Competition between traditional and low-cost airlines for local hub traffic

Abstract

It is conventional wisdom among informed observers of the U.S. airline industry that the passengers who fly full-service, hub-and-spoke-style, "traditional" airlines like American, United and Delta are significantly different from those who fly so-called "low-cost" airlines Southwest, RenoAir and Valujet. The former supposedly value level-of-service attributes like frequent flights, frequent flyer program, pre-assigned seating and first class cabin, while the latter are mostly concerned with obtaining a low fare. In markets where traditional and low-cost airlines compete, one would expect that the number of passengers flying each airline has statistically different responses to changes in important airline transport supply and market socioeconomic variables. However, few studies have tried to quantify these differences. This thesis tests the idea that traditional and low-cost airline passengers belong to different market segments. A series of econometric demand models are developed separately for the traditional and low-cost airline for short-haul markets in which the two compete. The markets connect the traditional airline's hub airport with some of its "spoke" cities. Elasticities of demand are calculated for population, per capita income, average fare, nonstop frequency, flight time, cross-fare and cross-frequency. To determine if traditional and low-cost airline passenger elasticities also differ by level of competition, demand models are estimated for three separate hub airports. Estimated demand model elasticities strongly suggest that traditional and low-cost airline passengers have significantly different valuations of airline trip attributes. The values of exogenous market variables also appear to have a differential effect. Specifically, changes in average fare and flight time seem to have a stronger effect on the number of low-cost airline passengers, while changes in population and per capita income seem to have a stronger effect on the number of traditional airline passengers. Flight frequency seems to have an effect sensitive to the relative number of individual airline flights, but independent of carrier type. Cross-fare and cross-frequency elasticity estimates indicate that, in general, passengers perceive traditional and low-cost airlines as rather poor substitutes.