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Cost of Regulation Essay


Introduction

Regulation is the process through which the activities of firms in a given industry are monitored and controlled by an independent organization or institution. The institution that is responsible for monitoring the activities of firms in the industry is thus referred to as the regulator.

The regulator has the right to formulate regulation policies and the authority to implement such polices (Davis &Lan 2001 p. 45). In most cases the regulator has the right to judiciously use penalties against firms that fail to comply with the rules and regulations that govern the industry. Such penalties include banning products, suspensions and cancellations of licenses. Regulation has three main purposes. First, it helps in protecting the clients by ensuring that quality standards are adhered to by firms (Davis &Lan 2001 p. 45).

Second, it aims at promoting fair competition by discouraging anti-competition strategies such as monopolies. Finally, regulations help in allocating scarce resources such as limited infrastructure (Davis &Lan 2001 p. 46). Even though regulation is associated with numerous benefits, it is also associated with costs that actual undermine the performance of firms and the industry in general. This paper will focus on the costs that are associated with regulation. The costs of regulating the airline industry in UK will be analyzed in the paper.

The UK Airline Industry

The airline industry is one of the highly regulated industries in UK. The need for a high level of regulation can be attributed to the following reasons. First, the industry is highly volatile. Thus the government believes that regulation will help in addressing the problems that cause inefficiency in the industry (Knorr, Lemper & Wohlmuth 2010, vol. 3, pp. 34-67).

Second, the government is keen on protecting the interests of the clients by ensuring that the prices are affordable. Third, the airline industry in UK is highly concentrated. This means that customers are likely to be exploited through excessive fees or prices due to the low levels of competition. Finally, lack of adequate infrastructure in terms of enough runways has prompted the government to regulate the use of the available facilities.

The Civil Aviation Authority (CAA) is the regulator of the UK’s airline industry. The UK airline industry was highly regulated in the 1960s and 1970s. However, after 1987 the government began the process of deregulating the industry in response to the inefficiency concerns that were raised by airlines (Graham 1994, vol.12, pp. 87-107).

The regulation in the industry focuses on the safety standards, prices and the use of infrastructure. The level of pollution, airline services agreements and route networks are also regulated. The costs associated with regulating the industry can thus be explained as follows.

The Costs Attributed to Regulation

Environmental Pollution

Despite the advancements in technology, technical inefficiency is still a common phenomenon in the UK airline industry. Besides, airlines are finding it extremely difficult to adopt new technology due to their financial constrains.

British Airways which is the leading airline in the industry by market share has not been able to purchase modern aircrafts in the recent years due to its poor financial performance (Gautam 2002, vol. 12, pp. 106-120). Environmentalists and other interest groups are increasingly becoming concerned with the pollution that is caused by aircrafts. Old aircrafts are particularly known for emitting high levels of greenhouse gases (Forsyth 2010, vol. 17, pp. 204-255).

The anti-pollution crusaders are also concerned with the noise that is caused by the aircrafts. In response to these concerns, the government through CAA has imposed high taxes on environmental pollution (Forsyth 2010, vol. 17, pp. 204-255). The same policy has been implemented across Europe.

The airlines usually transfer the high taxes to the consumers (passengers) by charging high prices. This has led to a significant reduction in the demand for flights especially at the domestic level. Travelers opt for cheaper alternatives such as train transportation. The profit margins of firms reduce as their sales volume decline due to low demand (Davis &Lan 2001 p. 89).

The high taxes also favor the competitors of UK airlines at the international level. This is because some economies especially in Africa have little regulation on pollution. Thus airlines from such economies can afford to charge lower prices and attract more customers.

Infrastructure

In adequate infrastructure has been a problem in the UK airline industry for a very long time. The problem is caused by “limited airport and traffic management capacities” (Graham 1994, vol.12, pp. 87-107). For example, Heathrow airport has never been expanded since its construction. Currently, Heathrow and Gatwick airports are not able to handle the sharp increase in demand for landing slots.

This problem is attributed to the increase in the number of airlines that operate from these airports (Knorr, Lemper & Wohlmuth 2010, vol. 3, pp. 34-67). Expanding these airports is the only permanent solution and this is already being implemented. However, expansion is a long-term investment whose benefits can not be realized at the moment. Consequently, CAA has resorted to price controls as the most efficient way of controlling the use of the limited capacity of the above airports.

Airlines are currently paying as high as 2 million pounds for slots at these airports (Knorr, Lemper & Wohlmuth 2010, vol. 3, pp. 34-67). Besides, airlines are sometimes forced to delay landing or taking-off when the runway is still being used by other airlines. The regulator believes that high fees will discourage the use of these airports in favor of the less busy airports such as the Manchester airport. The high cost of using the airports reduces the profit margins of UK airlines.

Prices and the Airline Services Agreement

The UK and other European governments have always used regulation policies to avoid competition from international or foreign airlines. This involves “restricting bilateral or airline services agreements between airlines” (Michael 2009, vol. 17, pp. 306-316). Under these restrictions airlines that are not registered in any of the countries that are signatories to the airline services agreement are not allowed to operate in the countries where such agreements are binding.

The agreements limit the number of airlines that can operate between member countries. The airline services agreement also dictate the capacity of each airline by deciding the optimal number of seats per aircraft (Michael 2009, vol. 17, pp. 306-316). This means that airlines do not have control over their growth plan since they are not able to decide their carriage capacities.

The principle of double approval is used to set the fare that can be charged by the airlines. This means that all signatories to the agreement must be consulted before changing “cross-boarder fares” (Michael 2009, vol. 17, pp. 306-316). Besides, the fares must be approved by the regulator.

Controlling the price of air tickets has cost airlines much more than the benefits that accrue from the airline services agreements. For example, it takes time to adjust the prices in response to economic factors such as increases in oil prices.

This means that airlines will continue to under-price their services as they wait for the regulator to approve the new prices. This translates into huge loses since airlines find it difficult to sustain the low prices. Restrictions on route network have prompted UK airlines to adopt the ‘connection’ model of business (Trethway 2004, vol. 10, pp. 3-14).

Under this model, an airline uses its competitors to connect its passengers to destinations that it is not allowed to fly to. The passengers are connected through a major hub (airport) (Trethway 2004, vol. 10, pp. 3-14). Heathrow and Gatwick are the major connection hubs in the UK. The use of these airports as connection hubs has resulted into more costs than benefits in the industry. This can be explained as follows.

First, the airports are usually “congested during the peak hours and idle during the off peak hours” (Trethway 2004, vol. 10, pp. 3-14). At the peak time, airlines spend more on fuel since their aircrafts are forced to delay their landing due to lack of space on the run way. At the off-peak period, the airports incur loses since they are not working at their full capacity.

Second, when the inbound flights fail to arrive in time, the connecting airlines are forced to delay their departure. This causes a lot of inconvenience to passengers. The connecting airlines on the other hand incur losses as passengers cancel their flights due to the delays (Trethway 2004, vol. 10, pp. 3-14).

Such inconveniences are particularly responsible for the high level of customer dissatisfaction in the UK airline industry. Third, aircrafts are not fully utilized per day since they wait for the passengers to be connected for a very long time. Consequently, airlines charge high prices in order to compensate for the under utilization of their aircrafts and cabin crew (Trethway 2004, vol. 10, pp. 3-14).

The model is also associated with high transaction costs. The high costs are attributed to the difficulty that is experienced in planning for the available capacity in the connecting airlines. Scheduling the flights and preparing the crew roster is also very expensive and needs a lot of time and coordination (Trethway 2004, vol. 10, pp. 3-14). The high costs are also attributed to the ground handling activities that are inevitable as passengers connect through different airlines.

Finally, the model has generally contributed to the decrease in demand for flights among airlines that have adopted it. This is because connection involves the use of a fare structure that is very complex and difficult to understand. Consequently, customers opt for direct flights that are associated with simple fare structures. Regulating the number of airlines that can operate from UK has reduced competition in the industry. However, it has resulted into more costs than benefits.

Security

Security in the UK airline industry relates to the safety of the passengers and the employees of the airlines. Passengers have always lost their lives due to aircraft accidents. The concerns over the safety of passengers and cabin crew have prompted CAA to impose tough safety measures in the industry (Trethway 2004, vol. 10, pp. 3-14).

According the safety rules and regulations, the aircrafts used by various airlines must be checked regularly to confirm if they meet the safety standards. This has resulted into an increase in maintenance costs as airlines straggle to keep their aircrafts in a sound mechanical condition.

The rise in cases of terrorist activities has forced airports to employ more security officers as well as investing in modern security equipment. CAA’s safety rules demand that all passengers must have travel insurance. This further increase costs and lowers demand for flights.

Conclusion

Regulation in the UK’s airline industry has always focused on ensuring stability in the industry. CAA has tried to achieve this objective by implementing policies that discourage customer exploitation. T

he regulation policies have also focused on optimal utilization of infrastructure and enhancing fair competition in the industry. Even though some of these objectives have been achieved, regulation has caused high level of inefficiency and high costs in the industry. It has particularly discouraged competition and quick growth in the industry (Trethway 2004, vol. 10, pp. 3-14).

Lack of competition is responsible for the low level of innovation in the industry. Thus stakeholders in the industry are currently lobbing for deregulation of the industry. Deregulation will enable airlines to create competitive advantages in the industry by responding effectively to market forces such as demand and supply. The recent “signing of free sky space between EU and US” (Trethway 2004, vol. 10, pp. 3-14) is an opportunity for the UK airline industry to realize the benefits of deregulation.

CAA is currently reviewing its regulation policies that control the formation of mergers and airline services agreements. British Airways has also signed “joint business agreement with US airlines” (Trethway 2004, vol. 10, pp. 3-14). This confirms the need for deregulation in the industry. Thus regulation can only be beneficial if it gives firms the freedom to decide their growth strategies.

References

Davis, H & Lan, P 2001, Management Economics, Prentice Hill, New York.

Forsyth, P 2010, ‘Environmental and financial sustainability of airline transport’, Journal of Air Transport Management, vol. 17, no. 8, pp. 204-255.

Gautam, G 2002, ‘Competition and regulation in the airline industry’, Economic Review, vol. 12, no. 1, pp. 106-120.

Graham, B 1994, ‘Regulation and liberalization in the UK scheduled airline industry’, Environment and Planning, vol. 12, no. 1, pp. 87-107.

Knorr, A, Lemper, A & Wohlmuth, K 2010, ‘Competitive advantage theory involving pricing strategies’, Journal of Air Transport management , vol. 3, no. 2, pp. 34-67.

Michael, G 2009, ‘Different models in different space or liberalization optimization? competitive strategies among low-cost carriers’, Journal of Transport Geography, vol. 17, no. 4, pp. 306-316.

Trethway, M 2004, ‘Distortion of airline revenues: why the network airline business model is broken, Journal of Air Transport management, vol. 10, no. 1, pp. 3-14.

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