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Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership ©Copyright 2003 Latham & Watkins. All Rights Reserved.
Exclusionary Conduct in the Airline Industry
John KallaugherLatham & WatkinsVisiting Professor University College London
1
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?
2
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
3
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”
4
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)
5
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
6
Air Canada
• Controversial aspect of decision – definition of “redeployment/recapture” and “disposal” as basis for avoiding costs
7
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
8
Lufthansa/Germania
• Germania entered FRA-TGL in competitionwith 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)
9
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
10
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?
11
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
12
Policy Choices for Article 82in Airline Sector
• Approach based on effects on structureOr
• Approach based on likely consumer harm
13
Traditional Article 82 Approachis Structural
• The “Field of Dreams” Approach
• Increasing “Barriers to Entry” is Abuse
• Barriers to Entry Defined Broadly
• New Entry Presumptively a “Good Thing”
14
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
15
Structural Approach requires Robust Market Definition
• Otherwise no economic validity
• Suggests that should not be applied where market definition is less than robust
16
Market Definition in Air Transportis 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
17
Aspects of Airline Competition Outside O&D City Pairs
• Network vs. Low cost• Capturing connecting traffic• Planning and capacity allocation• Corporate accounts• Tour operators
18
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
19
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?
20
Structural Approach leads to Consumer Loss
• Prohibiting Lufthansa price-matching directly harms consumers
• Limiting FFPs directly harms consumers
• Re-allocating slots directly harms consumers
21
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