259 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2003 Market Power: Airports MARCH Tomás Serebrisky Tomás Serebrisky Vertical Integration between Airports and Airlines (tserebrisky@worldbank.org) is an economist with the An emerging issue in privatized infrastructure sectors is how World Bank Institute. regulators should deal with proposed mergers that could potentially increase market power and lead to anticompetitive behavior. This Note looks at the issues in the airport sector, focusing on Argentina--the first developing country to confront a vertical merger NETWORK in a deregulated air transport market. In the late 1980s and the 1990s many countries ing it to the antitrust agency to decide whether privatized airports or concessioned their opera- to approve or reject a vertical merger. tion. The United Kingdom began the trend, fol- INFRASTRUCTURE lowed by other countries adopting new forms of The airport business and the vertical merger infrastructure ownership and management. To problem AND control infrastructure licensing and the "natu- Airlines provide air transport services by com- ral monopoly" characteristics of some airport bining aircraft, personnel, airport services, SECTOR services, governments developed regulatory and other inputs. Airports supply a series of policies for airport systems. services to air transport companies and to The operation of an airport creates incen- passengers: PRIVATE tives to transfer the airport's market power to Aeronautical services (rescue, security, fire- the air transport market. If the airport market is fighting, infrastructure supply, runway and regulated but the airport operator is allowed to taxiway maintenance). control at least one airline, those incentives can Aeronautical-related commercial services GROUP give rise to anticompetitive practices aimed at (catering; supply of fuel and lubricants; bag- displacing competing airlines. gage, passenger, and aircraft assistance). BANK When the regulatory framework for airports Commercial services (banks, hotels, restau- lacks explicit rules about such vertical integra- rants, car rental, car parking, retail shops, tion, that can have consequences for competi- duty-free shops). tion in the air transport market. Australia and A vertical relationship between airlines (down- WORLD Chile, for example, have an explicit prohibition stream) and airports (upstream) can be prob- on vertical integration. By contrast, Argentina lematic. Airports provide the "entry point" into THE has no restrictions on vertical integration, leav- the air transport network, through terminals and M A R K E T P O W E R : A I R P O R T S V E R T I C A L I N T E G R A T I O N B E T W E E N A I R P O R T S A N D A I R L I N E S runways. Thus for the air transport market to be Discrimination in access to ground handling ser- competitive, airlines must have access to airports. vices. If the operator controls the supply of In the airport sector it is usually more effi- ground handling services (baggage, passen- cient to have a single airport supplying a given ger, and aircraft assistance)--as AA2000 will volume of traffic.1 The reason is that airports for foreign airlines starting in 2009 unless have large economies of scale: the unit costs of they opt to self-handle--it could restrict the infrastructure supply fall as airport traffic access of competing airlines to their supply. increases, because of the high fixed costs of cap- Increases in transaction costs. The operator ital and of infrastructure and equipment main- could increase costs for competing airlines, 2 tenance. This situation implies a market such as through "administrative norms" on configuration with a monopolist airport opera- access to the airport. tor upstream and with passenger and freight air Predatory practices using cross-subsidies. Using transport companies downstream operating in a income from the airport market as a source of competitive market. cross-subsidies, the operator could reduce the If access to airports and tariffs for airport tariffs for its airline below the (competitive) services are not regulated, airport operators market cost, undermining the profitability of have no incentives to pursue vertical integra- competing airlines. Its ability to do so would tion. The operators can set tariffs high enough depend on the ability of the regulator, but the to seize all the rents generated in the competi- information asymmetries between regulators tive segment of the market. But in most coun- and operators (a problem in all regulated tries that have concessioned airport services, industries but more significant in developing tariffs and access rules are set by a regulatory countries) leave many openings for hidden agency.2 price discounts. Evasion of tariff regulation. Because the price A merger rejected, then allowed elasticity of demand for aeronautical services Argentina concessioned 33 airports as a group in is low, the operator would have an incentive 2000. By the end of 2001 the concessionaire, the to distort tariff regulation in order to airport system operator Aeropuertos Argentina increase the regulated prices. With cost-plus 2000 (AA2000), announced plans to acquire tariff regulation, the operator could inten- LAPA, the country's second largest airline by vol- tionally increase its costs to raise airport tar- ume of passengers. This vertical integration iffs, increasing costs for competing airlines. would have been the first case of an airport con- With price cap tariff regulation (as in cessionaire operating an airline in a deregulated Argentina and Australia), the operator might market. After a comprehensive and detailed try to persuade the regulator to reduce the analysis, the Argentine Antitrust Commission productivity adjustment factor X. That would rejected the merger. It based its decision on the lead to a smaller reduction in tariffs when anticompetitive practices that the airport opera- they are revised and thus have an adverse tor could potentially use to raise rival airlines' effect on the costs of competing airlines. costs and exclude them from the air transport This ruling took more than a year for the market. The ruling and its aftermath may have Argentine Antitrust Commission to complete, relevance in other countries. compared with an average of less than four The Argentine Antitrust Commission, in its months for mergers across all sectors. The ruling, surveyed the set of practices that the air- agency had to rely on partial information port operator, if merged with an airline, could because AA2000 and LAPA were reluctant to use to affect competition in the airline market: provide the information required. As the Diminution of quality. The operator could agency's ruling explains, airline executives reduce the quality of services rival airlines who testified as witnesses reported many can offer through its allocation of check-in instances of actual and potential anticompeti- space, seats in gate areas, VIP lounges, and tive behavior by the airport operator after it office space. announced the merger. The uncertainties air- lines faced and the resources the antitrust Vertical separation. The company that operates agency devoted to the merger ruling constitute in a regulated market segment is not allowed significant costs. to participate in the competitive segment. Another cost that will have an impact in the short run, and possibly the long run as well, is Vertical integration with regulation of damage to the reputation of the antitrust insti- conduct tutions. Causing the damage was a decision by Regulation of conduct can be ex ante or ex post. the secretary of competition and consumer Ex ante regulation uses two types of instru- affairs, who has the power to modify the ments: open access and accounting separation. 3 Antitrust Commission's rulings, to overturn the Open access policies compel the operators of agency's ruling (though it required the airport "bottleneck" infrastructure (essential infrastruc- operator to reduce its shareholding in LAPA to ture such as an airport) to offer access to all a minority interest). This decision shows a will- firms at reasonable prices. Such policies are ingness to interfere politically in the decisions of aimed at preventing "refusal to deal," but on the antitrust agency, creating a problematic their own they cannot prevent access discrimi- precedent. nation. Operators can effectively discriminate by resorting to factors other than price (such as Lessons and solutions for other countries through quality discrimination). Most countries bringing the private sector into Accounting separation regulations require the management of airports have no explicit vertically integrated companies to separate the provisions on vertical integration in the air accounting of each company under their con- transport market. But some countries, such as trol. This compels a vertically integrated com- Australia and Chile, recognized the need to pany to establish a price for each airport establish explicit rules against vertical integra- service it offers and to use these prices as trans- tion. Australia limits an airport operator's own- fer prices among the companies it controls. ership stake in an airline to 5 percent and The transfer prices must be the same as those explicitly prohibits vertical integration between the airport operator offers every other airline an airport operator and air transport compa- in the market. nies.3 In Chile the bidding guidelines for airport Accounting separation is aimed at prevent- concessions specify that the infrastructure con- ing price discrimination and cross-subsidies cessionaire cannot have decisive influence over between airport and air transport services. It the administration or management of compa- cannot prevent other kinds of discrimination nies (domestic or international) offering air and must be complemented by open access reg- transport services (Chile, Department of Public ulation to prevent restrictions on airport access. Works 1997). Although the private sector does Where only ex post regulations are used, the not have a significant role in the airport sector integrated company (airport operator and air- in continental Europe, the European Com- line) will be subject to the general antitrust laws. mission also recognized the potential problems To ensure that the antitrust agency can enforce of vertical integration in its analysis of the pro- these laws effectively, rules must be established posed merger between Air France and Sabena requiring information on the aeronautical ser- (European Commission 1992, p. 9). vices market to be made publicly available. Policy options for addressing potential anti- competitive practices in the air transport market Vertical separation fall into two main categories: Vertical separation of the airport operation Vertical integration with regulation of conduct. from the air transport market bars a company The regulated company (the airport) is from simultaneously controlling the airport allowed to operate competitively in competi- operator and companies that operate in the tive (nonregulated) segments, but restric- (nonregulated) air transport market. tions are imposed on its conduct as a Vertical separation offers benefits because it vertically integrated entity. prevents monopolistic practices by the airport M A R K E T P O W E R : A I R P O R T S V E R T I C A L I N T E G R A T I O N B E T W E E N A I R P O R T S A N D A I R L I N E S operator aimed at displacing competing airlines in the nonregulated air transport market. Vertical integration also offers benefits, in the Notes form of efficiencies in infrastructure develop- The author would like to thank Pablo Presso for joint ment: airlines have ample information on research in this area and Antonio Estache for comments. viewpoint trends in air traffic demand that is needed to 1. Airports are natural monopolies in most cities given plan infrastructure investment. But with an ade- the current demand for air transport. Some markets sus- quate regulatory framework for infrastructure tain more than one airport (London, New York, San is an open forum to development, these benefits can be obtained Francisco), but they are the exceptions. encourage dissemination of without vertical integration. 2. New Zealand is one country that does not regulate public policy innovations for Regulation of market structure--or vertical private airport operators, allowing them to freely set rates private sector­led and separation--offers advantages over regulation for the services they provide. market-based solutions for of conduct when the costs of anticompetitive 3. AirportsAct1996(seehttp://www.scaletext.law.gov.au). development. The views behavior are very high (adversely affecting the 4. Requiring vertically integrated firms to disinvest published are those of the general economic welfare) and the corrective may be advisable. But enforcing this action is time- authors and should not be actions needed are very difficult to carry out.4 consuming and requires a state that can resist private sec- attributed to the World Structural regulation also offers the advantage tor pressure. Bank or any other affiliated of low monitoring costs, while conduct regula- organizations. Nor do any of tion requires constant supervision by sophisti- References the conclusions represent cated regulators. For developing countries Australian Competition and Consumer Commission. official policy of the World with weak institutions and limited antitrust 1997. "Declaration of Airport Services: Section 192 of the Bank or of its Executive experience, structural regulation thus appears Airports Act." Draft Discussion Paper (December). Directors or the countries to be more attractive. The Argentine case illus- Canberra. they represent. trates the costs of not imposing structural Chile, Department of Public Works. 1997. Bases de regulation. Licitación, "Concesión Aeropuerto Internacional Arturo Merino To order additional copies Benítez de Santiago." Santiago. contact Suzanne Smith, Conclusion Crocioni, Pietro. 2000. "Defining Airline Markets: A managing editor, Regulating vertically integrated companies Room I9-009, Comparison of the U.S. and EU Experiences." Antitrust (through rules requiring open access and The World Bank, Bulletin 45(spring): 1­45. 1818 H Street, NW, accounting separation) and imposing vertical Doganis, Rigas. 2001. The Airlines Business in the 21st Washington, DC 20433. separation are the least costly instruments for Century. London: Routledge. ensuring competition in the commercial avia- Estache, Antonio, and Ginés de Rus, eds. 2000. Telephone: tion market. But to ensure that open access and Privatization and Regulation of Transport Infrastructure: 001 202 458 7281 accounting separation rules are effective, the Guidelines for Policymakers and Regulators. Washington, D.C.: Fax: sector regulator or antitrust agency must have a World Bank. 001 202 522 3480 good information system. European Commission. 1992. Air France­Sabena IV/M Email: International experience, including the 157. [http://europa.eu.int/comm/competition/mergers/ ssmith7@worldbank.org recent ruling by the Argentine antitrust cases/decisions/m157_fr.pdf]. agency, suggests that developing countries FIEL (Latin American Economic Research Copyedited and produced by designing airport concessions should include Foundation). 1999. La Regulación de la Competencia y de los Communications an explicit prohibition on vertical integration Servicios Públicos. Teoría y Experiencia Argentina Reciente. Development Inc. (or impose vertical separation) between the Buenos Aires. airport operator and airlines. This regulatory Printed on recycled paper approach has several major advantages: it keeps the costs of monitoring and information gathering low, eliminates the incentives to transfer market power to the transport sector, reduces conflicts between the regulatory agency and the antitrust agency, and provides certainty to airlines. 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