Re Qantas Airways Ltd
[2004] ACompT 9
•16 MAY 2005
AUSTRALIAN COMPETITION TRIBUNAL
Qantas Airways Limited [2004] ACompT 9
SUMMARY
File No 5 of 2003
RE:APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)
BY:QANTAS AIRWAYS LIMITED (ABN 16 009 661 901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)
Applicants
GOLDBERG J (President), MR G F LATTA and PROFESSOR D K ROUND
16 MAY 2005
MELBOURNE (Heard in Sydney and Melbourne)
SUMMARY
In accordance with the practice of the Australian Competition Tribunal (“the Tribunal”) the following summary has been prepared to accompany the Reasons for Determination made today. The summary is intended to assist in understanding the outcome of these proceedings and is necessarily not a complete statement of the reasoning or the conclusions of the Tribunal. The only authoritative statement of the Tribunal’s reasons is that contained in the published Reasons for Determination which is being published today and will be available on the internet at together with this summary.
The matter before the Tribunal was a review sought by Qantas and Air New Zealand of the Australian Competition and Consumer Commission’s (“the Commission”) refusal to grant them authorisation in respect of agreements relating to their activities across the Tasman and elsewhere. In essence, Qantas and Air New Zealand entered into a series of agreements, subject to authorisation, rationalising a number of their airline activities.
On 12 October 2004 the Tribunal handed down its determination in which it granted the authorisation sought. The Tribunal has found that although there is a detriment arising out of certain anti‑competitive aspects of the proposed agreements, there are public benefits accruing as a result of the proposal which outweigh that detriment.
In December 2002 Qantas and Air New Zealand applied to the Commission for authorisation for Qantas to acquire ordinary shares in Air New Zealand comprising up to a 22.5% voting equity interest, and for Qantas and Air New Zealand to enter into agreements for the coordination of their activities such as scheduling and pricing for all passenger and freight services on all Air New Zealand flights and all Qantas flights into, within and leaving New Zealand. There was also an application for authorisation of an agreement relating to co‑operation with respect to aspects of passenger and freight services with Air Pacific Limited. We refer to this acquisition and these agreements as “the Alliance”. The Alliance between Qantas and Air New Zealand involved, in substance, the combining of flights and the removal of competition between them in relation to matters such as pricing and scheduling.
On 9 September 2003 the Commission denied authorisation in respect of all the agreements on the grounds that they would involve a substantial lessening of competition and that the anti‑competitive effects of the proposed agreements would substantially outweigh the public benefits flowing from the agreements.
Qantas and Air New Zealand applied to the Tribunal to review the Commission’s decision. Qantas and Air New Zealand’s proposals were examined in relation to their effects in various markets. The markets were:
the trans‑Tasman air passenger services market;
the trans‑Tasman airfreight market;
the Australian domestic air passenger services market;
the Australia‑North America air passenger services market;
the Australia‑North America airfreight market; and
the market for travel distribution services.
The greater part of the hearing was taken up by a consideration of the trans‑Tasman air passenger services market, there being little controversy that there were any anti‑competitive effects in the other markets save for the Australia‑North America air passenger services market.
The Tribunal, using the “future with and without test”, considered the public benefits and anti‑competitive detriments which would flow or be likely to flow if authorisation were granted (“the factual”) and then compared them with the public benefits and anti‑competitive detriments which would occur, or be likely to occur, if authorisation were not granted (“the counterfactual”).
The Tribunal, consistently with its previous determinations, adopted a test of assessing the benefits to the public said to be generated from the Alliance by considering the benefits which flowed not only to ultimate consumers but also to the parties and their shareholders (described as the “total welfare” or “total surplus” approach), with a caveat that the weight that should be accorded to benefits achieved by producers might depend on whether and to what extent any cost savings or other benefits were passed through to consumers.
The benefits that were claimed by Qantas and Air New Zealand in relation to the trans‑Tasman air passenger services market were:
the enhancement of the national interest;
the benefits to Qantas’ network as a result of network extension with Air New Zealand;
international benefits of such network extension;
synergy benefits of such network integration;
scheduling benefits of such network integration;
pricing benefits of such network integration
tourism benefits.
In relation to the trans‑Tasman air passenger services market we found that, notwithstanding the substantial combined market share of Qantas and Air New Zealand of approximately 80% that would exist at the time the Alliance came into operation if it were authorised, there would be little anti‑competitive detriment arising from the fact that Qantas and Air New Zealand would not be competing against each other in the market, although we do recognise that some time‑sensitive passengers might on occasion experience some inconvenience, at least in the short‑run. We considered, with the exception of the time‑sensitive passenger, that any attempt by Qantas and Air New Zealand to act jointly in an anti‑competitive way, such as by limiting capacity or increasing prices, would be constrained by the presence and likely responses of two airlines in particular, Pacific Blue and Emirates. We were satisfied that Emirates and Pacific Blue, currently holding only a relatively small market share (but one that had significantly increased during 2003/2004), would act as a constraining influence upon Qantas and Air New Zealand, as they had available capacity and cost advantages which would enable them to attract travellers with competitive pricing and scheduling if Qantas and Air New Zealand raised their prices or restricted their capacity. We were satisfied that Emirates has made a commitment to the trans‑Tasman market at least for the five year period for which authorisation was sought, and that Pacific Blue is committed to the trans‑Tasman market, and that both airlines would attract passengers from Qantas and Air New Zealand if the Alliance sought to raise its prices or restrict its capacity.
The only significant detriment was in relation to the time‑sensitive passenger, usually a person travelling on business who wished to travel to and from Australia at short notice and had little flexibility as to the time at which he or she could travel, should flight frequencies be reduced.
In determining the constraining effects of Pacific Blue and Emirates we paid particular attention to their current and likely future strategic behaviour in the market, in addition to analysing past trends in market share for each of the participants in the market.
Ultimately, we reached the conclusion that any anti‑competitive detriment brought about by the proposals of Qantas and Air New Zealand in relation to the time‑sensitive passenger was relatively small and that it did not require a substantial public benefit to outweigh that detriment.
Although we reach a different conclusion to that reached by the Commission, it should be pointed out that at the time the Commission made its determination Pacific Blue had just started its trans‑Tasman flights and Emirates had not sought to promote its brand and build up its schedules across the Tasman in the manner it did between the time of the determination and the time at which the hearing commenced. As this was a de novo hearing held eight months after the Commission’s determination, we were considering a quite different market from that analysed by the Commission.
AUSTRALIAN COMPETITION TRIBUNAL
Qantas Airways Limited [2004] ACompT 9
TRADE PRACTICES – applications for review of a determination under s 101 of the Trade Practices Act 1974 (Cth) – proposed agreements between airlines to acquire shares and coordinate activities – agreements presumed to fall within the prohibitions in s 45 and s 50 of the Trade Practices Act 1974 (Cth) – review of determination of Australian Competition and Consumer Commission denying authorisation to the agreements – where combined market share of airlines under agreements would be substantial – whether agreements ought to be authorised – whether agreements likely to give rise to anti‑competitive detriment in a number of air passenger and airfreight service markets – whether agreements likely to give rise to public benefit – assessment of standard to be applied in assessing public benefit – whether public benefit outweighs anti‑competitive detriment.
Trade Practices Act 1974 (Cth) ss 88(1), 88(9), 90(6)‑(9), 90A(13), 101, 102(1), 109(2)
Convention on International Civil Aviation, opened for signature 7 December 1944, 15 UNTS 295 (entered into force 4 April 1947)
Applications for Authorisation A30220, A30221, A30222, A90862 and A90863: Acquisition by Qantas Airways Limited of ordinary shares in Air New Zealand Limited and cooperative arrangements between Qantas, Air New Zealand and Air Pacific Limited (Final determination, 9 September 2003, C2002/1775)
Air New Zealand v Commerce Commission (No 6) (unreported, High Court of New Zealand, Rodney Hansen J and KM Vautier, 17 September 2004), cited
Re Herald & Weekly Times Ltd on behalf of the Members of the Media Council of Australia (1978) 17 ALR 281, cited
Re Queensland Co‑operative Milling Association Ltd and Defiance Holdings Ltd (1976) 8 ALR 481, followed
Re Rural Traders Co‑operative (WA) Ltd (1979) 37 FLR 244, followed
Re G & M Stephens Cartage Contractors Pty Ltd on behalf of the Members of the Concrete Carters Association (Victoria) (1977) 16 ALR 387, cited
Re Media Council of Australia (No 2) (1987) 88 FLR 1, discussed
Re 7‑Eleven Stores Pty Ltd (1994) ATPR 41‑357, followed
Re Australian Competition and Consumer Commission by Australian Association of Pathology Practices Inc (2004) 206 ALR 271, cited
Re EFTPOS Interchange Fees Agreement (2004) ATPR 41‑999, cited
Re QIW Ltd (1995) 132 ALR 225, followed
Re Media Council of Australia (1996) ATPR 41‑497, followed
Re AGL Cooper Basin Natural Gas Supply Arrangements (1997) ATPR 41‑593, cited
Australian Wool Growers Association Ltd (2000) ATPR 41‑774, cited
Re Howard Smith Industries Pty Ltd (1977) 28 FLR 385, followed
Australian Gas Light Company v Australian Competition and Consumer Commission (2003) ATPR 41‑966, followed
Trade Practices Commission v Australian Iron & Steel Pty Ltd (1990) 22 FCR 305, cited
Refrigerated Express Lines (A/asia) Pty Ltd v Australian Meat and Live‑stock Corporation (1980) 29 ALR 333, cited
Hospital Benefit Fund of Western Australia Inc v Australian Competition and Consumer Commission (1997) 76 FCR 369, cited
Telecom Corporation of New Zealand Ltd v Commerce Commission (1991) 4 TCLR 473, followed
Trade Practices Commission v Australia Meat Holdings Pty Ltd (1988) 83 ALR 299, cited
Re Tooth & Co Ltd (1979) 39 FLR 1, cited
Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (1989) 167 CLR 177, followed
National Justice Compania Naviera SA v Prudential Assurance Co (“The Ikarian Reefer”) [1993] 2 Lloyd’s Rep 68, cited
Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 215 CLR 374, citedThe Hon MEJ Black, Practice Direction: Guidelines for Expert Witnesses in Proceedings in the Federal Court of Australia, issued 19 March 2004
Independent Committee of Inquiry (FG Hilmer, MR Rayner and GQ Taperell), National Competition Policy: Report by the Independent Committee of Inquiry, Australian Government Publishing Service, Canberra, 1993
MS Gal, Competition policy for small market economies, Harvard University Press, Cambridge, Massachusetts, USA, 2003
International Competition Network Working Group, Analytical Framework Subgroup, Project on merger guidelines: Report for the third ICN annual conference in Seoul, 2004
ME Levine, ‘Understanding airline strategic choices: How much do legacy carriers have to change to survive?’, paper presented at an Airline Economics Seminar at the Embry‑Riddle Aeronautical University, Washington DC, USA, 7 April 2004
Committee to Review the Trade Practices Act 1974 (TB Swanson et al), Report to the Minister for Business and Consumer Affairs, Department of Business and Consumer Affairs, Canberra, 1976File No 5 of 2003
RE:APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)
BY:QANTAS AIRWAYS LIMITED (ABN 16 009 661 901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)
Applicants
GOLDBERG J (President), MR G F LATTA and PROFESSOR D K ROUND
16 MAY 2005
SYDNEY (Heard in Sydney and Melbourne)
IN THE AUSTRALIAN COMPETITION TRIBUNAL
No 5 of 2003
RE:APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)
BY:QANTAS AIRWAYS LIMITED (ABN 16 009 661 901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)
Applicants
THE TRIBUNAL:
GOLDBERG J (President)
MR G F LATTAPROFESSOR D K ROUND
DATE OF DETERMINATION:
12 OCTOBER 2004
WHERE MADE:
SYDNEY (Heard in Sydney and Melbourne)
THE TRIBUNAL DETERMINES THAT:
1.The determination of the Australian Competition and Consumer Commission dated 9 September 2003 denying authorisation to applications A30220, A30221, A30222, A90862 and A90863 is set aside.
2.Pursuant to subs 88(1) of the Trade Practices Act 1974 (Cth) (“the Act”), the Tribunal grants an authorisation in respect of applications A30220 and A30221 to Qantas Airways Limited (“Qantas”) and Air New Zealand Limited (“Air New Zealand”) to make and give effect to the Strategic Alliance Agreement dated 25 November 2002 between Qantas and Air New Zealand under which:
(a)they will coordinate pricing, scheduling, marketing, sales and customer service activities for all Air New Zealand operated flights, all domestic New Zealand flights operated by Qantas, and Qantas operated international flights arriving in, departing from or transiting through New Zealand (“the JAO Network”);
(b)Qantas will have the right to codeshare on all Air New Zealand flights, and Air New Zealand will have the right to codeshare on all Qantas flights in the JAO Network and to codeshare on those other Qantas flights that reasonably connect to any flight in the JAO Network;
(c)Qantas and Air New Zealand will from time to time enter into contracts and arrangements and arrive at understandings that include exclusionary provisions (within the meaning of s 4D of the Act), including but not limited to in connection with the joint supply or joint acquisition by Qantas and Air New Zealand of air transportation services and other goods and services.
3.Pursuant to subs 88(9) of the Act the Tribunal grants an authorisation in respect of application A30222 to Qantas to acquire convertible notes and shares enabling Qantas to hold up to 22.5% of the capital of Air New Zealand as set out in the Subscription Agreement between Qantas and Air New Zealand dated 25 November 2002 in the terms set out in application A30222.
4.Pursuant to subs 88(1) of the Act the Tribunal grants an authorisation in respect of applications A90862 and A90863 to Qantas and Air New Zealand to make and give effect to the Cooperation Agreement made in or about December 2002 between Qantas and Air New Zealand.
5.The authorisations referred to in paragraphs 2 and 4 of this determination shall be in force for a period of five years commencing on the date upon which each of the said agreements is first given effect to, which date must be notified in writing by Qantas and Air New Zealand to the Commission (marked for the attention of the Chairman) within 14 days of such first giving effect. If either of the Strategic Alliance Agreement or the Cooperation Agreement referred to in paragraphs 2 and 4 of this determination is not given effect to within twelve months of the date of this determination the Commission may apply to the Tribunal to vary this determination by fixing a specific date on which the period in respect of which the authorisation in respect of that agreement shall commence.
6.Liberty is reserved to all parties to apply to the Tribunal for such further or other determinations as may be necessary to implement and carry into effect this determination.
IN THE AUSTRALIAN COMPETITION TRIBUNAL
No 5 of 2003
RE:APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)
BY:QANTAS AIRWAYS LIMITED (ABN 16 009 661 901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)
Applicants
THE TRIBUNAL:
GOLDBERG J (President)
MR G F LATTAPROFESSOR D K ROUND
DATE:
16 MAY 2005
PLACE:
SYDNEY (Heard in Sydney and Melbourne)
CONTENTS
INTRODUCTION ……………………………………………………………………………………. 1
THE PARTIES ……………………………………………………………………………………….. 4
Qantas ……………………………………………………………………………………………… 4
Jetstar …………………………………………………………………………………………… 5
QH Tours Ltd …………………………………………………………………………………… 5
Air Pacific ………………………………………………………………………………………. 6
Air New Zealand …………………………………………………………………………………… 6
Domestic Express ……………………………………………………………………………….. 7
Tasman Express …………………………………………………………………………………. 7
Freedom Air …………………………………………………………………………………….. 7
The Gullivers Group ……………………………………………………………………………….. 8
Other relevant airlines …………………………………………………………………………….. 8
Virgin Blue …………………………………………………………………………………….. 8
Fifth Freedom Carriers …………………………………………………………………………. 10Emirates – a particular case ……………………………………………………………………. 11
BACKGROUND TO THE AIRLINE INDUSTRY …………………………………..…………… 13
Revenue management ……………………………………..………………………………………. 13
Terminal scheduling and slot allocation …………………..………………………………………. 16
Interlining ……………………………………..……………………………………….………….. 17
Code‑sharing …………………..………………………………………………..…………………. 17
Regulatory framework ………………………….……………………………………….………… 17
Airline models: the FSA v the LCC …………………..………………………………………… 18Impact of the LCC model on the airline industry ………………………………………..…… 22
THE ALLIANCE …………………………………..………………………………….………….…. 24
The Equity Proposal ……………………………………..……………………………….……..…. 25
The Strategic Alliance Agreement ………..……………..……………………………....……….... 25The Cooperation Agreement ……………………..…………………………………………..….… 29
THE COMMISSION’S DETERMINATION …………………………………..………….….…… 30
Evidentiary changes since the Commission’s determination …………………………...…………. 33
THE HEARING BEFORE THE TRIBUNAL …………………………………..……………..….. 35
RELEVANT PROVISIONS OF THE ACT …………………………………..…………………… 35
Relevant test to be applied …………………..……………………………..………..……..……… 38
The future with and without test ………………………………………..……….……...……… 40
The meaning of “likely to result” …………….……………………………………….……….. 40
Efficiencies used to assess detriment and benefit ………………………………..…...……..… 42
The meaning of public benefit ………………………………………………….…...………... 43
Welfare standards – the connotation of “public” ………………………………....….………… 44
Benefits – domestic v foreign………………………………..….…………………….….….…. 52Quantification of benefits………………………………..….………………………………..… 54
THE EXPERT EVIDENCE …………………………………..………………………………..…… 57
The role of the expert …………………..…………………………………….…..……..………… 58
DEFINING THE MARKET …………..……………………………………..………………….….. 62
The relevant markets …………………………………..……………………………...…………… 64
The trans‑Tasman air passenger services market …………………..………….…..……..…… 67
The trans‑Tasman airfreight market …………………..……………………..…………..…... 68
The Australian domestic air passenger services market ……………….….……………..…... 69
The Australia–North America air passenger services market ……..………….…..….....…… 70
The Australia–North America airfreight market ………………..…………..…………...……. 71The market for travel distribution services …………………..…………..…………...…… 72
THE PRINCIPAL ISSUES …………………………………..…………………………..……..…... 73
Market share and market structure in the trans‑Tasman air passenger services market ……..……. 76
The likelihood and extent of further entry and expansion by Virgin Blue, Emirates and other FFCs in the trans‑Tasman air passenger services market …………………….…..……… 82
Virgin Blue ………………..…………..…………..………………..…………..………….. 83
FFCs and Emirates ………………..…………..…………..………………..…………..… 97Analysis of competition issues in the trans‑Tasman air passenger services market ………..…. 112
THE FACTUAL …………………………………..…………………………..……………………. 122
THE COUNTERFACTUAL …………………………………..……………..……………………. 134
Analysis of capacity and average fares in the trans‑Tasman air passenger services market .….…. 137
Continued operation of Air New Zealand in the trans‑Tasman air passenger services market .…. 140
DETRIMENT IN THE TRANS‑TASMAN AIR PASSENGER SERVICES MARKET ………. 144
DETRIMENT IN THE TRANS‑TASMAN AIRFREIGHT MARKET ………………………… 146DETRIMENT IN THE AUSTRALIAN DOMESTIC AIR PASSENGER SERVICES
MARKET …………………………………………………………………………………………… 146
Prospect of entry by Air New Zealand or another Star Alliance member .….………………….... 148
Qantas to capture feed from Air New Zealand ………………………………………………..….. 150
DETRIMENT IN THE AUSTRALIA–NORTH AMERICA AIR PASSENGER SERVICES MARKET ………………………………………………………………………………………….. 150
Re‑entry by Air New Zealand onto Australia–North America routes .….………………………... 151
Air New Zealand’s code‑share with United Airlines ………………………………………....…. 152Air New Zealand’s indirect services as a competitive constraint ……………………………..…. 156
DETRIMENT IN THE AUSTRALIA–NORTH AMERICA AIRFREIGHT MARKET ……… 160
DETRIMENT IN THE MARKET FOR TRAVEL DISTRIBUTION SERVICES .……….…. 161
Loss of competitive tension between the applicants and remuneration of travel agents ……...…. 163
Ability to favour own distribution channels ……………………………………………..…....…. 172
THE BENEFITS CLAIMED BY THE APPLICANTS ……………….…………………………. 175
The national interest ……....…………………………………………………………………….. 180
The benefits of expansion of Qantas’ domestic and international networks ……………………... 181
Synergy, scheduling and pricing benefits of network integration ………………………………… 186
Tourism benefits…………………………………….…..…..…………………………………….. 194
The context of LCC entry and growth, and increased activity of government‑funded global airlines, in the Australasian market ……………………………………………………………………….. 201COULD THE CLAIMED PUBLIC BENEFITS BE ACHIEVED IN THE ABSENCE OF THE ALLIANCE? ……………….……………………………………………………………………….. 204
THE WEIGHING EXERCISE ……………….………………………….………………………… 205
THE DETERMINATION ……………….………………………….……………………………… 207
IN THE AUSTRALIAN COMPETITION TRIBUNAL
No 5 of 2003
RE:APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)
BY:QANTAS AIRWAYS LIMITED (ABN 16 009 661 901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)
Applicants
THE TRIBUNAL:
GOLDBERG J (President)
MR G F LATTAPROFESSOR D K ROUND
DATE:
16 MAY 2005
PLACE:
SYDNEY (Heard in Sydney and Melbourne)
REASONS FOR DETERMINATION
INTRODUCTION
On 12 October 2004 we published our determination in these matters and we now publish our reasons for that determination.
In these reasons, where a question of law is determined, or a view is expressed, or a conclusion is reached, on a question of law, such question has been determined, such view is expressed and such conclusion has been reached, in accordance with the opinion of the presidential member, Goldberg J, pursuant to s 42 of the Trade Practices Act 1974 (Cth) (“the Act”).
A substantial part of the evidence we received was subject to confidentiality orders and undertakings. Where we have referred to information that was subject to a claim of confidentiality during the hearing, we have identified that information in a confidential schedule. A draft of this schedule and a draft of these reasons for determination were distributed to the legal representatives of the parties providing the confidential information prior to the publication of the reasons. The legal representatives were then given the opportunity to make submissions as to the contents of the schedule at a hearing before the presidential member. Confidential information referred to in these reasons has been enclosed in square brackets and given a [--] or letter designation and omitted from the published reasons. The confidential schedule will only be published to the legal advisers to the parties supplying the confidential information.
On 9 December 2002 Qantas Airways Limited (“Qantas”) and Air New Zealand Limited (“Air New Zealand”) (together, “the applicants”) lodged three applications with the Australian Competition and Consumer Commission (“the Commission”).
One application was made pursuant to s 88(9) of the Act for authorisation to acquire shares in the capital of a body corporate in circumstances where this may have the effect of substantially lessening competition in a market within the meaning of s 50 of the Act. The application sought authorisation for Qantas to acquire ordinary shares in Air New Zealand comprising up to a 22.5% voting equity interest.
The other two applications were made pursuant to s 88(1) of the Act for authorisation:
·to make a contract where a provision of the proposed contract would be, or might be, an exclusionary provision within the meaning of s 45 of the Act, and to give effect to that provision; and
·to make a contract a provision of which would have the purpose, or would have or might have the effect, of substantially lessening competition within the meaning of s 45 of the Act, and to give effect to that provision.
These applications sought authorisation for the applicants to enter into an agreement relating to passenger and freight services whereby the airlines would co‑ordinate the fares and schedules of all Qantas flights and Air New Zealand flights into, within, and leaving, New Zealand, and would agree not to compete with each other on other routes leaving from, or arriving in, Australia or New Zealand.
On 20 December 2002 the applicants made two further applications to the Commission for authorisation of an agreement with Qantas’ subsidiary, Air Pacific Limited (“Air Pacific”).
The applications were made pursuant to s 88(1) of the Act for authorisation:
·to make a contract where a provision of the proposed contract would be, or might be, an exclusionary provision within the meaning of s 45 of the Act, and to give effect to that provision; and
·to make a contract, a provision of which would have the purpose, or would have or might have the effect, of substantially lessening competition within the meaning of s 45 of the Act, and to give effect to that provision.
These subsequent applications sought authorisation for the applicants to enter into an agreement with Air Pacific that would allow the parties to co‑operate with respect to aspects of passenger and freight services.
On 9 September 2003 the Commission made a determination denying authorisation in respect of all of the applications: Applications for Authorisation A30220, A30221, A30222, A90862 and A90863: Acquisition by Qantas Airways Limited of ordinary shares in Air New Zealand Limited and cooperative arrangements between Qantas, Air New Zealand and Air Pacific Limited (“the Commission’ s determination”).
On 29 September 2003 the applicants, dissatisfied with the Commission’s determination, applied to the Tribunal for a review of the Commission’s determination pursuant to s 101 of the Act. The applicants, in effect, sought authorisation from the Tribunal in respect of the suite of agreements referred to above.
The applicants sought to have the various applications heard together. Having regard to the common factual substratum underlying each application, we exercised our discretion under s 90A(13) of the Act (being empowered by s 102(1) of the Act to exercise all the powers of the Commission) to treat the applications as if they constituted a single application and to give a single determination in respect of them.
Around the same time as the applicants made their applications to the Commission, they also made similar applications to the New Zealand Commerce Commission (“NZCC”) for authorisation pursuant to the Commerce Act 1986 (NZ) (“the Commerce Act”). On 23 October 2003 the NZCC made a final determination denying authorisation under the Commerce Act. The applicants appealed to the High Court of New Zealand against the NZCC determination, but this appeal was dismissed: see Air New Zealand v Commerce Commission (No 6) (unreported, High Court of New Zealand, Rodney Hansen J and KM Vautier, 17 September 2004).
THE PARTIES
The applicants for review are Qantas and a number of its subsidiaries and affiliated companies, and Air New Zealand and a number of its subsidiaries. A travel distribution group consisting of travel businesses located in Australia and New Zealand (collectively referred to as “the Gullivers Group”), was granted leave on 23 December 2003 to intervene in the proceeding as an interested party pursuant to s 109(2) of the Act. The Commission was also represented and provided assistance to the Tribunal.
QANTAS
The first applicant, Qantas, is a well‑known airline. Ranked the eleventh largest airline in the world on the basis of annual revenue passenger kilometres (“RPKs”), Qantas operates air passenger and freight services both internationally and domestically within Australia. As at the time of the hearing, it operated on average 4,600 domestic and 540 international flights per week, using a fleet of 196 aircraft and linking 135 destinations in 33 countries.
Qantas is what is known as a “full service airline” (“FSA”), providing a number of services which we shall later describe in more detail (see [83]–[86] below). Qantas provides air passenger services within Australia, to trans‑Tasman destinations and to other international destinations. It has an integrated network which enables it to offer:
·schedules that minimise connection time for transit passengers;
·seamless connections with a flight operated by another airline by means of “interline” and “code‑share” agreements (which are described in more detail at [73] and [74] below);
·baggage check‑through from the point of origin to the ultimate destination;
·frequent flights and adequate flight capacity to passengers, and
to assess route profitability on a network‑wide basis.
The appellation “trans‑Tasman” is used in a variety of contexts throughout these reasons. The appellation refers generally to cross‑border activity between Australia and New Zealand. When we refer to the “trans‑Tasman routes”, we generally mean the nine main routes between Australia and New Zealand, being Sydney–Auckland, Melbourne–Auckland, Brisbane–Auckland, Sydney–Wellington, Melbourne–Wellington, Brisbane–Wellington, Sydney–Christchurch, Melbourne–Christchurch and Brisbane–Christchurch. Qantas services these nine major trans‑Tasman routes by non‑stop flights. Other flights, for example, between Perth and Auckland, are serviced by connecting flights transiting at Sydney or Melbourne.
Qantas’ presence within Australia and on trans‑Tasman routes is used to develop goodwill, brand loyalty and traffic feed in Qantas’ other international markets. International travel accounts for approximately 55% of Qantas’ revenue. Qantas endeavours to make its business and flights attractive to a wide cross‑section of consumers. It tailors its flight services and facilities to customers who range from business travellers to leisure travellers, from frequent to infrequent travellers, and to both domestic travellers and international tourists. Qantas is currently a member of a major global marketing alliance called “oneworld”.
Jetstar
Qantas has recently established a wholly‑owned subsidiary airline named Jetstar to provide domestic services within Australia. Jetstar is managed separately from, and operates independently of, Qantas. At the time of the hearing, Jetstar was to commence services in May 2004. It is what is known as a “low cost carrier” (“LCC”), a term which we shall later describe in more detail (see [90]‑[91]). Jetstar is a point‑to‑point carrier servicing domestic leisure destinations, initially on routes of less than three and a half hours, without flight connections or baggage transfer. It also operates limited services on key business routes, Melbourne–Sydney and Melbourne–Brisbane, from its headquarters at Avalon Airport in Victoria.
QH Tours Ltd
QH Tours Ltd, trading under the brands “Qantas Holidays” and “Viva!Holidays”, is a wholly‑owned subsidiary of Qantas. It is established globally through subsidiary and associated companies in Asia and Europe and it wholesales domestic and international holidays. Within Australia, QH Tours Ltd markets travel packages and products to a wide range of international destinations, including Asia, Africa, Europe, the Pacific and North America. Internationally, it promotes primarily Australasian and some Asian destinations.
QH Tours Ltd distributes its inbound, outbound and domestic products in Australia and around the world through travel agents (approximately 37,400 worldwide), and directly to customers via the internet and call centres. It promotes inbound tourism by preparing brochures for provision to travel agents, and by providing access to its information technology infrastructure to licensed travel agents for its global network. This allows any licensed travel agent to have access to its products electronically via the internet as well as through the Global Distribution System (“GDS”).
Air Pacific
Qantas code‑shares on Air Pacific flights between Australia and Fiji.AirPacific is Fiji’s principal international airline. It operates from Fiji to Pacific and Asian destinations including Australia, New Zealand and the United States. The shareholders in Air Pacific are the Fijian Government, Qantas and Air New Zealand with shareholdings of approximately 51%, 46.32% and 1.97% respectively.
AIR NEW ZEALAND
The second applicant, Air New Zealand, has been ranked as the 33rd largest airline in the world based on annual RPKs (although the applicants contended that this ranking overstates Air New Zealand’s standing in the international airline industry). As at the time of the hearing, Air New Zealand operated an average of 2,998 domestic and 498 international return flights per week, using a fleet of 81 aircraft and linking 46 destinations in 16 countries.
Air New Zealand provides international and domestic air passenger and freight transport services within, to, and from, New Zealand. Air New Zealand also provides engineering services, airport services, cargo services and travel distribution services in New Zealand. Air New Zealand’s network consists of domestic New Zealand routes, international short‑haul routes (including trans‑Tasman routes) and international long‑haul routes.
Air New Zealand is currently a member of a major global marketing alliance called “Star Alliance”. In addition, Air New Zealand has a number of alliance arrangements with other airlines. Of particular relevance to the present proceeding is its Expansion Agreement with United Air Lines Inc (“United Airlines”). The Expansion Agreement has potential application network‑wide, but currently includes only services between New Zealand and major cities in the United States, selected New Zealand domestic services and services between New Zealand and the Pacific Islands and the United States. The Expansion Agreement has not been implemented on routes touching Australia because authorisation has not been granted in Australia.
Air New Zealand also operates a number of code‑share agreements and, in particular, operates a code‑share agreement with United Airlines between Australia and New Zealand. Excluding routes touching Australia, the Expansion Agreement is generally in effect on all Air New Zealand trans‑Pacific flights where Air New Zealand code‑shares on United Airlines flights. It does not cover flights via Tonga and flights from Auckland to Los Angeles via Papeete.
Domestic Express
Air New Zealand operates four regional airlines domestically within New Zealand, servicing major cities and regional New Zealand. In November 2002, Air New Zealand’s jet‑based regional airline changed its name from “National” to “National Express”. National Express and the three regional airlines are collectively branded “Domestic Express”.
Tasman Express
Following the introduction of Domestic Express, in July 2003 Air New Zealand relaunched its trans‑Tasman operations (with the exception of the Perth–Auckland route) as “Tasman Express”.
Freedom Air
Freedom Air was introduced by Air New Zealand in 1995. It operates as an LCC and has a separate reservation and pricing system to Air New Zealand. As at the time of the hearing, it operated four Boeing 737 aircraft and offered 50 return trans‑Tasman flights per week.
THE GULLIVERS GROUP
The intervener, the Gullivers Group, is an association of companies and firms which offers air travel services in competition with the direct retail and wholesale sales and distribution services provided by the applicants.
The Gullivers Group operates businesses in Australia and New Zealand in the tour and ticketing wholesale markets where it develops and markets domestic and worldwide holiday and ticket packages to travel agents. It participates in the retail leisure distribution market by operating branded travel agencies which service individual and small business needs domestically and throughout the world. The Gullivers Group also operates in the corporate travel distribution market, organising and managing the travel management requirements of large corporate organisations and selling tickets for sporting and other events.
In Australia, these businesses generate approximately $230 million in sales each year. In New Zealand, these businesses generate approximately NZ$1 billion in sales each year. Of particular relevance is SYNERGI Travel Australia Pty Ltd (“SYNERGI”), one of the companies in the Gullivers Group which operates in the corporate travel distribution/management market. SYNERGI is Australia’s fifth largest non‑airline owned travel management company.
OTHER RELEVANT AIRLINES
During the hearing, the parties placed considerable emphasis on the role which airlines other than Qantas and Air New Zealand will play in shaping the future of the airline industry in Australasia. We received considerable evidence regarding airlines which are LCCs, in particular, Virgin Blue Holdings Limited (“Virgin Blue”) and its subsidiary, Pacific Blue Airlines (NZ) Limited (“Pacific Blue”). Our attention was also directed to airlines which are referred to as “fifth freedom carriers”, and to one such carrier in particular, Emirates.
Virgin Blue
Virgin Blue commenced domestic services in Australia on 31 August 2000 and, as at the time of the hearing, was flying to all major Australian destinations, servicing 37 routes across Australia.
Virgin Blue deploys aircraft to its wholly‑owned subsidiary, Pacific Blue, which operates those aircraft on international routes, such as trans‑Tasman routes. In these reasons, on occasions, we refer to both Virgin Blue and Pacific Blue as “Virgin Blue.”
In September 2003 Virgin Blue announced that it would introduce trans‑Tasman services and on 29 January 2004 services commenced operating on the Brisbane–Christchurch route. Since then, direct Melbourne–Christchurch services commenced on 4 March 2004, followed by direct Sydney–Wellington and Sydney–Christchurch services on 10 March 2004. On 13 September 2004 Virgin Blue announced that from November 2004 it would commence operating on two new trans‑Tasman routes, being Gold Coast–Christchurch and Brisbane–Wellington.
As at the time of the hearing, Pacific Blue operated two aircraft on the trans‑Tasman routes, providing approximately 27 weekly return flights. In addition to these direct services, Pacific Blue offered a number of indirect or connecting services between Wellington and Christchurch and various Australian cities.
Virgin Blue is an LCC which seeks to offer affordable and convenient travel. It seeks to minimise costs by adopting efficient business strategies and cutting out extras, such as free meals. It passes on cost savings to passengers through low airfares. An important part of Virgin Blue’s brand and business model is to be seen always to offer low fares. Accordingly, if demand is strong, Virgin Blue is likely to increase capacity by putting on additional services rather than increasing its fare levels.
As at March 2004, Virgin Blue had captured over 33% of the Australian domestic market. Whilst Virgin Blue’s low fare offerings are attractive to leisure travellers, its market success in Australia has not been limited to leisure travellers and it also targets business routes and business travellers. Virgin Blue has aggressively targeted the corporate sector in Australia and has been successful in entering into contractual agreements with one‑third of the top 100 corporations in Australia. At the time of the hearing it is estimated that business travellers accounted for more than 40% of Virgin Blue’s total passengers.
For the financial year 2002‑03, Virgin Blue reported revenue of approximately $915 million, with post–tax profit of approximately $108 million, and serviced approximately 6.6 million passengers. For the financial year 2003‑04, Virgin Blue recorded revenue of approximately $1.362 billion, up 49% on the previous year, and a net profit after tax of $158.5 million, and serviced approximately 10 million passengers. In December 2003 it successfully completed an equity offering raising $666 million. However, at its Annual General Meeting on 4 August 2004 Virgin Blue announced that its earnings before tax for the first four months of the 2004‑05 financial year were down 22% compared to the corresponding period in the previous financial year.
Fifth freedom carriers
There are a number of non‑Australian, non‑New Zealand airlines that operate on trans‑Tasman routes pursuant to certain rights granted by Australia and New Zealand. At the time of the hearing, the airlines exercising these rights were Emirates, Thai International Airways, Royal Brunei Airlines, Royal Tongan, Garuda Indonesia, Lan Chile, Aerolineas Argentinas and Polynesian Airlines. We were informed that Malaysian Airlines ceased flying trans‑Tasman routes in 2004.
These airlines are able to operate on the trans‑Tasman routes because Australia and New Zealand have granted them “fifth freedom rights”. Countries often enter into agreements with one another granting reciprocal rights to the designated airlines of each country to various “freedoms of the air”. There are nine different freedoms of the air, but for present purposes it is sufficient to note that the fifth freedom is the right of an airline to land in another country, pick up and deliver traffic, and then fly to a second country, provided that the flight originates or terminates in the airline’s home country. Where fifth freedom rights are unrestricted, there are no limitations on the number of passengers or the sectors to which the airline may provide air services. We refer to airlines operating on the trans‑Tasman routes pursuant to fifth freedom rights as fifth freedom carriers (“FFCs”).
In addition to the FFCs mentioned above, a number of other airlines have fifth freedom rights to operate on the trans‑Tasman routes but do not currently exercise them, including Singapore Airlines, British Airways, United Airlines, Cathay Pacific, Air China, Air France, Lufthansa, Continental, Delta, American Airlines, Air Macau and Mandarin Airlines.
Flying trans‑Tasman involves an FFC in the extension of a flight in circumstances where most of the significant costs have already been incurred. FFCs operate trans‑Tasman flights to improve aircraft utilisation and because trans‑Tasman traffic adds demand to the FFC’s original flight. Trans‑Tasman flights allow the airline to service both New Zealand and Australia with the same aircraft.
Operating the trans‑Tasman leg is economically rational for an FFC if it can generate sufficient traffic on the trans‑Tasman leg to cover the marginal costs of that additional leg. The main marginal costs of operating a flight are personnel costs, fuel costs, landing charges and fees for the use of airport facilities. Therefore, generally it is more profitable for FFCs to be flying trans‑Tasman routes than for their aircraft to remain on the ground in Australia or New Zealand. Mr John Harrison, General Manager, Network, Revenue Management and Alliances Air New Zealand, gave evidence to this effect, which we accept.
For example, an extension of a flight from Australia to New Zealand will be feasible if there is available a sufficient turn‑around time before the return flight. Looking at the Australia–Auckland routes, generally an FFC could operate:
·Sydney–Auckland–Sydney, if it would have had a nine‑hour lay‑over on the ground in Sydney;
·Brisbane–Auckland–Brisbane, if it would have had a nine‑and‑a‑half‑hour lay‑over on the ground in Brisbane; or
·Melbourne–Auckland–Melbourne, if it would have had a nine and three‑quarter‑hour lay‑over on the ground in Melbourne.
Emirates – a particular case
Emirates is an FFC. It has fifth freedom rights between Australia and New Zealand and began operating in the trans‑Tasman market in August 2003.
The applicants submitted that Emirates was unlike other FFCs, having adopted a number of marketing and investment strategies which were said to represent a “new paradigm”, distinct from the traditional FFC model. There is substance in this submission.
Unlike other FFCs, Emirates has been spending a considerable sum of money in building its brand in Australasia. For example, Emirates sponsors races at the Melbourne Cup Carnival and the Australian Jockey Carnival in Sydney, the Holden Open golf tournament in Auckland, the Collingwood Australian Rules Football Club and three Australian symphony orchestras.
Other aspects of Emirates’ strategy also differentiate it from other FFCs. Dr Michael Tretheway, the Senior Vice President of Marketing and Chief Economist of InterVISTAS Consulting Inc, who was called by the applicants as an expert witness, observed during the hearing:
“[W]e are seeing a new paradigm being demonstrated by Emirates. In many ways, it is constructing a new FSA without what we refer to as the legacy costs associated with the historical FSAs. It is a relatively young carrier. It’s in a different labour management type environment than would be the case in the United States, Canada, Australia, New Zealand and so forth. So it is starting out with an FSA with a low cost structure. It has elements of its strategy that certainly are linked to the overall economic development of the United Arab Emirates. But I think it is the first of a few carriers that are seeing new FSA opportunities in the world … Its low cost structure is also enabling it to offer a very high level of service.”
In order to obtain evidence about the position of Emirates, we directed the Commission, pursuant to s 102(6) of the Act, to issue a subpoena requiring Emirates’ Area Manager for Australia, Mr Edward Lim, to give evidence.
We were told that, as at the time of the hearing, Emirates operated 21 flights per week across the Tasman and had plans to expand those services and add new routes. Emirates was flying Boeing 777‑300 aircraft on the Melbourne–Auckland and Brisbane–Auckland routes with capacity for 368 passengers in a first, business and economy class configuration. Emirates was flying Airbus 340‑500 aircraft on the Sydney–Auckland route with capacity for 258 passengers in a first, business and economy class configuration. Emirates was also planning to fly Airbus 340‑500 aircraft to Christchurch.
We heard from Mr Lim that Emirates expects to acquire [x]% of the business class segment of the trans‑Tasman market and [x]% of the economy class segment of the trans‑Tasman market. In the first quarter of 2004, Emirates had secured 8% of Sydney–Auckland passengers, 20% of Melbourne–Auckland passengers and 22% of Brisbane–Auckland passengers.
From April 2004, Emirates’ operation of its trans‑Tasman services has been making a positive contribution to its overheads. It took Emirates only eight months from the commencement of these services to operate them profitably. Emirates has made significant profits — for the 2003/04 financial year it made approximately US$476 million with a low break‑even load factor of 59% for the same period. As a network carrier, it generally views its profits on a network‑wide basis rather than on an individual sector basis. Therefore, if it is profitable overall in its network, it can expand its network, even if new sectors are not initially profitable.
Because of its recent and growing commitment to the trans‑Tasman region, we are satisfied, for reasons which we shall discuss in more detail later, that Emirates has made a substantial investment in the trans‑Tasman region not only by increasing its number of flights, but by its sponsorship of organisations and events in both Australia and New Zealand in a manner which has not been equalled or even remotely approached by any other FFC. We are also satisfied that these factors demonstrate that Emirates is intending to be a significant presence in the trans‑Tasman region for a number of years.
BACKGROUND TO THE AIRLINE INDUSTRY
In order to understand the context of the applications, a number of key concepts relevant to the airline industry may be explained, in particular, revenue management, terminal scheduling and slots, interlining and code‑sharing.
REVENUE MANAGEMENT
A factor which arises for consideration when examining competitive conduct and behaviour in the airline industry is the manner in which airlines price their available seats and the manner in which they price discriminate, referred to as revenue management.
There are two key aspects to revenue management which airlines employ in the lead up to the departure of a flight in order to maximise the revenue generated by the flight – short‑term capacity variations, and pricing and yield (or inventory) management.
Short‑term capacity variations are made by airlines when implementing schedules in order to manage capacity on particular flights. They are made in response to demand for flights which results from circumstances that do not apply for the entire schedule season (for example, the Easter weekend or the Bledisloe Cup). Short‑term capacity variations can be made in a number of ways, such as by swapping aircraft so that the size of the aircraft operating on a particular flight is changed, or by adding a flight on a particular day or not operating a flight on a particular day.
Pricing and yield management are used to practise price discrimination – that is, maximising revenue by selling the maximum number of seats and ensuring the fare paid by each passenger for a ticket is at, or as close as possible to, the limit of the passenger’s willingness to pay.
An airline typically has a number of fare “buckets” or categories for each flight which are each priced differently and have different service amenities, forward purchase requirements and travel restrictions. Pricing management involves setting the level of fares for each fare category and determining the conditions to apply in respect of each fare category.
Fare categories broadly relate to passenger categories. Generally, airline passengers are grouped into two main categories – price‑sensitive passengers and convenience or time‑sensitive passengers (hereafter referred to as time‑sensitive passengers). Price‑sensitive passengers usually travel for leisure or to visit friends and relatives (referred to as “VFR” travellers) but would also include some business travellers, usually from small to medium‑sized enterprises (“SMEs”). As the name suggests, price‑sensitive passengers have a reduced willingness to pay and will generally be flexible with their schedules and forego ticket flexibility in exchange for a lower fare.
Time‑sensitive passengers are usually business people whose fares are paid for under a contract between their employer and the airline, and who require greater flexibility to book later and change their travel plans. Time‑sensitive passengers have a greater willingness to pay for a ticket in exchange for convenient schedules and a flexible ticket.
Yield management is the practice of determining how many seats are to be made available on each flight in respect of each particular fare category. The objective of yield management is to maximise revenue in respect of each flight by maximising the quantity of seats sold and ensuring that all passengers are paying as close to the maximum amount as they are willing to pay for a seat.
As time‑sensitive passengers have a greater willingness to pay for a ticket, an airline is correspondingly willing to bear some additional risk of flying an unsold seat associated with ensuring seat availability close to the preferred time of departure, in order to meet the needs of these higher yielding passengers. By contrast, the price‑sensitive passenger has a reduced willingness to pay, but the sale of a ticket to this passenger in advance of departure and on restricted conditions enables the airline to manage the risk of flying with an empty seat.
The yield management objective of maximising revenue per flight is pursued by maximising “revenue per ASK” (available seat kilometres for that flight). Revenue per ASK is essentially the average revenue per seat, expressed in cents, generated by a flight for each kilometre travelled. It is calculated by multiplying the “yield” for a flight by the “load factor” for that flight, where:
·“yield” refers to the average fare paid by each passenger on a flight to fly one kilometre; and
·“load factor” is the proportion of seats on a flight that are filled with paying customers.
The capacity load factor is calculated by dividing the flight’s RPKs by its ASKs.
Securing an acceptable yield through the sale of tickets to high‑yield passengers close to the time of departure is an essential aspect of a network airline recovering its costs.
For each flight, there is an initial allocation of seats by the airline’s revenue management system to each fare category, based on the airline’s forecast of how many tickets it will sell at each available fare price. Yield management for a flight is a continual process throughout the twelve months prior to departure, with continual adjustments made to the allocation of seats between fare categories.
In making adjustments, specialist revenue management analysts will have regard to information on competitors’ flights on the relevant route, in particular, each competitor’s available capacity and prices for its various fare categories. Such a step is part of managing the risk of a flight operating with unsold seats.
Essentially, airline seats are highly perishable and where a flight takes off with an empty seat the airline can never recover that lost revenue. Therefore, tight inventory management, whereby loads for a flight are continually monitored and seats made available in different fare categories are adjusted accordingly, is extremely important to airlines.
TERMINAL SCHEDULING AND SLOT ALLOCATION
An issue which arises from time to time when analysing the extent of competition in any given airline market is the extent of access to airports by a new entrant or by an existing participant seeking to increase its number of flights. If an airport is unable to provide check‑in, boarding, disembarking and baggage handling facilities for an airline, the airline is faced with a barrier to entry or to expansion which inhibits its ability to compete in the relevant market and to be a competitive constraint on existing participants in the market.
Similarly, if an airline is unable to gain access to appropriate “slots” (a slot being a scheduled time of arrival or departure available for allocation by a slot co‑ordinator for aircraft movement on a specified date at a fully coordinated airport), then its ability to compete is impaired.
Although the Gullivers Group suggested that shortages of slots and airport infrastructure in Melbourne, Sydney and Auckland were a “significant problem” for new entrants, there was little evidence put before us that the obtaining of further terminal facilities and slots was a long‑run difficulty for Virgin Blue or Emirates. Accordingly, we have proceeded on the basis that any intention of Virgin Blue or Emirates to expand their services and flights can be accommodated at any of the relevant airports. Put shortly, the availability of terminal facilities and slots is not a barrier to entry or expansion in the foreseeable future.
INTERLINING
Interline agreements are common amongst independent airlines. They give an airline the ability to sell passengers one ticket that covers one or more legs of a trip on the airline’s own aircraft, as well as one or more legs of the same trip on aircraft operated by a different airline. Such arrangements provide a passenger with the convenience of needing only one ticket and to check‑in once for an entire journey, and also of being able to check luggage through to the final destination without the need to collect it and re‑check it at the points of connection between the two independent carriers.
CODE‑SHARING
Code‑share agreements involve an airline assigning its own designator code (a code which is allocated by the International Air Transport Association to identify the airline within schedules) to a flight operated by another airline. The essence of code‑sharing is that two or more airlines can each sell seats on the same flight with each airline using its own designator code and flight number to identify that flight in the schedule.
REGULATORY FRAMEWORK
Another important factor in understanding the context of the present applications is to appreciate the regulatory constraints operating on airlines generally.
The international airline industry is highly regulated. Every international airline market is underpinned by a network of international regulations whereby national governments grant passage and landing rights in exchange for reciprocal rights. There are a large number of Air Services Agreements (“ASAs”) which regulate international air transport. ASAs are commonly bilateral agreements between two States granting reciprocal rights to the designated carriers of each country to various freedoms of the air. The Convention on International Civil Aviation, opened for signature 7 December 1944, 15 UNTS 295 (entered into force 4 April 1947) (commonly known as the “Chicago Convention”) established the principle that each country has exclusive sovereignty over its own air space. Accordingly, international air transport cannot occur unless it is specifically authorised pursuant to ASAs.
An “open skies” arrangement is one form of ASA, pursuant to which liberal rights are conferred between States. An open skies arrangement removes most traffic and access constraints. However, restrictions often remain on foreign ownership and control of designated airlines and on the ability to operate domestic flights in the other country.
Prior to the late 1970s, governments imposed regulatory restrictions on the airline industry to protect their national airlines. Since that period, the Australian and New Zealand Governments have substantially liberalised their aviation policies and have granted a large number of foreign airlines unlimited rights to commence services on trans‑Tasman routes. (Although we note that the Gullivers Group pointed to the Australian Government’s decision in September 2003 to refuse Singapore Airlines access to the Australia–Los Angeles routes as evidence that the applicants do not compete in “truly open markets”).
In 1996 arrangements between Australia and New Zealand, known as the Single Aviation Market (“SAM”), came into operation which effectively liberalised access for all qualified Australian and New Zealand airlines. The SAM arrangements have subsequently been expanded in an open skies ASA between Australia and New Zealand which took effect in late 2000 and was formalised in 2002. The SAM arrangements, as they presently stand, effectively create a single aviation market across Australia and New Zealand. Any New Zealand or Australian designated airline or SAM airline (effectively an Australian or New Zealand based and controlled airline) may operate within and between Australia and New Zealand without restriction. The effect of the SAM arrangements is that, inter alia, Air New Zealand is permitted to operate domestic services within Australia and Qantas is permitted to operate domestic services within New Zealand. Passenger airlines currently designated under the open skies ASA are Qantas, Air New Zealand and Freedom Air. Asian Express (a freight operator) and Virgin Blue operate as SAM airlines.
Most of today’s national carriers, including Australia’s national carrier Qantas, were originally government–owned airlines and commenced operations prior to the deregulation and liberalisation of the airline industry.
AIRLINE MODELS: THE FSA v THE LCC
Finally, in order to understand the competitive environment in which the applicants operate, now and in the future, a further explanation of two predominant airline models is necessary – the FSA and the LCC. In the Australasian context, the applicants are examples of FSAs. Jetstar, Freedom Air and Virgin Blue are examples of LCCs.
We received detailed evidence regarding FSAs and LCCs. In particular, Dr Tretheway provided us with an extensive overview of the background to the FSA and LCC models and summarised the existing econometric evidence of the impact on fares in markets where LCCs competed with FSAs. He was in fact the only expert witness to model the impact of an LCC in the Australian market. Dr Tretheway undertook an empirical literature review and arranged for further research and econometric analysis of the impact of LCCs on average fares.
In brief, an FSA model promotes network depth (relating to the frequency and capacity of flights offered), network breadth (relating to geographic reach), and connectivity (relating to the ability of a passenger to connect to another service in order to reach an ultimate destination point). An FSA also enhances its product quality in order to distinguish its product from that of its competitors. This is contrary to the LCC model which is primarily focused on minimising cost.
A number of features of FSAs are predicated on the need to offer network depth, network breadth and connectivity. In particular:
·a range of aircraft types is required;
·information technology systems and additional staffing are required to enable ticketing and checking through of baggage across a number of different services, to manage flight schedules to maintain maximum flight connections and to manage pricing and revenue allocation;
·an FSA commonly operates a “hub and spoke” network structure, which facilitates the establishment of a “city‑presence” in the hub through the high frequency of inbound and outbound flights operated at the hub city;
·alliances with other airlines may be utilised to expand network depth and breadth;
·an FSA will assess the profitability and on‑going viability of a route on a network‑wide basis, having regard not only to the revenue earned on that particular route but also to the revenue earned due to traffic feed on other routes “before” and “beyond” the first‑mentioned route. An FSA may operate a loss‑making route due to the significance of that route in generating “before” revenue or “beyond” revenue respectively.
In addition to carrying passengers from point to point, FSAs also typically offer a number of services, including:
·business class on most domestic flights;
·first and business classes on most international flights;
·in‑flight catering and entertainment;
·airport lounges;
·club membership;
·valet parking;
·a frequent flyer or other loyalty program.
Such features of an FSA model necessarily involve costs additional to the costs involved in carrying passengers from point to point as is the case with an LCC. This becomes a significant factor when one considers the competitive issues which arise as between FSAs and LCCs.
The FSA model is typically attractive to time‑sensitive passengers who are looking for the ability to travel at particular times and at short notice. However, an FSA also needs to be attractive to price‑sensitive passengers, as commercially viable load factors (that is, the proportion of seats on a flight that are filled with paying passengers) require a combination of both categories of passenger.
In recent times, FSAs have struggled to earn their cost of capital over the longer term due to a combination of economic conditions, recent exogenous shocks experienced by the airline industry such as the outbreak of the SARS epidemic and the September 11 tragedy, and, significantly, the emergence of LCCs.
The United States saw the advent of the first LCC in the 1970s when Southwest Airlines commenced operations. From the mid‑1990s there has been a rapid acceleration in the number of LCCs commencing operation throughout the world, including Frontier Airlines, WestJet, EasyJet, Virgin Express, Skymark Airlines, Deutsche BA, Air Asia, JetBlue, Kulula, Germanwings, Independence Air, Freedom Air, CanJet, GOL, Valuair, JetStar and Virgin Blue, amongst others. We were also told that Virgin USA is expected to commence operations in the United States in 2005.
The LCC model typically has a number of features:
·the operation of a point to point service with no, or limited, connectivity with other flights, which in turn means that:
othe primary objective of scheduling is to minimise aircraft turn‑around time on the ground so as to maximise aircraft utilisation (the provision of convenient connections to passengers is not an objective of LCC scheduling);
othe LCC does not provide a seamless baggage checking system between interconnecting flights;
othe LCC does not have interline or code‑share arrangements with other airlines, either at all or at least to the same extent as FSAs;
·a single class aircraft configuration and smaller seat pitch (“pitch” being the distance between seats);
·a simple aircraft fleet (usually using models from a single aircraft family) is operated on all routes;
·“user pays” airport lounges, in‑flight catering and in‑flight services (if these services are provided at all);
·no frequent flyer or loyalty program (or at least, not one that is the equivalent of an FSA program);
·services primarily on “short‑haul routes” of less than five hours;
·the most up‑to‑date technology, including aircraft and information technology systems;
·a high level of outsourcing of maintenance and other operations;
·low‑cost distribution systems (such as the internet);
·a high proportion of direct ticket sales;
·utilisation of un‑congested secondary airports;
·no carrying of freight;
·a distinct corporate culture, which may include equity participation by staff;
·a different and simpler form of price discrimination, based primarily on time of purchase rather than traditional fare restrictions.
It is these features that enable an LCC to be competitive with FSAs which have greater network coverage. As a “greenfields” operation, an LCC is generally able to establish a lower cost base than an FSA. Unlike most FSAs, LCCs are not burdened with inefficient processes and structures that incur legacy costs, especially in labour agreements, and can instead establish the most efficient and cost‑effective means of operating their services. By using newer aircraft, LCCs reduce maintenance and operating costs. By not providing seamless baggage check‑through, LCCs are able to avoid the costs of the systems required to provide that service. By not offering business class and having a smaller seat pitch, LCCs are able to maximise the number of seats on aircraft and minimise costs per seat. By using a single aircraft family or a simplified aircraft fleet, LCCs can reduce maintenance costs in terms of both training and the required spare parts inventory and can also reduce flight crew training costs. Further, by emphasising direct ticket sales (such as internet sales), LCCs are not reliant on third‑party distributors with their associated higher distribution costs.
Impact of the LCC Model on the Airline Industry
The emergence of the LCC model has altered permanently the competitive dynamics of the airline industry. It has created a new competitive dimension for FSAs in which they have to re‑think business plans and their responses to the actions of LCCs in the marketplace.
Whilst the Gullivers Group in particular argued that the competitive challenges currently faced by the applicants were partially attributable to economic conditions, exogenous events such as the SARS epidemic and the September 11 tragedy, and inefficient operations, all parties agreed that the introduction of the LCC model in Australasia has had a significant impact on the way in which airlines do business now and will continue to have an impact on how they operate in the future.
The significance of the LCC model and its impact on the FSA model was rather dramatically explained by Professor Michael Levine, an Adjunct Professor of Law at Yale University who acts as a consultant to airlines and governments and who was called by the Commission as an expert witness. In a recent keynote address he delivered at a seminar in Washington DC entitled “Understanding airline strategic choices: How much do legacy carriers have to change to survive?” (paper presented at an Airline Economics Seminar at the Embry‑Riddle Aeronautical University, Washington DC, USA, 7 April 2004), Professor Levine painted a gloomy picture of the future for network carriers with legacy costs. He suggested that unless they could cut their costs dramatically, such carriers would become obsolete, with bankruptcy a likely outcome. We note that such legacy costs are typically associated with airlines operating under the FSA model.
When looking to the North American and European experience for guidance, the distinctive features of the Australasian airline industry – such as its smaller population and more limited opportunities to utilise secondary airports and develop new routes – must be borne in mind. Nevertheless, the overseas experience is instructive and in fact was a major focus of the expert evidence presented to us.
LCCs can offer lower fares as a result of their substantially lower cost base compared to an FSA. Because the lower cost structure of the LCC gives it the capacity to offer lower average fares per flight than an FSA, the entry of an LCC into a market will generally reduce average fares in that market. Overseas, and now local, experience shows that the result of the entry of an LCC into a market is an increased emphasis in the market on price competition, rather than on service offerings.
Lower fares in turn generally stimulate passenger demand. Thus, the success of the LCC model is dependent on its low fares both winning existing passengers and market share from the incumbent FSAs, as well as stimulating new passenger demand. As a result, LCCs tend to experience rapid growth and expansion of market share.
The amount of demand stimulation will depend on the price elasticity of market demand. The entry of an LCC and its lower fare offering may increase, decrease or not change market revenue, depending on the price elasticity of demand. For example, leisure travellers are typically price‑sensitive. Thus on predominantly leisure‑oriented routes, the entry of an LCC is more likely to result in a substantial increase in the number of flights demanded by passengers and an increase in market revenue.This may not be the case on routes more commonly frequented by business passengers, whose top priority is not price and who may not feel that the product offering of an LCC in terms of flight frequency, quality and range of service offerings are readily substitutable for those of an FSA.
As an LCC operates point‑to‑point services, LCCs are able to cherry pick the most profitable and busiest of an incumbent FSA’s routes. This, combined with the lower fares of the LCC, enables the LCC to win market share from the incumbent FSA.
An FSA is able to compete with an LCC by providing the benefits of an FSA at a price point which, although typically higher than that of the LCC, is regarded by the passenger as warranted because of the additional benefits. In the words of Mr Paul Edwards, Executive General Manager, Fleet, Network and Alliances at Qantas:
“LCC competition requires FSAs to focus on price and in so doing to focus on reducing their costs. The extra services offered by FSAs must be closely aligned to the benefit perceived by the passenger to be gained for the extra cost of FSA services. An LCC imposes a discipline on competing FSAs. It requires FSAs competing in the same market to focus primarily on the price standard set by the LCC rather than, as more traditionally was the case, competitive service offerings of the respective FSAs”.
All parties agreed that FSAs must meet the challenge of LCC entry, with the lower fares that challenge requires, by maintaining network depth and breadth, lowering costs, and closely aligning product offerings with the benefits valued by passengers. However, the necessary means by which FSAs such as the applicants are to achieve these imperatives were the subject of much contention.
THE ALLIANCE
The applicants contended that the global emergence of a sustainable LCC model has produced such fundamental changes to the structure of airline markets and competition in those markets that the formation of alliances between network carriers which operate as FSAs is now necessary in order for FSAs to remain competitive. Their response to LCC entry in Australasia has been to propose an alliance which coordinates a number of their activities (“the Alliance”).
In order to give effect to the Alliance, the applicants have entered into a series of agreements and deeds, expressed to be subject to authorisation from Australian and New Zealand competition authorities. Certain of these agreements are the subject of the present applications, as set out below.
THE EQUITY PROPOSAL
The first agreement, referred to as the “Equity Proposal”, provides for Qantas ultimately to acquire up to 22.5% of the voting equity in Air New Zealand. To that end, the applicants entered into a Subscription Agreement dated 25 November 2002 pursuant to which Qantas is to subscribe for, and Air New Zealand is to issue, redeemable convertible notes equivalent to 4.99% of the equity in Air New Zealand on receipt of certain shareholder approval. Such approval was obtained on 18 December 2002.
On receipt of authorisation by the NZCC and the Commission, and with the consent of Air New Zealand shareholders, the convertible notes convert to ordinary shares and Qantas is to subscribe for such number of Air New Zealand ordinary shares as would result in Qantas holding a total of 15% of the equity of Air New Zealand. Qantas would then, or at the end of a three‑year period would, subscribe for Air New Zealand equity securities that would result in Qantas holding 22.5% of the voting equity in Air New Zealand. Qantas will be entitled to maintain this level of shareholding under “top up” arrangements with Air New Zealand.
It can be seen from the general description of the Equity Proposal that its terms appear to fall within s 50 of the Act which provides that:
(1) A corporation must not directly or indirectly:
(a) acquire shares in the capital of a body corporate; or
(b) acquire any assets of a person;
if the acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in a market.
Accordingly, authorisation is sought in order to invoke the protection of s 88(9)(c) of the Act so that s 50 does not operate to prevent Qantas’ acquisition of shares in Air New Zealand.
THE STRATEGIC ALLIANCE AGREEMENT
The second agreement, dated 25 November 2002 and referred to as the “Strategic Alliance Agreement”, provides for the applicants to co‑ordinate their network operations, fares and schedules in relation to all Air New Zealand‑operated flights, all domestic New Zealand flights operated by Qantas, and Qantas international flights arriving in, departing from, or transiting through, New Zealand (defined as the “Joint Airline Operation Networks” or “JAO Networks”). It relates to passenger and freight services and in it, the applicants agree not to compete with each other on other routes leaving from, or arriving in, Australia or New Zealand.
The JAO Networks will cover the sectors flown by Air New Zealand and its affiliates (excluding sectors flown by Freedom Air) within New Zealand and internationally, including flights on which Air New Zealand code‑shares. The JAO Networks will also cover all domestic New Zealand sectors flown by Qantas and its affiliates and all international sectors flown by Qantas and its affiliates to or from New Zealand, including flights on which Qantas code‑shares. This arrangement will be commercially managed by Air New Zealand, subject to advice and direction from a Strategic Alliance Advisory Group which will include representatives of both airlines. Day to day flying operations will remain the responsibility of each airline.
The Strategic Alliance Agreement provides that the applicants will co‑ordinate the following services and activities:
·all aspects of the pricing of passenger and freight services on the JAO Networks and on the sectors operated by Freedom Air, including setting passenger fares and freight rates, the level of rebates, incentives, promotions and discounts offered to passengers, the level of service fees, development of new fare products, holiday package airfares, the levels of standard commissions and agency incentives, and joint tendering for corporate and government accounts;
·procedures for pricing and inventory management in order to facilitate the co‑ordination, and the setting and marketing, of fares and rates for passenger and freight services on the JAO Networks and the sectors operated by Freedom Air;
·scheduling, routings, capacity planning, frequencies, aircraft types, connection requirements and range of times for any services provided by the applicants on the JAO Networks, and scheduling, routings and capacity planning on sectors operated by Freedom Air; and
·the exchange of information relating to the JAO Networks and the sectors operated by Freedom Air between the applicants, including schedules, financial information, pricing, yields, seat availability, freight capacity availability, sales and other information.
This answer demonstrated that the estimates by Qantas of increased tourists was based on an assessment which was, at most, a guess. Nevertheless, in response to a question from a member of the Tribunal, Mr Bernardi said that what was involved was additional marketing which included:
“A focus of promoting New Zealand as well but not over and above Australia, whereas at the moment we do not promote it ex overseas in any great significance.”
Other valid criticisms by the Gullivers Group of Mr Bernardi’s evidence included the fact that Qantas had not prepared a model of the counterfactual in relation to increased tourism. It would be some considerable time into the period of authorisation before the ability to increase tourism might produce results, and the Gullivers Group’s overall criticism of the tourism benefits was that Qantas’ business plan was arbitrary in its content and not based upon any significant research or precise modelling.
The applicants relied upon the evidence of Mr Ergas that the Alliance had the potential to boost incoming tourism significantly in two ways. First, by creating incentives for Qantas to develop a dual destination product including Australia and New Zealand, for which there is currently no interest due to the free riding that would occur by Air New Zealand if Qantas promoted the product by itself. The Alliance would provide the two airlines with a unique ability to develop fares and packages for dual destination travellers that other airlines would not be able to match. Second, it would improve the effectiveness of the applicants’ offshore promotional activities designed to attract tourists to the region.
Mr Ergas estimated that these benefits could amount to $180 million in the first year of the Alliance, falling to $96 million by the fifth year, for a total over the period of some $631 million in net present value terms. This estimate was supported by Dr Tretheway.
Mr Ergas did not believe monopoly fares could be charged because of the degree to which tourists could easily substitute between tourist destinations, nor did he believe that there would be any increase in the effective price to tourists. Indeed, given the elastic nature of the demand for tourism to Australia, he expected that fares could fall as the cost reductions from the Alliance would be passed on to passengers.
In Mr Ergas’ opinion, the ability and incentive to promote dual destination travel would be enhanced by the Alliance, especially as the applicants could develop new flights and fares. As he put it, “[t]he combination of the Applicants’ operational networks both creates incentives for efficient levels of promotion of this product and facilitates development of new products” (emphasis in original). Tourists would be more easily able to optimise their travel arrangements. He conceded there would be some free rider problem still with Virgin Blue being the beneficiary, but as it was not a network carrier the spillover would be limited. The benefits would come from two sources: an absolute increase in tourism, plus greater utility for those who would have visited Australia anyhow, which he argued would in the long‑run lead to more tourists through greater current tourist satisfaction. He made no attempt to quantify the increased tourism associated with increased flights and new fares. However he believed that an extra 18,000 tourists per year would flow to Australia from the promotion of dual destination travel, based on data supplied by QH Tours Ltd, but some 14,000 Australians would travel to New Zealand as a result of QH Tours Ltd’s initiatives. So the likely net increase in tourists to Australia was around 4,000 people.
Mr Ergas was confident that the Alliance would lead to a much greater effectiveness in promotion, and opportunities for using buyer power to lower media rates, as well as potential for rationalising advertising expenditures. The search for economies of traffic density would drive such increased promotional effectiveness. Based on earlier work carried out by NECG, he asserted that the removal of rivalrous promotion would lead to about a 5% increase in promotional effectiveness (a figure he thought was conservative). This translated to an increase in tourist arrivals of about 0.85%, or some 23,186 people per year gross, or approximately 20,400 net excluding travellers from Australasia, a claim that led to serious questioning under cross‑examination.
Further, we were not satisfied that the quantification of the tourism benefits by Mr Ergas was warranted. In particular, there are areas where we believe there are elements of double counting. We accept the criticism of Mr Ergas’ claim of a 5% increase in promotional effectiveness. His 5% figure appeared to include an element relating to promotion of dual destination travel which resulted in a double counting.
The Gullivers Group criticised the method used by Mr Ergas in analysing tourism benefits. It noted that in estimating a 5% increase in promotional effectiveness, Mr Ergas had not explained the constituent elements of this term, for example, there was no indication as to whether it related to brand recognition, or to market penetration levels, or was a function of promotional expenditures. The Gullivers Group argued that because Mr Ergas did not reveal the current level of promotional effectiveness, it was not possible to apply this 5% estimate to a base figure.
The Gullivers Group submitted further that Mr Ergas had taken an unexplained weighted average elasticity of RPKs of 0.17 and applied it to the 5%, to obtain a multiplier to calculate the likely increases in tourist numbers from the increased promotional effectiveness. This produced a figure of 0.85% which, when multiplied by the total number of tourists who typically visit Australia each year, yielded the likely increase of tourists from promotional effectiveness. As a result of these calculations, Mr Ergas derived an increase in tourists from the enhanced promotional effectiveness of approximately 20,400 into Australia. However, as Mr Ergas himself conceded, Qantas was only responsible for about 40% of inbound tourists to Australia each year. Thus, a more appropriate figure would have been 0.85% multiplied by 0.4, which would produce 0.34% as the relevant multiplier. According to the Gullivers Group, a generous estimate in netting off the tourists travelling from Australia to New Zealand would produce a final net figure of an extra 9,000 tourists a year.
Notwithstanding these criticisms and the doubts we have about the quantification exercise conducted by Mr Ergas, we are satisfied that there are public benefits which would be derived in respect of tourism if the Alliance were to proceed. Although we do not accept the quantification of the benefits advanced by the applicants, we are satisfied that where two organisations such as Qantas and Air New Zealand jointly operate their activities in respect of the tourism market there is an obvious synergy and there are savings to be gained. For example, if each airline has a separate budget for promotional or for advertising activity, an amalgamation creates, we would believe, either greater buying power or a greater opportunity to derive cost savings. For example, two $5 million advertising budgets would probably not obtain as much exposure and coverage as one $10 million advertising budget. Alternatively, perhaps an $8 million joint budget could achieve the same coverage as two $5 million buying budgets. That is, the applicants would be able to obtain cost savings by merging their two budgets together. Of course, those amounts are hypothetical but are indicative of the type of situation which we would expect could arise.
So far as dual destination travellers are concerned, it is very easy to say that there was no substantial evidence of the existence of overseas travellers who wished to come to Australia and New Zealand but who were deterred from travelling at all because of the necessity to backtrack across the Tasman. That is a matter in respect of which we think there would be little evidence obtainable. Nevertheless, having regard to the geographical location and the geographical relativity of Australia and New Zealand, the logic of the opportunity to have these dual destination travellers travel because of the Alliance when they would otherwise not be able to do so, makes sense to us. It appears to us that there is a good case to be made for saying that there would be such dual destination travellers, particularly those who were travelling on holidays. There are attractions in visiting New Zealand as well as attracting tourists who are visiting Australia and the relatively short space of time it takes to travel from one country to another enhances the opportunity for promoting dual destination travel.
The end result is that we are unable to place any weight upon the figures for increased tourism generated by Qantas. We are comforted in this conclusion by the observation of Tourism Futures International, which was engaged by the applicants to perform an analysis of estimates which formed the basis of QH Tours Ltd’s business plan to verify its reasonableness. Its report stated:
“Various factors contribute as inputs to tourism forecasts, many of which are hard to process, or model, in a quantitative manner. This is a widely acknowledged limitation of tourism forecasting.”
The Gullivers Group also made a sustained attack on Qantas’ contention that there would be increased promotional effectiveness arising out of the opportunity for joint marketing and joint promotions. Although Mr Ergas estimated that the promotional effectiveness of the applicants would be improved by 5% following the Alliance, we are not satisfied that that figure was an accurate representation of what might occur. There was criticism of this figure because it seemed to be a duplication of other cost savings. In any event, the percentage increase of 5% was, on one view, meaningless because it was not clear what was the principal sum of which it was a percentage. No specific evidence was led as to the current level of the promotional effectiveness of either Qantas Holidays or Air New Zealand’s tourist arm.
The Gullivers Group submitted that the entire tourism analysis presented by the applicants ought to be dismissed as being “founded upon assumptions not made explicit within the material, and estimates and transpositions that generate ill‑substantiated conclusions”. The Gullivers Group perceived there to be a number of errors in the applicants’ arguments regarding tourism benefits. Firstly, the Gullivers Group criticised the assumption that improvements in effectiveness and efficiency would result from the Alliance and the related assumption that any improvements in effectiveness or efficiency could not be achieved otherwise than by the Alliance. It said that the Alliance would reduce competition and therefore would result in less efficient promotion of tourism to Australia and New Zealand than if the Alliance did not occur, in which case the applicants would have a greater incentive to promote travel in order to expand their markets. The Gullivers Group argued that this trend towards inefficient promotions, coupled with the reduced capacity which it was said was likely occur under the Alliance, would have a negative impact on the number of inbound tourists to Australia and New Zealand.
We are satisfied that there will be benefits obtainable in the tourism area although we are not satisfied that they can be quantified in the manner or to the extent suggested by Mr Ergas. Although there were some difficulties in accepting Mr Bernardi’s evidence, we are satisfied that tourism benefits will be derived from the opportunity of the applicants to market their products jointly, and to make available an extended integrated network both internationally and domestically. For example, Qantas will be able to offer an increased number of destinations throughout its network and will be able to offer a greater number of packages for travellers wishing to visit Australia and New Zealand. It seems clear to us that if the applicants are able to pool their promotional resources, they will be able to cut the overall costs of doing so or will have the opportunity to cover a more extended area of tourism without increasing the overall level of promotional expenditure.
We expect that as a result of the Alliance there will be either better or increased connections available for long‑haul flights and this will be of advantage to tourists visiting Australia and New Zealand. It is apparent that there are a considerable number of dual destination travellers visiting the trans‑Tasman region. We were given an example that it was not presently possible for a traveller from Japan to perform a triangular journey from Japan to New Zealand, then to Australia and then back to Japan, or vice versa on Qantas’ services. The reason was that Qantas does not have the bilateral traffic rights or code‑sharing arrangements necessary to provide these services. However, working together under the Alliance, the applicants can create a triangular journey for tourists from Japan visiting both Australia and New Zealand. Having an ability to avoid backtracking across the Tasman should be an attractive proposition for travellers both from a price and a convenience point of view. Avoiding backtracking means that travellers will be able to purchase less expensive tickets for dual destination travel and also reduce their travel time.
The opportunity to have joint promotions of the region advertising both Australia and New Zealand as tourist destinations must have a beneficial effect, not only for the applicants, but for the general community because of the funds that will be injected from such increased travel. Joint campaigns and joint promotions should allow the applicants to lower their promotions costs.
THE CONTEXT OF LCC ENTRY AND GROWTH, AND INCREASED ACTIVITY OF GOVERNMENT-FUNDED GLOBAL AIRLINES IN THE AUSTRALASIAN MARKET
Qantas submitted that the LCC competition on the trans‑Tasman routes provided by Virgin Blue was of significance in two important respects insofar as the consideration of the benefits and the importance of the Alliance was concerned. The first respect was that an LCC imposes a pricing discipline in the markets in which it operates which compels FSAs to ensure, as far as practical, that their networks are provided on the most efficient, cost‑effective and manageable basis. Qantas submitted that the Alliance provided efficiencies which were not otherwise available to individual airlines and that the Alliance was better able to offer network/FSA services across the trans‑Tasman at competitive prices. The second respect was that in the absence of the Alliance and in the face of Virgin Blue competition, each of Qantas and Air New Zealand would, in an attempt to maintain their individual market position, have to consider reducing capacity which was not easy to do because one did not simply remove seats but rather aircraft. Further, there would be a deleterious affect on the earnings and services which Qantas and Air New Zealand supplied trans‑Tasman.
As Dr Tretheway pointed out, the airline industry today is not in equilibrium due to the emergence of LCCs in almost all markets in the world. Dr Tretheway observed that because of the rapid increase in the traffic share of LCCs, FSAs were facing dramatic changes in their markets.
The significance of the network integration is that it will enable Qantas and Air New Zealand to be more competitive in a market where Virgin Blue and Emirates are active competitors.
The existence of an LCC in a market in which an FSA operates causes the FSA to become more price competitive, which carries with it a necessity for cost savings. The end result in a market in which an LCC operates is to provide a more dynamic and competitive market.
Qantas submitted that, as an LCC, Virgin Blue imposed a pricing discipline on the applicants and compelled them to operate in the most cost‑effective manner possible so as to offer competitive fares across the Tasman. Qantas submitted that FFCs provided a similar pricing discipline to that of an LCC because they can price on a marginal cost basis across the Tasman, getting in the process some contribution to the fixed costs of operating the flight from their home country to Australia which would not occur if the aircraft sat idle on the tarmac in Australia for a number of hours before returning overseas.
Qantas urged that a major benefit of the Alliance was that it avoided several possible outcomes that had unfavourable social implications. Qantas argued that one or both of the applicants would be forced to reduce capacity in the long‑run in the absence of the Alliance. Qantas submitted that such capacity reductions are lumpy and reduce the quality of an FSA’s offering whilst the FSA still incurs the costs of fighting for market share. Qantas suggested that, given its broader and deeper network, it would be likely that Air New Zealand would be the FSA that reduced capacity. Qantas postulated a number of outcomes from this.
The first possible outcome was that Air New Zealand failed, leaving only one FSA on the trans‑Tasman routes but without the benefit to consumers of Qantas having access to the network of Air New Zealand and the cost saving that would have been available under the Alliance. In addition, Qantas would be burdened with the costs of the competition that led to the failure of Air New Zealand.
The second possible outcome was that Air New Zealand would not fail but would suffer losses funded by the New Zealand Government. This would enable Air New Zealand to compete at unsustainable levels, distorting the market and forcing Qantas to match it, resulting in an extra cost burden, thereby affecting Qantas’ ability to grow, to the detriment of Australian passengers.
The third possible outcome was that Air New Zealand became a type of LCC, leaving Qantas as the only FSA on the trans‑Tasman but without the benefit of the quality of the combined network offering and cost savings.
Air New Zealand argued that under the Alliance the two airlines would still have to respond to changes in demand and increase capacity if needed, as otherwise in the presence of low barriers to entry and expansion on trans‑Tasman routes, other carriers would expand.
We accept this submission because it is of no advantage to either Air New Zealand or Qantas to allow their competitors to pick up any unsatisfied demands in circumstances where there is the excess capacity available.
Qantas also argued that, given the highly cyclical and volatile nature of the airline industry, it needed to develop every competitive advantage possible in order to compete effectively with government‑owned and supported airlines and that enabled it to be in a strong competitive position and that this would constitute a benefit to Australian consumers.
We have already found that it is in the national interest for Qantas to be in a strong competitive position internationally. The Alliance would enhance this position as it brings about cost savings and enables Qantas to deploy resources away from the trans‑Tasman and into other areas where they are most needed.
COULD THE CLAIMED PUBLIC BENEFITS BE ACHIEVED IN THE ABSENCE OF THE ALLIANCE?
The Commission argued that a number of the benefits which the applicants claimed would result from the Alliance could be achieved through means other than the formation of the Alliance. The Commission asserted that the counterfactual presented by the applicants did not represent the only choice available to them and that many aspects of the Alliance’s operations could be undertaken in the absence of the Alliance, a relevant consideration in assessing the public benefits said to be relevant to the authorisation test.
The Gullivers Group noted that each of the applicants had given detailed consideration to alternatives to the Alliance. It referred, in particular, to a confidential internal memorandum of Qantas from April 2003 that set out a number of alternative options which did not require as great a degree of cooperation and the resultant reduction in competition between the applicants as would occur under the Alliance. It also referred to confidential internal documents of Air New Zealand from 2003 that identified alternative strategies that did not involve cooperation with Qantas.
As the Tribunal in QCMA noted at 510, the broad conception of public benefit is qualified by the requirement that the benefit must not be able to achieved by means other than those for which the parties seek authorisation. The Tribunal stated at 511:
“The requirement that the public benefit should ‘not otherwise be available’ is a severe one. It carries with it the requirement that the acquisition be a necessary and sufficient condition for the probable achievement of the claimed benefit. Nevertheless, we think the requirement should be interpreted in a practical rather than an absolute sense, taking into account the commercial realities so far as the parties are concerned, and the possible social costs of some alternative course of action so far as the public is concerned.”
We are satisfied that a significant number of the benefits claimed by the applicants could not be achieved in the absence of the Alliance. It is, no doubt, open to Qantas, and indeed Air New Zealand, to seek independently to achieve cost savings and efficiencies in their administration and scheduling. However, a number of the benefits depend upon there being integration of activities brought about by the Alliance. For example, in the absence of the removal of wingtip flying, it would not be possible to deploy aircraft elsewhere without ceding market share to Qantas’ competitors. Further, the cost savings derived from the integration of information technology systems, tourism information activities and the like could not be achieved, at least to the same extent, in the absence of the Alliance. Without the prospect of achieving the whole package of efficiencies which the Alliance is expected to bring about, there would be little commercial incentive for Qantas and Air New Zealand to co-operate on a more limited sphere of activities. As the Tribunal observed in QCMA, the commercial realities and the costs of alternative options must be taken into consideration when assessing whether benefits can practically be achieved by means other than the proposed course.
THE WEIGHING EXERCISE
We return to the test for authorisation discussed earlier in pars [144] and following.
The Commission urged us to recall that competitive markets are the best means by which to ensure that the interests of consumers are best served. In this regard, the Commission relied on the evidence of Mr Webster of EasyJet who said:
“do not underestimate the power of efficiency in the transformation of the industry from a controlled, regulated industry to a deregulated one. Ultimately consumers will decide the winners and the losers, not the airlines anymore.”
The Commission submitted that it is the choices made by consumers in competitive markets that generate the information required by existing and potential participants and which maximise efficiency and create an incentive for innovation in those markets. Authorisation of the Alliance would sanction an “experiment” in an alternative market structure and protect the applicants from competitive forces compelling dynamic change.
The Commission concluded that given the high risk of anti‑competitive detriment, and the uncertainty relating to the existence or magnitude of any benefits, the Alliance should not be authorised.
The Gullivers Group argued that, on the one hand, there was the certainty under the Alliance of market concentration and dominance of a combined regional carrier having an 80%‑90% share of the market which would necessarily result in anti‑competitive detriment, and that on the other hand, the claimed benefits were of uncertain quantification and rested upon a series of variables which may or may not eventuate. It submitted that we should not “rely upon a contingency to constrain a certainty.”
The public benefits claimed to arise from the Alliance need to be assessed on a qualitative rather than on a quantitative basis. We have already concluded that the anti‑competitive detriments likely to arise out of the proposed Alliance are, relatively speaking, small and essentially confined to a particular segment of the trans‑Tasman market. Accordingly, we consider that it is only necessary to find a relatively small level of public benefit in order to warrant a conclusion that the authorisations sought should be granted.
Although eight main categories of public benefits have been relied upon it is the cumulative or synergistic effect of them which should be the subject of analysis and determination.
A number of the claimed benefits are not easily susceptible of precise monetary quantification. Nevertheless, we are satisfied that a number of those benefits, although not so quantifiable, can be seen to be tangible, credible and real. For example, each of the applicants in their tourism departments would have an advertising budget. The combination of the two advertising budgets would generate either a cost saving overall or alternatively, a substantially enhanced advertising program for the same amount of money.
We are satisfied that when one compares the factual scenario with the counterfactual scenario it is apparent that there will be benefits to the public arising out of the factual scenario which would not occur or exist in the counterfactual scenario. We are also satisfied that the benefits outweigh the detriment to the public constituted by any lessening of competition that would be likely to result from the factual scenario in relation to the frequencies of flights available to the time‑sensitive traveller across the Tasman.
We have reached this conclusion on the basis of looking at the benefits which flow from the Alliance and which accrue not only generally to members of the public, but also specifically to the travelling public, and to Qantas in the form of cost savings and the ability to re‑arrange flight schedules. We are satisfied that such cost savings and re‑scheduling of flights, although initially accruing to Qantas and its shareholders, are capable of being passed through in the form of either a potential lowering of fares, or a delay in increasing fares. We have evaluated these benefits on the basis of the direct benefits accruing to the travelling public and we have given due consideration to those benefits which flow initially to Qantas and to its shareholders. We are satisfied that these latter benefits should be taken into account in determining the extent of the public benefits arising out of the Alliance, but we have also given due weighting to the fact that these benefits will accrue initially to Qantas and its shareholders, and that not all the benefits will necessarily flow through to the travelling public. We have weighed and balanced such benefits accordingly. To the extent that benefits would flow through to foreign shareholders in Qantas, we have not attributed any weight to those benefits in accordance with our earlier discussion: [199]
For these reasons we made the following determination which was published on 12 October 2004.
THE DETERMINATION
The Tribunal determines that:
1.The determination of the Australian Competition and Commission dated 9 September 2003 denying authorisation to applications A30220, A30221, A30222, A90862 and A90863 is set aside.
2.Pursuant to subs 88(1) of the Trade Practices Act 1974 (Cth) (“the Act”), the Tribunal grants an authorisation in respect of applications A30220 and A30221 to Qantas Airways Limited (“Qantas”) and Air New Zealand Limited (“Air New Zealand”) to make and give effect to the Strategic Alliance Agreement dated 25 November 2002 between the applicants under which:
(a)they will coordinate pricing, scheduling, marketing, sales and customer service activities for all Air New Zealand operated flights, all domestic New Zealand flights operated by Qantas, and Qantas operated international flights arriving in, departing from or transiting through New Zealand (“the JAO Network”);
(b)Qantas will have the right to code‑share on all Air New Zealand flights, and Air New Zealand will have the right to code‑share on all Qantas flights in the JAO Network and to code‑share on those other Qantas flights that reasonably connect to any flight in the JAO Network;
(c)the applicants will from time to time enter into contracts and arrangements and arrive at understandings that include exclusionary provisions (within the meaning of s 4D of the Act), including, but not limited to, provisions in connection with the joint supply or joint acquisition by the applicants of air transportation services and other goods and services.
3.Pursuant to subs 88(9) of the Act the Tribunal grants an authorisation in respect of application A30222 to Qantas to acquire convertible notes and shares enabling Qantas to hold up to 22.5% of the capital of Air New Zealand as set out in the Subscription Agreement between the applicants dated 25 November 2002 in the terms set out in application A30222 and referred to as the Equity Proposal.
4.Pursuant to subs 88(1) of the Act the Tribunal grants an authorisation in respect of applications A90862 and A90863 to the applicants to make and give effect to the Cooperation Agreement made in or about December 2002 between the applicants.
5.The authorisations referred to in paragraphs 2 and 4 of this determination shall be in force for a period of five years commencing on the date upon which each of the said agreements is first given effect to, which date must be notified in writing by the applicants to the Commission (marked for the attention of the Chairman) within 14 days of such first giving effect. If either of the Strategic Alliance Agreement or the Cooperation Agreement referred to in paragraphs 2 and 4 of this determination is not given effect to within twelve months of the date of this determination the Commission may apply to the Tribunal to vary this determination by fixing a specific date on which the period in respect of which the authorisation in respect of that agreement shall commence.
6.Liberty is reserved to all parties to apply to the Tribunal for such further or other determinations as may be necessary to implement and carry into effect this determination.
I certify that the preceding seven hundred and seventy two (772) numbered paragraphs are a true copy of the Reasons for Determination herein of the Tribunal. Associate:
Dated: 16 May 2005
Counsel for Qantas Airways Limited: Mr A Bannon S.C. with Mr JRJ Lockhart Solicitors for Qantas Airways Limited: Blake Dawson Waldron until 6 July 2004 Johnson Winter & Slattery after 6 July 2004 Counsel for Air New Zealand Limited: Mr J Gleeson S.C. with Mr RA Dick Solicitors for Air New Zealand Limited: Freehills Counsel for the Australian Competition and Consumer Commission: Mr R Darke S.C. with Mr PJ Renehan Solicitor for the Australian Competition and Consumer Commission: Australian Government Solicitor Counsel for the Gullivers Group: Mr N Hutley S.C. Solicitors for the Gullivers Group: Gilbert & Tobin Dates of Hearing: 3-7, 10-14, 17, 20-21, 24 –26, 28 May 2004 Date of Publication of Determination: 12 October 2004 Date of Publication of Reasons for Determination: 16 May 2005
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