Pricing and Competition in the New Zealand Air Travel Market

This article analyses the impact of competition on pricing and price discrimination using data on 2053 flights on thirteen New Zealand routes observed in 2006 and 2007. The following analysis by Pratik Keshav is an interesting example for the dynamics of competition in an opening closed market.

The study finds that shorter distance routes have average fares per kilometre significantly greater than longer distance routes. It is also established that monopoly routes have average fares up to 20% greater than on a duopoly with Qantas offering fares on average up to 22% lower than those offered by Air New Zealand. Further, the analysis finds that shorter distance routes have a substantial price premium for peak time and sold-out flights compared to longer distance flights. There is also evidence of a negative relationship between competition and price dispersion, consistent with the conventional textbook treatment of price discrimination. This paper also provides verification of a fall in average fares in 2007 compared to 2006, following an announcement of lower Air New Zealand and Qantas fares in early 2007.

Contents:

1.0 Abstract and Introduction

2.0 First Part, Literature Review
2.1 The Changing Scene in New Zealand Aviation (Post Deregulation)
2.2 The Proposed Alliance between Air New Zealand & Qantas
2.3 Impact on Competition
2.4 The Impact of Low-Cost Carriers and the Rise of B2C in the Airline Industry
2.5 The Arrival of Pacific Blue and Possible Effects

3.0 The Database
3.1 Price Information
3.2 Cost Information
3.3 Measure of Market Concentration
3.4 Other Variables

4.0 Econometric Analysis
4.1 The Setup
4.2 The Results

5.0 Conclusion

1. Introduction

Since the deregulation of the airline industry in 1986, the New Zealand air travel market has seen four airlines attempt to compete with the major domestic carrier, Air New Zealand. Although the first three of these failed, in April 2001 a key rival in the form of Qantas started flying domestic routes in New Zealand. This duopoly of Air New Zealand and Qantas was joined on the main trunk routes by Pacific Blue, a subsidiary of Virgin Blue, from November 2007.

Air travel markets have undergone fundamental changes recently. The introduction of the low-cost business model by Southwest Airlines in the U.S. has been widely adopted by a number of so called low-cost-carriers. So much so, that this relatively new business model has challenged the more established 'legacy' carriers. In addition, the growth of the internet banished the traditional cheap fare requirement of Saturday night stay-over. Instead, airlines pioneered the new approach of booking flights through the internet based one-way fare system. Not only has this allowed the legacy airlines to reduce their costs, it has also rendered price comparison easier for travellers by allowing them to quickly identify the cheapest available flights.

December 2002 marked a key development in the New Zealand air travel industry, when Air New Zealand and Qantas submitted applications to both the New Zealand Commerce Commission (NZCC) and the Australian Competition and Consumer Commission (ACCC) for the formation of a 'strategic alliance'. This, in effect, would have monopolised the New Zealand passenger air travel market. It was this event that provided the catalyst for this study.
This paper makes use of new data on airfares to analyse whether competition between the national carrier, Air New Zealand, and the Australian airline, Qantas, affects prices on domestic New Zealand routes. Further, it presents a simple model of the standard form of price discrimination to examine how the dispersion of airfares varies on routes with different levels of seller concentration.

Additionally, this paper also investigates whether the domestic airfare structure has been lowered in 2007 compared to 2006. This follows announcements from Air New Zealand and Qantas in early 2007, in which both airlines claimed to have lowered their domestic New Zealand airfares.

Using a panel dataset of airfares, this study finds that the presence of Qantas on domestic New Zealand routes provides a strong competitive constraint. It also reveals a positive relationship between market concentration and price dispersion. These findings have important policy ramifications with the view that allowing for a greater level of competition would result in lower average fares and reduced price dispersion. Regarding the announcements from Air New Zealand and Qantas, it is found that the average price per kilometre of flights in 2007 is lower than the price in 2006. However, the results suggest that fare cuts are not spread across all routes with prices on some routes higher than they were in 2006.

This research article will be presented as a two part series. Part 1 will provide a brief chronology of the New Zealand airline industry as well as a literature review on airline pricing. Part 2 on the other hand will describe the dataset, the econometric techniques used and the findings of the study.

Air New Zealand aircraft in Melbourne. Photo: Michael Meier

Contents:

1.0 Abstract and Introduction

2.0 First Part, Literature Review
2.1 The Changing Scene in New Zealand Aviation (Post Deregulation)
2.2 The Proposed Alliance between Air New Zealand & Qantas
2.3 Impact on Competition
2.4 The Impact of Low-Cost Carriers and the Rise of B2C in the Airline Industry
2.5 The Arrival of Pacific Blue and Possible Effects

3.0 The Database
3.1 Price Information
3.2 Cost Information
3.3 Measure of Market Concentration
3.4 Other Variables

4.0 Econometric Analysis
4.1 The Setup
4.2 The Results

5.0 Conclusion

 

About the Author Pratik Keshav is a recent graduate of The University of Auckland Business School having completed a Bachelor of Commerce (First Class Honours) degree majoring in Economics and Finance. The following research was presented by him as part of his postgraduate studies under the supervision of Professor Tim Hazledine. Pratik has since moved to Sydney (Australia) where he currently works at Rabobank. To contact the author, please use our comment form   List of References