THE Competition Commission of Pakistan (CCP) recently fined two large manufacturers of electrical appliances for using retail price maintenance agreements (RPMs) to control the pricing of some of their products (especially split air-conditioners and refrigerators). The CCP also ordered the two companies “to cease and/or not repeat such conduct with immediate effect”.
The price fixing mechanism was detected in 2017 and the two companies were issued show-cause notices in 2019. The companies might yet contest the fines in higher courts, and the matter may not have reached a conclusion. The legal system works slowly.
RPMs are a form of anticompetitive business practice where, usually, an upstream player with more market power asks downstream players to maintain prices for downstream customers. In this case the two companies asked their distributors to not sell some of their products below set prices; not give customers discounts beyond a level; and not offer other gifts with the purchase.
RPMs are a way of reducing competition between distributors. If distributors cannot compete with each other on the margins they are making, their customers cannot bargain for better prices by pitching the distributors against one another. RPMs can also restrict competition between brands: they signal to the market that a competitor is not willing to sell below a certain price, which can allow manufacturers to set prices in coordination with each other. Clearly, RPMs are anticompetitive and they hurt consumer welfare.
Clearly, RPMs are anticompetitive and they hurt consumer welfare.
Here is an example of such a practice: imagine a store announcing that it will sell product X for Rs100. It offers a guarantee that if any customer can purchase X at another outlet for less than Rs100, the store will not only refund the difference to the customer, it will double the refund. If this sounds like a minimum price guarantee, it’s because it is one. The store is telling the customer it is offering the lowest possible price and, in the same message, also warning sellers of X that if they go below Rs100, there will be a price war. If the store offering this guarantee is a bigger player in the market, the threat will need to be taken seriously by the smaller players. It is a nice way of ensuring a price floor.
This is the reason almost all competition and fair practice laws across almost all jurisdictions see RPMs as restrictive. There is plenty of case law — again, from across the world — that makes this clear.
Why do competitors use them then? There are some cases in which products are complicated/sophisticated to the point where customers might need the assistance of specialised sales personnel to explain the working of the product before they can buy them. In such cases, since the manufacturer would want distributors to hire, train and deploy a sales force, which increases the costs for the distributor, RPMs can create a margin for the distributor to manage the higher cost they incur. RPMs also discourage individual distributors from ‘free riding’ on the specialised sales force employed by another distributor. Clearly, however, most consumer products like split air-conditioners and refrigerators are not the kind of machines that need elaborate guidance.
The CCP judgement acknowledges this possibility and also acknowledges that both the companies made this point, but then goes on to say — and rightly so — that this does not work as a defence in the case of air-conditioners and refrigerators.
RPMs can also help smaller distributors survive. This is a tougher argument to ignore. With RPMs, the smaller distributors are given equal footing when competing on prices against larger distributors, who get higher discounts from manufacturers. Under RPMs, the larger players cannot use those discounts to run the smaller distributors into the ground. If distribution networks in cities are very diverse in terms of size, removing RPMs might lead to some concentration of the network towards larger distributors, but this might not hurt the overall competition. However, not having smaller distributors in smaller cities can become an issue as it encourages oligopolies to emerge.
The CCP did not give much weight to the ‘diversity of distributor’ argument in its judgement. If the two companies go into appeal, the argument will definitely come up, and the court will have to decide if distributor diversity is important. If consumers can still get good prices and benefits of discounts even when the distributor network is more concentrated, why should this be a reason for allowing RPMs? The manufacturers will have to make a strong case.
The interesting question is: when there is so much evidence against RPMs, why were these companies still using them? The companies did make the argument that this is standard practice in the industry on consumer durables — but this can hardly be a legal defence. They also argued that RPMs are a demand of some distributors, but, again, that cannot be a legal defence. RPMs allow coordination in the inter-brand market (through the formation of an informal cartel) and this can be a serious issue. It can be a way of avoiding price wars with competitors, but, clearly, this is anti-consumer so it cannot be a valid argument. Maybe manufacturers also thought they would not get caught. The CCP has not been very active and/or effective in looking at competition and fair practice issues in general.
In Wealth of Nations, Adam Smith took a not-too-flattering view of businesses: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices…”. RPMs, in most cases, are just such a ‘conspiracy’ to raise prices and maintain them. Leaving aside the issue of distributor network diversity, the CCP has taken the right decision in this case. Hopefully, the appellate stages will not dilute the decision. However, it is not clear how the CCP came up with the fine amounts: these are fines, not estimates of what the RPMs might have cost the public. One hopes that in the future CCP can think about the loss to the consumer too when penalising corporations.
The writer is a senior research fellow at the Institute of Development and Economic Alternatives, and an associate professor of economics at Lums.
Published in Dawn, March 18th, 2022