Global airlines are set to record increased profits this financial year as they are buoyed by low oil prices. Traditionally, fuel accounts for about a third of airline operating costs, but with this fall in price, it’s dropped to as little as 15%. Why then, have airline profits not translated to cheaper tickets?
In the US, the failure to lower prices proportionately has been attributed to 15 years of consolidation in the airline industry, leaving only three major network carriers: American Airlines, United Airlines and Delta Airlines. Another reason is that hedge funds and other owners have a stake in multiple airline companies. Both these factors make airlines more likely to invest the extra profits in new planes or share buybacks, than try to undercut their competition.
Unfortunately, many of the surcharges added during periods of high oil prices have stayed put; as have many of the pricing structures which removed features instead of reducing ticket prices. The increasingly fragmented fares-structure is a classic case of price discrimination. (Think the concession movie ticket example in first-year econ). By charging separately for previously included extras like snacks and a humane amount of leg-room, airlines profit by offering products at the widest range of price-points. Every customer pays closer to their maximum.
The same occurs on a larger scale, with premium airlines offering their own budget carriers, such as Qantas’ Jetstar. This should allow airlines to offer more seats, because they can gain the low-budget customers with an affordable base fare, without losing the profit from those premium customers who will opt for the extras. However, with an oligopoly in the market, this isn’t necessarily the case.
Price discrimination also occurs through dynamic pricing algorithms. Airlines track seat capacity while selling tickets. They release seats and adjust prices based on how these compare to previous sales trends. This means there may be an ideal time out from the flight, or day of the week to buy tickets. This usually depends on the particular route and time of year, but Google your heart out.
Airlines can sense your inelastic demand, and raise prices accordingly. If you’ve shown too much interest in a ticket, it may be wise to clear your cookie cache, go incognito on a private server with a VPN, and make a series of false ticket searches, so they can’t tell how much you desperately want that flight.
Rather than putting on more flights to service the increased demand, airlines have been exercising ‘capacity discipline.’ This has caused the US Justice Department to investigate possible collusion between the major airlines. More likely, it is simply an uncompetitive industry, characterised by recent mergers.
Australia’s airline industry began substantial deregulation in the late 1980s, carried through the 1990s in line with National Competition Policy. Relaxations on restrictions, such as foreign airline ownership, has led to a more competitive industry. While national carrier Qantas continues to suffer, the average customer wins. No-one browsing budget flights seems haunted by the ghost of Ansett either.
There have been significant changes to the market shares for Australia’s international airline activity in terms of passenger carriage. Qantas has a 15.9% market share (down from 28% 10 years ago), Emirates 9.8% (up from 6.2% 10 years ago), Jetstar now has 9.2%, Singapore Airlines 8.6% and Virgin Australia 7.4%.
The 2015 Harper Review makes further Competition Policy recommendations. Reform in the sector should focus on jet fuel supply and Airservices Australia operations. Though it cautions against allowing competition restrictions to be imbedded in privatisation deals, as occurred for Sydney Airport. It also notes the ‘light-handed’ approach to price monitoring has allowed for very fast price increases at some airports, and would need to be reassessed if this continues.
However, many barriers to entry, like high start-up costs, are inherent to the industry. Could new business models ease what some would call price-gouging? For instance, frequent flyers for certain US routes can now take out a yearly subscription for their flights. Another company has started offering lay-by options for customers who can’t afford their flight up-front. And of course flight comparison sites have been allowing a more informed choice of carrier.
Despite the sales algorithms and separately purchased features, perhaps there is not enough price discrimination for some customers. Ryanair’s CEO Michael O’Leary has championed the introduction of £1-5 standing or saddle-like options to increase capacity. After all, he points out, a plane is “just a bloody bus with wings”. But this high-altitude race to the bottom has been repetitively blocked by safety regulators. A relatively uncompetitive industry, using more advanced price discrimination techniques, means airlines will continue to profit from cheap fuel more than we save.
Australian Government Department of Infrastructure and Regional Development. (2016). International Airline Activity. Retrieved from https://bitre.gov.au/publications/ongoing/international_airline_activity-annual_publications.aspx
Harper, I., Anderson, P., McCluskey S., & O’Bryan, M. (March 2015). Competition Policy Review Final Report. Retrieved from http://competitionpolicyreview.gov.au/files/2015/03/Competition-policy-review-report_online.pdf
McAfee, R. & Velde, V. (2004). Dynamic Price Discrimination. Retrieved from http://mcafee.cc/Papers/PDF/DynamicPriceDiscrimination.pdf
Milmo, D. (29 February, 2012). Ryanair Plan for Standing-only Plane Tickets Foiled by Regulator. Retrieved from https://www.theguardian.com/business/2012/feb/28/ryanair-standing-only-plane-tickets-regulator
Mouawad, J. (6 February, 2016). Airlines Reap Record Profits, and Passengers Get Peanuts. Retrieved from http://www.nytimes.com/2016/02/07/business/energy-environment/airlines-reap-record-profits-and-passengers-get-peanuts.html?_r=0
Pinsker, J. (7 March, 2016). Why is Flying Still Expensive Even Though Fuel’s Gotten So Cheap? Retrieved from http://www.theatlantic.com/business/archive/2016/03/why-is-flying-still-expensive-even-though-fuels-gotten-so-cheap/472359/
Smith, O. (3 February 2015). New Call for Standing Seats on Planes. Retrieved from http://www.telegraph.co.uk/travel/news/New-call-for-standing-seats-on-planes/