Does Product Differentiation Soften Price Reactions to Entry? Evidence from the Airline Industry
We examine the effects of entry on the pricing of legacy airlines facing a rapidly expanding low-cost newcomer. We estimate the timing and the determinants of responses allowing for asymmetry and product differentiation. We propose a decomposition procedure of time fixed-effects to control for unobserved heterogeneity, accounting for time-varying route-, city-, and carrier-specific unobservables. We find that incumbents do price-respond to actual but not to potential entry. The lack of preemption is due to financial distress, which precluded costly deterrence against a deep-pocketed newcomer. Our model also uncovers product differentiation stemming from more convenient flights. © 2012 LSE and the University of Bath
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