Intense competition in the airline industry led to instability, as the airlines fought market share battles with fare decreases. As major carriers consolidate, however, price wars are becoming less frequent, and are even allowing some carriers to raise prices. But for a price increase to succeed, other carriers have to follow. This time around, it appears that they have.
As in most industries, when one carrier raises prices, its customers tend to jump ship to another. This is especially true if the product is highly commoditized, as in the case of air travel. Since there are laws against outright price fixing, airlines must rely on other carriers seeing the benefits of a fare increase, instead of maintaining lower fares to mop up market share.
According to USA TODAY, there have been 10 attempts to raise fares so far this year, with only two being successful; both were performed by Delta Air Lines. Delta recently rolled back one fare increase after United Continental was the only other carrier to match it. 2013 has been a fairly unsuccessful year for fare increases compared to 2011 and 2012, where nearly half of the attempts were successful.
With Canada being the largest trading partner with the U.S., it is no surprise that flights across the U.S./Canadian border matter to major airlines. Although these flights do see significant demand, airlines nonetheless strive to make money on them in the face of competition. United Continental Holdings (NYSE:UAL) and Star Alliance partner Air Canada (TSX:AC.B) took a major step toward this goal by raising fares on transborder flights by approximately $10.
With such a poor record in 2013 for fare increases, the odds would tend to favor the latest United Continental/Air Canada fare increase getting rolled back. But this fare increase is "gaining some traction" according to USA TODAY, which reports that WestJet (TSX:WJA), US Airways (NYSE:LCC), and American Airlines (a subsidiary of parent company AMR (NASDAQOTH:AAMRQ)) have at least partially matched the increase. Having all major competitors on board is critical to a successful fare increase. I'll break down why each one matters in the following sections.
This airline has been a thorn in Air Canada's side since its founding, and has grown to become a major Canadian competitor for flights within North America. Operating as a discount carrier, WestJet typically gains market share by using its superior cost structure to undercut Air Canada's fares.
By raising its fares alongside Air Canada, WestJet is showing here that it will not undercut prices on every route, and that it will still seek to maximize revenues when situations permit. I would view this as a positive for Air Canada, since it gives the carrier more latitude to raise fares.
I also can see benefits for WestJet. By getting in on this model, WestJet remains competitive with other carriers, but sets itself up to continue generating strong earnings as its workforce ages and its cost advantage decreases.
American Airlines/US Airways
By now, day-to-day aviation industry followers know that these two airlines are in a legal battle to join together and form the world's largest airline. Outside of the courtroom, negotiations are probably going to happen sooner or later between the airlines and the Department of Justice, which will hopefully allow the merger to move forward.
Since the DOJ's arguing that a lack of competition in the industry will lead to higher future prices, American and US Airways are naturally hesitant to raise fares for fear of reinforcing the DOJ's argument. This may partly explain why previous fare increases failed, since these two major carriers have been unwilling to follow along. However, American and US Airways matched this latest fare increase on transborder routes, making it more likely to stick than previous attempts.
It's questionable how the DOJ will react to this fare increase with regard to merger negotiations. I can only speculate that the carriers must have examined the situation very carefully before following the fare increase, and concluded that it would not have a major impact.
IThe latest fare matching on transborder routes shows that fares increases are still able to gain traction among multiple major carriers.
For this particular increase, Air Canada and WestJet are the biggest beneficiaries, since they have a greater reliance on these routes than the four U.S. legacy carriers. However, I see this as a bullish development for the industry as a whole, and maintain a positive outlook on airline shares in general.
Alexander MacLennan owns shares of Air Canada, American Airlines, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.