Antitrust immunity and metal neutrality have changed the shape of the "poor man's merger" for good. As the global alliances become bigger and more powerful, internal differences grow and new challenges emerge. Are they the way of the future or just a blind alley? In the first of a four-part series, we examine the role of metal neutral ATI and its global implications, as well as the specific impact of this ATI for the various members of the alliances.
This is an extract from a report that appears in latest edition of Airline Leader, CAPA’s airline management magazine. Go to www.airlineleader.com to download the full edition.
It's not so long ago that people joked about how no one in United Airlines' Chicago head office even knew the carrier was a member of the Star Alliance. Not any more. And it was certainly never the case at Lufthansa, the promoter and mentor of the group. Leadership of the world’s biggest alliance has long been a core issue for the German flag carrier. And many other airlines have since been afflicted by a similar compulsion, as international services offer a safer haven than the commoditised short-haul markets in which they are now forced to compete. Today, the airline buzz is global alliances, the “poor man’s merger”. If airlines aren’t already members of one of the big three, then they – mostly – aspire to be. And, since the US and European Union granted antitrust immunity (ATI) to key members of each of the three alliances for trans-Atlantic services, allowing them to operate in “metal neutral” formation, the poor man has become a lot richer, at least for the chosen few.
oneworld membership has never had the same multilateral intensity as Star Alliance, being more based around a casual collection of close bilateral relationships, and there was never a meticulous and creative director like Lufthansa. In Star, those bilateral relationships have often followed the communal entry rather than precede it. SkyTeam came later and generally followed the Star model. All three of course were – and still are – very much based around a Euro-American axis, where the world’s biggest traffic flows are. One of the things we shall review in this report is whether that emphasis will persist.
The alliance expansion occurs against the background of two main influences: rapidly changing regulatory attitudes and the global power shift towards Asia. These potentially extreme variables make predictions of the shape of the industry over the next five years dangerous. But for now, alliances are in the ascendance. And those airlines at the heart of them have a very substantial vested interest in seeing that they remain that way.
Throughout the 1990s, several major airlines had embarked on bilateral alliances, mostly across the north Atlantic, although Delta had very early on ventured into Southeast Asia to take a small joint cross-shareholding with Singapore Airlines. The most successful, and in many ways the genuine missing link, was the long-lasting Northwest-KLM bilateral liaison which contained the real germs of a solid relationship. Each had behind-gateway operations that made their respective networks almost wholly complementary. That partnership has since expanded to embrace Delta and Air France, all now covered by metal neutral ATI on the north Atlantic.
ATI and metal neutral operations greatly change the shape of alliance membership relations – especially for the elite few. If the global alliances remained simple marketing extensions, complemented by bilateral airline arrangements, they would not have the power – or the value – they have today. As it is, they may be poised to grow exponentially, as the grant of antitrust immunity for metal neutral operations allows immunised member airlines to share information, pricing, capacity and frequency, as well as route strategies.
These enhancements raise the advantage of immunised joint ventures to something very close to merger in the markets where they apply or, perhaps even better in some ways, allowing the partners to avoid the complexity that goes along with full integration.
“Metal neutral” is the pinnacle of antitrust immunity. A recent report issued jointly by the US Department of Transportation (DoT) and the European Commission, TransAtlantic Airline Alliances: Competitive Issue and Regulatory Approaches, describes it as “effectively a close substitute to a merger because it typically involves full coordination of the major airline functions on the affected routes, including scheduling, pricing, revenue management, marketing and sales”.
For the time being, only a handful of national or supra-national (such as the EU) competition bodies have been involved in these in-depth arrangements, with the great weight of the important ATI grants being bilateral, as between DoT and the European Commission. However, other jurisdictions are increasingly playing a role.
In the case of the north Pacific ATI approvals, Japan’s regulatory authority had to sign off on the respective immunities granted to Star and oneworld carriers; on the south Pacific, where Delta-Virgin Australia, Qantas-American and Air New Zealand-United relationships need immunity, the respective Australian and New Zealand competition bodies necessarily become relevant, in some cases in a tri-partite way. Where Air Canada is involved in Star authorisations, the Canadian authority has parallel jurisdiction and so on.
Where the US is concerned, full immunity to operate as metal neutral will only be considered when one vital pre-condition exists: there must be an open skies agreement in place. The simple logic is that, if there is a ready potential for additional, unregulated competition, then allowing consolidation of interests – thus reducing direct competition – is less likely to be anti-competitive overall. If entry is restricted, that cannot be the case.
But this open skies condition is by no means a standard requirement outside the US, even though the broad principles may be similar. And this is a fault that permeates every bilateral ATI approval process. Every country with competition laws displays differences, whether in nuance or in substance. Thus, the US-EU paper notes that, while “the competitive assessments of both the Commission and DoT provide for the weighing of efficiencies and consumer benefits … the two authorities follow conceptually different approaches”.
The next major bilateral ATI application is currently under examination by the European Commission. It covers the Star Alliance’s Lufthansa application for immunity to work closely with All Nippon Airways in the Japan-Europe market, effectively giving expanded immunity to some of their operations – and, presumably, giving Lufthansa the first globe-circling combination of metal neutral agreements. Unlike the US-Japan situation, there is no open skies agreement between Japan and either Germany or the EU.
This level of immunity comes with both privileges and obligations. The airlines so immunised are not only permitted to cooperate extensively as metal neutral, but they must do so. That is because consumers won’t otherwise be able to benefit from the combining of fares and routings – “a key component” of the metal neutral concept.
The regulators’ goal, therefore, is to create a “neutral” situation where no airline in the joint venture gains anything by keeping passengers on its own flight – as opposed to losing them to its alliance partners’. This has been a flaw in many of the earlier agreements, reducing the value to consumers, because they become captive to one airline – usually the one which ticketed them. An example could be where two airlines in an agreement each operate between points A-B and share traffic, but only one of the airlines physically operates onwards, between B-C, then undercuts its partner on the through price A-C. In this way, it retains a bigger overall revenue share for itself. This indeed remains the situation in most of the bilateral arrangements inside the alliances, something which tends to give the more dominant airlines a great internal advantage over their partners.
As the US-EU report observes: “Integrated JVs give members of alliances the strongest incentives to cooperate on sales and pricing, because the individual carriers no longer seek to maximise their own revenue, but rather the revenue of the network. A key component of an agreement designed to achieve ‘metal neutrality’ is fare combinability, in which the customers are able to view fares for different segments and combine them easily into a single itinerary.”
The report continues: “Achieving fare combinability requires airlines to harmonise their fare class maps and rules. Absent an integrated alliance, airlines may not necessarily have the incentive to make these detailed changes to their pricing and selling processes because they remain focused on pricing and selling their own flights.”
So, for the US, the rule is seemingly: no open skies-no ATI – and nothing short of metal neutral ATI will be granted any more. With this background, it now appears that the DoT will only grant ATI where a metal neutral condition logically will be able to prevail.
This too is a thoroughgoing requirement. In May-2011, the DoT tentatively reversed its earlier rejection of a proposed JV between Delta and Australia’s Virgin Blue group. One of the reasons given for now (tentatively) granting ATI was that the former LCC had sufficiently upgraded its reservations IT platform to allow it to communicate effectively with Delta’s system. By “creating compatible systems and procedures to support automated codesharing between Delta and all carriers of the Virgin Blue group”, it was now possible to establish metal neutrality. Without the upgrade, ATI was off the agenda.
The immunised metal neutral airlines thus receive a massive advantage. But for other alliance partners, the message is not quite so good. They do not receive the same benefits; moreover, the immunised airlines may not even share price and capacity information with the others. Metal neutrality ATI firmly entrenches the gap between rich and poor.
Under the new system, each alliance has only three members that operate with a “high” level of cooperation, each having an “integrated JV in north Atlantic markets”, according to the US-DoT report. The spectrum of alliance membership then ranges through “medium” to “low”, depending on the degree of antitrust immunity granted, or necessary, for the activities in which each group of airlines engages. So alliance members gain very different value from their membership, even though it may not always be obvious to them.
Starting at the bottom, each member of the alliances qualifies necessarily as having all of the attributes at least for a “low” categorisation. That is, all 26 Star members, all 11 oneworld and all 12 SkyTeam airlines achieve at least low-level benefits.
Only nine Star members progress to the next level, “medium”: Air Canada, Austrian, bmi, LOT, Lufthansa, SAS, Swiss, TAP and United-Continental; five of the oneworld airlines, American, British, Iberia, Finnair and Royal Jordanian make it here; and five of the SkyTeam – Air France-KLM, Alitalia, Czech, Delta and Korean – are included.
But, in this game of Big Brother, at the highest, most exclusive – “strategic” – level, only three airlines in each alliance remain left to shine at the bright end of the spectrum.
These “core members”, as the report notes, “have deepened their cooperation by launching highly integrated JVs. Their stated goal is to become effectively indifferent to which plane or ‘metal' carries a passenger, i.e. they seek ‘metal neutrality’ in their cooperation.”
But from a high level perspective, granting some airlines much greater market power in such a key market as the north Atlantic must necessarily overflow into making those airlines’ other (non-immunised) global operations more effective. In global terms, the two major aviation powers are thus incidentally providing their select few “strategic”-level members a great advantage over all other international airlines, including their other alliance partners.
This is not an issue that national competition laws can easily address, although it may become relevant in future assessments of antitrust applications. For example, the nature of competitiveness beyond the immediate routes being considered for ATI should perhaps become relevant.
So, what’s in it for small member airlines?
As with any society, some animals are more equal than others. Also however, each airline member has different needs and contributes differently. For the large members, the value is often self-evident. Expanding into remote territories where they cannot fly, or cannot operate effectively in their own right, allows an airline greatly to enlarge its product offering and thereby widen its potential market.
For smaller members, joining a prominently branded alliance group can be a major benefit in its own right. Royal Jordanian Airlines was, for example, the first carrier in the Middle East to join an alliance when it entered oneworld in 2004. “We’re a small airline in a small country,” said its then-president and chief executive officer, Samer Majali, at the time. “By linking with oneworld partners, we’re extending our network without incurring the costs of doing so.” This is a common refrain.
Operationally, being associated with the big players, either bilaterally or multilaterally, can deliver a range of benefits. EgyptAir, for example, was able last year to gain US FAA accreditation for its maintenance and repair facility, something it would probably not have achieved without considerable support from the interested Lufthansa partner. When Korean Air went through a horror period of cockpit management issues and ensuing accidents several years ago, Delta moved in to help restore a better-based operation. There are many similar examples.
The bigger the alliances become, so the diversity of interests and of airlines becomes ever greater. As they have expanded and regulatory procedures – in particular the metal neutrality condition – have become more sophisticated and far-reaching, the gap between the haves and the have-nots has expanded greatly. To some extent, this is something that the leading airlines can help remedy, although it is often not in their own company’s interests to do so.
As eminent aviation law and policy veteran, Paul Mifsud, highlighted in a recent paper, Metal Neutrality and the Nation-bound Airline Industry, many of the [smaller] non-immune airlines who joined one of the three [global alliances] at a time when each of the partners participated with a fair degree of independence are suddenly confronted with a new situation. They are facing the prospect of relying on the networks of major partners who are legally required to behave as essentially one combined network that is legally obligated to compete – as though they are one entity – against their smaller partners within the same alliance.” (italics added).
This too is an example of how the world has moved along under the foundations of the original alliance concepts. Today, notes Mr Mifsud, “there are over fifty airlines participating in the three [global alliances]. When they first joined, it is unlikely that they fully considered the consequences of the fact that they now find themselves involved with partners who are involved in metal neutral joint ventures.”
There’s another issue that confines smaller carriers to a seat at the foot of the table. Membership brings with it considerable new demands, especially as an alliance grows in size. For members to play an active role in decision-making across all key issues, they must participate in numerous committee meetings and other deliberations, in order to make their voice heard. Absence from such meetings can mean they become party to agreements that are less than ideal for them. The time commitments involved in membership can be burdensome even for larger airlines, a feature which can only further emphasise internal difference in stature between members as the groups grow in numbers.
Nonetheless, in the aviation jungle, some backstops exist, even for the smallest members. Granting membership to new airlines, for example, can typically be vetoed by any single member airline in the region which believes it will be disadvantaged by the new entrant. The alliances follow generally similar principles, although their nature may be considerably different.
The bottom line is that, despite these growing inequities, significant benefits can exist for many smaller airlines in being linked to a global alliance, even if they are not as open and democratic as they might appear.