Liberalization in Aviation

Competition, Cooperation and Public Policy

Hartmut Wolf, Peter Forsyth, David Gillen, Kai Hüschelrath, Hans-Martin Niemeier, Hartmut Wolf, Peter Forsyth, David Gillen, Kai Hüschelrath, Hans-Martin Niemeier

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317105428
• Edition: 1
• Topic: Business
• Subtopic: Transportation Industry
• Index: Business

The last few decades have witnessed substantial liberalization trends in various industries and countries. Starting with the deregulation of the US airline industry in 1978, regulatory restructuring took place in further network industries such as telecommunications, electricity or railways in various countries around the world. Although most of the liberalization movements were initially triggered by the worrying performances of the respective regulatory frameworks, increases in competition and corresponding improvements in allocative and productive efficiency were typically associated with the respective liberalization efforts. From an academic perspective, the transition from regulated industries to liberalized industries has attracted a substantial amount of research reflected in many books and research articles which can be distilled to three main questions: (1) What are the forces that have given rise to regulatory reform? (2) What is the structure of the regulatory change which has occurred to date and is likely to occur in the immediate future? (3) What have been the effects on industry efficiency, prices and profits of the reforms which have occurred to date? Liberalization in Aviation brings together renowned academics and practitioners from around the world to address all three questions and draw policy conclusions. The book is divided into five sections, in turn dealing with aspects of competition in various liberalized markets, the emergence and growth of low-cost carriers, horizontal mergers and alliances, infrastructures, and concluding with economic assessments of liberalization steps so far and proposed steps in the future.

Chapter 1
Introduction and Overview

Peter Forsyth, David Gillen, Kai Hüschelrath, Hans-Martin Niemeier and Hartmut Wolf

In the last few decades, we have witnessed substantial liberalization trends in various industries, and in many countries around the world. Starting with the deregulation of the US airline industry in 1978, regulatory restructuring took place in many network industries such as telecommunications, electricity and railways. Most of the liberalization movements were initially triggered by the poor performance of existing regulatory frameworks: however, increases in competition, and the corresponding improvements in allocative and productive efficiency, are more typically associated with liberalization efforts.

From an academic perspective, the transition from regulated industries to liberalized industries has attracted a substantial amount of research, evidenced by the many books and research articles published on the subject. Although numerous ways to investigate regulation and deregulation processes are available, Perl’s methodology (1997) condenses them in to three main questions:

1. What are the forces that have given rise to regulatory reform?

2. What is the structure of the regulatory change that has occurred to date, and what is likely to occur in the immediate future?

3. What have the effects been on industry efficiency, prices and profits, of the reforms that have occurred to date?

This book addresses all three questions. The largely completed liberalization process of national aviation markets leads to a focus on the assessment of the effects on variables such as efficiency, prices, or profits. On the other hand, the partially regulated nature of international markets demands an assessment of both the forces that have given rise to regulatory reform, and the state and future development of future liberalization efforts.

Although this book provides insights on a broad range of topics related to aviation liberalization in various parts of the world, it is beyond the scope to cover all relevant areas in detail. Previous German Aviation Research Society books provide detailed coverage of specific topics such as the economic regulation of airports, competition and predation in aviation markets, airport slots and airport competition.1 Readers who are particularly interested in these topics will find our previous books useful complements to this one.

The contributions in this book are subdivided into five sections.

Part A, Liberalization and Airline Competition, is comprised of articles on various aspects of competition in liberalized airline markets, including the patterns and effects of entry, product differentiation strategies, competition in connecting markets and on thin (former) monopolized routes, failure of a national carrier, and the implications of competition on airline safety.

Part B, Liberalization and Low-cost Airline Competition, specifically focuses on the emergence and growth of low-cost carriers as one of the most important developments in the post-liberalization era in many countries around the world. The articles focus on the evolution of low-cost carriers in general, and their competitive (pricing) strategies in particular.

Although the liberalization of airline markets is aimed at increasing competition, cooperation among competitors is not necessarily bad. Cooperation might very well have the potential to improve performance and/or consumer welfare. Cooperation among airlines could take place in various areas and take various forms, and the focus of the articles in Part C of the book, Liberalization and Airline Cooperation, is horizontal mergers and alliances.

Access to infrastructure is a key precondition for workable competition in airline markets. If infrastructure capacities cannot meet the increase in demand following liberalization, and if existing infrastructure capacities are allocated by inefficient mechanisms, the benefits of competition are substantially reduced. Part D, Liberalization and Infrastructure, concentrates on selected infrastructure topics such as airport financial performance, ground handling and air navigation systems.

Although most national aviation markets have been liberalized in the last few decades, international aviation remains (at least partially) a regulated area. Part E, Liberalization and Public Policy, offers economic assessments of liberalization efforts to date, and also proposes ways that future liberalization can proceed.

Part A: Liberalization and Airline Cooperation

The deregulation of airline markets is generally aimed at encouraging competition, thereby realizing lower fares and improved services. The contributions in Part A study the many aspects of competition in various liberalized airline markets including patterns of entry and their effects, product differentiation strategies, competition in connecting markets and on thin (former) monopolized routes, the failure of a national carrier, and the implications of liberalization and competition on airline safety.

Chapter 2: Hüschelrath and Müller used T-100 traffic data and DB1B fare data from the US Department of Transportation to identify recent trends in the evolution of the domestic US airline industry. They also identified the patterns of entry and the effects of entry by network carriers, and low-cost carriers in particular. For the sample period from 1995 to 2009 they found that competition by low-cost carriers had a significant, competition-enhancing impact on the various characteristics of market structure and market performance. In particular, the entry activity of low-cost carriers also led to substantial fare reductions of, on average, 25 per cent for entries into monopoly markets. As route entries by network carriers do not show comparable effects, the existence and expansion of low-cost carriers must be considered as the main driver of competition in the domestic US airline industry.

Chapter 3: Fröhlich and Niemeier investigate the applicability of the economic theory of product differentiation to the airline industry. They seek to explore the product choices, the competitive strategies and the dynamic evolution of competition among airlines through the lens of models of product differentiation. While the chapter’s aim is not to look for the model of product differentiation, it points out what the models can be used for and under what circumstances they are applicable. The authors conclude that the extent to which airlines differentiate vertically is limited to the extent of available airport capacity and the particularities of the market. Although the chapter provides examples from European markets, the models of product differentiation might also shed some light on the dynamic developments in other markets.

Chapter 4: Lieshout and Burghouwt analyse airline competition in connecting markets. They build on the insight that the rise of hub-and-spoke networks has changed the way in which airlines and airports compete. Competition not only takes place in a direct way, but also in an indirect way. Therefore indirect connections should be taken into account when calculating competition levels. In particular, the authors describe a methodology to measure competition, taking into account both direct and indirect connections. The methodology is then applied to estimate the competition levels on connecting routes via the 13 largest European hubs. It is shown, for example, that connecting flights via Lisbon and Madrid experience the least competition, in particular with respect to connections to and from Latin America. For a large part, this has to do with the geographical location of these hubs as well as the socio-economic and socio-political relationships between Spain/Portugal and various Latin American countries. The carriers of the Star alliance at the Lisbon airport, and the oneworld alliance at the Madrid airport are expected to achieve high yields in these connecting markets. On the contrary, the connecting flights via Zurich and Heathrow, on average, experience relatively fierce competition. As Zurich and Heathrow airports mainly serve the larger European destinations, competition on most of the connecting routes is high and yields are expected to be low.

Chapter 5: Fageda is specifically interested in the effects of airline competition on thin routes. Using data for Spanish airline routes for the period 2001–2008, he finds a decrease in the proportion of routes that are monopoly routes, and a reduction in the traffic levels that would be needed to break up monopolies. An estimation of pricing and frequency equations for those routes that were monopolies in 2001 shows that the increase in competition has implied lower prices and higher frequencies. The magnitude of the effect is significant both from an economic and statistical point of view.

Chapter 6: Beria, Niemeier and Fröhlich analyse the case of Alitalia, Italy’s former flag carrier, as a case in point of a state-managed carrier failing due to the state’s behaviour. The chapter starts with a historical overview of the most important events in recent Alitalia history. Thereafter, the main causes of the airline’s weak competitive position relative to other European carriers are analysed. The authors argue that the underlying cause of the decline of Alitalia was the continuous political protection, the lack of a strategic vision in favour of short-term objectives and, in some cases in the past, poor managerial decisions.

Chapter 7: Papatheodrou, Polychroniadis and Kapturski investigate the relationship between airline market deregulation and safety, from both a theoretical and an empirical perspective. Their end result is rather inconclusive as the theoretical arguments take different directions: parts of the literature seem to support the view that liberalization had adverse effects on safety, while other authors believe that the implications for safety have been largely positive. Likewise, the empirical analysis is not conclusive on the existence of a systematic statistical pattern. Whether this is the result of relying on data that does not reveal the full complexity of the issue or is just the ultimate truth is not known. To complicate things even further, a lack of systematic behaviour may just be the result of countervailing powers (i.e. positive and negative implications) acting with the same intensity.

Part B: Liberalization and Low-cost Airline Competition

The emergence and growth of low-cost carriers (LCCs) must be considered as one of the most important developments in the post-liberalization era of aviation. In order to acknowledge this key role, the second part of the book is devoted to studies that focus on the evolution of low-cost carriers in general, and their competitive (pricing) strategies in particular.

Chapter 8: Mason, Morrison and Stockman examine airline entry and exit from the LCC sector for the period 1995–2011, and find that the real jump in growth began in 2002, continuing until 2006, with the number of exits also increasing significantly in 2003. Thus, while liberalization was a necessary condition for the growth of LCCs in Europe, the growth of LCCs was not closely correlated with key events in the liberalization process. In terms of the evolution of business strategies following liberalization, their analysis shows that LCCs are not simply one variety. Rather there are at least two definable stylized business models – the ‘truly low-cost’ (TLC) model and the ‘full-service airline competitor’ (FSAC) model – both of which seem to be successful strategies. Ryanair and Easyjet have sustained dominance in the LCC sector, both implementing business models that closely follow the TLC and FSAC models. To secure a larger slice of network carriers’ markets, the FSAC model seems to be evolving slowly towards the full-service carrier model.

Chapter 9: Wilken and Berster provide an overview of the characteristics of low-cost carriers, their development in Europe, with a special emphasis on Germany – in terms of supply features such as networks, routes, flights and seats offered, and, to a lesser degree, of passenger demand, passengers carried, and on demand generation. They find, for example, that low-cost carriers entered the European market in the late 1990s and achieved a market share of about 34 per cent in 2008, while Full Service Network Carriers (FSNCs) provided 58 per cent of seats available at European airports in 2008, and charter and regional carriers had a share of almost 5 per cent and 3 per cent respectively. For the autumn of 2010, the authors analysed prices offered by the most important LCCs serving the German market. Average prices were calculated by considering all of the routes and time spans between booking and flying day. While average net prices vary from €22 to €70 between airlines, total prices, including taxes, levies and other surcharges, vary from €35 and €144. The difference between net and total prices varies thus between €7 and €27 on average, and in specific situations the difference may be much greater.

Chapter 10: Klophaus argues that airline liberalization effects are not limited to lower air fares. The impact of liberalization also led to the extinction of simple fare structures. Many airlines adopted a strategy to unbundle their services in order to create additional revenue. This chapter focuses on the practice of à la carte pricing among European airlines that are categorized as LCCs, using the example of Ryanair. It examines the economic rationale for charging a separate fee for checked baggage. Results indicate that revenue gains reported by airlines practicing à la carte pricing may not be the result of unbundling services, but of higher prices. Hence, for consumers, the benefit of unbundling to pay only for services required could be negated by price increases that are not transparent to them. This requires regulatory efforts to ensure clarity on LCCs websites and other advertising to allow consumers to compare total air fares.

Part C: Liberalization and Airline Cooperation

The liberalization of airline markets is aimed at increasing competition, however, cooperation among competitors is not necessarily bad and might very well have the potential to improve overall welfare and/or consumer welfare. Although cooperation among airlines might take place in various areas and take various forms, the focus of the chapters in Part C is on horizontal mergers and alliances.

Chapter 11: Holtz, Hellmers, Fröhlich, Grimme, Németh and Niemeier present an assessment of the synergies and the success of cross-border airline mergers and acquisitions in Europe. While alliances provide a number of advantages in accessing international markets, some of the disadvantages of alliances, like instability and intra-alliance competition, can only be overcome with mergers or acquisitions. However, airlines have great difficulties in reaping these potential synergies and improving their competitive position. Therefore financial markets are, in general, neutral to this strategy.

Chapter 12: Hazledine reviews recent Air New Zealand antitrust cases to assess the question whether open skies policies and antitrust policies are substitutes or complements. He argues that appropriate regulatory decisions were finally made in all three merger or cartel cases covering the trans-Tasman passenger air travel market over the 2002–2010 period. Allowing the large incumbent legacy carriers Air New Zealand and Qantas to cartelize their operations would most likely have had a seriously detrimental effect on competition, as mainstream analysis would predict. Allowing Air New Zealand to combine forces with the LCC Virgin is perhaps less clearly justifiable, but at least so far, problems in the market have not manifested themselves. He concludes that antitrust policies and open skies policies must be considered as complements, at least under the present regulatory regime. ‘Openness’ simply is not sufficient to safeguard competition.

Chapter 13: Iatrou and Mantzavinou argue that global airline alliances have developed in response to the economic demand of global markets and to the opportunities provided by deregulation and liberalization initiatives. These cooperative agreements initially took the form of simple code-share agreements; but as deregulation started to take effect in the European Union and a Single Internal European Aviation Market was created, and as the US authorities pursued more ‘open’ and less restrictive bilateral air services with other countries, the horizontal links between carriers took the form of deeper and more complex cooperation. With a worsening financial environment and with restrictive bilateral agreements being gradually replaced by multilateral agreements between groups of countries, usually on a regional level, airlines are reassessing their priorities and are considering whether mergers and consolidations are the only way to secure a sustainable future and a viable and competitive airline system. The authors expect some merger activity within the next five years on an intraregional level, and more probably within the EU, but the early stage of consolidation does not allow predictions on what the future aviation markets will look like.

Chapter 14: Bilotkach and Hüschelrath start off with the observation that over the last ten to fifteen years we have witnessed a substantial increase in the size and depth of airline alliances in international air transportation. From a size perspective, more and more individual airlines have decided to join one of the three remaining global airline alliances, Star, SkyTeam or oneworld. From a depth perspective the granting of antitrust immunity by the responsible authorities provided members of these alliances with increasingly more freedom to coordinate various aspects of joint operations, including scheduling and pricing decisions as well...