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Competition and competition policy
- 1.1 Pricing strategy and competition
- 1.2 Analysing the market arena
- 1.3 Corporate strategy and market power
- 1.4 Competition
- 1.5 EU competition policy
This chapter will deal with the most important aspects of competition, competition law and competition law enforcement within Europe. This will be done, first of all, by means of a case study in which KLM and the airline market are introduced. Next, section 1.1 looks at the scope KLM has for adjusting its prices and how this ties in with the type of market in which it operates. Section 1.2 distances itself a little more from the case and explores the markets in which companies operate from various perspectives. Section 1.3 explores the relationship between corporate strategy and market power and the possibilities companies have to increase their market power. Next it is investigated in section 1.4 to what extent economic theories may help us in analysing market relations, particularly when there is full competition. Another aspect that is dealt with in this section is the way in which the European Union tries to increase internal competition by means of its internal market policy. Finally, section 1.5 provides a brief description of the way in which the EU uses its competition policy to respond to companiesā attempts to restrict competition among themselves and, possibly, abuse positions of power they have gained. Usually restriction of competition results in disadvantages for consumers and the economy as such, but this need not always be the case. In later chapters the above-mentioned subjects will be dealt with in greater detail.
Case study: KLM and the airline industry
The Royal Dutch Airline KLM, founded in 1919, has been operating within the holding company AIR FRANCE KLM since 2004. In the fiscal year 2008ā2009 the company realised a turnover of more than ā¬8 billion, employed a little over 36,000 people and carried 23.5 million passengers. Together with Air France it is the biggest airline in the world in terms of turnover.
The markets in which KLM operates are characterised by a number of features:
- There is a continuing process of liberalisation. The airline industry in the EU has been highly deregulated as a result of the creation of the internal market. In the past, governments had a significant influence over decisions on tariffs, granting, landing rights, etc., which resulted in only limited competition. Since the 1990s, however, the market has opened up. The so-called āopen skies agreementsā between the EU and the USA also contributed to this openness. At first agreements were made between the USA and individual EU countries, later on also between the USA and the EU as a whole.
- The lower entry barriers that were the result of this liberalisation have contributed to the rise of low-cost carriers such as Ryanair and easyJet.
- There is a strong move towards concentration. Many smaller companies (Belgian Sabena, for instance) have not been able to survive and other companies have merged and/or have concluded cooperation agreements. The merger of Air France and KLM is a case in point.
- Fuel prices have an important influence: the price increases of crude oil to a level of more than $150 a barrel (mid 2008) led to rocketing costs. In the third quarter of 2008, for example, Air France KLM reported an increase in fuel costs of ā¬498 million to ā¬1.6 billion (with a turnover of ā¬5.9 billion in the same quarter). Its reported loss over the fiscal year 2009ā2010 was largely attributed to increased fuel costs.
These developments mean that KLM is active in an environment with a lot of market turbulence. However, this does not mean that the degree of competition is the same on all routes. There are a number of routes on which competition is fierce, such as Amsterdam-London, and routes on which KLM faces hardly any competition, such as the Amsterdam-Paramaribo route.
1.1 Pricing strategy and competition
This section deals with the scope KLM has to make price adjustments. A distinction is made between the scope in a competitive market (the Amsterdam-London route) and the scope in a more monopolistic market (the Amsterdam-Paramaribo route).
Amsterdam-London, a competitive market
What is KLMās scope for setting the price in this market?
What KLM must take in to account is that travellers have numerous options. If they insist on travelling from Amsterdam to London Heathrow (Londonās main airport), KLM and British Airways offer the cheapest options, prices being approximately ā¬170 (2010). However, for travellers who are in a position to make use of alternative airports in London, easyJet offers flights at approximately ā¬85. And for travellers able to depart from Eindhoven airport instead of Amsterdam, Ryanair offers flights at ā¬59.
This may lead to the following considerations for KLM:
- Competition on short-haul routes is fierce. At the moment, KLM still attracts passengers who do not opt for one of the cost-cutters on the basis of the service offered by KLM and because of its reputation.
- Competition is not restricted to the Amsterdam-London route. Passengers will have fewer problems than in the past diverting to smaller airports, also because checking in and out at such airports takes less time.
- Competition is not restricted to other airline companies. Especially in the tourist market, the Channel Tunnel route (Calais-Folkestone) is a serious alternative for train travellers and motorists. To a somewhat lesser extent this also holds good for the crossing by ferry.
- The recession (from 2009) puts pressure on passenger numbers.
- Fuel prices are constantly going up and down. The question is to what extent the competition will include these changes in its pricing policy.
- Besides a decision about the prices to be charged, KLM should also reach a decision about the capacity (number of aircraft) to be employed on routes like these.
The conclusion following these considerations can only be that any price adjustments by KLM should be implemented with the greatest caution.
Amsterdam-Paramaribo, a 'monopolistic' market
The situation for KLM on the Amsterdam-Paramaribo route is of an entirely different order than for the route sketched above. Paramaribo is the capital of Surinam (South America), a former colony of the Netherlands. The route is used fairly often for family visits by Dutch people of Surinamese extraction.
In the summer season the price of a return ticket is around ā¬1,200.
The following considerations might be made:
- It was laid down in an agreement between the Dutch and Surinam governments in 1990 (valid until 2006) that KLM and Surinam Airways were to be the only airlines allowed to offer flights on this direct route. In practice KLM operated the flights in a joint venture with Surinam Airways (SLM). In 2006 this cooperation ended and it was agreed that other airlines would also be allowed to offer flights. Until now, though, KLM and SLM are still the only airlines to offer direct flights.
- Besides the direct routes there are indirect alternatives. However, possibilities are limited and considerably more expensive. A round trip with Delta Airlines, for instance (via Toronto and Port of Spain in Trinidad and Tobago), costs nearly ā¬3,000 (May 2010).
- For years now KLM has been under pressure from groups such as the Surinamese-Dutch association SHIVA and the Travellersā Association (Vereniging van Reizigers (VVR)), who accuse KLM of applying excessively high tariffs. In the past these groups pointed out that a round trip Amsterdam-Jakarta (Indonesia) was much cheaper while the distance is almost twice as great. (In 2010, however, this was much less the case: a round trip Amsterdam-Jakarta cost approximately ā¬1,150). The Travellersā Association also complained of the poor availability of flights, especially during the holiday season. As early as 1998 SHIVA lodged complaints about this with the Netherlands Competition Authority (NMa), but these complaints were rejected in 2001. In its ruling in 2001 the Authority concluded that KLM and SLM occupied a monopoly position on the non-stop route Amsterdam-Paramaribo by dint of their cooperation, but it did not find that this was a violation of the legal prohibition on an economic position of power by KLM/SLM. In 2003 the Travellersā Association lodged another complaint, which was in the first instance rejected by the Competition Authority in 2004 and again in 2006. However, an appeal by the Travellersā Association in August 2010 resulted in this case being considered once more by the Competition Authority.
- The majority of the flights on the Amsterdam-Paramaribo route are taken for family visits. Although the alternatives are limited, there certainly is a degree of price sensitivity: if tariffs are too high, people will decide to cancel their planned visit.
- Also for flights like these, there is the consideration that a recession will lead to less air traffic.
- Finally, KLM will have to decide if they are going to adjust the number of flights on this route, in other words deploy more or fewer aircraft.
Conclusion
KLM has more scope to change prices on a route on which there is little competition, for whatever reason, than on a route where competition is fierce (Amsterdam-London, for instance). This conclusion is open to generalisation: in a market with restricted competition a company has more freedom to set prices than in a market with fierce competition. As will be demonstrated later in this book, this does not mean that a company has an open field in the case of restricted competition. Obviously, it will have to include the (price) behaviour of consumers in its considerations. Nevertheless, it is attractive for a company to restrict competition as much as possible. In section 1.3 it will be discussed what kind of methods a company may employ in this.
1.2 Analysing the market arena
In this section we will take a somewhat more detached look at the market situation, following the initial analysis of KLMās scope to adjust prices.
The approach will be of a more general nature and it will be investigated how economic theories may help to get a better insight into companies that find themselves in such a situation. In the first place, in 1.2.1, an analysis will be made of a number of factors that influence a companyās power in a market. Next, in 1.2.2, the influence of the market type on a companyās power is discussed. In 1.2.3. the value chain concept developed by the American economist Porter is dealt with, and 1.2.4 discusses the analytical model of the Five Forces, also developed by Porter.
1.2.1 Market power
It is clear that the market situation for KLM is rather different in the two markets described: in one market (Amsterdam-London) there is intense competition and in the other (Amsterdam-Paramaribo) KLM practically has a monopoly. There is a difference in KLMās power in the two markets.
Price elasticity of demand
In economic theory, market power is defined as the extent to which a company is able to set its price above marginal costs. Marginal costs are the costs of producing an extra product unit. This market power is related to the price elasticity of the required quantity enjoyed by the company.
CASE STUDY 1.1 ELASTICITY
Elasticity is a measure of the sensitivity of a variable to a change in another variable. The price elasticity of demand shows to what degree the demand for a commodity is sensitive to price changes:
Usually the price elasticity of demand is negative: a price increase will result in diminished demand.
If Pe is between 0 and ā1, the demand price is inelastic: a price change results in a relatively smaller change in demand.
If Pe is ā1 or smaller (ā2 or ā3, for example), the demand price is elastic: a price change will result in a relatively bigger change in demand.
Price elasticity is often defined in absolute terms: the minus sign is left out.
Price elasticity is only one of the forms of elasticity. Any link between two variables may be expressed in terms of elasticity, such as the income elasticity of demand or the interest elasticity of investments.
In the case of elastic demand a companyās scope to increase prices is limited: consumers have various alternatives at their disposal. In the first place consumers may go to direct competitors (other airlines), but they also have the opportunity to use less direct alternatives (train, boat) and they may even decide to postpone the journey or cancel it. In the case of inelastic demand alternatives are less readily available. In our example of KLMās Amsterdam-Paramaribo route, alternatives are limited: there are no direct competitors. Consumers may decide to travel on an indirect route (via New York, for example) or go by boat; however, this a hardly a realistic alternative on account of the extra time involved. Here, too, though, at worst consumers may cancel th...
