Regional flight price gouging – guilty until proven innocent?
Fri 12 Sep 2014 by Benje Patterson in RegionalTransport

Airlines have dominated the news this financial reporting season, with results showing Air New Zealand going from strength to strength, while Jetstar lost significant ground in the New Zealand domestic market.  Although the ensuing media storm has centred on claims that Air New Zealand’s profit surge was partly driven by monopolistic exploitation of travellers from regional centres, it is more constructive to back up a couple of steps and try to understand the backdrop to the perceived problem.

Before calling in the Commerce Commission to investigate Air New Zealand’s behaviour, we should first:

  1. Investigate how substantive the evidence is that Air New Zealand is earning supernormal profits on regional flights, and;
  2. Examine why Jetstar’s competitive position in the domestic market appears to have been undermined over the past half year.

How to prove regional price gouging?

When considering the evidence, it is important to distinguish between high prices and large profits.  Although newspapers have been full of anecdotal “sob” stories of eye wateringly-high ticket prices paid for last minute flights out of regional centres, these stories are not the same as saying that Air New Zealand is price gouging and earning exorbitant regional profits.  Now I know this assertion will have made some shorter-fused readers’ blood boil, but at least hear me out.

The average cost of providing seats out of regional centres is high compared to main-trunk routes.  Not only does Air New Zealand have a lower volume of passengers over whom to spread the fixed costs of maintaining each regional link, but the smaller turboprop aircraft used on these routes have much higher operating costs per seat than on jet-serviced main-trunk routes.  Even so, this still begs the question – does the price premium charged by Air New Zealand on regional flights only reflect higher operating costs or has the airline also exploited their monopolistic position and overly fattened their profit margin on these flights?

Quite a simple question isn’t it? However, unfortunately the data to answer the question is not in the public domain.  And the more I think about this issue, the weaker I find Air New Zealand and its PR team’s attempts to explain themselves.  Their claims that tiny niche operators provide ample regional competition, and that pulling out of servicing the Masterton and Wanaka markets highlights tight regional profit margins, are insufficient to counter mounting anecdotal evidence against the airline.  If Air New Zealand has nothing to hide, then why not just release some of the numbers regarding regional profitability that will be sitting in-house in the airline’s own financial spreadsheets?

I realise that Air New Zealand probably views these financial numbers as commercially sensitive, but isn’t proactively releasing some independently audited profit margin data, and appeasing public opinion by being transparent, better than risking a full blown Commerce Commission inquiry?  As a starting point Air New Zealand could simply give a more detailed decomposition of its regional subsidiaries’ profitability (ie. Air Nelson, Eagle Airways, and Mount Cook Airline) as part of their annual results presentation.  I’m sure most minority Air New Zealand shareholders certainly wouldn’t object to knowing a little bit more about their bedfellow, and judging by John Key’s comments in the media this past week, neither would the government.

Why has Jetstar’s competitive position weakened?

Having suggested a more constructive approach to the regional airline pricing debate than the current mudslinging campaign, I now want to turn to the other issue of the day and ask why Jetstar’s competitive position appears to have weakened over the past year?

Some of you may wonder how this issue is relevant to regional airline pricing, given that Jetstar only flies main-trunk routes.  However, bear in mind that having a strong low cost option at main-trunk hubs does at least limit the upside to what Air New Zealand can charge on some regional flights.  This mechanism works in two major ways (among others):

  1. If price differentials between regional and main-trunk flights get too big then some price sensitive regional travellers will drive to a main-trunk airport and fly from there;
  2. If Jetstar is in a healthy financial position and profit margins on some regional routes look excessive, then there is always the risk that Jetstar invests in its own regional turboprop capacity.

Over the past year passenger numbers on Jetstar’s domestic flights fell by 7.7%.  Jetstar claims that this fall was mainly due to the airline having pulled out of the Wellington to Queenstown service.  However, the sheer magnitude of the decline in Jetstar’s passenger numbers by far outweighs any estimates of the underlying capacity that was removed from this service, suggesting that the airline also faced underlying weakness in its remaining domestic network.

So what could be behind Jetstar having lost some of its mojo over the past year?

One reason that immediately springs to mind is that the perceived unreliability of Jetstar could have put some travellers off flying the airline.  Even though a close examination of data released by Jetstar suggests that the reliability of the airline has improved significantly of late, it can take some time to change perceptions.  As a result, it could be a while until perceptions of unreliability cease to be a limiting factor on Jetstar’s domestic business.

Another potential reason for Jetstar’s falling passenger numbers may have been due to pressure from Jetstar’s parent company (Qantas Group) to improve profit margins.  Over the past year Qantas has bled cash and in this environment may have leaned on Jetstar to consolidate its market position, rather than try and aggressively expand market share via lower prices and narrower profit margins.  Although it is difficult to glean concrete evidence of this behaviour from the scant details available in Qantas’ annual results, the airline does at least comment that there has been strong yield improvement on Jetstar’s key domestic New Zealand routes in the June 2014 financial year.

A third reason that could explain Jetstar’s recent issues is that consumers view flying with the airline as an inferior good.  Economic theory says that an inferior good is one which people consume less of when they are earning more or feeling wealthier – the idea being that if you are in better financial health you will be more willing to splash out on deluxe options.  It could be that as the economy rapidly strengthens more people are choosing to fly Air New Zealand because they perceive our national carrier to offer a higher quality experience than that offered on Jetstar.

But regardless of why Jetstar has lost market share over the past year, let’s hope for the sake of ensuring ample competition that the airline’s share of domestic passengers stabilises in the 2014/15 financial year.  In the meantime, it would be wise for Air New Zealand to wade properly into the regional flight pricing debate and provide better evidence to show it is not exploiting regional travellers.  If the airline doesn’t justify its position in a more compelling manner soon then a Commerce Commission enquiry may be just around the corner.

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