UBC Theses and Dissertations

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UBC Theses and Dissertations

Strategies of a deregulated Canadian airline industry Laviolette, Julie Marie 1987

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STRATEGIES FOR A DEREGULATED CANADIAN AIRLINE INDUSTRY By JULIE M. LAVIOLETTE B.Comm., Concordia Univers i ty, 1986 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE (BUSINESS ADMINISTRATION) in THE FACULTY OF GRADUATE STUDIES (Department of Commerce and Business Administration) We accept th is thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA August 1987 ® Ju l ie M. Lav io le t te , 1987 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 A b s t r a c t The U . S . a i r l i n e i n d u s t r y ' s e x p e r i e n c e under a regime o f d e r e g u l a t i o n , as w e l l as the p o t e n t i a l forms o f s t r a t e g i c i n t e r a c t i o n i n a duopo ly a r e examined i n o r d e r t o de te rmine what s t r a t e g i e s C a n a d a ' s two major c a r r i e r s s h o u l d adopt i n t h e d e r e g u l a t e d Canadian a i r l i n e i n d u s t r y . The f o l l o w i n g recommendations a r e made t o A i r Canada and t o Canad ian A i r l i n e s I n t e r n a t i o n a l r e g a r d i n g p r i c e , s e r v i c e , and network s t r a t e g i e s . F i r s t , t h e c a r r i e r s s h o u l d s t r e n g t h e n t h e i r hub and spoke o p e r a t i o n s ( i . e . by f u r t h e r c o n s o l i d a t i n g f e e d e r c a r r i e r s , and o f f e r i n g a h i g h q u a l i t y o f s e r v i c e n e t w o r k - w i d e ) . S e c o n d , t h e a i r l i n e s s h o u l d s t r i v e t o c o n t r o l c o s t s ( i . e . by r e d u c i n g l a b o u r and f u e l c o s t s , w h i l e c a p i t a l i z i n g on the p o t e n t i a l economies o f scope a t t a i n a b l e t h ro u g h i n t e r n a t i o n a l o p e r a t i o n s ) . F i n a l l y , the c a r r i e r s s h o u l d a p p l y t h e i r m a r k e t i n g e x p e r t i s e ( i . e . by c o n t i n u i n g t o d e v e l o p t h e i r y i e l d management systems and f r e q u e n t f l i e r p rograms, as w e l l as a d o p t i n g i n n o v a t i v e , new p r i c i n g s t r a t e g i e s ) . - i i -T a b l e o f C o n t e n t s A b s t r a c t i i T a b l e o f C o n t e n t s i i i L i s t o f F i g u r e s v Acknowledgements v i 1) I n t r o d u c t i o n 1 2) An H i s t o r i c a l Overview o f the R e g u l a t i o n o f t h e N o r t h Amer ican A i r l i n e I n d u s t r y 7 2a) R e g u l a t i o n o f the U . S . A i r l i n e I n d u s t r y , 7 2b) R e g u l a t i o n o f the Canadian A i r l i n e I n d u s t r y , 9 3) The Nature o f C o m p e t i t i o n i n the R e g u l a t e d U.S A i r l i n e I n d u s t r y 15 4) A P r i o r i E x p e c t e d Outcomes o f A i r l i n e D e r e g u l a t i o n 24 5) A c t u a l Outcomes o f D e r e g u l a t i o n : The U . S . E x p e r i e n c e 28 I) The T h r e a t o f New E n t r a n t s , 28 II) I n t e r f i r m R i v a l r y , 49 I I I ) Buyer B a r g a i n i n g Power, 60 IV) S u p p l i e r B a r g a i n i n g Power, 63 V) The T h r e a t o f S u b s t i t u t e S e r v i c e s , 71 VI) C o n c l u s i o n s , 72 6) G e n e r a l D i f f e r e n c e s Between The Canadian and U . S . A i r l i n e I n d u s t r i e s 81 - i i i -7) S t r a t e g i c I n t e r a c t i o n i n the Canad ian A i r l i n e I n d u s t r y 88 7a) P o t e n t i a l Forms o f S t r a t e g i c I n t e r a c t i o n i n a Duopoly , 88 7b) A p p l i c a t i o n t o the Canadian A i r l i n e I n d u s t r y , 108 8) Recommendations t o Canadian A i r l i n e M a n a g e m e n t . . . . 118 I) The T h r e a t o f New E n t r a n t s , 118 II) I n t e r f i r m R i v a l r y , 12 0 I I I ) Buyer B a r g a i n i n g Power, 13 5 IV) S u p p l i e r B a r g a i n i n g Power, 137 V) The T h r e a t o f S u b s t i t u t e S e r v i c e s , 141 VI) Summary o f Recommendations, 14 6 A) Recommendations t o Both A i r Canada and CAIL , 14 6 B) Recommendations t o A i r Canada, 148 C) Recommendations t o CA IL , 150 B i b l i o g r a p h y 153 Appendix A 158 - i v -L i s t o f F i g u r e s F i g u r e 1-1 Ownership S t r u c t u r e o f CAIL 5 1-2 Ownership S t r u c t u r e o f A i r Canada 6 3-1 F o r c e s G o v e r n i n g C o m p e t i t i o n In An I n d u s t r y . . 16 5-1 Dominant C a r r i e r ' s Pe rcen tage o f D e p a r t u r e s a t La rge A i r T r a f f i c Hubs, 1977 V e r s u s 1984 . . 32 5-2 A i r l i n e T a k e o v e r s / M e r g e r s In The U n i t e d S t a t e s , 1979-1986 42 5-3 Two-F i rm C o n c e n t r a t i o n R a t i o s Based on Domest ic Enplanements a t Large A i r T r a f f i c Hubs, 1977 v e r s u s 1984 44 5-4 M a r k e t i n g A l l i a n c e s o f the F i v e M e g a c a r r i e r s (Agreements i n e f f e c t o r announced as o f June 1, 1986) 47 5-5 O p e r a t i n g P r o f i t Marg ins (OPM) o f the F i v e M e g a c a r r i e r s 74-75 5-6 O p e r a t i n g P r o f i t Marg ins o f the F i v e M e g a c a r r i e r s , (1984-1986) 77 5-7 Aggrega te O p e r a t i n g P r o f i t , A l l U . S . S c h e d u l e d A i r l i n e s , (1970-1985) 78 5-8 Aggrega te D a t a , 1977 v e r s u s 1984 79 5-9 P a s s e n g e r Revenue p e r Revenue P a s s e n g e r M i l e Domest ic T r u n k s ' S c h e d u l e d O p e r a t i o n s Y i e l d (cents) 1976-1986 80 7 - l a The P r i s o n e r ' s Dilemma P a y o f f M a t r i x 91 7 - l b P r o f i t P a y o f f M a t r i x 92 7-2 R e a c t i o n Curves 97 7 - 3 Models o f Duopoly 98 8- 1 M o n t r e a l - T o r o n t o C o r r i d o r 142 - v -Acknowledgements I am g r a t e f u l t o many p e o p l e who have made s i g n i f i c a n t c o n t r i b u t i o n s t o t h i s s t u d y , p a r t i c u l a r l y t o the t h r e e members o f my T h e s i s Committee, who have p r o v i d e d s u b s t a n t i a l a s s i s t a n c e and gu idance t h r o u g h o u t . I would l i k e t o thank my T h e s i s S u p e r v i s o r , Dr . M i c h a e l W. Tre theway , A s s i s t a n t P r o f e s s o r , T r a n s p o r t a t i o n , who has been an i n v a l u a b l e s o u r c e o f i n s i g h t and i n f o r m a t i o n on the a i r l i n e i n d u s t r y . Much g r a t i t u d e i s a l s o due t o Dr . James A . B r a n d e r , A s s o c i a t e P r o f e s s o r , P o l i c y A n a l y s i s , f o r h i s g u i d a n c e , encouragement , s u g g e s t i o n s and s t i m u l a t i n g d i s c u s s i o n s . I am a l s o g r a t e f u l t o Dr . Asha Sadanand, A s s i s t a n t P r o f e s s o r , P o l i c y A n a l y s i s , f o r h e r s u s t a i n e d i n t e r e s t , s u p p o r t and c o n s t r u c t i v e s u g g e s t i o n s th roughout t h i s p r o j e c t . The e x p e r t o p i n i o n o f Dr . W i l l i a m T . S t a n b u r y , UPS F o u n d a t i o n P r o f e s s o r o f R e g u l a t i o n and C o m p e t i t i o n P o l i c y , and vo luminous exchange o f thoughts a r e hereby g r a t e f u l l y acknowledged. The acknowledgements would be i n c o m p l e t e w i t h o u t my s i n c e r e thanks t o my A d v i s o r , Dr . P e t e r N. Nemetz, A s s o c i a t e P r o f e s s o r and Cha i rman, P o l i c y A n a l y s i s D i v i s i o n , f o r h i s a s s i s t a n c e and encouragement d u r i n g t h e p r e l i m i n a r y s t a g e o f t h i s p r o j e c t . F i n a l l y , the a u t h o r would l i k e t o acknowledge the generous f i n a n c i a l s u p p o r t o f the S o c i a l S c i e n c e s and H u m a n i t i e s R e s e a r c h C o u n c i l o f Canada (SSHRC), S p e c i a l M.A. S c h o l a r s h i p (1986-1987) , which made t h i s s tudy p o s s i b l e . - v i -1) I n t r o d u c t i o n In 1978 t h e A i r l i n e D e r e g u l a t i o n A c t was p a s s e d i n the U n i t e d S t a t e s . S i n c e t h e n , media r e p o r t s o f low f a r e s i n t h a t c o u n t r y have l e a d t o i n c r e a s i n g p r e s s u r e s on the Canad ian Government t o f o l l o w the i n i t i a t i v e o f the A m e r i c a n Government and t h e r e b y d e r e g u l a t e t h e Canadian a i r l i n e i n d u s t r y . W h i l e d e r e g u l a t i o n l e g i s l a t i o n i s no t e x p e c t e d t o e n t e r t h e Canad ian s t a t u t e books u n t i l l a t e 1987, Canadian a i r l i n e s have n e v e r t h e l e s s been o p e r a t i n g under a regime o f i n c r e a s i n g r e g u l a t o r y r e l a x a t i o n f o r the p a s t t h r e e y e a r s ( i . e . s i n c e t h e r e l e a s e o f t h e 'New Canad ian A i r P o l i c y ' on May 10, 1984) due t o the l i b e r a l i n t e r p r e t a t i o n s o f the e x i s t i n g l a w s . T h i s t r a n s i t i o n towards d e r e g u l a t i o n has prompted an i n d u s t r y - w i d e shakeout ( i . e . a s e r i e s o f c o n s o l i d a t i o n s , mergers and a l l i a n c e s - see F i g u r e s 1-1 & 1-2) w h i c h , as o f December 2 1986, has c u l m i n a t e d i n t h e emergence o f a v i r t u a l duopo ly i n t h e Canad ian a i r l i n e i n d u s t r y . In e s s e n c e , t h e r e now e x i s t s o n l y one a i r l i n e ( i . e . Warda i r ) independent o f the two major c a r r i e r s ( i . e . A i r Canada and Canad ian A i r l i n e s I n t e r n a t i o n a l L t d . ( C A I L ) ) . These developments have gone f a r i n u p r o o t i n g the u n d e r l y i n g c o m p e t i t i v e f o r c e s o f the i n d u s t r y wh ich e v o l v e d under t h e p r o t e c t e d env i ronment o f r e g u l a t i o n . Y e t , the t r a n s i t i o n towards d e r e g u l a t i o n i n Canada has been p r o c e e d i n g a t a much s l o w e r pace than i t d i d i n t h e U . S . . - 1 -T h u s , C a n a d i a n a i r l i n e management has had more t ime t o a d j u s t t o t h e c h a n g i n g c o m p e t i t i v e f o r c e s a n d , h e n c e , t o t h e new o p p o r t u n i t i e s and t h r e a t s t h a t have been u n l e a s h e d i n t o t h e i n d u s t r y . Moreover , Canad ian managers have had t h e advantage o f b e i n g a b l e t o o b s e r v e t h e e x p e r i e n c e o f t h e i r U . S . c o u n t e r p a r t s , and l e a r n from t h e i r m i s t a k e s . The aim o f t h i s paper i s t o de te rmine what s t r a t e g i e s ( i . e . network s t r a t e g i e s , p r i c i n g s t r a t e g i e s , and s e r v i c e s t r a t e g i e s ) s h o u l d be adopted by C a n a d a ' s two major c a r r i e r s i n l i g h t o f t h e U . S . e x p e r i e n c e under d e r e g u l a -t i o n , and i n l i g h t o f t h e i r i n t e r d e p e n d e n c e i n t h e d u o p o l -i s t i c Canad ian a i r l i n e i n d u s t r y . More p r e c i s e l y , what s t r a t e g i e s ( i . e . network , p r i c i n g , and s e r v i c e s t r a t e g i e s ) s h o u l d A i r Canada f o l l o w i f CAIL adopts a g i v e n s e t o f s t r a t e g i e s ? S i m i l a r l y , what s t r a t e g i e s ( i . e . network , p r i c i n g , and s e r v i c e s t r a t e g i e s ) s h o u l d CAIL adopt i f A i r Canada c h o o s e s t o f o l l o w a g i v e n s e t o f s t r a t e g i e s ? The answers t o t h e s e q u e s t i o n s a r e o f extreme i m p o r -t a n c e s i n c e , under a regime o f d e r e g u l a t i o n , market f o r c e s and n o t r e g u l a t o r s de te rmine c a r r i e r p e r f o r m a n c e . M o r e o v e r , as the U . S . e x p e r i e n c e has d e m o n s t r a t e d , the key s u c c e s s f a c t o r i n the a i r l i n e i n d u s t r y i s t h e soundness o r a p p r o p r i a t e n e s s o f an a i r l i n e ' s s e t o f s t r a t e g i e s . In t h i s c o n n e c t i o n , w h i l e t h e r e e x i s t s a v a s t body o f l i t e r a t u r e on t h e v a r i o u s s t r a t e g i e s adopted by U . S . c a r r i e r s s i n c e the passage o f the A i r l i n e D e r e g u l a t i o n A c t i n O c t o b e r 1978, i n c l u d i n g an e x c e l l e n t a c c o u n t by Byrnes - 2 -(1985) , none o f t h e s e works a p p l y d i r e c t l y t o the d u o p o l i s t i c Canad ian a i r l i n e i n d u s t r y . Tha t i s , the s i t u a t i o n f a c i n g C a n a d a ' s major a i r l i n e s , u n l i k e t h a t o f t h e i r U . S . c o u n t e r p a r t s , i s un ique i n t h a t t h e y w i l l be compet ing no t o n l y i n a d e r e g u l a t e d a i r l i n e i n d u s t r y , but a l s o i n a d u o p o l i s t i c one . Hence, t h e r e i s a gap t h a t needs t o be f i l l e d . To t h i s e n d , we b e g i n w i t h an h i s t o r i c a l overv iew o f t h e r e g u l a t i o n o f b o t h the U . S . and the Canad ian a i r l i n e i n d u s t r i e s , a l o n g w i t h a b r i e f d i s c u s s i o n o f t h e p e n d i n g Canad ian d e r e g u l a t i o n a c t ( i . e . The N a t i o n a l T r a n s p o r t a t i o n A c t , B i l l C - 1 8 ) . Nex t , we d i s c u s s the n a t u r e o f c o m p e t i -t i o n under r e g u l a t i o n , as w e l l as d e v e l o p i n g a s e t o f e x p e c t e d outcomes f o r the d e r e g u l a t e d a i r l i n e i n d u s t r y u s i n g P o r t e r ' s C o m p e t i t i v e F o r c e s Model as a g e n e r a l f rame-work. T h i s i s f o l l o w e d by a d i s c u s s i o n o f t h e a c t u a l outcomes o f d e r e g u l a t i o n i n the U . S . , as w e l l as o f the d i f f e r e n c e s t h a t e x i s t between the two c o u n t r i e s ' i n d u s -t r i e s i n o r d e r t o de te rmine the r e l e v a n c e o f the U . S . e x p e r i e n c e t o Canada. In the subsequent c h a p t e r , we e x p l o r e t h e p o t e n t i a l forms o f s t r a t e g i c i n t e r a c t i o n i n a d u o p o l y , a l o n g w i t h t h e i r a p p l i c a t i o n t o the Canad ian a i r l i n e i n d u s t r y . - 3 -F i n a l l y , i n l i g h t o f t h e f o r e g o i n g , we d e r i v e i m p l i c a t i o n s f o r Canad ian a i r l i n e management. More p r e c i s e l y , we make recommendations t o A i r Canada and t o Canad ian A i r l i n e s I n t e r n a t i o n a l L t d . r e g a r d i n g which s t r a t e g i e s t o adopt i n the new c o m p e t i t i v e e n v i r o n m e n t . - 4 -Ownersh ip Figure 1-1 S t r u c t u r e of GAIL Pac i f i c Western A i r l i n e s Corp. 100% Canadian A i r l i n e s In t e rna t iona l L td . 100% PWA L td . (now merged) 100% Canadian Pac i f i c A i r Lines (now merged) 35% N o r d a i r -Metro 100% Quebecair (now merged) 44% Time A i r Calm A i r * B u r r a r d A i r 30% Norcana i r 49% Ontario Express 22% A i r A t l a n CAIL has an agreement with privately owned Calm Air and Burrard Air to use CAIL's colours and Canadian Partner name on planes. Sources: Gillen, D.W., W.T. Stanbury and M. Tretheway, "Analysis of the Takeover of Canadian Pacific Air Lines by Pacific Western Airlines", Working Paper #1223, Faculty of Commerce and Business Administration, the University of Brit ish Columbia, January, 1987, p. 49. Won, S., "The New Kid On Block Has High Hopes", The Montreal Gazette, July 18, 1987, p. C - l . - 5 -Figure 1-2 Ownersh ip S t r u c t u r e of A i r Canada Federal Government 100% A i r Canada 100% A i r BC 75% * A i r Ontar io 60-70% of proposed Quebec 'feeder' 49% A i r Nova Former 'feeder' Austin Airways is now joined with. Air Ontario. Sources: Gillen, D.W., W.T. Stanbury and M. Tretheway, "Analysis of the Takeover of Canadian Pacific Air Lines by Pacific Western Airlines", Working Paper #1223, Faculty of Commerce and Business Administration, the University of Brit ish Columbia, January, 1987, p. 50. Won, S., "Why Air Canada Wants to Fly Own Way", The Montreal Gazette, July 11, 1987, p. D- l . - 6 -2) An H i s t o r i c a l Overview o f t h e R e g u l a t i o n o f t h e  North American A i r l i n e I n d u s t r y 2a) R e g u l a t i o n of the U.S. A i r l i n e I n d u s t r y The C i v i l A e r o n a u t i c s A c t of 1938 e s t a b l i s h e d t h a t the U.S. a i r l i n e i n d u s t r y would be r e g u l a t e d by the C i v i l A e r o n a u t i c s Board (CAB). T h i s independent a d m i n i s t r a t i v e body remained the s o l e r e g u l a t o r o f the i n d u s t r y u n t i l passage of the F e d e r a l A v i a t i o n A c t o f 1958 granted a u t h o r i t y t o the F e d e r a l A v i a t i o n Agency (FAA) f o r the r e g u l a t i o n of a i r s a f e t y . The CAB was then s o l e l y r e s p o n s i b l e f o r the economic r e g u l a t i o n o f the i n d u s t r y , s t r i c t l y c o n t r o l l i n g e n t r y i n t o the a i r l i n e b u s i n e s s , the r o u t e s which each c a r r i e r was p e r m i t t e d t o f l y , and the f a r e s t h e a i r l i n e s c o u l d charge consumers. A c c o r d i n g t o Taneja (1976), "ever s i n c e the e s t a b l i s h m e n t of the C i v i l A e r o n a u t i c s Board i n 1938, the c o s t s and b e n e f i t s of r e g u l a t i o n w i t h i n the a i r l i n e i n d u s t r y have been d e b a t e d . " 1 However, i n the mid 1970s, a i r l i n e r e g u l a t i o n was the s u b j e c t of i n c r e a s i n g c r i t i c i s m from consumers, academic t h e o r i s t s , p u b l i c o f f i c i a l s , i n d u s t r y p a r t i c i p a n t s , and even the Department of T r a n s p o r t . These c r i t i c s c l a i m e d t h a t a l t h o u g h CAB r e g u l a t i o n was necessary when the i n d u s t r y was i n i t s ^-Taneja, N.K., (1976), The Commercial A i r l i n e I ndustry, (Toronto: Lexington Books), p. 291. - 7 -f o r m a t i v e s t a g e s , i t was no l o n g e r i n the b e s t i n t e r e s t s o f e i t h e r consumers o r a i r c a r r i e r s . The d r i v e t o d e r e g u l a t e the i n d u s t r y and t o a b o l i s h t h e CAB was spearheaded by the " F o r d A d m i n i s t r a t i o n ' s p r o p o s e d A v i a t i o n A c t o f 1975 and the b i l l s emanat ing from h e a r i n g s c o n d u c t e d by S e n a t o r s Edward Kennedy and Howard Cannon, and by Congressman G lenn A n d e r s o n . " 2 These e f f o r t s c u l m i n a t e d i n the passage o f the A i r l i n e D e r e g u l a t i o n A c t i n O c t o b e r 1978. As a r e s u l t o f t h i s law, " the C A B ' s a u t h o r i t y o v e r r o u t e s e x p i r e d on December 31, 1981. I t ' s a u t h o r i t y o v e r f a r e s e x p i r e d on J a n u a r y 1, 1983. And i t went c o m p l e t e l y out o f b u s i n e s s on J a n u a r y 1, 1 9 8 5 . " 3 Today , t h e r e i s f reedom o f e n t r y i n t o the i n d u s t r y f o r new c a r r i e r s , the o n l y r e q u i r e m e n t b e i n g t h a t the new s e r v i c e must meet the • f i t , w i l l i n g and a b l e ' c r i t e r i a ( i . e . adequate s a f e t y l e v e l s and i n s u r a n c e c o v e r a g e ) . T h i s i s accompanied by f reedom o f e x i t ( i . e . an a i r l i n e can now abandon any r o u t e by s i m p l y g i v i n g CAB 90 days advance n o t i c e ) , and p r i c i n g f l e x i b i l i t y . F i n a l l y , each c a r r i e r i s a b l e t o s e l e c t as many new r o u t e s a y e a r as i t w ishes t o s e r v e . 2 A m e r i c a n E n t e r p r i s e I n s t i t u t e f o r P u b l i c P o l i c y R e s e a r c h , (1978) , A i r T r a n s p o r t a t i o n R e g u l a t o r y Reform (Washington , D . C : Amer ican E n t e r p r i s e I n s t i t u t e f o r P u b l i c P o l i c y R e s e a r c h ) , p . 1. 3 "Where D e r e g u l a t i o n Works: F o r A i r T r a v e l l e r s , I t ' s More Than a Buzz Word" , Consumer R e p o r t s , May 1979, p . 284. - 8 -2b) R e g u l a t i o n o f the Canadian A i r l i n e I n d u s t r y On A p r i l 10, 1937, T r a n s - C a n a d a A i r l i n e s (TCA) , now A i r Canada, was e s t a b l i s h e d as a Crown c a r r i e r ( i . e . w i t h t h e Canad ian N a t i o n a l R a i l w a y s h o l d i n g a l l i t s shares ) w i t h t h e mandate o f s e t t i n g up t r a n s c o n t i n e n t a l s e r v i c e . To r e g u l a t e i t s f l a g c a r r i e r , t h e Canad ian Government " took t h e e x i s t i n g Board o f r a i l w a y c o m m i s s i o n e r s , renamed i t the Board o f T r a n s p o r t Commiss ioners (BTC) and expanded i t s a u t h o r i t y t o c o v e r a i r l i n e r o u t e o p e r a t i o n s , r a t e s , and s c h e d u l e s . " 4 In t h e e a r l y 1940s, Canadian P a c i f i c R a i l w a y s (CPR) began i t s campaign t o g a i n market s h a r e i n t h e a i r t r a n s p o r t i n d u s t r y . By 1942, CP A i r had t h e p o t e n t i a l t o o f f e r a t r a n s c o n t i n e n t a l m a i n l i n e s e r v i c e . T h u s , i n 1943 t h e BTC awarded the V i c t o r i a - V a n c o u v e r r o u t e t o CP A i r , t h e r e b y a n g e r i n g Pr ime M i n i s t e r K i n g , who d e c l a r e d " C o m p e t i t i o n between a i r s e r v i c e s o v e r t h e same r o u t e w i l l no t be p e r m i t t e d whether between a p u b l i c l y - o w n e d s e r v i c e and a p r i v a t e l y - o w n e d s e r v i c e , o r between two p r i v a t e l y -owned s e r v i c e s . " 5 F u r t h e r m o r e , i n 1944, as a r e s u l t o f t h e B T C ' s a c t i o n s , the government t r a n s f e r r e d t h e B o a r d ' s powers t o a new t h r e e man A i r T r a n s p o r t Board (ATB) , which was under t h e a u t h o r i t y o f t h e M i n i s t e r o f T r a n s p o r t . 4 G i a l l o r e t o , L . , (1983) , An A n a l y s i s o f the Two  I r r e c o n c i l a b l e S o l i t u d e s o f A i r T r a n s p o r t - D e r e g u l a t i o n  F o r P r o f i t o r R e g u l a t i o n F o r P u b l i c N e c e s s i t y , p . 21 . 5 B u r g e s s - W e b b , R . , " H i s t o r i c a l Development o f A i r l i n e P o l i c y i n C a n a d a " , P i l o t Magaz ine , J a n u a r y 1981, p . 9 . - 9 -The ATB c o n t i n u e d i n i t s a d v i s o r y r o l e t o the government u n t i l 1967, when the N a t i o n a l T r a n s p o r t a t i o n A c t was p a s s e d . T h i s A c t d i d l i t t l e t o r e f o r m a i r t r a n s p o r t p o l i c y , b u t r a t h e r mere ly e s t a b l i s h e d t h e Canadian T r a n s p o r t Commission (CTC) , and changed t h e A T B 1 s name t o t h e A i r T r a n s p o r t Committee (ATC) . The next major change o c c u r e d i n 1977 w i t h t h e passage o f t h e A i r Canada A c t , which t r a n s f e r r e d the ownersh ip o f A i r Canada from CN R a i l t o the Government, and r e q u i r e d the a i r l i n e t o seek a p r o f i t by o p e r a t i n g under t h e r u l e s o f t h e p r i v a t e s e c t o r . T h i s a c t a l s o gave t h e ATC j u r i s d i c t i o n o v e r a l l o f the c a r r i e r s o p e r a t i n g i n Canada. The p e r i o d 1978-1982 was c h a r a c t e r i z e d by a s e r i e s o f d i s c u s s i o n s and d e c i s i o n s t h a t can b e s t be d e s c r i b e d as a s low t r a n s i t i o n towards i n c r e a s e d r e l i a n c e on market f o r c e s and c o m p e t i t i o n i n the Canadian a i r l i n e i n d u s t r y . 6 F o r i n s t a n c e , i n 1978, the C a b i n e t p e r m i t t e d t h e f i r s t i n t e r r e g i o n a l d o m e s t i c advance b o o k i n g c h a r t e r s (ABCs) on 6 T h i s d i s c u s s i o n i s based l a r g e l y on the f o l l o w i n g works: R e s c h e n t h a l e r , G . B . and W.T. S t a n b u r y , " D e r e g u l a t i n g C a n a d a ' s A i r l i n e s : Grounded by F a l s e A s s u m p t i o n s " , Canad ian P u b l i c P o l i c y , V o l . 9 (2 ) , June 1983. S t a n b u r y , W . T . , "Reforming D i r e c t R e g u l a t i o n i n Canada" i n K . J . B u t t o n and D. Swann (eds . ) The Age o f R e g u l a t o r y  Re fo rm , ( O x f o r d : O x f o r d U n i v e r s i t y P r e s s ) , t o be p u b l i s h e d i n 1987. S t a n b u r y , W.T. and F . Thompson, (1982) R e g u l a t o r y Reform i n  Canada, The I n s t i t u t e f o r R e s e a r c h on P u b l i c P o l i c y , M o n t r e a l , Quebec. - 10 -s c h e d u l e d f l i g h t s . R e s t r i c t i o n s on t h e s e were s u b s e -q u e n t l y reduced i n 1979-1980. Moreover , b e g i n n i n g i n 1978, Canad ian a i r l i n e s began t o o f f e r d i s c o u n t f a r e s , most s u b j e c t t o v a r i o u s c o n d i t i o n s ( i . e . advance b o o k i n g and round t r i p t r a v e l ) . However, on August 19, 1982, o f f i c i a l s o f t h e CTC, who f e a r e d t h a t c o m p e t i t i o n was becoming d e s t r u c t i v e between t h e two n a t i o n a l c a r r i e r s , p r o p o s e d p r o t e c t i o n i s t ' i n t e r i m ' r u l e s g o v e r n i n g f a r e s d i s c o u n t e d more t h a n 25 p e r c e n t below the l o w e s t a p p l i c a b l e u n r e s t r i c t e d p u b l i c f a r e . F o r i n s t a n c e , t h e recommended ' f e n c e s ' i n c l u d e d t h e r e q u i r e -ments t h a t r e s e r v a t i o n s be made 14 days i n a d v a n c e , and t h a t minimum s t a y i n c l u d e the f i r s t S a t u r d a y f o l l o w i n g the d e p a r t u r e . Nex t , i n 1979, a l l c a p a c i t y r e s t r i c t i o n s on CP A i r were removed and the a i r l i n e was encouraged t o c o n s o l i d a t e i t s l i c e n s e s . A l s o , i n August o f 1979 Warda i r o b t a i n e d a d o m e s t i c c h a r t e r l i c e n s e ( i . e . the ATC g r a n t e d W a r d a i r a temporary l i c e n s e t o o f f e r d o m e s t i c ABCs f o r two y e a r s e n d i n g O c t o b e r 31 , 1981, a f t e r which the l i c e n c e would be r e v i e w e d by t h e A T C ) . The l a t t e r g r e a t l y i n t e n s i f i e d c o m p e t i t i o n i n t h e c h a r t e r c l a s s marke t . However, i n August 1981, the DOT r e l e a s e d a s e t o f p o l i c y p r o p o s a l s d e s i g n e d t o d e f i n e (and r e s t r i c t ) the f u t u r e r o l e s o f C a n a d a ' s two n a t i o n a l , f o u r r e g i o n a l , and about s e v e n t y - f i v e t h i r d - l e v e l o r commuter a i r c a r r i e r s i n t h e 1980s. These r e s t r i c t i v e p r o p o s a l s were f o r the most - 11 -p a r t i n c o n s i s t e n t w i t h the Economic C o u n c i l o f C a n a d a ' s June 1981 recommendations f o r ' t a k i n g a d d i t i o n a l s t e p s towards d e r e g u l a t i o n 1 . T h e n , i n A p r i l 1982, the House o f Commons S t a n d i n g Committee on T r a n s p o r t r e l e a s e d i t s r e p o r t - Domest ic A i r C a r r i e r P o l i c y - which r e j e c t e d U S - s t y l e d e r e g u l a t i o n o r even a f i v e - y e a r , phased d e r e g u l a t i o n as p r o p o s e d by the Economic C o u n c i l . R a t h e r , i t endorsed the r e g u l a t o r y c o n t r o l o f the CTC w i t h i n a s e t o f p o l i c y g u i d e - l i n e s t h a t would c o n t i n u e t h e ' e v o l u t i o n a r y p r o c e s s ' toward g r e a t e r bu t c o n t r o l l e d c o m p e t i t i o n . Then , on May 10, 1984, L l o y d Axworthy , t h e n M i n i s t e r o f T r a n s p o r t , r e l e a s e d t h e government ' s 'New Canad ian A i r P o l i c y ' . W h i l e t h i s p o l i c y s ta tement l a c k e d l e g a l s t a t u s , i t e s s e n t i a l l y r e p r e s e n t e d t h e f i r s t s i g n i f i c a n t s t e p i n t h e r e g u l a t o r y r e l a x a t i o n o f t h e Canad ian a i r l i n e i n d u s t r y . T h u s , up u n t i l t h i s p o i n t Canadian r e g u l a t o r y p o l i c i e s had remained e s s e n t i a l l y unchanged from t h o s e o f the 1930s. F i n a l l y , t h i s p o l i c y i s t o be m o d i f i e d by the p e n d i n g l e g i s l a t i o n o f t h e N a t i o n a l T r a n s p o r t a t i o n A c t ( B i l l C -126) wh ich was g i v e n i t s f i r s t r e a d i n g i n t h e House o f Commons on June 26, 1986, and r e i n t r o d u c e d i n e s s e n t i a l l y t h e same form as B i l l C-18 i n November 1986. The b i l l has now p a s s e d t h e t h i r d r e a d i n g i n t h e House o f Commons, and i s m e r e l y a w a i t i n g Senate a p p r o v a l . Hence, i t i s expec ted t o become law i n l a t e 1987. T h i s a c t w i l l complete the t r a n s i t i o n towards d e r e g u l a t i o n by b r i n g i n g about some - 12 -changes a l o n g the l i n e s p r o p o s e d i n the 'Freedom t o Move' p a p e r p u t f o r t h by former T r a n s p o r t M i n i s t e r Don Mazan-kowski i n J u l y , 1985. The most s a l i e n t changes i n c l u d e : F i r s t , t h e a c t a l l o w s f o r f r e e r e n t r y i n t o the i n d u s t r y s i n c e " the t e s t f o r p u b l i c c o n v e n i e n c e and n e c e s s i t y (which p l a c e d the onus o f p r o o f o f p u b l i c c o n v e n i e n c e and n e c e s s i t y o f a new s e r v i c e on t h e new e n t r a n t ) w i l l be r e p l a c e d by a ' f i t , w i l l i n g and a b l e * r e q u i r e m e n t " 7 (under which c a r r i e r s must demonst ra te t h a t they o p e r a t e s a f e l y and have adequate i n s u r a n c e c o v e r a g e ) . L i c e n s e s w i l l no l o n g e r r e s t r i c t c a r r i e r s ' r o u t e s , equipment , o r t y p e o f s e r v i c e . Second , t h e new a c t a l l o w s f o r much e a s i e r e x i t ( i . e . c a r r i e r s w i l l be a b l e t o d i s c o n t i n u e s e r v i c e on a r o u t e a f t e r a maximum 60 days p u b l i c n o t i c e ) . T h i r d , c a r r i e r s w i l l be p e r m i t t e d t o e s t a b l i s h f a r e l e v e l s and t o lower f a r e s a t w i l l . However, f a r e i n c r e a s e s , p a r t i c u l a r l y on monopoly r o u t e s , w i l l be s u b j e c t t o a p p e a l t o t h e N a t i o n a l T r a n s p o r t a t i o n Agency (NTA), the new agency r e s p o n s i b l e t o the M i n i s t e r o f T r a n s p o r t which r e p l a c e s the CTC. F o u r t h , f o r N o r t h e r n and remote a r e a s "a s p e c i a l reg ime w i l l ensure e s s e n t i a l s e r v i c e s a r e not d i s r u p t e d f o r t h e s e t h i n , w i d e l y - d i s p e r s e d markets"** . F i f t h , " F e d e r a l f u n d i n g w i l l 7 B u r g e s s - W e b b , R . , "Canad ian A i r l i n e D e r e g u l a t i o n - An Overv iew o f the L e g i s l a t i o n " , P i l o t M a g a z i n e , August 1986, p . 6. 8 I m p a c t s o f the New T r a n s p o r t a t i o n L e g i s l a t i o n o f June 26: Reviewed a t CITL C o n f e r e n c e " , T r a n s p o r t a t i o n I n f o . , J u l y 4, 1986, p . 6. - 13 -be p e r m i t t e d t o m a i n t a i n e s s e n t i a l s e r v i c e s i n c a s e s o f u r g e n t n e c e s s i t y " 9 . F i n a l l y , t h e a c t " a l l o w s i n v e s t i g a -t i o n o f mergers and a c q u i s i t i o n s i n t r a n s p o r t a g a i n s t a • p u b l i c i n t e r e s t 1 t e s t . A i r l i n e s w i l l a l s o be s u b j e c t t o the Combines I n v e s t i g a t i o n A c t (renamed the C o m p e t i t i o n A c t as o f June 19, 1 9 8 6 ) " 1 0 ( s e e Appendix A ) . 9 I b i d . , p . 7. 1 0 F r e n c h , T . , "Canada: And Then There Two?" , A i r l i n e B u s i n e s s , O c t o b e r 1986, p . 1 5 . 3) The Na tu re o f C o m p e t i t i o n i n t h e R e g u l a t e d U.S.  A i r l i n e I n d u s t r y Throughout the f o r t y y e a r s o f r e g u l a t i o n i n the U . S . , t h e o b j e c t i v e o f the C i v i l A e r o n a u t i c s Board (CAB) had been t o maximize a i r l i n e s e r v i c e , w h i l e k e e p i n g the c a r r i e r s i n the i n d u s t r y f i n a n c i a l l y h e a l t h y . T h i s was a c h i e v e d t h r o u g h c r o s s - s u b s i d y whereby r e t u r n s earned on p r o f i t a b l e r o u t e s were d i v e r t e d i n t o "uneconomica l but p o l i t i c a l l y d e s i r a b l e g o a l s , such as s e r v i c e on s p a r s e m a r g i n a l r o u t e s and maintenance o f weaker c a r r i e r s . " 1 1 However, the use o f c r o s s - s u b s i d i z a t i o n n e c e s s i t a t e d c o n t r o l l i n g t h e c o m p e t i t i v e f o r c e s t h a t would o t h e r w i s e de te rmine t h e p r o f i t a b i l i t y o f f i r m s i n t h e i n d u s t r y . A c c o r d i n g t o P o r t e r (1979) t h e r e a r e f i v e such f o r c e s : the t h r e a t o f new e n t r a n t s ; buyer b a r g a i n i n g power; s u p p l i e r b a r g a i n i n g power; the t h r e a t o f s u b s t i t u t e s e r v i c e s ; and r i v a l r y among e x i s t i n g f i r m s (see F i g u r e 3 - 1 ) . Hence, the CAB, t h r o u g h i t s use o f e n t r y , e x i t and r a t e r e g u l a t i o n , c r e a t e d b a r r i e r s t o e n t r y i n t o , and e x i t f rom, the i n d u s t r y ; o v e r r o d e the i n t r i n s i c b a r g a i n i n g power o f b u y e r s and s u p p l i e r s ; and d i s c o u r a g e d the i n r o a d s o f s u b s t i t u t e s e r v i c e s , w h i l e l i m i t i n g t h e r i v a l r y among e x i s t i n g f i r m s t o t h e d i m e n s i o n o f s e r v i c e c o m p e t i t i o n . 1 1 B y r n e s , J . L . S . , (1985) D i v e r s i f i c a t i o n S t r a t e g i e s f o r  R e g u l a t e d and D e r e g u l a t e d I n d u s t r i e s : L e s s o n s from the  A i r l i n e s ( T o r o n t o : Heath L e x i n g t o n B o o k s ) , p . 4. - 15 -F i g u r e 3-1 Forces G o v e r n i n g Compet i t ion In A n Indus t r Source: Por ter , M.E. "How Competit ive Forces Shape Strategy", The Ha rva rd Business Review, M a r c h - A p r i l , 1979, p. 9 - 16 -F i r s t , t h e CAB e r e c t e d b a r r i e r s t o e n t r y i n t o the i n d u s t r y t h r o u g h c e r t i f i c a t i o n c o n t r o l s , w h i l e l i m i t i n g c a r r i e r m o b i l i t y t h r o u g h r o u t e a c q u i s i t i o n and abandonment p r o c e e d i n g s . The former r e s t r i c t i o n s " e n s u r e d e x i s t i n g c a r r i e r s o f p r o t e c t i o n from t h e e n t r y o f more e f f i c i e n t new a i r l i n e s " 1 2 , w h i l e p r e v e n t i n g the l a t t e r f rom " p i c k i n g - o f f t h e h i g h p r i c e d s e r v i c e s from which c r o s s - s u b s i d i e s were d r a w n " 1 3 . Meanwhi le , t h e b a r r i e r s t o m o b i l i t y and e x i t p r e v e n t e d incumbent f i r m s from "compet ing away t h e l u s h s o u r c e s o f c r o s s - s u b s i d y and from s h e d d i n g t h e m o n e y - l o s i n g s e r v i c e s t h a t were b e i n g s u p p o r t e d . " 1 4 T h u s , d e s p i t e the f a c t t h a t " p r i c e - i n s e n s i t i v e buyers on the pr ime r o u t e s (such as f r e q u e n t b u s i n e s s passengers ) had more i n t r i n s i c economic b a r g a i n i n g power than the p r i c e - s e n s i t i v e b u y e r s on m a r g i n a l s e r v i c e s (such as i n f r e q u e n t p a s s e n g e r s i n o u t l y i n g r e g i o n s ) " 1 5 , the b a r r i e r s e r e c t e d e n s u r e d t h a t p r i c e s were kept a r t i f i c i a l l y h i g h i n p r ime s e r v i c e s and a r t i f i c i a l l y low i n m a r g i n a l s e r v i c e s . T h i s was f u r t h e r f a c i l i t a t e d by t h e f a c t t h a t p r i c e -s e n s i t i v e b u y e r s i n s m a l l communi t ies had more p o l i t i c a l c l o u t . Tha t i s , a c c o r d i n g t o Byrnes (1985) " th rough t h e i r 1 2 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , (1985) D e r e g u l a t i n g the A i r l i n e s , (Cambridge, M a s s . : MIT P r e s s ) , p . 96. 1 3 B y r n e s , J . L . S . , p . 120. 1 4 I b i d . , p . 5. 1 5 I b i d . , p . 5. - 17 -r e p r e s e n t a t i v e s i n C o n g r e s s , numerous m a r g i n a l b u y e r s had i p r e s s u r e d t h e CAB i n t o p r o v i d i n g i n e x p e n s i v e s e r v i c e on r e l a t i v e l y s p a r s e r o u t e s " 1 6 . Hence, under r e g u l a t i o n , b u y e r b a r g a i n i n g power was d e t e r m i n e d by p o l i t i c a l i n f l u e n c e r a t h e r than by economic s t r e n g t h . S i m i l a r l y , s u p p l i e r b a r g a i n i n g power i n the r e g u l a t e d i n d u s t r y r e s t e d p r i m a r i l y upon a p o l i t i c a l r a t h e r t h a n an i n t r i n s i c a l l y economic b a s i s . That i s , w h i l e w o r k e r s ' n e g o t i a t i n g l e v e r a g e was augmented by the f a c t t h a t a i r c a r r i e r s o p e r a t e i n a s e r v i c e i n d u s t r y ( i . e . " a i r l i n e s cannot s t o r e o u t p u t , so s a l e s l o s t d u r i n g a s t r i k e a r e l o s t f o r e v e r " 1 7 ) , and t h a t many o f the employee groups a re " h i g h l y s k i l l e d and h i g h l y s p e c i a l i z e d , t h u s l i m i t i n g the a v a i l a b i l i t y o f s u b s t i t u t e s " 1 8 , t he e x i s t e n c e o f CAB r a t e r e g u l a t i o n appears t o have been the main f a c t o r t h a t p l a c e d a i r l i n e u n i o n s i n a s t r o n g b a r g a i n i n g p o s i t i o n . T h i s i s b e c a u s e , under r a t e r e g u l a t i o n , f a r e s were s e t a c c o r d i n g t o c o s t s . Hence , " i n c e n t i v e s f o r c a r r i e r management t o r e s i s t u n i o n demands a t t h e b a r g a i n i n g t a b l e were g r e a t l y 1 6 I b i d . , p . 57 . 1 7 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 96. 1 8 I b i d . , p . 96. - 18 -d i m i n i s h e d " 1 9 , and l a b o u r u n i o n s " b e n e f i t e d from l a r g e s e t t l e m e n t s t h a t were p a s s e d t h r o u g h t o p r i c e - i n s e n s i t i v e c u s t o m e r s . " 2 0 F o r i n s t a n c e , B a i l e y , Graham and K a p l a n (1985) have found t h a t f o r t h e p e r i o d 1957-1981 a i r l i n e workers were p a i d s u b s t a n t i a l l y more than workers d o i n g s i m i l a r work i n o t h e r i n d u s t r i e s . They c i t e v a r i o u s examples o f pay d i f f e r e n t i a l s i n j o b s where no i n d u s t r y - s p e c i f i c s k i l l s a r e r e q u i r e d . F o r example , i n 1980 "keypunch o p e r a t o r s who worked f o r t h e a i r l i n e s earned 31 p e r c e n t more than the average wage f o r a l l keypunch o p e r a t o r s " 2 1 , w h i l e the pay d i f f e r e n t i a l s f o r t y p i s t s , computer o p e r a t o r s , and c l e a n e r s were "41 p e r c e n t , 38 p e r c e n t , and 82 p e r c e n t " 2 2 , r e s p e c -t i v e l y . Moreover , where s k i l l s a r e s p e c i f i c t o t h e a i r l i n e i n d u s t r y , wage r a t e s seem t o r e f l e c t the workers* s u c c e s s i n c a p t u r i n g a s h a r e o f t h e i n d u s t r y ' s p r o d u c t i v i t y g a i n s . F o r example , " p i l o t s have succeeded i n c a p t u r i n g a c o n s i d e r a b l e s h a r e o f the c o s t s a v i n g s c r e a t e d by t e c h n o l o g i c a l advances ( i . e . l a r g e r and f a s t e r a i r c r a f t ) , and as a r e s u l t p i l o t c o s t s have no t f a l l e n as much as 1 9 B l u m e s t o c k , J . W . and E . A . Thomchick , " D e r e g u l a t i o n and A i r l i n e Labour R e l a t i o n s " , The L o g i s t i c s and T r a n s p o r t a t i o n Rev iew, December 1986, V o l . 2 2 ( 4 ) , p . 392. 2 0 B y r n e s , J . L . S . , p . 120. 2 1 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 102. 2 2 I b i d . , p . 102. - 19 -t e c h n o l o g i c a l change would have allowed. These g a i n s were ach i e v e d not o n l y through h i g h e r pay but a l s o through changes i n the work r u l e s t h a t i n c r e a s e d the r e q u i r e d number of employees. 1 , 2 3 In t h i s c o n n e c t i o n , the authors s t r e s s t h a t t o the e x t e n t t h a t r e s t r i c t i v e work r u l e s have been adopted under r e g u l a t i o n ( i . e . c o n t r a c t s t h a t r e s t r i c t the use o f p a r t - t i m e employees), p r o d u c t i v i t y growth has been h e l d below the l e v e l s t h a t c o u l d have been ac h i e v e d . The b a r g a i n i n g power of the o t h e r major s u p p l i e r s t o the a i r l i n e s , equipment manufacturers and f u e l s u p p l i e r s , a l s o appears t o have b e n e f i t t e d from CAB r a t e r e g u l a t i o n of t h e i n d u s t r y . That i s , s i n c e f a r e s were s e t a c c o r d i n g t o c o s t s , a i r l i n e s had l i t t l e i n c e n t i v e t o c o n t r o l r i s i n g c o s t s as t h e s e c o u l d simply be passed on t o p r i c e -i n s e n s i t i v e passengers by way o f h i g h e r f a r e s . Moreover, a i r c r a f t manufacturers, i n p a r t i c u l a r , would appear t o have b e n e f i t t e d from the s e r v i c e c o m p e t i t i o n t h a t r e g u l a t i o n encouraged s i n c e t h i s i n c r e a s e d the demand f o r new j e t a i r c r a f t (to be d i s c u s s e d l a t e r ) . Next, the i n r o a d s of s u b s t i t u t e s e r v i c e s appear t o have been e f f e c t i v e l y l i m i t e d by the CAB's c r o s s - s u b s i d y p o l i c y . For i n s t a n c e , w h i l e i t i s u n l i k e l y t h a t any s u b s t i t u t e modes of t r a v e l pose a r e a l t h r e a t i n long-haul markets s i n c e "as market d i s t a n c e i n c r e a s e s , s u r f a c e t r a v e l 2 3 I b i d . , p. 97. - 20 -becomes a p o o r s u b s t i t u t e f o r a i r t r a v e l " 2 4 , a i r s e r v i c e c o u l d p o t e n t i a l l y b e r e p l a c e d b y r a i l a n d / o r b u s s e r v i c e o n many s h o r t - t o - m e d i u m - h a u l r o u t e s . H o w e v e r , a s p r e v i o u s -l y m e n t i o n e d , f a r e s o n many s u c h t h i n d e n s i t y r o u t e s w e r e k e p t a r t i f i c i a l l y l o w b y t h e CAB i n o r d e r t o a p p e a s e t h e p o l i t i c a l l y i n f l u e n t i a l p r i c e - s e n s i t i v e t r a v e l l e r s o n s u c h r o u t e s , t h u s c o u n t e r i n g t h e c o s t a d v a n t a g e o f t h e s e p o t e n -t i a l s u b s t i t u t e s . F u r t h e r m o r e , t h e r a i l w a y i n d u s t r y was r e g u l a t e d a s w e l l , t h e r e b y l i m i t i n g i t s p r i c i n g f l e x i b i -l i t y . N e x t , s i n c e p r i c e c o m p e t i t i o n was l a r g e l y b a r r e d u n d e r CAB r e g u l a t i o n o f a i r f a r e s , i n t e r f i r m r i v a l r y p r i m a r i l y t o o k t h e f o r m o f s e r v i c e a n d c a p a c i t y c o m p e t i t i o n a s w e l l a s j o c k e y i n g f o r r e g u l a t o r y f a v o r s . I n t h e m i d - 1 9 6 0 s , c a r r i e r s b e g a n t o a c q u i r e new j e t a i r c r a f t a n d l a t e r w i d e -b o d i e d j e t a i r c r a f t s i n c e t h e s e a p p e a l e d t o p a s s e n g e r s w h i l e l o w e r i n g o p e r a t i n g c o s t s . H o w e v e r , u n d e r s e r v i c e c o m p e t i t i o n , " c a r r i e r s f a c e d i n c e n t i v e s t o p u r c h a s e a l a r g e r s t o c k o f e q u i p m e n t t h a n t h e y n e e d e d " 2 5 , r e s u l t i n g i n e x c e s s c a p a c i t y i n t h e i n d u s t r y . T h i s , i n t u r n , c a u s e d l a r g e w e l f a r e l o s s e s t o s o c i e t y . F o r i n s t a n c e , i n a 1977 R e p o r t t o C o n g r e s s , t h e C o m p t r o l l e r G e n e r a l o f t h e U.S. s t a t e d t h a t a i r l i n e s c o u l d h a v e p r o f i -t a b l y o p e r a t e d a t a l o w e r c o s t p e r p a s s e n g e r , " r e s u l t i n g i n 2 4 I b i d . , p . 5 3 . 2 5 I b i d . , p . 62. - 21 -l ower f a r e s and t h e r e f o r e s a v i n g s t o d o m e s t i c a i r t r a v e l -l e r s on the o r d e r o f $1.4 t o $3.8 b i l l i o n a y e a r . " 2 6 S i m i l a r l y , S e n a t o r Kennedy c l a i m e d t h a t as a d i r e c t r e s u l t o f a i r l i n e r e g u l a t i o n " the p u b l i c p a i d from 32% t o 47% i n e x c e s s a i r f a r e s " 2 7 , w h i l e K e e l e r ' s f i n d i n g s f o r 1972 s u g g e s t a markup o f "45 t o 84 p e r c e n t " 2 8 . Toward t h e l a t e r 1960s, t h e c a r r i e r s s h i f t e d t h e i r c o m p e t i t i o n toward s c h e d u l e and c a p a c i t y c o n t e s t s . T h i s was done i n r e s p o n s e t o t h e s - c u r v e e f f e c t , whereby " the market s h a r e o f a dominant c a r r i e r tended t o be more than p r o p o r t i o n a l t o t h e s c h e d u l e f r e q u e n c y . " 2 9 Hence c a r r i e r s f a c e d i n c e n t i v e s t o i n c r e a s e t h e f r e q u e n c y o f t h e i r f l i g h t s . T h i s s t r a t e g y , which r e q u i r e d p u r c h a s i n g even more a i r c r a f t , e x a c e r b a t e d the problem o f e x c e s s c a p a c i t y i n t h e i n d u s t r y u n t i l the a i r l i n e s were f i n a l l y l i m i t e d by t h e " i n a b i l i t y o f m a n u f a c t u r e r s t o s u p p l y more p l a n e s . " 3 0 F i n a l l y , under the regime o f r e g u l a t i o n , c a r r i e r s competed by t r y i n g t o o b t a i n f a v o r a b l e r e g u l a t o r y d e c i s i o n s 2 6 C i v i l A e r o n a u t i c s Board (Report t o C o n g r e s s ) , (1977) Lower A i r l i n e C o s t s Per P a s s e n g e r A r e P o s s i b l e In  The U . S . And C o u l d R e s u l t i n Lower F a r e s , (Washington, D . C . : C i v i l A e r o n a u t i c s B o a r d ) , p . 38. 2 7 D a v i s , G . M . , (1976) T r a n s p o r t a t i o n R e g u l a t i o n : A  P r a g m a t i c A s s e s s m e n t , ( I l l i n o i s : I n t e r s t a t e P r i n t e r s & P u b l i s h e r s I n c . ) , p . 213. 2 8 K e e l e r , T . E . , " A i r l i n e R e g u l a t i o n and Market P e r f o r m a n c e " , B e l l J o u r n a l o f E c o n o m i c s , Autumn 1972, p . 421. 2 9 B y r n e s , J . L . S . , p . 31 . 3 0 I b i d . , p . 31 . - 22 -( i . e . s u c h as pr ime r o u t e awards ) . In f a c t , a c c o r d i n g t o Meyer and O s t e r (1984) " to the e x t e n t t h e r e was r i v a l r y , under r e g u l a t i o n , i t was l a r g e l y r e s t r i c t e d t o c u r r y i n g advantage from the h i g h l y l e g a l i s t i c and p o l i t i c i z e d r e g u l a t o r y p r o c e s s . " 3 1 One such s t r a t e g y was t o under take what Byrnes (1985) r e f e r s t o as Type 1 d i v e r s i f i c a t i o n : " s i t i n g h o t e l s i n an at tempt t o g a i n d e s i r a b l e r o u t e s " 3 2 , s i n c e t h e C A B ' s c r i t e r i a f o r r o u t e development a b i l i t y i n c l u d e d a c a r r i e r ' s a b i l i t y t o p r o v i d e a c c o m o d a t i o n s . A l l i n a l l t h e n , i t would appear t h a t CAB r e g u l a t i o n was e f f e c t i v e i n l i m i t i n g the c o l l e c t i v e s t r e n g t h o f the i n d u s t r y ' s f i v e c o m p e t i t i v e f o r c e s . However, under economic d e r e g u l a t i o n o f the a i r l i n e i n d u s t r y , one would e x p e c t the s t r e n g t h o f t h e s e f o r c e s t o be a l t e r e d s u b s t a n t i a l l y f rom t h a t which e v o l v e d t h r o u g h o u t 4 0 y e a r s o f r e g u l a t i o n . L e t us examine the a p r i o r i e x p e c t e d outcomes o f d e r e g u l a t i o n , a g a i n u s i n g P o r t e r ' s C o m p e t i t i v e F o r c e s Model as a g e n e r a l framework. 3 1 M e y e r , J . R . and C . V . O s t e r , (1984) D e r e g u l a t i o n and The  New A i r l i n e E n t r e p r e n e u r s , (Cambridge, M a s s . : MIT P r e s s ) , p . 3. 3 2 B y r n e s , J . L . S . , p . 197. - 23 -4) A P r i o r i E x p e c t e d Outcomes o f A i r l i n e D e r e g u l a t i o n To b e g i n w i t h , g i v e n the removal o f r e g u l a t o r y b a r r i e r s t o e n t r y i n t o the i n d u s t r y and p a r t i c u l a r c i t y -p a i r m a r k e t s , new e n t r a n t s c o u l d pose a r e a l t h r e a t t o the i n c u m b e n t s . Tha t i s , new c a r r i e r s c o u l d be e x p e c t e d t o e n t e r t h e h i g h - d e n s i t y p r o f i t a b l e markets from which c r o s s -s u b s i d i e s were drawn t h e r e b y r e n d e r i n g the l a t t e r p o l i c y no l o n g e r v i a b l e . N e v e r t h e l e s s , the s e r i o u s n e s s o f t h i s t h r e a t o f e n t r y would appear t o be checked somewhat by the n o n - r e g u l a t o r y b a r r i e r s t o e n t r y e x i s t i n g i n t h e a i r l i n e i n d u s t r y , as w e l l as the p o t e n t i a l r e a c t i o n s o f e x i s t i n g c a r r i e r s . F i r s t , w i t h r e s p e c t t o n o n - r e g u l a t o r y e n t r y b a r r i e r s , w h i l e i t would appear t h a t the i n d u s t r y i s not s u b j e c t t o g r e a t economies o f s c a l e "w i th t h e l i m i t e d e x c e p t i o n s o f t e r m i n a l o p e r a t i o n s and m a r k e t i n g " 3 3 , i t i s c h a r a c t e r i z e d by d i f f e r e n t i a b l e s e r v i c e s , s i z e a b l e c a p i t a l r e q u i r e m e n t s ( i . e . e x p e n d i t u r e s on a i r c r a f t and u p - f r o n t a d v e r t i s i n g , and t h e need t o absorb s t a r t - u p l o s s e s ) , and l i m i t e d a c c e s s t o d i s t r i b u t i o n c h a n n e l s (en t renched companies have d e v e l o p e d s o p h i s t i c a t e d computer r e s e r v a t i o n systems t h a t p r e s e n t b i a s e d i n f o r m a t i o n t o t r a v e l a g e n t s ) . F u r t h e r m o r e , t h e incumbents would appear t o be p r e p a r e d f o r s h a r p r e t a l i a t i o n s i n c e t h e i n d u s t r y i s c h a r a c t e r i z e d by b o t h e x c e s s c a p a c i t y and s low growth ( i . e . 3 3 I b i d . , p . 57. - 24 -" a i r l i n e t r a f f i c has been growing at about 7% to 8% annually, while the a i r l i n e s have boosted capacity 10% to 11% per y e a r " 3 4 ) . Thus, while the strength of the threat of new entrants w i l l undoubtedly be augmented by deregulation, p o t e n t i a l r i v a l s could nevertheless entertain some second thoughts about barging into the industry. Secondly, under the regime of deregulation one would expect buyer bargaining power to revert to an economic basis. That i s , economically strong buyers ( i . e . frequent business t r a v e l l e r s ) should gain more value i n t h e i r transportation purchases, while economically weak buyers ( i . e . p r i c e - s e n s i t i v e buyers on marginal routes) could see service f a l l to economically supportable l e v e l s . S i m i l a r l y , under deregulation, supplier bargaining power can be expected to s h i f t from a p o l i t i c a l basis to an economic one. That i s , as new, more e f f i c i e n t c a r r i e r s enter the industry, the incumbents could face pressure to lower costs. To t h i s end, some suggest that "since most a i r l i n e costs are r e l a t i v e l y fixed (e.g. f u e l taxes, i n t e r e s t , insurance) the f u l l force of competition w i l l f a l l on the labour component. They predict that c o l l e c t i v e bargaining w i l l be tougher... and that there w i l l be a s h i f t from unionized to non-union l a b o u r . " 3 5 Hence, there w i l l 3 4 L a b i c h , K., "Winners i n the A i r Wars", Fortune Magazine, May 11, 1987, p. 79. 3 5Western Transportation Advisory Council, "A New Thresh-old for Canadian A i r Transportation", WESTAC Br i e f i n g , October 1986, p. 23. - 25 -be c o n s i d e r a b l e p r e s s u r e on the o l d e r c e r t i f i c a t e d a i r l i n e s t o move toward " c o m p e t i t i v e pay l e v e l s and more f l e x i b l e work r u l e s . " 3 6 N e v e r t h e l e s s , i t appears t h a t l a b o u r w i l l r e t a i n some b a r g a i n i n g power s i n c e , as a f o r e s a i d , many a i r l i n e employees a r e h i g h l y s k i l l e d and h i g h l y s p e c i a l i z e d , thus l i m i t i n g the a v a i l a b i l i t y o f s u b s t i t u t e s and b u i l d i n g up e m p l o y e r s ' s w i t c h i n g c o s t s ( i . e . t r a i n i n g e x p e n s e s ) . Wi th r e s p e c t t o the o t h e r major s u p p l i e r s t o the a i r l i n e s , a i r c r a f t m a n u f a c t u r e r s and f u e l compan ies , i t would appear t h a t d e r e g u l a t i o n w i l l b o t h i n c r e a s e the number o f b u y e r s , and p l a c e p r e s s u r e s on t h e a i r l i n e s t o o b t a i n l o w e r - c o s t f u e l and a i r c r a f t . T h e r e f o r e , w h i l e the a i r c r a f t m a n u f a c t u r i n g i n d u s t r y , i n p a r t i c u l a r , i s more c o n c e n t r a t e d than the a i r l i n e i n d u s t r y i t s e l l s t o , i s dominated by a few companies , and i t s p r o d u c t has b u i l t - u p s w i t c h i n g c o s t s ( i . e . s p e c i a l i z e d a n c i l l a r y equipment f o r t h e t r a i n i n g o f c a r r i e r p e r s o n n e l , such as f l i g h t s i m u l a t o r s ) , i t i s n e v e r t h e l e s s r e n d e r e d v u l n e r a b l e due t o i t s b e i n g c h a r a c t e r i z e d by h i g h sunk c o s t s ( u p - f r o n t r e s e a r c h and development expenses) and t o i t s p r o d u c t i o n o f p e r i s h a b l e goods ( i . e . p rone t o t e c h n o l o g i c a l o b s o l e s c e n c e ) . T h u s , on b a l a n c e , t h e s e f a c t o r s would appear t o r e d u c e the m a n u f a c t u r e r s ' b a r g a i n i n g power. 3 6 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 197. - 26 -F o u r t h l y , w h i l e as ment ioned e a r l i e r , i t i s u n l i k e l y t h a t any s u b s t i t u t e modes o f t r a v e l pose a r e a l t h r e a t i n l o n g - h a u l m a r k e t s , d e r e g u l a t i o n , by a l l o w i n g the u p s t a r t o f low c o s t - low f a r e o p e r a t i o n s , would appear t o f u r t h e r d i s c o u r a g e t h e i n r o a d s o f s u b s t i t u t e s e r v i c e s on s h o r t - t o -medium-haul r o u t e s . Thus the t h r e a t o f s u b s t i t u t e s e r v i c e s would no t appear t o be a v e r y s e r i o u s one . F i n a l l y , under f a r e d e r e g u l a t i o n , i t i s l i k e l y t h a t i n t e r f i r m r i v a l r y w i l l s h i f t from s e r v i c e and c a p a c i t y c o n t e s t s t o p r i c e c o m p e t i t i o n . That i s , p r i c i n g f l e x i b i l i t y s h o u l d a l l o w e f f i c i e n t c a r r i e r s t o p a s s c o s t s a v i n g s a l o n g t o consumers by way o f lower f a r e s . M o r e o v e r , t h i s r i v a l r y i s l i k e l y t o be i n t e n s e s i n c e , as p r e v i o u s l y m e n t i o n e d , t h i s m a t u r i n g i n d u s t r y i s c h a r a c t e r i z e d by h i g h f i x e d c o s t s , e x c e s s c a p a c i t y , and s low growth . F u r t h e r m o r e , t h e c a r r i e r s ' p r o d u c t ( i . e . a s e a t - m i l e ) i s p e r i s h a b l e ( i t i s consumed as i t i s p roduced and hence can not be s t o r e d as i n v e n t o r y ) , and n o n -r e g u l a t o r y e x i t b a r r i e r s a r e h i g h ( a i r c r a f t a r e v e r y s p e c i a l i z e d a s s e t s ) t h e r e b y c r e a t i n g s t r o n g t e m p t a t i o n t o c u t p r i c e s . T h u s , a l l i n a l l , the expec ted outcomes o f d e r e g u l a -t i o n p o i n t t o i n c r e a s e d i n t e n s i t y i n i n t e r f i r m r i v a l r y b r o u g h t about by t h e t h r e a t o f new e n t r a n t s , p r i c e c o m p e t i t i o n , and t h e i n c r e a s e d buyer b a r g a i n i n g power o f f r e q u e n t b u s i n e s s t r a v e l l e r s . - 27 -5) A c t u a l Outcomes o f D e r e g u l a t i o n : The U . S . E x p e r i e n c e W h i l e the j u r y i s s t i l l out w i t h r e s p e c t t o many o f t h e ' e f f e c t s ' o f the d e r e g u l a t i o n o f t h e U . S . a i r l i n e i n d u s t r y , s e v e r a l outcomes have now been a c c e p t e d by a l l as f a c t . F o r the most p a r t , t h e s e r e s u l t s appear t o be c o n s i s t e n t w i t h the a f o r e m e n t i o n e d e x p e c t e d outcomes which were d e r i v e d u s i n g P o r t e r ' s C o m p e t i t i v e F o r c e s p a r a d i g m . Tha t i s , we have w i t n e s s e d i n c r e a s i n g i n t e r f i r m r i v a l r y , p r i m a r i l y i n t h e form o f p r i c e c o m p e t i t i o n , b r o u g h t about by t h e i n c r e a s e d freedom o f e n t r y i n t o t h e i n d u s t r y , and t h e s h i f t o f s u p p l i e r and buyer b a r g a i n i n g power from a p o l i t i c a l t o an economic b a s i s . L e t us examine t h i s e x p e r i e n c e i n g r e a t e r d e t a i l . I) The T h r e a t o f New E n t r a n t s To b e g i n w i t h , the t h r e a t o f new e n t r a n t s i n i t i a l l y p r o v e d t o be v e r y r e a l . That i s , as r e g u l a t o r y b a r r i e r s t o e n t r y and m o b i l i t y were removed, incumbents f a c e d i n c r e a s e d r o u t e c o m p e t i t i o n as a i r l i n e s r e v i s e d t h e i r r o u t e s t r u c t u r e s ( i . e . d r o p p i n g u n p r o f i t a b l e r o u t e s and e n t e r i n g p r o f i t a b l e ones) and as new c a r r i e r s e n t e r e d t h e market . A c c o r d i n g t o J o r d a n (1986) " s t a r t i n g w i t h 27 a i r l i n e s i n 1978, t h e t o t a l number o f a i r l i n e s o p e r a t i n g j e t a i r c r a f t i n c r e a s e d each y e a r u n t i l 63 such a i r l i n e s p r o v i d e d s c h e d u l e d p a s s e n g e r s e r v i c e i n 1 9 8 4 . " 3 7 3 7 J o r d a n , W . A . , " R e s u l t s o f U . S . A i r l i n e D e r e g u l a t i o n : E v i d e n c e from the R e g u l a t e d Canad ian A i r l i n e s " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 2 2 ( 4 ) , December - 28 -F u r t h e r m o r e , as p r e d i c t e d , t h e s e new c a r r i e r s a t t a c k e d the " h e a v i l y t r a v e l l e d p l e a s u r e and b u s i n e s s r o u t e s (whose p r i c e s had been kept a r t i f i c i a l l y h i g h under CAB f a r e r e g u l a t i o n ) by d r a s t i c a l l y c u t t i n g p r i c e s . " 3 8 Hence , w h i l e d e r e g u l a t i o n "has r e s u l t e d i n lower f a r e s on h i g h e r d e n s i t y r o u t e s " 3 9 , f a r e s " i n c r e a s e d more on s h o r t ' t h i n ' r o u t e s , w i t h some h i g h e r i n a b s o l u t e d o l l a r terms t h a n f o r h e a v i l y -t r a v e l l e d r o u t e s f o u r t i m e s the m i l e a g e . " 4 0 N e v e r t h e l e s s , as a group t h e new e n t r a n t s have had s u b s t a n t i a l impact on t h e a i r l i n e i n d u s t r y . A c c o r d i n g t o B a i l e y , Graham and Kap lan (1985) "average f a r e s a r e s u b s t a n t i a l l y lower i n markets they s e r v e " 4 1 , and the new e n t r a n t s have encouraged t h e f o r m e r l y r e g u l a t e d c a r r i e r s t o become more e f f i c i e n t i n o r d e r t o respond c o m p e t i t i v e l y t o t h e i r f a r e s . T h u s , under t h e t h r e a t o f new e n t r a n t s , the g e n e r a l r a t e l e v e l o f p a s s e n g e r f a r e s e i t h e r d e c l i n e d o r r o s e a t a r a t e w e l l below the i n f l a t i o n r a t e . F o r example, " i n 1979 a i r f a r e s i n c r e a s e d by 5.3 p e r c e n t o v e r the p r e v i o u s y e a r bu t the Consumer P r i c e Index jumped by 11.3 1986, p . 301. 3 8 T h o r n t o n , R . L . , " A i r l i n e s and A g e n t s : C o n f l i c t and the P u b l i c W e l f a r e " , J o u r n a l o f A i r Law and Commerce, V o l . 5 2 ( 2 ) , W i n t e r 1986, p . 380. 3 9 C a l l , G . D . and T . E . K e e l e r , (1985) " A i r l i n e D e r e g u l a t i o n , F a r e s , and Market B e h a v i o u r : Some E m p i r i c a l E v i d e n c e " , i n A n a l y t i c a l S t u d i e s i n T r a n s p o r t  E c o n o m i c s , (Cambridge U n i v e r s i t y P r e s s ) , p . 235. 4 0 W E S T A C B r i e f i n g , p . 20. 4 1 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 108. - 29 -p e r c e n t . In 1980 a i r f a r e s r o s e by a lmost 7 p e r c e n t , but a g a i n t h e Consumer P r i c e Index i n c r e a s e d by 12.2 p e r -c e n t . " 4 2 Hence t h e r e was a n e t d e c l i n e i n r e a l f a r e s . The a b i l i t y o f t h e new c a r r i e r s t o charge lower f a r e s can be a t t r i b u t e d t o t h e i r lower o p e r a t i n g e x p e n s e s . T h i s , i n t u r n , can be a t t r i b u t e d i n l a r g e p a r t t o " h i g h e r employee p r o d u c t i v i t y r e l a t i v e t o the o r i g i n a l U . S . a i r l i n e s . " 4 3 In t h i s c o n n e c t i o n , a c c o r d i n g t o M o r r i s o n and Wins ton (1986) , the t h r e a t posed by t h e s e new e n t r a n t s has r e s u l t e d i n a g e n e r a l w e l f a r e g a i n t o consumers . Moreover , B a i l e y , Graham and Kap lan (1985) s t r e s s t h a t the c o m p e t i t i v e p r e s s u r e s o f open e n t r y have c a u s e d a l l c a r r i e r s t o "use t h e i r r e s o u r c e s more e f f i c i e n t l y " 4 4 -i n c r e a s e d u t i l i z a t i o n o f a i r c r a f t , s t a n d a r d i z a t i o n o f f l e e t s , i n c r e a s e d s e a t i n g d e n s i t y , a c c e l e r a t e d r e t i r e m e n t o f f u e l i n e f f i c i e n t a i r c r a f t a n d , h e n c e , reduced f u e l u s e , r a t i o n a l i z a t i o n o f r o u t e s , and a h i g h e r growth r a t e i n p r o d u c t i v i t y . F o r example , i n 1982, " U n i t e d A i r l i n e s o p e r a t e d a t 96.4% o f i t s 1978 c a p a c i t y , as measured i n a v a i l a b l e s e a t -m i l e s , w i t h 21% fewer w o r k e r s . The e n t i r e i n d u s t r y p r o v i d e d 19% more output w i t h fewer than 1% more 4 2 R o s e , W. , "Three Years A f t e r A i r l i n e Passenger D e r e g u l a t i o n i n t h e U n i t e d S t a t e s : A R e p o r t Card on T r u n k l i n e C a r r i e r s " , T r a n s p o r t a t i o n J o u r n a l , W in te r 1981, p . 57 . 4 3 J o r d a n , W . A . , (1986) , p . 308. 4 4 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 67. - 30 -e m p l o y e e s . " 4 5 S i m i l a r l y , Meyer and O s t e r (1981) , r e p o r t i n g on t h e e a r l y e x p e r i e n c e o f d e r e g u l a t i o n , c o n c l u d e d t h a t "as a r e s u l t o f p r o d u c t i v i t y g a i n s from t e c h n i c a l , o p e r a t i n g and m a r k e t i n g e f f i c i e n c i e s , the average a i r l i n e f a r e i s pe rhaps 8% t o 25% lower than i t would have been w i thou t d e r e g u l a t i o n . " 4 6 T h u s , a l l i n a l l , i t would appear t h a t t h e t h r e a t o f new e n t r a n t s was indeed i n i t i a l l y s u c c e s s f u l i n l i m i t i n g t h e p r o f i t p o t e n t i a l o f the i n d u s t r y . However, i n t h e l o n g e r r u n , a c c o r d i n g t o Byrnes (1985) " the removal o f r e g u l a t o r y b a r r i e r s t o e n t r y f o r c e d the a i r l i n e s t o t a k e s t e p s t o c o n s t r u c t new e n t r y b a r r i e r s t h a t were c a p a b l e o f p r o t e c t i n g t h e i r c o m p e t i t i v e p o s i t i o n s and i n s u l a t i n g them a g a i n s t d e s t r u c t i v e d i r e c t p r i c e c o m p e t i t i o n . 1 , 4 7 These i n c l u d e d : hub and spoke f e e d e r s y s t e m s , computer r e s e r v a t i o n s y s t e m s , and f r e q u e n t f l i e r p rograms . F i r s t , w h i l e most major a i r l i n e s employed some t y p e o f hub and spoke o p e r a t i o n p r i o r t o 1978 ( i . e . D e l t a and E a s t e r n had major hubs i n A t l a n t a , U n i t e d i n C h i c a g o , Amer ican i n D a l l a s , and US A i r i n P i t t s b u r g h ) , d e r e g u l a t i o n s u b s t a n t i a l l y a c c e l e r a t e d t h e i r use (see F i g u r e 5 - 1 ) . 4 5 " D e r e g u l a t i n g A m e r i c a . The B e n e f i t s B e g i n t o Show In P r o d u c t i v i t y , I n n o v a t i o n , and P r i c e " , B u s i n e s s Week, November 28, 1983, p . 86. 4 6 M e y e r , J . R . and C . V . O s t e r , (1981) A i r l i n e D e r e g u l a t i o n :  The E a r l y E x p e r i e n c e , ( B o s t o n , M a s s . : Auburn House P u b l i s h i n g Company), p. 89. 4 7 B y r n e s , J . L . S . , p. 56. - 31 -F i g u r e 5-1 Dominant C a r r i e r ' s P e r c e n t a g e o f D e p a r t u r e s a t L a r g e A i r  T r a f f i c Hubs, 1977 V e r s u s 1984 D e p a r t u r e s (%) L a r g e Hubs 1977 1984 P i t t s b u r g h 50 80 Newark 27 46 D a l l a s - F o r t Worth 36 50 C h i c a g o (O'Hare) 26 39 S t . L o u i s 35 46 Denver 26 36 New York (Kennedy) 14 20 A t l a n t a 41 45 Miami 37 40 M i n n e a p o l i s / S t . P a u l 38 41 Houston ( I n t e r c o n t i n e n t a l ) 40 42 S o u r c e : P h i l l i p s , L . T . " S t r u c t u r a l Change i n the A i r l i n e I n d u s t r y : C a r r i e r C o n c e n t r a t i o n a t L a r g e Hub A i r p o r t s and i t s I m p l i c a t i o n s f o r C o m p e t i t i v e B e h a v i o r " , T r a n s p o r t a t i o n J o u r n a l , V o l . 2 5 ( 2 ) , W in te r 1985, p . 25. - 32 -The e s s e n c e o f t h e s e hub and spoke r o u t e networks i s the c o n s o l i d a t i o n o f s p a r s e l y t r a v e l e d , l o w - d e n s i t y f e e d e r r o u t e s (spokes) a t s p e c i f i c p o i n t s (hubs) i n o r d e r t o a c h i e v e h i g h e r l o a d f a c t o r s , and t o e n a b l e t h e use o f l a r g e r a i r c r a f t w i t h lower u n i t c o s t s on t h e c a r r i e r s ' fewer l o n g - h a u l r o u t e s . The b e n e f i t s t o the a i r l i n e s a r i s e from economies o f s c o p e . T h a t i s , a c c o r d i n g t o M o r r i s o n and Wins ton (1986) "economies o f a i r c r a f t s i z e d e r i v e from more e f f i c i e n t use o f l a b o r and f u e l a s s o c i a t e d w i t h l a r g e r a i r c r a f t . " 4 8 The b e n e f i t s t o consumers a r i s e from the f a c t t h a t , a c c o r d i n g t o C a r l t o n , Landes and Posner (1980) , p a s s e n g e r s much p r e f e r s i n g l e - c a r r i e r s e r v i c e o v e r h a v i n g t o change a i r l i n e s i n m i d j o u r n e y . T h i s i s because a c o n n e c t i n g f l i g h t on the same a i r l i n e " a l l o w s p a s s e n g e r s t o t r a n s f e r more e a s i l y t o a n o t h e r f l i g h t and r e d u c e s t h e l i k e l i h o o d o f p o t e n t i a l s e r v i c e problems ( i . e . l o s t o r damaged l u g -g a g e ) " 4 9 . Hence, w h i l e i n 1977 " the p e r c e n t a g e o f t o t a l revenue p a s s e n g e r - m i l e s p r o v i d e d by s i n g l e c a r r i e r s e r v i c e was 75.4 p e r c e n t , by 1983 t h a t f i g u r e c l i m b e d t o 89.1 p e r c e n t . " 5 o 4 8 M o r r i s o n , S . and C . W i n s t o n , (1986) , The Economic  E f f e c t s o f A i r l i n e D e r e g u l a t i o n , (Washington, D . C . : The B r o o k i n g s I n s t i t u t i o n ) , p . 7. 4 9 P h i l l i p s , L . T . , " S t r u c t u r a l Change i n the A i r l i n e I n d u s t r y : C a r r i e r C o n c e n t r a t i o n a t Large Hub A i r p o r t s and i t s I m p l i c a t i o n s f o r C o m p e t i t i v e B e h a v i o r " , T r a n s p o r t a t i o n J o u r n a l , V o l . 2 5 ( 2 ) , W i n t e r 1985, p . 19. 5 0 M o r r i s o n , S . and C . W i n s t o n , p p . 8 - 9 . - 33 -However, as a s s e r t e d by T h o r n t o n (1986) , i d e a l l y , a t t h e hub c i t y , a l l o f the s m a l l and l a r g e spokes a re c e n t e r e d i n a s m a l l ga te a r e a o f t h e a i r p o r t . Ye t " s m a l l e r c a r r i e r s cannot amass enough a d j o i n i n g g a t e s i n s u f f i c i e n t amounts o f a i r p o r t s " 5 1 . Thus the l i m i t e d a v a i l a b i l i t y o f a d j o i n i n g g a t e s r e p r e s e n t s a s u b s t a n t i a l b a r r i e r t o e n t r y t o s m a l l e r c a r r i e r s , and a c o m p e t i t i v e advantage f o r the e n t r e n c h e d a i r l i n e s who s e c u r e d pr ime g a t e space w h i l e the i n d u s t r y was s t i l l r e g u l a t e d . Moreover , a c c o r d i n g t o M o r r i s o n and Winston (1986) , a w e l l - d e v e l o p e d h u b - a n d - s p o k e network can d i s c o u r a g e p o t e n t i a l c o m p e t i t o r s by i n c r e a s i n g t h e s c a l e o f e n t r y r e q u i r e d t o compete e f f e c t i v e l y a t a g i v e n hub c i t y . S e c o n d , s e v e r a l a i r l i n e s d e v e l o p e d t h e i r own computer r e s e r v a t i o n system (CRS) i n o r d e r t o p r o v i d e b e t t e r i n f o r m a t i o n t o p a s s e n g e r s v i a t r a v e l agents ( i . e . due t o t h e p r o l i f e r a t i o n o f f a r e s and s c h e d u l e s t h a t a r o s e under d e r e g u l a t i o n ) . However, t h e s e systems "have a h i s t o r y o f p r e s e n t i n g b i a s e d i n f o r m a t i o n , l i s t i n g t h e c a r r i e r - o w n e r ' s f l i g h t s so p r o m i n e n t l y t h a t t r a v e l agents a r e l e s s l i k e l y t o t i c k e t p a s s e n g e r s on compet ing c a r r i e r s . " 5 2 T h i s b i a s c o u l d have s e r i o u s r e p e r c u s s i o n s f o r t h e l a t t e r s i n c e " a l m o s t 90 p e r c e n t o f a l l d o m e s t i c a i r l i n e revenues a re now g e n e r a t e d by t r a v e l agents who use c a r r i e r - o w n e d computer 5 1 T h o r n t o n , R . L . , p . 382. 5 2 M o r r i s o n , S . and C . W i n s t o n , p . 69. - 34 -s y s t e m s . " 5 3 Two such s y s t e m s , Amer ican A i r l i n e s ' Sabre and U n i t e d A i r l i n e s ' A p o l l o , have come t o dominate the i n d u s t r y w i t h 1986 market s h a r e s o f U . S . t r a v e l agent l o c a t i o n s o f "39.3% and 2 7 . 4 % " 5 4 , r e s p e c t i v e l y . Moreover , w h i l e t h e CAB has d i r e c t e d r e m e d i a l a c t i o n t o d e - b i a s r e s e r v a t i o n d i s p l a y s , a c c o r d i n g t o Thorn ton (1986) " i t i s u n l i k e l y t h a t t h e s e s t e p s w i l l s u c c e e d because t h e p a y - o f f o f b i a s i s h i g h and the ways t o a c h i e v e i t a r e s u b t l e . " 5 5 B e s i d e s l e s s e n i n g c o m p e t i t i o n t h r o u g h i n f o r m a t i o n -b i a s , t h e s e CRS systems c o n s t i t u t e a s i g n i f i c a n t b a r r i e r t o e n t r y s i n c e "a newly formed a i r l i n e would not have the r e s o u r c e s t o c r e a t e i t s own a i r l i n e - o w n e d r e s e r v a t i o n s y s t e m . " 5 6 F u r t h e r m o r e , t h e h i g h c o s t s o f d e v e l o p i n g and m a i n t a i n i n g a CRS have been s u f f i c i e n t t h u s f a r t o " d i s c o u r a g e t h e development o f compet ing systems by n o n -c a r r i e r s . " 5 7 F i n a l l y , and perhaps most i m p o r t a n t l y , a c c o r d i n g t o Byrnes (1985) " the r e s e r v a t i o n systems r e q u i r e d i n a f e e d e r system p r o v i d e d b o t h a b s o l u t e c a p i t a l b a r r i e r s a g a i n s t new e n t r a n t s and t h e a b i l i t y t o implement s o p h i s t i c a t e d , f l e x i b l e p r i c e d i s c r i m i n a t i o n schemes based 5 3 I b i d . , 69 . 5 4 G a u d i n , P . , " R e s e r v i n g Judgment" , A i r l i n e B u s i n e s s , March 1987, p . 19. 5 5 T h o r n t o n , R . L . , p . 378. 5 6 I b i d . , p . 383. 5 7 M o r r i s o n , S . and C . W i n s t o n , p. 70. - 35 -on t h e demand p a t t e r n s f o r i n d i v i d u a l f l i g h t s . " 5 8 (The l a t t e r w i l l be d i s c u s s e d i n a l a t e r s e c t i o n ) . T h i r d , under d e r e g u l a t i o n c a r r i e r s adopted f r e q u e n t f l i e r p rograms . These e s s e n t i a l l y p r o v i d e f r e e f l i g h t s anywhere i n an a i r l i n e ' s system i n p r o p o r t i o n t o the number o f c u m u l a t i v e m i l e s f lown by a p a r t i c u l a r p a s s e n g e r on t h a t a i r l i n e . W h i l e t h e o r i g i n a l f r e q u e n t f l i e r p rogram, the ' A A d v a n t a g e ' , was d e v e l o p e d by Amer ican A i r l i n e s i n the s p r i n g o f 1981, today "most o f the l a r g e r a i r l i n e s have d e v e l o p e d s i m i l a r t y p e s o f p r o g r a m s . " 5 9 A c c o r d i n g t o T h o r n t o n (1986) " t h e i r p r i n c i p a l advantage i s t h a t t h e i r s a v i n g g o e s , not t o the p e r s o n who p a i d f o r t h e f l i g h t , bu t t o t h e p a s s e n g e r . F o r b u s i n e s s t r a v e l l e r s t h e b e n e f i t s from t h e program amount t o a pay i n c r e a s e . " 6 0 T h u s , f r e q u e n t f l i e r programs g i v e f r e q u e n t f l y i n g bus inessmen an i n c e n t i v e t o f l y a p a r t i c u l a r a i r l i n e r a t h e r t h a n i t s c o m p e t i t o r s . T h e r e f o r e , t h e y r e p r e s e n t one means f o r a i r l i n e s t o b u i l d up s w i t c h i n g c o s t s and hence t o f o s t e r ' b r a n d l o y a l t y ' f o r t h e i r s e r v i c e . However, f r e q u e n t f l i e r programs would a l s o appear t o c o n s t i t u t e a b a r r i e r t o e n t r y o f s i g n i f i c a n t p r o p o r t i o n s . A c c o r d i n g t o T h o r n t o n (1986) " the schemes t e n d t o p r e v e n t e n t r y i n t o t h e system and t o endanger t h e p r o f i t a b i l i t y o f 5 8 B y r n e s , J . L . S . , p . 56. 5 9 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 60. 6 0 T h o r n t o n , R . L . , p . 384. - 36 -t h e s m a l l e r o p e r a t o r s . 1 , 6 1 T h i s i s because "a s m a l l c a r r i e r would be f o r c e d t o o f f e r a reward w i t h s i g n i f i c a n t l y fewer f l i g h t s i n o r d e r t o a t t r a c t p a s s e n g e r s . . . . t h e r e b y r a i s i n g s m a l l e r r i v a l s ' c o s t s . " 6 2 Hence the c o n c l u s i o n o f B a i l e y , Graham and K a p l a n (1985) , " a l l e l s e e q u a l , t h e a i r l i n e t h a t s e r v e s t h e most markets has a c o m p e t i t i v e advantage w i t h a g i v e n f r e q u e n t f l i e r program: the more markets a c a r r i e r s e r v e s , t h e g r e a t e r the chance t h a t a g i v e n p a s s e n g e r w i l l be a b l e t o t r a v e l on t h a t a i r l i n e i n a p a r t i c u l a r m a r k e t . 1 , 6 3 A l l i n a l l t h e n , i n t h e l o n g e r r u n , i t would appear t h a t t h e a i r l i n e s have i n d e e d s u c c e s s f u l l y e r e c t e d n o n -r e g u l a t o r y b a r r i e r s t o e n t r y i n t o t h e i n d u s t r y . In a d d i t i o n t o t h e s e b a r r i e r s , however, t h e t h r e a t o f new e n t r a n t s has been c o n t a i n e d somewhat by U . S . a i r p o r t c a p a c i t y c o n s t r a i n t s , and e n v i r o n m e n t a l r e s t r i c t i o n s . That i s b e s i d e s t h e s h o r t a g e o f ga te space i n key t e r m i n a l s and l a n d i n g s l o t s a t major a i r p o r t s , a i r l i n e o p e r a t i o n s have a l s o been l i m i t e d by e n v i r o n m e n t a l r e g u l a t i o n s , such as n o i s e r e s t r i c t i o n s . 6 1 I b i d . , p . 384. 6 2 G i l l e n , D.W., W.T . S tanbury and M. Tre theway , " A n a l y s i s o f t h e T a k e o v e r o f Canad ian P a c i f i c A i r L i n e s by P a c i f i c Western A i r l i n e s " , Working Paper #1223. F a c u l t y o f Commerce and B u s i n e s s A d m i n i s t r a t i o n , t h e U n i v e r s i t y o f B r i t i s h C o l u m b i a , J a n u a r y 1987, p. 15. 6 3 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 6. - 37 -N o i s e r e s t r i c t i o n s have had " p a r t i c u l a r l y a d v e r s e consequences f o r a i r c a r r i e r s t h a t seek t o m a i n t a i n a c o m p e t i t i v e advantage on the b a s i s o f low f a r e s and c o s t s ( i . e . low c o s t new e n t r a n t s ) , wh ich i n t u r n r e q u i r e h i g h a i r c r a f t u t i l i z a t i o n . 1 1 6 4 However, perhaps more s e r i o u s has been t h e s h o r t a g e o f l a n d i n g s l o t s . A c c o r d i n g t o E l l i s o n (1981) " the d i f f i c u l t y o f newly e n t e r i n g c a r r i e r s i n o b t a i n i n g s l o t s a t some a i r p o r t s has caused t o d i m i n i s h the t h r e a t o f c o m p e t i t i o n . T h i s l a c k o f ready a c c e s s has o c c u r e d a t the p o p u l a r a i r p o r t s i n New Y o r k , C h i c a g o , and W a s h i n g t o n . 1 , 6 5 Hence i t would appear t h a t s u b s t a n t i a l b a r r i e r s t o e n t r y now e x i s t i n the d e r e g u l a t e d i n d u s t r y , r a i s i n g the p o s s i b i l i t y t h a t p o t e n t i a l c o m p e t i t i o n i n t h e i n d u s t r y c o u l d be s i g n i f i c a n t l y c o n s t r a i n e d . In t h i s c o n n e c t i o n , t h e c r u c i a l q u e s t i o n f o r t h e U . S . market i s whether i t has p r o v e n c o n t e s t a b l e . In o t h e r words , "whether c o m p e t i t i v e f o r c e s under d e r e g u l a t i o n have been s u f f i c i e n t t o d i s p l a c e the c o n t r o l s o f r e g u l a t i o n , by p e r m i t t i n g new e n t r a n t s t o e n t e r and e x i t the market f r e e l y , e f f e c t i v e l y p o s i n g a t h r e a t o f e n t r y s u f f i c i e n t t o keep f a r e s d o w n . " 6 6 6 4 P h i l l i p s , L . T . , p . 20. 6 5 E l l i s o n , A . P . , (1981) " U . S . A i r l i n e D e r e g u l a t i o n : I m p l i c a t i o n s f o r C a n a d a " , (Ottawa: Economic C o u n c i l o f Canada , R e g u l a t i o n R e f e r e n c e T e c h n i c a l R e p o r t No, 11, J u n e ) , p p . 126-127. 6 6 McGowan, F . , "Europe Ponders U . S . L e s s o n s " , A i r l i n e B u s i n e s s , March 1987, p . 16. - 38 -W h i l e t h e r e have been d i f f e r i n g v iews on t h e m a t t e r , the b a l a n c e o f e v i d e n c e s u g g e s t s t h a t , i n the l o n g r u n , the a i r l i n e i n d u s t r y does not s a t i s f y the c o n t e s t a b l e markets h y p o t h e s i s . Tha t i s , i t i s u n l i k e l y t h a t a i r f a r e s w i l l f a l l t o p e r f e c t l y c o m p e t i t i v e l e v e l s ( i . e . z e r o p r o f i t s ) due t o t h e absence o f a b s o l u t e l y f r e e e n t r y i n t o , and c o s t l e s s e x i t f rom, c i t y - p a i r m a r k e t s . F o r i n s t a n c e , w h i l e C a r l t o n , Landes and Posner (1980) s t r e s s t h a t " the extreme f l e x i b i l i t y o f a i r l i n e c a p i t a l e n a b l e s any a i r l i n e w i t h i n a r e g i o n t o e n t e r a new c i t y -p a i r s h o u l d c o m p e t i t i o n f a i l t o c o n t a i n p r i c e s t o the c o m p e t i t i v e l e v e l " 6 7 , B a i l e y and Panzar (1981) a rgued t h a t c i t y - p a i r markets were p e r f e c t l y c o n t e s t a b l e , and Meyer and O s t e r (1984) c o n c l u d e d t h a t "new e n t r a n t s have p r o v e d t h a t t h e y can e n t e r and e x i t markets r e l a t i v e l y i n e x p e n s i v e l y and q u i c k l y , a lmost e x a c t l y as h y p o t h e s i z e d t o p r o v i d e the c o n t e s t a b i l i t y needed t o c r e a t e a r e a s o n a b l y c o m p e t i t i v e market o u t c o m e " 6 8 , t h e m a j o r i t y o f more r e c e n t s t u d i e s have found t h a t t h e c o n t e s t a b l e markets h y p o t h e s i s does not h o l d . F o r example , Graham, K a p l a n , and S i b l e y (1983) found a p o s i t i v e r e l a t i o n s h i p o f f a r e s t o market c o n c e n t r a t i o n wh ich goes a g a i n s t the c o n t e s t a b i l i t y h y p o t h e s i s . Hence 6 7 C a r l t o n , D.W., W. Landes and R. P o s n e r , " B e n e f i t s and C o s t s o f A i r l i n e M e r g e r s : A Case S t u d y " , B e l l J o u r n a l o f E c o n o m i c s , V o l . 11 (1 ) , S p r i n g 1980, p . 80. 6 8 M e y e r , J . R . and C . V . O s t e r , (1984) , p . 223. - 39 -they c o n c l u d e d t h a t " p o t e n t i a l c o m p e t i t i o n was no t work ing as h y p o t h e s i z e d by the c o n t e s t a b i l i t y t h e o r y " 6 9 . S i m i l a r l y , B a i l e y and Baumol (1984) , and B a i l e y , Graham, and K a p l a n (1985) c o n c l u d e d , r e s p e c t i v e l y , t h a t " the c o n t e s t a b i l i t y benchmark does not f u l l y h o l d sway i n t h e f i r s t y e a r s a f t e r d e r e g u l a t i o n " 7 0 , and t h a t " c a r r i e r s i n c o n c e n t r a t e d markets have t h e a b i l i t y t o p r i c e above c o s t " 7 1 . In t h i s c o n n e c t i o n , P h i l l i p s (1985) c l a i m s t h a t f rom the e v i d e n c e g a t h e r e d t o da te " i t appears t h a t a i r l i n e markets a r e no t p e r f e c t l y c o n t e s t a b l e . Indeed many a i r f a r e s a r e n o t o n l y h i g h e r i n c o n c e n t r a t e d m a r k e t s , but w i t h i n c o n c e n t r a t e d markets the l e a d i n g f i r m s have h i g h e r f a r e s t h a n do s m a l l e r f i r m s . " 7 2 F i n a l l y , a c c o r d i n g t o M o r r i s o n and Winston (1986) " p e r f e c t c o n t e s t a b i l i t y i s no t p r e s e n t i n t h e a i r l i n e i n d u s t r y because new c a r r i e r s r e q u i r e t ime and must absorb sunk c o s t s t o o b t a i n g a t e space and e s t a b l i s h p a t r o n a g e . E s t a b l i s h i n g p a t r o n a g e can be p a r t i c u l a r l y d i f f i c u l t when compet ing a g a i n s t c a r r i e r s t h a t o f f e r f r e q u e n t f l i e r p rograms , which e f f e c t i v e l y i n c r e a s e the c o s t o f s w i t c h i n g 6 9 S i n h a , D. , "The Theory o f C o n t e s t a b l e Markets and U . S . A i r l i n e D e r e g u l a t i o n : A S u r v e y " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 2 2 ( 4 ) , December 1986, p . 417. 7 0 B a i l e y , E . E . , and W . J . Baumol , " D e r e g u l a t i o n and the Theory o f C o n t e s t a b l e M a r k e t s " , Y a l e J o u r n a l on R e g u l a t i o n , V o l . 1 ( 2 ) , 1984, p . 130. 7 1 B a i l e y E . E . , D.R. Graham and D.R. K a p l a n , p . 171. 7 2 P h i l l i p s , L . T . , p . 224. - 40 -c a r r i e r s , and t h a t d e v e l o p computer r e s e r v a t i o n systems t h a t b i a s i n f o r m a t i o n i n f a v o u r o f t h e i r f l i g h t s . " 7 3 Perhaps o f g r e a t e r c o n c e r n , w i t h r e s p e c t t o t h e degree o f market c o n t e s t a b i l i t y , i s the re -emergence o f an o l i g o p o l y i n t h e a i r l i n e i n d u s t r y . That i s , s i n c e 1984 "an a c c e l e r a t e d t r e n d toward merger and a c q u i s i t i o n has l e d t o c o n c e r n s t h a t a few a i r l i n e s c o u l d e x c l u d e o t h e r s from c o n t e s t i n g some a i r l i n e m a r k e t s " 7 4 . F o r i n s t a n c e , d u r i n g t h e s e c o n d h a l f o f 1986 "mergers on an u n p r e c e d e n t e d s c a l e i n v o l v e d 45 p e r c e n t o f the U . S . i n d u s t r y ' s c a p a c i t y and 43 p e r c e n t o f e m p l o y e e s " 7 5 . T h i s wave o f merger a c t i v i t y (see F i g u r e 5 - 2 ) , which i n c l u d e s Texas A i r ' s 1982 a c q u i s i t i o n o f C o n t i n e n t a l , and i t s r e c e n t (1986) a c q u i s i t i o n s o f E a s t e r n and Peop le E x p r e s s ( i n c l u d i n g F r o n t i e r ) , as w e l l as D e l t a ' s 1986 merger w i t h W e s t e r n , and N o r t h w e s t ' s merger w i t h R e p u b l i c , has r e s u l t e d i n the dominance o f f i v e m e g a c a r r i e r s ( i . e . T e x a s , U n i t e d , A m e r i c a n , Northwest and D e l t a ) who "now c o n t r o l w e l l o v e r 70% o f a l l U . S . a i r t r a f f i c . " 7 6 N e v e r t h e l e s s , the #6 c a r r i e r TWA (run by C a r l I c a h n ) , and t h e s m a l l e r US A i r ( f o r m e r l y A l l e g h e n y ) a r e a l s o 7 3 M o r r i s o n , S and C . W i n s t o n , p . 61 . 7 4 W E S T A C B r i e f i n g , p . 21 . 7 5 P a g e , K . , " A c t i o n Now On CRS" , A i r l i n e . B u s i n e s s , March 1987, p . 5 . 7 6 L a b i c h , K . , p . 69 . - 41 -F i g u r e 5-2 A i r l i n e T a k e o v e r s / M e r g e r s In The U n i t e d S t a t e s , 1979-1986 1979: - N o r t h C e n t r a l and Southern merge t o become R e p u b l i c 1980: - Pan Amer ican a c q u i r e s N a t i o n a l - R e p u b l i c a c q u i r e s Hughes A i r West - (Texas A i r c r e a t e s New York A i r ) 1981: - (Peop le E x p r e s s e n t e r s the i n d u s t r y ) 1982: - Texas A i r a c q u i r e s C o n t i n e n t a l 1983: - ( C o n t i n e n t a l e n t e r s C h a p t e r 11 b a n k r u p t c y bu t Texas A i r r e t a i n s c o n t r o l ) 1984: - none 1985: - U n i t e d A i r l i n e s a c q u i r e s Pan Am's P a c i f i c r o u t e s - P e o p l e E x p r e s s a c q u i r e s F r o n t i e r 1986: - C o n t i n e n t a l (Texas A i r ) a c q u i r e s E a s t e r n - C o n t i n e n t a l (Texas A i r ) a c q u i r e s P e o p l e E x p r e s s ( i n c l u d i n g F r o n t i e r * ) - D e l t a a c q u i r e s Western - Nor thwest a c q u i r e s R e p u b l i c - TWA a c q u i r e s Ozark - Amer ican a c q u i r e s A i r C a l * * - US A i r merges w i t h P S A * * * P e o p l e E x p r e s s put F r o n t i e r i n t o C h a p t e r 11 b a n k r u p t c y s h o r t l y b e f o r e the t a k e o v e r by C o n t i n e n t a l (which i s owned by Texas A i r ) * * P e n d i n g S o u r c e : G i l l e n , D.W., W.T. S tanbury and M. Tre theway, " A n a l y s i s o f t h e Takeover o f Canadian P a c i f i c A i r L i n e s by P a c i f i c Western A i r l i n e s " , Working Paper #1223, F a c u l t y o f Commerce and B u s i n e s s A d m i n i s t r a t i o n , t h e U n i v e r s i t y o f B r i t i s h C o l u m b i a , J a n u a r y 1987, p . 48. - 42 -i m p o r t a n t c o m p e t i t i v e p l a y e r s i n the i n d u s t r y , and s h o u l d n o t be u n d e r e s t i m a t e d d e s p i t e t h e i r s m a l l e r market s h a r e s . As s t a t e d by Murphy (1987) , i t seems o b v i o u s t h a t w i t h r e d u c e d c o m p e t i t i o n and hub o r market dominance, c a r r i e r s w i l l be a b l e t o e x t r a c t h i g h e r f a r e s from p a s s e n g e r s i n the c i t i e s and markets which they dominate . In f a c t , a c c o r d i n g t o a r e c e n t i s s u e o f the Economis t (November 15, 1986) , " f o r t h e f i r s t t ime s i n c e the shakeout b e g a n , a t r u c e i n t h e p r i c e war has been t a c i t l y a g r e e d . A l l o f them ( i . e . t h e B i g 5) s t a r t e d r a i s i n g f a r e s u n i f o r m l y a t the b e g i n n i n g o f O c t o b e r . " 7 7 Moreover , a c c o r d i n g t o T h o r n t o n (1986) , " the p r o b a b i l i t y o f the development o f an a i r l i n e c a r t e l so narrow as t o t h r e a t e n the c o n s u m e r ' s b e s t i n t e r e s t i s r e a s o n a b l y h i g h . " 7 8 As a r e s u l t o f t h e s e m e r g e r s , t h e degree o f c o n c e n t r a t i o n i n the i n d u s t r y , as r e f l e c t e d by t h e t w o - f i r m c o n c e n t r a t i o n r a t i o s ( the p e r c e n t a g e o f t o t a l s c h e d u l e d enplanements a t an a i r p o r t by t h e two l a r g e s t c a r r i e r s - s e e F i g u r e 5-3) i n c r e a s e d s i g n i f i c a n t l y a t c e r t a i n hub a i r p o r t s between 1977 and 1984. F o r example, i n terms o f enp lanements , t h e t w o - f i r m c o n c e n t r a t i o n r a t i o " i n c r e a s e d a t A t l a n t a from 88 p e r c e n t t o 93 p e r c e n t ; a t C h i c a g o 7 7 " S c h o o l s B r i e f - Open S k i e s Over A m e r i c a " , The E c o n o m i s t , November 15, 1986, p . 91 . 7 8 T h o r n t o n , R . L . , p . 392. - 43 -F i g u r e 5-3 T w o - F i r m C o n c e n t r a t i o n R a t i o s Based on Domest ic  Enp lanements a t L a r g e A i r T r a f f i c Hubs, 1977 v e r s u s 1984 Enplanements La rge Hubs 1977 1984 C h i c a g o (O'Hare) 48 72 A t l a n t a 88 93 D a l l a s - F o r t Worth 64 83 Los A n g e l e s 45 37 Denver 54 65 Newark 50 60 San F r a n c i s c o 57 52 New York (LaGuardia) 58 45 Bos ton 47 41 S t . L o u i s 61 86 New York (Kennedy) 33 41 Washington ( N a t i o n a l ) 40 36 P i t t s b u r g h 67 84 M i n n e a p o l i s / S t . P a u l 62 79 Miami 59 66 Houston ( I n t e r c o n t i n e n t a l ) 56 60 The t w o - f i r m c o n c e n t r a t i o n r a t i o i s t h e p e r c e n t a g e o f t o t a l s c h e d u l e d enplanements a t an a i r p o r t by the two l a r g e s t c a r r i e r s . S o u r c e : P h i l l i p s , L . T . , " S t r u c t u r a l Change i n the A i r l i n e I n d u s t r y : C a r r i e r C o n c e n t r a t i o n a t La rge Hub A i r p o r t s and i t s I m p l i c a t i o n s f o r C o m p e t i t i v e B e h a v i o r " , T r a n s p o r t a t i o n J o u r n a l , V o l . 2 5 ( 2 ) , W in te r 1985, p . 23 . - 44 -(O'Hare) f rom 48 p e r c e n t t o 72 p e r c e n t ; a t D a l l a s - F o r t Worth from 64 p e r c e n t t o 83 p e r c e n t ; a t S t . L o u i s from 61 p e r c e n t t o 86 p e r c e n t ; and a t M i n n e a p o l i s / S t . P a u l from 62 p e r c e n t t o 79 p e r c e n t . " 7 9 M o r e o v e r , as o f 1987, t h e s e c o n c e n t r a t i o n l e v e l s have i n c r e a s e d even f u r t h e r as r e f l e c t e d i n t h e dominant f i r m ' s s h a r e o f enp lanements . F o r example, " the N o r t h w e s t -R e p u b l i c merger w i l l i n c r e a s e N o r t h w e s t ' s market p o s i t i o n a t M i n n e a p o l i s f rom 43.1 t o 79 .6 p e r c e n t o f e n p l a n e -m e n t s . . . w h i l e Texas A i r ' s a c q u i s i t i o n s pushed i t s s h a r e o f Houston t r a f f i c t o o v e r 70 p e r c e n t . " 8 0 S i m i l a r l y , D e l t a "now has a l o c k on o v e r 75% o f S a l t Lake C i t y t r a f f i c as w e l l as o v e r h a l f o f A t l a n t a ' s b u s i n e s s , w h i l e Amer ican now e n j o y s b e t t e r t h a n a 60% market s h a r e a t i t s base ( i . e . D a l l a s - F o r t W o r t h ) . " 8 1 T h i s degree o f c o n c e n t r a t i o n a t l a r g e hubs c o u l d have s e r i o u s r e p e r c u s s i o n s f o r consumers when one c o n s i d e r s the r e s u l t s o f a r e c e n t s tudy which show t h a t a c a r r i e r ' s hub markets "p roduced average f a r e s r a n g i n g from 9.4 t o 26.8 p e r c e n t h i g h e r than i t s o t h e r markets i n t h e same d i s t a n c e c a t e g o r y . " 8 2 F u r t h e r m o r e , the h i g h l e v e l s o f c o n c e n t r a t i o n i n h u b -markets a r e e x a c e r b a t e d by t h e m a r k e t i n g a l l i a n c e s ( i . e . 7 9 P h i l l i p s , L . T . , p . 21 . 8 o M u r p h y , R . J . , " F a r e s Take a Back S e a t " , A i r l i n e B u s i n e s s , A p r i l 1987, p . 33 . 8 1 L a b i c h , K . , p . 78 . 8 2 M u r p h y , R . J . , p . 37. - 45 -f e e d e r and c o d e - s h a r i n g agreements - whereby the a l l i e d commuter 's s e r v i c e i s r e c o r d e d under the j e t a i r l i n e ' s two-l e t t e r code i n the CRS) between the t r u n k s and commuter a i r l i n e s . A c c o r d i n g t o T h o r n t o n (1986) , t h e t r u n k s " c o -o p t e d t h e commuters, f i r s t by g r a t e f u l l y abandoning t h e i r r o u t e s t o t h e commuters and t h e n by each o f them e n l i s t i n g as many minor o p e r a t o r s as they c o u l d i n t o segments o f each t r u n k ' s hub and spoke s y s t e m . " 8 3 Whereas, i n J a n u a r y 1985 o n l y 17 s u c h m a r k e t i n g a l l i a n c e s e x i s t e d , "by May 1, 1986 t h e r e were n e a r l y 60 such a g r e e m e n t s " 8 4 (see F i g u r e 5-4 f o r t h o s e o f t h e 5 m e g a c a r r i e r s ) . T h i s c o u l d have s e r i o u s r e p e r c u s s i o n s s i n c e , a c c o r d i n g t o O s t e r and P i c k r e l l (1986) , a c o d e - s h a r i n g agreement " h e l p s t i e commuter f e e d t r a f f i c t o a p a r t i c u l a r c a r r i e r , and , as a r e s u l t , r a i s e s f u r t h e r b a r r i e r s t o e n t r y i n t o the c a r r i e r ' s h u b . " 8 5 Hence , a l l i n a l l , i t would appear t h a t w h i l e the t h r e a t o f new e n t r a n t s was i n i t i a l l y e f f e c t i v e i n l o w e r i n g i n d u s t r y f a r e l e v e l s , more r e c e n t f i n d i n g s t e n d t o p o i n t t o i n c r e a s i n g b a r r i e r s t o e n t r y i n t o t h e i n d u s t r y , bo th i n the form o f a i r p o r t c a p a c i t y c o n s t r a i n t s , and c a r r i e r e r e c t e d b a r r i e r s (such as hub and spoke s y s t e m s , computer r e s e r v a -8 3 T h o r n t o n , R . L . , p . 380. 8 4 0 s t e r , C . V . and D .H . P i c k r e l l , " M a r k e t i n g A l l i a n c e s and C o m p e t i t i v e S t r a t e g y i n t h e A i r l i n e I n d u s t r y " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 2 2 ( 4 ) , December 1986, p . 371. 8 5 I b i d . , p . 382. - 46 -F i g u r e 5-4 M a r k e t i n g A l l i a n c e s o f t h e F i v e M e g a c a r r i e r s  (Agreements i n e f f e c t o r announced as o f J u n e 1, 1986) Ma jor J e t C a r r i e r M a r k e t i n g A l l i a n c e P a r t n e r Amer ican A V a i r ( f o r m e r l y A i r V i r g i n i a ) A i r Midwest C h a p p a r a l A i r l i n e s Command A i r w a y s Metro A i r l i n e s Simmons A i r l i n e s Wings West A i r l i n e s C o n t i n e n t a l (Texas) P i o n e e r A i r l i n e s R o y a l e A i r l i n e s D e l t a A t l a n t i c S o u t h e a s t A i r l i n e s B u s i n e s s E x p r e s s Comair R i o A i rways Nor thwest B i g Sky F i s c h e r B r o t h e r s Mesaba U n i t e d A i r W i s c o n s i n H o r i z o n A i r S o u r c e : O s t e r , C . V and D .H . P i c k r e l l , " M a r k e t i n g A l l i a n c e s and C o m p e t i t i v e S t r a t e g y i n the A i r l i n e I n d u s t r y " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 2 2 ( 4 ) , December 1986, p . 373. - 47 -t i o n s y s t e m s , and f r e q u e n t f l i e r p rograms, as w e l l as i n c r e a s i n g merger a c t i v i t y and t h e i n c r e a s e d use o f m a r k e t i n g a l l i a n c e s ) , w h i c h , i n t u r n , t h r e a t e n t h e f e a s i b i -l i t y o f t h e c o n t e s t a b l e markets h y p o t h e s i s , and t h u s c o u l d l e a d t o f a r e i n c r e a s e s i n the f u t u r e . - 48 -I I) I n t e r f i r m R i v a l r y As p r e d i c t e d , under d e r e g u l a t i o n o f the i n d u s t r y , i n t e r f i r m r i v a l r y p r i m a r i l y took the form o f p r i c e c o m p e t i t i o n . That i s , a c c o r d i n g t o Rose (1981) , " p r i c e r a t h e r t h a n s e r v i c e appears t o be the new c o m p e t i t i v e norm i n t h e i n d u s t r y . " 8 6 T h i s s h i f t i n f o c u s has g r e a t l y b e n e f i t t e d consumers . F o r i n s t a n c e , i n 1979 t h e y e a r a f t e r t h e A i r l i n e D e r e g u l a t i o n A c t was p a s s e d , t h e CAB e s t i m a t e d t h a t "consumers saved o v e r $1.5 b i l l i o n because o f c o m p e t i t i v e p r i c i n g . " 8 7 L e t us examine t h e new p r i c i n g s t r a t e g i e s adopted by the a i r l i n e s . These i n c l u d e : r e s t r i c t e d d i s c o u n t and c a p a c i t y - c o n t r o l l e d f a r e s ; peak -l o a d p r i c i n g ; r e d u c e d c o n n e c t i n g f a r e s ; volume d i s c o u n t s ; a i r p a s s e s ; coupon p r i c i n g ; and the a f o r e m e n t i o n e d f r e q u e n t f l i e r p rograms . To b e g i n w i t h , the a b i l i t y o f the c a r r i e r s t o s e p a r a t e t r a v e l l e r s i n t o two market segments a c c o r d i n g t o t h e i r p r i c e e l a s t i c i t y o f demand ( i . e . t i m e - s e n s i t i v e b u s i n e s s t r a v e l l e r s w i t h | E | < 1 , and p r i c e - s e n s i t i v e p l e a s u r e t r a v e l -l e r s w i t h |E|>1 ) 8 8 , and t o e n s u r e t h a t " the customer 8 6 R o s e , W. , p . 54. 8 7 C o h e n M . S . , " A i r l i n e D e r e g u l a t i o n : A Model f o r the 8 0 ' s " , J o u r n a l o f Contemporary B u s i n e s s , O c t o b e r 1980, p . 45 . 8 8 T h e s e e l a s t i c i t y f i g u r e s a r e c o n s i s t e n t w i t h the f i n d i n g s o f Ghosha l (1981) , t h a t the p r i c e e l a s t i c i t y o f s t a n d b y p a s s e n g e r s , who a r e presumably p l e a s u r e t r a v e l l e r s , i s - 2 . 2 2 , i n d i c a t i n g t h a t a one p e r c e n t i n c r e a s e i n the s t a n d b y f a r e r e l a t i v e t o the r e g u l a r f a r e would d e c r e a s e t h e number o f s tandby p a s s e n g e r s r e l a t i v e t o r e g u l a r p a s s e n g e r s by 2.22 p e r c e n t . - 49 -w i l l i n g t o pay the h i g h e r a i r f a r e no t g e t a c c e s s t o the low f a r e " 8 9 , has a l l o w e d the a i r l i n e s t o engage i n t h i r d degree p r i c e d i s c r i m i n a t i o n ( i . e . " d i f f e r e n c e s i n r a t e s no t b a s e d on c o s t " 9 0 ) . T h i s , i n t u r n , has r e s u l t e d i n the main new p r i c i n g s t r a t e g y : the use o f r e s t r i c t e d d i s c o u n t f a r e s . T h i s new s t r a t e g y has p roven e x t r e m e l y p o p u l a r s i n c e " d i s c o u n t t r a v e l grew from 39% o f t o t a l revenue p a s s e n g e r m i l e s i n 1977 t o 81% i n 1 9 8 4 . " 9 1 Moreover , as a r e s u l t o f d i s c o u n t f a r e s , i n 1981 " o n l y 25 p e r c e n t o f a l l U . S . t r a v e l l e r s t r a v e l l e d a t f u l l c o a c h f a r e . " 9 2 In o r d e r t o e x p l a i n t h i s p r i c i n g s t r a t e g y o f a i r c a r r i e r s under t h e t h r e a t o f e n t r y , C a l l and K e e l e r (1985) d e v e l o p e d t h e i r ' F a t C a t ' mode l , wh ich h y p o t h e s i z e s t h a t incumbent c a r r i e r s " w i l l t r y t o 'ma tch ' t h e f a r e o f the new e n t r a n t no t p e r f e c t l y , but by a d d i n g r e s t r a i n t s a t t e m p t i n g t o make t h e f a r e r e d u c t i o n a p p l i c a b l e o n l y t o t h e t o u r i s t m a r k e t . . . i n t h e b u s i n e s s market , the e s t a b l i s h e d f i r m would c o n t i n u e t o a c t l i k e a m o n o p o l i s t " 9 3 . 8 9 K r a f t , D . J . H . T . H . Oum and M.W. Tre theway, " A i r l i n e Seat Management", The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 22 (2 ) , 1986, p . 111. 9 0 D a v i s , G .M . and L . J . Combs, "Some O b s e r v a t i o n s R e g a r d i n g V a l u e - o f - S e r v i c e P r i c i n g i n T r a n s p o r t a t i o n " , T r a n s p o r t a t i o n J o u r n a l , S p r i n g 1975, V o l . 14 (3 ) , p . 50. 9 1 W E S T A C B r i e f i n g , p . 20. 9 2 C a l l , G . D . and T . E . K e e l e r , p . 275. 9 3 I b i d . p . 230. - 50 -T h u s , i n o r d e r t o p r e v e n t b u s i n e s s t r a v e l l e r s from p u r c h a s i n g t h e ' d i s c o u n t f a r e s ' , c a r r i e r s have a t t a c h e d v a r i o u s r e s t r i c t i o n s t o t h e s e f a r e s r a n g i n g from advance b o o k i n g and p u r c h a s e r e q u i r e m e n t s , t o minimum l e n g t h o f s t a y , and S a t u r d a y n i g h t s t a y o v e r r e q u i r e m e n t s . Such r e q u i r e m e n t s a r e o b v i o u s l y a t tempts t o f a c i l i t a t e p r i c e d i s c r i m i n a t i o n r a t h e r t h a n b e i n g de te rmined by c o s t - b a s e d d i f f e r e n c e s , s i n c e " i t i s i m p o s s i b l e t o b e l i e v e t h a t a round t r i p w i t h a minimum s t a y i s cheaper t o p roduce than an u n r e s t r i c t e d round t r i p . " 9 4 F o r example , Amer ican A i r l i n e s ' ' S u p e r s a v e r ' f a r e s between New Y o r k , Los A n g e l e s and San F r a n c i s c o "were s u b j e c t t o a t h i r t y day advance p u r c h a s e requ i rement and l i m i t e d t o round t r i p s o f seven t o f o r t y f i v e d a y s . " 9 5 A s l i g h t v a r i a t i o n t o the above p r i c i n g s t r a t e g y i s t h a t o f c a p a c i t y - c o n t r o l l e d d i s c o u n t f a r e s ( i . e . t h e y a r e a v a i l a b l e f o r o n l y a l i m i t e d number o f s e a t s on each f l i g h t ) . By l i m i t i n g t h e number o f ' d i s c o u n t ' s e a t s on each f l i g h t t h e f a r e s e s s e n t i a l l y a c h i e v e d the same above ment ioned o b j e c t i v e o f e n s u r i n g t h a t t h e d i l u t i o n o f e x i s t i n g b u s i n e s s o r r e g u l a r c o a c h f a r e s was m i n i m i z e d . F o r i n s t a n c e , E a s t e r n A i r l i n e s ' ' S u p e r c o a c h ' f a r e was a " c a p a c i t y - c o n t r o l l e d d i s c o u n t f a r e t h a t matched the f a r e o f 9 4 K e e l e r , T . E . and M. Abrahams, (1981) , "Market S t r u c t u r e , P r i c i n g , and S e r v i c e Q u a l i t y i n t h e A i r l i n e I n d u s t r y under D e r e g u l a t i o n " , i n A p p l i c a t i o n s o f Economic P r i n c i p l e s i n  P u b l i c U t i l i t y I n d u s t r i e s , p . 114. 9 5 B a i l e y , E . E . , D.R. Graham and D.R. K a p l a n , p . 43. - 51 -new e n t r a n t P e o p l e E x p r e s s . " 9 6 F u r t h e r examples i n c l u d e d : TWA's ' S u p e r - J a c k p o t 1 f a r e s , and A l l e g h e n y ' s (now US A i r ) ' S i m p l e S a v e r ' f a r e s . The most s i g n i f i c a n t f e a t u r e o f t h e s e d i s c o u n t s i s t h a t t h e f a r e s a r e c a p a c i t y c o n t r o l l e d on a f l i g h t - b y f l i g h t b a s i s ( i . e . y i e l d management). Tha t i s , " c a r r i e r s w i t h a s o p h i s t i c a t e d c o m p u t e r i z e d r e s e r v a t i o n system c o u l d even a l t e r the number o f s e a t s on an i n d i v i d u a l f l i g h t b a s i s , pe rhaps even making fewer d i s c o u n t s e a t s a v a i l a b l e on a p a r t i c u l a r f l i g h t i n r e s p o n s e t o a h i g h e r t h a n normal number o f advance f u l l - f a r e b o o k i n g s , and v i c e v e r s a . " 9 7 N e v e r t h e l e s s , t h e a b i l i t y o f c a r r i e r s t o p r i c e d i s c r i m i n a t e i s not p e r f e c t . That i s , "some b u s i n e s s t r a v e l l e r s a r e a b l e t o meet s u p e r - s a v e r r e s t r i c t i o n s , whereas some d i s c r e t i o n a r y t r a v e l does no t o c c u r because t h e t r a v e l l e r s cannot meet t h e s e r e s t r i c t i o n s . " 9 8 In o t h e r words , a c c o r d i n g t o K r a f t , Oum and Tretheway (1986) , t h e r e i s "a nonzero c r o s s - p r i c e e l a s t i c i t y between t h e two p r o d u c t s . Some o f the h i g h f a r e s o r u n r e s t r i c t e d p a s s e n -g e r s w i l l d i v e r t t o the low f a r e c a t e g o r y . " 9 9 F u r t h e r m o r e , t h e r e has been much debate r e g a r d i n g the l o n g - t e r m v i a b i l i t y o f t h i s p r i c i n g s t r a t e g y . A c c o r d i n g t o 9 6 M e y e r , J . R . and C . V . O s t e r , (1984) , p . 134. 9 7 I b i d . , p . 35. 9 8 C a l l , G . D . and T . E . K e e l e r , p . 230. " K r a f t , D . J . H . , T . H . Oum and M.W. Tre theway , p . 117. - 52 -Meyer and Os t e r (1981), w h i l e the e x t e n s i v e use of d i s c o u n t s "allowed the a i r l i n e s t o f i l l some unused c a p a c i t y i n the f i r s t stage o f d e r e g u l a t i o n , the f u r t h e r a t t r a c t i v e n e s s of t h i s s t r a t e g y i s l e s s c l e a r . . . excess c a p a c i t y i s l i k e l y t o be reduced and e x i s t i n g c a p a c i t y t o be used more p r o f i t a b l y . In consequence, p r i c e d i s c o u n t s and f a r e v a r i a t i o n s may become l e s s i m p o r t a n t . " 1 0 0 On the o t h e r hand, a c c o r d i n g t o K r a f t , Oum and Tretheway (1986) w h i l e the use of r e s t r i c t e d f a r e s i s d i s m i s s e d by some i n d u s t r y o b s e r v e r s as b e i n g a 'temporary phenomenon', "these d i s c o u n t f a r e s seem here t o s t a y . In f a c t , the number of r e s t r i c t e d f a r e s c o n t i n u e s t o i n c r e a s e . 1 , 1 0 1 F i n a l l y , w h i l e the trunk a i r l i n e s have used d i s c o u n t f a r e s e x t e n s i v e l y under f a r e d e r e g u l a t i o n , t h e i r use i n the commuter i n d u s t r y has been l i m i t e d thus f a r . N e v e r t h e l e s s , a c c o r d i n g t o Meyer and Oster (1984) "although d i s c o u n t f a r e s have not been w i d e l y used by commuters, some tendency toward i n c r e a s e d use of d i s c o u n t s and c a p a c i t y - c o n t r o l l e d f a r e s i s d i s c e r n i b l e , as i n c r e a s e d use of l a r g e r a i r c r a f t has a t t r a c t e d more d i s c r e t i o n a r y t r a v e l . " 1 0 2 A l l i n a l l , by l i m i t i n g the number o f d i s c o u n t passengers on a g i v e n f l i g h t , " r e s t r i c t e d d i s c o u n t s may a c h i e v e t h e same e f f e c t as peak-load p r i c i n g : passengers 1 0 0 M e y e r , J.R. and C.V. Oster, (1981), p. 57. 1 0 1 K r a f t , D.J.H., T.H. Oum and M.W. Tretheway, p. 115. 1 0 2 M e y e r , J.R. and C.V. Oster, (1984), p. 163. - 53 -t r a v e l i n g d u r i n g p e r i o d s o f h i g h demand w i l l , on a v e r a g e , pay h i g h e r f a r e s . " 1 0 3 We now t u r n t o a d i s c u s s i o n o f the l a t t e r t y p e o f p r i c i n g , which c o n s t i t u t e s the t h i r d new p r i c i n g s t r a t e g y adopted by U . S . c a r r i e r s under d e r e g u l a -t i o n . The demand f o r a i r t r a v e l v a r i e s by the s e a s o n , by the d a y , and by the h o u r . The key problem t h e n , g i v e n p r i c i n g f l e x i b i l i t y , i s t o d e c i d e how t o p r i c e the s e r v i c e d u r i n g peak p e r i o d s when c a p a c i t y may be f u l l y u t i l i z e d , and d u r i n g o f f - p e a k p e r i o d s , when i t may be s u b s t a n t i a l l y u n d e r u t i l i z e d . The s o l u t i o n , as adopted by U . S . c a r r i e r s i s p e a k - l o a d p r i c i n g . T h i s p r i c i n g s t r a t e g y e s s e n t i a l l y e n t a i l s c h a r g i n g " d i f f e r e n t p r i c e s t o consumers depending on when t h e y use the s e r v i c e . T h i s smooths out demand because some t r a v e l l e r s would be w i l l i n g t o change t h e i r d e s i r e d d e p a r t u r e t ime i f they c o u l d t r a v e l a t a reduced f a r e on a d i f f e r e n t f l i g h t . " 1 0 4 F o r i n s t a n c e , B a i l e y , Graham and K a p l a n (1985) g i v e t h e f o l l o w i n g example: suppose a v a c a t i o n i n g s t u d e n t and a sa lesman b o t h want t o d e p a r t a t 5 P .M. . The s t u d e n t , how-e v e r , might g l a d l y d e l a y h i s d e p a r t u r e 3 h o u r s f o r a 2 0% r e d u c t i o n i n h i s f a r e , whereas the sa lesman would n o t . The i n s t i t u t i o n o f such a f a r e d i f f e r e n t i a l between 5 P .M. and 8 P . M . f l i g h t s would i n c r e a s e t h e l o a d f a c t o r on t h e l a t e r 1 0 3 B a i l e y E . E . , D.R. Graham and D.R. K a p l a n , p . 47. 1 0 4 I b i d . , p . 56. - 54 -f l i g h t s w h i l e r e d u c i n g the number o f t r a v e l l e r s demanding s e r v i c e on t h e peak f l i g h t . Hence the ' s m o o t h i n g ' o f demand. Many o f t h e new e n t r a n t j e t s ( i . e . P e o p l e E x p r e s s , Southwest , New York A i r , and Midway A i r l i n e s ) adopted t h i s p r i c i n g s t r a t e g y . F o r i n s t a n c e , " o f f - p e a k weekend f a r e s a v e r a g e d o n l y 34 p e r c e n t o f t h e S t a n d a r d I n d u s t r y F a r e L e v e l (SIFL) f o r P e o p l e E x p r e s s , and 42 p e r c e n t o f t h e S I F L f o r S o u t h w e s t " 1 0 5 , w h i l e New York A i r ' s o f f - p e a k f a r e s "averaged about 45 p e r c e n t o f S I F L " 1 0 6 . F i n a l l y , i t would appear t h a t t h i s p r i c i n g s t r a t e g y i s no t m e r e l y a s h o r t - l i v e d phenomenon, but r a t h e r i s h e r e t o s t a y . F o r i n s t a n c e , E l l i s o n (1981) c i t e s an " i n c r e a s i n g use o f o f f - p e a k p r i c i n g by the c a r r i e r s " 1 0 7 u n d e r t h e regime o f d e r e g u l a t i o n . The f o u r t h p r i c i n g s t r a t e g y adopted by t h e a i r l i n e s under d e r e g u l a t i o n o f t h e i n d u s t r y i s t h a t o f ' r e d u c e d c o n n e c t i n g f a r e s ' . T h i s s t r a t e g y , a r i s i n g as a complement t o t h e a d o p t i o n o f h u b - a n d - s p o k e r o u t e s y s t e m s , i n d u c e s p a s s e n g e r s " to make an i n t e r m e d i a t e s t o p i n markets where c o n v e n i e n t nonstop s e r v i c e s a r e o f f e r e d by a r i v a l c a r r i e r . S i n c e c o n n e c t i n g i n such markets t a k e s l o n g e r than nonstop s e r v i c e , p a s s e n g e r s would p r e f e r i t o n l y a t a lower 1 0 5 M e y e r , J . R . and C . V . O s t e r , (1984) , p . 126. 1 0 6 I b i d . , p . 126. 1 0 7 E l l i s o n , A . P . , p . 119. - 55 -p r i c e . " 1 0 8 For example, Piedmont, which p r o v i d e s s e r v i c e i n t h e m i d - A t l a n t i c S t a t e s , "promotes 'Hop-Scotch' f a r e s t o Chicago from Washington and New Y o r k " 1 0 9 . These f a r e s e s s e n t i a l l y serve the same o b j e c t i v e as t h e aforementioned r e s t r i c t e d d i s c o u n t f a r e s : they enable c a r r i e r s t o accomodate passengers t r a v e l l i n g between two l a r g e c i t i e s a t a reduced r a t e i n o r d e r t o h e l p f i l l o t h e r w i s e empty s e a t s . The f i f t h new p r i c i n g s t r a t e g y a r i s i n g from the e l i m i n a t i o n o f p r i c e c o n t r o l s i s t h a t of o f f e r i n g d i s c o u n t s t o major commercial u s e r s of a i r t r a v e l and t o t r a v e l agents ( i . e . second degree p r i c e d i s c r i m i n a t i o n ) . That i s , " c a r r i e r s are now f r e e t o o f f e r c o r p o r a t i o n s volume d i s c o u n t s on a i r t r a n s p o r t a t i o n . . . T h i s i s roughly e q u i v a l e n t t o t h e volume d i s c o u n t s t h a t are p r e v a l e n t i n many i n d u s t r i e s . " 1 1 0 Furthermore, c a r r i e r s have e s t a b l i s h e d s p e c i a l d e a l s w i t h i n d i v i d u a l t r a v e l agents whereby the l a t t e r r e c e i v e d i s c o u n t s f o r p u r c h a s i n g l a r g e b l o c k s of s e a t s . The s i x t h i n n o v a t i v e p r i c i n g t o o l adopted under d e r e g u l a t i o n c o n s i s t s of American A i r l i n e s ' 'AAirpass' -"a pay now, f l y l a t e r p l a n t h a t guarantees a c e r t a i n number of 1 0 8 B a i l e y , E.E., D.R. Graham and D.R. Kaplan, p. 59 1 0 9 I b i d . p. 59. 1 1 0 I b i d . , p. 59. - 56 -f l i g h t m i l e s a t a s e t p r i c e . " 1 1 1 T h i s s t r a t e g y has the added advantage o f h e l p i n g t h e c a r r i e r r a i s e c a p i t a l -e s s e n t i a l t o t h e o p e r a t i o n s o f an a i r l i n e . The s e v e n t h p r i c i n g t o o l adopted by U . S . c a r r i e r s i n t h e new d e r e g u l a t e d regime c o n s i s t s o f coupon p r i c i n g . W h i l e U n i t e d A i r l i n e s was the f i r s t t o use coupon p r i c i n g t o reduce f l i g h t p r i c e s i n 1979 ( i . e . i t i s s u e d a coupon wh ich gave customers a f i x e d p e r c e n t a g e o f f the l i s t p r i c e o f any o f i t s U . S . f l i g h t s ) , s i n c e t h e n , many o t h e r c a r r i e r s have c o p i e d t h i s t e c h n i q u e . F o r i n s t a n c e , "Hughes A i r West i s s u e d coupons i n the w i n t e r o f 1980, E a s t e r n A i r l i n e s i n t h e summer o f 1980, and Western A i r l i n e s i n the w i n t e r o f 1 9 8 2 . 1 , 1 1 2 L a C r o i x (1984) c o n c l u d e s t h a t the use o f coupon p r i c i n g by U n i t e d a c h i e v e d a wide v a r i e t y o f g o a l s : "coupon p r i c i n g not o n l y a l l o w e d t h e f i r m t o d i s c r i m i n a t e i n p r i c i n g , t h e coupon p r i c i n g p l a n a l s o reduced t h e c o s t t o t h e f i r m o f t e m p o r a r i l y a d j u s t i n g the t r a n s a c t i o n p r i c e s o f i t s p r o d u c t s , p u b l i c i s i n g the new p r i c e s , s w i t c h i n g back t o t h e p r e v i o u s l i s t p r i c e s , and m a i n t a i n i n g i t s b rand name c a p i t a l . " 1 1 3 1 1 1 , , A m e r i c a n R e d i s c o v e r s I t s e l f " , B u s i n e s s Week, August 23, 1982, p . 67. 1 1 2 L a C r o i x , S . J . , " A i r l i n e Coupons and P r i c i n g A d j u s t m e n t s " , J o u r n a l o f T r a n s p o r t Economics and P o l i c y , V o l . 1 8 ( 3 ) , September 1984, p . 253. 1 1 3 I b i d . , p . 261. - 57 -F i n a l l y , the e i g h t h p r i c i n g t o o l adopted by a i r c a r r i e r s c o n s i s t s o f the a f o r e m e n t i o n e d f r e q u e n t f l i e r p r o g r a m s . These programs, as s e e n , e n a b l e c a r r i e r s t o a t t r a c t and keep l o y a l p a s s e n g e r s by r e w a r d i n g them w i t h f r e e f l i g h t s . A l l i n a l l t h e n , we f i n d t h a t a wide v a r i e t y o f p r i c i n g s t r a t e g i e s have been employed by U . S . c a r r i e r s under t h e new d e r e g u l a t e d r e g i m e . However, r e c e n t r e p o r t s s u g g e s t t h e r e t u r n o f q u a l i t y o f s e r v i c e c o m p e t i t i o n . F o r i n s t a n c e , a c c o r d i n g t o Brummer (1987) t o p management a t TWA have s t a t e d t h e i r i n t e n t i o n s o f becoming a q u a l i t y l o w -c o s t a i r l i n e . To t h i s e n d , t h e r e w i l l be " b e t t e r f o o d and b e t t e r s e r v i c e , and e v e r y l o n g d i s t a n c e TWA f l i g h t w i l l c a r r y a s e r v i c e m a n a g e r . " 1 1 4 S i m i l a r l y , Murphy (1987) s t r e s s e s t h a t "renewed emphasis i s b e i n g p l a c e d by t h e i n d u s t r y on q u a l i t y o f s e r v i c e c o m p e t i t i o n , w i t h t h e s e r v i c e e lements i n c l u d i n g e v e r y t h i n g from the c h o i c e o f d e s t i n a t i o n s o f f e r e d , and the speed and c o n v e n i e n c e o f s c h e d u l e s t o customer s e r v i c e s i n t h e r e s e r v a t i o n s and s a l e s a r e a . " 1 1 5 In f a c t , a c c o r d i n g t o L a b i c h (1987) " P e o p l e E x p r e s s f a i l e d i n p a r t because many p a s s e n g e r s would no l o n g e r s u f f e r t h e i n d i g n i t i e s heaped on them by P e o p l e ' s n o - f r i l l s a p p r o a c h . " 1 1 6 1 1 4 B r u m m e r , A . , "TWA W i l l I t S u r v i v e The R e s c u e ? " , A i r l i n e B u s i n e s s , March 1987, p . 46. 1 1 5 M u r p h y , R . J . , p . 33. 1 1 6 L a b i c h , K . , p . 79 . - 58 -N e v e r t h e l e s s , i t seems h i g h l y l i k e l y t h a t f a r e s w i l l s t i l l remain an impor tan t e lement o f c o m p e t i t i o n among a i r l i n e s . Tha t i s , a c c o r d i n g t o L a b i c h (1987) , s i n c e the f a c t o r s t h a t have kep t f a r e s down a r e no t g o i n g away ( i . e . a l l t h e m e g a c a r r i e r s have a g g r e s s i v e growth p l a n s , and they a r e b e t t e r o f f f i l l i n g a s e a t w i t h a p a s s e n g e r who pays a l a u g h a b l y s m a l l f a r e t h a n f l y i n g i t empty) " the b e s t guess i s t h a t t i c k e t p r i c e s on many r o u t e s w i l l remain r e l a t i v e l y low - a t l e a s t f o r a w h i l e . " 1 1 7 1 1 7 I b i d . , p . 79 . - 59 -I l l ) Buyer B a r g a i n i n g Power As e x p e c t e d , under d e r e g u l a t i o n , buyer b a r g a i n i n g power does appear t o have s h i f t e d from a p o l i t i c a l t o an economic b a s i s . T h a t i s , w h i l e some e a r l y i n d u s t r y o b s e r v e r s c l a i m e d t h a t e c o n o m i c a l l y s t r o n g b u y e r s ( i . e . f r e q u e n t b u s i n e s s p a s s e n g e r s ) d i d no t g a i n more v a l u e i n t h e i r t r a n s p o r t a t i o n p u r c h a s e s , f o r the most p a r t , r e c e n t s t u d i e s c o n c l u d e the o p p o s i t e . F o r i n s t a n c e , a c c o r d i n g t o Rose (1981) " b u s i n e s s t r a v e l e r s q u i c k l y d i s c o v e r e d t h a t they r e c e i v e d few p r i c e b e n e f i t s and t h a t s e r v i c e d e t e r i o r a t i o n was much i n e v i d e n c e . " 1 1 8 S i m i l a r l y , Meyer and O s t e r (1981) , r e p o r t i n g on t h e e a r l y e x p e r i e n c e , c l a i m e d t h a t " p r i c e i n e l a s t i c b u s i n e s s t r a v e l l e r s may a c t u a l l y be p a y i n g h i g h e r f a r e s t h a n t h e y would have w i t h o u t d e r e g u l a t i o n " 1 1 9 . . . Hence t h e y c o n c l u d e d t h a t t h e r e may be i m p l i c i t income r e d i s t r i b u t i o n s c r e a t e d by d e r e g u l a t i o n "ma in ly from b u s i n e s s t r a v e l e r s t o t o u r i s t and i n d i v i d u a l t r a v e l e r s " 1 2 0 . L i k e w i s e , E l l i s o n (1981) c o n c l u d e d t h a t " t r a v e l l e r s p a y i n g the normal coach f a r e s , many o f whom a r e t r a v e l l i n g f o r b u s i n e s s r e a s o n s , have e x p e r i e n c e d r e l a t i v e l y l i m i t e d f a r e r e d u c t i o n s , y e t a t 1 1 8 R o s e , W. , p . 57 . 1 1 9 M e y e r , J . R . and C . V . O s t e r , (1981) , p . 89 . 1 2 0 I b i d . , p . 269. - 60 -t h e same t ime they have been f a c e d w i t h t r a v e l l i n g on f l i g h t s w i t h i n c o n v e n i e n t l y h i g h l o a d f a c t o r s " 1 2 1 . More r e c e n t l y , however, Byrnes (1985) c o n c l u d e s t h a t " p r i c e - i n s e n s i t i v e b u y e r s - w i t h s u b s t a n t i a l , r e a l economic b a r g a i n i n g power - were b e t t e r a b l e t o make d e a l s w i t h t h e companies compet ing f o r t h e i r b u s i n e s s t h a n were the i n f r e q u e n t m a r g i n a l b u y e r s . " 1 2 2 In t h i s c o n n e c t i o n , as ment ioned e a r l i e r , "major c o r p o r a t i o n s a r e s t a r t i n g t o c o n t r a c t f o r c a p a c i t y on v e r y f a v o r a b l e t e r m s , much as major t o u r o p e r a t o r s have done t r a d i t i o n a l l y " 1 2 3 , and a c c o r d i n g t o T h o r n t o n (1986) "a b i g customer can expec t t o g e t b i g p r i c e b r e a k s " 1 2 4 . Moreover , a t r a v e l agent o p e r a t i n g i n a l l o f t h e c u s t o m e r ' s markets and c o n s o l i d a t i n g a s e t o f s e v e r a l b i g c o r p o r a t e cus tomers c o u l d " p l a c e enormous p r i c e p r e s s u r e on the a i r l i n e s . " 1 2 5 S e c o n d l y , " f r e q u e n t f l i e r programs a l s o i n c r e a s e d the v a l u e r e c e i v e d by t h i s p a r t i c u l a r l y d e s i r a b l e s e g m e n t " 1 2 6 , s i n c e , as p r e v i o u s l y m e n t i o n e d , f o r b u s i n e s s t r a v e l l e r s t h e b e n e f i t s f rom t h e programs amount t o a pay i n c r e a s e . 1 2 1 E l l i s o n , A . P . , p . 124. 1 2 2 B y r n e s , J . L . S . , p . 121 1 2 3 I b i d . , p . 57. 1 2 4 T h o r n t o n , R . L . , p . 385. 1 2 5 I b i d . , p . 385. 1 2 6 B y r n e s , J . L . S . , p . 57. - 61 -F i n a l l y , M o r r i s o n and Winston (1986) c o n c l u d e t h a t " t h e a b s o l u t e v a l u e s o f the w e l f a r e changes p e r t a i n i n g t o b u s i n e s s t r a v e l e r s a r e f a r g r e a t e r f o r e v e r y hub c l a s s i f i -c a t i o n t h a n t h e a b s o l u t e v a l u e o f the c o r r e s p o n d i n g changes f o r each c l a s s o f p l e a s u r e t r a v e l e r s . Indeed t h e net w e l f a r e g a i n t o t r a v e l e r s from a i r l i n e d e r e g u l a t i o n can be l a r g e l y a t t r i b u t e d t o the s u b s t a n t i a l g a i n s by b u s i n e s s t r a v e l e r s from i n c r e a s e d f l i g h t f r e q u e n c y . " 1 2 7 T h u s , a l l i n a l l , w i t h r e s p e c t t o t h i s c o m p e t i t i v e f o r c e , i t would appear t h a t the a p r i o r i e x p e c t e d outcomes o f d e r e g u l a t i o n have been r e a l i z e d . 1 2 7 M o r r i s o n , S . and C . W i n s t o n , p . 31. - 62 -IV) S u p p l i e r B a r g a i n i n g Power Once a g a i n , i t would appear t h a t t h e e x p e c t e d outcomes o f d e r e g u l a t i o n have m a t e r i a l i z e d . That i s , s u p p l i e r b a r g a i n i n g power has r e v e r t e d t o an economic b a s i s marked by r e d u c e d b a r g a i n i n g power on t h e p a r t o f b o t h l a b o u r and t h e o t h e r major s u p p l i e r s t o the a i r l i n e s ( i . e . a i r c r a f t m a n u f a c t u r e r s , and o i l c o m p a n i e s ) . To b e g i n w i t h , under d e r e g u l a t i o n , l a b o u r l o s t ground because i t became l e s s f e a s i b l e t o p a s s on h i g h c o s t s w i t h t h e new, l o w - c o s t e n t r a n t s (non-un ion o p e r a t i o n s w i t h lower wages and l e s s r e s t r i c t i v e work r u l e s ) s e e k i n g pr ime b u s i -n e s s . However, t h e " r e l a t i v e l y s low pace o f e s t a b l i s h e d c a r r i e r l a b o r c o s t ad jus tments gave the new e n t r a n t s an i m p o r t a n t temporary c o m p e t i t i v e c o s t a d v a n t a g e . 1 , 1 2 8 N e v e r t h e l e s s , i n an e f f o r t t o reduce l a b o u r c o s t s , incumbent a i r l i n e s have u t i l i z e d a v a r i e t y o f t e c h n i q u e s wh ich have r e s u l t e d i n a r e d u c t i o n i n l a b o u r ' s b a r g a i n i n g power. These i n c l u d e : l a y - o f f s and e a r l y r e t i r e m e n t ; the n e g o t i a t i n g o f new c o l l e c t i v e agreements , i n c l u d i n g the use o f t w o - t i e r wage s c a l e s ; and the s t a r t o f d o u b l e b r e a s t e d o p e r a t i o n s as w e l l as f i l i n g f o r b a n k r u p t c y under the B a n k r u p t c y Code . F i r s t , between 1980 and 1982, " the U . S . s c h e d u l e d a i r l i n e s f e l l $1.4 b i l l i o n s h o r t o f c o v e r i n g t h e i r o p e r a -t i n g c o s t s . F o r most c a r r i e r s the immediate s o l u t i o n 1 2 8 B y r n e s , J . L . S . , p . 18. - 63 -became l a y o f f s . Hence i n t h e f i r s t f o u r y e a r s o f d e r e g u l a -t i o n , s i x t y thousand employees l o s t t h e i r j o b s . " 1 2 9 More -o v e r , e a r l y r e t i r e m e n t packages were employed t o reduce b o t h management and u n i o n employment. S e c o n d , when t h i s p r o v e d i n s u f f i c i e n t t o c l o s e t h e gap i n c o s t s t r u c t u r e s , most a i r l i n e managements t u r n e d t o the b a r g a i n i n g t a b l e t o make ad jus tments i n l a b o u r c o n t r a c t s . A c c o r d i n g t o B lumestock and Thomchick (1986) , " c o n c e s s i o n b a r g a i n i n g s p r e a d t h r o u g h o u t the i n d u s t r y . " 1 3 0 Tha t i s , a i r l i n e s began n e g o t i a t i n g new c o l l e c t i v e agreements w i t h t h e i r employees f o r more modest wage s e t t l e m e n t s and more f l e x i b l e work and h i r i n g p r a c t i c e s ( e . g . a t w o - t i e r s t r u c -t u r e e s t a b l i s h i n g lower s t a r t i n g s a l a r i e s f o r new employ-e e s , and i n c r e a s i n g use o f p a r t - t i m e w o r k e r s ) . F u r t h e r m o r e , a c c o r d i n g t o M o r r i s o n and Winston (1986) "because b a r g a i n i n g i s c a r r i e r - s p e c i f i c , t h e r e i s no mechanism t o p r e v e n t a u n i o n a s s o c i a t e d w i t h one c a r r i e r f rom u n d e r c u t t i n g o t h e r c a r r i e r s ' l a b o r c o s t s . " 1 3 1 T h i s has s u b s t a n t i a l l y reduced l a b o u r ' s b a r g a i n i n g power. F o r i n s t a n c e , i n 1983 "Amer ican A i r l i n e s broke new c o n t r a c t b a r g a i n i n g ground when i t won the r i g h t from i t s t h r e e major u n i o n s t o h i r e new employees a t 30 t o 50 p e r c e n t below o l d wage r a t e s . . . T h i s use o f a t w o - t i e r wage 1 2 9 B l u m e s t o c k , J . W . and E . A . Thomchick , p . 395. 1 3 0 I b i d . , p . 397. 1 3 1 M o r r i s o n , S . and C . W i n s t o n , p . 43 . - 64 -sca le was to s t a r t a trend which spread among the other major c a r r i e r s . De l ta , Uni ted , Pan American, Republ ic , Western and F r o n t i e r have s ince es tabl i shed s i m i l a r two-t i e r wage scales with one or more of t h e i r u n i o n s . " 1 3 2 Moreover, t h i s innovative wage formula has s ince been copied " in d iverse indus tr i e s throughout the U . S . " 1 3 3 . According to Morrison and Winston (1986), because of t h e i r l i m i t e d a l t e r n a t i v e s , "p i lo t s made more contract concessions than a l l other a i r l i n e work groups combined. . . P i l o t s ' r e a l income i n 1984 ( i . e . $47 720) was lower than i t was i n both 1975 ( i . e . $48 216) and 1980 ( i . e . $50 2 8 4 ) . " 1 3 4 More recent ly , p i l o t s at TWA "on the average, took $3 0 000 i n pay cuts i n 1986, the f i r s t year of t h e i r contract with Icahn. For some j u n i o r captains that represented a 40% w h a c k " 1 3 5 . Meanwhile, United A i r l i n e s and Western "were able to reduce the crew complement of B-737 a i r c r a f t from three to two p i l o t s . . . and at a number of c a r r i e r s there has been a l i b e r a l i z a t i o n of work ru les to al low c a r r i e r s to increase the f l y i n g hours of t h e i r f l i g h t p e r s o n n e l . " 1 3 6 1 3 2 B l u m e s t o c k , J .W. and E . A . Thomchick, p. 398. 1 3 3 L a b i c h , K . , p. 74. 1 3 4 M o r r i s o n , S. and C. Winston, p. 46. 1 3 5 L o o m i s , C . J . , "Icahn's Juggle: TWA, USX, SEC", Fortune Magazine, May 11, 1987, p. 82. 1 3 6 B a i l e y , E . E . , D.R. Graham and D.R. Kaplan, p. 144. - 65 -The r e a s o n s why p i l o t s ' b a r g a i n i n g power i s r e l a t i v e l y low a r e t h a t " t h e i r s k i l l s a r e not t r a n s f e r a b l e , t h e i r s e n i o r i t y o n l y e x i s t s a t the a i r l i n e f o r which they work, and t h e y must c o n t i n u e t o f l y t o r e t a i n t h e i r l i c e n s e s . " 1 3 7 M o r e o v e r , t h e r e a r e an e x c e s s i v e number o f q u a l i f i e d p i l o t s on t h e market ( i . e . s u p p l y exceeds demand). Hence , no t s u r p r i s i n g l y , t h e p i l o t s u n i o n , t h e A i r l i n e P i l o t s A s s o c i -a t i o n (ALPA) , has been the most c o o p e r a t i v e d u r i n g d e r e g u -l a t i o n . T h i r d , " the t h r e a t o f s t a r t i n g an a l t e r ego a i r l i n e , o r d o u b l e b r e a s t e d o p e r a t i o n , has emerged as a n o t h e r b a r g a i n i n g c h i p f o r a i r l i n e management, s i n c e Texas I n t e r n a t i o n a l began the o p e r a t i o n o f New York A i r , a n o n -u n i o n s u b s i d i a r y a i r l i n e i n 1981. * ' 1 3 8 In t h i s c o n n e c t i o n , as Texas A i r c h i e f Lorenzo e n t e r s c o n t r a c t n e g o t i a t i o n s w i t h t h e u n i o n s o f newly a c q u i r e d E a s t e r n A i r l i n e s i n the s p r i n g o f 1987, i n a t tempts t o " reduce l a b o u r c o s t s by 29 p e r c e n t " 1 3 9 , h i s u l t i m a t e t h r e a t i s t h a t "he c o u l d s h i f t a l l a s s e t s t o n o n - u n i o n C o n t i n e n t a l A i r l i n e s . . . As a warn ing s h o t o v e r t h e u n i o n bows, s i x o f E a s t e r n ' s 34 A i r b u s A300s were t r a n s f e r r e d t o C o n t i n e n t a l i n F e b r u a r y (1987)"140. 1 3 7 B l u m e s t o c k , J . W . and E . A . Thomchick , p . 399. 1 3 8 I b i d . p . 398. 1 3 9 G a u d i n , P . , " L o r e n z o Takes On E a s t e r n ' s U n i o n s " , A i r l i n e B u s i n e s s , A p r i l 1987, p . 10. 1 4 0 I b i d . , p . 10. - 66 -In r e s p o n s e t o t h i s t h r e a t many rank and f i l e employees a r e s i g n i n g agreements t o c o o p e r a t e w i t h management i n t h e open ing o f u n i o n c o n t r a c t s "most o f which a r e no t due f o r r e n e g o t i a t i o n f o r a n o t h e r y e a r t o 18 m o n t h s " 1 4 1 . Hence t h e l a b o u r u n i o n s * c o l l e c t i v e b a r g a i n i n g power i s c l e a r l y b e i n g e r o d e d . F o u r t h , pe rhaps the u l t i m a t e t h r e a t t o l a b o u r b a r g a i n i n g power o c c u r e d i n September 1983, when Lorenzo " d e c l a r e d C o n t i n e n t a l b a n k r u p t , t h e n immed ia te ly reopened i t ( i . e . 3 days l a t e r ) as a n o n - u n i o n c a r r i e r , w i t h i t s l a b o r c o s t s s l i c e d n e a t l y i n h a l f " 1 4 2 . F i n a l l y , t h e s t r e n g t h o f a i r l i n e u n i o n s "has a l s o been weakened by t h e o v e r - s u p p l y o f employees s i n c e 1979, and t h e a i r l i n e s ' d i s p l a y e d a b i l i t y t o r e c r u i t r e p l a c e m e n t s q u i c k l y as a c o n t i n g e n c y a g a i n s t p o t e n t i a l s t r i k e s . " 1 4 3 N e x t , w i t h r e s p e c t t o the b a r g a i n i n g power o f a i r c r a f t m a n u f a c t u r e r s and f u e l s u p p l i e r s , i t would appear t h a t i t has a l s o been weakened umder d e r e g u l a t i o n . To b e g i n w i t h , a i r c r a f t m a n u f a c t u r e r s saw d e r e g u l a t i o n d r a s t i c a l l y reduce t h e i r b a r g a i n i n g power as c a r r i e r s e n t e r e d the new regime w i t h an e x c e s s s u p p l y o f a i r c r a f t . As a r e s u l t o f t h i s g l u t o f a i r c r a f t on t h e marke t , " c a r r i e r s have been c a n c e l l i n g o r d e r s f o r new equipment and 1 4 1 I b i d . , p . 10. 1 4 2 L a b i c h , K. p . 70 . 1 4 3 B l u m e s t o c k , J . W . and E . A . Thomchick , p . 401. - 67 -d e f e r r e d d e l i v e r i e s . " 1 4 4 F o r example, D u f f y (1983) p o i n t s out t h a t s i n c e 1978 t h e r e have been "93 c a n c e l l a t i o n s w h i l e i n t h e f o u r y e a r s p r e v i o u s t o d e r e g u l a t i o n t h e r e were o n l y 2 0 " 1 4 5 . F u r t h e r m o r e , " j e t a i r c r a f t o r d e r s dropped p r e c i p i -t o u s l y f rom t h e i r 1979 peak o f 354, t o o n l y 131 i n 1981. By 1982 o n l y 88 new a i r c r a f t were o r d e r e d by U.S. a i r -l i n e s . " 1 4 6 A t t h i s p o i n t , i t i s i m p o r t a n t t o n o t e t h a t t h e p r o l o n g e d economic slump between 1980 and 1982, w i t h t h e r e s u l t i n g downturn i n the demand f o r a i r t r a v e l , was l i k e l y a s t r o n g c o n t r i b u t i n g f a c t o r t o t h i s d e c l i n e . F u r t h e r m o r e , a i r l i n e s have been " r e n e g o t i a t i n g c o n t r a c t s w i t h a i r c r a f t b u i l d e r s t o change o r d e r s " 1 4 7 ( i . e . t o l o w e r - c o s t a i r c r a f t ) . A c c o r d i n g t o Byrnes (1985) " t h i s w i l l l i k e l y l e a d t o l o n g e r p r o d u c t i o n runs o f more s t a n d a r d i z e d a i r c r a f t . A t t h e same t ime t h e market f o r l o w e r - c o s t , used and r e l a t i v e l y f u e l - e f f i c i e n t a i r c r a f t w i l l l i k e l y r i s e . . . The ne t e f f e c t w i l l l i k e l y be t o improve t h e b a r g a i n i n g power o f l a r g e , w i d e - s e r v i c e c a r r i e r s t h a t can ensure economic p r o d u c t i o n runs o f new g e n e r a t i o n a i r c r a f t and can s e l l t h e i r a i r c r a f t on an a c t i v e s e c o n d - h a n d market . A m e r i c a n ' s r e c e n t v e r y 1 4 4 B a i l e y E . E . , D.R. Graham and D.R. K a p l a n , p . 63. 1 4 5 D u f f y , H. " D e r e g u l a t i o n F i v e Years L a t e r " , F requent F l y e r M a g a z i n e , O c t o b e r 1983, p . 58. 1 4 6 I b i d . , p . 58. 1 4 7 W E S T A C B r i e f i n g , p . 15. - 68 -f a v o r a b l e p u r c h a s e o f MD-80 a i r c r a f t p r o v i d e s an example o f t h i s . " 1 4 8 S e c o n d , i t would appear t h a t f u e l s u p p l i e r s ' b a r g a i n i n g power has been reduced by t h e growing c o n c e n t r a t i o n o f b u y e r s i n the d e r e g u l a t e d a i r l i n e i n d u s t r y , as w e l l as the growing a d o p t i o n o f f u e l - e f f i c i e n t f a n j e t e n g i n e s . Wi th r e s p e c t t o the f o r m e r , i t would appear t h a t w i d e l y d i v e r s i f i e d a i r l i n e s s u c h as U n i t e d ( i . e . i t p u r c h a s e d b o t h the H i l t o n I n t e r n a t i o n a l H o t e l c h a i n , and t h e H e r t z c a r r e n t a l company) can a p p l y s u b s t a n t i a l p r e s s u r e i n o r d e r t o r e c e i v e s i g n i f i c a n t volume d i s c o u n t s . F o r i n s t a n c e , " the s c a l e o f b u y i n g commodi t ies s u c h as l i q u i d f u e l s and even c o f f e e (of which UAL c l a i m s t o be t h e w o r l d ' s l a r g e s t p r i v a t e c o r p o r a t i o n buyer) g i v e s UAL an e x c e l l e n t n e g o t i a t i n g p o s i t i o n . " 1 4 9 M o r e o v e r , the a i r l i n e s would appear t o g a i n b a r g a i n i n g power r e l a t i v e t o t h e f u e l s u p p l i e r s s i n c e t h e s e ' b u y e r s ' pose a c r e d i b l e t h r e a t o f i n t e g r a t i n g backward t o make the i n d u s t r y ' s p r o d u c t . F o r i n s t a n c e , A l b e r t C a s e y , Chairman o f A m e r i c a n A i r l i n e s (AA) " f e l t t h a t b e i n g i n the o i l and gas b u s i n e s s (AA Energy C o r p . was s e t up i n 1977) gave AA an i n s i d e t r a c k f o r a i r l i n e f u e l p r o c u r e m e n t . " 1 5 0 1 4 8 B y r n e s , J . L . S . , p . 58. 1 4 9 G a u d i n , P . , "Wal l S t r e e t Blows C o o l On U A L ' s H i l t o n D e a l " , A i r l i n e B u s i n e s s , March 1987, p . 8. 1 5 0 B y r n e s , J . L . S . , p . 97. - 69 -Hence , a l l i n a l l , i t would appear t h a t s u p p l i e r ' s b a r g a i n i n g power was reduced i n the d e r e g u l a t e d r e g i m e . - 70 -V) The T h r e a t o f S u b s t i t u t e S e r v i c e s As p r e d i c t e d , i t appears t h a t no s u b s t i t u t e mode o f t r a n s p o r t has posed a r e a l t h r e a t t o t h e a i r l i n e s i n l o n g e r - h a u l markets under t h e regime o f d e r e g u l a t i o n . M o r e o v e r , t h e u p s t a r t o f low c o s t - low f a r e c a r r i e r s has i n d e e d l i m i t e d the i n r o a d s o f s u b s t i t u t e s e r v i c e s on s h o r t -t o - m e d i u m - h a u l r o u t e s , e f f e c t i v e l y p l a c i n g a c e i l i n g on the p r i c e s t h e y can c h a r g e . In f a c t , i t would appear t h a t the a i r l i n e s have become a t h r e a t t o some o f t h e o t h e r modes on s u c h r o u t e s . F o r i n s t a n c e , a c c o r d i n g t o M o r r i s o n and Winston (1986) , " a l t h o u g h the r e s p o n s e t o a i r l i n e d e r e g u l a t i o n by i n t e r c i t y p a s s e n g e r bus and r a i l c a r r i e r s has not been l a r g e , i n some t r a v e l c o r r i d o r s , such as the N o r t h e a s t , bus and r a i l f a r e s have been lowered i n r e s p o n s e t o i n c r e a s e d c o m p e t i t i o n from d e r e g u l a t e d a i r c a r r i e r s . " 1 5 1 Moreover , P a c i f i c Southwest A i r l i n e s ' low c o s t s e r v i c e on i t s Nevada r o u t e s , where f a r e s a r e about one t h i r d under the s t a n d a r d l e v e l , "have e n t i c e d p e o p l e out o f t h e i r a u t o m o b i l e s " 1 5 2 . T h e r e f o r e , i t does no t appear t h a t t h e t h r e a t o f s u b s t i t u t e s e r v i c e s has m a t e r i a l i z e d . 1 5 1 M o r r i s o n , S . and C . W i n s t o n , p . 51. 1 5 2 F e l d m a n , J . M . , " D e r e g u l a t i o n ' s F i r s t Year B r i n g s B e n e f i t s t o P S A " , A i r T r a n s p o r t W o r l d , A p r i l 1980, p . 69. - 71 -VI) C o n c l u s i o n s In summary, t h e d e r e g u l a t e d U . S . a i r l i n e i n d u s t r y saw an i n c r e a s e i n i n t e r f i r m r i v a l r y ( p r i m a r i l y i n t h e form of p r i c e c o m p e t i t i o n ) due t o the t h r e a t o f new e n t r a n t s , and t h e i n c r e a s e d b a r g a i n i n g power o f f r e q u e n t b u s i n e s s t r a v e l -l e r s . On t h e o t h e r hand , s u p p l i e r b a r g a i n i n g power appears t o have d e c l i n e d , w h i l e t h e t h r e a t o f s u b s t i t u t e s e r v i c e s i s pe rhaps weaker t h a n i t was under r e g u l a t i o n o f t h e i n d u s t r y . Under the c o l l e c t i v e s t r e n g t h o f t h e s e c o m p e t i t i v e f o r c e s , s e v e r a l new key s u c c e s s f a c t o r s have emerged. These i n c l u d e : the s t r e n g t h e n i n g o f hub and spoke o p e r a -t i o n s (which i n c l u d e s a c q u i r i n g t r a f f i c f e e d from o t h e r c a r r i e r s , and the use o f CRS) ; the a b i l i t y t o c o n t r o l c o s t s ( i . e . i n c r e a s i n g a i r c r a f t u t i l i z a t i o n , a c q u i r i n g more f u e l -e f f i c i e n t p l a n e s , and i n c r e a s i n g employee p r o d u c t i v i t y ) ; and the a p p l i c a t i o n o f m a r k e t i n g e x p e r t i s e ( i . e . d e v e l o p i n g i n n o v a t i v e p r i c i n g s t r a t e g i e s such as f r e q u e n t f l i e r p r o g r a m s , and y i e l d management s y s t e m s ) . F i n a l l y , under d e r e g u l a t i o n , a t f i r s t g l a n c e i t would appear t h a t t h e s e f o r c e s have s u c c e s s f u l l y l i m i t e d the p r o f i t p o t e n t i a l o f the a i r l i n e i n d u s t r y . That i s , many a i r l i n e s r e c o r d e d d e f i c i t s " t o t a l l i n g $6.6 b i l l i o n f o r the i n d u s t r y between 1979 and 1 9 8 3 " 1 5 3 , w h i l e 27 a i r l i n e s 1 5 3 W E S T A C B r i e f i n g , p . 23. - 72 -i n c l u d i n g two majors ( i . e . B r a n i f f and F r o n t i e r A i r l i n e s ) d e c l a r e d b a n k r u p t c y o r c e a s e d o p e r a t i o n s . M o r e o v e r , as seen i n F i g u r e 5 - 5 , t h e t r u n k c a r r i e r s ' average o p e r a t i n g p r o f i t marg ins ( i . e . o p e r a t i n g p r o f i t as a p e r c e n t a g e o f o p e r a t i n g revenue) based on t h e f i v e y e a r s p r i o r t o d e r e g u l a t i o n (1973-1977) , and t h e f i v e y e a r s f o l l o w i n g passage o f t h e ADA (1979-1983) , d e c l i n e s u b s t a n t i a l l y f o r a l l o f t h e m e g a c a r r i e r s e x c e p t Amer ican A i r l i n e s , which e x p e r i e n c e d a s l i g h t i n c r e a s e . F o r i n s t a n c e , C o n t i n e n t a l - T e x a s A i r ' s average o p e r a t i n g p r o f i t marg in f e l l f rom 7.2% t o -6 .6%, w h i l e D e l t a ' s , N o r t h w e s t ' s and U n i t e d ' s dropped from 8.98% t o 1.58%, 10% t o 1.46%, and 3.9% t o -2 .06%, r e s p e c t i v e l y . However, the d r a m a t i c f u e l p r i c e i n c r e a s e s betwen 1978 and 1981, as w e l l as the major r e c e s s i o n ( s e r v i c e i n d u s t r i e s l i k e the a i r l i n e s a r e g e n e r a l l y among t h e f i r s t segments o f t h e economy t o s u f f e r ) a t t h a t t i m e , c o n t r i b u t e d s u b s t a n t i a l l y t o the i n d u s t r y ' s poor f i n a n c i a l pe r fo rmance d u r i n g the e a r l y 1 9 8 0 ' s . A c c o r d i n g t o M o r r i s o n and Wins ton (1986) , " i t would have been worse had r e g u l a t i o n s t i l l been i n e f f e c t " 1 5 4 . F u r t h e r m o r e , more r e c e n t f i n d i n g s show t h a t U . S . a i r l i n e s ' o p e r a t i n g p r o f i t marg ins have i n c r e a s e d s u b s t a n t i a l l y s i n c e t h o s e o f the e a r l y 1 9 8 0 ' s . F o r i n s t a n c e , Texas A i r had a 1986 o p e r a t i n g p r o f i t marg in o f 1 5 4 M o r r i s o n , S . and C . W i n s t o n , p . 2 . - 73 -F i g u r e 5-5 O p e r a t i n g P r o f i t Margins (OPM) o f t h e F i v e M e g a c a r r i e r s American A i r l i n e s OPM 1973 -3.3 1974 1.9 1975 -2.5 1976 3.1 1977 2.8 Average OPM (1973-1977) 0.4 1978 3.1 1979 -0.3 1980 -3.5 1981 1.2 1982 -0.6 1983 5.9 Average OPM (1979-1983) 0.54 C o n t i n e n t a l A i r l i n e s (Texas A i r ) OPM 1973 4.4 1974 10.8 1975 6.6 1976 6.9 1977 7.3 Average OPM (1973-1977) 7.2 1978 5.9 1979 0.2 1980 -5.2 1981 -5.0 1982 -4.5 1983 -18.5 Average OPM (1979-1983) -6.6 Note: Texas I n t e r n a t i o n a l merged w i t h C o n t i n e n t a l i n November 1982. Data f o r Texas A i r f o r 1982 were i n c l u d e d w i t h C o n t i n e n t a l . * OPM = O p e r a t i n g P r o f i t as a Percentage o f Operating Revenue. - 74 -D e l t a A i r l i n e s OPM 1973 l i . o 1974 12.1 1975 4.8 1976 7.7 1977 9.3 Average OPM (1973-1977) 8.98 1978 9.6 1979 4.9 1980 5.4 1981 2.4 1982 -2.7 1983 -2.1 Average OPM (1979-1983) 1.58 Northwest A i r l i n e s OPM 1973 8.1 1974 12.3 1975 6.1 1976 12.4 1977 11.1 Average OPM (1973-1977) 10.0 1978 9.0 1979 5.0 1980 2.1 1981 0.3 1982 -2.4 1983 2.3 Average OPM (1979-1983) 1.46 U n i t e d A i r l i n e s OPM 1973 7.7 1974 8.0 1975 -0.2 1976 1.3 1977 2.7 Average OPM (1973-1977) 3.9 1978 8.2 1979 -7.3 1980 -1.6 1981 -3.3 1982 -1.5 1983 3.4 Average OPM (1979-1983) -2.06 Source: B a i l e y , E.E., D.R. Graham and D.R. Kaplan, (1985), D e r e g u l a t i n g the A i r l i n e s , (Cambridge, Mass.: MIT P r e s s ) , Appendix T a b l e C, pp. 208-213. - 75 -3.15%, w h i l e t h o s e o f the o t h e r m e g a c a r r i e r s , A m e r i c a n , U n i t e d , D e l t a , and Northwest i n c r e a s e d t o 7.9%, 6.83%, 5.65%, and 5.72%, r e s p e c t i v e l y . 1 5 5 ( s e e F i g u r e 5 - 6 ) . Hence , i n t h e l o n g e r r u n , i t appears t h a t r a t h e r than l i m i t i n g i n d u s t r y p r o f i t a b i l i t y , d e r e g u l a t i o n has i n c r e a s e d i n d u s t r y p r o f i t s . In f a c t , M o r r i s o n and Wins ton (1986) c o n c l u d e t h a t "under d e r e g u l a t i o n t r a v e l e r s have saved $6 b i l l i o n a n n u a l l y t h r o u g h lower f a r e s . . . and t h a t a i r l i n e s have improved t h e i r e a r n i n g s by $2.5 b i l l i o n a n n u a l l y " 1 5 6 . F o r a c o m p a r i s o n o f aggrega te d a t a f o r t h e i n d u s t r y p r i o r t o and f o l l o w i n g d e r e g u l a t i o n , see F i g u r e s 5 - 7 , 5 -8 , and 5 - 9 . 1 5 5 L a b i c h , K . , pp 70 -79 . 1 5 6 M o r r i s o n , S . and C . W i n s t o n , p . 2. - 76 -F i g u r e 5-6 O p e r a t i n g P r o f i t Margins o f t h e F i v e M e g a c a r r i e r s (1984-1986) 1984 1985 1986 American A i r l i n e s 6.7 8.6 7.9 C o n t i n e n t a l A i r l i n e s (Texas A i r ) 9.0 9.0 3.15 D e l t a A i r l i n e s 6.4 4.9 5.65 Northwest A i r l i n e s 3.9 2.9 5.72 U n i t e d A i r l i n e s 9.0 -6.7 6.83 Source: ALPA, " N e g o t i a t o r ' s Factbook of S e l e c t e d Economic and F i n a n c i a l S t a t i s t i c s " Majors and N a t i o n a l s 1985, p. 67. - 77 -F i g u r e 5-7 A g g r e g a t e O p e r a t i n g P r o f i t  A l l U . S . S c h e d u l e d A i r l i n e s  (1970 t o 1985) O p e r a t i n g P r o f i t ( M i l l i o n s $ U . S . ) 2 500 2 000 1 500 1 000 500 0 -500 -1 000 1970 1972 1974 1976 1978 1980 1982 1984 1986 S o u r c e : A n d r i u l a i t i s , R . J . , Frank D . L . , T . H . Oum and M.W. T re theway , (1986) , D e r e g u l a t i o n and A i r l i n e Employment:  Myth V e r s u s F a c t , (Vancouver , B . C . : U n i v e r s i t y o f B r i t i s h Co lumbia C e n t r e f o r T r a n s p o r t a t i o n S t u d i e s ) , p. 49. - 78 -F i g u r e 5-8 Aggrega te Data 1977 v e r s u s 1984 1977 1984 Revenue P a s s e n g e r s 240 350 ( m i l l i o n s ) S c h e d u l e d Revenue Passenger M i l e s 141.3 305.9 ( b i l l i o n s ) S o u r c e s : J o r d a n , W . A . , " R e s u l t s o f U . S . A i r l i n e D e r e g u l a -t i o n : E v i d e n c e from the R e g u l a t e d Canad ian A i r l i n e s " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 2 2 ( 4 ) , December 1986, p . 300. Western T r a n s p o r t a t i o n A d v i s o r y C o u n c i l , "A New T h r e s h o l d f o r Canad ian A i r T r a n s p o r t a t i o n " , WESTAC B r i e -f i n g , O c t o b e r 1986, p . 20. - 79 -F i g u r e 5-9 Passenger Revenue p e r Revenue Passenger M i l e  Domestic Trunks' Scheduled O p e r a t i o n s  Y i e l d (cents) 1976-1986 Year Y i e l d 1976 7.79 1977 8.24 1978 8. 08 1979 8.50 1980 10.96 1981 12.37 1982 11.60 1983 11. 61 1984 12.40 1985 11.65 1986 10.75 Sources: A i r T r a n s p o r t A s s o c i a t i o n o f America (ATA), Y i e l d and Cost Indeces, 1984-1986. B a i l e y , E.E., D.R. Graham and D.R. Kaplan, (1985) D e r e g u l a t i n g the A i r l i n e s , (Cambridge, Mass.: MIT P r e s s ) , p. 205. - 80 -6) G e n e r a l D i f f e r e n c e s Between The Canad ian and U . S .  A i r l i n e I n d u s t r i e s P r i o r t o d e r i v i n g i m p l i c a t i o n s f o r Canada from the U . S . e x p e r i e n c e under d e r e g u l a t i o n , i t i s i m p o r t a n t t o acknowledge t h e s i g n i f i c a n t d i f f e r e n c e s t h a t e x i s t between t h e two c o u n t r i e s ' a i r l i n e i n d u s t r i e s , and how t h e s e might a f f e c t t h e r e l e v a n c e , o f t h a t e x p e r i e n c e t o Canada. These d i f f e r e n c e s i n c l u d e : the number o f c a r r i e r s each market can s u p p o r t ; t h e market s i z e and t r a f f i c l e v e l s a t t a i n a b l e ; the r o u t e s t r u c t u r e s and p a t t e r n s o f t r a f f i c f l o w t h a t have e v o l v e d ; t h e degree o f t h e i n d u s t r i e s ' dependence on i n t e r -n a t i o n a l t r a f f i c ; the e x i s t e n c e o f a dominant Crown c a r r i e r i n t h e Canad ian i n d u s t r y ; the f i n a n c i a l c o n d i t i o n s o f the c o u n t r i e s ' c a r r i e r s ; and the l e v e l s o f c o n c e n t r a t i o n i n the r e s p e c t i v e m a r k e t s . F i r s t , w h i l e U . S . c a r r i e r s have b e n e f i t t e d from s u b s t a n t i a l economies o f t r a f f i c d e n s i t y , t r a f f i c l e v e l s i n Canada a r e i n s u f f i c i e n t t o a l l o w many new e n t r a n t s t o a c h i e v e t h e minimum e f f i c i e n t s i z e . In f a c t , G i l l e n , S t a n b u r y , and Tretheway (1987) p r e d i c t t h a t " c o s t m i n i m i -z i n g f o r c e s w i l l d i c t a t e t h a t many i f no t most markets can s u p p o r t , a t b e s t , two e f f i c i e n t c a r r i e r s " 1 5 7 . In c o n t r a s t , w i t h r e s p e c t t o U . S . m a r k e t s , e c o n o m i s t s p r e d i c t t h a t "by 1990 t h e r e w i l l be f o u r o r f i v e g i a n t a i r l i n e s " 1 5 8 . T h i s 1 5 7 G i l l e n D.W. , W.T. S tanbury and M. Tre theway , p . 9 . I 5 8 " D e r e g u l a t i n g A m e r i c a . The B e n e f i t s B e g i n To Show i n P r o d u c t i v i t y , I n n o v a t i o n , and P r i c e " , B u s i n e s s Week, November 28, 1983, p. 83. - 81 -t r e n d i s a l r e a d y apparen t s i n c e , as o f May 1987, as ment ioned above , " f i v e m e g a c a r r i e r s dominate U . S . s k i e s : Texas A i r , A m e r i c a n , U n i t e d , D e l t a , and N o r t h w e s t " 1 5 9 . Hence , i t i s u n l i k e l y t h a t the t h r e a t o f new e n t r a n t s i n t o t h e Canad ian i n d u s t r y under d e r e g u l a t i o n w i l l be as s e r i o u s as t h a t which o c c u r e d i n t h e U . S . . S e c o n d , the U . S . system i s much l a r g e r t h a n i t s Canad ian c o u n t e r p a r t . F o r i n s t a n c e , i n 1984, whereas C a n a d a ' s seven l a r g e s t c a r r i e r s combined earned C $4.2 b i l l i o n i n o p e r a t i n g r e v e n u e s , " the f o u r l a r g e s t U . S . c a r r i e r s each had o v e r US $4.7 b i l l i o n i n o p e r a t i n g r e v e -n u e s " 1 6 0 . F u r t h e r m o r e , i n 1985, "Amer ican and U n i t e d each c a r r i e d t w i c e the t r a f f i c o f the e n t i r e Canad ian i n d u s t r y , and U . S . growth a l o n e was g r e a t e r than C a n a d a ' s t h i r t e e n m i l l i o n d o m e s t i c p a s s e n g e r s " 1 6 1 . In f a c t , the t r a f f i c on our t o p t h r e e r o u t e s "would be 5 t n , 1 7 t h , and 6 2 n d , r e s p e c -t i v e l y , i f t h e y were i n the U . S . " 1 6 2 , and " p a s s e n g e r t r a f -f i c has c l i m b e d a p a l t r y 10% i n e i g h t y e a r s " 1 6 3 . 1 5 9 L a b i c h , K . , p . 68. 1 6 0 W E S T A C B r i e f i n g , p . 23. 1 6 1 F r e n c h , T . , p . 14. 1 6 2 H o u s e o f Commons, N i n t h Repor t by the S t a n d i n g Committee on T r a n s p o r t , Domest ic A i r C a r r i e r P o l i c y , Ot tawa, O n t . , March 30, 1982, p . 20. 1 6 3 G h e r s o n , G. , " U . S . A i r D e r e g u l a t i o n Turns S o u r " , The F i n a n c i a l P o s t , May 18, 1987, p. 10. - 82 -T h u s , t h e Canad ian incumbents can be e x p e c t e d t o r e t a l i a t e s t r o n g l y a g a i n s t new e n t r a n t s g i v e n the Canadian i n d u s t r y ' s more l i m i t e d a b i l i t y t o absorb t h e new a r r i v a l s . Hence, t h i s would t e n d t o l i m i t the t h r e a t o f new e n t r a n t s . T h i r d , the p a t t e r n s o f t r a f f i c f low d i f f e r s u b s t a n t i a l l y i n t h e two c o u n t r i e s . F o r i n s t a n c e , " the Canad ian i n d u s t r y f l i e s about o n e - f i f t e e n t h o f t h e t r a f f i c m i l e s o f U . S . c a r r i e r s , and 97% o f C a n a d a ' s d o m e s t i c t r a f f i c i s c o n f i n e d t o a narrow band o f S o u t h e r n c i t y -p a i r s . " 1 6 4 Tha t i s , w h i l e the U . S , i s "more d e n s e l y and e v e n l y p o p u l a t e d , w i t h t r a f f i c i n a l l d i r e c t i o n s , most Canad ians l i v e c l o s e t o t h e b o r d e r and d o m e s t i c t r a f f i c has an E a s t - W e s t f o c u s . " 1 6 5 T h e r e f o r e , a c c o r d i n g t o F r e n c h (1986) " the market m i l i t a t e s a g a i n s t U S - s t y l e h u b - a n d - s p o k e n e t w o r k s . " 1 6 6 Hence , the economies a r i s i n g from the e s t a b l i s h m e n t o f s e v e r a l h u b - a n d - s p o k e r o u t e systems i n the U . S . a r e l e s s l i k e l y t o m a t e r i a l i z e i n Canada s i n c e the l i n e a r p a t t e r n o f t r a f f i c f l o w s found i n t h i s c o u n t r y do not e a s i l y l e n d t h e m s e l v e s t o such s y s t e m s . N e v e r t h e l e s s , C a n a d a ' s e x i s t i n g h u b - a n d - s p o k e systems would appear t o be p l a y i n g an i n c r e a s i n g r o l e i n the i n d u s t r y . F o r example , " the 1 6 4 F r e n c h , T . , p . 14. 1 6 5 W E S T A C B r i e f i n g , p. 23. 1 6 6 F r e n c h , T . , p. 15. - 83 -V a n c o u v e r - V i c t o r i a r o u t e , the b u s i e s t and o l d e s t 'spoke' r o u t e i n Canada, i s now served by up t o 59 p r o p e l l e r - d r i v e n commuter f l i g h t s , most o f them t i e d i n t o A i r Canada and CAIL s c h e d u l e s . " 1 6 7 F o u r t h , Canadian a i r l i n e s are more dependent on i n t e r n a t i o n a l t r a f f i c than t h e i r U.S. c o u n t e r p a r t s . For example, w i t h r e s p e c t t o Canada, " i n t e r n a t i o n a l passengers account f o r 20% o f the t o t a l number c a r r i e d compared w i t h 7% f o r t h e U . S . " 1 6 8 Hence, w i t h the coming ' l i b e r a l i s a -t i o n ' of European c a r r i e r s , Canadian a i r l i n e s c o u l d f a c e heightened c o m p e t i t i o n from abroad. F i f t h , Canada has a l a r g e Crown a i r l i n e which "earned 4 6% of the i n d u s t r y ' s t o t a l 1984 o p e r a t i n g revenues. In the U.S. t h e r e are no government-owned scheduled a i r l i n e s , and the l a r g e s t p r i v a t e s e c t o r a i r l i n e earned 14% of t o t a l 1984 o p e r a t i n g r e v e n u e s " 1 6 9 . T h i s dominant c a r r i e r c o u l d use i t s s i z e t o o b t a i n s i g n i f i c a n t volume d i s c o u n t s over and above those o b t a i n e d by o t h e r Canadian c a r r i e r s , thus r e s u l t i n g i n a c o m p e t i t i v e advantage f o r A i r Canada. Moreover, th e sheer s i z e of A i r Canada c o u l d serve t o l i m i t s u p p l i e r b a r g a i n i n g power. 1 6 7 F r e n c h , C. , "New Deal i n S k i e s May Be Old Hat When I t A r r i v e s " , G l o b e and M a i l (Report on B u s i n e s s ) , December 8, 1986, p. c5. 1 6 8WESTAC B r i e f i n g , p. 23. 1 6 9 I b i d . , p. 23. - 84 -S i x t h , " the f i n a n c i a l c o n d i t i o n s o f Canad ian c a r r i e r s a r e v e r y d i f f e r e n t from t h o s e o f t h e U . S . a i r l i n e s i n 1978, when t h e y e n t e r e d d e r e g u l a t i o n on a wave o f r e c o r d p r o f i t s . C a n a d a ' s a i r l i n e p r o f i t r e c o r d s a r e p a t c h y , and b a l a n c e s h e e t s g e n e r a l l y weak, r e d u c i n g c o m p e t i t i v e and equipment o p t i o n s " 1 - 7 0 . F o r i n s t a n c e , CAIL has a heavy debt burden as r e f l e c t e d i n i t s " d e b t / e q u i t y r a t i o o f 5.4 t o l " 1 7 1 , whereas t h a t o f c o m p e t i t o r A i r Canada f o r t h e y e a r ended December 31st 1986 was 3.19 t o l . 1 7 2 M o r e o v e r , i t would appear t h a t Canad ian a i r l i n e s a r e s u b j e c t t o h i g h e r government - imposed c o s t s t h a n a r e t h e i r A m e r i c a n c o u n t e r p a r t s . F o r i n s t a n c e , w h i l e the government r e p r e s e n t s economic d e r e g u l a t i o n as l e a d i n g t o cheaper f a r e s , i t imposes more r e g u l a t i o n s and c o s t s i n o t h e r a r e a s ( i . e . u s e r c h a r g e s f o r a i r p o r t s , employment e q u i t y r u l e s , s t a t i s t i c a l r e c o r d k e e p i n g , and s a f e t y and s e c u r i t y ) which r a i s e s a i r l i n e s ' c o s t s . F u r t h e r m o r e , "Canad ian a i r l i n e s have been u n a b l e t o ge t the f u e l p r i c e c u t s e x p e r i e n c e d i n o t h e r c o u n t r i e s , f a c i n g p r i c e s exceeded o n l y by t h o s e i n I n d i a . . . The a i r l i n e s a re c o n c e r n e d t h a t f u e l t a x e s i n Canada w i l l c o n t i n u e t o r i s e , and t h a t p r i c e s charged by 1 7 0 F r e n c h , T . , p . 15. 1 7 1 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p . 20. 1 7 2 A i r Canada Annual R e p o r t , 1986, p . 24 - 85 -o i l companies i n Canada a r e not c o m p e t i t v e w i t h t h o s e c h a r g e d by o i l companies i n the U . S . " 1 7 3 . T h u s , g i v e n t h e above , i t seems f a i r t o c o n c l u d e t h a t , even under an i d e n t i c a l regime o f d e r e g u l a t i o n , a i r l i n e c o s t s w i l l l i k e l y not be as low i n t h i s c o u n t r y as they a r e i n t h e U . S . . From t h i s i t f o l l o w s t h a t p r i c e d i s c o u n t s a re u n l i k e l y t o r e a c h the l e v e l s a t t a i n e d i n the U . S . . F i n a l l y , t h e l e v e l o f c o n c e n t r a t i o n i s much h i g h e r i n t h e Canad ian a i r l i n e i n d u s t r y , w i t h A i r Canada and CAIL now a c c o u n t i n g f o r " o v e r 90% o f s c h e d u l e d d o m e s t i c revenue p a s s e n g e r m i l e s , and o v e r 80% o f the revenues o f d o m e s t i c c a r r i e r s " 1 7 4 . In c o n t r a s t , the 8 - f i r m c o n c e n t r a t i o n r a t i o i n t h e U . S . , b a s e d on t r a f f i c i n the f i r s t seven months o f 1986, was "87% o f the n a t i o n a l m a r k e t " 1 7 5 . Moreover , w h i l e t h e l a r g e s t U . S . c a r r i e r , the Texas A i r g r o u p , had a "1986 market s h a r e o f 2 0 % " 1 7 6 , the dominant Canadian a i r l i n e , A i r Canada, c a p t u r e d "more than 60% o f s c h e d u l e d R P M s " 1 7 7 . Hence , the degree o f c o n t e s t a b i l i t y i n Canad ian c i t y - p a i r markets i s l i k e l y t o be much l e s s than t h a t o f U . S . r o u t e s . 1 7 3 W E S T A C B r i e f i n g , p . 23. 1 7 4 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p . 16. 1 7 5 I b i d . , p . 6. 1 7 6 L a b i c h , K . , p . 70. 1 7 7 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p. 1. - 86 -T h u s , a l l i n a l l , w h i l e J o r d a n (1982) c l a i m s t h a t " the b a s i c per fo rmance s i m i l a r i t i e s o f f e d e r a l l y - r e g u l a t e d Canad ian and U . S . a i r l i n e s imp ly t h a t t h e U . S . e x p e r i e n c e under d e r e g u l a t i o n would be g e n e r a l l y d u p l i c a t e d i n Canada i f s i m i l a r p o l i c y changes were implemented i n t h i s c o u n t r y " 1 7 8 , i n l i g h t o f the above d i f f e r e n c e s , i t would appear t h a t the d e r e g u l a t e d Canad ian a i r l i n e i n d u s t r y , i n c o n t r a s t t o t h a t o f the U . S . , w i l l be c h a r a c t e r i z e d b y : a weaker t h r e a t o f new e n t r a n t s due t o the more l i m i t e d market s i z e and t r a f f i c l e v e l s a t t a i n a b l e i n Canada and h e n c e , the s t r o n g e r expec ted r e t a l i a t i o n o f i n c u m b e n t s ; and h i g h e r average f a r e s due t o t h e h i g h e r government - imposed c o s t s , t h e l e s s e r degree o f c o n t e s t a b i l i t y o f Canad ian c i t y - p a i r m a r k e t s , and l e s s e r economies from the more l i m i t e d development o f hub and spoke r o u t e s y s t e m s . 1 7 8 J o r d a n , W . A . , ( 1 9 8 2 ) , Per formance o f R e g u l a t e d Canadian  A i r l i n e s i n Domest ic and T r a n s b o r d e r O p e r a t i o n s , Bureau o f C o m p e t i t i o n P o l i c y , Consumer and C o r p o r a t e A f f a i r s Canada, p . 2. - 87 -7) S t r a t e g i c Interaction i n the Canadian A i r l i n e Industry As previously mentioned, the recent takeover of Canadian P a c i f i c A i r Lines (CPAL) by P a c i f i c Western A i r l i n e s (PWA) has created a v i r t u a l duopoly i n the Canadian a i r l i n e industry ( i . e . CAIL and A i r Canada) . While some observers, including the investment community, have welcomed the takeover as creating an e f f e c t i v e competitor for A i r Canada, others, such as the Consumers Association of Canada, pr e d i c t "less competition and more cooperation between Canada's two major a i r l i n e s . " 1 7 9 In t h i s chapter we explore the p o t e n t i a l competitive r e s u l t s of duopoly ( i . e . the possible forms of s t r a t e g i c i n t e r a c t i o n i n the industry), using the Prisoner's Dilemma paradigm as a general framework. 7a) Potential Forms of Strategic Interaction in a Duopoly The existence of a duopoly i n an industry lends i t s e l f well to analysis by means of the 2-person Prisoner's Dilemma Model. That i s , while the abstraction of the Prisoner's Dilemma paradigm i s a major s i m p l i f i c a t i o n of the range and scope of decisions facing two in t e r a c t i n g p a r t i e s , we f e e l i t s basic insights are useful i n that they allow us to recognize the basic p o s s i b i l i t i e s for s t r a t e g i c i n t e r a c t i o n i n a d u o p o l i s t i c industry. In essence, according to t h i s paradigm each player has two choices, 1 7 9McArthur, D., "Deregulation: Not What Was Expected", The Globe and Mail, December 8, 1986, p. C2. - 88 -namely c o o p e r a t e o r d e f e c t . 1 8 0 In a b u s i n e s s c o n t e x t , • c o o p e r a t e * would c o n s t i t u t e c o o r d i n a t i n g b e h a v i o u r so as t o l e s s e n c o m p e t i t i o n whereas ' d e f e c t ' would be u n d e r s t o o d t o mean i n c r e a s i n g c o m p e t i t i o n . A c c o r d i n g t o the b a s i c P r i s o n e r ' s Dilemma parad igm, t h e d e f e c t i n g c h o i c e i s the i n d i v i d u a l l y o p t i m a l c h o i c e ( i . e . t h e dominant s t r a t e g y ) f o r each d u o p o l i s t t o make, because t h i s c h o i c e ( i . e . t o lower p r i c e s ) p r o v i d e s the company a h i g h e r p a y o f f ( i . e . h i g h e r market share) than the c o o p e r a t i v e c h o i c e r e g a r d l e s s o f i t s c o u n t e r p a r t ' s c h o i c e . The dilemma i s t h a t i f b o t h d e f e c t ( i . e . t o u c h i n g o f f a p r i c e w a r ) , bo th do worse ( i . e . lower p r o f i t l e v e l s ) than i f b o t h had c o o p e r a t e d . Hence A x e l r o d ' s c o n c l u s i o n t h a t "what i s b e s t f o r each p e r s o n i n d i v i d u a l l y l e a d s t o mutual d e f e c t i o n , whereas everyone would have been b e t t e r o f f w i t h mutual c o o p e r a t i o n . " 1 8 1 Samuelson and S c o t t (1971) p r o v i d e an e x c e l l e n t example o f t h e b a s i c P r i s o n e r ' s Dilemma: Suppose t h a t B l a c k and Brown a r e two p r i s o n e r s who have been caught i n a j o i n t c r i m e . The Crown p r o s e c u t o r i n f o r m s each s e p a r a t e l y t h a t he has enough e v i d e n c e t o send him t o j a i l f o r a y e a r . However, he a l s o t e l l s each t h a t i f he a l o n e c o n f e s s e s t o 1 8 o A n e x c e l l e n t d i s c u s s i o n o f t h e P r i s o n e r ' s Dilemma a b s t r a c t i o n appears i n L u c e , R . D . and H. R a i f f a (1957) , Games and D e c i s i o n s : I n t r o d u c t i o n and C r i t i c a l S u r v e y , (New Y o r k : W i l e y ) . 1 8 1 A x e l r o d , R . , (1984) , The E v o l u t i o n o f C o o p e r a t i o n , (New Y o r k : B a s i c Books I n c . ) , p . 9 . - 89 -the 1 0 - y e a r c r i m e ( i . e . chooses t o ' d e f e c t ' ) , h i s sen tence w i l l be reduced t o 3 months w h i l e t h a t o f h i s a c c o m p l i c e w i l l be 10 y e a r s . On the o t h e r hand , he i n f o r m s them t h a t i f b o t h c o n f e s s , bo th must s e r v e 5 y e a r s (see the p a y o f f m a t r i x i n F i g u r e 7 - l a ) . Hence, B l a c k w i s h e s t o c o n f e s s i n o r d e r t o reduce h i s s e n t e n c e from 1 y e a r t o 3 months. M o r e o v e r , he r e a l i z e s t h a t Brown i s f a c e d w i t h t h e i d e n t i -c a l s e t o f i n c e n t i v e s . T h u s , i f B l a c k d o e s n ' t c o n f e s s and Brown d o e s , he s t a n d s t o ge t 10 y e a r s . He c o n c l u d e s i t i s b e t t e r t o c o n f e s s and ge t no worse than 5 y e a r s . T h u s , s e l f i s h n e s s l e a d s i n e v i t a b l y t o l o n g p r i s o n terms - 5 y e a r s f o r each ( i . e . c e l l D i n F i g u r e 7 - l a ) , whereas i f n e i t h e r had c o n f e s s e d ( i . e . bo th had ' c o o p e r a t e d ' ) t h e maximum s e n t e n c e f o r each would have been 1 y e a r . S i m i l a r l y , i n a b u s i n e s s c o n t e x t , B l a c k and Brown can be seen as two f i r m s i n a d u o p o l i s t i c i n d u s t r y . By c o o p e -r a t i n g and c h a r g i n g the common monopoly p r i c e , they can maximize t h e i r j o i n t p r o f i t s ( i . e . $6 000 i n c e l l A , F i g u r e 7 - l b ) . However, b o t h f a c e i n c e n t i v e s t o ' d e f e c t ' , r e s u l -t i n g i n a lower j o i n t p r o f i t l e v e l ( i . e . $2 000 i n c e l l D, F i g u r e 7 - l b ) . An e x t e n s i o n o f t h e b a s i c P r i s o n e r ' s Dilemma Model which a l l o w s f o r a s e r i e s o f s t a t i c games i s the r e p e a t e d P r i s o n e r ' s Dilemma M o d e l . As w i l l be seen l a t e r , g i v e n the - 90 -F i g u r e 7 - l a The P r i s o n e r ' s Dilemma P a y o f f M a t r i x Brown Not C o n f e s s (Cooperate) C o n f e s s (Defect ) A 1 Year B 3 Months Not C o n f e s s (Cooperate) Reward f o r mutual c o o p e r a t i o n B l a c k 1 Year 10 Years C 10 Years D 5 Y e a r s C o n f e s s (Defect ) Punishment f o r mutual d e f e c t i o n 3 Months 5 Years S o u r c e : Samuelson, P . A . and A . S c o t t , (1971) , E c o n o m i c s , ( T o r o n t o : M c G r a w - H i l l L t d . ) / P« 609. - 91 -Figure 7-lb P r o f i t Payoff M a t r i x Brown Cooperate Defect A $ 3 000 B 0 Cooperate Reward f o r mutual cooperation Black $ 3 000 $ 5 000 C $ 5 000 D $ 1 000 Defect Punishment f o r mutual d e f e c t i o n 0 $ 1 000 Source: Samuelson, P.A. and A. S c o t t , (1971), Economics, (Toronto: McGraw-Hill L t d . ) / P« 609. - 92 -p o s s i b i l i t y o f r e p e a t e d i n t e r a c t i o n , d e f e c t i o n i s no l o n g e r the dominant s t r a t e g y f o r the d u o p o l i s t s t o a d o p t . R a t h e r , t h e r e i s no dominant s t r a t e g y . However, t h i s model i s based on v a r i o u s s i m p l i f y i n g a s s u m p t i o n s some o f which r e p r e s e n t a c l e a r d e p a r t u r e from r e a l i t y . F i r s t , whereas i n r e a l i n t e r a c t i o n s , two compa-n i e s may f a c e s e v e r a l d imens ions a l o n g which c o m p e t i t i v e d e c i s i o n s must be made ( i . e . p r i c i n g , o u t p u t , a d v e r t i s i n g , s e r v i c e q u a l i t y , a c q u i s i t i o n s , e t c . ) , the a b s t r a c t i o n o f the P r i s o n e r ' s Dilemma reduces t h e s e t o one d e c i s i o n : c o o p e r a t e o r d e f e c t . Yet i t i s q u i t e p l a u s i b l e f o r f i r m s no t engag ing i n p r i c e c o m p e t i t i o n ( i . e . c o o p e r a t i n g w i t h r e s p e c t t o the p r i c e v a r i a b l e ) t o be f i e r c e c o m p e t i t o r s i n t h e a r e a o f s e r v i c e - q u a l i t y c o m p e t i t i o n ( i . e . t o d e f e c t w i t h r e s p e c t t o the q u a l i t y o f s e r v i c e v a r i a b l e ) . S e c o n d , w h i l e i n r e a l i t y d e c i s i o n outcomes can be c o n t i n u o u s i n n a t u r e ( i . e . a mat te r o f d e g r e e ) , the P r i s o -n e r ' s Dilemma paradigm assumes t h a t they a r e d i s c r e t e ( i . e . c o o p e r a t e o r d e f e c t c o m p l e t e l y ) . Hence the p o s s i b i l i t y o f the d u o p o l i s t s a g r e e i n g t o s e t p r i c e s w i t h i n a g i v e n range i s e l i m i n a t e d . T h i r d , the a b s t r a c t i o n assumes t h a t t h e r e i s no mecha-n ism a v a i l a b l e t o t h e p a r t i e s t o make e n f o r c e a b l e t h r e a t s o r commitments. R a t h e r , i t assumes t h a t t h e p a r t i e s can communicate w i t h each o t h e r o n l y t h r o u g h t h e i r b e h a v i o u r . Y e t b o t h v e r b a l and w r i t t e n communicat ion a r e a r e a l i t y i n modern i n d u s t r y , a l b e i t i l l e g a l i f c o l l u s i v e i n n a t u r e . - 93 -F i n a l l y , a c c o r d i n g t o A x e l r o d (1984) , the a b s t r a c t i o n o f t h e model i g n o r e s o t h e r impor tan t f e a t u r e s o f s t r a t e g i c i n t e r a c t i o n s , such as " the d i r e c t i n f l u e n c e o f t h i r d p a r -t i e s , and t h e problems o f implement ing a c h o i c e " 1 8 2 (such as t h e i n f l u e n c e o f i n s t i t u t i o n a l and l e g a l b a r r i e r s t o be d i s c u s s e d l a t e r ) . N e v e r t h e l e s s , the r e p e a t e d P r i s o n e r ' s Dilemma Model c a p t u r e s one e s s e n t i a l e lement o f r e a l i t y i n t h a t i t a l l o w s f o r the p o s s i b i l i t y o f i n d e f i n i t e f u t u r e i n t e r a c t i o n s between the two d u o p o l i s t s . That i s , i f t h e d u o p o l i s t s i n t e r a c t a known f i n i t e number o f t i m e s , t h e y w i l l have no i n c e n t i v e t o c o o p e r a t e . "On t h e n e x t - t o - l a s t move n e i t h e r p l a y e r w i l l have an i n c e n t i v e t o c o o p e r a t e s i n c e they can b o t h a n t i c i p a t e a d e f e c t i o n by the o t h e r p l a y e r on the l a s t m o v e . " 1 8 3 However, as A x e l r o d (1984) p o i n t s o u t , i n most r e a l i s t i c s e t t i n g s , the d u o p o l i s t s cannot be s u r e when the l a s t i n t e r a c t i o n between them w i l l t a k e p l a c e , and s i n c e they might meet a g a i n , the f u t u r e can a f f e c t the c u r r e n t s t r a t e g i c s i t u a t i o n . Hence, w i t h an i n d e f i n i t e number o f i n t e r a c t i o n s c o o p e r a t i o n can emerge. L e t us now examine the p o s s i b l e outcomes o f s t r a t e g i c i n t e r a c t i o n i n a duopo ly i n g r e a t e r d e t a i l . 1 8 2 A x e l r o d , R . , p . 19. 1 8 3 I b i d . , p . 10. - 94 -N o n - C o o p e r a t i v e Models To b e g i n w i t h , the n o n - c o o p e r a t i v e o r d e f e c t i n g o u t -come i s embodied i n C o u r n o t ' s Duopoly M o d e l . A c c o r d i n g t o t h i s m o d e l , d u o p o l i s t s u s i n g q u a n t i t i e s as t h e i r s t r a t e g i c v a r i a b l e s choose t h e i r o u t p u t s s i m u l t a n e o u s l y r e s u l t i n g i n the Cournot E q u i l i b r i u m ( i . e . a Nash E q u i l i b r i u m i n q u a n t i -t i e s ) , f rom which no f i r m would u n i l a t e r a l l y w i s h t o d e v i -a t e . However, p r i o r t o making t h e i r ou tpu t d e c i s i o n s , each d u o p o l i s t engages i n a r a t i o n a l thought p r o c e s s which r e s e m b l e s an i t e r a t i v e p r o c e d u r e i n which each s e q u e n t i a l l y a t tempts t o maximize i t s own p r o f i t s . C o r r e s p o n d i n g t o each ou tpu t c h o i c e by one f i r m i s a p r o f i t max imiz ing ou tpu t c h o i c e by the o t h e r ( i . e . one f i r m ' s o p t i m a l ou tpu t c h o i c e i s a f u n c t i o n o f i t s r i v a l ' s c h o i c e ) . T h i s i s demonst ra ted by the r e a c t i o n c u r v e s i n F i g u r e 7 - 2 , which show the p r o f i t - m a x i m i z i n g output c h o i c e f o r each f i r m g i v e n each p o s s i b l e ou tput c h o i c e by the o t h e r . G i v e n any o u t p u t q l , f i r m 2 w i l l choose t h e c o r r e s p o n d i n g output q2 on i t s r e a c t i o n c u r v e R2, and g i v e n any ou tpu t q2 , f i r m 1 w i l l choose the c o r r e s p o n d i n g output q l on i t s r e a c t i o n c u r v e R l . To show how t h i s thought p r o c e s s a r r i v e s a t an e q u i l i b r i u m , G r a v e l l e and Rees (1981) use the f o l l o w i n g h e u r i s t i c : I f f i r m 1 chooses ou tpu t q l l , f i r m 2 then c h o o s e s q21 . T h i s causes f i r m 1 t o r e v i s e i t s c h o i c e t o q l 2 , s i n c e t h i s c o r r e s p o n d s t o q21 on i t s r e a c t i o n curve R l . - 95 -However, the c h o i c e o f q l2 by f i r m 1 w i l l then induce f i r m 2 t o choose q22, s i n c e t h i s i s the ou tpu t c o r r e s p o n d i n g t o q l2 on i t s r e a c t i o n c u r v e . T h i s i n t u r n i n d u c e s f i r m 1 t o choose q l 3 , and so o n . Thus f i r m 2 moves a l o n g i t s r e a c -t i o n c u r v e th rough the p o i n t s a l , a3 , a 5 , . . . , w h i l e f i r m 1 moves t h r o u g h the p o i n t s a2 , a 4 . . . . Hence, b o t h converge on e , t h e e q u i l i b r i u m p o i n t ( i . e . the i n t e r s e c t i o n p o i n t o f t h e r e a c t i o n c u r v e s w i t h a s s o c i a t e d ou tpu t p a i r s ( q l * , q 2 * ) ) 1 8 4 . As seen i n F i g u r e 7 - 3 , t h i s e q u i l i b r i u m p o i n t c o r r e s -ponds t o i n d u s t r y p r i c e and o u t p u t , PA, QA, r e s p e c t i v e l y . "The Cournot p r i c e i s below and ou tpu t above t h e j o i n t p r o f i t m a x i m i z i n g l e v e l s ( i . e . a t PM, QM where the m a r g i n a l revenue and m a r g i n a l c o s t c u r v e s i n t e r s e c t ) because o f independent n o n - c o o p e r a t i v e b e h a v i o u r . " 1 8 5 More p r e c i s e l y , the Cournot E q u i l i b r i u m p r i c e ( i . e PA) i s somewhere i n between t h e c o m p e t i t i v e e q u i l i b r i u m p r i c e ( i . e . PB) and the monopoly s o l u t i o n ( i . e . PM) - see F i g u r e 7 - 3 . Moreover , f i r m s i n the i n d u s t r y p roduce ou tpu t not a t t h e l e v e l a t which the c o s t o f p r o d u c i n g each a d d i t i o n a l u n i t e q u a l s t h e revenue r e c e i v e d t h e r e f r o m , but r a t h e r , t o 1 8 4 G r a v e l l e , H. and R. R e e s , (1981) , M i c r o e c o n o m i c s , ( E s s e x , U . K . : Longman Group L t d . ) , p . 315. 1 8 5 G r e e n , C . , (1985) , Canad ian I n d u s t r i a l O r g a n i z a t i o n and  P o l i c y , ( T o r o n t o : M c G r a w - H i l l Ryerson L t d . ) , p . 152. - 96 -Figure 7-2 R e a c t i o n C u r v e s - 97 -Figure Models of 7-3 D u o p o l y QM QA QB Quantity PM = Profit maximizing price for the industry QM = Profit maximizing output for the industry PA = Cournot equilibrium price QA = Cournot equilibrium output PB = Bertrand equilibrium price QB = Bertrand equilibrium output MC = Marginal cost curve MR = Marginal revenue curve - 98 -the p o i n t where the m a r g i n a l c o s t exceeds m a r g i n a l revenue ( i . e . MC > MR). Hence, the Cournot E q u i l i b r i u m i s not P a r e t o Opt ima l from e i t h e r the p o i n t o f v iew o f the f i r m s o r t h a t o f consumers . That i s , "w i th each f i r m max imiz ing i t s own p r o f i t s , g i v e n i t s r i v a l ' s o u t p u t , the r e s u l t cannot be maximal o v e r a l l p r o f i t s , s i n c e i n c r e a s e s i n a s i n g l e f i r m ' s ou tput have a (negat ive ) e f f e c t on i t s r i v a l ' s p r o f i t s . " 1 8 6 Hence t h e Cournot E q u i l i b r i u m n e i t h e r maximizes d u o p o l y p r o f i t s nor consumers ' w e l f a r e . A c c o r d i n g t o S h a p i r o (1987) , a n a t u r a l o b j e c t i o n t o C o u r n o t ' s model i s t h a t " i n p r a c t i c e b u s i n e s s e s choose p r i c e s r a t h e r than q u a n t i t i e s as t h e i r s t r a t e g i c v a r i -a b l e s " 1 8 7 . Hence the second n o n - c o o p e r a t i v e o r ' d e f e c t i n g ' mode l : t h e B e r t r a n d O l i g o p o l y M o d e l . B e r t r a n d p o i n t e d out t h a t "wi th p r i c e s as s t r a t e g i c v a r i a b l e s , each o f two r i v a l f i r m s would have a s t r o n g i n c e n t i v e t o u n d e r c u t the o t h e r ' s p r i c e i n o r d e r t o c a p t u r e t h e e n t i r e m a r k e t . " 1 8 8 T h u s , g i v e n the assumpt ions o f e q u a l l y e f f i c i e n t f i r m s , c o n s t a n t m a r g i n a l c o s t s , and 1 8 6 S h a p i r o , C . , " T h e o r i e s o f O l i g o p o l y B e h a v i o u r " , D i s c u s s i o n Papers i n E c o n o m i c s , Woodrow W i l s o n S c h o o l o f P u b l i c and I n t e r n a t i o n a l A f f a i r s , P r i n c e t o n U n i v e r s i t y D i s c u s s i o n Paper #126, P r i n c e t o n U n i v e r s i t y , P r i n c e t o n , New J e r s e y , March 1987, p. 9 . 1 8 7 I b i d . , p. 16. 1 8 8 I b i d . , p . 16. - 99 -homogeneous p r o d u c t s , B e r t r a n d h y p o t h e s i z e s t h a t i n e q u i l i -b r ium each f i r m w i l l p r i c e a t m a r g i n a l c o s t ( i . e . a t p r i c e PB i n F i g u r e 7 - 3 ) . T h u s , u n l i k e the Cournot E q u i l i b r i u m p o i n t ( i . e . a t p r i c e PA and output QA i n F i g u r e 7 - 3 ) , i n d u s t r y ou tpu t i s p r o d u c e d a t l e a s t c o s t a t the B e r t r a n d E q u i l i b r i u m . T h i s i s because "wi th q u a n t i t y c o m p e t i t i o n , each f i r m r e a l i z e s t h a t the o t h e r i s committed t o p r o d u c i n g i t s announced q u a n t i t y ; w i t h p r i c i n g c o m p e t i t i o n , i n c o n t r a s t , each f i r m r e c o g n i z e s t h a t i t can t ake the e n t i r e market from i t s r i v a l i f i t o f f e r s a lower p r i c e . T h i s awareness l e a d s t o more a g g r e s s i v e b e h a v i o u r i n the c a s e o f p r i c i n g c o m p e t i -t i o n . " 1 8 9 However, a c c o r d i n g t o S h a p i r o (1987) , t h e p r e d i c t i o n o f m a r g i n a l c o s t p r i c i n g i s not i n a c c o r d w i t h t h e b u l k o f the e m p i r i c a l e v i d e n c e on o l i g o p o l y . T h i s , i n t u r n , i s due t o t h e u n r e a l i s t i c assumpt ions upon which the B e r t r a n d m o d e l ' s p r e d i c t i o n i s b a s e d . F i r s t , w i t h homogeneous g o o d s , " B e r t r a n d E q u i l i b r i u m i n pure s t r a t e g i e s t y p i c a l l y f a i l t o e x i s t absent the s p e c i a l assumpt ion o f c o n s t a n t m a r g i n a l c o s t . In the case o f i n c r e a s i n g r e t u r n s t o s c a l e , ' d e s t r u c t i v e c o m p e t i t i o n ' d r i v e s p r i c e s down t o m a r g i n a l c o s t , bu t t h i s cannot be an e q u i l i b r i u m as p r i c e s t h e n f a i l t o c o v e r average c o s t . A d d i n g even a s m a l l f i x e d c o s t t o the b a s i c B e r t r a n d Model 1 8 9 I b i d . , p . 22. - 100 -o f c o n s t a n t m a r g i n a l c o s t s c a u s e s n o n - e x i s t e n c e o f e q u i l i -b r i u m . " 1 9 0 S e c o n d , a l l o w i n g f o r p r o d u c t / s e r v i c e d i f f e r e n t i a t i o n ( i . e . t h e absence o f p e r f e c t s u b s t i t u t e s ) the a fo remen-t i o n e d B e r t r a n d E q u i l i b r i u m no l o n g e r h o l d s , r a t h e r p r i c e s exceed m a r g i n a l c o s t s " s i n c e each f i r m r e t a i n s some market power by v i r t u e o f p r o d u c t h e t e r o g e n e i t y . " 1 9 1 T h i r d , a c c o r d i n g t o S h a p i r o (1987) " p r i c i n g c o m p e t i -t i o n w i t h u n l i m i t e d c a p a c i t i e s would no t seem f e a s i b l e i f p r o d u c t i o n i s i n v a r i a b l y s u b j e c t t o c a p a c i t y c o n -s t r a i n t s . " I 9 2 F i n a l l y , t h e assumpt ion i m p l i c i t i n B e r t r a n d 1 s mode l , " t h a t one f i r m can c a p t u r e a l l o f i t s r i v a l ' s s a l e s s i m p l y by o f f e r i n g a lower p r i c e , l a c k s r e a l i s m . I t i s e x a c t l y i n such a s i t u a t i o n t h a t the r i v a l c o u l d be e x p e c t e d t o r e s p o n d most r a p i d l y and v i g o r o u s l y , but r e a c t i o n s a r e r u l e d out e n t i r e l y i n t h i s s t a t i c t h e o r y . " 1 9 3 A t h i r d n o n - c o o p e r a t i v e model which p r e d i c t s m a r g i n a l c o s t p r i c i n g ( i . e . p o i n t PB i n F i g u r e 7-3) can be d e r i v e d from the C o n t e s t a b i l i t y T h e o r y . A c c o r d i n g t o B a i l e y and Baumol (1984) , a market i s d e f i n e d t o be p e r f e c t l y c o n t e s -t a b l e i f no p r i c e i n t h a t market can be i n e q u i l i b r i u m when 1 9 0 I b i d . , p . 17 -18 . 1 9 1 I b i d . , p . 20. 1 9 2 I b i d . , p . 22 -23 . 1 9 3 I b i d . , p . 25 . - 101 -i t s magni tude i s such as t o enab le an e n t r a n t t o u n d e r c u t i t and n e v e r t h e l e s s e a r n a p r o f i t . T h e r e f o r e , p r i c e w i l l be i n e q u i l i b r i u m o n l y i f i t e q u a l s m a r g i n a l c o s t . A c c o r d i n g t o t h i s t h e o r y the t h r e a t o f new e n t r a n t s p r e c l u d e s p r i c i n g above m a r g i n a l c o s t s , and the e x i s t e n c e o f b o t h e x c e s s p r o f i t s and i n e f f i c i e n t f i r m s i n the l o n g r u n . T h u s , even a d u o p o l i s t i c i n d u s t r y can be p e r f e c t l y c o n t e s t a b l e i f i t i s c h a r a c t e r i z e d by comple te freedom o f e n t r y and e x i t . Hence, u n l i k e the r e q u i r e m e n t s f o r p e r f e c t c o m p e t i t i o n , a c c o r d i n g t o t h i s t h e o r y t h e r e need not be a v e r y l a r g e number o f f i r m s ( s u p p l i e r s ) , o r homogeneous p r o d u c t s i n the i n d u s t r y f o r i t t o be ' c o m p e t i t i v e 1 . However, i n r e a l i t y many i n d u s t r i e s a r e c h a r a c t e r i z e d by sunk c o s t s ( i . e . an o u t l a y t h a t cannot be recouped w i t h o u t s u b s t a n t i a l de lay ) which c o n s t i t u t e s i g n i f i c a n t b a r r i e r s t o e n t r y , as w e l l as v i o l a t i n g t h e requ i rement t h a t a b s o l u t e l y c o s t l e s s e x i t e x i s t s . - 102 -C o o p e r a t i v e Model Perhaps more c o n v i n c i n g than the above ment ioned n o n -c o o p e r a t i v e m o d e l s , i s the c o o p e r a t i v e o r c o l l u s i v e duopo ly model t o which we now t u r n . The i n c e n t i v e f o r d u o p o l i s t s t o c o l l u d e stems from the o b s e r v a t i o n t h a t the maximum p r o f i t wh ich t h e f i r m s can j o i n t l y e a r n would r e s u l t i f t h e y a c t e d as a m o n o p o l i s t . Tha t i s , a c c o r d i n g t o Samuel -son and S c o t t (1971) , " the two might c o l l u s i v e l y r a i s e p r i c e s t o t h e monopoly l e v e l t h a t maximizes j o i n t p r o f i t s and r e p r e s e n t s p > m c " 1 9 4 , ( i . e . p roduce a t a r a t e o f o u t p u t a t which m a r g i n a l revenue and m a r g i n a l c o s t a r e e q u a l , wh ich i m p l i e s t h a t p r i c e exceeds m a r g i n a l c o s t -p r i c e PM and output QM i n F i g u r e 7 - 3 ) . Hence, A x e l r o d ' s f i n d i n g t h a t "a b u s i n e s s f i r m i n an i n d u s t r y w i t h o n l y one o t h e r major company charges h i g h p r i c e s w i t h the e x p e c -t a t i o n t h a t t h e o t h e r f i r m w i l l a l s o m a i n t a i n h i g h p r i c e s -t o t h e i r mutual advantage and a t the expense o f the c o n s u -m e r . " 1 9 5 However, s i n c e c o l l u s i v e agreements a r e i l l e g a l under the C o m p e t i t i o n A c t , most a t tempts a t agreement a re c o v e r t o r t a c i t r a t h e r than o v e r t . In t h i s c o n n e c t i o n , G i l l e n , S t a n b u r y and Tretheway (1987) s t r e s s t h a t " d u o p o l i s t s can 1 9 4 S a m u e l s o n , P . A . and A . S c o t t , (1971) , E c o n o m i c s , ( T o r o n t o : M c G r a w - H i l l L t d . ) , p . 607. 1 9 5 A x e l r o d , R . , p. 5. - 103 -and do communicate by t h e i r a c t i o n s and t h e i r r e a c t i o n s -they d o n ' t need words o r even a 'wink and a n o d ' . " 1 9 6 Moreover , a c c o r d i n g t o S t i g l e r (1964) , what l i m i t s c o o p e r a t i v e b e h a v i o u r i n a c o l l u s i v e agreement , a s i d e from the l e g a l c o n s i d e r a t i o n s , a r e the c o s t s t o t h e c o l l u d i n g f i r m s o f m o n i t o r i n g , d e t e c t i n g and p r e v e n t i n g c h e a t i n g . More p r e c i s e l y , once a c o l l u s i v e arrangement i s i n e x i s -t e n c e , each f i r m has a p r o f i t i n c e n t i v e t o b reak away from the agreement by s e c r e t l y u n d e r c u t t i n g the agreed -upon p r i c e . M o r e o v e r , each f i r m i s l i k e l y t o r e c o g n i z e t h a t i t s c o m p e t i t o r has s i m i l a r i n c e n t i v e s t o d e a l s e c r e t l y , so f o r s e l f - p r o t e c t i o n , a f i r m may at tempt t o ' c h e a t ' f i r s t . The outcome o f t h i s c h i s e l l i n g i s an i n c r e a s e i n i n d u s t r y o u t p u t and h e n c e , lower i n d u s t r y p r i c e s and p r o f i t s i n the l o n g e r r u n . Note the P r i s o n e r ' s Dilemma s t r u c t u r e o f the p r o b l e m : each f i r m has an i n c e n t i v e t o d e f e c t from the c o l l u s i o n by p r o d u c i n g more o u t p u t , and bo th f i r m s end up w i t h lower p r o f i t s due t o t h e s e d e f e c t i o n s . N e v e r t h e l e s s , even i n the absence o f such c h e a t i n g b e h a v i o u r , t h e r e a re a number o f f a c t o r s t h a t tend t o e i t h e r p r e v e n t the r e a l i z a t i o n o f a c o l l u s i v e agreement o r t o undermine d u o p o l i s t i c c o o r d i n a t i o n once such an a g r e e -ment has been r e a c h e d . F i r s t , i n r e a l i t y , f i r m s may have i n c o m p l e t e i n f o r m a t i o n w i t h r e s p e c t t o p r o f i t s and c o s t s , and d i f f e r e n t e x p e c t a t i o n s and b e l i e f s about market 1 9 6 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p . 25. - 104 -c o n d i t i o n s . Hence, a c c o r d i n g t o G r a v e l l e and Rees (1981) " i t pays each f i r m t o o v e r s t a t e the amount o f p r o f i t i t would g e t i n the absence o f c o l l u s i o n , i n o r d e r t o i n c r e a s e i t s p r o f i t s h a r e under the c o l l u s i v e agreement . The c a s e might a r i s e t h e r e f o r e , where no agreement c o u l d s a t i s f y the ( i n f l a t e d ) p r o f i t demands o f the s e l l e r s . " 1 9 7 S e c o n d , the d u o p o l i s t s might f a i l t o agree on terms ( i . e . the c h o i c e o f a s p e c i f i c s e t o f o u t p u t s and p r i c e s ) . T h i s i s f u r t h e r c o m p l i c a t e d by the f a c t t h a t , i n the r e a l w o r l d , the agreement may have t o ex tend beyond p r i c e s and o u t p u t s t o i n c l u d e p r o d u c t / s e r v i c e q u a l i t y , a d v e r t i s i n g e x p e n d i t u r e s , a c q u i s i t i o n p l a n s , e t c . . T h i r d , g i v e n t h a t a c o l l u s i v e agreement i s r e a c h e d , " f a l l s i n demand and the development o f e x c e s s c a p a c i t y ( a r i s i n g out o f the p r o f i t a b i l i t y o f such an agreement which i n d u c e s f i r m s t o i n v e s t i n g r e a t e r c a p a c i t y ) may i n d u c e f i r m s t o a c t i r r a t i o n a l l y , and compete ('some f o o l a lways p a n i c s ' ) , the p r e s s u r e s t o do so b e i n g g r e a t e r , the lower a r e average v a r i a b l e c o s t s r e l a t i v e t o t o t a l c o s t s , and the l e s s e l a s t i c i s market d e m a n d . " 1 9 8 F o u r t h , the e x i s t e n c e o f n o n - p r i c e c o m p e t i t i o n may p l a c e s t r a i n s on the c o l l u s i v e agreement . Tha t i s , f i r m s may a t tempt t o i n c r e a s e t h e i r s a l e s a t t h e c o l l u s i v e p r i c e by a d v e r t i s i n g and s a l e s p r o m o t i o n , as w e l l as th rough 1 9 7 G r a v e l l e , H. and R. R e e s , p . 326. 1 9 8 I b i d . , p . 328. - 105 -p r o d u c t / s e r v i c e q u a l i t y v a r i a t i o n s and i n n o v a t i o n s . The p r o b l e m , as s t a t e d by G r a v e l l e and Rees (1981) , i s t h a t i f each f i r m a t tempts t o i n c r e a s e i t s s a l e s i n t h i s manner, t h e r e i s a c a n c e l l i n g out o f each o t h e r ' s e f f o r t s ( s i n c e o v e r a l l market demand i s r e l a t i v e l y u n a f f e c t e d ) , and thus f i r m s may f i n d they a r e d i s s i p a t i n g t h e i r p r o f i t s i n t r y i n g t o keep up w i t h the g e n e r a l l e v e l o f m a r k e t i n g a c t i v i t y . F i n a l l y , Green (1985) l i s t s s e v e r a l p o w e r f u l f o r c e s t e n d i n g t o undermine c o l l u s i v e agreements . These i n c l u d e : "a) the b a r g a i n i n g power o f b i g b u y e r s : c e t e r i s p a r i b u s , c h e a t i n g i s much more l i k e l y where b u y e r s a r e l a r g e ( i . e . p r i c e c u t s become g o s s i p among b u y e r s , who, i f p o s s e s s i n g b a r g a i n i n g power, w i l l i n t u r n demand s i m i l a r t rea tment from t h e i r s u p p l i e r s ) ; b) easy e n t r y c o n d i t i o n s : i n the absence o f e n t r y b a r r i e r s t h e r e i s l i t t l e o r no market power ( i . e . i n the absence o f b a r r i e r s t o e n t r y i n t o the marke t , the e x i s t e n c e o f ' s u p e r n o r m a l p r o f i t s ' - p r o f i t s i n e x c e s s o f a l l o p p o r t u n i t y c o s t s - w i l l a t t r a c t new e n t r a n t s , t h u s " l o w e r i n g the market p r i c e o r the c l u s t e r o f p r i c e s as i n d u s t r y ou tput i n c r e a s e s " 1 9 9 ; c) the number o f s e l l e r s , i n c l u d i n g the r e l a t i v e impor tance o f the ' c o m p e t i t i v e f r i n g e ' - the f i r m s u s u a l l y no t i n c l u d e d among t h e i n d u s t r y l e a d e r s ; d) c o s t d i f f e r e n c e s among f i r m s : l o w - c o s t f i r m s may have l i t t l e r e a s o n t o r e a c h agreements 1 9 9 L e f t w i c h , R . H . and R .D . E c k e r t (1985) , The P r i c e System  and Resource A l l o c a t i o n , ( C h i c a g o : The Dryden P r e s s ) , p . 411. - 106 -a c c e p t a b l e t o h i g h - c o s t f i r m s ; e) a h i g h degree o f p r o d u c t h e t e r o g e n e i t y : d i f f e r e n t i a t i o n i n c r e a s e s the i n c e n t i v e s t o , and the l i k e l i h o o d o f n o n - p r i c e forms o f c o m p e t i t i o n ; and f) a h i g h r a t i o o f f i x e d t o t o t a l c o s t s , which makes p r i c e c u t t i n g tempt ing when a c y c l i c a l d e c l i n e i n demand p r o d u c e s a s u b s t a n t i a l amount o f unused c a p a c i t y . " 2 0 0 A l l i n a l l t h e n , we f i n d t h a t the p o t e n t i a l r e s u l t s o f d u o p o l y a r e c o n s i s t e n t w i t h the p o t e n t i a l outcomes o f the P r i s o n e r ' s Dilemma: c o o p e r a t e o r d e f e c t . As s e e n , the c o o p e r a t i v e outcome i s embodied i n the c o l l u s i v e duopo ly m o d e l , w h i l e the d e f e c t i v e outcome i s r e f l e c t e d i n b o t h the Cournot ( i . e . q u a n t i t y c o m p e t i t i o n ) and B e r t r a n d ( i . e . p r i c e c o m p e t i t i o n ) mode ls , as w e l l as i n t h a t d e r i v e d from the C o n t e s t a b i l i t y T h e o r y . Whi le t h e s e models a r e not p e r f e c t , bu t r a t h e r l i m i t e d due t o t h e i r s i m p l i f y i n g a s s u m p t i o n s , they n e v e r t h e l e s s p r o v i d e u s e f u l i n s i g h t s f o r e x p l o r i n g the p o s s i b l e forms o f s t r a t e g i c i n t e r a c t i o n i n the d u o p o l i s t i c Canad ian a i r l i n e i n d u s t r y . 2 0 0 G r e e n , C . , p . 157. - 107 -7b) A p p l i c a t i o n t o the Canadian A i r l i n e I n d u s t r y 2 0 1 In o r d e r t o a p p l y the i n s i g h t s o f t h e f o r e g o i n g d i s c u s s i o n t o the d u o p o l i s t i c Canadian a i r l i n e i n d u s t r y , i t would appear t h a t an i n j e c t i o n o f r e a l i t y ( i . e . a d e p a r t u r e from some o f the assumpt ions o f the a b s t r a c t f o r m u l a t i o n o f t h e P r i s o n e r ' s Dilemma and o t h e r Duopoly models) i s now r e q u i r e d . To t h i s e n d , we s h a l l c o n s i d e r : the n a t u r e o f c o m p e t i t i o n i n the a i r l i n e i n d u s t r y ( i . e . the key s u c c e s s f a c t o r s and s t r a t e g i c v a r i a b l e s i n v o l v e d ) ; t h e r e l e v a n c e o f government p o l i c y ( i . e . the p o t e n t i a l e f f e c t s o f p r i o r r e g u l a t i o n o f the i n d u s t r y , and c o m p e t i t i o n p o l i c y ) ; and s e v e r a l a d d i t i o n a l r e l e v a n t f a c t o r s which t e n d t o p o i n t t o e i t h e r one o r t h e o t h e r o f t h e two p o t e n t i a l c o m p e t i t i v e outcomes. N e v e r t h e l e s s , a t t h i s p o i n t i t s h o u l d be no ted t h a t w h i l e c o n s i d e r a t i o n o f t h e s e f a c t o r s a l l o w s the f o r m u l a t i o n o f arguments i n f a v o u r o f e i t h e r i n c r e a s e d o r d e c r e a s e d c o m p e t i t i o n as p o t e n t i a l outcomes o f the s t r a t e g i c i n t e r a c t i o n i n t h i s d u o p o l y , i t does not l e a d one t o c o n c l u d e i n f a v o u r o f e i t h e r outcome. To b e g i n w i t h , the U . S . e x p e r i e n c e under d e r e g u l a t i o n has r e v e a l e d s e v e r a l key s u c c e s s f a c t o r s f o r f i r m s compet ing i n the a i r l i n e i n d u s t r y , as w e l l as t h e many 2 o l T h e f o l l o w i n g d i s c u s s i o n i s based l a r g e l y on G i l l e n , D.W. , W.T. S tanbury and M. Tre theway, " A n a l y s i s o f the Takeover o f Canadian P a c i f i c A i r L i n e s by P a c i f i c Western A i r l i n e s " , Working Paper #1223, F a c u l t y o f Commerce and B u s i n e s s A d m i n i s t r a t i o n , The U n i v e r s i t y o f B r i t i s h C o l u m b i a , J a n u a r y 1987. - 108 -v a r i a b l e s a l o n g which c o m p e t i t i v e d e c i s i o n s must be made. As ment ioned above , the former i n c l u d e : the a b i l i t y t o s t r e n g t h e n hub and spoke o p e r a t i o n s , the a b i l i t y t o c o n t r o l c o s t s , and the a p p l i c a t i o n o f m a r k e t i n g e x p e r t i s e . T h e s e , i n t u r n , p o i n t t o s e v e r a l d ime n s io n s a l o n g which s t r a t e g i c d e c i s i o n s must be made. B e s i d e s p r i c i n g ( i . e . f a r e s ) and ou tpu t d e c i s i o n s ( i . e . c a p a c i t y l e v e l s and f l e e t c o m p o s i -t i o n ) , c a r r i e r s must make d e c i s i o n s r e g a r d i n g : the l e v e l o f s e r v i c e q u a l i t y t o o f f e r ; the l e v e l o f e x p e n d i t u r e s on a d v e r t i s i n g , the development and maintenance o f computer r e s e r v a t i o n s y s t e m s , and f r e q u e n t f l i e r p rograms; as w e l l as a c q u i s i t i o n p l a n s ( i . e . a c q u i r i n g t r a f f i c f e e d from o t h e r c a r r i e r s whether t h r o u g h m a r k e t i n g a l l i a n c e s o r o u t r i g h t t a k e o v e r s ) . As G i l l e n , S tanbury and Tretheway (1987) p o i n t out " the l a r g e r the number o f c o m p e t i t i v e v a r i a b l e s a n d / o r the g r e a t e r the range o v e r which they may be u s e d , the h a r d e r i t i s f o r f i r m s i n a duopo ly t o c o o r d i n a t e t h e i r b e h a v i o u r so as t o r a i s e p r i c e s above the c o m p e t i t i v e l e v e l . More v a r i a b l e s a l s o i n c r e a s e the l e v e l o f u n c e r t a i n t y , which makes c o o r d i n a t i o n more d i f f i c u l t . " 2 0 2 Hence, t h e m u l t i d i -m e n s i o n a l and c o n t i n u o u s d e c i s i o n v a r i a b l e s e x i s t i n g i n the i n d u s t r y would t e n d t o p o i n t t o t h e i n c r e a s e d c o m p e t i t i o n outcome ( i . e . ' d e f e c t i o n ' i n the language o f t h e P r i s o n e r ' s D i lemma) . 2 0 2 I b i d . , p . 20. - 109 -S e c o n d l y , government p o l i c y ( i . e . the i n f l u e n c e of t h i r d p a r t i e s ) would appear t o p l a y a key r o l e i n c o n t r i -b u t i n g t o the c o m p e t i t i v e outcome o f the emergence o f a d u o p o l y i n the i n d u s t r y . A c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) " c o o r d i n a t i o n may be e a s i e r i n an i n d u s t r y wh ich p r e v i o u s l y had been r e g u l a t e d than i n an i n d u s t r y which has never been r e g u l a t e d . F i rms s h a r e d d a t a and l e a r n e d q u i t e a b i t about each o t h e r (beyond t h a t which i s o b t a i n a b l e th rough the h i s t o r y o f f i r m i n t e r a c t i o n ) t h r o u g h documents and h e a r i n g s a s s o c i a t e d w i t h r e g u l a -t i o n . " 2 0 3 F u r t h e r m o r e , they p o i n t out t h a t " t h i s i s an i n d u s t r y where c a r r i e r o f f i c i a l s r e g u l a r l y meet t o d i s c u s s t e c h n i c a l m a t t e r s , such as i n t e r l i n i n g o f baggage, s a f e t y , e t c . . Over two hundred y e a r s ago Adam Smith reminded us t h a t when men o f the same t r a d e meet, even f o r merr iment o r d i v e r s i o n , t h e t a l k soon t u r n s t o ways o f r e s t r i c t i n g c o m p e t i t i o n . " 2 0 4 T h u s , the i n f l u e n c e o f government r e g u l a -t i o n o f the i n d u s t r y would appear t o p o i n t t o t h e d e c r e a s e d c o m p e t i t i o n outcome ( i . e . ' c o o p e r a t i o n 1 ) . However, on the o t h e r hand , w h i l e the Supreme C o u r t o f Canada r u l e d i n t h e ' E l d o r a d o N u c l e a r ' c a s e t h a t Crown C o r p o r a t i o n s ( i . e . such as A i r Canada) were exempt from the Combines I n v e s t i g a t i o n A c t , " o f f i c i a l s o f the Bureau o f C o m p e t i t i o n P o l i c y b e l i e v e t h a t a n t i - c o m p e t i t i v e b e h a v i o u r 2 0 3 I b i d . , p . 25. 2 0 4 I b i d . , p . 25. - 110 -by the a i r l i n e s w i l l be s u b j e c t t o the new C o m p e t i t i o n A c t once B i l l C-18 (The N a t i o n a l T r a n s p o r t a t i o n Act ) i s e n a c -t e d . " 2 0 5 In f a c t , t h e new C o m p e t i t i o n A c t (as o f June 19, 1986) does a p p l y t o Crown C o r p o r a t i o n s as w e l l as t o p r i v a t e e n t e r p r i s e . M o r e o v e r , " i t appears t h a t w i t h a d u o p o l y f i r m s are more v u l n e r a b l e t o c o n v i c t i o n under the C o m p e t i t i o n A c t , i f t h e c o u r t f i n d s they formed an agreement t o l e s s e n c o m p e t i -t i o n . . . b e c a u s e w i t h t h e i r v e r y h i g h j o i n t s h a r e o f the market , c o m p e t i t i o n w i l l a lmost c e r t a i n l y be l e s s e n e d ' u n d u l y ' as t h a t word has p r e v i o u s l y been i n t e r p r e t e d by the c o u r t s . " 2 0 6 In t h i s c o n n e c t i o n , the new a c t r e p l a c e s the word ' u n d u l y ' w i t h ' s u b s t a n t i a l l y ' t h e r e b y i n c r e a s i n g the l i k e l i h o o d o f c o n v i c t i o n s i n c e the former r e q u i r e d p r o v i n g b o t h the e x i s t e n c e o f a c o l l u s i v e agreement and the i n t e n t t o r e s t r i c t c o m p e t i t i o n . In c o n t r a s t , the Crown need now o n l y p r o v e t h a t the a c c u s e d f i r m s i n t e n d e d t o and d i d e n t e r an agreement t o m a n i p u l a t e p r i c e s , not t h a t they i n t e n d e d t h a t t h e i r agreement undu ly l e s s e n c o m p e t i t i o n . T h u s , t h e i n f l u e n c e o f C o m p e t i t i o n P o l i c y would appear t o p o i n t t o the i n c r e a s e d c o m p e t i t i o n outcome ( i . e . • d e f e c t i o n ' ) , s i n c e the d u o p o l i s t s ' apparen t i n c r e a s e d 2 0 5 I b i d . , p . 38. 2 0 6 I b i d . , p . 26. v u l n e r a b i l i t y t o c o n v i c t i o n under the new C o m p e t i t i o n A c t c o u l d p r o v e an e f f e c t i v e d e t e r r e n t t o c o l l u s i v e b e h a v i o u r . T h i r d l y , t h e r e a r e v a r i o u s c o n s i d e r a t i o n s which would appear t o p o i n t towards c o o p e r a t i o n between the d u o p o l i s t s i n the i n d u s t r y , w h i l e o t h e r s would s u g g e s t i n c r e a s e d c o m p e t i t i o n o r ' d e f e c t i o n ' between the d u o p o l i s t s . With r e s p e c t t o the fo rmer , a c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) , " the p o s s i b i l i t y o f c o o r d i n a t i o n so as t o l e s s e n c o m p e t i t i o n may be enhanced by the r e c e n t h i s t o r y o f c o o p e r a t i o n between PWA and A i r Canada. A l t h o u g h t h e r e was never any w r i t t e n agreement , t h e two c a r r i e r s c o o p e r a t e d i n the f o l l o w i n g ways. i ) PWA a l t e r e d i t s s c h e d u l e s t o p r o v i d e f e e d f o r A i r Canada i n wes te rn Canada, i i ) PWA was h o s t e d on A i r C a n a d a ' s computer r e s e r v a t i o n system r a t h e r than on C P A L ' s s y s t e m , and i i i ) PWA o f t e n f o l l o w e d A i r C a n a d a ' s l e a d i n p r i c i n g and o t h e r a s p e c t s o f m a r k e t i n g ; e . g . i t j o i n e d A i r C a n a d a ' s F requent F l y e r program not C P A L ' s . " 2 0 7 M o r e o v e r , whereas PWA e x e c u t i v e s emphasized i n January o f 1987 t h a t the a i r l i n e ' s ' c o z y ' r e l a t i o n s h i p w i t h A i r Canada was a " temporary m a r r i a g e o f c o n v e n i e n c e " 2 0 8 , more r e c e n t l y , on June 1, 1987 A i r Canada and CAIL e n t e r e d i n t o a new h i g h t e c h n o l o g y j o i n t v e n t u r e t o i n t e g r a t e the computer r e s e r v a t i o n s and e l e c t r o n i c d i s t r i b u t i o n systems 2 0 7 I b i d . , p . 25 . 2 0 8 I b i d . , p . 26. - 112 -o f b o t h c a r r i e r s . T h i s new company w i l l "combine the e x i s t i n g computer communicat ions s y s t e m s , r e s o u r c e s , and a p p r o p r i a t e p e r s o n n e l o f A i r Canada and Canad ian A i r l i n e s I n t e r n a t i o n a l L i m i t e d . " 2 0 9 S e c o n d , the c o o p e r a t i v e outcome would appear t o be enhanced by the e x i s t e n c e o f s u b s t a n t i a l b a r r i e r s t o e n t r y i n t o t h e Canad ian a i r l i n e i n d u s t r y . As i n the U . S . a i r l i n e i n d u s t r y ( d i s c u s s e d i n Chapter 5, S e c t i o n I ) , t h e p r e s e n c e o f sunk c o s t s ( i . e . h i s t o r i c a l a d v e r t i s i n g e x p e n d i t u r e s , and i n v e s t m e n t s i n c o m p u t e r i z e d r e s e r v a t i o n systems and f r e q u e n t f l i e r programs as b a r r i e r s t o en t ry ) makes Canad ian c i t y - p a i r markets l e s s l i k e l y t o be c o n t e s t a b l e . F u r t h e r m o r e , a c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) , " the merger o f PWA and CPAL w i l l c r e a t e an ( a d d i t i o n a l ) e n t r y b a r r i e r because i t w i l l ex tend the d u o p o l y out o f the t r u n k markets and i n t o the t h i r d - l e v e l c a r r i e r m a r k e t s . . . T h e b a r r i e r i s c r e a t e d because t h e major t h i r d - l e v e l c a r r i e r s have a l r e a d y been a l i g n e d w i t h one o f t h e two a i r l i n e camps (see F i g u r e s 1-1 & 1 - 2 ) . T h e r e f o r e , i t w i l l be d i f f i c u l t f o r a new t u r b o p r o p c a r r i e r t o e n t e r s i n c e i t cannot o f f e r the same s e r v i c e q u a l i t y . " 2 1 0 Moreover , as p r e v i o u s l y ment ioned , c o s t m i n i m i z i n g f o r c e s i n d i c a t e t h a t many i f not most Canad ian c i t y - p a i r markets can s u p p o r t , a t b e s t , two e f f i c i e n t c a r r i e r s . 2 0 9 P e r s p e c t i v e , The A i r Canada S u p e r v i s o r ' s N e w s l e t t e r , No. 5, A p r i l 30, 1987, p . 1. 2 1 0 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p. 14. - 113 -Hence, g i v e n the absence o f a s e r i o u s t h r e a t o f new e n t r a n t s , one c o u l d expec t t o see s u p r a c o m p e t i t i v e p r i c e s i n the Canad ian a i r l i n e i n d u s t r y . T h i r d , whereas the development o f e x c e s s c a p a c i t y was c i t e d as one o f t h e f a c t o r s t e n d i n g t o undermine c o l l u s i v e agreements , the merger o f CPAL w i t h PWA w i l l reduce o v e r - c a p a c i t y and hence the p r e s s u r e t o o f f e r d i s c o u n t f a r e s . T h i s p o i n t s t o i n c r e a s e d c o o p e r a t i o n i n the i n d u s t r y . On t h e o t h e r hand , w i t h r e s p e c t t o t h e i n c r e a s e d c o m p e t i t i o n o r ' d e f e c t i n g 1 h y p o t h e s i s , a c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) , one f a c t o r which s u g g e s t s t h a t the a c q u i s i t i o n might not r e s u l t i n c o o p e r a t i o n between the two d u o p o l i s t s i s the h i g h d e b t / e q u i t y r a t i o o f CAIL ( i . e . 5.4 t o 1 a t the t ime o f the m e r g e r ) . They s t a t e t h a t " s h o u l d t r a f f i c f a l l o f f , the need t o s e r v i c e t h i s debt burden w i l l undoubted ly tempt CAIL t o m a i n t a i n o r i n c r e a s e c a s h f low by lower p r i c e s , o r o t h e r forms o f c o m p e t i t i o n , r a t h e r than r i s k b a n k r u p t c y . " 2 1 1 M o r e o v e r , g i v e n t h a t a i r t r a v e l i s q u i t e s e n s i t i v e t o economic c o n d i t i o n s ( i . e . demand i s c y c l i c a l ) , w h i l e b e i n g c h a r a c t e r i z e d by h i g h f i x e d c o s t s , t h e problem i s e x a c e r b a t e d by the c u r r e n t weakness i n the commodi ty -based economy o f wes te rn Canada. Hence the a u t h o r s p r e d i c t t h a t 2 1 1 I b i d . , p . 20. - 114 -CAIL i s l i k e l y t o a c t a g r e s s i v e l y ( i . e . t o c u t f a r e s ) i n o r d e r t o m a i n t a i n i t s c a s h f l o w . S e c o n d , CAIL has p u b l i c l y " i n d i c a t e d t h a t i t i n t e n d s t o i n c r e a s e i t s domest ic market s h a r e by about seven p e r c e n t a g e p o i n t s . T h i s by i t s e l f (an unambiguously v i s i b l e commitment i n the words o f S c h e l l i n g (I960)) s u g g e s t s t h a t CAIL i n t e n d s t o compete r a t h e r than l e t A i r Canada s e t a p r i c e u m b r e l l a . 1 , 2 1 2 T h i r d , a c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) , W a r d a i r , the ' c o m p e t i t i v e f r i n g e * , and the o n l y c a r r i e r o f any s i z e t h a t i s not a l i g n e d w i t h e i t h e r A i r Canada o r CAIL , c o u l d a c t as an impor tan t c o n s t r a i n t i n the e x e r c i s e o f market power by the two l a r g e c a r r i e r s , as l o n g as i t c o n t i n u e s t o be a c o s t l e a d e r , and i t i s c a p a b l e o f moving i n and out o f markets when the d u o p o l i s t s 1 p r i c e s a r e s u p r a c o m p e t i t i v e . F o u r t h , the emergence o f buyer b a r g a i n i n g power among e c o n o m i c a l l y s t r o n g b u y e r s i n the U . S . ( i . e . f r e q u e n t b u s i n e s s p a s s e n g e r s ) under the regime o f d e r e g u l a t i o n , p o i n t s t o the g r e a t e r l i k e l i h o o d o f c o m p e t i t i o n i n the d e r e g u l a t e d Canadian a i r l i n e i n d u s t r y s i n c e , as ment ioned above , t h e c h e a t i n g b e h a v i o u r t h a t undermines c o l l u s i v e agreements i s more l i k e l y t o o c c u r where b u y e r s a re p o w e r f u l . 2 1 2 I b i d . , p. 22. - 115 -F i n a l l y , i t appears t h a t the e x t e n s i v e media coverage s u r r o u n d i n g the t a k e o v e r and i t s c o n t i n u i n g developments has c o n t r i b u t e d a d d i t i o n a l p r e s s u r e t o t h e c a r r i e r s t o compete ( i . e . i t l e a v e s no o p p o r t u n i t y f o r the a i r l i n e s t o l e a d t h e ' q u i e t l i f e ' ) . F u r t h e r m o r e , government o f f i c i a l s , a l o n g w i t h v a r i o u s l o b b y groups c o n c e r n e d w i t h d e r e g u l a -t i o n , w i l l be m o n i t o r i n g the c a r r i e r s * p r i c i n g b e h a v i o u r now and i n t h e near f u t u r e i n o r d e r t o de te rmine whether d e r e g u l a t i o n was a ' s u c c e s s * . T h u s , the a d d i t i o n o f f u r t h e r r e a l i t y t o the p o t p o u r r i ( i . e . the i n f l u e n c e o f t h e s e t h i r d p a r t i e s ) would appear t o s u p p o r t the i n c r e a s e d c o m p e t i t i o n o r ' d e f e c t i o n ' h y p o t h e s i s . To c o m p l i c a t e m a t t e r s f u r t h e r , one c o u l d i n t r o d u c e a d d i t i o n a l p o s s i b l e outcomes ( i . e . such as t h e p o s s i b i l i t y t h a t t h e d u o p o l i s t s might agree t o d i v i d e up the Canad ian marke t , w i t h CAIL e f f e c t i v e l y a c q u i r i n g monopoly power i n Western Canada and A i r Canada o b t a i n i n g i t i n the E a s t -a l t h o u g h t h i s t y p e o f market s h a r i n g agreement appears u n l i k e l y g i v e n the r e c e n t t a k e o v e r s o f ' f e e d e r ' a i r l i n e s t h a t have r e s u l t e d i n two c a r r i e r s w i t h na t ionwide c a p a c i t i e s (see F i g u r e s 1-1 & 1 - 2 ) ) . However, p r e f e r r i n g t o a v o i d f u r t h e r c o m p l i c a t i o n , the e x i s t e n c e o f such a d d i t i o n a l p o t e n t i a l outcomes w i l l mere ly be acknowledged and not a d d r e s s e d f u r t h e r . A l l i n a l l t h e n , i t would appear t h a t s t r o n g arguments can be made f o r the emergence o f e i t h e r i n c r e a s e d o r d e c r e a s e d c o m p e t i t i o n as r a t i o n a l outcomes o f the r e c e n t - 116 -c r e a t i o n o f a duopo ly i n the Canadian a i r l i n e i n d u s t r y . L e t us now make recommendations t o C a n a d a ' s d u o p o l i s t s r e g a r d i n g what form o f s t r a t e g i c i n t e r a c t i o n t o engage i n . - 117 -8) Recommendations t o Canad ian A i r l i n e Management. Hav ing examined both the U . S . a i r l i n e i n d u s t r y ' s e x p e r i e n c e under a regime o f d e r e g u l a t i o n , and the p o s s i b l e outcomes o f a d u o p o l y , s e v e r a l i m p l i c a t i o n s can be drawn w i t h r e s p e c t t o the recommended form o f s t r a t e g i c i n t e r a c t i o n i n t h e Canad ian a i r l i n e i n d u s t r y . That i s , recommendat ions can be made t o C a n a d a ' s two major a i r l i n e s , A i r Canada and CAIL , r e g a r d i n g what p r i c i n g , s e r v i c e q u a l i t y and network s t r a t e g i e s t o a d o p t . L e t us examine t h e s e recommendations u s i n g P o r t e r ' s C o m p e t i t i v e F o r c e s Paradigm as a g e n e r a l framework. I) The T h r e a t o f New E n t r a n t s As p r e v i o u s l y ment ioned , the Canadian a i r l i n e i n d u s t r y i s c h a r a c t e r i z e d by s u b s t a n t i a l n o n - r e g u l a t o r y b a r r i e r s t o e n t r y . Tha t i s , t h e p r e s e n c e o f sunk c o s t s ( i . e . the h i s t o r i c a l a d v e r t i s i n g e x p e n d i t u r e s needed t o e s t a b l i s h r e c o g n i t i o n and r e p u t a t i o n among a s i g n i f i c a n t number o f c u s t o m e r s , and i n v e s t m e n t s i n c o m p u t e r i z e d r e s e r v a t i o n s y s t e m s , f r e q u e n t f l i e r programs - such as A i r C a n a d a ' s ' A e r o p l a n ' and C A I L ' s ' C a n a d i a n P l u s ' - and hub and spoke r o u t e networks) makes Canadian c i t y - p a i r markets l e s s l i k e l y t o be c o n t e s t a b l e . Moreover , as ment ioned above , t h e s e b a r r i e r s have e f f e c t i v e l y been extended i n t o t h i r d -l e v e l c a r r i e r markets as a r e s u l t o f the c o n s o l i d a t i o n s wh ich saw a l l o f the c a r r i e r s i n Canada, w i t h the e x c e p t i o n o f W a r d a i r , a l i g n e d w i t h one o f the two major c a r r i e r s . - 118 -S e c o n d l y , the incumbents would appear t o be p r e p a r e d f o r s h a r p r e t a l i a t i o n s i n c e t h e i n d u s t r y i s c h a r a c t e r i z e d by b o t h e x c e s s c a p a c i t y and s low growth ( i . e . " p a s s e n g e r t r a f f i c has c l i m b e d a p a l t r y 10% i n e i g h t y e a r s " 2 1 3 ) , thus l i m i t i n g t h e i n d u s t r y ' s a b i l i t y t o absorb new a r r i v a l s . The e x t e n t o f o v e r - c a p a c i t y and minimum p a s s e n g e r growth a l s o makes i t d i f f i c u l t t o r a i s e the c a p i t a l needed by wou ld -be new e n t r a n t s s i n c e t h e r e i s not the s u p p l y o f g o o d , i n e x p e n s i v e a i r c r a f t i n the s e c o n d - h a n d market t h a t t h e r e was i n 1978 when the U . S . d e r e g u l a t e d . T h i r d l y , as ment ioned above , c o s t m i n i m i z i n g f o r c e s i n d i c a t e t h a t most Canad ian c i t y - p a i r markets can s u p p o r t , a t b e s t , two e f f i c i e n t c a r r i e r s . T h u s , t h e e n t r y o f a t h i r d major a i r l i n e i n t o the Canadian a i r l i n e i n d u s t r y would appear t o be h i g h l y u n l i k e l y . A l l i n a l l t h e n , g i v e n t h a t the t h r e a t o f new e n t r a n t s i s not l i k e l y t o m a t e r i a l i z e , the duopo ly models d i s c u s s e d i n t h e p r e v i o u s c h a p t e r a r e indeed r e l e v a n t i n d e r i v i n g recommendat ions f o r A i r Canada and CAIL . 2 1 3 G h e r s o n , G . , p . 10. (see f o o t n o t e #163) - 119 -I I) I n t e r f i r m R i v a l r y W h i l e , g i v e n the U . S . e x p e r i e n c e under d e r e g u l a t i o n , one might expec t t h a t i n t e r f i r m r i v a l r y would s h i f t from s e r v i c e t o p r i c e c o m p e t i t i o n , p r i c e s i n Canad ian c i t y - p a i r markets a r e u n l i k e l y t o be c o n t a i n e d t o the ' c o m p e t i t i v e l e v e l ' ( i . e . p o i n t PB i n F i g u r e 7 - 3 ) . R a t h e r , i n l i g h t o f t h e l i m i t e d t h r e a t o f new e n t r a n t s , one can e x p e c t p r i c e s t o exceed m a r g i n a l c o s t , and f o r s e r v i c e q u a l i t y t o remain a f e a s i b l e d imens ion f o r c o m p e t i t i o n . Moreover , w h i l e CAIL has i n d i c a t e d i t i n t e n d s t o i n c r e a s e i t s domes-t i c market s h a r e by about seven p e r c e n t a g e p o i n t s , and the t a k e o v e r ( i . e . CPAL by PWA) has " f r e e d up from 5 t o 10 a i r c r a f t " 2 1 4 t h a t have been s h i f t e d t o s e r v e the l u c r a t i v e C e n t r a l Canada market ( i . e . M o n t r e a l - O t t a w a - T o r o n t o ) which has t r a d i t i o n a l l y been dominated by A i r Canada, and 14 new B o e i n g 767s a r e on o r d e r f o r d e l i v e r y i n mid 1988, " a g g r e s -s i v e c o m p e t i t i o n i n a duopoly can have s e v e r e c o n s e q u e n c e s , such as p r i c e o r c a p a c i t y ' w a r s ' , and p e r i o d s i n which b o t h f i r m s e a r n l e s s than t h e i r o p p o r t u n i t y c o s t o f c a p i t a l . " 2 1 5 T h u s , w h i l e CAIL has the p o t e n t i a l s t r e n g t h t o compete a c t i v e l y w i t h A i r Canada, and v i c e v e r s a , r e c o g n i t i o n o f t h e i r i n t e r d e p e n d e n c e g i v e s A i r Canada and CAIL an i n c e n -t i v e t o c o o p e r a t e . That i s , a c c o r d i n g t o G i l l e n , S tanbury and Tretheway (1987) , bo th c a r r i e r s a re l i k e l y t o s t r i v e 2 1 4 G i l l e n , D.W., W.T. S tanbury and M. Tre theway , p . 22. 2 1 5 I b i d . , p . 18. - 120 -t o a v o i d i n t e n s e c o m p e t i t i o n ( i . e . p r i c e o r c a p a c i t y wars) s i n c e "bo th a r e c e r t a i n t o be h u r t " 2 1 6 . A l o o k a t the U . S . e x p e r i e n c e c o n f i r m s t h i s . F o r example , when a i l i n g B r a n i f f s l a s h e d i t s p r i c e s on a l l t i c k e t s by 45% i n November 1981, Amer ican - w i t h 42% o f i t s f l y i n g i n B r a n i f f markets - had t o match B r a n i f f , a t an e s t i m a t e d c o s t o f $12 m i l l i o n a month i n l o s t r e v e n u e s . 2 1 7 Meanwhi le , B r a n i f f c u t i t s f a r e s by as much as 50% on s e v e r a l s h o r t e r runs where i t was c h a l l e n g e d by l o w - c o s t c o m p e t i t o r s . As a r e s u l t o f t h i s f a r e s l a s h i n g (and i t s r a p i d o v e r e x p a n s i o n s i n c e the passage o f the A i r l i n e D e r e g u l a t i o n Act ) B r a n i f f went bankrupt i n May 1982. S i m i l a r l y , Wor ld A i rways l o s t $15 m i l l i o n on 1981 s a l e s o f $370 m i l l i o n due t o i t s p r i c e - c u t t i n g a c t i v i t i e s . A n a l y s t s agreed t h a t W o r l d ' s c o u r s e o f c u t - r a t e f l i g h t s on r o u t e s i m p o r t a n t t o the major a i r l i n e s was i l l - a d v i s e d from the s t a r t because i t was i n e v i t a b l e t h a t the e n t r e n c h e d c a r r i e r s would f i g h t back d e s p i t e t h e heavy l o s s e s they i n c u r r e d . 2 1 8 T h e r e f o r e , the recommendation t o A i r Canada and CAIL i s t o a v o i d d e s t r u c t i v e c u t t h r o a t c o m p e t i t i o n . R a t h e r , the o p t i m a l s t r a t e g y f o r the two c a r r i e r s t o adopt on r o u t e s 2 1 6 I b i d . , p. 24. 2 1 7 " A m e r i c a n R e d i s c o v e r s I t s e l f " , B u s i n e s s Week, August 23, 1982, p . 67. 2 1 8 " H o w Two A i r l i n e s L o s t t h e i r Way", B u s i n e s s Week, September , 1982, p . 65. - 121 -they b o t h s e r v e , appears t o be t h a t o f ' t i t f o r t a t ' . That i s , as d i s c u s s e d i n A x e l r o d (1984), each c a r r i e r s h o u l d c o o p e r a t e on i t s f i r s t move, and then d u p l i c a t e the o t h e r c a r r i e r ' s p r e v i o u s move ( i . e . p r i c e - s e r v i c e o f f e r i n g ) . T h u s , i f b o t h c a r r i e r s ' management a r e r a t i o n a l , and both a r e aware o f the p o s s i b i l i t y o f i n d e f i n i t e f u t u r e i n t e r a c -t i o n between t h e m s e l v e s , bo th w i l l have an i n c e n t i v e t o c o o p e r a t e . T h i s would l e a d t o the o p t i m a l outcome ( i . e . j o i n t p r o f i t m a x i m i z a t i o n , p r i c e and ou tpu t PM and QM, r e s p e c t i v e l y , i n F i g u r e 7-3) f o r the d u o p o l i s t s . However, g i v e n the s t r e n g t h e n e d c o n s p i r a c y p r o v i s i o n s o f the C o m p e t i t i o n A c t , as ment ioned e a r l i e r , the duopo-l i s t s a r e more v u l n e r a b l e t o c o n v i c t i o n i f an agreement ( i . e . w i t h r e s p e c t t o p r i c e s o r market shares ) i s found t o e x i s t . Hence, t o a v o i d b e i n g p e r c e i v e d as h a v i n g e n t e r e d a c o l l u s i v e agreement , A i r Canada and CAIL s h o u l d s e t f a r e s on r o u t e s they b o t h s e r v e below the monopoly l e v e l . T h u s , g i v e n the r e a l i t y o f c o m p e t i t i o n p o l i c y , t h i s p r i c i n g s t r a t e g y would c o n s t i t u t e the o p t i m a l one f o r the c a r r i e r s t o adopt s i n c e i t would be s u s t a i n a b l e i n t h e f a c e o f t h e C o m p e t i t i o n A c t , whereas s e t t i n g f a r e s a t the p r o f i t m a x i m i z i n g l e v e l would l i k e l y r e s u l t i n c o n v i c t i o n and h e n c e , lower p r o f i t s i n t h e l o n g r u n . F u r t h e r m o r e , t h i s c o o p e r a t i v e p r i c i n g b e h a v i o u r would appear t o be r e i n f o r c e d by the r e d u c t i o n i n e x c e s s c a p a c i t y , and the ease w i t h which ' c h e a t i n g ' can be d e t e c -t e d i n t h i s d u o p o l i s t i c i n d u s t r y . Wi th r e s p e c t t o the - 122 -f o r m e r , a c c o r d i n g t o PWA spokesman J a c k Lawless "one o f the o t h e r b e n e f i t s o f the merger ( i . e . PWA and CPAL) i s t h a t i t w i l l r e d u c e o v e r - c a p a c i t y and hence the p r e s s u r e t o o f f e r l o t s o f d i s c o u n t f a r e s . " 2 1 9 In h i s v i e w , t h e r e a r e too many deep d i s c o u n t s e a t s o f f e r e d i n the d o m e s t i c a i r l i n e i n d u s t r y . T h i s s t r o n g l y s u g g e s t s t o A i r Canada t h a t a l t h o u g h the c o n t i n u e d s a l e o f a l i m i t e d number o f r e s t r i c -t e d d i s c o u n t s e a t s i s welcome, CAIL w ishes t o a v o i d f a r e w a r s . S e c o n d l y , w h i l e b o t h c a r r i e r s f a c e i n c e n t i v e s t o s e c r e t l y u n d e r c u t the ' c o o p e r a t i v e ' p r i c e l e v e l , i n a d u o p o l y p r o t e c t e d by s u b s t a n t i a l b a r r i e r s t o e n t r y such a c t i o n s a r e immedia te ly d e t e c t a b l e . Moreover , i n f o r m a t i o n r e g a r d i n g p r i c e s i s r e a d i l y a v a i l a b l e t h r o u g h t r a v e l agents and the c a r r i e r s ' own t i c k e t s a l e s o f f i c e s . Hence, such ' c h e a t i n g ' b e h a v i o u r i s u n l i k e l y t o take p l a c e . On the o t h e r hand , t h e r e a r e s e v e r a l f a c t o r s t h a t t h r e a t e n the f e a s i b i l i t y o f t h i s ' c o o p e r a t i v e ' b e h a v i o u r . These i n c l u d e : the e x i s t e n c e o f n o n - p r i c e c o m p e t i t i o n ( i . e . s e r v i c e d i f f e r e n t i a t i o n ) ; a h i g h r a t i o o f f i x e d t o t o t a l c o s t s ; and the growing impor tance o f t h e ' c o m p e t i t i v e f r i n g e ' . F i r s t , C a n a d a ' s two major c a r r i e r s compete t h r o u g h s e r v i c e q u a l i t y v a r i a t i o n s and i n n o v a t i o n s , as w e l l as by means o f p r i c e . F o r i n s t a n c e , w h i l e b o t h A i r Canada and CAIL charge $481 f o r a f u l l - f a r e one-way economy s e a t 2 1 9 G i l l e n , D.W., W.T. S tanbury and M. Tre theway, p. 21 . - 123 -f rom T o r o n t o t o V a n c o u v e r , A i r Canada a l s o o f f e r s a N i g h t f l i g h t s p e c i a l f o r $399, w h i l e b o t h c a r r i e r s o f f e r a 3 -day advance b o o k i n g f a r e o f o n l y $379. F u r t h e r m o r e , bo th have t h r e e d i f f e r e n t s e r v i c e o f f e r i n g s ( i . e . economy, b u s i n e s s , and f i r s t c l a s s ) on b o a r d . More r e c e n t l y , A i r Canada has i n t r o d u c e d non-smoking f l i g h t s on s e r v i c e between T o r o n t o , Ottawa and M o n t r e a l , and on the V a n c o u v e r - C a l g a r y r o u t e , as w e l l as low c a l o r i e meals " N u t r i C u i s i n e " f o r i t s b u s i n e s s c l a s s s e r v i c e i n N o r t h A m e r i c a . These p r o d u c t / s e r v i c e v a r i a t i o n s r e p r e s e n t a t tempts t o d i f f e r e n t i a t e what i s e s s e n t i a l l y a p e r i s h a b l e , homogeneous good ( i . e . a s e a t from p o i n t A t o p o i n t B) , w i t h p r i c e d i f f e r e n c e s b e i n g j u s t i f i e d on t h e b a s i s o f d i f f e r e n c e s i n p a s s e n g e r c o n v e n i e n c e . On t h e o t h e r hand , w h i l e t h i s form o f n o n - p r i c e c o m p e t i t i o n may p l a c e s t r a i n s on the c a r r i e r s * ' c o o p e r a t i v e ' b e h a v i o u r , i t a l s o p r o v i d e s the a i r l i n e s w i t h a means o f d e f e n s e a g a i n s t a l l e g a t i o n s o f c o l l u s i o n ( i . e . the p r o d u c t / s e r v i c e o f f e r i n g s a r e not i d e n t i c a l ) . S e c o n d , the a i r l i n e i n d u s t r y i s c h a r a c t e r i z e d by a h i g h r a t i o o f f i x e d t o t o t a l c o s t s , w h i c h , as ment ioned e a r l i e r , makes p r i c e c u t t i n g tempt ing when a c y c l i c a l d e c l i n e i n demand p r o d u c e s a s u b s t a n t i a l amount o f unused c a p a c i t y . T h i s t e m p t a t i o n may be e x a c e r b a t e d by the weak b a l a n c e s h e e t s o f A i r Canada and CAIL ( i . e . h i g h d e b t / e q u i t y r a t i o s ) . - 124 -T h i r d , the a b i l i t y o f the d u o p o l i s t s t o engage i n c o o p e r a t i v e b e h a v i o u r ( i . e . t o c o o r d i n a t e t h e i r p r i c e — s e r v i c e o f f e r i n g s on r o u t e s they b o t h serve ) c o u l d be l i m i t e d by t h e growing impor tance o f t h e ' c o m p e t i t i v e f r i n g e ' - W a r d a i r . W a r d a i r , which began o f f e r i n g s c h e d u l e d s e r v i c e i n Canada i n May o f 1986 ( i . e . i t now o f f e r s l i m i -t e d s c h e d u l e d s e r v i c e between T o r o n t o , M o n t r e a l , C a l g a r y , Edmonton and V a n c o u v e r , whereas f o r m e r l y i t o f f e r e d o n l y c h a r t e r f l i g h t s t o 32 i n t e r n a t i o n a l d e s t i n a t i o n s i n c l u d i n g B r i t a i n and P u e r t o R ico ) , has now c a p t u r e d 7 p e r c e n t o f the d o m e s t i c market . F u r t h e r m o r e , Warda i r has announced i t i s a c q u i r i n g 12 A-310-300 medium-range a i r c r a f t - t h r e e w i l l be d e l i v e r e d i n November and December 1987, w h i l e the b a l a n c e w i l l be r e c e i v e d i n 1988. With the a d d i t i o n o f t h e s e new a i r c r a f t , W a r d a i r ' s t o t a l c a p a c i t y w i l l i n c r e a s e by 2 6 % . 2 2 0 More -o v e r , t h e s e medium-range a i r c r a f t a r e w e l l s u i t e d t o the d o m e s t i c marke t , p a r t i c u l a r l y t h e l u c r a t i v e V a n c o u v e r -T o r o n t o - M o n t r e a l c o r r i d o r s . Hence the two major c a r r i e r s can e x p e c t t o see i n c r e a s e d c o m p e t i t i o n on t h e s e r o u t e s where p r i c e s a r e s u p r a c o m p e t i t i v e . Moreover , w h i l e W a r d a i r ' s o f f e r i n g s on t h e s e r o u t e s ( i . e . V a n c o u v e r - T o r o n t o - M o n t r e a l ) a re c u r r e n t l y l i m i t e d t o two d a i l y and one d a i l y f l i g h t , r e s p e c t i v e l y , (Wardair p l a n s t o i n c r e a s e i t s f l i g h t f r e q u e n c i e s once the new 2 2 0 I b i d . , p . 23. - 125 -a i r c r a f t a r e d e l i v e r e d ) , they n e v e r t h e l e s s a c t as a p o t e n -t i a l c o n s t r a i n t on p r i c i n g . F o r i n s t a n c e , w h i l e A i r Canada and CAIL charge $481 and $144 f o r a one-way, economy s e a t from T o r o n t o t o V a n c o u v e r , and T o r o n t o t o M o n t r e a l , r e s p e c -t i v e l y , W a r d a i r s e t s i t s f a r e s a t o n l y $399, and $109, r e s p e c t i v e l y . On t h e o t h e r hand , W a r d a i r ' s a b i l i t y t o a c t as an i m p o r t a n t c o n s t r a i n t i n the e x e r c i s e o f market power by the two l a r g e r c a r r i e r s may be l i m i t e d by t h e f a c t t h a t b u s i n e s s t r a v e l l e r s a r e l e s s p r i c e s e n s i t i v e than i t s u s u a l l e i s u r e p a s s e n g e r s , and hence p r i c e i s no t the most i m p o r t a n t f a c t o r . R a t h e r , the key t o a t t r a c t i n g b u s i n e s s p a s s e n g e r s i s t o o f f e r h i g h f l i g h t f r e q u e n c i e s c o u p l e d w i t h a f r e q u e n t f l i e r program, n e i t h e r o f which W a r d a i r has a t p r e s e n t ( i . e . a l t h o u g h the c a r r i e r i s c u r r e n t l y d e v e l o p i n g a f r e q u e n t f l i e r p l a n , and p l a n n i n g t o i n c r e a s e f l i g h t f r e q u e n c i e s i n the T o r o n t o - M o n t r e a l c o r r i d o r ) . Hence, d e s p i t e i t s lower f a r e , Warda i r i s c u r r e n t l y e x p e r i e n c i n g v e r y l i m i t e d s u c c e s s i n the T o r o n t o - M o n t r e a l b u s i n e s s c o r r i d o r ( i . e . average l o a d f a c t o r s a r e e s t i m a t e d t o be about 20%). S e c o n d l y , Warda i r has no f e e d e r system t o h e l p g e n e r a t e p a s s e n g e r s f o r i t s medium and l o n g e r h a u l r o u t e s , and as p r e v i o u s l y n o t e d , a l l the major t h i r d - l e v e l o r r e g i o n a l c a r r i e r s a r e owned o r a l i g n e d w i t h A i r Canada o r C A I L . - 126 -T h i r d l y , w h i l e Warda i r i s w i d e l y b e l i e v e d t o be a l o w - c o s t c a r r i e r , G i l l e n , S tanbury and Tretheway (1987) s u g g e s t t h a t t h i s i s a t t r i b u t a b l e , i n p a r t , t o the n a t u r e o f the markets i t has t r a d i t i o n a l l y s e r v e d ( i . e . d i s c r e -t i o n a r y / l e i s u r e t r a v e l l e r s on l o n g - h a u l f l i g h t s ) , and t h a t "as a d o m e s t i c s c h e d u l e d a i r l i n e , W a r d a i r ' s c o s t advantages a r e l i k e l y t o be r e d u c e d " 2 2 1 . N e v e r t h e l e s s , the growing p o t e n t i a l t h r e a t posed by Warda i r s h o u l d no t be o v e r l o o k e d by the d u o p o l i s t s . T h e r e f o r e , g i v e n t h a t Warda i r i s s u b s t a n t i a l l y expan-d i n g i t s d o m e s t i c c a p a c i t y , and t h a t CAIL w ishes t o i n c r e a s e i t s p r e s e n c e i n C e n t r a l Canada, t h e f i r s t r ecom-mendat ion t o A i r Canada w i t h r e s p e c t t o i t s network s t r a -t e g y i s t o c o n t i n u e expanding i t s i n t e r n a t i o n a l o f f e r i n g s . Tha t i s , A i r Canada, which now s e r v e s 34 i n t e r n a t i o n a l d e s t i n a t i o n s , and d e r i v e s "4 6 p e r c e n t o f i t s revenues from i t s i n t e r n a t i o n a l s e r v i c e s " 2 2 2 , s h o u l d seek growth on the p r o f i t a b l e o v e r s e a s r o u t e s . To t h i s e n d , A i r Canada has o r d e r e d f o u r new B o e i n g 767 j e t a i r c r a f t ( i . e . the backbone o f A i r C a n a d a ' s medium and l o n g - r a n g e f l e e t ) and a B o e i n g 747 Combi , and has u n d e r t a k e n i n i t i a t i v e s t o promote i t s a s p i r a t i o n s o v e r the P a c i f i c , t h r o u g h d e t a i l e d d i s c u s s i o n s w i t h r e p r e s e n t a t i v e s 2 2 1 I b i d . , p . 23 . 2 2 2 F o s t e r , C , "CAIL Launches i t s C h a l l e n g e t o A i r Canada" , The G lobe and M a i l , Repor t on B u s i n e s s , A p r i l 27, 1987, p. B l l . - 127 -f rom a number o f c o u n t r i e s i n the F a r E a s t , i n c l u d i n g : J a p a n , South K o r e a , M a l a y s i a and the P e o p l e ' s R e p u b l i c o f C h i n a . F u r t h e r m o r e , the c a r r i e r ' s r o u t e system w i t h i n Europe has been m o d i f i e d and extended t o i n c l u d e s e r v i c e t o V i e n n a , M u n i c h , F r a n k f u r t and M a n c h e s t e r . Meanwhile i n the C a r r i b e a n , s e r v i c e was i n a u g u r a t e d t o the Dominican Repub-l i c i n 1987. A c c o r d i n g t o P i e r r e J e a n n i o t , P r e s i d e n t and C h i e f E x e c u t i v e O f f i c e r o f A i r Canada, " A i r C a n a d a ' s new r o u t e s a r e f o l l o w i n g new i m m i g r a t i o n p a t t e r n s now from the P a c i f i c Rim and the Arab c o u n t r i e s . . . C a i r o i s on next y e a r ' s a g e n d a . " 2 2 3 These i n t e r n a t i o n a l r o u t e s a r e a t t r a c t i v e s i n c e t h e r e i s a "measure o f monopoly power a v a i l a b l e i n i n t e r n a t i o n a l m a r k e t s . . . which can be expec ted t o l e a d t o h i g h e r p r o -f i t s . " 2 2 4 Moreover , a c c o r d i n g t o Gel lman (1987) t h e s e markets p r o v i d e c a r r i e r s w i t h an o p p o r t u n i t y t o take advantage o f economies o f s c o p e . F o r i n s t a n c e , A i r Canada c o u l d e s t a b l i s h an i n t e r n a t i o n a l hub and spoke network and l i n k o v e r s e a s f e e d i n t o i t s d o m e s t i c network , t h e r e b y i n c r e a s i n g average t r a f f i c d e n s i t i e s w i t h a r e s u l t i n g drop i n u n i t c o s t s . 2 2 5 A l r e a d y , a t Tokyo , b o t h Nor thwest and 2 2 3 W o n , S . "Why A i r Canada Wants To F l y Own Way", The M o n t r e a l G a z e t t e , J u l y 11, 1987, p . DI . 2 2 4 G e l l m a n , A . J . , "New World Turns on the O l d " , A i r l i n e B u s i n e s s , May 1987, p. 19. 2 2 5 0 u m , T . H . and M. Tre theway, " A i r l i n e Hub and Spoke S y s t e m s " , F a c u l t y o f Commerce and B u s i n e s s A d m i n i s t r a t i o n , U n i v e r s i t y o f B r i t i s h C o l u m b i a , D r a f t 21 May, 1987, p. 6. - 128 -U n i t e d o p e r a t e i n a h u b - l i k e manner, w h i l e Pan Am o p e r a t e s a m i n i - h u b a t L o n d o n ' s Heathrow A i r p o r t , and TWA i s p r e p a r -i n g t o do the same i n S w i t z e r l a n d . 2 2 6 F u r t h e r m o r e , A i r Canada c o u l d c a p i t a l i z e on the economies o f s c a l e a s s o c i a t e d w i t h e n l a r g e d maintenance f a c i l i t i e s and o p e r a t i o n s , crew and s t a f f t r a i n i n g , marke t -i n g ( i . e . CRS) and f i n a n c e , and the b e n e f i t s o f i n c r e a s e d a i r c r a f t u t i l i z a t i o n . L i k e w i s e , the recommendation t o CAIL w i t h r e s p e c t t o i t s i n t e r n a t i o n a l network s t r a t e g y ( i . e . CAIL s e r v e s 21 i n t e r n a t i o n a l d e s t i n a t i o n s , i n c l u d i n g the South P a c i f i c -A u s t r a l i a and New Z e a l a n d - Hong Kong, T o k y o , S h a n g h a i , B e i j i n g , Bangkok, M e x i c o , s e v e r a l South Amer ican d e s t i n a -t i o n s , and the European c i t i e s o f Rome and Amsterdam) i s t o c o n t i n u e expanding i t s s e r v i c e on t h e s e r o u t e s due t o t h e above ment ioned b e n e f i t s o f s e r v i n g i n t e r n a t i o n a l m a r k e t s . In r e s p o n s e t o the p o t e n t i a l t h r e a t posed by A i r Canada i n the P a c i f i c , CAIL s h o u l d s t r i v e t o i n c r e a s e i t s p r e s e n c e and s e r v i c e o f f e r i n g ( i . e . i n c r e a s e the number o f f l i g h t s and t h e c a p a c i t y a v a i l a b l e ) . In t h i s c o n n e c t i o n , i t i s w i d e l y b e l i e v e d t h a t CP A i r ' s l i m i t e d f r e q u e n c y s e r v i c e ( i . e . the l a c k o f d a i l y f l i g h t s ) was p a r t i a l l y r e s p o n s i b l e f o r the s u c c e s s f u l growth o f Cathay P a c i f i c i n P a c i f i c m a r k e t s , and t h e f r e q u e n t l y c i t e d s t a t i s t i c t h a t 2 2 6 G e l l m a n , A . J . , p . 21. - 129 -90% o f Canad ian p a s s e n g e r s t r a v e l l i n g i n the P a c i f i c must f l y by f o r e i g n a i r l i n e s . Moreover , CAIL s h o u l d s t r i v e t o s t r e n g t h e n i t s p r e s e n c e i n Europe by i n a u g u r a t i n g s c h e d u l e d s e r v i c e t o London - t h e gateway t o E u r o p e . To t h i s e n d , s i n c e CAIL i s u n a b l e t o r e n e g o t i a t e the b i l a t e r a l t r e a t y between Canada and E n g l a n d , the c a r r i e r s h o u l d e n t e r i n t o n e g o t i a t i o n s w i t h W a r d a i r t o p u r c h a s e i t s London (Gatwick) r o u t e a u t h o r i t y . T h i s would p r o v i d e CAIL w i t h o v e r s e a s f e e d f o r i t s d o m e s t i c network , w h i l e h e l p i n g Warda i r r a i s e the c a p i t a l needed f o r i t s d o m e s t i c e x p a n s i o n . Meanwhi le , W a r d a i r c o u l d c o n t i n u e t o s e r v e the London market v i a i t s s u c c e s s f u l c h a r t e r f l i g h t s . A t t h i s p o i n t i t s h o u l d be no ted t h a t b o t h c a r r i e r s f a c e s i g n i f i c a n t c o m p e t i t i o n from non-US c a r r i e r s on a l l t h e s e i n t e r n a t i o n a l r o u t e s , and t h a t U . S . c a r r i e r s a re i n c r e a s i n g l y l o o k i n g t o i n t e r n a t i o n a l markets as a s o u r c e o f g rowth . T h u s , A i r Canada and CAIL can expec t h e i g h t e n e d c o m p e t i t i o n on t h e s e r o u t e s i n the near f u t u r e , and hence must ensure t h a t t h e i r p r i c e / s e r v i c e o f f e r i n g s a r e compe-t i t i v e . Wi th r e s p e c t t o d o m e s t i c network s t r a t e g i e s , as seen i n F i g u r e s 1-1 & 1-2, bo th A i r Canada and CAIL have the c a p a c i t y t o o f f e r f u l l t r a n s c o n t i n e n t a l s e r v i c e . That i s , t h r o u g h t h e i r a l l i a n c e s w i t h r e g i o n a l f e e d e r c a r r i e r s ( i n c l u d i n g A i r C a n a d a ' s p roposed f e e d e r i n Quebec, and C A I L ' s new commuter a i r l i n e i n O n t a r i o ' O n t a r i o E x p r e s s * - 130 -which was g r a n t e d CTC a p p r o v a l on June 15, 1987) , and t h e i r use o f m u l t i p l e hubs ( i . e . V a n c o u v e r , T o r o n t o and H a l i f a x ) , b o t h a i r l i n e s w i l l be a b l e t o o f f e r e x t e n s i v e s e r v i c e i n Canada . However, a t p r e s e n t A i r Canada i s s t i l l dominant i n t h e l u c r a t i v e T o r o n t o - O t t a w a - M o n t r e a l t r i a n g l e , as w e l l as i n t h e r e s t o f O n t a r i o th ro u g h i t s f e e d e r ' A i r O n t a r i o ' . M o r e o v e r , w h i l e CAIL has a c t e d t o i n c r e a s e t h e f r e q u e n c y o f i t s f l i g h t s i n the T o r o n t o - M o n t r e a l c o r r i d o r ( i . e . on June 1, 1987, CAIL i n c r e a s e d the number o f d a i l y f l i g h t s between M o n t r e a l and T o r o n t o from 10 t o 28) , a c c o r d i n g t o Russ MacCormack, A i r C a n a d a ' s D i r e c t o r o f Market Development f o r N o r t h A m e r i c a , "we have y e t t o be matched by a s i n g l e p r o d u c t , and u n t i l t h a t happens we w i l l no t be t h r e a t e n e d by any o t h e r b u s i n e s s s e r v i c e " . 2 2 7 I t does indeed appear t h a t A i r Canada has y e t t o f e e l t h e impact o f C A I L ' s i n c r e a s e d c a p a c i t y o f f e r i n g i n t h i s c o r r i d o r , s i n c e the average l o a d f a c t o r on i t s 31 d a i l y f l i g h t s between M o n t r e a l and T o r o n t o a c t u a l l y r o s e t o over 90% i n J u l y o f 1987. A c c o r d i n g t o i n d u s t r y i n s i d e r s , t h i s i s p a r t i a l l y due t o A i r C a n a d a ' s s u p e r i o r g a t e l o c a t i o n i n M o n t r e a l , and i t s use o f T e r m i n a l 1 i n T o r o n t o ( i . e . T e r m i n a l 2, where CAIL i s p r e s e n t l y l o c a t e d , i s ex t reme ly c o n g e s t e d c a u s i n g f l i g h t d e l a y s , e t c . ) . However, the l a t t e r d i s a d v a n t a g e c o u l d be overcome by CAIL th rough a 2 2 7 F r e n c h T . , (1986), p . 18. - 131 -r e l o c a t i o n t o T e r m i n a l 3 once i t i s comple ted ( the G o v e r n -ment i s c u r r e n t l y t a k i n g b i d s f o r i t s c o n s t r u c t i o n ) . F u r t h e r m o r e , the f e a r o f Warda i r e r o d i n g A i r C a n a d a ' s e a r n i n g s on t h i s b read and b u t t e r r o u t e i s d i s s i p a t e d by B r i a n W a l k e r , S e n i o r V i c e P r e s i d e n t S a l e s and M a r k e t i n g a t W a r d a i r , who s t a t e s "we cannot y e t a f f o r d t o go t o a h i g h - c o s t b u s i n e s s f a r e o f f e r i n g " . 2 2 8 Hence, F r e n c h ' s (1986) c o n c l u s i o n t h a t w h i l e A i r C a n a d a ' s d o m e s t i c market s h a r e may d i m i n i s h , the f r e q u e n c y and q u a l i t y o f b u s i n e s s -c l a s s s e r v i c e w i l l m a i n t a i n h i g h - y i e l d t r a f f i c . T h u s , the recommendation t o A i r Canada i s t o c o n t i n u e o f f e r i n g i t s h i g h q u a l i t y and f r e q u e n t s e r v i c e t o b u s i n e s s p a s s e n g e r s i n t h i s market , as w e l l as i n t r o d u c i n g f u r t h e r i n n o v a t i o n s t h a t c a t e r t o b u s i n e s s t r a v e l l e r s ( i . e . such as i t s s u c c e s s f u l A e r o p l a n Frequent F l y e r Program, and the l o w - c a l o r i e ' N u t r i C u i s i n e 1 m e a l s , and non-smoking f l i g h t s i n t r o d u c e d i n 1986) . In c o n t r a s t , CAIL p r e s e n t l y dominates the markets i n Western Canada, and the r e s t o f Quebec o u t s i d e the M o n t r e a l a r e a . Tha t i s , w h i l e A i r Canada has been mount ing an a t t a c k t h r o u g h i t s Western f e e d e r , A i r BC, CAIL s t i l l dominates t h e Vancouver hub, and the p r o f i t a b l e Edmonton-C a l g a r y c o r r i d o r w i t h i t s s h u t t l e s e r v i c e , as w e l l as the Saskatchewan market , where A i r Canada has no a l l y . F u r -t h e r m o r e , u n t i l i t s p roposed Quebec f e e d e r i s o p e r a t i o n a l , 2 2 8 I b i d . , p . 19. -132 -A i r Canada w i l l c o n t i n u e t o l o s e ground t o CA IL , which a c q u i r e d f e e d e r s N o r d a i r and Q u e b e c a i r . In t h i s c o n n e c t i o n , i n o r d e r t o c a p i t a l i z e on i t s Quebec ' f e e d ' and i t s s t r e n g t h i n the West , CAIL i s p l a n -n i n g t o i n c r e a s e the number o f d i r e c t f l i g h t s from M o n t r e a l t o Western Canada ( i . e . w i t h no s t o p o v e r i n the T o r o n t o hub) nex t summer when i t s t a r t s g e t t i n g d e l i v e r y o f i t s s i x B o e i n g 767 j e t s . 2 2 9 However, as G i l l e n , S tanbury and Tretheway (1987) p o i n t out " i t w i l l t ake some t ime f o r CAIL t o become a s m o o t h - r u n n i n g sys tem. CPAL has not y e t f u l l y ' d i g e s t e d ' i t s e a r l i e r a c q u i s i t i o n s (EPA, N o r d a i r , and Q u e b e c a i r ) " , 2 3 0 and one o f the most d i f f i c u l t c h a l l e n g e s s t i l l b e f o r e CAIL i s meshing the l a b o u r f o r c e s ( i n c l u d i n g s o r t i n g out s e n i o -r i t y and u n i o n a l l e g i a n c e s ) o f f o u r d i f f e r e n t a i r l i n e s ( i . e . CPAL, PWA, EPA and N o r d a i r ) . N e v e r t h e l e s s , CAIL s h o u l d c o n t i n u e expanding i t s s e r v i c e on b o t h t r a n s c o n t i n e n t a l , and C e n t r a l Canada ( i . e . M o n t r e a l - O t t a w a - T o r o n t o ) r o u t e s i n o r d e r t o c a p i t a l i z e on i t s s o l i d network o f f e e d e r c a r r i e r s i n b o t h Western Canada and Quebec. CAIL s h o u l d a l s o s t r i v e t o i n c r e a s e the p r e s e n c e o f i t s f e e d e r ' O n t a r i o E x p r e s s ' i n the O n t a r i o marke t . M o r e o v e r , th rough i t s Western f e e d e r s , CAIL s h o u l d s t r i v e t o dominate the h i g h d e n s i t y r o u t e between Vancouver 2 2 9 W o n , S . , "The New K i d on B l o c k Has H igh H o p e s " , The M o n t r e a l G a z e t t e , J u l y 18, 1987, p . C I . 2 3 0 G i l l e n , D.W., W.T. S tanbury and M. Tre theway , p . 17. - 133 -and V i c t o r i a , as w e l l as the h i g h l y p r o f i t a b l e N o r t h e r n B . C . and Yukon m a r k e t s , and the h i g h y i e l d A r c t i c r o u t e s ( t r a d i t i o n a l l y f lown by N o r d a i r ) . F i n a l l y , on the A t l a n t i c c o a s t , b o t h c a r r i e r s a re p r e s e n t l y f a i r l y e v e n l y matched w i t h A i r C a n a d a ' s f e e d e r , A i r Nova , o f f e r i n g s e r v i c e from H a l i f a x t o p o i n t s i n Nova S c o t i a and Newfoundland (and soon t o New Brunswick) , and C A I L ' s f e e d e r , A i r A t l a n t i c , s e r v i n g Nova S c o t i a , Newfoundland, and New Brunswick from H a l i f a x - t h e E a s t e r n ' h u b ' . The recommendation r e g a r d i n g p r i c e - s e r v i c e o f f e r i n g s on r o u t e s s e r v e d by b o t h c a r r i e r s i n t h i s market i s the same as t h a t r e g a r d i n g s e r v i c e i n t h e T o r o n t o - M o n t r e a l and the T o r o n t o - V a n c o u v e r c o r r i d o r s : c o o p e r a t e . -- 134 -I l l ) Buyer B a r g a i n i n g Power G i v e n the U . S . e x p e r i e n c e s i n c e the passage o f the A i r l i n e D e r e g u l a t i o n A c t i n 1978, under a regime o f d e r e g u l a t i o n i n t h e Canadian a i r l i n e i n d u s t r y , one would e x p e c t t h e b a r g a i n i n g power o f Canad ian t r a v e l l e r s t o a l s o r e v e r t t o an economic b a s i s . That i s , e c o n o m i c a l l y s t r o n g b u y e r s ( i . e . f r e q u e n t b u s i n e s s t r a v e l l e r s ) s h o u l d g a i n more v a l u e i n t h e i r t r a n s p o r t a t i o n p u r c h a s e s , such as i n c r e a s e d f l i g h t f r e q u e n c y , w h i l e e c o n o m i c a l l y weak b u y e r s ( i . e . b u y e r s on t h i n , m a r g i n a l r o u t e s ) c o u l d e x p e c t t o see s e r v i c e f a l l t o e c o n o m i c a l l y s u p p o r t a b l e l e v e l s . However, the Canad ian l e g i s l a t i o n w i l l r e t a i n a degree o f r e g u l a t i o n t o p r o t e c t t r a v e l l e r s i n t h i n and remote markets (see Append ix A) . Hence , i n the Canad ian c a s e i t would appear t h a t t r a v e l l e r s from s m a l l communi t ies w i l l r e t a i n a degree o f p o l i t i c a l b a r g a i n i n g power. T h u s , w h i l e A i r Canada and CAIL s h o u l d c o n t i n u e t o f i n e - t u n e t h e i r p r i c e - s e r v i c e o f f e r i n g s t o the needs o f e c o n o m i c a l l y s t r o n g buyers on r o u t e s they f l y ( i . e . by c o n t i n u i n g t o o f f e r b u s i n e s s c l a s s s e r v i c e and f r e q u e n t f l i e r p rograms , and by i n t r o d u c i n g volume d i s c o u n t s f o r major c o r p o r a t i o n s ) , the needs of s m a l l community t r a v e l -l e r s must no t be i g n o r e d . R a t h e r , th rough t h e i r f e e d e r c a r r i e r s ( i . e . t h a t s e r v i c e such p a s s e n g e r s ) , A i r Canada and CAIL s h o u l d c o n t i n u e t o p r o v i d e h i g h q u a l i t y s e r v i c e , d e s p i t e t h e absence o f s u b s t i t u t e s e r v i c e s i n such m a r k e t s , s i n c e the F e d e r a l Government w i l l p r o v i d e s u b s i d i e s i f a - 135 -s e r v i c e deemed e s s e n t i a l cannot be p r o v i d e d on a p u r e l y commerc ia l b a s i s . F u r t h e r m o r e , by p r o v i d i n g ' f e e d * f o r t h e c a r r i e r s ' i n t e r p r o v i n c i a l a n d / o r t r a n s c o n t i n e n t a l f l i g h t s , t h e s e p a s s e n g e r s a l l o w A i r Canada and CAIL t o a c h i e v e h i g h e r l o a d f a c t o r s and hence lower u n i t c o s t s than would o t h e r w i s e be a t t a i n a b l e . T h u s , the p r o v i s i o n o f t r a f f i c f e e d from the c a r r i e r s ' v a r i o u s ' s p o k e s ' , t o g e t h e r w i t h t h e c o n t i n u e d use o f the a i r l i n e s ' y i e l d management systems ( i . e . o f f e r i n g a l i m i t e d number o f r e s t r i c t e d d i s c o u n t f a r e s i n o r d e r t o f i l l o t h e r w i s e empty s e a t s ) s h o u l d a l l o w t h e c a r r i e r s t o a c h i e v e a h i g h e r l e v e l o f p r o f i t s . - 136 -IV) S u p p l i e r B a r g a i n i n g Power As p r e v i o u s l y ment ioned , under a regime o f d e r e g u l a -t i o n s u p p l i e r b a r g a i n i n g power i n the U . S . a i r l i n e i n d u s t r y r e v e r t e d t o an economic b a s i s , marked by reduced n e g o t i a -t i n g power on the p a r t o f b o t h l a b o u r and the o t h e r major s u p p l i e r s t o the a i r l i n e s ( i . e . a i r c r a f t m a n u f a c t u r e r s and o i l c o m p a n i e s ) . Wh i le one would e x p e c t t h e b a r g a i n i n g power o f Canad ian a i r l i n e i n d u s t r y s u p p l i e r s t o f o l l o w i n t h e same d i r e c t i o n under a s i m i l a r r e g i m e , t h e r e a r e v a r i o u s f a c t o r s which t e n d t o m a i n t a i n i t . F i r s t , w i t h r e s p e c t t o Canad ian l a b o u r ' s b a r g a i n i n g power, t h e absence o f a C h a p t e r 11 b a n k r u p t c y r e f u g e , and the l a c k o f l o w - c o s t new e n t r a n t s l e a v e Canad ian a i r l i n e managements v e r y l i t t l e l e v e r a g e t o g a i n u n i o n c o n c e s s i o n s . M o r e o v e r , w h i l e Canad ian a i r l i n e s a r e now b e g i n n i n g t o e n j o y s m a l l b e n e f i t s from l e s s r e s t r i c t i v e work r u l e s , and t w o - t i e r wage s t r u c t u r e s (won i n damaging s t r i k e s i n 1985 a t A i r Canada and PWA), l a b o u r c o s t s i n the Canad ian a i r l i n e i n d u s t r y a r e s t i l l s u b s t a n t i a l l y h i g h e r than t h o s e i n t h e U . S . . In t h i s c o n n e c t i o n , J o r d a n (1987) f i n d s t h a t U . S . c a r r i e r s have been a b l e t o a c h i e v e lower o p e r a t i n g expenses p e r revenue t o n - m i l e , due p r i m a r i l y t o h i g h e r l a b o u r p r o d u c t i v i t y . F o r example, " i n 1978, t h e US c a r r i e r s * employee p r o d u c t i v i t y was 15.9 p e r c e n t above t h a t o f the - 137 -Canad ian c a r r i e r s . . . i n 1984, i t was 31.6 p e r c e n t h i g h -e r . " 2 3 1 T h i s c o u l d have s e r i o u s i m p l i c a t i o n s f o r Canad ian a i r l i n e s ' c o m p e t i t i v e n e s s on i n t e r n a t i o n a l r o u t e s f lown by compet ing U . S . c a r r i e r s . T h u s , A i r Canada and CAIL must s t r i v e t o lower t h e i r l a b o u r c o s t s by r a i s i n g employee p r o d u c t i v i t y , and by g r e a t e r use o f t w o - t i e r wage s c a l e s , and p a r t - t i m e employment. S e c o n d , w i t h r e s p e c t t o a i r c r a f t m a n u f a c t u r e r s ' b a r -g a i n i n g power, as ment ioned above w h i l e t h e r e i s no t t h e s u p p l y o f i n e x p e n s i v e a i r c r a f t i n t h e second hand market t h a t t h e r e was i n 1978 when the U . S . a i r l i n e i n d u s t r y was d e r e g u l a t e d , t h e Canad ian a i r l i n e i n d u s t r y i s c h a r a c t e r i z e d by o v e r - c a p a c i t y and c o n c e n t r a t e d b u y e r s t e n d i n g t o d i m i -n i s h s u p p l i e r s ' b a r g a i n i n g power. N e v e r t h e l e s s , r e l a t i v e l y s p e a k i n g the Canadian a i r l i n e i n d u s t r y i s not an impor tan t customer o f a i r c r a f t s u p p l i e r s , hence A i r Canada and C A I L ' s n e g o t i a t i n g power i s somewhat l i m i t e d . T h i r d , the o p p o r t u n i t i e s f o r C a n a d a ' s major c a r r i e r s t o t a k e l a r g e c o s t - c u t t i n g b e n e f i t s a r e l i m i t e d by the p r e v i o u s l y ment ioned e x i s t e n c e o f h i g h government imposed f u e l t a x e s . A c c o r d i n g t o F r e n c h (1986) " F e d e r a l f u e l t a x e s mean Canad ian c a r r i e r s pay up t o 4 0 p e r c e n t more f o r f u e l t h a n U . S . a i r l i n e s . " 2 3 2 N e v e r t h e l e s s , Canad ian c a r r i e r s can g a i n b u y e r b a r g a i n i n g power v i s a v i s f u e l s u p p l i e r s by 2 3 1 J o r d a n , W.A. (1986) , p. 317. 2 3 2 F r e n c h , T . , (1986) , p . 22. - 138 -e n t e r i n g i n t o l a r g e vo lume, l o n g - t e r m f u e l s u p p l y c o n t r a c t s . These l o n g - t e r m c o n t r a c t s have the added advantage o f e n s u r i n g the c a r r i e r s a g u a r a n t e e d s u p p l y o f f u e l - a b e n e f i t i n t imes o f u n c e r t a i n f u e l s u p p l i e s . Moreover , i n o r d e r t o m i n i m i z e t h e i r f u e l u s e , A i r Canada and CAIL s h o u l d f u r t h e r c o n s o l i d a t e t h e i r o p e r a t i o n s ( i . e . t o ensure t h a t more f u e l e f f i c i e n t f e e d e r a i r c r a f t s e r v e s h o r t e r - h a u l t h i n r o u t e s ) , and r e p l a c e o l d e r f u e l i n e f f i c i e n t a i r c r a f t w i t h new g e n e r a t i o n u l t r a - h i g h bypass p l a n e s t o be d e l i v e r e d i n the e a r l y 1 9 9 0 ' s . I t i s e x p e c t e d t h a t t h e s e a i r c r a f t w i l l r educe c a r r i e r o p e r a t i n g c o s t s by about 45%, which t r a n s l a t e s t o 15% lower s e a t c o s t s . In t h i s c o n n e c t i o n , Crown-owned A i r Canada must r a i s e $2.5 b i l l i o n by the end o f the next decade t o renew i t s a g i n g f l e e t o f w i d e - b o d i e d Lockheed 1011s, and i t s s h o r t -to-medium range f l e e t o f f u e l - i n e f f i c i e n t D C 9 s . 2 3 3 To t h i s e n d , t h e c a r r i e r welcomes p r i v a t i z a t i o n which would g i v e i t the n e c e s s a r y f l e x i b i l i t y t o r a i s e the needed c a p i t a l . However, the F e d e r a l Government appears t o have s t a l l e d i n p u r s u i n g t h e m a t t e r ( i . e . the i n t r o d u c t i o n o f the p r i v a t i -z a t i o n b i l l has been de layed) d e s p i t e t h e a d v i c e o f 2 3 3 F o s t e r , C . , " A i r Canada Looks a t $2.5 B i l l i o n f o r New F l e e t " , The Globe and M a i l , Repor t on B u s i n e s s , June 23, 1987, p . B l l . - 139 -P r i v a t i z a t i o n M i n i s t e r B a r b a r a M c D o u g a l l . 2 3 4 Hence the f a t e o f A i r Canada remains t o be s e e n . 2 3 4 S t e w a r t - P a t t e r s o n , D . , " D e c i s i o n on A i r Canada S a l e E x p e c t e d T h i s Week", The Globe and M a i l , J u l y 8, 1987, p . A 5 . - 140 -V) The T h r e a t o f S u b s t i t u t e S e r v i c e s W h i l e , as ment ioned e a r l i e r , i t i s u n l i k e l y t h a t any s u b s t i t u t e modes o f t r a v e l pose a r e a l t h r e a t t o A i r Canada and CAIL i n l o n g - h a u l m a r k e t s , the same does no t h o l d t r u e on s h o r t - h a u l r o u t e s . That i s , g i v e n the s u b s t a n t i a l b a r r i e r s t o e n t r y t h a t w i l l remain i n t h e d e r e g u l a t e d Canad ian a i r l i n e i n d u s t r y , the u p s t a r t o f low c o s t - low f a r e a i r l i n e s t h a t would d i s c o u r a g e the i n r o a d s o f s u b s t i -t u t e s e r v i c e s (as o c c u r e d i n the U . S . ) i s u n l i k e l y t o m a t e r i a l i z e . Hence, the e x i s t e n c e o f a nonzero c r o s s - p r i c e e l a s t i c i t y ( i . e . a degree o f s u b s t i t u t i o n ) between modes o f t r a v e l has i m p l i c a t i o n s w i t h r e s p e c t t o p r i c e - s e r v i c e s t r a t e g i e s i n s h o r t - h a u l m a r k e t s . S p e c i f i c a l l y , A i r Canada and CAIL must ensure t h a t t h e i r s e r v i c e o f f e r i n g s ( i . e . c o m f o r t and a m e n i t i e s ) on t h e s e r o u t e s exceed t h o s e o f s u b s t i t u t e s e r v i c e s i n o r d e r t o ' j u s t i f y * t h e i r h i g h e r f a r e s . F o r i n s t a n c e , i n the M o n t r e a l - T o r o n t o b u s i n e s s c o r r i -d o r , w h i l e A i r Canada and CAIL charge $144 f o r a one-way economy s e a t , C i t y E x p r e s s (a t u r b o p r o p o p e r a t o r w i t h downtown T o r o n t o t o downtown M o n t r e a l s e r v i c e ) c h a r g e s a f a r e o f o n l y $69-$109, w h i l e V i a R a i l and Voyageur Bus L i n e s charge a mere $49 and $35 .70 , r e s p e c t i v e l y (see F i g u r e 8 - 1 ) . However, s i n c e t h i s c o r r i d o r i s t r a v e l l e d p r i m a r i l y by t i m e - s e n s i t i v e b u s i n e s s p a s s e n g e r s , t h e r a i l and bus modes pose no r e a l t h r e a t due t o t h e t ime and c o m f o r t advantages o f a i r t r a v e l v e r s u s s u r f a c e t r a n s p o r t . - 141 -F i g u r e 8-1 M o n t r e a l - T o r o n t o C o r r i d o r One-Way F a r e Depar tu re Frequency T r a v e l (h r . Time min . ) A i r Canada $144 31 /day 1 10 CAIL $144 28 /day 1 10 C i t y E x p r e s s $69-109* 8 /day 1 15 V i a R a i l $49 6 /day 4 30 Voyageur Bus $35.70 5 /day 7 00 * Depends on day and h o u r . - 142 -F o r example , the f l i g h t from M o n t r e a l t o T o r o n t o has a d u r a t i o n o f 1 hour and 10 minutes v e r s u s the 4 hours and 30 m i n u t e s , and 7 hours r e q u i r e d t o comple te t h e same t r i p by r a i l and c o a c h , r e s p e c t i v e l y . On t h e o t h e r hand , i n compet ing w i t h t h e t u r b o p r o p c a r r i e r , C i t y E x p r e s s , whose downtown t o downtown s e r v i c e g i v e s i t an o v e r a l l t ime advantage d e s p i t e i t s f l y i n g t ime o f 1 hour and 15 m i n u t e s , the two majors s h o u l d s t r e s s t h e i r second and t h i r d advantages which a p p e a l t o b u s i n e s s t r a v e l l e r s - t h e i r h i g h e r d e p a r t u r e f r e q u e n c i e s and hence g r e a t e r c o n v e n i e n c e ( A i r Canada and CAIL o f f e r 31 and 28 f l i g h t s p e r weekday, r e s p e c t i v e l y , whereas C i t y E x p r e s s o f f e r s o n l y 8 d a i l y f l i g h t s - see F i g u r e 8-1) , and t h e i r f r e q u e n t f l i e r p l a n s (wi th a g r e a t e r s e l e c t i o n o f d e s t i n a t i o n s due t o t h e i r l a r g e r n e t w o r k s ) . N e v e r t h e l e s s , t o m i n i m i z e the t ime d i s p a r i t y , CAIL and A i r Canada s h o u l d s t r i v e t o maximize t h e i r o n - t i m e per formance by m a i n t a i n i n g a h i g h p e r c e n t a g e o f o n - t i m e d e p a r t u r e s and a r r i v a l s ( i . e . a c c o r d i n g t o i n d u s t r y s t a n d a r d s , the o b j e c t i v e i s t o ensure t h a t 80% o f f l i g h t s d e p a r t w i t h i n 5 minutes o f t h e i r s c h e d u l e d d e p a r t u r e t i m e ) . Wi th r e s p e c t t o l o n g e r - h a u l r o u t e s , w h i l e no v i a b l e s u b s t i t u t e modes o f t r a v e l e x i s t , C a n a d a ' s major c a r r i e r s n e v e r t h e l e s s f a c e c o m p e t i t i o n from s u b s t i t u t e a i r l i n e s e r v i c e s . F o r i n s t a n c e , c h a r t e r a i r l i n e s ( i . e . such as Worldways, N a t i o n a i r and Wardai r ) as w e l l as nearby U . S . c a r r i e r s pose a p o t e n t i a l t h r e a t t o C a n a d a ' s d u o p o l i s t s - 143 -because o f the low f a r e s they c h a r g e . T h u s , CAIL and A i r Canada s h o u l d ensure t h a t t h e i r p r i c e - s e r v i c e o f f e r i n g s a r e c o m p e t i t i v e w i t h t h o s e o f t h e s e c a r r i e r s on common r o u t e s ( i . e . i f the d u o p o l i s t s ' f a r e s exceed t h o s e o f U . S . c a r -r i e r s by more than 10%-20%, Canad ian t r a v e l l e r s w i l l be i n d u c e d t o head South o f the B o r d e r as o c c u r e d d u r i n g the e a r l y y e a r s o f U . S . d e r e g u l a t i o n due t o t h e r o c k - b o t t o m f a r e s o f s t a r t - u p s l i k e Peop le E x p r e s s ) . F i n a l l y , as the U . S . e x p e r i e n c e has shown, a low s e r v i c e - low f a r e economy o f f e r i n g on l o n g e r - h a u l f l i g h t s w i l l a t t r a c t p r i c e e l a s t i c p a s s e n g e r s who o t h e r w i s e would no t t r a v e l . 2 3 5 Hence, on l o n g - h a u l f l i g h t s (such as the t r a n s c o n t i n e n t a l r o u t e from T o r o n t o t o Vancouver) s e r v i c e o f f e r i n g s ( i . e . d e p a r t u r e f r e q u e n c i e s , and o n - b o a r d a m e n i t i e s ) need no t be emphasized as much s i n c e p r i c e becomes t h e key s t r a t e g i c v a r i a b l e . T h u s , A i r Canada and CAIL s h o u l d engage i n more i n n o v a t i v e p r i c i n g s t r a t e g i e s ( a s i d e from o f f e r i n g d i s c o u n t f a r e s ) i n o r d e r t o a t t r a c t more p r i c e - e l a s t i c p a s s e n g e r s . F o r example, as the U . S . e x p e r i e n c e has shown, the use o f a i r p a s s e s ( i . e . pay now, 2 3 5 I n t h e i r book (1985), Canadian A i r l i n e D e r e g u l a t i o n and  P r i v a t i z a t i o n : A s s e s s i n g E f f e c t s and P r o s p e c t s , G i l l e n , D.W. , T . H . Oum and M. Tretheway show t h a t p r i c e e l a s t i c i t i e s a r e s i g n i f i c a n t l y h i g h e r f o r t r a v e l l e r s on v a c a t i o n r o u t e s , than t h o s e on b u s i n e s s r o u t e s , and t h a t t h e y a r e p o s i t i v e l y r e l a t e d t o d i s t a n c e ( i . e . t r a v e l l e r s on s h o r t d i s t a n c e r o u t e s a r e l e s s s e n s i t i v e t o a i r f a r e s than t h o s e on l o n g d i s t a n c e r o u t e s ) . F u r t h e r m o r e , the average p r i c e e l a s t i c i t y o f Canadian t r a v e l l e r s i s - 1 . 1 t o - 1 . 3 , w i t h f i r s t c l a s s t r a v e l l e r s h a v i n g p r i c e e l a s t i c i t i e s s m a l l e r than - 1 , and d i s c o u n t f a r e t r a v e l l e r s n e a r e r t o - 2 . - 144 -f l y l a t e r p l a n s t h a t guaran tee a c e r t a i n number o f f l i g h t m i l e s a t a s e t p r i c e ) can be i n s t r u m e n t a l i n s t i m u l a t i n g f u r t h e r demand f o r a i r t r a v e l , p a r t i c u l a r l y among p r i c e -s e n s i t i v e p l e a s u r e t r a v e l l e r s . - 145 -V I ) Summary o f R e c o m m e n d a t i o n s A l l i n a l l , i n l i g h t o f t h e c o m p e t i t i v e f o r c e s t h a t a r e l i k e l y t o c h a r a c t e r i z e t h e d e r e g u l a t e d C a n a d i a n a i r l i n e i n d u s t r y , we make t h e f o l l o w i n g r e c o m m e n d a t i o n s r e g a r d i n g p r i c e , s e r v i c e , a n d n e t w o r k s t r a t e g i e s . A) R e c o m m e n d a t i o n s t o b o t h A i r C a n a d a a n d C A I L 1. S e t f a r e s on common r o u t e s b e l o w t h e m o n o p o l y l e v e l . 2. S t r i v e t o m i n i m i z e f u e l u s e ( i . e . c o n s o l i d a t e f e e d e r c a r r i e r s a n d r e p l a c e f u e l i n e f f i c i e n t a i r c r a f t w i t h t h e new g e n e r a t i o n p l a n e s ) , a n d e n t e r i n t o l o n g - t e r m f u e l s u p p l y c o n t r a c t s t o e n s u r e f u e l a v a i l a b i l i t y . 3. E n s u r e t h a t t h e c a r r i e r s ' s e r v i c e o f f e r i n g s o n s h o r t -h a u l r o u t e s e x c e e d t h o s e o f s u b s t i t u t e s e r v i c e s ( i . e . s t r e s s t h e c a r r i e r s ' h i g h e r d e p a r t u r e f r e q u e n c i e s ) . 4. S t r i v e t o m a x i m i z e o n - t i m e p e r f o r m a n c e . 5. E n s u r e t h a t t h e i r p r i c e / s e r v i c e o f f e r i n g s a r e c o m p e t i t i v e w i t h t h o s e o f s u b s t i t u t e a i r l i n e s o n common l o n g - h a u l r o u t e s , w h i l e s t r e s s i n g t h e i r g r e a t e r c h o i c e o f d e p a r t u r e t i m e s . 6. E n s u r e t h a t p r i c e / s e r v i c e o f f e r i n g s a r e c o m p e t i t i v e w i t h t h o s e o f t h e o t h e r c a r r i e r s s e r v i n g i n t e r n a t i o n a l - 146 -m a r k e t s . To t h i s e n d , s t r i v e t o lower l a b o u r c o s t s i n c r e a s i n g employee p r o d u c t i v i t y , and by g r e a t e r use t w o - t i e r wage s c a l e s and p a r t - t i m e employment. - 147 -b) Recommendations t o A i r Canada 1. A v o i d d e s t r u c t i v e c u t t h r o a t c o m p e t i t i o n ( i . e . f a r e wars) w i t h C A I L . 2 . C o n t i n u e d e v e l o p i n g A i r C a n a d a ' s y i e l d management s y s t e m , bu t a l s o adopt new i n n o v a t i v e p r i c i n g s t r a t e g i e s , such as the use o f a i r p a s s e s . 3. R e t a i n a degree o f s e r v i c e d i f f e r e n t i a t i o n ( i . e . p r o d u c t / s e r v i c e v a r i a t i o n s and i n n o v a t i o n s , s u c h as ' N u t r i C u i s i n e ' ) . 4. C o n t i n u e o f f e r i n g h i g h q u a l i t y and f r e q u e n t s e r v i c e t o b u s i n e s s p a s s e n g e r s i n the l u c r a t i v e M o n t r e a l - T o r o n t o c o r r i d o r i n r e s p o n s e t o the t h r e a t posed by CAIL , w h i l e m a i n t a i n i n g A i r C a n a d a ' s s u c c e s s f u l ' A e r o p l a n ' F requent F l y e r Program i n o r d e r t o b u i l d and s u s t a i n customer l o y a l t y . 5. Through i t s f e e d e r c a r r i e r s , A i r Canada s h o u l d c o n t i n u e t o p r o v i d e h i g h q u a l i t y s e r v i c e t o t r a v e l l e r s i n s m a l l c o m m u n i t i e s . T h i s n e c e s s i t a t e s f i l l i n g i t s network gaps i n Quebec and Saskatchewan w i t h e f f i c i e n t commuter c a r r i e r s . - 148 -Continue expanding i n t e r n a t i o n a l o f f e r i n g s i n Europ the Far East, and over the P a c i f i c t o take advantage s i g n i f i c a n t economies of scope. - 149 -C) R e c o m m e n d a t i o n s t o C A I L 1. A v o i d d e s t r u c t i v e c u t t h r o a t c o m p e t i t i o n ( i . e . f a r e w a r s ) w i t h A i r C a n a d a . 2. C o n t i n u e d e v e l o p i n g C A I L ' s y i e l d management s y s t e m , b u t a l s o a d o p t more i n n o v a t i v e p r i c i n g s t r a t e g i e s i n o r d e r t o m a x i m i z e l o a d f a c t o r s . 3. S t r i v e t o m a i n t a i n a d e g r e e o f s e r v i c e d i f f e r e n t i a t i o n b y i n t r o d u c i n g p r o d u c t / s e r v i c e i n n o v a t i o n s . 4. E x p a n d s e r v i c e on b o t h t r a n s c o n t i n e n t a l , a n d l u c r a t i v e C e n t r a l C a n a d a r o u t e s ( i . e . M o n t r e a l - O t t a w a - T o r o n t o ) i n o r d e r t o c a p i t a l i z e on i t s s o l i d n e t w o r k o f f e e d e r s i n b o t h W e s t e r n Canada a n d Quebec. F u r t h e r m o r e , C A I L s h o u l d i m p r o v e t h e q u a l i t y o f s e r v i c e o f f e r e d t o b u s i n e s s p a s s e n g e r s i n t h e M o n t r e a l - T o r o n t o c o r r i d o r ( i . e . i n c l u d i n g r e l o c a t i n g t o T e r m i n a l 3 i n T o r o n t o o n c e i t i s c o m p l e t e d ) . 5. C o n t i n u e p r o v i d i n g h i g h q u a l i t y s e r v i c e t o t r a v e l l e r s i n s m a l l c o m m u n i t i e s t h r o u g h i t s f e e d e r c a r r i e r s . T h i s n e c e s s i t a t e s s t r e n g t h e n i n g t h e p r e s e n c e o f C A I L ' s f e e d e r ' O n t a r i o E x p r e s s ' i n O n t a r i o m a r k e t s . - 150 -6 . S t r i v e t o d o m i n a t e t h e h i g h d e n s i t y r o u t e b e t w e e n V a n c o u v e r a n d V i c t o r i a , a s w e l l a s t h e h i g h l y p r o f i t a b l e N o r t h e r n B.C., Y u k o n , a n d A r c t i c r o u t e s . 7. C o n t i n u e i t s p r o f i t a b l e s h u t t l e s e r v i c e b e t w e e n C a l g a r y a n d E d monton - a r o u t e t h a t A i r C a n a d a d o e s n o t f l y . 8. C o n t i n u e d e v e l o p i n g ' C a n a d i a n P l u s ' i t s f r e q u e n t f l i e r p l a n i n a n a t t e m p t t o b u i l d p a s s e n g e r l o y a l t y . 9. C o n t i n u e e x p a n d i n g s e r v i c e o f f e r i n g s o n P a c i f i c a n d S o u t h A m e r i c a n r o u t e s ( i . e . i n c r e a s e i t s c a p a c i t y a n d t h e f r e q u e n c y o f i t s f l i g h t s o n P a c i f i c r o u t e s i n r e s p o n s e t o t h e p o t e n t i a l t h r e a t p o s e d b y A i r C a n a d a ) . 10. I n i t i a t e n e g o t i a t i o n s w i t h W a r d a i r t o p u r c h a s e i t s L o n d o n ( G a t w i c k ) r o u t e a u t h o r i t y . - 151 -By a d o p t i n g t h e s e s t r a t e g i e s , C a n a d a ' s two major a i r l i n e s w i l l be w e l l on t h e i r way t o f u l f i l l i n g the t h r e e key s u c c e s s f a c t o r s t h a t emerged i n t h e d e r e g u l a t e d U . S . a i r l i n e i n d u s t r y . That i s , by s t r e n g t h e n i n g t h e i r hub and spoke o p e r a t i o n s ( i . e . c o n s o l i d a t i n g f e e d e r c a r r i e r s , and o f f e r i n g a h i g h q u a l i t y o f s e r v i c e n e t w o r k - w i d e ) , c o n t r o l l i n g c o s t s ( i . e . r e d u c i n g l a b o u r and f u e l c o s t s , w h i l e c a p i t a l i z i n g on economies o f scope and i n c r e a s i n g a i r c r a f t u t i l i z a t i o n ) , and a p p l y i n g m a r k e t i n g e x p e r t i s e ( i . e . c o n t i n u i n g t o d e v e l o p t h e i r y i e l d management s y s t e m s , and f r e q u e n t f l i e r p rograms, as w e l l as a d o p t i n g i n n o v a t i v e , new p r i c i n g s t r a t e g i e s ) , A i r Canada and CAIL w i l l be i n a b e t t e r p o s i t i o n t o f a c e the f i n a l s t a g e of d e r e g u l a t i o n , and h e n c e , i t i s hoped , t o a v o i d the f a t e t h a t b e f e l l many o f t h e i r U . 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A . and A . S c o t t , (1971), E c o n o m i c s , (Toron to : M c G r a w - H i l l L t d . ) . S c h e l l i n g , T . C . , (1960) , The S t r a t e g y o f C o n f l i c t , (Cambridge, M a s s . : Harvard U n i v e r s i t y P r e s s ) . S h a p i r o , C . , " T h e o r i e s o f O l i g o p o l y B e h a v i o u r " , P r i n c e t o n U n i v e r s i t y D i s c u s s i o n Paper #12 6, D i s c u s s i o n Papers i n E c o n o m i c s , Woodrow W i l s o n S c h o o l o f P u b l i c and I n t e r n a t i o n a l A f f a i r s , P r i n c e t o n U n i v e r s i t y , P r i n c e t o n New J e r s e y , March 1987. S i n h a , D . , "The Theory o f C o n t e s t a b l e Markets and U . S . A i r l i n e D e r e g u l a t i o n : A S u r v e y " , The L o g i s t i c s and T r a n s p o r t a t i o n Review, V o l . 22 (4 ) , December 1986. S t a n b u r y , W.T. and F . Thompson, (1982) , R e g u l a t o r y Reform  i n Canada, The I n s t i t u t e f o r R e s e a r c h on P u b l i c P o l i c y , M o n t r e a l , 1982, p p . 39-50 . S t a n b u r y , W . T . , "The New C o m p e t i t i o n A c t and C o m p e t i t i o n T r i b u n a l A c t : Not Wi th a Bang, But a Whimper", Canad ian B u s i n e s s Law J o u r n a l , V o l . 12, 1986-1987, p p . 2 -42 . S t a n b u r y , W . T . , "Reforming D i r e c t R e g u l a t i o n i n Canada" i n K . J . B u t t o n and D. Swann ( e d s . ) , The Age o f R e g u l a t o r y  Re form, ( O x f o r d : O x f o r d U n i v e r s i t y Press ) t o be p u b l i s h e d i n 1987. S t i g l e r , G . , "A Theory o f O l i g o p o l y " , J o u r n a l o f P o l i t i c a l Economy, F e b r u a r y 1964. T a n e j a , N . K . , (1976) , The Commercial A i r l i n e I n d u s t r y , ( T o r o n t o : L e x i n g t o n B o o k s ) . T h o r n t o n , R . L . , " A i r l i n e s and A g e n t s : C o n f l i c t and the P u b l i c W e l f a r e " , J o u r n a l o f A i r Law and Commerce, V o l . 52 (2 ) , W i n t e r 1986. Western T r a n s p o r t a t i o n A d v i s o r y C o u n c i l , "A New T h r e s h o l d f o r Canad ian A i r T r a n s p o r t a t i o n " , WESTAC B r i e f i n g , Oc tober 1986. - 157 -A p p e n d i x A The N a t i o n a l T r a n s p o r t a t i o n A c t ( B i l l C-18) 1) The C o n t r o l l i n g Body: The C a n a d i a n T r a n s p o r t C o m m i s s i o n (CTC) i s t o be r e p l a c e d b y a s m a l l e r , s t r e a m l i n e d N a t i o n a l T r a n s p o r t a t i o n A g e n c y (NTA) w h i c h w i l l b e b o u n d b y d i r e c t i v e s o f t h e G o v e r n o r i n C o u n c i l , t h r o u g h P a r l i a m e n t . W i t h up t o n i n e members a p p o i n t e d t o f i v e - y e a r t e r m s b y t h e g o v e r n m e n t , t h e NTA may c o n d u c t i n q u i r i e s a s r e q u e s t e d b y t h e M i n i s t e r o f T r a n s p o r t a n d i s empowered t o h e a r a p p l i c a t i o n s o r c o m p l a i n t s o n l i c e n s i n g , f a r e s , a n d s a f e t y . A g e n c y d e c i s i o n s a r e a p p e a l a b l e t o t h e C o u r t s , a n d may b e v a r i e d o r r e s c i n d e d b y t h e g o v e r n m e n t . 2) R e g u l a t i o n o f E n t r y : U n d e r t h e ' p u b l i c c o n v e n i e n c e a n d n e c e s s i t y ' t e s t , c a r r i e r s w i s h i n g t o b e g i n a s e r v i c e h a d t o p r o v e t h a t t h e s e r v i c e was e c o n o m i c a l l y v i a b l e a n d show i t h a d t h e s u p p o r t o f t h e c o m m u n i t i e s t o b e s e r v e d . T h i s t e s t i s t o be r e p l a c e d b y a ' f i t , w i l l i n g a n d a b l e ' t e s t u n d e r w h i c h c a r r i e r s m u s t s i m p l y d e m o n s t r a t e t h a t t h e y o p e r a t e s a f e l y a n d h a v e a d e q u a t e i n s u r a n c e c o v e r a g e . L i c e n s e s w i l l no l o n g e r r e s t r i c t c a r r i e r s ' r o u t e s , e q u i p m e n t , o r t y p e o f s e r v i c e . - 158 -3) R e g u l a t i o n o f E x i t : E x i t f rom markets o r s i g n i f i c a n t s e r v i c e r e d u c t i o n w i l l not be impeded, except by an advance p u b l i c n o t i c e r e q u i r e m e n t o f 60 d a y s . 4) T a r i f f R e g u l a t i o n : The new b i l l a l l o w s c a r r i e r s t o s e t f a r e s and reduce them w i t h o u t a p p r o v a l o r f i l i n g . I n c r e a s e s , p a r t i c u l a r l y on monopoly r o u t e s , w i l l be s u b j e c t t o a p p e a l t o t h e NTA. 5) N o r t h e r n and Remote A r e a s : S e r v i c e s t o remote a r e a s w i l l remain s u b j e c t t o a degree o f r e g u l a t i o n t o p r o t e c t a t h i n , h i g h l y d i s p e r s e d and f r a g i l e , y e t e s s e n t i a l market . Any p a r t y ( i n c l u d i n g communi t ies and c a r r i e r s ) w i l l be a b l e t o a p p e a l t o t h e NTA a g a i n s t the g r a n t i n g o f a new l i c e n c e , but w i l l have t o p r o v e t h a t a new s e r v i c e w i l l l e a d t o "a s i g n i f i c a n t d e c r e a s e o r i n s t a b i l i t y i n the l e v e l o f d o m e s t i c s e r v i c e " . L i c e n c e c o n d i t i o n s w i l l s t i l l l i m i t a s p e c t s such as the t y p e o f s e r v i c e ( c h a r t e r o r s c h e d u l e d ) , r o u t e s , p o i n t s t o be s e r v e d , and s c h e d u l e s . F a r e l e v e l s , as w e l l as i n c r e a s e s , w i l l be a p p e a l a b l e and can be d i s a l l o w e d . The f e d e r a l government may p r o v i d e d i r e c t o r i n d i r e c t s u b s i d y i f a s e r v i c e deemed e s s e n t i a l cannot be p r o v i d e d on a p u r e l y commerc ia l b a s i s . These s p e c i a l c o n d i t i o n s a p p l y o n l y t o t h o s e p a r t s o f Canada beyond the l i m i t o f r e g u l a r r o a d a c c e s s , i n c l u d i n g the n o r t h e r n t i p o f Newfoundland, - 159 -a l l o f L a b r a d o r , most o f the n o r t h e r n r e g i o n s o f Quebec, O n t a r i o and M a n i t o b a , the n o r t h e r n h a l v e s o f Saskatchewan, A l b e r t a and B r i t i s h C o l u m b i a , and a l l o f t h e Yukon and Nor thwest T e r r i t o r i e s . The demarca t ion l i n e s t a r t s a t the 5 0 t n p a r a l l e l on the A t l a n t i c c o a s t and g r a d u a l l y reaches t h e 55^h p a r a l l e l i n A l b e r t a and B . C . . 6) Mergers and A c q u i s i t i o n s : The A c t a l l o w s i n v e s t i g a t i o n o f mergers and a c q u i s i t i o n s i n t r a n s p o r t a g a i n s t a ' p u b l i c i n t e r e s t ' t e s t . Moreover , t h e NTA must be a d v i s e d o f any p r o p o s e d a c q u i s i t i o n o f 10% o r more o f the v o t i n g s h a r e s o f such companies t h a t have a s s e t s o r annua l s a l e s i n Canada o f $20 m i l l i o n o r more. * S e c t i o n s 2-4 a p p l y o n l y t o Southern Canada ( i . e . t o t h o s e p a r t s o f Canada l o c a t e d s o u t h o f the l i n e t h a t s t r e t c h e s from the 5 0 t n p a r a l l e l on the A t l a n t i c c o a s t t o the 5 5 t n p a r a l l e l i n A l b e r t a and B . C . ) . S o u r c e s : 1) F r e n c h , T . , "Canada: And Then There Were Two?", A i r l i n e B u s i n e s s , O c t o b e r 1986, p . 15. 2) Burgess-Webb, R . , "Canad ian A i r L i n e D e r e g u l a t i o n -An Overv iew o f the L e g i s l a t i o n " , P i l o t , August 1986, p . 6 -7 . - 160 -

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