Accepted variation to the undertakings given by National Express Group plc when it acquired Prism Rail plc.

Affected market: Public transport

No. ME/0152/00

Decision of the OFT dated 3 August 2006 to accept a variation of undertakings. Full text of decision published on 8 August 2006.

BACKGROUND

The OFT announced on 21 June 2005 that it had received a request from National Express Group PLC (NEG) to review undertakings it gave relating to fares on its London-Stansted coach service (the undertakings), with a view to examining whether by reason of any change of circumstances, the Undertakings are no longer appropriate and either NEG could be released from the undertakings or the undertakings needed to be varied or superseded by new undertakings pursuant to section 75J of the Fair Trading Act 1973 (FTA).
 
The undertakings were accepted by the Secretary of State for Trade and Industry pursuant to section 75G FTA in lieu of a reference to the Monopolies and Mergers Commission (now the Competition Commission) to address concerns arising from the acquisition by NEG of Prism Rail PLC (Prism) in 2000.  

The undertakings were specified in the Enterprise Act 2002 (Enforcement Undertakings) Order 2006, which came into force on 10 March 2006 (see note 1)  and thereby pursuant to paragraph 16 of Schedule 24 to the Enterprise Act 2002 the OFT was given the power to supersede, vary or release the undertakings instead of the Secretary of State.

On 5 July 2006, the OFT reported on the outcome of the review and invited comments on the proposed variation of the undertakings. No comments were received on the proposed variation.

THE UNDERTAKINGS

The acquisition by NEG of Prism gave NEG control of both the coach and the rail services from central London to Stansted Airport. At the time, the OFT had concerns that the merger would eliminate competition between these modes of transport, creating a public transport monopoly on the route. 

The undertakings sought to restore the competitive dynamic between coach and rail on the Stansted route by ensuring that the competitive constraints that NEG faced on its Heathrow coach service were replicated on its Stansted coach service, so that NEG would behave as if it were facing competition post-merger on the Stansted route. The undertakings implemented this aim by requiring that NEG's Stansted coach prices be capped at a level no higher than equivalent fares on its London-Heathrow coach service. NEG's Heathrow service was deemed an appropriate 'peg' or 'benchmark' for competitive Stansted coach prices because (i) it was a comparable London-area 'centre to airport' dedicated service, and (ii) this service competed with other operators providing public transport services (tube, rail and coach) between Heathrow and London.

The undertakings did not, however, contemplate two important changes that have arisen in the relevant markets. 

• Firstly, demand for Stansted air travel, and in turn for public transport serving the airport, rose significantly relative to demand for transport to Heathrow. At the time the undertakings were accepted in 2000, demand for travel to Heathrow was the greater of the two.
• Secondly, NEG has found it unprofitable to maintain its dedicated London to Heathrow service and has withdrawn it. (see note 2) It now offers passengers the Heathrow service as an intermediate stop on its networked services extending from London to points in the west and southwest of England.

NEG informed the OFT that, if it were not for the undertakings, it would cut prices for coach tickets between London and Heathrow by 50 per cent. It could do so profitably because the cost of filling empty seats between London and Heathrow on its networked services is relatively low. However, it would be unprofitable to do so currently because of the requirement that the same price cut must also be applied to the London-Stansted service.

NEG submitted a request to the OFT asking for variation of or release from the price control provisions of the undertakings. It observes that the undertakings are currently harming consumers on the London-Heathrow service, by depriving them of ticket prices at 50 per cent of their current level. 

The OFT accepts that the undertakings inhibit NEG from lowering its London-Heathrow prices because the undertakings link Stansted prices to those on the Heathrow service. In the OFT's judgment, while the undertakings remain, it would be rational for NEG to consider whether to lower or increase prices on the Heathrow route taking into account the impact on profitability on both the Heathrow and Stansted services. Absent the undertakings, price cuts on the Heathrow service might have stimulated extra demand and thus been profitable. However, the impact on profits on the London-Stansted coach route of lowering prices by a corresponding amount (on a route where demand is growing and NEG currently faces relatively little competition) would be likely to substantially outweigh any gains. This may be a partial explanation as to why the dedicated Heathrow service became unprofitable and was withdrawn. 

The OFT is therefore of the view that the undertakings may be contributing to consumer harm on the London-Heathrow route by depriving passengers of the benefits of substantially cheaper NEG coach tickets. 

ASSESSMENT

Price control provisions of the Undertakings

Material change of circumstances

The OFT believes that the discontinuation by NEG of the dedicated Heathrow coach service is a material change of circumstances by reason of which the price control provisions of the undertakings are no longer appropriate. In light of this change, the OFT has considered whether, pursuant to section 75J(a)(ii) FTA, NEG can be released from the price controls imposed by the undertakings or whether the undertakings need to be varied or superseded by new undertakings.

Alternatives to the price controls

The OFT's preferred remedy to an anticompetitive merger is most often a structural remedy, such as divestment of assets. (see note 3) However, it is not practically open to the OFT to propose a structural remedy in the context of an undertakings review, which the firm subject to the undertakings must itself voluntarily accept.

The OFT has therefore considered whether to replace the price control provisions of the undertakings with a different set of price controls.  It has concluded that it would be inappropriate to do so in the circumstances of this case.

• We considered in particular whether to propose replacing the 'competitive benchmark' character of the original price controls with a substitute competitive benchmark. Despite the problems that have since arisen, speaking in favour of the original controls was a relative simplicity of remedy design: the London-Heathrow coach service was an obvious comparator to the London-Stansted coach service and it was manifestly competitive in character (in view of the many competing public transport operators). The original controls were also relatively simple in terms of monitoring compliance (a straightforward comparison of two prices on two services). Any substitute mechanism considered by the OFT would introduce more complex or invasive regulation of coach services with serious construction, monitoring and enforcement questions. The risks of poor design or under-enforcement present a risk to consumers (as has occurred on the Heathrow service).
• We also considered price controls linked to the retail price index (RPI). Our concerns here were that RPI, unlike a comparative airport coach service, does not reflect the factors that drive coach prices, such as variable industry costs (e.g. fuel prices, driver salaries), passenger demand, and – most significantly – the intensity of competition between operators. In other words, it would substitute a mechanism designed to transfer the effect of competition from one service (London-Heathrow) to another (London-Stansted), with a price mechanism unrelated to the costs, demand and competition.  Adding complexity to the price formulae to reflect industry costs would raise monitoring and enforcement concerns and still fail to reflect competitive pressures. Such mechanisms can also act, in some cases, to deter entry by rivals and/or expansion and/or investment by the incumbent(s), thus distorting competition and service quality, with the resultant risk of consumer detriment.

Neither of the alternative price control mechanisms appears capable of restoring competition on the London-Stansted route. As the undertakings in question were designed to have a restorative effect, the OFT does not believe that reasonable alternative price control proposals are fit for this purpose, and therefore appropriate, in the present case. In the circumstances, the OFT considers that the desired restorative effect on competition is best achieved by the market itself, rather than by alternative price regulation. The OFT notes in this respect that one rival operator, Terravision, has entered since the Undertakings came into force. There is also reason to expect that further entry would be profitable given current margins and demand estimates for Stansted airport passenger traffic.  

Other provisions of the Undertakings

The undertakings also include provisions that impose on NEG the obligation to maintain fares and frequency where a competitor ceases to provide a coach service on the London-Stansted route (the Fare and Frequency Obligation). We have not identified any change of circumstance by reason of which these provisions might no longer be considered appropriate.

CONCLUSION

This review of undertakings has reinforced the importance of exercising caution in accepting behavioural undertakings that aim to remedy the loss of horizontal competition resulting from a merger by way of price controls. In this case, the undertakings appear to have had unforeseen consequences.  One such consequence is that the undertakings appear to be harming consumers on a market not affected by the merger: consumers are currently being deprived of tickets from London to Heathrow at around 50 per cent of their current price.

THIRD PARTY VIEWS

Following a consultation process ending on 19 July 2006 the OFT did not receive any responses about the proposed variation to the undertakings.

DECISION

The OFT considers that by reason of a change of circumstances the undertakings are no longer appropriate in part and need to be varied in part. The OFT hereby accepts the variation to the undertakings offered by NEG. The text of the undertakings and the variation to the undertakings are attached at Annexes 1 and 2 to this decision.

The OFT considers that no alternative undertaking reasonably open to it would have a restorative effect on competition. The OFT has therefore decided to release NEG from the price control provisions imposed by the undertakings so that consumers may benefit from lower London-Heathrow ticket prices that NEG intends to introduce. 

The OFT has decided to maintain the Fare and Frequency Obligation since there is currently no statutory basis for variation or release of these particular provisions.

This variation will take effect from this date. The undertakings shall continue to apply other than as amended by this variation.

NOTES

1. SI 2006 No. 354.
2. The undertakings do not require maintenance of any particular Heathrow service.
3. OFT Substantive Assessment Guidance, para. 8.6.

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