The European Commission's well-established analytical framework for mergers and alliances of airlines largely ignores the ongoing shift toward network-based competition. The rigid analytical framework through which the Commission reviews the concerns and benefits of deeper alliance integration often leads it to take an excessively interventionist approach on specific routes. For example, the Commission typically requires the alliance to divest assets such as airport slots. This approach favors hypothetical market entry over the real and immediate benefits resulting from optimized networks. While this framework is unlikely to change fundamentally in the near future, we believe that market developments will eventually force the Commission to relax or even abandon certain principled positions.

In addition to an overly rigid analytical framework, EU competition law also has procedural weaknesses. In many instances, competition law offers parties little legal certainty. Unless the transaction qualifies as a "concentration" under the merger control rules, the existing procedural framework leaves the Commission with a broad margin of discretion, which has led to diverging review processes to the detriment of ensuring a level playing field between market players.

This article examines two issues. Section 1 reviews the Commission's traditional approach to mergers and alliances in (passenger) air transport and highlights its primary weaknesses. Section 2 then analyzes the flaws of the procedural framework applicable to review of mergers and alliance agreements in the airline industry.

An Overly Rigid Analytical Approach to Cooperation Agreements and Alliances

Step I: Defining the Relevant Market and Assessing the Overlap. When considering mergers and alliances for passenger traffic, the European Commission examines the horizontal overlap on narrow markets resulting from the merger or alliance. To define the market, the Commission relies primarily on demand substitutability. The Commission analyzes demand strictly as the consumer's need to be transported from a point of origin to a point of destination (called "O&D").1 As a result, the Commission considers each point-to-point route as a separate market.2

In addition, the European Commission relies on a time/price factor to distinguish "premium" from "non-premium" passengers, which further narrows the market definition.3 Premium passengers encompass at least services in the first and business class, while non-premium passengers encompass services in restricted economy class. The Commission views these passengers as two distinct markets. The distinction between premium and non-premium passengers leads the Commission to (i) exclude indirect flights from the premium market and (ii) include only indirect flights as a "weaker" competitive constraint on non-premium traffic.4 Essentially, this narrow approach to market definition does not take into account the competitive constraint that competing alliances can exercise on the "market" using indirect flights. Also, premium markets confined to direct flights are generally highly concentrated as only the largest airlines are able to offer direct long-haul flights because of efficiencies gained through economies of scale. Furthermore, supply-side considerations bear little weight in the Commission's analysis of the markets. Supply substitutability is usually taken into account only if it has an equivalent impact on demand substitutability in terms of time and efficiency.5

Although airlines increasingly compete on a network-to-network basis, the Commission has thus far refused to step away from its narrow O&D approach. It maintains that alliances cannot claim to serve all destinations and that networks complete only the need to travel from a point of origin to a point of destination.6 Practitioners have criticized this market definition as overly static and failing to consider prospective developments. In particular, the Commission's definition fails to account for increased competition between alliances and increasing substitution between airports. The Commission's strict market definition has also limited the Commission's ability to recognize certain efficiencies that could, on balance, outweigh the restrictive effects of a horizontal overlap.

Unaccounted-For Benefits Under the Current Framework

Alliances can be beneficial to certain types of customers, such as corporate clients purchasing bundles of routes, because the geographic coverage of alliances goes beyond a specific O&D. In AirFrance/KLM, the Commission recognized that "in the case of corporate customers it is recognised that demand is driven both by network effects as well as O&D considerations."7 While consideration of the role of network effects in driving demand could have opened the door to an evolution in the Commission's market analysis, the Commission has not modified its understanding of the market to include networks. The more recent AA/BA/Iberia decision shows that the language in AirFrance/KLM has not yet led the Commission to abandon its O&D approach to market definition. The Commission continued to focus on the U.S./U.K. routes (as well as the routes between the U.S. and Spain) and ordered the parties to divest slots on certain routes as a condition for closing its investigation. The Commission declined to look at the broader-scale competitive impact of the alliances, despite the fact that the U.K. and U.S. are precisely the markets in which corporate customers benefit from network effects like strong alliance competition and large hubs in the U.S. and Western Europe.

The development of low-cost carriers on short-haul routes, as well as the development of fast train connections to airports, have undermined the competitiveness of traditional carriers. These new competitors show that a fresh assessment of the relatively strict approach to defining competing airports serving a route is needed. For example, Ryanair has become one of the largest European air carriers and has fully benefited from the Commission's policy of developing smaller regional airports. It operates short-haul flights on the basis of a disruptive competitive model that has significantly broadened the capture area of airports. This market trend has inevitably reduced the ability for traditional carriers to source their hubs with short-haul point-to-point traffic, leading to an even greater need for traditional carriers to integrate their coverage in order to maintain the necessary scale for long-haul flights.

Another negative consequence of the Commission's narrow market definition is that the O&D approach limits the Commission's ability to assess the pro-competitive benefits and efficiencies that result from increased integration of networks. Integrated alliances provide passengers with access to an optimized network. Without these alliances, passengers face a greater burden in creating their own trip as they lose the potential benefits of an optimized route in terms of price and time efficiency. While alliances may have restrictive effects, the benefits and efficiencies of an optimized route may outweigh the negatives of these restrictive effects.

The Commission does allow restrictions of competition if the restriction can be adequately remedied, but the narrow market definition precludes effective use of remedies. In order for remedies to be considered and to potentially justify a restriction of competition, carriers must demonstrate that the markets are "directly related" and that consumers benefiting from those efficiencies are "substantially similar."8 This requirement is overly restrictive when O&D markets, rather than networks, define the relevant analytical framework. Alliances can generate efficiencies on a full set of routes (in particular, thinner long-haul routes), and these should be considered when assessing the overall consumer welfare impact of a merger or an alliance.

Step II: Applying Remedies to Address Competitive Concerns. The second step (i.e., after defining the relevant market and assessing the overlap) in the Commission's analysis is focused on applying remedies to address the potential loss in competition that would result from a merger or alliance.

It can be inferred from the Commission's practice that the Commission has a preference for applying structural remedies over behavioral ones, and that it has a standard remedy package. In all problematic mergers and alliances, the Commission imposed slot remedies with associated market entry enabling remedies. In a few exceptional cases for specific routes, the Commission accepted alternative remedies (e.g., a frequency freeze). The Commission generally assumes that behavioral remedies (such as frequency freeze, commitments concerning fares, or commitments to halt further expansion of cooperation with other air carriers) may stifle or even halt competition.

The Commission's precedents lack a clear methodology for determining the number of slots that should be divested in a particular case. The Commission has preferred to assess the necessary slot divestitures on a case-by-case basis, leaving itself a wide margin of discretion. This discretion limits the carriers' ability to predict the potential "regulatory price" of cooperation and to ensure that this price is set in a nondiscriminatory fashion.

Two more fundamental questions in the application of remedies are whether slot remedies are necessarily the only suitable remedy and whether slot divestitures are really necessary. EC rules instruct that if less intrusive behavioral remedies are available to the Commission, such behavioral remedies should, in principle, be considered. In the AA/BA/Iberia case, the Commission agreed to an important change in its decisional practice when it accepted to limit the airlines' slot divestiture commitment to the leasing of slots, rather than their complete divestment. This shift is a welcome development as it is in line with the general principles governing remedies. Furthermore, it could be an important precedent for other divestment packages.

However, even when slots must not be fully divested, slot remedies remain an inherently contentious remedy. Slot remedies restrict an alliance's ability to expand in its hub airport, which is contrary to the essential need to attract traffic to the hub to fuel the network for long-haul routes. There are also relatively few instances where the slot remedies have proven to be effective enablers of market entry. An objective market study on the costs and benefits of slot remedies is needed to assess their effectiveness and prove the benefit of continued use.

An Under-Defined Procedural Framework

The European procedural framework makes a fundamental distinction between transactions that qualify as "concentrations" (i.e., mergers, acquisitions, or creation of full-function joint ventures) and other more cooperative types of agreements falling short of a "concentration." For concentrations with a Community dimension (i.e., exceeding the EU jurisdictional thresholds), merger control review is a mandatory ex ante review process pursuant to which concentrations are subject to prior Commission approval. This process is set in accordance with clearly defined procedural rules. The rules include hard deadlines that force the parties and the Commission to proceed with the investigation so as to attain a timely resolution. If a clearance decision is adopted at the end of the review, the decision offers legal certainty to the parties on the compatibility of their merger agreement with competition law.9

Alliance agreements falling short of a concentration (i.e., those that do not involve a change of control or the creation of a full-function joint venture) fall under a "self-assessment" regime that has been in place since 2004. The main advantage of the self-assessment regime is that it does not require a formal ex ante review process for all agreements that could potentially restrict competition as defined under EU competition law. The parties seeking an alliance "self-assess" the potential restrictive impact of their agreements on competition, and the likelihood for such agreement to be exempted from the general prohibition based on the pro-competitive benefits it entails. To guide parties in this exercise, the Commission has issued various Guidelines, Communications, and Notices that provide instructions for conducting a self-assessment of the agreement. The current regime also provides for an ex post control mechanism that allows the Commission to launch investigations, establish infringements of competition law, and impose remedies or sanctions in finding infringements.

Despite avoiding the burdens of ex ante review, the self-assessment regime offers little legal certainty to market players, particularly where they are seeking to engage in structural commercial ventures. Without the protection of a clearance decision from an ex ante review, the potential risk of a subsequent investigation and the absence of legal comfort on the validity of the agreement can affect the incentives for and willingness of parties to proceed with the proposed agreement. This concern is particularly true in the airline sector, where U.S. and EU carriers have undergone a significant degree of integration, but those integrations fall short of mergers because of foreign investment restrictions. These integrations seek to achieve an identical operational result to a merger using full-cost and profit-sharing arrangements (metal neutrality) without running afoul of other restrictions. In sharp contrast to the European self-assessment regime, the U.S. regime, where the Department of Transportation can grant companies immunity, provides companies with legal certainty and shields them from both private lawsuits challenging their cooperation arrangements and future infringement procedures.

The broad discretion exercised by the Commission in conducting its investigations adds to the uncertainty of the ex post review process. Whereas the EU Merger Control Regulation provides for a strict timetable for the Commission's investigation, there are no time constraints for ex post investigations. In practice, the Commission's probes into airline alliances have tended to drag on for several years. The Commission's investigation into the Star Alliance has been ongoing since April 2009.10 In January 2012, the Commission closed proceedings against eight members of the Skyteam alliance, but the investigation into the joint venture between Air France-KLM, Alitalia, and Delta continues.11 By comparison, the ex ante probe into the BA/AA/Iberia joint venture was completed in less than one year (from September 2009 until July 2010) after the parties offered a robust commitments package that obliged the long-term lease of slots and access to hub-to-hub and connecting routes for competitors.12 Such diverging timeframes for conducting the regulatory review obviously prevent the level regulatory playing field that the Commission should seek to ensure, regardless of the classification of a venture as a concentration.

Conclusion

The Commission's overly rigid analytical approach manifests itself in narrow market definitions and myopic focus on "in-market" efficiencies, while disregarding efficiencies resulting from networks. If the Commission loosened its rigid analytical approach and allowed greater consideration of the benefits accrued by alliances, the Commission might better regulate developments in the airline industry. Additionally, if the Commission adopted a definite, transparent procedure for review of non-merger agreements, then airlines might gain more certainty as to the legality of proposed alliances. However, a transparent and definite procedure alone will not offer airlines full legal certainty. Until the Commission can provide airlines with immunity from national infringement proceedings, the airline industry will continue to be less enthusiastic and less able to embrace efficient alliances that would ultimately benefit customers.

Footnotes

1 Commission Decision of Feb. 11, 2004, in Case COMP/M.3280—Air France/KLM, paragraph 9. See also judgments of the European Court of Justice in Case 66/86 Ahmed Saeed Flugreisen, Apr. 11, 1989, [1989] ECR 803, and of the European General Court in Case 2/93 Air France/Commission (TAT), May 19, 1994, [1994] ECR 323.

2 Commission Decision of Jul. 5, 2002, in Case No COMP/37.730—AuA/Lufthansa, OJ L 242, Sep. 10, 2002, p. 25. See also Commission Decision of 11/02/2004, in Case COMP/M.3280—Air France/KLM, paragraph 9, and Case 66/86 Ahmed Saeed Flugreisen, Apr. 11, 1989, [1989] ECR 803.

3 Commission Decision of Jul. 14, 2010, in Case No COMP/39.596—AA/BA/Iberia Case 2010, paragraphs 20–22.

4 Commission Decision of Jul. 14, 2010, in Case No COMP/39.596—AA/BA/Iberia Case 2010, paragraph 23.

5 Commission Notice on the definition of relevant market for the purposes of Community competition law of Dec. 9, 1997, no. 97/C 372/03, paragraph 20.

6 Commission Decision of Feb. 11, 2004, in Case COMP/M.3280—Air France/KLM, paragraphs 14 and 15. See also Commission Decision of Jul. 14, 2010, in Case COMP/39.596—AA/BA/Iberia Case 2010, paragraphs 17–19.

7 Commission Decision of Feb. 11, 2004, in Case COMP/M.3280—Air France/KLM, paragraph 16. Nevertheless, the Commission held the contrary in the Commission Decision of Jul. 14, 2010, in Case COMP/39.596—AA/BA/Iberia Case 2010, paragraphs 18–19.

8 Commission Decision of Feb. 11, 2004, in Case COMP/M.3280—Air France/KLM, paragraph 9: "The competitive constraint arising from supply side substitutability is normally only considered in the market definition when it has an immediate and effective impact on the relevant product market." See also Commission Notice on the definition of the relevant market for the purposes of Community Competition law, OJ C 372, 09.12.1997, p. 5–13.

9 The decision does not constitute the clearance of all restrictive covenants foreseeable in the context of the transaction, but only deals with its structural, concentrative part.

10 "Commission Opens Formal Proceedings Against Certain Members of Star and Oneworld Airline Alliances," MEMO/09/168, Apr. 20, 2009.

11 "Commission Opens a Probe Into Transatlantic Joint Venture Between Air France-KLM, Alitalia and Delta and Closes Proceedings Against Eight Members of SkyTeam Airline Alliance," IP/12/79, Jan. 27, 2012.

12 "British Airways, American Airlines and Iberia Commitments to Ensure Competition on Transatlantic Passenger Air Transport Markets Made Legally Binding," IP/10/936 and accompanying MEMO/10/330, Jul. 14, 2010. 

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