The airline industry: Predatory practices?

The airline industry: Predatory practices?

Lalu A. Damanhuri, Infrastructure Planning & Development Specialist,
Committee for Infrastructure Development Policy (KKPPI), Jakarta

With the promulgation of government regulation PP No. 40/95
concerning air transportation -- followed by a few ministerial
decrees -- a comprehensive legal framework for the development of
the airline industry is now in place.

The policy initiative and the legislation have paved the way
for new entrants in the air transportation industry. The ability
to serve new and growing markets, to fashion more extensive route
networks and to charge low fares had been severely constrained by
regulations.

These reconfigured services could be implemented in no small
degree due to innovations in technology that enabled the
development of sophisticated yield management systems.

Such systems allow airlines to offer and quickly change the
mix of high and low-fare seat capacity on any given flight, as
well as to manage both origin and destination traffic flow over
the entire network.

As the constraints on airline operations were lifted by
deregulation and the airlines quickly exercised their new route
and fare freedoms, consumers in many markets reaped substantial
benefits.

The benefits became less attributable to the actions of the
major network airlines and more attributable to the actions of a
small number of low-fare carriers. By the late 1990s, the major
airlines' domestic route networks had become fairly stable and
were built around hub airports dominated by a single or double
carrier.

These hub-based networks established geographic areas in which
each major network airline has substantial presence and market
power, especially in short-haul, smaller markets. Thus the
benefits of deregulation have increasingly come from competition
among major network carriers in long-haul markets and from lower
fares in short-haul markets served by low-fare carriers.

In many of the markets not served by low-fare carriers, the
benefits of deregulation may well be eroding. Entry by a low-fare
carrier either into the industry or into a new market is not
easy. New business ventures in all industries have a high failure
rate, and new airlines are no exception.

However, new airlines -- or established airlines entering new
markets -- must have an opportunity to compete for business on
the basis of the product or services they offer, rather than be
forced to contend with predatory practices by the incumbent
carriers.

An analysis of predatory practices has focused on predatory
pricing -- usually defined as a company pricing its product below
an appropriate measure of cost with the intent of driving a
financially weaker competitor out of business and establishing or
re-establishing monopoly power.

Defining the appropriate price to compare with the marginal or
average variable cost is also difficult. Airlines, of course,
charge multiple prices for the seats on a single flight.

Some differences in price are due to markedly different
service, such as first class, business class and economy class.
Other differences reflect discount fares and their various
restrictions.

The most common restriction requires an advance purchase, such
as Garuda. These restrictions mostly reflect attempts at price
discrimination by airlines to maximize revenue from a particular
flight by segmenting passengers according to their flexibility,
and charging those with less flexibility higher fares.

Because airlines have the potential to compete with multiple
tools, of which the ticket price is only one, a narrowly defined
predatory-pricing standard is almost certainly inadequate. Were
public policy to focus only on the ticket price, airlines would
have ample ways to engage in what are clearly predatory practices
without violating a narrow predatory pricing standard.

Similarly, because airlines compete through networks rather
than just in single city-pair markets, focusing only on the
market without considering the potential network effects is also
likely to be inadequate.

Conceptually, an airline could even engage in predatory
practices by making use of its network -- without changing its
behavior in any way in the specific city-pair market entered by
the new carrier.

The following table shows the fare offerings of the airlines
providing service on the Jakarta-Surabaya route. What is striking
is the degree of similarity in the fares offered by these major
carriers, particularly in the low-fare range.

While each airline uses different fare codes, the
corresponding fares are remarkably similar. In this market,
Garuda, Mandala and Bouraq offer several fares that do not seem
to have a counterpart with the other airlines, such as Indonesian
Air, Star Air and Pelita Air to a lesser extent. Also, Mandala
does not seem to offer the very highest first class fares. A
similar pattern prevails in other markets that were examined.

How can the airlines achieve this uniformity in their fare
offerings? The answer would appear to lie with the computer
reservations systems that allow competitors' prices to be
observed.

These fares are posted on the reservations systems well in
advance of any bookings made for these flights. The time lag
between posting the fares and booking any substantial number of
passengers gives each airline an opportunity to see what the
other airlines are charging and to make any needed adjustments.

There is no benefit from predatory behavior because the
airlines do not have the market power necessary to recoup the
losses incurred while driving a competitor out of the market. The
evidence clearly suggests that there is market power at some of
the major carriers' large hubs.

Some evidence of this market power is the persistence of fare
premiums at these hubs. Hub premiums represent the extent to
which fares to and from hub cities are higher than average fares
on similar routes throughout the domestic route system.

The characteristics of our airline industry, and the
persistence of market power at hub airports, make predatory
practices a recurring possibility in the domestic airline
industry. As such, they are a legitimate concern for competition
policy.

Because the presence of low-fare carrier service has such a
dramatic effect on hub premiums, predatory practices are
specially likely to be targeted at low-fare new entrants,
although such practices need not be confined to these situations.
Since many of the continuing gains from airline deregulation come
from the presence of low-fare carriers, an industry characterized
by vigorous opportunities for entry is essential for continuing
consumer gains.