Date created: 28 January 1998

Last modified:18 December 2002

Maintained by: John Quiggin

John Quiggin

Aussie Airlines' dog fight

Australian Financial Review

9 October 1997

The traditional Australian sympathy for the underdog will be called forth by suggestions of a new attempt to set up a third domestic airline. But the underdog will need more than sympathy if it is to succeed.

Australia is naturally a two-airline country. That is, most of the major Australian air routes are of a size that can most efficiently be served by one or two airlines. Any attempt at entry will, therefore, involve a fight to the death. In such a fight, the incumbents have substantial advantages. Most discussion of barriers to entry has focused on access to terminals for a new airline's flights and on access to appropriate facilities for ticketing, passenger lounges and so on. These barriers contributed significantly to the failure of Compass Mark I. Although terminal access remains a significant barrier, it is less of a problem than in the past. A central element of competition policy is a set of access rules designed to ensure that potential entrants to a market cannot be excluded by incumbents with control of essential facilities.

In all other respects, however, the prospects for a new entrant are considerably less promising than they were for Compass Mark I in 1990, when the old two-airline policy came to an end. Under the two-airline policy, the airlines were not permitted to offer discounts if the cost of doing so would require an increase in standard fares. This reduced their capacity to practise price discrimination, and permitted Compass to gain considerable market share with its one-class operation, in which all seats were sold at prices equal to or less than the incumbents' discount fares.

In the seven years since the two-airline policy was abolished, the incumbents have steadily refined their price discrimination policies. They have designed restrictive conditions on discount tickets, such as the 'Saturday night away' to ensure that as many business travellers as possible pay full economy or business class fares, while the rest of the plane is filled with private travellers paying discounted fares. The average discount ticket is now about 20 per cent cheaper, in real terms, than before deregulation, while the average standard fare is around 10 per cent dearer. Although only a minority of travellers pay the standard fare, they contribute most of the airlines' profits. The result is that an entrant who sold only discount fares and sought to undercut the incumbents would find it hard to operate at a profit even if the incumbents did not react by cutting fares and offering special deals.

Meanwhile, the incumbents have locked in large shares of the business market with frequent flyer programs, club lounges and the like. There may not be many business travellers who would be willing to fly to Perth and back for the frequent flyer points, as one well-travelled parliamentarian is said to have done. But there are plenty who would choose a more expensive ticket in order to travel with their usual carrier and enjoy the associated perks.

Finally, the airline market has been globalised. The Australian government took the lead in this process, merging Qantas with the former domestic carrier Australian Airlines, and selling a 25 per cent share to British Airways. Ansett started from behind, but has built up its own international links. Apart from the economies of scope associated with operation of both domestic and international routes, the incumbents, as global airlines, have obvious advantages in providing services to overseas tourists, who make up a significant part of the market for travel on domestic air routes. Unless a new entrant has the backing of a major international carrier, the chances of success look slim.

The integration of international and domestic markets has another implication. If the incumbent duopolists defeat a third attempt at entry, their dominance of the market will be unquestionable. The domestic market can therefore be used as a 'cash cow' to finance the struggle for international market share. Some analysts might welcome this outcome as a way of putting forward 'national champions', but domestic travellers cannot be expected to share their enthusiasm.

There are broader implications. The airline industry is one of many in Australia where duopoly appears well entrenched. National competition policy is designed to prevent mergers that would result in a duopoly, reflecting a belief that such market structures are bad for consumers. But once a duopoly is in place, with well-established barriers to entry, competition policy has little or nothing to offer. As long the duopolists are not so silly as to engage in overt collusion, they can earn comfortable super profits. What is needed is a policy framework that takes scale economies seriously and is not based on the implicit assumption that competition will always win out in the end.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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