Essay: To what extent is transport a contestable Market?
A contestable market is a market where there is freedom of entry and exit. This implies there are low (or zero) sunk costs in the industry. A sunk cost is a cost which cannot be recovered on leaving the market (e.g. spending on advertising). Therefore, the amount of sunk costs will determine the contestability of transport markets.
If we took a transport sector like railways, we find many barriers to entry which make the market uncontestable. Firstly, the fixed costs involved in building a national rail network are prohibitively high for any new firm to consider building its own network. Therefore, any new firm would have to use existing rail lines (managed by Railtrack). Furthermore, the nature of railways is that it is only really practical to have one train company using lines at a time. The only element of competition in trains is through the system of franchising, where firms bid for the right to run a line for a period of several years. However, if a firm was able to make supernomal profits running a line, there are barriers to entry preventing a new firm entering the market.
In a transport market like airlines, there is more contestability. For example, a company could rent planes for a period of a few years. Also, they can pay for landing slots and use the existing infrastructure of airports. For example, Ryanair and other budget airlines were able to enter the market by operating from less fashionable airports with relatively cheap landing slots. This shows it is possible for new firms to enter the market.
However, on prime landing slots at Heathrow for transatlantic flights, it is much more difficult to get a right to fly.
Also, even in the budget airline market, there are significant barriers to entry. There is a degree of brand loyalty. Although we love to joke about Ryanair – they do have a certain market presence and brand loyalty. A new firm may have to spend a lot on advertising to encourage people to use their planes. This advertising is a sunk cost. Buying or even renting planes involves certain fixed costs. Also in providing a comprehensive service, there are significant economies of scale in the industry. This can make it difficult for a new firm to enter unless it has significant resources.
Finally, the air industry has been struggling recently due to fears of terrorism, the recession and volcanoes disrupting flights. This has made the industry less profitable and is discouraging entry. If anything it may encourage a greater market concentration.