Luxury goods manufacturers such as those producing fine china, designer clothes, perfumes and leather goods require special marketing conditions in order to preserve the brand image of their goods. Certain luxury goods, such as consumer electronics, may be technically difficult to operate and require specialist assistance and information at the point of sale. Luxury goods manufacturers often therefore enter into selective distribution agreements, using only distributors who satisfy prescribed selection criteria. The Internet has evolved into a major sales channel for many products, including certain luxury items.

Historically luxury brand owners have been hesitant to sell over the Internet, fearing that the medium did not emphasize the value of their product and that it would lead to loss of control over their distribution network. However, Internet distribution is becoming a commercial imperative for many luxury brand owners. Furthermore, distributors of luxury products increasingly demand the use of the Internet as a sales and marketing tool. The European Commission’s competition policy towards Internet sales in the context of selective distribution agreements appears to be ambivalent. In several cases the Commission has indicated that banning Internet sales of luxury products is illegal and unenforceable.

Selective Distribution

Distribution agreements are typically used as a low risk means of expanding business into new markets or territories. In its simplest form, a distribution agreement enables a supplier or manufacturer to sell products to a distributor, who sells on the goods to his customers at an increased margin. The supplier therefore does not have a contractual link with the end customer. Manufacturers can choose only to sell in a particular territory to one distributor (an exclusive agreement), to that one distributor as well as their own outlets (a sole agreement), to multiple distributors (a non-exclusive agreement) or to select distributors. Under a   selective distribution system the supplier limits the distribution of goods only to those wholesalers and/or retailers who satisfy selection criteria. Usually distributors must agree only to sell to end users or to other approved distributors. This way the supplier retains control over how his products reach consumers. Selective distribution is typically used for luxury products and/or products requiring an enhanced level of service or advice at the point of sale and where the supplier or manufacturer may be required to provide after-sales support.

Selective distribution agreements pose potential competition risks and may infringe the EU prohibition on anti-competitive agreements (contained in Article 81(1) of the EC Treaty[1]). The potential risks include a reduction in intra-brand competition and the facilitation of collusion between suppliers or buyers. However, under EC competition law most distribution agreements will fall outside the scope of Article 81(1) if they fall within the “safe harbour” created by the Vertical Agreements Block Exemption Regulation^[2] (VABER) or if the pro-competitive results of the agreement outweigh the anti-competitive effects. In order to benefit from the VABER, a supplier’s market share must be below 30% and the agreement must not contain any hard-core restrictions, such as  fixed or minimum sales prices, certain customer restrictions, restrictions on cross-supplies, non-compete clauses lasting more than five years or a ban on sales to end users. Where an agreement benefits from the VABER, the supplier can impose quantitative (for example, minimum turnover requirements) as well as qualitative selection criteria on its distributors, and the products in question do not have to be “luxury” or technically complex.

Suppliers with market power

If a supplier has a market share above 30%, the supplier has less leeway but its selective distribution agreements may still be lawful and enforceable provided, broadly, that any anti-competitive effects do not outweigh pro-competitive benefits. The Commission’s Guidelines on Vertical Restraints (2000/C 291/01) contain detailed guidance on which types of agreements are likely to be lawful and enforceable. In particular:

·                    the nature of the products must be such that selective distribution is necessary to ensure their proper distribution (based, for example, on their trademark or technical complexities)

·                    dealers must be selected on the basis of objective, qualitative criteria

·                    admission to the selective distribution system must be effected on a non-discriminatory basis

·                    restrictions imposed on distributors are proportional to the requirements of the product.

Products for which a selective distribution system has been held to be justified include high value cosmetics (such as those made by Givenchy or Yves Saint Laurent), pharmaceutical products and electrical goods such as Grundig’s television and audio equipment and Bowers & Wilkins’ speakers. Other companies with selective distribution networks include fine china manufacturers Villeroy Boch and Llandor and designer clothes maker Hermes. Examples of lawful qualitative selective distribution criteria include:

·                    selling goods in a specially fitted shop or in a self-contained specialist department as is appropriate  to the brand’s image

·                    providing a separate display in an attractive setting, situating goods away from those “inconsistent” with the brand image

·                    providing suitably trained staff.

The above criteria are considered necessary to provide a sales environment consistent with the luxury image of the brand. For brands that may be technically complex selection criteria may also include ensuring:

·                    the pre-sales training of staff on technical aspects of the range; and

·                    the availability of after-sales support.

Selective Distribution and the Internet

Despite the protection afforded to their products by selective distribution agreements, luxury goods manufacturers may still face challenges to ensure that their goods are marketed in such a way to preserve their brand image. Non-authorised dealers may obtain the goods illegally and sell them on at a significant discount. Although it is possible to track such goods via their serial number, this takes much effort. In addition, both non-authorised dealers selling the goods “on the cheap” and authorised dealers may discount the goods leading to brand erosion. The Internet increases the risk of both of these problems as well as introducing difficulties in providing required service levels (particularly for technically complex goods) and the right ambiance for the product’s brand image. Thus, although Internet marketing increases exposure and brand awareness, many luxury goods companies have tried for years to protect their goods from being sold over the Internet. However, with the popularity of the Internet and the consumer benefits it provides, the Commission strongly encourages and supports Internet sales. In the Guidelines it is stated (at para 51) that “every distributor must be free to use the Internet to advertise or to sell products”. It is therefore important to ensure that provisions governing Internet sales within selective distribution agreements are legal and enforceable. Indeed, luxury goods suppliers are encouraged to seek competition advice in connection with the drafting of such provisions.

Neither the Commission nor the UK competition authorities have stated a clear position on the extent to which Internet sales may be expressly banned in the context of selective distribution systems. Furthermore, there is no case law (at either the EU or UK level) which directly addresses how, if at all, Internet sales may be prevented. Therefore the current position must be derived from the Guidelines, and relevant Commission publications, including the press releases on Yves Saint Laurent Parfums (YSLP) and on Bowers & Wilkins Loudspeakers’ (B&W).

The Guidelines state (at para 51) that an outright ban on Internet selling is possible with an objective justification. However, the Guidelines do not specify what qualifies as an objective justification. It is submitted that such a justification may be acceptable where products are extremely technically complex and/or where consumers’ safety may be compromised unless the products are sold at authorised premises with trained staff. However, such justifications have not been legally tested in the EU or in the UK.

In May 2001, the year following the publication of the Guidelines, the Commission approved a selective distribution system for YSLP. In the related press release the Commission stated that a ban on Internet sales, even in a selective distribution system, was not covered by the VABER. The YSLP selective distribution system was approved on the basis that, among other things, retailers who were approved to sell its product via a physical sales outlet were also permitted to sell YSLP products via the Internet. This position was re-iterated in a speech given by Mario Monti, the then Competition Commissioner, in the same month.[3] Mr Monti stated that “…restrictions preventing distributors from using the Internet as a distribution mechanism fall foul of Article 81. If the producer wants to ensure a certain quality of website and service for Internet sales, then there are less restrictive means to achieve that end than by banning Internet sales by its distributors.” 

An Internet-friendly stance was also taken in the Commission decision regarding B&W’s selective distribution system. In the related press release the Commission stated that the distribution system fell within the scope of the VABER after several restrictions on competition, including a prohibition on distance selling via the Internet, were removed.  As a result approved retailers could request permission from B&W to carry out Internet selling. B&W could only refuse in writing, by indiscriminately applying criteria which were comparable to those for sales from a traditional sales outlet that were based on maintaining the product’s brand image.

Thus, there appears to be a discrepancy between the Guidelines and the Commission’s subsequent publications. The former states that an outright ban is possible. The Commissioner’s speech and the Commission press releases indicate that the Commission is not favourably inclined towards a ban on Internet sales. Instead, it appears that Internet sales may only be limited based on selective restrictions which are similar to those applied to physical sales. An idea of how this can work in practice is detailed below.

Criteria for Luxury Goods Internet Distributors

Many luxury goods producers, such as YSLP and B&W, are addressing the risks and opportunities arising from the Internet by allowing their approved retailers to sell their products online and by imposing similar restrictions on virtual sales to those imposed on physical sales. In this way they are legally retaining control over the marketing and selling of their products whilst benefiting from the advantages of selling on the Internet. Criteria for a selective distribution system which involves Internet sales and marketing may include the following:

·                    banning online sales without the supplier’s prior written consent (not to be unjustifiably withheld)

·                    ensuring that the site name is compatible with the luxury status of the brand

·                    ensuring that the layout and image of the Web site and positioning of the products are suitable to protect and promote the supplier’s brand image and reputation

·                    providing that the virtual point of sale situates goods away from those “inconsistent” with the brand image of the product

·                    ensuring that there are no links to other sites, save those of the producer or other approved distributors

·                    banning advertisements or banners on the Web site capable of damaging the producer’s reputation or image of its products on the distributor’s site

·                    updating the Web site regularly to reflect the reality of the distributor’s stock

·                    suitably training sales advisors to answer questions and be readily available, such as by an e-mail and/or customer service function.

Including the above criteria in a selective distribution system along with those normally found within traditional, physical selective distribution arrangements (such as a clause to only sell to end consumers or other authorised dealers) should ensure the provision of the correct online ambiance, brand protection, and (where appropriate) the availability of technical expertise.

Conclusion

Selective distribution agreements provide a means for manufacturers of luxury goods to maintain some control over how their products are sold and marketed as well as protecting the brand and consumers. Internet sales have been perceived as a threat to that control and as a result have been an issue for many luxury goods producers. However, although the Commission’s policy towards Internet sales in the context of selective distribution agreements appears ambivalent, more recent Commission pronouncements indicate that an outright ban on Internet sales is unlikely to be accepted under EU competition law. Luxury goods manufacturers can no longer block Internet sales without incurring the risk unenforceability of their ban and fines from competition authorities. Some luxury goods manufacturers are approaching Internet sales by providing e-selection criteria with similarities to traditional “physical” selection criteria, only tailored in parts specifically to the online medium. With the right selection criteria, luxury goods can be effectively marketed and sold online, with the appropriate safeguards (including for brand protection and maintaining appropriate levels of technical advice). Luxury goods suppliers can start to enjoy the benefits of the Internet as opposed to fearing its perceived threats.

Davina Garrod is a Partner in the EU/UK Competition Group at McDermott Will & Emery UK LLP: dgarrod. Alana Tervo is a Trainee Solicitor in that Group.