managerial economics

Running Head: TERM PAPER 1

Term Paper

Qiujun Li & Jian Zou

Monroe College

MG640-153 Managerial Economics

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Economic Background

There are several market structure factors that play relative critical roles in managerial

decisions such as the number of firms competing in an industry, concentration which can also be

considered as the relative size of firms, technological and cost conditions and so on (Baye and

Prince, 2017). Industry concentration, as a key role of these market structure factors, measures

the size distribution of companies within a given industry (Baye and Prince, 2017). Four-firm

concentration ratio provides a brief overview of the concentration of an industry. It takes the sum

of the four largest firms’ sales in the industry and divided by the total industry sales. Generally,

the more concentrate an industry is, the more profit margin will be observed in that industry.

However, there are other factors that affect the profit margin in a given industry other than the

concentration. Using the airline industry as an example, the high concentration of industry is not

strictly indicating the high profit margin because the oil price affects the profit margin of the

industry as well.

Industry Introduction

Scheduled Passenger Air Transportation, which has a NAICS code of 48111, is the

industry comprises establishments primarily engaged in providing air transportation of

passengers or passengers and freight over regular routes and on regular schedules.

Establishments in this industry operate flights even if partially loaded. Scheduled air passenger

carriers including commuter and helicopter carriers (except scenic and sightseeing) are included

in this industry. During the recent years, amalgamation of businesses happened frequently in the

industry. The number of airline companies shrinks from 231 in 2009 to 55 in 2017 (Gale

Business Insights, 2019). As a result, the industry becomes more concentrated during the past

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years. The major player in 2007 are concluded as these top 4 airline companies: Lufthansa

Group, Air France, AMR Corp, Japan Airlines. After a series of airline M&A deals, especially in

the United States, the top 4 airlines in 2017 are American Airlines Group, Delta Airlines,

Lufthansa Group, United Continental Holdings.

Data Description

To analyze the relationship between the concentration and the profit of the scheduled

passenger air transportation industry, we used the following data:

● Scheduled Passenger Air Transportation Industry revenue from 2007 to 2017 (Gale

Business Insights, 2019)

● Scheduled Passenger Air Transportation Industry profit from 2007 to 2017 (International

Air Transportation Organization, 2018)

● Top four companies by revenue in the industry from 2007 to 2017 (Gale Business

Insights, 2019)

● The combined revenue for the top 4 companies each year for the 11 years from 2007 to

2017

● Number of total companies in the industry (Gale Business Insights, 2019)

Then, we calculated the profit margin for the industry to indicate the profitability and the

top four concentration as a measure of industry concentration. The calculations are as followed:

𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑃𝑟𝑜𝑓𝑖𝑡 𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

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𝑇𝑜𝑝 𝐹𝑜𝑢𝑟 𝐶𝑜𝑛𝑐𝑒𝑛𝑡𝑟𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑖𝑜 = 𝛴 𝑇𝑜𝑝 𝐹𝑜𝑢𝑟 𝐶𝑜𝑚𝑝𝑎𝑛𝑦 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

𝐼𝑛𝑑𝑢𝑠𝑡𝑟𝑦 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

The downloaded data and calculated results are listed in Table 1 in the appendix.

Data Analysis

Industry revenue of scheduled passenger air transportation has been rising since 2013 and

industry profit has been increasing since 2012. It is noteworthy that the industry experienced

negative profits in 2008 and 2009. The negative profits were mainly caused by soaring crude oil

prices and the Great Recession which started in late 2007. Airline profits are highly dependent on

crude oil price, the rising oil price led to a sharp increase in expense. Meanwhile, the Great

Recession caused reduced business trips and declined global trade businesses, leading to a

plummet in airline revenues. As a result of these dual effects, the profit of the airline industry

was hit terribly. The profit margin fluctuated in the first eight years, but the margins in the most

recent three years since 2015 were clearly higher than before.

The industry became more concentrated in terms of the number of companies, with the

total number of companies in the industry dropping from 206 in 2007 to 55 in 2017 (Gale

Business Insight, 2019). The combined revenue of the top four companies has also been

increasing, but there is no clear sign of increase as a percentage of total industry revenue.

The research question of this paper is whether a more concentrated industry will lead to a

higher industry profit margin. As stated before, we used the industry profit margin to show

profitability and the top four concentration ratio to show the degree of concentration. The

correlation coefficient between the two variables is 0.57, indicating a positive relationship. To

further analyze and visualize the relationship, we plotted a scattered chart and added a fitted line

to the chart. The result is shown in the chart below.

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There is a positive relationship between the top four concentration and profit margin, as

also indicated by the correlation coefficient. The regression equation is

𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 0.2851 × 𝑇𝑜𝑝 𝐹𝑜𝑢𝑟 𝐶𝑜𝑛𝑐𝑒𝑛𝑡𝑟𝑎𝑡𝑖𝑜𝑛 − 0.0466

The regression result shows that when the top four concentration increases by 1%, the

profit margin increases by 0.2851%, keeping all other variables constant. However, the t-statistic

of the slope coefficient is 2.06 and p-value is 0.07, so the result is not statistically significant at

5% level. The R-square is 0.3197, which indicates the model is not very good. The complete

regression result is shown in Table 2 in the appendix.

Conclusion

Although we expected a strong positive result because a more concentrated industry

means less competition and more pricing power, the regression shows the relationship between

concentration and profitability is not statistically significant for the scheduled passenger air

transportation industry. It is may because there are some other important factors affecting

industry profitability, such as the oil price and global business cycle. As with what happened in

2008 and 2009, the industry profits were negative because of rising oil prices and low business

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market. It seems that oil prices and global business conditions are more powerful in affecting

airline industry profitability than industry concentration alone. Thus, we could consider adding

those variables in the regression in future studies.

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References

Baye, M., & Prince, J. (2017). Managerial Economics & Business Strategy: 9th Edition. New

York, NY: McGraw-Hill Higher Education.

Gale Business Insights. https://bi.gale.com/essentials/

International Air Transportation Organization, Annual Report.

https://www.iata.org/about/Documents/iata-annual-review-2013-en.pdf

International Air Transportation Organization, Industry Fact.

https://www.iata.org/pressroom/facts_figures/fact_sheets/Documents/fact-sheet-industry-facts.pdf

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Appendix Table 1. Industry Statistics Year Revenue ($)

Profit($bn) Profit

Margin

# of Companie

s Top4 Sales ($bn)

Top 4 Concentration

2017 $588,740,450,000 37.6 6.39% 55 163.79 27.82%

2016 $565,469,830,000 34.2 6.05% 66 149.74 26.48%

2015 $464,945,640,000 36 7.74% 63 174.9 37.62%

2014 $492,542,580,000 13.8 2.80% 66 158.39 32.16%

2013 $470,923,400,000 10.7 2.27% 58 143.55 30.48%

2012 $1,368,945,110,000 7.6 0.56% 107 140.98 10.30%

2011 $659,800,890,000 8.8 1.33% 180 140.98 21.37%

2010 $598,070,900,000 19.2 3.21% 206 135.28 22.62%

2009 $563,927,970,000 -4.6 -0.82% 231 108.16 19.18%

2008 $492,842,370,000 -26.1 -5.30% 214 113.16 22.96%

2007 $472,635,630,000 14.7 3.11% 206 116.45 24.64%

Table 2. Regression