Case Study 4.

1 The characteristics approach and the provision of airline services Deregulation of airlines in the USA and Europe has seen the entry of new airlines and the development of new products. The most important of these has been the low-cost, no-frills service developed by South West Air in the USA and Ryanair and easyJet in Europe. This product has encouraged existing consumers to substitute these new-style offerings for older style packages of services and has attracted many new customers to use air services for the first time. The traditional, full-service airlines offered in a single aeroplane a variety of services that differed in terms of the quality of the facilities and services and in the absence of restrictions on the use of a given ticket. A comparison of the characteristics of the twomodels is presented in Table 4.2. In summary, the major characteristics that might be identified are quality of service and ticket restrictions together with price differences. Traditional airlines have offered a range of fare deals depending on class of travel and restrictions on the choice of outward and return flights: for example, a weekend stay has been charged a lower price than the daily charge to people travelling out and back between Monday and Friday. In Figure 4.5 the restrictions on the use of tickets are measured on the vertical axis and service quality is on the horizontal axis. Initially, two products are offered: first-class travel with few restrictions and high-quality service and tourist class with more restrictions on use and lower quality service, particularly higher seat density. The new, no-frills airlines offer products to the left of tourist class rather than between the two existing products, offering only one combination of service and ticket restrictions. In practice, for some airlines there are a number of combinations in terms of price with a given quality, because flights purchased early have a lower price than those bought closer to departure.

The no-frills airlines also offer lower prices than traditional carriers. The impact of the introduction of new products at lower prices is shown by changes in the efficiency frontier. Initially, the consumer is limited to choices on efficiency frontier EF. With the introduction of the low-fare, no-frills alternative the efficiency frontier moves from EF to HF, with point E becoming an inefficient point. The consumer with the preference function shown in the figure will move from E to F, which is on a higher indifference curve. Other consumers may still prefer traditional services, because of the higher quality associated with the major carriers.

Case Study 5.1 Own price elasticity and rail travel pricing Economists have measured the price elasticities of demand for railway journeys and found that for peak travel they are less than 1 and for off-peak travel they are greater than 1 (see Oum et al, 1992 and ORR 2001). Train-operating companies would be able to raise total revenue by increasing peak and lowering off-peak fares. The ability to raise fares successfully at peak will depend on any alternative forms of transport which travellers could use to avoid paying the higher price. Where the alternatives are impractical the passenger will continue to travel and pay the higher fare. However, in such circumstances the ability of the company to set fares to maximize revenue may be limited by regulatory action. To maximize revenue from each market segment, train-operating companies offer a range of prices, charging the highest prices to those consumers operating on the least elastic portions of their demand curves and the lowest prices to those consumers operating on the most elastic portions of their demand curves. In spring 2002, Virgin Trains offered at least eight fares for any journey from London to Manchester depending, in part, on the time of departure and the class of travel. The fares ranged from 252 for a travel-any-time, first-class ticket to 20 for a 14-dayadvanced-booking value ticket where travel both ways is by specified trains. Generally, the earlier a ticket is booked and the more restrictions imposed the lower the price; this is also a strategy adopted by low-cost airlines, such as easyJet and Ryanair the nearer the date of departure a flight is purchased the more expensive it is likely to be. Whether prices relate to elasticities of demand or an ability to plan ahead is a matter of debate. However, the laws of supply and demand come into play as the fewer the number of seats available relative to demand the higher the price, and only those willing to pay the higher price are able to travel at short notice

The vitamin cartel and the EU In both the EC and the UK all cartels are illegal, and firms participating in them are subject to fines of up to 10% of their turnover in the appropriate market. Each year a number of cartels are identified. One of the most significant in recent years was a vitamin cartel of 13 companies that engaged in a series of agreements to distort the market. Participants were fined a total of c 855.22m in June 2001. The cartel had earlier been identified in the USA, and executives received fines and jail sentences. The leading companies involved were Hoffmann-La Roche and BASF. The companies collusive behaviour enabled them to charge higher prices than if the full forces of competition had been at play, damaging consumers and allowing the companies to make greater profits. The participants in each of the cartels fixed the prices for different vitamin products, allocated sales quotas, agreed on and implemented price increases and issued price announcements in accordance with their agreements. They also set up machinery to monitor and enforce their agreements and participated in regular meetings to implement their plans. The EC estimated that European revenues from sales of vitamin C slumped from c 250m in the last year that cartel arrangements were in place (1995) to less than half c 120m three years later (1998). The EC found Hoffmann-La Roche and BASF to be the joint leaders and instigators of the collusive arrangements, and they were more heavily fined than the other participants. Eight companies were fined as follows:

Five companies were not fined, because they co-operated with the competition authorities