Dynamic Pricing and Market Segmentation Responses to Low-Cost Carrier Entry: The Econometrics of Airline Distribution Management under Increased Competition

Abstract

This paper develops an empirical model of online airfare determinants to inspect the impact of the entry of a low-cost carrier (LCC). In particular, we investigate whether the increased competition from a recently established LCC induces major carriers to respond in two competitive dimensions: pricing and distribution. We utilize an original database of airfares collected from the website of an online travel agent (OTA) comprising the domestic airport-pairs of the most populous metropolitan area in Brazil. We test whether incumbents reshape their airfare temporal profiles in an attempt to attract the price-sensitive passengers who constitute the target market of the newcomer. We find evidence that incumbents increase their airfare availability on the OTA by 11% and reduce fares by between 15% and 23% for advance purchases made approximately two months prior to departure. Our results suggest that LCC entry partially spoils the existing market segmentation schemes of incumbents, forcing them to revise their distribution management strategy, simplify their fare structure and migrate from a non-monotonic to a weakly monotonic price curve.