The Factors That Affect the Likelihood and Sustainability of Collusion in Air Travel Industry - Essay Example

The factors that affect the likelihood and sustainability of collusion in Air Travel Industry Introduction Collusion within an industry refers to the practice of all, or some of the players within an industry to coordinate their production and pricing, in such a way that they can increase prices or reduce production, for the sake of sustaining high prices for their commodities in the market1. However, any trade practice, in the form of collusion or conspiracy to restrict fair trade has always been treated as illegal, despite the fact that some firms still engage in it. Therefore, the reason as to why not all firms in all industries can be engaged in colluding is the fact that colluding is illegal, while it also creates a high possibility of cheating amongst the firms involved, thus it is most often unsustainable2. Fundamentally, collusion is aimed at restricting or distorting competition within the market that the firms in that industry serve, and thereby reap the benefit of high and uncontrolled profitability. Therefore, this analysis seeks to establish the factors that affect the likelihood of collusion within the Air Travel Industry, and how such collusion is sustainable. Factors that affect the likelihood of collusion and sustainability in the Air Travel Industry Hypothetical Case: Air Canada and West Jet have been accused in colluding on fares on direct flights from Edmonton to Fort McMurray. The Air Travel Industry is an industry that is fairly competitive, considering that there are various airlines that operate within any given country or region, thus making the business of air travel fairly competitive3. Nevertheless, the Air Travel Industry also presents the opportunity for creating a monopoly or an oligopoly, considering that it is an industry that has low number of players. Therefore, the factors that affect the likelihood of collusion and sustainability in the Air Travel Industry include: Ability to restrict entry into the market The Air Travel Industry is one of the few lucrative industries that have very few firms as the players, compared to other subsector firms in the transport industry. Whenever firms are few in the market, and whenever they bear similarity in terms of size and costs, then, the firms have a higher likelihood and incentives for cheating. Therefore, there are high barriers to the entry for new firms, considering that economic barriers such as the high cost of entry prevent investors from being able to enter the Air Travel Industry4. Thus, barriers to entry form one of the structural features of the market and industry that make collusion more common and sustainable in this industry. The market and industry structure of Air Travel entails a high initial cost of entry, because purchasing and licensing an aircraft to be used for Air Travel purposes is a costly affair, in addition to the legal barriers that are brought about by the government tight control of the industry5. Further, the Air Travel Industry depends highly ion the benefits of the economies of scale in order to survive and thrive to profit earning levels, which requires that the firm operating in the industry should have several aircraft that operates in different destinations, both locally and internationally, to ensure that the route that earns low profits is compensated for, by the one earning high profits, thus the average profitability of the firm becomes substantial6. This is an aspect that serves to reduce the threat of new entrants, since the new entrants will be required to purchase several aircrafts, and undergo the restrictive government legislation procedures in order to finally enter into the industry, thus making the threat of competition low7. It is this low threat of competition that serves as an incentive to encourage the collusion between the few firms that have managed to operate in the industry, and thus make such collusion sustainable, considering that virtually all the firms operating in this industry have overcome the market challenges involved, and thus no single firm can manage to drive the others out of the industry. This serves to make the collusion in the Air Travel industry common and more sustainable. The principle of ‘Most Favored Customer’ This is yet another factor that that affect the likelihood of collusion and sustainability in the Air Travel Industry. The firms operating this Industry, as opposed to those operating in other subsectors of the transport industry, must be very well established and known, because most customers will prefer to use an airline that is well established and that has build a good reputation, due to the high risks that are involved8. It is no wonder therefore, that most of the airlines that operate in different countries and regions are well known, and have been operating for quiet a number of years. The Air Travel Industry is one of the few industries that are not easily penetrated by new entrants, and thus most of the new Air Travel firms that emerge are either subsidiaries of an existing airline, or an airline formed through either a merger or acquisition of another9. Therefore, most customers, both individuals and corporate, prefers to use an airline that is well known to them, despite the costs involved, at the expense of another new airline that is not well known, even though it may offer lower pricing. The tendency of the buyers in a certain market to prefer a certain product of company regardless of the costs involved is referred to as the principle of Most Favored Customer, one of the most eminent practices under the Air Travel industry10. This results into a form of collusion that is referred to as Facilitating Practices collusion, where the few firms that are operating in an industry prefer to apply practices such as price matching policies, to facilitate their trade. This practice on the other hand makes it difficult for the firms to face competition, since they can set the prices of the industry at a level that insulates the firms from competition, through introducing lower prices that cannot cover the operating costs of the new entrants, effectively pushing them out of the market11. Therefore, the practice of preferring the well-known and highly reputed firms by the customers, also referred to as the principle of Most Favored Customer, makes collusion in the Air Travel industry most likely and highly sustainable. Interdependence and the ease with which firms can agree Interdependence is a major factor that characterizes the operations in the Air Travel Industry, where the operation of one airline are interdependent on the operation of the other, especially during emergencies or technical failures, a concept often referred to as Spontaneous cooperation12. Whenever a certain airline faces some technical difficulties, or whenever the airline is faced by an emergency that hinder it from effectively completing its journey, the practice has always been to route the scheduled flight to another airline, so that the customers involved are not inconvenienced. While this practice can be seen as a productive method of cooperation, aimed at giving the interest of the customers a priority, it creates an opportunity through which the firms operating in the industry can engage in collusion. The concept of interdependence and spontaneous cooperation brings about unhealthy business practices, such as price fixing, price standardization or following the rival’s price change13. These practices on the other hand creates a fertile ground for collusion between the firms, since the firms can agree to operate within certain policies, to enhance their cooperation practices, while applying the same concept to deliberately eliminate any threat of competition14. The most challenging aspect about this mode of collusion is that it is difficult to identify, to prove and correct, since it is integrated with the positive aspect of enhancing productive cooperation, and thus becomes even more difficult to consider it an illegality15. Despite the fact that such mode of collusion is difficult to achieve for many firms, it is the core of highly sustainable collusion practices within an industry. Therefore, considering that interdependence and spontaneous cooperation are common practices in the Air Travel Industry, the practices makes collusion in this industry most likely and highly sustainable. Stability of demand and the ability to elude detection Air Travel Industry is characterized by stability in demand, considering that there are always few firms to compete for the large numbers of the customers available16. Therefore, whenever a firm has gained entry into the Air Travel Industry, the firm is assured of getting a constant flow of customers, since there are always few firms that are involved in this industry, while the threat of new entrants is always low. Whenever the demand within any market is stable, the incentives for the firms involved in the market to collude and cheat are greater17. Further, the incentive to cheat is always added to, by the fact that the demand in the market or industry has a random component, making it difficult to differentiate between the fluctuation in demand that is caused by competition or the one caused by other market forces, which is the characteristic demand in the Air Travel Industry18. Generally, when it is difficult to monitor the causes of demand fluctuations, the firms involved in this industry are granted an opportunity to cheat, since it would be very difficult to detect an act of conspiracy and collusion, since it has to be related to demand fluctuations19. Therefore, demand concept in the Air Travel Industry and market, serves as an incentive for the firms operating in the industry to collude, making the collusion in this industry most likely and highly sustainable. Conclusion Collusion within an industry causes the players within an industry to coordinate their production and pricing, so that they can increase prices or reduce production to sustaining high prices for their commodities in the market. The factors that affect the likelihood and sustainability of collusion in Air Travel Industry include the interdependence and the ease with which firms can agree, the principle of ‘Most Favored Customer’ and the ability to restrict entry into the market. Considering that the Air Travel industry is a restricted industry with low threats of new entrants, collusion within the industry is highly sustainable. Bibliography Harrington, Joe. Lectures on Collusive Practices. Johns Hopkins University, June 29, 2011. 1-270. Church, Jeffrey and Ware, Roger. Industrial Organization: A strategic Approach. McGraw-Hills Companies Inc., 2002. 305-525. Dorman, Clive. “Are regulators protecting us or the big airlines?” The Sunday Morning Herald, September 13, 2010. http://www.smh.com.au/travel/blogs/travellers-check/are-regulators-protecting-us-or-the-big-airlines-20100913-157lz.html Fagan, Mary. “CAA condemns 'culture of collusion' in airline industry.” The Independent, Saturday December7, 2013. http://www.independent.co.uk/sport/caa-condemns-culture-of-collusion-in-airline-industry-1502040.html Milmo, Dan. “How arch rivals colluded to hike up cost of air travel: Whistle blown on illicit contacts which led to soaring fuel levy.” The Guardian, August 2, 2007. http://www.theguardian.com/business/2007/aug/02/britishairways.theairlineindustry2 Tirole, John. “Collusion and the Theory of Organizations", Advances in Economic Theory. Cambridge: Cambridge University Press,1992. 151-206. Are regulators protecting us or the big airlines? You could be forgiven for thinking that competition regulators in Australia and the US are reading from the wrong textbook or even just saying flat out "to hell with the little guy" when it comes to making rules for airlines. Of course, it's not that black and white but, at the very least, separate rulings last week by the Australian Competition and Consumer Commission and the US Department of Transportation were confusing. You could be forgiven for thinking that competition regulators in Australia and the US are reading from the wrong textbook ... when it comes to making rules for airlines.   Closest to home, the ACCC ruled that the proposed trans-Tasman alliance between Air New Zealand and Pacific Blue was not in the public interest because it gave the mooted combine 55 per cent of the seats in the market and could lead to fare increases on some minor routes15 – even though there would continue to be up to six airlines fighting it out on major routes3 like Melbourne, Sydney and Brisbane to Auckland. The ACCC said the alliance would reduce the number of trans-Tasman routes with three or more independent competitors from nine to four14. Indeed, Auckland's NZ Herald applauds the ACCC's protection of the public interest in an editorial. But Virgin Blue backer and co-founder Sir Richard Branson points out that, only weeks ago, the ACCC gave its backing a monopoly arrangement between Qantas and South Africa Airways on routes linking Australia and South Africa – where prices are almost as high as routes from Australia to Europe4. Virgin's V Australia has provided the only competition on the Australia-South Africa route in the past year, but it has decided to axe its two weekly Melbourne-Johannesburg services. The US DOT, meanwhile, has ruled the public interest isn't served by allowing America's Delta and V Australia to get together in an alliance on Australia-US routes to take on the might of the Qantas-American Airlines alliance, not to mention the well-established Star Alliance carrier, United Airlines. "The weight of the evidence suggests that the primary effect of a grant of antitrust immunity at this time would be to improve the market share of Delta and V Australia, without certainty that the applicants will be making structural improvements in the market that would create large-scale public benefits, such as increased capacity, lower fares, or more efficient services," the DOT says. Yet, only a month ago, the DOT authorised an alliance (with immunity from prosecution for collusion on fares, seats and schedules) for industry giants American Airlines and British Airways.17 Once again, Branson weighs in with the retort that the regulator's actions are "illogical". Just how much more price competition does the DOT want? Fares have fallen from $2000-$3000 return between Australia and the US to as low as $900 in the past two years, although they're back around $1200-$1500? Significantly, not one of the four carriers linking Australia and America is making money out of the deal. And routes across the Tasman have been swimming in red ink7, for that matter. Well it's your interest the regulators claim to be protecting. Do you trust them? Are you happy with the level of competition between Australia and New Zealand and between Australia and America? Would the alliances that are being proposed diminish competition as the regulators claim? How arch rivals colluded to hike up cost of air travel Whistle blown on illicit contacts which led to soaring fuel levy Dan Milmo, transport correspondent Thursday 2 August 2007 11.14 BST It was a phone call that cost British Airways ?270m and untold damage to its reputation among passengers worldwide. On August 9 2004 the airline's then head of communications, Iain Burns, contacted his opposite numbers at Virgin Atlantic and said BA was minded to increase the levy it puts on tickets to cover the rising cost of oil - otherwise known as its fuel surcharge. Simultaneous announcements of price hikes followed, establishing an illicit relationship that saw six further conversations and announcements by January 2006, while the surcharge climbed from ?2.50 to ?30 for a one-way ticket12, 19. Though BA yesterday distanced itself from former employees implicated in the scandal as the regulatory verdicts increased the likelihood of charges, the fines on the company are far from the end of the story. The criminal investigation on both sides of the Atlantic, by the Office of Fair Trading and the Department of Justice, is expected to focus on who initiated the discussions at BA. At its centre is Mr Burns and his immediate boss, former BA commercial director Martin George. Both resigned last year and, according to people with knowledge of the situation, the cases against them come down to "one person's word against the other's". BA's avuncular former PR chief was popular with journalists due to his eagerness to brief off-the-record on sensitive stories. His superior had been at BA for nearly two decades and was a powerful, driven figure who narrowly missed out on succeeding Sir Rod Eddington as chief executive. Their positions in the hierarchy were summed up by their pay-offs: the PR man got "next to nothing" while Mr George received up to ?1.6m. Mr George said in his resignation letter that his department might have discussed surcharges with a competitor, but "I was not involved in such conversations". He added that the BA board had found that he had not behaved "in a dishonest way". An alternative version of events would suggest the company's senior PR professional was instructed to call his counterparts at Virgin Atlantic to discuss surcharge increases. The calls were made at a time when the airline industry, battered by the fallout from September 11, was eager to shore up strained balance sheets as the market recovered slowly. Both executives are attempting to reconstruct their careers but the shadow of criminal charges hangs over them. They face jail terms of up to five years in the UK if they are found guilty of price fixing. BA declined to comment on speculation that two other executives, including an employee of its cargo division, have been suspended pending the outcome of the criminal investigations, which are also looking at collusion over fuel surcharges on cargo flights. Virgin Atlantic admitted "regret" that illegal contact had been made between the companies but would not reveal who took the calls from BA. Mr Burns's former opposite number and alleged recipient of the calls, Paul Moore, left the company about a month before Virgin Atlantic blew the whistle. Mr Moore, a respected PR professional and now the head of communications at FirstGroup, declined to comment. His former employer closed ranks yesterday as BA's chief executive, Willie Walsh, was forced to tour the broadcast studios apologising for a scandal that started more than a year before he took the post. The criminal inquiries to come will examine whether PR departments could by themselves coordinate the setting of fuel surcharges - a major commercial responsibility in such a competitive industry. Virgin Atlantic said it went to the authorities as soon as its legal team discovered details of the conversations in early 2006, about a month after Mr Moore's departure. It is understood that the calls were unearthed as lawyers responded to requests for information from the OFT on alleged collusion over surcharges on cargo flights. The airline declined to comment on speculation that it had deliberately reported BA in order to gain a competitive advantage over its rival8. Mr Walsh said yesterday he would have reported the illegal conversations immediately had he known about them. Friends of Mr Burns said BA had treated him "appallingly and unfairly" by releasing him with a minimal payoff whereas his former boss walked away from the company with payments that could total more than ?1.6m. Mr George left with ?467,000 in salary and benefits, with a "termination fee" of ?263,000. He was also given ?356,000 towards his legal fees, plus a ?555,397 payout from a BA incentive plan. He will receive a further ?263,000 if he does not find another job over the next six months. Mr George narrowly lost out to Mr Walsh in the contest to succeed Sir Rod Eddington, who was chief executive when the calls between BA and Virgin began. Mr Burns was forced to move away from his family in search of work. He now lives and works in the United Arab Emirates as head of communications at Etihad Airways. Mr Burns declined to comment yesterday as did Mr George's lawyers. Explainer: Fuel surcharges Fuel surcharges were the airline industry's response to rising oil prices, which have led to a sharp rise in recent years in the price of aviation fuel5. For much of the 90s the world oil price fluctuated either side of $20 a barrel but it began to rise in the new millennium. At the beginning of 2004, for example, the oil price reached $30 a barrel but yesterday it stood at an all-time peak of just below $78. Figures from the Air Transport Association show, that in the US, the average price paid for aviation fuel in 2003 was 84 cents a gallon. By last year that had more than doubled to $1.96. British Airways first introduced a fuel surcharge in May 2004 when it added ?2.50 to the price of long haul and short haul ticket prices. It was not alone. Most airlines responded to increasing fuel costs with surcharges. As oil prices continued to rise, so did the surcharges. BA, for instance, increased its surcharges twice in 2004, three times for long haul in 2005, and again for long haul last year. At the beginning of this year, the airline cuts its fuel surcharge on long haul but increased it again in May and June. Long haul passengers now pay a surcharge of ?43 on flights of more than nine hours and ?33 on shorter long haul flights12. BA, along with other airlines, argued that the increases in fuel costs were too severe to be absorbed by the airline and had to be passed on, at least in part, to passengers9. It estimates its fuel bill will top ?2bn this year and argues surcharges are the best way to show passengers the extent to which rising fuel prices are affecting its costs. But not everyone has the same approach. Ryanair has criticised surcharges and has made much of its determination not to introduce them9. Mark Milner Read More