How may secondary trading affect competition, according to existing findings? Market concentration concerns
The European Commission states that a system of secondary slot trading facilitates access to the market and has the potential to have pro-competitive effects.
It is widely recognised, however, that there is a risk that private benefits (to airlines) might include excessive profits for airlines resulting from distortions of competition, which would tend to reduce rather than enhance social welfare (DotEcon 2001; Gremminger 2006). There is a risk that slots would become concentrated amongst relatively few carriers. A high level of market concentration is likely to translate into higher airfares for consumers (Borenstein 1989; Lijesen 2004). For example, looking again at the US experience, a number of researchers state that the buy-sell rule in the US appears to have had the effect of reinforcing the dominant position of leading airlines and leading to higher average airfares (Pagliari 2001; Starkie 1998) (see also section 5.2).
Why would secondary trading result in market concentration concerns?
• Larger carriers are in a much stronger position financially to acquire existing slots from other airlines. New destinations and frequencies at a hub generate substantial network economies for the hub carrier. Newcomer airlines are not able to generate such network effects and for this reason their willingness to pay for a slot at a congested hub airport is bound to be lower compared to that of established airlines (Czerny & Tegner 2002). In addition, the more profitable incumbent airlines are likely to be able to expand their slot shares. According to the findings of Sened and Riker (1996) (in Czerny & Tegner 2002), the higher the percentage of occupied seats in each of its planes, the more likely a carrier was to purchase new slots.7
• The secondary slot market will lead to an efficient outcome only if certain conditions, in particular with respect to a large number of buyers and suppliers, are met (Lévêque 1998). At congested hub airports where the home carrier has a dominant position (for example, at Frankfurt, Amsterdam, and Paris CDG), the dominant carrier may strategically try to obtain more slots to limit competition. This is because the opportunity costs of a slot for the home carrier not only cover the foregone benefits of not trading the slot, but also include the reduced revenue
resulting from increased competition from the slot buyer (Lévêque 1998). So the dominant airline may use slots inefficiently to limit downstream rivalry (CAA/OFT 2005, p.12).
• Dominant carriers might pursue discriminatory practices among potential buyers of the slot (Gremminger 1996; Lévêque 1998). A dominant carrier might:
• Not want to sell to carriers it is competing with. However, this is not an effect of secondary trading itself, but of the dominant position the hub carrier built up before the introduction of secondary trading (CAA/OFT 2005, p. 12).
• Sell only at excessive prices. According to CAA/OFT, an observed high price may also reflect scarcity rents when demand for flights is high relative to capacity. Scarcity rents are reflected in the price of a slot. That a potential new entrant does not want to purchase at this price does not mean anti-competitive behaviour is taking place. • Include non-compete clauses.
• Sell only at unattractive times or to certain airlines. • Sell at higher prices to stronger competitors.
• Sell on condition that the buying airline uses other services of the seller.
The outcome depends to a large extent on the characteristics of the airport involved (traffic structure, number of airlines selling and buying) and on how the slot market is organized.
Considerations
The issue of market concentration is not as clear-cut as first appears. A number of factors should be considered: the definition of competition, an efficient level of competition, and empirical evidence on increasing slot concentration.
First, it is important to define the relevant market when analysing competition levels. Is it the relevant market at the airport level that is important, or that at the route level? Say that hub X has 4 carriers with a 25% market share at the hub but with a monopoly at all routes they serve. Now, consider hub Y with 4 carriers, again with a 25% market share at the hub, but competing vigorously at each of the routes each airline serves. Is it competition at the airport level or at the airport system level that counts? Services from one airport may to some extent substitute for services from another airport, and the potential of anti-competitive behavior at hubs might be overstated (CAA/OFT 2005; Sickmann 2006). Moreover, is it the intra-hub competition that is important, or the inter-hub competition? Consider, for example, KLM having a monopoly on a direct, long-haul route from Schiphol, but encountering fierce competition from Lufthansa, which serves the same route indirectly via its hub in Frankfurt.
In short, the level at which overall hub dominance is passed on to consumers depends also on the interaction between hub dominance and route dominance, the presence of a multi-airport system as well as the presence of inter-hub competition. In line with DotEcon (2001), we conclude that it is, therefore, difficult to use simple quantitative limits on slot holdings to control for market power. This is particularly true when attention is paid to the definition of the optimal level of competition (see below).
Second, it is important to consider the optimal level of competition. Pagliari (2001), Starkie (1998), and the European Commission (Gremminger 2006) doubt if new, large-scale entry at capacity- constrained hub airports is desirable from an economic efficiency perspective. The immediate effect of entry in oligopolistic and monopolistic markets is that the increased capacity offered by new services depresses the load factors of incumbent airlines in the short to medium term. Is over-capacity at the route level efficient while the airport’s slots are in short supply?
In addition, a concentration of slots at hubs in the hands of a few airlines is beneficial to society: connectivity externalities increase the value of the network for the consumer (Starkie 2006). On the supply side, network economies of hubs result in cost advantages. On the demand side, they result in more direct destinations, higher frequencies, and shorter transfer times. For transfer passengers, hub domination may be beneficial since they prefer online to interline connections (between different carriers).8 In a hub network, however, passengers at the spokes have fewer
direct services, longer journey times, and the inconvenience of changes of flights. Moreover, there is evidence that the domination of airport slots by the hub carrier do translate into higher airfares (hub premiums) at local routes (Borenstein 1989; Lijesen 2004).
At dominated hub airports, furthermore, 2nd-tier carriers may be much better able to provide effective competition to the dominant hub carrier than a range of smaller (new-entrant) carriers. Hub domination may pose fewer problems if strong 2nd -tier carriers operate from the airport and can use the secondary trading system to increase their slot holdings. Because of the so-called ‘S- curve effect’ (see footnote 3, p.16), small operators tend to receive a smaller share of passengers relative to their share of flights, and larger operators a larger share of passengers relative to their share of flights. As one airline representative stated in an interview:9
‘Look for example at London – New York. It’s not about allowing 8 new airlines to fly on this route; it’s about increasing competition with BA, with their huge slot portfolio and their operating 10 flights a day to New York. We [airline] provided them with decent competition and now we’re flying 6 times a day, because of the slot trading. Without slot trading we would be operating a maximum of 3 or 4 flights a day. The new-entrant rule allows new carriers to fly on a particular route, but it doesn’t establish a better position for the 2nd or 3rd carrier’.
The current new-entrant rule in combination with grandfather rights leaves few opportunities for such airlines, potentially effective competitors, to increase their slot holdings in the current EC Regulation:
We only have like 3% of the slots at Heathrow and 2% at Gatwick. We are too big to get anything out of the new-entrant rule. We are at such a disadvantage. We think we would do better out of that process than the current one.10
Third, although it is generally agreed that increasing hub domination leads to higher average airfares, the relationship between the introduction of secondary trading and growing hub domination is not clear-cut. Kleit and Kobashi (1996) found no evidence of slot hoarding by dominant carriers to prevent low-cost entry. In line with their conclusions, McGowan and
8 In theory, concentration is not a conditio sine qua non for connecting services. However, service quality improves if transfer times are minimised. Owing to information asymmetries between airlines, it is not possible for each airline to know the necessary details of other carriers’ networks so as to minimise transfer times.
9 Interview with an airline representative. 10 Interview with an airline representative.
Seabright (1989) concluded that airlines with market power do not engage in predatory bidding for slots to preempt competition. In a financially difficult market, it is an unnecessarily expensive way to drive out competitors. Incumbents with market power are more likely to direct entry- deterring behaviour to the route-specific service they operate (by means of predatory pricing of services) than to hoard slots.11
Overall
The overall impact of secondary trading on competition seems to be a mixed blessing. NERA (2004, p. 143) expects that hub carriers and their alliance partners will indeed increase their slot holdings at congested airports. However, strong competitors will also increase their holdings. These competitors can be divided into two groups. First, there may be scope for the entry of competitive long-haul carriers on particular routes, in particular at congested airports with high- density catchment areas. These carriers may be able to benefit from the withdrawal of less valuable slots used for short-haul and less profitable long-haul services.12 Such 2nd-tier carriers may be able to provide effective competition to the dominant carriers.
Second, there may be scope for low-cost airlines. Cost-minimising low-cost carriers (such as Ryanair) generally choose uncongested, secondary airports for their operations. Yet, more yield- oriented low-cost carriers such as easyJet compete directly with full-service airlines at the major airports. This is mainly the case at congested non-hub airports and hub airports where there are no other airlines which value the slots more highly than the low-cost carrier.
From the literature review, it clearly follows that concentration concerns should be taken into account when introducing a secondary trading regime in Europe.