The airline industry is known to be the fastest mode of transportation throughout the United States. Consumers are constantly trying to find cheaper fares, while airliners are constantly analyzing consumer’s trends to decide how to charge fares. Airliners ultimate goal is to increase revenue. Sometimes the increase can lead to bad service and unfriendly competitive practices. The present day airline industry is dominated by larger air carriers.
This paper will discuss why the airline industry has developed into an oligopoly, how price wars historically affected main carriers, why many startup carriers failed, and the advantages of price setting, variation in seat pricing and the advantages of collision of larger airlines. History The first successful flight occurred in 1903 with the Wright brothers in Kitty Hawk, North Carolina. This marked the beginning of the aviation industry. At first airplane travel was not popular. After the U. S. involvement in World War 1, the airline industry’s growth stagnated until 1927.
When Charles Lindberg successfully completed a solo flight across the Atlantic Ocean the industry began to evolve. A variety of air transport holding companies began to form, including American Airways, now know as American Airlines. In 1928, the Boeing Company and the United Aircraft and Transportation Corporation were developed. The United Aircraft and Transportation Corporation merged to form the United Airlines. A major growth of the industry occurred with the development of the mail transport system by the United States Postal System.
The Kelly Airmail Act of 1925, allowed private airlines to have the opportunity to function as mail carriers through competitive bids. This expanded the opportunities of carrying other forms of cargo, including passengers. In 1926, because of the massive amount of air traffic, the Air Commerce Act was passed and it allowed Federal regulations of air traffic rules to provide safety. There was not a lot of support to allow for research and development of aircrafts and air space. It was not until the World War II, where enough support was generated. Research provided a way for aircrafts to evolve into a more modernized industry.
There were still many air collisions, due to the fact that there was a lack of an accurate system in place, which could monitor the air traffic precisely. This flaw allowed for the founding of the Federal Aviation System and this agency was charged to develop the air traffic control system, to minimize air collisions. In the years to follow, the number of passengers, and the cost of fuel increased dramatically. The Deregulation of 1978 brought the growth of smaller air carriers and mergers of the larger carriers. This act also marked the beginning of the air industry as it presently stands today.
The Airline Deregulation Act Of 1978 Over the past 30 years, the airline industry has navigated away from the controlling over regulation strategies to almost no regulation at all. In the 1980’s, the Airline Deregulation Act was signed into law. The goals of the act were: to keep safety a priority; maximize reliance on competition in air transportation; avoid industry concentration, unreasonable increased prices, reduce service and exclusion of competition; and to encourage entry of new air carriers. This act contributed to the removal of government control over fares, routes, and market entry.
The FAA still had regulatory powers over all aspects of airline safety, but the Civil Aeronautics Board (CAB) powers of regulation were eventually phased out. The CAB regulated all domestic interstate air transport route as a public utility. It set the airline fares; routes travelled, and set schedules. As a result of the act fare prices were lower, passenger loads has risen, and aircrafts can go on longer routes. Costs had also fallen and competition had increased dramatically. Various conflicts with labor unions for many carriers, there were many airliners that went bankrupt or liquidated due to deregulation.
Point-to-point transport had declined in favor of the hub and spoke system for some until the growth of the low cost airlines. Southwest and Air Tran still dominate the airline industry to the present date. When these airlines started to multiply, they brought back the point to point service and they contributed to the development of wider range aircrafts types that are better and adaptable to various markets. Deregulation opened the opportunities for new jobs and new competition. Ticket prices were down because of the new competition. Service improved and the airline market expanded.
There were also negative aspects to the act also. The act gave way to bitter price wars and contributed to a major wage inequality. Airlines began to cut costs to maximize profit, and that had a major impact on the wages of employees. There were many layoffs, retirement benefits were reduced, and new employees were hired at lower wages, all in the hopes of maximizing profits. The Living Wage Act was established to help those that were at the bottom of the “wage pool”. The living wage was, “a wage sufficient to provide the necessities and comforts essential to an acceptable standard of living” (Merriam-Webster Dictionary, 2010).
Deregulation, opened the doors for many opportunities, good and bad. Oligopolies, start-up failures, unofficial price setting, variations in seat prices, and collusions are all products of deregulation. Airline Oligopoly The airline industry has developed into an oligopoly with several large carriers and numerous smaller carriers in many ways. The initial premise for the oligopoly was that larger the airlines would equate to greater efficiency, improved service and lower fares. A lot has to do with the deregulation act that permitted this oligopoly to occur.
An oligopoly occurs when there are a number of major suppliers and they act strategically in the market based on the how the other suppliers make decisions. In the airline industry this is shown when one airline announces a fare increase to see if the other airliners would increase there fares. If there is not enough bite to the bait, the first airline then cancels the fare hike. An oligopoly of the airline industry causes a non competitive state and fewer airlines. Dominant airlines know that they would not have to compete for routes because they are the only option, especially in the hub and spoke markets.
Airline Industry Price Wars After the deregulation of the airline industry, competition amongst the airlines has become very fierce. In the regulated environment, most of the cost increases were passed to consumers based on a fixed rate of return from pricing scheme. Labor unions had more power in the regulated environment. Newer carriers were able to compete with the established carriers, until the consolidation of the larger airlines began. Competition has resulted in lower air fares, frequent flier programs and has increased service frequency.
Many airlines have gone out of business due to the fierce competition that can also be labeled as price wars, especially the newer airlines that were developed right after deregulation. A price war is the most severe form of competition in the market place, resulting in great losses (Heil and Helsen, 2001). Consumers are the only ones to benefit from a price war in the airline industry. They may have the lower fares, but they may also be losing out on quality of service. Historically, price wars have affected the main carriers by making them to lower their fares to compete with the smaller carriers.
It has also caused the oligopoly of the larger carriers. Airline Startups Many startup carriers have failed historically because of the oligopoly that exists between the larger carriers within the airline industry, and the hub and spoke systems that are strategically in place. After deregulation, the barrier to entry into the airline industry was lowered and made it possible for new airliners to start up. They were able to easily obtain funding; aircrafts contracted hangar and maintenance services, trained new employees and recruited old staff that was laid off from other airlines.
Once normal business practices occurred the new start up airlines found it hard to compete with the larger airliners. The larger airliners began price wars and offered additional seats to dominate their routes. At the present time, the established carriers make it really hard for a new start up. The hub and spoke program plays a role in this. Since the FAA has given permission and restricts the number of takeoffs and landings during peak hours, established carriers will not give their slots up for any new comer (Labich, 1989). New entrants are not welcomed into the airline industry by larger carriers.
Larger carriers often hold long-term clauses allowing for clauses that allow them to control the construction of gates and other ground facilities that might accommodate a new start up airliner (Labich, 1989). There are many barriers to a new start up airliner, not to mention the fact that many larger airliners hold veto power over the new competition (Labich, 1989). Advantages Unofficial Price Setting The advantage to unofficial price setting in the airline industry is more revenue Airlines are inclined to assign prices for their services and to maximize their revenue profitability.
The prices are determined by utilizing a computerized system that monitor trends, and they anticipate and influence consumer behavior. The computerized reservation system performs analysis on various pricing structure. Unofficial price setting allows the airlines to change fares based on the trends of consumer interests. It also allows them to compete for consumers by lower their prices in comparison to their competitors. The frequent flier program is another way that airliners can use unofficial price setting to their advantage.
Consumers may feel loyal to the airline with this program because of the incentives that are offered. The airline can charge prices based on the fact that many passengers are willing to pay high prices knowing that they will receive some sort of incentive at a certain point and time. Variation in Seating Pricing There are a lot of variations in seat pricing because of the break even load factor. This states that the average percentage of seats that must be filled on an average flight at the current average fare for the airlines revenue to break even with the airline’s operating costs (Bureau of Transportation Statistics).
The break even factor makes airliners to charge various prices for their seats because they want to be able to break even with their operating costs. More seating room on a plane means more money would be paid for the seat. The computer reserve system can initiate price discrimination on seating prices, allowing the airliner to charge the highest price that they could without losing the consumer. First class seating offers more room, food and drink incentives, coach seating offers nothing but a cheaper fare. Some consumers are willing to pay more to be comfortable on their flights.
Through market analysis, airliners know that fact and set their seat prices to the market trends. Overbooking of seats is done by observing past behavior of consumers. Airliners can legally overbook a flight allowing more passengers to pay for seats that are not available. To eventually push a paying passenger off to a later flight. Overbooking is done to compensate revenue during hard economic times. Collusion of the Larger Carriers The collusion of larger carriers can be a major advantage over the smaller carriers.
Airline collusion is usually done through the computerized reservation system by means of price signaling. This tactic usually involves two or more airlines that raise their prices at the same time so there can be an equal profit. Smaller carriers suffer because they may lose their sales and have to declare bankruptcy. Collusion of the larger carriers can ultimately ruin the smaller carriers out of business, like it has been done in the past. The dominant airlines can raise their prices at the same time so every one can receive a profit.
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