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european flageuropa
the european commission

Competition
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Competition

EUROPEAN AIR LAW ASSOCIATION

11th Annual Conference
Recent developments in European air transport law and policy
Lisbon, Friday 5 November 1999

Panel discussion
"Current issues arising with airline alliances"

Presentation by Mr Joos Stragier
Deputy Head of Unit DG Competition
European Commission

  1. Beneficial and anti-competitive effects of airline alliances

    1. Deregulation has triggered a wave of co-operative arrangements or alliances between airlines. These are mainly designed to achieve fleet rationalisation, expansion and rationalisation of network structure, greater exploitation of cost-side economies of scale and reduction of costs through joint purchasing, joint marketing, etc.

      For historic reasons, both in the US and in the EU, foreign ownership of airlines is severely restricted. Alliances enable airlines to obtain the efficiencies and benefits normally linked with mergers and acquisitions.

      Airline alliances can also offer benefits to the consumer by offering seamless travel and services between a more extensive range of city pairs, reduction in travelling time, joint lounges and co-ordination of FFPs.

    2. The number of airline alliances has rapidly expanded the last few years. More importantly, although the scope and nature of these alliances differ, there is a tendency towards deeper alliances involving co-operation on all aspects of airline business, amounting to virtual merging of the alliance members' activities. Airline alliances therefore raise fundamental questions about their effect on competition in air services.

      • The effect on competition of airline alliances depends upon the nature of the allied networks. In particular, an alliance can significantly reduce competition on overlapping non-stop routes and overlapping connecting routes where the allied airlines were once main competitors. Even where the two networks do not overlap in the markets they serve, the alliance can have serious anti-competitive effects by reducing or eliminating competition on the hub-to-hub route(s) between the networks.

      • Moreover, alliances between airlines operating hub-and-spoke networks will normally enhance demand for the network as a whole and increase the market power of the network, especially at its hub airports. This entails the risk of rendering still more difficult new entry into the network's markets to the detriment of both international and domestic competition.

    3. Alliances, in particular global alliances, can also have a wider impact on international aviation policies. In particular, the question arises whether they are compatible with the long-term perspective of liberalisation of international transport.

    4. The development and maintenance of effective competition in the airline industry requires both effective liberalisation of markets and effective competition enforcement. Liberalisation and competition enforcement are mutually reinforcing policies. In particular, the disappearance of regulatory constraints increases competition between market players, but at the same time it increases the risk of anti-competitive behaviour by airlines which attempt to protect or maintain their previous market positions. Competition policy should seek to prevent that regulatory barriers are replaced by anti-competitive agreements (such as market sharing, price fixing, etc) between airlines or abusive behaviour by dominant carriers, which could significantly reduce or eliminate the benefits of liberalisation.

      Competition enforcement can also play a major role in bringing forward the necessary degree of liberalisation to ensure competitive markets. For example, in the draft proposals concerning the LH/SAS/UA and BA/AA alliances, the Commission envisaged that, in order to ensure a sufficient degree of competition, undertakings would be necessary from the German, Danish, Swedish and Norwegian governments to authorise any Community carrier established in the EEA to operate direct and indirect services between any airport in their territory and the USA and to set its fares freely.

  2. The assessment of intra-Community airline alliances and mergers

    1. In 1987, as part of the first step towards the liberalisation of the EU aviation market, Regulations 3975/87 and 3976/87 were adopted. Regulation 3975/87 (as amended in 1992) gives the Commission the power to apply the basic Community competition rules, i.e. Articles 81 and 82 EC Treaty, to air transport services within the EU. Regulation 3976/87 empowered the Commission to adopt certain group exemptions. Furthermore, the Commission is exclusively competent to deal with transactions, which fall within the scope of the EC Merger Regulation.

      Under the Community competition rules, in particular Article 81 EC Treaty, the Commission can only exempt a restrictive alliance if it considers that the economic efficiencies and overall benefits of the transaction outweigh the anti-competitive effects, and that, in particular, the co-operation's benefits are passed on to the consumer. In practice, the Commission's policy has been to accept the efficiencies and to mitigate all perceived harms on competition by a series of remedies. In case of airline mergers, the substantive test to be applied by the Commission is whether the transaction would lead to the creation or strengthening of a dominant position within the relevant market.

    2. So far, the Commission has only taken few decisions concerning alliances between airlines. They nevertheless serve as a point of reference for the Commission's policy in this field.

      In 1996 the Commission conditionally approved for a period of ten years a co-operation agreement between Lufthansa and SAS setting up an operationally and commercially integrated transport system. The Commission recognised the efficiencies of the co-operation arrangement and the gains for consumers. However, it imposed certain conditions designed to ensure that new entrants would be able to serve the routes covered by the alliance. These conditions concern essentially the giving-up of slots at saturated airports, a freeze on the number of frequencies operated by LH and SAS, the conclusion of interlining agreements with new entrants, participation by the latter in the FFPs of LH and SAS, and termination by the parties of some of their co-operation agreements with other airlines.

      Last August, the Commission took a decision relating to the alliance between Alitalia and KLM. This decision marks a certain development compared to the Commission's previous alliance decisions.

      First, concerning the legal basis, the alliance between KLM and Alitalia has been assessed under the EC Merger Regulation despite the fact that these airlines did not merge nor did they constitute a separate legal entity. However, the parties reached by contractual means such a degree of integration that the operation could be considered as the constitution of a full function joint venture under the Merger Regulation.

      The Commission considered that the KLM/Alitalia alliance was globally pro-competitive, in particular in view of the largely complementary nature of the parties' activities. Nevertheless, the Commission found that the operation would have led to monopoly positions on the two hub-to-hub routes involved by the operation: Amsterdam-Milan and Amsterdam-Rome.

      The Commission conducted several market tests to see what remedies would be necessary to facilitate effective and sufficient new entry on the two problematic routes and to prevent the establishment of a dominant position. The Commission found that the markets in question were characterised by significant barriers to entry such as congested airports at both ends of the routes and the high capacity offered by the parties compared to the relative thinness of the markets concerned. The Commission therefore not only required the parties to release slots at their congested hub airports allowing new entrants to operate a sufficient number of competing flights (up to 4 frequencies on each route, including 2 frequencies at peak times). It also required the parties to reduce their frequencies when a new entrant starts operating on the route. This reduction shall be equivalent to the number of frequencies operated by the new entrant (up to a maximum of 40% of the frequencies actually operated). The parties further undertook: to enter interline agreements with the new entrant airline; to give the new entrant the opportunity to participate in their FFPs; to refrain from tying travel agents by means of loyalty or fidelity schemes, and to allow any new entrant to be displayed in the first CRS screen. In order to ensure long-lasting and credible competition, the parties' undertakings shall remain valid until a competitor has operated on the routes concerned for at least two years.

    3. What conclusions can be drawn from the Commission's practice so far?

      • The approach to market definition for the assessment of competition of airline alliances has been based on city pairs, and a distinction is usually made between two categories of customers, i.e. time-sensitive (mostly business) travellers and leisure travellers. Competition concerns have focused primarily on the effects of alliances on time-sensitive travellers, flying over non-stop routes within city-pair markets.

      • Initially, it was thought that the divestiture of slots could effectively remedy the anti-competitive effects of certain alliances. However, experience has shown that additional measures are required which ensure that potential entrants have effective access to actual passenger traffic, and in particular business traffic, for an initial period of time.

      • While the remedies of the KLM/Alitalia case can to a certain extent serve as a point of reference, it can not be excluded that in future cases additional or different remedies might be necessary. In some cases, where the overlap is very substantial and potential entrants few and weak, prohibition of the transaction may be the only answer.

  3. The Commission's assessment of transatlantic air alliances

    1. The wave of alliances between airlines operating across the Atlantic has led to a number of important competition investigations. Since these alliances affect EU markets for air transport, the Commission has a clear obligation to ensure that they comply with the competition rules set out in Articles 81 and 82 of the EC Treaty.

    2. A number of factors seriously complicate the decisional process.

      • Absence of full liberalisation of international air transport

        International air services between most countries are far from being fully liberalised. Bilateral agreements continue to restrict competition on aspects such as the number of possible flights, the number and the identity of the carriers and the airports that can be served.

        Despite liberalised intra-European air services, flights between EU Member States and non-EU countries are still regulated on the basis of bilateral agreements, which impose a variety of restrictions on airlines. Even the more liberal "open skies" agreements between the US and some EU Member States (such as Germany and the Netherlands) include provisions, which directly limit competition between EU carriers. In addition, a bilateral open skies agreement with the US only benefits companies established in the Member State concerned which are majority owned and controlled by nationals from the Member State. These regulatory obstacles affect competition in transatlantic markets and they prevent European carriers from fully exploiting the internal Community aviation market as a basis for their transatlantic operations.

      • Lack of appropriate jurisdictional and procedural framework

      • While the Community competition rules (i.e. Articles 81 and 82 EC Treaty) fully apply to air transport between the EU and third countries, the Commission does not yet have the same type of investigation and enforcement powers it has in other industries to enforce these rules. Until secondary legislation had been adopted by the Council of Ministers, the Commission can only use the residual powers granted to it by a transitional provision of the Treaty to ensure the application of the competition rules in co-operation with the competent authorities in the Member States. The procedures involved are cumbersome and they do not allow the Commission to enforce decisions recording an infringement of the rules, nor to grant an exemption or impose fines upon infringing companies. The present situation is unsatisfactory and is harmful to industry and the public interest.

        The Commission has proposed the necessary legislation to the Council of Ministers enabling the Commission to apply Articles 81 and 82 EC Treaty to third country routes. Up to now, the Council has not yet adopted the Commission's 1997 proposals. In the meantime, the Commission is forced to continue to use the existing unsatisfactory procedures, which lead to confusion and legal uncertainty.

      • Potentially conflicting decisions and remedies

        A potential problem for airlines operating in an open global market environment would be that they might be subject to the competition rules of different constituencies. For example, alliances between airlines operating across the Atlantic are subject to the competition laws of both the EC and the US. The difficulty is that two or more competition authorities could reach conflicting or incoherent decisions. However, this is a relatively common issue in many global industries, and tried and trusted mechanisms exist to deal with it. For example, since 1994 the EU has had a co-operation agreement on anti-trust enforcement with the US Department of Justice and the Federal Trade Commission. Despite the differences in the respective competition laws and procedures, co-operation in the application of EU and US competition law in other global industries has been successful avoiding the potential problems of diverging decisions or inconsistent remedies. Moreover, this type of co-operation also leads to a certain convergence in how our different rules are applied.

        Further liberalisation of international air transport, and in particular between the EU and the US, should therefore not be conditional upon the creation of a common harmonised set of competition rules. Apart from the legal and technical problems that such approach entails, our successful experience of co-operating with the US authorities in other global industries makes us confident that extending this co-operation to air transport matters would avoid potential problems of having different competition rules to apply to international air transport markets. Practically speaking, the current EU/US co-operation agreement could be broadened or serve as a point of reference for co-operation with the US Department of Transport, which is responsible for applying US competition law to international aviation.

      • Analytical problems

        A major question in transatlantic airline alliances is whether, for time-sensitive passengers, competition should be assessed by reference to direct non-stop services between each of the relevant transatlantic city pairs, or whether indirect flights should be included in the relevant market for such long-haul routes. Another question is whether these traditional route-by-route or city-pair based approach to market definition is still appropriate in view of the trend towards network competition between alliances.

        Although it is true that airlines find it very important to increase the size of their network through the conclusion of global alliances, and, from a commercial point of view, present a large network to the public as being an advantage, this does not mean that this is the appropriate market definition for competition law purposes. Competition law is concerned with effects on the consumers of goods and services, and the first step in any market definition is to identify a group of products or services that consumers consider as substitute for each other. The question whether and to what extent indirect flights should be included in the relevant market for the assessment of the different transatlantic air alliances is not yet finally settled. Further empirical market investigations will be undertaken on a case-by-case basis.

      • Unstable alliances

        Airline alliances may change rapidly and are still to an extent in a state of flux.

        The apparently most stable and developed alliance is the Star alliance, based on Lufthansa/SAS/United Airlines. Other European carriers set to join are Austrian Airlines and British Midland.

        The Commission adopted in July 1998 a draft proposal under Article 85(1) (ex Article 89 (1)) EC Treaty setting out its preliminary competition assessment of the LH/SAS/UA alliance. The Commission made it clear that, in its view, clearance of the alliance agreements would be subject to conditions, including amongst others divestiture of slots and frequency reduction. The alliance members have been given the opportunity to respond to the Commission's preliminary assessment. The Commission is currently considering the various points raised by the parties, in particular the Commission's approach to market definition.

        The Commission also investigated the British Airways/American Airlines alliance and it adopted a draft proposal under Article 85(1) (ex Article 89(1)) EC Treaty in July 1998 indicating the conditions which needed to be fulfilled for clearance of these alliances under Community competition law. At the same time, and in contrast to the LH/SAS/UA alliance, the US Department of Transport did not grant antitrust immunity to the BA/AA alliance absent an Open Skies Agreement between the UK and the US and it has recently formally rejected the parties' application for antitrust immunity. The fate of the BA/AA alliance is therefore at present uncertain. It would appear that the parties have decided, at least temporarily, to scale down their co-operation and integrate their alliance in a looser form into the One World Alliance. The Commission's current proceedings will have to be reviewed in the light hereof.

        A third transatlantic alliance is built around KLM and Northwest and is set to be broadened with Alitalia following the latter's alliance with KLM. At the same time, Continental Airlines may join the alliance.

        The most recent major development is the alliance between Delta and Air France which was announced in June of this year and which is expected to be completed by the end of 1999. Following this new agreement, the fate of the Atlantic Excellence Alliance between Delta, Swissair, Sabena and Austrian Airlines is uncertain. Meanwhile Sabena and Swissair have announced a marketing alliance with AA and Austrian Airlines has chosen to join the Star Alliance.

  4. Conclusions

    1. Co-operation between airlines can facilitate the healthy restructuring of air transport in Europe and lead to an improvement in the quality of consumer services and better cost control. The Commission takes in principle a favourable attitude towards co-operation, in particular alliances, between airlines. However, the Commission must ensure that effective competition on all markets is maintained and that the alliances do not rule out opportunities for real competition from new operators on the main routes.

    2. Concerning global alliances, in particular transatlantic alliances, it is essential that further steps be taken to fully liberalise air transport services between the European Union and third countries. Moreover, the procedural framework for investigating such international alliances must be simplified and made more effective; in particular through the adoption of the Commission's proposals to extend its powers to apply directly the Community competition rules to air transport services on third country routes. At the same time, co-operation between the respective authorities which are responsible for competition enforcement must be strengthened with a view to avoid conflicting decisions and remedies and to enhance convergent application of the competition rules.

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