Collusion Between British Airways and Virgin

The tacit secret approval case to be discussed involves the illegal collusion and move of provide fleeces to commercial and cargo transatlantic fargons between British bank lineways (BA) and double-dyed(a) Atlantic Airways ( complete(a)). The factors which contributed to its success depart be discussed, as well as why, and its implications, of becoming public. To begin with, it would be beneficial to de attractive both(prenominal) calculating behaviour and the genius of the competition involved in the aviation industry. collusion is the act of a number of firms inside an industry agreeing to set a certain impairment, bring output or an some other parameter and is almost eternally against the law.This is as they all repugn in the given industry, with the setting of equipment casualtys or outputs done in favour of the companies, and is thitherfore anti-competitive behaviour, as this moves the outcome out from the commercialize equilibrium. The generated inefficiency i s considered illegal by The Office of honorable Trading (OFT) inside the UK, whos mission is to protect consumer welfargon whilst ensuring businesses re main(prenominal) competitive and moderately (OFT,2011). A brief overview of the UK aviation industry will help in in motleying and justifying certain factors which led to the booming collusion.Aviation is central not wholly for conveying pur irritates but for commercial flights, employing slightly 234,000 staff and contributing ? 18. 4 one million million million to Gross National Product (GNP). The industry is not only meaty for world(prenominal) business and trade, but 75% of all visitors to the UK travel by air and adds a further ? 14 billion towards GNP (BATA, 2011). The regular army and the European Union have signed an open skies balance al downhearteding to the skillful access to all routes between the two continents, although is to a greater extent restrictive to EU flight paths (IACA, 2007).In the particul ar case of BA and consummate(a), oil price rises ground on the price of barrel oil as shown in appendage 1, created rising fuel addresss and doubtfulness over future win levels. Several airways in the UK and global aviation industry brought in whippy fuel overcharges for passengers and cargo planes. The tacit collusion case of Virgin and BA showed that through with(predicate) with(predicate) communication, and agreeing to certain price rises at a given date, the nix impacts on production costs substructure be in grammatical constituent offset direct to the consumer. Through the instituteation of such an agreement, a prisoners dilemma gritty scenario is formed.This game revolves around joint outcomes based on individual actions, and the payoffs which are created from this. The choice to co-operate in decision making proves to be more beneficial than the absence of any collusive behaviour, although there is always the threat of deviation to add even more uncertainty to the question. Carlton and Perloff (2003) describes how in such a game, both firms must consider for each one rivals actions when making their own, and relate the combination of actions to determine outgo policy. Airline Market Transatlantic flights Virgin Atlantic High surcharge Low surchargeBritish Higher surcharge 25,25 15,30 Airways Lower surcharge 30,15 10,10 Profit from Cooperation = 25 + Profit from deviation= 30 + note ? D > ? C if r > 1 will prove that deviation from collusion unlikely This constructed game holds several(prenominal) assumptions which whitethorn be of use to explain the relative success of the collusive agreement. To begin with, it involves the firms meeting and setting prices more than once, in a repeated game, as fuel surcharges are relatively flexible prices which were changed to relate to the price of fuel, which was extremely volatile as shown in Appendix A.Following on from this repeated game, it is similarly for an undefined perio d. As the price rises came very suddenly, it created an uncertain future with no predictable end. Carlton and Perloff (2003) agree with the possibility that in a multi-period game, deviation plows much more costly, and through signalling can lead to self-made collusion to benefit both parties. Edgeworth (1897) touches upon efficacy constraints which are relative here in the theoretical success of this collusion, when based around the residual demand faced by both firms when looking at its pricing strategy (Carlton and Perloff, 2003).As the personality of the good is a seat on a plane, gain groundly capacity constraints are present in the form of the limited seating on aircraft, as well as the unfitness to in the short run increase output beyond full capacity. During the setting of price, clear communication will most likely go in a non-static equilibrium. As well as this, the symmetry in terms of the market and cost structures has played a part in creating a successful cartel . Each firm produces a relatively unvarying good in terms of economy, business or jump class, with a limited amount of features it can differentiate itself from its competitors.As well as this, utilise flesh 1, which will be discussed later on, demonstrates that the main costs to an airline are those which cannot be easily reduced or offset, most notably the cost of fuel and aircraft maintenance. Therefore both firms have near blameless knowledge of the cost structure and revenue through observing prices, and will aid in choosing a certain pricing strategy. What follows will be a detailed discussion of the specific market conditions which lead to the successful collusion between BA and Virgin.The UK Transatlantic Flight market as a whole can be said to hold more key factors which have led to successful collusion. The first is due to the proud levels of barriers to origination the level of costs specific to new entrants in the market. Barriers to entry show that new entrants find it extremely difficult to raise the pecuniary capital needed to establish themselves as long term competitors. The nature of these costs also plays a part, with a high amount resulting in sunk costs which are not transferable to any other industry such as an aeroplane and machinery specific to air travel.Emphasis also has to be placed on barriers to entry which do not relieve oneself a physical form, with the restricted capacity of umteen major airports and ordinance within the aviation industry epochally limits the ability to expand operations. An airline company needs to purchase several assets in order to whirl the product of a transatlantic flight to a HUB in the regular army. The first begins with the licence to operate in an airport and the parking/docking speak such as Manchester or Gatwick. With limited capacity at many a(prenominal) leading airports both in the UK and the USA, they become extremely costly.With Heathrow being utilise as the main airport for co mparison, due to the fact both BA and Virgin primarily operate there, Appendix B shows the extensive capacity constraints for all slots throughout each day. The purchase and maintenance of aircraft is clearly an inherent fixed cost, and with strict litigation procedures intending that there is elfin fortune to save costs. The last main fixed cost is in the form of come fees and en route charges, which each airline needs to pay. Figure 1 (British Airways, 2010)Figure 1 attempts to demonstrate these barriers to entry, which prevents new firms from entering the market after the monopoly pricing of fuel surcharges sends a signal to potential competitors for the opportunity of paranormal profits. The largest growth in the cost structure for British Airways has been in the sections discussed which pose the biggest barriers to entry fuel and oil costs at 44. 5%, landing fees at 14. 2% and engineering and other aircraft costs at 13. 1%, placing ever more emphasis on the difficulty for new firms to fence in this market (British Airways, 2010).Another key factor which contributed to the successful collusion was the indistinct buyer power in the demand for air travel, and in this specific case for transatlantic flights. The nature of the good is long distance travel, both for leisure and business with no other direct substitute in terms of time and comfort of travel. As well as this, Virgin and BA are both based primarily at Heathrow airport, and are the only two British airlines who offer extensive flights to several key HUBs in the USA.Along with three U. S airlines they make up the total flights offered to the USA from the busiest airport in the world in terms of international passengers (ACI, 2011). The two combined impact upon the price elasticity of demand, a key pattern which may help illustrate why the collusion was a success. The price elasticity to demand represents how responsive the consumers are to a change in price, in this case the change to the in crease in the price of the fuel surcharge from ? 5 to ? 0 between the period August 2004 January 2006 (OFT, 2007). The nature of the good is relatively price inelastic as no low cost airline or competitor can offer the very(prenominal) flight schedule to the fundamental airports in the US, such as modernistic York (JFK). Going hand in hand, this type of travel cannot simply be postponed or chosen differently, especially for business people who have little power over the price they will pay but kinda significantly have less financial constraints than those travelling for leisure.There have been many cases of tacit collusion which have been broken down within the UK, through the act of the Competition Commission (CC) and the OFT investigating what it deems could be ground to be collusive, illegal behaviour. The case of BA and Virgin is a unmatched one as to how it was broken down. The agreement finish directly through Virgin Atlantic Airways admitting to the collusive behaviou r directly to the Office of Fair Trade. There may be both relevant theoretical and concrete explanations as to why Virgin deviated from co-operation, which will be outlined briefly.Theoretically, as time continues the chance of deviation or being found out by legal bodies increases as the surcharges are fixed many times over an uncertain period, and oil prices showed no sign of stabilising. With no foreseeable end to the game leaving both firms with an area of uncertainty, and the threat of penalization playing an ever more important role, certain strategies in the game may have been altered. However, practically it may prove to offer a more credible reason as to why Virgin ended the collusive agreement by going to the relevant authorities.With the fine by the OFT standing at ? 121. 5 million, and the Department of Justice fining BA ? 148 million as the case was co-ordinated between both countries, the cost of colluding was unholy (OFT,2007 BBC, 2007). As well as this, the time line constructed in Appendix C highlights the previous hostile relationship of the two parties. Even though Virgin cannot compete financially or in number of flights/routes, a fierce competitor and competitive relationship has always hold uped with Virgin Atlantic being the only British non-flag carrier to survive the transatlantic flight market.This collusive agreement then goes exactly to the contrary of what has just been set out, so it may lead to one believing Virgin set out with this culture from the start, or once it became clear a court case would mean the parties involved would financially suffer, Virgin used the immunity clause to bear the collusion became public knowledge. To conclude, what has been set out is a set of conditions and assumptions within the game theory analysis, constructed for the collusive agreement between Virgin and BA.It back up in discussing the collusion itself, and the nature of which resulted in its success. Following on, the most significant market structural conditions were discussed relating to how they facilitated the successful collusion between the two parties. The main emphasis has to be placed through game theory that resulted in a long, unknown period of time through which repeated games and several instances of communication contributed to its success. The market conditions as a whole ed to the successful collusion, but in the case of barriers to entry it has to be emphasised that they exist in every aviation market and will only become more significant in the future, with the environmental issues and capacity constraints playing an important role. The weak buyer power of consumers contributed hugely, to not only the surcharge genuinely being introduced, but following on to at least 6 occasions of joint price increases. The amount BA was fined is a clear signal to all other firms that collusive behaviour will be punished severely, and therefore promotes its own punishment strategy.References ACI, 2011 Year t o date planetary Passenger Traffic December 2010, Airports Council International accessed from http//www. aci. aero/cda/aci_common/display/main/aci_content07_c. jsp? zn=aci&cp=1-5-212-1376-1379_666_2 as of 22nd defect 2010 BATA, 2011 Welcome to the British Air Transport association, British Air Transport Association accessed from http//www. bata. uk. com/ weathervane/Default. aspx as of 21st March 2011 BBC, 1993 1993 BA dirty tricks against Virgin cost ? 3m, accessed from http//news. bc. co. uk/onthisday/hi/dates/stories/january/11/newsid_2520000/2520189. immediate memory as of 24th March 2011 BBC, 2007 BAs price-fix fine reaches ? 270m, British Broadcasting Association accessed from http//news. bbc. co. uk/1/hi/business/6925397. stm as of 24th March 2011 British Airways, 2010 Chief Financial incumbents writing, 2008/09 Annual Report and Accounts, Table from page 14 accessed from http//www. britishairways. com/cms/global/microsites/ba_reports0809/pdfs/CFO. pdf as of 22nd March 2011Carlton and Perloff, 2003 Modern Industrial Organization, Chapter 6 Oligopoly, pages 160-192, Pearson information 4 edition (1 May 2003) Europa, 2000 COMMISSION DECISION of 14 July 1999 relating to a proceeding under Article 82 of the EC Treaty (IV/D-2/34. 780 . Virgin/British Airways), Official Journal of the European Communities, pages 1-4 accessed from http//eur-lex. europa. eu/LexUriServ/LexUriServ. do? uri=OJl200003000010024enPDF as of 24th March 2011 IACA, 2007 Press Releases EU-US Open SkiesDeal Not So Open for European Airlines, International Air Carriers Association accessed http//www. iaca. be/index. cfm? 79FD0308-BDBE-2776-0614-E6942D8F1AB5 as of 26th March 2011 Mongabay,2009 10-year commodity price chart for rude oil, Compiled by mongabay. com using figures from World Bank Commodity charge Data, accessed from http//www. mongabay. com/images/commodities/charts/crude_oil. html as of 11th March 2011 OFT, 2006 Report on Transport, UK airports Report on the market study and proposed decision to make a market investigation reference, page 139 accessed from http//www. ft. gov. uk/shared_oft/reports/transport/oft882. pdf as of twenty-third March 2011 OFT, 2007 The Office of Fair Trading, Press releases 2007 British Airways to pay record ? 121. 5m penalty in price fixing investigation, accessed from http//www. oft. gov. uk/news-and-updates/press/2007/113-07 as of 23rd March 2011 OFT,2011 The Office of Fair Trading, Making markets work well for consumers, accessed from http//www. oft. gov. uk/ as of 11th March 2011 Appendices Appendix A (Source Mongabay, 2009) Appendix B (Source OFT, 2006) Appendix C