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“The team was recently visible advising on a number of pharmaceutical cases. Sources agree that the team is “moving in the right direction” and are particularly impressed by its work in the pharmaceutical sector”.

 

Appearance of Strength

30.11.2015

Oleksandr Fefelov, Attorney at Law, Head of Antitrust and Competition Practice at Ilyashev & Partners Law Firm
Source: The Yurydychna Praktyka

The AMCU management considers appearance of a strong competitor in the market as the best possible and effective solution that will bring more benefits than problems to the public interest

It is hard not to notice how the work of a new composition of the Antimonopoly Committee of Ukraine (the AMCU, the Committee) has intensified in just a few months. It refers both to the problems inherited from the “paperednikov” (predecessors), when the friends enjoyed the most favored treatment, and others – as luck would have it.

In late September, after a number of meetings and round tables in the AMCU and the Ministry of Economic Development with the producers of cigarettes, deputies, representatives of trade the Committee recommended the producers to make public within a month the conditions of selection of the contractors having licenses for wholesale trade in tobacco products and distribution of tobacco products. The recommendations were aimed at stopping the monopoly of TC “Megapolis-Ukraine” (“Megapolis”) in the market of wholesale trade and distribution of cigarettes.

Since early October the AMCU began consideration of the case on the grounds of violation by Megapolis of legislation on economic competition protection in the form of abuse of monopoly (dominant) position in the national market for the supply of tobacco products to retailers through setting the selling prices, which would be impossible in a competitive environment. The Committee also recommended Megapolis to observe the rules of competition when setting markups.

It is perhaps one of the most interesting cases as the noble endeavor to de-monopolize the market is not so obvious as it seems at first glance, especially in the opinion of some government officials and the public. The desire to destroy the monopolies must be beneficial for both producers and end users.

Background

In recent years, the four largest cigarette producers manufacture more than 90% of legal cigarettes consumed by the Ukrainian smokers and use a single distributor (the very same Megapolis) for distribution of their products.

The unique position of Megapolis that brings it enormous profits resulted from a variety of reasons, which some commentators link to a specific attitude to the company of some representatives of the previous government and “cover” of highly profitable business, and others who know the cuisine of business processes for the distribution of this specific product say that Megapolis reached it in a natural way by absorbing smaller distributors with the permission of the AMCU and withdrawal of less efficient players from the market while the absence of real competitors does not threaten competition between the producers.

The producers noted at meetings and roundtable discussions that the situation was not harmful to the cigarette market, it contributed to development of the tobacco industry in general and increased competition between the producers.

The main advantage of cooperation with Megapolis is that it enables to achieve full and most comfortable satisfaction of consumer needs, which is extremely important for the producers. It is known that a smoker taken separately wants to get a pack of cigarettes of his favorite brand at any time and in any place, at a price affordable to him, and it often is about a pack rather than a block of cigarettes. The manufacturer is interested in maximum satisfaction of such need, psychological attachment to the smoker’s particular brand and availability of cigarettes manufactured by it in any tobacco shop. The expected quality of such brand is also important. Meanwhile this task is successfully performed by Megapolis, having the opportunity to make regular retail deliveries across the country by clearly observing the payment discipline in relations with the producers, storage rules in the appropriate warehouses and combating against smuggling. Further, when working with one distributor logistics costs reduce substantially.

If we withdraw from the political and psychological motives of rigid “dislike” to Megalopolis, it becomes evident that both producers and smokers enjoy comfort and profitability that a major market player is engaged in wholesales. However, no one would have objected to some competing wholesalers. Without wishing to paint Megapolis in bright colors, yet it must be said that it is too early to claim a violation of the competition law. After all, the AMCU initiated the case in early October and so far provided only fairly soft and justified in this situation recommendations.

What excites the market

In connection with the initiated case it is important to calculate how the results of its consideration will influence the economic situation of the producers, development of production and satisfaction of consumer needs. Considering quite general wording of Articles 6 and 13 of the Law of Ukraine “On Protection of Economic Competition”, so far it is difficult to state reliable legal grounds for proving creation by market players of artificial barriers to entry of other members to the market of wholesale trade, limiting their competitiveness without objectively justified reasons.

The international dimension of cooperation with one large wholesaler provides the producers at least some protection from sanctions by the EU for illegal supply of Ukrainian products to the countries of the Eurozone (smuggling and counterfeit). For information: the relevant groups of companies – cigarette producers signed contracts with the European Commission, in terms of which they have a duty to jointly fight the illegal trade in cigarettes in the EU. The obligations relate not only to cigarettes manufactured in the Ukrainian tobacco factories, but also to counterfeit. Smuggling and counterfeit control is conducted through the European Anti-Fraud Office (OLAF) being very active in respect of such products.

In addition, there are enough cases of payment of large fines upon detection in the EU of Ukrainian cigarettes illegally caught in Europe. The amounts of fines are so large that the producers are very interested in cooperation with the distributors able to provide reliable monitoring of passage of goods across the whole distribution chain from the producer to the end consumer in the country and prevent smuggling abroad. The contract of one of the producer groups envisages its obligations to fight against smuggling of cigarettes both produced at its factories and counterfeit, to pay annual fees and additional payments if such products are found in the EU. Illustrative of relations with the OLAF is the Protocol to the Agreement entitled “Know Your Customer”. The document commits the company to do business only with approved contractors, and the number of cigarettes produced should be commensurate with the demand for territorial market. The manufacturer can not increase productivity without increasing demand, even for the development of competition among distributors. The protocol includes strict requirements to the contractors, the determining factor is the ability of the distributor to observe the procedures for combat smuggling and counterfeiting, to conduct ongoing monitoring of the customers of the contractor.

The following figures show how serious is the problem of smuggling and trafficking in counterfeit cigarettes in the EU: 56.6 billion of such cigarettes were smoked in these countries in 2014 (10.4% of the total consumption of cigarettes). Thanks to the efforts of the producers and the OLAF and the established system of monitoring of the supply chain, the volume of illegal products is decreasing. Distribution through the company ensuring compliance with the requirements of the OLAF has positive results, at least in relation of increase in tax revenue to the budget from legitimate sales and reduction of “do not understand what” in the pockets of smokers.

At the same time, the media have repeatedly discussed that some wholesalers do not loathe illegal deliveries abroad of cigarettes produced in Ukraine. It is enough to recall the recent scandals in Mukachevo, which were largely connected with redistribution of influence in the activities related to the smuggling of cigarettes.

It is strange that only the AMCU became an instrument of struggle against Megalopolis, as there are still the possibilities envisaged in the Law of Ukraine “On licensing of economic activities”, e.g. restrictions for the companies originating from the aggressor country when obtaining or extending licenses.

Cigarettes are international goods, and as Ukraine has committed itself to harmonize its competition legislation with the EU legislation, it is important to know conditions of conclusion and implementation of the vertical agreement with a single distributor in the EU and whether a producer should be responsible in case of distribution of its products through the single contractor.

The Association Agreement with the EU stipulates that Ukraine is obliged to implement within three years the Commission Regulation (EC) No. 330/2010 of April 20, 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices. Article 101 of the Treaty applies to the agreements, including vertical, which may affect trade between Member States and prevent, restrict or distort competition. It establishes a legal framework for the assessment of vertical restraints, accounted for the differences between anti-competitive effects of the pro-competitive. Article 101(1) prohibits agreements which obviously restrict or distort competition, while Article 101(3) refers to the agreements, which should not be subject to restrictions of Article 101(1), since they have the advantages that exceed the anti-competitive effects. For most vertical restraints competition concerns can only arise if there is insufficient competition at the level of the supplier of goods, the buyer of goods or at both levels. It is important that the purpose of Article 101 is to prevent the threat of competition to the detriment of consumers.

Article 101(3) of the Treaty on the Functioning of the European Union excludes the liability of the members of vertical agreements if such agreements contribute to improving the production or distribution of products, technical or economic progress, while allowing consumers the opportunity to get a proper share of the benefits derived, do not impose on the parties restrictions that are not required to achieve such a goal, and do not give them the possibility of eliminating competition with respect to a substantial portion of the relevant products. At first sight, according to Article 101 of the Treaty there are no conditions for the prohibition of agreements with Megapolis.

It is important that in accordance with Regulation No. 330/2010 certain types of vertical agreements potentially promote economic efficiency in the chain of production and distribution by facilitating coordination between the economic entities that take part in it. They lead to a decrease in operating expenses of the parties, optimization and distribution of sales, increase of investment.

It is assumed that if the share in the relevant market of each of the parties to the agreement does not exceed 30%, and it contains no harsh restrictions on competition, such an agreement generally leads to improvement in production and (or) distribution and offers consumers a fair share of benefits.

Web sites of some manufacturers have already made public the criteria for selecting distributors (meanwhile in the form of projects to be evaluated by the AMCU). It is hoped that the AMCU will not regard them as discriminatory, i.e. creating obstacles to market access or removal from the market of certain buyers of the product, and will not apply to them the provisions of Article 13 of the Law. As for Megapolis, the initial plan of its division may not be implemented. Management of the Committee considers the emergence of a strong competitor in the market as an optimal solution in the development of competition, which is really justified and will be more useful than problem to the public interest.

 
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