The European Commission has stated that transforming the EU into a single digital market — that is, removing barriers to the free flow of online services — would contribute €415 billion per year to the economy and create hundreds of thousands of new job opportunities. For now, the existing online barriers still leave businesses to deal with 28 different contract and consumer law provisions. Although more and more goods are being traded over the Internet with an estimated 44% of EU citizens shopping online, cross-border online sales within the EU have remained sluggish. Only 15% of the consumers have said that they have tried to cross the national border while shopping online.

In early 2015, the Commission launched an antitrust inquiry into the e-commerce sector in the EU. According to its press release, the investigation will allow the authorities to identify concerns regarding the e-commerce. The Commission intends to focus on potential barriers instituted by companies on cross-border trade – particularly, in relation to e-goods and services where e-commerce is recognized to be the most widespread: electronics, clothing, shoes, and digital content.

The Commission has already sent requests for information to a range of stakeholders throughout the EU. The inquiry mainly focuses on two types of anticompetitive behaviors: contractual provisions between companies hindering cross-border trade (e.g. outright bans on online trade) and technical restrictions on cross-border trade (e.g. geo-blocking). It is expected that a preliminary report for the consultation will be published in 2016. In preparation for its release, here is an overview of the current state of the law and controversies surrounding bans on online trade.

Pierre Fabre and Consumer Welfare

Pierre Fabre, a cosmetic and personal care product manufacturer, sells its products via selective distribution mechanism. Distributors that sell its products must satisfy various standards. The distribution contracts in Pierre Fabre required that sales be made in brick-and-mortar stores in which a qualified pharmacist is available to provide assistance to the customers.

In 2011, the Court of Justice of the European Union (CJEU) interpreted this requirement as a de facto online sales ban and held that this was a “hard-core” restriction — the EU equivalent to a de facto per se illegality.  Moreover, the CJEU held that this type of restriciton was not exempted by the vertical agreements block exemption regulation, which exempts certain agreements between a supplier and its distributors from the prohibition on restrictive agreements.  The CJEU also rejected application of the individual exemption under article 101(3) Treaty on the Functioning of the European Union, which provides a defense to undertakings against a finding of an infringement. (See more on article 101(3) The slow death of Article 101(3)).

To deem a practice a hard-core restriction, plaintiffs must demonstrate that a certain activity is always anticompetitive. Only then may authorities label a restriction as per se illegal and presume anticompetitive effects without undertaking economic analysis.  While analyzing the contractual provisions adapted by Pierre Fabre, one may ask, why did it impose restrictions on e-commerce and in what way would this distribution model have increased its profits?

There is a common misconception that product manufacturers prefer high retail prices. In reality, they favor lower retail prices; once retail rates increase, the demand at a retail level goes down. In the short run this would have a positive effect on manufacturers’ income, which is dependent on fixed wholesale prices. However, such a practice would negatively affect profits in the long run, since distributors would need to purchase a lower quantity to account for the increase in price.

According to some economists, there is another, better mechanism to increase demand: offer consumers a set of intangible features of the product in question, such as quality service, advertising, and access to a brand name. This could be presented in a simple formula – d = f (s, p) – in which the consumer demand of the manufacturer (d) is negatively affected by the retail price (p) and positively affected by various intangible features (s).

In this way, the vertical restraint used by Pierre Fabre not only had a beneficial effect on the manufacturer’s profit, but may have also benefited the consumers. Indeed, evidence from behavior economics studies suggest that intangible characteristics of the product increase the psychological satisfaction rate of the consumer.  But there is more: if the demand increases solely based on a certain quality aspect (rather than coupled with a decline of a retail price) that means the intangible features have positively motivated the consumers to make certain purchases. By this logic, the online restrictions adopted in Pierre Fabre were not only profitable to the manufacturer but may well have enhanced consumer welfare.

Although the courts in Europe follow the Pierre Fabre precedent, there still exists great uncertainty surrounding the effects of such limitations on vertical agreements. In 2014, the French Court of Appeal found that the Danish high-end consumer electronics designer and manufacturer Bang & Olufsen had breached competition laws for imposing a de facto ban on its distributors from selling the high-end products online. Tellingly, the court substantially reduced the fine from €900.000 to €10.000 because the case law has not yet established set penalties on anti-competitive electronic commerce practices. Commentators have argued that one of the reasons for the remarkable size of the reduction of the fine is that the damage on the economy of the restriction in question was very limited. This decision highlights the need for guidelines and policy rationales that expand on the Pierre Fabre precedent.

United States Perspective

In the U.S., the Federal Trade Commission focuses its inquiry on inter-brand competition (between the companies acting at the same level) rather than intra-brand competition (among retailers or distributors of the same brand). As long as the agreement in question enhances inter-brand competition, the authorities are unlikely to hold that strategies affecting intra-brand competition are illegal. If, on the other hand, the intra-brand competition is limited and there are no pro-competitive effects on the inter-brand competition, the agreements might then be found to be in violation of the Sherman Act under the rule-of-reason test. This test requires courts to balance pro- and anti- competitive aspects of a practice in order to determine whether it is unreasonably in restraint of trade.

For almost two decades, all vertical restraints that were unrelated to price have been analyzed under the rule-of-reason test. However, in 2007, the Supreme Court’s decision in Leegin changed the antitrust approach towards price-related vertical restraints and held that price-related vertical restraints, too, must be analyzed under the rule-of-reason approach.

In 2008, the Ninth Circuit in Gerlinger scrutinized further vertical restraints related to e-commerce. The court analyzed the agreement between Borders Group Inc. (bookstore chain) and Inc. (online bookseller), under which a brick-and-mortar bookstore chain’s website automatically directed all its online customers to the online bookseller’s website. In return, the bookstore chain received payments for the sales that resulted from the automatic redirection to the online bookseller online shop. The bookstore chain also agreed not to participate in the online market. The court in Gerlinger favored the Amazon’s position and rejected the claim regarding the illegality of the agreement. Presumptively, in the EU this sort of practice would have amounted to a restriction of passive sales, as in Pierre Fabre, and would therefore be found to be de facto per se illegal.

Digital Market Integration vs. Consumer Welfarism

The U.S. antitrust regime is biased towards avoidance of type I errors, meaning false judgments in which the court condemns a conduct that was not, in fact, anticompetitive. According to economists Caroline Buts, Siska Troost and Julia Wahl this approach could be linked to the “error cost” explanation. Deriving from the neoclassical school of economic thought known as the “Chicago School,” the “error cost” framework suggests that the social costs of leaving an anticompetitive practice uncondemned are lower than the costs of an over-enforcement (where a procompetitive practices are held to be illegal). The Chicago School assumes that all the anticompetitive behaviors will, in the end, be fixed by competition itself. Therefore, some argue that it is better to under-enforce rather than make false condemnations. (See Antitrust (Over-?) Confidence).

In the EU, the CJEU has explicitly highlighted the importance of the promotion of online sales. It reasoned that the Internet broadens the market and makes products available to the consumers who are not very convenient with buying stuff from brick-and-mortar shops. Indeed, Secretary-General European Commission Alexander Italiener has argued that competition authorities should adapt to the rapid pace of Internet expansion provided by the digital age. In light of these perspectives, some have argued that unlike the US, the EU prefers type II errors, meaning a false judgment in which the court fails to condemn a conduct that is anticompetitive. Indeed, this preference reflects the intersection between the EU’s antitrust policy goal of consumer welfarism and the more fundamental policy aim of achieving a single digital market.

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