Individual Exemptions Individual Exemptions and the and the - - PowerPoint PPT Presentation

Individual Exemptions and the Strategic Threat Of Exit:

The Case of Airline Joint Service Agreements

Individual Exemptions and the Strategic Threat Of Exit:

The Case of Airline Joint Service Agreements

• C. Duncan MacRae &

Elizabeth Chase MacRae

Singapore Management University

• C. Duncan MacRae &

Elizabeth Chase MacRae

Singapore Management University

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Agenda Agenda

Background -- Australia, Singapore, and the Qantas- British Airways (Q- BA) Joint Services Agreement (JSA) Bargaining theory approach to analysis of interaction between competition authority and firms Australia and the JSA Singapore and the JSA Conclusions Background -- Australia, Singapore, and the Qantas- British Airways (Q- BA) Joint Services Agreement (JSA) Bargaining theory approach to analysis of interaction between competition authority and firms Australia and the JSA Singapore and the JSA Conclusions

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Qantas-British Airways JSA: Overview Qantas-British Airways JSA: Overview

Dating from 1995 (with restatements) Coordination of airline services on the Kangaroo Route between Australia and Europe, through Singapore and Bangkok

Scheduling Marketing Sales Prices Customer Service

Generally viewed as a “hard core” restriction But also viewed as yielding economic efficiencies Dating from 1995 (with restatements) Coordination of airline services on the Kangaroo Route between Australia and Europe, through Singapore and Bangkok

Scheduling Marketing Sales Prices Customer Service

Generally viewed as a “hard core” restriction But also viewed as yielding economic efficiencies

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Australia (AU) and JSA: Overview Australia (AU) and JSA: Overview

1974 Australian Trade Practices Act (TPA)

Original bargain

Prior to 1995 Qantas and BA applied to Australian Competition and Consumer Commission (ACCC) for JSA authorization under TPA 1995 JSA authorization by ACCC for 5 years

Renewal bargain I

1999 Q-BA authorization request for Restated JSA 2000 Restated JSA authorization by ACCC for 3 years

Plus further interim authorization

Renewal bargain II

2003 Q-BA reauthorization request for Restated JSA 2005 Restated JSA authorization by ACCC for 5 years

1974 Australian Trade Practices Act (TPA)

Original bargain

Prior to 1995 Qantas and BA applied to Australian Competition and Consumer Commission (ACCC) for JSA authorization under TPA 1995 JSA authorization by ACCC for 5 years

Renewal bargain I

1999 Q-BA authorization request for Restated JSA 2000 Restated JSA authorization by ACCC for 3 years

Plus further interim authorization

Renewal bargain II

2003 Q-BA reauthorization request for Restated JSA 2005 Restated JSA authorization by ACCC for 5 years

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Singapore (SG) and JSA: Overview Singapore (SG) and JSA: Overview

2004 Singapore Competition Act (CA)

Bargain

2006 Qantas and BA applied to Competition Commission of Singapore (CSS) for decision exempting Restated JSA from prohibition under CA 2007 CCS approved Restated JSA -- indefinitely exempted from CA prohibition

Subject to conditions

2004 Singapore Competition Act (CA)

Bargain

2006 Qantas and BA applied to Competition Commission of Singapore (CSS) for decision exempting Restated JSA from prohibition under CA 2007 CCS approved Restated JSA -- indefinitely exempted from CA prohibition

Subject to conditions

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Bargaining Theory Approach: Rationale Bargaining Theory Approach: Rationale

Variety of contexts in law & economics analyses for bargaining models

Bargaining between firms Bargaining between nations, governmental entities

This paper looks at the strategic interaction between competition authorities and firms Bargaining theory approach is reasonable because …

there may be an opportunity to divide benefits of greater economic efficiencies between firms and consumers or national as a whole government does not always “win” firms can threaten to exit the market or jurisdiction

• f the competition authority

Variety of contexts in law & economics analyses for bargaining models

Bargaining between firms Bargaining between nations, governmental entities

This paper looks at the strategic interaction between competition authorities and firms Bargaining theory approach is reasonable because …

there may be an opportunity to divide benefits of greater economic efficiencies between firms and consumers or national as a whole government does not always “win” firms can threaten to exit the market or jurisdiction

• f the competition authority

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Bargaining Model Assumptions (1) Bargaining Model Assumptions (1)

Two parties: Competition Authority and coalition of firms

Coalition of firms with a potentially anticompetitive agreement is seeking exemption by Competition Authority

Competition Authority wants to maximize total welfare for its jurisdiction

Model can be readily extended to include consumer surplus maximization by competition authority

Coalition of firms want to maximize producer surplus for firms

Coalition activities may provide economic benefits through gains in efficiency Coalition activities may reduce or transfer economic benefits through anti-competitive behavior

Two parties: Competition Authority and coalition of firms

Coalition of firms with a potentially anticompetitive agreement is seeking exemption by Competition Authority

Competition Authority wants to maximize total welfare for its jurisdiction

Model can be readily extended to include consumer surplus maximization by competition authority

Coalition of firms want to maximize producer surplus for firms

Coalition activities may provide economic benefits through gains in efficiency Coalition activities may reduce or transfer economic benefits through anti-competitive behavior

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Bargaining Model Assumptions (2) Bargaining Model Assumptions (2)

There is a range of possible conditions on the agreements, not just “yes/ no” approval from Authority

Restrictions on joint activities Remedies Time limits for duration of agreement

Range of possible conditions yields Pareto-

• ptimal tradeoff between objectives of two

parties There is time “impatience” pressure for both parties to reach a bargain

Both wish to enjoy the possible economic benefits from the agreement

There is a range of possible conditions on the agreements, not just “yes/ no” approval from Authority

Restrictions on joint activities Remedies Time limits for duration of agreement

Range of possible conditions yields Pareto-

• ptimal tradeoff between objectives of two

parties There is time “impatience” pressure for both parties to reach a bargain

Both wish to enjoy the possible economic benefits from the agreement

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Bargaining Model Assumptions (3) Bargaining Model Assumptions (3)

But there may be “inside options”

Both parties may enjoy, perhaps diminished, benefits during the bargaining process

And there may be “ outside options”

Firms may choose to exit the market to gain producer surplus Firms may even choose to exit the jurisdiction Competition authorities may choose alternative arrangements, perhaps different firms, to provide welfare to their jurisdiction

But there may be “inside options”

Both parties may enjoy, perhaps diminished, benefits during the bargaining process

And there may be “ outside options”

Firms may choose to exit the market to gain producer surplus Firms may even choose to exit the jurisdiction Competition authorities may choose alternative arrangements, perhaps different firms, to provide welfare to their jurisdiction

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Scenarios Scenarios

Scenario 1: Prior approval for agreement

Competition law is already in place Firms seek approval of possible anti-competitive agreement

Scenario 2: Renewal of approval

Firms have approval to operate under agreement Firms seek renewal of approval

Scenario 3: Posterior approval to operate under existing agreement

Firms already operating under anti-competitive agreement in absence of competition law Competition law is passed that prohibits such agreements subject to exemption

Scenario 1: Prior approval for agreement

Competition law is already in place Firms seek approval of possible anti-competitive agreement

Scenario 2: Renewal of approval

Firms have approval to operate under agreement Firms seek renewal of approval

Scenario 3: Posterior approval to operate under existing agreement

Firms already operating under anti-competitive agreement in absence of competition law Competition law is passed that prohibits such agreements subject to exemption

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Scenario 1: Qantas-British Airlines JSA 1995 Scenario 1: Qantas-British Airlines JSA 1995

Sought approval from the Australian Competition and Consumer Commission (ACCC) for Joint Services Agreement (JSA)

based on net economic benefit to Australia

Sought approval from the Australian Competition and Consumer Commission (ACCC) for Joint Services Agreement (JSA)

based on net economic benefit to Australia

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Scenario 1: Australia -- JSA 1995 (1) Scenario 1: Australia -- JSA 1995 (1)

Q-BA seek authorization for JSA Frontier shows Pareto-

• ptimal

possible agreements Both parties can gain by agreeing Q-BA seek authorization for JSA Frontier shows Pareto-

• ptimal

possible agreements Both parties can gain by agreeing

Producers’ Surplus Total Welfare

Possible agreements between ACCC and Q-BA (JSA) Current situation without JSA

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Inside Option Inside Option

Inside Option

Situation while bargaining is ongoing Affects the Nash bargaining solution

If TW0 and PS0 are the values for the inside option, then …

the Nash bargaining solution (NBS) is found by maximizing (TW- TW0)* (PS- PS0) along the Pareto frontier.

Inside Option

Situation while bargaining is ongoing Affects the Nash bargaining solution

If TW0 and PS0 are the values for the inside option, then …

the Nash bargaining solution (NBS) is found by maximizing (TW- TW0)* (PS- PS0) along the Pareto frontier.

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Scenario 1: Australia -- JSA 1995 (2) Scenario 1: Australia -- JSA 1995 (2)

Nash bargaining solution (NBS) Maximizes (TW-TW0)* (PS- PS0) JSA authorized

Net economic benefit Gains to Q-BA

Conditions

5 year term Other conditions

Nash bargaining solution (NBS) Maximizes (TW-TW0)* (PS- PS0) JSA authorized

Net economic benefit Gains to Q-BA

Conditions

5 year term Other conditions

Producers’ Surplus Total Welfare

NBS - Situation with authorized JSA -- gains from efficiency, net economic benefit; conditions imposed to increase TW Situation without JSA = inside option (PS0, TW0) JSA possible situation in absence of Competition Law

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Comments Comments

Approval for the JSA 1995 agreement did not give Qantas- British Airways everything they asked for In particular, the approval was only for 5 years, until 2000. In 1999, Q-BA applied for authorization for a restated JSA

Claimed that under continued authorization, even greater economic would occur Also claimed that without authorization, there would be a negative economic impact

Approval for the JSA 1995 agreement did not give Qantas- British Airways everything they asked for In particular, the approval was only for 5 years, until 2000. In 1999, Q-BA applied for authorization for a restated JSA

Claimed that under continued authorization, even greater economic would occur Also claimed that without authorization, there would be a negative economic impact

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Producers’ Surplus Total Welfare

JSA 1999 - inside option

Scenario 2: Australia -- JSA 2000 (1) Scenario 2: Australia -- JSA 2000 (1)

Q-BA apply in 1999 for renewed authorization of JSA

To start in 2000

Claim of greater economic benefits reflected in new Pareto frontier Q-BA apply in 1999 for renewed authorization of JSA

To start in 2000

Claim of greater economic benefits reflected in new Pareto frontier

Increased economic benefit from continued JSA

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Producers’ Surplus Total Welfare

JSA 1999 - inside option

Scenario 2: Australia -- JSA 2000 (2) Scenario 2: Australia -- JSA 2000 (2)

Counterfactual = impact of termination of JSA = outside option Threat of (limited) exit from market But ACCC and B-QA disagree on extent of impact

B-QA: More limited schedules and destinations ACCC: Not that much economic impact given market competition

Counterfactual = impact of termination of JSA = outside option Threat of (limited) exit from market But ACCC and B-QA disagree on extent of impact

B-QA: More limited schedules and destinations ACCC: Not that much economic impact given market competition

Counterfactual (B-QA) Counterfactual (ACCC)

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Outside Option Outside Option

Outside option is opportunity to unilaterally…

break off bargaining take up a better alternative offer or activity

Focus of outside option is on what could be gained, not on what other party would lose Outside options (or threats) limit the range of possible bargaining outcomes

They do not affect bargaining power

Counterfactual may be viewed as defining the value of the outside option

ACCC’s outside option is not to grant an exemption to anti-trust provisions Q-BA JSA’s outside option is to leave the market

Outside option is opportunity to unilaterally…

break off bargaining take up a better alternative offer or activity

Focus of outside option is on what could be gained, not on what other party would lose Outside options (or threats) limit the range of possible bargaining outcomes

They do not affect bargaining power

Counterfactual may be viewed as defining the value of the outside option

ACCC’s outside option is not to grant an exemption to anti-trust provisions Q-BA JSA’s outside option is to leave the market

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Producers’ Surplus Total Welfare

JSA 1999 - inside option

Scenario 2: Australia -- JSA 2000 (3) Scenario 2: Australia -- JSA 2000 (3)

Counterfactual =

• utside option

JSA’s outside option (as drawn) is not a viable threat ACCC assessment of counterfactual appears to provide a credible outside option for the ACCC (to deny authorization) In this example, the NBS is better for the ACCC than its threat Counterfactual =

• utside option

JSA’s outside option (as drawn) is not a viable threat ACCC assessment of counterfactual appears to provide a credible outside option for the ACCC (to deny authorization) In this example, the NBS is better for the ACCC than its threat

NBS - JSA 2000 based on inside option Counterfactual (ACCC)

• utside option

Counterfactual (B-QA)

• outside option

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Comments Comments

ACCC and JSA also disagreed on extent of new benefits from continued authorization of JSA.

This would be reflected in alternative positions of new frontier relative to previous frontier Not discussed here

JSA applied again in 2003 for authorization to continue

Scenario II analysis continues to apply; results are similar to 2000 situation Authorization was granted by ACCC in 2005

ACCC and JSA also disagreed on extent of new benefits from continued authorization of JSA.

This would be reflected in alternative positions of new frontier relative to previous frontier Not discussed here

JSA applied again in 2003 for authorization to continue

Scenario II analysis continues to apply; results are similar to 2000 situation Authorization was granted by ACCC in 2005

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Scenario 3: Singapore -- Pre-2004 Scenario 3: Singapore -- Pre-2004

No Competition Law in effect in Singapore Qantas and British Airways operate under their JSA through Singapore as a hub Efficiencies from the JSA provide both producer surplus and total welfare to Singapore We can postulate a Pareto frontier for trade-

• ffs between total welfare and producer

surplus, but…

Pre-2004 situation is NOT result of bargain in SG JSA operates based on its economic preferences subject to …

No Competition Law in effect in Singapore Qantas and British Airways operate under their JSA through Singapore as a hub Efficiencies from the JSA provide both producer surplus and total welfare to Singapore We can postulate a Pareto frontier for trade-

• ffs between total welfare and producer

surplus, but…

Pre-2004 situation is NOT result of bargain in SG JSA operates based on its economic preferences subject to …

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Scenario 3: Singapore Pre-2004 Scenario 3: Singapore Pre-2004

JSA has hub in Singapore Operates in environment with no Singapore competition law in effect JSA has hub in Singapore Operates in environment with no Singapore competition law in effect

Producers’ Surplus Total Welfare

Pre-2004 situation

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Singapore and JSA Singapore and JSA

No anti-competition restrictions in Singapore before 2004 So why does JSA not choose to have more producer surplus? Because it is bound by conditions of Australian approval for JSA

May limit scope of anti-competitive activities in Singapore

No anti-competition restrictions in Singapore before 2004 So why does JSA not choose to have more producer surplus? Because it is bound by conditions of Australian approval for JSA

May limit scope of anti-competitive activities in Singapore

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Scenario3: Singapore Pre-2004 (adjusted) Scenario3: Singapore Pre-2004 (adjusted)

Singapore frontier adjusted for effect of JSA authorization by ACCC Most restrictive jurisdiction (Australia) is binding Singapore frontier adjusted for effect of JSA authorization by ACCC Most restrictive jurisdiction (Australia) is binding

Producers’ Surplus Total Welfare

Pre-2004 situation

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Singapore Competition Act Singapore Competition Act

Passed in 2004 JSA is prima facie violation of anti-competitive restrictions Q-BA seek decision from the Competition Commission of Singapore (CCS) on whether JSA infringes the Act Outcome uncertain, so … .

JSA reduces some investment and maintenance in Singapore Operates at lower producer surplus while decision is pending

Passed in 2004 JSA is prima facie violation of anti-competitive restrictions Q-BA seek decision from the Competition Commission of Singapore (CCS) on whether JSA infringes the Act Outcome uncertain, so … .

JSA reduces some investment and maintenance in Singapore Operates at lower producer surplus while decision is pending

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Producers’ Surplus Total Welfare

Scenario 3: Singapore -- Competition Act (1) Scenario 3: Singapore -- Competition Act (1)

Operating at pre-2004 point requires ongoing investment and maintenance With no guarantee of exemption to anti-competitive provisions, JSA

• perates at less

than its long- term optimum Operating at pre-2004 point requires ongoing investment and maintenance With no guarantee of exemption to anti-competitive provisions, JSA

• perates at less

than its long- term optimum

Situation with reduced investment while awaiting decision - inside option Pre-2004 situation

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Producers’ Surplus Total Welfare

Scenario 3: Singapore -- Competition Act (2) Scenario 3: Singapore -- Competition Act (2)

Outside option for JSA involves moving its hub

• perations from

Singapore to Bangkok, a jurisdiction without a competition law In this example, the exit threat is viewed as viable However, it does not affect the bargaining solution Outside option for JSA involves moving its hub

• perations from

Singapore to Bangkok, a jurisdiction without a competition law In this example, the exit threat is viewed as viable However, it does not affect the bargaining solution

Situation with reduced investment while awaiting decision - inside option NBS -- JSA approved to operate Threat of exit -- JSA outside option

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Producers’ Surplus Total Welfare

Scenario 3: Singapore -- Competition Act (3) Scenario 3: Singapore -- Competition Act (3)

Note that CCS has limited scope for bargaining

Viable outside

• ption by JSA

inferred from ACCC 2005 authorization But CCS 2007 decision suggests not viable threat

• f exit

CCS cannot choose to be more liberal than ACCC

Existing limitations from ACCC

Note that CCS has limited scope for bargaining

Viable outside

• ption by JSA

inferred from ACCC 2005 authorization But CCS 2007 decision suggests not viable threat

• f exit

CCS cannot choose to be more liberal than ACCC

Existing limitations from ACCC

inside option B-QA outside

• ption (inferred

from ACCC 2005 authorization) JSA restrictions from ACCC NBS -- JSA approved to operate

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Conclusions (1) Conclusions (1)

Individual exemption authorization and decisions are bargains between firms requesting them and competition authorities granting them, each focusing on their own

• bjectives

Objective of competition authority is total welfare (or, perhaps, consumer surplus) Objective of firms is producer surplus

Bargain is not just whether to grant the exemption but under what conditions to grant the exemption

Yields a tradeoff between the objectives of the two parties over which to bargain

Individual exemption authorization and decisions are bargains between firms requesting them and competition authorities granting them, each focusing on their own

• bjectives

Objective of competition authority is total welfare (or, perhaps, consumer surplus) Objective of firms is producer surplus

Bargain is not just whether to grant the exemption but under what conditions to grant the exemption

Yields a tradeoff between the objectives of the two parties over which to bargain

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Conclusions (2) Conclusions (2)

Nash bargaining solution (NBS) analysis indicates for bargain

Relevance of inside option Relevance or irrelevance of threat of exit based on

• utside option

Bargains with international effects between firms and one competition authority can impose restriction on bargain between these firms and another competition authority Nash bargaining solution (NBS) analysis indicates for bargain

Relevance of inside option Relevance or irrelevance of threat of exit based on

• utside option

Bargains with international effects between firms and one competition authority can impose restriction on bargain between these firms and another competition authority

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References References

Australian Competition & Consumer Commission, Final Determination: Application for Authorisation A30202, 10 May 2000.

• -------, Final Determination: Applications for

Authorisation A30226 and A30227, 8 February 2005.

• K. Binmore, A. Rubinstein and A. Wolinsky, The Nash

Bargaining Solution in Economic Modeling, Rand Journal

• f Economics, 1986.

Competition Commission of Singapore, Notification for Decision by Qantas Airways and British Airways of their Restated Joint Services Agreement, 13 February 2007.

• J. Farrell, Negotiation and Merger Remedies, in H.

Shelanski & F. Leveque (eds.) Merger Remedies in Competition Policy, 2003.

• A. Muthoo, Bargaining Theory with Applications, 1998.

Australian Competition & Consumer Commission, Final Determination: Application for Authorisation A30202, 10 May 2000.

• -------, Final Determination: Applications for

Authorisation A30226 and A30227, 8 February 2005.

• K. Binmore, A. Rubinstein and A. Wolinsky, The Nash

Bargaining Solution in Economic Modeling, Rand Journal

• f Economics, 1986.

Competition Commission of Singapore, Notification for Decision by Qantas Airways and British Airways of their Restated Joint Services Agreement, 13 February 2007.

• J. Farrell, Negotiation and Merger Remedies, in H.

Shelanski & F. Leveque (eds.) Merger Remedies in Competition Policy, 2003.

• A. Muthoo, Bargaining Theory with Applications, 1998.

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Thank you.