Measures to protect and enhance competition in the South African domestic aviation industry

D.Comm.Economic conditions in deregulated domestic air transport markets developed differently from what was originally anticipated and the commercial conduct of airlines also differed from the conduct foreseen at the time of deregulation. The result was also different from what governments that had implemented air transport policies based on economic deregulation had expected. The overall result in such deregulated market was more consolidation and less competition than had originally been anticipated. It has been established that market access by means of economic deregulation is not sufficient to ensure a competitive domestic air transport market. Certain regulatory steps need to be taken to promote competition in the domestic air transport industry. It was established that competition in the airline industry differs from competition in many other industries in the following respects: •Airlines compete over networks. •Airlines compete using multiple competitive tools. •The air transport industry, as a network industry, has fundamentally different characteristics from those of the other industries on which traditional classic microeconomic models have been based. Apart from supply side efficiencies that are central in the traditional microeconomic models, the demand side effects within the airline industry have given rise to many of the commercial practices that the airlines have perfected (like loyalty programmes, including FFPs). These commercial practices have been designed to raise the switching costs for users of air services to change suppliers and to reduce the level of competition for the preferred customers. This would have to be taken into account in the formulation of policy. It was found that certain economic features of network industries, however, are also applicable in the airline industry and that this creates competition concerns as a result of the following features: •The bigger the network of an airline, the more useful it is. •The demand for air services on a particular airport-pair, city-pair, or even country-pair is derived from a multitude of separate origin/destination markets - a fact which creates a need for complex market definitions in airline competition. •The “indivisibility” of seating capacity on aircraft and of the deployment of aircraft within route networks can result in extremely low short-run marginal costs, with consequent difficulties in applying competition law to cases involving allegations of predatory pricing. •Many of the costs are sunk and unrecoverable once they are committed. •There is a history relating to cyclical provision of an overall excess capacity in the industry. Economies of scope in the airline industry clearly indicate that a larger network of services would be more attractive to the traveller, since the traveller will have more destinations and frequency of services to choose from and have a larger probability of finding a suitable connection from the passenger’s particular origin to any given destination. In particular, on a firm level, it has been found that economies of scope on the demand side are intensified by certain airline marketing practices including: •Frequent flyer programmes (FFPs). •Travel agent overriding commission agreements (TACOs). •Corporate discount schemes. The above create synthetic economies of scope on the demand side of the airline industry as they make it more attractive for passengers and travel agents to concentrate their demand on one airline and increase the loyalty of the customers towards the airline through an artificial increase in the switching costs. Predatory behaviour in the airline industry differs from such behaviour in other industries, where it mostly revolves around the approach of predatory pricing, as the increase of the provision of capacity cannot normally be implemented or dispersed as rapidly in other industries as in the airline industry. The air transportation industry was found to be especially susceptible to predatory responses of dominant airlines compared to dominant firms in other industries owing to the following factors: •Mobility of aircraft, as incumbents incur virtually no additional sunk costs when they increase capacity on challenged routes, while new entrants can be readily induced to depart because of their ability to move their equipment out of particular routes. As a result, network airlines can shift resources between markets much more readily to increase service frequency and capture a disproportionate share of traffic. •Access of airlines to comprehensive, “real time” information on their competitors’ activities through booking and other data generated by computer reservations systems (CRS). •Extreme sophistication of the yield-management practices of the major airlines using CRS, which enables such airlines to increase sharply the availability of deeply discounted fares on individual routes in response to competitive challenge and to withdraw them when the challenge disappears. •Ability of a major airline to price-discriminate to a much greater extent and to adjust its prices much faster in advance of flights actually taking place. As a result, airlines can respond to competitive initiatives more precisely and swiftly than enterprises in other industries, which implies that the competition rules should take cognisance of the differences in the commercial practices of airlines in the air transportation industry compared to those of enterprises in other industries. A number of problems relating to the competition policy and legislation in South Africa have been identified. They included the following: •Prohibited agreements are not immediately void in terms of the South African Competition Act. •Applying a narrow cost based standard of marginal or average variable cost is inappropriate for the airline industry in South Africa when compared to the principle of avoidable cost. •No specific guidance currently exists in the domestic air transport industry in South Africa relating to the particular forms of conduct that would be regarded as having an anti-competitive effect. •No measures currently exist in South Africa that enable the competition authorities to respond timeously (as required in the airline industry) to prevent anti-competitive or predatory conduct, to stop such conduct (in contravention of those guidelines) by means of cease and desist orders and effective interim orders where there is a danger that competition will be eliminated. •The dominant airline in South Africa, South African Airways (SAA), which is owned by the State, has not achieved an adequate return on assets and has received substantial financial state aid without any published conditions that would mitigate the anti-competitive effect of such state aid and promote competition in the air transport market. The risk of such state aid could enable the dominant state-owned airline, SAA, to: Deploy too much capacity on an uneconomical basis. Operate many services (frequency) at a lower income level than the cost of providing such services. Dump excess capacity on competitive routes at a lower fare than needed to provide a reasonable return on assets, and Conduct operations with the objective of earning a lower return on investment than would be required as a reasonable return on assets by competitors that are subject to normal financial markets and do not receive state financial aid. This study specifically dealt with: •The specific commercial practices adopted by airlines in domestic passenger air transport markets as well as the use of a combination of commercial practices in an anti-competitive or predatory manner. Some measures adopted elsewhere to mitigate the anti-competitive effect of such commercial practices and to stimulate competition following economic deregulation or liberalisation of such domestic air transport markets were identified. •Most importantly, the occurrence of anti-competitive conduct as well as predatory behaviour by airlines was investigated: generally, and specifically in the United States of America (USA) as well as in Canada. It was found that, in particular, predatory conduct in the airline industry that involves price cuts combined with significant capacity expansion by dominant incumbent airlines appears to be the most troublesome in domestic air transport industries in respect of a number of jurisdictions. In addition, it was established that incumbent airlines also conduct predatory actions in response to new entry by using tools other than price and quantity. An important recommendation is that a policy objective approach should be adopted to enhance or promote competition as criteria for regulatory consideration in the South African domestic air transport market. In this regard, the recommendations include an active involvement by the Department of Trade and Industry (DTI) in matters affecting competition in the South African domestic air transport market and that the Competition Commission, the Commissioner of Competition and the Competition Tribunal be given greater authority to specifically deal with particular aspects of concern relating to the air transport market. Recommendations have also been made relating to competition policy, competition legislation and some commercial practices within the domestic air transport industry in order to promote competitiveness in the South African domestic air transport industry.Prof. J. Walter