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South Africa: Competition Tribunal |
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THE COMPETITION TRIBUNAL
REPUBLIC OF SOUTH AFRICA
CASE NO: 68/IR/JUN 00
In the matter between:
National Association of Pharmaceutical Wholesalers 1st Applicant
Natal Wholesale Chemists (Proprietary) Limited
t/a Alpha Pharm Durban 2nd Applicant
Midlands Wholesale Chemists (Proprietary) Limited
t/a Alpha Pharm Pietermaritzburg 3rd Applicant
East Cape Pharmaceuticals Limited
t/a Alpha Pharm Eastern Cape 4th Applicant
Free State Buying Association Limited 5th Applicant
Pharmed Pharmaceuticals Limited 6th Applicant
L'Etangs Wholesale Chemist CC t/a L'Etangs 7th Applicant
Resepkor (Proprietary) Limited t/a Reskor 8th Applicant
Pharmaceutical Wholesalers Mainstreet 2 (Proprietary)
Limited t/a New United Pharmaceutical Distributors 9th Applicant
AND
Glaxo Wellcome (Proprietary) Limited 1st Respondent
Pfizer Laboratories (Proprietary) Limited 2nd Respondent
Pharmacare Limited 3rd Respondent
Smithkline Beecham Pharmaceuticals (Proprietary)
Limited 4th Respondent
Warner Lambert SA (Proprietary) Limited 5th Respondent
Synergistic Alliance Investments (Proprietary) Limited 6th Respondent
Druggists Distributors (Proprietary) Limited 7th Respondent
DECISION AND ORDER
INTRODUCTION
1. This is an application for interim relief by nine full-line wholesale distributors of pharmaceutical products. Five of the respondents are pharmaceutical manufacturers and importers (“the manufacturers”) who have established a joint exclusive distribution agency (“EDA”) for their products. The first, second, fourth and fifth respondents are multinational producers of ethical or patented pharmaceutical products. The third respondent, Pharmacare, is the largest South African producer of generic pharmaceutical products. The sixth respondent is a company formed by the manufacturers to establish the distribution agency; the distribution agency is the seventh respondent. This is in fact a re-hearing of an earlier interim relief application decided in 2000 which was sent back to the Tribunal by the Competition Appeal Court (“CAC”) on review1.
2. During the course of these proceedings, certain of the pharmaceutical companies have merged. Specifically, the 1st and 4th respondents merged to form GlaxoSmithKline (“GSK”) and the 2nd and 5th respondents merged to form the Pfizer Pharmaceutical Group (“Pfizer”). There are therefore now three manufacturers party to this application, GSK, Pfizer and Aspen Pharmacare (“Pharmacare”).
The ninth complainant, New United Pharmaceutical Distributors (“NUPD”), has recently been acquired by Clicks Pharmaceutical Wholesalers (“CPW”). An application was made to substitute NUPD with CPW at the commencement of the hearing. This application was unopposed and is accordingly granted.
FINDING
The application for interim relief is dismissed. The reasons for this decision follow.
APPLICATION TO RE-OPEN HEARINGS
5. This matter was heard on the 18-20 March 2003. Judgment was reserved.
6. On the 30 April 2003 the applicants filed an application to re-open the
hearings. This application was brought in response to the promulgation on the 28 March 2003 of Proclamation Numbers R23 and R24 in Government Gazette No. 24627 that determined the dates on which various amendments to the Medicines and Related Substances Act 101 of 1965 would come into force.
7. This application is dismissed. Reasons are provided below.
BACKGROUND
8. In South Africa the pharmaceutical wholesalers have traditionally effected the distribution of pharmaceutical products from the manufacturers to the retail pharmacies. That is to say, specialist pharmaceutical wholesalers purchased pharmaceutical products from the manufacturers and then on-sold these to retail pharmacies and other small purchasers. Although there was some slight variance in the discount extended by the manufacturers to the wholesalers, it is common cause that the standard rate of discount was 17,5% off the manufacturers’ list price. The wholesalers retained a portion of this discount, the difference between their purchasing price and their selling price constituting their trading margin. While there again appears to have been some variance in the size of this trading margin, the standard range appears to have been approximately 5%-7%. Note that the full-line wholesalers traded in all products traditionally available from retail pharmacists – hence the appellation ‘full-line’ - including ethical pharmaceutical products, over-the-counter pharmaceutical products and a range of fast moving consumer goods. Strictly speaking then the pharmaceutical wholesalers specialized in the wholesaling of the full range of products traditionally stocked by retail pharmacies, including, but not limited to, ethical pharmaceutical products.
9. In 1997 the manufacturers in this matter came together under the code name “Project Nasa” with the intention of establishing a joint EDA for their products. This followed on the heels of the formation by several other pharmaceutical majors of International Healthcare Distributors (IHD), an exclusive distribution agency for the products of its shareholders. In 1998 the members of Project NASA established a company called Synergistic Alliance Investment (“SAI”).
10. In February 1999, the erstwhile Competition Board (‘the Board’) announced that, pursuant to the complaint submitted by the wholesalers against IHD as well as an application for exemption by the respondents in this matter, it would conduct a formal investigation into EDAs in the pharmaceutical industry. It appears that the respondents – then the members of Project NASA – were concerned that their intention to impose standard credit and certain other trading terms on their customers through the medium of their planned joint distribution arrangement would fall foul of the prohibition on collusive horizontal agreements and so sought exemption for this aspect of their intended arrangement from the Board.
11. The Board released its findings in May 1999 (“Report 75”). It found that a joint exclusive distribution agency for pharmaceutical products would constitute a horizontal restrictive practice prohibited by the Maintenance and Promotion of Competition Act (‘the old Act’). The Board found that the formation of a joint EDA in this market would contravene the old Act.
12. The Board accordingly recommended that the identified restrictive practice be cured by way of a section 11 arrangement between itself and the manufacturers. Failing a section 11 arrangement, the Board recommended that the Minister of Trade and Industry, acting in terms of section 14(1) of the old Act, should declare the conduct of the manufacturers unlawful. In addition the Board recommended that the Minister request the Competition Commission to investigate the alleged horizontal restrictive practice between the manufacturers. The Minister decided not to implement the recommendation of the Board to declare exclusive distribution agencies in the pharmaceutical industry unlawful. He felt that the matter would be more effectively dealt with in terms of the then pending new Competition Act.
13. In March 2000, SAI announced that it would proceed to acquire Druggist Distributors (“DD”), one of the wholesale distributors, in order to convert DD into an EDA, or, into what it terms, an ‘integrated logistics service provider’ for SAI members. This took effect on 29 May 2000. Accordingly, with the conversion, DD – which was renamed Kinesis Logistics (Pty) Ltd (“Kinesis”) as at the conversion date - went from being a wholesaler, owning its stock and trading on its own account, to an agency distributor which distributed its principals’ stock at an agreed fee. Note that, at the time, DD and the ninth complainant in this matter, United Pharmaceutical Distributors (UPD), were the only national full-line wholesalers in existence.
14. The terms of the EDA provided that the shareholders of SAI would henceforth distribute all of their products through DD alone. This applied to all of their customers including retail pharmacists, dispensing doctors, hospital groups and the State. Note that the wholesalers had never been active in distributing pharmaceutical products to the large hospital groups and the State – these were serviced directly by the manufacturers. After DD’s conversion from a wholesaler into a distribution agent, Kinesis, ownership of the products sold through Kinesis remained with the manufacturer until the sale to the customer. This, we emphasise, contrasts with the wholesale mode of distribution where the wholesaler, a trader, takes ownership of the product from the manufacturer. The wholesaler then on-sells these products to the retailer, in this way effecting the distribution of pharmaceutical products. In addition to the task of physical distribution, Kinesis performs a range of other distribution related services including the taking of orders and collection of payment on behalf of the manufacturers. Kinesis undertakes these services on behalf of each principal in exchange for a fee agreed between each principal and the distribution agent.
15. In May 2001 SAI was sold to Tibbett and Britten (“T&B”), a UK logistics services provider. Kinesis is a wholly owned subsidiary of SAI. The manufacturers maintain that their relationships with their distribution agent are now governed by separate service level agreements concluded between the respective principals and T&B/Kinesis.
16. The interim relief application before us originates in the decision of the manufacturers in this matter to establish and utilize an exclusive distributor. On 7 June 2000 the applicants lodged their complaint with the Commission in terms of the then section 44 of the Act. They simultaneously filed an application for interim relief with the Tribunal on 8 June 2000. This application was made in terms of Section 59 of the Act, the then applicable section prior to the subsequent amendment to the Act.2
17. This interim relief matter was initially heard by the Tribunal in July 2000. On 28 August 2000, the panel decided to award interim relief to the pharmaceutical wholesalers against the manufacturers in terms of section 4(1)(a). The Tribunal ordered as follow:
“The applicants’ application for interim relief in terms of Section 59 of the Competition Act, 89 of 1998 is granted in respect of the respondents’ alleged contravention of Section 4(1)(a) of the said Act.
That the respondents supply their products directly to the complainant and other wholesalers on terms and conditions similar to those that applied to transactions between them and the complainant and other wholesalers immediately before the conversion of DD to a joint exclusive distribution agency for their products.
That this order remains in force until the earlier of -
the conclusion of the hearing into the prohibited practices alleged by the applicants to have been committed by the respondents; or
the date that is six months after the date of the issue of this order;
The respondents are ordered to pay the applicants’ costs in the application on the scale as between party and party, including the costs of two counsel and one attorney. “
18. The respondents took this decision of the Tribunal on review to the CAC.3 On 5 September 2001 the CAC ordered that the Tribunal’s decision and order be set aside and that the matter be remitted to the Tribunal for further hearing. On behalf of the court Selikowitz AJA (as he then was) found that the order was vague and embarrassing; that the manufacturers did not receive a fair hearing in respect of the relief that was ultimately granted; and that the order was overbroad.
19. The intention was therefore to “put the hearing back to the stage which had been reached before the decision was made”. Judge Selikowitz stated that, in setting aside the decision and order in this matter, the proceedings as a whole were not invalidated. In his judgment, the learned Judge noted that:
“The Tribunal may… have to reconsider the matter and re-examine its factual findings in the light of further evidence and the important developments that have come about since the order was made….In addition the Tribunal may have to reapply its mind to the evidence and decide whether or not the Applicants have established a prohibited practice in terms of sections 5,8 or 9-matters which have been raised or debated but which in the light of its finding of a prohibited practice in terms of section 4 have not yet been regarded as requiring a determination by the Tribunal” 4
20. Note that the sale of SAI and its subsidiary, Kinesis, to Tibbet and Britten had taken place in the period between the Tribunal’s decision and the hearing of the review. On the face of it this development may impact on the Tribunal’s finding under Section 4(1)(a) and undoubtedly accounts for Judge Selikowitz’s reference to ‘important developments that have come about since the order was made’. The learned Judge directed the Tribunal to decide upon further procedural steps in the setting down of the re-hearing.
21. At a pre-hearing held on 22 October 2001 it was agreed that supplementary papers be filed to update the matter before the Tribunal.
22. Lengthy supplementary filings ensued over a period of several months. The full record comprises the original interim relief application in 2000 (the “A” files) and the current supplementary papers (the “B” files), totaling more than 8000 pages. The supplementary papers filed comprise supplementary founding papers, answering papers and replying papers. The parties were also given leave to file further documentation in the form of a rejoinder and surrejoinder.
23. At a further pre-hearing held on 29 October 2002, it was agreed that the Chairman convene a new panel to hear the matters since the original panel members were no longer available.
APPLICABLE LEGISLATION
24. The complaint in terms of which this application for interim relief is sought was filed with the Commission in June 2000. The Act was amended in February 2001. The amendments to the Act have implications in the area of interim relief. Which version of the Act is then applicable to the current proceedings?
25. Prior to the amendment of the Act, Section 59 provided:
At any time, whether or not a hearing has commenced into an alleged prohibited practice, a person referred to in section 44 may apply to the Competition Tribunal for an interim order in respect of that alleged practice, and the Tribunal may grant such an order if –
there is evidence that a prohibited practice has occurred;
an interim order is reasonably necessary to –
prevent serious, irreparable damage to that person; or
ii. to prevent the purposes of this Act being frustrated;
the respondent has been given a reasonable opportunity to be heard, having regard to the urgency of the proceedings; and
the balance of convenience favours the granting of the order.
26. Section 49C of the amended Act provides:
1. “At any time, whether or not a hearing has commenced into an alleged prohibited practice, the complainant may apply to the Competition Tribunal for an interim order in respect of that alleged practice.
2. The Competition Tribunal–
a. must give the respondent a reasonable opportunity to be heard, having regard to the urgency of the proceedings; and
b. may grant an interim order if it is reasonable and just to do so, having regard to the following factors:
the evidence relating to the alleged prohibited practice;
the need to prevent serious or irreparable damage to the complainant; and
the balance of convenience.
3. In any proceedings in terms of this section, the standard of proof is the same as the standard of proof in a High Court on a common law application for an interim interdict…”
27. In particular then the amendments altered the standard of proof applicable in interim relief proceedings. Prior to the amendment the standard of proof was on a balance of probabilities. The amendment lowered the applicable standard of proof to the same as that on a common law application for an interim interdict. This latter has been authoritatively laid down as ‘prima facie established though open to some doubt’.5 In addition the factors that need to be established in order to sustain a claim for interim relief were amended.
28. Note also that the amended Act requires that we ‘have regard’ to three factors, namely, evidence relating to the alleged prohibited practice, the need to prevent serious or irreparable damage and the balance of convenience. In other words, we are required to balance these factors – for example, if we decided that the applicant was unlikely to succeed at the final hearing (that is, if evidence of a restrictive practice was found wanting) we may still grant interim relief if we felt the damage to be significant and the balance of convenience to rest firmly with a finding in favour of the applicant. By the same token, a strong likelihood of success may counterbalance unconvincing evidence of significant harm. While this balancing will be borne in mind, we have held elsewhere that we would be extremely reluctant to grant interim relief in the face of unconvincing evidence of a restrictive practice.6 Harm to a market participant may be inflicted perfectly legitimately in the process of competition – hence, in our view, in an anti-trust case such as this a showing of harm, even considerable harm, is, on its own, not sufficient, because to respond only to evidence of harm may significantly chill the competitive process. In any event, as will be elaborated below, we have found that the applicant has neither established evidence of a restrictive practice nor of significant harm.
29. We do not consider it necessary to make a finding on the applicable Act. It is our view that on both the pre-amendment and post-amendment versions of the Act, the applicants fail to sustain their claim. We will however proceed on the assumption that the applicants’ contention, namely that the amended Act applies, is correct.
THE ALLEGED CONTRAVENTIONS AND THE RELIEF SOUGHT
30. The applicants have alleged contraventions of Sections 4 (‘horizontal restrictive practices’), 5 (‘vertical restrictive practices’), 8 (‘abuse of dominance’) and 9 (‘price discrimination’) of the Act.
31. In its original Notice of Motion, filed on 8 June 2000, the applicants sought the following relief:
“1 The Applicants are hereby granted leave to bring this application as a matter of urgency and to argue this matter on the same papers as were filed by the parties in Case Number 53/IR/Apr00, which Application has been withdrawn.
2 The non-compliance with the time periods be and is hereby condoned.
3 The Respondents are hereby interdicted and restrained from converting the Seventh Respondent from a full-line wholesaler to an agency distributor.
4 The Respondents are ordered to terminate with immediate effect the exclusive agency distribution agreement between the Seventh Respondent and the First to Fifth Respondents.
5 The Respondents are hereby interdicted and restrained from inducing and/or allowing any other pharmaceutical manufacturer/importer to become a user or participant in the exclusive agency distribution arrangement that Seventh Respondent has with the First to Fifth Respondents.
The Respondents are hereby interdicted and restrained from forming any new agency distribution firm to distribute their products on an exclusive and/or discriminatory basis.
The Respondents are hereby interdicted and restrained from acquiring an interest in an existing agency distribution firm, whether it is solely or jointly owned, or contracting with such firm or any of its parent firms, for the purposes of distributing their products on an exclusive and/or discriminatory basis.
The Respondents are ordered to continue supplying their products to the Applicants on terms and conditions identical to those given by Respondents to DD.
The Seventh Respondent is hereby ordered to remain an independent wholesaler in the market that neither accepts from, nor grants to, the First to Fifth Respondents any commercial advantages that it does not accept from, nor grant to, other pharmaceutical manufacturers in equivalent transactions.
10 The Respondents are hereby ordered:
10.1 to advise all pharmacies, doctors or other purchasers that have been informed that it is to commence business on 29 May 2000 as an agency distributor that this will no longer be the position; and
not to make any further representations to pharmacists, doctors or other purchasers of pharmaceutical products that DD will act as agency distributor on behalf of the First to Fifth Respondents…“
As already noted, the CAC reviewed the decision of the previous Tribunal panel in this matter because it found the relief granted to be vague and embarrassing and overbroad. The court also found that the relief actually granted departed to such an extent from the relief claimed that the requirement of fairness dictated that the respondents be given a prior opportunity to be heard in relation to the relief actually granted.
33. Under these circumstances one may have been entitled to expect the applicants’ supplementary papers to evidence particularly close attention to the framing of the relief claimed. Indeed if this were not sufficient reason to focus on the question of relief, then the ‘further evidence and the important developments’ that had occurred since the initial finding and specifically alluded to by the Court should have alerted the applicants to the necessity to consider carefully the framing of the relief claimed.
34. However, far from producing greater clarity on the question of the appropriate relief, all that has ensued since the remittal by the CAC is characterized by the most unseemly confusion and vacillation, responsibility for which is to be laid firmly at the feet of the applicants. In the applicants’ supplementary papers submitted for this hearing, in each of the two versions of their heads of argument and in their oral argument we have been presented with a range of alternative options for relief – hence, we have been told that the relief specified in the original notice of motion applies;7 we have also been told that, despite the CAC’s strictures to the contrary, the claim for ‘further and/or alternative relief’ is a catch-all that effectively permits the Tribunal to grant whatever relief it deems appropriate as long as it affords the respondents the opportunity to be heard on the precise formulation;8 alternatively we have been presented with a bald claim for a restoration of the status quo ante and with an equally bald denial that a restoration of the status quo ante is sought;9 at the beginning of the hearing, in response to a request by the panel to identify the relief sought, we were presented by the applicants’ counsel with a precise formulation that purported to address the CAC finding that the relief was vague and embarrassing and overbroad and that, we understood, attempted to specify appropriate ‘further and/or alternative relief’ and that effectively replaced the relief claimed in the original notice of motion;10 and then finally, after a three day hearing, we were presented in the applicants’ oral reply with a formal application to amend the notice of motion to include, along with the original notice of motion, the formulation presented at the beginning of the hearing!11
35. We will return to this later, if only because the applicants’ treatment of the question of relief is sufficient ground for dismissal of their claim. Indeed, it verges on an abuse of the adjudicative process. For the present, it suffices to note that we are unable to identify precisely the relief sought by the complainant. We then proceed to examine whether sufficient evidence has been adduced to sustain the allegation that a range of restrictive practices have been perpetrated without clear knowledge of the remedial action that we would order should any of these allegations be sustained. One unsatisfactory consequence of the applicants’ failure to specify the relief that they seek is that it has left them at liberty to traverse the Act in search of a sustainable allegation, unconstrained by the usual requirement to specify what should be done in the event of such an allegation being sustained. While, as already noted and will be further elaborated, there is no doubt in our mind that this alone would constitute ground for dismissal, we nevertheless believe that after some three years of hearing an application for interim relief we have a public duty to examine the merits of this matter and it is to this task that we now turn albeit unguided by the light that clearly framed relief usually places at the end of that tunnel.
WHOLESALERS, DISTRIBUTORS AND THE CHAIN OF DISTRIBUTION
36. Before turning to the alleged restrictive practices, it is necessary to clarify pertinent aspects of the chain of pharmaceutical production and distribution.
37. In the pharmaceutical industry – as with many consumer goods – there are a relatively small number of manufacturers whose products are purchased by the final consumer through a relatively large number of retail outlets. In the case of ‘ethical’ or patented pharmaceutical products these retail outlets are a myriad of pharmacists, colloquially referred to in South Africa as ‘chemists’. The manufacturer is thus confronted with the formidable task of ensuring that its product is available in the required quantity and form at the ultimate point of sale. In a word, the manufacturer is confronted with the task of distributing its product to the retailers.
38. There are a number of alternative mechanisms for effecting distribution. The manufacturer may simply be approached by the ultimate interface with the final end consumer, that is, the retailer, take orders for the product and arrange for its transportation to these points of retail distribution. Indeed, in the case of very large retailers of pharmaceutical products – these being the large hospital groups, most particularly, although not exclusively, the state hospital services – this is precisely how distribution is effected to this day. In other words, there is, in this important latter segment of the pharmaceutical manufacturing and distribution chain, a direct interface between the manufacturer, on the one hand, and, on the other, the vehicle through which the final end consumer acquires pharmaceutical products. There has been no need, presumably either on the part of the seller or the buyer, for an intermediary between these two ends of the chain and so the wholesale trade, precisely the intermediary between manufacturer and retailer, has largely been absent from this segment.
39. However, there are a large number of consumers of pharmaceutical products who do not procure their medicines by attending a hospital. Instead, they approach, in a manner not fundamentally different to a purchaser of, for example, clothing or grocery products, a high street retailer in order to satisfy their needs. However, unlike in the case of grocery or mass clothing products, and this largely because of regulatory intervention, the retail pharmaceutical sector is not, at this stage, dominated by increasingly large outlets that, like, for example, Pick ‘n Pay or Edgars, are household names in the area of grocery or clothing retail. Note that the rise of the large retail grocery supermarket chains has all but eliminated the grocery wholesale trade. The retail pharmaceutical sector, on the other hand, is still characterized by a large number of small retailers and so the wholesalers have maintained a considerable presence in this segment of pharmaceutical distribution.
40. For a manufacturer, per definition skilled in and focused upon the innovation and production process, interfacing with a large number of retailer customers is highly undesirable. It is indeed, albeit for different reasons, no less taxing for a large number of retailers to deal with a small number of producers, particularly in an industry whose peculiar features demand that the retailer stock the product of all or most manufacturers. In a word, the high costs associated with transacting between a small number of manufacturers, on the one hand, and, on the other hand, a large number of retailers – costs borne in various ways by both parties to the transaction - have created an opportunity for a set of traders, the wholesalers, to simultaneously meet the requirements of both the manufacturers and retailers. Naturally, as in any trade, the rise of these intermediaries is accompanied by rules, associations, legislation, venerable firms and the like, by, in other words, a sense of permanence. However, it is essential to understand that the rise of this intermediary trading function, however ordered and permanent it may subsequently appear to be, was essentially a spontaneous, admirably opportunistic response to a particular set of market conditions, a response to the high transaction costs incurred in the process of direct trade between manufacturer and retailer. In other words, a changed set of market conditions may call forth a different response from the key participants.
41. The wholesaling function is, of course, by no means costless. It requires considerable investment and the investors naturally seek a reward – their decision to direct their resources to pharmaceutical wholesaling is not, after all, driven by charitable considerations. It is driven by commercial considerations, by the reward that the entrepreneurs and investors expect to receive in exchange for meeting a demand generated by market conditions. But they are traders – they seek their reward neither from those from whom they purchase product nor from those to whom they sell product. They garner their reward by buying cheap and selling dear. If market conditions change so as to cause a deterioration in the wholesalers’ terms of trade then they will either re-position themselves, usually by identifying value-added services that they introduce into the market thus allowing them to maintain or increase their overall trading margins, or they will face the risk of decline and, ultimately, outright elimination from the market.
42. It is clear that the writing has long been on the wall both in this particular sector of the economy and in the business of distribution more generally. In the pharmaceutical sector it is common cause that there is a hitherto unprecedented effort by the purchasers of pharmaceutical products and by those who finance the purchase of these products to secure a decrease in their prices. The buyers have, in short, sought to counter-balance the power of pharmaceutical manufacturers. For instance, the formation of large pharmacy chains such as Pharmacare, Hyperpharm, Dischem and Galleria are, in large part, inspired by an effort to constrain the prices of pharmaceutical products. In addition, increased monitoring of prices by managed health care organizations and medical aids as well as efforts through the formulary system, are all driven by the desire to constrain the pricing of pharmaceutical products.12 But this has also meant the entry of the large buyer into an area traditionally characterized by small retail pharmacies. These large purchasers are, like the state, perfectly capable of interfacing directly with the manufacturer. They do not, in other words, require the intermediation of the wholesaler.
43. This pressure to constrain their pricing behaviour has also caused the pharmaceutical manufacturers to focus on costs incurred in the chain of manufacturing and distribution and this, too, explains their increased attention to the mode of distributing their products. In other words, there is no doubt that the manufacturers, pressured to constrain their own pricing, will look to decrease costs and to appropriate pockets of profit in the value chain. They have clearly decided that there are costs that can be squeezed out of the distribution chain and/or that there are profits to be appropriated in undertaking this function differently to the traditional wholesaler model. There is, however, nothing necessarily sinister about this albeit that it may reverberate to the detriment of established pharmaceutical wholesalers – it is simply part of the competitive process, a process that we are charged with promoting rather than reifying.
44. This may all seem rather obvious. However we have found it necessary to elaborate these seemingly self-evident truths because, whether blinded by self-interest or hubris, they are not sufficiently appreciated by the applicants in this matter. They appear to have forgotten that great markets – and with them great products and services – have disappeared before and will do so again. Great companies have frequently been victims of this, the competitive process. Still greater companies, spurred by the competitive process, have repositioned themselves – they have found new value-adding services to offer their customers, they have developed new products, and, at times, they have entered new markets. However, the matter before us represents an effort by a group of companies which, when confronted by market dynamics, turn to regulation, rather than innovation, to rescue them.13 They insist in effect, that their service must remain viable for no greater reason than the time it has served as the industry’s standard mode of effecting distribution. They insist that we order the manufacturers to maintain a discount to the wholesalers for the sole purpose of allowing the wholesalers to continue buying cheap. However, we have no greater warrant for this sort of intervention than we would have for an order imposing a higher price on the wholesaler’s customers, the retailers, an intervention which would allow the wholesalers to sell ‘dearer’.
ASSESSMENT OF ALLEGED RESTRICTIVE PRACTICES
The Relevant Markets
45. The applicants insist that it is necessary to identify the markets relevant to the transaction. It is noted that both Section 4(1)(a) and 5 require a showing of a substantial preventing or lessening of competition ‘in a market’. While we have previously taken the view that Section 4 and 5 claims do not require a prior identification of the relevant market – that is, the relevant market can be read back, as it were, from evidence of the anti-competitive practice, thus side-stepping the formalism inherent in efforts at a prior identification of the market14 – Section 7 specifies that dominance is established with respect to market share. Establishing dominance is, in turn, a threshold condition for establishing a Section 8 ‘abuse of dominance’. A prior identification of the market is thus necessary in order to evaluate the allegations of abuse of dominance.
46. The applicants have referred, in the course of their written and oral submissions, to a wide range of markets. The respondents note that there are references to15:
“154.1 product markets based on therapeutic categories
154.2 a wholesale distribution market
154.3 a market for the wholesale distribution of pharmaceutical products
154.4 a market for agency distribution services
154.5 an oligopolistic market”
47. There are, in our view, two relevant markets implicated in this matter. The first is, strictly speaking, not a single market but a set of distinct markets. Given that a pharmaceutical product intended for one therapeutic use cannot be substituted by a product intended for another therapeutic use, anti-trust investigations of the pharmaceutical industry tend to use the ATC3 categories as the bases for identifying the relevant pharmaceutical product markets. While we are alert to the possibility that an uncritical adoption of the ATC3 categories may occasionally produce somewhat distorted outcomes from an anti-trust perspective, for the purposes of interim relief the therapeutic categories are an acceptable proxy for identifying relevant markets.16 However an important point to underline is that there can be no aggregation of pharmaceutical products into a single pharmaceutical product market.
48. The second market at issue is, it is argued, the market for the distribution of pharmaceutical products. This is the market in which Kinesis is said to compete with the applicants.17 However a number of caveats are in order:
49. Firstly, the applicants, by their own admission, do not compete for the full range of logistical services offered by Kinesis. For example, the applicants do not offer what they themselves refer to as ‘pre-wholesaling’ services.18 They only wish to provide what they at times identify as a ‘wholesaling’ or, at other times, refer to as a ‘fine distribution’ service. However, there is no apparent basis for their insistence that a particular set of distribution related functions (eg. fine distribution) properly and exclusively belongs to the realm of wholesaling, while others (eg. pre-wholesaling) may be performed in-house (as was historically the case) or by specialist logistic service providers (as is the case at present). The implicit suggestion made by the applicants, is that they contend for this ‘wholesaling’ or ‘fine distribution’ activity because that is all that they have always done in the past and that is all that they are interested in doing in the future.
50. The truth of the matter is that the wholesalers do ‘fine distribution’ as an intrinsic element of their role as wholesale traders – that is, they buy in bulk from the manufacturers and they sell in smaller quantities (‘fine distribution’) to the retailers and, in the process, are rewarded by the difference between their buying price and selling price less the cost (for example, warehousing) of this intermediation. They do not perform ‘fine distribution’ as a service charged out to the manufacturers. This is why the applicants occasionally slip into referring to a ‘wholesale pharmaceutical distribution market’ or even a ‘full-line wholesale pharmaceutical distribution’ market rather than to a pharmaceutical distribution market. In other words, they choose, for obvious reasons, to define the distribution market by reference to the characteristics of the wholesale mode of distribution, rather than by reference to the functional characteristics of the activity in question, these simply being distribution and related logistical functions. What the applicants’ approach conveniently serves to disguise is that they have been successfully challenged by competitors who effect distribution through a wholly new modality, a modality that is characterized not by wholesaling, but by the provision of a range of logistical services, including, but not limited to, fine distribution. It is wholly conceivable that these two distribution modalities may continue to co-exist and compete – this is precisely what is happening at present. But it is equally conceivable that, like the horse and buggy and the motor car, or the typewriter and the personal computer, the one modality may ultimately disappear in favour of a superior alternative.
51. Secondly, and this is also elaborated below, we are not persuaded that there is a separate market for the distribution of pharmaceutical products. That is, we know of no reason why, in the event that the specialist distributors of pharmaceutical services raise their charges, others who specialize in the production of distribution services generally should not offer their services to pharmaceutical manufacturers. There is, on the face of it, nothing unique about the distribution services required by pharmaceutical manufacturers. A more detailed examination of the evidence, of the sort possible at the final stage of determination, may persuade us that pharmaceutical distribution can only be carried out by dedicated, specialist wholesalers or by dedicated, specialist distribution service providers. But, on the face of it, the market is for the provision of distribution services, rather than pharmaceutical distribution services. As we elaborate below, this has a major, even dispositive, impact on the applicants’ allegations relating to foreclosure.
52. Thirdly, the applicants contend that the manufacturers and wholesalers compete in this distribution market, or, at any rate, in what the applicants identify in their heads of argument as ‘the relevant markets for the sale of products to retail pharmacies and to medical practitioners’. The gist of this argument seems to be that whereas previously only the wholesalers enjoyed direct access to the manufacturers, this has now been extended to retailers and medical practitioners as well. Because, under this new regime, both manufacturers and wholesalers interact directly with retailers, they are somehow divined to be competitors in the same market ‘for the sale of products to retail pharmacies and medical practitioners.’
53. We understand that the manufacturers have decided to interface directly, through their agent, Kinesis, with the retailers of their, that is, the manufacturers’, own products. We are prepared to concede, with some residue of doubt, that this places both wholesalers and distribution agent in the same distribution market – despite the incontrovertible fact that the former trades in pharmaceutical products and the latter trades in distribution and logistical services we concede that both do, in effect, distribute pharmaceutical products. However, we cannot agree that this places the manufacturers and distributors in the same market. Even if the manufacturers had elected to perform all the distribution functions in-house, that is, through a fully vertically integrated distribution division, this would not make them competitors in the distribution market any more than performing security functions in-house would make them participants in the security services market. There is no iron law that says that the manufacturing process begins and ends at pre-ordained points, much less that it is illegitimate from a competition perspective for the manufacturer to engage in any activity beyond those points. The products belong to the manufacturers and our starting point is that they are entitled to distribute it to their various customers as they see fit, just as they are entitled to secure their premises as they see fit. Indeed, if the wholesalers were to permit the general public to purchase products directly from their premises, the retailers would have no recourse under competition law19.
54. In fact, in this case, the manufacturers have not taken distribution services in-house – they have simply elected to determine price in a direct interface with the retailers and, in certain, but not all, instances they have decided that they will offer a uniform price regardless of the purchasers designation as ‘wholesaler’ or ‘retailer’. Most of the physical acts associated with the task of ensuring that their products arrive at the purchasers’ premises have been contracted out to a specialist provider of distribution services. If the wholesalers compete with anybody in this scheme then it is with the distribution agent and certainly not with the manufacturer. In short, further argument and evidence may well reveal that the wholesalers participate in the pharmaceutical wholesale market which, like the erstwhile market for typewriters, is in terminal decline, not because of a restrictive practice perpetrated by a customer or a competitor but because a wholly new product, a wholly new mode of distribution, has displaced it.
55. In summary, then, we conclude that there is a range of separate pharmaceutical product markets. While we note that closer examination may cause us to revise the use of ATC3 categories as the basis for designating these markets, this categorization will serve for the purposes of interim relief.
56. The distribution market is more difficult to identify with confidence on the basis of the evidence before us. Conventional wisdom appears to concede the existence of a market for the distribution of pharmaceutical products. However, just as those who, like the applicants, identify themselves as specialist distributors of pharmaceutical products, are nevertheless able to participate with apparent ease in the distribution of a range of non-pharmaceutical products, so too are we inclined to believe that specialist providers of distribution or logistical services could, with relative ease, participate in the distribution of pharmaceutical products.
57. Indeed, Tibbet and Britten is a case in point. It is a specialist supplier of logistical services that is now offering these services to pharmaceutical manufacturers and these include, but are by no means limited to, the ‘fine distribution’ performed by the wholesalers. Certainly, it is doing this through the medium of a specialist pharmaceutical distributor, Kinesis. However, it is clear that Kinesis is offering a range of logistical services identical to those offered by Tibbet and Britten to its other non-pharmaceutical clients. And, conversely, it is not immediately apparent what specialist facilities or capabilities are required in order to distribute pharmaceutical products. The existence of a cold chain is not peculiar to pharmaceutical products. Particular safety and security considerations may attach to distributing pharmaceutical products but then special treatment is required in the distribution of many products.
58. We are, in short, on the evidence presented, unable to reach a conclusion on the reach of the relevant distribution market. It may well be that further evidence supports the notion that there is a market for the distribution of pharmaceutical products. On the other hand, there are prima facie indications that a fuller investigation may reveal that the market is for the distribution of consumer goods generally and is not restricted to the distribution of pharmaceutical products.
Restrictive Horizontal Agreements
59. Section 4 of the Act provides:
“1. An agreement between, or concerted practice by, firms, or a decision by an association of firms, is prohibited if it is between parties in a horizontal relationship and if –
it has the effect of substantially preventing, or lessening , competition in a market, unless a party to the agreement, concerted practice, or decision can prove that any technological, efficiency or other pro-competitive gain resulting from it outweighs that effect; or
it involves any of the following restrictive horizontal practices:
directly or indirectly fixing a purchase or selling price or any other trading condition;
dividing markets by allocating customers, suppliers, territories, or specific types of goods or services; or
collusive tendering.”
60. Section 4 specifies two threshold conditions for an adverse finding under both sub-sections (a) or (b). These are, first, that there be an agreement or a concerted practice between firms or a decision by an association of firms. Second, that this agreement should be between firms in a horizontal relationship.
61. The manufacturers are all manufacturers of pharmaceutical products. We have determined that the relevant pharmaceutical product markets are, for present purposes, defined by ATC3 categories. For present purposes what is clear is that the manufacturers – the principals in the present agency arrangement – are in a horizontal relationship (or, more accurately, a number of horizontal relationships) to one another, that is, they do compete in several markets, although that horizontality extends only to those therapeutic categories in which more than one of the principals is active.
62. However, have these horizontally related firms concluded an agreement between themselves?
63. In the initial application for interim relief the Tribunal panel found that the respondents had contravened Section 4(1)(a) of the Act. The panel found that the element of agreement required to establish a claim under Section 4 resided in the respondents’ joint ownership of SAI and of its wholly owned exclusive distributor, Kinesis. It is noteworthy that the panel specifically concluded:
“The anti-competitive effects of this type of distribution arrangement derive from three important features of the arrangement: firstly, it is a joint exclusive initiative between competing manufacturers; secondly, the manufacturers jointly control the agency and thirdly, the manufacturers play a significant role in a number of therapeutic product categories in which they currently compete.
Without
the first feature, the arrangement would essentially be a vertical
agency agreement of the type that would not raise competition
concerns in terms of, for example, the EC's Guidelines on Vertical
Restraints. In terms of these guidelines an agency agreement is
considered not to be anti-competitive if the agent does not bear any
risk in relation to the business it conducts on behalf of the
principal. It is not material whether the agent acts for one or
several principals or if the agreement prevents the principal from
appointing other agents in competition with the contracted agent
(i.e. an exclusive agency agreement). Such an agency agreement,
however, becomes problematic where it facilitates collusion between
the principals. In the present case, the relevant characteristics
of
the distribution agent (DD) are that it is an exclusive agent; it
acts for several manufacturers; and it bears no risk in relation
to
the manufacturers' businesses. As such, in terms of the EC
guidelines, the individual bilateral agency agreements between each
of the manufacturers and DD are not in themselves problematic from a
competition perspective. The distribution arrangement that these
individual agreements establish is nevertheless anti-competitive
because it arises from a concerted initiative by competing
manufacturers.”20
64. However, the respondents insist that any ‘agreement’ that may have been imputed in consequence of the previous regime of joint ownership is clearly vitiated by the sale of SAI/Kinesis to Tibbet and Britten. What we have now, argue the respondents, are three separate agency agreements concluded between, respectively, GSK, Pfizer and Pharmacare, on the one hand, and, on the other hand, Tibbet and Britten and/or its wholly owned subsidiaries, SAI and/or Kinesis. The complainants nevertheless continue to insist that both Section 4(1)(a) and (b) have been contravened.
65. This respondents’ argument would, on the face of it, appear to be incontrovertible. In light of the abovementioned sale of SAI/Kinesis – surely one of the ‘important developments’ alluded to by the Competition Appeal Court - the applicants, in order to establish the continued existence of an agreement, would have to demonstrate, either that the sale to Tibbet and Britten was a sham designed to camouflage continued joint ownership, or that, notwithstanding the termination of the joint ownership arrangement, horizontal agreements remained in place that contravened either Sections 4(1)(a) or 4(1)(b), or, that the very decision by the respondents to sell SAI/Kinesis constituted an agreement in contravention of the Act, or that the decision/s of the manufacturers to enter into agency agreements with the new owners constituted such an agreement. Certainly, the Act gives a very wide meaning to ‘agreement’, a meaning that would extend some way beyond a legally enforceable contract.21
66. The requirements to prove that a contract of sale and the subsequent agency agreements constitute a mere sham are very onerous and no evidence of this has been presented despite the applicants’ bald characterization of the merger as ‘not a sincere commercial transaction motivated by normal business principles’.22
67. The applicants have alleged the existence of certain common practices (common, that is, between the manufacturers acting through their distribution agent) that, in their view, evidence the agreements contemplated in Section 4. Indeed they appear to claim that the subject matter of these alleged agreements conform to the agreements contemplated in Section 4(1)(b) and are therefore susceptible to the per se or outright condemnation provided for in that section of the Act. These refer variously to the alleged existence of a single credit application form, to the alleged existence of identical credit terms, to alleged co-ordinated revocation of credit, to the alleged fixing of delivery schedules and, then, to a thoroughly incomprehensible set of allegations derived from the allegedly oligopolistic nature of the pharmaceutical market and to parallel conduct allegedly engaged in by the participants in that market.23
68. Suffice to say that certain of these allegations refer, by the applicants own admission, to historical practices, that is, practices that have been discontinued and are thus no longer interdictable. In other instances the applicants have not proved that the practices alleged actually took place, much less that they were collusively determined. In other instances – and this refers particularly to allegations of the existence of an oligopolistic market and parallel conduct between the participants in this alleged oligopoly – it is frankly not possible to discern the conduct alleged. In the case of other practices – notably the allegations regarding the delivery schedules adhered to by Kinesis – it is clear that even if the conduct alleged actually occurs and even if these practices were collusively determined by Kinesis’ principals, they would nevertheless not fall to be condemned under Section 4(1)(b) which is exclusively concerned with ‘directly or indirectly fixing a purchase or selling price or any other trading condition’. We have previously determined that the ‘trading condition’ referred to in this section must relate to the price-quantity nexus and would certainly not cover delivery schedules.24
69. We should add that this raft of allegations is particularly difficult to sustain in the light of the clear evidence, which we understand to be common cause, that the core price-relevant trading conditions – specifically the scale and structure of their discounts – diverge significantly as between each of the manufacturer respondents.
70. The notion that the agreement required by Section 4 is manifest in the decision by the erstwhile owners to sell their stake in SAI/Kinesis is thoroughly unpersuasive. The Tribunal had previously found their joint ownership to underpin a contravention of the Act. As already noted, the manufacturers then took steps to bring themselves into compliance by selling their jointly owned distribution company to an independent owned supplier of logistic and distribution services. Given that they jointly owned SAI/Kinesis, per definition the decision to sell the distribution companies and thus bring themselves into conformity with the views expressed by the Tribunal would have to have been taken jointly. Are they to be penalized for bringing themselves into compliance with the Act?
71. What of the decision of the three respondents to then enter into EDAs with the new owners of Kinesis? In other words, argue the applicants, the respondents had not merely agreed to sell SAI and Kinesis to T&B, but they had also agreed to enter into EDAs with the new owners of SAI/Kinesis or, what is the same thing, they had all agreed to discontinue key elements of their traditional relationship with the wholesalers, notably the industry-wide practice of granting wholesalers a discount of 17.5% off the manufacturers’ list price.25 Indeed, insist the applicants, not only does this constitute an agreement for the purposes of meeting the threshold condition for Section 4, but, more than that, it constitutes an agreement about the pricing policy that they would follow. This, argue the applicants, is tantamount to ‘directly or indirectly fixing a purchase or selling price or any other trading condition’ and is thus vulnerable to the outright or ‘per se’ condemnation provided for in Section 4(1)(b).
72. It is reasonably clear that each of the manufacturers had, prior to the sale, agreed that they would utilize T&B as their exclusive distribution agent. Although there is no evidence that they had reached this agreement between themselves, it is entirely conceivable that T&B would not have agreed to purchase SAI/Kinesis from the manufacturers had they not been assured that each of the manufacturers would enter into EDAs post-sale. We are accordingly prepared to accept, for the purposes of this interim relief application, that each of the erstwhile owners of SAI/Kinesis had been aware that their fellow shareholders were entering into the process of concluding an EDA with the new owner, T&B, and that prior commitments to this effect had been made by the three sellers, subsequently the three principals. But this does not change the vertical character of the agreements in question.
73. The applicants make much of the fact that the Commission, in approving the sale (an ‘intermediate’ merger), had insisted on the omission, from the sale agreement, of the commitments apparently made by each of the sellers to enter into EDAs with T&B. But there is nothing to suggest thereby that the Commission had been concerned about a horizontal agreement between the respective sellers. Nor is there anything untoward at the parties to the sale agreement removing the condition, the requirement, to enter into EDAs from that agreement, and then subsequently concluding EDAs with the respondents or, for that matter, with any other manufacturers who wished to utilize their services. If these EDAs are then, as in the present matter, subject to anti-trust scrutiny, they are properly examined as a species of vertical agreement or, if dominance is established, abuse of dominance. But the mere fact that more than one manufacturer utilizes the distribution services of the same distributor does not transform a series of vertical agreements into a single horizontal agreement.26
74. In short, then, the allegation that the manufacturers have contravened Section 4 of the Act by entering into EDAs with Kinesis does not pass muster because the applicants have failed to establish the prima facie existence of an agreement between parties in a horizontal relationship. All that has been established is the existence of a number of vertical arrangements, and this, of course, has never been denied by the respondents.
75. We should add that even if the applicants had established the existence of a horizontal agreement this would not have been sufficient to secure an adverse finding under Section 4(1)(b) because in order to succeed under 4(1)(b) it would have to be established that the agreement fixed prices or any other trading condition or that it divided markets or that it amounted to collusive tendering.
76. A characteristic allegation of price fixing would allege that the three manufacturers in question each produce, for example, drugs for treating a particular cancer – that is, drugs within the same therapeutic category or relevant market - and that they are somehow utilizing their common distribution service as a mechanism for eliminating price competition in the sale of these drugs. This is not the allegation that has been made for the purpose of securing a conviction under Section 4(1)(b). What is alleged is that the three manufactures conspired to cut the discount extended to the wholesalers – the standard 17.5% in respect of GSK and Pfizer and 10% in respect of Pharmacare – in order to give a competitive edge to ‘their’ exclusive distributor, Kinesis. The manufacturers have not hesitated to point out that if there ever was a price fixing element in existence here then it is probably to be found precisely in the standard 17,5% received by wholesalers prior to the decision of the respondents to enter into the EDA agreements.
77. In this case as already noted, the applicants insist that because the effect of the EDAs was to reduce the discount available to the wholesalers that this establishes that the ‘agreement’ covered ‘pricing policy’ and hence offended Section 4(1)(b)(i). In other words, the manufacturers, argue the applicants, have collusively decided to reduce the discount, or, what is the same thing, increase the price, at which they make their products available to the wholesalers thus contravening the prohibition on price fixing.
78. We cannot agree with this. This attempt to conflate pricing policy, or, more properly, distribution policy, with price fixing, would severely inhibit innovation in the distribution of pharmaceutical products. It would effectively ensure that the existing pharmaceutical wholesalers or any who set themselves up as wholesalers of pharmaceutical products would be entitled, as of right, to receive, in perpetuity, a preferential discount off the manufacturer’s list price in order to enable them to effect the distribution of the manufacturers’ products even if the manufacturers had, as in this case, made alternative arrangements for the distribution of their products. We are asked to find that a refusal on the part of more than a single manufacturer to extend this preferential discount to the wholesale trade is a manifestation of a price fixing conspiracy.
79. We should add that the applicants are constrained to demand more than mere preference in the discounting structure – they must stake a claim for a preference sufficiently great to enable them to insert themselves between the manufacturers and the retailers and it is for this reason, above all, that this dispute has such strong commercial overtones.
80. This latter point cannot be emphasized too strongly. We are in effect being asked to set the price of pharmaceutical products to the wholesale trade. For the interim it appears that we are being asked – although given the confusion surrounding remedies this is by no means clear – to order the manufacturers to extend precisely the same discount to the wholesalers as was extended prior to the introduction of the EDAs. The applicants argue that this is merely an interim remedy implying that in the final hearing a more ‘market-friendly’ solution, one more in keeping with the fundamental mission of a competition authority, may be found. But what could this possibly be? The wholesalers themselves insist that the discount is the basis of existence of their trade, and the size of the discount – that is, the size of the differential between the price received by the wholesalers and that received by other purchasers of pharmaceutical product – is a critical determinant of the viability of the wholesale trade. We must then, perforce, be asked again at the final stage to order a discount for wholesalers and one great enough to ensure their viability. Implicitly, we will also be asked then – as now – to order that the ‘wholesalers’ discount’ not be extended to any of the ‘wholesalers’ customers’. For the present these seem to be confined to retail pharmacies, although there is no particular reason for this limitation. The wholesalers may, for example, desire to intermediate between the manufacturers and the state hospitals – what, on their present argument, would prevent them from approaching the Tribunal for an order giving them a discount that enabled them to trade profitably in this segment of the pharmaceutical market?
81. The truth is that the change in the discount available to the wholesalers flowed directly from the vertical agreements, that is, the EDAs – it arises, in other words, as a direct consequence of the decision to opt for one mode of distribution over another. Even if the applicants had managed to prove the existence of an agreement between the respondents to move from one mode of distribution to another this would not constitute a price fixing agreement.
82. Moreover, the contents of each of the vertical agreements provide no evidence of a price fixing conspiracy. Certainly, post the sale to Tibbet and Britten, the wholesalers are treated differently by each of the manufacturers in question – GSK appears to trade off a single, uniform discount off its list price; Pfizer’s discount structure is volume based; and Pharmacare appears to be operating on much the same basis in relation to the wholesalers as it ever did. That is, while Kinesis handles Pharmacare’s physical distribution, wholesalers are nevertheless still encouraged to trade in this manufacturer’s product by the availability of a discount larger than that received by its other customers.27 All that can be shown is that three manufacturers have elected to enter into EDAs with a service provider; it has not even been shown that this was the product of an agreement between the manufacturers concerned, much less that the agreement fixed any price.
83. To succeed under Section 4(1)(a), the complainants would have to establish that the agreement substantially prevented or lessened competition in a market. There are allegations scattered around the volumes of documents submitted that allege the fixing of non-price conditions. For example it is consistently alleged that the principals have fixed the delivery schedules at a single delivery per day in contrast with the multiple daily delivery service offered by the wholesalers. However, properly speaking these are not conditions fixed by the principals but rather refer to the services provided by the distributor. In any event, the applicants would still, in order to succeed under Section 4(1)(a), have to show that the agreement substantially prevented or lessened competition in a market. They have averred that the allegedly exclusive nature of the agreements between each of the manufacturers and their distributor has eliminated intra-brand competition in markets characterized by an absence of inter-brand competition. These are the allegations made in order to establish their claim under Section 5(1) for the existence of a vertically restrictive agreement and we shall examine these under that section of the Act.
Restrictive Vertical Agreements
84. Section 5(1) of the Act provides:
“1. An agreement between parties in a vertical relationship is prohibited if it has the effect of substantially preventing or lessening competition in a market, unless a party to the agreement can prove that any technological, efficiency or other pro-competitive gain resulting from that agreement outweighs that effect.”
85. In this matter it is alleged that the respondents, by entering into contracts to establish an exclusive distribution agency, have fatally compromised intra-brand competition, competition between alternative sellers of the same brand. This, argue the applicants, should be of particular concern to the competition authorities because, it is alleged, it takes place in the context of an industry notable for the absence of inter-brand competition, competition between producers of alternative brands.
86. It is also alleged that the EDA effectively constitutes a barrier to new entry at the manufacturing level. Full-line wholesalers will, it is alleged, not be able to continue in business if they are not able to trade in the full range of pharmaceutical products. This means that pharmaceutical distribution will be dominated by agencies all in the exclusive service of active participants in the industry. Any would-be new entrant would then either have to persuade its competitors to undertake distribution on its behalf or, alternatively, face the formidable hurdle of entering at the distribution and manufacturing levels simultaneously.
87. Moreover, when the EDA under scrutiny here is seen in the context of the establishment of two other exclusive arrangements that serve a number of other multinational producers of ethical pharmaceutical products – namely, the IHD and PHD arrangements - we are invited by the applicants to conclude that the mechanism of EDAs is part of a conspiracy to prevent generic products in particular from entering the market.
88. We will examine each of the elements of these allegations:
89. Firstly, certain particular features of this EDA call the applicants’ contentions into question. Hence, we note that the EDA under scrutiny provides for an asymmetric form of exclusivity. That is to say, while the principals are contractually bound to exclusively use the distribution and other services offered by the agent, the agent is under no obligation to offer its services to the founding principals on an exclusive basis. Indeed it is pointed out that the principals have a positive interest in their distribution agent extending its client base to the extent that this permits the realization of scale economies and a consequent reduction in the unit costs of distribution. It appears, in fact, that the service level agreements between the principals and the distribution agent explicitly provide that the existing principals benefit from further scale economies realized by the agent through the expansion of its client base.
90. We are also asked to note that South Africa’s largest generic producer – Pharmacare – is one of the principals served by the distribution agent in question here and that other smaller generic producers also utilize the services of Kinesis. Moreover, it appears that the other EDAs count generic producers in their client base. Hence even if Kinesis were prevailed upon by one its principals to exclude a competing generic producer, this would not preclude one of the other EDAs whose principals were not in competition with the generic producer in question from distributing the latter’s product. We have also been presented with evidence that demonstrates that important generic producers – inter alia, Adcock Ingram – are successfully distributing their own product.
91. In general, in order to sustain this allegation of likely foreclosure we would have to be persuaded that Kinesis is dominant in the pharmaceutical distribution market – which is manifestly not the case – or that it has entered into a conspiracy with the other EDAs. There is no evidence of such a conspiracy. But even this would not suffice to persuade us. There are other pharmaceutical distribution mechanisms in place, other, that is, than the various EDAs, to be found not least of all in the ranks of the present applicants. Moreover, as we have already indicated in our discussion of the relevant market, we have no reason to believe that other distributors, that is, providers of distribution and other logistic services in other sectors of the economy, would not be able to effect the distribution of pharmaceutical products. There are, we acknowledge, particular unique features that attach to the distribution of pharmaceutical products, but this applies to a range of products – fresh and frozen food products with their cold chain requirements is a pertinent example - and these have not precluded specialist logistic providers from meeting the requirements of manufacturers of these products. Indeed, as already noted, we are yet to be persuaded that the relevant market for the purposes of our present examination is correctly identified as that for the provision of distribution services to the pharmaceutical industry.
92. In other words the fuller examination of the evidence permitted by adjudication of the evidence presented at the final stage of the complaint referral, may well show that the relevant market is simply that for the provision of distribution services generally. Just as international freight forwarders, as well as shippers and air freight companies, participate in the export and import distribution of a range of products from fresh fish to diamonds, many with exotic regulatory and other requirements, so too is it wholly conceivable that providers of logistic and distribution services on the domestic market will respond positively to a commercial incentive to distribute pharmaceutical products.28
93. The applicants counter that, whatever the theoretical prospects for new entry may be, this has not occurred for many years and that the allegedly low returns earned by the wholesalers are an effective deterrent to new entrants.29 Again, we are skeptical. Low returns may be endemic and permanent in the pharmaceutical wholesale trade. But this may be a signal that the wholesale mode of distribution has, like the typewriter, finally run into the sand. Wholesalers unwilling to grasp this nettle and reconsider their business model may well find themselves subject to endemically low returns. However, it is not for the competition authorities to protect them from their commercial folly. Certainly, as the present case exemplifies, there has been new entry by providers of logistic and distribution services. In other words, low returns may well be the outcome of a comfortable oligopoly whose participants are content with the easy life, with passing on pharmaceutical products and the associated margins to their long-standing and, it frequently appears, captive customers30. Low returns are not necessarily indicative of robust competition.
94. We should note another feature of the exclusivity that attaches to this particular EDA. Certainly, Kinesis is exclusively contracted to perform a range of distribution and logistical services on behalf of its principals. But this does not preclude wholesalers from procuring product through the agency of Kinesis for on-sale to the retailers. Nor, naturally, are the retailers precluded from sourcing the principals’ product through the wholesale channel. The wholesalers argue that by establishing an identical price for retailers and wholesalers any possible incentive for retailers to purchase their requirements from the wholesalers has been eliminated – the wholesalers would either have to charge the retailers a higher price than that available through the EDA or they would have to forego all margin. But this seemingly self-evident contention requires considerably closer scrutiny. Certainly, it is common cause that Pharmacare actually maintains an explicit price differential between its wholesale customers and its retail customers.31 Pfizer’s pricing structure is explicitly determined by the volume of purchases and so there appears to be a margin available for those wishing to purchase in bulk for on-sale to smaller purchasers. GSK, the third principal, appears to maintain a uniform pricing structure.
95. However pricing aside, that is, even if we assumed that wholesalers and retailers were in fact charged an identical price, does this serve to eliminate the possibility of other pro-competitive offerings from the wholesalers? For example, the wholesalers insist that the full-line service that they offer is a convenient alternative for small retailers who, in the absence of such an offering, would have to place orders with a number of different EDAs. If this is indeed so, then why are wholesalers not able to charge for the convenience of one-stop purchasing? The greater frequency of the deliveries from the wholesalers is also presented as one of their competitive strengths. In other words, the EDA does not preclude the wholesalers from inserting themselves between the principals and their retail customers. However the test for a successful and sustainable pro-competitive insertion is that the wholesalers provide a pro-competitive rationale for their existence. If these additional offerings cannot be charged out, then it is clear that they are not valued by the market. It is not then for the competition authorities to foist these upon the market by providing that the wholesalers’ position be secured through the provision of a price advantage.
96. Secondly, we have to examine the contention that the EDA has eliminated vigorous intra-brand competition, that is, competition between wholesale distributors of the identical pharmaceutical brand. Exclusive distribution arrangements do, per definition, eliminate intra-brand competition. However, there is insufficient evidence of vigorous competition between wholesalers (that is, intra-brand competition) in the pre-EDA era to sustain the allegation that this amounts to a substantial lessening of competition. We are asked to infer high levels of competition between the various wholesalers from the allegedly low returns earned by the latter. However, as already noted, this may well be indicative of a monopolist or a group of co-operating oligopolists who value the quiet life over and above high returns.
97. This latter interpretation is supported by other prima facie evidence of co-operation, rather than vigorous competition, between the wholesalers, the uniform discount demanded from the manufactures not the least of these indicators. Furthermore, the respondents have submitted evidence suggesting that, far from vigorous competition between wholesalers for the custom of the retailers, many of the latter are effectively tied into supply arrangements with one or other full-line wholesalers. These ties are variously cemented – in some instances it appears that the retailer customers of the full-line wholesalers own equity stakes in the latter; at other times, there is evidence of wholesaler financial assistance to the retailer in exchange for a commitment on the part of the retailer to purchase supply exclusively or predominantly through the wholesaler in question.32
98. In the face of these prima facie indicators of co-operation as well as evidence submitted by the respondent’s we are not able to accept, without further evidence, the complainant’s bald assertion of strong intra-brand competition for pharmaceutical products in the pre-EDA era.
99. We should also note the argument, widely supported in contemporary competition analysis, that holds that insofar as a diminuition of intra-brand competition occurs as a result of an exclusive distribution arrangement, that this will be likely compensated for by more intensive inter-brand competition, that is, by competition between competing brands – in other words, that the distributor’s focus on procuring competitive advantage for its clients brands will intensify competition with brands that do not enjoy the services of the distribution agent.
100. In opposition to this argument, the applicants contend that the pharmaceutical industry is characterized by unusually low levels of inter-brand competition. This contention appears to derive from two features associated with the market for pharmaceutical products. These are, first, the widespread use of intellectual property protection of pharmaceutical products. And, second, the ‘must-have’ nature of the product, the fact that product and brand selection of pharmaceutical products is made by the prescribing doctor thus eliminating the ability of the actual purchaser of the product to exercise any competitive choice.
101. We, of course, acknowledge ubiquitous use of patents in this sector. We note, however, the respondents’ observation that even many patent protected products face competition from products applicable for the same broad therapeutic purpose.33 Moreover, we are constrained to observe that on closer appraisal of the evidence, the market for ethical pharmaceutical products may well be an innovation market, that is, that competition occurs in the innovation stage of the product life-cycle. This latter form of competition is not diminished by patent protection – indeed, it is competition in order to achieve patent protection in respect of a new innovation. The evidence before us does not justify a far-reaching judgment on the state of competition in the market for pharmaceutical products. We stress that further evidence and argument may well establish low levels of inter-brand competition in the pharmaceutical products market – certainly the exceptional returns posted by the pharmaceutical majors suggest low levels of competition. However, this conclusion cannot be justified on the papers submitted in this application for interim relief.
102. Even the ‘must-have’ nature of pharmaceutical product consumption has been called into question by relatively recent developments that have been highlighted by the respondents. We refer, of course, to increasing evidence of demand side buying power supported by legislative intervention that requires the use, under a range of circumstances, of cheaper products than those frequently prescribed by the consumer’s doctor, as well as increasing pressure from medical aid schemes to contain costs34. Again, the respondents’ counter arguments by no means dispose of their opponents’ contentions. But they do unquestionably call them into a degree of doubt sufficient to constrain a granting of interim relief – in a word, more evidence is required to resolve this argument.
103. In summary then, based on general pharmaceutical product characteristics – the widespread use of patent protection and the ‘must-have’ nature of the product – the applicants argue that inter-brand competition is already considerably muted and that the formation of an EDA will eliminate intra-brand competition. However, contrary evidence submitted by the respondents suggests that intra-brand competition has never been particularly strong and that inter-brand competition may well be a great deal more robust than suggested by the applicants.
104. In the absence of further evidence, we accordingly cannot find that the vertical agreement between the respective principals and the distribution agencies as represented by three EDAs in question has resulted in a substantial preventing or lessening of competition in any of the relevant markets implicated in this matter.
105. In the light of this finding, we are not obliged to determine the conflicting claims made regarding the efficiency or otherwise of the EDAs over the wholesale form of distribution.
Abuse Of Dominance
106. The applicants also allege contravention of Sections 8 (a), (b) (c ) and (d)(i). These contraventions would all constitute abuses of a dominant provision. Section 9 prohibits price discrimination by a dominant firm.
107. We should state at the outset that the allegations relating to abuse of dominance have been particularly poorly framed by the applicants. Indeed, in most instances while a raft of allegations pertaining to abuse of dominance have been made in the original notice of motion, they are barely referred to in the papers subsequently filed or in the argument before the Tribunal.
Dominance
108. The threshold necessary to sustain an allegation of abuse of dominance, is that dominance in a market should be established. It is here that the applicants’ difficulties begin.
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