28-Mar-2016 12:24 PM

North Atlantic airline market. Closed JVs to have 78% of ASKs in 2016. Weighing the benefits

Analysis

When the regulators approved metal-neutral joint ventures over the North Atlantic, initially involving major airlines in the three global alliances (the JV between Delta and Virgin Atlantic came later), the justification was that they would be in the public interest. In general, the so-called immunised joint ventures have encouraged better capacity and frequency coordination, and a convergence of product and service quality towards that provided by the superior partner (although there is still room for improvement in many cases).

Schedules data from OAG indicate that 78% of North Atlantic ASKs will be operated by these JVs in summer 2016 (assuming that Aer Lingus joins oneworld and its JV). Although airlines outside the JVs are growing their share - led by LCCs, airlines owned by leisure groups and Turkish Airlines - this high concentration illustrates the impact that the JVs have had on reducing competition.

This report examines historical North Atlantic capacity trends and considers some of the issues discussed by a panel at CAPA's Airlines in Transition (AIT) conference in Dublin in Mar-2016, moderated by John Byerly, a former Deputy Assistant Secretary for Transportation at the US State Department.

Summary

Metal-neutral joint ventures over the North Atlantic have reduced competition and increased concentration of ASKs.
The three main joint ventures in the global alliances control 72% of ASKs on the North Atlantic in summer 2016.
The share of ASKs operated by leisure groups and LCCs has increased from 2% to 5% in summer 2016.
Turkish Airlines is not part of any joint venture, but there is a case for it to join the Atlantic++ JV.
The main consumer benefits of joint ventures are increased route options and capacity.
There is a debate over the impact of joint ventures on consumer benefits and the need to review antitrust immunity.

North Atlantic JVS: three in the global alliances, plus Delta-Virgin

Following the Open Skies Agreements between the US and the Netherlands in 1992 and between the US and Germany in 1996, the first trans-Atlantic revenue-sharing joint ventures with immunity from US antitrust laws were two - between Northwest and KLM (1992), and between United and Lufthansa (1996).

These relationships preceded the formation of the three branded global alliances, which followed in 1997 (Star) and 1999 (oneworld and SkyTeam). Other airlines formed other JVs on the North Atlantic also, and the first two were joined by new partners.

The JV landscape has evolved to arrive at the situation today - three major JVs made up of airlines within each of the three alliances. A number of mergers have taken place between airlines in the JVs, leading to changes in their composition.

The three principal North Atlantic JVs are:

within SkyTeam, Air France, KLM, Alitalia, and Delta Air Lines;
the Atlantic++ JV within Star, which groups Lufthansa, SWISS, Austrian, Brussels Airlines, Air Canada and United Airlines; and
the oneworld grouping of British Airways, Iberia, Finnair and American Airlines.

It is expected that Aer Lingus, which was acquired by IAG in Aug-2015, will join the oneworld North Atlantic JV from summer 2016, although there has as yet been no announcement about this. Aer Lingus will need regulatory approval for both: joining oneworld and joining the JV.

In addition to the three JVs within the global alliances there is also a joint venture between Delta and Virgin Atlantic (in which Delta owns a 49% equity stake). Virgin is not a member of SkyTeam and its North Atlantic capacity is not part of the JV involving Delta and its three alliance partners, but all five airlines cooperate on traffic flows in this market.

Three main JVs have 72% of North Atlantic ASKs in summer 2016

According to data from the OAG Schedules Analyser, the three principal immunised JVs will control 72% of ASKs on the North Atlantic (i.e. between Europe and North America) in the summer 2016 schedule. This share has fallen in each of the past two summers: it compares with 74% in summer 2015 and 75% in summer 2014.

However, in summer 2006 only 23% of North Atlantic ASKs were operated within an immunised JV (KLM-Northwest within SkyTeam and Lufthansa-United within Star). Air France, Delta and Alitalia joined KLM and Northwest in an immunised JV from summer 2008.

Air Canada and Continental joined Lufthansa and United in forming Atlantic++, with immunity from Oct-2009. Austrian and SWISS joined this Star JV in Jul-2011 and Brussels Airlines joined it in Mar-2012.

The oneworld JV, also called a joint business agreement, was formed in Oct-2010 by BA, Iberia and American. Finnair joined in Jul-2013 and US Air in summer 2014.

Share of Europe-North America ASKs that are operated within the three main joint ventures* with antitrust immunity, summer schedule 2006 to 2016

JV share is 77% with Virgin Atlantic added, and 78% if Aer Lingus joins oneworld JV

If Virgin Atlantic's capacity is added to the 72% controlled by the three main JVs, then the total share of ASKs that is part of a JV amounts to 77% in summer 2016. If, as expected, Aer Lingus is successful in joining the oneworld JV the total will increase to 78%. This is still less than the 79% share in JVs during summer 2015, and the 80% figure for summer 2014.

The summer of 2014 was the last time that the share of North Atlantic capacity within a JV increased in the summer schedule compared with the previous year. In that summer, US Air's capacity joined the JV within oneworld as a result of its merger with American Airlines, and Virgin Atlantic's capacity became part of its JV with Delta.

Share of Europe-North America ASKs that are operated within all joint ventures* with antitrust immunity, summer schedule 2006 to 2016

Leisure groups, LCCs and Turkish Airlines are increasing their share

The drop in the JVs' combined share of North Atlantic ASKs between summer 2014 and summer 2016 has been accompanied by an increase in the share operated by leisure groups and LCCs.

Airlines owned by leisure groups (primarily Thomas Cook Group and TUI Group) have grown their share of ASKs from 1% to 2%, while the share operated by LCCs has increased from 1% to 3%. Note that these LCC figures do not include airlines that are designated as LCCs but which are also owned by a leisure group (and so, are already included in the share operated by the leisure groups).

The combined 5% of North Atlantic ASKs operated by leisure groups and LCCs in summer 2016 is higher than it has been for any summer season over the past decade. It was close to 3% in summer 2007, before dropping to less than 1% in summer 2010. Norwegian, Westjet, WOW Air and Eurowings are leading the LCC growth.

The share of North Atlantic ASKs flown by fifth freedom operators has remained steady at 2% since summer 2011, but has fallen from 3% in summer 2006.

The share of ASKs between Europe and North America operated by airlines from Russia and the Commonwealth of Independent States has increased from 2% in summer 2011 to 4% in summer 2016. The share of airlines that are not in a JV, are not LCCs or part of leisure groups - Russian/CIS airlines, fifth freedom operators or Turkish Airlines (see next paragraph) - has dropped from 16% in summer 2011 to less than 8% in summer 2016.

There has been an increase in Turkish Airlines' share of ASKs between Europe and North America, from just under 3% in summer 2014 to almost 4% in summer 2016. Turkish Airlines had considerably less than 1% of ASKs on the North Atlantic in summer 2006.

Share of Europe-North America ASKs that are operated within all joint ventures* and by other main categories of airline, summer schedule 2011 to 2016

Turkish Airlines is not in Star's Atlantic++ JV, but "a case could be made"

Turkish is the most significant North Atlantic operator not to be included in a joint venture, although it is a member of the Star Alliance. Its routes between Istanbul and North America also provide feed for its Istanbul services to Asia Pacific, Middle East and Africa and so, they compete with the Lufthansa Group's European hubs for sixth freedom traffic flows between North America and these regions.

Moreover, the strength of Turkish Airlines in secondary European cities, particularly in Germany, also places it in competition with Lufthansa for traffic from Europe and these regions. Tension between Turkish and Lufthansa led to the end of codeshares between the two in 2013.

Nevertheless, speaking at CAPA's AIT event, Star Alliance CEO Mark Schwab said that a case could be made that Turkish Airlines could add value if it joined the Atlantic++ JV. "On a theoretical basis, it would make sense", he said. He added that it would "add bulk", providing a bigger network to offer corporate customers - but he did not expect it to happen any time soon.

Consumers benefit from more route options

The main consumer benefits of immunised joint ventures flow from the airlines' ability to coordinate schedules and prices. This leads to more route options and increased capacity.

Star's Mr Schwab noted that before its joint venture with Lufthansa United had struggled with filling two daily flights to Germany (one to Frankfurt and one to Munich). "Now," said Mr Schwab, "there is a huge increase in capacity as a result of the JV, which has served consumers very well".

But evidence suggests there is no longer a capacity stimulation impact from JVs

However, the main capacity stimulation effect may come from Open Skies air traffic agreements, which are a prerequisite for US to grant antitrust immunity to a joint venture increase (but slower capacity growth on North Atlantic).

Certainly there is no real evidence to suggest that the phase of antitrust approvals for the existing three main JVs on the North Atlantic, which were granted immunity in the period 2008-2010, led to capacity growth. Total ASKs between Europe and North America were the same in summer 2013 as in summer 2007.

In fact, the total North Atlantic market has grown since 2013, with summer ASKs up by 28% in the summer 2016 schedule relative to three summers earlier. However, the members of the three principal immunised JVs have grown their collective ASKs at the slower rate of 20% over the same period.

The initial period of flat market capacity coincided with the global financial crisis and its negative impact on capacity, so the evidence is perhaps inconclusive. Nevertheless, the immediate effect of immunised JVs after the 2008-2010 period was to limit capacity.

Moreover, it has taken several years for market capacity to return to a significant growth path and this growth has been led by airlines that are outside the JVs. It is in the JVs' interest to limit capacity in the market.

Airlines benefit from less competition and their greater pricing power

The benefits to airlines that form immunised joint ventures are those that stem from what is effectively legalised internal collusion: less competition and greater pricing power. In addition, the EU partners in the Atlantic JVs need a US partner in order to gain access to the domestic US market, since EU-US Open Skies does not provide cabotage rights (domestic access) for EU airlines.

This is in contrast to the beyond rights enjoyed by US airlines in the EU (these beyond rights exclude domestic markets within individual EU member states, but allow onward routes to other member states).

Finnair's "big discussion" before joining oneworld's JV

The JVs on the North Atlantic were largely built around the larger members of the global alliances, who were also the larger players in the Europe-North America market. Nevertheless, they also include some smaller/mid-size market participants, as illustrated by Finnair's inclusion in the oneworld JV from Jul-2013.

There is also a qualitative element to the market power generated by the major JVs, aside from the sheer market size. The flow on marketing benefit of combining large airlines at either end of the Atlantic routes, along with the stickiness of their joint frequent flyer programmes and connectivity means that the profile of traveller the alliances carry is more heavily weighted to business and corporate travel. This factor was adverted to by Finnair's Chief Commercial Officer, Juha Jarvinen.

Mr Jarvinen told CAPA's AIT conference that there had been a weighty discussion within the airline about whether or not to join the JV. The deciding factors were the importance of the corporate segment and "the need to have relevance in North America", according to Mr Jarvinen.

He added that the ability to coordinate fares with British Airways also improved Finnair's position in Asia. Nevertheless, there were also some challenges, such as an initial loss of traffic in Canada due to reduced flexibility over pricing. Mr Jarvinen noted that Finnair's inclusion in the JV had ultimately increased its agility over pricing, and he argued that those airlines that are not in JVs were also pushing the JVs hard.

The case for reviewing antitrust immunity for North Atlantic JVs

As illustrated earlier in this report, a very large share of North Atlantic capacity is concentrated in the hands of the immunised joint ventures. John Hanlon, President of the European Low Fares Airline Association, argued at AIT that the case for antitrust immunity was probably worth revisiting, "not to remove it, but to remind participants of their commitments to greater competition".

Finnair's Mr Jarvinen supported open competition, but pointed out that non-JV traffic was growing rapidly. Star's Mr Schwab commented that the share controlled by the JVs had grown initially but this was now reversing, and that the JVs competed vigorously with each other. Nevertheless, Mr Schwab conceded that pricing levels were similar across the market; "fare differentials are not that great, but that's how the airline business works".

The joint venture phenomenon has now spread from the North Atlantic to the trans-Pacific, to Europe-Asia and to Australasia-China and Australasia-Japan. There is a growing argument in favour of reviewing the grant of antitrust immunity to the joint ventures on the North Atlantic, with a focus on the consumer benefits (or otherwise). Research studies*, while also noting that there are consumer benefits, have pointed to concerns over their impact on the consumer.

Among the conclusions of these studies are that fares in non-stop trans-Atlantic markets are higher when there are fewer independent competitors. There is also evidence to suggest that alliances can help pricing efficiency for connecting traffic but antitrust immunity is not necessary to achieve this.

In addition, it has been suggested that immunity can inhibit individual partners' network development and have a negative impact on interline markets for competing airlines.

*For example, Antitrust Immunity and International Airline Alliances by William Gillespie and Oliver M Richard, Economic Analysis Group, US Department of Justice, Feb-2011; and Antitrust Immunity for Airline Alliances by Volodymyr Bilotkach and Kai Hueschelrath, Centre for European Economic Research,

JVs may be a stepping stone towards merger

Immunised joint venture agreements are the closest to being trans-continental cooperation that is available in today's airline regulatory environment. Ownership and control restrictions are still a major hurdle to cross-border mergers and the alliances and JVs have therefore evolved in reaction to this.

The JVs could act as a stepping stone towards eventual mergers, if restrictions on ownership and control and on market access are relaxed at some point in the future. They certainly provide partners with an opportunity to deepen their relationship without the legal permanence and execution risks of a merger or acquisition.

Nevertheless, the impact of JVs in terms of consumer benefits is at best debatable and they have undoubtedly reduced the level of competition.

As ELFAA's Mr Hanlon argued at AIT, "Restrictions on ownership and control are outdated. They relate to restrictions on market access. Within the EU, there is no problem. Once you have Open Skies, there is no need to worry about who owns whom. The question is the competitive threat and how to deal with it".

There is an argument that achieving a market operating more effectively requires liberalisation of the airline industry, but in this half-way world there remain questions over the efficacy of JVs in reaching their stated goals; particularly for consumers.