|Type of paper:
|Marketing Airline industry Business strategy
In the 1990s the American Airlines was investigated for using predatory pricing to kill competition in the industry. The case was dismissed because it was difficult to prove that the airline tickets of American airlines were sold below cost. With the use of economic tools, this paper presents the possibility the competition did not involve predatory prices, but other strategies that give the American Airline a competitive advantage. The three concepts included in this paper include economies of scale and scope, Bertrand oligopoly, and market entry dynamic games.
The paper structure of the paper is presented as follows. The first part which is the case presents a summarised version of the American case. The second part presents the concepts of economies of scale and scope and how the give larger firms a competitive advantage in the long run. Section three highlights the Bertrand competition in the airline industry. The aim of this paper is to show that competition on price setting alone may not be enough to achieve a larger market share in the airline industry. The paper will also use game theory to convey the notion that market entry and exit decision on one firm has implications on the behavior of other firms in the industry.
The deregulation of the United States airline industry induced aggressive competition among airline companies between 1995 and 1997. A case worth noting is the one involving routes connected to the Dallas-Fort Worth hub. Several low-cost airlines competed with the American airline on the Dallas routes. The low-cost carries were selling their tickets significantly low price, and this led to an increase in the demand for the plane travels. The American airline responded by matching the prices offered by the new entrants. In addition to matching the prices, The American increased to the jets on each of the routes involved. The response by American made it difficult for the Low-cost carriers to sustain their existence in the industry, and therefore filed for bankruptcy and exited the market. Upon the exit of the competitors, American airline increased its prices and reduced the volume of jets on each route to previous levels.
The conduct of American airlines prompted investigations into the pricing strategy that was employed by the airlines. The accusation was that the airline had intentionally set its ticket prices below cost to drive away competitors from the sector. The American airline, however, insisted that its competition with the low-cost carriers was on merits.
Economies of Scale and Scope
In industries with a higher level of competition, firms use several strategies to be able to beat other firms and remain unbeaten in the industry. Predatory pricing is one of the methods that a firm might employ. This method entails setting the price below cost to drive away competitors from the industry (Barnett, Saliba, & Block, 2007). The main aim of predatory pricing is to drive away competitors even if the result would lead to making loses in the short run. The American airline was accused of using this strategy in the 1990s when it competed with several low-cost carriers, an act that led its competitors to exit the airline industry (Chi & Koo, 2009). Economic theory, however, can be used to show that the exiting of other firms could be a result of economies of scale and not necessarily predatory pricing.
The concept of economies of scale refers to the cost advantages that firms enjoy when their production becomes efficient (Raskin & Williams, 2017). Usually, there is a positive correlation between the size of the firms and their efficiency. The larger the company, the more efficient productions becomes. Larger firms can spread their fixed and variable costs over a more significant number of goods or services provided. In any industry, larger firms experiencing economies of scale always have a competitive advantage over smaller firms. This concept can, therefore, be applied to the case of the airline industry involving American Airline and the other smaller cost carriers.
A similar concept that can be applied to the American airline case is that of economies of scope. Economies of scope enable firms to supply different cost goods or products in a very cost-effective way (Kelly & Booth, 2013). The concept illustrated how the long run average cost of a company decreases because of producing complementary services. Just like economies of scale, they have enjoyed more prominent companies.
The deregulation of the airline industries leads to the reduction of entry barriers to the airline industry. This gave the low-cost carriers to enter the market and compete away the profits enjoyed by the airline companies that existed before deregulation. American airline was one of the few firms that existed before the liberalization of the industry. The entry of new firms led to reduced concentration in the airline industry and ultimately into reduced prices as firms engaged in a price war. In the long run, firms stop making a profit.
The zero-profit condition in the long run which is associated with industry competition means that there are no longer incentives for new firms to enter the market. In the long term, the survival of the firm depends on its cost structure. Low-cost carriers cannot sustain themselves in the industry due to the inability to generate revenue in the face of high average cost. Larger, firms, on the other hand, can sustain themselves due to economies of scale and economies of scope.
According to the case, the American airlines changed their pricing structure in the 1990s to when the low-cost airlines entered the market. In response to the competitive threat posed by these new entrants, American Airlines responded by reducing its prices as well as increasing the number of routes to match its competitor's operation in the Dallas Fort Worth Area.
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