Problems of cost recovery by European airlines since market liberalization

Abstract

The institutional background against which air transport is supplied has been changing rapidly. The initiation of market forces has led to lower fares, additional services, and more efficient airline companies as competitive pressures have grown. A major concern, however, is whether the resultant airline market is sustainable in the long-term. There have been periodic short-term shocks to the market, the most recent being the rapid rise in kerosene prices, but there are more fundamental issues concerning the possibility of excess competition being a generic feature of providing scheduled services in a competitive environment. Market stability is not easily tested, but some indicators can be explored to get better insights. Here we examine the fares offered in selected Portuguese air transport markets for 2005–2006 to assess the ability of carriers to recover their full costs – a necessary condition for stability. In particular, the paper is concerned with the pressures of competition on the ability of airlines to increase the fares that they offer as the scheduled date of departure approaches; such fares contribute significantly to an airline's recovery of full costs. The evidence suggests that in many cases airlines cannot, when confronted by competition, extract additional revenues from last minute, low-price elasticity passengers and that this could reduce the economic sustainability of some services in Europe.