We Regroup Two Presentations Dealing with the Possible Merger of Air Canada and Canadian Airlines International Ltd

We regroup two presentations dealing with the possible merger of Air Canada and Canadian Airlines International Ltd. The first was the kick-off presentation at a student lunch-debate at the University of Montreal on November 8, 1999, and the second was the basis of the two-hour testimony given in front of the Permanent Transport Committee of the House of Commons of Canada on September 28, 1999. As the Annex is part of the testimony, it is included here despite the fact that it appeared as “Airport Subsidies and Congestion in North America : the Need for Accounts and a Regulator within Virtual World Trade Organisation Rules”, Journal of Air Transport Management, 7, 35-41, 2001. Should the Two Largest Canadian Airline Companies be Merged? by Marc Gaudry • Bureau d’économie théorique et appliquée (BETA) Université Louis Pasteur, Strasbourg et • Département des sciences économiques Université de Montréal, Montréal [email protected] Agora Jules DupuitPublication AJD-60 Centre de recherche sur les transportsPublication CRT-99-54 December 1999, September 2002 RÉSUMÉ Nous regroupons deux textes traitant de la fusion possible d’Air Canada et des Lignes aériennes Canadien International Ltée: le premier donnait le coup d’envoi au débat-midi étudiant du 8 novembre 1999 à l’Université de Montréal et le second a été présenté au Comité permanent des transports de la Chambre des communes du Canada le 21 octobre 1999 dans le cadre d’un témoignage de deux heures. Mots-clés: Air Canada, Lignes Aériennes Canadien International Ltée, Onex Corporation, Chambre des Communes, Université de Montréal. ABSTRACT We regroup two related texts pertaining to the potential merger of Air Canada with Canadian International Airlines Ltd. The first one was the kick-off for a student lunch-debate at the University of Montreal on November 8, 1999, and the second one was deposited with the Permanent Transport Committee of the House of Commons of Canada on October 21, 1999, within the context of a two-hour long interrogation. Keywords : Air Canada, Canadian Airlines International Ltd, Onex Corporation, House of Commons, University of Montreal. SOMMAIRE Résumé...........................................................................................................................................….. ii Abstract..........................................................................................................................................…... ii Four questions about the two airline issue…………………………………………………………… 1 Why is the idea of an AC-CAIL merger a public policy issue of national interest?................. 1 What is meant by a middle-size player? ……………………………………........................... 1 Are there other economic issues of general interest? ……....................................................... 2 What process leads to a successful result?……........................................................................ 2 On the Onex proposal…….................................................................................................................. 4 Context……............................................................................................................................... 4 Key elements of the air industry environment............................................................................ 4 A handle to influence outcomes.................................................................................................. 6 Framework elements.....................................................................................................……...... 8 Other issues……........................................................................................................................ 9 References............................................................................................................................... 10 Annexe 1. Subventions aéroportuaires et congestion aérienne en Amérique du Nord : plaidoyer pour un régulateur et pour l’établissemement d’une comptabilité collective........... 11 About the author.............................................................................................………………… 23 ii Four Questions about the Two-Airline Issue1 by Marc Gaudry We need a framework to evaluate from a general interest perspective the potential net gains arising from the various proposals to integrate Air Canada (AC) and Canadian Airlines (CA), or from the current and forthcoming variants of these or new proposals. We focus on net gains to Canada, irrespective of the location of underlying gains or losses. Players and proposals are mentioned in stylised fashion, without due precision or formality. 1. Why is the idea of an AC-CA merger a public policy issue of national interest? We may still have the opportunity to foster the establishment of a healthy middle-size carrier, with its head-office in Canada and chances of surviving and growing within international alliances. This opportunity arises from the fact that these two airlines currently hold almost all rights to serve international routes within bilateral air treaties signed by Canada. Without the “ national designation ” and these treaties, we risk being overtaken by our geography and becoming the mere spokes on American hubs that we might well have been had Canada been sold to the U.S., as Louisiana and Alaska were in their time. But the value of these rights is threatened by the increasing liberalisation and “ open skies ” policies pursued principally by the United States. These policies increase the relative attractiveness of itineraries passing through American hubs on the way from Canada to other continents and could well lead to a collapse of the entire structure of restrictive bilateral treaties generating the profitable franchises. In addition, even foreign ownership rules imposed on airlines might be profoundly affected by a parallel movement, recently initiated by the American Transportation Research Board, to scrap the 25% limit generally applied. 2. What is meant by a middle-size player? As Professor Oum of the University of British Columbia pointed out in 1992-1993, airline head office functions are foot-loose and can be gained and lost easily; moreover, in this still relevant view, a major head office would have its best chances of survival if a Canadian player of reasonable size could be formed and became an anchor-airline within the growing world of notoriously unstable international air alliances. Although AC does not have its close Continental Airlines partner anymore, a healthy and growing anchor based on truly merged firms is still worth a try: note how Canadian National Railways (CN) moved from the status of maintained consumer of public subsidies, responsible for perhaps 11-15 % of the national debt between its inception and its privatisation, to that of contributor to the public purse and healthy Class I railway competitor. The form of the CN network is rapidly being transformed from a market fringe line-shape to a market core T-shape reaching ever further through alliances across all of the North American continent. CN has become in 3 years an anchor-railway for Canada. In a few years, it might have been too late to start. 1 Kick-off notes prepared for the November 8, 1999, students’ lunch-debate (“ Débat-midi ”) at the University of Montreal. Fuller notes are found in “ On the Onex Proposal ” , a summary of comments made to the House of Commons ad hoc and Permanent committees on September 28 and October 21, respectively. This summary is available from the author ([email protected]) in both French or English versions. The author is professor of Economics, co-founder and occasional director of the multi-university Centre for Research on Transportation (CRT) in Montreal and a former commissioner of the Royal Commission on National Passenger Transportation (1989-1992). 1 3. Are there other economic issues of a general interest? First, there is the subsidy issue. The Royal Commission on National Passenger Transportation recommended in 1992 against subsidies to mature networks. But in our problem, AC officials are reported to have said a number of times that, in their offer to maintain two firms under separate brand names, they might simply pull the plug under CA after paying shareholders their agreed amount, should the creditors of that airline not go along with the “ restructuring ” of the value of their claims, betting that the Canadian Government would step in with a subsidy to avoid the bankruptcy. If correct, this information shows that the expectation of a subsidy can still be part of a take-over bid. Second, there is the economic efficiency argument. Clearly, only a true merger will yield both the revenue and the cost savings necessary to maximise combined gains. Also, all other formulas restrict the ability of the merged firm to create new and better services with less resources, to the benefit of Canada. One should not underestimate the ability of a larger firm to create new “ goods ” : all feasible paths and services among all origins and destinations are termed the “ scope ” of the firm and generate synergies (economies of scope) not available to firms serving few points. The Onex proposal obtains efficiencies of all kinds without the threat of subsidies. But cost synergies can be negative. How could AC create a low-fare airline with high-cost CA employees in Hamilton—a place where this idea has been tried without success? Of course, this type of question has been asked and answered before—in the case of short rail lines

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