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The case discusses two American airlines, Spirit and Northwest Commercial carriers, that engaged in a fierce price war in the late 1990s. The former was a regional airline, while the latter provided international flight services. The rift between the two was due to a disagreement over price charges on two local routes that each served, namely, Boston-Detroit and Detroit-Philadelphia. Spirit argued that Northwest dramatically lowered their prices, which they perceived as predatory and a violation of the Sherman Act. On the other hand, Northwest firm defended its position, stating that its actions were permissible and did not violate the antitrust laws. The case elucidates the legal and economic aspects of predatory pricing. It also illuminates the economical disposition of price competition between Northwest and Spirit commercial airlines.
Predatory pricing is a trading strategy designed by an incumbent firm to create dominance or monopoly over a small rival or entry company. It is achieved through cutting prices and creating doubts on prospects of success for other competitors. This case explains that vigorous pricing is only beneficial to customers during the price war but detrimental in the long run due to monopolistic charges. As for the predator company, recoupment for losses during the price war only happens if the target firm exits the market or the incumbent firm ascends to a position of dominance.
The article also elaborates on the difficulty encountered in distinguishing predatory pricing from legitimate competition. Multiple theories to solve this dilemma have been discussed; however, commentators dispute these proposals, claiming that none provide an accurate framework for distinguishing between predatory and authentic pricing. The case also discusses the three-step approach crucial in proving a company’s engagement in predatory pricing. It includes analysis of the relevant market to determine if its structure favors one company to excise market power over the other, economic assessment to evaluate if predatory prices are below appropriate, and evaluation of the likelihood of a predatory company to recoup losses after the exit of a target rival.
The case provides a brief chronology of events from the establishment of Spirit and Northwest Airlines to the predation period. Northwest Airlines was founded in 1926 as a local mail carrier before it proceeded to provide passenger services. In 1986 it merged with other Republic Airlines and commenced its international flights. At the time, Spirit Air Company was a low-fare local carrier with a low economic profile compared to Northwest Airlines. Both commercial Airlines served the Detroit-Philadelphia and Detroit-Boston route, but Spirit’s average fares were consistently lower. In 1995, Spirit Airlines introduced a single nonstop flight in the DTW-PHL route, and Northwest did not respond to this change.
However, when Spirit introduced a second nonstop flight, the rival company dramatically lowered their fares and increased their capacity. A similar incident happened in the DTW-BOS route in 1996, whereby Spirit Airlines introduced a single nonstop flight, and Northwest Flight company responded by ridiculously lowering their prices to match that of their rival. The power move by Northwest carrier in both incidents led to Spirit Company withdrawing their flights on both routes. After Spirit Airlines canceled its flights, Northwest company raised its prices sharply on the routes.
An economic analysis of Northwest Airlines’ conduct was essential to determine if the company’s actions were predatory and in violation of the Sherman Act. The three-pronged method of assessment was employed in this investigation. Market definition required the involved parties to agree on the geographical extent and market products. Both Airlines agreed the geographical routes were the city pairs DWT-BOS and DWT-PHL.
However, there was a dispute concerning clients to be considered in the assessment as Spirit Airlines excluded connecting passengers, a concept the Northwest company did not support Similarly, Northwest carrier included non-price-sensitive passengers in their evaluation, which contradicted Spirit Airlines standpoint. The latter argued that dramatic price changes by their counterparts influenced decisions made by price-sensitive passengers, which ultimately led to a reduction in load factors. On the other hand, their rivals provided compelling evidence demonstrating that regardless of whether a passenger is price sensitive or not, they would still pay higher fares if the Spirit Airline were not an option.
An assessment of market power revealed that Northwest’s conduct was not predatory. Though they imposed losses on rivals by lowering their fares, their operations were sustainable and remained profitable throughout the predatory period. Evidence showing that Northwest Airlines did not incur losses by lowering their fares proved that the company’s response to the entry of their counterparts was non-predatory.
The final step in assessment is a recoupment test to evaluate whether losses incurred by the predatory company are remunerative upon withdrawal of the target firm. In this case, the recoupment test showed that the Northwest carrier was not predatory since there were no losses in the predatory period. Additionally, their economic estimates did not reveal an anticipated loss that would be recovered by Northwest carrier through monopolistic charges. The Spirit vs. Northwest lawsuit ended with a “whimper,” with the latter company filing for bankruptcy within the same year. Spirit changed ownership and gradually established itself as a prosperous local airline. It is recognized as the successful plaintiff that won the fierce predatory pricing lawsuit.
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