Long-awaited clarity for dual distribution
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.