RBB Economics

ACE TOULOUSE ADRIAN MAJUMDAR

RYANAIR / AER LINGUS

30 November 2007
 RBB Economics

Merger of highly differentiated

services
ADRIAN MAJUMDAR

• Product differentiation:
• Ryanair (FR) “low frills” vs Aer Lingus (EI) “mid frills”, by its
own admission
2 • FR average fare (€41) less than half that of EI (€91)
Adrian.Majumdar@rbbe

• Geographic differentiation:
• EI flies DUB to “primary” airport
• FR flies (typically) DUB to “secondary” airports
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• Overlap on 16 “airport pairs” and further 19 “city pairs”

• European Commission (EC) used econometrics to assess

30 NOVEMBER 2007

closeness of competition…
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Commission results: impact of FR

frequency on EI fares
ADRIAN MAJUMDAR

• EC adopts fixed effects panel for Irish routes. Taking

results at face value:

3 • “a 1% increase in Ryanair frequencies… is associated with a

0.028% reduction in Aer Lingus’ prices” (A IV, 218)
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• “a 1% increase in frequencies by Ryanair is associated,

respectively, with a 0.044% and 0.026% decrease in Aer
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Lingus’ fares when serving the same airport or a different

airport in the same city-pair” (A IV, 229 [with typo corrected])
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• FR is not a strong constraint on EI. 20% increase in FR

frequency would not even have 1% impact on EI fares!
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Commission results: presence of FR

ADRIAN MAJUMDAR

• When FR present, its share is substantial, c. 40-60% typically

• “…on average, Aer Lingus prices are 7.7% lower when Ryanair is also
present on the route…” (A IV, 200)
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• But FR not likely to reduce frequency substantially post merger
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• Would not be profitable to withdraw from overlap routes

• FR has obligations to (nearly) double its fleet in next 5 years, with

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options to (nearly) triple it.

• So any reductions in frequency, if at all, would be marginal…

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• and the EC frequency regression implies such changes will have

no noticeable impact on EI fares
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Double standards
ADRIAN MAJUMDAR

• Welcome use of empirical analysis & “data room” but must treat
all evidence equally, a few (of many) examples include

• EC and EI regressions suffer from endogeneity: EI fare regressed

on EI frequency, +ve sign consistent with demand determining fares
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and frequency together (as with +ve sign for other rivals)
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• EC critique of FR approach – bias arises from correlation of EI entry

and cost and demand variables. OK but if entry is endogenous, the
same bias arises in EC panel.
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• EC Claim that presence regression is “extraordinarily robust” (A IV,

299), BUT minor change in modeling seasonality and allowing for
within route serial correlation has substantial impact both in reducing
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coefficient AND removing statistical significance of FR presence

• NB: also different standards for evidence on operating cost

comparisons and, crucially, base competition.
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Does EI constrain FR?

ADRIAN MAJUMDAR

• EI very rarely enters FR routes so not sufficient variation for

standard fixed effects approach… but can combine some
benefits of panel with cross section to test impact of EI…

6 • No systematic effect of EI on FR is found (Annex IV, para

316).
Adrian.Majumdar@rbbe

• “Asymmetric constraint” is intuitive… FR more likely to

constrain EI than the reverse, since:
• FR more efficient and dynamic (track record of growth and
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fares reductions)
• On average, FR fares less than half of EI fares
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• Commission results indicate that FR constraint on EI is

small even on airport pairs… so the EI constraint on FR is,
at most, very small
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Barriers to entry
ADRIAN MAJUMDAR

• Entry required only to restore lost competitive constraints

• Asymmetric constraints…
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• No material constraint on FR lost, so none to restore

Adrian.Majumdar@rbbe

• Key question: would entry prevent higher EI fares?

con.com

• New entry is common place in airline industry and supported

very recently by OFT, BKA

• OFT BA Connect / FlyBe (merger to monopoly constrained by

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ease of entry)

• BKA (Air Berlin/LTU – low entry barriers)

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Base competition (1)

ADRIAN MAJUMDAR

• EC Claim: Being based at an airport generates the following

airport related advantages:

• scale economies which reduce cost

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• ability to respond quickly to anticipated demand shocks

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• NOTE: “bases” are not “hubs”

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• Point-to-point “bases” do not benefit from “feeder traffic” (as

EC acknowledges)
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 RBB Economics

Base competition (2)

ADRIAN MAJUMDAR

• No empirical evidence of substantial cost advantages:

• Cost advantages tend to be network related (e.g. network

wide bargaining with ground handlers)
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• FR operational costs do not differ at Cork (one FR aircraft
based) and Dublin (19 aircraft based). Further, increment in
Adrian.Majumdar@rbbe

FR Dublin based aircraft by 50% had no impact on reducing

operating costs.
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• Marketing economies exist but are not substantial – FR has v

low advertising spend per pax despite period of rapid
expansion to new bases and new countries
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• Above evidence rejected yet EI cost efficiency claims based

on assertion (as EI admitted) were taken at face value and
unchallenged (double standards)
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Base competition (3)

ADRIAN MAJUMDAR

• “Flexibility” claims are speculative:

• EC Claim: more aircraft based gives more flexibility

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• BUT actually more flexibility arises when bases are spread
out (cf FR’s strategy to serve DUB from aircraft based in
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the UK).

• Anticipated demand is, by definition, easy to meet (cf

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seasonal ski or sun routes – the hallmark of the charter

model) [NB – EC acknowledged charters to be “in” the
market]
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 RBB Economics

Competition from “other end” of the

route
ADRIAN MAJUMDAR

• New entry is common place in airline industry and

supported very recently by OFT, BKA

• Base advantages are small and would certainly apply for

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rivals based at the destination for whom new entry would
be straightforward
Adrian.Majumdar@rbbe

• 23/35 “overlap” routes have competitor based at

destination (and where rival not based at destination,
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routes typically are seasonal, i.e. suitable for charter

entry)
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Commission claims regarding

potential competitors
ADRIAN MAJUMDAR

• Less committed to DUB, but

• why if entry / expansion driven by pursuit of profit?

• Different business models, but

12 • same applies to FR and EI; EI is mid frills, FR low frills
• entry needs constrain EI, not FR
Adrian.Majumdar@rbbe

• Flag carriers, Aer Arann, bmi, etc would take EI’s profitable
later bookers (i.e. business), so important competitors

•
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Disadvantaged if most originating pax are Irish, but

• applies for minority of routes (i.e. rivals typically have
advantage)
• strong Irish origination applies primarily for seasonal routes
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suitable for charter entry

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Reputation as a barrier to entry (1)

ADRIAN MAJUMDAR

• Theory
• Price high now, protected by threat to lower price in response to
entry

13 • Reality
• FR prices low now; FR does not price higher on “monopoly” routes
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• Entry “deterred” because consumers are currently well

served – this is NOT an entry barrier!
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• EC claim that FR increased entry barriers by fighting off entry (6

examples) but post exit, FR’s fare was lower and capacity higher
than the pre-entry scenario… consistent with FR needing to offer a
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better deal to deter entry (contestability)

• Over 60 examples of entry against FR in 3 years

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Reputation (2)
ADRIAN MAJUMDAR

How can FR strategy have raised entry barriers, if FR

offers a better deal post-exit relative to pre-entry?

utility Asserted aggressive

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strategy Post-exit utility
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Pre-entry utility
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time
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Congestion
ADRIAN MAJUMDAR

• Peak time capacity constraints?

• Not important for leisure routes (unlike business pax where

travel is time critical)
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• Not an issue if based at the destination since do not arrive

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and depart at peak times

• In any case, FR offers slot remedies

con.com
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 RBB Economics

Efficiencies
ADRIAN MAJUMDAR

• FR has track record for fare reduction, cost reduction, output

expansion and improving efficiency of acquired airlines (cf Buzz
integration 2003)

• Merger specific:
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– FR’s substantially larger network generates purchasing economies
clearly not possible via EI organic growth!
– FR 12 routes in 1996, 540 routes in 2007; considerably larger fleet
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than that of EI
– FR turnaround at DUB 25 mins vs EI at 40-55 mins… EI has
observed this yet failed to emulate this efficiency
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• Verifiable: Benefits of bulk buying well known; turnaround times

observable

• Customer benefits: Incremental decision is an additional frequency.

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Lower ownership and operational costs plus faster turnaround times

should increase frequencies.

• FR so confident of efficiencies that volunteers EI fare reduction

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Ryanair’s case in a nutshell

ADRIAN MAJUMDAR

• Merger of highly differentiated services, even on airport pairs but

especially on city pairs
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• Commission’s empirical analysis implies limited lost competitive
constraint on Aer Lingus; no material constraint lost on Ryanair
Adrian.Majumdar@rbbe

• New entry is abundant in the airline sector and this threat would
“restore” any lost constraint on the parties (notably on Aer Lingus)
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• Aer Lingus would benefit from substantial operating and aircraft

ownership efficiencies such that increasing frequencies becomes
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more attractive (i.e. output expansion)

• At most, minor remedies to facilitate entry would be required.

 RBB Economics

BACKGROUND FOR REFERENCE

ADRIAN MAJUMDAR

• Commission survey was not best practice!

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•
Adrian.Majumdar@rbbe

Remedies
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 RBB Economics

Passenger survey – not best practice!

ADRIAN MAJUMDAR

• Self completion survey (i.e. respondents fill in details

themselves)

• Selection issues
19 • e.g. to assess importance of business passengers on London-
DUB, EI pax traveling on a Saturday (and then compared to FR
pax traveling midweek)!
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• At face value, EC survey did not support city pair at London, e.g.
only 18% of EI pax “considered” FR

• Results weighted inappropriately

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• Framing effects / complex questions

• Clear contradictions with CAA “best-practice” survey results
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• Respondents steered to cite FR and EI above others…

– Inappropriate use of term “consider”
– Signpost FR and EI but not their competitors
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and EI
Framing effects – steer towards FR
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Remedies
ADRIAN MAJUMDAR

• SIEC asserted on all overlaps yet weak evidence for across the
board SIEC, especially where rival based at other end or city pair with
high share of time sensitive pax using EI (i.e. London)

• Traditionally congestion is the main barrier to entry. Rejection of

21 slot commitments to facilitate entry is a (surprising) rejection of threat
of new entry as sufficient constraint
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• Up-front buyer with many based aircraft at DUB

• critical issue but only one paragraph in decision (395) devoted to
“base advantages increase with size of the base”
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• no empirical evidence to support required number of based aircraft

(EC requirement contradicts even EI’s claim regarding extent of
base efficiencies)
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• FR offers 2 based for DUB-LON plus [4-8] based immediately with

scope for up to 10. EC denies opportunity for gradual build up of
based aircraft.