Towards a more sustainable approach in European competition Law? A discussion based on the example of merger control in the aviation industry

Daniel Metz* & Agnes Fischl**

ABSTRACT

The objective of this paper is to explain how environmental and sustainability aspects can be taken into account in European merger control. We explain why there is currently a need to take environmental and sustainability aspects into account in competition law and describe the legal framework for the application of such aspects in the area of merger control. We then develop a theoretical concept of a more sustainable approach and describe how this model could be applied to airline mergers. Finally, we argue that there is already a scope, albeit a narrow one, for the consideration of environmental and sustainability aspects in European merger control. 

I. INTRODUCTION

For decades, there has been literature on how to take account of non-competitive considerations in competition policy.[1]  In the field of European competition law, the Wouters judgment of the ECJ of 2002 is often cited to justify the consideration of general interests (in the context of Article 101(1) TFEU).[2] Nonetheless, a practical application of these considerations has so far remained only theoretical.  This consideration was revived in the context of the Siemens/Alstom merger, which the Commission prohibited because of competition concerns, even though the merger was supported by policymakers on the basis of overriding general interests.[3] Following on from this, Germany and France published a joint manifesto for industrial policy in 2019, calling for more flexible European merger control, which should also include industrial policy considerations.[4]

Apart from these economic and political considerations, mankind is facing immense challenges caused by climate change. The new European Commission under Ursula von der Leyen, for example, has declared the European Green Deal, which aims to make the European Union climate-neutral by 2050, to be its top priority.[5] The following quote from Margrethe Vestager, Commissioner for Competition, should also be seen in this context: "Sustainability has gone from being something we talk about, to a central goal of policies around the world. All of Europe's policies - including competition policy - have a role to play to get us there.".[6] This raises the question of how environmental and sustainability aspects can be taken into account in competition policy.

A.     Concept of competition and new challenges for competition policy

Competition policy is one of the most important areas of state regulatory and economic policy. The main purpose of competition law is to ensure and protect effective competition in the interests of consumers and businesses. However, a rational and science-based competition policy requires a clear and coherent agreement between political and economic actors on what competition is. The supposedly easy answer to this important question is more complex than one would expect, since the ideas of competition, parallel to the current economic and social order, are in a constant process of transformation.

The question then arises as to whether the current social and economic market conditions still correspond to the initial situation as they were at the time the concepts of competition were established. In contrast to the 20th century, which can be described as the starting point for the present competition concepts, two major changes in market conditions can be observed:

(i) The world population has risen since 1927 from around 2 billion to almost 8 billion people today, with a further increase of 2 billion people expected in the next 30 years.[7] 

(ii) Climate change and the associated consequences require a strong reduction in CO2 emissions, also with a view to achieving the 2-degree objective of the Paris Agreement.[8]

On this basis, the following conclusions can be drawn for future competition policy: With steady population and economic growth, value chains must be designed to be climate-neutral.  Companies must increasingly focus on new recycling technologies and improve their energy and resource efficiency.  In addition, companies will have an increased capital requirement for research and the implementation of progressive environmental protection and sustainability measures.  A stronger cooperation between companies will also become necessary.

In the sense of a classic market economy approach, it could now be argued that no state steering effects are necessary with regard to these changes, because companies, which do not operate in a resource- and energy-efficient manner, will not survive on the market in the long term. This argument, however, ignores essential market parameters. For a large number of products, the resulting environmental costs are not reflected in the price, but are incurred by the general public. This shifting of costs to the general public can lead to a distortion of prices.  It should also be noted that existing steering models (such as the European Union Emission Trading Scheme) or market-inherent incentive systems (such as environmental protection as a competitive advantage over competitors) are often insufficient to achieve climate targets. In this respect, the thesis can be put forward that today's competition policy must pay more attention to sustainability and environmental protection aspects.

B.     Contradiction between competition and environmental protection?

First of all, it should be noted that there is no inherent contradiction between competition and environmental protection, because environmental pollution is not a direct consequence of a market-based economic system, but is generally an imprint of an industrial social order.  However, there are many interactions between competition and environmental protection, because both regulatory issues pursue the same ultimate goal, namely the optimal allocation of resources.[9] Furthermore, there may also be restrictions between competition and environmental protection. The degree of restriction depends on the specific implementation in each individual case. For instance, the likelihood of a restriction of competition through environmental protection measures will normally decrease the broader the scope of the environmental protection measure is defined. For instance, if an environmental protection measure only applies to one industry (e.g. air transport) but not to another industry (e.g. rail transport), the risk of a restriction of competition through this environmental protection measure increases.

II. ENVIRONMENTAL AND SUSTAINABILITY CONSIDERATIONS IN EU MERGER CONTROL

Article 2 of the EU Merger Regulation 139/2004 (EUMR)[10] contains the assessment basis for the substantive examination of concentrations with a Community dimension. According to Article 2(2) and (3) EUMR, it is decisive whether a merger would significantly impede effective competition in the common market or in a substantial part of it, in particular by creating or strengthening a dominant position. The significant impediment to effective competition, also referred to as SIEC test is the central material assessment criterion of European merger control.

The EUMR allows for the consideration of environmental and sustainability aspects, albeit in theory and within a narrow framework. According to Recital 23 of the EUMR, the Commission must be guided by the fundamental objectives of the European Union when assessing a merger. Recital 23 also explicitly refers to Article 2 of the Treaty establishing the European Community, which, inter alia, sets as objectives of the European Union the sustainable development of economic activities and a high level of protection and improvement of the quality of the environment. Academics support the inclusion of sustainability and environmental considerations in the examination of efficiency gains.[11]  In this sense, sustainability and environmental factors could be assessed as possible efficiencies that outweigh the negative effects of a merger.[12]

In practice, however, no significant consideration of environmental or sustainability aspects has yet been given to merger control. Since the early 2000s, the European Commission has increasingly adopted a more economic approach in the implementation of its competition policy.[13] According to this approach, economic models are to be increasingly used for decision-making in competition law proceedings. A merger of companies is to be prohibited above all if it is highly likely to lead to rising prices and/or declining quality. Furthermore, there has never been a case in which a merger that led to a significant impediment to competition was cleared solely on the basis of efficiency gains.[14]

III. A CONCEPT FOR A MORE SUSTAINABLE APPROACH FOR MERGER CONTROL IN THE AVIATION INDUSTRY

The European Commission takes a fundamentally positive view of consolidation in the European aviation industry but examines concrete mergers of airlines very carefully.[15] Therefore, most airline mergers in Europe became subject to remedies.[16]

A.     The problem of today’s merger control in the aviation industry

Taking the example of the strict merger control following the Air Berlin insolvency in 2017, which gave consumers the lowest air fares since 2012[17], it can be argued that the consistent application of merger control has clearly been successful, at least if one thinks within the current concept of competition and adopts its regulatory and evaluation apparatus. If one places consumer welfare in the sense of economic efficiency at the forefront of state competition policy, then a number of things have been done right in European air transport recently. But should consumer welfare, and therefore ultimately also price, be the primary assessment criterion for competition?

The downside of this competition policy is that parameters such as environmental protection and sustainability are only given secondary consideration. And since environmental goods are public goods, the resulting environmental costs are not reflected in the prices, but have to be borne by society. Even if they were serious about it, airlines find it difficult to include the overall environmental costs in their air fares because of the high level of price competition in the aviation industry.

It is therefore questionable whether a competition policy based purely on low prices for consumers hinders urgently needed climate protection measures? At least for the aviation industry, it can be argued that due to fierce price competition and low profit margins for airlines[18], there is little room for costly environmental and sustainability measures. For this reason, competition policy could reward airlines that nevertheless introduce progressive environmental protection and sustainability measures. In this sense, rewarding means that the implemented environmental protection and sustainability efforts are evaluated in terms of an overall assessment, for example in the case of a merger. This is not about removing competition concerns, but about creating incentives for environmental and sustainability measures.

B.     Concept of a more sustainable approach

The concept of a more sustainable approach for merger control in the aviation sector could be oriented towards promoting and rewarding positive measures by airlines in the field of environmental protection and sustainability. This does not mean that airline mergers that raise competition concerns would now be cleared if the merging parties could demonstrate positive efforts in the area of environmental protection and sustainability. Rather, it is a question of taking into account aspects of environmental protection or sustainability in addition to known parameters such as market shares at airports or the number of slots as part of an overall assessment. In principle, these considerations would be possible (1) in the area of efficiencies or (2) in the area of remedies.

(1) Efficiencies

As discussed above, under the Commission's horizontal merger guidelines it is possible that the efficiencies generated by a merger may outweigh the resulting impediments to competition.[19] Efficiency gains are usually described in terms of purely economic competition parameters, such as cost savings or economies of scale.[20] However, it is questionable whether this view is not too narrow, i.e. too much reliance on purely economic parameters.

According to paragraph 76 of the horizontal merger guidelines: "Corporate reorganisations in the form of mergers may be in line with the requirements of dynamic competition and are capable of increasing the competitiveness of industry, thereby improving the conditions of growth and raising the standard of living in the Community".

Recital 4 of the EUMR also states: "Such reorganisations are to be welcomed to the extent that they are in line with the requirements of dynamic competition and capable of increasing the competitiveness of European industry, improving the conditions of growth and raising the standard of living in the Community".

It is therefore evident that the assessment of efficiency gains is ultimately based on living standards in the Union. And environmental protection and sustainability are undoubtedly part of the overall standard of living.[21] It can therefore be argued that environmental protection and sustainability factors can be seen as efficiencies in the broader sense. In order for efficiencies to be taken into account under the EUMR, they (i) must benefit consumers, (ii) be merger-specific and (iii) be verifiable.

(i) Benefit to consumers:

The benefit for consumers may arise from the fact that the merger of airlines may have positive effects on environmental protection or sustainability. Consumers benefit indirectly because, for example, they can profit from a reduction in CO2 emissions or sustainable business practices in the form of an improved quality of life. According to the horizontal merger guidelines, the efficiency benefits should be realized in time.[22] In the area of environmental protection measures, the focus should not be on the time of the (measurable) impact on the environment, but rather on the time when the environmental protection measures are taken. It is only important that, from an objective point of view, the environmental protection measures can ex ante lead to positive effects on the environment. In the case of a CO2 reduction as a result of a merger, positive effects would therefore probably have to be assumed in principle, which can already arise from the time of the first CO2 reduction. The same will apply to sustainable measures, such as the use of plastic-free materials.

(ii) Merger specificity:

The efficiencies must be a direct consequence of the notified concentration and must not be capable of being achieved to a similar extent by less anti-competitive alternatives.[23] A possible scenario could be the following: The large airline A, which does not have a specific environmental and sustainability policy, is economically weakened and is for sale. Airline B, which is a leading airline in the field of environmental protection and sustainability, wants to buy Airline A. The Commission takes a critical view of the merger because it would further increase the already high market shares of Airline B at certain airports. As a result of the merger, Airline B would introduce its advanced environmental and sustainability programmes to Airline A. For example, Airline B would invest in new low-emission aircraft for Airline A and extend its biofuel and zero-waste programme to Airline A. As a result, the merger would lead to efficiencies in environmental protection and sustainability. Merger specific efficiencies would be all the more significant if airline A operated in country X and airline B in country Y. The merger would lead to efficiencies in terms of environmental protection and sustainability measures in country X, which would ultimately improve the quality of life in country X and in the Union as a whole.

(iii) Verifiability:

The efficiencies have to be verifiable, such that the Commission can be reasonably certain that the efficiencies are likely to materialise.[24] Since the effects of environmental protection and sustainability measures are difficult to prove ex ante, the criterion of verifiability must not be applied too strictly.[25] It should therefore be sufficient for airlines to set out their environmental protection and sustainability measures and to provide an estimate of the positive effects on the environment based on current scientific criteria.

(2) Remedies

In the case of large mergers, it is common for the notifying parties to offer commitments to address the Commission's competition concerns.[26] The Commission may then grant clearance under Articles 6 and 8 EUMR, subject to conditions or obligations. As the primary purpose of such commitments is to remove the competition concerns raised by the notified concentration, it is in principle unlikely that behavioural commitments in relation to environmental and sustainability measures will be able to remove such competition concerns.

In practice, it is more likely that behavioural commitments regarding environmental and sustainability measures could be part of a package of commitments. In the aviation industry, for example, structural commitments, such as slot divestitures, are very often agreed.[27] It is feasible that behavioural commitments regarding environmental protection and sustainability measures could be combined with such structural commitments. This would make it possible to include environmental protection and sustainability aspects in merger control.

From a legal point of view, however, two problems arise: Firstly, it is questionable whether the Commission is not exceeding its competence by actively including behavioural commitments on environmental protection and sustainability measures for the purpose of promoting environmental protection. Secondly, it must be taken into account that such behavioural commitments with regard to environmental protection and sustainability measures can, in principle, never eliminate the concrete competition concerns of a merger. Such behavioural commitments can, at most, be a positive "add-on" to structural commitments (such as slot divestiture) and can be interpreted positively in a prima facie manner for an undertaking in the form of a goodwill. However, it is important to recognise that competition concerns (as in the past) are primarily removed only by "genuine" remedies.

IV. CONCLUSION

Already under the current EUMR regime, environmental and sustainability aspects could play a role in merger control. These aspects are most likely to be taken into account in the examination of efficiencies. However, it should be noted that environmental and sustainability aspects cannot, in principle, remove competition concerns. On the contrary, environmental and sustainability aspects could become more important in the context of a comprehensive balancing of possible positive and negative effects. It is therefore a question of extending the catalogue of balancing criteria to include environmental protection and sustainability aspects, because the Commission generally examines mergers from a strictly economic point of view. Ultimately, the question of integrating environmental protection and sustainability aspects into competition policy is also a political question, because it concerns the hierarchy of European Union law. Does European competition law only serve competition as such or possibly higher-ranking objectives of the European Union such as those of environmental protection or the standard of living of its citizens?  In this sense, where there's a will there's a way!

* Daniel Metz is a graduate student at the Faculty of Law of the University of Vienna and founder of ‘Aviation and Competition Law Research’, a non-profit research organisation for competition law issues in the aviation industry.

** Agnes Fischl is a researcher at Aviation and Competition Law Research and has been involved in sustainability research for many years.

[1] For example Miriam Lenz, The interplay between the environment and competition law in the EU: an analysis of environmental agreements and their assessment under Article 81 EC (2000); Suzanne Kingston, The Role of Environmental Protection in EC Competition Law and Policy (2009).

[2] See further Case C-309/99 Wouters v Algemene Raad van de Nederlandse Orde van Advocaten [2002] ECR I-1577.

[3] See Siemens/Alstom (Case M.8677) decision of 6 February 2019.

[4] A Franco-German Manifesto for a European industrial policy fit for the 21st Century (19.02.2019) <https://www.bmwi.de/Redaktion/DE/Downloads/F/franco-german-manifesto-for-a-european-industrial-policy.pdf?__blob=publicationFile&v=2>.

[5] Communication on The European Green Deal, COM(2019) 640 final (11.12.2019) <https://ec.europa.eu/info/sites/info/files/european-green-deal-communication_en.pdf>.

[6] Tweet of Margrethe Vestager regarding the GCLC Conference on Sustainability and Competition Policy (24.10.2019) <https://twitter.com/vestager/status/1187308316973850625?lang=de>.

[7] United Nations, World Population Prospects 2019.

[8] See further Paris Agreement under the United Nations Framework Convention on Climate Change (22.04.2016).

[9] Jose´ Carlos Laguna de Paz, Protecting the Environment Without Distorting Competition (2012) Journal of European Competition Law & Practice, 2012, Vol. 3, No. 3, p 249.

[10] Council Regulation (EC) No 139/2004 of 20 January 2004 on the control of concentrations between undertakings, Official Journal L 024, 29/01/2004 P. 0001 – 0022.

[11] See Suzanne Kingston, The Role of Environmental Protection in EC Competition Law and Policy (2009) 222;  

Simon Holmes, Climate Change, Sustainability and Competition Law (Draft 26/09/2019) 23.

[12] See further Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings (Horizontal merger guidelines) 2004/C 31/03, para 76-88.

[13] See further Nadia Calvino, When do Mergers Raise Concerns? An Analysis of the Assessment Carried out by the European Commission under the New Merger Regulation (2011) Journal of European Competition Law & Practice, 2011, vol. 2, no. 6, pp 521-528.

[14] See Richard Whish/David Bailey, Competition Law (Ninth Edition 2018) 898.

[15] See Lucia Bonova/Dagmara Koska/Axel Specker, Consolidation of the EU airline industry: How the Commission kept seatbelts fastened in the 2009 airline merger wave (2009) Competition Policy Newsletter, Number 3 – 2009, pp 53-57.

[16] See further Frank Fichert, Remedies in Airline Merger Control – The European Experience (2011), in Szeto, W.Y. / Wong, S.C. / Sze, N.N. (eds.), Transportdynamics, Proceedings of the 16th International Conference of Hong Kong Society for Transportation Studies, Hong Kong, pp 359-366.

[17] See further German Aviation Association (BDL), The annual state of the industry: Report for the first half of 2018, 9 August 2018, p 5, <https://www.bdl.aero/wp-content/uploads/2018/08/bdl_halbjahresbilanz_2018_Pr%C3%A4sentation-1.pdf>.

[18] See further IATA, Profitability and the air transport value chain, Economic Briefing No 10.

[19] Horizontal merger guidelines, para 76-88.

[20] Horizontal merger guidelines, para 80.

[21] See Article 3(3) of the Treaty on European Union, which explicitly mentions "a high level of protection and improvement of the quality of the environment".

[22] Horizontal merger guidelines, para 79.

[23] Horizontal merger guidelines, para 85.

[24] Horizontal merger guidelines, para 86.

[25] Simon Holmes, Climate Change, Sustainability and Competition Law (Draft 26/09/2019) 24.

[26] See further See Richard Whish/David Bailey, Competition Law (Ninth Edition 2018) 907.

[27] See further Frank Fichert, Remedies in Airline Merger Control – The European Experience (2011), in Szeto, W.Y. / Wong, S.C. / Sze, N.N. (eds.), Transportdynamics, Proceedings of the 16th International Conference of Hong Kong Society for Transportation Studies, Hong Kong, pp 359-366.

Competition in the aviation industry

“Aviation and Competition Law Research” founder Daniel Metz recently published an article about competition in the aviation industry on airliners.de – the leading German speaking aviation industry portal. Click here to read the German version on airliners.de or read the english translation below:

Aviation in Europe: Competition at any price?

From the point of view of competition policy, the current competition in the aviation industry is exemplary. Consumers benefit from low ticket prices and inefficient airlines are forced out of the market in order to initiate the necessary market-economy regulatory processes. But is our idea of “competition” still contemporary?

The aviation industry is booming and attracting consumers with cheap tickets. Especially in the DACH region, where many low-cost airlines are represented with Eurowings, Easyjet, Laudamotion, Level, Ryanair, Vueling and Wizzair, competition among airlines is tougher than ever. But for industry experts such as Wizz Air founder József Váradi, it is clear that this brutal competition cannot be sustainable and that flying will become more expensive in the future. This is also illustrated by current developments: Ryanair issued its second profit warning since October and is putting the brakes on growth, Norwegian is implementing an ambitious savings programme and Austrian Airlines is also changing its route network to save costs in the long term. Lufthansa CEO Carsten Spohr and Ryanair founder Michael O’Leary are already predicting a market shakeout in the aviation sector this year. Small airlines in particular are at risk. The major players in the industry, on the other hand, are waiting for the moment to take advantage of takeovers to expand their leading position on the international aviation market in the long term. An oligopoly has long been a reality in the USA, where the five largest airlines have a combined market share of just under 90%. The competition authorities are also preparing for the coming consolidation, but fear increased political influence.                          

Competition policy and the concept of competition

Competition policy is one of the most important areas of state regulatory and economic policy. The main purpose of antitrust law is to ensure and protect effective competition in the interests of consumers and businesses. However, a rational and science-based competition policy requires a clear and coherent agreement between political and economic actors on what “competition” is. However, the supposedly easy answer to this important question is more complex than one would expect and basically not conclusive, since the ideas of competition, parallel to the current economic and social order, are in a constant process of transformation. Already in the last centuries different economic models were founded and developed with the classical school of national economy and the theory of the complete competition and the welfare optimum.

It was from these considerations that the three schools of thought – the Harvard School, the Chicago School and the Austrian School – that emerged in the 20th century and are still valued today. While the Harvard School is guided by the concept of workable competition, according to which competition should satisfy certain economic models (distributive justice, consumer sovereignty, etc.), for the Chicago School only consumer welfare in the sense of economic efficiency is decisive. The Austrian School, on the other hand, regards competition as a method of discovery. The core of the competitive process is ultimately the rivalry between companies. In contrast to the Chicago School, however, the Austrian School focuses on the freedom of competition itself (and less on efficiency).

“More economic approach” in European competition policy

Since the beginning of the 2000s, the European Commission has increasingly followed a “more economic approach” in implementing its competition policy. According to this (in part strongly criticised) approach, economic models should be increasingly used in decision-making in competition law proceedings. Accordingly, it is no longer competition per se (as a discovery procedure) that should be protected, but the benefit for consumers that should be in the foreground. A merger of companies is to be prohibited in particular if it is highly likely to lead to rising prices and/or falling quality. A typical example of the application of the “more economic approach” is the prohibited merger of the airlines Ryanair and Aer Lingus, which failed for the third time in 2013. The long procedure was characterised above all by econometric expert opinions of the parties involved, some of which were clearly contradictory. Finally, the merger was unsuccessful because the Commission feared that the merger would lead to a reduction in supply and higher prices for air travellers.

Modus Operandi of the European Commission in merger proceedings in the aviation sector

The European Commission takes a fundamentally positive view of consolidation in the European aviation industry, but examines concrete mergers of airlines very carefully and generally requires the companies concerned to comply with a number of commitments which they must comply with after the merger in order to minimise the risk of restrictions of competition. The starting point for any merger control is the definition of the relevant market. The Commission and most national competition authorities use a route-based analysis, the so-called “point of origin / point of destination (O&D) pair approach”. Accordingly, from the consumer’s point of view, each individual route (e.g. Vienna – Frankfurt) is treated as a separate relevant market. In individual cases, several airports can also be combined to form a catchment area. In a previous merger procedure, for example, the three London airports of Heathrow, Gatwick and City were considered to be a single point of departure.

The Commission then focuses on the overlapping routes of the airlines concerned, analysing both the current market situation and potential negative effects on competition. In many cases, the Commission extends its classic route analysis and also examines whether other means of transport (car, train, ship or connecting flights) might be an alternative for consumers. The Commission may also subdivide the markets further (long-haul and short-haul, charter and scheduled, business and leisure). Network carriers, on the other hand, argue that a route-based analysis of the market is not effective and that instead, from the point of view of the suppliers, the network of routes should be used. However, the Commission and most competition authorities reject this network approach, as it is in many cases irrelevant to the individual consumer (who simply wants to get to his destination) whether the airline in question has a global network of different routes.

In large merger cases, which may have potentially negative effects on competition, competition authorities typically require that parts of the business have to be sold in order to reduce the risk of monopoly formation. In the aviation industry, such an approach is generally not effective, as airlines are very flexible in their offer planning and can adapt quickly to new market conditions. For this reason, the competition authorities focus primarily on keeping market access open for competitors on problematic routes or at contested airports. The airlines concerned are therefore in many cases obliged to surrender certain slots or reduce their frequencies.

Merger control after Air Berlin insolvency

The individual acquisition processes following the Air Berlin insolvency in 2017 were similarly difficult for the competition authorities and the airlines involved. The takeover of the Air Berlin subsidiary Luftfahrtgesellschaft Walter by Lufthansa was approved by the Commission under strict conditions after the previously planned takeover of NIKI by Lufthansa was abandoned. Among other things, Lufthansa had to surrender take-off and landing rights at Düsseldorf Airport and surrender aircraft already purchased from Niki to Niki buyer Laudamotion. On the other hand, the Commission approved unconditionally Easyjet’s acquisition of another part of Air Berlin.

From the point of view of the competition authorities and consumers, the consistent application of merger control was clearly successful in these cases, at least if one thinks within the current view of competition and adopts its regulatory and evaluation apparatus. A good two years after the Air Berlin insolvency, consumers are again benefiting from low ticket prices. According to a report by the Bundesverband der Deutschen Luftverkehrswirtschaft (Federal Association of the German Air Transport Industry), prices are currently even at their lowest level since 2012. According to the Bundeskartellamt, a previously determined price increase of 25 to 30 % for Lufthansa flights was related to the sharp decline in capacity on the affected routes triggered by the insolvency, which subsequently led to lower prices due to the market entry of Easyjet and other players and the associated increase in supply. The Vienna – Berlin route can also currently be purchased for an unbeatable 50 euros (return flight). Is the liquidation of Air Berlin’s insolvency therefore an exemplary example of the functioning of current competition policy in the aviation sector?

Towards a more sustainable approach?

At any rate, if consumer welfare in the sense of economic efficiency is placed at the forefront of state competition policy, a number of things have recently been done right in European air transport. But should consumer welfare and ultimately price be the primary evaluation criterion of competition? In view of the low air fares, especially in relation to alternative means of transport, the question could be raised as to whether flying is currently not too cheap? This question should also be accompanied by a rethink of the concept of competition and the maxims of low prices and maximum consumer benefit. Another economic problem of low fares is that they can indirectly lead to the exploitation of the monopoly on certain routes. The core of this problem lies above all in the low profit margins in the aviation industry: in order for airlines to be able to compete at all with other airlines through low fares, they have to raise prices on routes where they have a quasi-monopoly in order to be profitable in the long term.

So do we need a new social discourse about what our idea of functioning competition looks like? Competition policy considerations may need to take even greater account of criteria such as the durability of competition or the impact on the environment and society. Similar considerations are currently taking place in another case, namely the prohibited merger between Siemens and Alstom. While the Commission took a critical view of the merger of the industrial giants and consequently prohibited it, political actors argued with the importance for jobs and Europe’s position in global competition.

USA as a role model?

With regard to future merger proceedings in the aviation sector, competition authorities could, for example, focus more on whether potential purchasers will retain jobs, use environmentally friendly aircraft types or have the necessary capitalisation to survive in the face of fierce competition in the long term. The oligopolistic market structure of the US aviation market in particular could serve as a role model here. According to a theory of competition, competition between fewer, but economically strong, airlines should in any case be more stable than competition between many small, but weak airlines.

After years of economic crisis, the US airlines in particular are in a better position than ever before. Contrary to the opinion of many economists, the painful market shakeout in the USA had positive effects. The major players in the industry, such as American Airlines, Delta and United Airlines, have been able to start long overdue transformation processes through the bundling of capital as a result of mergers. This period of economic regeneration benefited not only the major airlines themselves, but also consumers by increasing the capacity of seats offered and investing in new aircraft and services. The European competition authorities, which are still increasingly pursuing the diversity approach, do not have to fear possible mergers of large European airlines. Ultimately, the only important thing is that (as has been the case up to now) the merging airlines will be required to make strict commitments and that new competitors will continue to be allowed to enter the market.

In terms of competition in the aviation industry, the USA could also set an example in other respects. With regard to possible reform efforts, the German Monopolies Commission proposes a comprehensive change to the system for the allocation of take-off and landing rights. Currently, a company that uses these rights remains in possession of the rights and can only dispose of them to a limited extent. In the view of the Monopolies Commission, the slots should be auctioned in a similar way to telecommunications frequencies. In the USA, an auction of take-off and landing rights has long been common practice. This may well be one of the reasons why there is still intense competition between airlines in the oligopolistic US market. Achim Wambach, Chairman of the Monopolies Commission, also recommends investing the proceeds of the auction in air traffic again (for example in airport infrastructure). This idea is to be supported in principle; if necessary, part of this revenue could also be channelled into state funds and used for environmental protection measures or research projects on resource-saving and low-emission technologies. This would benefit society as a whole and if flying would become more expensive as a result, then this may also be the case. 

Market definition in the aviation industry

In this post I would like to give you a brief overview of the concept of market definition in the aviation industry. First of all, the basic concept of market definition in the aviation industry does not differ, at least concerning the essential characteristics, from the general concept of market definition that is used in Competition Law all over the world. However, specific aspects and principles of the aviation sector have been adopted and utilized by competition authorities and courts for defining the relevant aviation market.

Starting point: Market definition

The first step in any competition analysis is the definition of the relevant market. There are two fundamental dimensions of market definition:

• the product market; and

• the geographic market.

Market definition takes into account both the demand and supply considerations. If markets are defined too narrowly in either product or geographic terms, significant competition may be excluded from the analysis. On the other side, if the product and geographic markets are too broadly defined, the degree of competition may be overstated. Too broad or too narrow market definitions lead to understating or overstating market share and concentration measures.

For more information see OECD, Glossary of Industrial Organisation Economics and Competition, paragraph 125

Commission Notice on the Definition of Relevant Market

According to section I paragraph 2 of the Commission Notice on the Definition of Relevant Market for the Purposes of Community Competition Law [1997] OJ C372/03:

“Market definition is a tool to identify and define the boundaries of competition between firms. It serves to establish the framework within which competition policy is applied by the Commission. The main purpose of market definition is to identify in a systematic way the competitive constraints that the undertakings involved face.”

According to section II paragraph 7 of the Notice ‘Relevant product markets‘ are defined as follows:

“A relevant product market comprises all those products and/or services which are regarded as interchangeable or substitutable by the consumer, by reason of the products’ characteristics, their prices and their intended use.”

Pursuant to section II paragraph 8 of the Notice ‘Relevant geographic markets‘ are defined as follows:

“The relevant geographic market comprises the area in which the undertakings concerned are involved in the supply and demand of products or services, in which the conditions of competition are sufficiently homogeneous and which can be distinguished from neighbouring areas because the conditions of competition are appreciably different in those area.”

ICN Recommended Practices

Another interesting source for market definition matters are the ICN Recommended Practices, for example the Recommended Practices for Merger Analysis or the Recommended Practices for Dominance Substantial Market Power Analysis Pursuant to Unilateral Conduct Laws. According to the ICN the purpose of market definition (in merger control) is to identify an appropriate frame of reference for assessing whether a merger may create or enhance market power. Therefore, competition agencies should assess the competitive effects of a merger within economically meaningful markets. With regard to the assessment of dominance / substantial market power (in unilateral conduct cases) the ICN states that competition agencies should use a sound analytical framework firmly grounded in economic principles in determining whether dominance / substantial market power exists.

Aviation-related situations in which it is necessary to define the relevant market

• When determining whether an agreement between
  aviation market actors has the appreciable effect of restricting competition (Article 101(1) TFEU)

• When determining whether an agreement between aviation market actors has an appreciable effect on trade between Member States (Article 101(2) TFEU)

• When determining whether an agreement between aviation market actors would substantially eliminate competition (Article 101(3)(b) TFEU)

• When determining whether an aviation undertaking has a dominant position (Article 102 TFEU)

• When determining whether a aviation related merger would have a negative effect on competition (EU Merger Regulation)

• When determining whether a block exemption is applicable

Demand-side and supply-side substitution

The demand-side substitutability is the fundamental and most effective test to define the relevant market. According to section II paragraph 15 of the Notice:

“The assessment of demand substitution entails a determination of the range of products which are viewed as substitutes by the consumer.”

In contrast, the supply-side substitutability may be taken into account when defining markets in those situations in which its effects are equivalent to those of demand substitution in terms of effectiveness and immediacy. According to section II paragraph 20 of the Notice:

“This means that suppliers are able to switch production to the relevant products and market them in the short term without incurring significant additional costs or risks in response to small and permanent changes in relative prices.”

Point of origin / point of destination (O&D) pair approach

The European Commission and the European courts define the relevant product and geographic in the aviation sector, in most cases, on the basis of the ‘point of origin / point of destination’ (O&D) pair approach, according to which every combination of a point of origin and a point of destination should be considered as a separate market from the customer’s viewpoint; therefore following the principle of demand substitution (see Case C-66/86 Ahmed Saeed Flugreisen [1989] ECR 803, para 39 et seq and Case No COMP/M.3280 – AIR FRANCE / KLM, para 9 et seq).

Consequently, according to the classic O&D pair approach the (flight) route between London Heathrow (LHR) and Paris Charles de Gaulle (CDG) constitutes a separate market.

Source: Aviation and Competition Law Research

Usually, the Commission looks at the different transport possibilities in that market, that is, not only at the direct flights between the two airports concerned (LHR and CDG), but also other alternatives to the extent that they are substitutable to these direct flights. Thereby, the model that is used today by the Commission and other competition authorities can be described as an extended version of the classic O&D pair approach.

These alternatives can be:

• Direct flights between the airports whose respective catchment areas significantly overlap with the catchment areas of the airports concerned at each end (airport substitution)

• Indirect flights between the airports concerned (only if the overall travel time is not to long)

• Other means of transport, so called 'inter-modal substitution' (train, road, sea)

Source: Aviation and Competition Law Research

Further distinction by the European Commission

On a case-by-case basis, the European Commission regularly distinguishes between:

• Long-haul flights and short-haul flights

• Charter flights (bundled flights) and non-charter flights (unbundled flights)

• Direct flights (e.g. A to B) and indirect flights (e.g. A to C to B)

• Premium (time sensitive) passengers and non-premium (non-time sensitive) passengers

Supply-side substitution: Network competition?

Network carriers that operate a hub-and-spoke system usually argue that the market definition should take into account that the airline industry is characterised by network competition between airlines alliances. This rationale represents a supply-side perspective and reflects the business model of network carriers rather than the customer needs to be served. For the most part, the European Commission does not agree with this reasoning as the network approach is normally of little relevance to the individual consumer who wishes to travel from a point of origin to a specific point of destination (especially on short-haul flights).

However, the Commission sometimes does include effects of network competition in her overall competition assessment. In Case No COMP/M.3280 – AIR FRANCE / KLM, para 17 the Commission stated that

“Supply side considerations instead play an important role when considering the competitive constraint which individual carriers may exert on a certain market. The hub-and-spoke system determines the network carriers decision to operate (or not) a passenger air transport service on a particular O&D pair. Network airlines concentrate traffic into a specific hub and disperse passengers via connection to numerous spokes. This increases the load factor of aircrafts and allows airlines to exploit economy of density. They normally refrain from entering city pairs which are not connected to their respective hubs. At the same time the concentration on their hubs reinforces their position at these airports which often makes entry of competing airlines more difficult.”

The outcome: Complex market definition

Complex market definition questions can arise in aviation markets, particularly when competition authorities apply the point of origin / point of destination (O&D) pair approach. In practice, every flight route of the undertakings concerned has to be identified and considered as a separate market. In a second step, the overlapping routes of the undertakings have to be detected and examined for potential anti-competitive effects. Complicating matters further is the fact that the aviation industry is very dynamic and airlines can reorganise their business activities in a short time, meaning that competition authorities also have to take into account that airlines can ‘create’ new O&D pairs (and therefore new separate markets) by changing their flight schedule. Nevertheless, this ‘flexibility’ can be restricted by other parameters, such as slot availability at certain airports.

Computerised Reservation Systems and Competition Law

In my article from 25 November 2018, I already outlined the European Commission’s recent investigation on Computerised Reservation System providers ‘Amadeus‘ and ‘Sabre‘. Now, in this article I want to talk more about the business model behind Computerised Reservation Systems, how the aviation distribution market works and which implications these elements have on Competition (Law) issues in the aviation industry.

Oligopoly market

With three companies (Amadeus, Sabre, Travelport) controlling over 90% of global CRS/GDS air bookings, the market for Computerised Reservation Systems is highly concentrated.

Global shares of CRS/GDS air bookings

Source: Belobaba/Barnhart/Swelbar, Information Technology in Airline Operations, Distribution and Passenger Processing, MIDT Booking Data, January–December 2013.

Double-edged sword: High ROIC

Remember? In my article from 25 November 2018, I have already mentioned the high return on invested capital (ROIC) Computer Reservation System services have in the air transport supply chain (ROIC of 20%). In contrast, the airline sector with an ROIC of 4% earns the lowest return on capital.

As can be seen, returns are unevenly and inefficiently distributed across the air transport supply chain. The risk for investors is also distributed very unequally. Apparently, according to IATA some of the sectors with the highest returns (Computer Reservation System services, aviation services) face the lowest volatility of returns. As a rule, you would think that – in competitive markets – investors would expect to earn a higher return on investment if they face a higher risk or volatility or returns. But not when in comes to Computer Reservation System services!

Why is the ROIC of Computer Reservation System services so high, especially compared to the average aviation sector ROIC?

ROIC = indicator for anti-competitive effects?

One reason for the above mentioned observation could be that market forces are not working to allocate risk efficiently. Furthermore, a lack of competitive pressures can cause market inefficiencies. While the ROIC is not expressis verbis an indicator for anti-competitive effects in Competition Law, we can not deny that the extraordinarily high ROIC of Computer Reservation System services (vis-à-vis the average aviation sector ROIC) is quite unusual. The high ROIC might simply be caused by distinctive market conditions, nonetheless we should still keep our eyes open for potential anti-competitive effects.

How the market works in detail

Travel agents usually pay a subscription fee to rent Computerised Reservation System tools to which they subscribe. As travel agents typically subscribe to only one Computerised Reservation System, the Computerised Reservation System providers compete to attract the travel agents to their system by paying them incentives per segment booked on their system. For smaller agents, the incentive payments can often compensate the subscription fee. For larger travel agents, which can generate substantial booking fee revenue, the Computerised Reservation Systems effectively pay the travel agents to subscribe.

Source: Commission, Impact assessment {COM(2007) 709SEC(2007) 1497}; Graphic: Aviation and Competition Law Research

When a travel agent books a ticket using a Computerised Reservation System, the airline pays the Computerised Reservation System a booking fee. The booking fee is a flat charge per passenger per flight segment. In order to include all travel agents, airlines typically need to participate in all Computerised Reservation Systems. This gives the Computerised Reservation System providers significant bargaining position vis-à-vis the airlines.

Two-sided market structure

The diagram shows that the market for Computerised Reservation Systems is a two-sided market, namely between airlines and travel agents. Because of this particular two-sided market structure, the Computerised Reservation System providers tend to have more market power vis-à-vis the airlines than vis-à-vis the travel agents.

The distinct economics of this two-sided market, and the lack of competition in the upstream market (airlines – Computerised Reservation Systems), motivate Computerised Reservation Systems and travel agents to increase the incentive payments. At the end of the distribution chain, the consumer pays a fare– which includes the increasing booking fees – and sometimes a service fee to the travel agent.

Watch out! European Commission looks into Computerised Reservation Systems (CRS)

On 23 November 2018 the European Commission (DG COMP) informed that it has opened a formal investigation to assess whether agreements between Computerised Reservation System providers ‘Amadeus‘ and ‘Sabre‘ on the one hand, and airlines and travel agents on the other hand, may restrict competition. Amadeus and Sabre are leading worldwide suppliers of so called Computerised Reservation Systems (CRS), that are known to be a Competition Law issue in the aivation industry.

So, what are Computerised Reservation Systems in the first place?

According to Article 2 number 4 of the Regulation (EC) No 80/2009 of the European Parliament and of the Council of 14 January 2009 on a Code of Conduct for Computerised Reservation Systems

“a Computerised Reservation System or CRS means a computerised system containing information about, inter alia, schedules, availability and fares, of more than one air carrier, with or without facilities to make reservations or issue tickets, to the extent that some or all of these services are made available to subscribers.”

Therefore, Computerised Reservation Systems act as technical intermediaries between the airlines and the travel agents. The Computerised Reservation Systems typically provide their subscribers with instantaneous information about the availability of air transport services and the fares for such services. To sum up, Computerised Reservation Systems are used for hosting airline seat inventory and seat reservation transactions.

Importance of Computerised Reservation Systems

First of all, the investigation by the European Commission is kind of interesting because Computerised Reservation Systems are basically past their peak, as direct sales are a growing sales channel for airlines. Aviation IT-company SITA predicts that by 2020 only 29.3% of total airline sales will be made via partners/GDS/travel agents, whereas 70.7% of total airline sales will be made via airline direct web/phone/ticket offices & airline apps (Source: SITA 2017 Air Transport IT Trends Insights, page 21). What is also particularly interesting here is that mobile app sales (i.e. flight booking via a mobile app of an airline) will continue to grow faster than any other sales channel.

However, according to an IATA Economic Briefing (conducted by McKinsey & Company) the highest returns in the air transport supply chain are earned in the distribution sectors. Computerised Reservation System services earn an average return on invested capital (ROIC) of 20%, double their 10-11% cost of capital (WACC). In comparison, the airline sector with an ROIC of 4% earns the lowest return on capital, yet faces the second highest volatility of returns or risk.

Total airline sales made via sales channel

Return on capital varies throughout the value chain (ROIC excluding goodwill of sample, period 2004-2011, %)

Source: IATA, Profitability and the air transport value chain, Economic Briefing No 10

History of Computerised Reservation Systems

The early development of Computerised Reservation Systems began in the 1950s, when American Airlines partnered with IBM, and the first Computerised Reservation System was implemented by American Airlines in 1962 (known as ‘Semi-Automated Business Research Environment’, or ‘SABRE’). Originally developed, owned and operated by airlines itself, the use of Computerised Reservation Systems had been extended to travel agents as an irreplaceable distribution tool.

Before the development of Computerised Reservation Systems, only airline carriers or travel agents sold airline tickets. The travel agent would question the traveler an then turn to the Official Airline Guide (a book containing carrier schedules and fare information). The travel agent would then determine the flights and carriers that could best fit the customer’s needs. As you can see, ticket distribution used to be quite complex before the introduction of Computerised Reservation Systems.

What is the difference between Computerised Reservation Systems and a Global Distribution Systems?

The European Commission states that “Computerised Reservation Systems are also known as ‘Global Distribution Systems“. This perception is not entirely correct. A Global Distribution System (GDS) is a computerised network system that enables transactions between travel industry service providers (i.e. airlines, hotels and travel agencies).

While Computerised Reservation Systems are solely responsible for the inventory management (available seats = inventory; so broadly speaking ‘inventory management’ means the selling of seats), Global Distribution Systems combine the inventory management systems of multiple Computerised Reservation Systems from major airlines. Thus, Global Distribution Systems operate the Computerised Reservation System and provide access to all reservation systems.

Although, Computerised Reservation Systems have evolved into Global Distribution Systems over the years that host inventory of multiple airlines and other modes of travel and travel related associated services, airline transportation is still the most important travel service sold through these systems.

Source: Aviation and Competition Law Research

Competition Law and Computerised Reservation Systems

In order to promote fair competition in the airline sector and to ensure that consumers benefit from more choice and lower ticket prices, it is necessary to have regulations on Computerised Reservation Systems. For this reason, the European Commission adopted a 1989 Regulation (No 2299/89), last amended in 2009 (No 80/2009), to ensure that air services by all airlines are displayed in a non-discriminatory way on the travel agencies computer screens.

Regulation 80/2009 maintaines safeguards that protect against potential competitive abuses by airlines owning or controlling a Computerised Reservation System (so called ‘parent carrier’). Ultimately, Regulation 80/2009 aims to establish a a level playing field between Computerised Reservation Systems and airlines, therefore complementing Competition Law rules under Article 101 and 102 TFEU.