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Before we discuss government intervention and its affect on an industry’s competition we must first seek to understand the five forces framework. The theory, discussed in 1979 by Micheal Porter seeks to evaluate the attractiveness of an industry. Throughout this essay I will explore the theory and then relate government action and its well-documented affects on the airline industry.
The strength or weakness of each competitive force in the model will determine the overall attractiveness of a market. The diagram below (adapted from M. Porter, Competitive Strategy CH.1) shows in simple form the five forces, which can be seen as determinants of industries profitability.
There are two reasons why a firm may perform well in an industry, either 1) the industry is attractive to any firm 2) the firm is better and outperforms it’s rivals. Porter’s theory therefore can be used to discover the markets that are attractive to firms or, in those which aren’t breaking down the five forces so a strategy for success can be developed. In general the firm with be more profitable if each of the forces is low, that is to say there is a low threat of new firms entering, if buyers and suppliers have little power over the firm, if there is a low threat from substitute products and if competitive rivalry is low.
The Five forces in the airline industry can be easily broken down, firstly the threat of new entrants. Over the last 10 years there has been a huge influx of new low cost companies in Europe such as “Easyjet”, or “Ryan Air” as the low cost niche slowly becomes more full we are seeing less and less entrants since the market has become saturated. The better an airlines brand image, such as British Airways being a recognised name and the use of frequent flier or airmiles schemes the less likely a new entrant with lower prices will be able to break into the market. Next we have Supplier and buyer power in the industry. In terms of the suppliers of aircraft the main two are Airbus and Boeing and so it may seem that this few suppliers would have a lot of power over the airlines, but intact it tends to just increase the competition between the suppliers as they fight for major contracts with the big airlines. The bargaining power of customers in the
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With the basis of the airline industry established we can now go on to talk about government intervention and its affects. In America up until 1975 the airline industry was tightly regulated by a government body (Civil Aeronautics Board) that ensured airlines needed licenses to run a route with their planes. For a new airline to gain a route license was incredibly difficult until the later 70’s early 80’s where the organisation became more liberal after a deregulation act was passed in 1978. This lead to increased competition. Why? Because it was now easier to enter the market, and exit, sunk costs were low meaning new airlines were less afraid to try new routes. The deregulation increased the power of the customers giving them more choice and putting an end to the control over fare prices. The new airlines forced the more established ones to increase efficiency again another bonus for consumers. Competitive rivalry increased to such a point that the 15 major airlines, which accounted for 90% of the industry (Business Economics: Ferguson, Ferguson and Rothschild Ch16.8.6) had merged into just 8 by 1989. The number of people choosing the airlines was increasing every year, as choice widened and costs fell the threat of substitution was greatly reduced.
The American airline industry case is an example of the Government employing a Competition policy as its way of intervening in the market. This policy essentially aims to increase the competition in a market and reduce the oligopolistic and monopolistic market structures. The government can encourage competition in two main ways, firstly by monitoring business conduct. In the UK this is done by the office of fair-trading which can make sure there is no underhand tactics being used by one company against another, such as predatory pricing or collusive practices. Secondly through merger policy, which is where a major merger will be investigated to see if it will be good or bad for a market and therefore whether it will be allowed to go ahead. This is more of a modern idea and wasn’t really considered for the mergers in late 80’s America.
In some instances airlines are partially or entirely owned by governments, for example air France, Malta and most of the Asian airlines. When this is the case the five forces are affected in different ways. Since competition in these cases is often reduced. The threat of new entrants in the host country is low since the government often won’t allow it, customers and suppliers will have very little power since there is very little choice and the threat of substitutes is low for the same reasons as before. When the airline is government owned its objectives are often different from that of a company such as Virgin, which seeks to make profits. The government airline is going to be more about prestige, tourism and supporting the countries other industries such as aeronautics and engineering.
In terms of affecting the airline industry there is another major factor in which the government plays a role and that is through environmental management. The consumer’s awareness of environmental effect of airlines is highlight through the media, and through websites, which allow you to calculate your pollution in tonnes of CO2 on each flight you take. This consumer pressure has forced governments to take a more active role in the environment. In turn the government puts pressure on airlines to become more environmentally friendly. The affects on the 5 forces can be easily understood. Associated with becoming environmentally friendly is an increase in costs. Increased costs means it will become less likely that other airlines will be set up if the profit margins begin to fall. At the same time the costs to customers may go up meaning that the substitutes may become more appealing to air travel itself.
Opponents say that government is the biggest weakness of Porter’s theory and that really it should be a 6th force, but as Porter explains it may be the most important economic agent, but it actually affects each of the 5 forces, and so in itself is not a single force. The essay has shown this to be the case, with government intervention having an effect on each of the forces, and changing it for the better or worse to make an industry more or less attractive.
The Lecture notes of Dr Rob Branston and Dr Eleanor Morgan.
Business Economics by P. Ferguson, G Ferguson, R Rothschild, 1993.