The Qantas Counterfactual Can Be Examined at the Aggregate Level

PUBLIC VERSION CHAPTER 5 THE COUNTERFACTUAL 1373359:SCK 1 PUBLIC VERSION TABLE OF CONTENTS INTRODUCTION .............................................................................................................................................3 SECTION 1: BREAKDOWN OF QANTAS’ CAPACITY INCREASES ...................................................4 Domestic New Zealand.................................................................................................................................4 Modelling of Commission’s growth assumptions ..................................................................................6 Tasman..........................................................................................................................................................6 Other international routes .............................................................................................................................7 SECTION 2: QANTAS’ DOMESTIC NEW ZEALAND EXPANSION .....................................................7 SECTION 3: QANTAS’ COMMITMENT TO DOMESTIC NEW ZEALAND.........................................9 SECTION 4: COMMERCIAL RATIONALE FOR QANTAS’ COUNTERFACTUAL.........................10 Network benefits.........................................................................................................................................12 City presence benefits.................................................................................................................................15 City presence analysis of Qantas Counterfactual................................................................................19 SECTION 5: ORIGIN PACIFIC...................................................................................................................21 SECTION 6: EFFECT OF COUNTERFACTUAL ON AIR NEW ZEALAND.......................................22 SECTION 7: COMMISSION MODELLING OF QANTAS’ COUNTERFACTUAL.............................23 ANNEX A: TIMELINE OF QANTAS’ DOMESTIC NEW ZEALAND PRESENCE.............................24 Timeline......................................................................................................................................................24 ANNEX B: DESCRIPTION OF ESTABLISHMENT OF JETCONNECT ...............................................26 Introduction ................................................................................................................................................26 Jetconnect ...................................................................................................................................................26 Introduction of aircraft to the NZ register...................................................................................................26 1373359:SCK 2 PUBLIC VERSION INTRODUCTION 5.1 In its Draft Determination on the proposed Alliance between Qantas and Air New Zealand, the Commerce Commission (“Commission”) discounted Qantas’ view of its likely future if the Alliance were not to proceed. Qantas’ view of its future in the absence of the Alliance with Air New Zealand remains unchanged. This document sets out further material for the Commission’s consideration, which addresses each of the arguments made in the Draft Determination, demonstrating why Qantas’ Counterfactual is the most likely future outcome if authorisation is not granted. 5.2 The Commission argued that the expansion of capacity by Qantas under the Counterfactual should be discounted based essentially on the following factors. (a) First, few parties considered the “war of attrition” to be a likely Counterfactual because Qantas would not want to release planes from its Australian domestic fleet. (b) Second, if capacity expansion were Qantas’ optimal strategy, it might be expected that such behaviour would be evident now, but this does not appear to be the case. (c) Third, the increase in capacity reflected in Qantas’ Counterfactual would be inconsistent with commercially rational behaviour. (d) Fourth, the Qantas capacity increase would be unlikely to succeed if the Air New Zealand shareholders were to demonstrate a willingness to resist such behaviour by committing to support the company through any war of attrition and because the exit of Air New Zealand, the assumed outcome of the war of attrition, would leave no other airline to exercise the country’s bilateral air rights. 5.3 Instead, the Commission expressed the preliminary view that if authorisation were blocked, then Qantas’ next most preferred option might be to enter into tacit collusion with Air New Zealand. However, despite this preliminary view, the Commission reached a preliminary conclusion that the likely Counterfactual would involve, in the short-run, a continuation of competition from Qantas on the Tasman and domestic New Zealand routes, but with capacity being expanded in line with market growth, not accelerated to produce a “war of attrition”. 5.4 Before turning to the issues listed above, the Applicants raise three preliminary matters. 5.5 First, the Applicants note that the Commission failed to consider any further the implications of Qantas’ statements regarding the likelihood of tacit collusion as a preferred outcome for Qantas. If the Commission considered this a likely outcome then clearly the detriments of the proposed Alliance would have been substantially lower than those presented in the Draft Determination, yet the Commission does not acknowledge this. 5.6 Second, the Applicants note that the Commission’s preliminary conclusion regarding the Counterfactual is inconsistent with the advice received from the Commission’s own financial experts, Taylor Duignan Barry Ltd. In a letter to the Commission dated 11 April1 these experts provided the following advice in relation to the Commission’s Counterfactual: 1 This letter was forwarded to Bell Gully by email on the 14th of May by Janet Whiteside. 1373359:SCK 3 PUBLIC VERSION “The one comment (which we have already made) in relation to this Counterfactual is that the discussion on Qantas is specified in terms of an outcome for Qantas (i.e. “Qantas grows in line with the market”), that as far as we are aware has not been demonstrated to be commercially viable or attractive as a business strategy. We suggest this aspect of the Counterfactual is vulnerable to a Qantas response that such an outcome is not a sustainable position for them. The Counterfactual may therefore lose credibility. An alternative for the Commission might be to say something like “competition in the domestic market continues as before”, with the precise outcome left unspecified.” 5.7 Third, the Applicants draw the Commission’s attention to the use of the term “war of attrition”. Qantas’ proposed increase in capacity, including in domestic New Zealand, is consistent with commercially rational behaviour and not unrealistically intense competition. It is the outcome of this increase in capacity leads to a “war of attrition”, not an overly aggressive attack on Air New Zealand’s market share, but a steady and gradual wearing down due to competitive pressure. 5.8 The remainder of this document is set out as follows: (a) Section 1 provides a break-down of Qantas’ planned capacity increases in domestic New Zealand under the Counterfactual to demonstrate that this expansion rate is consistent with the relatively early stages of an entry strategy, which includes not only the increase of capacity on existing routes, but the extension of services to new routes. (b) Section 2 explains why the timing of Qantas’ expansion plans into domestic New Zealand is consistent with Qantas’ views on its future in the absence of the Alliance with Air New Zealand, as claimed by the Commission. (c) Section 3 explains Qantas’ commitment to domestic New Zealand. This is important given that the extent of Qantas’ commitment might not have been understood by third parties. (d) Section 4 examines why Qantas’ Counterfactual is consistent with commercially rational behaviour. (e) Section 5 describes Qantas’ code-share arrangement with Origin Pacific (“Origin”), and the likely impact of the Alliance, and the Counterfactual, on Origin. (f) Section 6 describes the effect of the Counterfactual on Air New Zealand which is explained in more detail in Chapter 6 of this Submission. (g) Section 7 compares the Commission’s proposed Counterfactual to that modelled by its economic expert, Professor Gillen, and discusses the inconsistency in the approaches adopted. 5.9 Because Sections 1 to 5 involve matters confidential to Qantas, they are described from Qantas’ point of view. Section 6 is from Air New Zealand’s point of view. Section 7 is from the perspective of the Applicants collectively. SECTION 1: BREAKDOWN OF QANTAS’ CAPACITY INCREASES Domestic New Zealand 5.10 The Commission’s concerns regarding the plausibility of Qantas’ planned expansion of capacity under the Counterfactual appear to focus predominantly on 1373359:SCK 4 PUBLIC VERSION domestic New Zealand. In domestic New Zealand, Qantas’ Counterfactual Schedules reflect an increase in Qantas operated capacity by a total of [CONFIDENTIAL] between 2002/03 and year 3 of the Counterfactual. This equates to an increase from 5 B737s to [CONFIDENTIAL] B737s. 5.11 While this may seem like a large expansion on an aggregate basis, it must be understood that Qantas is still in the relatively early stages of the establishment of Qantas is still its domestic New Zealand operations, and hence much of the planned additional in the early

Load more