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CHAPTER 6

PROBLEMS IDENTIFIED IN THE SOUTH AFRICAN

DOMESTIC AIR TRANSPORT MARKET

6. 1 INTRODUCTION

The purpose of this chapter is to identify the problems in the South African domestic air

transport market from a competition perspective. Specific objectives that will be established

in this chapter are:

• The market dominance of SAA and its domestic alliance partners.

• Industry structure (ownership) of state-owned airlines.

• State financial assistance to SAA.

• The occurrence of anti-competitive conduct, abuse of a dominant position or

predatory conduct by dominant airlines.

• Measures to ensure access and to level the playing field for new entrants.

• Price discrimination.

Smith E stated that a remarkable difference resulted from the deregulation of the domestic air

transport market in South Africa in comparison with the results of such deregulation in the

USA with regard to:

• The structure of airline ownership (that of state control in South Africa), and

• The increased market share of SAA that demonstrated dominance following

deregulation. 1)

It would appear that limited measures were intended to be introduced to “level the playing

field” and reduce barriers to entry at the outset of deregulation of the domestic air transport

market in South Africa. The major deviation from the objectives set in 1988 pertaining to

deregulation relates to the issue of a lack of effective competition, especially by smaller

concerns. Smith E stated that the concept of a level playing field identified in 1990 was not

adhered to, as can be seen from the recommendations made in terms of SAA’s position in the

domestic market. 2) In addition, the 1990 policy did provide for an active role for the then

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existing Competition Board that did not have the statutory authority to perform such duties.

3) The competition policy, competition institutions and associated legislation were

substantially amended following the deregulation of air services. The adequacy of these

needs should be considered in the light of experience of competition bodies in dealing with

air transport matters in South Africa and elsewhere.

The original deregulation policy relating to the domestic air transport market in South Africa

envisaged some restructuring of the activities of SAA and an active institutional role for the

then Competition Board. As will become evident, the restructuring of the activities of SAA

did not materialise and a new competition policy and legislation were introduced during the

period 1997 to 1998.

As demonstrated in 4.2.3 of chapter 4, the commercial practices of airlines have also changed

as a result of deregulation, mostly in the area of economies of scope from a demand point of

view. Some of these practices do present advantages from the perspective of a small segment

of consumers but, from an overall consumer welfare point of view, they may also be used in

an anti-competitive manner and even in a way that would indicate unacceptable behaviour in

the form of an abuse of a dominant position or predatory conduct by dominant airlines that

has longer term consequences.

It should be noted that the objectives contained in the 1996 White Paper on National

Transport Policy of the South African Government also included:

• The setting of level playing fields.

• Promotion of competition. 4)

The purpose of this chapter is to identify a number of structural difficulties with regard to

competition in the domestic air transport market in South Africa, including the findings and

conclusions of Smith E.

Specific objectives that will be established in this chapter relate to the dominance of the

SOE, SAA, and its effect on the level of competition, specifically with regard to the

following dimensions:

• Market dominance of SAA and its domestic alliance partners.

• The vertical integration of SAA.

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• Industry structure (ownership) of state-owned airlines.

• Conduct of SAA in the domestic market.

• Anti-competitive conduct, abuse of a dominant position or predatory conduct by

dominant airlines.

• Measures to ensure access and to level the playing field for new entrants.

6.2 THE ECONOMIC REGULATION OF THE SOUTH AFRICAN AIR

TRANSPORT INDUSTRY

6.2.1 INTRODUCTION

A short perspective is necessary with regard to the historical development of air transport

policy prior to the deregulation of air services in South Africa, in order to demonstrate that

scheduled transportation did not originate as a state enterprise in South Africa, but in the

private sector. Economic regulation, in the form of minimum air tariffs, was only introduced

in South Africa when a private scheduled air service (Union Airways) started to compete on

an inter-modal basis with the railway services of the SAR&H. This effectively led to the

establishment of a state owned airline SAA as part of the SAR&H.

6.2.2 MEANS OF ECONOMIC CONTROL OVER AIR TRANSPORT

SERVICES IN SOUTH AFRICA

The rationale for the introduction of economic or commercial control in the South African air

transport industry was researched in an earlier study Economic Control over Domestic Air

Transportation in South Africa (1996). 5) Successive South African governments established

economic control over domestic air transport services by means of a number of mechanisms:

• Contractual conditions to postal airmail subsidy agreements.

• Preconditions for the conclusion of airmail subsidy agreements, including the

imposition of minimum air tariffs.

• Proclamation of conditions under which feeder air services may be operated.

• Legislation and regulations that regulated the economical entry of airlines as well

their conduct in the market. 6)

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6.2.3 DEVELOPMENT OF SCHEDULED AIR TRANSPORT IN SOUTH

AFRICA PRIOR TO THE ESTABLISHMENT OF SAA

Prior to the establishment of SAA as departmental air services by the SAR&H, domestic

scheduled air services in South Africa were provided by three foreign owned airlines and a

domestic privately owned airline during the period 1929 to 1935. 7)

These were:

• Union Airways (Pty) Ltd, based in Port Elizabeth under an air mail contract for domestic

air services in South Africa from 1929. 8)

• Junkers Flugzeugwerk AG under an airmail contract for the establishment of South

West Airlines in South-West Africa from 1931. 9)

• The Imperial Airways Mail Service between London and Cape Town in 1929 which

included domestic and regional services conducted by Imperial Airways which was later

replaced by the flying boat Empire Air Mail scheme from 1934 to which the South

African Government contributed financially.10) The original service connected at

Kimberley with the services of Union Airways and Junkers Flugzeugwerk. SAA took

over the control of the Germiston-Cape Town portion of the London-Cape Town airmail

service in 1936. 11) A flying boat service of Imperial Airways/British Overseas Airways

Corporation continued operations between the Vaal Dam and Durban but Imperial

Airways’ Germiston-Cape Town service was not allowed. 12)

• The Johannesburg-Pietersburg route operated by Rhodesian and Nyasaland Airways

Ltd, that was extended to Salisbury in 1933. 13)

During the Second World War, domestic services in South Africa were conducted by:

• Southern Rhodesian Airways in terms of an agreement with SAA that was concluded in

1941. 14)

• Imperial Airways/British Overseas Airways Corporation’s Vaal Dam - Durban services

up to 1946. 15)

• Cape Town – Johannesburg – Bloemfontein - Elizabethville services operated by

Sabena as from 1946. 16)

Competition developed between railway services of the SAR&H and Union Airways from 1931

to 1932, which resulted in SAR&H procuring governmental economic regulation of minimum

tariffs for air transport services to protect its railway services. This was followed by financial

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difficulties at Union Airways and resulted in the purchase of the business and assets of Union

Airways in 1934 by the SAR&H and that of South West African Airways in 1935. 17)

6.2.4 POST SECOND WORLD WAR SOUTH AFRICAN AIR TRANSPORT

POLICY

The development of post Second World War air transport policy granted a protected monopoly

to SAA on major trunk routes but the establishment of a Feeder Air Service Policy in 1946

envisaged a limited role for smaller private sector airlines in South Africa. 18) The NTC

extended the same principles of protection of the railways services to airways services in

1948. 19) In 1952 a comprehensive air policy was formulated by the NTC. 20)

In a previous study, it was found that formal economic regulation of air transport services in

South Africa was introduced in 1949 and applied in order to protect, subsidise and further the

interests of the State-owned enterprise, the SAR&H currently Transnet Limited. The

economic control over civil air transport in South Africa was not aimed at protecting the

interests of the public ("users") directly affected by air services, but rather at the protection of

the interest of the operator (SAR&H) as a result of its public ownership, which was regarded

as being "in the interest of the public”. 21)

The regulatory framework established by the Transport Co-ordination Act of 1948, the Air

Services Act of 1949 and the Comprehensive Air Policy of the NTC protected the air

services of the SAR&H (operated under the name SAA) until the adoption of a Domestic Air

Transport Policy in 1990 and a new Air Services Act of 1990 that became effective during

1991. 22)

The statutory position of SAA and protection against competition emanated from a

governmental policy of state ownership of a public enterprise as a national carrier. As

explained in the official yearbook of South Africa 1983, it was a “feature of the South

African economy that ownership of a number of basic enterprises vested in the state. State

ownership of these undertakings is the result not of nationalisation but of a policy of

promotion by the state of those industries or services which are either key undertakings or

industries of strategic importance” 23) and the desire to establish, protect and subsidise the

state's own interest, namely that of the SAR&H. 24)

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6.2.5 STATUTORY PROTECTION FOR SAA

SAA was protected from competition through:

• Its status as a (state-owned) public enterprise enjoying the benefits of State support

and financial aid, and

• Statutory protection granted to SAA as a result of the interpretation of the NTC of

entry criteria and the provisions of Section 10 of the Air Services Act of 1949.

In South Africa, statutory economic regulation was established shortly after the Second

World War. Initially, control was implemented by means of regulations, to achieve "order in

the air", and this was followed by the enactment of the Air Services Act, 1949. 25) In terms

of Section 2 of the Air Services Act no person may have used an aircraft to provide any air

service for reward unless a license to do so has been granted by the NTC. In terms of

Section 10 of the Act, the NTC was not allowed to grant a license to an airline in competition

with an existing licensee, if the service provided by the existing licensee was satisfactory and

sufficient to meet the needs of the public concerned at charges that were reasonable.

According to the Margo Commission these restrictions were substantially in accord with the

previous patterns in the USA and the UK, and with the existing patterns elsewhere, “save that

the economic regulation of non-scheduled air services has largely been dropped in other

countries". 26)

The Margo Commission stated that the view of SAA was that it should have the “exclusive right

to operate regional services” and only in cases where it could not operate any such service

economically, it should be empowered to “contract with one of the commuter airlines to operate

such service on its behalf until such time as sufficient traffic has developed and SAA is ready to

take over”. The Margo Commission stated that SAA claimed this right on the basis of a Cabinet

resolution. 27)

Section 10 of the Air Services Act of 1949 was interpreted as to restricting the NTC "not to

grant a license in competition with an existing license if the service provided by the existing

licensee is satisfactory and sufficient to meet the needs of the public concerned at charges

which are reasonable". 28)

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The similarity of the focus of the wording of the entry conditions of "in the public interest"

(section of the Air Services Act of 1949) and SAA as a public enterprise relating to the

“public” is unmistakeable. 29)

During this time span of 40 years, SAA entrenched its position by establishing an absolute

monopoly on the "main domestic trunk routes" which accounted for 95 percent of the

domestic passenger market and 97 percent of the domestic air freight market in 1987. 30)

It should be noted that prior to the establishment of a national airline SAA in 1934 as part of

the SAR&H, the Union Government applied a very liberal air transport policy, which

allowed cabotage and partially and fully foreign owned airlines. Since the establishment of

SAA, the domestic air transport policy was protectionist in nature to further the interests of

the SAR&H and its successors as well as the national state owned airline SAA and protect its

monopoly in the provision of domestic air services on the main routes in South Africa. 31)

This protectionist policy was relaxed in 1990 with the adoption of the deregulation of the

domestic air transport market, while certain elements of protection still remained. 32)

6.2.6 COMPONENTS OF THE DEREGULATED DOMESTIC AIR

TRANSPORT POLICY OF 1990

The original Domestic Air Transport Policy consisted of three elements.

• The Domestic Air Transport Policy, published in May 1990 in which the Government

accepted the four basic principles for a new Domestic Air Transport Policy. 33)

The four basic principles of the deregulated domestic air transport policy were the

following:

o “Air safety was of paramount importance.

o Economic decisions should be left to the market to resolve (as opposed to the

regulator).

o The users' interest and views should be explicitly taken into account.

o All participants should be treated equally before the law i.e. all operators should

be subject to the same set of rules”. 34)

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Certain recommendations regarding the implementation of the principles "which affect

the position of SAA in a deregulated domestic air transport market" were not accepted at

the outset. The Government decided to comment on those, depending "on the outcome

of the investigation into the most suitable future structure of SAA within a deregulated

domestic air transport market". 35)

• The public announcement of the Minister of Private Enterprises on 25 April 1991

pertaining to the "ring-fencing" of SAA and access of new entrants to infrastructure and

“bottleneck facilities” in order to “level the playing field”. 36)

• The Addendum to the Domestic Air Transport Policy, May 1990 dated August 1991 in

which the Government's decisions were published pertaining to the recommendations

and Cabinet decisions regarding:

o The role of SAA.

o The role of the Competition Board.

o Responsibility of the DOT with regard to access to airport facilities and pilot

training standards and the testing of pilots. 37)

The reliance on market forces to determine the behaviour of airlines as a result of economic

deregulation of domestic air transport services was a fundamentally different approach towards

the economic regulation of domestic air transport services from the approach that was

previously followed in South Africa (from 1934 until 1990), following the establishment of

SAA, that was based on precise regulation of entry and conduct of airlines).

The White Paper on National Transport Policy of 1996 recommended that the existing air

transport policy in relation to the domestic air transport in South Africa should stay as it was

on the basis of the principles of:

• Safety, which was regarded as being of paramount importance.

• Market driven solutions that should be promoted.

• Users’ interests that had to be considered at all times.

• Equal treatment of all participants in the market. 38)

The DOT and the Air Services Licensing Council (ASLC), in consultation with stakeholders,

would continue to refine the details of the policy, as and when necessary, within the

framework of the accepted principles. In addition, to reduce the likelihood of future

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disruptions of services, the ASLC would strengthen financial entry requirements for

domestic services. 39)

6.3 MARKET DOMINANCE AND THE SCOPE OF SAA

According to Smith E, comparing SAA’s market share prior to deregulation versus the

situation following deregulation implied that, “in reality the airline did not lose as much

market share as was initially thought would happen, but instead carefully realigned itself

with SAX and SAL to become a more powerful airline than in the past”. 40) In this section

the market dominance of SAA in the domestic air transport market is examined.

6.3.1 MARKET SHARE OF PASSENGERS CARRIED AND CAPACITY

PROVIDED

A feature that is prevalent in the South African domestic air transport market is the lack of

independently published information and statistics, which severely complicates market

analysis and hampers the identification of the effects of policy in the market and inhibits

planning and rational decision-making. Smith E also found a “general lack of information on

the results achieved through deregulation, impacting on the reliability of research results”.

41)

With regard to the establishment of the market shares of various airlines involved in the main

trunk routes in South Africa, the following isolated indications provide some idea of the level

of dominance of SAA.

According to the Transportation Systems Division of Van Wyk and Louw Inc. the following

related to the period of April 1987 to March 1988:

• Total number of passengers carried on all domestic routes was 4,077 million.

• Market share of SAA was 3,84 million or 94.1 percent with all other airlines carrying

only 5.9 percent of the total number of passengers.

• 67 percent or 2,7 million passengers were carried on only four major routes:

o Johannesburg to Cape Town and return.

o Johannesburg to Durban and return.

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o Johannesburg to Port Elizabeth and return.

o Cape Town to Durban and return. 42)

At that time, 77 percent of passenger flights had an origin and destination in Johannesburg.

43) This demonstrates that Johannesburg is the major hub for the domestic passenger traffic

and could be regarded as the hub of operations of SAA.

According Prins V and Victor WC, the overall market share of SAA decreased from 94% to

81% after the commencement of operations of Flitestar from October 1991 to April 1992.

Flitestar had approximately 15 percent of the overall market. 44)

Flitestar compiled the following comparison (contained in table 6.1) in 1993 for its internal

use relating to market share of the domestic airlines on the major route between

Johannesburg and Cape Town.

Table 6.1: Comparison of the Market Share of Domestic Airlines Johannesburg/

Cape Town Route in 1993

Percentage of Seats Percentage of Passengers

SAA Flitestar Comair SAA Flitestar Comair

June 1993 66.4 24.3 9.3 64.7 24.2 11.1

July 1993 67 24.2 8.8 63.3 25.2 11.5 Source: Proseski J, Market share comparison, unpublished internal comparison, Johannesburg, August 1993. 45)

The above implies that since the entry of competing airlines to the market as a result of

deregulation, the market share of SAA declined. Although the market share of SAA has

declined since deregulation, its position in the market is of such a nature that SAA has

market power of an order that gives it dominance of the domestic air transport market.

This is important; as such market power enables SAA to control prices, or to exclude

competition or to behave to an appreciable extent independently of its competitors, customers

or suppliers. It would also imply that any abuse of its dominance would be prohibited in

terms of the South African Competition Act of 1998. 46)

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Section 7 of the Competition Act of 1998 provides that a firm is dominant in a market if:

• It controls at least 45 percent of that market.

• It controls at least 35 percent, but less than 45 percent, of that market, unless it can

show that it does not have market power, or

• It has less than 35 percent of that market, but has market power. 47)

In a complaint lodged to the Competition Commission by Nationwide in October 2000, it

was alleged that SAA had 45 percent or more of the market, at which level dominance is

presumed without further evidence of the existence or absence of market power being

required. 48)

The Competition Tribunal found that SAX had a 13 percent market share and SAL an 11

percent market share, based on the evidence submitted by such airlines to the Competition

Tribunal. 49)

Nationwide alleged that SAX and SAL form part of the same control structure as the first

respondent, SAA, and that as a result the market shares of all three respondents should be

combined which would give them a market share in excess of 45 percent. 50)

Nationwide also contended that the relevant market was not the entire domestic air market,

but was instead the relevant city-to-city-pairs. Nationwide identified three routes or city-

pairs as the relevant markets for its complaints. These were the Johannesburg-Cape Town,

Johannesburg-Durban and the Johannesburg-George routes. Based on other international

cases that adopted the use of city-to-city parings as the relevant market, the Competition

Tribunal ruled that the conventional approach in antitrust cases in the airline industry would

apply, in that the three city-to-city pairs constitute the relevant market for the purpose of the

abuse of dominance complaint of Nationwide. 51)

Nationwide submitted two schedules setting out SAA’s seating capacity for each of the three

routes on two selected days, as a percentage of the total market of seating capacity, both in

relation to that of BA/Comair and itself.

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This schedule is set out in table 6.2 below:

Table 6.2: Market Share Comparison of Capacity provided on three Routes in

2000

On Friday 24/11/00:

Route SAA Nationwide BA/Comair

JNB-CPT 59% 13% 28%

JNB-DBN 62% 15% 22%

JNB-GRG 77% 24% N/A

On Monday 27/11/00:

Route SAA Nationwide BA/Comair

JNB-CPT 64% 10% 26%

JNB-DBN 63% 10% 27%

JNB-GRG 68% 32% N/A 52) Source: Manoim N, Lewis D. and Terblanche D. - Competition Tribunal Republic of South Africa, Decision on application for interim relief in terms of section 59 in the matter between applicants (Nationwide Airlines (Proprietary) Limited, Nationwide Air Charter (Proprietary) Limited and others and first respondent (SAA (Proprietary) Limited), second respondent (South African Express Airways (Proprietary) Limited) and third respondent (South African Airlink (Proprietary) Limited), case no. 92/IR/Oct00, Competition Tribunal Republic of South Africa, http://www.comptrib.co.za/Nationwide%20Airlines.htm, Pretoria, 21 December 2000.

SAA submitted that seat capacity data are not identical to passenger conveyance data, which

represent the ultimate test of market share. The Competition Tribunal stated, however, that

total seat capacity shares might differ from seat capacity shares in the lower fare classes. The

latter was the market segment in which the complainant, Nationwide, principally competed

and accordingly it could be expected that its share of seat capacity in these fare classes might

be somewhat higher than its share of total seat capacity. 53)

The Competition Tribunal noted that SAA did not itself present data contesting the allegation

of dominance in the three relevant markets whilst it had provided ample opportunity for SAA

to do so. SAA did however present data for the domestic air travel market from which it

concluded that SAA had a 43 percent market share. The Competition Tribunal queried why

SAA did not have data on city-to-city routes if SAA has data on total domestic market share.

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The Competition Tribunal suspected that SAA had such information and concluded that the

reluctance of SAA to disclose its data on the routes strengthened Nationwide's contention

that they enjoyed more than 45 percent market share of these routes. 54)

The Competition Tribunal stated that it is not unknown in competition analysis to utilises a

surrogate for sales in calculating market share where actual sales are not known. In the

Virgin/BA case, the EC identified a combination of factors that led to the conclusion that BA

enjoyed a dominant position in the market for air travel, one of which was to examine how

many slots BA held at airports. 55)

The Competition Tribunal found that the contention of Nationwide that SAA’s domestic

market share figure of 43 percent was very close to the threshold of 45 percent was realistic.

Even if the seat capacity figures exaggerate SAA’s actual share the Competition Tribunal

held that they were all sufficiently well above the 45 percent figure to suggest that SAA is

dominant on all three routes and is established by reason of the presumption contained in

section 7(1)(a) of the Competition Act of 1998. The Competition Tribunal further held that

even if SAA’s market share was below this figure of 45 percent, the onus in terms of section

7(b) of the Competition Act was on SAA to rebut the inference of market power. Nothing in

the record suggested that it had done this and for this reason the Competition Tribunal stated

that it was also unnecessary to decide whether the respondents constitute a single controlled

entity and hence their market shares be combined, as the Competition Tribunal found SAA

was dominant based solely on its share of the relevant market. As a result, the Competition

Tribunal concluded that Nationwide had established that SAA was dominant in the three

relevant markets for the purpose of its claim of predatory conduct. 56)

As a result, it is concluded that SAA is dominant in the domestic air transport market in

South Africa. The implications of being a dominant carrier is that certain actions are

prohibited in terms of the Competition Act, 1998, although similar prohibitions may not

apply to smaller airlines that do not possess market power.

In particular, the Competition Act of 1998 prohibits a dominant firm such as SAA to:

• “Charge an excessive price to the detriment of consumers.

• Refuse to give a competitor access to an essential facility when it is economically

feasible to do so.

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• Engage in an exclusionary act, other than an act listed in section (d), if the anti-

competitive effect of that act outweighs its technological, efficiency or other pro-

competitive gain, or

• Engage in any of the following exclusionary acts, unless the firm concerned can show

technological, efficiency or other pro-competitive gains which outweigh the anti-

competitive effect of its act:

o Requiring or inducing a supplier or customer not to deal with a competitor.

o Refusing to supply scarce goods to a competitor when supplying those goods

is economically feasible.

o Selling services on condition that the buyer purchases separate services

unrelated to the object of a contract, or forcing a buyer to accept a condition

unrelated to the object of a contract.

o Selling services below their marginal or average variable cost, or

o Buying-up a scarce supply of intermediate goods or resources required by a

competitor.

• Price discrimination by dominant firm prohibited.

An action by a dominant firm, as the seller of services is prohibited price

discrimination, if –

o It is likely to have the effect of substantially preventing or lessening

competition.

o It relates to the sale, in equivalent transactions, of goods or services of like

grade and quality to different purchasers, and

o It involves discriminating between those purchasers in terms of:

The price charged for the goods or services.

Any discount, allowance, rebate or credit given or allowed in relation

to the supply of goods or services.

The provision of services in respect of the goods or services, or

Payment for services provided in respect of the goods or services”. 57)

The issue of price discrimination in the South African airline industry is more fully discussed

in 6.10 below; the way exclusionary acts would relate to the manner in which specific

commercial practices of airlines distort market forces is examined in chapter 4 and, most

importantly, the occurrence of predatory practices in the airline industry is examined in 5.6.9

and 5.6.10 of chapter 5) and solutions found elsewhere are identified in chapters 7 and 8).

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6.3.2 THE SHAREHOLDING AND ALLIANCE BETWEEN SAX, SAL

AND SAA

The South African Alliance

Originally, SAX operated a scheduled domestic passenger and cargo service. The

Competition Tribunal found that Transnet, who held 76.01 percent of its issued share capital

and Thebe Investment Corporation Limited, who held 23.99 percent thereof, controlled SAX.

58)

According to the July 2003 Airline Alliance Survey compiled by Air Transport Intelligence,

SAA currently owns 100 percent of SAX. 59)

With regard to SAL the Competition Tribunal found that the shareholders of SAL were

Osprey Airline Investments (Proprietary) Limited that held 45.9 percent of the entire issued

share capital, Rodger Arnold Foster, who held a 19.35 percent shareholding, Barrie James

Webb, who held 19.35 percent thereof and SAA, whose shareholding amounted to 10 percent

of the entire issued share capital. 60)

SAA realigned itself with SAX and SAL, it the view of Smith E, to become “a more

powerful airline than in the past”. 61) In this regard, SAA extended its network of operations

effectively into the smaller routes of South Africa, which offer further economies of scope.

The alliance agreements between SAA, SAX and South African Airlink and shareholdings of

SAA and Transnet in such airlines, effectively brought an end to the Feeder Air Service

Policy that was established in 1946 that created a role for smaller private sector airlines in

South Africa. 62)

SAX

According to SAX, the three airlines, SAA, SAX and SAL, currently dominate

approximately 75 percent of the domestic market. SAX stated that SAA operates between the

primary routes, and that SAX is being the secondary route carrier. 63) Should this statement

be correct, it would imply that SAA itself has a market share 51 percent after the deduction

of the market shares of SAX and SAL, submitted to the Competition Tribunal as identified

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above. SAX also stated that although it was operationally independent of SAA, its flights are

incorporated within the SAA Alliance and the airline uses SAA reservations and check-in

facilities. 64)

As a result, it is clear that, according to SAX’s version, the alliance agreements mean that the

three airlines SAA, SAX and SAL, has the effect of currently dominating approximately 75

percent of the domestic market. The alliance agreements have the economic effect of

increasing the dominance of SAA. As noted above, the Competition Tribunal did not need to

decide whether SAA, SAX and SAL “constitute a single controlled entity”. 65)

SAX makes use of the following SAA services:

• Ticketing services.

• Passenger handling.

• Training facilities.

• Voyager FFP. 66)

From 24 April 1994, SAX initially replaced SAA on a limited number of domestic routes:

• Johannesburg - Kimberley - Upington - Cape Town.

• Bloemfontein - Durban. 67)

SAX also replaced a number of SAA jet services with turboprop aircraft and in addition

launched a number of other services. 68)

SAX’s fleet consisted of:

• Six modern Canadair regional jets.

• Seven De Havilland Dash 8 300 turboprop aircraft. 69)

SAX’s destinations include:

• Twelve within South Africa.

• Regionally to Gaborone (Botswana) and Walvis Bay (Namibia). 70)

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SAL

According to SAA, the mission of SAL is to link the smaller towns, regional centres and

hubs throughout South Africa. 71)

SAL’s fleet consists of sixteen, 29-seater Jetstream 41 aircraft, the third biggest Jetstream 41

fleet in the world. The aircraft that are in operation, carry over 48 000 passengers per month.

In addition, SAL ordered 30 Embraer (ERJ 135) turbofan jets that have a maximum cruise

speed of 833 km per hour and operate at 37 000 feet. SAL has the option of extending the

order by another 40 ERJ 135 aircraft. 72)

The destinations serviced by SAX include 22 destinations in Southern Africa. According to

SAA this is “more local destinations than any other airline”, operating 3,000 flights per

month. 73)

From a competition perspective, further issues relating to the markets and networks of SAX

and SAL are, however, relevant and require further study. These include:

• Whether the commercial conduct of, for example SAX, would constitute conduct of

SAA as a result of the alliance agreement that SAX has with SAA or by virtue of the

100 percent shareholding of SAA in SAX.

• Whether the commercial conduct of SAL within the network of SAA, from a

competition point of view, would be seen to constitute conduct of SAA in terms of

the alliance agreement that SAL has with SAA in addition to the shareholding of the

holding company of SAA, Transnet, of 10 percent in SAL.

• Whether SAX and SAL are also dominant on the routes that are operated by them and

or whether their route networks, deployment of capacity and commercial conduct

restrict entry or distort competition in such smaller markets due to their alliance with

SAA, in particular, the access and membership of SAA loyalty schemes.

• Whether the alliance agreements of SAX and SAL with SAA confer commercial cost

and other advantages on SAX and SAL that may restrict entry and distort competition

in the markets and routes operated by SAX and SAL, for example by very small start-

up airlines. Such advantages may include agreements that could lock in support from

agents and corporate clients for SAX and SAL directly or as a result of their

association and alliance with SAA. The effect of the SAA Voyager passenger loyalty

scheme and agent and corporate loyalty schemes of SAA, to which SAX and SAL

will probably be entitled as part of the SAA alliance, could effectively exclude

Chapter 6 Page 632

enough support of traffic for the development of entry on smaller routes or

competition from smaller new entrant airlines. In this context, it could be argued that

equal access to SAA Voyager passenger loyalty scheme and agent and corporate

loyalty schemes and interlining with the networks of SAA, SAX and SAL would

constitute a prerequisite that would be necessary for entry to such markets in much

the same way as access to essential facilities. In other words, the concept of an

essential facility could in this context include commercial arrangements that would

probably be of a confidential nature in terms of the alliance agreements between

SAA, SAX and SAL.

The three alliance partners operate the different aircraft to suit their various routes. With

regard to flight identification in the SA code-sharing agreement, SAA’s flights utilise the

three digits series. SAX utilises the thousand series and Airlink utilises the eight thousand

series. 74)

The exact nature of the alliance agreements between SAA, SAX and South African Airlink

should be considered from a competition and public policy point of view as it could have an

effect on competition or potential competition on these lower density routes. Both SAX and

SAL have code-sharing agreements with SAA. 75) These agreements would confer

additional scope advantages on SAA. Further study would have to be undertaken to identify

the competitive effects of such scope advantages on competition and entry to the market.

Based on the principles identified in 4.9.2, the code-sharing agreement between SAA, SAX

and SAL enable the two latter smaller airlines to share the same identification (designator)

code as SAA on airline schedules. As a result, SAA can advertise flights to a much larger

market area and expand its market at relatively low cost. The lesser known commuter

airlines, SAX and SAL, benefit from the brand name of SAA.

According to Wells AT, the major airlines were partly motivated by the desire to control the

commuters' low cost feed to their hubs, but are also concerned about gaining enough control

to ensure that quality and safety were being provided in a manner consistent with the

company's image. 76)

Chapter 6 Page 633

There is, however, a risk that equally convenient connections, or those that may better meet

consumer preferences, may not be as fairly treated in CRSs because of the preference given

to on-line connections of a code-sharing partner of the major airline. As a result, consumers

may not always benefit from code sharing. 77)

The effects of code sharing on competition may, according to Wells AT, imply that:

• Many routes might only be served by a single commuter airline.

• A major airline could further protect its dominance at its hub by effectively

controlling the commuter traffic arriving at its hubs, through CRS listings or outright

ownership of the commuter airline.

• Code sharing also makes it difficult for other regional airlines to compete with the

code-sharing partner in markets in which sufficient demand would support more than

one carrier, as only one commuter airline will be able to share the CRS code, which

could ultimately lead to reduced competition in the regional airline segment of the

industry and higher fares for consumers travelling from small communities.

• By extending the service networks offered by large carriers, often at a cost lower than

that which the large carrier could offer directly, code sharing enhances the economies

of scope enjoyed by larger carriers. 78)

According to Kinghorn C, the establishment of the relationship of SAA with the two other

domestic South African carriers, SAL and SAX reduced the level of competition. 79)

With an overall market share of 24 percent of the overall domestic air travel market (a 13

percent market share of SAX and a 11 percent market share of SAL), as determined by the

Competition Tribunal, 80) these airlines are already airlines of a substantial size. It may be

probable that such airlines may dominate certain smaller routes but, on the other hand, they

may be restricted in as far as competition with SAA is concerned (as a result of the

shareholding of SAA or the conditions contained in the code-sharing agreements), which

may limit the scope of their operations. As a result, further study needs to be conducted as far

as the effect of the arrangements between SAA, SAX and SAL on competition is concerned.

This should include whether SAA, SAX and SAL constitute a single controlled entity for

purposes of considering commercial practices within the alliance group of SAA.

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It should be noted that the Competition Commission has already intervened in the

exclusionary actions that prevented other airlines from obtaining landing rights at the

Margate Airport for the Johannesburg - Margate flight route.

The Competition Tribunal confirmed a consent order in favour of the Competition

Commission in the matter against SAL and Hibiscus Coast Municipality, a local authority

situated at the Margate Airport. 81)

Intensive Air laid the original complaint with the Commission, alleging a restrictive vertical

agreement between SAL and Hibiscus Municipality, wherein exclusive landing rights at

Margate Airport were granted to SAL in exchange for a loan for the upgrading of landing

rights at the airport. 82)

In terms of the consent order, SAL and Hibiscus Municipality have agreed to remove the

offending provision in their agreement, which has been found by the Competition

Commission to be in contravention of the Act. In terms of the Competition Act, the ruling of

the Competition Tribunal, which confirmed the consent order, rendered the clause void. 83)

The parties have also agreed to grant access and use of Margate Airport to operate a

scheduled air service to competitors. In terms of the order, the Commission reserves the

right to review and assess any anti-competitive effects, which may arise in future within the

context of SAL's conduct towards its competitors. 84)

Advocate Simelane M, the Competition Commissioner, stated that this demonstrated the

Competition Commission's willingness to resolve complaints by means of entering into

agreements with parties who contravene the Competition Act, resulting in an improved level

of competition for SA consumers. 85)

In the referral of the complaint to the Competition Tribunal the Competition Commission

stated that the agreement represented a contravention of section 5(1) of the Competition Act,

prohibiting agreements between parties in a vertical relationship if they have the effect of

substantially preventing or lessening competition. There was no proof that efficient

technological or pro-competition factors outweigh the substantial lessening of competition.

86)

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Although the agreement was for a period of five years, the Competition Commission had

evidence that the agreement had already negatively affected competition and consumers'

rights of choice. The Competition Commission was clearly concerned about the effect that

this agreement had on limiting future entry to the market, as despite the subsequent

insolvency of the complainant, the Competition Commission continued with its investigation

because the agreement would exclude other airlines from obtaining landing rights at the

Margate Airport for the Johannesburg - Margate flight route. 87)

6.3.3 OTHER INDICATIONS OF THE DOMINANCE OF SAA

6.3.3.1 International and Regional Air Services

SAA operates passenger services in a domestic, a regional and an international market with a

generally limited freight/cargo service. SAA is the largest domestic airline in the country.

88)

As a result, some network benefits and cost reduction may result from the integration of the

fleet of aircraft operating both domestic and international services, as well as passenger

traffic feed through domestic sectors of the network. In addition, the opration of FFPs (both

on earning credits and redeeming miles or points credited) and special offers that combine

domestic and international flight sectors, may also have an impact on domestic competition.

The materiality of the above and their effect on entry and competition in the domestic market

is an area for further study.

In the initial phase of deregulation, SAA separated its domestic services from its regional and

international services. This was later undone and a single organisational structure and network

was adopted. The flexibility that SAA has to use the same aircraft on domestic and

regional/international services provides SAA with the benefits of increasing services (flights)

with smaller increments in fixed costs than would be the case if the full costs of an additional

aircraft had to be recovered by domestic services alone. As a result, by not allocating the full

fixed costs pertaining to aircraft performing a dual role in both the high yielding

regional/African services to domestic services of SAA (as well as its associated idle time costs)

SAA may account for artificially low cost in its domestic network which cannot be matched by

Chapter 6 Page 636

domestic competitors that do not have access to the high yields and scope of the regional/

international networks. 89)

6.3.3.2 Other code-sharing agreements and alliances

According to Mountford T, SAA has code-sharing or commercial agreements with Air New

Zeeland, BMI, Cathy Pacific, Delta Air Lines, El Al, Emirates, Linhas Aereas de

Mozambique, Lufthansa, Thai Airways and Varig. 90) SAA together with its airline partners

is able to serve over 500 destinations. SAA regarded its airline partners as:

• Air France.

• British Midland.

• Cathy Pacific.

• Delta Air Lines.

• El Al.

• Emirates.

• Lufthansa.

• Qantas.

• Thai Airways.

• SAX.

• SAL.

• Varig. 91)

According to Viljoen A, SAA is a major player in the global village today. One of the major

thrusts of the airline's vision for the future is continued global expansion in conjunction with

strategic airline partners. 92)

It may well be that where the designated carrier, on most international routes, has been

concentrated on a single large state airline, SAA, that is also the dominant airline in the

domestic market, commercial agreements that increase scope advantages of the combined

route network of code-sharing agreements and loyalty sharing agreements of international

routes (combining the attractiveness benefits of international routes and alliance agreements

with overseas airlines) could confer advantages on SAA that increase the dominance of the

airline. The existence of such advantages in alliance agreements has been identified in

sections 4.10.2 to 4.10.4 of chapter 4. This has resulted in action being taken by Competition

Chapter 6 Page 637

authorities elsewhere (refer to sections 4.10.6 of chapter 4) to mitigate the anti-competitive

effects of marketing conduct that emanate from such alliance agreements, in order to allow

the opration of market forces in the domestic market and limit the distortion created by such

practices. The practical application of such practices emanating from alliance agreements

with a dominant domestic airline in South Africa requires further research, but it is expected

to have the same effect of distorting the free working of market forces, as has been the case

elsewhere.

Nothing, however, prevents the Competition and International Aeronautical Authorities in

South Africa from adopting the pro-competitive conditions for approval of commercial

agreements set by Competition authorities elsewhere.

The CAA noted competition concerns as a result of industry structure/market dominance. 93)

According to the CAA, the industry structure/market dominance relates to the “powerful

advantages” of established national carriers by virtue of their:

• Strong market identities.

• Strong networks.

• Associated benefits of economies of scope and sometimes scale. 94)

In contrast, a new entrant that would like to challenge a major incumbent on one or more of

its main routes would have to commit itself to a large investment (sunk costs) which will at

best only show a return after a number of years. In addition to its better-known trade name, a

dominant incumbent usually has the resources to respond aggressively if it believes the

routes on which competition develops are strategically important. 95)

6.3.3.3 The v ertical integration of SAA

SAA is a vertically integrated airline that includes a number of support and essential facilities

including:

• Maintenance facilities.

• Central reservations.

• Training facilities.

• Apron services at airports. 96)

Chapter 6 Page 638

These activities were historically handled by SAA, as no other alternative service providers

existed at the time. However, the Minister of Public Enterprises and Economic Co-

ordination regarded equal access to these facilities as essential. 97)

Subsequently, the level of vertical integration increased when SAA purchased all the issued

shares in an upstream service provider, Air Chefs, 51 percent from Transnet Limited and 49

percent from Fedics. This was also based on the rationale that SAA was concerned that it was

paying too much for the catering services supplied by Air Chefs because of an evergreen

management agreement, that contained a cost-plus 250 percent mechanism. It was also not

satisfied with the service levels that Air Chefs supplied. Air Chefs (Pty) Ltd was established

as a joint venture between Transnet and Fedics Strategic Investments (Pty) Ltd. An evergreen

management agreement vested control of Air Chefs with Fedics. 98)

In addition, with regard to CRSs, further vertical integration was established between SAA

and the dominant CRS in South Africa, Galileo Southern Africa, when the latter became a

subsidiary and business unit of SAA. 99) The market share of Galileo Southern Africa was

about 88 percent of the Global Distribution System (GDS) of the Southern African region,

which clearly demonstrated dominance in the CRS market. 100) (This matter is discussed in

more detail in 4.6.9 of chapter 4 as part of the section dealing with the use of computer

reservation services in the conduct of airline marketing practices.) This dominance in the

CRS field in South Africa and the vertical integration of SAA and Galileo Southern Africa

provides a reason for the introduction of regulatory measures with regard to CRSs as has

been done in most countries where air transport has been deregulated and liberalised. This

matter is dealt with in section 4.6.10 of chapter 4.

As a result of the above, it is evident that SAA has been expanding the scope of its activities

since deregulation in 1991 by means of amongst other things, vertical integration of its

activities in South Africa.

In the view of Van Siclen S, enterprises are restructured mainly when they include both

potentially competitive parts and natural monopoly parts, but enterprises should also be

restructured to facilitate economic regulation. According to Van Siclen S, restructuring of

such industries normally feature two types of splits:

• Separating the natural monopoly from the potentially competitive parts.

Chapter 6 Page 639

• Dividing the latter to create several competitors (to reduce dominance). 101)

Van Siclen S compared the effect of vertical separation (accounting, functional, corporate,

joint ownership, operational and ownership) on:

• The incentives of the monopolist to discriminate against competitors who need

access to essential facilities of the monopolist, as well as

• The ability of the monopolist to discriminate against non-integrated competitors.

102)

In the opinion of Van Siclen S, only separate ownership solves the fundamental problem of a

vertically integrated company that has incentives to discriminate in favour of its subsidiary

in the competitive market. 103)

Some weaker types of vertical separation that are in use in a number of OECD Member

countries were analysed by Van Siclen S. These include:

• Accounting Separation

Different parts of the same enterprise keep separate accounts, sometimes as though

they were separate corporations. In the view of Van Siclen S, the accounting

separation of different parts of the same enterprise has no effect on the enterprise’s

incentives to discriminate against non-integrated rivals, and very little effect (without

much more regulation) on the enterprise’s ability to discriminate. 104)

• Functional separation

Different parts of the same enterprise keep separate accounts, personnel, information

system, and management. Van Siclen S stated that this was thought to be marginally

more effective than “accounting separation”, but that many of its proponents have

reversed their position and now advocate separation of ownership. 105)

At the outset of deregulation in South Africa, the Minister of Mineral and Energy and Public

Enterprises announced in Parliament on 10 May 1990 that a consultant would be appointed to

“investigate the most suitable and appropriate structure within which SAA should be

operating in a deregulated market”. He stated, "before a final decision about the privatisation

of SAA will be taken, it will be important to have determined whether:

• SAA should be split into different parts.

• Formed into an international company, or

Chapter 6 Page 640

• Other configurations from the integrated SAA structure as it operates today,

in order to be conducive to greater competition in the air transport industry. 106)

The report of the investigation on the most suitable and appropriate structure relating to SAA

was, however, never published, nor did any restructuring with regard to its composition or

division into different entities SAA take place.

The Minister also referred to pending deregulation of the air transport industry and stated that

“barriers to entry” will be removed and those who would have wished to participate in the

past will then be able to do so. 107) He stated that the “dominant position of SAA may,

however, inhibit or deter entry, notwithstanding a deregulated market. The Government's

objective is to create more competition in air transport services, which may necessitate

further fragmentation of SAA.” 109) The Government may for instance find it was conducive

to greater competition in the Air Transport Industry to form an international company, or other

configurations from the integrated SAA structure as it operates today”. 108)

As such, the South African government therefore considered whether SAA should be split into

different parts. This was however considered on the basis that the dominant position of SAA

might inhibit or deter entry and therefore obviate the objective of achieving meaningful

competition. As will become evident from this chapter, entry did take place but it was found that

in the cases of both Flitestar and Sun Air, operations could not be sustained while at the time

allegations of predatory behaviour was levelled against SAA.

SAA remained dominant after deregulation and became more vertically integrated, 110) 111)

112) during the period of deregulation.

6.4 STATE OWNERSHIP OF AIRLINES

6.4.1 NATURE OF STATE OWNED AIRLINES

According to Kinghorn C, state ownership of airlines was not conducive to a truly

competitive environment (as state subsidies allow state airlines to survive when they are

doing badly and a civilian private sector airline would have failed under the same

Chapter 6 Page 641

circumstances). Kinghorn C was of the opinion that the South African Government should

continue its initiatives to privatise these airlines. 113) This issue relates to the concept of

state ownership and state financial aid that is dealt with elsewhere in this chapter.

The conflict of interest of the South African Government as ultimate regulator and owner of

the national carrier has been recognised previously in South Africa. In particular, the Margo

Commission referred to “the repeated and unavoidable clash of interests between SAA and

other operators, there has been a loss of confidence by the outside industry in the

independence of the NTC and in the ability to detach itself from the claims of the national

carrier”. It referred to “the requirement that any tribunal charged with such great

responsibility must not only be independent and just in fact, but must also bear the image of

independence and justice”. 114)

As a result of the investigations conducted by the Margo Commission it is clear that there has

historically been a difficulty regarding the inability of the regulatory authority in South

Africa to act independently in the interests of the SOE.

As noted above, developments in general economic policies, especially those of airline

deregulation afforded the opportunity for privately owned airlines to enter the domestic

market. With the participation of airlines in the private sector, the Government was faced

with a conflict of interest in its decision on whether the interests of the public should be

based on the economic policies applicable to other industries and as a result primarily on the

interest of the users, or alternatively, whether the focus should be on the interests of the

national carrier on the basis that the government should protect state assets. It was suggested

that one way that the government could ensure that it was acting as an objective and

impartial regulator, was to divest itself from ownership of airlines participating in the market

in order to avoid a conflict of interests between airlines in the domestic air transport market.

115)

The DOT concluded that in order to meet the principles of equal treatment of all participants

in the market, which could be jeopardised by the state ownership of airlines, the state would

have to reduce its direct involvement in the provision of air services in what was meant to be

a deregulated and openly competitive environment. The DOT would oversee the process of

restructuring of state assets in the transport sector. 116)

Chapter 6 Page 642

Apart from the difficulties of regulatory conflicts of interest, state ownership also provides

the ability to distort the free working of market forces by the state corporation that in turn

reduces the ability to create sustainable conditions in which the benefits of competition will

be retained for consumers.

The Ministry of Public Enterprises supported the conclusions of former World Bank Chief

Economist, Stiglitz J, that:

• The State enterprises are inefficient.

• Their losses contributed to the Government's budget deficit.

• They contributed to macro instability. 117)

In particular, Stiglitz J noted that privatisation has been less successful where private

ownership has not been accompanied by greater market competition. Where competition was

lacking, creating a private, unregulated monopoly would likely result in even higher prices

for consumers. In addition, private monopolies may suffer from several forms of inefficiency

and may not be highly innovative if insulated from competition. 118)

The Commission of Air Transport of the ICC noted an increasing tendency for states to

relinquish control over their airlines by selling off all or part of them to private investors,

many of whom are non-nationals. Countries privatise their airlines because of:

• National budget constraints, which make it difficult for certain governments to

continue meeting the airline's requirements for fleet replacement and operating

expenses.

• The inability of some countries that can no longer afford to bail out carriers

experiencing financial difficulty.

• The realisation of some countries that, in liberalised and competitive markets, state

ownership is no longer defensible. 119)

The Commission of Air Transport of the ICC noted that privatisation loosens the ties

between governments and their airlines and allows management the flexibility to make the

commercial decisions required by changing market conditions. 120)

According to Donoghue JA, there has been a shift away from government ownership of airlines

around the world “concurrent with the move to market-demand management”. In his view the

Chapter 6 Page 643

idea that a nation’s citizens should benefit from the profits of a national carrier became difficult to

sustain in the light of billions of dollars in losses. He stated that the “business model of a

government-owned airline just doesn’t work”. In his view a government owner/manager has

many goals apart from profitability, including politics in one form or another, which in his view

was “about power and keeping it spending money, not making it”. He observed that as a result of

the “ill effects of the lost billions which far overbalanced the goodwill gained in running an airline

poorly, governments have been shedding themselves of airline ownership”. 121)

According to Goldstein AE, the role of the South African government will be that of:

• Ensuring level playing fields.

• Regulation for safety.

• Leaving the operator as much freedom as possible to provide customer service as

demanded in a competitive environment. 122)

The restructuring of the SOE, Sun Air, through a full privatisation that included a black

economic empowerment group with no airline experience and a competitor, failed amid,

allegations of predatory behaviour by SAA. This issue is summarised in annexure “Z”.

The restructuring of SAA through a partial privatisation, however, resulted in the status quo

ante following the failure of Swiss Air and the repurchase of the privatised interest by

Transnet. This issue is summarised in annexure “T”.

6.4.2 LESSONS FROM THE PRIVATISATION OF SUN AIR

As stated above, the restructuring of the SOE, Sun Air, is dealt with in annexure “Z”. Some

lessons can, however, be drawn from the developments identified in annexure “Z” which are

set out below.

6.4.2.1 Preconceived ideas on the shareholding of Sun Air as part of its

privatisation

The Government applied a number of pre-conceived ideas to the full privatisation of Sun Air.

These had a distinct effect, limiting the ability of Sun Air to survive in a very competitive

market dominated by SAA.

Chapter 6 Page 644

The Sun Air privatisation did not provide for the inflow of substantial new capital into the

business of Sun Air itself in order to re-capitalise the airline to put it in a position to be

sustainable over the long term. The major empowerment shareholder, Rethabile was in itself

also undercapitalised and relied on dividend flow from Sun Air to finance the purchase price

of its investment in Sun Air. The use of Special Purpose Vehicles, (SPV) financing

structures for funding of shareholders in the privatisation of airlines would seem to be

inappropriate as being too heavily geared and too reliant on dividend flows from the

investment to sustain its financing ability. 123)

The complex shareholding structure of Sun Air, which included a competitor of Sun Air, as a

result of its privatisation, did not provide for the ability for Sun Air to raise additional capital

as required. The representation on the board of directors (as a result of the shareholding) by a

competitor airline (BA/Comair) resulted in conflicts of interest that created unnecessary

tension and suspicion and inhibited the strategic direction of Sun Air.

The ability of the black economic empowerment company, Rethabile to make the last

payment for the purchase price of Sun Air, depended on SPV financing structures that in turn

relied on dividend flow that would emanate from the profitability of Sun Air. This type of

financing structure exposed Rethabile to the risk of inadequate profitability of Sun Air and

which in turn was damaged by a prolonged price and over-capacity “war” with SAA which

affected the ability of Sun Air to earn a reasonable return on assets. 124)

It was noted in 8 of annexure “Z” that following the substantial increase in capacity by SAA,

the financial situation of Sun Air deteriorated rapidly. In section 23.3 of annexure “Z” it was

concluded that the excess capacity and low tariffs provided by SAA in the market soaked up

demand by lower yield passengers and reduced income rapidly for Sun Air, resulting in too

little net income to service its gearing of debt (interest and lease payments), which resulted in

losses (with no dividend prospects) and in turn destroyed the financial viability and dividend

flow on which continued financing of Rethabile relied for its investment in Sun Air.

6.4.2.2 International Ownership Restrictions on Domestic Airlines

The Government made it known that it would prevent substantial investment by foreign

airlines in Sun Air in order to protect SAA. 125)

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Maharaj M clearly wanted to avoid control of Sun Air by one of the foreign airlines

operating on an international scale in order to prevent them from having a “strategic

foothold” in South Africa to “enable them to undercut SAA”. 126)

6.4.2.3 Aggressive action of SAA and lack of adequate Competition Policy

enforcement

Of all the structural difficulties involved in the privatisation of Sun Air (which might have

affected its performance), two overriding factors contributed to its substantial financial

deterioration, which in turn set in motion a series of events which resulted in the closure and

demise of Sun Air. These included a combination of the market power derived from the

dominance of SAA and the lack of adequate competition rules and vigorous and timeous

enforcement of such rules.

Makings R reported that the three domestic carriers, Sun Air, BA/Comair and Nationwide

alleged that SAA had flooded the market with extra capacity designed to bring fares down to

unprofitable levels. Makings R noted that Sun Air later withdrew its complaint against SAA

to the Competition Board as a result of its attempt to come to some arrangement with SAA.

Andrews C admitted to Makings R that South Africa had the “lowest fares in the world” and

that as long as he was chief executive of SAA “that will remain the case or very close to it”.

127)

This clearly indicated the intent of SAA to keep fares down, which it could probably do due

to its position of dominance as market price leader. The evidence of losses that were incurred

by SAA at the same time that SAA was flooding the market with uneconomical fares, only

emerged later. SAA reported a headline loss of R735m for the 2001 financial year only a few

months after Mr Andrews left. 128)

Jeter J stated that by slashing fares and flooding South Africa's skies with cheap flights,

Andrews C “bludgeoned Sun Air into bankruptcy within a year of his arrival, leaving SAA

to gobble up most of its passengers and expand its share of the regional market”. 129)

In this regard, Goldstein AE identified that the three privately–owned domestic airlines filed

a complaint against SAA with the Competition Board in late 1998, accusing the parastatal of

Chapter 6 Page 646

predatory behaviour. The three airlines argued that SAA’s large capacity increases on a

number of domestic routes, combined with pricing policies which “are clearly below cost,

constitute predatory behaviour on the part of a dominant market share holder”. The airlines

alleged that on the Johannesburg–Durban route, SAA increased flight capacity by 50 per

cent and charged prices that cannot even cover its costs. As South Africa’s overall

competition policy was being overhauled, no formal investigation waslaunched until mid

1999. 130)

In the opinion of Makhado S, the Government was partly to blame for SAA’s anti-

competitive behaviour as it failed to create an antitrust environment in which domestic

airlines could operate. In addition, he alleged that "the Competition Board dragged its feet on

the seat-dumping complaint brought by Sun Air, Nationwide and BA/Comair against SAA

earlier, but that it was quick to give the go-ahead for the sale of the majority shareholdings in

Sun Air to SAA”. 131)

The failure of the Competition Board to take timeous active steps relating to complaints of

predatory conduct was a serious lapse of responsibility in enforcing the law (Competition

Act), with disastrous consequences for Sun Air.

Makings R reported that the demise of Sun Air may add R200 million profitability a year to

SAA’s bottom line. According to Moses K, one of the liquidators of Sun Air, this was due to

the fact that SAA would profit because most of Sun Air's 70,000 to 80,000 monthly

passengers would probably use SAA. Moses K submitted that SAA had been prepared to pay

R100-million (R50 million to lessor Safair and R50 million to co-shareholder Rethabile) as

part of a deal which resulted in Sun Air's closure. At the time, money in the bank and income

due to Sun Air from ticket sales meant it would have had sufficient funds to pay its major

creditors and remain in business. 132)

SAA paid Safair R50 million as compensation for any losses the company might incur

through not re-leasing five MD80 twin-engined jets within Southern Africa. According to

Moses K, SAA and Safair planned to claim Sun Air's assets in this way and split the value

between themselves. This would allow SAA to recoup the R50 million. According to Moses

K, Safair would have sold four DC9s (for which Investec Bank was owed R70 million

against which Investec held R28 million in securities and R19 million in trusts). According

Chapter 6 Page 647

to an agreement between SAA and Safair, which came into the possession of the liquidators,

Safair would have used the sale proceeds to pay off Investec and any surplus would have

been used towards repaying SAA. If Investec chose to keep the R47 million held in securities

and trusts, Safair would have been obliged to pay only the outstanding R23 million. In

addition, the two companies would have been able to sell an unencumbered DC9 and spares

with an estimated value of a further R22 million. SAA would have been paid the balance on

its R50-million and the rest would be split 40 percent to SAA and 60 percent to Safair.

Moses stated that the R47 million held by Investec and proceeds from the sale of the DC9

and spares was in his opinion money that belonged to Sun Air. Moses K stated that this was

“why we had to liquidate the trust to prevent the deal going through. Surpluses could have

amounted to about R50 million, none of which would have gone to creditors" of Sun Air.

133)

This calculation would appear to indicate that a reasonable possibility existed of rapid

recoupment by SAA from its investment in the provision of excess capacity at insufficient

fares as well as to the recoupment of the investment contemplated by its proposed agreement

for purchase and liquidation of Sun Air within one year, and the losses incurred by the

provision of excess capacity at low yield tariffs. It may be probable that on this basis, the

full investment in losses as well as the purchase consideration would have offered an

exceptional payback and return. In this regard, Fedusa assistant general secretary George D

stated on 29 December 1999 that the evidence presented during the liquidation inquiry

confirmed labour’s suspicions that there had been foul play on the part of SAA. He said an

application would be lodged with the Competition Commission early in 2000. BA/Comair,

Sun Air and Nationwide unsuccessfully lodged a similar application with the former

Competition Board in 1998 when they alleged that SAA was engaged in a price war and had

cut fares of certain routes for a period of time to drive its competitors out of business. 134)

Grawitzky R stated that BA/Comair, Sun Air and Nationwide claimed that SAA would

eventually recoup losses sustained by charging monopolistic prices. At the time SAA insisted

it was simply reducing prices and increasing output to competitive levels. 135)

As is established in chapters 7 and 8, predatory conduct in the airline industry in the USA

and Canada was found to be rational due to the dramatic effect that it has on smaller

competitors within a very short time. This makes recoupment of losses incurred upon the

Chapter 6 Page 648

exit of a small carrier feasible and profitable. This is dealt with in sections 7.5.2 of chapter 7

and 8.8.7 of chapter 8, where it was concluded that the competition did not have the luxury

of waiting because of the drastic financial impact on airline operations, which resulted in the

need to take extraordinary measures to react quickly in order to protect competition.

The findings of Oster C and Strong J in the USA were that:

• Predatory practices of this kind are a rational business strategy in the airline industry

in that there is an expectation that any losses or reduced profits will be recouped after

a rival has been driven from the market where there is sufficient market power, as in

the case of a dominant airline.

• Antitrust laws, as applicable to other industries, may not be sufficient to identify and

deal with such practices in the airline industry timeously. 136)

The events in South Africa are similar to practices encountered in the USA and Canada,

which clearly demonstrated the very powerful effect that a combination of a substantial

increase in the capacity of seats available and fares that are below the cost of provision of

such seats (capacity) has when perpetrated by a dominant airline and targeted against smaller

rivals.

This issue was the major focus of the proceedings in the USA (refer to sections 7.5.2, 7.6 and

7.7 of chapter 7) and remedial steps became part of the enforcement guidelines that were

introduced by legislation and regulations in Canada (refer to section 8.11 and 8.12 of chapter

8).

In addition, the rapid and serious financial effect of such action by a dominant carrier has

resulted in provision being made for the issue of temporary cease and desist orders in Canada

(refer to sections 8.12.3, 8.15, 8.15.2, 8.15.5, 8.15.6, and the strengthening of such powers

afterwards in 8.23.6 of chapter 8).

6.4.3 LESSONS FROM THE PART-PRIVATISATION OF SAA

As stated above the restructuring of the SOE, SAA is dealt with in annexure “T”. This

included the sale of a 20 percent stake in SAA to Swiss Air, which had to be re-acquired by

Chapter 6 Page 649

Transnet following financial difficulties at Swiss Air. Some lessons can however be drawn

from the developments identified in annexure “T”, which are set out below.

The DPE originally hoped to list SAA on the Johannesburg Stock Exchange in 2002 but

Swissair's difficulties coupled with the poor financial performance of SAA and controversy

over hiring foreign executives to run the airline have marred what was expected to be a

turnaround in the airline's performance. 137) Owing to financial difficulties encountered by

Swissair, the airline could no longer maintain its investment in SAA. 138)

Following the re-acquisition of the 20 percent interest by Transnet that was previously sold

in a part-privatisation exercise, Radebe J announced that Government would consider how to

find another strategic partner that will again imply a partial privatisation. As such, the

Government had no option but to re-acquire the Swissair stake, which Radebe J regarded as

being in the best interests of the country. 139) 140)

As identified by ABSA, the sale of minority stakes in State companies to foreign investors is

risky in the sense that the strategic foreign equity partners that acquire such minority stakes

may decide to sell their investments back to the South African Government. 141) This

prospect became reality when the 20 percent interest in SAA was subsequently re-purchased

by Transnet.

In essence, part privatisation based on the concept of a strategic partner affords the equity

investor that ends up with the minority interest in the SOE the opportunity of gaining

management control over quite large SOEs, but without incurring the financial commitment

that would normally be associated with such control. Should something go wrong, there is

always a reasonable prospect that the Government will provide financial aid to the SOE (in

order to guarantee debt) and be prepared to purchase the interest of the equity partner. From

an economic perspective, the government as majority shareholder effectively retains the risk

of the SOE while disproportionate control over the SOE is vested in the strategic partner,

enabling the strategic partner to use the SOE in its global network and alliance strategy,

which may not be based on the interests of South Africa, but on the interests of the global

alliance that such strategic partner operates. A number of advantages of allowing SAA to be

part of an international global alliance were identified on 25 June 1999 when the agreement

to acquire a 20 percent stake in SAA from Transnet by Swiss Air was announced. The

Chapter 6 Page 650

agreement was regarded to as representing a “fine example of the implementation of

government policy for the restructuring of State-owned enterprises”. 142)

6.5 PUBLIC OWNERSHIP (STATE-OWNED AIRLINES) AND STATE

AID

The concern relating to the provision of state financial aid to SOEs that operate in competition

with operators in the private sector has been identified in 4.11.3 of chapter 4. It is generally

held that state aid to SOEs creates potential distortions of competition and does not subject

state owned airlines to the same financial discipline as private sector operators in the market.

In the following sections the extent of state financial aid to SAA and concern with regard to

its consequences for competition in the air transport market are identified.

6.5.1 RINGFENCING OF SAA

The 1998 Moving South Africa (MSA) strategy stated that SAA is currently insulated from

the consequences of its own performance, since its operations are supported by Transnet

profits elsewhere in the firm. It stated that the ringfencing principle operates in sharp contrast

to the current practice of Transnet. Such ringfencing would ensure sustainability by allowing

customers to pay for the value they can support, if the application of funds is ringfenced to

the customer segment that benefits. The principle of ringfencing also implies that shared

infrastructure must be split proportionately to assign appropriate costs to different segments

of users. In this regard, the MSA strategy recommended ringfencing airlines to ensure

sustainability with the key objective of allowing airlines, especially SAA, to be sustainable as

a key strategic action. Ringfencing the financial operations of the airlines would permit them

to be economically self-sufficient, and creates an incentive for the shareholders to take

measures that will improve operational efficiencies. This will make the ability to raise and

fund necessary fleet upgrading and capital expansions more transparent. 143)

According to Williams F, Transnet Limited has announced that it will not in future publish

separate financial statements for SAA. 144)

This action is a definite move away from the abovementioned principles advocated by MSA

strategy. Such action will also make it impossible to establish whether the dominant airline in

the South African domestic airline market is producing a reasonable return on capital. Such

Chapter 6 Page 651

operations at too low a return on assets will distort the market, as has been found to be the

case in the past. 145)

6.5.2 RECENT STATE FINANCIAL AID FOR SAA

6.5.2.1 Extent of recent grant of State financial aid to SAA

According to Wray Q, in a surprising move on 13 August 2003, Mokeyane E of the DPE

announced that SAA was “technically insolvent” and that the government had to step in to

guarantee its debts. 146) Mokeyane E stated that the state had agreed to step in to reassure

investors that their money was safe as it was necessary to “protect our investment and to

safeguard South Africa’s reputation as a responsible and creditable investment destination”.

Mokeyane E also added that if the government had failed to step in and SAA’s credit rating

had been degraded, it could have affected the pricing of similar debt, with negative

consequences for the other parastatals. 147)

According to Chalmers R, the government issued a R3,5 billion guarantee to key lenders to

SAA and its parent company, Transnet, following nervousness over the carrier's expected

currency related losses of up to R6bn in 2002/03. Talks around the guarantee are the main

reason the state owned company's financial results were delayed by almost two months. 148)

The Director-General of the DPE, Mokeyane E stated on 13 August 2003 that the

government had taken the decision to guarantee the losses to ensure it kept the confidence of

investors. According to Mokeyane E “the sovereign” will support the losses (via) a debt

guarantee of R3,5 billion to lenders. 149) Mokeyane E stated that the DPE was comfortable

that this was a “responsible shareholders' decision”. SAA’s currency-related losses came as a

blow to the airline as it was due to post strong growth in revenue and operating profit for the

year ended 31 March 2003. 150)

Chalmers R reported that SAA officials stated that the strength of the SA Rand against the

dollar, coupled with the implementation of a new accounting statement, AC133, had

adversely affected the airline's net profit. 151)

Chapter 6 Page 652

Chalmers R reported that the Government's decision to underwrite part of the R6 billion in

currency-related losses made by SAA in its 2003 financial year was an unusual step,

highlighting the level of concern being expressed by the airline's lenders. The decision to

issue a R3,5 billion guarantee to lenders was taken at a cabinet briefing where a report

suggested that SAA’s losses meant it was technically insolvent. 152) Chalmers R concluded

that it meant that the potential liabilities of SAA were greater than its assets. 153)

According to the commentary to the Group audited results of SAA relating to the year ending

31 March 2003, the net shareholders deficit amounted to R 1,410 million. 154)

The holding company of SAA, Transnet, agreed to subordinate its right to claim repayment

of loans totalling R 1,754 million until the assets of SAA exceed its liabilities. 155) Transnet

has also agreed to provide additional subordinated loans up to a total facility of R4,100

million should this be required. This includes the R 1,754 million. In addition, the

Government provided a state guarantee for R3,500 million to key lenders of SAA. 156) The

above imply that total financial aid amounting to R7,600 million was provided to SAA

between SAA and Transnet according to the comments on its financial results as at 31 March

2003.

According to Chalmers R the losses of SAA relate to two issues:

• SAA’s hedging programme, and

• The implementation of the new accounting standard AC133. 157)

6.5.2.2 SAA’s hedging programme

SAA used derivative instruments to protect itself against currency volatility for a long time.

It was regarded as a critical aspect of its business, as a large portion of airlines' costs are

dollar denominated, notably the fuel bill and lease payments on aircraft.

When SAA bought 41 new Airbus aircraft, it acquired a portfolio of derivative instruments to

cover against risk of a decline in the SA Rand exchange rate against foreign currencies. This

was regarded as necessary in light of the large sums involved. SAA estimated it would have

to spend between $2 billion and $2,5 billion over 10 years. Chalmers R stated that about 70

Chapter 6 Page 653

percent of SAA’s liabilities were as a result hedged against foreign currency fluctuations.

158)

The net effect is that the airline makes big gains or losses when the SA Rand weakens or

strengthens against the dollar. In the 2002 financial year, when the SA Rand was trading at

about R10 to R11 to the dollar, SAA made a R2,5 billion gain from derivative instruments. In

the following financial year, the SA Rand was trading at R7 to R8 to the US Dollar, which

resulted in a R6 billion reversal. 159)

6.5.2.3 Implementation of new accounting standard AC133

The accounting standard AC133 requires companies to reflect financial tools from derivative

instruments to private equity investments in their balance sheets at fair value, based on

market valuations. The aim is to boost transparency in financial statements, reflecting the

financial health of a company as accurately as possible. The implementation of AC133 has

had a substantial influence both on SAA and on its parent company, Transnet. 160)

According to Viljoen A, operating profit is what SAA should be judged on as opposed to net

profit. Chalmers R reported that SAA’s operating profit for the year 2003 was expected to

have “staged a dramatic turnaround, from an R834m loss the previous year to a profit of

more than R450m”. Operating profit was regarded by Viljoen A, as one of the key measures

used by analysts to assess the performance of an airline. 161)

6.5.3 OTHER STATE FINANCIAL ASSISTANCE TO SAA AND

TRANSNET

It would appear that state ownership of SAA may create an expectation that state financial

aid (including guarantees) would be available to the airline. The South African Government

has, in the past, provided guarantees for the financing of aircraft on behalf of SAA. In

addition, debt relief of R3,057 billion was granted to SAA (of which, R1,724 billion was

absorbed by Transnet and R1,333 billion was taken over by the government by means of a

liquid (tradable) instrument to the value of R1,333 billion plus interest payable semi-annually

until maturity). 162) This debt relief was provided by means of an Act of Parliament, the

SAA Unallocatable Debt Act OF 1999. 163) Note should also be taken of the debt reduction

Chapter 6 Page 654

of Transnet where R10,394 billion of the pension fund shortfall was provided and

subsequently funded by the issue of loan stock by the government also referred to as the T11

bond valued in the company's balance sheet at R8,4 billion. All these actions imply that

substantial state financial aid has been made available while SAA competes with other

domestic airlines that do not receive such assistance. These actions create the impression the

South African government would step in as the lender of last resort with financial assistance

(irrespective of what the causes are).

This feature of the South African domestic airline industry, of a dominant state-owned

airline, represents a major structural problem to the development of a truly competitive air

transport industry.

6.5.4 ANALYSIS OF RECENT STATE FINANCIAL AID FOR SAA

According to Vermeulen A, the following are among the debates that require fresh

discussion:

• “Does South Africa need – but, more importantly, can it afford - a national state-

owned airline when the rest of the world has moved towards privatisation?”

• “Should South Africa’s competition authorities not show some gumption and step in

when clearly the State’s continued support of an unprofitable and anti-competitive

airline has been at the expense of other privately owned and operated airlines that

don’t enjoy the same benefits as SAA?” 164)

Vermeulen A also posed the question of “whether SAA is competing unfairly against its

much smaller competitors (SAA already has around 65 percent of the domestic market) as a

result of the state’s continuous rescues”. 165) She stated that SAA “was supposed to have

been corporatised, run on private sector principles where competitive principles apply”. 166)

The action of the government in guaranteeing SAA’s debt was clearly aimed at protecting

other parastatals from the possibility of losing creditworthiness or being downgraded, which

could affect the pricing of similar debt, with negative consequences for the other parastatals.

This implies that large amounts of state financial aid have to be granted to SOEs as a result

of such SOEs being heavily borrowed, which implies that the government is effectively in a

debt trap.

Chapter 6 Page 655

Government guarantees granted in favour of SAA are to cover losses and to ensure

confidence by lenders in repayment and servicing of debt. This will distort the working of

market forces, as it does not subject SAA to the normal financial disciplines of the market in

the same way as its competitors are subjected to such financial disciplines. In addition, there

does not appear to be any time limit to the guarantees the government granted in favour of

SAA. It also appears that the government did not set any conditions to the grant of the state

aid to mitigate against the potential anti-competitive effects of such state financial aid.

In addition, it would seem as if the airlines’ hedging policy, effectively underwritten by the

government, is of a permanent nature and that it will provide protection from a softening of

the SA Rand/US Dollar exchange rate. This would have a negative impact on competitors

that do not have access to such a facility. This could imply that the hedging facility by the

government provides an unfair advantage to the dominant airline that is contrary to the

principle of levelling the competitive playing field. It would appear as if state ownership of

SAA may create an expectation that state financial aid (including guarantees) would be

available to the dominant airline. This feature of the South African domestic airline industry,

relating to the reputation of the dominant state-owned airline of reacting in an extremely

aggressive manner with the backing of state financial aid as discussed in 6.5.3 above,

represents a major structural problem to the development of a truly competitive air transport

industry in which market forces will determine the conduct of operators.

As a result, additional measures would have to be implemented to mitigate the anti-

competitive effects of such state guarantees.

As noted in 4.11.3 of chapter 4, it would appear that there is a risk that state ownership may

result in lower than expected returns on investment by the dominant airline that would also

be the price leader in the market and that debt relief and state guarantees might have to be

granted by the Government to cover losses incurred by inadequate returns on investment.

In this way, the operation of market forces may be distorted as a result of different financial

objectives of operators in the private sector competing against the dominant state-owned

operator, as noted in 4.11.1 of chapter 4. This could have a negative impact on the possibility

of operators in the private sector earning a reasonable return on investment, which forms the

basis of attracting investment. In addition, such lower than expected returns on investment

Chapter 6 Page 656

would act as an economic barrier to entry to new entrants and scare away new investment in

an industry that is known to be capital intensive and require major equipment renewals from

time to time.

The following table compares the recent state aid granted by the South African Government

to SAA, with the recommendations of the ICC pertaining to an airline that receives

government financial assistance or state aid. 167)

Table 6.3: Evaluation of the recent state aid granted to SAA against the

Recommendations of the ICC pertaining to an airline receiving

government financial assistance or state aid

Recommendations of the ICC pertaining

to an airline receiving government

financial assistance or state aid

Evaluation of the recent state aid granted

to SAA in the form of debt relief and state

guarantees

The state airline should be prohibited from

using that assistance to expand capacity and

should, where feasible, effect a significant

reduction in its capacity.

In the case of SAA, the state guarantees are

actually intended to assist in the funding of

the acquisition of major capacity expansion.

As a result it may be probable that a chronic

situation of state funded excess capacity

could develop in the South African air

transport market, which could inhibit the

development of competitive airlines in the

South Africa.

The state airline should be prohibited from

using that assistance to buy or take over

another carrier.

All the shares in SAX were acquired by

SAA, which increased the scope of the

combined network in favour of SAA.

The state airline should be compelled to

bear the burden of proof in demonstrating

that competitive interests of other airlines

will not be negatively impacted.

No public announcement or any publication

was found that indicated that any attempt

was made by SAA to demonstrate that the

competitive interests of other airlines will

not be negatively impacted.

That any state assistance should be assessed

in the first instance by independent experts,

No public announcement or any publication

was found that indicated that independent

Chapter 6 Page 657

preferably by independent auditors from the

chartered accountancy sector, to determine

whether it adheres to the principles

discussed in these recommendations.

experts would establish or assess what the

effect of state assistance granted by SAA

would be on competition.

That an independent auditor from the

chartered accountacy sector should monitor

the effect on competition of any state

assistance at a later stage of its

implementation. The results of the

monitoring process should be transparent

and should be made available to the public.

No public announcement or any publication

was found that indicated any future

monitoring of the effect of any state

assistance on competition.

Source: International Chamber of Commerce Commission on air transport, policy statement state aid to airlines document no. 310/430 rev. 2, International Chamber of Commerce, http://www.iccwbo.org/home/statements_rules/statements/1995/state_aid.asp, Paris, 13 June 1995: 1,2

As a result of the abovementioned analysis, there seems to be a risk that a competitive airline

industry would be adversely affected for the period for which such state aid is in existence.

As identified in 4.11.1 of chapter 4, state aid does distort the free working of market forces in

competitive markets. In 4.11.4 of chapter 4, it was noted that the EC enforces rules pertaining

to state aid in Europe with administrative fines imposed on governments for providing such

state financial aid. Although application of such rules would act as a governance or policy

guideline in South Africa, no super-national authority exists to impose such fines on the

government itself. Such an authority would have to be specifically created administratively

and enforceable by the Competition Commission or Competition Tribunal. As a result,

creating a level playing field between market participants in the private sector and state

owned participants (especially those that receive state financial aid) is important. In addition,

careful consideration should be given to the institutional authority that would be responsible

for maintaining such a level playing field, as such authority would need to withstand the

pressures that may be brought to bear on the government by state corporations that

structurally report to a Minister who is part of the government.

Recent exposure of SAA to the cost of leasing aircraft instead of the lower cost relating to

low interest state loans to SAA is positive from a competition point of view. According to

Mabaso S, the chief financial officer of Transnet Limited, SAA has adopted a strategy of

Chapter 6 Page 658

leasing aircraft rather than owning aircraft. As such, at the end of March 2002, SAA leased

48 aircraft in comparison with 39 at the end of March 2001. 168)

This approach is welcomed from a competition perspective, in that it would expose SAA to

the same type of cost structure (relating to the cost of the use of aircraft) as would be

applicable to other private sector operators in the air transport market. There is, however, a

need to reduce government guarantees for the financing of aircraft acquisition for SAA,

especially if no such financial assistance is available to competitors in the private sector. The

focus on leasing would, however, not be enough to normalise the effect that such state

guarantees have on distorting market forces.

The issue of state ownership and state aid was raised at a recent conference on competition in

South Africa. The role that the Competition Commission can play in dealing with the whole

question of state aid was highlighted. It was submitted that financial institutions and banks,

when dealing with an SOE, are comfortable (as investors and bankers) about investing in or

lending money to that particular company owing to the fact that the majority shareholder in

that particular company is the state. It was submitted that there was room for a change in the

Competition legislation to make sure that the Competition Commission does probe issues of

state aid. 169)

At the conference it was also submitted that the Competition Act does actually empower the

Competition Commission to implement measures to increase market transparency. Among

other things, the Competition Commission is entitled to review legislation and public

regulations, and report to the Minister concerning any provision that permits uncompetitive

behaviour. 170)

6.6 MARKET CONDUCT OF DOMINANT STATE-OWNED AIRLINES

Allegations made by smaller carriers relating to anti-competitive behaviour by the larger

incumbents that are mostly partly or fully state-owned in Europe demonstrate the risk

associated with conduct of airlines receiving state financial aid. The CAA noted that

complaints made under these circumstances dealt with a wide range of activities, including

Chapter 6 Page 659

allegations of the following:

• Predatory pricing.

• Refusal to interline.

• The anti-competitive effects of FFPs.

• Excessive pricing on selective routes (some coupled with aggressively low fares on

other routes).

• Collusive behaviour relating to pricing.

• Discriminatory discounts on airport charges.

• Slot allocation.

• Pressurising agents not to sell competitors tickets.

• Introductions of aggressive low fares as result of being granted state aid.

• Alliance agreements in which competition is reduced (in which conditions were set

relating to surrendering of slots, constraints on alliance’s frequencies on routes,

access to the alliance’s FFP in order to ensure competitive entry). 171)

With regard to South Africa, a number of complaints have been raised by private sector

airlines about the commercial practices of SAA as set out below. Certain complaints relate to

a specific practice adopted by SAA while others relate to predatory conduct by means of the

provision of capacity (in terms of seats and frequency of service) far in excess of market

demand at such low fares that it soaks up demand for seats and deprives its competitors of

enough support for their services to be viable. There appears to be a risk that the expectation

of future provision of state financial aid (including guarantees), combined with dominance,

could result in an abuse of dominance, which could become a barrier to entry and restrict the

development of competitive conditions.

Goldstein AE noted that it was not so clear that the entry and exit of new entrants in South

Africa was in response to market dynamics only, as:

• In 1993 the Competition Board, following a complaint from Flitestar accusing SAA

of unfair competition, recommended that SAA increase its fares.

• In 1997 BA/Comair accused SAA of poaching cabin staff using illegal means.

• The three privately owned domestic airlines filed a complaint against SAA with the

Competition Board in late 1998, accusing the parastatal of predatory behaviour. The

three airlines argued that SAA’s large capacity increases on a number of domestic

routes, combined with pricing policies which “are clearly below cost, constitute

Chapter 6 Page 660

predatory behaviour on the part of a dominant market share holder”. The airlines

charged that on the Johannesburg–Durban route, SAA increased flight capacity by 50

per cent and charged prices that could not even cover its costs. 172)

Goldstein AE noted that as South Africa’s overall competition policy was being overhauled

at that time, no formal investigation was launched.

The Competition Board found that the pricing policy of SAA since Flitestar's entry into the

market and the failure of SAA to reduce capacity commensurate with the Government's

policy objectives and the practical business situation appreciably affected Flitestar's

profitability and viability. This had the effect of restricting Flitestar's entry into the market

and therefore also restricting effective competition between the two airlines. The same was

true mutatis mutandis in respect of the then BA/Comair. The Competition Board accordingly

concluded that in certain material respects SAA’s behaviour constituted a restrictive practice

warranting appropriate remedial action. 173) A synopsis of the informal investigation of the

Competition Board into the domestic air transport market in 1993 is attached as annexure

“U”. The Competition Board regarded the actions of SAA in reducing yields per passenger to

below levels where it or its competitors could operate profitably, as anti-competitive. SAA

did not decrease its seating capacity but increased the number of flights, which were

scheduled in close proximity to those of Flitestar. This excess capacity created by SAA was

also regarded as anti-competitive behaviour and the Competition Board made

recommendations for temporary interventionist measures to be taken to remedy imbalances

in the market place. 174)

Further allegations relating to restrictive practices by SAA, resulting from SAA's dominant

position in the domestic air transport market, were made relating to:

• Its FFP.

• Exclusive corporate discount arrangements.

• TACOs.

• The perceived improper use of its CRS. 175)

An air fares war between SAA and BA/Comair saw some fares being cut by up to 60 percent

in some cases. Kinghorn C regarded this as a case of predatory pricing that should have been

Chapter 6 Page 661

covered under the Competition Act's restrictive practices provisions, but found that no action

was taken. 176)

As a result of a complaint filed with the Competition Commission by Nationwide against

certain practices of SAA during 2000, the Competition Commission decided to refer the

complaints to the Competition Tribunal for a decision. In particular the Commission dealt

with

• TACOs.

• Travel agent employee (consultants) travel incentives. 177) 178)

It is evident that competitors in the private sector have at different times made allegations

relating to many of the same commercial practices against SAA. Many of the same

commercial practices have presented difficulties of a competition nature in other countries as

well as in South Africa as noted in chapter 3. As a result, many of the same solutions that

were arrived at in other countries may be applicable to the domestic air transport field in

South Africa.

The action of SAA in reducing average yields per passenger together with substantial

increases in the provision of capacity was in one case regarded as anti-competitive by the

Competition Board in South Africa during 1993, whilst similar allegations have been made

by Sun Air and BA/Comair at later stages. In 5.6 of chapter 5 it has been established that this

particular type of conduct occurs frequently in domestic air transport markets elsewhere

where a large airline dominates the market or particular hub airports. This has been held to

represent anti-competitive behaviour (or even predatory behaviour) as well as an abuse of

dominant position. The concern and some possible solutions with specific regard to its

occurrence in the USA and Canada are dealt in inter alia 7.9.5, 7.5.2 and 7.5.3.2 of chapter 7

as well as in 8.12.5.1 of chapter 8.

6.7 ANTI-COMPETITIVE CONDUCT, ABUSE OF A DOMINANT

POSITION OR PREDATORY CONDUCT BY DOMINANT AIRLINES

Examples noted in the USA and Canada are dealt with in chapters 7 and 8. The occurrence of

this particular type of behaviour, involving action by a dominant airline to reduce prices

Chapter 6 Page 662

combined with substantial increases in capacity, has clearly demonstrated that such an abuse

of a dominant position or predatory conduct is not dependent on state financial aid alone, but

also occurs where large network airlines have the ability to abuse their dominance (market

power).

In the USA, the DOT received 32 informal complaints about unfair competitive practices

between 1993 and 1999. According to Oster CV and Strong JS, half of these complaints

involved allegations of unfair pricing and capacity responses – the dumping of low-fare

capacity in the city-pair market, and in some cases the adding of flights. Others involved

allegedly unfair uses of marketing and airport handling relationships, such as higher travel

agent commissions. 179)

In ten of the twelve cases considered, the new entrant's fare was at least 50 percent lower

than the average fare of the incumbent(s) during the quarter preceding entry. In three-fourths

of the cases, within two quarters the average fare of the incumbent fell by a third or more,

and in four cases total incumbent passenger traffic rose by more than a third. Within eight

quarters after entry, the new entrant had exited in half the cases; while in two cases additional

market load factors were so low that survival was uncertain. In three of the six cases where

the entrant exited, average fares then rose to above pre-entry levels, while in the other three

markets average fares rose above the level of the entry period. In contrast, fares remained

lower in all but one of the markets in which entry was sustained. 180)

In Canada, the Competition Tribunal found that for the period 1 April 2000 to 5 March 2001,

Air Canada operated or increased capacity at fares that did not cover the avoidable costs of

providing the service on the Toronto – Moncton return route. 181)

The abovementioned examples should demonstrate the risk of restructuring SAA by means

of privatisation of the entire airline, in a way that would maintain the dominance of SAA in

the domestic market. Such action would probably not solve the risks of dominance by SAA

and an abuse of such dominance in the domestic air transport market.

As a result, regulatory action would be required to “level the playing fields” and to protect

competing airlines. This discussion provides clarity on the nature of a number of commercial

practices that are adopted in the airline industry to capitalise on increasing economies of

Chapter 6 Page 663

scale and that result in inhibiting competition. In addition, some examples of regulatory

intervention are provided as well as the effect that such regulatory measures have had in

promoting competition.

6.8 MEASURES TO ENSURE ACCESS TO LEVEL THE PLAYING

FIELD FOR NEW ENTRANTS

6.8.1 THE APPLICATION OF COMPETITION POLICY TO THE

DOMESTIC AIR TRANSPORT MARKET

As a result of the changes relating to full economic deregulation of entry into the domestic

air transport market in South Africa, the Cabinet decided in 1991 that the Competition Board

should play a definite role in to the Domestic Aviation Policy. 182) Certain structural

deficiencies prevented the Competition Board from performing the duties that the Cabinet

agreed to in terms of the Domestic Air Transport Policy. 183) According to Smith E there

were visible shortcomings that included the lack of an authority empowered to enforce the

four principles set out in the 1990 domestic aviation policy. 184) As a result, the current

situation in South Africa resulted, more or less, in a laissez-faire approach initially. (Refer to

2.2.3 of chapter 2 for a more comprehensive discussion).

Williams G stated that “the ability of large incumbent carriers to contain the destructive

elements of the competitive process... is prodigious”. 185) He was of the opinion that “reliance

by regulatory authorities on antitrust legislation to prevent competition being constrained in this

manner was likely to prove of only limited success. Ensuring that the competitive process

cannot be artificially constrained by powerful suppliers may well necessitate more direct forms

of intervention”. 186)

In this regard, it is important to note that there may be a difference between a governmental

policy objective of deregulation and a policy objective of fostering/enhancing competition. It

is submitted that the policy in South Africa changed from focusing on deregulation to a focus

on competition with the adoption of the new Competition Policy in South Africa in 1997 and

associated legislation in 1998. 187)

Chapter 6 Page 664

According to the OECD, deregulation “is a subset of regulatory reform and refers to complete or

partial elimination of regulation in a sector to improve economic performance” 188). “Such

regulatory reform that encourages reliance on competitive market forces can lower costs of

entry and expansion and produce more competitive and efficient industry structures”. 189)

“Successful reform should be built on a foundation of effective competition policy, indeed

reform efforts may fail to deliver potential benefits if competition issues are not adequately

addressed. Failures of regulatory reform in some countries are at least partly due to the lack of

adequate measures to protect and promote competition during the crucial transitional phase.”

190)

Whilst specific tasks were allocated to the Competition Board to perform with regard to the air

transport market at the time of deregulation in South Africa, such specific tasks would appear to

have fallen away with the introduction of the Competition Act of 1998, as no such authority was

specifically created for the new institutions that replaced the Competition Board and came into

force in terms of the Competition Act of 1998 with regard to the air transport market.

6.8.2 REGULATORY STEPS TO ACHIEVE A LEVEL PLAYING FIELD

FOR COMPETITION

6.8.2.1 Introduction to regulatory intervention in the economy

The then South African Minister of Public Enterprises and Economic Coordination

announced on 25 April 1991 that certain measures would be taken to ensure that no barriers

exist to potential entrants and that a level playing field and equal access to support facilities

are assured. 191) Smith E later established, however, that the concept of a “level playing

field was not adhered to”. 192)

Perhaps because of the basic philosophy with regard to the concept of deregulation adopted

in South Africa, which included an objective to “minimise control by the State over

economic and business activities” 193) as contained in the 1987 White Paper on

Privatisation and Deregulation, 194) the Government avoided the introduction of regulations

save for those relating to safety as well as security pertaining to advance bookings for

passengers. No regulations were, however, introduced in South Africa that would actually

Chapter 6 Page 665

enhance competition or ensure that equal access to essential facilities is granted, barriers to

entry are eliminated or measures are established to level the playing field.

6.8.2.2 The trend of pro-competitive measures (regulatory intervention) to

assure level playing fields for competitors

The approach of creating regulations to promote competitive conditions has been identified

by the OECD as necessary in certain circumstances where it has been found to be difficult to

assure level playing fields for competitors. The OECD also stated that regulatory reform

that enhances competition and reduces regulatory costs was the type of regulatory reform

that should be sought as an objective. 195)

As will be demonstrated, the countries within the EU have adopted specific measures, by

means of regulations, within the ambit of competition law, of a pro-competitive nature. In

the USA this has been done mostly within the ambit of transport legislation where both the

US DOT and the Antitrust Division of the DOJ have statutory obligations to prevent anti-

competitive conduct. In Canada pro-competitive regulations were introduced that were

specifically aimed at the air transport market within the ambit of competition legislation, but

the Canadian Transportation Agency maintained certain mandates relating to certain issues

such as the code of practice relating to CRSs.

The development of pro-competitive measures along the lines adopted in the USA, the EU

and Canada will be studied in order to recommend appropriate measures to be adopted in

South Africa, especially in view of the situation of overall dominance of SAA.

6.8.2.3 Pro-competitive measures (regulatory intervention) to assure level

playing fields for competitors in Europe

The EU implemented a number of regulatory measures as part of a liberalised air transport

market in order to “enable the players in air transport to compete on a level playing field”.

196) These regulatory measures have been agreed to and implemented by the EU and

European governments following proper investigation and due process. As a result of this

example, it is recommended that similar regulatory steps be investigated and applied in

South Africa by means of regulations in order to ensure a comparable level playing field.

Chapter 6 Page 666

The following summary of the regulations adopted within Europe will illustrate the type of

regulatory measures that have been adopted in addition to subjecting the air transport

industry to competition rules and enforcement thereof within Europe.

• Slots.

• Ground Handling.

• Distribution Networks (CRSs) in Travel Agencies.

• Airport charges.

• Strict Rules on state aid. 197)

6.8.2.4 Measures to ringfence SAA provide access of new entrants to

infrastructure and bottleneck facilities in order to level the playing field

in South Africa

An analysis with regard to the measures that the government announced to grant access of

new entrants to infrastructure and bottleneck facilities in order to level the playing field in

South Africa is attached in annexure “AA”. The table below represents a synopsis of such

measures that were announced by the Minister of Public Enterprises as well as those that

formed part of the Addendum to the Domestic Air Transport Policy as well as the level of

compliance thereto.

Table 6.4: Conclusions relating to the measures that were announced and contained

in the Addendum to the Domestic Air Transport Policy to ring-fence

SAA, provide access to new entrants to infrastructure and bottleneck

facilities in order to level the playing field

Measures that were announced by the

Minister of Public Enterprises and

contained in the Addendum to the

Domestic Air Transport Policy

Conclusion relating to the Measures that

were announced and contained in the

Addendum to the Domestic Air Transport

Policy.

The transfer of the South African transport

services to Transnet will not be to the

advantage or disadvantage of SAA’s

competitive position, with specific

reference to the valuation of assets. 198)

The Competition Board concluded that the

valuation of the assets had been responsibly

executed as to basis and method. 199)

The valuation of assets did not, however,

Chapter 6 Page 667

include the costs associated with route and

systems development and the accumulation of a

dominant position. These included substantial

sunk costs in start up and route development.

Access to the domestic air transport

market. 200)

The only restrictions on entry are those of

safety, dependability, insurance and residence.

201)

Access by new entrants and other domestic

competitors to infrastructure and facilities,

which were identified as advantageous to

SAA as a result of its dominant position in

the market. The activities almost

exclusively operated by SAA and identified

as possible restrictions to new entry

included: 202)

• Maintenance facilities.

• Computer reservations system.

• Training facilities/services.

• Apron services at airports.

The Competition Board recorded its

satisfaction with the quality of the

maintenance service rendered by SAA.

The Competition Board was not in a position

to express an opinion whether SAA’s charges

for ground handling were reasonable or not.

203)

No opinion has yet been expressed on:

• CRSs.

• Training facilities/services.

Van Siclen S, stated that only separate

ownership solves the fundamental problem of

a vertically integrated company that has

incentives to discriminate in favour of its

subsidiary in the competitive market. 204)

SAA must operate autonomously and on a

commercial basis. 205)

Constraints exist on SAA as a division of

Transnet relating to:

• Major asset acquisition.

• Borrowings.

• Fare determinations.

The Competition Board noted that SAA did

not set its fares autonomously and was

therefore, not in a position to adjust fares

Chapter 6 Page 668

unilaterally, if and when necessary, to achieve

the required returns.

As a result, the Competition Board concluded

that “SAA was not being operated on a

commercial basis”. 206)

SAA must be prevented from using profits

made on its international services to

subsidise its domestic services. 207)

Adjust SAA’s internal structure to ensure

that no cross subsidisation between its

international and domestic services take

place. 208)

The Competition Board found that it was “not

possible to state categorically that cross-

subsidisation between international and

domestic operations did not take place”. 209)

Mutual cross-subsidisation between SAA

and Transnet must be prevented. 210)

SAA will not enjoy any preferential

treatment or advantage through its

relationship with Transnet. 211)

Smith E stated that the financial statements of

Transnet did not reflect such detail. 212)

The most obvious area of cross-subsidisation

would be in the providing of financial

assistance (by means of guarantees or low

interest rates or extension of payment

pertaining to loans). It is presently not possible

to identify the effect of such items.

SAA will not render any services to the

government below actual cost. 213)

The Competition Board found that

government departments paid normal fares for

services required. 214)

It is, however, questionable whether exclusive

corporate discount schemes should be allowed

between SAA and state departments.

SAA will not enjoy any privileges in terms

of any legislation or any other practice as a

result of its being part of Transnet or as a

result of its being a government enterprise.

215)

This would include special arrangements for

funding Transnet Limited contained in the

Legal Succession to the South African

Transport Services Act 9 of 1989. In terms of

this legislation, Transnet has the advantage of

Chapter 6 Page 669

obtaining government guarantees for raising

financial instruments including stock issues on

the Stock Exchange. 216) Transnet has

therefore the benefit of:

• Obtaining creditworthiness - borrowing

against government guarantees instead of

the normal credit risk assessments that are

applicable in the private sector.

• Lower cost of borrowings as the effective

rate on the quoted stock issued by Transnet

Limited is far lower than ordinary

borrowings in the private sector.

The government will not in future

guarantee new loans to SAA or any other

airline with Government interests, while

private airlines have to borrow at their own

risk. 217)

The government issued a R3,5 billion

guarantee to key lenders to SAA and its

parent company Transnet following

nervousness over the carrier's expected

currency related losses of up to R6 billion in

its 2003 financial year. 218)

The Minister gave instructions to Transnet

to restructure SAA:

• As a fully self-sustaining business unit.

• Properly ringfenced from Transnet.

• Not cross-subsidised in any way. 219)

It appears that SAA never became:

• A fully self-sustaining business unit.

• Properly ringfenced from Transnet.

• Free from any cross-subsidisation.

No statements of compliance to the instructions

of the Minister were ever issued by Transnet or

SAA.

SAA will present financial statements in

accordance with normal accounting

principles. 220)

After publishing two years of abridged financial

statements for SAA, Transnet Limited

announced that it will not in future publish

separate financial statements of SAA. 221)

From the above, it is evident that the measures that were intended to restructure and

ringfence SAA as well as to level the playing field in the domestic air transport market in

South Africa at the outset of the deregulation of air transport services, were generally not

Chapter 6 Page 670

implemented. As a result, these issues, the applicability thereof, as well as the adequacy of

such measures and the feasibility of their being implemented have to be revisited in the light

of experiences in South Africa and elsewhere.

6.9 PRICE DISCRIMINATION IN THE DOMESTIC AIRLINE

INDUSTRY IN SOUTH AFRICA

6.9.1 PRICE DISCRIMINATION AND SIMILARITY OF FARES AND

TARIFFS IN THE DOMESTIC AIRLINE INDUSTRY IN SOUTH

AFRICA

An analysis of the fares and tariffs of domestic airlines is attached as annexure “C1” and

“C2”. This analysis clearly indicates a remarkable similarity of fares and tariffs of domestic

airlines owing to the openness or visibility of fares and conditions (rules and restrictions) in

CRSs in South Africa, as well as the practice of matching fares in the industry. Such

matching of prices is probably not based on relative similar costs of the airlines, but rather on

a practice of matching fares by the airlines using CRSs. It would appear that as a result, price

competition in the domestic airline industry is not achieved by means of CRSs but rather by

means of negotiated fares, with larger travel agencies, corporate customers and special offers

to frequent flyer members via direct offerings, the e-mail and the Internet.

6.9.2 PRICE DISCRIMINATION BY DOMINANT FIRMS IS PROHIBITED IN

SOUTH AFRICA

Price discrimination for goods or services by a dominant firm is prohibited under Section

9(1) of the Competition Act of 1998, i.e. this is a per se prohibition. Price discrimination is

defined in 6.9.3 below.

According to the Competition Commission discrimination would be where the dominant firm

could be considered to be applying dissimilar conditions to equivalent transactions, i.e.

different prices are charged to different sets of clients. For price discrimination to be feasible,

the firm has to be able to segment the market in some way and also has to be able to enforce

the segmentation, so that trading between the different categories of customers who are

charged different prices is not possible.

Chapter 6 Page 671

In general, the Competition Commission stated that the dominant firm would need to set

prices above average variable costs so that common costs are recovered. Price discrimination

between different groups can be the means of achieving this, it can increase output and lead

to customers who might otherwise have been priced out of the market being served. 222)

Conduct involving differential treatment of purchasers is not prohibited price discrimination

if the dominant firm establishes that the differential treatment meets the following conditions:

• It makes no more than reasonable allowance for differences in cost or likely cost of

manufacture, distribution, sale, promotion or delivery resulting from the differing

places to which, methods by which, or quantities in which, goods or services are

supplied to different purchasers.

• It consists of doing acts in good faith to meet a price or benefit offered by a

competitor, or

• It is in response to changing conditions affecting the market for the goods or services

concerned, including:

o Any action in response to the actual or imminent deterioration of perishable

goods.

o Any action in response to the obsolescence of goods.

o A sale pursuant to a liquidation or sequestration procedure, or

o A sale in good faith in discontinuance of business in the goods or services

concerned. 223)

6.9.3 ANALYSIS OF THE CONDITIONS IN THE AIRLINE INDUSTRY

PERTAINING TO PRICE DISCRIMINATION WITHIN THE

CONTEXT OF SECTION 9(1) OF THE COMPETITION ACT OF 1998

IN SOUTH AFRICA

The South African Competition Act prohibits price discrimination not only relating to the

supply of goods but also to services. Air transport services would constitute services as

contemplated by the South African Competition Act. In considering price discrimination in

the field of air transport it would appear that such discrimination is applied not only with

regard to fares (tariffs) but also with regard to the applicable conditions (fare rules),

confidential corporate discounts (rebates) and the provision of frequent flyer credits, frequent

Chapter 6 Page 672

flyer awards or tier status of frequent flyer passengers. Further studies and research should be

conducted to determine the monetary effect of these dimensions of the airline product in

South Africa.

Price discrimination by a dominant firm is prohibited in terms of section 9 (1) of the

Competition Act. The section provides that “an action by a dominant firm, as the seller of

goods or services, is prohibited price discrimination, if:

(a) it is likely to have the effect of substantially preventing or lessening competition.

(b) it relates to the sale, in equivalent transactions, of goods or services of like grade

and quality to different purchasers, and

(c) it involves discriminating between those purchasers in terms of:

(i) the price charged for the goods or services.

(ii) any discount, allowance, rebate or credit given or allowed in relation to

the supply of goods or services.

(iii) the provision of services in respect of the goods or services, or

(iv) payment for services provided in respect of the goods or services.

(2) Despite subsection (1), conduct involving differential treatment of purchasers in

terms of any matter listed in section c of that subsection is not prohibited price

discrimination if the dominant firm establishes that the differential treatment-

(a) makes only reasonable allowance for differences in cost or likely cost of

manufacture, distribution, sale, promotion or delivery resulting from the

differing places to which, methods by which, or quantities in which goods or

services are supplied to different purchasers.

(b) is constituted by doing acts in good faith to meet a price or benefit offered by

a competitor, or

(c) is in response to changing conditions affecting the market for the goods or

services concerned, including-

(i) any action in response to the actual or imminent deterioration of

perishable goods.

(ii) any action in response to the obsolescence of goods.

(iii) a sale pursuant to a liquidation or sequestration procedure, or

(iv) a sale in good faith in discontinuance of business in the goods or

services concerned”. 224)

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The following analysis indicates that price discrimination by a dominant airline may in South

Africa at least prima facie be in contravention of the prohibition against price discrimination

included in the South African Competition Act.

In 3.10.4 of chapter 3, it was established that the TRB had found that buyers with inelastic

demands (business travellers) are charged the highest prices while leisure travellers who are

sensitive to price (price-elastic) are charged fares roughly equal to the marginal cost of

serving them, but apparently insufficient in the aggregate to cover the full cost of maintaining

the airline networks. As airlines must cover their total costs in competing for capital in

private financial markets, they apparently cover any shortfall in revenues from leisure

travellers by charging higher prices, or whatever the traffic will bear, to price-inelastic

business travellers (as Ramsey pricing would suggest). The combination of yield

management techniques and the level of fare dispersion could imply that the level of fares

that would be achievable for new entry into the air transport market, relating to the segments

of the market that are not foreclosed by loyalty schemes (rebates to the client and traveller) in

the form of:

• FFPs (FFPs).

• Travel agent commission overrides (TACOs).

• Corporate discounts as identified in 3.10.3 and 3.10.7,

might not be sufficient to cover the total cost of operations of such a new entrant.

No actual complaint has at the time of writing been lodged with the Competition

Commission. It is probable that consumers or bodies representative of consumers (and in

particular business travellers) would have to lodge any such complaints, rather than smaller

competitive airlines whose fares and tariffs are remarkably similar owing to the practice of

matching in CRSs.

A comparison between the provisions of the prohibition contained in the Competition Act

and circumstances in the air transport industry is provided in table 6.5 below in order to

illustrate the probability that such practices may in fact be unlawful in the air transport

industry in South Africa.

Chapter 6 Page 674

Table 6.5: Comparison of discriminatory price practices in the airline industry

with the provisions of section 9(1) of the Competition Act of 1998

Provisions of section 9(1) of the

Competition Act of 1998 (per sé

prohibition of price discrimination by

dominant firm) 225)

Nature of discriminatory price practices in

the airline industry

An action by a dominant firm 226) The Competition Commission found that SAA

is a dominant firm. 227)

As the seller of goods or services is

prohibited 228)

Air transport services are services and not

goods. The Robinson-Patman Act in the USA

prohibits discrimination in the sale of goods,

not services. 229) As a result, the USA has no

precedence in this regard.

Price discrimination

(According to the Competition

Commission, discrimination would be

where the dominant firm could be

considered to be applying dissimilar

conditions to equivalent transactions, i.e.

different prices are charged to different

sets of clients.) 230)

According to Kahn AE, the carriers have

become extremely sophisticated in practicing

price discrimination, which has produced an

enormously increased spread between

discounted and average fares, on the one hand,

and full fares, on the other. 231)

According to Dempsey PS, a discriminating

rate structure with price differences between

different markets reflecting not relative costs

but the differing degree of competition exists in

the airline industry. 232) As a result, the price

discrimination in the airline industry would fall

within the ambit of that contemplated by this

requirement.

If, it is likely to have the effect of

substantially preventing or lessening

competition; 233)

According to Kahn AE, yield management

adopted in the airline industry “. . . had already

- and, so far as I know, close to universally -

entailed just such rationing”. In the assessment

of Kahn AE, the explicit rationing of the

Chapter 6 Page 675

number of seats per flight, resulting in an

inability or failure of carriers to satisfy demand

for discounted seats on particular flights, is the

principal tool of yield management. Certain

conditions are established (such as a Saturday

night stay-over, advance purchase, or penalties

for changes) that limit the demand itself.

Kahn AE concluded that the establishment of

such conditions constitutes rationing and that

the conditions are the particular method that

carriers use to accomplish it. 234) As a result, it

would seem that such price discrimination

would probably have the effect of substantially

preventing or lessening competition as

envisaged by the wording of this subsection.

If, it relates to the sale, in equivalent

transactions, of goods or services of like

grade and quality to different purchasers;

235) and

The airlines’ yield management systems mean

that passengers on the same flight will have

paid different fares, depending on how far in

advance they made their booking and how

many restrictions they were willing to accept in

return for a lower fare. 236) 237) 238)

Airlines attempt to sell as many seats as

possible at the highest fares, those charged for

unrestricted travel, and as few seats as possible

at the lowest discount fares. Passengers paying

the highest fares obtain the advantages of

flexibility and last-minute access to seats. They

can book seats just before the flight, change

their reservation without penalty, and obtain a

full refund if they do not use the booking.

Passengers travelling on most discount fares, in

contrast, typically have to book seats several

Chapter 6 Page 676

days or more before the flight, have to pay in

advance for their seats, cannot change a

reservation without paying a penalty, and

cannot obtain a cash refund if they cancel their

trip.

Although business travellers can use some

discount fares, the cheapest discount fares

frequently have a Saturday night stay

requirement to discourage business travellers

from using them. To save seats for passengers

willing to pay for unrestricted fares bought

shortly or immediately before the flight, airlines

limit the number of seats made available at the

lower fare levels. 239) 240)

If, it involves discriminating between

those purchasers in terms of: 241)

The discrimination in fares also reflects the

willingness of business travellers, but to a lesser

degree, leisure travellers, to pay for frequent

and convenient flights. 242) 243) 244) It would

appear as if discrimination for essentially the

same service offering does take place.

• The price charged for the goods or

services; 245)

Airlines developed complex fare structures

designed to maximise revenues on each flight

through price discrimination and the use of

CRSs. 246) 247) discrimination takes the form

of differences in the prices charged to different

customers.

• Any discount, allowance, rebate or

credit given or allowed in relation to

the supply of goods or services; 248)

Apart from the fare structures as evidenced by

tariff and applicable conditions (rules),

confidential corporate discounts (rebates) that

are applicable in the airline industry might also

fall within the ambit of this subsection. 249)

• The provision of services in respect of

the goods or services; or 250)

In this regard, the provision of frequent flyer

credits, tier status of frequent flyer passengers

Chapter 6 Page 677

and awards to frequent flyer passengers (in

terms of different credits required for the same

reward as well as the availability and timing of

seats to be used as awards) might represent the

provision of services provided in respect of the

air services provided by a dominant airline as

envisaged by the wording of this subsection.

251)

• Payment for services provided in

respect of the goods or services. 252)

It is doubtful whether different credit terms are

offered that could be attributed to

discrimination in the domestic airline industry.

It is expected that such discrimination (should it

exist) would depend on economic grounds or

creditworthiness and volume of business.

Despite subsection (1), conduct involving

differential treatment of purchasers in

terms of any matter listed in section (c) of

that subsection is not prohibited price

discrimination if the dominant firm

establishes that the differential treatment:

253)

Makes only reasonable allowance for

differences in cost or likely cost of

manufacture, distribution, sale, promotion

or delivery resulting from the differing

places to which, methods by which, or

quantities in which, goods or services are

supplied to different purchasers. 254)

According to the Secretary for Transportation

of the USA, higher fares charged by network

airlines in hub markets without competition

reflect in part market power, not costs, demand

characteristics, or service features 255)

Kahn AE also recognised that price

differentiation also reflects wide differences in

real costs between:

• Long and short, dense and thin routes

and

• The hour of the day and day of the week

• Holding seats open for last-minute

Chapter 6 Page 678

availability.

Discriminatory fare differentials make it

possible to use larger, more efficient planes and

offer more convenient scheduling on a greater

number of routes than would have been

possible if all fares had to be uniform. 256)

These factors do not, however, contribute to the

conditions set as the basis of discrimination on

price as set out above.

• Is constituted by doing acts in good

faith to meet a price or benefit offered

by a competitor; or 257)

Historically, price leadership, price

discrimination and yield management were

initiated by SAA in the airline industry in South

Africa. In addition the defence of matching

pricing by a dominant airline has been rejected

in Canada owing to service and attribute

differentials of airlines as identified in 8.12.5.1

of chapter 8.

• Is in response to changing conditions

affecting the market for the goods or

services concerned, including: 258)

It is doubtful whether the time factor of flights

approaching their departure times/dates could

be regarded as changing conditions affecting

the market services, as the time factor is

recurring in nature and actually the basis of

some of the conditions that result in price

discrimination.

o Any action in response to the

actual or imminent deterioration of

perishable goods; 259)

This exception only relates to goods and not to

services. As a result, this exception is not

applicable in the airline industry.

o Any action in response to the

obsolescence of goods; 260)

This exception only relates to goods and not to

services. As a result, this exception is not

applicable to the airline industry.

o A sale pursuant to a liquidation or

sequestration procedure; or 261)

This is not applicable in the ordinary course of

business of the dominant airline in South

Africa.

Chapter 6 Page 679

o A sale in good faith in

discontinuance of business in the

goods or services concerned. 262)

This is not applicable in the ordinary course of

business save for withdrawing from certain

routes. A reduction of flight frequency should

in the writer’s opinion not be regarded as a

discontinuance of business. Sources: Compiled by the author from:

Section 9(1) of the Competition Act of 1998 Competition Commission, Guide to Prohibited Practices Manoim N, Lewis D and Terblanche D, Decision On Application For Interim Relief in terms of Section 59, Case No: 92/IR/Oct00, 21 December 2000 Section 7, Competition Act 1998 as amended Dempsey PS, Flying Blind: The Failure of Airline Deregulation, 1990 Kahn AE, Whom the Gods Would Destroy or How Not to Deregulate, First Distinguished Lecture, 2001 Levine ME, Airline Competition in Deregulated Markets: Theory, Firm Strategy, and Public Policy, Spring 1987 TRB Special Report 255, July 1999 United States of America Department of Transportation Office of the Secretary, Enforcement Policy Regarding Unfair Exclusionary Conduct in the Air Transportation Industry - Findings and Conclusions on the Economic, Policy, And Legal Issues, Department of Transportation, 17 January 2001 Oster CV and Strong JS, Predatory Practices in the USA Airline Industry, Domestic Aviation Competition Series USA Department of Transportation, 15 January 2001 Kahn AE, Statement on asserted predatory airline pricing before the subcommittee on antitrust of the United States Senate Committee on the Judiciary, 2 May 2000.

6.10 FINDINGS AND CONCLUSIONS

Specific objectives that were established in this chapter relate to the dominance of the SOE

SAA and its effect on the level of competition and with regard to the following dimensions

that were analysed and discussed:

• Market dominance of SAA and its domestic alliance partners

In 6.3 it was established that SAA has dominance over the domestic air transport

market in South Africa. This was demonstrated in the market share of passengers

carried and capacity provided by SAA, as well as the code share and other

commercial alliance arrangements with SAX and SAL. This implies competition

concerns in the following markets:

o The domestic markets that are being serviced by turbojet powered aircraft

between larger airports by competitors of SAA, in which regard the code-

sharing and other agreements with SAA might provide exclusive feed and

distribution for SAA and not for other potential competitors.

o Entry to an expansion of smaller domestic markets that are being serviced by

turboprop aircraft and regional jets on smaller routes might be restricted by

Chapter 6 Page 680

the code-sharing and other agreements with SAA if potential competitors of

SAX and South African Airlink are not granted similar facilities by SAA.

In 6.3.2 other indications of the dominance of SAA were identified, including:

o Dominance over international and regional air services in 6.3.2.1.

o Other code-sharing agreements and alliances to which SAA is a party in

6.3.2.2.

o The vertical integration of SAA was identified in 6.3.3.3. It was established

that the “most suitable and appropriate structure within which SAA should be

operating in a deregulated market” was considered at the outset of

deregulation. The recommendations included that SAA:

Should be split into different parts.

Should be turned into an international company, or

Other configurations from the integrated SAA structure.

• Industry structure (ownership) of state-owned airlines

In 6.4.1 the nature of state owned airlines was considered. Concern was expressed

with regard to conflict of interests where the South African government is the

ultimate regulator and owner of the national carrier in South Africa. An increasing

tendency for governments to relinquish control over their airlines by selling off all or

part of them to private investors, many of whom are non-nationals, was identified.

Some lessons from the privatisation of Sun Air were identified in 6.4.2. It was

established that the government applied a number of pre-conceived ideas with the full

privatisation of Sun Air as identified in 6.4.2.1. These had a distinct effect of limiting

the ability of Sun Air to survive in a very competitive market dominated by SAA.

In 6.4.2.2 it was established that the government had clearly made it known that it

would prevent substantial investment by foreign airlines in Sun Air in order to protect

SAA.

Aggressive action taken by SAA and lack of adequate competition policy

enforcement were identified in 6.4.2.3. In short, SAA flooded the market with excess

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capacity and unprofitable fares at a time when it had incurred substantial losses and

enjoyed the benefit of government financial aid.

A number of lessons from the part-privatisation of SAA were drawn in 6.4.3. It was

suggested that the restructuring of SAA should be considered from the perspectives

of:

• Reducing the financial risk for the government of a single large dominant

operator.

• Reducing of the dominance of a single large dominant operator and possibly

its vertical integration,

in order to create suitable conditions for the development of a competitive domestic

air transport industry to create a sustainable competitive domestic air transport

industry.

• State financial assistance to SAA

State financial assistance to SAA was identified in 6.4.2.4 and it was suggested that

due regard should be had to conditions and limitations as introduced in Europe to

mitigate the distortion that state aid has on market forces as set out in 6.5.3 and 6.5.4.

In 6.5.2 the different forms in which state aid has been known to be granted were

identified. A private sector perspective of the grant of state aid to airlines was noted in

6.5.4. The recent actual grant of substantial amounts of state financial aid to SAA was

dealt with in 6.5.6. The implications of the recent state financial aid for SAA and its

possible effect on distortion of market forces were discussed in 6.5.10.

• The Conduct of dominant state-owned airlines funded by state aid

Based on complaints of smaller carriers relating to anti-competitive behaviour by the

larger incumbents that are mostly partly or fully state-owned, a wide range of

activities of dominant incumbents were identified in 6.6. In addition, certain

allegations of a similar nature were also identified in South Africa.

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• Anti-competitive conduct, abuse of a dominant position or predatory conduct by

dominant airlines

In 6.6, it was noted that allegations made by smaller carriers relating to anti-

competitive behaviour by the larger incumbents that are mostly partly or fully state-

owned in Europe demonstrate the risk associated with the conduct of airlines

receiving state financial aid. With regard to South Africa, a number of complaints

have been raised by private sector airlines about the commercial practices of SAA as

noted in 6.6. Certain of these complaints relate to a specific practices adopted by

SAA while others relate to predatory conduct by means of the provision of capacity

(in terms of seats and frequency of service) far in excess of market demand at such

low fares that it soaks up the demand for seats and deprives its competitors of enough

support for their services to be viable.

As noted in 6.7, it was established that specific examples in the USA and Canada

have clearly demonstrated that an abuse of a dominant position or predatory conduct

is not dependent on state financial aid alone, but also occurs where large network

airlines have the ability to abuse their dominance. These examples demonstrate the

risk that restructuring of SAA by means of privatisation of the entire airline, in a way

that would maintain the dominance of SAA in the domestic market, will not

necessarily solve the risks of the dominance being abused in the domestic air

transport market.

As a result, regulatory action would be required to “level the playing fields” and to

protect competition. This provides some clarity of the nature of a number of

commercial practices that have been adopted in the airline industry, the operation of

which increase the advantages of economies of scale and the resultant inhibiting

effect on competition. In addition, some examples of regulatory intervention are

provided as well as the effects that such regulatory measures have had in promoting

competition.

• Measures to ensure access and to level the playing field for new entrants

In 6.8.1 the essential role of the competition authorities and the application of

competition policy to the domestic air transport market was highlighted. It was

speculated that while specific tasks were allocated to the Competition Board to perform

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with regard to the air transport market at the time of deregulation in South Africa, such

specific tasks would appear to have fallen away with the introduction of the Competition

Act of 1998, as no such authority was specifically created for the new institutions that

replaced the Competition Board and came into force in terms of the Competition Act of

1998 with regard to the air transport market.

At the outset of deregulation of the domestic air transport market in South Africa,

certain measures, were taken to ensure that no barriers exist to potential entrants and

that a level playing field and equal access to support facilities were assured. The

concept of a level playing field was later not adhered to, as was examined in 6.8.8.4.

It is evident that the measures that were intended to ringfence SAA, provide access

for new entrants to infrastructure and bottleneck facilities in order to level the playing

field in South Africa at the outset of deregulation of air transport services, were

generally not implemented. As a result, these issues, this applicability, and the

adequacy of such measures and the feasibility of their being implemented have to be

revisited in the light of experiences in South Africa and elsewhere.

• Price discrimination

Price discrimination in the airline industry in South Africa was dealt with in 6.9. In

6.9.1, price discrimination and similarity in fares and tariffs were found to exist in the

domestic airline industry in South Africa. An analysis of the conditions in the airline

industry pertaining to price discrimination, within the context of section 9(1) of the

Competition Act of 1998 in South Africa, was made in 6.9.3. It was concluded that

price discrimination by a dominant airline may at least be prima facie in

contravention of the prohibition against price discrimination in the South African

Competition Act. It is evident that the issue of price discrimination by the dominant

airline, SAA, in South Africa would require further study.

• Consumer interests

Although strictly they fall outside the scope of this study, in 5.10.2 of chapter 5 some

developments in other jurisdictions were identified that are in the interests of

consumers and that could be considered in South Africa. In this regard, annexures

“V” and “W” provide some guidance for further studies.

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• Problems relating to the Competition Act in South Africa

Certain problems relating to the Competition Act in South Africa were identified in

5.10 of chapter 5, in particular:

o The occurrence of powerful SOEs in 5.10.3 of chapter 5.

o Time-consuming procedures for complaints in 5.10.5 of chapter 5.

o The fact that prohibited agreements are not immediately void, in 5.10.6 of

chapter 5.

o The application of a strict cost standard of marginal or average variable cost

for the airline industry in South Africa in 5.10.7 of chapter 5 as well as

annexure “X”.