International Air Transport Association

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1 International Air Transport Association IATA Centre, Route de l Aéroport 33 P.O. Box 416 CH-1215 Geneva 15 Airport, Switzerland By Ms. Lowri Evans Director, Directorate D Services Directorate-General for Competition European Commission B-1049 Brussels, Belgium 16 February 2005 Subject: DG-Competition Consultation on the Revision of Regulation 1617/93 Additional IATA Comments on the Feasibility of a Posted-Price System Dear Ms Evans, Thank you again for taking the time to meet with us on 3 February The meeting generated a productive discussion regarding the main issues in the interline tariff consultation case and we look forward to continuing that dialogue with you and the rest of the DG-Competition services. Further to your request during the 3 February meeting, please find attached additional comments on the viability and implications of a posted-price system as a potential alternative to the IATA interline tariff consultations. The attached paper explains why a posted-price system cannot fully replicate the consumer benefits of the existing IATA system. The paper also highlights that the crucial issue to focus on is not whether a posted-prices system is technically possible, but rather whether it would be commercially feasible. A close examination of how airlines operate and what would be required to create a new system leads to the conclusion that an industry posted-price system is unlikely to emerge. Instead the more likely outcome is a system of "ad-hoc" posted prices that would impose numerous disadvantages on consumers in terms of both price and flexibility compared to the existing IATA system. We hope the attached submission answers your questions regarding a posted-price system and leads DG-Competition to abandon the idea as a proposal that should continue to receive consideration. However, we would be happy to meet with you and answer any further questions you might have. Should DG-Competition nevertheless decide to again put forward a posted-prices system for further consideration, IATA would encourage you to consider including the attached paper with the consultation document and inviting interested parties to comment on IATA's analysis, in particular the key issues identified in the last section of the paper. Sincerely, Encl. Discussion Paper on posted-prices Carlos Grau Tanner Director Government & Industry Affairs IATA

2 Discussion Paper on Posted Prices The purpose of this paper is to address a central issue in the consultation process regarding renewal of Regulation 1617/93 the viability of a multilateral interline system based on posted prices as a substitute for the current IATA system based on prices discussed in IATA tariff conferences. While IATA has addressed the legal implications of a posted-price system in its submissions dated 6 September and 22 December 2004, this paper focuses on the economic and commercial context for assessing a posted-price system. The discussion below demonstrates that a posted-price system cannot fully duplicate the benefits of a system based on IATA tariffs, even if a posted-price system could be agreed as an industry standard to replace the current conference-based tariff system. Furthermore, the commercial realities of the airline marketplace mean that it is unlikely that an industry standard posted-price system will emerge if the tariff-conference system is abandoned. It is much more likely that a system of ad hoc posted prices would prevail, resulting in less flexibility and higher prices for consumers as well as fewer opportunities for smaller/regional airlines. 1. Background The Role of IATA Tariffs in the Multilateral Interline System The goal of a posted-price system would be to create a substitute for the tariffs agreed at IATA tariff conferences. In considering whether a posted-price system could replace IATA tariffs and thus duplicate the benefits of the current system, it may be useful to recall the role played by the IATA tariffs in the current system: IATA tariffs set the consumer price for an interlineable itinerary. Where there is an IATA interline tariff covering a city pair, this tariff sets the consumer price paid for any reasonably direct itinerary between those two cities. This price may be discounted by carriers that actually provide transport on one or more sectors on a back-end basis (i.e., a discount on coupons flown or transport with the carrier). The interline tariff thus operates as an effective ceiling on the price that may be charged for the IATA product and provides the basis for changing carriers or routings given that the tariff will be accepted by all carriers participating in the IATA system. IATA tariffs establish the basis for fare construction on city pairs where no specific tariff has been set. On city pairs where there is no agreed IATA tariff, other IATA tariffs may be combined to establish a tariff in accordance with the fare and rate construction rules adopted by the relevant conference. This system allows an IATA interline tariff to be constructed for almost every international city pair if none is otherwise specified. IATA tariffs provide the basis for acceptance of interline bookings without discussion or approval of fares for a specific itinerary. Because the fare for an interline ticket is established by the IATA tariffs and related rules, there is no need for the airlines involved in an itinerary to agree on a fare for a specific customer or customers. The prorate rules ensure that each airline receives an appropriate share of the revenue generated by a booking. 1 The airlines can be confident that, on average, the fare will generate sufficient incremental revenue to make participation in the itinerary worthwhile. 1 The default rule for allocating revenue generated by an IATA interline itinerary is that each airline receives revenue on the basis of its percentage share of mileage flown. Additional rules are in place to ensure that the revenue sharing does not unduly disadvantage one or more carriers (i.e., mileage weighting factors for the 1

3 2. How would a Posted-Price System Function as a Substitute for Industry Fares? The idea of posted prices as a substitute for conference-set IATA tariffs is not new. It featured in the investigation of the IATA tariff system by the US Civil Aeronautics Board in the late 1970 s and has emerged sporadically since. The central element of a posted-price system is the idea that each participating airline would post the price that it would require as a condition for accepting an interline booking on a particular sector. The fare for travel on a multi-sector itinerary would then be the sum of the posted prices of the airlines providing the service on each of the sectors in that itinerary. Proration or division of the fare would not be necessary since each airline would receive the price that it had posted. Advocates of this system postulate two advantages: (i) the posted-price system will eliminate the supposed anticompetitive effects of IATA tariff consultations; and (ii) posted prices would lead to lower fares than the current system because airlines would compete to attract interline business by posting lower sector prices. The mechanics of a posted-price system are, perhaps inevitably, not clearly established. Some proposals appear to envision a system where posted prices are directly accessible by consumers, who could then construct the through fare themselves. Other proposals contemplate that the posted price would be provided to other airlines and travel agents who could sell a ticket to the final destination, providing one or more sectors themselves and/or combining the services of multiple airlines. In either case, the proposals appear to assume that the price posted by an airline will be available to all carriers/travel agents (or consumers) for any itinerary that uses the relevant sector as part of an interline itinerary. These proposals all appear to assume that the technical arrangements operated by IATA to facilitate interlining (such as common protocols for ticketing, baggage handling, or communications) will continue to remain in effect under the new system. 3. Alternatives to an Industry Posted-Price System Bilateral Arrangements and Ad Hoc Posted Prices The industry posted-price system described above should be distinguished from (i) bilateral arrangements involving special prorates; and (ii) published retail carrier fares that can be combined to construct interline itineraries thereby creating de facto posted prices. As regards bilateral special prorates, it is common under the present system for airlines to agree bilaterally to accept an interline booking from another carrier and to agree in advance specific rules for sharing the joint revenue including, for example, an agreement not to apply their proviso requirements. These bilateral arrangements differ from an industry posted-price system in that they are not available to all carriers seeking to provide services and are likely to be limited in terms of the routes covered. A ticket issued under these conditions is also limited to travel on the carriers and routings concerned the change of carrier or itinerary possible under an IATA ticket is not present. As regards published carrier-specific interlineable fares, it is possible under the present system to construct a connecting itinerary using the sum of carrier-specific fares for each of the sectors. Airlines may specify, however, that they will accept an interline booking only in respect of a higher cost of short-haul services or differences in cost levels in different regions, as well as provisos and the related minimum prorate rule). For further details, see the description of the IATA prorate system in the annex attached to this paper. The attached description of the prorate system was prepared some months ago and provided to the competition authorities in France and the UK in response to questions they had. 2

4 specified fare. Often lower fare classes are not available on this basis. (Airlines follow this practice to reserve traffic on the connecting itinerary to their own network.) Today nothing prevents an airline from attempting to attract interline business by publishing a lower fare that is only available for use on an interline connecting itinerary. This effectively creates an ad hoc posted price. Such interline-specific fares can in principle be limited to specific routings. Taking such limitations into account and given that the fare by definition is unique to the carrier posting it, the changes of carrier and/or itinerary possible under an IATA tariff are again absent under this scenario. 4. Differences between a Posted-Price System and the Current IATA tariff System A posted-price system will differ from the present system of conference-set IATA tariffs in two key ways: In a posted-price system the flexibility of the IATA ticket is lost. Under the current system, passengers with an IATA interlineable ticket can select the itinerary that suits their schedule and which provides them with their desired stopover and transfer points; after the initial booking they can change airlines and/or routing without needing to purchase a new ticket. This flexibility is inevitably lost in a posted-price system since another airline cannot be bound to accept the fare posted by the first airline in the original booking. Where another airline rejects the price initially paid, the passenger will need to purchase a new ticket and seek a refund under the previous ticket with significant transaction costs for both the passenger and the airlines concerned. A simple example may help to illustrate this point. Between Budapest and Edinburgh there are no direct scheduled flights. Passengers wishing to travel between these cities must find connections via intermediate points. At an IATA fare, a Budapest-originating passenger has a choice of 12 intermediate cities (Amsterdam, Brussels, Cologne, Copenhagen, Frankfurt, Hamburg, London, Manchester, Milan, Paris, Prague and Zurich) that have scheduled service to both Budapest and Edinburgh. (Additional connection points are available at Dublin, Milan and Stockholm but in these cases a surcharge of up to 20% would apply to the IATA fare since the Maximum Permitted Mileage is exceeded on these indirect routings.) Although, due to independent scheduling decisions of the individual airlines, connections via these 12 transit points may not be available each day, the IATA system allows the consumer to choose from all available flights and to pick those that suit his or her purposes. Regardless of which connecting point and participating carrier the passenger chooses, the fare is the same. Connection and stopover opportunities are not limited to a single transfer point. The IATA industry fares permit any number of stopover or transfer points between origin and destination, subject only to the maximum 20% mileage deviation. A passenger who wishes can book complex itineraries with multiple stopovers such as Budapest - Zurich - Brussels - Edinburgh, Budapest - Prague - Amsterdam - Edinburgh, or Budapest - Vienna - Brussels - Edinburgh. S/he could choose one routing on the outbound and a different routing on the return. The IATA system expands the consumer s choice allowing him or her to mix and match non-stop, on-line connecting, alliance connecting and interline connecting flights at a single price in a single transaction. Any decision by passengers to change their flights and/or connecting points can be made at no additional cost and with minimal transaction cost for the airlines concerned. 3

5 In a posted-price system there is no ceiling on the point-to-point fare. Under the current system, the price for a connecting itinerary is often significantly below the price for the sum of the sectors making up that itinerary. This results from the fact that the industry price for the city pair is set on a point-to-point basis without regard for whether the actual itinerary is provided on a non-stop or connecting basis. In a posted-price system, in contrast, there is no generally applicable city pair fare the fare paid by the passenger is the sum of the prices posted by the airlines. Unless the posted prices are very significantly lower than the prices charged by the airlines for non-stop service on the sectors involved, the price paid by the consumer is higher in the posted-price environment. 2 In assessing this second point it is important to appreciate the difference between tariffs in a posted-price system and provisos under the present system. The current system allows an airline to file a proviso that entitles it to a specified amount for any specific sector with a distance of less than 1,750 miles. Assertion of a proviso cannot, however, lead to an increase in the fare charged to the consumer above the industry fare for the full itinerary nor can it leave the other participating carriers with disproportionately low revenue shares. Where either of these rules apply, the provisos are ignored and revenue is shared on a straight mileage basis without any impact on the consumer. In a postedprice system, in contrast, all posted prices are applicable and the consumer would inevitably pay a higher price in both situations where the current provisos are disallowed. Provisos are currently in place for over 95% of intra-eea sectors. These provisios, however, are rarely applied for intra-eea travel because in combination they almost always exceed the existing IATA fares. This result is strong circumstantial evidence that consumers would pay a higher price under a posted-price system. 5. Key Issues for Assessing the Posted-Price Alternative In its previous submissions, IATA has explained that from a legal perspective the inability of a posted-price system to deliver the benefits of the current system in terms of flexibility and lower through fares mean that the present system satisfies the indispensability requirements of Article 81(3). If the Commission nonetheless considers it useful to engage in further exploration of the posted-price alternative, the following issues must be relevant: Is a posted-price system technically feasible? The 30 June consultation document focused on the technical feasibility of a posted-price system. It is clear to IATA that constructing a posted-price system would involve substantial sunk costs and require resolution of complex technical and contractual issues. IATA does not contend, however, that creating an industry system based on posted prices would create insuperable technical difficulties. (The more complex alternatives suggested by the German authorities in their submission appear, in contrast, to be practically impossible to implement.) How would a posted-price system in the EEA interact with industry fares for traffic to third countries? In the absence of industry fares within Europe, the application of the 2 It will be noted that this is in effect a double marginalisation issue. On any multi-sector itinerary where the sectors are not perfectly competitive, consultation on the itinerary price may lead to a welfare gain by moderating the demands that each airline would make individually. Economists will recognize this as a form of the effects identified by Cournot when two monopolists combine to provide a joint product. 4

6 multilateral interline system to itineraries that include a sector between points in the EEA will become difficult. Will the ability of an airline to claim a proviso now relate to that airline s posted price on the EEA sector? Will the passenger be able to change a booking where a proviso was applicable to a sector within the EU? If so, does the new carrier s posted price become the basis of the proviso and therefore will the passenger be forced to pay more to make such a change? Given the need to resolve these issues, it is possible that consultations on tariffs to third countries may need to exclude the sectors within the EEA from application of an industry fare, leading to higher prices and increased complexity for consumers who do not originate and/or end their journey at a long-haul gateway airport. Would posted prices be lower than carrier fares on the sector? The proponents of posted prices contend that competition for interline bookings would lead to lower prices. Implicit in this argument is the assumption that airlines will post prices for interline sectors lower than the price they charge for point-to-point traffic on the same sector. There is, however, no basis for this assumption. The likely scenario is that all or nearly all posted prices will be the same as the carrier s city-pair tariff on that sector: o Using the sector tariff minimizes transaction costs. o A lower interline price would undercut the carrier s on-line pricing structure (why would an airline provide its product to a competing airline at a price lower than it would sell to its own customers?). o The sector tariff reduces the likelihood of cannibalizing traffic that would otherwise use the airline s own network. This last point is particularly important because it reveals one of the essential difficulties with the theory underlying posted prices the idea that airlines would compete in a notional market for carrying interline traffic that is distinct from their principal markets. In reality, airlines that operate on a network basis maximize revenues by attracting traffic to their own networks and keeping that traffic on the network as long as possible. The present system works because where an airline can provide an on-line connection, it can almost always undercut the industry fare. No airline will maintain a system that allows a competitor on one sector (Sector A) to offer a competitive connecting product on combined sectors A and B, through a lower price on sector B. The loss of revenue on Sector A will outweigh any increased revenue on Sector B. If an airline sees a prospect of increased revenue from interline bookings, it is far more likely to pursue that revenue through bilateral arrangements than by posting a lower industry price. Is an industry posted-price system commercially feasible? The real issue that the Commission must address is whether there is a commercial likelihood that an industry posted-price system would emerge if the current tariff conference system is terminated. The Commission should note in this regard: o There is no industry posted-price system in the United States or in any other domestic jurisdiction where the tariff conference system does not operate. 5

7 o No system of industry posted prices has emerged in the cargo sector following the cancellation of interlineable rates and charges within the EEA. As a result, a number of carriers, particularly those on the periphery of Europe and/or with small/medium-sized European networks, have seen their intra-eea interline business reduced substantially. Shippers have shifted to carriers with larger and more comprehensive networks and these larger carriers have made no discernable efforts to replace industry interlining. o Some airlines have already noted in their comments that an industry system is unlikely to emerge. o Some airlines may not regard participation in a new industry system (allowing all of its competitors global access to its production for all itineraries) as commercially advantageous. o The current block exemption requires that participants in the tariff conference system agree to interline at the IATA fares set in the conference it is not possible for airlines to interline on specific routings or exclude specific airlines. In contrast, since a posted-price system is unlikely to be found restrictive for purposes of Article 81 EC under any theory, including those set out in the 30 June 2004 Consultation Paper, the Commission would lack any basis under Article 81 for imposing conditions on participation in such a system. The most likely outcome of terminating the existing system is an ad hoc posted-price system. IATA regards it as inherently unlikely that terminating the present system will lead to emergence of an industry posted-price system. The likely outcome of terminating the existing system will instead be a system of ad hoc posted prices based on airline sector fares. Even if an industry system covering some airlines developed, it is almost inevitable that some key participants will opt out. In an ad hoc system, airlines will be able to limit the sectors where they post prices and restrict the itineraries where the posted price can be used. This will raise substantial further issues of potential exercise of market power and double marginalization. The net result is likely to be higher prices and reduced consumer choice. Conclusion A posted-price system does not constitute a less restrictive alternative to the current system of interline tariffs set in IATA conferences. Not only does a posted-price system fail to generate the same benefits as the current system (as required under Article 81(3) EC) the theoretical benefits of an industry posted-price system are unlikely to be realized in practice. The likely outcome of terminating the block exemption would not be an industry posted-price system but a system of ad hoc posted prices. This, in turn, would result in a significant reduction in consumer welfare, compared to the system in place today. 6

8 Annex to Discussion Paper on Posted Prices Overview of IATA Proration mechanisms International Air Transport Association Route de l'aeroport 33 PO Box 416 CH Geneva 15 Airport Switzerland Tel: Fax:

9 Overview of IATA Proration mechanisms As airlines are not able to provide route networks which cover the globe, they need to be able to arrange transhipment with other airlines in order that passengers and freight are carried to their final destinations. Where one airline issues a ticket or air waybill for transportation partly on its own services and partly on the services of one or more other airlines, the issuing airline or its agent collects the price of the entire itinerary from the passenger or shipper. In order for passengers or cargo to switch from one airline to another using the same ticket or air waybill, the airlines involved need to have a method of calculating and sharing the revenues earned from that joint operation. Important as this proration is for large airlines, it is essential for smaller airlines with more restricted route networks who need to rely on interlining to provide their customers with the level of service they demand and to compete with airlines with more extensive route networks. In 1950 airlines began holding meetings to develop multilateral agreements for the sharing of interline revenue. The IATA Prorate Agency was established in 1957 to provide a forum for those meetings. The objective was to promote interline traffic and to facilitate and standardise interline revenue accounting. Over time, the Prorate Agency has overseen the development of agreed calculation methods and weighting factors applicable worldwide for the sharing of interline revenue. Airlines are free to decide whether or not they wish to participate in those developed agreements. The Prorate System is key to the IATA interlining system. Interlining in the aviation industry refers to the transportation of passengers or cargo which actually, or potentially (because the fare concerned allows for the itinerary to be changed), involves two or more airlines on a single ticket or air waybill. The IATA interlining system is a cornerstone of the international air transport industry. The system allows passengers and freight shippers to purchase multi-sector journeys involving transportation on any number of different airlines in one currency, over the counter from one travel agent or freight forwarder or airline. The interline system could not operate efficiently unless, where interlined carriage has taken place, the participants involved in that interlined carriage had an agreed mechanism for sharing the revenue collected by the ticketing carrier. Participation in the Prorate Agency In 2005 there are 191 airline signatories to the Multilateral Prorate Agreement. Of those 28 are not Members of IATA. The objective of the airlines participating in activities of the Prorate Agency is to develop multilateral agreements for the sharing of interline revenue in a manner which is acceptable for the greatest proportion of interline traffic on the route concerned. Airlines are free to decide whether they will participate in the developed agreements or not. 1

10 The Multilateral Prorate Agreements Passenger and Cargo developed through the Prorate Agency set out a methodology for the sharing of revenue for interline journeys. In simple terms, revenue is shared on the basis of mileage flown. If one airline flies a passenger 800 miles and another 200 miles, the revenue share is 80/20. This is known as a straight rate prorate. A regional cost factor is, however, applied to these mileages to compensate airlines operating in high cost environments, and the calculations set out within the agreements also compensate for the higher cost of short distance sectors. The latter is particularly important for small airlines, which often perform shorter sector services than the large airlines. In addition, airlines can file exceptions, known as provisos, to the straight rate proration methodology through which they stipulate a percentage of a base fare or rate as the share of the revenue they require for interlining on a particular sector. The Multilateral Prorate Agreements also include a mechanism to ensure that provisos are not applied where they would result in an unreasonably low revenue share for any of the airlines involved. Non-signatory airlines In order to simply participate in the proration rules contained in one or more of the Prorate Agency s multilateral proration agreements, and have its own proration data included in the relevant Prorate Manual, without becoming a participant in the Prorate Agency itself, an airline only needs to provide the Prorate Agency with a written statement confirming that it accepts the terms and conditions of the relevant multilateral proration agreement. Prorate Meetings The proration rules and procedures contained in the MPAs are agreed at meetings of the airlines participating in the Prorate Agency. There are two types of meetings which can be held: General Prorate Meetings these meetings deal with all Prorate Agency matters, including prorate matters, administrative matters and the election of the Interline Prorate Advisory Committee; Special Prorate Meetings these meetings are limited to prorate matters relating to either passenger or cargo. General Prorate Meetings must be held at least once every three years. Special Meetings or additional General Meetings can be held at any time at the request of nine of the airline signatories to the Prorate Agency Agreement, the IATA Director General, or the Interline Prorate Advisory Committee. Who can attend Any airline, whether or not it has signed the Prorate Agency Agreement, is entitled to attend a Prorate Meeting. Voting is, however, limited to those airlines which are signatories to the Prorate Agency Agreement and, in relation to some issues, those which have also signed one or both of the Multilateral Prorate Agreements. 2

11 Straight rate proration Straight rate proration is the basis of the proration rules which have been developed through the Prorate Agency. Under straight rate proration the revenue from an interlined journey is simply shared in proportion to the mileage flown by each airline. The two elements of straight rate proration are: the amount to be prorated; and prorate factors. Amount to be prorated for an interlined passenger journey, the carrying airline s prorated share is calculated from the fare collected by the issuing airline on a oneway basis, provided it is a valid published fare. This is known as the amount to be prorated ( ATBP ). Return journeys will typically consist of two ATBPs one for the outward part and the other for the inward part. Prorated shares are calculated and collected separately for each ATBP. There are detailed rules in the Multilateral Prorate Agreement Passenger dealing with how this fare is to be determined where it is not stated on the ticket, such as where the ticket is for a round trip and the fare is shown as a single amount, and where the fare includes a surcharge or differential or stopover charge. Likewise, the amount to be prorated on an interlined cargo shipment is simply the rate or charge collected by the issuing airline. This is a more straightforward exercise than for passenger proration as cargo shipments only travel in one direction. Prorate factors the amount to be prorated is shared in proportion to the prorate mileage flown by each airline involved in the journey. Straight rate proration is not simply carried out on the basis of the actual mileage flown. Instead, the mileages are adjusted to take into account the differences in cost levels in different parts of the world and the higher cost of short haul services. For passenger proration, the mileage is constructed by taking the ticketed point mileage ( TPM ), which is the shortest distance between any two points on an operated route, and applying a worldwide cost weighting formula, which is then adjusted by an area cost weighting according to the geographical sector in which the particular flight has been performed. The resulting weighted mileage is known as a prorate factor. The same process is used for cargo proration except that great circle miles are used instead of TPMs. The Prorate Agency calculates the prorate factor for each city pair for which there is a scheduled passenger or cargo service, and publishes those factors in the Prorate Manual Passenger and Cargo respectively. In 2004, the Prorate Manual Passenger contained 55,708 prorate factors, corresponding to 27,854 city pairs. The current edition of the Prorate Manual Cargo contains 684,454 prorate factors, corresponding to 342,227 city pairs. 3

12 Provisos Airlines which have either signed the Multilateral Prorate Agreement, or which are not signatories but participate in the Prorate System by subscribing to one of the Prorate Manuals, can file exceptions, known as provisos, to the application of the straight rate proration rule on sectors on which they operate. These provisos are published in the Prorate Manual Passenger. An airline can only file a proviso in relation to a particular sector if it has full traffic rights to operate on that sector. Provisos for the proration of revenue from passenger interlining are expressed as a percentage of a Base Amount. The base amount is the fare level for the sector concerned, which is exclusive of tax and which has received all necessary approvals. The proviso percentage cannot be greater than 100%. The Prorate Agency maintains a database of the base amounts, which are published in the Prorate Manual Passenger. Passenger provisos can be specified to apply to an airline s specific city pairs, or, if it wishes the same proviso conditions to apply to a group of city pairs, it can aggregate by country or region or all of its services worldwide. They can also be expressed to apply to all fares, or can be specified for particular fare types. A proviso cannot be expressed to be limited to applying only where it will produce a higher revenue share than would be derived from straight rate proration. The proration rules developed through the Prorate Agency contain mechanisms designed to ensure that a proviso is not applied where it would result in the airline concerned receiving a disproportionately high share of the revenue. These mechanisms are as follows: 1,750 maximum TPM any passenger proviso for a sector that has a TPM of more than 1,750 miles will not be applied. Proration is instead performed on the straight rate prorate principle. This rule is intended to ensure that provisos are only used to protect the position of short haul services; Provisos in excess of the total amount to be prorated where proration on the basis of applicable provisos would result in prorated shares which exceed the total amount which is being prorated, those provisos will be ignored and straight rate proration applied instead; Minimum Prorate Rule percentage if proration on the basis of applicable passenger provisos would result in a non-proviso airline receiving less than the Minimum Prorate Rule percentage of the prorate factor for its sector, then those provisos will be ignored and straight rate proration applied instead. The Minimum Prorate Rule percentage is calculated each year by ICAO on behalf of the Prorate Agency and published in the Prorate Manual Passenger. It is intended to ensure that an airline involved in an interlined journey does not receive a prorated share that is below a reasonable threshold as a result of the application of a proviso by another airline. In 1993 ICAO calculated the average airline yield to be 5.75%. This figure was established as the base Minimum Prorate Rule percentage, and each year it is 4

13 revised by ICAO in accordance with the worldwide average change in fares over the previous year. The current Minimum Prorate Rule percentage is 10.8% Proration on the basis of a proviso is performed by applying the percentage specified in the proviso to the base amount published in the Prorate Manual Passenger for that sector. The issuing airline receives the revenue remaining after deduction of the proviso share from the revenue being prorated. If this residual share represents less than 10.8% (the current Minimum Prorate Rule percentage) of the prorate factor for that airline s sector then the proviso will not apply and the proration must be done on a straight rate proration. The same principle applies if there are more than two airlines involved in the interlined carriage. If an airline, which does not have a proviso for its sector, interlines with two airlines that have filed provisos for their sectors, then the two proviso airlines shares are calculated in accordance with their provisos and the non-proviso airline receives the residual revenue. If, however, that residual revenue is less than the Minimum Prorate Rule percentage then the provisos are ignored and the proration of all three airlines shares is done on the straight rate proration basis. 5

14 Example 1 application of a passenger proviso proviso allowed Itinerary: Paris Amsterdam Singapore Total fare: USD 4,561 Prorate factors: Paris Amsterdam (Airline A): 726 Amsterdam Singapore (Airline B): 6,936 Total 7,662 Airline A s proviso: 100 % of the base amount on all flights between The Netherlands and France Base amount: USD 461 Value of Airline A s proviso: 100% x USD 461 = USD 461 Minimum Prorate Rule: Residual revenue = USD 4,561 - USD 461 = USD 4,100 Residual prorate factors = 6,936 (Airline B) Ratio of residual revenue to factors = USD 4,100 / 6936 = Airline A s prorate share: The ratio of the residual revenue (after deducting Airline A s proviso) to the residual prorate factors is greater than the MPR percentage of 10.8% (i.e ) so Airline A s proviso is allowed and they will receive USD

15 Example 2 application of a passenger proviso proviso disallowed Using the same facts as in Example 1 except now the value of Airline A s proviso is EUR 161. Itinerary: Paris Amsterdam Singapore Total fare: USD 821 return Prorate factors: Paris Amsterdam (Airline A): 726 Amsterdam Singapore (Airline B): 6,936 Total 7,662 Airline A s proviso: 35% of the base amount on all flights between the Netherlands and France Base amount: USD 461 Value of Airline B s proviso: 35% x USD 461 = USD161 Minimum Prorate Rule: Residual revenue = USD USD 161 = USD 249 Residual prorate factors = 6,936 Ratio of residual revenue to factors = USD 249 6,936 = Airline B s prorate share: The ratio of the residual revenue (after deducting Airline A s proviso) to the residual prorate factors is less than the MPR percentage of 10.8% (i.e ) so Airline A s proviso is disallowed. Airline A s prorate share is instead calculated using straight rate proration Straight Rate Proration factors percent Paris Amsterdam % Amsterdam Singapore 6, % Total 7, % Airline A receives Airline B receives USD one way USD one way 7

16 Example 3 Example of minimum fare to enable provisos Itinerary: Paris Amsterdam Singapore Prorate factors: Paris Amsterdam (Airline A): 726 Amsterdam Singapore (Airline B): 6,936 Total 7,662 The Minimum Prorate Rule ensures that non proviso sectors maintain a threshold yield, to protect against aggressive provisos. One quick method to determine the point at which a proviso will apply or not is to multiply the non proviso prorate factor miles by the MPR factor of (.101). Using this example of a routing: Amsterdam Singapore (non proviso sector) 6,936 x.108 USD On a round trip basis, (USD x 2 = USD 1,498.18) USD 1, is the minimum round trip amount a carrier flying Amsterdam-Singapore needs before a carrier flying Amsterdam Paris can achieve a proviso. Converted to EUR using exchange rates on 21 September 2004 USD 1, x = EUR1, Airfares available on 21 September 2004 between Paris and Singapore are available as low as EUR 680 return. With fares so low, it is impossible for provisos to be honoured. This is due to the high MPR %. If the long haul (non proviso) cannot receive the minimum, the journey is straight-rateprorated. 8

17 Proration EC Competition Law perspective Regulation (EEC) No 3975/87 1 clearly indicated that proration activities fell outside the scope of Article Article 2 on Exceptions for certain technical agreements stated: 1. The prohibition laid down in Article 85 (1) of the Treaty shall not apply to the agreements, decisions and concerted practices listed in the Annex, in so far as their sole object and effect is to achieve technical improvements or cooperation. This list is not exhaustive. Among such technical concerted practices and agreements, the list mentioned : (j) Arrangements as to the sale, endorsement and acceptance of tickets between air carriers (interlining) as well as the refund, pro-rating and accounting schemes established for such purposes; Regulation 1/2003 has repealed Regulation However, there are no indications whatsoever that the EC has changed its views on proration and its compatibility with EU Competition Law. September COUNCIL REGULATION (EEC) No 3975/87 of 14 December 1987 laying down the procedure for the application of the rules on competition to undertakings in the air transport sector 9