How Does Competition Affect Product Choices? An Empirical Analysis of the U.S. Airline Industry

Abstract

This paper studies major airlines' choice of whether or not to outsource operations to regional airlines across routes and over time. Using panel data of the U.S. airline industry, we find significant differences on the pattern of outsourcing to regional airlines depending on whether the major airlines operate their own major fleets on the route as well. Our results suggest that if HHI increases by 0:1, the log likelihood of a major airline choosing complete outsourcing relative to no outsourcing, goes up by 3.3%. This log likelihood goes down by 5.8% if the major airline's market share increases by 0.1. In contrast, the log likelihood of partial outsourcing relative to no outsourcing goes down by 16.7% if HHI goes up by 0.1, and goes up by 17.8% if the major airline's market share goes up by 0.1. Taking into account the ownership of regional airlines, we find that when facing more LCC competition, major airlines are more likely to rely on wholly owned subsidiaries relative to independent regional airlines. This lends support to the commonly held view that major airlines rely on regional airlines to compete with LCCs. We also investigate how major airlines adjust their prices when facing either LCC entry threat or actual entry. For carrier-routes with no outsourcing, we find that major airlines do not respond in prices to either threat of or actual LCC entry. In contrast, on carrier-routes with partial outsourcing, major airlines lower their prices by about 5.2% one quarter after LCC entry, with no adjustments in other periods.