Additional reporting by Kazunori Takada and Michael Martina of Reuters

Two significant events in the first week of August reaffirmed China’s increasingly proactive and aggressive effort to stamp out anti-competitive behaviour. On Aug. 1, the Shanghai High People’s Court ruled that pharmaceutical giant Johnson & Johnson had violated China’s anti-monopoly law by forcing resale price maintenance (RPM) – where manufacturers and their retailers set certain prices at which retailers could resell their products – on its distributor. Barely a week later, China’s National Development and Reform Commission (NDRC) fined six baby formula makers a record total of $110 million for engaging in price fixing and anti-competitive practices. An increasing number of foreign firms are finding themselves on the receiving end of severe fines handed down by the authorities. Many are complying with investigations and have moved swiftly to make their prices more competitive. However, the incentive for companies to self-report still remains low due to uncertainty and a lack of transparency in China’s procedural rules.

Swift punishment

In its Aug. 1 judgment, the Shanghai High People’s Court ordered Johnson & Johnson to pay 530,000 yuan ($86,000) in damages to its former dealer, Rainbow Medical. The court ruled that the U.S. pharmaceutical company’s Chinese subsidiaries displayed anti-competitive behaviour by forcing RPM on Rainbow via a price floor. The case marks the first vertical monopoly lawsuit and also the first ruling in favour of the plaintiff in an antitrust case in China, reported the China Daily.

Lawyers say that the Johnson & Johnson decision will offer businesses some guidance on the application and legality of RPM in China. Yizhe Zhang, a competition law expert and Beijing-based partner at Jones Day, says that China’s current anti-monopoly law does not strictly prohibit RPM agreements. Instead, the law only forbids RPM if it is found to be restricting competition. “From a theoretical point of view, you cannot prosecute a company just based on the RPM contract itself, because the law requires that there is some negative effect on competition,” says Zhang. “RPM can sometimes be beneficial in certain circumstances, like eliminating the problem of free-riding, and helping to promote brand image or product safety. However, the pro-competitive benefits are very difficult to prove in practice. On the other hand, restriction on competition is obvious in most cases. That’s why RPM was found to be illegal in most, if not all, cases,” she adds.

On Aug. 7, the NDRC – China’s top economic planner and enforcer of its antitrust rules on pricing – fined six baby formula makers a record total of $110 million following a four-month investigation into price fixing and anti-competitive practices. At the receiving end of the penalties were Mead Johnson, France’s Danone, New Zealand’s Fonterra, Abbott Laboratories, Dutch dairy cooperative FrieslandCampina and Chinese firm Biostime International Holdings.

The NDRC said the milk powder companies broke China’s five-year-old anti-monopoly law by having RPM agreements in place with its distributors. The companies used methods such as contracts, direct and covert fines and rebates, as well as controlling and cutting supply to get retailers to comply.

Biostime was fined the equivalent of 6 percent of its 2012 China sales, the highest of those penalised. Mead Johnson was penalised the equivalent of 4 percent of its 2012 sales, while Danone, Abbott, FrieslandCampina and Fonterra were each told to pay 3 percent of last year’s sales. A day after imposing the fines, the NDRC toughened its stance further and threatened heavier fines against companies involved in price fixing and anti-competitive behaviour. “These are really significant fines for China, which has typically not issued large fines for antitrust violations,” Peter Wang, a Shanghai-based antitrust partner at Jones Day, told Reuters.

Cause for concern?

Wang added that while a Chinese firm got the biggest rap on the knuckles, foreign companies were clearly no longer shielded from NDRC investigations. “It is a shift in that the foreign companies are so prominently being pursued. But that is normal. That is the way you would expect the antitrust system to mature,” Wang told Reuters.

Other analysts too have claimed that foreign companies are being actively pursued by the NDRC. However, Zhang does not see a particular increase in attention on foreign companies. “The NDRC is targeting both domestic and foreign companies. After the anti-monopoly law came into effect in 2008, I have seen a mix of investigations involving both foreign and domestic companies, including state-owned enterprises,” says Zhang. Indeed, it was Guangzhou-headquartered Biostime that received the heaviest fine out of the six baby formula makers.

Despite negative publicity and heavy fines on the foreign firms, analysts say this is unlikely to damage the reputation of the affected companies. Some add that foreign infant formula makers might actually increase their market share because of the price cuts. “It will have an impact on domestic brands over the long term as the prices of high-end premium brands come down. Customers will tend to buy the foreign brands as the price gap between domestic and foreign brands narrows,” Jacqueline Ko, an analyst at Maybank Kim Eng Research, said to Reuters. But the essence of antitrust law is to protect competition, not competitors, says Zhang: “The purpose is to promote competition so it will bring down the price and create better quality goods for consumers. Ultimately, the consumers will be the ones to benefit.”

Grey areas

Foreign companies are said to be more compliant and aware of anti-monopolistic principles largely due to the developed anti-monopoly laws in other countries in which they operate. However, lawyers say that despite the NDRC’s recent crackdown, foreign firms operating in China are still unlikely to self-report violations of the anti-monopoly law, partly because the procedural rules in China are hazy. “Right now, the self-reporting procedure is not as transparent as in other jurisdictions like the U.S. and EU. In China, some companies might feel hesitant to turn themselves in, because they do not know what will happen if they do. However, the NDRC, in its decisions on baby formula makers, has started to encourage companies to self-report and make voluntary corrective actions by granting exemptions or a reduction of fines,” says Zhang.

Meanwhile, the NDRC has upped its efforts, and is carrying out separate pricing investigations into 60 foreign and local pharmaceutical firms, as well as companies involved in gold trading, reports Reuters. For her part, Zhang expects to see more investigations in the next few months, especially across industry sectors like automobiles, telecommunications and banking.

The NDRC has sent a clear message in its recent handling of price-fixing investigations: When it comes to rooting out offenders of China’s anti-monopoly law, no stone will be left unturned. “Both foreign and domestic companies will need to re-evaluate their business practices, and should avoid RPM agreements because they are very risky in China,” advises Zhang. With consumer goods companies under the NDRC’s microscope, not only is the risk greater, but so is the severity of the punishments. Companies will need to carefully review their business models and operations in China to ensure compliance with the antitrust law. Failing to do so may result in severe consequences.

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