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The debate on the future of the aviation sector and the viability of its traditional business practices is the core of this book. The liberalization of the EU market in the 1990s has radically modi?ed the competitive environment and the nature of airline competition. Furthermore, the new millennium began with terrorist attacks, epidemics, trade globalization, and the rise of oil prices, all of which combined to push the industry into a “perfect storm”. Airline industry pro?tability has been an elusive goal for several decades and the recent events has only accentuated existing weaknesses. The main concern of ind- try observers is whether the airline business model, successful during the 1980s and 1990s, is now sustainable in a market crowded by low-cost carriers. The airlines that will respond rapidly and determinedly to increase pressure to restructure, conso- date and segment the industry will achieve competitive advantages. In this context, the present study aims to model the new conduct of the ‘legacy’ carriers in a new liberalized European market in terms of network and pricing competition with l- cost carriers and competitive reaction to the global economic crises.



The Airline Industry in Perspective

1. Introduction

From the mid-1990s to the beginning of the new millennium, the aviation industry faced one of the biggest booms in its history. Worldwide increases in GDP, riding on the wave of the new economy, and a greater demand for travel resulting from globalization stimulated the airlines to healthy growth of around 4–6 percent per year. However, this tendency was not continued in subsequent years. At the beginning of 2000, the economic slowdown brought an end to the growth phase, and the terrorist attacks of 11 September 2001 and the SARS virus in 2003 exacerbated the situation. In 2004, the airline industry probably faced the most difficult period of its existence.

2. Characteristics of the Airline Industry

In recent years, the European airline industry has exhibited impressively dynamics. The sector has gone through a drastic change on both the supply and the demand side. Unlikely in other industries, the driving forces governing the recent changes do not depend mainly on technological factors, but on developments in the legal, institutional, and cultural domains. Legal and institutional aspects have clearly affected the structure of the market, while cultural forces have influenced spatial mobility and its characteristics.

Coping with Crises in the Airline Industry

3. Short- and Long-Term Reaction to Exogenous Demand Shifts

In less than 10 years, the liberalization of the European airline industry has placed flag carriers in a highly competitive and dynamic environment. One of the reasons for the demand dynamic clearly results from the peculiarity of the industry: airline carriers have to produce one of the most perishable goods (passenger transport). This fact has forced carriers to implement and refine practices and strategies in order to react promptly to the ups and downs of the demand. In Chap. 2 we described the common practices employed to face short-term demand fluctuations that usually rely on advanced pricing policies, called ‘yield management’. Long-lasting demand shifts require a reaction in terms of capacity supply described in Sect. 2.4.2 as ‘network planning’.

4. The Airlines Conduct during the Crises of 2001/2003

One of the conclusions of Chap. 3 was that, non-flexible carriers, i.e. carriers with high adjustment costs, typically present a small reaction to short- and long-term variables. This behaviour results from the fact that a non-flexible carrier sets high capacity levels during the crisis to push its competitors out of the market and to reduce the set-up costs of re-entering. On the other hand, flexible carriers present high responsiveness to both short- and long-term profitability. As described in Chap. 3 in the North American and the Asian crises, the typology of the shocks and the characteristics of the markets were different. Nevertheless, the empirical analysis of both crises should confirm the theoretical results presented in Chap. 3 that there is a trade-off between short- and long-term goals among carriers for both the first and the second crisis.

The Rise of Low-Cost Carriers

5. Effects of LCC Entry on Pricing in Aviation

A low-cost carrier (LCC) has been defined, in Chap. 2, as an airline designed to have a competitive advantage in terms of costs over a full-service carrier (FSC). An LCC relies on a very simple firm organization and logistic principles. In Chaps. 5 and 6 we try to explain the airline supply process by analysing the LCC versus the FSC network configuration. In contrast to the hub-and-spoke structure of the FSC, the LCC offers point-to-point connections from secondary airports, i.e. smaller airports — such as London Luton — that are less expensive in terms of landing tax and handling fee than bigger airports such as Heathrow or Manchester. The fleet generally includes one type of aircraft that operates more hours a day than the traditional carriers in order to maximize its utilization on a daily basis. The LCC product is not differentiated and the distribution is as simple as possible, by making use of Internet direct sales and electronic tickets. The resulting cost gap between the low-cost model and the FSC model allows the LCC to set airfares on average much lower than traditional carriers.

6. Network Competition: the Coexistence of Hub-And-Spoke and Point-To-Point Systems

The deregulation of the aviation market in the United States in 1978 has intensely affected the airlines' network configuration. As described in Chap. 2, a number of ‘trunkline’ carriers have rapidly reorganized their network structures from point-to-point (PP) systems into hub-and-spoke (HS) systems. In the EU the deregulation process produced similar results, although its effect on the market was not so radical. European carriers had already concentrated intercontinental flights into an HS structure, while they developed a mixed HS and PP network for shorter distances (national and international flights). The low-cost carriers (LCCs) model boomed in both the US and the EU thanks also to lower operational costs and a simplified business model. In Chap. 2 we showed that the LCCs' cost advantage is the outcome of a streamlined production process in contrast to the complexity of the hub-and-spoke system of the FSC. Thus, in this chapter we compare the FSC business model and the new LCC business model in terms of their network configuration. Here the analysis is performed from a theoretical point of view, while the empirical application will be carried out in Chap. 7. We examine a game-theoretical context where carriers are allowed to play three different strategies: point-to-point (PP), hub-and-spoke (HS), or multi-hub (MH), and we identify the conditions under which asymmetric equilibriums may exist. We further discuss how the outcomes of the model can be used to describe the observed coexistence of different business models.

7. New Measures to Compare Network Configurations of Full-Service and Low-Cost Carriers

Traditional analyses of airline networks have attempted to measure the network configuration by means of variables such as traffic distribution or flight frequency concentration (McShan 1986; Caves et al. 1984; Toh and Higgins 1985; Reynolds-Feighan 1994, 1998, 2001; Bowen 2002). These methodologies have mainly addressed the issue of describing and classifying networks in terms of measures of geographical concentration, but they have not addressed this issue as a comparison of real network configurations with ideal HS and PP structures. Although geographical concentration and network configuration are related concepts, they are not coincident. Geographical concentration indices, such as the Gini or the Theil indices, provide a measure of how strong the frequency concentration is in the main airports. HS and PP measures of network configuration do indeed depend upon the shape of the network and the connectivity of airports.


8. Retrospect and Prospect

The current evolution of the aviation sector in Europe can be described in terms of the combination of two main factors. The first concerns the liberalization process which began in the EU during the 1990s and was then succeeded by the boom of the low-cost carriers. This process has radically modified the competitive environment where traditional airlines operate. The nature of competition has changed as new entrants or potential entrants have different business models, especially concerning the network organization (i.e. low-cost carriers). The second factor is related to specific exogenous factors such as terrorism, epidemics, and globalization that have pushed the aviation industry into a ‘perfect storm’. The main concern is whether this model, successful during the 1980s and 1990s, is now sustainable in a market crowded by low-cost carriers. Within this frame of discussion, the objective of this study is to analyse the new strategic conduct of the full-service carriers (FSCs) in a more liberalized European market in terms of how they cope with global economic crises and increased competition with low-cost carriers (LCCs).


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