Selective distribution and online sales

Distribution of some products boils down to finding as many retail outlets as possible that are willing to put the product on their shelves. Other products sell much better if they have an aura of luxury and exclusivity and the retailer provides an appropriately curated selling environment, bespoke advice, and after-sales services. This is particularly true of luxury goods, which very much depend on brand image, and for technically complex products, which require professional pre-sales advice and after-sales services. Suppliers of those products often resort to selective distribution.

In a selective distribution system, a supplier agrees to supply only to distributors which meet certain requirements, such as an appropriate selling environment, pre-sale advice, and after-sale services. However, EU competition law puts certain restraints on what requirements the supplier can and cannot impose on its distributors in a selective distribution system. Along with the tremendous growth of e-commerce following COVID-19, those concerning online sales are becoming increasingly relevant.

Catching the Metro

When defending restrictions imposed on distributors in a selective distribution system – including constraints on online sales – the supplier’s weapon of choice should be the so-called Metro criteria. The ECJ formulated them in a judgment of 1977, concerning a supplier’s refusal to admit Metro to its selective distribution network. If they are met, the restrictions are not considered anticompetitive at all so there is no need for further justification or exemptions. In order to rely on them, the organizer of a selective distribution system must demonstrate in particular that: (i) the nature of the products concerned necessitates selective distribution in order to preserve their quality and ensure their proper use; (ii) the restrictions are laid down uniformly for all resellers and are not applied in a discriminatory way; and (iii) they are proportionate.

Although the Metro criteria were defined more than 40 years ago, they still form the basic framework today for assessing selective distribution systems. Unfortunately, they are not easy to apply. On the one hand, it is often unclear if the nature of a product requires selective distribution. For example, in the past, personal computers and cameras were considered fit for selective distribution, but mass-produced watches were not. On the other hand, the vagueness of the proportionality criterion makes it prone to arbitrary assessment by authorities and courts.

A recent example of the application of the Metro criteria to online sales restrictions in a selective distribution system appears in the Coty judgment, which we discuss below. However, even if these criteria are not met, a viable selective distribution system can still be constructed within the confines of the Block Exemption.

Towards more certainty – and back

Beyond Metro and to provide more legal certainty, the block exemption regulation for vertical agreements (VBER) can be relied on. The VBER creates a safe harbour for selective distribution agreements, provided that neither the supplier’s nor the distributor’s market share exceeds 30% and that the agreement does not contain so-called hard-core competition restrictions and meets certain other conditions. As such, it is a second-line defence for restrictions imposed on distributors in a selective distribution system – to be relied on if the Metro criteria are not met or if their application leads to uncertain results.

One of the conditions for the application of the VBER to a selective distribution system is that the supplier should not attempt to limit its authorized distributors’ reach for example by imposing territories or limiting customer groups. In other words, suppliers are free to restrict the distributor in how it sells, but not as to where he sells or to whom. This rule works well in the offline environment: suppliers are free to impose requirements as to how premises should be fitted out or concerning training and skills of personnel, the level of pre- and after-sale services, etc., as long as they do not try to restrict their distributors’ catchment area. However, the application of this rule to online sales can be more of a challenge.

To separate the wheat from the chaff, the European Commission assumes that the requirements that a supplier imposes in respect of online sales must be generally equivalent to the criteria imposed for sales from a brick-and-mortar shop (the equivalence principle). Otherwise, the argument would be, the supplier is probably not trying to increase quality, but to dissuade its distributors from increasing their reach (and thus from competing with each other).

The equivalence principle is not unreasonable. However, it effectively deprives online sales of the VBER’s main benefit: legal certainty. This is because it is often unworkable without explicit guidance from courts or authorities. The reasons are twofold. First, it can be very difficult to tell what is and what is not “equivalent”, as online and offline sales are two very different worlds (is a two-day delivery in an online shop equivalent to the instant delivery in a brick-and-mortar outlet)? Second, some criteria for online sales do not have any counterparts in the offline environment, which makes comparisons difficult (e.g., requirements concerning bricks and mortar stores or permissible search engine optimization methods).

Go with the flow

Thus, often the most practical solution is to strictly follow the courts’ and authorities’ guidelines on each and every type of online restriction, if available. And what do they already tell us?

First of all, since the Pierre Fabre case (ECJ judgement of October 13, 2011, C-439/09) we know that an outright ban on online sales will almost certainly violate competition law. Interestingly, this concerns both direct and indirect bans. For example, the Polish competition authority fined Royal Canin around €0.5 million for introducing an obligation to ensure that a dietary compound feed is sold only after a consultation with a veterinarian (which indirectly but surely banned online sales).

Second, thanks to the Coty case (ECJ judgement of December 6, 2017, C-230/16), we know that suppliers of luxury goods can prohibit their distributors from using third-party marketplaces if such a prohibition meets the Metro criteria. The ECJ provided guidance for such assessments – in this and other similar cases in the future – in relation to the proportionality principle. The court held that a marketplace ban is appropriate for the legitimate objective of preserving the luxury image of the distributed goods. This is in particular because the supplier does not have any legal basis to require the third-party platform directly to comply with its quality conditions. A marketplace ban also does not go beyond what is necessary to achieve the legitimate objective of preserving the luxury image of the goods concerned, as it is not an absolute prohibition to sell online. The ECJ further clarified that an online sales restraint of this type does not constitute a hardcore competition restriction (which would have precluded the application of the VBER in case the Metro criteria were not met).

Finally, after Guess (Commission Decision of December 17, 2018, AT.40428) we know that stopping distributors from using the supplier’s brand name for the purposes of online search advertising is a no-go. This is a rather popular tactic aimed at decreasing the supplier’s online ads spending by reducing competition between the supplier and the distributor when both place bids on the same keywords. The same decision tells us that a supplier cannot introduce an authorization procedure for online sales without specifying precise quality criteria for deciding whether or not to grant an authorization. For these (and some other) violations the Commission fined Guess close to €40 million.

Of course, the above list of leading cases barely scratches the surface. There are many more online restrictions on which we have at least some guidance from authorities and courts. Examples include: a ban on price comparison websites, pre-approval of third-party platforms, obligation to translate a website into specified languages, limiting permissible SEO methods, restriction on using trademarks in the website’s URL, dual-pricing (using different wholesale prices depending on whether the products will be sold online or offline), requiring a specified proportion of online and offline sales, limiting the number of goods which can be sold to one customer, requiring distributors to have one or more brick-and-mortar shops, etc.

On the other hand, the legality of some of those restrictions is still under discussion. Undoubtedly, there are also many restrictions for which we have no guidance at all, simply because they have not yet gotten on competition authorities’ radar. A hot topic of debate is of course to what extent online sales restrictions can be defended in the case of non-luxury goods (especially as national courts and authorities clearly cannot come to a consensus in this regard). Last but not least, the question remains how to assess cases in which the supplier uses several forms of online sales restrictions in parallel.

VBER and beyond

The VBER expires on May 31, 2022. The Commission is currently analysing whether to let the VBER lapse, to prolong, or to revise it. Selective distribution and online sales are certainly at the heart of this analysis, as both have grown immensely since the VBER was adopted in 2010. However, informal hints from Commission officials suggest that we should not expect a revolution.

In particular, one might expect that the basic framework for assessing online restrictions will remain the same. On the other hand, it can be reasonably expected that the Commission will provide some more guidance on different types of online sales restrictions. Given the difficulties of applying the current assessment framework, such guidance would be most welcome. Adjustments of the current approach to some restrictions, such as, e.g., dual pricing, are also not out of the question.

In any case, we will know more after the Commission’s Staff Working Document is published, which is expected to happen by the end of the third quarter of 2020. However, until the VBER is revised, uncertainty will persist for many distribution strategies.