Description
Civil aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
ICAO’s estimates every 100 $ spent on air travel produces benefits worth 325 $ to the
Economy. It generates 100 additional jobs in air transport & 610 related jobs. Indeed this
was reiterated by our minister of Civil Aviation, Mr. Praful Patel who projected that 40
lakh aviation jobs would be available in the next 10 years.
Almost 35 % of exports from India & 97% foreign tourists to India arrive by Air each
year. Aviation sector has undergone a major facelift in past 3-4 years.
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Nancy Shah
[email protected]
Competition Issues in the
Civil Aviation Sector
Evaluating Competition related
issues pertaining to the Indian
Airlines’ Industry, with Special
Reference to M&A in light of
Competition Act, 2002
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1
Prepared in fulfillment of the requirement as part of Economics, M.A in Gokhale Institute of Politics & Economics.
A study paper submitted for Internship June-July, 2007 to
Competition Commission of India (CCI).
Competition Commission of
India (CCI)
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 1
DISCLAIMER
This project report/dissertation has been prepared by the author as an intern
under the Internship Programme of the Competition Commission of India for
academic purposes only. The views expressed in the report are personal to the
intern and do not necessarily reflect the view of the Commission or any of its
staff or personnel and do not bind the Commission in any manner. This report
is the intellectual property of the Competition Commission of India and the
same or any part thereof may not be used in any manner whatsoever, without
express permission of the Competition Commission of India in writing.
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Table of Contents
Part I: Introduction………………………………………………………………………....10
Part II: Drivers to Growth………………………………………………………………….15
Part III: Types of Air Services……………………………………………………………..17
Part IV: Players of the Industry.................................................................................................18
Part V: Importance of Competition……...……………………………………..….…….....22
Part VI : Relevant Market Concept……………...………………………….....…………...27
Part VII : Competition related issues pertaining to the Aviation Sector.………..………….31
a. Loyalty Programs ( FFP’s & Travel Agent Programs)……....….…...…...… 31
b. Multi Contact………………………....………….…........................................34
c. Competition in Vertically Related Markets. …………………………...….....34
d. Price Transparency & Collusion………...……………….………………......36
e. Alliances & Competition related issues with them…...…….…………….......37
Part VIII: Airlines M&A:
a. Regulations governing M&A in India..…………...………...……………..….48
b. Cases of M&A Abroad……………...………………..…………..……...…...53
i. Air France & KLM
ii. US Airways & United Airlines
c. Cases of M&A in India.……………………..……...………………………....58
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 3
i. Jet-Air Sahara Merger
ii. Indian Airlines – Air India Merger
iii. Kingfisher—Air Deccan Merger
Part IX : Competition Related Issues Pertaining to the Indian Aviation Sector
a. Regulatory Barriers……………….………………………………………….....59
b. Scarcity of Slots………………………………….………………………….….65
c. Cartelization……………………………………………………..………….…..73
d. Regulation of Combinations.………………………………………………..…..86
Part X: Conclusion…………………..……………………………………………………...101
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ACKNOWLEGMENT:
I want to express my sincere thanks to Member, CCI, Mr. Vinod Dhall and
my guide Mr. Peter Augustine, Economic Advisor, CCI for having given me
an opportunity to work on the topic of my choice, The Aviation Sector.
I’m indebted to the Member for giving me an opportunity to work in his
esteemed organization. I take this opportunity to thank Mr. Peter Augustine
for guiding me during this study right from the beginning and providing me
constructive suggestions throughout the preparation of the dissertations.
I’m highly thankful to our Librarian, Mr. G. Sreeniwas for his
resourcefulness. I would also like to thank ASSOCHAM for giving me access
to their Study Report-“Road Map to Civil Aviation”. I would also like to
take the opportunity to thank, Dr. Anil Kumar, Assistant Director,
(Research) for making my stay at CCI so comfortable.
Last but not the least, I would like to thank my Family without whose
support and inspiration, this project would have been possible.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 5
LIST OF FIGURES
Number Page Numbers
Fig 1: Market Share of Domestic Carriers……………………………………….……….20
Fig 2: Level of Congestion at major city airports…………………………….…………..65
Fig 3: Distribution of flights operating everyday between Delhi to Mumbai…………….66
Fig 4: Indicative growth rates of passenger, airports & aircrafts……………………...….81
Fig 5: Comparison of Revenue per Aircraft of the Domestic carriers with the Global
Standards………………………………………………………………..……………….107
Fig 6: Traffic on International Routes………………………………………………….…63
LIST OF TABLES:
Table 1: HHI Calculations…………………………………………………………..…….76
Table 2: Combined Turnovers of the Merged Carriers………………………….………..85
Table 3: Comparison of Market shares Pre & Post Mergers…………………...………….96
Table 4: Current & Fleet on Order Status of Domestic Carriers……………..………….106
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EXECUTIVE SUMMARY
Civil Aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
International Civil Aviation Organizations’ estimates, every 100 $ spent on air travel
produces benefits worth 325 $ to the Economy.
The Indian Aviation Sector has witnessed tremendous growth in the recent past which is
driven by sound demographic, macroeconomic, government aided reforms & market
dynamics. The three fold increase in consumerism, rising disposable income; booming
aviation sector; burgeoning middle class; increasing business travel; government reforms;
entry of low cost carriers; increasing competition etc have positioned the Indian Aviation
Sector in a high growth trajectory.
In order to maintain this high growth trajectory, it is very important that competitive
forces must continue to operate with in this sector. In this report my focus shall be on the
competition related issues surrounding Airlines with special emphasis on M&A in light
of Competition Act, 2002.
There are some characteristics inherent to this sector that are anti-competitive in nature.
For Instance Loyalty Programs like Frequent Flier Programs & Travel Agent Incentive
Schemes. Airlines use the above-mentioned loyalty programs to distinguish between
business travelers & those traveling for leisure purposes. The ones traveling for Business
Purposes have a high opportunity cost of time & therefore have a very inelastic response
w.r.t. changes in prices vis-à-vis Leisure Travelers who are flexible about the days &
timings & hence they benefit from a wide choice of routes available & also a higher level
of competition. All Competitive concerns addressed in this report are focused on the time
sensitive passengers as they have no other substitute mode of transport that matches the
speed of air travel. Hence, the relevant market for our analysis is defined as “a City Pair
Market at a particular time on a particular day”.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 7
Unlike other industries, capacity in the aviation sector cannot be immediately augmented
in face of rising demand. Airports have a capacity constraint binding on them in terms of
the landing, take off facilities, air traffic controllers, refueling, maintenance, clearing &
catering services etc. It is this capacity constraint that might act as an entry barrier for
new entrants. Landing & take off rights are referred to as Slots. These slots are an
important consideration for an entrant as peak timed slots register higher passenger load
factors as compared to the oddly timed slots. With most of the country’s trunk route
airports hitting their capacity mark, only oddly timed slots may be available at major
metropolitan city airports to a new entrant which discourages new entry.
There are some regulatory barriers inherent in our domestic air transport policy which
may constrain new entry & have anti-competitive effects. While the regulations
governing minimum fleet size , minimum equity requirements , route dispersal guidelines
to the domestic operations are act as an entry barriers; the regulations governing
minimum fleet & experience requirements for International Operations & exclusive right
to National carriers to fly to Gulf Routes etc are highly discriminative & are constraining
new entry & strengthening the incumbents position. The current regulations seem to
favor only the incumbents namely Air India-Indian Airlines and J et-Sahara. None of the
other players are allowed to operate internationally. Given that maximum passenger load
factor is registered on Gulf Routes, the exclusive right given to the national carriers is
highly a restrictive practice.
The Year-2007 has been the year of M&A in the Indian Skies. First, it was Indian
Airlines & Air India then J et & Air Sahara and last but the least to tie the knot was
Kingfisher & Air Deccan. The industry sources favored these mergers as they believed
that these mergers would benefit the already bleeding Industry. It would help to bring in
some route; network & fleet rationalization. The merged entities are expected to benefit
from joint operations & would share synergies of joint operations. However, equally
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justified are the consumers groups who are fearing that post consolidation, prices may
increase more so after the consummation of Air Deccan.
All three M&A very well come under the lens of the Competition Commission of India’s
as they meet the benchmarks standards laid down by the Competition Act, 2002 with
regard to Regulations of M&A. As far as IA-AI Merger is concerned it doesn’t pose
much problem from competition angle as the merging entities have complementary
networks with AI having International presence with negligible domestic presence and IA
having heavy domestic presence with negligible international presence. However, the
exclusive right to fly to Gulf routes is unfair as its depriving the other domestic players
from an important source of revenue. Consumers too don’t have much option w.r.t. mode
of transportation & the choice of the carrier.
With the take over of Sahara by J et, some important issues over competitive concerns
need to be addressed. J et and Sahara have peak slots available on all major metropolitan
airports at peak timings. As defined earlier that relevant market in our analysis is a city
pair market, on a particular day, at a particular time. Hence peak timed slots are a major
determinant of profitability. Concerns have been expressed last year when J et announced
its plan to take over Sahara. Air Sahara's rights must be redistributed to all airlines in
order to prevent J et Airways from attaining a dominant position in slots as this would
restrain growth of competition. I suggest that Air Sahara's aviation rights should not
automatically accrue to J et; the latter should instead be required to re-apply for securing
additional rights. The DGCA, as the competent authority should use this window to re-
distribute Air Sahara's rights to all airlines. Had Air Sahara continued and given the
inevitability of its closure, its rights would have anyway got released for distribution to
others and not available only to J et.
Another important issue that needs to be addressed is that post J et-Sahara Deal & IA-AI
deal , the number of players serving the International Routes have been reduced to half
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 9
as no other domestic player is eligible for flying Internationally as per the current
regulatory framework.
With top 3 players having more than 80% of market share; chances of Cartelization are
more likely with the industry getting consolidated. Such attempts have been made in the
past. FIA-Federation of Indian Aviation was set up in 2005 by top airline industry
honchos to voice their needs to the government. Among its first meet, the federation had
thought of discussing pricing issues. However, this was aborted by timely intervention of
CCI. However, such attempts can be made again as cooperation is more easy with the
industry getting consolidated. So CCI must keep an eye on such instance of price
coordination. The transparency in fare dissemination news facilitates cooperation among
the colluding members.
For simplicity sake, the report is divided in various sections. The first three sections
include an introduction to the sector, its players and types of air services. The fourth
section highlights the importance of competition with reference to the Competition Act,
2002 followed by the concept of relevant market in the next section. Having defined the
Relevant market, section 7 will address the general competition related issues pertaining
to the Airline Industry. Section 8 will focus of regulations governing M&A in India,
cases of M&A Abroad and cases of M&A in India. Last but the least, Section 9 will
address all competition related issues pertaining to the Indian Airline Industry with
special reference to M&A in light of Competition Act, 2002. Section 10 incorporates the
Conclusion.
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SECTION I
INTRODUCTION
Civil aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
ICAO’s estimates every 100 $ spent on air travel produces benefits worth 325 $ to the
Economy. It generates 100 additional jobs in air transport & 610 related jobs. Indeed this
was reiterated by our minister of Civil Aviation, Mr. Praful Patel who projected that 40
lakh aviation jobs would be available in the next 10 years.
Almost 35 % of exports from India & 97% foreign tourists to India arrive by Air each
year. Aviation sector has undergone a major facelift in past 3-4 years.
Phase I of Indian Aviation Sector (up till 1986):
The legacy of Indian aviation dates back to 1912 when India’s first air mail service was
started by Tata Airlines. Tata Airlines though was started as an air mail service but soon
ventured in carrying scheduled passenger traffic. In 1946, Tata Airlines was renamed as
Air India. In early 1948, a joint sector company, Air India International Ltd., was
established by the Government of India and Air India (earlier Tata Airline) .At the time
of independence the number of companies operating with in and beyond frontiers of the
country were 8 namely: Tata Airlines, Indian National Airways, Air service of India,
Deccan Airways, Ambica Airways, Bharat Airways and Mistry Airways.
The government in 1950 had set an Air Traffic Enquiry Committee to look into the
problems faced by the airlines. The soaring prices of aviation fuel, mounting salary bills
and disproportionately large fleets took a heavy toll of the then airlines. The financial
health of companies declined despite liberal Government patronage, particularly from
1949, and an upward trend in air cargo and passenger traffic. Though the Committee
found no justification for nationalization of airlines, it favored their voluntary merge. So
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 11
Government in the wake of deteriorating financial conditions of the Airlines decided to
step in and nationalize the air transport industry and accordingly, two autonomous
corporations were created on August 1, 1953. In 1953, the government nationalized the
airlines via. The Air Corporations Act, 1953, which gave birth to Indian Airlines and Air
India. Indian Airlines was formed with the merger of eight domestic airlines to operate
domestic services, while Air India International was to operate the overseas services. The
Act also gave monopoly power to Indian Airlines to operate on domestic scheduled
services to the exclusion of any other operator. Air India became the only Indian carrier
to operate on international routes except for some routes to the neighboring countries
which were given to Indian Airlines.
Phase II (1986-2003):
The second phase of Indian aviation began in the year 1986 with granting of permission
to private sector players to operate as air taxi operators. The private players allowed to
operate as air taxi operators included Air Sahara, J et Airways, Damania Airways, East
West Airlines, Modiluft and NEPC Airways. In 1994, government of India repealed the
Air Corporation Act there by. Following this measure in 1995, govt. granted scheduled
carrier status to six private air taxi operators. However, not many operators were able to
continue their business and by 1997 only four operators started operations followed the
deregulation continued to operate: J et Airways; Air Sahara; J agsons and Spicejet
(previously operated as Modiluft ) .Eventually, by 1998, at least six private airlines, East-
West, Modi-Luft, NEPC, Damania, Gujarat Airways and Span Air were closed and
according to an estimate, the capital losses involved in these closures were to the tune of
Rs 10 billion.
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Phase III: (2003 – 2006)
Only two private carriers survived to see the dawn of the new century. The duopoly of J et
and Sahara as private carrier was challenged in 2003 by Air Deccan whose operations in
scheduled services began in August. The entry of Deccan changed the entire canvas on
which the aviation sector was defined. Air Deccan gave India its first Low Cost Carrier
(LCC) or no frills Airline! This marked as a turning point in the history of Indian
Aviation Sector as it marked a shift from the stereo type economy fares & business fares
to the era of check fares ; web fares ; APEX fares ; internet auctions ; Special discounts ;
Corporate plans ; last day fares; promotional fares etc. Arrival of Deccan has bought a
revolution in this sector, it changed the common man’s perception of flying by matching
airline fares neck to neck with upper class railway fare. Air traffic growth since then has
witnessed tremendous growth rates. The figure shown below indicates the growth in
passenger volumes:
P
ost 2003, we see a 3 fold increase passengers traveling by air in India. Spurred by the
initial success of LCC Model, other airlines entered the sector and opted for No-Frill
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 13
Model. Since then 5 other airlines namely Spice jet ; Kingfisher ; Indigo ; Paramount ;
Go Air have begun operations in India .Licenses have been issued to new carriers such as
Star Airlines ; Skylark ; Magic Air ; Air One and many more in the pipeline.
Phase IV: (Year 2006 onwards) :
Yet another milestone in the history of the Indian Aviation sector came in the year 2007
which is the year of Marriages in the Indian Skies! Though the marriage of J et-Sahara &
IA-AI was announced in 2006 but the ultimate consummation materialized only in 2007.
The current year has witnessed a series of M&A of airlines namely: Indian-Air India; the
J et-Sahara Deal; the Kingfisher-Deccan Deal. These players post consolidations have
claim over 80% of the market share.
The industry sources favored the consolidation attempts, as the proposed mergers would
help the carriers get rid of the widespread duplication of capacity, rationalization in the
route networks & fleets and also facilitate sharing of infrastructure, which would help the
merged entities, save a lot on its operational costs & enable the sector to tide over huge
industry losses. The mergers are expected to help the firms break even & there by ensure
carriers’ sustainability in long term. However, there is another side to this rosy picture.
Equally justified are the consumer groups who are feeling vulnerable& expect that post
absorption of important competitors such as Deccan & Sahara prices may increase in the
future. Air Deccan, India’s pioneer low costs airline made air travel affordable; with in
the reach of the common man. With its absorption, consumers fear that the days of low
fares are over. In this report, we will therefore analyze the relative merits and more
importantly highlight the appreciable adverse effects of mergers that will or may arise in
future; the potential threat that the proposed mergers might pose to competition.
The general perception is that competition is healthy for all the market as it guarantees
maximum benefits being trickled to the consumer groups. However, this doesn’t hold true
for industries where there is room for economies of scale and scope. Undoubtedly, airline
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is one such industry where there exists economies of scale. There needs to be a minimum
efficient scale of operation to be sustained for breaking even. That’s probably the reason
for the oligopolistic structure of this industry.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 15
SECTION II
DRIVERS TO GROWTH:
Indian Aviation Sector has witnessed tremendous growth in the recent past which is
driven by sound demographic, macroeconomic, government aided reforms and market
dynamics. Industry sources call it the PEST Mechanism namely P-Political; E-Economic
S-Socio-Cultural; T-technological. The drivers to growth are:
• Increase in Consumerism
• Rising Disposable incomes
• Rising Middle Class Population
• Untapped Market
• Increasing Business Travel
• Increasing Tourists Travel
• Entry of Low Cost Carriers
• Increasing Competition
• Government Reform Measures
The mix of the above mentioned fundamentally strong favorable dynamics has positioned
India’s Aviation industry in a high growth trajectory in the foreseeable future. World
wide, air traffic has a strong correlation with economic growth and in emerging markets
like India, a rise of 1% in GDP is expected to result in a 2% increase in air traffic.
Disposable income in India has gone up by 5 times in the last 2 decades and the
expenditure on transportation has risen from 6% to 14% in the same period.
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The increase
in trade activity within the nation is leading to the development of various mini metros.
This results in increased demand. It is expected that the emerging middle class along with
upper middle population will grow at 40 % of the total population in 2007, creating huge
demand for air-travel services.
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However, the penetration level of air services in India has been very low at 20 trips
/annum/thousand passengers in 2005 as against 2,300 trips/annum/thousand passengers in
United States and over 60 trips per annum per thousand passengers in China. India is one
of the least developed markets in the World and is among the most expensive in the
world (after adjusting for purchasing power parity).
2
ASSOCHAM Study: Road map to Civil Aviation, 2007.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 17
SECTION III
TYPES OF AIR SERVICES
1. Scheduled Air Transport Service means an air transport service undertaken between
the two or more places and operated according to a published time table or with flights so
regular or frequent that they constitute a recognisably systematic series.
2. Non-Scheduled Operation includes services other than scheduled air transport service
Eg: charter basis and/or non-scheduled basis. The operator is not permitted to publish
time schedule and issue tickets to passengers
3. An air cargo service means air transportation of cargo and mail. Passengers are not
permitted to be on these operations. It may be on scheduled or non-scheduled basis.
NOTE: In this report, our focus will be only on Scheduled Air Transport Service.
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SECTION IV
PLAYERS IN THE MARKET
Indian skies are housing a decent number of airlines today vis-à-vis the one man army
scenario prior to 1990’s. The proud residents of Indian skies include the following:
1. Air India : India’s Legacy Carrier
The history of Air India is the History of Indian Aviation. Air-India began operating in
1932 as Tata Airlines, named after J . R. D. Tata, its founder. Founded as a small, private,
domestic carrier in 1932, Air-India is now government owned. It flies only International
routes and has negligible presence felt while catering to the domestic traffic.
2. Indian Airlines : With nationalization of Air Transport in 1953 via Air Corporation
Act,1953 , National Flag carriers : Indian and Air India were born. Indian was born from
merger of 8 domestic carriers .It caters mainly to domestic routes with some presence felt
in neighboring nations. Like Air India it’s a full service carrier. It has a subsidiary
‘Alliance Air’ .Its Symbol is Asoka’s Chakra. For a long spell of time, the two national
carriers enjoyed sole monopoly in the air transport segment as private carriers were
barred from entering the segment as per Air Corporation Act, 1953. It was after the New
Economic Policy, 1991 after which things fell in the right places and successful attempts
were made to enter the segment by private players like J et, Sahara and others. Yet
another, turning point has come in the history of the Indian Aviation Sector when Air
India was granted permission from the Government of India to merge with Indian
Airlines, the two flag carriers of India.This Mega Merger marked the first marriage in the
Indian skies which was followed by two more marriages. The name of the new airline
will remain Air India, since it is known worldwide. They have been in the works of
completing the merger since J anuary 2007, after permission.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 19
3. Jet Airways :
In 1993, J et commenced its operations after the ban was lift by the government following
the repeal of Air Corporation Act.1956. J et Airways will be the most preferred domestic
Airline in India. It will be the automatic first choice carrier for the traveling public and
set standards, which other competing airlines will seek to match. It is the only airline that
stood the crunch of late 1990’s. J et started its International Operations in 2004 and carries
more than 7 million passengers per annum. Recently, the company made news when
Naresh Goel led J et Airways took 100 % stake in their arch old rival Air Sahara in May,
2007. This earmarked the second marriage of the season in the Indian Skies after the AI-
IA deal.
4. Air Sahara:
Like J et, Sahara too began its operations in 1993 after the domestic Air Market was
opened by the govt. in 1990’s. Air Sahara Limited is a leading private airline in India,
owned by the diversified Sahara India Parivar group. After J et, it was only airline that
could stand the torrential winds of late 1990’s. After series of controversies Air Sahara
has been taken over by J et Airways in May, 2007. The airline is now renamed as “J et
Lite”. J et has intensions of converting Air Sahara in sync with LCC model to reach every
segment of air travelers.
5. Air Deccan:
India’s first budget carrier and now the largest flew its first carrier in 2003.Headed by
Captain Gopinath, Air Deccan truly redefined the accessibility to the Indian Skies. It
injected competitive spirits into the system and gave common man wings by reducing air
fares which matched the first Class Railway Fares. The third wedding in skies was
marked when Dr Vijay Mallya of Kingfisher Airlines picked up 26 % stake in Air
Deccan.
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6. Kingfisher:
The Airline began its operation in May, 2005 .it’s the by far the most flamboyant airline
in India, giving tough competition to J et Airways in in-flight services. It is a major Indian
luxury airline operating an extensive network to 34 destinations, with plans for regional
and long-haul international services. Kingfisher Airlines, through one of its holding
company UB holdings Ltd has acquired 26% stake in the budget airline Air Deccan and
has offered to buy further of 20% stake from the secondary market.
7. GoAir:
The most colourful airline in India (comes in 6 colours) started its operations from
November, 2005. It belongs to the Wadia group.
8. Indigo:
The airline made heads turn when it placed the ambitious order of 100 aircrafts with
airbus. The carrier began its operations in August, 2006.
9. Paramount:
It’s the only high value flier that India can boast of .It is the only carrier that uses 70
passenger capacitated Embraer Aircraft.The airline started operations in October 2005. It
was established by Madurai-based textile company Paramount Group. Paramount
presently operates only in South India. There was news of Paramount showing interest in
in picking up stake in Go Air and Spicejet so as to foray into Northern India
easily.However, so far dotted line has not been signed with any carrier.
10. Spicejet:
SpiceJ et, a reincarnation of ModiLuft marked its entry in service by offering fares priced
at Rs.99 fares for the first 99 days since its inception in 2005. The carrier is giving tough
competition to Railways.This airline is known to have had made the least number of
mistakes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 21
Fig 1:
As on 30
th
April 2007, the status in the Indian skies is as follows:
MARKET SHARES OF DOMESTIC CARRIERS
Mkt . Shar e
23%
22%
18%
8%
6%
7%
3%
2%
11%
IA JET AIRDECCAN SPICEJET INDIGO AIR SAHARA GOAIR PARAMOUNT KINGFISHER
Source: Business Standard
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SECTION V:
IMPORTANCE OF COMPETITION
5.1 In common parlance competition in the market means sellers striving
independently for buyer’s patronage to maximize profit or other business objectives. A
buyer prefers to buy a product at a price that maximizes his benefits whereas seller
prefers to sell the product at a price that maximizes his profit. Competition makes an
enterprise more efficient and offers wider choice to consumers at lower price. Fair
competition is beneficial for the Consumers, Producers / Sellers and finally for the whole
society since it induces economic growth. In order to realize this objective to competition
in the economy, the Competition Act, 2002 was passed which replaced MRTP Act, 1969
.The objective of Competition Act is to prevent anti-competitive practices, promote and
sustain competition, protect the interest of the consumers and ensure freedom of trade.
The objectives of this Act are to be achieved through the instrumentality of the
Competition Commission of India (CCI) which has been established by the Central Govt.
w.e.f 14
th
October, 2003.
Areas focused under the MRTP Act, 1969:
i. Prohibition of concentration of economic power to the common detriment;
ii. Control of monopolies; and
iii. Prohibition of monopolistic, restrictive & unfair trade practices.
Where as the theme areas for the Competition Act, 2002 are as follows:
i. Prohibition of anti-competitive agreements;
ii. Prohibition of abuse of dominant position;
iii. Regulation of combinations ;
iv. Competition Advocacy;
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 23
5.2 Competition Act, 2002 shall prohibit anti-competitive agreements and abuse of
dominance and regulate combinations (mergers amalgamations or acquisition) through a
process of inquiry. It shall give opinion on competition issues on reference received and
is also mandated to undertake competition advocacy, create awareness and impart
training on competition issues.
Combinations that exceeds threshold limits specified in the Act in terms of assets and
turnover which causes or is likely to cause an appreciable adverse effect on competition
with in the relevant market in India can be scrutinized by the Commission. The
prescribed turnover levels for Merger & acquisitions are: Assets of the merged entity
more than Rs. 1000 Crores or turnover of more than Rs. 3000 Crores (these limits are US
$ 500 millions and 1500 US$ in case one of the firms is situated outside India.). The
limits are more than Rs 4000 Cr or 12000 Cr and US$ 2 billions and 6 billions in case the
merged entity belongs to a group in India or outside respectively.
Therefore this Act has been devised keeping in view the economic development of the
country by preventing practices which have appreciable adverse effect on competition.
Some important terms relevant from competition angle are explained below:
1. Abuse of dominance: According to Section 4, Competition Act, 2002 dominance is
defined as a position which enables a dominant firm to operate independently of
competitive forces or to effect its competitors or consumers or the market in its
favour. A firm may achieve dominance through innovation; superior Products;
affordable prices; efficient distribution system; satisfactory after sale service;
entrepreneurial efforts. Abuse of dominant position impedes fair competition
between firms, exploits consumers and makes it difficult for other players to
compete with dominant undertaking on merit. Abuse of dominant position
includes imposing unfair conditions or price, predatory pricing, limiting
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production/market, creating barriers to entry and applying dissimilar conditions to
similar transactions.
There shall be abuse of dominant position if an enterprise.—-
(a) directly or indirectly, imposes unfair or discriminatory—
(i) condition in purchase or sale of goods or service; or
(ii) price in purchase or sale (including predatory price) of goods or service,
(b) limits or restricts—
(i) production of goods or provision of services or market therefore; or
(ii) technical or scientific development relating to goods or services to the
prejudice of consumers; or
(c) indulges in practice or practices resulting in denial of market access; or
(d) makes conclusion of contracts subject to acceptance by other parties of
supplementary obligations which, by their nature or according to commercial
usage, have no connection with the subject of such contracts; or
(e) uses its dominant position in one relevant market to enter into, or protect, other
relevant market.
2. Anti-Competitive Agreements : As per Section 3 of Competition Act, 2002, any
agreement entered into between enterprises or associations of enterprises or
persons or associations of persons or between any person and enterprise or
practice carried on, or decision taken by, any association of enterprises or
association of persons, including cartels, engaged in identical or similar trade of
goods or provision of services, which—(a) directly or indirectly determines
purchase or sale prices;(b) limits or controls production, supply, markets,
technical development, investment or provision of services; (c) shares the market
or source of production or provision of services by way of allocation of
geographical area of market, or type of goods or services, or number of customers
in the market or any other similar way;(d) directly or indirectly results in bid
rigging or collusive bidding, shall be presumed to have an appreciable adverse
effect on competition
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 25
3. Relevant market is a key concept in application of competition law. It provides
as a tool in competitive assessment by identifying those substitutes products or
services which provide an effective constraint on competitive behavior of
products or services being offered in market by parties under investigation. As
defined by Section 2 of Competition Act,2002 Relevant product Market is defined
as a market comprising of all those products and services which are regarded as
interchangeably or substitutable by the consumer , by reason of characteristics of
the products or services; their price & intended use.
Relevant geographic market means a market comprising the area in which the
conditions of competition for supply of goods or provision of services or demand
of goods or services are distinctly homogenous and can be distinguished from the
conditions prevailing in the neighboring areas;
4. Regulations of Combinations ( i.e. Mergers & Acquisitions ): Combinations that
exceeds a threshold limits specified in the Act in terms of assets and turnover
which causes or is likely to cause an appreciable adverse effect on competition
with in the relevant market in India can be scrutinize by the commission. The
prescribed turnover levels are for Merger & acquisitions are: Assets of the merged
entity more than Rs. 1000 Crores or turnover of more than Rs. 3000 Crores (these
limits are US $ 500 millions and 1500 US$ in case one of the firms is situated
outside India.). The limits are more than Rs 4000 Cr or 12000 Cr and US$ 2
billions and 6 billions in case the merged entity belongs to a group in India or
outside respectively.
5. Competition Advocacy: As per Section 9 of Competition Act, 2002, the
Commission takes suitable measures, as may be prescribed, for the promotion of
competition advocacy i.e. creating awareness and imparting training about
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competition issues. In formulating a policy on competition (including review of
laws related to competition), the Central Government may make a reference to the
Commission for its opinion on possible effect of such policy on competition and
on receipt of such a reference, the Commission shall, within sixty days of making
such reference, give its opinion to the Central Government, which may thereafter
formulate the policy as it deems fit.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 27
SECTION VI
DEFINING RELEVANT MARKET
6.1 Now focusing on Aviation Sector, we go on to define the relevant market.
Relevant market is a key concept in application of competition law. It provides as a tool
in competitive assessment by identifying those substitutes products or services which
provide an effective constraint on competitive behavior of products or services being
offered in market by parties under investigation. As defined by Section 2 of Competition
Act, 2002 Relevant product Market is defined as a market comprising of all those
products and services which are regarded as interchangeable or substitutable by the
consumer , by reason of characteristics of the products or services; their price & intended
use.
An analysis of nature of competition in the airline industry starts with identification of the
set of services the industry provides and the nature of demand for those services. Broadly
speaking the airline industry provides air transport services, which is divided into two
categories – passengers and freight (cargo). For our analysis we shall focus only on
passenger services.
Air transport services face a degree of competition (at the margin) from other modes of
transportation. The set of potential substitutes for air travel depends upon the purpose of
travel. Now, the nature demand for air services is different across different class of
Travelers.
6.2 Travelers differ widely, in their ability to be flexible about origin and
destination airports and about time and day of travel and in their opportunity cost of time
spent traveling. Because most travelers are not flexible about their origin & destination
cities, airline markets are usually defined as “city pair” markets.
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6.3 Travelers who have a lower opportunity cost of travel generally enjoy a wider
choice of routes between the origin & the destination cities and hence benefit from level
of higher competition. But for time sensitive passengers indirect routes may not be an
adequate substitute for non-stop services. Hence there arises two separate categories of
travelers: one which is time sensitive who is traveling for business purposes-whose
opportunity cost of time is very high & the second category which is the leisure travelers
whose opportunity cost of time is not very high & their price elasticity of demand is very
high. The leisure travelers are highly responsive to price changes unlike the business
travelers who have a strict preference for time, day of travel and non-stop routings versus
indirect routings.
6.4 Therefore, competition concerns are focused more on time sensitive passengers as
their price elasticity of demand is significantly low. Evidence shows that for an
identifiable group of time-sensitive business passengers, one-stop service is not a
reasonable substitute for nonstop service; they would not switch to one-stop service in
response to a price increase in nonstop service. The airlines can and do charge these
travelers different prices than leisure travelers, targeting time-sensitive passengers with
fare restrictions and conditions. Airlines practice use variety of ticketing practices to
discriminate between time sensitive and non-time sensitive passengers. Some popular
practices are: (a.) Frequent flier programs which rewards loyal customers with free air
travel (b) through negotiating special arrangements with large corporate customers who
provide incentives for all travel with single airline. This practice allows airlines to price
discriminate even more precisely among purchasers with varying degrees of price and
time preferences.
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Nancy Shah, 30.7.07 29
Recent econometrics work that shows that time-sensitive, business type consumers have a
strong preference for nonstop versus one-stop travel
3
and by evidence regarding
corporate travel policies. The value that business passengers place on their time would
also make them unlikely to switch to one-stop service in response to an increase in
nonstop prices. Eg: If a non stop flight from Delhi-Mumbai is for Rs. 4000 on ABC
Airways then a 5 % increase in fares would amount to Rs. 200.Assuming that a transfer
caused a delay of about 2 hours for some technical reasons. Obviously, any business that
valued its executive’s time by more than Rs.100 per hour & would be willing to pay an
extra 5 % fare & board the alternate flight.
4
Having built these blocks we go on defining the relevant market. Firstly, the relevant
market for time sensitive passengers is different from the relevant market for non-time
sensitive. As non-time sensitive passengers are flexible with respect to their choice of
route and mode of transportation so question so competition concerns doesn’t arise with
them.
6.5 Reiterating the relevant market concept: it is said to incorporate all substitutes
products and regions which provide significant competitive constraint on the products
and regions of interest. As far as substitutes go, Railways are a near substitute for air
services but only valid for short to medium distance journeys. But for longer journeys,
3
See, Berry, Steven, Carnall, Michael and Spiller, Pablo, "Airline Hubs: Costs,
Markups 5 and the Implications of Customer Heterogeneity," NBER Working Paper
5561, May 1996.
4
According, to 1996 American Express Survey of Business Travel Management, 78
% of all companies have a policy to in place requiring employees to use lowest
logical fare but only 25 % of these corporates want their employees to use connecting
flights to achieve lowest fares.
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there isn’t a substitute available to match air services. Eg: if a person has to reach
Mumbai from
Delhi then no other mode of transportation can take him to Delhi in the same day. Given
that in India we don’t have any super fast trains!
So we define relevant market as market for time sensitive passengers where market is
defined as a city pair market between origin and destination cities at a specified date and
specified time of the day. Business passengers have a preference for non-stop routes over
connecting routes. In absence of substitutes & the strict preference of time day & route,
airlines are likely to exploit business travelers.
In a nutshell, non-stop ,city pair wise flights at a particular time of a specific day is the
relevant market…In a nutshell, non-stop ,city pair wise flights at a particular time of a
specific day is the relevant market
Now keeping this key concept of relevant market in the backdrop we proceed with our
analysis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 31
SECTION VII
COMPETITION ISSUES PERTAINING TO THE AVIATION SECTOR:
7.1 Of late, there has been a lot of hue and cry over the mega mergers in the aviation
sector among the airlines. The consumers are feeling vulnerable and fear fares would
increase post consolidation. While industry sources condemn such fears & voice their
support in favor of consolidation on grounds that consolidation would bring some sanity
and rationality in the pricing pattern and end the saga of blood bath that inevitably every
carrier was witnessing. All most all carriers were bleeding and industry losses were
calculated to be around 500 million USD for 2006—07 as per Industry sources. The
mergers would benefit carriers from the joint. The mergers are expected to help the
industry tide over losses which would be ensured via network optimization; operational
rationalization and fleet rationalization. However, equally justified are the fears of the
consumer groups anticipating price rise post mergers. Definitely, these mergers have
competition related issues involved to them. Before dwelling on Mergers and Acquisition
cases, we will first identify the competition related issues pertaining to this sector.
Certain features of the airline industry favor anti-competitive practices.
In particular, the high degree of price transparency and multi-market contact among
the major airlines may facilitate coordinated behavior. Airlines also use Loyalty
Programs to discriminate between the time sensitive businessmen and the ones traveling
for leisure purposes.
I. Loyalty Programs:
Airlines attempt to raise the cost of switching between airline companies in three ways,
which are collectively called “loyalty programmes”:
1. Through frequent flyer programs, which reward loyal customers with free travel;
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2. Through travel agent incentive schemes (such as the so-called travel agent
commission override ) which reward travel agents for directing the bulk of their travel
towards a specific airline; and
3. Through negotiating special arrangements with large corporate customers who
provide incentives for taking all (or nearly all) travel with a single airline.
7.2 In passing, I may add that larger airlines can enhance their demand relative to
smaller airlines in many ways: For example, if airlines allow a traveler to change but not
cancel a reservation at the last minute, atraveler with uncertain plans will prefer an
airline with more frequent flights to the same destination than an airline with one
flight per day.
Loyalty programs such as Travel agents schemes; Frequent flier programs are Anti-
Competitive in Nature.
A1.Frequent flier program is a device chosen by the airlines to distinguish between
Business class and those traveling for leisure purposes. The business class passengers are
price inelastic and carriers can capitalize on this aspect by overcharging the business
class.
7.2 Frequent flyer programs operate like a volume discount. Once a customer has
flown on a particular airline with a frequent-flyer program, the value of subsequent
flights is enhanced by the increased opportunities for free travel. Because the marginal
value of the reward increases as the customer builds up miles or points on a single airline,
frequent-flyer programs encourage travelers to choose the airline that they are most likely
to fly on in the future.
7.3 The size of the loyalty effect will depend upon how rapidly free travel is earned,
on the size of the airline’s network and on the location of the customer. The larger
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Nancy Shah, 30.7.07 33
the airline’s network, the more valuable is the free travel, as more opportunities
are available to the frequent traveler (the nature of the destinations may also
matter). The larger the number of flights offered by an airline at the customer’s
home city, the more likely the customer is to travel on a route served by the
airline, the faster the accumulation of awards, the greater the range of possible
free-travel destinations and the more likely there will be a nonstop flight to the
desired destination. Carriers might try to abuse their dominant positions as they
know that there isn’t an alternative available in the relevant market. For a business
passenger traveling on work related matter, doesn’t mind paying an extra Rs 1000
as his opportunity cost of time is much higher than that.
7.4 Indian; J et; Kingfisher and Air Sahara operate Frequent Flier Programs. J et has 3
tiers of loyalty program namely J P-Silver; Gold and Platinum Card which can be
redeemed. Similar is the structure for Kingfisher whose 3 tiers are Red (person traveling
more than 3 flights); Silver (if flights exceed 30) and most prestigious is Gold which is
obtained if annual flights exceed 60. Benefits such as Personalized Web Access
Membership Tier Bonus ;e-ticketing; IVR ; Pay Online Service ; Tele Check-in facility;
Web Check-in; Kiosk Check-in ;Complimentary Upgrade Vouchers; No Blackout
periods for J et Awards; Lounge access at select airports; Additional baggage allowance
on J et Airways; Priority tagging of baggage ; Guaranteed reservation up to 24 hours
before departure; Check-in at Club Premiere & PREMIERE counters; Cancellation fees
waived on published fares; Priority Standby ;Partner Benefits ; Dedicated customer
service center .
Hence a close review of frequent travelers programs and other loyalty programs for anti-
competitive issues is a must.
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A2.Travel agent incentive schemes
7.5 Airlines may also be able to enhance the demand for their services through
incentives & commissions on travel agents. Most travel agents earn increased
commission rates from at least one airline in return for steering passengers to those
airlines. There is a widespread belief within the industry that TACOs are most effectively
used by the dominant airline in an area. J ust as with frequent-flyer plans, the rewards for
increased bookings on an airline are designed to encourage the agent to concentrate
bookings on a single carrier. Travel agent incentive schemes appear to be particularly
effective at increasing demand.
7.6 For example, in 1995 Air South, a low-fare airline which was concerned about its
inability to attract business travelers on its routes in the South East of the US, hired a
private consultant to test the extent to which travel agents may have been steering traffic
away from Air South. The consultant found that agents in some cities dominated by one
airline often did not provide Air South’s competing flight options in response to
anonymous inquiries, even though those options were listed in CRSs. In Miami, for
example, travel agents did not initially inform callers of available Air south flights 56
percent of the time, and even after the lowest fare was requested the agents did not
mention Air South 30 percent of the time. Instead the agents frequently recommended
flights by American Airlines, the largest carrier in Miami.
II. Multi-Contact:
7.7 It has long been posited that when firms face each other in a large number of
markets, they may compete less vigorously by allowing each other more or less exclusive
number spheres of influence. Put another way, the number of markets in which firms
meet is a factor influencing the likelihood of oligopolistic coordination or “tacit
collusion” This result arises from the fact that a dominant firm in an oligopolistic market
has more to lose in a price war than a firm with a small market share. A firm with a small
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 35
market share is therefore a threat to the margins of the dominant firm unless the roles are
reversed in some other market. When each firm has one or more “home” markets in
which it is dominant, it is less likely to challenge the dominant position of a rival firm in
the rival’s “home” market, for fear of facing competition in its home market. Such an
arrangement is likely to settle down into a “live and let live” situation. Conversely, the
biggest threat to such comfortable arrangements is likely to come from rival firms with
no domestic dominant position.
III. Competition in Vertically Related Markets:
7.8 It was noted earlier that the provision of air services requires the inputs of a host
of other Complementary airport services, including take-off and landing slots, air-traffic-
control services, gates, passenger handling facilities, baggage handling facilities,
refueling, maintenance, cleaning and catering services and so on. In some cases
regulatory or security requirements or physical limitations on space limit the number of
firms that can provide these services. A merger or alliance between two or more firms,
which provide services in these markets, can both reduce competition in these markets
and can potentially distort competition in air transport services. As is well established,
competition enforcers need to consider the effect of mergers and alliances on all markets
in which the merged firms provide services.
7.9 A merger or alliance between two firms, which collectively have a dominant
position in these vertically related markets, could have an important impact on
competition in air services. In particular, a merger or alliance between two airlines
between two airlines which collectively hold a dominant position in slots or gates,
baggage-handling facilities, maintenance or in the ownership of a CRS could reduce
competition in these markets and allow these firms to abuse this dominant position to
constrain competition in the market for air services. Post merger, the merged entity
inherits extensive route networks and higher frequency of flights operating per day. This
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helps the carrier build loyalty of tourists as well as frequently traveling business class.
Hence, infrastructural scarcity acts as a bottleneck for new entry & there by strengthens
the merging /incumbents position as the case may be. We will further dwell on this issue
in later half of this report.
IV. Price Transparency & Collusion:
7.10 The airline industry features a very high degree of transparency over prices
and volumes. All of an airline’s future fares are instantaneously available over computer
reservation systems, to which rival airlines can subscribe. Unlike other industries, such
transparency can be an instrument for collusion as it facilitates the detection of cheating
on a cartel agreement. It appears to be common practice for an airline to announce,
through the CRSs that its price on a certain route will increase by some amount beginning
on a certain date in the future. The colluding parties take advantage of this transparency
& enter to a tacit collusion. The carrier then waits to see if others will match. If they do,
the price increase is implemented. If they don’t, the airline suggesting the increase will
either withdraw it or push back the implementation dates. Other airlines might
counteroffer with a smaller increase, effective a day after the first increase. Then the first
airline may proceed with a smaller increase or counteroffer again. All of this occurs
without the airlines changing prices on actual sales.
7.11 This transparency acts as a boon and as a bane too. While transparency in the
pricing pattern is important to Consumer so as to make choice keeping in mind the cost,
schedule and time taken to complete the journey. At the same time, chances of
cartelization can’t be ruled out either. As discussed above, the CRS system facilitates
Cartelization.
With respect to the Indian Scenario, after the series of marriages in the Indian Skies; the
chances of Cartelization has increased by many folds. With top 3 players pocketing more
than 80 % market share, chances of prices increasing on key routes, which are essentially
long distance and have no immediate substitutes are likely.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 37
7.12 The setting up of FIA-Federation of Indian Airlines , a conglomerate of top
honchos of domestic airlines met in 2005 to form a federation that will provide a
common platform to debate industry issues and lobby the government and hammer out
solutions. To their misfortune, at their first meeting they had pricing issues on their
agenda, which by timely intervention of CCI was hauled and hence the very first step
towards cartelization was aborted. Moreover, that time the industry was scattered into
many players so chances of deviations were very high. In today’s scenario, chances of
cartelization and its materialization are quite high as post consolidation with less number
of players tacit collusion is more chase able and deviation is less unlikely. So CCI must
keep an eye on such tendencies. More over, chances of coordination in prices might
become even higher if the Alliance between AI and J et materializes. It is highly
recommended that the commission scrutinizes the proposal & its prospective pros and
cons before the two are allowed to sign on the dotted line.
V. Alliances & Competition Related Issues:
7.13 It is virtually impossible for a single carrier to serve all the places across the
World. However, what carriers can & definitely do is that they tie up with carriers of
other countries entering into alliances. An airline alliance is an agreement between two
or more airlines to cooperate for the foreseeable future on a substantial level.
The degree of cooperation differs between alliances. Airlines throughout the world have
entered into alliances for some time. The various co-operative arrangements include
(such as code sharing, blocked space, co-operation in frequent flyer programs, joint
marketing, service and purchasing, and franchising). These are undertaken to strengthen
or expand the aligning member’s market presence and to redefine or consolidate their
position in an increasingly competitive environment across the globe.
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7.14 The idea of alliances is that when carriers of different communities come
together, the combined route structure of the members of the alliances will be able to
cover as much as real estate as possible. Airline alliances benefits to the consumer by
offering seamless travel and services between a more extensive range of city pairs,
reduction in traveling time, joint lounges and co-ordination of FFPs.
7.15 Within the EU, for example, following successive deregulation directives for
air transport, any EU airline may now, in principle, serve any EU route. Air transport
within the EU has been liberalized with the aim to integrate the entire market as a "single
market" of air transport in Europe. With the aim of providing access to the entire
European Market uniformly, alliances seemed to be the need of the hour as no airline
alone could have a network vast enough to cater to every possible nook and corner of
Europe.
7.16 The liberalization process of developing a “single market” for EU had led to
stronger competition, a significant increase in the supply of air transport and lower tariffs,
especially on routes where airlines compete. The deregulation of the airline industry
allowed airlines to lower costs through restructuring largely around the hub-and-spoke
form and has enhanced the number of city-pair combinations that are served by non-stop
or one-stop service. Prices have also declined on average, particularly for discretionary
travelers and the volume of air travel has significantly increased. Even in the case of the
US, the deregulation of the airline industry has led to substantial benefits for consumers
On the other hand, the alliances have an anti-competitive effect also. There are also
factors which prevent consumers from benefiting fully from the positive effects of
liberalization as some cooperative agreements have anti-competitive effects. Alliances
involving code sharing can have significant procompetitive as well as significant
anticompetitive potential. On the anticompetitive side, they can result in market
allocation, capacity limitations, higher fares, or foreclosure of rivals from markets, all to
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 39
the injury of consumers. On the procompetitive side, they can create new service,
improve existing service, lower costs, and increase efficiency, all to the benefit of
consumers. When a code share is proposed to link a city-pair market served by one
carrier with a city-pair market served by the other, rather than to cover a city-pair market
in which both carriers are actual or potential competitors, the proposed code share would
create what is referred to as an “end-to-end efficiency,” which is generally pro
competitive. Hence, Code sharing generates both pro as well as anti competitive effects.
Code sharing is a bane as the potential loss to the consumers exceed the benefit when the
share of overlapping routes are extensively large.
Hence each alliance is reviewed on a case- by -case basis by the Competition
Authorities to see that there isn’t any adverse able effect of the alliance on
competition.
7.17 Before discussing the anti-competitive effects of Alliances, we first need to
understand what is Code Sharing: Code-share is an arrangement whereby an airline sells
seats, under its own name, on another carrier's flight. Code Sharing is the most common
form Alliance. E.g.: A women had purchased a ticket from Boston to Amsterdam on
KLM-the Dutch carrier. However, KLM doesn’t fly to Amsterdam. Though, the ticket
had the blue livery of the Dutch airline however, the code was that of North West
Airline-An American Carrier. This is referred to as code sharing where by one airline
sells seats under its own name on other carriers’ flights.
How does code sharing lead to anti-completion effects:
Generally, the greatest threat to competition comes when two of very few airlines that
compete in a market enter into a code-share agreement in that market.
7.18 Code sharing raises competitive concerns when the aligning members have
overlapping route networks. To better explain this, let us take a hypothetical example:
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Suppose neither Delta nor American Airlines operate a direct or a connecting flight from
Atlanta to the Kansas City. However, Delta operates a direct flight from Atlanta to Dallas
City while American operates a direct flight from Dallas to Kansas City. The routes in
the example above are complementary because together, they allow travel between two
cities (Atlanta to Kansas City) that is not possible on any one of the airlines in the
example. A code-sharing agreement between the two airlines allows each to sell tickets
on each other’s airline in the Atlanta to Kansas City market. The current literature
generally agrees that complimentarily in route networks among alliance partners ought to
benefit consumers both through reduced fares and expanded networks. However, suppose
prior to the code-share alliance both airlines in the example above offered competing
online service in the Atlanta to Los Angeles market, then this portion of the airlines’
route networks are overlapping, and the alliance could facilitate price collusion. To the
extent that collusion occurs on Overlapping routes, fares on these routes may increase,
causing consumers’ welfare to fall. Hence there are increase in chances of a potential
collusive effect on products that were traditionally competed prior to the alliance, rather
than code-sharing per se.
Alliance allowed with Remedy:
7.19 The European Competition Commission under the provisions of the EC
Merger Regulation cleared the alliance between KLM & Alitalia. The Commission
considered that the alliance was globally pro-competitive, in particular in view of the
largely complementary nature of the parties' activities. Nevertheless, the Commission
found that the operation would have led to monopoly positions on two markets:
Amsterdam-Milan and Amsterdam-Rome. The parties had therefore to accept
undertakings with a view to attract potential new entrants on these markets and to
exercise a competitive pressure on the parties. The remedies included inter alia the
release of a significant number of slots at the congested airports in question and the
reduction of the parties' frequencies (up to 40% of the frequencies actually operated)
when a new entrant starts operating the problematic routes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 41
7.20 International travel is not yet liberalized. It is still dominated by bilateral
agreements where by two nations sign an agreement to allow civil aviation between their
territories. Bilateral agreements continue to restrict competition on aspects such as the
number of possible flights, the number and the identity of the carriers and the airports that
can be served. There fore arose the need for transatlantic alliances. The EU airlines
forged an alliance with American Airlines to increase their connectivity.
Alliance rejected out rightly:
1. American Airlines and the TACA group composed of six Central American airlines
serving Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Republic of
Panama. American and some TACA carrier operated overlapping nonstop flights on
virtually all routes between Miami -- the principal Latin American hub in the United
States -- and the gateway cities in the Central American countries just mentioned, so that
American and TACA had combined market shares ranging from 88 percent to 100
percent on those overlap city pairs. At the same time, the number of passengers traveling
between Interior points in the United States beyond the Miami gateway and interior
points beyond the Central American gateways -- the only passengers who could not
already obtain full on-line service available from either American or the TACA group --
was an extremely small fraction of passengers flying gateway-to-gateway. So we found
this to be an almost exclusively horizontal agreement, in contrast to the largely end-to-
end international code-share agreements we had previously reviewed.
The DOJ concluded that the claimed efficiency benefits that are specific to the
transaction are very slight, while some potential risks to competition would inevitably
persist despite the best efforts to eliminate them through imposing conditions.
2. American Airlines/British Airways proposal.
The two carriers competed in a number of large nonstop city-pair markets, but also, as
was the case with USAir and British Airways in 1991, they compete for passengers
traveling between interior U.S. points and the United Kingdom. A key issue is whether
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and under what circumstances it is likely that "future competitors" will replace the
competition lost as a result of the proposed alliance. With open skies, new entry might be
likely on many of the overlapping city pairs in the absence of airport access constraints,
but the fact is that constraints on new or expanded service at London's Heathrow Airport
are significant. Consequently, we are assessing whether there are any conditions that can
resolve the Heathrow access problems to allow sufficient entry to replace the competition
lost from an American/British Airways combination. Since the DOJ was unsure about the
viability of new entry of a competitive airline service between the United States and the
United Kingdom, DOJ disapproved the alliance.
3. Delta, Continental, and Northwest Alliance:
In August 2002, Delta, Continental, and Northwest submitted code-sharing to the U.S.
Department of Transportation (DOT) for review. The DOT expressed concerns about the
potential competitive effects of the proposed Delta/Continental/Northwest code-sharing
alliance. The DOT’s main concern lies in the significant extent to which the three
airlines’ route networks overlapped, which is unlike any other existing domestic alliance.
The DOT’s analysis revealed that the three airlines offered overlapping services in 3,214
markets accounting for approximately 58 million annual passengers. Given the broad
nature of discussions that is required to implement the alliance, the DOT is concerned
that such communications among the carriers may result in collusion, either tacit or
explicit, on fares and service levels.
7.21 Note: Similar to this domestic alliance, is the recent announcement of Jet Group
Led Naresh Goyal’s willingness & keen ness to forge an alliance with AI for its
International Operations. All though, nothing official has been made till date, however if
the two enter in an alliance with one another in the near future, it would have serious anti-
competitive effects. Things wouldn’t have been different had IA not merged with AI.
Now, things are different. The same alliance would have been a welcome change had IA
not merged with AI. Since, the domestic & the International Carriers have merged, hence
any attempts made towards alliance will have severe impact on competition as the two
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Nancy Shah, 30.7.07 43
operating carriers have heavy domestic presence. The two carriers have an extensively
overlapping network of routes in the country. Coordination among fares may get
enhanced on domestic operations more than International operations. Together , J et & IA
serve around 50 % of the Indian market .This 50 % is an aggregate all India figure;
however in individual city pair markets , their share may vary from 60% to even 90 % for
different routes owing to their vast route networks and frequency of flights operating per
day. Both of them are Full service carriers with the most extensive route network, which
no other domestic carrier in the country has. The two being the oldest airlines have access
to the peak slots at the congested airports, hence they have a dominant position w.r.t to
certain flights operating on key routes at peak slots. There fore, the commission must
review the Alliance if it takes place in future. It is highly recommended that the
commission must not permit J et & IA to get into Code Sharing Arrangement where by
the two coordinate their prices. The two carriers’ operation’s must be strictly kept
independent in terms of pricing and marketing via Blockaded Seat Arrangement (which I
will discussed shortly). Also, the committee must see whether there exists chances of new
entry if the proposed alliance is leading to anticompetitive effects or say on monopoly on
some routes.
7.22 Hence, in particular, an alliance can significantly reduce competition on
overlapping non-stop routes and overlapping connecting routes where the allied airlines
were once main competitors. Even where the two networks do not overlap in the markets
they serve, the alliance can have serious anti-competitive effects by reducing or
eliminating competition on the hub-to-hub route(s)
5
between the networks. Moreover,
alliances between airlines operating hub-and-spoke networks will normally enhance
demand for the network as a whole and increase the market power of the network,
especially at its hub airports. This entails the risk of rendering still more difficult new
entry into the network's markets to the detriment of both international and domestic
competition.
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In contrast, when a code share is proposed to link a city-pair market served by one carrier
with a city-pair market served by the other, rather than to cover a city-pair market in
which both carriers are actual or potential competitors, the proposed code share would
create what is referred to as an “end-to-end efficiency,” which is generally
procompetitive.
The commission must weigh both the pro and anti-competitive effects of the proposed
alliance before finally granting the anti-trust immunity to the alliance members.
Some important issues relating code sharing from competition angle:
7.23 If the code share partners will both operate flights in the market, the
Division/Commission then considers whether the agreement is structured in a way that
the partners’ capacity, scheduling, and pricing decisions will remain independent -- that
is, whether it is structured in a way that gives each carrier the strongest possible
incentive to sell seats on the flights it operates rather than on those of its code-share
partner, and to cut its prices and improve its service to gain market share against its
partner.
Now, code share agreements are of different types. The carrier that actually carries the
passenger is called as the ‘operating carrier’ while the carrier that doesn’t operate that
Route, yet it markets that route is called as the ‘marketing carrier’. Now, there are
different levels of cooperation’s possible in code sharing. First of all, airlines might give
their code-sharing agreement partners free or limited access to their seats. Free flow (free
sale) code-sharing agreements give the marketing carrier access to the operating carrier’s
inventory and allow it to market seats independently of the operating carrier. The risk is
completely on the operating carrier since the marketing carrier functions almost as an
agent.
5
Refer to Appendix for Hub-Spoke Network
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Nancy Shah, 30.7.07 45
7.24 With respect to pricing, airlines might set the price of the seat sold under a
code-sharing agreement either in a coordinated way, which may lead to the result that the
seat will be sold at the same price wherever (operating or marketing carrier) the ticket is
bought, or each airline participating in the agreement can set its prices independently.
Where the code share does not entail a blocked space agreement, airlines have to agree on
how to compensate each other for the seats sold on one another’s flights. This is normally
done in special pro-rate agreements which establish the terms of revenue proration
between the partners.
7.25 One approach taken in some code shares to preserve some independence in
pricing and marketing of seats on the shared flights has been to use a block seat
arrangement, where the marketing carrier purchases a fixed number of seats and bears
the risk of loss if those seats are not sold. The block-seat arrangement is not an ideal
solution, because the cost of the block of seats to the non-operating carrier, which is the
key determinant of the ultimate fare to the consumer, is set by agreement between
competitors. But the block seat arrangement is an improvement over joint sales and
marketing, because it can create some additional incentive to each partner to market its
seats aggressively.
In cases in which independent operations by the two partners are not contemplated or
considered likely under their proposed code-share agreement, and the Division concludes
that the code-share agreement would reduce or eliminate competition between the code-
share partners in certain city-pair markets, the next step in the Division’s analysis will be
to consider how likely it would be that new competitors would enter these markets in
response to any anticompetitive behavior by the code-share partners. If sufficient and
timely entry could be expected to neutralize any anticompetitive behavior, then the
Division would conclude that the code-share agreement would not be likely to create or
facilitate the exercise of market power by the code-share partners.
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7.26 At the international level (and outside the EU), bilateral agreements continue
to strictly limit the scope for competition. In particular, bilateral agreements limit, in
various ways, the number and identity of the airlines that can provide services between
two countries, the routes that can be flown, the number of flights that can be offered on
each route and sometimes the capacities and fares that can be offered. Bilateral
agreements often also prevent indirect flights from undercutting the price of non-stop
service. The bilateral system has been used to sustain inefficient national “flag carrier”
airlines and in the process has kept fares up, raising costs to consumers and to other
industries and has impeded the development of new travel products. In recent years some
countries (particularly the US) have sought to negotiate “open skies” agreements which
are less restrictive in regard to the number and identity of airlines and the routes or
capacities that can be flown. A number of such agreements have been signed between the
US and individual EU countries. These agreements still do not permit entry from carriers
based in countries outside the agreement to fly on routes covered by the agreement (e.g.,
a USUK open skies agreement would not permit Alitalia to fly London-Rome-New
York). Nor do the agreements permit cabotage (e.g., an US-UK agreement would not
allow BA to carry passengers from New York to San Francisco when flying London-New
York-San Francisco). There remains considerable scope for further multilateral
liberalisation, particularly in relation to the discriminatory treatment of foreign-owned
airlines.
7.27 Hence, in the case of an international code share, an important threshold factor
in assessing likelihood of new entry is whether the market is covered by an “open skies”
bilateral agreement. Open skies means that new entry by a carrier is legally possible,
although we would still need to investigate how likely such entry actually would be in the
event the code-share partners attempted to raise fares or reduce service. However, new
entry is legally constrained by a restrictive bilateral agreement, the threat to competition
of a code share on that city pair could be substantial, particularly if the code-share
partners were the only two carriers authorized under the bilateral agreement.
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Nancy Shah, 30.7.07 47
Conclusion:
7.28 The Antitrust Division assesses on a case-by-case basis -- and market-by
market basis -- whether a proposed code-share alliance is likely to act as a disincentive
for the alliance partners to enter markets served by the other or to compete vigorously in
markets that they both serve. Commission must look to see whether the alliance is likely
to divide and allocate markets, or to produce high fares. Commission will place critical
importance on carefully reviewing the actual terms of each alliance agreement. Incentive
for each partner to market its own seats. Similarly, they would also look to see if there
were persuasive evidence that the code-share agreement would result in significant
procompetitive efficiencies in serving other city pairs on a code-share basis -- efficiencies
that could not otherwise be obtained except through the code share. If so, also would
assess whether the procompetitive effect of these efficiencies would outweigh the
potential competitive harm in the overlap city pair.
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PART VIII:
AIRLINES MERGERS & ACQUISITIONS:
VIII.A
REGULATIONS GOVERNING M&A IN INDIA
8.1 Before going into the competition related issues pertaining to M&A of
airlines, we’ll first have a look at the current policy framework going M&A in India.
Regulations governing Mergers & Acquisitions in India:
1. Mergers and acquisitions are regulated by the provisions of the Companies Act, 1956,
as amended (‘Companies Act’)
2. Securities and Exchange Board of India Act, 1992 (‘SEBI Act’) and the guidelines,
rules and regulations framed there under specifically the Securities and Exchange Board
of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, as
amended, (‘Takeover Code’)
3. Other legislations governing commercial transactions eg: Independent Regulator’s
approval.
4. The Competition Act, 2002 (‘Competition Act’) that has been enacted but is not yet
fully enforced, contains provisions for governing competition issues relating to mergers
and acquisitions.
8.2 The Takeover Code requires an acquirer of shares which (taken together
with his existing shares or voting rights) would entitle him to more than five per cent of
the shares or voting rights in the target company, to make disclosures to the target
company and to the stock exchanges where the shares of the target company are listed.
The acquirer(s) is also required to make a public announcement in case he acquires
shares or voting rights (taken together with his existing shares of voting rights) that
would entitle him to fifteen per cent or more of the voting rights in the target company.
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The Takeover Code also restricts consolidation of holdings and indirect acquisition of
control over the target company without making a public announcement. Takeover
Code applies only to listed companies.
8.3 Sections 391 to 396 of the Companies Act embody the law relating to
mergers, amalgamations and reconstruction of companies. Under the said provisions
the merging companies have to approach the appropriate High Courts (amended to
National Company Tribunal by the Companies (Second Amendment) Act, 2002 but not
enforced as yet) for convening a meeting of the shareholders. The shareholders have to
pass the scheme of merger by a three-fourth majority. The scheme is also required to
be approved by the High Court. Section 396 also empowers the central government to
recommend mergers or amalgamations of companies in the national interest.
8.4 The Companies Act also provides restrictions on acquisition or transfer of
shares. These restrictions however apply only to a ‘dominant undertaking’, the term
being defined under the Monopolies and Restrictive Trade Practices Act, 1969 (‘MRTP
Act’) to mean an undertaking having a market share of at least twenty five per cent.
Section 108A of the Companies Act requires prior approval from the central
government for acquisition of shares exceeding 25 per cent (taken together with any
existing shareholding in the target company) of the total paid-up capital of a public
company or a private company that is a subsidiary of a public company. Section 108B
requires a body corporate or a group of bodies corporate under the same management
and holding 10 per cent or more of equity shares of a company to notify the central
government of any transfer of equity shares. Also, any transfer of equity shares by a
body corporate or bodies corporate holding 10 per cent or more of the equity capital of
a foreign company requires prior approval of the central government before
transferring such shares to an Indian citizen or a company established in India. The
central government has the power to restrict acquisition or transfers that may result in
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change in the controlling interest in the company and which is prejudicial to the
interest of the company or to the public interest.
8.4 The Competition Act contains provisions for regulation of acquisitions,
takeover mergers etc. of enterprises. Section 5 of the Competition Act , 2002 has laid
down some benchmarks standards on whose satisfaction ,the Commission will invoke an
enquiry into the proposed Mergers seeking to check whether it has any anti-competitive
effects or not. No person or enterprise shall enter into a combination which causes or is
likely to cause an appreciable adverse effect on competition within the relevant market in
India and such a combination shall be void.
Section 5 of Competition Act, 2002:
8.5 The acquisition of one or more enterprises by one or more persons or merger
or amalgamation of enterprises shall be a combination of such enterprises and persons or
enterprises, if—
(a) any acquisition where—
(i) the parties to the acquisition, being the acquirer and the enterprise, whose
control, shares, voting rights or assets have been acquired or are being acquired
jointly have,—
(A) either, in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which the enterprise whose control, shares, assets or voting
rights have been acquired or are being acquired, would belong after the
acquisition, jointly have or would jointly have,—
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Nancy Shah, 30.7.07 51
(A) either in India, the assets of the value of more than rupees four
thousand crores or turnover more than rupees twelve thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than two billion US dollars or turnover more than six billion US dollars; or
(b) acquiring of control by a person over an enterprise when such person has already
direct or indirect control over another enterprise engaged in production, distribution or
trading of a similar or identical or substitutable goods or provision of a similar or
identical or substitutable service, if—
(i) the enterprise over which control has been acquired along with the enterprise over
which the acquirer already has direct or indirect control jointly have,—
(A) either in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which enterprise whose control has been acquired, or is being acquired,
would belong after the acquisition, jointly have or would jointly have,—
(A) either in India, the assets of the value of more than rupees four thousand crores or
turnover more than rupees twelve thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more than two billion
US dollars or turnover more than six billion US dollars; or
(C) any merger or amalgamation in which—
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(i) the enterprise remaining after merger or the enterprise created as a result of the
amalgamation, as the case may be, have,—
(A) either in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees, three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which the enterprise remaining after the merger or the enterprise created
as a result of the amalgamation, would belong after the merger or the
amalgamation, as the case may be, have or would have,—
(A) either in India, the assets of the value of more than rupees four-
thousand crores or turnover more than rupees twelve thousand crores; or
(B) in India or outside India, the assets of the value of more than two
billion US dollars or turnover more than six billion US dollars.
However, the Competition Act has not been enforced as yet. The Competition
Commission of India (‘CCI’) established under the provisions of the Competition Act
will regulate mergers and has the power to reverse a merger or acquisition if it is of the
opinion that a merger or acquisition will have or is likely to have an appreciable adverse
effect on competition in India.
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Nancy Shah, 30.7.07 53
VIII.B
CASES OF M&A ABROAD:
Case of Air France and KLM:
8.6 As the name suggests Air France is a French based Airline with significant
international operations. The Air France group has three main activities: passenger airline
transport, cargo transport and maintenance services. Air France operates a hub-and-spoke
network with its principal hub for international operations at Paris Charles de Gaulle
airport and its main domestic hub at Paris-Orly airport. It is also one of the founding
members of the SkyTeamalliance, which members are, in addition to, Alitalia, Delta,
CSA Czech Airlines, Korean Air and Aeromexico.
8.7 Where as KLM is a Dutch-based full-service carrier operating worldwide. The
KLM group has four main activities: passenger airline transport, cargo transport,
maintenance services and the operation of charter and low-cost/low-fare scheduled
services by its subsidiary Transavia. KLM operates a hub-and-spoke network with its
principal hub at Schiphol airport. KLM has an alliance with Northwest Airlines covering
principally operations on North Atlantic routes and related feeder routes.
Now Air France while is part of the Sky Team Alliance who is bound by “Global
Alliance Agreement” where in members had entered into separate bilateral agreements.
Air France had entered into agreements with Delta, Alitalia and CSA Czech Airlines.
KLM has, on its side, concluded an Enhanced Alliance Implementation Agreement with
Northwest to form the KLM/NW J oint Venture. This agreement establishes a
transatlantic joint venture pursuant to which the two partners coordinate scheduling,
marketing, sales and prices on all their transatlantic operations and on routes beyond their
respective hubs.
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On 18 December 2003, Air France and KLM notified a framework agreement according
to which Air France will acquire control of KLM. Although the deal will create the
largest airline group in Europe, the companies’ networks are largely complementary, the
Commission’s investigation showed. Air France is more present than KLM in Southern
Europe and Africa, for example, whereas KLM operates a higher number of routes to
Northern Europe and the Far East.
8.8 From a consumer point of view, the combination will allow KLM customers
to have access to more than 90 new destinations while Air France customers will be
offered 40 new routes. The combination of the two airlines is also expected to bring
benefits to consumers and the economy as a whole from costs savings as well as from
service improvements resulting from combined networks.
8.9 The Commission has always looked favorably on the consolidation on the
airline sector, but has also insisted that consolidation would not be done at the detriment
of consumers. This is true for the alliances that have taken place in the last decade. It is
even truer for mergers which are cleared once and for all, as opposed to the six-year
Antitrust immunity usually granted to alliances.
Despite it being largely complementary, the Air France/KLM deal - the first real merger
in the European airline industry - will eliminate or significantly reduce competition on 14
routes where they currently compete actively of potentially. These are:
1. Intra-European routes (Amsterdam-Paris, Amsterdam-Lyon, Amsterdam-Marseille,
Amsterdam-Toulouse, Amsterdam-Bordeaux, Amsterdam-Rome, Amsterdam-Milan,
Amsterdam-Venice and Amsterdam-Bologna).
2. Intercontinental or long-haul routes (Amsterdam-New York, Paris-Detroit,
Amsterdam-Atlanta, Paris-Lagos (Nigeria) and Amsterdam-Lagos).
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The Commission’s experience in this field shows that the main barrier to market entry
lies in the scarcity of take-off and landing rights at the highly congested European
airports and Paris and Amsterdam are no exception. Remaining national regulatory
restrictions may also prevent free competition especially with regard to indirect flights on
long haul routes.
Commitments
8.10 In order to overcome the Commission’s concerns, the parties have
committed themselves to surrender 47 pair of slots (i.e. 94 single take-off and landing
slots) per day. This creates the conditions for a total of up to 312 new return flights a day
to emerge on the affected routes. This means, for example, that a competitor could start
six new daily return flights between Paris and Amsterdam and the same or another
competitor would also offer one daily return flight between Amsterdam and New York
guaranteeing that passengers on these routes have a choice of services and competitive
prices. For the first time, the surrender of slots is for an unlimited duration, compared
with six years for the alliances, and the slots must be returned to the slot coordinator if
they are misused or underused by the new entrant, not to the airline partners. In order to
encourage market entry, a new operator might also acquire so-called grandfather rights
over the slots obtained for the Paris-Amsterdam route after a confidential period,
provided that the new entrant stays on the route for at least three years. This means he
will be able to use them for other destinations once the high speed railway link will be
completed between the two capitals or when other competitors will have emerged. The
impact of such a provision is to increase the value of the slots released, and, thereby, to
significantly reduce the risk of lack of new entry.
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Merger of United Airlines with U.S Airways:
8.11 United Airlines and US Airways initially announced their proposed
merger in May 2000.
The parties made submissions to the Department and announced some changes in J anuary
2001, United and US Airways are the second and sixth largest U.S. airlines. The
acquisition would give United a monopoly or duopoly on nonstop service on over 30
routes, where consumers spend over $1.6 billion annually, and substantially limit the
competition it faces on numerous other routes representing over $4 billion in revenues.
US Airways is United’s most significant competitor on densely-traveled, high revenue
routes between their hubs, such as Philadelphia and Denver, as well as for nonstop travel
to and from Washington D.C. and Baltimore, and on many routes up and down the East
Coast.
8.12 The Department maintains that the proposed acquisition would violate the
antitrust laws by reducing competition in:
1. Hub-to-Hub Nonstop Markets Passengers spend over $900 million annually to travel
on routes between United’s and US Airways’ hubs. On seven of these routes, US
Airways and United are each other’s most significant competitor, and on four of those
(Philadelphia-Los Angeles, San Francisco and Denver; and Pittsburgh-Washington, D.C.)
US Airways and United are each other’s only nonstop competitor. On the other seven
hub-hub routes, US Airways is currently the only airline offering nonstop service, and
United is the most likely airline to enter.
2. Washington, D.C. and Baltimore Nonstop Markets. United and US Airways offer
competing nonstop service between Washington, D.C. and many cities, such as
Rochester, NY, and New Orleans, LA. They are also the only two airlines providing
nonstop service between Baltimore and Los Angeles and San Francisco. Consumers
spend over $1 billion each year to travel in these markets.
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Nancy Shah, 30.7.07 57
3. East Coast Connect Markets. Because they operate most hubs that provide
connecting service between cities in the eastern United States, United and US Airways
are the only two airlines, or two of only three airlines, offering connecting service
between northeast cities such as Albany, NY and Burlington, VT, and southeast cities
such as Greensboro, NC and Roanoke, VA. The acquisition would solidify their control
over the major connecting hubs for east coast traffic -- Pittsburgh, Philadelphia,
Washington-Dulles, and Charlotte.
4. International Routes. US Airways compete with United (through United’s marketing
alliance with Air Canada and Lufthansa) in a number of international markets. In several
of these, including Philadelphia-Toronto and Philadelphia-Frankfurt, the acquisition
would eliminate the only nonstop competitor for United’s alliance partner.
5. Corporate and Government Business. Like the other major airlines, United and US
Airways bid for high volume contracts with large corporations, negotiating discounts to
their airfares in return for a corporation’s commitment to concentrate travel on the airline.
They compete vigorously against each other, particularly when the corporation requires
significant travel on nonstop routes where United and US Airways compete. United and
US Airways also compete for the $1 billion the U.S. government spends on air travel, and
were the only two, or two of only three bidders, on many city pairs.
6. Airline Service Concentration. United’s acquisition of US Airways will create or
enhance dominance at many cities throughout the United States, including Boston,
Washington, and Philadelphia. Competition for the millions of passengers traveling to
and from these cities will decrease, resulting in higher fares and reduced service.
8.13 United and US Airways offered proposals to limit the loss of competition
from this merger by proposing to - a divest assets at Reagan National airport and a
promise by American Airlines to fly five routes on a nonstop basis was found insufficient
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by the Commission. The proposal did not assure competition for those adversely affected
by the acquisition, such as passengers in east coast connect markets. Hence, the merger
was aborted in its initial stages.
VIII.C
CASES OF M&A IN INDIA:
1. The Jet-Sahara Mega Merger:
On 20 th April , 2007 J et acquired 100% stake in Air Sahara 15 months after signing the
original purchase agreement. J et purchased its arch rival for INR 14.5 billion (3500 USD
Million) which is 35 % less than the price agreed in 2006. The ultimate consummation of
Sahara represented the conclusion of the arbitration exercise that has been going on since
J ully, 2006. J et has announced its going to re brand Sahara as “J etlite” which would
operate as a value carrier. The new entity would offer reduced frills but would be over
and above LCC in terms of service .They together account for a market share of 28% as
on May.2007 which is sharply in contrast to their market share in J an, 2006 which was
more than 45% reflecting increase in competition and fragmentation since then.
2. The Air Deccan-Kingfisher Merger:
The merger between the pioneer LCC and liquor baron was announced on 31
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May, 2007
as the United Brewies, picked up 26% stake in Air Deccan and propose to buy another 20
% via an open offer. The deal UB group paid a whopping INR 550 Crore to pick up a
26% stake in the LCC.
3. The Air India-Indian Merger:
The two state run carriers entered into a merger in April, 2007 in a bid to consolidate and
optimize the use of the assets of the two public sector airlines. The will help the two
airlines to synergize their operations.
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SECTION IX
COMPETITION ISSUES RELATED TO THE INDIAN AVIATION SECTOR:
9.1 Competition Act, 2002 prohibits associations or enterprises to enter into an
agreement in respect of production, supply, distribution, storage, acquisition or control of
goods or provision of services, which causes or is likely to cause an appreciable adverse
effect on competition within India. The central theme of the competition act, 2002 is to
prohibit:
i. Anti-competitive agreements
ii. Abuse of dominance
iii. Regulation of M&A
Now, we shall be analyzing the Competition related issues with the above-mentioned
themes in the background.
9.2 The Indian aviation sector has its own competition related issues that need to
address. Some need to be addressed by the ministry where as some must be evaluated by
the competition authorities. The Indian aviation sector in a nutshell is plagued with the
following issues:
1. Regulatory Barriers
2. Scarcity of slots
3. Cartelization
4. Regulation of M&A
Now we shall be addressing each issue separately and analyzing the competition related
matters with the same.
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I. REGULATORY BARRIERS:
One of the most important considerations in front of the Commissions across the world
when evaluating cases from Competition angle is to consider the possibility of new entry.
The Competition Authorities may not interfere in a case even if an existing incumbent is
making super normal profits by abusing his dominant position. Reason being the
possibility of new entry which would erode the incumbency benefit and bring prices back
to the normal level. However, problem may arise in those cases where the incumbency
benefits can not be checked by possibility of new entry. This is indeed the problem with
the Airline Industry. There isn’t free entry in this industry. New entry is curtailed owing
to the regulatory barriers & capacity constraints (namely slot allocation-competition in
vertically related markets) & hence an important source of competition is & will be lost.
First, we will focus on Regulatory Barriers.
Though the Domestic Air travel Policy is reasonable and liberal. But there are several
issues which may require some reconsideration. These are stipulation about minimum
fleet size and minimum equity capital for new entrants and route dispersal guidelines as
mentioned below.
The key features of present domestic air transport policy are:
1. Private sector is allowed to operate scheduled and non-scheduled services.
2.. The scheduled operators are required to follow route dispersal guidelines - an
administrative mechanism that was aimed at extending air transport services to
regions/routes that is not necessarily commercially viable where by each domestic carrier
is suppose to deploy some fixed % of its capacity on class II & III Routes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 61
3. Operators are required to have a stipulated level of fleet size and subscribed equity
capital. For example, scheduled operators should have five aircraft (by outright purchase
or lease) and a minimum subscribed capital of Rs. 10 crores. (Rs. 30 crores if operators
have an aircraft of maximum take-off mass exceeding 40,000 kg.).
4. Foreign equity participation up to 49 per cent and investment by Non-Indian Residents
(NRIs), Overseas Corporate Bodies (OCBs) up to 100% is allowed. The representation of
the foreign investing institution/entity on the Board of Directors of the company shall not
exceed one-third of the total.
5. Foreign airlines are not permitted to pick up equity. Foreign financial institutions and
other entities who seek to hold equity in the domestic air transport sector shall not have
foreign airlines as their share holders.
6. Open skies policy for cargo services.
7. As regards safety and security arrangements, the operators must ensure compliance
with relevant regulatory requirements stipulated respectively by the Director General of
Civil Aviation (DGCA) and the Bureau of Civil Aviation Security (BCAS).
8. A domestic carrier must have flown for at least 5 years before entering the
International Skies.
Source: Domestic Air Transport Policy, Ministry of Civil Aviation
1. Min Capital Requirements & Fleet Size
The government’s announcement of minimum equity requirement & fleet size is
essentially considered to be obstructive. According to the Naresh Chandra Committee
Report, 2003 such requirements and analysis may be better left to the investors including
their bankers, financial institutions, and financial analysts or a regulator.
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2. Route Dispersal Guidelines:
Likewise, to safeguard the interest of remote and backward areas, in 1994 the
government issued ‘route dispersal guidelines’ for scheduled services operations on
domestic routes. Under these guidelines, any one who operated services on specified
trunk routes will have to provide a minimum proportion of such services on non-trunk
routes and remote and backward areas. These guidelines are mandatory.
9.3 These guidelines have taken their tolls on the profitability and viability of
airlines & making the airline business unattractive. The route dispersal guidelines may be
inadvertently hindering the emergence of specialized airlines with appropriate aircraft to
cater to regional and short-haul feeder routes. This is because given that the larger
airlines are bound by the route dispersal guidelines to operate a specified percentage of
their deployed capacity on Category II & III routes (regardless of viability of such
operations) they can (potentially) undercut the specialized airlines on these routes.
Recently, government announced its desire to develop Specialized Regional airlines. In
face of the current regulation, the route dispersal guidelines will definitely hurt the
regional as well as large carriers. The implicit subsidy is indirect and not transparent and
therefore not appropriate from general economic point of view. From a long-term point of
view, there should be a clear policy on subsidizing air transport services on these routes
by reimbursing the carriers from a Universal Fund Scheme (just like we have it for
Telecom Sector). Or another way of preserving profitability & as well the objective of
access to the remote locations is by allowing major carriers to focus on trunk routes of
their choice and enable specialized carriers to service such feeder airlines.
3. Minimum Requirement of Domestic Flying for 5 Years & Min fleet of 20 aircrafts is a
must for seeking permission to fly internationally.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 63
9.4 This policy regulation is highly discriminative and is leading to a near
duopoly situation in terms of the number of domestic players allowed to serve the
International Skies. International flights are a major attraction for the nascent domestic
players owing to their high profitability on these routes. Under the current policy regime
only J et/Sahara and AI/IA are now allowed to serve internationally, as they are the only
two players who meet these criteria. However, the nascent players who began their
operations in 2003 have given these incumbents a tough competition in terms of service,
route networks, and market shares. They too have been able to match the incumbent’s
standards & that the reason why the incumbents could not help prevents their slipping
market share. But these Incumbents seem to enjoy an unrivalled position as they are the
only domestic carriers flying internationally. What further adds salts to the wounds of the
new players is that government is allowing other new international players with fleet size
and experience which is far less than the Indian Regulation to fly in & out of the country.
Eg. Nok Air.
Hence, the current policy regulation is highly discriminative and is undoubtedly favoring
the incumbents. The scenario has become more grave now as the domestic players in the
international skies have been reduced to two players as compared to four players prior to
the merger of J et – Sahara ; IA-AI.
4. Benefits accruing to State carriers as they are the only domestic carriers allowed to fly
to the Gulf.
The existing policy framework bars the domestic carriers other than the national carriers
from entering the Gulf Routes. The Gulf Routes are an important source of revenue as
they have maximum number of passengers traveling to these routes as shown below:
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Fig 6:
Tr affic on Int er nat ional Routes
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9.5 According to unofficial estimates, the state carrier AI pulls out around 40 % of
their earnings from these Gulf Routes. The national carriers are dominant players on
these sectors & are enjoying monopoly gains and are depriving other carriers from an
important source of revenue. However, some socialists who are favoring the current
reservation argue that the provision of exclusive right to the national carriers will help the
carriers cross subsidize their operations to the routes which are unviable but have to be
served as they are the country’s national carriers. However, this subsidization argument is
depriving other industry players from an important source of revenue. Consumers are
also worse off as they have no choice in terms of carrier or any substitute mode of
transport.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 65
II. CAPACITY CONSTRAINTS:
9.6 Going by simple rule of demand & supply, if demand for one good is rising
then supply correspondingly is increased to match the demand. However, this is not
possible for the
Aviation sector as capacity cannot be augmented in response to demand. Airports have a
fixed capacity and in terms of their ability to handle traffic. In absence of alternate
airports, the major metropolitan airports are becoming congested and are constrained in
terms of capacity. Now this may act as a barrier to entry for new entrants as there is acute
shortage of slots
6
, ground handling and others. This might act as an entry barrier in the
current regime where slots’ allocation is based upon grand fathered rights
7
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9.7 Slots are rights to take off or land at particular time of the time. The issue of
slots is important as the existent carriers may shoo away competition by taking advantage
of the capacity constrained airports.
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Slots are referred to as rights to take off or land at a certain time of the day.
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Fig-2
LEVEL OF CONGESTION AT MAJOR CITIES
9.8 As seen above, the current capacity is struggling to keep pace with the current
demand at the major metropolitan airports. The allocations of slots are a prime issue in
front of the new entrant as it will decide its profitability. The passenger load factors are
highest on the metropolitan routes like Delhi-Mumbai at peak times. As we earlier
defined that the relevant market is the travel from city of Origin to the destination city at
a particular time on a particular day. Route & time are important factors governing the
profitability of this sector. E.g. Delhi-Mumbai sector is the most congested sector with
maximum passenger load registered for morning and evening slots.
9.9 Capacity constraint benefits the Incumbents more than the late entrants as they
are able to occupy airport infrastructure on a first come first serve basis. We
go a step ahead to dwell on this issue: Say I take a route, which is Delhi-
Mumbai. It is the most populous and the most crowded route. Reason being,
Mumbai is the commercial and the financial hub of the nation where as Delhi
7
Grand Fathered Rights are rights issued on first come first Serve Basis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 67
is the national capital. Millions of passengers shuttle everyday between Delhi
and Mumbai. Most of them for business purposes while some for leisure
purposes, the ratio being 65:35. I have deliberately chosen Delhi-
Mumbai Route as over half of India’s 33 million passengers traffic per annum is
generated from this route.
8
9.10 Now carriers try & target the business class more than the leisure class as
their responsiveness to price changes (5-10%-SSNIP Test) is negligible. The relevant
market as defined earlier is Origin & Destination Wise City Pair Market that is serving a
particular market at a particular time. Time is money and carriers understand this very
well, that is why carriers like IA and Jet have strategically timed flights to fit the
schedules of the business class. E.g. IA has occupied prime slots and timed its flights at
strategic timings such as 7AM;8AM;9AM;10AM;11AM;12AM;1AM ,5PM,6PM, 7PM,
8PM, 9PM.Similar is the case for Jet. However, this entails Incumbency Benefits as these
two incumbents have cornered peak slots on major trunk routes which may deprive the
late entrants from having access to such peak slots.
The following figure gives the distribution of the number of carriers operating on a
particular day on Delhi- Mumbai route:
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Fig 3:
Distribution of flights operating between
Delhi to Mumbai during on a particular day.
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Time Slots
DEL-MUM
Goair
Indigo
Spicejet
Kingfisher
Air Deccan
Air Sahara
J et
Indian
9.11 From the figure, it is evident that the peak slots are morning and evening
slots. Typically morning slots between 6:00-8:00 AM are very popular with
businessmen as they can reach their destination by 11 AM, finish off their work and
go back by evening & this explains the skewed nature of the graph towards 18:00-
20:00 slot. Now airlines want to capitalize on this weakness of passengers knowing
8
Source : http://www.dnaindia.com/report.asp?NewsID=1111855
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 69
that there isn’t any alternative present with the passengers. Passengers flying to
Bombay are unlikely to swap their morning flights with evening flights irrespective of
the fare differences. Say ,if a person swaps his morning flight & delays his trip by 5
hours ,he is able to save Rs 1000 i.e. effectively Rs. 200 per hour, however the
opportunity cost for his business would any day be more than the income saved !
Opportunity costs would be grater than Rs 200 /hr atleast. Time is money. Imagine an
entire work day being wasted just to save Rs 1000. Instead of catching a 10’o clock
flight, he catches a 3 ‘o clock flight. By the time, he makes his way through the
densely populated city, its already 6’o clock, time for the markets to close. Imagine, a
man going to Bombay to sign a contract. What would he do, take a 3’o clock flight or
morning flight?
9.12 The financial markets namely the National Stock Exchange and BSE are
closed by 4’o clock. In such a scenario, employers whether self employed or
otherwise give priority to their million dollar work than the peanut differences in air
fares. No wonder, this is the reason that despite their being availability of oddly timed
cheaper tickets such as Air Deccan, most of IA and J et’s executive class seats for
peak slots goes full when checked for availability, one day before departure.
Carefully examining the schedules, we find heavy presence of J et, Indian on morning
flights and evening flights. Both the carriers have chosen very strategic time slots:
having a close look at Indian’s schedule, we find that IA has placed each successive
morning & evening flight at a distance of one hour each. Similar tendencies are seen
with J et who has occupied prime slots. Since the relevant market for our analysis is
referred to as Origin & Destination passengers traveling between Delhi-Mumbai who
are time sensitive businessmen & whose elasticity of demand is therefore low in
responsiveness. There lies the catch for Abuse of Dominance. These carriers will
have enhanced pricing power w.r.t exploiting the business class. Both of them (IA &
Jet) are full service carriers. They adopt loyalty programs such as frequent flier
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programs; corporate discounts; travel agent schemes etc to distinguish between the
business class and others. Both the Incumbents have access to good quality of slots
which there by entails the problem of Incumbency Benefits in face of growing
infrastructural capacity constraints at the airports. It is clear that slot constraint acts
as a major competition issue since it acts as a barrier to new entry and deprives the
new entrants from an important source of income & consumers of an important
choice. What is more important is having quality of slots than having quantity of
oddly timed slots. The incumbents are better off as they have the best slots. The
domestic policy must therefore address the slot allocation problem more clearly. With
the recent merger of Jet and Sahara, Jet has acquired all the user slots of Sahara.
With this, Jet has the best of both the world’s. Jet has quantity as well as quality of
peak slots which it might use to abuse its dominant position on key trunk routes. I
have just picked one of the Twelve Trunk routes. Similar Incumbency benefits might
be present on all other routes as well.
9.13 In the wake of the recent mergers , there is an addition in the current domestic
air transport policy i.e. if the acquiring carrier doesn’t use the existing user rights of the
carrier that it is taking over then in that case they will be by default passed on to the
Airports Authority of India(AAI). The user rights are essentially part of AAI and cannot
be passed on between airlines. They will essentially be distributed by AAI & Directorate
General of Civil Aviation (DGCA). However, this regulation of use-it-or-loose it user
rights doesn’t address the problem completely. Firstly, why will an acquiring carrier give
up peak slots. Secondly, nothing concrete has been said in the literature about the
incumbency benefits that accrue to the niche players as the current slot allocation system
is based upon grand fathered rights. J et , Sahara , IA are having access to peak slots
which is depriving the other players who too might want to service the trunk routes at the
same time.
The concerns have been expressed last year when J et announced its plan to take over
Sahara. Air Sahara's rights must be redistributed to all airlines in order to prevent J et
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 71
Airways from attaining a dominant position in slots as this would restrain growth of
competition. Air Sahara's aviation rights should not automatically accrue to J et; the latter
should instead be required to re-apply for securing additional rights. The DGCA, as the
competent authority should use this window to re-distribute Air Sahara's rights to all
airlines. Had Air Sahara continued and given the inevitability of its closure, its rights
would have anyway got released for distribution to others, and not available only to J et.
The DGCA must take into account these factors.
Hence, fair allocation of slots is an important issue that needs to be addressed as it will
enhance competition and wipe off age old incumbency benefits if any. The literature is
full of methods for allocation of slots, however, these methods are not free from cons
9
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Regulations regarding M&A in our Domestic Air Transport Policy:
Consistent with the global trends in aviation, aviation sector in India has & is likely to
witness consolidation amongst airlines. The question regarding use of airport
infrastructure in case of merger / take over of airlines and sale / transfer of aircraft etc.
has drawn attention of the Government for quite some time. The following general
principles formed the basis for consideration in our Domestic Air Transport Policy:
1. After examining the pros and cons of the various alternatives particularly with
reference to the position of the civil aviation sector in the Indian context, it has
been decided that the airlines that takes over the aircraft pursuant to merger / take
over or sale / transfer of the aircraft may be allowed the use of airport
infrastructure like parking bays, landing slots etc., which is allotted by Airport
Operator without any payment. This was particularly necessary as the transferred
aircraft is in operation in the country already availing the airport infrastructure.
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Refer to APPENDIX IV for methods for Allocation of slots
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2. In terms of schedules / connectivity etc. it will be in public convenience if usage
of such infrastructure is allowed to the airline that take over the aircraft provided
the user rights are actually used by the airline. Only the user rights over such
infrastructure that are given to an airline on non-payment basis e.g. parking bays,
landing slots etc. may be allowed to be used by the airline that takes over the
aircraft. For all other rights, the terms of lease / sale agreement between the
airport operator and the airline may apply.
3. It may be clearly stated that the user rights belong to the Government / airport
operator and therefore, cannot be transferred by one airline to the other airline in
any event. The Government / airport operator shall allow the user rights to be
availed by the airline that takes over the aircraft.
4. User rights may be allowed to be used by the airline that takes over the aircraft
only in respect of those rights, which are actually under use by the airline that
transfers the aircraft. All other rights will be taken over by the Government /
airport operator. The user rights will be available with the airline that takes over
the aircraft only till such time that the infrastructure concerned is under actual use.
If the airline that takes over the aircraft does not use the concerned infrastructure,
it will lose the user rights over the infrastructure.
As mentioned before that this policy regulation solves the problem of incumbent
carriers hoarding the unviable slots for restricting new entry but still it doesn’t
solve the incumbency problem. Still slots are allocated on Grand fathered rights
system
10
. Given that relevant market is 0rigin & Destination city pair market at a
particular time, so timings play a pivotal role in determining the revenue receipts
of various carriers. At least 50 % of FSC are business travelers at an aggregate
level. Carriers use corporate bulk purchases; frequent flier programs; travel agents
schemes to identify the business class traveling on board. Due to sporadic
availability of slots, entrants find it very hard to acquire sufficient slots to
10
Grand Fathered Rights: Rights assigned on first come first serve basis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 73
establish a viable service pattern in city pair markets at the Convient timings.
Authorities however on record haven’t documented any policy to wipe off this
kind of incumbency benefits although there is news of the requisite provision
being made in Vision 2020, which is currently under, scrutiny of the Group of
Ministers.
III. CARTELISATION:
People of the same trade seldom meet together, even for merriment and diversion,
but the conversation ends in a conspiracy against the public, or in some
contrivance to raise prices.
Adam Smith, The Wealth of Nations, 1776
A cartel is a group of formerly independent producers whose goal is to increase their
collective profits by means of price fixing, limiting supply, or other restrictive practices.
Cartels typically control selling prices, but some are organized to control the prices of
purchased inputs. Cartels are prohibited by antitrust laws in most countries; however,
they continue to exist nationally and internationally, openly and secretly, formally and
informally.It may be guilty of abusing said monopoly in other ways. Cartels usually
occur in oligopolies, where there are a small number of sellers and usually involve
homogeneous products.
As per section 3 of the Competition Act, 2002 any agreement which causes or is likely to
cause, appreciable adverse effects on competition in markets in India is prohibited.Any
such agreements will be void.
Any agreement entered into between enterprises or associations of enterprises or persons
or associations of persons or between any person and enterprise or practice carried on, or
decision taken by, any association of enterprises or association of persons, including
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cartels, engaged in identical or similar trade of goods or provision of services shall be
presumed to be anti-competitive if they —
a.) directly or indirectly determines purchase or sale prices;
When the parties enter into collusion, they draw out various tacit agreements. One such
agreement is to fix sales price or fix purchase price depending upon whether the
agreement is drawn from sellers’ side or buyers’ side.
b.) limits or controls production, supply, markets, technical development, investment or
provision of services;
The second kind of agreement is where by the production, supply is deliberately
constrained to justify the artificial raise in prices & be able to charge an exorbitant
amount from the consumers.
c.) shares the market or source of production or provision of services by way of
allocation of geographical area of market, or type of goods or services, or number of
customers in the market or any other similar way;
Here, the colluding parties divide the entire market amongst themselves based upon
geographical area, types of goods and services, or number of customers in the market &
others.
d.) directly or indirectly results in bid rigging or collusive bidding;
"Bid rigging" means any agreement, between enterprises or persons engaged in identical
or similar production or trading of goods or provision of services, which has the effect of
eliminating or reducing competition for bids or adversely affecting or manipulating the
process for bidding.
Collusive bidding or bid rigging may be of different kinds, namely, agreements to submit
identical bids, agreements as to who shall submit the lowest bid, agreements for
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 75
submission of cover bids ( voluntary inflatory bids), agreements to bid against each other
agreements on common norms to calculate prices or terms of bids , agreements to
squeeze out outside bidders , agreements designating bid winners in advance on a
rotational basis , or on a geographical or customer allocation basis . Inherent in some of
these agreements, is a compensation system to unsuccessful bidders by dividing a certain
percentage of profits of successful bidders.
History of Collusion:
It has long been posited that when firms face each other in a large number of markets
they may complete less vigorously by allowing each other more or less exclusive spheres
of influence. Put another way, the number of markets in which firms meet is a factor
influencing the likelihood of oligopolistic coordination or “tacit collusion”.
The FIA-Federation of Indian Airlines, a conglomerate of top honchos of domestic
airlines met in 2005 to form a federation that will provide a common platform to debate
industry issues and lobby the government and hammer out solutions. To their misfortune,
at their first meeting they were discussing about pricing issues, which timely was bought
to the notice by CCI, and hence the very first step towards Cartelization was aborted.
Moreover, that time the industry was scattered into many players so chances of deviations
were very high. In today’s scenario, chances of Cartelization and its materialization are
quite high as post consolidation with less number of players tacit collusion is more chase
able and deviation is less unlikely. So CCI must keep an eye on such tendencies. More
over, chances of coordination in prices might become even higher if the Proposed
Alliance between AI and J et materializes. It is highly recommended that the Commission
scrutinizes the proposal & its prospective pros and cons before the two are allowed to
sign on the dotted line.
It is in this regard, that the Commission has identified some conditions conducive for
Cartelization. Cartels usually function in secrecy. The member of a cartel by and large
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seeks to camouflage their activities to avoid detection by commission. If there is effective
competition in the markets, cartels would find it difficult to be formed & sustained.
Some of the conditions conducive to formation of cartels by the Commission are:
1. High concentration
2. High entry & exit barriers
3. Homogeneity of products
4. Similar production costs
5. Excess capacity
6. High dependence of consumers on the product
7. History of collusion
Now keeping these factors in the backdrop, we check for cartelization tendencies in the
Aviation Sector.
1. High Concentration
In order to calculate the potential monopoly power from a merger, a commonly accepted
measurement is the Herfindal-Hirschman Index (HHI). In fact, this index is a measure of
Industry concentration. According to U.S Merger Guidelines, if post merger, HHI takes a
value between 1,000 and 1800 and merger adds more than 100 points, the merger is
likely to be challenged ;whereas if post merger HHI takes a value higher than 1800 and
merger adds more than 100 points, the merger should be challenged. To illustrate the
effects of mergers happening in the Indian Skies, the HHI index was calculated before
and after the merger and the results are presented in following table:
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 77
Table 1:
HHI Calculations (National Mkt)
*HHI is the Sum of Squares of Market Shares
Firm Mkt Share (As
on May'07)
Squares of Mkt.
Sh
Squares of Mkt
Sh (Post Jet
Deal)
Squares of Mkt
Sh (Post
Kingfisher
Deal)
IA 22 484 484 484
J ET 22.3 497.29 864.36 864.36
AS 7.1 50.41
AD 18.2 331.24 331.24
KgF 11.1 123.21 123.21 858.49
SJ 8.3 68.89 68.89 68.69
IndG 6.3 39.69 39.69 39.69
Go 3.2 10.24 10.24 10.24
PA 1.5 2.25 2.25 2.25
HHI 1607.22 1923.88 2327.72
With respect to the HHI ratios, we have come to the conclusion that the concentration is
fairly high in the industry with top 3 players pocketing about 80% of market share. So in
terms of concentration, this industry crosses the benchmark standard of 1800 fairly well
after the takeover of Air Sahara by J et. Kingfisher Deccan Deal showed similar trend.
However, the commission must also note that Airline Industry across the world is an
oligopolistic Industry owing to its capital intensive nature. There are very few players in
the market .Therefore, following the HHI benchmark of 1800 blindly would be wrong as
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the concentration is any ways bound to be high in this Industry. The benchmark standards
for such oligopolistic industries must be set on a case-by-case basis.
We also calculated the HHI Ratio for the Delhi-Mumbai route between 6AM-8AM as
this was identified as the peak slot. More than half of Air Travel Passengers in India are
located on this route, hence this route is very important.
HHI Calculations, prior to M&A on Relevant Market of Del-Mum Route
between 6.00-8.00 A.M:
Table 1 (a)
Carriers Mkt Share (%) Sum of Squares of
Mkt. Shares
IA 25 625
J et 25 625
Sahara 12.5 156.25
Deccan 12.5 156.25
Spicejet 12.5 156.25
Indigo 12.5 156.25
HHI=1875
HHI Calculations, post M&A on Relevant Market of Del-Mum Route
Between 6.00-8.00 AM:
Table 1 (b)
Carriers Mkt Share (%) Sum of Squares
of Mkt. Shares
IA 25 625
J et/Sahara 37.5 1406.25
Deccan 12.5 156.25
Spicejet 12.5 156.25
Indigo 12.5 156.25
HHI= 2500
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 79
As mentioned in the previous section that relevant market comprises of a city pair
market at a particular time, on a particular route. Since half of India’s air travelers are
concentrated on Del-Mum Route so I deliberately chose this route to calculate HHI & to
show the level of concentration. On the Delhi to Mumbai Route, J et & IA operate 13
flights per day while Sahara operates around 5 flights. Post merger, J et’s share in this 6-
8AM slot has increased to 37.5 %. The concentration on this route is high for the morning
slot as post merger; the concentration has increased to 2500 between 6-8AM Slots.
Similarly, HHI Ratios for the peak evening slots were calculated & it was found that the
concentration prior to merger was 1156 & after the merger, the concentration increased to
1875 on the Delhi-Mumbai Route for the 18.00-20.00 Slot. Hence, the increase in the
percentage points of concentration is fairly high after the merger be it at the national level
or for a peak route such as Delhi-Mumbai at the peak timings.
2. High Entry & Exit Barriers:
Aviation Industry has high entry barriers. Not any one and every one can enter the sector.
The following entry barriers are faced by a new entrant:
1. High capital cost of purchase of aircrafts. But this to some extent is tide over by
leasing of aircrafts. But still leasing too doesn’t come very cheap. Undoubtedly
Aviation is highly capital intensive Sector.
2. Regulations governing new entry:
i. Route Dispersal Guidelines: They as discussed earlier are constraining the
profitability of the carriers. The airlines are expected to serve a fixed % of
their capacity to category II –III routes which is making their operations
unviable and in turn making the industry less attractive as far as new entry is
concerned.
ii. Minimum Equity & Fleet Requirements for domestic operations is again
increasing the entry cost.
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iii. Minimum 5 years of domestic experience and Minimum fleet size of 20
aircrafts is restricting entry in International skies
iv. Slot Constraint: Capacity constraint acts as a major entry deterrent and
increases the cost of entry as unavailability of desirable slots will have its
impact on the profitability. Allocation of slots have been grand fathered and
entails incumbency benefits. In allocation of slots, what is more important is
have good quality of slots that are strategically placed than have a quantum of
slots which are oddly timed & result in lower passenger loads & higher costs.
The merging carriers may inherit prime slots which they might exert to abuse
their dominant position by increasing the prices. This practice if detected is
highly anti competitive
3. Homogeneity of Products:
The Airlines typically delivers the same product i.e. transferring scheduled passenger
traffic from their origin to the destination. There are 2 sets of Models namely Full Service
Carriers and Low Cost Carriers. The full service carriers (FSC) take passengers from
origin to destination but in a more luxurious manner. They offer free on board Food &
entertainment where as Low Cost Carriers (LCC) doesn’t go out of the way as far as
delivering these amenities are concerned. They largely have a higher seating capacity eg
Air Deccan’s airbus has capacity of 180 while same airbus model for kingfisher has a
capacity of 150 seats. So in terms of customer comfort, FSC takes more marks than Low
cost carriers. The markets for LCC & FSC carriers essentially different as one caters to
the leisure class while other caters to the needs of the time sensitive & the upper class.
4. Similar production costs:
The airlines’ production costs are more or less similar. Most of their revenue receipts go
in paying the fuel bill. The Aviation Turbine Fuel (ATF) is the most costly in India when
compared to other nations. The liberal taxes imposed on the imports of ATF has made air
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 81
travel expensive. Of late, airlines have started charging a Congestion Cess of Rs 150 from
passengers despite Govt.’s opposition. Airlines find it justified as they feel that
a lot of precious fuel is wasted when the aircrafts circle in the air before they finally get a
green signal to land at the congested city airports. However, justification of this cess is
highly debatable as consumers bear the maximum brunt. Firstly, it is there trip that is
getting delayed and further to add salts to the wounds, they are made to pay for the delay
also!
ATF prices for domestic operations include freight charges from the Gulf to India, ad
valorem customs duty of 10% (which adds up to an effective rate of approx 20%
inclusive of the CVD and cess), domestic transportation and other charges, excise duty of
8.24% (including cess), sales tax levied by State governments that average at 25% across
the country. All these costs, along with the marketing margin of oil companies and
throughput charges paid to the airports authority, are over and above the Arabian Gulf
ATF prices. In India, ATF prices are 60% higher than the average ATF prices globally.
The industry loses $450 million or Rs 1,988 crore a year due to the high tax structure.
The industry players always complained of monopoly of public sector companies: Indian
Oil Corp.; Bharat Petroleum Corp.; Hindustan Petroleum Corp. Ltd. as the only ATF
suppliers at the airports. The Govt. Recently has approved demand of airlines to infuse
competition in the ATF business by bringing public sector monopoly to an end. In initial
stages, Govt. plans to allow private players for marketing ATF at smaller airports. AAI
now has approved Reliance Industries to set up ATF business in 25 non-metro airports.
However, a major part of fuel uplift is from major metro airports. Presently, the public
sector companies are expected to charge a margin of 20-25% on ATF sold by them The
entry of RIL is expected to bring down fuel prices ( margins are expected to reduce by 5-
10% with entry of private players ) considerably ,if only it is permitted to operate in
metro airports.
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Other costs include parking charges; landing fees; hangar charges; maintenance; repair;
personnel; entertainment etc. The cost differences between LCC & FSC arise only w.r.t.
food and beverage costs & other frills such as entertainment provided by FSC.
5. Excess Capacity:
The sector doesn’t have much excess capacity. Carriers need to ascertain their demand a
couple of years in advance as the delivery of aircrafts is made with a lag of 3-5 years.
However, in the near future the growth in capacity is likely to surpass the demand as
shown below. Fig 4
Indicative growth rate of Airports; Passenger & Aircrafts
Source
GCA;AAI;CAPA;Boeing;Airbus
11
Most of the carriers have gone on a shopping spree indicative of an aggressive fleet
acquisition plan are committed significant sums to expand their fleets by nearly 250
11
Aviation & Tourism Investment Summit, 2007.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 83
aircrafts over the next 5 years
12
. The current aircraft fleets in the country are way below
even other less developed nations with population far lesser than India. The Indian
carriers have initiated their expansion program as they for see a lot of untapped demand
coming from the ever-booming Indian Economy and its ever burgeoning upper middle
class.
However, capacity comes at a price. There can be excess capacity if airlines charge
exorbitant fares. At the same time, there can be full passenger load factors on the carriers
if fares are rationally priced. So in a nutshell, capacity comes at a price.
6. High dependence of consumers on Product:
Consumers are addicted to this mode of transportation as there exists no other mode in
India that can make a passenger reach his destination within a couple of hours. In India,
we are yet to introduce High Speed Rails which can give airlines a tough competition. As
of now, there isn’t much alternative present with the time sensitive passengers segment
who wants to reach his destination on time. Air Travel is undoubtedly the fastest mode in
India for Medium and long distance journeys.
7. History of Collusion:
The sector has witnessed collusive tendencies internationally. Collusion among carriers is
in terms of prices. They pre set the prices in advance on specific sectors where there used
to exist a duopoly or an oligopolistic competition before. Such amateur attempts have
been made in India also, though timely intervention of CCI aborted such attempts. The
FIA-Federation of Indian Airlines was formed in 2005 as a conglomerate of top industry
honchos of the aviation industry in India. The agenda of their first meet was to discuss
pricing issues which by timely intervention of Competition Commission was stopped.
12
Refer to Appendix II for Orders placed by Indian Carriers.
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That time the industry was very much fragmented and any ways cooperation over prices
would not have been possible. Today’s scenario is best suited for coordination in prices.
With top 3 players having more than 80 % of market share, cooperation between the
players is highly feasible.
Airlines have had a strong International past over cartelization. In 1994, the J ustice
Department settled an antitrust suit today against six major airlines that agreed to changes
in a computerized reservation system .The Government said that airlines used CRS to
communicate & fix air fares. Without admitting or denying the accusation, the airlines --
American Airlines, Delta Air Lines, Continental Airlines, Northwest Airlines, Trans
World Airlines and Alaska Airlines -- agreed to end the practice of communicating
proposed fare increases to each other through the computerized system maintained by the
Airline Tariff Publishing Company. A J ustice Department spokesman called the system
"an electronic smoke-filled room" used by airlines to float "trial balloon" price increases,
make and receive counterproposals and reach a consensus on the amount and timing of
price increases or the removal of discounts.
All the Alliances formed abroad are under the close scrutiny of the Competition
Authorities Abroad as Alliances incorporate practices like code sharing, blockaded space
agreements, sharing of lounges etc which may have anti-competitive effects. So taking an
anti-trust immunity shield from the commission is a must before commencement of
operations.
The U.S Government identified more than 50 separate price-fixing agreements covering
hundreds of routes. As a result of one agreement, consumers paid as much as $138 more
for travel between Chicago and Dallas. In another, airlines agreed to raise discount one-
way fares by $20, the agency said. The antitrust division, said the airlines used the Airline
Tariff Publishing system "to carry on conversations just as direct and detailed as those
traditionally conducted by conspirators over the telephone or in hotel rooms."
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 85
CAPA SURVEY
Acc to a survey done by CAPA presented at the recent fourth annual India and Middle
East Low-Cost Airline. This CAPA survey was conducted on over 2000 passengers at
key airports in India including Delhi; Mumbai.
a. Symposium reported that 67 % of passengers’ travelers in FSC would have traveled by
air even if Fare doubled of what they paid. Also, 50 % of LCC passengers surveyed
shared the same feeling.
b. Also the survey reported that only 9% of the LCC traveled for the first time while for
FSC the figure was 5%.
c. Nearly half of FSC surveyed were travelers on business (47%), against 30 % in case of
LCC counterparts.
d. Acc to the survey, 4 out of 10 did not pay for their tickets (about 42%) which is more
than twice than that on LCC.
e. About 43 % of LCC travelers, twice the proportion of FSC buyers bought the tickets over
the internet. Which implies that still 80 % of FSC book their tickets via the travel agents.
f. About 38 % of the FSC passengers received less than Rs 40000 per month as against 46
% for LCC users.
If these numbers are to be believed, then the survey might send wrong signals to the
niche Carriers who may be encouraged to hike prices, undertake price setting; form a
cartel. Post consolidation, coordination will become easier for price setting on Route I
category of States. As J et /J etLite is planning to enter in an alliance with AI/IA for
seeking cooperation in its International Services ,chances of coordination in prices across
peak routes and peak slots are enhanced. With take over of Deccan by Kingfisher, there is
expected to be some rationality in terms of pricing .It will end the era of Predatory
Pricing & enhance the chances of a coordinated behavior.
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IV: REGULATING M&A:
As per Section 5 of the Competition Act, 2002, all M&A are bound to come under CCI’s
lens if they meet the following bench marks:
1. The prescribed turnover levels for M&A are : Assets of the Merged entity if is
more than Rs. 1000 Crores or a turnover of more than Rs 3000 Crores (these
limits are US $ 500 millions and 1500 US$ in case one of the firms is situated
outside India.).
2. The limits are more than Rs 4000 Cr or 12000 Cr and US$ 2 billions and 6
billions in case the merged entity belongs to a group in India or outside
respectively.
Evaluating the Benchmark levels to the recent Mergers, we find that:
Table 2:
Combined Turnover of the Merged Carriers
Carrier Combined
Turnover
IA-AI Rs. 15000 Cr
J et-Air Sahara Rs. 7000 Cr
Kingfisher-Air Deccan Rs. 6000 Cr
Hence, all three mergers comfortably qualify for the Competitive scrutiny of CCI for any
possible anti-competitive effects and abuse of dominance cases.
Firstly, the IA-AI Merger:
While AI is essentially serves International routes with negligible domestic presence, IA
has tremendous domestic presence with negligible International presence. The AI-IA
Merger doesn’t pose as much problem as the merging entities do not serve same routes so
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Nancy Shah, 30.7.07 87
there is no question of reduction of competition in question. Although, the exclusive
reservation of Gulf Routes is highly an anti-competitive practice which needs to be
addressed. However, competition authorities have every reason to inspect mergers like
J et and Kingfisher as they have overlapping routes. To better explain this, I take up an
example. The recent Tata – Corus deal and the Mittal- Arcelor Deal are very much fresh
in our minds. Now, the Mittal – Arcelor deal had to go thru a long period of wait before
finally getting a green signal for the two to sign on the dotted paper. There was a lot of
hue and cry from different groups across European Community as the merging entities
were both Europeans However this frenzy was absent when Tata took over Corus Steel as
Tata primarily served Indian Markets while Corus had International Presence. So the two
entities had complementing networks. It doesn’t pose as such a problem to Competition
Authorities. Problem arises when two dominant players serving the same market merge
making consumers vulnerable to chances of Monopoly or Duopoly or even collusion.
Hence, the IA-AI merger will have no impact what so ever from competition angle as the
two have complementary networks. While IA is primarily a domestic carrier with
negligible presence felt around neighboring countries, AI is primarily targeting
International Skies with negligible presence in domestic territory. Hence the two are not
relevant from competition angle. Though, the state carriers are accused of enjoying
Incumbency Benefits. They enjoyed monopoly gains prior to the 1993 as they were the
sole operators in the Nation. However, even after Deregulation, AI maintains the
exclusive right to fly to Gulf, which is discriminatory, as existent Indian carriers too want
to fly to Gulf Routes seeing the large Volume of Demand for the same. While IA is
deriving its share of incumbency benefits from its Peak slots’ pool.
Secondly, the Jet-Sahara Deal & Kingfisher-Air Deccan Deal:
While J et has taken over 100 % stake in Sahara, Kingfisher has picked up 26 % in Air
Deccan and has intentions of picking up another 20% from an open offer. The J et-Sahara
Deal was announced in 2006 but it took a long time before, things could be finalized. J et
& Sahara share common history. Both began their operations at the same time, both have
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been the only carriers who survived the decade of 90’s.The two carriers essentially have
overlapping route networks. The major problem that arises with this merger is that these
two airlines being the oldest have access to prime slots. Slot constraint is a major entry
deterrent. Post consolidation, there will be Route restructuring to attain maximum
benefits on these prime slots at the major metropolitan airports. The concerns were
expressed when J et announced its desire to take over Air Sahara last year. The takeover
of the user rights might give J et a dominant position. Air Sahara's aviation rights should
not automatically accrue to J et; the latter should instead be required to re-apply for
securing additional rights. The DGCA, as the competent authority should use this
window to re-distribute Air Sahara's rights to all airlines. Had Air Sahara continued and
given the inevitability of its closure, its rights would have anyway got released for
distribution to others, and not available only to J et. The DGCA must take into account
these factors.
The Air Deccan-Kingfisher Deal: What separates this deal from J et-Sahara Deal is that
the merging carriers essentially cater to different class of passengers. While Kingfisher is
a full service carrier, Air Deccan’s Market comprises more of Leisure Travelers whose
elasticity of Demand is essentially very high. Where as J et & Sahara are both FSC. J et
has declared that it will change Sahara to a Value Based Carrier which will essentially be
above the LCC Model but the main question is that post merger, J et has got access to
Sahara’s Frequent Flier’s also. As told as earlier, Frequent Flier’s are essentially business
travelers whose elasticity of demand is very low vis-a-vis Kingfisher & Air Deccan Deal
where in both have agreed to preserve the differences in their Business Model.
Secondly, what separates the J et Deal from the Kingfisher Deal is that J et and Sahara
both used to compete on International Routes Prior to Merger. Post consolidation, now
there is reduction in competition as IA-AI have merged & with J et-Sahara merging, the
effective competition in International Skies reducing by half & with rumours taking
rounds that J et is keen on forging an alliance with Air India for International Operations,
which will further dampen competition. Where as bound by the current regulation,
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Nancy Shah, 30.7.07 89
neither Air Deccan nor Kingfisher qualifies for International Operations there by deriving
the merged entity from an important source of revenue.
However, what binds the J et Deal with Kingfisher Deal is the problem of Overlapping
Routes. Though the country has big enough potential market -over 1.1 billion citizens and
a middle class of over 300 million greater than the entire population of U.S or U.K – to
support a large fleet, the current composition of route networks is overly duplicative with
a few cities being dangerously over served. The concentration of services in major
metropolitan has diminished very slightly but still accounts for 82% of passengers flown
within the country. The most congested Airports being Mumbai; Delhi; Chennai;
Bangalore etc. The most congested route being Delhi-Mumbai .Deccan has achieved its
market share owing to the wide network it has across the nation. It serves around 70
destinations while J et serves only 48.
The trouble plaguing the Kingfisher – J et deal is the fear among the Consumer Groups
who are feeling vulnerable as to that fact that the consolidation would end the days of
Low Fares. It was with Air Deccan’s entry that introduced cheap fares and enabled the
Air fares to match First class A.C Railway tickets. With its consolidation, consumers fear
that prices will rise. Air Deccan initiated predatory pricing by selling tickets for dirt
cheap rates. Other carriers were forced to match its prices in order to be in the industry.
Hence, the entire industry bleeded. Air Deccan’s aggressive pricing strategy helped her
gain market share but at the cost of its profitability. For how long can a company survive
with out funds. Not, much & that is the reason why it went Bankrupt & had to seek solace
with Kingfisher. Prices must represent the true cost structure. Air fares must reflect the
cost of ATF & other operational costs. So on that count if Air Deccan’s Fare rise then its
fair enough. However, in a nation like India where Air Travel is rated to be the most
expensive in across World (after adjusting for Purchasing Power Parity), we definitely
cannot afford higher mark ups. Hence, prices need to monitor to check out for any unfair
practices.
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Factors Considered by the Commission in evaluating combinations & their appreciable
adverse effects.
Under Section 1V of the Competition Act, 2002, the Commission considers some
factors in determining whether a combination would have or is likely to have appreciable
adverse effect on competition in the relevant market. The following factors are
considered for evaluation for M&A:
1. Actual or Potential Level of Competition through imports in the Market:
Prior to the consolidation, the number of players in the domestic market were 10
(including AI with negligible domestic presence). However, post consolidation, the
number of players in the market has reduced down to 7. The HHI (prior to M&A) was
1607 but post consolidation of the three deals namely, AI/IA; J et-Sahara; Deccan-
Kingfisher, it has risen to 2327. The current policy regulation doesn’t allow foreign
airlines to hold a stake in domestic airlines which is depriving the industry from getting
an exposure to the expertise as well as the finance needed by the domestic industry.
Therefore, unlike other Industries where supply can be augmented by importing the
goods which there by countervails the monopoly of the domestic player and helps in
checking such tendencies. The fear of import of external competition is absent for the
airlines industry as no foreign airline can commence domestic operations in India.
2. Extent of Barriers to entry into the market:
As discussed previously under Regulatory Barriers, there exists high entry barriers.
Barriers in terms of high sunk costs; regulatory barriers; predatory behavior by
incumbents etc.
In terms of sunk Costs: Aviation Industry is a capital intensive industry. Costs of
purchase of aircrafts is huge but this to some extent is tide over by leasing of aircrafts.
However, huge amounts are still spent of marketing and promotion of the carriers.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 91
In terms of regulatory barriers, there are a number of regulations barring entry. To name a
few, we have:
a. Operators are required to have a stipulated level of fleet size and subscribed equity
capital. For example, scheduled operators should have five aircraft (by outright purchase
or lease) and a minimum subscribed capital of Rs. 10 crores. (Rs. 30 crores if operators
have an aircraft of maximum take-off mass exceeding 40,000 kg.). However, these
requirements and analysis wrt to min capital requirements must better be left to the
investors including bankers; financial institutions; financial regulators etc.
b. Foreign airlines are not permitted to pick up equity. Foreign financial institutions and
other entities who seek to hold equity in the domestic air transport sector shall not have
foreign airlines as their share holders. As told earlier also, that those interested in airlines
will be airlines only. By imposing a regulation of not allowing foreign airlines to pick up
a stake in Domestic airlines, an important source of competition, finance and expertise is
deprived.
c. A domestic carrier must have flown for at least 5 years before entering the
International Skies. This is acting as an entry barrier as its hindering the new players
from plunging in the international skies. International routes are long haul journeys, they
are very profitable. The current regulation is only favoring the incumbents namely: J et &
Sahara.
d. Route Dispersal Guidelines:
The route dispersal guidelines have contributed to a great extent in reducing the
profitability of the existing carriers. The domestic carriers are forced to operate on
remote, unviable places as part of these guidelines. Hence, the domestic players cut own
on the trunk routes to obey the guidelines. More over, the carriers are not reimbursed for
these unviable operations.
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The regulation of not flying internationally and the obligation to serve category II & III
routes has taken its toll on the profitability of most of the existent carriers. The industry
registered loss worth 500 million USD last financial year. The continuous loss made by
the industry has sent negative impression across the conglomerate of venture capitalists
who are convinced that aviation is not a good investment.
f. Exclusive rights given to the National Carriers to Fly to the Gulf Routes is highly
unfair and is depriving other players of an important source of Revenue.
3. Level of Combination in the Market:
The wave of M&A in the Aviation Industry began with the merger of IA and AI.
Followed by this, was J et-Sahara Deal. Last but not the least, the Indian skies witnessed
the merger of Deccan and Kingfisher. While, the J et – Sahara deal is a 100 % stake in
Sahara Group, the Deccan-Kingfisher Deal forged an alliance to the extent o 26 % in
Deccan by Kingfisher Airlines. Though , rumours are taking rounds that Paramount is in
talks with Go Air and Spice J et for a proposed merger, however none has signed on them
have signed the dotted line so far. So the year, 2007 was the season of Marriages in the
Indian Skies! In the wake of intense competition; predator pricing; continued losses, the
players decided to bring in some rationality in the pricing by agreeing to join hands.
Consolidation if done properly will provide synergy benefits, efficiencies; give critical
mass and eases competitive pressures as the number of rivals in the market has reduced.
4. Degree of countervailing power in the market:
The market comprises of 10 players namely IA; AI; J et; Sahara; Deccan; Kingfisher; Go
Air; Indigo; Spicejet; Paramount. Now there exists no market where either of the carriers
have monopoly on the domestic routes. Maximum number of carriers operate on trunk
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 93
routes. These trunk routes are a major source of revenue for the carriers owing to the
huge demand on these sectors. Indian carriers compete in the same relevant market. This
results in aggressive pricing strategy and low yields. On other routes like category II &
III, there isn’t much traffic and consequently carriers who currently are serving these
routes , subsidizes their operations and sell tickets at throw away prices to fill in as many
seats as possible. So there is a sufficient amount of countervailing power present in the
market in terms of the number of competitors present on the key trunk routes. The current
composition of route networks is overly duplicative with a few cities being dangerously
over served.
However this countervailing power in the market might diminish if relevant market is
defined as the time sensitive passengers who have strict preferences for time and days to
their destination. There can be a situation where the merged entity has prime slots on key
trunk routes. Although, the merged entity still has to face its rival; however, the merged
entity enjoys an undisputed position in some peak slots of the day which may have little
or no competition. So the commission must look into this aspect as the degree of
countervailing power which varies at different time slots, for different cities. Therefore, a
case by case evaluation of the trunk routes must be made.
5. The likelihood that the combination would result in the parties to the combinations being
able to significantly and sustainable increase prices or profit margins.
Acc to the recent CAPA survey presented at the recent fourth annual India & Middle East
Low Cost Airline reported that 67% of the passengers traveling by FSC would travel by
air even if the fare doubled. Also, 50% of LCC carriers shared the same feeling. The
survey was conducted on over 2000 passengers at leading airports like Delhi; Mumbai.
With such kind of market sentiment, carriers are bound to get encouraged to hike the
fares on congested cities seeing the rising demand. Post merger, the prices of Air
Deccan’s tickets has increased on an average by Rs. 300- Rs. 500 plus a congestion cess
of Rs. 150 which is re imposed by Air Deccan. Although a fare hike for Air Deccan may
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be justified as it was badly under pricing its tickets in a bid to gain maximum market
share. However, post consolidation, the hike in fares introduced so far is to ensure that
the company breaks even in the near future.
However, one signal that is clearly sent across the board is that the days of low fares are
now over. Consolidation is expected to bring some rationality in the pricing patterns.
Consumers are definitely not expecting low fares but are at least expecting status-quo to
be maintained. However, post consolidation , with top 3 players pocketing 80 % market
share have good incentives to hike fares by at least 5 % which would not have that much
effect on demand as there exists more than half of the passenger bulk who are willing to
travel by air even if air fares double.
6. Extent of effective competition that is likely to sustain in the market.
One merger in the market was followed by the other. Prior to 2006, there was no News of
mergers’ in the nascent Aviation Sector. However, year 2007 saw three mega mergers all
in a span of 6 months. All most all the carriers are bleeding today. The industry has
registered losses worth 500 million USD. The industry was characterized by the
following: the predatory pricing, the lack of rationality in pricing; new airlines coming up
but none of them have been able to carve a niche; capacity constraints at the major
airports. Most firms are going bankrupt, so in this kind of scenario they had only 2
alternatives, either shut down their business or enter in to a merger with another airline. A
merger would benefit the falling firm in the sense that it will help the merged entity
derive benefits from combined synergies of the two carriers’ networks and save on the
operational costs by sharing of the infrastructure. Merger helps the falling firm buy some
time to re-engineer itself; gets to learn the nitty gritties of the system from its financially
viable counter part. Merger eases competitive concerns. The merging entities are
expected to benefit from consolidation, as it would enable them to undertake network
optimization; operational rationalization & fleet simplifications. Hence, consolidation
was touted to be the need of the hour by the industry honchos to tide over the current
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 95
industry losses. No, doubt Airline is an industry that involves economies of scale and
scope, but how relevant is the falling firm argument. Allowing a merger on the pretext
that in its absence, the firm would have to quit is not compelling as in perennial gale of
creative destruction, those who can’t survive the stormy winds must exit the market
13
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of now, the number of players in the market are seven. However, rumours are taking
rounds that there may be more mergers in store. The authorities as of now have though
denied the link ups of Paramount with Go Air & Spicejet but it can not be surely rejected
in future. If this is the scenario then the market will have only a limited number of large
players. Post consolidation, we already have three big players in the market. Indigo
entered the market with a big bang by placing an order of 100 Airbuses, with passage of
time, it too will become a massive player. The remaining players are small fishes, they
have strong incentives to merge as none of the players have been able to cast a niche for
them selves. CAPA projects that in the near future the Industry might comprise of a few
dominant players instead of the current situation where the market is scattered.
As of now, the number of players in the domestic markets are seven. Airline is any ways
an oligopolistic Industry across the world with little number of players operating. The
current players in the Indian market are sufficient to sustain competition on various
routes as there exists no route where any airline has a monopoly & is capitalizing on it.
However, some carriers may be at an advantageous position registering full load factors
on key routes at peak timings. But more or less, on an average, the Indian aviation sector
has a highly duplicative route network system. There is intense competition on key routes
whereas some routes are badly under served.
7. Market share, in the relevant market of the persons or enterprises in a combination,
individually and as a combination;
The market shares aggregated across all relevant markets are only available at this stage.
However, what is more important is the disaggregated market shares of each player in
13
Schumpeter said this.
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each relevant market which could not be presented due to lack of data. Going by the
market shares of the each carrier, prior to the consolidation market was fragmented with
no player touching the 25 % mark, however, post consolidation, top 3 airlines pocketed
more than 80 % of market shares. The particulars are given below:
Table 3:
Comparison of Market Shares Pre & Post Merger
Pre Merger (Mkt. Share-National)
CARRIERS
(Prior to M&A) MKT. SHARE
J et 22
Sahara 7
Indian 23
Air Deccan 18
Kingfisher 11
Go Air 3
Paramount 2
Spice J et 8
Indigo 6
Post Merger (Mkt Share-National)
CARRIERS
(Post M&A) MKT. SHARE
J et/J et Lite 29
Indian 23
Deccan /Kingfisher 29
Indigo 6
Spice J et 8
Go Air 3
Paramount 2
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Nancy Shah, 30.7.07 97
8. Likelihood that the combination would result in the removal of a vigorous competitor or
competitors in the market
The combination of J et-Sahara has led to merger of FSC Carriers. These two carriers
were the only private carriers who could stand the down turn of late 1990’s. These two
share the same history. They were arch rivals at one time. They shared common history.
Both entered the industry at the same time & began operations as air taxi operators. Post
de-regulation, both entered the scheduled passenger traffic market and are arch rivals
since then. Many airlines came and drowned during the decade of 1990’s .However, these
two airlines survived the turmoil. Sahara has Boeing fleets which complements J et’s
existing Boeing fleet of aircrafts. The merger of the two oldest private carriers is
expected to solve the problem of overly duplicative network & rationalize routes. Both
the merging entities are full service carriers, however, in the wake of rising popularity of
LCC , the decision has been made by the J et Group to make Sahara as a value based
carrier which would essentially operate on LCC model. Similarly, following the
acquisition of 26% stake in Kingfisher, the group announced that it would let Air Deccan
operate on the LCC model only. Like Sahara, Deccan too was effective competitors to all
the niche players. It was the first LCC of the country, it introduced cheap fares and
triggered price wars. With in a matter of few years, it managed to be in the list of the top
three players. Deccan’s prices were dirt cheap and forced the other players to pass on the
benefits to the consumer. With exit of Deccan’s aggressive pricing strategy post take
over, many industry people are taking a sigh of relief as they expect some rationality &
stability to come in terms of prices. Deccan, India’s Pioneer LCC ever since its inception
has kept other carriers on their tows. So in a nutshell, absorption of Sahara and Deccan
has deprived the Industry of two strong potential competitors.
9. Nature & Extent of Vertical Integration in the Market.
This is one sector where vertical integration is difficult to forge. Airports are now getting
privatized, in future a situation may arise where the partial owners of airports pick up a
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stake in the airlines. This might pose a threat to the other carriers. However, such a
possibility is rare. The second issue that arises is with reference to Maintenance & Repair
Issues. It is mandatory for aircrafts to under go aircrafts maintenance checks every day,
fortnights, monthly and evenly yearly basis. Indian is trying to enter in a J V with
Lufthansa Technik, an MRO in association with Hyderabad International Airport.
Similarly, J et is in talks to open its independent MRO facility to service its fleet of 141
aircrafts in service & on order. The other complementary inputs might include take-offs
and landing slots; air traffic control services; passenger handling facilities; baggage
handling facilities ; refueling; maintenance; ;clearing and catering services & so on.
However all of the above are under regulatory regime either the AAI or DGCA or BCAS.
Therefore, with reference to the vertical integration, not much scope lies.
10. Possibility of failing firm:
The recent mergers have been approved by the industry sources blindly based upon the
falling firm argument. Most of the existing players have not been able to break even and
running into huge losses. The loss making enterprise would have no alternative than to
die in absence of mergers. The alarm bells for Sahara & Deccan had been rung; the two
carriers were in neck deep debt & badly needed an investor to bail them out. Given that
most of the players in the Indian Markets are not able to break even & sustain the
benchmark revenue per aircrafts compared to the global standards barring a few domestic
players
14
. So possibility of falling firm was & is still very high.
11. Nature & Extent of Innovation:
The domestic carriers don’t have much scope for Innovation barring a few. In an attempt
to woo the passengers, some carriers have introduced schemes like Web-Check In; access
to airport lounges in case of delays; a 24 x7 customer support center; in flight
entertainment such as access to television; radio; availability of tickets at convenient
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 99
retail outlets such as petrol pumps; cyber café’s apart from the travel agents; providing a
pick & drop facility etc. Carriers in a bid to woo passengers are attaching more & more
frills to make themselves more popular with the travelers.
12. Relative advantage, by way of contribution to the economic development by any
combination having or likely to have an appreciable adverse effect on competition.
The appreciable advantage that the mergers have is that it will replace the duplicative
capacity from the system. To support a large fleet, the current composition of route
networks is overly duplicative with a few cities over served. The metropolitan passengers
still account for 82 % of the passengers flown every year.” The only realistic cure for
profit cutting over capacity will be for carriers to either exit or merge”, according to
CAPA. The removal of duplication will help the carriers focus on other routes. So
mergers are touted to be an attempt made towards right sizing .The merging firms are
likely to benefit from the merger by capitalizing from the joint synergies of operation;
sharing the infrastructure etc. Kingfisher expects to save Rs. 300 Million post merger.
The merged entities have route, network & fleet rationalizations on their agenda to derive
maximum benefit from consolidation. So the merger will benefit the industry as it will
help the carriers avoid duplicative networks, save on a lot of operational costs; network
rationalization will help the merged business spread its wings to other routes; increase
frequency of International flights.
13. Whether benefits of the combination outweigh the adverse impact of combination, if any:
The recent wave of mergers have their pros &cons. Pros in terms of the efficiency gains
as mentioned above and cons in terms of the likely anti-competitive impact the proposed
merger might or is likely to have. The chances of price increase; enhanced chances of
14
Refer to APPENDIX-III for benchmark levels of Revenue / aircrafts.
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collusion & restraint on new entry are some of the harmful effects. The commission must
evaluate the merits & the demerits of the mergers on a case by case basis.
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Nancy Shah, 30.7.07 101
SECTION X
CONCLUSION
10.1 The Indian aviation sector has witnessed tremendous growth in the recent
years driven by a combination of macroeconomic; demographic; government reforms and
market lead dynamics. Ever since 2003, growth had witnessed tremendous increase post
arrival of LCC’s. Hence if the current growth trajectory is to be preserved, it is very
important that competitive forces must continue to operate in the system.
There are some factors intrinsic to the aviation industry that are anti-competitive. For
example: Frequent Flier Programs which airlines use to discriminate between the leisure
travelers and business travelers. The business class is a huge attraction for the FSC as
they have very low price elasticity of demand, which the carriers want to capitalize on.
Similarly other loyalty programs include Travel Agent Incentive Schemes where by the
commission given to the travel agents are tied to the sales of that Carrier.
10.2 Price transparency in the system of fare declaration is both a boon as well as a
bane. A bane as it enhances chances of collusion. Parties entering in a collusion find it
easy to ensure cooperation as the follower will implement the price increase only after
seeing the leader make the agreed changes. If any one deviates then the other airline can
at a very short notice revert back to the original prices without bearing much cost. So it’s
a win –win situation.
10.3 Slot constraint is another problem constraining new entry. Landing & take off
rights are referred to as Slots. These slots are an important consideration for an entrant as
peak timed slots register higher passenger load factors as compared to the oddly timed
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slots. The capacity of airports is fixed. The supply of airports cannot be immediately
increased in face of rising demand, hence arises scarcity of infrastructure.
10.4 There are some regulatory barriers inherent in our domestic air transport
policy are constraining new entry & having anti-competitive effects. The regulations
governing minimum fleet size; minimum equity requirements; route dispersal guidelines;
min fleet & experience requirement of 5 years for International Operations; exclusive
right to National carriers to fly to Gulf Routes etc are constraining new entry &
strengthening incumbents position.
10.5 The year 2007 was the year of M&A in the Indian Skies. Post consolidation
IA-AI; J et-Sahara ; Kingfisher-Deccan, these top three players have pocketed 80% of
Market Shares .While the industry sources favored these mergers as they believe that
these mergers will benefit the already bleeding Industry . It’ll help to bring in some route;
network & fleet rationalization. The merged entities are expected to benefit from joint
operations & would share synergies of joint operations. The network served is highly
duplicative i.e. few metropolitan cities being dangerously over served. The consolidation
according to Industry sources would help to bring in some rationalization in routes &
help carriers focus on other routes. However, equally justified are the consumer groups
who are fearing that post consolidation prices may rise. The frenzy among consumer
groups was more in case of Kingfisher – Deccan Deal as Deccan initiated the low fare
war. With its consummation, consumers fear a price rise may soon be on cards.
10.6 All three M&A very well come under the lens of the Competition
Commission of India’s lens as they meet the benchmarks standards laid down by the
Competition Act, 2002 with regard to Regulations of M&A. As far as IA-AI Merger is
concerned it doesn’t pose much problem from competition angle as the merging entities
have complementary networks with AI having International presence with negligible
domestic presence and IA having heavy domestic presence with negligible international
presence. However, the exclusive rights to fly to Gulf routes are unfair as its depriving
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Nancy Shah, 30.7.07 103
the other domestic players from an important source of revenue. Consumers too don’t
have much option w.r.t. mode of transportation & the choice of the carrier.
10.7 The J et-Sahara Deal took a long time to materialize until 2007 when J et
signed on the dotted paper & agreed to take over 100% stake in its arch rival, Air Sahara.
The two carriers share the same history, both began their operations as air taxi operators
& later became full service carriers. J et & Sahara were the only two private airlines that
could stand the decade of 90’s. With the take over of Sahara by J et, some important
issues over competitive concerns need to be addressed. J et and Sahara have peak slots
available on all major metropolitan airports at peak timings. As defined earlier in the
report that Relevant Market in our analysis is a city pair market, on a particular day, at a
particular time. Hence peak timed slots are a major determinant of profitability.
Concerns had been expressed last year when J et announced its plan to take over Sahara.
Air Sahara's rights must be re-distributed to all airlines in order to prevent J et Airways
from attaining a dominant position in slots as this would restrain growth of competition.
Air Sahara's aviation rights should not automatically accrue to J et; the latter should
instead be required to re-apply for securing additional rights. The DGCA, as the
competent authority should use this window to re-distribute Air Sahara's rights to all
airlines. Had Air Sahara continued and given the inevitability of its closure, its rights
would have anyway got released for distribution to others and not available only to J et.
The DGCA must take into account these factors. What further adds salts to the wounds is
that J et & Sahara both are Full Service Carriers. Post consolidation, J et along with the
User rights would also take over Sahara’s Frequent Flier’s. As mentioned earlier, FFP’s
are a tool which airlines use to discriminate between business travelers & leisure
travelers. Business travelers have low price elasticity of demand as compared to leisure
travelers. It is this weakness that the carriers try to capitalize via such loyalty programs.
10.8 Another important issue that needs to be highlighted is that post J et-Sahara
Deal & IA-AI deal , the number of players serving the International Routes has reduced
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to half as no other domestic player is eligible for flying Internationally as per the current
regulatory framework. Though the later entrant have given the incumbents a run for their
money & have taken away a major chunk of domestic market share from these
Incumbents by matching their networks and services but they are still barred from joining
the International Skies. Ever since 2003, post their entry in the Aviation Sector, benefits
have trickled down to the consumers in terms of low fares. What is even more
disheartening is that new International players with scanty fleet size & minute experience
are allowed to operate in & out of the country but ironically the domestic players who are
much better in terms of safety, experience are barred from flying the same International
Routes.
10.9 The Kingfisher-Deccan Deal was plagued with a lot of hue & cry coming
from various industry groups post consolidation as the consumers are feeling vulnerable
& expect that fares may rise in future. The merging carriers i.e. Kingfisher – Deccan have
over lapping route networks they essentially cater to different set of consumers. While
Kingfisher is a Full Service Carrier, Deccan essentially caters to the leisure travelers with
its Low Cost Model. Air Deccan triggered price wars in the Indian Skies which forced
other players to match Air Deccan’s prices. The consumers benefited while carriers lost.
Air Deccan gained market share but at the cost of profitability. Post its consummation,
industry sources expect some rationalization in pricing strategy. The rise in current fares
will be justified as long as they reflect the true cost of ATF Fuel & other operating
expenses. However, what a country like India where air travel is rated to be the most
expensive across the World is any further mark ups.
10.10 Post consolidation, with top 3 players have more than 80% of market share, so
chances of cartelization are enhanced with the industry getting consolidated. Such
attempts have been made in the past.. FIA-Federation of Indian Aviation was set up in
2005 by top airline industry honchos to voice their needs to the government. Among its
first meet, the federation had thought of discussing pricing issues. However, this was
aborted by timely intervention of CCI. However, such attempts can be made again as
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Nancy Shah, 30.7.07 105
cooperation is more easy with the industry getting consolidated. So CCI must keep an eye
on such instance of price coordination.
APPENDIX I :
Domestic Carriers- Current & Fleet on Order Status
Table 4
Airline
Current
Fleet Fleet on Order
Indian 73 43
J et 58 40
Air India 45 68
Air Deccan 40 90
Air Sahara 28 10
Kingisher 22 84
Spicejet 9 20
Go Air 7 20
Indigo 5 95
* As on May Source: ASSOCHAM
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APPENDIX II:
Fig 5
Comparison of Revenue per Aircraft of the
Domestic carriers with the Global Standards
APPENDIX III:
The Hub-Spoke Network:
There are important economies of both scale and scope in the airline industry. Travelers
prefer “seamless” connections and more frequent services. In the presence of loyalty
schemes such as frequent-flyer programs, many travelers also prefer networks that serve
a larger number of destinations. Larger airline networks organized in the “hub and
spoke” form can take advantage of cost economies and can offer more seamless
connections, more frequent services and a greater range of destinations than can smaller
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airline networks, making their networks more attractive, especially to full-fare paying
passengers.
An airline hub is an airport that an airline uses as a transfer point to get passengers to
their intended destination. It is part of a hub and spoke model, where travelers moving
between airports not served by direct flights change planes en route to their destinations.
Some airlines may use only a single hub, while other airlines use multiple hubs. Hubs are
used for both passenger flights as well as cargo flights. Many airlines also utilize focus
cities, which function much the same as hubs, but with fewer flights. Airlines may also
use secondary hubs, a non-technical term for large focus cities.
The effects of hub-and-spoke operation on operating costs can easily be illustrated.
Suppose an airline provides air services between a set of 6 cities. In the absence of
economies of scale, the airline could provide these services with direct connecting flights
between each pair of cities (serving n (n-1)/2 routes) i.e. 15 routes However, if there are
no economies of scale and if some of the routes do not generate sufficient traffic to allow
operation at the minimum efficient scale, total unit costs can be lowered by reducing the
number of routes, increasing traffic on the remaining routes. In fact, the same 6 cities,
with no loss in services, can be served with just 5 routes, reducing the total number of
routes served and increasing the average traffic on each route by a factor of 3. This is
illustrated as follows:
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Point-To-Point Network Hub-and-Spoke Network
15 distinct routes served 5 distinct routes served
Even where there is enough traffic on a route for the minimum efficient scale to be
obtained, hub and- spoke operation may allow an increase in the frequency of flights
(and therefore an increase in the overall level of demand) without any one flight
dropping below the minimum efficient level of traffic. In addition, hub-and-spoke
operation may allow service to be provided to airports for which the volume of traffic
to any other single city would be insufficient (under point-to-point operation) to
justify service. All major airlines now have one or more hubs at which many of their
long-distance passengers change planes. This approach has allowed carriers to fill a
higher proportion of the seats on their planes and to increase flight frequency of non-
stop routes between their hubs and other airports.
Large networks enjoy both cost and demand advantages over smaller networks (although
these advantages can sometimes be offset in part by carriers that have substantially lower
operating costs). Travelers prefer connections between flights of the same airline to
flights between distinct airlines, because “seamless” connections are typically more
convenient and offer greater security in the event of delays on the incoming or outgoing
flights or in the event of lost luggage. Travelers also prefer airlines with more frequent
service, because they offer enhanced travel flexibility in the event of a last-minute change
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Nancy Shah, 30.7.07 109
of plans. Airlines also enhance demand for their services through loyalty programs, such
as frequent flyer programs or travel agent commission override programs, which provide
incentives for travelers and travel agents to focus their bookings on a single airline. Such
programs benefit larger airline networks more than smaller airline networks. These
programs are especially targeted at attracting and retaining high-margin time-sensitive
business travelers. Larger networks can also exploit to a greater extent the “hub and
spoke” form of organization. Hub and spoke operation allows an airline to concentrate
traffic on certain routes, allowing both larger, more efficient, planes and more frequent
service. In addition, hub-and-spoke operation allows for a greater range of destinations
and city-pair combinations to be served, including city pair combinations, which would
not normally generate enough traffic to justify a regular service. The addition of a new
spoke to a hub-and-spoke network significantly increases the city-pair combinations
served by the network, at a minimal additional cost. There are limits to hub-and-spoke
operations. The efficiencies of hub and spoke operation derive from converting a large
number of point-to-point flights into a smaller number of connecting flights via one or
more hubs served by larger, more efficient planes. But connecting flights are not a perfect
substitute for non-stop flights. Pressures towards hub-and-spoke operation are strong, but
there are also offsetting cost and demand factors. Although hub-and-spoke operation
lowers unit costs by increasing load factors, it also increases the distances, raising the
cost and the time taken for the average journey. Now, for time sensitive passengers a
connecting service (through a hub) may not be an adequate substitute for a nonstop
service. So most networks are likely to combine some aspects of both hub-and-spoke and
point-to-point operations. . At first sight it might be thought that the cost advantages that
arise from hub-and-spoke operation imply that a larger network has a cost advantage over
a smaller network or a point-to-point operator, on the basis that smaller (e.g., point-to-
point airlines) cannot benefit from the feeder traffic which maintains load factors and cost
efficiencies on trunk routes. But this argument is incomplete. Since passengers can
change airlines as well as planes at a hub airport, a point-to-point airline could still
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benefit from feeder traffic supplied by other airlines operating other spoke routes into and
out of the hub.
Competing airlines on a spoke route get little benefit from the feeder traffic flowing into
and out of a hub, and they typically cannot offer a loyalty program or flight frequencies
to match that of hub operators. As a result, rival airlines are unable to capture a
proportionate share of the higher margin time-sensitive passengers, which are necessary
to sustain the service. For these reasons, well-developed hub-and-spoke airlines tend to
be dominant on non-stop spoke routes. For the same reasons routes between two
networks’ hub airports tend to be dominated by the networks operating the hubs at each
end. When Northwest proposed the acquisition of a controlling stake in Continental, it
was found that they jointly held a market share of 100 percent on seven of the nine routes
between their respective hubs.
There are three possible sources of such Cost Efficiencies. These are:
•First, the spoke routes in and out of a hub are complementary inputs in the provision
of end to- end transport services. Spoke routes are therefore in a vertical relationship to
one another. If competition on each spoke is less than perfect, the airlines operating each
spoke will mark up prices above marginal cost. These mark-ups accumulate, leading to
the problem known as “double marginalization”. Vertical integration can eliminate this
inefficiency;
• Second, a traveler may be subject to delays or problems for a variety of
unforeseeable reasons, such as weather or overbooking. Where the travel involves several
different segments, a delay or unforeseeable event on one segment will lead to problems
making connections on other segments. Where the segments are operated by independent
airlines the traveler may face higher costs or difficulties completing the travel. In
addition, individual airlines may not take into account the effects that overbooking will
have in disrupting bookings on future segments. Alliances between the airlines can
ameliorate these problems. Vertical integration lowers these transactions costs associated
with providing a “seamless” end-to-end service desired by travelers;
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 111
• Third, co-ordination of flights, gates, arrival and departure times necessary to
provide an efficient hub-and-spoke service may require relationship-specific investment.
The provision of an efficient hub-and-spoke system requires relatively close co-
ordination at the hub. Arriving flights must be timed to co-ordinate with out-going
flights. Incoming flights must arrive at gates, which are in relatively close physical
proximity to out-going flights. Baggage from the incoming flight must be efficiently
interlined to the outgoing flight. Coordinating airlines must therefore make certain
relationship-specific investments. Having made these investments, the airlines are
exposed to strategic behaviour by the other airlines, again raising transaction costs. These
issues can be resolved through detailed long-term contracts or through vertical
integration. As a result of these effects, there are distinct cost efficiencies (i.e. economies
of scope) in hub operations.
15
Implications of Hub-Spoke Network:
1. Due to the economies of scope, non-stop competition may not be sustainable on spoke
routes (except non-stop routes to another network’s hub, which may be served by the
networks at both ends). Consider competition on the route A-B in the following network
in which B is the hub and the incumbent network also services C, D and E:
15
Brueckner and Whalen (1998) find that transatlantic routes involving several legs
are 18-28
percent cheaper when provided by a single network than when the same route is
provided by two or more non-aligned carriers.
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A stylized hub-spoke network
The economies of scope identified earlier have a number of effects on competition in the
route A - B:
• The cost-side economies of scope imply that the incumbent airline has a cost
advantage in the provision of connecting services A-B-C, A-B-D and A-B-E.
(Specifically, for flights in either direction on these routes, the incumbent airline can
eliminate the double marginalization problem and better co-ordinate the arriving and
departing flights to provide seamless operation). With this cost advantage, the incumbent
will be able to price the connecting services in such a way as to ensure that it captures all
the connecting or “feeder” traffic. If the incumbent can cut off the competitor from the
feeder traffic, the competitor is restricted to only A-B traffic (so-called “local” traffic). In
some cases the local traffic alone may be insufficient for the entrant to sustain a viable
service. Even where there is sufficient traffic to sustain a stand-alone service, the entrant
will not have the same total traffic volumes and will be unable to match the flight
frequency of the incumbent;
•Even if there is sufficient local traffic to sustain some A-B flights, the benefits of the
loyalty programs give the incumbent airline a strong competitive advantage in flights
originating at B, especially among frequent-flying high-margin travelers. As a result the
incumbent can offer a more attractive service simply by matching the price offered by the
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 113
entrant. Conversely, the entrant will need to offer a sizeable discount below the
incumbent to attract a sufficient volume of traffic. In the most extreme case, the entrant
will attract little of the traffic from B to A, thereby raising its average costs for the A-B
round-trip service.
Competition will be sustainable on the A-B route in the event that either (i) the
competitor airline has significantly lower costs than the incumbent, or (ii) the competitor
offers a significantly different product than the incumbent (differentiating itself in some
other way) or (iii) A is a hub for the competitor airline, giving it a degree of
countervailing power against the incumbent airline.
This analysis suggests the following three predictions:
•First, an airline is likely to fly a large proportion of all the non-stop routes flown out
of its hub(s). This is confirmed by the trend towards single-airline dominance of airports.
“As airlines have moved from a linear route structure to a hub-and-spoke method of
delivery, many airports have become dominated by a single carrier. In nine of the top 25
airports, the dominant carrier is responsible for over 50 percent of the enplanements at
the airport.”
16
•Second, airline networks are likely to be dominant and to enjoy market power on
non-stop routes originating or terminating at their hubs. Studies show that incumbent
airlines charge more than rivals do on flights to and from hub airports, suggesting that
incumbent airlines enjoy market power on nonstop routes to and from their hub.
Borenstein notes: “It has been clearly and frequently demonstrated that average prices for
local traffic at concentrated airports are significantly higher than prices on other routes
17
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Evans and Kessides agree: “[A] carrier that dominates traffic through a city tends to
16
Evans and Kessides (1992), page 463.
17
Borenstien (1989), GAO (1990),DOT(1990),Berry(1990 b), Abramowitz and Brown (1990),Evans
and Kessides (1992).
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receive significantly higher prices on trips beginning or ending in that city. This result
has now been replicated in a number of studies. … The dominant firm receives a 4.7 to
16 percent price premium on traffic originating or ending at the dominated city. This
price effect is significantly larger than any price increase caused by a lack of potential or
actual competition that we estimated at route level.”
•Third, hub-hub routes (routes from one network’s hub to another network’s hub)
are likely to be served predominantly or exclusively by the networks at each end. In this
case, both networks are likely to enjoy market power on these routes.
Borenstein notes: “The hub-and-spoke networks have evolved to the point where one
airline will generally fly to another airline’s hub only from its own hub. United, for
instance, offers non-stop service to Atlanta – Delta’s major hub – only from Denver,
Chicago-O’Hare and Washington-Dulles – three of United’s four largest hubs. The
markets for travel to and from hub airports tend to be more concentrated than at non-hub
airports”. “Effective new entry for the provision of non-stop service in the hub-to-hub
markets is unlikely by any carrier without a hub at one of the endpoints of the city pair. A
hub carrier has significant cost advantages over a non-hub carrier attempting to offer
service originating at the hub airport. Building a competing hub in the same city would
require considerable time and investment and is not likely to occur in response to fare
increases in the hub-to-hub markets.
New entry is also impeded by other factors, including difficulty in obtaining access to
gate facilities; the effects of travel agent incentive programs offered by dominant
incumbents; frequent flyer programs; and the risk of aggressive responses to new entry
by the dominant incumbent carrier serving a particular market”. For example, Northwest
Airlines operates hubs at Detroit, Minneapolis and Memphis. Continental operates hubs
at Newark, Cleveland and Houston. There are, therefore, nine hub-hub routes. The
market share accounted for by Northwest and Continental is no less than 100 percent on
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 115
seven of these nine routes. On the remaining two routes the market share of Northwest
and Continental combined is 94 percent (Detroit-Cleveland) and 87 percent (Detroit-
Newark). These three predictions summaries key features of the nature of competition
between airline networks.
Hence, Feeder flights to and from a hub are complementary to the services of the airline
operating the hub. To avoid double marginalization and to promote needed relationship-
specific investment, these services are usually more efficiently provided when integrated
with the hub airline. As a result hub-and-spoke airlines tend to be dominant at their hub
airports, holding a large share of the total passenger traffic. Studies show that incumbent
airlines charge more than rivals do on flights to and from hub airports, suggesting that
incumbent airlines enjoy market power on nonstop routes to and from their hubs.
As an aside, it is worth remembering that the fact that competition is limited on non-stop
spoke and hub-hub routes does not mean that competition is necessarily limited over
connecting flights over the same or other routes. In fact, such competition can be intense.
New entry can, in some circumstances, erode this market power. One entry strategy is to
introduce services from existing network hubs or from new entrants that can form
alliances with existing networks. British Midland, for example, has signed a series of
non-exclusive code sharing agreements with almost all-major US airlines.
A second entry strategy is to offer a differentiated service that avoids direct competition
with the incumbent. In the UK, for example, a number of budget carriers have established
successful services carrying point-to-point leisure travelers within Europe, often focusing
on lesser-utilised airports. Virgin has focused on routes with a high level of point-to-point
business and leisure travelers.
A third entry strategy involves providing services that are complementary to the
incumbent, such as spoke services. Because of the advantages of providing such services
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in a manner integrated with the activities of the incumbent, such services are typically
provided under some form of arrangement with the incumbent, such as a franchise. This
last strategy, although enhancing the range of services available, provides no competitive
pressure on the incumbent.
2. There are strong incentives for mergers and alliances between airlines. Depending on
the nature of competition between the networks prior to the merger, a merger or alliance
can allow the merged airline to lower costs and enhance demand for its services by
rationalizing hub-and-spoke structure(s), achieving greater cost efficiencies and offering
a greater range of seamless connections. On the other hand, a merger or alliance will
reduce competition and could enhance market power on routes where the networks had
previously overlapped, especially on spoke and hub-hub routes.
An alliance or merger of two hub-and-spoke networks has three broad effects:
First, a merger will typically yield cost efficiencies. There are two forms of these cost
efficiencies - the first comes from the rationalization of the network, and the second from
the cost economies of scope that arise at a hub. The greatest opportunity for
rationalization arises when the networks overlap in the markets they serve. In this case,
the merger will allow a strengthening of the hub spoke arrangement by a re-focusing of
the flights on the existing hubs, a reduction in the number of nonstop flights and an
increase in the traffic density (and flight frequency on the overlapping spokes). This is
illustrated in the following diagram. Prior to the merger there are two fully overlapping
networks centered on different hubs. The merger leads to a rationalization and a single-
hub operation:
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Nancy Shah, 30.7.07 117
The anti-competitive effects of a merger, on the other hand, depend upon the extent
of overlap of the networks, or more precisely, the number of markets that the
networks were both serving (or may have both served). In addition, a merger will
have the effect of enhancing the demand for the network. This can increase the market
power of the network, especially at its hub airports and especially when the merger
increases the range of services available from a hub.
Case I:
The most straightforward cases to consider are those where the two networks do not
overlap in the markets they serve (except, perhaps, on the hub-hub route between the
networks) and the two networks are not potential entrants into each other markets. This
situation arises in international airline alliances, where international regulatory
restrictions prevent the two networks from competing. In these cases the alliances can
yield efficiency gains in the form of enhanced operation. These gains must be considered
alongside the anti-competitive effect of a reduction in competition on the hub-hub
route(s) and the anti-competitive effect of an enhancement of the demand for the network
as a whole.
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Case II:
Slightly more difficult are cases in which the two networks do not overlap but share a
common hub. In these cases, the merger can yield significant efficiency gains. These
gains need to be considered along with the anti-competitive effect of the increased market
power of the merged airline at its hub.
A study by Kim and Singal of all airline mergers in the US between 1985 and 1989
found that on non-overlapping routes which share a common hub, the efficiency effect
dominates: a merger of two solvent firms serving those routes leads to a decline in prices
of 11 percent on such routes. Borenstein finds that, in the case of the October 1986
merger of Northwest and Republic, prices in and out of the hub they shared
(Minneapolis) rose by 11 percent faster than the national average from the year before the
merger to the year after. The largest price increases occurred on routes where the two
merging airlines had been the only competitors, increasing 23 percent faster than the
national average.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 119
Case III:
More difficult still are those cases in which the two networks overlap. In this case the
efficiency benefits of the merger can be significant due to the rationalization of the hub-
spoke system. However, the merger can also reduce competition in many markets. These
mergers present the greatest problems for competition authorities. The Kim and Singal
study found that in the 1985-1989 period, on average the market power effect dominated.
Prices rose by an average of almost four percent on overlapping routes. Interestingly, the
Kim and Singal study also found that prices rose on non-overlapping routes, due, perhaps
to a reduction in potential competition, or an increase in multi-market contact.
Conclusion:
There are important economies of both scale and scope in the airline industry. Travelers
prefer “seamless” connections and more frequent services. In the presence of loyalty
schemes such as frequent-flyer programs, many travelers also prefer networks that serve
a larger number of destinations. Larger airline networks organized in the “hub and
spoke” form can take advantage of cost economies and can offer more seamless
connections, more frequent services and a greater range of destinations than can smaller
airline networks, making their networks more attractive, especially to full-fare paying
passengers. Carriers that have significant operating cost advantages, both network
carriers and point-to point carriers, have been able to compete successfully with larger
networks in a few markets. As a result of the above-mentioned cost and demand factors,
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hub-and-spoke airlines tend to be dominant on spoke and hub-hub routes, and jointly
dominant (with the corresponding rival networks) on routes to and from other networks’
hubs. Hub-and-spoke airlines tend to enjoy market power on non-stop routes to and from
their hubs. In addition, there is a tendency for airlines to have a high share of the total
traffic at their hub airports.
New entry to erode this market power is difficult. Successful new entry has occurred from
rival networks (or virtual networks), from new services that are sufficiently differentiated
to avoid head-to-head competition, or, in a few city pairs, from carriers that have
substantially lower operating costs.
Airline mergers and alliances can allow airlines to lower cost and enhance demand by
rationalizing the combined networks, and expanding the scope of seamless service. On
the other hand, airline mergers and alliances can reduce competition and enhance
market power, especially on non-stop routes to and from hub airports. The relative
balance of the efficiency benefits and the competition effects depends on a number of
factors, including the degree of overlap in the airlines’ networks prior to the merge.
International or cross-border mergers are typically prevented by domestic rules
prohibiting foreign ownership. In such circumstances, airlines forge international
alliances, which seek to capture some of the benefits that would normally be achieved
through merger. Alliances differ in the depth to which they try to co-ordinate the
activities of the member airlines. An alliance may not be as efficient as a full merger –
the transactions costs are likely to be higher and joint investment (fearing hold up or the
break-down of the alliance) is likely to be lower. Nevertheless, a carefully worked-
through alliance could approach a full merger as regards both "pro" and anti-
competitive effects.
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Nancy Shah, 30.7.07 121
APPENDIX IV:
Methods for Allocation of Slots
The literature is full of different Methods of Slot Allocation. However, none of them are
free from cons.
1. Trading of Slots:
In theory, the existence of a buy/sell market for slots should create a market price that
results in an efficient allocation among users. No matter how slots are distributed
(including a government giveaway to market incumbents), as long as a secondary market
exists and transaction costs are low, slots should be bought and sold until each finds its
highest valued use. In practice, as validated by U.S example that the, slot market did not
result in an efficient allocation among incumbents, nor did it facilitate competitive entry
in the constrained airports. The secondary market never became sufficiently liquid to
achieve these results as it lacked transparency.
Transparency in the market for slots is one reason the secondary market never became
sufficiently liquid. Transparency means that the identity of buyers and sellers is widely
known. Transparency in the secondary slot market permits strategic purchases by
incumbents to prevent new entry. An incumbent carrier holding slots probably would
never knowingly sell to an entrant that was likely to compete against it, given that such a
sale would likely decrease the slot holder’s profitability. More importantly, a potential
entrant would have equal difficulty buying from other slot holders. Because the rents
from limiting competition almost always exceed the more competitive rents an entrant
would earn, the threatened incumbent should be willing to outbid the entrant, even if it
would use the slots in an economically less efficient manner. Strategically purchasing
available slots can be an effective entry deterrent, especially since multiple slot holdings
required for significant entry rarely come up for sale.
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Another reason the secondary slot market never became sufficiently liquid is that the
initial allocation of slots (made by FAA
18
) gave the bulk of all slots to incumbent
carriers. This allocation gave those carriers much larger market shares in slots than any
other carrier could obtain, and effectively limited the amount of competition other
carriers could offer on at least some routes. For those incumbents with extensive
operations at an airport, any slot they sold would have almost certainly been used to
compete with them on some route. Therefore, the incumbents were unwilling to sell slots
to potential competitors, making the bulk of slots unavailable to others.
2. Congestion Pricing
Under a congestion pricing system, the existing slot allocation system would be abolished
in favor of congestion fees set for particular times. Airlines currently pay weight-based
fees for landing. The consequence of the weight-based fee structure is that a small
regional jet, which causes just as much airspace congestion as the largest 737, pays
a much lower landing fee than the much larger plane. Airlines thus do not face a price
that reflects the fact that airspace is a scarce input. If airlines were charged a flat landing
fee based upon demand at particular times of day, regardless of the size or type of plane,
smaller aircraft such as regional jets would appropriately have to bear a higher per-
passenger cost for using an airport’s scarce landing capacity than they do now. Regional
jets would continue to be part of the airport’s mix of aircraft, but at the margin where
airlines are choosing between larger jets and regional jets, larger jets operating slightly
less frequently will become a more attractive option than scheduling multiple trips on
regional jets. The result would be an increase in passenger throughput at capacity-
constrained airports. The advantage of congestion pricing is that it is relatively easy to
implement. The regulator would set prices for slots at different times and airlines would
set their quantities accordingly. If the prices are initially too low, then the congestion
prices can be raised over time to ration demand. A uniform fee for landing at a particular
time would reduce the congestion bias caused by the current system of weight-based
18
FAA-The Federal Aviation Administration (FAA) is an agency of the United States Department of
(footnote continued)
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 123
landing fees. Although congestion pricing is likely superior to administrative allocation, a
drawback to congestion pricing is the regulator’s lack of knowledge about what price to
set. A regulator may not have good enough information to allow it to set the right price
without frequent experimentation. Even that mechanism may have problems because the
necessary feedback for quantity adjustment may be slow. In particular, airlines often
advertise service well in advance so as to schedule and make ground facility
arrangements efficiently. This, in turn, implies that adjustments based on the changing
price of arrival authorizations may be slow. For highly congested airports, the cost of
setting the wrong price and getting too much (or too little) airline traffic may be high.
3. Slot Auction
A slot auction would allocate scarce arrival authorizations through a periodic open-
bidding mechanism.
A well-designed slot auction would both assign prices to allocate efficiently scarce
airport resources, and limit the maintenance or accumulation of market power by
individual carriers. Such goals require careful attention to the details of auction design.
For instance, the auction should limit informational feedback during the auction itself.
Bidders might know the aggregate level of demand and supply of all arrival
authorizations in each time period, but not be permitted to know the identity of the other
bidders. This practice is fairly typical at auctions and is designed both to limit collusion
among bidders and to prevent strategic bidding. Although more information allows more
informed bidding on the part of bidders in ways that can be efficient, full knowledge of
which airlines are bidding for which slots in an auction could encourage incumbent
airlines to attempt to foreclose entry by particularly strong competitors. In this case, the
government’s interest in preserving competition among carriers should take priority over
bidders’ desires to have complete information about rival bids.
Transportation with authority to regulate and oversee all aspects of civil aviation in the U.S.
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Any auction design must allow for sufficient liquidity so that potential entrants are not
unnecessarily impeded. Annual auctions of a significant portion of airport arrival capacity
(20%, for instance) would help allow for rapid entry when it is efficient. Such as a five-
year rotation would provide a concrete duration for the property right, and therefore assist
airlines in valuing the slots. A switch to a market-based mechanism for allocating arrival
authorizations will not by itself achieve the twin goals of reducing congestion and
encouraging more competitive outcomes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 125
BIBLOGRAPHY:
1. Airlines Mergers & Alliances: OECD Document, 2000.
2. Indian Civil Aviation Industry: Road Map for Growth by ASSOCHAM in
association with Ernst-Young, 2007.
3. Background Note for the Economic Editor’s Conference Organized by PIB on
16-18th Nov. 2005 On Latest developments & policy initiatives relating to the
Ministry of Civil Aviation.
4. Aviation Analyst, Asia Pacific; CAPA Journal. Issue: 77; May, 2007.
5. Indian Aviation – A good Investment by Andrew Miller, CAPA Consulting;
Aviation & tourism Summit, 2007.
6. Chicago Beyond Open Skies, European Commission Paper, Dec 5-7, 1999.
"Global Airline Industry Competition and Service Adequacy in an Open Market
Environment" Presentation by Mr J.F.PONS, Deputy Director-General DG
Competition European Commission.
7. European Air Law Association: 11
th
Annual Conference Recent developments in
European air transport law and policy Lisbon, Friday 5 November 1999 Panel
discussion "Current issues arising with airline alliances" Presentation by Mr. Joos
Stragier Deputy Head of Unit DG Competition European Commission
8. International Aviation Alliances, Market Turmoil and the future of Airline
Competition”, Statement of R. Hewitt Pate, Deputy Assistant Attorney General;
Anti-Trust Division, DOJ.
9. Airline Code-share Alliances and their Competitive Effects By Philip G. Gayle
Kansas State University September 8, 2006 in Journal of Law and Economics.
10. Antitrust for Airlines Remarks by J. Bruce McDonald Deputy Assistant
Attorney General Antitrust Division U.S. Department of Justice.
11. Regulation (EEC) No 4064/89 Merger Procedure Case No COMP/M.3280 -Air
France / KLM.
12. A.Y. Chitale &Associations: Regulations regarding M&A in India. Link:
http://www.iclg.co.uk/index.php?area=4&country_results=1&kh_publications_id=
44&chapters_id=1105
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13. Anti-Trust By Airlines, DOJ: A paper presented by J. Bruce MacDonald on 3
rd
November, 2005.
14. Airport Congestion and Noise: Interplay of Allocation and Distribution Wayne
Brough, Edward Clarke and Nicolaus Tideman: http://clarke.pair.com/ANCW.html
15. Directorate for financial, fiscal & enterprise affairs Committee on Competition
Law & Policy Competition Policy & International Airport Services: OECD
Document, 1998.
16. Annual Reports of DGCA, 2005-06
17. Competition Policy & International Air Transport Services, OECD Document,
1998.
18. Testimony of Albert A. Foer on behalf of the American Antitrust Institute,
concerning Airlines Mergers, June.2000.
19. Naresh Chandra Committee Report, 2003
20. Domestic Air Transport Policy, Ministry of Civil Aviation’s website.
21. Code Sharing arrangement in Scheduled Passenger Traffic, European
Competition Authorities Document.
22. Aviation Industry in India, Challenges by Low Cost Carriers by Shashi Sharma.
23. Privatization, Deregulation & Competition: evidence from Mexican Airline
Industry by Fabian Sánchez and Alejandro Somuano.
24. Department of Justice, Statement of John M.Nannes, concerning Consolidation
in the AirlineIndustry; June 4, 1998.
25. Mergers between major airlines: the anti-competitive & anti-consumer effects
of creating a private cartel by Dr Mark N Cooper, Consumer Federation of
America Document, March.2001.
26. Transformation of India’s domestic airlines by John F. O’Connell and George
Williams
27. The Competition Act, 2002.
28. Kingfisher-Air Deccan merger best fit by Rabin Ghosh,
http://www.dnaindia.com/report.asp?NewsID=1111855.
doc_129770445.pdf
Civil aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
ICAO’s estimates every 100 $ spent on air travel produces benefits worth 325 $ to the
Economy. It generates 100 additional jobs in air transport & 610 related jobs. Indeed this
was reiterated by our minister of Civil Aviation, Mr. Praful Patel who projected that 40
lakh aviation jobs would be available in the next 10 years.
Almost 35 % of exports from India & 97% foreign tourists to India arrive by Air each
year. Aviation sector has undergone a major facelift in past 3-4 years.
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Nancy Shah
[email protected]
Competition Issues in the
Civil Aviation Sector
Evaluating Competition related
issues pertaining to the Indian
Airlines’ Industry, with Special
Reference to M&A in light of
Competition Act, 2002
1
1
Prepared in fulfillment of the requirement as part of Economics, M.A in Gokhale Institute of Politics & Economics.
A study paper submitted for Internship June-July, 2007 to
Competition Commission of India (CCI).
Competition Commission of
India (CCI)
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 1
DISCLAIMER
This project report/dissertation has been prepared by the author as an intern
under the Internship Programme of the Competition Commission of India for
academic purposes only. The views expressed in the report are personal to the
intern and do not necessarily reflect the view of the Commission or any of its
staff or personnel and do not bind the Commission in any manner. This report
is the intellectual property of the Competition Commission of India and the
same or any part thereof may not be used in any manner whatsoever, without
express permission of the Competition Commission of India in writing.
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Table of Contents
Part I: Introduction………………………………………………………………………....10
Part II: Drivers to Growth………………………………………………………………….15
Part III: Types of Air Services……………………………………………………………..17
Part IV: Players of the Industry.................................................................................................18
Part V: Importance of Competition……...……………………………………..….…….....22
Part VI : Relevant Market Concept……………...………………………….....…………...27
Part VII : Competition related issues pertaining to the Aviation Sector.………..………….31
a. Loyalty Programs ( FFP’s & Travel Agent Programs)……....….…...…...… 31
b. Multi Contact………………………....………….…........................................34
c. Competition in Vertically Related Markets. …………………………...….....34
d. Price Transparency & Collusion………...……………….………………......36
e. Alliances & Competition related issues with them…...…….…………….......37
Part VIII: Airlines M&A:
a. Regulations governing M&A in India..…………...………...……………..….48
b. Cases of M&A Abroad……………...………………..…………..……...…...53
i. Air France & KLM
ii. US Airways & United Airlines
c. Cases of M&A in India.……………………..……...………………………....58
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 3
i. Jet-Air Sahara Merger
ii. Indian Airlines – Air India Merger
iii. Kingfisher—Air Deccan Merger
Part IX : Competition Related Issues Pertaining to the Indian Aviation Sector
a. Regulatory Barriers……………….………………………………………….....59
b. Scarcity of Slots………………………………….………………………….….65
c. Cartelization……………………………………………………..………….…..73
d. Regulation of Combinations.………………………………………………..…..86
Part X: Conclusion…………………..……………………………………………………...101
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ACKNOWLEGMENT:
I want to express my sincere thanks to Member, CCI, Mr. Vinod Dhall and
my guide Mr. Peter Augustine, Economic Advisor, CCI for having given me
an opportunity to work on the topic of my choice, The Aviation Sector.
I’m indebted to the Member for giving me an opportunity to work in his
esteemed organization. I take this opportunity to thank Mr. Peter Augustine
for guiding me during this study right from the beginning and providing me
constructive suggestions throughout the preparation of the dissertations.
I’m highly thankful to our Librarian, Mr. G. Sreeniwas for his
resourcefulness. I would also like to thank ASSOCHAM for giving me access
to their Study Report-“Road Map to Civil Aviation”. I would also like to
take the opportunity to thank, Dr. Anil Kumar, Assistant Director,
(Research) for making my stay at CCI so comfortable.
Last but not the least, I would like to thank my Family without whose
support and inspiration, this project would have been possible.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 5
LIST OF FIGURES
Number Page Numbers
Fig 1: Market Share of Domestic Carriers……………………………………….……….20
Fig 2: Level of Congestion at major city airports…………………………….…………..65
Fig 3: Distribution of flights operating everyday between Delhi to Mumbai…………….66
Fig 4: Indicative growth rates of passenger, airports & aircrafts……………………...….81
Fig 5: Comparison of Revenue per Aircraft of the Domestic carriers with the Global
Standards………………………………………………………………..……………….107
Fig 6: Traffic on International Routes………………………………………………….…63
LIST OF TABLES:
Table 1: HHI Calculations…………………………………………………………..…….76
Table 2: Combined Turnovers of the Merged Carriers………………………….………..85
Table 3: Comparison of Market shares Pre & Post Mergers…………………...………….96
Table 4: Current & Fleet on Order Status of Domestic Carriers……………..………….106
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EXECUTIVE SUMMARY
Civil Aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
International Civil Aviation Organizations’ estimates, every 100 $ spent on air travel
produces benefits worth 325 $ to the Economy.
The Indian Aviation Sector has witnessed tremendous growth in the recent past which is
driven by sound demographic, macroeconomic, government aided reforms & market
dynamics. The three fold increase in consumerism, rising disposable income; booming
aviation sector; burgeoning middle class; increasing business travel; government reforms;
entry of low cost carriers; increasing competition etc have positioned the Indian Aviation
Sector in a high growth trajectory.
In order to maintain this high growth trajectory, it is very important that competitive
forces must continue to operate with in this sector. In this report my focus shall be on the
competition related issues surrounding Airlines with special emphasis on M&A in light
of Competition Act, 2002.
There are some characteristics inherent to this sector that are anti-competitive in nature.
For Instance Loyalty Programs like Frequent Flier Programs & Travel Agent Incentive
Schemes. Airlines use the above-mentioned loyalty programs to distinguish between
business travelers & those traveling for leisure purposes. The ones traveling for Business
Purposes have a high opportunity cost of time & therefore have a very inelastic response
w.r.t. changes in prices vis-à-vis Leisure Travelers who are flexible about the days &
timings & hence they benefit from a wide choice of routes available & also a higher level
of competition. All Competitive concerns addressed in this report are focused on the time
sensitive passengers as they have no other substitute mode of transport that matches the
speed of air travel. Hence, the relevant market for our analysis is defined as “a City Pair
Market at a particular time on a particular day”.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 7
Unlike other industries, capacity in the aviation sector cannot be immediately augmented
in face of rising demand. Airports have a capacity constraint binding on them in terms of
the landing, take off facilities, air traffic controllers, refueling, maintenance, clearing &
catering services etc. It is this capacity constraint that might act as an entry barrier for
new entrants. Landing & take off rights are referred to as Slots. These slots are an
important consideration for an entrant as peak timed slots register higher passenger load
factors as compared to the oddly timed slots. With most of the country’s trunk route
airports hitting their capacity mark, only oddly timed slots may be available at major
metropolitan city airports to a new entrant which discourages new entry.
There are some regulatory barriers inherent in our domestic air transport policy which
may constrain new entry & have anti-competitive effects. While the regulations
governing minimum fleet size , minimum equity requirements , route dispersal guidelines
to the domestic operations are act as an entry barriers; the regulations governing
minimum fleet & experience requirements for International Operations & exclusive right
to National carriers to fly to Gulf Routes etc are highly discriminative & are constraining
new entry & strengthening the incumbents position. The current regulations seem to
favor only the incumbents namely Air India-Indian Airlines and J et-Sahara. None of the
other players are allowed to operate internationally. Given that maximum passenger load
factor is registered on Gulf Routes, the exclusive right given to the national carriers is
highly a restrictive practice.
The Year-2007 has been the year of M&A in the Indian Skies. First, it was Indian
Airlines & Air India then J et & Air Sahara and last but the least to tie the knot was
Kingfisher & Air Deccan. The industry sources favored these mergers as they believed
that these mergers would benefit the already bleeding Industry. It would help to bring in
some route; network & fleet rationalization. The merged entities are expected to benefit
from joint operations & would share synergies of joint operations. However, equally
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8
justified are the consumers groups who are fearing that post consolidation, prices may
increase more so after the consummation of Air Deccan.
All three M&A very well come under the lens of the Competition Commission of India’s
as they meet the benchmarks standards laid down by the Competition Act, 2002 with
regard to Regulations of M&A. As far as IA-AI Merger is concerned it doesn’t pose
much problem from competition angle as the merging entities have complementary
networks with AI having International presence with negligible domestic presence and IA
having heavy domestic presence with negligible international presence. However, the
exclusive right to fly to Gulf routes is unfair as its depriving the other domestic players
from an important source of revenue. Consumers too don’t have much option w.r.t. mode
of transportation & the choice of the carrier.
With the take over of Sahara by J et, some important issues over competitive concerns
need to be addressed. J et and Sahara have peak slots available on all major metropolitan
airports at peak timings. As defined earlier that relevant market in our analysis is a city
pair market, on a particular day, at a particular time. Hence peak timed slots are a major
determinant of profitability. Concerns have been expressed last year when J et announced
its plan to take over Sahara. Air Sahara's rights must be redistributed to all airlines in
order to prevent J et Airways from attaining a dominant position in slots as this would
restrain growth of competition. I suggest that Air Sahara's aviation rights should not
automatically accrue to J et; the latter should instead be required to re-apply for securing
additional rights. The DGCA, as the competent authority should use this window to re-
distribute Air Sahara's rights to all airlines. Had Air Sahara continued and given the
inevitability of its closure, its rights would have anyway got released for distribution to
others and not available only to J et.
Another important issue that needs to be addressed is that post J et-Sahara Deal & IA-AI
deal , the number of players serving the International Routes have been reduced to half
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 9
as no other domestic player is eligible for flying Internationally as per the current
regulatory framework.
With top 3 players having more than 80% of market share; chances of Cartelization are
more likely with the industry getting consolidated. Such attempts have been made in the
past. FIA-Federation of Indian Aviation was set up in 2005 by top airline industry
honchos to voice their needs to the government. Among its first meet, the federation had
thought of discussing pricing issues. However, this was aborted by timely intervention of
CCI. However, such attempts can be made again as cooperation is more easy with the
industry getting consolidated. So CCI must keep an eye on such instance of price
coordination. The transparency in fare dissemination news facilitates cooperation among
the colluding members.
For simplicity sake, the report is divided in various sections. The first three sections
include an introduction to the sector, its players and types of air services. The fourth
section highlights the importance of competition with reference to the Competition Act,
2002 followed by the concept of relevant market in the next section. Having defined the
Relevant market, section 7 will address the general competition related issues pertaining
to the Airline Industry. Section 8 will focus of regulations governing M&A in India,
cases of M&A Abroad and cases of M&A in India. Last but the least, Section 9 will
address all competition related issues pertaining to the Indian Airline Industry with
special reference to M&A in light of Competition Act, 2002. Section 10 incorporates the
Conclusion.
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10
SECTION I
INTRODUCTION
Civil aviation plays an integral role in development of an economy. It helps in realizing
the socio-economic objective of providing connectivity to foster travel & trade. As per
ICAO’s estimates every 100 $ spent on air travel produces benefits worth 325 $ to the
Economy. It generates 100 additional jobs in air transport & 610 related jobs. Indeed this
was reiterated by our minister of Civil Aviation, Mr. Praful Patel who projected that 40
lakh aviation jobs would be available in the next 10 years.
Almost 35 % of exports from India & 97% foreign tourists to India arrive by Air each
year. Aviation sector has undergone a major facelift in past 3-4 years.
Phase I of Indian Aviation Sector (up till 1986):
The legacy of Indian aviation dates back to 1912 when India’s first air mail service was
started by Tata Airlines. Tata Airlines though was started as an air mail service but soon
ventured in carrying scheduled passenger traffic. In 1946, Tata Airlines was renamed as
Air India. In early 1948, a joint sector company, Air India International Ltd., was
established by the Government of India and Air India (earlier Tata Airline) .At the time
of independence the number of companies operating with in and beyond frontiers of the
country were 8 namely: Tata Airlines, Indian National Airways, Air service of India,
Deccan Airways, Ambica Airways, Bharat Airways and Mistry Airways.
The government in 1950 had set an Air Traffic Enquiry Committee to look into the
problems faced by the airlines. The soaring prices of aviation fuel, mounting salary bills
and disproportionately large fleets took a heavy toll of the then airlines. The financial
health of companies declined despite liberal Government patronage, particularly from
1949, and an upward trend in air cargo and passenger traffic. Though the Committee
found no justification for nationalization of airlines, it favored their voluntary merge. So
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 11
Government in the wake of deteriorating financial conditions of the Airlines decided to
step in and nationalize the air transport industry and accordingly, two autonomous
corporations were created on August 1, 1953. In 1953, the government nationalized the
airlines via. The Air Corporations Act, 1953, which gave birth to Indian Airlines and Air
India. Indian Airlines was formed with the merger of eight domestic airlines to operate
domestic services, while Air India International was to operate the overseas services. The
Act also gave monopoly power to Indian Airlines to operate on domestic scheduled
services to the exclusion of any other operator. Air India became the only Indian carrier
to operate on international routes except for some routes to the neighboring countries
which were given to Indian Airlines.
Phase II (1986-2003):
The second phase of Indian aviation began in the year 1986 with granting of permission
to private sector players to operate as air taxi operators. The private players allowed to
operate as air taxi operators included Air Sahara, J et Airways, Damania Airways, East
West Airlines, Modiluft and NEPC Airways. In 1994, government of India repealed the
Air Corporation Act there by. Following this measure in 1995, govt. granted scheduled
carrier status to six private air taxi operators. However, not many operators were able to
continue their business and by 1997 only four operators started operations followed the
deregulation continued to operate: J et Airways; Air Sahara; J agsons and Spicejet
(previously operated as Modiluft ) .Eventually, by 1998, at least six private airlines, East-
West, Modi-Luft, NEPC, Damania, Gujarat Airways and Span Air were closed and
according to an estimate, the capital losses involved in these closures were to the tune of
Rs 10 billion.
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Phase III: (2003 – 2006)
Only two private carriers survived to see the dawn of the new century. The duopoly of J et
and Sahara as private carrier was challenged in 2003 by Air Deccan whose operations in
scheduled services began in August. The entry of Deccan changed the entire canvas on
which the aviation sector was defined. Air Deccan gave India its first Low Cost Carrier
(LCC) or no frills Airline! This marked as a turning point in the history of Indian
Aviation Sector as it marked a shift from the stereo type economy fares & business fares
to the era of check fares ; web fares ; APEX fares ; internet auctions ; Special discounts ;
Corporate plans ; last day fares; promotional fares etc. Arrival of Deccan has bought a
revolution in this sector, it changed the common man’s perception of flying by matching
airline fares neck to neck with upper class railway fare. Air traffic growth since then has
witnessed tremendous growth rates. The figure shown below indicates the growth in
passenger volumes:
P
ost 2003, we see a 3 fold increase passengers traveling by air in India. Spurred by the
initial success of LCC Model, other airlines entered the sector and opted for No-Frill
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 13
Model. Since then 5 other airlines namely Spice jet ; Kingfisher ; Indigo ; Paramount ;
Go Air have begun operations in India .Licenses have been issued to new carriers such as
Star Airlines ; Skylark ; Magic Air ; Air One and many more in the pipeline.
Phase IV: (Year 2006 onwards) :
Yet another milestone in the history of the Indian Aviation sector came in the year 2007
which is the year of Marriages in the Indian Skies! Though the marriage of J et-Sahara &
IA-AI was announced in 2006 but the ultimate consummation materialized only in 2007.
The current year has witnessed a series of M&A of airlines namely: Indian-Air India; the
J et-Sahara Deal; the Kingfisher-Deccan Deal. These players post consolidations have
claim over 80% of the market share.
The industry sources favored the consolidation attempts, as the proposed mergers would
help the carriers get rid of the widespread duplication of capacity, rationalization in the
route networks & fleets and also facilitate sharing of infrastructure, which would help the
merged entities, save a lot on its operational costs & enable the sector to tide over huge
industry losses. The mergers are expected to help the firms break even & there by ensure
carriers’ sustainability in long term. However, there is another side to this rosy picture.
Equally justified are the consumer groups who are feeling vulnerable& expect that post
absorption of important competitors such as Deccan & Sahara prices may increase in the
future. Air Deccan, India’s pioneer low costs airline made air travel affordable; with in
the reach of the common man. With its absorption, consumers fear that the days of low
fares are over. In this report, we will therefore analyze the relative merits and more
importantly highlight the appreciable adverse effects of mergers that will or may arise in
future; the potential threat that the proposed mergers might pose to competition.
The general perception is that competition is healthy for all the market as it guarantees
maximum benefits being trickled to the consumer groups. However, this doesn’t hold true
for industries where there is room for economies of scale and scope. Undoubtedly, airline
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is one such industry where there exists economies of scale. There needs to be a minimum
efficient scale of operation to be sustained for breaking even. That’s probably the reason
for the oligopolistic structure of this industry.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 15
SECTION II
DRIVERS TO GROWTH:
Indian Aviation Sector has witnessed tremendous growth in the recent past which is
driven by sound demographic, macroeconomic, government aided reforms and market
dynamics. Industry sources call it the PEST Mechanism namely P-Political; E-Economic
S-Socio-Cultural; T-technological. The drivers to growth are:
• Increase in Consumerism
• Rising Disposable incomes
• Rising Middle Class Population
• Untapped Market
• Increasing Business Travel
• Increasing Tourists Travel
• Entry of Low Cost Carriers
• Increasing Competition
• Government Reform Measures
The mix of the above mentioned fundamentally strong favorable dynamics has positioned
India’s Aviation industry in a high growth trajectory in the foreseeable future. World
wide, air traffic has a strong correlation with economic growth and in emerging markets
like India, a rise of 1% in GDP is expected to result in a 2% increase in air traffic.
Disposable income in India has gone up by 5 times in the last 2 decades and the
expenditure on transportation has risen from 6% to 14% in the same period.
2
The increase
in trade activity within the nation is leading to the development of various mini metros.
This results in increased demand. It is expected that the emerging middle class along with
upper middle population will grow at 40 % of the total population in 2007, creating huge
demand for air-travel services.
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However, the penetration level of air services in India has been very low at 20 trips
/annum/thousand passengers in 2005 as against 2,300 trips/annum/thousand passengers in
United States and over 60 trips per annum per thousand passengers in China. India is one
of the least developed markets in the World and is among the most expensive in the
world (after adjusting for purchasing power parity).
2
ASSOCHAM Study: Road map to Civil Aviation, 2007.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 17
SECTION III
TYPES OF AIR SERVICES
1. Scheduled Air Transport Service means an air transport service undertaken between
the two or more places and operated according to a published time table or with flights so
regular or frequent that they constitute a recognisably systematic series.
2. Non-Scheduled Operation includes services other than scheduled air transport service
Eg: charter basis and/or non-scheduled basis. The operator is not permitted to publish
time schedule and issue tickets to passengers
3. An air cargo service means air transportation of cargo and mail. Passengers are not
permitted to be on these operations. It may be on scheduled or non-scheduled basis.
NOTE: In this report, our focus will be only on Scheduled Air Transport Service.
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SECTION IV
PLAYERS IN THE MARKET
Indian skies are housing a decent number of airlines today vis-à-vis the one man army
scenario prior to 1990’s. The proud residents of Indian skies include the following:
1. Air India : India’s Legacy Carrier
The history of Air India is the History of Indian Aviation. Air-India began operating in
1932 as Tata Airlines, named after J . R. D. Tata, its founder. Founded as a small, private,
domestic carrier in 1932, Air-India is now government owned. It flies only International
routes and has negligible presence felt while catering to the domestic traffic.
2. Indian Airlines : With nationalization of Air Transport in 1953 via Air Corporation
Act,1953 , National Flag carriers : Indian and Air India were born. Indian was born from
merger of 8 domestic carriers .It caters mainly to domestic routes with some presence felt
in neighboring nations. Like Air India it’s a full service carrier. It has a subsidiary
‘Alliance Air’ .Its Symbol is Asoka’s Chakra. For a long spell of time, the two national
carriers enjoyed sole monopoly in the air transport segment as private carriers were
barred from entering the segment as per Air Corporation Act, 1953. It was after the New
Economic Policy, 1991 after which things fell in the right places and successful attempts
were made to enter the segment by private players like J et, Sahara and others. Yet
another, turning point has come in the history of the Indian Aviation Sector when Air
India was granted permission from the Government of India to merge with Indian
Airlines, the two flag carriers of India.This Mega Merger marked the first marriage in the
Indian skies which was followed by two more marriages. The name of the new airline
will remain Air India, since it is known worldwide. They have been in the works of
completing the merger since J anuary 2007, after permission.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 19
3. Jet Airways :
In 1993, J et commenced its operations after the ban was lift by the government following
the repeal of Air Corporation Act.1956. J et Airways will be the most preferred domestic
Airline in India. It will be the automatic first choice carrier for the traveling public and
set standards, which other competing airlines will seek to match. It is the only airline that
stood the crunch of late 1990’s. J et started its International Operations in 2004 and carries
more than 7 million passengers per annum. Recently, the company made news when
Naresh Goel led J et Airways took 100 % stake in their arch old rival Air Sahara in May,
2007. This earmarked the second marriage of the season in the Indian Skies after the AI-
IA deal.
4. Air Sahara:
Like J et, Sahara too began its operations in 1993 after the domestic Air Market was
opened by the govt. in 1990’s. Air Sahara Limited is a leading private airline in India,
owned by the diversified Sahara India Parivar group. After J et, it was only airline that
could stand the torrential winds of late 1990’s. After series of controversies Air Sahara
has been taken over by J et Airways in May, 2007. The airline is now renamed as “J et
Lite”. J et has intensions of converting Air Sahara in sync with LCC model to reach every
segment of air travelers.
5. Air Deccan:
India’s first budget carrier and now the largest flew its first carrier in 2003.Headed by
Captain Gopinath, Air Deccan truly redefined the accessibility to the Indian Skies. It
injected competitive spirits into the system and gave common man wings by reducing air
fares which matched the first Class Railway Fares. The third wedding in skies was
marked when Dr Vijay Mallya of Kingfisher Airlines picked up 26 % stake in Air
Deccan.
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6. Kingfisher:
The Airline began its operation in May, 2005 .it’s the by far the most flamboyant airline
in India, giving tough competition to J et Airways in in-flight services. It is a major Indian
luxury airline operating an extensive network to 34 destinations, with plans for regional
and long-haul international services. Kingfisher Airlines, through one of its holding
company UB holdings Ltd has acquired 26% stake in the budget airline Air Deccan and
has offered to buy further of 20% stake from the secondary market.
7. GoAir:
The most colourful airline in India (comes in 6 colours) started its operations from
November, 2005. It belongs to the Wadia group.
8. Indigo:
The airline made heads turn when it placed the ambitious order of 100 aircrafts with
airbus. The carrier began its operations in August, 2006.
9. Paramount:
It’s the only high value flier that India can boast of .It is the only carrier that uses 70
passenger capacitated Embraer Aircraft.The airline started operations in October 2005. It
was established by Madurai-based textile company Paramount Group. Paramount
presently operates only in South India. There was news of Paramount showing interest in
in picking up stake in Go Air and Spicejet so as to foray into Northern India
easily.However, so far dotted line has not been signed with any carrier.
10. Spicejet:
SpiceJ et, a reincarnation of ModiLuft marked its entry in service by offering fares priced
at Rs.99 fares for the first 99 days since its inception in 2005. The carrier is giving tough
competition to Railways.This airline is known to have had made the least number of
mistakes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 21
Fig 1:
As on 30
th
April 2007, the status in the Indian skies is as follows:
MARKET SHARES OF DOMESTIC CARRIERS
Mkt . Shar e
23%
22%
18%
8%
6%
7%
3%
2%
11%
IA JET AIRDECCAN SPICEJET INDIGO AIR SAHARA GOAIR PARAMOUNT KINGFISHER
Source: Business Standard
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SECTION V:
IMPORTANCE OF COMPETITION
5.1 In common parlance competition in the market means sellers striving
independently for buyer’s patronage to maximize profit or other business objectives. A
buyer prefers to buy a product at a price that maximizes his benefits whereas seller
prefers to sell the product at a price that maximizes his profit. Competition makes an
enterprise more efficient and offers wider choice to consumers at lower price. Fair
competition is beneficial for the Consumers, Producers / Sellers and finally for the whole
society since it induces economic growth. In order to realize this objective to competition
in the economy, the Competition Act, 2002 was passed which replaced MRTP Act, 1969
.The objective of Competition Act is to prevent anti-competitive practices, promote and
sustain competition, protect the interest of the consumers and ensure freedom of trade.
The objectives of this Act are to be achieved through the instrumentality of the
Competition Commission of India (CCI) which has been established by the Central Govt.
w.e.f 14
th
October, 2003.
Areas focused under the MRTP Act, 1969:
i. Prohibition of concentration of economic power to the common detriment;
ii. Control of monopolies; and
iii. Prohibition of monopolistic, restrictive & unfair trade practices.
Where as the theme areas for the Competition Act, 2002 are as follows:
i. Prohibition of anti-competitive agreements;
ii. Prohibition of abuse of dominant position;
iii. Regulation of combinations ;
iv. Competition Advocacy;
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 23
5.2 Competition Act, 2002 shall prohibit anti-competitive agreements and abuse of
dominance and regulate combinations (mergers amalgamations or acquisition) through a
process of inquiry. It shall give opinion on competition issues on reference received and
is also mandated to undertake competition advocacy, create awareness and impart
training on competition issues.
Combinations that exceeds threshold limits specified in the Act in terms of assets and
turnover which causes or is likely to cause an appreciable adverse effect on competition
with in the relevant market in India can be scrutinized by the Commission. The
prescribed turnover levels for Merger & acquisitions are: Assets of the merged entity
more than Rs. 1000 Crores or turnover of more than Rs. 3000 Crores (these limits are US
$ 500 millions and 1500 US$ in case one of the firms is situated outside India.). The
limits are more than Rs 4000 Cr or 12000 Cr and US$ 2 billions and 6 billions in case the
merged entity belongs to a group in India or outside respectively.
Therefore this Act has been devised keeping in view the economic development of the
country by preventing practices which have appreciable adverse effect on competition.
Some important terms relevant from competition angle are explained below:
1. Abuse of dominance: According to Section 4, Competition Act, 2002 dominance is
defined as a position which enables a dominant firm to operate independently of
competitive forces or to effect its competitors or consumers or the market in its
favour. A firm may achieve dominance through innovation; superior Products;
affordable prices; efficient distribution system; satisfactory after sale service;
entrepreneurial efforts. Abuse of dominant position impedes fair competition
between firms, exploits consumers and makes it difficult for other players to
compete with dominant undertaking on merit. Abuse of dominant position
includes imposing unfair conditions or price, predatory pricing, limiting
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production/market, creating barriers to entry and applying dissimilar conditions to
similar transactions.
There shall be abuse of dominant position if an enterprise.—-
(a) directly or indirectly, imposes unfair or discriminatory—
(i) condition in purchase or sale of goods or service; or
(ii) price in purchase or sale (including predatory price) of goods or service,
(b) limits or restricts—
(i) production of goods or provision of services or market therefore; or
(ii) technical or scientific development relating to goods or services to the
prejudice of consumers; or
(c) indulges in practice or practices resulting in denial of market access; or
(d) makes conclusion of contracts subject to acceptance by other parties of
supplementary obligations which, by their nature or according to commercial
usage, have no connection with the subject of such contracts; or
(e) uses its dominant position in one relevant market to enter into, or protect, other
relevant market.
2. Anti-Competitive Agreements : As per Section 3 of Competition Act, 2002, any
agreement entered into between enterprises or associations of enterprises or
persons or associations of persons or between any person and enterprise or
practice carried on, or decision taken by, any association of enterprises or
association of persons, including cartels, engaged in identical or similar trade of
goods or provision of services, which—(a) directly or indirectly determines
purchase or sale prices;(b) limits or controls production, supply, markets,
technical development, investment or provision of services; (c) shares the market
or source of production or provision of services by way of allocation of
geographical area of market, or type of goods or services, or number of customers
in the market or any other similar way;(d) directly or indirectly results in bid
rigging or collusive bidding, shall be presumed to have an appreciable adverse
effect on competition
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 25
3. Relevant market is a key concept in application of competition law. It provides
as a tool in competitive assessment by identifying those substitutes products or
services which provide an effective constraint on competitive behavior of
products or services being offered in market by parties under investigation. As
defined by Section 2 of Competition Act,2002 Relevant product Market is defined
as a market comprising of all those products and services which are regarded as
interchangeably or substitutable by the consumer , by reason of characteristics of
the products or services; their price & intended use.
Relevant geographic market means a market comprising the area in which the
conditions of competition for supply of goods or provision of services or demand
of goods or services are distinctly homogenous and can be distinguished from the
conditions prevailing in the neighboring areas;
4. Regulations of Combinations ( i.e. Mergers & Acquisitions ): Combinations that
exceeds a threshold limits specified in the Act in terms of assets and turnover
which causes or is likely to cause an appreciable adverse effect on competition
with in the relevant market in India can be scrutinize by the commission. The
prescribed turnover levels are for Merger & acquisitions are: Assets of the merged
entity more than Rs. 1000 Crores or turnover of more than Rs. 3000 Crores (these
limits are US $ 500 millions and 1500 US$ in case one of the firms is situated
outside India.). The limits are more than Rs 4000 Cr or 12000 Cr and US$ 2
billions and 6 billions in case the merged entity belongs to a group in India or
outside respectively.
5. Competition Advocacy: As per Section 9 of Competition Act, 2002, the
Commission takes suitable measures, as may be prescribed, for the promotion of
competition advocacy i.e. creating awareness and imparting training about
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competition issues. In formulating a policy on competition (including review of
laws related to competition), the Central Government may make a reference to the
Commission for its opinion on possible effect of such policy on competition and
on receipt of such a reference, the Commission shall, within sixty days of making
such reference, give its opinion to the Central Government, which may thereafter
formulate the policy as it deems fit.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 27
SECTION VI
DEFINING RELEVANT MARKET
6.1 Now focusing on Aviation Sector, we go on to define the relevant market.
Relevant market is a key concept in application of competition law. It provides as a tool
in competitive assessment by identifying those substitutes products or services which
provide an effective constraint on competitive behavior of products or services being
offered in market by parties under investigation. As defined by Section 2 of Competition
Act, 2002 Relevant product Market is defined as a market comprising of all those
products and services which are regarded as interchangeable or substitutable by the
consumer , by reason of characteristics of the products or services; their price & intended
use.
An analysis of nature of competition in the airline industry starts with identification of the
set of services the industry provides and the nature of demand for those services. Broadly
speaking the airline industry provides air transport services, which is divided into two
categories – passengers and freight (cargo). For our analysis we shall focus only on
passenger services.
Air transport services face a degree of competition (at the margin) from other modes of
transportation. The set of potential substitutes for air travel depends upon the purpose of
travel. Now, the nature demand for air services is different across different class of
Travelers.
6.2 Travelers differ widely, in their ability to be flexible about origin and
destination airports and about time and day of travel and in their opportunity cost of time
spent traveling. Because most travelers are not flexible about their origin & destination
cities, airline markets are usually defined as “city pair” markets.
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6.3 Travelers who have a lower opportunity cost of travel generally enjoy a wider
choice of routes between the origin & the destination cities and hence benefit from level
of higher competition. But for time sensitive passengers indirect routes may not be an
adequate substitute for non-stop services. Hence there arises two separate categories of
travelers: one which is time sensitive who is traveling for business purposes-whose
opportunity cost of time is very high & the second category which is the leisure travelers
whose opportunity cost of time is not very high & their price elasticity of demand is very
high. The leisure travelers are highly responsive to price changes unlike the business
travelers who have a strict preference for time, day of travel and non-stop routings versus
indirect routings.
6.4 Therefore, competition concerns are focused more on time sensitive passengers as
their price elasticity of demand is significantly low. Evidence shows that for an
identifiable group of time-sensitive business passengers, one-stop service is not a
reasonable substitute for nonstop service; they would not switch to one-stop service in
response to a price increase in nonstop service. The airlines can and do charge these
travelers different prices than leisure travelers, targeting time-sensitive passengers with
fare restrictions and conditions. Airlines practice use variety of ticketing practices to
discriminate between time sensitive and non-time sensitive passengers. Some popular
practices are: (a.) Frequent flier programs which rewards loyal customers with free air
travel (b) through negotiating special arrangements with large corporate customers who
provide incentives for all travel with single airline. This practice allows airlines to price
discriminate even more precisely among purchasers with varying degrees of price and
time preferences.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 29
Recent econometrics work that shows that time-sensitive, business type consumers have a
strong preference for nonstop versus one-stop travel
3
and by evidence regarding
corporate travel policies. The value that business passengers place on their time would
also make them unlikely to switch to one-stop service in response to an increase in
nonstop prices. Eg: If a non stop flight from Delhi-Mumbai is for Rs. 4000 on ABC
Airways then a 5 % increase in fares would amount to Rs. 200.Assuming that a transfer
caused a delay of about 2 hours for some technical reasons. Obviously, any business that
valued its executive’s time by more than Rs.100 per hour & would be willing to pay an
extra 5 % fare & board the alternate flight.
4
Having built these blocks we go on defining the relevant market. Firstly, the relevant
market for time sensitive passengers is different from the relevant market for non-time
sensitive. As non-time sensitive passengers are flexible with respect to their choice of
route and mode of transportation so question so competition concerns doesn’t arise with
them.
6.5 Reiterating the relevant market concept: it is said to incorporate all substitutes
products and regions which provide significant competitive constraint on the products
and regions of interest. As far as substitutes go, Railways are a near substitute for air
services but only valid for short to medium distance journeys. But for longer journeys,
3
See, Berry, Steven, Carnall, Michael and Spiller, Pablo, "Airline Hubs: Costs,
Markups 5 and the Implications of Customer Heterogeneity," NBER Working Paper
5561, May 1996.
4
According, to 1996 American Express Survey of Business Travel Management, 78
% of all companies have a policy to in place requiring employees to use lowest
logical fare but only 25 % of these corporates want their employees to use connecting
flights to achieve lowest fares.
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there isn’t a substitute available to match air services. Eg: if a person has to reach
Mumbai from
Delhi then no other mode of transportation can take him to Delhi in the same day. Given
that in India we don’t have any super fast trains!
So we define relevant market as market for time sensitive passengers where market is
defined as a city pair market between origin and destination cities at a specified date and
specified time of the day. Business passengers have a preference for non-stop routes over
connecting routes. In absence of substitutes & the strict preference of time day & route,
airlines are likely to exploit business travelers.
In a nutshell, non-stop ,city pair wise flights at a particular time of a specific day is the
relevant market…In a nutshell, non-stop ,city pair wise flights at a particular time of a
specific day is the relevant market
Now keeping this key concept of relevant market in the backdrop we proceed with our
analysis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 31
SECTION VII
COMPETITION ISSUES PERTAINING TO THE AVIATION SECTOR:
7.1 Of late, there has been a lot of hue and cry over the mega mergers in the aviation
sector among the airlines. The consumers are feeling vulnerable and fear fares would
increase post consolidation. While industry sources condemn such fears & voice their
support in favor of consolidation on grounds that consolidation would bring some sanity
and rationality in the pricing pattern and end the saga of blood bath that inevitably every
carrier was witnessing. All most all carriers were bleeding and industry losses were
calculated to be around 500 million USD for 2006—07 as per Industry sources. The
mergers would benefit carriers from the joint. The mergers are expected to help the
industry tide over losses which would be ensured via network optimization; operational
rationalization and fleet rationalization. However, equally justified are the fears of the
consumer groups anticipating price rise post mergers. Definitely, these mergers have
competition related issues involved to them. Before dwelling on Mergers and Acquisition
cases, we will first identify the competition related issues pertaining to this sector.
Certain features of the airline industry favor anti-competitive practices.
In particular, the high degree of price transparency and multi-market contact among
the major airlines may facilitate coordinated behavior. Airlines also use Loyalty
Programs to discriminate between the time sensitive businessmen and the ones traveling
for leisure purposes.
I. Loyalty Programs:
Airlines attempt to raise the cost of switching between airline companies in three ways,
which are collectively called “loyalty programmes”:
1. Through frequent flyer programs, which reward loyal customers with free travel;
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2. Through travel agent incentive schemes (such as the so-called travel agent
commission override ) which reward travel agents for directing the bulk of their travel
towards a specific airline; and
3. Through negotiating special arrangements with large corporate customers who
provide incentives for taking all (or nearly all) travel with a single airline.
7.2 In passing, I may add that larger airlines can enhance their demand relative to
smaller airlines in many ways: For example, if airlines allow a traveler to change but not
cancel a reservation at the last minute, atraveler with uncertain plans will prefer an
airline with more frequent flights to the same destination than an airline with one
flight per day.
Loyalty programs such as Travel agents schemes; Frequent flier programs are Anti-
Competitive in Nature.
A1.Frequent flier program is a device chosen by the airlines to distinguish between
Business class and those traveling for leisure purposes. The business class passengers are
price inelastic and carriers can capitalize on this aspect by overcharging the business
class.
7.2 Frequent flyer programs operate like a volume discount. Once a customer has
flown on a particular airline with a frequent-flyer program, the value of subsequent
flights is enhanced by the increased opportunities for free travel. Because the marginal
value of the reward increases as the customer builds up miles or points on a single airline,
frequent-flyer programs encourage travelers to choose the airline that they are most likely
to fly on in the future.
7.3 The size of the loyalty effect will depend upon how rapidly free travel is earned,
on the size of the airline’s network and on the location of the customer. The larger
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 33
the airline’s network, the more valuable is the free travel, as more opportunities
are available to the frequent traveler (the nature of the destinations may also
matter). The larger the number of flights offered by an airline at the customer’s
home city, the more likely the customer is to travel on a route served by the
airline, the faster the accumulation of awards, the greater the range of possible
free-travel destinations and the more likely there will be a nonstop flight to the
desired destination. Carriers might try to abuse their dominant positions as they
know that there isn’t an alternative available in the relevant market. For a business
passenger traveling on work related matter, doesn’t mind paying an extra Rs 1000
as his opportunity cost of time is much higher than that.
7.4 Indian; J et; Kingfisher and Air Sahara operate Frequent Flier Programs. J et has 3
tiers of loyalty program namely J P-Silver; Gold and Platinum Card which can be
redeemed. Similar is the structure for Kingfisher whose 3 tiers are Red (person traveling
more than 3 flights); Silver (if flights exceed 30) and most prestigious is Gold which is
obtained if annual flights exceed 60. Benefits such as Personalized Web Access
Membership Tier Bonus ;e-ticketing; IVR ; Pay Online Service ; Tele Check-in facility;
Web Check-in; Kiosk Check-in ;Complimentary Upgrade Vouchers; No Blackout
periods for J et Awards; Lounge access at select airports; Additional baggage allowance
on J et Airways; Priority tagging of baggage ; Guaranteed reservation up to 24 hours
before departure; Check-in at Club Premiere & PREMIERE counters; Cancellation fees
waived on published fares; Priority Standby ;Partner Benefits ; Dedicated customer
service center .
Hence a close review of frequent travelers programs and other loyalty programs for anti-
competitive issues is a must.
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A2.Travel agent incentive schemes
7.5 Airlines may also be able to enhance the demand for their services through
incentives & commissions on travel agents. Most travel agents earn increased
commission rates from at least one airline in return for steering passengers to those
airlines. There is a widespread belief within the industry that TACOs are most effectively
used by the dominant airline in an area. J ust as with frequent-flyer plans, the rewards for
increased bookings on an airline are designed to encourage the agent to concentrate
bookings on a single carrier. Travel agent incentive schemes appear to be particularly
effective at increasing demand.
7.6 For example, in 1995 Air South, a low-fare airline which was concerned about its
inability to attract business travelers on its routes in the South East of the US, hired a
private consultant to test the extent to which travel agents may have been steering traffic
away from Air South. The consultant found that agents in some cities dominated by one
airline often did not provide Air South’s competing flight options in response to
anonymous inquiries, even though those options were listed in CRSs. In Miami, for
example, travel agents did not initially inform callers of available Air south flights 56
percent of the time, and even after the lowest fare was requested the agents did not
mention Air South 30 percent of the time. Instead the agents frequently recommended
flights by American Airlines, the largest carrier in Miami.
II. Multi-Contact:
7.7 It has long been posited that when firms face each other in a large number of
markets, they may compete less vigorously by allowing each other more or less exclusive
number spheres of influence. Put another way, the number of markets in which firms
meet is a factor influencing the likelihood of oligopolistic coordination or “tacit
collusion” This result arises from the fact that a dominant firm in an oligopolistic market
has more to lose in a price war than a firm with a small market share. A firm with a small
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 35
market share is therefore a threat to the margins of the dominant firm unless the roles are
reversed in some other market. When each firm has one or more “home” markets in
which it is dominant, it is less likely to challenge the dominant position of a rival firm in
the rival’s “home” market, for fear of facing competition in its home market. Such an
arrangement is likely to settle down into a “live and let live” situation. Conversely, the
biggest threat to such comfortable arrangements is likely to come from rival firms with
no domestic dominant position.
III. Competition in Vertically Related Markets:
7.8 It was noted earlier that the provision of air services requires the inputs of a host
of other Complementary airport services, including take-off and landing slots, air-traffic-
control services, gates, passenger handling facilities, baggage handling facilities,
refueling, maintenance, cleaning and catering services and so on. In some cases
regulatory or security requirements or physical limitations on space limit the number of
firms that can provide these services. A merger or alliance between two or more firms,
which provide services in these markets, can both reduce competition in these markets
and can potentially distort competition in air transport services. As is well established,
competition enforcers need to consider the effect of mergers and alliances on all markets
in which the merged firms provide services.
7.9 A merger or alliance between two firms, which collectively have a dominant
position in these vertically related markets, could have an important impact on
competition in air services. In particular, a merger or alliance between two airlines
between two airlines which collectively hold a dominant position in slots or gates,
baggage-handling facilities, maintenance or in the ownership of a CRS could reduce
competition in these markets and allow these firms to abuse this dominant position to
constrain competition in the market for air services. Post merger, the merged entity
inherits extensive route networks and higher frequency of flights operating per day. This
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helps the carrier build loyalty of tourists as well as frequently traveling business class.
Hence, infrastructural scarcity acts as a bottleneck for new entry & there by strengthens
the merging /incumbents position as the case may be. We will further dwell on this issue
in later half of this report.
IV. Price Transparency & Collusion:
7.10 The airline industry features a very high degree of transparency over prices
and volumes. All of an airline’s future fares are instantaneously available over computer
reservation systems, to which rival airlines can subscribe. Unlike other industries, such
transparency can be an instrument for collusion as it facilitates the detection of cheating
on a cartel agreement. It appears to be common practice for an airline to announce,
through the CRSs that its price on a certain route will increase by some amount beginning
on a certain date in the future. The colluding parties take advantage of this transparency
& enter to a tacit collusion. The carrier then waits to see if others will match. If they do,
the price increase is implemented. If they don’t, the airline suggesting the increase will
either withdraw it or push back the implementation dates. Other airlines might
counteroffer with a smaller increase, effective a day after the first increase. Then the first
airline may proceed with a smaller increase or counteroffer again. All of this occurs
without the airlines changing prices on actual sales.
7.11 This transparency acts as a boon and as a bane too. While transparency in the
pricing pattern is important to Consumer so as to make choice keeping in mind the cost,
schedule and time taken to complete the journey. At the same time, chances of
cartelization can’t be ruled out either. As discussed above, the CRS system facilitates
Cartelization.
With respect to the Indian Scenario, after the series of marriages in the Indian Skies; the
chances of Cartelization has increased by many folds. With top 3 players pocketing more
than 80 % market share, chances of prices increasing on key routes, which are essentially
long distance and have no immediate substitutes are likely.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 37
7.12 The setting up of FIA-Federation of Indian Airlines , a conglomerate of top
honchos of domestic airlines met in 2005 to form a federation that will provide a
common platform to debate industry issues and lobby the government and hammer out
solutions. To their misfortune, at their first meeting they had pricing issues on their
agenda, which by timely intervention of CCI was hauled and hence the very first step
towards cartelization was aborted. Moreover, that time the industry was scattered into
many players so chances of deviations were very high. In today’s scenario, chances of
cartelization and its materialization are quite high as post consolidation with less number
of players tacit collusion is more chase able and deviation is less unlikely. So CCI must
keep an eye on such tendencies. More over, chances of coordination in prices might
become even higher if the Alliance between AI and J et materializes. It is highly
recommended that the commission scrutinizes the proposal & its prospective pros and
cons before the two are allowed to sign on the dotted line.
V. Alliances & Competition Related Issues:
7.13 It is virtually impossible for a single carrier to serve all the places across the
World. However, what carriers can & definitely do is that they tie up with carriers of
other countries entering into alliances. An airline alliance is an agreement between two
or more airlines to cooperate for the foreseeable future on a substantial level.
The degree of cooperation differs between alliances. Airlines throughout the world have
entered into alliances for some time. The various co-operative arrangements include
(such as code sharing, blocked space, co-operation in frequent flyer programs, joint
marketing, service and purchasing, and franchising). These are undertaken to strengthen
or expand the aligning member’s market presence and to redefine or consolidate their
position in an increasingly competitive environment across the globe.
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7.14 The idea of alliances is that when carriers of different communities come
together, the combined route structure of the members of the alliances will be able to
cover as much as real estate as possible. Airline alliances benefits to the consumer by
offering seamless travel and services between a more extensive range of city pairs,
reduction in traveling time, joint lounges and co-ordination of FFPs.
7.15 Within the EU, for example, following successive deregulation directives for
air transport, any EU airline may now, in principle, serve any EU route. Air transport
within the EU has been liberalized with the aim to integrate the entire market as a "single
market" of air transport in Europe. With the aim of providing access to the entire
European Market uniformly, alliances seemed to be the need of the hour as no airline
alone could have a network vast enough to cater to every possible nook and corner of
Europe.
7.16 The liberalization process of developing a “single market” for EU had led to
stronger competition, a significant increase in the supply of air transport and lower tariffs,
especially on routes where airlines compete. The deregulation of the airline industry
allowed airlines to lower costs through restructuring largely around the hub-and-spoke
form and has enhanced the number of city-pair combinations that are served by non-stop
or one-stop service. Prices have also declined on average, particularly for discretionary
travelers and the volume of air travel has significantly increased. Even in the case of the
US, the deregulation of the airline industry has led to substantial benefits for consumers
On the other hand, the alliances have an anti-competitive effect also. There are also
factors which prevent consumers from benefiting fully from the positive effects of
liberalization as some cooperative agreements have anti-competitive effects. Alliances
involving code sharing can have significant procompetitive as well as significant
anticompetitive potential. On the anticompetitive side, they can result in market
allocation, capacity limitations, higher fares, or foreclosure of rivals from markets, all to
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 39
the injury of consumers. On the procompetitive side, they can create new service,
improve existing service, lower costs, and increase efficiency, all to the benefit of
consumers. When a code share is proposed to link a city-pair market served by one
carrier with a city-pair market served by the other, rather than to cover a city-pair market
in which both carriers are actual or potential competitors, the proposed code share would
create what is referred to as an “end-to-end efficiency,” which is generally pro
competitive. Hence, Code sharing generates both pro as well as anti competitive effects.
Code sharing is a bane as the potential loss to the consumers exceed the benefit when the
share of overlapping routes are extensively large.
Hence each alliance is reviewed on a case- by -case basis by the Competition
Authorities to see that there isn’t any adverse able effect of the alliance on
competition.
7.17 Before discussing the anti-competitive effects of Alliances, we first need to
understand what is Code Sharing: Code-share is an arrangement whereby an airline sells
seats, under its own name, on another carrier's flight. Code Sharing is the most common
form Alliance. E.g.: A women had purchased a ticket from Boston to Amsterdam on
KLM-the Dutch carrier. However, KLM doesn’t fly to Amsterdam. Though, the ticket
had the blue livery of the Dutch airline however, the code was that of North West
Airline-An American Carrier. This is referred to as code sharing where by one airline
sells seats under its own name on other carriers’ flights.
How does code sharing lead to anti-completion effects:
Generally, the greatest threat to competition comes when two of very few airlines that
compete in a market enter into a code-share agreement in that market.
7.18 Code sharing raises competitive concerns when the aligning members have
overlapping route networks. To better explain this, let us take a hypothetical example:
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Suppose neither Delta nor American Airlines operate a direct or a connecting flight from
Atlanta to the Kansas City. However, Delta operates a direct flight from Atlanta to Dallas
City while American operates a direct flight from Dallas to Kansas City. The routes in
the example above are complementary because together, they allow travel between two
cities (Atlanta to Kansas City) that is not possible on any one of the airlines in the
example. A code-sharing agreement between the two airlines allows each to sell tickets
on each other’s airline in the Atlanta to Kansas City market. The current literature
generally agrees that complimentarily in route networks among alliance partners ought to
benefit consumers both through reduced fares and expanded networks. However, suppose
prior to the code-share alliance both airlines in the example above offered competing
online service in the Atlanta to Los Angeles market, then this portion of the airlines’
route networks are overlapping, and the alliance could facilitate price collusion. To the
extent that collusion occurs on Overlapping routes, fares on these routes may increase,
causing consumers’ welfare to fall. Hence there are increase in chances of a potential
collusive effect on products that were traditionally competed prior to the alliance, rather
than code-sharing per se.
Alliance allowed with Remedy:
7.19 The European Competition Commission under the provisions of the EC
Merger Regulation cleared the alliance between KLM & Alitalia. The Commission
considered that the alliance was globally pro-competitive, in particular in view of the
largely complementary nature of the parties' activities. Nevertheless, the Commission
found that the operation would have led to monopoly positions on two markets:
Amsterdam-Milan and Amsterdam-Rome. The parties had therefore to accept
undertakings with a view to attract potential new entrants on these markets and to
exercise a competitive pressure on the parties. The remedies included inter alia the
release of a significant number of slots at the congested airports in question and the
reduction of the parties' frequencies (up to 40% of the frequencies actually operated)
when a new entrant starts operating the problematic routes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 41
7.20 International travel is not yet liberalized. It is still dominated by bilateral
agreements where by two nations sign an agreement to allow civil aviation between their
territories. Bilateral agreements continue to restrict competition on aspects such as the
number of possible flights, the number and the identity of the carriers and the airports that
can be served. There fore arose the need for transatlantic alliances. The EU airlines
forged an alliance with American Airlines to increase their connectivity.
Alliance rejected out rightly:
1. American Airlines and the TACA group composed of six Central American airlines
serving Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Republic of
Panama. American and some TACA carrier operated overlapping nonstop flights on
virtually all routes between Miami -- the principal Latin American hub in the United
States -- and the gateway cities in the Central American countries just mentioned, so that
American and TACA had combined market shares ranging from 88 percent to 100
percent on those overlap city pairs. At the same time, the number of passengers traveling
between Interior points in the United States beyond the Miami gateway and interior
points beyond the Central American gateways -- the only passengers who could not
already obtain full on-line service available from either American or the TACA group --
was an extremely small fraction of passengers flying gateway-to-gateway. So we found
this to be an almost exclusively horizontal agreement, in contrast to the largely end-to-
end international code-share agreements we had previously reviewed.
The DOJ concluded that the claimed efficiency benefits that are specific to the
transaction are very slight, while some potential risks to competition would inevitably
persist despite the best efforts to eliminate them through imposing conditions.
2. American Airlines/British Airways proposal.
The two carriers competed in a number of large nonstop city-pair markets, but also, as
was the case with USAir and British Airways in 1991, they compete for passengers
traveling between interior U.S. points and the United Kingdom. A key issue is whether
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and under what circumstances it is likely that "future competitors" will replace the
competition lost as a result of the proposed alliance. With open skies, new entry might be
likely on many of the overlapping city pairs in the absence of airport access constraints,
but the fact is that constraints on new or expanded service at London's Heathrow Airport
are significant. Consequently, we are assessing whether there are any conditions that can
resolve the Heathrow access problems to allow sufficient entry to replace the competition
lost from an American/British Airways combination. Since the DOJ was unsure about the
viability of new entry of a competitive airline service between the United States and the
United Kingdom, DOJ disapproved the alliance.
3. Delta, Continental, and Northwest Alliance:
In August 2002, Delta, Continental, and Northwest submitted code-sharing to the U.S.
Department of Transportation (DOT) for review. The DOT expressed concerns about the
potential competitive effects of the proposed Delta/Continental/Northwest code-sharing
alliance. The DOT’s main concern lies in the significant extent to which the three
airlines’ route networks overlapped, which is unlike any other existing domestic alliance.
The DOT’s analysis revealed that the three airlines offered overlapping services in 3,214
markets accounting for approximately 58 million annual passengers. Given the broad
nature of discussions that is required to implement the alliance, the DOT is concerned
that such communications among the carriers may result in collusion, either tacit or
explicit, on fares and service levels.
7.21 Note: Similar to this domestic alliance, is the recent announcement of Jet Group
Led Naresh Goyal’s willingness & keen ness to forge an alliance with AI for its
International Operations. All though, nothing official has been made till date, however if
the two enter in an alliance with one another in the near future, it would have serious anti-
competitive effects. Things wouldn’t have been different had IA not merged with AI.
Now, things are different. The same alliance would have been a welcome change had IA
not merged with AI. Since, the domestic & the International Carriers have merged, hence
any attempts made towards alliance will have severe impact on competition as the two
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 43
operating carriers have heavy domestic presence. The two carriers have an extensively
overlapping network of routes in the country. Coordination among fares may get
enhanced on domestic operations more than International operations. Together , J et & IA
serve around 50 % of the Indian market .This 50 % is an aggregate all India figure;
however in individual city pair markets , their share may vary from 60% to even 90 % for
different routes owing to their vast route networks and frequency of flights operating per
day. Both of them are Full service carriers with the most extensive route network, which
no other domestic carrier in the country has. The two being the oldest airlines have access
to the peak slots at the congested airports, hence they have a dominant position w.r.t to
certain flights operating on key routes at peak slots. There fore, the commission must
review the Alliance if it takes place in future. It is highly recommended that the
commission must not permit J et & IA to get into Code Sharing Arrangement where by
the two coordinate their prices. The two carriers’ operation’s must be strictly kept
independent in terms of pricing and marketing via Blockaded Seat Arrangement (which I
will discussed shortly). Also, the committee must see whether there exists chances of new
entry if the proposed alliance is leading to anticompetitive effects or say on monopoly on
some routes.
7.22 Hence, in particular, an alliance can significantly reduce competition on
overlapping non-stop routes and overlapping connecting routes where the allied airlines
were once main competitors. Even where the two networks do not overlap in the markets
they serve, the alliance can have serious anti-competitive effects by reducing or
eliminating competition on the hub-to-hub route(s)
5
between the networks. Moreover,
alliances between airlines operating hub-and-spoke networks will normally enhance
demand for the network as a whole and increase the market power of the network,
especially at its hub airports. This entails the risk of rendering still more difficult new
entry into the network's markets to the detriment of both international and domestic
competition.
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In contrast, when a code share is proposed to link a city-pair market served by one carrier
with a city-pair market served by the other, rather than to cover a city-pair market in
which both carriers are actual or potential competitors, the proposed code share would
create what is referred to as an “end-to-end efficiency,” which is generally
procompetitive.
The commission must weigh both the pro and anti-competitive effects of the proposed
alliance before finally granting the anti-trust immunity to the alliance members.
Some important issues relating code sharing from competition angle:
7.23 If the code share partners will both operate flights in the market, the
Division/Commission then considers whether the agreement is structured in a way that
the partners’ capacity, scheduling, and pricing decisions will remain independent -- that
is, whether it is structured in a way that gives each carrier the strongest possible
incentive to sell seats on the flights it operates rather than on those of its code-share
partner, and to cut its prices and improve its service to gain market share against its
partner.
Now, code share agreements are of different types. The carrier that actually carries the
passenger is called as the ‘operating carrier’ while the carrier that doesn’t operate that
Route, yet it markets that route is called as the ‘marketing carrier’. Now, there are
different levels of cooperation’s possible in code sharing. First of all, airlines might give
their code-sharing agreement partners free or limited access to their seats. Free flow (free
sale) code-sharing agreements give the marketing carrier access to the operating carrier’s
inventory and allow it to market seats independently of the operating carrier. The risk is
completely on the operating carrier since the marketing carrier functions almost as an
agent.
5
Refer to Appendix for Hub-Spoke Network
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Nancy Shah, 30.7.07 45
7.24 With respect to pricing, airlines might set the price of the seat sold under a
code-sharing agreement either in a coordinated way, which may lead to the result that the
seat will be sold at the same price wherever (operating or marketing carrier) the ticket is
bought, or each airline participating in the agreement can set its prices independently.
Where the code share does not entail a blocked space agreement, airlines have to agree on
how to compensate each other for the seats sold on one another’s flights. This is normally
done in special pro-rate agreements which establish the terms of revenue proration
between the partners.
7.25 One approach taken in some code shares to preserve some independence in
pricing and marketing of seats on the shared flights has been to use a block seat
arrangement, where the marketing carrier purchases a fixed number of seats and bears
the risk of loss if those seats are not sold. The block-seat arrangement is not an ideal
solution, because the cost of the block of seats to the non-operating carrier, which is the
key determinant of the ultimate fare to the consumer, is set by agreement between
competitors. But the block seat arrangement is an improvement over joint sales and
marketing, because it can create some additional incentive to each partner to market its
seats aggressively.
In cases in which independent operations by the two partners are not contemplated or
considered likely under their proposed code-share agreement, and the Division concludes
that the code-share agreement would reduce or eliminate competition between the code-
share partners in certain city-pair markets, the next step in the Division’s analysis will be
to consider how likely it would be that new competitors would enter these markets in
response to any anticompetitive behavior by the code-share partners. If sufficient and
timely entry could be expected to neutralize any anticompetitive behavior, then the
Division would conclude that the code-share agreement would not be likely to create or
facilitate the exercise of market power by the code-share partners.
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7.26 At the international level (and outside the EU), bilateral agreements continue
to strictly limit the scope for competition. In particular, bilateral agreements limit, in
various ways, the number and identity of the airlines that can provide services between
two countries, the routes that can be flown, the number of flights that can be offered on
each route and sometimes the capacities and fares that can be offered. Bilateral
agreements often also prevent indirect flights from undercutting the price of non-stop
service. The bilateral system has been used to sustain inefficient national “flag carrier”
airlines and in the process has kept fares up, raising costs to consumers and to other
industries and has impeded the development of new travel products. In recent years some
countries (particularly the US) have sought to negotiate “open skies” agreements which
are less restrictive in regard to the number and identity of airlines and the routes or
capacities that can be flown. A number of such agreements have been signed between the
US and individual EU countries. These agreements still do not permit entry from carriers
based in countries outside the agreement to fly on routes covered by the agreement (e.g.,
a USUK open skies agreement would not permit Alitalia to fly London-Rome-New
York). Nor do the agreements permit cabotage (e.g., an US-UK agreement would not
allow BA to carry passengers from New York to San Francisco when flying London-New
York-San Francisco). There remains considerable scope for further multilateral
liberalisation, particularly in relation to the discriminatory treatment of foreign-owned
airlines.
7.27 Hence, in the case of an international code share, an important threshold factor
in assessing likelihood of new entry is whether the market is covered by an “open skies”
bilateral agreement. Open skies means that new entry by a carrier is legally possible,
although we would still need to investigate how likely such entry actually would be in the
event the code-share partners attempted to raise fares or reduce service. However, new
entry is legally constrained by a restrictive bilateral agreement, the threat to competition
of a code share on that city pair could be substantial, particularly if the code-share
partners were the only two carriers authorized under the bilateral agreement.
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Nancy Shah, 30.7.07 47
Conclusion:
7.28 The Antitrust Division assesses on a case-by-case basis -- and market-by
market basis -- whether a proposed code-share alliance is likely to act as a disincentive
for the alliance partners to enter markets served by the other or to compete vigorously in
markets that they both serve. Commission must look to see whether the alliance is likely
to divide and allocate markets, or to produce high fares. Commission will place critical
importance on carefully reviewing the actual terms of each alliance agreement. Incentive
for each partner to market its own seats. Similarly, they would also look to see if there
were persuasive evidence that the code-share agreement would result in significant
procompetitive efficiencies in serving other city pairs on a code-share basis -- efficiencies
that could not otherwise be obtained except through the code share. If so, also would
assess whether the procompetitive effect of these efficiencies would outweigh the
potential competitive harm in the overlap city pair.
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PART VIII:
AIRLINES MERGERS & ACQUISITIONS:
VIII.A
REGULATIONS GOVERNING M&A IN INDIA
8.1 Before going into the competition related issues pertaining to M&A of
airlines, we’ll first have a look at the current policy framework going M&A in India.
Regulations governing Mergers & Acquisitions in India:
1. Mergers and acquisitions are regulated by the provisions of the Companies Act, 1956,
as amended (‘Companies Act’)
2. Securities and Exchange Board of India Act, 1992 (‘SEBI Act’) and the guidelines,
rules and regulations framed there under specifically the Securities and Exchange Board
of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, as
amended, (‘Takeover Code’)
3. Other legislations governing commercial transactions eg: Independent Regulator’s
approval.
4. The Competition Act, 2002 (‘Competition Act’) that has been enacted but is not yet
fully enforced, contains provisions for governing competition issues relating to mergers
and acquisitions.
8.2 The Takeover Code requires an acquirer of shares which (taken together
with his existing shares or voting rights) would entitle him to more than five per cent of
the shares or voting rights in the target company, to make disclosures to the target
company and to the stock exchanges where the shares of the target company are listed.
The acquirer(s) is also required to make a public announcement in case he acquires
shares or voting rights (taken together with his existing shares of voting rights) that
would entitle him to fifteen per cent or more of the voting rights in the target company.
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Nancy Shah, 30.7.07 49
The Takeover Code also restricts consolidation of holdings and indirect acquisition of
control over the target company without making a public announcement. Takeover
Code applies only to listed companies.
8.3 Sections 391 to 396 of the Companies Act embody the law relating to
mergers, amalgamations and reconstruction of companies. Under the said provisions
the merging companies have to approach the appropriate High Courts (amended to
National Company Tribunal by the Companies (Second Amendment) Act, 2002 but not
enforced as yet) for convening a meeting of the shareholders. The shareholders have to
pass the scheme of merger by a three-fourth majority. The scheme is also required to
be approved by the High Court. Section 396 also empowers the central government to
recommend mergers or amalgamations of companies in the national interest.
8.4 The Companies Act also provides restrictions on acquisition or transfer of
shares. These restrictions however apply only to a ‘dominant undertaking’, the term
being defined under the Monopolies and Restrictive Trade Practices Act, 1969 (‘MRTP
Act’) to mean an undertaking having a market share of at least twenty five per cent.
Section 108A of the Companies Act requires prior approval from the central
government for acquisition of shares exceeding 25 per cent (taken together with any
existing shareholding in the target company) of the total paid-up capital of a public
company or a private company that is a subsidiary of a public company. Section 108B
requires a body corporate or a group of bodies corporate under the same management
and holding 10 per cent or more of equity shares of a company to notify the central
government of any transfer of equity shares. Also, any transfer of equity shares by a
body corporate or bodies corporate holding 10 per cent or more of the equity capital of
a foreign company requires prior approval of the central government before
transferring such shares to an Indian citizen or a company established in India. The
central government has the power to restrict acquisition or transfers that may result in
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change in the controlling interest in the company and which is prejudicial to the
interest of the company or to the public interest.
8.4 The Competition Act contains provisions for regulation of acquisitions,
takeover mergers etc. of enterprises. Section 5 of the Competition Act , 2002 has laid
down some benchmarks standards on whose satisfaction ,the Commission will invoke an
enquiry into the proposed Mergers seeking to check whether it has any anti-competitive
effects or not. No person or enterprise shall enter into a combination which causes or is
likely to cause an appreciable adverse effect on competition within the relevant market in
India and such a combination shall be void.
Section 5 of Competition Act, 2002:
8.5 The acquisition of one or more enterprises by one or more persons or merger
or amalgamation of enterprises shall be a combination of such enterprises and persons or
enterprises, if—
(a) any acquisition where—
(i) the parties to the acquisition, being the acquirer and the enterprise, whose
control, shares, voting rights or assets have been acquired or are being acquired
jointly have,—
(A) either, in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which the enterprise whose control, shares, assets or voting
rights have been acquired or are being acquired, would belong after the
acquisition, jointly have or would jointly have,—
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 51
(A) either in India, the assets of the value of more than rupees four
thousand crores or turnover more than rupees twelve thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than two billion US dollars or turnover more than six billion US dollars; or
(b) acquiring of control by a person over an enterprise when such person has already
direct or indirect control over another enterprise engaged in production, distribution or
trading of a similar or identical or substitutable goods or provision of a similar or
identical or substitutable service, if—
(i) the enterprise over which control has been acquired along with the enterprise over
which the acquirer already has direct or indirect control jointly have,—
(A) either in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which enterprise whose control has been acquired, or is being acquired,
would belong after the acquisition, jointly have or would jointly have,—
(A) either in India, the assets of the value of more than rupees four thousand crores or
turnover more than rupees twelve thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more than two billion
US dollars or turnover more than six billion US dollars; or
(C) any merger or amalgamation in which—
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(i) the enterprise remaining after merger or the enterprise created as a result of the
amalgamation, as the case may be, have,—
(A) either in India, the assets of the value of more than rupees one
thousand crores or turnover more than rupees, three thousand crores; or
(B) in India or outside India, in aggregate, the assets of the value of more
than five hundred million US dollars or turnover more than fifteen
hundred million US dollars; or
(ii) the group, to which the enterprise remaining after the merger or the enterprise created
as a result of the amalgamation, would belong after the merger or the
amalgamation, as the case may be, have or would have,—
(A) either in India, the assets of the value of more than rupees four-
thousand crores or turnover more than rupees twelve thousand crores; or
(B) in India or outside India, the assets of the value of more than two
billion US dollars or turnover more than six billion US dollars.
However, the Competition Act has not been enforced as yet. The Competition
Commission of India (‘CCI’) established under the provisions of the Competition Act
will regulate mergers and has the power to reverse a merger or acquisition if it is of the
opinion that a merger or acquisition will have or is likely to have an appreciable adverse
effect on competition in India.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 53
VIII.B
CASES OF M&A ABROAD:
Case of Air France and KLM:
8.6 As the name suggests Air France is a French based Airline with significant
international operations. The Air France group has three main activities: passenger airline
transport, cargo transport and maintenance services. Air France operates a hub-and-spoke
network with its principal hub for international operations at Paris Charles de Gaulle
airport and its main domestic hub at Paris-Orly airport. It is also one of the founding
members of the SkyTeamalliance, which members are, in addition to, Alitalia, Delta,
CSA Czech Airlines, Korean Air and Aeromexico.
8.7 Where as KLM is a Dutch-based full-service carrier operating worldwide. The
KLM group has four main activities: passenger airline transport, cargo transport,
maintenance services and the operation of charter and low-cost/low-fare scheduled
services by its subsidiary Transavia. KLM operates a hub-and-spoke network with its
principal hub at Schiphol airport. KLM has an alliance with Northwest Airlines covering
principally operations on North Atlantic routes and related feeder routes.
Now Air France while is part of the Sky Team Alliance who is bound by “Global
Alliance Agreement” where in members had entered into separate bilateral agreements.
Air France had entered into agreements with Delta, Alitalia and CSA Czech Airlines.
KLM has, on its side, concluded an Enhanced Alliance Implementation Agreement with
Northwest to form the KLM/NW J oint Venture. This agreement establishes a
transatlantic joint venture pursuant to which the two partners coordinate scheduling,
marketing, sales and prices on all their transatlantic operations and on routes beyond their
respective hubs.
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On 18 December 2003, Air France and KLM notified a framework agreement according
to which Air France will acquire control of KLM. Although the deal will create the
largest airline group in Europe, the companies’ networks are largely complementary, the
Commission’s investigation showed. Air France is more present than KLM in Southern
Europe and Africa, for example, whereas KLM operates a higher number of routes to
Northern Europe and the Far East.
8.8 From a consumer point of view, the combination will allow KLM customers
to have access to more than 90 new destinations while Air France customers will be
offered 40 new routes. The combination of the two airlines is also expected to bring
benefits to consumers and the economy as a whole from costs savings as well as from
service improvements resulting from combined networks.
8.9 The Commission has always looked favorably on the consolidation on the
airline sector, but has also insisted that consolidation would not be done at the detriment
of consumers. This is true for the alliances that have taken place in the last decade. It is
even truer for mergers which are cleared once and for all, as opposed to the six-year
Antitrust immunity usually granted to alliances.
Despite it being largely complementary, the Air France/KLM deal - the first real merger
in the European airline industry - will eliminate or significantly reduce competition on 14
routes where they currently compete actively of potentially. These are:
1. Intra-European routes (Amsterdam-Paris, Amsterdam-Lyon, Amsterdam-Marseille,
Amsterdam-Toulouse, Amsterdam-Bordeaux, Amsterdam-Rome, Amsterdam-Milan,
Amsterdam-Venice and Amsterdam-Bologna).
2. Intercontinental or long-haul routes (Amsterdam-New York, Paris-Detroit,
Amsterdam-Atlanta, Paris-Lagos (Nigeria) and Amsterdam-Lagos).
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 55
The Commission’s experience in this field shows that the main barrier to market entry
lies in the scarcity of take-off and landing rights at the highly congested European
airports and Paris and Amsterdam are no exception. Remaining national regulatory
restrictions may also prevent free competition especially with regard to indirect flights on
long haul routes.
Commitments
8.10 In order to overcome the Commission’s concerns, the parties have
committed themselves to surrender 47 pair of slots (i.e. 94 single take-off and landing
slots) per day. This creates the conditions for a total of up to 312 new return flights a day
to emerge on the affected routes. This means, for example, that a competitor could start
six new daily return flights between Paris and Amsterdam and the same or another
competitor would also offer one daily return flight between Amsterdam and New York
guaranteeing that passengers on these routes have a choice of services and competitive
prices. For the first time, the surrender of slots is for an unlimited duration, compared
with six years for the alliances, and the slots must be returned to the slot coordinator if
they are misused or underused by the new entrant, not to the airline partners. In order to
encourage market entry, a new operator might also acquire so-called grandfather rights
over the slots obtained for the Paris-Amsterdam route after a confidential period,
provided that the new entrant stays on the route for at least three years. This means he
will be able to use them for other destinations once the high speed railway link will be
completed between the two capitals or when other competitors will have emerged. The
impact of such a provision is to increase the value of the slots released, and, thereby, to
significantly reduce the risk of lack of new entry.
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Merger of United Airlines with U.S Airways:
8.11 United Airlines and US Airways initially announced their proposed
merger in May 2000.
The parties made submissions to the Department and announced some changes in J anuary
2001, United and US Airways are the second and sixth largest U.S. airlines. The
acquisition would give United a monopoly or duopoly on nonstop service on over 30
routes, where consumers spend over $1.6 billion annually, and substantially limit the
competition it faces on numerous other routes representing over $4 billion in revenues.
US Airways is United’s most significant competitor on densely-traveled, high revenue
routes between their hubs, such as Philadelphia and Denver, as well as for nonstop travel
to and from Washington D.C. and Baltimore, and on many routes up and down the East
Coast.
8.12 The Department maintains that the proposed acquisition would violate the
antitrust laws by reducing competition in:
1. Hub-to-Hub Nonstop Markets Passengers spend over $900 million annually to travel
on routes between United’s and US Airways’ hubs. On seven of these routes, US
Airways and United are each other’s most significant competitor, and on four of those
(Philadelphia-Los Angeles, San Francisco and Denver; and Pittsburgh-Washington, D.C.)
US Airways and United are each other’s only nonstop competitor. On the other seven
hub-hub routes, US Airways is currently the only airline offering nonstop service, and
United is the most likely airline to enter.
2. Washington, D.C. and Baltimore Nonstop Markets. United and US Airways offer
competing nonstop service between Washington, D.C. and many cities, such as
Rochester, NY, and New Orleans, LA. They are also the only two airlines providing
nonstop service between Baltimore and Los Angeles and San Francisco. Consumers
spend over $1 billion each year to travel in these markets.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 57
3. East Coast Connect Markets. Because they operate most hubs that provide
connecting service between cities in the eastern United States, United and US Airways
are the only two airlines, or two of only three airlines, offering connecting service
between northeast cities such as Albany, NY and Burlington, VT, and southeast cities
such as Greensboro, NC and Roanoke, VA. The acquisition would solidify their control
over the major connecting hubs for east coast traffic -- Pittsburgh, Philadelphia,
Washington-Dulles, and Charlotte.
4. International Routes. US Airways compete with United (through United’s marketing
alliance with Air Canada and Lufthansa) in a number of international markets. In several
of these, including Philadelphia-Toronto and Philadelphia-Frankfurt, the acquisition
would eliminate the only nonstop competitor for United’s alliance partner.
5. Corporate and Government Business. Like the other major airlines, United and US
Airways bid for high volume contracts with large corporations, negotiating discounts to
their airfares in return for a corporation’s commitment to concentrate travel on the airline.
They compete vigorously against each other, particularly when the corporation requires
significant travel on nonstop routes where United and US Airways compete. United and
US Airways also compete for the $1 billion the U.S. government spends on air travel, and
were the only two, or two of only three bidders, on many city pairs.
6. Airline Service Concentration. United’s acquisition of US Airways will create or
enhance dominance at many cities throughout the United States, including Boston,
Washington, and Philadelphia. Competition for the millions of passengers traveling to
and from these cities will decrease, resulting in higher fares and reduced service.
8.13 United and US Airways offered proposals to limit the loss of competition
from this merger by proposing to - a divest assets at Reagan National airport and a
promise by American Airlines to fly five routes on a nonstop basis was found insufficient
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by the Commission. The proposal did not assure competition for those adversely affected
by the acquisition, such as passengers in east coast connect markets. Hence, the merger
was aborted in its initial stages.
VIII.C
CASES OF M&A IN INDIA:
1. The Jet-Sahara Mega Merger:
On 20 th April , 2007 J et acquired 100% stake in Air Sahara 15 months after signing the
original purchase agreement. J et purchased its arch rival for INR 14.5 billion (3500 USD
Million) which is 35 % less than the price agreed in 2006. The ultimate consummation of
Sahara represented the conclusion of the arbitration exercise that has been going on since
J ully, 2006. J et has announced its going to re brand Sahara as “J etlite” which would
operate as a value carrier. The new entity would offer reduced frills but would be over
and above LCC in terms of service .They together account for a market share of 28% as
on May.2007 which is sharply in contrast to their market share in J an, 2006 which was
more than 45% reflecting increase in competition and fragmentation since then.
2. The Air Deccan-Kingfisher Merger:
The merger between the pioneer LCC and liquor baron was announced on 31
st
May, 2007
as the United Brewies, picked up 26% stake in Air Deccan and propose to buy another 20
% via an open offer. The deal UB group paid a whopping INR 550 Crore to pick up a
26% stake in the LCC.
3. The Air India-Indian Merger:
The two state run carriers entered into a merger in April, 2007 in a bid to consolidate and
optimize the use of the assets of the two public sector airlines. The will help the two
airlines to synergize their operations.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 59
SECTION IX
COMPETITION ISSUES RELATED TO THE INDIAN AVIATION SECTOR:
9.1 Competition Act, 2002 prohibits associations or enterprises to enter into an
agreement in respect of production, supply, distribution, storage, acquisition or control of
goods or provision of services, which causes or is likely to cause an appreciable adverse
effect on competition within India. The central theme of the competition act, 2002 is to
prohibit:
i. Anti-competitive agreements
ii. Abuse of dominance
iii. Regulation of M&A
Now, we shall be analyzing the Competition related issues with the above-mentioned
themes in the background.
9.2 The Indian aviation sector has its own competition related issues that need to
address. Some need to be addressed by the ministry where as some must be evaluated by
the competition authorities. The Indian aviation sector in a nutshell is plagued with the
following issues:
1. Regulatory Barriers
2. Scarcity of slots
3. Cartelization
4. Regulation of M&A
Now we shall be addressing each issue separately and analyzing the competition related
matters with the same.
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I. REGULATORY BARRIERS:
One of the most important considerations in front of the Commissions across the world
when evaluating cases from Competition angle is to consider the possibility of new entry.
The Competition Authorities may not interfere in a case even if an existing incumbent is
making super normal profits by abusing his dominant position. Reason being the
possibility of new entry which would erode the incumbency benefit and bring prices back
to the normal level. However, problem may arise in those cases where the incumbency
benefits can not be checked by possibility of new entry. This is indeed the problem with
the Airline Industry. There isn’t free entry in this industry. New entry is curtailed owing
to the regulatory barriers & capacity constraints (namely slot allocation-competition in
vertically related markets) & hence an important source of competition is & will be lost.
First, we will focus on Regulatory Barriers.
Though the Domestic Air travel Policy is reasonable and liberal. But there are several
issues which may require some reconsideration. These are stipulation about minimum
fleet size and minimum equity capital for new entrants and route dispersal guidelines as
mentioned below.
The key features of present domestic air transport policy are:
1. Private sector is allowed to operate scheduled and non-scheduled services.
2.. The scheduled operators are required to follow route dispersal guidelines - an
administrative mechanism that was aimed at extending air transport services to
regions/routes that is not necessarily commercially viable where by each domestic carrier
is suppose to deploy some fixed % of its capacity on class II & III Routes.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 61
3. Operators are required to have a stipulated level of fleet size and subscribed equity
capital. For example, scheduled operators should have five aircraft (by outright purchase
or lease) and a minimum subscribed capital of Rs. 10 crores. (Rs. 30 crores if operators
have an aircraft of maximum take-off mass exceeding 40,000 kg.).
4. Foreign equity participation up to 49 per cent and investment by Non-Indian Residents
(NRIs), Overseas Corporate Bodies (OCBs) up to 100% is allowed. The representation of
the foreign investing institution/entity on the Board of Directors of the company shall not
exceed one-third of the total.
5. Foreign airlines are not permitted to pick up equity. Foreign financial institutions and
other entities who seek to hold equity in the domestic air transport sector shall not have
foreign airlines as their share holders.
6. Open skies policy for cargo services.
7. As regards safety and security arrangements, the operators must ensure compliance
with relevant regulatory requirements stipulated respectively by the Director General of
Civil Aviation (DGCA) and the Bureau of Civil Aviation Security (BCAS).
8. A domestic carrier must have flown for at least 5 years before entering the
International Skies.
Source: Domestic Air Transport Policy, Ministry of Civil Aviation
1. Min Capital Requirements & Fleet Size
The government’s announcement of minimum equity requirement & fleet size is
essentially considered to be obstructive. According to the Naresh Chandra Committee
Report, 2003 such requirements and analysis may be better left to the investors including
their bankers, financial institutions, and financial analysts or a regulator.
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2. Route Dispersal Guidelines:
Likewise, to safeguard the interest of remote and backward areas, in 1994 the
government issued ‘route dispersal guidelines’ for scheduled services operations on
domestic routes. Under these guidelines, any one who operated services on specified
trunk routes will have to provide a minimum proportion of such services on non-trunk
routes and remote and backward areas. These guidelines are mandatory.
9.3 These guidelines have taken their tolls on the profitability and viability of
airlines & making the airline business unattractive. The route dispersal guidelines may be
inadvertently hindering the emergence of specialized airlines with appropriate aircraft to
cater to regional and short-haul feeder routes. This is because given that the larger
airlines are bound by the route dispersal guidelines to operate a specified percentage of
their deployed capacity on Category II & III routes (regardless of viability of such
operations) they can (potentially) undercut the specialized airlines on these routes.
Recently, government announced its desire to develop Specialized Regional airlines. In
face of the current regulation, the route dispersal guidelines will definitely hurt the
regional as well as large carriers. The implicit subsidy is indirect and not transparent and
therefore not appropriate from general economic point of view. From a long-term point of
view, there should be a clear policy on subsidizing air transport services on these routes
by reimbursing the carriers from a Universal Fund Scheme (just like we have it for
Telecom Sector). Or another way of preserving profitability & as well the objective of
access to the remote locations is by allowing major carriers to focus on trunk routes of
their choice and enable specialized carriers to service such feeder airlines.
3. Minimum Requirement of Domestic Flying for 5 Years & Min fleet of 20 aircrafts is a
must for seeking permission to fly internationally.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 63
9.4 This policy regulation is highly discriminative and is leading to a near
duopoly situation in terms of the number of domestic players allowed to serve the
International Skies. International flights are a major attraction for the nascent domestic
players owing to their high profitability on these routes. Under the current policy regime
only J et/Sahara and AI/IA are now allowed to serve internationally, as they are the only
two players who meet these criteria. However, the nascent players who began their
operations in 2003 have given these incumbents a tough competition in terms of service,
route networks, and market shares. They too have been able to match the incumbent’s
standards & that the reason why the incumbents could not help prevents their slipping
market share. But these Incumbents seem to enjoy an unrivalled position as they are the
only domestic carriers flying internationally. What further adds salts to the wounds of the
new players is that government is allowing other new international players with fleet size
and experience which is far less than the Indian Regulation to fly in & out of the country.
Eg. Nok Air.
Hence, the current policy regulation is highly discriminative and is undoubtedly favoring
the incumbents. The scenario has become more grave now as the domestic players in the
international skies have been reduced to two players as compared to four players prior to
the merger of J et – Sahara ; IA-AI.
4. Benefits accruing to State carriers as they are the only domestic carriers allowed to fly
to the Gulf.
The existing policy framework bars the domestic carriers other than the national carriers
from entering the Gulf Routes. The Gulf Routes are an important source of revenue as
they have maximum number of passengers traveling to these routes as shown below:
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Fig 6:
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9.5 According to unofficial estimates, the state carrier AI pulls out around 40 % of
their earnings from these Gulf Routes. The national carriers are dominant players on
these sectors & are enjoying monopoly gains and are depriving other carriers from an
important source of revenue. However, some socialists who are favoring the current
reservation argue that the provision of exclusive right to the national carriers will help the
carriers cross subsidize their operations to the routes which are unviable but have to be
served as they are the country’s national carriers. However, this subsidization argument is
depriving other industry players from an important source of revenue. Consumers are
also worse off as they have no choice in terms of carrier or any substitute mode of
transport.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 65
II. CAPACITY CONSTRAINTS:
9.6 Going by simple rule of demand & supply, if demand for one good is rising
then supply correspondingly is increased to match the demand. However, this is not
possible for the
Aviation sector as capacity cannot be augmented in response to demand. Airports have a
fixed capacity and in terms of their ability to handle traffic. In absence of alternate
airports, the major metropolitan airports are becoming congested and are constrained in
terms of capacity. Now this may act as a barrier to entry for new entrants as there is acute
shortage of slots
6
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current regime where slots’ allocation is based upon grand fathered rights
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9.7 Slots are rights to take off or land at particular time of the time. The issue of
slots is important as the existent carriers may shoo away competition by taking advantage
of the capacity constrained airports.
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Fig-2
LEVEL OF CONGESTION AT MAJOR CITIES
9.8 As seen above, the current capacity is struggling to keep pace with the current
demand at the major metropolitan airports. The allocations of slots are a prime issue in
front of the new entrant as it will decide its profitability. The passenger load factors are
highest on the metropolitan routes like Delhi-Mumbai at peak times. As we earlier
defined that the relevant market is the travel from city of Origin to the destination city at
a particular time on a particular day. Route & time are important factors governing the
profitability of this sector. E.g. Delhi-Mumbai sector is the most congested sector with
maximum passenger load registered for morning and evening slots.
9.9 Capacity constraint benefits the Incumbents more than the late entrants as they
are able to occupy airport infrastructure on a first come first serve basis. We
go a step ahead to dwell on this issue: Say I take a route, which is Delhi-
Mumbai. It is the most populous and the most crowded route. Reason being,
Mumbai is the commercial and the financial hub of the nation where as Delhi
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Grand Fathered Rights are rights issued on first come first Serve Basis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 67
is the national capital. Millions of passengers shuttle everyday between Delhi
and Mumbai. Most of them for business purposes while some for leisure
purposes, the ratio being 65:35. I have deliberately chosen Delhi-
Mumbai Route as over half of India’s 33 million passengers traffic per annum is
generated from this route.
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9.10 Now carriers try & target the business class more than the leisure class as
their responsiveness to price changes (5-10%-SSNIP Test) is negligible. The relevant
market as defined earlier is Origin & Destination Wise City Pair Market that is serving a
particular market at a particular time. Time is money and carriers understand this very
well, that is why carriers like IA and Jet have strategically timed flights to fit the
schedules of the business class. E.g. IA has occupied prime slots and timed its flights at
strategic timings such as 7AM;8AM;9AM;10AM;11AM;12AM;1AM ,5PM,6PM, 7PM,
8PM, 9PM.Similar is the case for Jet. However, this entails Incumbency Benefits as these
two incumbents have cornered peak slots on major trunk routes which may deprive the
late entrants from having access to such peak slots.
The following figure gives the distribution of the number of carriers operating on a
particular day on Delhi- Mumbai route:
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Fig 3:
Distribution of flights operating between
Delhi to Mumbai during on a particular day.
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J et
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9.11 From the figure, it is evident that the peak slots are morning and evening
slots. Typically morning slots between 6:00-8:00 AM are very popular with
businessmen as they can reach their destination by 11 AM, finish off their work and
go back by evening & this explains the skewed nature of the graph towards 18:00-
20:00 slot. Now airlines want to capitalize on this weakness of passengers knowing
8
Source : http://www.dnaindia.com/report.asp?NewsID=1111855
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 69
that there isn’t any alternative present with the passengers. Passengers flying to
Bombay are unlikely to swap their morning flights with evening flights irrespective of
the fare differences. Say ,if a person swaps his morning flight & delays his trip by 5
hours ,he is able to save Rs 1000 i.e. effectively Rs. 200 per hour, however the
opportunity cost for his business would any day be more than the income saved !
Opportunity costs would be grater than Rs 200 /hr atleast. Time is money. Imagine an
entire work day being wasted just to save Rs 1000. Instead of catching a 10’o clock
flight, he catches a 3 ‘o clock flight. By the time, he makes his way through the
densely populated city, its already 6’o clock, time for the markets to close. Imagine, a
man going to Bombay to sign a contract. What would he do, take a 3’o clock flight or
morning flight?
9.12 The financial markets namely the National Stock Exchange and BSE are
closed by 4’o clock. In such a scenario, employers whether self employed or
otherwise give priority to their million dollar work than the peanut differences in air
fares. No wonder, this is the reason that despite their being availability of oddly timed
cheaper tickets such as Air Deccan, most of IA and J et’s executive class seats for
peak slots goes full when checked for availability, one day before departure.
Carefully examining the schedules, we find heavy presence of J et, Indian on morning
flights and evening flights. Both the carriers have chosen very strategic time slots:
having a close look at Indian’s schedule, we find that IA has placed each successive
morning & evening flight at a distance of one hour each. Similar tendencies are seen
with J et who has occupied prime slots. Since the relevant market for our analysis is
referred to as Origin & Destination passengers traveling between Delhi-Mumbai who
are time sensitive businessmen & whose elasticity of demand is therefore low in
responsiveness. There lies the catch for Abuse of Dominance. These carriers will
have enhanced pricing power w.r.t exploiting the business class. Both of them (IA &
Jet) are full service carriers. They adopt loyalty programs such as frequent flier
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programs; corporate discounts; travel agent schemes etc to distinguish between the
business class and others. Both the Incumbents have access to good quality of slots
which there by entails the problem of Incumbency Benefits in face of growing
infrastructural capacity constraints at the airports. It is clear that slot constraint acts
as a major competition issue since it acts as a barrier to new entry and deprives the
new entrants from an important source of income & consumers of an important
choice. What is more important is having quality of slots than having quantity of
oddly timed slots. The incumbents are better off as they have the best slots. The
domestic policy must therefore address the slot allocation problem more clearly. With
the recent merger of Jet and Sahara, Jet has acquired all the user slots of Sahara.
With this, Jet has the best of both the world’s. Jet has quantity as well as quality of
peak slots which it might use to abuse its dominant position on key trunk routes. I
have just picked one of the Twelve Trunk routes. Similar Incumbency benefits might
be present on all other routes as well.
9.13 In the wake of the recent mergers , there is an addition in the current domestic
air transport policy i.e. if the acquiring carrier doesn’t use the existing user rights of the
carrier that it is taking over then in that case they will be by default passed on to the
Airports Authority of India(AAI). The user rights are essentially part of AAI and cannot
be passed on between airlines. They will essentially be distributed by AAI & Directorate
General of Civil Aviation (DGCA). However, this regulation of use-it-or-loose it user
rights doesn’t address the problem completely. Firstly, why will an acquiring carrier give
up peak slots. Secondly, nothing concrete has been said in the literature about the
incumbency benefits that accrue to the niche players as the current slot allocation system
is based upon grand fathered rights. J et , Sahara , IA are having access to peak slots
which is depriving the other players who too might want to service the trunk routes at the
same time.
The concerns have been expressed last year when J et announced its plan to take over
Sahara. Air Sahara's rights must be redistributed to all airlines in order to prevent J et
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 71
Airways from attaining a dominant position in slots as this would restrain growth of
competition. Air Sahara's aviation rights should not automatically accrue to J et; the latter
should instead be required to re-apply for securing additional rights. The DGCA, as the
competent authority should use this window to re-distribute Air Sahara's rights to all
airlines. Had Air Sahara continued and given the inevitability of its closure, its rights
would have anyway got released for distribution to others, and not available only to J et.
The DGCA must take into account these factors.
Hence, fair allocation of slots is an important issue that needs to be addressed as it will
enhance competition and wipe off age old incumbency benefits if any. The literature is
full of methods for allocation of slots, however, these methods are not free from cons
9
.
Regulations regarding M&A in our Domestic Air Transport Policy:
Consistent with the global trends in aviation, aviation sector in India has & is likely to
witness consolidation amongst airlines. The question regarding use of airport
infrastructure in case of merger / take over of airlines and sale / transfer of aircraft etc.
has drawn attention of the Government for quite some time. The following general
principles formed the basis for consideration in our Domestic Air Transport Policy:
1. After examining the pros and cons of the various alternatives particularly with
reference to the position of the civil aviation sector in the Indian context, it has
been decided that the airlines that takes over the aircraft pursuant to merger / take
over or sale / transfer of the aircraft may be allowed the use of airport
infrastructure like parking bays, landing slots etc., which is allotted by Airport
Operator without any payment. This was particularly necessary as the transferred
aircraft is in operation in the country already availing the airport infrastructure.
9
Refer to APPENDIX IV for methods for Allocation of slots
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2. In terms of schedules / connectivity etc. it will be in public convenience if usage
of such infrastructure is allowed to the airline that take over the aircraft provided
the user rights are actually used by the airline. Only the user rights over such
infrastructure that are given to an airline on non-payment basis e.g. parking bays,
landing slots etc. may be allowed to be used by the airline that takes over the
aircraft. For all other rights, the terms of lease / sale agreement between the
airport operator and the airline may apply.
3. It may be clearly stated that the user rights belong to the Government / airport
operator and therefore, cannot be transferred by one airline to the other airline in
any event. The Government / airport operator shall allow the user rights to be
availed by the airline that takes over the aircraft.
4. User rights may be allowed to be used by the airline that takes over the aircraft
only in respect of those rights, which are actually under use by the airline that
transfers the aircraft. All other rights will be taken over by the Government /
airport operator. The user rights will be available with the airline that takes over
the aircraft only till such time that the infrastructure concerned is under actual use.
If the airline that takes over the aircraft does not use the concerned infrastructure,
it will lose the user rights over the infrastructure.
As mentioned before that this policy regulation solves the problem of incumbent
carriers hoarding the unviable slots for restricting new entry but still it doesn’t
solve the incumbency problem. Still slots are allocated on Grand fathered rights
system
10
. Given that relevant market is 0rigin & Destination city pair market at a
particular time, so timings play a pivotal role in determining the revenue receipts
of various carriers. At least 50 % of FSC are business travelers at an aggregate
level. Carriers use corporate bulk purchases; frequent flier programs; travel agents
schemes to identify the business class traveling on board. Due to sporadic
availability of slots, entrants find it very hard to acquire sufficient slots to
10
Grand Fathered Rights: Rights assigned on first come first serve basis.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 73
establish a viable service pattern in city pair markets at the Convient timings.
Authorities however on record haven’t documented any policy to wipe off this
kind of incumbency benefits although there is news of the requisite provision
being made in Vision 2020, which is currently under, scrutiny of the Group of
Ministers.
III. CARTELISATION:
People of the same trade seldom meet together, even for merriment and diversion,
but the conversation ends in a conspiracy against the public, or in some
contrivance to raise prices.
Adam Smith, The Wealth of Nations, 1776
A cartel is a group of formerly independent producers whose goal is to increase their
collective profits by means of price fixing, limiting supply, or other restrictive practices.
Cartels typically control selling prices, but some are organized to control the prices of
purchased inputs. Cartels are prohibited by antitrust laws in most countries; however,
they continue to exist nationally and internationally, openly and secretly, formally and
informally.It may be guilty of abusing said monopoly in other ways. Cartels usually
occur in oligopolies, where there are a small number of sellers and usually involve
homogeneous products.
As per section 3 of the Competition Act, 2002 any agreement which causes or is likely to
cause, appreciable adverse effects on competition in markets in India is prohibited.Any
such agreements will be void.
Any agreement entered into between enterprises or associations of enterprises or persons
or associations of persons or between any person and enterprise or practice carried on, or
decision taken by, any association of enterprises or association of persons, including
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cartels, engaged in identical or similar trade of goods or provision of services shall be
presumed to be anti-competitive if they —
a.) directly or indirectly determines purchase or sale prices;
When the parties enter into collusion, they draw out various tacit agreements. One such
agreement is to fix sales price or fix purchase price depending upon whether the
agreement is drawn from sellers’ side or buyers’ side.
b.) limits or controls production, supply, markets, technical development, investment or
provision of services;
The second kind of agreement is where by the production, supply is deliberately
constrained to justify the artificial raise in prices & be able to charge an exorbitant
amount from the consumers.
c.) shares the market or source of production or provision of services by way of
allocation of geographical area of market, or type of goods or services, or number of
customers in the market or any other similar way;
Here, the colluding parties divide the entire market amongst themselves based upon
geographical area, types of goods and services, or number of customers in the market &
others.
d.) directly or indirectly results in bid rigging or collusive bidding;
"Bid rigging" means any agreement, between enterprises or persons engaged in identical
or similar production or trading of goods or provision of services, which has the effect of
eliminating or reducing competition for bids or adversely affecting or manipulating the
process for bidding.
Collusive bidding or bid rigging may be of different kinds, namely, agreements to submit
identical bids, agreements as to who shall submit the lowest bid, agreements for
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 75
submission of cover bids ( voluntary inflatory bids), agreements to bid against each other
agreements on common norms to calculate prices or terms of bids , agreements to
squeeze out outside bidders , agreements designating bid winners in advance on a
rotational basis , or on a geographical or customer allocation basis . Inherent in some of
these agreements, is a compensation system to unsuccessful bidders by dividing a certain
percentage of profits of successful bidders.
History of Collusion:
It has long been posited that when firms face each other in a large number of markets
they may complete less vigorously by allowing each other more or less exclusive spheres
of influence. Put another way, the number of markets in which firms meet is a factor
influencing the likelihood of oligopolistic coordination or “tacit collusion”.
The FIA-Federation of Indian Airlines, a conglomerate of top honchos of domestic
airlines met in 2005 to form a federation that will provide a common platform to debate
industry issues and lobby the government and hammer out solutions. To their misfortune,
at their first meeting they were discussing about pricing issues, which timely was bought
to the notice by CCI, and hence the very first step towards Cartelization was aborted.
Moreover, that time the industry was scattered into many players so chances of deviations
were very high. In today’s scenario, chances of Cartelization and its materialization are
quite high as post consolidation with less number of players tacit collusion is more chase
able and deviation is less unlikely. So CCI must keep an eye on such tendencies. More
over, chances of coordination in prices might become even higher if the Proposed
Alliance between AI and J et materializes. It is highly recommended that the Commission
scrutinizes the proposal & its prospective pros and cons before the two are allowed to
sign on the dotted line.
It is in this regard, that the Commission has identified some conditions conducive for
Cartelization. Cartels usually function in secrecy. The member of a cartel by and large
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seeks to camouflage their activities to avoid detection by commission. If there is effective
competition in the markets, cartels would find it difficult to be formed & sustained.
Some of the conditions conducive to formation of cartels by the Commission are:
1. High concentration
2. High entry & exit barriers
3. Homogeneity of products
4. Similar production costs
5. Excess capacity
6. High dependence of consumers on the product
7. History of collusion
Now keeping these factors in the backdrop, we check for cartelization tendencies in the
Aviation Sector.
1. High Concentration
In order to calculate the potential monopoly power from a merger, a commonly accepted
measurement is the Herfindal-Hirschman Index (HHI). In fact, this index is a measure of
Industry concentration. According to U.S Merger Guidelines, if post merger, HHI takes a
value between 1,000 and 1800 and merger adds more than 100 points, the merger is
likely to be challenged ;whereas if post merger HHI takes a value higher than 1800 and
merger adds more than 100 points, the merger should be challenged. To illustrate the
effects of mergers happening in the Indian Skies, the HHI index was calculated before
and after the merger and the results are presented in following table:
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Nancy Shah, 30.7.07 77
Table 1:
HHI Calculations (National Mkt)
*HHI is the Sum of Squares of Market Shares
Firm Mkt Share (As
on May'07)
Squares of Mkt.
Sh
Squares of Mkt
Sh (Post Jet
Deal)
Squares of Mkt
Sh (Post
Kingfisher
Deal)
IA 22 484 484 484
J ET 22.3 497.29 864.36 864.36
AS 7.1 50.41
AD 18.2 331.24 331.24
KgF 11.1 123.21 123.21 858.49
SJ 8.3 68.89 68.89 68.69
IndG 6.3 39.69 39.69 39.69
Go 3.2 10.24 10.24 10.24
PA 1.5 2.25 2.25 2.25
HHI 1607.22 1923.88 2327.72
With respect to the HHI ratios, we have come to the conclusion that the concentration is
fairly high in the industry with top 3 players pocketing about 80% of market share. So in
terms of concentration, this industry crosses the benchmark standard of 1800 fairly well
after the takeover of Air Sahara by J et. Kingfisher Deccan Deal showed similar trend.
However, the commission must also note that Airline Industry across the world is an
oligopolistic Industry owing to its capital intensive nature. There are very few players in
the market .Therefore, following the HHI benchmark of 1800 blindly would be wrong as
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the concentration is any ways bound to be high in this Industry. The benchmark standards
for such oligopolistic industries must be set on a case-by-case basis.
We also calculated the HHI Ratio for the Delhi-Mumbai route between 6AM-8AM as
this was identified as the peak slot. More than half of Air Travel Passengers in India are
located on this route, hence this route is very important.
HHI Calculations, prior to M&A on Relevant Market of Del-Mum Route
between 6.00-8.00 A.M:
Table 1 (a)
Carriers Mkt Share (%) Sum of Squares of
Mkt. Shares
IA 25 625
J et 25 625
Sahara 12.5 156.25
Deccan 12.5 156.25
Spicejet 12.5 156.25
Indigo 12.5 156.25
HHI=1875
HHI Calculations, post M&A on Relevant Market of Del-Mum Route
Between 6.00-8.00 AM:
Table 1 (b)
Carriers Mkt Share (%) Sum of Squares
of Mkt. Shares
IA 25 625
J et/Sahara 37.5 1406.25
Deccan 12.5 156.25
Spicejet 12.5 156.25
Indigo 12.5 156.25
HHI= 2500
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 79
As mentioned in the previous section that relevant market comprises of a city pair
market at a particular time, on a particular route. Since half of India’s air travelers are
concentrated on Del-Mum Route so I deliberately chose this route to calculate HHI & to
show the level of concentration. On the Delhi to Mumbai Route, J et & IA operate 13
flights per day while Sahara operates around 5 flights. Post merger, J et’s share in this 6-
8AM slot has increased to 37.5 %. The concentration on this route is high for the morning
slot as post merger; the concentration has increased to 2500 between 6-8AM Slots.
Similarly, HHI Ratios for the peak evening slots were calculated & it was found that the
concentration prior to merger was 1156 & after the merger, the concentration increased to
1875 on the Delhi-Mumbai Route for the 18.00-20.00 Slot. Hence, the increase in the
percentage points of concentration is fairly high after the merger be it at the national level
or for a peak route such as Delhi-Mumbai at the peak timings.
2. High Entry & Exit Barriers:
Aviation Industry has high entry barriers. Not any one and every one can enter the sector.
The following entry barriers are faced by a new entrant:
1. High capital cost of purchase of aircrafts. But this to some extent is tide over by
leasing of aircrafts. But still leasing too doesn’t come very cheap. Undoubtedly
Aviation is highly capital intensive Sector.
2. Regulations governing new entry:
i. Route Dispersal Guidelines: They as discussed earlier are constraining the
profitability of the carriers. The airlines are expected to serve a fixed % of
their capacity to category II –III routes which is making their operations
unviable and in turn making the industry less attractive as far as new entry is
concerned.
ii. Minimum Equity & Fleet Requirements for domestic operations is again
increasing the entry cost.
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iii. Minimum 5 years of domestic experience and Minimum fleet size of 20
aircrafts is restricting entry in International skies
iv. Slot Constraint: Capacity constraint acts as a major entry deterrent and
increases the cost of entry as unavailability of desirable slots will have its
impact on the profitability. Allocation of slots have been grand fathered and
entails incumbency benefits. In allocation of slots, what is more important is
have good quality of slots that are strategically placed than have a quantum of
slots which are oddly timed & result in lower passenger loads & higher costs.
The merging carriers may inherit prime slots which they might exert to abuse
their dominant position by increasing the prices. This practice if detected is
highly anti competitive
3. Homogeneity of Products:
The Airlines typically delivers the same product i.e. transferring scheduled passenger
traffic from their origin to the destination. There are 2 sets of Models namely Full Service
Carriers and Low Cost Carriers. The full service carriers (FSC) take passengers from
origin to destination but in a more luxurious manner. They offer free on board Food &
entertainment where as Low Cost Carriers (LCC) doesn’t go out of the way as far as
delivering these amenities are concerned. They largely have a higher seating capacity eg
Air Deccan’s airbus has capacity of 180 while same airbus model for kingfisher has a
capacity of 150 seats. So in terms of customer comfort, FSC takes more marks than Low
cost carriers. The markets for LCC & FSC carriers essentially different as one caters to
the leisure class while other caters to the needs of the time sensitive & the upper class.
4. Similar production costs:
The airlines’ production costs are more or less similar. Most of their revenue receipts go
in paying the fuel bill. The Aviation Turbine Fuel (ATF) is the most costly in India when
compared to other nations. The liberal taxes imposed on the imports of ATF has made air
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 81
travel expensive. Of late, airlines have started charging a Congestion Cess of Rs 150 from
passengers despite Govt.’s opposition. Airlines find it justified as they feel that
a lot of precious fuel is wasted when the aircrafts circle in the air before they finally get a
green signal to land at the congested city airports. However, justification of this cess is
highly debatable as consumers bear the maximum brunt. Firstly, it is there trip that is
getting delayed and further to add salts to the wounds, they are made to pay for the delay
also!
ATF prices for domestic operations include freight charges from the Gulf to India, ad
valorem customs duty of 10% (which adds up to an effective rate of approx 20%
inclusive of the CVD and cess), domestic transportation and other charges, excise duty of
8.24% (including cess), sales tax levied by State governments that average at 25% across
the country. All these costs, along with the marketing margin of oil companies and
throughput charges paid to the airports authority, are over and above the Arabian Gulf
ATF prices. In India, ATF prices are 60% higher than the average ATF prices globally.
The industry loses $450 million or Rs 1,988 crore a year due to the high tax structure.
The industry players always complained of monopoly of public sector companies: Indian
Oil Corp.; Bharat Petroleum Corp.; Hindustan Petroleum Corp. Ltd. as the only ATF
suppliers at the airports. The Govt. Recently has approved demand of airlines to infuse
competition in the ATF business by bringing public sector monopoly to an end. In initial
stages, Govt. plans to allow private players for marketing ATF at smaller airports. AAI
now has approved Reliance Industries to set up ATF business in 25 non-metro airports.
However, a major part of fuel uplift is from major metro airports. Presently, the public
sector companies are expected to charge a margin of 20-25% on ATF sold by them The
entry of RIL is expected to bring down fuel prices ( margins are expected to reduce by 5-
10% with entry of private players ) considerably ,if only it is permitted to operate in
metro airports.
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Other costs include parking charges; landing fees; hangar charges; maintenance; repair;
personnel; entertainment etc. The cost differences between LCC & FSC arise only w.r.t.
food and beverage costs & other frills such as entertainment provided by FSC.
5. Excess Capacity:
The sector doesn’t have much excess capacity. Carriers need to ascertain their demand a
couple of years in advance as the delivery of aircrafts is made with a lag of 3-5 years.
However, in the near future the growth in capacity is likely to surpass the demand as
shown below. Fig 4
Indicative growth rate of Airports; Passenger & Aircrafts
Source
GCA;AAI;CAPA;Boeing;Airbus11
Most of the carriers have gone on a shopping spree indicative of an aggressive fleet
acquisition plan are committed significant sums to expand their fleets by nearly 250
11
Aviation & Tourism Investment Summit, 2007.
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 83
aircrafts over the next 5 years
12
. The current aircraft fleets in the country are way below
even other less developed nations with population far lesser than India. The Indian
carriers have initiated their expansion program as they for see a lot of untapped demand
coming from the ever-booming Indian Economy and its ever burgeoning upper middle
class.
However, capacity comes at a price. There can be excess capacity if airlines charge
exorbitant fares. At the same time, there can be full passenger load factors on the carriers
if fares are rationally priced. So in a nutshell, capacity comes at a price.
6. High dependence of consumers on Product:
Consumers are addicted to this mode of transportation as there exists no other mode in
India that can make a passenger reach his destination within a couple of hours. In India,
we are yet to introduce High Speed Rails which can give airlines a tough competition. As
of now, there isn’t much alternative present with the time sensitive passengers segment
who wants to reach his destination on time. Air Travel is undoubtedly the fastest mode in
India for Medium and long distance journeys.
7. History of Collusion:
The sector has witnessed collusive tendencies internationally. Collusion among carriers is
in terms of prices. They pre set the prices in advance on specific sectors where there used
to exist a duopoly or an oligopolistic competition before. Such amateur attempts have
been made in India also, though timely intervention of CCI aborted such attempts. The
FIA-Federation of Indian Airlines was formed in 2005 as a conglomerate of top industry
honchos of the aviation industry in India. The agenda of their first meet was to discuss
pricing issues which by timely intervention of Competition Commission was stopped.
12
Refer to Appendix II for Orders placed by Indian Carriers.
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That time the industry was very much fragmented and any ways cooperation over prices
would not have been possible. Today’s scenario is best suited for coordination in prices.
With top 3 players having more than 80 % of market share, cooperation between the
players is highly feasible.
Airlines have had a strong International past over cartelization. In 1994, the J ustice
Department settled an antitrust suit today against six major airlines that agreed to changes
in a computerized reservation system .The Government said that airlines used CRS to
communicate & fix air fares. Without admitting or denying the accusation, the airlines --
American Airlines, Delta Air Lines, Continental Airlines, Northwest Airlines, Trans
World Airlines and Alaska Airlines -- agreed to end the practice of communicating
proposed fare increases to each other through the computerized system maintained by the
Airline Tariff Publishing Company. A J ustice Department spokesman called the system
"an electronic smoke-filled room" used by airlines to float "trial balloon" price increases,
make and receive counterproposals and reach a consensus on the amount and timing of
price increases or the removal of discounts.
All the Alliances formed abroad are under the close scrutiny of the Competition
Authorities Abroad as Alliances incorporate practices like code sharing, blockaded space
agreements, sharing of lounges etc which may have anti-competitive effects. So taking an
anti-trust immunity shield from the commission is a must before commencement of
operations.
The U.S Government identified more than 50 separate price-fixing agreements covering
hundreds of routes. As a result of one agreement, consumers paid as much as $138 more
for travel between Chicago and Dallas. In another, airlines agreed to raise discount one-
way fares by $20, the agency said. The antitrust division, said the airlines used the Airline
Tariff Publishing system "to carry on conversations just as direct and detailed as those
traditionally conducted by conspirators over the telephone or in hotel rooms."
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 85
CAPA SURVEY
Acc to a survey done by CAPA presented at the recent fourth annual India and Middle
East Low-Cost Airline. This CAPA survey was conducted on over 2000 passengers at
key airports in India including Delhi; Mumbai.
a. Symposium reported that 67 % of passengers’ travelers in FSC would have traveled by
air even if Fare doubled of what they paid. Also, 50 % of LCC passengers surveyed
shared the same feeling.
b. Also the survey reported that only 9% of the LCC traveled for the first time while for
FSC the figure was 5%.
c. Nearly half of FSC surveyed were travelers on business (47%), against 30 % in case of
LCC counterparts.
d. Acc to the survey, 4 out of 10 did not pay for their tickets (about 42%) which is more
than twice than that on LCC.
e. About 43 % of LCC travelers, twice the proportion of FSC buyers bought the tickets over
the internet. Which implies that still 80 % of FSC book their tickets via the travel agents.
f. About 38 % of the FSC passengers received less than Rs 40000 per month as against 46
% for LCC users.
If these numbers are to be believed, then the survey might send wrong signals to the
niche Carriers who may be encouraged to hike prices, undertake price setting; form a
cartel. Post consolidation, coordination will become easier for price setting on Route I
category of States. As J et /J etLite is planning to enter in an alliance with AI/IA for
seeking cooperation in its International Services ,chances of coordination in prices across
peak routes and peak slots are enhanced. With take over of Deccan by Kingfisher, there is
expected to be some rationality in terms of pricing .It will end the era of Predatory
Pricing & enhance the chances of a coordinated behavior.
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IV: REGULATING M&A:
As per Section 5 of the Competition Act, 2002, all M&A are bound to come under CCI’s
lens if they meet the following bench marks:
1. The prescribed turnover levels for M&A are : Assets of the Merged entity if is
more than Rs. 1000 Crores or a turnover of more than Rs 3000 Crores (these
limits are US $ 500 millions and 1500 US$ in case one of the firms is situated
outside India.).
2. The limits are more than Rs 4000 Cr or 12000 Cr and US$ 2 billions and 6
billions in case the merged entity belongs to a group in India or outside
respectively.
Evaluating the Benchmark levels to the recent Mergers, we find that:
Table 2:
Combined Turnover of the Merged Carriers
Carrier Combined
Turnover
IA-AI Rs. 15000 Cr
J et-Air Sahara Rs. 7000 Cr
Kingfisher-Air Deccan Rs. 6000 Cr
Hence, all three mergers comfortably qualify for the Competitive scrutiny of CCI for any
possible anti-competitive effects and abuse of dominance cases.
Firstly, the IA-AI Merger:
While AI is essentially serves International routes with negligible domestic presence, IA
has tremendous domestic presence with negligible International presence. The AI-IA
Merger doesn’t pose as much problem as the merging entities do not serve same routes so
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Nancy Shah, 30.7.07 87
there is no question of reduction of competition in question. Although, the exclusive
reservation of Gulf Routes is highly an anti-competitive practice which needs to be
addressed. However, competition authorities have every reason to inspect mergers like
J et and Kingfisher as they have overlapping routes. To better explain this, I take up an
example. The recent Tata – Corus deal and the Mittal- Arcelor Deal are very much fresh
in our minds. Now, the Mittal – Arcelor deal had to go thru a long period of wait before
finally getting a green signal for the two to sign on the dotted paper. There was a lot of
hue and cry from different groups across European Community as the merging entities
were both Europeans However this frenzy was absent when Tata took over Corus Steel as
Tata primarily served Indian Markets while Corus had International Presence. So the two
entities had complementing networks. It doesn’t pose as such a problem to Competition
Authorities. Problem arises when two dominant players serving the same market merge
making consumers vulnerable to chances of Monopoly or Duopoly or even collusion.
Hence, the IA-AI merger will have no impact what so ever from competition angle as the
two have complementary networks. While IA is primarily a domestic carrier with
negligible presence felt around neighboring countries, AI is primarily targeting
International Skies with negligible presence in domestic territory. Hence the two are not
relevant from competition angle. Though, the state carriers are accused of enjoying
Incumbency Benefits. They enjoyed monopoly gains prior to the 1993 as they were the
sole operators in the Nation. However, even after Deregulation, AI maintains the
exclusive right to fly to Gulf, which is discriminatory, as existent Indian carriers too want
to fly to Gulf Routes seeing the large Volume of Demand for the same. While IA is
deriving its share of incumbency benefits from its Peak slots’ pool.
Secondly, the Jet-Sahara Deal & Kingfisher-Air Deccan Deal:
While J et has taken over 100 % stake in Sahara, Kingfisher has picked up 26 % in Air
Deccan and has intentions of picking up another 20% from an open offer. The J et-Sahara
Deal was announced in 2006 but it took a long time before, things could be finalized. J et
& Sahara share common history. Both began their operations at the same time, both have
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been the only carriers who survived the decade of 90’s.The two carriers essentially have
overlapping route networks. The major problem that arises with this merger is that these
two airlines being the oldest have access to prime slots. Slot constraint is a major entry
deterrent. Post consolidation, there will be Route restructuring to attain maximum
benefits on these prime slots at the major metropolitan airports. The concerns were
expressed when J et announced its desire to take over Air Sahara last year. The takeover
of the user rights might give J et a dominant position. Air Sahara's aviation rights should
not automatically accrue to J et; the latter should instead be required to re-apply for
securing additional rights. The DGCA, as the competent authority should use this
window to re-distribute Air Sahara's rights to all airlines. Had Air Sahara continued and
given the inevitability of its closure, its rights would have anyway got released for
distribution to others, and not available only to J et. The DGCA must take into account
these factors.
The Air Deccan-Kingfisher Deal: What separates this deal from J et-Sahara Deal is that
the merging carriers essentially cater to different class of passengers. While Kingfisher is
a full service carrier, Air Deccan’s Market comprises more of Leisure Travelers whose
elasticity of Demand is essentially very high. Where as J et & Sahara are both FSC. J et
has declared that it will change Sahara to a Value Based Carrier which will essentially be
above the LCC Model but the main question is that post merger, J et has got access to
Sahara’s Frequent Flier’s also. As told as earlier, Frequent Flier’s are essentially business
travelers whose elasticity of demand is very low vis-a-vis Kingfisher & Air Deccan Deal
where in both have agreed to preserve the differences in their Business Model.
Secondly, what separates the J et Deal from the Kingfisher Deal is that J et and Sahara
both used to compete on International Routes Prior to Merger. Post consolidation, now
there is reduction in competition as IA-AI have merged & with J et-Sahara merging, the
effective competition in International Skies reducing by half & with rumours taking
rounds that J et is keen on forging an alliance with Air India for International Operations,
which will further dampen competition. Where as bound by the current regulation,
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Nancy Shah, 30.7.07 89
neither Air Deccan nor Kingfisher qualifies for International Operations there by deriving
the merged entity from an important source of revenue.
However, what binds the J et Deal with Kingfisher Deal is the problem of Overlapping
Routes. Though the country has big enough potential market -over 1.1 billion citizens and
a middle class of over 300 million greater than the entire population of U.S or U.K – to
support a large fleet, the current composition of route networks is overly duplicative with
a few cities being dangerously over served. The concentration of services in major
metropolitan has diminished very slightly but still accounts for 82% of passengers flown
within the country. The most congested Airports being Mumbai; Delhi; Chennai;
Bangalore etc. The most congested route being Delhi-Mumbai .Deccan has achieved its
market share owing to the wide network it has across the nation. It serves around 70
destinations while J et serves only 48.
The trouble plaguing the Kingfisher – J et deal is the fear among the Consumer Groups
who are feeling vulnerable as to that fact that the consolidation would end the days of
Low Fares. It was with Air Deccan’s entry that introduced cheap fares and enabled the
Air fares to match First class A.C Railway tickets. With its consolidation, consumers fear
that prices will rise. Air Deccan initiated predatory pricing by selling tickets for dirt
cheap rates. Other carriers were forced to match its prices in order to be in the industry.
Hence, the entire industry bleeded. Air Deccan’s aggressive pricing strategy helped her
gain market share but at the cost of its profitability. For how long can a company survive
with out funds. Not, much & that is the reason why it went Bankrupt & had to seek solace
with Kingfisher. Prices must represent the true cost structure. Air fares must reflect the
cost of ATF & other operational costs. So on that count if Air Deccan’s Fare rise then its
fair enough. However, in a nation like India where Air Travel is rated to be the most
expensive in across World (after adjusting for Purchasing Power Parity), we definitely
cannot afford higher mark ups. Hence, prices need to monitor to check out for any unfair
practices.
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Factors Considered by the Commission in evaluating combinations & their appreciable
adverse effects.
Under Section 1V of the Competition Act, 2002, the Commission considers some
factors in determining whether a combination would have or is likely to have appreciable
adverse effect on competition in the relevant market. The following factors are
considered for evaluation for M&A:
1. Actual or Potential Level of Competition through imports in the Market:
Prior to the consolidation, the number of players in the domestic market were 10
(including AI with negligible domestic presence). However, post consolidation, the
number of players in the market has reduced down to 7. The HHI (prior to M&A) was
1607 but post consolidation of the three deals namely, AI/IA; J et-Sahara; Deccan-
Kingfisher, it has risen to 2327. The current policy regulation doesn’t allow foreign
airlines to hold a stake in domestic airlines which is depriving the industry from getting
an exposure to the expertise as well as the finance needed by the domestic industry.
Therefore, unlike other Industries where supply can be augmented by importing the
goods which there by countervails the monopoly of the domestic player and helps in
checking such tendencies. The fear of import of external competition is absent for the
airlines industry as no foreign airline can commence domestic operations in India.
2. Extent of Barriers to entry into the market:
As discussed previously under Regulatory Barriers, there exists high entry barriers.
Barriers in terms of high sunk costs; regulatory barriers; predatory behavior by
incumbents etc.
In terms of sunk Costs: Aviation Industry is a capital intensive industry. Costs of
purchase of aircrafts is huge but this to some extent is tide over by leasing of aircrafts.
However, huge amounts are still spent of marketing and promotion of the carriers.
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Nancy Shah, 30.7.07 91
In terms of regulatory barriers, there are a number of regulations barring entry. To name a
few, we have:
a. Operators are required to have a stipulated level of fleet size and subscribed equity
capital. For example, scheduled operators should have five aircraft (by outright purchase
or lease) and a minimum subscribed capital of Rs. 10 crores. (Rs. 30 crores if operators
have an aircraft of maximum take-off mass exceeding 40,000 kg.). However, these
requirements and analysis wrt to min capital requirements must better be left to the
investors including bankers; financial institutions; financial regulators etc.
b. Foreign airlines are not permitted to pick up equity. Foreign financial institutions and
other entities who seek to hold equity in the domestic air transport sector shall not have
foreign airlines as their share holders. As told earlier also, that those interested in airlines
will be airlines only. By imposing a regulation of not allowing foreign airlines to pick up
a stake in Domestic airlines, an important source of competition, finance and expertise is
deprived.
c. A domestic carrier must have flown for at least 5 years before entering the
International Skies. This is acting as an entry barrier as its hindering the new players
from plunging in the international skies. International routes are long haul journeys, they
are very profitable. The current regulation is only favoring the incumbents namely: J et &
Sahara.
d. Route Dispersal Guidelines:
The route dispersal guidelines have contributed to a great extent in reducing the
profitability of the existing carriers. The domestic carriers are forced to operate on
remote, unviable places as part of these guidelines. Hence, the domestic players cut own
on the trunk routes to obey the guidelines. More over, the carriers are not reimbursed for
these unviable operations.
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The regulation of not flying internationally and the obligation to serve category II & III
routes has taken its toll on the profitability of most of the existent carriers. The industry
registered loss worth 500 million USD last financial year. The continuous loss made by
the industry has sent negative impression across the conglomerate of venture capitalists
who are convinced that aviation is not a good investment.
f. Exclusive rights given to the National Carriers to Fly to the Gulf Routes is highly
unfair and is depriving other players of an important source of Revenue.
3. Level of Combination in the Market:
The wave of M&A in the Aviation Industry began with the merger of IA and AI.
Followed by this, was J et-Sahara Deal. Last but not the least, the Indian skies witnessed
the merger of Deccan and Kingfisher. While, the J et – Sahara deal is a 100 % stake in
Sahara Group, the Deccan-Kingfisher Deal forged an alliance to the extent o 26 % in
Deccan by Kingfisher Airlines. Though , rumours are taking rounds that Paramount is in
talks with Go Air and Spice J et for a proposed merger, however none has signed on them
have signed the dotted line so far. So the year, 2007 was the season of Marriages in the
Indian Skies! In the wake of intense competition; predator pricing; continued losses, the
players decided to bring in some rationality in the pricing by agreeing to join hands.
Consolidation if done properly will provide synergy benefits, efficiencies; give critical
mass and eases competitive pressures as the number of rivals in the market has reduced.
4. Degree of countervailing power in the market:
The market comprises of 10 players namely IA; AI; J et; Sahara; Deccan; Kingfisher; Go
Air; Indigo; Spicejet; Paramount. Now there exists no market where either of the carriers
have monopoly on the domestic routes. Maximum number of carriers operate on trunk
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Nancy Shah, 30.7.07 93
routes. These trunk routes are a major source of revenue for the carriers owing to the
huge demand on these sectors. Indian carriers compete in the same relevant market. This
results in aggressive pricing strategy and low yields. On other routes like category II &
III, there isn’t much traffic and consequently carriers who currently are serving these
routes , subsidizes their operations and sell tickets at throw away prices to fill in as many
seats as possible. So there is a sufficient amount of countervailing power present in the
market in terms of the number of competitors present on the key trunk routes. The current
composition of route networks is overly duplicative with a few cities being dangerously
over served.
However this countervailing power in the market might diminish if relevant market is
defined as the time sensitive passengers who have strict preferences for time and days to
their destination. There can be a situation where the merged entity has prime slots on key
trunk routes. Although, the merged entity still has to face its rival; however, the merged
entity enjoys an undisputed position in some peak slots of the day which may have little
or no competition. So the commission must look into this aspect as the degree of
countervailing power which varies at different time slots, for different cities. Therefore, a
case by case evaluation of the trunk routes must be made.
5. The likelihood that the combination would result in the parties to the combinations being
able to significantly and sustainable increase prices or profit margins.
Acc to the recent CAPA survey presented at the recent fourth annual India & Middle East
Low Cost Airline reported that 67% of the passengers traveling by FSC would travel by
air even if the fare doubled. Also, 50% of LCC carriers shared the same feeling. The
survey was conducted on over 2000 passengers at leading airports like Delhi; Mumbai.
With such kind of market sentiment, carriers are bound to get encouraged to hike the
fares on congested cities seeing the rising demand. Post merger, the prices of Air
Deccan’s tickets has increased on an average by Rs. 300- Rs. 500 plus a congestion cess
of Rs. 150 which is re imposed by Air Deccan. Although a fare hike for Air Deccan may
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be justified as it was badly under pricing its tickets in a bid to gain maximum market
share. However, post consolidation, the hike in fares introduced so far is to ensure that
the company breaks even in the near future.
However, one signal that is clearly sent across the board is that the days of low fares are
now over. Consolidation is expected to bring some rationality in the pricing patterns.
Consumers are definitely not expecting low fares but are at least expecting status-quo to
be maintained. However, post consolidation , with top 3 players pocketing 80 % market
share have good incentives to hike fares by at least 5 % which would not have that much
effect on demand as there exists more than half of the passenger bulk who are willing to
travel by air even if air fares double.
6. Extent of effective competition that is likely to sustain in the market.
One merger in the market was followed by the other. Prior to 2006, there was no News of
mergers’ in the nascent Aviation Sector. However, year 2007 saw three mega mergers all
in a span of 6 months. All most all the carriers are bleeding today. The industry has
registered losses worth 500 million USD. The industry was characterized by the
following: the predatory pricing, the lack of rationality in pricing; new airlines coming up
but none of them have been able to carve a niche; capacity constraints at the major
airports. Most firms are going bankrupt, so in this kind of scenario they had only 2
alternatives, either shut down their business or enter in to a merger with another airline. A
merger would benefit the falling firm in the sense that it will help the merged entity
derive benefits from combined synergies of the two carriers’ networks and save on the
operational costs by sharing of the infrastructure. Merger helps the falling firm buy some
time to re-engineer itself; gets to learn the nitty gritties of the system from its financially
viable counter part. Merger eases competitive concerns. The merging entities are
expected to benefit from consolidation, as it would enable them to undertake network
optimization; operational rationalization & fleet simplifications. Hence, consolidation
was touted to be the need of the hour by the industry honchos to tide over the current
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Nancy Shah, 30.7.07 95
industry losses. No, doubt Airline is an industry that involves economies of scale and
scope, but how relevant is the falling firm argument. Allowing a merger on the pretext
that in its absence, the firm would have to quit is not compelling as in perennial gale of
creative destruction, those who can’t survive the stormy winds must exit the market
13
. As
of now, the number of players in the market are seven. However, rumours are taking
rounds that there may be more mergers in store. The authorities as of now have though
denied the link ups of Paramount with Go Air & Spicejet but it can not be surely rejected
in future. If this is the scenario then the market will have only a limited number of large
players. Post consolidation, we already have three big players in the market. Indigo
entered the market with a big bang by placing an order of 100 Airbuses, with passage of
time, it too will become a massive player. The remaining players are small fishes, they
have strong incentives to merge as none of the players have been able to cast a niche for
them selves. CAPA projects that in the near future the Industry might comprise of a few
dominant players instead of the current situation where the market is scattered.
As of now, the number of players in the domestic markets are seven. Airline is any ways
an oligopolistic Industry across the world with little number of players operating. The
current players in the Indian market are sufficient to sustain competition on various
routes as there exists no route where any airline has a monopoly & is capitalizing on it.
However, some carriers may be at an advantageous position registering full load factors
on key routes at peak timings. But more or less, on an average, the Indian aviation sector
has a highly duplicative route network system. There is intense competition on key routes
whereas some routes are badly under served.
7. Market share, in the relevant market of the persons or enterprises in a combination,
individually and as a combination;
The market shares aggregated across all relevant markets are only available at this stage.
However, what is more important is the disaggregated market shares of each player in
13
Schumpeter said this.
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each relevant market which could not be presented due to lack of data. Going by the
market shares of the each carrier, prior to the consolidation market was fragmented with
no player touching the 25 % mark, however, post consolidation, top 3 airlines pocketed
more than 80 % of market shares. The particulars are given below:
Table 3:
Comparison of Market Shares Pre & Post Merger
Pre Merger (Mkt. Share-National)
CARRIERS
(Prior to M&A) MKT. SHARE
J et 22
Sahara 7
Indian 23
Air Deccan 18
Kingfisher 11
Go Air 3
Paramount 2
Spice J et 8
Indigo 6
Post Merger (Mkt Share-National)
CARRIERS
(Post M&A) MKT. SHARE
J et/J et Lite 29
Indian 23
Deccan /Kingfisher 29
Indigo 6
Spice J et 8
Go Air 3
Paramount 2
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Nancy Shah, 30.7.07 97
8. Likelihood that the combination would result in the removal of a vigorous competitor or
competitors in the market
The combination of J et-Sahara has led to merger of FSC Carriers. These two carriers
were the only private carriers who could stand the down turn of late 1990’s. These two
share the same history. They were arch rivals at one time. They shared common history.
Both entered the industry at the same time & began operations as air taxi operators. Post
de-regulation, both entered the scheduled passenger traffic market and are arch rivals
since then. Many airlines came and drowned during the decade of 1990’s .However, these
two airlines survived the turmoil. Sahara has Boeing fleets which complements J et’s
existing Boeing fleet of aircrafts. The merger of the two oldest private carriers is
expected to solve the problem of overly duplicative network & rationalize routes. Both
the merging entities are full service carriers, however, in the wake of rising popularity of
LCC , the decision has been made by the J et Group to make Sahara as a value based
carrier which would essentially operate on LCC model. Similarly, following the
acquisition of 26% stake in Kingfisher, the group announced that it would let Air Deccan
operate on the LCC model only. Like Sahara, Deccan too was effective competitors to all
the niche players. It was the first LCC of the country, it introduced cheap fares and
triggered price wars. With in a matter of few years, it managed to be in the list of the top
three players. Deccan’s prices were dirt cheap and forced the other players to pass on the
benefits to the consumer. With exit of Deccan’s aggressive pricing strategy post take
over, many industry people are taking a sigh of relief as they expect some rationality &
stability to come in terms of prices. Deccan, India’s Pioneer LCC ever since its inception
has kept other carriers on their tows. So in a nutshell, absorption of Sahara and Deccan
has deprived the Industry of two strong potential competitors.
9. Nature & Extent of Vertical Integration in the Market.
This is one sector where vertical integration is difficult to forge. Airports are now getting
privatized, in future a situation may arise where the partial owners of airports pick up a
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stake in the airlines. This might pose a threat to the other carriers. However, such a
possibility is rare. The second issue that arises is with reference to Maintenance & Repair
Issues. It is mandatory for aircrafts to under go aircrafts maintenance checks every day,
fortnights, monthly and evenly yearly basis. Indian is trying to enter in a J V with
Lufthansa Technik, an MRO in association with Hyderabad International Airport.
Similarly, J et is in talks to open its independent MRO facility to service its fleet of 141
aircrafts in service & on order. The other complementary inputs might include take-offs
and landing slots; air traffic control services; passenger handling facilities; baggage
handling facilities ; refueling; maintenance; ;clearing and catering services & so on.
However all of the above are under regulatory regime either the AAI or DGCA or BCAS.
Therefore, with reference to the vertical integration, not much scope lies.
10. Possibility of failing firm:
The recent mergers have been approved by the industry sources blindly based upon the
falling firm argument. Most of the existing players have not been able to break even and
running into huge losses. The loss making enterprise would have no alternative than to
die in absence of mergers. The alarm bells for Sahara & Deccan had been rung; the two
carriers were in neck deep debt & badly needed an investor to bail them out. Given that
most of the players in the Indian Markets are not able to break even & sustain the
benchmark revenue per aircrafts compared to the global standards barring a few domestic
players
14
. So possibility of falling firm was & is still very high.
11. Nature & Extent of Innovation:
The domestic carriers don’t have much scope for Innovation barring a few. In an attempt
to woo the passengers, some carriers have introduced schemes like Web-Check In; access
to airport lounges in case of delays; a 24 x7 customer support center; in flight
entertainment such as access to television; radio; availability of tickets at convenient
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Nancy Shah, 30.7.07 99
retail outlets such as petrol pumps; cyber café’s apart from the travel agents; providing a
pick & drop facility etc. Carriers in a bid to woo passengers are attaching more & more
frills to make themselves more popular with the travelers.
12. Relative advantage, by way of contribution to the economic development by any
combination having or likely to have an appreciable adverse effect on competition.
The appreciable advantage that the mergers have is that it will replace the duplicative
capacity from the system. To support a large fleet, the current composition of route
networks is overly duplicative with a few cities over served. The metropolitan passengers
still account for 82 % of the passengers flown every year.” The only realistic cure for
profit cutting over capacity will be for carriers to either exit or merge”, according to
CAPA. The removal of duplication will help the carriers focus on other routes. So
mergers are touted to be an attempt made towards right sizing .The merging firms are
likely to benefit from the merger by capitalizing from the joint synergies of operation;
sharing the infrastructure etc. Kingfisher expects to save Rs. 300 Million post merger.
The merged entities have route, network & fleet rationalizations on their agenda to derive
maximum benefit from consolidation. So the merger will benefit the industry as it will
help the carriers avoid duplicative networks, save on a lot of operational costs; network
rationalization will help the merged business spread its wings to other routes; increase
frequency of International flights.
13. Whether benefits of the combination outweigh the adverse impact of combination, if any:
The recent wave of mergers have their pros &cons. Pros in terms of the efficiency gains
as mentioned above and cons in terms of the likely anti-competitive impact the proposed
merger might or is likely to have. The chances of price increase; enhanced chances of
14
Refer to APPENDIX-III for benchmark levels of Revenue / aircrafts.
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collusion & restraint on new entry are some of the harmful effects. The commission must
evaluate the merits & the demerits of the mergers on a case by case basis.
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SECTION X
CONCLUSION
10.1 The Indian aviation sector has witnessed tremendous growth in the recent
years driven by a combination of macroeconomic; demographic; government reforms and
market lead dynamics. Ever since 2003, growth had witnessed tremendous increase post
arrival of LCC’s. Hence if the current growth trajectory is to be preserved, it is very
important that competitive forces must continue to operate in the system.
There are some factors intrinsic to the aviation industry that are anti-competitive. For
example: Frequent Flier Programs which airlines use to discriminate between the leisure
travelers and business travelers. The business class is a huge attraction for the FSC as
they have very low price elasticity of demand, which the carriers want to capitalize on.
Similarly other loyalty programs include Travel Agent Incentive Schemes where by the
commission given to the travel agents are tied to the sales of that Carrier.
10.2 Price transparency in the system of fare declaration is both a boon as well as a
bane. A bane as it enhances chances of collusion. Parties entering in a collusion find it
easy to ensure cooperation as the follower will implement the price increase only after
seeing the leader make the agreed changes. If any one deviates then the other airline can
at a very short notice revert back to the original prices without bearing much cost. So it’s
a win –win situation.
10.3 Slot constraint is another problem constraining new entry. Landing & take off
rights are referred to as Slots. These slots are an important consideration for an entrant as
peak timed slots register higher passenger load factors as compared to the oddly timed
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slots. The capacity of airports is fixed. The supply of airports cannot be immediately
increased in face of rising demand, hence arises scarcity of infrastructure.
10.4 There are some regulatory barriers inherent in our domestic air transport
policy are constraining new entry & having anti-competitive effects. The regulations
governing minimum fleet size; minimum equity requirements; route dispersal guidelines;
min fleet & experience requirement of 5 years for International Operations; exclusive
right to National carriers to fly to Gulf Routes etc are constraining new entry &
strengthening incumbents position.
10.5 The year 2007 was the year of M&A in the Indian Skies. Post consolidation
IA-AI; J et-Sahara ; Kingfisher-Deccan, these top three players have pocketed 80% of
Market Shares .While the industry sources favored these mergers as they believe that
these mergers will benefit the already bleeding Industry . It’ll help to bring in some route;
network & fleet rationalization. The merged entities are expected to benefit from joint
operations & would share synergies of joint operations. The network served is highly
duplicative i.e. few metropolitan cities being dangerously over served. The consolidation
according to Industry sources would help to bring in some rationalization in routes &
help carriers focus on other routes. However, equally justified are the consumer groups
who are fearing that post consolidation prices may rise. The frenzy among consumer
groups was more in case of Kingfisher – Deccan Deal as Deccan initiated the low fare
war. With its consummation, consumers fear a price rise may soon be on cards.
10.6 All three M&A very well come under the lens of the Competition
Commission of India’s lens as they meet the benchmarks standards laid down by the
Competition Act, 2002 with regard to Regulations of M&A. As far as IA-AI Merger is
concerned it doesn’t pose much problem from competition angle as the merging entities
have complementary networks with AI having International presence with negligible
domestic presence and IA having heavy domestic presence with negligible international
presence. However, the exclusive rights to fly to Gulf routes are unfair as its depriving
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Nancy Shah, 30.7.07 103
the other domestic players from an important source of revenue. Consumers too don’t
have much option w.r.t. mode of transportation & the choice of the carrier.
10.7 The J et-Sahara Deal took a long time to materialize until 2007 when J et
signed on the dotted paper & agreed to take over 100% stake in its arch rival, Air Sahara.
The two carriers share the same history, both began their operations as air taxi operators
& later became full service carriers. J et & Sahara were the only two private airlines that
could stand the decade of 90’s. With the take over of Sahara by J et, some important
issues over competitive concerns need to be addressed. J et and Sahara have peak slots
available on all major metropolitan airports at peak timings. As defined earlier in the
report that Relevant Market in our analysis is a city pair market, on a particular day, at a
particular time. Hence peak timed slots are a major determinant of profitability.
Concerns had been expressed last year when J et announced its plan to take over Sahara.
Air Sahara's rights must be re-distributed to all airlines in order to prevent J et Airways
from attaining a dominant position in slots as this would restrain growth of competition.
Air Sahara's aviation rights should not automatically accrue to J et; the latter should
instead be required to re-apply for securing additional rights. The DGCA, as the
competent authority should use this window to re-distribute Air Sahara's rights to all
airlines. Had Air Sahara continued and given the inevitability of its closure, its rights
would have anyway got released for distribution to others and not available only to J et.
The DGCA must take into account these factors. What further adds salts to the wounds is
that J et & Sahara both are Full Service Carriers. Post consolidation, J et along with the
User rights would also take over Sahara’s Frequent Flier’s. As mentioned earlier, FFP’s
are a tool which airlines use to discriminate between business travelers & leisure
travelers. Business travelers have low price elasticity of demand as compared to leisure
travelers. It is this weakness that the carriers try to capitalize via such loyalty programs.
10.8 Another important issue that needs to be highlighted is that post J et-Sahara
Deal & IA-AI deal , the number of players serving the International Routes has reduced
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to half as no other domestic player is eligible for flying Internationally as per the current
regulatory framework. Though the later entrant have given the incumbents a run for their
money & have taken away a major chunk of domestic market share from these
Incumbents by matching their networks and services but they are still barred from joining
the International Skies. Ever since 2003, post their entry in the Aviation Sector, benefits
have trickled down to the consumers in terms of low fares. What is even more
disheartening is that new International players with scanty fleet size & minute experience
are allowed to operate in & out of the country but ironically the domestic players who are
much better in terms of safety, experience are barred from flying the same International
Routes.
10.9 The Kingfisher-Deccan Deal was plagued with a lot of hue & cry coming
from various industry groups post consolidation as the consumers are feeling vulnerable
& expect that fares may rise in future. The merging carriers i.e. Kingfisher – Deccan have
over lapping route networks they essentially cater to different set of consumers. While
Kingfisher is a Full Service Carrier, Deccan essentially caters to the leisure travelers with
its Low Cost Model. Air Deccan triggered price wars in the Indian Skies which forced
other players to match Air Deccan’s prices. The consumers benefited while carriers lost.
Air Deccan gained market share but at the cost of profitability. Post its consummation,
industry sources expect some rationalization in pricing strategy. The rise in current fares
will be justified as long as they reflect the true cost of ATF Fuel & other operating
expenses. However, what a country like India where air travel is rated to be the most
expensive across the World is any further mark ups.
10.10 Post consolidation, with top 3 players have more than 80% of market share, so
chances of cartelization are enhanced with the industry getting consolidated. Such
attempts have been made in the past.. FIA-Federation of Indian Aviation was set up in
2005 by top airline industry honchos to voice their needs to the government. Among its
first meet, the federation had thought of discussing pricing issues. However, this was
aborted by timely intervention of CCI. However, such attempts can be made again as
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 105
cooperation is more easy with the industry getting consolidated. So CCI must keep an eye
on such instance of price coordination.
APPENDIX I :
Domestic Carriers- Current & Fleet on Order Status
Table 4
Airline
Current
Fleet Fleet on Order
Indian 73 43
J et 58 40
Air India 45 68
Air Deccan 40 90
Air Sahara 28 10
Kingisher 22 84
Spicejet 9 20
Go Air 7 20
Indigo 5 95
* As on May Source: ASSOCHAM
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APPENDIX II:
Fig 5
Comparison of Revenue per Aircraft of the
Domestic carriers with the Global Standards
APPENDIX III:
The Hub-Spoke Network:
There are important economies of both scale and scope in the airline industry. Travelers
prefer “seamless” connections and more frequent services. In the presence of loyalty
schemes such as frequent-flyer programs, many travelers also prefer networks that serve
a larger number of destinations. Larger airline networks organized in the “hub and
spoke” form can take advantage of cost economies and can offer more seamless
connections, more frequent services and a greater range of destinations than can smaller
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 107
airline networks, making their networks more attractive, especially to full-fare paying
passengers.
An airline hub is an airport that an airline uses as a transfer point to get passengers to
their intended destination. It is part of a hub and spoke model, where travelers moving
between airports not served by direct flights change planes en route to their destinations.
Some airlines may use only a single hub, while other airlines use multiple hubs. Hubs are
used for both passenger flights as well as cargo flights. Many airlines also utilize focus
cities, which function much the same as hubs, but with fewer flights. Airlines may also
use secondary hubs, a non-technical term for large focus cities.
The effects of hub-and-spoke operation on operating costs can easily be illustrated.
Suppose an airline provides air services between a set of 6 cities. In the absence of
economies of scale, the airline could provide these services with direct connecting flights
between each pair of cities (serving n (n-1)/2 routes) i.e. 15 routes However, if there are
no economies of scale and if some of the routes do not generate sufficient traffic to allow
operation at the minimum efficient scale, total unit costs can be lowered by reducing the
number of routes, increasing traffic on the remaining routes. In fact, the same 6 cities,
with no loss in services, can be served with just 5 routes, reducing the total number of
routes served and increasing the average traffic on each route by a factor of 3. This is
illustrated as follows:
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Point-To-Point Network Hub-and-Spoke Network
15 distinct routes served 5 distinct routes served
Even where there is enough traffic on a route for the minimum efficient scale to be
obtained, hub and- spoke operation may allow an increase in the frequency of flights
(and therefore an increase in the overall level of demand) without any one flight
dropping below the minimum efficient level of traffic. In addition, hub-and-spoke
operation may allow service to be provided to airports for which the volume of traffic
to any other single city would be insufficient (under point-to-point operation) to
justify service. All major airlines now have one or more hubs at which many of their
long-distance passengers change planes. This approach has allowed carriers to fill a
higher proportion of the seats on their planes and to increase flight frequency of non-
stop routes between their hubs and other airports.
Large networks enjoy both cost and demand advantages over smaller networks (although
these advantages can sometimes be offset in part by carriers that have substantially lower
operating costs). Travelers prefer connections between flights of the same airline to
flights between distinct airlines, because “seamless” connections are typically more
convenient and offer greater security in the event of delays on the incoming or outgoing
flights or in the event of lost luggage. Travelers also prefer airlines with more frequent
service, because they offer enhanced travel flexibility in the event of a last-minute change
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Nancy Shah, 30.7.07 109
of plans. Airlines also enhance demand for their services through loyalty programs, such
as frequent flyer programs or travel agent commission override programs, which provide
incentives for travelers and travel agents to focus their bookings on a single airline. Such
programs benefit larger airline networks more than smaller airline networks. These
programs are especially targeted at attracting and retaining high-margin time-sensitive
business travelers. Larger networks can also exploit to a greater extent the “hub and
spoke” form of organization. Hub and spoke operation allows an airline to concentrate
traffic on certain routes, allowing both larger, more efficient, planes and more frequent
service. In addition, hub-and-spoke operation allows for a greater range of destinations
and city-pair combinations to be served, including city pair combinations, which would
not normally generate enough traffic to justify a regular service. The addition of a new
spoke to a hub-and-spoke network significantly increases the city-pair combinations
served by the network, at a minimal additional cost. There are limits to hub-and-spoke
operations. The efficiencies of hub and spoke operation derive from converting a large
number of point-to-point flights into a smaller number of connecting flights via one or
more hubs served by larger, more efficient planes. But connecting flights are not a perfect
substitute for non-stop flights. Pressures towards hub-and-spoke operation are strong, but
there are also offsetting cost and demand factors. Although hub-and-spoke operation
lowers unit costs by increasing load factors, it also increases the distances, raising the
cost and the time taken for the average journey. Now, for time sensitive passengers a
connecting service (through a hub) may not be an adequate substitute for a nonstop
service. So most networks are likely to combine some aspects of both hub-and-spoke and
point-to-point operations. . At first sight it might be thought that the cost advantages that
arise from hub-and-spoke operation imply that a larger network has a cost advantage over
a smaller network or a point-to-point operator, on the basis that smaller (e.g., point-to-
point airlines) cannot benefit from the feeder traffic which maintains load factors and cost
efficiencies on trunk routes. But this argument is incomplete. Since passengers can
change airlines as well as planes at a hub airport, a point-to-point airline could still
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benefit from feeder traffic supplied by other airlines operating other spoke routes into and
out of the hub.
Competing airlines on a spoke route get little benefit from the feeder traffic flowing into
and out of a hub, and they typically cannot offer a loyalty program or flight frequencies
to match that of hub operators. As a result, rival airlines are unable to capture a
proportionate share of the higher margin time-sensitive passengers, which are necessary
to sustain the service. For these reasons, well-developed hub-and-spoke airlines tend to
be dominant on non-stop spoke routes. For the same reasons routes between two
networks’ hub airports tend to be dominated by the networks operating the hubs at each
end. When Northwest proposed the acquisition of a controlling stake in Continental, it
was found that they jointly held a market share of 100 percent on seven of the nine routes
between their respective hubs.
There are three possible sources of such Cost Efficiencies. These are:
•First, the spoke routes in and out of a hub are complementary inputs in the provision
of end to- end transport services. Spoke routes are therefore in a vertical relationship to
one another. If competition on each spoke is less than perfect, the airlines operating each
spoke will mark up prices above marginal cost. These mark-ups accumulate, leading to
the problem known as “double marginalization”. Vertical integration can eliminate this
inefficiency;
• Second, a traveler may be subject to delays or problems for a variety of
unforeseeable reasons, such as weather or overbooking. Where the travel involves several
different segments, a delay or unforeseeable event on one segment will lead to problems
making connections on other segments. Where the segments are operated by independent
airlines the traveler may face higher costs or difficulties completing the travel. In
addition, individual airlines may not take into account the effects that overbooking will
have in disrupting bookings on future segments. Alliances between the airlines can
ameliorate these problems. Vertical integration lowers these transactions costs associated
with providing a “seamless” end-to-end service desired by travelers;
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Nancy Shah, 30.7.07 111
• Third, co-ordination of flights, gates, arrival and departure times necessary to
provide an efficient hub-and-spoke service may require relationship-specific investment.
The provision of an efficient hub-and-spoke system requires relatively close co-
ordination at the hub. Arriving flights must be timed to co-ordinate with out-going
flights. Incoming flights must arrive at gates, which are in relatively close physical
proximity to out-going flights. Baggage from the incoming flight must be efficiently
interlined to the outgoing flight. Coordinating airlines must therefore make certain
relationship-specific investments. Having made these investments, the airlines are
exposed to strategic behaviour by the other airlines, again raising transaction costs. These
issues can be resolved through detailed long-term contracts or through vertical
integration. As a result of these effects, there are distinct cost efficiencies (i.e. economies
of scope) in hub operations.
15
Implications of Hub-Spoke Network:
1. Due to the economies of scope, non-stop competition may not be sustainable on spoke
routes (except non-stop routes to another network’s hub, which may be served by the
networks at both ends). Consider competition on the route A-B in the following network
in which B is the hub and the incumbent network also services C, D and E:
15
Brueckner and Whalen (1998) find that transatlantic routes involving several legs
are 18-28
percent cheaper when provided by a single network than when the same route is
provided by two or more non-aligned carriers.
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A stylized hub-spoke network
The economies of scope identified earlier have a number of effects on competition in the
route A - B:
• The cost-side economies of scope imply that the incumbent airline has a cost
advantage in the provision of connecting services A-B-C, A-B-D and A-B-E.
(Specifically, for flights in either direction on these routes, the incumbent airline can
eliminate the double marginalization problem and better co-ordinate the arriving and
departing flights to provide seamless operation). With this cost advantage, the incumbent
will be able to price the connecting services in such a way as to ensure that it captures all
the connecting or “feeder” traffic. If the incumbent can cut off the competitor from the
feeder traffic, the competitor is restricted to only A-B traffic (so-called “local” traffic). In
some cases the local traffic alone may be insufficient for the entrant to sustain a viable
service. Even where there is sufficient traffic to sustain a stand-alone service, the entrant
will not have the same total traffic volumes and will be unable to match the flight
frequency of the incumbent;
•Even if there is sufficient local traffic to sustain some A-B flights, the benefits of the
loyalty programs give the incumbent airline a strong competitive advantage in flights
originating at B, especially among frequent-flying high-margin travelers. As a result the
incumbent can offer a more attractive service simply by matching the price offered by the
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 113
entrant. Conversely, the entrant will need to offer a sizeable discount below the
incumbent to attract a sufficient volume of traffic. In the most extreme case, the entrant
will attract little of the traffic from B to A, thereby raising its average costs for the A-B
round-trip service.
Competition will be sustainable on the A-B route in the event that either (i) the
competitor airline has significantly lower costs than the incumbent, or (ii) the competitor
offers a significantly different product than the incumbent (differentiating itself in some
other way) or (iii) A is a hub for the competitor airline, giving it a degree of
countervailing power against the incumbent airline.
This analysis suggests the following three predictions:
•First, an airline is likely to fly a large proportion of all the non-stop routes flown out
of its hub(s). This is confirmed by the trend towards single-airline dominance of airports.
“As airlines have moved from a linear route structure to a hub-and-spoke method of
delivery, many airports have become dominated by a single carrier. In nine of the top 25
airports, the dominant carrier is responsible for over 50 percent of the enplanements at
the airport.”
16
•Second, airline networks are likely to be dominant and to enjoy market power on
non-stop routes originating or terminating at their hubs. Studies show that incumbent
airlines charge more than rivals do on flights to and from hub airports, suggesting that
incumbent airlines enjoy market power on nonstop routes to and from their hub.
Borenstein notes: “It has been clearly and frequently demonstrated that average prices for
local traffic at concentrated airports are significantly higher than prices on other routes
17
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Evans and Kessides agree: “[A] carrier that dominates traffic through a city tends to
16
Evans and Kessides (1992), page 463.
17
Borenstien (1989), GAO (1990),DOT(1990),Berry(1990 b), Abramowitz and Brown (1990),Evans
and Kessides (1992).
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receive significantly higher prices on trips beginning or ending in that city. This result
has now been replicated in a number of studies. … The dominant firm receives a 4.7 to
16 percent price premium on traffic originating or ending at the dominated city. This
price effect is significantly larger than any price increase caused by a lack of potential or
actual competition that we estimated at route level.”
•Third, hub-hub routes (routes from one network’s hub to another network’s hub)
are likely to be served predominantly or exclusively by the networks at each end. In this
case, both networks are likely to enjoy market power on these routes.
Borenstein notes: “The hub-and-spoke networks have evolved to the point where one
airline will generally fly to another airline’s hub only from its own hub. United, for
instance, offers non-stop service to Atlanta – Delta’s major hub – only from Denver,
Chicago-O’Hare and Washington-Dulles – three of United’s four largest hubs. The
markets for travel to and from hub airports tend to be more concentrated than at non-hub
airports”. “Effective new entry for the provision of non-stop service in the hub-to-hub
markets is unlikely by any carrier without a hub at one of the endpoints of the city pair. A
hub carrier has significant cost advantages over a non-hub carrier attempting to offer
service originating at the hub airport. Building a competing hub in the same city would
require considerable time and investment and is not likely to occur in response to fare
increases in the hub-to-hub markets.
New entry is also impeded by other factors, including difficulty in obtaining access to
gate facilities; the effects of travel agent incentive programs offered by dominant
incumbents; frequent flyer programs; and the risk of aggressive responses to new entry
by the dominant incumbent carrier serving a particular market”. For example, Northwest
Airlines operates hubs at Detroit, Minneapolis and Memphis. Continental operates hubs
at Newark, Cleveland and Houston. There are, therefore, nine hub-hub routes. The
market share accounted for by Northwest and Continental is no less than 100 percent on
Competition Issues in the Civil Aviation Sector
Nancy Shah, 30.7.07 115
seven of these nine routes. On the remaining two routes the market share of Northwest
and Continental combined is 94 percent (Detroit-Cleveland) and 87 percent (Detroit-
Newark). These three predictions summaries key features of the nature of competition
between airline networks.
Hence, Feeder flights to and from a hub are complementary to the services of the airline
operating the hub. To avoid double marginalization and to promote needed relationship-
specific investment, these services are usually more efficiently provided when integrated
with the hub airline. As a result hub-and-spoke airlines tend to be dominant at their hub
airports, holding a large share of the total passenger traffic. Studies show that incumbent
airlines charge more than rivals do on flights to and from hub airports, suggesting that
incumbent airlines enjoy market power on nonstop routes to and from their hubs.
As an aside, it is worth remembering that the fact that competition is limited on non-stop
spoke and hub-hub routes does not mean that competition is necessarily limited over
connecting flights over the same or other routes. In fact, such competition can be intense.
New entry can, in some circumstances, erode this market power. One entry strategy is to
introduce services from existing network hubs or from new entrants that can form
alliances with existing networks. British Midland, for example, has signed a series of
non-exclusive code sharing agreements with almost all-major US airlines.
A second entry strategy is to offer a differentiated service that avoids direct competition
with the incumbent. In the UK, for example, a number of budget carriers have established
successful services carrying point-to-point leisure travelers within Europe, often focusing
on lesser-utilised airports. Virgin has focused on routes with a high level of point-to-point
business and leisure travelers.
A third entry strategy involves providing services that are complementary to the
incumbent, such as spoke services. Because of the advantages of providing such services
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in a manner integrated with the activities of the incumbent, such services are typically
provided under some form of arrangement with the incumbent, such as a franchise. This
last strategy, although enhancing the range of services available, provides no competitive
pressure on the incumbent.
2. There are strong incentives for mergers and alliances between airlines. Depending on
the nature of competition between the networks prior to the merger, a merger or alliance
can allow the merged airline to lower costs and enhance demand for its services by
rationalizing hub-and-spoke structure(s), achieving greater cost efficiencies and offering
a greater range of seamless connections. On the other hand, a merger or alliance will
reduce competition and could enhance market power on routes where the networks had
previously overlapped, especially on spoke and hub-hub routes.
An alliance or merger of two hub-and-spoke networks has three broad effects:
First, a merger will typically yield cost efficiencies. There are two forms of these cost
efficiencies - the first comes from the rationalization of the network, and the second from
the cost economies of scope that arise at a hub. The greatest opportunity for
rationalization arises when the networks overlap in the markets they serve. In this case,
the merger will allow a strengthening of the hub spoke arrangement by a re-focusing of
the flights on the existing hubs, a reduction in the number of nonstop flights and an
increase in the traffic density (and flight frequency on the overlapping spokes). This is
illustrated in the following diagram. Prior to the merger there are two fully overlapping
networks centered on different hubs. The merger leads to a rationalization and a single-
hub operation:
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Nancy Shah, 30.7.07 117
The anti-competitive effects of a merger, on the other hand, depend upon the extent
of overlap of the networks, or more precisely, the number of markets that the
networks were both serving (or may have both served). In addition, a merger will
have the effect of enhancing the demand for the network. This can increase the market
power of the network, especially at its hub airports and especially when the merger
increases the range of services available from a hub.
Case I:
The most straightforward cases to consider are those where the two networks do not
overlap in the markets they serve (except, perhaps, on the hub-hub route between the
networks) and the two networks are not potential entrants into each other markets. This
situation arises in international airline alliances, where international regulatory
restrictions prevent the two networks from competing. In these cases the alliances can
yield efficiency gains in the form of enhanced operation. These gains must be considered
alongside the anti-competitive effect of a reduction in competition on the hub-hub
route(s) and the anti-competitive effect of an enhancement of the demand for the network
as a whole.
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Case II:
Slightly more difficult are cases in which the two networks do not overlap but share a
common hub. In these cases, the merger can yield significant efficiency gains. These
gains need to be considered along with the anti-competitive effect of the increased market
power of the merged airline at its hub.
A study by Kim and Singal of all airline mergers in the US between 1985 and 1989
found that on non-overlapping routes which share a common hub, the efficiency effect
dominates: a merger of two solvent firms serving those routes leads to a decline in prices
of 11 percent on such routes. Borenstein finds that, in the case of the October 1986
merger of Northwest and Republic, prices in and out of the hub they shared
(Minneapolis) rose by 11 percent faster than the national average from the year before the
merger to the year after. The largest price increases occurred on routes where the two
merging airlines had been the only competitors, increasing 23 percent faster than the
national average.
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Nancy Shah, 30.7.07 119
Case III:
More difficult still are those cases in which the two networks overlap. In this case the
efficiency benefits of the merger can be significant due to the rationalization of the hub-
spoke system. However, the merger can also reduce competition in many markets. These
mergers present the greatest problems for competition authorities. The Kim and Singal
study found that in the 1985-1989 period, on average the market power effect dominated.
Prices rose by an average of almost four percent on overlapping routes. Interestingly, the
Kim and Singal study also found that prices rose on non-overlapping routes, due, perhaps
to a reduction in potential competition, or an increase in multi-market contact.
Conclusion:
There are important economies of both scale and scope in the airline industry. Travelers
prefer “seamless” connections and more frequent services. In the presence of loyalty
schemes such as frequent-flyer programs, many travelers also prefer networks that serve
a larger number of destinations. Larger airline networks organized in the “hub and
spoke” form can take advantage of cost economies and can offer more seamless
connections, more frequent services and a greater range of destinations than can smaller
airline networks, making their networks more attractive, especially to full-fare paying
passengers. Carriers that have significant operating cost advantages, both network
carriers and point-to point carriers, have been able to compete successfully with larger
networks in a few markets. As a result of the above-mentioned cost and demand factors,
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hub-and-spoke airlines tend to be dominant on spoke and hub-hub routes, and jointly
dominant (with the corresponding rival networks) on routes to and from other networks’
hubs. Hub-and-spoke airlines tend to enjoy market power on non-stop routes to and from
their hubs. In addition, there is a tendency for airlines to have a high share of the total
traffic at their hub airports.
New entry to erode this market power is difficult. Successful new entry has occurred from
rival networks (or virtual networks), from new services that are sufficiently differentiated
to avoid head-to-head competition, or, in a few city pairs, from carriers that have
substantially lower operating costs.
Airline mergers and alliances can allow airlines to lower cost and enhance demand by
rationalizing the combined networks, and expanding the scope of seamless service. On
the other hand, airline mergers and alliances can reduce competition and enhance
market power, especially on non-stop routes to and from hub airports. The relative
balance of the efficiency benefits and the competition effects depends on a number of
factors, including the degree of overlap in the airlines’ networks prior to the merge.
International or cross-border mergers are typically prevented by domestic rules
prohibiting foreign ownership. In such circumstances, airlines forge international
alliances, which seek to capture some of the benefits that would normally be achieved
through merger. Alliances differ in the depth to which they try to co-ordinate the
activities of the member airlines. An alliance may not be as efficient as a full merger –
the transactions costs are likely to be higher and joint investment (fearing hold up or the
break-down of the alliance) is likely to be lower. Nevertheless, a carefully worked-
through alliance could approach a full merger as regards both "pro" and anti-
competitive effects.
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APPENDIX IV:
Methods for Allocation of Slots
The literature is full of different Methods of Slot Allocation. However, none of them are
free from cons.
1. Trading of Slots:
In theory, the existence of a buy/sell market for slots should create a market price that
results in an efficient allocation among users. No matter how slots are distributed
(including a government giveaway to market incumbents), as long as a secondary market
exists and transaction costs are low, slots should be bought and sold until each finds its
highest valued use. In practice, as validated by U.S example that the, slot market did not
result in an efficient allocation among incumbents, nor did it facilitate competitive entry
in the constrained airports. The secondary market never became sufficiently liquid to
achieve these results as it lacked transparency.
Transparency in the market for slots is one reason the secondary market never became
sufficiently liquid. Transparency means that the identity of buyers and sellers is widely
known. Transparency in the secondary slot market permits strategic purchases by
incumbents to prevent new entry. An incumbent carrier holding slots probably would
never knowingly sell to an entrant that was likely to compete against it, given that such a
sale would likely decrease the slot holder’s profitability. More importantly, a potential
entrant would have equal difficulty buying from other slot holders. Because the rents
from limiting competition almost always exceed the more competitive rents an entrant
would earn, the threatened incumbent should be willing to outbid the entrant, even if it
would use the slots in an economically less efficient manner. Strategically purchasing
available slots can be an effective entry deterrent, especially since multiple slot holdings
required for significant entry rarely come up for sale.
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Another reason the secondary slot market never became sufficiently liquid is that the
initial allocation of slots (made by FAA
18
) gave the bulk of all slots to incumbent
carriers. This allocation gave those carriers much larger market shares in slots than any
other carrier could obtain, and effectively limited the amount of competition other
carriers could offer on at least some routes. For those incumbents with extensive
operations at an airport, any slot they sold would have almost certainly been used to
compete with them on some route. Therefore, the incumbents were unwilling to sell slots
to potential competitors, making the bulk of slots unavailable to others.
2. Congestion Pricing
Under a congestion pricing system, the existing slot allocation system would be abolished
in favor of congestion fees set for particular times. Airlines currently pay weight-based
fees for landing. The consequence of the weight-based fee structure is that a small
regional jet, which causes just as much airspace congestion as the largest 737, pays
a much lower landing fee than the much larger plane. Airlines thus do not face a price
that reflects the fact that airspace is a scarce input. If airlines were charged a flat landing
fee based upon demand at particular times of day, regardless of the size or type of plane,
smaller aircraft such as regional jets would appropriately have to bear a higher per-
passenger cost for using an airport’s scarce landing capacity than they do now. Regional
jets would continue to be part of the airport’s mix of aircraft, but at the margin where
airlines are choosing between larger jets and regional jets, larger jets operating slightly
less frequently will become a more attractive option than scheduling multiple trips on
regional jets. The result would be an increase in passenger throughput at capacity-
constrained airports. The advantage of congestion pricing is that it is relatively easy to
implement. The regulator would set prices for slots at different times and airlines would
set their quantities accordingly. If the prices are initially too low, then the congestion
prices can be raised over time to ration demand. A uniform fee for landing at a particular
time would reduce the congestion bias caused by the current system of weight-based
18
FAA-The Federal Aviation Administration (FAA) is an agency of the United States Department of
(footnote continued)
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Nancy Shah, 30.7.07 123
landing fees. Although congestion pricing is likely superior to administrative allocation, a
drawback to congestion pricing is the regulator’s lack of knowledge about what price to
set. A regulator may not have good enough information to allow it to set the right price
without frequent experimentation. Even that mechanism may have problems because the
necessary feedback for quantity adjustment may be slow. In particular, airlines often
advertise service well in advance so as to schedule and make ground facility
arrangements efficiently. This, in turn, implies that adjustments based on the changing
price of arrival authorizations may be slow. For highly congested airports, the cost of
setting the wrong price and getting too much (or too little) airline traffic may be high.
3. Slot Auction
A slot auction would allocate scarce arrival authorizations through a periodic open-
bidding mechanism.
A well-designed slot auction would both assign prices to allocate efficiently scarce
airport resources, and limit the maintenance or accumulation of market power by
individual carriers. Such goals require careful attention to the details of auction design.
For instance, the auction should limit informational feedback during the auction itself.
Bidders might know the aggregate level of demand and supply of all arrival
authorizations in each time period, but not be permitted to know the identity of the other
bidders. This practice is fairly typical at auctions and is designed both to limit collusion
among bidders and to prevent strategic bidding. Although more information allows more
informed bidding on the part of bidders in ways that can be efficient, full knowledge of
which airlines are bidding for which slots in an auction could encourage incumbent
airlines to attempt to foreclose entry by particularly strong competitors. In this case, the
government’s interest in preserving competition among carriers should take priority over
bidders’ desires to have complete information about rival bids.
Transportation with authority to regulate and oversee all aspects of civil aviation in the U.S.
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Any auction design must allow for sufficient liquidity so that potential entrants are not
unnecessarily impeded. Annual auctions of a significant portion of airport arrival capacity
(20%, for instance) would help allow for rapid entry when it is efficient. Such as a five-
year rotation would provide a concrete duration for the property right, and therefore assist
airlines in valuing the slots. A switch to a market-based mechanism for allocating arrival
authorizations will not by itself achieve the twin goals of reducing congestion and
encouraging more competitive outcomes.
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BIBLOGRAPHY:
1. Airlines Mergers & Alliances: OECD Document, 2000.
2. Indian Civil Aviation Industry: Road Map for Growth by ASSOCHAM in
association with Ernst-Young, 2007.
3. Background Note for the Economic Editor’s Conference Organized by PIB on
16-18th Nov. 2005 On Latest developments & policy initiatives relating to the
Ministry of Civil Aviation.
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