Forward Vertical Integration by Contract in the light of Shamsher Kataria Case

In Shamsher Kataria v. Honda Siel Cars India Ltd.[1], an appeal[2] was filed by Toyota Kirloskar Motor Private Limited (Toyota), Ford India Private Limited (Ford) and Nissan Motor India Private Limited (Nissan) against the common order of the Competition Commission of India (Commission) dated 25-8-2014 under Section 53-B of the Competition Act, 2002 (the Act) before Competition Appellate Tribunal (COMPAT).

Emphasising on clauses in relation to sale of automobile components only in the aftermarket, the following are allegations raised by Mr Shamsher Kataria (informant) in the form of information filed by him on 18-1-2011 before the Commission and investigation report made by the Director General (DG).

(i) The authorised dealers could source spare parts including diagnostic tools, technical information, fault codes, repair manuals, etc. only from original equipment manufacturers (OEMs) or their approved vendors. Thus, there are restrictions on authorised dealers from sourcing spare parts from OEMs of other vehicle manufacturers (VMs). Such agreements were therefore found by the DG to be in the nature of exclusive supply agreements in terms of Section 3(4)(b) of the Act.

(ii) Also, not only purchase but there are restrictions imposed on the sale of spare parts including diagnostic tools, technical information, fault codes, repair manuals, etc., by the OEMs on their authorised dealers to independent repairers. Such agreements were therefore found by the DG to be in the nature of exclusive distribution agreement and refusal to deal in terms of Sections 3(4)(c) and 3(4)(d) of the Act.

Held by COMPAT

  1. The appellants are abusing their dominant position by imposing unfair conditions on purchase or sale of goods or services on their authorised dealers and original equipment suppliers thereby violating Section 4(2)(a)(i) of the Act.
  2. The appellants acted in violation of Section 4(2)(c), indulging in practices which result in denial of market access to independent repairers of automobiles to the spare parts in the aftermarket.

Summary

The reasoning given by COMPAT while analysing dominance seems inadequate and the below given additional explanation is more appropriate.

The author has analysed dominance in the light of forward vertical integration by contract as given under Section 19(4)(e) of the Act. As not all vertical integrated firms are dominant, thus what needs to be analysed is:

When does Vertical Integration Amounts to Dominance

The concept of forward vertical integration by contract is applicable to Section 3(4) case as well. This vertical integration in the light of cumulative restrictive effect has led to foreclosure of market access. As all the OEMs in the upstream market and their authorised dealers in the downstream market collectively hold a dominant position, as seen below, the cumulative restrictive effect by these dominant entities has led to complete elimination of competition as the customers are locked in to buy the spare parts from the authorised dealer only of the vehicle they have purchased.

Introduction

The Indian competition law is influenced greatly by the EU legislature and therefore the author first briefly discusses the shortcomings present in Section 4 of the Act with comparison to EU antitrust law.

Further, the concept of “forward vertical integration by contract” is applicable to both Sections 3(4) and 4 of the Act, as explained below. Relying on this concept the author analyses the effect on downstream competitors wherein the “independent dealers” are harmed in downstream market, thus leading to the attainment of “dominance” by the OEMs. All vertical integrations are not dominant firms. But due to presence of conditions such as restrictions on essential facilities and difficult to replicate the goods produced, features unique to automobile component industry, make the automobile firms and their authorised dealer collectively dominant.

Implementation of Chicago School of Thought entirely cannot be relied in the present case. Usually, as per Chicago School of Thought, people are rational and markets are self-correcting. A monopolist’s higher profits attract new entry into such market. As will be seen below this rational cannot be applied to the present case as there is no effect on the reputation of the OEMs, in spite of high prices, due to the competitive primary market and the locked-in effect. Also a mere final consumer loss/welfare cannot be the sole criteria as in this case there is complete elimination of competition. Even though there is technological superiority and consumer welfare is met as there is quality, productive and allocative efficiency, the preamble of the Act suggests that the Commission is established “to promote and sustain competition in markets”. Thus, pointing towards a “workable competition”.

Analysis

Every trader has the right to choose its trading partner and freely to dispose of one’s property and incursion on those rights require careful justification — Oscar Bronner case[3].

Shortcomings in Competition Law in India under Section 4 of the Act

There are some shortcomings when it comes to analysing abuse of dominance under the Act. As the objective justification test that is applicable to abuse of dominance under Article 102 of the Treaty on the Functioning of the European Union (TFEU), the test does not provide a defence to a practice/conduct in pursuance of an agreement that amounts to an abuse of dominant position in India. Also, the word “shall” used in Section 4 of the Competition Act clarifies it. Thus where a dominant undertaking conducts itself having such an effect as per exhaustive list of instances given under Section 4 of the Act, it shall be construed as an abuse.

The language suggests that the authority is duty-bound to hold the dominant firm abusive once it is shown that the alleged party acts in a manner the effect of which is as per Section 4(2)(e) of the Act. Thus, the nature of any exclusive purchasing/distributive agreement on the part of a dominant undertaking is abusive as there is denial of market access to certain portion of traders, irrespective of the positive impact of the agreement on the competition[4]. The Commission must be very careful while concluding a firm to be dominant. Thus applying the principle of vertical integration to this case leads to rational consideration of relevant facts and holistic application of various aspects of Indian economy. The concept of collective dominance being not included in our Indian legislature has led to many difficulties one of them being the non-implementation of the vertical integration as given under Section 19(4)(e) of the Act in its fullest sense.

But the author has gone ahead and analysed vertical integration under Sections 3(4) and 4 of the Act holding both the OEMs as well as the authorised dealers cumulatively and collectively liable respectively causing harm to downstream competitors such as the independent repairers leading to dominance and complete elimination of competition as discussed below.

Defining Market Power and Dominance

Under Section 3(4) read with Section 3(1) of the Act “appreciable adverse effect on competition” are likely to occur when at least one of the parties has or obtains some degree of market power and the agreement contributes to the creation, maintenance or strengthening of that market power or allows the parties to exploit such market power.[5] While the word “appreciable” as given under Section 3(4) read with Section 3(1) of the Act is not defined and no provision for block exemptions are provided in the Act, the legislature has left it to the courts to interpret the word “appreciable” in context to the facts of each case. Further Explanation to Section 4 of the Act defines dominant firm as “position of strength” that “enables it to affect its competitors or consumers or the relevant market in its favour”.  Section 4 cases are to be held abusive only when a party is in a dominant position.

Market power is an economic concept whereas dominance is a legal concept. There are links between the two concepts. Economic concept in the sense the entity has power over price i.e. if the firm unilaterally increases its prices, it will lose some but, crucially, not all of its sales. Whereas legal concept means “the fact that an undertaking is compelled by the pressure of its competitors’ price reductions to lower its own prices is in general incompatible with that independent conduct which is the hallmark of a dominant position”. (Hoffmann-La Roche & Co. v. Commission of the European Communities[6] at para 71.) Thus to be regarded as dominant in an economic sense, a firm, or group of firms, must have sufficient market power to enable it to raise price or act in some other way independently of its rivals.[7] Thus taking into consideration the economic sense of dominance and the case at hand which deals with overpricing, it can be seen that the entities not only possess market power as defined under Section 3(4) of the Act but are dominant entities in their relevant market as defined under Section 4. This severe form of market power under Section 3(4) along with cumulative restrictive effect is studied below.

Section 4 of the Act

When does Vertical Integration Amounts to Dominance

Section 19(4)(e) of the Act provides that while assessing dominance the court must have due regard to vertical integration.

The Commission is required to take due regard of vertical integration, by contract, as it necessarily forecloses access to a segment of the market, since competitors of the integrating firm often can no longer deal with such enterprise and because of such foreclosure, vertical integration has been viewed as an evil in itself[8].

The point that needs to be considered while evaluating vertically integration, whether actual or potential competitors can be expected to provide an effective competitive pressure in the form of either existing or potential competing facilities or services that other firms might offer? The key question is therefore whether competitors have the ability or not to bypass or duplicate the facility[9]? If, instead, the goods provided by a dealer in the exclusive network could be easily replicated by other manufacturers (that is, barriers to entry are low), then costs of the monopolistic firm’s rivals would not increase and there would be no harm to consumers. The spare parts used in automobiles cannot be easily replicated, bearing a few generic spare parts like tyres, batteries, etc.

Further, in a vertical integration set-up, vertical foreclosure effects are very likely to arise where a combined undertaking controls essential facilities[10]. Istituto Chemioterapico Italiano SpA v. Commission of the European Communities[11], the Court of Justice indicated that “a dominant undertaking which both owns or controls and itself uses an essential facility i.e. a facility or infrastructure without access to which competitors cannot provide services to their customers, and which refuses its competitors access to that facility or grants access to competitors only on terms less favourable than those which it gives its own services, thereby placing the competitors at a competitive disadvantage, infringes Article 86, if the other conditions of that article are met”.

The OEMs and the authorised dealers are vertically integrated by contract and the competitors of the authorised dealers are the independent repairers who are refused access to spare parts thus placing them at a competitive disadvantage. Although the concept of collective dominance is not present in our Competition Act but both the OEMs and the authorised dealer collectively hold a dominant position on account of vertical integration by contract.

But to prove abuse of dominance, it is not a particular market structure that Section 4 prohibits rather the negative impact of unilateral conduct of the party, with market power, on the consumers within the relevant market.

Thus as vertical integration is a market strategy, it can be relied on to prove source of dominance. Thus the impact of behaviour, in pursuance of the agreement is the next step to be proved to amount to abuse in accordance to the exhaustive list of instances given under Section 4. In this section of the study the author has only dealt with dominance as the reasoning given by COMPAT for relevant market and abusive conduct is clear and explicit.

Section 3(4) of the Act

Vertical Integration under Section 3(4) of the Act

Vertical relation arises when there is any agreement amongst enterprises or persons at different stages or levels of the production chain in different markets, in respect of production, supply, distribution, storage, sale or price of, or trade in goods or provision of services[12]. Further Section 3(1) of the Competition Act states: “No enterprise or association of enterprises or person or association of persons shall enter into any agreement in respect of … control of goods … which causes or is likely to cause an appreciable adverse effect on competition within India.”

In automobile component sector there is an agreement between authorised dealers and OEMs such as the dealership agreement, forming a vertical relation. Although the sale of components (by the authorised dealer) and the manufacture of such components belong to independent entities, Section 3(1) read with Section 3(4) of the Act provides for indirect control exercised by an OEM on their downstream market in regard to sale of automobile components in the aftermarket where an exclusive distribution agreement is signed between them, forming a forward vertical integration[13] by contract through clauses such as non-compete and refusal to deal.

How is Control Exerted in Vertical Integration by Contract

The chief distinction between ownership and contract as devices for vertical integration is the means of control available for coordination of the organisation involved. Ownership integration maximise control exerted by corporate directives and enforced by status sanctions. Control is more indirect when contract integration is employed. The tradition contract remedies such as damages, rescission, and specific performance. The threat of non-renewal is equally potent. For many purposes, these indirect sanctions control the integrated firm as effectively as the status sanctions of ownership.[14]

Effect-Based Approach Adopted under Section 3(4) and Cumulative Restrictive Test

Firstly, for vertical agreements to be restrictive of competition by effect they must affect actual or potential competition to such an extent that on the relevant market negative effects on prices, output, innovation, or the variety or quality of goods and services can be expected with a reasonable degree of probability[15].

In a vertical integration set-up, vertical foreclosure may occur for potential entrants when a number of major competing suppliers enter into single branding contracts with a significant number of buyers on the relevant market (cumulative effect situation)[16]. As independent repairers provide services for mostly all brand of vehicles and there is vertical foreclosure due to practices in the automobile component industry whereby mostly all the competing OEMs in India enter into an exclusive distributive agreement with their downstream retailer, causing a cumulative restrictive effect. Thus, leading to market foreclosure.[17]

Also, where the Competition Commission found it relevant to consider the behaviour of similar practices by other OEMs, cumulative restrictive effect test follows.

Further negative effects on prices on existing competitors can be expected with a reasonable degree of probability in a vertical integration in the following circumstances:

A manufacturer must promote competition between the retailers. If competition at the retail level is weak, retailers will have market power and will be able to apply a high margin on top of the manufacturer margin[18]. Also, sometimes in order to convince retailers to accept single branding, the supplier may have to compensate them, in whole or in part, for the loss in competition resulting from the exclusivity.[19] Thus in a vertical agreement amounting to exclusive distributive agreement infringing Section 3(4) read with Section 3(1) of the Act, both (or all) of the parties to the agreement will be held liable. It is the anti-competitive agreement which is held to be violative.

As the end consumers have to incur heavy amount to service their car due to lack of competition and limited availability of service stations. The OEMs along with their authorised dealers are dominant entities as seen above. They are responsible for complete elimination of competition in a vertically integrated market set-up due to the locked-in effect as they have made it commercially viable for the independent dealers to operate.

Conclusion

We can conclude by saying that in an exclusive network players cumulatively and collectively along with their authorised dealer holding a dominant position require a detailed and a more elaborate justification to show that their actions do not amount to a vertical restraint rather than a mere single player with market power entering into such an exclusive agreement.


  BSL LLB, LLM, e-mail: irani_sharmin@yahoo.com.

[1]  2014 SCC OnLine CCI 95.

[2]  Toyota Kirloskar Motor (P) Ltd. v. Competition Commission of India, 2016 SCC OnLine Comp AT 452.

[3]  Oscar Bronner GmbH & Co. KG v. Mediaprint Zeitungs-und Zeitschriftenverlag GmbH & Co. KG, ECLI:EU:C:1998:569 : (1999) 4 CMLR 112, para 56.

[4]  Competition Law by Richard Whish and David Bailey, Seventh Edition, Oxford University Press, p. 684.

[5] Guidelines on Vertical Restraints, European Commission, Brussels, SEC(2010) 411 <http://ec.europa.eu/competition/antitrust/legislation/guidelines_vertical_en.pdf>, last seen 30-10-2017, 11.39.

[6]  1979 ECR 461.

[7] Market Power and Dominance, Compecon — Competition Economics, <http://www.compecon.ie/ attachments/File/Dominance(1).pdf>.

[8]  Competition, Contract, and Vertical Integration, Friedrich Kessler and Richard H. Stern, Yale Law School <http://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article =3733&context =fss_papers>, last seen 30-10-2017, 11.39.

[9]  Competition Assessment of Vertical Mergers and Vertical Agreements in the New Economy, Gide Loyrette Nouel, November 2001, <http://ec.europa.eu/DocsRoom/documents/3658/ attachments/1/translations/ en/renditions/native>, last seen 30-10-2017, 11.39.

[10]  Competition Assessment of Vertical Mergers and Vertical Agreements in the New Economy, Gide Loyrette Nouel, November 2001, <http://ec.europa.eu/DocsRoom/documents/ 3658/attachments/1/translations/ en/renditions/native>, last seen 30-10-2017, 11.39.

[11]  1974 ECR 223.

[12]  S. 3(4) of the Competition Act, 2002.

[13]  Cole defines “vertical integration” as “that type of organisation that comes into existence when two or more successive stages of production and/or distribution are combined under the same control”.

[14] Competition, Contract, and Vertical Integration by Friedrich Kessler and Richard H. Stern, Yale Law School <http://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article =3733&context=fss_papers>.

[15] Guidelines on Vertical Restraints, European Commission, Brussels, SEC(2010) 411 <http://ec.europa.eu/competition/antitrust/legislation/guidelines_vertical_en.pdf>, last seen 30-10-2017, 11.39.

[16] Guidelines on Vertical Restraints, (2010/C 130/01), European Commission, <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:130:0001:0046:EN:PDF>, last seen 30-10-2017, 11.39.

[17]  Market foreclosure is the exclusion that results when a downstream buyer is denied access to an upstream supplier.

[18] Limited Distribution: A Self-Assessment Exercise, Jan Peter van der Veer Partner, RBB Economics, <http://www.consiliulconcurentei.ro/uploads/docs/items/bucket7/id7178 /jan_peter_van_der_veer_limited_distribution.pdf>, last seen 30-10-2017, 11.39.

[19] Guidelines on Vertical Restraints, (2010/C 130/01), European Commission, <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:130:0001:0046:EN:PDF>, last seen 30-10-2017, 11.39.


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