Airline Competition Always Fair?
Should established carriers be allowed
to sell tickets below cost, and below startup carriers'
fares, so as to starve the startup carrier into bankruptcy?
RIP Eos Airlines, 2005
merely the most recent of many airlines that have started
up, briefly traded, and then closed down to vanish without
It is a classic scenario that
has been played out many times before. A new airline
starts up, offering a lower priced service on a route that had
previously suffered from either very high fares or very few
All of a sudden, existing
carriers - by amazing coincidence - discover the same route.
They add extra flights and drop their fares, sometimes to less
than half their earlier fares.
The traveling public, which had
reacted supportively and with pleasure to the new airline, is
now doubly delighted, and flock to their preferred carriers to
take advantage of the new services, rock bottom fares, and often
other benefits such as double frequent flier miles too.
A vicious cycle of matching
discounts and promotions, and too little support for the new
airline, sees the new airline fail and disappear.
And then, by amazing
coincidence, the established carriers cut back their services,
and increase their fares once more. Within only a few
short months, there's no longer any trace of the former massive
over scheduling of flights and discounting of fares.
The Department of Justice and
the courts believe this to be fair competition and open market
forces working the way they should, and has refused to sanction
the major airlines when they adopt these tactics.
What do you think?
Another week passes, another airline passes. Or so is the
situation at present (this is being written in April 2008), with
airlines dropping like flies. The last week saw the sudden
shutdown of Eos - the all first class airline that formerly
operated service between London's Stansted airport and New
Background to the Eos Airlines
Eos seemed to have a lot
going for itself. The closure of a competitor in December
2007, Maxjet (an all business class airline, also with service
between Stansted and JFK) had presumably removed one source of
competitive pressures from Eos; the regular bullish statements
from Eos itself about its tremendous ongoing success, growth
plans and financial security; and, lastly, a press release
barely a week prior to its closure advising that it had secured
an injection of additional funding from one of its current
shareholders which was described as sufficient to carry them
over to profitability in 2009.
All these factors would have
seemed to indicate an airline that was growing and thriving.
what Eos said about itself after the Maxjet closure in Dec
Industry failures, rising oil prices, a weakening economy
and planned reductions in corporate travel have neither
diminished travelers enthusiasm for Eos Airlines' "uncrowded,
uncompromising" Eos Class experience, nor hindered the
company's march toward becoming an unqualified business
success. Eos today announced record Guests during October
and November 2007, citing a surge in passengers of 64%
versus the same time last year and 14% since September,
after adding 12 additional weekly flights in October. The
company recently secured $50 million in equity capital from
institutional and private sources and took delivery of their
fifth and sixth aircraft. Continued expansion is expected
for 2008, with as many as three new routes and the delivery
of aircraft seven and eight.
Eos President and CEO Jack Williams commented, "I am
delighted that after our second successful year more people
than ever are choosing to fly with Eos. Our passenger
numbers are at record highs and load factors are
consistently strong - including peaks in June (76%), July
and September (both 73%). We are flight level profitable and
all signs point toward continued success in 2008."
With a strong financial position and backed by committed
investors, Eos delivers both service and value by offering a
first class experience at fares that are 25% less than
traditional carriers' business class. Designing the world's
only fleet of Boeing 757s outfitted for just 48 Guests and
removing the crowds and stress from air travel has resulted
in an unprecedented amount of word-of-mouth endorsement from
a community of loyal and like-minded Guests. ...
what Eos said on 19 April about securing more financing
the face of tight credit markets and an economic environment
that has led to several industry failures, Eos Airlines
announced today that it has agreed to a term sheet outlining
the terms on which Eos will secure an additional $50 million
in capital from a current investor. The transaction, which
is scheduled to close May 1, 2008, is seen as underscoring
confidence in Eos’ business model built around an entirely
new class of air travel.
“When we closed on our last round of financing, we were
clear that we would need to raise additional capital,” said
Jack Williams, Eos President and CEO. “Our success - in the
face of this extremely challenging economic and credit
environment - shows that investors continue to be
enthusiastic about our business model.
“At a time when much of the airline industry is mired in
misery, we have provided outstanding service and shown an
uncompromising commitment to quality. We’ve achieved an
extremely high level of satisfaction among our Guests, many
of whom have personally embraced the company and become our
de facto ambassadors. We have the most efficient business
model, our flight loads have increased and our revenues have
“Now we have a term sheet with a current investor for the
financing needed to take us to corporate profitability in
Well, apparently Eos hadn't
secured the financing and were a bit premature in sending out
their press release, because one week later, they filed for
bankruptcy and ceased operations entirely.
'Many a slip 'twixt cup and
lip' seemed to be the applicable adage, and the press release
advising their closure referred obliquely to 'some issues arose
that we could not overcome' that prevented them securing the
financing that had seemed to have already been obtained.
Why did Eos Fail?
So, what caused the demise
of this airline and are there any lessons to be learned?
Interestingly, the airline avoided trotting out the usual
scapegoats, and didn't even refer to high fuel prices at all.
The obvious immediate cause
of the Eos failure was the inability to secure necessary
additional funding to enable it to continue operations.
The peculiar situation where they first issue a press release
announcing an agreed input of $50 million extra funding, and
then a week later announce the collapse of the funding and of
the entire airline for non-specified reasons leaves much
It is not for me to
determine the cause of Eos' failure when they themselves prefer
not to comment. Clearly we don't have all the facts at our
disposal to fully understand the EOS collapse just yet, in
particular what caused the financing they had announced the
previous week to evaporate unexpectedly. But some things
are already plain, and have a very familiar ring to them.
We've seen such things many times before, with other startups
and other markets.
The pony-in-the-corner, and
the odiferous pile of dung associated with it, is the curious
coincidence of American Airlines choosing to inaugurate twice
daily competing service between JFK and Stansted (STN).
Did AA with its competing
flights, complete with aggressive pricing, promotion, and
mileage premiums, simply bludgeon Eos out of the market?
The answer to that will be seen as time passes - if AA keeps its
STN services and current prices/mileage premiums/etc in place,
then we'll know that AA was not acting in an unfair
anti-competitive manner. But if the STN services either
disappear or skyrocket up in price, we should draw our
I offered these comments
about American's actions in my newsletter back on 5 October 07 :
London's Stansted Airport used to be a little airport north
of London that no-one in the US had ever heard of.
Everyone wanted to go to Heathrow (for reasons I've never
understood) and would grudgingly accept Gatwick as second
best. Other London area airports such as Stansted or
Luton were deemed unacceptable for American flights and
But then two new startup airlines successfully challenged
conventional wisdom. They started offering flights
between the US and Stansted (STN) rather than to LHR or LGW
- Maxjet with all business class seating and Eos with all
first class seating. They offered excellent service at
massively discounted rates compared to what major airlines
were charging for first and business class.
- guess what. American Airlines, clearly hurting from
the lost revenue caused by passengers switching from their
overpriced premium cabins to Maxjet and Eos have suddenly
discovered STN and decided they too will offer service to
STN. And, amazingly, AA's fare to STN is massively
less expensive than its fare to LHR. $2730 will get
you to Stansted and back, but you could be up for $10,000
and more to get to LHR.
- and you can get up to 12,000 bonus Aadvantage miles too.
What an amazing thing this is, isn't it. We are
expected to believe that American is fairly charging $2,730
to fly to one airport, but is also fairly charging $10,000 +
(four times as much) to fly to another airport that is
almost the same identical flight distance from New York.
Don't reward bad behavior. Make a point of booking
Maxjet and Eos rather than American, because without them,
there's almost no chance that AA's flights to STN will
continue, and even if they do continue, what do you think
the chances are that fares will remain at a quarter the
price of fares to LHR?
The most amazing part of this? That such behavior on a
dinosaur's part is not considered to be unfair by any of the
various watchdog organizations (in both the US and UK).
After Maxjet had been forced
out of the market in late December, I observed :
Let's see how much longer AA keeps up its discount flights
to Stansted now that Maxjet has gone. Already both BA
and Virgin Atlantic have indicated they are slowing down on
plans to introduce all business class service across the
Atlantic; although neither airline is saying 'we don't need
to do this so much now that one of our competitors has
already been squeezed off the route'.
I repeat that comment now -
let's see what AA does to its frequency of flights to STN and
the fares it charges. There is still one remaining
competitor across the Atlantic though that AA may wish to see
off - Silverjet, which operates all business class flights
between London's Luton Airport and Newark Airport. So
there'll likely be some anomalous pricing and scheduling for a
little while longer.
Update, June 08 :
Read the postscript at the bottom of this article for the
totally unsurprising outcome of this story.
How to Starve a Competitor to
This situation highlights
the vulnerability of any startup airline operating with only a
few city pairs - a dinosaur can come along and bleed them dry.
What does AA care if it loses a little money on STN services for
a short while, if it kills off a competitor as an outcome - the
money it lost on the STN services will quickly be recouped once
the competitor is killed.
Indeed, depending on how
American costs out those flights - ie marginal or full costing,
and how they account for revenue from people flying extra
sectors in addition to the JFK-STN flights, you can endlessly
debate how much money they may have lost or not lost, and
therefore if their rates are fair or unfair. But, if they
did lose some money, it is sure to be quickly recouped as their
competitors fail, and if AA now returns their STN services to
full rates. Or, on the other hand, the loss would end if
AA discontinues these flights entirely, and AA would then start
generating profits by selling the $10,000+ JFK-LHR tickets to
the people who would have otherwise purchased the $2730 JFK-STN
Eos and other similar
airlines can indeed construct sensible business plans, operate
profitably, and succeed, but for one small thing. Unfair
This is the Achilles heel of
all such carriers, and is the blind spot of regulatory bodies
the world over who see nothing untoward in an established
airline suddenly flooding a market with flights when it
previously operated none or only a very few, and with these new
flights coincidentally timed the same as the new competitor's
flights, and with these new flights at rates that (in this case)
are one third the rates they had previously sold fares at.
Amazingly, the same 'regulators' (perhaps an inappropriate term
that fails to recognize their passivity and gullibility) still
see nothing wrong when, after the new airline fails, the
established carriers suddenly cancel the new services and return
fares to their historic levels.
Am I the one eyed man in the
kingdom of the blind here? Is it only me that sees this for what
it is? Predatory and anti-competitive tactics on the part
of established carriers to kill off competitors?
When Price Matching is actually
I'd written a commentary
much as you read above on an industry discussion board, and got
the following response back from an airline official :
Gentlemanly competition is more likely to run afoul of our
competition laws than playing hardball against a new
entrant. Predatory pricing is a difficult and complex
thing to prove. It is not enough to show its affect on
Eos, it is the AA’s ability to recoup its losses in the face
of remaining competition. Returning to the status quo
is insufficient evidence of predatory pricing.
Competitors who enter the market thinking they can sell
cheaper than an established competitor over the long term
need more than high hopes and pre-entry market prices as
Consider a new gas station opening up across from an
incumbent. The incumbent replies by lowering his price
below the new station and answering every competitive move
with a lower price. If the new entrant runs out of
money and closes, must the incumbent continue to sell at the
Note that he is talking
about things such as 'hard to prove' and 'insufficient evidence'
rather than what is fair and right and proper.
There's a mile of difference
between 'gentlemanly competition' (which he seems to offer as a
pejorative term) and predatory pricing. Somewhere along
the continuum the overarching concept of 'fair competition'
starts and stops - it isn't necessary to exactly define the
limits of these grey areas, but suffice it to say that some of
us (usually people who don't work for airlines) can readily
recognize when those limits are clearly broken.
It is a bit like
pornography, isn't it - there are some things which are in a
grey area of maybe being acceptable and maybe not, but just
because it is difficult to label these grey area things doesn't
mean we can't clearly recognize flagrant pornography if we see
Only the airlines and
'regulators' seem unable to see the reality of predatory
pricing, and to get hung up in the grey ambiguities without
looking beyond them to flagrant uncompetitive actions.
There are any number of simple 'smell' tests that can be applied
to determine the fairness or otherwise of airline pricing.
One of the major
justifications by established carriers - 'we are not trying to
kill the other guy, we're just competitively responding to
something he started; it's not our fault, he made us do it' is
so thin as to be almost completely transparent. There is a
valuable 'bundle of benefits' associated with a mainline carrier
that a new tiny startup with a thin route structure can't offer,
other than by pricing at a discount to reflect the lack of the
soft and not so soft benefits associated with flying on the
This 'bundle of benefits'
includes such things as more flights to choose from, a frequent
flier program, easier luggage transfer on to other airlines, a
wider number of cities served, the 'brand equity' of the name
brand carrier, airport lounges, and all sorts of various other
So when the major carriers
set the same price as the discount carrier, they are in effect
discounting, because they are including all these other benefits
for free. How much are these benefits worth? That is
hard to say, but let's look at what the dinosaurs themselves
tell us. Bob Crandall (former CEO of American Airlines)
used to proudly claim that customers would willingly pay a 30%
premium to fly on a name brand carrier, and his fellow dinosaur
CEOs all enthusiastically agreed. The airlines should be
held to that claim, and 'regulators' should recognize that
matching price responses to an inferior product are actually
massively underpricing the new guy (because of all the included
extra benefits), not matching the new guy.
It is very rare for an
upmarket anything in any industry to respond to a downmarket
competitor by selling their superior product at the same price.
Lexus doesn't compete against Toyota on price. Ruth's
Chris Steak House doesn't compete against Denny's on price.
Leather furniture doesn't compete against vinyl on price.
And so on and so on. But when airlines do this, against a
backdrop where they themselves have championed the price
differential they claim people will willingly pay, we're
expected to nod sagely and accept it as sensible and fair
It is (or should be) a valid
assumption for a new entrant to believe it can sell cheaper than
established competitors, as witness the Eos business plan.
Eos' problem was not any difficulty in getting passengers, or in
operating profitably on the basis originally projected, and with
lower fares than the ruling rates. Their problem occurred
when the established competitors unfairly responded. If AA
had ignored Eos, then Eos would still be laughing all the way to
the bank. There was a clear pricing differentiation
between the low Eos fare and the high AA fare - more than the
30% needed to persuade customers to consider a non-mainline
carrier - that many passengers felt was sufficient to justify
the loss of frequent flier miles and other benefits. But
when AA dropped their prices by two thirds, that differential
was no longer sufficient.
We're all grownups here.
We all know that when a major carrier massively increases
frequencies, or introduces entirely new services, and when it
halves its fares in response to a new entrant, and then when it
pulls back frequencies, cancels services, and returns fares to
their earlier levels after driving the new entrant bankrupt; we
know those actions stink to high heaven and are in no way fair.
Only the airlines and 'regulators' seem able to suggest with a
straight face that it is normal and fair.
Comparing Airlines to Gas
As for the gas station
analogy by the airline apologist/official, reasoning by analogy
is seldom accurate because there is usually not a one to one
relationship between the analogy and the situation being
directly discussed. In this case, like most others the
analogy is not fair. But let's make the analogy more fair,
and see how it stands up then.
It would be more accurate if
the established gas station offered full service and green
stamps, whereas the new startup was a self-serve with no
attendant benefits. In that case, it would be unusual and
worthy of comment to see the established station price match its
superior service and extra benefits to those of the new
no-frills startup. And if it started offering double green
stamps as well as price matching, that would be even more
As best I remember it, full
service (haven't seen any of it around here in years) used to
command 20c or more a gallon premium, and that was back when gas
was around $1 a gallon, and green stamps (also a thing of the
past!) had some sort of trivial value too. Now substitute
concepts like broader network, greater frequency of flights,
baggage transfer agreements, frequent flier miles, etc, for full
service and green stamps, and you have a fairer analogy.
Back to the gas station.
If the incumbent station started selling below cost (due to the
extra costs of full service and stamps) the new station would
have valid cause for complaint. So why not with airline
The Bottom Line - Who Benefits
An underlying assumption of
a free economy and unregulated competition is that market forces
are fair and end up giving consumers the best values and
services as a result of the competitive pressures acting on the
Can anyone talk about best
values and best services, and the airline industry, in the same
sentence and keep a straight face?
When Eos started service,
there was a clear benefit to travelers. Some travelers who
couldn't previously afford first class tickets could then enjoy
first class at a reasonable price, and other passengers who were
choosing to pay massive premiums for first class could then do
so with huge savings. The consumers won from the
But when American Airlines
in effect undercut its competitor, and caused Eos to lose so
much money that investors apparently lost confidence in it and
refused to help it grow to profitability, Eos was forced to
close down, and the consumer benefit disappeared.
I'm absolutely not
advocating a return to a fully regulated airline industry.
But when the free market assumption proves to be failing, as
happened with first Maxjet and now Eos, maybe it is time to
consider some simple pricing and scheduling parameters which
airlines must meet. These would be easy to create, and
even if the airlines could partially cheat in their responses
and implementations, there might be sufficient control placed on
the marketplace to allow quality discount carriers to succeed,
which is, after all, surely what we as passengers most want.
Postscript, June 2008
The last of the three all
premium cabin private airlines, Silverjet, closed down suddenly
at the end of May.
Within days of that
event, American Airlines cancelled its services to Stansted.
They have disappeared, and so too has their very low competition
killing $2730 fare.
This is completely
counter-intuitive. In any other business environment, the
loss of competitors in a marketplace means the remaining
supplier(s) can expect more business and more profit because
they have a larger share of the market, and don't have to
contest it so fiercely with other competitors. If there
was a bona fide business case for AA starting service to
Stansted last year, the loss of its two Stansted competitors,
making it the only remaining airline operating that route, and
the loss of the closely related competitor to Luton should have
encouraged AA to add extra services, not to cancel their
Was it a coincidence that
AA started competing service, and then ended it as soon as its
competitors had been starved into submission? Was it fair
competition? Or is it something more nefarious?
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2 May 2008, last update
28 May 2011
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