By Mike Tretheway, InterVISTAS Consulting Inc
Proposals for airline mergers and alliances typically come under scrutiny by competition authorities. These authorities often base their assessment of the competition effects on the expected change in average fare prices. If average fare prices are expected to increase significantly the proposal is unlikely to be approved.
However, this approach is fundamentally flawed, and relying solely on an average fare analysis can lead to the wrong conclusions and incorrect decisions. This is because:
- Firstly, rates of return need to be considered. If loss-making (or low return) routes or services are removed through a merger it is likely to raise the average fare price paid across the airline. However, it also improves economic efficiency within the market and the sustainability of the airline.
- Secondly, the use of price discrimination must be recognised. Airlines charge different prices to different passengers, not a uniform price. For each route or service offered, economic efficiency is achieved if the marginal (not the average) passenger is charged a price equal to its cost of provision. A higher average fare can actually increase economic efficiency.
For example, an airline merger could lead to the introduction of new, higher-value services that were not viable beforehand. As such, the average fare paid across the new airline is likely to increase, but existing passengers still pay a similar price for their services as before. Value has been created, but would not be recognised through an analysis of average fares.
With merger and acquisition activity set to increase in the airline industry, it is essential that competition authorities consider each proposal on a more accurate and realistic basis. Such an approach would recognise the actual pricing practice of airlines and would lead to a more accurate appraisal of the effects of the merger.