Exclusionary Conduct in the Airline Industry

Exclusionary Conduct in
the Airline Industry

John Kallaugher
Latham & Watkins
Visiting Professor
University College London

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INTRODUCTION

•   Recent Airline Cases Highlight Issue of
    Exclusionary Conduct
    • AMR – US – July 2003
    • Air Canada -- Canada – July 2003
    • Lufthansa/Germania – Germany 2002

•   What are lessons for EU?

                                              1

AMR

•   AMR responded to low cost entry on DFW city
    pairs by:
     • Matching fares
     • Increasing capacity
     • Allocating more seats to lower fare classes

•   AMR internal models had predicted that these
    steps would not be profitable

                                                     2

AMR

•   US law test for predatory pricing
    • Below appropriate cost measure
    • Possibility of recoupment

•   Issue in AMR was what cost measure to use

•   Cost issue was cost of “added capacity”

                                                3

AMR

Cost tests (based on tests used in AMR internal systems):

•   Fully allocated earnings plus upline/downline contribution
    net of costs (NO -- approximated total costs – not variable
    costs)

•   Variable earnings plus upline/downline contribution net of
    costs (NO arbitrary allocation of system variable cost)

•   Short run profit maximization (NO it showed foregone
    profit as cost)

                                                           4

Air Canada

•   Two sample routes for application of new
    predation test in Canadian Airline Regulations

•   Competition tribunal considered how
    “avoidable cost” test of regulations should be
    applied

                                                     5

Air Canada

•   Controversial aspect of decision – definition
    of “redeployment/recapture” and “disposal” as
    basis for avoiding costs

                                                6

Air Canada

•   Tribunal found that
    •   System labour costs
    •   Station labour costs
    •   Aircraft labour costs
    •   Non-labour system and sunk costs
    •   Aircraft ownership and insurance

             were all avoidable costs
                                           7

Lufthansa/Germania

•   Germania entered FRA-TGL in competition
    with LH

•   LH matched Germania fare

•   Cartel Office ruled that higher quality of LH
    product meant that same price was actually
    undercutting Germania

•   LH ordered to increase fare by 35 Euros
    (30.50 on appeal)
                                                    8

Lufthansa/Germania

•   Legal Test:
        Balance interests of parties to protect
        competitive structures and chances of
        market entry

•   Court found
    •   only objective reason for conduct was to
        exclude Germania
    •   But no evidence of subjective intent
                                                   9

Comparing the Cases

•   Interesting issues on costs
    •   What is avoidable costs?
    •   When are averages relevant?
    •   How do you allocate costs?

•   Interesting issues on revenues
    •   Allocation of upline/downline revenue
    •   Do you look at revenue or at fare classes?

                                                 10

Legal Test Follows Policy

•   Real lesson – abuse test follows policy
    •   US: policy based on consumer welfare/preventing
        economic harm means strict cost-based approach

    •   CANADA: sympathy for cost-based approach
        tempered by “paramount position” of AC -- more
        intervention justified

    •   GERMANY – Ordoliberal structural approach
        justifies high level of intervention – cost-based test
        less relevant
                                                                 11

Policy Choices for Article 82
                in Airline Sector

•   Approach based on effects on structure
    Or
•   Approach based on likely consumer harm

                                             12

Traditional Article 82 Approach
                is Structural

•   The “Field of Dreams” Approach

•   Increasing “Barriers to Entry” is Abuse

•   Barriers to Entry Defined Broadly

•   New Entry Presumptively a “Good Thing”

                                              13

Problems of Structural Approach

•   Structural approach is static and historical

•   Structural approach requires robust market
    definition

•   Structural approach requires “hands on”
    intervention

•   Structural approach leads to false positives –
    consumer loss

                                                     14

Structural Approach requires Robust
          Market Definition

•   Otherwise no economic validity

•   Suggests that should not be applied
    where market definition is less than
    robust

                                           15

Market Definition in Air Transport
             is not “Robust

•   No need to revisit question of market
    definition based on city pair markets

•   But this definition is not strong – it does
    not cover many important aspects of
    airline competition

                                                  16

Aspects of Airline Competition
       Outside O&D City Pairs

•   Network vs. Low cost
•   Capturing connecting traffic
•   Planning and capacity allocation
•   Corporate accounts
•   Tour operators

                                       17

Consequences of Non-Robust
            Market Analysis

•   Weakness of market definition means
    that relationship of structural effects to
    real consumer harm is tenuous

•   Competition authority must act on faith

                                                 18

Structural Approach Requires
      Micromanagement by Competition
                   Authority

•   Remember British Midland / Aer Lingus?

•   How could Lufthansa know it was supposed
    to charge 35 Euros more than Germania
     • Or was it 30.5?

                                             19

Structural Approach leads to
            Consumer Loss

•   Prohibiting Lufthansa price-matching
    directly harms consumers

•   Limiting FFPs directly harms consumers

•   Re-allocating slots directly harms
    consumers

                                           20

Conclusion

•   In air transport intervention only makes sense
    where there is likelihood of consumer harm

•   Structural approach is inadequate

•   Argues for
    •   strong cost-based tests
    •   Scepticism on non-price abuse

                                                 21