Competition and coordination in the U.S. airline hub-to-hub markets: An industry pre-merger case study

Prasun Bhattacharjee

doi:10.3926/jairm.50

Abstract

Purpose: This paper investigates the nature of conduct that existed in the U.S. airline hub-to-hub markets prior to the recent merger wave of the legacy carriers. We explore the strategic importance of network carrier hubs in form of “spheres of influence” on airline market conduct. We also simultaneously recognize the overgrowing role played by Low Cost Carriers (LCC) over the years by estimating two conduct parameters - one in markets where LCCs directly compete head-to-head with legacy carriers and the other for markets which LCCs do not serve but has presence in the hub airports or adjacent airports comprising the market endpoints. Thus our supply side framework also sheds some light on the issue of perfect contestability in airline industry.Design/methodology/approach: We estimate a structural oligopoly model for differentiated products with competitive interactions using DB1B data for first quarter of 2004.Findings: Our results imply that the nature of competition is more aggressive relative to Bertrand behavior in hub-to-hub markets and that these markets are less than perfectly contestable.Originality/value: This paper adds to the empirical literature of airline competition by enabling estimation of the actual conduct parameter assuming firm price setting behavior in presence of product differentiation. Contrary to existing literature on airline competition, a structural model enables us to systematically separate out effects of demand, cost and strategic factors on observed airline prices.

Highlights

The U.S airline industry has experienced substantial consolidation in the last decade following three mergers among the large network carriers namely Delta Airlines and Northwest Airlines in 2008, United Airlines and Continental Airlines in 2010 and American Airlines and U.S Airways in 2013
This paper explicitly estimates conduct parameters in hub-to-hub airline markets i.e. markets characterized by presence of network carrier hub airports at both market endpoints prior to the onset of the merger wave of the network carriers in the 2000s
The competitive intensity is found to be higher in markets served by Low Cost Carriers (LCC) compared to those where LCCs are potential entrants implying that airline markets are less than perfectly contestable

Summary

Introduction

The U.S airline industry has experienced substantial consolidation in the last decade following three mergers among the large network carriers namely Delta Airlines and Northwest Airlines in 2008, United Airlines and Continental Airlines in 2010 and American Airlines and U.S Airways in 2013. Our study focusses on a subset of airline markets namely hub-to-hub markets i.e. markets comprising of hubs of network carriers which are supposedly the vantage point of market power for these airlines Several studies such as Borenstein (1989), Evans and Kessides (1993), Lee and LuengoPrado (2005) have already documented how hubs can generate significant market power for the hub airline allowing it to charge supracompetitive prices for flights to and from hub airports. The idea is based on the fact that since an airline has more to lose in its hub airport in the event of a price war, carriers will refrain from undercutting one another when they meet each other in their respective hub markets.

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