Nova workboard

a blog from young economists at Nova SBE

In reply to “Franchising – Not that bad after all?!”

The 1986 Pronuptia case presents itself indeed as a landmark in European competition policy history as there had been the urgent need to deal with franchise agreements given the rising importance of such business practices. Rest assured, the decision of the court paved the ground for the growth of franchising in Europe.

As the European Court ruled, franchise agreements were from then on to be evaluated on a case-by-case basis and not by general rule, and would fall under the vertical restraint legislation. But why is it necessary to assess each individual case alone, and why do practices within franchise contracts have such ambiguous effects on competition?

It is important to notice that franchising is not merely a contract bearing a set of vertical restraints – it works a vertical restraint by itself. Setting up a franchise can be understood as a vertical integration process or a method of selective distribution. Hence, as other vertical devices, the negative effects on competition it entails can be overruled by the gains in efficiency, which makes theme legible for exemption.

Moreover, vertical restraints are deemed necessary for the franchisor to protect the brand reputation. While franchises provide better alternative relatively to chain stores, it is still the manufacturer’s brand that is at stake; the franchisor should then be entitled to set restraints on the franchisee as rules of conduct for the better functioning of the business. The same goes for intellectual property; as stated in the aforementioned post, the franchisor incurs in a significant transfer of know-how without the risk of benefiting competitors, meaning that it will have to protect its intellectual rights somehow and may chose to do so by vertical restraints.

There are, of course, ambiguous effects resulting from the establishment of franchise agreements. When affecting intra-brand competition (that can be taken as competition between franchisees), the restraints of franchise contracts aim at solving externalities and improve efficiency of the businesses. Regarding intra-brand competition, however, there can be an eroding effect; franchises can erect significant barriers to entry or decrease competition in the market the same way a vertical merger would. That is why these agreements need to be evaluated on a case basis, assessing all the possible consequences of the installment and verifying if the actions are indeed justifiable given the context.

As the original post concludes, anti-competitive restrictions are inherent to a franchise contract as they guarantee a proper functioning of the settlement. The effects of the agreement, however, need to be properly assessed as any other vertical restraint would be, but are justifiable when the benefits of efficiency outweigh the losses in competitiveness.

 

Carla #636

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Author: studentnovasbe

Master student in Nova Sbe

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