Competition Commission and South African Airways (Pty) Ltd (final) (18/CR/Mar01) [2005] ZACT 50 (28 July 2005)

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Competition Commission and South African Airways (Pty) Ltd (final) (18/CR/Mar01) [2005] ZACT 50 (28 July 2005)

.RTF of original document

IN THE COMPETITION TRIBUNAL

REPUBLIC OF SOUTH AFRICA

Case Number: 18/CR/Mar01

In the matter between:

The Competition Commission Complainant

and

South African Airways (Pty) Ltd Respondent

REASONS AND ORDER

Introduction

This case concerns the legality of two incentive schemes, which the respondent, South African Airways (Pty) Ltd (“SAA”), the country’s largest domestic airline, has with travel agents. The Commission brings this complaint referral pursuant to a complaint brought by the Nationwide Airlines Group (“Nationwide”) a domestic rival of SAA. The Commission alleges that the incentives constitute an abuse of dominance designed to exclude or impede SAA’s rivals in the domestic airline market. The Commission seeks an order declaring that the schemes constitute prohibited practices and the imposition of a fine of R 100 million. SAA denies liability and has put all the issues in dispute. We have found that SAA has contravened Section 8(d)(i) and our reasons for this conclusion follow.

Background to the case

On 13 October 2000 Nationwide lodged a complaint with the Competition Commission against SAA. In brief the complaint alleged that SAA was trying to exclude it from the domestic airline market by engaging in a number of practices that were prohibited under the Competition Act (the ‘Act’). Four anti-competitive practices were alleged – (i) SAA was engaged in predatory pricing (ii) SAA was poaching key staff (iii) SAA had concluded agreements with travel agents in terms of which they received commissions on an incremental basis that it alleged had an exclusionary effect (iv) SAA had a reward scheme for employees of travel agents, known as “Explorer”, which it was also alleged had an exclusionary effect.

These claims formed the subject matter of an interim relief application that Nationwide then brought unsuccessfully against SAA in October 2000. The reasons for the failure of Nationwide’s application are set out in our decision in Nationwide Airlines (Pty) Ltd and Others versus South African Airways (Pty)Ltd and Others and no more need be said of that here, although it suffices to say the incentive schemes which are at the heart of the present case were the subject matter of the interim relief application, although they were alluded to in passing.

Subsequently, the Commission concluded its investigation into the Nationwide complaint. It referred the complaint to the Tribunal on the 18 May 2001. In its complaint referral the Commission relies on only two of the alleged restrictive practices that were in the original Nationwide complaint, viz. those that relate to the incentive schemes for travel agents and the Explorer scheme. The other practices complained of have not found their way into the case before us nor has Nationwide pursued them by way of a non-referral. It would appear that the reason for the Commission’s selection of certain practices to constitute the basis of its present referral, are that similar practices have been scrutinised in cases in other countries and the Commission has sought to rely on this jurisprudence in this case.

It is worth noting at this stage that although this case is most commonly associated with Nationwide it is not confined to it. On 23 August 2001 the Commission amended its complaint referral to refer, inter alia, for the first time to the alleged exclusionary effects of the scheme on the complainant and “other competitors”. It is common cause that the only other competitor at the time was Comair Limited a company which operates a passenger service in the Southern African region. By virtue of a licence from British Airways, it uses the name BA/Comair. We will for this reason refer to this firm as BA/Comair.

According to the Commission the abuse that is alleged in this case commenced in about April 1999 and by the end of the hearing (December 2004) was believed to still be continuing. Nevertheless the evidence we have had presented in this case has not always correlated with that period or with any consistent time period. The Commission has provided some figures for the period ending March 2001 (travel agents sales figures and sales of airline tickets at Johannesburg International), others for the period ending May 2001(Table B in figures bundle 2 a comparison of travel agency flown revenue and BSP), some for June 2001 (Table E2 which relates to passenger information on BA/Comair), and yet others until October 2004 (Table G figures bundle 2 which relates to passenger sales on Nationwide).

Perhaps the reason for this unevenness in selection is that information was collected at different times during the long life of this case and earlier information was not updated to conform to a common endpoint. We do not wish to exaggerate the difficulties in these inconsistencies as some of the information is of less probative value than others or the use of different periods has been appropriate because the data is being employed to illustrate different points.

Nevertheless from the point of view of fairness the case had to be pinned down to a finite period. For reasons that will become clearer later it is not the existence of the schemes in question that is pertinent but their nature, which has changed over time. For this reason, we have decided that for the purpose of assessing the duration of the abuse, we shall assume that the evidence of its existence commences in October 1999 and ends in May 2001, the latter date being the date, according to the Commission, when its investigative period ended. We will refer to this from now on in the decision as the ‘relevant period’. This is a period for which most of the more important information on effects is presented, although we will, for the purpose of interpreting information, make use of figures that come before and after that period. It is common cause however that the Explorer scheme ended in June 2002 and that the override scheme was still in existence at the end of this case.

Thus what we are saying is that it may well be that the effects of these two schemes may have been in existence for long after our reference period, but we believe that it is necessary to confine our findings to a finite period which corresponds with a period where evidence on market shares, sales of tickets through travel agents and effects on rivals’ sales of tickets can reasonably be correlated.

10.

As will be evident from the date that this complaint was lodged by Nationwide (October 2000), and the date we heard final argument, (5 March 2005), this case has taken a long time to conclude. The blame for this delay has itself been a subject of contention between the Commission and SAA, and is discussed more fully below. It suffices to say at this stage that we find it highly undesirable for litigation to take so long to reach conclusion and that it satisfies neither the interests of complainants, consumers or respondents.

Synopsis of our approach

11.

We first examine the operation of the two schemes at issue in these proceedings, as this is necessary to understand the case before us. We then examine briefly the theory of harm advanced by the Commission and SAA’s response to it. We then consider the various elements of the case that the Commission needs to establish in order to prove a contravention. We first, as is customary, analyse the relevant markets, then consider if the respondent is dominant in these markets and then move on to consider the abuse. The section on the abuse first considers arguments on what the legal test is and then examines the factual issues in light of that conclusion.

12.

Finally, since we have found that SAA has contravened section 8(d)(i), we consider what remedy is appropriate.

PART I – THE MERITS

The incentive schemes

13.

The three airlines that competed in the domestic market during the relevant period, all made use of travel agents’ services to sell domestic tickets, for which they paid by way of commissions.

14.

Initially it appears that the structure of the commissions was quite straightforward and travel agents received a standard basic commission. At some stage, and it is not clear from the evidence exactly when, but certainly well prior to the relevant period, airlines began introducing what is known as an override incentive scheme for paying commission.

15.

The SAA override incentive scheme works in this way. Agents receive a flat basic commission for all sales up to a target figure that is set for them in the contract. The target figure is expressed in rand value. If they exceed the target they become eligible for two further types of commission that are paid over and above the basic commission, which continues to be paid on sales over the target. The first category is what is termed the ‘override commission’. This is an additional commission paid if the agent meets and exceeds the target. However, the override commission is not limited to the amount above the target, but is payable on the total of all sales achieved above and below the target. Thus assume the firm has a target of sales set at R 100 million. If it exceeds this target by R 10 million it will receive an override commission, typically set at 0,5%, on all it sales i.e. it will amount to R 550 000. Note because the firm continues to receive its basic commission of 7% as well, the average rate would now be 7,5%. Because the override commission is payable on all sales earned, even those below the target, it is referred to as the ‘back to rand one’ principle. In some contracts the override commission is set at a constant rate, in others, it is subject to a continual increase as the firm’s sales reach continually higher targets. Thus in the American Express contract the override rate is a constant 0,5%. In the Luxavia agreement, the override rate increases the more the agent exceeds its target. The rate starts at 0,5% when the firm reaches its target, but moves to as high as 1,55%, if it exceeds its target by 25%. The figures show that if it attains its peak override commission at this level, it would not only earn a base commission of around R 37 million, it would also earn an override commission on top of that of R 8 million.

16.

But there is also a second category of commission for which the firm that exceeds its target is eligible and this is referred to as the ‘incremental commission’. If the travel agent earns a certain percentage of sales above target it then becomes eligible for this additional commission. This commission, unlike the override commission, is payable only on the amount above the target and is not therefore back to rand one, but is ‘back to rand base’. For this reason the incremental commission rate is typically much higher than the override and base commission rate, and in some agreements, is subject to escalation as well. Going back to our two models; in the American Express agreement, its incremental commission kicks in when it achieves sales in excess of 15% of its base target. The incremental rate commences at 14% for sales 15% above target, but rises steeply so that sales 35% above target are rewarded at a rate of 31%. Note the effect this has on the respective commissions. When American Express gets to 15% above target its basic commission is about R6,3 million while its incremental commission (14%) amounts to R1.6 million. When it reaches its peak at 35% sales above target its basic commission is R7,4 million, but its incremental commission (31%) is now R 8,5 million thus exceeding the basic commission.

17.

The Luxavia agreement also has an incremental commission although it is structured differently. Here the incremental commission kicks in when sales are 5% above target, although the rate starts at only 5% and increases to a rate of 20% for sales that exceed the target by 25%. It thus differs slightly from the American Express structure in that the incremental commission starts becoming payable earlier, but at a lower rate and reaches a lower peak commission.

18.

The target is a key feature in these agreements. Agencies do not face a common target that they must meet. Each firm is set a custom made target based on its previous annual sales figures with a percentage increment. Even the increments are not uniform and appear to be the subject of negotiation between the firm and SAA. In the agreement with American Express, the agency is required to achieve an annual growth of 25% from its target in the preceding financial year.

19.

It is not clear from the evidence as to whether SAA introduced the override scheme into the market or whether they reacted to what British Airlines was doing internationally. Nothing turns on this. What we do know is that when SAA first introduced the scheme there was no complaint in the market place. Mr Viljoen, the chief executive officer of South African Airways at the relevant time, has testified that he found these types of agreements in place when he joined SAA and that an agent had told him that they had been around since 1980.

20.

In October 1999, SAA, according to the evidence of Viljoen, adopted a more aggressive approach to the override scheme. In Viljoen’s words, he was not prepared to reward agents for generic growth i.e. growth that came about from inflation, as opposed to an increase in sales. SAA remedied this by firstly reducing the basic commission from 9% to 7%. Then it made the attainment of override and incremental commission more challenging, either by raising targets annually over and above the rate of inflation, and/or raising the point at which incremental commission became payable. At the same time, it increased the rate of the incremental and override commission. It is common cause that in order to retain their previous level of profitability, agents would not only have to exceed their targets, but also exceed them by some margin to take advantage of the override and incremental commissions. However for those who could ascend the peaks the rewards were bountiful. It is this mechanism and the alleged incentives it entails that are at the heart of the Commission’ s case on the abuse.

Explorer Scheme

21.

The Explorer scheme rewarded individual travel agent consultants with a free international air ticket based on their achieving SAA’s sales targets. Conceptually it resembles frequent flyer schemes for passengers. The crucial distinction between the override scheme and Explorer is that Explorer is targeted at employees of the agency while the override scheme is aimed at the firm and hence its shareholders benefit.

22.

SAA was the only airline offering this type of incentive to local travel agents. Mr Venter, the Financial Director of BA/Comair, testified that his airline could not match such a scheme because BA/Comair’s volume base of sales was too low in relation to that of SAA, to make it viable.

23.

A second aspect of the Explorer Scheme was a bonus pool that allocated points to an agency as whole, based on the sales of all its consultants. More points are obtainable depending on the agency’s share of total SAA sales. According to Viljoen, this aspect of the scheme incentivises not only the individual consultant, but also the staff of the travel agency as a whole.

24.

The Commission state that the Explorer Scheme was in full operation during the relevant period and, in conjunction with the override incentive scheme, aggravated the anti-competitive effect of the override incentive schemes.

The Commission’s case

25.

The Commission’s case is that the abuse of dominance relates to two relevant markets. The first is the market for domestic scheduled airline travel and the second is the market for South African travel agency sales of domestic scheduled air travel in South Africa. SAA is alleged to be dominant in both. It alleges that SAA has used its dominance in the travel agency market to impose on travel agents a system of compensation that not only rewards them in terms of an unobjectionable basic commission, but also rewards them additionally by means of commission calculated on the override and incremental incentives we referred to above. For the sake of convenience we refer to these latter two additional methods of compensation, collectively, as the override incentive scheme. The Commission argues that the effect of the override incentive scheme is to induce travel agents to sell more SAA tickets and less of those of its rivals when the agent has an opportunity to do so. The reason is that as the agent sells more SAA tickets its, rewards increase significantly. These rewards would be foregone if the agent instead sells tickets of SAA rivals. Thus agents have a compelling financial incentive to prefer to sell an SAA ticket to a customer over that of a rival. Crucial to the Commission’s case, is the fact that SAA re-designed its override compensation in 1999 by reducing the basic commission and increasing rewards via the override and incremental incentives, but travel agencies needed to achieve much higher levels of sales before these additional rewards became payable to them. Once attained however, the rewards became increasingly lucrative.

26.

How does the travel agent manage this if the customer wants to fly with a rival? The Commission argues that the travel agents are not always able to influence the customer’s choice, but can do so frequently enough for their intervention to matter. The reason agents have this ability, is that airline ticket prices are so volatile that they are not transparent to customers and hence they are willing to accept the agent’s advice. The increased business that the scheme brings to SAA does not come so much out of new business, but rather at the expense of SAA’s rivals who, because their compensation schemes are less lucrative, since they sell less tickets, will never be in a position to reward the agent in the way the SAA scheme does. Thus the agent earns more by selling its next ticket on an SAA flight than on a Nationwide flight.

27.

This, says the Commission, is what makes the conduct exclusionary in nature. The imposition of the Explorer scheme on top of the override scheme serves to enhance its exclusionary nature as the Explorer scheme operates at the level of individual consultants and employees.

28.

The Commission goes on to argue that because travel agents can and do distort consumer choices to accomplish their own commercial objectives, this leads to two competitive harms. The first is that consumers in the short run will be flying on more expensive tickets and at less preferable times than if the ticket offering had been unbiased. Secondly, that SAA is able to perpetuate its existing dominance and to restrict new entry into the market and to inhibit its existing rivals from expanding in the market.

29.

The net result of an anti-competitive exclusionary strategy is a less competitive market in which there are higher fares, less choice for consumers and less innovation.

SAA’s case

30.

SAA embarked on a war of attrition against the Commission’s case. Not only does it dispute the Commission’s approach to market definition as we later discuss, but it goes on to deny that it is dominant, even if these definitions are accepted. Secondly, it contests the notion that travel agents either have the inclination or the ability to move passengers away from their airline of choice to SAA. Thirdly, SAA disputes the Commission’s case on the effects of the schemes. SAA argues that not only has the Commission failed to establish a causal link between the schemes and the expansion of SAA in the market, and the corresponding demise of its rivals, but that it has also failed to demonstrate harm to consumers.

31.

SAA does not deny having re-designed its override scheme in 1999, but claims that this was not done to introduce exclusionary incentives, but rather to lower the costs of its distribution system by making agencies more efficient and not to reward them for sales growth that they had no part in i.e. increases due to ticket price inflation.

32.

Finally SAA invokes the efficiency defence contemplated in sections 8(c) and 8(d). It argues that even if the scheme is found to be anti-competitive, it nevertheless enhances the efficiency of its distribution network because travel agents are incentivised to become more familiar with SAA products and hence better able to guide consumer choice.

The Relevant Markets

33.

As this case concerns an alleged abuse of dominance, it is trite law that the Commission needs to establish that SAA is dominant in respect of some market for the conduct alleged to be abusive to be unlawful. In most abuse cases only one potential market is implicated and the relevant market debate turns on whether it has been defined with sufficient precision with respect to potential substitutes. In this case the debate is somewhat different, as we are dealing with the relationship between two possible relevant markets. These are not alternative market definitions, as SAA in its heads of argument suggests, but interdependent markets – without the one, the abuse could not be effected, without the other, the exclusion would be ineffectual.

34.

In our view this is an aspect of the case that SAA has failed to grasp and hence its counter-definition of the relevant market as one premised on specific routes at specific times ignores the possibility of the relationship.

35.

That more than one market can be implicated in an abuse case is not novel in competition law. Cases in the European Union have dwelt upon these possibilities. Whish states that in the EU, it is not required that the abuse, dominance and the effects of the abuse all occur in the same market. For instance, in the Commercial Solvents case, Commercial Solvents ceased supplying its downstream customer with a raw material to manufacture a particular drug, since it wanted itself to enter the downstream drug-manufacturing market. It was found to have abused its dominant position in the market for the supply of the raw material in order to better its own position in the downstream drug market, in which it had no presence, let alone being dominant. In the European cases of tie-ins, it is common for the abuse to be perpetrated in one market, while the effect is felt in another market.

36.

There is nothing in our Act that suggests that an abuse of dominance cannot be perpetrated in one market and the effect thereof be experienced in another related market. Any contrary interpretation would mean that a dominant firm could leverage its market power from one market into another, with impunity.

First relevant market – travel agency services

37.

The Commission first alleges that there is a relevant market for “South African travel agency sales of domestic scheduled air travel in South Africa”.

38.

Let us see how they get to this conclusion. Airlines use travel agents to sell their tickets. To do this they remunerate travel agents for their services by way of a commission. This is not the only model for their remuneration, but was during the period of complaint. Airlines have various options besides travel agents for selling their tickets. They may do so directly themselves, or use some other method such as the internet. The Commission argues that the latter two options are not adequate and hence not competitively relevant substitutes for the services of travel agents. In any event, the evidence is that during the relevant period 70-85% of domestic airline tickets, depending on the airline, were sold through travel agents. It is also the evidence of Viljoen that if travel agents did not provide this service, each airline would have to set up satellite offices to provide these services. He states:

“This of necessity would require enormous capital expenditure and overheads which could only be recouped by airlines by way of possible fare increases. Such a result is clearly detrimental to passengers.”

39.

There is a prior question – is the travel agent, the agent of the customer or the airline? The question is answered by understanding what we are analysing. Where the practice complained of relates to the effect of a remuneration scheme for travel agents, then the appropriate definition is that of a market in which airlines purchase ticket distribution services from travel agents.

40.

The best evidence for the centrality of travel agents as a distribution mechanism is that of Viljoen who, in an effort to justify the override scheme, has argued that for airlines to duplicate these services by creating networks that replicate those of travel agents would be prohibitive.

“If I had to replicate that overnight, I don’t know how I will, we will have to treble, as I said our IT platforms. We would have to employ staff at a huge cost and train them.”

41.

The reason for this is fairly clear, as the Commission argues. Internet sales, at least at this time, did not account for a significant number of sales during the relevant period. This is evidenced by the airline’s own Internet sales data: in 2001, SAA sold less than 0.3% of its ticket revenue through its own website.

42.

Direct distribution channels are not an alternative for consumers who want to examine their choices. Thus although these channels are alternative means for airlines to sell tickets to consumers, they were not during the relevant period, satisfactory substitutes for consumers shopping for the best available options on domestic flights and the preponderance of consumers choosing travel agents over the other options speaks most powerfully to this point. Nor indeed is it likely that airlines would need to bother with incentive schemes if this outlet was not of such centrality. The best evidence for their centrality during the period is the significant percentage of each of the three airlines’ tickets sold through travel agents during the relevant period. (See Table 1 that appears below)

43.

The figures show that all three airlines relied, during the relevant period, on travel agents for the sale of the bulk of their domestic airline tickets. By comparison, other vehicles for ticket sales cannot be regarded as competitively significant substitutes.

44.

We find that first relevant market is the market for the purchase of domestic airline ticket sales services from travel agents in South Africa.

Dominance

45.

Having defined this market we now turn to the question of whether SAA is dominant in this market. Table 1 below sets out the respective sales of SAA, BA/Comair and Nationwide for one year during the relevant period, July 2000 to June 2001. These figures come from tables prepared by the Commission based on documents discovered by the three respective airlines. SAA has not challenged the veracity of the figures, insofar as they purport to represent the respective ticket revenues from sales through travel agents, and they constitute a useful proxy for the market shares in the travel agent market during the relevant period.

46.

SAA’s dominance as a seller of tickets emerges from these figures. Not only does it account for 65,7% of total sales but also 69% of sales through travel agents.

Table 1: SAA’s Market Shares Relative to its Competitors *

	SAA	BA/Comair	Nationwide
Sales Domestic	65.7%	27.6%	6.6%
Airline’s Sales through travel agents	69%	25.3%	5.7%
Proportion of sales through travel agents relative to total sales	85%	74%	70.2%

Source: Tables A.1-A.3 Pages 1-3 Figures Bundle 2- * (July 2000 to June 2001)

47.

As Table 1 shows, SAA’s sales dwarf those of its two domestic rivals. This difference in volumes is relevant to the theory of exclusion that the Commission advances. It is not only SAA’s absolute size that matters, but also its size relative to that of its rivals.

48.

SAA sales constitute over 45% of sales of domestic airline tickets through travel agents and hence it is presumed to have market power in terms of section 7(a).

Second relevant market - Market for domestic airline travel

49.

The Commission’s second relevant market is the market for “scheduled domestic air travel in South Africa.”

50.

This relevant market definition was the subject of great contestation. SAA disputes the way the Commission has defined the market not, as is usual, in a debate over possible substitutes, but at the conceptual level as to what market is relevant given the nature of the complaint. Secondly, even if the Commission’s definition is accepted, SAA disputes the method that the Commission has adopted to count market shares.

51.

SAA has not presented a consistent position on the relevant market. In its answering papers, Viljoen argues for a market for the provision of domestic air travel services in the conveyance of passengers on particular domestic airlines routes, on particular flights, at particular times on particular days.