Raising Rivals Costs by Customer Diversion: Evidence from Airline Baggage Fees

Abstract

This study examines the effects of airline baggage fees as a method for diverting high cost passengers to rival airlines that do not charge such fees. We show that the latter in turn must raise their fares, thereby weakening their competitive constraint on carriers with fees and permitting the latter actually to raise their fares. Our empirical evidence focuses on routes where legacy carriers with baggage fees compete with Southwest, which has never had such fees. Consistent with the above implications of the model, we find nontrivial cost and price increases for Southwest and corresponding nontrivial fare increases by legacy carriers on routes on which they overlap with Southwest. These results provide support for the theory of "raising rivals’ costs", this in airlines, but common in other settings where unbundled pricing shifts customers between firms.