Incumbents’ Pricing and Nonpricing Responses to Entry in Vertically Differentiated Markets

Abstract

We investigate incumbents’ pricing and nonpricing responses to product entry in market with vertical product differentiation. Using data from international airline markets, we observe price reductions by connecting incumbents in response to high-quality (direct) entry. We also find evidence of product repositioning (increases in total itinerary distance) by connecting incumbents. However, we do not observe significant policy changes by incumbents offering nonstop flights. A theoretical model as well as empirical evidence suggest that the reason for the response by connecting incumbents is the opportunity cost of connecting at desirable airports such as airline hubs.

Keywords: Entry response, Nonstop entry, International airline markets