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Network Structure and Design in the Deregulated U.S. Airline Industry: an Argument for Re-Regulation?

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Author Info
Sayed Ajaz Hussain
Serkan Bahceci

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Abstract

This paper develops a model to explain and analyze the evolution of network structure (connectivity)and design (flight frequency, aircraft size, prices) in the post-deregulation U.S. airline industry. We show that legacy carriers choice of Hub-and-Spoke networks and the emergence of low cost carriers (LCCs) operating Point-to-Point networks were optimal choices. We demonstrate that LCCs need not necessarily charge lower prices, and their entry impacted legacy carriers’ prices in all markets, even those where there is no direct competition. We show that in response to entry, legacy carriers optimally lower flight frequency, leading to longer wait times between flights for which passengers are compensated by lower prices; conversely, if the entrant later exits, legacy carriers raise flight frequency and therefore prices, which may erroneously appear to be predatory pricing when in fact it is the consequence of optimal network redesign. Finally, we demonstrate that even though low cost carriers lower prices, total social welfare with competing network structures can also be lowered. In other words, the poor financial performance of legacy carriers is not due to their inefficiency per se but due to an efficient Hub-and-Spoke network undermined by competition from inefficient Point-to-Point networks. We argue that social welfare may have been, and still can be, higher if entry and exit in air passenger travel industry is regulated.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-325.

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Length: 39 pages
Date of creation: 08 Aug 2008
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Handle: RePEc:tor:tecipa:tecipa-325

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Related research
Keywords: Networks; Airlines; Regulation;

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Find related papers by JEL classification:
L4 - Industrial Organization - - Antitrust Issues and Policies
L5 - Industrial Organization - - Regulation and Industrial Policy
L9 - Industrial Organization - - Industry Studies: Transportation and Utilities
C6 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming
M2 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics

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  1. Christopher Mayer & Todd Sinai, . "Network Effects, Congestion Externalities, and Air Traffic Delays: Or Why All Delays Are Not Evil," Zell/Lurie Center Working Papers 393, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania. [Downloadable!] (restricted)
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  2. Barla, P., 1999. "Demand Uncertainty and Airline Network Morphology with Strategic Interactions," Papers 99-06, Laval - Recherche en Energie.
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  3. Bittlingmayer, George, 1990. "Efficiency and entry in a simple airline network," International Journal of Industrial Organization, Elsevier, vol. 8(2), pages 245-257, June. [Downloadable!] (restricted)
  4. Youdi Schipper & Piet Rietveld & Peter Nijkamp, 1998. "Deregulation and Schedule Competition in Simple Airline Networks," ERSA conference papers ersa98p205, European Regional Science Association. [Downloadable!]
  5. Morrison, Steven A & Winston, Clifford, 1990. "The Dynamics of Airline Pricing and Competition," American Economic Review, American Economic Association, vol. 80(2), pages 389-93, May. [Downloadable!] (restricted)
  6. Evans, William N & Kessides, Ioannis N, 1993. "Localized Market Power in the U.S. Airline Industry," The Review of Economics and Statistics, MIT Press, vol. 75(1), pages 66-75, February. [Downloadable!] (restricted)
  7. Borenstein, Severin, 1992. "The Evolution of U.S. Airline Competition," Journal of Economic Perspectives, American Economic Association, vol. 6(2), pages 45-73, Spring. [Downloadable!] (restricted)
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  8. Darin Lee & María José Luengo-Prado, 2005. "The Impact of Passenger Mix on Reported “Hub Premiums” in the U.S. Airline Industry," Southern Economic Journal, Southern Economic Association, vol. 72(2), pages 372–394, October.
  9. Tae Hoon Oum & Anming Zhang & Yimin Zhang, 1995. "Airline Network Rivalry," Canadian Journal of Economics, Canadian Economics Association, vol. 28(4a), pages 836-57, November.
  10. Aaron S. Edlin & Joseph Farrell, 2004. "The American Airlines Case: A Chance to Clarify Predation Policy," Law and Economics 0401003, EconWPA. [Downloadable!]
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  11. Severin Borenstein, 1989. "Hubs and High Fares: Dominance and Market Power in the U.S. Airline Industry," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 344-365, Autumn. [Downloadable!] (restricted)
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