CHAPTER 4: ECONOMIC CHARACTERISTICS OF AIRLINES

What are some other "Unique Economic Characteristics"?

1. Government Financial Support 2. High Technology Turnover 3. High Labour and Fuel Expenses 4. The Competitive Advantage of Schedule Frequency 5. Excess Capacity and Low Marginal Costs 6. Sensitivity to Economic Fluctuations 7. Government Regulation

Why does "Price Rigidity and Non-Price Competition" occur in an oligopolistic industry? (like the airline industry)

Firms in an oligopolistic industry find it easier to maintain constant prices rather than rocking the boat due to mutual dependence and fear of price wars. As such, carriers then compete in the non-price arena, using advertising and increased customer service to gain market share. Price reductions only occur due to severe pressures resulting from weakened demand and excessive capacity.

How are "Higher Barriers to Entry" applicable in the airline industry?

Access to many markets have become extremely difficult in the late 1990s because of the difficulty of obtaining terminal space at hub airports and risks associated with competing with airlines at one of their hubs. Start-up costs to provide competitive level of service at a hub is substantial. Includes: - Expenditure for advertisement - Personnel - Aircraft, etc. It is difficult to compete with a major carrier due to his extensive network which allows him increase service (additional flights) at lower costs. New entrant would hence face the incumbent airlines predatory pricing strategy. Dominant airlines associated with some hubs tend to control usage of airports, hence impeding new airlines to obtain slots and terminal capacity

How is "Mutual Dependence" applicable in the airline industry?

Airline competitors are mutually dependent in service, pricing, routes, etc. The mutual dependence in pricing has led to the climate of predatory pricing, price wars, and have resulted in dramatically reduced net profits. Today, 90% of passengers pay an average of 30% of the full price of service.

What are the general characteristics of an oligopoly?

An oligopoly is an industry comprising of very few firms providing similar or differentiated services. Other characteristics are: 1. Higher barriers to entry 2. Substantial economies of scale 3. Growth through merger 4. Mutual dependence 5. Price rigidity and non-price competition

Define "Economies of Scale". How can they be achieved?

EOS means that a firm's long-term average costs decrease as the the size of its operations increase. Airlines must have a large volume of production in order to lower the cost per unit of output and to achieve economies of scale in production. EOS can be achieved by: - Labour specialisation - Management specialisation - Effective utilisation of technology - Effective utilisation of by-products.

Describe "Excess Capacity and Lower Marginal Costs"

Excessive capacity mean that at least 1/3 of ASMs remain unsold with no shelf life. The demand of consumers for schedule frequency provides excess capacity that has no shelf life, further increasing costs. The demand of consumers for lower prices and the perception that air transportation is virtually an undifferentiated commodity drives prices down to the level that often fail to cover fully allocated costs.

Why has there been a tendency towards mergers in oligopolistic industries over the years? What are some of the reasons air carriers have merged?

Many of the oligopolies that exist today have resulted from mergers of competing firms over the years. Companies merge to gain substantial increase in market share, greater economies of scale, greater purchasing power in the purchase of resources, and various other advantages smaller firms do not possess to the same extent. Reasons why air carriers have merged is to: - Purchase the entire structure of another carrier - Eliminate possibility of bankruptcy in the case of one of hte carriers - Eliminate competition in certain route segments - Reduce seasonality problems where one carrier's route complement the other's. - Enhance service by reducing transaction cost.

Describe "The Competitive Advantage of Schedule Frequency".

The effect of a slight change in departure on a customer's buying behavior creates a powerful incentive for airlines to increase flight frequency, even when there is spare capacity on existing flights. When an airline enjoys a schedule frequency advantage over another on a particular route, the competitive value of that advantage is more than proportional. Customers perceive the more frequent service as offering them greater flexibility to change their plans at the last minute. Hub-and-spoke system provides more convenient services between cities, and the introduction of a new route would create enormous range of products and competitions.