04 May 2018

(by Tom Carr) On the 12 April 2018 the BBC that International Airlines Group (IAG) had acquired a 4.6% stake in Norwegian Air Shuttle (Norwegian). IAG (which includes BA, Iberia and its most recent acquisition, Aer Lingus) that their “minority investment is intended to establish a position from which to initiate discussions with Norwegian, including the possibility of a full offer for Norwegian”. Norwegian is bigger than Aer Lingus at Gatwick, has a higher route overlap than BA had with Aer Lingus, and is currently an industry disrupter in the lucrative transatlantic market. Will the standard remedy of a few slot divestitures be sufficient to address the competition concerns, or is it time to start blocking mergers?

This is the latest expansion and consolidation move by IAG, despite concerns raised by competition authorities at each of its prior expansions. In IAG/Aer Lingus, the European Commission’s were about overlaps on some routes, and the possible loss of Aer Lingus customers connecting with rival long-haul flights. The latter was remedied by a requirement for IAG to enter into connection agreements with long-haul rivals. Following standard practice, the overlap concerns were remedied by the divestment of five slot pairs at, somewhat surprisingly, Gatwick (i.e. not at Heathrow where the Commission appeared to have most concern).

Some market context

Airlines operate in a unique regulatory environment:

  • Ownership rules prevent consolidation outside of the EU and can restrict the ability of airlines to fly internationally;
  • ‘Freedoms of the air’ (the ability to fly) are set out in often restrictive bi-lateral air service agreements – things are more liberal under the EU-US open skies agreement for traffic between Europe and the US but not as liberal as in the internal aviation market of the EU;
  • At congested airports, airlines must acquire landing slots to access airports, these are not linked to specific services; and
  • Competition authorities usually view airline competition as taking place on a city pair basis.

The transatlantic market (EU to USA and Canada) is dominated by the three airline alliances providing 87 per cent of total capacity. From London to the US, IAG and One World are the dominant capacity providers. While still relatively small, Norwegian has and has ambitious growth plans. It has a pan Europe low cost short-haul network based around a fleet of modern aircraft. It is the largest player in Europe rolling out low cost long-haul, taking advantage of efficient aircraft to fly mostly across the Atlantic. Its capacity over the Atlantic between 2016 and 2017 making it larger than Virgin Atlantic in that market. It now serves 10 US destinations from London Gatwick generally cheaper, by a fair margin, than other airlines. New entry has not been easy as incumbents fought the low cost long-haul model on both sides of the Atlantic. American airlines and unions fought a regulatory challenge to Norwegian’s right to fly and the major European carriers are launching low cost long-haul fighting brands.

Route pairs and slot divestments

Let’s get back to merger remedies. Airline markets are typically defined on a route pair basis; that is travel between cities, or in some cases specific airports within a city. This works well for point-to-point operations and reflects the competition we see between the likes of easyJet and Ryanair. It is the general approach that competition authorities employ for overlap routes to facilitate new entry in congested airports. IAG remains subject to several slot divestment remedies from prior mergers, even before the purchase of Aer Lingus in 2016. The Commission’s key concern in the latter was the Heathrow to Dublin route. Heathrow was considered to be a differentiated product to other London airports, yet the Commission applied a wider market definition including both London Gatwick and London City airports. To clear the merger the commission :

“the release of five daily slot pairs at London-Gatwick airport to facilitate the entry of competing airlines on routes from London to both Dublin and Belfast; and Aer Lingus continuing to carry connecting passengers to use the long-haul flights of competing airlines out of London-Heathrow, London-Gatwick, Manchester, Amsterdam, Shannon and Dublin.”

Another reason the slot remedy appears odd, is that it is stated in the Commission’s report that there was no problem in getting slots at Gatwick. This is reflected in the relative at Gatwick (c.£1m) compared to Heathrow (£10-20m+). The value of the merger for IAG was in the Heathrow slots.

Slot remedies provide a static solution to a dynamic market. Most slots are flexible: airlines use them to deploy aircraft to fit their strategy and fit demand. Remedy slots on the other hand are generally ring-fenced for a purpose, e.g. flights from London to Boston. This means that an entrant must compete on that specific route regardless of how those slots could best be utilised by an entrant. It also means that, in this instance, IAG’s slot holding grows (as not all acquired slots are divested) but with windows for targeted competition on routes that may or may not be strategically important for IAG. Given the number of slots that would be purchased with Norwegian at Gatwick, the effect of prior remedies would likely be muted. Would, then, another slot divestment be an appropriate remedy?

In this currently hypothetical case, no. Whilst individual divestments may facilitate entry on specific routes, they do not facilitate competitive entry across the macro market, in this case the transatlantic. Under the sway of any of the alliances, Norwegian loses its position as a disruptor and its ability to grow into the varying routes available across the Atlantic. Its strategic independence as an innovator makes it a greater competitive threat than simply being a low-cost airline on a few specific routes. Competition agencies must adopt a longer term, more strategic approach to ask: whether airlines can sustainably enter routes on limited slots; whether more competitive pressure can be generated by allowing more liberal use of slots; and, in this case, whether the merger should be blocked.

A brief review of flight comparison sights such as Skyscanner indicates that for both London to Chicago and New York flying in a couple of weeks one-way Norwegian was less than half the price of the next cheapest airline. Checked on 27 April 2018 to fly on 18 May 2018.

It took three years for the DoT to provide Norwegian a Foreign Carrier Permit given the level of position. See Department for Transport (2016), Final Order, Docket DOT-OST-2013 0204, 2 December 2016

Notably Lufthansa operates EuroWings for low cost long haul and KLM-AirFrance has launched Joon.

Iberia/Vueling (), the British Airways, American Airlines and Iberia joint venture (see ) and British Airways/BMI ()

London Stansted, London Luton and Southend airports were excluded from the market definition.