Consider the airlines’ marketing situation, particularly in the United States. On a single city-pair one airline may predominate flying, say, 50 per cent of all who travel to barcelona or travel between those two cities by air even though it only flies, say, 45 per cent of the seats. It has this extra market share because it flies more flights each day than its competitors and it has proved that frequencies are a dominant force in attracting traffic.
Maybe the airline is not making money on that route for any one of a dozen reasons. Perhaps it is breaking even or earning a bit, but not enough. It is spreading some overheads which would have to be paid whether it flew that route or not— and it might even be that rarity, a profitable route. But there’s always room for improvement.
How about cutting costs? Well, it could fly bigger, more efficient aircraft and cut its cost per passenger mile that way. But if it does that it will have to reduce frequencies or it will be flying more empty seats and be worse off than it was before.
It could fly those bigger aircraft if it could attract more passengers and so maintain its frequencies. So what about charging less than the competitor charges, gaining extra revenue from attracting more passengers and keeping the savings from being able to use bigger aircraft to make the route more attractive?
If one airline discounts and the others do not, big gains may accrue to the discounter. If the others match fares, there are no gains for anyone, but bigger losses for all since the lower fares will not persuade more people to fly. This has been proved by Boeing. The reductions necessary to attract a significant number of new customers are so great it would be necessary to operate with 120 per cent of the seats filled to make a profit!)
It being self-evident that the competitor will match discounts as a matter of self-preservation, it may seem prudent and good business to keep the price as it was.
But what if the competitor cuts his price and the dominant airline does not?
Then it stops being dominant, loses market share and volume, reduces frequencies and sees another airline effectively force it out of a market that maybe did not make big profits, but absorbed a lot of fixed costs and overheads. It has to match or go below its competitor.
That situation is called the “Prisoner’s Dilemma” in games theory.
The Prisoner’s Dilemma was developed in the 1950′s as a strategy exercise. It is based on a mythical situation in which a player’s gains vary according to his opponent’s response and his own initiative. The idea is described in a number or unbelievable fictions, but basically it is supposed to be a prisoner who is told that if he will give evidence against his partner in crime while the partner refuses to give evidence against him, he will get off scot-free and his partner will get five years in prison. If, on the other hand, the partner acts and he doesn’t, he will get five years. If both confess, both get three years. If neither confesses, both get two years. Both get the same offer at the same time.