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Industry consolidation: fact or fiction?

There are many "facts" that are accepted by everybody in the industry. These "facts" make intuitive sense, follow a certain logic and seem to be supported by reality. Unfortunately, often it turns out that, upon close examination, the "facts" are, in fact, not true. For example, Mr. Crandall, chairman of American Airlines, claimed that airlines lost in 1990-1991 more than the industry has ever made since the first flight at Kitty Hawk. This remark has all the attributes of a catchy and cute phase, perfect to be repeated by everybody in the industry. In fact, I have heard this line repeated many times by countless speakers, most recently on the lecture circuit in Sweden. Nobody, though, is able to provide data to support such an assertion.

My attempts to duplicate the "fact" finally resulted in an approximation of data that would support the "fact." If you take a certain definition of profits, for the U.S. industry only and in nominal terms, you can get results that almost verify the often-repeated Crandall statement. In nominal terms, by the way, means that a million dollar loss today is counted the same way as a million dollar profit generated by the industry three or four decades ago. Such analysis is, of course, nonsensical.


One of the most prevalent new "facts" in the airline industry are rumors of supposed consolidations. Everybody "knows" that airlines are growing all the time, that only the largest survive, and that we have much less competition than in past years. As the industry is consolidating, fewer and fewer big players form cartels and conspire to raise ticket prices. This fact is accepted as gospel in the industry and is repeated continuously by everybody.

Theoretically, however, the above-mentioned "fact" does not lead to the conclusions drawn by "everybody" even were the "fact" to be correct. Economists use the term "contestable" markets that supports a view that the potential of competition may be as powerful a factor restraining prices in oligopolistic markets as actual competition. For example, even if only one airline flies between Kalamazoo and Kankakee, it does not follow that this airline will enjoy monopoly profits. As long as the market is "contestable," i.e., others can enter it when enough money is to be made, profits will be modest. Also, fewer but larger airlines do not necessarily lead to less competition on individual markets. It can happen that six large airlines compete so that there are, on average, two players competing in any given market. In the case of four even larger mega-carriers, average competition per market can be up to three. As a matter of fact, there seems to be relatively strong empirical support for such a theoretical possibility in the U.S. market.

Less Consolidation, Not More

The question about consolidation is relatively easy to verify empirically. Is the airline industry in the world getting more or less concentrated? Figure One shows the evidence for 1970 and 1990. Any way you slice it, the data refute the "fact" accepted by "everybody" in the industry. The data seem to be counter-intuitive but very consistent. The industry is getting less, rather than more, concentrated. For example, the top ten world airlines accounted for almost two-thirds of all traffic in 1970 but only for about half of all traffic in 1990.
Figure One

Measure of Concentration of
World Airline Industry

Number of Firms 1970 1990

 1 17.2% 12.8%
 4 39.1% 30.8%
 8 60.0% 45.0%
 10 64.6% 50.9%
 20 81.2% 67.8%
 30 88.4% 77.8%
 40 92.45 84.2%
 50 95.0% 88.3%
100 99.7% 97.2%

Herfindahl Index 0.06189 0.03898

To verify the fact that I established here, it is prudent to probe deeper and find out how robust the results are. Maybe the dates selected were very unusual? No, when comparing different time frames, we get similar results. How about excluding the largest airline in the world (Aeroflot)? Again, the results do not change significantly. But, some may argue that the perceived decrease of concentration is only a statistical artifact. As Asian carriers grow much faster than world average, they take over the top positions in world's rankings, making it appear that traffic is getting less concentrated. That argument is not valid, either.

How Many Others?

When doing a similar analysis separately for North America, Latin America, Pacific/Asia, Europe, Middle East and Africa, we find substantial decrease in five out of the six cases--the only exception is Latin America. As a last test, I pursued the thought mentioned earlier that concentration of airlines is not identical with a concentration of markets. Examining all 19 existing international markets, we find that in 16 cases concentration decreased from 1970 to 1990, producing results similar to those displayed in Figure One. Only three small regions had an increase in their concentration.

So, upon careful examination, we find the "fact" that "everybody" believes in and bases decisions on, has no empirical support in reality. Airline consolidation, at least so far, is only a figment of some industry experts' imagination. How many other "facts" that we accept as self-evident are indeed based on false assumptions rather than true facts?

ADAM M. PILARSKI, PH.D., is the chief economist at McDonnell Douglas Corporation and has written extensively in the field of economics.
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Title Annotation:Economic Outlook
Author:Pilarski, Adam M.
Publication:Business Forum
Date:Jun 22, 1993
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