The container shipping industry is faced with the challenge of ever-decreasing freight rates that can only be served viably with larger, more efficient vessels. However, market growth does not allow each individual line to increase the size of its ships to the larger, more efficient ships and at the same time keep a utilisation rate that would justify the introduction of these ships.

This problem is worsened by the industry’s average financial performance which does not generate the returns to invest in this new capacity without considerable financial risk. There are only two alternatives: either an all-out battle for market share in the hope that several lines simply abandon a particular trade or even exit the market completely allowing the surviving lines to capture the volumes freed up by these departing lines, or collaboration with other lines to allow more efficient and rational capacity utilisation. The presence of state-owned or state-backed lines on many trades combined with the current financial position of many private lines does not make the first option attractive let alone realistic, leaving only the second.

The optimal way of achieving a more rational capacity allocation would be through consolidation. However, the reluctance of many lines or their shareholders to cede control makes this too unlikely – at least for many lines. This leaves only strategic alliances as a vehicle to achieve the capacity rationalisation.

The paradox is that while the shipping industry is the industry most in need of genuine strategic alliances which can have a meaningful impact on capacity and encourage rational capacity re-allocation, it is the least willing to experiment. By contrast, the airline industry which suffers from a similar capacity issue with the larger aircraft having the lower seat mile costs and thus a need to achieve economies of density, has adjusted. Over 90 per cent of transatlantic passenger traffic is now carried by one of the three major ‘metal neutral’ joint ventures (A++, Skyteam and oneworld) and similar joint ventures are being put in place on Asian routes. A major difference is that the airline industry has embraced, and secured regulatory approval for these ‘metal neutral’ virtual joint ventures which set prices jointly and share revenues, whereas the shipping industry seems reluctant to move beyond traditional vessel-sharing agreements based on the EC’s liner shipping block exemption with a 30 per cent market share threshold and a restriction on price discussion or revenue-sharing.

The answer is the shipping industry can do more and follow the airline model. The basic rules are the same: EU, US, Chinese, Japanese and Korean antitrust/competition laws apply equally to both industries; even the regulators are saying so.

The head of the transport unit at the European Commission’s competition directorate-general has publicly said that the block exemption is acting as a straitjacket on the industry and that the industry should study whether it can follow the airline industry’s example. When even the competition regulator is encouraging the industry to be more imaginative and to stop structuring alliances around the block exemption, that is an unmistakable sign that there is much more room for manoeuvre. 

First of all, it is important to understand that the block exemption in no way sets a maximum scope for co-operation. Rather, the block exemption sets out a safe harbour where any alliance within the block exemption is presumed pro-competitive or at least not anti-competitive.

Co-operation outside the block exemption in no way is presumed anti-competitive, rather it must be assessed on its own merits. Much co-operation outside the block exemption is likely to be pro-competitive. This is what the airlines have done. And the competition regulators have specifically approved  their alliance.

The key feature of the airline alliances is their ‘metal neutrality’. This means that the financial structure of each joint venture is such that the airline that sells the passenger its ticket is indifferent whether the passenger flies on its aircraft or one of its partners’ aircraft as it will benefit financially in the same way.

This means that the airlines can agree which partner’s capacity is best suited to the particular part of the network or flight, and design schedules (and capacity) to be as attractive to the passenger as possible, eliminating any rivalry between the partners as to which one will operate a particular flight and how to route the passenger. 

In turn, this leads to a concentration of flights at the key hubs increasing the density of the network and thus reducing cost. Key to this is the joint setting of prices so that there is no price competition between the partners and sharing of revenues.

It is this that creates the incentives and gives each individual airline the comfort to design the network as optimally as possible. 

In the case of the A++ alliance between Air Canada, Lufthansa and United, which is the alliance that has created the most efficiencies and thus been approved with the fewest remedies, the airline partners undertook a detailed economic and legal analysis which measured the cost savings and other efficiencies to passengers created by the joint venture as designed, as compared with the benefits that passengers could get under a ‘non-restrictive’ form of co-operation – in that case, simple code-sharing.

They were able to show that the benefits that would accrue to passengers in the form of cost savings and other efficiencies from the integrated joint venture were significantly greater and thus justified the joint price-setting and revenue-sharing. The comfort the parties derived from these really did allow them to design a network that was that much more efficient. 

Where the airline industry differs from the shipping industry is that many passengers in the airline industry are connecting passengers – either single-connect or double-connect – and because of the ownership restrictions on airlines, no single airline can serve many of the double-connect itineraries. It must co-operate with a carrier in another country. 

The benefits of the alliance will be distributed differently among the non-stop overlap passengers, single-connect and double-connect passengers with the greatest benefits for the double-connect passengers due to the elimination of double marginalisation.

Nevertheless, significant benefits also accrued to the non-stop overlap passengers via, in particular, greater frequency (as more flights are added to accommodate the connecting passengers) with larger, more efficient aircraft. 

First of all, this shows that if some lines wish to negotiate a deeper alliance involving deeper co-operation there is no reason not to explore the work. If economic and legal analysis can show greater cost savings and other efficiencies for this alliance than under the current ‘block exemption inspired VSAs’ then there is every reason to believe they can be approved by competition authorities formally or informally.

This applies to all authorities: the European Commission, the Chinese NDRC (which is also reviewing airline JVs) and the US FMC in particular. Secondly it indicates that if some lines wish to co-operate more closely and run their ships in a form of rationalised virtual joint venture then there is every reason to believe this can be achieved as long as the economic and legal analysis of the proposal reveals enough cost savings and efficiencies.

We advised United Airlines in the A++ joint venture and were instrumental in developing the regulatory approach to analysis of the efficiencies which ultimately led the alliance to be cleared with only minimal remedies.

This type of forward looking, creative and ‘out of the box’ thinking is our hallmark.