The current global crisis is accelerating the pace of consolidation in the airline industry and airlines around the world are seeking to create synergies by merging or creating alliances. This consolidation is, however, by no means a straightforward process, not least because of restrictions in a number of countries on foreign ownership of airlines. An alternative for airlines who wish to cooperate without having to overcome the hurdles to a full merger or a fully-fledged alliance is to enter into codeshare agreements.
However, codeshare agreements are not without their own issues and in the current context of competition regulators world-wide investigating the industry for possible anticompetitive arrangements in relation to freight rates, any cooperation between airlines needs to be assessed carefully to ensure compliance with competition rules. Further, the traditional heavy regulation of air transport markets has led to a high degree of concentration on certain passenger routes. In concentrated markets, any codeshare agreement has the potential to have restrictive effects on competition.
What are the advantages of codesharing? Codeshare agreements enable airlines to expand the number of destinations they serve under their own brand, offering more choice to their customers, by allowing them to market seats on flights operated by partner airlines. All codeshare agreements have in common that they allow the marketing airline to use its designator codes to sell seats on the operating carrier’s planes. Beyond this core feature, there is a broad variety of arrangements for codesharing, with some providing for comprehensive cooperation between the parties, involving joint decisions on price, capacity, schedules, marketing and other competitively sensitive matters.
In the current difficult economic context, are competition authorities likely to view codesharing arrangements more favourably? Competition regulators have sometimes been doubtful of the economic benefits created by codeshare agreements, especially when these relate to routes operated by few competing airlines. An economic study prepared in 2007 for the European Commission shows that evidence of benefits brought about by codeshares was at best inconclusive.1 The Australian competition authority’s recent decision to block a proposed codeshare and revenue pooling agreement between Air New Zealand and Air Canada shows that the depressed economic context has not affected regulators’ reluctance to allow cooperation among competing airlines.2
Against this background, we explain below the principles that competition regulators apply when assessing codeshare arrangements and the competition concerns that might arise. Our focus is the application of EC competition law, but decisions of other antitrust authorities are also discussed where relevant.
Application of competition laws to codeshare agreements
Codeshare agreements may be subject to antitrust rules in a number of jurisdictions depending on the nature of the agreement and the location of customers or business partners. Their effect will mainly be felt at each end of the relevant route, but competition regulators elsewhere may also assert jurisdiction based on network effects or more simply on account of sales of codeshare tickets in their jurisdiction.
Under EC competition law, companies are prohibited from entering into agreements and concerted practices which restrict competition within the EU unless the conduct can be exempted on account of redeeming economic benefits. Competition laws of other jurisdictions contain similar provisions. The prohibition of restrictive agreements applies to both horizontal agreements (concluded between competitors) and vertical agreements (concluded between a supplier and a reseller).
Competition law analysis of codeshare agreements requires consideration of both their horizontal and vertical aspects. The right of the marketing carrier to sell the operating carrier’s capacity gives rise to a distribution or “vertical” economic relationship: restrictions on the marketing carrier’s ability to sell may fall within the scope of the prohibition. Where parties compete on the route covered by the agreement, there is a “horizontal” relationship among the parties. Even where the parties do not compete directly on the route, the codeshare agreement will affect the “horizontal” competitive relationship among the parties, as the marketing carrier may be a potential entrant on the market.
Codeshare agreements may also be caught by competition law provisions prohibiting an abuse of a dominant position if one or both parties to the codeshare agreement are dominant in the market concerned and where the codeshare agreement contributes to the creation, maintenance or strengthening of their market power or allows them to exploit such market power.
Assessing the competitive impact of codeshare agreements
In determining the potential anti-competitive effects of a codeshare agreement, competition authorities will consider the extent to which the cooperation proposed under the codeshare agreement would result in a lessening of competition.
Restrictions of competition are much more likely to arise where the parties to the agreement are both operating flights on the route covered by the agreement. Competition authorities will also take into account whether one of the parties is a potential competitor with the other, as the conclusion of a codeshare agreement between the operating carrier and a potential competitor may result in the suppression of that competitive constraint.
Regulators will carefully assess the degree of horizontal cooperation between the parties. Horizontal restraints such as price fixing, market sharing or limiting capacity will almost always be prohibited. Other types of cooperation will need to be analysed more carefully in order to assess their potential negative effects on the market and whether they may on the other hand lead to substantial economic benefits for consumers. Each agreement is therefore analysed on a case by case basis and placed in its economic context. Codeshare agreements which provide for some form of coordination on key competition parameters will usually have substantial restrictive effects. For example, the EC Commission has held that close coordination and integration of scheduling, revenue sharing, capacity co-ordination, marketing and pricing would, as a matter of fact, eliminate all competition among the parties as these parameters are key elements on which airlines normally compete with each other.3 Therefore, the more elements that are included in the cooperation, the more likely is it that restrictive effects on competition will occur (for example joint planning of flight schedules, joint use of FFPs, etc).
In addition, regulators will examine whether the parties to the codeshare agreement hold any substantial market power on the route(s) concerned, whether jointly or individually. Market power is mainly assessed by examining the parties’ combined market share. The higher the combined market share, the higher the risk that the codeshare agreement will have restrictive effects. In particular, competition authorities will verify that the codeshare agreement does not contribute to the creation, maintenance or strengthening of a dominant position, or allow the parties to exploit such a position.
In assessing whether the vertical relationships created by the codeshare lead to antitrust concerns, regulators are likely to examine whether capacity is made available under a free-flow or a hard blocked space arrangement. As a general rule, the “free flow” model will be considered more restrictive of competition: authorities typically consider that free sale arrangements do not lead to an increase in competitive pressure, whereas under a hard blocked space agreement, the revenue risk is borne by both parties thereby providing incentives for airlines to compete for passengers to fill their share of seats on the plane.4 Accordingly, from an antitrust risk management perspective, codeshares where each party retains the strongest possible incentive to sell seats on the flights it operates will create fewer issues. This is particularly the case where each party to the agreement is able to cut its prices and increase its operating capacity to gain market share.
Besides analysing the agreements themselves, regulators also remain watchful for any competition law breaches that may arise during the codeshare’s lifetime. As they offer a platform for ongoing discussion and cooperation and because they increase price transparency among the parties, codeshare agreements may sometimes lead to the exchange of competitively sensitive information that is not strictly required for the codeshare’s operation, or to outright agreements on prices or capacity. As a result, competition law compliance does not end with the design of the agreement, but requires continued monitoring during its lifetime.
Are codeshare agreements that restrict competition always prohibited?
Codeshares which bring about restrictive effects on the market may still be exempted if they create efficiency gains and other economic benefits for consumers. In some jurisdictions, parties will need to apply for a formal exemption or immunity from the competition authority; in other jurisdictions (as is the case in the EU) parties will have to make this assessment themselves, with limited scope to obtain formal comfort from the authorities.
Depending on market circumstances, economic benefits that will justify an exemption or immunity include increased destinations, complementary networks, increased capacity (additional seats, frequencies, etc), new or improved airline services, improved connectivity, better scheduling, shorter transfer times, higher load factors, better seat management, increased availability and flexibility of discounted tickets, improved frequent flyer programmes, more efficient use of resources (ground handling, information technology), interlineability of tickets, etc. Authorities are however very careful in their analysis of such benefits. The onus is on the parties to show that these benefits would not arise absent the conclusion of the codeshare agreement with its particular cooperative features. In addition, the antitrust authorities need to be convinced that the agreement does not enable the parties to eliminate all competition in the relevant markets.