Type of Document Dissertation Author Daraban, Ioan Bogdan URN etd-07052007-015055 Title Low Cost Carrier Entry, Incumbent Responses and Spatial Competition in the U.S. Airline Industry Degree Doctor of Philosophy Department Economics, Department of Advisory Committee
Advisor Name Title Gary M. Fournier Committee Chair David A. Macpherson Committee Member Mark W. Horner Committee Member Thomas W. Zuehlke Committee Member Keywords
- Low Cost Carriers
- Spatial Econometrics
Date of Defense 2007-06-26 Availability unrestricted AbstractThe successful emergence of the Low Cost Carriers (LCCs) represents one of the most important structural developments in the U.S. airline industry after it was deregulated in 1978. With a more efficient cost structure and a different business strategy, in 2006 the LCCs served 32.9% of all domestic origin and destination passengers and about 75% of all domestic passengers had access to LCC service. Moreover, Southwest Airlines, the pioneer of the Low Cost business model is currently the largest U.S. carrier in terms of passengers. It should be of no surprise then that the impact of LCCs on airfares and airline markets in general has attracted a lot of attention from economists, policy makers and the general public. In this dissertation I will address several limitations of the previous literature on the topic of the impact of LCCs on airfares.
Previous analyses do not fully capture the spatial nature of competition in airline markets. The arbitrage actions of travelers selecting among alternative airports is likely to create co-movements of prices across routes with common or nearby destinations. Therefore airfares in adjacent routes are likely to be correlated and the competitive effects of the LCCs are not limited to the routes they enter but also extend to adjacent routes. In the first chapter of the dissertation I examine alternative empirical approaches to assessing the cost savings travelers have enjoyed from low cost carriers, when the impact extends across adjacent routes. I demonstrate the advantages of spatial econometric approaches in capturing indirect effects that are missed in standard regression models. An empirical analysis of Southwest Airlines and other low cost carriers for 1998 and 2004 in top U.S. routes is provided to illustrate how estimates of cost savings may be substantially altered when attention is paid to spatial modeling considerations.
In addition to controlling for time-invariant route characteristics, the availability of route level panel data also makes it possible to examine the dynamic nature of competition in airline markets. In chapter 3, I extend the route level analysis by estimating a spatial panel model with time and route specific fixed effects and investigate the dynamic responses of the incumbent carriers faced with entry from LCCs. The empirical analysis revealed that the incumbent legacy carriers reduce airfares pre-emptively before LCCs enter the route, most likely in an attempt to gain market share and induce loyalty among travelers. Also the results from the empirical analysis suggest that most of the pro-competitive effects manifest themselves after the LCC entry and they accumulate beyond the initial entry period. While the evolution of the post-entry fares charged by the incumbents follows the same pattern irrespective of the identity of the carriers, the Southwest effect is twice as large compared to the effect of the other LCCs. When LCCs exit a route, the incumbents raise airfares to the point where most of the pro-competitive entry effects are being offset. This chapter fills the gap in the literature on the dynamic responses of the incumbents to LCC entry by making use of spatial econometric panel data models that allow for explicitly modeling time and space fixed effects as well as the spatial dependence among route level airfares. Moreover, I show how spatial econometrics methods can be used to fully assess both the direct and indirect effects of the LCCs. The savings to travelers that can be attributed to competition from LCCs are calculated for each quarter from the fourth quarter of 1994 to the fourth quarter of 2004.
In contrast to the impact on route level airfares, the impact of LCCs on airport level airfares is less well studied in the literature. In Chapter 4, I estimate the effect of LCC entry on an airport level fare index as well as on the fare differential between alternative airports. The results indicate that the entry of Southwest Airlines at an airport induces fare effects with a dynamic pattern similar to that observed in the route level analysis. Both pre-entry and post entry effects were identified for Southwest, but the estimated effect of the other LCCs was close to insignificant indicating their inability to exert more generalized competitive pressures at airport level, beyond their actual service offerings. Moreover, the presence of spatial correlation among airport level airfares suggests that the competitive conditions at one airport either through entry from LCCs or other factors, will be reflected in the prevailing airfares at nearby airports.
Overall, the results of the dissertation improve the understanding of the role of the LCCs in the US airline industry by making use of the best available data and the proper estimation techniques, in particular spatial econometrics methods that are amenable to the spatial nature of data from the airline industry.
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