Case Study 7.3r "Deregulation and a World-Wide Oligopoly” What will the airline industry look like and how will airlines respond to pending changes in their market? "

A Historical Perspective:

In 1978, the airline industry in the U. S. was liberalized when the federal government withdrew from economic regulation. Since that time any airline that can prove its competence to the FAA has been free to fly where and when it wanted at prices determined by the market.

Most studies contribute the increase in air travel and the lower fares to the effects of deregulation. While the five major airlines still have approximately two-thirds of the market, many new low-cost carriers such as Southwest Airlines and Air-Tran have benefited from deregulation.

Another benefit that was spurned from deregulation was the hub and spoke system that is prevalent among U.S. carriers. By developing hubs (major city airports) that are fed by smaller regional markets (spokes), more seats are filled on major routes and thus there is a greater economy of scale.

While the American consumer is often confused by the myriad configurations of pricing and schedules offered by airlines, there is no doubt that the consumer has benefited by the deregulation of airlines in the United States .

Nearly 20 years after the airline industry in America was deregulated, the European market as a result of the development of the European Union began to apply the same rules. Since 1997, virtually any EU airline was free to set up anywhere and fly anywhere within the EU.

The results in Europe were not dissimilar to the results in America . Fares are now lower and a number of small low-cost carriers have emerged in many EU countries. In fact the small carriers are capturing approximately the same market share that the small carriers have in the United States (25%).

The combination of the US air market and the European air market accounts for over 50% of the world's air travel. Therefore it was no surprise in the 1990's when US air carriers and European carriers started asking their governments for bilateral agreements that would open the skies between the two markets. In essence, European carriers want to fly to more US cities and American carriers want to fly to more European cities.

Current Affairs in the Airlines:

Most European nations have a single flagship carrier such as British Airways in the UK , Air France In France, Alitalia in Italy , and KLM in the Netherlands . In the 90's, many European nations 'single flag carriers were allowed to form alliances with American partners and were given immunity from American antitrust law to fix prices. One of the first such agreements was with KLM and Northwest. The alliance concept has grown beyond just the European and American skies to include carriers from around the world. Recently, Air France has merged with KLM, thus gaining control of Amsterdam and Paris , two of the long haul hubs in Europe . The other two hubs are Frankfurt and London . This merger of two large European airlines could be a signal of future changes in the airline industry.

If these alliances result in more than simply mergers based on shared marketing and the trend for liberalizing the barriers to international air routes continues, many economists think that the world airline industry may change substantially.

The more the restrictions between countries are lifted, the more appealing it is for air carriers to merge. Global takeovers will be possible and the result could be a small number of mega-airlines that would rule the skies. Indeed over 60% of the world's passenger air traffic is now within three major alliances, (Star, Skyteam or oneworld).

Open aviation between EU countries and the United States is projected to produce consumer cost savings in excess of $5 billion. And even though IATA (International Air Transport Association) is campaigning for a freer market, there are still many hurdles to overcome including some protectionists feelings in places like England where British Airways has a lock on the flights in and out of Heathrow.

The next twenty years will undoubtedly be a time of change and transition for the world's passenger airlines.

Questions for consideration and research:

1. Will the worldwide airline industry develop into an oligopolistic or a monopolistic competition model? Why? Give reasons and examples.
2. Research the industry and compare the air passenger and the air freight industry. Do they face similar challenges and changes? How are they similar or different?
3. What is a duopoly? Is the manufacture of planes a duopoly or an oligopoly? Explain.
4. Since deregulation, there have been many charges of price-fixing and collusion in the airline industry. In your research, find some examples and explain. With the pending changes do you think that these allegations will increase or decrease? Explain.
5. Is the telecommunications industry facing the same challenges as the airline industry? Why or why not? What similarities or differences can you describe?