June 30, 2020

European Distribution Strategy in the eCommerce Age – A Primer on Selective Distribution

European Distribution Strategy in the eCommerce Age

The explosive growth of eCommerce channels has required brands to completely rethink their go-to-market strategies. Across Europe, the commercial dynamics created by eCommerce, in particular the growth of open online marketplaces like Amazon, have rendered many decades-long business practices obsolete.

There are a number of concrete steps that brands may want to consider taking now to improve the legal and commercial robustness of their current European distribution arrangements in the face of these developments. One such step is a move from exclusive to selective distribution.

Traditionally, brands often relied on so-called “exclusive distribution” in Europe – an approach whereby a brand designates a single, exclusive distributor for a particular territory (often a country) or customer group and prohibits its exclusive distributors from “active” selling, e.g. via direct marketing, into other distributors’ exclusively allocated territories/customer groups.

Prior to the rise of eCommerce, exclusive distribution provided distributors with effective incentives to promote brands and create strong, committed distribution networks within their exclusive territories. Consumers tended to purchase from brick-and-mortar stores within their home country, with retailers’ assured purchases from their territory’s allocated distributor ensuring that the investment made by the exclusive distributor was protected.

However, as eCommerce has advanced across Europe, the way in which many consumers purchase their products has fundamentally changed. Rather than limiting their purchases to retailers within the territory or country in which they are based, consumers are able to use the internet to shop on a cross-border basis throughout Europe. As a result, it has become far easier for distributors and retailers to look beyond exclusive distribution territories and reach customers across Europe, simply by buying and selling online (often assisted by online marketplaces). While providing many benefits for customers, this development has made it a lot more difficult for brands to maintain the integrity of their distribution channels.

In order to understand the options available to brands for regaining control over their European channels, it is important to understand the legal framework. The EU’s Vertical Block Exemption Regulation, or ‘VBER’, provides a ‘safe harbour’ from EU competition law for common forms of distribution agreement, provided that specific conditions are met. In particular, the agreement must not contain any ‘hardcore’ restrictions of competition and the brand and each of its authorised distributors must have market shares of under 30% on the relevant market(s). If market shares are over 30% an individual assessment under EU competition law may be required.

As well as prohibiting any form of resale price maintenance, the VBER limits brands’ ability to limit the freedom of their distributors to choose their own customers freely, for example by reference to a potential customer’s location. Thus, the VBER defines any restriction on a distributor’s ability to respond to unsolicited sales inquiries (known as ‘passive sales’) from customers located anywhere in Europe as a hardcore restriction. Since selling from a website is treated as a form of passive sale for EU competition law purposes, this means that brands cannot simply prohibit their distributors from selling online. If an agreement contains such a limitation, it is no longer protected by the VBER safe harbour and is presumptively unlawful.

Once a distributor has sold a brand’s products, the lack of any contractual nexus means that the brand has almost no control over how those products are subsequently resold by the distributor’s downstream customers. Although the brand retains its trademark rights, once the distributor has sold the products with the brand’s consent anywhere within the European Economic Area (EEA), they are effectively in free circulation. As a result, any downstream customer can resell the brand’s products however it wishes, including on online marketplaces all over Europe, without any regard to quality control, brand image, support for marketing and promotions, or other efforts the brand expects from its authorised sellers. The end result is that resellers are able to free-ride on the efforts of the brand’s authorised sellers, eventually discouraging those authorised sellers from supporting the brand, thereby damaging the brand’s reputation – the exact problems that exclusive distribution was intended to avoid in the first place.

While exclusive distribution may still be appropriate for brands that want to focus on driving sales in particular territories, or who have particularly strong local relationships that they wish to cultivate, these developments mean it may no longer be the best strategy for brands looking to exert maximum control over how and by whom their products are sold, and thereby protect their brand equity and maximise overall commercial return.

Instead, brands are increasingly turning to selective distribution. In a selective distribution system, a brand effectively creates a closed network of authorised distributors, which have been selected by the brand on the basis of specified criteria, and undertakes to sell products only through that network. Authorised distributors are permitted to sell only to other authorised distributors within the selective distribution system, or to end users, i.e. consumers. Conversely, they must be free to sell – both actively and passively – to each other across the brand’s network.

Once implemented, selective distribution thus allows brands to refuse supply to unauthorised sellers, who remain outside the selective distribution system, and to take direct enforcement action against authorised sellers who sell to unauthorised resellers, in breach of their selective distribution agreement with the brand. In some countries, a brand may also be able to bring legal claims against unauthorised distributors that acquire products from network members (in breach of their selective distribution agreement), notwithstanding the lack of any contractual relationship. Moreover, selective distribution allows the brand to require all authorised distributors to take proactive steps to protect the integrity of the network, ensuring that all members remain incentivised to support action by the brand to prevent sales to - or by - unauthorised sellers.

For brands considering a transition from exclusive (or open) distribution to selective distribution in response to the novel challenges presented by today’s market, there are certain issues that require analysis and strategic planning. For more information about the selective distribution model and how to implement it, read our recently published white paper co-authored with Euclid Law, an award-winning boutique competition law firm with offices in London and Brussels: https://econtrol.vorys.com/european-distribution-strategy-whitepaper