Collusion Between British Airways and Virgin

Topics: Airline, Collusion, British Airways Pages: 7 (2518 words) Published: November 13, 2012
The tacit collusion case to be discussed involves the illegal collusion and setting of fuel surcharges to commercial and cargo transatlantic fares between British Airways (BA) and Virgin Atlantic Airways (Virgin). The factors which contributed to its success will be discussed, as well as why, and its implications, of becoming public. To begin with, it would be beneficial to define both collusive behaviour and the nature of the competition involved in the aviation industry. Collusion is the act of a number of firms within an industry agreeing to set a certain price, output or another parameter and is almost always against the law. This is as they all compete in the given industry, with the setting of prices or outputs done in favour of the companies, and is therefore anti-competitive behaviour, as this moves the outcome away from the market equilibrium. The generated inefficiency is considered illegal by The Office of Fair Trading (OFT) within the UK, who’s mission is to protect consumer welfare whilst ensuring businesses remain competitive and fair (OFT,2011). A brief overview of the UK aviation industry will help in explaining and justifying certain factors which led to the successful collusion. Aviation is key not only for transportation purposes but for commercial flights, employing around 234,000 staff and contributing £18.4 billion to Gross National Product (GNP). The industry is not only essential for global business and trade, but 75% of all visitors to the UK travel by air and adds a further £14 billion towards GNP (BATA, 2011). The USA and the European Union have signed an ‘open skies agreement’ allowing full access to all routes between the two continents, although is more restrictive to EU airlines (IACA, 2007). In the specific case of BA and Virgin, oil price rises based on the price of barrel oil as shown in ‘Appendix 1’, created rising fuel costs and uncertainty over future profit levels. Several airlines in the UK and global aviation industry brought in flexible fuel surcharges for passengers and cargo planes. The tacit collusion case of Virgin and BA showed that through communication, and agreeing to certain price rises at a given date, the negative impacts on production costs can be in part offset direct to the consumer. Through the formation of such an agreement, a ‘prisoner’s dilemma’ game scenario is formed. This game revolves around joint outcomes based on individual actions, and the payoffs which are created from this. The choice to co-operate in decision making proves to be more beneficial than the absence of any collusive behaviour, although there is always the threat of deviation to add even more uncertainty to the question. Carlton and Perloff (2003) describes how in such a game, both firms must consider each rival’s actions when making their own, and relate the combination of actions to determine best policy. Airline Market - Transatlantic flights | |

| | Virgin Atlantic| |
| | High surcharge| Low surcharge|
British| Higher surcharge| 25,25| 15,30|
Airways| Lower surcharge| 30,15| 10,10|

| |
| | | |
Profit from Cooperation = 25 + Profit from deviation= 30 + Note: ∏D > ∏C if r > 1 will prove that deviation from collusion unlikely

This constructed game holds several assumptions which may be of use to explain the relative success of the collusive agreement. To begin with, it involves the firms meeting and setting prices more than once, in a repeated game, as fuel surcharges are relatively flexible prices which were changed to relate to the price of fuel, which was extremely volatile as shown in Appendix A. Following on from this repeated game, it is also for an undefined period. As the price rises came very suddenly, it created an uncertain future with no foreseeable end. Carlton and Perloff (2003) agree with the theory that in a multi-period game, deviation becomes much more costly, and through signalling can lead to successful collusion...

References: (Source: Mongabay, 2009)
Appendix B
(Source: OFT, 2006)
Appendix C
(Sources : BBC, 1993; Europa, 1999)
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