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Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

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Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007
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Page 1: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

Ryanair / Aer Lingus

Giulio Federico

ACE Conference - Toulouse, November 30 2007

Page 2: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

2 ACE Toulouse – November 2007

A politicised case…

…with dangerous consequences for advisors?

Page 3: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

3 ACE Toulouse – November 2007

Outline

• A straightforward merger of two closest competitors?

• Ryanair’s arguments

• Conclusive evidence? The econometrics of unilateral effects

• A fixable deal? – Efficiencies

– Remedies

Page 4: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

4 ACE Toulouse – November 2007

A straightforward (and problematic) horizontal merger?Some qualitative evidence

• Similar “low-frills” business model– Aer Lingus moved to low-frills operation during 2004 and 2005– Key product features include: one-class service; one-way non-refundable

fares; no meals on board; charges for baggage– Vast majority of bookings are on-line– Some quality differentiation remains (primary airports; seat allocation)

• Both are “Irish” airlines, with a large base at Dublin– Account for all large short-haul aircraft based at Dublin (23 planes for Aer

Lingus; 20 for Ryanair)– Base economies give significant competitive advantages– Most recognised airlines in Ireland (e.g. awareness > 75%, vs. other rivals

at 20-30%)

• Both monitor each other’s prices, and react ‘automatically’ to changes in residual demand (through yield-management systems)

Page 5: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

5 ACE Toulouse – November 2007

Ryanair refers to Aer Lingus directly in its ads…

Page 6: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

6 ACE Toulouse – November 2007

…and so does Aer Lingus

Page 7: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

7 ACE Toulouse – November 2007

31

4

16

3

0

5

10

15

20

25

30

35

40

2002 2003 2004 2005 2006 2007

Significant, and growing, horizontal overlap…

32 Dublin overlap routes account for 70% of 2007

summer capacity

Number of overlap routes, using Commission’s market definition

Page 8: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

8 ACE Toulouse – November 2007

…with very problematic combined shares

Summer 2007 capacity data.

Airport overlapCity overlap

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

SN

N-L

ondo

n

OR

K-L

ondo

n

DU

B-B

HX

/EM

A

DU

B-G

lasg

ow

DU

B-E

dinb

urgh

DU

B-N

CL/

Dur

ham

DU

B-B

russ

els

DU

B-A

lican

te/M

urci

a

DU

B-M

ilan

DU

B-R

ome

DU

B-F

aro

DU

B-B

erlin

DU

B-V

enic

e

DU

B-T

LS/C

arca

sson

ne

DU

B-H

ambu

rg

DU

B-T

ener

ife

DU

B-B

ilbao

/Vito

ria

DU

B-B

olog

na

DU

B-L

yon

DU

B-S

evill

e

DU

B-M

arse

ille

DU

B-P

ozna

n

DU

B-M

anch

este

r

DU

B-M

alag

a

DU

B-K

rako

w

DU

B-B

arce

lona

DU

B-V

ienn

a/B

ratis

lava

DU

B-L

ondo

n

DU

B-R

iga

DU

B-W

arsa

w

DU

B-M

adrid

DU

B-F

rank

furt

OR

K-M

anch

este

r

DU

B-P

aris

Page 9: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

9 ACE Toulouse – November 2007

Customer survey evidence confirms closeness of competition

0

10

20

30

40

50

60

70

80

Fra

nkf

urt

Ro

me

Lo

nd

on

Gat

wic

k

Bru

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Par

is

Rig

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on

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ton

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sg

ow

Lo

nd

on

LH

R

% o

f p

assa

ng

ers

% of Ryanair passengers whoconsidered Aer Lingus

% of Aer Lingus passengers whoconsidered Ryanair

Source: results of survey carried out by Commission at Dublin Airport, February 2007

Page 10: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

10

ACE Toulouse – November 2007

However Ryanair argued otherwise….

• Ryanair claimed that its business model is based on targeting discretionary passengers whose alternative is not so much to fly with another airline but not to fly at all

• Ryanair’s closest constraint is therefore price sensitivity of its target customer base – not Aer Lingus. Since that constraint will remain post merger, the concern that Ryanair would raise fares as a result of the Concentration is not supported by the available evidence

• It also claimed that there is no statistical support for the view that Aer Lingus is a closer competitor to Ryanair than other airlines, or that Aer Lingus does not exert any competitive pressure on Ryanair

• Whilst according to Ryanair the main issue in the merger assessment is whether the transaction would reduce constraints on Aer Lingus post-merger, Ryanair also claimed that there is no evidence that Ryanair currently constrains Aer Lingus

• Finally, Ryanair argued that the Commission should not “miss out” on the opportunity of the competitive stimulus which would occur when the most efficient low fares carrier acquires one of the more sleepy traditional airlines

Page 11: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

11

ACE Toulouse – November 2007

Econometric evidence: Analysis of Aer Lingus dataOverview

• Key Question: Is there any evidence that Ryanair imposes a competitive constraint on Aer Lingus?

– Investigate whether Aer Lingus’ average fares and load factor on a given route systematically differ whenever Ryanair also serves that particular route

• Two main sources of data used for empirical analysis:– Monthly data on Aer Lingus’s average one-way fare and load

factor on all of its short-haul routes out of Dublin

– Monthly data from the Dublin Airport Authority (DAA) on the total number of scheduled departures and seats (i.e. capacity) by airline on all routes out of Dublin

• Analysis carried out at airport-pair and city-pair level

Page 12: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

12

ACE Toulouse – November 2007

Econometric evidence – Choice of estimatorCross-sectional vs Fixed-effects panel estimation

• Fixed-effects estimator: models Aer Lingus’ fares (load factor) over time on each route in terms of the variation in Ryanair’s participation decision, everything else being equal (i.e. what is the effect of Ryanair’s entry on Aer Lingus?)

• Cross-sectional estimator: models Aer Lingus’ fares (load factor) at a given point in time by comparing routes on which Ryanair is and is not present, controlling for other route characteristics

• Much of the econometric discussions in this case revolved around which estimator to use

– There was enough variation in Ryanair’s presence over time to use a fixed-effects estimator

– The cross-sectional approach requires large amount of information on route characteristics (as opposed to simple dummies in the FE estimator)

Page 13: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

13

ACE Toulouse – November 2007

Econometric evidence – Effects on Aer LingusBasic setup and results

• Two groups of “explanatory variables” for Aer Lingus’ fares and load factors:

– Competition factors that reflect Ryanair’s presence and size on a given route, as well as competition effects due to other airlines being present on a given route; and

– Control factors that capture influences on pricing that are not due to the level of competition (e.g. route-specific or seasonal effects).

• Finding (1): everything else being equal, Aer Lingus’ fares and load factor are systematically lower on average on routes served by Ryanair (by at least 5-10%)

• Finding (2): effect is stronger when carriers fly to same airport, rather than different airport in same city

• Finding (3): Aer Lingus’ average fares are reduced more by Ryanair’s presence (both at the same airport and at a different airport) than by presence of other airlines.

Page 14: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

14

ACE Toulouse – November 2007

Econometric evidenceComparison of Aer Lingus, Ryanair and the Commission’s analysis

• The Commission replicated the fixed-effects regressions and showed that Ryanair’s entry on city-pair overlap routes reduced Aer Lingus’ fares by 7-8%

– This impact is much stronger (at least double) than any other airline

– The frequency specification confirmed these result, showing that at end-2006 Ryanair’s presence on overlap routes reduced Aer Lingus’ fares by 11%

• The Commission did not draw any definitive conclusion from cross-sectional evidence due to the difficulty of controlling for unobserved determinants of fares and the risk of “omitted variables bias”

– This conclusion applied both to the Commission’s own cross-sectional estimates and to those submitted by Ryanair (based on a number of alternative methodologies)

• Similarly, no weight was attached in the Decision to the results of the regressions measuring Aer Lingus’ impact on Ryanair, given the limited number of Aer Lingus entry episodes

• Commission concludes that “the finding that the presence of Ryanair has a statistically and economically significant effect on Aer Lingus’ prices is extraordinarily robust”

Page 15: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

15

ACE Toulouse – November 2007

Can the competitive constraint be asymmetric?

• The econometrics analysis clearly showed that Ryanair exerts a significant constraint on Aer Lingus– In itself a sufficient reason to expect a substantial lessening of competition

from the merger– Constraint in the other direction cannot be properly tested with the data

• Does this mean however that Aer Lingus does not materially constrain Ryanair and that Ryanair’s fares cannot be expected to increase post-merger?

• There are reasons to suggest that the competitive constraint between the parties could not be strongly asymmetric (given their relative sizes in the market)– The econometrics indicates that presence of a significant “switchable”

margin of customers, who must be “marginal” also for Ryanair and affect its pricing decisions

– The merger would allow Ryanair to internalise the proportion of these customers who would switch back to Aer Lingus in the event of an increase in fares

• Commission: “if customers respond by switching to a change in relative prices in one direction, at least this customer group can be expected to switch back if the change of relative prices is reversed”; and “if one firm constrains the other, the reverse is also true at least for some range of prices”

Page 16: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

16

ACE Toulouse – November 2007

Efficiency arguments were not accepted

• Ryanair claimed that it would be able to implement efficiencies that would reduce Aer Lingus costs significantly through:– Buyer power (reduced input prices)– Operational efficiencies, specific to Ryanair (“secret sauce”).

• Commission Decision completely excluded all efficiency claims– Buyer power does not necessarily reduce variable costs and in

some cases it is simply a transfer of existing financial assets– Noted that the claims with respect to operating costs appeared to

involve major changes to the Aer Lingus product and a reduction in quality

– Noted that several efficiencies are not merger-specific (e.g. operational efficiencies)

Page 17: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

17

ACE Toulouse – November 2007

Successive remedy packages failed to resolve competition concerns

I November

II December

III April

IV May

10% reduction in AL fares

Preserve competing brands

Eliminate fuel surcharge

LHR daily slots [1-4] [1-4] ? [2-6] x 2

Dublin slots Limited [2-6] aircraft[4-8]

aircraft[4-8] aircraft

Destination airport slots 7 routes 7 routes ? (excludes key primary airports)

Cork/Shannon slots

Frequency freeze

“Upfront buyer”

Market-tested

Page 18: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

18

ACE Toulouse – November 2007

Traditional slot-based remedies could not address loss of competition

• Market test reveals that slots are not the main barrier to entry– No competitor stating that they would actually enter any of the non-LHR

overlap routes (only 3 would consider entering on limited routes)– No competitor would open a new base at Dublin (“to consider competing

with Ryanair at its own base would be financially irresponsible for just about any company”)

– Easy Jet has no plans to fly to Dublin or to open a base

• Behavioural and slot remedies cannot replicate competitive pressure exercised by Aer Lingus– Scale of overlap too large to allow a remedy package to “re-engineer” a

competitive outcome– Entry with 12+ aircraft at Dublin required to match Aer Lingus’ presence on

overlap routes, creating excess capacity and unacceptable risk for a new entrant

– Only possible remedy is divestment of Aer Lingus’ short-haul operations (= prohibition of merger)?

Page 19: Ryanair / Aer Lingus Giulio Federico ACE Conference - Toulouse, November 30 2007.

19

ACE Toulouse – November 2007

ConclusionsLessons for future cases

• Hard to merge with your closest competitor!

• The Commission is increasingly sophisticated in the use of quantitative techniques– CET played a key role, both as arbiter of different economic

submission and in producing a rigorous economic assessment of the transaction

• Efficiency-based arguments remain difficult to sustain in the face of strict economic analysis and strong unilateral effects

• Traditional slot remedies not necessarily sufficient to address problematic airline mergers


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