Effect Of Privatization On The Aviation Industry: Aviation Research Paper

Length: 5 pages Sources: 1+ Subject: Transportation Type: Research Paper Paper: #38946162 Related Topics: Aviation Management, Deregulation, Aviation, Profit Maximization
Excerpt from Research Paper :

Aviation: Effect of Privatization on the Aviation Industry

The aviation industry is one of the fastest growing global industries - contributing large amounts to the nation's revenue kitty every year, while also facilitating tourism, international investment, world trade, and economic growth. The industry is, "therefore, central to the globalization taking place in many other industries" (Ochieng & Ahmed, 2014, p. 10). Being one of the most competitive, the industry pushes airlines to stay abreast with relevant developments and make radical changes to their structures if need be. The new trends that have been observed within the industry include airport and airline privatization, liberal bilateral agreements, aviation policy liberalization, and increased globalization - all of which revolve around deregulation. This text examines how these trends have affected the aviation industry, and in particular, how they affect the quality of service delivery and airline operational costs.

A Brief Overview

Privatization of state enterprises serves five major objectives; i) reducing government size; ii) increasing the economy's productivity; iii) eliminating subsidies and expenditure that do not improve the welfare of citizens; iv) giving government ample time to concentrate on more strategic, high-priority issues; and v) improving the status of public financing (Kinnamon, 2002). In consideration of these objectives, the U.S. government, in 1976, "set out to create a multi-step privatization process divisible into four stages; selection, deregulation, preparation, and sale" (Kinnamon, 2002, p. 7). It was, however, not until 1978 that the industry was fully deregulated. With President Carter's assent, the Airline Deregulation Act took effect, leaving airlines to enter any route, charge the fares they desired, and exit the industry at will.

The Effect of Deregulation and Privatization on the Aviation Industry

Privatization has generally improved the quality of service delivery in the U.S. aviation industry, as has been discussed in the subsequent subsections of this text.

I) On the Quality of Customer Service

Load Factor: service quality in the airline industry can rightly be measured by the ease with which a customer can secure a seat on their preferred flight (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995). A low load factor implies that a customer can easily acquire a seat in the flight of their choice, and vice versa (Eckel, Eckel & Singal, 1997). As load factor increases, so does the probability that a traveler's preferred flight will be totally sold out, forcing them to settle for one whose terms are not as convenient.

Privatization has had the effect of increasing load factor; an observation that has been attributed to reduced airfares. However, in as much as this may be so, the effect has not been uniform (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995). Load factor has been observed to have reduced for short routes, and increased for long ones. Prior to deregulation, airfares "were set below cost for short routes and above cost for long routes" (Morrison et al., 1995, p. 24). When fare regulation was phased out, airlines raised the fares and increased their frequency over short routes where the demand was low, and also reduced fares while decreasing service frequency over long routes so as to take advantage of the rising demand for long-route air tickets (Morrison et al., 1995).

Hub-and-Spoke Structures: approximately 32% of air passengers take connecting flights everyday (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995). Prior to deregulation and privatization, these

...

Thanks to the elimination of entry barriers, interline connections "have been replaced by online connections, which passengers prefer" because they only change the plane (Morrison et al., 1995, p. 24).

On another note, deregulation has facilitated the operation of the hub-and-spoke model, which makes it possible for "passengers bound for many destinations" to be flown in a single plane service (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995, p. 24). This has been put forward as one of the greatest benefits of privatization in the airline industry, especially because it has brought about increased service frequency (Morrison et al., 1995)

Travel Agent Commission Overrides: under regulation, commissions for travel agents were regulated, and were a fixed proportion of the airfare (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995). There was literally no room for rebates, and hence "competition among airlines for travel agents was suppressed" (Morrison et al., 1995, p. 31). Deregulation gave airlines the privilege to set their own agent commissions. Competition has deepened as airlines undercut each other in an attempt to win travel agents, and in the end, the customer benefits from the high real commission.

This, however, also poses a problem that is equally-significant. The rewards are non-linear and increase with the number of bookings, and since airlines base their override rates on their total sales, there is the likelihood that the whole idea benefits large carriers more than it does the smaller ones - and in so doing, interferes with intra-industry competition, and gradually monopolizes the industry (Eckel, Eckel & Singal, 1997).

Frequent Flier Services: these are, in a way, quantity discounts advanced to passengers by airline companies. Points are awarded for every mile a passenger travels, such that any passenger whose points surpass a given threshold is given the opportunity to redeem the same, and win rewards, either in the form of "free travel, or an upgrade to another class" (Morrison, Yorrow, Lawton-Smith, Yamauchi & Murakami, 1995, p. 27). Deregulation led to a reduction in airfares, which implies that passengers have higher probabilities of benefiting from such flier programs (Morrison et al., 1995). Thanks to the high levels of competition brought about by the high rate of privatizations, all major airlines today offer frequent flier services to their customers.

On the other hand, there is the possibility that such programs could, in the near future, lead the aviation industry to becoming a monopoly. Large carriers ply large route systems and, hence, they not only give their customers greater mile-earning opportunities, but "also have a more diverse set of destinations to offer when the traveler accumulates enough miles to earn an award" (Morrison et al., 1995, p. 27). What then happens to that small airline company that serves, say only ten destinations; what happens when a customer wins a mile-point reward ten times? Are they rewarded with a trip to a place they had visited before?

Online Bookings and Reservations: privatization opened doors for innovation in the aviation industry. Customers no longer have to make physical trips to the airport because bookings and reservations are only a click away. Customers can now make reservations at their own convenience, in which case they get to save both time and money (Ochieng & Ahmed, 2014).

II) On Airline Companies' Operational Costs

Privatization reduces a company's operational costs, and the effect is then passed over to the customer in form of reduced airfares (Eckel, Eckel & Singal, 1997). The 1987 privatization of British Airways, for instance, saw the airfares in the global market it had in its portfolio fall by "a significant 14.3% relative to those on other transatlantic routes" (Eckel, Eckel & Singal, 1997, p. 276). When a company is privatized, control moves from the state, to the hands of a private investor, and the goal, hence, changes from that of welfare-maximization to that of profit-maximization (Eckel, Eckel & Singal, 1997). Since the investor's ultimate goal is to maximize profits, he is deemed to engage in cost-cutting measures such as retrenchments and board scaling (Ochieng & Ahmed, 2014). Additionally, the reduction of the bureaucratic activities synonymous with state-owned enterprises increases transparency and staff accountability by making financial records easily accessible by the public (Ochieng & Ahmed, 2014). These factors interplay to bring about improvements in the company's solvency, profitability, liquidity, and efficiency - all of which are dependent on operational costs.

Eckel,…

Sources Used in Documents:

References

Eckel, C., Eckel, D. & Singal. V. (1997). Privatization and Efficiency: Industry Effects of the Sale of British Airways. Journal of Financial Economics, 43(2), 275-298.

Kinnamon, D. (2002). The Effect of Privatization on Industry Wages: A Study of Four Cases in Mexico. Stanford University. Retrieved 28 April 2014 from https://economics.stanford.edu/files/Theses/Theses_2002/Kinnamon.pdf

Morrison, S.A., Yorrow, G., Lawton-Smith, H., Yamauchi, H. & Murakami, H. (1995). International Comparison of Privatization and Deregulation among the U.S.A., the UK, and Japan. Economic Research Institute. Retrieved 28 April 2014 from http://www.esri.go.jp/jp/archive/bun/bun143/bun143a-e.pdf

Ochieng, M.D. & Ahmed, A.H. (2014). The Effect of Privatization on the Financial Performance of Kenya Airways. International Journal of Business and Commerce, 3(5), 10-26.


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