Competition and regulatory issues in. the civil aviation sector. Liberty Mncube Chief Economist Competition Commission of South Africa

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1 Cmpetitin and regulatry issues in the civil aviatin sectr Liberty Mncube Chief Ecnmist Cmpetitin Cmmissin f Suth Africa 04 Nvember 2014

2 Structure Cmpetitive landscape f the airline industry What des an airline need t enter and cmpete? What d airlines cmpete n? Airline cmpetitin issues and cmpetitin enfrcement Alliances Cartels Abuse f dminant psitin Financial distress and gvernment interventin

3 Understanding the cmpetitive landscape in the airline industry What des an airline need t enter and cmpete effectively? This questin relates t the barriers t entry in the prvisin f passenger air transprt services Structural barriers Aircrafts (e.g. thrugh wnership r lease), perating licences and traffic rights, persnnel, feeder access, take-ff and landing slts, access t airprt facilities (e.g. check-in facilities and gates) Strategic barriers Originate frm the exclusinary behavir f firms present in the market What d airlines really cmpete n? This questin deals with the main parameters n which airlines cmpete, namely price and quality. Price Quality Depends n a variety f factrs, such as travel date and time, rigin and destinatin, travel class, bking methd, number f purchased tickets r lyalty prgrams Schedule and n-time perfrmance, number f flight cancellatins, rate f missing baggage, frequency f verbking and number f custmer cmplaints. Lyalty schemes such as frequent flyer schemes and travel agents cmmissins

4 Airline cmpetitin issues and cmpetitin enfrcement Hrizntal agreements (alliances) Alliances are hrizntal c-peratin agreement falling shrt f a merger, and vary widely in scpe and strength. Which cmpetitin cncerns arise frm airline alliances Alliances may harm cmpetitin, e.g. by raising entry barriers and leading t higher fares, especially n hub-t-hub and nn-stp rutes Bth the ptential fr synergies and the risk f anti-cmpetitive effects may increase with the depth f c-rdinatin and integratin within the alliance Internal c-rdinatin is at the heart f alliances and requires exemptin frm cmpetitin law An exemptin is written permissin received by firms frm the Cmmissin t engage in a prhibited practice, shuld their exemptin applicatin meet the criteria set ut Lapsing in the Cmpetitin Act. Exemptin Duratin Nature f Exemptin Date 1 year 6 mnths 30-Jun-02 C-rdinate cmmercial passenger airline activities SAA and Qantas Have alliances succeeded? 2 years 18-Dec-05 2 years 31-Dec-07 3 years 31-Dec-10 2 years 31-Dec-12 1 year 6 mnths 31-Dec-13 SAA/Star Alliance 5 years 31-Dec-10 Star Alliance and jint Star prducts 1 year 31-Dec-10 Participatin in Meeting Plus. 5 years 31-Dec-15 Participatin in the Star Alliance and jint Star prducts SAA/Etihad 5 years 31-Dec-19 Jint pricing and schedule crdinatin n primary and secndary rutes

5 Airline cmpetitin issues and cmpetitin enfrcement Hrizntal agreements (cartels) Hrizntal agreements (cartels) While evaluating the SAA/Qantas applicatin, the Cmmissin discvered that SAA had entered int a number f ther bilateral agreements, fr which n exemptin had been sught Lufthansa and SAA In 2006, the Cmmissin cncluded against SAA and Lufthansa s bilateral agreement ( price fixing) and thrugh settlement agreements the Cmpetitin Tribunal impsed sanctins Fuel surcharge cartel (invlved arund 20 airlines wrldwide.) The Far East Asia cartel In January 2008, the Cmmissin initiated a cmplaint against SAA, Singapre Airlines and Malaysian Airlines fr their invlvement with Cathay Pacific in a cartel t fix air fare increases n bth ecnmy and business class flights int and ut f Suth Africa t the Far East Asia Singapre Airlines and SAA have settled the case and paid administrative penalties fr their participatin in the cartel In July 2010, the Cmmissin referred a cmplaint relating t the fixing f fuel surcharges and carg rates in internatinal airline freight services t the Tribunal fr adjudicatin. The respndents in this matter were SAA Carg, British Airways, Air France-KLM, Alitalia Carg, Carglux, Singapre Airlines, Martinair and Lufthansa. Criminal sanctins are cming All members f the Internatinal Air Transprt Assciatin (IATA)

Airline cmpetitin issues and cmpetitin enfrcement Exclusinary unilateral practices One cmmn type f exclusinary selling strategy which has been fund t have anticmpetitive effects relates t reward

6 Airline cmpetitin issues and cmpetitin enfrcement Exclusinary unilateral practices One cmmn type f exclusinary selling strategy which has been fund t have anticmpetitive effects relates t reward schemes aimed t increase custmer lyalty In July 2005, the Cmpetitin Tribunal fund that SAA cntravened the Cmpetitin Act, because it had engaged in prhibited practices in the perid frm Octber 1999 t May 2001 (SAA I) The Tribunal fund that the travel agent cmmissin payment scheme implemented by SAA during this perid was anticmpetitive. This was primarily due t the fact that this scheme had a retractive (r back t Rand 1 ) structure. Relied n the extensive evidence n the ability and incentives f travel agents t divert traffic between airlines (that is, engage in s-called directinal selling ) as a result f perfrmance schemes such as the nes ffered by SAA This evidence was based in turn n factual testimny frm travel agents and airline executives, rather than n data n travel agent sales Fr this cnduct, the Tribunal impsed an administrative fine f R45 millin.

Airline cmpetitin issues and cmpetitin enfrcement Exclusinary unilateral practices Varius similar agreements remained in place beynd 2001.

The eliminatin f the retractive design f the incentive cntracts, applicable frm April 2005, then frmed part f a settlement agreement with Cmmissin.

7 Airline cmpetitin issues and cmpetitin enfrcement Exclusinary unilateral practices Varius similar agreements remained in place beynd Cmair ldged a cmplaint with the Cmmissin abut these pst-2001 agreements in Octber 2003 Shrtly after the SAA I, SAA s agreements were changed. The eliminatin f the retractive design f the incentive cntracts, applicable frm April 2005, then frmed part f a settlement agreement with Cmmissin. The Tribunal cnfirmed the settlement agreement in December SAA agreed t pay an administrative fine f R15 millin. The SAA cases represent a clear example f why rivals in the market were nt able t prfitably match the incentive schemes f SAA which led t their freclsure in the dmestic market.

8 Airline cmpetitin issues and cmpetitin enfrcement Financial distress and gvernment interventin Financial distress and gvernment interventin The airline industry is famus fr number f distressed firms, bankruptcies and market exits In the case f Suth Africa, three lw-cst dmestic carriers have exited the market in recent times (Natinwide, Velvet Sky and 1Time) Questins remain Is financial distress inherent t the industry? Are airlines cndemned t face financial difficulties at sme pint? What explains that legacy carriers are struggling, whereas sme lw-cst carriers have been successful? Is it a matter f gd management, business mdel, market structure, state supprt, r deregulatin? Internal and external factrs Internal factrs primarily pertain t bad management decisins, including excess capacity investments, inflated persnnel, excessive bureaucracy, unprfitable rutes and ineffective netwrk planning. External factrs ften relate t fuel price vlatility, financial and ecnmic crises, shifting demand, labur csts r increased effective cmpetitin On effective cmpetitin, in highly cmpetitive markets, nly the mst prfitable and wellmanaged carriers may be sustainable Where business recvery tls fail, the Suth African gvernment like tters elsewhere has faced the tugh questin f whether r hw t respnd State aid t SAA has been in the frm f cncessinary financing and guarantees

9 Prfit/lss in millins f rands Airline cmpetitin issues and cmpetitin enfrcement Financial distress and gvernment interventin SAA applied fr and received a R5.006 billin ging cncern guarantee frm Gvernment, taking effect frm 1 September 2012 t 30 September 2014 The Guarantee reduces the cst f brrwing fr SAA t belw market levels and reduces the perceived risk t lenders The Cmmissin has nt assessed cmplaints relating t the exercise f public pwers Gvernment supprt is cntrversial, it carriers varius challenges, let alne the risk f a failed rescue plan. The first challenge is that state interventin may distrt the playing field. A secnd challenge is that state supprt may increase inefficiencies verall, as it sends a strng signal that inefficient airlines culd be rescued. Cmpetitin authrities cannt review any decisin taken by Gvernment Departments. 0 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013 Where the state exercises its pwer thrugh a vehicle such as a firm, cmpetitin authrities have intervened Natinwide exits SAA Cmair 1time exits

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