The Australian Competition and Consumer Commission authorises Qantas and China Eastern's cooperation agreement.

24 August 2015

Kathryn Edghill, Cicely Sylow, Zhaofeng Zhou

On 21 August 2015, and after nine months of deliberations, the Australian Competition and Consumer Commission (ACCC) authorised Qantas and China Eastern's cooperation agreement, subject to strict capacity conditions and reporting on seats and passengers flown as well as average fares for routes between Australia and Shanghai.

For the airlines concerned, the ACCC's decision is no doubt a welcome one. For Qantas, the China Eastern partnership now completes a trifecta of cooperation agreements for Qantas strengthening its gateway strategies. The Emirates partnership links Qantas to Europe through Dubai while the recently deepened partnership with American Airlines links Qantas with North America. The partnership with China Eastern will create a Shanghai hub to access other cities in China. For China Eastern, the decision opens a gateway to travel in Australia, especially for the increasing numbers of Chinese tourists.

It is not a decision, however, which comes without a price. The authorisation is for five years - provided, of course that the predicted capacity and other conditions can be met. That proviso throws into sharp highlight the risks associated with investment in an airline partnership or alliance, in this case the need for a commitment to capacity before having the commercial certainty that it is justified. There is also a price to pay for both airlines in terms of increased ACCC scrutiny of their respective operations over that 5 year period. In this article we examine the rationale for the decision and the signals its sends for the future of airline alliances.

Early turbulence - the ACCC's draft determination

It hasn't always been smooth flying for the cooperation agreement. In March 2015 the ACCC issued an unexpected draft determination proposing to deny the authorisation. It cited concerns that the combined market share of 83% on the Sydney-Shanghai route would give the airlines an "increased ability and incentive to unilaterally reduce capacity, or limit growth in capacity, to increase airfares" and expressed reluctance to accept capacity conditions as a means of overcoming its concerns. It is extremely rare for the ACCC to subsequently approve an authorisation application it previously proposed to deny.

Clear skies - what happened between the draft determination proposing to deny the authorisation and final decision to approve the authorisation?

Many questioned the ACCC's draft determination and criticised it for being too narrowly focussed on the Sydney to Shanghai route and not giving due weight to the wider Australia-China market. The draft determination attracted a wave of further submissions from government departments, federal parliamentarians, airlines, airports, and tourism bodies as well as a number of institutions that represent the interests of Chinese and Australian business, urging the ACCC to reconsider its position.

Following the draft determination, the airlines provided the ACCC with further information to support their claims that the cooperation agreement was likely to facilitate the adoption of more frequencies of flights and destinations. In particular, China Eastern advised that it would introduce a year round service on a new route (the particular route is still confidential at this time) and additional seasonal services between Shanghai and Sydney, Melbourne and Cairns, with possible further increases to Sydney and Melbourne to year round depending on demand. The airlines also proposed to increase the range of destinations covered by their codeshare agreements to cover more domestic routes in their respective countries.

Authorisation is subject to strict conditions

The ACCC is focussed on ensuring that there is sufficient growth in capacity on the Australia-Shanghai routes and has foreshadowed that the failure to add significant capacity over the course of the alliance will impact on the likelihood of re-authorisation in 5 years' time.

The authorisation is subject to the airlines maintaining current capacity (in aggregate) across all Australia-Shanghai routes, growing capacity on these routes by a compound annual growth rate of 4% (which amounts to an increase of 21.67% within 5 years) and to maintain the current level of capacity on the Sydney-Shanghai route. But that's not all. The ACCC has the right to review the capacity growth obligation on the Australia-Shanghai routes and impose a specific growth obligation on the Sydney-Shanghai route.

The ACCC is asking the airlines to commit to capacity in advance of the airlines being able to determine whether or not the additional capacity is actually warranted. The need for capacity will depend on how successfully the gateway strategy has been implemented. However, without this capacity commitment, the ACCC stated it would be difficult for it to accept the alliance would facilitate the public benefits the airlines assert, such as additional new frequencies and destinations.

The ACCC has reiterated its concern that the alliance could result in significant public detriment for customers flying only point-to-point, between Sydney and Shanghai. The conditions require the airlines to report each scheduling season on seats and passengers flown, route specific costs and revenues and average fares. This information will allow the ACCC to closely monitor any possible detrimental effects of the alliance.

Authorisations no longer clear you for take-off

While this authorisation opens up China to Qantas it is not a carte blanche tick of approval as it subjects Qantas and China Eastern to extensive monitoring and oversight by the ACCC. The conditions around capacity will affect the airline's ability to independently adjust demand according to market forces.

This authorisation may be an indication of the times ahead for airlines. Obtaining authorisation is set to be a more complicated and delicate process affected by political ambitions for greater growth between nation states. A gateway strategy, and reliance on codeshares with partner airlines to service beyond routes, is a strategy being pursued by a greater number of airlines. As more airlines focus on servicing their domestic markets and only key international routes, we are likely to see more examples of two airlines with a dominant presence on key route between countries seeking to partner with one another. Such airlines will need to consider their appetite to commit to capacity conditions in advance of hard evidence that the additional capacity is in fact warranted.

As for Qantas and China Eastern, it will be a case of watch this space over the next 5 years - something the ACCC will be closely doing.

Authors

Kathryn Edghill

Partner
Australia

Call me on: +61 2 9226 9888
Cicely Sylow

Cicely Sylow

Associate
Australia

Call me on: +61 2 9226 9888