price discrimination in the airline industry - Fagbokforlaget
price discrimination in the airline industry - Fagbokforlaget price discrimination in the airline industry - Fagbokforlaget
How would competition affect the profitability of versioning in the airlineindustry? Dana (1998) shows that in theory versioning could be observed also in anenvironment with low market concentration. Again, casual evidence indicates that actualperformance is consistent with the theoretical prediction: versioning is also observed in acompetitive market outcome in the airline industry.There are some studies that tests for how price discrimination in the airlineindustry is affected by competition. Some studies find that the average price level in theairline industry increases with market concentration (see Borenstein, 1992; Morrison andWinston, 1990). But this does not say anything about whether the price discrimination ismore prevalent in a competitive setting. Borenstein and Rose (1994) find that pricedispersion in the airline industry is larger in a competitive market situation than in amonopoly market situation. This suggests that firms price discriminate more in acompetitive setting. Stavins (2001) tests more directly for how versioning is affected bycompetition. She considers two kinds of product damaging: Saturday night stay-overrequirements and advance-purchase requirements. By using data from the U.S. airlineindustry for 1995, she tests for how those two restrictions affects the discounts. Discountscan be seen as the difference between the price of the high quality version and the priceof the damaged version. No surprise, it is found that both restrictions lead to lowerairfares. Less obviously, though, is how competition affects the discount. She finds thatthe discounts are larger in markets with low market concentration, and this is true bothfor the Saturday night stay-over restriction and the advance-purchase restriction. Sheconcludes as follows:‘The results are consistent with the hypothesis that, as more carriers operate on a givenroute, the carriers’ competition for consumers with higher price elasticity of demandincreases, while fares charged to consumers with inelastic demand stay high.’ (Stavins,2001, p. 202).Her results are consistent with the results found in the Norwegian airline industry (seeSteen and Sørgard, 2001). Using data for the period 1996-2001, it was found that a shiftfrom monopoly to duopoly had no effect on the price of the high quality version (the© Steen and Sørgard 20
flexible air ticket, labeled C-class ). On the other hand, a shift from monopoly to duopolyhad a price-decreasing effect – although of minor magnitude – on the price of thedamaged product (the restrictive ticket, labeled the M-class).Discounts for large consumersWhile versioning is an example of second degree price discrimination, discounts given toselective groups is an example of third degree price discrimination. As far as we know,there are no studies in the existing international literature of third degree pricediscrimination in the airline industry. However, this kind of price discrimination playedan important role in the Norwegian airline industry in the period 1998-2001. Let usexplain the experience from the Norwegian airline industry.After the deregulation in 1994 of the domestic airline market, the airlines SASand Braathens were the only competing firms. Both had routes throughout Norway, andcompeted head to head on the largest routes. We did not observe any changes in theprices of the flexible tickets (high quality product) after deregulation. These were ticketsintended for the business segment. Despite this, the airlines started to compete on pricesfor the business segment. Gradually large firms that were demanding large quantities ofthose flexible tickets starting exploiting their buying power. Each firm asked both SASand Braathens to offer discounts to the firms’ purchase of airline tickets, and each firmtypically wrote an exclusive contract with one of the airlines.The discounts were typically a discount on the price of the flexible ticket,typically a percentage discount. In the first years after the deregulation in 1994, thediscounts were very limited. But from 1998 and onward this changed. Some firms wereoffered substantial discounts. There are examples of firms that were offered a discount ofmore than 50% on particular routes, which implied that they paid a price of the flexibleticket that was below the average price of the restricted ticket.If we take a closer look, it is quite obvious that the discount we have described isa result of competition rather than deliberate price discrimination. As is well known fromtheory of third degree price discrimination, a firm would find it profitable to set a highprice in a segment with price inelastic demand and a low price in a segment with priceelastic demand. However, we observe the opposite in the Norwegian airline industry.© Steen and Sørgard 21
- Page 1 and 2: PRICE DISCRIMINATIONINTHE AIRLINE I
- Page 3 and 4: various kinds of price discriminati
- Page 5 and 6: If the quality of the good equals Q
- Page 7 and 8: As shown in Figure 3, the quality o
- Page 9 and 10: consumers’ consumer surplus. Rear
- Page 11 and 12: products. This would lead to an inc
- Page 13 and 14: A price increase for the group with
- Page 15 and 16: Even if third degree price discrimi
- Page 17 and 18: The solid line is the demand if the
- Page 19: 3. THE AIRLINE INDUSTRYIn the previ
- Page 23 and 24: city pair market and the importance
- Page 25 and 26: very intense rivalry on prices. The
- Page 27 and 28: When airlines compete, there might
- Page 29 and 30: Holmes, T. J. (1989): ‘The Effect
How would competition affect <strong>the</strong> profitability of version<strong>in</strong>g <strong>in</strong> <strong>the</strong> airl<strong>in</strong>e<strong>in</strong>dustry? Dana (1998) shows that <strong>in</strong> <strong>the</strong>ory version<strong>in</strong>g could be observed also <strong>in</strong> anenvironment with low market concentration. Aga<strong>in</strong>, casual evidence <strong>in</strong>dicates that actualperformance is consistent with <strong>the</strong> <strong>the</strong>oretical prediction: version<strong>in</strong>g is also observed <strong>in</strong> acompetitive market outcome <strong>in</strong> <strong>the</strong> airl<strong>in</strong>e <strong>in</strong>dustry.There are some studies that tests for how <strong>price</strong> <strong>discrim<strong>in</strong>ation</strong> <strong>in</strong> <strong>the</strong> airl<strong>in</strong>e<strong>in</strong>dustry is affected by competition. Some studies f<strong>in</strong>d that <strong>the</strong> average <strong>price</strong> level <strong>in</strong> <strong>the</strong>airl<strong>in</strong>e <strong>in</strong>dustry <strong>in</strong>creases with market concentration (see Borenste<strong>in</strong>, 1992; Morrison andW<strong>in</strong>ston, 1990). But this does not say anyth<strong>in</strong>g about whe<strong>the</strong>r <strong>the</strong> <strong>price</strong> <strong>discrim<strong>in</strong>ation</strong> ismore prevalent <strong>in</strong> a competitive sett<strong>in</strong>g. Borenste<strong>in</strong> and Rose (1994) f<strong>in</strong>d that <strong>price</strong>dispersion <strong>in</strong> <strong>the</strong> airl<strong>in</strong>e <strong>in</strong>dustry is larger <strong>in</strong> a competitive market situation than <strong>in</strong> amonopoly market situation. This suggests that firms <strong>price</strong> discrim<strong>in</strong>ate more <strong>in</strong> acompetitive sett<strong>in</strong>g. Stav<strong>in</strong>s (2001) tests more directly for how version<strong>in</strong>g is affected bycompetition. She considers two k<strong>in</strong>ds of product damag<strong>in</strong>g: Saturday night stay-overrequirements and advance-purchase requirements. By us<strong>in</strong>g data from <strong>the</strong> U.S. airl<strong>in</strong>e<strong>in</strong>dustry for 1995, she tests for how those two restrictions affects <strong>the</strong> discounts. Discountscan be seen as <strong>the</strong> difference between <strong>the</strong> <strong>price</strong> of <strong>the</strong> high quality version and <strong>the</strong> <strong>price</strong>of <strong>the</strong> damaged version. No surprise, it is found that both restrictions lead to lowerairfares. Less obviously, though, is how competition affects <strong>the</strong> discount. She f<strong>in</strong>ds that<strong>the</strong> discounts are larger <strong>in</strong> markets with low market concentration, and this is true bothfor <strong>the</strong> Saturday night stay-over restriction and <strong>the</strong> advance-purchase restriction. Sheconcludes as follows:‘The results are consistent with <strong>the</strong> hypo<strong>the</strong>sis that, as more carriers operate on a givenroute, <strong>the</strong> carriers’ competition for consumers with higher <strong>price</strong> elasticity of demand<strong>in</strong>creases, while fares charged to consumers with <strong>in</strong>elastic demand stay high.’ (Stav<strong>in</strong>s,2001, p. 202).Her results are consistent with <strong>the</strong> results found <strong>in</strong> <strong>the</strong> Norwegian airl<strong>in</strong>e <strong>in</strong>dustry (seeSteen and Sørgard, 2001). Us<strong>in</strong>g data for <strong>the</strong> period 1996-2001, it was found that a shiftfrom monopoly to duopoly had no effect on <strong>the</strong> <strong>price</strong> of <strong>the</strong> high quality version (<strong>the</strong>© Steen and Sørgard 20
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