Tuesday, November 4, 2008
Network Structure and Design in the Deregulated U.S. Airline Industry: An Argument for Re-Regulation?
Posted by D. Daniel Sokol
Sayed A. Hussain, University of Toronto and Serkan Bahçeci, J.P. Morgan Chase & Co. - JPMorgan Asset Management discuss Network Structure and Design in the Deregulated U.S. Airline Industry: An Argument for Re-Regulation?
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.