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The maintenance of price floors is not the only means whereby no-frills retailers may be prevented from taking a free ride on the promotional efforts of their full-service rivals. A manufacturer may insulate its distribution network from the activities of free riders by selecting its members on the basis of qualitative criteria and by prohibiting any sales to unauthorised dealers, namely to wholesalers and retailers which fail to satisfy the necessary requirements as specified by the manufacturer and dictated by the nature of the contract goods. Being a unilateral act, a non-dominant manufacturer’s refusal to deal with a specific distributor – any distributor and for whatever reason – falls outside the ambit of Article 101 TFEU. The manufacturer, however, cannot effectively prevent unauthorised dealers from carrying its products unless it ensures that they will not have access to alternative sources of supply. The fundamental characteristic of selective distribution therefore consists in the manufacturer’s right to allow the resale of its products only to approved dealers and end users.

Article 101(1) TFEU is generally not applicable to purely qualitative selective distribution. In order for such a system to escape the prohibition of Article 101(1) three conditions must be met. First, selective distribution must be necessary in light of the nature of the products concerned, a requirement typically satisfied by distribution networks in ‘the sector covering the production of high quality and technically advanced consumer durables’.¹⁸⁰ Second, the selection of the authorised distributors must be based on a set of

179 Note that the Vertical Guidelines expressly state that agency agreements found to facilitate horizontal collusion will be caught by Article 101(1), even if the principal bears all the relevant financial and commercial risks. As examples of commercial agency which may potentially give rise to collusive outcomes, the Guidelines refer to situations in which ‘a number of principals use the same agents while collectively excluding others from using these agents, or when they use the agents to collude on marketing strategy or to exchange sensitive market information between the principals’; Vertical Guidelines, para 20.

180 Case 26/76, Metro SB-Großmärkte GmbH & Co KG v Commission (Metro I) [1977] ECR 1875, para 20.

175 objective criteria of a qualitative nature, which are applicable to all potential dealers in a non discriminatory way. And third, these criteria must be proportional and not go beyond what is necessary for the effective distribution of the contract goods.¹⁸¹ In addition to these three conditions outlined in the Vertical Guidelines, the European Courts further require that the result sought by the distribution system be capable of enhancing competition, thus counterbalancing the restriction of competition inherent in selective distribution.¹⁸² However, even where these requirements are not met, qualitative – as well as quantitative – selective distribution systems fall within the scope of the Vertical Block Exemption Regulation insofar as the individual market shares of both the supplier and the buyer do not exceed 30 percent of the relevant markets.¹⁸³

The early case law of the CJEU on selective distribution established that intrabrand price competition may be curtailed where demand for the goods in question is contingent upon the provision of product-specific services or the preservation of their high-quality image. Lying at the very heart of selective distribution, the free rider argument and its

‘quality certification’ variant have thus always been, whether explicitly or implicitly, integrated in the enforcement logic of Article 101 TFEU. In the landmark Metro case, the CJEU conceded that ‘although price competition is so important that it can never be eliminated it does not constitute the only effective form of competition or that to which absolute priority must in all circumstances be accorded’.¹⁸⁴ Accordingly, the Court noted that the relative structural price rigidity observed in selective distribution networks does not amount to a restriction of competition within the meaning of Article 101(1), provided that the operation of similar systems in a given industry is not widespread.¹⁸⁵ In AEG-Telefunken, the Court of Justice further refined the concept of selective distribution:

there are legitimate requirements, such as the maintenance of a specialist trade capable of providing specific services as regards high-quality and high-technology products, which may justify a reduction of price competition in favour of competition relating to factors other than price. Systems of selective distribution, in so far as they aim at the attainment of a legitimate goal capable of improving

181 Vertical Guidelines, para 175.

182 See Case T-19/92, Groupement d’achat Edouard Leclerc v Commission [1996] ECR II-1851, para 112.

183 Vertical Guidelines, para 176.

184 Case 26/76, Metro I [1977] ECR 1875, para 21.

185 Ibid, para 22.

176 competition in relation to factors other than price, therefore constitute an element of competition which is in conformity with Article [101](1).¹⁸⁶

In light of this assumption, a manufacturer who has set up a selective distribution network does not need to prohibit discounted retail sales of its products. In fact, the manufacturer has selected its distributors on the basis of their ability to provide the necessary product-specific services, and upon the understanding that they will not engage in aggressive price competition with each other. As a substitute for unlawful RPM, the very nature of selective distribution guarantees that the goods concerned will be carried by full-service, full-price outlets. If a retailer operating within the framework of such a network starts undercutting systematically its rivals in order to expand its market share, the manufacturer may assume that the maverick retailer has been taking a free ride on the other members’ promotional efforts. Alternatively, it could be the case that it has adopted a different marketing strategy, having been transformed into a no-frills outlet whose reputation is not compatible with the offered goods. In any event, EU competition law recognises the manufacturer’s right to punish any deviation from the system’s operational framework by terminating the price-cutting retailer and excluding it from the network. Its authorisation to carry the contract goods having been withdrawn, the latter will consequently be unable to obtain supplies either from the manufacturer or from the remaining members of the network. Absent any additional clauses that raise antitrust concerns, courts and competition authorities would be expected to uphold the termination.

Put differently, there can be no misunderstanding that the price rigidity derives from the very purpose and nature of selective distribution, which is designed to restrict the availability of a given manufacturer’s products through a limited number of non-differentiated retail outlets¹⁸⁷ characterised by similar cost structures. Thus, in citing the pro-competitive effects of vertical restraints, the Vertical Guidelines acknowledge that selective distribution may provide a solution to the archetypical free rider problem,¹⁸⁸ as well as prevent no-frills retailers from taking advantage of the quality certification associated with the endorsement of the product by reputable outlets.¹⁸⁹ The Guidelines

186 Case 107/82, Allgemeine Elektrizitäts-Gesellschaft AEG-Telefunken AG v Commission [1983] ECR 3151, para 33, recently reiterated in Case C-439/09, Pierre Fabre Dermo-Cosmétique SAS v Président de l’Autorité de la concurrence [2011] ECR I-9419, para 40.

187 The idea that even a strictly qualitative selective distribution network is intrinsically limited in scope is based on the obvious assumption that ‘[t]o be meaningful, qualitative criteria must have a quantitative effect’; JS Chard, ‘The Economics of the Application of Article 85 to Selective Distribution Systems’ [1982]

7 EL Rev 83, 97.

188 Vertical Guidelines, paras 107(a) and 185.

189 Ibid, para 107(c).

177 further accept that selective distribution may be designed to remedy any positive or negative vertical externalities¹⁹⁰ or to facilitate the attainment of economies of scale in distribution.¹⁹¹ Finally, this form of restricted dealing may contribute to the uniformity and quality standardisation of the distribution network.¹⁹²

In light of the free rider rationale, therefore, vertical price fixing and selective distribution may be employed as alternative commercial methods in pursuit of the same objective, namely to ensure the provision of the necessary demand-stimulating services.¹⁹³ In AEG-Telefunken v Commission, the CJEU rejected AEG’s assertion that the protection of its selective distributors’ profit margin by means of RPM was indispensible for the viability of the specialist trade. The Court held instead that, by excluding from its distribution network all dealers who could not supply the requisite product-specific services to consumers, the manufacturer ‘had at its disposal all the means necessary to enable it to ensure the effective application of the system’.¹⁹⁴ However, although ostensibly constituting interchangeable remedies to the free rider problem, RPM and selective distribution are nonetheless only imperfect substitutes. A manufacturer relying on qualitative selective distribution is likely to encounter two noteworthy problems that may undermine the system’s successful operation.

First of all, no-frills retailers may still have the possibility to purchase the contract goods from members of the distribution network. While the manufacturer has the ability contractually to prevent the latter from selling the products concerned to unauthorised outlets, ensuring the admitted dealers’ compliance with the agreed upon restriction is an entirely different issue. As the likelihood of sales to non-eligible dealers threatens selectivity with erosion and re-affirms the prospect of free riding, the manufacturer will have to incur the additional cost of policing the distribution network, which equals the cost of detecting and preventing any deviations.¹⁹⁵ Under these circumstances, the manufacturer may decide that its interests are better served by RPM. Given that the detection of systematic price-cutting is likely to be less burdensome than the active supervision of the approved dealers’ conduct in the marketplace, the manufacturer may be inclined to adopt a

190 Ibid, para 107(f).

191 Ibid, para 107(g). Subsequently, however, the Commission asserts that ‘such an efficiency is usually only marginal in selective distribution systems’; ibid, para 185.

192 Ibid, para 107(i).

193 That selective distribution and RPM constitute interchangeable solutions to the free rider problem has also been acknowledged by Telser; see LG Telser, supra n 129, 94 (‘The manufacturer has still another alternative to resale price maintenance. He may refuse to sell his product to any retailer who does not provide the requisite special services’).

194 Case 107/82, AEG-Telefunken [1983] ECR 3151, para 43.

195 LG Telser, supra n 129, 94 at fn.7.