Abstract
Legacy carriers operate hub-and-spoke networks because they believe that such networks offer demand and cost advantages, which allow the hub carrier to charge a higher price. However, some empirical studies have found that the hub premium has declined in recent years. This study examines hub-and-spoke networks to assess the change in the hub premium over time. It uses a structural model to jointly estimate the demand and supply parameters. Then, a counterfactual exercise is carried out to capture the impact of low-cost carriers (LCCs) on hub carriers’ premiums under different economic conditions. The major finding is that, on average, consumers respond differently when facing a price change by a legacy carrier and by an LCC. However, this price sensitivity reduces in the later years of the study period. Further, we show that legacy carriers dominated airfares in the late 1990s. Nevertheless, the growing expansion of LCCs is significantly harming the economies of density of legacy carriers.
Highlights
Legacy carriers operate hub-and-spoke networks because they believe that such networks offer demand and cost advantages, which allow the hub carrier to charge a higher price
This study examines hub-and-spoke networks to assess the change in the hub premium over time
While passengers still find it more convenient to choose itineraries offered by hub airlines and benefit from frequent-flyer membership with a hub airline, this study investigates the extent to which the presence of low-cost carriers (LCCs) has influenced the dominance of network carriers
Summary
The rapid changes in demand and market structure over the past two decades have challenged the premium on hub-and-spoke networks. Legacy carriers operate hub-and-spoke networks because they believe that such networks offer. Threat of entry by Southwest Airlines, while Brueckner et al (2013) [9] investigated the impact of potential competition from several LCCs and found similar results These empirical findings, focusing on price regressions, suggest that the price premiums of legacy carriers at hub airports have declined in recent years. Berry et al (2006) [12] used a differentiated products supply-and-demand framework to analyze the role of hub-and-spoke operations and found that different levels of willingness to pay by consumers could lead hub carriers to increase their markups on hub-originating flights. Where uijm is the indirect utility of consumer i purchasing product j in market m and x jm is a vector of the non-price observable product characteristics, such as the number of intermediate stops in a product, a measure of itinerary convenience, hub size, and other variables related to the hub premium. Having estimated the demand and marginal cost parameters for each year, we can compute the predicted markup and marginal cost and the counterfactual experiments can be carried out
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