Airlines and the Oligopoly Market Structure - Assignment Example

Airlines and the Oligopoly Market Structure Competitive advantages and core competencies The article, “The joys of oligopoly” describes a situation in which American-based airline companies are receiving both criticism and accolades for their current operating efforts as it relates to mergers, their new business strategies in the face of deregulation, and their market service principles. Each of the major airlines, United Airlines, American Airlines, US Airways, Southwest Airlines, United, Northwest and Continental all maintain their own unique competitive advantages, despite their oligopolistic market structure that drives business decision-making. These advantages are witnessed in service pricing, destination services, marketing and promotion, as well as the established hub philosophy that drives either point-to-point destination services or major hub development. Much of these competitive advantages come from establishing a market-oriented culture, defined as “delivering superior value to customers” (Narver, Slater & Tietje 1998, p.242). It is about aligning the business model based on three dimensions, having a customer orientation, a competitor orientation, and the ability to coordinate all business units with an inter-functional, systems-based philosophy and structure (Gauzente 1999, p.2). The majority of the airlines identified in the research article have established a market-oriented business model and internal culture, that provides both competitive advantages over other airlines in this oligopoly as well as a strong brand in the consumer market. A market orientation strategy “is a powerful competitive advantage, because it is an invisible asset that takes a long time to establish and one that is difficult to imitate” (Johnson & Verayangkura 2001, p.2). The key phrase is difficult to imitate since businesses that operate in the oligopoly market structure usually create business strategies that mimic or parallel one another in an effort to maintain market share. The competitive behaviours of firms that operate in an oligopoly demand that this paralleling activity occur. Since there are few competitors in such a market structure, constant environmental scanning occurs to witness the competitive behaviours of rival firms to avoid market share losses or loss of brand reputation in consumer markets. Nickels, McHugh & McHugh (2005) identify a competitive advantage as better development of core competencies. These are “functions that the organisation can do as well or better than any other organisation in the world” (Nickels, et al., p.257). In the article “the joys of oligopoly”, it is identified that the core competencies of Southwest Airlines, as one example, is the ability of the firm to structure its scheduling, labour, and point-to-point destination services to provide low-cost, no-frills service that continues to bring the business significant revenues from satisfied customers. While larger competitors with more market presence continue to provide customers better in-flight services that require a higher pricing model, Southwest is able to manage its services effectively and with limited perks for the more frugal consumer. Southwest is also able to follow an A to B flight philosophy which fills more seats daily rather than waiting at a regional hub for connecting traffic that allows for almost instantaneous departure after a flight has arrived at the airport (Associated Press 2001). The core competencies of Southwest are labour-related, flight capacity scheduling, and independence from hub philosophy. However, other airlines that do utilize a hub philosophy consider this a competitive advantage in this market structure as it provides “greater frequency, more destinations and lower fares than customers could expect without it” (Associated Press, p.3). However, as more competing airlines adopt this hub philosophy, competitive advantage is lessened which is leading regulators to applaud the opportunity for consolidation in these industries to create four mega-carriers through merger or acquisition. Southwest’s ability to seize market share from larger carriers is one reason why airlines are concerned about their competitive advantages and seek to create consolidated airline companies for better cost control and to improve on their internal core competencies for better advantages. In the oligopoly, as has been identified, it is necessary for competitor analysis to become part of the regular environmental scanning process in order to determine the best strategy to gain higher revenues and more market presence. However, in this market structure, it becomes necessary for airlines to examine their internal organisational structure to determine whether paralleling activities will be beneficial or whether the dynamics of the business model can support redevelopment to benchmark or exceed rival operations. Strategic alliances Having identified the definition of core competencies and competitive advantage, it would be relevant to determine whether strategic alliances would be beneficial to the airlines rather than outright consolidation that continues to meet with social and corporate resistance. A strategic alliance is “a long-term partnership between two or more companies established to assist in building competitive advantages” (Nickels, et al, p.79). Strategic alliances differ from the joint venture as they do not typically share risks, costs, profits or even management. Instead, they provide access to capital, technical expertise and provide greater access to consumer markets (Nickels). Technical expertise might involve establishing cooperation between both marketing divisions to establish sponsorship programmes or involve dual-financing for special project development that benefits both parties for long-run gains. In 2008, Fiat, a large European automaker, developed a strategic alliance with Chrysler and Cerberus Capital Management. In this agreement, the goal was to renew its product variety, strengthen its marketing brand, increase the speed of international expansion, and also improve their industrial systems (Just-Auto 2009). In this deal, Fiat was granted equity interest in the Chrysler group and achieved new market presence in a variety of consumer markets. Chrysler received new opportunities to develop fuel-efficient cars, engines and engine components in areas where Fiat already has strong market presence and development in Europe (Just-Auto). Taking a lesson from Fiat, if the airlines identified in the research article, such as United and Continental, established a strategic alliance, they could benefit from dual-marketing programmes, or even achieve new financing with shared credit worthiness to establish more hubs, improve their fleet size, or any other venture that would lead to better and long-term competitive advantages. Rather than an outright acquisition or merger, such an alliance allows for better operational developments which can be terminated at the end of the objective with each competitor returning to their business functions, independently, with better-designed business philosophy or structural capacity. A strategic alliance is described as “a tool to unlock value” that “lies somewhere between the firm and the market” (Rogers 2008, p.40). By gaining access to critical expertise and allocating this knowledge between two or more firms, the strategic alliance offers opportunities for new flexibility, innovation, and performance-based teamwork. Joia & Malheiros (2009, p.539) affirm that in order for a company to thrive and survive in a globalised world, their capacity for innovation derived from employees, production process quality, and customer service are paramount business developments. Strategic alliances provide the framework for improving all of these competencies by sharing information as part of dual knowledge management practices. The oligopoly and monopoly An oligopoly is defined as “a market dominated by a small number of participants who are able to collectively exert control over supply and market prices” (investorwords.com 2011, p.1). In this business structure, the functions of advertising and marketing are two of the most important business objectives and usually produce branded products or services (tutor2u.net 2011). There are typically large barriers to new market entry from new competition due to regulatory presence or simply due to the initial capital required to launch a successful business model that can compete, such as the case with the American-based airlines identified in the research article. In order to compete successfully in airline travel, fleet development is required, contractual agreements with regional airports or hub airports, extensive service-based and technical labour, provisions for maintenance, and many other high-expenditure operational components. Thus, typically the oligopoly consists of three to six large competitors that maintain the capital and market control needed to compete and gain revenues. In the oligopoly, using Michael Porter’s Five Forces Model as the relevant framework, suppliers are typically made weak due to high market dominance (Porter 2011). Why is this? Suppliers of products or services that are required for airline success rely on the competitive positioning of these businesses and their revenue creation in order to sell their products, since they have no other buyers to choose from. Because there are high volumes of barriers to market entry, suppliers will lose their own revenues if these airlines refused a pricing model or refused to negotiate on contractual agreements and decided to choose another competing supplier. This would leave the suppliers with no other business resource for procurement, thus essentially having the market control and domination to put these companies out of business. This is why businesses that operate in the oligopoly market structure have considerable advantages in the supply chain, especially when there is a high volume of suppliers that service airlines’ needs and they can defect to a different vendor. Thus, it should be said that airlines in the oligopoly have considerable market power and the ability to set or alter prices. Firms in this structure are largely inter-dependent due to the fact that each rival firm recognises that their own market authority is vulnerable to decay by the actions of competitors (Rubin & Joy 2005). Further, the oligopoly usually has considerably high fixed costs and there is a need for large capital investment in order to build competitive capacity (Rubin & Joy). What are the fixed costs for airlines? Oil and petroleum are some of the largest fixed costs since they are required to perform their branded services. Even though price of these goods are controlled by market forces and supply/demand issues, it represents a good that is a necessity in operations. Many businesses attempt to offset the prices of fuel through investment hedging practices, however it typically represents a majority of operating costs that continue to deplete customer revenues especially when market forces (such as OPEC or investor confidence) drive up these prices. It is because of these high fixed costs that firms in the oligopoly work toward consolidating business roles, outsourcing technical labour (such as maintenance), or looking for other cost-cutting functions through lean supply or other similar strategies related to operations. When airlines are able to reduce prices by streamlining their organisational structure or redeveloping their passenger scheduling more effectively, it represents a competitive advantage and, when possible, rival firms will attempt to benchmark these practices. Thus, there is considerable rivalry that is ongoing in the oligopoly structure. The fixed costs were identified as it relates directly to the research article regarding the need and desire for consolidation with the airline companies. Since 1978, as identified by the article, the costs per passenger mile in the United States have risen disproportionately to the speed of revenue growth, a trend until at least 2000 (Associated Press). Today, airlines attempt to offset these rising fixed and variable costs of operations by applying additional luggage fees or other service fees. However, this causes problems with consumers who become disgruntled by higher pricing by these firms in the oligopoly and price-sensitive buyers will look to cheaper alternatives, such as Southwest if this particular firm (or one like it in the no-frills category) can fit their destination needs. It is because of the tangible need to raise prices to offset rising costs and customer willingness to defect to lower-cost airlines that consolidation is desired by certain large airlines. Gary Kelly, Southwest Airlines’ Chief Financial Officer believes that consolidation or mergers of the largest American-based airlines is “ridiculous” and “just another attempt to stifle competition” (Associated Press, p.4). Southwest recognizes that its position in this oligopoly is unique as no other airline is currently able to copy its business model to offer lower-prices and thus it is the most profitable airline compared to larger rivals. Consolidation of larger airlines, Southwest believes, is an attempt to drive their competitive advantages out of structure so that airlines such as Continental and United can regain their market control. Through mergers and consolidation, larger airlines would have a larger pool of capital to work with, more credit worthiness, and a more well-equipped technical organisational structure to guide innovation and cost control. Critics of consolidation in these airlines believe that the ultimate loser would be Southwest as well as consumers who now have fewer options to choose from when selecting a carrier which could lead to higher prices. However, the Economic Strategy Institute in Washington, D.C. believes that the merger between United and US Airways, as one example, is a novel idea and sees this as an advantage to consumers. This institute offers that post-merger competition would actually rise by 74 percent in some markets and decline in only 13 percent of the markets due to the current market presence and hub bases that service the airlines (Associated Press). Such mergers would improve access to destinations and increase traffic volume that would have benefits to consumers. However, this position does not seem to be supported well by fact considering it has been established that new market entry into the airline oligopoly requires significant capital investment and asset procurement to launch a new rival firm. Michael Levine, a former manager at TWA and a Harvard graduate, believe that a merger between American Airlines and United is an attempt to ensure higher fare generation for consumers (Associated Press). Levine essentially removes Southwest from the competitive equation, believing that a merger between these two airlines would give them more leisure travellers due to their development of dual secondary airport usage away from their main hubs (Associated Press). All of these conflicting opinions are not supported by hard, quantitative economic data and seem to be a result of mistrust in the oligopoly rivals to serve customers effectively and still be able to use ethical pricing structures in the process. Negative sentiment over consolidation of the airlines likely stems from pre-existing attitudes about the dangers of monopolies to consumers, which requires some discussion. A monopoly is a market structure where there is only a singular supplier of a product or service with zero competition and where there are no substitute products available close to the good or service being produced (Nat. Council on Econ. Education 2010). Microsoft, as one example, has been accused of being a monopolistic company (even though it has competitors) for its dominance in personal computer operating systems. Though this criticism does not hold up in fact, it is an example of certain monopolistic strategies to dominate a market. A monopoly maintains natural barriers to entry that leave the single entity as the sole market force for a particular good or service. These barriers includes economies of scale, those created by government forces, protectionism related to intellectual property, or direct actions by the monopolistic company to create barriers (Boyes & Melvin 2007). A monopoly typically has the power to control supply and demand and set virtually any price on its product unless otherwise regulated by anti-trust or anti-monopolistic regulations. One of the criticisms and concerns of monopolistic strategies is price discrimination, a situation where customers in one area are charged differently for the same product. An example of price discrimination is charging senior citizens a lower price than the rest of society for theatre tickets or pharmaceuticals (Boyes & Melvin). The criticisms associated with potential consolidation in the airlines is that it is moving closer to becoming a monopoly as mergers and acquisitions erode the volume of choice that customer have in selecting their airline carriers. This can lead to significant price increases when consumers are left with little to no market power. There are anti-monopolization laws in place, such as the Sherman Act or Article 82 of the Treaty Establishing the EU, that prevent excessive price discrimination and other monopolistic strategies from occurring (Dibadj 2008). There are some in government and society that believe that anti-monopolization laws should be applied to the oligopoly market structure to achieve a competitive equilibrium related to pricing and other consumer interests. Again, this is likely why the oligopoly related to the U.S. airline industry continues to meet with ongoing criticism about the dangers of monopoly-like strategies. However, the evidence seems to suggest that there is much more governmentally-driven advocacy for consolidation in the airline industry, thus invoking more robust anti-monopoly regulations does not look to be a reality. The U.S. is a free market society, thus there is supposed to, in theory, be a separation between governmental influence and the corporate machine. There would be considerable business-based backlash from American airline companies if government attempted to impose a high volume of anti-monopolistic regulations to impede their free market activities. Thus, it would appear that consolidation in these U.S.-based airline companies will continue to be a reality that does really seem to limit the scope of competitive forces for consumer choice. Conflict in the oligopoly There also seems to be an imbalance in price-setting as it was identified in the chosen research article. The article identifies significant pricing differences that occur simply by changing the date of departure for a consumer business traveller. A USD $543 ticket from Washington, D.C. to San Francisco with a departure of Saturday and a return of Monday is a typical fare rate for round-trip service on the major carriers. However, if the traveller leaves Washington, D.C. on Sunday for a Monday meeting in San Francisco, the fare increases to $2,248 (Associated Press). This is a 242 percent increase in price that occurs over less than a 24 hour period on the same airline. “Consumers are disgruntled” (Associated Press, p.3), and with good reason if these types of fare imbalances exist. This could very well be another reason why critics of the consolidation believe that price gauging or price discrimination, much like a monopolistic entity, could continue to plague the pocketbooks of many different consumer demographics without governmental regulations imposed. This is likely another reason why Southwest Airlines has been able to raise such high profitability over the other oligopoly players by having a more stable pricing scheme with more predictable fares associated with its no-frills, low-cost model. Conclusion Time will determine whether or not the U.S.-based airline companies will consolidate their services through acquisitions or mergers until competition is significantly reduced further than it already seems to be. However, if the businesses choose to seek strategic alliances rather than flat acquisition or merger philosophy they may be able to gain more competitive advantage and improve their core competencies to better effectively compete with rivals. This market structure is a typical oligopoly with much parallel business decision-making and considerable market control which does not look to be serving consumer interests enough, thus making Southwest an exception under the typical oligopoly guiding structure of competition. It will be interesting to witness whether the airlines actually do continue to consolidate their services and businesses, thus approaching a more monopolistic structure where price discrimination requires anti-monopolization laws to reduce negative consequences to the consumer. In any event, it has been established that there are monopolistic-like strategies occurring, such as in the case of the 241 percent fluctuating airfare costs, thus raising what seem to be legitimate questions about the integrity, ethics and viability of such consolidation occurring in the near future. Whether a critic or opponent of airline consolidation, the airlines will continue to operate in an oligopoly until market entry barriers are reduced and it requires less initial capital investment to become a rival firm. References Associated Press. 2001. The joys of oligopoly, Is consolidation in the American market a good thing? Boyes, W. & Melvin, M. 2007, Economics, 6th ed. Houghton Mifflin Company Dibadj, R. 2008, Tacit cartels, oligopolies and the problem of conscious parallelism, Social Science Research Network, SSRN Working Paper Series. Gauzente, C. 1999 [internet] Comparing market orientation scales: a content analysis, Marketing Bulleting, vol.10, pp.76-82. [accessed October 25, 2011 at http://marketing-bulletin.massey.ac.nz/V10/MB_V10_N4_Gauzente.pdf] Investorwords.com. 2011 [internet] Oligopoly [accessed October 24, 2011 at http://www.investorwords.com/3404/oligopoly.html] Johnson, W. & Verayangkura, M. 2001 [internet] Market orientation in the Asian mobile telecom industry: do buyer and seller perceptions concur? [accessed October 24, 2011 at http://www.hicbusiness.org/biz2003proceedings/william%20C.%20Johnson.pdf] Joia, L.A. & Malheiros, R. 2009, Strategic alliances and the intellectual capital of firms, Journal of Intellectual Capital, 10(4), p.539. Just-Auto. 2009, Fiat: 2009 company profile edition 3: Chapter 10 prospects. Narver, J., Slater, S. & Tietje, B. 1998, Creating a market orientation, Journal of Market Focused Management, vol. 2, pp.241-255. Nickels, W.G., McHugh, J.M. & McHugh, S.M. 2005, Understanding Business, 7th ed. London: McGraw-Hill Irwin. Porter, Michael. 2011 [internet] Porter’s Five Forces: A Model for Industry Analysis [accessed October 24, 2011 at http://www.quickmba.com/strategy/porter.shtml] Rogers, B. 2008, Contract sales organisations: making the transition from tactical resource to strategic partnering, Journal of Medical Marketing, 8(1), pp.39-48. Rubin, R.M. & Joy, J.N. 2005, Where are the airlines headed? Implications of airline industry structure and change for consumers, The Journal of Consumer Affairs, 39(1), pp.215-228. Tutor2u. 2011 [internet] Oligopoly [accessed October 24, 2011 at http://www.tutor2u.net/economics/content/topoics/monopoly/oligopoly_notes.htm] Read More