlé and Procter & Gamble now find themselves competing for shelf space with their biggest customers, like Tesco and Walt-Mart. ” Kumar & Steenkampt, Private label strategy – How to meet the store brand challenge, 2007 8

Supplier-retailer relationships • Conventional view: seller power – Inter-brand competition – Intra-brand competition • Modernization: supermarket platforms – Two-sided markets – Supermarkets as hubs & spokes • Conclusions 9

Conventional View • Seller power and intra-brand competition: EC Article 101(3) Guidelines (pars. 17 -18) – Vertical BER & Guidelines • RPM: cardinal sin • Listing fees: supplier 2 supplier foreclosure (Guidelines, pars. 203 -208) • Category management: supplier 2 supplier foreclosure (id. , pars. 209213) • Retailer subcontracting manufacture of own brand is not a competitor (id. , par. 27) – Car BER: oligopolistic market • Multi-brand retailers: – Old BER: access to 2 competing brands (essential facility? ) – New BER: specific (low) market-shares for “cumulative effect of parallel agreements” test (40%/30%) • Independent spare-parts manufacturers & repair services 10

Conventional View • Seller power and inter-brand competition – Hub & spokes as a refined version of seller market power – Collusion at the same chain level through an agent upstream/downstream • N suppliers through a retailer – purchase price to the retailer? Retailer pushing prices down – purchase/retail price to all retailers? Retailer pushing other retailers’ prices up • N retailers through a supplier: RPM • N retailers and N suppliers: horizontal + horizontal 11

The olive oil decision (Spain) • The Spanish Competition authority fined the Leading Manufacturer Brand (LMB) and several retailers for RPM in 2002 -2004 (File 612/02, Aceites 2, annulled on appeal) • The largest retail chain (Carrefour) objected and delisted the LMB • Market shares in 2004: LMB, 35%; retailer brands 50%; others 15% • Market shares 2009: retailer brands, 70%; LMB, 20%; others 10% • In 2010 LIB market-share up: Carrefour listed it again and low-price strategy (opposite of RPM) 12

Modernization • Retailers operate as “platforms” operating in two-sided markets (Katz&Shapiro, 1985; Rochet & Tirole, 2001) • Retailers and suppliers compete through branded products: their dealings are horizontal – Draft Horizontal Guidelines, commercialisation agreements, Section 6 • Supermarkets are hubs and independent and retail brands are spokes: new forms of horizontal competition raise new collusion/foreclosure challenges – Manufacturer - retailer (horizontal brand competition) – Manufacturer – buying alliance (horizontal brand + horizontal retailer competition) – Retailer label manufacturer-retailers (horizontal brand + horizontal retailer competition): RLM tycoons (Cott, Mc. Bride, etc. ) 13

Modernization Source: PMLA 14

Modernization • Supermarket platforms as competitive bottlenecks: multi-homed suppliers and single-homed shoppers (Armstrong, 2006) • Single home: shoppers’ switching costs (Diamond, 1971; Klemperer, 1995); role of price frames (OFT, 2010); role of choice framing and intermediaries’ bias (OFT, 2010; Bennett& Collins, 2010) • Supermarket platforms have customers on both sides (see EC Mastercard decision): suppliers buy access, shoppers buy products • Supermarket platforms are often special: they keep traditional retailer functions in their favour: facings, retail pricing (RPM ban) • Intra-platform (product) competition: high % of product selection is made instore and is influenced by supermarket-platform • Inter-platform competition: supermarkets compete for shoppers and, in rare instances, for suppliers (exclusive retail brand suppliers) 15

Modernization • The triangular hub & spoke risk overshadowed by the supermarket platform dominance – Suppliers’ incentive to collude or apply minimum RPM diminishes: loss of market-shares to retailers’ brand risk of retailer retaliation – Large retailers’ incentives to force/induce suppliers into wholesale price increase or RPM to all retailers increase: • they enjoy access fee mark-up over smaller competitors • the create a price gap with their own brands (Nocke&White, 2005) • they control supplier/retailer deviation and punish it (Toys R Us; ITWAL) – Large retailers may unilaterally achieve this outcome • they extract fees/transfer costs unilaterally (Cruz Roche, 1999; Meza&Shedir, 2009) • they demand guaranteed margins/sales (Butz, 1993) • they demand MFN protection (Butz, 1993; Tirole&Rey, 2006) • they create artificial gaps in retail prices (Oubiña et. al. , 2000) 16

Toys R US • Toys R Us v. FTC, 221 F 3 d 928 (7 th Cir. 2000): a retailer with just a 22% market-share forces main toy suppliers into exclusionary conduct towards some retailers – “Swindle contended that rather than there being "hub and spoke" arrangement directed by TRU or some other type of horizontal conspiracy among manufacturers, the "glue that held TRU’s scheme together was each manufacturer’s individual decision not to cross its most important customer’s interests. " The Commissioner concluded: “I am simply unable to find a horizontal boycott on the basis of this evidence. The gaps and ambiguities in the record require that I dissent from the conclusion that TRU orchestrated an anticompetitive horizontal agreement. " (FTC Press Release, citing a Commissioner’s partially dissenting opinion) 17

Chocolate cartel (Canada) • Alleged chocolate cartel in Canada: a wholesaler coop (ITWAL) threatened retaliation if suppliers did not increase prices to other retailer. According to Competition Authority’s document: – Cartel started with threat letter from ITWAL to manufacturers in order to have trade spending reduced: “At the ‘end of the day, ’ it is only the suppliers’ control and discipline of trade spending that can restore the functionality of the marketplace. The problem is very serious and completely out of control on the part of the suppliers. I am being forced to reexamine how we operate in the market and I am not sure it would be in the best interests of Nestlé. I urge you to meet and take action before this chocolate bar ‘bubble bursts. ’” – ITWAL regularly monitored progress from manufacturers: “Further to my letter of February 21, 2002, please find attached information forwarded by Members on product and pricing available from diverters. In view of the seriousness of the problem, I will forward information as received under the acronym, T. A. N. , which stands for 'TAKE ACTION NOW!' I trust you will accept the information in the spirit with which it is intended. I look forward to meeting with you to learn what steps Cadbury is taking to address this problem. ” – ITWAl threatened action if prices were not increased/supplies continued to specific retailers. 18

Conclusions (I) • The hub & spoke tree is hiding the supermarket-platform forest • Suppliers’/retailers’ incentives to enter into hub & spokes diminish/increase • Large retailers’ non-coordinated practices replicate the same outcome • Ban on RPM (regulation/competition law) helped emergence of supermarket-platforms! • Should RPM be allowed? Is it too late? 19

Conclusions (II) • Are supermarket platforms reducing intra/inter-platform competition? – One-side competitive bottleneck = market power or market dominance? – Even intense one-side (shopper) competition is compatible with sub-optimal competition on the other side (suppliers): balancing the two-sides? – Platform & brand integration compounds the anticompetitive risk: platform neutrality? • Compare antitrust & regulatory intervention in other two-sided markets: MIFs, TV advertising, call termination, international roaming, Apple, Internet neutrality… 20

How retailers see card platforms [MIF: 3%] Source: Eurocommerce 21

How could suppliers see supermarket platforms? [Access fees: 10%, 20%, 30%, 40%? ] Retailers Retailer Brands Retail Alliances Manufacturer Brands 22

THANK YOU! Javier Berasategi Torices Email: jb@berasategi. es Móvil: +34 688 606 389 T. 9 4 6 5 F. 9 4 4 9 Rodríguez B I L 7 8 6 0 1 4 5 0 2 9 Arias 23 B A O T. F. Cla M 9 1 4 2 3 0 9 9 0 9 1 8 0 0 3 0 4 7 udio Coello 124 A D R I D www. berasategi. es