American Airline Essay

(Part 2)

 

Furthermore, according to the data of Herfindahl-Hirschman index (HHI), American ranged from 5150 to 9939, for the year 1999 on the nonstop routes from DFW and ranged from 4368 to 8539 on other routes in service. Both data showed that HHI were almost close to 1000 which means American got nearly hundred percent market share on the routes from DFW. Clearly, American wanted to be a monopoly and set entry barriers against new competitors. In addition, the price-cost margins were 28%, 41% and 36% in DFW-ICT, DFW-LGB and DFW-COS routes respectively. Price-cost margin is the method to tell the difference between price and marginal cost. It also indicates the market power because the larger the margin, the larger the difference between price and marginal cost: the larger the distance between the price and the competitive price. Here I noticed that 41% price-cost margin is quite high. It means the price is 1.41 times more than its cost. If American’s cost increases lightly, it will influence the price dramatically. I think although American might have lost some money at the beginning due to over increase flights, they can compensate the loss in the end. Because the fewer competitors, the more chance travelers will choose to take American’s flight. Even if they increased the price after some competitors left the pool, it is a high possibility that most customers will choose to take American Airlines because they serviced more flights than the other companies.

Speaking in the short-term, the customer is the biggest winner of this competition. When each airline tried to undercut other companies’ price, customer can take advantage from this war. Customer could not only enjoy the low cost air plane ticket, but he also gets convenience by number of flights. Speaking in the long-term, American is still the champion of this air-fare war. The reasons as follow: American Airlines, before this competition, had more power, wealth and resources than other company. They weren’t afraid to lose this game. It didn’t matter what company to decrease price or add more flights. American could still invest more money to against it. Some airlines couldn’t compete and leave. And some company either kept low price tickets or decreased the number of flights, which all allow American took advantage. Because American still could match the low price and service more flights. Therefore, American gained the market share, increased sales and revenue. They become the winner in the end. I think American engaged in predatory pricing and intended to become monopoly when they competed with Western Pacific in 1995. The reasons are as following: # (1) Western Pacific had around 28% share of the route of DFW-COS (Colorado Spring) but fell below 20% when American fought to gain the market share by reducing the price. However, American’s market share increased to 43% by upgrading aircraft and adding flights. American was aware that DFW-COS was one of the top five contributing routes of Western Pacific. When American captured more market share on this route, Western Pacific suffered by losing the most important source of its revenue. In this case, Western Pacific left the market. After this, American could offer the most services and became monopoly. (2) During 1995, American’s average revenue actually fell from $124 to about $106, and in July average revenue fell below $100. In 1997, American’s FAUDNC and other related profitability measures showed a decline and became negative. Although American faced a financial problem, they still were able to provide lower fares, increased flights and even improved aircraft. It does not make business sense. I think American considered all of its hubs and routes as forever. They didn’t just want to kick other LCC out of the market, but they also wanted to build airline-empire. Thus, they could become the king of the market and adjust prices however they wanted. (3) In May 1996, Western Pacific reduced DFW-SEA flight due to poor connection with its hub and didn’t prepare well to compete with American. American subsequently canceled the matching fare on its DFW-SEA non-stop. Clearly, all the actions that American took were force Western Pacific out of the market. After Western Pacific reduced the services and left the market, American no longer provided so many flights and increased the fares immediately. It is part of predatory pricing strategy. American used different methods against its competitors such as increased services, upgraded aircraft and below low prices which lower than the cost. All of these were very heavy threats for its competitors. When competitors tried stead for it and provided better strategy to fight back, they still failed. After competitors left, American increased its prices. There are fewer competitors and services in the market now. Even though American increased the price, consumers have no other choice and only can choice American’s flight. (4)American’s average local fare in DFW-DEN decreased from $180 to $129 then $108. After Western Pacific left this route, American reduced capacity and also price rose to $119. Because of the aggressive actions by American, Western Pacific ceased all operations and filed for bankruptcy on October 5, 1997. American got their goal which was to force its competitors out of the market. Now they don’t need to worry about competitors will provide even lower price. In addition, American built strong entry barriers against other potential competitors trying to enter this field. American could successfully own the most of market now.

In 1993, SunJet serviced route DFW-EWR (Newwark) and also bore financial difficulties because of American strong pricing strategy. American increased flights responding to SunJet’s announcement to expand DFW’s service. American added more flights and also matched low fares. SunJet couldn’t overcome this competition and exited this route. American reduced capacity at once. The same situation occurred at the route of DFW-LGB (Long Beach). When SunJet added more round-trip flights, its profit actually went from $175,040 to $41,284. At the same time, American added one more flight and kept low fares, they profited $1 million by this action. It says that, no matter what strategy that American picked, they are still the biggest winner of this game. They could offer low price ticket and add capacity without bankruptcy. The purpose is to drive competitors out of the market and then they can make more profit than before.

From my perspective, I think when American attempted to become a monopoly and used predatory pricing strategy, they also considered their reputation issue. However, the reputation didn’t change their market position because customers didn’t notice and will understand American just play a pricing game. On the other hand, from the supplier’s perspective, it might threaten American’s reputation. Because American has an aggressive personality, the suppliers won’t take a risk to cooperate with them.

Decision FAUDNC is a fully allocated earnings measure. It could be impacted or affected by anticipated changes in overall system capacity or traffic over an 18-month planning horizon. In June 1994, 55% of American’s routes were FAUDNC negative and lasted over 18 months. American increased domestic routes and resulted in FAUDNC decrease and negative. It means during this time, American didn’t make any money but still spent certain amount of money on increasing service. This is unusual and doubtable. American probably increased the expenditure to provide better service against its competitors. Although they tolerated their overall revenue decrease over 18 months, they still had capability to wait out other competitors. After certain competitors couldn’t compete, American removed some routes and increased the fares. Therefore, I would say American engaged in potential predatory pricing.

I think maybe the markup for American is higher than other companies. Yet, when American competed with LCCs, their average revenue and ticket price were lower than market. Thus, they didn’t charge a large markup fee. Lerner Index was probably even lower than its competitors. It is the evidence that American acted as predator to provide lower cost ticket price to capture more passengers. According to the case author, American just wanted to survive this competition. They didn’t undercut any LCCs in the specific routes. However, they really provided superior service to their customers by advanced seats selection, frequency of flights schedule. Author thinks although some people stated that American used predatory pricing strategy to drive competitors out of the market, American as a business company, they just do what they have to do. The increased price after competitors exited is reasonable because American indeed provided more service and really regarded customers as their priority.

 

 

American Airline