Businesses have used different ways to ensure customer loyalty – supermarkets started with loyalty cards (which entitle customers to a discount on subsequent purchases), credit card companies started offering free points on every purchase and recently, Freecharge sells free coupons of equivalent value on every mobile recharge, Standard Chartered Bank and ICICI Bank started offering a cash-back option on the purchase of Samsung smartphones.

Loyalty programs can be extremely novel – however, businesses creating loyalty programs in India need to ensure that they are not in violation of India’s competition law.

How is competition law relevant for startups and SMEs?

Apart from the possibility of using competition law against their ‘larger competitors’, startups may also have to be careful about not committing competition law violations themselves. Competition law becomes relevant, especially for startups which have scaling up fast (e.g. Flipkart), for a very simple reason – many startups are now emerging in newer market segments, which are often unpopulated by the established industry giants. These startups gain market share very quickly in a new market, which can bring their business practices under the radar of competition authorities. Such business practices usually relate to marketing or selling arrangements – startups often enter into several co-branding arrangements, loyalty programs and other ‘bundling’ arrangements with other businesses (these ‘other businesses’ are very often well-established players) to market their products, which can fall under the competition authority’s radar.

The risks of a competition law violation in India can be significant – businesses may have to pay up to 10 percent of their average turnover or a penalty of up to thrice their profit. The Competition Commission (called the CCI) has also become very proactive in the recent past with the enforcement of the Competition Act.

Let’s see what happened to Apple’s distribution strategy when it had launched the iPhone in India. Of course, Apple was a well-established phone manufacturer internationally (and not a startup), but the commission’s attitude towards certain business arrangements will be relevant for startups.

Telecom and loyalty programs

Selling smartphones such as iPhone and Blackberry which are locked to a particular service provider under a contract has been an established distribution strategy in the UK and US. This strategy has tangible benefits for a customer – for example, a locked iPhone 5, which would otherwise cost USD 600 in the US, is available for USD 200 – 300. Apple initially started selling iPhones in India on a similar model – it entered into arrangements with Vodafone, Airtel and subsequently with Aircel to sell locked iPhones (locked iPhone 4 and 5 are still being bundled with Aircel’s services). The CCI, which started an investigation into this strategy, recently issued its decision, to which we will refer shortly.

What were the benefits of this strategy for Apple? Did telecom service providers benefit?

Primarily, there were two benefits of selling locked phones:

1. For Vodafone and Airtel (and later on Aircel), the lock-in ensures that a customer who has purchased a locked iPhone uses their service (and does not migrate to another company) for the duration of the contract, e.g. a 2 year period.
2. For Apple, it reduced marketing and establishing costs – it did not have to open its own retail stores across India and could piggyback its marketing campaign for the iPhones through Vodafone and Airtel’s campaigns.

Does this strategy unfairly affect competition? Does it harm consumer interest?

Did Apple’s strategy unfairly restrict a consumer’s ability to migrate to another service provider? For example, is a customer who uses the iPhone on a Vodafone connection prevented from migrating to Airtel? Would it prejudice Airtel? Does it unfairly prejudice Apple’s competitors in the smartphone market, such as HTC, Sony or Samsung? These are the issues the Competition Commission was asked to decide in case of the iPhone.

Why Apple was saved

Apple’s selling arrangements were given the green signal, for the following reasons:

#1 – iPhone had an insignificant market share in the smartphone market

The iPhone had a very small market share (less than 6 percent in the smartphone market) – typically, a business is required to have at least a 50 per cent market share in the concerned market segment in order to come under a competition authority’s radar. However, depending on the specific arrangement, this may not be the only factor that the commission will scrutinize.

#2 – Customers had some level of freedom to choose the service provider for their iPhone.

Apple had entered into arrangements with multiple operators which had a nation-wide market share, i.e. Vodafone, Airtel and later Aircel – it did not, for example, offer iPhones only through only one of the service providers. Therefore, a purchaser of iPhone anywhere in India had some level of choice while choosing the service provider.

#3 – Customers could also subsequently migrate to other cellphone carriers by paying a small fee to unlock the smartphone which did not create a barrier for migration

We are not sure that it would have arrived at the same conclusion if another company sold locked phones. For example, if Samsung locked all of its premium smartphones to a particular service provider – imagine a situation where the premium Galaxy smartphones such as Galaxy Grand, Note 2, S3 and S4 had 70 percent market share in the higher-end of the smartphone market and all of them were locked to Vodafone, the Commission could have arrived at a different conclusion.

#4 – Consumers could buy iPhones through other means as well, apart from buying locked iPhones

As per the arrangements with Vodafone and Airtel, Apple had the freedom to sell the iPhone through other channels, apart from selling locked iPhones through Vodafone and Airtel. Vodafone and Airtel were required to provide services to customers who purchased unlocked through other channels (although these channels were relatively few at that time). Therefore, a customer using, say, unlocked iPhones which were imported from US would be able to use Vodafone or Airtel’s services on such phones and would not be required to purchase the iPhone through the 2-year contract.

How to build a CCI-proof customer loyalty program in India

Loyalty programs are a great way of retaining customers and ensuring that they keep coming back to you. Here are three simple checks you can observe to reduce the risk of your loyalty program coming under Competition Commission’s scanner:

#1 – What is your market share? Do you have a dominant position in the market in which you operate? For most markets, when a single brand has a market share greater than 50 percent, it leads to a finding of dominance. If you are not dominant, there are lesser chances of yours being held liable for violation of competition laws. However, market share is found out only after investigation by the commission and risk of inquiry still exists, even if the business is ultimately not held liable. Further, the commission has freedom to identify the appropriate market in which you operate – if you are a niche operator or a boutique firm, the commission may identify a smaller market and consider you to be the dominant operator in that market.

#2 – Is the customer free to choose your competitor’s products, or are you excluding the competitor itself from competing in the market?

You are free to offer a cheaper product you can give any discount you wish. However, are you selling your products below cost price? Are you using other methods to eliminate competition? For example, Intel offered attractive rebates to computer manufacturers if they bought all of their processors from it – the European Competition Commission imposed a fine of 1 billion euros for this practice, since it had the effect of completely excluding AMD’s products in the market.

#3 – If you are bundling your products / services with those of other entities (e.g. through co-branding arrangements), how difficult is it for customers to migrate to other?

If you are bundling your products with those of another business (let’s call it a bundling partner) which operates in another market segment (for example, in case of iPhone, we are referring to Airtel and Vodafone as the service providers with which Apple bundled the iPhone), you need to understand how easy or difficult it is for the customer to migrate to competitors of your bundling partner. Are there significant financial or other barriers that would prevent the customer from migrating to alternatives?

This is an excerpt from  diploma course in Entrepreneurship Administration and Business Laws, which has been launched with the objective of simplifying business law for entrepreneurs, managers, decision-makers, working professionals and lawyers. The diploma course is offered in collaboration with NUJS, Kolkata, one of the premier national law universities in India. The course has over 900 students from 12 countries currently. Admissions for the 6th batch of the course will start in November 2014. Click here for more details.