No. 1/2002

Competitive AirlinesTowards a more vigorous competition policy in

relation to the air travel market

Com

petitive Airlines Tow

ards a more vigorous com

petition policy in relation to the air travel market

No. 1/2002

Kilpailuvirasto/KonkurrensverketPostbox 332, 00531 Helsinki, Finland

Telephone: +358 9 73 141Telefax: +358 9 7314 3405

http://www.kilpailuvirasto.fi/

KonkurrencestyrelsenNørregade 49, 1165 Copenhagen, DenmarkTelephone: +45 3317 7000Telefax: +45 3332 6144www.ks.dk

Konkurrensverket103 85 Stockholm, SwedenTelephone +46 8 700 1600

Telefax: +46 8 24 55 43www.kkv.se

KonkurransetilsynetPostbox 8132 Dep, 0033 Oslo, Norway

Telephone: +47 22 40 09 00Telefax: +47 22 40 09 99

www.konkurransetilsynet.no

SamkeppnisstofnunPostbox 5120, 125 Reykjavik, IcelandTelephone: +354 552 7422Telefax: +354 562 7442www.samkeppni.is

Report from the Nordic competition authorities

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Competitive AirlinesTowards a more vigorous competition policy

in relation to the air travel market

Report from the Nordic competition authorities

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Contents

PREFACE.......................................................................................................................................... 4

EXECUTIVE SUMMARY .............................................................................................................. 5

Aviation is a network industry ................................................................................................ 5Merger and alliance control ..................................................................................................... 6Slot allocation procedures ........................................................................................................ 7Predatory behaviour ................................................................................................................. 7Frequent flyer programmes ...................................................................................................... 8Tariff consultations ................................................................................................................... 9State aid, public procurement, taxation, and subsidies ............................................................ 9Travel agent agreements, corporate discount schemes, and computer reservation systems .......................................................................................... 9Competition between airports ................................................................................................ 10Ground handling services ....................................................................................................... 10Concerted action is needed .................................................................................................... 11

1 INTRODUCTION ................................................................................................................. 12

1.1 Theoretical perspective .......................................................................................................... 121.2 Barriers to airline competition .............................................................................................. 131.3 Deregulation in the USA ........................................................................................................ 131.4 The European experience and outlook ................................................................................... 151.5 Outline .................................................................................................................................... 16

2 MARKET DESCRIPTION ................................................................................................. 18

2.1 Air travel demand in the Nordic countries ............................................................................ 182.2 The supply side: carriers operating in the Nordic countries .................................................. 22

3 LEGAL FRAMEWORK ...................................................................................................... 27

3.1 Community Law/EEA Law .................................................................................................... 273.2 Exemptions for the airline industry ....................................................................................... 293.3 Bilateral agreements ............................................................................................................... 303.4 National competition legislation ............................................................................................ 313.5 Aviation legislation and institutional conditions ................................................................... 37

4 TOPICS IN AVIATION ECONOMICS .............................................................................. 41

4.1 Aviation network economics ................................................................................................. 414.2 Price discrimination and economic welfare ........................................................................... 494.3 The cost structure of the airline industry ................................................................................ 524.4 Comparative airline productivity ............................................................................................ 60

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5 TAXES, SUBSIDIES, AND PUBLIC CHARGES ............................................................. 67

5.1 Taxes and charges in Nordic aviation .................................................................................... 675.2 External costs of aviation ...................................................................................................... 745.3 State aid .................................................................................................................................. 75

6 BUSINESS CONDITIONS AND STRATEGIES............................................................... 77

6.1 Frequent flyer programmes .................................................................................................... 776.2 Corporate discount schemes ................................................................................................... 856.3 Travel agent agreements ........................................................................................................ 886.4 Corporate cards and related discounts ................................................................................... 916.5 Computerised reservation systems ........................................................................................ 926.6 Interlining ............................................................................................................................... 966.7 Airport capacity ................................................................................................................... 101

7 SUMMARY AND CONCLUSIONS .................................................................................. 109

7.1 Network economics and competition ................................................................................... 1097.2 Airline mergers and alliances ............................................................................................... 1117.3 Community and EEA Law ................................................................................................... 1117.4 Contestability and predation ............................................................................................... 1127.5 Scarcity of slots .................................................................................................................... 1137.6 Interlining and tariff consultations ....................................................................................... 1147.7 Frequent flyer programmes .................................................................................................. 1147.8 Corporate discount schemes ................................................................................................. 1167.9 Computerised reservation systems ....................................................................................... 1167.10 Corporate cards and electronic ticketing ............................................................................ 1167.11 Travel agent agreements ....................................................................................................... 1177.12 Taxes, subsidies, and public procurement............................................................................. 1177.13 Ground handling ................................................................................................................... 1177.14 The Nordic aviation market ................................................................................................. 118

LITERATURE .............................................................................................................................. 119

Preface

During their joint meeting in Skagen (Denmark) on 6-7 September 2001, the competition authorities of the Nordic countries established a task force to examine the degree of competition in Nordic aviation and to suggest measures to enhance it. Their report is hereby submitted. The analyses, conclusions and recommendations contained herein are unanimous.

The Nordic Task Force on Airline Competition has consisted of the following persons:

Lasse Fridstrøm (chairman), Norwegian Competition Authority, Frode Hjelde, Norwegian Competition Authority,Helle Lange, Danish Competition Authority,Erik Murray, Swedish Competition Authority,Antti Norkela, Finnish Competition Authority,Torben Thorø Pedersen, Danish Competition Authority,Niels Rytter, Danish Competition Authority,Catherine Sandvig, Norwegian Competition Authority,Marianne Skoven, Danish Competition Authority, andLine Solhaug, Norwegian Competition Authority.

The Nordic competition authorities are grateful for the assistance extended to the Task Force in theform of discussions with the Antitrust Division of the US Department of Justice (on 2 January2002), with the General Directorate for Competition of the European Commission (on 1 February2002), with the Scandinavian Airlines System (SAS) (on 21 January 2002), and with the GermanCompetition Authority (Bundeskartellamt) (on 15 March 2002).

The authors are also indebted to a number of researchers, consultants, colleagues, and advisors, fortheir written contributions, constructive criticism, and suggestions. They are especially grateful toProfessor Siri Pettersen Strandenes, Professor Frode Steen, and Professor Lars Sørgard of theNorwegian School of Economics and Business Administration, and to Dr. Peeran van Reeven ofthe Erasmus University.

Copenhagen/Helsinki/Oslo/Stockholm

18 June 2002

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EXECUTIVE SUMMARY

1. The Nordic Task Force on AirlineCompetition has examined the aviation mar-kets in Denmark, Finland, Norway, andSweden, with a view to suggesting measuresto enhance competition.

2. The Task Force has focused on numerousbarriers to airline competition in theNorthern European region, as well as in awider pan-European or global perspective.

3. The Task Force believes that the Europeanaviation industry may be facing a period ofstrong consolidation over the next few years.Such consolidation may in some circum-stances have positive effects on economicefficiency. But in combination with the anti-competitive effects of the hub-and-spokemode of operation, of the frequent flyer pro-grammes, and of other restrictions on com-petition, the horizontal and vertical concen-tration in the aviation industry represents aformidable challenge to European competi-tion authorities at the national andCommunity level. A vigorous competitionpolicy will be required in order to enhance –or even preserve – the present degree ofcompetition in the air travel markets.

4. First of all, the competition authoritiesshould strengthen their efforts to enhancecompetition through• Adequate control of airline mergers and

alliances • Efficient interventions against predatory

pricing and other abusive behaviour• Efficient restrictions on frequent flyer pro-

grammes• Prohibition on airline price cooperation

through tariff consultations • Open and non-discriminatory business

conditions in travel agent agreements • Interventions against anti-competitive

effects of corporate discount schemes • Control of the configuration and use of

ticketing and computer reservation systems

5. Second, public regulations in all relevantareas should be developed in order to limittheir anti-competitive effects:• More efficient and non-discriminatory slot

allocation procedures • Enhanced competition between airports • Enhanced access to ground handling and

other infrastructure services • Competition neutral tax rules in aviation

and related activities

6. Third, governments should promote compe-tition through initiatives such as:• Reduced state aid and subsidies to airlines • Public procurement tendering that facili-

tates competition

7. Since many of these measures fall outsidethe scope of competence of national orCommunity competition authorities, concert-ed action will be needed between variousgovernment and Community agencies.

Aviation is a network industry 8. The aviation industry is characterised by

large network externalities, in the sense thatthe costs and revenues involved in carryingpassengers on different, interconnectedroutes are interdependent. There are, in otherwords, large economies of scale, scope anddensity present.

9. A particularly efficient way of organising anaviation network is the hub-and-spoke modeof operation. Rather than operating a largenumber of point-to-point, non-stop routes,the airline company channels all or mostpassengers through a «hub» airport, fromwhich all connections extend like the spokesof a wheel. In this way the number of differ-ent non-stop routes needed to serve all pos-sible pairs of destinations is drasticallyreduced, allowing for quite remarkable costsavings.

10. Judging by the experience earned through23 years of deregulated aviation markets inthe United States, the airline industry –when left without regulation – will tend toconsolidate into a few, large air carrier con-

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cerns with continent-wide hub-and-spokenetworks.

11. While obviously economically efficient tothe individual carrier firm, the hub-and-spoke system of operation may have stronganti-competitive effects. The economies ofscope and density characteristic of thesenetworks are such as to grant the (one andonly) hub airline very considerable marketpower at and around its hub. Since differ-ent airlines choose to operate hubs at dif-ferent airports, the hub-and-spoke systemas operated among a set of large individualcarriers is liable to practically divide themarket between the airlines. Although thenetworks of different carriers overlap, veryfew origin-destination pairs, if any, willexhibit more than two carriers operatingnon-stop flights.

12. In Europe, the hub-and-spoke mode ofoperation has an even longer history thanin the US, having grown out of the pastregulatory framework and of the prevailinggeographic and political conditions, ratherthan as an autonomous market process.Each nation has had its own «flag carrier»,with a privileged position in and around itsdomestic market and frequently a largegovernment ownership share. More oftenthan not, flag carriers have been benefitingfrom considerable amounts of subsidies ordirect financial support from the state.

13. The flag carrier typically organises its net-work around a hub located near the nation-al capital or main business centre. At itshub airport, the flag carrier tends to haveconsiderable direct and indirect influenceon slot allocation practices, on ground han-dling services, and on other essential facili-ties. Backed by its own government, theflag carrier usually also tends to obtainprivileged positions in whatever bilateralaviation agreements are signed with othercountries. Each flag carrier thereforeenjoys considerable market power at andaround its domestic hub. Thus, althoughthere are almost as many flag carriers asthere are European nations, the competitionbetween them is severely restricted, as they

have been able to divide the marketbetween them to a very considerableextent. In many (short-haul) markets, themost effective competitor to the Europeanflag carrier is not another airline company,but a surface mode of travel, representedby a railway company, a bus service, or theprivate car.

Merger and alliance control14. More extensive networks are more attrac-

tive to customers and offer largereconomies of scope to the carrier. Airlinecarriers therefore form alliances in order toexploit each other’s networks and tostrengthen the competitive positions of allalliance partners. Establishing an alliancewith an «adjacent» carrier may also be anefficient way for competitors to divide themarket between them.

15. Bilateral aviation treaties often assure theaffected national flag carriers more or lessexclusive traffic rights between the twocountries. These rights might be forfeited ifthe flag carrier is merged with a foreignairline – whence the widespread practice offorming alliances rather than full-fledgedmergers between European airlines. In anopinion delivered by the Advocate Generalto the European Court of Justice on 31January 2002, it is proposed that individualmember states no longer be allowed toentertain such individual aviation treatieswith non-EU countries. To the extent thatthis view is upheld by the Court, it may beforeseen that the associated change in theregulatory regime will spark a developmenttowards massive consolidation withinEuropean aviation.

16. Faced with this scenario, it is essential thatEuropean competition and aviation authori-ties consider carefully all measures suscep-tible of opening the air travel markets andenhancing competition. While in terms ofcompetition and efficient resource alloca-tion, full-fledged mergers may well bepreferable to looser alliances, it is para-mount to the protection of consumers andother air travel customers that the resulting

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number of European aviation concerns oralliances not become too low. The consoli-dation process must therefore be followedcarefully by the relevant competitionauthorities. Alliances should be treatedwith the same rigour as traditional mergers.

Slot allocation procedures17. The airport capacity constraints and the slot

allocation regimes and practices currentlyin effect in Europe constitute major barriersto entry and hence to competition and eco-nomic efficiency.

18. Incumbent airlines throughout Europeanairports benefit from so-called «grandfatherrights», by which they are entitled to therenewal of all slots for which the degree ofutilisation during the previous periodexceeds 80 per cent. In congested airports,this regime makes it quite difficult forpotential new entrants to obtain a sufficientamount of attractive slots. To add to theproblem, incumbent airlines may have anincentive to «babysit» some of their slots, i. e. to make use of them for the sole pur-pose of not having to relinquish them to acompetitor. While commercially expedient,such practices are obviously not compatiblewith an economically efficient resourceutilisation.

19. There is thus a pressing need for animproved and less discriminatory slot allo-cation procedure in all congested airports,which would facilitate market entry forsmaller airlines and other non-incumbentcarriers. Unfortunately, the remedy is lesseasily found than the diagnosis.

20. At present, the legal ownership to slots andthe rights attached to such ownership arematters of ambiguity. A prerequisite forarriving at a more efficient slot allocationis to determine unequivocally who ownsthe slots – the airline, the airport, or thegovernment. The Task Force appreciatesthe initiative of the European Commissionto clarify these questions.

21. Creating an open market for slots may

seem like an obvious solution to the eco-nomic efficiency problem. There may,however, be cases where open tradingwould not ensure equitable access to theaviation market for all carriers. Dominantairlines may be able to derive profit fromholding a slot that would otherwise becomeavailable to a competitor. They may there-fore be willing to bid up the price of cer-tain slots to a level that will deter potentialnew entrants.

22. One way to ease such a situation might beto use so-called blind bidding in periodicauctions. Here, the bidders’ identities arekept secret, so as to conceal whether thebids are made by new entrants or incum-bent airlines. In such a case, a strategy ofbuying up slots for less valuable uses inorder to preclude entry would becomerather more expensive, and hence less com-mon.

23. The traditional economic solution to con-gestion problems is marginal cost (peakload) pricing. Another way to bring marketforces to bear on the slot allocation systemcould therefore be to apply this principleand allow airport charges to vary over theday (between peak and off-peak).

24. As a minimum requirement for efficientand non-discriminatory airport slot alloca-tion, whatever formal or informal connec-tion might exist between the slot coordina-tor institute and the local flag carrier com-pany should be severed. Slot coordinatorsneed to be unquestionably neutral withrespect to all of their incumbent or poten-tial client airlines.

Predatory behaviour25. Prior to and shortly after the US deregula-

tion, it was generally thought that aviationmarkets would in general be highly con-testable, as it would be easy for any carrierto relocate aircraft and personnel so as toservice a new route. In practice, it hasturned out that the barriers to entry aremuch more important than previouslybelieved. Incumbent airlines can lower

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their fares and/or increase their capacitypractically overnight, so as to raise the costand/or reduce the revenue of rival newentrants. Any potential new entrant would,of course, be aware of this, and hesitate tochallenge the incumbent carrier even if thelatter may be making a considerable profitin the current (monopolised) situation.

26. To increase contestability it might be desir-able to constrain the incumbent carriers’ability to abuse their dominant position bydumping their fares and/or boosting theircapacity in response to rival new entrants.National and Community competitionauthorities should keep a keen eye onpredatory pricing practices and preparecontingency plans to act against them atshort notice. The recent intervention byGermany’s Bundeskartellamt, requiringLufthansa to keep a e 35 fare diffferentialwith respect to Germania on the Berlin-Frankfurt route, is an example, the benefitsand possible drawbacks of which would beinteresting to follow.

27. The Council Regulation (EEC) No.2409/92 deals with fares and rates for airservices. To the Task Force, it appears clearthat this regulation ought not restrain thecompetence of national competition author-ities in relation to interventions againstpredatory pricing. To the extent that thisview is seen as contentious, we suggestthat the issue be examined further at theEuropean Community level.

28. Similar arguments apply to CouncilRegulation (EEC) No. 2408/92 on accessfor Community air carriers to intra-Community air routes. Given the specialcharacteristics of the aviation market, interventions against excess capacity mightbe appropriate in order to ensure competi-tion, in the event of a dominant carrier’spredatory behaviour.

Frequent flyer programmes29. Almost all major airlines offer their trav-

ellers a carefully designed frequent flyerprogramme (FFP). As intended, the FFPs

are without doubt very efficient means toenhance customer loyalty or fidelity. Theyconstitute another well thought-out strategyby which the carriers are able to practicallydivide the market between them and thuslessen the competition in each market seg-ment. As such, they are clearly at variancewith the spirit of competition law in mostcountries.

30. Most FFPs have the following characteris-tics in common: • «Discounts» are granted not in the form

of money, but in the form of free services,not necessarily of the same type as pur-chased. The frequent flyer points are noordinary rebate.

• To obtain free flights to more or less dis-tant destinations, the customer needs tosurpass certain thresholds in terms oftravel purchases. The customer thus hasan incentive to concentrate his purchasesto one or a few providers. The closer thecustomer gets to a threshold, the strongeris his incentive to buy another flight fromthat particular airline or alliance.

• The «discount» is given to the traveller,who – in the case of business travel –tends to differ from the purchaser. Thisgives rise to a pronounced principal-agentproblem, by which the decision maker(agent) is faced with a quite different setof incentives from those of his superior(principal). This may lead to a distorted(inefficient) resource allocation.

• Although in principle taxable in manycountries, the private use of frequent flyerpoints earned by an employee is in prac-tice rarely taxed, for lack of informationon the part of the government. This taxloophole is likely to aggravate the ineffi-ciency due to the principal-agent problem.

• Alliance airlines join their FFPs to offerattractive, extended networks to bonuspoint travellers. Smaller airlines oralliances have a distinct competitive dis-advantage. The FFPs are thus liable tostrengthen any dominant position and toreinforce the anti-competitive effects ofhub-and-spoke networks. They thereforeact as important barriers to entry.

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31. Hence, all European competition authori-ties should consider critically the anti-com-petitive effects of FFPs on domestic routes.

Tariff consultations32. Commission Regulation (EEC) No.

1617/93, Art. 4, grants the airlines withinthe European Union a block exemption forconsultation on passenger tariffs with theaim of facilitating interlining. Airlines tendto argue that the IATA tariff consultations,in which airlines agree on a common set offares for fully flexible tickets, form aninextricable part of the interlining system.The Task Force, however, believes that asystem of posted prices for wholesale(inter-airline) purposes might be sufficientto maintain the interlining system withoutthe price collaboration. Such a systemwould mean less transparency of faresbetween airlines and hence probably moreintense competition, without jeopardisingthe efficiency gains connected with inter-lining.

State aid, public procurement, taxation,and subsidies33. Some airline carriers have continued to

receive substantial amounts of direct orindirect aid from the national government.Such transfers may destroy the level play-ing field between airlines and should beminimised.

34. In many countries, the public administra-tion is itself a major airline client. The TaskForce recommends that governments usetheir negotiating power to enhance compe-tition, by adhering to the following princi-ples in public procurement agreements:• Public purchases should, if possible, be ten-

dered in small portions, e. g. route by route,so that small size companies may bid.

• Preference clauses, if present, shouldadmit that, notwithstanding the publicprocurement deal, the government isalways free to make use of a cheaperand/or higher quality service that may beoffered by someone else.

• Fixed fares (over a certain time lapse) arepreferable to percentage discounts off thenominal fare. This is so because percent-age discount agreements tend to bid upthe fare for all those clients who do nothave a comparable agreement.

35. Tax rules applicable to the aviation indus-try and its related activities should be neu-tral with respect to, inter alia, in-houseproduction in a vertical chain compared tooutsourcing (confer para. 49 below).

Travel agent agreements, corporate dis-count schemes, and computer reserva-tion systems 36. Travel agent agreements sometimes pro-

vide incentives for an agent to concentratehis sales to one or a few larger airlines.Such contracts may be anti-competitive andin disagreement with the principles laiddown by the EU Commission in theVirgin/BA case on 14 July 1999. There isreason to question whether all carrier-agentagreements and practices have yet beenbrought in accordance with these princi-ples. Competition authorities should directattention to this problem and exert a morevigorous control.

37. Corporate discount schemes are agree-ments by which large airline customershave been able to negotiate lower (net)fares on all of or on certain parts of an air-line’s network. From a competition angle,these deals have ambiguous effects.

38. On the one hand, they reflect a certaintransfer of market power from the seller tothe buyer. As such, they can be viewed assound examples of enhanced competition.

39. However, many of these deals take formsthat engender important lock-in effects, aswhen the rebate is somehow progressive, i.e. the percentage discount given dependson the total volume of sales through a cer-tain period of time on a certain air travelnetwork. Such agreements provide anincentive for the buyer to concentrate hisdemand to one or a few carriers. Larger

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carriers will obtain an inherent advantagecompared to smaller ones. Such corporatediscount schemes have, in other words,clear anti-competitive effects.

40. Corporate discounts may conceivably havethe effect of raising the price for all thosecompanies that do not benefit from them.Interestingly, there are even indications thatcorporate discount schemes may lead tohigher nominal fares in a duopoly situationthan in a comparable monopoly setting.This is so because the duopoly will putpressure on the percentage discount. Tocompensate for this, airlines may want toincrease their nominal fares. A monopolyairline, on the other hand, has a muchstronger negotiating position and need notagree to large discounts in order to keep itslargest corporate clients.

41. The computer reservation systems areessential facilities in the marketing of airtravel services. EU Council Regulation2299/89 stipulates a code of conduct forthese systems, meant to ensure fair andnon-discriminatory service. Informal infor-mation nevertheless suggests that, in manytravel agencies, these systems are operatedin ways that do leave something to bedesired in terms of neutrality and non-dis-crimination. A closer control with the waythese systems are used and operated mayseem appropriate. It is, e.g., essential thatall airline carriers enjoy equal opportunitiesfor presentation and sale to a client, andthat no airline carrier be able to access allthe information stored in an independenttravel agent’s data base and use it for theirown marketing purposes.

42. Electronic ticketing (e-ticketing) is becom-ing more widespread. In these cases, reser-vations are usually done over the Internet,and no hard-copy ticket is issued. To theextent that e-ticketing is not based on openstandards, but requires the traveller to holdan electronic card specific to a particularcarrier or alliance, such a ticketing systemmay be liable to restrict competitionbetween airlines. This is particularly so ife-ticketing is integrated with the airline’s

frequent flyer programme, by making use,e. g., of the FFP membership card.

43. Further investigations into the businesspractices surrounding computer reserva-tion systems, travel agent agreements, andticketing systems at a European levelwould be appropriate. Further analyseswould also be required in order to assessmore accurately the anti-competitive effectof corporate discount schemes and thepossible remedies for it.

Competition between airports44. While most of the larger European airports

are slot constrained, there are a number ofsecondary airports with ample slot capaci-ty. By offering inexpensive services, lessbusy airports might be able to attract sub-stantial volumes of traffic and therebyrealise considerable economies of scale andenhanced consumer satisfaction. Low costairlines have started to exploit this opportu-nity, challenging the traditional carriers andtheir hubs by offering point-to-point ser-vices between smaller airports.

45. The promise of this development is, howev-er, limited by the relative shortage of com-mercially independent airports. In manycases, all or most of a country’s airports areowned and operated through one (govern-ment) agency. To enhance competition, itmight be desirable for European govern-ments to pave the ground for behaviourallyindependent airports. Ideally, two adjacentand hence potentially competing airportsshould not have the same owner. In thisway, a certain amount of market pressuremight be brought to bear on the presentlyinefficient slot allocation procedures.

Ground handling services46. Ground handling services are essential to

all air carriers, although different airlinesdemand services of differing degree ofsophistication. «No frills» airlines, e. g.,typically do not require catering services,nor the more advanced baggage handlingsystems necessary for interlining.

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47. Larger carriers typically operate their ownground handling services, sometimesthrough subsidiary companies. In manycases they offer their services also to com-peting airlines. From a competition point ofview, the problem arises when the onlyprovider of ground handling services at agiven airport is owned by a dominant hubcarrier. In such a case, small rival airlinesmay be confined to buy these services fromtheir dominant competitor.

48. There is thus a need for independentground handling services at most airports.In the opinion of the Task Force, a maxi-mally effective competition among serviceproviders and among airlines would, inprinciple, be achieved if (i) all ground han-dling service providers were legally andfinancially independent of the airline carri-ers, and (ii) all such providers wereensured free and unimpeded entry into themarket for ground handling services at anyairport. While it is difficult in practice toimagine a regulation in which carrierswould no longer be allowed to self-handle,the Task Force believes that the CouncilDirective 96/67/EC does not ensure suffi-ciently free access to the market for third-party ground handling services at allCommunity/EEA airports, and should beamended accordingly.

49. To the extent that providers integrated withor controlled by an airline do get to partici-pate in ground handling, it is important thatthe tax rules not favour such own-accountmodes of operation compared to outsourc-ing. If, e. g., independent ground handlingproviders are subject to output value addedtax (VAT), without the airline companies

being able to deduct the correspondinginput VAT, then larger carriers having theirown catering firm or department will havea distinct cost advantage compared tosmaller carriers which need to buy theseservices in the market, and which, on topof everything, may have to buy them fromtheir dominant competitor.

Concerted action is needed50. The obstacles to competition in European

aviation are such as to require a concertedaction by various government andCommunity agencies, including the compe-tition authorities, the transport authorities,the fiscal authorities, and the legislativebodies. Perhaps the single most importantbarrier to entry at the European level is theinsufficient availability of airport slots andthe notoriously inefficient method of allo-cation for this scarce resource. Thus, avia-tion authorities are called upon to imple-ment economically more efficient and lessdiscriminatory slot allocation regimes.Also, these authorities should pave theground for less discriminatory ground han-dling services. Competition authorities arecalled upon, inter alia, to intervene againstloyalty programs and predatory pricing andto ensure an adequate airline alliance andmerger control. Fiscal authorities shouldensure non-distortionary tax regimes inrelation to aviation and their related activi-ties. Legislative changes may in somecases be needed in order to ensure thatgovernment bodies have the provisionsnecessary to pursue an effective competi-tion policy towards the air travel industry.

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The limited degree of competition in NorthernEuropean aviation is a matter of deep concernto the Nordic competition authorities.Subsequent to the SAS-Braathens merger inDecember 2001, very few routes within orbetween Denmark, Finland, Norway, andSweden have more than one airline companyoperating.

More generally, the Nordic competition author-ities would like to raise the issue of enhancingairline competition in a broader, pan-Europeanor global perspective.

1.1 Theoretical perspectiveMonopolies have an incentive to reduce theiroutput so as to be able to charge a price thatexceeds the marginal cost of production. Theygenerally also have the market power to do so.This behaviour gives rise to a so-called dead-weight loss, meaning that the sum of the con-sumer and producer surpluses becomes smallerthan achievable under free competition.Although the producer surplus does increase,this gain is usually more than outweighed by alarge loss on the part of consumers, some ofwhich have to pay more for the product thanthe marginal cost, while others are «priced offthe market», incurring a welfare loss given bythe difference between their willingness-to-payand the marginal cost of production.

Theoretical considerations thus lead us toexpect relatively high prices in monopolisticmarkets. Informal observation from the Nordicair travel markets happens to appear consistentwith such a prediction.

Another important objection against monopo-lies is that the incentive to cost efficient pro-duction is reduced. In the absence of competi-

tors, a firm may survive and earn a profit evenif it does not adhere to the most efficientmethod of production. Competitive pressurewill help resolve this problem.

There are, nevertheless, circumstances inwhich a monopoly may represent a more efficient technology of production than whatwould follow from open competition. The so-called natural monopolies are characterisedby their ability to produce a given output moreeconomically than any collection of independ-ent, smaller firms.

Several authors have pointed out that, as a network industry, aviation does in fact exhibitseveral characteristics typical of naturalmonopolies. Suffice it here to mention the keywords economies of scale, economies of scope, and economies of density.1

To reach a verdict on the overall merits ofcompetition versus monopolistic production,one must balance the deadweight loss and theinefficiency due to missing competitive pres-sure against the economies of scale, scope anddensity. In many cases, the outcome of thistrade-off will depend on the size of the market.In smaller markets, there is less room for effec-tive competition.

As applied, however, to the great bulk of theEuropean air travel market, the latest theoreti-cal and empirical insights appear to suggestthat the efficiency gains connected with com-petition more than outweighs the advantages ofmonopolisation. We believe there are substan-tial potential gains to be reaped from a signifi-cantly enhanced competition within Europeanaviation in general, and within the Nordic airtravel markets in particular.

1 A more thorough discussion will be offered in Chapter 4.

1. INTRODUCTION

1.2 Barriers to airline competition There are several circumstances that, separate-ly or in combination, serve to reduce the possi-bility of a more competitive air travel market.

Possible barriers to entry and to effective com-petition include the hub-and-spoke system ofairline operation, the economies of scale, scopeand density typical of aviation, the present andfuture airline mergers, alliances, and codeshare arrangements, the bilateral aviationtreaties between countries, the frequent flyerprograms (FFPs), the corporate discountschemes, the computer reservation systems(CRSs), the travel agent agreements, the slotallocation regimes, the IATA (interlining) tariffconsultations, the system of taxation and sub-sidisation, the structure of airport charges, thevertical integration between ground handlingand operations in the air, etc. In this report, allof these issues will dealt with in smaller orgreater detail.

1.3 Deregulation in the USAThe American airline industry was deregulatedin 1978. By comparison, the single Europeanaviation market has – in principle – been ineffect since 1997, and remains far from fullyderegulated in practice.

As a backdrop to our discussion of airlinecompetition in Europe, it may therefore seemfruitful to start by an examination of theAmerican experience. Drawing on the lessonslearnt during 23 years of a deregulated aviationmarket, one might be able to foresee certainpatterns of development, certain opportunities,or certain obstacles to competition, that are yetto manifest themselves clearly in Europe.

A bit simplified, we think the principal pointsto be noted relate to • hub-and-spoke operations,• contestability, • consolidation,• frequent flyer programs (FFPs), and • slot allocation regimes.

1.3.1 Hub-and-spoke operations

Shortly after the US airlines were granted com-plete freedom to organise their own operations,the hub-and-spoke network system became thestandard mode of operation for all major air-lines. Rather than operating a large number ofpoint-to-point, non-stop routes, the airlinecompany channels all or most passengersthrough a «hub» airport, from which all con-nections extend like the spokes of a wheel.This way the number of different non-stoproutes needed to serve all possible pairs of n destinations is drastically reduced, from n(n-1)/2 to n-1. This allows for quite remark-able cost savings on account of the economiesof scale, scope and density inherent in a network structure. A fuller account of theseconcepts is given in Chapter 4 below.

Thus, almost all major American airlines oper-ate one or more hubs (the exception being lowcost airlines such as Southwest). Different air-lines choose different airports for their hubs.The hub airline therefore tends to dominate itshub airport and the area around it. No otherairline is able to offer a comparable frequencyof service into or out of the hub. Owing to theimportant network economic effects at play,the hub airline will often be able to cross-subsidise feeder routes into the hub, so as toeffectively outdo any smaller rival airlinewhich may want to offer services on just oneor a few spokes.

In terms of competition, the hub-and-spokesystem of operation therefore amounts to afairly pronounced division of the market,between the major airlines operating differenthubs. In the US, there is hardly any example ofa city pair with more than two airlines operat-ing a non-stop connection. The US market fornon-stop flights is, in other words, charac-terised by local monopolies or, at best, duopo-lies. Since time sensitive business travellersusually require non-stop trips, it is fair to saythat the competition in the US market for busi-ness travel is severely restricted.

There are, however, usually a fairly large num-ber of airlines serving the same city pair byconnections via a third (hub) airport. These

13

connections are, of course, slower than thedirect flights. But since leisure travellers tendto be less concerned about travel time losses,the US market for leisure travel is generallyconsidered to be fairly competitive.

1.3.2 Contestability

Prior to and shortly after the deregulation, itwas generally thought that aviation marketswould in general be highly contestable, as itwould be easy for any carrier to relocate air-craft and personnel so as to service a newroute.

In practice, it has turned out that the barriers toentry are much more important than previouslybelieved. Incumbent airlines can lower theirfares and/or increase their capacity practicallyovernight, so as to raise the cost and/or reducethe revenue of rival new entrants. Any poten-tial new entrant would, of course, be aware ofthis, and hesitate to challenge the incumbentcarrier even if the latter may be making a con-siderable profit in the current (monopolised)situation.

1.3.3 Consolidation

Following a period of rather fierce competitionin the early phases of deregulation, the US air-line industry has consolidated into a few largecarriers with nationwide networks. As of theend of 2001, there were at present six large,«traditional» carriers operating in the USdomestic travel market:

• American Airlines (AA), • United Airlines (UA),• Delta Air Lines• Northwest Airlines (NWA),• Continental Airlines (CA), and• U S Airways (USAir).

In addition, there is a rapidly growing low-costcarrier operating, viz.• Southwest Airlines (SWA).

NWA and CA are, however, about to merge.Altogether, there are thus only six independent,larger carriers operating.

1.3.4 Frequent flyer programmes

Frequent flyer programmes originated in theUS in the early 1980s. Being based on non-linear bonus systems applicable to repeatedpurchases, they act as loyalty or fidelity discounts for the customers, providing thesewith a certain incentive to stick to one and thesame provider (see Section 6.1 below for amore in-depth description). FFPs are now anintegral part of any US airline’s marketingstrategy (except for low-cost carriers). Theyremain popular also with large parts of thepublic and with the political establishment.

Thus, although obviously liable to restrictcompetition, the FFPs have not been the sub-ject of any serious attempt at intervention onthe part of the US competition authorities.Since all major carriers operate comparableprogrammes, and since there are several carri-ers providing extended, nationwide services,FFPs are generally not seen as the most impor-tant obstacle to competition in the US domesticmarket.

1.3.5 Slot allocation regimes

As in Europe, the slot allocation process isgenerally governed by history and tradition(«grandfather rights»).

In principle, there is a market for (ownershipto) slots in the US. However, this market is notvery liquid, as the turnover is quite small. Fewslots are ever sold. The time restricted leasingof slots is much more common.

The reason is not hard to understand. Even if acarrier may take care not to sell its slot to anairline that competes in the same market, itcannot prevent the buyer to resell the slot at alater stage, possibly to a fierce competitor ofthe original owner.

This suggests that attractive slots will rarely besold to new entrants. Although the new entrantmay not be a menace to the airline offering theslot, it might be a threat to some other, incum-bent carrier. This incumbent carrier wouldtherefore normally be willing to bid up theprice considerably, in order to use or «babysit»

14

the slot and avoid the nuisance of enhancedcompetition. The slot seller will therefore beable to reap a higher benefit by offering to sellto an incumbent airline than to a new entrant. The principal lesson to be learnt is that astraightforward, market based system of slotownership will not necessarily result inenhanced competition or challenges to incumbent airlines.

1.4 The European experience and outlook

1.4.1 National carriers and hubs

In Europe, the hub-and-spoke mode of opera-tion has an even longer history than in the US,having grown out of the past regulatory frame-work and of the prevailing geographic andpolitical conditions, rather than as anautonomous market process. Each country hashad its own national airline, or «flag carrier»,with a privileged position in and around itsdomestic market and frequently a large govern-ment ownership share. More often than not,flag carriers have been benefiting from consid-erable amounts of subsidies or direct financialsupport from the state.

Even more importantly, they have, up untilrecently, been benefiting from very consider-able amounts of indirect government support,in the form of heavily protected domestic andinternational markets.

The flag carrier typically organises its networkaround a hub located near the national capitalor main business centre. At its hub airport, theflag carrier tends to have considerable directand indirect influence on slot allocation prac-tices, on ground handling services, and onother essential facilities. Backed by its owngovernment, the flag carrier usually also tendsto obtain privileged positions in whatever bilat-eral aviation agreements are signed with othercountries. Each flag carrier therefore enjoysconsiderable market power at and around itsdomestic hub.

Thus, although there are almost as many flagcarriers as there are European nations, thecompetition between them is severely restrict-

ed, as they have been able to divide the marketbetween them to a very considerable extent. Inmany (short-haul) markets, the most effectivecompetitor to the European flag carrier is notanother airline company, but a surface mode oftravel, represented by a railway company, abus service, or the private car.

1.4.2 Regulation and deregulation

While in the US deregulation of the aviationmarket was done so to speak overnight, theEuropean liberalisation process is much moregradual, extending over more than a decade. Itis, in fact, still to be completed.

Until 1992, air traffic to and from any singlecountry was generally regulated by bilateralaviation agreements, by which exclusive trafficrights were usually reserved for the flag carri-ers of the two respective countries.

In 1987, the European Council agreed on atriple package of measures to liberalise airtransport. The approach was to be one of step-wise relaxation of controls covering the keyareas of tariff approval, market access, capaci-ty, and the application of the competition rules.

The first package, effective January 1993,opened the market for international flightswithin the Community. Airlines were givengreater freedom to provide capacity to matchmarket demands. New, more flexible proce-dures for the approval of fares meant thatmember states could no longer block proposalsfor economic low fares. These measuresenabled smaller airlines that had previouslyconcentrated on domestic or regional servicesto operate on important intra-Communityroutes and gave them increased freedom tocharge the fares they wished and providecapacity to meet market demands.

The second package carried these reforms fur-ther by increasing market access and the rightof European airlines to carry traffic betweentwo other European countries as part of a flightoriginating in its home country (so-called FifthFreedom rights). Governments were no longerable of deny airlines entry if they fulfilled allthe technical and safety standards. The second

15

package also expanded the scope for fare dis-counting within certain geographic zones.

In the third and final package, which camefully into effect in April 1997, European carri-ers were granted full traffic rights within theEuropean Economic Area (EEA)2 – includingcabotage rights – and the ability to set fares.The single European aviation market, compris-ing a 370 million population, had become reality.

Thus, through the first, second and third pack-ages of liberalisation, most regulations imped-ing competition in European aviation havebeen lifted, although some of them still remain.Perhaps the most important of these are thebilateral aviation agreements still in effectbetween single European countries and nationsoutside the Community. Some of these havethe form of so-called «Open Skies» agree-ments, by which any carrier belonging to eitherone of the two countries enjoys unrestrictedtraffic rights between the countries. Otheragreements, however, are much more restric-tive, like the «Bermuda II» treaty currently ineffect between the US and the UK. Accordingto this agreement, only four carriers – twoBritish and two American – are allowed to flybetween London and the US.

Thus, bilateral aviation treaties still ensureEuropean flag carriers a considerable degree ofmarket protection as far as extra-Communityair services are concerned. The exclusive traf-fic rights granted under such treaties might beforfeited if the flag carrier is merged with aforeign airline – whence the widespread prac-tice of forming alliances rather than full-fledged mergers between European airlines. In an opinion delivered by the AdvocateGeneral of the European Court of Justice on 31January 2002, it is proposed that individualmember states no longer be allowed to enter-tain such individual aviation treaties with non-EU countries. To the extent that this view isupheld by the Court, and assuming that such a

decision will be followed by the conclusion ofOpen Skies agreements between the EU andother countries, it will, in principle, also openthe extra-Community aviation market to anyEuropean carrier. As such, it could be viewedas the final step toward deregulation of the avi-ation industry in Europe.

It will, however, not automatically meanenhanced overall competition. When bilateraltreaties are replaced by Community levelagreements with non-EU countries, a majorimpediment to mergers involving two or moreflag carriers will have been removed. It may beforeseen that such a change in the regulatoryregime will spark a development towards mas-sive consolidation within European aviation. While in terms of competition and efficientresource allocation, full-fledged mergers maywell be preferable to looser alliances, it is para-mount to the protection of consumers and otherair travel customers that the resulting numberof European aviation concerns or alliances notbecome too low.

1.5 OutlineThe remaining part of this report is outlined asfollows.

In Chapter 2, we offer a general description ofthe aviation markets in the Nordic countries3.

Chapter 3 describes the relevant competitionlaw currently in effect in the respective coun-tries. While, in most cases, competition law isin line with the legal framework of theEuropean Union (EU), there are some excep-tions and deviations to be noted.

Chapter 4 focuses on the economics of avia-tion, with particular emphasis on the conceptsof network economics, price discrimination,costs, and productivity.

Chapter 5 is a brief discussion of taxation andairport charging schemes, as they affect the

16

2 The European Economic Area comprises Norway, Iceland, and Liechtenstein in addition to the European Union (EU).3 Throughout this report, we limit our attention to Denmark, Finland, Norway, and Sweden. It has been beyond the scope of the Task Force’s work

to explicitly include Iceland, Greenland, and the Faroe islands.

incentives faced by clients and operators in theair travel market and the externalities connect-ed to airline operations.

In Chapter 6, we discuss the various possiblebarriers to competition inherent in the market-ing practices and mode of operation of modernairlines and airports. These barriers include fre-

quent flyer programmes, corporate discountschemes, travel agent agreements, fare cooper-ation, inefficient slot allocation, etc.

In Chapter 7, we summarise and conclude thediscussion, putting forward a set of recommen-dations to the Nordic and European authorities.

17

Denmark, Finland, Norway, and Sweden forma relatively homogeneous region in NorthernEurope. Their populations count, as of mid-2000, 5.3, 5.2, 4.4, and 8.9 million, respective-ly. While Denmark covers a relatively smallsurface and hence has a comparatively densepopulation, with 124 inhabitants per squarekilometre, the opposite is true of Finland,Norway, and Sweden, where the populationdensities are 15, 14, and 20 inhabitants persquare kilometre, respectively.

2.1 Air travel demand in the Nordiccountries

Figure 2.1 shows the level and development ofdomestic air traffic in the four countries overthe last few years. In 2000, more than 23 million domestic air trips were made in theNordic countries, i. e. almost one trip per capita.

One notes that Norway, despite being thesmallest country in terms of population, hasthe largest domestic market, followed bySweden. The Danish and Finnish domestic airtravel markets are comparatively small.

The national propensity to travel by air mustbe understood in relation to numerous, coun-try-specific characteristics, including geo-graphic extension or size, topography, popula-tion spread, surface transport level-of-service,economic factors, etc. Air travel has its com-parative advantage on longer distances, and/orin cases where, although the distance is shortas the crow flies, alternative travel modes areslow on account of topography or inefficientsurface transport networks. This probablyexplains the relatively high propensity to travelby air in Norway, and the low propensity inDenmark.

Figure 2.2 shows the densest single domestic

routes within each of the four countries. Onenotes that no less than five domestic routes inScandinavia exceed one million passengers peryear. Three of these routes are Norwegian.Oslo-Trondheim, Oslo-Bergen, and Stockholm-Gothenburg compete neck and neck to be thedensest route.

In Figure 2.3, we exhibit some main statisticsconcerning the size of the international airtravel market between the Nordic countries,and between each country and the EEA. Notethat intercontinental traffic is not included, norare those European trips that have one end out-side the EEA.

The largest country also has the largest interna-tional European traffic, totalling more than 14million passengers annually to/from the EEA.Of these, 4.6 millions travel to or from theother Nordic countries. In Denmark, there are4.1 million travellers to or from the Nordiccountries, while in Norway and Finland thefigures are 2.9 and 1.8 million, respectively.

The total international inter-Nordic trafficamounts to 6.7 million passengers per year4.Trips between the Nordic countries and theremaining EEA total almost 28 millions.Adding the 23 million domestic trips men-tioned above, we arrive at a total annual airtravel frequency of approximately 57 millions,not counting intercontinental trips or Europeantrips outside the EEA. This corresponds toapproximately 2.4 trips per capita.

In Figure 2.4, we show how the densest inter-Nordic and extra-Nordic5 routes compare tothe rest of Europe. Six routes between or intothe Nordic countries are among the top 24international routes in the Europe. Only four-teen international European routes are denserthan the Stockholm-Copenhagen route.

Some further statistics are given in Table 2.1.

18

2. MARKET DESCRIPTION

19

4 One half of the sum of the national figures, since each inter-Nordic passenger has been counted twice. 5 Routes between Nordic countries are shown by red bars, while routes into the Nordic region are represented by blue bars. Note that domestic

European routes are not taken account of. Some of these exceed three million annual passengers and are hence denser than the London-Dublinroute.

2129 20921769 1745 1654

23232640

2973 28723100

9280

982210222

10565 10536

65786794

72297613

7943

0

2000

4000

6000

8000

10000

12000

1996 1997 1998 1999 2000

1000 domestic

passengers

Denmark

Finland

Norway

Sweden

Figure 2.1: Domestic air passengers in Denmark, Finland, Norway, and Sweden1996-2000

590390

272208

107

640287

279210

207

13401330

1050790

700

13201190

870700

410

0 200 400 600 800 1000 1200 1400

Copenhagen-Aalborg

Copenhagen-Aarhus

Copenhagen-Karup

Copenhagen-Rønne

Copenhagen-Billund

Helsinki-Oulu

Helsinki-Rovaniemi

Helsinki-Kuopi

Helsinki-Jyväskylä

Helsinki-Vaasa

Oslo-Trondheim

Oslo-Bergen

Oslo-Stavanger

Oslo-Tromsø

Bergen-Stavanger

Stockholm-Gothenburg

Stockholm-Malmö

Stockholm-Luleå

Stockholm-Umeå

Stockholm-Östersund

1000 passengers during 2000

Figure 2.2: The five densest routes in Denmark, Finland, Norway, and Sweden, respectively

20

1999

0,00

1,92

0,43

1,51

1,76

1,171,92

1,27

1,13

8,21

3,94

5,66

9,99

1,76

0,43

0,05

0,130

2

4

6

8

10

12

14

16

Denmark Finland Norway Sweden

Mill passengers

To/from remaining EEA

To/from SwedenTo/from NorwayTo/from FinlandTo/from Denmark

Figure 2.3: International air traffic between each of the Nordic countries and the EEA, by countryof destination/origin. 1999. Source: Eurostat: International Transport by Air

0,0 0,5 1,0 1,5 2,0 2,5

London-Oslo

Helsinki-Stockholm

Oslo-Stockholm

London-Munich

Barcelona-London

Geneva-London

Copenhagen-London

Barcelona-Paris

Copenhagen-Oslo

Copenhagen-Stockholm

London-Zürich

Amsterdam-Paris

Brussels-London

Paris-Milan

London-Stockholm

Paris-Rome

London-Milan

London-Madrid

Paris-Madrid

London-Rome

Frankfurt-London

Paris-London

Amsterdam-London

Dublin-London

Mill passengers 2000

Figure 2.4: Densest 24 international city pairs in European aviation. Year 2000. Source: Association of European Airlines (AEA)

21

6 Including charter flights.

Table 2.1: Summary air traffic statistics for the Nordic countries, as of March 2002.

2.1.1 Denmark

In Denmark, the distances between the majorcities are short, and the bridge between theislands of Zealand and Funen, which opened in1997 for trains and in 1998 also for cars, hasshortened the time between the provinces byanother 1- 11/2 hours. This meant that thedomestic air traffic has decreased to an evensmaller level than before the opening, as threeroutes have been shut down due to the compe-tition from cars and trains. Today the domestic

air traffic involves six routes to and fromCopenhagen. Only 1.7 million people used theplane for domestic travelling in 2000, or 16.7per cent of all travellers, when internationaland charter passengers are included as well.The route with most passengers wasCopenhagen-Aalborg with just under 600 thou-sand passengers in 2000 (see Figure 2.2), followed by Copenhagen-Aarhus (400 thou-sand passengers).

Denmark Finland Norway Sweden

Passengers on scheduled domestic

routes in 2000

1 654 080 3 099 968 10 536 000 7 943 000

Domestic routes

6 21 112 Appr. 40

Passenger kms in 2000 (millions) 333 1 286 4 312 3 620

Passengers in 2000 (in per cent)

- scheduled domestic

- scheduled international

- charter flights

-

16.7

70.9

12.3

44.9

46.0

9.1

48.6

39.6

11.8

49.16

50.96

Regulated domestic routes (PSO)

0 0 50 10

Scheduled international routes out

of largest domestic airport

- Nordic routes

- other European routes

- intercontinental routes

-

Copenhagen:

111

26

65

20

Helsinki:

39

6

27

6

Oslo:

34

10

23

1

Stockholm/ARN

73

16

44

13

Scheduled international routes out

of second largest domestic airport

- Nordic routes

- other European routes

intercontinental routes

Billund:

15

5

10

0

Oulu:

1

1

0

0

Stavanger:

6

2

4

0

Göteborg:

27

8

18

1

Scheduled international routes out

of third largest domestic airport

- Nordic routes

- other European routes

intercontinental routes

Aarhus:

4

3

1

0

Turku:

2

20

0

Bergen:

5

1

4

0

Malmö/Sturup:

4

1

3

0

Gothenburg:

22

7 The Danish, Swedish and Norwegian states own 50.8 % of SAS, while private investors own 49.2% (see facts about SAS 2001/2002,www.sas.se). The Finnish state owns 58.4 % of Finnair, while private investors own the remainder.

8 EuroBonus and Finnair Plus are the frequent flyer programmes of SAS and Finnair, respectively.

2.1.2 Finland

Finland, on the other hand, is characterised byfairly large distances. Here, however, almostall the major cities are located relatively closeto each other in the southern part of the coun-try. There is thus very little air traffic betweenthe three largest cities in Finland. Despite therelatively sparse population none of the 21major domestic routes are run as public serviceobligation routes. In total, 3.1 million passen-gers travelled by air in 2000. This was a thirdmore than in 1996 and 44.9 per cent of thetotal air traffic, when international and chartertraffic is included. Helsinki-Oulu is by far thedensest route, carrying 600 thousand passen-gers in 2000, compared to only 300 thousandpassengers on the second largest route,between Helsinki and Rovaniemi.

2.1.3 Norway

In Norway, domestic air travel demand isunusually high, on account of the considerabledistances between the major cities and on therelatively low level-of-service offered by alter-native modes of transport. The main cities aresituated in the southern part of the country andalong the western coast, whereas the northernpart of the country has a very sparse popula-tion. As a consequence of the dependence onair transport in and to/from the more remoteareas, the Norwegian government has imposeda public service obligation on approximately50 of the 112 domestic routes. In 2000, 48.6per cent of all air passengers travelled ondomestic routes, totalling approximately 10.5million passengers. Oslo-Trondheim and Oslo-Bergen both have more than 1.3 million pas-sengers. The Oslo-Stavanger route comes third,with slightly more than a million.

2.1.4 Sweden

Domestic air traffic in Sweden is also affectedby the considerable distances between the mainpopulation centres. The main cities are foundin the central and southern part of the country,

while the northern part of the country is spare-ly populated. Here, the government hasimposed a public service obligation on 10 ofthe approximately 40 domestic routes (begin-ning in November 2002). The large distanceshave made the plane an important travel mode.In total, 7.9 million passengers travelleddomestically in 2000, the domestic trafficaccounting for 49.1 per cent of the total airpassenger number in Sweden. The densestroute is the one between Stockholm andGothenburg (1.32 million passengers), whileStockholm-Malmö comes in second (1.19 million).

2.2 The supply side: carriers operatingin the Nordic countries

2.2.1 Cooperation, integration, and domesticmarket performance

Traditionally the national flag carriers havebeen the biggest suppliers of domestic air trav-el services of the four countries. In Denmark,Norway, and Sweden the national carrier is theScandinavian Airlines System (SAS), while inFinland the national carrier is Finnair.7

More than 90 per cent of the domestic passen-gers in Finland fly Finnair. In comparison,SAS’ share of the domestic passengers inDenmark, Norway and Sweden is 60, 35, and74 per cent, respectively. In reality, SAS’ andFinnair’s market power is further strengthenedby cross-ownership and cooperation agree-ments with other airlines (see Table 2.2). BothSAS and Finnair have code-sharing agreementswith their cooperating airlines, just as it is pos-sible to collect EuroBonus or Finnair Pluspoints8 on flights with some of the cooperatingairlines. Code-share partners also often runadvertisement campaigns together.

These structures have led to a situation inwhich domestic competition is limited, notonly on the thinner routes, but on most of thedenser routes as well. Only in Sweden and

23

9 The Norwegian Competition Authority did not intervene against SAS’ acquisition of Braathens, since Braathens was a failing firm.10 Since 12 May 2002, Maersk Air no longer serves the domestic Danish market. 11 Air Botnia stopped domestic operations in 2002.12 Comparable data for British Airways have not been available. Their domestic market is, however, relatively small. Also, note that the figures for

Air France do not include flights to the French territories overseas. 13 Not including Widerøe flights.

Denmark do airlines compete, and only on alimited number of routes. In Norway, SAS andBraathens have been competing on severalroutes up until 2001. After the merger9, theyhold a 98 per cent market share. The competi-tion in Norway is thus practically non-existent,

and the same is true for Finland. The compet-ing company to Finnair, Air Botnia, has decid-ed to focus on regional traffic instead ofdomestic traffic, and the airline has stopped alldomestic operations.

In some cases, however, depending on the dis-tances and on the quality of transport infra-structure and level-of-service, surface travelmodes may be substitutable for air transportservices, at least within some traveller seg-ments. This is probably the case for some ofthe shorter air routes in Finland and Sweden,and to a lesser extent in Denmark and Norway.Hence, although there is no effective competi-tion between airlines, the market power of car-riers may be limited by the competitive chal-

lenge posed by railways, bus services, or evenprivate cars.

In Figure 2.5 an attempt is made to charac-terise the domestic market performance of theNordic flag carriers, i. e. the SAS Group andFinnair, compared to their French and Germancounterparts12. Here, we consider the «domes-tic» market of the SAS Group to consist of allflights inside Scandinavia (Denmark, Norway,and Sweden)13.

Table 2.2: The domestic airlines in Denmark, Finland, Norway, and Sweden

Country Airline Domestic share of

passengers (per cent)

Ownership and cooperation

Denmark

SAS 59.4 -

Cimber Air 24.1 Owned 26 % by SAS

+ cooperation with SAS

Maersk Air 16.510 Cooperation with SAS

Finland Finnair 91.9 -

Golden Air 5.7 Cooperation with Finnair

Air Botnia 2.411 Fully owned by SAS

Norway Braathens 50 Fully owned by SAS (as of 2002)

SAS 35 -

Widerøe 13 Owned 96.4 % by SAS

Other 2

Sweden SAS 74 -

Skyways 13 Owned 25 % by SAS

+ cooperation with SAS

Malmö Aviation 10

Other 3

24

After the SAS-Braaathens merger, the SASGroup probably enjoys the largest «domestic»market of any European carrier, in absolute,RPK14 terms as well as relatively speaking. Noother major European carrier has anywherenear 35 per cent of its activity in the domesticmarket.

The airport in Copenhagen, Kastrup, functionsas the main hub for SAS. It is also the biggestairport in the Nordic countries with 16.4 mil-lion passengers passing through in 2000. Thereare currently 111 international routes to andfrom the airport (see Table 2.1). Due to the

minimum amount of domestic air traffic theinternational travellers account for around 90per cent of the passengers, a very high percent-age compared to most other airports. Thismeans that a lot of the feeder traffic comesfrom the surrounding countries, primarily fromSweden and Norway. For that purpose, SAShas direct routes between Copenhagen and thesmaller Swedish and Norwegian cities, plus adense schedule between the three capitals. Onaccount of this extensive network, SAS is quitedominant in Kastrup airport, having 58 percent of the departures in 2000.

Figure 2.5: Domestic market performance of the Nordic, French, and German flag carriers. Source: Airlines’ annual reports for 2000.

SAS is just as dominant in their secondaryhubs, Arlanda airport in Stockholm andGardermoen airport in Oslo. This is also due tothe extensive network of domestic routes thatfeed passengers to SAS’ international routes toand from Arlanda and Gardermoen. This net-work has given SAS a dominant position in theair traffic within, between, into and out of thethree Scandinavian countries.

Finnair has a similar network of domesticroutes, which feeds passengers into their hub inHelsinki, from where 39 scheduled internation-al routes originate. This has also given Finnaira strong position in Finland. The carrier hasalso a set of European routes (12 in 2001) originating from Stockholm, and it also operates to Skavsta airport near Stockholm. To some extent it also feeds passengers toSAS’ routes from Stockholm and Copenhagen.

14 Revenue Passenger Kilometres.

25

SAS and Finnair both cooperate with other airlines. Where SAS is a member of the StarAlliance, a cooperation between fifteen air-lines, Finnair is a member of the other bigalliance, Oneworld, where eight airlines cooperate.

2.2.2 SAS in an international perspective 15

To get an idea of the positioning of theEuropean airlines, and in particular of SAS’position in this market, we present, in Table2.3, some key figures for 22 of the largest air-lines. The numbers are from 1995/1996. Even

Table 2.3: Descriptive statistics for 22 of the world’s largest airlines in 1995.

15 This section draws heavily on the report by Steen and Strandenes (2002), using parts of their text verbatim.

Airline Revenue

tonne kms

(millions)

Number of

passengers

(thousand)

Number of

employees

(units)

Per cent

internat’l

RTK

Stage

length

(kms)

Passenger

load

factor (%)

North America

American 17 660† 79 389† 90 980 36. 9 1 799 69†

United 19 637† 81 945† 80 902 42.3 1 683 72†

Delta 15 168† 97 271† 62 832 30.7 1 224 70†

Northwest 12 821† 52 722† 44 682 47.8 1 363 73†

US Air 5 949† 56 893† 43 614 7.4 904 69†

Continental 6 009† 35 986† 32.272 20.0 1 315 68†

Air Canada 3 453 12 801 20 503 67.3 1 536 63

Canadian 2 948 8 578† 13 228† 70.1 1 681 71†

Average North America 10 456 53 198 48 627 40.3 1 438 69.4

Asia-Pacific

Japan 10 204 28 880 20 482 85.6 2 348 68

Nippon 4 583 37 870 14 649 41.2 1 112 64

Singapore 9 512† 12 022† 13 258 100.0 4 300 74†

Korean Air 8 261 21 422 16 478 93.9 1 714 65

Cathay 7 092† 10 985† 15 657† 100.0 3 283 74†

Qantas 5 603† 15 551† 24 429† 79.5 2 064 72†

Thai 3 795 12 821 20 718 92.0 1 559 67

Average Asia-Pacific 7 007 19 936 17 953 84.6 2 340 69.1

Europe

Lufthansa@ 12 205 32 599 26 578 95.2 1 131 70

British Airways 12 215 35 000† 50 477 98.1 1 863 72†

Air France 9 701 14 498 36 384 91.1 1 846 71

SAS 2 195 19 828† 21 348† 83.1 728 64†

KLM 8 630† 12 285 26 385† 99.9 1 748 76†

Swissair 3 574 8 826† 16 520 99.0 1 268 64

Iberia 2 850 14 600† 22 500 79.6 1 194 70

Average Europe 7 339 19 662 28 599 92.3 1 397 69.6

Source: Oum and Yu (1998a), quoted by Steen and Strandenes (2002).

†1996 data@

Lufthansa went through dramatic restructuring during 1994-1995. Its Technical Services and Cargo divisions

became independent public limited companies on 1 January 1995. The parent company Lufthansa AG is now

purely a scheduled passenger airline company.

the newest studies of airlines (e.g. Ng andSeabright 2001) only include data up to 1995.Hence, since we are using secondary sources,all comparisons done here are based on data upto 1995. Note that, since then, the SAS Grouphas grown considerably through the acquisitionof Braathens.

As can be noted from Table 2.3, the US air-lines are the world’s largest. Only two of theEuropean carriers can compete among thetop ten, i. e. KLM and British Airways. SASis the smallest among the 22 carriers inTable 2.3 if we look at the revenue tonnekilometres figure, but ranks 11 in terms ofpassenger volume. This reflects the fact thatSAS has by far the lowest average stagelength, with only 728 kms, suggesting alsothat they have a cost disadvantage comparedto their competitors (see Chapter 4).

On the other hand, if we look at the employee/passenger ratio, the SAS figure (1.08) is bestin Europe if one disregards Lufthansa,whose data are not exactly comparable dueto their restructuring (see note to the table).

Actually, the SAS figure is closer to theNorth American average (0.91) than to theEuropean average (1.45). Air France hasmore employees compared to passengersthan any other carrier (2.51). The differencesbetween Europe and both North Americaand Asia-Pacific suggest a much higher pro-ductivity within the latter two industries.

The «Per cent internat’l RTK» statistic is thepercentage of the revenue tonne kilometresthat stems from international transport. TheNorth American carriers have a significantlysmaller international share than any of theother carriers: 40 per cent, as compared tothe European and Asian-Pacific averages of84 to 92 per cent. SAS has, along withIberia, the lowest international share of theirincome from abroad (83 per cent) amongEuropean carriers, but this figures is stillhigher than for any North American carrier.However, if we account for the fact thatSAS’ domestic market consists of threecountries, Denmark, Norway, and Sweden,their «domestic base» is much higher than17 per cent, as illustrated in Figure 2.5.

26

27

16 Art. 53 and 54 of the EEA Agreement follow Art. 81 and 82 of the EC Treaty verbatim. They have been implemented in Norwegian Lawthrough Act of 27 November 1992 No. 109.

3.1 Community Law/EEA LawArticles 81 and 82 of the EC Treaty, andArticles 53 and 54 of the EEA agreement16, setout general prohibitions on anti-competitiveagreements and abuse of dominant position.

Article 81(1) prohibits agreements, decisions,and concerted practices between undertakings,if they have as their object or effect to distortcompetition, and if they affect trade betweenMember States. The prohibition covers cooper-ation between two or more undertakings. Cooperation may take place through an agree-ment, a decision by an association of undertak-ings, or through concerted practices of under-takings. A decision by an association of under-takings would, for instance, be where a tradeassociation, by virtue of its rules of associa-tion, would be able to determine or change thebehaviour of other undertakings on the market.

Concerted practices refer to those situationswhere undertakings, without having a formalagreement, apply a certain form of behaviourjointly. For this to be regarded as a concertedpractice, some form of communication musthave taken place between the undertakings.Natural parallel behaviour, where a number ofundertakings act in the same way without hav-ing either a direct or indirect agreement, is notby itself subject to prohibition. These situationswill, however, be difficult to distinguish.

In Article 81, a number of examples of cooper-ation are given that are regarded as being par-ticularly restrictive in terms of competition.The list of examples is not exhaustive sincethere are other forms of cooperation that areanti-competitive. The Article is particularlystrict as regards price cooperation. Agreementswhere there is direct price cooperation, andalso where prices are indirectly determined, areprohibited. It makes no difference whether the

undertakings involved cooperate directly orindirectly in e.g. a purchasing or trade associa-tion. As will be pointed out below, airlines areexempt from this as regards price consultationsfor interline tickets.

If companies want to be assured that theiragreements do not infringe the CommunityRegulations, they can notify the agreements tothe Commission with request for negativeclearance or individual exemption according toArticle 81(3). Certain types of agreements areexempted from the prohibition against anti-competitive cooperation. These have beengrouped into block exemptions. An undertak-ing itself may, at its own risk, decide whetheran agreement is covered by a block exemptionand thus exempt from the prohibition.

Article 82(1) prohibits abuse of dominant posi-tion by one or more undertakings if it affectstrade between Member States. For the prohibi-tion to be applicable, an undertaking isrequired to have not only a dominant positionin the market, but also be abusing its position.Being dominant is not in itself prohibited, what is prohibited is the abuse of a dominantposition.

As a rule a dominant position is based on anumber of factors, each of which does not byitself have to be critical. Examples of factorsthat are important, are financial strength, barri-ers to entry into the market, patents and indus-trial property rights, as well as technology andother knowledge oriented advantages. Animportant factor is the market share of theundertaking in the relevant market. A marketshare of between 40 and 50 percent is regardedas being a clear indication of a dominant posi-tion. If the market share exceeds 65 percent,the presumption of a dominant position is virtually conclusive.

3. LEGAL FRAMEWORK

28

17 Council Regulation (EEC) No. 4064/89 of 21 December 1989 on the control of concentrations between undertakings, OJ L 395 30.12.1989 p. 1,amended by Council Regulation (EEC) No. 1310/97 (OJ L 180 09.07.1997 p.1). EEA Agreement Art. 57, Annex XIV. Implemented inNorwegian Law through Act of 27 November 1992 No. 110 and Regulation No. 966 of 2 December 1992 and Regulation No. 964 of 2December 1992.

18 Defined in Regulation 4064, Article 1.19 Council Regulation 17/62: First Regulation implementing Articles 85 and 86 of the Treaty, OJ 013 21.02.1962 p. 204. EEA Agreement Protocol

21, The Surveillance and Court Agreement Protocol 4, Part I, Chapter II. Implemented in Norwegian Law through Act of 27 November 1992No. 110 and Regulation No. 966 of 2 December 1992.

20 Council regulation 17/62, Article 3.21 Council Regulation 17/62, Article 15 and 16.22 Case 127/73, Belgische Radio en Televisie and Société Belge des Auteurs, Compositeurs et Editeurs (BRT) de Musiqe v. SV SABAM and NV

Fonior, Judgment of the Court of 30 January 1974, European Court reports 1974 page 51.23 Case 453/99 Courage v. Crehan, Judgement of the Court of 20 September 2001.24 Council Regulation No. 141/62, Exempting transport from the application of Council Regulation No. 17, OJ 124 28.11.1962 p. 2751.25 Court Ruling in Ministère Public v. Lucas Asjes and Others, Judgement of the Court of 30 April 1986, Joined Cases 209-213/84, European

Court reports 1986 page 1425.26 Council Regulation (EEC) No. 3975/87 of 14 December 1987 laying down the procedure for the application of the rules on competition to

undertakings in the air transport sector, OJ L 374 31.12.1987 p.1, amended by Council Regulation (EEC) No. 1284/91 (OJ L 122 17.05.1991p.2), amended by Council Regulation (EEC) No. 2410/92 (OJ L 240 24.08.1992 p.18). EEA Agreement Protocol 21, The Surveillance and CourtAgreement Protocol 4 Part II, Chapter XI. Implemented in Norwegian Law through Act of 27 November 1992 No. 110 and Regulation No. 966of 2 December 1992.

The Article lists a number of examples of prac-tices that can be regarded as constituting abuse.The list of examples below is not exhaustive.An example of unfair purchase or sellingprices is when excessive prices are set. Anotherexample is predatory pricing, i. e. where adominant undertaking applies prices belowthose that would normally be needed to covercosts and where the aim is to eliminate com-petitors or make market entry more difficult.

In 1989, the Council issued Regulation 4064on merger control.17 All mergers, take-oversand joint ventures of EU dimension18 are to benotified to the European Commission forapproval. If the Commission considers a con-centration to create or strengthen a dominantposition, resulting in a significant impedimentto competition in the common market, theCommission can declare the concentrationincompatible with the common market.

Council Regulation No. 17/6219 empowers theCommission to require necessary informationand to undertake investigations in matters con-cerning violations of Articles 81 and 82. Incase of violation the Commission can decidethat the infringement should be terminated.20

The Commission also has the power to imposefines and periodic penalty payments.21

Enforcement through the Commission is com-plemented by enforcement brought by privateparties through national courts. This is a conse-quence of the doctrine of direct effect.22

Agreements or clauses in an agreement cov-

ered by the prohibition against anti-competitivecooperation are void, according to Article81(2). Pursuant to case law an undertakingmay also be liable to pay damages to anotherundertaking.23

Originally, Regulation No. 17 did not apply tothe transport sector,24 and air transport was notincluded in the EC Treaty provisions on trans-port policy. Therefore, it was not possible forthe Commission to investigate violations ofArticles 81 and 82 in cases concerning airtransport.

Inspired by the deregulation of domestic airtransport in the USA in 1978 as well as by thedecision of the European Court of Justice inthe so-called Nouvelles Frontières case,25 theCouncil decided to establish a single Europeanaviation market. Thus, the market for air travelin Europe was liberalised in three steps around1990, known as the three packages.

By the first package in 1987, the Commissionreceived means to treat infringements in themarket for air transport in the same way as inmost other markets within the EU. The follow-ing two packages (in 1990 and 1992) includedrenewals and supplementary regulation to thefirst package.

Council Regulation No. 397526 lays down theprocedure for the application of the rules oncompetition set out in the Treaty, as CouncilRegulation No. 17/62, as mentioned before,

29

27 See the Court Ruling in Ahmed Saeed Flugreisen, Judgement of the Court of 11 April 1989, Ahmed Saeed Flugreisen and Silver Line ReisebüroGmbH v Zentrale zur Bekämpfung unlauteren Wettbewerbs e.V., Case 66/86, European Court reports 1989 Page 0803.

28 Council Regulation (EEC) No. 3976/87 of 14 December 1987 on the application of Article 85 (3) of the Treaty to certain categories of agreements and concerted practices in the air transport sector, OJ 1987 L 374/9, amended by Council Regulation (EEC) No. 2344/90 (OJ 1990 L 217/15), amended by Council Regulation No. 2411/92 (OJ 1992 L 240/19).

29 Regulation Nos 2671-2673/88.30 Commission regulation (EEC) No. 1617/93 (OJ 1993 L 115/18), amended by Commission regulation (EEC) No. 1523/96 (OJ 1996 L 190/11),

amended by Commission regulation (EEC) No. 1083/99 (OJ 1999 L 131/27), amended by Commission regulation (EEC) No. 1324/01 (OJ 2001L 177/56. EEA Agreement Annex XIV p. 6) no. 11b. Implemented in Norwegian Law through Act of 27 November 1992 No. 110 andRegulation No. 964 of 2 December 1992.

does not apply to transport services. Accordingto its preamble, the Regulation aims in particu-lar to give the Commission the means forinvestigating cases of suspected infringementof Articles 81 and 82 in this sector, and thepowers to take decisions and impose appropri-ate sanctions in order to put an end to infringe-ments recorded by the Commission.

Agreements solely on technical standards,improvements and cooperation of technicalmatter are excepted from the prohibition laiddown in Article 81 of the Treaty.

3.2 Exemptions for the airline industryCouncil Regulation No. 3975 applies only toair transport between Community airports. This means that agreements or behaviour concerning air transport between MemberStates and third countries may still constituteinfringements of Articles 81 and 82, only theCommission will not be empowered to investigate it or impose sanctions.

It is fully optional for a Member State to enterbilateral agreements with third countries con-cerning air transport between the two. But theMember States’ national authorities are notallowed to approve or encourage agreementsthat are contrary to Articles 81 and 82.27

Bilateral agreements are discussed below.

By Council Regulation No. 3976,28 theCommission was given power to adopt blockexemption to certain categories of agreements,decisions, and concerted practices as listed inArticle 2(2) of the Regulation. A block exemp-tion means that the prohibition set out inArticle 81(1) does not apply to the types ofagreements mentioned in the regulation con-cerned.

As a part of the liberalisation programme, theCommission granted wide block exemptions inthe area of air transport related services. In1988, the Commission issued three blockexemptions concerning capacity planning, revenue sharing, tariff consultation, slot alloca-tion, computer reservation systems, and groundhandling services, in each case subject todetailed conditions.29 These block exemptionshave been updated continuously throughout the1990s.

The block exemption on cooperation betweenairlines including slot allocation was renewedin 1993, and has been amended several timessince.30 By the latest amendments, the extentof the block exemption has been narrowed sig-nificantly. The block exemption thus no longerexcepts joint planning and coordination ofschedules and consultations on cargo tariffsfrom the prohibition in Article 81. After the lat-est amendment, the Regulation applies until 30June 2002 to agreements concerning consulta-tions on passenger tariffs, and until 30 June2004 concerning slot allocation.

The Regulation on passenger tariff consulta-tions only affects one organisation, IATA,whose primary purpose is to organise interlin-ing and coordinate tariffs in this connection.The airline companies’ cooperation throughIATA is described below in Chapter 6.

The Commission has been examining whetheror not to amend the block exemption on pas-senger tariff consultations. The question to beconsidered is whether the advantages of coop-eration outweigh the disadvantages of allowingthe companies to exchange information onprices. There is, as of May 2002, a proposalpending to prolong the exemption until 30 June2005.

30

31 Council Regulation (EEC) No. 2409/92 (OJ 1990 L 240/15). EEA Agreement Annex XIII, Chapter VI. Implemented in Norwegian Law throughAct of 11 June 1993 No. 101 and Regulation No. 691 of 15 July 1994.

32 Council Regulation (EEC) Nos 2407 and 2408/92 (OJ 1990 L 240/1 and 8). EEA Agreement Annex XIII, Chapter VI. Implemented inNorwegian Law through Act of 11 June 1993 No. 101 and Regulation No. 691 of 15 July 1994.

33 Article 4(1)(a).34 Council Regulation (EEC) No. 95/93 (OJ 1993 L 14/1). EEA Agreement Annex XIII, Chapter VI. Implemented in Norwegian Law through Act

of 11 June 1993 No. 101 and Regulation No. 691 of 15 July 1994.35 Council Regulation (EEC) No. 2299/89 of 24 July 1989 on a code of conduct for computerised reservation systems OJ L 220 29.07.1989 p.1,

amended by Council Regulation (EEC) No. 3089/93 (OJ L 278 11.11.1993 p.1), amended by 0323/99 (OJ L 040 13.02.1999 p.1). EEAAgreement Annex XIII, Chapter VI. Implemented iin Norwegian Law through Act of 23 June 2000 No. 54.

36 Council Directive (EEC) No. 96/67 (OJ 1996 L 272/36). EEA Agreement Annex XIII , Chapter VI. Implemented in Norwegian Law throughAct of 11 June 1993 No. 101 and Regulation No. 1096 of 11 March 2000.

By the adoption of the third package, theCouncil allowed free tariff fixing31 and intro-duced Community-wide procedures for licens-ing carriers, so that Member States wererequired to allow any licensed Community car-rier to operate between any two points withinthe Community.32 This also removed theremaining restrictions on domestic air trans-port. The result of these Regulations was thatairlines – and especially national carriers –could no longer rely on government protectionand had to adapt to a more competitive envi-ronment.

Still, if a Member State and the Commissioncan agree upon certain routes in «thin» areas asvital to the economic development of the con-cerned regional area, Regulation 240833

authorises the Member State to impose a public service obligation to the routes.

In 1993, the Council issued a Regulation oncommon rules for the allocation of slots atCommunity airports.34 The purpose of theRegulation is to facilitate the entry of new car-riers into the market, by requiring all MemberStates to manage and allocate airport slotsunder the same rules. According to theRegulation, a carrier is allowed to maintain aslot if the slot has actually been used 80 percent of the time during the period for which ithas been allocated – the so-called «grandfatherrights». Furthermore, the Regulation states thatairline companies can exchange slots amongeach other.

At present, the Commission is planning arenewal of the Regulation to ensure an easierentry into the market for new carriers. TheCommission also wants to clarify the legal sta-tus of slots in order to open up the possibility

to exchange or even trade slots between airlinecompanies. Slots and capacity are discussedmore thoroughly below in Chapter 6.

In 1989, the Commission released a Code ofConduct for computer reservation systems.35

By the Regulation, the Commission wanted toensure that such systems be used in a non-dis-criminatory and transparent way, and to avoidany abuse of the computer reservation systemsthat might distort the competition between aircarriers. Computer reservation systems are discussed further in Chapter 6.

In 1996, the Council passed a directive to theeffect that agreements on ground handlingservices were no longer exempt from article81(1).36 To fulfil the obligations contained inthe directive, Community airports with morethan 2 million passengers a year must open upthe market for ground handling services in theairport to at least two third-party suppliers. Forsmaller airports, the directive does not requiremember states to ensure free access for third-party ground handling suppliers.

3.3 Bilateral agreementsAir traffic between states that are not bothmembers of the EU/EEA, are to be negotiatedbilaterally. Bilateral agreements include ruleson the establishment of routes, quantities andprice structures on all origin-destination pairsbetween the two countries concerned.

The USA offers so-called Open Skies agree-ments to countries wanting bilateral treaties oncross-Atlantic flights to the USA. A bilateralOpen Skies agreement between the USA and athird country gives complete freedom for air-lines registered in the two countries to travel

31

37 Austria, Belgium, Denmark, Finland, Germany, Italy, Luxembourg, Netherlands, Portugal, and Sweden.38 The «Bermuda II» treaty places particularly severe restrictions on the US-London service, especially in regard to Heathrow Airport. Only four

carriers – American Airlines, British Airways, United Airlines, and Virgin Atlantic Airways – are allowed to provide services between Heathrowand the USA. The treaty also limits the number of US cities that may be served from London’s Gatwick Airport. Finally, the Bermuda II agreement permits either government to restrict capacity expansion in any US-UK city pair, and to restrict carrier pricing in certain respects.

39 C-466-469/98, C-471-472/98 and C-475-476/98. The cases are still pending before the Court.40 The Norwegian Competition Act is currently (as of May 2002) under revision. One issue being considered is precisely whether to harmonise

the Act with Community Law. 41 Consolidated Act No. 687 of 12 July 2000 on Competition.42 In this report, «billion» means «1000 millions».

between the two, both on new and existingroutes.

The European Commission has been trying forsome years to negotiate such a deal with theUSA on behalf of all 15 EU Member States,but has still not succeeded. Thus, severalMember States have individually negotiatedOpen Skies agreements with the USA.37 TheUnited Kingdom has a rather restrictive bilater-al agreement with the USA, the so-called«Bermuda II» treaty38.

The Commission considers bilateral agree-ments to infringe Community Regulations, asthe agreements only ensure the Member State’sown air carriers the right to fly from their terri-tory to the USA. According to the Commission,the involved Member State in this way createsserious discrimination and distortions of com-petition towards other Member States. TheCommission has therefore submitted applica-tions to the Court against the Member Statesthat have made bilateral agreements with theUSA.39 In an opinion delivered by theAdvocate General to the European Court ofJustice on 31 January 2002, it is proposed thatindividual member states no longer be allowedto entertain such individual aviation treatieswith non-EU countries.

As to the EEA countries, there are no formallimitations to the possibilities to negotiatebilateral agreements. Both Iceland and Norwayhave signed Open Skies agreements with theUSA.

3.4 National competition legislationIn the EU member states Denmark, Finland,and Sweden, the competition legislation is, ingeneral, more or less fully harmonised with

Community law (see Subsections 3.4.1, 3.4.2,and 3.4.4 below).

In Norway, however, important differences stillpersist 40, especially as regards the prohibitionagainst the abuse of dominant position. Atpresent, such a prohibition does not exist under Norwegian law. On the other hand, theNorwegian Competition Authority has exten-sive powers to intervene against (e.g. prohibit)any action or agreement which is liable torestrict competition contrary to the goal of effi-cient resource allocation (see section 3.4.3).Also, whenever the trade between EEA mem-ber states is affected, Articles 53 and 54 of theEEA agreement (corresponding to Articles 81and 82 of the EC treaty) become applicable.Thus, the EU/EEA competition rules are validalongside the Norwegian competition regula-tion. In case of conflict, the EEA rules prevail,making the prohibition against abuse of domi-nant position applicable even in Norway.

3.4.1 Denmark

Effective 1 January 1998, the DanishCompetition Act was amended to achieve ahigher degree of EU-conformity. The amend-ment introduced a prohibition against anti-competitive agreements and against abuse ofdominant position – both similar to the onescontained in Articles 81 and 82 of the ECTreaty. Effective 1 October 2000, rules onmerger control were introduced in theCompetition Act as well.41 In accordance withthe wish to achieve EU-conformity, theCompetition Act has been construed in a man-ner similar to the EU competition rules.

The limit for agreements of minor importancein the Danish Competition Act is a turnover of1 billion42 Danish kroner and a 10 per cent

32

43 For example 96/180/EC: Commission Decision of 16 January 1996 in case IV/35.545 - LH/SAS, OJ L 054, 05/03/1996 p. 28. 44 Commission Decision of 18 July 2001in Sun-Air v. SAS and Maersk Air, OJ 2001 L 265/15.

share of the relevant market. Mergers are onlysubject to Danish merger control if the mergingcompanies have a joint turnover in Denmark ofmore than 3.8 billion Danish kroner.

Violations of the Competition Act are sanc-tioned by fines. But the Danish CompetitionAuthority is not empowered to impose thefines. Instead, the Competition Authority mustask the police to press charges for violations ofthe Competition Act.

Violations of the Competition Act are not sub-ject to imprisonment or personal penalty forthe physical persons involved.

Regarding competition in the air transport sector, the leading case in Danish Competitionpractice concerns agreements between twoDanish airline companies (SAS and CimberAir). The two companies had negotiated apackage of bilateral agreements on code shar-ing, use of SAS’ frequent flyer programme onCimber Air routes, joint advertising and jointground handling. The parties had also madecommon traffic planning on four routes onwhich they were both operating. The agree-ments were notified to the Danish CompetitionBoard with request for negative clearance orindividual exemption.

The Competition Board granted individualexemption to the agreements on several condi-tions and obligations. The most importantterms were the following: Any airline companyshould have access to buy through tickets onthe domestic routes concerned on open andnon-discriminatory terms, and any airline com-pany should have access to SAS’ frequent flyerprogramme on the routes concerned on openand non-discriminatory terms, if the airlinewas not connected to other international fre-quent flyer programmes. This condition wasmade in accordance with previous decisions bythe Commission.43

On 18 July 2001, the Commission decided to

impose fines on SAS and Maersk Air, in theamounts of e 39 and 13 million, respectively,for having made illegal market sharing agree-ments.44 During a dawn raid, the Commissionfound proof of secret market sharing agree-ments of two types between the parties.

In a general market sharing agreement, thecompanies had agreed upon leaving eachother’s «home markets». This meant that SASwould withdraw from routes out of MaerskAir’s hub in Billund in Jutland, while MaerskAir would keep from starting up new routesout of Copenhagen, unless SAS allowedMaersk Air to do so.

In a more concrete market sharing agreement,the parties divided specific routes among them:Maersk Air would stop flying Copenhagen-Stockholm. In compensation for this, SASwould leave the route Copenhagen-Venice toMaersk Air. Finally, SAS would stop flyingBillund-Frankfurt and leave the route toMaersk Air.

The agreements made SAS almost totally dom-inant on the very important route betweenCopenhagen and Stockholm. Meanwhile, thegeneral part of the agreement strengthened thealready existent hub-and-spoke structure ofSAS, controlling all air traffic out ofCopenhagen, while Maersk Air would be ableto underpin its position in Jutland.

The Commission stated that the agreementsconstituted a most serious infringement ofArticle 81.

3.4.2 Finland

The material rules of the Finnish competitionlaw are to be found in the Act on CompetitionRestrictions (no. 480/92), which came intoforce on 1 September 1992. The last amend-ment of the Act entered into force on 1 March2002. The Act is based on the prohibition principle.

Finland’s Act on Competition Restrictions isnot applied to competition restrictions occur-ring outside Finland, insofar as they are notdirected against a Finnish clientele.

There are no exclusions or special rules regard-ing small and medium sized firms.

Article 4 in the Act prohibits resale price main-tenance. The prohibition covers both maximumand minimum prices, but it does not coverprice recommendations.

Article 5 in the Act on CompetitionRestrictions prohibits tendering cartels. Theprohibition does not cover joint tendering forjoint performances.

In Article 6 paragraph 1 of the Act onCompetition Restrictions, horizontal agree-ments, recommendations and other sucharrangements concerning prices or charges, areprohibited. The prohibition against price coop-eration applies not only to the prices chargedfor goods or services, but also to discounts,delivery charges, and delivery conditions.

Article 6 paragraph 2 of the Act onCompetition Restrictions as a rule forbids hori-zontal agreements between undertakings aimedat limiting production and dividing markets orsources of supply. The prohibition does not,however, cover restrictions that are necessaryfor arrangements that contribute to the efficien-cy of production or distribution, or promotetechnical or economic development, the benefitof which mainly accrues to customers or con-sumers. Naked restrictions of production ordivision of markets or sources of supply, whichrestrict competition and benefit only the under-takings involved, are per se prohibited.

The Act on Competition Restrictions prohibitsabuse of a dominant position by an undertak-ing or association of undertakings. Article 7 ofthe Act lists examples of abusive and henceprohibited practices, which include refrainingfrom a business relationship without a justifiedcause; tying; excessive, predatory, and discrim-inatory pricing practices; and the use of a dom-inant market position to restrict competition inthe production or marketing of other commodi-

ties (e.g. cross-subsidisation).

Article 9 of the Act covers vertical restrictionsexcluding resale price maintenance and abuseof a dominant market position. It also appliesto horizontal restraints not explicitly prohibit-ed. These restraints are treated under the so-called abuse principle, which means thatrestraints are evaluated case by case. Where arestraint is deemed both to have harmfuleffects and to be incompatible with sound andeffective economic competition, action can betaken to eliminate such effects.

In the first stage the Finnish CompetitionAuthority will negotiate with the undertakingsconcerned. In case the harmful effects cannotbe eliminated through negotiations, theAuthority shall refer the case to the MarketCourt, which can prohibit the restraint.

According to Article 8 of the Act onCompetition Restrictions the CompetitionCouncil can impose a penalty payment on abusiness undertaking or an association of business undertakings based on a proposal by the Finnish Competition Authority.

The prohibitions of Articles 4-6 (resale pricemaintenance, tendering cartels, horizontal car-tels) of the Act on Competition Restrictionsmay qualify for an individual exemption fromthe prohibitions. This requires that the restric-tion promotes the production or distribution ofcommodities or technical or economic devel-opment, and that the benefit primarily accruesto the clients or the customers.

Applications for exemptions are made to theFinnish Competition Authority, which in thefirst instance decides whether an exemptioncan be granted. If the Authority does not grantan exemption, the decision can be appealed tothe Market Court.

The Finnish competition legislation largelycorresponds to the EC competition rules.Horizontal cartels, resale price maintenance,and abuse of a dominant market position areprohibited competition restraints.

As far as prohibition against horizontal cartels

33

is concerned, the Finnish Act on CompetitionRestrictions outright prohibits price and othercartel agreements without stating anything onthe consequences of the restraint or themotives of the parties concerned.

Pertaining to the abuse of a dominant marketposition, it differs from Article 82 primarilywith respect to wording of the lists of exam-ples on an abuse. In practice, both provisionslead to the same conclusion. However, unlikeArticle 82, the Finnish Act on CompetitionRestrictions (Article 7) explicitly mentions theuse of exclusive agreements as a means ofabuse and the use of a dominant position torestrict competition in the production or mar-keting of other products.

A significant difference between the Finnishand EC competition rules lies with the treat-ment of vertical restraints. Whereas the EUapplies the prohibition principle, in Finland anabuse principle is applied. An exception to thisis the prohibition against resale price mainte-nance covered by Article 4 of the Finnish Acton Competition Restrictions.

The control of concentrations began in Finlandon 1 October 1998. The provisions on the con-trol of concentrations apply to concentrationswhere the combined turnover of the parties tothe concentration exceeds e 336 375 853 andthe turnover of a minimum of two partiesexceeds e 25 228 189.

In the Act on Finland’s entry into the EuropeanUnion (No. 1540/94), it is stated that the provi-sions of the EC Treaty are effective in Finland.On the basis of this and of the direct applica-bility of certain provisions of the Treaty, theFinnish competition Authorities have been con-sidered empowered to apply the provisions ofthe EC Treaty that are in force as Finnish law.

As of May 2002, the Finnish CompetitionAuthority is examining the possible abuse ofdominant market position by Finnair. The caseinvolves many aspects of the carrier’s businessactivities including the use of FFPs, corporatecustomer agreements, travel agencyagreemeents, and ground handling.

In the year 2000 the Competition Authorityapproved – subject to conditions – the travelagency Fritidsresor’s acquisition of Finnmatkat,which was a part of the Finnair group.

3.4.3 Norway

Act No. 65 of 11 June 1993 relating toCompetition in Commercial Activity (theCompetition Act) contains a combination ofprohibitions and provisions to intervene againstrestraints on competition. The Competition Acthas a defined purpose in Section 1-1, viz. toachieve efficient utilisation of society’sresources by providing the necessary conditions for competition.

The prohibitions in the Act are contained inSections 3-1 to 3-4. According to Section 3-1,it is prohibited for two or more undertakings tocooperate on prices, mark-ups, or discounts.Section 3-2 covers cooperation and influenceon tenders, while Section 3-3 deals with mar-ket sharing and Section 3-4 with commercialregulations and restrictions.

The Norwegian Competition Authority (NCA)may, according to Section 3-9, through individ-ual decisions or regulations, grant exemptionsfrom the prohibitions in Section 3-1 to 3-4 fora limited period of time. Conditions may beimposed for exemption.

A rather powerful set of provisions is includedin Section 3-10, on «Interventions against anti-competitive behaviour». According to thissection, the NCA may intervene by individualdecision or regulation against terms of busi-ness, agreements, and actions, where theAuthority finds that these have the purpose oreffect of restricting competition, or are liable todo so, contrary to the purpose stated in Section1-1 of the Act.

It is, in other words, not necessary for theNCA to prove that an action actually has hadthe effect of restricting competition – it is sufficient to show that it is liable to do so.

Section 3-11 of the Norwegian CompetitionAct deals with merger control. The NCA mayprohibit acquisitions of enterprises if the NCA

34

35

45 For implementation of the EEA agreement in Norwegian Law, see section regarding EU/EEA.

finds that the acquisitions creates or streng-thens a significant lessening of competition,contrary to the goal of efficient resource utilisation set out in Section 1-1.

According to the guidelines of the NCA, thefailing firm argument may be invoked to justi-fy an acquisition. If one of the enterprises is afailing firm, and if bankruptcy does not lead toa preferable situation in terms of competition,the conditions for intervention by the NCA arenot fulfilled. On account of this argument, theNCA did not intervene against the mergerbetween the two largest Norwegian domesticair carriers, SAS and Braathens, which becameeffective in December 2001.

Pursuant to Section 1-7 the prohibitions ofSection 3-1 to 3-4 do not encompass agree-ments between undertakings or concerted prac-tices which come under the rules concerningcategories of agreements under Article 53 (3)of the EEA Agreement or which have beengranted individual exemption under Article 53(3) of the EEA Agreement.

Any of the NCA’s decisions may be appealedto the Ministry of Labour and GovernmentAdministration within three weeks of the dateof the decision.

The sanctioning for infringement of theNorwegian Competition Act differs from theEU/EEA law in the way that persons can beliable to imprisonment, normally for up tothree years, and under aggravating circum-stances for up to six years pursuant to Section6-6. According to Section 6-5, an undertakingthat has achieved a gain from infringing theCompetition Act, may be required wholly orpartly to relinquish it. The NCA may issue awrit giving an option of relinquishment of suchgain. Agreements and clauses that infringe theprohibitions in the Act are invalid between theparties according to Section 5-1. Parties canalso claim damages in national courts pursuant

to general rules relating to damages, as well asapply for an interim measure pursuant to theEnforcement Act.

Norway entered into the European EconomicArea (EEA) Agreement on 2 May 1992, andthe agreement came into force on 1 January1994. The Agreement and its regulations anddirectives have been implemented in Norwaythrough laws and regulations.45

The rules are enforced by the EFTASurveillance Authority and the ECCommission according to Article 56 of theEEA Agreement.

The EEA competition rules are valid alongsidethe Norwegian competition regulation, but incase of conflict the EEA rules prevail, accord-ing to the EEA Act Section 2. According toArticles 53 and 54 of the main agreement, therules become applicable if the trade betweenmember states is affected.

Article 57 of the EEA Agreement concernsmergers that create or strengthen a dominantposition. The control of concentrations shall becarried out by the EC Commission or by theEFTA Surveillance Authority. Council regula-tion (EEC) 4064/89 defines which concentra-tions need to be notified to the ECCommission or to the EFTA SurveillanceAuthority. Whether a concentration is coveredby article 57 and Regulation 4064/89 depends,inter alia, on whether the companies’ turnoverexceeds certain thresholds. If the concentrationmeets these requirements, the NorwegianCompetition Act is inapplicable.

Pursuant to Section 3-10 of the NorwegianCompetition Act, the Norwegian CompetitionAuthority has recently intervened against thefrequent flyer programmes of the SAS Group.Further details are given in Subsection 6.1.6 ofthis report.

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46 The Swedish Competition Authority’s Annual Report 2000.

3.4.4 Sweden

The Swedish Competition Act (1993:20) thatentered into force on 1 July 1993 is basedentirely on the principle of prohibition. Inmaterial terms, the prohibition provisionsclosely resemble the competition rules set outin the EC Treaty. EC case law shall be takeninto account when applying the Swedish Act. Itcontains prohibitions against anti-competitivecooperation, Article 6, and abuse of a dominantposition, Article 19.

Infringements of the Competition Act are sub-ject to powerful sanctions. The Act also con-tains rules governing concentrations betweenundertakings. Violations of the CompetitionAct are, however, not subject to imprisonmentor personal penalty for the physical personsinvolved.

A year before the law took effect, the SwedishCompetition Authority was founded. Enforcingthe new Competition Act is one of its primetasks. A series of amendments have been madeto the Act in order to make the monitoring ofcompetition more effective in increasinglyinternational markets. The CompetitionAuthority has since 1 January 2001 the powersto directly apply provisions of the EC Treatycontained in the Articles 81 and 82, i. e. theprohibitions against anti-competitive coopera-tion and abuse of a dominant position. Thepower to grant negative clearance has, howev-er, been limited to cases that are of special rel-evance to Sweden. In addition, the power togrant an exemption according to Article 81 isrestricted.

Undertakings unsure of whether an agreementor a practice is in conflict with either or bothprohibitions in the Act may apply to theCompetition Authority for negative clearanceor exemption. Granting negative clearancemeans that the Competition Authority regardsthe agreement or practice as not being in con-flict with the Competition Act.

Decisions made by the Authority under theCompetition Act usually apply with immediateeffect, and thus have direct effect on the mar-ket. This applies even though the decision maybe appealed against.46

Anti-competitive cooperation prohibited inaccordance with the Competition Act may begranted exemption, providing the undertakingcan show that the cooperation has favourableeffects outweighing the unfavourable ones.

In the event of an infringement of a prohibi-tion, an undertaking may under penalty of afine be ordered to terminate the infringement.In addition, agreements or clauses in an agree-ment covered by the prohibition against anti-competitive cooperation are void. An undertak-ing may also be liable to pay damages toanother undertaking.

The Act also contains rules governing concen-trations of undertakings. In cases where theundertakings concerned have a combinedaggregate world-wide turnover of more thanSEK 4 billion and at least two of the undertak-ings concerned have a turnover in Sweden ofmore than SEK 100 million each, the acquisi-tion shall be notified to the CompetitionAuthority. The Competition Authority mayintervene against an acquisition where thereare adverse effects in the long run.

According to Article 6 of the Competition Act,cooperation between companies is prohibited,if it has the object of preventing, restricting ordistorting competition in the market to anappreciable extent, or if it leads to such results.Cooperation restricts competition, if it in anyway restricts the possibility for one or moreundertakings to act independently of eachother. Cooperation between small and medium-sized undertakings where the products regulat-ed by the agreement cover a smaller part of therelevant market, normally falls outside thescope of the prohibition.

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47 Consolidated Act No. 769 of 16 August 2000 on Aviation, paragraph 74a.48 Consolidated Act No. 769 of 16 August 2000 on Aviation, paragraph 71.49 Executive Order No. 933 of 9 December 1997 on Ground handling Services in Danish Airports.50 Consolidated Act No. 699 of 17 July 2000 on Marketing, paragraph 6.

The first paragraph of Article 19 in theCompetition Act states that abuse of a domi-nant position by one or more undertakings onthe market is prohibited.

Due to the complaints filed by Malmö AviationAB, formerly known as Braathens Sverige AB,and Svenska Resebyråföreningen (the SwedishTravel Agents’ Association), the SwedishCompetition Authority intervened, in 1999,against the frequent flyer programmes of theSAS carrier group. Further details can be foundin Subsection 6.1.5 of this report.

3.5 Aviation legislation and institutionalconditions

The main regulatory system for civil aviationwas determined by the Chicago convention of1944, where the most important principle wasthat each country should have full sovereigntyover its airspace. As a result of the Chicagoconvention, the ICAO (International CivilAviation Organisation) was formed. ICAOdetermines international standards and recom-mendations for safety in the civil aviation area.In addition, there are bilateral agreementsbetween individual countries, as well as agree-ments within the framework of theInternational Air Transport Association (IATA),the representative international organisation forairline carriers. The EC regulatory frameworkin the aviation area applies to air travelbetween airports within the Community.

3.5.1 Denmark

The Danish Aviation Act states that the provi-sions of the act only apply if the concernedmatter is not covered by EU regulation.47

Denmark being an EU Member, the EU regulations on air transport are all applicable in Denmark.

According to the Aviation Act, the Ministry ofTransport is the permitting authority regardingall air services on Danish territory. This means

that the Ministry of Transport controls alllicences on air transport as well as aviationsecurity matters.

Public airports are empowered to collectcharges for use of the airport facilities. Thecharge level is to be approved by the DanishParliament under rules set by the Minister ofTransport. Only Copenhagen Airports Inc. canfix the charge level without previous approval.Taxes can also be collected on the use ofDanish air territory.48

Danish civil airports have different structuresof ownership:

Copenhagen Airports Inc., which runs KastrupAirport (the largest airport in Denmark) andthe smaller Roskilde Airport, is owned 33.8 percent by the Danish State, while the rest of theshareholders are private investors.

Billund, Aarhus, Aalborg, Karup, andSoenderborg Airports are all owned by sur-rounding local communities in joint ownership.The Danish State owns Roenne Airport.

The Council Regulation on Ground handlingwas implemented in Denmark in 1997.49 OnlyKastrup Airport has more than 2 million pas-sengers a year and is therefore the only Danishairport subject to the obligation of opening upthe market for ground handling services in theairport to third-party suppliers. Apart from theairport itself, there are three independentground handling providers in Kastrup Airport.

The Danish Marketing Act50 contains a generalprohibition on throw-in in consumer sale. Butthere is an exemption in the act especially tofrequent flyer programmes. The exemption wasadded in 1992 to make it possible for Danishairline companies to compete with foreign airlines in the international market. Due to theprovisions of the Marketing Act, it will not bepossible to make an overall prohibition of fre-quent flyer programmes as such in Denmark.

3.5.2 Finland

In Finland, the legislation regarding the field ofaviation has been harmonised with EU legisla-tion. The Finnish market forms part of the EUcommon market, and it is not possible to inter-vene with operations therein other than in indi-vidual cases cited in the community legislation(e.g. the «downward spiral» of prices or publicservice obligations).

The majority of the existing norms on aviationare security-based and correspond in content tothe Joint Aviation Requirements (JAR) of theJoint Aviation Authorities (JAA). Some of theJAR norms have also been included in thecommunity legislation. To the extent that theyhave not been included in the community leg-islation, they have been enforced in Finland asaviation regulations pursuant to the AviationAct.

The main Act governing aviation is theAviation Act (281/1995), which is a so-calledframework act. Its focus is on safety aspects.Under the Aviation Act, the Finnish CivilAviation Authority (FCAA) is the competentauthority, which issues permits to new compa-nies and maintains an aircraft register. Companies having obtained a permit for airtraffic within the EU area are allowed to con-duct air traffic in Finland after having appliedfor a route permit from the FCAA, to whichcompanies have a near automatic right undercommunity legislation. With respect to carriersfrom within the EU region, registration of air-craft cannot be forbidden on market-basedgrounds. Refraining from registration is onlypossible on the basis of safety norms in such asituation.

With respect to third countries, air traffic isgoverned by mutual bilateral agreements,which may contain considerably tighter con-straints for air traffic operations.

Under the Act on the Finnish Civil AviationAuthority (1123/1990), the FCAA, which com-menced operations in 1991, is a state enterpriseoperating under the Ministry of Transport andCommunications. The FCAA finances its oper-

ations entirely through its own revenue, with-out support from the state budget. The StateCouncil sets the FCAA’s service, operational,and result targets. The FCAA is the topmostauthority in the field of aviation in Finland,and its duty is to produce airport and air safetyservices for the needs of civil and military avi-ation and to conduct other business related toits field. The FCAA operates 25 airports inFinland. In addition, there are two municipalairports in operation.

It is also the task of the FCAA to supervisegeneral aviation safety, to give orders andinstructions on aviation, to handle aviationlicences, permits and other matters related toair traffic, air eligibility, and registration of air-craft, and to otherwise promote aviation, itsdevelopment and control. The FCAA also man-ages international agreements related to civilaviation and the international cooperation ofcivil aviation, to the extent that these do notfall within the competence of another authority.

The maintenance of aviation safety duties hasbeen separated from business operations into aunit of its own – aviation safety management –the head of which solves matters concerningthe issuing of orders and instructions, controlof civil aviation, permits, air traffic, air eligi-bility, and registering. In the commentary tothe government bill on the Act on the FinnishCivil Aviation Authority, it is said that theFCAA is not in a competitive situation in itsfield, making it unnecessary to separate theofficial duties from the FCAA.

The operating objectives of the aviation safetymanagement are approved and provided for bythe Ministry of Transport andCommunications. It also determines the feescollected by the aviation safety management,which shall correspond to the costs incurred ofthe goods produced. Security demands and thepromotion of aviation may be considered inpricing, however, which is why the prices ofmany official goods produced often remainlower than the costs incurred. The state enter-prise FCAA prices the services and goods pro-duced on commercial grounds.

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39

51 Its activities are regulated in Instruction for the Civil Aviation Authority of 10 December 1999.52 Regulation No. 1273 of 12 12 October 1999.53 Its activities are stated in Instruction for the Norwegian Air Traffic and Airport Management of 10 December 1999.54 Council Reg. 2408/92 Art. 4.55 Regulation No. 1112 of 16 October 199756 This subsection relies heavily on SCA (1998:63ff).

3.5.3 Norway

The EEA Agreement contains rules regardingthe civil aviation market in Annex XIII, chap-ter VI, see chapter regarding EU/EEA legisla-tion.

Act of 11 June 1993 No. 101, The AviationAct, regulates the Norwegian civil aviationmarket. The Ministry of Transport andCommunication is responsible for the supervi-sion of the Act and has issued supplementaryregulations. Norway signed the Chicago con-vention in 1944. In addition, there are bilateralagreements between Norway and other coun-tries, as well as agreements within the frame-work of IATA.

The Norwegian Air Traffic and AirportManagement (NATAM) is a state enterpriseaccountable to the Ministry of Transport andCommunication. The activities of NATAM aredivided into two parts. NATAM owns andoperates 45 airports all over the country, 11 inassociation with the armed forces. NATAM isalso responsible for air traffic control servicesin Norway.

From 1 January 2000 the aviation authoritywas separated from NATAM’s commercialservices in a new administrative unit, the CivilAviation Authority (CAA).51 The Ministry ofTransport and Communication has delegatedits authority over civil aviation to the CAA,and in particular the power to enforceRegulation No. 691 of 15 July 1994, regardingimplementation and enforcement of the EEA-agreement in the aviation sector.52

The CAA is an independent body under theMinistry.53 Its main objective is increased safe-ty within the aviation market. Decisions madeby the CAA can be appealed to the Ministry.This means that the CAA monitors theAviation Act and its supplementary regulations.

The CAA also controls the quality of materialand issues licences to airlines, pilots, and crew.

A member state may impose a public serviceobligation on routes that are not commerciallyattractive.54 The right to operate such servicescan be offered by public tender. The Ministryof Transport and Communication has issuedRegulation No. 256 of 15 April 1994 regardingpublic tender on certain routes. In the first public tender held in 1997 for the period 1998-2000, the Widerøe airline carrier won all concessions. The tender for concessions from2001 through to 2003 was held in 2000.Whereas Widerøe was able to renew most oftheir concessions, they did lose some westernNorwegian routes to Coast Air.

The power to issue regulations and decisions inorder to enforce Council Regulation 2409/92,regarding tariff fixing, is delegated to theNCA.55 Regulation No. 1050 of 2 November1998 is issued by the NCA and states that airlines operating routes within Norway andbetween Norway and other EEA countries arerequired to report their prices on full-fare tickets to the NCA.

3.5.4 Sweden56

The EC regulatory framework and the nationalSwedish Aviation Act (1957:297) regulate conditions for transit over Swedish territory. In addition, regulations issued by the SwedishCivil Aviation Authority (SCAA) apply to eachcivil airport and airline. These regulations govern the activity and follow in principleinternational standards.

The SCAA plays a central role in the Swedishaviation market. The SCAA is a commercialpublic utility with certain authority functionsand has overall responsibility for airports andaviation in Sweden. The Administration is

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57 www.lfv.se (2002-05-07)

responsible for the operation of around 19state-owned airports, of which five are militaryairports open to civil aviation. The SCAAresponsibility covers different infrastructureservices such as air traffic control, fire andemergency services, as well as security checks.Other services are more commercially focused.In addition, the SCAA carries out the tasks ofan authority in e.g. the air safety area, wherethe Aviation Safety Department has an inde-pendent position.

There are altogether 43 airports in Sweden.57

In addition to state owned airports, there are 24municipal or private airports with facilities forscheduled air transport. The municipal airportsare in essence financed not only by state butalso municipal funds, but in the majority ofcases they are dependent on municipal grantsfor maintaining operations.

Prior to the deregulation of Swedish domesticcivil aviation, SAS and its associated company,Linjeflyg, had a monopoly on the primaryroutes, i. e. those routes that were part of thesecompanies’ domestic route network. Beingbased on established practice, the monopolywas not laid down in law, neither was thereany support for it in the Aviation Act. This Actstipulated that domestic air transport shouldonly be operated by Swedish citizens and legalentities controlled by Swedish citizens – theprohibition on cabotage – and that SAS hadpreferential access to international routes. Inaddition, a permit issued by the government

was required in order to operate scheduledflights. The conditions governing the rightsgranted to SAS and Linjeflyg included a clauseon price regulation, which meant that priceshad to be approved by the Swedish Board ofCivil Aviation.

The deregulation of domestic civil aviation inSweden was initiated at the end of the 1980s,since air transport during this period wasundergoing rapid development. The aim ofderegulation was to create a more «consistent»transport policy, where different modes oftransport would be treated equally. An addi-tional reason for the deregulation was that thenew market situation would strengthen thecompetitiveness of Swedish companies prior tothe forthcoming European deregulation.

In its report «Competition in Domestic avia-tion» (SOU 1990:58), the CompetitionCommission proposed that routes with morethan 300 000 passengers per year – in practicethe 8-10 major routes – be exposed to competi-tion. In April 1992, the Swedish Governmentdecided to deregulate the domestic civil avia-tion market as of 1 July 1992.

Under the new, deregulated regime, anySwedish airline company could obtain alicence to operate a given route, and no compa-ny would have preferential rights. In addition,free pricing was introduced, subject, however,to the obligation to notify the SCAA.

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58 This section is based in part on the paper by Steen and Strandenes (2002), using elements of their text more or less verbatim.

The aviation industry exhibits a number ofinteresting characteristics in terms of network-ing, cost structure, yield management, andmarketing strategies. A competition analysisbearing on the airline industry must take theseaspects into account. In this chapter, therefore,we present and discuss some of the industry’smost important economic characteristics.

Section 4.1 explains the concept of networkeconomics and its relevance to aviation. InSection 4.2, we discuss the economic welfareeffect of price discrimination, a marketingpractice that seems to be more widespread inthe airline industry than in most other businesssectors. Section 4.3 deals with the cost struc-ture of the airline industry. Finally, in Section4.4, we reproduce certain comparative resultsfrom the literature, shedding light on the costand productivity level of the most importantAmerican and European carriers.

4.1 Aviation network economics 58

The aviation industry can be described as asystem of links (routes) that connect nodes(airports). It is, in other words, a networkindustry.

As such, the aviation industry is characterisedby large network externalities, in the sense thatthe costs and revenues involved in carryingpassengers on different, interconnected routesare interdependent. There are, in other words,large economies of scale, scope, and densitypresent. These externalities may originateeither at the supply (production) side or at thedemand (consumption) side.

Economies of scope signify that it costs less toproduce services jointly by one firm ratherthan separately by different firms. Economiesof density exist if an airline’s unit costs, or the

travellers’ generalised costs, decline when theairline adds flights or seats on existing routes.

Other typical characteristics of network indus-tries are switching costs and lock-in effects(Shy 2001). High switching costs result in cus-tomers being locked in. This limits competitionbetween operators by stopping price differen-tials from being competed away.

4.1.1 Economies of scale

Generally speaking, supply side economies ofscale exist when the average production costsdecline with the number of units produced.Economies of scale are also called increasingreturns to scale. The combination of a largefixed cost and small constant marginal costs isa common source of economies of scale on thesupply side.

Using a larger aircraft reduces the cost perpassenger. Pilots and crew costs do not riseproportionally with the number of seats.Landing fees are partly calculated per passen-ger and partly set by the weight of the aircraft.When landing fees are weight based, the costper passenger falls with aircraft size.

The Swedish Civil Aviation Authority(Luftfartsverket 2001) refers to AEA (1998),where it is argued that the estimated economiesof aircraft size are often exaggerated sincecosts are compared for the different aircraft intheir typical routes. Since larger aircraft tendto be used on longer distances, the economiesof stage length may influence the comparison.Specific estimates of scale economies at vehi-cle level may be overstated if the effects of dif-ferences in stage length are not adjusted for.Economies of vehicle size are, however, wellknown in transport industries, including in airline operations.

4. TOPICS IN AVIATION ECONOMICS

Obtaining lower unit costs for large aircraftrequires that the number of passengers per seat– the load factor – not be reduced when intro-ducing larger aircraft. Thus, the increasingreturns to aircraft size cannot be achievedunless demand in the relevant airline market iscorrespondingly higher. The link between unitcost and load factor is illustrated in Figure 4.1,and indicates a wide variation in average loadfactor across airlines.

Longer stage length reduces the costs per pas-senger in two ways. Firstly, landing fees, han-dling cost, and ground manoeuvring cost fallrelative to the passenger kilometres produced.In addition, the capacity of the aircraft is betterutilised since the aircraft is grounded for ashorter time. Turn-around between flights isreduced with longer stage lengths and fewerlandings per period. This is illustrated inFigure 4.2 showing unit costs vs. stage length.

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Figure 4.1: Unit cost and load factor, 1995. Source: Oum and Yu (1998a)

Figure 4.2: Unit cost and stage length, 1995. Source: Oum and Yu (1998a)

So far we have looked at scale economiesrelated to costs characteristics for a singleflight. Caves et al. (1984) try to identifyeconomies of firm size in the airline industry.From data for trunk and local service airlinesin USA, they study whether airlines operatinglarger networks enjoy lower unit costs. Theyfound that any differences in scale had no rolein explaining higher cost for small airlines. Theprimary factor explaining cost differences wasdensity of traffic within an airline’s network.Hence, a large airline will incur similar costsas a medium sized airline when it operates thesmaller airlines’ routes. Both earlier and laterstudies, e.g. Caves (1962), Strazheim (1969),White (1979), and Gillen et al. (1985, 1990),confirm that there are no significant economiesof scale at the firm level.

Ng and Seabright (2001) argue, in a study ofstate ownership impact on costs, for scaleeconomies in airline operations. They estimatethe effect on cost of an increase in networksize. Whereas most studies use increase in out-put and points served when estimatingeconomies of scale, Ng and Seabright (2001)measure size by the number of city routesserved. They reject the hypothesis of constantreturns to scale in their sample of Americanand European airlines. By using network sizethey also, however, capture scope effects.

Thus, the economies of scale in air transportare linked to aircraft size, load factor, and stagelength. Any given route is, however, charac-terised by a certain load factor and a certainstage length. The optimal aircraft size thereforefollows from route characteristics. This impliesthat the unit cost per revenue passenger kilo-metre mirrors the network operated by an air-line. Hence, a large airline operating the net-work of a medium sized airline will incur simi-lar unit costs on that part of its operations tothose faced by the smaller carrier. In otherwords, there are no significant economies ofscale from operating costs at the firm level.Economies of firm size are exhausted at anintermediate level. Even so, economies ofscope may be present.

On the demand side, economies of scale appearwhen the demand for a good increases with the

total number of goods sold. This happens when the utility that a user derives from theconsumption of a good increases with the num-ber of other agents consuming the same good.

Demand side economies of scale can appear intwo types. They can be direct as in a telephonenetwork. A telephone user benefits directlyfrom others being connected to the same network.

In certain industries, indirect economies ofscale may appear on the demand side as aresult of increasing returns to of scale on thesupply side. A greater number of complemen-tary goods can, e.g., be supplied, and at alower price, when a network grows. A case inpoint is the software industry. In aviation, sucheffects are probably of limited importance,although it might be argued, e.g., that the moreeconomical, larger aircraft may also appearmore comfortable and secure to the traveller,and hence induce a certain additional air traveldemand.

4.1.2 Economies of scope

In general, economies of scope on the supplyside are present when the cost of producingtwo products or services by the same firm islower than when they are produced by separatefirms. There are, in other words, cost-savingexternalities between production lines.

Well-known economies of scope in the airlineindustry arise from the combined production ofpassenger transport and air cargo. SAS exploit-ed this opportunity in the early 1970s whencarrying fresh salmon to the USA. Anothertraditional source of scope economies that mayallow airlines to better utilise the fleet, is toengage in both scheduled and charter traffic.Braathens exploited this possibility by operat-ing some aircraft in the charter market duringweekends. In a study of Canadian Airlines,Gillen et al. (1990) found, however, that therewas lack of cost complementarity betweenschedule and charter operations for airlineswhere charter services exceed 7 per cent oftotal output. Thus, this cost effect is alsoexhausted at a low level.

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44

59 See Subsection 4.1.3 on hub-and-spoke networks.

However, the most important economies ofscope in the aviation industry no doubt arisefrom the complementarity of routes within thenetwork. By operating several interconnectedroutes, the airline company is able to utiliseaircraft, crew, reservation systems, marketingdevices, and other overhead cost items in vari-ous production lines (i. e., city pair connec-tions).

This complementarity is important for severalreasons. First, an airline that supplies end-to-end trips consisting of at least two legs butonly operates on one of the leg routes, has tobuy a seat on this route from another airline. Incontrast, an airline that operates on both legscan supply all parts of the same end-to-endflight itself. In general, this difference gives acompetitive advantage to the latter airline. Ifcompetition on the leg routes is imperfect, theselling airline marks up the price of the seatabove marginal costs. This mark-up is a cost tothe buying airline, which means that an airlineoperating on both legs can supply the end-to-end flight at a lower cost than an airline thatoperates on only one of them. The selling air-line is, in other words, able to raise its rival’scost.

Second, efficient operation within a networkrequires a close coordination at airport nodes.Incoming flights must be coordinated with out-going flights and arrive at gates close to thegates of the relevant outgoing flights.

Thus, economies of scope may be particularlyimportant when slot capacity at airports is lim-ited. Airlines operating several flights out ofone airport obtain flexibility to adjust their net-work to changes in the demand pattern. Theymay switch the use of a slot from one route toanother, when demand develops differently intwo market segments. Thus an airline willenjoy flexibility by concentrating severalroutes on a hub59 airport.

Much of this coordination depends on city pairspecific investment at the hub airport. If two

legs forming an end-to-end flight are operatedby independent airlines, unforeseen events onthe first leg may not be accounted for by theairline that operates the second leg. Furthermore, free-rider problems may meanthat all needed investments are not made, andhaving made the necessary city pair specificinvestments, the airlines are exposed to strate-gic behaviour by their rivals. Both problemsmay mean that the transaction costs in the hubairport are higher than if one airline operatesall leg routes.

These sources of economies of scope all origi-nate from the production side. Perhaps evenmore important economies of scope emergefrom the demand side. This occurs when thedemand for a range of goods is larger than ifthe same goods were offered individually. Forexample, it is often assumed that the demandfor an airline’s services increases with thenumber of routes that are covered by its network. A carrier offering a larger network ofservices will be more attractive to the traveller,since she will have more destinations to choosefrom and a larger probability of finding a suit-able connection from her particular origin toany given destination.

Economies of scope on the demand side of theairline industry are due to two factors:

• Consumer preferences • Marketing practices

Consumer preferences

Economies of scope on the demand side due tomore routes served are connected to the con-cept of switching costs, which customers haveto pay when they shift from one supplier toanother. Without switching costs, a customer’schoice of airline on a flight from A to C via Bdoes not depend on whether it is the same oranother airline that operates on the route A-Band the route B-C. When switching has a price,the customers care about the full range ofproducts sold by each supplier.

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60 For a discussion of FFPs and travel agent agreements, see Sections 6.1 and 6.3.61 Whereas tourist class travellers have relatively high price elasticity of air travel, business class travellers are more sensitive to travel time.

Shapiro and Varian (1998) group the typicalswitching costs into: contracts, training andlearning, data conversion, search costs, andloyalty costs.

In the airline industry, switching costs mayappear because many people prefer a trip by asingle airline compared to one involving twoor more airlines. A high quality end-to-endjourney via a connecting airport requires thatthe passengers be able to go through the con-nection without delays, baggage handlingproblems, extra costs, or other unforeseeableevents. However, the risk of such events isoften perceived as higher when two or moreairlines are involved, and the respective air-lines’ liability vis-à-vis the traveller becomesless clear. In addition, some passengers thinkthat travelling by one airline is more comfort-able than using two or more carriers.

Switching costs mean that the airlines realiseeconomies of scale on the demand side byincreasing the number of routes. An increase inthe number of routes means fewer transfersbetween aircraft for the passengers. As manypassengers prefer fewer shifts, more routesmake the airline’s services more attractive tothe passenger, and the airline will face anincreased demand.

Marketing practices

Economies of scope on the demand side areoften intensified by the marketing practices ofthe airlines. Examples of such marketing prac-tices are frequent flyer programmes (FFPs) andtravel agent agreements 60.

Schemes and programmes such as these createsynthetic economies of scope on the demandside because they make it more attractive forpassengers and travel agents to concentratetheir demand at one or a few airlines. Theschemes and programmes increase the loyaltyof the customers toward the airlines through anartificial increase in the switching costs.

4.1.3 Economies of density

In aviation, supply side economies of densityexist if an airline’s unit cost declines when theairline adds flights or seats on existing routes,all other things held constant (Gillen et al.1985). These increasing returns to density aredue primarily to improved utilisation of aircraftcapacity and crew.

Even more important are the demand sideeconomies of density. A higher route frequencywill decrease the average time cost experi-enced by the traveller and hence induce a higher demand for air transport, especiallyfrom business travellers.61 Morrison andWinston (1986) found that a doubling of thefrequency of domestic routes in USA wouldincrease the demand from business travellersby 21 per cent.

This feedback mechanism, implying that thedemand for travel in a network is in a senseself-reinforcing, is sometimes referred to as the Mohring effect (Mohring 1972). As thedemand for travel increases, a higher frequencyof departures can be supported, and a smalleraverage generalised cost is incurred by theindividual user. This in turn induces a stillhigher demand, and so on until equilibrium isreached.

The generalised cost concept implies that it isnot only the out-of-pocket expenditure thatmatters when a consumer chooses betweenmodes of travel. The opportunity cost in theform of waiting and in-vehicle travel time matters at least as much. As a higher frequencyof service reduces the average waiting time,the service becomes more attractive.

The Mohring effect has traditionally beenapplied to means of transport where the time ofdeparture is hard to predict accurately, such asdaily commuting by a public transport system.

In the airline industry, a Mohring effect due tomore frequent service is likely to have some

significance in the business segment, while thedemand for leisure air travel is less likely to bemuch affected by the frequency of service.Most leisure trips are planned days, weeks, ormonths in advance. Whether there are two orthree daily departures on a route is unlikely toinfluence demand. In contrast, business tripsare generally planned or changed on shortnotice.

A Mohring effect due to a higher quality of theservices offered is likely to be a more generalphenomenon. Other things being equal, bothleisure and business travellers are likely tochoose the more comfortable and punctual oftwo alternative airlines. In addition, air travelis likely to gain competitiveness versus othertravel modes if it is seen as more comfortableor punctual.

Of particular importance for the economies ofdensity involved in aviation networks is thehub-and-spoke mode of operation. Rather thanoperating a large number of point-to-point,non-stop routes, the airline company channelsall or most passengers through a «hub» airport,from which all connections extend like thespokes of a wheel. In this way the number ofdifferent non-stop routes needed to serve allpossible pairs of destinations is drasticallyreduced, allowing for quite remarkable costsavings.

Figure 4.3: Point-to-point network

In a point-to-point network with n>2 cities anairline has to operate n(n-1)/2 two-way routesto offer services between each pair of cities inthe network, cf. Figure 4.3. In a hub-and-spoke

network an airline can service n cities withonly n-1 two-way routes, cf. Figure 4.4.

Figure 4.4: Hub-and-spoke network

Hanlon (1999) argues that the most importanteconomies of scope in the aviation industrystem precisely from the carriers’ possibilities toconsolidate traffic by employing a hub-and-spoke network. This consolidation enables air-lines to obtain economies of density fromdirecting passengers via hubs, since they mayuse larger aircraft and/or fly with higher fre-quencies.

The lower number of routes in the hub-and-spoke network means that by transforming itsnetwork from a point-to-point network into ahub-and-spoke network, an airline is able toreduce its costs without lowering the numberof served destinations.

Furthermore, the operation of a hub-and-spokenetwork often allows an airline to offer airservices on routes that, in isolation, do not gen-erate sufficient volume of traffic to justifyservice. Flights out of a hub airport to spokeairports can be loaded with feeder traffic fromother spoke routes into the hub. In addition,feeder routes always collect or generate somevolume of local traffic. Both the local trafficand the feeder traffic mean higher load factorson other flights out of the hub. On some spokeroutes, the load factor will be raised from alevel below to a level above the minimumviable scale load factor. In these cases, thehub-and-spoke network is a decisive factor inmaking the routes profitable.

46

Using a formal model, Hendricks et al. (1995)find the hub-and-spoke network to be optimalfor a monopoly airline, when there are sucheconomies from consolidating passengers. Inthe above discussion of a simple hub-and-spoke network we disregarded this effect ofdensity since we (implicitly) assumed that thevariable costs of carrying one passenger didnot change, i. e. that the airline used the sametype of aircraft irrespective of the networkstructure chosen.

Nero (1999) analyses competitive advantage ina large hub-and-spoke network. He finds thatadding destinations to a hub-and-spoke net-work show decreasing returns to firm or net-work size. This is consistent with our discus-sion of economies of scale. This negativeeffect is dominated, however, by the positiveeffect due to economies of traffic density. Nero(1999) assumes that adding destinations doesnot result in congestion at the hub airport orhigher cost from increased circuitry. The effecton density comes from spillover effectsthroughout the hub-and-spoke network, whichtranslate into higher traffic and lower fares inthe model.

However, there are also disadvantages connect-ed to the hub-and-spoke network structurecompared to the point-to-point network struc-ture. Passengers who must travel via a hub alsoface an increase in trip duration as compared toa direct point-to-point service.

On the average, a hub-and-spoke journey islonger than a point-to-point flight. For exam-ple, a trip from A to C is clearly longer inFigure 4.4 than in Figure 4.3. This is especiallytrue when the hub-and-spoke network is geo-graphically very dispersed. Longer flightsincrease the airlines’ operating costs and thepassenger’s total travel time.

Thus, the economies of density involved inhubbing must be traded against the disadvan-tage of increased trip duration and against theinconvenience of passengers having to transferbetween flights. Typically, business travellersare highly time sensitive. They will thereforehave a strong preference for point-to-point

services, even if this may mean considerablyhigher fares.

4.1.4 Aviation networks and competition

The increasing returns to scale, scope and density in the airline industry have severalanti-competitive implications.

First, economies of scale on the supply sidesets a natural limit to the number of competi-tors that can operate without economic loss ona given route. The combination of a large fixedcost and small variable cost gives rise to a min-imum viable scale, which has to be exceeded inorder for the firm to earn a profit in the market.If this minimum viable scale is greater thanhalf the total industry demand, the industrymay be regarded as a natural monopoly wherecompetition is unsustainable. Aircraft can easi-ly be transferred between routes, but each air-craft operating on a given route invokes a fixedcost.

Second, economies of scope on the demandside may reduce the competition in the airlineindustry, as they give the airlines an incentiveto merge or join alliances with other airlines soas to increase the number of routes offered andthe flight frequency on every route. Entry isoften not possible on the scale of one or a fewproducts. To be competitive, and exploit theeconomies of scope, each firm in the industryoften has to produce a full range of products.

Third, the hub-and-spoke system of operation,while economically efficient to the individualcarrier firm, seems to give rise to strong anti-competitive effects. The economies of scopeand density characteristic of these networks aresuch as to grant the (one and only) hub airlinevery considerable market power at and aroundits hub. Hence, different airlines have an incen-tive to operate hubs at different airports, asindeed they do. The hub-and-spoke system asoperated among a set of large individual carriersis therefore liable to practically divide the mar-ket between the airlines. Although the networksof different carriers overlap, very few origin-destination pairs, if any, will exhibit more thantwo carriers operating non-stop flights.

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Thus, even though the European airline indus-try has been liberalised for some time, almost75 percent of all non-stop routes within theEEA-area were monopolised (served by a single airline) in 2000, cf. Table 4.1. In mostcases the monopolist competes against otherairlines on other routes, and on many of themonopoly routes there is no serious threat ofeffective competition. Many monopolies are

due to low demand and economies of scale onthe supply side. This last claim is supported bythe fact that only about 40 percent of the available seats in 2000 were offered on the 73 percent monopolised routes, cf. Table 4.1.Other monopolies are due to legal restrictionsto entry. For example, on some routes a licenseis required to operate, and only one license isgranted.

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The competitive advantage of hub-and-spokenetworks is effectively reinforced through theloyalty programmes operated by the carriers. A frequent flyer programme becomes moreattractive to the traveller the larger is the carri-er’s network of destinations, and vice versa.

In total, the competitive advantages allow thehub airline to dominate most routes out of thehub airport. This is confirmed empirically bythe fact that in eight of the top 10 Europeanairports, the hub airline in 2000 accounted formore than 50 per cent of the traffic to and fromthe airport (European Commission 2001).

Today, most major airlines concentrate a largeshare of their traffic at one, two, or three so-called hub airports. For example, in the US,Northwest Airlines operates hubs at Detroit,Minneapolis, and Memphis. ContinentalAirlines operates hubs in Newark, Cleveland,and Houston. In the EU, KLM operates a hubin Amsterdam, SAS operates hubs inCopenhagen, Oslo, and Stockholm, whileLufthansa operates hubs in Frankfurt andMunich, and Finnair in Helsinki, cf. Table 4.2.

Furthermore, in the nineties, most major airlineshave joined alliances with other airlines thatoperate in complementary regions or continents.Today a few global alliances cover more thanfifty percent of the world passenger market.

Several studies have confirmed the role of net-work economics for the development of theairline industry in the years after the liberalisa-tion. A study from 1999 concluded that therewas no sign of cost advantages to large-scaleairlines before the deregulation. However, bybuilding hub-and-spoke networks the large air-lines had managed to gain competitiveness byexploiting technical economies of scope (ordensity).

However, studies have also shown that the costadvantages related to network economics arenot always reflected in lower airfares. In manycases dominance of a hub-and-spoke networkgives rise to market power. There is at leastsome empirical evidence that this marketpower is exploited by the airlines to increasethe fares especially on outgoing flights fromairports that are highly dominated by the hubairline, cf. Lijesen et al. (2000).

Number of carriers

on route

Number

of routes

Per cent

of routes

Number

of seats

Per cent

of seats

1 (Monopoly) 3 445 73.2 3 650 165 41.7

2 (Duopoly) 1 056 22.4 3 960 942 45.2

3 177 3.8 1 001 285 11.4

4 20 0.4 113 265 1.3

5 8 0.2 31 870 0.4

Total 4 706 100.0 8 757 527 100.0

Source: European Commission (2001).

Table 4.1: Competition on intra-EEA, non-stop routes, July 2000

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Table 4.2: Selected airlines’ hub domination in 1999 and 2000

Airline City Hub

airport

Airline’s

percentage of hub

departures in 1999

Airline’s

percentage of hub

departures in 2000

SAS Copenhagen Kastrup 53 55

Stockholm Arlanda 46 50

Oslo Gardermoen 43 44

Finnair Helsinki H.-Vantaa 64* 63

British Airways London Heathrow 37 38

Gatwick 64 65

Lufthansa Frankfurt Rhein-Main 62 59

Munich Franz

Joseph

Strauss

50 53

KLM Amsterdam Schiphol 44 41

Iberia Madrid Barajas 55 55

Air France Paris C. de Gaulle 57 55

Orly 47 55

Alitalia Rome Fiumicino 53 50

Sources: www.cph.dk, SAS (1999), SAS (2000), and European Commission (2001).

* Data covering the last 3 months of 1999 and the first 3 months of 2000.

It must be predicted that hub airlines have mar-ket power on almost all spokes out of the hubairport. Empirically, this thesis is partly con-firmed by Lijesen et al. (2000). According totheir study, among European airlines there isevidence of a significant and positive hubdominance premium for Swissair, Air France,and Lufthansa, but not for KLM, BritishAirways, Alitalia, Sabena, or Olympus.

Obviously, in a hub-and-spoke network, exter-nalities abound on the cost side as well as onthe revenue side. The incremental cost of oper-ating an extra route in a hub-and-spoke net-work is often smaller than suggested by theaverage unit cost of the network. Moreover, anextra route may generate feeder traffic – andhence revenue – to the larger network. It will,in other words, be relatively inexpensive for anincumbent hub airline to cross-subsidise62 a sin-gle spoke route or a limited set of such routes.

Essentially, this leaves a dominant hub airlinewith ample opportunity to fight a rival newentrant through increased capacity, dispropor-

tionately reduced fares, and/or other predatorystrategies. Unless met by timely and resoluteinterventions on the part of the competitionauthorities, such strategies could make themarket almost incontestable.

4.2 Price discrimination and economicwelfare 63

Price discrimination is observed in manyindustries. It implies that firms are chargingdifferent prices from different customers, andthat the price difference cannot be explainedby cost differences. It is well known that theairline industry has been practicing price dis-crimination for many years.

One type of price discrimination used is ver-sioning (see Subsection 4.2.1). One can buy anexpensive, flexible ticket, which can bechanged or even cancelled without costs. Orone can buy a cheaper ticket, with more or lesssevere restrictions: Saturday night stay-over,advance-purchase, etc. These different versionsare, in principle, all available to each and everypassenger.

62 Fjell et al. (2000) provide a discussion of the cross-subsidisation problem in relation to competition. 63 This section draws heavily on the paper by Steen and Sørgard (2002), using parts of their text almost verbatim.

Another type of price discrimination is repre-sented by the corporate discount schemes(Subsection 4.2.2). Large customers use theirbuying power to obtain special fare contractswith an airline, whereby a certain discount isgiven on every ticket bought.

It might be argued that frequent flyer programmes constitute a third type of price discrimination practiced in aviation, althoughsuch an interpretation is not obviously appro-priate (Subsection 4.2.3). The bonus pointsearned by frequent flyers can later beexchanged for extra flights, hotel visits, car rental, etc.

Does airline price discrimination increase ordecrease the welfare of passengers and of soci-ety? To shed light on this question, we shallreview all of the above three forms, regardingthem in a theoretical economic perspective.

In the literature, it is common to distinguishbetween three different degrees of price dis-crimination. Varian (1989) uses the followingdefinitions:

• First degree: The seller charges a differentprice for each unit, so that the price of eachunit equals maximum willingness to pay.

• Second degree: Each consumer faces thesame price schedule, but the scheduleinvolves different prices for different amountsof the good purchased.

• Third degree: Different consumers arecharged different prices, but each consumerpays a constant price for each unit of thegood bought.

How do the three forms of price discriminationwe described – versioning, corporate discounts,and frequent flyer programmes – fit into thesedefinitions?

4.2.1 Versioning

Versioning implies that all consumers are fac-ing the same price schedule. They can chooseto buy an expensive, high quality version or acheap, low quality version. Technically, this is

an example of second degree price discrimina-tion. The consumers pay different prices fordifferent amounts of quality of the good pur-chased.

Versioning usually implies that one version ofthe product is deliberately made less attractive.The consumer with a low willingness to pay isoffered this inferior version, while a full quali-ty version remains available to those with ahigh willingness to pay.

The inferior version must be sufficiently unat-tractive to the customers with a high willing-ness to pay, that they choose to adhere to – i.e., pay for – the superior quality version. Otherwise the seller will only be able to chargethe same low price from (almost) every cus-tomer. Typically, the airline carrier would offerthe leisure traveller a «damaged» – i. e., inflex-ible – ticket, in order to make the inexpensiveversion unattractive to the less price elastic business traveller segment.

At first sight this may seem clearly detrimentalto welfare. Such is, however, not necessarilythe case. It depends on what the alternative toversioning might be. According to Varian(1996), the key question is whether versioningleads to an increase in total output. If version-ing implies that some groups are served thatwould otherwise not have been served, ver-sioning may lead to higher welfare.

In the airline industry, an increase in total out-put is typically related to frequency. Higherdemand means that the airline can find it prof-itable to offer more flights and thereby toincrease the frequency. If so, versioning has apositive externality. In the business segment, inparticular, higher frequency is valuable, since atypical business passenger would benefit froma large choice of departure times.

Given that the airline needs a certain revenuein order to cover its fixed costs, a discriminat-ing price structure may in fact be the mostappropriate one from a societal and economicperspective. The welfare loss due to pricesabove marginal costs is at a minimum if theprice-cost margins are high in segments withprice inelastic demand and low in segments

50

51

64 See Section 6.2 for a more detailed discussion of corporate discount schemes in general. In this subsection, only the price discrimination aspect is dealt with.

with price elastic demand. This is exactly whatwe observe in an airline industry environmentwith versioning and competition.

Steen and Sørgard (2002) suggest three condi-tions that may contribute to welfare improvingversioning: (i) the fraction of consumers withhigh willingness to pay is large, (ii) their valu-ation of extra quality is high, and (iii) the othergroup’s valuation of quality degradation is lim-ited.

It may be argued that all of these conditionsare commonly present in the air travel market.A large part of the market is made up by busi-ness travellers, whose willingness to pay forquality is high. The product damaging is harm-ful for those who do not buy the inexpensiveticket, but probably not very harmful to thosewho do buy it. A leisure traveller might travelduring the weekend, and then a Saturday nightstay-over is not harmful at all.

Moreover, the alternative to versioning mightbe that no low quality version would beoffered. Without the ability to price discrimi-nate, many routes would become unprofitableto the airline and hence not be served at all.Other routes would have a much less frequentservice, the capacity being determined by thevolume of business travel demand. In such acase, the segment with low willingness to paywould have been hurt by a shift from version-ing to no versioning.

Finally, empirical studies indicate that competi-tion leads to a cheaper «damaged» product.Since this segment is typically quite price elas-tic, it would lead to a substantial outputincrease and thereby a substantial welfareincrease at the end of the day.

In conclusion, Steen and Sørgard (2002) there-fore suggest that versioning, as practiced in theairline industry, is ultimately welfare improving.This is so in a monopoly situation, and probablyeven more so in a competitive setting.

One aspect, however, that should not be over-looked is the fact that versioning reduces pricetransparency. The more versions are offered inthe market, at different prices, the harder itbecomes for a consumer to compare prices andquality between suppliers. An incumbent sup-plier may exploit this to reduce a new entrant’spotential for attracting customers through pricerivalry, thus easing the competitive pressure.

4.2.2 Corporate discount schemes 64

These kinds of agreements are examples ofthird degree price discrimination.

Usually, price competition will be more intensein some market segments than others. Largeprivate and public customers – say, segment A– may be able exploit buying power by trigger-ing competition between the producers for anexclusive contract involving large discounts.By allowing for such price discrimination, onemay actually trigger intense price rivalry in theaffected segment.

In spite of this, such price discrimination maybe detrimental to welfare, for the followingreasons. Among other customers – say, seg-ment B – there may be no buying power pres-ent and hence no discounts available. The pricesetting in this segment is no longer constrainedby the competition for large corporate con-sumers. The company may increase the pricein segment B, without losing business in seg-ment A.

The net welfare effect of the price discrimina-tion scheme will depend on the respectiveprice elasticities of demand in the two seg-ments. Steen and Sørgard (2002) show that ifsegment A is comparatively inelastic, even alimited price increase in segment B may leadto a loss of output and welfare that outweighsthe welfare gain in the segment with intenseprice rivalry.

Unlike versioning, corporate discount schemes

52

65 For a monopoly, it may still be optimal to discriminate according to price elasticity. 66 Case AKZO v. Commission [1991] ECR I-3359.

usually discriminate between customers not onthe basis of price elasticity, but on the basis ofbuying power. At least this tends to be so undercompetition 64. Thus there is no guarantee thatthe more price elastic segment receives thelower price – in fact the opposite may seemmore likely. This increases the risk that thewelfare gain in the large customer segment (A)will be more than outweighed by the lossaffecting all other clients (B).

So far we have assumed the same degree ofcompetition both before and after the introduc-tion of third degree price discrimination. Note,however, that such discrimination may jeopar-dise profits among the firms involved in pricerivalry. If so, competition may no longer beviable. Then the alternatives to consider are (i)competition without price discrimination and(ii) monopoly. In most cases, welfare will behigher under effective competition than undermonopoly, implying that society as a whole isbetter off with no third degree price discrimi-nation in a competitive environment.

In summary, corporate discount schemes haveambiguous effects on welfare. Discounts maytend to be large in segments with quite inelas-tic demand. This is not an optimal way for theairlines to cover their fixed costs. Moreover,selective discounts may lead to intense pricerivalry between suppliers. Large customer dis-counts may therefore lead to exits from themarket, because not all the airlines are able tocover their fixed costs. In a similar manner,potential entrants might be deterred, knowingthat the incumbent airline is able to meet anychallenger by offering selective discounts tolarge, attractive clients. Since these discountsare secret and therefore difficult to detect forcompetition authorities, such price discrimina-tion may make predation a more crediblethreat. This suggests that corporate discountschemes are anti-competitive, especially in asetting with a dominant, incumbent carrier andsmaller potential entrants.

4.2.3 Frequent flyer programmes

Although such an interpretation is not obvious-ly appropriate, a frequent flyer programme(FFP) may be regarded as an example of sec-ond degree price discrimination. The con-sumers are rewarded for large purchases, andthey receive a special kind of quantity dis-count.

Note, however, that the discount is given, notin the form of a reduced price, but in the formof added quantity. Also, note that the extragood provided «for free» is not necessarily ofthe same type or quality as the good purchased.To most customers, bonus trips are generallyavailable only on certain flights. Moreover,although the customer may have earned herfrequent flyer points buying fully flexible tick-ets, the bonus tickets are generally inflexiblefrom the time they are issued. A bonus trip is,in other words, no ordinary rebate.

The price discrimination aspect of FFPs istherefore, in our view, not the most important.They are more appropriately analysed withinthe framework of loyalty or fidelity inducingmarketing strategies. For such a discussion, werefer the reader to Section 6.1 ahead.

4.3 The cost structure of the airlineindustry

From a competition viewpoint, an interestingsubject of investigation would appear to be thevariable costs in a given market, as their size inrelation to the price of a service or productmay indicate the presence of abuse of a domi-nant position as regards pricing under Article82 of the EC Treaty.65

Obtaining reliable estimates of air carrier costsis, however, a very difficult task, not leastbecause carriers generally tend to be reluctantto release such information

A number of cost items are often hard to applyin estimates and analyses. In order to compare

53

67 To mention one example, an airline operating in a network with longer stage lengths will on the average face lower unit cost per seat kilometrethan one with shorter average distances, since it will make fewer landings per period. The Nordic airlines have shorter average stage lengthsthan US airlines. Braathens flies shorter stage lengths than SAS and Finnair.

68 SCAA (2001:84ff).69 Ljung (1995).70 Ljung (1995:61).71 SCAA (2001:84ff).

costs with each other and between differentcountries, an appropriate rule of measure isneeded. One such measure might be cost perseat and kilometre.

This measure does have its limitations, howev-er, since the costs per seat kilometre across air-lines will depend on the structure of the air-line’s network67.

Data concerning the costs of aviation in theNordic countries are hard to come by, and forthis reason the present section offers compar-isons with the situation in the US, where com-parable cost data are more readily available.

Costs may, in principle, be divided betweendirect and indirect costs, or between fixed andvariable costs. Operating costs are usuallydivided into direct and indirect. In theory, the

difference between the two terms is relativelyclear, but in practice a number of problemsarise. In the case of carriers operating regularair services, direct operating costs generallyamount to just over one half of the total operat-ing costs.68

4.3.1 Direct versus indirect costs

The division of costs into direct and indirect isbased on the way financial accounting dealswith costs.69 This makes it possible to see howcosts are distributed step by step. First, costsare divided into different cost categories. Thus,costs that can be directly charged to a cost unitare considered direct costs. Indirect costs arethose that cannot be immediately debited to acost unit. These must first be collected togetherat cost centres before being distributed to costunits:

Cost category Indirect Cost centre Indirect cost distribution Cost unit

Direct

Costs, then, can be distributed or debited to a:

• Cost category: Costs of approximately thesame kind can be debited to the same catego-ry. One example is costs for raw materials.

• Cost centre: The company department inwhich the cost arose. For example, an organi-sational unit with cost responsibility.

• Cost unit: That which is produced. The prod-uct that is to bear the cost. Examples includea product or an order.

Direct costs are costs where the connectionsbetween products/services and costs are rela-tively clear-cut. It may for instance be a simple

matter to estimate the cost of the raw materialsfor a specific product.70 So direct costs are thosethat can be attributed directly to a cost unit.Direct operating costs should include all thecosts associated with and contingent upon thetype of aircraft used, which means that costschange when the model changes. Pilots’ wagesand fuel costs, as well as the aircraft’s mainte-nance and capital costs, are to be counted asdirect operating costs. Often, infrastructurecharges, which are generally based on maxi-mum weight at takeoff, are also included.71

Indirect costs are also referred to as overheadsand comprise other kinds of costs that are notdirect. These can be debited to cost centres. Indistributing them, a standard model is often

54

72 Ljung (1995:61).73 Olsson and Skärvad (1997:109).74 SCAA (2001:84ff).75 It is possible, however, to avoid costs for items like infrastructure charges, fuel and wear by cancelling flights.

used.72 Indirect operating costs are all coststhat are not contingent upon the type of aircraftused. This means that such costs are passengerrelated rather than aircraft related. These costscover items like passenger service in the airand on the ground, sales and distribution, andadministration. Costs for cabin crew are gener-ally counted as indirect costs (part of the costsfor passenger services), despite the fact that thenumber of cabin crew used depends on howlarge the aircraft is and on its seating capacity.

4.3.2 Fixed versus variable costs

Fixed costs are costs that are unaffected bychanges in volume. These costs are alwaysconstant even when production varies. Oneexample of a fixed cost is rent of premises.

Variable costs are costs that increase ordecrease with fluctuations in production.Wages are normally considered a variablecost.73 This is based, however, on a situationinvolving piece wages only and on the assump-tion of transferable labour between differentmanufacturing processes. Such conditions donot always pertain, however, and for this rea-son it is often more appropriate, when takingshort-term decisions, to treat all wages (bothblue and white collar) as fixed. In the longerterm, though, total wage costs change in rela-tion to volume of activity as a result of recruit-ment, retirement, and dismissals. If labour istransferable between different products, wagescan be treated as variable costs even in short-term product costing. In the aviation market,infrastructure, wear, and the bulk of the fuelare often placed in the variable cost bracket.

When analysing changes in fixed and variablecosts at different points in time, it is oftenadvisable to start by asking: When would acost disappear should production cease imme-diately?

In the extremely short term, all costs are fixed,while all costs may be regarded as variable in

the very long term. For the purpose of pricing,for instance, a cost structure is required thatexpresses the time horizon at which differentcost categories may be considered fixed orvariable.74 To describe dependence on a timehorizon satisfactorily, at least three differenttime spans are required:

• Medium-long term: Once the schedule is inplace, the costs of operating air services arerelatively fixed. This means that capital costsfor aircraft, pilots’ wages, technical staff andother skilled labour cannot be influenced.75

• Short term: Once the carrier decides toembark on the flight, all costs under theMedium-long term heading become fixed asdo the costs for infrastructure charges (exceptpassenger service charges), wear and the bulkof the fuel.

• Very short term: The costs for ticketing, food,travel agency commissions, and extra fuelconsumption due to the advent of an extrapassenger become fixed once the carrier hasdecided to accept a ticket reservation.

Wage, capital, and fuel costs, which are centralcost items, are decided to a great extent in markets where it may reasonably be assumedthat a single carrier has little influence overprices. Experience shows, however, that majorcarriers are able to influence all the abovecosts through negotiation. It is very difficult,though, for observers outside the carrier community to assess the extent of these potential negotiating gains.

4.3.3 Factors affecting airline costs

In the US, air carriers have a wide-rangingobligation to report to the Department ofTransportation (DoT). Confidentiality does notapply, and it is actually possible to obtain dataper type of aircraft and carrier even when thecarrier only has one aircraft.

55

76 www.avmarkinc.com

These data provide valuable insights into thecost structure of airline operations. Whenapplied to the Nordic countries, it must, however, be born in mind that American andNordic conditions differ considerably betweenthem, primarily because the American domes-tic market is vastly superior in size, andbecause the stage length is generally larger inthe US. Also, for such comparisons to be reliable, adjustments should be made for differences in network structure, density, air-space charges, fuel prices, maintenance costs,insurance costs etc.

Yet, in 1999 the US statistical instituteAvmark76 produced a comparative study ofAmerican domestic aviation and the data thatSAS had reported to the Association ofEuropean Airlines (AEA). These data concerned the entire SAS operation and gave a good idea of the differences in size. Avmarkconcluded that there were no significant differ-ences in the costs for flight staff, nor in capitalcosts.

Types of aircraft

When studying costs for passenger services, itis important to note differences in costs due tothe type of aircraft used on the service orroutes in question. Even if many of the air-craft’s technical properties directly influenceoperating costs, size and speed are the mostcrucial factors for productivity.

In general, larger aircraft could be said to gen-erate lower operating costs per unit produced,i. e. per seat kilometre. In costs terms, there-fore, it should be more advantageous to meethigher demand with larger aircraft and noalteration in flight frequency, than withincreased flight frequency and the same size ofaircraft.

Bearing in mind the relatively low density of

population in the Nordic countries, it is reason-able to expect that relatively small aircraft willbe needed if acceptable levels in terms ofdeparture rate and cabin factor are to beachieved. The demographic factor can there-fore be expected to give rise to higher costs perpassenger in the Nordic countries than in coun-tries with a higher population density.

In Sweden, for example, besides the Boeing737–600 jet, SAS has now introduced theBoeing 737–700 and Boeing 737–800 as wellas the de Havilland Dash 8-Q400 propeller air-craft. Malmö Aviation has purchased a largermodel of the four engine Avro RJ85 (formerlythe BAe 146), the RJ100. In the case of thisspecific model, maintenance costs are substan-tially affected by letting four engines do whatcould easily be done by two, or, purely interms of traction, by a single engine. Fuel con-sumption, too, increases with a four-engine air-craft. City Airlines uses by far the smallest jetin regular passenger service, the 37-seatEmbraer 135. Skyways has the somewhat larg-er EMB 145 model with 48 seats but no longeruses it for domestic flights. Nordkalottflygoperates a northern service with a 7-seater pis-ton engine aircraft, the Piper Chieftain.

Speed is an important factor for inclusion incost estimates, as a fast jet plane can fly thesame route more frequently than a slow pro-peller plane. Apart from the Saab 2000 and thede Havilland Dash 8-Q400, propeller planestend to be slower than jet planes. If you can flytwice as fast between A and B on one and thesame day with a jet plane than with a propellerplane, you can in theory fly twice as many pas-sengers and thereby use all your resources tobetter advantage. Staff costs per seat kilometreand day, for instance, will be lower as they canbe spread over a larger number of seatsoffered. It should be noted, however, that agreater number of passengers also meansincreased passenger and security costs.

56

77 Dahlin and Sjögren (1997).

Production volume, occupancy, and average speed

Production measures commonly used for pas-senger traffic are revenue passenger kilome-tres/miles (RPK/RPM), aircraft kilometres/miles, and airborne time. Usually, aircraft timeis either the time it takes from the point atwhich the plane leaves the terminal building atone airport to the point at which it parks at theterminal building of another – block time, orsimply the time between takeoff and landing –airborne time. (The terminology is not thesame everywhere.) Block time in Swedishdomestic aviation can be roughly estimated atapproximately 1.2 times airborne time, at leastfor flights to and from Arlanda. In the US, dis-tances are greater but so too is airport conges-tion.

The level of utilisation in terms of block hoursper day is slightly higher in the US than inScandinavia. The SAS annual report for 2000specifies around 7.5 hours on average for theDC 9, MD 80, MD 90 and Boeing 737. TheBoeing 767 used for long-distance flightsexceeds 14 hours on average. In terms of blockhours per aircraft and day, these levels maywell be below the equivalent US levels but stillbe close to the ideal from the SAS’ viewpoint.

4.3.4 Costs and charges

Fuel costs

Aircraft fuel is almost invariably what isreferred to in Scandinavia as Jet A, jet propul-sion fuel. In 1999, the average US airline pricewas 53 cents/USG (US Gallon), a sharp dropfrom the 1997 level of 64 cents. For the year2000 as a whole, the average price was 81,while the December quotation was 92. By May2001, however, the price had dipped to 79. Inview of this situation, it is advisable when per-forming cost estimates not to tie oneself downto a specific price level. In the Nordic coun-tries, there are differences concerning the bur-den of VAT, energy tax, other taxes, and envi-

ronmental charges on aircraft fuel. In addition,it is important, incidentally, to remember thatfuel prices vary significantly from airport toairport. In Sweden, e. g., the list price mayincrease by almost SEK 1 per litre fromArlanda to Kiruna.

Fuel costs typically amount to 10-15 per centof total costs (9 per cent for SAS in 2000, seeTable 4.3). Because fuel prices may be lowerin other countries, it might be profitable to buyfuel on an international flight and then do thenext domestic flight on the cheaper fuel. It isimportant, though, to bear in mind that extrafuel means extra weight, which in the endmeans that the aircraft uses more fuel on theflight than would have been the case withoutthe extra fuel. In addition, in many cases pilotsdo not order more fuel than they will use ontheir remaining trips. Otherwise the next pilotwill have more weight than calculated.

* Interval between airlines with the lowest, respectively highest percentage.

As SAS purchases its fuel for its entire opera-tion and not for its domestic flights alone, it isable to procure substantial discounts on listprices. The 1997 Aircraft Fuel Committee77

guessed that on a list price at Arlanda of SEK2.41 per litre, SAS had in practice paid littlemore than 65 per cent or SEK 1.50, and theregional airlines around 85 per cent or approxSEK 2.10.

For carriers it is also important to support thecompanies on the spoke airports that providethem with fuel. Otherwise they could be out ofbusiness and therefore be forced to close.

Table 4.3: Airline cost distribution

Costs Normal range* SAS (2000)

Labour costs 25–35% 32%

Capital costs 6–20% 8%

Fuel costs 10–15% 9%

Aviation charges 8%

Source: SCAA (2001)

57

78 www.avmarkinc.com79 www.svensktflyg.se80 SCAA (2001:88).

Repair and maintenance costs

By tradition rather than for any rational reason,safety philosophy in the aviation field is basedon a guild system – aircraft mechanics – andon monopolised spare part manufacturing. Thismeans that competition for maintenance workis meagre, while at the same time spare partprices are assuming truly absurd proportions.There is reason to suspect that this set-updrives up costs to a greater extent in smallermaintenance markets, like those of the Nordiccountries, than in a large market like theAmerican one.

According to an assessment of AEA byAvmark78, maintenance costs for SAS areabout 25 per cent higher than for US domestictraffic. The difference could be greater when itcomes to Scandinavian domestic traffic, andstill greater for the regional carriers, where theproduction volume per aircraft model is low.Because of the relatively low production vol-ume the demand for maintenance is fairly low,which means that it would be difficult for newentrants to challenge already existing mainte-nance shops in Scandinavia. Moreover, it isexpensive for airlines to fly the plane to foreign maintenance shops that might be competitive.

Insurance costs

Following the events of autumn 2001, previousdata concerning insurance premiums are nolonger applicable. At present, it is difficult toassess how insurance costs will develop in thelong term. The Swedish trade associationSvenskt Flyg79 predicts that the long-terminsurance cost level will be approximately US$ 2 per passenger, more or less irrespectiveof the length of the flight. Thus, on account ofthe differences in stage length, it will influencecosts per seat kilometre more for the Nordicthan for several European and most US carriers.

Capital costs

Apart from the costs for infrastructure finan-cing, carriers are able to finance their aircraft indifferent ways. They can either buy the planesvia credit financing, which means acceptingcosts for interest on borrowed capital, or theycan lease or hire their planes from a leasingcompany, which means accepting leasing orhire costs. For new planes, capital costs will behigher than for second hand aircraft. Capitalcosts typically amount to 6-20 per cent of totalcosts (8 per cent for SAS in 2000)80. Sinceleasing of aircraft is an international business,the costs do not depend on the nationality ofthe airline. Similarly, airlines may borrowmoney in international capital markets if theychoose debt financing. Differences in capitalcosts should thus relate to equity capital.

Even if an older plane is less costly to buy, an overall assessment may show that the accumulated cost of operating an old planemay be no lower than for a new one, as olderplanes with less modern engines tend to consume more fuel than newer planes. Also, as older engines may emit more exhaust, emission charges may be higher for olderplanes. Furthermore, insurance premiums maybe higher for older planes than for new ones.

Crew costs

Crew costs comprise wages and social contributions for pilots and cabin crew, andovernight accommodation costs. In addition,costs include living-out allowances, insurancepolicies, and pension benefits. Both wages andsocial costs may vary from country to countrydepending on the terms of wage agreements.Also, wages are affected by market develop-ments, i. e. if there is a labour surplus ordeficit.

According to Avmark, cabin crew costs may beestimated at US$ 20-50 per block hour depend-ing on the size of plane and the age of staff.

58

81 SCAA (2001:88).82 SCAA (2001:89).

Wage levels are very different from those ofpilots, and the costs for cabin crew compriseonly about one per cent of total costs.

Labour costs as a whole typically comprise 25-35 per cent of total costs (32 per cent forSAS in 2000).81

Airport and airspace charges

Carriers pay charges for the use of airspaceand airport infrastructure. These costs are usually debited per landing, aircraft tonnage,kilometre, or passenger. It is therefore notstraightforward to translate them into rates perseat and kilometre. Another complication isthat airspace charges incorporate a significantelement of capacity cost and must cover long-term investment needs.

Aviation charges

In this section, we describe various types ofaviation charges. There could be tariff varia-tions between different airports in the Nordiccountries. A description of the differences incharges between the Nordic countries can befound in Chapter 5. Aviation charges amountedto just over 8 per cent of total SAS costs in2000.82

Air carriers operating domestic services insome Nordic countries pay passenger servicecharges and security charges to the airports.Many municipal airports, however, do not levypassenger service charges. Also, at airports thatare not state-owned, security is taken care ofby police and therefore does not command acharge.

In 1999 the gap between highest and lowestpassenger service charges and landing fees inSweden was substantial. In the tariff for 2001the variations are considerably smaller. Thisspread in charges constitutes a problem whenperforming cost calculations, that could besolved by introducing a weighted average

charge, where the weights are the number ofpassengers. A similar approach could be usedfor security charges.

As a rule, rates are increased or at least revisedat least once a year, usually at the end of theyear. According to the trade associationSvenskt Flyg, however, a doubling of theSwedish security charge from its previous levelcan be expected as a result of all the costlyadjustments required to produce a moreexhaustive control system.

In addition, carriers in some countries have topay a terminal navigation charge (TNC) and aroute charge for use of airspace. The TNCvaries depending of the weight of the aircraft.In practice planes smaller than the Saab 340are not liable to this charge.

Finally, a noise surcharge and an exhaust emis-sion surcharge could be payable on the landingfee. The noise surcharge has the character ofan environmental tax, i. e. it reflects actualnoise disturbance. Its size is determined by thedegree of sensitivity to noise in the relevantairport approach zone and also varies with theamount of noise generated by each aircraft.The figures are calculated by means of a high-ly complicated formula, the results of whichsuggest insignificant differences in overalloperating costs.

There could also be an exhaust emission sur-charge concerning nitrogen oxides (NOx),uncombusted hydrocarbons (HC), and carbondioxide, often based on the starting weight ofthe aircraft. As an environmental charge, it isless effective than the noise surcharge, as itonly varies with the properties of the aircraftand takes no account of the distance flown.Consequently it does not reflect actual emis-sions. On a Swedish average, the surcharge is10.5 per cent of the landing fee. Under therates, aircraft are subject to charges in propor-tion to their ICAO certified emissions in gramsper kilonewton (kN) of traction.

59

83 European Commission (1999).

Traction is specified only in the case of jetengines, which lack engine shafts on which tocalculate power. Propeller engines are meas-ured in the usual way in terms of power, kW orHP, but the ICAO does not provide emissioncertification for turboprop engines. There is noclear-cut correlation between traction andpower. Power is defined as traction work per-formed per unit of time (1 kW = 1 newton-metre/sec; 1 HP = 75 kilopondmetres/sec).Thus conversions between power and tractionrequire an assumption as to the speed(metres/sec) at which traction operates. Theaviation tariff gives the impression that only jetengines are subject to charges, but with thehelp of its own calculation model the SCAA isable to convert the specified engine power ofturboprop engines into traction and place themin an appropriate charge bracket.

Landing fees, terminal navigation charges androute charges could in some cases be paid viaannual cards for aircraft. These cards are oftenbased on the maximum starting weight. Thismeans that for some carriers, such costs couldbe lower than the list price because they arepaid for in advance.

Handling, de-icing, and other costs

Three Swedish carriers interviewed in 1999, allof which used no larger than 19-seat aircraft,agreed that the costs for ground services couldbe estimated at approximately SEK 1 500 perlanding and de-icing at approx SEK 2 500 atime. Spread over a year, the number of occa-sions when de-icing is required is not likely toexceed about 3 per cent of total flights.Svenskt Flyg has stated that costs for this service have not increased to any great extentsince 1999.

In the case of jets, the issue is more complicat-ed. SAS operates its own ground services andalso offers them to other carriers. At major airports, competing companies offer groundservices. Pricing is a matter of negotiation.

The only indication available hitherto is thatthis cost would appear to diminish, calculatedper seat, as the aircraft size increases.

Other costs such as parking, cleaning, etc. arealso incurred. These may vary considerably,due in part to who performs the cleaning workand at which airport the plane is parked. Forthe purpose of calculation, it would seemappropriate to use an estimated percentagemark-up for this cost.

The events of autumn 2001

The autumn of 2001 brought the terror attackson New York and Washington, the shootingdown of a plane over the Black Sea, the SAScrash in Milan and the American Airlines crashin New York. The result was a drastic reduc-tion in the demand for intercontinental flightsin particular. The duration of the slump is hardto predict. It strikes chiefly at the carrier revenue side. On the cost side, these eventshad one particularly strong immediate effect:insurance premiums rose dramatically. In theslightly longer term, costs will rise for a rangeof more or less justified security measures. Aninevitable effect in the medium term will belower capital costs as the fall in demand for airtravel will lead to an excess supply of aircraft.Both second hand prices and leasing costs maybe expected to decline as a result.

4.3.5 Low cost carriers

Low cost carriers are a relatively new phenom-enon in the aviation field, even if there aremany similarities between them and traditionalcharter companies. The most successful lowcost carrier in the US is Southwest Airlines,which since its arrival in 1967 has grown toalmost three times the size of SAS in terms ofpassenger volume. The EU Commission estimated that European low cost carrierstransported approximately 4 per cent of all passengers in the EU in 1997.83 In Europe, themost successful carrier of this type appears to

60

84 SCAA (2001:74)85 SCAA (2001:74). Comparable figures for other airlines are: Virgin Express 81.7 %, Go rejser 77.1 %, Easy Jet 83.0 %,

KLM 76.5 %, and BA 71.9 %.86 This section is reproduced more or less verbatim from Steen and Strandenes (2002).

be Ryanair, which has grown to about a thirdof the size of SAS since entering the arena in1985. In 2000, Ryanair’s profit margin was justover 20 per cent while the SAS margin (for allmarkets) was just over 7 per cent. Ryanair’scost per revenue passenger kilometre is onlyabout half as high as that of SAS.84

Ryanair and Southwest use Boeing 737s only,which is also the aircraft on which SAS basesmost of its domestic operation. SAS’ operationhad a cabin factor (i. e., travellers per seatavailable) of 64 per cent while Southwest hadjust over 70 per cent and Ryanair 77 per cent.85

It is worth noting that a lower cabin factorimplies a higher number of departures for agiven number of passengers.

Low cost carriers have been able to reducecosts in a number of different ways. Below aresome examples of cost reducing factors.

• Few departures per route and day• No interlining with other carriers or between

own routes• No entry into very short-haul air markets• Travel to and from major connecting points• Closer seating• More efficient utilisation of aircraft• More efficient utilisation of cabin crew

(serving passengers, cleaning the aircraft,running tax free shops, etc.)

• Lower pay, smaller crews• Cheaper remote airports via special

agreements• Single aircraft model in the fleet – cheaper

maintenance• Lower service level• Minimised costs for lounges, the carrier’s

airport staff, and baggage handling• No free meals or drinks on board• Lower distribution costs, i. e. mainly direct

online sale to the customer• No travel agency commissions• Lower booking and sales costs• Marketing via discount prices

• Less administration From the perspective of the traveller, the costadvantage of low cost carriers must, in otherwords, be traded against certain competitivedisadvantages in terms of reduced quality ofservice compared to traditional carriers.

4.4 Comparative airline productivity 86

In this section we will summarise a few empirical studies of airline productivity, so as to shed light on the relative competitiveposition of European carriers in general and of the Scandinavian flag carrier in particular.The studies in question unfortunately do notinclude Finnair. In general, they should beinterpreted with some caution, as they are allbased on data from before 1995.

4.4.1 Factor productivity and input efficiency indices

The simplest way to evaluate a productionunit’s productivity is to calculate the ratio of itsoutput to input. But as long as an airline usesseveral inputs, this method will be partial.Observed measures of these input and outputvariables will be affected by the size and struc-ture of the airline network, and hence of manyoperating variables that are exogenous: stagelength, output composition, etc. They musttherefore be interpreted with considerable care.

Average partial factor productivity measuresrepresenting labour, fuel, aircraft, and materialsefficiency are tabulated in Table 4.4.

In the labour efficiency indices, variables suchas stage length and output mix have been atleast partly controlled for. Asian carriers havethe highest average labour productivity. NorthAmerican carriers have higher labour efficien-cy than European, but the North Americangrowth rate in labour productivity was substan-tially lower than for both of the others. One ofthe explanations for this result is that the num-

61

87 For aircraft efficiency the effect of stage length and output mixed is removed using regression techniques.

ber of employees is used to measure labourinput, and Asian employees work more hours.The growth rate in labour efficiency has beenhighest for the European carriers, indicating apossible catch-up process. Fuel efficiency ishighest in Europe, partly mirroring the lowerfuel prices in the US.

Looking at average aircraft efficiency, Europealso takes the lead.87 In general, the NorthAmerican aircraft efficiency is declining for allcarriers. This is true also for most Europeancarriers, but less evident for the Asian carriers.

Table 4.4: Average airline efficiency measures as of 1993, relative to American Airlines 1990.

It is possible that the higher European aircraftproductivity might be explained by differencesin ownership structure between the US andEurope. Within the corporate finance literature,several authors have argued that it is easier toraise money for investments when the firm ispublicly owned, as compared to raising thesame amount of money for a private enterprise.The European carriers are predominantly flagcarriers owned, at least in part, by govern-ments, whereas the North American carriers toa larger extent are privately owned.

4.4.2 Total factor productivity analysis

Total factor productivity (TFP) is the mostcommonly used productivity measure.Accounting for the effect that multiple outputsare produced using various inputs, the TFP

measure represents an integrated measure ofproductivity. TFP is defined as the amount ofaggregate output produced by a unit of aggre-gate input. Using the standard definition ofCaves et al. (1982), Oum and Yu (1998a) cal-culate gross TFP indices for the airlines repre-sented in Table 2.3 of Chapter 2 above.

In general, the TFPs grow over the period. A lot of airlines experienced a fall in TFPgrowth between 1990 and 1992, most probablydue to the recession and the Gulf war. SASexhibits the lowest TFP growth in all but twoyears.

However, gross TFP measures might be misleading for the same reasons as the partialefficiency scores. Exogenous differences innetwork size, stage length, and production

North America Europe Asia

Labour

Mean 1.041 0.925 1.480

Standard error 0.206 0.212 0.330

Fuel

Mean 1.049 1.191 1.086

Standard error 0.060 0.067 0.299

Aircraft

Mean 0.920 1.139 1.082

Standard error 0.135 0.232 0.256

Materials

Mean 0.871 0.802 0.677

Standard error 0.071 0.101 0.163

Number of carriers 8 6 7

Source: Oum and Yu (1998a)

62

88 See Bauer (1990) for a review of the literature.

environments might influence the numbers.One way to solve this is to look instead atresidual TFP using regression techniques. Theidea is to undertake a second regression analy-sis on the gross TFP to decompose TFP differ-entials into various sources, including efficien-cy. Examples can be found in Caves et al.(1981) and in Erlich et al. (1994). Here, thegross TFP is regressed against variables thatcontrol for the exogenous differences in theoperating environment believed to affect pro-ductivity, and the residual from this regression– the residual TFP – is now capturing efficien-cy differences that are not attributable to theexogenous factors.

This residual TFP index can be used to com-pare efficiency across firms and within firmsover time. By including variables such as out-put, stage length, revenue shares for freight,revenues from non-scheduled and incidentalservices, load factor, and firm dummies, Oumand Yu (1998a) calculate residual TFP meas-ures. In their regression model, stage lengthhas a positive and significant effect on produc-tivity. The same is true for revenue stemmingfrom non-scheduled and incidental services.They find significant firm dummies, implyingthat there are significant differences in growthrates across airlines.

Turning to the results for the individual carri-ers, the European carriers’ productivity seemsto grow faster than the American carriers’ pro-ductivity. British Airways is found to have thehighest growth in Europe during 1986-93 (4per cent per annum). SAS had, together withIberia, the lowest performance as measured byresidual TFP growth, even after accounting forother exogenous factors.

4.4.3 Stochastic frontier analysis

The stochastic frontier method postulates thatsome firms never reach the production frontier.The method assumes that inefficiencies exist,and that these cannot be fully explained by

measurable variables. Instead, two disturbanceterms are introduced into the models. In addi-tion to the traditional symmetric noise term, aone-sided «error term» is included in themodel in order to capture non-efficiencies thatcannot be explained by the variables includ-ed.88

Typically, a firm is said to be «cost efficient» ifa specified output is produced at the minimalcost, given the relevant input prices and exist-ing technology. The question is then whichexogenous variables determine the one-sided«error term». In our case this would forinstance be variables representing the outputmix and/or the network characteristics.

There exist several studies on airlines usingthis methodology. Barla and Perelman (1989)were among the first to apply the stochasticfrontier method to measure airline productivity.Good et al. (1993) used the methodology tocompare performance of the largest Europeancarriers and their American counterparts. Oumand Yu (1998a) did the same, but included alsothe largest Asian airlines. Other studies usingthis methodology on performance includeBruning (1991) and Jha and Sahni (1992).

Good et al. (1993) used a panel of 12 airlines,of which four were European and eight wereUS carriers. Their panel runs from 1976 to1986. They found a clear productivity gapbetween Europe and the US. The US had anefficiency score in the range of 77 to 79 percent (on a scale up to 100), whereas theEuropean score was in the range of 63 to 65per cent. The European growth rate was alsolower in five out of eleven years. BritishAirways had the highest growth rate over theperiod and the highest productivity in Europeby 1986 (71 per cent).

Oum and Yu (1998a) use newer data from1986 to 1993 to analyse all the carriers fromTable 2.3 above. They found the European car-riers to have a higher growth rate than both the

Table 4.5: Airline unit cost decomposition and cost competitiveness, 1993. Percentage differences relative to American Airlines.

North American and the Asian carriers. BritishAirways had the second highest productivity,whereas KLM had the highest scores, as in theresidual TFP analysis. SAS came out with thelowest productivity scores.

To qualify this result, we shall look into ananalysis of unit costs and competitiveness.

4.4.4 Unit cost comparisons and competitiveness

What are the consequences of low efficiency?First and foremost, low productivity might leadto low cost competitiveness relative to otherairlines. From the consumer or economic effi-ciency perspective, one might be concernedthat it could lead to higher prices and smalleroutput.

One way of looking at competitiveness is tocompare unit costs between carriers. However,this is not a straightforward technique. Nowell-established measure of cost competitive-ness exists. Some studies have systematicallyexamined this issue. Windle (1991) attempts toattribute unit cost differences between carriersusing annual cross-section data for 1983 cover-ing 14 US and 27 non-US carriers. Good andRhodes (1991) looked at competitivenessamong 37 airlines in the Pacific region. A morerecent study by Baltagi et al. (1995) applied atranslog variable cost function to a US panel(1971-86) to analyse changes in the pre- andpost-deregulation US industry. Later, Oum andYu (1998b) used a translog approach to estab-lish unit cost and decompose differences incompetitiveness into potential sources: firmattributes, network characteristics, and outputmix. Their results are presented in Table 4.5.

63

Airline

Unit cost

difference

(1)

Stage

length

(2)

Output

mix

(3)

All input

prices

(4)

Efficiency

(5)

Cost compe-

titiveness

(6)=(4)+(5)

North America

American 0.0 0.0 0.0 0.0 0.0 0.0

United -1.7 -1.2 0.2 3.7 -3.8 -0.1

Delta 13.5 7.7 3.1 7.4 -5.6 1.8

Northwest -3.7 3.3 2.1 4.6 -9.9 -5.3

US Air 40.9 17.6 -4.2 2.6 17.4 19.9

Continental -10.7 3.8 -2.6 -11.4 -0.7 -12.1

Air Canada 12.7 1.9 3.1 -11.5 19.9 8.5

Canadian 3.6 -1.1 1.5 -8.6 13.7 5.0

Average North America

(non-weighted and

excluding American)

7.8 4.6 0.5 -1.9 4.4 2.5

Europe

Lufthansa 29.2 11.2 -2.0 16.8 3.8 20.6

British Airways 21.9 -2.4 11.0 -2.9 10.2 7.3

Air France 19.3 -1.2 -0.8 8.8 12.4 21.2

SAS 81.5 25.0 -4.7 25.4 17.0 42.4

KLM 3.3 -6.2 1.7 16.0 -5.3 10.7

Swissair 46.4 5.4 -2.2 35.5 2.8 38.3

Iberia 36.9 7.6 2.8 5.1 16.4 21.5

Average Europe

(non-weighted)

34.1 5.6 0.8 15 8.2

23.1

Source: Oum and Yu (1998b)

64

89 The result is also supported by a study of Röller and Sickles (1994), who use a quite different methodology. They estimate a structural model toestablish the market power and rent sharing in the airline industry in Europe. However, they also provide an estimate of technical efficiency. By 1990 (their last sample year), SAS had a technical efficiency score of 52.2 per cent as compared to 100 per cent, which is normalised to represent Northwest Airlines. Only Air France is worse off with a score of 47.6 per cent.

In column (1) the estimated unit costs peraggregate unit of output are tabulated. Thenumbers are expressed in percentage differ-ences relative to American Airlines (AA). Forinstance, Lufthansa has a 9.2 per cent higherunit costs than AA, Continental a 10.7 per centlower cost, etc. The general impression is quiteclear: the European carriers have all positiveand large numbers, indicating high unit costs.On the (non-weighted) average, the Europeancarriers have 34 per cent higher unit costs thanAmerican Airlines.

There are two outliers: KLM has only 3.3 percent higher unit costs then AA, being best inEurope and ranking fourth even among theNorth American companies. SAS is worse offthan the others, having as much as 81 per centhigher unit costs than AA. SAS has a very dif-ferent route structure from the other Europeancarriers, with an average stage length of only728 kilometres (see Table 2.3).

Looking at column (2), where the effect ofstage length is decomposed, we find this effectverified. In this column, percentage differencesin unit costs between each airline and AA,attributable to differences in stage length, aretabulated. As much as 30 per cent (25/81.5) ofthe SAS unit cost differential is due to shorterstage length. If we compare SAS with US Air,which has an average stage length in the samerange as SAS (904 km), we see that even thiscompany exhibits high unit costs: 41 per centhigher than AA, the highest figure in the NorthAmerican group. US Air also has the secondhighest figure when we look at the stage lengtheffect (17.6 per cent).

Input prices (column 4) also have a large effecton SAS’ unit costs – accounting for another 30per cent of their unit cost differential. The mostimportant contributing factor here turns out tobe SAS’ labour costs.

It is interesting to note that SAS has the high-est negative figure of all North American and

European carriers when we look at output mixunit cost differential (–4.7 per cent). Here itseems that SAS has a unit cost advantage. Thismight capture some of the quality dimension.SAS has successfully aimed at the businesssegment in their marketing profile. This mayhave given them a competitive advantage with-in this segment. This effect should be evenmore significant as viewed from the revenueside, since the costs associated with servingthis segment is less significant than theincreases in revenue.

Cost competitiveness is summarised in the lastcolumn. This figure is the combined effect ofhigh input prices and efficiency. SAS ranks asthe least competitive firm, 42.4 per cent lesscompetitive than AA.

In summary, SAS appears to have, at least dur-ing the 1980s and early 1990s, significant costdisadvantages. Being confirmed by a variety ofstudies and methodological approaches, thisresult appears to be quite robust.89

4.4.5 Financial performance and developmentin yields

Profitability depends not only on cost competi-tiveness, but also on the company’s ability toprice above costs. The latter in turn depends onseveral factors, such as the firm’s ability toexert market power, practice price discrimina-tion, or exploit other marketing strategies totheir benefit. Conceivably, this might helpexplain the relatively strong competitive position and good financial results obtaineduntil recently by the SAS.

McGowan and Seabright (1989) compare thewages and labour productivity of Europeancarriers to those found among US carriers.They find that European airlines pay a signifi-cant mark-up over US rates for all categoriesof personnel, whereas their labour productivitytends to be lower. This is also what Neven andRöller (1996) conclude in their study of

Table 4.6:. Differences in rent sharing across European carriers. Point estimates, with t-statistics in parentheses.

European airlines over the period 1976-90.They find strong support for the hypothesisthat lax competition induces extensive rentsharing through excessive wages. They alsofind that this rent sharing varies considerablyacross carriers.

Looking at the differences in rent sharing,Neven and Röller estimate a model with firmspecific effects for eight European carriers.Their results are presented in the second col-umn of Table 4.6. The third column includes

the labour cost estimates of McGovan andSeabright. Interestingly, SAS ends up with thehighest estimated rent sharing parameter, sug-gesting that the missing competition may havelead to comparatively high levels of remunera-tion for the employees. According to figuresproduced by McGovan and Seabright, SAS hasthe second highest labour cost estimate. KLM and BA are the two carriers exhibitingthe lowest rent sharing estimates, indicating amore competitive environment for both ofthem.

65

Oum and Yu (1998a) have used their outputdata to look at the development in the airlinecompanies’ yield. They have calculated theaverage yield and compared it to the unit costover the period 1986 to 1995.

With the exception of two carriers (US Air andDelta) previously known as high cost airlines,the average yield for the North American carri-ers measured in constant domestic currencydecreased less than 20 per cent during the sam-ple period.

Looking at Europe, British Airways, KLM, andSwissair managed changes in average yieldsand unit costs in order to secure profits. Allthree airlines managed to widen the gapbetween average yield and unit costs from1990, ensuring increased profitability. It isremarkable that KLM and Swissair remained

profitable despite the fact that their averageyields, in real domestic terms, decreased by 32 per cent and 38 per cent, respectively. AirFrance had real financial difficulties through-out the sample period. Increases in averageyield were far short of increased costs.

Turning now to SAS, the average yield, asmeasured in Swedish kronor, decreased byonly 3 per cent between 1986 and 1995. Thus,SAS appears to have dealt with its rising unitcosts by rising yields, i. e. by increasing airfares. SAS average yield in 1995 was 2.5 timeshigher than that of KLM.

One might think of two main explanations forthis result. In part, it can be due to SAS’ rela-tively large and protected «domestic base»market. As shown Table 2.3, SAS has a largershare of its income from the domestic market

Airline Estimated rent sharing parameter

1976-90 (Neven and Röller 1996)

Labour cost 1989. Per cent of US level –

cabin crew (McGovan and Seabright

1989)

Air France 0.548 (3.14) 273 (UTA only)

Alitalia 0.650 (3.89) Na

British Airways 0.245 (2.71) 94

Lufthansa 0.436 (7.02) 141

Iberia 0.520 (6.07) 231

KLM 0.090 (0.31) Na

SAS 0.612 (2.17) 251

Sabena 0.660 (3.02) 167

Source: Neven and Röller (1996).

66

90 Iberia also has a large share of its income from the domestic market. Along with SAS, they are a high cost airline, and may also have benefitedfrom its domestic market power.

than any other European airline. As pointed outin Chapter 2, this market consists of threecountries, exhibiting high air travel frequenciesbetween them, and of which two – Norway andSweden – are also among the largest in Europein terms of domestic air travel demand.90

The second explanation might be SAS’«Business traveller profile». This will typicallyresult in a higher average yield than obtainedby the competitors.

In summary, SAS seems to be a high cost air-

line no matter how one does the calculation.Their surprisingly good performance is proba-bly explicable in terms of their high yield.Their ability to maintain a high yield may inturn be understood in terms of their dominantposition in a large «domestic» market.

Note, however, that since the data underlyingthe above analysis and conclusions are nomore recent than from 1995, there is reason tointerpret the results with caution, as applied totoday’s situation.

The taxation system represents an importantpart of the institutional and economic frame-work within which the aviation industry, or anyother trade, must operate. In general, taxes,subsidies, and public charges represent power-ful policy instruments, by which governmentsmay influence the activity in any particularsector, if they so desire.

In this chapter, therefore, we present a briefsurvey of the duties, charges, subsidies, and taxrules of most immediate importance to theNordic aviation sector. A general discussion ofthe corporate taxation systems of the Nordiccountries would, however, be far beyond thescope of this report.

In Section 5.1, a fairly systematic overview intabular form is presented. Some of the dutiesand charges are further described and analysedin relation to competition. Section 5.2 is a briefaccount of the environmental externalities gen-erated by aviation. To the extent that paymentscorrespond to such externalities, they may beseen, according to standard economic thinking,as efficiency enhancing forms of taxation.Section 5.3 contains a short description of theuse of state aid in Nordic aviation.

5.1 Taxes and charges in Nordic aviationIn Table 5.1, we present a survey of taxes andcharges in the Nordic aviation industry.

A general note should be made. For most ofthe charges there are exemptions, be it forsmall aircraft, passengers under two years ofage, airline employees, etc. In the context ofthis report, it has not been possible, or desir-able, to give a complete, detailed descriptionand interpretation of all the regulations current-ly in effect.

As can be seen from Table 5.1, taxes andcharges are not quite uniform across countries,although there are many similarities.

The total effect of the taxes and charges, i. e.

the sum of effects on demand and on the air-lines’ costs, depends on additional factors likethe general corporate taxation, the cost of capi-tal, the cost of labour, etc. Furthermore, whenit comes to charges for state aviation facilitiesand services, they will differ between routes,aircraft types, etc. This section will thereforeconcentrate on the taxes and charges that mayhave a more direct impact on competition, andwe consider the competitive effects of each taxand charge separately. It is therefore not possi-ble to draw conclusions on the airlines’ com-plete competitive situation from this analysis.

5.1.1 Passenger tax

Denmark levies a passenger tax, while Finland,Norway, and Sweden have no such tax. InNorway, however, an air passenger tax wasbeing levied until 1 April 2002.

The passenger tax is a pure fiscal tax, chargedon trips from domestic airports. As a result,domestic trips face, roughly speaking, twicethe tax of international trips. Whether the tax ispassed on to the passengers or not, it is liableto reduce the airlines’ revenue, in the formercase because demand is constrained.

The tax is the same for all airlines operating inthe same market, but airlines having the greaterpart of their operations in the domestic marketare hit harder than airlines operating primarilyin international markets. Perhaps of greaterimportance is the fact that the passenger taxaffects the low cost carriers proportionatelyharder than the «ordinary» airlines, in the sensethat the tax corresponds to a larger fraction ofthe total ticket expenditure. Hence, it may beargued that the passenger tax is particularly«effective» in preventing entry by low costcarriers.

5.1.2 The VAT system in general

In all the Nordic countries there is a generalobligation to pay VAT on both goods and serv-ices. In Finland and Sweden, passenger trans-

67

5. TAXES, SUBSIDIES, AND PUBLIC CHARGES

68

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72

port by air is part of the general VAT system.In Denmark and Norway, on the other hand,the passenger transport by air is not included inthe VAT system.

When the airlines’ operations are included inthe VAT systems, input VAT will be deductible.When an industry is left out of the system,such an option to deduct input VAT is not pres-ent. However, Denmark and Norway haverules allowing the airlines to deduct input VATregarding their international operations, thuspreventing a concealed tax on export. Not allVAT will be deductible, however. This maycause certain competitive distortions.

All the Nordic VAT systems are set up in sucha manner that the VAT is not dependent on anairline’s nationality, but on where the purchaseis being done. There are, to some extent, dif-ferent rules for domestic and foreign compa-nies when it comes to registration and deduc-tion, but the results and realities turn out quitesimilar.

Nevertheless, the VAT systems may give riseto competitive distortions. Vertical integrationand the airlines’ distribution between domesticand international traffic are some factors ofimportance when considering the competitiveeffects of the VAT systems. The same will betrue of some of the other taxes and charges. Inaddition, different VAT regimes may lead tounequal profitability levels on account of dif-ferences in demand patterns and cost struc-tures.

5.1.3 Ground handling

Norway

Ground handling services are liable to duty. Ifaviation is within the VAT system, input VATwill be deductible for the airlines. In such acase the airlines will, roughly speaking, beindifferent between buying and producing theground handling services.

A decision to remove passenger transport byair from the VAT system, effective 1 April2002, has been passed by the Norwegian

Parliament. As a consequence, airlines will nolonger be able to deduct input VAT for theirdomestic operations, nor, in fact, for all of theirinternational passenger traffic.

Carriers buying ground handling services fromthird-party suppliers will be charged with inputVAT, which, in principle, is not deductible.They will to some extent be able to deductinput VAT regarding international traffic, but asmost of the ground handling services are con-sidered to be produced in Norway, the optionto deduct is somewhat limited. However, theairlines will still be able to deduct input VATfor fuel and catering for use exclusively oninternational routes. Apart from this, airlinesbuying third-party ground handling serviceswill face up to 24 per cent higher costs thanairlines relying on self-handling, which, ofcourse, is not subject to VAT.

This could represent an important source of com-petitive distortion, not only in the ground hand-ling market, but also in the air travel market.

Potential entrants have to decide whether toestablish their own production of ground han-dling services or to buy these from third-partysuppliers. Self-handling is uneconomicalunless operated at a fairly large scale. Theinvestments necessary to set up a self-handlingapparatus will, at least partly, be «sunk costs»,which cannot be recovered in the event of aprospective exit from the market. Any smaller,new entrant relying on self-handling thereforeexposes himself to an increased risk.

For potential entrants, a much more attractiveoption will be to purchase ground handlingservices from a third-party provider. But underthe current Norwegian VAT regime, airline-independent ground handling providers areunlikely to survive. Only the large carriersthemselves will be able to support such facili-ties, meaning that any new entrant will have nooption but to buy their ground handling servi-ces from a large competitor. On account ofthis, larger carriers will have a distinct compet-itive advantage over the smaller ones, makingthe entry of smaller carriers more risky andhence less likely.

73

96 In Sweden, this is limited to the airports owned by the Swedish Civil Aviation Administration (19 out of 44 airports). In Norway, there is one airport (Torp) not operated by the state. In Denmark, on the other hand, the principal airport – Kastrup – is privately owned and operated.

Denmark

The situation in Denmark is to some extent thesame, but in Denmark the permission to deductinput VAT associated with ground handlingservices depends on the plane’s next destination,not on where the services are carried out. As aconsequence, in Denmark the discriminationproblem will only arise for domestic flights.

The domestic market consists mainly of feederroutes. It is possible that the VAT rules mayhave some impact on competition, but consid-ering the size of the domestic market, thiseffect will probably be limited.

Finland and Sweden

In Finland and Sweden, passenger transport byair is part of the VAT system, and all airlinesmay deduct input VAT. These countries aretherefore not affected by the abovementionedproblem.

5.1.4 Fuel

The fuel used by aircraft is subject to VAT and,in Norway, to an additional CO2 tax. Neithertax is, however, levied for international flights.

Norway differs from the other Nordic countrieswhen it comes to the assessment of cabotage.In all the other countries, cabotage is consid-ered part of the international flight and istherefore not liable to VAT.

If the fuel is bought in Norway and the plane’snext destination is domestic, the charges apply.There is no charge for fuel that is imported onboard the plane, even if this is used on domes-tic flights. The charges are independent of theairline’s nationality and will therefore notinfluence, at least not directly, the competitionbetween national and foreign companies.

Instead, it might influence competition in thedomestic market. An airline operating both inthe domestic and in the international markethas the opportunity to acquire fuel abroad, thus

avoiding the charges. The tax-free fuel cansubsequently be used for domestic flights.Hence, a certain competitive distortion arisesbetween airlines able to acquire fuel abroadand airlines that do not have such opportu-nities. For the airline, there is an incentive toalter the utilisation of aircraft between domes-tic and international flights for the purpose ofusing tax-free fuel.

The effects will be present in all the Nordiccountries, but to different degrees. In Denmark,the domestic market is small, consisting main-ly of feeder routes. The problem is thereforeprobably of minor importance. In Norway, onthe other hand, the problem might be of con-siderable importance since there are two taxes– both VAT and CO2 tax – that are levied in thedomestic market only. In Sweden and Finland,only the VAT applies.

In addition to the effects on competition, suchacquisition of fuel has an environmental side.To the extent that aircraft carry more weightin order to take advantage of the cheaper fuelabroad, the CO2 tax may be partially counter-productive. In 1999 the Institute of TransportEconomics (TØI) calculated these effects,under a research contract for Braathens, and concluded that the VAT and CO2 tax might lead to increased emissions of CO2 inNorway.

5.1.5 Airport charges

Airport charges typically include passenger,take off, en route navigation, and terminal nav-igation charges. Apart from the En route AirNavigation Facility Charge, they are usuallynot directly cost based.

They are, in general, uniform across all airlinecarriers, and also, with few exceptions, uni-form across all airports within a given country. This uniformity of charges implies, at least inFinland, Norway, and Sweden, that there is asystem of cross-subsidisation between the air-ports.96 The larger and more profitable airports

generate revenue that is used to support thesmaller ones.

At first sight, the airport charging system thusappears to be competition neutral in relation tothe carriers.

It is, on the other hand, not very susceptible toenhance competition or to ensure an economi-cally efficient allocation of resources. Onemight ask whether a system of differentiatedairport charges might be conducive to a moreefficient use of airport capacity and to intensi-fied competition. Charges may, e.g., be madeto vary (i) over the day, (ii) between airports,(iii) in relation to the amount of services usedby the carrier, or (iv) in relation to the farespaid by passengers.

Option (i) would make reasonably good sensein terms of resource allocation, being in linewith the traditional economic solution to con-gestion problems, which is marginal cost (peakload) pricing. If arrivals and departures couldbe spread more evenly across the day, theamount of airport capacity needed and the unitcost of operation would decrease.

Option (ii) could be seen as an alternative tothe present cross-subsidisation system, bywhich the same amount is charged for using afully equipped international hub as for a verysimple, regional airport facility. If charges weredifferentiated according to the level of servicesprovided, chances are that smaller regional air-ports would become more commercially attrac-tive to the airlines, especially to low-cost carri-ers. It is possible that the increase in trafficvolume associated with such a developmentcould more than offset the loss of cross-subsi-dies from the present airport revenue system.

Low-cost carriers tend to demand simpler andcheaper airport services, being independent ofcatering services, interline baggage handling,aircraft docking, etc. A system (iii) by whichairlines pay according their actual use of facili-ties might contribute to the entry of low-costcarriers.

Alternative (iv) would also imply considerableadvantages for low-cost carriers compared to

today’s system, in which the airport chargebears no relationship to the fares paid by trav-ellers. On account of this, it might stimulatecompetition. From the perspective of the air-port authority, one disadvantage would be thatthe airport revenue would be less predictable,being dependent not only on the traffic vol-ume, but also on the carriers’ pricing policy. Itmay also be argued against such a scheme thatit is generally not related to marginal costs and,on account of this, less susceptible to enhanceefficiency.

5.2 External costs of aviation In its Green Paper on transport pricing, theEuropean Commission (1996) estimated theexternal environmental cost of aviation withinthe EU at e16.4 billion per annum, of which e12.4 billion relate to passenger transport ande 4 billion to freight. Air pollution and climatechange account for an estimated e13.6 billion,while e 2.8 billion is the estimated noiseannoyance cost.

Later estimates, by Maibach et al. (2000), aregenerally higher, amounting to e 29 billionper annum for passenger transport and to e 2.8billion for freight.

As reckoned per air passenger kilometre, exter-nal environmental cost estimates range from e 0.0178 (European Commission 1996) to e 0.048 (Maibach et al. 2000). As applied toNorway, Eriksen et al. (1999) arrive at an estimate of NOK 0.21 per passenger kilometre,corresponding approximately to e 0.025.

In a market economy, external effects are nor-mally not taken account of by decision makers,unless their costs have been «internalised», i.e.incorporated in the market price by means of atax. External effects lead, in principle, to aninefficient (distorted) resource allocation. Putsimply, the volume of a polluting activitybecomes larger than desirable, unless the pol-luter is made to pay. Ideally, the pollutershould be charged a tax that, on the margin, isexactly equal to the value of the external dam-age generated.

In this perspective, it would not seem unrea-

74

75

sonable if airline operations were subject to amodest fiscal tax, in addition to charges fortheir use of infrastructure. Assuming an aver-age stage length of 728 kilometres (cf. SAS’figure in Table 2.3), an air passenger tax some-where between e 13 and e 35 per departure, oran equivalent charge per litre of fuel, would beconsistent with the range of environmental costestimates produced by the EuropeanCommission (1996) and by Maibach et al.(2000), respectively.

As of today, airlines enjoy a considerable com-petitive advantage in relation, e.g., to roadtransport, in that they usually (except fordomestic flights in Denmark and Norway) donot have to pay tax on their use of fossil fuel.Railways, on the other hand, may seem toenjoy an even more advantageous position, tothe extent that they do not pay tax on theirenergy use. Even if railways running on elec-tricity do not cause any direct emissions, theelectricity used may have been produced bythermal plants. It would, at any rate, arguablyhave an environmental «opportunity cost» interms of reduced emissions from such plants.

Adding to the economic distortion problem isthe fact that aviation, along with most othermodes of transport, is more or less exempt ofVAT. This distorts the resource allocation infavour of transport activities in general, at theexpense of most other lines of production andconsumption.

Finally, congestion in the air corridors, and atthe airports, gives rise to another important setof externalities, which, although they affect theair carriers and passengers themselves, are rel-evant to consider in an economic analysis ofoptimal airport charges, cf. option (i) above, onpeak load (congestion) pricing.

5.3 State aid

5.3.1 Direct and indirect subsidies

In many European countries, national carriershave, up until recently, continued to receivesubstantial amounts of direct or indirect aidfrom the national government. Such transfersmay destroy the level playing field betweenairlines and could therefore be harmful to competition.

Following the terror attacks in the UnitedStates on 11 September 2001, several govern-ments – including in the US – have been grant-ing direct and indirect financial aid. The air-lines have been compensated for the four daysof closed American airspace and have receivedtemporary government assistance in relation toinsurance coverage. The EuropeanCommission and the EFTA SurveillanceAuthority have accepted these actions andgiven the airlines temporary exemptions fromthe prohibition against state aid.

5.3.2 PSO routes

Apart from these extraordinary measures, the only direct state aid given to the Nordicaviation industry in recent years is linked tothe so-called public service obligation (PSO)routes.

In most cases, these are thin routes servingfairly remote areas. Operating these routes iseconomically unprofitable, but politicallydesirable. Following public tendering, a timerestricted, exclusive concession is given to thecarrier willing to fulfil the service obligationfor the smallest amount of subsidies. Thus,although there is no competition in the market,there is competition for the market.

As of May 2002, Sweden has one PSO route.Starting November 2002, 10 more PSO routeswill be opened.

In Norway, there are approximately 40 PSOroutes. Their number is, in fact, not given;instead there are certain route areas subject tocompetitive tenders.

Denmark and Finland have no PSO routes.

5.3.3 Public procurement

In most countries, the public administration isitself a major airline client. As such, the gov-ernment may be able to negotiate favourablefare or rebate agreements for public servantstravelling on business7. More favourable agree-ments are likely to be obtainable if the govern-ment grants the airline some kind of preferenceor exclusivity. In so doing, however, the gov-ernment stifles the competition. In terms ofcompetition policy, it would be preferable ifgovernments used their negotiating power toenhance rivalry in general rather than to obtainprivileged fares for their own servants. To theextent that this strategy contributes to pricecompetition, even the public treasury will ben-efit, perhaps to an extent that more than out-weighs the discounts currently obtained in pub-lic procurement deals.

To enhance competition, it might be recom-mended that the following principles beadhered to in public procurement agreements:(i) Public purchases should be tendered insmall portions (e.g. route by route), so thatsmall size companies may have a chance tobid. (ii) Preference clauses should admit that,notwithstanding the public purchase agree-ments, the government is always free to makeuse of a cheaper and/or higher quality servicethat may be offered by someone else. (iii)Fixed fares (over a certain time lapse) arepreferable to percentage discounts off the nom-inal fare. This is so because percentage dis-count agreements tend to bid up the fare for allthose clients who do not have a comparableagreement.

76

97 Public procurement should not be confused with public service obligation (PSO). In the latter case, the government accepts to pay a subsidy inorder for the carrier to offer all travellers a certain level-of-service at a certain price. In the former case, the government negotiates a deal exclu-sively for its own purchases.

77

98 On some carriers, passengers collect bonus points on tickets within every fare class. Other carriers award points only on business class tickets orsimilar. Most carriers award more points on expensive ticket types than on the cheaper ones.

99 Empirical evidence shows that 95 per cent of the points are used for free air tickets, while only 3 per cent are used for hotel accommodation and1 per cent for car rentals.

In this chapter, we focus our discussion on themost important market conditions, strategiesand competitive restrictions characterising theaviation industry.

Section 6.1 deals with frequent flyer pro-grammes (FFPs), Section 6.2 with corporatediscount schemes, and Section 6.3 with travelagent agreements. Corporate travel cards arediscussed in Section 6.4 and computerisedreservation systems in Section 6.5. In Section6.6, we discuss the interlining cooperationand the IATA tariff consultations. Last, but notleast, in Section 6.7 the topic is the scarcity ofairport slots and the need for improvements tothe slot allocation systems currently in use.

6.1 Frequent flyer programmesFrequent flyer programmes (FFP) were intro-duced as a new marketing strategy byAmerican Airlines in the early 1980’s. OtherUS carriers were quick to follow suit.European airlines took up their example in theearly 1990s. Today almost every major airlinehas its own programme or is connected to one.

6.1.1 General characteristics

Most FFPs have the following characteristicsin common: • Membership is free and open to any traveller. • Members accumulate bonus points when

making (certain types98 of) trips or purchaseswith the airline carrier, with one of itsalliance partners, or with other business asso-ciates, such as, e.g., a car rental company or ahotel chain.

• The number of points accumulated varieswith the distance and with the fare class.Travellers on long distance flights collectmore points than short-haul passengers.Business class passengers earn more points

than economy class travellers.• When a certain amount of points is accumu-

lated, they can be exchanged for free air tick-ets, hotel accommodation, service upgrades,etc.99 Travellers who have accumulated largeamounts of points receive various forms ofpreferential customer treatment.

• «Discounts» are, in other words, granted, notin the form of money, but in the form of freeservices. However, the service provided «forfree» is not necessarily of the same type orquality as the one purchased. To most cus-tomers, bonus trips are available only on cer-tain flights. Moreover, although the customermay have earned her frequent flyer pointsbuying fully flexible tickets, the bonus ticketsare generally inflexible from the time theyare issued. A bonus trip is, in other words, inseveral respects different from an ordinarymonetary rebate.

• To obtain free flights to more or less distantdestinations, the customer needs to surpasscertain thresholds in terms of travel purchaseswithin a certain time period (say, five years).The closer the customer gets to a threshold,the stronger is her incentive to buy anotherflight from that particular airline or alliance.The programmes have, in other words, a non-linear (progressive) structure, conferringupon the customer an incentive to concentrateher purchases to one or a few providers.

• In all FFPs, membership is individual andpersonal. The points are awarded to the trav-eller and, as a rule, only the traveller and hisor her closest family or travel companion canmake use of them. In the case of businesstravel, the traveller tends to differ from thepurchaser. This may give rise to a pro-nounced principal-agent problem, by whichthe traveller (agent) is faced with a quite dif-ferent set of incentives from those of heremployer (principal).

• Although in principle taxable in many coun-

6. BUSINESS CONDITIONS AND STRATEGIES

78

100 This subsection draws heavily on Steen and Sørgard (2002), using parts of their text almost verbatim.101 The difference could, alternatively, be explicable in terms of selectivity bias: it is entirely possible that more price elastic individuals choose to

travel so rarely that they do not see the point of becoming FFP members. 102 1.05/0.83 = 1.265.103 Some employers deny their employees the right to use bonus points for private purposes, in order to avoid the principal-agent distortion. 104 See, for example, Klemperer (1984, 1995) and Carns and Galbraith (1990).

tries, the private use of frequent flyer pointsearned by an employee is in practice rarelytaxed, for lack of information on the part ofthe tax authorities. This tax loophole is likelyto aggravate the principal-agent problem.

• FFPs become more attractive the more exten-sive a network can be offered for bonus pointredemption. Alliance airlines therefore mergetheir FFPs for mutually enhanced competi-tiveness.

6.1.2 Economic welfare effects 100

Although such an interpretation is not obvious-ly appropriate, a frequent flyer programmemight be regarded as an example of seconddegree price discrimination (see Section 4.2above). The consumers are rewarded for largepurchases, and they receive a special kind ofquantity discount. As noted above, however, abonus trip is no ordinary rebate. It is more rea-sonably understood as a reward for loyalty.

In a situation with only one airline, and disre-garding the principal-agent problem, Steen andSørgard (2002) show that the frequent flyerprogrammes have an ambiguous effect on theconsumer surplus. In the first instance, it maylead to a higher willingness to pay and henceto a larger consumer surplus for a given price.But the airline’s response may be to set a high-er price, in order to exploit this higher willing-ness to pay. The extent to which price or quan-tity goes up will depend on the price elasticityof demand. Among relatively inelastic cus-tomers, such as business travellers, the price islikely to increase more than the quantity.

If one takes the principal-agent problem intoaccount, it becomes overwhelmingly likely thatthe FFP will lead to distortions in decisionmaking and hence in the resource allocation. Ineffect, the bonus programme drives a wedge inbetween the personal interest of the businesstraveller and the economic interest of her com-pany. The two of them are facing different

prices or rewards. While the company maywant to limit its travel costs, e.g. by replacingphysical trips by other forms of communica-tion, and by choosing – whenever travelling –the most inexpensive travel modes, routes, andcarriers, the business traveller will have aninterest in frequent travelling by her assignedFFP membership airline, preferably usingexpensive, business class tickets.

This is not to say that all business travellerswill act disloyally to their employer, or that thefringe benefits accruing from an FFP member-ship may not be a deliberate part of the compa-ny’s remuneration policy and in this senseimplicitly internalised by the employer. Buteven in these cases, the tax subsidy connectedto bonus point redemption is liable to distortdecisions: benefits from FFPs become a cheap-er way to compensate employees than the ordi-nary, taxable payroll. In theory, this shouldlead to an excess consumption of travel by airand to a certain welfare economic loss.

The actual loyalty effect of FFPs on Danishdomestic (monopoly) routes has been analysedby Cowi Consult (1998). The analysis shows aprice elasticity of demand of –1.05 amongtravellers not participating in a frequent flyerprogramme, but only –0.83 among FFPs mem-bers who are allowed by their employer tomanage and use their own points. This sug-gests, roughly speaking101, that the airline isable to charge a 26 per cent102 higher pricefrom these customers, without losing business,than they would have been able to without theFFP. For travellers whose FFP is controlled bythe employer103, a medium range elasticity of–0.93 is estimated by Cowi Consult (1998).

What happens under competition, i. e. if thereis more than one active firm, or one active andat least one potential firm? In the literature, itis pointed out that frequent flyer programs areloyalty inducing.104 The consumers are becom-ing loyal to one firm, so as to accumulate fre-

79

105 EuroBonus is SAS’ frequent flyer programme.

quent flyer bonus with this particular firm. Onthe other hand, firms compete to attract newconsumers that can become loyal. Although thenet effect is ambiguous in theory, in his surveyKlemperer (1995:536) concludes that loyaltyprograms are typically detrimental to welfare:

«While there are exceptions to these conclu-sions, they suggest a presumption that publicpolicy should discourage activities thatincrease consumer switching costs (such as airlines’ frequent flyer programs), andencourage activities that reduce them.»

The author concludes that frequent flyer pro-grammes must be expected to have anti-com-petitive effects. In particular, there is reason tobe aware of such effects in a setting with one(or a few) established firm(s) and a potentialentrant. If incumbent carriers have been able torecruit a large part of the potential clienteleinto their frequent flyer programmes, a newentrant may find it exceedingly difficult to cap-ture an economically viable market share.

Unfortunately, there are few empirical studiesof the effect of frequent flyer programs. Weshall be referring to the few studies that we areaware of.

Nako (1992) quantifies the effects of FFPs onthe business travellers’ choice of airlines, andfinds it to be substantial. However, the effectvaries between airlines. One important deter-minant is whether the airline is present in thetraveller’s hometown. The frequent flyer pro-gramme reinforces this relationship.

In a telephone interview survey undertaken forSAS by the Norwegian market research organi-zation MMI Interactive (2001), SASEuroBonus105 members were asked how theywould react to a ban on the frequent flyer pro-grammes as practiced in the domesticNorwegian market. 42 per cent of theEuroBonus members interviewed answeredthat they would then probably prefer anotherairline than SAS on international flights. This

suggests that the loyalty effect of such a pro-gram is substantial. Furthermore, more thanhalf of those who had completed a free bonusflight, answered that they would not have madethe trip if they had had to pay for it. This sug-gests that the consumer surplus accruing fromthe bonus flights might be limited.

Proussaloglou and Koppelman (1995) modelair carrier demand, identifying and measuringthe relative importance of factors that influenceair travel demand. They show, among otherthings, the importance of a carrier’s frequency(number of flights) in a city pair market andthe importance of a frequent flyer programmefor a passenger’s choice of airline. Theydemonstrate in the empirical part of their studythe dramatic impact of frequent flyer pro-grammes on carrier choice for individualflights. Furthermore, they found that theseeffects are particularly strong among the fre-quent business travellers.

The latter result is of interest. Most probably, itis explained by the non-linear (progressive)structure of the programme. As the travellerreaches certain threshold levels, she is entitledto some extra benefits from the frequent flyerprogramme. For example, a member of SASEuroBonus is entitled to becoming a silvermember after a certain number of pointsearned in one year, and entitled to becoming agold member when she reaches an even higherthreshold. At the highest level the member isentitled to extra service, for example highestpriority if the flight is overbooked. Obviously,this means that each traveller has an incentiveto concentrate her purchases to one carrier.

This kind of programme, where the accumulat-ed purchase is of importance for the benefitsderived, is described in textbooks as an opti-mal way to create loyalty among consumers(see Shapiro and Varian 1998). To economicwelfare, however, such programs are detrimen-tal. Loyal consumers would lead to less fierceprice competition, higher prices, reduced out-put, and a non-negligible deadweight loss, i. e.

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106 Court Ruling in Hoffmann-La Roche & Co. AG v Commission of the European Communities, Judgement of the Court of 13 February 1979, Case 85/76, European Court Reports 1979 Page 461.

107 Premise 90.108 Court Ruling in Michelin v Commission of the European Communities, Judgement of the Court of 9 November 1983, Case 322/81,

European Court Reports 1983 Page 3461.

a reduction in the consumer surplus not offsetby a corresponding increase in the producersurplus.

In a situation with one incumbent carrier andone or more potential new entrants, the incum-bent’s frequent flyer programme would repre-sent a powerful barrier to entry, increasing theprobability that the market will remain monop-olised.

FFPs enhance the customer loyalty by impos-ing an indirect switching cost on any change ofairline or alliance. The phenomenon of switch-ing cost is not uncommon. It is likely also toappear in the industry of mobile phones, whena person changes phone from one operator toanother, or in the software industry, when aperson changes from one computer operatingsystem to another. The switching costs betweenairlines are somewhat different from the othertypes of switching costs, because they are arti-ficial, caused by a deliberate marketing strate-gy rather than by a difference in the technicalsystems.

If there were no switching costs, the demandfor one journey would be independent of thedemand for other journeys. When there areswitching costs, on the other hand, travellerscare about the full range of products sold byeach firm, in this instance the airlines’ destina-tions and extra services. The switching costswill induce a person to use the same airlineevery time, or as often as possible. Thedemand for different flights in time and spaceis thereby linked together, and a situation ofsynthetic economies of scope on the demandside is created. The FFPs thereby favour air-lines with a more extensive networks, becausethey are able to offer a bigger variety of depar-tures and routes.

When FFPs are no longer innovations butsomething that every airline has or participatesin, one might argue that the overall marketing

advantage for the airline will disappear. It willno longer be an efficient instrument to capturetravellers from the other airlines. Yet no airlinewill unilaterally revoke the program, even ifsuch an action would save costs, since it willmean a loss of that particular carrier’s marketshares, especially in the corporate segment.This is a situation well known from game theo-ry, referred to as the «prisoner’s dilemma».The flag carriers acknowledge that they have acommon interest in keeping up the existingstructure, which allows each of them a domi-nant position in their respective «home» mar-ket. This structure is effectively reinforced bythe hub-and-spoke mode of operation.Together, the FFPs and the hub-and-spoke networks allow the major European airlines todivide large parts of the market between them.

6.1.3 Community case law

The European Court has dealt with loyaltyrebates on a few occasions. In its ruling in theHoffmann-La Roche106 Case, the Court statedthat if an undertaking which is in a dominantposition in a market ties purchasers by an obli-gation to obtain all or most of their require-ments exclusively from the said undertaking, itabuses its dominant position. Furthermore, theCourt stated that

«obligations of this kind to obtain suppliesexclusively from a particular undertaking[…] are incompatible with the objective ofundistorted competition within the commonmarket, because […] they are not based onan economic transaction which justifies thisburden or benefit but are designed to deprivethe purchaser of or restrict his possible choic-es of sources of supply and to deny otherproducers access to the market»107.

In the Michelin108 Case, the concerned dis-count system was based on an annual referenceperiod. This meant that discounts were grantedaccording to quantities sold during a relatively

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109 Commission Decision of 16 January 1996 in SAS/Lufthansa, OJ L 54 5.3.1996 p 28, Commission Decision of 13 September 1991 in Delta/Pan Am, OJ C 289 17.11.1991, Commission Decision of 11 December 1992 in British Airways/TAT, OJ C 326 11.12.1992, andCommission Decision of 5 October 1992 in Air France/Sabena, OJ C 272 21.10.1992.

long period. In this case the variations in thediscount rate over a year were then in factbased on the volume of the last order, as itaffected the dealer’s margin of profit on thewhole year’s sale. If a competitor then wishedto offer the dealer a competitive offer, especial-ly at the end of the year, he had to take intoaccount the absolute value of Michelin’s annu-al target discount. The Court concluded thatbinding the dealers in that way was an abuse ofdominant position.

As there are no obligations to use only oneFFP to collect points or obtain membershipadvantages, FFPs do not formally presupposeexclusivity in the same way as the fidelityrebates in the Hoffmann-La Roche Case. Theeffect of the FFPs is more similar to the targetrebate system in the Michelin Case.

So far, no case concerning airline FFPs hasbeen tried by the European Court. To use thecase law from the Michelin Case, one wouldhave to claim that the concerned airline holds adominant position in the relevant market.

In 1992, the European Commission’sCompetition Directorate, DG IV, carried out aninformal study of FFPs. The study was basedon information collected from all largerEuropean airlines. The result of the study wasthat FFPs as such could not be considered tobe anti-competitive, but in cases of alliances ormergers, FFPs might constitute barriers toentry.

The European Commission has dealt withFFPs in four cases concerning cooperationbetween airline companies (cooperation inalliance programmes)109. As part of the allianceagreements, the airline companies allowed thealliance partner’s clients to collect and useaccumulated points in each other’s FFPs. InSAS/Lufthansa, the Commission stated that thecooperation between the two companies onFFPs was likely to be a not inconsiderable bar-rier to market entry, and therefore a breach of

Article 81(1). The Commission’s condition forapproval under Article 81(3) was that any otherairline which provided or wished to provideservices on the routes in question, and whichdid not have a FFP applicable at the interna-tional level, should be afforded the opportunityof participating in the programme.

6.1.4 Denmark

By paragraph 11 in the Danish CompetitionAct, abuse of a dominant position by one ormore undertakings on the market is prohibited.Such abuse may, in particular, consist in: • directly or indirectly imposing unfair pur-

chase or selling prices or other unfair tradingconditions,

• limiting production, markets, or technicaldevelopment to the prejudice of consumers,

• applying dissimilar conditions to equivalenttransactions with other trading parties, there-by placing them at a competitive disadvan-tage, or

• making the conclusion of contracts subject toacceptance by the other parties of supplemen-tary obligations, which, by their nature oraccording to commercial usage, have no con-nection with the subject of such contracts.

For the prohibition to be applicable, an under-taking is required to have not only a dominantposition on the market, but also be abusing itsposition. A dominant position means that anundertaking has a strong economic position,making it possible for the undertaking in ques-tion to prevent effective competition by actingindependently of its competitors and customersand ultimately of consumers.

As a rule, a dominant position is based on anumber of factors, each of which in itself doesnot necessarily have to be critical. Examples offactors that are important are financial strength,barriers to entry into the market, access to cap-ital goods, patents, and industrial propertyrights, as well as technology and other knowl-edge-oriented advantages. An important factor

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110 Commission Decision of 18 July 2001 in cases COMP.D.2 37.444 (SAS/Maersk Air) and COMP.D.2 37.386 (Sun-Air v. SAS and Maersk Air),OJ 2001 L 265/15.

is the market share of the undertaking in therelevant market. In air transport cases, theDanish Competition Authority define the relevant market by a city-to-city principle inaccordance with Community Practice forexample in the SAS/Maersk case.110 A marketshare of between 40 and 50 percent is regardedas being a clear indication of a dominant posi-tion. If the market share exceeds 50 percent,the presumption of a dominant position is virtually conclusive.

According to paragraph 6 in the DanishCompetition Act, any conclusion of agree-ments between undertakings etc. that have astheir direct or indirect object or effect therestriction of competition, shall be prohibited.Such agreements may, for instance • fix purchase or selling prices or any other

trading conditions, • limit or control production, markets, technical

development, or investment, • share markets or sources of supply,• apply dissimilar conditions to equivalent

transactions with other trading parties, thereby placing them at a competitive disadvantage, or

• make the conclusion of contracts subject toacceptance by the other parties of supplemen-tary obligations that, by their nature oraccording to commercial usage, have no con-nection with the subject of such contracts.

The paragraph is only applicable to agreementsbetween companies. As a FFP in itself is notsuch an agreement, the prohibition againstanti-competitive agreements does not apply toFFPs as such. But if two companies make anagreement, for example on use of each other’sFFPs, paragraph 6 in the Danish CompetitionAct does apply.

The Danish Competition Authorities have dealtwith FFPs regarding paragraph 6 on anti-com-petitive agreements between companies. In anotification case concerning a cooperationagreement between two airlines (SAS and

Cimber Air), the Competition Council adaptedthe viewpoint of the Commission in theSAS/Lufthansa case; i.e. the agreement wasgranted exemption under the DanishCompetition Act on the condition that competi-tors should be allowed to participate in SAS’FFP under non-discriminatory terms. Theagreement is only granted exemption untilOctober 2003. Subsequently, the CompetitionAuthorities will have to consider the caseagain.

The use of FFPs may constitute an infringe-ment of paragraph 11 in the DanishCompetition Act on abuse of dominant positionsince it has a significant loyalty inducing effectand makes it more difficult for other airlines tostart or maintain competing domestic air serv-ices. The Danish Competition Council is exam-ining whether the construction and administra-tion of FFPs on Danish domestic routes consti-tutes an abuse of dominant position.

6.1.5 Sweden

Swedish Law concerning abuse of dominantposition is very similar to that of Denmark (cf.Subsection 6.1.4 above)

The SAS’s EuroBonus scheme has beendeemed to constitute an infringement of theSwedish Competition Act, since it has a signif-icant loyalty inducing effect and makes it moredifficult for other airlines to start or maintaincompeting domestic air services.

The Competition Authority, in a decision inNovember 1999, had ordered the ScandinavianAirlines System (SAS), on penalty of a fine ofSEK 100 million, not to apply its EuroBonusloyalty scheme or take part in schemes of asimilar nature, in such a way that passengersearning points were able to redeem them asbonus awards or the equivalent when usingdomestic air services. The practice was deemedto be an abuse of SAS’s dominant position inbreach of Section 19 of the Competition Act.

SAS appealed to the Market Court and request-ed that it reverse the decision in the firstinstance or, alternatively, modify the injunctionso that it would not enter into force until eightmonths after the date on which the Courtannounced its decision. Further, SAS askedthat the penalty sum be reduced to an equitablelevel.

SAS argued that the practice did not infringethe Competition Act, and that in any event theCompetition Authority’s determination of therelevant market was incorrect and thus incom-patible with EC case law. Further, theCompetition Authority’s injunction contra-vened the principle of priority for Communitylaw over national law.

In its ruling of 27 February 2001 (MarketCourt 2001:4), the Swedish Market Court,which is the court of appeal in competitionmatters, only altered the decision from theSwedish Competition Authority inasmuch asSAS was ordered, on penalty of a fine of SEK50 million, not to apply, as of 27 October2001, its EuroBonus scheme, or participate inschemes of a similar nature, in such a way asto enable passengers earning points to redeemthem as bonus awards or the equivalent. Theruling applies to domestic air travel in Swedenbetween cities where SAS, or airlines cooperat-ing with SAS on the scheme, encounter com-petition through existing or newly establishedscheduled air passenger traffic. At the momentthis concerns seven routes. The decision wasbased on the Swedish Rule on abuse of domi-nant position. The initiative will hopefully helpreducing the barriers to entry for other airlinesand thereby increase the overall level of com-petition.

The Court defined the relevant market asdomestic scheduled air passenger traffic. Theuniform application of Community law wasnot considered to be jeopardised by such amarket definition, nor was it felt that this defi-nition infringed upon Community law in anyother respect. In the market thus determined,the SAS was considered to have a dominantposition.

The Court then considered the question of

whether the practice constituted an abuse ofthe SAS’s dominant position. According to theCourt, a bonus scheme undoubtedly has a loyalty inducing effect. The allegiance to SASand its partners promoted by the EuroBonusrestricts the possibilities of companies outsidethe scheme to attract passengers. It also makesit more difficult for new entrants to becomeestablished in the domestic Swedish aviationmarket.

The Court continued: As a result of its previ-ous monopoly in this area, SAS has a strongposition on the market. The basic structuralconditions therefore lead to a market situationin which competition per se is limited. TheEuroBonus scheme applied by SAS, with itssignificant loyalty inducing and entry impedingeffects, is placing further obstacles in the wayof proper maintenance and development ofexisting competition in the market. Underthese circumstances, SAS’s application of theEuroBonus scheme cannot be considered anacceptable competitive practice.

Hence, SAS’s application of the EuroBonusprogramme in the domestic Swedish aviationmarket was to be considered an abuse of thecompany’s dominant position.

With regard to SAS’s alternative claim, theCourt expressed the following opinion: Com-petitive conditions in the domestic Swedishaviation market are limited. Competing trafficis only deemed possible at the present time ona limited number of routes. Under these cir-cumstances, an order not to apply or assist inthe application of the EuroBonus schemeshould be restricted to traffic between pointswhere SAS, or an SAS partner involved in thescheme, encounters competition through exist-ing or newly established scheduled air passen-ger traffic. Traffic to cities with one or moreairports, such as Arlanda and Bromma inStockholm, is to be regarded as traffic to oneand the same destination. A penalty sum ofSEK 50 million was deemed adequate.

In reaching its decision, the Market Courtattached considerable importance to the struc-tural state of the market for Swedish domesticair travel and the lack of adequate competitive

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conditions there. In such a situation, the appli-cation of a practice that has a significant loyal-ty inducing effect is not an acceptable meansof competition. Conditions in other marketsand SAS alliance agreements with foreign air-lines did not alter this assessment. Nor wereSwedish national restrictions on the EuroBonusscheme incompatible with Community Law.

The decision applies to all domestic air servi-ces where the EuroBonus scheme is applied bySAS and its partners. SAS may not assist in theapplication of other airlines’ loyalty schemes toservices provided by SAS or its partners. Theinjunction entered into force eight months afterthe decision of the Court and is applied imme-diately as and where competition arises. Thecourt’s ruling that the practice in question con-stitutes an abuse of SAS’s dominant positionwould, however, appear to apply immediately.

6.1.6 Norway

As shown in Chapter 3 above, the Norwegiancompetition legislation remains, as of May2002, in important respects different fromCommunity case law, and hence also fromDanish, Finnish, and Swedish Law.

Being based on an intervention principle ratherthan on a prohibition principle, NorwegianLaw does not in general require proof that anact of conduct constitutes abuse of dominantposition, in order for the NorwegianCompetition Autority (NCA) to be able tointervene against the practice. As noted inSubsection 3.4.3, it is sufficient for the NCA toshow that an action is liable to restrict compe-tition, contrary to the purpose of efficientresource utilisation.

On 18 March 2000, the NorwegianCompetition Authority decided to disallow theSAS air carrier group to award frequent flyerpoints on any domestic Norwegian routes.

The prohibition was issued pursuant to Section3-10 of the Norwegian Competition Act. TheSAS Group filed a complaint with theNorwegian Ministry of Labour andGovernment Administration – the instance ofappeal foreseen by the Competition Act. On

June 7 2002, however, the Ministry turneddown the complaint. The prohibition thusbecomes effective on 1 August 2002.

The SAS Group will still be allowed to awardfrequent flyer points on international trips andto offer their customers any kind of services,including bonus trips inside Norway, inredemption of frequent flyer points alreadyearned.

After the SAS-Braathens merger in December2001, the SAS Group has an approximate 98per cent market share in domestic Norwegianaviation. The NCA views the present interven-tion as an essential step towards reopening theNorwegian market for competition. In view ofthe country’s relatively large aviation market,the NCA believes that there is ample room forcompetition on numerous domestic routes,once an important barrier to entry has beenremoved. Operations based on smaller aircraftmight turn out profitable even on the lessdense routes.

Unlike the situation in Sweden, the prohibitionin Norway applies on all domestic routes,competitive or not. The NCA considers thatsuch an all-out ban may be necessary in orderto dismantle the barriers to entry and reopenthe market for competition. Although the rele-vant market consists of a single city pair, a banaffecting only certain routes would, on accountof the important network economic effects atplay (cf. Section 4.1), still mean that the domi-nant network airline would retain an importantcompetitive advantage, even on the routesaffected by a bonus collection ban.

Moreover, a ban affecting only certain selectedroutes, and this contingent upon the entry ofsome second carrier, might not convey a suffi-ciently unequivocal and transparent message toboth sides of the market – travellers and poten-tial new entrants.

The SAS Group has expressed concern that aunilateral restriction on their FFP would putthe carrier at a substantial competitive disad-vantage in the international market. The NCAhas paid careful attention to this argument, butfinds it exaggerated. In the opinion of the

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NCA, whether or not the SAS Group wouldlose international competitiveness dependslargely on the company’s own business strate-gy. Of particular importance would be whetherand how the company chooses to reallocate thedomestic frequent flyer points now «saved» toits international routes. Among Norwegian cus-tomers, more than half the EuroBonus pointsare earned on domestic routes. Thus, by reallo-cating «vacant» domestic points to their inter-national flights to or from Norway, the SASGroup would, in principle, be able to morethan double their assignment of frequent flyerpoints on these routes, thus enhancing the car-rier’s competitiveness in these city pairs.Although competing airlines might then chooseto respond by similarly boosting their bonuspoint assignment, they cannot, like SAS, dothis without incurring extra costs.

Even if the SAS Group were to face intensifiedinternational competition, the NCA hasexpressed that it fails to see this as a validargument against the prohibition. Enhancedcompetition on routes to and from Norwaywould benefit consumers and the economy ingeneral.

6.1.7 Finland

The Act on Competition Restrictions prohibitsabuse of a dominant position by an undertak-ing or association of undertakings. Article 7 ofthe Act lists examples of abusive and henceprohibited practices which include:• refraining from a business relationship with-

out a justified cause,• use of business terms which are not based on

fair trade practices and which restrict thefreedom of action of the client (e.g. tying),

• use of exclusive selling or purchasing agree-ments without a justified cause,

• application of a pricing practice which isunreasonable or which is likely to restrictcompetition (excessive, predatory, and dis-criminatory pricing practices) and

• use of a dominant market position to restrictcompetition in the production or marketing ofother commodities (e.g. cross-subsidisation).

In the Finnish scheduled domestic air traffic, theonly operators as of May 2002 are Finnair and

its cooperating partner Golden Air. Even beforeAir Botnia’s decision to shut down the domesticoperations, the situation on the domestic marketwas different compared to e.g. Sweden, in thatall passengers travelling on scheduled domesticroutes had the possibility to collect points eitherwith Finnair or with SAS.

Even though the Finnish legislation would inprinciple allow for an intervention of the samecharacter as the Swedish Market Court’sRuling – where SAS’ application of theEuroBonus-programme was prohibited ondomestic routes with competition – such asolution would not be possible in view of thecurrent market situation.

As of May 2002, the Finnish CompetitionAuthority is considering the impact of FFPs, aspart of a larger survey on the Finnish aviationmarkets.

6.2 Corporate discount schemesAirlines conclude discount agreements on airtravel services with their major customers,such as corporations and the public sector.

Usually, the agreements are not very bindingfor the customer. They typically contain a men-tion that the customers seek to concentratetheir air travel purchases to the airline in ques-tion, or that the customer promises the carrier aso-called preferred airline status in its internalcommunication.

The agreements contain provisions on theacquisition and use of flight tickets and theagreed discounts. The conditions may, e.g.,prescribe that the tickets must be obtainedfrom the country affected by the agreement,and impose limits on the use of discount tick-ets and on the changes made to reservations.

Discounts are typically given on the totalamount of purchases made during the agree-ment period and on tickets obtained for sepa-rately agreed routes. The term negotiated faresis used for route and customer specific prices.

Target sums are set in the agreements for dis-counts granted from the total amount of pur-

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86

111 The authors run a regression model controlling for: distance (kms), aircraft kms, airborne hours, fuel cost per seat km, passenger tax per seatkm, wage costs per seat km, population in city pair, employment in city pair, tax revenue in city pair, and the consumer price index.

chases, usually containing one to three steps.When the customer has reached a certain step,the airline commits itself to paying a compen-sation, defined as a percentage off the value ofpurchases. Such payments are usually effectu-ated every 3, 6, or 12 months.

The content of the corporate discount schemesdiffers between customers, in terms of the con-ditions laid down as well as with respect to thesize and form of the discount.

Negotiated prices are usually considerablylower than the prices published by the airlines.Discounts of 30 to 50 per cent are common onbusiness class tickets. Further discounts maybe granted to corporate customers at the timeof purchase.

Exact terms of agreement are defined in nego-tiations between the client managers of airlinesand the clients themselves. When terms anddiscounts are defined, factors such as changesin the companies’ travel needs and the generalmarket development are considered. Terms anddiscounts are affected primarily by the devel-opment of corporate purchases during the pre-vious agreement period and by expected devel-opments during the impending period.

6.2.1 Market effects

Corporate accounts are valuable to airlines.However, during 2000, airlines appear to havelost customers from business classes, partly onaccount of reduced travelling, but also becausecorporate customers have begun to use theeconomy class tickets.

Large companies have considerable buyingpower in relation to the airlines, as shown e.g.in the difference between negotiated and pub-lished prices. Put simply, the most solvent cus-tomers receive the best terms of trade and thelargest discounts.

Due to the large volumes of corporate purchas-es and the considerable benefits granted tothem, corporate discount schemes have a majoreffect on market equilibrium and competition.

Corporate customer schemes have been foundto have clear effects on the general (published)price level in regular service. Steen andSørgard (2001) examine the partial correlationbetween listed prices and corporate discount onfour domestic Norwegian routes. One of theroutes was a monopoly, the other three beingduopolies.

Between 1998 and 2000 three kinds of devel-opments could be observed: (i) The amount ofcorporate customers had increased on all fourroutes. (ii) The level of the lowest negotiatedfares had fallen. (iii) The published C-class(business class) prices had increased.

Other things being equal111, the publishedprices were higher on duopoly routes than onmonopoly routes.

This finding could probably be explained bythe effects of corporate discount schemes.Under monopoly, the airline customers have apoor bargaining position, resulting in smallcorporate discounts. Under duopoly, however,there is rivalry for the corporate clients, result-ing in large discounts. To compensate for thisloss of revenue, and/or to dampen the effect ofa given nominal rebate off a listed price, air-lines are led to increase their published fares.The larger the number of corporate discountagreements concluded on certain routes, andthe larger the discounts granted to companies,the stronger is the pressure on airlines to raisetheir listed prices.

As noted in Subsection 4.2.2, the use of corpo-rate discount schemes may represent importantbarriers to entry. Potential new entrants mightbe deterred by the fact that the incumbent air-

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112 See Subsection 6.113 Commission Decision of 14 July 1999 in Virgin/British Airways, OJ L 030, 4.2. 2000 p. 1-24

line is prepared to offer large, selective dis-counts to the most solvent and attractiveclients.

Although corporate discount schemes amount,in essence, to a set of quantity rebates, many ofthem do have tying effects. Agreements areusually concluded for one year at a time, theterms being affected by the volume of purchas-es effectuated the previous year. Often, thestructure of the agreement or the developmentof negotiations provide the companies with anincentive to concentrate as many of theirflights as possible to one single airline.

The tying effects of corporate discountschemes are alleviated when corporate clientsconclude agreements with more than one air-line or alliance. Even though it might be costsaving to concentrate purchases to one carrier,travel costs are not typically a decisive costitem for companies. Other considerations maymake it rational for companies to spread theirpurchases between several aviation concerns.

6.2.2 Community case law

The discount schemes of dominant companiesare assessed more strictly than the discounts ofcompanies operating in a competitive market.With respect to dominant companies, both loy-alty and target rebates are forbidden under theEuropean competition laws, due to their tyingand harmful effects. This principle was estab-lished in the rulings of the European Court inthe Hoffmann-La Roche and Michelin cases112.

Even dominant companies are allowed to usevolume discounts. However, the use of theserequires that the discount systems be fair andtransparent and treat similar customers in asimilar way. If a company uses differing models of agreements, it must have justifiablecriteria for offering a certain type of agreementto a certain customer. If discounts of differentsizes are granted to different customers, they

must be based on the amount of purchaseseffectuated. In the Virgin-British Airways decision, the European Commission113 referredto previous decisions in the Hoffmann-LaRoche and Michelin cases and found it to beapplicable in evaluating the loyalty creatingeffects of the travel agent agreements used byBritish Airways at the time:

«The Hoffmann-La Roche and Michelincases establish a general principle that adominant supplier can give discounts thatrelate to efficiencies, for example discountsfor large orders that allow the supplier to produce large batches of product, but cannotgive discounts or incentives to encourageloyalty, that is for avoiding purchases from acompetitor of the dominant supplier. Theyalso establish that the two discount schemesthat gave rise to the cases were of that typeand abusive. The commission schemes oper-ated by BA are in breach of this general prin-ciple and are very close in form to that con-demned by the Court in the Michelin case.Although it is true, as BA argues, that casesmust be read in context and that Michelinshould be considered «in the context ofRoche» this cannot mean that a commissionscheme that shows all the same features thatthe Court found determinative in Michelinmust also show the features of the schemecondemned in Hoffmann-La Roche to beconsidered abusive. The two cases takentogether establish that a dominant companycan only give rebates in return for efficien-cies realised and not in return for loyalty, and establish that the two particular discountschemes concerned are of the type thatrewards loyalty rather than efficiencies.»

It would not seem unreasonable to adopt thesame principles in relation to corporate dis-count schemes as well. Some of these agree-ments are constructed in such a way as toallow one customer to receive bigger rebatesfor smaller purchases than another customer

for purchases of larger volume. This kind ofasymmetry and non-linearity could be consid-ered abuse of dominant position.

6.3 Travel agent agreementsTraditionally, airlines have used travel agenciesas a distribution channel for selling flight tic-kets. The cooperation is based on agreementsbetween airlines and travel agencies, the latterusually acting as agents for the former. Thismeans that the flight tickets are the property ofthe airline, and the airlines can, among otherthings, determine their retail price. Airlinecompanies pay travel agencies a commissionon the issuance of the tickets. The amount ofthe commission varies according to the type ofticket involved; for example, the commissionspayable on domestic and international ticketsare different.

In addition, airlines include other incentiveschemes in the agreements. For example, anairline may provide training for the travelagency staff and pay a compensation for itbased on a percentage of the total sales duringthe contract period, or the airline can carry outa marketing campaign, or similar, together withthe travel agency, for which it receives a com-mission. In the interest of efficient competi-tion, the overriding issue is the additionalbonuses on ticket sales.

As a rule, the agreements are made for oneyear at a time. Under the agreements, travelagencies are paid an additional bonus based ona percentage of total sales during the contractperiod. The basis for determining the addition-al bonus is agreed for 6 months at a time.Often, the bonus systems for ticket sales aredevised in the same way as corporate discountschemes. Commissions are based on thresholdsfor ticket sales defined in the agreements. Suchthresholds may be either monetary amounts orindex values. The indices are formulated byassigning a value of 100 to the actual sales atthe corresponding time in the preceding year. A certain additional bonus is paid when athreshold is exceeded. Typically, the additionalbonuses amount to a few per cent:

Sales result (e.g. business class) Bonus

105 1.5 %

110 2.0 %

115 3.0 %

Last year = 100

Usually, both the sales targets and the amountof bonus paid vary according to the type ofticket involved and whether the travel agency’scustomer has a corporate agreement with theairline.

The agreements may also specify a certainbonus on electronic tickets sold through theagencies, or that a bonus is paid on sales thatgenerate Frequent Flyer Programme (FFP)points for customers.

6.3.1 Effects on agency behaviour

Bonuses linked to total sales may give rise toeffects between airlines and travel agenciessimilar to those created by FFPs between air-lines and customers. Benefits related to«economies of scope» are created for travelagencies when arrangements are made to makethe sales efforts on behalf of a single airlineprofitable. If the agreement specifies, as a cri-terion for any additional bonus, that the salesof the airline’s products must reach a certainpercentage of the travel agency’s total sales,the agency has an ever greater incentive tofocus on selling tickets for a certain airline, incontrast to a situation where a bonus is onlypaid for the volumes sold. If the airline’s mar-ket share is included in the bonus agreement,the travel agency will lose the bonus payableby such an airline if it increases sales for com-peting airlines.

The additional bonuses can constitute a signifi-cant part of the profits earned by travel agen-cies. Over the past few years, their importancefor agencies that receive these bonuses hasprobably increased as airlines reduced theirticket commissions during 1997-1998, at leastin Scandinavia. Even though the bonuses areusually of the magnitude 1 to 3 per cent of thesales, their effect on agency behaviour can bequite significant because the bonuses do notrequire any incremental expenditure. Thus the

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bonuses can provide quite a strong incentivefor an agency to concentrate efforts on thesales of a certain carrier.

The impact of these agreements on the opera-tion of travel agencies depends largely on thestructure of the air travel market. If a companyenjoys a dominant position in the air transportmarket and in relation to travel agencies, theagreements may greatly influence the behaviourof individual travel agencies and, consequently,competition in the air transport market.

6.3.2 Effects on the market

The travel agency agreements create the frame-work for a principal-agent relationship betweenthe airline companies and the travel agencies.At the same time, airlines use the agreementsto secure their position in the air transport mar-ket. Specifically for this purpose, the agree-ments offer additional bonuses for the attain-ment of predefined sales targets. By payingcompensation and bonuses for sales and otherperformances, the airlines seek to make theconcentration of sales efforts on their productsprofitable for the travel agencies.

If there is adequate competition between thevarious airline companies, these types of agree-ments can be regarded as acceptable competi-tive tools. However, if the market is dominatedby a single airline, the agreements may have anumber of negative effects.

The more the agreements favour the concentra-tion of ticket sales on a single airline company,and the more dependent the travel agencies areon such a company, the more effectively theagreements prevent entry into the market.

Because airline companies are vertically inte-grated into the travel agency market, bonusagreements are one potential way of favouringthe airline’s own travel agencies. By awardingmore favourable terms to their own agencies,the airlines can improve their relative competi-tive position.

Although travel agencies compete with oneanother, and the customer can ask for quota-tions from several agencies, proper precondi-tions for competition do not exist if, for exam-ple, all the travel agencies in a national marketare dependent on an airline company thatenjoys a dominant market position.

Usually the airline companies do not paybonuses to all travel agencies. It is predictablethat bonus agreements will be made with thebiggest travel agencies, and that smaller players only receive commission for writingtickets. In this way, the effect of bonus agree-ments can become rather significant, depend-ing on the level of concentration in the airtransport and travel agency markets.

Usually the established carriers (flag carriers)are vertically integrated to the travel agencymarket as well. For instance, in Finland in2001, the five biggest travel agencies wereresponsible for 91 per cent of the businesstravel sales and for 85 – 90 per cent of all theIATA-tickets. Two agencies out of these fiveare subsidiaries of Finnair, the flag carrier.

6.3.3 The Virgin/British Airways decision ofthe EU Commission

In 1993 Virgin Atlantic Airways Limited(Virgin) lodged a complaint to the Commissionof the European Union against British Airwaysplc (BA) and its new scheme on travel agentbonuses. The idea of BA’s new scheme was toreward larger travel agents for increasing theirsales of BA tickets. In 1998 Virgin made a sup-plementary complaint when BA reduced thestandard rate of commission to 7 per cent of allsales and at the same time introduced yetanother bonus scheme, this time for all thetravel agents.

The schemes were constructed so that theagents would receive an increased commissionfor the tickets sold if they were able to achievetargets set out in their agreements with BA.The targets were expressed as percentages ofthe agent’s sales of BA tickets the previousyear.

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114 Commission decision of 14 July 1999 (2000/74/EC)115 The principles issued by the Commission used British Airways as an example. Here the company’s name has been replaced with «carrier».

In 1999 the Commission made a decision114 inthe case, where it found the BA schemes to bein breach of Article 82. The Commission statedin its decision that BA was the dominant pur-chaser in the UK market for air travel agencyservices. This dominance was the result ofBA’s position in the UK air travel market. Itoffered significantly more routes to and fromthe United Kingdom than any other airline,accounting, in 1998, for 39.7 per cent of UKsales of air travel through the travel agent set-tlement scheme operated by IATA. This sharewas a multiple of the share of any other airline.The Commission also mentioned BA’s propor-tion of slots at relevant airports. For instance,in the winter of 1998 BA held 38 per cent ofthe slots at Heathrow while the nearest com-petitor held only 14 per cent. As a result theCommission held that BA was «an obligatorybusiness partner for travel agents».

Thus BA’s schemes were considered illegal,since they were in fact loyalty discounts. Thesediscounts were aimed at creating extra incen-tives for the travel agents to concentrate theirefforts on increasing the sales of the BA tick-ets. As a consequence the schemes were fore-closing the market from the dominant firm’scompetitors.

As the market for travel agency services wasdefined by the Commission as national, thefindings of this decision are relevant for all theEuropean countries with potentially dominantflag carriers.

The Commission issued a set of principles thatshould be applied by dominant airline carriersto travel agency agreements after the Virgin/British Airways decision. The principles readas follows:

1. Commissions offered to different travelagents are differentiated to the extent thatthe differences reflect

1.1 Variations in the cost of distributionthrough different travel agents; or

1.2 Variations in the value of services pro-vided to the carrier115 by different travelagents in the distribution of its tickets.

2. Commissions increase at a rate, whichreflects:

2.1 Savings in the carrier’s distributioncosts; or

2.2 An increase in the value of servicesprovided by the travel agent to the carrier in distribution of its tickets.

3. Commissions relate to sales made by thetravel agent in a period not exceeding sixmonths.

4. Commissions do not have targets that areexpressed by reference to the sales made bythe travel agent in the preceding period.

5. Commissions increase on a straight-linebasis above any base line stated in the agreement.

6. The commission paid on any ticket does notinclude any increase in the commissionspaid on all other tickets of the carrier issuedby the travel agent.

7. Travel agents are free to sell the tickets ofany other airline and the goods or servicessupplied by any third party.

Airline companies in a dominant position inrelation to travel agencies should apply thesecriteria in the drafting of travel agent agree-ments of different types and sizes. In their cur-rent form, the existing agreements are hetero-geneous and prepared specifically for eachindividual company. It is probable that someairline companies in a dominant market posi-tion still entertain agreements that do not satis-fy the criteria described above. Competitionauthorities may want to carefully analyse – incase they have not already done so – the travelagent agreements used by dominant carriers,requiring changes in these agreements to theextent necessary for compatibility with theprinciples laid down in the Virgin/BA case.

6.4 Corporate cards and related discounts

Airlines have devised cards that allow corpo-rate staff to travel without a flight ticket byalternatively presenting the card; this is mainlyto facilitate business travel. Also, airlines havecards that can be pre-loaded with a certainnumber of trips or an unlimited number of tripsfor a predefined period of time for a particularroute. When these cards are used, no conven-tional paper ticket is required.

6.4.1 Electronic ticketing and travel passes

SAS has launched a corporate card calledTravel Pass Corporate (TPC) for ticketlesstravel, and a card for pre-loading several tripscalled Travel Pass. In addition, SAS offers anelectronic ticket (e-ticket) for ordinary cus-tomers to replace the conventional paper ticket.Finnair has a corresponding e-ticket for ticket-less travel and the MultiFLYe card for pre-loading.

SAS’s TPC is non-transferable between usersand can be used on flights between Finlandand other Scandinavian countries, and a num-ber of destinations in mainland Europe, Asia,and the USA. The prices are based on the low-est business class rates on which a certain dis-count is granted. In addition, the corporate cus-tomer will receive a bonus afterwards if theymake the reservation themselves on theInternet or through the automatic telephoneservice. There is no minimum purchaserequirement and the tickets are paid for inarrears. Finnair does not offer a similar card.

SAS’s Travel Pass is available for domestictravel in Denmark, Norway, and Sweden, onroutes between the Nordic Countries, orbetween Scandinavia/Finland and selectedEuropean destinations. The Travel Pass is alsoavailable for travel from the United Kingdomto selected European destinations.

A Travel Pass is either Limited or Unlimited.An Unlimited Travel Pass is valid for as manytrips as a customer likes on a specific route orwithin a particular zone or country for a periodof, e.g., 6 or 12 months, depending on the

country and the destination. A Limited TravelPass is valid for a fixed number of trips on aspecific route or particular zone, 12 monthsfrom the date of purchase. The customer maybuy, e.g., 10, 20, or 40 trips at a time. The ticket is non-transferable between users and thelevel of discount increases with the number oftrips purchased.

Finnair’s MultiFLYe is intended for businesstravel between two localities on all Finnair andGolden Air routes in Finland and on selectedinternational Finnair routes (to Sweden,Norway, Denmark, and Estonia). A certainnumber of one-way trips on a specific route arepreloaded onto the card. Seats can be bookedthrough the Internet or WAP services.

The price reduction offered by the card is 10 or 12.5 per cent depending on the number oftrips booked and the destination involved. The customer signs a billing agreement withFinnair, who provides a password and theMultiFLYe cards. The minimum order is 20one-way flights that are valid for 6 months.The trips are not user-limited but can be usedby all of the company employees identified inthe agreement.

The MultiFLYe card gives the following dis-counts: 10 per cent on 20 to 40 domesticflights and 12.5 per cent on a minimum of 50flights. On international flights, the discount is10 per cent of the standard rate for a one-waybusiness ticket for 20 to 90 trips and 12.5 percent for a minimum of 100 trips.

Finnair’s or SAS’s e-Ticket does not, as such,offer the holder any discounts.

6.4.2 Effects on competition

Ticketless systems simplify business travel for corporations. By encouraging companies touse electronic cards, the airlines are able tosave costs related to reservations, issuance of tickets, and check-in. By compensating customers for booking seats, and by the otherbenefits offered to airlines by ticketless travel,in the form of discounts, the carriers make thesystem more attractive to customers.

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Corporate cards are one method employed byairlines to reward customers for concentratingtheir travel purchases, and so their impact oncompetition does not differ from the impact ofother corporate discounts. The volume discountoffered to customers encourages them to max-imise the reduction in price and to buy therequired number of tickets from one and thesame airline. As a result, a company with fre-quent fliers has valid reasons for acquiring acorporate card. The number of trips purchasedmay be somewhat limited by the fact that thebookings are only valid for 6 to 12 months.Consequently, companies probably buy fewertrips on the cards than they actually fly, reload-ing it when more trips are needed. Because thediscount percentage is determined by the num-ber of trips purchased at any one time, thegreater discount percentage may be out ofreach for smaller companies.

From the point of competition and economicefficiency, the acceptability of rebate schemesmay depend on whether they are linked to cor-responding cost savings.

A corporate card facilitates corporate traveladministration and offers savings both to thecompanies and the airlines. Compared withconventional travelling with a paper ticket, thedifference is that a company buys a certainnumber of seats in advance without necessarilyknowing exactly when they will be used. Thisrebate can be regarded as a volume discountgranted for a purchase of a certain size. Byusing the corporate card, it is possible to by-pass one intermediary, i. e. the travel agency,between the customer and the airline. If thecustomer, for instance, books the flight on theInternet, the amount of work required on thepart of the airline is reduced even further.Therefore, it is safe to assume that certain sav-ings are made. On the other hand, the volumesinvolved when making one-off purchases aremuch lower than in the case of traditionalannual agreements. Presumably, the discountsgranted are also lower. On the face of it, dis-counts granted to holders of corporate cardsappear more justified than discounts based oncontracts. However, the acceptable amount ofthe discount must be determined as explainedabove.

Ticketless air travel is growing relative to con-ventional travel with paper tickets. For exam-ple, SAS is determined to increase the volumeof ticketless travel considerably. Such a changemay have far-reaching implications for travelagencies and their profitability. In turn, thismay lead to accelerating centralisation. To theextent that bypassing one intermediary in thesupply chain improves efficiency and reducesproduction costs, the implications for cus-tomers may be beneficial despite increasingconcentration.

To the extent, however, that e-ticketing is notbased on open standards, but requires the trav-eller to hold an electronic card specific to aparticular carrier or alliance, such a ticketingsystem may be liable to restrict competitionbetween airlines. This is particularly so if e-ticketing is integrated with the airline’s fre-quent flyer programme, by making use, e. g.,of the FFP membership card.

6.5 Computerised reservation systems The Council has adopted a Regulation(2299/89) on a code of conduct for comput-erised reservation systems (CRS). According tothe regulation, CRS shall mean a computerisedsystem containing information about, interalia, air carriers’ schedules, availability, faresand related services with or without facilitiesthrough which reservations can be made ortickets may be issued, to the extent that someor all of these services are made available tosubscribers. The Regulation states that theCRSs, when properly used, may provide animportant and useful service. To ensure this,the Regulation includes a number of provisionsrelated to fair and non-discriminatory service,the accuracy and transparency of the informa-tion supplied to the system and unfair contractterms.

CRSs provide services to both travel vendorsand subscribing agencies. Most of the CRSsare owned by airlines. The major CRSs arecomprised of a core facility, a holding compa-ny, which provides its functionality, andnational marketing companies, which distributeand support the CRS services in national orregional markets. For instance, in Finland,

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Finnair holds 95 per cent of the capital stock ofAmadeus Finland, a distribution company forthe reservation system supplier AmadeusGlobal Travel Distribution. Amadeus GlobalTravel Distribution holds the remaining 5 percent of Amadeus Finland.

CRSs are essential to all but the smallest full-service agencies. In 1995, it was estimated thatover 85 per cent of IATA agency sales ofscheduled airlines services were arranged viaCRSs. These systems appear essential for allbut the smallest carriers.

6.5.1 How do CRSs work?

A national licensee or a marketing companysigns agreements both with the system sub-scribers and with the vendors selling theirproducts through the system. Travel agenciesare not charged any admission fee to join thesystem; they only pay for any computer accessor other technical services. Only the vendorsoffering their products for sale via the system(such as airlines and tour operators) arerequired to pay for the listing of their productswithin the system.

Two types of searches can be performed in thesystem: if a neutral search between two citiesis made, the system returns all the flights andclasses with free seats in a neutral order. Thismeans that the system shows all the flights inthe order of superiority, which is based onflight time and the type of flight, so that a non-stop flight is considered better than a flightwith an intermediate landing, which again isconsidered better than a flight with an interme-diate landing involving a change of planes. Atpresent, all airlines are required to report flighttimes to an accuracy of five minutes. The ruleswere tightened because some airlines werefound to be trying to improve their relativeposition by reporting excessively short flight times to an accuracy of a minute.

For commercial duplicates, i. e. in cases wherethe marketing company is different from theoperating one, the system shows both the company marketing the flight and the airlineactually flying it. In accordance with theCouncil Regulation, only two physically

identical connections are displayed for suchflights on the screen at any one time. Primarily,the system will show the online connections operated by a single company, the connectionsoffered by airlines belonging to the samealliance, and «true interline» connections.

Searches can be performed according to timeof departure or arrival, or according to totalflight time. With additional attributes, it is possible to limit the search by specifying theairline, alliance, or stop-overs. These types of«partial searches», showing only the flights ofa particular airline or alliance, are normallyused when specifically requested by the cus-tomer. Amadeus offers travel agencies a specialValue Pricer service that allows the agencies tosearch for flights according to price.

The marketing company providing systemaccess configures each terminal to specifywhat/whose information it is capable ofretrieving. As a rule, travel agencies can accessthe information of airlines and the tour opera-tors they represent, the airlines can see theirown information plus that of other airlines,while the tour operators usually have accessonly to their own information.

6.5.2 Global CRSs

The major CRSs – Amadeus, Sabre,Worldspan, and Galileo – are able to providetwo different types of booking facilities: oneadapted to traditional travel agencies and oneadapted to the Internet for online travel agen-cies. To the extent that they contain air trans-port products, when offered for use and/or usedin the territory of the Community, they mustcomply with the abovementioned RegulationEEC 2299/89.

Only some CRSs are used globally. In theNordic countries, Amadeus, Sabre, and Galileoare the most commonly used.

Amadeus was founded in 1987, and has beenfully operational since 1992. Since 1999 it hasbeen a publicly listed company. Three founderairline shareholders currently hold 59.92 percent of the company: Air France (23.36 percent), Iberia (18.28 per cent) and Lufthansa

(18.28 per cent). The remaining shares are heldpublicly. Amadeus’ headquarters are in Madrid,Spain. The worldwide market share ofAmadeus is approximately 35 per cent. Itsshare is about 60 per cent in Europe and 80-95per cent in Norway, Sweden, and Finland.

Through the Amadeus system, over 55 000travel agency locations and almost 8 500 air-line sales offices in 199 countries are able tomake bookings with around 500 airlines, repre-senting more than 95 per cent of the world’sscheduled airline seats.

Sabre is listed on the New York StockExchange and has its headquarters in Dallas,USA. At the moment, the AMR Corporation –a parent company to American Airlines – holdsthe majority of the shares.

Sabre connects more than 59 000 travel agentsaround the world, providing content from 450airlines. Sabre’s market share in Europe isapproximately 14 per cent.

Galileo International was founded by majorNorth American and European airlines: AerLingus, Air Canada, Alitalia, Austrian Airlines,British Airways, KLM Royal Dutch Airlines,Olympic Airways, Swissair, TAP Air Portugal,United Airlines, and US Airways. In 1997,Galileo International became a publicly tradedcompany, listed on the New York and ChicagoStock Exchanges, with headquarters in the USA.

The Galileo and Apollo systems connect over178 000 subscriber powered workstations toover 500 airlines throughout the world. Thereare over 44 000 travel agents at locations in115 countries. Galileo’s market share inEurope is less than Sabre’s.

Worldspan was founded in 1990. It has head-quarters in Atlanta, USA. The Worldspan reser-vation system contains more than 20 210 travelagencies that are able to make bookings with533 airlines. Worldspan serves customers innearly 70 countries or territories worldwide. It

is owned by affiliates of: Delta Air Lines, Inc.(40 per cent), Northwest Airlines (34 per cent),and TWA Airlines LLC – a wholly-owned sub-sidiary of American Airlines, Inc. (26 per cent).

Of the four CRSs listed above, Worldspan hasthe smallest market share in Europe.

6.5.3 Effects on competition

The Commission has stated in its decisions thatthe GDS116 market includes the provision ofGDS (or CRS) over the Internet to virtual travel agencies, as well as the provision of traditional systems to non-virtual travel agen-cies. The relevant market for the abovemen-tioned major GDSs/CRSs has usually beenregarded as national in character, mainlybecause the conditions of sale vary from country to country, and because travel agenciesoperate in national markets.

Assessing the competitive and efficiencyeffects of CRSs is difficult. A reservation sys-tem is a necessity for travel agencies, and asystem without price information is of no use.The problem arises from the fact that, throughCRSs, the entire global market for passengertransport by air becomes completely transpar-ent when it comes to prices. This again facili-tates both explicit and tacit collusion and willcertainly have a negative effect on price com-petition between different carriers. All futurefares of airlines are available over CRSs.

Through the CRSs, all airlines are aware ofmost of the prices applied by the other airlines.The only prices not disclosed in the system arecorporate rates negotiated specifically by eachindividual customer. Also, a travel agencyowned by an airline can find out about theprices of the airlines and tour operators includ-ed in the system. Transparency applies to thepackage tour market as well. The decision bythe Finnish Competition Authority (5 April2000) concerning an acquisition by Finnmatkatstates that the CRS contributes to transparencyin the package tour market and may thus facili-

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116 Global Distribution System

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117 Case IV/M.1524 L093 13.4.2000, p. 1-33. 118 OJ C239, 30.7.1998, p. 4119 OJ L040 13.2.1999, p. 1-8.

tate the attainment of a dominant market posi-tion. A similar conclusion was reached by theEuropean Commission in the decision onAirtours/First Choice.117

Bohrenstein (1992) writes in his article «Theevolution of US Airline Competition» as follows:

«It appears to be common practice for an air-line to announce, through the CRSs, that itsprice on a certain route will increase by someamount beginning on a certain date in thefuture. The carrier then waits to see if otherswill match. If they do, the price increase isimplemented. If they don’t, the airline sug-gesting the increase will either withdraw it orpush back the implementation dates. Otherairlines might counteroffer with a smallerincrease, effective a day after the firstincrease. Then the first airline may proceedwith a smaller increase or counteroffer again.All of this occurs without the airlines chang-ing prices on actual sales…»

Each CRS enjoys a strong position in the coun-try in which it is, or has been, owned by theflag carrier of that particular country. Forexample, Amadeus’ market share in Finland isabout 95 per cent. Once a travel agency hasacquired a certain system, its willingness toswitch to a new system diminishes significant-ly. This is so because the agency’s other sys-tems are designed to support the existing seatreservation system. When an existing system isreplaced by a new one, additional cost isincurred.

The owner of the CRS can also restrict compe-tition by charging a high fee for access to theessential facility, in the form of high chargesfor each ticket issued through the CRS. UnderEC rules, a CRS must charge the same bookingfees to all airlines, but such a non-discrimina-tion rule cannot affect the price or cost paid bythe airline-owner for booking its own tickets.As with other vertically related services, there

is a concern that the airline owning the CRSmay use its dominant position over the CRS torestrict or prevent competition in the airlineindustry. Initial concerns focused on the possi-bility that the airline owning the CRS woulddisplay its own flights more prominently thanthose of its competitors.

When investigating the LH/SAS/UA andBA/AA alliances, the Commission looked intothe possibility that the flights of allied airlinesor their partners displayed on several rows in acomputerised reservation system may com-pletely fill the first page, particularly on routeswith a large number of flights. According to itsnotice of 30 July 1998118, the Commissionintended to identify the flights that must bedisplayed on a single row in a CRS. In accor-dance with the subsequent amendment of 8February 1999119 to Regulation 2299/89, onlytwo physically identical connections may beshown on screen for commercial duplicates. Tothe extent that these regulations are adhered to,the concern that a single alliance’s flights mayfill the entire screen would seem unjustified.

Airlines are vertically integrated into the travelagency and tour operator markets, too. In a sit-uation where a travel agency or tour operatorowned by an airline, or an independent travelagency or tour operator, joins the CRS, dis-criminatory practices may arise if the CRS isowned or controlled by an airline.

Vertical integration can – at least in principle –facilitate the abuse of information stored in atravel agent’s CRS, for the purpose of a singleairline’s commercial marketing. A carrier thatobtains access to information on the bookingsmade with competing airlines may, e.g., beable to selectively undercut prices or offersextended by these competitors to specified,attractive customers, without risking the loss of revenue connected with general fare reductions. There may be reason to investigatewhether the control and enforcement mechanisms currently implemented for CRSs

are sufficient to preclude such practices, whichare to be considered discriminatory and clearlypredatory.

6.6 InterliningThe Commission Regulation (EEC) No.1617/93 of 25 June 1993 Article 4 grants theairlines within the European Union a blockexemption for consultation on passenger tariffswith the aim of facilitating interlining. Article5 of the Regulation grants the airlines a blockexemption for consultation on slot allocationand airport scheduling. The Regulation becamepart of the EEA-agreement when the agree-ment was established in 1994 and thus grantsthe airlines of Norway and Iceland the samebenefits as the airlines within the Community.

The Commission Regulation (EEC) No.1324/01 of 29 June 2001 prolonged the exemp-tion for consultation on passenger tariffs, Art.4, to 30 June 2002 and the exemption for con-sultation on slot allocation and airport schedul-ing, Art. 5, to 30 June 2004.

6.6.1 Description of interlining

The interlining system allows passengers tobuy a single ticket in one transaction and inone currency for a journey consisting of multi-ple sectors, where passengers may travel bydifferent airlines on/through different sectors.The system allows passengers the possibility tochange flights, airlines, and routings beforeand during their journey between A and B. Thesystem also allows passengers to travel to theirdestination by one airline and return by anoth-er, including one-sector journeys. In principle,passengers can choose between all airlines par-ticipating in the interline system.

The through baggage and ticketing check-inservice is an important part of the interline sys-tem. This service limits the number of check-ins to one, although the journey may involvemore than one airline and more than one sector.

6.6.2 IATA Passenger Tariff Conferences

In the opinion of the International AirTransport Association (IATA), the system ofinterlining cannot be maintained unless the airlines are allowed to consult each other onwhat fares they can charge from passengers.These consultations are conducted duringIATA Passenger Tariff Conferences. Theconsultations establishing interline fares within Europe take place during the meetings«Within Europe sub-area» of Passenger TariffCoordinating Conference 2. The meetings areheld three times a year and address changes to pre-existing fares, charges, and related conditions for different types of interline tickets.

6.6.3 IATA resolutions/agreements and conferences regarding interlining

IATA decides on and manages a number ofother agreements (resolutions) which are anessential part of the interline system. TheMultilateral Prorate Agreement decides therevenue distribution among participating air-lines. The agreement describes a weightingsystem which determines how much an airlinewill receive when carrying a passenger with aninterline ticket on any given sector of a jour-ney. The Multilateral Interline TrafficAgreement binds participating airlines to issueand accept each other’s tickets according to thefares and conditions decided by the carryingairline. The IATA Passenger Agency Programis an agreement between airlines and travelagents, that determines the conditions underwhich agents can issue tickets for all IATA air-lines. The IATA Passenger Service Conferencesagree on common standards in areas such asbaggage handling and ticketing and on com-mon rules for fare construction such as agreedmileage and currency conversion.

6.6.4 Effects of interlining for passengers

A major advantage of the interlining system isthe flexibility provided. It allows passengers tochoose among all participating airlines’ flightsbetween two destinations when a journey cov-ers one or more sectors. Passengers can also

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120 To choose among different routings between two destinations implies that passengers can choose to travel via Paris, London, Frankfurt etc. on a journey from e.g. Oslo to Athens.

choose between different routings120 betweenthe destination of departure and the destinationof arrival on a journey covering multiple sec-tors. The interlining system allows this flexibil-ity for both fully flexible and discounted tick-ets before the journey takes place. Passengersbuying fully flexible tickets may in additionchange their routings, time of arrival anddeparture, or carrying airline, during their jour-neys.

This flexibility reduces the travel time becauseof the increased number of options to passen-gers regarding carriers, flights, and routings.The interlining system may be particularlyadvantageous in sectors where the airlinesoffer just a few flights a day. The reduction oftravel time is particularly valuable for businesspassengers, who tend to value travel time high-ly, relative to travel costs.

On several occasions, IATA has emphasisedthat the way interline ticket fares coveringmore than one sector are constructed, is amajor advantage to passengers. The throughticket fare is the sum of the ticket fare of eachsector decreased by a discount. Without theIATA price collaboration, ticket fares coveringmore than one sector will simply be the sum ofticket fares of all sectors without any discount,which will result in more expensive tickets.Another point stressed by IATA is that withoutprice collaboration, different routings betweentwo destinations will result in different fares.These advantages will be further examined inSubsection 6.6.6.

The through baggage and ticketing check-inservice is another major advantage of the inter-lining system. The service limits the number ofcheck-ins to one during a journey involvingmore than one sector. It will make transfers ofpassengers between airlines less time consum-ing for both passengers and airlines. Thus theservice reduces the duration a journey, to theadvantage of both passengers and airlines. Itmay also reduce the airlines’ costs caused bypassenger transfers.

The through ticketing service reduces the num-ber of travel documents to one. This advantageseems to be less significant but may reduce theairlines’ costs of issuing tickets and may ofcourse make a journey less troublesome for theabsent-minded passenger.

6.6.5 Effects of interlining for smaller airlines

The interlining system has been claimed to beadvantageous for smaller airlines. This point ofview may at least be questionable.

Presumably, one advantage is their possibilitiesto issue tickets to destinations where they haveno service. If the smaller airline does not faceany or very little competition on its routes/sec-tors, passengers have no alternative to the small-er airline’s service regarding air transport. Whenproviding interline through-tickets, at (discount-ed) IATA prices, this may increase demand forits services and thus the airline’s revenue. Onthe other hand, this will also give passengersthat nevertheless travel by the airline an optionto buy cheaper tickets. That may reduce the air-lines’ revenue from these passengers. It is diffi-cult to predict in general terms what the neteffect on the airline’s income will be.

The interlining system may be to the advantageof the smaller airline if it faces competition inits sectors from a larger airline, and if both air-lines have only a few arrivals/departures in thesectors in question. The interlining system willresult in more flexibility by allowing passen-gers to choose among both airlines’ flights.This may increase the number of passengerstravelling by the smaller airline and increase itsincome. Because this flexibility is of particularimportance to time sensitive business passen-gers, the system may increase the smaller air-line’s market share in this market segment,which will be particularly profitable.

The advantages of the system for the smallerairline may be less obvious if the larger airlinehas a substantial or much larger proportion ofthe arrivals/departures in the sectors in ques-

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121 This subsection relies heavily on the study by Economic-Plus Limited GRA, Inc. (2000)

tion, compared to the smaller one. Under thesemarket conditions, the flexibility of the inter-line tickets may be less valued. The time sensi-tive business passengers may thus be less like-ly to buy substantially more expensive IATAtickets than airline unique tickets. If, in addi-tion, the larger airline participates in analliance, it will be able to provide passengerswith alliance unique tickets covering a largerange of destinations in addition to destinationscovered by its own network. The demand forinterline tickets may then be further reduced.But there is at least one example of the inter-lining system’s importance to smaller airlines’competitiveness.

In 1996 the Swedish Competition Authority(SCA) initiated legal proceedings againstScandinavian Airlines System (SAS) for theimposition of a fine of SEK 10 million for theundertaking’s refusal to conclude an interliningagreement with a significantly smaller com-petitor, Nordic European Airlines. The CityCourt ruled in favour of the Authority and con-sidered that SAS by virtue of its refusal hadabused its dominant position. The City Courtimposed fines of SEK 1 million on the groundsthat the practice had only been operating for ashort period (around 8 months) and that itseffects had been limited. Both SAS and theAuthority appealed to the Market Court, whichupheld the decision of the City Court.Participating in an interlining system was inthis case judged to be important to the smallerairline’s ability to compete with the dominantairline.

In conclusion, it is questionable whether theinterlining system in general offers any signifi-cant advantages to smaller airlines. When boththe small and the large airline have only a fewarrivals or departures each in a specific sector,the interlining system may create more demandfor the smaller airline’s services. As shown bythe abovementioned case, however, interven-

tion by the competition authorities is some-times necessary in order to secure these advan-tages for the smaller airlines.

6.6.6 Economic importance of interlining 121

One indication of the importance of interliningis the proportion of the tickets that are actuallyused to interline. Another indication is the proportion of tickets sold that allow for interlining.

The Norwegian Competition Authority (NCA)requested in 1997 information from the threelargest domestic airlines on the amount ofinterline tickets sold on domestic Norwegianroutes, and on how large proportions of thesetickets were actually used to interline. The firstfinding of the NCA was that the airlines’ statis-tics on this matter were varying in accuracy.Based on the information received, the NCAdid find that the proportion of tickets thatcould be used to interline, was about 44 percent (by volume). The proportion of ticketsused for interlining was estimated to be about16-20 per cent (volume figures) of the totalannual sale of tickets.

From the European Commission DGCompetition’s consultation paper «IATAPassenger Tariff Conferences» of February2001, we learn that about 30 per cent of allintra-EU passengers buy a ticket allowingsome form of interlining. This number alsoincludes a large (but not specified) number ofnon-IATA tickets. Non-IATA interlining is alsoknown as «club» or «bilateral» interlining andis based on commercial agreements betweenairlines. These agreements do not involve coordination of passenger fares. They are treated as technical cooperation underCommission Regulation 3975/97 and are notcaught by Art. 81(1). Fully flexible interlinetickets are used by about 10 per cent of allintra-EU passengers.

One cannot, however, simply add togetherbusiness passengers’ expenditure on fully flexi-ble interline tickets in order to assess their util-ity of such tickets, for the following reasons.

Business passengers may wish to buy fullyflexible interline tickets because they need tobe able to change their arrival or departuretime or their routings during a journey. Theimportance of these tickets to business passen-gers can thus be measured by the amount ofmoney they spend on these tickets or by thenumber of these tickets they buy comparedwith the total number of tickets sold. But thisapproach assumes that the business passengersare free to choose among different types oftickets on an equal basis. Usually one can buya fully flexible ticket closer to the departuretime than a less flexible ticket. This will leavebusiness passengers no other option but to buya fully flexible ticket on journeys that aredecided upon at short notice. Another questionis to what extent less flexible tickets are pro-vided on different routes compared to the pro-portion of fully flexible tickets. A third rele-vant point to make is whether or not the possi-bility to collect more FFP bonus points/milesincreases the probability that the business pas-sengers buy more expensive, fully flexibletickets.

In a meeting with the Scandinavian transportand competition authorities on 8 January 2001,IATA representatives presented an analysiscontaining an estimate of consumer benefitsattributable to the fare and service features ofinterlining. This part of the report was basedon statistical data for international routes toand from USA. If the results of the analysiswere to be representative on a global basis, itsestimates imply that the annual consumers wel-fare losses without IATA interlining would beabout US$ 2.9 billion on a global basis.

In order to calculate consumer benefits fromthe service effect (the through baggage andticket check-in system), the assumption wasmade that without the IATA ServiceConferences, passengers must spend more timeto make connections between less coordinatedservices on a multiple sectors journey. It wasassumed that the minimum connecting time

would be increased by 30 minutes.

As for the fare effect, the assumption was thatwithout the IATA Tariff Conferences, the air-lines would only accept a sum of sector faresregarding interline tickets covering more thanone sector. Today, these fares are the sum ofsector fares reduced by a discount.

The latter assumption is questionable, to saythe least. It is rather difficult to predict whatsector fares will emerge in the markets withoutthe IATA Tariff Conferences. Prices establishedin markets by collaboration among theproviders will generally be higher than pricesestablished independently by the sameproviders under free competition. Chances arethat fares would be considerably lower on mostsectors, were it not for the IATA price collabo-ration.

Another advantage claimed for IATA interlin-ing system is that different routings betweentwo destinations will have the same fare. Butthe fact that different routings may get differ-ent fares is not a competition problem, nor aneconomic efficiency problem, if passengersremain free to choose among the different rout-ings. On the contrary, such a system may pro-vide sound incentives for carriers and passen-gers to choose short and energy economic rout-ings.

The Nordic competition authorities do notquestion that the flexibility of the interline sys-tem and the through baggage and check-inservice as such are advantageous to passengers.However, we find reasons to question whetherthe advantages of the IATA Passenges TariffConferences are larger than the drawbacks. Wealso do not think that the price collaborationsystem is necessary to maintain the interliningsystem.

The alliances have been able to offer allianceunique tickets to an increasing number of des-tinations. In the US, very few tickets are nowsold or used for interlining. A similar develop-ment may be foreseen in Europe. Along withthe growth of global alliances, the importanceof the IATA interlining system is, generallyspeaking, likely to decline over time.

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122 DG Competition Consultation Paper «IATA Passenger Tariff Conferences» of February 2001, Annex 1.

6.6.7 Anti-competitive effects of IATAPassengers Tariff Conferences

When considering the anti-competitive effectsof the IATA Passengers Tariff Conferences, oneshould take into account the number of airlinesparticipating and the number of routes andfares in question. One should further considerwhat information is exchanged by the partici-pants of the IATA conferences. In additionthere is a need to examine if fares establishedat the IATA conferences have any influence onthe airline and alliance unique fares, which areset independently by each airline and alliance.

According to IATA122, as many as 39 Europeanairlines participate in the meetings of «WithinEurope sub-area» of the Passenger TariffCoordinating Conference 2. The airlines establish at least one fare for each one of 6 950origin-destination pairs within the EEA. Fullyflexible and promotional/discounted fares areestablished for about 6 700 routes. It is diffi-cult to find any statistics, which provide accu-rate information about IATA tickets’ proportionof annual sales (volume figures) on the routes.But the number of airlines participating in theconsultations and the number of routes in ques-tion suggest that the anti-competitive effectsmay be substantial. The findings of DGCompetition, which indicate that on around 45 per cent of the busiest EU-routes (in 1997),no airline offers other flexible business-classtickets than the IATA fully flexible fare, dosupport this conclusion.

The IATA tariff conferences may have otheranti-competitive effects in addition to thosefollowing from consultation on fares. The tariff conferences provide a unique forum forbilateral and multilateral exchange of informa-tion, of a kind that would hardly be allowableunder Community or national competition law,were it not for the block exemption. Airlinemanagers may discuss whether or not to amendIATA fares and conditions in all classes

between all airports in their countries. Thesediscussions allow airlines to share their analy-ses of why some routes are under- or over-priced, and of how business and full economytickets should be priced in relation to cheaperfares. The airlines thus obtain informationabout the thinking behind their competitors’pricing strategy, something which is rarelyseen in other industries or markets. This obvi-ously is liable to restrict competition amongairlines.

6.6.8 Interlining without price consultations

The through baggage service implies that pas-sengers do not have to take care of their bag-gage when transferring between flights of dif-ferent airlines. This service is based on com-mon standards for classification of the bag-gage. From a technical point of view, this serv-ice may be maintained without IATA price col-laboration.

The IATA claims that this service is part of thejoint (interline) product, the price of which isdetermined through price/fare consultations. Ifthe airlines cannot establish a common price ofthe product on IATA conferences, the airlineswill have no interest to maintain any part ofthe joint product. This point of view indicateseither that the through baggage service is of noadvantage to the airlines themselves, or that theairlines will not behave like «economic men»in the markets.

It is, however, rather likely that this servicedecreases the airlines’ cost for passenger trans-fers. And it does not stand to reason that theairlines should close down an operation thatreduces their costs.

In its Consultation Paper «IATA TariffConferences» of February 2001, DGCompetition presented two options to maintainthe interlining system without the tariff consul-tations, both of them highly interesting.

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123 Council Directive 96/67/EC of 15 October 1996 on access to the ground handling market at Community airports. 124 A coordinated airport is defined in the Slots Regulation as an airport for which a coordinator has been appointed, whose task is to facilitate the

operations of airlines operating or intending to operate at that airport. A fully coordinated airport is a coordinated airport where, in order toland or take off, during the periods for which it is fully coordinated, it is necessary for an airline to have a slot allocated by a coordinator.

One option would be to create a system where-by the airlines inform each other on whatprices they would charge on any given route inorder to carry the passengers of other airlines.These prices could then be considered as«wholesale» prices, which would be basis forthe airlines’ construction of interlining tickets.

Another option would be that the airlinesinform each other on what fares they offer thepassengers in each sector («retail» prices). Onthis basis, passengers would be allowed tocombine any number of different routes or sec-tors and different airlines.

Both options require that the airlines have asystem for posting their prices so it can be pos-sible to calculate and issue interlining tickets.There is, however, reason to think that such asystem would mean less transparency of faresbetween airlines and hence probably moreintense competition, without jeopardising theefficiency gains connected with interlining.

6.7 Airport capacity Since the liberalisation of European aviation inthe 1990s, there have, in principle, been noregulations limiting free market access for airtransport within the EEA zone.

In practice, however, market access and devel-opment have been hampered by the scarcity ofinfrastructure services. First of all, airlinesneed airtime and air traffic control (air slots).Second, they need starting and landing time ona runway (airport slots) in the airport of depar-ture as well as in the airport of arrival. Third,they need access to other airport facilities andservices, such as terminals, gates, and groundhandling services, i. e. catering, baggage han-dling, security control, de-icing, maintenance,and refuelling of the aircraft.

In principle, all three factors might, in a givensituation, effectively limit the access to themarket for air transport. At present, however,only airport slots constitute a scarce resource.The supply of ground handling services is,generally speaking, large enough to meetdemand, and the constraints on capacity of airtime and air traffic control are not binding.In some instances airlines complain that theground handling services are not always supplied at non-discriminatory terms.However, the problem may appear limited inthe major European airports. All EU airportswith more than two million passengers a yearare required to open the market for groundhandling services to independent suppliers.123

In order to deal with the slot scarcity problem,many European airports are designated as so-called coordinated or fully coordinated air-ports.124 The European Commission has drawnup a number of requirements that must be metbefore an airport may be designated as coordi-nated. Once the requirements have been met,the Council Regulation (EEC) No. 95/93 of 18January 1993 on Common Rules for theAllocation of Slots at Community Airports,henceforth referred to as the Slots Regulation(see Subsection 6.7.3), will apply at the airport.

But in practice, capacity problems and regula-tory shortcomings still tend to make it difficultfor airlines to obtain the slots they need inorder to develop their services. In particular,this applies to new entrants. One reason is thatincumbent airlines have long-established rightsin the form of so-called grandfather rights (see Subsection 6.7.2).

Thus, opportunities for establishing new services are limited, and competition is beinghampered on existing services. If incumbentairlines were to lay claim to all available slots,this would represent an obstacle for a potential

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125 This section does not deal with air slots, i. e. the right to use specified airspace. There are many different terms to describe takeoff and landingslots. In this document, the term slots will be used for takeoff and landing slots, for arrival and departure times, as well as for movements.

126 OJ C 270 E/131, 25.9.2001.127 Article 8.1a of the Slots Regulation.

competitor. In theory, an incumbent airlinemight choose to fly at low capacity specificallyfor the purpose of preventing a competitorfrom starting up on a certain route.

6.7.1 The definition and ownership of airport slots

Under the Slots Regulation, an airport slot isdefined as the scheduled time of arrival ordeparture available or allocated to an aircraftmovement on a specific date at a coordinatedairport (Article 2a)125.

The definition of arrival and departure times inthe Regulation only refers to actual situations.Airlines have contended that slots are theirproperty, on which they have based their net-work of routes. On the other hand, airportsclaim right of ownership to the slots on thegrounds that the slots are inseparable from air-port infrastructure. It is important, therefore, toclarify the legal position of slots and create thekind of stable conditions for slot allocation thatwould enable both airlines and airports to plantheir operations to the greatest possible benefit.

To solve this ownership conflict, an amend-ment to the Slots Regulation has been pro-posed126. The amendment defines a slot as theentitlement of an airline to use a coordinatedairport on a specific date and time for the purpose of landing and take off as allocated bya coordinator in accordance with the SlotsRegulation. This makes clear that access toslots does not confer any right of ownership.Access to a slot only gives the carriers theright to take off and land and access to the airport facilities on specific dates and at specific times.

6.7.2 The role of the International AirTransport Association (IATA)

Slot allocation is a complicated procedure thatinvolves coordination between a large numberof airports with the same kind of capacityproblems all over the world.

The International Air Transport Association(IATA), the representative body of the airlinesindustry, has a strong position in this coordina-tion process. Since 1947, slots at the variousairports of the world have been allocated inaccordance with the World-wide SchedulingGuidelines (WSG) from IATA. The guidelinesin WSG contain administrative rules of proce-dure and recommendations concerning order ofpriority in the slot allocation system.

The airlines meet twice a year for schedulingconferences, the objective of which is to facili-tate and develop flight connections etc. for theforthcoming season. All airlines have foundthese conferences to be in their interest. Theconferences are aimed at all airlines and coor-dinators on a global basis.

The slot allocation conferences are held aboutthree months before the season begins. Prior toeach conference, carriers present their slotrequests to the coordinator for the airport con-cerned. By applying the WSG principles, thecoordinating body in IATA then compiles theschedules in strict secrecy.

One of the most fundamental priorities in theWSG principles is the principle of grandfatherrights. This principle is a «use or lose it» rule,which means that if an airline has used an air-port slot in accordance with the instructionsfrom the coordinator, the airline is entitled toclaim the same slot in the next equivalentscheduling period127. Basically, the principle ofgrandfather rights states that airlines can claim

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128 See Article 10.3 and 10.5 of the Slots Regulation. 129 In the Slots Regulation this is described as follows: In process of the slot allocation, for each coordinated period, a pool of free slots has to be

created. The pool must contain new slots, unused slots, and slots that are given up or have become available for other reasons.130 The Slots Regulation applies only when an airport is classed as coordinated.131 The criteria for airport coordination are specified in Article 3 of the Slots Regulation.132 See Pricewaterhouse Cooper (2000).

the same slot in the next period if they candemonstrate that they have exploited the slot at least eighty percent of the time during theperiod for which it had been allocated128.

In addition, the WSG gives priority both tochanges in schedule and to new entrants. Newentrants are entitled to fifty percent of the slotsin what is termed the slots pool129, once theinitial allocation of established times has beencompleted and changes in schedule have beensorted out. Times that are not utilised are to bereturned to the coordinator for reallocation.Commercial traffic is given precedence overmilitary and other non-commercial traffic. All-year traffic is given precedence over othertraffic.

The IATA system is founded on a specific air-line administering the allocation of slots at oneor more airports. In Europe, it used to be com-mon practice for the national carriers to allo-cate the slots at their country’s airports.

6.7.3 Slot regulation in the EU

In 1993, the EU introduced binding rules forthe aviation field by adopting the SlotsRegulation130. The aim was to create a com-mon set of rules for slot allocation to fit thenew liberalised European airline industry.

The Slots Regulation requires each MemberState to decide whether an airport should besubject to coordination131 and prescribes certaininstitutional arrangements as well as a system oflegally binding rules for slot allocation. Also,the rules state that airports that are subject tocoordination are obliged to create a coordinationbody that allocates the slots in an objectivemanner. The Slots Regulation declares that air-port slots are to be allocated in a neutral, non-discriminatory and transparent way.

Today, the degree of implementation of theSlots Regulation differs among Member States. The Commission’s studies have revealed anumber of matters requiring clarification, andthe Commission has raised these questions inits discussions with Member States and theparties concerned. It has pointed out that com-petition has been hampered by the inability ofnew entrants to gain access to attractive slots atcongested airports in Europe, and that this situ-ation would have to change. The Commissionhas also pointed to the need to clarify andimprove the slot allocation system with regardto the carriers’ position vis-à-vis the coordina-tors and to the Member States’ possibilities ofsupporting the development of regional traffic.42

At a number of EU airports there are too fewairport slots to enable new entrants to competewith the incumbent airlines. The EU is torevise the Slot Regulation in an effort to dealwith this problem. On 22 June 2001 theCommission presented a draft amendment tothe rules. The amendment is subsequently pub-lished in the Official Journal C 270 E/131,25.9.2001.

6.7.4 The current slot allocation process in theory

The Slots Regulation states that in case ofexcess demand for slots, the airport has to setup a coordination body to allocate slots for theairport. The coordinator is obliged to act inaccordance with the Slots Regulation in a neu-tral, non-discriminatory and transparent way.The coordinator is also to supervise and con-trol that the slots are exploited by the airlines.

After the slots are allocated, on request andwithin a reasonable time, the coordinator isobliged to make the following informationavailable to all interested parties:

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133 Commission Regulation (EEC) No. 1617/93 of 25 June 1993 on the application of Article 85 (3) of the Treaty to certain categories of agree-ments and concerted practices concerning joint planning and coordination of schedules, joint operations, consultations on passenger and cargotariffs on scheduled air services, and slot allocation at airports. The regulation has been amended by Commission Regulation No. 1324/2001 asregards consultations on passenger tariffs and slot allocation at airports, No. 1083/99 and No. 1523/96.

134 Article 10 of the Slots Regulation states that a pool shall be set up for each coordinated period and shall contain newly created slots, unusedslots, and slots that have been given up by an airline during, or by the end of, the season, or that otherwise become available. Any slot notutilised shall be withdrawn and placed in the appropriate slot pool unless the non-utilisation can be justified by reason of the grounding of anaircraft type, the closure of an airport or airspace, or other similarly exceptional case.

135 See Article 8.4 of the Slots Regulation.

• The historical allocation of slots • Each airline’s request for slots • All allocated slots and outstanding slot

requests• Remaining available slots• All details of the criteria being used in the

allocation.

Each Member State is obliged to ensure thatthe coordinator carries out his duties under theSlots Regulation in an independent manner.

Furthermore, coordinators are required to par-ticipate in international scheduling conferencesthat are permitted by Community law.133 Thisis a reference to the IATA slot conferences.The IATA conferences provide airlines with agood opportunity to organise their schedulingeffectively so as to match their operative capa-bilities. Prior to the conference, coordinatorsare to deal with the airlines’ schedulingrequests in strict secrecy and allocate slots inaccordance with the priority rules laid down inthe Slots Regulation and WSG from IATA.

At the IATA conferences, the coordinatorinforms airlines of the result of their applica-tions. The airlines whose requests are not met,are offered the nearest alternative slot before orafter. A new slot proposal means that the air-line has to adjust its schedule, not only at theairport concerned, but also at all the other air-ports it will be trafficking. Should other air-ports have capacity problems, an alternativeslot may necessitate fresh contact with the par-ties concerned. The allocation process contin-ues until such time as the airline has obtainedan operatively feasible programme of sched-ules. The fact that all coordinators participatein the IATA conferences, as well as a largenumber of airlines, makes rescheduling easier.

A fully coordinated airport is also required to

have a coordinating committee. The committeemust be open at least to the airlines that use theairport at a regular basis and/or to their repre-sentative organisations, to the airport authori-ties concerned, and to representatives of the airtraffic control. The committee is to assist thecoordinator in a consultative capacity.

In addition, priority is given to changes inschedule and to new entrants. The latter areentitled to fifty percent of the slots in the slotpool that develops following the initial alloca-tion of historical slots and the completion ofchanges in schedule.134 A new entrant that hasbeen offered slots within two hours before orafter the time requested but has not acceptedthis offer, is not allowed to retain its newentrant status. Unused times are to be returnedto the coordinator for reallocation. This alsoapplies after the conference and during sched-uling periods already under way.

Under Article 9 of the Slots Regulation, the EUcountries may in certain circumstances reservecertain slots at a fully coordinated airport forscheduled domestic services.

Slots may be freely exchanged between air-lines or transferred by an airline from oneroute or type of service to another, by mutualagreement, or as a result of a total or partialtake-over. However, any exchanges or transfersmust be transparent and approved by the coor-dinator. The conditions for approval ofexchanges are (a) airport operations would notbe prejudiced, (b) limitations imposed by aMember State according to Article 9 arerespected, and (c) a change of use does not fallwithin the scope of Article 11.135

Slots may not be sold, given away or leasedout. However, monetary payments are notexplicitly forbidden when slots are exchanged.

6.7.5 Evaluation of the current slot allocation process

From an economic point of view, the currentEuropean slot allocation process performsrather poorly. The process does not in any wayallocate slots with the objective of generatinggreatest benefit for the consumers or the econ-omy in general.

The concept of grandfather rights (seeSubsection 6.7.2) is a central feature of thecurrent slot allocation regime. Grandfatherrights mean that the users of a slot (the incum-bent airlines) enjoy a perpetual usage right,almost only subject to a «use it or lose it» obli-gation. An incumbent airline can expect towithhold its landing and departure slots at agiven airport if it can prove that the slots areexploited at least eighty percent of the time.

This priority to historic users of slots makesentry into an airport at a large scale very diffi-cult and quite rare. Experience shows that theturnover of existing slots and the creation ofnew slots are normally very limited. As a con-sequence, the level of competition between air-lines is reduced, and thereby also the overalllevel of efficiency within the airline industry,for lack of competitive pressure. The BritishCivil Aviation Authority (CAA 1998) pointsout that 70 per cent of the densest internationalroutes within the EU, including all the top ten,have a seriously constrained airport at one orboth ends. On these routes, there would beample room for more competition, had it notbeen for the limited airport capacity.

6.7.6 Proposals for a more efficient slot allocation process

Basically, there are two ways to improve theeconomic efficiency of the slot allocationprocess. First, the current process can bechanged to take more account of economicefficiency. Second, the current process can be replaced by a whole new regime of slotallocation. While the first approach may seemeasier to implement, only the second approachis likely to yield significant efficiencyimprovements.

Changing the current slot allocation process

In the following, only four of the most obviousways to change the current process aresketched. Although it is unclear how large isthe potential for improvements, it appears like-ly that at least some efficiency enhancementwould be possible.

First, an increase in the total slot capacitywould, at least in principle, constitute one wayout. For environmental reasons, however,extending the most crowded airports does notin general seem like a politically viable option.

Second, the current regime could be improvedby enforcing the «use it or lose it» obligationmore strictly than today. The lack of properenforcement makes it possible for incumbentairlines to decrease competition at peak hours.To an incumbent airline, it may be more profitable to use an attractive slot for a lowdensity route than to give it up. This kind ofconduct, i. e. to make use of the slot for thesole purpose of not having to relinquish it to acompetitor, is called «babysitting» of slots.While commercially expedient, such practicesare obviously not compatible with an economi-cally efficient resource utilisation.

A stricter enforcement of the «use it or lose it»obligation could be achieved in several ways.An obvious solution is to reserve some slotcapacity during the peak hours to certain highdensity routes. This would make it more diffi-cult for incumbent airlines to «babysit» attrac-tive slot capacity by operating unprofitableroutes. Another solution would be to increasethe threshold condition in the grandfather rulesfrom eighty to, say, ninety per cent. This could,however, become counterproductive, at least inthe short term, if carriers respond by increased«babysitting».

Third, entry and competition could be promot-ed by the creation of a secondary market forfree slot capacity. One of the reasons why«babysitting» of attractive slots is profitablecould be that giving up attractive slots involvesno reward for the incumbent airlines. If theincumbent airlines could sell the attractive slotcapacity to their future competitors, «baby-

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136 http://www1.oecd.org/daf/clp/roundtables/airport.pdf.

sitting» would become more expensive andless attractive.

The traditional economic solution to conges-tion problems is marginal cost (peak load)pricing. A fourth possible way to bring marketforces to bear on the slot allocation systemcould therefore be to apply this principle andallow airport charges to vary over the day(between peak and off-peak).

In general, it will be important to determinewho should receive the revenue – if any – fromslot trading or price differentiation. If the rev-enue accrues to the airport, an incentive is cre-ated to build more capacity to the extent thatthere is a corresponding demand. The longterm effect of this might be an improvedaccess to low-priced slots.

Alternative slot allocation processes

If the current «use it or lose it» slot allocationregime were to be replaced by a whole newregime, two possible regimes seem most obvi-ous: An auction system and an administrativeprocess, which is often dubbed a «beauty con-test» system.

The auction system implies that the free slotsare sold by auction and allocated to the highestbidding airline. A beauty contest system ismore similar to the current IATA system. Here,the airlines apply for slots, and a slot allocatingbody evaluates the airlines’ offers and deter-mines the final allocation of slots, based –preferably – on neutral, transparent, and non-discriminatory procedures

Both an auction system and a beauty contestsystem are likely to involve a much higherturnover of slots than today’s system. Also,both of them would make it easier for newentrants to get access to attractive slots.

A basic element of both systems would be thatthe «use it or lose it» rule should be replacedby usage right for a limited period of time.

When the period has expired, a new round ofslot allocation is conducted. A change from the«use or lose it» rules to a time-limited usageright will almost certainly lessen the barriers toentry.

Which system, auctioning or beauty contest,will be most efficient? At first sight, it mayseem obvious that the auctioning system ismore efficient, since the most efficient carrierwill be able to derive the highest private bene-fit from using a slot and then also have thehighest willingness to pay for it, i. e. the highest bid. In a beauty contest, however, it is much less likely that the winner is also theeconomically most efficient firm.

This line of reasoning would appear tenable ifall carriers competed on an equal basis. If,however, one or more carriers enjoy marketpower to start with, a different set of argu-ments may apply. A dominant carrier will typi-cally be able to derive profit from «babysit-ting» a slot that would otherwise become avail-able to a competitor, because keeping the rivalout of the market would allow the dominantcarrier to raise its fares. The dominant carrierwill therefore have a higher willingness to payfor attractive slots than most other airlines, andmay be able to bid up the price to a level deter-ring potential new entrants. Such a processwould certainly not ensure economic efficiencyor effective competition.

In a 1998 OECD Competition PolicyRoundtables report136, it is suggested that oneway to ease such a situation might be to useso-called blind bidding in periodic auctions.Here, the bidders’ identities are kept secret, soas to conceal whether the bids are made bynew entrants or by incumbent airlines. If desir-able, even the number of bids can be keptsecret. Says the OECD (1998:123f):

«When an incumbent has market power on aparticular route, a periodic auction wouldaffect the cost the incumbent would have topay to pursue an anticompetitive strategy by

outbidding potential entrants. Under the cur-rent system, an incumbent interested in pro-tecting certain routes does not have to buy upall surplus slots that come on the market.Small numbers of slots do not present athreat to traffic on lucrative business routesbecause without adequate frequency, anentrant will generally be unsuccessful incompeting with an incumbent. Similarly,slots traded or sold between existing incum-bents at an airport often do not represent athreat of new entry because with their huband spoke structures, many incumbents donot compete on nonstop routings to the sameHDTA [High Density Traffic Airport]. With aperiodic auction, however, all slots wouldbecome available over time, and a strategy ofbuying up slots for less valuable uses inorder to preclude entry would become muchmore expensive.

The existing system whereby the sellerknows who is bidding on the slots alsomakes entry deterrence by incumbents morelikely than under a periodic auction wherethe identity (and even the number) of poten-tial buyers could be concealed. As notedabove, knowing the identity of a bidder isoften the equivalent of knowing the likelyuse of a particular set of slots. Thus, sellersof slots can use the identity of a potentialentrant to solicit a counter offer from anincumbent that would be threatened by entry.In contrast, if the incumbent is uncertainabout who is bidding on a set of slots, therewill be less incentive to bid up the slots foranticompetitive reasons. Although blind bid-ding in periodic auctions can increase thecost of entry deterrence, periodic auctionscannot eliminate the possibility that anincumbent will use slot purchases to acquiremarket power or prevent entry. If entry deter-rence is sufficiently profitable, then anincumbent may still be willing to buy upspare slots over time in a periodic auction inthe same way that an incumbent could buyup slots in the secondary market today.

Periodic auctions could discourage neededinvestments if slot holding were leased fortoo short a period of time. Consequently,periodic auctions must be designed carefully

to balance the availability of slots with a rea-sonably long period of time during which anairline could establish service at an airport.There are sunk costs associated with entry onairline routes, and airport authorities alsomay have difficulty making the necessaryadjustments to accommodate excessiveturnover at any one time. Nevertheless, if(for example) 10 per cent of an airport’scapacity became available each year under a10 year lease, the vast majority of all flightsat any airport would be unaffected, especiallysince existing users of the slots being put upto bid might well reacquire some of the slotsif they offer the most efficient service. »

Thus, although blind bidding does not com-pletely eliminate the market power of domi-nant carriers as a factor in slot allocation, itgoes a long way to reduce its importance.

However, other design aspects may lead to aconclusion in favour of transparency and thusagainst a blind auction. In the end, the finalchoice of auction design may involve severalcomplex trade-offs. The experience from themobile phone industry with the UMTS auc-tions showed that the process of running anauction is not simple, even when the number of objects is as low as four, five, or six. If auctions are to be held over usage rights forairport slot capacity, it is most likely that therewill be thousands of objects to be auctioned offsimultaneously. The auction system will thushave to be much more complex than in theEuropean UMTS auctions.

Second, it is essential that the auction systembe compatible with other slot allocation sys-tems. Departure slot capacity in one airport hasto be matched with corresponding landing slotcapacity in other airports. Moreover, the air-lines have a legitimate interest in obtainingslots for landing, ground handling, and take-offthat allow for efficient operation at one and thesame airport.

Of course, the coordination concern is also rel-evant in a beauty contest system. But there arereasons to believe that the problem is morelimited in a beauty contest than in an auctionsystem. Flexibility is the key to solving the

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coordination problem, when it comes to slotcapacity in airports in other countries. At thispoint a beauty contest may be thought to perform better than an auction system. Boththeory and experience show that an auctionsystem is economically efficient only if therules are clear and strictly enforced. This isclearly difficult to combine with flexibility. In contrast, the efficiency of a beauty contest is not likely to change significantly if the rulesare enforced with some degree of discretion.

Finally, it should be mentioned that in combi-nation with a shift from the current «use it or

lose it» rule to a usage right system, a lotterysystem could also be considered. Such a sys-tem would make it easier for entrants to gainaccess to free slot capacity than under today’s«use it or lose it» rule. Their chance to gain anattractive slot capacity would be just as goodas the incumbent’s chance. However, a lotterysystem will obviously be economically ineffi-cient, as the allocation will in no way be basedupon an economic assessment. A lottery system does not create the same incentive to be efficient as both an auction system and abeauty contest system.

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The Nordic Task Force on Airline Competitionhas examined the aviation markets inDenmark, Finland, Norway, and Sweden, and –more generally – the European aviation indus-try, with a view to suggesting measures toenhance competition.

7.1 Network economics and competitionThe aviation industry can be described as asystem of links (routes) that connect nodes(airports). It is, in other words, a networkindustry.

As such, the aviation industry is characterisedby large network externalities, in the sense thatthe costs and revenues involved in carryingpassengers on different, interconnected routesare interdependent. There are, in other words,large economies of scale, scope and densitypresent. These externalities may originateeither at the supply (production) side or at thedemand (consumption) side.

Supply side economies of scale originate fromusing larger aircraft (assuming a constant loadfactor), from increasing the load factor, or fromlonger stage lengths. All of these reduce thecost per passenger kilometre. Economies ofscale due to firm size are, however, quicklyexhausted in the airline industry.

On the demand side, certain indirecteconomies of scale may appear as a result ofincreasing returns to scale on the supply side.In aviation, such effects are probably of limitedimportance, although it might be argued, e.g.,that the more economical, larger aircraft mayalso appear more comfortable and secure to thetraveller, and hence induce a certain additionalair travel demand.

Economies of scope on the supply side are,generally speaking, present when the cost ofproducing two products or services by thesame firm is lower than when they are pro-duced by separate firms. There are, in otherwords, cost-saving externalities between pro-

duction lines. The most important economiesof scope in the aviation industry no doubt arisefrom the complementarity of routes within thenetwork. By operating several interconnectedroutes, the airline company is able to utiliseaircraft, crew, reservation systems, marketingdevices, and other overhead cost items in vari-ous production lines (i. e., city pair connec-tions). Economies of scope may be particularlyimportant when slot capacity at airports is lim-ited. Airlines operating several flights out ofone airport obtain flexibility to adjust their net-work to changes in the demand pattern.

Perhaps even more important economies ofscope emerge from the demand side. A carrieroffering a larger network of services will bemore attractive to the traveller, since she willhave more destinations to choose from and alarger probability of finding a suitable connec-tion from her particular origin to any givendestination.

Economies of scope on the demand side areoften intensified by the marketing practices ofthe airlines, such as the frequent flyer pro-grammes and the corporate discount schemes.These may create artificial economies of scopebecause customers avoid a certain switchingcost if they concentrate their demand to one ora few airlines.

In aviation, supply side economies of densityexist if an airline’s unit cost declines when theairline adds flights or seats on existing routes,all other things held constant. These increasingreturns to density are due primarily toimproved utilisation of aircraft capacity andcrew.

Even more important are the demand sideeconomies of density. A higher route frequencywill decrease the average time cost experi-enced by the traveller and hence induce a high-er demand for air transport, especially frombusiness travellers. This feedback mechanism,implying that the demand for travel in a net-work is in a sense self-reinforcing, is some-

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7. SUMMARY AND CONCLUSIONS

times referred to as the Mohring effect. As thedemand for travel increases, a higher frequencyof departures can be supported, and a smalleraverage generalised cost is incurred by theindividual user. This in turn induces a stillhigher demand, and so on until equilibrium isreached.

A particularly efficient way of organising anaviation network is the hub-and-spoke mode ofoperation. Rather than operating a large num-ber of point-to-point, non-stop routes, the air-line company channels all or most passengersthrough a «hub» airport, from which all con-nections extend like the spokes of a wheel. Inthis way the number of different non-stoproutes needed to serve all possible pairs of des-tinations is drastically reduced, allowing forquite remarkable cost savings. The operation ofa hub-and-spoke network often allows an air-line to offer air services on routes, which inisolation do not generate sufficient volume oftraffic to justify service. On some spoke routes,the load factor will be raised from a levelbelow to a level above the minimum viablescale load factor.

Judging by the experience earned through 23years of deregulated aviation markets in theUnited States, the airline industry – when leftwithout regulation – will tend to consolidateinto a few, large air carrier concerns with con-tinent-wide hub-and-spoke networks.

While obviously economically efficient to theindividual carrier firm, the hub-and-spoke sys-tem of operation may have strong anti-compet-itive effects. The economies of scope and den-sity characteristic of these networks are such asto grant the (one and only) hub airline veryconsiderable market power at and around itshub. Since different airlines choose to operatehubs at different airports, the hub-and-spokesystem as operated among a set of large indi-vidual carriers is liable to practically divide themarket between the airlines. Although the net-works of different carriers overlap, very feworigin-destination pairs, if any, will exhibitmore than two carriers operating non-stopflights.

In Europe, the hub-and-spoke mode of opera-

tion has an even longer history than in the US,having grown out of the past regulatory frame-work and of the prevailing geographic andpolitical conditions, rather than as anautonomous market process. Each nation hashad its own «flag carrier», with a privilegedposition in and around its domestic market andfrequently a large government ownershipshare. More often than not, flag carriers havebeen benefiting from considerable amounts ofsubsidies or direct financial support from thestate.

The flag carrier typically organises its networkaround a hub located near the national capitalor main business centre. At its hub airport, theflag carrier tends to have considerable directand indirect influence on slot allocation prac-tices, on ground handling services, and onother essential facilities. Backed by its owngovernment, the flag carrier usually also tendsto obtain privileged positions in whatever bilat-eral aviation agreements are signed with othercountries. Each flag carrier therefore enjoysconsiderable market power at and around itsdomestic hub. Thus, although there are almostas many flag carriers as there are Europeannations, the competition between them isseverely restricted, as they have been able todivide the market between them to a very con-siderable extent.

In summary, the hub-and-spoke mode of opera-tion generates abundant network externalitieson the cost side as well as on the revenue side.The incremental cost of operating an extraroute in a hub-and-spoke network is oftensmaller than suggested by the average unit costof the network. Moreover, an extra route maygenerate feeder traffic – and hence revenue –to the larger network. It will, in other words,be relatively inexpensive for an incumbent hubairline to cross-subsidise a single spoke routeor a limited set of such routes.

Essentially, this leaves a dominant hub airlinewith ample opportunity to fight a rival newentrant through increased capacity, dispropor-tionately reduced fares, and/or other predatorystrategies. Unless met by timely and resoluteinterventions on the part of the competitionauthorities, such strategies could make the

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137 As of May 2002, the Norwegian Competition Act is under revision.

market almost incontestable (confer Section7.4 below).

The anti-competitive effects of hub-and-spokenetworks are likely to be strongly reinforcedby the carriers’ frequent flyer programmes, andvice versa (see Section 7.7).

7.2 Airline mergers and alliancesMore extensive networks are more attractive tocustomers and offer larger economies of scopeto the carrier. Airline carriers therefore formalliances in order to exploit each other’s net-works and to strengthen the competitive posi-tions of all alliance partners. Establishing analliance with an «adjacent» carrier may also bean efficient way for competitors to divide themarket between them.

Bilateral aviation treaties often assure theaffected national flag carriers more or lessexclusive traffic rights between the two coun-tries. These rights might be forfeited if the flagcarrier is merged with a foreign airline –whence the widespread practice of formingalliances rather than full-fledged mergersbetween European airlines. In an opiniondelivered by the Advocate General to theEuropean Court of Justice on January 31,2002, it is proposed that individual memberstates no longer be allowed to entertain suchindividual aviation treaties with non-EU coun-tries. To the extent that this view is upheld bythe Court, it may be foreseen that the associat-ed change in the regulatory regime will spark adevelopment towards massive consolidationwithin European aviation.

Faced with this scenario, it is essential thatEuropean competition and aviation authoritiesconsider carefully all measures susceptible ofopening the air travel markets and enhancingcompetition. While in terms of competition andefficient resource allocation, full-fledged merg-ers may well be preferable to looser alliances,it is paramount to the protection of consumers

and other air travel customers that the resultingnumber of European aviation concerns oralliances not become too low. The consolida-tion process must therefore be followed care-fully by the relevant competition authorities.Alliances should be treated with the samerigour as traditional mergers.

It would, of course, not make sense to prohibitjust about every possible airline merger or newalliance. There is therefore a pressing need fora long term Community level strategy provid-ing guidelines as to what merger and allianceagreements cannot be concluded without caus-ing unacceptable damage to competition.

7.3 Community and EEA LawArticles 81 and 82 of the EC Treaty set outgeneral prohibitions on anti-competitive agree-ments and abuse of dominant position.Generally speaking, these articles obviouslyalso apply to the aviation industry, forming thebasis of Danish, Finnish, and Swedish compe-tition policy in relation to the air travel market.

Although Norway is not an EU member, thesame articles have been implemented inNorwegian Law, in the form of Articles 53 and54 of the European Economic Area (EEA)Agreement. Norwegian Law is, however, as of2002137 not fully harmonised with CommunityLaw. Being based on an intervention principlerather than on a prohibition principle,Norwegian Law does not in general requireproof that an act of conduct constitutes abuseof dominant position, in order for theNorwegian Competition Autority (NCA) to beable to take action against the practice.According to Section 3-10 of the NorwegianCompetition Act, it is sufficient for the NCA toshow that an action is liable to restrict compe-tition, contrary to the purpose of efficientresource utilisation, in order for the NCA tointervene. It may thus appear that Norwegiancompetition authorities have a somewhat morepowerful provision to intervene, compared to

the other Nordic countries. This may partlyexplain the apparent differences in competitionpolicy between the respective countries, espe-cially, perhaps, in relation to frequent flyerprogrammes (see Section 7.6 below).

The competitive situation of the European airline industry is affected, not only by thegeneral Community competition law, but alsoby a number of special regulations, decisions,and agreements, the presumably most impor-tant of which are the following:

1. Council Regulation (EEC) No. 2408/92 onaccess for Community air carriers to intra-Community air routes (see Section 7.4below).

2. Council Regulation (EEC) No. 2409/92 onfares and rates for air services (see Section7.4).

3. Council Regulation (EEC) No. 95/93 oncommon rules for the allocation of slots atCommunity airports, commonly known asthe «Slots Regulation» (see Section 7.5).

4. Commission Regulation (EEC) No. 1617/93granting the airlines within the EuropeanUnion a block exemption for consultation onpassenger tariffs, as well as on consultationon slot allocation and airport scheduling.The regulation has been amended byCommission Regulations No. 1324/2001,No. 1083/99, and No. 1523/96, prolongingthe exemption for consultation on passengertariffs to 30 June 2002 and the exemptionfor consultation on slot allocation and air-port scheduling to 30 June 2004. As of May2002, it appears that both exemptions willbe prolonged until 30 June 2005 (seeSections 7.5-7.6).

5. Commission Decision of 16 January 1996 incase IV/35.545 on the Lufthansa/SAS coop-eration, establishing conditions concerning,inter alia, the access of third carriers to theLufthansa/SAS frequent flyer programmes,and the divestiture of slots at the Frankfurt,Düsseldorf, Stockholm, and Oslo airports(see Section 7.7).

6. Court Rulings in the Hoffmann-La Rocheand Michelin cases, of 13 February 1979and 9 November 1983, respectively, on theuse of loyalty discounts (see Sections 7.7,7.8, and 7.11).

7. Council Regulation (EEC) No. 2299/89 on acode of conduct for computer reservationsystems (CRSs), amended by CouncilRegulation No 323/99 (see Section 7.9).

8. Commission Decision of 14 July 1999(2000/74/EC) in the Virgin/British Airwayscase concerning travel agent agreements(see Section 7.11).

9. Council Directive 96/67/EC on access to theground handling market at Community air-ports (see Section 7.13).

10. Numerous bilateral aviation agreementsbetween individual EU member states andnon-EU nations. Some are Open Skiesagreements, others – like the Bermuda IIagreement between the UK and the USA –are much more restrictive. In the nearfuture, these agreements may be challengedby the European Court of Justice (seeSection 7.2 above).

7.4 Contestability and predation Prior to and shortly after the deregulation ofthe US aviation market in 1978, it was general-ly thought that air travel markets would in gen-eral be highly contestable, as it would be easyfor any carrier to relocate aircraft and person-nel so as to service a new route. In practice, ithas turned out that the barriers to entry aremuch more important than previously believed.Incumbent airlines can lower their fares and/orincrease their capacity practically overnight, soas to raise the cost and/or reduce the revenueof rival new entrants. Any potential newentrant would, of course, be aware of this, andhesitate to challenge the incumbent carriereven if the latter may be making a considerableprofit in the current (monopolised) situation.

To increase contestability it might be desirableto constrain the incumbent carriers’ ability toabuse their dominant position by dumping their

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fares and/or boosting their capacity in responseto rival new entrants. National and Communitycompetition authorities should keep a keen eyeon predatory pricing practices and prepare con-tingency plans to act against them at shortnotice. The recent intervention by Germany’sBundeskartellamt, requiring Lufthansa to keepa e 35 fare differential with respect toGermania on the Berlin-Frankfurt route, is anexample, the benefits and possible pitfalls ofwhich would be interesting to assess.

Given the special characteristics of the aviationmarket, interventions against excess capacitymight be appropriate in order to ensure compe-tition, in the event of a dominant carrier’spredatory behaviour. However, CouncilRegulation (EEC) No 2408/92, which guaran-tees free access for EEA air carriers to intra-EEA air routes, might be interpreted to pre-clude such intervention from Community ornational competition authorities. There is thusa need to clarify the legal provisions availableto competition authorities in this area, and pos-sibly to improve them.

Similar arguments apply, with even greaterforce, to Council Regulation (EEC) No2409/92, which deals with fares and rates forair services. In the opinion of the Task Force,this regulation ought not restrain the compe-tence of national competition authorities inrelation to interventions against predatory pricing. To the extent that this view is seen ascontentious, we suggest that the issue be exam-ined further at the European Community level.

7.5 Scarcity of slotsThe airport capacity constraints and the slotallocation regimes and practices, allowable onaccount of Council Regulation (EEC) No.95/93 and the block exemption currently ineffect in the EEA, constitute major barriers toentry and hence to competition and economicefficiency.

Incumbent airlines throughout European air-ports benefit from so-called «grandfatherrights», by which they are entitled to therenewal of all slots for which the degree ofutilisation during the previous period exceeds

80 per cent. In congested airports, this regimemakes it quite difficult for potential newentrants to obtain a sufficient amount of attrac-tive slots. To add to the problem, incumbentairlines may have an incentive to «babysit»some of their slots, i. e. to make use of themfor the sole purpose of not having to relinquishthem to a competitor. While commerciallyexpedient, such practices are obviously notcompatible with an economically efficientresource utilisation.

There is thus a pressing need for an improvedand less discriminatory slot allocation proce-dure in all congested airports, which wouldfacilitate market entry for smaller airlines andother non-incumbent carriers.

At present, the legal ownership to slots and therights attached to such ownership are mattersof ambiguity. A prerequisite for arriving at amore efficient slot allocation is to determineunequivocally who owns the slots – the airline,the airport, or the government. The initiativetaken by the European Commission to clarifythese questions is commendable.

Creating an open market for slots may seemlike an obvious solution to the economic effi-ciency problem. There may, however, be caseswhere open trading would not ensure equitableaccess to the aviation market for all carriers.Dominant airlines may be able to derive profitfrom holding a slot that would otherwisebecome available to a competitor. They maytherefore be willing to bid up the price of certain slots to a level that will deter potentialnew entrants.

One way to ease such a situation might be touse so-called blind bidding in periodic auc-tions. Here, the bidders’ identities are keptsecret, so as to conceal whether the bids aremade by new entrants or incumbent airlines. In such a case, a strategy of buying up slots for less valuable uses in order to preclude entry would become rather more expensive,and hence less common.

The traditional economic solution to conges-tion problems is marginal cost (peak load)pricing. Another way to bring market forces to

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bear on the slot allocation system could there-fore be to apply this principle and allow airportcharges to vary over the day (between peakand off-peak).

As a minimum requirement for efficient andnon-discriminatory airport slot allocation,whatever formal or informal connection mightexist between the slot coordinator institute andthe local flag carrier company should be sev-ered. Slot coordinators need to be unquestion-ably neutral with respect to all of their incum-bent or potential client airlines.

While most of the larger European airports areslot constrained, there are a number of second-ary airports with ample slot capacity. By offer-ing inexpensive services, less busy airportsmight be able to attract substantial volumes oftraffic and thereby realise considerableeconomies of scale and enhanced consumersatisfaction. Low cost airlines have started toexploit this opportunity, challenging the tradi-tional carriers and their hubs by offering point-to-point services between smaller airports.

The promise of this development is, however,limited by the relative shortage of commercial-ly independent airports. In many cases, all ormost of a country’s airports are owned andoperated through one (government) agency. To enhance competition, it might be desirablefor European governments to pave the groundfor behaviourally independent airports. Ideally,two adjacent and hence potentially competingairports should not have the same owner. Inthis way, a certain amount of market pressuremight be brought to bear on the presently inefficient slot allocation procedures.

7.6 Interlining and tariff consultationsThe aim of the block exemption for consulta-tion on passenger tariffs has been to facilitateinterlining. There are hardly grounds to question that interlining provides importantefficiency gains to carriers and passengers.

Airlines tend to argue that the IATA tariff consultations, in which airlines agree on acommon set of fares for fully flexible tickets,form an inextricable part of the interlining

system. There is, however, reason to think thata system of posted prices for wholesale (inter-airline) purposes might be sufficient to main-tain the interlining system without the pricecollaboration. Such a system would mean lesstransparency of fares between airlines andhence probably more intense competition,without jeopardising the efficiency gains connected with interlining.

7.7 Frequent flyer programmesAlmost all major airlines offer their travellers acarefully designed frequent flyer programme(FFP). Most FFPs have the following charac-teristics in common:

• «Discounts» are granted not in the form ofmoney, but in the form of free services, notnecessarily of the same type as purchased.The frequent flyer points are no ordinaryrebate.

• To obtain free flights to more or less distantdestinations, the customer needs to surpasscertain thresholds in terms of travel purchas-es. The customer thus has an incentive toconcentrate her purchases to one or a fewproviders. The closer the customer gets to athreshold, the stronger is her incentive to buyanother flight from that particular airline oralliance.

• The «discount» is given to the traveller, who– in the case of business travel – tends to differ from the purchaser. This gives rise to a pronounced principal-agent problem, bywhich the decision maker (agent) is facedwith a quite different set of incentives fromthose of her superior (principal). This maylead to a distorted (inefficient) resource allocation.

• Although in principle taxable in many coun-tries, the private use of frequent flyer pointsearned by an employee is in practice rarelytaxed, for lack of information on the part ofthe government. This tax loophole is likely toaggravate the inefficiency due to the princi-pal-agent problem.

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• Alliance airlines join their FFPs to offerattractive, extended networks to bonus pointtravellers. Smaller airlines or alliances have adistinct competitive disadvantage. The FFPsare thus liable to strengthen any dominantposition and to reinforce the anti-competitiveeffects of hub-and-spoke networks.

Professional economists have been fairly unan-imous in concluding that frequent flyer pro-grammes are – as intended – loyalty inducing,giving rise to artificial economies of scope andswitching costs. As such, they have welfaredecreasing and anti-competitive effects, andare clearly at variance with the spirit of compe-tition law in most countries.

In particular, there is reason to be aware of theanti-competitive effects in a setting with one(or a few) established firm(s) and a potentialentrant. If incumbent carriers have been able to recruit a large part of the potential clienteleinto their frequent flyer programmes, a newentrant may find it exceedingly difficult to capture an economically viable market share.

The European Court has dealt with loyaltyrebates on a few occasions. FFPs do not for-mally presuppose exclusivity in the same wayas the fidelity rebates in the Hoffmann-LaRoche Case. The effect of the FFPs is moresimilar to the target rebate system in theMichelin Case.

So far, no case concerning airline FFPs hasbeen tried by the European Court. To use thecase law from the Michelin Case, one wouldhave to claim that the concerned airline holds adominant position in the relevant market.

The European Commission has dealt withFFPs in four cases concerning cooperationbetween airline companies (cooperation inalliance programmes). As part of the allianceagreements, the airline companies allowed thealliance partner’s clients to collect and useaccumulated points in each other’s FFPs. InSAS/Lufthansa, the Commission stated that thecooperation between the two companies onFFPs was likely to be a not inconsiderable bar-

rier to market entry, and therefore a breach ofArticle 81(1). The Commission’s condition forapproval under Article 81(3) was that any otherairline which provided or wished to provideservices on the routes in question, and whichdid not have a FFP applicable at the interna-tional level, should be afforded the opportunityof participating in the programme.

In Scandinavia, the attitude towards FFPs iscritical.

In its ruling of 27 February 2001, the SwedishMarket Court ordered the SAS not to apply itsFFP in such a way that passengers earningpoints were able to redeem them as bonusawards or the equivalent when using certain airtravel services. The practice was deemed to bean abuse of SAS’s dominant position in breachof Section 19 of the Competition Act. The rul-ing applies to domestic air travel in Swedenbetween cities where SAS, or airlines cooperat-ing with SAS on the scheme, encounter com-petition through existing or newly establishedscheduled air passenger traffic.

On 18 March 2000, the NorwegianCompetition Authority ordered the SAS aircarrier group to stop awarding frequent flyerpoints on domestic Norwegian routes. Unlikethe Swedish ruling, the prohibition in Norwayapplies on all domestic routes, competitive ornot. It becomes effective on 1 August 2002.The complaint filed by SAS has been turneddown by the Norwegian Ministry of Labourand Government Administration.

To become maximally effective, restrictions onthe use of FFPs should be multilateral ratherthan unilateral, i. e. applicable to all(European) carriers and routes rather than to afew designated air travel sectors. The TaskForce therefore would like to urge theEuropean Commission to open up for a thor-ough investigation of the FFPs under theArticle 81 and Article 82 provisions. In paral-lel, national European competition authoritiesmay want to consider critically the anti-com-petitive effects of FFPs on domestic routes.

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7.8 Corporate discount schemesCorporate discount schemes are agreements bywhich large airline customers have been ableto negotiate lower (net) fares on all of or oncertain parts of an airline’s network. Discountsof 30 to 50 per cent are not uncommon onbusiness class tickets.

Corporate discount schemes have ambiguouseffects on welfare. On the one hand, theyreflect a certain transfer of market power fromthe seller to the buyer. Large private and publiccustomers may be able to exploit buying powerby triggering competition between the produ-cers for an exclusive contract involving largediscounts. By allowing for such price discrimi-nation, one may actually trigger intense pricerivalry, resulting in enhanced welfare in theaffected segment.

However, many of the corporate discountschemes take forms that engender importantlock-in effects, as when the rebate is somehowprogressive. Often, the structure of the agree-ment or the development of negotiations provide the airline customers with an incentiveto concentrate their demand to one or a fewcarriers. If so, larger carriers will obtain aninherent advantage compared to smaller ones.

Unlike the differentiation between businessclass and economy class tickets, corporate discount schemes usually discriminate betweencustomers not on the basis of price elasticity,but on the basis of buying power. Thus there is no guarantee that the more price elastic seg-ment receives the lower price – indeed, theopposite may seem more likely. This increasesthe risk that the welfare gain among large cus-tomers will be more than outweighed by theloss affecting all other clients.

Discounts may tend to be large in segmentswith quite inelastic demand. This is not anoptimal way for the airlines to cover their fixedcosts. Moreover, intense price rivalry betweensuppliers may therefore lead to exits from themarket, because not all the airlines are able tocover their fixed costs. In a similar manner,potential entrants might be deterred, knowingthat the incumbent airline is able to meet any

challenger by offering selective discounts tolarge, attractive clients. Since these discountsmay be directed exclusively to a small set ofcustomers, without affecting market prices ingeneral, such price discrimination serves tomake predation much less expensive to thedominant supplier, and hence a more crediblethreat to potential entrants.

This suggests that corporate discount schemesare anti-competitive, especially in a settingwith a dominant, incumbent carrier and smallerpotential entrants.

7.9 Computerised reservation systemsThe computerised reservation systems (CRSs)are essential facilities in the marketing of airtravel services. In some cases, airlines are ver-tically integrated with or cooperating closelywith travel agencies and with the providers ofCRSs. In such cases, the airline should be pre-vented from using its dominant position torestrict or prevent competition, by having, e.g.,the CRS display its own flights more promi-nently than those of its competitors.

EU Council Regulation 2299/89 stipulates acode of conduct for these systems, meant toensure fair and non-discriminatory service.Informal information nevertheless suggeststhat, in many travel agencies, these systems areoperated in ways that do leave something to bedesired in terms of neutrality and non-discrimi-nation. A closer control with the way these sys-tems are set up and operated may seem appro-priate. It is, e.g., essential that all airline carri-ers enjoy equal opportunities for presentationand sale to a client, and that no airline carrierbe able to access all the information stored in a travel agent’s data base and use it for its ownmarketing purposes.

7.10 Corporate cards and electronic ticketing

Airlines have devised cards that allow corpo-rate staff to travel without a hard-copy flightticket. Such corporate cards can be pre-loadedwith a certain number of trips or an unlimitednumber of trips for a predefined period of timefor a particular route. Discounts are generally

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granted compared to the fare charged for con-ventional tickets. The size of the discount maydepend on the number of trips purchased atany one time. From the point of view of com-petition and economic efficiency, the accept-ability of these rebate schemes may hinge onwhether they are linked to corresponding costsavings. To the extent that customers arerewarded for concentrating their demand, thecorporate cards are loyalty inducing and harm-ful to competition.

A corporate card facilitates corporate traveladministration and offers savings both to thecompanies and to the airlines. Such electronicticketing (e-ticketing) is growing relative toconventional travel with paper tickets. Thismay have far-reaching implications for travelagencies and their profitability and, in turn,lead to accelerating centralisation. To theextent that by-passing one intermediary in thesupply chain improves efficiency and reducesproduction costs, the implications for cus-tomers may be beneficial despite increasingconcentration.

To the extent, however, that e-ticketing is notbased on open standards, but requires the trav-eller to hold an electronic card specific to aparticular carrier or alliance, such a ticketingsystem may be liable to restrict competitionbetween airlines. This is particularly so if e-ticketing is integrated with the airline’s fre-quent flyer programme, by making use, e. g.,of the FFP membership card.

7.11 Travel agent agreementsTravel agent agreements sometimes provideincentives for an agent to concentrate his salesto one or a few larger airlines. Such contractsmay be anti-competitive and in disagreementwith the principles laid down by the EUCommission in the Virgin/BA case on 14 July1999.

There is reason to question whether all carrier-agent agreements and practices have yet beenbrought in accordance with these principles.Competition authorities may want to directattention to this problem and exert a more vig-orous control.

7.12 Taxes, subsidies, and public procurement.

Some airline carriers have continued to receivesubstantial amounts of direct or indirect aidfrom the national government. Such transfersmay destroy the level playing field betweenairlines and should be minimised.

In many countries, the public administration isitself a major airline client. Governments maywant to use their negotiating power to enhancecompetition, by adhering to the following principles in public procurement agreements:(i) Public purchases should, if possible, be tendered in small portions, e. g. route by route,so that small size companies may bid. (ii) Preference clauses, if present, should admitthat, notwithstanding the public procurementdeal, the government is always free to makeuse of a cheaper and/or higher quality servicethat may be offered by someone else. (iii) Fixed fares (over a certain time lapse) arepreferable to percentage discounts off the nominal fare. This is so because percentagediscount agreements tend to bid up the fare forall those clients who do not have a comparableagreement.

Tax rules applicable to the aviation industryand its related activities should be neutral withrespect to, inter alia, in-house production in avertical chain compared to outsourcing (conferSection 7.13).

7.13 Ground handlingCouncil Directive 96/67/EC ensures minimumstandards of access to ground handling at allairports with at least two million passengersannually. In the Nordic countries, numerousairports do not surpass this threshold and arehence not affected by the Directive. This isliable to restrict competition, not only in theground handling market, but even in the airtravel market, because, as a consequence,smaller carriers may have no option but to buyground handling services from their dominantcompetitor. In certain cases, this setting mayact as a barrier to entry. Moreover, even for thelarger airports, the Directive does not ensurefree and unimpeded access to any interested

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supplier; it only prescribes that the number ofthird party providers not be fewer than two, ofwhich at most one may be controlled by anincumbent airline. Thus, there may be reasonfor national competition and transport authori-ties to impose more demanding regulations onairports than what follows from the Directive.

Another possible competitive restriction con-cerning ground handling services relates to thetaxation system. To the extent that providersintegrated with or controlled by an airline par-ticipate in ground handling, it is important thatthe tax rules not favour such own-accountmodes of operation compared to outsourcing.If, e. g., independent ground handlingproviders are subject to output value added tax (VAT), without the airline companies beingable to deduct the corresponding input VAT,then larger carriers having their own cateringfirm or department will have a distinct costadvantage compared to smaller carriers thatneed to buy these services in the market. Infact, such a setting will make it quite difficultfor independent ground handling firms to survive at all.

7.14 The Nordic aviation marketThe air travel market within and between theNordic countries is surprisingly large, as seenin relation to the countries’ relatively modestpopulation. Among about 24 million inhabi-tants, 29 million (one-way) air trips are madeevery year within or between Denmark,Finland, Norway, and Sweden. Another 28 mil-lion trips per annum are made between theNordic countries and the rest of the EuropeanEconomic Area (EEA).

Some Nordic routes are quite dense. Oslo-Trondheim, Oslo-Bergen, and Stockholm-Gothenburg all exhibited more than 1.3 millionpassengers in 2000. The Stockholm-Malmöroute carried close to 1.2 million travellers,while the Oslo-Stavanger, Copenhagen-Stockholm, and Copenhagen-Oslo routes all

had close to one million passengers over theyear. Between 700 and 900 thousand passen-gers were carried on each of the routesStockholm-Luleå, Oslo-Tromsø, Stockholm-Oslo, Stockholm-Helsinki, Stockholm-Umeå,and Bergen-Stavanger.

The densest routes out of the Nordic area areStockholm-London, Copenhagen-London, andOslo-London, with about 1.1, 0.9, and 0.7 mil-lion passengers in 2000, respectively.

Traditionally, the Nordic aviation markets havebeen more or less dominated by the two flagcarriers SAS and Finnair. The former carrier isowned approximately 3/14 by the Swedishstate, 2/14 by the Danish state, and 2/14 by theNorwegian state, the remaining half being privately owned. Since the SAS-Braathensmerger in December 2001, there are very few examples of effective airline competitionwithin the Nordic networks.

This situation is a matter of deep concern tothe Nordic competition authorities. On accountof the size of the respective city pair markets,there is reason to think that numerous Nordicroutes may provide sufficient room for compe-tition between carriers operating above theminimum viable scale of production. Suchcompetition is likely to enhance economic effi-ciency and welfare.

More generally, the Nordic competition author-ities are concerned by the many restrictionsaffecting airline competition at the Community,pan-European, and global level. Despite thefact that the Community air travel marketshave been gradually deregulated, a number ofmarket imperfections persist, preventing aneconomically optimal resource utilisation.There is reason to fear that, without a morevigorous competition policy at the national andCommunity levels, the welfare losses stem-ming from an insufficient competitive pressureon airlines are due to increase rather thandiminish over time.

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No. 1/2002

Competitive AirlinesTowards a more vigorous competition policy in

relation to the air travel market

Com

petitive Airlines Tow

ards a more vigorous com

petition policy in relation to the air travel market

No. 1/2002

Kilpailuvirasto/KonkurrensverketPostbox 332, 00531 Helsinki, Finland

Telephone: +358 9 73 141Telefax: +358 9 7314 3405

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Report from the Nordic competition authorities

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