Pricing Behaviour and Non-Price Characteristics in the Airline Industry (Advances in Airline Economics)

303 Pages·2012·23.56 MB·English

by  James Peoples

PRICING BEHAVIOR AND
NON-PRICE CHARACTERISTICS
IN THE AIRLINE INDUSTRY
ADVANCES IN AIRLINE
ECONOMICS
Series Editor: James Peoples
Recent Volumes:
Volume 1: Competition Policy and Anti-Trust, Darin Lee
Volume 2: The Economics of Airline Institutions,
Operations and Marketing, Darin Lee
ADVANCES IN AIRLINE ECONOMICS VOLUME 3
PRICING BEHAVIOR
AND NON-PRICE
CHARACTERISTICS IN
THE AIRLINE INDUSTRY
EDITED BY
JAMES PEOPLES
University of Wisconsin-Milwaukee, WI, USA
United Kingdom – North America – Japan
India – Malaysia – China
LIST OF CONTRIBUTORS
Volodymyr Bilotkach Senior Lecturer in Strategic Management
and International Business, Newcastle
Business School, Northumbria University,
Newcastle upon Tyne, UK
Jeffrey P. Cohen Associate Professor of Economics,
University of Hartford, CT, USA
Cletus C. Coughlin Senior Vice President and Policy Adviser,
Office of the President, Federal Reserve
Bank of St. Louis, MO, USA
Yan Du PhD of Economics, Oregon State
University, OR, USA
Alexander Eisenkopf Professor, Zeppelin University,
Friedrichshafen, Germany
David Gillen Professor, Sauder School of Business,
University of British Columbia,
Vancouver, Canada
Tim Hazledine Professor, University of Auckland,
Auckland, New Zealand
Kevin E. Henrickson Associate Professor of Economics,
Gonzaga University, WA, USA
Manuel A. Hernandez Postdoctoral Fellow, International Food
Policy Research Institute,
Washington DC, USA
Christian Hofer Assistant Professor of Supply Chain
Management, University of Arkansas,
AR, USA
Marc Ivaldi Toulouse School of Economics, School of
Advanced Studies in the Social Sciences,
Toulouse, France
vii
viii LIST OFCONTRIBUTORS
Andreas Knorr Professor of Economics, German
University of Administrative Sciences
Speyer, Speyer, Germany
Andreas Lueg-Arndt Professor of Economics, Cologne Business
School. European University of Applied
Sciences, Cologne, Germany
Dan Mahoney Department of Economics,
University of Oregon, OR, USA
B. Starr McMullen Professor, Oregon State University,
OR, USA
Marija Pejcinovska University of California, Irvine, CA, USA
James Peoples Professor of Economics, University of
Wisconsin-Milwaukee, Wisconsin, USA
Nicholas G. Rupp Associate Professor of Economics,
East Carolina University, NC, USA
Ian Savage Department of Economics and the
Transportation Center, Northwestern
University, IL, USA
John Scott Gonzaga University, WA, USA
Anirban Sengupta Director, Analysis Research and Planning
Corporation, Washington DC, USA
Senay Sokullu Assistant Professor, Department of
Economics, University of Bristol,
Bristol, UK
Tuba Toru Toulouse School of Economics, School of
Advanced Studies in the Social Sciences,
Toulouse, France
Steven N. Wiggins Professor, Texas A & M University,
TX, USA
Wesley W. Wilson Professor of Economics, University of
Oregon, OR, USA
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CHAPTER 1
PRICING BEHAVIOR AND
NON-PRICE CHARACTERISTICS
OF THE AIRLINE INDUSTRY:
INTRODUCTION AND OVERVIEW
James Peoples
Air transportation service is an important part of globalization for businesses
and leisure travelers in part because it provides relatively affordable and fast
transportacrosslongdistances.Societybenefitsfromeasyaccesstoanefficient
airtransportationsystemthatenhancesface-to-facebusinesstransactionamong
international companies and promotes tourism worldwide. Travelers have
apparently taken advantage of the benefits arising from the use of air
transportation,asglobalpassengertrendsindicateimpressiveindustrygrowth.
Information from the International Air Transport Association reports leisure
andbusinesstravelbyairgrew7percentannuallyfrom1980to1990.Thesame
IATAdatashowthelargestshareofairpassengersarefromflightsoriginatingin
theUnitedStates,Canada,andWesternEurope.Highconsumerdemandforair
transportation service, though, is hardly limited to traditional developed
countriesasairtraveloriginatingfromemergingeconomiesinAsiaisgrowing
rapidlyatanannualratenear9percent(IATA).Giventheeconomicandsocial
benefitsassociatedwithglobalaccesstoanaffordableairtransportationsystem,
itisimportanttounderstandthefactorscontributingtolowairfaresaswellas
examinewhetherthepracticeofcharginglowfaresiscommononallroutes.
PricingBehaviorandNon-PriceCharacteristicsintheAirlineIndustry
AdvancesinAirlineEconomics,Volume3,1–9
Copyrightr2012byEmeraldGroupPublishingLimited
Allrightsofreproductioninanyformreserved
ISSN:2212-1609/doi:10.1108/S2212-1609(2011)0000003003
1
2 JAMES PEOPLES
Regulatoryreformbeginninginthelatterpartofthelastcenturyplayeda
key role stimulating worldwide competition in passenger transportation
services.1Forinstance,removalofregulatoryratesettingandeasingofentry
restrictions had an immediate impact on the air transportation business
environmentintheUnitedStates.Thenumberofcertificateofservicestripled
in the six years following airline deregulation (Card, 1998), and average
passenger airfares fell by 33 percent (Winston, 1998). In this more highly
competitive environment, carriers had greater incentive to incorporate
efficiency-enhancing operating techniques and cost-saving technology.
Arguably the most prominent cost-saving technique employed by legacy
carrierswasthedevelopmentofhub-and-spokenetworks.Theintroduction
ofthistechniquecontributedtoincreasedload-factorsbyallowingcarriersto
transportpassengersfromoriginatingcitiestoamajor airport,whichisthe
airline’s hub. From the hub travelers from different originating cities are
groupedtogethertotakeconnectingflightstoacommondestination.Savings
arisebecauseflightscarryingloadsnearpassenger-capacitylevelsreduceper
passengerunitcosts.Continuedinvestmentinfuel-efficientaircraftsfurther
contributestocarriercost-savings.2
Despite impressive passenger welfare gains associated with a more
competitive and efficient airline industry, past research indicates that the
introductionofthehub-and-spokesystemaswellascarrierdominanceofa
fewcomputerreservationsystemscontributedtononcompetitivepricingfor
routesservedprimarilybythehubcarrier(Borenstein,1989).Chaptersinthis
volume contribute to the debate on fares charged by airline carriers by
examining pricing behavior such as nonlinear and competitive pricing.
Analysesperformedbythesestudiesincludeexaminationofpricingdecisions
associatedwithstrategicalliances,competitionfromlow-costcarrier(LCC),
and fare setting when facing financial distress. Research contributions on
pricing behavior by these studies present a nuanced analysis of fare
determination that includes new ways of examining whether the prices
charged by carriers are welfare enhancing. Examination of airline carrier
pricing, though, only tells part of the story of firm behavior, as analysis of
carriers’ ability to provide quality services and the social externalities
associated with providing air transportation services is also significant in
understandingtheeconomicsofthisindustry.Thisvolumecontributestothe
analysisofnon-pricecharacteristicsofairtransportationbusinessoperations
by examining frequency of service, passenger safety, availability of aircraft
typesfordifferenttransportationservicesandthegeographicdistributionof
airtransportationrelatednoisebyaircraftdeparturesandarrivalsatairports.
Introduction andOverview 3
COMPETITION, ONLINE TICKET AGENCIES,
CARRIER FINANCIAL CONDITIONS,
AND AIRLINE PRICING
Research analyzing competition and individual carriers’ financial condi-
tion’s influence on pricing behavior in the airline industry are presented in
the first part of the book. The initial chapter by Manuel Hernandez,
Anirban Sengupta, and Steven Wiggins directly tests whether competition
createsachallengeforlegacycarrierspracticingnonlinearpricingsuchthat
passengers are charged different prices for the same flight without cost
justification. The authors use transactions level data, which has the
advantage of allowing an empirical examination of the effect of Southwest
and other LCCs on both the level and structure of fares of legacy carriers.
Theanalysisisperformedbydefiningamenuofairlinefaretypesaccording
torestrictiveticketcharacteristicstothenevaluatethecompetitiveeffectsof
both Southwest and other LCCs, including adjacent and potential
competition from Southwest, on the relative pricing behavior of major
carriers. Findings suggest that competition from Southwest has an
important effect on both the level and fare structure of legacy carriers. In
particular, direct and potential competition from Southwest both lower the
farepermileandcompressthefarestructurebydecreasingthepremiaofthe
highest fares, including first-class tickets, over the lowest fares. Adjacent
competition from Southwest and direct competition from other LCCs only
seem to significantly affect the fare level.
The following chapter by David Gillen and Tim Hazledine further
contributestotheanalysisofnonlinearpricingbyfocusingontheinfluence
of LCCs and the adoption of Internet-based ticket sales systems on legacy
carriers’ ability to charge prices that differ by the date of purchase. The
authors use price data for over 1,700 flights on 39 Canadian and trans-
border US routes observed in May 2006 to explore fare determination of
legacycarriersinthismorecompetitivebusinessenvironment.Theirfindings
suggest that there continues to be extensive price discrimination based on
date of purchase of ticket and other factors. However, average prices are
nevertheless still significantlydetermined bythe number andsize of airlines
supplying a route. The authors also find that established ‘‘legacy’’ carriers
canstillchargeasubstantialpricepremiumoverLCCs,andtheinternetfare
systems may have made it easier for legacy carriers to coordinate the
typically substantial increases in their fares over the last two weeks before
the departure flight date.
4 JAMES PEOPLES
WhileGillenandHazledine’sanalysisrevealsthesignificanceofconsider-
ing how competition influences the pricing power of legacy carriers when
tickets are sold close to the fight departure, the need to fill remaining seats
mightstrengthenthenegotiationadvantageofpassengerswhowaitandshop
for the best fares as departure time nears. In the succeeding chapter
Volodymyr Bilotkach and Nicholas Rupp explore the possibility of
passengers benefiting from purchasing tickets at a late date by constructing
and analyzing price-offer curves (the dynamics of offered prices as the
departuredateapproaches)for105specificround-tripitinerarieson50busy
USroutes.Datausedforthisanalysiswerecollectedfromthethreeleading
onlinetravelagents’websites.Thebenefitassociatedwithusingthesedatais
that it permits the authors to exploit across-route variation in the level of
competitionandpresenceofLCCs,inparticularSouthwestAirlines(acarrier
that does not sell its tickets through online travel agents). Findings suggest
thatfaresandyieldsareconsistentlyhigheralongtheentireprice-offercurve
on less competitive markets, and on routes without LCC presence. Price
changesaresmootheroncompetitiveroutesthanonmarketswithoneortwo
competitors.Pricedropsareobservedacrossaspectrumofthemarkets,and
at any day prior to departure. In particular, at least one price drop was
observedwithin10daysbeforetheflightforabouthalfofalltheroundtrips
theytracked.Inaboutone-thirdofround-tripitineraries,theyobservedprice
dropsinthelastweekpriortodeparture.Atthesametime,theshapeofthe
averageprice-offercurveisasexpected–flatuptoaboutthreeweeksbefore
the flight, and rising rapidly afterwards. The findings do not suggest
systematic differences across online travel agents; however, differences in
pricequotesarenotinfrequent.Simplecost-benefitanalysisalsoshowsthat
whenbookingaticketclosertotheplanneddeparturedateatravelershould
comparison-shop.
Chapters1–4revealtheincreasingimportanceofonlinetravelagenciesto
post information on fares. In Chapter 5 Volodymyr Bilotkach and Marija
Pejcinovska explore the ability of these agencies to use their market power
to post fare quotes that may provide a competitive advantage to carriers.
These authors use evidence from the travel services distribution industry to
examine the impact of intermediaries that are supposedly pure distributors
on thefinalprice quotesobserved by thecustomers. They analyze asample
of fare quotes, collected from the three leading online travel agents on 50
large US airline markets. Looking at the lowest fares available reveals
interesting results. For example, the fewer the agents who offer the lowest
fare, the higher the fare is. The effect on fares is more pronounced in those
airlinemarketsthatarelesscompetitive.Finally,theyfind individualagents