Airline deregulation in the USA and Europe



Airline deregulation in the USA and Europe

A case study of contestable markets

If a market is highly contestable, the mere threat of competition may be successful in keeping prices and profits down. Of course, established firms would not like this! They would be keen to erect barriers to entry and to make exit more costly for any firm that did enter.

Governments around the world are generally in favour of increased competition and frown on the erection of entry barriers. This means that they generally prefer not to intervene if markets are competitive or highly contestable, but may attempt to regulate the prices, profits or behaviour of firms where competition or contestability is limited. Conversely, if markets have been regulated and yet are potentially competitive, many governments have then deregulated them (i.e. removed regulations).

A good case study of deregulation and contestability (or lack of it) is the airline industry.

The USA

The airline industry in the United States has been deregulated since 1978. Prior to this, air routes were allocated by the government, with the result that many airlines operated as monopolies or shared the route with just one other airline. Now there exists a policy of ‘open skies'.

Initially the consequences were dramatic, with lower fares and, over many routes, a greater choice of airlines. The Brookings Institute calculated that, in the first ten years of deregulation, the lower fares saved consumers some US$100 billion. One consequence of the increased competition was that many US airlines went out of business. Gone are famous names such as Eastern and PanAm. In the depth of the 1992 recession, 32 American carriers went out of business.

Even where routes continued to be operated by just one or two airlines, fares still fell if the route was contestable: if the entry and exit costs remained low. In 1992, despite the bankruptcies, 23 new carriers were established in North America, and many routes were taken over by existing carriers.

But deregulation has not made all routes more contestable. In some cases the reverse has happened. In a situation of rising costs and falling revenues, there are likely to be mergers and take-overs of the vulnerable airlines. Some seven airlines now account for over 90 per cent of American domestic air travel, compared with fifteen in 1984, and merger talks continue between various pairs from the seven. With this move towards greater monopolisation, some airlines have managed to make their routes less contestable. The result has been that airfares over the past 10 years have risen faster than prices in general.

A key ingredient in making routes less contestable has been the development of a system of air routes radiating out from about 30 key or ‘hub’ airports. With waves of flights scheduled to arrive and depart within a short space of time, passengers can make easy connections at these hub airports.

The problem is that several of these hub airports have become dominated by single airlines which, through economies of scale and the ownership or control of various airport facilities, such as boarding gates or check-in areas, can effectively keep out potential entrants. The problem is worse in airports which are congested and where room for a new entrant could only be made if existing airlines cut back their flights: something they will obviously resist. By 2002, at 15 of the hub airports, including some of the busiest, the dominant airline had a market share in excess of 70 per cent.

The airlines have also used measures to increase ‘customer loyalty' and thereby make entry barriers higher. These measures include frequent flier rewards, deals with travel agents and code sharing with ‘partner' airlines.

On some routes, however, rival airlines have managed to enter successfully. In 2001, the US Department of Transportation identified 19 such cases. Resulting price reductions ranged from 33 to 55 per cent, and increases in passengers ranged from 61 to 86 per cent.

So how could routes from these hub airports be made more contestable? Part of the answer may be to deregulate even further. For example, the practice could be ended whereby new take-off or landing slots at certain airports are auctioned among airlines already operating out of that airport.

Part of the answer, however, may be to introduce new regulations. For example, airlines which already have more than a certain percentage of slots could be prevented from obtaining new ones. Also airlines could be prevented from anti-competitive practices, such as ‘predatory pricing'. This is where big airlines undercut the prices of small new entrants so as to drive them out of the market. The Department of Justice has begun investigating such cases, and under US law can order airlines to end such practices.

Europe

Until the early 1990s, the European air transport industry was highly regulated, with governments controlling routes. National routes were often licensed to the national airline and international routes to the two respective national airlines. Since 1993, the industry has been progressively deregulated and competition has increased, with a growing availability of discount fares. Now, within the EU, airlines are free to charge whatever they like, and any EU airline can fly on any route it wants, providing it can get the slots at the airports at either end.

As in the USA, however, whilst increased competition has benefited passengers, many of the airlines have tried to make their routes less contestable by erecting entry barriers. Predatory pricing has occurred, as the established airlines have tried to drive out new competitors. What is more, the proliferation of fare categories has made it hard for consumers to compare prices, and established carriers' highly publicised fares often have many restrictions, with most people having to pay considerably higher fares. As in the USA, code sharing and airline alliances have reduced competition. Finally, at busy airports, such as Heathrow, the shortage of check-in and boarding gates, runways and airspace has provided a major barrier to new entrants.

Nevertheless, by using other airports, such as Stanstead and Luton in the case of London, new low-cost airlines, such as EasyJet and Ryan Air, are increasingly providing effective competition for the national carriers. The question is whether the middle-sized national carriers, with relatively high fixed costs, will be able to survive the competition. The filing for bankruptcy and subsequent baling out of Swissair and Sabena (the Belgian airline) following the September 2001 attack on the World Trade Center in New York, illustrates the vulnerability of such airlines. Since that time several of the medium-sized carriers have been forced into merger or acquisition in order to survive, the most recent being the announcement in late 2009 of a merger between British Airways and Spain’s Iberia Airline. The question in the future may be whether the market will remain sufficiently competitive or contestable to prevent large fare increases.

 

Question

Make a list of factors which would influence competition or contestability in the Australian domestic airline industry.

 

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