Virgin-Delta granted tentative anti-trust immunity by DoT. “Another one we can tick off the list”

Virgin Australia’s luck appears to have turned. After a few grey days late last year when the new CEO’s alliance plans were looking ragged, the Group has now received what will almost certainly be formal approval to operate closely with Delta, sharing capacity scheduling, frequency and pricing plans. This will allow the two to cooperate closely both on their Australia-US gateways and behind those gateways on each others’ domestic services. This is another – vital – step in Mr Borghetti’s plans to expand Australia’s rebranded second airline into a global player through partnerships, as well as gradual organic growth.

The US Department of Transportation (DoT) on 10-May-2011 granted tentative approval to Virgin Blue Group and Delta’s application for anti-trust immunity to operate in concert across the Pacific and behind gateways in their respective countries. Mr Borghetti described this as “another one we can tick off the list. The carrier now has partnerships with Air New Zealand (which has also acquired a 15% share in the Virgin Blue Group”), Etihad and Delta, giving substantial network coverage. All that remains now is to expand into Asia. The carrier is looking for partners in the region and is also equipped, with its five B777s and a growing fleet of A330s, to operate there with its own metal.

The DoT decision was taken after a thorough revision of the original proposal to meet the Department’s primary concerns that any grant of ATI would lead to a substantial reduction in competition. As the DoT’s tentative order on 10-May-2011 noted, “they have effectively submitted a new application.”

DoT is now satisfied that competition levels will be maintained

In the order, the DoT described its earlier concerns as follows: “The combination of the global recession and the substantial increase in capacity resulted in exceptionally lower fares and passenger revenue in the US-Australia market.  Average fares between the U.S. and Australia, according to Bureau of Transportation Statistics Origin and Destination (O&D) data, plummeted by nearly 50 percent from mid 2008 to mid 2009.  Total O&D revenue in the US-Australia market dropped over 38 percent from second quarter 2008 to second quarter 2009.

“In the shifting structure of the U.S.-Australia market, combined with the global recession, the Department was uncertain that the market, over the long term, could sustain the added capacity.  Therefore, a grant of antitrust immunity could have provided the applicants with extra incentive and ability to reduce capacity in the market to put upward pressure on fares.”

These concerns have now been assuaged by a combination of improved market conditions and the interim behaviour of the two carriers.

The order continued, “in response to Order 2010-9-4 and 2010-11-22, the applicants pointed to new evidence that the increased capacity, due largely to their entry, had remained steady for nearly 18 months.   Fares and passenger revenue in the market had stabilized and had begun to increase.  The new data on the record show that, by the second quarter 2010, total O&D revenue in the US-Australia market had rebounded to levels less than five percent below total revenue during the second quarter 2008.”

There is considerable strength given to this argument by the fact that Qantas still dominates the market, albeit not to the extent that it did pre-2009. Qantas and oneworld partner American Airlines have anti-trust immunity to operate parallel routes.  Delta and V Australia are still the price leaders. As the DoT noted, “MIDT and O&D data provided by the applicants through the end of 2010 show that passenger and fare levels are continuing to recover and that the long-time incumbent carriers – United, Qantas, and Air New Zealand – still command a significant premium in the market.”   

And, as if to congratulate itself on its foresight, the Department noted that “the fact that there are concrete signs of robust recovery with the additional capacity suggests that this market was ripe for additional competition.  In light of the traffic, fare, and capacity trends between the U.S. and Australia over the past several quarters, the Department is tentatively satisfied that the volatility in the market has diminished.” 

Despite this, Mr Borghetti as good as confirmed today that V Australia is losing money on the route at present. “We got into the black earlier this year. But then fuel prices took off.” He will be hoping that a closer working relationship with Delta will help improve that bottom line.

Capacity commitments made to keep levels up for at least two years

As noted, the DoT had initially been concerned that granting anti-trus immunity would give Delta and V Australia the opportunity to reduce capacity. At the time the market was sagging and there was considerable “excess capacity” – at least relative to the then current demand as the GFC continued to bite.

Now, not only was the DoT able to find that recent behaviour and market conditions made capacity reductions unlikely, because “the applicants have offered to maintain capacity in the market for at least two years” under a “Mutual Capacity Commitment Agreement” this should eliminate any concern that Delta or Virgin Blue Group would reduce their nonstop U.S.-Australia service level as a result of antitrust immunity

Under these terms, Delta must operate at least 656 annual transpacific segments (U.S. mainland to points in Australia) and “Virgin Blue’s capacity commitment will be met if the carrier operates at least 1260 annual transpacific segments” (Australia to points in the U.S.mainland).  Each must file details of their annual compliance, and provide “adequate data and explanation” to the Department.

The authorisation will be valid for five years.

Market shares show Qantas still dominates the market

According to the DoT’s “examination of historical onboard traffic in the U.S.-Australia market”, it was able to determine “little, if any, reason for competitive concern.” It continued,  “Qantas is a relatively stronger competitor compared to its position at the network level, as its historical onboard share is nearly half of all U.S.-Australia passengers in 2010.  United carries nearly a quarter of the traffic, while Delta and V Australia combined carry just over a quarter of the onboard passengers.”

Share of Passengers in Contiguous U.S.-Australia Nonstop Market

Furthermore, if the New Zealand component of the trans-Pacific operation is taken into account, the Delta-V Australia component diminishes further.

Share of Passengers in Contiguous U.S.-Australia/New Zealand Nonstop Market

IT systems entrenched as an important part of the “metal neutral” alliance anti-trust immunity

The grant of ATI requires the two airlines to operate effectively as one – they must become “metal neutral” in terms of pricing and capacity/frequency. This fulfils one of the core competiton requirements of the grant.

However, when the application was first made, Virgin Blue was in the throes of attempting a cut over to a more sophisticated and interactive/connective system than its previous “Open Skies”, stripped down LCC-style reservations system. That this transformation has now largely been achieved also formed an important decision criterion for the DoT.

The order notes that “the applicants also provided additional information on the management of the Virgin Blue Group to address our concerns about potential barriers to integration that would prevent full cooperation between the parties.  

“Specifically, the applicants provided clarification on the operational structure of the Virgin Blue Group and added that the Delta flights would receive “highly preferred, metal neutral access” to Virgin Blue’s domestic Australian and regional Tasman Sea markets. Furthermore, in response to our concerns that the disparate reservations systems of carriers within the Virgin Blue Group would hinder the delivery of consumer benefits, the applicants provided the Department with updates on their efforts to move to a harmonized system.  On April 20, 2011, the applicants notified the Department that the Virgin Blue Group had successfully upgraded its reservation system on April 17, 2011, creating compatible systems and procedures to support automated codesharing between Delta and all carriers of the Virgin Blue Group.””

A global alliance role for Virgin Australia

Mr Borghetti was coy about joining one of the major global alliances and, indeed, there are reasons for and against. As he says, “for the moment, we’ll just look at the bilateral agreements we have and see where the gaps are.”

There are advantages in remaining relatively neutral in that this makes it easier to cater for any of the non-one world carriers which partner Qantas. But as Virgin Australia spreads its wing internationally it too becomes a competitor for some of the Star and SkyTeam carriers who might otherwise fall Virgin Australia’s way. Qantas currently has very close codeshare relationships with both Air France and Lufthansa, neither of whom operates beyond southeast Asian gateways, preferring to use Qantas to connect their services into Australia.

With close partnerships with Star’s Air New Zealand and SkyTeam’s Delta, along with the UAE’s globally-oriented Etihad, Virgin Australia is in any event a very odd fowl. From here anything is possible. There may be a few more “to tick off the list” before the end of this year.

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