International Cartel Of The Airline Industry Economics Essay
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Published: Mon, 5 Dec 2016
In layman’s term cartel is an agreement between rival businesses or firms on not to compete with each other. They are kept classified and discussions take place informally. The most common aspect of cartelisation is price fixing. The other aspects are limiting productivity, hoarding, bid rigging, output levels etc. In economics terminology, cartel usually happens in an Oligopolistic environment especially in Collusive Oligopoly. Oligopoly refers to an industry environment where few firms dominate and recognise the rivalry and interdependence of each other. For every action taken by a firm there will be counter strategies by the other. Cartels generally operate in Collusive Oligopoly.
In non collusive oligopoly a firm when devising strategies will use random or planned guesswork and calculations to handle reactions from rivals and consumers whereas in collusive oligopoly it is centrally commanded by a group of firms. OPEC is one of the best known examples of all cartels. They determine the costs for aircraft turbine fuel and other aircraft fuel essentials which are then transferred to the airline industry which then affects the end user. Cartels act as single firms to maximise profits.
‘Paradox’ is the most common one word description by economists for the aviation industry. Ever since the advent of aviation it has always seen continuous and rapid growth in demand for services. Any business or industry will do their best to make hay when sun shines, however the airlines has always been marginally profitable.
The low cost carriers, on the other hand, with a shaky start in the beginning seemed economically profitable as compared to the regular service providers. No- frills strategy is to deliver the core product. The core product for airlines would be to transport passengers from A to B. No major focus is laid on delicious food, seats that would normally come with a full serviced flight. The European airline industry is more popular with low cost brand names like Easyjet and Ryanair.
The discussion further, is about a cartel that has been in operation in the no-frills European airline sector for the past 5 years. The objective is to discuss the factors that will end collusion amongst the members and to evaluate strategies that will keep the cartel from breaking apart.
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices or would be consistent with liberty and justice.”
Adam Smith, The Wealth of Nations, 1776
Cartel operations are always known to be short lived. The ever present incentive to cheat amongst the members of a cartel has always lead to withdrawal for firms, and eventually disbanding the cartel. Individual firms or oligopolist, in collusion will always have desire to cut down price or sell more than what the cartel has agreed.
No frills airline have short haul flights and always had one class of service unless a flight more than two hours long may have two or more class of service. On a single class of service, cartel members may decide to have a standard price with minor disparities depending on whether the flight is at off peak or peak hours of service. At seasonal periods the unexpected huge rush may favour a particular airline that has better scheduling. This may incite or tempt the other competitors to join in the foray breaking all the informal agreements. This would be done by assessing past experience of company or could possibly be the counter measure for surprises thrown by cartel members. This would also lead to price discrimination for the consumer since a particular route frequented by several no-frills carriers are being charged exorbitantly high and vary from one service provider to another.
And those airlines predicting misfortune that they have to fly empty seats may drop the prices all together ensuring marginal revenue resulting in further price conflict among cartel members.
In an oligopolistic environment, few no-frills airlines that are not dominant will be a ‘price taker’ because of small fleet size and low passenger load factor it will not have any major contributions to a particular routing. Reasons could vary from off peak routing to poor scheduling of flights. Even if it did make any kinds of additional revenue it will only equate to marginal revenue. This could lead for a smaller airline to pull out from the cartel.
“Game theory is sort of an umbrella or ‘unified field’ theory for the rational side of social science, where social is interpreted broadly, to include human as well as non-human players. ” (Aumann 1987)
The objective of game theory is to give everybody in the cartel equilibrium. It provides strategies for airlines from the host of options available to make the right choice for the optimum outcome. However, it can be highly unpredictable if an airline adopts a completely different strategy. This would jeopardise the entire decision making for the businesses and hence the cartel.
In a cartel, at least one or two airlines will have better standing in terms of fleet size, support functions like baggage, ramp handlers etc and other such necessities to run an airline business. Big carriers like Ryanair will be able to get ground support services at cheaper prices since they provide larger contracts. In the event of a recession, established firms will try adopting one policy option or its dominant strategy that will be best suited for them against the interest of the cartel. They are able to do this because of the strong support units from vendors which allow them stay afloat with marginal revenue.
Equilibrium for cartel firms will only emerge when all airline companies are happy with their present strategies based on what their rivals have adopted. For Airline industry profits have always been seasonal. This makes the predicting the markets continuously unstable.
Cartels fear the potential entrance of new firms eating into the market share. There is a huge demand in the airlines industry which invites new players in the market. To avoid any further competition established firms or airlines would increase their fares to the highest price. This strategy, they believe, can charge their passengers without inducing new firms in to the competition. However, smaller players in the cartel are also at the receiving end of such a strategy.
Other factors that also lead to the disintegration of cartel are low demand, competition outside the cartel, diversification into a full service or charter service, government or legislative restrictions etc. Government restrictions appear when low cost carriers may involve operations in more than one country. Weather is also one of the factors that may contribute for firm to break away from a cartel. The recent ash cloud crisis in the European aerospace resulted in $ 1.8 billion loss in revenue by the European carriers. This would mean a big impact for small carriers in the no-frills sector.
The best interest for all players in a cartel is to remain in collusion. When they come together they will be able to maximise their profits in aviation industry. Cartels are able to last long provided they are effective enough.
Collusion will be effective when there are few players in the market. Fewer airlines mean they can co-ordinate very well and reduce the level of uncertainty. The rivals in cartel will not have to worry about any surprises strategies by rest. They will be able to monitor each other very well since they share same airports. The ground staff is outsourced and most airlines will have the same vendor. The flight operations, scheduling will all be on the lines of the agreement. Collusion with fewer members will help them agree on price, market share, sales promotion and expenditure. Fewer firms also mean larger market share and high individual pay-offs. However if the cartel players are unable to restrict entry of new players the market share for individual players are reduced and cheating is back on everyone ones mind.
Airlines industry does not always have a stable demand year round. The cartel industry needs to strategies operations in consultation with all cartel members on flight operations during poor demand. This would help all airline members to reorganise and replan, not just with better flight scheduling but also concentrating on other aspects like aircraft maintenance, crew trainings, product improvisation etc.
The objective for firms to form a cartel is to limit competition and increase profits. Airlines would need to set a monopolistic agenda by restricting output and increasing price. They may set fewer flights in a particular sector and raise fares. This would help all cartel members maximise profits. Cartel members should operate the industry in equilibrium. Equilibrium must help the airliners increase fares among the profitable routes and at the same time allocating less profiting sector among all players fairly. It should also provide a methodology or mechanism to distribute the less profitable routes amongst all players. No-frills airlines may introduce an incentive structure that may reward based on monitoring each airline for their operations based on the agreed rules. They may also penalise to prevent any kind of cheating. Repeated interaction by the no-frills players for future collusive benefits may also deter cheating.
Every cartel will have a major player. Major players in no-frills airline business like Ryanair are able to command a price because of the dominant position in the no-frills sector. This makes Ryanair the price leader in the sector. Collusion may take place informally by smaller players recognising the fares setters in the industry and will act as followers. This may help smaller airlines maximise their profits since they can be assured the fare hike is in line with the industry standards and justified. Cartels may also collude together and raise ticket fares simultaneously. Such a phenomenon is common in the fuel industry and also difficult to distinguish. At times a smaller airline may also be known to have good knowledge on pricing trends in the industry they will also be followed by other cartel members. It is known as barometric price leadership.
Organisational mechanisms or structures can also be introduced in a cartel. The structure would be like those of any organisation. The mechanism should incorporate external fluctuations like environment, government restrictions, fuel prices etc. For no-frills sector costs need to be kept very low. Environment and fuel hikes leave major impact on revenue. The mechanisms could involve negotiations on cost of fuel which could be provided at subsidised rates to every airliner. No-frills airlines need to make significant investment in the development of organisational mechanisms and organisational skills so that it makes cheating a secondary issue and is deemed inappropriate future action by the members.
Research says that some cartels last on an average of 5 years. However, variance in the duration is high for several other cartels. The no-frills airline cartels need to address problems of co-ordination, cheating and entry. Cartels that are able to introduce organisational mechanisms among the members are able to progress as successfully.
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