Competition News, Edition 12, June 2003

In Conclusion

The ESI has undergone various reforms worldwide, some more successful than others. The choice of a restructuring model depends on the specific characteristics of each country. However, competition at the generation and retail stages is important if consumer welfare is to be enhanced. Getting the structure of the markets right before introducing competition is also crucial, as is taking cognisance of the international investment climate. Government should look at the realities of the industry and employ a cautious approach by developing policies that are clear and that send proper signals to investors. At the moment, however, the industry is clouded with many uncertainties.

4. Assessing Code-share Markets in Aviation

Over the past decade, code-sharing has shaped the international airline industry in a manner similar to the transformation of domestic airline operations into hub-and-spoke networks after deregulation. Airline code-sharing is a form of co-operation by which an airline sells tickets on another airline's flight. In essence, code-sharing amounts to an operational merger on the affected routes¹, should they be serving the same routes.

Some economists have alleged that the airline industry is moving from the one extreme of regulation and ownership, to another extreme of global consolidation - with little or no exposure to competition in between². On closer enquiry into the nature of the industry this is understandable. Large economies of scale and scope prevail, which facilitate the formation of consolidated but diversified structures such as code-share arrangements³. In addition, in many countries bilateral agreements, designation rules, and foreign ownership restrictions prevail, which means that "natural" consolidation (via mergers) in the airline industry is hindered. Airline alliances, like code-sharing, are the partial and provisional answer to the need for restructuring⁴.
Of all strategic alliances in the airline industry, code-sharing is the most common form of collaboration⁵. Because of the competitive complexity of code-sharing, any market definition analysis needs to be thoroughly defined because both supply and demand-side considerations are at stake.

The supply-side

1. 
   The routes concerned
   
   When defining a relevant market in the airline industry the main consideration is the applicable route or bundle of routes. Each point-of-origin / point-of-destination (O&D) pair should constitute a relevant market, and should include the overlap of the direct and indirect services:
   

• 
  Between the two applicable airports;
  
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  Between those airports whose respective catchment areas significantly overlap with the catchment areas of the airports concerned; as well as
  
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  The overlapping services where only one party operates direct flights.
  

Generally, indirect routes are not good substitutes for direct routes, especially over short distances. With regard to longer routes, the degree of substitutability would depend on flight times, frequencies, schedules and travel conditions.

2. 
   Networks

   Airlines with large networks have a strong competitive advantage, especially on routes connecting their hub airports. As a result, in a deregulated market, competition occurs between relatively dominant, regionally based airline networks⁶. However, the phenomenon of "network competition" does not replace the traditional approach to market definition, i.e., that each city pair constitutes a distinct market. Still, the consumer insists on a transport service between two points and, despite the evolution of the supply-side, in the short term airlines are not readily able to market and operate services between all transoceanic city-pairs without incurring significant additional costs and risks. The possible impact of network competition on the definition of the market is even less with respect to local air services⁷.

   
   

The demand-side

1. 
   Airport substitution
   
   The question arises whether flights from two airports belong to the same relevant market. First, the answer depends on the number of passengers that live in the catchment area of both airports. If sufficient passengers were present, airlines at both airports would compete. Secondly, the services offered by the airports would play a role as frequencies, schedule, connectivity and overall quality of airport service are important to time-sensitive travellers.
   

2. 
   Other transport services
   
   The Commission must consider whether other transport services such as car, coach or train, which in view of their physical and technical characteristics, are functionally interchangeable with air transport services at a given price. This is especially important in European countries where high-speed trains over medium distances offer viable substitution possibilities⁸.
   

3. 
   Time-sensitive and non time-sensitive passengers
   
   Time-sensitive and non time-sensitive passengers must be distinguished from each other, as time constraints could be an important factor in the choice among airlines. In addition, other factors that influence the time-sensitive passenger's choice are schedule, frequency, quality of service and overall travel comfort. Generally, the time-sensitive passengers require the flexibility to change routes and flight times, and are therefore willing to pay more.
   

The Potential Competition Consideration

In developed countries, aviation markets mostly consist of many competing airlines. However, in many markets (for example African markets) potential competition is the most relevant consideration. To be regarded as a potential entrant in the airline industry an entrant would need to show:

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  An appropriate business plan;
  
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  The amount of finance available for the business plan proposed;
  
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  The airline experience of senior management;
  
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  The airline's current airport presence;
  
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  Steps towards securing aircraft;
  
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  Steps towards obtaining an air operators certificate and an airline license from the appropriate authorities;
  
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  Steps towards obtaining access to a computer reservation system;
  
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  Steps toward securing airport facilities (take-off and landing slots at peak times); and
  
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  Steps towards establishing a sales network⁹, which would include frequent flyer programme and corporate contracts¹⁰.
  

In addition, major airlines have transformed their route structure from a point-to-point network to a "hub-and-spoke" network. Possible new entrants would therefore only consider entry if the new service could be operated from their current hubs. In the process, the potential entrant would also need to generate sufficient point-to-point and connecting traffic to allow operation at the minimum efficient scale¹¹. The question may arise whether an external potential code-sharer is also a potential competitor. This may be the case, but under the circumstances the alliance, and not the actual potential code-sharer, would be regarded as the competitor.