Competition Analysis
Introduction
8.20 The Commission must determine whether the airfield services supplied by AIAL are supplied in a market in which competition is limited (or is likely to be lessened).
8.21 In Chapter 3, the Commission came to the conclusion that, for the purposes of this Inquiry, the relevant product market is the airfield services market, as defined by the airfield activities in the Airport Authorities Amendment Act 1997. The issue of whether airports are in competition with each other in the airfield services market, or whether each operates in a geographically distinct market, was also broadly canvassed. The Commission came to the preliminary view in Chapter 3 that, in terms of the geographical dimension of the market, its generic analysis of passenger and airline demand suggested that, for most traffic, none of the three airports faced significant competition either from each other, or from other regional airports.
8.22 In assessing AIAL's ability to exercise market power, the following considerations, which are further addressed below, are important:
- On the supply-side of the market, the actual competition from existing airports, or potential competition from new airports.
- On the demand-side, the possibility of airlines and their passengers and freight customers switching to other airports.
- The potential countervailing power of airlines.
- The present regulatory regime.
Demand Characteristics
8.23 The weighted elasticity of demand determined for Auckland International Airport in Chapter 3 was [...].
Competition and Substitutes
8.24 In Chapter 3, the Commission noted that the nature of the investment in international airport facilities (with very large sunk costs), such as those at Auckland International Airport, is likely to mean barriers to entry are high and, that in consequence, competition from potential entrants is low. It was noted that Auckland, like the other international airports, may face competition from other airports in the provision of airfield services. This competition may be the potential competition from prospective new entrants, and the existing competition from other airports already operating. The specific circumstances of Auckland International Airport are now examined.
8.25 In response to the Draft Report, AIAL submitted that the relevant market constituted a number of different segments for international flights, commercial domestic flights, and general aviation flights. AIAL argued that the Commission's finding of limited competition could differ for the various segments such that only a subset of the airfield services market could have limited competition.278 The analysis of competition in airfield services at Auckland International Airport is separated into these three segments.
General Aviation
8.27 Airport substitutability from a supply-side perspective depends largely upon the size of aircraft. Smaller aircraft are more flexible as to where they can land. For small, general aviation (GA) aircraft, Ardmore Airport is a possible substitute for Auckland International Airport in the Auckland region.279 AIAL has endeavoured to encourage GA operators to use alternative airports like Ardmore through the setting of landing charges (GA aircraft landing charges have seen the biggest increases in the last ten years). Although much of the GA traffic has been forced out of Auckland International Airport at peak times, GA aircraft still use Auckland International Airport, and some operators have a preference to do so because of the better facilities and location.
Domestic Aircraft
8.27 From a supply-side perspective, and focusing only on domestic traffic, which does not involve the use of the larger aircraft, there appears to be considerable scope for substitution between a number of airports in large centres and regional areas.
8.28 However, while there are many airports capable of servicing domestic aircraft, domestic travel tends to be destination specific. Other airports are, therefore, unlikely to be a substitute for Auckland when passengers wish to go there. For example, most people wishing to travel to Auckland - whether business people on a day return trip, leisure travellers making international connections, or commuter travellers who are interlining (who would suffer the inconvenience of having to transfer between airports if they were delivered to one airport but making a connection at another) - would find Ardmore orhamilton a poor substitute because of the time delays and the extra costs imposed.
8.29 Even if AIAL imposed a substantial increase in airport charges, competition between the domestic airlines would probably ensure that Auckland remained the destination. If an increase in charges were to cause an airline to stop servicing Auckland International Airport, another airline would likely start operating as demand for air travel to and from Auckland would still exist, or, alternatively, remaining airlines would probably increase flight frequencies to fill the gap. Further, airport charges are not the most significant operating cost for an airline, so airlines would likely accept an increase in costs, rather than fly to an alternative airport and lose to a competitor the business generated from servicing Auckland International Airport (given the additional loss of losing connecting international flights or not being a person or entity's preferred airline because all airports are not serviced). This suggests that, for domestic services, Auckland International Airport has essentially a regional monopoly, in that, in the majority of cases, there are no substitutes for its services for travellers wishing, and freight needing, to fly into or out of Auckland.
8.30 AIAL suggested that a second domestic airport might be developed in the Auckland region using the air force base at Whenuapai, if and when it is decommissoned.280 This might obviate the lengthy gestation period needed for the building of a wholly-new airport. However, AIAL dismissed Whenuapai as a possible competitor because of the need to completely rebuild its runway and add new land-side facilities.281 Further, AIAL indicated that the planning ramifications of a new domestic airport at Whenuapai would be substantial.282 It also stated that reports commissioned by the Auckland Regional Council confirmed that the military base was unsuitable.283 This suggests that entry is unlikely to be made significantly easier by the adaptation of an existing airforce facility.
International Aircraft
8.31 As noted above, Auckland International Airport is New Zealand's largest and busiest airport for passengers and freight. Sixty per cent of passenger movements are international. Christchurch International Airport is the only other airport in New Zealand that is also capable of handling the largest jets. As such, in the supply of airfield services to long-haul international flights, Auckland only faces competition from Christchurch International Airport (in terms of point of entry or exit from New Zealand). However, Christchurch is very much a secondary airport for such flights, with flights to and from Christchurch often being reduced and/or stopped as demand and other circumstances change. In addition, hubbing by the airlines284 is likely to further reduce the potential for competition. In New Zealand, Auckland International Airport acts as a hub for international travel for Air New Zealand.
8.32 While Auckland International Airport faces little competition in the supply of airfield services to long-haul international flights, there is potential for more competition in shorter distance international routes such as Australia and the South Pacific. A number of airports can, and currently do, service the smaller Boeing 737 and 767 aircraft that are operated on these routes. In Auckland's case,hamilton Airport is the most likely competitor in terms of outbound flights by New Zealand residents, with Air New Zealand operating its discount Freedom Air services from there to Australia. The discounted fares currently offered by Freedom Air are unlikely to be low enough that Auckland residents would be prepared to drive tohamilton to fly. While 80 minutes travel to an international airport is not much by international standards, the presence of lower "cut price" airfares are likely to be required before Aucklanders will travel tohamilton (rather than just going to Auckland International Airport). As such, the Commission considers thathamilton does not provide sufficient competition to be viewed as a close substitute for most travellers.285 In terms of inbound tourists, their choice of airport is likely to be driven by destination.
8.33 Auckland International Airport has the largest share of New Zealand's international traffic. AIAL seems to have advantages over the other two major international airports because of the larger population in its catchment area, its relative importance in air freight (Auckland carries most New Zealand-originating international freight), and its proximity to international aviation routes.286 It also has the necessary infrastructure associated with servicing international airlines. It has a further advantage over Wellington (and other airports) in being able to handle the largest international jets needed for maximum flight distances. Apart from destinations in Australia (where all three airports host airlines with direct flights) the majority of New Zealand residents go through Auckland airport to join connecting flights en route to their final destination.
8.34 It is understood that plans have been aired at certain regional airports, such as Rotorua and Tauranga, to extend the runways to accommodate international flights. This would potentially increase the number of alternative suppliers of airport facilities for international flights. However, the international airlines have said they would be reluctant to use such additional airports for international traffic, given the costs they would incur in putting on extra international flights (costs of aircraft, crew and fuel) for little or no benefit to them. Nonetheless, AIAL noted there is scope for certain airports to compete for traffic at the margin.
8.35 AIAL also mentioned plans being promoted by the Palmerston North City Council for Ohakea to be established as an international airfreight gateway287, although the likelihood of this happening is not known. This might provide competition for Auckland in respect of freight services, particularly in respect of exports. However, for it to happen, the Government would need to approve Ohakea for combined civilian-military use and Ohakea's runway would need to be reconstructed (at a reported cost of $20m).
Conclusion
8.36 The Commission considers there are generally no significant supply side substitutes for the airfield services supplied by AIAL. The potential or existing competition faced by AIAL in supplying airfield services is low.
Constraints on Exercise of Market Power
8.37 As noted in Chapter 3, the current regulation of airports relies principally upon the countervailing power of airlines, and the requirements on airport operators to disclose information about their operations and to consult substantial customers.
Countervailing Power
8.38 At the Conference and in submissions, views of the airlines and AIAL on the strength of countervailing power of airlines differed markedly. BARNZ agreed with the Commission's preliminary finding in the Draft Report that AIAL is unlikely to be significantly constrained by the countervailing power of airlines under the current regime, and that the airlines stand to lose greater amounts than AIAL from withdrawing custom.288 In contrast, AIAL considered the Commission had not given sufficient weight to the regulatory regime and countervailing power of the airlines, although AIAL stated it had never denied that competition is limited in its market for airfield activities.289 AIAL noted that six airlines had ceased business in recent times leaving over $1.5m owing and unpaid to AIAL. Further, while Air New Zealand and AIAL were in litigation, the Air New Zealand group withheld $1.63m in additional landing charges. AIAL also submitted that it had limited ability to enforce payment of landing charges.290
8.39 AIAL argued that, on the basis of its corrections to the Commission's preliminary figures, there was no evidence of excess returns being earned and, hence, that no market power had been exercised by AIAL. AIAL also said the current regulatory regime had not yet been fully tested, and it was premature to draw conclusions about its effectiveness. AIAL also emphasised that the existing regime includes provisions which allow for its modification and for further direction and control by way of the powers given to the Secretary of Transport under regulation 17 of the Disclosure Regulations.291 AIAL suggested that any excessive returns (due to actual aircraft movements being higher than forecast) might feed into lower charges over time, whereas it did not expect to be able to recoup any sub-normal returns caused by unexpectedly low levels of activity.292
8.40 AIAL considered that the strength of the countervailing power of airlines is shown by their representation on numerous airport planning and operational committees, their collective strength through BARNZ and the international aviation alliances, and their demonstrated willingness to resort to expensive legal and payment-withholding tactics.293 Moreover, although airfield charges are low in relation to an airline's total costs, the airlines seek to minimise all costs given their thin profit margins. Hence, AIAL argued that, although competition is likely to be limited, the limitation is not absolute, and there are significant factors constraining the Airport's ability to abuse its market power.294
8.41 The Commission notes that, in general, a buyer must account for a substantial portion of a supplier's business before it has the potential to exert significant countervailing power against that supplier. The threat by a small buyer to switch its business elsewhere will have little impact on the supplier's behaviour. Thus, the size of the airlines and their collective efforts are an important determinant of any countervailing power against the market power of the airports.
8.42 The number of airlines operating at Auckland International Airport is quite small, and fewer than five (the key ones being Air New Zealand and Qantas) provide the bulk of AIAL's revenues from landing charges. In addition, there is a growing tendency for international airline alliances. Airlines have also demonstrated capability to act collectively, as through BARNZ, and to engage in lobbying, in pursuit of common interests. This suggests that the buyer concentration needed as a prerequisite for the exercise of countervailing market power exists at Auckland International Airport, at least in principle. The question is whether it is effective.
8.43 The ability to switch to alternative suppliers is crucial to the exercise of countervailing power. The behaviour of a supplier with market power is likely to be moderated where a significant buyer can credibly threaten to switch its custom elsewhere.
8.44 One factor favouring countervailing power is that the capital of airlines (in contrast to that of AIAL) is relatively mobile, and hence has the potential to be relatively easily deployed elsewhere. For example, overseas-based international airlines have the power to deploy their limited fleets to destinations in other countries, and some have withdrawn services to New Zealand, or resorted to code-sharing when this proved more cost-effective than providing a direct service. having said this, airlines do invest in costs which arguably become sunk at particular airports (e.g., maintenance facilities), thereby reducing their ability (and hence the credibility of any threat) to move elsewhere, thereby undermining any countervailing power they might possess. It is difficult to see how Air New Zealand, for example, could withdraw from providing international air services to this country, or move its international hub from Auckland. Air New Zealand has a strong position in New Zealand and relies on the country to some extent for its marketing and brand image. The airline also has significant maintenance facilities at Auckland International Airport.
8.45 The major airlines have demonstrated a willingness to withhold airport payments and to consider court action. This indicates that the airlines do have some power to impose, or to threaten to impose, costs on AIAL.
Consultation
8.46 Airlines, as users interested in minimising their costs, want to monitor airport charging and efficiency. The statutory consultation process provides an avenue through which this monitoring may take place. However, the airlines have been dissatisfied with the consultation process and its outcomes to date.
8.47 In October 1999, AIAL initially proposed a cumulative increase in landing charges of 35.54% over the following three years (2000-2002). During consultations with the airlines, the proposed increase fell. In August 2000, AIAL announced a total increase of 18.5% in its landing charges over the three years.
8.48 In October 2000, Air New Zealand initiated court proceedings against AIAL in respect of the increases and AIAL's obligation to consult, and as part of this action refused to pay the increases in charges until the matter was resolved. AIAL could do little, being unable to deny access to aircraft, nor impound them in cases of non-payment. When the case was settled in November 2001 (a little over a year after it commenced), Air New Zealand paid the outstanding charges (less the agreed 1% rebate).
8.49 However, while the Air New Zealand experience was contentious and protracted, AIAL stated in its submission on the Draft Report that the Commission had overlooked the successful conclusion of its consultation process with its second largest customer, Qantas Australia. AIAL reached agreement with Qantas on the level of price increases to apply for five years; terms which were also available to other airlines. AIAL argued this illustrated that a reasonable commercial approach could emerge under the current regulatory regime.
8.50 AIAL's recent consultation suggests that the airlines may have some power to moderate prospective increases in charges, at least in some circumstances. However, the results of the recent consultation may have to some extent been influenced by the existence of this Inquiry.
Conclusion
8.51 There are clearly widely disparate views on the effectiveness of countervailing power of the airlines, as augmented by the regulatory requirement for AIAL to consult with its substantial customers, and to publish information under disclosure requirements.
8.52 The Commission considers that the countervailing power of the airlines cannot be ignored as a feature of the relevant markets. The current regulatory regime appears to provide some constraint on AIAL. However, the Commission is of the view that there are not sufficient constraints on the exercise of market power by AIAL. While AIAL is required to consult with substantial customers before setting charges, AIAL ultimately has the power to set whatever charges it thinks fit. There is no requirement to negotiate or reach commercial agreement. Airlines do have some power, but their ability to effectively exercise that power is limited.
Assessment of Whether Competition is Limited
8.53 AIAL has relatively high market power in the market for airfield services due to the lack both of supply side substitutes and adequate countervailing power of airlines. It is not economical, and often not possible, to duplicate many of the assets associated with facilitating aircraft movement in a particular region, and demand tends largely to be region-specific. The lack of alternative airports to meet customer-driven origin and destination demand, means airlines cannot credibly threaten to remove sufficient custom to produce an undesirable consequence, and thereby discipline an airport's pricing decisions. Any reduction in use by one airline will tend to be replaced by increased use by another airline, as that second airline moves to meet the customer-driven origin and destination demand in the competitive market.
8.54 The structure of the market, and the impact of a regulatory approach designed to encourage countervailing power, provide a counter-weight to the potential market power of AIAL. However, the presence of such a regulatory framework indicates a concern about possible market power. The evidence of litigation also indicates there is dissatisfaction with the outcome of AIAL's consultation process, although, as mentioned above, an agreement has recently been reached. However, the commercial agreements that were reached between AIAL and a number of airlines in 2001 may not necessarily be indicative of countervailing power, but may be due to other factors such as the presence of this Inquiry or, in the case of Air New Zealand, the airlines' financial position.
8.55 The Minister's Notice requires the Commission to report to the Minister on whether "airfield activities provided by the three major international airports are supplied or acquired in a market in which competition is limited or is likely to be lessened". The airfield services supplied by AIAL to aircraft operators form the bulk of the airfield services market at Auckland International Airport and are, in the Commission's view, subject to limited competition. The goods or services (falling within the definition of airfield activities) provided by AIAL to aircraft operators that are subject to limited competition are set out in Table 12.
Table 12: Airfield Services Supplied by AIAL Subject to Limited Competition
| Airfield Activities | Goods and Services Supplied by AIAL |
|---|
| Airfields, runways, taxiways, and parking aprons for aircraft | Airfields, runways, taxiways, and aprons. |
| Facilities and services for air traffic control | None. |
| Facilities and services for parking apron control | Apron control service at the international terminal apron (note: these costs are currently recovered through the international terminal services charge). |
| Airfield associated lighting | Cable ducts and light pots for the entire airfield; cabling for light fittings for aprons and first taxiways; and apron lights. |
| Services to maintain and repair airfields, runways, taxiways, and parking aprons for aircraft | Services to maintain and repair airfields, runways, taxiways, and parking aprons for aircraft. |
| Rescue, fire, safety, and environmental hazard control services | Rescue, fire, safety, and environmental hazard control services. |
| Airfield supervisory and security services | Provides and maintains security fencing. |
| Facilities/assets held for future airfield activities | Holds land for second runway. |
8.56 The Commission has reached the conclusion that the airfield services supplied by AIAL are supplied in a market in which competition is limited (or is likely to be lessened). The first requirement of section 52 is, therefore, satisfied. The remainder of this Chapter considers whether it is necessary or desirable for the prices, revenue, or quality standards of any of the goods or services identified above to be controlled in the interests of acquirers; and whether airfield activities should be controlled.
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