Express may hinder deal with Qantas

By BRIAN FALLOW


In launching its cut-price Tasman Express service this week, Air New Zealand may have made it harder to persuade competition authorities to approve its proposed alliance with Qantas.

That is because, in deciding whether to allow the alliance, the Commerce Commission and its Australian counterpart, the Australian Competition and Consumer Commission (ACCC), have to peer into not one crystal ball but two.

They have to come to a view about what the future would be like if the deal goes ahead, but also what it would be like without it - what in the jargon is called the "counterfactual". Tasman Express is liable to make the counterfactual look more attractive.

In assessing and quantifying the economic harm the deal would do and the offsetting benefits, they have to compare it not with the situation now but with what it would be without the deal.

The airlines have a dilemma here. They risk being seen as trying to have it both ways.

When the focus is on the benefits of the alliance - or the cartel, as its critics call it - they have an interest in painting the counterfactual as black as possible.

They talk of a "war of attrition" with both airlines, Qantas in particular, adding capacity in a bid for market share and in the process driving costs up and prices and profits down.

Avoiding the waste and inefficiency caused by this is one major benefit claimed for the alliance.

When it comes to assessing what a "war of attrition" means in practice - how many more seats on which routes - a veil of commercial secrecy descends.

Qantas and Air New Zealand have separately revealed what they would do if the alliance is rejected, but only to their joint economic consultants, NECG, and the competition authorities. These claims cannot therefore be tested or contested by anyone else. The parts of next week's "public" hearing relating to them will be held in secret.

In its draft determination - the half-time score of the authorisation process - the NZ commission rejected the war-of-attrition scenario.

If aggressively expanding capacity was a sensible profit-maximising strategy for Qantas, why was it not doing it now?

Air New Zealand's cost per passenger appeared to be lower, the commission said, which implied that Qantas would incur a greater loss per passenger than Air New Zealand in the event of a price war.

When the airlines turn to quantifying the downside of the alliance, they tell a rather different story. In this part of the argument they have an interest in downplaying the competition that would prevail if the alliance does not proceed.

Instead of warfare they talk of limited, "Cournot" competition.

Roughly, that means a competitor does whatever it takes to defend its customer base in response to a move by its rivals to increase capacity or cut prices - but no more. Escalation is not the name of the game, minimising damage to the bottom line is.

Professor Tim Hazledine of Auckland University, who has made a study of the airlines' behaviour, especially since Kiwi International - remember it? - arrived on the scene, says that Cournot might be a fair enough approximation of the way airlines play the competitive game in normal times.

But these are not normal times, and in recent years their behaviour has been more robustly competitive.

If NECG's model is adjusted to reflect a more vigorous competitive environment should the alliance be rejected, the detriments arising from allowing the deal rise substantially, Hazledine says.

The actual counterfactual that is emerging is one with "Express" fares on both domestic and Tasman routes and with entry about to occur from other carriers such as Emirates in the transtasman market.

"That's a fairly competitive situation. If the two biggest carriers can form a cartel, the question is how much pressure that would take off the competition we are enjoying at the moment."

Another model, commissioned by the Commerce Commission from Canadian economist Professor David Gillen, also reflects a more robustly competitive counterfactual and concludes that the detriments would be substantial.

But Gillen's work has drawn a broadside of criticism not only from NECG but from Princeton's Professor Robert Willig.

Some of those cannonballs may have found their mark. Gillen is a conspicuous absentee from next week's hearing.

In any case, a judgment on how intense the competition would be without the alliance is a key call the Commerce Commission has to make in its deliberations.

Part of that calculation is the prospects of Virgin Blue (or some other value-based airline) entering the Tasman or domestic main-trunk markets.

Qantas and Air New Zealand have argued that its entry would be more likely if the alliance goes ahead because there would be less capacity and higher prices under that scenario, therefore more room for a new entrant.

Virgin Blue initially rejected that, and said the prospect of having to take on what would amount to a single 900-pound gorilla of an incumbent made entry less likely.

However, it has since said it expects to be flying the Tasman by Christmas. It no longer demands that Air New Zealand sell its no-frills arm, Freedom Air.

But it is keeping its own counsel where entering the domestic market is concerned.

About half of the benefit that Qantas and Air New Zealand claim for the deal is from the boost to inbound tourism they say would follow.

At first they claimed Qantas Holidays would be able to steer another 50,000 tourists a year our way, which would be worth $148 million for the New Zealand economy in year three of the alliance.

Both the number of additional tourists and the method used to calculate the economic benefit drew fire.

The airlines subsequently boosted to 60,000 their forecast of the number of extra tourists but halved their claim as to the economic benefit, to $73 million in year three.