Exclusive Distributorship

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What is Exclusive Distribution?

Exclusive distribution takes place when a supplier grants a distributor exclusivity of the sale of the contract goods or services within a territory, or to a specific group of customers. In exchange, the distributor will usually agree to sell goods or services of the supplier’s competitors. Exclusive distribution falls within the category of non-price vertical restraints.

The Rationale Behind Exclusive Distributorships

Exclusivity is often used for the distribution of high quality or technically complex products that require a relatively high level of expertise. Staff may need specialized training to be able to sell those goods, as is the case, for instance, with pharmaceutical products. Moreover, when purchasing certain goods such as cars or electronics, customers may require specialized aftersales services such as repair and maintenance.

The restraints imposed by exclusive distribution agreements are often procompetitive.  For example:

  • Contracting costs are reduced, which may make distribution more efficient and less costly;
  • The supplier can exert greater quality control over a limited number of distributors, as it is easier to make sure that they are complying with the required promotional efforts; and
  • The distributor is protected from ‘free riders’, who may take advantage of the dealers’ investments on the contract goods (promotion, aftersales services, etc.) and sell the same products at a cheaper price.

Nonetheless, such business practices may also raise some competition concerns.

Section 1 of the Sherman Act

Given that exclusivity over a supplier’s products is granted to a single distributor within an area,  interbrand competition (between products of competing brands) may be enhanced, but intrabrand competition (between different distributors of the same product) is virtually eliminated. This can have indirect consequences on price, and may raise concerns under Section 1 of the Sherman Act. As a result, the Supreme Court originally treated such restraints as per se illegal. Until 1977, the per se rule established in the seminal Dr. Miles case applied to exclusive distribution.[1]

As antitrust scholarship progressed, courts progressively recognized the benefits of exclusive distributorships. As a consequence, in 1977 the Sylvania ruling already extended the application of the rule of reason to all non-price vertical restraints.[2] Representatives of the Chicago School – Judge Richard Posner in particular – even argued that exclusive distribution should be legal per se.[3] Nevertheless, the courts have not fully accepted this position, and will look at the specific conditions of the exclusive distributorship in each scenario (length of time of the exclusivity, geographic area, interbrand competition) before coming to a decision as to the legality of the scheme in question. In essence, intrabrand restrictions will be tolerated provided interbrand competition is enhanced or remains unaffected,[4] the duration of the exclusivity is reasonable,[5] and the exclusive territory is not excessively broad.[6]

Section 2 of the Sherman Act

It is rare that exclusive distribution agreements will be considered part of an attempt to monopolize in violation of Section 2 of the Sherman Act.[7] However, it is more likely that these agreements will be deemed unlawful in the event that either the supplier or the buyer hold a dominant position.[8] For Section 2 to apply, an intention to eliminate competitors through the exclusive distribution contract would need to be demonstrated; that is to say, the restrictions would have to be part of a wider anti-competitive scheme.[9]

The courts have clarified that it is lawful to restrict the number of existing distributors by granting exclusivity to an existing buyer and terminating all others that were previously active in that same area. Generally, agreements that reduce the number of dealers are not currently considered to be illegal, unless the supplier is a monopolist.[10]

Conclusion

It can be said that exclusive distribution does not tend to raise problems under Sections 1 and 2 of the Sherman Act where:

  • interbrand competition remains unaffected;
  • the territory and the length of time for which the exclusivity is granted are reasonable;
  • neither party holds a dominant position; and
  • the restrictions are not part of a wider anti-competitive scheme.

[1] Dr. Miles Medical Co. v. John D. Park & Sons, 220 US 373 (1911).

[2] GTE Sylvania Inc. v. Continental TV Inc., 537 F.2d 980 (9th Cir, 1976).

[3] R Posner, ‘The Next Step in the Antitrust Treatment of Restricted Distribution: Per Se Legality’ (1980), 48 University of Chicago Law Review 6, 589.

[4] US v. Arnold, Schwinn & Co. 220 US 373 (1967).

[5] Quality Mercury, Inc. v. Ford Motor Co., 542 F.2d 466 (8th Cir. 1976)

[6] United States v. Chicago Tribune-N.Y. News Syndicate, Inc., 309 F. Supp. 1301 (1970

[7] Photovest Corp. v. Fotomat Corp., 606 F.2d 704 (7th Cir. 1979), cert, denied, 445 U.S. 917 (1980).

[8] Hershey Chocolate Corp. v. FTC, 121 F.2d 968 (1941).

[9] US v. American Smelting and Refining Co., 182 F.Supp. 834. (S.D.N.Y. 1960).

[10] US v. Arnold, Schwinn & Co. 220 US 373 (1967).

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