Collusion and Interdependence in the Airline Industry: A Theoretical Analysis of the Sicilian Route Case

In this blog entry we will discuss how 4 major airline companies: Ryanair, easyJet, Wizz air and ITA have been accused of colluding on routes to and from Sicily from a very theoretical and analytical lens. The airline industry is an oligopolistic market structure; this occurs when small number of large firms dominate the industry. Interdependence is a feature of an oligopolistic market structure because firms must consider the actions of their competitors when making decisions, especially price-setting ones.    

Diagram 1 represents the oligopolistic airline industry. P1-Q1 is the price and quantity the airlines would sell at if they did collude, as they want to produce at the profit-maximizing level where marginal cost (MC) intersects marginal revenue (MR), and they would sell at the highest possible demand at this quantity. Since firms in an oligopoly are interdependent, each airline’s pricing decisions are influenced by the actions of its competitors. If one airline lowers prices, others may be forced to follow to maintain market share, which is why collusion can be tempting. It allows firms to coordinate rather than competing. However, this would cause an allocative inefficiency. Allocative efficiency is when societal welfare is maximized PE-QE. The inefficiency here is shown as P > MC and a deadweight welfare loss identified as triangle ABC on the diagram is created. This would cause the loss of consumer surplus shown as trapezium P1-A-B-Pe, causing wealth to be distributed away from the consumer and manifesting itself in higher prices, and too little quantity for the consumer.    

As the airlines were accused of colluding, it would most likely have been a formal collusion: when firms illegally agree to sell at the same price rather than competing independently. A disadvantage of collusion for the producer is evidently anti-competitive behaviour and risks heavy fines and legal consequences by the Autorità Garante della Concorrenza e del Mercato which aims to prevent firms from exploiting their interdependent relationships to the detriment of consumers.  

On the other hand, the advantage of the Airlines colluding and selling at P1Q1 would allow them to make profit shown as rectangle P on the diagram. Moreover, they would be able to avoid price wars and have the need for less expenditure into non-price competition (e.g. marketing) – which may lead to a lower long run average total cost curve on the long run and allow them to increase profit margins. However, due to their interdependence, each firm faces an incentive to cheat others to gain market share, making collusion unstable.   

The prisoner’s dilemma in Diagram 2 illustrates the interdependence between Ryanair, EasyJet, Wizz Air, and ITA Airways in their pricing decisions. If all four airlines collude and keep prices high, they each earn €50M, maximizing joint profits.

However, each airline has an incentive to cheat by lowering prices to attract more passengers. If, for example, EasyJet lowers its fares while the others maintain high prices, it gains market share and increases its profit to €70M, while Ryanair, Wizz Air, and ITA Airways suffer losses, earning only €30M each. This creates instability, as the remaining airlines may retaliate by also lowering prices, leading to a full-scale price war where all firms' profits drop to €35M each. Ultimately, it would lead to an unsustainable price war. Additionally, anti-competitive organizations intervene to prevent such anti-competitive behaviour, further discouraging formal collusion.   While collusion provides profits for the Airlines, it is highly unsustainable due to the interdependent nature of the airline industry. The prisoner’s dilemma analysis demonstrates why firms face a strong incentive to cheat, to attempt increase market share. However, it proves to lead to a price war, reducing profits for all firms, underscoring the instability that is caused by the 4 firms colluding.    

Lastly, one limitation of this analysis is that it assumes firms only compete on price, while airlines also engage in non-price competition such as advertising or loyalty programs for their customers. Moreover, other factors like economies of scale, seasonal demand influenced by peak seasons, and government intervention can influence price competition. It is also important to note while collusion is illegal, silent collusion (where firms price-fix without agreeing) can occur, making it harder for anticompetitive organizations to catch them: this is likely when taking into consideration the statements made by easyJet and Wizz air, being open to cooperation with the authorities. Finally, in the long run, firms in the industry may be whistleblowers with the aim to protect themselves and avoid fines should they be caught. All these factors play into how interdependency influences decision making in collusion.