Is the Airline Market

Contestable?
Roshan Mistry, Kunal Shah, Amit Desai
What is a Contestable Market?

One in which there is one firm (or a small number of firms)

Because of freedom of entry and exit, the firm faces competition and so operates
like a perfectly competitive firm

The threat of “hit and run entry” from new firms may be sufficient to keep the
industry operating at a competitive price and output

The key requirement for a contestable market is the absence of sunk costs – I.e.
costs that cannot be recovered if a business decides to leave a market

When sunk costs are high, a market is more likely to produce an price and output
similar to monopoly (with the risk of allocative inefficiency because P>MC)

A perfectly contestable market occurs only when entry and exit into and out of a
market is perfectly costless
The airline industry is a transportation industry
You use it every time you got to an airport
Time line
Liberalisation of the European Airline Market in late 1990s
Traditional “flag-flying” airlines faced new competition
Barriers to entry in the industry were lowered (including greater
use of leased aircraft)
New Entrants
Easy Jet
Buzz
Ryan air
GO (set up by British Airways) eventually sold off
BMI Baby
My Travel
May 2002 – Easy Jet announces the purchase of GO to create a
major player in the European airline industry
Are they contestable
The cost of an Easy Jet flight

Maintenance, 10% Profit, 9%

Groundhandling,
9%
Crew, 10%

Tax, 4%
Airport, 12%

Aircraft, 11%
Credit card, 2%

Advertising, 4% Administration ,
Navigation, 7% 12%
Fuel, 10%
No Not Contestable!!!
Advertising

Planes

Airports

Fuel

Staff
Not contestable
Pricing strategy used by Airline industries:
Easy Jet use a penetration pricing strategy, to put other
low cost air lines out of business
This decreases contestability as there are lower prices
hence firms wanting to enter the market cannot
compete with his price hence do not enter
But, lets think!!
Easy Jet are low cost and budget, but firms like BA are
too expensive and people may be looking for middle
ground hence contestability may exist as it is easy to
enter in this market.
 Low cost airlines aim to keep its operating costs lower than the 'traditional' flag-
carrying airlines;
 (1) Use of the Internet to reduce distribution costs: over 90%
 (2) Maximise the utilisation of the aircraft assets: Each Boeing new 737 aircraft costs
almost $35 million. Therefore maximising utilisation of each aircraft reduces the unit
cost
 (3) Direct sell only: easyJet only sells tickets over the Internet, through the telephone
sales centre
 (4) Ticketless travel: easyJet passengers instead receive an email containing their
travel details and confirmation number when they book online.
 (5) No free airline food: no catering eliminates catering space (used for passenger
seats instead), reduces cleaning costs and speeds the turnaround time of aircraft.
 (6) Use smaller airports: within the UK, easyJet uses smaller airports as its base
airports. Smaller airports - such as London Luton or Liverpool – are cheaper to fly
from than bigger airports such as Heathrow, or Manchester
 (7) One kind of aircraft: easyJet only operates Boeing 737 series aircraft, the
workhorse of the low-cost airline sector. Each aircraft has 149 seats. Commonality
maximises efficiency in the recruitment and training of staff
Thousands Per Year EASYJET PASSENGER NUMBERS

9000

8000 7,664

7000
5,996
6000

5000

4000 3,670

3000

1,880
2000
1,140
1000
420
30
0
1995 1996 1997 1998 1999 2000 2001
Source: EasyJet Web Site
 EASYJET REVENUE AND PROFIT

400 45

350 40

35
300
30
250
£ million

25
revenue (£m)
200
profit (£m)
20
150
15

100
10

50 5

0 0
1998 1999 2000 2001
Source: EasyJet Web Site
They may not be contestable
Existing firms like BA will engage in predatory behaviour
to make entry more costly or exit more expensive
Raising rivals’ costs
Vertical integration means that some firms act as
component suppliers to other firms in their industry – they
have control over the supply-chain
Reducing rival’s revenues – I.e. through the practice of
“bundling”
A monopoly can use profits in one market to boost its
market power in another (cross-subsidisation)