8 Oct 2014

How airlines trick their clients

Dennis M writes:*

When travelling by air, customers often get asked whether they are interested in becoming a member of an airline alliance. Being a member of such an alliance offers several benefits, such as receiving access to airline lounges or being able to take along extra luggage. Clients perceive these benefits as rewards for customer loyalty, but it is important to be aware of the fact that in reality air alliances serve a far more self-seeking purpose.

Before the foundation of these alliances, the competition between single airlines was much higher, but today collaboration protects airlines from underbidding each other. In other words, an airline alliance is an establishment that makes sure that airfares do not sink too far. The airlines do this by agreeing on who is offering which service at which price. An important component of this system is the idea of code sharing which enables airlines to share aircrafts and other resources. This business structure allows each airline to save costs and increase its revenue as it gets access to new markets.

In addition, we can observe that there are multiple airline alliances working on the aviation market. The three largest alliances, Star Alliance, Oneworld, and SkyTeam, transport 73% of all global passengers [pdf], which gives them large control over the aviation market. In this market structure, also known as an oligopoly, different airline alliances cooperate with one another in order to prevent any price dumping. This kind of collusion and strategic behavior makes the alliances not only interdependent, but it also enables them to set the airfares at the highest possible price. This would be a price at which each of the alliances is able to make profit, since an economic loss for a certain alliance would force it to lower its prices and the cartel would break apart. In order to increase their profit, alliances aim at increasing their passenger share, but instead of lowering prices, they do this by offering extra services to their members.

The collaboration among alliances profits the airlines that are members of an alliance and discriminates independent airlines and customers. Airlines that are not part of an alliance are increasingly struggling with selling their tickets to customers, as they do not have the same financial means, and are therefore not able to offer the same customer services. The only option left for these firms is to lower their prices, which becomes increasingly difficult as they have to pay all operating costs themselves while alliances are able to share these costs. Therefore, we are, and will continue to see single airlines either going bankrupt or joining an alliance. This decrease in competition will tie travellers even more to the airfares set by the alliances.

Bottom Line: When being a member of an airline alliance, travellers are mistaken when believing that they are profiting from this system. In fact, airlines bait customers by offering travel benefits in order to increase their own profit. This is mainly done through collusion and keeping airfares artificially high. It is of utmost importance that airline clients are aware of this when deciding whether to become a member of an alliance.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.