Michael Arendt
Economics 320
Term paper
“How deregulation has changed the appearance of the
Airline Industry”
The airline industry has seen many changes and
important events occurring to make it one of the most
dominant industries of today.
It has seen deregulation
occur in the late 1970’s in the U.S. and also major
innovations, which has evolved it into a monopolistic
empire.
Before deregulation occurred it had the features
of an oligopolistic industry.
This particular event is
also happening currently in Europe and is changing somewhat
slowly.
This paper will primarily focus on the industries
before and after deregulation describing the
characteristics that have evolved over time.
With these
important changes comes the mergers which have also led to
some great efficiencies and inefficiencies in this dominant
traveling industry.
These mergers are occurring at much
faster rates due to competitiveness, but also to the gain
in market shares or power which changes how companies price
their airfares.
Yes, the airline industry has come a long way since
the good old days in KittyHawk, North Carolina where the
Wright brothers first started this industry.
Deregulation is occurring currently in the airline
industry specifically in the European countries.
This
event is occurring just as how the U.S. airlines industry
became deregulated in the Airline Deregulation Act of 1978.
Thus to explain the market conditions and the theoretical
models (before and after deregulation) there will be
specific examples from both U.S. and European markets to
describe the models.
Before deregulation the airline industry was regulated
by the governments, which controlled and created these
oligopolistic-style industries.
They regulated how each
airline priced their airfares, but also to the extent of
how pricing was established in the respective markets that
they were established in.
A good example of this
occurrence was by the Civil Aeronautics Board, which
controlled the U.S. industry.
They controlled what
airlines worked in what markets and at what price each
could charge.
They basically fixed all the prices, where
it seemed to work like an oligopoly but also a legalized
cartel.
Another point stated by Robert Hardaway was that
“airlines were reduced to competing by offering such frills
as free cigarettes and liquor”.
This was the situation for
the U.S. airlines before 1978, of which is shown also in
the markets across seas.
Currently most airline in Europe
are located in regional specific markets, showing
oligopolistic features also.
Such airlines as British
Airways, Lufthansa, Debonair and Air France only work out
of their central markets, where they have control of
airport resources.
This is an example of how they are
established in areas and how they are able to keep costs
low compared to other airliners in other markets.
We now turn our attention to the deregulated side of
the airline industry, where the characteristics show more
of a monopolistic competitive model.
After deregulation
occurred, we have seen the elimination of high cost
carriers such as Eastern Airline, which went bankrupt in
the 1980’s.
Also with the increase of owning parts of
airports have led to some low cost carriers being
eliminated.
This in a way is a control of a specific
resource, of which, when owned by one airliner another may
not gain access to that resource.
A good example is United
where “its built 75% market share in Denver by serving the
business flier and the leisure traveler” from Denver’s new
airport(Business Journal).
Thus when they compete with low
cost carriers they are able to lower fares in different
markets efficiently to drive out low cost carriers, which
have no airport access or resources to actually place their
airplanes and incurring high costs.
We also see that prices do fluctuate during different
parts of the year, due to market conditions, which creates
limited competition among the few airline companies.
This
particularly takes place in the U.S. major markets such as
Chicago, New York, Los Angeles, Detroit, and Dallas/Fort
Worth.
In the article “Passengers must take stand in
battle between Air Carriers”, it states that “majors have
learned that their bigness gives them the power to compete
selectively”.
Thus it means when major carriers are
influenced by low cost carriers to lower its own fares, it
can lower price below their costs to drive out the
competition.
Once this occurs and the low cost carrier
goes out of business the fares can then be raised again to
monopolistic prices in search of monopoly rents.
Another
way these air carriers promote flying with their airline is
through frequent flier programs.
Frequent Flier Programs
is where a consumer can earn free tickets to any
continental route as long as they earn enough mileage of
flying within a certain period of time.
A good example that furthered monopolistic innovation
was raised during the strike earlier this year with
American Airlines.
The pilots noticed that the new turbo
prop jets being created could actually effect their own
jobs.
This was due to the fact that these jets were able
to carry more people than before, with much lower fixed and
variable costs because of the improvement in research and
design.
These planes could fly longer and be refueled less
between destinations.
With these concerns in their minds,
the pilots made sure that American Airline pilots would be
flying these planes , instead of their subsidiary pilots
from American Eagle.
Thus by having a strong hold on how
the market might be affected by a strike, the A.A. pilots
restricted who flies these new planes.
In a sense this is
restricting output while also controlling prices relative
to other air carriers.
This also is a concern in Europe where the
oligopolistic conditions existing are causing problems for
some airlines, who want to earn and achieve monopolistic
profits but cannot.
For these airlines many
characteristics of monopolistic competition is hard to
develop yet alone propose.
prisoner’s dilemma.
It is like that of the
These few firms that exist in their
originating markets can stay in their originating markets,
but also then must be prepared for possible competition
from other carriers.
Or they can spread into other markets
where they can compete for more profits, but also incurring
some possible losses if they are not successful.
This is a prime concern for the airlines because the
costs and more competition could actually lower price
resulting in possible failures.
In “Much ado about
Nothing?” it states reasons why deregulation has created
fear in the industry.
British Airways (a major carrier),
for example, has decided to expand to other markets,
however, they have also had enormous start-up costs and
have not been as successful as projected.
The new costs
incurred are projects like setting up overseas operations,
finding slot availability at other airports along with
crews, maintenance, and aircraft stations.
These costs can
only be incurred by Lufthansa and British Airways, for now,
because they are the major carriers or furthest most
developed airlines in Europe.
Their plan of strategy was
to buyout or merge with other carriers, which now has
little control in some markets as compared to none before.
This allows them to compete in other markets where they are
now at an advantage to take more capacity at “secondary
airports”, but also to grab
more profits if they are
successful.
These examples of conditions will probably exist where
oligopolistic and monopolistic characteristics are both
present.
However, the U.S. industry has shown greater
characteristics of both oligopolistic (before) and
monopolistic competition (after) deregulation.
Before
deregulation they showed divided markets, few firms in each
market, prices regulated by government so they didn’t
fluctuate, and the firms were restricted to a certain
output due to their limited capability in the market
structure.
Thus these conditions, which looked like a
cartel were abolished.
In return, deregulation hopefully
would lead to better prices, quality an competition.
Conditions after deregulation look more like monopolistic
competition.
Air carriers can raise and lower prices, in
respect, to other carrier fares during different market
conditions.
This high cost operating industry creates
barriers to entry, but also these firms sometimes also make
zero economic profits when faced with competition.
This
leads to them having downward residual demand curves,
because of the different programs that each carrier
provides and offers.
Such programs as frequent flier
programs, Star Buck Coffee served on flights, or even
quicker, safer, cheaper plane trips leads to choices of
preference for the consumer.
Also under some circumstances
the air carrier can promote predatory pricing to avoid
competition and getting away with it, however, if they do
then there will be a chance of losing profits.
Thus many
air carriers have gone to another alternative such as
merging with other carriers.
This leads us to how the
European market is forming currently if they are going to
survive.
The emergence of major air carriers merging with
smaller carriers has been a significant factor in terms of
efficiency.
Just recently in December of 1996, Delta and
Continental Airlines(#3 and #5 in the industry) were in
talks about merging which would make them the major firm in
the industry.
This led to American Airlines and British
Airways talking about merging.
This arises to the problem
of less competition in the markets, if these mergers go
through.
With less competition these firms can possibly
eliminate some firms from entering some markets.
This
results in price rises, elimination of some airlines,and
possible loss of choices and preferences for the consumer
creating inefficiency.
However, these mergers could cause some benefits
according to “Rivals are buzzing all around Lufthansa”.
Lufthansa, a major carrier, is now facing higher costs
compared to rivals.
Thus there are talks underway with
United Airlines, Air Canada and Thai International Airways.
This is because rivals like British Airways, which has
costs 25% lower than Lufthansa, are able to enter in such
markets now and engage in price wars.
Thus lowering of
prices will lead to lower profits, along with possible
strikes by unions, this could change the outlook for them.
Unless they acquire or merge with other airlines to help
compete with rivals they possibly might go under.
However,
if they do merge, this can strengthen competition in other
markets, while gaining more market share and power.
This
helps the consumer benefit with lower prices and gives
support for the major carriers to strengthen their market
share and be more efficient.
Right now the airline industry is constantly changing.
These airlines are trying to become more competitive in new
markets, while also trying to keep competition out of their
central markets.
Thus deregulation in Europe has made this
industry go into a complete restructuring program, where
they are trying to become monopolistically competitive.
Merging of airline carriers helps to keep the market
competitive, but also with cost cutting programs on the
verge, it also leads to lower profits.
This could lead to
poorer quality of service, possibly less competition with
some air carriers not surviving and falling out of the
industry in the possible future.
This might lead to once
again a regulated industry, however these changes are
occurring elsewhere such as the public utilities and
telecommunications field.
Deregulation causes change in
the way an industry is related to an economic model.
Mergers can create more competitiveness in this high cost
industry, but also monopolistic competition.
We live in
the decade where change is an understatement, and as for
the future “only time will tell us what to expect” from the
airline industry.
Bibliography
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