CHAPTER 8 FOSTERING COMPETITION AND PROTECTING THE PUBLIC INTEREST DURING THE CONSOLIDATION AND RESTRUCTURING OF THE AIRLINE INDUSTRY IN CANADA 8.1 PURPOSE AND OBJECTIVES The purpose of this chapter is to deal with the salient aspects relating to competition in the domestic airline industry in Canada, as a result of the deregulation of domestic air transport services and the subsequent consolidation of the industry into an overall dominant airline, Air Canada. In particular the occurrence of predatory practices in the airline industry in Canada, by means of a combination of the provision of too much capacity and lowering of air tariffs, will be examined in order to establish what remedies were adopted by the Canadian government to prevent anti-competitive behaviour in the airline industry and to foster competition. Specific objectives that will be established are: • To document some of the salient aspects of the development of deregulation in the Canada. • To describe the recent consolidation in the domestic airline industry in Canada that resulted in an overall dominance by Air Canada. • To identify the advice and recommendations of the Commissioner of Competition of the Competition Bureau on restructuring of the airline industry in Canada. • To document the revision of the Canadian domestic air transport policy. • To identify the enforceable undertakings provided by Air Canada to the Commissioner of Competition to enhance competition in a restructured airline industry. • To document the Canadian airline restructuring legislation that includes: Chapter 8 Page 848 o The enforcement guidelines on the abuse of dominance in the airline industry, which serves as a code of conduct relating to the practices of anti-competitive acts in the airline industry. o The airline regulations enacted following restructuring of the Canadian airline industry. o The definition of anti-competitive acts by legislation and regulations. o The grant of temporary cease and desist order relating to the abuse of dominance provision by the Competition Tribunal. o The identification of the occurrence of anti-competitive acts in the airline industry by means of the Avoidable Cost Test (as compared with the average variable cost test). • To identify the commercial conduct of Air Canada following the extensive review of legislation and regulations pertaining to competition in the Canadian air transport market in relation to new entrants and smaller airlines. • To assess the actual working of the regulatory steps that were adopted in Canada with regard to complaints raised by new entrants and smaller airlines against the conduct of Air Canada. This would include complaints of a competitive nature by such airlines. • To assess the evaluation of the regulatory steps adopted in Canada with regard to the promotion of competition in the air transport industry in Canada in the future. • To consider some advice and institutional arrangements of the Competition Authorities in Canada. 8.2 DEVELOPMENTS IMMEDIATELY PRECEEDING AIRLINE CONSOLIDATION AND RESTRUCTURING 8.2.1 CANADIAN GOVERNMENT POLICY Since 1988, with the deregulation of the domestic airline industry, there has been a steady tendency to liberalise both domestic and international services. Initiatives included: • Deregulation of domestic prices and routes. • Liberalisation of international carriage, including "Open Skies" with the USA. Chapter 8 Page 849 • Privatisation of air traffic control to Navigation Canada. • Transfer of airports to the private sector. • Liberalisation of international charter regulations for cargo and passenger services. Liberalisation led to profound changes in what the Canadian government can and cannot do. Since the government did not control domestic routes or prices, it could not use air services as a tool of economic or social policy. However, there are a number of areas where the government remained very much involved. These include: • Areas of safety. • Negotiating the rules around international carriage, which is governed by Canadian policy within a complex set of agreements between nations, and • Regulation of the framework in which CRSs operates. Recent developments pertaining to air transport regulation in Canada were initiated by a financial crisis at two of the largest Canadian airlines, which resulted in the domestic market being clearly dominated by a single Canadian carrier. This chapter summarises the developments in the structure of the Canadian airline industry, which paved the way for government intervention. The Canadian government made a number of choices relating to air transport policy. From the interim report of the Independent Transition Observer on Airline Restructuring in February 2001 1) and that of the Commissioner of Competition of the CCB in May 2001 relating to the then current state of airline operations in Canada, it would appear thatthe failure and subsequent acquisition of Canadian Airlines by Air Canada dramatically reduced the level of competition in domestic airline markets despite numerous actions taken by the Canadian government to create the opportunity for entry to the market. 2) The inability of new entrants to profitably enter the air transport market suggested that while entry into the scheduled domestic market may be possible, there are serious doubts about the ability of such firms to remain as sustainable competitors in the face of Air Canada's dominance. The Commissioner of Competition was of the opinion that the need for significant legislative and regulatory changes to promote competition in the airline industry remained strong. 3) Chapter 8 Page 850 Canada is in aviation terms Canada is geographically located between the USA and UK and Europe and as a result subject to developments in those countries. As stated, there appears to be a major focus on Canadian control and ownership over Canadian domestic airlines. At the time of writing, such national control and ownership was mirrored in the USA whereas in Europe inter-European ownership and establishment rules have been relaxed substantially. South Africa originally based the Air Services Act of 1949 on the Canadian Air Services Act. 4) 5) and the competition legislation in South Africa has drawn on Canadian competition legislation. 6) The latter was recently substantially altered to cater for the specific needs of the Canadian domestic air transport industry. 7) 8.2.2 INTRODUCTION TO THE CANADIAN DOMESTIC AIRLINE INDUSTRY Canada's domestic airline industry evolved from being a Canadian government-owned monopoly to a virtually deregulated industry where the market is open to any carrier that can obtain an operating licence and pass a financial fitness test. This environment came about in response to pressure from carriers for less government regulations to allow them to compete in the domestic marketplace. The Canadian government passed the National Transportation Act in 1987, which brought about the economic deregulation of Canada's domestic airline industry. Since deregulation of air transport services in Canada, there has been a consolidation of the airline industry as a result of a series of mergers and acquisitions. Canadian Airlines International Ltd (CAIL) evolved through the merging of Canadian Pacific (CP Air) with Eastern Provincial Airways, Nordair, Quebecair and Pacific Western Airlines in 1986, and the purchase of Wardair in 1989. Air Canada consolidated its position by becoming a privatised corporation in 1988, which enabled it to compete without the constraints of being a Crown corporation, including the need for government approval of corporate and financial plans. It also acquired regional airlines, which strengthened its position further. What eventually emerged from this process was a duopoly controlling 75-85 percent of domestic airline traffic. Both Air Canada and CAIL allied themselves with international Chapter 8 Page 851 alliances - Air Canada as part of Star and CAIL as part of Oneworld. According to the SCOT of Canada, alliances between international airlines acts as a major competitive force in global aviation, providing greater efficiencies of scope, and better service. The SCOT concluded that alliances enabled air carriers to benefit from increased traffic, increased revenues and decreased costs. In particular, membership of global alliances improved the productivity of flight assets through code-sharing, interlining and brand recognition, and enhanced the return on non-flight assets through other sharing activities, usually involving co-locating to share gates, baggage handling, ground handling equipment, ticketing offices and corporate sales forces. Carriers retained their identity, national character and marketing presence while also receiving foreign market presence at relatively low cost. While the airlines were free to compete, the SCOT heard that it was the view of many witnesses that this duopoly led to destructive competition - competition that has proved to be unhealthy for both carriers and consumers. Instead of the two carriers reaching a stable competitive equilibrium, they chose instead to compete head-to-head even when there was insufficient traffic for two carriers (as a result of excess capacity overall in comparison with demand). The result was that in 1998 CAIL was in serious financial difficulty and Air Canada did not achieve the profitability or share value that might have been attained had they engaged in less destructive competitive behaviour. In the summer of 1998, CAIL stated that it was in critical financial shape and