Virgin Blue-Air New Zealand alliance rejected–at least temporarily. Mr Borghetti needs a luck change

Virgin Blue CEO, John Borghetti might want to take the weekend off. He certainly shouldn’t be heading for the casino. In the space of two days, two key planks of the carrier’s cooperation strategy, with Delta and Air New Zealand, appear to be under serious threat. A few days ago they looked relatively safe and were on the way to making the Virgin Blue Group a serious competitive force against its much larger competitor, Qantas.

Today, the Australian Competition and consumer Commission (ACCC) tentatively decided that “the alliance is likely to reduce competition in the market for trans-Tasman air passenger services,” arguing that “Virgin Blue is a significant competitor to Air New Zealand and there are a number of trans-Tasman routes where the alliance raises competition concerns. These routes account for around one quarter of passenger traffic in the trans-Tasman market. This means that more than one million passengers per year may be adversely affected by the removal of competition between Virgin Blue and Air New Zealand."

As a consequence, the parties will have to work hard to change the Commission’s mind.

The ACCC determination is odd in several ways.:

(1) The Qantas-Air New Zealand proposal was approved

Perhaps the most striking feature is that only a few years ago a much more far-reaching Qantas-Air New Zealand proposal to cooperate on the Tasman was only disallowed because the New Zealand Commerce Commission rejected it - mainly on the grounds of reduced domestic NZ competition. At the time the two airlines held an 80% market share. It is hard to fathom why that proposal would be acceptable for the Australian authorities if Virgin Blue’s – apparently much more modest one - is not (although that proposal first went through the process of an appeal to the Competition Tribunal on the Australian side, after the ACCC first rejected it).

(2) Virgin Blue as a “maverick” – does the evidence bear this out?

In this case Pacific Blue has already decided to pull out of the domestic New Zealand market (after losing some AUD20 million in two years) and has typically been very cautious in its entry to the “bloodbath” of the Tasman market. Despite this, one feature that the ACCC seized upon was Virgin Blue/Pacific Blue’s “maverick” role in pricing on the Tasman. This is more or less consistent with the approach taken by the ACCC in its determination on the Delta cooperation application. But it seriously questionable whether there is evidence to suggest that has been – or, much less likely, will be – the carrier’s role here.

A maverick in these terms has the propensity to “disrupt coordination by initiating price wars, aggressively discounting or by not following rivals attempts to raise the market price”, according to the ACCC’s draft determination.

In fact, an earlier short examination by the Centre, of pricing behaviour around the time the application was made showed that the higher cost Virgin Blue product was being priced in the dangerous position of halfway between Jetstar’s and the Qantas and Air New Zealand fares. See related report: Virgin Blue-Air New Zealand “cooperation”. A game-changer - perhaps

That is hardly “maverick” behaviour and appeared in fact to illustrate the airline’s precarious position in the Tasman marketplace.

(3) The Tiger role

There was broad opposition to the proposal from directly affected interests, like Tiger Airways, which saw an enhanced competitive threat, and airports such as Dunedin, where Air New Zealand and Pacific Blue are the only two operators. This latter is undoubtedly a concern for that airport and its city pair connections, but competition bodies, taking a wider view of the market, can usually see beyond that and even separate out the particular ingredients of a route or destination in its approvals.

Tiger’s position is different. It clearly does not want to see a more powerful set of opposition, right across the board. Yet, from the ACCC’s position it is odd that there was no detailed consideration of the potential role of Tiger - the real maverick in the market - with its lower costs and different product, if prices were to get out of line on the Tasman. The threat of entry is necessarily a real feature, especially as Tiger grows its bulk in the Australian market.

(4) All parties agree that the Tasman competition is currently unsustainable

Such a statement of course needs to be taken in context. The entire global aviation industry in its present form is unsustainable. But that doesn’t mean that it is not a good place for consumers – quite the reverse. And, as liberalisation spreads, the prospect of market exit improves. (That is a key factor for improving the viability of the industry, as market entry is in fact relatively easy; but as long as large old airlines are propped up by their governments, genuine economic viability is a difficult target.)

But here the situation is very different. Qantas and its strategically valuable subsidiary, Jetstar, hold 65% of the Australian market and nearly 90% of the corporate business. In reality, Virgin Blue is fighting to establish a permanent foothold in Australia as a serious full service competitor. It is a listed airline that has no necessary claim on perpetuity.

These are not issues that fall directly into the scope of an ACCC determination. The competition laws under which the Commission must work tend to have narrow scope and don’t necessarily lead to outcomes that “market logic” would suggest.

Nonetheless, there would have to be a reasonable prospect at least that this draft determination, if confirmed, will head straight for appeal at the Competition Tribunal, where, on the precedent of the Qantas-Air New Zealand decision, a more favourable outcome is likely.

The trouble with that, even assuming a positive result, is that it chews up more time. For very good reasons, Virgin Blue and Mr Borghetti, are keen to move fast. And they need a better run of luck.

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