Thursday, March 17, 2011

Parts 1 and 2: Is Nestle guilty of predatory pricing

"Is Nestle guilty of predatory pricing" - Complete Series
Part 1 of the article by Jose Pablo Salud, published in Business Mirror/Philippines Graphic appears here.
Complete parts 1 and 2 appear below, by Jose Pablo Salud (original article available online here).

"Nestlé Philippines, a subsidiary of the world’s largest food conglomerate Nestlé International (2008 net profit: US$16 billion), is facing charges of alleged predatory pricing before the Department of Trade and Industry (DTI).

Locking horns with Nestlé Philippines are its own distributors—Service Edge Distribution Inc. (SEDI) and FDI Forefront II Trading. Both alleged that the multinational corporation “caused them to incur P300 million in losses because of the strict controls and aggressive sales targets of Nestlé.”

According to Atty. Lorna Kapunan, legal counsel for the respondents: “The complaint alleged that the pricing policies of Nestlé constituted predatory pricing because Nestlé was selling its products at a very low price, intending to drive competitors out of the market or create a barrier of entry for potential new competitors.”

Predatory pricing
Predatory pricing, by definition, should not be confused with normal price competition. In a nutshell, predatory pricing is the slicing down of prices to levels way below competitive standards for the mere intention of cutting down competitors.

The practice of vertical price restraint pertains to the agreement between manufacturer and distributor on the setting of minimum price levels at which the product can be sold in the market.

Purportedly, Nestlé Philippines denied the allegations in the complaint, claiming that “the individual respondents did not do anything wrong; that the FDI issue is closed because of the quit claim; and that SEDI’s distribution agreement has been received,” according to the distributor’s counsel.

As such, following the legal technicalities that ensued, Nestlé argued in its Motion to Dismiss that “the DTI has no jurisdiction over the case because it is merely a civil suit masquerading as a regulatory case to escape the payment of filing fees.”

Furthermore, Nestlé insisted that respondents had failed to solidify a case of predatory pricing by “failing to hurdle the two-pronged test in the US case of Brooke vs. Brown.”

“We filed our Oppositions on the two Motions, arguing that the grounds cited in the Motions to Dismiss are best threshed-out in the trial on the merits and that the hearing officer only followed its mandate to arrive at a just resolution of the case in a speedy and expeditious manner,” counsel for the respondents said.

The hearing officer thereafter issued an Order requiring the Bureau of Trade Regulation and Consumer Protection (BTRCP) of the DTI to see if there is “probable cause” to file a formal charge against Nestlé.

“We filed a Manifestation stating that a formal charge is to enforce the administrative liability and not criminal liability as implied by the term ‘probable cause,’” counsel for the respondents explained. “We also informed the DTI that we have filed a criminal case in Quezon City to enforce the criminal liability of Nestlé.”

Also last year, following an independent investigation of the case at hand, one of the country’s largest banks—Banco de Oro (BDO)—hauled Nestlé Philippines in a P170-million legal debacle.

Business model
Kapunan said that Nestlé Philippines follows the typical Fast Moving Consumer Goods (FMCG) distribution flowchart, wherein distributors purchase bulk amounts of Nestlé products and re-sell them to retailers with a small profit margin.

Re-orders and re-stocking, which siphon huge amounts of capital from distributors, are done periodically, depending on how fast a distributor can resell the goods.

Nestlé, for its part, promised support for its distributors through marketing, promotional and advertising efforts, and assurances of reasonable income.

A regional or area manager’s performance and compensation benefits are wholly tied in with how much his or her distributors purchase from the company.

Nestlé’s distributorship business model, however, were reportedly all good only on paper; in practice, Nestlé allegedly reneged on the promised support to its distributors, forcing the latter to spend more on such efforts to meet aggressive sales targets.

Bearing the weight
According to Kapunan, the practice of vertical price restraint weighed down retailers and distributors for no less obvious reasons: Spending more in order to market and sell the goods purchased from manufacturers.

Apparently, competitive or even low prices are not sufficient to convince the market to purchase their goods, hence the need to boost sales by adding promotional and demonstration efforts. The cost of such efforts, which multinational manufacturers feel are vital to the whole thrust of marketing and selling the products, are now passed on to the retailer who needs to dispatch the products more creatively and vigorously in order to reach cutthroat sales targets.

Kapunan explained: “The most obvious disadvantage of vertical price restraint is to the small- and medium-scale entrepreneur, who in the Philippines typically acts as a retailer and/or distributor for large multinational manufacturing or production firms like Nestlé. Nestlé’s current distributorship agreement, for instance, does not take into account all relevant costs associated with distribution of its products. The costs are borne by the distributors, with lackluster or merely initial support on the part of Nestlé in terms of marketing or promotional work.”

Kapunan adds: “Such practice of making the Filipino small- and medium-scale entrepreneurs suffer the costs of distribution, and without considering such costs in driving down or setting prices, is a potential threat to the greater market as it results in productive inefficiency. Productive inefficiency results by incurring higher production costs as there are no competitive forces to reduce costs to the lowest possible level.”

She said that such underhanded practices reduce the Filipino entrepreneur into what can be deemed as a losing proposition, bearing the brunt and cost of fixed pricing as demanded by the multinational manufacturer. It also poses a serious threat to competitors.

The end game, so to speak, is for conglomerates like Nestlé to sell its products at its desired price, sans the intention of backstopping any or all additional costs incurred by its distributors through the latter’s promotional efforts to boost sales and meet target quotas.

What is worse, is that vertical price restraints every so often force the small- and medium-scale entrepreneur to arrive at certain compromises if only to make ends meet or bring in some semblance of profit.

Illegal under Swiss law
What is disturbing in all this, according to Atty. Kapunan, is that such practices by Nestlé, if set in train in Switzerland, its home country, is considered a threat to competition under Swiss law (Article 5 [1 and 4] of the Swiss Competition Act), thus making it illegal.

“(1) Agreements, which substantially restrict competition on a market for good services and which are not justified by economic efficiency, as well as agreements which prevent competition on a market for goods and services, are illegal… (4) Agreements between enterprises on different market levels regarding fixed or minimum prices… are deemed to prevent competition.”

With the Swiss government’s Revised Notice on Competition Law Treatment of Vertical Restraints, revised in July 2007, it is clear that under Swiss law, the practice of vertical price restraint or even the mere restriction of inter-brand competition in a distribution system triggers an irrefutable “presumption that competition has been eliminated, and may result in a fine in an amount equal to a maximum of ten percent (10%) of the company’s turnover during the past three (3) business years.”

In the United States, vertical price restraint agreements are not illegal per se, so long as in the practice of it all relevant economic factors and effects are taken into account. This is called the Rule of Reason. Without considering the so-called Rule of Reason, “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among several states, or with foreign nations, is declared to be illegal.” (15 U.S.C. § 1).

Anti-trust in PHL law
In Philippine law, however, such penalties or policy framework are non-existent, hence unable to address economically inefficient agreements between manufacturer and distributor.

A thorough browse of the anti-trust provisions in the 1987 Philippine Constitution reveals that State must “regulate or prohibit, for the sake of public interest, monopolies, combinations in restraint of trade, and other unfair competition practices, and to protect Filipino enterprises against unfair foreign competition and trade practices.” (Article XII Sections 1 and 19).

Clearly noticeable in these provisions are the lack of specific definitions between competition and unfair competition, as well as penalties due to the lack of actual cases to which the courts can apply the said law. That such laws warrant jurisprudence in the exercise of the Rule of Reason presents a problem as to the test and sufficiency of the legal doctrine.

Face the music
It is clear that moral issues have to be considered in the practice of vertical price restraint in order for Filipino entrepreneurs to stand on equal footing with titan conglomerates like Nestlé.

It may not be illegal, per se, in the Philippines, but agreements between manufacturer and partner-distributors should nonetheless guarantee support from multinational manufacturers and a fair return to their Filipino partners. Recovering capital or the hope for a return on investments is a fundamental business paradigm even Nestlé presumably understands.

The country must look into ways whereby it can crank up judicial and legislative frameworks as to distributorship agreements between Filipino entrepreneurs and multinational giants like Nestlé. A nation that prides itself in business process outsourcing has no choice but to look into the relevance of policies and laws that deal with predatory pricing.

While granting that the business community is a tightly welded cauldron of secrets, every so often these secrets find a way out to nudge an unsuspecting public—through hairline cracks on the seams, or in this case, an alleged business practice gone awry. Walls have eyes and ears, needless to say, and little can be said about scandals in this country, save the fact that in most cases, the public will find out—sooner or later. G"

1 comment:

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