Pricing and the online channel

Brand owners are often concerned about how their brands are sold online. What are the issues and what can brand owners do about them?

The commercial issue

The continued rise in online sales has fundamentally changed the retail landscape for brand owners.  Brands which are sold online by third parties, either via retailer websites or marketplaces, often view the online distribution of their products as a double-edged sword.  On the one hand, most brands welcome and have embraced the opportunities that online selling can offer in terms of reaching a significantly larger customer base.   On the other hand, online retailers are often able to sell at lower prices than their brick-and-mortar counterparts, which can leave brands concerned that the low-end position of their products in the market is damaging.

Online sales control lies at the heart of this commercial tug-of-war.  Brands are always looking for ways in which they can control the price, presentation, and distribution of their products which are sold by third parties online.

The legal issue

Brands’ understandable desire to control the distribution of their products can put them on a collision course with competition law, where the consumer is king.  The overriding principle of all the complex competition law rules and restrictions is to promote competition, as this drives brands to sell their products at lower prices, invest in better quality, and develop new products – all of which benefit the consumer.

As brands which have found themselves on the wrong side of the line when it comes to competition law will warn, it can seem like the law is against you when it comes to putting in place controls on distribution.  Such controls are usually intended to maximise profit and enhance the integrity of the brand, both of which are commercially sound aims.  For example, some brands seek to compel their distributors to sell at the brand’s RRP.  This is resale price maintenance, which is one of the most flagrant infringements of competition law.   If setting fixed or minimum prices for the resale of products was not prohibited in all but exceptional circumstances, those in the supply chain would benefit from a greater margin, but this would ultimately cost the end consumer.

There are a number of restrictions which UK and EU competition law view as “hardcore” restrictions (that is, the most serious kind of restriction).  If you include a hardcore restriction in one of your supply agreements, you cannot take advantage of the safe harbour available for certain kinds of vertical agreements and you are at serious risk of being found to have infringed competition law.  Some examples of hardcore restrictions are:

1. fixing or setting minimum resale prices;
2. imposing restrictions on the territory into which or the customers to whom distributors may sell the products (with certain exceptions); and
3. various restrictions on sales of the brands’ products by distributors belonging to a selective distribution system.

However, whilst the general rule is that by imposing hardcore restrictions upon its distributors,  a brand owner is likely to be infringing competition law, much will depend upon an analysis of the relevant market in which the parties operate, the purpose and likely economic effects of the restriction in question and whether the restriction has beneficial effects on competition which outweigh the negative effects.  Essentially, in deciding whether a restrictive measure will lead to the brand infringing competition law, two fundamental questions need to be asked:

1. is the measure justified by a legitimate aim; and
2. if it is, do the ends justify the means (in other words, could another less restrictive measure have been used to achieve the same aim)?

Under UK competition law, penalties can be imposed not only on the brand (which could face a fine of up to 10% of its worldwide turnover for the previous business year) but also in some circumstances on the individuals that manage it. 

The changed landscape and challenges for brands and regulators

There has been increasing recognition in the last few years that the growth of the online channel has changed the way in which brands distribute their products.  More manufacturers are operating directly at the retail level, where they can retain full control over pricing and presentation of their products.  In addition, there is an increasing use by brands of specific types of distribution agreements (such as selective distribution agreements) which are intended to limit and control distribution models.

There has also been a recognition that the growth of the online channel can present real problems for brands and their bricks-and-mortar retailers.  The most notable problem is that of free-riding, where   bricks-and-mortar retailers may be reluctant to invest in the promotion of products if the customer can (and probably will) buy the products from an online retailer which has not made any investment in the promotion of the products and can sell at lower prices.   In addition, the driving down of product prices, whilst beneficial to consumers in some ways, can be problematic if, as a consequence, brands are more reluctant to invest in innovative product development.  

What can brand owners do? Is selective distribution the answer?

In light of this, what can brands do to maintain satisfactory control over how and where their products are sold online?  There are various types of distribution systems which a brand can put in place, such as exclusive distribution and selective distribution systems, which will assist the brand to control distribution to an extent. 

A selective distribution system can enable a brand to restrict the distribution of its products only to those distributors which fulfil specific criteria as to how the products must be sold. Criteria include:

• a requirement to operate a bricks-and-mortar outlet,
• selling products alongside brand adjacent products on and offline,
• displaying products in-store and online in a certain manner, each as appropriate and proportionate to the character of the underlying products.

Whilst selective distribution can provide for a method of control as to the distribution of products in a way that extends beyond carving up territories or customer groups (as provided by exclusive distribution), care needs to be taken that the selective distribution agreement itself does not fall foul of competition law.

With care it may also be open to a brand to use various tactics to achieve some control. For example, online presence may be used to channel footfall into chosen instore retailers or to identify online retailers which add value to the customer experience or brand.

In contrast other tactics such as:

• the use of discounts and special promotions to distributors; and
• the use by a brand of monitoring software or pricing algorithms, 

will be considered in future issues of Fashion Focus.

We have advised numerous brand owners on maintaining control of the sale of their brands on-line and the use of selective distribution agreements, whilst mindful of the pitfalls of competition law.