The Costs of Competition

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As a reaction Air Turin announced that it would compete with Schnell Airs pricing by selling return tickets at a very low price. See Table 3 for a comparison between the old and new prices that were set by Air Turin. Air Turin scratched their discounted economy fare and decreased the price of a full fare economy with 174,000 lire, below the price of Schnell Airs’ full fare economy (table 4).

Table 3. Fares Air Turin before and after Sep 1997

Air Turin Fares

Prices before Sep 1997

Prices after Sep 1997

Difference in Price

Business

1,260,000

1,260,000

0

Full fare economy

1,080,000

906,000

174,000

Superpex

480,000

453,000

27000

Apex

375,000

362,000

13000

Table 4. Comparison of Full fare economy fares (lire)

Schnell Air fare without discount

Air Turin before Sep 1997

Air Turin after Sep 1997

Full fare economy

979,200

1,080,000

906,000

Contrary to the reaction of Air Turin, the management of Innsbruck Air did not lower any prices but decided to improve the quality of their flights with an additional 5% of direct variable costs on the route. Furthermore their management also decided to add two daily flights to their schedule, even on Saturdays and Sundays; which meant that Innsbruck Air, just like Schnell air, now offers three daily flight services.

Air Turin and Innsbruck Air can both be described as high cost carriers and in order for them to increase their market share again, they will face profit loss by either changing their service and having additional costs or by reducing their prices. Known that both operators are dealing with a significant loss in market share, all their direct costs will have increased after Schnell Airs entry. Both actions that the two operators have undertaken can be subscribed to the actions of predatory pricing. On the other hand there is not enough data and/or evidence to conclude this fact.

In general there are several aspects in the data that could make us assume that both operators should be accused of predatory pricing. However according to article 85 and 86 of the treaty of Rome, predatory pricing requires a predator to have a dominant market position at the time that the predatory pricing takes place. When Turin Air and Innsbruck Air reacted to Schnell Airs’ entry and strategy, both operators had already lost their dominant market position given that their market share decreased to 32 and 22% respectively. If this rule applies in this case, we cannot accuse Turin Air and Innsbruck Air of doing predatory pricing.

- With respect to the introduction of the fourth flight what advice would you give to Schnell Air?

I would not advise Schnell Air to introduce the fourth daily flight because they already have three daily flights and they should keep their load factor as high as possible to achieve low cost profit maximization. The airline was able to reach an average load factor of 85% within only 9 months time. Their strategy was to deliver good service quality for low prices. With this service they attracted many passengers from the competitors to their airline, and the total amount of passengers on the Innsbruck-Turin route increased with 30%. Schnell Air should therefore maintain those 3 daily flights, keep the load factors high, keep the costs low and the profits high.

Assuming that Schnell Air has a lower cost structure than its two rivals, I would advise the operator to keep their prices very competitive and set them even lower as the new fares from Turin Air, if they can maintain their high load factor. Turin Air and Innsbruck Air are at this stage most likely operating at a loss, which means that they won’t be able to stay in the market much longer if they keep following their new strategy.

One last thing that I could advise Schnell Air is to look for partners with whom it can offer connecting flights to consumers. This might increase the number of consumers willing to fly on the Innsbruck-Turin route and thereby increase the load factors and profits.