The Way of Offering Vertically Differentiated Airline Services

Abstract

This paper investigates should an airline offer vertically differentiated services, which are substitutes of its own services. The airline operates a certain number of direct flights to offer various types of services including nonstop, one-stop, or multiple-stop services. Homogenous passengers care about the fare and the flight(s) schedule when using a service. Under this general setting, we show that it is optimal for the airline to offer only one type of service in any particular city-pair market. This result supports a number of previous works that primarily argue network efficiency under the condition that only one type of service is offered in a particular market. This result also provides a theoretical explanation for the empirical finding that airlines that offer one-stop service through a hub are less likely to enter that same market with nonstop service than those that do not. This paper also presents an example of that if passengers horizontally differentiate among the type of services by other factors, the airline may offer multiple types of substitutive services in a market on its network.