Media Assignment



University of Technology, Sydney: School of Finance and Economics> Media AssignmentDelta and United fly into airfare war across Pacific – Oligopoly in PracticeJohanan OttensooserMay 6, 2009Contents TOC \o "1-3" \h \z \u Delta and United fly into airfare war across Pacific PAGEREF _Toc229293827 \h 2Report – The Effects of Increasing Competition PAGEREF _Toc229293828 \h 41)Introduction PAGEREF _Toc229293829 \h 4a)Article Summary PAGEREF _Toc229293830 \h 4b)Justification of the Topic PAGEREF _Toc229293831 \h 42)Report PAGEREF _Toc229293832 \h 5Bibliography PAGEREF _Toc229293833 \h 8Delta and United fly into airfare war across PacificTHE cheap trans-Pacific fares that accompanied V Australia's arrival show no signs of abating with Delta Air Lines yesterday launching another round of cut-price offerings.Author: Steve Creedy, Aviation WriterDate: March 17, 2009Source: The AustralianDelta, which plans to launch a Sydney-Los Angeles service on July 3, entered the battle with pre-tax return economy fares from Sydney to Los Angeles of $747 and with pre-tax business class fares starting at $7777.But it was beaten to the punch by United Airlines which said it was offering all-inclusive, advance purchase return Sydney-Los Angeles business class fares from $6876 and Melbourne-Los Angeles from $6859. United also launched a pre-tax economy fare of $747 return.Both airlines indicated they were also offering deals for travel beyond the US West Coast gateway cities.V Australia, which is already flying from Sydney and starts flying from Brisbane on April 8, has been offering a tax-inclusive business class fare to Los Angeles from $6999 return as well as economy fares from $971 and premium economy from $1999.The airfare skirmishes come as the American Express Business Travel Monitor found published fares to the US recorded the biggest drop of any routes from Australia.But Virgin chief executive Brett Godfrey yesterday played down the arrival of Delta, saying a fourth carrier had been expected and would not have been a problem in normal times."The question is making sure we don't lose too much between now and when the market turns," he said. "When the market turns, as it inevitably will, I think that will still be quite a good market for us."Fares to the US fell 5 per cent, compared with a 3 per cent fall on domestic routes and no change for travel to Europe, the Middle East and Africa. The survey found fourth-quarter business discount airfares across the Asia-Pacific fell 6 per cent compared with the previous quarter.Meanwhile, Virgin Blue's shares jumped 3c to close at 20.5c yesterday as the carrier recorded January domestic traffic growth of 8.7 per cent and filled more seats.The 17 per cent surge in shares came after Virgin was trading at record lows that saw it queried last week by the stock exchange when the price hit 15c. More than 28 million shares were traded yesterday, or about 2.6per cent of the shares outstanding.Domestic passenger numbers rose by 7.4 per cent over the previous year and load factors rose 1.2 percentage points to 84.4 per cent.The biggest gain was on international routes, where passenger numbers soared 33.4 per cent as the airline moved planes offshore.Report – The Effects of Increasing CompetitionIntroductionArticle SummaryThis article dissects the effect that the destabilisation of the LAX-SYD route Oligopoly has had on the price of flights, detailing the subsequent price war, described as “airfare skirmishes” (with prices falling from highs of more than $1400 return [pre-tax] last year to $747 return [pre-tax] this year). This article then discusses the inevitable re-stabilisation of the market, with “Virgin chief executive Brett Godfrey ... [saying] ‘when the market turns, as it inevitable will, I think that will still be quite a good market for us’”. Finally, this article outlines consumer responses to this market destabilisation via share market activities, showing a positive response to decreasing fares and increasing competition. A 5% average fall in fares lead to a 33.4% increase in international passengers in the route as well as a 17% increase in Virgin Blue’s share-price (Steve Creedy, 2009).Justification of the Topic4039235957580Economic Principles, Second Edition (Jackson, McIver, & Bajada, 2007, p. 699), defines Oligopoly as “the situation when the number of firms in an industry is so small that each must consider the reactions of rivals in formulating its price policy”. Furthermore, pointing out two qualities that identify an oligopoly, “fewness” and slightly differentiated products (pp. 182, 183).Figure 1: Data courtesy of Anna Aero (Morgan, 2009)Inner ring represents 2008 outer ring represents 2009Concentration ratios and market share allow a responder to extract the quality of “fewness”. Concentration ratios require a ratio of dominant to non-dominant businesses; this is not available in this industry, given that there are only four market entrants. Hence, a market share analysis is required. In early 2008, Qantas and United split the market 67% according to flights per week. In 2009, due the entrance of V Australia and Delta, Qantas’ share of the market fell to 45%. However, with only four entrants, the smallest securing 10% of the market, even the 2009 values fall well within the boundaries of “fewness” (Morgan, 2009, pp. 1, Table 1), see figure 1.Secondly, the industry, offering identical flights between Sydney and LA, with only superficial differences in service quality and advertising.Since this industry satisfies the requirements of “fewness” and slightly differentiated products, it is defined as an Oligopoly, and can be analysed as one.ReportOne of the major causes of Oligopoly is barriers to entry. In the case of this industry, these barriers were twofold: legal and natural. The legal barriers in place were legislated restrictions on air-travel between Australia and the U.S. High start-up costs also hindered entry to this industry. As such, until mid last year trans-pacific (Sydney to Los Angeles) air-travel has been a strict Oligopoly (a Duopoly, in fact); with Qantas and United unequally dividing market share (Morgan, 2009, pp. 1, Table 1).Last year, however, Australia and the U.S. signed the “open-skies” agreement, “eliminating restrictions on U.S.-Australia air services” (Dow Jones Newswire, 2008). This eroded a major barrier to entry, and, since then, the strict Duopoly has been upset, with V Australia (the international wing of Virgin Blue) and Delta Airlines entering this market (O'Sullivan, 2008).Firm A’s Pricing StrategyFirm B’s Pricing StrategyHighLowHighFirm A and Firm B receive $12m profitFirm A receives $15m profit, Firm B receives $6m in profitLowFirm A receives $6m in profit, Firm B receives $15m in profitFirm A and Firm B receive $8m in profitFigure 2: based on Figure 6.4 CITATION Joh071 \p 185 \l 3081 (Jackson, McIver, & Bajada, 2007, p. 185)Barriers to entry are, however, still quite limiting, with Virgin Blue set to record annual losses due to the high investment costs of V Australia, especially in acquiring new aircraft (Morgan, 2009). These barriers are therefore still extant. However, their relaxation has destabilised the previous Oligopoly’s “friendly competition” (Hannaford, 2007) with prices aimed at securing market share.Game Theory, or, indeed, the kinked demand curve that it generates, could have predicted this price war. Both these price-models are dependent on a derivative of the concept of “fewness” – the idea that in an Oligopoly, there are few enough parties that each firm considers the possible actions of the other in their pricing decisions. From this, a simplified platform, a “profit grid”, illustrates the price-choices of each firm, as represented in Figure 2.In this case, the natural response for both companies is to price low, according to the Maximin rule (earning $8m each). However, in time, with repetition, the price tends to be less competitive, instead edging towards the “Pareto optimum”, in this example, both pricing high, with each company earning $12m in profits. This might occur through collusion, whereby the companies agree not to compete on price, and set prices at above-market rates. The players in this industry are not above collusion, with Qantas recently fined $70m for “participating in a cartel to fix air cargo prices” (Boles, 2007). Without collusion, it is almost impossible to achieve the Pareto optimum, it only being achievable through repetition of the game, in the case of the Figure 2, or long-term market-share stability, in the case of the airlines – taking “the edge” off the competition, since neither company wants to eat away at their own profits by lowering their prices (Hannaford, 2007). 3552190834390 This was, arguably, the case with the LAX-SYD route before the “free-skies” agreement. However, when V Australia and Delta entered the market, they came seeking market share, immediately pricing low to attract customers. This situation is best represented in the example with Firm A representing Qantas and United, and Firm B representing the newcomers. In the case described, Firm B will have entered the market pricing low. Here, Firm A (Qantas and United) has two choices, either cutting their prices to match Firm B’s, in a Maximin solution where they receive $8m in profit; or by leaving prices as they are, reducing their profit to only $6m. As is predictable, Qantas and United lowered their prices to reduce lost profits. Figure 3: Price and Cost changes on a kinked demand curveThe above information, notably the tendency to “follow” lower prices, unified, becomes the kinked demand curve, as shown in Figure 3. Point P1Q1 (herein, the equilibrium) represents the stable equilibrium price of the Oligopoly. This price is important is doubly important. Firstly, it is the point around which the elasticity of demand changes. Secondly, it exemplifies that, for an Oligopolist, price and cost are relatively disassociated, and, therefore, that a decrease in costs will not directly lead to a decrease in price.The first concept, that of changing elasticity of demand, is a graphical representation of the solution to the game discussed above. The points on the right of the equilibrium, such as P2Q2, are lower priced than the equilibrium. If a firm prices in this region, it is in the competing firm’s best interest to follow suit, as illustrated by Figure 2: if they follow suit, they would earn $8m, if they leave their prices be, profits will fall to $6m. Thus, in the area to the right of the equilibrium, all price changes are replicated: the consumer will be no more inclined to shop at the firm that originally lowered the price. This, in turn, translates into low price elasticity, since a unit decrease in price will lead to a smaller increase in quantity demanded.The points on the left of the equilibrium, such a P3Q3, require a price higher than the equilibrium. Here, it is more likely for competing firms to keep their own prices steady, since this maximises their profit. Therefore, when one firm increases price, the other firms are less likely to follow suit, thus the consumer will be able to find the same product for cheaper. This translates into high price elasticity above the equilibrium: a small increase in price offered leads to a large change in quantity demanded.This change in elasticity is illustrated by Figure 3, whereby identical changes in price (P1:P2 and P1:P3) yield dramatically different changes in demand. The decrease to P2 only marginally increasing quantity demanded, and the increase to P3 reducing demand on a larger scale. Thus, for a stable Oligopoly, every possible change in price leads to decreased profitability, from which the concept of “price inflexibility” can be derived (Jackson, McIver, & Bajada, 2007, pp. 189, 190).The cost-price isolation of oligopolies is illustrated in Figure 3: a shift between Marginal Cost (MC) MC1 and MC2 would not cut into Marginal Revenue (MR), since it is around the equilibrium where MR is discontinuous. A decrease in cost would therefore not directly lead to a change in price. This, when coupled with the “price inflexibility” of Oligopolies, helps to explain the high equilibrium price before the Oligopoly was destabilised. In the industry, there was “price leadership”, whereby Qantas and United followed each other’s pricing. Here, even when costs decreased with increasing technological efficiency, the price remained stagnant, since neither wanted to lose profits. When more firms entered the industry, they were willing to sacrifice profit for increased market share, decreasing prices. Following the logic of game theory, the companies new to the industry thus became price leaders, and it was up to the larger firms to follow their price reductions or risk losing market share.The Sydney to Los Angeles air route was a stagnant and non-competitive Oligopoly until the signing of the “free-skies” agreement. This agreement has led to increased competition and decreasing prices, as would be expected through economic analysis. This increased will be good for both the airlines and the passengers, since airlines will enjoy increasing numbers of travellers, and the passengers will enjoy lower prices.Bibliography BIBLIOGRAPHY Boles, C. (2007, November 28). Qantas fined $70m for price fixing. The Australian .Dow Jones Newswire. (2008, March 31). "U.S., Australia sign open skies agreement". The Wall Street Journal - Market Watch .Hannaford, S. (2007, December 3). Defining the New Oligopoly. Retrieved April 29, 2009, from Oligopoly Watch: , J., McIver, R., & Bajada, C. (2007). Economic Principles (2 ed.). Sydney: McGraw-Hill Irwin.Morgan, J. (2009, February 27). "V Australia finally launches with Sydney to Los Angeles route". Anna Aero .O'Sullivan, M. (2008, December 29). "Delta's Sydney-LA flights tipped to hurt Australian carriers". The Age .Steve Creedy, A. W. (2009, March 17). "Delta and United fly into airfare war across Pacific". The Australian . ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download