Jim Eagles: Share some tips on fares

How important is competition in keeping down air fares? And, in particular, how important is competition between Air New Zealand and Qantas in keeping down fares on domestic and transtasman routes?

Those are questions of more than just academic interest as travellers await the Ministry of Transport's decision on a proposal by Air NZ and Qantas to enter a codeshare agreement for transtasman flights.

And it so happens that an academic study, published in the latest issue of Competition and Regulation Times, offers some timely answers.

The magazine, put out by the Institute for the Study of Competition and Regulation, is probably not the sort of light reading the average traveller would choose to take on a flight from Auckland to Sydney, but this article looks at the issue of competition and offers a useful tip on how to get the best value out of the airlines' pricing system.

Tim Hazeldine, economics professor at the University of Auckland, and Callum MacLennan, a graduate of the university's economics department, analysed 1001 flights on eight domestic and 21 transtasman routes.

Their first finding was that there is a clear statistical relationship between the extent of structural competition on each route and the prices charged.

Their calculations imply, in particular, "that routes served by just one carrier have prices around 20 per cent higher than duopoly routes".

This is what regional centres served only by Air NZ have long complained. I was living in Napier about 10 years ago when Origin Pacific started a service to Hawkes Bay and it was noticeable how Air NZ's prices suddenly dropped.

Such behaviour is not limited to Air NZ. If you have ever booked a flight on a route served only by Qantas - I've just had to buy tickets to fly Auckland-Darwin - you'll know that the prices are astronomical.

Air NZ and Qantas argue that in the transtasman market, where they are seeking to codeshare, prices would be kept down by competition from the likes of Emirates and Pacific Blue.

Air NZ chief executive Rob Fyfe told me in in May that the fact that the proposed codeshare arrangement would have a 76 per cent share of the transtasman market was irrelevant.

"What impacts prices in the aviation industry is not market share but the competition for the marginal seat," Fyfe said.

For example, he said, on an Air New Zealand Airbus 320, which typically would have 100 passengers in its 140 seats, "the difference between profit and loss is about five passengers.

"So an airline with only 5 per cent of the market can still take away enough of those marginal passengers to force you from being profitable to break-even or even loss-making.

"What airlines have to do in that situation is to say, 'Oops, I'm losing passengers, I need to drop my prices in order to increase my load factor'.

"In other words, in the airline industry it isn't market share which keeps the lid on prices, it's all about these marginal customers, who make the difference between profit and loss."

He added that we needn't just take his word for it. During the debate about the previous merger plan "the competition authorities on both sides of the Tasman accepted our argument on this".

Hazeldine and MacLennan say pricing on a route is "systematically related to the overhang of the empty seats".

Other things being equal, if an airline increases the proportion of seats sold by 5 percentage points - for example, going from 70 per cent utilisation to 75 per cent - fares on that route will tend to increase at the same rate (and, presumably, fares drop as the load factor falls).

But - and this is a very important but - that doesn't tell the whole story.

Regardless of seat occupancy levels and the extent of competition, the research also found that "Air NZ is able to set its lowest prices higher than other airlines". In the case of its big rival, Qantas, Air NZ's lowest fares on the routes studied were an average 8 per cent higher.

In the case of fringe competitors such as Emirates and Pacific Blue, its lowest fares were more than 20 per cent higher. I imagine that is partly because some of us like to support our brave little national carrier.

But Hazeldine and MacLennan think it also shows that "large incumbent carriers are able to charge a price premium".

In light of that, the Ministry of Transport should ask itself: If fares are already higher on routes where there is only one carrier (and even when there is competition the big carriers are able to get away with charging a premium) what will happen when the two biggest carriers get together?

In the meantime, while we still have head-to-head competition, the study also offers a useful insight into the way the airlines' pricing policies operate.

As the authors note, the pricing system is designed to "take good advantage of the linkage between willingness to pay and ability to commit to travel in advance of a flight by raising the lowest-offered fare as the flight date approaches".

Looking at how this works in practice they found that eight weeks from a flight you can usually get a ticket for about two-thirds the cost of a last-minute ticket.

Prices gradually increase as seats fill up "with most of the increase taking place in the last two weeks before the flight".

The helpful message from that information is that if you aren't in a position to pick up a cheap seat eight weeks before your trip you should certainly try to make your booking two weeks in advance before prices really start to soar.

Who says the result of economic research don't relate to the real world?