Exclusionary Conduct in the Industry

John Kallaugher Latham & Watkins Visiting Professor University College London

Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership ©Copyright 2003 Latham & Watkins. All Rights Reserved. INTRODUCTION

• Recent Airline Cases Highlight Issue of Exclusionary Conduct • AMR – US – July 2003 • -- Canada – July 2003 • /Germania – 2002

• What are lessons for EU?

1 AMR

• AMR responded to low cost entry on DFW city pairs by: • Matching fares • Increasing capacity • Allocating more seats to lower fare classes

• AMR internal models had predicted that these steps would not be profitable

2 AMR

• US law test for predatory pricing • Below appropriate cost measure • Possibility of recoupment

• Issue in AMR was what cost measure to use

• Cost issue was cost of “added capacity”

3 AMR

Cost tests (based on tests used in AMR internal systems):

• Fully allocated earnings plus upline/downline contribution net of costs (NO -- approximated total costs – not variable costs)

• Variable earnings plus upline/downline contribution net of costs (NO arbitrary allocation of system variable cost)

• Short run profit maximization (NO it showed foregone profit as cost)

4 Air Canada

• Two sample routes for application of new predation test in Canadian Airline Regulations

• Competition tribunal considered how “avoidable cost” test of regulations should be applied

5 Air Canada

• Controversial aspect of decision – definition of “redeployment/recapture” and “disposal” as basis for avoiding costs

6 Air Canada

• Tribunal found that • System labour costs • Station labour costs • Aircraft labour costs • Non-labour system and sunk costs • Aircraft ownership and insurance

were all avoidable costs

7 Lufthansa/Germania

• Germania entered FRA-TGL in competition with LH

• LH matched Germania fare

• Cartel Office ruled that higher quality of LH product meant that same price was actually undercutting Germania

• LH ordered to increase fare by 35 Euros (30.50 on appeal)

8 Lufthansa/Germania

• Legal Test: Balance interests of parties to protect competitive structures and chances of market entry

• Court found • only objective reason for conduct was to exclude Germania • But no evidence of subjective intent

9 Comparing the Cases

• Interesting issues on costs • What is avoidable costs? • When are averages relevant? • How do you allocate costs?

• Interesting issues on revenues • Allocation of upline/downline revenue • Do you look at revenue or at fare classes?

10 Legal Test Follows Policy

• Real lesson – abuse test follows policy • US: policy based on consumer welfare/preventing economic harm means strict cost-based approach

• CANADA: sympathy for cost-based approach tempered by “paramount position” of AC -- more intervention justified

• GERMANY – Ordoliberal structural approach justifies high level of intervention – cost-based test less relevant

11 Policy Choices for Article 82 in Airline Sector

• Approach based on effects on structure Or • Approach based on likely consumer harm

12 Traditional Article 82 Approach is Structural

• The “Field of Dreams” Approach

• Increasing “Barriers to Entry” is Abuse

• Barriers to Entry Defined Broadly

• New Entry Presumptively a “Good Thing”

13 Problems of Structural Approach

• Structural approach is static and historical

• Structural approach requires robust market definition

• Structural approach requires “hands on” intervention

• Structural approach leads to false positives – consumer loss

14 Structural Approach requires Robust Market Definition

• Otherwise no economic validity

• Suggests that should not be applied where market definition is less than robust

15 Market Definition in Air Transport is not “Robust

• No need to revisit question of market definition based on city pair markets

• But this definition is not strong – it does not cover many important aspects of airline competition

16 Aspects of Airline Competition Outside O&D City Pairs

• Network vs. Low cost • Capturing connecting traffic • Planning and capacity allocation • Corporate accounts • Tour operators

17 Consequences of Non-Robust Market Analysis

• Weakness of market definition means that relationship of structural effects to real consumer harm is tenuous

• Competition authority must act on faith

18 Structural Approach Requires Micromanagement by Competition Authority

• Remember British Midland / ?

• How could Lufthansa know it was supposed to charge 35 Euros more than Germania • Or was it 30.5?

19 Structural Approach leads to Consumer Loss

• Prohibiting Lufthansa price-matching directly harms consumers

• Limiting FFPs directly harms consumers

• Re-allocating slots directly harms consumers

20 Conclusion

• In air transport intervention only makes sense where there is likelihood of consumer harm

• Structural approach is inadequate

• Argues for • strong cost-based tests • Scepticism on non-price abuse

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