EC competition policy: Contradictions March 2012

The European Commission’s airline competition policy is coming under increasing scrutiny with regard to the apparent contradiction between its apparent support for mergers and deep alliances among intercontinental network carriers and its opposition to mergers between intra-European point-to-point operators.

The EC’s approach to analysing the competitive implications of mergers concentrates on direct city-pairs (rather than wider markets or networks). So when it conditions a merger it normally demands the surrender of slots on main routes on which the merging carriers operate. Have these forced slot sales to new or existing competitors restored competition on consolidated routes?

The answer in a study by the Dutch consultancy Airneth is that only 36% of all slot surrenders result in new entry and just over half of these new entrants managed to operate the routes for more than two years after entry (20% of the initial slot surrender demands). The slot remedies required for approval of the Vueling-Clickair merger have had the highest rate of new entry, at 68%, due to Ryanair’s entry into the Barcelona and Valencia markets. New entry is substantially lower on hub-to-hub routes than on other city-pairs, and on long-haul compared to short-haul. Airneth’s analysis showed that competition didn’t return to the levels that existed pre-merger on any of the seven intra-Europe remedy routes affected from five mergers (Air France-KLM, Lufthansa-Austrian, Lufthansa-Swiss, Lufthansa-Brussels and Iberia-Vueling-Clickair).

The ineffectiveness of remedies on short-haul routes is because these slot surrenders largely do not relate to the needs of the European LCCs. The timings of the slot pairs divested by network carriers tend to be incompatible with LCC operations. Most LCCs operate 25-35 minute turnaround times (TATs) while many of the short-haul slot sales by network carriers were for slot pairs with much longer TATs.

Also, the EC often requires the acquiring airline to commit to operate the particular route for a minimum of four seasons (two years), and in some cases eight seasons have been required. This introduces a risk of significant losses for several years on the part of the new entrant. In the case of a slot-constrained airport, a new entrant or one without a “viable presence” must assess the prospects of being able to grow to a viable size at that airport and the extent to which the incumbent network carrier will be able to sustain a price war to fend off the new entrant. The weakness of airline merger policy from the perspective of an LCC is that it doesn’t take account of the barriers to entry in many markets.

Chris Gadsden, Regulatory Affairs Manager at easyJet, suggests the EC authorities should simply address the following two issues:

• Can a new carrier enter airports affected by a merger (and obtain peak slots)?
• Can a new carrier compete in a meaningful way — what is the risk that the merged entity would “destroy” the new competition?

Meanwhile, Alexander Italianer, the Director General for the EC’s Competition Directorate, has been explaining some of the methodology behind the EC’s two prohibition decisions. In the case of Aer Lingus/Ryanair, he argued that the wealth of data on competing routes provided by the two parties allowed for a relatively sophisticated econometric analysis of the effects of a merger on passengers and that this analysis indicated that it would “not have been a good deal” for the affected passengers.

In the case of Olympic/Aegean, by contrast, the data provided was not sufficient to carry out the relevant analysis; there was also a lack of detailed historical data, owing in part to Olympic’s privatisation in October 2009. Curiously, the EC has yet to officially publish its reasons for blocking the Olympic/Aegean merger in January 2011. There are suggestions that the EC sought one or both of these remedies: divestment of part of the joint fleet and/or the transfer of one of the two brands to a third carrier. It is difficult to comprehend the logic behind the former remedy as the only way such an asset sale could be successful to a new entrant would be in the event of a fire sale. The second remedy pre-supposes the existence of a candidate for new entry into a Greek market.

One crucial factor that may have not been given adequate attention in the Greek case is the “failing firm” argument which allows for otherwise anti-competitive mergers when one or both of the merging parties face possible liquidation, which has become a distinct possibility in the backdrop of the ever worsening Greek economic situation.

In any case, Olympic and Aegean appear to have agreed on a virtual merger; Olympic has withdrawn from western European cities (selling its Heathrow slots to Aegean), Aegean has withdrawn from eastern European points, pricing by the two airlines the domestic market is remarkably close, and they share business lounges. There are of course no cost benefits from rationalising the two managements, as should have happened in an actual merger.

The fact that the only airline mergers that have been blocked by the EC since 2004 are Aer Lingus/Ryanair and Olympic/Aegean would add weight to those such as Hubert Horan, a US analyst, who argues that the EU is wedded to its O&D approach to analysing markets, largely ignoring network effects on competition when it suits its wider objectives, and rubber stamping the various North Atlantic anti-trust immunity (ATI) applications. In 1991, Hubert Horan’s analysis indicates that the top three market leaders on the North Atlantic accounted for 51% of the market, with 15 other competitors having market shares of over 2%. By 2001, this had changed slightly to 47% and 11 respectively. However, by 2012, the top three, which he terms the “LH-led, AF-led and BA-led collusive alliances, accounted for 98% of the market. He lambasts the US Department of Transport (DOT) which has effectively decided that “every reduction of competition reduces fares”. But Horan’s analysis of DOT data shows that average fares on North Atlantic routes have risen three times faster than US domestic fares since consolidation via mergers and granting of ATI gained pace after 2004.

Part of the motivation to consolidate now comes from the inexorable rise of the Gulf-based super-connectors — Emirates, Etihad and Qatar Airways. Some of the European network carriers have been lobbying the EC through various industry associations, mainly the AEA, claiming unfair competition – the inevitable “level playing field” argument.

However, there seems to be a lack of robust evidence against the Gulf carriers to date. EU Regulation 868 regarding state aid to non-ECAA carriers has never been invoked despite the fact that many airlines around the world that compete with European carriers receive some form of state subsidy. Using it against the Gulf carriers might appear to be being selectively targeting those airlines who are a competitive threat to the EU incumbents.