Changes in market condition effects on the airline industry
The purpose of this assignment is to study the changes in market condition that have affected the airline industry. The Airline industry has been introduced to the world since 1909.Airline services vary from intercontinental, to intra continental, domestic or international. They are portrayed through an oligopoly structure which is limited number of firms overlook the industry to produce imperfect competition. We discuss about airline oligopoly structure and current economic environment that shows an impact to the airline industry. The effects of technology advancement and competitive market will trigger the airline industry in terms of benefits and burden. We study the airline oligopoly structure, current economic and noneconomic environment, change in technology, effect of externalities and price discrimination shows an impact in the airline industry. Currently the airline industry is in high competition market causing a wide shakedown which will have long distance effect on the trend of expanding the market. Airline industry was at least part government owned during the past but in the U.S most of the airlines are private owned.
Airline Industry Structure
The airline industry is classified as one of the oligopoly market structure. The oligopoly market is dominated by a number of firms that control the whole industry and this is a type of imperfect competition. Oligopoly firms have the rights in setting the price of a certain goods and also creating many types of output levels. When the oligopoly takes place in the market, competitors will compete with each other due to producing the same goods. Therefore, they will develop new ideas such as lowering the price of their goods and also other ways to improve the market share. In other words, oligopoly firms are interdependent.
Besides that, an oligopoly firm such as the airline industry requires a huge capital investment to expand the business which will result in a higher cost. Based on the Air Transport Association (2002), roughly two thirds of the overall airline industry cost structure is fixed cost. According to Pettit and Murphy (2001), when there are over capitals, the airline industry cannot possibly generate sufficient revenues to cover up their total fixed cost hence the industry. In order to increase the number of passengers, the firm must reduce its cost and also to be given a fixed capital requirements.
Moving on, airline industries are highly potential in producing efficiencies such as providing a better service and lower price to consumers. Through optimization, the airline industry may achieve higher profits and increasing the load factors, reducing the maintenance cost, settle off overhead cost for operating through synergies (Petit and Murphy 2001), and also suggested to reduce the flights to a weaker market. (Sharkey 2003)
Next, an oligopoly firm may use the market power to control competition but however new innovation firms can overcome it by using the strategy of the low fare airlines. Although there is difficulty to enter the industry such as high cost and capital requirement, the industry appears to be more competitive as proven by the low-fare transport. Hence, new market competitors can continue experiencing high growth in profit unlike the bigger competitors.
In the airline industry, it consists of smaller and bigger airline when both merge together, the antitrust considerations may prevent it from happening. According to Blair and Harrison (1999) and Moorman (2002), in order to protect new competitors in the market from an unfair competition and also anti competitive acquisitions, the antitrust provisions are required to change and enforce.
Lastly, the price determination and economies of scale as well as the low cost competitors show that the airline industry is not a stable industry. Thus, structure with the lowest cost would be the survivor when the sales in the industry decrease.
Current Economic and Noneconomic environment
The airline industry has been facing a chain of unpredicted and noneconomic factors such as terrorist attack in 2001, spreading virus of severe acute respiratory syndrome (SARS) and also economic slow down. The airports have increased the cost of airlines after the September 11 attack, resulting impact on demand for air flights and also traveled time due to intensive security check. The 9/11 event had raise losses of that year to $7.7 billion, regardless government intervention of $5billion for the cost of shutting down the aviation system.
Beside terrorist attack, airline industry had come across economic slowdown in early 2000. The economic slowdowns ease the business traveler, when the airline is depending on gainful sales of high price seats. According to Newman 2003, he suggested that even before the terrorist attack the airline industry is experiencing slow growth of passenger travel. Highly competitive airline is another factor affecting the airline industry. Until late 1990s, major airlines enjoy competition with low fare carriers. The new competitors are having lower cost per seat mile while making profit at lower fares.
Microeconomics and macroeconomic market factors have lowered demand and increased elasticity demand in the industry. Figure 1 shows demand for airline tickets has decreased from D1 to D2 becoming more elastic. Is becomes flatter when there is higher price responsiveness, represented by decrease in price from P1 to P2. The equilibrium will shift from E1 to E2. Oligopoly industry will be motivated by the change in demand to reduce supply of seat in order to reduce the cost with a constant price at P1, supply curve shift from S1 to S2 with equilibrium at E3.
Effect of technology changes
The world’s airline industries have been using technologies to build customer relationship and also generate income to solve some of their difficulties. For airlines, technology like Electronic ticketing (ET) only offers in certain airlines decades ago. The main purpose of it was to encourage the implementation of ET with lower distribution costs and also to enhance online environment of airlines. Technology has transformed how airlines work back then. It is so much easier to manage the check-in system. Most airlines are taking up system that runs automated check-in. Instead of arriving at the airport early, traveler could just swipe their credit card through a machine and print out the e-ticket which saves a lot of time.
Technology could be use to boost customer relationship. Through the Web, industry could offer travelers to customize their specific travel. For example a traveler that flies frequently are most likely to enjoy the airport lounge services, therefore the Web interface could direct the service with a higher cost with satisfaction.
Figure 2 shows the effect of technology advancement in the airline industry.
When demand for air ticket increases, the demand curve eventually shift upwards. The initial equilibrium is at E1 with initial price and quantity at P1 and Q1 respectively. With increase of demand, price will increase from P1 to P2 and quantity demanded will increase from Q1 to Q2 and the new equilibrium at E2. When airline industry is enjoying their benefits from cost saving, consumers gain benefits from greater price transparency and other choices.
According to Newman 2003, he suggested webcasting and other types of telecommunication shows impact in the airline industry because there are increase in business travelers and consumers. Many business meeting or interview are conducted through video conferencing which save time and cost. Also employee could easily apply for overseas job via audio and video streaming at a distance location. (Cope 2002) Technologies that can communicate with each partner is essential for future benefits in the industry especially green technologies which could build a sustaining future.
Price discrimination is defined as a firm selling same goods at different prices to different types of customers. Price discrimination is also a known as price strategy. Example of firms that applies the price discrimination is the low cost airlines. Promotions for cheap air tickets are always advertised to attract customers to buy their air tickets earlier by giving a lower price. This enables the airline firm to have advantage of knowing their flight seat status and also a source of cash flow. When the date of the flight is getting nearer, the price of air tickets increases therefore customers that buy the tickets are likely to be paying at a higher price.
In other words, this represents the concept of price elasticity of demand. Price elasticity of demand basically measures how much the quantity demanded of certain goods responds to a change in price of the particular goods. The figure below shows the effect of price elasticity of consumers on total revenue.
Based on figure 3, we can observe that when the demand is elastic, the quantity demanded which are Q1 and Q2 will be greater than the percentage change in price P1 and P2. The total revenue after decreasing the price from P1 to P2 is greater than before the decreasing it. This is proven that the sales of the airline increased due the increase in quantity hence in this airline industry, consumers are relatively responsive towards to the changes in price.
Effects of Externalities
The airline industry growth has been increasing year by year. We can observe that nowadays many people are taking airplane to travel around the world. Furthermore, based on research during 1990 the number of passengers was approximately 125 billion and after 10 years it has increased to approximately 260 billion passengers. This showed that the demand increases every year because of the new development of technologies and also new low-cost airlines firms.
Although the airline industry shows a positive growth every year, the negative external cost of flying more passengers pollutes the environment. Based on Dr Keith Tovey, energy science director at the University of East Anglia’s carbon reduction project. “If you fly to Sydney, Australia, a plane will emit 5.6 tons of carbon dioxide per passenger, which is as much as an average household will emit a year.” Moreover, aviation is one of the fastest growing sources of the greenhouse gas hence in future the percentage of emission will increase and affect the environment.
In order to overcome this problem, the government has introduced a new solution which is the aviation tax to curb the environment damages. This would affect the increase airfare prices because of the tax on suppliers which had increased their cost of production.
Based on figure 4, when the government implies the aviation tax on the suppliers, suppliers will reduce their supplies to reduce their cost. The supply curve S will to S1 hence the decrease in supply will lead to a decrease in number of quantities from Q to Q1 therefore the price will increase from P to P1.
In a nutshell, the changes in the airline industry market will affect the consumers to make decision. Certain airlines are cutting cost in order to increase their profit. Technology such as Wi-Fi is highly recommended in flight to satisfy customer’s need. (Newman, 2003)
Small changes in the number of flight passengers can affect the airline financial result. Whenever there is a reduction in airline industry like the one during 2008, airport operating cost remain constant. Coy (2002) noted that every seats remaining available are consider as a lost although its at reduced fares. This is where price discrimination takes place.
The global airline industry lost $50 billion in the past 10 years with $11billion last year alone. It would take at least three years to improve the industry. Worsen of airline has forced some airline corporate to file for bankrupt. According to IATA Chief Economist, the industry worst loss was $13 billion in 2001 with the September 11 event, and $80 billion income drop last year. To improve the economy, there should be more new entrants in the market to be more efficient. Regardless of any factor, the airline industry will always be unstable. Price will normally rise when there is tax charged by government. Thus, consumers plays a vital role in adjusting the changes occurs in the airline industry.