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Network Competition in the Airline Industry: An Empirical Framework
59 Pages Posted: 27 Sep 2018 Last revised: 12 May 2020
Date Written: August 23, 2024
Abstract
The Hub-and-Spoke network is a defining feature of the airline industry. This paper is among the first in the literature to introduce an empirical framework for analyzing network competition among airlines. Airlines make market entry decisions and choose flight frequencies in the first stage, followed by price competition to attract passengers in the second stage. A key feature of this model is the linkage between direct and indirect flights, which is described by a technological relationship (and estimated using data) that proxies the Hub-and-Spoke network. The paper estimates the marginal costs of serving passengers and operating flights using first-order conditions, bounds the entry costs using inequalities derived from the reveal-preference argument, and employs a state-of-the-art econometric method to conduct inference for entry cost parameters. Ignoring network externality underestimates the benefits of operating an additional flight by 13.2%, and airlines would schedule 21.53% fewer one-stop flights had they made flight operation decisions independently for each market. To evaluate the impact of a hypothetical merger, the paper proposes a novel equilibrium concept that makes it feasible to compute the industry equilibria. Counterfactual analyses indicate that a hypothetical merger between Alaska and Virgin America would \textit{increase} consumer surplus as the merged airline would offer direct flights in 10% more markets while the overall post-merger price effect would likely be muted.
Keywords: Airline Industry, Entry Models, Network Competition, Moment Inequality, Network Externality
JEL Classification: C51, L13, L14, L93
Suggested Citation: Suggested Citation
Yuan, Zhe,
Network Competition in the Airline Industry: An Empirical Framework
(August 23, 2024). Available at SSRN: https://ssrn.com/abstract=3246222 or http://dx.doi.org/10.2139/ssrn.3246222
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