1. An analysis of the airline industry
Introduction
As of 2022, the global airlines industry has a market size of $591.8 billion, with the
number of flights increasing continuously with each year (IBISWorld, 2021). The airline industry
is a sub-sector of the aviation and travel industries. It offers services for transporting passengers
or goods via the air. Consumers typically purchase seats for a scheduled date on flights to travel
to different areas of the world. The services provided may be tangible, for example: a lounge
area and inflight entertainment or intangible: customer service. The reason for this focus on the
airline industry is due to the COVID-19 pandemic, where flights were greatly affected, and the
number of flights dropped to 16.9 million during 2020 (Statista, 2022). According to statistics, air
travel declining sharply in 2020 amid travel restrictions. This caused US carriers to lose a
combined total of $35 billion on an after-tax basis during this period (Bureau of Transportation
Statistics, 2021).
There are different categories of the airline industry, mainly international, national, and
regional. International airlines generate more than $ 1 billion in revenue annually, and typically
operate large passenger jets (Bonsor, n.d.). They offer global services, transporting passengers
and goods to hundreds of destinations. National airlines generate between $100 million and $1
billion annually and operate medium-sized and large jets (Bonsor, n.d.). They offer
transportation services to areas within the airline’s home country, as well as internationally.
However, the destinations that the airlines offer flights are based on seasonal variations and
demand (Revfine, n.d.). Regional airlines offer transportation services only within specific
regions, typically to destinations with lower demands (Revfine,n.d.).
2. US airline industry
The airline industry that we would be looking into is the US domestic market. Airlines are
classified into three business models: full-service carriers, low-cost carriers (LCCs), and
regional carriers (Camilleri, 2018).
Full-service carriers offer different classes of service: economy, business, and premium
and operate over a large domestic and international route structure (Alternative Airlines Ltd,
n.d.). Examples of services that full-service carriers provide are inflight entertainment and meal
service. Data have shown that full-service carriers account for more than half of the domestic
US market (Statista, 2022). Examples of full-service carriers are American Airlines, Delta Air
Lines, and United Airlines.
Low-cost carriers (LCCs) offer lower fares with limited services as compared to full-
service carriers due to lower operating costs (Alternative Airlines Ltd, n.d.). According to Gillen
and Lall (2004), most LCCs offer short-haul point-to-point services, allowing aircraft to perform
more take-offs and landings and thus spend less time on the ground. Data have shown that
LCCs account for 30 percent of the domestic market (Statista, 2022). An example of a low-cost
carrier is Southwest Airlines.
Regional carriers provide small-jet service and operate shorter distance flights under the
brand of full-service partners to areas that lack sufficient demand (AeroGuard Flight Training
Center, n.d.). An example of a regional carrier is United Express, a brand under United Airlines.
3. Few firms with large market shares
According to Statista (2022), the major players in the US airline industry by domestic
market share from 2021 to 2022 are American Airlines, Southwest Airlines, Delta Air Lines and
United Airlines. An oligopoly market structure would be expected from the US airline industry,
where the industry is dominated by a few firms with large market shares. Data showed that
American Airlines is the leading US airline with a domestic market share of 19.5 percent,
followed by Southwest Airline with 17.4 percent, Delta Air Lines with 16.3 percent, and United
Airlines with 12.9 percent (Statista, 2022). The 4 dominating airlines have a combined market
share of over 50 percent (Statista, 2022). This implies that there is a high concentration ratio,
and all these airlines have substantial influence over the airline industry. However, this does not
mean that each airline has the ability to influence the airline market individually.
Differentiated products and services
The product substitutability of the airline industry suggests that it is an oligopoly market
structure. The four major airlines offer different services, products, and quality, and thus there is
product differentiation. Products are imperfect substitutes— American Airlines, a full-service
carrier, offers different values of services at differentiated prices (Marketline, 2017), whereas
Southwest Airlines, a low-cost carrier (LCC) offer lower fares with limited services (Alternative
Airlines Ltd, n.d). Aspects such as aircraft capacity, demand, and other yield management
system inputs also influence the pricing of flight tickets that each airline may set (Botimer &
Belobaba,1999).
4. High technical barriers to entry
In the airline industry, the development and production of new aircraft are subjected to
economies of scale, which makes it unprofitable for more than a few airlines to exist together in
the market (GAO, 2014). Additionally, if a firm wishes to enter the airline industry, there are
typically high costs involved for huge capital investment to build capacity. It is mentioned that
fixed costs account for approximately two-thirds of the cost structure in the airline industry (Air
Transport Association, 2002). Since there is too much capital in the industry, airlines face
challenges in consistently producing sufficient revenues to cover total fixed costs or gain stable
profits (Pettit & Murphy, 2001).
Research conducted by GAO (2014) mentioned that the cost of jet fuel poses another
challenge for new airlines entering the industry. In 2012, the price of fuel rose to 30 percent of
US Airline’s operating costs and rendered less fuel-efficient aircraft cost-prohibitive (GAO,
2014).
Limited capital was also identified as a barrier to entering the industry as new airlines
faced difficulties in securing the capital needed to expand their fleets (GAO,2014). Airlines may
also need to invest in endogenous sunk costs for advertising and to expand their road structure
(Giovanni, 2012).
Highly competitive strategy
When new entrants enter the airline industry, they will be competing in mature markets
with few domestic routes. American Airlines, Delta Air Lines and United Airlines have national
networks that offer services to most domestic and international markets (GAO,2014). Hence, if
new airlines are unable to provide the same level of service as to destinations and frequency,
they would not be able to compete with these established airlines (GAO,2014). Thus, it would
5. be difficult for new firms to enter due to established airlines adopting a highly competitive
strategy.
In addition, research conducted by GAO (2014) found that another barrier to entry is the
inability to get access and acquire a foothold at some main airports. Although slot controls aided
in handling congestion, they also limit access for new entrants to major airports (GAO,2014).
Thus, obtaining landing rights at major airports also poses a challenge for new airlines (GAO,
2014).
The last barrier to entry identified is loyalty programs and corporate discounts. Typically,
these loyalty programs and corporate discounts provide consumers and companies with
incentives and discounts (GAO,2014). Hence, new airlines that cannot offer such incentives
may be at a significant disadvantage over established airlines.
Interdependent in pricing and output decisions
Since the industry adopts a highly competitive strategy, airlines do not have the ability
individually to control prices as other airlines have equal market power. An oligopolistic market
will operate based on its competitor’s actions, also known as strategic interdependence
(Pindyck & Rubinfeld, 2019). However, an oligopoly market structure may encourage formal
collusion between firms for mutual benefits such as restricting output to gain a higher economic
profit (Clarke,1983).
In 1971, Southwest Airlines developed a low-cost carrier (LCC) model which provided
lower airfares to consumers (Diaconu & Popescu, 2011). This caused changes in airfares,
passenger traffic, and competition, and full-service carriers responded to Southwest’s entry by
lowering their fares to strengthen their consumer’s loyalty (Goolsbee & Syverson, 2008).
6. The action of the other airlines to follow and lower their fares shows that they are highly
responsive to their competitor’s behaviour to maintain their market position. Hence, airlines
follow an oligopolistic market since their price or output is set depending on their competitor’s
decisions (Pindyck & Rubinfeld, 2019). Since airlines will follow their competitor’s decision to
avoid losing consumers, it follows a kinked demand curve where the elasticity of demand
changes at lower and higher prices.
Changes to scope
In the event that the scope is expanded to Europe’s transportation system instead of
solely airlines, the market structure would still be an oligopoly. In Europe, the five main transport
modes frequently used are road, rail, inland waterways, air and maritime (Eurostat, 2021). Road
transport accounted for over half of all tonne-kilometres travelled in Europe at 54.7 percent,
maritime transport at 29 percent, rail at 11.9 percent and inland waterways at 4.1 percent
(Eurostat, 2021). Air transport played a minor role in intra-EU freight transport, accounting for
only 0.3 percent in 2020 (Eurostat, 2021). The transport modes of all offers similar product and
services, with their main objective to transport passengers. Similarly, to the airline industry, the
transport industry has a few firms dominating the market. New entrants may also face high
barriers to entry, as entering the market typically involve high capital investment (Allied Market
Research, 2021). Thus, airlines in the Europe transport system would still be an oligopoly,
despite it being a much smaller percentage since most of its characteristics falls under a
oligopoly market structure.
7. Conclusion
Based on the findings above, my study confirms that the airline industry follows an
oligopoly market structure, where there is imperfect competition in which a small number of
firms dominate the industry, with a combined market share of over 50 percent. Since airlines
produce similar outputs, they are mutually interdependent on one another for their decisions and
subjected to high demand volatility and uncertainty (Borenstein & Rose, 2008). This also implies
that their pricing strategies, advertising strategies and new product development are
interdependent on one another. As mentioned earlier, the products and services offered by
airlines are usually differentiated, where we see the biggest contrast between full-service
carriers (American Airlines, Delta Air Lines, United Airlines) and low-cost carriers (Southwest
Airlines).
The high barriers to enter the airline industry prevent new competitors from easily
entering the market. We have identified high capital costs, limited capital, large economies of
scale, loyalty programs, corporate discounts and infrastructure constraints that limit the
availability of slots as challenges new firms may face when entering the airline industry.
However, in situations where firms engage in restrictive trade practices such as collusion to
raise price and limit production, the market may imitate a monopoly-like structure (Kararach,
2014).
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