The case deals with several concepts that are often debatable within competition policy. Most significant for the case at this point, is the revoke of European Patent Office of Nestle’s patent for the function of the food processing giant’s coffee brand Nespresso. In this regard, as the recent blog elaborates on, there is a dispute on the inter-brand level competition because of competitors copying similar processes of Nespresso and its capsules. This however, has created less of a problem for Nestle due to the high quality position of the products of Nespresso. Moreover, with the revoke of patent, the case stipulates the issues revolving around free riding Nestle’s advertising and promotion of Nespresso capsules in particularly intra-brand spill over to competitors. These competitors are taking advantage of the distribution channels of Nespresso by creating capsules that fit in the actual machines of Nespresso.
For years the protection by intellectual property rights for the intra-brand to secure the R&D of Nestle, has enabled Nestle to pick the berries off the tree whilst sitting safely in their own nest. In general, Neslte’s large market share and control of value chain for in this case coffee, as a producer, retailer and distributor thereof, does not help them in their argumentations to remain control of their capsule distribution. Being such a significant player is more likely to fall under dominant position article and the abuse of attempting to protect what essentially is tying consumers to a product purchase.
Whereas the central idea of internalising business activities through a company’s own distribution channel, and in this case the brand of Nespresso, may be welfare generating it may in the lack of competition also be welfare deteriorating. The internalisation process essentially aims at reducing transaction cost for the firm in reducing the marginal cost of activities and coordination across the value chain. The positive notion of this from the consumer perspective is that this may reduce the end price in the market. Albeit, insofar as there is a patent involved for the given product, this creates a strong vertical restraint for the supply chain of in this case coffee in capsules. In this circumstance, it includes internal exclusive distribution of the brand and for the potential of Nestle to drive up its end prices for consumers. This in turn may have a negative impact on consumer surplus. Initially the critical point of this effect is considering the relevant market and its alternatives of coffee supply for which creates the demand substitution rate for the consumer.
Arguing for Nestle, the protection through patent and internal distribution has been control of their own brand in what is a related product tie and therefore per-se not an illegal process. Accordingly, due to consumers having had and do have sufficient inter-brand alternatives to enjoy, the process does not have a negative impact on consumer welfare. Thus, the product of Nespresso is one of many options consuming and preparing coffee. The sole argumentation that there exist adequate inter-brand competition makes the lack intra-brand competition for capsules for Nestle’s own Nespresso machines a marginal problem and more so rather irrelevant in conceptualising welfare losses. A consumer is completely free to choose from alternative ways to purchase and brew their coffee. Hence, the Nespresso capsules are a unique feature of the product quality for the machine. More so, the revocation of Nestle’s patent on capsules for its own Nespresso machines is a reduction of production surplus. It incentivises the company to one hand, very well decrease prices for capsules, – but on the other increase prices of Nespresso machines and possibly reduce the quality of end product and thereby potentially consumers’ rent and thereof consumer welfare.
Sources: Financial Times (2013) Competition hots up for coffee capsule market smooth operators [internet] Available from: http://www.ft.com/intl/cms/s/0/d8c237a4-489c-11e3-8237-00144feabdc0.html#axzz2wg8lEqks. Accessed: [March, 21st, 2014]
Alan Brejnholt #381