Segmented Competition in Airlines: The Changing Roles of Low-Cost and Legacy Carriers in Fare Determination

Abstract

The rapid growth of low-cost carriers has transformed the U.S. airline industry over the past decade. Low-cost carriers (LCCs) now are much larger overall, sometimes even dominating individual routes, and have moved into more direct competition with legacy carriers. This paper re-examines fare determination, using standard data sources but modifying existing models to allow for this new structure. It finds that LCC presence has a larger fare impact than do legacies, but that their fare-reducing effect diminishes past some total share point and dominance of the low-cost segment or on a route results in diminished fare reduction relative to a more fragmented market. Other issues include the effects of individual carriers on overall fares, and their effects on LCC vs. legacy prices. This paper also establishes the importance of potential competition and the imperfect substitutability of connect service and adjacent-airport service. All of these results cast new light on airfare determination in the modern industry.