Essays on Network Competition in the Airline Industry

This thesis studies the network structure and network competition (Chapter 1), strategic entry deterrence (Chapter 2) and demand (Chapter 3) in the airline industry. Chapter 3 extends the pricing competition stage in Chapter 1 and estimates a structural model of demand and price competition. However, both Chapters 1 and 3 ignore the entry deterrence motives of the airlines which are analyzed in Chapter 2. The first chapter studies network competition in the US airline industry. I propose a structural model of oligopoly competition where the set of endogenous strategic decisions of an airline includes its network structure (i.e., the set of city-pairs where the airline operates nonstop flights), capacities (i.e., flight frequency and number of seats) for every city-pair where they are active, and prices for nonstop and one-stop routes. In this paper, I propose and implement simple methods for the estimation of the model and for the evaluation of counterfactual experiments that avoid the computation of an equilibrium. The estimation of the model shows that ignoring the endogenous network structure in this industry implies a substantial downward bias in the estimates of marginal revenues and marginal cost of capacity. The estimated model is used to evaluate the effects of the counterfactual entry of JetBlue into the segment between Atlanta and New York. I find that the JetBlue entry into this city-pair (segment) would have substantial competition effects in other city-pairs, even in those that that are not directly connected to Atlanta or New York. The second chapter empirically studies three different but not mutually exclusive hypotheses on entry deterrence that have been proposed to explain the observed patterns of airline entry-exit decisions in city-pair markets. The first hypothesis establishes that the dominant positions of an airline in an airport can help to deter entry. The second hypothesis is based on product proliferation: an incumbent airline may want to provide more differentiated products (schedules) in order to lower the potential profitability of its competitors. The third hypothesis establishes that a hub-and-spoke network can be an effective mechanism to deter entry in spoke markets. I propose an approach to empirically distinguish the contribution of these hypotheses to explain airline entry and exit decision in city-pair markets. My results are based on new measures from combining of two U.S. Department of Transportation databases: DB1B and T100. I construct and estimate a structural entry game with incomplete information, and use the estimated model to separate the contributions of these three hypotheses. I find empirical evidence for all of the three hypotheses. The third chapter studies how different network structures and flight frequencies affect consumer willingness-to-pay and airline ability to serve passengers, for both nonstop and one-stop services. In this paper, I propose and construct new measures of airline flight frequencies in each of nonstop and one-stop service. I consider a discrete choice demand model where airlines' flight frequencies and hub status enter into consumer utility. I separate the contribution of these two product characteristics: airline flight frequencies and airline hubs indexes on consumer willingness-to-pay and marginal cost of serving passengers. My empirical findings show that when nonstop flight frequency of an airline increases by one daily flight, average consumer utility increases by $9. When one-stop flight frequency of an airline increases by one unit, average willingness-to-pay by $2.4. Although scheduling additional flights is costly for airlines, I find that, in addition to the positive effect it has on consumer demand, it also reduces the marginal cost of serving passengers. My estimates show that an increase in flight frequency by one daily flight implies reductions of $1.6 and $0.4 in the marginal cost of serving nonstop passengers and one-stop passengers, respectively.

Keywords: Airline Industry
Demand Estimation
Entry Deterrence
Entry Models
Network Competition
Advisor: Aguirregabiria, Victor