Unpacking Antitrust: What Are Vertical Restraints?
March 21, 2023
Author: Molly Donovan
The Short Answer: Companies that operate on different levels of the supply or distribution chain are vertical to one other. For example, a parts supplier and manufacturer. A manufacturer and a distributor. A distributor and retailer. Vertical companies don’t compete with one another. They’re more likely business counterparties.
An agreement reached by two or more vertical actors that restrains competition can be illegal under the antitrust laws. Whether a vertical agreement is illegal is generally determined according to the rule of reason—a balancing test that weighs harm to competition against the procompetitive justifications behind the restraint.
Have I Reached an Agreement?
At the threshold, a vertical restraint requires an agreement. For compliance purposes, “agreement” should be construed broadly. There need not be a signed contract or even a written set of terms. An agreement does not require a “yes” or an “I agree.” Instead, an “agreement” can be implied or consist merely of a “wink and a nod.”
A unilateral policy is not an agreement. For example, a manufacturer’s unilateral policy that its products not be sold for less than a specifically-identified retail price (a resale price maintenance policy) is not a vertical restraint because it’s missing an agreement with a market counterparty. (Of course, if the policy is not truly unilateral based on the circumstances, it will be deemed an “agreement” subject to a vertical restraints analysis.)
Hypothetical: A manufacturer announces a unilateral resale price maintenance policy. Subsequently, a violating retailer tells the manufacturer that the policy is unfair in its unique circumstances—can’t the policy be altered to accommodate the retailer? The manufacturer agrees. Now, there’s a very good argument that the unilateral policy has transformed into an agreement.
Is My Agreement Vertical or Horizontal?
While seemingly straightforward, sometimes the question whether an agreement is vertical or horizontal becomes quite complex. For example, if an agreement between a manufacturer and its resellers (vertical) is designed to further a horizontal agreement (among the resellers), it’s possible a court would rule that the manufacturer-reseller agreement should be treated as a horizontal, rather than a vertical, restraint. In that case, the manufacturer could be subject to per se antirust liability whereby harm to competition is presumed.
Absent such circumstances, it’s generally safe to assume that an agreement between two companies who don’t compete with one another, and operate on different levels of the distribution chain, are vertical.
Does My Vertical Agreement Restrain Competition?
It probably does. It’s difficult to imagine an agreement between two market actors that doesn’t somehow restrain competition. If an agreement restricts a company’s choices—the prices a company may charge, the parties with whom a company may deal, even where products are displayed in a store—there is some restraint on competition.
Whether or not that restraint is unreasonable and thus, illegal, under the antitrust laws is a different question.
Here are Common Examples of Vertical Restraints:
- A minimum advertised price agreement
- A resale price maintenance agreement
- An agreement not to deal with, or to boycott, another market player
- An agreement to deal only with each other (exclusive dealing)
- Loyalty discounts
- An anti-steering agreement (you can’t dissuade your customers from using my product and/or you can’t encourage your customers to use my competitor’s product)
- An agreement with an employer that an employee will not compete following the termination of employment
Is My Vertical Restraint Illegal?
Under federal law, vertical restraints are generally judged by the rule of reason. These days, that’s true even if the restraint is price based (like a resale price maintenance agreement between a manufacturer and a reseller).
According to the Department of Justice (“DOJ”), the rule of reason asks the “central question” whether the agreement “likely harms competition by increasing the ability or incentive profitably to raise price above or reduce output, quality, service or innovation below what likely would prevail in the absence of the relevant agreement.”
In essence, a court or an agency asks whether the restraint is more harmful than it is helpful to consumers. This requires an analysis of (i) the relevant product and geographic market; (ii) market power of those reaching the agreement in the relevant market; (iii) the existence of anticompetitive effects. Assuming these elements are satisfied, a court would then shift the burden to the defendant to show a procompetitive justification – an explanation why the challenged restraint, on balance, benefits competition and ultimately, consumers.
The inquiry is flexible and no one factor is dispositive – in part, because the considerations will vary depending on the market circumstances. With that said, here are some questions that are often part of the mix:
- Is the market concentrated?
- Do you have a large market share? Does the company you’ve agreed with have a large market share?
- Does the restraint foreclose, or mostly foreclose, anyone from competing in the market?
- Does the restraint affect price or output? If the agreement is already in place, can increased price or decreased output be observed?
- Does the agreement deter independent interbrand competition?
- How long is the agreement meant to last? Can it be terminated?
- Will new entrants dilute the anticompetitive effects of the agreement?
- What is the business purpose of the agreement? Is the agreement necessary to achieve the purported procompetitive benefits?
- Is there any anticompetitive intent?
The analysis can be quite complex. For example, there may not be an obvious product (or even geographic) market or a discernible anticompetitive effect. For an accurate assessment of any particular restraint, the analysis is best undertaken by antitrust counsel, possibly with the help of an economist. In any event, the relevant questions should be analyzed at the front end so that risk can be mitigated to the extent possible.