Contestability in the
Market for Leisure Travel
Steve Earley
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Neo-classical theory suggests that economic efficiency depends on the number of firms in a market. The
further the market is away from the monopoly end of the spectrum, the greater the efficiency.
•
The theory of contestability, put forward by William J. Baumol, said that it is access to markets which is
important for market efficiency because firms react to the potential for competition.
•
The mere threat of a challenge for market share will force existing providers to act as if competition was
present.
• Baumol’s analysis implies that the degree to which barriers to entry are present in an industry will
determine business behaviour.
• Even in a monopoly situation the firm will have to work in an economically efficient manner or else new
firms will enter to compete away any advantage.
• The central point about contestability is ease of access. The lower the obstacles to new firms entering a
market the more contestable, and economically efficient, that market will be.
• Start-up costs: It is difficult to break into travel markets as the sheer size of capital expenditures can be
huge e.g the price of a Boeing 747 is over £150 million.
• Sunk costs: These are costs that are not recoverable should the incoming firm have to leave the industry.
The higher they are the less contestable the market.
• Contractual and capacity obstacles: New entrants may encounter barriers such as access to take-off slots
for airlines or in the rail industry where the network is split into legal franchises.
• Brand loyalty: Consumers may feel comfortable with the existing firm in the market. New firms will have
to spend heavily to overcome this brand loyalty.
• It is rare for an existing company to be challenged on the entirety of their market, e.g. Virgin Atlantic
started with a single airplane. This makes entry cheaper and easier.
• Start-up costs can be lowered if incoming firms do not buy ‘new’. They could purchase second-hand
airplanes or rolling stock or even lease them.
• Capacity transfer. A company already working in the market could shift to another part of the market
and be competitive. If an airline gives up one route it could move its resources to challenge on another
route.
• Brand loyalty may not be too much of a barrier. Virgin Atlantic and Virgin Rail were established on the
back of the Virgin brand which was originally developed for a record shop. Also, easyJet and Ryanair
were able to break into the air travel market even without having established brands.
• Contestability holds that it is the threat of a challenge for market share that forces incumbent firms to be
more efficient.
• Barriers to entry determine the extent of this threat and so dictate the degree of contestability in a
market.
• In holiday and leisure travel markets common barriers to entry can be identified.
• Such barriers are a matter of degree rather than it being about their mere existence.
• Each holiday and leisure travel market will have their own blend of barriers to entry such that
judgements on the amount of contestability will be specific to each situation.
• Why is the number of firms in an industry not relevant to the existence of a contestable market?
• How far do sunk costs represent a barrier to entry in the ferry travel market?
• Comment on how far you believe contractual and capacity constraints limit the degree of contestability
in a different transport market.
• Why might increased contestability in travel markets be considered desirable?
• Each holiday and leisure travel market will have their own blend of barriers to entry such that
judgements on the amount of contestability will be specific to each situation.