Assessing low-fare entry in airline markets : impacts of revenue management and network flows

Abstract

(cont.) the essential factors affecting traditional measures of airline performance following low-fare entry. Our simulation results show that these measures are greatly affected by the entrant's capacity relative to the incumbent, by the incumbent carrier's competitive pricing response, and by the competitive revenue management situation. For example, average fares on the incumbent carrier can either increase or decrease following entry by a new competitor, depending on whether one or both airlines perform revenue management. In an extension of the simulations to a larger network environment, it is also shown that network flows of passengers affect the performance of all competitors, as measured by aggregate measures of performance. Furthermore, use of advanced network revenue management allows the incumbent carriers to rely on connecting passengers to mitigate the effect of entry on network revenues, but leads to amplified effects at the local market level. Consequently, this research establishes that traditional aggregate measures of airline performance on their own do not constitute a reliable indication of the response of incumbent carriers, and provide even less information on their strategic intent, which is critical in identifying predation. This research also demonstrates the relationships between aggregate measures of performance and previously overlooked factors including relative entrant capacity, competitive pricing and revenue management, and flows of network passengers.

The recent growth of low-fare, low-cost carriers has changed the competitive airline environment. In the US alone, low-fare carrier market shares have increased from just over 5% in 1990 to almost 25% in 2003. Traditional network carriers have consequently had to adjust to the changing competitive environment, which has led to cost reductions, fare structure simplifications and service adjustments. In addition, competitive responses of incumbent network carriers to low-fare entry have prompted concern regarding the potential for predatory practices in the airline industry. Assessment of unfair competitive practices in airline markets has typically been based on the analysis of changes in aggregate measures, such as average fares, traffic and revenues. In this research, the effect of low-fare entry on incumbent network carriers is examined, with special focus on the impacts of entry on traditional measures of airline performance. An analysis of various markets with low-fare competition highlights the typical effects of low-fare entry on these traditional aggregate measures. In a thorough analysis of two specific cases, we show that these measures, although affected similarly by entry, were very poor predictors of the new entrant's success in these markets, and inadequate indicators of incumbent response. AirTran successfully entered the Atlanta-Orlando market, while Spirit failed to maintain its operations in the Detroit-Boston market. We highlight the differences between these two markets and explain why the performance of these two carriers was so different. In a second part, a simulator of competitive airline networks--the Passenger Origin Destination Simulator--is used to model various scenarios of entry in a single market environment so as to determine