Predatory Pricing in the

Airline Industry: Spirit

Airlines v. Northwest
Airlines (2005) Industrial Economics
Prof. Dr. Kai Hüschelrath

Name Matrikelnummer

NGUYEN, NGOC TUAN ANH 308701

NGUYEN, PHUOC BAO ANH 308733

CUNG, THI THU HUONG 308643

 2

Presentation : Agenda

Overview Spirit Airlines

vs Northwest Airlines

Predatory Pricing

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Economic Analysis of
Northwest’s Conduct
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Spirit Airlines
vs Overview

Northwest
Airlines
 Northwest Airlines vs Spirit Airlines
Overview

• Operation in 1926 • A low-fare, regional carrier

• One of the five largest passenger airlines in • Operated 28 aircraft in 2000
the world in 1990s • Around 2000 employees
• Around 53,500 employees • Serving 2.8 million flown passengers.
• Serving 58.7 million flown passengers in 2000 • Offered regularly scheduled air service to 13
• Domestic hubs in Detroit, Memphis and city pairs in the US
Minneapolis; and many international • Primary business: Detroit to Florida and other
destinations entertainment destinations
 5

Northwest Airlines vs Spirit Airlines

Entry, aggressive pricing, and exit

Detroit to Philadelphia (DTW-PHL) Detroit to Boston (DTW-BOS)

Market share Northwest was the

only airline offering
Northwest Airway (70%) non-stop local
& passenger airline
service
US Airway (30%)

Source: Kenneth G. Elzinga and David E. Mills, Predatory Pricing in the Airline Industry: Spirit Airlines v. Northwest Airlines (2005), publication at:
https://www.researchgate.net/publication/242139660
 6

Northwest Airlines vs Spirit Airlines

Entry, aggressive pricing, and exit

Spirit introduced a 2nd daily Spirit exited the DTW-PHL

nonstop flight market
Northwest dropped its fare to $49 Northwest responded by raising
and added another daily flight. its fares and reducing capacity.

12/1995 08/1996

06/1996 09/1996

Spirit started once-daily Spirit canceled one of

flights from DTW-PHL with its daily flights
fares $49
----------
Northwest's lowest fare $125
Detroit to Philadelphia (DTW-PHL)
 7

Northwest Airlines vs Spirit Airlines

Entry, aggressive pricing, and exit

Spirit introduced a single daily Spirit exited the DTW-BOS

nonstop flight with average market
fare in the range of $67-75 Northwest responded by raising
its fares and reducing capacity.

Prior to 04/1996 Late 04/1996

15/04/1996 08/09/1996

Northwest added two

Northwest was an only airline
additional daily nonstop flights
serving the route. Average
and offered a matching fare to
fares $411 for an unrestricted
Spirit
ticket and lowest restricted
fare was $129.

Detroit to Boston (DTW-BOS)

 Northwest Airlines vs Spirit Airlines
Entry, aggressive pricing, and exit

Source: Lu´ıs Cabral (2009), Spirit Airlines, Published By LEONARD N. Stern School Of Business New York University
Predatory
Pricing
 Predatory Pricing
Definition

Cutting price below rivals’ average

cost, even if this means short-run
losses for itself as well, to drive rivals
from the market.

Predatory pricing is a business

strategy designed to create or
maintain a monopoly position.

Raising price and collects enough

economic profit to more than balance
out any short-term losses.

Source: Kenneth G. Elzinga and David E. Mills, Predatory Pricing in the Airline Industry: Spirit Airlines v. Northwest Airlines (2005), publication at:
https://www.researchgate.net/publication/242139660
 Predatory Pricing
Distinguishing Predatory Pricing from Competition

Step 1
Define the relevant market to determine if
the defendant can establish monopoly
power within structural conditions in that
Step 2 market.
Determine if the price of the
defendant in the relevant market is Step 3
below the cost benchmark (Average Investigates the likelihood that the defendant
Variable Cost). could charge monopoly prices high enough and
long enough after disposing of the targeted rival
to recoup the losses during the period of low
prices.
Source: Kenneth G. Elzinga and David E. Mills, Predatory Pricing in the Airline Industry: Spirit Airlines v. Northwest Airlines (2005), publication at:
https://www.researchgate.net/publication/242139660
Step 1: Relevant Market & Monopoly
Power
 PAGE

Step 1: Relevant market and monopoly power

a) Relevant market

• The relevant geographic markets: Spirit and

Northwest agreed for passenger air travel between the
city-pairs of DTW-BOS and DTW-PHL

• The relevant product markets: There is the difference

of opinion.
 Spirit: all local passengers flying on the DTW-PHL
route and DTW-BOS route AND only leisure-
oriented price-sensitive local passengers on 2
routes

 Northwest: all passengers who traveled on 2

routes AND no distinction between price- and
non-price-sensitive passengers.
 Step 1: Relevant market and
monopoly power
a) Relevant market

SPIRIT
defining the product market
expansively to include all local
passengers exaggerates the
substitutability of alternative
tickets for many passengers who
happen to be flying on the same
route.

14
 PAGE 15

Step 1: Relevant market and monopoly power

Step 1: Relevant market and monopoly power
a) Relevant market

Northwest’s bimodal fare structure illustrates

weak substitutability

claimed and supports separate product markets for

price-sensitive and price-insensitive
passengers.
 PAGE

Step 1: Relevant market and

monopoly power
a) Relevant market

Northwest disagreed that

there were separate product
markets for price sensitive and
non-price-sensitive passengers
 Step 1: Relevant market and monopoly power
b) Monopoly Power (Market Share)

1995
Before Spirit’s entry

DTW-BOS DTW-PHL
US Airways
10%
US Airways
31%

Northwest
Northwest 69%
90%
 Step 1: Relevant market and monopoly power
b) Monopoly Power (Market Share)

2000
After Spirit’s entry
DTW-BOS DTW-PHL
Rest
14%

Rest
36%

Northwest Northwest
86% 64%
 PAGE

Step 1: Relevant market and monopoly power

b) Monopoly Power (Entry Conditions)

Brand loyalty Supply of ground-based facilities

 PAGE

Step 1: Relevant market and monopoly power

b) Monopoly Power (Entry Conditions)

• Northwest: leased 64 out of 86 gates at DTW until 2008

• Spirit: served 19,000 passengers from Detroit in December 1997 without a

gate

25 percent surcharge over the rates

charged to other carriers
 PAGE

Step 1: Relevant market and monopoly power

b) Monopoly Power (NorthWest’s Argument)

US Airways Pro Air

a competitor
sufficiently Spirit could
formidable have operated
to prevent at the
Northwest’s secondary
exercising Detroit airport
monopoly
power
 PAGE

Step 2: Analysis of NorthWest’s

Revenue and Costs
 PAGE

Step 2: Analysis of Northwest’s Revenues and Costs

Northwest’s flight-specific costs

Non-passenger variable
expenses
incurred when adding an

01 03
additional flight or substituting a
larger plane on an existing flight
- cost of fuel, pilots, maintenance
- landing fees

02
Passenger variable Fixed expenses
expenses unlikely to change when
vary with the number of additional passengers and
passengers on a given flight flights are added
- issuing tickets
- in-flight food and beverages
- insurance
 PAGE

Step 2: Analysis of Northwest’s Revenues and Costs

Spirit’s Analysis
 PAGE

Step 2: Analysis of Northwest’s Revenues and Costs

Northwest’s Analysis

Market definition

Connecting passengers Price-insensitive local passengers

 PAGE

Step 2: Analysis of Northwest’s Revenues and Costs

Northwest’s Analysis

Each Northwest flight in and

out of DTW is part of a network
Eliminating a connecting passenger on that flight would
reduce the company’s net revenues on other flights
elsewhere in the network

No need to calculate and

compare average variable costs Northwest’s remaining all-passenger revenues in
both markets always exceeded several incremental
cost measures

Northwest’s response to Spirit’s

entry was profitable in the short run
and therefore non-predatory.
 PAGE

Step 3: Recoupment
 PAGE
28

Step 3: Recoupment

• Predatory pricing is being

like an investment
opportunity

• The insight that predatory

pricing is an investment
strategy is what lies
behind the
recoupment test
 PAGE

Step 3: Recoupment
Spirit Assumption

Assumption 1
Northwest has the ability to foresee
what its likely future fares and
passenger loads would be whether or
not Northwest launched its allegedly
predatory response
Assumption 2
Northwest could reasonably anticipate
what its fares and the number of
passengers carried would be during the
alleged predatory period and beyond

Assumption 3
Northwest could compare its anticipated loss during predation
and the gain it anticipated during subsequent recoupment
 PAGE 30

Step 3: Recoupment

Spirit used two approaches to estimate

Northwest’s otherwise prevailing fares.

Cost-based approach: estimated those fares using

Northwest’s fully allocated cost of service in the
markets in question applied in all other DTW-
based markets

claimed Comparable market approach: Spirit used to

estimate Northwest’s otherwise prevailing fares
exploited the fact that Northwest and Spirit also
competed with each other on flights between
DTW and New York’s LaGuardia Airport (LGA)
Step 3: Recoupment

Spirit used these estimates of

Northwest’s (actual and
hypothetical) fares and passenger
loads to calculate the month-to-
month loss and gain that
Northwest might anticipate from
predatory pricing.

31
 PAGE

Step 3: Recoupment

 Northwest claimed that entry

conditions in DTW-PHL and DTW-
BOS would not provide the
necessary shelter for Northwest to
recoup alleged predatory losses

 Northwest expected Spirit to

remain in the DTW-PHL and DW-
BOS markets in spite of
Northwest’s response to Spirit’s
entry
 PAGE

Case Result
 PAGE

Northwest Airlines vs Spirit Airlines

The Court’s decision

Average
Variable
Relevant Cost
market

THE JUDICIAL TEST Price-Cost

comparision

The District court’s initial opinion:

Northwest won a summary judgement in
March 2003.
 PAGE

A CASE FOR INCREASED REGULATION OF

AIRLINE INDUSTRY
 Increased Regulation of Airline Industry
36

Hub dominance
(Lease Gates)

GATE MONOPOLIZATION ROLE IN ABILITY TO

Raised concerns regarding alleged GENERATE PROFIT
unlawful suppression of competition Scheduling flexibility and
insulation from new competition

DOT RESTRICTING ACCESS

The most concentrated hubs TO GATES
produced the highest air fares poses significant barriers to entry
for an airline competitor and
implicates market contestability.
GENERAL ACCOUNTING OFFICE
>50% HUB MARKET
Passenger fare is often 27 percent
greater at concentrated hubs Passengers end up paying
significantly more than the
industry norm

Source: Erica Wessling, Spirit Airlines, Inc. v. Northwest Airlines, Inc.: A Case for Increased Regulation of the Airline Industry, 6 Wm. & Mary
Bus. L. Rev. 711 (2015), http://scholarship.law.wm.edu/wmblr/ vol6/iss2/9
 PAGE

Increased Regulation of Airline Industry

Northwest Airline
• Decline in competitive • Spend more than
service $100,000 to obtain gate
• passengers often pay • monopoly over 64 of the access
significantly more than 86 airport gates at the • Forced to pay a 25
the industry norm Detroit Metro airport
percent higher landing
• received business from fee than legacy carriers
The harm of gate 78% of passengers flying
through the airport.
monopolies
Spirit Airline

Source: Erica Wessling, Spirit Airlines, Inc. v. Northwest Airlines, Inc.: A Case for Increased Regulation of the Airline Industry, 6 Wm. & Mary Bus. L. Rev. 711
(2015), http://scholarship.law.wm.edu/wmblr/ vol6/iss2/9
 38

Increased Regulation of Airline Industry

New Regulations

Inhibiting Enacting regulations that lower

competition by barriers to entry by ensuring
penalizing fair access to routes and to
gate and terminal leases.
defendants

Source: Erica Wessling, Spirit Airlines, Inc. v. Northwest Airlines, Inc.: A Case for Increased Regulation of the Airline Industry, 6 Wm. & Mary
Bus. L. Rev. 711 (2015), http://scholarship.law.wm.edu/wmblr/ vol6/iss2/9
HAVE ANY
QUESTION
?
 Discussions

The court declared Northwest Airlines won the case, is this

judgement satisfied for you and why?

What else the government could do to strengthen the

regulations for protecting new entries from predator
strategy in the Airline industry?
 41

References

• Lu´ıs Cabral (2009), Spirit Airlines, published by LEONARD N. STERN SCHOOL OF BUSINESS NEW
YORK UNIVERSITY
• Erica Wessling, Spirit Airlines, Inc. v. Northwest Airlines, Inc.: A Case for Increased Regulation of
the Airline Industry, 6 Wm. & Mary Bus. L. Rev. 711 (2015), http://scholarship.law.wm.edu/wmblr/
vol6/iss2/9
• Kenneth G. Elzinga and David E. Mills, Predatory Pricing in the Airline Industry: Spirit Airlines v.
Northwest Airlines (2005), publication at: https://www.researchgate.net/publication/242139660
• Bamberger, Gustavo E. and Dennis W. Carlton, “Predation and the Entry and Exit of Low-Fare
Carriers,” Advances in Airline Economics, v. 1, Darin Lee, ed., Amsterdam: Elsevier (2006)
• United States Court of Appeals, Sixth Circuit (December 15, 2005) SPIRIT AIRLINES, INC., Plaintiff-
Appellant, v. NORTHWEST AIRLINES, INC., Defendant-Appellee, No. 03-1521. Available at:
https://caselaw.findlaw.com/us-6th-circuit/1060723.html?fbclid=IwAR0aiqXDL-Oo-
ANlo4VurV2TUaAVFvT6s_3wiOa6qMCvfOiQlvzMIqMwla8
THE END