1. www.biicl.org 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

2. HUB AND SPOKE BIICL 15 NOVEMBER 2010 MICHAEL HUTCHINGS INTRODUCTION

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

4. 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

5. THEMES FROM WHELAN RESEARCH Innocuous information exchanges may be anti-competitive 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

6. 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

7. Hub & spoke is dead: welcome to the era of retailer power Javier Berasategi Torices BIICL Hub & Spoke Conference London, 15.11.2010

8. “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

9. 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

10. Conventional View Seller power and intra-brand competition: EC Article 101(3) Guidelines (pars. 17-18) – Vertical BER & Guidelines RPM: cardinal sin Listing fees: supplier2supplier foreclosure (Guidelines, pars. 203-208) Category management: supplier2supplier foreclosure (id., pars. 209- 213) 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

11. 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

12. 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

13. 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, McBride, etc.) 13

14. Modernization 14 Source: PMLA

15. 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 in- store and is influenced by supermarket-platform Inter-platform competition: supermarkets compete for shoppers and, in rare instances, for suppliers (exclusive retail brand suppliers) 15

16. 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 and 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

17. Toys R US Toys R Us v. FTC, 221 F3d 928 (7th 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

18. 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

19. 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

20. 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

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

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

23. Javier Berasategi Torices T. 91 423 09 90 F. 91 800 30 47 Claudio Coello 124 MADRID T. 94 657 86 01 F. 94 494 50 29 Rodríguez Arias 23 BILBAO Email: jb@berasategi.esjb@berasategi.es Móvil: +34 688 606 389 www.berasategi.es THANK YOU!

24. Hub & Spoke Arrangements: A Comparative View A view from Germany by Thomas Lübbig, Berlin 15 November 2010

25. Contents Germany: a retail market of its own Strong enforcement priority on resale price maintenance, typically vertical cases, no established case law on Hub & Spoke Current investigation into food retail by German Federal Cartel Office is shaking up the market

26. The OTC experience You won‘t find it cheaper anywhere else!

27. Shelf space management revisited

28. It‘s all about communication Again: It‘s your margin you are eating into...

29. Current case law on Vertical Restraints 8 January 2008: decision against trade associations of OTC drug companies and Pharmacy Federation for organising seminars at which pharmacists were encouraged to shy away from retail price competition (moderate fine of € 465,000) 8 April 2009: fine against Microsoft for agreeing retail prices for “Office Home & Student 2007” software with retailer on at least two occasions (fine of € 9 million) 15 October 2009: fine against Phonak (Swiss hearing aid manufacturer) for systematically monitoring and hunting down price cuts by internet distributors (fine of € 4.2 million) 25 September 2009: Fine against CIBA Vision (contact lense manufacturer) for interfering with internet sales including Ebay sales as well as “agreeing” retail price maintenance with individual resellers by offering incentives or rewards (fine of € 11.5 million)

30. No clear position on Hub & Spoke in previous case law as focus was always on bilateral vertical agreements Obiter dictum in CIBA Vision case whereby a concerted practice on a horizontal level between distributors could be achieved via the hub of the manufacturer, but ultimately left open

31. The January 2010 Big Bang 14 January 2010: comprehensive dawn raid of four food manufacturers and eleven retailers by German Federal Cartel Office Targets of the Investigation:  alleged vertical restraints: rewards for compliance or punishment for non-compliance with recommended resale prices  alleged Hub & Spoke practices with regard to price increases for FMCG products  highly controversial intervention by German Federal Cartel Office with established practice of communication between manufacturers and retailers in food distribution

32. “Preliminary advice” to companies cooperating with the German Federal Cartel Office Establishment of a „black“ and a „grey“ list, the grey list outlining practices that would not be seen as a violation of the law on a stand-alone basis, but could become an issue in combination with other objectionable practices Interim Guidance letter of 13 April 2010 by the FCO

33. Black List Clear-cut agreement of resale prices or minimum retail prices Carrot and stick policies used by manufacturers to ensure compliance by retailers with recommended resale prices

34. Grey List Raising the issue of recommended resale prices over and over again with retailers and proactively discussing price cuts below the level of recommended retail prices Coordinated monitoring of resale price discipline by manufacturers and retailers Sending of cash receipts to retailer as proof of general compliance with recommended resale prices Printing of recommended resale prices on food packaging if practised in combination with other elements of retail price maintenance policy Clear identification of Hub & Spoke practices as a means of horizontal coordination between retailers

35. General stance of German Federal Cartel Office against “Preispflege” “ Preispflege“, translated as price maintenance policies - a collection of commercial tools taught at business school in order to avoid “value destruction“ “ Preispflege“ could be popular where there is a meeting of minds between a manufacturer interested in the universal resale of its products at a high margin, and a retailer interested in general resale price stability

36. Outlook on current investigation by Federal Cartel Office The Federal Cartel Office has publicly confirmed that it is only interested in the most severe practices of resale price maintenance agreement, and would not go after a stand-alone incident of a manufacturer resending its price list three times in a year Investigation seems to be focused on bilateral vertical issues, it may be further extended to Hub & Spoke situations, but that does not seem to be the primary concern of the authority at the moment

37. © Freshfields Bruckhaus Deringer LLP 2010 This material is for general information only and is not intended to provide legal advice.