European Commission publishes Final Report on e-commerce Sector Inquiry

In brief

On 15 September 2016, the European Commission published its Preliminary Report on its e-commerce sector inquiry. The Preliminary Report:

• confirms the Commission’s initial results in relation to geo-blocking set out in its Issues Paper published in March 2016
• sets out pricing restrictions/practices that could be problematic
• discusses certain licensing practices in relation to online content
• discusses bans in relation to selling via the internet or on parts of the internet (for example, price comparison websites) which could be problematic from an antitrust perspective, and
• elaborates on certain restrictions relating to particular distribution models, including restrictions in the context of exclusive agreements and selective distribution models, which could raise issues under EU competition law.

Background to the Preliminary Report

The Commission launched its E-commerce Sector Inquiry in May 2015. The Sector Inquiry forms part of the Commission’s broader Digital Single Market Strategy, also adopted in May 2015. It covers e-commerce in relation to both consumer goods and digital content. On 18 March 2016, the European Commission published its initial findings on the results of its public consultation on geo-blocking, including an issues paper on relevant practices in e-commerce, together with the results of its "mystery shopping survey", which analysed the form and prevalence of geo-blocking restrictions in the EU. The Commission’s initial findings indicated:

• widespread agreement on the definition of geo-blocking as the practice of preventing users based in a different Member State from the online provider accessing and purchasing consumer goods/digital content services online
• widespread geo-blocking, through both unilateral decisions by companies not to sell abroad and contractual barriers to cross-border purchases, and
• a variety of forms of geo-blocking and heightened geo-blocking in particular Member States and product categories.

Please see our elexica article for further information on the Commission’s initial results. On 25 May 2016, the European Commission announced a proposed Regulation on geo-blocking as part of a broader package of measures proposed in the context of the Digital Single Market strategy. The proposed Regulation would result in significant obligations for companies if it becomes law. Please see our elexica article for further information.

The Commission’s Preliminary Report is based on information gathered from 1,800 stakeholders across all 28 Member States (including manufacturers which were not covered in the Commission’s initial consultation), and the Commission’s review of approximately 8,000 distribution agreements. In relation to consumer goods, the Commission approached manufacturers, retailers, platforms (ie marketplaces and price comparison websites) and payment service providers across a variety of product categories including clothing, shoes, consumer electronics, books, CDs, DVDs, computer games and healthcare. In relation to digital content, service providers and right holders offering films, sports, music, news, and other content were sent requests for information by the Commission.

The key findings in the Preliminary Report

Geo-blocking

Geo-blocking refers to commercial practices whereby online providers prevent users from accessing and purchasing consumer goods/digital content services offered on their website based on the location of the user in a Member State different from that of the provider. Geo-blocking measures include: (a) blocking access to websites by users located in another Member State; (b) automatic re-routing of users to another website of the same or a different service provider (possibly with a different price); and (c) delivery and/or payment refusals based on the location/place of residence of the user. These matters are covered in the Commission’s proposed Regulation on geo-blocking. Please see our article on the draft Regulation. Geo-blocking can be distinguished from geo-filtering, which refers to commercial practices whereby online providers allow users to access and purchase consumer goods/digital content services cross-border, but offer different terms and/or conditions depending on the location of the user in a Member State different from that of the provider.

The Commission’s preliminary results show that geo-blocking is widespread throughout the EU and is mostly based on unilateral business decisions of retailers in the case of consumer goods. To implement geo-blocking, retailers collect various types of information on the location of the user, most commonly their postal address, followed by the user’s debit/credit card details or country of residence.

Around 38% of respondent retailers use geo-blocking in order to restrict cross-border online sales. While most of the geo-blocking measures are based on the unilateral decision of retailers, nearly 12% of respondent retailers reported that they have contractual cross-border sales restrictions in at least one of their product categories. The product category in which the highest proportion of retailers experience cross-border sales restrictions is clothing and shoes, followed by consumer electronics.

In the case of digital content, the Commission’s preliminary results show that geo-blocking is mostly contractually required by rights holders (70% of respondents restrict access to their online digital content services and almost 60% of respondents are contractually required to do so). IP address verification is the prevalent form of technical implementation of geo-blocking in relation to digital content.

If geo-blocking is based on unilateral business decisions by a non-dominant company not to sell abroad such behaviour falls outside of the scope of EU competition law rules. However, in some cases, geo-blocking appears to be contained in agreements between suppliers and distributors. Such agreements may restrict competition in the EU single market in breach of EU competition law, though this needs to be assessed on a case by case basis. The Commission recognises in its Preliminary Report that contractual cross-border sales restrictions have multiple forms and are not always written in agreements, but may also be communicated orally.

Price restrictions

In the Preliminary Report, at least a third of the respondent retailers in each product category for goods covered by the sector inquiry state that they have received some form of price restrictions or recommendations from manufacturers. According to the Commission, nearly 30% of the respondent manufacturers indicated that they systematically track the prices of their products sold via independent retailers and 67% of the manufacturers use manual tracking. The Commission recognises in its Preliminary Report that increased price transparency through price monitoring software may facilitate or strengthen collusion between retailers and thereby impact competition.

Agreements that establish a minimum or fixed price (or price range) are a restriction of competition by object under Article 101(1) TFEU. It is important that manufacturers do not take action that interferes with the freedom of retailers to set their final prices to customers either directly through contractual means or indirectly by exerting pressure on retailers.

Distribution models

The Preliminary Report indicates that the prevalence of selective distribution systems has significantly increased with the growth of e-commerce in the last ten years. Around 56% of manufacturers stated in their responses to the Commission that they make use of selective distribution agreements. The Commission sets out the following potential concerns with selective distribution models:

• The requirement in selective distribution agreements for retailers to operate at least one brick and mortar shop (so excluding all pure online players), while generally covered by the Vertical Block Exemption Regulation (which creates a safe harbour for certain vertical arrangements provided certain conditions are met), may require further scrutiny in individual cases. This would be the case when this requirement is imposed for particular products which online retailers might be as qualified to sell as physical retailers.
• The potential lack of transparency and objectivity of the selection criteria used by some manufacturers to choose the members of their distribution network.
• Some so called "discount" retailers raised concerns to the Commission, suggesting that even if they complied with all quality criteria, some manufacturers would refuse their admission to the network based on the low retail prices they set for products. According to these retailers, due to high price transparency online, they would be seen by manufacturers as driving down product prices, thereby putting at risk the margins of other authorised distributors in the network.
• Around 24 % of the manufacturer respondents reported that they do not communicate their selective distribution criteria to retailers who wish to participate in their selective distribution network. Even some manufacturers, who do communicate criteria, would not necessarily do so when it clearly appears that a particular retailer would not fulfil their selection criteria based on the information available regarding the retailer. However, these manufacturers would typically send a letter to the retailer stating the reason for the refusal.

In light of the above, the Commission states in its Preliminary Report that it may investigate potential anti-competitive obligations in selective distribution agreements.

Vertical restraints

The Commission’s Preliminary Report also examines other potentially problematic arrangements between operators at different levels of the supply chain (so called vertical restraints). The Commission notes that almost half of the manufacturers who responded to the Commission’s consultation make use of territorial exclusive distribution agreements. However, only a small portion of their total distribution relationships are in fact based on territorial exclusivity. The Commission’s preliminary results indicate that manufacturers that implement territorial exclusive distribution models typically appoint an exclusive distributor at the wholesale level as opposed to the retail level. In some cases, territorial exclusivity at the wholesale level is combined with a selective distribution network at the retail level. In these cases, the wholesale distributor has responsibility for developing and managing the network of authorised retailers, on the basis of the criteria set by the manufacturer in a given Member State.

The Commission’s Preliminary Report suggests that several territorial restrictions could raise concerns under EU competition rules. In particular:

• Contractual restrictions limiting the ability of retailers to sell to customers outside their home Member State or to customers located in certain Member States.
• Some suppliers appear to restrict active sales (sales involving the taking of a step by the seller to approach customers) by retailers outside a designated territory. This restriction appears to be irrespective of whether other territories have been reserved to the supplier or exclusively allocated.
• Some manufacturers appear to restrict passive sales (sales involving unsolicited requests from individual customers) into territories that have been reserved for the supplier or exclusively allocated to other distributors. Restrictions on passive sales are considered to be a serious infringement of competition law rules.
• Some suppliers operating a selective distribution system across multiple Member States seem to be limiting the ability of authorised retailers to actively and passively sell to all customers within those Member States. In some cases, this extends to limiting the ability of retailers to launch websites targeting other Member States.
• A few manufacturers limit the ability of an exclusively appointed wholesaler to actively sell to all authorised distributors within the Member States in which the manufacturer’s selective distribution network is operational.
• Territorial exclusive distribution agreements can only partly justify the existence of restrictions on (active) cross-border sales. According to the Commission’s review of distribution agreements, many EU cross-border sales restrictions are unrelated to exclusive distribution arrangements (ie potentially a form of geo-blocking).

Marketplace restrictions

The Commission’s preliminary results also suggest that manufacturers implement different vertical restraints such as marketplace restrictions in order to build and maintain brand image and quality reputation. Just below one in five retailers are restricted from selling via online marketplaces. The Commission’s Preliminary Report also finds that just below one in ten retailers are restricted from placing offers on price comparison web sites. The Commission recalls in its report that absolute internet bans constitute hardcore restrictions under EU competition laws.

In relation to marketplace restrictions, the Commission does not consider that (absolute) marketplace bans have the object of segmenting markets in the internal market based on territory or customers. They concern the question of how the distributor can sell the products over the internet and do not have the object of restricting where or to whom distributors can sell products. However, the Commission’s Preliminary Report notes that this does not mean that absolute marketplace bans are always or generally compatible with EU competition law. The Commission may decide to review certain marketplace bans in agreements falling outside the safe harbour created by the Vertical Block Exemption Regulation.

In relation to price comparison bans, the Commission notes these bans may make it more difficult for customers to find a particular retailer's website thereby potentially limiting the (authorised) retailer's ability to promote its own online offer and decreasing price transparency. Such bans could also make it more difficult to attract customers outside the physical trading area of the retailer, via online promotion channels. The Commission notes however that restrictions on the use of price comparison tools based on objective qualitative criteria in the context of a selective distribution system are in principle permissible under EU competition law.

Agency agreements

Interestingly, the Commission specifically mentions agency agreements in its Preliminary Report. It notes that manufacturers generally use agency agreements with their wholesalers rather than with retailers. They do so to exercise increased control over the distribution of their products while saving on the costs of setting up their own sales force/infrastructure in a given market. These agreements often establish that the wholesaler, as the agent of the manufacturer, is under the obligation to ensure that the retailers comply with established quality criteria for the sale of products.

From a competition law perspective, agency relationships typically allow for better control over retail activities than other distribution models, for instance over prices or the geographic scope of sales. However, this comes at a cost for the principal who must make sure that the agent does not bear, or only bears to a limited extent, any financial or commercial risks for its activities. Genuine agency agreements are not subject to Article 101 TFEU.

Licensing practices in relation to digital content

The Commission’s preliminary results indicate that contractual restrictions relating to licensed transmission technologies, timing of releases and licensed territories are the norm in digital content markets.

Geo-blocking in relation to digital content appears to result from contractual restrictions in licensing agreements between rights holders and digital content providers. Almost 60% of digital content providers who responded to the Commissions consultation said that they are contractually required by right holders to geo-block. The majority of licensing agreements submitted to the Commission include geo-blocking requirements for all product types, except for news products. The Commission’s Preliminary Report indicates that geo-blocking is most prevalent in agreements for films, sports and TV series.

The Commission considers that its provisional findings could suggest that certain licensing practices may make it more difficult for new online businesses to emerge and for new or smaller players to enter existing markets or to grow their activities into other markets. This could be the case in particular when online rights are sold exclusively on a per Member State basis or bundled together with rights for other transmission technologies.

The Preliminary Report notes that licensing agreements are often concluded for long durations and the parties to such agreements often renew agreements on the basis of specific clauses (such as automatic renewal clauses, first negotiation clauses and or a matching offer right). This leads to long term contractual relationships. New entrants and smaller operators wishing to grow their digital content businesses may find it difficult to obtain licenses because of the relatively long and stable exclusive contractual relationships between right holders and established digital content providers. This may be exacerbated by certain contractual clauses that are part of the licensing agreements (such as those mentioned above).

In relation to exclusivity, there are complex licencing practices whereby exclusivity may be granted in different forms. The Commission notes that an important element of the assessment of exclusive licensing is the presence of market power at different levels of the supply chain which, being closely related to the specific product and/or geographic market, needs to be examined on a case-by-case basis.

In relation to payment structures for online content, the Commission’s preliminary findings show that the payment mechanisms which determine the amounts paid by digital content providers to right holders for licensed online rights are highly complex. While online business models have led to the introduction of new payment models including on a per title basis, the Commission’s findings also suggest the widespread use of minimum guarantees and fixed/flat fees. These payments are often used in conjunction with advance payments, which could make it more difficult for new entrants to gain a foothold in the market.

The Commission concludes that the availability of online rights depends on whether and how the rights have been split up by right holders, the extent to which they may have been bundled with other rights, and on the duration of both specific licensing agreements and contractual relationships, which in general tend to be long-term. Moreover, the choice of fee structure may in some cases increase the fixed cost of entry for digital content providers. However, the structure of payments and their level may serve other purposes, such as optimal risk sharing and streamlining of incentives along the supply chain. Nevertheless, the Commission’s preliminary findings suggest that multiple business models and a great diversity of licensing practices are available and indeed used, which can cater for the needs of both right holders and digital content providers.

The Commission states that it will therefore assess on a case-by-case basis whether certain licensing practices may be restrictive or distortive of competition and whether enforcement action is necessary in such cases.

Commentary and next steps

In light of the Preliminary Report, the Commission and national competition authorities are likely to increase their enforcement activity in e-commerce markets as has previously been the case when the Commission has conducted sector inquiries. In particular, there could be investigations into geo-blocking practices in relation to online and physical goods (indeed a number of investigations are already under way) as well as possible probes into the use of territorial restrictions in agreements and other problematic restrictions in the context of selective distribution systems. Resale price maintenance and marketplace or price comparison bans are other areas where the Commission could focus its enforcement activities. In relation to online content, the use of long or exclusive contracts or geo-blocking practices could come under scrutiny. Therefore, it is very important that companies review their current distribution arrangements in order to ensure compliance with EU competition law.

A number of the issues raised in the Commission’s Preliminary Report are already the subject of investigations by either the Commission or national competition authorities. For example, the Commission continues its investigation into geo-blocking obligations in contracts between several US studios and European broadcasters (such as Sky). On 26 July 2016, the Commission announced that it had made binding on Paramount commitments which oblige it not to restrict Sky from making its pay TV services available to customers in the EEA outside the UK and the Republic of Ireland in response to unsolicited requests. The Commission is also conducting an investigation into online restrictions in relation to consumer electronic goods. The UK Competition and Markets Authority is also active in the digital space, having recently sent a statement of Objections to Ping, a sports equipment supplier, which states that Ping is banning retailers from selling its products online. Other national competition authorities are also pursuing cases in this area, including in France and Germany.

The Preliminary Report is open to public consultation until 18 November 2016. The Commission expects to publish the Final Report in the first quarter of 2017. Interested parties should take this opportunity to engage with the Commission’s process.