Market condition changes that have affected of airline industry

The purpose of this paper is to show the changes in the market condition that have affected of airline industry. We test the impacts of current improvements in technology, the effects of externalities and price discrimination which will leads to increase in cost and competitive structures, giving a basis for future data analysis of the effects of these changes on the airline industry. We discuss the airline industry in the context of oligopoly structure, the current economic environment, the effect of externalities, the effect of technological change on airlines and consumers and price discrimination. Finally, in conclusion, we present our views of how the structure of oligopoly industry and how it’s changing competitive environment will affect the market and consumers.

AIRLINE INDUSTRY STRUCTURE

Airline industry can be described by an oligopoly market structure which is a form of imperfect competition in where there is only a few numbers of firms which contributing to the whole market share. Oligopoly firms are price-setter. When an oligopoly firm takes an action, it will be noticed by its competitors because firms complete with each other when they produce same or similar outputs. Therefore, rivals may try to lower the price or other attempts to increase market share. Thus, oligopoly firms are interdependent, and every strategy dependent on individual rival firm’s behavior.

Oligopoly firms require high investment of capital to develop capacity, which will end up in higher fixed costs. Air Transport Association 2002 states that the case of the airline industry, with around two-thirds of the cost structure is the fixed costs. Referring to Pettit and Murphy (2001), when capital are too much in the industry, the airlines cannot always produce enough revenues to cover the total fixed costs. At nominal marginal cost for each flight, number of passengers can be rise by decreasing average cost given fixed capital requirements.

Oligopoly firms can potentially produce efficiencies that give lower-priced or better products to consumers. According to Pettit and Murphy 2001, airlines may gain more profit by optimization to raise load factors, lowering the maintenance cost, lowering the operating costs through synergies by leveraging overhead costs and by utilizing the use of existing aircraft fleets, and more efficient various forms of code-share alliances and reduce flights to smaller or weaker markets (Sharkey 2003).

Firms can make a position though airlines by using the new innovative which is the skill of planning of the low-fare regional airlines. Firms can use oligopoly market strength to limit the competition. Borenstein 1989; Hendricks, Piccione, and Tan 1997, states that a fully-established hub-and-spoke route network gives a considerable barrier, but possibly penetrable for new airlines. Even though the entry cost are high and the entry is hard for the aircraft acquisition and other capital requirements, the industry seem more contestable, which can be prove by the increase of lower-fare transports. These market entrants can slowly reduce a strong transport’s market share even at huge hub airports. Some of the new market entrants will continue to experience profit and growth which is different from other larger firms.

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In bigger airlines even between smaller airlines, antitrust considerations may prevent two or more airlines joining together, though when industries are merged, they are expected to gain higher capital efficiency. Borenstein (1992) illustrates that when industry merging happens, price regulation will be needed. According to Blair and Harrison (1999) and Moorman (2000), to save new firms from anti-competitive acquisitions and unfair competition, antitrust provisions has to be changed and strictly enforced.

Price decision, product differentiation, economies of scale and contestability with low-cost competitors are the market power characteristics which illustrates that airlines are naturally an unstable industry. After the global downturn, airlines create too much capacity when macroeconomic expand. When sales of the industry drop, the lowest cost structures will survive. According to Dreazen, Ip, and Kulish (2002) note, industry shakeout often results in a competitive industry.

CURRENT ECONOMICS ENVIROMENT

The airlines are bouncing back more strongly than expected from a global economic downturn which had measurable adverse effects on airline load factors. For example, the percentage of seats occupied. Rising variable costs for fuel, coupled with high and inflexible fixed costs, further reduce the airlines’ ability to compete on the basis of price.

Microeconomic market factors have lowered demand and increase elasticity of demand in the airline industry. For example, in Figure 1, it demonstrates the demand for airline tickets [D1] has decreased and also become more elastic [D2]. It becomes flatter, showing the higher price change responsiveness as potential passengers weigh alternative travel modes. This is represented by a decrease in price from [P1] (at [E1]) to [P2] (at [E2]). Oligopoly industry will reduce supply when it is motivated by changes in demand. In this figure, airlines reduce the supply of passenger seats by maintaining prices at [P3](at [E3]) and reduce cost.

figure 1.png

FIGURE 1

EFFECTS OF EXTERNALITIES

– GOVERNMENT POLICY OPTION

In 20 years time, there has been a dramatic growth of economy in the airline industry. From 125 billion of passengers in 1990, it had increased to 269 billion in 2000. Air freight grew at the rate of 9 % per year which is even faster. 32 million people is using the British airport in 1970, 260 million in 2004 and government predict it will be around 500 million in 2030. Factors that are affecting the rising of demand for airline travel are the emergency of low-cost flying and new technologies.

The external cost of flying is the damaged caused to the environment. According to Aviation ‘huge threat to CO2 aims’ (BBC), one return flight to Florida is producing carbon dioxide as a motor in a year. While a return flight to Australia is three cars in a year. Aviation is contributing 5% of carbon dioxide emissions to the UK. It is estimated that in 10 years time, airline industry will contribute 15%.

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Government introduced an aviation tax on airline to control the environment damage which is relatively increasing the airfares because the supplier’s cost of production had increased.

figure 3.pngFIGURE 2

Figure 2 show that when government implies tax on supplier, the airline industry will reduce its supply to reduce cost. The supply curve [S] will shifts upward and become [S1]. The supply will decrease from [Q1] to [Q2] and the price of airfares will increase to [P1].

EFFECTS OF TECHNOLOGICAL CHANGE

Technologies have changed the airline and consumer travel decision making. For example, by purchasing tickets through travel agencies is the long-term aspect of the airline industry.

Nowadays, most of the consumers know how to use the Internet. Computer Industry Almanac Press Release 2002 states that the invention of competitive direct airfares, on the both of individual airline and web sites of discount travel, has completely changed the usual way of marketing and tickets selling. Number of people who booked by using the Internet had increased, (Travel Industry Association of America Press Release 2002). This results in considerable cost savings for airlines, (Miller 1999). According to Miller 1999, Distribution had been reduced by the savings from Internet and selling cost is 10% lesser of the total cost of an airline. Consumers gain benefits from higher price transparency and choice of other large number of fares. On the other hand, the airline industry also gains benefits by the low cost online purchases.

The airline industry also affected by improvements in videoconferencing, webcasting, and other types of higher telecommunication technologies. Video conferencing is developing and increasingly available for some business travelers, and consumer, (Newman 2003). As an example, there are many online job interviews which can be done at a distance location by interviewing candidates, and students nowadays are taking classes from their home campus. Businesses conduct group meetings via streaming audio/video also saving the time and expense of airline fares, (Cope 2002).

PRICE DISCRIMINATION

Price discrimination is a price strategy that the low-cost airlines will follow. Customers are encouraged to book earlier by giving lower prices. Airline will gain benefits of knowing how many passenger seats will be taken and a source of cash-flow. Customers who book late are likely to be willing to pay at a much higher price. This is actually a concept of price elasticity of demand. Mackinac Center for Public Policy 1997 says that 85 % of all airline tickets purchased are for leisure travel and the elasticity of demand is a relatively high 2.4. Figure 3 shows the effect of price elasticity of consumers on total revenue.

figure 2.png

FIGURE 3

When the demand is elastic, the percentage change quantity demanded [Q1Q2] will be greater than the percentage change in price [P1P2]. This means that the total revenue after the decrease of price which is [0P1 E1 Q1] is greater than the total revenue before the decrease of price which is [0P1 E1 Q1]. As an example, sales are increased by 20% when fares are reduced by 8%. This proves that in this industry, consumers are greatly responsive to price changes.

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CONCLUSION

The changes in the airline industry have many important effects for consumer travel decision making. Airlines consumers can expect continuation of the current trends. Prices will be pressured down with increased of Internet ticket purchases, rise of ticket price due to aviation tax, transparency and competitions. For an example, in 2003, National Public Radio 2003 states that the duty tax on airline tickets was 22%, increased 8% in ten years time.

Airlines continue to cut costs by reducing or eliminating such as in-flight meals and newspapers. Some airlines that are likely to expand are increasing their profit by selling snacks and meals on flight. However, Newman 2003 states that technology advancement, such as individual television and data ports, need to be available for consumer, as airlines search for competitive ways to get passengers. On the other hand, according to Coy (2002) notes, even at reduced fares, the airlines industry need to fill every seat because unfilled seats represent lost revenue. To achieve the highest selling number of seats on every flight, airlines uses price discrimination in response to these economic incentives.

The increase of usage of videoconferencing, and other modes of transportation, for example the high-speed Acela trainhttp://kona.kontera.com/javascript/lib/imgs/grey_loader.gif that connects Washington, DC, to Boston is affecting the airline industries. Strassmann (1990), states that substitutes will leads to a greater impact on market power than the threat of other new and potential competitors.

When airline industry merged to correct the high capital, consumer will experience impact from airline industries, which will result in market failure of allocative inefficiency. Joining together might raise the market power of large joining airlines but such power will not go unchecked. Low-fare competitors are believed to enter the industry when they are attracted by potential profits. When the cost gap between low-cost carriers and bigger established airlines widens, the profit margin will increase and becomes more attractive for the vulnerable start-ups. They will fill in a small area of trade within the economy, at certain regions of the state or giving point to point contact to particular markets. Antitrust measures are needed to let new competitors to compete with existing oligopolists because low-fare transports are an effective curb against noncompetitive oligopolistic airline pricing.

Economic improvements, including increased numbers of competitors from new competitors of low-fare airlines, are leading the major airlines to become more efficient. Enhanced price transparency and extra time-efficient flight choices are the results in development in technology and industry practices. Despite this, the airline industry will always remain unstable. Some price raised is inevitable because of the increasing of costs such as the aviation tax. Therefore, traveling consumers will have both responsibilities in shaping and in becoming familiar to the big changes in the airline industry.

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