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a blog from young economists at Nova SBE


In response to: Coffee war “what else” – in defence of Nespresso

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

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Play by the book?

Although still a tiny market in continental Europe, there is no doubt that e-books have a large potential when we consider their growth and share among total book sales in the US and the UK [1]. From its nature, sales of e-books depend on device penetration, with the most successful e-book reader being the aggressively marketed Amazon Kindle. Other competitors followed such as Apple which has also been selling e-books for its devices, including the iPad which has been launched across Europe by mid-2010. In its attempt to compete with Amazon, it entered in arrangements with several book publishers (Hachette Livre, Harper Collins, Simon & Schuster, Verlagsgruppe Georg von Holtzbrinck, and Penguin) which have been alleged to restrict competition and thus illegal, both, in the US and the EU [2][3].

Specifically, the publishers jointly switched from an independent distributor agreement to an agency agreement with Apple where publishers controlled the price of e-books that Apple, solely as an agent, sold via its online store. Additionally, a “most favoured nation” clause (MFN) among the publishers ensured that if an e-book was available at a lower price elsewhere, its publisher would have to match that price in Apple’s iBookstore. Both sides, Apple and the publishers, hoped to end the downward spiral of e-book prices mainly spurred by Amazon’s e-book store. Apple might also be able to gain competitiveness as a distributor against Amazon. From the publishers’ perspective, this would furthermore induce other retailers to enter into similar agency agreements. As the agent model allows the publishers to control the price on Apple’s and other participants’ stores, this would indirectly establish a resale price maintenance (RPM).

From an economic perspective, RPM is likely to increase welfare effects when it affects intra-brand competition [4]. More specifically, the horizontal externalities of services or promotion offered by a retailer could induce free riding. Retailers which do not invest have lower costs, but would still benefit from the additional services. RPM avoids that free-riding retailers cut prices and gives incentives for investments in non-price competition, especially additional services and marketing efforts.

Whether this is true or not for the e-book market, there are concerns that the MFN clause hinders price competition. Publishers are unlikely to reduce the price for other retailers because they would have to offer the same discount to Apple, implying a “double cost”. This would additionally support to overcome a commitment problem among the publishers by inducing them to prevent Amazon from continuing to sell cheaper e-books and finally to establish a similar agency model with Amazon.

The motivation of the RPM and the joint switch to an agency model increases the likelihood that the agreements have not been set merely bilaterally between each publisher and Apple, but rather indicates the existence of “horizontal” collusion. Based on this, a US District Court and the European Commission (EC) have started investigations in April 2011 and December 2011, respectively. In its preliminary assessment [5], “the [European] Commission took the preliminary view that to achieve such a joint switch, each of the four publishers disclosed to, and/or received information from, the other four publishers and/or Apple, regarding the four publishers’ future intentions”. Regarding the MFN, the EC expressed the concern that “the financial implications for publishers of the retail price MFN clause were such that this clause acted as a joint ‘commitment device’. Each of the four publishers was in a position to force Amazon to accept a change to the agency model or otherwise face the risk of being denied access to the e-books of each of the four publishers […]”. The fact that publishers coordinate the market conduct and the prices through Apple in order to increase retail prices of e-books, or at least limit retail price competition, would pose an infringement of EU competition law.

Subsequently, while Apple and four publishers (Hachette Livre, Harper Collins, Simon & Schuster, Verlagsgruppe Georg von Holtzbrinck) accepted the remedies and agreed to terminate the agency agreements already in December 2012, the last publisher in scope, Penguin, followed in July 2013.

Although agency agreements and MFN clauses are not unlawful per se, this case sheds light on how vertical agreements can be used to facilitate horizontal collusion. Apple, as a retailer, indirectly acts as a “hub” for the coordination of prices of the publishers that compete with each other and therefore facilitates the enforcement of the “horizontal” agreement.

Trieu Pham #578

Sources:

[1] http://www.letsgoconnected.eu/files/Lets_go_connected-Full_report.pdf

[2] http://www.nortonrosefulbright.com/knowledge/publications/104551/competition-world-a-global-survey-of-recent-competition-and-antitrust-law-developments-with-practical-relevance

[3] http://www.lexology.com/library/detail.aspx?g=7d27a1ac-46c4-469a-aba2-242a75edb178

[3] http://nautadutilh.nl/PageFiles/9151/07-12-Resale-price-maintenance-economics-call-for-a-more-balanced-approach-kneepkens.pdf

[4] http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2013:073:0017:01:EN:HTML


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Nestlé: Abusive Clauses

In 2006, the Portuguese Competition Authority sentenced Nestlé to pay a fee of one million euros as it was proved the practice of illegal clauses in the contracts of its supply of coffee.

Evidences showed that the contracts of Nestlé were violating the antitrust laws, due to the fact that it was restricting competition in the market of coffee consumption that was not at home.

These contracts were made between Nestlé and the Horeca distribution channel, the latter being the sector of food service industry, which consists of establishments that prepare and serve food and beverages.

In order to understand the case in question, it is necessary to understand the economics behind the violation of these antitrust laws. It is important to underline that Nestlé and the Horeca channel came in agreement between clauses that jeopardize the vertical structure of the sector when Nestlé applied vertical constraints in the contracts. These vertical constraints are denominated exclusive dealing, more specifically exclusive supply, due to the fact that the Horeca channel was restricted to buy its products to resell from one single supplier: Nestlé.

So, it is worth noting the importance of the vertical agreements and what are the impacts to the consumers that lay in the bottom part of the structure.

In this kind of vertical structure, the producers do not sell their products directly to the final consumers; instead they need to provide their goods to the retailers who are the ones responsible for the distribution to the public in general. Often, producers find it necessary to make agreements with the retailers in order to force the latter into behaving in a certain matter.

Returning to the case in study, Nestlé imposed certain clauses that forced Horeca channel to stay exclusively in business with them by an uncertain period of time, combined with a mandatory quantity of coffee purchased.  This meant that Horeca could not resort to other suppliers for an indeterminate period of time. Furthermore, Nestlé imposed that after 5 years of contract, if the distributors had not bought the minimum quantity agreed, they were forced to continue under contract, with the penalty of paying restitution.

These types of contracts lead to a lack of competition between producers of coffee, as the Horeca channel could not chose to buy from others suppliers. This led to a decrease in intrabrand competition. The investigation showed that the market for immediate consumption of coffee (the one in question) was provided by four big companies: Nestlé, Delta, Segafredo e Multicafés; and the distribution was made by Horeca. As such, the market for this immediate consumption of coffee was the distribution provided by Horeca and the geographical market was Portugal.

After the investigation provided by the Competition Authority, Nestlé was forced to pay a fee of one million euros and to eliminate all those clauses (contracts with duration above 5 years, as described above) for their contracts from that moment on. 

 

Maria Almeida #637

Competition Policy


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Coffee war, “what else?”

Nestlé was the pioneer in the market for single-serve coffee, by selling Nespresso machines and its corresponding coffee capsules, since 1986. For a long time, Nespresso saw its popularity and sales increasing and Nestlé was enjoying its monopoly in the European market, due to their effort in advertisement but, more importantly, due to the patent of its own product. Eventually, Nespresso’s dominance would come to an end.

Like we also see in the case of the printer and ink cartridges market, the purchase of the Nespresso machines could be done at a relatively low price, whereas the fitting capsules were sold at high prices. Moreover, its strategy involved selling those products in exclusive Nespresso boutiques, with a certain level of service. In the meantime, other Nestlé’s brand, Nescafé machine and capsules Dolce Gusto, appeared as a cheaper alternative for consumers. Nespresso was very well know, but Nescafé, without the same level of service, was becoming dominant and increasing sales. Nespresso ads resulted in positive externalities for other Nestlé’s products.

The single-serve coffee business became so profitable that, other suppliers, namely Sara Lee started to sell its own low-cost version of espresso machine, the Senseo, and its capsules in supermarkets in France. The Ethical Coffee Company began to supply biodegradable capsules.

Yet, due to Nespresso product’s convenience and high-quality reputation a significant group of consumers had already purchased the machine. Those consumers were in a situation of tying. This means that they had bought the Nespresso machines, and were now forced to purchase several times more expensive Nespresso capsules if they wanted to still make use of their machine. The key profits were coming from the pods.

Nestlé’s dominance happened to be under more serious threat when new rivals capsules that are compatible with Nespresso machines arrived. “Real” competition started. This new generic pods were cheaper and sold in grocery stores, making it much more accessible to consumers. Nestlé has sued its rivals, accusing them of violating the intellectual property regarding their creation of this homemade coffee system. It could have tried changing its strategy, either by initiating a price war, or increasing distribution. Instead, Nespresso have tried to protect its dominance through the use of patents and legal actions or even by creating new machines with small hooks inside to make all rival capsules incompatible. However, Nespresso’s legal intents to block the rivals have been revoked by the European competition courts. It was argued by the rivals that Nestlé’s actions were harming consumers’ choice, by abusing its dominant position, and other manufacturers were needed to supply alternatives. Hence, as patents expired in 2012 and competition was showing up in whole Europe, Nespresso decided to keep the same strategy for more exclusive consumers. Despite, some shift of demand to the new generic capsules, most consumers’ loyalty may be due to the high quality of Nespresso’s coffee. Besides, some complaints regarding rival’s low coffee quality, or even generic capsules ruining Nespresso machines show how this vertical restraint can be used to protect the quality and reputation of the product.

 

Beatriz Luís, #648


Franchising – Not that bad after all?!

In 1986, the Pronuptia de Paris GMbH case received great attention and showed that the European Union takes a relatively positive attitude towards franchising agreements. The case is considered a major case in the field of franchising, and dealt with a franchising agreement under the trademark Pronuptia de Paris in order to sell wedding dresses. The franchisee had the exclusive right to use the trademark for marketing purposes and received assistance from Pronuptia, e.g. regarding marketing or education issues. At the same time, Pronuptia agreed to not open any stores or provide any products to third party in the respective territory of the franchisee. On the other hand the franchisee agreed to sell wedding dresses under the trademark Pronuptia de Paris. Moreover, it was required to purchase 80% of the wedding dresses from Pronuptia and pay an entry as well as royalty fees. Additionally, it was forbidden to compete with Pronuptia in any way.

However, the franchisee was sued later for refusing to pay royalties. Court of Justice ruled that the compatibility of franchise agreement was to be evaluated in the light of provision of each agreement and the economics context. What can be learned from this case is that there are inherent restrictions in each franchising system. Firstly, the franchisor must be able to communicate his know-how and assistance to the franchisee without the risk of benefitting competitors. This implies that provisions, which are essential in order to avoid the risk of benefitting competitors, are not seen as restrictions on competition under European Law (Article 81). Also, the franchisee may not open a shop or transfer a shop to another party without approval of the franchisor – again an actual limit on competition, however granted by European Law. Secondly, the franchisor must be able to take measures in order to maintain the identity a reputation of his business. This implies that undertakings, which serve the control of that purpose, also do not constitute restrictions on competition under Article 81 of the European Law.

Concluding, it becomes clear that the benefits of franchising agreements lead the European Law to not restrict franchising agreements per se, but rather evaluated systems based on the economics context. Anti-competitive restrictions are almost always present in a franchising system, however they are not always forbidden by European Law, as they are necessary measures in order for a franchising system to properly work. The inherent benefits of franchising systems might outweigh the costs of these anti-competitive restrictions.

 Markus Eyting, 1722


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Sport TV caught Offside

Aside from the two biggest antitrust cases showing up in the news – the mergers between Zon and Optimus and between PT and the Brazilian Oi –, another case has been around for a while now: the partial acquisition of the sports events PPV operator Sport TV by PT

In mid-December 2012, Controlinveste, owner of Sport TV, decided to restructure the shareholding structure of the company, integrating in it two other firms of the group: PPTV, manager of the television sporting broadcasting rights and of sporting advertisement, and Sportinveste Multimedia, manager of the internet rights of many sports clubs (among which Sporting, Porto and Benfica). Sport TV was held by Controlinveste but also by Zon, with 50% each, while Sportinveste Multimedia was similarly held by Controlinveste and PT. In the end, Sport TV was to be held by Zon, PT (each with 25%) and Controlinveste (with 50%).

Confused? A little bit confused? Totally lost? Just to recap: i) what’s at stake is sporting media rights; ii) PT had 50% stakes in the main internet rights operator, while Zon held 50% of the main television broadcaster; iii) Controlinveste, the holder of the other 50% in each, merged it all in Sport TV; iv) the new Sport TV would be not just a PPV broadcaster, but also the manager of both TV and Internet rights of all that matters in the national sporting media (at least at the time; we’ll go there in a second); v) Zon and PT, which had stakes in the Controlinveste group but in different markets, become stakeholders with crossed interests. One fact that is most curious is that PT had already had a 50% stake in Sport TV in the past, when Zon was still PT Multimédia.

This naturally raised antitrust concerns, namely the fact that PT was considered as the only potential entrant in the market for broadcasting sports events and that this partial acquisition would erase the incentives for PT to enter that market. This is a kind of “portfolio effect”, whereby firms exert limited competitive pressure to rivals in the same markets because the former have stakes in the latter. Besides, small TV operators (such as Vodafone or Cabovisão) contested that Sport TV could raise its prices to them and in favor of PT and Zon and it was also claimed that clubs would also be harmed by this concentration.

This was the argument presented by the upstream side of this market, as the Portuguese Professional Football League (LPFP) filed a complaint against what it perceived as the reinforcement of a dominant position; in fact, the same institution had already pressed charges against Sport TV against abuse of dominant position in football match broadcasting in September 2012. A study by Luís Cabral (from Stern School of Business and hired precisely by LPFP) concluded that this operation would increase Sport TV’s monopsony power and that the clubs would lose one third of their broadcasting rights revenues. Besides such unilateral effect (the reinforcement of market power coming from a merger or partial acquisition), the economist managed to foresee also coordinated effects, as such joint shareholding would enable Zon and PT to better communicate into collusion.

After a favorable legal opinion by the Communications regulator (conditional on the elimination of a no-competition agreement between the three shareholders of Sport TV) and after achieving the advanced stage of investigation with the Competition Authority, the process went all the way back to stage zero following the merger process between Zon and Optimus. Interestingly enough, in the meanwhile the market got a proof of contestability, with BenficaTV emerging as the new player by broadcasting all home matches of Benfica and also the English Premier League, which brought already 300.000 subscribers to the channel (only roughly 200.000 less than Sport TV).

Sport TV lost its monopoly position and had to respond by offering one cheaper channel to face this entry. However, one would only need semantics to see that Benfica TV is far from being a perfect substitute for all consumers (at least for the majority of Sporting fans like myself). At this stage, the Competition Authority is investigating the case, more concerned than ever with an input lock-in, whereby PT and Zon would keep potential entrants from accessing broadcasting rights through exclusive, long-term contracts (non-disputed by any potential entrant, as the one for the EPL was). This concern is more than reasonable, both because of the coordinated effects mentioned above and because other Portuguese clubs will hardly see in BenficaTV an alternative broadcaster of their matches. Moreover, this new contestant has, by definition, privileged access to the most valuable input in the market (as the associated club has the largest fan base in the country, at roughly 60% of the domestic population), something which no other potential entrant, whether “independent” or not, can have (again, by the definition implied by “independent”). For the time being, the ball is on the regulator’s side.

João Garcia, #618


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Exclusive Dealings: a benefit or a cost?

As one of the most used vertical restraints by dominant undertakings, exclusive dealings have been focus of European Commission and also US competition authorities lately.

An exclusive agreement is often explained by a deal between a manufacturer and a retailer, where the first imposes special clauses conferring exclusivity on the business with the retailer.

Some positive effects on business were considered, as facilitating the distribution of products, creating a closer and more loyal relation between producer and the seller and controlling quality (Fernandez, 2007). Though, if the undertaking has a dominant position in the market, it may create distortions and harm competition and the social welfare overall: competitors would have a strong barrier to enter, and consumers would be confined to one supplier, compromising diversity.

By itself, an undertaking with a dominant position relatively to the market size, has already the attention by competition authorities, it is more likely to harm competition rather than small players. At an extreme level, it may even eliminate competition.

To approach exclusive dealings, even though there is no general resolution, EC regards some common topics it found in previous cases: evaluating the foreclose effects created by the agreement (i.e. information asymmetries effects within a market), the possible efficiencies produced, the access needs to distribution by rivals to relate with the real impact on competition, and how it is harming consumers (e.g. by limiting diversity).

Having all the inputs, authorities apply the rule-of-reason, contrasting the eventual benefits generated and costs. Therefore, for each case a specific resolution is addressed.

A different perspective is taken by Chicago School. According to its theory, exclusive dealings should be regarded considering the efficiencies created over the foreclosures. The main idea behind is that if an undertaking offer improves efficiency, retailers will take it, otherwise, they will refuse it, avoiding market inefficiencies. The role of regulators is somehow limited, and even though respected it is a theory that has not so much influence in Europe as it has in US.

At European level, by EC, more emphasis is given to how exclusive dealings may also incentive discrimination through buyers to deter entrants to the market. Undertakings may find as possible way to maintain its monopoly (or dominant position in the market) targeting specific buyers (or retailers as it was previously exemplified) offering them special conditions by an exclusive agreement.

With no consensus, depending a in its majority on the specifications of each economy, there is no special medicine for those practices.

Ana Santos