AUSTRALIAN COMPETITION TRIBUNAL

 

Qantas Airways Limited [2004] ACompT 9

 

 

 

 

SUMMARY

 

 

 

 

 

 

 

 

 

File No 5 of 2003


RE:     APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)

 

BY:      QANTASAIRWAYSLIMITED(ABN16009661901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)

Applicants


GOLDBERG J (President), MR G F LATTA and PROFESSOR D K ROUND

16 MAY 2005

MELBOURNE (Heard in Sydney and Melbourne)

 


SUMMARY


1.                  In accordance with the practice of the Australian Competition Tribunal (“the Tribunal”) the following summary has been prepared to accompany the Reasons for Determination made today.  The summary is intended to assist in understanding the outcome of these proceedings and is necessarily not a complete statement of the reasoning or the conclusions of the Tribunal.  The only authoritative statement of the Tribunal’s reasons is that contained in the published Reasons for Determination which is being published today and will be available on the internet at www.fedcourt.gov.au, together with this summary.


2.                  The matter before the Tribunal was a review sought by Qantas and Air New Zealand of the Australian Competition and Consumer Commission’s (“the Commission”) refusal to grant them authorisation in respect of agreements relating to their activities across the Tasman and elsewhere.  In essence, Qantas and Air New Zealand entered into a series of agreements, subject to authorisation, rationalising a number of their airline activities. 


3.                  On 12 October 2004 the Tribunal handed down its determination in which it granted the authorisation sought.  The Tribunal has found that although there is a detriment arising out of certain anti‑competitive aspects of the proposed agreements, there are public benefits accruing as a result of the proposal which outweigh that detriment.


4.                  In December 2002 Qantas and Air New Zealand applied to the Commission for authorisation for Qantas to acquire ordinary shares in Air New Zealand comprising up to a 22.5% voting equity interest, and for Qantas and Air New Zealand to enter into agreements for the coordination of their activities such as scheduling and pricing for all passenger and freight services on all Air New Zealand flights and all Qantas flights into, within and leaving New Zealand.  There was also an application for authorisation of an agreement relating to co‑operation with respect to aspects of passenger and freight services with Air Pacific Limited.  We refer to this acquisition and these agreements as “the Alliance”.  The Alliance between Qantas and Air New Zealand involved, in substance, the combining of flights and the removal of competition between them in relation to matters such as pricing and scheduling.


5.                  On 9 September 2003 the Commission denied authorisation in respect of all the agreements on the grounds that they would involve a substantial lessening of competition and that the anti‑competitive effects of the proposed agreements would substantially outweigh the public benefits flowing from the agreements.


6.                  Qantas and Air New Zealand applied to the Tribunal to review the Commission’s decision.  Qantas and Air New Zealand’s proposals were examined in relation to their effects in various markets.  The markets were:

 

·              the trans‑Tasman air passenger services market;

·              the trans‑Tasman airfreight market;

·              the Australian domestic air passenger services market;

·              the Australia‑North America air passenger services market;

·              the Australia‑North America airfreight market; and

·  the market for travel distribution services. 

 

The greater part of the hearing was taken up by a consideration of the trans‑Tasman air passenger services market, there being little controversy that there were any anti‑competitive effects in the other markets save for the Australia‑North America air passenger services market.


7.                  The Tribunal, using the “future with and without test”, considered the public benefits and anti‑competitive detriments which would flow or be likely to flow if authorisation were granted (“the factual”) and then compared them with the public benefits and anti‑competitive detriments which would occur, or be likely to occur, if authorisation were not granted (“the counterfactual”). 


8.                  The Tribunal, consistently with its previous determinations, adopted a test of assessing the benefits to the public said to be generated from the Alliance by considering the benefits which flowed not only to ultimate consumers but also to the parties and their shareholders (described as the “total welfare” or “total surplus” approach), with a caveat that the weight that should be accorded to benefits achieved by producers might depend on whether and to what extent any cost savings or other benefits were passed through to consumers. 


9.                  The benefits that were claimed by Qantas and Air New Zealand in relation to the trans‑Tasman air passenger services market were:

 

·  the enhancement of the national interest;

·  the benefits to Qantas’ network as a result of network extension with Air New Zealand;

·  international benefits of such network extension;

·  synergy benefits of such network integration;

·  scheduling benefits of such network integration;

·  pricing benefits of such network integration

·  tourism benefits. 


10.              In relation to the trans‑Tasman air passenger services market we found that, notwithstanding the substantial combined market share of Qantas and Air New Zealand of approximately 80% that would exist at the time the Alliance came into operation if it were authorised, there would be little anti‑competitive detriment arising from the fact that Qantas and Air New Zealand would not be competing against each other in the market, although we do recognise that some time‑sensitive passengers might on occasion experience some inconvenience, at least in the short‑run.  We considered, with the exception of the time‑sensitive passenger, that any attempt by Qantas and Air New Zealand to act jointly in an anti‑competitive way, such as by limiting capacity or increasing prices, would be constrained by the presence and likely responses of two airlines in particular, Pacific Blue and Emirates.  We were satisfied that Emirates and Pacific Blue, currently holding only a relatively small market share (but one that had significantly increased during 2003/2004), would act as a constraining influence upon Qantas and Air New Zealand, as they had available capacity and cost advantages which would enable them to attract travellers with competitive pricing and scheduling if Qantas and Air New Zealand raised their prices or restricted their capacity.  We were satisfied that Emirates has made a commitment to the trans‑Tasman market at least for the five year period for which authorisation was sought, and that Pacific Blue is committed to the trans‑Tasman market, and that both airlines would attract passengers from Qantas and Air New Zealand if the Alliance sought to raise its prices or restrict its capacity.


11.              The only significant detriment was in relation to the time‑sensitive passenger, usually a person travelling on business who wished to travel to and from Australia at short notice and had little flexibility as to the time at which he or she could travel, should flight frequencies be reduced. 


12.              In determining the constraining effects of Pacific Blue and Emirates we paid particular attention to their current and likely future strategic behaviour in the market, in addition to analysing past trends in market share for each of the participants in the market.


13.              Ultimately, we reached the conclusion that any anti‑competitive detriment brought about by the proposals of Qantas and Air New Zealand in relation to the time‑sensitive passenger was relatively small and that it did not require a substantial public benefit to outweigh that detriment. 


14.              Although we reach a different conclusion to that reached by the Commission, it should be pointed out that at the time the Commission made its determination Pacific Blue had just started its trans‑Tasman flights and Emirates had not sought to promote its brand and build up its schedules across the Tasman in the manner it did between the time of the determination and the time at which the hearing commenced.  As this was a de novo hearing held eight months after the Commission’s determination, we were considering a quite different market from that analysed by the Commission.



AUSTRALIAN COMPETITION TRIBUNAL

Qantas Airways Limited [2004] ACompT 9

 

TRADE PRACTICES – applications for review of a determination under s 101 of the Trade Practices Act 1974 (Cth) – proposed agreements between airlines to acquire shares and coordinate activities – agreements presumed to fall within the prohibitions in s 45 and s 50 of the Trade Practices Act 1974 (Cth) – review of determination of Australian Competition and Consumer Commission denying authorisation to the agreements – where combined market share of airlines under agreements would be substantial – whether agreements ought to be authorised – whether agreements likely to give rise to anti‑competitive detriment in a number of air passenger and airfreight service markets – whether agreements likely to give rise to public benefit – assessment of standard to be applied in assessing public benefit – whether public benefit outweighs anti‑competitive detriment.


Trade Practices Act 1974 (Cth) ss 88(1), 88(9), 90(6)‑(9), 90A(13), 101, 102(1), 109(2)


Convention on International Civil Aviation, opened for signature 7 December 1944, 15 UNTS 295 (entered into force 4 April 1947)


Applications for Authorisation A30220, A30221, A30222, A90862 and A90863:  Acquisition by Qantas Airways Limited of ordinary shares in Air New Zealand Limited and cooperative arrangements between Qantas, Air New Zealand and Air Pacific Limited (Final determination, 9 September 2003, C2002/1775)


Air New Zealand v Commerce Commission (No 6) (unreported, High Court of New Zealand, Rodney Hansen J and KM Vautier, 17 September 2004), cited

Re Herald&Weekly Times Ltd onbehalf of theMembers of the Media Council of Australia (1978) 17 ALR 281, cited

Re Queensland Co‑operative Milling Association Ltd and Defiance Holdings Ltd (1976) 8 ALR 481, followed

Re Rural Traders Co‑operative (WA) Ltd (1979) 37 FLR 244, followed

Re G & M Stephens Cartage Contractors Pty Ltd on behalf of the Members of the Concrete Carters Association (Victoria) (1977) 16 ALR 387, cited

Re Media Council of Australia (No 2) (1987) 88 FLR 1, discussed

Re 7‑Eleven Stores Pty Ltd (1994) ATPR 41‑357, followed

Re Australian Competition and Consumer Commission by Australian Association of Pathology Practices Inc (2004) 206 ALR 271, cited

Re EFTPOS Interchange Fees Agreement (2004) ATPR 41‑999, cited

Re QIW Ltd (1995) 132 ALR 225, followed

Re Media Council of Australia (1996) ATPR 41‑497, followed

Re AGL Cooper Basin Natural Gas Supply Arrangements (1997) ATPR 41‑593, cited

Australian Wool Growers Association Ltd (2000) ATPR 41‑774, cited

Re Howard Smith Industries Pty Ltd (1977) 28 FLR 385, followed

Australian Gas Light Company v Australian Competition and Consumer Commission (2003) ATPR 41‑966, followed

Trade Practices Commission v Australian Iron & Steel Pty Ltd (1990) 22 FCR 305, cited

Refrigerated Express Lines (A/asia) Pty Ltd v Australian Meat and Live‑stock Corporation (1980) 29 ALR 333, cited

Hospital Benefit Fund of Western Australia Inc v Australian Competition and Consumer Commission (1997) 76 FCR 369, cited

Telecom Corporation of New Zealand Ltd v Commerce Commission (1991) 4 TCLR 473, followed

Trade Practices Commission v Australia Meat Holdings Pty Ltd (1988) 83 ALR 299, cited

Re Tooth & Co Ltd (1979) 39 FLR 1, cited

Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (1989) 167 CLR 177, followed

National Justice Compania Naviera SA v Prudential Assurance Co (“The Ikarian Reefer”) [1993] 2 Lloyd’s Rep 68, cited

Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 215 CLR 374, cited


The Hon MEJ Black, Practice Direction:  Guidelines for Expert Witnesses in Proceedings in the Federal Court of Australia, issued 19 March 2004

Independent Committee of Inquiry (FG Hilmer, MR Rayner and GQ Taperell), National Competition Policy: Report by the Independent Committee of Inquiry, Australian Government Publishing Service, Canberra, 1993

MS Gal, Competition policy for small market economies, Harvard University Press, Cambridge, Massachusetts, USA, 2003

International Competition Network Working Group, Analytical Framework Subgroup, Project on merger guidelines:  Report for the third ICN annual conference in Seoul, 2004

ME Levine, ‘Understanding airline strategic choices: How much do legacy carriers have to change to survive?’, paper presented at an Airline Economics Seminar at the Embry‑Riddle Aeronautical University, Washington DC, USA, 7 April 2004

Committee to Review the Trade Practices Act 1974 (TB Swanson et al),Report to the Minister for Business and Consumer Affairs, Department of Business and Consumer Affairs, Canberra, 1976


File No 5 of 2003


RE:     APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)

 

BY:      QANTASAIRWAYSLIMITED(ABN16009661901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)

Applicants

GOLDBERG J (President), MR G F LATTA and PROFESSOR D K ROUND

16 MAY 2005

SYDNEY (Heard in Sydney and Melbourne)


IN THE AUSTRALIAN COMPETITION TRIBUNAL

No 5 of 2003

 

RE:     APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)

 

BY:      QANTASAIRWAYSLIMITED(ABN16009661901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)

Applicants

THE TRIBUNAL:

GOLDBERG J (President)

MR G F LATTA

PROFESSOR D K ROUND

DATE OF DETERMINATION:

12 OCTOBER 2004

WHERE MADE:

SYDNEY (Heard in Sydney and Melbourne)

 

THE TRIBUNAL DETERMINES THAT:

1.       The determination of the Australian Competition and Consumer Commission dated 9 September 2003 denying authorisation to applications A30220, A30221, A30222, A90862 and A90863 is set aside.

 

2.       Pursuant to subs 88(1) of the Trade Practices Act 1974 (Cth) (“the Act”), the Tribunal grants an authorisation in respect of applications A30220 and A30221 to Qantas Airways Limited (“Qantas”) and Air New Zealand Limited (“Air New Zealand”) to make and give effect to the Strategic Alliance Agreement dated 25 November 2002 between Qantas and Air New Zealand under which:

 

(a)         they will coordinate pricing, scheduling, marketing, sales and customer service activities for all Air New Zealand operated flights, all domestic New Zealand flights operated by Qantas, and Qantas operated international flights arriving in, departing from or transiting through New Zealand (“the JAO Network”);

 

(b)        Qantas will have the right to codeshare on all Air New Zealand flights, and Air New Zealand will have the right to codeshare on all Qantas flights in the JAO Network and to codeshare on those other Qantas flights that reasonably connect to any flight in the JAO Network;

 

(c)         Qantas and Air New Zealand will from time to time enter into contracts and arrangements and arrive at understandings that include exclusionary provisions (within the meaning of s 4D of the Act), including but not limited to in connection with the joint supply or joint acquisition by Qantas and Air New Zealand of air transportation services and other goods and services.

 

3.         Pursuant to subs 88(9) of the Act the Tribunal grants an authorisation in respect of application A30222 to Qantas to acquire convertible notes and shares enabling Qantas to hold up to 22.5% of the capital of Air New Zealand as set out in the Subscription Agreement between Qantas and Air New Zealand dated 25 November 2002 in the terms set out in application A30222.

 

4.         Pursuant to subs 88(1) of the Act the Tribunal grants an authorisation in respect of applications A90862 and A90863 to Qantas and Air New Zealand to make and give effect to the Cooperation Agreement made in or about December 2002 between Qantas and Air New Zealand.

 

5.         The authorisations referred to in paragraphs 2 and 4 of this determination shall be in force for a period of five years commencing on the date upon which each of the said agreements is first given effect to, which date must be notified in writing by Qantas and Air New Zealand to the Commission (marked for the attention of the Chairman) within 14 days of such first giving effect.  If either of the Strategic Alliance Agreement or the Cooperation Agreement referred to in paragraphs 2 and 4 of this determination is not given effect to within twelve months of the date of this determination the Commission may apply to the Tribunal to vary this determination by fixing a specific date on which the period in respect of which the authorisation in respect of that agreement shall commence.

 

6.         Liberty is reserved to all parties to apply to the Tribunal for such further or other determinations as may be necessary to implement and carry into effect this determination.



IN THE AUSTRALIAN COMPETITION TRIBUNAL

No 5 of 2003

 

RE:     APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)

 

BY:      QANTASAIRWAYSLIMITED(ABN16009661901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)

Applicants

THE TRIBUNAL:

GOLDBERG J (President)

MR G F LATTA

PROFESSOR D K ROUND

DATE:

16 MAY 2005

PLACE:

SYDNEY (Heard in Sydney and Melbourne)

CONTENTS

INTRODUCTION …………………………………………………………………………………….       1

 

THE PARTIES ………………………………………………………………………………………..       4

Qantas ………………………………………………………………………………………………        4

Jetstar ……………………………………………………………………………………………        5

QH Tours Ltd ……………………………………………………………………………………        5

Air Pacific ……………………………………………………………………………………….        6

Air New Zealand ……………………………………………………………………………………        6

Domestic Express ………………………………………………………………………………..       7

Tasman Express ………………………………………………………………………………….       7

Freedom Air ……………………………………………………………………………………..        7

The Gullivers Group ………………………………………………………………………………..         8

Other relevant airlines ……………………………………………………………………………..          8

Virgin Blue ……………………………………………………………………………………..          8

Fifth Freedom Carriers ………………………………………………………………………….       10

Emirates – a particular case …………………………………………………………………….       11

BACKGROUND TO THE AIRLINE INDUSTRY …………………………………..……………      13

Revenue management ……………………………………..……………………………………….       13

Terminal scheduling and slot allocation …………………..……………………………………….          16

Interlining ……………………………………..……………………………………….…………..        17

Code‑sharing …………………..………………………………………………..………………….       17

Regulatory framework ………………………….……………………………………….…………        17

Airline models:  the FSA v the LCC …………………..…………………………………………           18

Impact of the LCC model on the airline industry ………………………………………..……           22

THE ALLIANCE …………………………………..………………………………….………….….      24

The Equity Proposal ……………………………………..……………………………….……..….       25

The Strategic Alliance Agreement ………..……………..……………………………....………....       25

The Cooperation Agreement ……………………..…………………………………………..….…       29

THE COMMISSION’S DETERMINATION …………………………………..………….….……     30

Evidentiary changes since the Commission’s determination …………………………...………….         33

THE HEARING BEFORE THE TRIBUNAL …………………………………..……………..…..     35

RELEVANT PROVISIONS OF THE ACT …………………………………..……………………      35

Relevant test to be applied …………………..……………………………..………..……..………       38

The future with and without test ………………………………………..……….……...………        40

The meaning of “likely to result” …………….……………………………………….………..         40

Efficiencies used to assess detriment and benefit ………………………………..…...……..…         42

The meaning of public benefit ………………………………………………….…...………...          43

Welfare standards – the connotation of “public” ………………………………....….…………        44

Benefits – domestic v foreign………………………………..….…………………….….….….        52

Quantification of benefits………………………………..….………………………………..…        54

THE EXPERT EVIDENCE …………………………………..………………………………..……      57

The role of the expert …………………..…………………………………….…..……..…………        58

DEFINING THE MARKET …………..……………………………………..………………….…..      62

The relevant markets …………………………………..……………………………...……………       64

The trans‑Tasman air passenger services market …………………..………….…..……..……      67

The trans‑Tasman airfreight market …………………..……………………..…………..…...        68

The Australian domestic air passenger services market ……………….….……………..…...        69

The Australia–North America air passenger services market ……..………….…..….....……        70

The Australia–North America airfreight market ………………..…………..…………...…….       71

The market for travel distribution services …………………..…………..…………...……            72

THE PRINCIPAL ISSUES …………………………………..…………………………..……..…...      73

Market share and market structure in the trans‑Tasman air passenger services market ……..…….       76

The likelihood and extent of further entry and expansion by Virgin Blue, Emirates and other FFCs in the trans‑Tasman air passenger services market …………………….…..………                                                            82

Virgin Blue ………………..…………..…………..………………..…………..…………..        83

FFCs and Emirates ………………..…………..…………..………………..…………..…          97

Analysis of competition issues in the trans‑Tasman air passenger services market ………..….        112

THE FACTUAL …………………………………..…………………………..…………………….      122

THE COUNTERFACTUAL …………………………………..……………..…………………….      134

Analysis of capacity and average fares in the trans‑Tasman air passenger services market .….….       137

Continued operation of Air New Zealand in the trans‑Tasman air passenger services market .….         140

DETRIMENT IN THE TRANS‑TASMAN AIR PASSENGER SERVICES MARKET ……….    144

DETRIMENT IN THE TRANS‑TASMAN AIRFREIGHT MARKET …………………………    146

DETRIMENT IN THE AUSTRALIAN DOMESTIC AIR PASSENGER SERVICES

MARKET ……………………………………………………………………………………………      146

Prospect of entry by Air New Zealand or another Star Alliance member .….…………………....        148

Qantas to capture feed from Air New Zealand ………………………………………………..…..      150

DETRIMENT IN THE AUSTRALIA–NORTH AMERICA AIR PASSENGER SERVICES MARKET …………………………………………………………………………………………..                          150

Re‑entry by Air New Zealand onto Australia–North America routes .….………………………...       151

Air New Zealand’s code‑share with United Airlines ………………………………………....….         152

Air New Zealand’s indirect services as a competitive constraint ……………………………..….         156

DETRIMENT IN THE AUSTRALIA–NORTH AMERICA AIRFREIGHT MARKET ………   160

DETRIMENT IN THE MARKET FOR TRAVEL DISTRIBUTION SERVICES .……….….      161

Loss of competitive tension between the applicants and remuneration of travel agents ……...….          163

Ability to favour own distribution channels ……………………………………………..…....….          172

THE BENEFITS CLAIMED BY THE APPLICANTS ……………….………………………….     175

The national interest ……....……………………………………………………………………..         180

The benefits of expansion of Qantas’ domestic and international networks ……………………...         181

Synergy, scheduling and pricing benefits of network integration …………………………………         186

Tourism benefits…………………………………….…..…..……………………………………..       194

The context of LCC entry and growth, and increased activity of government‑funded global airlines, in the Australasian market ………………………………………………………………………..                                                201

 

COULD THE CLAIMED PUBLIC BENEFITS BE ACHIEVED IN THE ABSENCE OF THE ALLIANCE? ……………….………………………………………………………………………..                             204

THE WEIGHING EXERCISE ……………….………………………….…………………………      205

THE DETERMINATION ……………….………………………….………………………………     207

 




IN THE AUSTRALIAN COMPETITION TRIBUNAL

No 5 of 2003

 

RE:     APPLICATION FOR REVIEW OF THE DETERMINATION OF THE AUSTRALIAN COMPETITION AND CONSUMER COMMISSION MADE ON 9 SEPTEMBER 2003 DENYING AUTHORISATION IN RELATION TO APPLICATIONS A30220, A30221, A30222, A90862 AND A90863 (PROPOSED ACQUISITION BY QANTAS OF ORDINARY SHARES IN AIR NEW ZEALAND AND COOPERATIVE ARRANGEMENTS BETWEEN QANTAS, AIR NEW ZEALAND AND AIR PACIFIC)

 

BY:      QANTASAIRWAYSLIMITED(ABN16009661901) and AIR NEW ZEALAND LIMITED (ABN 70 000 312 685)

Applicants

THE TRIBUNAL:

GOLDBERG J (President)

MR G F LATTA

PROFESSOR D K ROUND

DATE:

16 MAY 2005

PLACE:

SYDNEY (Heard in Sydney and Melbourne)


REASONS FOR DETERMINATION

Introduction

1                     On 12 October 2004 we published our determination in these matters and we now publish our reasons for that determination.

2                     In these reasons, where a question of law is determined, or a view is expressed, or a conclusion is reached, on a question of law, such question has been determined, such view is expressed and such conclusion has been reached, in accordance with the opinion of the presidential member, Goldberg J, pursuant to s 42 of the Trade Practices Act 1974 (Cth) (“the Act”).

3                     A substantial part of the evidence we received was subject to confidentiality orders and undertakings.  Where we have referred to information that was subject to a claim of confidentiality during the hearing, we have identified that information in a confidential schedule.  A draft of this schedule and a draft of these reasons for determination were distributed to the legal representatives of the parties providing the confidential information prior to the publication of the reasons.  The legal representatives were then given the opportunity to make submissions as to the contents of the schedule at a hearing before the presidential member.  Confidential information referred to in these reasons has been enclosed in square brackets and given a [--] or letter designation and omitted from the published reasons.  The confidential schedule will only be published to the legal advisers to the parties supplying the confidential information.

4                     On 9 December 2002 Qantas Airways Limited (“Qantas”) and Air New Zealand Limited (“Air New Zealand”) (together, “the applicants”) lodged three applications with the Australian Competition and Consumer Commission (“the Commission”).

5                     One application was made pursuant to s 88(9) of the Act for authorisation to acquire shares in the capital of a body corporate in circumstances where this may have the effect of substantially lessening competition in a market within the meaning of s 50 of the Act.  The application sought authorisation for Qantas to acquire ordinary shares in Air New Zealand comprising up to a 22.5% voting equity interest.

6                     The other two applications were made pursuant to s 88(1) of the Act for authorisation:

·                    to make a contract where a provision of the proposed contract would be, or might be, an exclusionary provision within the meaning of s 45 of the Act, and to give effect to that provision; and

·                    to make a contract a provision of which would have the purpose, or would have or might have the effect, of substantially lessening competition within the meaning of s 45 of the Act, and to give effect to that provision.

 

These applications sought authorisation for the applicants to enter into an agreement relating to passenger and freight services whereby the airlines would co‑ordinate the fares and schedules of all Qantas flights and Air New Zealand flights into, within, and leaving, New Zealand, and would agree not to compete with each other on other routes leaving from, or arriving in, Australia or New Zealand.

 

7                     On 20 December 2002 the applicants made two further applications to the Commission for authorisation of an agreement with Qantas’ subsidiary, Air Pacific Limited (“Air Pacific”). 

8                     The applications were made pursuant to s 88(1) of the Act for authorisation:

·                    to make a contract where a provision of the proposed contract would be, or might be, an exclusionary provision within the meaning of s 45 of the Act, and to give effect to that provision; and

·                    to make a contract, a provision of which would have the purpose, or would have or might have the effect, of substantially lessening competition within the meaning of s 45 of the Act, and to give effect to that provision.

 

These subsequent applications sought authorisation for the applicants to enter into an agreement with Air Pacific that would allow the parties to co‑operate with respect to aspects of passenger and freight services.

 

9                     On 9 September 2003 the Commission made a determination denying authorisation in respect of all of the applications:  Applications for Authorisation A30220, A30221, A30222, A90862 and A90863:  Acquisition by Qantas Airways Limited of ordinary shares in Air New Zealand Limited and cooperative arrangements between Qantas, Air New Zealand and Air Pacific Limited (“the Commission’ s determination”). 

10                  On 29 September 2003 the applicants, dissatisfied with the Commission’s determination, applied to the Tribunal for a review of the Commission’s determination pursuant to s 101 of the Act.  The applicants, in effect, sought authorisation from the Tribunal in respect of the suite of agreements referred to above.

11                  The applicants sought to have the various applications heard together.  Having regard to the common factual substratum underlying each application, we exercised our discretion under s 90A(13) of the Act (being empowered by s 102(1) of the Act to exercise all the powers of the Commission) to treat the applications as if they constituted a single application and to give a single determination in respect of them.

12                  Around the same time as the applicants made their applications to the Commission, they also made similar applications to the New Zealand Commerce Commission (“NZCC”) for authorisation pursuant to the Commerce Act 1986 (NZ) (“the Commerce Act”).  On 23 October 2003 the NZCC made a final determination denying authorisation under the Commerce Act.  The applicants appealed to the High Court of New Zealand against the NZCC determination, but this appeal was dismissed: see Air New Zealand v Commerce Commission (No 6) (unreported, High Court of New Zealand, Rodney Hansen J and KM Vautier, 17 September 2004).

The Parties

13                  The applicants for review are Qantas and a number of its subsidiaries and affiliated companies, and Air New Zealand and a number of its subsidiaries.  A travel distribution group consisting of travel businesses located in Australia and New Zealand (collectively referred to as “the Gullivers Group”), was granted leave on 23 December 2003 to intervene in the proceeding as an interested party pursuant to s 109(2) of the Act.  The Commission was also represented and provided assistance to the Tribunal.

Qantas

14                  The first applicant, Qantas, is a well‑known airline.  Ranked the eleventh largest airline in the world on the basis of annual revenue passenger kilometres (“RPKs”), Qantas operates air passenger and freight services both internationally and domestically within Australia.  As at the time of the hearing, it operated on average 4,600 domestic and 540 international flights per week, using a fleet of 196 aircraft and linking 135 destinations in 33 countries.

15                  Qantas is what is known as a “full service airline” (“FSA”), providing a number of services which we shall later describe in more detail (see [83]–[86] below).  Qantas provides air passenger services within Australia, to trans‑Tasman destinations and to other international destinations.  It has an integrated network which enables it to offer:

·                    schedules that minimise connection time for transit passengers;

·                    seamless connections with a flight operated by another airline by means of “interline” and “code‑share” agreements (which are described in more detail at [73] and [74] below);

·                    baggage check‑through from the point of origin to the ultimate destination;

·                    frequent flights and adequate flight capacity to passengers, and

to assess route profitability on a network‑wide basis.

16                  The appellation “trans‑Tasman” is used in a variety of contexts throughout these reasons.  The appellation refers generally to cross‑border activity between Australia and New Zealand.  When we refer to the “trans‑Tasman routes”, we generally mean the nine main routes between Australia and New Zealand, being Sydney–Auckland, Melbourne–Auckland, Brisbane–Auckland, Sydney–Wellington, Melbourne–Wellington, Brisbane–Wellington, Sydney–Christchurch, Melbourne–Christchurch and Brisbane–Christchurch.  Qantas services these nine major trans‑Tasman routes by non‑stop flights.  Other flights, for example, between Perth and Auckland, are serviced by connecting flights transiting at Sydney or Melbourne.

17                  Qantas’ presence within Australia and on trans‑Tasman routes is used to develop goodwill, brand loyalty and traffic feed in Qantas’ other international markets.  International travel accounts for approximately 55% of Qantas’ revenue.  Qantas endeavours to make its business and flights attractive to a wide cross‑section of consumers.  It tailors its flight services and facilities to customers who range from business travellers to leisure travellers, from frequent to infrequent travellers, and to both domestic travellers and international tourists.  Qantas is currently a member of a major global marketing alliance called “oneworld”.

Jetstar

18                  Qantas has recently established a wholly‑owned subsidiary airline named Jetstar to provide domestic services within Australia.  Jetstar is managed separately from, and operates independently of, Qantas.  At the time of the hearing, Jetstar was to commence services in May 2004.  It is what is known as a “low cost carrier” (“LCC”), a term which we shall later describe in more detail (see [90]‑[91]).  Jetstar is a point‑to‑point carrier servicing domestic leisure destinations, initially on routes of less than three and a half hours, without flight connections or baggage transfer.  It also operates limited services on key business routes, Melbourne–Sydney and Melbourne–Brisbane, from its headquarters at Avalon Airport in Victoria.

QH Tours Ltd

19                  QH Tours Ltd, trading under the brands “Qantas Holidays” and “Viva!Holidays”, is a wholly‑owned subsidiary of Qantas.  It is established globally through subsidiary and associated companies in Asia and Europe and it wholesales domestic and international holidays.  Within Australia, QH Tours Ltd markets travel packages and products to a wide range of international destinations, including Asia, Africa, Europe, the Pacific and North America.  Internationally, it promotes primarily Australasian and some Asian destinations.

20                  QH Tours Ltd distributes its inbound, outbound and domestic products in Australia and around the world through travel agents (approximately 37,400 worldwide), and directly to customers via the internet and call centres.  It promotes inbound tourism by preparing brochures for provision to travel agents, and by providing access to its information technology infrastructure to licensed travel agents for its global network.  This allows any licensed travel agent to have access to its products electronically via the internet as well as through the Global Distribution System (“GDS”).

Air Pacific

21                  Qantas code‑shares on Air Pacific flights between Australia and Fiji.  Air Pacific is Fiji’s principal international airline.  It operates from Fiji to Pacific and Asian destinations including Australia, New Zealand and the United States.  The shareholders in Air Pacific are the Fijian Government, Qantas and Air New Zealand with shareholdings of approximately 51%, 46.32% and 1.97% respectively. 

Air New Zealand

22                  The second applicant, Air New Zealand, has been ranked as the 33rd largest airline in the world based on annual RPKs (although the applicants contended that this ranking overstates Air New Zealand’s standing in the international airline industry).  As at the time of the hearing, Air New Zealand operated an average of 2,998 domestic and 498 international return flights per week, using a fleet of 81 aircraft and linking 46 destinations in 16 countries. 

23                  Air New Zealand provides international and domestic air passenger and freight transport services within, to, and from, New Zealand.  Air New Zealand also provides engineering services, airport services, cargo services and travel distribution services in New Zealand.  Air New Zealand’s network consists of domestic New Zealand routes, international short‑haul routes (including trans‑Tasman routes) and international long‑haul routes.

24                  Air New Zealand is currently a member of a major global marketing alliance called “Star Alliance”.  In addition, Air New Zealand has a number of alliance arrangements with other airlines.  Of particular relevance to the present proceeding is its ExpansionAgreementwith United Air Lines Inc (“United Airlines”).  The Expansion Agreement has potential application network‑wide, but currently includes only services between New Zealand and major cities in the United States, selected New Zealand domestic services and services between New Zealand and the Pacific Islands and the United States.  The Expansion Agreement has not been implemented on routes touching Australia because authorisation has not been granted in Australia. 

25                  Air New Zealand also operates a number of code‑share agreements and, in particular, operates a code‑share agreement with United Airlines between Australia and New Zealand.  Excluding routes touching Australia, the Expansion Agreement is generally in effect on all Air New Zealand trans‑Pacific flights where Air New Zealand code‑shares on United Airlines flights.  It does not cover flights via Tonga and flights from Auckland to Los Angeles via Papeete.

Domestic Express

26                  Air New Zealand operates four regional airlines domestically within New Zealand, servicing major cities and regional New Zealand.  In November 2002, Air New Zealand’s jet‑based regional airline changed its name from “National” to “National Express”.  National Express and the three regional airlines are collectively branded “Domestic Express”.

Tasman Express

27                  Following the introduction of Domestic Express, in July 2003 Air New Zealand relaunched its trans‑Tasman operations (with the exception of the Perth–Auckland route) as “Tasman Express”.

Freedom Air

28                  Freedom Air was introduced by Air New Zealand in 1995.  It operates as an LCC and has a separate reservation and pricing system to Air New Zealand.  As at the time of the hearing, it operated four Boeing 737 aircraft and offered 50 return trans‑Tasman flights per week.

The GulliversGroup

29                  The intervener, the Gullivers Group, is an association of companies and firms which offers air travel services in competition with the direct retail and wholesale sales and distribution services provided by the applicants. 

30                  The Gullivers Group operates businesses in Australia and New Zealand in the tour and ticketing wholesale markets where it develops and markets domestic and worldwide holiday and ticket packages to travel agents.  It participates in the retail leisure distribution market by operating branded travel agencies which service individual and small business needs domestically and throughout the world.  The Gullivers Group also operates in the corporate travel distribution market, organising and managing the travel management requirements of large corporate organisations and selling tickets for sporting and other events.

31                  In Australia, these businesses generate approximately $230 million in sales each year.  In New Zealand, these businesses generate approximately NZ$1 billion in sales each year.  Of particular relevance is SYNERGI Travel Australia Pty Ltd (“SYNERGI”), one of the companies in the Gullivers Group which operates in the corporate travel distribution/management market.  SYNERGI is Australia’s fifth largest non‑airline owned travel management company. 

Other relevant airlines

32                  During the hearing, the parties placed considerable emphasis on the role which airlines other than Qantas and Air New Zealand will play in shaping the future of the airline industry in Australasia.  We received considerable evidence regarding airlines which are LCCs, in particular, Virgin Blue Holdings Limited (“Virgin Blue”) and its subsidiary, Pacific Blue Airlines (NZ) Limited (“Pacific Blue”).  Our attention was also directed to airlines which are referred to as “fifth freedom carriers”, and to one such carrier in particular, Emirates. 

Virgin Blue

33                  Virgin Blue commenced domestic services in Australia on 31 August 2000 and, as at the time of the hearing, was flying to all major Australian destinations, servicing 37 routes across Australia. 

34                  Virgin Blue deploys aircraft to its wholly‑owned subsidiary, Pacific Blue, which operates those aircraft on international routes, such as trans‑Tasman routes.  In these reasons, on occasions, we refer to both Virgin Blue and Pacific Blue as “Virgin Blue.”

35                  In September 2003 Virgin Blue announced that it would introduce trans‑Tasman services and on29 January2004services commenced operating on the Brisbane–Christchurch route.  Since then, direct Melbourne–Christchurch services commenced on 4 March 2004, followed by direct Sydney–Wellington and Sydney–Christchurch services on 10 March 2004.  On 13 September 2004 Virgin Blue announced that from November 2004 it would commence operating on two new trans‑Tasman routes, being Gold Coast–Christchurch and Brisbane–Wellington. 

36                  As at the time of the hearing, Pacific Blue operated two aircraft on the trans‑Tasman routes, providing approximately 27 weekly return flights.  In addition to these direct services, Pacific Blue offered a number of indirect or connecting services between Wellington and Christchurch and various Australian cities.

37                  Virgin Blue is an LCC which seeks to offer affordable and convenient travel.  It seeks to minimise costs by adopting efficient business strategies and cutting out extras, such as free meals.  It passes on cost savings to passengers through low airfares.  An important part of Virgin Blue’s brand and business model is to be seen always to offer low fares.  Accordingly, if demand is strong, Virgin Blue is likely to increase capacity by putting on additional services rather than increasing its fare levels. 

38                  As at March 2004, Virgin Blue had captured over 33% of the Australian domestic market.  Whilst Virgin Blue’s low fare offerings are attractive to leisure travellers, its market success in Australia has not been limited to leisure travellers and it also targets business routes and business travellers.  Virgin Blue has aggressively targeted the corporate sector in Australia and has been successful in entering into contractual agreements with one‑third of the top 100 corporations in Australia.  At the time of the hearing it is estimated that business travellers accounted for more than 40% of Virgin Blue’s total passengers. 

39                  For the financial year 2002‑03, Virgin Blue reported revenue of approximately $915 million, with post–tax profit of approximately $108 million, and serviced approximately 6.6 million passengers.  For the financial year 2003‑04, Virgin Blue recorded revenue of approximately $1.362 billion, up 49% on the previous year, and a net profit after tax of $158.5 million, and serviced approximately 10 million passengers.  In December 2003 it successfully completed an equity offering raising $666 million.  However, at its Annual General Meeting on 4 August 2004 Virgin Blue announced that its earnings before tax for the first four months of the 2004‑05 financial year were down 22% compared to the corresponding period in the previous financial year.

Fifth freedom carriers

40                  There are a number of non‑Australian, non‑New Zealand airlines that operate on trans‑Tasman routes pursuant to certain rights granted by Australia and New Zealand.  At the time of the hearing, the airlines exercising these rights were Emirates, Thai InternationalAirways,Royal BruneiAirlines,RoyalTongan,GarudaIndonesia,Lan Chile, Aerolineas Argentinas and Polynesian Airlines.  We were informed that Malaysian Airlines ceased flying trans‑Tasman routes in 2004.

41                  These airlines are able to operate on the trans‑Tasman routes because Australia and New Zealand have granted them “fifth freedom rights”.  Countries often enter into agreements with one another granting reciprocal rights to the designated airlines of each country to various “freedoms of the air”.  There are nine different freedoms of the air, but for present purposes it is sufficient to note that the fifth freedom is the right of an airline to land in another country, pick up and deliver traffic, and then fly to a second country, provided that the flight originates or terminates in the airline’s home country.  Where fifth freedom rights are unrestricted, there are no limitations on the number of passengers or the sectors to which the airline may provide air services.  We refer to airlines operating on the trans‑Tasman routes pursuant to fifth freedom rights as fifth freedom carriers (“FFCs”).

42                  In addition to the FFCs mentioned above, a number of other airlines have fifth freedom rights to operate on the trans‑Tasman routes but do not currently exercise them, including Singapore Airlines, British Airways, United Airlines, Cathay Pacific, Air China, Air France, Lufthansa, Continental, Delta, American Airlines, Air Macau and Mandarin Airlines. 

43                  Flying trans‑Tasman involves an FFC in the extension of a flight in circumstances where most of the significant costs have already been incurred.  FFCs operate trans‑Tasman flights to improve aircraft utilisation and because trans‑Tasman traffic adds demand to the FFC’s original flight.  Trans‑Tasman flights allow the airline to service both New Zealand and Australia with the same aircraft. 

44                  Operating the trans‑Tasman leg is economically rational for an FFC if it can generate sufficient traffic on the trans‑Tasmanleg to cover the marginal costs of that additional leg.  The main marginal costs of operating a flight are personnel costs, fuel costs, landing charges and fees for the use of airport facilities.  Therefore, generally it is more profitable for FFCs to be flying trans‑Tasman routes than for their aircraft to remain on the ground in Australia or New Zealand.  Mr John Harrison, General Manager, Network, Revenue Management and Alliances Air New Zealand, gave evidence to this effect, which we accept.

45                  For example, an extension of a flight from Australia to New Zealand will be feasible if there is available a sufficient turn‑around time before the return flight.  Looking at the Australia–Auckland routes, generally an FFC could operate:

·                    Sydney–Auckland–Sydney, if it would have had a nine‑hour lay‑over on the ground in Sydney;

·                    Brisbane–Auckland–Brisbane, if it would have had a nine‑and‑a‑half‑hour lay‑over on the ground in Brisbane; or

·                    Melbourne–Auckland–Melbourne, if it would have had a nine and three‑quarter‑hour lay‑over on the ground in Melbourne.

 

Emirates – a particular case

46                  Emirates is an FFC.  It has fifth freedom rights between Australia and New Zealand and began operating in the trans‑Tasman market in August 2003. 

47                  The applicants submitted that Emirates was unlike other FFCs, having adopted a number of marketing and investment strategies which were said to represent a “new paradigm”, distinct from the traditional FFC model.  There is substance in this submission.

48                  Unlike other FFCs, Emirates has been spending a considerable sum of money in building its brand in Australasia.  For example, Emirates sponsors races at the Melbourne Cup Carnival and the Australian Jockey Carnival in Sydney, the Holden Open golf tournament in Auckland, the Collingwood Australian Rules Football Club and three Australian symphony orchestras. 

49                  Other aspects of Emirates’ strategy also differentiate it from other FFCs.  Dr Michael Tretheway, the Senior Vice President of Marketing and Chief Economist of InterVISTAS Consulting Inc, who was called by the applicants as an expert witness, observed during the hearing:

“[W]e are seeing a new paradigm being demonstrated by Emirates.  In many ways, it is constructing a new FSA without what we refer to as the legacy costs associated with the historical FSAs.  It is a relatively young carrier.  It’s in a different labour management type environment than would be the case in the United States, Canada, Australia, New Zealand and so forth.  So it is starting out with an FSA with a low cost structure.  It has elements of its strategy that certainly are linked to the overall economic development of the United Arab Emirates.  But I think it is the first of a few carriers that are seeing new FSA opportunities in the world … Its low cost structure is also enabling it to offer a very high level of service.”

 

50                  In order to obtain evidence about the position of Emirates, we directed the Commission, pursuant to s 102(6) of the Act, to issue a subpoena requiring Emirates’ Area Manager for Australia, Mr Edward Lim, to give evidence. 

51                  We were told that, as at the time of the hearing, Emirates operated 21 flights per week across the Tasman and had plans to expand those services and add new routes.  Emirates was flying Boeing 777‑300 aircraft on the Melbourne–Auckland and Brisbane–Auckland routes with capacity for 368 passengers in a first, business and economy class configuration.  Emirates was flying Airbus 340‑500 aircraft on the Sydney–Auckland route with capacity for 258 passengers in a first, business and economy class configuration.  Emirates was also planning to fly Airbus 340‑500 aircraft to Christchurch.

52                  We heard from Mr Lim that Emirates expects to acquire [x]% of the business class segment of the trans‑Tasman market and [x]% of the economy class segment of the trans‑Tasman market.  In the first quarter of 2004, Emirates had secured 8% of Sydney–Auckland passengers, 20% of Melbourne–Auckland passengers and 22% of Brisbane–Auckland passengers.

53                  From April 2004, Emirates’ operation of its trans‑Tasman services has been making a positive contribution to its overheads.  It took Emirates only eight months from the commencement of these services to operate them profitably.  Emirates has made significant profits — for the 2003/04 financial year it made approximately US$476 million with a low break‑even load factor of 59% for the same period.  As a network carrier, it generally views its profits on a network‑wide basis rather than on an individual sector basis.  Therefore, if it is profitable overall in its network, it can expand its network, even if new sectors are not initially profitable.

54                  Because of its recent and growing commitment to the trans‑Tasman region, we are satisfied, for reasons which we shall discuss in more detail later, that Emirates has made a substantial investment in the trans‑Tasman region not only by increasing its number of flights, but by its sponsorship of organisations and events in both Australia and New Zealand in a manner which has not been equalled or even remotely approached by any other FFC.  We are also satisfied that these factors demonstrate that Emirates is intending to be a significant presence in the trans‑Tasman region for a number of years.

Background to the airline industry

55                  In order to understand the context of the applications, a number of key concepts relevant to the airline industry may be explained, in particular, revenue management, terminal scheduling and slots, interlining and code‑sharing.

Revenue management

56                  A factor which arises for consideration when examining competitive conduct and behaviour in the airline industry is the manner in which airlines price their available seats and the manner in which they price discriminate, referred to as revenue management.

57                  There are two key aspects to revenue management which airlines employ in the lead up to the departure of a flight in order to maximise the revenue generated by the flight – short‑term capacity variations, and pricing and yield (or inventory) management. 

58                  Short‑term capacity variations are made by airlines when implementing schedules in order to manage capacity on particular flights.  They are made in response to demand for flights which results from circumstances that do not apply for the entire schedule season (for example, the Easter weekend or the Bledisloe Cup).  Short‑term capacity variations can be made in a number of ways, such as by swapping aircraft so that the size of the aircraft operating on a particular flight is changed, or by adding a flight on a particular day or not operating a flight on a particular day.

59                  Pricing and yield management are used to practise price discrimination – that is, maximising revenue by selling the maximum number of seats and ensuring the fare paid by each passenger for a ticket is at, or as close as possible to, the limit of the passenger’s willingness to pay.

60                  An airline typically has a number of fare “buckets” or categories for each flight which are each priced differently and have different service amenities, forward purchase requirements and travel restrictions.  Pricing management involves setting the level of fares for each fare category and determining the conditions to apply in respect of each fare category. 

61                  Farecategoriesbroadly relatetopassengercategories. Generally,airline passengers are grouped into two main categories – price‑sensitive passengers and convenience or time‑sensitive passengers (hereafter referred to as time‑sensitive passengers).  Price‑sensitive passengers usually travel for leisure or to visit friends and relatives (referred to as “VFR” travellers) but would also include some business travellers, usually from small to medium‑sized enterprises (“SMEs”).  As the name suggests, price‑sensitive passengers have a reduced willingness to pay and will generally be flexible with their schedules and forego ticket flexibility in exchange for a lower fare.

62                  Time‑sensitive passengers are usually business people whose fares are paid for under a contract between their employer and the airline, and who require greater flexibility to book later and change their travel plans.  Time‑sensitive passengers have a greater willingness to pay for a ticket in exchange for convenient schedules and a flexible ticket. 

63                  Yield management is the practice of determining how many seats are to be made available on each flight in respect of each particular fare category.  The objective of yield management is to maximise revenue in respect of each flight by maximising the quantity of seats sold and ensuring that all passengers are paying as close to the maximum amount as they are willing to pay for a seat.

64                  As time‑sensitive passengers have a greater willingness to pay for a ticket, an airline is correspondingly willing to bear some additional risk of flying an unsold seat associated with ensuring seat availability close to the preferred time of departure, in order to meet the needs of these higher yielding passengers.  By contrast, the price‑sensitive passenger has a reduced willingness to pay, but the sale of a ticket to this passenger in advance of departure and on restricted conditions enables the airline to manage the risk of flying with an empty seat.

65                  The yield management objective of maximising revenue per flight is pursued by maximising “revenue per ASK” (available seat kilometres for that flight).  Revenue per ASK is essentially the average revenue per seat, expressed in cents, generated by a flight for each kilometre travelled.  It is calculated by multiplying the “yield” for a flight by the “load factor” for that flight, where:

·                    “yield” refers to the average fare paid by each passenger on a flight to fly one kilometre; and

·                    “load factor” is the proportion of seats on a flight that are filled with paying customers. 

 

The capacity load factor is calculated by dividing the flight’s RPKs by its ASKs. 

66                  Securing an acceptable yield through the sale of tickets to high‑yield passengers close to the time of departure is an essential aspect of a network airline recovering its costs.

67                  For each flight, there is an initial allocation of seats by the airline’s revenue management system to each fare category, based on the airline’s forecast of how many tickets it will sell at each available fare price.  Yield management for a flight is a continual process throughout the twelve months prior to departure, with continual adjustments made to the allocation of seats between fare categories. 

68                  In making adjustments, specialist revenue management analysts will have regard to information on competitors’ flights on the relevant route, in particular, each competitor’s available capacity and prices for its various fare categories.  Such a step is part of managing the risk of a flight operating with unsold seats.

69                  Essentially, airline seats are highly perishable and where a flight takes off with an empty seat the airline can never recover that lost revenue.  Therefore, tight inventory management, whereby loads for a flight are continually monitored and seats made available in different fare categories are adjusted accordingly, is extremely important to airlines. 

Terminal scheduling and slot allocation

70                  An issue which arises from time to time when analysing the extent of competition in any given airline market is the extent of access to airports by a new entrant or by an existing participant seeking to increase its number of flights.  If an airport is unable to provide check‑in, boarding, disembarking and baggage handling facilities for an airline, the airline is faced with a barrier to entry or to expansion which inhibits its ability to compete in the relevant market and to be a competitive constraint on existing participants in the market.

71                  Similarly, if an airline is unable to gain access to appropriate “slots” (a slot being a scheduled time of arrival or departure available for allocation by a slot co‑ordinator for aircraft movement on a specified date at a fully coordinated airport), then its ability to compete is impaired.

72                  Although the Gullivers Group suggested that shortages of slots and airport infrastructure in Melbourne, Sydney and Auckland were a “significant problem” for new entrants, there was little evidence put before us that the obtaining of further terminal facilities and slots was a long‑run difficulty for Virgin Blue or Emirates.  Accordingly, we have proceeded on the basis that any intention of Virgin Blue or Emirates to expand their services and flights can be accommodated at any of the relevant airports.  Put shortly, the availability of terminal facilities and slots is not a barrier to entry or expansion in the foreseeable future.

interlining

73                  Interline agreements are common amongst independent airlines.  They give an airline the ability to sell passengers one ticket that covers one or more legs of a trip on the airline’s own aircraft, as well as one or more legs of the same trip on aircraft operated by a different airline.  Such arrangements provide a passenger with the convenience of needing only one ticket and to check‑in once for an entire journey, and also of being able to check luggage through to the final destination without the need to collect it and re‑check it at the points of connection between the two independent carriers. 

code‑sharing

74                  Code‑share agreements involve an airline assigning its own designator code (a code which is allocated by the International Air Transport Association to identify the airline within schedules) to a flight operated by another airline.  The essence of code‑sharing is that two or more airlines can each sell seats on the same flight with each airline using its own designator code and flight number to identify that flight in the schedule.

Regulatory framework

75                  Another important factor in understanding the context of the present applications is to appreciate the regulatory constraints operating on airlines generally.

76                  The international airline industry is highly regulated.  Every international airline market is underpinned by a network of international regulations whereby national governments grant passage and landing rights in exchange for reciprocal rights.  There are a large number of Air Services Agreements (“ASAs”) which regulate international air transport.  ASAs are commonly bilateral agreements between two States granting reciprocal rights to the designated carriers of each country to various freedoms of the air.  The Convention on International Civil Aviation, opened for signature 7 December 1944, 15 UNTS 295 (entered into force 4 April 1947) (commonly known as the “Chicago Convention”) established the principle that each country has exclusive sovereignty over its own air space.  Accordingly, international air transport cannot occur unless it is specifically authorised pursuant to ASAs.

77                  An “open skies” arrangement is one form of ASA, pursuant to which liberal rights are conferred between States.  An open skies arrangement removes most traffic and access constraints.  However, restrictions often remain on foreign ownership and control of designated airlines and on the ability to operate domestic flights in the other country.

78                  Prior to the late 1970s, governments imposed regulatory restrictions on the airline industry to protect their national airlines.  Since that period, the Australian and New Zealand Governments have substantially liberalised their aviation policies and have granted a large number of foreign airlines unlimited rights to commence services on trans‑Tasman routes.  (Although we note that the Gullivers Group pointed to the Australian Government’s decision in September 2003 to refuse Singapore Airlines access to the Australia–Los Angeles routes as evidence that the applicants do not compete in “truly open markets”).

79                  In 1996 arrangements between Australia and New Zealand, known as the Single Aviation Market (“SAM”), came into operation which effectively liberalised access for all qualified Australian and New Zealand airlines.  The SAM arrangements have subsequently been expanded in an open skies ASA between Australia and New Zealand which took effect in late 2000 and was formalised in 2002.  The SAM arrangements, as they presently stand, effectively create a single aviation market across Australia and New Zealand.  Any New Zealand or Australian designated airline or SAM airline (effectively an Australian or New Zealand based and controlled airline) may operate within and between Australia and New Zealand without restriction.  The effect of the SAM arrangements is that, inter alia, Air New Zealand is permitted to operate domestic services within Australia and Qantas is permitted to operate domestic services within New Zealand.  Passenger airlines currently designated under the open skies ASA are Qantas, Air New Zealand and Freedom Air.  Asian Express (a freight operator) and Virgin Blue operate as SAM airlines.

80                  Most of today’s national carriers, including Australia’s national carrier Qantas, were originally government–owned airlines and commenced operations prior to the deregulation and liberalisation of the airline industry.

Airline Models:  The FSA v the LCC

81                  Finally, in order to understand the competitive environment in which the applicants operate, now and in the future, a further explanation of two predominant airline models is necessary – the FSA and the LCC.  In the Australasian context, the applicants are examples of FSAs.  Jetstar, Freedom Air and Virgin Blue are examples of LCCs. 

82                  We received detailed evidence regarding FSAs and LCCs.  In particular, Dr Tretheway provided us with an extensive overview of the background to the FSA and LCC models and summarised the existing econometric evidence of the impact on fares in markets where LCCs competed with FSAs.  He was in fact the only expert witness to model the impact of an LCC in the Australian market.  Dr Tretheway undertook an empirical literature review and arranged for further research and econometric analysis of the impact of LCCs on average fares. 

83                  In brief, an FSA model promotes network depth (relating to the frequency and capacity of flights offered), network breadth (relating to geographic reach), and connectivity (relating to the ability of a passenger to connect to another service in order to reach an ultimate destination point).  An FSA also enhances its product quality in order to distinguish its product from that of its competitors.  This is contrary to the LCC model which is primarily focused on minimising cost. 

84                  A number of features of FSAs are predicated on the need to offer network depth, network breadth and connectivity.  In particular:

·                    a range of aircraft types is required;

·                    information technology systems and additional staffing are required to enable ticketing and checking through of baggage across a number of different services, to manage flight schedules to maintain maximum flight connections and to manage pricing and revenue allocation;

·                    an FSA commonly operates a “hub and spoke” network structure, which facilitates the establishment of a “city‑presence” in the hub through the high frequency of inbound and outbound flights operated at the hub city;

·                    alliances with other airlines may be utilised to expand network depth and breadth;

·                    an FSA will assess the profitability and on‑going viability of a route on a network‑wide basis, having regard not only to the revenue earned on that particular route but also to the revenue earned due to traffic feed on other routes “before” and “beyond” the first‑mentioned route.  An FSA may operate a loss‑making route due to the significance of that route in generating “before” revenue or “beyond” revenue respectively. 

 

85                  In addition to carrying passengers from point to point, FSAs also typically offer a number of services, including:

·                    business class on most domestic flights;

·                    first and business classes on most international flights;

·                    in‑flight catering and entertainment;

·                    airport lounges;

·                    club membership;

·                    valet parking;

·                    a frequent flyer or other loyalty program.

86                  Such features of an FSA model necessarily involve costs additional to the costs involved in carrying passengers from point to point as is the case with an LCC.  This becomes a significant factor when one considers the competitive issues which arise as between FSAs and LCCs.

87                  The FSA model is typically attractive to time‑sensitive passengers who are looking for the ability to travel at particular times and at short notice.  However, an FSA also needs to be attractive to price‑sensitive passengers, as commercially viable load factors (that is, the proportion of seats on a flight that are filled with paying passengers) require a combination of both categories of passenger.

88                  In recent times, FSAs have struggled to earn their cost of capital over the longer term due to a combination of economic conditions, recent exogenous shocks experienced by the airline industry such as the outbreak of the SARS epidemic and the September 11 tragedy, and, significantly, the emergence of LCCs.

89                  The United States saw the advent of the first LCC in the 1970s when Southwest Airlines commenced operations.  From the mid‑1990s there has been a rapid acceleration in the number of LCCs commencing operation throughout the world, including Frontier Airlines,WestJet, EasyJet, Virgin Express, Skymark Airlines, Deutsche BA, Air Asia, JetBlue, Kulula, Germanwings,Independence Air,Freedom Air,CanJet,GOL,Valuair,JetStarandVirgin Blue,amongst others.  We were also told that Virgin USA is expected to commence operations in the United States in 2005. 

90                  The LCC model typically has a number of features:

·                    the operation of a point to point service with no, or limited, connectivity with other flights, which in turn means that:

o                    the primary objective of scheduling is to minimise aircraft turn‑around time on the ground so as to maximise aircraft utilisation (the provision of convenient connections to passengers is not an objective of LCC scheduling);

o                    the LCC does not provide a seamless baggage checking system between interconnecting flights;

o                    the LCC does not have interline or code‑share arrangements with other airlines, either at all or at least to the same extent as FSAs;

·                    a single class aircraft configuration and smaller seat pitch (“pitch” being the distance between seats);

·                    a simple aircraft fleet (usually using models from a single aircraft family) is operated on all routes;

·                    “user pays” airport lounges, in‑flight catering and in‑flight services (if these services are provided at all);

·                    no frequent flyer or loyalty program (or at least, not one that is the equivalent of an FSA program);

·                    services primarily on “short‑haul routes” of less than five hours;

·                    the most up‑to‑date technology, including aircraft and information technology systems;

·                    a high level of outsourcing of maintenance and other operations;

·                    low‑cost distribution systems (such as the internet);

·                    a high proportion of direct ticket sales;

·                    utilisation of un‑congested secondary airports;

·                    no carrying of freight;

·                    a distinct corporate culture, which may include equity participation by staff;

·                    a different and simpler form of price discrimination, based primarily on time of purchase rather than traditional fare restrictions. 

 

91                  It is these features that enable an LCC to be competitive with FSAs which have greater network coverage.  As a “greenfields” operation, an LCC is generally able to establish a lower cost base than an FSA.  Unlike most FSAs, LCCs are not burdened with inefficient processes and structures that incur legacy costs, especially in labour agreements, and can instead establish the most efficient and cost‑effective means of operating their services.  By using newer aircraft, LCCs reduce maintenance and operating costs.  By not providing seamless baggage check‑through, LCCs are able to avoid the costs of the systems required to provide that service.  By not offering business class and having a smaller seat pitch, LCCs are able to maximise the number of seats on aircraft and minimise costs per seat.  By using a single aircraft family or a simplified aircraft fleet, LCCs can reduce maintenance costs in terms of both training and the required spare parts inventory and can also reduce flight crew training costs.  Further, by emphasising direct ticket sales (such as internet sales), LCCs are not reliant on third‑party distributors with their associated higher distribution costs. 

Impact of the LCC Model on the Airline Industry

92                  The emergence of the LCC model has altered permanently the competitive dynamics of the airline industry.  It has created a new competitive dimension for FSAs in which they have to re‑think business plans and their responses to the actions of LCCs in the marketplace. 

93                  Whilst the Gullivers Group in particular argued that the competitive challenges currently faced by the applicants were partially attributable to economic conditions, exogenous events such as the SARS epidemic and the September 11 tragedy, and inefficient operations, all parties agreed that the introduction of the LCC model in Australasia has had a significant impact on the way in which airlines do business now and will continue to have an impact on how they operate in the future.

94                  The significance of the LCC model and its impact on the FSA model was rather dramatically explained by Professor Michael Levine, an Adjunct Professor of Law at Yale University who acts as a consultant to airlines and governments and who was called by the Commission as an expert witness.  In a recent keynote address he delivered at a seminar in Washington DC entitled “Understanding airline strategic choices: How much do legacy carriers have to change to survive?” (paper presented at an Airline Economics Seminar at the Embry‑RiddleAeronauticalUniversity,Washington DC,USA,7 April2004),Professor Levinepainted a gloomy picture of the future for network carriers with legacy costs.  He suggested that unless they could cut their costs dramatically, such carriers would become obsolete, with bankruptcy a likely outcome.  We note that such legacy costs are typically associated with airlines operating under the FSA model.

95                  When looking to the North American and European experience for guidance, the distinctive features of the Australasian airline industry – such as its smaller population and more limited opportunities to utilise secondary airports and develop new routes – must be borne in mind.  Nevertheless, the overseas experience is instructive and in fact was a major focus of the expert evidence presented to us.

96                  LCCs can offer lower fares as a result of their substantially lower cost base compared to an FSA.  Because the lower cost structure of the LCC gives it the capacity to offer lower average fares per flight than an FSA, the entry of an LCC into a market will generally reduce average fares in that market.  Overseas, and now local, experience shows that the result of the entry of an LCC into a market is an increased emphasis in the market on price competition, rather than on service offerings. 

97                  Lower fares in turn generally stimulate passenger demand.  Thus, the success of the LCC model is dependent on its low fares both winning existing passengers and market share from the incumbent FSAs, as well as stimulating new passenger demand.  As a result, LCCs tend to experience rapid growth and expansion of market share. 

98                  The amount of demand stimulation will depend on the price elasticity of market demand.  The entry of an LCC and its lower fare offering may increase, decrease or not change market revenue, depending on the price elasticity of demand.  For example, leisure travellers are typically price‑sensitive.  Thus on predominantly leisure‑oriented routes, the entry of an LCC is more likely to result in a substantial increase in the number of flights demanded by passengers and an increase in market revenue.  This may not be the case on routes more commonly frequented by business passengers, whose top priority is not price and who may not feel that the product offering of an LCC in terms of flight frequency, quality and range of service offerings are readily substitutable for those of an FSA.

99                  As an LCC operates point‑to‑point services, LCCs are able to cherry pick the most profitable and busiest of an incumbent FSA’s routes.  This, combined with the lower fares of the LCC, enables the LCC to win market share from the incumbent FSA.

100               An FSA is able to compete with an LCC by providing the benefits of an FSA at a price point which, although typically higher than that of the LCC, is regarded by the passenger as warranted because of the additional benefits.  In the words of Mr Paul Edwards, Executive General Manager, Fleet, Network and Alliances at Qantas:

“LCC competition requires FSAs to focus on price and in so doing to focus on reducing their costs.  The extra services offered by FSAs must be closely aligned to the benefit perceived by the passenger to be gained for the extra cost of FSA services.  An LCC imposes a discipline on competing FSAs.  It requires FSAs competing in the same market to focus primarily on the price standard set by the LCC rather than, as more traditionally was the case, competitive service offerings of the respective FSAs”. 

 

101               All parties agreed that FSAs must meet the challenge of LCC entry, with the lower fares that challenge requires, by maintaining network depth and breadth, lowering costs, and closely aligning product offerings with the benefits valued by passengers.  However, the necessary means by which FSAs such as the applicants are to achieve these imperatives were the subject of much contention.

the alliance

102               The applicants contended that the global emergence of a sustainable LCC model has produced such fundamental changes to the structure of airline markets and competition in those markets that the formation of alliances between network carriers which operate as FSAs is now necessary in order for FSAs to remain competitive.  Their response to LCC entry in Australasia has been to propose an alliance which coordinates a number of their activities (“the Alliance”). 

103               In order to give effect to the Alliance, the applicants have entered into a series of agreements and deeds, expressed to be subject to authorisation from Australian and New Zealand competition authorities.  Certain of these agreements are the subject of the present applications, as set out below.

The Equity Proposal

104               The first agreement, referred to as the “Equity Proposal”, provides for Qantas ultimately to acquire up to 22.5% of the voting equity in Air New Zealand.  To that end, the applicants entered into a Subscription Agreement dated 25 November 2002 pursuant to which Qantas is to subscribe for, and Air New Zealand is to issue, redeemable convertible notes equivalent to 4.99% of the equity in Air New Zealand on receipt of certain shareholder approval.  Such approval was obtained on 18 December 2002.

105               On receipt of authorisation by the NZCC and the Commission, and with the consent of Air New Zealand shareholders, the convertible notes convert to ordinary shares and Qantas is to subscribe for such number of Air New Zealand ordinary shares as would result in Qantas holding a total of 15% of the equity of Air New Zealand.  Qantas would then, or at the end of a three‑year period would, subscribe for Air New Zealand equity securities that would result in Qantas holding 22.5% of the voting equity in Air New Zealand.  Qantas will be entitled to maintain this level of shareholding under “top up” arrangements with Air New Zealand.

106               It can be seen from the general description of the Equity Proposal that its terms appear to fall within s 50 of the Act which provides that:

(1)       A corporation must not directly or indirectly:

            (a)        acquire shares in the capital of a body corporate; or

            (b)        acquire any assets of a person;

if the acquisition would have the effect, or be likely to have the effect, of substantially lessening competition in a market.

 

107               Accordingly, authorisation is sought in order to invoke the protection of s 88(9)(c) of the Act so that s 50 does not operate to prevent Qantas’ acquisition of shares in Air New Zealand.

The Strategic Alliance Agreement

108               The second agreement, dated 25 November 2002 and referred to as the “Strategic Alliance Agreement”, provides for the applicants to co‑ordinate their network operations, fares and schedules in relation to all Air New Zealand‑operated flights, all domestic New Zealand flights operated by Qantas, and Qantas international flights arriving in, departing from, or transiting through, New Zealand (defined as the “Joint Airline Operation Networks” or “JAO Networks”).  It relates to passenger and freight services and in it, the applicants agree not to compete with each other on other routes leaving from, or arriving in, Australia or New Zealand. 

109               The JAO Networks will cover the sectors flown by Air New Zealand and its affiliates (excluding sectors flown by Freedom Air) within New Zealand and internationally, including flights on which Air New Zealand code‑shares.  The JAO Networks will also cover all domestic New Zealand sectors flown by Qantas and its affiliates and all international sectors flown by Qantas and its affiliates to or from New Zealand, including flights on which Qantas code‑shares.  This arrangement will be commercially managed by Air New Zealand, subject to advice and direction from a Strategic Alliance Advisory Group which will include representatives of both airlines.  Day to day flying operations will remain the responsibility of each airline.

110               The Strategic Alliance Agreement provides that the applicants will co‑ordinate the following services and activities:

·                    all aspects of the pricing of passenger and freight services on the JAO Networks and on the sectors operated by Freedom Air, including setting passenger fares and freight rates, the level of rebates, incentives, promotions and discounts offered to passengers, the level of service fees, development of new fare products, holiday package airfares, the levels of standard commissions and agency incentives, and joint tendering for corporate and government accounts;

·                    procedures for pricing and inventory management in order to facilitate the co‑ordination, and the setting and marketing, of fares and rates for passenger and freight services on the JAO Networks and the sectors operated by Freedom Air;

·                    scheduling, routings, capacity planning, frequencies, aircraft types, connection requirements and range of times for any services provided by the applicants on the JAO Networks, and scheduling, routings and capacity planning on sectors operated by Freedom Air; and

·                    the exchange of information relating to the JAO Networks and the sectors operated by Freedom Air between the applicants, including schedules, financial information, pricing, yields, seat availability, freight capacity availability, sales and other information.

 

111               There are also a number of provisions recording the following agreements:

·                    Qantas will have the right to code‑share on all Air New Zealand flights and Air New Zealand will have the right to code‑share on all Qantas flights in the JAO Networks and to code‑share on those other Qantas flights that reasonably connect to any flight on the JAO Networks;

·                    the applicants will agree to enter into special pro rate agreements with respect to their operations on the JAO Networks;

·                    QH Tours Ltd will take all reasonable steps to maximise the provision of new tourism products which utilise the JAO Networks as part of itineraries offered by QH Tours Ltd, including the promotion of New Zealand and Australia as a joint destination;

·                    the applicants agree to co‑ordinate their freight operations;

·                    the applicants agree to co‑ordinate their sales and marketing functions relating to the JAO Networks, including operating joint offices and joint retail sales outlets, co‑locating certain facilities and staff, appointing common general sales agents in countries other than Australia and New Zealand, conducting joint promotions, offering co‑ordinated incentive programmes for agents, resellers and passengers, providing shared access to airport lounges, ground services and freight handling services, and providing equivalent customer services to each other’s passengers where the other party is unable to offer customer service facilities;

·                    the applicants agree to enter into a frequent flyer agreement (which enables their frequent flyer program members to redeem points on all the applicants’ flights on the JAO Networks, all Freedom Air flights and all Qantas flights on its non‑JAO Network sectors, and provides for no preferential access to redemption seat allocation as between those members), while Qantas and Air New Zealand’s frequent flyer programs shall remain separate and autonomous;

·                    the applicants agree to give priority to each other in the display of each other’s flights (for both JAO and non‑JAO Networks) to the greatest extent possible in their respective reservations systems; and

·                    Air New Zealand is obliged to procure Freedom Air’s co‑operation in respect of the co‑ordination of several of the services and activities described above.

 

112               The Strategic Alliance Agreement provides for equitable profit distribution in accordance with a specified formula. 

113               The Strategic Alliance Agreement also imposes a number of restrictive covenants which prevent the applicants from competing with one another in respect of flights departing from, or arriving at, an airport in Australia or New Zealand and restricts their ability to compete with one another on any sectors that do not arrive at, or depart from, Australia or New Zealand.  Hence, under the Strategic Alliance Agreement:

·                    Qantas and its affiliates must not operate on any sectors which depart from or arrive at an airport in New Zealand, other than by flying as part of the JAO Networks;

·                    Air New Zealand must not, and must procure that Freedom Air and its affiliates do not, operate on any non‑trans‑Tasman sectors which depart from or arrive at an airport in Australia (except that Air New Zealand shall be permitted to continue to operate its Sydney–Los Angeles sector.  However, we note that Air New Zealand announced the suspension of its direct Sydney–Los Angeles flights on 10 February 2003, effective from 28 April 2003);

·                    Air New Zealand (including Freedom Air) and Qantas may operate at any time on any sector that does not arrive at, or depart from, New Zealand or Australia.  However, before commencing to do so on a sector where the other party is already operating, the party wishing to commence operations must not do so without first discussing its intentions with the Strategic Alliance Advisory Group;

·                    neither Qantas nor Air New Zealand (including Freedom Air) shall take any step in relation to any third‑party airline (including an airline in which Qantas or Air New Zealand has a shareholding but not effective control, or with which they have an alliance agreement) which would encourage or assist that airline to compete against the JAO Networks or operate in a manner contrary to the interests of the Alliance.

 

114               In addition to setting out a scheme covering the JAO Networks, the Strategic Alliance Agreement also makes provision for co‑operation in relation to non‑JAO Networks, that is, the applicants’ flights that are not flights into, within, or out of New Zealand.  Where they consider it efficient and beneficial to do so, the applicants can co‑ordinate scheduling and pricing and co‑operate with respect to such other services, businesses or operations as they consider appropriate in respect of non‑JAO Networks.  This co‑operation in relation to non‑JAO Networks includes:

·                    developing and implementing further arrangements and structures designed to deliver additional benefits to each other’s passengers and frequent flyer program members;

·                    developing the in‑flight experience for passengers, including the sharing of information technology, plans and know‑how and the co‑ordination and convergence of their in‑flight products with respect to safety, comfort, entertainment, catering and customer service.

 

115               The Strategic Alliance Agreement is expressed to be for a term of not less than five years but contains provisions for earlier termination.

The Cooperation Agreement

116               The third agreement, dated 20 December 2002 and referred to as the “Cooperation Agreement”, provides that Qantas, Air New Zealand and Air Pacific will agree to co‑operate in relation to such aspects (including pricing and scheduling) of their services, businesses or operations as they consider appropriate.  In substance, the Cooperation Agreement covers areas which are not included in the JAO Networks and so have not been covered by the Strategic Alliance Agreement.  It is effectively an agreement to agree, should the parties consider it appropriate at a future time.  It also provides for third parties to be invited to become parties to the Agreement and it terminates upon the termination of the Strategic Alliance Agreement.

117               As can be seen from the general description of the Strategic Alliance Agreement and the Cooperation Agreement, a number of their provisions appear to fall within s 45 of the Act, which provides that:

(2)       A corporation shall not:

(a)        make a contract or arrangement, or arrive at an understanding, if:

(i)         the proposed contract, arrangement or understanding contains an exclusionary provision; or

(ii)        a provision of the proposed contract, arrangement or understanding has the purpose, or would have or be likely to have the effect, of substantially lessening competition; or

 

(b)        give effect to a provision of a contract, arrangement or understanding, whether the contract or arrangement was made, or the understanding was arrived at, before or after the commencement of this section, if that provision:

(i)         is an exclusionary provision; or

(ii)       has the purpose, or has or is likely to have the effect, of substantially lessening competition.

 

118               Therefore, authorisation is sought in order to invoke the protection of ss 88(1)(c), (d) and (e) of the Act so that s 45 does not operate to prevent Qantas, Air New Zealand or Air Pacific from entering into or giving effect to the Strategic Alliance Agreement and the Cooperation Agreement.

The Commission’s determination

119               The applicants sought authorisation from the Commission for these agreements which give effect to the Alliance.  On 9 September 2003 the Commission made a determination declining to authorise the agreements.

120               In order to assess public benefit and detriment, the Commission had to consider the likely situation if the Alliance were granted authorisation and implemented (referred to as “the factual”), and the likely situation if the Alliance were not granted authorisation and so were not implemented (referred to as “the counterfactual”).  The applicants had submitted before the Commission that in the counterfactual a more aggressive level of competition and increased capacity across the applicants’ Australasian networks would occur, leading to Qantas increasing capacity on routes on which the two airlines currently competed so that a capacity war would break out which would possibly lead to the demise of Air New Zealand.  The Commission rejected this counterfactual, instead concluding that, absent the Alliance, the applicants were likely to exhibit a measured approach to growing capacity in the trans‑Tasman market, reflecting natural growth and developments in the market.

121               The Commission found that material anti‑competitive detriment would result from the Alliance in a number of the relevant markets defined by it for the purposes of its assessment.  It took the view that the Alliance was likely to lead to an increase in fares and decreased capacity and quality of services on routes involving Australia where both of the applicants had a presence. 

122               In summary, the Commission found that the Alliance would result in significant anti‑competitive detriment:

·                    in the trans‑Tasman air passenger services market by substantially reducing competition between network carriers and detrimentally impacting on price, service, product choice and innovation;

·                    in the trans‑Tasman airfreight services market by exacerbating pressure on freight rates in an environment of diminishing freight capacity;

·                    in the Australian domestic air passenger services market by enhancing the market power of Qantas and acting as a barrier to entry to new entrants;

·                    in the Australia–North America air passenger services market by deterring Air New Zealand from re‑entering that market;

·                    in the Australia–North America airfreight market by giving rise to slightly higher charges and lower capacity in the medium‑term where the applicants were the primary providers;and

·                    in the sale of air travel through the joint setting of commissions payable to travel agents for travel sold in Australia which falls within the coverage of the Alliance.

 

123               The Commission considered the competitive significance to the Alliance of Virgin Blue, concluding that it was likely that Virgin Blue would establish itself as a permanent component of the trans‑Tasman market over time, but remaining sceptical as to whether Virgin Blue would impose a significant competitive constraint in that market.  The Commission also considered the impact of Emirates and concluded that it would be premature to recognise Emirates as providing a significant, long‑term competitive constraint on the Alliance, as it thought that Emirates’ impact remained to be seen and Emirates could easily and rapidly exit the market.

124               The applicants had submitted before the Commission that a number of public benefits would flow from the Alliance.  In relation to each category of benefit, the Commission rejected the likelihood of such benefits eventuating or otherwise doubted the magnitude of the claimed benefits. 

125               In relation to the claimed cost efficiency savings, the Commission accepted that this benefit would result from the Alliance but had substantial reservations about the estimates provided.  In relation to the public benefits arising from scheduling changes, the Commission concluded that such benefits were likely to be minor and in fact, schedule efficiency adjustments could result in services being removed.  In relation to the claimed new direct services, the Commission thought that these might not be commercially viable and so may be withdrawn and that their attractiveness to both existing indirect passengers and new passengers would be reduced due to the low frequencies of the services.  In relation to the claimed increase in tourism, the Commission doubted this would eventuate in an environment of higher fares and reduced capacity that would also arise and concluded that any public benefits from tourism would be marginal.  In relation to the proposed additional freight services, the Commission thought that these were just as likely under the counterfactual as the factual, and that these services were unlikely to be economic and so likely to be withdrawn.  In relation to the claimed increased global competitiveness of Qantas, the Commission thought that this would only give rise to marginal benefits given Qantas’ strong position relative to other international airlines and the small contribution that Air New Zealand would bring to the Alliance.  Finally, the Commission was not satisfied that Australia’s national interest was served by the Alliance proceeding.

126               The Commission concluded that the Alliance would not give rise to public benefits of any significance. 

127               With respect to the balancing of anti‑competitive detriment and public benefits, the Commission concluded at [15.6]‑[15.7] of its determination that:

“[T]he highly anti‑competitive effects of the [Alliance] identified by the Commission would, for the foreseeable future, significantly outweigh the low public benefits flowing from the [Alliance] accepted by the Commission.

 

The Commission is of the view that the gap between the anti‑competitive detriments and public benefits likely to flow from the [Alliance], in comparison with the situation likely to arise without the [Alliance], is substantial.”

 

128               However, the Commission noted that its determination was being made in the context of a highly dynamic and rapidly developing airline industry.  It recognised that, as a result, it might potentially reach a different conclusion on a later occasion, stating at [12.294] of its determination:

“[This] assessment of anti‑competitive detriment has been made at a time when the aviation industry and individual markets are subject to rapid change and development.  The Commission recognises that if this rate of change should continue it is possible that the Commission could, on a later occasion, reach a different conclusion as to the level of anti‑competitive detriment in a market such as the trans‑Tasman market.”

 

Evidentiary changes since the Commission’s determination

129               As foreshadowed by the Commission, the trans‑Tasman market has undergone considerable change since the Commission’s determination was delivered.  The Commission’s determination was delivered on 9 September 2003.  The hearing before us commenced on 3 May 2004 and concluded on 28 May 2004, subsequent to which further material was made available to us.  This meant that we have enjoyed the benefit of observing the subsequent developments in the competitive interaction between the airlines operating in the trans‑Tasman market which were the subject of speculation only at the time of the Commission’s determination.  We have also had the benefit of considerable empirical, lay and expert evidence that was not available to the Commission.

130               The evidentiary changes between the Commission’s determination and the hearing before us generally fall into two categories: first, changes in the competitive environment facing the applicants, particularly on trans‑Tasman routes, as a result of significant market developments occurring subsequent to the Commission’s determination; second, changes in the opinions expressed, and evidence provided, by third parties in respect of the effects of the Alliance.

131               One of the most significant market developments that has occurred since the Commission’s determination is the entry of Pacific Blue onto a number of trans‑Tasman routes, beginning with the commencement of flights on the Brisbane–Christchurch route on 29 January 2004, and the subsequent commencement of flights between Melbourne and Christchurch on 4 March 2004 and between Sydney and each of Wellington and Christchurch on 10 March 2004.  The expansion of Emirates on trans‑Tasman routes and the raising of its profile, particularly in New Zealand, since it commenced trans‑Tasman services in August 2003 has also been a significant development.

132               While the Commission recognised in its determination that it was likely that Virgin Blue would enter trans‑Tasman routes and establish a permanent presence on them, that entry had not occurred at the time of the Commission’s determination.  By contrast, we have had the benefit of evidence relating to the first sevenmonths of Virgin Blue’s trans‑Tasman operations, including, for example, evidence of its success in capturing passenger share on each of the trans‑Tasman routes on which it operates and evidence of its future plans for expansion.

133               Similarly, at the time of the Commission’s determination, Emirates had been operating on trans‑Tasman routes for approximately one month.  We have had the benefit of evidence relating to approximately twelve months of Emirates’ trans‑Tasman operations together with evidence of its expansion plans for the region.  We have also had the benefit of hearing oral evidence from Emirates’ Area Manager for Australia, Mr Lim.

134               As a result, we were in the fortunate position of having far greater evidence than was available to the Commission regarding the likely future presence of Virgin Blue and Emirates on trans‑Tasman routes and the extent to which they may impose a competitive constraint on the applicants in the future.

135               We were also presented with opinions and evidence by some parties with respect to the effects of the Alliance that had altered since the time of the hearing before the Commission.  For example, before the Commission, Virgin Blue’s position was that it would only be in a position to impose an effective competitive constraint on the applicants if undertakings were given by the applicants in relation to their strategic use of capacity and in relation to barriers to entry in the form of access to airport facilities.  By contrast, in the proceeding before us, Virgin Blue’s position appeared to be that it was in a strong position to enter quickly or expand on trans‑Tasman routes and that such undertakings were no longer essential.

The hearing before the Tribunal

136               This proceeding is a hearing de novo.  It does not involve an analysis of the Commission’s determination for the purpose of identifying error and the applicants are not required to demonstrate any error on the part of the Commission.  Rather, we must reach our own conclusions on whether the relevant tests for authorisation are satisfied on the evidence put before us, bearing in mind that there is no presumption in favour of the findings of the Commission:  QCMA at 487; Re Herald&Weekly Times Ltd onbehalf of theMembers of the Media Council of Australia (supra) at 295; Re Rural Traders Co‑operative (WA) Ltd (1979) 37 FLR 244 at 260.

137               Thus, we note that this proceeding differs from the appeal brought by the applicants before the High Court of New Zealand.  In the New Zealand proceeding, the appeal was not by way of a hearing de novo.  The task for the High Court of New Zealand was to decide whether the NZCC had erred in a material way in reaching its decision.  That task was significantly different to the task we faced in considering all relevant evidence afresh without the need to assess the Commission’s determination for error.

138               The applicants sought the following determination from the Tribunal:

“(a)     that authorisation be granted for the acquisition by Qantas of ordinary shares comprising up to a 22.5% voting equity interest in [Air New Zealand], as set out in the Subscription Agreement between Qantas and [Air New Zealand] dated 25 November 2002;

 

(b)               that authorisation be granted for a period of not less than five years for the implementation of the Strategic Alliance Agreement dated 25 November 2002 between Qantas and [Air New Zealand] and all Related Documents (collectively, the Strategic Alliance Proposal); and

 

(c)               that authorisation be granted for the implementation of a Cooperation Agreementdated20 December2002betweenQantas,[Air New Zealand]and Air Pacific Limited.”

 

Relevant provisions of the Act

139               The applicants are seeking authorisation of the Equity Proposal under s 88(9) of the Act.  Authorisation of the Strategic Alliance Agreement and the Cooperation Agreement is sought under s 88(1) of the Act.

140               The applicable tests for authorisation pursuant to ss 88(1) and (9) are set out in ss 90(6)‑(9) of the Act in the following terms:

“90(6)The Commission shall not make a determination granting an authorization under subsection 88(1) … in respect of a provision (not being a provision that is or may be an exclusionary provision) of a proposed contract, arrangement or understanding, in respect of a proposed covenant, or in respect of proposed conduct (other than conduct to which subsection 47(6) or (7) applies), unless it is satisfied in all the circumstances that the provision of the proposed contract, arrangement or understanding, the proposed covenant, or the proposed conduct, as the case may be, would result, or be likely to result, in a benefit to the public and that that benefit would outweigh the detriment to the public constituted by any lessening of competition that would result, or be likely to result, if:

 

(a)          the proposed contract or arrangement were made, or the proposed understanding were arrived at, and the provision concerned were given effect to;

 

(b)     the proposed covenant were given, and were complied with; or

(c)          the proposed conduct were engaged in;

as the case may be.

(7)       The Commission shall not make a determination granting an authorization under subsection 88(1) … in respect of a provision (not being a provision that is or may be an exclusionary provision) of a contract, arrangement or understanding or, in respect of a covenant, unless it is satisfied in all the circumstances that the provision of the contract, arrangement or understanding, or the covenant, as the case may be, has resulted, or is likely to result, in a benefit to the public and that that benefit outweighs or would outweigh the detriment to the public constituted by any lessening of competition that has resulted, or is likely to result, from giving effect to the provision or complying with the covenant.

 

(8)       The Commission shall not:

(a)       make a determination granting:

(i)        an authorization under subsection 88(1) in respect of a provision of a proposed contract, arrangement or understanding that is or may be an exclusionary provision; …

                                …

unless it is satisfied in all the circumstances that the proposed provision or the proposed conduct would result, or be likely to result, in such a benefit to the public that the proposed contract or arrangement should be allowed to be made, the proposed understanding should be allowed to be arrived at, or the proposed conduct should be allowed to take place, as the case may be; or

 

(b)        make a determination granting an authorization under subsection 88(1) in respect of a provision of a contract, arrangement or understanding that is or may be an exclusionary provision unless it is satisfied in all the circumstances that the provision has resulted, or is likely to result, in such a benefit to the public that the contract, arrangement or understanding should be allowed to be given effect to.

 

(9)       The Commission shall not make a determination granting an authorization under subsection 88(9) in respect of a proposed acquisition of shares in the capital of a body corporate or of assets of a person or in respect of the acquisition of a controlling interest in a body corporate within the meaning of section 50A unless it is satisfied in all the circumstances that the proposed acquisition would result, or be likely to result, in such a benefit to the public that the acquisition should be allowed to take place.

 

141               Section 90(9A) of the Act provides that, in determining what amounts to a “benefit to the public” for the purposes of s 90(9), regard must be had to the following as benefits to the public (in addition to any other benefits to the public that may exist):

·                    a significant increase in the real value of exports (which was not in issue in the proceeding);

·                    a significant substitution of domestic products for imported goods (which was not in issue in the proceeding); and

·                    all other relevant matters that relate to the international competitiveness of any Australian industry.

 

142               On review of a determination by the Commission regarding an application for authorisation, the above provisions apply to the Tribunal in the same manner as they apply to the Commission, pursuant to s 101(2) of the Act.  (We note that s 101(2) does not specifically refer to s 90(9A) as applying to the Tribunal.  However, given that s 90(9A) merely expands upon s 90(9), and s 90(9) applies to the Tribunal, we consider that the Tribunal should take s 90(9A) into account in carrying out its functions under s 90(9)).

143               We note that in assessing an application for authorisation, we are not required to ask whether the parties need to seek authorisation, that is, whether the proposed agreement or acquisition would, if carried into effect, breach the relevant sections of the Act:  Re Rural Traders Co‑operative (WA) Ltd (supra) at 247; Re G & M Stephens Cartage Contractors Pty Ltd on Behalf of the Members of the Concrete Carters Association (Vic) (1977) 16 ALR 387 at 434.  Instead, once an application for authorisation has been made, it is presumed that authorisation is necessary and our task is to assess only whether authorisation should be granted on the public benefit grounds set out in s 90 of the Act.

Relevant test to be applied

144               Sections 90(6)‑(9) prescribe the test for authorisation in somewhat different language for:

·                    authorisation of a provision that may substantially lessen competition – in which case ss 90(6) and (7) of the Act provide that authorisation must not be granted under s 88(1) unless the Tribunal is satisfied that the provision would result, or be likely to result, in a benefit to the public and that that benefit would outweigh the detriment to the public constituted by any lessening of competition that would be likely to result; and

·                    authorisation of an exclusionary provision or an acquisition of shares that may substantially lessen competition – in which case ss 90(8) and (9) provide that authorisation must not be granted under ss 88(1) or (9) unless the Tribunal is satisfied that the proposed exclusionary provision or proposed acquisition would be likely to result in such a benefit to the public that the exclusionary provision or the share acquisition should be allowed. 

 

145               In contrast to ss 90(6) and (7), ss 90(8) and (9) do not explicitly require a weighing of public benefits against the detriment constituted by any lessening of competition.

146               In a number of decisions, the Tribunal has previously expressed the view that the test for authorisation is the same regardless of whether the provisions under consideration constitute a contract, arrangement or understanding governed by ss 90(6) or (7), or an exclusionary provision or acquisition governed by ss 90(8) or (9): Re Media Council of Australia (No 2) (1987) 88 FLR 1 at 9; Re 7‑Eleven Stores Pty Ltd (1994) ATPR 41‑357 at 42,654.

147               This traditional view was challenged in the recent decision of Re Australian Competition and Consumer Commission by Australian Association of Pathology Practices Inc (2004) 206 ALR 271 at [86]–[93] in which the Tribunal observed that, while a weighing of benefit and detriment is an element of both tests, it does not follow that the two tests are precisely the same in all circumstances.  The Tribunal there observed at [93] that while the test under ss 90(6) and (7) is confined to a consideration of detriment arising from a lessening of competition, the test under ss 90(8) and (9) may not be so confined and could include a broader category of detriment. 

148               The correctness of this broader approach to detriment under ss 90(8) and (9) was raised in Re EFTPOS Interchange Fees Agreement (2004) ATPR 41‑999 at [25], but the issue was not finally determined by the Tribunal.  Similarly, in the present proceeding no detriment other than detriment arising from a lessening of competition has been raised.  Accordingly, for present purposes, the practical application of the two tests is the same, although we reserve for further consideration in future proceedings the question of whether the two tests have differing applications.

149               Therefore the applicable test for present purposes is that articulated by the Tribunal in Re 7‑Eleven Stores Pty Ltd (supra) at 42,654:

“the Tribunal must examine on the one hand the anti‑competitive aspects of the conduct … and on the other hand the public benefits arising from it and weigh the two.”

 

150               The detriment to be taken into account in the present instance is thus the detriment to the public caused by any lessening of competition resulting from the Alliance.  This type of detriment is still, however, to be broadly construed.  As the Tribunal in Re 7‑Eleven Stores Pty Ltd (supra) went on to note at 42,683:

“As with the assessment of benefit we give the characterization of the ‘detriment to the public’ a wide ambit, namely, any impairment to the community generally, any harm or damage to the aims pursued by the society including as one of its principal elements the achievement of the goal of economic efficiency, in the sense we have adopted.”

 

The future with and without test

151               In identifying and weighing the public benefits and detriment associated with the Alliance, we must compare the “future with” the Alliance (the factual), and the “future without” the Alliance (the counterfactual).  This test was explained by the Tribunal in Re QIW Ltd (1995) 132 ALR 225 at 276:

“The test is not to compare the present situation with the future situation, were the acquisition to take place:  a ‘before and after’ test.  Rather the test is to appraise the future, were the acquisition to take place, in light of the alternative outcome, were the acquisition not to take place:  the ‘future with‑and‑without’ test.

 

That does not mean that we prophesy the future.  As QCMA expressed the point … :

 

‘We are to be concerned with probable effects rather than with possible or speculative effects.  Yet we accept the view that the probabilities with which we are concerned are commercial or economic likelihoods which may not be susceptible of formal proof.  We are required to look into the future, but we can be concerned only with the foreseeable future as it appears on the basis of evidence and argument relating to the particular application.’

 

Plainly we should take into account any likely changes to the business environment in which the proposed conduct would operate.  We should also assess the benefit and detriment from the proposed conduct in light of any alternative conduct that would thereby be ruled out.  In the present context, this does not mean that we undertake some mechanical comparison of the desirability of alternative merger scenarios; but the terms of s 90(9) require us to appraise the acquisition the subject of the application for authorisation ‘in all the circumstances’, and those circumstances include the likely alternatives to the merger in question.”

 

(See also Re Media Council of Australia (1996) ATPR 41‑497 at 42,241; Re AGL Cooper Basin Natural Gas Supply Arrangements (1997) ATPR 41‑593 at 44,174‑5; and Australian Wool Growers Association Ltd (2000) ATPR 41‑774 at [15].)

 

The meaning of “likely to result”

152               Our task of comparing the public benefits and detriments “likely to result” in the future with, and in the future without, the Alliance, was complicated in the present instance by the highly dynamic nature of competition in the airline industry and the picture of the counterfactual painted by the parties.  For this reason, the meaning of “likely to result” is of particular importance as it dictates our assessment of the probability of occurrence of a public benefit or detriment in the future with, as compared to without, the Alliance.

153               In Re Howard Smith Industries Pty Ltd (1977) 28 FLR 385 (“Re Howard Smith”), the Tribunal observed at 405 that in authorising a merger it had to be satisfied of a number of matters and that:

“[t]his involves the tribunal in a consideration of what is likely to result, in this case a consideration of what is likely to result from the proposed merger if authorized.  This involves a consideration of commercial likelihoods.  As part of that consideration, it is necessary to consider what is likely to result if the proposed merger is not authorized.  This does not mean that the likely effects must be more probable than not, but rather there must be a tendency or real possibility of a particular result following the refusal of an authorization.  This is an aspect of the main matter for consideration, namely commercial likelihoods resulting from the proposed merger if authorized.”

 

154               The phrase “likely to have the effect” was the subject of more recent consideration by French J in Australian Gas Light Company v Australian Competition and Consumer Commission (2003) ATPR 41‑966.  His Honour concluded that the use of the phrase, in the context of s 50 of the Act, referred to a significant finite probability or “a real chance or possibility” rather than “more probable than not” or a “mere possibility”.  French J referred to the Tribunal’s decision in Re Howard Smith and stated at [348]:

“The assessment of the risk or real chance of a substantial lessening of competition cannot rest upon speculation or theory.  To borrow the words of the Tribunal in the Howard Smith case, the Court is concerned with ‘commercial likelihoods relevant to the proposed merger’.  The word ‘likely’ has to be applied at a level which is commercially relevant or meaningful as must be the assessment of the substantial lessening of competition under consideration”.

 

155               Although Pt VII of the Act is dealing with different subject‑matter than Pt IV, and having duly considered the reservations expressed by Lockhart J in Trade Practices Commission v Australian Iron & Steel Pty Ltd (1990) 22 FCR 305 at 321 regarding the causal nexus to be applied in s 50 and s 90 of the Act, we are satisfied that French J’s observations in relation to the phrase “likely to have the effect” are equally applicable in respect of the phrase “likely to result” in ss 90(6), (7), (8) and (9) of the Act.

156               Thus, for a benefit or detriment to be taken into account, we must be satisfied that there is a real chance, and not a mere possibility, of the benefit or detriment eventuating.  It is not enough that the benefit or detriment is speculative or a theoretical possibility.  There must be a commercial likelihood that the applicants will, following the implementation of the relevant agreements, act in a manner that delivers or brings about the public benefit or the lessening of competition giving rise to the public detriment.  We must be satisfied that the benefit or detriment is such that it will, in a tangible and commercially practical way, be a consequence of the relevant agreements if carried into effect and must be sufficiently capable of exposition (but not necessarily quantitatively so) rather than “ephemeral or illusory”, to use the words of the Tribunal in Re Rural Traders Co‑operative (WA) Ltd (supra) at 263.

Efficiencies used to assess detriment and benefit

157               In assessing the nature and extent of public detriment and benefit, it is necessary to consider the significance of any issues of allocative, dynamic and productive efficiency.

158               In brief, allocative efficiency occurs when the optimal level of resources is employed in a market at a given point in time (it is a static concept), as a result of the efficient operation of the independent market forces of supply and demand.  When allocative efficiency is achieved, as a result of the responses of firms to market signals, the socially optimal level of output will be produced, at the minimum achievable long‑run cost.  No alternative allocation of resources could improve the market’s outcome.  In the reverse situation, allocative inefficiency is caused by socially non‑optimal prices or output decisions.

159               Dynamic efficiency is a concept that involves consideration of adaptation by firms to the evolving supply and demand forces in the market.  It is a function of innovation and change, and relates to the search for new ideas, new products and new production methods, all of which can expand consumer choice, raise output levels and lead to cost savings in production.

160               Productive or technical efficiency relates to the most efficient use of the resources and technology currently available to a firm, in any given time period.  In this climate, the firm will produce the maximum output possible from its available inputs, given the various technological constraints under which it may be operating, resulting in the minimum possible costs of production for that time period.

161               A component of productive efficiency is “x‑inefficiency”, which refers to those forms of productive inefficiency that result from the lack of competitive pressures on and incentives for a firm with market power.  The greater the competitive pressures to which a firm is exposed, the greater the pressure on it, for example, to keep costs low, innovate in its production technology and processes, and motivate or induce people to work harder.  By contrast, a firm with market power can allow inefficient management and production practices to occur and to persist over time.  In addition, resources may be expended by such a firm on maintaining or enhancing its market power through lobbying of governments and regulators or undertaking excessive public relations campaigns. 

162               Generally, where a merger or set of arrangements enhances a firm’s market power and leads to an increase in prices or fares, it is said to reduce allocative efficiency and create what is referred to in economic terms as “deadweight loss” (that is, the loss of producer and consumer surplus resulting from price increases).  Such inefficiency amounts to a public detriment.  However, the result of a merger or set of arrangements might also be that efficiencies are generated which lead to increased welfare, thereby constituting a public benefit.

The meaning of public benefit

163               The expression “benefit to the public” in s 90 of the Act has been interpreted broadly by the Tribunal, beginning with QCMA where the Tribunal said at 510 that public benefit included:

“anything of value to the community generally, any contribution to the aims pursued by the society including as one of its principal elements (in the context of trade practices legislation) the achievement of the economic goals of efficiency and progress.”

 

164               In Re Rural Traders Co‑operative (WA) Ltd (supra) the Tribunal said at 261‑262:

“It is undesirable to attempt to fix in advance the limits of what the concept of ‘benefit to the public’ encompasses or to exclude, in advance, from its ambit any contribution to the legitimate aims pursued by society.”

 

165               More recently, the Tribunal in Re 7‑Eleven Stores Pty Ltd (supra) expanded on the wide ambit of this definition and observed at 42,677:

“Plainly the assessment of efficiency and progress must be from the perspective of society as a whole:  the best use of society’s resources.  We bear in mind that (in the language of economics today) efficiency is a concept that is usually taken to encompass ‘progress’; and that commonly efficiency is said to encompass allocative efficiency, production efficiency and dynamic efficiency.

 

Welfare standards – the connotation of “public”

166               The question of which efficiencies should be taken into account as public benefits (or which inefficiencies constitute relevant public detriment) necessarily involves an assessment of the welfare implications of income distribution or, put another way, an assessment of who constitutes the “public” – an assessment that is not without controversy.

167               This issue arose squarely in the present proceeding because a significant component of the public benefits claimed by the applicants were in the nature of cost savings.  Accordingly, the question arose as to whether cost savings that accrued to the applicants and their shareholders, in the absence of pass through to consumers, would constitute a public benefit which should be taken into account. 

168               The applicants contended that in assessing a benefit to the public for the purpose of authorisation under s 90, the Tribunal should consider every member of the community to be a member of the public, including both final consumers and producers of goods and services, and also that the Tribunal should not give any greater or lesser weight to a benefit on the basis that the benefit flowed to a particular member, or group of members, of the public. 

169               The Commission countered that the applicants were seeking to apply a total welfare or total surplus standard (the terms being inter‑changeable) to determine net public benefit and submitted that this was not the correct approach to take.  Both the Commission and the Gullivers Group submitted that, unless benefits were shared with consumers, it was inappropriate to characterise such benefits as “public” benefits, except in exceptional circumstances, which circumstances they said were not present in this proceeding.  They submitted that if these benefits were considered to be public benefits, when assessing the weight to be given to such benefits the Tribunal should regard them as deserving of little or no weight.  By implication, the Commission and the Gullivers Group appeared to be advocating the use of the consumer welfare standard. 

170               Part of the difficulty with the consumer welfare standard is that, if it is designed with the object of achieving a distributional outcome, it will often not achieve this result.  The application of a consumer welfare standard carries with it the proposition that the loss to each consumer, and the benefit obtained by each shareholder, should be treated as being on an equal footing; (see MS Gal, Competition Policy for Small Market Economies, Harvard University Press, Cambridge, Massachusetts, USA, 2003 at pp 203‑204).  However, inevitably consumers and shareholders will have different incomes, wealth accumulation, and socio‑economic attributes, making such an assumption of equality of impact a risky one to make.

171               The total welfare standard involves taking into account, in the context of approving a merger, those efficiencies that accrue either to consumers of the products of the merged firms, or that accrue to the producers of the products (which may then be converted into competitively significant expenditures, such as improved services, or retained by the firm for use in other ways).  By contrast, the consumer welfare standard only takes into account efficiencies that will be passed on to consumers in the form of lower prices or better products. 

172               The basis for the application of the total welfare standard is usefully explained by Gal (op cit) at p 204‑205:

“Competition policy is therefore a blunt instrument for redistributional goals.  The premise of the total welfare test, by contrast, is that wealth redistribution is best left for government instruments such as taxation and social insurance or welfare systems that are designed for that purpose, and through which redistribution is more directly observed or monitored by the voters to whom government is responsible. 

…

Total welfare predictions also involve a number of difficult analytical and qualitative issues that place a heavy burden on the regulator.  Nevertheless, while it is true that total welfare is hard to predict, when such predictions can be made, there is a strong case in favour of adopting such a standard, especially in small economies, as it is the standard for reviewing mergers most consistent with promoting economic efficiency.”

 

173               The difference between the outcomes of the two standards is that, under the total welfare standard, if the benefits associated with the proposed merger exceed the amount of the deadweight loss, then total welfare increases and the merger is allowed to proceed even if it might enhance market power.  Under this standard, equal weight is assigned to the loss in consumer welfare and any corresponding increase in producer surplus.  By contrast, under the consumer welfare standard, a proposed merger that would enhance market power is not allowed to proceed unless a net benefit to consumers can be demonstrated in terms of lower prices, or new or improved products.  Under this standard, a sufficient portion of the benefits of a merger must actually be passed on to consumers.  Put simply, the difference in the underlying rationale of the two standards is that under the total welfare standard, no weight is accorded to the transfer from consumers to producers, instead such redistribution is regarded as neutral.  Under the consumer welfare standard, redistribution towards consumers is valued to the exclusion of redistribution towards producers. 

174               It can therefore be seen that the consumer welfare standard sets a significantly higher bar for a proposed merger to overcome than the total welfare standard, which is less demanding.  Yet, in certain circumstances, the total welfare standard may not be satisfied where there already exists significant market power.  In such a situation, the deadweight loss will be increased, perhaps by a large amount, necessitating the achievement of much higher efficiency gains in order to justify the approval of the merger.

175               Various approaches to welfare standards in the merger context have been adopted around the globe.  For example, Canada initially endorsed a total welfare standard, but now appears to apply a variety of standards depending on the case, which possibly includes the balancing weights approach.  New Zealand is said to apply the total welfare standard.  The United States, the European Union and, to some extent, the United Kingdom, are generally viewed as having adopted the consumer surplus standard.  For a useful summary of the various standards, see the International Competition Network Merger Working Group: Analytical Framework Subgroup, Project on Merger Guidelines:  Report for the third ICN annual conference in Seoul, 2004, (available online at <http://www.internationalcompetitionnetwork.org/seoul/analysisofmerger.html>) (“the ICN Report”).

176               However, as the provisions and objectives of the Act differ from competition legislation in other jurisdictions, the choice of standard in other jurisdictions is of little relevance to the choice of standard applicable in Australia.  Indeed, as was noted in Chapter 6 of the ICN Report, “no one modality for the treatment of merger efficiencies is necessarily correct or appropriate for all countries” and which standard is appropriate will vary depending on a number of factors specific to the particular country, including the goals of its competition law.

177               Looking to the object and purpose of the Act, the objects clause of the Act was the result of a report released in August 1993 – the Independent Committee of Inquiry (FG Hilmer, MR Rayner and GQ Taperell), National Competition Policy: Report by the Independent Committee of Inquiry, Australian Government Publishing Service, Canberra, 1993 (the “Hilmer Report”).  The Hilmer Report concluded that the appropriate role for the restrictive trade practices provisions of the Act was the protection of the competitive process, rather than the conferral of benefits on particular sectors of society.  In unequivocal terms, the Hilmer Report stated with respect to the restrictive trade practices provisions of Pt IV at p 26:

“In broad terms, competitive conduct rules could have two possible objectives.  First, they could be designed to protect the competitive process per se.  In such a regime, the effective functioning of the competitive process, and hence economic efficiency and the welfare of the community as a whole, is the primary objective.  Consumers and competitors benefit from such rules to the extent that their interests coincide with the interests of the community as a whole.

 

Secondly, such rules might be cast so as to confer special benefits on a particular sector of the community, whether that be consumers or a particular class of competitors, such as small businesses.  Under a regime of this kind, the benefits to the community as a whole are subordinated to the interests of a particular category of beneficiaries.

 

The Committee unhesitatingly embraces the objective of protecting the competitive process as that most appropriate for the competitive conduct rules of a national competition policy.  The rules themselves should not be aimed at favouring particular sectors of society.”

 

178               The objects clause in s 2 of the Act thus states:

“The object of this Act is to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.”

 

179               Looking to the relevant provisions, s 90 is found in Pt VII of the Act, whereas the proscribed conduct in respect of which authorisation is being sought is located in Pt IV of the Act.  In our view, the purpose of Pt IV of the Act is the promotion of competition, as a means by which to promote efficient resource allocation and maximise community welfare, rather than any distributional objective.  In Refrigerated Express Lines (A/asia) Pty Ltd v Australian Meat and Live‑stock Corporation (1980) 29 ALR 333 Deane J described the purpose of Pt IV of the Act at 340 as follows:

“The general purpose and scope of the Part can be described by saying that it contains provisions which proscribe and regulate agreements and conduct and which are aimed at procuring and maintaining competition in trade and commerce.”

 

180               However, it does not necessarily follow that the net public benefit test for authorisation in s 90 of the Act also has as its sole objective the unconstrained promotion of efficient resource allocation.  The authorisation provisions of the Act, unlike those of Pt IV, are not solely concerned with the promotion of competition or the achievement of a socially efficient allocation of resources.  The test for authorisation does, after all, provide for a balancing of public benefit against anti‑competitive detriment, which necessarily calls on us to consider policy imperatives and broader social values, and balance those against competition concerns.  As the Tribunal stated in Re 7‑Eleven Stores Pty Ltd (supra) at 42,677:

“The object of the restrictive practices provisions of the Act is the promotion of competition.  Nevertheless, the very existence of authorization points to the recognition that there may be exceptional circumstances in which business conduct associated with a lessening of competition may have value to society.  We cannot rely upon the functioning of competitive markets to deliver everything ‘of value to the community generally’.”

 

181               Whilst never specifically using the economic terminology of a total welfare standard or consumer welfare standard, the Tribunal has previously addressed the issue of what efficiencies can be taken into account as public benefits.  In QCMA the Tribunal said at 510:

“Must a benefit which accrues to the private parties be ‘passed on’ to members of the wider community before it can be considered?  The Commission has expressed its view in its First Annual Report (Year ended 30th June, 1975), that the test requires ‘benefits to the public and not merely to the applicant or some other limited group’ (p 41).  While agreeing with this statement as far as it goes, we would not wish to rule out of consideration any argument coming within the widest possible conception of public benefit.  This we see as anything of value to the community generally, any contribution to the aims pursued by the society including as one of its principal elements (in the context of trade practices legislation) the achievement of the economic goals of efficiency and progress.  If this conception is adopted, it is clear that it could be possible to argue in some cases that a benefit to the members or employees of the corporations involved served some acknowledged end of public policy even though no immediate or direct benefit to others was demonstrable.”

 

182               QCMA was delivered on 5 March 1976.  In August 1976 a report was published which considered the nature of the authorisation test – Committee to Review the Trade Practices Act 1974 (TB Swanson et al), Report to the Minister for Business and Consumer Affairs, Department of Business and Consumer Affairs, Canberra, 1976 (“the Swanson Report”).  The Swanson Report appeared to lean towards a consumer welfare standard as it was only prepared to consider that authorisation should be granted if there were “public benefits” as opposed to benefits to the parties who were the subject of the authorisation.  The Swanson Report stated at 238:

“[C]ompetitive behaviour is to be valued for the benefits that it brings to the community at large.  However, if in a given case it can be shown that public benefits, i.e. not merely benefits to the parties to the restrictive conduct, are available, and that those benefits outweigh the benefits to the public foregone by the absence or restriction of competition, then that conduct should be permitted to continue.  In other words we still favour the maintenance of the primary position that competitive behaviour is to be preferred, but that many who engage in restrictions of competition should be able to obtain an authorisation if they can show that on balance there are public benefits that outweigh the effects on the public of the restrictions of competition.”

 

183               In the following year, the decision of the Tribunal in Re Howard Smith was handed down.  Notwithstanding the view of the Swanson Report, the Tribunal there stated at 391‑392:

“The tribunal has to determine what constitutes ‘the public’ in order to assess whether there is likely to be a substantial benefit to the public from a proposed merger.  It is not simply the public as consumers.  If a merger is likely to result in the achievement of economies of scale and a considerable saving in the cost of supplying goods or services this might well constitute a substantial benefit to the public, even though the cost saving is not passed on to the consumers in the form of lower prices.  Nevertheless, if such a merger benefited only a small number of shareholders of the applicant corporations through higher profits and dividends, this might be given less weight by the tribunal, because the benefits are not being spread widely among members of the community generally.”

 

184               In Hospital Benefit Fund of Western Australia Inc v Australian Competition and Consumer Commission (1997) 76 FCR 369 Carr J cited this passage from Re Howard Smith and expressly approved of, and adopted, its last sentence saying at 376:

“Whether a matter is to be regarded as a benefit to the public must surely be a question of degree.  It involves assessments of the extent of the benefit and the relevant weight to be attached to it.”

 

185               In our view, the objective and statutory language of the Act, as well as precedent, support the use of a form of the total welfare standard as the most appropriate standard for identifying and assessing public benefit.  We say a “form of” the total welfare standard because, as the passage cited from Re Howard Smith shows, whilst the Tribunal does not require that efficiencies generated by a merger or set of arrangements necessarily be passed on to consumers, it may be that, in some circumstances, gains that flow through only to a limited number of members in the community will carry less weight.

186               The Tribunal in Re Rural Traders Co‑operative (WA) Ltd (supra) at 262 thought that a benefit could only be regarded as a benefit to the public for the purposes of s 90 if it could be seen as a benefit to the community generally.  The Tribunal there noted that this was not to say that private benefits are necessarily irrelevant, as the encouragement or enabling of an individual to pursue legitimate ends or to attain legitimate rewards may well be beneficial to the community generally.  The Tribunal found that the assessment of whether the benefit pertains to the community generally will ordinarily involve the consideration of whether “the community generally has an interest in the individual or group being so benefited … and whether the benefit…involves…benefit to other individuals or groups.” The Tribunal said at 262:

“Before a benefit (or detriment) can properly be regarded as a benefit (or detriment) to the public for the purposes of the assessment of public benefit required by s. 90(9), it must be seen as a benefit (or detriment) to the community generally.  This does not mean that private benefit or private detriment are necessarily irrelevant.  Injury to an individual can itself, in many circumstances, constitute a detriment to the community generally.  Injustice to an individual will commonly do so.  The encouragement or enabling of an individual to pursue legitimate ends or to attain legitimate rewards may well be beneficial to the community generally.  When a benefit or a detriment to a particular individual or segment of the public is pressed as a relevant benefit or detriment to the public for the purposes of s. 90(9), the Tribunal must assess whether the benefit or detriment to the individual or group can properly be so categorized.  That assessment will ordinarily involve the consideration of whether the community generally has an interest in the individual or group being so benefited or disadvantaged and whether the benefit or detriment involves detriment or benefit to other individuals or groups.”

 

187               We consider that the phrase “benefit to the public” is to be given a broad definition which, in addition to group interests, takes into account (with appropriate weighting) individual interests to the extent that such interests are considered by society to be worthy of inclusion and measurement.  This broad approach to public benefit promotes the achievement of both static and dynamic efficiencies. 

188               Given the above reasoning, we have formed the view that the “public versus private” dichotomy used by the parties in relation to cost savings is of fairly limited assistance when examining the benefits relied upon for the purposes of s 90.  Rather, the enquiry should be directed towards the extent to which the benefit has an impact on members of the community, that is society.  Does it fall into the category of “anything of value to the community generally”?  If it does, what weight should be given to that benefit, having regard to its nature, characterisation and the identity of the beneficiaries of it?

189               It follows that cost savings achieved by a firm in the course of providing goods or services to members of the public are a public benefit which can and should be taken into account for the purposes of s 90 of the Act, where they result in pass through which reduces prices to final consumers, or in other benefits, for example, by way of dividends to a range of shareholders or being returned to the firm for future investment.  However, the weight that should be accorded to such cost savings may vary depending upon who takes advantage of them and the time period over which the benefits are received.

190               Our reference to, and adoption of, a total welfare standard – subject to a caveat regarding the weight to be given to public benefits to the extent to which they are not shared among members of the community generally – should not be seen as a new development in the jurisprudence of authorisation.  The expression is no more than an economic label describing an analytical tool for determining net public benefit.  It may be that this expression has not been explicitly used by tribunals and courts during the history of Australian authorisation decisions.  Nevertheless, the doctrine and principles which it represents may be found consistently in the decisions to which we have referred, commencing with QCMA, and it is an appropriate standard to use given the objects sought by the Act and the language employed in the relevant legislative provisions relating to authorisation.

191               The adoption of the total welfare approach, albeit with the caveat to which we have referred, has particular application in the present case where it is a key part of the applicants’ case that the Alliance will give them, inter alia,a greater network depth and breadth, and will lead to numerous synergies, that will put them in a position to compete more effectively and efficiently in international markets.  As Gal (op cit) points out, at p 203:

“a policy that requires a high standard of proof of no negative effect on consumer welfare may well lead to market stagnation of oligopolistic structures that not only charge supracompetitive prices, but do not achieve productive efficiency.  The total welfare approach will thus reduce productive and even dynamic inefficiency.”

 

We consider these observations apposite in the present circumstances.

Benefits – domestic v foreign

192               If cost savings accruing to the applicants and their shareholders are to be regarded as public benefits (with the appropriate weight to be given to those benefits in this proceeding yet to be determined), a further issue arises as to whether those benefits accruing to Qantas’ substantial foreign shareholding are public benefits for the purposes of the Act.

193               At the time of the hearing before the Commission, around half of Qantas’ shareholding was foreign‑owned.  The Commission thus expressed substantial reservations in its determination about the quantum of the public benefit claimed to arise from cost savings because it thought that such savings were likely to accrue to Qantas’ shareholders.

194               Subsequently it was reported in the press that British Airways had sold its shareholding in Qantas.  We are not aware of the identity of the purchasers of that shareholding.  We understand that Qantas still has a number of foreign shareholders but that considerably less than 50% of the total shareholding is now owned by foreign interests. 

195               It is therefore appropriate to set out the principles which should apply when a company seeking authorisation under the Act has a share register with a significant foreign element. 

196               Re Howard Smith establishes that, in applying the net public benefit test, it is benefits to the Australian public, not to the overseas public, to which the Tribunal should have regard.  However, the Tribunal noted the practical difficulties involved in limiting one’s consideration to benefits to the Australian public.  The Tribunal stated at 392:

“Secondly, it may be asked whether the benefit to be assessed is the benefit to the Australian public or to some wider group, including the residents of overseas countries.  This question is of some relevance to the present application.  It was put to the tribunal that a substantial benefit of the proposed merger was the earlier modernization of the tug fleets in the subject ports, leading to better towage services to ocean‑going vessels without increased charges.  An improvement in towage services of this kind will probably benefit overseas ships using Australian ports to a greater extent than Australian‑owned ships.  Should we therefore restrict our attention to that fraction of the benefit (if any such benefit is established) which accrues to Australian residents?  In principle, we think this would be the right approach.  In practice, it will probably be difficult to discover what fraction of the benefit does remain in this country.  In the present case, greater efficiency and economy in the provision of towage services may ultimately benefit Australian exporters as well as overseas shipping lines carrying the exports.  Even Australian consumers could benefit to some slight degree if the greater efficiency of tug operations resulted in slightly lower landed prices for imported goods.”

 

197               The question whether benefits accruing to a foreign‑owned firm and its shareholders constitute benefits to the New Zealand public was considered by the High Court of New Zealand in Telecom Corporation of New Zealand Ltd v Commerce Commission (1991) 4 TCLR 473.  The Administrative Division of the High Court of New Zealand stated at 531:

“We reject any view that profits earned by overseas investment in this country are necessarily to be regarded as a drain on New Zealand.  New Zealand seeks to be a member of a liberal multilateral trading and investment community.  Consistent with this stance, we observe that improvements in international efficiency create gains from trade and investment which, from a long‑run perspective, benefit the New Zealand public.

 

On the other hand, if there are circumstances in which the exercise of market power gives rise to functionless monopoly rents, supranormal profits that arise neither from cost savings nor innovation, and which accrue to overseas shareholders, we think it right to regard these as an exploitation of the New Zealand community and to be counted as a detriment to the New Zealand public.”

 

198               We are guided by the treatment in the New Zealand jurisprudence of benefits accruing to foreign‑owned corporations and their shareholders in the assessment of public benefits.

199               Accordingly, we conclude that, where we are satisfied that the Alliance would be likely to result in a lessening of competition, any associated supra‑competitive returns likely to accrue to Qantas’ foreign shareholders (due, for example, to higher fares or reduced capacity which, by definition, involve an income transfer from consumers, including Australian consumers), should not be regarded as apublic benefit for the purposes of s 90.  This would include any cost savings retained by Qantas for the benefit of its foreign shareholders which constituted such supra‑competitive returns.  (Similarly, any deadweight loss associated with higher fares or reduced capacity that accrues to Qantas’ foreign shareholders should also be disregarded, as this does not constitute a detriment to the Australian public).  However, we acknowledge that, in some circumstances, returns to foreign shareholders of Australian companies may be re‑invested in the Australian economy or might result in further foreign investment in Australia, in which case there would be a public benefit for the purposes of s 90.

Quantification of benefits

200               We recognise that, in theory, a wide range of benefits, including static and dynamic efficiencies, can result from a merger or arrangement.  Some of these may be classified as private benefits, others may be classified as public benefits if they are passed on to the community either directly or indirectly in whole or in part.  Pass through may not be immediate, but the gain to the public is nevertheless real and tangible.  All such benefits may be hard to estimate in advance with any great precision, but their achievement will clearly be a motivating factor for a proposed coalition or arrangement.  Thus, the precise extent to which synergies may follow from a merger or arrangement cannot be foretold, but rather must await the evolution of the new entity or arrangement.  Any expected cost savings will usually not be immediately available, but will unfold as the new entity commences operations under its new corporate structure or the arrangement is put into practice.

201               The Act does not require an applicant for authorisation to quantify, in precise terms, the benefits claimed to arise if authorisation is granted.  However, there must be a factual basis for concluding that the public benefits are likely to result.  In Re Howard Smith, the Tribunal said in relation to mergers at 392 that:

“Often it will be difficult to measure the public benefit from a merger in precise quantitative terms.  At the time of a commission or tribunal hearing the claimed benefits of the merger are largely prospective.  Indeed, the applicant companies themselves may not be able to estimate the likely commercial benefits accurately until after the merged venture has been in operation for some time.  Apart from the commercial benefits there can be a variety of possible economic and social benefits and detriments flowing from a merger.  Some of these may have to be expressed in qualitative rather than quantitative terms, because of the absence of suitable statistical information.  Nevertheless, general statements about possible or likely benefits are not usually helpful to the tribunal in making its assessment if they cannot be backed up by some factual material.”  [Emphasis added]

 

202               The Tribunal left open the question of the nature and extent of the factual material required to support the existence of a relevant public benefit.  Over the decades which have passed since Re Howard Smith it has become apparent that the Tribunal needs to enunciate in somewhat greater detail the nature and extent of the factual material required to support the existence of a public benefit. 

203               An accurate, objective quantification of public benefits is difficult, in part because benefits have to be estimated for some period in the future and so their magnitude becomes a matter not only of empirical estimation based on assumptions but also one of statistical likelihood.  Data, assumptions and models can be, and indeed in this proceeding have been, hotly contested. 

204               We consider that the nature of public benefits needs to be defined with some precision, a degree of precision which lies somewhere between quantification in numerical terms at one end of the spectrum and general statements about possible or likely benefits at the other end of the spectrum. Whilst the diverse and speculative nature of potential benefits makes it impossible to lay down any definitive test of the degree to which, or manner in which, benefits should be quantified, the following observations should be borne in mind by any party seeking to assert a likely benefit.

205               Benefits must be of substance and have durability.  In Re Rural Traders Co‑operative (WA) Ltd (supra) the Tribunal concluded at 262‑263 that:

“the net or overall benefit which the tribunal finds would result from the proposed acquisition must be seen by the tribunal to be of substance as distinct from ephemeral or illusory.”

 

206               Any estimates involved in benefit analysis should be robust and commercially realistic, in the sense of being both significant and tangible.  The assumptions underlying their calculation must be spelled out in such a way that they can be tested and verified.  Care must be taken to distinguish between one‑off benefits and those of a more lasting nature.  Appropriate weighting will be given to future benefits not achievable in any other less anti‑competitive way, and so the options for achieving the claimed benefits must be explored and presented.

207               Whilst we recognise that public benefits are easy to assert, but are much harder to prove in advance of their creation, that does not deter us from demanding a high standard of commercial and social accountability in the estimates presented to us.  Accordingly, we do not believe that there is anything to be gained by fanciful and speculative modelling of benefits where the underlying assumptions are not clearly spelled out, where the estimates have not been subject to rigorous sensitivity analysis, and where the estimating process is not wholly transparent.  Further, we observe that point estimates of the estimated dollar value of benefits purport to give the estimates a level of specificity that cannot be justified in most circumstances.

208               All other things being equal, detailed quantification is the best option.  However, quantification at all costs is not required by the Act, and has never been sought by the Tribunal.  There are diminishing returns to the quantification exercise.  Benefits should be quantified only to the extent that the exercise enlightens the Tribunal more than the alternative of qualitative explanation.

209               Where benefits cannot be quantified in monetary terms, they can still be claimed in qualitative terms.  The authorisation test is, after all, a balancing exercise that requires judgment over a wide range of tangible and intangible factors.  The final result will depend on the relative weight assigned to each of these factors. 

210               In the present proceeding, the applicants attempted to quantify with some precision a number of claimed benefits.  As a general note, we observe that if parties wish to rely upon quantifiable monetary benefits it is desirable, indeed necessary, that the calculation of such monetary benefits be justified and explained.  We expect the basic assumptions underlying the quantification to be spelled out, along with the reasoning process by which the final figures are derived.  In a number of respects, such exercises were not carried out in support of the figures that were put before us in the present proceeding. 

211               To quantify their claimed benefits, the applicants called Mr Henry Ergas, the ManagingDirectorofNetworkEconomicsConsultingGroup(“NECG”). Some of the claimed benefits were quantified by Mr Ergas using models developed by his firm, referred to as the NECG Cournot cost and tourism models.  Whilst Mr Ergas is a very experienced witness in matters relating to competition in Australia and New Zealand in general, and in airline and related markets in particular, his evidence provided little real illumination of the extent of the public benefits that were said to arise from the Alliance.  His identification of the categories of benefits was apposite.  However, in his attempt to quantify these benefits, his method and explanation left much to be desired and lacked clarity, detail and transparency.  Accordingly, we place little weight on the precise quantification of benefits presented by the applicants.

The expert evidence

212               Before turning to a consideration of market definition and the relevant markets, we wish to make some observations about expert evidence.  A number of economists were called to present expert testimony to us.  The applicants called three economists from the United States, Canada and Australia.  The Commission called two economists from the United States and Canada.  The Gullivers Group called one economist from New Zealand.

213               The economists provided written reports in the form of statements and statements in reply in which they covered a wide range of issues.  Thereafter their evidence before the Tribunal was presented in three stages.  Prior to the economists being called into the hearing to give evidence, they were requested to meet together to discuss the issues which had been raised in the factual evidence and to see whether they could reach a measure of agreement on relevant issues and, if not, to identify areas of disagreement.  A written report was prepared by the economists in relation to this meeting and was made available to the Tribunal and to the parties.  The matters which were the subject of agreement between the economists were relatively inconsequential and the meeting of the experts was not as successful as we had hoped.  Their report contained little agreement on the substantive issues before us.  Nevertheless, we propose to persist in future hearings with arranging and directing such a pre‑hearing conference, although we propose to do so in circumstances where the conference will be chaired and supervised by a Registrar of the Tribunal.  In this way we would hope that there would be greater definition of the relevant issues.

214               In order to focus the attention of the economists on relevant issues, we prepared a list of questions which we required the economists to answer.  These questions were based upon a number of assumptions.  The assumptions recorded either non‑controversial factual matters or probabilities as to conduct and events in the future which we considered were open to us on the evidence in respect of which we ultimately made findings.  We consider some of these questions and responses given by each of the economists later in these reasons for determination. 

215               The list of questions was given to the economists when they were called together to give their evidence in the process which has become colloquially known as the “hot tub”.  The hot tub procedure involves the expert witnesses being called before the Tribunal to give evidence at the same time.  Each, in turn, makes an opening statement and after that is completed the economists are given the opportunity to question each other and develop a dialogue with one another to encourage consensus on issues that are non‑contentious, and to clarify points of difference on those issues upon which expert opinion remains divided.  They are then cross‑examined by relevant counsel. 

The role of the expert

216               The role of expert witnesses appearing before the Tribunal is to instruct on areas of specialist knowledge in a manner that is ultimately designed to inform rather than to advocate a particular view.  Obviously, parties will call upon experts whose opinions support their view of the case.  However, it is not appropriate for an expert witness to act as an advocate for the instructing party at all costs, and professional witnesses should be willing to concede points which, whilst not advancing the case of the party engaging them, they believe to be open as a fair and reasonable assessment on the material before them.  The Tribunal will be assisted by expert witnesses who can clearly explain the relevant issues and concepts and can pinpoint the differences between opinions in the profession and the reasons for such differences so that an informed decision can be made as to which opinion should be accepted on the available evidence.  The Tribunal will not be assisted by experts who uncritically push a party line, avoid challenging questions, and seek to obscure the real issues in contention.

217               Whilst the Tribunal is not bound by the rules of evidence, pursuant to s 103 of the Act, we consider that the Practice Direction issued by the Chief Justice of the Federal Court of Australiaentitled “Guidelines for Expert Witnesses in Proceedings in the Federal Court of Australia” (“the Guidelines”) should apply mutatis mutandis to the Tribunal.  According to the Guidelines:

“1.2     An expert witness is not an advocate for a party.

1.3       An expert witness’s paramount duty is to the Court and not to the person retaining the expert.”

 

218               The Explanatory Memorandum to the Guidelines states that an expert witness:

“does not compromise objectivity by defending, forcefully if necessary, an opinion based on the expert’s specialised knowledge which is genuinely held but may do so if the expert is, for example, unwilling to give consideration to alternative factual premises or is unwilling, where appropriate, to acknowledge recognised differences of opinion or approach between experts in the relevant discipline.”

 

219               The Guidelines and the Explanatory Memorandum thus make it clear that an expert witness may advocate an opinion, but should not advocate for a party.

220               The duties and responsibilities of expert witnesses in this regard were also discussed by Cresswell J in National Justice Compania Naviera SA v Prudential Assurance Co (“The Ikarian Reefer”) [1993] 2 Lloyd’s Rep 68 at 81 as follows:

“1.       Expert evidence presented to the Court should be, and should be seen to be, the independent product of the expert uninfluenced as to form or content by the exigencies of litigation …

 

2.         An expert witness should provide independent assistance to the Court by way of objective unbiased opinion in relation to matters within his expertise … An expert witness in the High Court should never assume the role of an advocate.”

 

221               Generally, whether an expert’s opinion is confined to his or her area of expertise and whether experts state the factual basis upon which they have formed their opinion, are useful considerations in determining at what point an expert witness ceases to be impartial and has moved beyond the bounds of legitimacy into advocating for a party.  Another indicator is the willingness of an expert to respond to questions whose answers may provide support for a view which is contrary to the interests of the party calling them. 

222               With regard to the latter, we note that on many occasions in the present proceeding two experts in particular, being Mr Ergas, called on behalf of the applicants, and Professor Timothy Hazledine, a Professor of Economics at the University of Auckland, called on behalf of the Gullivers Group, appeared reluctant to respond to questions whose answers might have been adverse to the case put by the party calling them.  Instead, they provided non‑responsive answers and deviated to discussions of other issues which supported the case of the applicants and the Gullivers Group respectively.  On some occasions, the presiding member asked the experts whether they could answer the question put to them and asked them not to give a long explanation, but to no avail.  Such an attitude and conduct of an expert witness leads to a conclusion of partiality and an inability to express an objective expert opinion upon which reliance can be placed.

223               Further, a number of Professor Hazledine’s comments in relation to the applicants’ case – for example, describing the claimed cost savings as “almost entirely bogus”, their submissions regarding barriers to entry on trans‑Tasman routes as a “desperate attempt to bolster a case which has failed comprehensively …” and stating that the applicants “may have attempted to finesse [a particular] issue with the aid of a cunning but long discredited concept of contestability” – gave us no confidence that we could rely upon him for independent expert testimony.

224               The role of the expert witness in a proceeding such as this proceeding is also to provide a detailed and accurate analysis of the relevant market or markets, enabling informed predictions to be made of likely market behaviour under specified conditions.  The nature of the analysis required in competition law is such that the specific circumstances of the relevant market must be considered and generalisations based on other markets are of little utility if no attempt is made to link them to the relevant market.  Overseas experts may be very experienced and highly qualified, but this is no substitute for familiarity with, or knowledge of, the relevant market.  We will be assisted by experts who have familiarised themselves with the facts at hand and can provide current information which is specific to the market under consideration.  We will not be greatly assisted by an expert who focuses exclusively on markets which are geographically or temporally distinct from the relevant market without any analysis of the specific features and context of the market under consideration.

225               We note that there were occasions in this proceeding when the evidence of some of the experts and their responses under cross‑examination revealed little knowledge about the relevant markets.  In particular, Professor Tae Hoon Oum, the UPS Foundation Professor in Transport and Logistics at the University of British Columbia and President of the Air Transport Research Society, who was called on behalf of the Commission, did not appear to have made any systematic attempt to familiarise himself with the relevant markets, particularly the crucial trans‑Tasman market.

226               The High Court of New Zealand in its decision on this matter, Air New Zealand v Commerce Commission (No 6) (supra), noted at [51] that the expert witnesses who appeared before it placed considerable emphasis on overseas markets and observed that this was possibly due to the fact that the opening up of the Australasian airline markets to competition was a comparatively recent event, and that the LCC model has only been present in the region for a few years.  We similarly acknowledge the difficulties that the experts who appeared before us may have faced in obtaining, and making forecasts about, data specific to the relevant markets.  Nevertheless, we feel that insufficient steps were taken by some of the experts to make any attempt to familiarise themselves with the relevant markets and to link their evidence to the facts in the proceeding.  We note in this regard that Dr Tretheway was the sole overseas expert who attempted to become familiar in detail with the trans‑Tasman market scene.

227               Thus, whilst we were, in general, assisted by the evidence provided by most of the experts, we were concerned that on many occasions the expert opinions lapsed into advocacy, there were occasions when crucial assumptions underlying various factual calculations were not spelled out in as much detail as we would have liked, and the use of supporting empirical literature was at times selective.  In addition, it was clear to us that some experts were not particularly well informed about the various airline markets pertinent to the present proceeding, leading them to base much of their testimony on their experience in airline markets distant in both geography and time to the markets under consideration and by reference to outdated material of limited assistance, and we adjusted the weight we gave to their evidence accordingly.

Defining the market

228               In order to assess the likely anti‑competitive detriment associated with the authorisation of the Alliance, we must consider all the markets in which the Alliance may have an anti‑competitive effect that, in turn, may cause a detriment to the Australian public.

229               The definition of “market” in s 4E of the Act gives primacy to substitution in identifying the boundaries of the relevant market or markets.  It provides:

“For the purposes of this Act, unless the contrary intention appears, ‘market’ means a market in Australia and, when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are substitutable for, or otherwise competitive with, the first‑mentioned goods or services.”

 

230               The seminal statement on market definition by the Tribunal is to be found in the oft‑quoted passage from QCMA at 517:

“A market is the area of close competition between firms or, putting it a little differently, the field of rivalry between them (if there is no close competition there is of course a monopolistic market).  Within the bounds of a market there is substitution — substitution between one product and another, and between one source of supply and another, in response to changing prices.  So a market is the field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, at least in the long run, if given a sufficient price incentive.  Let us suppose that the price of one supplier goes up.  Then on the demand side buyers may switch their patronage from this firm’s product to another, or from this geographic source of supply to another.  As well, on the supply side, sellers can adjust their production plans, substituting one product for another in their output mix, or substituting one geographic source of supply for another.  Whether such substitution is feasible or likely depends ultimately on customer attitudes, technology, distance, and cost and price incentives.

 

It is the possibilities of such substitution which set the limits upon a firm’s ability to ‘give less and charge more’.  Accordingly, in determining the outer boundaries of the market we ask a quite simple but fundamental question:  If the firm were to ‘give less and charge more’ would there be, to put the matter colloquially, much of a reaction?  And if so, from whom?  In the language of economics the question is this: From which products and which activities could we expect a relatively high demand or supply response to price change, ie a relatively high cross‑elasticity of demand or cross‑elasticity of supply?”

 

231               As noted by the Tribunal in QCMA, delineation of market boundaries requires a consideration of both the demand side and the supply side of a market, that is of substitution possibilities in both consumption and production:  Trade Practices Commission v Australia Meat Holdings Pty Ltd (1988) 83 ALR 299 at 316–317.

232               A market is thus the smallest area of product, functional and geographic space within which firms could collectively possess substantial market power, that is the power to raise price above their opportunity costs by restricting output, or otherwise to act in a manner unconstrained by competitors (ie no or little substitution in consumption or production), for a sustained period of time.

233               In assessing competitive constraints, it is long‑run rather than short‑run substitution possibilities that are relevant: QCMA at 517; Re Tooth & Co Ltd (1979) 39 FLR 1 at 38‑9.  The period within which substitution possibilities must crystallise to be considered within the defined market is known as the temporal dimension of the market.

234               Given the dynamic nature of competition in the provision of air passenger services on trans‑Tasman routes, it is important to distinguish between the temporal dimension of market definition and the time horizon for the assessment of the competitive effects of the Alliance.

235               The temporal dimension of market definition specifies the period within which current substitution possibilities must become realities in order for them to be included in the defined market.  In Re AGL Cooper Basin Natural Gas Supply Arrangements (supra), the Tribunal recognised that substitution possibilities and market boundaries may change over time.  It concluded that, given the dynamic quality of gas markets and the emerging competition between gas and electricity due to technological change, it was necessary to define the relevant market at three points in time for the purpose of assessing the competitive effects of the proposed long‑term supply contract between the Australian Gas Light Company and a group of producers in the Cooper Basin.  The Tribunal stated at 44,210:

“We have concluded, as canvassed with counsel in the course of the hearing, that the appropriate approach in this matter is to think in terms of a market expanding over time”.

 

236               A purposive approach is taken to market definition in Australian competition law:  Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (1989) 167 CLR 177 at 187 per Mason CJ and Wilson J; Re QIW Ltd (supra) at 262.  In Re Media Council of Australia (supra) at 42,262, the Tribunal articulated this proposition in the context of review of an authorisation determination, stating:

“For trade practices adjudication, the market is the network of actual and potential transactions between buyers and sellers of goods or services that are, or could be, in close competition. … The choice of market definition, i.e. the specification of relevant markets in the particular case, must depend upon the issues for determination.  For the Tribunal’s purposes it is the identification of a market or markets that best enables it to evaluate the likely effects of authorised conduct”.

 

237               The purpose of market definition in the present proceeding is to facilitate an assessment of whether the Alliance will enhance the power of the applicants to act without significant competitive constraint.  Accordingly, the starting point for defining the boundaries of the relevant market is the product supplied by the applicants.  It is then necessary to identify the sources of actual and potential competition, whose existence could significantly restrain the applicants’ power.  As Mason CJ and Wilson J observed in Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (supra) at 187–8:

“In identifying the relevant market, it must be borne in mind that the object is to discover the degree of the defendant’s market power.  Defining the market and evaluating the degree of power in that market are part of the same process, and it is for the sake of simplicity of analysis that the two are separated.  … After identifying the appropriate product level, it is necessary to describe accurately the parameters of the market in which the defendant’s product competes: too narrow a description of the market will create the appearance of more market power than in fact exists; too broad a description will create the appearance of less market power than there is.”

 

We have adopted this process.

The relevant markets

238               The relevant markets in which the applicants operate were not particularly contentious as between the parties, although issues did arise in relation to the geographic dimension of the markets and as to whether separate air passenger services markets should be identified for business travellers and leisure travellers on trans‑Tasman routes.

239               As to the geographic dimension of the markets, the applicants observed that the relevant geographic field of competition was arguably “Australasian” as a result of the open skies and SAM arrangements between Australia and New Zealand, and the actual and potential supply‑side substitution between routes within Australasia.  However, they accepted a narrower geographic market definition, involving separate trans‑Tasman and Australian domestic markets, for the purposes of the proceeding.

240               As to the issue whether separate air passenger services markets should be identified for business travellers and leisure travellers on the trans‑Tasman routes, the Gullivers Group initially contended that there were separate markets for business and leisure travellers, although they did not pursue this contention in final submissions.  The applicants contended that separate markets for air passenger services should not be defined by reference to the purpose of travel (eg business versus leisure) or booking class (eg economy versus business or first class).  Such an approach was said to be more consistent with the commercial reality, in which business people travel in economy class, particularly on short‑haul routes and in which Virgin Blue actively pursues corporate accounts and the provision of services to business travellers.  The Commission contended that separate markets were not relevant in view of the purposive aspect of market definition, and considering the short‑haul nature of many of the routes affected by the Alliance.

241               We recognise that, in some circumstances, it may be appropriate to define distinct markets for different customer types.  Where a systematic variation in available competitive alternatives as between different customer types (eg business and leisure travellers) results in a marked discontinuity in substitution possibilities, this may suggest that the suppliers supply one product into a number of distinct customer markets.  Where the available competitive alternatives vary systematically as between customer types, the area over which a hypothetical monopolist may profitably impose a small but significant and non‑transitory increase in price (referred to as the “SSNIP test”) will be determined by reference to customer type, provided that the hypothetical monopolist is able to engage in price discrimination between the various customer groups. 

242               We are satisfied, on the evidence, that business and leisure travellers have different demand characteristics and that these differing demand characteristics are reflected in different demand elasticities for the two groups.  There was much discussion by the parties of the relative time sensitivity of business travellers (ie their desire for flexibility, short stay and short lead booking times) and the greater value they place on such things as frequent flyer schemes and executive lounges.  By contrast, the leisure traveller is primarily price‑driven.  Indeed, it is these varying demand characteristics that govern the airlines’ yield management practices. 

243               However, we also heard evidence that the applicants, as FSAs, must target leisure travellers in addition to business travellers to ensure each flight’s financial viability, and that Virgin Blue, an LCC, targets the business traveller as well as the leisure traveller.  There was also evidence that many business travellers fly in economy class for reasons of price and that leisure travellers may also fly in business class. 

244               In our opinion, the difference in the overall demand characteristics of business and leisure travellers is therefore not so great that a discontinuity in substitution possibilities between business and leisure travellers can be said to exist, justifying the characterisation that the applicants supply air passenger services into two distinct markets in the trans‑Tasman, namely a business traveller market in which the applicants are the primary competitors along with Emirates, and a leisure traveller market in which Virgin Blue and Emirates are also competitors.  This is particularly so given the short‑haul nature of the trans‑Tasman routes in which substitution between both the class of travel and the travel product more generally is more likely, as a result of which the services provided by FSAs and LCCs on these routes provide real competitive alternatives for both business and leisure travellers.  Using the SSNIP test, if the Alliance were to raise the price of the package associated with business class passengers by 5%, could these passengers switch to economy class products?  For short‑haul flights across the Tasman, most of which are shorter than a Sydney–Perth flight, we believe that such substitution could occur to a significant extent.  Air New Zealand’s decision to use Airbus 320s in place of Boeing 767s as the main aircraft for trans‑Tasman flights (which have a much smaller number of business class seats than Airbus 320s), indicates a commercial belief that business travellers are content with an economy class product and are adopting travel characteristics similar to those of leisure passengers across the Tasman.  We therefore conclude that there is a single passenger market that includes both business and leisure travellers. 

245               Ultimately, we proceeded on the basis, which was generally agreed by the parties, that the relevant markets for the purpose of assessing the anti‑competitive detriment associated with the Alliance were:

1.                  the trans‑Tasman air passenger services market;

2.                  the trans‑Tasman airfreight market;

3.                  the Australian domestic air passenger services market;

4.                  the Australia–North America air passenger services market;

5.                  the Australia–North America airfreight market; and

6.                  the market for travel distribution services (also referred to during the course of the proceeding as the “sale of air travel market”).

 

246               ThepartiesagreedthattheAlliance primarily affected competition in the trans‑Tasman air passenger services market, and to a lesser extent in the Australia–North America air passenger services market, with the other markets being of marginal relevance only.

The trans‑Tasman air passenger services market

247               The trans‑Tasman air passenger services market includes routes between any point in Australia and any point in New Zealand.  As noted earlier, there are nine main routes in the trans‑Tasmanmarket, being Sydney–Auckland, Melbourne–Auckland, Brisbane–Auckland, Sydney–Wellington, Melbourne–Wellington, Brisbane–Wellington, Sydney–Christchurch, Melbourne–Christchurch and Brisbane–Christchurch.

248               Five main airlines or groups of airlines currently participate in the trans‑Tasman air passenger services market, namely Qantas, Air New Zealand, Virgin Blue, Emirates and FFCs other than Emirates.

249               The applicants operate on all of the nine main trans‑Tasman routes.  At the time of the hearing,oneofEmiratesorVirgin Blueoperatedon seven of the main routes.  Emirates operated on the Sydney–Auckland, Melbourne–Auckland and Brisbane–Auckland routes, and Virgin Blue operated on the Sydney–Christchurch, Melbourne–Christchurch, Brisbane–Christchurch and Sydney–Wellington routes.  On 3 July 2004, Emirates announced that it would commence operations on the Melbourne–Christchurch route and on 13 September 2004 Virgin Blue announced that it would commence two new trans‑Tasman direct routes, being Gold Coast–Christchurch and Brisbane–Wellington.  In addition, a number of other FFCs operate on the Sydney–Auckland and Brisbane–Auckland routes. 

250               Both Virgin Blue and Emirates have plans to commence operating on additional trans‑Tasman routes in the near future.

The trans‑Tasman airfreight market

251               Airfreight or cargo is carried in the belly hold of passenger aircraft or in dedicated freight‑only configured aircraft.  The trans‑Tasman airfreight market is the market between Australia and New Zealand comprising dedicated airfreight services and cargo‑hold capacity in passenger services. 

252               In addition to the applicants, current competitors in the trans‑Tasman airfreight market include Asian Express Airlines, Thai Airways International, Cargolux Airlines International, Singapore Airlines Cargo, DHL, Emirates, Virgin Blue, Malaysian Airways, Garuda Airways, Lan Chile, Aerolineas Argentinas, Royal Tongan and United Airlines.  Air New Zealand leases space on a dedicated freighter which Lufthansa operates in this market.

253               The vast majority of trans‑Tasman airfreight is general cargo, that is airfreight which is not mail or express freight.  General cargo can be carried as loose cargo or unitised on pallets or in containers.  With the exception of a particular type of container (LD3‑45 which has limited uses), containers cannot be carried on narrow‑bodied aircraft.  Freight forwarders prefer to use pallets or containers for the transportation of freight on most international routes, including trans‑Tasman routes, as it is less time‑consuming and less expensive to uplift, load and unload containerised freight. 

254               In October 2003 Qantas and Air New Zealand’s respective market shares in the overall trans‑Tasman airfreight market were 37.34% and 27.08%.  However, in September 2003 Air New Zealand commenced replacing its wide‑bodied Boeing 767 aircraft flying trans‑Tasman with narrow‑bodied Airbus 320 aircraft, a process which it anticipated would be completed by 2006.  Air New Zealand therefore effectively signalled that it would no longer be a major player in this market.

The AUSTRALIAN domestic air passenger services market

255               At the time of the hearing, Qantas had a share of the Australian domestic air passenger services market in the region of 70%, with Virgin Blue having a share in the region of 30% with a number of other small players having relatively small shares also.  The smaller short‑haul or regional airlines include Regional Express (Australia‑wide Airlines Limited, trading as Regional Express) (“REX”) and O’Connor Airlines.

256               REX is Australia’s largest independent regional airline, in terms of both available capacity and passengers carried.  It operates 32 routes and connects 29 metropolitan and regional centres across New South Wales, Victoria, Tasmania and South Australia.  REX was launched in August 2002 and was formed by consolidating the assets of Kendell and Hazelton Airlines (wholly‑owned subsidiaries of Ansett Australia Limited) following the Ansett collapse.  A private shareholding group, based in Singapore, is the majority shareholder in REX.

257               O’Connor Airlines is a Qantas‑affiliated airline in that it has contractual arrangements with Qantas pursuant to which it is hosted in Qantas’ reservations system, its tickets are sold through Qantas call centres and it has the ability seamlessly to transfer a passenger from its services to any of Qantas’ services and destinations.

The Australia–North America air passenger services market

258               The Australia–North America air passenger services market is a sizeable market, with approximately1.8 millionorigin/destination passengers between Australia and North America each year.  In 2002, around 11% of Australia’s international travellers had North America as an origin or destination. 

259               At the time of the hearing, only two airlines provided non‑stop services between Australia and North America – Qantas and United Airlines.  United Airlines is a United States‑based carrier and is one of the largest schedule passenger airlines in the world.  In 2003, United Airlines’ Asia–Pacific operations accounted for 16% of its operating revenues. 

260               A number of carriers operate one‑stop services between Australia and North America, including Air New Zealand, Qantas, Air Canada and Hawaiian Airlines. 

261               Air New Zealand used to operate non‑stop services between Australia and North America, but “suspended” these services from 27 April 2003.  Air New Zealand currently code‑shares with United Airlines on flights between Australia and North America.

262               Currently, both Star Alliance and oneworld are able to offer round trip services from North America, taking in both Australia and New Zealand.

263               The Department of Transport and Regional Services (“DOTARS”) provided information which showed that each carrier’s share of Australia–North America origin/destination passengers for the period of 1999 to 2003 was as follows:


Annual Australia–North America Origin/Destination Passenger

Shares by Carrier

Airline

1999

2000

2001

2002

2003

*Allowing for rounding errors

Qantas

47.8%

44.4%

44.8%

47.1%

49.8%

United Airlines

24.7%

23.9%

22.3%

20.6%

18.8%

Air New Zealand

14.3%

14.4%

12.5%

10.3%

9.2%

Air Canada

–

0.8%

6.1%

8.3%

7.7%

Singapore Airlines

1.9%

2.7%

2.5%

2.9%

2.8%

Cathay Pacific

1.4%

1.3%

1.4%

1.8%

1.7%

Japan Airlines

1.8%

2.2%

1.8%

1.6%

1.6%

Air Pacific

1.2%

1.0%

0.8%

1.0%

1.2%

Malaysian Airlines

1.1%

1.2%

1.2%

0.9%

1.0%

Thai International

0.7%

0.6%

0.7%

0.7%

0.9%

Other

5.2%

7.5%

5.9%

4.8%

5.2%

Total

100%

100%

100%

100%

100%

 

264               The above figures somewhat overstate the current origin/destination passenger share of Air New Zealand, as Air New Zealand withdrew its direct Australia–North America services in April 2003.  More recent Australian data provided by DOTARS for origin/destination passengers discloses that Air New Zealand’s passenger share is smaller in each month in the period January 2004 to June 2004 (with the exception of May 2004), relative to its share in the same month in 2003.  Despite this, Air New Zealand retains the third greatest share of Australia–North America origin/destination passengers. 

The Australia–North America airfreight market

265               The Australia–North America airfreight market is the market between Australia and North America comprising dedicated airfreight services and cargo‑hold capacity in passenger services.

266               In addition to the applicants, a number of dedicated freight carriers operate in this market, including Federal Express Corporation, Polar Air Cargo, Lufthansa German Airlines, United Parcel Service, Cargolux and Air Canada.  There are also a number of carriers who provide belly hold freight capacity in the market. 

The market for travel distribution services

267               The market for travel distribution services is essentially the Australian market for the supply of services by travel agencies and other like distributors to consumers.  In this market a number of products and services are supplied, including airline tickets, holiday packages, car rental, hotel accommodation and travel planning advice to customers. 

268               The products and services supplied in this market relate to travel in domestic Australia as well as international travel, including trans‑Tasman travel.

269               The market for travel distribution services is comprised of the following channels for distribution of airline tickets and travel‑related services to consumers:

·                    airlines distributing tickets directly to the public via their own internet sites and telephone service centres;

·                    airlines distributing tickets to businesses direct and via their own tour package wholesalers and own retail travel centres;

·                    airlines distributing tickets via consolidators who purchase blocks of tickets and on‑sell to travel distributors, who then distribute tickets direct to the public;

·                    airlines distributing tickets via wholesalers who purchase tickets and packages with other products (eg accommodation), and then on‑sell to travel distributors, who then distribute tickets direct to the public;

·                    airlines distributing tickets via retail travel agents, travel management companies (or corporate travel agents), interline airline partners and third‑party owned internet portals. 

 

270               Notwithstanding the growth in internet bookings for air passenger services, approximately 50% of domestic air passenger tickets and 80% of international air passenger tickets are still booked in Australia utilising the services of travel agents.

271               The applicants currently distribute tickets through all of the above distribution channels.  They are a source of supply of air tickets (inventory) to travel agents and they also compete with travel agents in the market for travel distribution services.

272               As mentioned earlier, Qantas has its own Australian wholesaler of domestic and international holidays, QH Tours Ltd.  It also operates a corporate travel service, Qantas Business Travel, and has a 50% interest in a wholesale travel operation called Escape Holidays.  SYNERGI, of the Gullivers Group, competes with Qantas Business Travel. 

273               Similarly, Air New Zealand distributes tickets through its own retail travel distributor, Travelcentre, through the Air New Zealand call centre, and through Business Direct, which deals directly with businesses and government agencies providing them with travel booking services.

274               Generally, travel agents are able to access airline fares through an airline’s website (which provides access to the same fares as offered to passengers purchasing directly through the airline’s website), and through a GDS, which provides access to the booking systems of a number of airlines around the world. 

275               Mr John Andrew Bagnall, a director and shareholder of the member companies of the Gullivers Group,described how travel service distributors would source the best available fares for clients, usually employing tenders for corporate contracts and using a GDS to locate the best available fares for individual travellers.  In addition, travel service distributors offered itinerary planning services for accommodation, car hire, tours and packages.  Mr Bagnall observed that travel service distributors also provided the infrastructure for overseas airlines, including FFCs, to sell their products into and out of Australia. 

The Principal issues

276               In considering the applications we are required, in general terms, to consider whether the Alliance would result in benefits to the public that would outweigh the detriment to the public constituted by any lessening of competition. 

277               The applicants asserted that the competitive constraints imposed upon them meant that the Alliance would not substantially lessen competition in the relevant markets and would result in substantial benefits to the Australian public.  The Commission and the Gullivers Group asserted that the public benefits which would be likely to arise from the Alliance were insubstantial and were clearly outweighed by the detriment to the public constituted by the resultant lessening of competition that the Alliance would occasion.  In the words of Professor Levine, the real benefit being sought by the applicants in forming the Alliance was to eliminate “each other’s competition as a constraint on the exercise of market power” and to generate “monopoly rents to help fund their cost disadvantages.”

278               The parties made extensive submissions in relation to the nature and extent of the public benefits which were said to be likely to result from the Alliance.  The applicants asserted that the Alliance would result in substantial public benefits for Australia and outlined a number of categories of benefits.  These claimed public benefits were disputed by the Commission and the Gullivers Group, who questioned the extent to which these benefits would eventuate under the Alliance, queried whether some of the benefits were more accurately described as private rather than public benefits, and cast doubt on the reliability of the applicants’ quantification of the benefits.

279               During the hearing, most of the evidence regarding detriments was directed towards competition in the trans‑Tasman air passenger services market.  The principal concern in relation to this market was whether the elimination of competition between the applicants would cause a substantial lessening of competition with a resultant detrimental effect on fares, capacity, frequency and product offering.  The applicants asserted that there would be no lessening of competition in this market under the Alliance largely due to the competitive constraints imposed upon them by Virgin Blue and FFCs such as Emirates.  However, the Commission and the Gullivers Group considered that Virgin Blue and Emirates could not be relied upon to constitute a competitive constraint on the applicants and that the significant market share held by the applicants under the Alliance would substantially reduce competition, resulting in anti‑competitive detriment.

280               Although the Commission initially contended that the Alliance would significantly increase the market power of the applicants in the trans‑Tasman airfreight market, during the course of the hearing the Commission conceded that any anti‑competitive detriment in this market would be restricted to the short to medium‑term due to Air New Zealand’s plans to replace its wide‑bodied aircraft with narrow‑bodied aircraft which do not have the capacity to carry freight.  Accordingly, there was no real issue in relation to the trans‑Tasman airfreight market.

281               The main issue in relation to the Australian domestic air passenger services market was whether, in the absence of the Alliance, Air New Zealand, either alone or together with another Star Alliance carrier, would enter the market.  Another issue was whether the Alliance would enable Qantas to capture further domestic feed in the form of on‑carriage traffic from Air New Zealand, at the expense of REX and Virgin Blue. 

282               In relation to the Australia–North America air passenger services market, a major issue was whether Air New Zealand might re‑enter this route in the absence of the Alliance.  A further issue in this market was whether the cessation of Air New Zealand’s code‑share arrangements with United Airlines would weaken United Airlines’ competitive position.

283               In relation to the Australia–North America airfreight market, the Commission conceded that the high levels of competition in the market, particularly from dedicated freight carriers, meant that the Alliance would be unlikely to have a material anti‑competitive effect in this market.  Accordingly, there was no real issue in relation to the Australia–North America airfreight market.

284               In relation to the market for travel distribution, the major issue was whether the Alliance would result in independent travel service distributors being unable to use the competitive tension between the applicants to obtain the best fare for customers.  There were also the issues of the reduction of travel agent commissions, the preferential treatment of the applicants’ own distribution channels and, more generally, the enhancement of the applicants’ substantial power in the market to the detriment of other players in the market.  The Gullivers Group were particularly concerned about the impact of the Alliance in this market.

285               In order to identify and weigh public benefits against any anti‑competitive detriment associated with the Alliance, we must compare the factual and the counterfactual.  We are required to consider the likely future with the Alliance and the likely future without the Alliance and to assess the benefits which are likely to occur under the Alliance which could not be otherwise achieved, as well as any detriments which are likely to arise out of any lessening of competition under the Alliance.

286               The parties were not in agreement with respect to the likely future with or without the Alliance.  This was not surprising, having regard to the highly dynamic nature of the aviation industry and, in particular, the current level of competition on trans‑Tasman routes.  The task was made all the more difficult because of the state of competition as it existed across the Tasman both at the time of the hearing and subsequent to the hearing.  Since we reserved our determination in this matter, a number of circumstances have occurred which could have a bearing on the issues presently under consideration.  We refer, by way of example, to Virgin Blue’s earnings downturn announcement on 4 August 2004, Virgin Blue’s withdrawal from the Sydney–Canberra route, Virgin Blue’s announcement on 13 September 2004 of its proposal to commence flying Gold Coast–Christchurch and Brisbane–Wellington on 1 November 2004, and Air New Zealand’s announcement of its proposal to commence a direct Auckland–San Francisco service.

287               There is also the inherent difficulty of two competitors seeking to reach agreement, or compare notes, in relation to their future business activities and predictions of market conduct and behaviour in a counterfactual situation where they are not in alliance but are competitors.

288               As we have noted earlier, the principal focus of the parties in this proceeding was on the trans‑Tasman air passenger services market.  Before undertaking the exercise of identifying and comparing the factual and the counterfactual, it is therefore necessary to look at the features of the trans‑Tasman air passenger services market. 

289               In particular, the position of Virgin Blue and Emirates in the trans‑Tasman air passenger services market is critical to an understanding of both the factual and the counterfactual scenarios.  That position underpins both of them.  Any prediction of the behaviour and conduct of the applicants under the Alliance must take into account what actions Virgin Blue and Emirates might take in the future and what strategies they might develop.  Any prediction as to the counterfactual must likewise take into account the expected conduct of Virgin Blue and Emirates in the absence of the Alliance.

Market share and market structure in the trans‑Tasman air passenger services market

290               Market share was a key issue in the submissions relating to anti‑competitive detriment in the trans‑Tasman air passenger services market.  The Commission and the Gullivers Group emphasised the applicants’ combined market share of the trans‑Tasman air passenger services market in submitting that the Alliance was likely to result in significant anti‑competitive detriment in that market.  We note that this was the only market where the issue of market share and market structure was given substantial consideration.

291               We turn to a number of statistics which were presented to us in relation to market share on various trans‑Tasman routes.  However, we note at the outset that appropriate consideration must also be given to the constraints placed on the behaviour of market participants, a factor to which we shall turn shortly.

292               As noted earlier, there are nine main trans‑Tasman routes in the trans‑Tasman market.  These routes account for more than 90% of all the trans‑Tasman non‑stop capacity.  All nine routes are currently served by both of the applicants. 

293               We received data from the Department of Immigration and Indigenous Affairs and from DOTARS, as well as other data from the parties.  Where the data varied, we substantially relied upon the DOTARS data.

294               Data presented to us by the parties showed that, in the trans‑Tasman market, the combined market share of the applicants of both origin/destination passengers and total passengers in each of the 1999‑2003 calendar years was approximately 90%. 

295               Data produced by DOTARS of passenger share for trans‑Tasman routes showed that the combined market share of the applicants of New Zealand origin/destination passengers for each month in the periods January 2003 to June 2003 and October 2003 to June 2004 was as follows:


Applicants’ shares of total New Zealand origin/destination passengers

Month

Qantas

Air New Zealand

Freedom Air

Combined share

*Allowing for rounding errors

2003

2004

2003

2004

2003

2004

2003

2004

January

38.1%

38.4%

34.2%

31.7%

19.3%

15.1%

91.6%

85.2%

February

40.8%

39.7%

34.3%

31.4%

16.4%

13.0%

91.5%

84.1%

March

43.5%

37.2%

33.7%

30.0%

15.3%

13.5%

92.5%

80.7%

April

38.9%

37.7%

34.8%

29.7%

17.7%

12.1%

91.4%

79.5%

May

39.9%

40.7%

37.6%

29.9%

17.0%

13.1%

94.5%

83.7%

June

37.4%

37.8%

36.8%

29.6%

18.7%

14.2%

92.9%

81.6%

---

---

---

---

---

---

---

---

---

October

41.6%

–

32.1%

–

15.9%

–

89.6%

–

November

41.0%

–

33.4%

–

13.7%

–

88.1%

–

December

37.3%

–

34.2%

–

15.3%

–

86.8%

–

 

296               As can be seen from this table, there has been a general downward trend in the applicants’ combined market share of origin/destination passengers in the trans‑Tasman market between January 2003 and June 2004.  This has been accompanied by a general upward trend in the combined market share of origin/destination passengers of Virgin Blue, Emirates and other FFCs.  The market share of New Zealand origin/destination passengers for each of these carriers for each month in the period January to June 2003 and October 2003 to June 2004 was shown to be:

Virgin Blue, Emirates and other FFCs’ shares of total New Zealand origin/destination passengers

Month

Virgin Blue

Emirates

Other fifth freedom

Total

*Allowing for rounding errors

2003

2004

2003

2004

2003

2004

2003

2004

January

–

0.2%

0.2%

8.3%

8.3%

6.5%

8.5%

15%

February

–

3.8%

0.1%

6.2%

8.4%

6.0%

8.5%

16%

March

–

8.5%

0.2%

5.9%

7.3%

4.9%

7.5%

19.3%

April

–

8.4%

0.1%

6.7%

8.6%

5.6%

8.7%

20.7%

May

–

7.6%

0.1%

3.6%

5.5%

5.2%

5.6%

16.4%

June

–

8.0%

0.1%

4.8%

7.1%

5.6%

7.2%

18.4%

---

---

---

---

---

---

---

---

---

October

–

–

4.3%

–

6.0%

–

10.3%

–

November

–

–

6.5%

–

5.5%

–

12%

–

December

–

–

7.5%

–

5.9%

–

13.4%

–

 

297               The consolidated data for origin/destination passenger shares for the nine main trans‑Tasman routes in the period January to July 2004 was thus: 

Share of origin/destination passengers across the

nine main trans‑Tasman routes

Month

 

 

2004

Qantas

Air NZ

(including

Freedom

Air)

Applicants

combined

share

Virgin Blue

Emirates

Other

FFCs

Total

non‑applicant

combined

share

Total origin/

destination passengers

*Allowing for rounding errors

January

43.34%

43.16%

86.5%

0.16%

7.75%

5.59%

13.5%

384,981

February

45.62%

41.45%

87.07%

2.84%

5.41%

4.68%

12.93%

328,558

March

43.15%

40.28%

83.43%

7.34%

4.88%

4.35%

16.57%

368,236

April

41.17%

39.73%

80.9%

7.8%

6.1%

5.2%

19.1%

381,704

May

42.94%

42.94%

84.63%

7.32%

3.41%

4.12%

14.85%

301,213

June

41.27%

42.34%

83.61%

8.03%

4.27%

4.08%

16.38%

308,116

July

42.99%

37.84%

80.83%

8.94%

6.98%

3.24%

19.16%

372,927

 

298               Given that Virgin Blue, Emirates and other FFCs were operating on Australia–New Zealand routes during 2004, it is also useful to consider the consolidated data for each of the Australia–Auckland, Australia–Wellington and Australia–Christchurch route groups in the period January to July 2004, as set out below:


Share of origin/destination passengers on the main Australia‑New Zealand routes

Month

 

 

2004

Qantas

Air NZ (including

Freedom

Air)

Applicants

combined share

Virgin Blue

Emirates

Other

FFCs

Total

non-applicant

combined

Share

Total origin/

destination

passengers

*Allowing for rounding errors

Australia–Auckland

January

40.08%

40.55%

80.63%

–

11.26%

8.11%

19.27%

265,081

February

44.44%

40.15%

84.59%

–

8.26%

6.89%

15.15%

215,137

March

44.11%

41.20%

85.31%

–

7.76%

6.92%

14.68%

231,440

April

40.89%

41.47%

82.36%

–

9.52%

8.12%

17.64%

244,529

May

42.23%

46.03%

88.26%

–

5.31%

6.43%

11.74%

193,266

June

41.34%

45.74%

87.08%

–

6.60%

6.32%

12.92%

199,228

July

43.82%

39.94%

83.76%

–

10.85%

5.39%

16.24%

224,191

Australia–Wellington

January

46.09%

53.91%

100%

–

–

–

–

38,847

February

47.48%

52.52%

100%

–

–

–

–

34,015

March

41.02%

47.78%

88.8%

11.20%

–

–

11.20%

42,690

April

37.94%

45.25%

83.19%

16.81%

–

–

16.81%

46,926

May

45.54%

41.08%

86.62%

13.39%

–

–

13.39%

38,299

June

41.75%

43.69%

85.44%

14.57%

–

–

14.57%

39,113

July

44.30%

38.72%

83.02%

16.97%

–

–

16.97%

48,749

Australia–Christchurch

January

52.69%

46.57%

99.26%

0.74%

–

–

0.74%

81,053

February

48.01%

40.22%

88.23%

11.77%

–

–

11.77%

79,406

March

41.77%

34.58%

76.35%

23.65%

–

–

23.65%

94,106

April

43.59%

32.16%

75.75%

24.26%

–

–

24.26%

90,249

May

43.50%

32.20%

75.70%

24.30%

–

–

24.30%

69,648

June

40.80%

31.89%

72.69%

27.31%

–

–

27.31%

69,775

July

40.50%

32.70%

73.20%

25.08%

1.72%

–

26.80%

99,987

 

299               Broadly speaking, the data shows that prior to January 2004 the applicants had a combined market share of all origin/destination trans‑Tasman passengers of around 90%.  After taking account of FFCs and, in particular, Emirates, and the introduction of Virgin Blue, the combined percentage market share of the applicants fell on average to around the low eighties.  Within a very short time, Virgin Blue built up a market share of approximately 9% of the aggregated main trans‑Tasman routes.  As at June/July 2004, Emirates was enjoying a market share of approximately 10% on the aggregated Australia–Auckland routes.  At the same time, theotherFFCshadamarket shareof6%ontheaggregated Australia–Auckland routes.  Although the market share of Emirates and other FFCs declined over the period January to July 2004, the combined market shares of the applicants was still well below that of the comparable period for 2003. 

300               The Commission acknowledged that Emirates and Virgin Blue experienced an increase in origin/destination passenger share in June and July 2004, relative to the May 2004 data provided by DOTARS, but attributed this to the volatility in their market shares. 

301               TheCommission’ssubmissionsemphasisedthatontheaggregated Australia–Auckland routes, which they said catered for the majority of business passengers, the applicants’ combined origin/destination passenger share disclosed in the data increased from 80.63% in January 2004 to 83.76% in July 2004.  The Commission reasoned that this provided further support for its contention that the entry of FFCs on such routes would not sufficiently constrain the Alliance, particularly in respect of business travellers.

302               Conversely, the applicants contended that the number of passengers being carried by FFCs and now Virgin Blue was material and growing, imposing a significant competitive constraint on the Alliance in both the factual and the counterfactual, and that their passenger share and capacity share had declined significantly from the corresponding period twelve months earlier.  The applicants argued that Virgin Blue, Emirates and other FFCs had secured a significant share of passengers and capacity in the trans‑Tasman market.

303               The applicants contended that, notwithstanding the aggregation of their significant market share in the trans‑Tasman market, the ability of the Alliance to raise fares sustainably or reduce capacity would be materially constrained by the operations of Virgin Blue and FFCs, including, in particular, Emirates, and the threat of entry and expansion by existing or new participants. 

The likelihood and extent of further entry and expansion by Virgin Blue, Emirates and other FFCs in the trans‑Tasman air passenger services market

304               In order to assess whether there will be competition in a market, the traditional approach has been to look to the structure of the market.  One basic structural factor is the number of participants in the market and what share of the market they each possess.  This is a factor upon which the Commission and the Gullivers Group primarily focused.  However, we believe that to determine whether participants in a market are in a position to compete, that is, to contest for the business of consumers, one should look at a number of factors that contribute to the way parties interact in the market. 

305               In particular, competition analysis demands an assessment of what barriers to entry and expansion exist in a market in order to discover what constraints operate to affect the behaviour of participants in the market.  As the Tribunal’s classic formulation of the term “competition” in QCMA at 516 shows:

“Competition is a process rather than a situation.  Nevertheless, whether firms compete is very much a matter of the structure of the markets in which they operate.  The elements of market structure which we would stress as needed to be scanned in any case are these: (1) the number and size distribution of independent sellers, especially the degree of market concentration; (2) the height of barriers to entry, that is the ease with which new firms may enter and secure a viable market; (3) the extent to which the products of the industry are characterised by extreme product differentiation and sales promotion; (4) the character of ‘vertical relationships’ with customers and with suppliers and the extent of vertical integration; and (5) the nature of any formal, stable and fundamental arrangements between firms which restrict their ability to function as independent entities.  Of all these elements of market structure, no doubt the most important is (2), the condition of entry.  For it is the ease with which firms may enter which establishes the possibilities of market concentration over time; and it is the threat of the entry of a new firm or a new plant into a market which operates as the ultimate regulator of competitive conduct”

 

306               We would note that it is entry as a behavioural phenomenon that is important in the analysis of competition rather than considering entry as a purely structural construct.

307               This aspect of the market was a major focus of the submissions of the applicants and was an area upon which we had the benefit of further evidence and experience than had previously been available to the Commission in reaching its determination.

308               The importance of potential competition from prospective entrants was reiterated by the Tribunal in relation to mergers in Re Howard Smith,where the Tribunal stated at 393‑394:

“[I]n analysing the likely pro‑competitive or anti‑competitive effects of a merger, the tribunal cannot limit its consideration to the effects on existing competition alone.  It is necessary also to consider whether there is potential competition from prospective entrants into the relevant market and whether this potential competition is likely to be affected by the merger.”

 

309               As we have noted, the applicants contended that, whilst the Alliance would see their combined market share increase, it would not result in any anti‑competitive detriment in the trans‑Tasman air passenger services market because of the competitive constraints on their operations imposed by the entry and expansion of Virgin Blue and Emirates, the conduct of other FFCs, and the threat of entry by further LCCs and FFCs.

310               The Commission and the Gullivers Group countered that Virgin Blue and other FFCs including Emirates would not impose an adequate competitive constraint on the Alliance as there were significant barriers to entry and expansion which minimised the threat of entry by other LCCs and FFCs or the likelihood of an increased presence of existing LCCs and FFCs. 

311               We note at the outset that any intention of Virgin Blue or Emirates to expand their services and flights can be accommodated at any of the relevant airports as there was no evidence before us, aside from an unsubstantiated assertion by the Gullivers Group, as to difficulties with terminal scheduling or slot allocation.

Virgin Blue

312               As we have already noted, Virgin Blue has established a significant Australian presence.  It has captured around 30% of the domestic Australian market in less than three years. 

313               Mr David Huttner, Head of Strategy and Communications at Virgin Blue, said that Virgin Blue considered the trans‑Tasman and domestic New Zealand markets to be natural extensions of its domestic Australian network and markets and that it was in a strong position to enter them.  Virgin Blue had been able to gain access to facilities at Wellington, Christchurch and Auckland airports for the purposes of providing trans‑Tasman services and has been able to obtain access to slots to meet its needs.  Virgin Blue intended to commence domestic New Zealand services by the end of 2004, but it had yet to determine which routes it would fly and when those services would commence. 

314               Mr Huttner said that, whilst there was no fixed long‑term plan, Virgin Blue intended to expand the number of services it offered across the Tasman.  It had three aircraft in operation in domestic Australia in Virgin Blue (Pacific Blue) livery which were capable of being deployed across the Tasman in approximately two months. 

315               Virgin Blue is therefore readily able to add another 42 weekly return flights across the Tasman.  As an LCC, Virgin Blue requires growth in order to achieve economies of scale.  Trans‑Tasman routes are attractive to Virgin Blue because they are short‑haul routes between reasonably substantial population centres, and there is significant scope to stimulate demand on these routes by offering widely available and consistently low fares. 

316               Mr Huttner said that Virgin Blue would not deploy aircraft to commence services on a trans‑Tasman route unless it considered that services on that route could be profitable on a stand‑alone basis and more profitable than other potential services that Virgin Blue could offer at that time.  Mr Huttner said that ideally Virgin Blue liked to have at least two months to add a new route.

317               There was evidence to show that Virgin Blue had not been making profits on the trans‑Tasman routes and that its load factors were not optimal.  Nevertheless, Mr Huttner said that it was Virgin Blue’s standard policy to assume that most routes would not make money in the first twelve months or more and that Virgin Blue was currently happy with its load factors on the trans‑Tasman routes.

318               We note Mr Huttner’s evidence, which we accept, that Virgin Blue would be in a strong position to enter and expand on any trans‑Tasman city‑pair as it has a large Australian domestic network to provide feeder traffic to its trans‑Tasman services.  Further, it now has strong brand recognition in New Zealand, it has all the necessary regulatory approvals, it has access to sufficient aircraft and financial resources and it has access to the necessary airport facilities for the purposes of providing trans‑Tasman services. 

319               Professor Janusz Ordover, a Professor of Economics at New York University called on behalf of the applicants, focused primarily on barriers to entry and expansion, stressing the primacy of the conditions of entry and expansion in markets, in a behavioural as well as a structural sense, in developing a framework for evaluating the impact on competition of an alliance such as the one proposed by the applicants.  Professor Ordover’s opinion was that there were no insurmountable barriers to entry or expansion in the trans‑Tasman air passenger services market.  This assertion was borne out by Mr Huttner of Virgin Blue, whose evidence we have summarised above. 

320               The Commission submitted that it was too early to predict what Virgin Blue would do on the trans‑Tasman routes.  It argued that to rely on expansion by Virgin Blue on trans‑Tasman routes would be an insufficient basis to support the approval of an Alliance which, in the absence of such an expansion, would be clearly anti‑competitive.  We are satisfied that there was sufficient information ultimately available to us to make an informed prediction as to the likely presence of Pacific Blue in the trans‑Tasman market over the five‑year period for which the authorisations have been sought. 

321               The Commission also submitted that it was unlikely that Pacific Blue would expand in the foreseeable future unless the applicants and Emirates reduced capacity on trans‑Tasman routes and that Pacific Blue was less likely to expand without the Alliance, although expansion with the Alliance was also uncertain.  However, we consider that such expansion would be likely to occur were the applicants to reduce capacity or increase fares significantly on trans‑Tasman routes.

322               The Gullivers Group submitted that Pacific Blue faced significant barriers to expansion across the Tasman, including profitability, lack of access to feeder traffic, the vertical integration of the applicants, and lack of access to facilities and economies of scope.  It also submitted that surplus capacity on trans‑Tasman routes was likely to be a significant impediment to Virgin Blue’s entry on new routes and expansion on existing routes.

323               The Gullivers Group further submitted that there were numerous structural barriers to entry in the trans‑Tasman market including:

·                    the need to comply with air operating certificate requirements and the cost of obtaining such certificates;

·                    obtaining terminal capacity at airports on appropriate commercial terms as well as gaining access to gates, check‑in counters, maintenance facilities, baggage handling facilities and slots;

·                    gaining access to feeder services;

·                    the cost of establishing integrated support functions or otherwise gaining access to support services on fair commercial terms;

·                    overcoming consumer preferences for established brands such as those of the applicants;

·                    overcoming consumer preferences, in particular the preferences of high‑margin business travellers, to travel with the applicants in order to enjoy the benefits of their frequent flyer programs (which benefits a broad alliance network, such as the Alliance proposed by the applicants, would be uniquely positioned to offer);

·                    the need for significant capital, given the high sunk costs for new entrants;

·                    the need for access to a large network in order to achieve economies of scale and scope.

 

324               We accept that the trans‑Tasman market has generally been more competitive than the Australian domestic market in which Virgin Blue has been a successful competitor.  We also recognise that the surplus capacity on certain trans‑Tasman routes may delay Virgin Blue’s plans for entry and expansion on those routes.  However, we are persuaded by Mr Huttner’s evidence that Virgin Blue is in a strong position to enter and expand on any trans‑Tasman city‑pair and that eventually it will enter the Auckland routes.  From the point of view of Virgin Blue, further entry into and expansion in the trans‑Tasman market is not precluded or inhibited by any barriers to entry or expansion.  There was no evidence, other than a brief submission by the Gullivers Group unsupported by facts, that there was any difficulty in getting slots at relevant airports in Australia and New Zealand, nor was there any evidence that there was any capital raising barrier facing Virgin Blue as we were told that towards the end of 2003 Virgin Blue had a successful capital raising of some $666 million.

325               We consider that Pacific Blue will expand on trans‑Tasman routes as market opportunities arise and as more aircraft become available.  While we recognise that Virgin Blue’s strategy is to deploy aircraft to routes it considers most profitable, we do not believe that it will withdraw from the trans‑Tasman market, which it considers to be an extension of the Australian domestic market.  We note that at the time of the hearing, we were informed that Virgin Blue intended to commence operating domestic New Zealand services from December 2004 and hoped to include routes to and from Auckland should it gain access to airport facilities in Auckland.  This indicates that Virgin Blue intends to remain competitive in the trans‑Tasman market and suggests that it may enter the trans‑Tasman Auckland routes to enable connectivity with its domestic services.  Further, Mr Huttner said that Pacific Blue was highly unlikely to withdraw from trans‑Tasman routes.  It is possible that rather than causing Pacific Blue to withdraw capacity from trans‑Tasman routes, if Jetstar is successful on Australian domestic routes, Pacific Blue might choose to deploy that capacity to more profitable trans‑Tasman routes.

326               We do not consider that any of the matters identified by the Gullivers Group as barriers to entry and expansion in fact operate as a barrier to entry or expansion for Virgin Blue.  Its capital requirements are catered for, having had a capital raising of some $666 million in 2003, and it has had success in developing and promoting its own brand.  With the possible exception of a limited class of business travellers, we consider it will be able to meet consumer preferences by its pricing policies.  Access to feeder services and a large network would obviously be helpful but we do not regard Virgin Blue’s situation in that respect as a barrier to expansion across the Tasman.

327               We therefore find that there are no significant barriers to entry or expansion on trans‑Tasman routes facing Pacific Blue, or indeed, for that matter, for Emirates to which we refer later. 

328               Looking at the ability of Virgin Blue to constrain the Alliance, it is important to recall Professor Levine’s evidence, the economist called on behalf of the Commission, that LCCs such as Virgin Blue would always maintain a cost advantage over legacy carriers such as the applicants.  As an LCC, Virgin Blue enjoys a substantial cost advantage over Qantas’ core FSA model.  Its cost per ASK was 8.16 cents for the full financial year ended 31 March 2004.  Its cost per ASK for the second half of the year ended 31 March 2004 was 7.73 cents.  This compares to an average 10.9 cents for Qantas’ domestic FSA operations.

329               Both of the applicants gave evidence that the entry of Pacific Blue into the trans‑Tasman air passenger services market, and the potential for it to enter further routes, impacted upon their pricing decisions.

330               Air New Zealand said that most of its pricing focus and tactical pricing activity had been driven by FFCs and Virgin Blue.  There was evidence that the introduction by Air New Zealand of Tasman Express in August 2003 was primarily in response to the anticipated entry of Virgin Blue on trans‑Tasman routes.  There was also evidence that since Virgin Blue commenced promoting its services, Air New Zealand had responded to Virgin Blue’s pricing by offering similar fares to those offered by Virgin Blue and had made competitive responses in the form of specific fare promotions. 

331               Air New Zealand said that Virgin Blue also influenced fares on routes on which it did not operate because of the ability of a passenger to obtain lower fares by building an itinerary which might involve an inexpensive domestic flight and then taking a flight across the Tasman.  It was therefore not possible for Air New Zealand to sustain a fare level on a trans‑Tasman route if there was a carrier offering a significantly lower fare on another trans‑Tasman route.  Further, an LCC such as Virgin Blue was able to introduce a service on a particular trans‑Tasman route if there was a price incentive to do so.

332               Qantas submitted that it was forced to restructure its fares and conditions on trans‑Tasman routes in September 2003, largely in response to the introduction of Tasman Express, but also partly in response to the anticipated entry of Virgin Blue.  This restructure led to decreases in average Qantas fares on trans‑Tasman routes and in the level of fares in each ticket category.  Mr Robert Gurney, Head of Sales and Distribution at Qantas,gave evidence that Qantas would make the same changes in response to Virgin Blue’s actual entry on trans‑Tasman routes.

333               Qantas said that its restructured fares and conditions related to all Tasman routes, not only those announced by Virgin Blue, because it was difficult to charge a higher fare for comparable distance city‑pair routes once a benchmark had been established in consumers’ minds in relation to a particular route.  If a carrier charged a higher fare for one city‑pair as opposed to another there was usually media and consumer pressure to make fares consistent and invariably competition would come into the market if one fare was artificially higher.  Further, an indirect routing to obtain a low fare would be available to passengers which may cause a review of the overall fares package and, as leisure passengers make up the majority of passengers on all routes, competition between different destinations could also ensure fares were similar across all city‑pairs.

334               Qantas also said that it was forced to respond to promotional and headline fares offered by Pacific Blue on trans‑Tasman routes, albeit with a price premium, to ensure it retained market share in the growing trans‑Tasman market.  Qantas said that this had resulted in a substantial fall in promotional and headline fares.  Mr Gurney said that under the Alliance, Qantas would be compelled to respond to the fare categories offered by Virgin Blue, albeit with a price premium.  He considered that as Pacific Blue grew, the Alliance would be able to command less and less of a price premium over and above Pacific Blue’s fares.  He stated that if Pacific Blue reached a market share of above 15%, average fares on trans‑Tasman routes would be dictated by the fares set by Pacific Blue.  Qantas noted that Pacific Blue had a 20% capacity share on the trans‑Tasman routes other than Auckland.  We were also informed that at the time of the hearing Virgin Blue had an average market share of approximately 20% across all routes bar the Australia–Auckland routes.

335               More generally, Qantas submitted that the level of competition between LCCs and FSAs was more intense than that between FSAs, and that Qantas would be constrained in its pricing in respect of all trans‑Tasman routes, regardless of whether Virgin Blue was servicing the particular route. 

336               Dr Tretheway noted that there had been price competition between the applicants over the period 2000‑2003, but cautioned that such competition as there had been was of a quite different nature to that introduced by Pacific Blue which involved the introduction of discounted one‑way fares which had the effect of lowering fares and giving business travellers more flying options for their convenience. 

337               The applicants’ submissions regarding the constraining effect of Pacific Blue on their operations was supported, in part, by Mr Huttner of Virgin Blue.  Mr Huttner agreed that the fact that an FSA matched the headline fare of an LCC indicated that LCCs exercised a constraining effect on fares.  He noted that probably two years ago the applicants would not have offered the same kind of fares they offered today.

338               Mr Huttner also agreed that entry by Pacific Blue onto routes such as those to Christchurch had a constraining effect upon fares on trans‑Tasman routes into Auckland.  Mr Huttner generally agreed that an LCC such as Pacific Blue required only 5% of traffic on a route before it became an effective constraint on an FSA.

339               The applicants’ position was also supported by Mr Edwards who said that Pacific Blue was a price–leader on trans‑Tasman routes and that, even though Pacific Blue did not operate on all the main routes, it influenced fares on other routes.  For example, fares on the Sydney–Auckland route are influenced by fares on the Sydney–Christchurch route, in so far as Sydney–Auckland passengers could, in the event that they can secure cheap transport between Christchurch and Auckland, travel via Christchurch if they are unable to buy a cheap direct fare to Auckland.

340               Virgin Blue’s practice is to enter markets as a price‑leader and to maintain its low fare position.  It is becoming increasingly attractive to the corporate sector.  Virgin Blue’s entry and the prospect of entry onto further routes has therefore resulted in a reduction of fares across all trans‑Tasman sectors.

341               The Commission contended that Pacific Blue was unlikely to constrain the applicants.  The Commission noted that Pacific Blue did not operate on the Auckland routes and the current level of Pacific Blue’s operations on trans‑Tasman routes was very small compared with the applicants’ services (Pacific Blue operated approximately 56 flights per week compared to approximately 600 flights per week operated by the applicants combined, including Freedom Air).  The Commission submitted that even the applicants’ experts were in agreement that at its current level of operations, Pacific Blue would not provide such a constraint upon the Alliance to ensure that no anti‑competitive detriment would arise. 

342               We note, however, as Professor Ordover pointed out, there was nothing to stop Pacific Blue expanding its network.  Further, Dr Tretheway considered, and we accept, that a demonstration of an ability to expand operations at a sustained rate over a period of time, combined with some actual expansion, would operate as a constraint on the applicants.

343               The Commission submitted that even if Pacific Blue expanded onto Auckland routes, this expanded presence would unlikely be sufficient to constrain the Alliance in relation to time‑sensitivepassengers.  TheCommissionreliedontheevidenceofProfessor Levine who considered that, while Pacific Blue offered a service that many business travellers utilised, it was not a full substitute for an FSA which can offer product attributes desirable to time‑sensitive passengers, such as standard industry interlining protocols and priority baggage delivery.

344               The Gullivers Group argued that the competitive constraint currently exercised by Virgin Blue upon the applicants was “diluted” by the fact that:

·                    Virgin Blue operated on limited frequency and city‑pairs, and the presence of JetConnect and Freedom Air on Auckland routes made them unsuitable for Virgin Blue as each of JetConnect and Freedom Air had a lower cost base than Virgin Blue;

·                    Virgin Blue only offered a single class product, lacked a frequent flyer or other loyalty program and, as an LCC, offered business travellers less in terms of product quality;

·                    Virgin Blue would not appeal to the business traveller who placed a high emphasis on frequency, reliability, breadth of network and service enhancements such as frequent flyer programs and airport lounges.

 

345               The Gullivers Group noted Professor Ordover’s view that “when a market is already fully served by efficient incumbents and fares are at competitive levels, profitable entry may not be possible even by an equally efficient competitor.  Such entry may simply create more supply than can profitably be sold to consumers”.  Whilst this may be so, we note that profitable expansion in the long‑run would be open to Virgin Blue were the applicants to reduce capacity or increase fares significantly on trans‑Tasman routes.

346               The Gullivers Group relied on the evidence of Professor Hazledine, who has been quantitatively modelling the behaviour of the applicants since 1996, and has presented numerous papers from this work, including appearing before the NZCC at its hearings in respect of the Alliance.  Professor Hazledine developed a spreadsheet model, in the form of a Cournot model, to predict the effect of the Alliance on the trans‑Tasman market.  Using this model, he predicted that the applicants, both with and without the Alliance, would increase fares by a large percentage (some 11%‑16%), thereby ceding easy market share (some 30%) to Virgin Blue and FFCs.  Professor Hazledine believed that these increased fares would make it “comfortable” for Virgin Blue to work on the trans‑Tasman routes, although they would charge less for their “lower quality” product.  Professor Hazledine also held the view that Virgin Blue would implicitly take advantage of the Alliance by taking advantage of its predicted fare‑raising and raising its own fares.  However, he acknowledged that his model “barely has Virgin Blue in there at all … These models are not designed to be reliable for very small numbers of such market share”.  He also indicated that his models assumed a single price market and that he had taken the view that the relevant markets were “mainstream, conventional and normal.”

347               We have formed the view that Professor Hazledine’s modelling did not take account of the actual or potential interactive rivalry between the incumbents, new entrants, and potential entrants, and proceeded mechanistically to its conclusions based on static and structural assumed market share parameters.  In such circumstances, we regard Professor Hazledine’s evidence as having little probative value.  The Gullivers Group was admitted to the proceeding partly on the strength of its submissions that Professor Hazledine’s model offered a different and enlightening approach to assessing the implications of the Alliance.  That submission was not fulfilled.  Professor Hazledine was a dogmatic witness who assumed what he set out to demonstrate, and who was not prepared to admit any shortcomings in his modelHis model was therefore of little assistance. 

348               As we noted earlier, the expert witnesses were asked to respond to a number of questions based on assumptions drawn from the evidence.  In relation to Virgin Blue, the experts were asked to consider the following question (Question 2):

“Assume the following:

(a)       Pacific Blue currently operates two aircraft on trans‑Tasman routes providing approximately 27 weekly return flights (allowing for maintenance works) and currently operates one daily return service on each of the following routes: Brisbane/Christchurch, Melbourne/Christchurch, Sydney/Christchurch, Sydney/Wellington;

 

(b)       Virgin Blue currently has three aircraft in Pacific Blue livery operating on routes in Australia (over and above the two Pacific Blue aircraft currently operating on trans‑Tasman routes), each of which could provide approximately 14 return flights per week if they were re‑deployed to trans‑Tasman routes (subject to maintenance which may reduce this number slightly);

 

(c)        from September of this year, following the redeployment of one of the three aircraft referred to directly above to Pacific Island routes, there may be two or more aircraft in Pacific Blue livery (over and above the two Pacific Blue aircraft currently operating on trans‑Tasman routes) which could be re‑deployed to trans‑Tasman routes;

 

(d)       at some indeterminate time within the next 5 years, Pacific Blue will commence operations between the east coast of Australia and Auckland;

 

(e)        it would take Virgin Blue a period from weeks to two months to increase Pacific Blue’s frequency on existing, or introduce Pacific Blue services on new, trans‑Tasman routes;

 

(f)        Virgin Blue is well capitalised;

 

(g)       Pacific Blue has gained access to facilities (including terminal space, counter space and slots) at Wellington, Christchurch and Auckland airports for the purpose of providing trans‑Tasman services and Virgin Blue has to date been able to obtain access to the slots it needs, although it is unclear whether access to slots will be an issue for Pacific Blue going forward;

 

(h)       Virgin Blue intends to deploy aircraft to Pacific Blue for domestic New Zealand services which are currently anticipated to commence by the end of 2004 but no final decision has been made as to when the services will commence and on what routes;

 

(i)        it is unclear whether Virgin Blue will be able to negotiate with Auckland Airport commercially viable arrangements for access to facilities for the purpose of providing domestic services, or whether Virgin Blue may be able to use Whenupai Air Force Base in Waitakere (North Auckland) for this purpose;

 

(j)        Pacific Blue is opportunistic, continually reviewing all trans‑Tasman routes for potential opportunities for expansion and likely to deploy capacity or further capacity (as the case may be) on a trans‑Tasman route in response to either (i) a material withdrawal of capacity by participants on that route or (ii) authorisation of the [Alliance].

 

Does making these assumptions have any implications for your conclusions with respect to the competitive effect of the [Alliance] in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counter‑factual?  Explain the factors that you will take into account in assessing these questions.”

 

349               The experts gave the following answers in response: 

·                    Professor Ordover said that the above assumptions were consistent with his conclusion of an absence of a substantial lessening of competition in the form of no material increase in average fares or in the distribution of fares.  In relation to capacity, if capacity were withdrawn but the quality of services was not lessened because of more efficient utilisation of aircraft, that was also a benefit overall because that aircraft was likely to be utilised elsewhere and deliver the kind of benefit which might not otherwise be available. 

·                    Professor Levine considered that, based on the evidence of Mr Huttner, Virgin Blue was unlikely to enter Auckland any time soon and perhaps not during the term of the Alliance.  He said that there was separation between the markets in New Zealand because they were long drives apart and it was relatively inconvenient for passengers to get from one destination to the other.  Fares in Auckland would be priced to make the market unattractive to Virgin Blue but would not be priced at the lowest fare possible.  The average fare level would be higher in the factual than in the counterfactual.  Convenience fares (that is, fares for time‑sensitive passengers) might be constrained a little by Virgin Blue.

·                    Dr Tretheway noted that these assumptions differed from his opinion in his report that Virgin Blue would be unable to enter the domestic Auckland market.  If Virgin Blue entered the domestic Auckland market, it would move the passenger traffic from points other than Wellington, Christchurch and Auckland across either the Wellington or Christchurch trans‑Tasman gateways but Virgin Blue would still flow that traffic on to trans‑Tasman routes.  He maintained his opinion that prices would not be higher in the factual or counterfactual despite differences in capacity between the factual and counterfactual.

·                    Professor Hazledine said that he did not assume any difficulties faced by Virgin Blue in expansion and that the above assumptions were implicitly assumed in the analysis he prepared.  He maintained his view that the Alliance would result in an increase in average fares or a reduction in capacity in the market in the factual as compared to the counterfactual.

·                    Mr Ergas said that these assumptions were consistent with his conclusion that there was no durable adverse impact on competition and consistent with the factual and counterfactual schedules that underpinned the cost savings set out in his statement.  These assumptions meant that there was no reduction in capacity in the factual relative to the counterfactual because of the persistence of competitive constraint.  Further, there would be no material and sustained increase in fares in both the business and leisure markets.

·                    Professor Oum considered that these assumptions did not change his conclusion that an increase in average fares or reduction of capacity in the trans‑Tasman market in the factual relative to the counterfactual would occur.  However, he thought that the degree of the increase or reduction may be less given these assumptions.

 

350               We note Professor Ordover’s view that an LCC like Virgin Blue has the ability to constrain the applicants in the trans‑Tasman air passenger services market and FFCs, whether committed long‑term or not, could have a significant impact on competition throughout the market by competing for customers at the margin. 

351               The answers provided by the experts in response to Question 2 do not result in us changing our views and conclusions as to the extent to which Virgin Blue would operate as a competitive constraint on the applicants in the future.

352               Professor Ordover made four important points regarding the constraints imposed by entry and expansion in a market, with which we agree:

·                    competitive constraints occur at the margin, and impact on the marginal passenger.  Rivals or potential competitors do not need to appeal to all of the incumbent’s passengers to exercise a competitive constraint on them.  Rather, it is necessary only that enough customers are affected at the margin to make any increase in fares by the incumbents unprofitable;

·                    while an LCC’s product may be different from that of an FSA, LCCs can and do constrain the conduct of the FSA;

·                    constraints imposed by entrants do not depend on an immediate ability to increase capacity, but on their ability to implement a sound business plan over a well‑defined period of time; and

·                    incumbents will be constrained from charging supra‑competitive fares, not by the threat of entry on a particular route, but by the potential for new entrants to enter trans‑Tasman routes and gain profitable market share .

 

353               Professor Ordover’s view was that fares in airline markets were driven generally by the competition for customers at the margin, and that this competition was provided by new entrants and other airlines seeking either to fill scarce capacity by marginal cost pricing, or by introducing a new set of competitive strategies generally to which incumbent airlines were compelled to respond.  Professor Ordover believed that entry and expansion barriers were so low that the market was, in his words “workably contestable”, that is that any attempt by the Alliance over the five‑year authorisation period to raise average fares would divert so many passengers to its rivals that it would not be profitable to do so.  His evidence, which we accept, was that a 10% fare increase would divert so many passengers away from the Alliance that such an elevation in fares would be unsustainable.

354               We recognise that Pacific Blue does not satisfy the needs of all time‑sensitive passengers, but we have formed the view that it is likely that it will be successful in acquiring more business travellers as it continues to target the corporate market and to increase frequencies on existing routes and eventually enter the Auckland routes.  Pacific Blue’s inability to offer sufficient frequencies is somewhat alleviated by the increasing availability of one‑way fares, which mean that passengers may choose their own schedules using different airlines.  One of the key features of Pacific Blue’s business plan is the promotion of one‑way fares.  Mr Huttner said that Pacific Blue was currently pursuing that strategy across the Tasman and that most of its competitors were copying its price and fare structures and offering one‑way fares.  Accordingly, passengers may fly Pacific Blue one‑way and another airline on the return trip.

355               We consider that Pacific Blue currently acts as a pricing constraint on routes it currently serves as well as on some routes which it does not currently serve.  This is primarily because it poses a threat to other airlines that it will enter routes where fares are artificially high.  Consumer pressure may have some effect in ensuring the price differential between the various trans‑Tasman routes is not too high. 

356               We consider that the evidence that Pacific Blue is likely to enter the Auckland routes should those routes become more profitable demonstrates that Pacific Blue is likely to provide a competitive constraint on those routes under the Alliance.  The Alliance partners will be aware that if they attempt to increase fares above current levels, Pacific Blue is likely to enter those routes, and in any event people will take advantage of capacity offered by FFCs. 

357               In summary, the proper question to ask in this regard is not what is the current position but what is it anticipated will be the position under either a factual or counterfactual scenario over the next five years?  We consider that eventually Pacific Blue will enter the Auckland routes, particularly since this will enable it to provide more comprehensive domestic New Zealand services.  Virgin Blue’s evidence suggested that its trans‑Tasman activities would be stronger under the Alliance, in particular, that it would be more likely to enter the Auckland routes if the Alliance were to proceed.  In any event, we consider that under the Alliance, fares on those routes will continue to be constrained by Virgin Blue’s threatened entry and by fares on other routes.

358               In our view, Virgin Blue is unlikely to operate under a price umbrella as this is contrary to Virgin Blue’s philosophy which is to pursue volume, to spread its fixed costs over greater volume and to pass its cost savings on to consumers in the form of lower fares in order to obtain more volume.

359               We do not consider that Virgin Blue, on its own, would necessarily act as a sufficient constraint on the applicants, but we regard the position as quite different when its activities and market conduct are taken together with that of Emirates.

FFCs and Emirates

360               As noted at [40], a number of FFCs currently operate on the trans‑Tasman routes.  The parties to the proceeding mainly focused upon Emirates, as it exhibited many of the common features of an FFC but was said to be even better placed to impose a competitive constraint on the applicants.

361               Emirates is a rapidly expanding, high quality international airline owned by the Government of Dubai.  It is creating a global network, including Australia and New Zealand, from its Dubai hub and specialises in top‑end service.  As Emirates’ trans‑Tasman service is the same as that provided on its international flights,it provides a long‑haul standard service on a short‑haul route and offers a larger seat pitch to economy passengers than other airlines.  The Airbus 340‑500 aircraft which will fly on some trans‑Tasman routes also offers full sleeper seats for first class passengers.  Emirates operates one of the youngest fleets in the industry with an average age of 46 months, compared with the industry average of 156 months.  Unlike the applicants, as a comparatively young airline, it is not burdened by legacy costs.

362               Emirates utilises its aircraft which would otherwise have extended layovers on the ground in Australia (primarily to allow return connections to Dubai) to operate extensions from Australia to New Zealand.  Emirates provides trans‑Tasman services on a marginal cost basis and it is generally more profitable for Emirates to be flying trans‑Tasman routes than for its aircraft to remain on the ground in Australia.

363               At the time of the hearing, Emirates operated 21 flights per week across the Tasman and had plans to expand those services and add new routes. 

364               Emirates seeks to attract all passenger sectors of the available trans‑Tasman market.  This includes the corporate and government markets, the Marketing Incentive Conventions and Exhibition (“MICE”) market, the VFR market and the leisure market.  Emirates offers convenient flight schedules and one‑way fares so that travellers can fly Emirates one‑way and another airline the other way, thereby choosing an itinerary which suits their travel plans and budget.  Emirates is thus relatively attractive to the business market in terms of offering daily flights and a high quality product.  Emirates has non‑exclusive travel accounts with six major Australian institutions and a significant part of its promotional activity is directed towards the business market.  We are satisfied that Emirates matches or exceeds the quality of service of competing FSAs such as the applicants in relation to seats, meal services, entertainment services and lounges.  On certain routes, Emirates does not need to offer multiple daily frequencies in competition with the applicants in order to attract business travellers because of its high quality product.

365               At the time of the hearing, Emirates’ passenger traffic on trans‑Tasman routes comprised 30% business, 30% leisure and 40% VFR traffic.  In the first quarter of 2004, Emiratessecured8%oftheSydney–Aucklandpassengers,20%oftheMelbourne–Aucklandpassengers and 22% of the Brisbane–Auckland passengers.  Emirates expected to acquire [x]% of the business class segment and [x]% of the economy class segment of the trans‑Tasman market.

366               Air New Zealand emphasised Emirates’ capability and current success in attracting trans‑Tasman origin/destinationpassengers in contrast to other FFCs.  We received data which showed that, between January and March 2004, of all trans‑Tasman passengers flying on FFCs (excluding Emirates), 33.4% were travelling beyond the FFC’s hub, 31.4% were travelling to the FFC’s hub and 35.2% were travelling trans‑Tasman only.  When factoring in Emirates, these figures changed to 31.9%, 20.8% and 47.3% respectively, showing that Emirates has a significantly higher proportion of trans‑Tasman passengers than other FFCs.

367               As we noted earlier, Emirates commenced flying trans‑Tasman in August 2003 and as at the time of the hearing was operatingdailyflightsonthe Sydney–Auckland, Melbourne–Auckland and Brisbane–Auckland routes.  At the hearing, Mr Lim informed us that from August 2004Emirates planned to have six flights a week from Melbourne to Christchurch and that this could be increased to daily flights in the near future.  After Emirates commenced its double daily flights from Dubai to Sydney, Mr Lim said that Emirates might commence operating flights four times a week from Sydney to Christchurch or Auckland from November 2004, expanding to a daily service from March 2005.  Mr Lim also said that Emirates may operate a flight into [C] from Dubai which will most likely to lead to a service between [C] and [B] or [A].  Mr Lim said that there was currently no plan to fly from Perth across the Tasman because presently the schedule of flights from Dubai to Perth allowed no time for this service.  However, Emirates may consider flights between [D] and [B] if it were to operate additional flights into [D] from Dubai.  According to Mr Lim, Emirates would not expand further than this and would not fly into Wellington. 

368               Emirates’ area marketing plans for the 2004/05 financial year indicated that [B] would remain a key focus for Emirates as that location provided an opportunity for Emirates to raise awareness within the corporate market of its schedule and superior product, which may also lead to business travellers using Emirates for long‑haul routes.

369               There was some suggestion by Air New Zealand that Emirates might establish a hub in Christchurch or Auckland enabling it to provide travel around the world by flying across the Pacific to the mainland United States.  However, Mr Lim said that Emirates had no plans to fly to the United States from the Pacific over the next five years and also said that there was no reason for Emirates to build a hub in Australasia, being “the extreme end of the world”, noting that Dubai was in the fortunate position of being located in the middle of the world.  We are unable to conclude on the basis of the evidence whether Emirates wants to establish an Australasian hub or not, but it is clear that it wants to establish a significant presence in Christchurch.

370               Financial records for Emirates’ trans‑Tasman services indicated that during Emirates’ first months of operations, those services were not earning the anticipated contribution to corporate overheads.  Mr Lim’s view was that there had been a turn‑around in the position and that trans‑Tasman services were making a positive contribution to corporate overheads from April 2004 and would continue to do so in the future.

371               As a network carrier, Emirates views its profits on a network‑wide basis rather than an individual sector basis.  Therefore, if it is profitable overall in its network, it can expand its network, even if new sectors are not initially profitable. 

372               The view expressed by Mr Lim on behalf of Emirates was that Emirates did not believe that it faced any significant barriers to entry or expansion across the Tasman.  Mr Lim said that he was not aware of any regulatory barriers, nor slot barriers, nor any entrenched brand preferences.  However, Mr Lim did confirm that a memorandum of understanding existed between the governments of the United Arab Emirates and Australia which only gives Emirates beyond Australia rights to two places in New Zealand.  Mr Lim said that Emirates was not concerned about the proposed Alliance between the applicants and considered it would have no problems competing with the Alliance.

373               The Commission and the Gullivers Group submitted that Emirates’ advertising and building its brand in Australasia was primarily related to its long‑haul operations from Australasia through Dubai to destinations including Europe and could not be taken as a measure of Emirates’ commitment to trans‑Tasman services, which were incidental to these long‑haul operations.  The Gullivers Group also emphasised that Emirates’ interest in the trans‑Tasman routes was derivative and secondary and that its operation of such routes was ultimately governed by global factors.  Nevertheless, we are satisfied that Emirates is committed to the trans‑Tasman air passenger services market at least in the short to medium‑term. 

374               Professor Levine suggested that it would be difficult for Emirates to achieve and sustain profitable operations on a fifth freedom sector at the end of a long‑haul route with aircraft that were oversized, overpowered and overweight, while competing in the home markets of two substantial operators using appropriate‑sized aircraft.  Professor Levine compared this to Qantas’ attitude in relation to its Singapore route on which it has expressed difficulties in relation to selling seats because it has to compete with Singapore Airlines in its hub and home country.  He suggested, based on his commercial experience, that Emirates would be forced to contract or it would lose large sums of money.  Professor Levine concluded:

“When Emirates is inevitably required to take a hard look at its operations, it will probably conclude that committing a billion dollars worth of equipment to this market is wasteful and that the trans‑Tasman market merits only one frequency a day from them, probably via different gateways on some days rather than others.  Until then, trans‑Tasman passengers are getting foreign aid from the Government of Dubai and/or other Emirate [States].”

 

375               However, Emirates has successfully extended its long‑haul flights through Australia to New Zealand and its performance as at the date of our determination suggests that Professor Levine’s view will not hold true.

376               Whilst the Commission pointed to the proposition that FFCs have limited ability to constrain competitive activity at the end of the network having regard to their global network, we believe that Emirates appears to have presented a new paradigm in the airline industry and we are satisfied that Emirates should not be considered in the same way as other FFCs.  We are satisfied that Emirates has developed a business or commercial strategy which is designed to increase its presence in Australasia.

377               It may well be, as submitted by the Commission, that Emirates is building its brand in Australasia for the prime purpose of supporting its long‑haul operations from Australasia through Dubai to destinations including Europe.  Nevertheless, there is a spin‑off in relation to these operations across the Tasman and we are satisfied that the evidence in relation to Emirates is to be taken as a measure of its commitment to trans‑Tasman services as well as to international services into and out of Dubai, Australia and New Zealand.

378               As Emirates prices its trans‑Tasman operations on an incremental cost basis, it is unlikely that it will stop flying trans‑Tasman routes because it is more profitable for Emirates to be flying trans‑Tasman routes than for its aircraft to remain on the ground in Australia.  If anything, there will be an increase in its activities over the next few years and it is likely that Emirates will increase services to new destinations.  Emirates has substantial growth plans and the Dubai Government wishes to make Dubai a hub and international travel centre, as well as a financial centre.

379               We understand that Emirates needs a load factor of not less than [x]% for trans‑Tasman flights to break even.  Its business model operates on achieving load factors significantly greater than that.  The result is that Emirates expects its trans‑Tasman services to operate on a basis that makes a significant contribution to corporate overheads and profits.  We note that Emirates’ market share for origin/destination for trans‑Tasman passengers for the first three full months of the trans‑Tasman operations (October to December 2003) was only 6.1%, contrasted with the combined market share of the applicants of something around 88.1% and that it has had low break‑even load factors relative to the applicants.  These are matters we have taken into consideration in determining the extent to which Emirates may be a competitive constraint upon the applicants on its own.  However, the evidence suggests that Emirates is intending to “grow” its presence in Australasia.  The evidence from Mr Lim was equivocal in relation to an [C–B] service and a [D–B] service, but the increase in flights from the east coast of Australia to New Zealand exemplifies Emirates’ increased presence in Australasia.  We also accept the evidence of a number of witnesses that all airlines face difficulties in planning for any significant period ahead in time.  The evidence as a whole points to the conclusion that Emirates will not be reducing its services or withdrawing from Australia or New Zealand at least in the short to medium term. 

380               The tables to which we referred above, (see [296], [297] and [298]), demonstrate Emirates’ ability to be competitive and to take market share from the applicants.  It has the ability to attract passengers at the margin and we are satisfied that it is committed to developing its trans‑Tasman market over the next few years.  This can be seen, for example, from the extent to which it has sponsored and supported local Australian and New Zealand cultural and sporting activities (see [48]).

381               In this regard it is important to recognise the financial strength of Emirates.  At the time of the hearing it had announced a record year with a profit of US$476 million on revenues of US$3.8 billion for the year ended 31 March 2004.  Emirates shareholders’ funds as at 31 March 2004 were US$1,334 million (up by 32.1% compared with the year ended 31 March 2003). 

382               It was apparent to us that Emirates perceived no barriers to entry or expansion across the trans‑Tasman and that the possibility of Emirates withdrawing from the trans‑Tasman market or scaling back its expansion plans appears to be very low as Emirates has only ever withdrawn from two destinations, Comoros and Baku in Azerbaijan, neither of which resembles the trans‑Tasman market.

383               Looking at the ability of Emirates to constrain the Alliance, the applicants submitted that FFCs, in particular Emirates, would provide a sufficient constraining effect upon the Alliance, particularly when combined with the constraining effect of Virgin Blue.

384               Air New Zealand submitted that FFCs in general, and Emirates in particular, affected the applicants’ pricing activities.  Firstly, the capacity and low fares of FFCs impacted upon forward bookings and so FSAs such as the applicants could not afford to price uncompetitively because forward bookings would decline as passengers switched to FFCs and, as a result, more seats on the flight would be allocated to low fare buckets.  Secondly, the pricing of FFCs would impact upon passenger perceptions of appropriate fare levels across all trans‑Tasman routes.  In this way, FFCs set the base or benchmark price point that the market perceives as a reasonable price for fares on these routes.

385               The impact on pricing was demonstrated by Mr Harrison of Air New Zealand who said that in June 2003, Air New Zealand reduced its “T” class for four trans‑Tasman routes by [--]% principally because it anticipated the entry of Emirates on its Sydney–Auckland and Melbourne–Auckland routes.  In April 2003 Air New Zealand increased its fares by approximately [x]% on the Auckland routes and the Sydney–Wellington and Melbourne–Wellington routes in response to trans‑Tasman fare changes by other airlines, especially FFCs, in particular Garuda Indonesia, Malaysian Airlines and Thai International.  Furthermore,Air New Zealand had reduced its business class fares on the Brisbane–Auckland route by 23% to compete more effectively against FFCs, in particular Malaysian Airlines, Garuda Indonesia and Thai International.

386               Professor Ordover accepted that the limited frequency typically offered by an FFC like Emirates across the Tasman would restrict its attraction to business travellers.  However, he contended that the important issue was how many passengers there were on the margin who would view an FFC’s schedules and other aspects of its service as attractive enough to switch away from the incumbent firm to the FFC, as “[o]ne does not need [to] appeal to each and every business passenger; one needs [to] appeal to a sufficient number of marginal passengers in order to exert the kind of constraint that we would like to see exerted.”  

387               Professor Levine considered that long‑haul FFCs were virtually always weak competitors for time‑sensitive passengers in shorter‑haul markets that would support multiple flight frequencies.  He held this view because bilateral arrangements did not permit FFCs in a market to shuttle aircraft back and forth between fifth freedom points without regard to the timings of services in their home markets.  He contended that the value of the equipment they operated made it difficult and expensive (in utilisation penalties and inconvenience to through passengers) to adapt long‑haul schedules to short‑haul needs. 

388               The Gullivers Group emphasised the fact that Emirates did not determine its schedules and operations in response to price and capacity signals from dedicated carriers, but instead responded to compatibility with its long‑haul routes.  It argued that Emirates was therefore less suited to meeting the preferences of passengers who valued reliability, frequency, flexibility of flights and frequent flyer benefits.

389               Whilst Emirates may be limited in the trans‑Tasman market by the fact that its trans‑Tasman activities are dictated by the times at which, and the extent to which, it flies to Australia, particularly the east coast, that is not to say that it will not offer trans‑Tasman competition to the extent to which it operates on those routes.  We find that Emirates, along with Pacific Blue, is able to impose a competitive constraint on the applicants by reason of its ability to sustain fares on a marginally costed basis on trans‑Tasman routes.  That the business flights operated by Emirates and other airlines impact upon the applicants’ pricing is evident from the fact that the applicants have adopted a practice of monitoring the pricing and other activities of these airlines.

390               As an FFC, Emirates operates aircraft designed for long‑haul international travel and therefore has an in‑cabin product offering on trans‑Tasman routes that is often of superior quality to that of the applicants.  This is attractive to many business travellers.  Although as an FFC Emirates does not offer the same frequency of service as the applicants, it provides a competitiveconstraintbecausea key demand characteristic of trans‑Tasman origin/destination passengers is price sensitivity. 

391               In regards to the ability of FFCs in general, and Emirates in particular, to attract time‑sensitive travellers, we make the following observations.  In our view, there are broadly three types of business travellers on the trans‑Tasman routes:

·                    those who travel from Australia to New Zealand and return the same day. We consider that there would not be many passengers in this category as most business people would plan to spend longer than a few hours in New Zealand.  Nevertheless, for these travellers, at the time of the hearing, Emirates’ schedules on the Sydney–Auckland and Brisbane–Auckland routes were convenient.  For example, the schedule of Emirates’ flights across the Tasman showed that if a business traveller were seeking to fly from Sydney to Auckland and back within a day, Emirates provided a good option, leaving Sydney at 7:50am and departing Auckland at 6:00pm;

·                    those who leave Australia in the morning of one day and return on a subsequent morning.  At the time of the hearing Emirates did not provide a convenient schedule for these travellers because it did not offer any morning flights from Auckland.  However, given the now wide‑spread nature of one‑way fares, travellers could have flown Emirates to New Zealand and returned on another airline;

·                    those who leave Australia in the morning one day and return on a subsequent evening.  Similar to the first category, at the time of the hearing such travellers would have had many options in relation to carriers and schedules and Emirates provided a convenient schedule in both  directions on each of the Sydney–Auckland, Brisbane–Auckland and Melbourne–Auckland routes. 

 

392               The time differences between Australia and New Zealand make it difficult for time‑sensitive passengers to complete a round business trip from Australia to New Zealand within one day.  Whilst the general consensus between the economists was that the ability of FFCs to attract business travellers was limited due to their relative infrequency of flights compared to the applicants, the significance of the time differences between the east coast of Australia and New Zealand somewhat diminishes the relevance of the daily flight schedules.

393               As New Zealand time is two hours ahead of the time on the east coast of Australia, the problem does not arise for the time‑sensitive passenger who wishes to travel from New Zealand to Sydney, Melbourne or Brisbane, and return to New Zealand after a full day of business commitments.  A passenger leaving New Zealand at or about 7:00am will arrive in Sydney or Melbourne at or about 8:30am.  If that passenger returns to New Zealand on the same day and left Sydney or Melbourne at or about 6:00pm, he or she would arrive in New Zealand at or about 11:30pm.  We did not understand there to be any issues of a curfew at any of the major New Zealand airports prior to midnight.

394               However,thetimedifference does significantly impact upon time‑sensitive passengers who wish to travel from Australia to New Zealand for a morning appointment.  If such passengers had taken a 7.00am flight out of Sydney or Melbourne, because of the time difference, they would not arrive in New Zealand until the early afternoon.  It follows that a traveller who wishes to arrange a morning meeting in New Zealand is compelled to arrive the previous day or the previous evening.  This situation applies in the factual, the counterfactual or any other scenario in relation to trans‑Tasman business travel.

395               It can therefore be seen that if, under the Alliance, the applicants were to reduce the frequency or capacity of flights, the only type of passenger who would be inconvenienced would be the time‑sensitive passenger who wished to travel to New Zealand and return to Australia in the one day.  Such passengers could not be adequately accommodated by the limited schedules offered by FFCs.  Whilst these passengers could still leave Sydney or Melbourne early in the morning they would only have available for business commitments and activities no more than approximately two to three hours before having to return to the airport to travel back to Sydney or Melbourne.  If, under the Alliance, the applicants were to reduce frequency of or capacity on late afternoon/early evening flights from New Zealand to Australia, then the inconvenience would be demonstrable. 

396               Whilst an airline offering greater frequency than its competitors on the trans‑Tasman routes could expect to attract a greater proportion of business travellers and achieve higher average fares than those competitors, this advantage is diminished when one recognises that today one‑way fares are the rule, rather than the exception, and daily round trips are unlikely to occur with any great frequency due to the time differences referred to above.

397               Although some witnesses referred to the lack of a frequent flyer program, or a frequent flyer program with a number of participants, in relation to Emirates and others as a disincentive for time‑sensitive passengers to fly with those airlines, we consider that the time‑sensitive passenger is likely to be motivated more by price considerations than the ability to participate in a frequent flyer program.  We should point out that a number of the economists expressed views on the preferences of time‑sensitive passengers.  However we have reservations about the qualifications of these experts to express views on such matters.  Having regard to the circumstances in which the need to undertake a business flight arises, we consider that the order of priority for a time‑sensitive passenger is generally the schedule or flight time, followed by the price, and only thereafter would considerations of the availability of a frequent flyer program come into play.

398               Whilst we have looked at the particular case of Emirates, we believe that these findings are of general application to FFCs and their ability to act as a competitive constraint on the applicants.  Dr Tretheway’s evidence, which we accept, was that the trans‑Tasman market was highly suitable for the operation of FFCs, as otherwise such carriers’ aircraft would spend many hours idle at Australian airports due to time zone and curfew constraints at their originating airports.  He believed that there was strong evidence that fifth freedom operations can be sustainable, even in the long‑run, and that they could “press the Alliance even more firmly on high‑quality dimensions of the full service airline”.  His expectation was that the applicants would respond to further entry or expansion by FFCs by lowering fares or by increasing the capacity they allocated to the lower fare buckets.

399               We have formed the view that the ability of FFCs, including Emirates, to engage in marginal cost pricing allows them to target price‑sensitive trans‑Tasman origin/destination passengers and, in so doing, provide a competitive constraint on the applicants because a significant demand characteristic of Tasman origin/destination passengers is price sensitivity, as evidenced by the recent success of online internet bookings of cheap fares and the continued prevalence of discounted fares.

400               We are satisfied that there will be a number of passengers at the margin to whom FFC services will appeal.  Whilst it is likely that the schedules offered by FFCs will not appeal to all passengers, and in particular, may not appeal to some time‑sensitive passengers, we are satisfied that the FFC service will appeal to a sufficient number of marginal passengers to impose a significant competitive constraint upon the Alliance. 

401               We consider that the constraining effect of FFCs would extend to routes other than the Auckland and Christchurch routes on which they operate.  Market forces would not allow a significant fare differential between the Auckland routes and the remaining main trans‑Tasman routes because, if fares on, say, the Wellington–Sydney route are significantly higher than fares on the Auckland–Sydney route, then passengers will travel to Auckland and fly from Auckland to Sydney, rather than from Wellington to Sydney.

402               We are not satisfied that Emirates or any of the other FFCs alone constitute a complete restraint on the applicants in respect of the conduct proposed under the Alliance.  This must inevitably follow from the number of flights operated by Emirates and the other FFCs compared to the number of flights operated by the applicants.  It also follows from the greater “city presence” of the applicants in Australia and New Zealand compared to Emirates and the other FFCs.  However, we are satisfied that, taken in conjunction with the position and activities of Pacific Blue, Emirates and other FFCs will consolidate the competitive constraint which we have found will be placed upon the applicants by Pacific Blue.

403               A question was put to the experts regarding the likely impact of Emirates on the Alliance (Question 1).  It provided as follows:

“Assume that Emirates:

(a)       is an active and committed competitor on trans‑Tasman routes between major Australian cities and Auckland and is committed to establishing a Christchurch presence;

 

(b)       currently operates daily return flights on each of the following routes:  Sydney/Auckland (with a seat capacity of 258 per flight), Melbourne/Auckland (with a seat capacity of 368 per flight), and Brisbane/Auckland;

 

(c)        within the next twelve months, Emirates will commence operating:

i.          six return flights on the Melbourne/Christchurch route (with a seat capacity of 248 per flight); and

ii.         an additional daily return trans‑Tasman flight ex‑Sydney to either Christchurch or Auckland, but likely Christchurch (with a seat capacity of 248 per flight);

 

(d)       within the next two months, Emirates will commence operating daily return flights on the Perth/Auckland route (with a seat capacity of approximately 250 per flight;

 

(e)        within the next 5 years, Emirates may operate:

i.          an additional return flight on the [G]/[A] route; and

ii.         a return service between [C] and either [A] or [B];

 

(f)        within the next 2‑7 years, there will be a series of staggered aircraft substitutions on the [F]/[B], [G]/[A] and [H]/[B] routes ultimately increasing likely seat capacity per flight to 600, with this substitution occurring relatively earlier on the [F]/[B] route;

 

(g)       has a break‑even load factor of approximately [x]% for trans‑Tasman routes;

 

(h)       faces regulatory barriers to entry on trans‑Tasman routes to New Zealand cities other than Auckland and Christchurch, as Emirates’ fifth freedom rights under the relevant United Arab Emirates bilateral agreements extend only to these two New Zealand cities; and

 

(i)        does not face any barriers to the introduction of the services specified above.

 

Assume also that daily services are sufficient to attract the business passenger and the current breakdown of Emirates’ passenger traffic on trans‑Tasman routes is comprised of 30% business, 30% leisure and 40% visiting friends and relatives (‘VFR’).

 

Does making these assumptions have any implications for your conclusions with respect to the competitive effect of the [Alliance] in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counterfactual?”

 

404               We note that there were some variations between these assumptions and the evidence before us.  Nevertheless, we are satisfied that the assumptions substantially reflect the evidence before us or, at least, inferences which can be drawn from that evidence.  We do not consider that these variations were material to the opinions which the experts gave in relation to Emirates.  The experts gave the following answers:

·                    Professor Ordover considered that under these assumptions, the likelihood of adverse outcomes, in the form of higher fares, from the Alliance would be lessened.  He said that Emirates’ constraint was likely to be effective on the routes it serviced.  However, he noted that Emirates served only Christchurch and Auckland and could not fly into Wellington. 

·                    Professor Levine considered that the assumptions were not realistic commercially.  However, assuming the assumptions applied, he said that fares in Wellington and some fares in Auckland would not be constrained by Emirates.  There would be an increase in fares for time‑sensitive passengers in Wellington and other markets not served by Emirates and there would be some impact on fares for time‑sensitive passengers in Auckland because of the limited schedule for those passengers who cannot accommodate themselves to Emirates’ schedule.  The incumbent carriers might find it necessary to withdraw some capacity.

·                    Dr Tretheway said that, assuming Virgin Blue would continue to operate in the trans‑Tasman market and there was some expansion in domestic New Zealand, these assumptions did not change his opinion because the LCC is the price‑leader in the market.  Dr Tretheway agreed with Professor Levine that the amount of capacity being deployed by Emirates would be likely to cause the applicants to change the capacity they offered.  However, he thought that this would be likely to occur in both the factual and the counterfactual.

·                    Professor Hazledine agreed with Dr Tretheway that Emirates’ increases in capacity applied both to the counterfactual and the factual.  He considered that these increases would reduce prices by about 2% in the counterfactual relative to the situation without the expansions in capacity, and by about 3% in the factual.

·                    Mr Ergas considered that the capacity Emirates offered would have a constraining impact on the business market.  He said that the frequencies Emirates offered would be sufficient to have the effect of attracting a substantial, or at least a material, amount of business traffic.  Although Emirates does not operate in the Wellington market, Emirates’ activities on the Auckland and Christchurch routes would also have an impact in this market because the prices between the city‑pairs could not diverge significantly for extended periods of time.

·                    Professor Oum said that Emirates would pose a competitive threat in the factual and the counterfactual in a short‑run period of about six months to one year.  He thought that, because in the factual there would be one less carrier competing than under the counterfactual, there would be less competition in the factual which would impact on prices and outputs.

 

405               These views do not cause us to alter our conclusion that Emirates, along with Pacific Blue, will operate as a competitive constraint on the applicants in the trans‑Tasman air passenger services market.

406               We also asked the experts to consider the following question (Question 3):

“Making the assumptions outlined at 1 [in relation to Emirates] and 2 [in relation to Virgin Blue] above, do you consider that the [Alliance] will have an anti‑competitive effect in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counterfactual?  Explain the factors that you will take into account in assessing these questions.”


(These assumptions being those set out in Questions 1 and 2 above at [403] and [348] respectively).

 

407               The experts provided the following answers:

·                    Professor Ordover said that a factor in assessing the anti‑competitive effect of the Alliance included whether Virgin Blue’s and an FFC’s schedules and products were likely to be attractive to the flying public.  If they were, he thought that they would have a constraining effect on fares.  He said that another factor would be the ability and incentive of these carriers to provide attractive pricing.  He considered that because of either the substantial efficiency of LCCs, or the different flight economics that FFCs have, these airlines were capable of providing attractive pricing.  He noted that another relevant factor would be barriers to entry and expansion.  He said that if they exist in the trans‑Tasman market, they appeared to be transitory and insubstantial.  Professor Ordover noted that cost efficiencies and product improvements were also relevant factors. 

·                    Professor Levine considered that whether or not the Alliance would have an anti‑competitive effect in these circumstances depended on whether Emirates had plans to change its pricing policy.  Emirates had said that it was not a price‑leader.  Accordingly, if the assumptions in Question 1 were true it would be flying enormous amounts of empty seats across the Tasman.  If Emirates decided to price its seats in order to fill them, leisure fares would not rise on any of the routes it served and fares would be held low enough that they would affect prices on other routes.

·                    Dr Tretheway said that if the assumptions in Questions 1 and 2 were true it would result in a fundamental change in the market in the counterfactual.  If Emirates and Virgin Blue were to survive this change, Dr Tretheway considered that both the applicants would not be able to survive.  Accordingly, the factual would resemble the counterfactual.

·                    Professor Hazledine agreed with Professor Levine and Dr Tretheway that these assumptions made a big difference to the market.  However, he suggested that if Emirates were to expand capacity as in Question 1, rather than the applicants reducing capacity as suggested by Dr Tretheway, Virgin Blue may not find it attractive to serve a lot of markets and might reconsider its plans.

·                    Mr Ergas considered that the implication of making the assumptions in Questions 1 and 2was that barriers to expansion faced by well‑placed competitors were low and accordingly, the long‑run competitive disciplines were, and would remain, effective with the effect that there could not be a material or durable increase in average fares or a reduction in capacity.  If the assumptions were correct, then in the medium‑term Air New Zealand could find it extremely difficult to sustain a viable presence in the trans‑Tasman market.  Mr Ergas agreed with Dr Tretheway that the counterfactual would converge to the factual with the impact that there would be no substantial lessening in competition or anti‑competitive effect as a result of the Alliance.

·                    Professor Oum said that his conclusion would not change in light of the assumptions.  However, as noted in his answer to Question 2, Professor Oum considered that the degree of the increase in average fares and the degree of the reduction in capacity may be moderated given these assumptions.

 

408               Overall, the weight of these opinions support the view that there would be competitive constraints on the Alliance from Virgin Blue and Emirates which would limit the extent to which fares would rise and capacity would be reduced in the trans‑Tasman air passenger services market.

Analysis of competition issues in the trans‑Tasman air passenger services market

409               A substantial part of the expert witnesses’ evidence and the submissions of the parties focused on the impact that Virgin Blue, Emirates and other FFCs have had, and are likely to have in the future, upon competition in the trans‑Tasman air passenger services market.  Dr Tretheway was of the view that the trans‑Tasman marketwas unlikely to be affected by the Alliance due to the large amount of capacity provided by FFCs, the entry and expansion of Pacific Blue, and the effect of Pacific Blue being likely to spread to other routes not presently served by it.  Dr Tretheway was an impressive and credible witness.  He alone of the overseas experts made some attempt to become familiar with the trans‑Tasman market scene and to collect data and estimate the impact of structural changes in Australia’s airline market following the collapse of the Ansett group of companies in September 2001 and the entry of Virgin Blue.  He also commissioned new econometric evidence from the United States on the impact of LCCs, compared with FSAs, in affecting average fare levels.  We found him to be cogent, persuasive and balanced in his testimony.

410               Mr Ergas’ view was that barriers to entry and expansion on trans‑Tasman routes were low and so “long‑running competitive disciplines are effective and … will remain so.”  He believed that little anti‑competitive detriment would result from the Alliance and that any small detriment which did occur would not be durable due to the ease of entry and expansion into the market.  He found it especially relevant that barriers to expansion were low because he felt that there were well‑placed competitors already present in the markets.

411               Professor Ordover thought that the Alliance could lead to some potential short‑term, anti‑competitive detriment on trans‑Tasman routes on which the applicants currently competed.  However, in the long‑run (being the five‑year period for which authorisation of the Alliance is sought), Professor Ordover believed that no anti‑competitive detriments were likely to arise because of the condition of easy entry and expansion, especially as regards Virgin Blue. 

412               By contrast, Professor Levine’s view was that passengers would suffer from the withdrawal or rescheduling of existing and competing services presently being offered by the applicants if the Alliance proceeded.  He was concerned that the public would lose the benefits of convenience and innovation, as well as suffering fare increases.  He thought that such service withdrawals could only be made through the use of market power and argued, contrary to the experts called by the applicants, that there would be no constraint remaining upon the applicants under the Alliance as Virgin Blue and Emirates could not be relied upon to offer a sustained long‑run constraint, at least at this stage of their history in the trans‑Tasman market. 

413               In the face of competition from LCCs, Professor Levine believed that the large legacy costs of FSAs (especially their high labour costs, infrastructure and information technology systems) meant that FSAs sought to exploit or create market power in order to generate rents to pay for their commitments.  He believed that the applicants were seeking, through the Alliance, to eliminate each other’s competition in order to generate monopoly rents to help fund their cost disadvantages, although he thought that “the effects of this suppression may ultimately be undone by other competitors over time.”

414               Professor Levine stressed the importance to FSAs of retaining the custom of premium‑paying, time‑sensitive passengers, for whom schedule frequency was critical.  He accepted that LCCs would also try to attract these customers, but thought that they would not change their business model in such a way as to raise fares for their price‑sensitive passengers.  Professor Levine ultimately considered that inter‑FSA competition was stronger than competition between the Alliance on the one hand and LCCs and FFCs on the other. 

415               Professor Levine regarded the trans‑Tasman routes as “relatively defensible territory” for the applicants, although he thought that Virgin Blue would grow over time.  Both the applicants, he opined, could and would compete if the Alliance did not take place, consumers would benefit from lower fares and innovation, and the applicants would have time to adapt to the new competitors in the market.

416               Having considered the evidence before us, including the views of the expert witnesses, we have reached the following conclusions.  We do not foresee a de novo committed long‑term entrant in the trans‑Tasman air passenger services market that could constrain the applicants as being a realistic likelihood over the period of authorisation, being the next five years.  Any competitive constraints will come from the conduct of Virgin Blue and Emirates.  As there are no natural or strategic barriers to their long‑run expansion, Virgin Blue and Emirates are in a position to expand their current market shares.  We consider they are likely to do so, and in the process will act to constrain any anti‑competitive tendencies that might follow from the formation and implementation of the Alliance. 

417               No evidence has been presented that Virgin Blue and Emirates are niche players that do not seek to expand their market shares.  They are airlines with high growth profiles which appear to have committed themselves in the trans‑Tasman market.  There appear to be no supply or demand‑side factors that will hamper their expansion in this market.  They have strong brand images.  There appear to be no funding problems, and no difficulties in sourcing aircraft.  Both airlines told us that they believed that they faced no long‑term problems in obtaining access to airport gates or slots.

418               On the demand side, their rapid growth in collective market share in less than a year suggests that Virgin Blue and Emirates face no intrinsic strategic disadvantage with respect to product differentiation or brand credibility, such that the applicants could afford to ignore their pricing, scheduling and product initiatives.

419               Even though the Alliance would, in the short‑run, command a high share of the trans‑Tasman air passenger services market, we believe that there would be little scope for any significant long‑run damage to the competitive process.  If the Alliance were to go ahead, there would not be any barriers to significant entry nor would there by any barriers to effective expansion by either or both of Virgin Blue or Emirates.  In such circumstances, the behaviour of the applicants would be constrained.

420               It is true that in the short‑run the constraints offered by Virgin Blue and Emirates may be confined to some sectors of the market only, for example to some kinds of leisure travellers.  However, such competition at the margin can quickly spread to other consumers as their expectations are raised and all players will seek constantly to gain a strategic advantage, however fleeting, over their rivals.  Constant renewals of competitive initiatives, either in response to those developed by rivals or developed as part of a new strategy, can be expected to occur, to the lasting benefit of travellers.  In particular, we expect that persistent bouts of competitive pricing in the market from time to time will exist.  The applicants will be compelled to respond to the competitive initiatives of Virgin Blue and Emirates.  Not to do so in the absence of barriers to expansion would quickly cede market share to Virgin Blue and Emirates.  Prices will not last for long at supra‑competitive levels in the absence of barriers to entry or barriers to expansion.  We believe that such an outcome is likely in both the factual and the counterfactual.

421               Competition is a long‑run phenomenon, a process whose ultimate benefits may not always be immediately apparent.  New competitive strategies such as the development of a frequent flyer program can take time to be developed and put into operation, and potential passengers may at first be reluctant to fly with an airline with which they have never before flown – the phenomenon of consumer inertia in the presence of information costs and switching costs.

422               While one relatively new airline that is predisposed to compete could by itself force much larger incumbents to react competitively to its expansion strategies, the pro‑competitive impact of two such rivals seeking to expand contemporaneously could be magnified more than proportionately, especially if they each introduce into the market a different set of strategic initiatives and new commercial emphases.  That is, the combined impact of two such firms seeking to expand in the market at the same time could yield synergies for competition that would not be available from the temporally sequential expansion of the two new rivals.  Not only would the applicants have to respond to two new sets of commercial initiatives, but the other players will also be reacting competitively to each other as well as to the applicants, leading to a greater number of permutations of strategies that will compel the development of competitive counter‑strategies.

423               Virgin Blue and Emirates have by their actions to date in the trans‑Tasman market exhibited different endowments, motives, strategies and competitive characteristics.  Both have the ability to play the role of a maverick in the market, thereby keeping the applicants on a continual competitive alert, both proactively and reactively.  Their impact on customers at the margin has already been significant.  Virgin Blue’s modus operandi is transparent and has been on display now for a few years in the Australian domestic market. 

424               Virgin Blue represents the current reality of aggressive, pro‑competitive market expansion.  It has quickly gained a significant share of many city‑pair routes across the Tasman.  There appear to be no structural barriers to its further expansion, and to date it has met all the strategic challenges thrown at it by the applicants.  It has announced it will enter the Sydney–Auckland route and domestic New Zealand routes when it assesses market conditions are favourable to do so.  Such a signal, with its stated ability to bring capacity quickly into the market, offers a constraint both real and likely to the applicants.

425               The long‑term strategy (as distinct from its perceived strategy in the next few years) of Emirates is less easily discernible, either from its published documents, its press releases or from its actions to date in the trans‑Tasman market.  It is primarily a long‑haul operator with little experience in operating relatively short‑haul flights.  Its long‑term motives in flying trans‑Tasman sectors appear to be based on aircraft utilisation.  Although its long‑term commitment to the trans‑Tasman market is arguably less certain than that of Virgin Blue, we are satisfied that it is committed to that market at least in the short to medium term.

426               However, that in itself puts Emirates in the role of a competitive “wild‑card”.  While its scheduled frequency of operation for the foreseeable future does not match that of the Alliance, its superior product, current high levels of excess capacity, and its ability to price at close to marginal cost should it so desire, means that it looms as an ever‑present competitive threat at the margin.  Should the applicants take advantage of the high market share gained as a result of the Alliance to the detriment of passengers, Emirates has the ability to turn this threat into the reality of lower fares, thereby taking away from the Alliance the marginal customers whose custom can be the difference between a profitable flight and an unprofitable one.

427               Virgin Blue also has significant plans to expand in the trans‑Tasman market.  This latent threat of further expansion by both Virgin Blue and Emirates, either to further their own growth ambitions or in response to profit opportunities created by the actions of the Alliance, will, in our opinion, work to the long‑run benefit of the competitive process in this market.

428               Prior to the recent entry by Virgin Blue and Emirates, the trans‑Tasman market was one where the applicants faced little sustained or significant competitive threat by any other operator on its constituent city‑pair routes.  If the Alliance were to proceed, there would exist in this market three committed long‑run sources of commercial rivalry, which, in our opinion, represents a significant gain for travellers and for the competitive process.

429               We are not dissuaded from our conclusions in this area of analysis by the fact that, as at the time of the hearing, the applicants had a combined market share of trans‑Tasman passengers of approximately 80% and a combined share of trans‑Tasman capacity of approximately 70%.  The combined market share of the applicants as at the time of the hearing does not reveal the full picture of competition for the marginal customer.  An analysis of the twelve months up to around July 2004 clearly indicates that there was substantial competition for the trans‑Tasman marginal customer.  We have no reason to doubt that these competitive forces will not continue into the future.  In particular, we note that once Virgin Blue and Emirates respectively entered and expanded in the trans‑Tasman market, the combined market share of the applicants dropped from approximately 90% to something around 80%.  The competition for the customer at the margin does not stay with that customer, but those fares necessary to attract the marginal customer will be available to all buyers in the market.  The competition for an extra 1% of market share has an advantage and benefit for all passengers who are within a similar passenger profile as the marginal passengers.  All customers have the ability to get the same advantage and benefit.  Therefore, the competition for the marginal passenger spreads throughout the market. 

430               We wish to make it clear that we accept that an 80% share of a market is a substantial market share.  Moreover, we are not saying that there is no competition issue by allowing two competitors to merge in a market with a total market share post‑merger of 80%.  It is a simple exercise to take a snapshot of a market at a moment in time and see a combined market share of 80%.  However, such a snapshot tells us nothing about the conduct in the market leading to that market share, or about the potential dynamic interaction in that market with other competitors within the market who have either recently entered it or who have recently commenced an expansion of their activities in it. 

431               We emphasise that although there must be recognition given to market share data when considering a merger of the type under consideration, it must also be recognised that significant consideration should be given to predictions of dynamic changes and competitive initiatives in the market in the future by rival firms, albeit with a relatively small market share, but who face no significant barriers to expansion.  Market share tells us nothing about future competitive initiatives and outcomes in the market.  Nor does it tell us anything about how that market share was arrived at.  In the present circumstances, the applicants either obtained or arrived at their respective market shares at a time when Virgin Blue and Emirates, in particular, were not pursuing competitive initiatives like they have pursued in the twelve months or thereabouts preceding the date of this determination.  It must be remembered that Virgin Blue only entered the trans‑Tasman market in January 2004 and Emirates entered that market in August 2003.

432               Clearly the Alliance will result in the applicants acquiring a substantial market share in the trans‑Tasman market, if not in all the markets under consideration.  We must consider how the structure of the market will affect the applicants’ ability to exercise market power.  The Commission’s submissions and those of the Gullivers Group tended, at times, to equate market share with an enhanced ability to exercise market power.  The applicants, on the other hand, sought to emphasise elements of market behaviour, such as barriers to entry and expansion and the resultant ability of current rivals and potential entrants to constrain the exercise of market power.

433               As to market share, the data and statistics available demonstrate that Virgin Blue and Emirates have made a noticeable and significant impact on the applicants’ activities across the Tasman.  Virgin Blue’s and Emirates’ expanded flights across the Tasman have created a viable alternative to flying with the applicants, with a caveat in respect of some time‑sensitive passengers seeking to fly across the Tasman at short notice. 

434               Whilst there have been fluctuations in the relative market shares of Virgin Blue and Emirates since the inception of their expanded trans‑Tasman flights which have not necessarily fitted a consistent pattern, overall it is apparent that there are viable trans‑Tasman flight options other than those of the applicants.  The picture of the market we have gleaned from the evidence is one in which the applicants’ combined share of Tasman origin/destination passengers has been trending downwards over the ten months to the end of July 2004, and there is currently significant excess capacity in the trans‑Tasman market. 

435               We observe that market shares for the trans‑Tasman market can only be calculated on the basis of historic passenger and capacity numbers, with the result that they are not necessarily representative of the long‑run impact of the Alliance on competition.  The ability for new competitors to enter, or for existing competitors to expand in, the trans‑Tasman market is critical to our assessment.  It is barriers to entry and expansion that confer the ability to exercise market power:  Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (supra) at 189.  In the absence of barriers to entry and expansion, the applicants’ combined market share may be transient.  They have already each lost a significant amount of market share since the entry of Virgin Blue and Emirates in recent months.

436               The nature and extent of Virgin Blue’s and Emirates’ activities across the Tasman demonstrate that if the applicants were to raise fares or restrict flights there would be a competitive response from Virgin Blue and Emirates which would increase their load factors and take passengers away from the applicants.  Put another way, there would be a constraint upon, or disincentive for, the applicants to act as if they were unconstrained as to do so would be to their commercial and economic disadvantage.

437               We accept that in relation to some time‑sensitive passengers the proposed Alliance will create some difficulties and that they may be limited in respect of their choice of airline.  However, the fact remains that the entry of Virgin Blue into the trans‑Tasman market and the increased profile and marketing of Emirates has reduced the extent of the applicants’ market share.  Apart from the time‑sensitive passenger to whom we have referred, most other passengers would view Virgin Blue and Emirates as viable alternatives were the applicants to raise their fares significantly or limit the availability of seats or flights. 

438               Further, although market share can be a significant factor in determining the extent of competition in a market, we believe that prime attention must be paid to market conduct.  A structuralist approach that focuses heavily on an increase of market power by using market shares as a proxy to assess market power fails to assess the whole picture.  If competition is a process, then there must be a significant, and on one view primary, focus on conduct and behaviour.  Strategic behaviour is thus a significant analytical tool for market analysis; see McHugh J in Boral Besser Masonry Ltd v Australian Competition and Consumer Commission (2003) 215 CLR 374 at 478‑80.

439               A key driver of market conduct is the extent to which entry or expansion may be difficult, either because of some exogenously determined or natural market forces, or because of the strategic barriers to entry or expansion created deliberately by the incumbent firms which hold large market shares.

440               High market shares, by themselves, in the absence of barriers to entry or expansion, do not guarantee that the firms holding such market positions will be able to act to the detriment of the competitive process.  A high market share indicates only that at a point of time the firm in question has been able to command the patronage of many customers in the market.  Such patronage may be due to the fact that the firm has been able to offer the right “price‑product‑service packages” to consumers and customers (to use the language of the Tribunal in QCMA at 515), such that these consumers and customers have rewarded it with a large share of the market.  Of course, it may also be the case that the firm has been able to achieve its sales by excluding rivals from the market, or by preventing smaller rivals from expanding.

441               Nevertheless, when entry barriers are low or non‑existent, in the sense that there exist no impediments to competitively significant entry – entry that will serve to constrain the firm in question – then if the firm currently enjoys a high share of the market, this will not of itself signal that the firm can be expected in the future to behave in an anti‑competitive manner.

442               The reason for this is that any attempt to “give less and charge more” (see QCMA at 517) will provide an opportunity for smaller rivals to expand, given the absence of any barriers to expansion.  Should the Alliance, for example, raise its fares above prevailing levels in an attempt to exploit its market position, Virgin Blue or Emirates could be expected to treat this as an invitation to keep their fares at their current level, in order to attract the customers at the margin who may be quite indifferent as to the airline with which they fly.

443               It can be safely assumed that the Alliance would not want to cede market share to these expanding carriers.  After all, the data reveal that they have already made significant inroads into the trans‑Tasman market in a relatively short period of time.  As the Tribunal in QCMA noted at 515, “[c]ompetition is a dynamic process; but that process is generated by market pressure from alternative sources of supply and the desire to keep ahead.”

444               We therefore expect that competition for passengers at the margin will be intense.  Each percentage point of market share gained is worth a considerable amount of profit to the airlines.  Further, because airlines cannot easily discriminate between passengers at the margin and committed passengers, the low fares offered by Virgin Blue and Emirates in their attempts to gain market share at the expense of the Alliance will flow through to all passengers in the market who wish to take advantage of them.

445               Thus, in the absence of barriers to expansion for Virgin Blue and Emirates, and given the capacity available to Virgin Blue and Emirates, we expect that the Alliance will be promptly and competitively constrained should it seek to raise fares.  Such a fare increase would likely be welcomed by the two newer carriers, as it would provide them with the opportunity to increase their market shares without having to lower their own fares, advertise more heavily, or otherwise engage in expensive brand and product differentiation.  We do not expect that the Alliance would be so commercially inept as to present Virgin Blue and Emirates with such a golden opportunity to expand at its expense.  Commercial self‑interest will demand that the Alliance compete heavily for the all‑important marginal passenger, and this natural interplay of responsiveness to market forces of supply and demand will not be likely to produce any anti‑competitive detriment.

446               The approach we have taken places particular emphasis on strategic market behaviour rather than emphasising the structural nature of the market.  For, if competition is a “dynamic process” (see QCMA at 515), there must be a significant focus on conduct and behaviour.  We note that the Commission in its determination and submissions to us focussed heavily on market shares and structure.  However, at the time the Commission handed down its determination it did not have available to it any of the significant developments and evidence of interactive rivalry which has occurred across the Tasman with the introduction of Virgin Blue and the expansion of Emirates’ activities.  At that stage the Commission could only speculate as to the future.  By the time of the hearing before us, a significant part of that “future” had arrived.  We therefore had the opportunity to examine the strategic behaviour which had occurred and in respect of which we had the basis for assessing future market conduct. 

447               The dynamic market having been established, it has now moved on and will continue to move, ebb and flow according to the competitive interplay of market forces of supply and demand, particularly in relation to the marginal passenger.

The factual

448               The factual situation is found in the agreements forming the Alliance into which the applicants propose to enter.  If these agreements are carried into effect, it is apparent that in a number of areas there will no longer be competitive interaction between the applicants.  In particular, Air New Zealand will not be scheduling flights alongside or in competition with Qantas.  Also, Qantas and Air New Zealand’s joint marketing activities will be substituted for what, hitherto, were separate marketing structures.  Put shortly, the factual situation means that the applicants will not be competing against each other in a number of areas, but will rather be combining their resources under the one umbrella.

449               The Commission and the Gullivers Group saw a substantial lessening of competition in these circumstances.  There would no longer be competitive interaction between the applicants in areas of flight schedules, pricing, tourism activities and other areas.

450               Comparing the future with and the future without the Alliance, the Commission and the Gullivers Group submitted that the Alliance would result in an increase in average fares, a reduction in capacity and frequency on some trans‑Tasman routes, and a concentration of market power in the applicants.  Further, the Commission argued that higher average fares were likely to arise from reductions in capacity which would in turn restrict passenger choice.  This was contrary to Air New Zealand’s contention that any increase in average fares would be as a consequence of increased demand for better services, whereby passengers were choosing to pay higher fares to obtain an improved product.  The Commission also argued that the applicants had failed to establish that the reduced frequencies likely to occur under the Alliance at times of peak passenger demand would not have the consequence of also reducing capacity at those times.  The Gullivers Group further submitted that, in the factual, choice and quality of service on routes presently serviced by both the applicants would be decreased.

451               The applicants would share approximately 80% of the trans‑Tasman air passenger services market at the time the Alliance came into operation (if it were authorised).  However, the answer to the concerns that there would be a substantial lessening of competition resulting in higher fares, decreased capacity and frequency of flights, and a reduction in product quality and choice, is found in the presence of Virgin Blue and Emirates in the trans‑Tasman passenger air services market and the competitive constraint they would impose, as discussed above.

452               In short, we believe that Virgin Blue and Emirates are well placed to act, and would act, in response to any attempt by the applicants to reduce capacity, increase fares or offer poorer quality or more limited trans‑Tasman services.

453               Although we consider that Virgin Blue and Emirates will act as a competitive constraint in relation to any attempt by the applicants to raise fares, we recognise that there may be instances of particular fare increases which might not be met by a competitive response from Virgin Blue or Emirates.

454               However, care needs to be given to any discussion about the level of fares on any one flight and at any given time.  A $100 fare for a route payable three months in advance of the flight is a different fare from a $200 fare payable one week before the flight.  Most airlines publish what are called “headline” fares which are designed or intended to bring potential travellers into the airline or travel agent office or website.  It is conceivable that, under the Alliance, what one might call “average” fares will rise although there may not be any significant rise in the price of a ticket purchased at a particular time prior to the departure of the flight. 

455               Whilst the Commission relied upon the evidence of witnesses who asserted that higher average fares would result on some trans‑Tasman routes if the Alliance went ahead, we believe that one must compare like with like, and it seems to us that what a number of these witnesses were saying was that average fares would rise in the factual because different product offerings might be sought by passengers.  The evidence upon which the Commission relied to support the proposition that average fares would increase must be looked at in that context.  For example, in the factual situation, there might be a greater number of flight frequencies with the consequence that passengers who valued flexibility would be prepared to pay more for a flight which offered them greater flexibility.  There is also the situation of passengers who might be expected to purchase a ticket in a higher fare bucket than they would otherwise have done depending upon the time of the flight.  An increase in average fares does not, therefore, have as a necessary consequence an absolute increase in any particular fare level or fare structure.

456               We note in this regard that Mr NormanThompson, Air New Zealand’s Group General Manager, Marketing Network and Sales,confirmed that the likely result of the Alliance would be that Air New Zealand would achieve higher average fares or yield.  Through the Alliance, the applicants would offer an improved product, offering passengers greater flexibility.  Although the posted prices of a current range of fares might remain the same, the mix within that current range of particular prices would vary so that the average fare could increase.  According to Mr Thompson, average fares would increase only if the higher‑yielding passengers valued the improved product offering, that is the seating and side benefits, otherwise there would be no difference in average fares with or without the Alliance.

457               The end result of this analysis is that it does not appear that there would be any absolute rise in a given range of posted prices, but rather that average fares could rise because passengers were choosing, of their own volition, without being induced or pressured to do so by the applicants, to purchase products with greater flexibility.  We therefore accept that there may, or probably will, be situations arising whereby the applicants might achieve higher average fares under the Alliance.  Such a situation would occur where passengers who value flexibility will choose a carrier that offers the greatest alternatives for flexibility in relation to changing flights.  This may result in passengers choosing flights which nevertheless require them to pay a higher price because they fall into a different fare bucket.  In such circumstances we consider that, in this respect, there will be little, if any, detriment arising out of the Alliance as it will be within the power of passengers to choose their own times to fly and the point of time at which they wish to book their tickets.

458               To the extent to which there is an increase in average fares, we consider it to be of little consequence in the overall matrix of the Alliance which the applicants are seeking to implement.

459               We consider that in the factual scenario real fares have a propensity to trend downwards (with one possible exception, fares on the various Australia–Auckland routes) for three reasons.  First, because Virgin Blue is positioned to enter or expand in the market on any route at relatively short notice.  There are available aircraft in Australia already in Pacific Blue livery, which could be switched over to trans‑Tasman routes, if there were any signs that the current competitors were to increase fares.  Second, because the Alliance would allow the applicants to shift the cost curve down and to travel down along the cost curve, or at least maintain its position even if it were to lose traffic to others.  Therefore, under the Alliance the airlines would be in a lower cost position and could pass these savings through to consumers in the form of lower fares, in order to fill increased capacity and further expand the airline.  Third, Virgin Blue, Emirates and other FFCs will continue to constrain the pricing of the airlines operating under the Alliance for the reasons we have discussed.

460               The present level of heavy discounting of trans‑Tasman fares, especially on the Australia–Auckland routes (which routes, we note, Virgin Blue had not yet entered at the time of our determination), led to some debate as to whether fares on the Australia–Auckland routes were sustainable, and whether they might in fact rise in both the factual and the counterfactual scenarios. 

461               Mr Huttner claimed that the current fares were at a low level and were not sustainable.  It follows that average fares would increase in the counterfactual.  The Commission submitted that this contention should be rejected and that, in the absence of the Alliance, low average fares, even if leading to losses, could be sustainable by the applicants.  The Commission noted that Mr Huttner addressed the sustainability of fares from an LCC perspective, and that that contention was not applicable to the sustainability of fares from an FSA perspective, for which loss‑making average fares may be sustainable due to the significance of a route to total network revenue.  The Commission argued that the applicants were unlikely to raise fare levels on the Australia–Auckland routes in the counterfactual because such routes were important in securing through traffic for the applicants’ wider networks.

462               The applicants submitted that if average fares did increase in the factual, it would not be due to a general increase in fare levels arising from a lack of competitive pressure on the Alliance, but rather would be due to some passengers opting for flights that offered greater convenience and for which they were prepared to pay more.

463               It seems to us that in the factual scenario, the applicants would need to be cautious in raising fares on the Australia–Auckland routes.  Whilst the applicants might suffer some loss of profits at current fare levels, such losses would be offset to a certain extent by those trans‑Tasman passengers who fly further on in the applicants’ networks.  Furthermore, to raise fares unilaterally on these routes might provide the incentive for Virgin Blue to enter the Australia–Auckland routes (we accept that Virgin Blue would likely need higher fares than currently exist after the usual start‑up period to be profitable on a stand‑alone basis, not being a networked carrier) and take market share from the applicants.  In addition, an increase in fares would provide Emirates with the opportunity to increase its loads by either not matching the increased fares or by raising its fares by a smaller amount.

464               If fares were to rise in the factual, it would not necessarily be the result of the applicants taking advantage of their market position, but rather a consequence of the market forces (namely excess supply) that had previously caused fares to fall to commercially unsustainable levels.  Further, it would be likely to be a small increase, and a potentially transient one, given the uncertainties as to the competitive strategies that could be employed by Emirates, and the clear desire of Virgin Blue to grow across the Tasman and its capacity to do so within a relatively short time‑frame.

465               The situation would, we believe, be similar in the counterfactual.  Whilst it is true that the current rivals have set fares on the Australia–Auckland routes at levels resulting in little, if any, profit on a fully‑costed, stand‑alone basis, and so may have a desire to raise fares, there would exist the risk that rivals such as Virgin Blue and Emirates, hungry for market share, would not follow an increase in fares, even by a small amount.  The price‑sensitive passenger at the margin would in all likelihood elect to travel with the lower‑priced carrier, leaving the airline with the higher fare experiencing a lower level of ticket sales.  Given the elastic demand for travel on these routes, such a loss of passengers would lead to lower revenues for the airline which raised fares, rather than the expected higher revenues. 

466               We query whether any airline would be prepared to raise its fares first in such a scenario, given the uncertainties as to whether its rivals would follow its lead, and the financial penalties that it would incur should no other airline increase its fares to the same level or at all.  It should be clear to any airline that it is not optimal to raise ticket prices on a sustained basis in a market with the competitive characteristics of the trans‑Tasman air passenger services market.

467               So long as there exists in the market just one firm that is prepared to expand its market share, even temporarily, should a rival raise its fares, sustainable fare increases are unlikely to take place.  We believe that the trans‑Tasman market has two such rivals in operation – Virgin Blue and Emirates – both seeking growth in their share of the market, and that their competitive strategies would be the same in both the factual and the counterfactual.  Accordingly, we expect there to occur little, if any, sustainable increase in fares in the trans‑Tasman air passenger services market if the Alliance were to proceed. 

468               In relation to the issue of capacity and average fares, the experts were asked to consider two questions.  The first question (Question 4) was:

“Assume that:

A slot may be obtained by a new entrant at:

i.          Auckland International Airport within 1 hour of the slot requested during periods of congestion (i.e. between 11am and 4pm, 5am and 7am and 11pm to midnight for arrivals and between 1pm and 4pm for departures) and without difficulty at other times;

 

ii.         Christchurch International Airport with difficulty prior to 7am but without any difficulty after this time and during the course of the day; and

 

iii.        Wellington International Airport within 1 hour of the slot requested during periods of congestion (i.e. between 2pm and 5pm and between 6am and 8am) and without difficulty at other times.

 

b.         By late October 2004 (or thereabouts) there will be no constraints on access to check in counter or baggage handling facilities by a new entrant at Auckland International Airport.  By mid 2005, there will be no constraints on access to stands and gates by a new entrant at Auckland International Airport.

 

c.         Ground services are provided by a competitor to the Applicants at each of Auckland, Wellington and Christchurch International Airports.

 

d.         There are no constraints on access to any of gates, check in counters or baggage handling facilities by a new entrant at Wellington International Airport and Christchurch International Airport.

 

Does making these assumptions have any implications for your conclusions with respect to the competitive effect of the [Alliance] in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counterfactual?  Explain the factors that you will take into account in assessing these questions.

 

469               The second question (Question 5) was:

“Making the assumptions outlined at 1, 2 and 4 above, do you consider that the [Alliance] will have an anti‑competitive effect in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counterfactual?  Explain the factors that you will take into account in assessing these questions.”

 

470               Again, as with previous questions, we consider that these assumptions are warranted by the evidence or are inferences which may be drawn from the evidence.

471               The experts answered these questions as follows:

·                    Professor Ordover said that issues of airport access were important as it was one of the main barriers to entry.  However, he agreed that the access impediments were either immaterial or sufficiently transitory so as to not alter his opinion in relation to the competitive effects of the Alliance;

·                    Professor Levine said that access was not a factor in his analysis.  Accordingly the assumptions in Question 4 did not change his analysis or the answers he gave in respect of Questions 1 to 3 (see [349], [404] and [407]);

·                    Dr Tretheway considered that these assumptions were broadly consistent with the assumptions underlying his statement.  Accordingly, he said that the assumptions reinforced and did not change his opinion;

·                    Professor Hazledine agreed that matters such as access to airport facilities were not constraining in the trans‑Tasman market.  He considered that the important question was not whether Virgin Blue could expand but whether it would want to expand, and by how much, should the Alliance proceed;

·                    Mr Ergas confirmed his opinion that, given these assumptions, the Alliance would be unlikely to result in an anti‑competitive effect in the trans‑Tasman market;

·                    Professor Oum considered that the assumptions in Question 4 would make it easier for other competitors to enter the trans‑Tasman market.  However, he said that his conclusion in respect of the increase in average fares and reduction in capacity in the trans‑Tasman market in the factual as compared to the counterfactual would stay the same, because actual entry is different from potential entry.  Making the assumptions in Questions 1, 2 and 4, Professor Oum considered that Virgin Blue would pose a credible threat, especially in the markets where there are more than two competitors. 

 

472               In a related question, the experts were asked (Question 6):

“Assume that:

·                a premium product (in terms of frequency, amenities etc.) does not enable an airline to command a premium price on trans‑Tasman routes – that is, a business traveller may be prepared to pay a small differential in price for such a premium product and an airline offering such a premium product would likely attract a business traveller in the event that the fares of it and its competitors were commensurate, but a business traveller will likely choose an airline on the basis of price if there is anything more than a marginal differential in the price of the premium product;

 

·                on initially offering a route, a LCC will likely attract a higher proportion of leisure and VFR passengers relative to corporate passengers but, as the LCC establishes a presence and increases its frequency on the route, the proportion of corporate passengers increases;

 

·                Virgin Blue has contractual arrangements with approximately 1/3 of the ASX Top 100 corporates in respect of air passenger services in the domestic Australian market.  Nearly all of these are non‑exclusive in nature.  Some of these require the corporate to use Virgin Blue for the majority of their travel requirements and some only for the minority of their travel requirements; and

 

·            Pacific Blue does not currently meet the needs of a segment of corporate passengers, as:

 

i.          it commenced operating on trans‑Tasman routes in January of [2004];

 

ii.         it does not currently operate services to Auckland; and

 

iii.        a segment of corporate passengers desire greater frequency than is presently offered by Pacific Blue on trans‑Tasman routes.

 

Does making these assumptions have any implications for your conclusions with respect to the competitive effect of the [Alliance] in the trans‑Tasman air passenger services market?  Based on these assumptions, do you consider that Pacific Blue will impose an effective competitive constraint on the Applicants in the factual?  Based on these assumptions, do you consider that the [Alliance] would result in an increase in average fares or reduction in capacity in this market in the factual, as compared to the counterfactual?  Explain the factors that you will take into account in assessing these questions.”

 

473               The experts gave the following answers:

·                    Professor Ordover continued to believe that business class passengers’ fares would likely be constrained and would not materially diverge from fares in the counterfactual; 

·                    Professor Levine said that under these assumptions, the applicants would create some market power for themselves with respect to time‑sensitive passengers and would not be fully constrained by Virgin Blue;

·                    Dr Tretheway considered that there would not be any competitive detriment for the time‑sensitive passengers, either because the LCC would carry them or because the FSAs would produce benefits for these passengers by offering lower one‑way fares as part of their competitive response;

·                    Professor Hazledine considered that these assumptions were consistent with his view that the LCC’s product and the FSA’s product are not perfectly substitutable.  Accordingly, these assumptions did not change any statements he made about the effect of the Alliance on prices;

·                    Mr Ergas said that the relevant question was not whether the LCC and the FSA were perfect substitutes but whether they were sufficiently close substitutes that in the event of an attempted price increase by the FSA, a sufficient number of business travellers would be willing to shift to the LCC to make the attempted price increase unprofitable.  These assumptions suggested that a sufficient number of business travellers would be willing to shift with the result that the FSA’s pricing would be constrained;

·                    Professor Oum considered that if premium prices diverged to become low‑cost fares, this would cause a problem in terms of competition.  If there was not much of a price differential between FSAs and LCCs, it would induce the LCCs to become more like FSAs and to offer the same type of product and services because there would be no advantage for consumers to fly with the LCC

 

474               The weight of these answers, on balance, supports our view as to the effect on competition if the Alliance were to proceed.  That is, Virgin Blue and Emirates, taken together, would operate as an effective constraint on the applicants.

475               It appears that the only significant anti‑competitive detriment which might occur in the trans‑Tasman air passenger services market in the factual scenario is in the area involving the time‑sensitive traveller who wishes to travel between cities in Australia and New Zealand at short notice and within a particular timeframe.  In all other respects we do not consider that the factual scenario will involve any other significant detriment.  We note that the parties’ submissions primarily focused upon the factual scenario in the trans‑Tasman air passenger services market, and little attention was paid to the other markets.

476               The Commission and the Gullivers Group submitted that the factual scenario would result in x‑inefficiencyin the trans‑Tasman air passenger services market.

477               The Commission relied upon the evidence of Professor Oum.  He asserted that the Alliance would result in a loss in productive efficiency, or x‑inefficiency, of 1% per year (a shift upwards in the average and marginal cost curves), leading to a total loss of $654 million in its first five years, due to the market power it would develop, and that this exponentially‑growing efficiency loss would quickly overwhelm the one‑shot saving achieved through improved economies of traffic density (a movement along the average cost curve).

478               Qantasresponded that x‑inefficiency can only occur if the Alliance does in fact lead to significant anti‑competitive detriment in the markets in which it will operate, a condition which it submitted would not occur.

479               Qantas argued that it operated a network system‑wide business that extended over many separate economic markets for air travel.  The trans‑Tasman market accounted for about 15% of the overall business of Qantas.  It argued that the Alliance would not negate any incentive to save costs on the trans‑Tasman segment of its operations, as higher costs would impact on its entire network and would put it at a cost disadvantage relative to its rivals in other markets.  It would therefore not be commercially rational to allow costs to drift up in the trans‑Tasman segment of its operations.  Because of the close relationship between Qantas’ trans‑Tasman network and its other networks, it would not be commercially rational or feasible to provide differing standards of service or quality on the trans‑Tasman routes. 

480               This contention was supported by Mr Ergas, who was of the opinion that because of the presence of actual and potential competitors in the trans‑Tasman market, the Alliance was not likely to fall into a situation of x‑inefficiency or raise its fares.  To do so would be commercially irrational in the face of actual and potential competition.  We agree with this proposition and we accept Qantas’ contention.

481               Qantas also asserted that it had been forced to cut costs in order to compete in Australia with Virgin Blue and that it would be imperative to do the same in order to compete with Virgin Blue in the trans‑Tasman market.  The Alliance was seen by the applicants as a key way to achieve cost reductions, but cost‑cutting would occur whether the Alliance proceeded or not.  In addition, the agreements forming the Alliance give market share to the airline with the most efficient capacity, providing a built‑in driver for cost efficiency.

482               Furthermore, Qantas criticised the studies relied on by Professor Oum because they did not deal with situations where only one aspect of an airline’s integrated operations was operated in an allegedly non‑competitive market.  Qantas argued that the studies, based on old data, did not prove that there was an observable link between deregulation and individual airline operating efficiency, nor did they allow for the impact of LCCs or for their threat of entry.  Professor Oum was of the opinion that any productive efficiency effects would only occur in the longer term.  However, Qantas noted that he made no allowance for the dynamic changes in the trans‑Tasman market in that period and the benefits stemming from the Alliance would be evident before any inefficiency effect would occur.  We accept this criticism of Professor Oum’s evidence.

483               We do not accept Professor Oum’s conclusions that if the Alliance were to go ahead there would be at least an annual 1% x‑inefficiency cost of $650 million over a five‑year period.  We do not understand how this conclusion was reached, particularly having regard to Professor Oum’s opinion that barriers to entry were not insurmountable and the fact that he focused his analysis on the assumption that entry could occur.  In such circumstances, it would be commercially irrational for the incumbent firm to let its costs rise artificially as, by doing so, it would need to raise its fares and that would open it up to the loss of market share. 

484               X‑inefficiency cannot occur in a competitive market.  We have found that Qantas is subject to a number of competitive constraints.  Further, being a network carrier, Qantas cannot have x‑inefficiency on one route without it spreading to all routes.  It would not, therefore, be commercially rational for Qantas to let costs rise on the trans‑Tasman routes.

485               According to the applicants, the factual would bring about a number of benefits which may lead to lower fares, better quality product and other advantages to which we refer later.  This was contested by the Commission which argued that the claimed benefits would not arise under the factual, or would arise but were not as significant as the applicants claimed. 

The counterfactual

486               The principal focus of the parties in the counterfactual scenario was on the trans‑Tasman air passenger services market, and little attention was paid to the counterfactual scenario in the other markets. 

487               Qantas submitted a counterfactual in which:

·                    there would be increased capacity by Qantas on the trans‑Tasman routes by approximately [x]% per annum for three years.  Qantas’ planned increase in capacity would be the necessary consequence of Qantas’ “home base” including New Zealand.  The capacity would be necessary to provide the network required to deliver the expected FSA product to passengers.  This would not result in a complete replication of Air New Zealand’s network.  However, to the extent that it did replicate Air New Zealand’s network, it would be at a cost greater than that which would be required to achieve an entire replication of both under the Alliance;

·                    Air New Zealand would deploy additional capacity on the trans‑Tasman routes;

·                    there would be continued expansion by Virgin Blue on the trans‑Tasman routes;

·                    there would be increased capacity by FFCs on the trans‑Tasman routes, including increased expansion by Emirates on other routes;

·                    average fares would not necessarily fall on the trans‑Tasman routes as a result of capacity increases by the applicants.  If fares did fall, any period of lower fares would be short‑term and result in an unsustainable period of disequilibrium under which the applicants would be likely to suffer losses as a result of fares which did not cover the costs of flights;

·                    Air New Zealand would have to contract because it was the airline without the cost advantage of the LCC or FFC and it did not enjoy the network advantages of Qantas.  Air New Zealand’s network strength could diminish and it would either fail or would move away from the FSA model.

 

488               The counterfactual advanced by Air New Zealand in its closing submissions took into account, in particular, evidence given during the hearing in relation to the activities of Virgin Blue and Emirates.  In its closing submissions, Air New Zealand considered that the likely counterfactual in relation to the trans‑Tasman market over the next two to five years could be summarised as follows:

·                    Qantas was likely to continue to provide an FSA service with a substantial city presence across the Tasman.  In order to continue its aim of being able to offer the best overall network for domestic and international travel in and from the Australian region Qantas would have strive to have the most frequency and presence across the Tasman;

·                    Air New Zealand was also likely to continue to provide an FSA service with substantial city presence across the Tasman.  Although Air New Zealand did not plan to grow in capacity above the market rate, it would have to seek to maintain its city presence across the Tasman.  It was most likely that in two to five years time Air New Zealand would still be flying across the Tasman, even if unprofitably.  A less likely scenario was said to be that identified by Dr Tretheway that, as Air New Zealand (and Qantas) lost passenger share to Emirates and possibly Virgin Blue, Air New Zealand would be forced to reduce its capacity across the Tasman or even exit the trans‑Tasman market;

·                    it was likely that the applicants would charge fares consistent with the factual, which were declining in real terms;

·                    it was highly improbable that Freedom Air would be deployed on additional routes across the Tasman or with significantly greater frequency on existing routes or in replacement of Air New Zealand services on the Tasman;

·                    it was likely that within two to five years Virgin Blue would have entered the domestic New Zealand market and further trans‑Tasman routes.  Virgin Blue would expand swiftly if Air New Zealand and Qantas were to increase fares in the trans‑Tasman market.  Even if the applicants were to continue to price on a real declining basis, it was probable that Virgin Blue would still seek to expand, although it would be one route at a time and slower than its rate of expansion in domestic Australia;

·                    Emirates was likely to expand its presence across the Tasman by increasing flights and city‑pairs and employing larger aircraft.  Emirates would seize a significant share of both corporate and leisure passengers;

·                    FFCs other than Emirates would continue to offer capacity across the Tasman at low fares for as long as such airlines were flying to the east coast of Australia and the aircraft were otherwise idle for the day.

 

489               While the Commission did not expressly set out an alternative counterfactual to that claimed by the applicants, it disputed their suggested counterfactual scenarios and suggested a number of features of a more likely counterfactual which largely reflected the present day conditions on the trans‑Tasman.  In summary, the Commission contended that:

·                    the capacity increases presented in the applicants’ counterfactual scenarios did not represent a realistic or likely outcome in the trans‑Tasman market as Qantas had considered counterfactual options which involved significantly reduced capacity commitments;

·                    were there to be significant capacity increases in the counterfactual, as envisaged by the applicants, this capacity competition would lead to a decrease in average fares such that the average fare level under the factual in comparison with the counterfactual would be even greater than that asserted by Air New Zealand witnesses;

·                    the vigorous competition between the applicants would continue in a similar way to the present and the recent past;

·                    the applicants would act rationally and assume that they were both in the trans‑Tasman market for the long‑term and would not add uneconomic capacity;

·                    average fares on the trans‑Tasman would remain low and consequently large numbers of passengers would fly across the Tasman;

·                    it was not likely that Air New Zealand would exit the market over the next five years;

·                    Virgin Blue’s presence on the trans‑Tasman routes was likely to be smaller than in the factual due to differing levels of average fares.  It might, or might not, enter the Auckland routes or expand beyond its present operations.

 

490               The Gullivers Group asserted that the likely counterfactual scenario in the trans‑Tasman market involved the following:

·                    continued vigorous competition from Qantas across the Tasman which could be sustained for a considerable period of time, with Qantas leveraging off its significant “fortress hub” advantages across all Australian ports;

·                    Qantas increasing its existing level of capacity on trans‑Tasman routes;

·                    Air New Zealand remaining a strong competitor on trans‑Tasman routes at the same level of capacity it currently has;

·                    continuing reductions in airfares across the Tasman leading to a likely stimulation of demand for travel and tourism in Australia;

·                    a viable and continuing Air New Zealand able to sustain competition in the Tasman, as a core market, and with strong “fortress hub” advantages across its New Zealand ports;

·                    limited entry by Virgin Blue on trans‑Tasman leisure routes utilising a small number of aircraft, with no immediately foreseeable entry on the Sydney–Auckland and Melbourne–Auckland routes;

·                    limited increased capacity by Emirates on trans‑Tasman routes.

Analysis of capacity and average fares in the trans‑Tasman air passenger services market

491               There was evidence on behalf of the applicants that, in the counterfactual, capacity would not be reduced but would in fact be increased.  For example, Mr Edwards of Qantas described Qantas’ need to expand its network offering and consolidate its city presence.  There was little challenge to this evidence and we accept it.  Mr Gurney took the view that the greater capacity expected in the counterfactual would not necessarily result in a reduction in average fares, as they would depend on a range of factors and, in particular, on the rate of growth of market demand.  Mr Gurney conceded that:

“if there is an over‑supply of seats you could draw from that that there will potentially be a reduction in prices over a short period of time.”

 

492               He also conceded that, under competitive conditions, excess capacity can translate to a lower fare.  Mr Gurney further stated:

“On a route like Sydney/Auckland where potentially Qantas might have more seats than it can sell, if it was operating with no competition then it may not choose to lower prices but just sell less seats at a higher price.  But that of course is not the case.  So while there are competitors that are prepared to sell seats at a lower price then, yes, it generally results in a downward pressure on price.”

 

493               Qantas relied on the evidence of Mr Gurney in contending that any period of lower average fares in the counterfactual would be unsustainable.  Specifically, while Mr Gurney conceded that “excess capacity to an airline is a low price seat to a customer”, he asserted that low prices and excess capacity may prevail only for a short period – that such prices are “not always sustainable”. 

494               Mr Edwards’ evidence was that if Qantas’ plans to expand capacity in the counterfactual were implemented as proposed, he would expect this to lead to reductions in average fares on all trans‑Tasman routes, and that such fare reductions would be even greater if Qantas’ competitors responded by expanding their capacity in an attempt to maintain their market share.  However he contended that any such fare reduction would be short term.  While Mr Edwards stated that any such fare reduction associated with Qantas’ capacity expansion in the counterfactual would occur “in the short term”, Mr Edwards went on to explain the meaning of “short term” in this context as follows:

“It would depend whether or not that level of capacity was sustained.  You know, it would depend upon what happened to the actual growth in the market as a result of the lower fares, because the lower fares may actually stimulate the market so the growth did in fact come back to where it had been expected to be.”

 

495               Mr Edwards agreed that in those circumstances Qantas’ capacity growth would be greater than that planned, as its objective would be to outstrip growth in market demand, and then continued:

“I suppose I’m just trying to get at there’s obviously a lag between making the decision to put on the capacity and then the actual use of that capacity, and that time lag can be, you know, six months.”

 

496               We are satisfied, on the basis of Mr Edwards’ evidence, that there may be periods of time, of perhaps six months in length, in which unexpected growth in market demand outstripped Qantas’ capacity expansion.  However, we consider that this would be a short‑lived result.  Qantas would expand capacity yet further to outstrip that growth in market demand.  Mr Gurney’s evidence to the effect that any reduction in average fares in the counterfactual associated with Qantas’ capacity expansion was to a similar effect. 

497               We are satisfied that if the Alliance did not proceed, so that a counterfactual scenario applied, average fares overall would fluctuate over the succeeding five years, but the level of average fares in real terms would remain at or about current levels overall, having regard to the pressures of excess capacity on most trans‑Tasman routes.  However, we recognise that fares for some types of travel on some trans‑Tasman routes might, on occasions, be higher than hitherto, but that overall the potentially higher fares would be counterbalanced by the likelihood of lower fares at some times on some routes.

498               We are satisfied that in the counterfactual it would be important for both airlines, and for Air New Zealand in particular, to maintain their presence across the Tasman.  Although there might be a tendency in the factual for the applicants to reduce capacity, there was sufficient excess capacity available to compensate for any reduction.  Both Virgin Blue and Emirates had available capacity which could compensate passengers (with the exception of some time‑sensitive passengers), for any reduction in capacity by the applicants. 

Continued operation of Air New Zealand in the trans‑Tasman air passenger services market

499               Qantas contended that one outcome of the counterfactual might be that Air New Zealand would fail or, more likely, move away from the FSA model and convert to an LCC model.  Qantas asserted that if its capacity increases in the counterfactual were in fact to lead to lower fares, as the Gullivers Group contended, this would lead to an unsustainable period of disequilibrium under which both the applicants would be likely to suffer losses.  If the market reached such a state of disequilibrium, then, applying rational profit maximising assumptions, there would have to be a dynamic response in the marketplace.  Qantas contended that Air New Zealand would inevitably have to contract because it lacked the cost advantage of an LCC or an FFC (across the Tasman) and did not have the network advantages of Qantas. 

500               Qantas relied principally on the evidence of Dr Tretheway, the only expert to hold the opinion that Air New Zealand would fail within the five‑year period over which authorisation is sought.  Dr Tretheway predicted a scenario in which Air New Zealand would face network envelopment on its international routes.  He noted that as government barriers were removed the stronger carriers were developing even larger networks, and at the same time Air New Zealand would be facing fare pressures on its domestic and trans‑Tasman routes from Virgin Blue, Qantas and FFCs.  Dr Tretheway thought it unlikely that Air New Zealand would obtain the necessary financing to replace its fleet, update its product and expand and that, in particular, it was unlikely to secure any further government investment.  Dr Tretheway believed that these factors would lead Air New Zealand to reach a point where its positive cash reserves fell to a critical level and, because New Zealand law did not allow for reorganisation with bankruptcy protection, Air New Zealand would be forced to cease operations.

501               Dr Tretheway also referred to the evidence of Mr MichaelSwiatek, General Manager, Joint Ventures at Air New Zealand, which was to the effect that few sectors worldwide can support more than two airlines flying non‑stop.  Mr Swiatek relied upon data collated from an independent airline industry service, the Official Airlines Guide, which showed that almost 70% of sectors flown in the world on a non‑stop basis were served by only one airline and that almost 90% of sectors were served by only one or two airlines. 

502               A scenario in which Air New Zealand continued to operate but abandoned the FSA model was supported by the evidence of Professor Ordover, Professor Hazledine and Professor Levine.  These experts agreed, with varying degrees of confidence, that both the applicants were likely to survive in one form or another as trans‑Tasman carriers over the next five years, irrespective of whether the agreements forming the Alliance were authorised.  For example, Professor Levine stated:

“The trans‑Tasman routes represent relatively defensible territory for the FSAs.  The stage lengths are relatively long.  Each of the two incumbents has a substantial local network from which it can feed its routes.  Air New Zealand has made considerable progress in getting its costs under control.  Qantas is well‑financed and profitable and has made some progress towards overcoming its legacy costs.  Pacific Blue is a very small presence.  It will grow, and perhaps the Applicants’ dire predictions will come true some day, although my experience and judgment tells me otherwise.  But the Tribunal need not predict the future, because at present the Applicants can and will compete if the Agreement is not approved.  It will be a long time before either of the Applicants meet any form of failing company test.”

 

503               Qantas’ submissions were also supported by the evidence of its lay witnesses.  For example, Mr Edwards of Qantas said that if the Alliance were not authorised and Qantas, Air New Zealand and Virgin Blue proceeded with the capacity expansion plans announced or anticipated under the counterfactual, one outcome might be that one of the FSAs suffered sufficient losses in the process such as to withdraw capacity and reduce its network offering.

504               Air New Zealand’s counterfactual differed to that of Qantas’ as Air New Zealand contended that it was not likely that any “war of attrition” between carriers operating on trans‑Tasman routes would result in Air New Zealand exiting the market.  Air New Zealand did, however, indicate that its prospects without the Alliance were dim. 

505               Mr Ralph Norris, CEO and Managing Director of Air New Zealand, gave evidence that Air New Zealand’s long‑haul operations [--].  Mr Norris indicated that since 2002 Air New Zealand could not and still could not, and in the medium‑term in the absence of the Alliance might not be able to, [--] nor could it identify such a business case for [--]. Air New Zealand’s long‑haul Boeing 747‑400 fleet would need to be replaced in around [x] at a cost of approximately NZ$[x] in 2004 dollar terms, with a commitment to replacement required by around [x].  He acknowledged that Air New Zealand could not [--] and because of the uncertainty surrounding the Alliance.  Mr Norris provided compelling evidence that, apart from a further NZ$150 million in capital funding set aside for Air New Zealand, the New Zealand Government would not be willing to provide Air New Zealand with any further capital.  Without replacement of its long‑haul fleet, Mr Norris said that Air New Zealand’s long‑haul product offering would become increasingly unattractive relative to that of its competitors and Air New Zealand [--].  However, Mr Norris said that the airline did not believe it was feasible voluntarily to abandon those operations as they were critical to provide traffic feed to Air New Zealand’s domestic and short‑haul routes and Air New Zealand would face substantial costs in contracting its operations.

506               Mr Norris stated that contraction of Air New Zealand’s trans‑Tasman operations was also not a viable medium‑term option for Air New Zealand, as these operations attracted high value passengers in New Zealand by offering both domestic New Zealand and trans‑Tasman routes with an adequate frequency of service.  As it would lose these passengers if it contracted its network, it was likely that revenues would contract more quickly than costs.  Mr Norris was not confident that Air New Zealand was well able to meet the challenge [--] but that it would endeavour to ensure [--].  He said that Air New Zealand would likely be forced to deploy further and probably unprofitable capacity on trans‑Tasman routes in the counterfactual to try to protect its core market for as long as possible.

507               Finally, Mr Norris acknowledged that Air New Zealand’s financial position was stronger at the time of the hearing than at the time when it entered into the agreements forming the Alliance, but said that, while Air New Zealand would meet its financial targets for the first six months of the 2003/04 financial year, its performance would not be as good as was achieved in the same period in 2003.  Mr Norris further contended that Air New Zealand had 75% of its assets tied up in servicing markets, and that it was [--]. 

508               The Commission contended that the exit of Air New Zealand from the market was not a likely outcome in the counterfactual and that Air New Zealand could continue to operate without the Alliance. 

509               The Commission disputed the contention that the trans‑Tasman market could not support two FSAs.  It contended that at least the nine main trans‑Tasman routes would support two FSAs, relying upon the statements by Mr Swiatek that where two FSAs are supported on a sector, it is usually the case that each of FSA has a strong city presence at one end of the sector and that on the nine main trans‑Tasman routes, both the applicants had a strong city presence at one end of each route.

510               The Commission contended that the trans‑Tasman market contained a number of high traffic‑density routes and the current market structure included two FSAs and an LCC.  The Commission drew an analogy with routes in the United States such as Detroit–St Louis, Atlanta–Detroit, Atlanta–Minneapolis, Houston–Chicago and Seattle–San Francisco, where, as in the trans‑Tasman market, the FSAs have traffic flow support available for their services at one or both ends of the route.  The nine main trans‑Tasman routes were also said to be comparable with European routes, such as London–Amsterdam and London–Rome, each of which support more than one FSA and an LCC

511               The Commission also referred to a number of the applicants’ Board papers, which evidenced the increased strength of Air New Zealand since early 2002. 

512               Similarly, the Gullivers Group relied on a series of Air New Zealand media releases that evidenced Air New Zealand’s improved financial position since the applicants had entered into the agreements forming the Alliance in November 2002.  These media releases disclosed that Air New Zealand achieved a net profit after tax of NZ$94 million for the six months ending 31 December 2002, with an accompanying increase in revenue of 2%, decrease in costs of 8% and increase in earnings before interest and taxof NZ$201 million, a profit before unusuals and tax of NZ$220.3 million, up 567% on the previous financial year, and a net profit after tax of NZ$165.7 million for the year ended 30 June 2003.  The Gullivers Group also relied on numerous other press articles and media comments by Air New Zealand which evidenced the improved financial position and viability of Air New Zealand.

513               The Gullivers Group also pointed to statements made by Air New Zealand’s lay witnesses, in particular Mr Swiatek, in contending that Air New Zealand would not fail during the proposed period of authorisation of the Alliance.  The Gullivers Group relied upon the evidence of Mr Swiatek to the effect that the nine main trans‑Tasman routes were capable of supporting two FSAs and that there was no evidence that Air New Zealand was, at this stage, a failing airline, in financial difficulty or unable to compete actively against Qantas, in the absence of authorisation. 

514               Subsequent to the hearing, on 2 June 2004, Air New Zealand issued a media release announcing a Memorandum of Understanding, subject to Air New Zealand shareholder approval, to acquire eight Boeing 777‑200ERs and two Boeing 7E7s (now referred to as Boeing 787s) and rights and options to acquire a further 42 long‑haul aircraft.  Four of the Boeing 777‑200ERs are to be purchased and four are to be leased.  The cost of the four aircraft and the infrastructure required to service all eight is in excess of NZ$1 billion. 

515               The aircraft on order are expected to facilitate the replacement of Air New Zealand’s fleet of ageing Boeing 767s and the expansion of its long‑haul fleet.  It was contemplated that the expansion of Air New Zealand’s long‑haul fleet would facilitate the addition of new routes by Air New Zealand. 

516               This announcement demonstrated [--].  Nevertheless, it demonstrated that in a counterfactual situation, [--].

517               We are mindful that Air New Zealand’s representation of its financial position and long‑term viability in the counterfactual may, due to issues of commercial sensitivity, have been somewhat guarded.  Nevertheless, we believe that, on balance, the evidence supports a likely scenario in the counterfactual in which Air New Zealand continues to operate.

518               We are not satisfied that in a counterfactual scenario Air New Zealand would either close down or abandon its character as an FSA, although there would be pressure to rationalise some of the FSA offerings it presented.  We acknowledge that most of Air New Zealand’s capital assets are tied up in its long‑haul fleet, but accept that Air New Zealand has an attachment to the trans‑Tasman market in which it operates.  We are satisfied that for perception, marketing, political and practical reasons, Air New Zealand would want to maintain its city presence across the Tasman.  Although it is likely that Air New Zealand (and Qantas) would lose passenger share to Emirates and Virgin Blue in the counterfactual, and might be forced to reduce trans‑Tasman capacity, it is unlikely that Air New Zealand will exit the trans‑Tasman market in the next five years. 

519               We note that the Gullivers Group made a number of submissions with respect to the appropriate consideration of a “failing firm” argument.  However, we do not consider it necessary to canvass these here, as we are satisfied that Air New Zealand is not likely to fail in the proposed five‑year period of authorisation.

detriment in the trans‑Tasman air passenger services market

520               As we have discussed, most of the evidence and submissions were directed towards the trans‑Tasman air passenger services market.  The principal concern in relation to this market was whether the elimination of competition between the applicants would cause a substantial lessening of competition with a resultant detrimental effect on capacity, fares, frequency and product offering. 

521               The applicants asserted that there would be no lessening of competition in this market under the Alliance, largely due to competitive constraints imposed on the applicants by Virgin Blue and FFCs such as Emirates.  However, the Commission and the Gullivers Group considered that Virgin Blue and Emirates could not be relied upon to constitute a sustained competitive constraint on the applicants, and the significant market share held by the applicants under the Alliance would substantially reduce competition, resulting in anti‑competitive detriment.

522               Whether the Alliance would result in any anti‑competitive detriment in the trans‑Tasman air passenger services market depends on the competitive interaction of the airlines that currently operate in this market in the factual, as against the counterfactual (no evidence was provided as to likely new entrants within the foreseeable future).  We have already considered the likely presence and role of Virgin Blue and Emirates on the trans‑Tasman air passenger services market at [304]‑[408] above. 

523               As we have found earlier, it appears that the only significant anti‑competitive detriment that might occur is in the area involving the time‑sensitive traveller who wishes to travel between cities in Australia and New Zealand at short notice and within a particular time‑frame (see [395]).  As we have found, in the factual scenario, time‑sensitive passengers might be faced with situations of unavailability of seats at particular times, although second‑best choices would probably be readily available with a maximum delay of no more than half a day.  We have considered the number of time‑sensitive passengers who might be inconvenienced in the manner just discussed, but were not provided with data to support any firm conclusions.  Nevertheless, we consider that the number of such passengers would be relatively small compared to the overall number of passengers travelling trans‑Tasman.

524               In reaching these findings we have not overlooked the fact that, at any time of the day or night, there may be a reduction of flights or a reduction in capacity, so that the business traveller who has to travel on the spur of the moment may not have an available seat on the next scheduled flight.  This is always a problem independently of the proceeding before us.

525               In all other respects, we do not consider that the factual scenario will involve any other significant detriment which should be taken into account in carrying out the weighing of benefits against detriments, for the reasons discussed in our assessment of the likely factual scenario at [448]‑[485]. 

detriment in the trans‑Tasman airfreight market

526               In relation to the trans‑Tasman airfreight market, the Commission initially contended that the Alliance would significantly increase the market power of the applicants in this market, with an accompanying increase in freight rates and reduction in the quality and quantity of freight services to the detriment of trans‑Tasman importers and exporters.  However, during the course of the hearing the Commission conceded that any anti‑competitive detriment in this market would be restricted to the short to medium term, as Air New Zealand planned to replace its wide‑bodied aircraft with narrow‑bodied aircraft by 2006 and such aircraft were unsuitable for the efficient carriage of airfreight.  The Commission also conceded that entry to this market was relatively easy.  The Commission submitted that there would be some competitive detriment in the short‑term but that this would be progressively eroded throughout the period to 2006.  The Gullivers Group did not make any submissions in respect of any airfreight market. 

527               While the applicants have had considerable market shares in the overall trans‑Tasman airfreight market, the fact that Air New Zealand has publicly announced and commenced implementation of plans to replace all wide‑bodied aircraft flying trans‑Tasman with narrow‑bodied aircraft means that, within a fairly short span of time, and at least by 2006, Air New Zealand will cease to be a significant competitor in the general freight category. 

528               In the final analysis, no contentious issue was raised in relation to this market.  We are satisfied that, as a result of Air New Zealand’s plans to replace its entire trans‑Tasman wide‑bodied fleet by early 2006, regardless of whether the Alliance proceeds or not, the Alliance will not have a material anti‑competitive effect on the trans‑Tasman airfreight market. 

detriment in the Australian domestic air passenger services market

529               The main issue in relation to this market was whether, in the absence of the Alliance, Air New Zealand either alone or together with another Star Alliance carrier, would enter the domestic Australian market.  Another concern was whether the Alliance would enable Qantas to capture further domestic feed, in the form of on‑carriage traffic from Air New Zealand, at the expense of REX and Virgin Blue.  The Gullivers Group submitted that Virgin Blue, being a new entrant with a relatively low profit base, had a limited capacity to compete vigorously in the long‑term in this market.

530               The applicants contended that there was no realistic prospect of Air New Zealand entering the Australian market, even with a partner, and that the feed from Air New Zealand was not significant to the business of REX.

531               The Commission contended that, following the collapse of Ansett, there existed a commercial impetus for Air New Zealand or another Star Alliance member to commence operations in the Australian domestic air passenger services market in order to capture feed traffic for Star Allianceinternationalcarriers.  WhilsttheCommissionacknowledgedthatAir New Zealandhad stated that it had no intention of entering the Australian domestic market, it maintained that as a result of this commercial impetus, entry by a Star Alliance carrier in concert with Air New Zealand or through Star Alliance support of entry by Air New Zealand, was a real prospect.  By removing Air New Zealand as a potential entrant, the Alliance would render the prospect of entry by a Star Alliance member extremely unlikely.

532               Mr Hans van Pelt, Executive Commercial Manager at REX, contended that the Alliance would enable Qantas to capture further domestic feed, being the on‑carriage traffic from Air New Zealand.  He gave evidence that this would impact adversely on carriers such as REX.

533               We note that Mr Hans van Pelt called by the Commission, raised a number of additional concerns regarding the effect of the Alliance.  However, these additional claims were not pursued by the Commission.

534               The applicants responded that the Alliance would not result in any anti‑competitive detriment in the Australian domestic market because:

·                    Air New Zealand did not currently operate in the Australian domestic market, it had no plans to enter the Australian domestic market and no partner had come forward with a proposal for entry to the market with Air New Zealand;

·                    Air New Zealand had no plans to deploy Freedom Air in the Australian domestic market, either by itself or in conjunction with a Star Alliance member, as it would be difficult for more than one LCC to operate successfully in the market (we note also that at the time of the hearing Jetstar, Australia’s second LCC was about to commence operations); and

·                    Air New Zealand feed was not significant to the business of REX.

Prospect of entry by Air New Zealand or another Star Alliance member

535               At the time of negotiating the Alliance with Qantas, the Air New Zealand Board considered that Qantas’ motivation for entering into the Alliance was to lock out defensively other airlines from the Air New Zealand share register that might use Air New Zealand as a “back door” means of entering the Australian domestic market.  A discussion paper prepared in November 2003 for consideration by the Qantas Board reflected, in broad terms, these concerns and noted that Air New Zealand’s entry into the Australian domestic market would most likely be effected through [--]. 

536               However, Mr Norris of Air New Zealand said that entry into the Australian domestic market by Air New Zealand would not be commercially rational having regard to the existing competition in that market.  Mr Norris said that with Qantas, Virgin Blue and soon Jetstar operating, there was aggressive competition in the Australian domestic market such that entry by Air New Zealand would result in significant oversupply and associated losses.  Mr Norris said that for Air New Zealand to reconsider entry to the Australian domestic market, one of the current participants would have to exit the market.  Mr Norris said that overall the risk was high for Air New Zealand and he believed that the competitive environment in Australia, with an FSA such as Qantas providing a depth of schedule, frequency and capacity, and with an LCC such as Virgin Blue operating, would leave Air New Zealand somewhat stranded in the middle.  Mr Norris said that Air New Zealand took the view that it did not seem to be a risk worth taking and it felt that the chances of success were far too low.

537               When asked whether the Air New Zealand Board was considering looking to deploy Freedom Air in Australia under the Star Alliance brand in the event that the Alliance with Qantas did not proceed, Mr Norris acknowledged that this option had been considered but “was very quickly despatched to the waste paper bin.”

538               We were told by Mr Ray Webster, Chief Executive Officer of EasyJet, that the LCC with “the lowest cost base ultimately will win the game”, as consumers select a low cost airline on the basis of its fares.  Consumers were essentially buying a commodity, as they did not value brand or differences in the product offering.  Mr Webster observed that once the marketplace was covered with a commodity, it was very difficult for a new commodity to come in and displace the original one unless it had a superior cost base.  Even if it did, the cost base advantage was probably going to be so small that the opportunity to displace the original carrier would be very difficult and very expensive for the new entrant.  Mr Webster therefore believed that there was little opportunity for Freedom Air to establish the same presence in Australia as the first mover, Virgin Blue. 

539               We accept that the Board papers relied upon by the Commission evidence the continuing “strategic imperative” for Air New Zealand or a Star Alliance member to enter the Australian domestic market and the likely continuing re‑assessment by Air New Zealand and Star Alliance members of opportunities for entry.  However, no documentary evidence was produced by the Commission to demonstrate that Air New Zealand’s consideration of entry to the Australian domestic air passenger services market had crystallised into a plan for entry.  We are satisfied that entry by Air New Zealand or a Star Alliance member during the period of the Alliance is not commercially likely.  We accept the evidence of Mr Norris that Air New Zealand would not pursue this strategic imperative “at all costs” and that entry, at this time, would undermine the commercial viability of Air New Zealand.

540               Further, we are not satisfied that entry by a third‑party carrier would promote competition in the Australian domestic market.  We consider that the evidence relied on by the Commission in endeavouring to demonstrate that the Australian domestic market was not competitive is not adequate to found such a conclusion.  The business model of Virgin Blue, involving as it does the aggressive pursuit of growth in order to reduce progressively unit costs by spreading fixed costs over greater volume, and Qantas’ recent launch of Jetstar, satisfy us that the Australian domestic market is competitive and that entry by a third‑party carrier would, thus, be unlikely to further enhance competition.

541               For these reasons, we are satisfied that the Alliance would not result in any anti‑competitive detriment in the Australian domestic air passenger services market by eliminating any prospect for entry by Air New Zealand or another Star Alliance member.

Qantas to capture feed from Air New Zealand

542               REX had arrangements in place with Air New Zealand pursuant to which it made tickets available to Air New Zealand to sell to its passengers for travel on REX flights.  Mr van Pelt of REX who was called by the Commission said that, despite these arrangements, REX had not been able to capture significant feed from Air New Zealand.  REX had sought agreements with Air New Zealand which would allow for seamless passenger and baggage check‑in.  However, Air New Zealand had refused to enter into the agreement on the basis that it would require considerable information technology resources and Air New Zealand had competing priorities for these resources that were considered to be of greater commercial importance to it.

543               The evidence showed that REX had not been able to capture Air New Zealand traffic feed of the magnitude previously supplied to Kendell and Hazelton Airlines.  The number of passengers booked by Air New Zealand on REX flights between March 2003 and March 2004 represented an insignificant contribution to the respective revenues of Air New Zealand and REX

544               We do not consider that there is any substance in the lost opportunity proposition put by the Commission in view of the fact that REX does not currently obtain a sizeable amount of feed from Air New Zealand and in view of the evidence in relation to the prospects of Air New Zealand developing its relationship with REX in the counterfactual, which was to the effect that Air New Zealand was unlikely to view the development of its relationship with REX, which was of limited commercial significance, as a significant priority in allocating its resources.  We do not consider that REX would secure additional and material Air New Zealand on‑carriage in the counterfactual.  Accordingly, we are satisfied that the capture of Air New Zealand traffic feed by Qantas would not result in any anti‑competitive detriment in the Australian domestic air passenger services market.

detriment in the Australia–North America air passenger SERVICES market

545               Three main issues arose in relation to the Australia–North America air passenger services market.  Firstly, whether, in the absence of the Alliance, Air New Zealand might re‑enter the Australia–North America routes.  Secondly, whether the cessation of Air New Zealand’s code‑share arrangements with United Airlines under the Alliance as well as the increased market power to the applicants under the Alliance would weaken United Airlines’ competitive position in the Australia–North America market and result in anti‑competitive detriment to consumers in that market.  Finally, whether Air New Zealand’s indirect services via Auckland currently impose a competitive constraint in the market and whether the competition between Qantas’ direct services to North America and Air New Zealand’s indirect services would be eliminated under the Alliance. 

Re‑entry by Air New Zealand onto the Australia–North America routes

546               The Gullivers Group argued that the Alliance would lessen competition in the Australia–North America air passenger services market by eliminating any possibility of Air New Zealand re‑commencing direct Sydney–Los Angeles flights. 

547               The applicants submitted that there was no business case for Air New Zealand to fly a direct Sydney–Los Angeles service as it did not have a domestic Australian network.  Since the demise of Ansett, Air New Zealand has had no domestic Australian feed, with the result that the Australia–North America routes are no longer profitable and are now considered “stranded” routes.  Thus, in the counterfactual advanced by the applicants for the Australia–North America air passenger services market, Air New Zealand would not re‑commence non‑stop Sydney–Los Angeles services, nor would it commence operating any other non‑stop services between Australia and North America. 

548               Air New Zealand ceased flying direct services between Australia and North America (specifically between Sydney and Los Angeles) on 28 April 2003.  It is true that at that time Air New Zealand “suspended”, rather than “discontinued” its direct Sydney–Los Angeles route.  However, a number of Air New Zealand witnesses made it clear that Air New Zealand now considers that it is more financially advantageous for Air New Zealand to operate the aircraft that previously flew the Sydney–Los Angeles route on the Auckland–San Francisco route.

549               Similarly, Mr Thompson gave evidence that the Sydney–Los Angeles service operated by Air New Zealand was generally unprofitable subsequent to the demise of Ansett.  The service was initially retained following Ansett’s collapse as, according to Mr Thompson, it represented the best use of the aircraft at that time and Air New Zealand recognised the potential for growth of the dual destination market from the United Kingdom, Europe and the Americas.  However, a 2003 internal Air New Zealand document evidencing the business case for suspending the Sydney–Los Angeles service discloses that the commercial reasons behind the suspension of the service were the route’s unprofitability and the opportunity to capitalise on unfulfilled demand in the Auckland–Los Angeles market following United Airlines’ withdrawal from that route.

550               Finally, Professor Ordover contended that as Air New Zealand did not face re‑entry barriers on the Sydney–Los Angeles route, the fact that it has not re‑entered the route since April 2003 suggested that Air New Zealand considers entry would not be profitable.  He reasoned that competition on the Australia–North America non‑stop routes was not likely to weaken in the near future, with the result that the profitability of re‑entry for Air New Zealand is unlikely to improve.  He said that, in any event, the exit of Air New Zealand in 2003 did not appear to have resulted in a significant increase in fares on the route, suggesting that Air New Zealand’s re‑entry on the routewouldnotbelikelytohaveasignificanteffecton competition on the Sydney–Los Angeles route. 

551               We are satisfied on the evidence presented to us that under the counterfactual it is unlikely that Air New Zealand would recommence the Sydney–Los Angeles route within the five‑year period for which authorisation of the Alliance has been sought.

Air New Zealand’s code‑share with United Airlines

552               United Airlines and Air New Zealand entered into code‑share arrangements in December 1996.  Under these arrangements, the two carriers code‑shared on each other’s trans‑Pacific services.  In addition, United Airlines code‑shared on Air New Zealand’s trans‑Tasman, domestic New Zealand and Pacific Islands services, and Air New Zealand code‑shared on United Airlines’ services beyond Los Angeles and San Francisco. 

553               The Commission submitted that the Alliance would result in an anti‑competitive detriment in the Australia–North America air passenger services market primarily because it would give rise to a risk that United Airlines, Qantas’ only competitor in the provision of direct services between Australia and the mainland of the United States, would exit the market.  The Commission reasoned that to remain viable an airline’s operation in the Australia–North America air passenger services market required a source of passenger feed at both ends of the route and that United Airlines was reliant to a significant extent upon Air New Zealand’s passenger feed from its trans‑Tasman and domestic New Zealand operations for its continued viability.  The Commission acknowledged that Air New Zealand had offered an undertaking with respect to the continuation of its code‑share arrangements with United Airlines, but submitted that the undertaking was inadequate.

554               The Commission further contended that United Airlines’ competitive position would be weakened by the Alliance, as United States‑originating passengers wishing to visit both Australia and New Zealand would be compelled to fly with the applicants, rather than United Airlines.  This was said to be because United States‑originating passengers could currently travel to both Australia and New Zealand using the services of either Star Alliance members or oneworld members, but under the Alliance Air New Zealand would leave Star Alliance and join oneworld.  Thus, under the Alliance, United States originating passengers could not undertake such a journey using these services of Star Alliance members and would need to use the services of the applicants.  The higher fares likely to be associated with travelling one leg with a Star Alliance member and the trans‑Tasman leg with the applicants, relative to travelling with the applicants for the entire journey, could be expected to result in passengers travelling with the applicants for the entire journey. 

555               The Commission concluded that, in the event that United Airlines was unable to continue to provide services in the Australia–North America market in the factual, the applicants would be left with a monopoly with respect to air passenger services between Australia and North America operating both directly and via New Zealand.  The Commission reasoned that it was very unlikely that another United States carrier would enter the Australia–North America air passenger services market.  Further, no carrier from a third country would be able to enter, as Australia’s bilateral arrangements currently prevented carriers from countries other than Australia and the United States from entering the market.  The Commission argued that a weakening of United Airlines’ competitive position would amount to an anti‑competitive detriment in the Australia–North America air passenger services market because United Airlines was the only competitor to Qantas in that market offering direct non‑stop services between Australia and North America, and the prospect of new entry to the Australia–North America air passenger services market in the medium‑term was exceedingly low.

556               United Airlines, supported by Professor Levine, contended that the Alliance would result in anti‑competitive detriment to consumers in the Australia–North America air passenger services market due to the likely cessation of United Airlines’ code‑share arrangements with Air New Zealand under the Alliance.  Mr Stephen Pearse, General Manager of United Airlines in Australia, said that the cessation of these code‑share arrangements was likely to weaken United Airlines’ competitive position in the Australia–North America market.  He argued that this would depriveUnited Airlinesof passengers that Air New Zealand booked on United Airlines’ flights.  It would also prevent United Airlines from offering its passengers Air New Zealand’s trans‑Tasman and New Zealand to United States services.  Mr Pearse’s evidence was that United Airlines had booked nearly 9,000 passengers on Air New Zealand’s flights during a period which we assume is March 2003 to February 2004.  Finally, Mr Pearse argued that it would result in few, if any, dual destination passengers travelling on United Airlines’ Australia–North America services, as a passenger could not acquire a single triangular itinerary from the one carrier.

557               The applicants submitted that the concerns regarding the viability of United Airlines’ services, and its overall competitive position, on the Australia–North America routes were adequately addressed by the undertaking which Air New Zealand was prepared to offer United Airlines, which was to the effect that Air New Zealand would continue the current code‑sharing arrangement with United Airlines between New Zealand and Los Angeles and across the Tasman. 

558               Air New Zealand contended that United Airlines’ concerns in relation to the effect of the Alliance on its overall competitive position on the Australia–North America routes were overstated as United Airlines believed that Singapore Airlines would (subject to regulatory approval) enter the Sydney–Los Angeles route within a timeframe of eighteen months to three years, and United Airlines’ response may be to offer additional capacity on the route.  Air New Zealand also noted that Qantas and United Airlines had entered into a special pro‑rate agreement, United Airlines and Virgin Blue have entered into a code‑share arrangement, and that United Airlines was considering contacting Emirates to establish a special pro‑rate agreement in respect of trans‑Tasman routes.

559               We observe that any detriment to United Airlines resulting from a loss of its code‑share agreement with Air New Zealand would be small, as United Airlines provided data which disclosed that only [x] Air New Zealand passengers have code‑shared on United Airlines’ Sydney–Los Angeles route in the twelve months to May 2004 and that these passengers accounted for only [x]% of United Airlines’ revenue on its Sydney–Los Angeles route.  Similarly, Mr Thompson of Air New Zealand stated that, in the twelve months ending January 2004, the number of Air New Zealand passengers travelling on United Airlines flights between Sydney and Los Angeles was [x], while the number travelling on United Airlines flights between Sydney and San Francisco was [x]. 

560               More importantly, however, we are of the view that much of the argument surrounding United Airlines’ competitive position and the code‑share agreement appeared to miss the point.  United Airlines’ major complaint, which was supported by the Commission, seemed to be that United Airlines would suffer if the Alliance were to proceed, whereas the relevant enquiry to make is whether competition as a dynamic process would suffer.  Even if the applicants proceeded with the Alliance, other carriers would account for some 20% of the market and could therefore act as a constraining influence on the Alliance’s conduct and activities.  We note, in particular, that Air Canada entered the Australia–North America air passenger services market four years ago and had established a market share of approximately 7.7% by 2003.  We also note the recent entry of Hawaiian Airlines into this market.  Thus, there may be an effect on United Airlines as a participant in the market.  The impact of the Alliance, were it to proceed, on United Airlines (which is, in our view, relatively small in terms of the number of passengers carried), would be likely to have little detrimental effect on competition as a dynamic process in this market. 

561               Furthermore, while not the subject of submissions by either of the applicants, we observe that the evidence before us gave rise to a further issue, specifically the possibility of entry (subject to government approvals) to the Australia–North America air passenger services market by Singapore Airlines.  We note that such entry would have a pro‑competitive impact on the Australia–North America market, although Singapore Airline’s ability to operate in this market is presently hampered by what could be described as government barriers to entry.

562               We note that in response to United Airlines’ concerns about the Alliance, Air New Zealand offered to give an undertaking to us to continue its code‑share arrangements with United Airlines in respect of Air New Zealand’s flights until such time as United Airlines, or another carrier with which it code‑shares, commences operations or commences code–sharing on any route between Australia and the United States or until the termination of the Alliance.  However, given our finding that the implementation of the Alliance would not give rise to an anti‑competitive detriment in relation to the code‑share arrangements, there is little purpose in analysing the issue of undertakings to be offered to United Airlines.  Such an undertaking is not necessary.

Air New Zealand’s indirect services as a competitive constraint

563               The Gullivers Group emphasised the elimination of competition with Qantas by Air New Zealand’s indirect services to North America via Auckland in contending that the Alliance would result in a substantial lessening of competition in the Australia–North America air passenger services market.  The Gullivers Group reasoned that there was some degree of substitutability between the direct Sydney/Melbourne/Brisbane to Los Angeles routes and indirect services via Auckland on Qantas or Air New Zealand flights, as evidenced by the operation of one‑stop, long‑haul services en‑route to Sydney, Brisbane or Auckland by FFCs.  It argued that a competitive constraint was imposed on pricing on the direct Sydney–Los Angeles, Melbourne–Los Angeles and Brisbane–Los Angeles routes by the availability of indirect carriage via Auckland by both the applicants, as there was substitutability between this direct and indirect carriage.  It contended that the Alliance would eliminate the indirect competition out of Auckland, and would accordingly have an anti‑competitive effect on the Australia–North America air passenger services market. 

564               The Commission made a similar submission, relying on the DOTARS evidence of Air New Zealand’s share of Australia–North America origin/destination passengers.  This data supported an assertion made by Mr Norris during the course of explaining why re‑entry to the Sydney–Los Angeles route by Air New Zealand was unlikely.  Mr Norris said that Air New Zealand was instead endeavouring to capturepassenger feed out of Australia from Melbourne, Sydney and Brisbane via Auckland to the United States.  He said that Air New Zealand “have been reasonably successful in being able to capture some traffic from Melbourne, Sydney and Brisbane by flying them to Los Angeles over Auckland.” 

565               It was apparent that the Alliance would eliminate any fare competition that existed between Air New Zealand’s indirect services and Qantas’ services in the Australia–North America air passenger market.  The issue confronting us was the extent to which Air New Zealand’s indirect services imposed a competitive constraint in this market.

566               The DOTARS data disclosed that, in the six‑month period January to June 2004, Air New Zealand achieved a monthly average share of Australia–North America origin/destination passengers of approximately 8.0%.  This made Air New Zealand the third largest competitor in the Australia–North America market, behind United Airlines with an average monthly share of 18.5% and Qantas with an average share of 50.75%. 

567               Qantas submitted that Air New Zealand’s indirect services did not constrain pricing on the Australia–North America routes because of the high level of discounting necessary to attract custom onto the indirect routing.  Qantas did not point to any evidence in support of this proposition, in particular, it did not point to any evidence establishing the high level of discounting required for Air New Zealand to attract custom, and there did not appear to be any evidence to support this contention. 

568               As noted earlier, the economists prepared a report on the matters agreed between them.  This report stated that:

“The experts agree that Air New Zealand provides some competitive discipline at present in the US‑Australia markets for price‑sensitive passengers, convenience‑sensitive passengers and for business class passengers.”

 

569               While there was agreement between the economists that Air New Zealand provided some competitive discipline in respect of all passenger segments in the Australia–North America air passenger services market, Professor Ordover concluded that:

“Given that Air NZ serves only a small share of all Australia–North America passengers and is most likely to attract to [sic] very price sensitive customers, removal of Air NZ as an active competitor can plausibly be assumed to have only a limited effect on fares.”

 

570               Professor Ordover described Air New Zealand as having an 8.8% share of travel agent bookings for connecting and non‑stop Australia–North America passengers for the period February 2003 to January 2004 and said this was “a relatively low – albeit non‑trivial share of all Australia–North America travellers”.  He noted that this share might be an overestimate as this period included a number of months in which Air New Zealand was still providing a direct Sydney–Los Angeles service.  However, as already observed above, Air New Zealand’s average monthly share of Australia–North America origin/destination passengers in the period January to June 2004 was approximately 8.0%, negating this contention. 

571               Professor Ordover reasoned that the competitive constraint imposed by Air New Zealand in the Australia–North America air passenger services market would be limited because:

·                    Air New Zealand’s connecting services were “not a perfect substitute” for non‑stop flights, as they involved longer travel times and were less convenient.  Professor Ordover contrasted the fastest travel time in posted schedules for the week of 20‑26 June 2004 for a Qantas non‑stop flight and an Air New Zealand one‑stop flight and concluded that the Qantas non‑stop flights were at least two‑and‑a‑half hours faster than the quickest services provided by Air New Zealand;

·                    Air New Zealand competed with Qantas primarily for price‑sensitive passengers that did not have a strong preference for travel convenience;

·                    Qantas would be unable to raise fares profitably for these price‑sensitive passengers in the absence of any competitive constraint from Air New Zealand under the Alliance, as:

o                    many of them would choose not to travel at all at the higher fares; 

o                    they would also decide to travel to alternate destinations if leisure fares were to rise in the Australia–North America air passenger services market;

o                    some of these price‑sensitive passengers may not have a pronounced preference for Qantas – they may be “burning” their frequent flyer points – and thus could be readily attracted to United Airlines flights, especially if they intended to travel in the United States as well. 

 

572               By contrast, Professor Levine disagreed with Professor Ordover’s proposition in [569].  He noted that Professor Ordover supported his proposition by asserting that:

“Air New Zealand’s  less direct routings mean that removal of its competition from the market won’t matter either to convenience‑oriented travellers.”


We took Professor Levine to be saying that Professor Ordover was asserting that removal of Air New Zealand’s indirect services would not be a matter of concern either to price‑sensitive passengers or to convenience (time)‑sensitive passengers).  He accepted that while all fares and many passengers would not be affected, some would be affected.  He considered that Professor Ordover’s proposition was:

 

“entirely inconsistent with the Applicants’ case in chief, emphasized in its analysis of the trans‑Tasman market, that even competitors with small market shares and whose service does not directly compete can fully replace a competitor in disciplining the market.”

 

573               Professor Levine’s criticism of Professor Ordover’s evidence does not accurately reflect that evidence.  In particular, it does not take account of Professor Ordover’s proposition that one must compare like with like; he was comparing indirect services with non‑stop flights.  Further, when Professor Levine says that the applicants’ case‑in‑chief was that “even competitors with small market shares and whose service does not directly compete can fully replace a competitor in disciplining the market”, he mis‑states the applicants’ case and states a proposition in respect of which we have made a different finding.  We do not accept that the service provided by Virgin Blue and Emirates does not directly compete with the applicants across the Tasman.  We have found to the contrary.  What we have found is that, in a number of respects, Virgin Blue and Emirates do “directly compete” with the applicants in the trans‑Tasman market.

574               It is also important to observe that the contrast between the evidence of Professor Ordover and Professor Levine highlights the need to be careful in considering effects on competition and not just competitors.  In our analysis of the trans‑Tasman air passenger services market we emphasised the need to focus on market behaviour and not limit the analysis to a consideration of market shares. 

575               If Air New Zealand’s indirect services were to be withdrawn by the Alliance, approximately 8.0% of the market would become available for competition between the other airlines, both the airlines offering direct services (Qantas and United Airlines) and those currently offering indirect services (such as Air Canada and Hawaiian Air).  The prospect of securing a share of those former Air New Zealand passengers would, we believe, result in strong competitive rivalry within, and between, those two groups of airlines.

576               Accordingly, competition for those passengers would be unlikely to be affected significantly by the withdrawal of Air New Zealand’s indirect services.

577               Professor Levine’s observation fails to take account of the competitive dynamic in that market in which Virgin Blue and Emirates, by their conduct and projected plans, are well placed to compete actively with the Alliance.  Their market share at the date of the determination must be looked at against that background.  Similarly, when considering the effect of any withdrawal by Air New Zealand of indirect services in the Australia–North America air passenger services market, it is important to take into account the expected responses of other airlines in that market.

578               Against that background, we prefer the evidence of Professor Ordover.  It takes account of the extent to which the characteristics of indirect services differ from those of direct services and it allows for a consideration of the interaction of all airlines flying in this market.

579               We have formed the view on the available evidence that Air New Zealand’s indirect services are not the only competitive constraint operating upon Qantas and that were the Alliance to proceed there would be a number of other airlines offering indirect services to the mainland of the United States, including Japan Airlines, Singapore Airlines, Cathay Pacific, Air Pacific, Malaysian Airlines, Thai Airways, Air Canada and Hawaiian Air, who have in the vicinity of 20% of the market.  The loss of Air New Zealand’s indirect services as a competitive constraint needs to be assessed against the existence of these other competitors and their expected growth profiles and, in our opinion, we do not consider there will be any significant anti‑competitive detriment arising from the withdrawal of Air New Zealand’s indirect services.

detriment in the Australia–North America airfreight market

580               The parties agreed that the high levels of competition in this market, particularly from dedicated freight carriers, meant that the Alliance would be unlikely to have a material anti‑competitive effect in this market. 

581               We are therefore satisfied that the Alliance would not have any anti‑competitive effect in the Australia–North America airfreight market.

detriment in the market for travel distribution SERVICES

582               The market for travel distribution services was a major focus of the Gullivers Group which argued that the Alliance would cause significant anti‑competitive detriment in this market.  The submissions of the Gullivers Group were generally supported by the Commission. 

583               The Gullivers Group asserted that, under the Alliance, the applicants’ substantial market power and degree of vertical integration would be increased to dominant levels.  It argued that, as Qantas is the only major travel wholesaler in Australia, there would be no countervailing power in this market sufficient to constrain the pricing and output decisions of the applicants if the Alliance went ahead.  It contended that there would be no credible threats of new entry into the market because of the high barriers to entry. 

584               The Gullivers Group thus predicted that, under the Alliance, the applicants would be in a position to develop a range of business strategies that could result in the withdrawal of travel service distributors from the market.  These strategies were said to include the applicants not paying commissions to travel agents, offering discounted travel on their own websites, providing special exclusive deals to each other for their own distribution, and expanding deals available to members of their frequent flyer programs which would be unavailable through travel services distributors.  The Gullivers Group contended that under the Alliance the applicants would be able to further favour their own distribution services by offering corporate and government clients discounts and other inducements.

585               The Gullivers Group submitted that if the Alliance were allowed to proceed, independent travel service distributors would be unable to engage in their current practice of using the competitive tension between the applicants to obtain the best fares for customers.  Without being able to add value in this manner, a large proportion of their business would disappear, forcing many travel service distributors to exit the market.  This exodus was said to be likely to impact adversely on the distribution infrastructure which is currently provided by independent travel service distributors for overseas airlines, including FFCs, to sell their product into and out of Australia.  The Gullivers Group said that the loss of a distribution infrastructure for overseas airlines would have flow‑on effects for the trans‑Tasman market as it would impede the ability of imported air travel services to challenge the dominance of the applicants in that market. 

586               Qantas submitted that the Alliance would have no relevant impact on the travel distribution services market.  It contended that there was no foundation for the Gullivers Group’s argument that the Alliance would deprive travel agents of the opportunity to make a commission, or would reduce the quantum of commission made on bookings.  It said that, in any event, this was not a relevant anti‑competitive detriment to be taken into account.  It also argued that the Alliance would not diminish the current role of travel agents in negotiating deals between airlines and corporations.  Finally, Qantas argued that it would not be in a position to take advantage of any increased bargaining power over travel agencies which the Alliance would bring about to the detriment of competitors.  It submitted that if such bargaining power were used to lower commissions paid to travel agents, then the results – a reduced incentive for travel agents to book flights with the applicants and the possibility that the efficiencies in distribution costs and cost savings achieved would be passed on to consumers – would not harm the applicants’ competitors nor consumers.  Alternatively, if the increased bargaining power were used to introduce commission structures which forced travel agents to discriminate against the applicants’ competitors, competitors could be presumed to respond in a manner to attract travel agents and the use of other distribution channels would also be open to consumers.

587               Similarly, Air New Zealand argued that the Alliance would not have a detrimental effect on competition in the market for travel distribution services.  It noted that the market was characterised by a large number of distribution channels, with a large number of players distributing fares and that travel agents sold a significant proportion of fares for FFCs.  Air New Zealand submitted that travel agents would continue to be an important part of its distribution system under the Alliance and that the Alliance would not affect its travel distribution policies and specifically would not affect its remuneration structure for travel agents, noting that it would be commercially irrational for either it or Qantas to discourage sales of airfares through travel agents.  Air New Zealand argued that travel agents did not have a role to play in promoting competitive tension between it and Qantas, as it did not provide special corporate rates for domestic and short‑haul international sales and nor would it do so under the Alliance.  Furthermore, Air New Zealand noted that when it did provide special rates, the fare was generally negotiated directly with the corporate customer rather than through a travel agent.  Air New Zealand said that it offered special corporate rates to particular corporate customers on long‑haul international routes, which practice would remain unchanged under the Alliance. 

LossOFcompetitivetensionbetweentheapplicantsandRemunerationof travel agents

588               The Gullivers Group submitted that under the Alliance, whilst the applicants would retain their current distribution structures, they would also be able to negotiate jointly with distribution channels in relation to commissions, incentives and other agency terms, with the result that independent travel service distributors would be unable to use the competitive tension between the applicants to obtain the best fares for customers. 

589               Consistent with the Gullivers Group’s contentions, the Commission submitted that the Alliance may lead to the applicants assuming common policies with respect to the release of inventory and the commission paid to travel agents, in which case the ability of many travel agents to provide travel planning services to consumers would likely be compromised, with a resultant detriment to consumers, particularly those wishing to travel overseas. 

590               Both the Commission and the Gullivers Group relied heavily on the evidence of Mr Bagnall, the sole lay witness for the Gullivers Group, and Mr Paul Scurrah, Global General Manager (Product) for Flight Centre, called by the Commission.  A substantial part of Mr Bagnall’s evidence was objected to on the ground that he was not qualified by experience or qualifications to express his opinions and that he also failed to establish an evidentiary basis for his opinions.

591               In particular, Mr Bagnall contended that:

·                    SYNERGI would not be able to offer its “best fare of the day” service because if the applicants were authorised to co‑ordinate pricing pursuant to the Alliance, SYNERGI would not be able to rely on the competitive tension between the applicants to obtain the “best” fare;

·                    SYNERGI would not be able to offer competitively a contract negotiation service for domestic, trans‑Tasman and international corporate air travel, as these negotiations rely on there being more than one major FSA.  Under the Alliance, SYNERGI would become a price‑taker in the negotiation of contracts for corporate travel; 

·                    SYNERGI would no longer be able to compete effectively in the provision of tender management and evaluation services for government departments or corporations, as tenders to determine the best product–service mix would be unnecessary in the event the Alliance proceeds as the applicants would then offer only very limited options. 

 

592               As a result, he contended that a large portion of the distributors’ business would disappear and many would be forced to exit relevant markets with a diminution of such countervailing power such distributors had. 

593               Mr Bagnall further contended that a reduction in the number of independent travel service distributors as a result of the Alliance would, in turn, exacerbate any diminution of competition in the air passenger services markets within, into and out of Australia in particular, the Australian domestic and trans‑Tasman markets.  This would follow because FFCs would lose the channel for distribution of their airfares offered by independent travel distributors, while the Alliance would reduce the likelihood that Air New Zealand’s and Qantas’ own distribution centres would promote FFCs’ airfares to the same extent as their own airfares. 

594               Mr Scurrah observed that travel agents are dependent on airlines releasing tickets to the market for sale to travellers and that, accordingly, airlines can control the level of inventory available to travel agents, distributors and other retailers of airline tickets (and presumably also the prices thereof).  He was of the view that Air New Zealand’s price differentiation strategy – of structuring the distribution of its tickets so that travellers obtained the cheapest fares for Air New Zealand flights from purchasing directly from Air New Zealand – meant that travel agents did not have an incentive to sell Air New Zealand tickets because agents could not offer their customers the most competitive tickets for Air New Zealand flights.  Mr Scurrah concluded that if the applicants adopted Air New Zealand’s price differentiation strategy as their common policy under the Alliance there would be an anti‑competitive detriment to consumers in the market for travel distribution services.  Without access to the full range of tickets being sold for travel on the applicants’ flights and with the ability to derive an income from the sale of those tickets being compromised, the ability of travel agents to provide travel planning services to consumers would be compromised.  Mr Scurrah argued that “consumers may be deprived of the ability to organise travel involving flights on either Qantas or Air New Zealand through a travel agent … Given the dominance of the applicants in these markets, if their distribution arrangements are not attractive to travel agents, those agents have few alternatives to offer consumers.”

595               The applicants submitted that travel agents would not suffer as a result of the loss of any competitive tension between the applicants.

596               The applicants noted that none of the experts had expressed any concerns or raised any issues as to the effect of the Alliance on the travel distribution market.  They relied upon the evidence of Mr Thompson who acknowledged that sometimes travel agents seek to produce competitive tension between Air New Zealand and Qantas, to advance the interests of their customers but said that this did not occur in respect of corporate or SME customers.

597               The applicants pointed to the existence of competitive tension in trans‑Tasman airfares from FFCs.  They also noted that the travel distribution services market contained a large number of distribution channels and a large number of participants, and trans‑Tasman airfares were just one product amongst many available for distribution in the market for travel distribution services.

598               The applicants submitted that if the Alliance proceeded, there would be a continuing role for travel agents in identifying and negotiating the best deals for their customers available from various airlines including the Alliance, Emirates, Virgin Blue and other FFCs and that this role might become a more important one in respect of trans‑Tasman routes as travel agents sought out the best available fares, including promotional deals and the identification of “mix and match” itineraries using one‑way fares, from these participants.  There would thus be a continuing competitive tension in respect of trans‑Tasman airfares under the Alliance, particularly in regard to FFCs, that would be available for use by travel agents.  Further, both parties asserted that they had no plans to change their current policies.  They also contended that concerns about a reduction in commissions received by travel agents under the Alliance were without foundation and irrelevant to the proceeding. 

599               At the time of the hearing, the applicants were employing different policies as to the release of inventory and the payment of commission on fares to travel agents.  Air New Zealand had unbundled the costs of distribution from the costs of fares, so as to:

·                    reduce distribution costs through the shift of distribution towards the low cost internet channel;

·                    position itself strategically for LCC entry by offering travellers airfares that did not incorporate distribution costs through its internet distribution channel.

 

This strategy of Air New Zealand to meet competition from LCCs would apply in both a factual and counterfactual scenario.

 

600               The result of Air New Zealand unbundling the costs of distribution from the costs of the fares was that Air New Zealand could offer travel agents in New Zealand an incentive commission but not a base commission for fares sold for domestic or trans‑Tasman routes.  Air New Zealand did, however, pay travel agents based in Australia both a base commission and an incentive commission.  Further, all distribution channels were subject to a charge to cover the costs associated with that distribution channel.  For example, Air New Zealand imposed a surcharge on the internet fare where a ticket was purchased through a GDS which reflected the charge it incurred for each booking made through a GDS.  Each distribution channel could impose self‑governed service fees for services provided to a traveller.

601               Air New Zealand provided the same access to different classes of “Express” airfares (Air New Zealand’s Domestic Express, Tasman Express and Pacific Express airfares) and to capacity to all distribution channels.  Air New Zealand structured the distribution of its airfares so that consumers obtained the cheapest fares for travel with Air New Zealand by purchasing directly from Air New Zealand.

602               Unlike Air New Zealand, at the time of the hearing Qantas was paying travel agents in both Australia and New Zealand a base commission and an incentive commission (with the exception of Jetstar which was not paying commission of any kind to travel agents) and did not restrict airfares released to travel agents for sale.

603               In contrast to the evidence of Mr Bagnall and Mr Scurrah, Qantas’ and Air New Zealand’s lay witnesses were of the view that independent travel service distributors were an important part of the applicants’ distribution networks in Australia, and that the Alliance would not result in any change in the travel distribution policies of the applicants, including their remuneration structure for travel agents.  Mr Thompson summarised the position of the applicants, when he stated that:

“[A]s far as agency distribution is concerned under the alliance, … we do not expect any changes to the way we do business today.  Travel agents are an integral part of whether it be Air New Zealand or Qantas’ distribution, and that will continue.”

 

604               Mr Thompson’s evidence was that there was no proposal at present to change remuneration under the Alliance.  Mr Thompson was also of the view that the applicants pay similar base and incentive commissions to travel agents in Australia and that, while Air New Zealand does not pay base commission in New Zealand and Qantas does, Air New Zealand’s higher incentive commission for travel agents in New Zealand means that those travel agents can earn similar remuneration from Air New Zealand and Qantas. 

605               Mr Gurney of Qantas stated that Qantas did not consider that the Alliance would provide it with an opportunity to reduce the rate of incentive commissions for travel agents in respect of the distribution of trans‑Tasman airfares.  Qantas was of this view, he said, because of its heavy dependence on travel agents for the distribution of international airfares, in respect of which competition is particularly fierce.  For example, he estimated that 90% of Qantas’ international airfare revenue was generated by travel agents.  Mr Gurney stated that Qantas was concerned that a reduction in incentive commissions for travel agents in respect of trans‑Tasman routes may result in a reduction in its international airfare revenues, due to retaliatory action by travel agents.  Mr Gurney said that, with trans‑Tasman routes accounting for approximately 10% of Qantas’ international revenue, the cost savings generated by a reduction in incentive commissions for trans‑Tasman airfares would not justify the risk to its international revenue.  He reasoned that any reduction in the absolute amount of incentive commissions payable by the applicants to travel agents would be the result of a shift by consumers towards the internet distribution channel, because Qantas could facilitate the sale of airfares for Air New Zealand flights through the internet by listing these airfares on the Qantas website.  We find this evidence persuasive.  As it happened, the subsequent increase in the purchase in Australia of Air New Zealand airfares via Air New Zealand’s website suggested that such savings may have been significantly eroded since the time Qantas formed this view. 

606               Air New Zealand asserted that it would not provide special corporate rates or rebates for domestic and short‑haul international routes irrespective of whether the Alliance were implemented, having ceased to offer special corporate rates or rebates for domestic New Zealand and trans‑Tasman flights on the introduction of its Domestic Express and Tasman Express initiatives respectively.

607               With respect to the contention that the role of travel agents in negotiating deals between airlines and corporations would be eliminated by the Alliance, the applicants argued that negotiations for corporate accounts generally occur directly between the airline and the corporation in any event, with possible engagement of a travel management consultant to implement the agreement.  They pointed out that Air New Zealand does not offer special corporate rates or rebates for domestic New Zealand or trans‑Tasman routes.  They also submitted that travel agents would have a continuing role of maintaining current information on airfares, promotional deals and sales by Virgin Blue, Emirates and other FFCs and providing consumers with this information as a service as well as seeking out the best deal for consumers. 

608               In submitting that the trend towards reduced travel agency remuneration was not related to the Alliance, Qantas relied on Mr Gurney’s evidence that the percentage of Qantas’ domestic Australian and trans‑Tasman airfares booked over the internet was ever‑increasing and the acknowledgement by Mr Bagnall that a shift towards internet distribution channels was occurring throughout the world, regardless of the Alliance. 

609               Air New Zealand contended that the practice of price differentiation between fares sold through an airline’s own internet site and fares sold through a GDS represented a general trend in the airline and travel distribution industries and would continue to occur in the absence of the Alliance.  In support of its contention, Air New Zealand pointed to the practice of airlines of offering customers access to a number of distribution channels, the trend towards giving customers the option of booking tickets directly on the internet and the increasing number of customers that elected to do so (as demonstrated by the evidence of Mr Bagnall, Mr Scurrah and Mr Gurney).  It referred to the increased pressure on airlines to reduce distribution costs and develop more efficient channels of distribution, noting the removal of base commissions by a number of American based airlines, the worldwide trend for declining distribution costs and the pressure to reduce distribution costs due to the threat of LCC entry.  Air New Zealand also pointed out that Virgin Blue engages in price differentiation between different distribution channels, and hence, Mr Scurrah’s concerns in respect of the effects of Air New Zealand’s price differentiation practices applied equally to Virgin Blue. 

610               Finally, Qantas stated that it was not clear how any reduction in agents’ commissions could result in any relevant anti‑competitive detriment in any market. 

611               We do not accept Mr Bagnall’s evidence in relation to the negotiation of contracts between corporate accounts and airlines.  He did not have any relevant knowledge or experience.  He conceded that he had not personally been involved in the negotiation of any contracts between airlines and corporations and was unable to provide the name of a single client for which SYNERGI negotiated a contract with the airline, rather than simply performing the role of a travel management consultant. 

612               We accept that Air New Zealand ceased to offer special corporate rates or rebates for domestic New Zealand and trans‑Tasman flights on the introduction of its Domestic Express and Tasman Express initiatives respectively.  It follows that we reject Mr Bagnall’s proposition that a consequence of the Alliance would be that Air New Zealand and Qantas would no longer compete on tendering for corporate and government accounts and that as a result, corporate customers and government organisations would lose the ability to seek and obtain discount deals on bulk purchases of flights in the absence of competitive bidding between Air New Zealand and Qantas. 

613               Mr Bagnall’s evidence was also countered by the existence of a Strategic Commercial Agreement between Qantas and the Gullivers Group.  Pursuant to this Agreement, Qantas is a preferred carrier for the Gullivers Group and the Gullivers Group has an obligation to market and promote Qantas as such.  Mr Bagnall contended that Air New Zealand was also a preferred carrier for the Gullivers Group and that the Gullivers Group nonetheless was able to exploit any competitive tension between various airlines to optimise or maximise the gains to its customers. 

614               We are not satisfied that there will be any significant loss of competition or detrimental effect upon competition in the market for travel distribution services if the Alliance goes ahead.  The consequence of the Alliance in relevant terms will be that there will be occasions, and they may be numerous, where a travel agent will not have the opportunity to obtain a competitive fare from Qantas or Air New Zealand as the case may be, having obtained a quote from the other.  At an earlier point of time the travel agent only had the opportunity to “play off” the applicants against the other.  More recently, however, Virgin Blue has entered the trans‑Tasman market and Emirates has expanded its presence.  If the Alliance were to go ahead, although there might not be the opportunity to obtain competitive quotes as between the applicants, there would nevertheless be the opportunity to obtain competitive quotes from Emirates and Virgin Blue. 

615               It is of little consequence that Mr Bagnall’s organisation may want to place a large part of its business with either Qantas or Air New Zealand.  It is the process of competition with which we are concerned, not the protection of competitors. 

616               Of course, there may be some routes where the range of relevant carriers may be limited to the applicants in respect of the travel plans of a particular client of a travel agency.  We do not ignore the fact that such a situation might occur.  Nevertheless, we consider that such an effect, in public terms, is relatively small having regard to the totality of the whole of the trans‑Tasman market.  Whereas once Mr Bagnall might have gone to Qantas or Air New Zealand for alternative quotations, now he might go to the applicants, Virgin Blue or Emirates. 

617               Put shortly, the fact that a travel agent might be deprived of an opportunity to make a commission by establishing competitive tension between two airlines does not necessarily, without more, mean that there will be any detrimental effect on the competitive process in the travel services distribution market.  For the reasons to which we have referred we consider that the competitive process will be maintained in the air travel industry generally and in the travel distribution services market.  Travel agents will continue to remain an important part of the applicants’ distribution systems under the Alliance.  It is trite to say that a reduction in agents’ commission is not ipso facto a relevant competitive detriment in any market.  There will also remain a number of different distribution channels after the Alliance including, as we have already noted, the airlines themselves, travel agents and the internet. 

618               There was a degree of artificiality and lack of business understanding in the Gullivers Group’s submissions that the applicants would effectively disregard the travel agents and deal directly with the retail market.  Although the airlines have established a distribution system, we are satisfied that there will still remain a substantial number of independent travel agents, that is travel agents independent of the airlines.  We consider that it would be commercially irrational for the airlines to disregard independent travel agents in their marketing activities.  The independent travel agents have, in general terms, a strong presence in many shopping centres and shopping strips throughout Australia and New Zealand.

619               We accept Mr Gurney’s evidence that Qantas does not consider that the Alliance provides any real opportunity to reduce the rates of incentive commissions for travel agents because of Qantas’ significant dependence on travel agents for the distribution of international airfares where competition is fierce.

620               Mr Scurrah confirmed Mr Thompson’s observations in relation to the greater administrative convenience for travel agents of booking tickets through a GDS, relative to through an airline’s website.  Mr Scurrah’s evidence also established that some incentives existed for travel agents in Australia to book tickets through a GDS rather than through Air New Zealand’s website, as a result of Air New Zealand distribution policies designed to minimise its distribution costs.  Australian travel agents, such as Flight Centre, receive the same commission in respect of a booking made through the Air New Zealand website as they do for a booking through a GDS, although there is a surcharge.  Flight Centre also receives a rebate when it makes a booking through a GDSFFCs have limited channels for the distribution of their trans‑Tasman airfares in Australia and New Zealand, with the result that it is reasonable to expect that most Australian travel agents’ bookings for FFCs’ trans‑Tasman flights would occur through a GDS.  Mr Scurrah confirmed this when he stated that Flight Centre makes bookings through the Air New Zealand and Virgin Blue websites, but not through the Emirates’ website. 

621               The concerns of Mr Bagnall and Mr Scurrah with respect to the loss of the competitive tension between the applicants would only come to fruition if there was no competitive tension between the applicants and other airlines in the relevant air passenger services markets that travel agents could exploit in the provision of distribution services to their customers.  As highlighted by the submissions of the applicants, if the Alliance did not result in any lessening of competition in the relevant air passenger services markets, travel agents would not suffer as a result of the loss of any competitive tension between the applicants and there would not be any associated anti‑competitive detriment in the market for travel distribution services, due to the availability of competitive tension between other participants in these air passenger services markets for exploitation by travel agents and other travel distributors.

622               The reduction of travel agent remuneration by Qantas or the adoption by Qantas of a price differentiation policy between different distribution channels, as a result of the Alliance, would not harm independent travel distributors and so would not reduce competition in the travel services distribution market, unless the Alliance also conferred market power on the applicants in the upstream air passenger services markets.  In the absence of such a conferral of market power by the Alliance, the consequence of a reduction in travel agent remuneration or the adoption of a price differentiation strategy by Qantas would more likely be a financial disadvantage for Qantas.

Ability to favour own distribution channels

623               The Gullivers Group submitted that the Alliance would enable the applicants to favour their own distribution channels which would threaten the viability of independent travel service distributors and further reduce such distributors’ ability to seek the best deals for consumers.  For example, the applicants would be in a position to offer corporate and government clients discounts and other inducements in return for booking exclusively through the airline’s own distribution system, which discounts and inducements would generally not be available to corporate and government clients through independent travel agents.  The Gullivers Group observed that the existing convention that airlines do not sell travel directly to the public at prices lower than those that travel agents can offer is being eroded (for example, through cheaper internet fares), with the potential for it to be dismantled altogether. 

624               The Gullivers Group reasoned that the applicants would be able to favour their own distribution channels because their substantial power in the travel distribution services market would be further enhanced by the Alliance, the applicants would dominate air travel between Australia and New Zealand, as well as inbound and outbound travel to and from Australia and New Zealand, and the Alliance would increase the vertical integration in the travel industry such that the applicants would gain a more dominant position in the travel distribution market. 

625               Similarly, the Commission submitted that the Alliance would likely provide the applicants with even greater leverage in their dealings with travel agents, which would be likely to allow the applicants more scope to favour their own distribution channels over those of independent travel agents and to increase the incentive for travel agents to sell the product of the applicants rather than that of other airlines. 

626               Again, the Gullivers Group and the Commission relied upon the evidence of Mr Bagnall.  Mr Bagnall expressed concern that if the Alliance proceeded, independent travel service distributors would be adversely affected by the applicants preferring their own distribution channels.  Such preferential treatment of the applicants’ own distribution channels would involve the provision of lower fares by the applicantstoQH Tours Ltd,Viva!Holidays,QantasBusinessTravel,Air New Zealand Business Direct and Travelcentre.  In support of this contention, Mr Bagnall asserted that QH Tours Ltd is the dominant wholesaler in Australia, in part, because of the provision of special pro rates (ie discount deals) by Qantas to it that were not made available to QH Tours Ltd’s competitors.  Further, the applicants could offer corporate and government clients discounts and other inducements for booking exclusively through the airline’s own distribution channels, rather than through an independent travel service distributor.  Such inducements are generally not available to business through independent travel service distributors.

627               Mr Bagnall also advanced the view that Qantas’ and Air New Zealand’s vertically‑related travel service distributors, specifically Qantas Business Travel and Air New Zealand Business Direct, would be given a pricing and information advantage, following the implementation of the Alliance, and to this end pointed to a clause of the Strategic Alliance Agreement pursuant to which the applicants agreed to exchange information in relation to schedules, financial matters, pricing, yields, seat availability, freight capacity and sales.  This was said to constitute a disadvantage to SYNERGI and other independent travel service distributors relative to Qantas Business Travel and Air New Zealand Business Direct, as independent travel distributors relied on the ability to receive or purchase certain types of information from the applicants to provide such services as seat allocation, management reporting information, air carrier benchmarking, frequent flyer point tracking and e‑ticket tracking.  Mr Bagnall asserted that such behaviour by the applicants might result in the exit of independent travel service distributors from the market, so lessening competition. 

628               The applicants did not specifically address Mr Bagnall’s submission that the Alliance would confer an enhanced ability to favour their own distribution channels.  However, Qantas addressed the related issue that the Alliance would confer greater bargaining power in the applicants’ dealings with travel agents, which could be used by the applicants to increase the incentives for travel agents to sell the applicants’ tickets rather than those of their competitors. 

629               Qantas submitted that any increase in the applicants’ bargaining power would, given the cost reduction imperatives of FSAs, be likely to manifest itself in lower commissions offered by the applicants, which would simply reduce incentives for travel agents to book flights with the applicants rather than their competitors and would not harm other airline competition.  Qantas said that even if commission structures were introduced that forced travel agents to discriminate against the applicants’ competitors, passengers would not be foreclosed from purchasing tickets on competing airlines via any one of the alternative distribution channels.  Furthermore, competitors such as Virgin Blue could counter such behaviour by increasing their travel agent commissions.

630               We find that the increased distribution through internet channels and associated reduction in agency remuneration and the practice of price differentiation between different distribution channels, are trends in the airline and travel distribution industries generally, and not related to, or the result of, the Alliance.

631               We find that the Gullivers Group’s concern that the Alliance would facilitate behaviour by the applicants favouring their own vertically‑related distribution channels at the expense of competition in the travel services distribution market is essentially a concern that the applicants would leverage their market power in the air passenger services markets to adversely affect competition in the travel services distribution market and advantage their vertically‑related affiliates in that market.  The Alliance would only facilitate behaviour by the applicants favouring their own vertically‑related distribution channels if the Alliance conferred enhanced market power on the applicants in the upstream air passenger services markets.  Mr Bagnall recognised as much when he summarised this particular concern as follows:

“Qantas and Air New Zealand can be expected to use their increased market power to favour their own distribution channels including their own airline websites, preferred distributors, their own distributors such as Qantas Holidays and Qantas Business Travel and reduce or eliminate commission rates to independent travel agents.”

 

632               Thus, the important question is not whether the Alliance enables the applicants to co‑ordinate favourable offerings to their own distribution channels, but what additional market power is conferred by the Alliance which would enable them to engage in behaviour which, presumably, they are presently incapable of engaging in.

633               We are satisfied that the Alliance would not enhance market power in the upstream markets for the reasons to which we have already referred.

the benefits claimed by the applicants

634               The applicants contended that the Alliance would enhance each of their networks enabling them to provide a better product offering at a lower cost and thereby provide public benefits to Australia.

635               In particular, Qantas contended that the Alliance would offer it a unique opportunity to work with Air New Zealand to establish a significant network carrier grouping which could secure a sustainable long‑term position in the global market from which it could grow.  Air New Zealand submitted that, as a network carrier, it needed to serve a global market and offer connectivity and that its international growth was constrained by its small domestic passenger base which was located at the end of the world’s major passenger and airfreight routes.  The Alliance would give Air New Zealand the prospect of achieving a durable business model and balance sheet, which was essential for it to contend with the changes to the airline industry brought about by LCC growth and the industry’s exposure to severe, one‑off events. 

636               The applicants identified a number of specific benefits that they claimed would be a direct, lasting and significant consequence of the proposed Alliance.  They submitted that the Alliance would be in the national interest of Australia because of the manner in which it would generally enhance Qantas’ position.  A number of general categories of public benefit were also identified, including the benefits of extension of Qantas’ domestic and international networks; synergy, scheduling and pricing benefits of network integration; and tourism benefits.  These benefits were said to be especially important in the context of the current airline industry which involved LCC entry and growth, and the increased activity of government-funded global airlines in the Australasian market.

637               Some of these benefits were expressed in dollar terms.  Other benefits were measured in terms of their qualitative enhancement of social welfare.  The applicants claimed that these benefits were benefits to the public that would be received either directly or as a result of private benefits ultimately becoming public benefits in the hands of consumers by means of the operation of pass through mechanisms.  Generally, the applicants argued that they would be forced to pass on private gains, either in whole or in part, as a consequence of the unrelenting competitive forces faced by the two airlines in the situation represented by the factual case that was advanced in argument.

638               We have already noted that it is not necessary for an applicant for authorisation to give a monetary quantification of the public benefit claimed.  However if a party chooses to assess the monetary benefit to be derived from proposed conduct, it is important that the methodology by which, and the assumptions upon which, such monetary quantification is calculated be carefully and properly applied and that those methodologies and assumptions be made explicit.

639               The Commission did not appear to challenge the nature of the general categories of public benefit claimed by the applicants.  For example, the Commission acknowledged that the establishment of a broader and deeper network was capable of being a public benefit but asserted that the evidence concerning the network consequences of the Alliance did not establish any significant benefit to the public.

640               However the extent of the claimed benefits was strongly contested by the Commission and the Gullivers Group in terms of  their existence, whether they were in whole or in part private benefits, and whether they had been accurately quantified.  The Commission and the Gullivers Group were critical of a number of the costing aspects of the applicants’ claimed public benefits.  There was considerable merit in these criticisms.

641               Importantly, the applicants argued that in the counterfactual scenarios, as best we understood it (and we were not greatly assisted by the parties in this regard), none of the claimed benefits were likely to be available.  This was contested by the Commission and the Gullivers Group who claimed that a number of the efficiencies identified by the applicants as a likely result of the Alliance could be achieved through other means.  The Commission asserted that the counterfactual presented by the applicants did not represent the only choice available to them, and that many aspects of the Alliance’s operations could be undertaken in the absence of the Alliance, a consideration in assessing the public benefits said to be relevant to the authorisation test.

642               The Commission focused its criticism of the public benefits claimed by the applicants on three general areas.  It contended that:

·                    the elimination of wingtip flying would not bring about any benefit;

·                    the cost savings calculated by Mr Ergas were based upon factual and counterfactual scenarios which were not necessarily the only choices open to the applicants;

·                    the tourism benefits asserted were illusory because the dual destination market propounded by the applicants, and the factual basis for the tourism increases asserted by Mr Simon Bernardi, General Manager of QH Tours Ltd, and their costings by Mr Ergas, were not supported.

 

643               The Gullivers Group was more critical than the Commission and offered a more detailed analysis of the tourism benefits claimed by the Alliance, probably because of its vested interest in this area.

644               As regards the expert evidence on public benefits, the applicants largely relied upon Mr Ergas to support their claims.  Dr Tretheway added some general comments that supported Mr Ergas’ assumptions, methods and conclusions, but provided no substantive analysis of his own. 

645               Professor Oum commented upon Mr Ergas’ estimates, although in the final result his evidence focused almost exclusively upon the estimated cost savings.  He provided no critique of Mr Ergas’ calculations of the claimed tourism benefits.  We had little confidence in the methodology used by Mr Ergas to quantify the public benefits claimed by the applicants and accordingly we were not persuaded by the estimated figures he ultimately reached for each category of benefit. 

646               The remaining expert witnesses offered only passing descriptive comment, if they made any comment at all, on the claimed benefits.

647               We have found a relatively limited anti‑competitive detriment arising out of the Alliance.  Accordingly it does not require a substantial public benefit to outweigh such detriment. 

648               We turn to the issue of cost savings.  We accept the proposition that revenue in the factual and the counterfactual must be taken into account, as well as the relative cost savings in each scenario.  We accept, that there were probably a number of different counterfactual scenarios which might have been considered.  Nevertheless, we are satisfied that in a number of respects it would be inevitable in a commercial arrangement such as the Alliance that there would be significant cost savings which Qantas could use to pass on to travellers by way of lower fares or to delay any fare increases having regard to the competitive pressure on it, particularly from Virgin Blue and Emirates.  We point, for example, to integration of information technology and networks, management of inventory and spare parts, integration of management, crewing and maintenance, and those aspects of airline operations which would necessarily be duplicated in an alliance‑type situation. 

649               The Gullivers Group was particularly critical of Mr Ergas’ calculation of $670 million as being the quantification of the benefit arising primarily from the removal of duplicative capacity.  Its principal criticism in this respect was that the Alliance was not a closed system but was rather a small constituent part of the global Qantas operations.  It submitted, with some cogency, that it was impossible to know the net costs of the Alliance without assessing the holistic impact of the Alliance on the entire Qantas business.  We agree with this criticism and would say further that it would be inconsistent with Qantas’ submission that it was not subject to x‑inefficiency, to look at its cost savings on an Alliance-only basis.

650               As the Gullivers Group pointed out, given the fact that Qantas is an integrated network airline, any quantification of the benefits accruing to Qantas from the Alliance should have involved a comparison of the costs and revenue of the whole Qantas fleet as between the factual and the counterfactual scenario.  Although Mr Ergas considered it obvious that assets, otherwise not used in the Alliance, and deployed elsewhere and would incur both costs and revenue, he took neither of these factors into account in calculating the cost savings.

651               We are not satisfied that a quantification of the net benefits derived from the saving of costs brought about by the Alliance, such as that done by Mr Ergas, could be persuasive unless more detailed arithmetical operations were undertaken.  Even then the determination of a single dollar figure could be open to numerous challenges.  Besides, until such a figure was determined, it would not be possible to know whether the net outcome of the subtraction of the costs from the benefits in the factual exceeded that in the counterfactual.  Mr Ergas’ calculations appeared to be predicated upon unstated assumptions and suppositions rather than on precisely spelled out inputs.

652               Although Mr Ergas asserted that estimated cost savings of $670 million over five years would largely be passed through to travellers, we are not satisfied that such an amount can be accepted as likely to be passed through, in the absence of a detailed analysis of the means by which pass through would occur, and over what time period this would take place. 

653               Nevertheless, we are satisfied that there will be significant cost savings (albeit of an indeterminate amount) for the reasons to which we have referred.  We are also satisfied that it would be in Qantas’ commercial interests to pass on these cost savings to travellers either by way of fare reductions or other benefits in order for it to remain competitive.  It should also be remembered that the Alliance would only be given an authorisation for five years, and if Qantas were interested in having the Alliance continue thereafter it would be necessary for it to demonstrate during the five‑year period of the authorisation that there had been significant benefits which had been passed through in large part to travellers.

654               The Commission also submitted, with some force, that Qantas had looked at areas of potential co‑operation which could be achieved with Air New Zealand without the necessity for the creation of the Alliance.  Hence the benefits being sought could be achieved in the absence of the Alliance.  There will always exist the opportunity with organisations such as Qantas and Air New Zealand to co‑operate in cost‑saving ventures.  However, we accept that if two competitors, such as Qantas and Air New Zealand, were to consider co‑operative ventures they would need to take care to avoid any allegations of contraventions of Pt IV of the Act.  To that extent, we place little weight on the fact that Qantas and Air New Zealand could well have entered into some sort of co‑operative venture in the absence of the Alliance. 

THE national interest

655               Qantas claimed that it was the only network carrier that could deliver certain important benefits to Australia.  These included providing the most complete and sustained coverage of domestic Australian and international routes between the rest of the world and Australia (unlike the opportunistic entry and exit of many other international carriers), and generating significant economic benefits for Australia through its investment and employment and through its high standards of corporate social responsibility and corporate sponsorships.  This raises for consideration the issue of the national interest.  This issue specifically falls within the requirement in s 90(9A)(b) of the Act that, when assessing public benefits relating to a share acquisition for the purposes of s 90(9), regard must be had to all relevant matters that relate to the international competitiveness of any Australian industry.

656               This issue of the national interest was picked up by Mr David Hawes, the Head of Government and International Relations at Qantas.  Mr Hawes said:

“Australia needs a strong locally based airline to provide critical international, domestic and regional links between markets and with trading partners on a commercially sustainable basis.  This is particularly important for a country of Australia’s size and geographical isolation.

 

As a locally based integrated network airline, Qantas is uniquely placed to deliver the following benefits to Australia:

 

(a)       Qantas ensures, and has an incentive to maintain, the most complete coverage of routes within Australia and between Australia and the rest of the world

…”

657               We should interpolate at this stage that Qantas will no doubt be in a somewhat similar situation in any counterfactual scenario, but its strength will be enhanced if the Alliance were to proceed.

658               We are satisfied that in the factual scenario proposed by the applicants, the ability of Qantas to compete on the international scene as a viable and efficient international airline will be enhanced.  We consider that it is in the national interest of Australia for Qantas to be a strong and efficient airline, particularly in the light of experience over the last few years when a number of international airlines have withdrawn services to and from Australia.  It is also relevant to take into account recent mergers of overseas airlines, such as KLM Royal Dutch Airlines and Air France,which might have been thought, at one time, were efficient in their own right and not susceptible to merger or takeover.

659               The relevance of the national interest was not challenged by the Commission or the Gullivers Group, although the Commission did submit that the Alliance would add little to the global competitiveness of Qantas as Qantas already had access to most of the New Zealand market, and had strong operations domestically and internationally, whilst its proposed alliance partner, Air New Zealand, was relatively small and had a limited network. 

660               We consider that any alliance which will strengthen Qantas’ ability to compete on the international scene will be in the national interest, and therefore a public benefit, so long as there is no significant detriment from such alliance which outweighs that benefit.  We do not consider this to be the situation in this proceeding. 

the benefits of EXPANSION of QANTAS’ domestic and international networks

661               Qantas asserted that it had increasingly treated trans‑Tasman destinations as an integral part of its network operations in a manner akin to that of its domestic destinations, with the result that its natural “homebase” or domestic market was effectively Australia, the trans‑Tasman and New Zealand.  It currently offered relatively few flights within New Zealand, but under the Alliance it would be able to offer Australian travellers many more flights to, from and within New Zealand than are presently available. 

662               Qantas argued that the underlying assumption behind its entry into the Alliance was that Qantas would be better off under the Alliance as it would be more profitable for Qantas to achieve the expansion of its network in New Zealand by sharing Air New Zealand’s network rather than undertaking the cost of expanding its own. 

663               Qantas submitted that the quality of its service would accordingly be substantially enhanced, and this would represent a benefit to both Qantas and to Australian consumers.  In addition, this benefit would be achieved without Qantas needing to undertake the investment otherwise necessary to replicate Air New Zealand’s network of flights, a saving of $12.5 million in the first year of the Alliance, $13.3 million in the second year and $19.7 million in each of the remaining three years.  Under this factual scenario, Qantas argued that fewer, more efficiently used aircraft would be used than under the counterfactual, leading to significant savings.  Further, the applicants would not mirror each other’s schedules across the Tasman and would offer additional flights on various routes.  Put another way, wingtip flying would be expunged for extra and more frequent services. 

664               Qantas claimed that these savings represented a public benefit due to a more efficient allocation of resources, and that the money saved on not having to replicate the Air New Zealand network would enhance the ability of Qantas to compete on other routes.  If the Alliance were not approved, Qantas said it would expand in New Zealand, but not so as to fully replicate the Air New Zealand network, thereby never reaping the full benefit of such a network.  Should the Alliance be rejected, or delayed, Qantas submitted that the Air New Zealand network would be “unlikely to continue in its current valuable form” due to the potentially irreversible competitive inroads being made by Virgin Blue and Emirates, with a consequent loss to Qantas and hence Australian consumers.

665               Whilst Qantas argued that to try to predict revenues precisely under the Alliance would be “wholly unrealistic”, it submitted that the real saving would be greater than the amounts set out in [663] because if it added capacity into New Zealand, this would escalate competition with Virgin Blue, with its attendant higher costs of competition.  Furthermore, it would have to overcome a natural preference of New Zealanders for Air New Zealand.

666               Qantas also submitted that a number of benefits of extension of its international network would occur as a result of the Alliance, in terms of a broader and deeper network yielding improved schedules, new direct non‑stop services, better connections and the development of new markets and existing hubs. 

667               The Commission argued that the Alliance would not significantly add to the breadth or depth of Qantas’ network, which it said was already extensive. 

668               The Commission argued that while the creation of a deeper and broader network in theory could constitute a public benefit, the evidence did not establish any such benefit in significant terms, that any public benefits from increased connectivity appeared at best to be of marginal significance, and that many of the claimed network improvements could be achieved without the formation of the Alliance.

669               Qantas said that, compared with its major overseas rivals such as Singapore Airlines, Thai Airways, Emirates and Cathay Pacific, it operated at a major disadvantage because it did not have a geographically central hub location at which it could aggregate traffic.  It said that Australia is an “end of route” destination.  Qantas could not, for example, replace Singapore‑deplaning passengers in Singapore with other passengers for its Singapore–London leg of a flight from Australia–London.  Thus it operates this second leg at a lower load factor, making it less profitable for Qantas compared with its rivals, and thus making it more difficult for Qantas to offer strong competition to these airlines for passengers in and out of Australia.  Qantas submitted that this situation acted to the detriment of Australian travellers.

670               As a result, Qantas said that it developed Singapore as a “mini‑hub” for passengers departing Australia from cities other than Sydney or Melbourne. 

671               We are satisfied that by securing access to the Air New Zealand network, and especially its Auckland–Singapore flights, Qantas would derive a significantly enhanced ability to develop the Singapore mini‑hub.  Not only would it get additional feed, but it would deprive Singapore Airlines of some of its feed, thus earning additional income for both Qantas and Australia.  The overall result would be an enhanced and stronger international airline for Australia, with a better capability to provide a comprehensive international network to Australians travelling overseas and to travellers coming to Australia.

672               Qantas submitted that if the Alliance were not approved it would introduce [--].  Such a capacity extension, like expansion in the domestic New Zealand market, would in effect be a substitute for the network extension available under the Alliance – what it called a “second best replication of the network which it gets access to under the Alliance” – because the capacity extensions would not cover the depth or breadth of the Air New Zealand network or benefit from Air New Zealand’s bilateral agreements, nor get a share of the revenue from all of Air New Zealand’s flights. 

673               Qantas submitted that if it could avoid that one replication, it would save $[x] annually after three years of the Alliance, a large efficiency gain that would enhance Qantas’ ability to compete elsewhere.  This was said to be important because Qantas had to operate at as low a cost as possible in order to compete with government‑owned and supported airlines like Singapore Airlines and Emirates.  In addition, avoiding such replication would avoid the costs of competing with [--] on that leg.

674               Avoiding such a replication does, we agree, provide a benefit to Qantas with a public component as it enables Qantas to deploy resources in other areas and build a more efficient FSA with a greater opportunity to compete across international networks. 

675               Qantas also introduced the claim, which we accept, that by extending its network to include that of Air New Zealand, Alliance passengers travelling from Japan could travel on a loop across the Tasman without the need to backtrack.  Qantas by itself could not offer this benefit as Australia does not have the rights to operate from Japan to New Zealand.  The ability to offer such a seamless network from Japan, within New Zealand, across the Tasman and back to Japan would increase the potential for Qantas to attract visitors to Australia.

676               Generally, Qantas argued that the geographical proximity of Australia and New Zealand and their isolation from the origins of visitors rendered the applicants incapable of offering coverage of both areas, however, the combination of the applicants’ networks and brands, with their strong regional associations, would provide an important competitive advantage.  We agree with this submission to the extent that we agree that this combination of the applicants will strengthen the extent to which the Alliance could offer competitive tension to other international airlines.

677               These are all matters which are of a benefit to passengers, although they may not be able to be quantified in any precise manner.  Nevertheless, we are satisfied that there are efficiency gains to be obtained from an integration like the Alliance which will benefit travellers by providing a more efficient and comprehensive network with the attendant features travellers seek from an FSA such as schedule co‑ordination and better baggage handling features.

678               Qantas submitted that the key to understanding these benefits was to understand that Qantas is an FSA operating an interconnected network business.  Higher levels of interconnected flight frequencies provide significant benefits to a wide range of passengers, including seamless baggage transfers and connections, convenience and consistent availability of flights.  Qantas operates an integrated business over its whole network rather than on the route‑by‑route basis that characterises the operation of LCCs, and so the profitability of the total network is significant rather than the profit on any particular route, and the operation of certain profitable routes can generate important revenue on other routes.

679               We accept that Qantas is the only network carrier that can deliver important benefits to Australia, including providing a complete and sustained coverage of domestic Australian and international routes between Australia and the rest of the world, with the result that significant economic benefits for Australia will be generated through its investment and employment and through its high standards of corporate social responsibility and corporate sponsorship.

680               We find that some benefits of network extension will result under the Alliance as Qantas will have a more efficient allocation of resources by not having to replicate the Air New Zealand network, resulting in savings which will enhance Qantas’ ability to compete on other routes.  We believe that this will constitute a public benefit.  We also note that there will be the additional benefit to Australian consumers of more seamless connections, as Australian travellers will have available through Qantas a greater range of destinations to, from and within, New Zealand.  Load factors and traffic feed from across the Tasman to Australian destinations will be increased, which will lead to greater operational efficiency. 

681               We also find that public benefits are likely to result under the Alliance, in terms of Qantas developing a broader and deeper network with improved schedules, new direct non‑stop services, better connections and the development of new markets and existing hubs and Air New Zealand and Qantas being able to code‑share on each others’ flights with resultant improved efficiencies. 

682               We are satisfied that there is a demonstrable public benefit in Australia having Qantas strengthened as an domestic international FSA with an enhanced ability to compete across international networks with LCCs and strong government‑based airlines. 

synergy, scheduling and pricing benefits of network integration

683               Qantas submitted that the Alliance was a natural “fit” for two strong regional brand networks such as the applicants which are geographically and culturally proximate and which are substantially complementary.  Qantas said that any overlap between the two could be eliminated without lessening competition and that the application of the ordinary assumption of profit maximisation to the applicants “compels a conclusion that synergy benefits will be achieved.”

684               Qantas stated that it was not possible either to identify or quantify all the synergy benefits until the Alliance came into effect.  However, it submitted that the following benefits, inter alia, would be realised:

·                    the ability to operate joint rather than separate facilities in numerous areas such as sales teams, airport customer service, freight handling and frequent flyer lounges; and room to save costs also in catering, cleaning and finance areas, as well as in joint tourism and promotional activities;

·                    joint procurement and/or development of new generation information technology systems at a lower cost;

·                    efficiencies through the consolidation and joint maintenance of both airlines’ aircraft; and

·                    economies of scale in operation and purchasing, and in fleet upgrading, leading to a greater ability to adopt innovations.

 

685               In support of its contentions, Qantas pointed to its experience in its Joint Services Agreement with British Airways, and also noted that the achievement of such synergy benefits has been the common experience of other international integrated airline alliances. 

686               Air New Zealand argued that the Alliance would offer greater opportunities for better connectivity through Air New Zealand and Qantas code‑sharing on each others’ flights, through schedule co‑ordination, and through co‑ordinated ticketing and baggage handling.  Passengers would benefit in many ways, including reduction in waiting times, better itineraries for dual destination travellers, better access to lounges, and through-checking of baggage.

687               Support for Qantas’ submissions can be found in the Gullivers Group acknowledgement that public benefits would potentially result from improved scheduling and enhanced connectivity, although it thought that these were likely to be overstated, noting difficulties in valuing the time difference between preferred times and scheduled times.

688               We find that, while not easily quantifiable, it is our expectation that such synergy benefits would be achievable in most business amalgamations.  Indeed it is unlikely that the applicants would agree to form the Alliance unless the available facts indicated that such benefits were likely.  However, we are unable to form an exact view on the timing and extent of such benefits.

689               The applicants submitted that the Alliance would mean that the applicants no longer have to fly wingtip flights across the Tasman at the same or very similar times.  Two overlapping flights could be replaced by one flight operated by a larger, more efficient aircraft.  Schedules could be organised to meet consumer demand, giving passengers a greater choice of flight times that would enhance the value of fully flexible tickets, if not of all cheaper priced tickets.

690               Airline seats are highly perishable.  Where a flight that takes off with an empty seat, the airline can never recover the revenue from that empty seat.  This point highlights the importance to airlines of tight inventory management, whereby loads for a flight are continually monitored and the seats made available in different fare categories are adjusted accordingly.  Qantas explained that FSAs like Qantas or Air New Zealand need to keep some seats unsold in order to cater for last‑minute passengers who are prepared to pay premium prices, and that it is generally not possible to predict such demand with great precision.  Currently, the applicants each hold back a number of high fare category seats.  Qantas submitted that this is inefficient and that if the two airlines could combine their demand for seats there would be less need to hold back as many high fare seats and so more lower fare seats would be provided, leading to higher loads, higher average revenue, greater flight profitability and more efficient use of aircraft.  We accept this submission and see an advantage, and an attendant public benefit, in combined inventory management.  As Mr Edwards explained, inventory management will involve a more efficient use of protecting seats for higher-yielding passengers who may come along just before the flight. 

691               Air New Zealand emphasised that the Alliance would permit the applicants to select the most appropriate aircraft for any given route, avoiding wasteful excess capacity and leading to substantial cost savings.  It noted especially that further cost efficiencies would result from the highest margin carrier being assigned to operate any specific route.  Because of the intense competition on the trans‑Tasman, this would equate to the lowest cost carrier.

692               Qantas argued that the Alliance also offered the possibility of introducing new direct services for the benefit of passengers who currently have to travel via an intermediate port.  Time savings for these travellers are an important benefit.  This will stimulate demand on that city‑pair.  Also, as traffic is removed from the indirect flights, these seats have to be filled, which, Qantas submitted, would lead to lower fares by means of the operation of the yield management system discussed above at [56]‑[69].

693               Air New Zealand submitted that the Alliance would make it more feasible for Air New Zealand and Qantas to develop new markets as they would be able to aggregate demand to get large enough load factors to make the new routes viable.

694               Professor Levine believed the applicants’ claims were “vastly overstated” with respect to the elimination of wingtip flying and development of new routes, and that projected aircraft cost savings from using larger aircraft at peak hours were either non‑existent or negative.  He did not believe the applicants would pass on more than a portion of their cost savings because of their market power, a conclusion that is the opposite to that of Professor Ordover and Mr Ergas. 

695               The Commission challenged the applicants’ submission that the elimination of wingtip flights would result in a benefit because aircraft could be released for other routes.  It was part of the Commission’s case that the Alliance was proposed with a view to reducing capacity across the Tasman.  This was denied by the applicants and we accept the applicants’ submissions in this respect as they appear to us to be more in conformity with commercial reality.  It was put by the Commission to Mr Harrison, Air New Zealand’s General Manager, that the Alliance envisaged a reduction in capacity across the Tasman.  Mr Harrison rejected this proposition and we accept that it would not be commercially advantageous for Qantas or Air New Zealand to reduce capacity at the times that wingtip flying occurred, because of the availability of excess capacity across the Tasman.  As we understand the situation, the applicants proposed that wingtip flying would be eliminated and that if the demand existed then an aircraft with a greater capacity would be scheduled at that time.  It does not make commercial sense for the applicants to reduce capacity in circumstances where this would cede demand or lose passengers to other airlines such as Virgin Blue and Emirates.  We accept Mr Harrison’s evidence that there would only be a reduction in capacity over the trans‑Tasman route by the applicants if they were able, by doing this, to respond to the market more efficiently without losing market share. 

696               A number of witnesses gave evidence to this effect.  Mr Norris said that one of the benefits of the Alliance arose from the more efficient use of capacity on trans‑Tasman routes.  By combining their networks and schedules Air New Zealand and Qantas could offer passengers a greater spread of flights throughout the day.  This would enable them better to match supply with customer demand and remove inefficient capacity.  He said that research undertaken by Air New Zealand indicated that customers had preferences for convenient schedules and that in short‑haul air travel frequency was valued by customers second only to price.

697               Mr Norris put the matter this way:

“Take Wellington for example.  Wellington at the moment we fly wingtip to wingtip out of Wellington in the morning and back in the evening.  If there is a situation where there is a significant number of passengers who want to still travel at the peak time, rather than each of us running a 737 or an A320, it would be more cost effective for us to run a wide bodied A330‑200 or a 767‑300 where customers of both airlines would fly on that route, and also providing you with the opportunity that the other airline partner flies at, let’s say, 9 o’clock or 10 o’clock in the morning a lower gauged aircraft, which may be a 737 or an A320 where you are effectively satisfying 150% of the peak demand — all of the peak demand — with a more effective aircraft and providing the opportunity of one [sic] flight.  So you get away from the wingtip to wingtip flights and you end up with a better schedule and a better set of options for the customers.”

 

698               Mr Harrison said that under the Alliance there would be a reduction of the equivalent of three Boeing 737 (presumably of Air New Zealand aircraft) each of which contain about 130 seats.  Because of the market and revenue share premium that could be obtained from more frequencies throughout the day, Mr Harrison said the market could be adequately served and more efficiently served with three fewer aircraft without losing market share at a rate directly proportional to the aircraft lost.  However, Mr Harrison doubted that there would be a reduction in total industry capacity on trans‑Tasman routes because of the expansion from Virgin Blue and the growth of some of the FFCs.  He expected that any gap where there was actual demand would be filled by one of those carriers or by Air New Zealand and Qantas.  We would expect that Virgin Blue and Emirates would expand their flights and frequencies having regard to their demonstrated ability to expand their flights across the Tasman.

699               Qantas witnesses supported Air New Zealand witnesses in this respect.  Mr Edwards said that Qantas would not reduce capacity under the Alliance because a reduction in capacity by Qantas would make it easier for Virgin Blue and Emirates to pick up traffic.

700               Mr Gurney said that there would be a difference in how combined capacities would be managed under the Alliance.  The applicants would be able to manage the revenue of the flights jointly.  Because they would be aware of each other’s inventory they would manage inventory better so as to increase their load factors on current services.  The average revenue they earned per aircraft would also increase as a result.  Mr Gurney said that the elimination of “wingtip” flying should also improve profitability because if there is the right match of supply and demand, two smaller, single aisle aircraft could be replaced by a larger, twin aisle aircraft which generally deliver a lower seat mile cost than smaller aircraft.  This would mean that airlines would generate more profit by producing seats at lower costs and accommodating the same number of passengers.  Mr Gurney said that it would also enable Air New Zealand and Qantas to “spread the schedules and potentially use an alternative aircraft or slot to operate a different service and broaden the choice to the consumer.”

701               In response to the contention that the integration of the applicants’ respective networks would result in a better spread of flights, the Commission submitted that the present schedules of the applicants already met demand on trans‑Tasman routes.  The Commission also argued that the evidence regarding the new direct services to be offered under the Alliance was ambiguous, that the limited frequency of flights to be offered on the new routes undermined their utility, and that the new routes were unlikely to be sustainable in the short to medium‑term given that they had not already been provided by the applicants or any other airline.  The Commission also noted that Qantas had already announced the commencement of services on one of the proposed “new” direct services to be available under the Alliance, being the Adelaide–Auckland route.

702               The Commission and the Gullivers Group criticised the assumptions upon which the elimination of wingtip flying and the consequential public benefit was based, and also the methodology and quantification of the benefits to be derived from improved flight timing through the elimination of wingtip flying.  The Commission asserted that the present schedules offered by the applicants were designed to meet existing demands.  In its final submissions it stated:

“The elimination of certain ‘wingtip’ flights and placing such removed flights into ‘gaps’ in the schedules relies upon the assumption that consumers will place greater value on a flight at, say, 1.00pm than having a second flight at a peak demand time of, say, 8.00am.  That assumption has simply not been established by the evidence and is also counter‑intuitive.” 

 

703               We have formed the view that benefits would be likely to arise as the result of more aircraft becoming available for use leading to enhanced timetables and greater consumer choice.  However, we are not satisfied that the figures provided by Qantas are reliable.

704               There is a logical basis underlying the removal of wingtip flying.  An aircraft is freed up which could be used by the airlines to derive revenue elsewhere.  It should not be assumed that if wingtip flying were eliminated an aircraft would be kept in the hangar.  It is in the interests of an airline to have its aircraft in the air earning revenue, rather than standing idle on the ground.  The aircraft which is released is able to provide a route for the public on which to travel and to derive revenue which is a benefit, and the issue which arises is whether there is a loss of revenue compared with the use which might have been made had it continued wingtip flying. 

705               The criticism was made that if wingtip flying were eliminated, there would be an unsatisfied demand at the peak time.  If there were an unsatisfied demand at such a peak time it would not be unreasonable to assume that the Alliance would not want to cede market share to any other airline, but would rather seek to meet that demand by putting on aircraft with a larger capacity.  Whether or not bringing in a larger aircraft would mean a loss of revenue elsewhere and whether or not the aircraft released from wingtip flying would derive greater revenue elsewhere is ultimately a matter for careful yield management analysis.  Further, it is not unreasonable to assume that within that demand at peak times there would be some passengers who might be prepared to fly earlier or later.  Accordingly, other flights could be scheduled which could cater for such persons and which could stimulate demand for flying at those alternative times. 

706               We do not believe that if there was demand at peak times which was significantly unsatisfied the Alliance would not do anything to meet it in some other way.  We do not believe that with Virgin Blue and Emirates waiting in the wings, albeit not necessarily with the same frequencies as the Alliance, the Alliance would willingly concede a significant part of market share to them on major routes without requiring them to fight for that increased market share. 

707               There is no simple answer to this issue but we are satisfied that it would be a matter that would be taken into account by the Alliance as it would not simply leave demand at peak times unsatisfied. 

708               However, there is a further dimension to the effect on peak-time loads if wingtip flying were removed.  Mr Ergas had distributed desired passenger departure times uniformly over the period of one day.  The Gullivers Group, as did the Commission, contended that this distribution was both counter‑intuitive and assumed what it intended to show.  There is merit in this criticism, but as Mr Ergas pointed out it is “particularly difficult” to quantify the benefits from improved flight timing because an accurate estimate of these benefits required detailed information relating to consumer travelling preferences which information and data was not available to Mr Ergas. 

709               We are not disposed to accept Mr Ergas’ quantification of the net benefit to be derived from the elimination of wingtip flying.  Rather, we consider a better approach is to accept that the elimination of wingtip flying will free up aircraft to provide further flights either on the same sector or on other sectors which will have the advantage of providing the public with flights on other sectors or increased frequencies on the same sector.  To this extent there is an identifiable public benefit.

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