Long-awaited clar­ity for dual dis­tri­bu­tion

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Ai­dan Scallan & Schalk van Rens­burg

DUAL dis­tri­bu­tion is po­ten­tially a very ef­fec­tive method for man­u­fac­tur­ers to get their prod­ucts to mar­ket. It can al­low them to take ad­van­tage of ef­fi­cien­cies of­fered by third party dis­trib­u­tors while si­mul­ta­ne­ously al­low­ing them to han­dle cer­tain as­pects or parts of their dis­tri­bu­tion chain them­selves.

Un­til now, th­ese po­ten­tial ef­fi­cien­cies and benefits had to be weighed against the risk that such a strat­egy would be con­sid­ered by the South African com­pe­ti­tion au­thor­i­ties to fall foul of the Com­pe­ti­tion Act. How­ever, the re­cent de­ci­sion by the Com­pe­ti­tion Ap­peal Court in the decade-long legal battle be­tween South African Brew­eries (SAB) and the Com­pe­ti­tion Com­mis­sion pro­vides clar­ity on the le­gal­ity of such a strat­egy and is a wel­come de­ci­sion for any busi­ness wish­ing to en­gage in such a method of dis­tri­bu­tion.

In essence, dual dis­tri­bu­tion en­vis­ages a sys­tem in terms of which a man­u­fac­turer uses the ser­vices of a third party dis­trib­u­tor or whole­saler to sell its prod­ucts to its end cus­tomers but also sells its prod­ucts di­rectly to end cus­tomers it­self. There are end­less rea­sons why a man­u­fac­turer may choose to adopt such a strat­egy. The ad­van­tages are many, both for the busi­ness’s bot­tom line, and for the end cus­tomer, who hope­fully gets to pur­chase the prod­uct at a cheaper price than oth­er­wise.

A clas­sic ex­am­ple of a com­pany us­ing dual dis­tri­bu­tion to max­imise ef­fi­cien­cies is that of SAB. Its dis­tri­bu­tion sys­tem has be­come a thing of leg­end; the ef­fi­ciency with which it is able to dis­trib­ute its beer to the fur­thest cor­ners of SA is al­most un­par­al­leled. It there­fore would have been of some con­cern, to SAB in par­tic­u­lar, and man­u­fac­tur­ers in gen­eral, that the Com­pe­ti­tion Com­mis­sion took is­sue with its dis­tri­bu­tion sys­tem.

Its sys­tem works thus: it sells its beer prod­ucts by way of a pri­mary dis­tri­bu­tion net­work from its seven brew­eries to its own wholly owned de­pots as well as to a limited num­ber of ap­pointed dis­trib­u­tors. A sec­ondary dis­tri­bu­tion chan­nel en­sures that beer is dis­trib­uted by the de­pots and th­ese ap­pointed dis­trib­u­tors to cus­tomers. Each of th­ese ap­pointed dis­trib­u­tors is as­signed an ex­clu­sive ter­ri­tory to ser­vice. Per­son­nel of SAB are sta­tioned at the rel­e­vant ap­pointed dis­trib­u­tor in or­der to con­duct mar­ket­ing func­tions, and the ap­pointed dis­trib­u­tors must ad­here to strict ser­vice stan­dards. Their op­er­a­tional sys­tems are fully in­te­grated into SAB’s sys­tems. They are re­mu­ner­ated by SAB in two ways: they are paid a han­dling fee for each unit sold, and a de­liv­ery fee is paid for each unit de­liv­ered.

The Com­pe­ti­tion Com­mis­sion’s al­le­ga­tions against SAB were wide-rang­ing, but the com­plaint (which was ini­tially brought by a num­ber of in­de­pen­dent dis­trib­u­tors) can be summed up as fol­lows:

SAB was in a hor­i­zon­tal re­la­tion­ship with its ap­pointed dis­trib­u­tors (ie SAB and its ap­pointed dis­trib­u­tors were com­peti­tors in re­la­tion to dis­tri­bu­tion func­tions) and there­fore the ex­clu­sive ter­ri­tory pro­vi­sions of their agree­ments con­sti­tuted mar­ket di­vi­sion in con­tra­ven­tion of the Com­pe­ti­tion Act. Im­por­tantly, were the Com­pe­ti­tion Com­mis­sion to suc­ceed on this point, SAB would not have been able to of­fer any de­fence as such con­duct is au­to­mat­i­cally and ab­so­lutely pro­hib­ited in terms of the Com­pe­ti­tion Act;

If SAB and its ap­pointed dis­trib­u­tors were not in a hor­i­zon­tal re­la­tion­ship, their ver­ti­cal re­la­tion­ship (ie their cus­tomer­sup­plier re­la­tion­ship) re­sulted in a sub­stan­tial pre­ven­tion or less­en­ing of com­pe­ti­tion in con­tra­ven­tion of the Com­pe­ti­tion Act;

That the re­mu­ner­a­tion sys­tem adopted by SAB to its ap­pointed dis­trib­u­tors amounted to price dis­crim­i­na­tion in con­tra­ven­tion of the Com­pe­ti­tion Act; and

SAB had en­gaged in min­i­mum re­sale price main­te­nance, also in con­tra­ven­tion of the act.

In its de­ci­sion, the ap­peal court con­sid­ered whether the ar­range­ments be­tween SAB and the ap­pointed dis­trib­u­tors, which pos­sess el­e­ments of both hor­i­zon­tal and ver­ti­cal re­la­tion­ships, should fall to be an­a­lysed as one or the other or both. In par­tic­u­lar, whether their con­duct could be “characterised” as mar­ket di­vi­sion within the mean­ing of the Com­pe­ti­tion Act and there­fore fall foul of the Com­pe­ti­tion Act. The ap­peal court found that although SAB and the ap­pointed dis­trib­u­tors were in a hor­i­zon­tal re­la­tion­ship at the dis­tri­bu­tion level, “the hor­i­zon­tal el­e­ments of the agree­ment were in­cor­po­rated in aid of the pri­mary ver­ti­cal pur­poses of the agree­ment. They were ra­tio­nal in­ci­dents of a ver­ti­cal ar­range­ment, not in­de­pen­dent ar­range­ments in­cor­po­rated merely for con­ve­nience into a dis­tri­bu­tion con­tract.” Viewed in this light, the ap­peal court found the hor­i­zon­tal fea­tures of the agree­ments with the ap­pointed dis­trib­u­tors should not fall to be ex­am­ined in terms of the act’s mar­ket di­vi­sion pro­vi­sions.

In re­la­tion to the al­le­ga­tion that, when viewed as a ver­ti­cal re­la­tion­ship, the re­la­tion­ship be­tween SAB and the ap­pointed dis­trib­u­tors re­sulted in a sub­stan­tial pre­ven­tion or less­en­ing of com­pe­ti­tion, the ap­peal court found that the ev­i­dence, when viewed as a whole, showed over­whelm­ingly that this was not the case. The Com­pe­ti­tion Com­mis­sion ul­ti­mately failed in its at­tempt to prove an anti-com­pet­i­tive ef­fect as re­quired by the Com­pe­ti­tion Act.

The ap­peal court did not con­sider whether the re­mu­ner­a­tion sys­tem adopted by SAB to its ap­pointed dis­trib­u­tors amounted to price dis­crim­i­na­tion as it found that the con­duct did not re­sult in a sub­stan­tial pre­ven­tion or less­en­ing of com­pe­ti­tion as re­quired by the Com­pe­ti­tion Act, and there­fore it was un­nec­es­sary to con­sider the is­sue any fur­ther. Fi­nally, the ap­peal court found that the ev­i­dence did not sup­port a case for min­i­mum re­sale price main­te­nance. The Com­pe­ti­tion Com­mis­sion’s ap­peal was there­fore dis­missed with costs.

Of course, the court’s de­ci­sion does not mean that all dual dis­tri­bu­tion ar­range­ments are now au­to­mat­i­cally per­mis­si­ble in terms of the Com­pe­ti­tion Act. It does, how­ever, ad­vance South African ju­rispru­dence re­gard­ing the treat­ment of such ar­range­ments to bring it in line with in­ter­na­tional best prac­tice. Pro­vided they are struc­tured prop­erly, busi­nesses will now be able to im­ple­ment dual dis­tri­bu­tion ar­range­ments with the con­fi­dence that they will not be found to have breached the pro­vi­sions of the Com­pe­ti­tion Act.

Dis­tri­bu­tion method fi­nally clar­i­fied af­ter 10-year legal battle and will be taken on a case-by-case ba­sis

Ai­dan Scallan is a se­nior as­so­ciate and Schalk van Rens­burg a can­di­date at­tor­ney in ENSafrica’s com­pe­ti­tion depart­ment.

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