Is the UK airline industry competitive?

Significant reform throughout the 1990’s has plainly resulted in a more

competitive UK airline industry. The conception of the ‘no-frills’, budget
carriers have revolutionised the industry, pioneering markets for the
masses, inducing airfares to plunge and passenger numbers to expand
considerably. As a consequence of the gradual liberalisation, the UK
airline industry has shown ‘symptoms’ of a market growing in
competition, with lower airfares, increased service frequency,
differentiated products and greater consumer choice. However, as an
industry nurtured and developed under a framework of considerable
structural barriers and tough regulations, the challenge to adapt to post
liberalisation market forces is arduous and ongoing. Therefore confirming
if the UK airline industry has yet reached a competitive state requires
analysis of various factors.

Defining the UK airline industry has become an increasingly convoluted

task. Liberalisation has permitted overseas firms to compete alongside
established domestic firms on many routes with relatively minimal
restriction. Accordingly, airlines such as Ireland based Ryanair have
attained a dominant position in certain airline markets despite foreign
ownership. The industry is further complicated with variances in services
provided. There are full service carriers offering first, business and
economy class tickets to both short and long haul destinations at major
international airports. In contrast, the modern budget carriers offer cheap
homogenous tickets connecting more inconvenient, minor airports.
Uncertainty over the direct substitutability between carrier services
suggests that competitiveness may well be quite varied. Therefore, for
simplicity of analysis, focus will be placed upon firms that are based in the

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UK. British Airways, Easyjet and Ryanair will be primarily utilised as key
industry incumbents for the purpose of more detailed examination.

To comprehensively examine the UK airline industry, the Structure,

Conduct and Performance (SCP) paradigm will be utilised. The concept
represents a framework widely used in competition analysis to examine
industries and predicts that as industry concentration increases, fares
increase and barriers to competition intensify (Bain 1956). The UK airline
industry is particularly relevant to the SCP model due to the high level of
concentration and distinct degrees of competition.

Establishing the nature of the market demand is imperative to reveal the

structure of the UK airline industry. Air travel demand is appreciably
income elastic, with UK passenger growth rates consistently in excess of
economic growth rates since deregulation (Njegovan, N 2005). Unlike
many large economies, the UK has a comparatively small landmass which
results in low demand for domestic carriers. Rail services, developed road
networks and public transport mean that there are strong substitutes.
Demand for overseas travel however is remarkably strong owing to high
average earnings, a large rising population, the societal desire to travel
and few practical substitutes. Furthermore, with major UK cities proving
influential internationally, the business travel sector is also sizeable. As a
result of these strong demand qualities, the UK airline industry has had an
incentive to expand (Figure 1). Therefore the structural expectation is for
large firms to develop, garnering large economies of scale, market power
and concentration.

Since April 1997, EU airspace has been opened to free carbotage following
the implementation of the final package of deregulation. This greatly
reduced the archaic, state imposed structural barriers that had existed

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ever since the inauguration of the industry. The relatively lower barriers
encouraged entry to the market which provoked a fall in the industry 3-
firm concentration ratio (3CR) by 15% (Figure 2). The Herfindahl-
Hirschman Index (HHI) in Figure 3 further demonstrates the fall in industry
intensity. This more accurate measure of industry concentration
measured in terms of airline revenues and also passenger output clearly
shows a profound decline over the period. Although this evidence shows a
clear fall in concentration, the currently observed industry level is
maintained at an oligopolistic intensity. A HHI in excess of 1800
represents a highly concentrated market (US Department of Justice 2002).

Compared to many large industries, the costs of setting up and

maintaining an airline are relatively low (Hanlon 2006). Aircraft can be
leased and if purchased sold with ease in the developed second hand
market. Hanlon further suggests that once the minimal efficient scale is
reached, there is little evidence to show further economies of scale. This
effectively means that small airlines are very much able to compete with
larger airlines cetiris paribus. Therefore, disregarding government
regulation, the structural conditions of the UK airline industry reveal a
market with a significant capacity for competition and low barriers to
entry or exit. This underlines the magnitude and impact of liberalisation,
leading to an expectation for a more competitive airline environment.

There is great variety in concentration across many EU routes. Many

major connections between key airports maintain a number of carriers
leading to strong competition. However many routes operate as
monopolies and duopolies. Here results can be varied with evidence to
show that monopolistic routes yield higher fares (Pels, Njegovan &
Behrens 2009). Evidence does also suggest that potential competition on
a proportion of these routes does keep airfares at expected levels.

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The UK airline industry has been subject to some remarkable conduct
scandals. High court actions have punished uncompetitive practice, such
us the ‘dirty tricks’ controversy (Gregory 2000). Such behaviour prompted
reform and highlighted the capacity for competition. Today, the pricing
strategies of firms, such as price discrimination, indicate the competitive
environment faced by carriers. Where concentration decreases, price
discrimination has been shown to become more prevalent (Giaume &
Guillou 2004). This negative relationship supports the hypothesis that
airlines have become more competitive. Budget airlines such as Ryanair
and Easyjet have also injected a strong element of price competition
between carriers. This has generally resulted in lower airfares, however
outside the EU where budget carriers do not yet operate there has been
little change. Finally, figure 5 shows how volatile jet fuel costs have
surged over the last decade. Despite jet fuel representing a fairly
significant proportion of airlines total costs there has been surprisingly
little transference of these ‘shocks’ to airfares. This again suggests
competitive forces are prominent.

The performance data for UK airlines shows two distinct trends that both
support a decrease in concentration leading to more competition. British
airways and other older incumbents have been subject to a consistent
period of decline since deregulation in terms of market share and profit
rates (Figures 4 & 6). On the other hand, the newer incumbents reported
impressive market share gains and profit rates in excess of the industry
average. Here the differences between the full service carriers and budget
airlines become quite evident. The budget airline model functions on a low
cost and high efficiency basis, with less attention to quality. The full
service carriers however strive for exemplary quality of service to
differentiate their product and thereby charge higher prices. Since EU
liberalisation and the pressures of a more competitive open market, the
full service carriers are beginning to cut costs and are gradually
converging towards the budget carrier model.

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Despite the clearly identifiable gains achieved over the course of
economic liberalisation, the antiquated, traditional practices established
over the course of heavy state control still beleaguer and inhibit the
industry (Smith & Cox 2002). Prior to the onset of deregulation the UK
airline industry, unrestrained by competitive forces, was increasingly
subject to higher costs. Unions, strengthened under regulation, pushed
wages up and implemented policies conducive to inefficiency. The effects
of such inefficiencies are most prominent among the more established
incumbent firms such as British Airways (Figure 4). BA illustrates the
significant difficulties faced by the industry to transition to a competitive
structure. Much has been made of the difficulties BA faces to cut costs,
notably in terms of labour expenditure (BBC News 2010).

The current recession has lead to considerable turbulence within the

market. Profit rates have plummeted for all incumbents (Figure 6).
Although the effects of the downturn are only beginning to surface, the
early signs seem to expose much of the industry’s shortcomings. However
this shock may provide the biggest boost to competitiveness since the
deregulation. Although concentration may well rise in the short term, with
only the larger firms able to weather the instability, airlines have been
forced to scrutinise their operating model and cost conditions much faster
than would naturally occur under a stable market. Time will tell if this
restructuring will revive the industry, but the outlook is positive.

In summary, the UK airline industry is clearly an industry with varied

intensities of competitiveness and concentration levels. Certain European,
high traffic routes are most certainly operating with low fares, indicating
high competition. Conversely, some long haul routes, subject to less
stifling regulations, are still able to make high profits, signifying a lack of
competitiveness and perhaps alluding to implicit collusion. However the

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aggregate picture of the UK airline industry suggests that competition is
sufficient to offer a reasonably good deal to consumers, which is the
underlying significance of competition analysis. Furthermore the evidence
makes a strong case for the level of competition to increase over time.
Airlines are undoubtedly wrestling with reform in a dynamic and
transformative market, such that realising a competitive UK airline
industry is very much on the horizon.

Bibliography

Bain, J (1956) Barriers to new competition Harvard University Press

BBC News (2010) British Airways to cut 1,700 jobs [online]

http://news.bbc.co.uk/1/hi/8293536.stm (accessed 13/3/2010)

Giaume, S & Guillou, S (2009) Price discrimination and concentration in

European airline markets Journal of Air Transport Management Vol.10,
pp.305–310

Gregory, M (2000) Dirty Tricks: British Airways secret war against Virgin
Atlantic Virgin Books

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Hanlon, J (2006) Global Airlines: Competition in a Transnational Industry
Butterworth-Heinmann

Njegovan, N (2005) Elasticities of demand for leisure air travel: A system

modelling approach Journal of Air Transport Management Vol.12, Iss.1,
pp33-39

Pels, E, Njegovan, N & Behrens, C (2009) Low-cost airlines and airport

competition Transportation Research Part E Vol. 45, pp.335-344

Romero-Hernandez, M & Salgado, H (2006) Economies of Scale and

Spatial Scope in the European Airline Industry Institute of Transportation
Studies, UC Berkeley

Smith, F & Cox, B (2008) Airline Deregulation The Concise Encyclopedia of

Economics, Liberty Fund Inc (3rd Edition)

US Department of Justice (1992) Horizontal Merger Guidelines [online]

http://www.justice.gov/atr/public/guidelines/horiz_book/15.html (accessed
12/03/10)

Appendix (Figures are authors own work)

Figure 1

Source: Civil Aviation Authority & Financial Reports

Figure 2

Source: Civil Aviation Authority & Financial Reports

Figure 3

Source: Civil Aviation Authority & Financial Reports

Figure 4

Source: Civil Aviation Authority & Financial Reports

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Figure 5

Source: Civil Aviation Authority & Financial Reports

Figure 6

Source: Civil Aviation Authority & Financial Reports