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By most economic and marketplace measures, the airlines are either an oligopoly or a monopoly.

Whichever it is they are, there seem to be no positive features for us as travelers, and plenty of negatives.

 
 
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Airline Competition 1980-2010 R.I.P.

Part 3 :  The numbers prove the lack of competition
 

An oligopoly is when four companies have more than 50% of the market.  Across the Atlantic, two companies have more than 50% and four companies have 90%.

Part of a series on airline competition - see extra articles listed in the right hand column.

 

 

Economic textbooks are full of the theory and explanation of how monopolies and oligopolies can break the ideal balance between commerce and consumers, and while economists rarely agree on much, there is close to universal agreement that a few major companies dominating a market is a bad thing.

Let's take the theory and see if it applies to the airline industry as it presently is in the US and across the Atlantic.

The Reality of Airline Market Dominance

When is a market 'dominated' by one (or more than one) airline(s) and when is a marketplace fairly competitive?

We quote the generally accepted definitions of oligopolies and monopolies in part one of this article series.  Basically, any time four (or sometimes more; and of course, definitely if fewer) companies have 50% or more of a market, this is probably an oligopoly, and if these four (or fewer) companies control more than 80% of the market, it is most likely a monopoly (even though more than one company is present).

US market statistics

So how do the US airlines stack up against this measure?

Using the excellent Bureau of Transportation Statistics, we see the following results for US airlines :

US Market Shares, RPMs, Q3 2009

Rank

Airline

RPMs (in billions)

Share %

Cumulative Share

  1

Delta & Northwest

46.5

21.8

21.8

  2

American

32.4

15.2

37.0

  3

United

27.6

13.0

50.0

  4

Continental

21.6

10.1

60.1

  5

Southwest

19.7

9.3

69.3

  6

US Airways

15.7

7.4

76.7

  7

JetBlue

7.0

3.3

80.0

  8

AirTran

5.2

2.4

82.4

  9

Alaska

5.0

2.4

84.8

 10

SkyWest

3.3

1.5

86.3

 

  All others

29.2

13.7

100

 

  Total

213.2

100

 

 

The four largest carriers have 60.1% of the total market (in terms of passenger miles flown) and so, on the face of it, seem to be in an oligopolistic situation.

Interestingly, if the merger between Northwest and Delta had not been allowed to proceed, the four largest carriers would then be AA, DL, UA and CO, with a 51.8% market share between them - right on the cusp of becoming an oligopoly.  The DL/NW merger, between the formerly second and sixth largest carriers (as measured by passenger miles flown) has now cemented the assumption in place that the airline industry is oligopolistic.

The previous major merger - between US Airways and America West - resulted in the new merged carrier taking the sixth place on this list.  There is also a secondary measure of oligopolistic markets that looks at the market share belonging to the eight largest competitors - so this merger concentrated more power in the eight largest airlines, while not affecting the market power of the four largest airlines.

A mooted future merger between United and Continental, should it subsequently occur, would combine the third and fourth largest carriers, moving Southwest up to the fourth slot, and would therefore concentrate 69.3% of the market into the top four carriers.  This would definitely tilt the market appreciably further towards being severely oligopolistic.

The reality is worse than this table suggests

This summary table is however deceptively optimistic in its nature, because it conceals within the totals lots of market pairs and lots of cities where the market isn't split into a somewhat oligopolistic situation with four carriers controlling 60% of the market, and with many other smaller carriers also actively present.  As you surely know from personal experience, we have 'fortress hubs' and strategic routes where instead of four airlines sharing 60%, one airline alone might have 60% (or more), creating not just oligopolistic service but near monopolistic service for many routes.

The real scenario is that there are lots of monopolistic markets within the broader total US market, with some airlines controlling some monopolies, and other airlines controlling other monopolies, such as to sort of 'average out' and, in summary, look more benign than the underlying actuality of routes and cities.

Trans-Atlantic market statistics

Let's also look at the international market, using DOT figures for the 12 months ended June 2009 as reported in their Show Cause order tentatively approving the AA/BA anti-trust immunity application.

This shows the following market shares :

Market Share US-EU Market 12 months through June 2009 per DOT

Alliance

Member Airlines

Share %

Star

Austrian, bmi, Continental, LOT, Lufthansa, SAS, Swiss, TAP, United, Air New Zealand

31.7

Skyteam

Air France, Alitalia, Delta/Northwest, KLM, Czech

28.9

Oneworld

American, British Airways, Iberia, Finnair

22.3

  -

Virgin Atlantic

7.1

  -

US Airways

4.6

  -

All other airlines

5.5


In this situation, where 19 airlines have collapsed themselves into three anti-trust immune alliances, and where they hold 82.9% of the market between them (or 87.5% if US Airways is added in with the rest of its Star Alliance partners), this is not just an oligopoly by all measures, but probably a textbook monopoly (monopolies can have more than one major player).

And so we feel sadly justified in describing this event (anti-trust immunity being granted to the Oneworld Alliance) as marking the death of airline competition (across the Atlantic).

Other Factors To Test for Oligopoly/Monopoly

The market share test we've used in the preceding tables is a simplistic test that isn't always completely correct, and so, in cases of doubt, economists use some additional tests to see not only if the numbers show there could be an oligopoly, but to confirm if companies are indeed acting that way.

Sometimes, oligopolies can be present when companies have smaller market shares than the theory would suggest, other times, oligopolies are not present even when companies have much larger market shares than needed to cross the threshold level for oligopoly.

These tests are discussed in detail here and here.  To boil down the economic theory into key bullet-point type concepts, oligopoly can be considered by marketplace characteristics and marketplace behaviors.

The marketplace characteristics have three main elements :

  • Small number of suppliers who between them control most of the market :  We've spoken before about measuring markets in terms of the total share owned by four and sometimes eight companies, but oligopolies can sometimes have as many as about 20 different companies, depending on other conditions.

  • Barriers to Entry :  It is difficult for new companies to enter the market.  Maybe there are huge capital investments required, long leadtimes, legislative restrictions, limited resources, or patent restrictions.

  • Common Product Types :  Members of an oligopoly provide similar products, perhaps with no distinction at all (eg raw materials such as metals and foodstuffs) or perhaps with distinction/branding but very similar functionality (eg automobiles).

The marketplace behaviors are

  • Interdependence :  This is a key measure of an oligopoly.  The actions of each company in the marketplace influences the market as a whole, and will cause the other oligopolies to react/respond - not necessarily to copy, but in some way or another to respond.  This means that each company, in choosing new products, prices, or other changes to their activities considers not just how the marketplace will respond but also how their fellow oligopolies will respond.

  • Mergers and Collusion :  Because there are few companies in an oligopoly, mergers or collusion give the companies involved substantial extra marketplace control.  Companies have a tendency/preference to merge or collude with each other rather than to compete.

  • Nonprice Competition :  Oligopolies would prefer not to compete on price, preferring instead to create differentiations of products (that may be as much illusion as reality) and to advertise and promote their brand and products.

Think about the airlines under these two sets of three parameters.  Small number of suppliers?  Check - see the tables above.  Barriers to entry - check.  Starting an airline is a time consuming capital intensive business, needs regulatory approvals, and needs access to scarce resources (airport gates, etc).  And all airlines, much as they pretend to the contrary, provide the basic identical service - a flight that lasts about the same duration, between the same cities, on the same plane, in the same sort of seat, for the same price.

As for the second three, we see interdependence all the time.  An airline will try and raise prices, and if the other airlines don't follow, it will bring its prices back again.  An airline will introduce a new service (or fee) and the other airlines generally copy.  Airlines are aggressively seeking to merge or collude, either officially with DOT permission or unofficially through backdoor arrangements (such as alliances) and sometimes through methodologies of dubious legality such as 'signaling' possible price rises.  Lastly, airlines attempt not to compete on price, choosing to charge almost exactly the same fares.  Instead they choose to promote things such as their frequent flier programs, their lounges, and - well, there's not much else, is there.

By all of these measures, airlines are exhibiting oligopolistic behavior.

Are Oligopolies Good or Bad

Not all oligopolies are bad.  Some can be good.  The extra profit potential for a company in an oligopolistic market can be used to fund new product development, service enhancements, and so on (think computers for a vivid example of this).  And the large sized companies can enjoy substantial economies of scale as a result of their large sales volumes.

But, for reasons beyond the purview of this article series, airlines are seldom profitable, and in any case, even if they had excess profit to invest in R&D, most of the need for R&D in the airline/aviation industry lies in related fields - aircraft design and manufacture and air traffic control in particular.

And, as discussed in the second part of this series, the nature of the airline business does not allow for economies of scale; indeed, paradoxically, the bigger airlines are less efficient than the small ones.

So neither of the two main potential benefits of oligopolies apply to the airline oligopoly.

Let's hope the two downsides of oligopolies also don't apply.  They are a risk of inefficiency, and a concentration of wealth and social power.

Oligopolies can be even more inefficient than monopolies.  Monopolies are more closely subject to legislative and social scrutiny, oligopolies are less visible so can get away with more.  Many people don't even know what an oligopoly is, thinking there to be only two types of market - monopolistic and competitive.

As we saw in the second part of this series, the bigger the airline (and therefore the more it is part of the oligopolistic process) the higher its costs and the less efficient it was (which its profits did not grow in line with its costs/revenue).  Airlines would seem to suffer from this downside aspect of oligopolies.

As for the concentration of wealth and social power, this definition explains

While the concentration of wealth is not bad unto itself, such wealth can then be used (or abused) to exert influence over the economy, the political system, and society, which might not be beneficial for society as a whole.

Doesn't that describe the airlines and their very efficient government lobbying processes?  They have an amazing example to stall passenger friendly legislation, and to draw out requirements for expensive retrofits to their fleets proposed by the NTSB on safety grounds.

Aren't the airlines hovering in the 'too big to fail' category, possibly abusing the Chapter 11 process, and being subject to supportive Presidential intervention in the past when it seemed they were about to be impacted by labor strikes?

It seems that while airlines have neither of the redeeming upsides to their oligopolistic nature, they do suffer strongly from both the classic two downsides.

Summary

The airlines meet the classic tests for being oligopolies - both the quantitative numerical test and the more qualitative other observations of their characteristics and behaviors.

Although oligopolies can sometimes bring consumer benefits, the airline tie-ups seem to do no such thing, but rather bring out the potential downside negative aspects of such business arrangements.

Recent merger approvals have cemented in place the oligopolistic nature of the airlines.

Part of a series on airline competition - please see extra articles listed at the top in the right hand column

 

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Originally published 12 Mar 2010, last update 19 Dec 2013

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.

 
 
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3. The airlines are oligopolies
4. The demonstrated lack of growth in airlines to date
 
 
 

 


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